Mainly burst of asset bubble - an evil that the banks and financial institutions (BFIs) themselves created over the past half decade of low interest regime - will deal its first lethal blow to the financial institutions. Liquidity crunch will exacerbate the problem for banks, eating away their profitability and bloating non-banking assets.
Banks that managed to win Rs 620.60 billion in deposits on July 30, 2010 are reporting that their deposits still hover at Rs 620 billion at December end; meaning they have failed to lure the money from the market despite jacking up savings rate by at least 2 percentage point during the period.
Nepal Rastra Bank (NRB) says money pumped out into the market is taking much longer than the anticipated period of some three weeks to come back into the system. Even worse, a significant chunk of those withdrawals are never finding way back to the banks.
People continue to exhibit low confidence in the banking system -- thanks largely to the central bank’s weak money management that prevented people from getting hold of their own savings at their time of need before Dashain last year. Political instability; doubt over timely conclusion of the peace process and constitution drafting; and the overall confusion over the future State structure and economic policy are anticipated to drive away high-end savers. This will leave banks liquidity situation as vulnerable as ever in 2011.
In these circumstances, banks will find executing the two major NRB-pushed overhauls -- limiting real estate exposure to 10 percent from the existing 20 percent and doubling investment in productive sectors from the existing 10 percent -- a tough nut to crack.
Latest trend further reveals that the market has fast become interest sensitive. Development banks and finance companies, which are offering as much as a 3 percentage point higher returns than ‘Category A’ banks, have already taken away some Rs 4 billion of the commercial banks’ deposits over the last one month.
This will clearly mount pressure on the bank management to provide higher returns, ending the current ‘agreed’ cap of 12 percent. 2011, hence, will be heydays for depositors, but difficult for borrowers.
Mainly the country’s productive sectors, which reel under lack of innovation and competitiveness, are not expected to demand substantial credit. Fiscal and monetary policy, on the other hand, will continue to recoil consumption, forcing personal financing business to shrink.
Initial reports have made clear: demand for home loans -- one of the major retail business -- is down and will remain low in 2011, thanks to the realty market downturn and high interest rates, which is soon expected to touch 18 percent.
Auto loans and hire purchase too will drop further as the recent duty hike, which sent vehicle prices up substantially, and the rise in the interest rate to 17 percent, is already driving borrowers away.
This will force banks to revise their high growth strategy, which will be a correction of a sort from the ‘unnatural’ trend of the past. And the bursting of the asset bubble will give the industry quite a jolt early in 2011.
With realty slowdown and land prices sliding, more borrowers are likely to default on their loan repayments. This will expose over Rs 40 billion of banks and financial institutions loans in real estate (a great majority of which is suspected to be of the sub-prime kind) to grave risk.
This will mainly hit some half a dozen banks, over 20 finance companies and half a dozen development banks that have high exposure to real estate -- much above NRB’s prescription of 10 percent.
The cracks will mainly surface from finance companies, which are poorly monitored and supervised, and extend to other players, sending non-performing assets and non-banking assets soaring. Many will find their profitability seriously jeopardized, while some will turn sick.
These unprecedented challenges facing the financial sector clearly demands chief executives, board members and top managers to act more creatively and proactively. But the reality is -- rapid changes in policy, market dynamics and deepening problems have largely shattered CEOs confidence of late. NRB and the Ministry of Finance should take note of this fact while managing the sector in the New Year.
Good thing though, all these challenges will force BFIs management and promoters to go for merger and acquisition to consolidate their positions.
Financial sector reforms are also expected to get clear direction in 2011, although the government’s plan to ask Nepal Bank Limited and Rastriya Banijya Bank to sell their non-banking assets at this juncture to recapitalize them does not appear to be a prudent move.
In 2011, financial inclusion and people’s access to formal banking services too is anticipated to improve - thanks to central bank’s policy and incentives to lure BFIs to rural areas.
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