Macro Economic Factors & Banking Industry: How They Influence Each Other?

February 23, 2021 | Mukunda Tripathee

Bank is a financial supermarket, where lots of financial facilities are available nowadays. Collecting scattered surplus money from the market and lending it to needy people only is a traditional concept of banking. Banking has become more advanced in our country too. Thus, banks and financial institutions (BFIs) have been providing a different chunk of financial services/facilities to the customers as and when needed. With the development of information technology (IT), BFIs have digitized their activities. Due to this, a customer can carry out different financial activities staying in a place through their laptop and smartphone via QR code, internet banking, IPS, POS, prepaid cards, and so on.

As of date mid-December-2020, more than 11.91 million people have been using mobile banking services. Likewise, more than one million people are using internet banking facilities. Similarly, there are more than 7.66 million debit cards, 168,000 credit cards, and 58,000 prepaid cardholders.

In Nepal, 27- A-class licensed institutions “commercial bank”, 19- B class licensed institutions “development bank”, and 21- C class licensed institutions “finance companies” have been conducting banking business. BFIs have been mobilizing Rs. 4,191 billion deposit and Rs. 3,522 billion credit into the country’s economy as of the date mid-December-2020. Total deposit to GDP is 111.25 % and total credit to GDP is 93.50%. So that, it is quite essential to everyone to have general information regard on this topic.  How would the banking industry and economic factors inter-relate and influence each other?

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Fiscal Policy

Fiscal policy is an economic policy dealing with economic stabilization, price stability, equal distribution of wealth and income, optimum use, and allocation of resources through the good management of public debt for the expressed purpose of government. Fiscal policy is concerned with the use of government expenditure and revenue to influence the economy. Government expenditure, public taxation, public debt, and government budget are the major instruments of fiscal policy. Fiscal policy has different implications in different countries. The developing countries use this policy to attain a sustained economic growth rate. Whereas, the developed economics use this policy for the stabilization of general price level and thereby the entire economy.

Further, fiscal policy is categorized in expansionary and contractionary. In the expansionary policy, the demand for goods and services will increase through the increasing of government expenditures or reducing the tax rate. Here, the government aims to expand the transactions by creating demand. This scenario is favorable to BFIs. BFIs shall have to supply more funds into the economy on one side. Likewise, on the other side, government expands its facilities to the public through different economic and development activities. Which leads to the increase in the demand for loans and investment opportunities to BFIs.

On the contrary, if the fiscal policy aims to reduce the demand for goods and services in the economy through the reduction of government expenditures or increase taxation it is known as a contractionary policy. This scenario is not favorable to BFIs. This tightens the bank’s lending due to contractions of demand of goods and services, and economic and development activities of nations. Likewise, people would have to pay more charges for the goods and services.

Monetary Policy

Monetary policy is concerned with controlling and managing of money of a nation for economic stabilization and supporting economic growth adjusting the quantity of money, credit, and cost of credit exercised by the central bank. Managing adequate liquidity for economic growth, maintaining stability, redistribution of income and wealth through measures of financial access and directed credit programs are the major objectives of monetary policy.

Monetary policy is an important instrument for economic stabilization and influences the cost and supply of money. Open market operations, bank rate, cash reserve ratio (CRR), statutory liquidity ratio (SLR), credit to core capital and domestic deposit ratio (CCD-Ratio), capital adequacy ratio (CAR), single obligor limit (SOL), regulatory requirement portfolio, regulatory retail portfolio (RRP), etc. are the major instruments of monetary policy.

If the monetary policy is expansionary, it will be supportive for the banking business and creates more opportunities to invest the fund to the secured sectors by BFIs. If the scenario is reversed, a huge amount of fund/investment is required to maintain CRR and SLR, more funds shall be maintained for liquidity and CCD. Banks cannot invest more amount in a single unit because of SLR. This would lead to contractions of the bank’s business and profit, which would have a significant impact on government revenue as well.

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Inflation is a stage where the purchasing power of currency will decline over the period. Consequently, the general level of prices of goods and services will rise. Inflation is the result of excess aggregate demand over the available aggregate supply and true inflation would start only when full employment happens as per the modern theory of inflation.

As per the NRB report, in mid-February 2019, the overall inflation of Nepal was 4.3%. Likewise, in mid-January and mid-February 2020 overall inflation was stood 6.82 and 6.87 % respectively. This means the purchasing power of currency was gradually increasing in the reviewed period. Real activity is negatively correlated with inflation through the money demand effect. If the general level of prices of goods and services is raised, then more money is required to fulfill/obtain goods. Thus, it will directly impact the saving/investment. So, there would be fewer investment opportunities for BFIs. Both high inflation and deflation are not better for the economy.

So, price stability and proper money supply in the market should be done wisely and demand and supply of goods shall be adjusted as per market scenario.

Foreign Exchange Rate

The rate at which one unit of foreign currency expressed in terms of the unit of home currency is the foreign exchange rate. Likewise, it is the amount of the local currency essential to buy one unit of foreign currency. The foreign exchange rate plays a crucial role in international trade. Basically, it is required for carrying our merchandise goods and services between countries, for the smooth movement of a natural person for the different purpose across the border of different countries and in order to keep records of the capital transfer and capital investment between or among countries.

When the rate of foreign exchange increases, we have to pay more domestic currency to buy foreign currency. It means domestic currency devaluates. Thus, the higher domestic currency would have to be paid while importing merchandized goods and services. As a result, the price of imported goods and services increases. This decreases the demand for goods and services in the domestic country. This would lead to a slowdown in the economic transaction of the nation. Thus, the demand for import business loans will decline for the BFIs. Letter of credit, Telegraphic transfer, the draft-related transactions would be decreased. Which, directly impacts the bank’s funded and non-funded income. It is not a favorable scenario to the BFIs business and the domestic country as well.

However, the export-related business would be benefited in case of an increase in the foreign exchange rate. The demand of export-related business loans would increase in BFIs. Thus, BFIs would provide different funded and non-funded facilities to exports related business houses.

As per data released by NRB under the title of Current Macroeconomic and Financial Situation of Nepal based on Mid-November, 2020/21, the Balance of Payment of Nepal stood as a surplus of Rs. 110.65 billion in the review period. It means excess exported over the imported in economic transactions of the nation.

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Gross Domestic Product

Gross domestic product (GDP) is the sum total of the value of goods and services produced during a given period of time through the use of domestically produced resources. GDP is a number that expresses the worth of the output of a country in local currency. GDP is widely used by economists to follow how the economy is moving. Higher GDP represents the economic prosperity of the country.

If economic activities are growing gradually, there would be an opportunity to invest money into different sectors. Thus, demand for loans will increase. BFIs shall lend money to productive sectors on the basis of choice. So that, the demand for deposit and credit will increase. BFIs would encourage to people to save their earning in to banks to collect loanable funds. With the increase of GDP, the prosperity of BFIs is possible. The government can increase the demand of good and services in the economy by increasing government expenditures and consumption.

Industrial Production Growth

Industry is a business house that produces goods and services by using different resources. Country’s prosperity is possible through industries only. The government would be benefited from tax, investors would get good returns for their investment, the public would get qualitative goods and services at a reasonable price, employment services, and investment opportunities in to shares and debentures.

Similarly, BFIs would be benefited through the industry. BFIs are seeking secured investment sectors. Thus, BFIs offers different kinds of services to industries such as long-term loans, short-term loans, demand loans, bank guarantees, letter of credits, telegraphic transfers, drafts, and so on. If the numbers of business organizations are growing, bank’s business and facilities would be growing voluminously. So, banks and business houses both will be in win-win situations.

(Mr. Mukunda Tripathee is currently working in the banking sector.)

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