In a clear indication that the liquidity situation in the banking system is easing notably, Nepal Rastra Bank (NRB) issued a reverse repo worth Rs 5 billion last week. A reverse repo is the central bank's monetary instrument to mop up excess liquidity from the market. While issuing the reverse repo, the central bank borrows money from commercial banks to mop up liquidity in the banks. It was the first time in 18 months that the central bank took a move to absorb excess money in circulation. Earlier, the NRB issued a reverse repo amounting to Rs 28.35 billion on July 20, 2021. According to an NRB official who spoke under the condition of anonymity, the latest reverse repo was issued to test the market response. “The banks responded by parking their funds in the central bank which suggests the liquidity situation in the banking sector is easing,” said the official.

Easing of liquidity also means that loanable funds are available with the banks.

Another indication of the easing liquidity in the banking system is the decreasing interest rate of inter-bank lending which has come down to 4.23 percent on January 27 from 7.34 percent on January 18. According to NRB, the interest rate was 8.15 percent on January 1. “The banks are not using the standing liquidity facility (SLF) and the overnight liquid facility (OLF) to inject liquidity for the last few weeks,” another official of NRB said. “This suggests that liquidity has eased in the banking sector. It will help to reduce interest rates in the coming days.” According to the official, banks have already started lowering the interest rate on deposits and interest rate on lending is also expected to be lowered at least after the fourth quarter of the current fiscal year. The banking system faced a prolonged and a severe liquidity crunch which resulted from massive lending and slow deposit collection in the early months of the last fiscal year 2021/22. With deposits not increasing in the proportion of the lending, the banking system faced a severe liquidity crunch forcing the banks and financial institutions to suspend new lending from the second half of the last fiscal year. Through the monetary policy for the current fiscal year, NRB announced measures to help banks and financial institutions to maintain more liquidity. NRB reduced the targeted growth rate of credit expansion to the private sector to 12.6 percent from the targeted 19 percent in the last fiscal year. As the overexpansion of credit caused a steep jump in imports leading to the depletion of foreign currency reserves besides contributing to high inflation in the last fiscal year, the central bank came up with a plan to reduce the expansion of credit and money supply in the market through the monetary policy. With the banks focusing on deposit collection mostly through fixed deposits, total deposits from the start of the current fiscal year increased by Rs 200 billion till January 28 while the total extension of loans increased by Rs 103 billion, according to NRB. “With deposits increasing by a higher percentage than lending, there has been improvement in liquidity,” the NRB official said. However, most of the deposits the banks and financial institutions received are in the form of fixed deposits. The ratio of fixed deposits to total deposits is around 60 percent, according to NRB. “That’s why many banks will face a liquidity shortage if a few big fixed depositors withdraw their deposits,” said a CEO of a commercial bank.