With the first half of the current fiscal year already gone, the country’s banking system is facing multiple challenges—from liquidity constraint to potential risk of huge realty loan defaults. The second half is likely to be a testing time for the domestic financial sector.

The half-yearly results of banks show that there has been decline in the deposits of commercial banks in the last six months, but lending has increased. The decline in deposits and increment in lending has resulted in the drop in the presence of liquidity in the banking system.

The liquidity constraint has forced the central bank to inject liquidity through repo (central bank injecting fund in banks by purchasing their treasury bills). The central bank has already injected Rs 18 billion over the last two weeks in banks through repo to ease liquidity crisis.

The banking system had also faced liquidity crunch during the first half of last year. Though last year’s crunch was much severe than this year’s, bankers say the liquidity situation is still tight and they are finding it difficult to lend.

Deposits of commercial banks, in the first six months, declined to Rs 625 billion from Rs 631 billion at the end of the fiscal year 2009-10. However, their lending soared to Rs 500 billion from Rs 462.24 billion. This has resulted in increase in credit-to-deposit ratio, lessening the presence of liquidity in banks.

Current scenario of domestic banking sector, according to Sashin Joshi, president of Nepal Bankers’ Association, signals more challenges for banks in the second half of the fiscal year. “The actual picture can be seen after banks start unveiling their half yearly results. However, results do not seem to be bright,” said Joshi.

Decline in deposits, according to bankers, indicates the emergence of ‘informal economy’.

Currently, banks are taking loans from other banks (inter-bank lending) at more than 10 percent interest to ease their liquidity crunch. Although inter-bank lending rate has fallen from last week’s 12 percent, bankers say that the rate remaining stagnant at 10 percent is a sign of liquidity crisis.

According to bankers, tighter liquidity situation has made difficult for them to lend. The situation is such that some banks are postponing loan commitment dates for big clients. “We are postponing the dates due to tighter liquidity,” said Janardan Acharya, chief executive officer of Rastriya Banijya Bank (RBB).

The RBB witnessed its deposit increasing in the sixth month of the fiscal year after five consecutive months of decline. The increment in the sixth month, according to RBB’s Acharya, was due to the pensions worth Rs 2 billion reimbursed by the government. “It has eased our liquidity situation to some extent,” said Acharya.

Bankers say the liquidity satiation further tightened after the government issued bonds worth Rs 4 billion. “It resulted in the withdrawal of deposits from the banking system,” said a banker. “The government move was impractical, as it had enough resources to spend.”

According to the Nepal Rastra Bank (NRB) statistics, the government has Rs 29 billion in its treasury at the end of the first six months, which is historically highest during the period. If that amount was spent, banks’ liquidity situation would ease to some extent, as they would receive deposits.

A senior NRB official said the banking system faced the liquidity crunch, as they kept on lending despite stagnation in their deposits. “The central bank wants that banks lend rationally on the basis of deposit growth,” the NRB official said.

Bankers say banks’ profit would take a hit due to rise in the cost of fund and squeeze in the spread rate. In fact, symptoms are already visible, with banks’ net profit declining to Rs 3.46 billion in the first quarter of FY 2010-11 from Rs 3.80 billion in the same period last year. Joshi estimates that the spread rate has gone below 3 percent which was at 3.8 percent by the end of the last fiscal year.

Even the central bank officials say that banks profits this year will not be as high as those in earlier years. “Their profits may not go higher than last year’s figure, but will not drop significantly either,” said Maha Prasad Adhikari, deputy governor of the NRB.

With realty transactions coming down and price remaining stagnant, borrowers involved in real estate sector are finding it hard to repay bank loans. “There can be more realty loan defaults with slowdown in realty business,” said Joshi.

As banks are not renewing realty loans to reduce their lending in the realty sector to bring it down within the NRB set limit, borrowers are facing increased pressure to repay loans. Some bankers are now calling for some relaxation by the central bank in the provision on realty sector lending. “If relaxed, crisis in the banking can be resolved,” said a banker.

The central bank also admits that possibilities of defaults are high and NPA may go up. “The impact of speculative transactions may be seen this year,” said Adhikari.

source: The Kathmandu Post:Money (2011),"Testing times ahead for banks", The Kathmandu Post, 22 jan 2011, page 1