Rise in lending to the non-performing sector is responsible for the shortage of liquidity

Despite central bank directives repeatedly to banks and financial institutions to increase the share of lending to the productive sector, banks have increased lending to the unproductive sector in recent years.

A study by the Confederation of Banks and Financial Institutions of Nepal (CBFIN) found that lending to the nonperforming sector has increased in recent years. The study pointed to these loans as one of the reasons for the shortage of liquidity in the banking sector.

As of mid-December 2021, banks and financial institutions had outstanding loans totaling Rs. banks and financial institutions, says the study report titled ‘The Causes of the Shortage of Liquidity and Recommendations to Solve the Problem’ released on Sunday. The total outstanding credits of the banking sector as of mid-December stood at 4.603 billion rupees.

The share of these “purposeless loans” was 17% in mid-December 2020 and 16.42% in mid-December 2019.

In addition to increased lending to sectors with unclear targets, overall lending to less productive sectors, including wholesale and retail trade, finance, insurance, real estate, other services, consumer loans and others in mid-November 2021 stood at 59.18%, according to the report.

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

“There is a clear link between the increase in loans in the least productive sector and the unnatural increase in imports,” the study says. “It is natural that liquidity management becomes difficult when lending to the non-performing sector increases.”

In the first half of the current fiscal year, the country’s import bill reached nearly one trillion rupees. According to customs departmentNepal’s import bill in the first half of the current financial year 2021-22 has reached a staggering mark of Rs 999.34 billion, an increase of 51.13% year-on-year.

Central bank officials say bank lending fueled imports, which contributed to the growing balance of payments deficit and the rapid depletion of foreign exchange reserves.

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

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

Although the report highlighted excessive lending in less productive sectors, especially to finance imports, as one of the main reasons for the current crisis cash shortagehe also pointed out why banks and financial institutions have been forced to increase lending as much as possible.

The report blamed both central bank policy and the tendency of shareholders to seek quick returns as major factors in the current liquidity crisis.

According to the study, since the central bank ordered banks and financial institutions to increase their paid-in capital, banks began to experience reduced liquidity.

Through the monetary policy for the 2015-16 financial year, the central bank had asked banks and financial institutions to increase their paid-in capital by several times. For example, commercial banks were required to increase paid-in capital to 8 billion rupees from Rs2 billion.

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

“The central bank should have prioritized mergers and acquisitions instead. But it allowed capital to be raised through right-share issues,” the report said.

As banks and financial institutions focused on increasing profits and distributing free shares to increase their paid-in capital, they began to over-lend, according to the study team members. “It’s a side effect of central bank policy to increase paid-in capital,” said Bal Narsingh Gharti, a member of the study team.

According to a report, before the introduction of the paid-in capital increase policy in 2015, the liquidity position of banks and financial institutions hovered around 30%, but fell to around 21% in 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 this program, but since they were unable to repay on time amid the protracted pandemic, the central bank allowed banks to roll over these 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.

Declining non-interest income from the banking sector has also forced banks and financial institutions to increase for-profit lending, according to the report.

According to the report, the non-interest income of Nepalese banks is the lowest in South Asia. The non-interest income of Nepalese banks stands at 21.76% of their total income, compared to 56.68% in Bangladesh and 36.95% in India, the report said.

“One of the factors explaining the weakness in non-interest income is the lower fees that banks charge customers for services,” Gharti said. “Another reason is the inability of Nepalese banks to explore new avenues for non-interest income.”

He said as the share of non-interest income began to fall, they focused on increasing lending.

Banks have given priority to mobilizing time deposits rather than savings deposits and current accounts. “Because of the growing reliance on time deposits, their interest charges have increased, forcing them to lend more for profit, which ultimately hurt liquidity,” Gharti said.

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