Level & Structure Of Interest Rate

Interest is the cost of borrowing while the interest rate is the rate expressed as a percentage of the total sum borrowed for a stated period of time. All business organizations or individuals are responsive to interest rate of banks and financial institutions in one-way or another. Interest rate structure is the relationship between maturity and yield in order to determine bow the bond portfolio behaves in matching the maturity structure. The change in interest rate with correct adjustment influences the portfolio return. Thus, interest rate structure and its level depends upon (a) the behavior of the yield curve (b) composition of the maturity structure (c) sensitivity of the change in the interest rate and (d) default risk included in matching the level of interest rate and its relationship with the yield curve.
However, in the context of Nepal, interest rate is regulated by the central bank during the early stage of financial market development taking the period from 1955 to 1965. But, the country's central bank namely Nepal Rastra Bank gradually began to liberalize the determination of interest rate on a phase-wise basis according to compatibility, efficiency and maturity of the banks and the financial institutions that have developed in the country. But for national interest from the monetary stability view point, Nepal Rastra Bank can get in the way in guiding the banks and financial institutions to relate interest rate to economic growth.
In the early mid 1980's the country has adapted liberal economic policy. Number of finance companies and commercial banks began to develop and government made the liberal policy in maintaining the interest rate structure. Liberalization in determining market interest rate was encouraged for commercial banks, established under joint venture in association with foreign banks in private sectors.

The level of interest rate
A bond's value depends on the three important factors that include coupon rate, the market interest rate and level of interest rate. A term is the date when the repayment of the face value amount of a financial claim is due. The coupon rate is the stated rate. This will be paid annually or semiannually or quarterly as interest when the holder redeems coupons attached to the bond at specified period of time.In Nepal also, Nepal Rastra Bank determines the interest rate on Government Development Bond and National Saving Certificate. In these instruments issued to the public, there is a lot of variation in interest rate in different periods depending upon the state of the economy. At present, deregulation of the interest rate as result of economic and financial liberalization has brought autonomy and determination of the level of interest rate to the banks and financial institutions guided to follow the directives of the unified Umbrella Act.
Upon maturity, the bondholder redeems the bond at the face value. The level of interest rate is the most important factor, which influences the value of bond. Therefore, every investor should know the basic factors that influence the level of interest rate and changes from one level of interest rate to another level of interest rate. Various theories have been developed to examine why interest rates are high, low rising or falling. Fisher classical theory is one of them. In 1930, Irving Fisher found that normal interest rates tend to rise and fall in relation to the rate of inflation.
However, in economic perspective, the theory of interest rate determination focuses on general level of interest rate in an economy showing the relationship between borrowers and lenders. The decision on saving and borrowing is guided by the popular Fisher's Theory under a classical approach based on marginal rate of time preference for consumption. The saving and investment comes in equilibrium through interest rate determination. Saving decision is income while investment means directing savings to increase firm's capacity to produce. But, in this regard, marginal productivity of capital is negatively related to amount of investment. Negative relationship shows downward sloping line. As such, the firm will invest as long as marginal productivity of capital exceeds or equals the rate of interest. The equilibrium rate of interest comes from interaction of supply and demand functions where supply of savings equal total borrowing and investment. From time to time, there exists frequent results of a shift in demand for savings and supply of savings. At the same time, the loanable funds theory is expansion of Fisher's theory of interest rate to the extent that interest rate is determined by complex interacting forces to total demand for and supply of funds by firms, government, financial institutions, banks and individuals. This is due to the government deposit institutions creating money and borrowing funds.

Interest rate structure in Nepal
Interest rate charged differ in government securities, refinances of loan, commercial bank deposit and loan floated by other financial institutions in this five year period from 2002 to 2007.
In T-bills, interest rates decreased from 4.94 percent in 2002 to 3.95 percent in 2004. In National savings bond, Interest rate recorded 7.13 percent in 2004 and legal of development bond recorded 3.8 percent in 2004. Refinancing rate of NRB varied from 2 percent to 5.5 percent in 2004. During same period refinance rate against foreign
currency loan is 2 percent during same period. The deposit rate of these commercial banks varies from 2 periods to 7.5 period taking savings deposit and various time deposits of minimum 3 months to 2 years and above in 2004.
Then lending rates vary from 4 percent to 16 percent for kinds of loan offered such as industrial loan. agricultural loan, export bills, commercial loans and overdrafts. The interest rates charged by other financial institutions are from 10 percent to 10 percent. But in 2005 the Treasury bill rate is 3.94 percent and it decreases to 3.13 percent in 2006. At the same time the development bank remains at the constant rate of 6.5 percent to 13 percent. But the development bond rate varies from 3 percent to 8 percent. The refinance rate of the Nepal Rastra Bank decreases to 1.5 percent to 6 percent in 2006. The deposit rate of commercial bank for 3 months to 2 years is 2 to 5 percent in 2006. While a lending rate is 8.25 percent to 13.5 percent in case of industry, agriculture, commercial loans and overdraft. But for other financial institutions the interest rate varies from 10.5 percent to 13.5 percent.
The percent per annual interest rate has varied from 3.13 to 2.13 percent in T-bills during 2007 and national savings, it has decreased to 8.15 percent and development bonds provide the maximum interest rate 6.75 percent. The refinancing rate of NRB has decreased to 3.5 percent and in case of foreign loans it comes to 3.25 percent. In case of commercial banks, interest rate on deposits increased slightly 5.5 percent although, the pressure of liquidity has raised interest rate 6 percent and maximum to 7 percent. The lending rate of commercial banks has increased to 14.4 percent. For other financial institutions the interest rate in 14 percent. At present, NRB as well as the investors are finding the interest rate provided by banks is not compatible to the market interest rate.