However, even before the monetary policy was made public, central bank in some sort of haste announced a few measures that would apparently appease the banking sector. It clicked. Banking community welcomed the move with a grin. As the financial year came to a close, the fear of having to produce a balance sheet either in red or with decline in profits was worrying bankers in general. Their plea then was to have some change in accounting policies that would enable them to show profits.
The arrangement that the loans for which all outstanding interest is settled at the close of the financial year could be renewed, without having to make provision for losses, will increase bank profits by the amount of provision not so made. Without this new arrangement, such loans would have been categorized as “substandard” or “doubtful” or “bad” requiring 25 to 100 percent of provisioning. Loans thus classified as “good” will only attract a provisioning of just 1 percent. Clearly, this will give a great facelift to the balance sheet.
There’s one more shift in accounting policy. Bank interest income in Nepal for quite a few years has been reported on cash basis. The recent change offers another breather to the bankers. Now, interest income for the financial year just ended could be reported even with the cash collected a month later. In the normal regime such cash collection would have been the interest income for the current year and not for the year preceding. This again will boost profits.
But, will these changes increase the chance of loans turning really good? It is doubtful. Because much of such loans are for property investments whose values may not again touch the same peak. There will be losses. The question is who will bear them: Banks or the borrowers? Central bank knows this and no less knowledgeable are the bankers. However, this problem deferral tactics is going to create another problem for the banking community. The cosmetic profits of the preceding financial year would be subject to 30 percent corporate tax. This means there will be a cash drain from the banks and financial institutions. Profits would also mean dividend payout either in cash or in stock. There will, therefore, be a further drain in cash. Stock dividend is an option for cash conservation, but that will dilute future earnings per share.
Critics may have varied opinion, but the fact of the matter is that the proposed policy mix in the monetary policy is the best that central bank could possibly think of in the current context. It is balanced, yes, just as it claims to be.
This was the time for cash conservation more than the need for showing higher profits. Had the banks been reporting profits the usual way, the tax burden for the preceding financial year would invariably have been lower. In case the loans subsequently turned good, then the tax payments could be deferred to the period when the profits really arise. Banks are feeling good, but very soon they will realize the folly. Accounting losses presumably are not always bad. On critical occasions those in fact help conserve cash.
Central bank reduced the Cash Reserve Ratio (CRR), while maintaining the Statutory Liquidity Ratio (SLR) as it is. The argument given while doing so is that the central bank wanted to see a spurt in productive sector lending. There was even mention of the amount of 4 billion rupees to be available for extending such loans. This is a myth. In fact, this will not release any further cash for the credit expansion. With SLR kept at the same old 15 percent level for commercial banks, the reduction in CRR by 0.5 percentage point would only change the composition of liquidity. The reduction in cash will have to be made up by an increase in other liquid assets so that SLR can be kept intact. Therefore, the cash so released will at best go to acquire government treasury bills. This will in no way be available for further lending. Yes, this will certainly increase the profitability of banks as liquid instruments other than pure cash normally earn some interest.
There was another demand that the banking community was making—a reduction in the bank rate. The rationale given was that such a reduction would help reduce the market interest (for loans, of course). Central bank didn’t concede this and for good reasons. With inflation expected at 7 percent, bank rate anywhere below that would mean either zero or negative real interest rate for the depositors. Keeping real interest rate positive is absolutely necessary to induce savings and rationalize ever-rising consumption. This is also necessary to keep our currency stable.
Central bank is increasingly making its open market operations robust. Two discernible changes proposed for this year are good. In order to respond to the liquidity demand of the market, the promise for increased frequency of repurchase operation is a welcome step. At the same time, inclusion of development bonds for the repurchase is a good move and this should certainly be helpful to development banks and financial institutions.
Lingering liquidity problem in the second half of last fiscal year is the fallout low interest and liquidity overhang for a longer period of time in the past when remittance flow was rising rapidly and investment opportunities were constrained. This led to excessive lending in highly leveraged property market. Lower interest on deposits also prompted people to park money in high-yielding financial instruments, bank deposits or insurance schemes, across the border.
In order not to allow this situation to recur in the future, central bank was considering the introduction of interest rate corridor mechanism. Under the proposed mechanism banks when having excess liquidity would have recourse to interest-bearing deposit facility with the central bank. This rate would constitute floor rate and the upper ceiling would be existing stand-by liquidity facility rate, which the banks can access when in need of liquidity. This mechanism would have supplemented open-market operations in liquidity management, as well. This would also ensure interest rate stability and predictability, particularly for the depositors. Interest rate stability is necessary if the rise of risky informal financial market is to be contained. Monetary policy this time missed out on this. But this can be thought of in course of the year.
The percentage of loan to deprived sector has been raised by 0.5 percentage point for each category of banks and financial institutions with commercial banks required to earmark 3.5 percent of the total loan portfolio to this sector. Central bank has made the intention clear that in the next three years, it will be raised by 0.5 percentage point each year.
The disclosure of this intention is good as this will allow banks ample time for planning. Well, there is a debate whether this is really good. The best, of course, would have been banks themselves seeing potentially good market in deprived sector. This really is, but many banks are yet to realize this. Nevertheless, in view of the need of the economy, the direction that the central bank is taking is right one.
rameshorek@gmail.com
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