Nepal is grappling with interest rate and liquidity volatility as well as a relatively large banking sector that has 28 commercial banks. Chiranjibi Nepal, governor of Nepal Rastra Bank, tells Stefania Palma how the central bank is addressing these issues.

Chiranjibi Nepal

One of the greatest tasks facing Chiranjibi Nepal, governor of Nepal Rastra Bank (NRB), the country's central bank, lies in consolidating its banking sector. NRB is currently supervising 196 banks and financial institutions, including 28 commercial banks, for an economy of just $21bn.

In 2015, Mr Nepal tried to cut the number of banks by increasing the paid-up capital requirement fourfold to Nrs8bn ($76.4m). Some mergers and acquisitions (M&A) materialised, with 157 financial institutions merging into 39, but these mainly involved small lenders and not commercial banks.

Maximising capital

Many market participants argue this is because the NRB allowed banks to meet the Nrs8bn requirement via rights issues. Mr Nepal says this decision was based on the fact that the capital increase was in itself already uncomfortable for lenders; and that his main priority was to increase banks’ paid up capital.

“[Without enough capital], no bank can invest in big projects, there is no stability,” he says. Indeed, the capital increase was as much about triggering bank consolidation as it was about ending Nepal’s reliance on external donors and looking to local banks instead.

While many bank chiefs believe the country has too many lenders, Mr Nepal believes it is impossible to say as the true depth of the economy is unknown. “Our gross domestic product [GDP] is underestimated. You cannot say at present if this number of banks is sufficient or not,” he says.

The true size of the economy will be revealed after the country officially implements its new federal system in December, which will split the country into seven provinces, he adds. “When the economy grows, investment will come from outside, the inner economic environment will [grow], and then [we might not be able to] say that this number of banks was sufficient.” Only then will the central bank tackle bank consolidation again. And at that point, forced mergers are likely to be the only solution, says Mr Nepal.

But for now, the number of financial institutions in the country is set to rise. The central bank will grant 50 new licences to microfinance companies to boost financial inclusion in Nepal’s remote regions, taking the total to about 100. “Banks don’t like to go to remote areas, but financial inclusion is very important for microfinance [companies], so we have given them preference,” says Mr Nepal.

Monetary stability

On a monetary policy level, Nepal suffers from strong volatility in liquidity levels and interest rates. The government’s slow pace of capital expenditure is widely considered to be to blame for this. In Nepal, there is typically excess liquidity at the beginning of the fiscal year, which starts in mid-July, as the government is slow to start spending its own budget. By the third quarter, government spending and, in turn, bank lending accelerates, sometimes leading to a liquidity crunch.

The NRB tries to minimise these swings by asking banks to lend only up to 80% of the sum of their core capital and deposits. But some lenders exceed this limit, as was the case after the catastrophic 2015 earthquakes.

In 2016, Nepal’s GDP growth shrunk to 0.56%, banks had nobody to lend to and excess liquidity built up in the economy. In response, the governor suggested setting up a disaster relief fund to which the banks and the government could contribute. But the government changed shortly thereafter and the idea “just disappeared. Two months later, there was no money in the market,” says Mr Nepal. “There is pressure from banks’ investors [to generate] profits... so CEOs started lending like anything,” he adds. The NRB asked banks to bring their lending ratios back to 80% by July 2017.

Uneven government spending and liquidity booms and crunches also create interest rate volatility. In 2016, the central bank introduced an interest rate corridor with a ceiling of 7% and a floor of 3% to minimise rate moves. Rates now sit at 4%. But to maintain this level, the central bank mopped up NRs104bn ($1bn) from the market just in the first two months of fiscal year 2017/18, up from NRs85bn in the same period in 2016/17.

“In the short run [this policy works], but [mopping up means] there is less liquidity in the market and it will not encourage economic development. Why should we keep all this money in the central bank? It should be in the market,” says Mr Nepal.

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