We can’t expect the economy to improve unless credit mobilisation of BFIs to the private sector picks up

The country’s banking sector has been moving ahead through a turbulent time along with consistent slowdowns in the economy for the last few years. Soaring non-performing loan (NPL) has raised eyebrows regarding the asset quality of banks. Low credit growth, recovery challenges, and negative profit growth have posed manifold challenges in the financial sector as well as the economy. However, along with the gradual rebound of the economy the prevailing challenges witnessed in the financial sector are expected to be resolved gradually. The HRM Nepal caught up with Ratna Raj Bajracharya, Chief Executive Officer of Global IME Bank, to learn more about how the banking sector is coping with the current challenges. Excerpts:

Q. How would you analyse the current scenario of the banking sector?
A. The Nepali banking sector is facing a multitude of challenges. A sluggish economy is hindering loan recoveries, leading to a rise in non-performing assets. Low business confidence is further dampening growth. Compounding the issue, unpaid contractors are not only defaulting on loans but also impacting the debt servicing ability of their suppliers. Finally, a stagnant property market is hindering asset sales, even for businesses seeking to settle debts through asset disposal. Potential buyers are either offering significantly lower prices or hesitant to purchase due to liquidity concerns.

Q. Despite ample liquidity in banks and lowered interest rates, loan applications remain sluggish. Why are businesses hesitant to borrow, and how can this challenge be addressed?
A. BFIs benefit from two main deposit sources: individuals and institutions. Individual deposits are rising thanks to salaried workers and consistent remittance inflows. Likewise, institutional deposits are growing due to the continuous flow of funds into pension funds and insurance companies.

However, slow loan disbursement suggests a slowdown in business activity. While deposits are satisfactory, loan uptake is lagging behind expectations, creating excess liquidity. This inevitably puts pressure on interest rates, for both deposits and loans, as we’re already seeing.

The only long-term solution is economic revival, which will boost business confidence and overall market demand. This will not only stimulate production and imports but also raise the demand for loans. In my view, this isn’t a challenge. We need to maintain the current single-digit lending rates for some time to improve the country’s investment climate. While deposit rates may seem lower than before, they remain justified considering inflation.

Q. Some analysts point to a troubling situation in Nepal’s banking sector. They argue that corporations with existing large loans are hesitant to borrow more, and banks are struggling to find new credit-worthy borrowers. What’s your perspective on this issue?
A. Corporate loan demand is intrinsically linked to economic growth, a pattern that has held true throughout Nepal’s banking history. The definition of ‘corporate’ lending has simply evolved alongside the economy. Decades ago, a 50 million rupee loan qualified as corporate, but inflation and economic activity have driven up investment needs, requiring larger financing. Today’s ‘corporate’ loan varies by bank, typically starting at Rs 250 million. Some larger corporations have diversified interests and significant group exposure, often financed through syndicated loans from multiple banks.

Whether existing corporate borrowers are overleveraged depends on their business activity. However, the number of companies with sizable loans is definitely increasing.

As for identifying new borrowers, banks are actively reaching out beyond corporations. Loans to SMEs, MSMEs, and retail borrowers have grown significantly in recent years, especially with the expansion of BFIs into all municipalities. This, coupled with NRB’s push for financial literacy, is bringing banking services and financial awareness to a wider population, although local money lending practices persist. This highlights the need for further progress in financial inclusion and literacy efforts.

Q. The asset quality of banks is being questioned following the two-fold surge of NPL in the previous year. What would you like to say on this?
A. Economic slowdown has squeezed borrowers, dampening repayment ability and doubling NPLs in a year. Despite this, BFIs remain stable. Strong capital buffers (12% average), ample liquidity (over 20%), and comfortable net NPL levels ensure their solvency.

However, the NPL calculation itself needs revisiting. Unlike international norms, Nepal classifies NPLs solely on overdue interest, disregarding loan type, purpose, or collateral. This approach arguably exaggerates the health of Nepali BFIs. The current NPL surge is likely temporary, tied to the economy’s recovery. However, a broader economic collapse could worsen NPLs.

Q. There have been reports of individuals, possibly with anarchist leanings, encouraging borrowers to default on their loans from banks and financial institutions. Have these activities been brought to the attention of regulators and the government?
A. The financial sector is facing a troubling trend: some politicians are exploiting public sentiment by encouraging loan defaults. While these public pronouncements aren’t directly aimed at specific institutions and haven’t been flagged to regulators, individual incidents of borrower harassment by such individuals have been reported.

This poses a major concern for the entire financial system. A lack of action could erode public trust and embolden bad actors to exploit the situation. We’ve already seen cases where borrowers, emboldened by these pronouncements, are being pressured to default on loans. These incidents, along with threats against bank staff, have been reported to local authorities who have been supportive in providing security.

However, the lack of concrete action from the government, despite pronouncements against such anarchists, is worrying. We fear this inaction could lead to a larger, more coordinated campaign undermining the financial system.

Q. Bankers have been saying that collateral may not serve the loan amount. So, why don’t we resort to project financing instead of relying on collateral based lending?
A. While lending for business, banks rely on the cash flows the business generates, the managerial capability of the borrower and market analysis. However, as mark of caution, collaterals are also sought, which is obviously considered as secondary in case of fall out.

Yet, it must be admitted that banks prefer obtaining collateral though it may not serve the loan amount. I would say, this is mostly sentimental to keep the borrower within financial discipline. Secondly, the prevailing legal practices have yet to provide the required security to banks in case of default. For instance, in case of working capital recovery, banks are not protected for recovering from the assigned debtors. It is difficult to take possession of the stock and resale.

The practice of project financing is already in existence. Industrial projects are good examples. BFIs do not seek ‘additional’ collateral other than those assets created under the ‘project’. Seeking collateral is usually in existence in case of trading business and personally managed ‘projects’.

Q. There are concerns that project costs, particularly in hydropower, are being inflated. This directly impacts the returns for equity investors and shareholders. Why do banks appear to be inadequately evaluating these project proposals?
A. Banks struggle with technical expertise, potentially limiting even the best credit managers’ ability to assess project costs accurately. Despite these limitations, banks still evaluate proposals scrutinising similar projects for cost comparisons. However, this approach doesn’t eliminate inflated costs entirely. Banks suspect and anticipate potential cost inflation.

To mitigate this, banks typically require promoters to contribute equity before loan disbursement and release funds based on project progress and supporting invoices. These controls aim to limit cost inflation, yet vulnerabilities remain.

A recent concern in hydropower financing is the ‘IPO mania’. Unlike previous projects, many are going public, with older projects following suit. Ironically, public listings allow promoters to sell their holdings freely, potentially leading to higher prices. This incentivises short-term profits from share sales rather than long-term energy production, raising concerns about ownership transition and project management after such sales.

Q. The last fiscal recorded a marginal credit growth of 3%. What could be the scenario of this fiscal while analysing the situation of three quarters?
A. Credit growth remains stagnant due to lacking government or NRB policies stimulating demand. The NRB’s relaxed personal lending terms haven’t significantly impacted overall growth. Specific policies to boost business confidence and consumer spending are yet to materialise.

However, a turnaround is likely. Nepal’s informal economy limits access to finance for many. Increased financial inclusion efforts by BFIs and the government can lead to more economic activity and higher credit growth. The national budget projects 6% growth, and supportive monetary policy is expected to achieve this, encompassing a broader economic segment. Maintaining current single-digit lending rates for at least a year could be a guiding policy. Special treatment for loans to manufacturing and commercial agriculture can further boost employment. The future holds promise.

Q. Are you satisfied with your bank’s performance in the first half of this year?
A. Not at all. NPLs have severely eroded our profitability. Non-receipt of accrued interest has pushed distributable profits into negative territory. Additionally, the tax implications of bargain purchase gains have taken a bite. Our capital ratio, once a healthy 13.5%, has shrunk to 12%, jeopardizing lending capacity despite ample liquidity.

Q. Development finance institutions are eager to invest in Nepal and some have mobilised investment through banks. How can Nepal avail benefit from this?
A. This is a good sign, I would say. Obviously, from my understanding, these institutions are expressing their increased level of confidence in Nepali economy/banking practices and its health. This is surely an encouraging outcome. Secondly, the rate of interest they are offering (SOFR + premium at 3+%) are attractive enough. It seems expensive at the moment due to higher rate of SOFR in the international market. Once it goes down to normal, the rate will be within an affordable limit for Nepali banks. However, as a note of caution, the prospective hedging cost may restrict its general acceptability
Nepal benefits from this in two ways. First, it will show the ‘accepted quality’ of Nepali banks and secondly, it will help increase our forex reserves.

Q. What feedback would you like to provide to the regulator and the government to address the current challenges?
A. In my understanding, and which is also been largely put forth by all, the Nepali economy requires fresh initiation that will support the circulation of money. Many borrowers whom we talked to admit that they have earlier ‘syphoned’ the funds from their business for personal use, mostly in acquiring landed property, in temptation to earn some profit from ever increasing prices. Misguided expectations fuelled a land buying frenzy, with borrowers assuming ever-increasing prices. However, the bubble burst, leaving them stuck with illiquid assets as prices stagnated or fell. Businesses eager for revival are now hamstrung by a lack of capital.
At this juncture, what is needed, in my view, is to facilitate some concessions to support re-origination of the cycle of cash. A remedy would be to encourage banks to extend finances for recapitalisation of the existing businesses by offering mortgage loans. This may sound like encouraging the BFIs to lend more in the unproductive sector (mortgage loan). However, this will help produce the much needed cash for businesses. Banks’ position will also become better with additional security.

Similarly, during this difficult period, there may be a large number of businesses that are suffering losses and have already closed operation and are trying to dispose properties to settle their liabilities. A more supportive/accommodative approach in providing them room to dispose their property could be arranged.
Public trust in cooperatives is another area needing urgent policy reform. This is crucial to maintain confidence in the entire financial system. Reports suggest not all cooperatives misused funds. Many faced a liquidity crisis due to panicked withdrawals mirroring the collapse of other cooperatives. Stricter regulations are essential to ensure future stability. However, as a stopgap measure, cooperatives should be allowed to sell performing loans to BFIs. This would generate cash to meet withdrawal demands and prevent further erosion of public trust, a critical factor in economic recovery.

Q. The central bank has oriented the banks to be cautious about climate induced disasters while issuing loans? Your thoughts…
A. Climate financing has become a buzz word already. Since banks are the lenders to any project, the proper climate control/mitigation norms may be appropriately ensured through the lenders. Nepal Rastra Bank has also acted in line with the international community and has required the banks to include climate financing norms in their activities. It’s happening. Some banks have even started reporting ‘emission control’ chart related to their lending portfolios.

This is an excellent initiative that is recommended for support by all. As for us, we have already set up a separate unit to look into the issue on a continuous basis. One of our international lenders has also been coming forward to support us in our capacity building. Further, we have already signed a contract with International Finance Corporation (IFC) for advisory services in risk management that include climate/gender financing aspects as well.

Q. What are your suggestions to the private sector for keeping reservations on working capital and asset classification guidelines?
A. Central bank Working Capital Guidelines are a positive step promoting proper use of borrowed funds. However, a lack of clear understanding seems to be causing hesitation.

Businesses have two working capital needs: permanent and temporary. Permanent capital covers ongoing expenses like stock and receivables, growing alongside sales. Temporary capital supports seasonal sales surges. The Working Capital Guidelines aim for businesses to understand this cycle and borrow accordingly. Loans for seasonal needs are temporary and must be fully repaid annually (phased settlements are now an option). This shouldn’t be a problem if the loan was used as intended. Permanent working capital loans are repaid regularly, with options for multiple tranches based on business needs, assessed every six months.

Businesses accustomed to freely accessing working capital loans may find the new guidelines restrictive. Previously, some even exceeded credit limits. The guidelines now require adherence to responsible borrowing practices, ensuring loans align with actual needs. This shift can cause initial hesitation, but as businesses adapt to the new system, concerns will likely dissipate.

Q. Considering the current challenges faced by the banking sector, what are the key areas where the forthcoming fiscal and monetary policies for 2024-25 can potentially make a positive impact?
A. The budget has provided no specific solution to the current economic slowdown. Not even a commitment has been made to release payments to the contractors, which would otherwise provide relaxation to the supply chain as well. A sort of ‘concession’ was anticipated regarding payment of tax (VAT and Income tax) during this period. For instance, credit realisation from the market is slow, which will impact the capability to pay regular VAT and also the installments of income tax. The cash outgo in tax without recovery has resulted in deteriorating their liquidity situation and impacting debt service as well.

In this regard, I am tempted to cite a discontentment in that ever since the Covid period, including the present economic slowdown period, the government has not come forward providing any direct stimulus packages that would support continuation of demand in the economy. Nepal Rastra Bank has been providing some temporary relief facilities, e.g., interest deferrals, refinance facility etc., to impacted businesses through banks. In this respect, if the economy does not come back on track soon, those businesses that have opted for deferment of interest will be facing a situation requiring to pay increased amount in interest obligation (regular + deferred). Settlement of principle dues, including installment of permanent working capital loan will create additional burden. The course of action that NRB could take in this situation is still not clear and hence adds to our worry.

The continuing economic slowdown will put pressure on some to close down their businesses. Post closure of the business, it will require disposal of the properties for settlement of debts. This is creating a problem since the current real estate market has not been supportive. We feel that the situation will have to be understood fully by all and continue providing support for revival.

The implementation of NFRS -9 for banks is going to be a major issue in the coming days. The implementation of this entirely depends on the ‘appropriate financial statements’ and financial discipline of the borrowers. A root correction has to be made by providing awareness for producing ‘acceptable’ financial statements. This remains a major concern during this ‘bad’ period.

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