‘‘CEOs of banks are under pressure when promoters ask for 40-50 per cent return on their investments

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Dr Yuba Raj Khatiwada, the Governor of Nepal Rastra Bank (NRB) is set to retire on 23rd March completing his five-year term. He is admired for saving the Nepali banking sector from a 'systematic failure.' However, he is also criticised for micro-managing the banking sector. In an interview with Janardan Baral of New Business Age, Dr Khatiwada talked about a number of issues including the monetary and fiscal policies, reasons behind the rising inflation, need for merger in the banking industry, initiatives taken by the central bank to manage the real estate and housing sector, among other issues. Excerpts:
Every central bank aims to keep the inflation rate low. However, Nepal saw a persistently high inflation rate during your term. What do you say?
Two or three things are very important for a central bank: maintaining adequate forex reserve and taming the inflation rate. Nepal Rastra Bank (NRB) has been successful in strengthening the forex reserve and the return from such forex reserves have been higher than expected. As a result, NRB's profit surged five-fold. However, we could not tame the persistently high consumer prices. The inflation rate remained in single-digit but it was towards the higher end. There was high pressure from the rising prices of agricultural products and this still continues. We say, let's increase lending to the 'productive' sectors and increase the supply of agricultural products to control the prices of those products instead of tightening the money supply. As the investment in productive sectors is increasing, we can hope that in the coming days the rise in production of agricultural goods would lower the food prices, ultimately lowering inflation. 
The first six months of the current fiscal year saw a lower inflation rate? Can this be treated as a trend?
One reason for this is the higher base prices of the last year. Secondly, the fall in oil prices this year has also helped check the inflation of non-food commodities. Similarly, due to the import of rice from India and lower transportation cost due to lower oil prices, prices have come down also in food items. This, however, is not a long-term trend because our per capita disposable income is rising by 15 per cent annually, whereas, production is increasing by just around five per cent. However, the production of commodities which have higher demand such as vegetables, fruits, dairy products and meat has not grown even at this rate. It is possible to control the prices of these items by increasing their production through the support from the banking sector.  
That means our inflation is not controllable by the monetary policy?
Yes, that is why I have been talking about controlling the prices through the credit policy. Credit policy is another aspect of the monetary policy. Though money supply does not increase without growth in credit, our effort should be to control inflation not by tightening the money supply, but through credit management so as to increase the production of commodities of which the prices are increasing. For that, we need to fine-tune the monetary policy a little. Policies such as quantitative easing or tightening won't work in our context as it does as in the advanced economies. Our market is different from theirs. Our consumption basket contains such very essential items, whose demand cannot be reduced. So controlling inflation through the demand side is difficult in our case. Instead, we need to control the inflation through the supply side. For that, the monetary and credit policies are required to be driven forward together to balance the supply and demand and we have been doing just that. 
NRB's policies are blamed for hindering the growth of once emerging sectors such as real estate and stock market. What do you say?
In the real estate sector, the normal transactions are in increasing trend. We cannot say the real estate business has grown if there is growth in buying and selling of only paper receipts of money paid as advance for a land deal. We have found that a real estate trader did three-way financing to run his business. Similarly, banks were also seen investing 80-90 per cent of their sources in the housing and real estate business. It is not unusual for these people to blame the NRB. They were not real bankers at all. They were real estate and housing businessmen who operated their businesses by obtaining banking license from the NRB. I think Nepali real estate business has just started to be orderly. We still need to take certain steps in the real estate and housing sector. First, formulation and implementation of land planning is necessary to allow real estate businesses only in locations suitable for it. Secondly, individual brokers need to be discouraged and registered property dealers should be made mandatory in real estate deals. Third, the relationship between real estate businessmen, banks and land revenue offices should be well regulated. We should not rejoice at the increased state revenue when the same plot of land is sold and purchased three times within a day. 
You carried a merger drive for BFIs during your tenure. But the 2014 Nobel laureate in Economics Jean Tirole has warned that mergers would create monopoly. What is your comment?
Professor Tirole is right. Large multinational companies are very few in every sector. Telecom and airline giants are very few. Merger between Boeing and Airbus would create a monopoly. We have clearly stated in the policy that we are alert to the possibility of monopolistic trend due to mergers. We have not said that our target is to reduce the number of banks to five through the mergers. We have only asked the banks and financial institutions operated by the same business group to merge. We estimated that due to mergers the number of commercial banks will come down to 25, and perhaps that will happen. Therefore, I don’t think mergers will bring about monopoly in the Nepali banking sector. 
Until sometime ago, bankers were blamed for practicing cartel in interest rates. Do you see this still happening? 
I see a very slim chance of banks going for cartel in the interest rate. It’s not that there haven’t been attempts of collusion in the past to make NRB's policies futile. For example, banks tried this on the interest rate of Treasury Bills. But we foiled these attempts. The competition is so high that there is no possibility of banks practicing cartel in interest rates. We felt that the banks were in collusion in fixing the service charge but we have resolved even this issue now. 
There was a time when you compared certain banks with babies born with undeveloped organs. Will a marriage (merger) between such banks produce healthy offsprings?
I had said that the finance companies which became commercial banks and regional-level institutions which became national-level institutions in no time were like babies born with undeveloped organs. Institutional improvement is one of the aims of merger. Situations of capital inadequacy require investors who can inject capital; merger serves this objective. Similarly, merger provide exit to bank promoters who are not operating their institutions properly. Mergers are necessary also to improve the situation of banks which hastened to become big. 
Do you think Nepal’s banking sector truly reflects the country's economy?
No, it’s not. The 'real sector' of our economy is a small services sector. Growths of the agricultural and industrial sectors which occupy 50 per cent share of the economy are in a situation of no further growth. BFIs are focusing their investments on a few services sectors rather than agriculture and industry. They are generating profit from the services sector and are encouraging others to enter the same sector. There was unchecked distribution of licenses of BFIs in the past without evaluating the need. My predecessors distributed bank licenses arguing that it is an open market policy practice. I don't want to comment on that. I am often asked when I am abroad, 'Why are there so many financial institutions in an economy like Nepal?' We need to understand that opening up of BFIs should be need-based, not demand-based. Excessive number of BFIs has made the competition really tough. So, the BFIs were lured to earn profit by unethical practices when they failed to generate money from ethical ways. They had the compulsion to invest in bad projects. That led to distorted real estate business about which I already explained. It was banks that destroyed that emerging business. 
Why could not the Nepali banking be made to follow international best practices? They are like village money lenders focused only on interest earnings, not interested in innovation?
The banking sector is like this everywhere in the world. Globally, banks levy service charges on their clients. Banking is perhaps the only sector in the world that is always in profit. Airlines are in loss everywhere. As banks operate based on margins, they can decide the interest rates on lending and deposits depending on the likelihood of profits.  However, there has to be a limit to the profit margin. A 10, 15 or 20 per cent return on capital is normal. But, bank CEOs are under pressure when promoters ask for 40-50 per cent return on their investments. Performance of CEOs is tied to the incentives they receive. This has ultimately resulted in developing wrong trend. 
Nevertheless, we are not behind the best international banking practices. We are among the few countries in South Asia and Southeast Asia to implement the Basel II regulatory framework. We are now moving toward Basel III and International Financial Reporting Standards (IFRS). Similarly, we are about to implement the risk-based supervision system. IT-based banking system is an area which is not so much developed in Nepal. We are slowly advancing into this. Lack of awareness and education is one of the reasons for this. We are gradually making progress in receiving information in real-time and taking action in real-time.
Nepal Rastra Bank has recently issued a directive to banks to issue loans to those debtors who are now off the blacklist. Is this an issue for which the central bank needs to bring out a directive?
Not really. But there are people who were blacklisted because of various reasons such as the armed conflict. There is no reason why those who have cleared their loans and have therefore been removed from the blacklist shouldn’t get fresh loans. We have a situation where, on the one hand, notices are published in the government gazette to revive the sick industries, pardoning all their mistakes, on the other hand, people who became defaulters because of unavoidable circumstances are deprived of opportunity to do business. This isn’t fair. So, we issued this directive.
But isn’t a person automatically entitled to receive loans once s/he is off the blacklist?
We had to issue such directive as the banks refused to issue them loans. There was a widespread rumour that the NRB hadn’t issued any directive to give loans to such people. We just tried to dispel that rumour.
Normally, monetary policy and fiscal policy are taken as parallel policies and their independent status is accepted. But in our case, the monetary policy comes as a supplement to the fiscal policy. Why?
The monetary policy becomes active in situations where the fiscal policy doesn’t work. At times, even the government budget is not sure to be announced. The monetary policy became active in those times. When the government spending becomes low leading to idle funds in the government treasury, a relatively flexible monetary policy is practiced. This is the reason why we have practiced a relatively flexible monetary policy in recent years. The problem of excess liquidity in Nepal is not because of the government. Rather, government has mopped up liquidity. Therefore, we have been fine-tuning the monetary policy. When the government starts making big expenditures, the government’s deficit goes on increasing and when the fiscal policy causes excess liquidity flow into the economy, the monetary policy needs to be tightened. The complementariness of the monetary policy and the fiscal policy is seen in such situations. As the central bank is the government’s economic advisor, it should support the government policy related with economic growth. But free market economists say that the central bank has sided with the government. However, as the central bank is a part of the state, it has a role in nation-building. We have been working accordingly. The brighter side today is that the monetary policy hasn’t faced any pressure because of the fiscal policy.
Nepal’s economy is linked to India in more than one aspect. The Nepali currency is pegged to the Indian currency. In such a situation, is the monetary policy we have been practicing an independent one or a shadow of the Indian monetary policy?
There are bound to be some effects (of India's on Nepal’s monetary policy). In the context of today’s globalised world, no country can practice a solitary monetary policy. Trade is free between Nepal and India. So is foreign exchange. However, this doesn’t mean that everything in India and Nepal has to be equal. Today, the interest rate on deposits in India is 8-9 per cent; the interest rate on bonds is 7-8 per cent. But this is not the case in our country. Still, we fear of capital flight. Our markets are not that integrated. Those who deposit capital in India have to meet certain KYC norms as well. So, we don’t have a situation where Nepalis could take capital from Nepal and park it in India. We are not that integrated financially. So, one cannot say that Nepal’s monetary policy is a shadow of the Indian monetary policy. We have to fix our exchange rate based on the IC-USD rate. It is true that this arrangement has, on occasions, led to the devaluation of our currency in situations that didn’t really require such devaluation. But we can manage the effects of this arrangement. We have tools that are managing our monetary policy. When inflation in India has gone high, our inflation hasn’t gone higher than that. And when it (inflation in India) has come down, ours hasn’t come down at the same pace and in the same pattern. It means our policy, too, has an effect on our inflation. So, we shouldn’t feel helpless and say that we cannot do anything; we should be able to use the space we have got.

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