The Nepal Rastra Bank (NRB) has allowed commercial banks to borrow funds equivalent to up to 25 percent of their core capital from foreign financial institutions. The central gave this permission to ease the shortage of loanable funds that has gripped the banking sector for quite some time.

 If all commercial banks borrow funds in convertible currency from abroad, over Rs75 billion will enter the country, as Class ‘A’ financial institutions held a combined core capital of Rs301.3 billion as of mid-December, NRB report shows.

 This inflow of funds from abroad is expected to replenish the stock of loanable funds in the banking sector, as commercial banks can treat loans obtained from foreign financial institutions as deposit.

 Banks are currently facing severe shortage of funds that could be disbursed as loans due to deceleration in deposit growth and growing credit demand. This asset-liability mismatch is the result of haphazard lending in the first quarter of this fiscal year.

To ensure funds borrowed from abroad are not used carelessly as in the past, the NRB has identified areas where the funds should be channelled.

 Funds borrowed from abroad, for example, must be used to provide loans to borrowers who are building hydroelectricity projects, power transmission lines, roads, tunnel ways, airports, cable cars and bridges, says a directive issued by the NRB on Tuesday.

 Funds borrowed from abroad can also be used to provide loans to tourism, agriculture and microfinance sectors that can generate earnings in foreign currency. But foreign loans should not be channelled towards housing and real estate sectors, says the directive.

 The interest on convertible currency borrowing should not exceed “six-month Libor plus 3 percent”. This interest rate should include all fees and commissions, adds the directive.

 The repayment period for funds borrowed from foreign financial institutions should not exceed five years but should not be less than a year. Also, Nepali banks should not obtain loans from foreign financial institutions on the back of any form of collateral, bank guarantee and other securities, says the directive. Funds borrowed from abroad should not be used for interbank lending purposes.

 The permission to borrow funds in convertible currency will help banks that are facing severe shortage of funds that could be disbursed as loans. Yet the downside of this facility is fluctuation in exchange rate, which could inflate debt servicing cost of banks. In other words, if Nepali rupee weakens rampantly, those who have borrowed funds in convertible currency may have to fork out huge sum to repay the debt.

 This may even push banks to the verge of collapse, triggering an economic meltdown. Possibilities of such an accident taking place cannot be ruled out, as seeds of the Asian Financial Crisis of 1997 were sown by companies and financial institutions that heavily relied on foreign debt to expand their businesses. “This is the reason why we have created a threshold on borrowing amount and interest rate,” said a senior central bank official.

Source: The Kathmandu Post