Nepal Rastra Bank recently published a Mid-Term Review of the Monetary Policy. It gives the current status of all key economic indicators along with some proposed changes in the policy. It has been proposed that banks be allowed to consider the weighted average of the interest rates on deposits and loans only for the calculation of the spread rate and not be allowed to consider investments in government securities. A couple of months ago, a component of the base rate, the return on assets, was removed from the prevailing formula. Its combined effect is expected to reduce the banking industry’s profits by around Rs13 billion resulting in a drop in tax collection of about Rs4 billion. The stock market, where banks account for about 70 percent of the listed shares, will face the effects too.

Nepal Rastra Bank has also proposed to set a limit on the premium rates charged by banks on different loans. This may reduce the lending rate which will reduce interest income and ultimately profits for banks. The existing policy of the central bank guides banks to create a risk bearing fund which includes 1-2 percent of the loan amounts. As a risk bearer, banks should have the liberty to use a risk-based pricing method to determine the premium on loans. Such intervention is depressing and an unacceptable practice in a free market economy.                       

There are misconceptions among the general public about the profits banks are making as only the figure in the balance sheet is being considered. But the important thing that needs to be considered is the return on equity which is just 15.57 percent. This is very low compared to other industries. Moreover, banks are not able to issue a cash dividend equal to the interest rate on fixed deposits. Nepal Rastra Bank’s vision of having branches of commercial banks in all 753 local units prompted them to go for rapid expansion. Accordingly, bank branches have been established in 704 local units so far. But most of them are facing losses due to the small volume of transactions.

It has been proposed to cap the proportion of call deposits at 10 percent. If this policy is implemented, it will create a problem for banks as they need to replace the excess share of call deposits by other forms of deposits to maintain the credit to core capital plus deposit ratio. This may create unhealthy competition among banks. Since there is not much fresh deposits in the market, it may lead to an interest rate war, ultimately resulting in interest rate instability which hampers the economy. It is suggested to apply this rule only to non-banks and financial institutions.

It has been proposed that banks must compulsorily issue long-term bonds. Recently, NIC Asia Bank issued long-term debentures worth Rs4 billion at 10 percent, but the issue was largely undersubscribed. NMB Bank is also issuing 10-year debentures worth Rs1.2 billion at the same rate. It will be very challenging to sell them as the public may not be interested in buying long-term bonds when the interest rate is the same as for fixed deposits.

It has also been proposed that for all foreign currency pre-shipment and post-shipment loans, banks be allowed to charge up to one-year London Inter-bank Offered Rate plus 1.25 percent only. But banks themselves are bearing the London Inter-bank Offered Rate plus 3 percent. This doesn’t seem practicable, so a quick revision is essential.

The interest rate should be determined by the market mechanism, that is demand and supply. Intervention by pressure groups may result in market failure which restricts the efficient distribution of resources in a free economy. Currently, the Nepali banking industry is facing a credit crunch. Demand for loans is still acute as the private sector is keen to invest due to political stability and availability of electricity, but the supply of deposits is relatively low. Unless there is a good amount of investment, this problem won’t be solved easily.

Nepal Rastra Bank and the government should concentrate on solving the burning issue of the banking industry, that is shortage of loanable funds. The government should emphasise timely spending of the capital expenditure budget. Export industries should be encouraged while imports should be discouraged which may help to control the negative balance of payments to some extent. Along with that, efforts should be made to attract foreign investment in Nepal. The Nepal Investment Summit 2019 slated for March 29-30 is a golden opportunity for the Nepali economy to accelerate growth and development. We have to wait and watch how the current government capitalises on that opportunity.

The central bank should act and introduce policies for banks and financial institutions that help to achieve the macroeconomic goals. Sustainable development and growth of banks and financial institutions should go hand in hand with the Nepali economy as a whole.

Lakhey is a research assistant at the Nepal Bankers’ Association.