Ratnaraj Bajracharya is the Chief Executive Officer of Global IME Bank Ltd.  Madan Lamsal, the Editor-in-Chief of New Business Age, recently talked to the seasoned banker on the lack of liquidity in the financial system and other issues related to the Nepali banking industry. Excerpts:

The banking system has lacked liquidity for a long time. How long will this situation last and what do you think is the solution?
 There is always a lack of liquidity in a developing country like Nepal. This is because we are not in a position to meet the required capital. At present, branches of banks have reached all 753 local units as per the government policy. Due to this, the demand for loans coming through formal channels has also increased. Global IME Bank has 288 branches. We give not only big loans but also small loans up to Rs 50,000. This means that the demand for loans from the informal sector has shifted to the formal sector.

There was an uproar when the NRB increased the capital of banks from Rs 2 billion to Rs 8 billion. That was because banks were worried about whether their businesses would grow as per the capital. However, the banks did not lack business. Today, there is no bank with a capital of less than Rs 10 billion. Similarly, no bank does less than Rs 100 billion in business.

Economic activity stalled for two years due to the COVID-19 pandemic. Business activities declined across the country. Liquidity in the banking system increased at that time as people were saving more and spending less. As the impact of COVID-19 subsided, banks started investing aggressively. We saw how imports increased during the period.

Developing countries need more liquidity. In that sense, the problem of lack of liquidity cannot be solved quickly. The government has not been able to spend the money it has. Money has piled up in the government coffers. The NRB has government money of about Rs 333 billion. Money is not flowing into the market.

So what is the solution to the problem?
In the budget for the coming fiscal year, Minister for Finance Janardan Sharma has set an economic growth target of 8%. However, he did not say how much investment is needed for that. The governor has said Rs 800 billion might need to be spent to meet that target. In the current fiscal year too, we have set a target of increasing credit expansion by 19% to meet the growth target of 7.5%. That is also around Rs 800 billion. Banks need a capital of Rs 1,000 billion to disburse around Rs 800 billion in loans. There should be a discussion on how the banks will mobilise funds. Revenue targets are set on this basis. If we don’t have money, how will we arrange a source for Rs 800 billion? There should be clear guidelines. We are saving about 9-10% of GDP at present, which is about Rs 400 billion. Thus, there is still a gap of Rs 400-500 billion. You just can’t tell banks to bring foreign currency loans. There should be necessary facilitation. There is a need to launch a national-level campaign to increase deposits in banks.

Banks were lending aggressively lately. There is an analysis that credit flow towards imports and consumption could not contribute much to the economy. What do you say?
This analysis is a bit immature as our credit growth rate is only 13-14% which is a bit higher compared to the first quarter. A bank always thinks about maximising earnings by investing the capital it has. The bank credit may have gone to the stock market, housing, or real estate sectors. Looking at imports, it may have gone to procure iron, billets, LP gas and petroleum products, and food grains. As soon as economic activity started to increase after COVID subsided, people became aggressive in expanding their businesses. They also imported more than they needed to make up for past losses.

 Maybe banks didn’t study which loans were necessary and which were not. So far, we have failed to analyse where the bank loans are actually going. Also, it is not clear which sectors are considered productive and which sectors are unproductive. Banks will continue to invest as long as there is demand in the market.  The biggest attraction for commercial banks around the world is collateral lending. Then there is the hire purchase. This is because banks think a person who can buy a house or a car can pay the EMI of the bank well. Our irony is that we take short-term deposits and are expected to invest in hydropower projects for the next 15 years.

 We do not have specialised institutions to invest in any sector. Therefore, if hydropower, agricultural products, or any other sector is in need of credit, commercial banks are instructed to give them loans. Because only commercial banks have the capacity. Banks will have to meet whatever demand there is in the market. If only loans to manufacturing companies are considered productive sectors, the demand is only Rs 700-800 billion. Therefore, the demand from industries has to increase.

Banks and financial institutions are directed to end about half of the total loans to hydropower, agriculture, and SME loans. Why are these sectors not developed yet?
I think the modality of our economic development can be questioned. If we look at agriculture, we also need loans to cultivate one kattha of land. Commercial agriculture has not increased. When banks extend small loans to such farmers, it is like we are giving some relief to those who were earlier taking money from the informal sector. Microfinance companies are doing the same. As our land is fragmented, so is the demand. Banks have only displaced the village lenders.

Now it is the time to promote commercial agriculture through land pooling. Technology can be used which increases production. Banks finance such projects from the very beginning. Farmers had to hurry to pay the money of village lenders right after the harvest. Because of this, they had to accept whatever price was offered. However, banks offer three months of storage time. It also gives credit for building warehouses. If the price of products increases by say 20-25% in three months, farmers will make a profit even after setting aside 3% interest on loans and 2% for warehouse expenses.

I talked to a big businessman about working on this model of storing agro prduce. But the businessman said it would be troublesome to bring 100 farmers together.

On the other hand, we are not studying statistics correctly. Economic activity has increased after we ensured access to finance for unbanked people. Even cement and pharmaceutical companies were not regarded as productive sectors in the past. There is no clear definition of what a product is. Another thing is that bank loans alone will not develop the industry. Even if we make a credit guideline for development of a specific industry, other policies will not help. Why would one open an industry when s/he has a profit margin of 15-20% by hiring just five people and running a trade? Where is the policy to encourage businesspeople to open industries? The state should say you will get certain facilities if you open an industry.

 Even though interest rates have to be managed by the market, there are allegations that the banks have been promoting a cartel by forging ‘gentleman’s agreement’?
 There are four risks involved in operating a bank. These include credit risk, foreign exchange risk, operating risk, and market risk. Market risk includes fluctuations in interest rates. If the interest rate on loans goes down by 2-4%, it affects the balance sheet and stability of the bank because banks have promised a certain rate to depositors. Institutional depositors are the big players in the deposit market. When banks are flush with money, they request banks to take the money. But when there is a lack of liquidity, they start to bargain on interest rates. We are not dissatisfied just because they are negotiating for a higher interest rate. The Nepal Rastra Bank has said bank's institutional deposits cannot be more than 50% of total deposits. The rule was introduced to ensure some stability. If the market conditions become tight when an institutional deposit is maturing, there is a risk of a bank losing deposits if it cannot match the interest rate of the market. That will have a huge impact on the bank’s resources. The interest rate went out of control as banks tried to retain such deposits. If it were not for the gentleman's agreement, the interest rate on fixed deposits would have reached 15%. It would have left the entire economy panicked.

 It is okay to pay more interest than not getting money, right?
It also has to be sustainable. The customer must also have the ability to pay. If the interest rate of a 15-year home loan increases from 8 to 12%, the customer will be in trouble because his/her income isn’t rising. Elsewhere in the world, an interest rate hike of 1% would leave everyone panicked. Sometimes I feel we are doing immature banking.

What is the reason for banks not being able to get loans from abroad?
A foreign lender may make loan financing to banks here on the basis of trust and goodwill. But as Nepal doesn’t have a credit rating, there is a lack of trust. Lenders do our DDA which takes about six to eight months. As the NRB has said that banks can borrow from foreign banks at interest rates by adding upto 4% on LIBOR  rate, foreign lenders will also try to fix maximum rates. Hedging increases the cost by 5.5%. The total interest would be around 9-10%. How much interest can we charge on consumers? This is a big problem. The central bank neither has the resources to bear the hedging costs nor the provision.

The bad loans of Nepali banks are the lowest in South Asia. Some say the banks are hiding bad loans. What is the reality?
It all depends on how you calculate. The method of calculation is different in Nepal and the rest of the world. Here we divide loans into four categories and prepare a watchlist every month. We classify a loan as a bad loan only when a customer fails to pay three instalments. In India, bad loans are about 9-10%. In most countries in the world, it is only around 2%. One of the reasons why we don’t have high bad loans is that we don’t have exposure to project loans. Customers can borrow from one bank to pay instalments at other banks. As our businesspeople are more into trading, they borrow to make imports, and clear the loans once they send goods to the market. No industry is on the verge of collapse. Why would there be a bad loan? Most small and medium loans are collateralised loans. Customers are worried that banks will publish their names in the media and auction the collateral if they  do not repay the loan on time. Because of this fear, they are doing debt servicing on time.

 Banks have high credit exposure to hotels. More money has flowed to the sector as instructed by the central bank because of the COVID pandemic. In other countries, governments provided relief to protect the sectors affected by the pandemic. Here, only the banks provided some relief. Therefore, instead of saying bad loans increased or decreased, banks should be thanked first. As per the timeframe provided by the central bank, banks will have to pay instalments from coming September. But since the tourism season begins in September only, banks will find it difficult to collect the instalments. There may be some difficulties at that time.

Society has started thinking that banks are only friends in good times. How true is it?
Banks have a way of doing business. They raise money by promising interest to depositors. They also need to provide a return to the investors. For this, they need to collect interest from debtors. Debtors may not feel the need to repay loans until they are pressured.

Today, people are seeking relief from the high interest rates of microfinance institutions too. Struggle committees have been formed. The government also waived off certain farm loans in the past. Only a few people, who seek loan waivers, say banks are creating difficulties.

Covid has affected all sectors. However, it is argued that only banks make a profit. What do you say?
Everyone sees profits in billions. One must see how much can be earned by handling hundreds of billions of rupees. Similarly, one must consider what is left after paying income tax, employee bonuses, and dividends. Banks can’t survive if they can't make a profit of even 10%. Is any other business in loss? People are talking about us because we are transparent and make public our financial results. The return that investors are getting is declining.

Why do  you think big mergers are not happening despite the central bank’s push?
We are doing it. Through mergers, we have become the biggest bank in the country. What we have to look at is, an individual is involved with a bank for a long time. When the bank pursues a merger, s/he will naturally think about what his/her position will be after the merger. Likewise, it is also about the concern over the safety of billions of rupees.  Had the central bank allowed banks to have nine members in the board instead of seven after the merger, it could have increased the confidence of the promoters.

Remittance growth has slowed. What do you think are the reasons?
The decline in remittances is mainly due to the growth of the informal sector. Remittance growth slowed due to the tendency of under-invoicing imported goods at customs and sending the remaining balance through informal channels. To control this, let’s evaluate the goods at the customs point based on their price in the international market. Let’s reduce customs duty if needed. This way, we can reduce the flow of money toward informal channels to some extent. Similarly, we can also see whether young people in overseas destinations abroad are sending their earnings home.

Today, we have to show our income source while depositing more than one million rupees in banks. Informal channels like hundi can be controlled if financial information units in foreign countries become as strict as us. If only $50 is entering the country while exporting goods worth $100, agencies like the Department of Money Laundering Investigation must investigate through which channel the remaining money is coming. This will also make some corrections.
It is, however, difficult to break the nexus of hundi operators because they provide quick service at people's doorsteps and charge lower rates.People have easy access to them.

The central bank is also criticised for micromanaging. How do you analyse the role of NRB?
We have also created an environment for the NRB intervention. If the interest rate cap is removed, we will soon raise it to 15%. In some cases, we ourselves reach out to the central bank to complain about other banks. Banking is the backbone of the economy. Banking is very transparent. We do not see corporate governance in other areas. Its good practices can be replicated in other areas. If we cannot increase people’s confidence in banking, let’s not decrease it. Because as long as there is confidence in the banking sector, the country will survive.

Whatever policy or directions the central bank brings, those are necessary to sustain the banking industry. Sometimes, we lack self-discipline. We raise interest rates. If NRB does something, somebody can term it micromanagement. But, I think it is necessary because of our own deeds. NRB’s decisions ensure financial stability.

(You can visit Youtube.com/c/NewBusinessAgeNepal for a detailed interview.)