Easing the Burden

  10 min 42 sec to read
Easing the Burden

Borrower rejoice as banks lower rates.

Banks Lower Interest Rates, Easing Burden on Borrowers
It has been nearly a year since banks started imposing a staggering double-digit interest rate, surpassing a whopping 17%, on loans. The banks and financial institutions (BFIs) have shrewdly used the excuse of insufficient loanable funds to justify these skyrocketing interest rates, which plays a vital role in the government's market regulation policy. Surprisingly, just last month, the banks finally yielded to the mounting pressure and agreed to decrease interest rates on deposits, as they found a much-needed cushion to manage their funds.
After subjecting their customers to exorbitant interest rates for over a year, banks have taken a step forward and lowered their interest rates on deposits to single digits. This decision brings a sense of relief to the entrepreneurs who have been battling against the banks' excessive interest rates. While this reduction may not be sufficient to spur a massive surge in investment and drive the economy forward, it does offer a glimmer of hope for a more favourable business environment.
Interest rate, as a form of compensation for monetary capital, wields substantial influence over the economy. It serves as a critical macroeconomic indicator that has a profound impact on economic decisions and overall performance. The interest rate plays a pivotal role in shaping the aggregate demand of an economy by affecting both investment and consumer spending. By altering the cost of borrowing and lending, the interest rate influences the propensity of businesses to invest in new ventures and individuals' ability to make purchases, thus shaping the trajectory of economic activity.
The determination of interest rates primarily hinges on the interplay between the demand and supply of loanable funds. In a free market system, banks determine interest rates based on their liquidity status. The availability of funds in the market and the perceived risk associated with loans are key factors that shape interest rates. Nevertheless, the central bank policies also exert significant influence on market interest rates. The actions and decisions of the central bank can directly impact the overall interest rate environment, affecting borrowing costs and influencing the behaviour of lenders and borrowers in the market.
As the interest rates on deposits and loans are positively correlated, bankers say the banks will further reduce the interest rates on loans. 
Liquidity position
Based on the records of the Nepal Rastra Bank (NRB), as of the second week of May, banks and financial institutions (BFIs) have amassed a total of Rs 5.488 trillion in deposits, while their lending activities amounted to Rs 4.845 trillion. In the first nine months of the current fiscal year, BFIs have accumulated an additional Rs 270 billion in deposits, while disbursing loans amounting to Rs 108 billion. This surplus has resulted in a significant cushion of spare liquidity, exceeding Rs 163 billion for the BFIs.
At present, the credit-deposit ratio of the financial institutions (BFIs) stands at 84.92%. In recent months, the BFIs have faced challenges in meeting the central bank's prescribed threshold of 90% for the credit-deposit ratio. 
Bankers say the surplus margin and healthy deposit mobilisation have empowered them to extend loans amounting to over Rs 200 billion. The BFIs find themselves in a favourable position due to a rise in deposits coupled with a reduced demand for loans, primarily caused by the burden of high interest rates. This scenario has led to a significant accumulation of liquidity within the BFIs. "The high interest rates have discouraged borrowers from seeking additional loans, which has resulted in a substantial liquidity reserve," said a banker.
NRB’s policy tools
The monetary policy for 2022/23 fiscal year introduced in July last year entailed a series of adjustments. These adjustments included an increase of 1.5 percentage points in bank rates, policy rates, and deposit collection rates. Consequently, the rates were raised to 8.5%, 7% percent, and 5.5%, respectively. The adjustments were aimed at aligning the rates with the prevailing economic conditions and the central bank's strategic objectives for the fiscal year.
In response to a significant increase in imports, particularly in the post-pandemic period, the Nepal Rastra Bank (NRB) deemed it necessary to adopt a contractionary monetary policy. The lenient policies implemented by the central bank during the COVID-19 pandemic, such as providing refinance facilities and loan rescheduling to support crisis-ridden private firms, inadvertently led to a substantial surge in the country's import expenses. As a result, the NRB has recognized the need to implement measures aimed at controlling the expansion of the money supply and curbing import-driven inflation, thereby adopting a contractionary monetary policy stance.
In recent years, there has been a notable rise in credit extended to the private sector. The total credit to the private sector witnessed a significant increase of 17.5% in 2020/2021. Furthermore, until mid-March of the following fiscal year, 2021/2022, the credit grew by 13.9%. However, the central bank officials have expressed concerns that the increased money supply has been directed towards unproductive sectors. Despite the central bank's intention to provide relief to struggling firms amidst a severe downturn in their businesses, it appears that the funds were not entirely utilised in a productive manner.
In response to the increased spending on unproductive businesses, the NRB implemented a stringent monetary policy aimed at curbing such practices. However, this policy has had a notable impact on the private ector's ability to secure loans. As a result, consumer spending experienced a significant decline, leading to changes in overall consumption patterns. Moreover, the policy discouraged private firms from seeking additional loans to establish new ventures or expand their production capacity. The reduced access to credit has impeded their growth potential and hindered their ability to contribute to economic expansion.
Impacts of contractionary monetary policy
Banks have witnessed a significant increase in their base rate since October 2022, thanks to the tightened monetary policy. The base rate, which serves as a benchmark for lending rates, has risen to approximately 12%. Lending rates have surged even higher, reaching levels as high as 18.28%. In comparison, the base rate averaged around 9.42% until the last quarter of the fiscal year 2021/2022. This upward trend in interest rates reflects the impact of the tightened monetary policy on the cost of borrowing for individuals and businesses, potentially influencing investment decisions and economic activities.
According to the Federation of Nepalese Chambers of Commerce and Industry (FNCCI), there has been a significant decline in the total credit flow in the first four months of the current fiscal year. The credit flow amounted to only Rs 60 billion, which is considerably lower compared to the credit flow of Rs 450 billion witnessed in the first six months of the previous fiscal year. This decline in credit expansion can be attributed to the adverse effects of high interest rates and soaring market prices, which have negatively impacted economic activities.
The repercussions of this slump in economic activities have affected various sectors of the economy. For instance, in the first seven months of the current fiscal year (until mid-February), the manufacturing of construction materials such as iron rods and cement plummeted to only 30% of their total capacity. This indicates a substantial decrease in production and highlights the challenges faced by the manufacturing sector amidst the prevailing economic conditions.
According to a study conducted by the FNCCI, various sectors have experienced significant declines in transactions. Consumption of everyday essentials has witnessed a drop of 18%, while transactions related to electrical appliances have fallen by 55%. The automobile industry has been hit hard, with transactions dropping by 75%. The restaurant business has also suffered a decline of 20%, and the real estate sector has experienced a significant setback with transactions decreasing by 48%.
Additionally, the capital market has seen a substantial decline of 40% in transactions, indicating reduced activity in investment and trading. The insurance sector has also been affected, with transactions dropping by 30%. These figures illustrate the broad impact of the economic downturn, affecting various industries and indicating a slowdown in economic activity across multiple sectors.
The negative impacts became more visible in cooperative businesses and blacklisting ratio of the borrowers of the banks. While borrowers did not turn up to pay their outstanding dues, cooperatives faced a massive shortfall in their liquidity position. Operators of many cooperatives have fled and depositors are struggling to get their money back. 
Similarly, the cases of blacklisting by banks increased by more than two-folds in the first six months of the current fiscal year. The Credit Information Center registered over 15,000 individuals and firms under blacklisting over the period.
Traders highlighted the spiral effect of the higher interest rate on the economy, citing two major consequences. Firstly, it results in a cash crunch for firms, restricting their financial resources. Secondly, it raises the cost of funds for entrepreneurs, making it more expensive for them to secure capital. This combination of factors can potentially lead to financial stagnation within the economy. This impact is evident in the significant reduction in transactions at the country's secondary market, where investors have suffered substantial losses amounting to billions of rupees over the past year. Bharat Raj Acharya, an entrepreneur, emphasised this point, underscoring the detrimental effects of the higher interest rate on the overall economic situation.
Jyotsana Shrestha, vice-president of the FNCCI, said high interest rates have taken down the confidence of the businesspersons. “Although the economy has improved nominally in the past six months, the business activities have slumped due to this reason,” said Shrestha, adding that the interest rate should be brought down to a single digit in order to boost economic activities in the country. 
Likewise, Umesh Prasad Singh, president of the Federation of Nepalese Cottage and Small Scale Industries, said around 80% of the small firms have been managing their financial resources by taking loans from banks. “Due to the high interest rates, the small businesses are not in a situation to pay back their loans” Singh said.  
According to the 2018 National Economic Census, 35.5% of the micro, small and medium enterprises have access to credit. Small enterprises have borrowed in the range of Rs 1 million to Rs 5 million, and medium enterprises took loans ranging from Rs 5 million to Rs 150 million, show the records of the NRB.
The tight monetary policy however has had positive impacts on the country’s balance of payments (BoP) and foreign currency reserves. The BoP that plunged to a notable negative balance, corrected to a surplus of Rs 180.17 billion and the foreign currency adequacy that once dropped from financing the country’s imports to below six months to more than 10 months, as of mid-April 2023.    
Revised monetary policy and current situation
With the massive downturn in the consumption and production related activities, private businesses even launched protests to pressurise the central bank to review the interest rates. 
While the private businesses and even the government have been putting pressure to lower the interest rates, the central bank is on the side of the market determined interest rates; nevertheless it has altered the policy rates by a nominal value, which ultimately affects the market interest rates. 
According to the NRB, the capital adequacy ratio of banks is above 13%, while the net liquidity ratio is more than 23%, while the ratio of bad debt has crossed 3%.
Through the third quarterly review of the monetary policy, the NRB has revised only selected policy measures. The bank rate has been reduced to 7.5% from 8.5% percent. Likewise, the central bank has increased the threshold of restructuring and rescheduling of credit to Rs 50 million from Rs 20 million for small enterprises. Similarly, banks have been permitted to include debentures also for the credit-deposit ratio.
The private sector criticised the newly revised monetary policy by the NRB, stating that the policy measures were not adequate to address the ongoing economic crisis. However, the new policy has started showing its positive impacts as bankers have admitted that the interest rates will drop dramatically in the coming days.  
Sunil KC, president of Nepal Bankers’ Association, said the lending rate will fall by a notable value along with the declining operating cost of banks. According to him, banks now have a sufficient amount of loanable funds. “Moreover, the increased government expenditure by the fiscal year end will help increase more cash flow into the economy, bringing the interest rates further down,” he added. 
NRB Governor Maha Prasad Adhikari said banks are free to fix their interest rates based on the market situation. “However, there is a clear indication that the interest rates will come down in the near future,” Adhikari said. 

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