The most troubling aspect about the recent liquidity crisis is that there were warning signs, as early as the first half of 2009, about a possible crisis in the financial sector. However, neither the BFIs nor Nepal Rastra Bank (NRB) seemed much bothered. Together, the BFIs and the NRB simply ignored the tell-tale signs.
First, historical data from over the world shows that liquidity creation right before any liquidity crisis is always high. Money supply has been decreasing ever since the Nepali economy was liberalized after the advent of democracy in 1990. After 2001, however, the data shows an increasing trend. The increase continued right up until the end of 2009, after which the liquidity crisis hit the Nepali financial system hard. So, literature review suggests that the recent crisis was predictable. The question then is: Why did nobody, especially the NRB researchers, fail to predict it?
Second, the BFIs themselves had been forecasting net losses from their outstanding loans. The forecasted capital levels were continually on a decline, and the BFIs were increasingly worried about not meeting the NRB set standard in this regard. Delinquencies were on the rise since 2007. If these internal problems were not the signs of an impending liquidity crisis, what else could be! Unlike natural disasters, liquidity crisis does not come suddenly. It comes out of a systemic and compounding failure of the financial market and its overseer. The BFIs and the NRB should thus shoulder the responsibility for the recent crisis. It was of their own making, and the reason it lasted as long owed to their inability in seeing it coming as well as their incapability in moving in to solve it swiftly.
Third, even if the BFIs were lying and covering up their losses, the financial market as a whole should have known of such cover-ups. After all, increasing charge offs and delinquencies as well as decreasing profit and capital levels are not hidden. These are publicly available data. So, those working in the financial market as well as those monitoring it (i.e. the NRB) should have been aware that the BFIs were fudging their books. The recent liquidity crisis was, therefore, a slap in the face to those who claim to know the Nepali financial market and those who claim to monitor it.
Fourth, when the crisis hit our financial market, initially, there was no response to nip it in the bud. The BFIs went about their business, crossing their fingers, hoping that the liquidity “crunch” would not transform into a crisis. The NRB looked the other way, again hoping that the market would correct itself. That was a mistake. Eventually, after two years of crisis, the NRB decided to raise the insured deposit amounts. Although this should have been done as soon as the crunch hit the market, NRB’s step should be viewed as “better late than never”.
With all these signs foretelling the severity of the crisis, the concerned authorities did not actively seek to halt or mitigate it. As a result, the market suffered for over two years. The worst affected were those involved in the real estate sector. As a result of the liquidity crisis, house and land sales all over the country, especially in the Kathmandu valley, have all but died out.
The most troubling aspect about the recent liquidity crisis is that the tell-tale signs as early as first half of 2009 were completely ignored.
However, the past is past. Instead of ruing over the crisis, we should think about avoiding future liquidity crisis. What can be done? First and foremost, the NRB should improve on its duty as a monitor of the financial market. Simply granting licenses to open new banks is not its sole duty. It needs to monitor, evaluate and investigate the BFIs for any wrongdoings. Anyone found guilty needs to be punished, not bailed out. Bailouts should happen only if absolutely necessary.
While it is true that excessive liquidity hurts the bottom line of BFIs, they should also realize that having too little may put them out of business. The NRB cannot come to the rescue of every single bank that goes bankrupt. It has its own criteria and limits. Therefore, BFIs should have enough short-term liquid assets at their disposal. They can use such assets to ease the liquidity crunch if one presents itself in the coming future.
Also, the proverbial “don’t put all your eggs in the same basket” saying applies to our BFIs as well. Nepali real estate sector received as high as 70 percent of all loans made by our banks. Therefore, the recent liquidity crisis occurred due to our BFI’s inability to recoup their loans from this sector. Diversifying the portfolio of investments can save them if one of our economic sectors suffers a crisis. The losses can always be recouped from other stronger sectors if the portfolio is diverse. Until our BFIs learn this lesson, there is always another liquidity crisis looming.
The writer is an economist
mukhanal@gmail.com
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