Faced with a liquidity glut and few borrowers, the Nepal Bankers' Association has tossed out the long-standing system of uniform interest rates and freed banks to set their own rates. Analysts expect bank interest rates to come down as a result.

On Thursday, the apex body decided to give banks free rein as high interest rates were keeping potential borrowers away. From July 17, the beginning of the new fiscal year, banks will be allowed to determine interest rates on their own.

Bankers say that banks that are unable to invest due to reduced capital funds are in favour of reducing the interest rate on deposits further. This is because increased liquidity means increased expenses for them. But those who have the capacity to invest are likely to keep the rates as they are, according to insiders.

Banks have been inundated with deposits due to rising remittances and increased government spending as usually happens towards the end of the fiscal year.

Nepal Rastra Bank says remittance inflows amounted to a staggering Rs1.11 trillion in the first 11 months of the fiscal year ended mid-June. The river of money represents a 22.7 percent increase year-on-year.

“With an ease in liquidity, 'A' class commercial banks agreed to fix the interest rates on their own rather than go for a common agreement,” said Santosh Koirala, vice-president of the Nepal Bankers' Association.

Like the free market economy, Thursday’s decision has also freed banks to fix interest rates on their own, he said.

Currently, the interest rate on ordinary term deposits is 9.99 percent.

Banks can only reduce the maximum interest rate of 9.99 percent by 10 percent, which means the maximum interest on deposits will come down by 0.99 percentage point to 9 percent.

"Banks kept the interest rates constant when liquidity was tight and there was high fluctuation of interest rates between banks," said Koirala, who is also the CEO of Machhapuchchhre Bank.

"With liquidity in the banks, interest rates are expected to fall down further. If banks decide to decrease the interest rate on deposits, the interest rate on loans will also subsequently drop," he added.

"With the implementation of base rates from July 17, the loan interest rates will drop by 1 percent," he said.

According to Nepal Rastra Bank, deposits at banks and financial institutions increased by Rs445.13 billion (8.8 percent) in the first 11 months of the current fiscal year compared to an increase of Rs266 billion (5.7 percent) in the corresponding period of the previous year.

On a year-on-year basis, deposits at banks and financial institutions expanded by 12.2 percent in mid-June 2023.

Private sector credit from banks and financial institutions increased by Rs157.36 billion (3.4 percent) in the review period compared to an increase of Rs552.71 billion (13.5 percent) in the corresponding period of the previous year.

The credit-deposit ratio of banks is 82.11 percent. The weighted average interbank deposit rate was 7.99 percent and credit was 12.53 percent during the review period.

It has been projected that by the end of the fiscal year, liquidity will reach Rs500 billion.

“The decision that allows banks to take decisions separately on interest rates according to their resources will help in managing the flood of liquidity,” said Anil Kumar Upadhyay, former president of the Nepal Bankers’ Association.

"As liquidity is expected to increase further and may pile up in the banks at the end of the fiscal year, it will raise the cost which may impact the growth and performance of individual banks," Upadhyay said.

“So, to make it market friendly also, to release the money in the market, this new practice has been adopted,” he said.

The common agreement among banks will lower the interest rates of both deposits and loans, bankers said.

There is a need to attract investment so the banks will reduce the interest rates as per their standards, said bankers.

According to Upadhyay, banks decided to fix the interest rates through a gentleman’s agreement nearly three years ago due to the crisis caused by the Covid-19 pandemic.

There was a liquidity crisis and the regulatory body also introduced the limit.