KATHMANDU: Damages caused by the devastating earthquake of April 25 and subsequent aftershocks to private and public physical infrastructure may lead to potential runs on the banking sector and trigger a liquidity crisis, says a latest report of the World Bank (WB).
“This may pose short- to medium-term risks to the country’s financial sector stability,” says the WB’s Global Economic Prospects.
Currently, around 60 per cent of the loans extended by banks and financial institutions (BFIs) are backed by land and buildings pledged as collateral, show the data of Nepal Rastra Bank.
Since the earthquake has caused huge damage to the real estate sector, many BFIs may ask borrowers to pledge additional collateral or repay a portion of loan to cover the losses. And if borrowers fail to do so, the quality of credit extended to them will deteriorate, which will force BFIs to set aside additional funds to cover potential lending risks.
So, ‘banks may see their capital buffers erode by the physical destruction of real estate pledged as collateral or a surge in non-performing loans as income streams of debtors are disrupted’, says the WB report.
Such a situation will ultimately lower profits of most of the BFIs.
The situation is predicted to remain the same in other sectors, like tourism, housing, insurance, trade and manufacturing, which are expected to witness slow growth, or even negative growth, because of the domino effect of the quake, which has killed over 8,600 people.
This will ultimately affect the country’s economy.
Already, the Central Bureau of Statistics has said Nepal’s economic growth will slow down to 3.04 per cent at basic price this fiscal year, from pre-quake estimate of 4.58 per cent.
Yet, the WB is hopeful of recovery once reconstruction efforts get underway.
Also, relatively healthy service sector growth and higher private consumption spending due to greater inflow of remittances are expected to support economic recovery, says the WB report, which has predicted economic growth (at market price) of 4.5 per cent in the next fiscal.
Besides, Nepal may also benefit from strengthening growth and lower inflation in India over the forecast period because of the peg between Nepali and Indian currencies.However, the WB has warned policymakers to focus on other sectors, like hydro, to stimulate growth, as ‘the disaster has created uncertainty over the extent to which foreign direct investment commitments translate into hydropower investments’.