Nepal’s banking sector is currently undergoing a stress test of its own kind. The struggle that the banks are facing to pass this test has led to peculiar other problems. Also, the regulator of this sector is undergoing similar stress test. Because, if the regulator is not careful enough to help the banks pass this test, the macroeconomic repercussions may be devastating. Anyways, as a central bank, it is continuously under a stress to meet the challenge of impossible trinity - price stability, balance of payments and financing to meet government’s target for economic growth.
Banks are finding it increasingly difficult to collect enough deposits to meet the growing demand of credit. The result is rising interest rate war. The latest manifestation of this was the threat by rest of the commercial banks to boycott NIC Asia. The episode was clearly an example of interest rate cartel, but neither can the interest rate war be allowed to go uncontrolled. But who should control this – the central bank or the bankers’ association? Unfortunately, the central bank’s response to this problem was not immediate.
Obviously, at the root of this interest rate war is the shortage of loanable funds. And there are number of reasons for this. One is the failure of the government to spend money as planned and accumulated with it. Second is rising liquidity preference of businesses and the general people (due to legal restriction on cash withdrawal from banks and suspicion on the coming policies of the new government). Third is the stagnant inward remittance coupled with heavy repatriation of funds out of the country as reported by the central bank in its successive monthly reports. Fourth, the liquidity has reduced also because the bank promoters took heavy loans from each other to buy shares in their own banks to fulfill the central bank requirement of minimum capital.
In the meantime, banking institutions are also finding it difficult to strike a balance between the interests of the board directors and the principle of prudential banking. The boards are pressing the management to meet very high business targets to ensure returns commensurate with increased capital. Unwilling to bear mounting pressure and increasing intervention from the Board, CEOs are rather resigning.
There is another cause for concern in the banking industry. The amount of wealth they hold make them a tempting target for frauds. Fraudulent lending and manipulation of customer accounts to swindle fund aren’t new. And with online transactions booming in Nepal, the cyber risks are also becoming big issues.
Banking is a sensitive business and a long term one. Nepal’s banking is obviously at a critical juncture now. A small discrepancy now can send adverse ripple effects across the entire banking sector and the entire macro-economy, leaving long term impact, from which recovery may take a very long period. That is the very reason why this sector is heavily regulated in every country across the world. But the regulator too must be careful to not trespass its boundary and get bogged down in micromanaging the banks. This balancing challenge is more important stress test that the central bank itself has to pass now.