Banks and financial institutions are sitting atop excess liquidity of around Rs94 billion as cash flow in the banking sector increased towards the end of the last fiscal year due to rise in the government’s capital spending.

A significant chunk of this excess fund, however, cannot be extended as loans to the private sector, as banks and financial institutions have to maintain credit to core-capital-cum-deposit ratio of 80 percent, which means 20 percent of total deposit and core capital cannot be issued as credit.

The banking sector’s excess liquidity, which had shrunk to around Rs20 billion in May, had suddenly gone up, as the government started settling payments of contractors, who had worked on its behalf, towards the end of the last fiscal year, which ended on July 15. 

Because of this, deposits of commercial banks jumped by a whopping Rs123 billion in the one-and-a-half-month period between June 2 and July 15, show the statistics of the Nepal Bankers’ Association, the umbrella body of commercial banks. 

The banking sector generally sees a sudden rise in deposit stock towards the end of the financial year due to rise in public spending. Also, the maturity of one-year NRB Bonds had injected around Rs31 billion towards the end of last fiscal year.

As a result, the excess liquidity in the banking sector had topped Rs106 billion on July 17.

“To manage the excess liquidity, we will introduce instruments to mop up funds so that short-term interest rates do not get further suppressed,” Nara Bahadur Thapa, executive director of the Research Department of the Nepal Rastra Bank (NRB), said.

Since the beginning of this year, the NRB—the central monetary authority—has introduced money market instruments thrice to extract excess liquidity.

On July 19, the NRB had floated term deposit instrument with a maturity period of one week to mop up Rs20 billion from the banking sector. Although the auction received bids worth Rs27.5 billion, the central bank issued instruments worth only Rs15.75 billion as the interest demanded by remaining bidders was higher than the cut-off rate. 

The second auction of one-week term deposit worth Rs10 billion, however, was fully subscribed. The third auction of one-week term deposit worth Rs15 billion was also fully subscribed.

During all these auctions, weighted average interest rate hovered between 0.33 percent to 0.36 percent, show the NRB data. These rates correlate with the average interbank lending rate of commercial banks which currently stands at around 0.2 percent to 0.3 percent.

Although the short-term market rates have plunged to the lowest levels, retail interest rates have shot through the roof, as banks and financial institutions are facing shortage of funds that could be immediately extended as loans.

In mid-June, for instance, weighted average lending rate of commercial banks stood at 11.3 percent, while weighted average deposit rate stood at 5.9 percent.