Kathmandu, May 27

Nepal Rastra Bank (NRB) is launching a brand new money market instrument called Nepal Rastra Bank Bond on Sunday to mop up excess liquidity from the banking sector.

NRB Bonds are unlike other bonds floated by NRB, on behalf of the government, to mobilise debt from the domestic market.

“It is purely a money market instrument floated by NRB to soak up excess liquidity that has built up in the banking sector. Funds raised from these tools will not be used to finance government’s development activities,” said Min Bahadur Shrestha, head of the Public Debt Management Department at NRB.

Initially, NRB will be floating Rs 10 billion worth of these instruments with a tenure of one year.

This is the first time NRB is introducing sterilisation bonds with such a long maturity period. So far, the maturity period of such instruments has not exceeded three months.

“We hope to effectively address the problem of excess liquidity with the use of these bonds,” said Shrestha. Excess liquidity in the banking sector currently hovers between Rs 20 billion to Rs 30 billion.

Such surplus funds, which do not generate any return, tend to hit the profitability of banking institutions.

Although the problem of excess liquidity has been affecting the banking sector for a few years now, NRB had previously hesitated to introduce long-term instruments to absorb surplus funds citing ‘excess reserves are a result of banks’ failure to seek out lending opportunities and actively contribute to economic development’.

NRB, thus, ‘did not want to reward such inactivity through remunerated reserves or debt issuance to mop up liquidity’, said the Article IV Report of the International Monetary Fund published in July 2014.

Also, NRB, at that time, ‘did not regard excess liquidity as a cause for concern, as it had not translated into excessive lending or higher inflation’.

The latest decision to issue these bonds indicates that NRB expects the problem of excess liquidity to prolong for some time.

In this regard, NRB is planning to float additional Rs 40 billion worth of these bonds till the end of this fiscal year through mid-July.

The yield on these bonds will be fixed through competitive bidding.

“But if the quoted rates are way higher than return on recently issued 364-day treasury bills or the latest interbank rate, the central bank may use its discretionary power to not issue bonds to such applicants,” Shrestha said, adding, “We have incorporated this provision to prevent applicants from quoting unnaturally high interest rates.”

The bidding competition is open to all banks and financial institutions in the country but the applicant must apply for at least Rs 10 million worth of bonds.

Funds invested in these instruments can be factored in while calculating statutory liquidity ratio and liquidity ratio.

But these investments should not be taken into account while calculating the cash reserve ratio, the portion of deposits that banks and financial institutions must park at NRB, Shrestha said.