Excess Liquidity in Financial System Triggers Decline in Money Value as Deposits Increase

April 6, Kathmandu – The value of money in deposits kept with banks and financial institutions is steadily falling. This decline in value is attributed to decreased interest rates driven by excess liquidity in the financial system.

Generally, to prevent depreciation in money value, interest rates in the market must at least align with inflation rates. Nepal Rastra Bank has reported a 3.62 percent inflation rate for the month of Falgun, whereas the maximum interest rate on savings stands at 2.75 percent.

This situation arises partly because the central bank has set the lower limit of the interest rate corridor. Without such control, the abundant liquidity might push interest rates even lower.

Economist Dr. Ramesh Paudel explains that since inflation outpaces the interest rates offered on deposits by banks and financial institutions, the real value of money is declining.

“Fluctuations in inflation and interest rates determine whether the value of money rises or falls,” Paudel elaborated. “According to economic principles, the interest rate on savings should at least equal inflation; if it is lower, the money’s value diminishes.”

He further noted that while money supply in the financial system has increased, demand remains steady, creating excess liquidity.

To date, approximately NPR 1.1 trillion has been deposited in the financial system. Paudel suggests that to improve the situation and enhance money value, efforts must focus on expanding investment. Additionally, he emphasized the government’s role in developing solutions to effectively utilize the excess liquidity present in the financial sector.

Former Central Bank Executive Director Narbahadur Thapa considers the increase in deposits a positive development but warns that the lack of corresponding growth in investments is a negative issue.

He stressed the importance of channeling financial resources into capital formation and business expansion.

“It is regrettable if the available financial resources are not invested properly,” Thapa stated. “The government must implement policy measures to manage the surplus liquidity and direct those funds towards development and job creation.”

Thapa also expressed that along with ongoing administrative reforms, the government needs to take effective actions for economic reform.

“Only by introducing solid economic plans in tandem with governance reforms will the financial system improve, facilitating resource mobilisation and employment generation,” he added.

He reiterated that investments from the financial sector should focus on business growth and capital building.

Thapa lamented that savers are not receiving adequate returns amid high liquidity. “While inflation is rising, the interest rates on savings are unable to keep pace with inflation,” he said. “Without serious reforms and direction in the economy, the current situation may worsen without meaningful change.”

He expressed hope that the upcoming fiscal budget would bring positive economic improvements. “If issues are overlooked in the budget, the economic situation could become complicated,” he cautioned. “Economic reforms must accompany administrative reforms to steer the economy in a new direction.”

According to Nepal Rastra Bank data up to Wednesday, total deposits in banks and financial institutions amounted to NPR 7.941 trillion, exceeding Nepal’s GDP by 20 percent.

The National Statistics Office estimates the current fiscal year’s GDP at NPR 6.6 trillion. The slower economic momentum alongside rising remittances and exports has contributed to growing deposits in the financial system, which in turn reduces the real value of money.

The income generated from deposits held at banks and financial institutions appears low due to excess liquidity. Consequently, the central bank has utilized instruments ranging from long-term bonds to short-term fixed deposit schemes to absorb NPR 1.09 trillion.

The status of total deposits and loan investments in the financial sector indicates that demand for credit has not risen sufficiently. Currently, banks and financial institutions maintain an average loan-to-deposit ratio of 73.23 percent.

The central bank has had to allocate significant annual expenditure for managing liquidity; in the previous fiscal year alone, NPR 1 billion was spent on liquidity management.

Despite an increase in default rates on old loans, banks are cautious with new lending, which keeps investments below expected levels. Slow investment results in money accumulating within the financial system. However, continuous growth in deposits without economic activity improvements signals a negative outlook for the economy.

As of April 5, total deposits in banks and financial institutions reached NPR 7.945 trillion, while total loan investments were NPR 5.878 trillion. According to central bank statistics, commercial banks hold NPR 7.165 trillion in deposits, with development banks and finance companies holding NPR 0.781 trillion.

This data reflects a slowdown in loan demand growth. The average loan-to-deposit ratio for banks and financial institutions is 73.23 percent but has the potential to reach up to 90 percent. Up to Falgun, loans disbursed to the private sector increased by 4.4 percent, equivalent to NPR 243.54 billion.