On Sunday, NMB Bank launched an attractive two-year fixed deposit scheme offering an annual interest of 12 percent. This basically means depositors who park, say Rs100 at NMB, will be guaranteed a return of Rs12 per year for a two-year period.

Banks generally offer higher interest on fixed deposits because the money is locked in for a specified period. If depositors wish to breach the contract and withdraw the amount before the expiry of the deadline, penalty needs to be paid.

What is unique about NMB’s latest offer is that depositors need not pay the fine if they wish to extract the money before the two-year tenure is over. This means parking money at NMB, under the latest scheme, is akin to putting funds in a current account, but with better returns.

Banks are resorting to unconventional measures, as they face an acute shortage of funds that could be immediately extended as loans. Some banks are even facing problems in meeting the regulatory requirement on lending, which, in the present situation, can only be addressed by raising more deposits.

It is therefore not surprising that Himalayan Bank and Sunrise Bank recently offered up to 12 percent interest on fixed deposit schemes of various tenures.

These schemes have been introduced at a time when inflation has cooled off to a 12-year low of 3.8 percent. This allows depositors, who have always complained about negative real interest rates because of greater inflationary pressure, to reap real benefits by parking money at banks.

But there is a catch: higher interest rates can also create distortions in the market, triggering a cut-throat pricing competition among banks to attract deposits, bankers say.

Until September, interest on fixed deposits parked by individuals stood at a maximum of 7 percent. By January that rate had gone up to 10 percent. Now, the rate is 12 percent.

“If this continues, rates will continue to rise, resulting in an interest rate war among the banks. This will create a vicious circle, wherein deposit will move to and fro banks,” said Sanima Bank CEO Bhuvan Kumar Dahal. “This will make it difficult for banks to meet the regulatory lending requirement because the same deposit will move from one bank to another.”

Banks are currently allowed to lend 80 percent of their total local currency deposits and core capital combined. On January 27, 28 commercial banks in aggregate breached this lending limit by over 1 percentage point. Since then corrections have been made. Yet there is very little room for credit expansion, as around 79 percent of the total quota for loan disbursement has been utilised, according to the latest data of the Nepal Bankers’ Association (NBA).

The banking sector is facing severe problems in keeping itself within the lending boundary because of the mismatch in deposit collection and credit disbursement. This was triggered by a combination of deceleration in remittance inflow, which caused deposit growth to slow down, and higher demand for credit since the end of the Indian trade embargo.

Banks have collected Rs184 billion in fresh deposits from the beginning of this fiscal year till February 3, whereas credit disbursement in the same period stood at Rs231 billion, the NBA data show.

As banks extended loans aggressively—despite knowing the flow of fresh deposits had decelerated, they started breaching the regulatory lending limit on purpose, the Nepal Rastra Bank recently found. And the “quarterly financial reports they submitted included window dressing”.

This was exposed during special inspections of 13 commercial banks. Although the names of the banks have not been revealed, many were found to be borrowing funds from other banks at the end of every quarter through interbank lending to meet the regulatory lending limit, the NRB said in a statement.

The banks resorting to interbank lending were also found to offer 0.5 percent extra in interest to cover up the malpractice, the statement added.

“The NRB must come up with an amicable solution. Otherwise, things can get out of hand,” said Dahal.