Treasury Management in Nepal
By Resta Jha
Nepali banking sector has witnessed some innovative products in loans and deposits following various reforms started some years ago, but unfortunately, Treasury Management continues to be elementary. Treasury departments of most of the banks in Nepal are limited to fund management and foreign exchange management rather than operating as independent profit centres. This does not allow the banks to explore into more innovative and sophisticated global treasury products, which is hindering the revenue maximization avenues of the banks.
There are three major factors responsible for this:
a. Lack of infrastructure to support treasury transactions
b. Unavailability of global market treasury products
c. Lack of expertise among the market players
Above three weaknesses are dealt in following sections in relation to various areas of treasury management:
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Assets & Liability Management (ALM)
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Foreign Exchange Management
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Money Market Operations
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Government Securities Operations
ALM
Primarily, Nepali Treasuries are confining their Assets and Liability Management functions to ‘Gap Analysis’, without doing much work in terms of number of stress tests, which is very important from the ALM perspective. If we conduct liquid asset ratio test for Nepali banks, it comes out misleading as most of the banks fund their G-sec portfolio from call market interbank borrowings. Unavailability of underwriting standards for appropriate stress testing is another factor for existing ALM practices in the Nepali market. Therefore, Nepali financial market needs to be more matured in terms of carefully managing their balance sheets from the ALM’s perspective. Some of the players have already burnt their figures due to failure in managing their ALM risks in an efficient manner. With increasing volumes and due to large swing in local and foreign currency interest rates, prudent ALM practices are becoming increasingly important.
FOREIGN EXCHANGE MANAGEMENT
The Nepali Forex Market Paradox
“Whenever there is a rainfall in India, we have no option but to open our umbrellas here”. This statement appropriately explains the Catch 22 situation of Nepal’s Treasury Market, which cannot get way from fixed parity system with India. This is mainly attributable to socio- political reasons, whereby there is free flow (and acceptability) of Indian rupee in and out of Nepal. This is facilitated by the long open border between the countries. Nepal’s huge interdependence with India in trade can be termed as primary reason for the need of fixed parity between the two countries.
Since NPR is pegged with Indian Rupee our actions are limited in following the trend of INR against US Dollar and other major currencies while determining the exchange rate between NPR and USD and other major currencies. If there is any factor which affects India’s dollar-rupee market, then it has a direct impact on USD/NPR exchange rate in Nepal. For example, if there is an increase in foreign direct investments (FDIs) in India which increases dollar supply in India, INR becomes stronger against USD and so does NPR. Similarly, if Reserve Bank of India (RBI) intervenes in the market by buying excess US dollars in order to protect Indian exporters, Nepali exporters are protected as well, by default. Or if there is a soaring demand of dollars among Indian corporates, especially to import raw materials, it raises the demand for USD, which leads to appreciation of USD against INR and again we have no choice but to follow Indian trend and appreciate USD against the local unit. There could be many more similar examples, where Nepali forex market is heavily dependent on Indian market.
However, this reliance on Indian market should not be considered as an excuse for a very primitive domestic foreign exchange market. There are certain structural weaknesses in Nepal such as:
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non-existence of two-way dollar-rupee market
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non-existence of standardized cross-currency spot market
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non-existence of forward exchange market
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non-availability of derivative products, viz. options, swaps, forwards, futures and other structured international treasury products
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lack of product expertise among the foreign exchange market players
The current situation of one-way quote, which is very basic and rudimentary, must be overcome by allowing bigger banks to take responsibilities of being market makers. This is a very basic requirement and must be considered as a first step to move forward. The moment two-way dollar rupee market is created, it will eradicate the need to quote the same dollar-rupee rate by almost all the banks in Nepal (by and large all the banks are quoting the same USD/NPR rate). Some time back, government-owned banks that were running under foreign management teams, had decided to get away from this system. However, they are back to square one again. In any case, these two large state-owned banks do not influence the forex market much, as in the recent years they have been primarily focused on restructuring the bank, rather than doing aggressive business.
When I shared this fact (same quotation of USD/NPR rates by all the banks) some time ago with one of my colleagues at HSBC Bank in Sri Lanka, it apparently became a good lunchtime joke for them. “How can all the banks quote the same rate? What kind of understanding is this? Where are the market forces? These were few questions asked by my Sri Lankan friends with a completely astonished feeling about Nepali market. But the reality is, with the current situation, there is no option but to have an understanding among the banks for quoting similar rate for US dollars.
We talk about the situation. What is the situation like? In management, “Contingency” or “Situational” approach is widely implemented and considered very popular. This phenomenon applies to forex market as well. In the absence of efficient market makers and an “open window” at regulator’s dealing room, country’s overall system is clearly struggling. If any bank is short or surplus in US dollars and if there is no corresponding demand or supply of US dollars in the market, banks normally have to proceed through the window of FEDAN. There are numerous instances where such purchase or sale transactions got delayed either due to lack of information flow or inefficiency in forex operations. In the absence of real-time dealing mechanism in our forex market, customers will keep paying the ultimate price of this inefficiency. This is one of the primary reasons for a higher spread of 60 basis points between buying and selling rates of US dollar.
Nepal being an import-based economy, most of the banks here are net buyers of foreign currencies, although of late inward remittance has primarily flushed the market with excess dollar liquidity. In present system, banks, more particularly the smaller ones, are required to hold on to dollars for relatively longer period of time, for which they are bearing the holding costs in terms of interest and exchange risks. Understandably, such costs borne by the banks are passed on to the customers.
Together with the absence of two-way dollar-rupee market, Nepal does not have a standardized cross-currency market. The need to go beyond the borders to the foreign banks for cross currency dealings, that too with one-way quote mechanism, has its own limitation. Again, unavailability of foreign exchange market makers in the country and non-existence of real time dealing system can be considered as the major factors behind this limitation.
There is no forward market and local rupee yield curve is not available-neither in G-sec nor in the call money market. These can be considered as other major limiting factors. If there is a need to do a 180-day forward, we can easily obtain a 180-day USD LIBOR rate, but for the local rupee 180-day rate, it might have to be referred from something which is already three months old. Moreover, an arbitrary method of adding 15 paisa for first fifteen days and 10 paisa each for every next 15 days sums up the primitive nature of our forward exchange market. Logically speaking, currently the importers (buyers of USD) should be getting discount while booking forward USD purchase transactions, as USD interest rates are higher than NPR. However, they are still being charged premium through the above-mentioned arbitrary method. Nepal’s Treasury market must move out of this inefficiency real fast.
The second step required is to do something about the lack of derivatives market. Nepali banking sector is highly primitive in terms of offering derivative products. Only plain vanilla forward contract products are being offered, that too with highly irrational pricing as mentioned above. There is no risk-based pricing available for these forward contract products. Some banks deal in plain vanilla foreign exchange swaps, however, only a few such transactions have been done so far. In the Nepali banking sector, there are no other derivative products like Interest-Rate Swaps, Options and Futures. When the entire world, including our very close South Asian neighbours, is widely practicing derivative products, we are yet to introduce most of these products in our market. Hence, it is very important to increase the knowledge level and application of derivative products among our market players. Banks need to invest in training and development of their human resources in Structured Derivatives. They also need to provide a constructive feedback to the central bank for establishing necessary infrastructure for developing the derivatives market.
Paradox in Interest Rates
While interest rates in India are rising, Nepal’s interest rates are remaining stagnant. Nepal’s interest rates have direct relation with the country’s developmental expenditure. Until and unless there is a conviction and environment for developmental expenditure to increase manyfold, one cannot expect NPR interest rates to rise. On the other hand, despite falling international oil price, the inflation rate is still higher. These two factors are pushing Nepal’s economy towards stagflation, which is not a good sign.
Hopefully, with stabilizing political and economic scenario, developmental expenditure along with capital investments will surge in Nepal and therefore the real interest rates will increase. In case we cannot move with the region in terms of interest rates, there will always be the threat of capital flight.
Bank treasuries in stagflationary situation need to be more careful while managing their balance sheets.
Open Market Operations (OMO)
Liquidity Monitoring Forecasting Framework (LMFF) under the OMO as guided by monetary policy of NRB can be considered as one positive development in Nepal’s Treasury market. Currently, LMFF indicator has highlighted that the market has tightening liquidity compared to the past. Hence the Standby Liquidity Facility (SLF) has been increased from 50% to 90% of the total government security holding of a bank concerned. When the central bank’s primary goal is to mop up excess liquidity from the market, keeping a conservative cap can be considered as a positive move.
Despite the problems mentioned above, the Nepali treasury market along with its market players need to be positive and must welcome positive changes in the market. A couple of years back, International Monetary Fund (IMF) did a survey on Nepal’s forex market and suggested certain reforms, such as creating advanced forex system and eradicating some of the limitations mentioned above.
Also, market players must have their vision out of the box in terms of educating themselves on the versatility of the forex market, which if operated in right manner, can have abundant opportunities in store for the country.
(The writer is Head of Financial Markets at Standard Chartered Bank-Nepal)
