The interest rate corridor, which is making a debut tomorrow (August 10) to reduce interest rate volatility, is not likely to meet its core objective in the short term because of the formula used to calculate various rates.
Nepal Rastra Bank, the central monetary authority, is introducing the corridor as per the announcement made through the monetary policy of this fiscal year. The corridor is being launched by floating a two-week instrument called term deposit to mop up Rs 20 billion from the banking sector.
The Open Market Operations Committee (OMOC), which comprises senior officials of NRB and the Ministry of Finance, today fixed interest of 0.3045 per cent on the two-week instrument, which can be subscribed by commercial banks, development banks and finance companies.
The rate was fixed by deducting 10 basis points, or 0.10 percentage point, from weighted average interbank rate of commercial banks of Monday. This means weighted average interbank rate of commercial banks stood at 0.4045 per cent on Monday.
NRB, in a guideline on interest rate corridor introduced today, has said term deposit rate would be fixed by deducting 0.10 percentage point from weighted average interbank rate of commercial banks of two working days ago.
The term deposit rate, under the corridor, is the rate at which NRB borrows money from banks and financial institutions (BFIs) for a period of two weeks in case of excess liquidity in the banking system. This rate forms the lower bound, or floor, of the corridor.
NRB’s decision to launch the corridor has been welcomed by bankers, who were calling on the central bank to introduce a system to keep interest rates within a certain band to reduce interest rate volatility.
“This is a positive move,” said Sanima Bank CEO Bhuvan Kumar Dahal.
“But will it be able to stabilise the interest rates because the difference between the ceiling and floor rates is very wide?” Dahal questioned.
The corridor basically comprises of three rates: standing liquidity facility (SLF), or ceiling, rate; repo, or policy, rate; and term deposit, or floor, rate.
SLF rate is the rate at which NRB provides loans to BFIs for a maximum of five days in case there is severe shortage of cash. This rate, which forms the upper bound, or ceiling, of the corridor, has been fixed at seven per cent.
In contrast, the floor rate, or term deposit rate, has been fixed at a low of 0.3045 per cent.
This means the wedge between the ceiling and floor rates stands at 6.6955 per cent. This also means interest rates can fluctuate within a band of seven per cent and 0.3045 per cent, which appears volatile and will not prevent deposit rates from suddenly hitting rock bottom and lending rate from going through
“In the short run, our target is to narrow the wedge to 4.2 per cent,” Min Bahadur Shrestha, executive director at NRB’s Public Debt Management Department, which oversees open market operations, told The Himalayan Times.
This means if SLF rate stands at seven per cent, then two-week term deposit rate, in the coming days, would hover around 2.8 per cent. This difference is still huge and will not address the problems of depositors, who complain about losing money by parking savings in banks because of negative real interest rate, or borrowers, who gripe about sudden hike in lending rates.
This wedge between ceiling and floor rates will remain wider in the coming days as well because of the formula devised to fix repo rate, or policy rate.
Repo rate is the rate at which NRB provides loans to BFIs for a period of two weeks in case of liquidity crunch in the banking system. This rate, which moves in the middle of the corridor, is fixed by adding 200 basis points, or two percentage points, to weighted average interbank rate of commercial banks of two working days ago.
Since interbank rate is being used to fix policy as well as floor rates, the wedge between policy and floor rates will always stand at 2.10 per cent. For instance, tomorrow’s policy rate stands at 2.4045 per cent, whereas floor rate stands at 0.3045 per cent.
This is because term deposit, or floor, rate is fixed by deducting 0.10 percentage point from weighted average interbank rate of commercial banks, while repo, or policy, rate is fixed by adding two percentage points to the same weighted average interbank rate.
“We are aware of this and will revisit the formula when we review the monetary policy after the end of the first quarter of this fiscal year,” Shrestha said, adding, “For now, our main objective is to raise the floor rate.”
To lift the term deposit, or floor, rate, the OMOC will be mopping up liquidity from the banking sector every week from now onwards. “This will exert upward pressure on interbank rate, which is very low,” said Shrestha. “Once interbank rate starts going up, floor rates will also start rising.”
Interbank rate of commercial banks has remained suppressed for a long time because of excess liquidity in the banking system — a result of lethal combination of rise in flow of money sent by Nepalis working abroad and lower demand for loans from the private sector coupled with inadequate supply of instruments to mop up excess liquidity.
To gradually raise interbank rate, Dahal opined the OMOC should also raise the supply of instruments to absorb liquidity.
“If supply of term deposit instrument is way lower than the volume of excess liquidity in the banking sector, then interbank rates will not go up,” he said.
Term deposit subscription conditions
A version of this article appears in print on August 10, 2016 of The Himalayan Times.