Monday, March 12, 2018

Banking cartel in Nepal in the veil of an association

Recently, Nepal Bankers’ Association (NBA) decided to punish NIC Asia, a member commercial bank, by excluding it from interbank lending, which is crucial for managing immediate liquidity needs among banks. A rising interbank rate indicates tight liquidity in the banking system. Interbank rate has been rising in recent months, thanks to liquidity pressures arising from deceleration of remittance income and low capital spending (the latter case is normal).

What did NIC Bank do? Well, it broke away from collusion among 28 commercial banks, under the veil of a professional association, and started offering higher interest rates on deposits, which NBA has fixed (with “informal understanding”) at 11%. It started offering 12% on fixed deposit and 10% on savings deposit. The NBA went up in arms with NIC Asia and threatened to scrap its NBA membership in addition to barring it from interbank lending. Meanwhile, Nepal Rastra Bank (NRB), the central bank (which has been one of the most ineffective under the current leadership), remains indifferent to the tussle between NBA and NIC Asia.

Few things to consider here:
  • First, NBA is behaving like a cartel, manned by CEOs who thrive on moral hazard, that preaches free market but engages in anti-competitive practices to fix deposit rates (but not lending rates). Even Development Bankers’ Association lent support to NBA because they usually offer deposit rates one or two percentage points higher than commercial banks (same with their lending rates). They feel threatened by NIC Asia encroaching on their interest rate territory. In principle, any bank should be allowed to fix their own deposit and lending rates.
  • Second, NBA argues that without a ceiling on deposit rates, lending rates will spiral up. If banks offer 11% interest on deposit  and with 5% minimum cost of managing funds, final retail lending rate can easily go over 16%. This increases cost for individual borrowers and firms. NBA argues that its measures will help to stabilize interest rates and economy.
  • Third, it is not the job of NBA to decide on stabilizing interest rates. The NRB has interest rate corridor in place to do this. If NBA can dictate interest rates, then what is the relevance of NRB? Repeated financial crisis is a sign that NRB has been window dressing real issues: that systemic risks to financial sector are recurring and are exacerbated by faulty banking practices and corporate malgovernance. NRB increased capital base to NRs8 billion from NRs2 billion to force merger of the banks. But, the banks found a way out to be a NRs8 billion capital bank and avoid merger (cause too many managers will lose jobs and promoters/board will not be able to dictate lending terms to suit them or their businesses). The way NRB implemented the capital increase requirement was inherently faulty as it didn't achieve the main objective to reduce the number of banks. 
  • Fourth, the current NBA vs. NIC Asia fiasco has its root in Nepal having too many banks for a restricted depositor base. They can't survive without collusion/carteling. It's getting late to clean up the banking system. Same with hospitals, schools, colleges, airlines, etc. Syndicates and cartels rule almost all sectors. 
Update (2018-03-14): NIC Asia gives into the demand of NBA (informally assisted by the NRB). NIC Asia has now agreed to offer returns within the threshold created by the NBA. Meanwhile, the NRB has issued a directive on interest rate spread, which cannot be more than 5% (it was 6% before). Any BFI violating this requirement will not be allowed to distribute bonus and cash dividend next fiscal year. They will also be barred from opening new branches in places others than local bodies where there are no existing bank branches. Also, they won’t be able to avail refinancing facility on loans (except for those related to post-earthquake reconstruction of houses).

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