1 pc interest cap on money market instruments is not fair
Nepal Rastra Bank, the central bank, introduced Monetary Policy for Fiscal Year 2016-17 last week. Rupak D Sharma of The Himalayan Times caught up with Bhuvan Kumar Dahal, CEO of Sanima Bank and member of Nepal Bankers’ Association, to get an insight into how provisions laid in the policy would affect banks and financial institutions.
Nepal Rastra Bank has come up with a contractionary monetary policy. How will it affect banks and financial institutions?
The Monetary Policy looks contractionary (because money supply growth target for the current fiscal year has been fixed at 17 per cent to contain inflation at 7.5 per cent). But to meet the money supply growth target, NRB has not revised some of the crucial rates. For instance, cash reserve ratio — (the portion of deposits that banks must park at the central bank) — has been kept intact at six per cent. Similarly, no change has been made to the statutory liquidity ratio — (portion of deposits banks must invest in government securities). Also, credit to core capital cum deposit ratio and liquidity-deposit ratio have not been changed. In this context, the monetary policy, which appears contractionary, is not likely to affect banks and financial institutions.
The main highlight of the monetary policy was the plan to introduce interest rate corridor in this fiscal year. What is your take on the issue?
NRB’s decision to introduce the corridor is a very positive move. The main objective of the corridor is to bring stability in interest rates so that depositors and borrowers do not have to suffer from frequent swings in deposit and lending rates. However, the interest spread in the corridor will be very wide at the time of its launch because policy repo and term deposit rates — (two of the three components that will determine rates in the corridor) — will be fixed on the basis of weighted average interbank rate, which has always remained low in Nepal. So, this problem must be addressed to reap maximum benefit from the corridor.
How can this problem be addressed?
Interbank rate of commercial banks — (or the rate at which banks borrow money from each other) — has always remained low because of shortage of debt instruments. So, the government must raise supply of debt instruments, such as development bonds and treasury bills. Currently, commercial banks have to maintain liquidity-deposit ratio of 20 per cent, which means a fifth of our deposits cannot be extended as loans. Although we are allowed to invest a huge portion of this money in government securities, the government never floats adequate instruments to meet our need. The government has announced its decision to issue Rs 111 billion worth of debt instruments in this fiscal year. But we don’t think the government will fulfil this promise, as it maintains huge treasury surplus due to inability to spend available money on time. Also, the government’s revenue collection is likely to improve this fiscal year because we are not anticipating supply disruptions as in the last fiscal year. So, it may not feel the need to raise money from the domestic market. This means a huge portion of our cash will remain idle in this fiscal year, which will put downward pressure on interbank rates. So, unless the supply of debt instruments goes up, interbank rates will continue to remain on the lower side and interest rate corridor will not function properly.
NRB raised the supply of money market instruments in the last fiscal year to mop up excess liquidity. Yet, interest rates did not go up because banks quoted low rates during auctions. Shouldn’t banks take some blame for this?
Interest rates on money market instruments, such as term deposit and NRB Bond, remained very low because NRB has put a cap of less than one per cent on returns. In other words, banks that quoted return of one per cent or more were not included in the auction. NRB did this to reduce financial burden, because it has to fork out its own cash to pay interest on money market instruments. But using this as a pretext to bar banks that have quoted higher rates from taking part in the auction is not fair. If NRB continues to do this, real deposit rates will continue to remain in negative territory. But if NRB abolishes this practice of capping interest rate on money market instruments, we will get better returns and will be in a position to transfer those benefits to depositors.
Are you implying that NRB will not be able to solve perennial problems, such as low deposit rates and frequent fluctuation in lending rates, even after the introduction of interest rate corridor?
The ultimate goal of the corridor is to ensure depositors do not lose money by parking their savings in banks because of negative real interest rate. The corridor should also ensure that borrowers do not have to deal with sudden swings in lending rates. But I am a bit sceptic about the corridor meeting these objectives also because of the low spending capacity of the government. In a country like Nepal, where there is huge development need, the government maintains a treasury surplus of over Rs 150 billion. If this idle money is used to build roads and hydropower projects, then it will crowd in private investment, which will raise demand for loans. This will ultimately help raise deposit rates and returns on government securities. However, initiative taken by NRB to introduce the corridor is praiseworthy and if certain improvements are made, it will reduce interest rate volatility in the long run.
The new monetary policy has also proposed to make it mandatory for banks to directly issue two per cent of the total credit to borrowers seeking micro loans. What is your take on this issue?
Currently, commercial banks have to extend five per cent of the total credit to the deprived sector. This means of every Rs 100 issued as loans, five rupees has to go towards the deprived sector. We were meeting this target by providing wholesale loans to microfinance institutions and cooperatives; through equity investment in microfinance institutions; and by extending micro loans directly to borrowers. The new provision seeks banks’ direct engagement in issuance of at least two per cent of total credit to micro borrowers. This means of every five rupees in credit being extended to the deprived sector, two rupees has to be issued directly to borrowers seeking micro loans. NRB probably introduced this provision to trigger competition in the market and compel microfinance institutions, charging annual interest of as high as 20 per cent or more, to reduce lending rates. So, the intention of NRB is noble. But it will be very tough for commercial banks to meet this target because we generally do not deal with micro loans of, say, Rs 100,000 or Rs 200,000.
As you said, NRB may have incorporated this provision to bring down lending rates at microfinance institutions. Isn’t that a positive move?
We are not questioning the intention of NRB. But NRB could have met this objective without introducing that provision. For example, NRB could have said microloans issued directly to borrowers would be assigned double the weight while assessing whether banks have met five-per-cent deprived sector lending target. This would have encouraged banks to directly reach out to micro borrowers. But NRB imposed its decision on us, which is not a good thing in a free market economy.
But the latest monetary policy also says credit of up to Rs one million extended to commercial agriculture projects could be categorised as deprived sector lending. Wouldn’t that provision help banks to meet the two-per-cent target?
That’s a positive move and that provision would certainly help us in meeting the target. Banks do want to increase their exposure to the agriculture sector and this provision would encourage banks to issue more loans to those engaged in agriculture. But again it would have been better if the regulator had offered us incentives to alter lending patterns, rather than imposing a decision on us.
Lastly, what is your take on NRB’s decision to reduce loan-to-value ratio for commercial real estate lending to 50 per cent from 60 per cent? Also, what is your take on NRB’s decision to bar banks and financial institutions from extending over 50 per cent of share’s value as margin loan?
The decision to reduce loan-to-value ratio for commercial real estate lending is a good move because demand for real estate loans has once again started to go up. This measure will prevent creation of bubbles in the sector. In terms of margin lending, commercial banks have issued less than two per cent of their total credit as margin loans. So, exposure of commercial banks to the stock market is very low. However, it is said few smaller financial institutions have extended 80 to 90 per cent of total credit in the form of margin loans. The new provision would prevent those institutions from extending such loans in a haphazard manner.