Kathmandu. The base rate of banks and financial institutions, which has been continuously decreasing for the last few years, has stopped falling.
The decline in the base rate has come to a halt as the space for further improvement in the cost structure of the banks has narrowed, even as the demand for credit has been weak and deposits have piled up in the banking system. The data of the last two months has shown that the base rate has started to rise normally.
The average base rate of banks and financial institutions has increased from 4.72 percent in July to 4.75 percent in September. Although this increase of 0.03 percentage points in a period of two months is not a big one, it indicates a significant turning point in the phase of reducing the interest rate in the banking sector. Since the base rate is the main basis in determining the interest rate of the loan, its direction has now become a matter of concern for the borrower as well.
When there is sufficient liquidity in the banking system, there is usually pressure to reduce interest rates. When deposits are high and loan expansion is slow, banks have to compete to reduce interest rates to increase the flow of new credit. This is why in recent years, the base rate of banks has been continuously falling as the cost of deposits has fallen.
However, the current situation is somewhat different. Even though the banks have enough money to invest, the credit expansion is relatively weak. In such a situation, the banks are trying to reduce the cost by reducing the interest rate of deposits a lot, but it seems that it has reached its limit. On the other hand, the system of including operating expenses and other costs in the base rate has also brought a general increase in the base rate in recent times.
The Rastra Bank has made a provision to allow banks and financial institutions to calculate a certain portion of the operating expenses at the base rate. Earlier, there was a provision to include up to 85 percent of the operating expenses in the base rate, which has been increased to 90 percent from August. This provision has given an opportunity to cover an additional part of the cost on the basis of interest determination, especially for banks where operating expenses are comparatively high.
The direct impact of this has been seen on the base rate of the last two months. The average base rate of the banks has gone up by 0.03 percentage points as the amount of operating expenses can be included in the base rate by an additional five percentage points. However, this increase is not big in itself, but it shows that the possibility of the banks reducing the base rate only by reducing the cost is limited.
The increase in the base rate does not mean that the interest rate of all types of loans will increase immediately in the same proportion. Banks determine the interest rate on the basis of the nature of the loan, the premium and other conditions. However, since the base rate is the basis for determining the interest rate of the loan, its increase works to weaken the downward pressure on the interest rate of the loan.
Another important aspect now is the cost of deposits. The average interest rate of deposits in banks and financial institutions is 3.15 percent. The average interest rate of savings account is 2.73 percent, the average interest rate of fixed deposits is 4.73 percent and the average interest rate of current account is 0.49 percent. This shows that the deposit cost of banks has been much lower than in the past.
However, it is not easy for the banks to continuously reduce the interest rate of deposits. One reason for this is that the interest rate of the Rastra Bank is linked to the lower limit under the corridor. In case of excess liquidity, the banks can keep their surplus money in the Rastra Bank and earn a fixed interest income. For this, the banks have a limit to bring the interest rate of deposits below a certain level.
Currently, the lower limit of the interest rate corridor is 2.75 percent. Banks are maintaining interest rates around this level on ordinary savings and short-term term deposits. If the interest rate of deposits is reduced below this, the banks may have to pay a lower rate to the depositors than the return they get by keeping the excess liquidity they have in the central bank. This can also affect the liquidity management of the bank.
This is the reason why even though a large amount of investable money is deposited in the banking system, there is no situation to reduce the interest rate of deposits unlimitedly. At present, banks are keeping about Rs 9 trillion in the central bank at an interest rate of 2.75 percent. This shows how much liquidity is more than the demand for credit in the banking system.
However, having excess liquidity and continuously decreasing the cost of the bank is not the same thing. Banks may have a lot of money when credit demand is low, but the ability to reduce the base rate may be limited due to operating expenses, minimum cost of deposits, and regulatory arrangements. In this situation, the base rate of banks seems to be looking for a lower limit in recent times.
This does not mean that the interest rate in the banking sector will increase immediately. The current data mainly indicates that the long-standing trend of interest rate declining has stopped. As long as the demand for credit remains weak, the competition among banks to attract borrowers will continue, so there is no immediate possibility of a big jump in loan interest rates.
However, if the demand for credit starts increasing, the situation may be different. If the demand for credit increases while the deposit costs and operating expenses of banks remain the same, banks may feel less pressure to attract customers by reducing interest rates. In such a situation, the chances of the base rate remaining stable or gradually going up are strong.
This shows that the direction of interest rates in the coming days will not be determined only by the liquidity situation. The cost of deposits, operating expenses, loan demand, competition of banks and the interest rate corridor of the Rastra Bank will all be effective simultaneously.
Looking at the current situation, the fall in the base rate has been stopped not because of the shortage of money in the banking system, but because the banks have limited space to reduce the cost further. Therefore, for the borrower who expects the interest rate to come down further, the most important issue will not only be the liquidity in the banking system but also the loan demand and the actual cost structure of the banks.
