Coping With Liquidity Crunch

The liquidity crunch has been witnessed in the banking sector for the last few years. Technically, the liquidity crisis hitting the banking sector at present is not a liquidity crisis. A liquidity crisis is a situation in which banks and financial institutions (BFIs) are short of cash or near-cash assets. At present, BFIs are in a position to encash cheques presented by depositors. What the ongoing liquidity crunch denotes is lack of loanable funds. Owing to a tight position of deposits, commercial banks are not in a position to disburse loans. 

Economic activity in Nepal, as in the rest of the world, was badly affected during the COVID-19 pandemic. Industry, business, tourism and other economic activities decreased, throwing a large number of people out of a job. With the pandemic receding in the country, industrialists, businessmen, tourism entrepreneurs and others have been eager to resume, or expand, their business. But they have sunk into the Slough of Despond as they are not able to avail themselves of loans from BFIs.

Excess disbursement 

The current liquidity crisis has arisen owing to excess disbursement of loans by commercial banks after the COVID-19 scare subsided in order to boost the economic activities buffeted by the pandemic so that the country could advance on the path of economic recovery. The crux of the problem is a mismatch between deposits and credit. As things stand, the demand for loans is increasing, whereas the mobilisation of deposits is disproportionally low. Commercial banks have increased the rate of interest on deposits to woo more and more deposits. Now, fixed deposits attract as much as 12.13 per cent interest. Still, commercial banks have not been able to mobilise required deposits. Consequently, most commercial banks have stopped the disbursement of new loans. 

The Nepal Rastra Bank (NRB), the central bank of Nepal, intervenes in the banking sector from time to time whenever there is a crisis. The NRB adopts various measures such as a repo and a standing liquidity facility (SLF) to ease the crisis in the market by injecting funds into the market. A repo is a repurchase agreement. Under the agreement, when they need funds, commercial banks give securities to the NRB as collateral, agreeing to repurchase the securities at a higher rate than the original rate. The SLF, on the other hand, is a facility offered to commercial banks through which they can borrow funds from the NRB against government securities for a short term. 

There are several factors contributing to the liquidity crisis. A low level of government spending is one of them. Every year, a huge amount is set aside for capital expenditure. But a big portion of the amount is locked up in state coffers. If capital expenditure takes place as planned in the budget, the amount will land in commercial banks. This will help in increasing deposits. Under-spending has been a perennial problem. Every year, the amount earmarked for development projects is not spent in full. And the remaining amount gets frozen. Such a trend is a stumbling block to development.   

Remittances play a big role in the economy of a country. There are many Nepali migrant workers in the Gulf countries and other labour destinations. They remit money to their families back home. Commercial banks have offered one per cent higher interest on remittance fixed deposits than on normal fixed deposits so as to retain the remittance money in the banking sector. However, not all migrant workers remit money through the banking channels. For one reason or the other, they prefer to remit money through the informal (non-banking) channels. There is a pressing need to convince the migrant workers to use the banking channels while remitting money. Identifying and curbing the informal channels like the hundi system is a hard nut to crack. If all the remittance money could be channelised through the banking system, the liquidity problem could be solved to a great extent. 

Trade deficit 

Other factors contributing to the liquidity crisis may be a burgeoning trade deficit and a BOP (balance of payments) deficit. Nepal is an economy based on imports. The government is import-minded. Development of agriculture, industry, commerce and other sectors is not copacetic. As a result, imports preponderate over exports, resulting in a colossal trade deficit year after year. Even so, the government has not come up with any solid strategy to reduce the trade deficit such as through import substitution. With huge imports, the country’s foreign exchange reserves have also dwindled. The government has tightened the exchange of foreign currency for travel purposes and banned the import of certain things considered non-essential or luxurious, including certain vehicles. 

The liquidity crunch has been festering for long, which is not a good omen for the economy. The NRB should seek long-term solutions. The flow of funds to the unproductive sector should be curbed. Such funds do not expand economic activity; rather, they stoke inflation. That many people are dying to get loans from commercial banks indicates that there are prospects for expanding economic activity. When economic activities expand, many job opportunities are created. This will lower the jobless rate in the country. On the other hand, this will also strengthen the economy. As such, it is high time the government and the NRB took adequate measures to resolve the long-lingering liquidity crisis.   

(Maharjan has been regularly writing on contemporary issues for this daily since 2000. uttam.maharjan1964@gmail.com)