Regulatory crisis in the Nepalese banking sector
Nepal’s banking sector is heading down a dangerously risky path, not only due to a seasonal and often recurring shortage of loanable funds, but due to a combination of factors ranging from poor regulation and supervision by the authority monetary policy to blatant compromises in corporate governance practices by banks and financial institutions. institutions themselves in their functioning and affairs.
A recent International Monetary Fund report (IMF) has categorically pointed the finger at the ineffective regulatory and supervisory role of the country’s monetary authority, Nepal Rastra Bank, which results in a lack of “accurate assessment of the quality of banks’ assets and which better captures existing risks”. He also referred to the failure of the central bank to fully implement the first phase of the supervisory information system for class A (commercial) banks and to move to the second phase and extend it to the class B (development banks) and class C (financial companies).
The lack of adequate data to enable effective (online) supervision and methods for calculating non-performing loans were also detected by the visiting IMF delegation which finalized the IMF extended credit facility (loan) of approximately $396 million in Nepal. Interestingly, fiscal and financial sector stability is one of the three components where the loan amount will be used. Such a loan with a very short repayment period of only three years should ideally have been used in more productive sectors of the economy than in reform type spending.
Over the years, the Nepalese financial sector has grown considerably. According to Nepal Rastra Bank latest data, Nepal’s financial system has 27 commercial banks, 17 development banks, 17 finance companies, 67 microfinance financial institutions and one infrastructure development bank under the central bank’s supervision radar. The number of bank branches excluding those of microfinance institutions is 6,154, or more than 50%. Prompt and effective supervision of all, especially on-site, is indeed a herculean responsibility for an under-automated supervisor like Nepal Rastra Bank with only 50% officer-level staff among over 1,000 employees.
Apparently, the poor regulatory framework has alarmingly increased the incidence of regulatory arbitration. These phenomena manifest themselves in different forms. the profit published provisionally of 27 commercial banks in the first half of the current financial year crossed Rs33 billion. The annual rate of return on the 285 billion rupees total paid-up capital of these Class A banks cross 25% by the end of the fiscal year. The only interpretation of these high bank profits, despite the Covid-19 pandemic and the incessant complaints about a liquidity crisis, could be that the regulator of the monetary system, in essence, failed to tame them.
There are larger structural issues blunting the regulatory teeth of the Nepal Rastra Bank. The central bank as a federal entity exercises the sole implementing authority of Schedule 5(5) of the constitution with respect to money and banking, and monetary policy. The central bank currently plays a dual role of monetary authority and regulatory and supervisory authority of the country’s financial system. A monetary authority’s exercise of powers as a central bank independent (from political interference) is unquestionable and in line with global best practice. Whether the central bank of Nepal has positioned and behaved as a fully autonomous institution is, however, another matter altogether, as also indicated in the aforementioned IMF report.
But when it comes to regulatory and supervisory functions, the monetary authority messed up badly and exhibited the “I-control-everything” mentality of the pre-reform era central bankers. Many economies have split the monetary policy function and the regulatory functions and created separate dedicated institutions for each of these two distinct tasks so that monetary authorities can focus more effectively on the central bank’s core functions of targeting the economy. inflation and systemic risk analysis. This practice turns out to be more robust than the previous one, therefore it is rapidly gaining popularity. But, in Nepal, even a meaningful discussion has not yet started in this direction. The competent authorities seem to ignore this need. At the heart of this inertia is the reluctance of central bank mandarins to relinquish its traditional role as regulator and supervisor (as well).
It is perhaps for this reason that the Nepal Rastra Bank, while updating its laws and regulations after the country was restructured into a federal policy, did not even consider creating adequate legal space for provincial governments to collaborate and provide support in its regulatory functions. This would certainly have created more desirable financial governance outcomes.
Despite the proud claims of industry players as the “most transparent” company in Nepal, mainly due to the fact that they are obliged to publish quarterly provisional balance sheets and reports on stock transactions, the Nepalese banking sector gradually turns into simple wear. cartel – compromising almost every standard of corporate governance. Massive insider loan, the complete disregard for apparent conflicts of interest, the “falsification” of books of account and the pervasive corrupt practices in lending, even in private sector banks, are some of the perversions that have exposed the whole of financial architecture at imminent risk of collapse.
To cite just one burning example, the current loanable funds crisis has been caused not only by the much lower than expected level of government investment expenditure (so far only 15 percent of allowance) but also the irresponsible lending of the banks themselves. Their greed is evidenced by the “fantastic” level of profit made by exhausting all lending opportunities beyond self-managing liquidity risks. The true extent of their overexposure to speculative sectors like real estate remains largely unknown, even to the regulator. In the long run, the cumulative result of all of this is bound to be suicidal for the entire industry. When private companies in particular engage in unethical practices as such, the free market economy is defamed through no fault of its own. The regulator and the industry must learn at least some lessons from the crisis that the Nepalese economy has already faced.