KATHMANDU, July 17

Excess liquidity is building up rapidly in the banking sector even as the central bank is mopping up billions of rupees every week from the market, indicating long spell of depressed deposit rates will not end soon.

Banks and financial institutions are currently sitting on top of excess liquidity of record-high level of around Rs 126 billion, largely because of rise in inflow of money sent by Nepalis working abroad in the aftermath of earthquakes of April and May, according to Nepal Rastra Bank, the central bank.

Per day workers’ remittance inflow stood at Rs 2.1 billion in the 10th month (mid-April to mid-May) of Fiscal Year 2014-15, which ended yesterday, as against Rs 1.58 billion in the days prior to earthquake. Daily remittance flow even reached as much as Rs 5 billion at one point after the quakes, NRB said.

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

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

“Also, liquidity level usually rises towards the end of fiscal years, as banks do not issue fresh loans during the book-closure period and instead encourage borrowers to repay the credit,” head of Research Department at NRB Min Bahadur Shrestha said, adding, “All these reasons are pushing up liquidity level in the banking sector.”

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

These incidents are unlikely to occur in Nepal at the moment as most of the banks and financial institutions have virtually stopped extending loans against security of real estate, including land and houses, in the aftermath of quakes.

Banks and financial institutions here extend almost 50 per cent of credit on the back of land and buildings.

“But we have stopped issuing loans against these collaterals at the moment because many borrowers cannot submit building completion certificate,” said Sanima Bank CEO Bhuvan Kumar Dahal.

Although it was mandatory for borrowers to submit this certificate prior to the quakes, banks were not strict about it in the past. However, with the change in risk perception, borrowers are now being asked to submit this document.

“Also, the government has put a moratorium on approval of building designs, without which new houses cannot be built,” Dahal said. “So, we have not been able to issue new home loans either.”

Although these reasons, coupled with fragile investment and business climate, have reduced credit demand, the possibility of funds flowing into unproductive sectors cannot be ruled out, as average credit-deposit ratio —technically referred to as credit to core-capital-cum-deposit ratio — of commercial banks now stands at around 74 per cent, as against 78 per cent in mid-April. This shows banks now have more room to convert deposit into loans.

To prevent this excess liquidity from building inflationary pressure, NRB mopped up Rs 50 billion this week alone by floating money market instrument called ‘term deposit’. NRB is absorbing another Rs 22 billion from the banking sector on Sunday.

Despite these efforts, the level of excess liquidity is expected to remain high in the banking sector in the coming days, as credit demand generally does not go up in the first quarter of every fiscal year and many instruments issued by NRB in the past are also maturing, which will send money back into the banking sector.

“This means depositors will have to brace for lower deposit rates (which stood at 4.06 per cent in mid-May as against inflation of 7.1 per cent) in the days to come,” Dahal said.