Financial Market and Base Rate on Lending Interest Rate
Interest rate is the price of the fund. Inflation rate & premium for risk is the key determining factor of the interest rate. However, demand & supply of the fund, competitor’s rate and cost of the fund are also the determining factors for interest rate. In the Nepalese financial markets, for last two years lending interest rate is being practiced charging premium rate on the base rate.
Base rate is the sum of the percentage of the cost of fund, percentage of the cost of compulsory reserve, percentage of the cost of statutory reserve and percentage of the operating cost. Previously percentage return on the capital investment would also be added which now has been removed. In the particular financial institution base rate is common at a time for all type of the lending product and customers. And different interest rate is applied to different lending product or customers applying different premium rate based on level of risk on the particular credit request. Level of risk is calculated based on various factors like time period of the credit, size & financing ratio, relation history with the client, financial indicators & its reliability, management aspect, security position, market & product scenario of the business of the client etc. Sometimes bargaining habit & environment of the client also plays role to negotiate the premium rate.
Premium rate may be published premium rate and sanctioned premium rate. BFIs decide & publish different range of premium rate for different credit product like premium rate 2percent to 5percent over the base rate for overdraft and premium rate 2percent to 6percent over the base rate for term loan. And while sanctioning the particular credit request, premium rate is decided normally within range of published premium rate like overdraft request of ABC Co. approved at premium rate of 3percent over the base rate.
As per the Unified Directives, 2075 of Nepal Rastra Bank, the Bank & Financial Institutions in Nepal must calculate & report the base rate on monthly basis. Different premium rate should be decided as per the nature of the credit product to fix the lending interest rate taking calculated base rate and same is to be published on quarterly basis. BFIs have option to change the published premium rate on the particular credit product on half yearly basis.
BFI must decide & clearly mention the premium rate on each lending decision. The BFI is not allowed to decide the premium rate on any credit sanction more than the published premium rate. Base rate is always changeable and premium rate once decided for the particular credit request, it can’t be increased except on the condition (i) agreed by the customer or (ii) default record on the credit or client did not follow the terms of credit sanction. In case of increment on the base rate, the BFI can increase the interest rate keeping same premium rate & if it is decreased, the interest rate on all the regular credit accounts is to be decreased respectively by the same percentage. But BFI has option not to increase the interest rate even in case of increment on the base rate. Interest rate on all the regular credit account is to be reviewed taking new base rate after each quarter end.
In case of lending on Deprived Sector & Priority Sector, BFIs are allowed to sanction the credit at interest rate even below than the base rate i.e. on negative premium rate.
BFIs, while deciding the premium rate for the different credit product must keep in mind the provision of NRB Directive regarding the average spread rate. As per the NRB Directive 2075, the “A” class commercial banks must keep the average spread rate within 4.5percent and for the “B & C” class financial institutions, it is 5percent.
Interest rate on the deposit is the key factor to determine the lending interest rate. Previously interest rate both on deposit & lending would change on the same direction at the same time hence even now a days public expects to decrease in the lending interest rate immediately when interest rate on deposit decreases. Media also flow the massage of possibility of decreasing lending interest rate immediately when interest rate on deposit starts to decrease. As per the present lending interest rate practice, base rate is implemented on quarterly basis hence effect of decreasing interest rate on deposit comes only after the end of the quarter not immediately. But when interest rate on deposit starts to increase, BFIs starts immediately to sanction credit at higher side of published premium rate and so, customers feel the unfair increase on the interest rate of the loan.
Lending interest rate taking base rate with the fixed premium rate is always changeable. Every quarter, the lending interest rate may be changed. And accordingly the changed interest rate, the installment of the loan repayment will also be changed. Hence the borrowers need to know the new interest rate & accordingly the repayment installment amount every time. In the interest rate increasing scenario, the loan customers need to manage either the higher installment amount or they should be ready to pay the same installment amount for longer time.
For the proper implementation of base rate concept on interest rate the banking software must be supportive. There are three components to calculate the interest amount properly i.e. base rate, premium rate and interest rate. In case of many BFIs in Nepal, each time interest rate is inserted on the credit account manually taking the approved premium rate on newly calculated base rate and also the new installment is re-generated on the account. Interest rate change & installment schedule re-generation globally taking single new base rate is not possible in many of the Nepalese BFIs. Because of the manual effort & intervention, implementation of the base rate concept may not be timely and properly.
In line of NRB Directives, BFIs decide & publish the premium rate over the base rate on quarterly basis. Premium rate is published on the range as per the nature of credit product. However, there is no clear guideline about the gap of premium rate on a single credit product and among the credit products. NRB has restricted to impose the premium rate more than the published rate but there is no provision regarding maximum gap between lowest & highest published premium rate. And also, there is no clarity whether the BFI can allow premium rate lower than the published rate or not. NRB seems indifferent regarding the gap of the published premium rate & lending below the published rate but due to this un-clarity, few influencing customer may have been taking benefit of lower side published premium rate or even below the published premium rate charging highest premium rate to the innocent & honest wide number of the small customers.
NRB Directive is un-clear regarding the interest rate on the consortium financing. Consortium can decide the interest rate differently than the above mentioned provision
i.e. charging premium over the base rate. Some cases may be there, consortium is formed only to get the benefit of interest rate even lower than the base rate.
As per the NRB Directive, base rate is to be calculated & reported on monthly basis and it should be published along with premium rate on quarterly basis. However still there is no clarity whether (i) to implement base rate of last month of the quarter, or (ii) the average base of the three months of the quarter, or (iii) average base rate of all previous months of the running fiscal year. Hence, it would be similar practice on all the BFIs if NRB made clear about average base rate.
In the scenario of banking software in many BFIs not supportive for implementation of the base rate properly, it may be doubtful whether all BFIs are following the Directive properly or not. NRB should strengthen the supervisory role to confirm the proper implementation of the Directive.
Manual effort for timely & properly implementation of the base rate is not enough hence it should be implemented by advance & supportive banking software hence BFIs are suggested to upgrade the software.
Large number of small size customers are paying higher premium rate to compensate the effect of lower premium rate to few influencing customer. Premium rate decision must be on the logical ground. Hence, clear guidelines must be there to decide the premium rate for all type of credit products with appropriate gap and also to sanction the credit request with premium rate on logical ground. Provision of maximum spread rate of 4.50percent to “A” class & 5percent to “B & C” class may not enough to control the interest rate on lending.
The guidelines for the premium rate decision (like base on calculated level of risk) must be there so that small innocent customer will be safe from charging highest premium rate for the benefit of few powerful customers. NRB can instruct the BFIs to develop internal policy for defining basis or mechanism of premium rate decision. And also, there must be clear guidelines regarding the interest rate on the consortium financing like; premium rate on average base rate of the consortium financing members or premium rate on base rate of individual participating BFI.
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