Interest rates, regulated by the Nepal Rastra Bank (NRB), are vital in shaping Nepal’s economy. The central bank sets guidelines to maintain stability and ensure that depositors and borrowers are treated fairly. Recently, some significant developments have taken place in Nepal’s banking sector, impacting interest rates and the availability of loans.

The government issued a directive requiring banks to collect 60 percent of local-level deposits by August 11, 2023. This has led to a significant increase in deposits in the banking system and has relaxed the Credit-Deposit (CD) ratio and the net liquid Assets-Deposit (LD)—the essential metrics in the banking industry—by approximately 1 percent. This relaxation meant more money was available for banks to lend to borrowers. The CD ratio measures how much of the bank’s deposits are used for lending, while the net LD ratio indicates the bank’s liquidity position. In Nepal, the NRB mandates that the CD ratio not exceed 90 percent, and the net LD ratio not fall below 20 percent. These ratios ensure that banks maintain a healthy balance between lending and liquidity.

In mid-September 2023, the CD ratio among commercial banks in Nepal stood at approximately 82.5 percent, and the net LD ratio was roughly 26 percent. This suggested that commercial banks could extend additional loans to roughly Rs300 billion, averaging Rs15 billion per bank. This surplus of loanable funds was significant for Nepal’s financial market. The demand for credit has slowed down for various reasons, leading to a reduction in the interbank lending rate and the base rate for loans. This decline in interest rates signalled a dynamic economic environment and discussions about managing non-performing assets. Additionally, foreign exchange reserves increased during this period.

Surprising interest rates

Many expected a substantial decline in bank lending rates between August and October, but the actual interest rates surprised many. The highest interest rate on one-year individual fixed deposits increased from 10.896 percent in August to 11.054 percent in October. The minimum threshold for high interest rates on savings deposits also rose from 5.966 percent to 6.054 percent. As per NRB regulations, the spread between the maximum bank interest rate and the minimum savings deposit interest rate should not exceed 5 percent.

Different banks in Nepal offered varying interest rates on one-year personal term deposits for October 2023. Standard Chartered Bank showed the lowest rate at 7.79 percent, while Prime Commercial Bank initially posted the highest rate at 11.36 percent but had to adjust it due to non-compliance with NRB regulations. Similarly, NIC Asia Bank declared an interest rate of 11.054 percent. These interest rates impact the decisions of depositors on where to invest their money.

In August 2021, the interest rate scenarios of banks in Nepal were different. The average CD ratio was 87.89 percent, and the net LD ratio was 23.42 percent. Sunrise Bank had the highest interest rate at 10.07 percent, while Standard Chartered Bank offered the lowest rate at 7.5 percent. This period saw 27 commercial banks actively operating in Nepal.

Influencing factors

Several factors influenced the publication of elevated deposit interest rates in September-October 2023. First, the interest rate differential—the difference between the weighted average interest rate of loans and deposits—remained above 4 percent, indicating a reluctance to lower deposit interest rates. Second, some banks had limited buffer room within their CD ratio, making them cautious about lowering interest rates. Third, fixed deposit interest rates were higher than the yield on government securities, encouraging banks to retain deposits. Also, borrowers often choose banks with competitive prime lending rates, making it challenging for banks to lower base rates. Finally, the government’s outstanding loan portfolio grew, limiting non-interest-bearing idle funds.

The surge in non-performing loans among financial institutions has raised concerns about depositors' confidence in the banking sector. It is crucial for all stakeholders—banks, regulators and the government—to work together to address economic issues and find solutions. Lowering deposit and loan interest rates can stimulate economic competitiveness and benefit Nepali citizens. Priority should be given to borrowers in key sectors like import substitution, export expansion and tourism promotion.

Recent developments in interest rates have significant economic implications. The unexpected rise in deposit interest rates has raised questions about the country's financial stability and economic growth. This could lead to higher borrowing costs for individuals and businesses, potentially deterring investments and affecting consumer spending. While it may attract more funds into the banking sector, it also poses challenges for banks regarding profitability.

The competitiveness of Nepali businesses, especially small and medium-sized enterprises, could be impacted by higher interest rates, affecting their ability to compete globally. Managing the government's growing loan portfolio becomes crucial, as banks may reduce their holdings of government securities due to higher deposit interest rates, affecting the government's financing capabilities and fiscal health.

The impact on foreign exchange reserves is complex, with higher interest rates potentially attracting foreign investment and leading to exchange rate volatility. Interest rates also influence inflation, as they can affect consumer spending. Maintaining depositor confidence is essential for the banking sector’s stability.

Needless to say, interest rates are critical in Nepal’s banking sector, affecting both depositors and borrowers. Recent developments in deposit rates and the factors influencing them have significant implications for our economy. All stakeholders should collaborate and make informed decisions regarding interest rates to ensure the stability and growth of the financial sector.