What effect does the reduction in interest rate spread have in the current position of the banks?

-Puskar Shrestha

Interest rate spread is the interest rate charged by banks on loans to prime customers minus the interest rate paid by commercial or similar banks for demand, time or savings deposits. It can be defined as the difference between the average lending rate and the average borrowing rate for a bank or other financial institutions.

It is calculated as: (interest income ÷ interest earning assets) – (interest expense ÷ interest bearing liabilities)

The table given below shows the net interest rate spread of the commercial banks as per the financial report of third quarter of the current fiscal year.

As it has been known that the recently unveiled monetary policy has reduced the net interest rate spread to 4.5% from the previous rate of 5%. In the above mentioned list, there are 8 banks whose interest rate spread exceeds the recently unveiled rate of 4.5%.

The reduction in the interest rate spread implies that the banks will have to offer higher rates if they charge high interest rate to the borrower or vice versa. In other words, the profit of the commercial banks is bound to decrease by a margin.

The previous spread of 5% was also not much of a success as it can be seen that the banks had failed to maintain the spread under the given margin. The topic does not stop here as the Rastra Bank plans to bring the spread rate down to 4.4% by the Fiscal Year 2077/78.

Even when Rastra Bank had reduced the spread rate to 5%, the bankers had objected about the decision due to which the central bank had allowed some flexibility in the calculation of such spread. It is yet to be seen how effective the reduction in the current monetary policy would be and what response will be observed from the banking fraternity.