It is imperative that at macro level, Nepal needs to structurally design a policy to promote exports by focusing on manufacturing and industrial base and create an environment to attract and facilitate the FDI inflows to meet the funding requirements of the country

Credit to Deposit Ratio (CDR) is one of the most important ratios for liquidity management and is used globally in banking regulation and asset and liability management.

Regulators in most of the countries monitor CDR as a risk indicator. Many big banks use CDR for internal control and disclosure purposes. In Nepal, we have recently been hearing arguments such as CDR. CDC (Credit to Deposit plus Capital) in Nepal’s case should be abolished once the liquidity ratios and parameters of Basel III come into implementation as the risk will be sufficiently covered by these ratios.

Rapid growth of assets which was readily and cheaply funded by the availability of the liquidity in the wholesale market suddenly evaporated and the instantaneous reversal in the market condition was experienced as the global financial crisis hit hard.

Basel III has adopted two new global liquidity ratios: The Liquidity Coverage ratio (LCR) and the Net Stable Funding ratio (NSFR).

The objective of the LCR is to ensure that banks hold sufficient High-Quality Liquid Assets (HQLA) to cover its total net cash outflows over 30 days. This will enable banks liquidity profile to be resilient in the short term by maintaining sufficient stock of unencumbered HQLA which can be converted to cash fast and easily in the market to meet the liquidity needs for a 30 calendar days in a liquidity stress scenario.

The Net Stable Funding Ratio (NSFR) on the other hand monitors the proportion of long-term assets which are funded by long-term, stable funding. This ratio should be equal to at least 100% on an on-going basis.

Stable funding includes customer deposits, long term wholesale funding and equity, however weightage on components of these stable funding is not equal and carries different values.With this background, we believe that the senior bankers and central bank of Nepal will consider these factors in the process of taking prudent decisions while implementing any such ratios and abolition of any.

At the crux of these arguments, liquidity and supply of funds to support the asset growth seems to be the primary concern and hence it is important to look at the issues on the liquidity and the lendable funds.

As per the World Bank report, credit growth in Nepal reached a five-year high of 31.9% in Feb 17 and tapered off to 27.9% in March. With expansion of 400+ new bank branches in the pipeline owing to country moving into federal structure, it is expected that there will be consistent credit demand.

The biggest component of source of funds for Nepal, remittances – as per the World Bank report — have seen robust growth over time, from 2 percent of gross domestic product (GDP) in FY2000 to 15 percent in FY2005, 22 percent in 2010, and as much as 30 percent in FY2016. Nepal has one of the highest remittance inflows in percent of GDP.

Another source of funds, exports, has historically remained weak for Nepal due to poor manufacturing and industrial base.

As per the World Bank report, exports from Nepal is hovering around US$60 million per month, down from the already weak five-year average of US$84 million. As import continues to rise sharply and exports flattened, the trade deficit surged further and reached a record high, crossing US$700 million per month for the first time in Feb 2017.

As per the World Bank report, FDI inflows in Nepal average less than 1 percent of GDP, even trailing behind other smaller landlocked countries like Bhutan. Foreign owned firms are not only critical for accessing new technologies and business practices but also even more important to fulfill the required funding that cannot be met by the domestic sourcing alone.

Given the small domestic fund base, attracting FDI and facilitating it is immensely important for Nepal to support the developmental needs of the country.

We have been widely discussing Nepal government’s inability to spend the development expenditure. Only 65% of the allocated budget on the capital expenditure was utilized in the last fiscal year 2016/17 and almost 36% of the total capital spending took place in the last three weeks of the fiscal year end.

However, the counter argument could be, even if the government will be able to spend the full budgeted amount, in a nation that hardly manufactures anything, most of these expenses will be used to import the goods and services thereby money will flow out from the country.

Given the situation, it is imperative that at macro level, Nepal needs to structurally design a policy to promote exports by focusing on manufacturing and industrial base and create an environment to attract and facilitate the FDI inflows to meet the funding requirements of the country.

While the components like remittances is mostly driven by global dynamics with little or no domestic control, managing and promoting exports and FDI will take longer time.

Hence, as a short-term tactical tool, immediate actions to manage the potential credit crunch and steepening of the interest rate could be curtailing the imports to reduce the trade deficit and re-adjusting the Credit to Deposit plus Capital (CDC) ratio to provide some headroom of lendable funds for the banking industry.