Liquidity Crisis
With the Kathmandu Interbank Call Rates now ruling at over 7%, there is growing fear of liquidity crisis in the market. The central bank is trying to use this opportunity to force the banks to raise the interest rate on deposits. And that effort is bearing fruit to some extent.
Nepal Bankers Association has submitted a six-point memorandum to the central bank asking for relief measures such as reduction in the CRR from present 5 percent to 3 percent, reduction in the penal rate of interest when the banks borrow from the central bank and increase in the repayment period when the banks borrow against the security of treasury bills.
The banks’ fear is well founded in that the call rate that was around 4 percent in the middle of December reached 8 percent in the last week of January.
However, it must be recalled that the period from mid-December to mid-April is historically a period of high call rate. This year the rate has shot up over 7 percent compared to about 4 percent last year and the reason is that this year the government is borrowing heavily from the market compared to the last year as the government is suffering huge deficit in its budgetary operations compared to surplus in the previous years by this time.
And the reluctance of the central bank to oblige by the request of the bankers’ association is understandable. The rate of interest offered by the banks to the depositors is negative when compared with the rate of inflation. Therefore, the central bank has taken this liquidity crunch as an opportunity to put pressure on the banks to raise the interest rate on deposits. However, the tactic still does not seem to have been effective. Though the banks are seen revisiting their interest rate structure, surprisingly they have revised upward the interest rate also on the loans, thus effectively maintaining the interest spread intact.
This goes against the objective of reform agenda in this area which is to reduce the spread. For this, the rates on deposits have to go up while the rate on the loan remains the same or preferably is reduced. The present stance of the central bank seems to be ineffective to achieve this purpose.
Also the reason the banks are reluctant to reduce the rate on lending is understandable. Most of them are still loaded heavily with bad loans which pushes up their effective cost of fund. This is particularly so in case of the largest and government owned banks – Nepal bank Ltd. and Rastriya Banijya Bank though some private sector banks too are suffering from the same malaise. While most of the banks are thus forced by the bad debt problem to maintain a very high interest spread, the others who have low cost of fund can attract enough deposits and extend enough loan even at a slightly higher or lower interest rates.
Also a reference to the recent international developments has to be made in this connection. While the Federal Reserve Board of USA has introduced massive rate cuts in January, Reserve Bank of India in its policy review late January refused to follow the Fed’s steps and left all the key rates unchanged. This means India is still an attractive destination for Nepali funds due to the higher interest rates there. Therefore, the solution to the problem lies not only in pumping in additional liquidity. Rather it requires more extensive reforms in the banking sector including tougher steps to reduce the bad debt.
Interbank Call Rates |
Period |
Call Rate |
16-20 December |
4.25% |
23-28 December |
5.4% |
30 December -January 4 |
6.5% |
6-11 January |
6.5% |
13-18 January |
7% |
20-25 January |
7.7% |
27 January – 1 February |
8% |
