Behind the Numbers: How NRB directives promote interest rate hikes ?

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Interest rates play a crucial role in the growth of the economy by influencing spending and investment. Lower interest rates encourage borrowing and consumption, whereas higher interest rates discourage both, thus playing a pivotal role in either boosting or slowing down the economy. Interest rates also affect inflation, currency exchange rates, direct resources and investment, and maintain financial stability. Overall, interest rates are powerful tools used by central banks to manage the economy and guide it toward desired outcomes. During periods of declining interest rates, everyone tends to think that everything is okay; however, there are some anomalies in the directives and regulations issued by NRB (Nepal Rastra Bank), the central banks that support higher deposit rates. Let's discuss this further.

Does NRB regulation promote for BFI's interest rate hike?

Currently, we are experiencing declining deposits rates offered by BFIs. However, we were experiencing opposite scenario, few months back. In the month of Ashwin, Interest rates were hiked by some commercial banks, despite the central bank lowering policy rates. This move from large commercial banks like NABIL, Standard Chartered, and Everest was in opposition to the expectations of the general public. We even experienced higher interest rate offerings from commercial banks than development banks in fixed deposits. However, on analyzing closely the directives issued by the NRB, and the risks faced by commercial banks hike in interest rates had been an expected move by Banks.

NRB regulations and their impact on interest rates

NRB regulation prescribes lending rates in Nepal to be determined on a base rate plus a premium mechanism. This results in more incentives for lower base rates to borrowers, as the income of BFIs will be derived from the spread/premium charged on loans, regardless of higher/lower interest rates. Under the current interest rate setting mechanism, the profitability of Banks and Financial Institutions (BFIs) depends on the following factors:

·       Amount of funds lent to borrowers

·       Spread rate / premium charged on the loan.

The limited spread rate allowed over the base rate requires BFIs to increase loanable funds, the primary source of which is deposits.

The higher deposit rate offerings are required to attract new depositors and also to retain existing deposit holders, where peers are offering higher rates. The interest rates published by BFIs in Bhadra and Ashwin, after the end of interest rate cartelization, showed a contrast in the action of BFIs in just two months. All the BFIs offering higher fixed deposit rates in Bhadra had reduced their deposit rates in Ashwin whereas, BFIs offering lower deposit rates in Bhadra had hiked the deposit rates. This reduces the deposit rates offerings gap between BFIs.

Hike in deposit rates to maintain investible funds despite excess CD ratio

The current NRB directives also require BFIs to publish deposit rates on a monthly basis and change in deposit rates offered in the particular month shall not exceed 10% of the average deposit rate offered by the industry in the previous month. This provision exposes risks of deposits shifting on BFI's offering lower interest rates within a month (short period). BFIs with lower deposit rates like Himalayan, Everest, Nepal Investment Mega, and Standard Chartered were obliged to increase the deposit rates to maintain the current level of deposits to finance their lending despite operating with an excess CD ratio, expecting favorable lending environment in the future.

Targeting institutional investors

Further, BFIs might also requires to choose a strategic move to target large institutional investors with deposit rate hikes on individuals as current regulation requires a 200 basis point difference between individual and institutional fixed deposit rates as the deposit market of Nepal is largely ruled by institutional investors like Insurance Companies, retirement pension schemes, and Telecommunication companies, amongst others.

Regulations favoring merged entities:

The NRB regulation provides additional spread rate facility for the period of one year in case of merged BFIs. This temporary incentive for merged banks also contributes to the higher deposit rates to get additional investible funds at the end of additional spread rate facility. As additional investments  and investible funds are crucial to maintain the same level of profitability after the lapse of additional spread rate facility.

My opinion on the matter

In my opinion, NRB regulations plays a role in the determination of interest rates by BFIs. The base rate plus premium mechanism incentivizes banks to compete for deposits by offering higher interest rates. Additionally, the monthly publication of deposit rates and the cap on individual rates relative to institutional rates create further pressure on banks to raise rates as deposit markets are ruled by the institutional depositors. However, it is important to note that other factors, such as economic conditions and bank-specific risk assessments, also play a role in interest rate decisions.

Conclusion

The interest rate hike in Nepal is a complex issue with no easy answers. NRB regulations will likely play a role, but other factors are also at play. It is important to consider all of these factors when trying to understand why interest rates rises?

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