KATHMANDU: Interest rates on both deposits and loans of banks and financial institutions have declined due to excess liquidity in the banking system. The increase in liquidity has led banks to reduce interest rates on deposits, lowering costs and making interest on loans cheaper.

According to information published by the banks, the quarterly average base rate of commercial banks was 8.35 percent from mid-May to mid-June of the current fiscal year. At the beginning of the previous year, the average quarterly base rate was 10.14 percent, but it decreased by 1.79 percentage points towards the end of the fiscal year. As banks reduced interest on deposits from mid-May to mid-July, it appears that the quarterly base rate to be implemented from mid-July will be even lower.

With the decrease in the base rate, interest on loans have also become cheaper. According to the base rate determination procedure, banks and financial institutions determine the base rate by adding a 0.75 percent return to their cost. Banks then determine interest in loans by adding a premium to the base rate, with the current maximum premium being 4 percent.

The base rate for the last three months is used when investing in a new loan, and the premium specified in the loan agreement cannot be changed. Thus, when the average base rate decreases each quarter, interest on loans automatically decrease and vice versa.

From mid-May to mid-June, Standard Chartered Bank had the lowest quarterly base rate among commercial banks at 6.26 percent, while Kumari Bank had the highest at 9.48 percent. Sixteen banks have base rates below 9 percent.

"In the current year, after banks reduced interest on deposits, interest rates on loans also decreased," said former banker Parshuram Kunwar Chhetri. "However, interest rates on loans are still high." He explained that due to the lack of liquidity in previous years, banks raised long-term deposits at high interest rates, which kept loan interest rates from decreasing as expected. "The cost of banks is high because they raised deposits at high prices in the past. It seems that interest on loans will remain high until new, cheaper deposits are introduced."

Due to the lack of liquidity, interest rates increased in previous years, but they have started to decrease since the recently ended fiscal year. As liquidity began to ease, the Nepal Bankers Association decided to end the gentlemen’s agreement at the beginning of the last fiscal year (mid-July 2023) and set interest rates at will. After that, the interest rates on deposits increased slightly until October but have been continuously decreasing since then.

In last July, the average interest rate on deposit of commercial banks was 9.83 percent, but it reached 10.26 percent in October. Since then, the average interest rate has continuously decreased to 6.72 percent as of July this year.

Although the interest rates on loans have dropped, the credit flow from banks has not increased. By May, deposits in banks and financial institutions increased by 9 percent, while credit flow to the private sector increased by only 5.1 percent. The NRB's monetary policy for the year 2080/81 targets 11.5 percent credit expansion.

Due to the increase in deposits, there is more than Rs 700 billion of investable capital in banks and financial institutions due to a lack of credit flow. By Sunday, banks and financial institutions had collected a total of Rs 6482 billion in deposits and disbursed loans of 5160 billion. On Sunday, the average credit-deposit ratio (CD ratio) of banks fell to 77.61 percent. Banks can grant loans by maintaining a CD ratio of up to 90 percent.