NRB likely to further reduce interest rate spread cap

Published On: June 28, 2017 01:20 AM NPT By: Republica  | @RepublicaNepal

KATHMANDU, June 28: Nepal Rastra Bank (NRB) officials have hinted that the central bank may further reduce interest spread for bank and financial institutions (BFIs) from the monetary policy of the upcoming fiscal year 2017/18. 

As commercial banks have been maintaining huge profitability despite the banking industry facing liquidity crunch, the central bank is preparing to narrow down the 5 percent interest spread between deposits and lending rates. However, the central bank officials have not said yet by how much percent the interest spread rates will be reduced. 

Interest spread rate in general refers to the difference between deposit rate offered by a bank and interest rate that it charges on credit.

The central bank had introduced average interest spread of 5 percent through the monetary policy of fiscal year 2013/14, prompting objections from the banking executives.

However, the BFIs were convinced with the new measure after the central bank allowed some flexibility in the calculation of such spread in line with the demand of the bankers. 

The spread rate cap would mean that banks have to offer higher rates if they charge high interest rates to borrower or vice-versa. 

By capping interest spread at an average of 5 percent, the central bank had made it mandatory for BFIs to reduce difference between their interest rates on deposit and lending to 5 percent with some relaxation on calculation. This relaxation means there would not be net 5 percent difference. 

“The 5 percent interest spread has never been good. This disparity of interest between deposit and lending has not helped in the development of the private sector. Nor has the high intermediary cost helped in encouraging businesses,” said Nara Bahadur Thapa, an executive director at the NRBs said, signaling that there could be further reduction in the spread rate cap. “Such rate is 3 percent in India, while it is even lower in other advanced economies. The spread interest rate is very high in Nepal and we are not satisfied with it,” Thapa, who heads the Research Department of the NRB, told Republica.

The central bank's preparation to reduce spread rate comes in the wake of concerns from the business community that the lending rates have remained very high even when banks were offering low returns on deposits. Bringing down spread rate is one of the plans that the government has put in its priority for financial development of the country. In its Financial Sector Development Strategy (2016/17-2020/21), the Ministry of Finance has stated that its plan is to reduce the spread rate from existing 5 percent. 

The strategy has a target to bring spread rate down to 4.4 percent by Fiscal Year 2020/21.

NRB officials have been frequently expressing their dissatisfaction over the failure of the BFIs in implementing the 5 percent average interest spread and controlling anomalies in interest rates. 

Earlier on February 8, the central bank had summoned bankers for moral suasion where the NRB Governor Chiranjibi Nepal issued a strong-worded warning to the BFIs over their inefficiency to implement the 5 percent spread rate. The suasion, a tactic used by the central bank to influence and put pressure on banks into adhering to its policy, was issued when the financial friction was being seen in the banking industry due to aggressive lending practices of the BFIs despite slow deposit growth, leading to the breach of prudential lending limits. 

“Our attention has been drawn toward the practice of raising lending rates by 5/6 percentage points at once. While the rate of fixed deposits has been raised, the interest rates of small and longer-term deposits have been kept unchanged. As the 5 percent interest spread is seemingly becoming inefficient, the Nepal Rastra Bank has been compelled to think about this,” read the statement issued by the central bank after the meeting with bankers.

Bankers, however, argue that the cap on interest spread rate would kill the efficiency of the BFIs instead. “Interest spread rate cap are imposed in countries where there is monopoly or duopoly. There is a stiff competition in banking industry here which means there is competition for interest rates also. When banks want to maintain return on equity through their efficiency, why should there be cap on the interest spread rate?” Bhuvan Dahal, an executive member of Nepal Bankers' Association questioned.

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