Money, Money Everywhere, Not a Place to Invest BANK LIQUIDITY

The Boss, 2009

Liquidity in the banking system until the second week of July 2002 was Rs 39 billion, which, according to officials then, was not sufficient to rejuvenate the ailing economy. On July 15 2002 Nepal Rastra Bank (NRB) announced a new monetary policy whereby the compulsory Cash Reserve Ratio (CRR) would be whittled down by 1%. This was the second such cut in six months. The move was prompted by the need to create extra liquidity in the banking system so that the cost of fund would decline and enable banks to provide more soft loans. In a matter of three months Rs 1.75 billion was injected but the move failed to generate a 'visible impact' in the money market. The CRR, cut down by one percentage point neither induced investments nor created any economic activities. However, Dr. Yuba Raj Khatiwada, executive director of Research Department at the NRB had said then, "It is too early to make an opinion about the new policy."

On February 2003 a report in a business magazine stated that, 'One interesting fact is that the Nepalese banking system is the excessive liquidity. Banks are flooded with money and there is no place for investment. The economy is virtually turning out to be remittance economy…The amazing liquidity should be transformed into better investment thereby creating more employment opportunities so that the banking system will not be blamed for pushing the nation towards a failed state.'

So one can assume that Dr Khatiwada was right and that between the third quarter of 2002 and end of 2003, a situation had been created that not only could be said to be a success of NRB's policy, but exceeded the goal. However, one can also presume that it couldn't have been only the cut in CRR alone that prompted excessive liquidity in the banking system. Obviously, avenues for investment had been severely limited and as far as big projects were concerned, there were too few to even matter. In addition, the massive increase in flow of remittance from abroad, now made more transparent through proper money channels, can be assumed to be one of the major causes of increasing bank liquidity.

According to senior officials at the NRB, remittance was said to be the prime reason for the increase in the volume of liquidity in the banking sector. According to the NRB statistics, over Rs. 62 billion in remittances were received in 2003. Over and above this, officials claim that another Rs. 20 billion was remitted through unofficial channels.

It seemed that not only was Nepal's economy facing a situation of excessive liquidity, but that it was a worldwide phenomenon in the year 2003.

A report in the November 2003 issue of the international financial magazine, Money, stated that Warren Buffet, Chairman of Berkshire Hathaway had a hoarding of $28 billion in cash. In June 2000 Buffet had just $1.9 billion in liquid funds. In the same issue it was reported that Bill Gates also had exceptionally large cash reserves, $49 billion, and that in the United States almost $4 trillion was in retail money market and bank accounts. 2003 was obviously not a good year for investment activities.

How has the scenario changed in 2004? According to a report of August 26 2004, 'If the government or Nepal Rastra Bank fails to take timely measures to introduce new investment opportunities, economists fear that the ever-growing volume of liquidity would swallow up a number of banking institutions.' No doubt, the frequent bandhs, blockades and violence are the main reasons for ‘excess liquidity’ but other factors like lack of portfolio diversification, increase in remittances and lack of investment in the primary sector must also be blamed for expanding its size.

Bankers claim that a large amount of their money has remained idle due to the unsafe environment and that despite having adequate liquidity, there is no demand for money because of insecurity. Banking sectors, investors and borrowers are not in a comfortable position, says an official of Nepal Bankers Association.

NRB statistics shows that the deposit in the banking sector has increased by 15 per cent in comparison to the last fiscal year. The broad money this year has increased to 13 per cent in comparison to the 10 per cent of last year. Similarly, narrow money has also increased to 12 per cent.

In an interview to a magazine in March 2004, Jitendra Basnyat, General Manager of Nepal Investment Bank had said, 'Due to volatile situation we had to change focus from long term development to short term loans… our focus is on short term lending and fee based business. It is probably not a good time to invest in long term projects apart from few sectors like hydroelectricity''. Similarly, in the same issue, Radesh Pant, MD, Bank of Kathmandu, says, ''The bank's key focus …in remittance, retail lending and small scale deposit'.

According to SS Dabbas, Executive Director of Everest Bank, 'The banks have sustained growth by diversifying their product line and by keeping their spreads high." He also adds, ' For sometime, there was excess liquidity but Nepal Rastra Bank was trying to follow the peace budget. Big and new investments, like hydropower, will happen only if peace is restored. And if that happens, this liquidity, which seems to be in excess today, would fall short. In that case, we will have to look abroad to financing our projects.'

Well, seeing that the volatile political situation does not look like stabilizing soon, we can presuppose that excessive liquidity in the banking system will be a plague for the country's economy in the future. It does not need an expert to know that decreased capacity for liquidity absorption points toward a decline in economic activities. Doubtless, a robust stock market could definitely be the answer to solving this problem. For example, in the US in 1983, when a similar situation had arisen, just 15% of cash withdrawn from money funds had increased the DOW Jones Index by 36%. Unfortunately the stock market in Nepal can be said to be anything but robust and has little investor confidence with the result that even at low interest rates, money is being hoarded in banks.

The excessive liquidity in banks not only deprives depositors of better interests on their deposits, but the day is not far off when the ever-growing volume of liquidity might well swallow up a number of banking institutions. Restoration of peace and investments in large infrastructure development seems to be the only way out of the morass. However, the government has not been borrowing money from the NRB rather it has been depositing it since the last three years. According to Gokul Thapa, Director of the Public Debt Department of the NRB, the government had deposited Rs. 462 million in the fiscal year 2002/03 and Rs. 2.2 billion in FY 2003/04.

At the same time, the Nepal Rastra Bank needs to up the ante and come out with some original ideas to right the money market. One idea it did implement in October this year was to issue Rs.300 million worth of treasury bills (TB) through auction but most commercial banks shied away from it and instead took more liquidity (Rs. 7 billion) from the NRB's Standing Liquidity Facility (SLF).

Officials declared that 'This has proved that issuance of TB has contributed to reduce the excess liquidity of the commercial banks.' However, Anil Shah, General Manager of Nabil Bank, pointed out that the timing had been wrong as depositors withdrew their deposit before Dashain leading to liquidity crunch in the commercial Banks. He did admit that the issuance of TB had helped reduce the liquidity to some extent but added that 'liquidity will increase after Tihar and TB will have to be issued time and again.'

According to Thapa of NRB, 'Treasury bills were issued to move up the excess liquidity of the commercial banks, in the context that they were being compelled to reduce the interest rate on deposit, which has already come below three per cent (2.5 per cent).' At the same time, he says, “But the money acquired by NRB will have ‘no utility’. However, issuing treasury bills was the right move to maintain the financial stability.”

NRB had till September 2004 acquired liquidity amounting to Rs. 9.55 billion through six auctions of treasury bills whose maturity period is from July12 2005 to September 27 2005.