A July 13 decision by the Nepal Bankers’ Association, which is an umbrella organisation of the nation’s 20 commercial banks, to allow its members to freely fix interest rates on deposits and loans as they see fit drew widespread praise. Previously, rates were set by the association, and its decision was binding on all its members. NIC Asia Bank tried once to go on its own, but was soon forced to join the herd as it was ostracised by fellow banks. In a budding market economy, the centrally decided uniformity in rates among leading banks reflects poorly on banking leadership, including Nepal Rastra Bank, the nation’s central bank, whose job it is to regulate not to let this type of collusion take place at all.

It is anyone’s guess as to what might have led the association to change course. Finance Minister Prakash Sharan Mahat has a PhD from a United States university, so it is possible he gave these executives a lesson or two about free markets. There is also no shortage of loanable funds currently. Banks are wallowing in deposits, and loan demand is not keeping pace. As of mid-July, commercial banks held Rs5,086 billion in deposits and Rs4,309 in loans. Whatever the motive behind the association’s action, there is, however, no guarantee that it will not revert to the old practice. In fact, in December 2018, it similarly removed a cap on fixed deposits, giving the then 28 members autonomy, only to renege on it later.

The irony in all this is that this has the tacit approval of Nepal Rastra Bank, which counts interest rates as its primary policy tool. It is a shame that one after another governor has given the association free rein to thumb its nose at the central bank. The price of money is being fixed within four walls and not through the supply-demand dynamics of markets. Long term, the association is being penny wise and pound foolish by choosing the easy way out now at the cost of not being ready to compete with international players tomorrow. The bigger irony is that it takes umbrage at suggestions that its behaviour equates to a cartel. If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

Cartel-like behaviour

In a cartel, rivals in the same industry seek to reduce competition by agreeing to control prices. The tricks used include collusive bidding, market carving, reduction of supply, price fixing and so forth. The biggest downside to this market anomaly is that lack of competition leads to lack of innovation. The members of the cartel benefit, of course, but the consumer and competition suffer. Cartel members lack exposure to competitive market forces, hence they will not be ready when the tough times arrive. Consumers, on the other hand, are left with no choice. If, for instance, they do not like how rates are fixed by commercial banks, they can go to development banks, which not only lack scale but also charge higher rates.

The lack of a genuinely competitive environment is evident in the spread rate, which is the difference between what commercial banks pay their depositors and what they charge on loans. The higher the spread, the higher the interest income for banks. At present, there is plenty of liquidity in the system. The credit-to-deposit ratio is well under the Nepal Rastra Bank-mandated 90 percent. One would think these banks would use any legitimate means possible to compete for business. Ideally, a bank with higher liquidity and lower risk can afford to lower its spread to generate loan demand. A lower spread rate enables that by lowering the rate at which loans are being disbursed. This, however, is not the case.

Commercial banks were required to lower their spread rate to 4 percent by mid-July, which marks the end of the 2022-23 fiscal year; seven of the 20–Nabil, Nepal Investment Mega, Kumari, Global IME, Prabhu, Himalayan and Laxmi Sunrise–were still north of 4 percent. They, however, will not be breaking any rule; they merged last year. As one of the carrots used by Nepal Rastra Bank to prod commercial banks into merger and acquisition, merged banks were allowed a spread of 5 percent by mid-July. If they felt competitors could come after their lunch, they would feel the need to lower the spread to be at least on par with competition, just so they do not at least risk losing market share.

Mispriced assets

What the Nepal Bankers’ Association practices amounts to rate manipulation. The Libor scandal in this regard is worth a look. The London Interbank Offered Rate was a key benchmark for setting the interest rates on variable-rate mortgages, credit default swaps and asset-backed securities. Each day, estimates from up to 18 global banks, including Deutsche, Barclays, JPMorgan Chase and UBS, were collected. In the US, the Secured Overnight Financing Rate, which is based on the rates US banks pay each other for overnight loans, has now replaced Libor, which was based on participating banks’ submissions of ideas on what they think they would pay, leaving room for manipulation. Manipulate they did–big time.

In 2012, it was revealed that traders at several of the 18 institutions colluded with each other to manipulate Libor. They sought to influence Libor by purposely submitting artificially low or high interest rates with a view to support their employers’ derivative and trading activities. This resulted in mispriced assets throughout the global financial system. Libor was once used in over $200 trillion of financial instruments. Later, several traders served jail time for the rate rigging; Libor itself has been phased out. The rate-setting collusion in Nepal is nowhere near in scale as the Libor scandal, but customers–its primary assets–are indeed taken for a ride, by either paying less on deposits or charging more on loans.

Banking executives seem to forget that banking is not like any other business solely motivated by profit. It is a cliché, but preservation of customer deposits should be the guiding force, not the bottom line. Willingness to collude is a sign that they are ready to abuse the power customers have given them. If not stopped in time, this can get worse as there are fewer and fewer of these banks. Incidentally, quite a few of them are controlled by big business houses with a presence in several other businesses. If these managements judge it proper to collude on interest rates, risks arise collusion might take place elsewhere. This is a serious matter, and needs to be openly discussed in the Cabinet.