Impact of Deposit Volume, Interest Rate, and Non-

Performing Assets on Lending of Commercial Banks

A Dissertation Proposal

By
Jharana KC

Roll No. 36819/21

TU Reg. No: 7-2-38-770-2016

Padma Kanya Multiple Campus

Kathmandu

2024
Table of Contents
Introduction ............................................................................................................... 1

1.1 Background ................................................................................................... 1

1.2 Statement of the Problem ........................................................................... 2

1.3 Objective of the Study................................................................................. 3

Review of Literature ............................................................................................... 4

2.1 Related Theory ............................................................................................. 4

2.1.1 Loanable Fund Theory ............................................................................ 4

2.1.2. Review of Empirical Literature .............................................................. 5

2.1.3. Specification of variables......................................................................... 7

Research Methodology........................................................................................... 9

3.1 Research Design .......................................................................................... 9

3.2 Native and Sources of Data ..................................................................... 10

3.3 Population and Sample Method ................................................................10

3.4 Data Analysis Tool and Techniques .............................................................10

3.4.1 Statistical Tools ...................................................................................... 10

3.4.2 Financial Tools…………………………………………………………………..14

3.5 Limitation of the study ................................................................................16

References
 INTRODUCTION

1.1 Background

Amadeo (2019) says an interest rate is the percentage of principal charged by the lender
for the use of its money. The principal is the amount of money lent. As a result, banks
pay an interest rate on deposits. They are borrowing that money from you. Anyone can
lend money and charge interest, but it's usually banks. They use the deposits from
savings or checking accounts to fund loans. They pay interest rates to encourage people
to make deposits. Banks charge borrowers a little higher interest rate than they pay
depositors so they can profit. At the same time, banks compete with each other for both
depositors and borrowers. The resulting competition keeps interest rates from all banks
in a narrow range of each other.

Murray (2018) says lending (also known as "financing") is the temporary giving of
money or property to another person with the expectation that it will be repaid. In a
business and financial context, lending includes many different types of commercial
loans. Lenders are businesses or financial institutions that lend money, with the
expectation that it will be paid back. The lender is paid interest on the loan as a cost of
the loan. The higher the risk of not being paid back, the higher the interest rate. Lending
to a business (particularly to a new start up business) is risky, which is why lenders
charge higher interest rates and often they don't give small business loans.Types of
Commercial Loans are Bank financing for small business start-up and working capital,
Asset financing for equipment and machinery or business vehicles, Mortgages, Credit
card financing, Vendor financing (through trade credit), Personal (unsecured) loan.

Khan ( 2019) Suggest when the Federal Reserve raises or lowers its target interest rate,
the change affects consumers too. The federal rate helps determine the interest you pay
on loans and earn on savings, so it matters to just about everyone. Here’s what might
change when rates rise or fall. Mortgage payments - If there will be a fixed-rate
mortgage, then it won’t be affected by a rate change. However, with an adjustable-rate
mortgage, rate and payments can potentially increase or decrease. If interest rates are
rising, check with lender to find out how much payment will increase and if it benefits
to refinance into a fixed-rate loan. If planning to refinance a mortgage or searching for

1
a new fixed-rate loan, doing so after the Fed has trimmed rates might allow to lock in a
lower interest rate. However, other factors also play a role, such as credit score. Car loans
- A low interest rate environment is good news for those looking to finance a car because
people can borrow money more cheaply, but a rate increase makes financing a

car more expensive. People with higher-interest car loans might benefit from refinancing
if rates drop, depending on how big the difference is and the length of the loan term.
Credit card rate - The annual percentage rate (APR) on most credit cards is variable.
That means an increase in the target rate will likely drive up the interest pay on account
balance, while a decrease can potentially lower the interest pay—which may make it
easier to pay down debt more quickly. Private student loans - Interest rates on federal
student loans are fixed, so those rates remain locked. If taken out private loans, however,
interest payments may increase or decrease with rate changes. Whether loans are private
or public, a lower interest rate environment might be a good time to check options for
consolidation to see it can get a lower overall rate.Returns on savings - One positive
effect of a target rate increase may be higher interest rates banks pay customers in
savings vehicles such as CDs, money market accounts and basic savings accounts.
Although higher rates are good news for savers, don’t expect an immediate, dramatic
change; rates tend to move gradually. When rates move lower savings vehicles could
generate smaller returns.

1.2 Statement of the problem

Interest rate is the amount a lender charge for the uses of asset expressed as a percentage
of the principle. Interest rate changes plays an important role in making lending
decisions for any individuals or any institutions.Interest rate changes posses certain
impact on lending activities of commercial banks.

The research is the vast investigation of the problem. The possible problems are faced
by policy maker of commercial banks will be mentioned below:

1. Is there significant difference on interest rate, deposit volume, non-performing loan

and lending loan across types of banks?
2. What is the relationship between interest rate, deposit volume and non-
performing loan with lending loan?

3. How does the interest rate, deposit volume and non-performing loan effect on
lending loan?

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 1.3 Objective of the study
The major objective of the study is to find out the impact of interest rate changes on
lending. Besides, the overall objectives of this study are as follows:
1. To analyse the difference on interest rate, deposit volume, non-performing loan
andlending across private banks and joint venture banks.
2. To examine the relationship between interest rate, deposit volume and
nonperforming loan with lending of sample banks.

3. To examine the effect of interest rate, deposit volume and non-performing loan
onlending.

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 REVIEW OF LITERATURE

2.1 Related theory

2.1.1 Loanable fund theory

The neo-classical theory of interest or loanable fund theory of interest was first develop
by the Swedish economist Kunt Wicksell. Later economists Ohlin, Myrdal, Lindahl,
Robertson and J. Viner had considerably contributed to this theory. According to this
theory, rate of interest is determined by the demand for and supply of loanable funds.
This theory was more realistic and broader than the classical theory of interest.Loanable
funds theory differs from the classical theory in the explanation of demand for loanable
funds.According to this theory demand for loanable funds arises for the following three
purposes i.e.; Investment, hoarding and dissaving. Investment isthe main source of
demand for loanable funds is the demand for investment. Investment refers to the
expenditure for the purchase of making of new capital goods including inventories. The
price of obtaining such funds for the purpose of these investments depends on the rate
of interest. An entrepreneur while deciding upon the investment is to compare the
expected return from an investment with the rate of interest. If the rate of interest is low,
the demand for loanable funds for investment purposes will be high and vice- versa. This
shows that there is an inverse relationship between the demands for loanable funds for
investment to the rate of interest.The demand for loanable funds is also made up by those
people who want to hoard it as idle cash balances to satisfy their desire for liquidity. The
demand for loanable funds for hoarding purpose is a decreasing function of the rate of
interest. At low rate of interest demand for loanable funds for hoarding will be more and
vice-
versa.Dissaving’s is opposite to an act of savings. This demand comes from the people
at that time when they want to spend beyond their current income. Like hoarding it is
also a decreasing function of interest rate.

The supply of loanable funds is derived from the basic four sources as savings,
dishoarding, disinvestment and bank credit.Savings constitute the most important source
of the supply of loanable funds. Savings is the difference between the income and
expenditure. Since, income is assumed to remain unchanged, so the amount of savings

4
varies with the rate of interest. Individuals as well as business firms will save more at a
higher rate of interest and vice-versa.Dishoarding is another important source of the
supply of loanable funds. Generally, individuals may dishoardmoney from the past
hoardings at a higher rate of interest. Thus, at a higher interest rate, idle cash balances
of the past become the active balances at present and become available for investment.
If the rate of interest is low dishoarding would be
negligible.Disinvestment occurs when the existing stock of capital is allowed to wear
out without being replaced by new capital equipment. Disinvestment will be high when
the present interest rate provides better returns in comparison to present earnings. Thus,
high rate of interest leads to higher disinvestment and so on.Banking system constitutes
another source of the supply of loanable funds. The banks advance loans to the
businessmen through the process of credit creation. The money created by the banks
adds to the supply of loanable funds.

According to loanable funds theory, equilibrium rate of interest is that which brings
equality between the demand for and supply of loanable funds. In other words,
equilibrium interest rate is determined at a point where the demand for loanable funds
curve intersects the supply curve of loanable funds.

2.2 Review of empirical literature

Roseline, Esman and Anne (2011) studied the interest rate pass-through Kenya. The
study aims to quantitatively measure the size and speed of monetary policy interest rate
transmission to long term interest rates in Kenya. The study used autoregressive
distributed lag specification re-parameterized as an error correction model and mean
adjustment lag methods. In this study the researcher had found incomplete passthrough
of policy rates both in the short and the long run. It is approximately between 11 months
to two years for policy interest rate to be fully transmitted to long term interest rates.
The variables selected in this study are the volume of loan granted and the quality of
precaution reserve they choose to hold. Lending interest rate and deposit interest rate are
taken as independent variable where the interbank rate, 91-day rate and REPO rate were
entered alternately. The MAL formula is used to show the result of incomplete interest
rate pass-through both in short and long run. The study sought to provide some insight
into the relationship between policy rates and commercial bank interest rates. The study
indicates stickness of policy transmission from policy interest rates to commercial bank
rates both for the deposit and lending rates. The magnitude of transmission is less than
0.34 for both lending and deposit rates. The findings of this study will therefore inform

5
policy makers of the effectiveness of their policy decision and facilitate timely monetary
policy actions.

Ansari and Goy (2014) Studied bank completion, managerial efficiency and the interest
rate pass- through in India. The study shows how banks solve an intertemporal problem
under adverse selection and moral hazard with bank specific factors, regulatory and
supervisory features, market structure and macroeconomic factors can be expected to
affect banks loan interest rates and their spread over deposit interest rates. To examine
interest rate pass-through for India banks in a period following extensive financial
reform, after controlling for all factors, the researchers estimate the determinants of
commercial banks loan pricing decisions using the dynamic panel data methodology
with annual data for a sample of 33 banks over the period from 1996 to 2012. The result
shows commercial banks consider several factors apart from the policy rate. The
independent variables are loan interest rate and deposit interest rate and dependent
variables are loan maturity, product diversificationand managerial inefficiency, return on
equity, liquidity and size. The researcher use descriptive statistics for data analysis. Here
APRD measures estimating marginal costs using Translog Cost Function which
quantifies the impact of marginal costs on performance, measured in terms of market
shares. The absolute value of the ARPD measure is used in our regression since it used
straightforward interpretation. Higher the coefficient in absolute sense, higher is the
competition. The competition in the banking sector increased from 2002 where in 2006
and 2007 marginal decrease. The main finding is that loan interest rates spread are
positively impacted by policy variables, more competition reduces transmission by
reducing the loan rate but positive policy shock increases the cost of funds and reduces
the spread. The interaction between policy rate and competition in the banking sector
had a negative and highly significant coefficient, which is the impact of competition on
interest rate pass-through. An exogenous shock forced banks to minimize costs, offer
services at lower prices and at the same time increase profits. Efficient banks will
increase in size and market share at the expense of less efficient banks. MI interaction
puts significant downward pressure on loan pricing which leads to increased share in
competitive loan market which helps in increase in profit. Cost of deposit affect on loan
rate. The results highlight the role of operating efficiency, risk aversion, asset-liability
management and credit risk management in commercial banks loan pricing.

Proposed Research Framework

The research will be based upon the International Journal of development “Interest

6
Rate Pass-through in Kenya” which was conducted by M.N. Roseline, M.N. Esman &
K.W. Anne in 2011 and Contemporary Study in the economy and financial analysis
“Bank Competition Managerial Efficiency and the interest rate pass-through in
India” which was conducted by J. Ansari and A. Goyal in 2014.
2.3.1 Specification of variables

Interest rate

Lending loan
Deposit volume

Non-performing
loan
Types of banks
(Private vs. Joint
Venture)

Figure 2.1: Conceptual frame work

1. Independent variables
1. Interest rate
2. Deposit volume
3. Non-performing loan

2. Dependent variable
1. Lending loan

3. Moderate variable
1. Private Banks
2. Joint Venture Banks

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Table 2.1
Review of empirical studies

Study Major Findings

The study shows quantitatively measure the size and speed of monetary policy
Roseline, Esman, & Anne(2011) interest rate transmission to long term interest rates in Kenya.

Loan interest rates spread are positively impacted by policy variables, more
Ansari & Goyal (2014) competition reduces transmission by reducing the loan rate but positive policy
shock increases the cost of funds and reduces the spread

8
 Research Methodology
This chapter will present a description of the methodology that will be used in the
study. It spells out the techniques and methods of sampling, data collection,
processing analysis and the area in which the study will be carried out. The
chapter will also highlight the limitations and problems that will be encountered
while collecting data in final report.

3.1 Research design

The main purpose of this research is to know about the impact of interest rate
changes on Lending in Commercial Banks of Nepal. Two Foreign Joint Venture
Bank i.e Himalayan Bank Limited and Everest Bank Limited and three private
banks i.e. Prime Bank Limited, Kumari Bank Limited and NMB Bank Limited as
sample survey organizations. The research will use hypothesis test to determine
relationship and provide a conclusion about the tested variables.

The research will be based on quantitative analysis in which the data collected
will be statistically analyzed using MS excel, SPSS. The data is aimed to collect
from secondary sources through annual report published in website.

The research design is the specific action of methods and procedure for acquiring
the information needed to structure of solve problems. In other word, it is the
conceptual framework within which research is conducted. In this study,
descriptive and analytical research designs are applied to achieve the research
objectives. For analytical purposes, the annual reports published by the related
banks. After tabulation, they will analyze by applying both financial anpred
statically tools. Descriptive research is the systematic collection and presentation
of data to give a clear picture of a particular situation.

3.2 Nature and sources of data

This study based only on secondary data. To collect the secondary data, published
annual reports are viewed in websites of sampled banks.

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3.3 Population and sample method

Population refers to the entire group people, events or things of interest that a
researcher wishes to investigate.There are 20 commercial banks (including
government owned, public and joint venture) are operating in Nepal. It is difficult
to study all of them regarding the study topic because of limited time and
resources factors too. So only following five banks are selected as sample.
They are as follows:

• Himalayan Bank Limited

• Everest Bank Limited

• Prime Bank Limited

• Kumari Bank Limited

• NMB Bank Limited

3.4 Data Analysis Tools and Techniques

The thesis will cover and include the financial and statistical tools to analyse the data in
order to reach the conclusion of the research. For the analysis of the data, MS WORD,
SPSS and MS EXCEL will be used. For the data of five years were taken as sample from
2020/21 to 2022/23. Firstly, the collected data are presented in proper forms, grouped in
various table and then compared with other to interpret results. For this study statistical
tools are going to be used.

3.4.1 Statistical tools

Various statistical tools related to this study will be drawn to make the conclusion more
reliable according to the available financial data. Statistic tool is also used to test the
hypothesis that is set to know the information of population. For this, following
statistical tools will be used.

1. Arithmetic Mean or Average (A.M):- The Mean or average value is a single value
within the range of data is used to represent all the values in the series. It
represents the entire data which lies almost between the two extremes. An
average is somewhere within the range of the data, it is also called a measure of
central value. In this study, mean is calculated to find out the average of the

10
 variables used in research they are interest rate, deposit volume, nonperforming
loan and lending loan. It is calculated an all samples:

Mean (

Where, x = Value of responses of each independent or dependent variable

N = Number of observations
∑ = Sum of value of all items

2. Median:- Median is a tool to measure the centre of a numerical data set. It

summarizes large amounts of data into a single value. It can be defined as the
middle number of a group of numbers that have been sorted in ascending order.
In other words, the median is the number which would have the same amount of
numbers both above and below it in the specified data group. It is commonly
used measure of data sets in statistics and probability theory. In this study, median
is calculated to find out the mid value of the variable used in the research they
are interest rate, deposit volume, non-performing loan and lending loan. The
formula for the median is as follows:

Median (Md) =

Where, N = Number of observations

3. Standard Deviation (S.D.):- The standard deviation is the measure that is most
often used to describe the variability in data distributions. It can be thought of as
a rough measure of the average amount by which observation deviate on either
side of the mean. It is calculated for selected dependent and independent variable
specified. It is positive square root of mean squared deviation from the arithmetic
mean. The more spread out the data, the higher the standard deviation. In this
study, standard deviation is calculated of the variable used in the research they
are interest rate, deposit volume, non-performing loan and lending loan. The
formula for the standard deviation is as follows:

∑
√
SD =

Where, SD = Standard Deviation

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 = Sum of square of the standard deviation measured from arithmetic
average

Total number of observations

4. Coefficient of Variation (CV):- Coefficient of Variation (CV) reflects the relation

between standard deviation and mean. The relative measure of dispersion based
on the standard deviation is known as coefficient of standard deviation. The
coefficient of dispersion based on the standard deviation multiplied by 100 is
known as CV. It is used for comparing variability of two distributions. If the X
is the arithmetic mean and standard deviation of the distribution. In this study,
coefficient of variance is calculated of the variable used in the research they are
interest rate, deposit volume, non-performing loan and lending loan. The formula
for the coefficient of variation is as follows:

C.V. = ( ) x 100%
5. Correlation (r):- Correlation is a statistical tool designed to measure the degree
of association between two or more variables. In other words if the changes in
one variable affects the change in another variable, then the variable are said to
be co- related when it is used to measure the relationship between two variables,
then it is called simple correlation. The coefficient of correlation measure the
degree of relationship between two sets of figures. Among the various methods
of finding out coefficient of correlation, Karl Pearson’s method is applied in the
study. In this study, correlation is calculated for the observation to find out the
degree of relation between independent and dependent variables for all samples.

It is expressed as: r =
Where,
r = Coefficient of Correlation
=
=
=

6. Regression: - Regression is a statistical measure that attempts to determine the

strength of the relationship between one dependent variable and one or more
variables. It includes many techniques for modelling and analysing several

12
 variables to understand the relationship between variables. In this study,
regression is calculated for the observation to find out direction of relationship
between independent variables and dependent variable for all samples. The
theoretical model for the relationship is formulated as equation below:
Y= a+ + +
Where, Y =
Lending a=
intercept
= Interest Rate
= Deposit Volume
= Non-Performing Loan
= Coefficient of Interest Rate
= Coefficient of Deposit Volume
= Non-Performing Loan

3.4.2 Financial tools

There are various financial tools to measure the performance of an organization. Financial
ratios will be based on CAMEL Framework are related to capital, assets, mangement,
earnings and liquidity considerations.. The following financial tools will be used for the
analysis:
i. Return on Assets (ROA)
ii. Return on Equity (ROE)
iii. Capital Adequacy Raio (CAR)
iv. Non-performing Loan Ratio (NPLR)
v. Credit to Deposite Ratio(CDR)
vi. Interest Expenses to Total Loan (IETTL)

Return on Assets (ROA)

Return on assets (ROA) is an indicator of how profitable a company is relative to its total
assets. ROA gives a manager, investors, or analyst an idea as to how efficient a company's
management is at using its assets to generate earnings. Return on assets is displayed as a
percentage.
Net Income
ROA =
Total Assets

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Return on Equity (ROE)
Return on equity (ROE) is a measure of financial performance calculated by dividing net
income by shareholders' equity because shareholders' equity is equal to a company’s assets
minus its debt, ROE could be thought of as the return on net assets.
Net income
ROE=
Shareholder‘s Equity

Capital Adequacy Ratio (CAR)

The capital adequacy ratio (CAR) is a measurement of a bank's available capital expressed
as a percentage of a bank's risk-weighted credit exposures. The capital adequacy ratio, also
known as capital-to-risk weighted assets ratio (CRAR), is used to protect depositors and
promote the stability and efficiency of financial systems around the world. Two types of
capital are measured: tier-1 capital which can absorb losses without a bank being required to
cease trading, and tier-2 capital which can absorb losses in the event of a winding-up and so
provides a lesser degree of protection to depositors.
𝑇𝑖𝑒𝑟 1 𝐶𝑎𝑝𝑖𝑡𝑎𝑙+𝑇𝑖𝑒𝑟 2 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
CAR=
𝑅𝑖𝑠𝑘 𝖶𝑒𝑖gh𝑡𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠

Non Performing Loan Ratio (NPLR)

Non-performing Loan (NPL) ratio compares non-performing loans to the total loan portfolio
(loans are assets for the bank), and the higher ratio means higher risk of losses for some of
the loans. Non-performing loans are those loans that are late on payments (common term is
90 days but it may depend on the financial regulations in the market).
𝑁𝑜𝑛 𝑃𝑒𝑟𝑓𝑜𝑟𝑚𝑖𝑛g 𝐿𝑜𝑎𝑛
NPL Ratio =
𝑇𝑜𝑡𝑎𝑙 𝐿𝑜𝑎𝑛

Credit Deposit Ratio (CDR)

Credit Deposit ratio is the ratio that shows how much a bank lends out of the deposits it has
mobilized. It indicates how much a bank funds are being used for lending, the main banking
activity. A higher ratio indicates more reliance on deposits for lending, and vice- versa.

14
Interest Expenses to Total Loan (IETTL) Ratio
The Interest Expense to Total Debt ratio measures the estimated interest rate the company is
paying on its total debt. This ratio assumes both Short Term Debt and Long Term Debt
are summed together, as the Interest Expense figure is usually shown on the income
statement as a summation of short and long-term interest expenses.
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑒𝑠𝑒
IETTL =
𝑇𝑜𝑡𝑎𝑙 𝐿𝑜𝑎𝑛

15
3.5 Limitation of the study

As we know that every activity has limitations due to time and resources, this thesis also
pass through some boundaries. The main limitations of study are mentioned below:

1. The samples are taken only from five commercial banks, other financial
intermediaries are not included in the study.

2. The lending amounts of commercial banks are influenced by several factors.

However, this study mainly focuses on the interest rate changes, deposit and non-
performing loan.

3. The study is based on secondary data only.

4. The study only covers ten fiscal years, i.e. 2012/13 to 2022/23.

16
References

Amadeo, K. (2019, 05 12). the balance. Retrieved May 12, 2019, from the balance
Website: https://www.thebalance.com
Ansari, J., & Goyal, A. (2014). Bank Competition Managerial Efficiency and the
interest rate pass- through in India. Contemprorary Study in Economic and
Financial Analysis, 96, 317-339.
Barone, A. (2019, 4 23). Investopedia. Retrieved April 23, 2019, from Investopedia Web
site: https://www.investopedia.com
Fadiran, G. (2014). Bank competition interest rate pass-through in the BRICS.
International Journal of Emerging Markets, 9(4), 471-487.
Khan. (2019). Khan Academy. Retrieved from Khan Academy Website:
https://www.khanacademy.org
Murray, J. (2018, 11 22). Small Business. Retrieved October 22, 2018, from Small
Business Web site: https://www.thebalancesmb.com
Roseline, M. N., Esman, N. M., & Anne, K. W. (2011). Interest Rate Pass-through in
Kenya. International Journal of Development, 10(2), 170-182.

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