Following the Cash

Our economy is the combination of simple day to day activities together forming a complex macro system. For instance, every activity in the economy may seem independent however the catalyst of all these activities being cash/money printed by Nepal Rastra Bank (NRB) links them all. So every favorable or reverse situation in one part of the economy causes a domino effect in the whole economy when the regular velocity of money is disturbed. In the present case, we can see it due to the Covid-19 crisis.

The very link to the economic activities, money, has its own interesting story. As we all know that money, paper or in other forms, can only be produced by the NRB its flow is also controlled by the very institution. When the printed money is circulated in the economy, it is done through various BFIs (Banking and Financial Institutions). We all know that these BFIs charge a certain rate of interest when flowing money to the economy. These rates of interest in a normal sense are extra burden to the borrowers. They pay these interests through their productivity and the BFIs primarily survive through these paid interest. The interest in itself is paid in terms of money on top of the borrowed amount. This leads to an interesting phenomenon where more money is to be printed to pay the interest of the previously printed money. It is simply because we cannot deposit productivity as payments of interest to our banks.

Looking this way we can say that a BFI survives due to the ever-growing productivity of its borrower. As the Covid-19 pandemic has reduced the productivity of majority borrowers, the interest income has reduced. This is ultimately producing pressure to the reserves of BFIs as they are obliged to pay their fixed cost, interest to the deposits along with other expenses. If the economy remains what it is right now for a long period of time, ultimately the present banking system may collapse. This, in turn,  would create havoc to the present system of the economy.

 

One of the solutions to contain this havoc may be more circulation of the money in the economy. This in turn would accelerate the supply push inflation in the economy which would again not justify present compensation to productivity in the economy. The only rational solution can be an increase in the capital base of all BFIs to absorb the economic shock and adequate insurance and re-insurance of the banking system as a whole.

Now how do we increase the capital base in the banking industry when the future is uncertain? Even investors of the industry have limited cash in this adverse situation. The solution here can me mergers- some mega, some micro, and some mini. These mergers should be executed depending upon the risk associated with the portfolio managed by respective BFIs and not just the ownership cross-holdings.

This would not only create a stable banking system and the economy but also give stability in the capital market system of Nepal where the majority of scripts traders are of this particular industry.

– Astitwa Sharma

(The writer is an investor in the capital markets of Nepal for a decade with exposure to Indian Capital Markets. You can reach out to him via twitter: twitter.com/@DGywali )