Views of a Nepali Economist

Recent Liquidity Crisis in Nepal: Predictable, Avoidable and Not Over Yet

There are feelings among those involved in the Nepali financial market that the recent liquidity crisis—that started in the late 2009 and lasted until late 2011—is over. That is a dangerous feeling to have because the crisis is not over, yet. It would be foolish to assume the crisis as being over simply on the basis of a slightly buoyed confidence among the banks and financial institutions (BFIs). Although there has been a rise in market transactions among the BFIs, overall confidence among core financial market consumers—those buying and selling real estate—is still very low.

The worst feeling to come out of the recent Nepali liquidity crisis is that there were warning signs, in the early 2009, about a possible crisis in the financial sector. However, neither the BFIs nor Nepal Rastra Bank (NRB) seemed bothered by the impending loom. Together, the BFIs and the NRB ignored the signs.

First, historical data from all over the world shows that liquidity creation right before any liquidity crisis is always high. Money supply had a decreasing trend after the Nepalese economy was liberalized after the democracy in 1990. After 2001, however, the data shows an increasing trend. The increase kept happening right up until the end of 2009, after which the liquidity crisis hit the Nepalese financial system hard. So, literature review suggests that the recent crisis was predictable. The question then becomes: Why did nobody, especially the NRB researchers, predict it?

Second, the BFIs themselves had been forecasting net losses from their outstanding loans. The forecasted capital levels were continually on a decline, and the BFIs were increasingly worried about not meeting the NRB set standard in this regard. Delinquencies were on the rise since 2007. If these internal problems were not the signs for an impending liquidity crisis, I don’t know what were. Unlike natural disasters, liquidity crisis does not come suddenly. It comes out of a systemic and compounding failure of the financial market and its overseer. The BFIs and the NRB should shoulder the responsibility for the recent crisis. It was their own making, and the reason it lasted as long as it lasted was due to their inability in seeing it coming in advance as well as their inefficiency and incapability in solving it swiftly after it arrived.

Third, even if the BFIs were lying and covering up their losses, the financial market as a whole should have known of such cover-ups. After all, increasing charge offs and delinquencies as well as decreasing profit and capital levels are not hidden information. These are publicly available data to anybody and everybody who seeks them. So, those working in the financial market as well as those monitoring the financial market (i.e. the NRB) should have been aware that the BFIs were fudging their books. The recent liquidity crisis was, therefore, a slap in the face to those who claim to know the Nepalese financial market and those who claim to monitor it.

Fourth, when the crisis hit our financial market, initially, there was no response to halt this crisis. The BFIs went about their business, crossing their fingers, hoping that the liquidity “crunch” would not transform into a crisis. The NRB looked the other way hoping that the market would correct itself. That was a mistake. Eventually, after two years of crisis, the NRB decided to raise the insured deposit amounts. Although they should have done this as soon as the crunch hit the market, the NRB’s step should be viewed in terms of “better late than never”.

With all these signs foretelling the severity of the crisis, the concerned authorities did not actively seek to halt or mitigate the crisis. As a result, the market suffered for over two years. The worst affected were those involved in the real estate sector. As a result of the liquidity crisis, house and land sales all over the country, especially in the Kathmandu valley, have all but died out.

However, the past is past. Instead of ruing over the crisis, we should think about potentially avoiding any future liquidity crisis. What can be done? First, and foremost, the NRB should increase, improve and fulfill its duties as a monitor of the financial market. Simply granting licenses to open up new banks is not its sole duty. It needs to monitor, evaluate and investigate the BFIs for any wrongdoings. Anyone found guilty needs to be punished, and not bailed out. Bail outs should happen only if, absolutely, necessary.

While it is true that having excessive liquidity in their hands hurts the bottom line of our BFIs, they should also realize that having too little has a tendency to put them out of business. The NRB cannot come rescuing every single bank that goes bankrupt. It has its own criteria and limits. Therefore, BFIs should have enough short-term quickly liquidable assets at their disposal. They can use such assets to ease the liquidity crunch if one presents itself in the coming future.

Also, the proverbial “don’t put all your eggs in the same basket” saying applies to our BFIs as well. Nepali real estate sector received as high as 70 percent of all loans made out by our banks. Therefore, the recent liquidity crisis occurred due to our BFI’s inability to recoup their loans from this sector. Diversifying the portfolio of investments can save them if one of our economic sectors suffers from a crisis. The losses can always be recouped from other stronger sectors if the portfolio is diverse. Until our BFIs learn this lesson, there is always another liquidity crisis looming in our horizon.