The market is flooded with excess liquidity. The banks and financial institutions (BFIs) don’t espy many areas of investment at a time the pandemic has made everything come to a standstill. As the BFIs have been unable to lend, the Nepal Rastra Bank (NRB) has mopped up excess liquidity from the market. But this is only a short-term solution while the country’s financial sector suffers from a chronic excess liquidity. Nepal’s banking sector appears to be increasingly biased to holding liquid assets rather than supporting productive investment through lending.
The slump in demand for credit is one reason for excess liquidity in the financial sector. The NRB pulled $600 million through reverse repo auction on a cumulative basis in the first month of fiscal 2020/21, up from $300 million in the corresponding period in fiscal 2019/20. Borrowers are shying away from credit because the BFI lending is conservative and does not encourage new ideas and project concepts. Normally, this is the season that potential borrowers start processing loans, but this tendency has significantly decreased thanks to the pandemic and restricted economic activities.
The NRB statistics show 79 percent of BFI loans in the first month of 2020/21 has been approved against collateral such as land, building, or current assets such as agricultural and non-agricultural products. This shows our financial sector is not project-financing friendly. There is minimal investment from BFIs in new business ideas and projects with no assets to use as collateral.
The NRB should encourage the BFIs to be more supportive of new ideas that they can support with loans, and not to discourage individuals and firms from approaching BFIs when they need additional funds. Alternatively, the NRB also needs new instruments to manage excess liquidity effectively and strategically. Given the nature of our remittances inflow and country’s peg to Indian currency, ad hoc mopping of the liquidity may not be sufficient, nor would it provide the level of predictability needed for effective market functioning. In the current scenario, it would be wise to lend to small and medium enterprises (SMEs) that could generate jobs and utilize resources.
The government claims the economy is still on right track despite months-long lockdown and restrictions on economic activities. We have to be cautious about how these numbers are crunched. Private sector credit has gone down significantly as the pandemic limits economic activities. SMEs consider access to finance a major bottleneck for their growth in Nepal even in normal times. They have been under added pressure from ad hoc lockdowns and restricted economic activities. There is also a huge gap between urban and rural populations in terms of their access to finance. All these issues reinforce the need to expand financial sector and make it more output-oriented. This can be done by lending to SMEs and enterprising individuals.
The NRB has had a deprived sector lending policy since the 1990s but it is not working. The country currently needs investments in services and ideas. The whole idea of deprived sector lending is to help people have funds even if they do not have assets for collateral. But it is not working that way. The BFIs are doing collateral based lending regardless. This is also not serving the supporting sectors that are breaking new frontiers.
Covid-19 has changed the entire outlook of the economy. In these times, extending credit to firms and individuals with solid ideas should be the new normal. It is best to let money circulate through the veins of nation’s economy than let it stagnate in bank vaults.