Interest rates corridor comes into implementation

Published On: August 10, 2016 01:10 AM NPT By: Sagar Ghimire  | @sagarghi

KATHMANDU, Aug 10: Nepal Rastra Bank (NRB) is introducing interest rates corridor system from Wednesday as part of its effort to control the interest rates volatility that has been grappling the banking and financial system.

The new system, which was announced in the monetary policy for the current fiscal year, aims to keep interest rates within a certain band.

This means that there will be an upper bound and lower bound of interest rates. The rates cannot fall below the lower bound, while it cannot go higher than upper bound.

"The main thrust of the interest rates corridor system is to keep interest rates at a desired level so that there is no big fluctuation in rates," Min Bahadur Shrestha, an executive director of NRB, says.

The interest rates corridor idea was first floated by the then NRB Governor Yuba Raj Khatiwada in the monetary policy for 2012/13. But the policy could not be implemented then. Even the International Monetary Fund (IMF) has for the past many years been recommending that the central bank pursue the interest rate corridor system. In its Article IV Consultation Report last year, IMF said that a key recommendation has been for NRB to adopt an interest rate corridor to provide more systematic guidance to short-term interest rates with a view to strengthening the monetary transmission mechanism.

It had made such recommendation in 2014 as well.

IMF seemed to be satisfied by the central bank officials' consideration to implement its recommendation as it had stated in the report of 2015 that the recommendation regarding the interest rate corridor system is 'under consideration for implementation over the longer-term'.

The central bank has determined the statutory liquidity facility (SLF) rate as the upper bound for the interest rate, while the lower bound has been fixed at 0.3045 percent.

SLF refers to the money that banks borrow from the central bank by keeping the government bills as collateral for five days. That means the gap between the upper bound and lower bound will be 6.696 percent.

And this 'huge' gap between the ceiling and the floor rates has left the bankers worried.

"The main objective of the interest rates corridor system is to keep the interest rates to a certain range. This system was long overdue in Nepal's banking system which has been observing frequent swings in interest rates," Bhuvan Dahal, CEO of Sanima Bank Ltd, says. "However, there is a huge gap between the upper bound and lower bound. The 7 percent ceiling versus 0.3045 percent floor in the corridor does not help to meet the very objective of keeping interest rates in a certain range."

According to Dahal, the 6.696 percent gap does not bode well for the banking system at a time when the central bank has fixed 5 percent interest spread cap for the commercial banks.

The lower and upper bound gap in the interest rate corridor system is 1 percent in India.

NRB officials say that they will 'narrow down' the corridor range gradually. "This is not the desired gap. This would be narrowed down gradually, say in three months. Even in India, the 3 percent gap was brought down to 1 percent from two percent," Shrestha, the executive director at the Public Debt Management at the NRB, says.

Bankers say that the implementation of the interest rates corridor is a 'good beginning' which would be passed on to the depositors and borrowers.

"Such upper bound rates, which the central bank charges to inject money, and lower bound, which we get from the central bank, will not become volatile. So will be the deposit and borrowing rates as there will be transmission of the policy," says Dahal. "We hope that the central bank will take into consideration the huge gap as we move along on the new system. Nevertheless, we have taken the bus, and the speed, stops and other factors will be reviewed as we move on,” he adds.

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