Decision to raise internal loans could worsen liquidity crunch

As the government struggles to spend its existing resources, it has started to raise internal loans, fueling fears that this will lead to a further shortage of financial resources at banks which are already under pressure to lend due to the lack of of cash.

On Friday, the Nepal Rastra Bank solicited applications from banks and financial institutions and ordinary citizens to subscribe to the Development Bonds worth Rs 10 billion for the second time in less than a week in a bid to raise loans on the domestic market for the government.

The central bank has set an auction date of Jan. 30 for the four-year development bonds.

On Wednesday, the central bank sold 10 billion rupees of development bonds-2024, a debt instrument with a two-year maturity to banks and financial institutions.

According to the central bank, banks and financial institutions had applied for development bonds worth Rs 52 billion.

Even though the government continued to underperform on the expenditure part, the government continued to increase internal lending, which led to hoarding resources with the government.

“The decision to raise internal loans now was made because raising all loans in the last quarter of the fiscal year could disrupt the market,” said Mukti Pandey, head of the public debt management office. “Given weak government spending so far and tight liquidity in the banking sector, we are not increasing lending much in the third quarter.”

The government, through the Replacement Bill, had in September revised its internal lending to 239 billion rupees for the current financial year from the earlier plan to raise 250 billion rupees.

Government spending as of January 27 stands at around 33% while capital spending is around 15%, according to the Office of the Comptroller General of Finance, which maintains records of government revenue and expenditure.

As the government collected the first installment of income tax in mid-January, the public treasury was flooded with money.

Although the Treasury’s cash reserves remained idle, the government failed to channel them into the banking sector. As a result, the private sector finds it difficult to receive loans from banks and financial institutions.

Bankers said they were barely making any new loans.

“We have been very selective in lending as our credit to deposit ratio has been around 90 percent,” said Anil Kumar Upadhyay, managing director of the Agricultural Development Bank. “They are intended for long-term ongoing projects and new projects such as hydroelectric projects.”

However, demand from banks and financial institutions for government bonds – five times larger – on Wednesday raised questions about the reality of the liquidity crisis in the banking system. The demand from banks and financial institutions stood at around 52 billion rupees, while the government said it was issuing bonds worth 10 billion rupees.

“I’m not sure about the liquidity situation in the banking sector after the oversubscription of development bonds,” Pandey said.

The bankers specified that they demanded the government bonds only to manage their liquidities, which they must obligatorily preserve.

“We need to maintain liquidity outside the 90% credit-to-deposit ratio, with 10% coming from deposits and paid-up capital,” Upadhyay said. “Some of the government securities have matured and are maturing and buying new government securities will help adjust the spread once the existing securities mature.”

But bankers also argued that banks could also buy government securities at less than 90% of the credit-to-deposit ratio.

“If liquid funds are available and there is a good rate, banks can also buy government securities at less than 90% of deposits that can usually be lent,” said Nischal Raj Pandey, managing director of Sanima Bank.

He said, however, that this would not seriously affect banks’ ability to lend under normal circumstances, as they can receive a standing liquidity facility from the central bank by depositing the government securities.

Bankers, however, have argued that banks are unlikely to buy development bonds from the portion of deposits that should be used to make loans.

Due to excessive lending in the first quarter of the current fiscal year without paying much attention to collecting deposits, the banking system currently does not have adequate resources to make new loans. Some banks have completely halted new lending while others have been selective in granting loans.

Upadhyay, who is also the chairman of the Nepal Bankers Association, said banks are no longer offering large-scale loans since the banking sector is facing shortages of loanable funds.

The central bank said half of lending in the first quarter was for import financing, which contributed to a massive balance of payments deficit and the depletion of foreign exchange reserves.

Today, the private sector does not even get loans to invest in the productive sector. Due to weak public spending, the flow of financial resources from the public treasury to the banking sector does not occur on a large scale, which contributes to the continued shortage of liquidity in the banking sector.

Citing shortages of loanable funds from the banking sector, the government has delayed lifting internal loans this year.

In the last fiscal year 2020-21, the government had started raising internal loans in early October.

But bankers have said the government should step up spending to deal with shortages of loanable funds.

Finance Minister Janardan Sharma told a meeting of the finance committee formed under the Intergovernmental Provincial Council on Friday that the government would encourage increased spending.

“The government will provide more budget to offices that can spend more,” he said, according to a press release issued by the minister’s personal secretariat.