The banking sector is once again facing a shortage of lendable funds, driving up interest rates. This comes at a time when the economic activities are gradually returning to normality. Nepal Rastra Bank (NRB) recently intervened in the market to cap the rate that a bank can increase on deposits. Still, the situation is not likely to improve anytime soon.

Ajaya Bikram Shah is the CEO of Laxmi Bank Limited. He was also recently elected as an executive committee member of Nepal Bankers' Association. In an interview with Sagar Ghimire of New Business Age, Shah talked about issues ranging from the troubling problem of liquidity to the impact of the pandemic on the banking sector and the economy and the overall performance of his own bank. Excerpts:

The issue of liquidity has long become a headache for the banking sector. What are the structural issues in our economy that causes the never-ending shortage of liquidity in the banking system?
There are both structural and cyclical reasons that cause shortage in our system. The government is the biggest employer or buyer in our economy. So, whenever the government delays spending it impacts everyone in the chain from contractors to manufacturers to SMEs and households due to the prolonged credit period. Unfortunately, this has happened right at the time when economic activities are picking up with gradual ease in the pandemic which has led to increased credit demand. The slack from workforce-remittance has further compounded the current situation. There appears to be a direct correlation between fall in remittances versus rise in imports leading to a belief that informal or Hundi activities are diverting precious foreign currency away from the country. At a more structural level, it is clearly evident that our national output and savings rate is not nearly enough to support the kind of investments required for industrialisation of our economy and building long term infrastructure assets. We have not been able to match the outflow from imports to inflow from exports or other sources and as long as this continues, we will continue to face volatility in terms of liquidity and it’s pricing.

Do you think the monetary policy can alone help address the liquidity problem and what are the possible solutions?
Monetary policy helps in setting short term interest rates to some extent but cannot in itself address the issue of availability of the financial resources over the long term. We could argue that changes in the percentage of credit to deposit (CD) ratio may inject liquidity, but that again is short term and not sustainable. The only sustainable solution is to increase our national productivity and income. This obviously cannot happen overnight and needs long term vision, planning and execution. There are however things we can do in the short term such as placing excess government funds, i.e. the difference between the budgeted spending and actual spending with banks in the form of deposits. Discouraging spurious trade activities that do not contribute to the national economy or income will also help protect our foreign currency reserves. Policy level steps to control informal remittances can help strengthen our foreign exchange reserves and thereby help domestic liquidity. We have also not been able to attract foreign currency deposits or loans from international institutions or individuals including non-resident Nepalis. While there are regulations in place to allow NRNs to invest in Nepali banks in the form of foreign currency deposits we have not been able to benefit from this. There are both procedural and confidence issues when it comes to NRNs depositing money in Nepal which, if resolved, can be a long term and relatively stable deposit source.

There were interventions in the market by NRB when banking institutions were competing to raise deposit rates. Rather than trying to address it through regulatory intervention, shouldn't that have been left to the market?
There is no doubt that the market is more efficient when it is allowed to discover the price of any scare resource including deposits based on demand and supply principles. But we should not forget that market regulators exist for a reason and that is to intervene if the market is not working as it should or is involved in risky behaviour that threatens other parts of an economy. Also, I don’t think a full free market exists anywhere in the world, except perhaps in text books. Central banks around the world are seen to be taking more and bolder and direct actions to influence the money market especially after the global financial crisis of 2008.

However, I also believe such interventions should be used only for a short term, until the market reaches some sort of stability. Otherwise, artificial price control, be it price of deposits, food, rent will only help create further shortage as sellers will look for alternative markets where their goods or deposits are more valued. Also, in case of deposits – controlling interest rate is a risky proposition especially if price levels or inflation cannot be similarly managed within a targeted level. Why would any depositor put money in a bank account if it does not yield a positive rate of return?

Interest rates are going up and up. The private sector has been demanding that the lending rate should stay in single digits. Do you see that happening?
There has never been or ever will be a consensus on what is an acceptable interest rate or a natural rate of interest. Interest rates are never absolute but always relative, relative to maybe a certain point in time or another asset. In an ideal world we would have a natural or targeted interest rate – a rate that does incentivize both savers and borrowers and does not create asset bubbles or inflation with appropriate policies to maintain that rate. But that is not possible especially in a developing economy like ours that lacks many fundamentals such as a yield curve, a bond market etc.

The private sector has the right to demand or expect a low or single digit borrowing rate, but we must not forget the voice of the depositors. If their savings is not respected, i.e. earn a positive rate of return they will take away their savings and invest elsewhere, maybe in land, gold or other assets or even capital flight. Almost in every situation liquidity or availability is more important than price. Again, it is the market that determines pricing and policies may influence that to an extent by ensuring inflation stays low or within target, so savers are not discouraged. In our case injecting liquidity in the system through loan refinancing not only helps liquidity but also helps lower the cost of borrowing. This is perhaps the most effective monetary tool available to help manage liquidity and the interest rate.

It is a rather unfortunate situation in that the banking industry has to ration or halt their lending because of the lack of loanable funds. How can this be resolved?
I would not characterise it as an ‘unfortunate situation’, but it is indeed a ‘situation’ that we need to manage. We are hopeful that both market forces as well as policy level intervention will help.

When interest rates start going up, the market forces work to slowdown credit growth. Due to the high cost for loan servicing, borrowers will start repaying their loans faster. In the last two years, the interest rates were so low that cheap credit available has encouraged higher indebtness in firms as well as households. Low interest rates have also inflated the asset prices – both financial and fixed since 2020. So, when interest rates rise, borrowings are scaled back, and more savings encouraged both of which will lead to correction or improvement in the overall liquidity situation.

Since this correction will take time, NRB’s refinancing scheme can help ensure that there is adequate liquidity in the system to continue credit to priority sectors.

NRB was after enforcing prudential measures to prevent excessive credit growth. There were banks who took the opposite direction. Aren't bankers to be blamed for the current situation?
At the beginning of the last fiscal year [2020/21], I had put forth my view that the credit growth was unnatural. But such a trend was welcomed from many quarters, citing the growth as ‘historic’ and good especially in the middle of a pandemic. How much growth is healthy and good? That is a very important question. The monetary policy sets a target of private sector credit growth normally between 15 and 20 percent. This policy level message should be meaningful but that has not been the case recently with some banks pursuing super aggressive growth. You could say that such decisions are made by individual banks and that they should be left to make and execute their own strategy. But I disagree that the banking business should be allowed to operate on a laissez-faire basis due to the simple fact that we need to be accountable to depositors ensuring safety of their hard-earned money. Also, any bank failure would cause a knock-on effect within the system.

Having said this, how much can bank influence credit growth? This is an interesting question and difficult to answer. Credit demand is a function of the overall market conditions such as asset prices, opportunity costs, business confidence, future expectations and of course interest rates etc. As a banker I would say that non-inflationary credit growth should be viewed as a net positive.

Bank executives, through Nepal Bankers Association, are now calling for a relaxation on the Credit to Deposit Ratio of 90 percent. Why do banks always look for a relaxation on regulation when they face shortage?
Again, I disagree that banks always look for relaxation. As a regulated sector we always abide by prevailing rules and regulations. Yes, when some regulations appear to be causing unintended consequences then Nepal Bankers Association puts forward requests for review and revision along with supporting justification showing that such revisions would benefit all stakeholders and not just banks. Addressing your question on CD of 90 percent, one must remember that 90 percent is a number that can be changed upwards or downwards at the discretion of the central bank – it can be further tightened to restrict credit growth or loosened to help credit growth.

Though the average non-performing loan (NPL) ratio of banks is a regulatory requirement, there are also concerns that banks tend to hide the true picture of their asset quality. Also, do you think Covid-19 will deteriorate the asset quality of banks when the central bank winds down relaxation on loan loss classification?
I don’t agree that commercial banks are hiding NPLs, at least on a widespread, industry level. There may be specific cases within specific banks but I do not have enough information to comment on this. I can however say NRB’s supervision is effective enough at least at the level of commercial banks to ensure that bad loans are recognised, and remedial actions taken.

A second thing I want to say is that there is often thoughtless benchmarking with ‘international standards’. We need to take in the limitations and reality of operating in a landlocked country. The time and costs for importing goods is much longer than other countries which will obviously lead to longer working capital cycles for our businesses. This is again compounded by the fact that our poor transport infrastructure and terrain means goods reach each point in the distribution chain relatively more slowly than most countries. So, is it unnatural for our working capital loans to be outstanding longer than ‘international standards’? Also, credit period is stretched throughout the chain unnecessarily due to delays right from the top, i.e. government. If the government delays payment, it cascades right down to the local tea shop. This obviously affects the length of the working capital loans. Therefore, we must view this allegation in the correct context.

I believe that it is still too early to say how much Covid-19 will affect bank loans in some sectors such as transportation, tourism, hospitality etc. Yes, there have been relaxations provided by NRB, but banks are carrying additional loan loss provisioning against such deferrals in anticipation of possible future problems.

It seems the banking industry made billions in profit during the pandemic when other sectors of the economy were hit hard.
It seems to be quite fashionable to say banks make billions in profits but there is already adequate data publicly available that shows reducing returns on assets and equity for banks. On the other hand, the banking industry can hold its head up high for having served our customers throughout the worst days of the pandemic, amid lockdowns and health threats. We ensured that customers had access to their money, got their salaries and remittances in their accounts on time and helped facilitate imports of crucial medical equipment and medicines.  

As a bank CEO who deals with businesses from all sectors that rely on bank financing, how do you assess the pandemic's impact on their business?
I still believe that we are yet to see the full and final impact of the pandemic. Let us not forget that the pandemic isn’t over yet – there are indications that the pandemic is coming to an end but even then the after-effects will be something that is unknown. For example, there are indications of high inflation in advanced economies, supply chain problems leading to increased costs of transportation.

There are some sectors which have done exceptionally well for example the construction sector, steel and cement, real estate, two-wheel vehicle segment. On the other hand, sectors like tourism are obviously struggling and may continue to struggle well into the future. This means that we are likely to see an uneven or K-shaped recovery.

Do you believe our economy is on the road to recovery?
There is a difference between ‘rebound’ and ‘recovery’. A rebound is a growth that we see when the base level goes really low or even negative, just like a ball bouncing once it hits the floor. This is easy and happens naturally. However, an economic recovery is long term and a much more difficult proposition. Recovery must be engineered and executed properly at the policy and implementation level. So, I do not believe we are on the road to recovery yet.

Are there any lessons that our economic policy makers should learn from this crisis?
I am worried we may have lost an opportunity created by the pandemic. There is a saying in that never let a crisis go waste. But we faced the crisis and we are letting the opportunity go to waste. What did we do to come out of it stronger? I haven't seen anything change that will create a better environment for business. As the pandemic winds down, we are back to the old normal. This was and maybe still is an opportunity for what is now referred to as the Great Reset. We could have used the downtime to improving and simplifying our tax systems, creating MSME supporting institutions, making our bureaucracy more efficient and investment friendly, ramped up the efforts around creating a digitized national ID or even migrating to the international fiscal calendar. It seems that we are expecting different outputs by using the same input. Lately, the private sector confidence appears to be quite low – and this is an important barometer for our economy and for our ability to attract foreign investments. The recent political developments seem to have pushed the economic agenda down the list of priorities. We still have a short window for us to change or overhaul the system. If we lose this opportunity, then we will fall further behind than other countries who have taken strong steps to reform their public systems and the overall economy.  

Let's talk about the bank that you lead. What can you tell us about the bank performance of Laxmi Bank?
I leave it to our stakeholders to evaluate our performance. I would like to however explain our approach or how and why we do what we do. Firstly, we always take a long-term view on how to grow our brand and business. For us growing our brand is as important to growing our business and hence we invest in both. We have embraced the ‘Phygital’ strategy which means expanding physically and digitally. The pandemic has affected our balance sheet growth, but I am confident we will be able to catch up and make up for lost ground.

Our approach to customers is relationship based rather than transaction based. This means we provide real value and reasons for firms and households to trust us with their finances. We do not believe in short term marketing gimmicks or a business model that depends on advertisements for customer acquisitions. We would rather grow at a steady and sustainable pace leveraging on the goodwill and word of mouth advocacy of our existing customers. That may mean we will not grow to be the biggest bank in the country, but we’d rather be the strongest than the biggest, any day.

Laxmi Bank was at the forefront in the adoption of technology or modern banking services. But there have not been any innovative services in recent days.  
There is a time for innovation and a time for improvement. Anyways, many of the so-called innovations in the fintech space are actually improvements on existing capabilities. Laxmi Bank pioneered the use of technology in banking services from online banking to mobile banking. We have continued to improve these products by adding more capabilities and making them more user friendly and relevant in line with the needs of the changing times.

A very important mindset change that we have taken is that we have realised that it is beneficial for us and our customers to be part of a larger shared and interoperable network rather than going at it alone.  I believe that our digital channels- mainly online and mobile banking- are the best in the industry in terms of usability, utility and security. We have continued to explore new technologies such as blockchain, robotic process automation, machine learning for products such as BNPL etc. Some of these are already in use and some in the pilot stage. Technology is ever evolving and at a faster pace than yesterday, so we are aware that we need to become smarter in terms of recognising what adds real value for our customers and avoid superficial and fancy trends that do not offer long term benefit.

We have recently announced LxB Connect, an application programming interface (API) platform that allows fintechs to connect to our test systems directly enabling them to learn, test and create products and solutions that will benefit the company and our customers.

It was heard that Everest Bank and Laxmi Bank were going to merge. Has Laxmi Bank now decided to give up the merger plan?
I have not been involved or am aware of any merger talks with the bank that you refer since I took over as the CEO. We have always maintained that we are open to mergers with like-minded institutions that meet our governance standards and are a cultural and balance sheet fit. Mergers between the right partners that complement each other’s strength and weaknesses will bring long term value and benefit in terms of scale and efficiency at least in theory. However, like every business decision, merging with another entity is a risk, so such decisions should not be forced or rushed and leaving such decisions to the market dynamics and competitive pressures will be the most efficient way to achieve the desired goals of the regulators and all stakeholders.