Through its monetary policy for the current fiscal year [2021/22], Nepal Rastra Bank (NRB) announced that it would ditch credit-to-core capital (CCD) ratio regime and embrace credit-to-deposit (CD) ratio. The central bank later rolled out various provisions along with the CD ratio requirement in its circular to bank and financial institutions.

The central bank’s decision to repeal the CCD ratio that was capping the overall credit risk and acting as the nominal anchor of financial stability comes in line with the demand of bankers.

However, bankers now do not seem happy with NRB’s new plan.

While they say that there was a need for a departure from the CCD ratio requirement, the central bank’s decision to replace it with the CD ratio defeats the very purpose of removing the existing provision on prudential lending limits.

Introduced in 2009/10, CCD ratio, the liquidity ratio, served Nepal well and helped the central bank maintain financial stability. The CCD ratio was often blamed for the shortage of lendable funds in the banking system.

Bank and financial institutions (BFIs) were required to maintain an 85 percent CCD ratio which means their outstanding credit should not exceed 85 percent of their core capital and total deposits. Under the new rule as announced through the monetary policy for the current fiscal year, the situation of liquidity in the financial system will be governed by the CD ratio whereby a banking institution’s credit capacity will be limited to 90 percent of its deposits plus some other funds such as borrowings from abroad and money received from NRB under refinancing.

While this shift gives an impression that a bank will have a leeway to extend more loans, the new ratio will further curtail the lending capacity and lead to a spike in interest rates, argue some bank executives. But, others as well as NRB officials say that the switch to CD ratio will rather help BFIs in maintaining liquidity in the coming months. They say that the CCD ratio was increased to 85 percent in the last fiscal year only as a temporary relaxation during the pandemic and a return to the previous limit of 80 percent would have strained banks who have already crossed (or are close to) that level.

Stating that Nepal was the only country where CCD ratio requirement was in place, NRB Governor Maha Prasad Adhikari says that the central bank’s decision to switch to the new liquidity ratio indicator is in line with international best practices.

According to Adhikari, it would not make a huge difference in terms of liquidity position of the overall banking sector due to the shift to the CD ratio. As refinancing funds as well as foreign currency borrowing are allowed to be included in the deposit portion rather than pure deposits only, the CD ratio will make it easier for BFIs to mobilise their resources, NRB officials say.

While bankers and NRB officials are divided over the reasons, they agree on the possibility of higher interest rates in the current fiscal year.

The gradual return to normality from the pandemic in the days to come is expected to drive up interest rates. As economic activities gain momentum along with the vaccination drive, there will be a surge in the demand for loans. When the Covid-19 threat starts to fade, many businesses will start new projects while those who have kept on hold any expansion plan will also implement it. This will accelerate the demand for bank loans.

But there is not a possibility of deposits going up significantly immediately in line with the growth in bank loans. There are already indications that the interest rate will rise in the current fiscal year. Interbank interest rates are already on an upward trend. Concerned with the possibility of a liquidity crunch, BFIs are already increasing the interest on deposits to remain on the safe side.

Analysts say that the central bank’s monetary policy did not take adequate measures to prevent the interest rates from rising which could hurt businesses which are already suffering from the impact of Covid-19.

More Incentives for M&A
The central bank gave continuity to its policy to encourage mergers and acquisitions (M&A) in the banking industry. BFIs (except the category B and C) have been offered various incentives and facilities to do this.

In addition to various incentives that that are already there for BFIs that go for merger, the central bank introduced new regulatory relaxations for those who complete their M&A within the current fiscal year. They include extensions to the deadline to meet the directed sector lending requirement by one year, a 0.5 percentage point waiver on cash reserve ratio requirements and one percentage point on statutory liquidity ratio requirement for one year and five percentage points higher limit on deposits per institution.

Similarly, the cooling-off period has been extended by six months for board directors and senior management staff of BFIs that go for M&A in the current fiscal year. If the CD ratio is breached during the integrated operation, the merged entity will get one year to bring the ratio to the regulatory level.

Amid growing competition and rising operational costs, BFIs in recent years have opted to undergo M&A largely for their own business interests to become bigger or due to market pressure. Whether the central bank’s incentives and facilities will accelerate the amalgamation process and yield the desired results is yet to be seen.

According to the NRB, 220 BFIs have undergone M&A as of mid-June 2021. Out of which, the licences of 166 BFIs were revoked thereby forming 54 BFIs.

Though there were expectations that NRB would pursue a carrot and stick approach for M&A, the central bank has so far shied away from taking a tougher stance on bank consolidation. The pandemic is also said to have made the central bank reconsider its earlier plans to push for forceful mergers in the banking industry.

Bankers, however, call for more incentives and facilities for mergers and acquisitions. They say that the government should introduce more incentives including a waiver on corporate income tax for BFIs to encourage them to undergo an M&A through the fiscal policy.

Relief for Covid-affected Sectors
Like in the last fiscal year, the central bank has announced various relief measures for businesses and borrowers hit by Covid-19. Borrowers hit by Covid-19 containment measures will be eligible for a repayment deferral until mid-January next year.

The central bank has decided to suspend repayment for restaurants, party palaces, public transportation, educational institutions and leisure centres, among other highly affected sectors, for one year without any penal interest.

The central bank has prohibited BFIs from initiating or publishing notices on loan recovery or auctions for businesses, industries or other professions in those areas that are under prohibitory orders. BFIs have been allowed to lower the loan repayment installment and extend the maturity period for borrowers whose cash flow has been hit by the pandemic.

Similarly, the central bank has also paved the way for BFIs to allow entrepreneurs to change business models or business ideas and utilise loans based on the proposals of borrowers or assessments based on Covid-19’s impact. This flexibility is expected to provide some relief for entrepreneurs who want to utilise bank loans for different business purposes due to the impact of Covid-19.

NRB officials say that giving continuity to the refinancing facility, business continuity loans and other concessional loans in the current fiscal year would also help businesses and borrowers affected by the pandemic to remain afloat during this unprecedented crisis.

Major Highlights of the Monetary Policy:
1. Inflation target at 6.5 percent; Private sector credit projected to expand by 19 percent
2. CCD ratio requirement of 85 percent scrapped to adopt 90 percent CD ratio requirement
3. Continuity of support for borrowers hit by the pandemic including refinance facility, business continuity loan, rescheduling and restructuring of loans
4. Limit on loans against share pledges—Rs 40 million from one bank or financial institution and Rs 120 million in total
5. Rs 1.5 million business loans under deprived sector for those people who lost jobs in tourism due to Covid-19
6. BFIs not allowed to charge more than 2 percent premium on base rate for business loans below Rs 10 million
7. Feasibility study will be carried out on central bank digital currency
8. Digital lending framework will be formulated to facilitate BFIs for online lending services
9. Deferral of implementation of Counter Cyclical Buffer measures until mid-July next year
10. Base Rate formula to be revised