Will decision to regulate deposit rates bring down credit rates?

Friday, June 22nd, 2018 | | Money

The Nepal Bankers’ Association (NBA) has once again decided to regulate deposit rates without providing assurance of reining in runaway lending rates. This is an indication that commercial banks are more interested in reducing their expenses by forcefully lowering deposit rates, while maximising their income by keeping lending rates high.

The NBA today barred all 28 commercial banks from offering annual interest of over 11 per cent to retail depositors who park money in fixed deposit accounts. The interest threshold on funds deposited by institutional depositors in fixed accounts has been set at 10.5 per cent. The NBA has also said yields on money parked in savings deposit
accounts should not exceed seven per cent.

The decision to regulate deposit rates was made as banks ‘started engaging in unhealthy competition to poach deposits from other institutions, pushing up interest on deposit’, according to Sanima Bank CEO Bhuvan Dahal, who had attended the NBA meeting.

Deposit rates are lately rising largely because of moderate growth in remittance income, slow public capital spending and soaring imports, which is triggering capital flight. These reasons had prompted interest on institutional fixed deposit to surge past 13 per cent recently. This deposit rate would have been acceptable to many around two years ago when inflation stood in double digits. But now inflation has cooled down to 4.1 per cent, meaning the value of money is eroding at a lot slower pace than before. It is also believed that inflation will hover around this level in the foreseeable future if the government manages to remove supply constraints, as India, from where most of Nepal’s imports come from, has introduced a policy of limiting inflation in the range of two to six per cent.

These developments suggest deposit rates should not be too high, said Sashin Joshi, former CEO of Nabil Bank. “Having said this, I do not quite like the practice in which NBA is making intervention, as it will set a bad precedence,” Joshi added.

The NBA is an umbrella body of commercial banks and lobbies to protect their interest. However, it is not authorised to regulate interest rates. But this is not the first time the NBA has resorted to this measure. It had put a ceiling on deposit rates earlier too, but had later rolled back the decision after banks started breaching the threshold set by it.

How long will the banks abide by NBA’s latest instruction is not known. But what is surprising is that the NBA had acted on the advice given by Nepal Rastra Bank (NRB), the banking sector regulator.

“We called representatives of banks which were raising deposit rates for a meeting and told them to work towards stabilising the deposit rates,” said NRB Spokesperson Narayan Prasad Paudel. “The latest initiative taken by banks to stabilise deposit rates is rational.”

This raises the question on who regulates Nepal’s banking sector: the NBA or the NRB?

“Of course it is our responsibility to ensure banking sector stability,” said NRB’s Paudel. “But we only have indirect instruments to make interventions. What is needed at the moment is direct intervention. But we cannot do that, as it would be against the policy of market economy,” said Paudel.

But Joshi does not want to buy this argument. “The NRB cannot shirk from one of its primary responsibilities of ensuring interest rate stability,” Joshi said. “If it does not have an instrument, it should create one. Where is innovativeness?”

The NRB should shoulder the responsibility of stabilising interest rate because along with deposit rates, lending rates also need to be kept within a certain band so that they are affordable to borrowers. Currently, credit offered by banks is expensive than that of microfinance institutions, which are barred from charging lending rate of over 18 per cent.

The issue of containing lending rates was raised during NBA’s meeting today. “But most of the NBA members said drop in deposit rates would automatically bring down lending rates,” two bankers, who had attended the meeting, said.

But this has not been the case in the past.

When the NBA regulated deposit rates in the past, lending rates had continued to surge, raising the debt servicing cost of borrowers. So, the possibility of regulated deposit rates failing to contain lending rates cannot be ruled out. Such a scenario will bring more suffering to borrowers, especially enterprises, which cannot afford to pass all of the additional debt servicing cost to consumers because of chances of losing competitive edge.

“The problem of high interest rates stemmed from haphazard credit disbursement in the first quarter of this fiscal year,” said NRB’s Paudel, calling the move short-sighted, as credit was expanded without identifying proper deposit collection sources. Because of this, credit disbursement of commercial banks has surpassed deposit collection so far this fiscal year. Commercial banks collected Rs 270 billion in fresh deposits since the beginning of this fiscal year in mid-July through June 15, but disbursed Rs 334 billion in loans in the same period, shows NBA’s latest report.

“Unless banks fail to strike a balance between assets (credit disbursement) and liabilities (deposit collection), the problem will continue to recur,” Paudel said.