Excess liquidity in banking sector drops to Rs 59bn

Kathmandu, July 31

Interest rates on interbank lending and money market instruments introduced by Nepal Rastra Bank (NRB) have gradually started going up, with the aggressiveness shown by the central monetary authority to mop up excess liquidity from the banking sector.

Since July 12, NRB has absorbed over Rs 110 billion from the banking sector using instruments such as term deposit.

As a result, the excess liquidity in the banking sector has dropped to around Rs 59 billion from around Rs 126 billion in the second week of July.

With rapid absorption of excess funds, weighted average interest rate on three-month term deposit instrument jumped to 1.58 per cent today — the highest since NRB started floating these instruments in August 2014. On July 12, weighted average interest rate on term deposit instrument had fallen to an all-time low of 0.065 per cent.

Along with the hike in the interest rate of money market instruments, interbank lending rates among commercial banks — the rate at which a class ‘A’ financial institution lends money to others — have gradually started going up.

Today, weighted average interest rate on interbank lending stood at 0.4269 per cent, as against 0.2511 per cent on July 1.

Falling returns on money market instruments and interbank lending have lately been posing a big problem for banks and financial institutions (BFIs). BFIs have long been saying yields on money market instruments and interbank lending have been falling due to low supply of money market and debt instruments, and had asked NRB to float more of these instruments.

Returns on money market instruments and interbank lending had started falling with the rise in portion of excess liquidity.

Excess liquidity, in turn, is increasing in the banking system largely because of a rise in inflow of money sent by Nepalis working abroad in the aftermath of the earthquakes of April and May.

Per day workers’ remittance inflow stood at Rs 2.1 billion in the 10th and 11th month (mid-April to mid-June) of fiscal year 2014-15, which ended on July 16, as against Rs 1.58 billion in the days prior to the earthquakes. Daily remittance flow even reached as much as Rs five billion at one point after the quakes, NRB said.

Another reason for high liquidity in the banking sector is rise in inflow of foreign aid in the aftermath of the quakes.

The downside of liquidity surge is it tends to reduce lending rates.

This is in fact good news for genuine borrowers, but falling credit rates also raise the risk of funds flowing into unproductive sectors, such as real estate and secondary market, inflating asset prices and subsequently raising prices of other goods and services.

Low credit rates also encourage borrowers to acquire loans from domestic institutions and park funds in banking institutions of foreign countries, such as India, where deposit rates are relatively higher or invest in destinations where business climate is better.