Nepal | June 26, 2019

Financial stability: Is capital hike a remedy?

Pralhad Giri

While the capital hike is now to be implemented, the challenges are also growing. In an open market system, where actors perceive risks of capital hike to be small, the lending rate would be relatively insensitive towards how much the capital has increased. This could increase more supervision guidelines

Commercial BanksThe hullabaloo is almost over for the hike in paid-up capital requirements of Nepali banks. Almost all big (commercial) banks have now submitted their capital hike plans to the Central Bank and also made them public through their web portals. The decision is really a hard nut to crack with severe impacts if such decisions are not taken. Central Bank, by its objective of establishment, ensures financial stability. However, many bankers thought after the decision was made that it may be late as the tendency would be sluggish. They reasoned that the process would be lengthy and critical. One of the prime reasons could be a major hindrance in merger and acquisitions processes.

Initial ripples may now have been wiped out. Investors and bankers have now understood enough that a low capital base is unable to step into a project requiring a huge investment. There will be no consortium financing. Larger capital base is basically aimed at financing any project by a bank from its own source.

The major option of hiking paid-up capital requirements is merger. It is however complex to adopt. A few financial entities for a strong financial showing are the ultimate need of the current financial system. Not surprisingly, many bankers still fear possible failure or collapse if the merger process is not spontaneous. The key to success though is a wish to choose from different alternatives.

Certainly the Central Bank is adamant about the proclaimed capital hike within the prescribed time. It would be achieved by a mutual understanding of financial actors.

Obstruction may come through restriction on deposit mobilization, loan disbursement and branch expansion, but the benefit of becoming robust, strong and risk-taking financial institutions are what the nation is looking for. After all, it’s all about the matter of balanced economy. The economy needs a huge investment, that can be only ensured through adequate level of capital needed.

Indeed, financial services are the backbone of development. A robust economy is strengthened when industries are in operation and jobs are created. For such positive happenings, ensuring financial accessibility is vital.

As much as 60% of Nepalese are still deprived of basic financial services. Mushrooming banking business is narrowed through merger and acquisition at a time when the country is focusing on financial accessibility. One significant reason for this is to ensure banks are able to take unprecedented losses on the value of losses in recovery of loan honoring withdrawals with other essential obligations.

Risk management has its own culture. The future is typically known to be uncertain. It is wise to take appropriate measures to cope with the upcoming risks and uncertainties. Capital plans open to the public by banks these days have an important message. Many argue that making a capital plan public was the easiest way to manipulate the stock market. Stock market is of a volatile nature. Manipulation is an obscene crime, but it has a legitimate cover. This brings confusion obviously. Growing confusion is detrimental for the financial market. Thus, a regulator should develop a harmonious rapport and win-win approach to overcome such confusions. This will imply a positive approach for investment, risk culture and economic growth.

Despite the intense pressure, the decision for capital hike won’t be rolled back. However, complexities on the process for capital growth must be eased. Every risk factor has to be analyzed and we should ponder if we are unknowingly threatening the overall banking credibility. Capital hike policy, indeed, underlies the economic rationale for imposing regulations for the banking industry with an eye to establishing the professional culture too.

While the capital hike is now to be implemented, the challenges are also growing. In an open market system, where actors perceive risks of capital hike to be small, the lending rate would be relatively insensitive towards how much the capital has increased. This could increase more supervision guidelines, and monitoring which results in a rise in the cost of funding. Eventually, banks might increase the interest rate to meet the cost. This would lead to the tightening of credit conditions to wide investment in the real sector which hampers growth.

Therefore, a sound macro prudential policy is essential to address the gap. The gap is fueling tensions and fear amongst bankers. A regime of capital buffers under Basel Accord is mandatory, but the present needs for improvement goes beyond that extent. The capital buffer, however, must increase a credit boom and find out necessary avenues for business activities expansion.

In this regard a sectoral capital directive can be introduced for exuberant lending. For instance, direct lending and other wholesale banking need a directed sectoral capital requirement for self-insurance for the system as a whole. Exposures merely are not enough, and it is effective implementation that counts.

Giri is Assistant Director at Nepal Rastra Bank.

 


A version of this article appears in print on December 01, 2015 of The Himalayan Times.


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