In a much-needed respite to the banks and financial institutions (BFIs) stricken by a deeper liquidity crunch, the government has allowed banks to consider the majority of reserves funds of local government as bank deposits till the end of the current fiscal year. In December last year, the government decided to allow the commercial banks to count up to 80 percent of the reserve funds of the local governments deposited in commercial banks as deposits till the end of the last fiscal year 2021/22. Earlier, only 50 percent of such funds could be counted as deposits. In September this year, the deadline for counting such funds as deposits was extended further till mid-January 2023. The measure helped commercial banks to keep their credit-to-deposit (CD) ratio to the regulatory limit of 90 percent.

With the banking sector continuing to face a shortage of loanable funds which resulted in surging interest rates in recent months, the government decided to extend the deadline further till the end of the current fiscal year. “The Ministry of Finance made such a decision early this week,” a senior official of Nepal Rastra Bank said. “This is expected to help the banks from getting their liquidity further.”

The monetary arrangement, which allows banks to consider the reserve funds of the local governments as deposits, has helped banks to count the funds of local governments of over Rs 100bn as liquidity, according to the central bank. The non-extension of the deadline would have caused havoc in the liquidity position of banks by the middle of January next year when people are likely to withdraw a large chunk of money from the banks and financial institutions to pay the first installment of income tax. As per the Income Tax Act, taxpayers are required to pay income tax in three installments in January, April, and July. As a result of the excessive lending in the early months of last fiscal year, the banking sector faced a liquidity crunch as deposits could not grow in proportion to the lending. According to the central bank, there has been some improvement in liquidity in the last few months as the CD ratio has come down to around 86 percent. BFIs have hardly issued new loans while there has been a marked improvement in deposit collection due to an increased inflow of remittances as well as increasing government spending. NRB data show that nearly Rs 100bn has been collected by banks as deposits since the start of the second quarter of this fiscal year while the banks and financial institutions have lent around just Rs 3bn. “The latest trend of deposit and lending has helped to bridge the gap created by higher lending and lower deposit collection in the past,” the NRB official said. The liquidity is expected to be eased relatively in the second half of the current fiscal year provided the remittance inflows continue to increase and government spending also picks up. The government’s capital spending also usually increases in the second half of the fiscal year which will help bring cash into the banking system easing the liquidity crunch. As of December 26, capital expenditure is just over 10 percent, according to the Financial Comptroller General Office. “As development activities will pick up in the second half of fiscal, there will be a rise in capital expenditure which will help improve the liquidity situation of the banking sector,” the NRB official said.