The ongoing credit crunch has become a major issue in the Nepali economy. Commercial banks have been facing a lack of loanable funds from the first quarter of this year. Nepal Rastra Bank has set the regulatory core capital-cum-deposit (CCD) ratio at 80 percent, and many banks are very close to it. Currently, many banks are facing a shortage of loanable funds and are not in a position to lend although there is huge demand. The positive political changes that Nepal has experienced since the promulgation of the constitution has undoubtedly paved the way towards political stability. The new majority government and the institutionalisation of a democratic system of governance following the successful holding of federal, provincial and local elections is also a positive step forward. 

These changes have encouraged private entities to invest in the manufacturing and productive sectors, which has led to an increase in demand for investible funds. Ensuring easy access to loans will help enhance these productive sectors, which include agriculture, energy and tourism, as they experience growth. Similarly, reconstruction efforts following the devastating 2015 Gorkha earthquakes, which caused massive destruction of residential, public and private infrastructure, sustain demand for loans. 

Monetary policy

The economic growth rate for this fiscal year 2018-19 was targeted at 8 percent. 

To achieve this goal, the central bank introduced an expansionary monetary policy by reducing the cash reserve ratio (CRR) for commercial banks from 6 to 4 percent and the statutory liquidity ratio (SLR) from 12 to 10 percent. This has injected extra liquidity into the banking industry worth Rs48 billion. The monetary policy has also targeted private credit growth of 20 percent to support the targeted economic growth. 

Banks charge interest on loans based on their base rate plus a premium. The base rate is the summation of five components—cost of funds, cost of CRR, cost of the SLR, operating costs and return on assets. Among these components, the cost of funds forms a major proportion of the base rate. The rise in the cost of banks will lead to a rise in the base rate. So, the root cause of the rising market interest rate at present is reflected in the tight cash concentration and disbursement (CCD) ratio.

All indicators like the CCD, base rate and cost of funds are lower for government banks than private banks. At the end of the first quarter of 2018-19, the CCD ratio of 12 commercial banks was higher than 79 percent while it was 75 percent for the rest—except for Rastriya Banijya Bank, Nepal Bank and Standard Chartered Bank.

Supply has fallen behind demand for loans as banks have not been able to collect deposits. Deposit collection has increased 4.29 percent while loan disbursement surged 11.09 percent at the end of the first quarter of 2018-19 compared to the end of 2017-18. Banks have started to increase their interest rates in order to retain existing deposits and attract new ones. However, this response has not been favorable to the overall economy. This is not going to increase the profitability of banks but certainly raise the market interest rate—igniting a ripple effect of stagnation across various stakeholders. The situation will hamper the manufacturing and productive sector, the general public, and ultimately, the whole economy. 

Looking at the larger picture, this will ultimately thwart the economy’s goal of achieving the targeted annual growth rate of 8 percent. According to a report released by the Financial Comptroller General Office in December, the government’s capital expenditure remains very low at 12.78 percent. Because of the snail-paced spending, a huge amount of money that should be circulating remains parked in the central bank’s vault. 

Pile of cash

There will be a massive addition to this pile of cash in mid-January. An estimated Rs45 billion in taxes is expected to pour into the government coffers at the end of the second quarter, thus extracting money in banking circulation. This may create pressure on banks to maintain the CCD as a huge amount of deposits will be withdrawn. The tight CCD may again create the aforementioned problems in the economy.

Several weeks ago, Nepal Rastra Bank deposited 50 percent of the local government budget of around Rs39 billion in commercial banks which is an appreciable step. Emphasis should be put on increasing government spending by making capital expenditure as estimated in the budget so that there will be uniform circulation in the economy. Although the government, Nepal Rastra Bank and banks themselves have been making efforts, there has been no significant contribution to offering a solution to the problem. Banks, Nepal Rastra Bank and the government should work hand in hand and bring some strong long-term solution to take the Nepali economy on the growth path considering the ultimate goal of financial stability. 

Lakhey is a research assistant at Nepal Bankers’ Association.