Nepal Rastra Bank’s new rule to calculate the spread rate is bound to affect bank profits, even as the central bank has defended the rule saying that it is more rational to calculate the spread rate that would have negligible impact on the banks’ earnings.

The spread rate is the difference between the interest rates on deposits and loans. Banks have to consider the weighted average of the interest rates on deposits and loans while calculating the spread rate. Earlier, banks were allowed to calculate the interest rate on loans by taking into account the interest earned on their investments in government securities too.

By amending the Unified Directive 2018 August 5, Nepal Rastra Bank has set a new rule to calculate the spread rate, in which the central bank has removed the components of the banks’ investment in government securities along with the earnings from those government securities while calculating the weighted average of the interest rates on loans.

Bankers said the removal of the provision of the government securities would affect actual spread rate by around one point percent than what the regulator has asked the banks to maintain. “As banks now cannot include the yields generated from investment made in government securities, such as bonds and treasury bills when calculating interest spread, it would reduce the profit margin of the banks,” said Bhuwan Dahal, chief executive officer of Sanima Bank.

Nepal Rastra Bank had been looking to reduce the spread rate citing to check excessive hikes in interest rates. During the last fiscal year, the central bank had lowered the spread rate to 4.5 percent from earlier 5 percent. Now, it has further directed the banks to reduce the interest spread to 4.4 percent by mid-July 2020.

“Although the banks are asked to take the spread rate of 4.4 percent, in the new rule, they would have to rely on the interest spread of only 3.4 percent in the new rule,” said Dahal.

The central bank’s provision has allowed the banks to invest only 80 percent of the deposits collection in lending. Out of the 20 percent, the banks can invest in government securities.

Parshuram Kunwar Chhetri, chief executive officer of Janata Bank Nepal, said the new rule would directly hit the banks investment portfolio management. “In turn, it will affect the earning per shares of the financial institutions and will hit the government revenue via the heavy reduction in income tax being paid by the banking sector,” said Chhetri.

Gyanendra Prasad Dhungana, president of Nepal Bankers’ Association, said amendment of spread rate rule is estimated to reduce the banks’ profit by Rs30 billion annually. “It means the banks will have to compromise in 25 percent less income than what they have been earning at present,” said Dhungana who is also the chief executive officer of Nepal Bangladesh Bank.

Nepal Rastra Bank however said the new rule has now set the actual norms of calculating the spread rate. Laxmi Prapanna Niroula, spokesperson of Nepal Rastra Bank, said the new spread rate calculation complies with the practice being implemented by a large number of countries globally.

Niroula acknowledged that the new system could shrink the banks’ capacity of investing in government securities. “It could affect the banks’ profits, but at a very negligible rate,” said Niroula.

According to Nepal Rastra Bank, previously, the value of actual spread rate was low when the banks were allowed to include the income from government securities in the lending average. “Based on the low value and the central bank fixed spread rate, banks could take advantage of around 1.5 percent in the spread, by charging a higher interest rate on the loan. But in the new rule, the margin is reduced to make it at par of the rate fixed by the central bank, by which the banks might not enjoy the cushion of charging high interest rate on the loan they provide,” said a high level official of Nepal Rastra Bank under condition of anonymity.

Till the date, banks have been securing large amount of profit by charging exorbitant interest on the lending while providing the nominal interest to the depositors. Despite the central bank making mandatory to lower the spread rate to below 5 percent last fiscal year, most of the time the banks had been operating at an average of 5.56 percent interest spread, shows the 11 months Current Macroeconomic Report published by Nepal Rastra Bank. It shows that the banks have been breaching the directive of the regulator.

Niroula said the banks might not have now luxury to secure high profit through the huge interest spread gap. “Rather they need to improve their efficiency and to reduce the operation costs if they want to have high profit and to ensure high rate of dividends to their shareholders,” he said.