Wed, May 29, 2024

‘Govt should prioritise climate, environmental risks in energy projects’

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Sunil KC

CEO, NMB Bank and President of Nepal Bankers’ Association

Nepali banks and financial institutions (BFIs) are facing the perennial challenge of loanable fund crisis that has in turn been escalating problems for borrowers due to short-term volatility of interest rates. Against this backdrop, tight financial conditions imposed in credit issuance hit almost every sector of the economy. Pushpa Raj Acharya of Business 360 caught up with Sunil KC, CEO, NMB Bank and President of Nepal Bankers’ Association to learn about how the slowdown in the economy affects BFIs and what are some of their strategies to navigate the banking sector during turbulent times. Excerpts:

Nepali banks are facing the perennial challenge of loanable fund crisis. What could be the solutions?

Moving towards a developing nation category by 2026, Nepal needs to have a greater appetite for absorbing private sector credit growth. The BFIs have already been managing deposits more than the size of the country’s GDP whereas its credit exposure is nearing the GDP size. The demand for credit is expanding as there has been a major funding gap in the growth of productive and development sectors such as energy, infra and commercialised agriculture as the country seeks to become self-reliant in these. The government must enhance investment in these sustainable sectors that in the longer term will provide more stability in the external sector. A majority of banking loans in Nepal are predominantly funded through local currency deposits. Moreover, there has been a mismatch in assets and liability as long-term loans are currently being financed by short-term sources. The BFIs must address the assets liability mismatch by diversifying the sources. Nepali banks have already started to focus on External Commercial Borrowings (ECB) and have the potential to attract more Foreign Direct Investment (FDI) as Nepal currently remains one of the least FDI receiving countries in South Asia. There should be reforms in policies and tax structure to attract more foreign investment and debts in real sectors for which the government should initiate obtaining Country Sovereign Ratings as well as introduce hedging options to safeguard against foreign currency risk. The development of Capital Market, and Private Equity and Venture Capital should be emphasised and be seen as tools for raising equity in the country, while the focus should also be on the issuance of bonds in offshore and local markets and developing FX/Commodity Derivative Market to provide a platform for enabling physical market participants to discover and hedge their price risk.

It is believed that the BFIs’ strategy to raise deposit rate has adversely affected borrowers as credit rate skyrocketed and pushed businesses into difficulties when they were already struggling with the manifold challenges caused by the pandemic followed by the impacts of Russia-Ukraine tensions?

The interest rate market in Nepal has always been volatile due to numerous market factors directly or indirectly impacting liquidity. It's true that in the past few months, deposit interest rates have been increased by the banks; however, the decision to hike the interest rates was purely based on market determinants. During 2022 only, the United States Federal Reserve raised the federal funds rate seven times in its quest to tame inflation, and some countries have interest rates as high as 75%. All central banks worldwide have been raising interest rates to combat the rising inflation and it is expected to continue even in 2023. If you reckon during the Covid period, the facilities given to the borrowers for their business survival, be it in the form of discounts in interest payment, restructuring and rescheduling facilities, waivers of penal interest in late payment of interest, additional Covid loan top-up or any other support were all provided at the expense of banks’ profits’. The banks at the time diligently executed their responsibility as corporate citizen to support the economy even when they knew that it would significantly reduce their profitability and somehow compromise their overall risk on lending portfolio. The support passed on to the borrowers by the banks played a major part in reviving the country’s economy within a year. Banks have always been compassionate towards the business community and understand that its survival depends upon the survival of business entities and the smooth functioning of the economy. The cost of acquiring deposits has increased in many countries as the impact of Russia-Ukraine war has started to hit hard the economy worldwide. However, the hike in lending rates is not unnatural and relatively more stable or significantly lesser than the interest hikes in other countries. Moreover, if we compare our lending rates before the pre Covid period to the current interest rates, we can observe that the average lending interest rates at present is only around 1.5% higher. Moreover, there are many determinants of interest rates, and the BFIs follow the Central Bank’s guidelines on determining its base rates. In today’s context, the operating cost of the banks has also been increasing and its return on investment has already decreased by over 50% in the last 10 years. Despite the adversities faced by the banking sector, it is still offering loans to Agri/SME/MSMEs at just 2% risk premium over its base rates. BFIs have been considerate about the financial burden that the hiked interest rates in lending would cause to the businesses and have been trying hard to reduce or at least maintain the deposit interest rates within the same level. As the liquidity situation seemed to be improving, the banks just a month ago decided to lower the interest rates on deposit and will continue to monitor the situation to ease pressure on everyone.

The rising level of Non-Performing Loans (NPL) shows the greater extent of credit defaults. The business community has been seeking a certain period of moratorium again until the economy revitalises. Your thoughts.

The rising level of NPL is definitely a cause of concern for the BFIs. But one thing that’s more troubling for BFIs is the struggle to service debt on a regular basis by the majority of SMEs and other businesses that were hit hard during the Covid period. However, the impact of Covid on the performance of SMEs and the degradation of assets quality were expected to continue for some years to which most of the banks had started to adopt a cautionary approach in recovery efforts. However, the NPA of Nepali banks though increasing and requires greater caution, is still the lowest amongst South Asian banks. To combat the rising NPA level, the central bank at the request of Nepal Bankers’ Association has included provisions to provide some relaxations to SMEs through its six months review of monetary policy, which is expected to normalise the situation of NPA to a large extent in coming days.

Banks are alleged to having become more ruthless regarding the problems being faced by their borrowers...

Banks are one of the driving pillars of the Nepali economy and one of the most transparent sectors of the country as it always remains within the regulatory frameworks rolled out by Nepal Rastra Bank. Being a responsible corporate citizen, banks are also accountable for the loan investments they choose for growth. As the economy is paralysed by many factors including Russia-Ukraine war, rising imports and reducing exports, fiscal imbalances, banks have additional responsibility to create a rational framework for credit growth and adopt a stringent credit risk measure. BFIs are trust-based institutions. Depositors keep deposits in banks as long-term security for their earnings. The banks mobilise the deposits from customers in the economy in the form of loans based upon trust with the borrowers and provide returns to the depositors in the form of interest thus playing a part in the circular economy. Today, banks have been providing various banking services to the people by expanding to 752 out of 753 local levels, thus supporting financial inclusion and development of the local economy as well. Furthermore, the BFIs consider the borrowers to be their business partners as it has invested at least 70% in their business. Having said that, there are sporadic voices who are protesting against the market principles and established practices with the hope that they could benefit from this situation which is not a good practice and not supportive as well for an overall revival of the economy. Any negative impact on the banking sector can disintegrate the overall economy for a long time. Also, the crisis in this sector may affect the credibility of Nepali banking in the international market. Blaming the BFIs is not a solution. Bank’s interest rates are determined by market conditions rather than other activities to influence the will of free market.

Is there room for BFIs to be flexible?

Banks have always been considerate towards the growth of the private sector and accountable towards the growth of national economy. The hike in interest rates is not only the cause of decrease in demand for credit. The adversaries on the country’s external sector due to Russia-Ukraine war and other major international events, increase in dollar rates creating an inflationary pressure amid increase in prices of consumer goods have also resulted in decrease in credit demand. In this scenario, the businesses are also sceptical about expanding their business despite the banks readiness to invest in the productive sector. Despite the rising cost of operations, banks have managed to keep the deposits interest rates steady and will reduce it when the liquidity scenario improves. This will help to reduce the lending rates in the future. Moreover, the half-yearly review of monetary policy has provisions to provide flexibility in loan repayment for SMEs which shall eventually be passed by the banks to the borrowers. Recently, the banks reduced the deposit interest rates by 1.1% which will help to bring down the cost of borrowings in the future.

The central bank has lifted the requirement of cash margin while opening LCs. What does it indicate?

The policies adopted by the central bank are in particular making the entire banking sector safe and more robust. In order to support the overall economy of the country and to balance inflation, it is within the jurisdiction of the central bank to regulate credit flow through different measures. All macroeconomic indicators were at severe stress when the central bank issued the requirement of cash margin while opening LCs for imports. The foreign currency reserves quickly depleted, and trade deficit was widening adding more pressure on market liquidity. The cash margin requirement in LCs for imports was successful in decreasing the import levels from that of last year and improving the foreign currency reserves as well as we can see. In the past few months, there are signs of improvements in the external sectors with overall surplus in Balance of Payments. The country’s inflation has decreased from over 8.08% in the beginning of the fiscal year to 7.26% by the end of six months in the current fiscal year. With NRB lifting the cash margin requirement in LC, the import volume is expected to rise in coming months and add to building government revenue thus avoiding the situation of fiscal deficit. Global economic situation is predicted to be more adverse in 2023. The International Monetary Fund has projected a slowdown in global growth to merely 2.7% and the per capital income of the developing economies will hover below the Covid 19 period. What sort of challenges do you foresee in Nepal's economy and particularly in the financial sector this year? Current global issues, including the Russia-Ukraine war, the stalemate situation between the US and OPEC countries in oil production, the China-Taiwan standoff, and the prolonged impact of Covid in China disintegrating global supply chain have primarily affected the world economy. Nepal’s economy being largely dependent upon imports has not remained unfazed by these international incidents. The cost of living has considerably risen due to the increasing cost of dollars leading to higher inflation than the preceding year. These geopolitical issues have also resulted in energy crises, currency depreciation, increase in interest rates and dampening business confidence across many countries worldwide, including Nepal. Slowing economic growth and possible global recession could have a direct impact on tourism, remittance and export. The slump in the economy has resulted in lower business confidence and less demand for credit offtake. The delayed and significantly lower budgeted capital expenditure by the government and early indications of fiscal deficit could also deliberately impact the banking sector going forward. The performance of the banking sector primarily reflects the performance of the economy as a whole. As the economy is saddled by inflationary pressures, trade deficits and fiscal deficits, it has adversely affected the banking sector as well. The prolonged tight liquidity situation has slowed down overall business growth and profitability of almost every sector in recent times. There has been a meteoric rise in non-performing loans of BFIs due to declining market activities and businesses inability to repay loans. The imminent global recession could further worsen the situation as it could directly hit the remittance inflow in the country. However, despite the adversities and challenges, the Nepali economy, as in the past, does have the potential to bounce back, to which the banking sector will continue to be a prime facilitator. The banking sector has already passed through various externalities throughout its history and has always emerged to be resilient, performing better than most South Asian countries. The BFIs have been contributing to overall financial inclusion with presence in all local levels as it is also one of the major contributors of tax revenue to the government and a key driver of economic growth. However, for a resilient banking sector, it needs support from each member and entity in the society to be transparent, accountable, and responsive in all their endeavours and actions.

The central bank has been encouraging the consolidation of BFIs through mergers and acquisitions. Is this to bring stability to the financial system?

Banks and financial institutions are in a serious business of managing people’s money and acts as one of the major players of the economy. As the economy expands, it becomes imperative for these BFIs to expand its capital base as well to funnel further credit growth. Furthermore, there has been a growing challenge for BFIs to keep up with the regulatory costs, while at the same time there is a heightened need for them to invest in digital infrastructure and security systems. As the BFIs have to compete in the same market, it has started to become difficult for many to deliver consistent return to shareholders as well. The best way to strengthen the BFIs in this scenario and achieve growth in the longer term by seizing market opportunities is the consolidation of like-minded BFIs. This is also vital for the BFIs to strengthen their market presence with sound retail deposit and lending portfolio, reduce their loan-loss provision and NPA level, improve the geographical mix of their business and strengthen capital base to funnel future growth. The strengthening of BFIs will definitely bring a stability in the financial system. The mergers and acquisitions of BFIs in the financial sector so far has delivered a fair result and bolstered their capability to deliver a consistently superior growth.

But with multiple mergers and acquisitions, have banks become too big?

The size of the economy has been continuously growing and this has increased the demand for credit. The United Nations Committee for Development Policy (CDP) in 2021 recommended Nepal’s graduation from the least developed country category to a developing country. We have already witnessed two scheduled federal and local level elections, which are expected to further institutionalise the federal structure and support the development of the local economy. The country is also a part of United Nation’s Sustainable Development Goals and to fulfil which the government is required to make huge investments in different sustainable sectors. As the size of the country’s economy gets bigger and the local markets are further developed, there will be ample opportunities for BFIs to expand their business as well and achieve a justified profit. Moreover, Nepal’s proximity with the two largest economies of the world and their more than ever increasing demand for clean energy offers banking sector a tremendous potential to expand their portfolio in the sustainable sectors. The growing youth population of the country and their potential demand for new-age banking will also pave a more sustained path towards financial prosperity for the banks. The country as part of its Sustainable Development Goals has nationally determined contribution of generating 15,000 MW of energy and major improvements in other infra projects to fulfil which requires a huge funding from the private sector. There is also the opportunity for larger banks with strong capital base to bridge the funding gap particularly in infra and hydro-sector. Moreover, the increased capital base will also allow domestic banks to plan expansion into international markets and realise bigger dreams.

Many experts argue that the pitfalls to having bigger banks outweigh its benefits. What do you have to say on this?

The banking sector is one of the most regulated sectors. Moreover, being one of the key contributors of the country’s economy, BFIs need to maintain a high degree of governance and transparency in all its endeavours. Nepal’s banking industry is still going through a developing phase. The growth in the number of financial institutions before mergers and acquisitions were prioritised by the central bank was the prerequisite to increase financial inclusion and access to credit, given the need to grow local markets throughout the country. The growth of local credit demand and the saturation of urban-centric markets to catapult further growth required banks to move to new markets thus forcing them to compete in the same regional and local markets for the same pie. This situation would eventually lead to mergers as the banks also need to focus on its bottom-line profit. When Nepal Rastra Bank started to pass the benefits of mergers and acquisitions to BFIs, it also provided an opportunity for them to strengthen their market position and diversify portfolio sources. However, despite the mergers and acquisitions to be the bigger bank, the banking sector will continue to remain within regulatory frameworks and will adopt best international practices in governance. The talents in this sector will continue to be absorbed within the industry as the banking sector continues to go through a paradigm shift with the advent of digitalisation in the country and the need to adopt more agility in its operations. The talents from the banking sector will also find new opportunities in other sectors as in the past thus institutionalising and increasing performance and governance standards of those sectors as well.

With the consolidation policy substantially minimising finance companies, development banks and sub-regional development banks, will it limit SMEs’ access to credit?

I personally don’t think that the consolidations so far have limited SMEs’ access to credit. All kinds of BFIs operate in the same market and compete for the same business pie. The banks have expanded to 752 local levels out of 753 within the country. The opening of new physical branches in growing markets has been increasing. In fact, even after the mergers and acquisitions of many BFIs, the number of branches throughout the country has increased compared to what it was prior to M&A.

Your suggestions to policymakers to bring the economy back on track?

The government must have a single agenda of economic development as the country can no longer sustain economic backlash arising due to political deadlocks. To create momentum in the domestic economy, the government must expedite capital expenditure with a significant focus on sustainable mega infrastructure projects. There should be a particular focus and support on tourism to revive the industry and develop it as a reliable source of foreign currency. The government should prioritise direct banking finance to real economy sectors such as agriculture, energy, tourism, etc., to gradually become self-reliant in these sectors and achieve sustainable growth. The focus should also be on a low-carbon economy to seek international investment opportunities. The strategic geolocation and neutral ground offer Nepal plenty of opportunities to facilitate growth in the region. Nepal is surrounded by two of the top five economies in the world and one-third population within its close radius. As the global economy has been reeling from the energy crisis, the demand for clean energy has increased within the regional blocks to sustain their economic growth. Nepal should seek this opportunity to attract international investments in the energy sector and arrange to build a closer integration with the South Asian market, especially India, to fuel their increasing demand for clean energy. To unleash the tremendous potential in the country's energy sector and ensure Green Resilient Inclusive Development (GRID) model, the government should prioritise climate and environmental risks in energy projects to attract cheaper climate and energy investment into Nepal. The diplomatic ties with India and other regional countries should be strengthened to develop power exchange prospects and fulfil their ever-growing energy demand. READ ALSO:
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APRIL 2024

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