The exposure of commercial banks to overdraft, a loan product considered highly risky by the banking sector regulator, is increasing rapidly, with the credit making a contribution of as high as 37 percent to the total loan portfolio of a bank.

This has raised the eyebrows of the Nepal Rastra Bank (NRB), the banking sector regulator, as it believes a big portion of overdraft is used for speculative purposes in real estate and stock market. This tends to heat up asset prices and stoke inflation.

Commercial banks were sitting on overdraft portfolio of Rs310.5 billion at the end of fiscal year 2016-17, which concluded on July 15, show the latest central bank data. This portfolio was 29.4 percent bigger than in 2015-16. This growth was witnessed after commercial banks extended Rs70.5 billion in overdraft in 2016-17. This means more than a fifth of the total overdraft was disbursed in 2016-17 alone.

The NRB has previously expressed displeasure over the surge in loan products such as overdraft. Its monthly Macroeconomic Report published in January said: “Credit excesses in risky areas could divert bank credit from productive sectors.”

Overdrafts are credit lines extended by banks to businesses and individuals. Once the credit lines are offered, borrowers can use the loan amount whenever they want, albeit they have to be renewed once a year in most of the cases.

Businesses, in theory, use overdraft to manage cash flow and working capital. Banks can extend as much overdraft to businesses depending on their credit policy.

However, banks are barred from issuing overdraft in excess of Rs7.5 million to individuals.

The banking sector regulator fixed a cap on overdraft for individuals after borrowers started using the credit to bet on assets such as real state and equities.

But lately, the regulator has started suspecting that a big chunk of overdraft issued to businesses is also being used for speculative purposes.

“To curb misuse of loan, we have recently directed banks to make it mandatory for borrowers [businesses] to specify the purpose for which overdraft is being obtained,” NRB Deputy Spokesperson Rajendra Pandit said. The instruction was issued

after businesses kept banks in the dark about the use of overdraft.

This lax oversight has prompted some of the commercial banks to issue more than a third of the total loan as overdraft. The exposure of Bank of Kathmandu to overdraft, for instance, stood at 37.3 percent of the total credit portfolio at the end of 2016-17. A year ago, the share stood at 27.3 percent.

The newly appointed CEO of Bank of Kathmandu, Shovan Dev Pant, said: “I haven’t been able to go through all the data, as I am currently focusing on strengthening the governance of the bank. I’ll look into this problem and see what action needs to be taken.”

Another bank with big exposure to overdraft is Mega Bank.

Around 33.4 percent of the total loan issued by the bank was in the form of overdraft at the end of 2016-17. Next in line is NCC Bank (28.6 percent), followed by Global IME Bank (27.7 percent) and Kumari Bank (27.4 percent).

“The growth in overdraft should not sound alarm bells, as a big portion of these loans has been provided to businesses looking for quick flow of working capital and cash to manage day-to-day works,” Mega Bank CEO Anil Keshary Shah said. “Also, these loans are not unsecured.”

Yet the downside of greater exposure to overdraft is the strain it puts on liquidity, as chances of borrowers using the entire credit line in one go cannot be ruled out. If this drawdown is not matched by adequate flow of deposits, banks may face asset-liability mismatch, leaving them with very little or no cash to disburse fresh loans or reimburse depositors.