Despite the central bank’s directives on several occasions to banks and financial institutions to increase the portion of lending to the productive sector, banks are found to have increased lending to the unproductive sector in recent years.

A study carried out by the Confederation of Banks and Financial Institutions of Nepal (CBFIN) revealed lending to the unproductive sector has been increasing in recent years. The study has termed such lending as one of the reasons for the liquidity crunch in the banking sector.

By mid-December 2021, banks and financial institutions had outstanding credits totalling Rs1,055 billion in areas whose purpose is not clear and such lendings account for 23 percent of the total outstanding credits of the banks and financial institutions, states the study report titled ‘The causes of liquidity crunch and recommendations for solving the problem’ released on Sunday. Total outstanding credits of the banking sector as of mid-December stood at Rs4,603 billion.

The portion of such ‘lending without purpose’ was 17 percent in mid-December 2020 and 16.42 percent in mid-December 2019.

Besides the increasing lending in the sectors whose purposes are not clear, overall lending in less productive sectors including in the areas of wholesale and retail, finance, insurance, real estate, other services, consumption loans and others as of mid-November 2021 stands at 59.18 percent, according to the report.

This revelation comes at a time when the central bank has been focusing on increasing lending in the productive sectors by directing the banks and financial institutions to provide certain portions of credits to sectors such as hydropower; agriculture; tourism; manufacturing; and micro, small and medium enterprises, among others.

“There is a clear link between rising lending in the less productive sector and unnatural rise in imports,” the study says. “It is natural that managing liquidity becomes difficult when lending to the unproductive sector increases.”

During the first half of the current fiscal year, the country’s import bill reached nearly one trillion rupees. According to the Department of Customs, Nepal’s import bill during the first half of the current fiscal year 2021-22 reached a staggering Rs999.34 billion mark, a rise of 51.13 percent year-on-year.

Officials at the central bank say that lending by banks fueled imports, which have contributed to a ballooning balance of payment deficit and fast depletion of foreign exchange reserves.

“Our study shows that there is an urgent need to reduce lending to unproductive or less productive sectors and increase lending in the areas that support the real sectors of the economy (agriculture and manufacturing among others),” said Upendra Paudyal, coordinator of the study team. “We have called for developing a roadmap for sustainable financing in the long-run.”

CBFIN is an umbrella organisation of people representing the boards of directors of banks and financial institutions.

Although the report has highlighted excessive lending in less productive sectors, particularly to finance imports, as a major reason for the current liquidity crunch, it has also pointed out why the banks and financial institutions were forced to boost lending as much as possible.

The report has blamed both the central bank’s policy and tendency among shareholders to seek quick returns as major factors for the current liquidity crunch.

According to the study, ever since the central bank ordered banks and financial institutions to increase their paid-up capitals, banks started experiencing reduced liquidity.

Through the monetary policy for the fiscal year 2015-16, the central bank had told the banks and financial institutions to increase their paid-up capitals by several fold. For example, commercial banks were required to increase the paid-up capital to Rs8 billion from Rs2 billion.

According to a report, the policy of increasing the paid-up capital prompted banks and financial institutions to increase lending excessively. “As a result, liquidity that had remained healthy until 2015, started depleting in the following years.

“The central bank should have prioritised mergers and acquisitions instead. But it allowed increasing the capital through issuances of right shares,” state the report.

As the banks and financial institutions focussed on increasing profits and distributing bonus shares to increase their paid-up capitals, they started lending excessively, according to study team members. “This is a side effect of the central bank’s policy of increasing the paid-up capital,” said Bal Narsingh Gharti, a member of the study team.

According to a report, before the policy to increase paid-up capitals was introduced in 2015, the liquidity position of banks and financial institutions hovered around 30 percent, but it has fallen to around 21 percent by mid-December 2021.

After the Covid-19 pandemic hit businesses, the central bank introduced a policy allowing banks and financial institutions to provide working capital to businesses. Many businesses borrowed loans under the scheme but as they were unable to repay on time amid the protracted pandemic, the central bank allowed banks to renew such loans. As a result, the trend of credit expansion continued without repayment and hit the liquidity base of the banking sector, according to the report.

According to the report, decreasing non-interest income of the banking sector has also forced the banks and financial institutions to increase lending for profits.

Non-interest income of Nepali banks is the lowest in South Asia, according to the report. Non-interest income of Nepali banks stands at 21.76 percent of their total income compared to 56.68 percent in Bangladesh and 36.95 percent in India, the report says.

“One factor behind low non-interest income is declining fees that banks levy on customers for services,” said Gharti. “Another reason is Nepali banks’ failure to explore new avenues for non-interest income.”

He said as the portion of non-interest income started to fall, they focussed on increasing lending.

Banks prioritised mobilising fixed deposits instead of saving and current account deposits. “Due to increasing reliance on fixed deposits, their interest expenses increased forcing them to lend more for profit and this ultimately hit liquidity,” said Gharti.