Banks and financial institutions may have to change the interest rate on lending on a monthly basis like they do in the case of deposits so that the central bank’s effort to raise it can be implemented as early as possible.

Through the Monetary Policy 2022-23 unveiled on Friday, the Nepal Rastra Bank (NRB) has increased bank rates, policy rates and deposit collection rates by 1.5 percent each to 8.5 percent, 7 percent and 5.5 percent, respectively.

The bank rate means the interest rate a nation's central bank charges the domestic banks when they borrow money.

Policy rate means the interest rate that the central bank will pay or charge the banks for their deposits or loans, respectively. The deposit collection rate means the rate that the central bank offers to the banks when they park their cash in the central bank.

Charging higher rates for providing cash to the banks will make the cost of funds for the banks expensive and that will result in increased lending rate.

Likewise, offering higher rates for parking their cash and other liquid assets at the central bank means the banks will prefer to park them at the central bank instead of increasing lending so that credit flow would be reduced.

“We want interest rates for lending to be hiked as early as possible as per the monetary policy so that the demand for credits falls,” said Prakash Kumar Shrestha, chief of the economic research division at the central bank. “The monthly review of the interest rates on lending means the increased cost of funds for the banks and financial institutions will pass on to the borrowers as early as possible.”

According to him, the plan may be included during the review of existing policy provisions on determination of interest rates of the banks and financial institutions as per the new monetary policy.

“But it is not the decision already taken,” he added.

Considering that increased money supply and credit expansion contributed to the growth in demand for market goods, which resulted in increased imports and inflation, the central bank, through the monetary policy, has targeted to reduce both credit expansion and money supply.

As per the monetary policy, the credit expansion to the private sector will be confined within 12.6 percent, a sharp reduction from the targeted 19 percent in the last fiscal year.

The new monetary policy also aims to limit the growth of money supply (cash, demand deposits, non-cash assets that are very liquid and that are easily convertible into cash) to 12 percent from the last fiscal year’s target of 18 percent.

While reviewing the interest rate determination system, the central bank also aims to hike the interest rate on deposits so that banks and financial institutions could attract more savings.

According to Shrestha, the NRB may scrap the provision that the banks and financial institutions could change the interest rate on deposits by a maximum 10 percent from the previous month.

In October last year, the central bank had introduced such a provision so that hike in interest rate on deposits won’t transfer into lending rates. With the country’s economy making a recovery from the impact of Covid-19 pandemic, the central bank adopted the policy of making credits available at cheaper rates to borrowers to help the economy to recover.

But the same policy gave rise to excessive lending, leading to massive imports, wider balance of payment deficit, depleting foreign exchange reserves and rising inflation.

“The scrapping of this provision is expected to increase the interest rate on deposits and the cost borne by the banks and financial institutions will transfer into the lending rate,” said Shrestha.

Besides, there may be a change in the current provision that the gap between maximum and minimum interest rates on deposits should not exceed five percent, according to Gunakar Bhatta, spokesperson for the central bank.

The provision was made in December, 2020 to encourage deposits in savings accounts, instead of fixed accounts, through the quarterly review of the Monetary Policy 2020-21.

“Nothing has been decided yet but these aspects will come under review in the coming days,” said Bhatta.