BANKING IN THE TIME OF COVID-19

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BANKING IN THE TIME OF COVID-19

After staying relatively aloof from political and economic crises over the years, banks now find themselves surrounded by several problems in the wake of the global health emergency.

--BY MUKUL HUMAGAIN AND SANJEEV SHARMA

"I have been in the banking sector for last 30 years. But never before have I seen the commercial banks' income and profit declined like in the last fiscal year," says Bhuvan Kumar Dahal, president of Nepal Bankers’ Association (NBA).  Dahal, who is also the CEO of Sanima Bank Limited, was referring to the sharp decline in profits of commercial banks as seen in their unaudited financial statements of the fourth quarter of FY2019/20.

The four-month-long nationwide lockdown imposed by the government to contain the spread of cronavirus from late March to mid-July of this year and its subsequent impacts on the economic activities has put a dent on earnings of banks and financial institutions. Of the 27 commercial banks, only five banks have reported increase in profit in the last fiscal year with all major banks reporting slump in their earnings as a result of the economic slowdown hitting their income sources.

The challenges for banks have exacerbated in the current fiscal year as restrictions over movement of people and economic activities have frequented with the rise in Covid-19 infections throughout the country. “Of late, major income sources of banks such as interest income, LC income, forex income, guarantee income, card income have slowed down and there is less letter of credit (LC) issuance as well as less outward remittance,” says Dahal.  

With the business prospects in the country diminishing due to the pandemic-induced uncertainty, the demand for new loans has declined sharply and liquidity in the banking system keeps on piling creating a big challenge for banks. Similarly, the non-repayment of loans is causing an increase in non-performing asset (NPA), an area banks were in comfort zone till a couple of months ago, signaling more turbulence ahead.

Bankers admit the Covid-19 pandemic is the major challenge that the Nepali banking sector has faced in recent times. “Banks are facing several challenges at the moment. Cash flow of banks and businesses has not been as expected even with the start of the new fiscal year,” says Sunil KC, CEO of NMB Bank Limited, adding, “We hope that the current crisis will subside and business activities will resume in the coming days, but it cannot be said when the situation would normalise.”

Dealing with Declining Profit
For years, the image of Nepali banks has been high profit earning entities weathering political and economic turbulences. The time has become different now as bankers are forced to face a grim reality created by the global health emergency. “Presently, we are not looking to earn any profit. Our current focuses are to maintain stability of balance sheet and to sustain the current crisis,” expresses Anil Keshary Shah, CEO of Nabil Bank Limited.

The total profit of commercial banks dipped to 13.79 percent in FY2019/20 from 25.10 percent in FY2018/19. According to NMB Bank CEO KC, profit of banks for the current fiscal year depends on how lives of people and business activities will return to normalcy.

In the meantime, the situation is looking more difficult for development banks. “The average profit of development banks in the last fiscal year was just 7 percent with several banks registering negative profit growth,” informs Govinda Prasad Dhakal, president of Development Bankers’ Association and CEO of Garima Bikas Bank Limited.

The already stressed banking sector has come under further pressure due to the prohibitory orders enforced in over half of the 77 districts of the country since the third week of August. Economic activities in the country's major business centres including Kathmandu valley have almost come to a grinding halt due to latest restrictions.

“The silver lining amid this crisis is that banks were still in profit last year. But, given the pandemic-induced uncertainty, the current fiscal year remains critical for the banking sector,” thinks NBA President Dahal. According to him, the scale of the impact of the pandemic in the banking sector can be gauged by the fact that due amount in interest payment of banks has increased to Rs 51 billion by mid-July 2020 which was Rs 11 billion in mid-July 2019. “It means banks' due interest payment amount expanded by Rs 40 billion in last one year. This has happened because of the adverse impact of Covid-19 and anticipation of the borrowers that central bank would offer some type of relaxation,” says Dahal, adding, “Even those who're in position to pay the installment, interest and principal amounts did not pay their dues.” According to him, the interest spread has been narrowed from an earlier 4.5 percent to 4.4 percent with conservative formula from bankers’ perspective. “This will drastically reduce the interest income of banks by 20-25 percent. Of late, some barriers have erected in fee-income which will further erode their income,” mentions Dahal.

The Flood of Excess Liquidity
As an impact of the suppressed consumer spending and dramatic decline in demand of loans due to the Covid-19 pandemic, the Nepali banking system is currently awash with investment-grade liquidity with deposits breaking previous records. Currently, the banking system has accumulated Rs 200 billion in excess liquidity. The sharp increase in liquidity has been attributed to growing savings and remittance income coupled with the lack of investment demand. “At present, the banking system is dealing with the problem of excess liquidity and lack of investment demand,” says Dr Gunakhar Bhatta, spokesperson of Nepal Rastra Bank (NRB). He is hopeful that the demand will rise when the Covid-19 crisis starts to subside. According to bankers, the demand of new loans was declining even before March when the outbreak of coronavirus became a full-blown crisis the world over.

With the government formally lifting the lockdown in July, lending of banks began to improve with the beginning of the new fiscal year (mid-July) indicating that the country’s derailed economy is slowly getting back on track. According to data provided by Nepal Bankers’ Association, the total credit flow of commercial banks grew by Rs 11 billion to Rs 2,878 billion during mid-July to mid-August which was Rs 2,867 billion earlier. Similarly, their deposits during the period grew by Rs 23 billion to Rs 3,479 billion from Rs 3,344 earlier. As the country’s economic engine slowly began to gather steam with the easing of restrictions, banks started introducing a number of loan schemes at cheap interest rates for personal and commercial purposes to attract potential borrowers. Also, the central bank directed commercial banks to provide additional 10 percent loans to the clients affected by Covid-19 crisis. But the hopes of improvement of bankers got dashed after the enforcement of prohibitory orders crippling economic activities in over half of the country.

Interest Rate Plunge and Anomalies
The excess liquidity situation in the banking system at present is a sharp contrast to some two-and-a-half years ago when banks were reeling with an acute shortage of investible funds. The oversupply of money has plunged bank interest rate to a four-year low.  Since the eruption of Covid-19 crisis, has been a continuous decrease in interest rates of both deposits and loans in the last six months.

As of mid-July, the average deposit interest rate of commercial banks stands at 6.1 percent which was 6.15 percent in 2017. Similarly, average interest rate on credit has also come down to a four-year low at 10.11. Same is with the average base rate of commercial banks which has hit multi-year low of 8.50 percent.

The excess of liquidity has started to cause several anomalies in the system which bankers have tried to avoid for over the past one-and-a-half year. The decision to abolish the so-called ‘gentlemen agreement’, which was implemented in December 2018 amid the liquidity crunch to maintain interest rate stability, by Nepal Bankers’ Association members on July 13 has opened doors for unhealthy competition among banks.

With the interest rate stability gone, banks are seen taking aggressive moves to compete in order to expand their credit portfolio. Industry insiders say that the abrupt halt in the flow of credit has given to several anomalies in the banking sector. A banker said that banks are engaged in poaching of each other’s debtors. “Existing borrowers of a bank are being poached by another bank by offering loans at interest rates on-par or even lower than the base rate. Banks with lower base rates are poaching debtors of banks that have higher base rates,” he mentions requesting anonymity. According to him, this is a violation of central bank’s direction not to provide loans lower than base rate. As per the existing arrangement of NRB, banks are required to loan money to borrowers after adding premium to their base rates. “There will be more problems in the banking system if this anomaly is not checked soon,” warns the banker.

NPA Concerns
The rising NPA level is another major area of concern. NPA of commercial banks rose to 1.74 percent in mid-July from 1.44 percent prior to the lockdown. The increase is primarily due to the new classification of loans and rescheduling of debt repayment. During the lockdown, NRB directed banks to defer installment and interest payments of loans till mid-July. “The increase in NPAs as seen in the last fiscal year’s financial reports of banks is because of non-payment of interest and installment of principal amount by borrowers. In that period many of our borrowers, who are in position to pay their debts, did not clear their dues,” says Nabil Bank CEO Shah, adding, “However, we have not classified such loans as ‘inactive credit’.”

As per the new loan classification norms as mentioned in the Monetary Policy for FY2020/21, a credit which had remained good until mid-January 2020 could be counted as good credit till mid-July. And, even if an installment is not paid by mid-April, banks can make provisioning of just 5 percent of such loans which otherwise had to be 25 percent. Bankers see increasing NPA as one of the major areas of concern as this could damage the financial health of banks. “As a bank CEO, my major worry for now is the management of bad loans which I think is the case with other CEOs as well,” expresses NBA president Dahal. According to him, NPA of almost all sectors including hotel, transport and education has increased due to the Covid-19 pandemic and sluggish economic activities. “Hence, this year is the time for banks to manage their books smartly,” he cautions.

NMB Bank CEO KC agrees with Dahal. “Currently, we need to focus on recovery of loans rather than investing in new sectors,” he says.

Reduced Dividend Distribution Capacity
Compared to investors in other companies, shareholders of banks for years have profited from higher dividend distribution. But now the prospects have become grim as banks face uphill challenges to maintain their balance sheets. There is an erosion in capacity of commercial banks to distribute dividends to their shareholders. The unaudited financial statements of the fourth quarter of FY2019/20 have shown that 26 commercial banks may distribute a dividend of 11.14 per cent on average. This is approximately 7.75 percent less than in FY2018/19 when the rate averaged 18.92 percent.

Nabil Bank has the highest potential dividend rate at 30.13 percent; the bank has a distributable profit of 3.4 billion for the last fiscal year. This rate of the bank was 35.34 percent in the previous fiscal year. Everest Bank has the potential to distribute 19.66 percent in dividend from the profit of the last fiscal year followed by Nepal Bank at 19.59 percent. Likewise, the rate stands at 18.92 percent for Standard Chartered Bank Nepal, 14.83 percent for NIC Asia Bank, 13.97 percent for Himalayan Bank, 12.72 percent for Sanima Bank, around 11 percent each for Prime Commercial, Laxmi, and Nepal SBI, 11.50 percent for Rastriya Banijya Bank, around 10 percent each for Machhapuchhre Bank, Prabhu Bank, Bank of Kathmandu and NMB Bank, and 9.13 percent for Global IME. At 3.15 percent, the dividend distribution potential of Civil Bank isat the lowest among class ‘A’ banks’; the bank has distributable profit of Rs 252.1 million.

“We had already expected a decline in distributable profit as our business slumped massively in the fourth quarter of the last fiscal year,” says NBA president Dahal. According to him, the condition deteriorated even after the exemption provided by NRB on loan classification and loan-loss management. “However, the situation for banks would have been much worse with the exemptions,” comments Dahal.  “In the past, there used to be hue and cry over the earnings of banks. Now people must know that banks also face reduction in income and distributable profits due to the economic shocks,” he adds.

NMB Bank CEO KC thinks the dividend distribution capacity of banks at present is reasonable. According to him, profits and distributable profits of banks decreased because they made provisioning of loans more than what was required by the central bank. CEO of Prabhu Bank Ashok Sherchan says that the loan repayment concessions provided to debtors have played a major role in the decline in interest income of banks ultimately reducing their profits and dividends.

Withstanding the Shock
With banks facing several headwinds at once due to the demand and supply side shocks created by the pandemic, there are concerns among banking sector stakeholders about the financial health of banks. As banks are considered ‘too big to fail’ entities, the concerns are legitimate as failure of even one commercial bank or a major development bank can spell catastrophe for the country’s overall financial system.

Nevertheless, bankers say that banks are able to withstand the current shocks. According to NBA President Dahal, strong capital base of banks enables them to face the crisis. The capital adequacy ratio (CAR), a measure of available capital expressed as a percentage of risk-weighted credit exposures, of commercial banks currently is in the range of 12-20 percent against the requirement of minimum 8.5 percent. “Given that banks are already under stress from the start of the current fiscal year, we may see some of the banks going into loss this year,” he says, adding, “Even if such a situation arrives, depositors need not to worry about their deposits. This is basically because banks are in a comfortable position in terms of maintaining capital adequacy ratio (CAR).”

According to data provided by NBA, the net worth of commercial banks stands at around Rs 480 billion and they have also maintained around Rs 60 billion for loan-loss provision. The estimated capital fund of the commercial banks currently is around Rs 600 billion with total loans of around Rs 3,000 billion. “And even if 20 percent of such loans, or Rs 600 billion, turns into bad debt, banks have the capacity to withstand that shock. Moreover, banks take collateral while providing loans. As of now, commercial banks have the capacity to absorb the Rs 600 billion loss and depositors' money will still be safe,” informs Dahal.

Despite this, bankers caution that the coming days can be more difficult as the recession is likely to deepen adding to the difficulties of banks. They ask the central bank to carefully make moves in terms relaxing credit and other arrangements so as to avoid big troubles in the future. “Given the scale of the impact of the pandemic, the central bank has the authority to be accommodative and relax the provisions. But such relaxations should not be in place for any extended period as it will affect the health of banks,” concludes Dahal.

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