The Nepal Rastra Bank, the central monetary authority, will inject Rs20 billion into the banking sector on Sunday, as the stock of excess liquidity in many banks and financial institutions is fast depleting. The central bank is offering the fund using money market instrument called repo at 5 percent interest. This open market operation is being conducted using the revised interest rate corridor which was launched on Wednesday.

The main objective of the new interest rate corridor is to keep all interest rates in the banking system within a band of 3 percent to 7 percent. The NRB will use three tools to operate the new corridor. First is the standing liquidity facility (SLF), using which the NRB will inject liquidity into the banking sector at 7 percent interest rate. The SLF forms the upper bound, or ceiling, of the corridor. 

Second tool is repo, which is referred to as policy rate. The tool will be used to inject liquidity into the market for a period of two weeks at 5 percent interest rate. The repo floats in the middle of the corridor. The third tool used in the interest rate corridor is the term-deposit. This tool will be used to mop up liquidity from the banking sector at 3 percent interest rate. This rate forms the lower bound, or floor, of the corridor. 

On the day of the launch of the corridor, the NRB floated term deposit instrument to mop up Rs15 billion from the banking sector. However, demand for this instrument was low with only one bank, Bank of Kathmandu, ending up subscribing term deposit worth Rs100 million.

On the day the term deposit was floated, weighted average interbank rate of commercial banks—the rate at which commercial banks borrow funds from each other—had exceeded 5-percent mark, an indication that excess liquidity in many banking institutions was drying up.  This prompted the NRB to launch repo to inject Rs20 billion into the banking sector on Friday. However, the response, again, was not enthusiastic, as instruments worth Rs7.95 billion were subscribed.

The NRB is again floating repo to inject another Rs20 billion into the banking sector on Sunday. If Friday’s indications are anything to go by, the market response will not be that great. Also, the banking sector is still sitting atop excess liquidity of around Rs20 billion. 

Yet the NRB is optimistic.

“You never know how liquidity positions change. It can be different in the morning, different in the afternoon and different in the evening. It is not something that remains static,” NRB Spokesperson Narayan Prasad Paudel said. 

The size of excess liquidity in the banking sector is rapidly becoming smaller because of rapid collection of domestic debt by the government. 

The domestic debt collection cycle, which used to begin in the third quarter of the fiscal year in the past, began early this year due to concerns that the government may face shortage of funds following decision to transfer first tranche of grants of Rs75 billion to newly-formed local bodies in the beginning of the fiscal year. Because of this, NRB, on behalf of the government, has raised over Rs100 billion by issuing treasury bills and development bonds since mid-July, when fiscal year 2017-18 began. 

As supply of debt instruments is increasing and portion of excess liquidity is reducing, yields on development bonds have also surged to five-year high of 6.5 percent, while even 91-day treasury bills have started generating returns of over 4 percent.