Bankers' Insight & Issues

Bhutanese Economy and Banking Sector; Category: Business article December 2015 Author : P.B. Moktan The economic environment of Bhutan is in challenging phase with increasing macroeconomic imbalances, inappropriate macroeconomic policies, and deep uncertainty fueled by trade deficit with India and acute rupee shortage in the country. Annual credit growth rate decreased from average 33% in 2012, to below 10 percent in 2014 due to credit restriction imposed by RMA in import driven sectors. Since then, and following the re- introduction of housing and vehicle loans in September 2014  (suspended in 2012), annual credit growth rate has slightly increased to 13.5 % as of March 2015 from 9.4 % as of December 2014. However, real activity in the economy is sharply contracting, with GDP growth of only 2.1% as of Dec 2014 and inflation rate hovering around 6-7% during the year. Unsustainable fiscal imbalances, loose monetary conditions and trade deficit with India were key to the deteriorating situation in Bhutanese economy. The government deficit is increasing every year without proper fiscal deficit management policy in place and a sharp increase in central bank financing of the government deficit by way of special WMA with RMA and Bank of Bhutan and 91-day Govt. treasury bills. The policy response to the deteriorating situation has been inappropriate. Expansionary monetary policy measures; e.g., a lowering of reserve requirements from 17% to 10% in 2012 and further from 10% to 5% in 2013 and Govt. ESP of around nu. 2.1 bn injection in banks have further worsened the excess liquidity conditions in banking sectors coupled with restriction imposed in lending side creating further mist-match in the balance sheet. For e.g; BoBL alone had excess liquidity of nu. 6.3 bn as on December, 2013 further increased to 13.3 bn as of Dec 2014. The ensuing excess liquidity induced a drop in treasury bill rates from 2.3 percent to below 0.14 percent in 2015. Recently RMA has increased the CRR from 5% to 10 % basically to mob-up the excess liquidity from the banking system, which did not give any respite to the banks in reality. Contrary to this situation other banks’ base rate dropped by 45 basis point in an average whereas BOBL increased by 17 basis point in 2015.  The base rate decreased in other banks were primarily attributed to their prudent liquidity management practices; since many banks were cautious when it came to accepting large deposits. Banks were not interested to accept deposits since they were already flooded with excess deposit. This ultimately resulted in lower cost of fund, resulting in decreased their base rates. On the other hand, BoBL has contradicting goal; to be as competitive as private bank but with social mandate precluding from partaking in free market competition. Consequences of this contradictory goal forced bank to accept deposits resulting in increased in base rate of the bank. The reduction in nominal interest rate means that together with an inflation rate of 6.2 percent, real interest rates are sharply negative. The deteriorating macroeconomic environment has put considerable strain on the financial condition of the banking system. Even though the system has proved so far to be remarkably resilient, some banks have been weakened considerably, and are prone to further deterioration in light of the significant risks. Reported high capital adequacy ratios found to be overstated due to insufficient provisioning. In addition, asset quality has deteriorated. The ratio of gross nonperforming loans (NPAs) to total loans has increased from 3 percent as of 2012 to 9.8 percent at the end of 2014 on an average in the economy. The banking sector of Bhutan consists of 5 banks. Two of them are state-owned, two are domestic privately owned and one foreign privately owned bank. The banking system, have been plagued by a large stock of NPAs and weak provisioning practices. The Banking sector in Bhutan is not yet in compliance with the Basel Core Principles for Banking Supervision (BCP), it suggests that even though existing loan classification and provisioning rules are broadly adequate, they are not well implemented in practice and banks are under provisioned in terms of operation risk and credit risk management. Disclaimer : The views expressed in this working paper are those of the author(s) and do not necessarily represent any banks or institutes.