Banking sector faces threat from its regulatorOn August 15, the Nepal Rastra Bank, the banking sector regulator, barred banks and financial institutions from factoring in deposit collected from other banking institutions to gauge their lending capacity.
On August 15, the Nepal Rastra Bank, the banking sector regulator, barred banks and financial institutions from factoring in deposit collected from other banking institutions to gauge their lending capacity.
The provision was introduced after commercial banks were found using the interbank window to extend loans to finance companies. Finance companies then used to park the fund back in call deposit accounts of commercial banks, generally at the end of every quarter of the fiscal year.
This enabled some of the commercial banks to keep the credit to core-capital-cum-deposit (CCD) ratio within the regulatory limit.
This window dressing had previously triggered severe shortage of funds that could be immediately extended as loans, because banks were relying on ‘fake deposits’ parked in call accounts-which could be withdrawn at any time-to enhance their lending capacity.
The CCD ratio for banks and financial institutions currently stands at 80 percent. This means banking institutions cannot extend more than 80 percent of the local currency deposit and core capital as loans.
In other words, lending limit for banks and financial institutions has been fixed at 80 percent of local currency deposit and core capital combined. But using ‘fake deposits’, banks were lending more than what they could, posing a threat not only to the banking sector but the entire financial sector.
To put an end to this malpractice, the NRB, on August 15, barred banks and financial institutions from factoring in interbank deposit while calculating CCD ratio. This meant a bank or a financial institution that had accepted deposit from another financial institution was prevented from taking this fund into account while calculating CCD ratio. Now, this provision has been removed.
Issuing a directive on Thursday, the NRB said interbank deposit would denote only those funds acquired by, say, financial institution ‘A’ from financial institution ‘B’ and parked in the form of deposit back in financial institution ‘B’.
This implies loans acquired by financial institution ‘A’ from financial institution ‘B’, but parked in financial institution ‘C’ would not be considered as interbank deposit.
The NRB, whose main job is also to ensure financial stability, has made a mockery of itself by rolling back its own decision in less than two weeks. This counterproductive move was made after some of the commercial and development banks with high exposure to interbank deposit exerted pressure on the central bank.
This is not the first time the NRB has come under the influence of some of the bankers, who like to bend the rules.
In March, the NRB had allowed banking institutions to calculate CCD ratio by deducting 50 percent of loans extended to the productive sector. The step was taken to replenish the stock of loanable funds, which had depleted to a level never seen in the recent history of the banking sector.
The move in itself was controversial, as it rewarded banks that had extended loans beyond their limit. But the central bank decided to drag itself into another controversy by extending the deadline of the controversial provision from mid-July to mid-October.
What is even more controversial is that the new deadline does not apply to all the banks. It only applies to “two banks” that failed to bring their CCD ratio within the regulatory limit within mid-July, the NRB said without disclosing the names of the banks.
This kind of regulatory relief for those who play foul will discourage those, who play by the rules, from engaging in ethical business. This will ultimately create a vicious cycle wherein banking institutions will continue to lend beyond their limit, raising the spectre of Nepal facing another banking or even financial crisis.
The last time Nepal faced a banking crisis was in 2010-11 when the real-estate bubble burst. At that time, runway rise in real-estate prices, particularly land, had created bubbles, thanks to easy availability of credit.
This prompted the banking sector regulator to introduce risk-based supervision of banks and financial institutions, on top of compliance-based supervision.
This paved the way for the NRB to conduct supervision not only on the basis of compliance of financial parameters, like capital adequacy ratio, and results of transactions made in the past, but through thorough and regular analysis of risks that are prevalent in the system or are likely to emerge in future.
Risk-based supervision, among others, entails rigorous analyses of data provided by financial institutions. This helps the regulator to identify inherent risks, issue warnings in advance and propose corrective measures.
The NRB, through data supplied by banking institutions, has already found that a big chunk of credit extended by banks and financial institutions is not going towards desired sectors. The NRB had raised a red flag as early as January after banks and financial institutions extended 14 times more overdraft loan in between mid-July and mid-December 2016 than in the same period a year ago.
No wonder, the most recent Article IV Report of the International Monetary Fund (IMF) states: “A clean-up period for overdraft loans needs to be introduced. The urgency of this move, which would bring Nepal more into line with the Basel Core Principles, is highlighted by the surge in overdraft loans in recent months.”
Since then, the NRB has reduced the threshold for individual overdraft to Rs7.5 million from Rs10 million. But it has not bothered to trace the whereabouts of overdraft loans extended to firms.
Is the NRB sweeping the problem under the rug? If not, why isn’t it doing anything despite knowing a big chunk of overdraft is not being used for the purpose mentioned at the time of borrowing the loans?
These suspicious activities of the NRB are coming to the fore at a time when the IMF has reported of “ever-greening of loans” in Nepal.
Ever-greening is a practice under which banks extend new loans to borrowers to repay the old debt that is about to go sour. For instance, a bank may extend a credit line of Rs1.5 million to a borrower seeking credit of only Rs1 million.
The extra credit is provided to help the cash-strapped borrower to repay the debt and such credit line may be extended further to prevent the borrower from defaulting on the credit.
In a 2014 report, the World Bank had said: “Much is still unknown about the true health of [Nepal’s] financial sector, as ever-greening is believed to be widespread.”
This basically means the level of bad debt, or non-performing loan, in the banking sector may be higher than what has been reported.
It is, thus, time for the NRB to act proactively, rather than relent to bankers’ pressure, and prevent a disease, which is probably in its initial stage, from becoming malignant.