The private sector has been saying that the unstable interest rate is deteriorating the business environment in Nepal. Under immense pressure from the private sector, Nepal Rastra Bank recently introduced a few measures through the revised monetary policy aimed at bringing down the interest rate. However, banks have raised serious concerns about different provisions introduced by the central bank and stated that such provisions will further promote unhealthy interest rate competition. Sujan Dhungana of The Himalayan Times talked to Ashok Sherchan, CEO of Prabhu Bank, and Hari Bhakta Sharma, president of Confederation of Nepalese Industries, to know details on this issue. Excerpts: Interest rate is something that is determined by the market — Ashok Sherchan What is your view on the recent interest rate issue in the banking system? Taking into consideration the overall scenario of Nepal’s economy at present, the interest rate being levied on both lending and deposit is reasonable. Interest rate is something that is determined by the market. The interest rate goes up amid resource deficit in the market while it falls when there are ample resources. I believe that even the industrial sector takes into consideration the resource availability factor while pricing their products. Basically, ‘crunch’ results in rise in price. The country today is plagued by liquidity crunch. However, banks have reached various understandings with industrialists and depositors time and again to tackle the credit crunch situation. However, a few industrialists today are raising the interest rate issue vigorously, which I believe is unnecessary. Though you mentioned that interest rate is determined by the market, deposit rates have not increased in line with lending rates. Why is it so? The interest rates on deposits that banks are providing are reasonable and at par with those being provided by banks in neighbouring countries. Banks are giving up to 6.5 per cent interest on savings accounts. Similarly, banks have been giving up to 9.75 per cent interest on individual fixed deposits and up to 9.5 per cent on corporate fixed deposits. Meanwhile, interest rate is also associated with inflation. Generally, interest rate on deposit has to be one per cent above the inflation rate and the country’s inflation today is four per cent. This shows that interest rate on deposit in Nepal is reasonable. Similarly, the interest rate on loan at present is around three per cent above the interest on deposit, which is also reasonable in the context of rising operation and administrative costs of banks. Moreover, we need to understand that banks have not been earning much. The return on equity of banks is at around 11 per cent while such return of firms in other sectors is higher. Instead of raising the interest rate issue on loans, industrialists should sit with bankers to know the details. Banks have enough logic and evidences to justify the current interest rate. However, the low inflation in recent years should have eased the operation of banks and ultimately the interest rates. Isn’t it so? Had the government improved its spending capacity along with the fall in inflation, it would have generated enough resources (liquidity) in the market. We need to understand that the largest customer of any product or service is the government. The government runs mega development projects and other programmes intended to generate employment. And if expenditure in such projects is not good, it will affect the financial market and result in liquidity problem. Once the government improves its spending capacity, interest rates (both on loan and deposit) will automatically come down. For interest rate on loans to come down, interest rate on deposits should compulsorily come down as banks cannot charge an interest rate on loan that is below the interest on deposits. The central bank has asked us to revise interest rate every three months based on the base rate and we have been doing that. I believe that a majority of general depositors do not have complaints on the current interest rate. There are suspicions that some groups in the market have been ‘intentionally’ raising the interest rate issue at present backed by some vested interest. Why have bankers expressed their objection to a few provisions introduced by Nepal Rastra Bank to bring down the interest rate through the revised monetary policy? I would rather say that bankers have given suggestions to NRB regarding different provisions in the revised version of the monetary policy. The NRB stated it would revise the existing formula to calculate interest rate spread by including the weighted average interest rates on deposit and lending. However, banks have also invested in bonds and treasury bills and the central bank has failed to acknowledge this concern of banks. Regarding the NRB’s provision directing banks to bring the share of call deposits to total deposit below 10 per cent, we have only sought some more time from NRB to implement this provision. However, we expect the central bank to hold enough discussions with banks while introducing new provisions in the banking sector. The supply-demand gap of credit needs to be filled — Hari Bhakta Sharma How has the private sector taken the ongoing volatility in the interest rate? Industrialists are the primary victims of the unstable financial sector, especially the fluctuating interest rate. We had alerted the government three years back, immediately after the interest rate started fluctuating, to take necessary measures to address the issue. Earlier, we had warned the government that the country’s economy is facing a systemic problem and urged the government and regulating agencies to adopt necessary precaution. However, failure of the government to tactfully manage this issue has resulted in the interest rate volatility today. Along with the rise in credit requirement in the market, the saving ratio kept falling resulting in low liquidity. Similarly, foreign direct investment and foreign assistance in Nepal has declined at present and capital formation in the country is highly dependent on the inflow of remittance. However, there is a big gap between capital formation based on remittance and the actual capital that the country needs. Thus, the mismatch between supply and demand of capital is the crux to the current volatility in the interest rate. Similarly, the inability of different government institutions and funds to spend their money in the market is also a big problem. Roughly, 50 per cent deposit of the country’s total deposit today belongs to different government agencies including Citizen Investment Trust, Employees Provident Fund and Nepal Telecom. Such institutions, which have high deposits, started bargaining with banks for higher interest rates that later resulted in unhealthy competition among banks to collect deposits. This is where government intervention is necessary. Similarly, such government institutions with huge capital should not only look for depositing their money in banks and earning interests. They should invest in the market to keep the economy vibrant. This is how the resource deficit in the market can be filled. The entire economic system of Nepal has more than $3 billion deficit today. So, the government should seek measures to inject the deficit amount in the market if the liquidity issue is to be addressed properly. Issuing sovereign bond in US dollars, attracting foreign investment and increasing the size of refinancing facility to almost Rs 200 billion could be some of the other measures the government can adopt to generate capital in the market. The private sector too seems to be divided over the interest rate issue. What do you have to say on this? Every suggestion that CNI gives to the government intends to promote the economy of the country. All the private sector players need to develop a better understanding of issues and be farsighted while giving suggestions to the government, which has not always been the case. It is not that only banks are responsible for the ongoing volatility in interest rate. It is a result of a mismatch between credit demand and supply of capital. Among other reasons, the credit crunch situation in recent years is also due to the failure of banks to inject new capital while raising their paid-up capital to Rs eight billion. Instead of bringing in new capital, banks managed to reach the Rs eight billion paid-up capital provision through inter-bank borrowings. As a result, new capital was not injected into the system while existing capital in the banking sector was transferred from one bank to another. The private sector should have an understanding of all such issues. How has the private sector taken the provisions adopted by the central bank through the revised monetary policy to address the interest rate issue? The revised monetary policy seems to be trying to focus on generating capital to meet the credit demand in a bid to bring down the interest rate. Among others, NRB has proposed to widen the refinancing pool to Rs 50 billion from the existing Rs 35 billion, which is good. The size of the refinancing fund is not enough. The refinancing pool should be expanded to at least Rs 200 billion. The central bank should try introducing long-term measures to bridge the credit gap in the market. As a temporary measure, the government should prevent banks from lending haphazardly in unproductive sectors.