A Realty Check

Wednesday - 11th February, 2009 | ResCon

Preamble

Realty Sector has been one of the lucrative investments for Nepalese banks/lending institutions for couple of years now. The steady and increasing amount of inflow of remittance has been credited for this housing boom. But given the current global financial crisis, instigated by the subprime meltdown in the US, it certainly forces everyone in Nepal to ponder about the housing boom here itself. And that further leads to the burning question of the moment: Are the lending institutions, esp. the banks, shielded from the exposure to realty meltdown in Nepal?

If we look into investment portfolios of Nepalese banks, it clearly shows that realty sector has a huge share of the pie. The present statistics show that on an average a bank has around 57% of its investment in real state. The main reasons behind such an overwhelming presence of realty sector in banks’ portfolios are as follows:

  1. Demand for houses/lands
  2. High faith of Bankers in Realty sector
  3. Profit margin for the banks 

HouseDriven by the above key points, many Nepalese banks have footprints in realty sector. Agriculture Development Bank of Nepal has invested 99% of total investment in this particular sector while Standard Chartered Bank has 38% investment in real estate. Not only the old and established banks but also the new banks are eagerly investing a considerable amount in real state by giving it a major priority. Prime Bank and Bank of Asia have invested 86% and 82% of total investment in Realty respectively.

When will the boom backfire?
As we all know a bank accepts deposits and channelizes that to loans. For every amount it accepts as deposits it pays interest and for every amount it lends, it receives interest. Hence the interest differential becomes the major source of income for the bank. Now let’s exemplify the above statement within the realty domain. For ease of understanding, let’s assume a single depositor (X) and single customer (Y) taking loan. X deposits Rs 100 at the bank and as part of the scheme receives Rs 10 as annual interest. Now let’s say the bank lends Rs 100 to Y and receives Rs 12 as annual interest income. From the interest income, the bank will now pay Rs 10 to X as interest for deposit and keeps Rs 2 as the net income. As far as Y pays interest charge to bank, everything is smooth and good. But as and when Y stops paying interest charge to the bank, the problem arises. As you see from the above example, the bank is paying the interest to X through the interest income it receives from Y. Now as Y stops paying the interest charge, bank will also have difficulties paying the interest to the depositor. Let’s assume that the bank is not at all able to recover the loan and is forced to announce it as bad loan (non-performing loan). Thus at the end of this event, Rs 100 is wiped off and bank is now forced to file for bankruptcy. If we extrapolate the above instance to bigger sample, the gravity of situation can be easily seen. That is when we will have a housing boon turning into a curse.    

Apart from the above point, our bank may face the dire situation if the following case arises. Many banks around the world were hit by the financial crisis triggered by Subprime lending as they had purchased the “Subprime Mortgage Package”. Since Nepalese banks didn’t have enough capacity to purchase subprime mortgage package, they were free from the crisis. But if the foreign banks, where the Nepalese banks have deposited their money, were to declare insolvent, it will then impact our economy directly. The Nepalese banks will lose their money which in turn will spurt the crisis in Nepal too.

Statistics Check

  1. Present statistics show no liquidity problem in the current fiscal system, according to Nepal Rastra Bank (NRB).  A statement by the central bank shows that the announcement of Rs 1 billion Treasury Bill was able to attract Rs 4.222 billion from the market. This clearly shows the amount of liquidity present in the market.
  2. Nepal has witnessed a strong growth in remittance inflow and exports, two critical sectors of the economy, in the first two months of the current fiscal year, says a report of NRB. During the period, the country received Rs. 31.88 billion as remittance from Nepalese working abroad. The figure is a whopping 74 percent rise over the receipts for the same period last year.
  3. Likewise, the country’s total exports bounced back by more than one-third and touched Rs. 13.46 billion in the first two months of 2008/09, compared to a decline of 3 percent in the same period last year. Of the total exports, sales to India - Nepal’s largest market - went up by over 12 percent to reach Rs. 7.28 billion. Exports to other countries also soared by 82 percent and amounted to Rs. 6.17 billion.
  4. As per the Quarterly Highlights published by NRB for Q1 of 2065/2066, 17 out of 23 commercial banks have non performing asset below 5% margin. This clearly shows the health of these lending institutions and further, we can safely assume that the customers of these banks haven’t defaulted (unlike in the US).

Hence, rolling all above statistics into one, we can, at the moment, say that our economy is liquid and the loans provided by many lending institutions are good. As long as we have the above facts going for us, there is no need to panic.

What do the experts say?

According to Anil Shah, the CEO of Nabil Bank Ltd., “The crisis may gradually impact the financial institutions of Nepal. The country has been facing a problem of capital flight since 3- 4 years ago. Investors have taken loan by pledging their property. All those capital have been invested in share market and real estates. If real estate and stock market deteriorate, banks will be on crisis situation because they may not able to get their loan. So, the banks should be alert and conscious about their future security.”

Radesh Pant, President of Nepal Bankers’ Association and CEO of Bank of Kathmandu; Dr. Chiranjivi Nepal, former chairman of the SEBON and Mr. Rewat Bahadur Kark, Chairman of NEPSE also said that the present financial crisis will not affect Nepal because it doesn’t have any direct link with the world. “We may be affected little on the part of export and remittance, but real estate and share market do not have any reason to be affected”, Radesh Pant said.

What does ResCon say?
The current global financial crisis has taught us many lessons. All the relevant stakeholders- esp. the Bankers & central regulator - NRB, must analyze this situation and ensure that such a financial crisis doesn’t hit Nepal. Bankers must be cautious while giving loans while NRB must be coming up with necessary policies and regulations to provide check and balance mechanism in the economy as and when needed. Realty sector still remains one of the lucrative areas for our banks and our bankers must responsibly provide loans to those who have sound financial health. As of now, based on the data available, we don’t see a crisis in the housing sector. Lending institutions are healthy and their customers are healthy too.

The present world crisis may not directly affect our economy, but we need to be vigilant enough and better prepare ourselves to ward off the evil should it strike.