Key concerns on Current Regulatory Changes
If we consider Nepalese Market, the volatility of interest rates and stressed liquidity environment are the key symptoms that translate the whole dimension of funds mobilization throughout the year and thus have been a major factor that has kept the lending rates higher in general in the hands of the borrower than expected. No matter what the rate of inflation is or no matter what the GDP growth rate is. It is not always relevant to say that higher interest rates are only due to the huge spread rates being maintained by the Banks. The spread rates when introduced for the first time by Central Bank was almost 20 years ago when the spread rate was thereon assessed half-yearly on the basis of six months average cost of fund and yield on loans and investment. After couple of years of implementation. Spread was removed and once again reintroduced some 4 years ago. The Base Rate was another key indicator that played a significant role in changing models of fixation of interest thus trying to cope up with transparency issues.
The recent changes in the calculation of spread rate by removing investment on Government Securities have drastically changed the scene thus the spread rates which previously were supposed to be within limits have now ballooned and crossed the earlier limits as well.
It is easier for a general public to understand spread without considering return on investments on Government Securities as one would always link the interest rates earned on Deposits and Interest rates charged on Loans and Advances to calculate simple interest spread. However, as the Spread Rates with and without taking consideration of investment on Government Securities make a impact of almost 0.5 to 2.00 % which ultimately drains the revenue of Banks if it to be excluded suddenly as a change in the formula.
The larger picture we need to go through is the Banks have operating cost of at least 2:00% and if the spread rate is to be 4.5% without considering investments on Government Securities, the spread rate would be only 3.5% or so if the investments are removed. So from the last year's spread rate, if we have to adjust for this reason, the whole system would generate only 1.5% return over the loans and advances which lets say if for an average banks of loan size of say 70-80 Billion would be only Rs. 1.05 Billion. And this is a gross income. Very specific to this return, Banks would be making net profit after tax of 650-700 Million thus available distributed income would be around 500 Million only which will be around 6-7% on 8 Billion Capital.
We can agree banks may have some income as commission on non-funded obligations but that would not even be adequate to justify in terms of their capital charge. The Counter Cyclical buffer requirement of 2% pronounced would also make a pressure to capital and banks would not be able to take more non-funded obligation. Change in spread in the times of additional capital requirement has limited the capital growth of the Banks thus tending to restrict their business growth.
There is an argument by bankers that by virtue of being a commercial bank, there need to be some playing field for banks to compete in the market with their strength to earn better margin whereas current situation of consensus in deposit rates have not given to a larger extent such scope for the stronger banks. And again the spread rate restriction would not allow the Banks to use their muscle for saving more by attracting low cost deposit as the scenario would be limited and somewhat determined for all banks how much banks can earn in a given period of time despite there being opportunities.