Days ahead not easy for the banking fraternity

KATHMANDU: Let no loans be made that are not secured beyond a reasonable contingency. Do nothing to foster and encourage speculation. Give facilities only to legitimate and prudent transactions. Make your discounts on as short term as the business of your customer will permit , and insist upon the payment of all paper at maturity, no matter whether you need the money or not. Never renew a note or bill merely because you may not know where to place the money with equal advantage if the paper is paid. In no other way can you properly control your discount line, or make it at all times reliable.”

“Distribute your loans rather than concentrate them in a few hands. Large loans to a single individual or firm, although sometimes proper

and necessary, are generally injudicious, and frequently unsafe.

Large borrowers are apt to control the bank; and when this is the relation between a bank and its customers, it is not difficult to decide which in the end will suffer. Every dollar that a bank loans above its capital and surplus it owes for and its managers are therefore under the strongest obligations to its creditors, as well as to its stockholders, to keep its discounts constantly under its control.”

“Trust your customers liberally, bearing in mind the fact that a

bank prospers as its customer

prospers, but never permit them

to dictate your policy.”

“If you doubt the propriety of discounting an offering, give the

bank the benefit of doubt and decline it; never make a discount if you doubt the propriety of doing it. If you have reasons to distrust the integrity of a customer; close his account. Never deal with a rascal under the impression that you can prevent him from cheating you. The risk in such cases is greater than the profits.”

“Pay your officers such salaries as will enable them to live comfortably and respectably without stealing, and require of them their entire services. If an officer lives beyond his income, dismiss him; even if his excess of expenditure can be explained consistently with his integrity, still dismiss him. Extravagance, if not a crime, very naturally leads to crime. A man cannot be a safe officer of a bank who spends more than he earns.”

“The capital of a bank should be reality, not a fiction; and it should be owned by those who have money to lend, and not by borrowers. The comptroller will endeavor to prevent by all means within his control, the creation of a nominal capital by national banks, by the use of their circulation, or any other artificial means; and in his effort to do this, he confidently expects the cooperation of all the well-managed banks.”

“Pursue a straightforward, upright, legitimate banking business. Never be tempted by the prospect of large returns to do anything but what may be properly done under the National Currency Act. ‘Splendid financing’ is not legitimate banking, and ‘splendid financiers’ in banking are generally either humbugs or rascals.” The above quotes were made in 1863 by Hugh McCulloch who was then the Comptroller of the Currency and later the Secretary of the Treasury, Government of the United States of America.

This was addressed to all national banks in the United States. Those institutions had only lately been organised and their executives, one must assume, were more in need of the Comptroller’s verbal lashings than bankers ever have been since.

Some 250 years since Mr McCulloch’s sage admonition on banking, never has it been so relevant to the banking industry as a whole in general and to Nepal’s Banks and Financial Institutions in particular as it is today. What was mentioned some two and a half centuries ago we apply in the present context in the form of Capital Adequacy, Cash Reserve Ratio, Market, and Credit and Operational Risk. No matter how advanced the systems may be, the basics cannot be ignored for prudential banking. The banking and financial industry in Nepal is facing its most trying period. Liquidity is tight, investment areas are limited, margins are narrowing and prospects that the macroeconomic environment will improve seem evasive. Under such circumstances what does an industry such as this, which has been resilient, transparent, profitable and one of the major employers of professional talent, do to maintain its decorum? The answer is going back to basics.

The subprime chaos that led to the dissolution of many investment banks has had its ripple effect around the globe. Complex financial instruments were created and distributed, which were not understood by the bankers, rating agencies or the investors. Profits were made, bankers and their boards, investors, share holders and the tax man were all happy and then the bubble burst. Until that moment risk management of the entire system was in the back burner. The effect of the international economic crisis was thought not to have much impact

on Nepal’s economy as was forecast

by Nepal Rastra Bank in a visceral

announcement through the

Monetary Policy. Some six months since the monetary policy

announcement for this fiscal year, we find our economy in jeopardy; our remittances have decelerated, our balances of payments are in the negative and our banks are facing a liquidity crunch. And everyone is talking about the real estate bubble, which hasn’t quite factored in, as of yet, to the crisis. The question is whether the ripples of the international crisis has finally caught up with us or have our problems been home grown due to continuous neglect of the economy by successive governments.

The deceleration of growth in remittances most certainly is a ripple effect in the slowdown of the international economy, and more so, it is also due to the lack of importance or focus given by the government to buttress this sector by not being pre-emptive in strategy to avoid such a situation from arising. The lack of facilitation and clear policies in attracting foreign investments, the complete apathy towards the existing industries and their security, lack of much needed infrastructure to support the economy and governance issues are the major reasons for the state of the present economy. Ironically, what has been getting the brunt of every ones ire has been the real estate bubble and liquidity. “Banks have lent more than their capacity”, “their credit deposit ratios are out of whack” and “they have lent to the unproductive sector i.e. real estate” have been the often read remarks in recent months. Although there is some truth to the above quotes by no means are they the only reasons for the dismal state of our economy as what has been led to believe recently.

In any economy there has to be some generation of wealth for it to prosper. Remittances from abroad for us have been the sustaining factor. Due to lack of investment areas, ours has been a consumer driven economy. Statistics show that we only save 8 per cent of the GDP and spend 92 per cent. A result of this spending is the massive foreign trade deficit of about Rs 100 billion. The export-import ratio stood at 84:16. The price increase in the urban real estate and until recently speculation led by easy credit has unrealistically hiked all areas relating to land purchase. An area that has gone unregulated, the cooperatives are said to have invested many folds more than the banking sector in real estate. There are no data to corroborate this. Furthermore, the housing sector is not an unproductive sector as it employs many through the employment of and investment in peripheral industries. Real Estate speculation is unproductive and has rightly been curtailed due to tightening of credit by the banks and financial institutions. Investment in gold is unproductive and more so when the national reserves of foreign currency is being depleted for the purpose. The question of liquidity crisis has been the topic in recent days. There have been many misnomers about the liquidity crisis. Banks’ investment into real estate alone does not cause a liquidity crunch.

The mismanagement of their balance sheet does, when there is a discrepancy in the asset liability mix then the onus is on the individual bank to manage its liquidity. Statistics show that the average investment that the banks have made in this sector is about 20 per cent of their total

loans outstanding. Not a great

amount considering that figure also includes personal housing (which is the safest form of investment). However there have been cases of

some banks and financial institutions with high Credit Deposit Ratio,

which means their loans are greater than their deposit base. Without proper gap analysis, liquidity problem for individual banks can arise due to this mismatch. What actually has triggered the liquidity crisis?

When our trade deficit widened, and we were opening letters of credits to import petroleum products, gold, vehicles and all other goods we depend on, our dollars instead of returning to Nepal Rastra Bank in the form of intervention was going to honour the letters of credit in foreign banks for the imports. Some 40 percent decrease in intervention in the last four months has denied that amount of Nepali rupees being injected into the system from the Central Bank vaults. The fact that government development spending has been almost zero hasn’t helped the liquidity situation either. The revenue generation through taxes steadily increasing does not bode well for the availability of currency in the banking system unless government spending is jacked up. The other reason could be after the Dasain Tihar currency crisis, people feel safer keeping a little bit more in their homes and pockets. This has a lot to do with inflation, which is in double digits. The demand for money is increasing and, one doubts, whether the authorities concerned have taken this into account. Furthermore, the recent disclosure directives on anti-money laundering may have deterred some to use the banking system. Hence, the liquidity crunch for the entire banking sector and a crisis for some banks.

There is not much hope that the government will address this situation besides harping from the angle of the monetary policy and being absolutely oblivious to the fiscal problems. Unless and until a holistic approach is taken our economy will continue to slide. The tightening of interest rates does not bode well for the real sector. Internal Rate of Returns for investors may not make sense anymore in an interest rate increasing environment. How an economy like Nepal’s expects to make any progress under these circumstances remains questionable. In the mean time, what the bankers need to do is to go back to basics, work hard to maintain their good asset quality, and be well capitalised to withstand any adverse economic climate, ensure their credit deposit ratios are within the limit and continue in the tradition of transparency. Days ahead are not going to be easy for the banking fraternity; this will be a trying case for them to show their professionalism.

The author is Chief Executive Officer, Ace Development Bank Ltd.