Report Number: 24959-NEP
Document of The World Bank Public Disclosure Authorized NEPAL Public Disclosure Authorized
C.
1 ., ~ * Public Disclosure Authorized FINANCIAL SECTOR STUDY October 16, 2002
Private Sector Finance Division SASFP South Asia Region Public Disclosure Authorized CURRENCY EQUIVALENTS
Currency Unit = rupee (NR) 1 rupee = US$0.01308 US$1 rupee 76.475 (December 2001)
FISCAL YEAR
July 16 - July 15
ABBREVIATIONS AND ACRONYMS
ADB Asian Development Bank ADB/N Agricultural Development Bank of Nepal BOD Banking Operations Department (NRB) BTC Banker's Training Center CBA Commercial Banking Act (1974) CBO Community Based Organizations CBPASS Commercial Bank Problem Analysis and Strategy Study CEAPRED Center for Environmental and Agricultural Policy Research, Extension and Development CIB Credit Information Bureau CIT Citizens' Investment Trust CMF Center for Micro Finance CRR Cash Reserve Requirement CSD Center for Self-Help Development DBA Development Bank Act (1996) DflD Department for International Development (United Kingdom) DEPROSC Development Project Service Center ESGS Employees Savings Growth Scheme EPF Employees Provident Fund FCA Finance Companies Act (1985) FDI Foreign Direct Investment FIA Financial Intermediary Act (1998) FNCCI Federation of Nepali Chambers of Commerce and Industry FSSS Financial Sector Strategy Statement (or HMG/N) GBB Grameen Bikas Bank GDP Gross Domestic Product GNP Gross National Product HMGN His Majesty's Government of Nepal HR Human Resources HRD Human Resource Development IAS International Accounting Standards IDA International Development Association IFC International Finance Corporation IFI International Finance Institution IMF International Monetary Fund INGO International Non-Government Organization ISD Inspection and Supervision Department (NRB) L/C Letter of Credit LIC Life Insurance Company (of India) MCPW Micro Credit Project for Women MFI Micro Finance Institution MIFAN Micro Finance Association of Nepal MIS Management Information Systems MLD Ministry of Local Development MOF Ministry of Finance MOU Memorandum of Understanding NBFI Non-Bank Financial Institution NBI, Nepal Bank Limited NCF National Cooperative Federation NEFSCUN National Federation of Savings and Credit Cooperative Unions Limited NEPSE Nepal Stock Exchange NGO Non-Government Organization NIC National Insurance Corporation NIDC Nepal Industrial Development Corporation NLGI Nepal Life and General Insurance NPA Non Performing Assets NPL Non-Performing Loans NRB Nepal Rastra Bank OCR Office of the Company Registrar PAF Poverty Alleviation Fund PCRW Production Credit for Rural Women PKSF Palli Karma Shahayak Foundation (Bangladeshi micro-finance NGO) RBB Rastriya Banijya Bank RN'IDC Rural Micro Finance Development Center ROSCA Rotating Savings and Credit Association RRBD Regional Rural Development Banks RSRF Rural Self Reliance Fund SAPPROS Support Activities for Poor Producers in Nepal SBI State Bank of India SCC Savings and Credit Cooperatives SCO Savings and Credit Organizations SEACEN South East Asian Central Bank Research and Training Center SEC Securities Exchange Center SEBO Securities Board of Nepal SFCL Small Farmers' Cooperatives Limited SFDP Small Farmer Development Program SLR Statutory Liquidity Ratio SMIE Small and Medium Enterprises SPO Sub-Project Office TA Technical Assistance VD)C Village Development Committee VRS Voluntary Retirement Scheme WDD Women's Development Division (of the MLD)
This report is the result of work carried out over a series of missions during 2000 and 2001. The World Bank team consisted of Simon Bell (Team Leader and Capital Markets), Nagavalli Annamalai (Legal), Karma Tshiteem (Macro-monetary & Commercial Banks), Alain Vedrenne-Lacombe (Banking Supervision), Christopher Juan Costain (Insurance, Pensions and Provident Funds), Shakti Prasad Shrestha (Finance Companies), Mudassir Khan (Development Banks) and Md. Reazul Islam & Shamsuddin Ahmed (Micro Finance). The World Bank team worked with the staff from the Research Department of Nepal Rastra Bank led by Yuba Raj Khatiwada. The Lead Advisors/Peer Reviewers for this study are Tom Rose (World Bank) and Jeremy Carter & Wafa Abdelati (International Monetary Fund). Mr. Kenichi Ohashi is the Country-Director in the World Bank for Nepal. Marilou Uy is the Sector Director for Finance and Private Sector issues in the South Asia Region. Mieko Nishimizu is the Vice President for the South Asia Region.
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Table of Contents
EXECUTIVE SUMMAiRY ...... (i -xi)
CHAPTER ONE - Macro Monetary Policy, the Central Bank and Overview of Nepal's Financial Sector
1. General Macro-economic Environment .I 2. Macro Monetary Policy .2 Trends in the Money Supply .2 Inflation .3 Exchange Rate .4 Government Domestic Borrowing .5 Banking System Credit .6 Excess Liquidity .7 3. Overview of the Financial System .8 Commercial Banks .9 Development Banks .10 Regional Rural Development Banks .10 Finance Companies .11 Micro-finance Institutions .11 The Nepal Stock Exchange .11 The Insurance Industry .12 Money Changers (Foreign Exchange Bureaus) .12 Postal Savings Bank .12 Employees Provident Fund .12 Citizens Investment Trust Mutual Fund .12 4. Nepal Rastra Bank .13 Background .13 Legal Position .13 Board of the Bank .13 Organizational Structure .14 Banking Supervision .14 Human Resource Management and Development .15 Instruments of Monetary Policy .16 Refinance Policies .18 Open Market Operations .18 The Clearing and Payments System .18 Auditing and Accounting of the Central Bank's Accounts .19 Taxation of Financial Institutions .19 Economic Statistics .19 5. Linkages Between the Real and the Financial Sectors .19 6. Issues .21 The Role of the Government in the Financial Sector . 21 The Role of Nepal Rastra Bank .21 A Weak/Fragmented Legal Financial Environment .21 Social Dimensions of Banking .22 A Lack of Competition .22 iv
A Weak Accounting and Auditing Environment ...... 22 Human Resources Development ...... 22 Other Important Issues ...... 22 7. Recommendations ...... 23
CHAPTER TWO - The Legal Financial Environment
1. Introduction ...... 25 2. Nepal Rastra Bank Act 1955 ...... 25 Objectives and Payment System ...... 25 Autonomy ...... 25 Goverance .26 Lending to Government .26 Regulation of Financial Institutions .26 Regulatory Burden of NRB .26 Lending to Specified Sectors .26 Lender of Last Resort .26 Exchange Policy, International Reserves and Foreign Exchange Operations ...... 26 Developmental Role of the Central Bank ...... 27 Deposit Liability ...... 27 Accounts and Audits ...... 27 Overall Comment ...... 27 3. Commercial banking Act 1974 ...... 27 Poor Definition ...... 27 Prompt Corrective Action and Remedial Powers ...... 28 Governance ...... 28 Ownership/Mergers/Deposit Protection ...... 28 Enforcement ...... 28 New Law ...... 28 Tiered Regulation ...... 29 4. Development Banks ...... 29 5. Micro-finance and deposit taking NGOs ...... 29 Loan Classification Reporting Requirements ...... 29 Auditing, Supervision, and Rating ...... 30 NRB's Role ...... 30 6. The Financial Intermediary Act 1998 ...... 30 Salient Issues ...... 30 NRB's Role ...... 30 7. Company Law ...... 31 Governance ...... 31 Director's Duties ...... 31 Accounting Standards ...... 31 Insider Dealing ...... 31 Submission of lnformation ...... 31 Foreign Companies ...... 31 Major Policy Issues ...... 32 Disclosure Requirements ...... 32 The Company Board ...... 32 Registrar/Enforcement ...... 32 8. Insolvency and Liquidation ...... 32 Current Insolvency Regime ...... 33 v
9. Securities Regulation ...... 33 10. Debt Recovery ...... 33 Section 47A ...... 33 Comment ...... 34 11. Secured Transactions ...... 34 Registration/Notice System in Nepal ...... 34 Current Developments ...... 34 12. General Implementation and Enforcement ...... 35 13. Recommendations ...... 35
CHAPTER THREE - Banking Supervision
I. Introduction .37 2. Regulatory, Supervisory and Other Issues .37 Fragmentation .37 Poor Banking Culture .38. Excessive Government Involvement .38 Poor Governance and Transparency Procedures .39 Weak Supervision of Banks .39 An Inadequate Legal Base .40 Inadequate Organizational Structure .40 Limited Resources .40 Deficient Tools and Practices .41 3. Developing Banking Supervision .41 Strengthening the Supervisory Framework .41 Prioritizing .42 Meeting Pre-Conditions .42 4. Creation of New Framework for Supervision .42 Defining Regulations .42 Developing the Supervisory Capacity .43 Building Supervisory Authority .43 Enforcement .43 Sanctioning .43 5. Recommendations .44
CHAPTER FOUR - The Commercial Banking Sector
1. Introduction .45 2. Consolidated Financial Highlights of the Commercial Banks .46 3. The Government Established Commercial Banks .49 Nepal Bank Limited .49 Rastriya Banijya Bank .50 4. Issues in the Government Established Commercial Banks .51 Severe Governance and Management Shortfalls .51 Dysfunctional Lending Processes .52 Primitive and Flawed Accounting Practices .52 Absence of Strategic Planning and Poor Business Planning and Budgeting .52 Low Morale, Numerous Human Resources Issues .52 NBL is Trading in Negative Equity on the Stock Exchange .52 5. The Three Largest Joint Venture Commercial Banks .53 Nepal Standard Chartered Bank .53 vi
Himalayan Bank ...... 54 Nepal Arab Bank Limited (Nabil) ...... 55 6. The Other Joint Venture Commercial Banks ...... 56 7. Issues in the Joint Venture Commercial Banks ...... 57 Restrictions on Foreign Ownership of Banks ...... 57 Government Ownership and Representation on Boards of Joint Venture Banks ...... 57 Government Mandated Directed Lending Schemes and Branch Policy ...... 57 Branch Policy ...... 58 Cross Ownership of Private Banks by RBB, NBL and the Central Bank ...... 58 8. Recommendations ...... 58 Recommendations for the Government Established Commercial Banks ...... 58 Recommendations for the Joint Venture Commercial Banks ...... 58
CHAPTER FIVE - Development Banks and the Post Office Savings Bank
1. Introduction ...... 62 2. The Agricultural Development Bank of Nepal (ADB/N) ...... 62 3. The Nepal Industrial Development Corporation (NIDC) ...... 66 4. Sector/institutional Issues ...... 69 5. The Postal Savings Bank ...... 69 6. Recommendations ...... 70 The Agricultural Development Bank of Nepal (ADB/N) ...... 70 The Nepal Industrial Development Corporation ...... 70 Other ...... 71
CHAPTER SIX - The Finance Companies of Nepal
1. Introduction ...... 72 2. Characteristics of Finance Companies ...... 72 Services and Credits ...... 72 Resource Mobilization ...... 72 Investment in Government Securities ...... 72 Profitability ...... 73 3. Regulatory and Supervisory Framework for Finance Companies ...... 73 Regulatory Framework ...... 73 Supervision and Inspection ...... 73 4. Issues ...... 73 Low Credibility ...... 73 Poor Regulatory Framework ...... 73 Financial Sustainability ...... 73 Higher Concentration and Growing Competition ...... 74 Weak Supervision ...... 74 Self Dealing ...... 74 5. Recommendations ...... 74
CHAPTER SEVEN - Micro Finance
1. Introduction .76 2. Overview of Institutional Players in Micro-finance .77 Informal Institutions and Arrangements .77 Formal Institutions .78 vii
The Government Owned Formal Institutions and Programs ...... 78 Private Sector Owned Institutions ...... 79 3. The Regulatory Framework ...... 80 4. Challenges in Micro-credit Delivery in Nepal ...... 81 5. Issues ...... 82 Dominance of the Government and its Agencies in Micro-Credit ...... 82 Restructuring of the GBB's to Reduce Public Sector Dominance ...... 82 Limited Outreach in the Terai and Hilly Areas ...... 84 Diffused Focus ...... 85 Choice of Delivery Mechanism ...... 85 Role of INGO's, SCO's, and SCC's ...... 86 Role of Donors in the Development of the Sector ...... 86 Regulatory Framework ...... 86 Role of NGO's/MFI's ...... 87 Role of Apex Wholesale Institutions ...... 87 Sustainability and Lending Interest Rates ...... 88 6. Recommendations ...... 89
CHAPTER EIGHT-Pension and Retirement Savings Schemes
1. Introduction ...... 91 2. An Overview of Institutions Involved in Pensions ...... 91 Social Security ...... 91 Provident Funds ...... 91 Employees Provident Fund ("EPF") ...... 92 EPF Investments ...... 94 EPF Pension Fund ...... 96 Private Pension Funds ...... 97 Civil Service Pensions ...... 97 Life Insurance ...... 98 National Insurance Corporation ("NIC") ...... 99 National Life & General Insurance("NLGI") ...... 99 Citizens' Investment Trust ("CIT') ...... 100 3. Issues ...... 102 Limited Investment Opportunities ...... 102 Poor Governance ...... 102 Concentration of Investments ...... 102 Government Influence in the EPF ...... 102 Introduction of Defined Benefit Plans ...... 103 Lack of Enforcement of Participation ...... 103 Tax Benefits ...... 103 Fiscal Burden of the Civil Service Pension Scheme ...... 103 Lack of Timely Production of Accounts ...... 103 4. Recommendations ...... 103
CHAPTER NINE - Capital Market Development in Nepal
I. Introduction .105 2. The Nepal Stock Exchange .105 3. Recent Activity on the Nepal Stock Exchange .107 4. Problems with the Nepal Stock Exchange ...... 110 viii
Accounting Standards and their Enforcement ...... 110 Listing Requirements ...... 111 Corporate Governance ...... 111 Mutual Funds ...... 111 Permitting Government Bonds to be Traded on the NEPSE ...... 11...... I Investment by Insurance, Pension and Provident Funds in the NEPSE ...... 11...... I Preponderance of Investment in Banking Stocks ...... 112 Poor Business Environment ...... 112 5. Recommendations ...... 112
CHAPTER TEN - Summary and Main Recommendations
I. Summary. 114 2. Recommendations ...... 115 ix
TABLES, CHARTS AND BOXES
Chapter One
Table 1.1 Monetary Survey, 1991 -2001 ...... 3 Table 1.2 Outstanding Government Domestic Borrowing 1991 - 2001 ...... 5 Table 1.3 Bank Credit, 1991 - 2001 ...... 7 Table 1.4 Liquidity of the Banking System (1990 - 2001) ...... 8 Table 1.5 Total Financial System Assets, July 2001 ...... 9 Table 1.6 Nepal Rastra Bank: Assets and Liabilities, 1991 - 2001 ...... 15 Table 1.7 Main Lending and Deposit Interest Rates, 1995 - 2001 ...... 17 Table 1.8 Total Credit by Sector, 1990 - 2001 ...... 20
Chart 1.1 GDP Growth, 1994 - 2002 ...... I Chart 1.2 Money Supply Growth, 1990 - 2001 ...... 2 Chart 1.3 Inflation, 1985 - 2002 ...... 4 Chart 1.4 Exchange Rate of the NR Against the USD, 1985 - 2000 ...... 4
Chapter Three
Box 3.1 Deposit Taking Institutions in Nepal ...... 37
Chapter Four
Table 4.1 Joint Venture Commercial Banks ...... 53 Table 4.2 Sources and Uses of Funds, Commercial Banking Sector ...... 59
Chart 4.1 Commercial Banks, Share of Total Assets 2001 ...... 45 Chart 4.2 Commercial Banks: Breakdown of Deposits, 1994 - 2001 ...... 46 Chart 4.3 Commercial Banks: Sources of Funds, 1994 - 2001 ...... 47 Chart 4.4 Commercial Banks: Uses of Funds, 1994 - 2001 ...... 48 Chart 4.5 NBL: Assets, Deposits, Investment & Credit, 1994 - 2001 ...... 50 Chart 4.6 RBB: Assets, Deposits, Investment & Credit, 1994 - 2001 ...... 51 Chart 4.7 Standard Chartered Bank: Assets, Deposits, Investment and Credit, 1994 - 2001 ...... 54 Chart 4.8 Himalayan Bank: Assets, Deposits, Investment and Credit, 1994 - 2001 ...... 55 Chart 4.9 Nepal Arab Bank: Assets, Deposits, Investment and Credit, 1994 - 2001 ...... 56
Box 4.1 Commercial Bank Problem Analysis and Strategy Study (CBPASS) ...... 60
Chapter Five
Table 5.1 Assets and Liabilities of the Agricultural Development Bank of Nepal (ADB/N) ...... 65 Table 5.2 Total Investment in Agriculture (up to 2001) ...... 65 Table 5.3 Assets and Liabilities of the Nepal Industrial Development Corporation (NIDC) ...... 68 Table 5.4 Total Investment by Industry (up to 2001) ...... 68
Chapter Six
Table 6.1 Financial Performance of Finance Companies ...... 75 x
Chapter Seven
Table 7.1 Outreach of MicroCredit in Nepal ...... 77
Box 7.1 Grameen Bank Has changed the life of Ms. Bhagia Devi ...... 83 Box 7.2 A Savings and Credit Group in Darichoke Fisling, Chitwan ...... 85
Chapter Eight
Table 8.1 Breakdown of Membership and Accumulated Deposit by Industry Sector, July 1999 ...... 93 Table 8.2 EPF Membership by Year ...... 93 Table 8.3 EPF Total Assets and Investment Distribution by Year ...... 95 Table 8.4 Calculation of EPF Pension Benefits ...... 96 Table 8.5 Gratuity Calculation ...... 98 Table 8.6 Citizen Investment Trust - Total Assets & Membership by Scheme ...... 101 Table 8.7 Citizen Investment Trust- Asset Distribution February 2001 ...... 102
Chart 8.1 EPF Rate of Return vs. Inflation ...... : 94
Chapter Nine
Table 9.1 Nepal Stock Exchange Limited - Summary Sheet of Transactions - 2000 and 2001 ...... 108 Table 9.2 List of Top Ten Companies - Top Ten on the Basis of Amount Traded, 2001 ...... 109 Table 9.3 Nepal Stock Exchange - Basic Information, 1995 to 2000 ...... 109 Table 9.4 Comparative Table - South Asian Stock Exchanges - Basic Information, 2000. 110 xi
ANNEXES
Annex One Nepal's Financial System As Of Mid July 2001 ...... 118 Annex Two Financial Sector Strategy Statement ...... 122 Background ...... 122 The Banking Sector ...... 122 The Non-Banking Sector ...... 123 The Government's Role ...... 124 The Role and Strategy of Nepal Rastra Bank ...... 124 Reform in the Financial Sector Legislation ...... 125 Strengthening Bank Supervision and Inspection ...... 125 Restructuring and Privatization of NBL and RBB ...... 125 Enhance Competition in the Banking Sector ...... 126 Reform on Auditing and Accounting Capabilities ...... 126 Board Based Banking ...... 126 Streamlining Ownership Structure ...... 126 Establishment of Bankers' Training Institute ...... 127 Restructuring of Credit Information Bureau ...... 127 Establishment of Assets Reconstruction Company ...... 127 Revamping Research and Financial Monitoring Strength of NRB ...... 127 Broadening and Deepening the Financial System in Nepal ...... 127 Meeting Sector Financing Requirements ...... 127 Other Measures ...... 127 Establishment of Development Banks at Regional Level ...... 128 Strengthening of Rural Development Banks ...... 128 Establishment of Credit Rating Agency ...... 128 Timetable ...... 128 Annex Three Commercial Bank's Sources And Uses Of Funds ...... 129 Annex Four Finance Companies in Nepal ...... 144 Annex Five Case Studies of Micro-Finance in Nepal ...... 145 A Proxy Loan Put To Good Use ...... 145 A Well-Off Borrower Of Grameen Bikash Bank ...... 145 Successful Micro-enterprise Activity In Low Hills ...... 146 Sunila Lama ...... 146 Annex Six Institutional Players In Micro-Finance ...... 147 Annex Seven Contractual Savings Schemes ...... 155 Annex Eight Population and Population Charts ...... 156 Annex Nine Tax Treatment Of Pensions And Insurance ...... 158 Annex Ten Recommendations from the Report ...... 160 Macro Monetary Policy ...... 160 Legal Financial Environment ...... 160 Banking Supervision ...... 161 The Commercial Banking Sector ...... 161 The Development Banks and the Post Office Savings Bank ...... 162 The Finance Companies of Nepal ...... 163 Micro Finance ...... 163 Pension and Retirement Savings Schemes ...... 165 Capital Market Development in Nepal ...... 165
Executive Summary
Despite a small and underdeveloped economy, Nepal has a reasonably diversified financial sector with a large number of varied institutions playing active roles. In 1984, when Nepal began reforming its financial sector, all activity was dominated by the 2 state-owned commercial banks. Since then the financial system has grown to include 15 commercial banks, 8 development banks, 5 regional rural development banks, I postal savings bank, 48 finance companies, 30 non-government micro-credit institutions, and 35 non-government cooperative societies involved in limited banking activities.
OVERVIEW OF THE ISSUES
Although financial institutions have proliferated, the Nepalese people have not yet reaped the potential gains of the government's efforts to liberalize and reform the financial sector. There are four main reasons for this: excessive government involvement in the sector, a weak central bank, a poor banking environment, and a lack of adequate banking services for the poor.
Excessive Government Ownership. At the heart of virtually all the problems in the financial sector in Nepal is the overwhelming dominance of the government. It owns the largest commercial bank (RBB), is the biggest shareholder in the second largest one (NBL), and holds significant shares in virtually all the joint-venture banks (all joint venture banks are 50 percent Nepali owned with shares generally being held by NRB, NBL, RBB or the Employees Provident Fund). In addition, the government owns the two largest development banks - the Agricultural Development Bank of Nepal and the Nqepal Industrial Development Corporation - insurance companies, pension and provident funds, regional rural development banks, and is heavily involved in micro-finance institutions.
As in many countries, government ownership has led to poor internal governance, weak management, fragile financial health, and an unhealthy politicization of these state-owned institutions. There is thus an urgent need for the government to divest its ownership of most of these financial institutions and replace the public sector with "fit and proper" private owners and operators.
A Weak Central Bank While the government has dominated the financial system as an owner and operator, it has failed to perform adequately as a supervisor and regulator of the system. Poor supervision by the central bank, Nepal Rastra Bank, is in part to blame for the severe problems oi the two largest commercial banks and for the general deterioration in the system. However, the central bank is in no position to adequately discharge its responsibilities. It is handicapped by a lack cf autonomy, an inadequate and outdated legal framework, and an excessive number of poorly trained and unproductive staff- as well as being in need of radical restructuring. Moreover, its direct participation in the financial sector through representation on bank boards and ownership of development banks has added to its diffuse responsibilities, created conflicts of interest, and undermined its credibility.
The weak and outdated legal framework is among the main sources of the central bank's ineffectiveness. Adopted in 1955, the Nepal Rastra Bank Act was designed for a central bank operating in a government- controlled economy - and supervising government-owned banks - and is ill suited to the development of a complex, modern central bank and banking system. The act bestowed too little power on the central bank for effectively managing monetary policy, improving the financial infrastructure, strengthening and improving financial markets and their supervision, and facilitating the growth of the financial sector. Parliament recently approved a modern central bank law, however, which came into effect in January 2002. This new Act will largely address all of these concerns - if the Act is meaningfully enforced. ii
Poor Banking Environment. Outdated and inappropriate laws similarly lead to weaknesses throughout the Nepalese financial system. Other problems also plague the banking environment, including weak corporate governance, lack of competition, the absence of a sound banking culture, and asymmetries in information.
Weak and Fragmented Legal Framework The Commercial Banking Act (1974) has critical gaps in coverage and needs to be replaced with a new law covering all deposit taking institutions in Nepal (a new draft Banking and Financial Institutions Act is currently under consideration). Other parts of the legal framework for the financial sector also need to be strengthened or amended, including the Financial Intermediary Act (1998), Company Law, and Insolvency and Liquidation Laws. Enforcement too needs to be strengthened. Anecdotal evidence suggests that court action against defaulters tends to be excessively delayed, and asset liquidation has rarely been successful. Without strengthened laws and proper enforcement, any intervention in the financial sector is unlikely to have a meaningful and long- lasting impact.
Another problem is the proliferation of laws and regulations applying to specific institutions rather than generalized banking functions. For example, neither of the two largest development banks is governed by the Development Banks Act; instead, both operate under their own, institution-specific legislation. Such institution-specific laws and regulations have created a fragmented legal environment and, as a result, a fragmented financial system, thereby stifling competition. So at the same time that the legal framework is strengthened, it also needs to be rationalized and simplified.
Weak Corporate Governance. Corporate governance is extremely weak in Nepal. There are no clear rules of engagement between a company's management, its board, its shareholders, and other stakeholders. Aggravating this situation are weak systems, poor procedures, and information asymmetry.
Accounting and auditing traditions are also weak. Many banks cannot provide financial statements, and at times the accounts that banks do provide are un-audited - even though banks and finance companies are required to be audited annually by external auditors selected at general assemblies. The three largest banks - Rastriya Banijya Bank, Nepal Bank Limited, and the Agricultural Development Bank of Nepal, accounting for almost 60 percent of commercial banking assets - do not maintain up-to-date, externally audited financial data. One of them, Rastriya Banijya Bank, has produced no externally audited accounts or annual report for around seven years. The central bank serves as a poor role model for the system that it purports to supervise and regulate; it too fails to maintain good, up-to-date, externally audited accounts.
The government's involvement in the sector as owner and operator inevitably leads to conflicts of interest, particularly for the central bank. Many banks and other financial institutions have interlocking ownership, with Nepal Rastra Bank playing a prominent role. Despite its supervisory role, Nepal Rastra Bank funds some development banking activities and holds shares in several banks. Several central bank officials, including some involved in banking supervision, represent the government on bank boards. Cross-holding of bank shares is also a major problem, as is the reported practice of insider or self-dealing.
Lack of Competition. Although Nepal's financial system has grown rapidly over the past decade, it still lacks the competitive environment critical for ensuring that financial intermediation benefits borrowers, depositors, other users of financial services, and shareholders. The lack of competition reflects the fragmentation of the system, but it also stems from the dominance of the two large (but inefficient) government-established commercial banks, which account for more than half the commercial banking system's assets. The result is that the Nepalese people have enjoyed only marginal benefits from the liberalization of the financial sector.
Only by taking action to increase competitive pressures will the government be able to ensure that banks provide more efficient and cost-effective services to the banking public. However, efforts to enhance iii competitive pressure should rely on market-oriented approaches rather than mandates such as those for interest rate spreads and priority sector lending. Such directives have increased distortions in the market and further burdened financial institutions already having difficulty carrying out their normal business. While the objectives (smaller interest rate spreads and more lending to disadvantaged groups) are intrinsically desirable, they could be better achieved through more focused interventions and more market-oriented policies.
Poor Banking Culture. The elements of a good banking culture are almost nonexistent in Nepal, whether among banks or among their customers. Banks find it difficult to make informed lending decisions because many of their private sector clients fail to maintain good financial information on their activities or are unwilling to reveal their true financial position. As a result, firm level data are largely unreliable, and banks are forced to reconstruct firm accounts from client estimates. Even when banks can undertake a proper financial analysis, they often extend credit on the basis of collateral rather than creditworthiness. Lenders always request primary collateral, and request secondary collateral or guarantees if needed. Nonetheless, they assess the value of the collateral only informally and do not re-evaluate it regularly.
The Credit Information Bureau maintains a blacklist of customers to whom banks cannot extend credit. The bureau, however, established jointly by the central bank and the Bankers Association, is hindered in its operations by the inability or reluctance of the two largest banks to provide it with data. The apparent lack of follow-up by these banks when a customer defaults results in a downward spiral of poor banking behavior.
Another part of the problem lies in the implementation/enforcement of the prudential regulations. To date, only a small number of banks have established satisfactory internal guidelines.
These lending problems, which affect the largest financial institutions in Nepal, have important ramifications for the entire financial sector. The market leaders maintain high real interest rates and margin spreads to cover high operating costs and large losses, while private banks are able to earn substantial profits by hiding behind these high prices. As a result, private banks have not been forced to compete for more customers or to expand their activities outside a few main cities. They merely offer much better service at the prices set by the large banks.
Information Asymmetry and Lack of Financial Sophistication. The public has limited knowledge of the financial position of banks, creating a situation of severe moral hazard. The general public is financially unsophisticated and most people have little access to financial information. When financial institutions' accounts and annual statements are disclosed, they are neither timely nor reliable - even if audited. Moreover, accounting and auditing practices in Nepal do not conform to international standards.
Consider these striking illustrations of the poor public knowledge of financial sector issues. After public announcements were made that management teams were being placed in Nepal Bank Limited, the bank's stock price doubled - despite the general knowledge that the bank had a negative net worth. Depositors also continued to place funds in both Nepal Bank Limited and Rastriya Banijya Bank after a KPMG Barents Group consultancy report disclosed their extremely poor financial health and highly negative capital base. Also implicit in these examples is the banking public's belief that, althou,gh Nepal has no deposit insurance scheme, the government will provide a safety net in the event of a banking failure.
Corruption. Given all these factors - poor supervision, a weak legal environment, poor corporate governance, lax accounting and auditing standards, and an underdeveloped banking culture - it is no surprise that corruption has been a big contributor to the poor financial health of many of the financial institutions in Nepal. Fraud, self-dealing, insider dealing, and improper evaluation of collateral have been among the reported abuses. Such actions have taken resources from the poor and given them to the rich. iv
Stemming corruption will require putting in place transparent systems, checks and balances at every level, and a system of continuous monitoring within and between financial institutions.
Inadequate Banking Services for the Poor. Given the large number of poor people in Nepal, it is also no surprise that the government has emphasized the social dimensions of banking. Notwithstanding this, most of the policies aimed at benefiting the poor (directed credit, branch opening policies) are too broad, and they create considerable operating disincentives within the financial system while achieving a minimal or even negative impact on their intended target audience. These policies need to be more sharply focused to minimize their negative effects and enhance their benefits for poor and rural communities. At the same time, the delivery mechanisms for development banking need to be reformed, to work through, and with, private partners wherever possible. The current system of publicly owned development banks and state-dominated micro-finance institutions has failed to produce the intended results - while creating large contingent liabilities for the government.
THE CENTRAL BANK - NEPAL RASTRA BANK
A stronger, more effective central bank is essential for healthy financial sector development in Nepal. To play its role well, Nepal Rastra Bank needs significant internal restructuring and reengineering, including, most importantly, an overhaul of its human resource function. Among the core functions of the central bank, proper banking supervision is particularly important, to ensure prudent banking practices and to help develop healthy financial intermediation that can support the growth of the economy. NRB is being assisted in its re-engineering with support from the International Monetary Fund's MAE department and a World Bank Financial Sector Technical Assistance (FSTA) project.
Need for Restructuring. The central bank has far more staff than it needs (particularly at lower levels), poor incentive mechanisms, a severely compressed salary structure, and inadequate training opportunities. If Nepal Rastra Bank is to develop, attract, and retain a professional workforce, radical reforms will be required.
Although the bank is in urgent need of "right sizing," this step should be preceded by an in-depth assessment to identify the most appropriate organizational structure. A voluntary retirement scheme carefully tailored to the Nepalese environment should then be implemented, accompanied by a move to merit-based promotion rather than the current "time-in-grade" system of staff development. Removal of excess workers would allow the bank to decompress its salary structure so that it can adequately compensate professional staff. In addition to improving the benefits package, the bank should enhance the general working environment - with an emphasis on automation - to increase productivity.
Deficiencies in Banking Supervision. A June 1999 assessment of Nepal's compliance with the Basel Core Principles for Effective Banking Supervision concluded that Nepal Rastra Bank fails to comply fully with two-thirds of the criteria and is unable to fulfill its supervision mandate. Moreover, almost none of the preconditions required by the Basel Committee exist in Nepal - an adequate legal framework and judicial procedures, sound accounting principles and auditing practices, a market-based banking business, exit and crisis management policies, and deposit insurance and safety net schemes. The accumulated weaknesses of the central bank inhibit management from taking action against problem banks even when the potential consequences of inaction are serious.
The deficiencies in banking supervision are reflected in the poor and deteriorating state of the two largest commercial banks and of other weak institutions that have been permitted to conduct business without sanction by the government or central bank. Many financial institutions have a weak capital base and high levels of non-performing loans and even face allegations of corruption and of inappropriate action by management. Seven new banking regulations, issued in March-April 2001, address weaknesses in v banking, but the central bank will need to ensure that the regulations are fully enforced if they are to have a positive effect on the Nepalese financial sector.
Although the central bank is charged with regulating and supervising banks and financial institutions, the present system does not provide supervisors with adequate legal protection or with the operational independence and resources they need to perform their jobs well. As a result, supervisors are often unable or reluctant to enforce the corrective measures needed to prevent and resolve banking problems. Moreover, most of the old regulations allowed long delays before action, failed to define legal or financial penalties, and did not mandate specific actions to be taken by the banking authorities. The revised regulations of 2001 have attempted to correct the weaknesses in the old regulations, to provide greater regulatory authority to the central bank - but by early 2002 Nepal Rastra Bank was already encountering resistance to their implementation.
The institutional setup for supervisory functions within Nepal Rastra Bank is also less than ideal. Responsibility for supervision is shared by four units, under two different deputy governors, and cooperation between them is weak. In addition, the central bank has limited capacity for supervisory work. Its staffing policy ensures the recruitment of quality staff, a good mix of MIBAs, chartered accountants, and economists. However, promotion is driven by seniority, staff are not appointed on the basis of merit and competence, and the salary scale is tied to low public sector levels - all of which have undermined morale and performance. Moreover, the central bank's policy of rotating staff among departments has been counterproductive; effective supervision requires stability to foster commitment among officers and allow them to develop skills, master techniques, and acquire experience.
Off-site surveillance of financial institutions does not exist as a specific function. Reporting of information is neither timely nor comprehensive enough to permit a full analysis, and the integrity of the data remains doubtful. Most data are excessively delayed and, if collected, are not analyzed. The central bank imposes no sanctions for late reporting and has not enforced penalties for non-compliance with regulations except for those relating to the cash reserve ratio and directed lending. Supervisors do perform timely monitoring of the cash reserve ratio, interest rate spread, and priority and deprived sector lending, but none of these is a prudential issue. If supervisors spot a problem, they request additional information from the bank, essentially so that they can cross-check the data. If the problem remains, a penalty is finally debited from the bank's account with Nepal Rastra Bank.
Role in Reform. It is important that the central bank play a lead role in implementing the financial sector reform program. An active role will not only provide first-hand experience - important for internal capacity building - but will also enable the central bank to clearly establish its authority as the chief regulatory and supervisory body. The central bank will need to pay especially close attention to banking supervision during the reform to curtail further deterioration in the system, reduce opportunities for looting and other abuses, and thus protect the funds of depositors. Continued support from the IMF, DFID, and the World Bank is expected to be able to assist NRB in meeting these objectives.
NEPAL BANK LIMITED AND RASTRIYA BANIJYA BANK
The problems faced by the two largest commercial banks warrant high priority, to stem further deterioration in these institutions. A comprehensive assessment of Nepal Bank Limited and Rastriya Banijya Bank, carried out under Nepal Rastra Bank's direction in June 2000 by the KPMG Barents Group, found serious shortfalls in all aspects of the governance, management, and operations of these banks. The KPMG report concluded that the banks' loan assets are highly overstated and extremely risky and that, as a consequence, the banks are technically insolvent. The report estimated the negative net worth of Nepal Bank Limited at NR 6-10 billion (US$85 to 142 million) and that of Rastriya Banijya Bank at NR 14-18 billion (US$200 to 255 million). This condition is of grave concern, since these two vi
banks account for about half the assets of the commercial banking system. The report also concluded that while the banks suffer from almost identical problems, those of Rastriya Banijya Bank are more severe. Key highlights include:
* Years of political interference in senior appointments and lending and operational decisions in both banks have led to poor governance and management, exacerbated by a general lack of prudent, internationally experienced, and commercially oriented bankers in board and senior management positions. These problems are reflected in - and compounded by - the lack of a business strategy, the absence of financial management information, poor board and management practices, low morale, counterproductive union activities, and inadequate compensation packages.
* Unsound banking practices have helped to undermine the banks' credit portfolios. The banks lack the policies, processes, and procedures needed to support profitable commercial banking practices, and the problem is aggravated by senior managers unconcerned about high-risk lending, boards more responsive to client pressures than to prudent practice, and poorly trained and motivated staff.
* Information systems and accounting and record keeping practices are also extremely poor. Loan files, loan ledgers, accounting records, operational statistics, and data on human resources are poorly maintained and substandard. All this results in serious information gaps.
* The banks undertake no strategic planning, in part because the units responsible for this function are inadequately staffed and have limited capacity. Budgeting processes are primitive, with little monitoring of variances and no well-defined penalty and reward system to enhance accountability.
* A poor incentive system, below-market pay structure, and weak staff and management discipline have eroded the motivation and productivity of employees. With few opportunities for training that could provide exposure to international best practices, the skills of staff and management are likely to become even weaker. Strong unions have aggravated the situation by successfully pushing for the employment of an excessive number of unskilled staff at lower levels.
* The government's approach to privatizing Nepal Bank Limited - providing workers with parcels of shares, which are now openly traded on the Nepal Stock Exchange - has effectively privatized the bank but has also resulted in widely dispersed ownership, with no strong strategic investor.
As a first step in dealing with these two troubled banks, Nepal Rastra Bank has decided to recruit two international management teams to take over their day-to-day operation. The management teams are expected to help immediately stabilize the banks' operational and financial positions, bring in accounting teams to help strengthen their accounts, develop human resource programs (including a training program, a retrenchment program, and a more appropriate remuneration package for bank staff), and prepare the banks for privatization (or a satisfactory alternative). The management teams are likely to face strong resistance from many quarters - the boards, workers, unions, and influential private businesses - and even from the government, which may not consider liquidation, for example, a politically acceptable restructuring option. Thus the teams will need to be exceptionally professional and committed, and fully supported by the government, the central bank, and the donors.
Reducing the excessive staffing in both banks, through a voluntary retirement scheme, must be a part of the bank's restructuring. This exercise should also try to professionalize the role of the unions, with a view to minimizing their often excessive interference in management and operational matters. vii
THE DEVELOPMENT BANKS
While smaller than the two major commercial banks, the government-owned development banks - the Agricultural Development Bank of Nepal and the Nepal Industrial Development Corporation - face similar problems. The Agricultural Development Bank had long survived on concessional loans from the Asian Development Bank (ADB). However, the ADB has now stopped providing funding because of increasing concerns about the bank's operations, confirmed by an ADB-commissioned report that concluded that the bank is neither financially viable nor effective in meeting its objectives. The Nepal Industrial Development Corporation, funded by World Bank and German aid funds for nnany years, has also lost its external funding after having failed to meet the expectations of its financiers.
The cessation of funding has led to a shift away from development banking activities. Many urban branches of the Agricultural Development Bank now conduct commercial banking activities - and these are reported to be growing rapidly. Moreover, because these two development banks are governed only by the statutes that incorporated them, they are conducting banking activities without being subject to either the Development Bank Act or the Commercial Banking Act. Their foray into commercial banking makes this situation a serious concern.
This "legal arbitrage" must be corrected, and the two development banks brought immediately under the full supervision of the central bank. These institutions need close attention to arrest their deterioration until an adequate restructuring plan has been formulated. The Agricultural Development Bank embarked on an institutional reform program in 1997 that focused on improving collection rates and closing under- performing branches (32 were identified for closure). The reform program appears to have led to some increase in loan recovery, but the improvement is far from sufficient to sustain the institution or make it more effective. More comprehensive reform needs to be considered, perhaps including the privatization or even liquidation of the bank. Any reform within the ADB/N, however, must be fully coordinated with the on-going restructuring and reform programs within RBB and NBL.
With no incoming funding, a weak and deteriorating loan portfolio, and poor internal governance, the Nepal Industrial Development Corporation is in poor financial and operational health. Given its relatively small size and an increasing belief that even long-term industrial lending could be undertaken as a commercial activity, there needs to be a thorough examination of whether any role remains for the bank. Its current performance and limited lending activity suggest that the most appropriate course of action may well be liquidation.
Similarly, the government needs to revisit the rationale for the regional rural development banks (the Grameen Bikas Banks) owned in part by the central bank. Nepal Rastra Bank needs to cease its direct participation in these development banks, as in all financial institutions (and indeed this process did begin in early 2002). Consideration should be given to restructuring these banks (including re-capitalizing them) to prepare them for privatization.
MICRO FINANCE
Micro-finance will continue to pose big challenges in Nepal. The Grameen model of micro-credit delivery has brought some benefits to the terai (plain) region, which has larger population concentrations and greater endowments of physical infrastructure than the hill areas of Nepal. However, this model is unsuitable for extending micro-credit to the inaccessible hill and mountain regions of the country. These sparsely populated regions will require a different approach which involves greater participation by the local population; involves more focused government assistance in terms of infrastructural and other support; and can defray costs by spreading management responsibilities over wider areas. viii
While sustainability must be an important goal of micro-credit programs, the scope for achieving this in these inaccessible regions is limited in the short run. Incentives, grants, and concessional loan support will be required, to build the capacity and subsidize the operations of institutions working in these regions and to ease the interest burden on the very poor borrowers who are accessing funds from them. Care should be taken, however, that the support is provided through transparent means. It will also be important to ensure proper targeting of beneficiaries - so as to achieve maximum impact and avoid a mis- direction of subsidies to unintended groups.
The delivery of micro-credit through public agencies in Nepal has clearly been unsatisfactory: the Grameen Bikas Banks are nearly insolvent, other programs have achieved limited outreach, and the hard- core poor have largely been excluded. Yet these outcomes are hardly surprising - public institutions all over the world have failed to effectively deliver micro-credit to the poor. The evidence suggests that the government of Nepal should consider leaving the business of micro-credit to the private sector and to nongovernmental organizations, which appear to have a comparative advantage in this area. To the extent that the Government wishes to pass subsidies through to these target populations, these should be explicit and channeled through these private institutions.
Since the Grameen Bikas Banks are the largest micro-credit operations, restoring their operational and financial efficiency is particularly critical to the health of the sector. Steady deterioration in the quality of their portfolios, combined with continuing losses, has eroded their equity, making these five banks technically insolvent. Discussions with their management indicate many problems:
* Central bank staff have been appointed as chief executive officers of the banks, resulting in a lack of ownership, commitment, and management efficiency.
* Management is centralized, with little delegation of power or responsibility to departments or staff.
* Management and personnel decisions are subject to strong political influence, which has led to the opening of unprofitable branches and the recruitment of incompetent staff in excessive numbers. Unions also interfere in the management of the institutions.
* Loans tend to be large, with the size determined not by management advice but by board directives.
* The institutions face funding shortages, since even the equity holders (Nepal Rastra Bank and commercial banks) are unwilling to lend to them for fear of losing their money.
* Sources of funds for the banks are limited and interest rates are high.
* The lending rate of the banks (10 percent) is inadequate to cover operating costs and thus to generate a surplus.
* The institutions lack proper management information systems, training programs for staff, and career development programs.
All these problems point to the need for a major restructuring of these institutions. The private Grameen Replicator Banks, which have been much more successful, may well provide an effective and sustainable model for micro-finance activities in Nepal. Building upon these successful examples will be important for the future growth of these Grameen Replicators. ix
OTHER ISSUES
The financial sector also faces other issues that impede its development:
* A poorly functioning credit bureau. The Credit Information Bureau functions poorly, largely because of the inability or reluctance of the two largest commercial banks to provide it with information on bad credit risks. Improving the bureau's ability to make comprehensive credit information easily available in Nepal could spur the development of the financial sector.
* Risky finance companies. A study commissioned by the Asian Development Bank points to the risk of family combines using public deposits in finance companies to fund high-risk activities within their own companies (self-dealing). Another concern is that some weak finance companies are functioning like ponzi schemes, sustaining high interest payments on deposits through the inflow of new deposits.
* Ceiling on foreign ownership. The 50 percent limit on foreign ownership of commercial banks (increased to 66 percent in 2001) discourages reputable international banks from entering the market, adding to the deterrent effects of the small market and difficult operating conditions. The presence of such banks could help improve discipline in the market, increase competition, enhance services, and add know-how. The government needs to lift this restriction as soon as possible while permitting the entry only of "fit and proper" bankers.
* Limited financial services. Financial institutions offer only basic services, with lending based largely on collateral. Poor training and limited exposure to banking practices elsewhere have slowed the development of new products and services. If the financial sector is to provide more effective intermediation, it clearly needs to increase the range of services and products offered.
* Poor accounting standards. Weak accounting and auditing standards are among the most important impediments to the development of the Nepal Stock Exchange. Many company financial statements are not credible - and some companies listed on the exchange have not produced accounts for several years, Nepal Bank Limited among them. When accounts are prepared, they are often of such poor quality that they provide no guidance on the company's true financial health. In some cases company accounts are purposefully misleading. These problems have led to a general disillusionment with investing on the exchange.
* Limited use of information technology. Around the world, the financial sector is typically an early adopter of new information and communications technologies, for the big gains in efficiency and productivity that they offer. The excessive staffing, poor information management, and weak communications in many Nepalese financial institutions all point to the conclusion that increased automation could yield significant benefits.
THE WAY AHEAD FOR FINANCIAL SECTOR REFORM
The many serious issues in the financial sector are now widely acknowledged and well publicized in Nepal. In November 2000 the government issued a paper outlining its proposed financial sector reform program for the medium term - the Financial Sector Strategy Statement. The strategy statement touches on all the major issues and provides sufficient basis for undertaking far-reaching reforms. It also demonstrates the government's commitment to the reform program - and, most important, its commitment to withdraw from the sector as an owner and operator. x
Yet the strategy statement remains only a broad outline of intent. The government will need considerable support and resources to translate the FSSS into a fully implementable strategy and action plan. Developing such a longer term, more detailed, and action oriented vision for the development of the financial sector must, however, assume increasing importance within Nepal Rastra Bank. Given the wide-ranging reforms required, and the importance of the financial sector to the further growth and development of Nepal, donors must also stand ready to extend all available assistance to this reform initiative, closely coordinating their efforts.
While the government's heavy hand has been largely detrimental to the development of the financial sector, one aspect of its ownership seems to have exerted a benign effect - the implicit assurance that it would rescue ailing banks. That assurance has kept a potential financial crisis in check. It is now time, however, to subject the financial markets to the discipline of the markets and to ensure their proper and prudent functioning. The recent issuance of new banking supervision regulations, the new Nepal Rastra Bank Act and the efforts under way to revise the Commercial Banking Act also bode well for the reform process and the establishment of an appropriate environment within which market oriented institutions can operate in an orderly manner. Sequencing reforms correctly can be critical, however, and these changes need to precede the full impact of reforms and further liberalization of the financial sector - even as reform commences in the two largest commercial banks.
In the short term the government's financial sector reforms should center on five important principles:
(a) Withdrawing the government from ownership offinancial institutions - beginning with RBB and NBL - and bringing in ':fit and proper" bankers to replace it in this role. The reform program should begin by placing Rastriya Banijya Bank and Nepal Bank Limited under conservatorship arrangements so as to gain financial control - developing a sense of the balance sheets and profit and loss positions of the two banks as quickly as possible. The next step should be to control costs and increase profitability - by implementing a voluntary retirement scheme to downsize the two banks as rapidly as possible, cutting back on unprofitable bank branches, and introducing stringent loan recovery programs for defaulting borrowers. Once a modicum of financial control has been achieved, long-term plans should be developed to liquidate, further downsize, split, or privatize the banks - to ensure a fundamental change in their governance. Restructuring of these two large banks should be undertaken in conjunction with a program of complimentary reform within the Agriculture Development Bank of Nepal.
(b) Significantly strengthening the central bank to make it afully professional institution. Radical restructuring should be undertaken to transform Nepal Rastra Bank into a professional central banking institution. The reform should focus initially on developing an appropriate structure, shifting to merit-based promotion, implementing a voluntary retirement scheme to reduce staffing to more appropriate levels, and decompressing the salary structure. Within the central bank, the establishment of a strong bank supervisory capacity - both on-site and off-site inspection - with fully implemented enforcement powers, will be critical to the evolution of a well functioning and prudently operated banking sector in Nepal.
(c) Restructuring the ADB/N and Closing NIDC The reforms in RBB and NBL must also be undertaken in close coordination with the proposed restructuring plan within the ADB/N. With an equally large branch network and presence throughout Nepal - it is likely that important synergies will exist between the reform programs in these three institutions with respect to branch rationalization, staffing reductions, and the provision of banking services throughout the country- side. Close coordination and cooperation between these various efforts will require close involvement from the central authorities within Nepal Rastra Bank. As a deposit taking institution, the ADB/N also needs to be quickly brought under the purview of the bank inspection department of the central bank. In addition, given the dire financial position of the Nepal xi
Industrial Development Corporation, its lack of funding, its weak loan portfolio - in combination with its small size and the capacity of other financial institutions to provide industrial finance - the central authorities should give serious consideration to quickly closing NIDC and winding up its operations.
(d) Creating an appropriateenvironment for establishing a sound financial sector. An effective system of checks and balances should be rapidly developed in the financial system, by:
* Implementing the provisions of the new Nepal Rastra Bank Act and finalizing the new Banking and Financial Institutions Act as quickly as possible so that it can be enacted. * Strongly enforcing the new regulations on bank supervision - with no exceptions. Banks failing to comply with the regulations within the period specified should have their banking licenses revoked and/or be forced to merge with other banks. * Requiring all financial institutions to submit externally audited financial statements to the central bank within four months after the end of the year - or risk losing their license. Ideally, the auditing should conform to international accounting standards. * Requiring the central bank to dispose of shares in any institution that it supervises and to develop a five-year plan for disposing of shares in all financial institutions.
(e) Developing an improved system of micro-finance. The government needs to determine how to deliver financial services to the poor more effectively as part of its poverty reduction efforts. To this end, it should investigate the immediate restructuring and privatization of the Grameen Bikas Banks and consider ways of ultimately providing sustainable micro-finance services through private sector institutions - building upon the good/sustainable micro finance examples which exist within Nepal and learning from the best practice examples which exist within the region.
These steps are only the very first that must be taken - over the short to medium term - to begin restoring credibility and soundness to the financial system in Nepal. Only after these initial - but extremely difficult - steps have been taken will it be possible to devise a strategy for the longer term. Elements of this strategy can, however, be drawn from the other recommendations of this study (see Annex 10). Nonetheless, development of this longer term strategy for the financial sector will be an important next step in the long road towards true financial sector reform in Nepal.
October 16, 2002
CHAPTER ONE Macro Monetary Policy, the Central Bank and Overview of Nepal's Financial Sector
1. General Macro-economic Environment Nepal is a landlocked country, wedged between China and India. It has a population of 24 million and its GDP at current prices in fiscal year (FY)' 2000/01 was US$5.6 billion. Its annual income per capita of US$220 is lower than the average for South Asia (US$336), and it is one of the poorest countries in the world. Almost 90 percent of the population lives in rural areas and are dependent on subsistence farming. With population growth of 2.3 percent; agricultural growth of 2.0 percent; and projected per capita GDP growth of only 3.1 percent in 2002; the absolute 2 number of people living in poverty is expected to have been increased . Low levels of investment, political instability, an underdeveloped infrastructure base, unskilled human resources, and poor institutional capacity have all limited the country's growth potential.
In 1991, multi-party democracy was established, and the new democratic government gave increased momentum to the reform process, aimed at accelerating development and promoting a modem market-oriented economy, including deregulation and closer convergence of development programs and public needs. While the transition to democracy has resulted in a high degree of political instability (with a dozen governments between 1991 and 2001), the macro-economy has remained relatively stable with low rates of inflation and a reasonably stable (albeit slowly depreciating) currency. Some progress has been made on price reform, privatization, financial sector reform (partial deregulation), and trade liberalization. Nonetheless, the slow pace of structural reforms is largely to blame for the low rates of growth. As a result, GDP growth in Nepal faltered from an average rate of 5.5 percent over the period 1991 to 1994 to 5.0 percent in 1997; and 3.0 percent in 1998. It increased to 6.5 percent in 2000 and decreased to 5.3 percent in 2001. It is projected to decrease further to 3.0 percent in 2002.
Chart 1.1: GDP Growth, 1994 - 2002 9 8
7 - ______
5
3 2
0 1994 1995 1996 1997 1998 1999 2000 2001 2002
Fiscal Years
Source: IMF.
The Fiscal Year begins on July 15. All years are quoted in fiscal years. 2 According to a 1996 World Bank estimate, 42 percent of Nepalis live below the poverty line 2
2. Macro Monetary Policy
Trends in the Money Supply. Nepal's money supply has grown at an average rate of around 19 percent per annum over the period 1991 to 2001 (Chart 1.2). However, growth over this period has been erratic with very low growth in 1996 and 1997 - mainly as a consequence of a slow increase in net foreign assets during those two years. The major source of monetary growth over the decade has been an increase in lending to the private sector (claims on the private sector) which grew at an average annual rate of almost 25 percent per annum over this period. Whereas net foreign assets had been a major source of monetary growth in many of the years under review, its contribution to money supply growth has slowed more recently - increasing by only 10 percent in 2001 - and reflecting a slow down in export growth in Nepal. Another notable change in 2001 was the slow down in credit growth to the private sector and a jump in credit to the government (over 25 percent for the year) in line with the deteriorating fiscal position of HMGN. This compares to a growth rate of around 11 percent per annum in credit to the government in the earlier part of the period.
This growth in the money supply was reflected in a faster rate of growth of broad money over the ten year period (19 percent per annum) compared to narrow money (15.7 percent per annum) - reflecting a deepening of the financial system as more financial sector assets moved into longer term instruments. Again this trend was reversed in the most recent year under observation. Nonetheless, the share of narrow money to broad money decreased from 43.2 percent in 1991 to 32.8 percent - indicating a movement of financial assets within the financial system into more longer term instruments. This is one indicator of a reasonably sophisticated system and one which was deepening and broadening over the course of the I 990s. It may also reflect, however, a lack of alternative investment avenues in Nepal.
Chart 1.2: Money Supply Growth, 1990-2001
25-
20
15
c e10a10
5-
0 , 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01
Fiscal Years
Source: Nepal RastraBank 3
Table 1.1: Monetary Survey, 1991 to 2001 (in billions of rupees)
Claims Net Claims Claims on Other Fiscal Foreign on On Public Private Time Assets Narrow Broad Year Assets Government Enterprises Sector Deposits Net Money Money
1991 16.2 16.8 3.6 14.1 21.4 12.9 16.3 37.7 1992 20.8 19.0 4.8 17.8 26.2 16.7 19. 5 45.7 1993 29.1 23.4 4.8 21.2 34.5 20.2 23.13 58.3 1994 36.2 23.5 4.7 29.6 41.3 24.3 28.5 69.8 1995 37.1 25.2 5.1 41.9 48.0 28.3 33.4) 81.0 1996 37.7 27.5 6.2 55.5 56.2 34.3 36.5 92.7 1997 40.2 29.2 7.0 64.7 65.3 37.4 38.5 103.7 1998 55.6 31.8 7.2 76.8 81.3 44.9 45.2 126.5 1999 65.0 34.9 9.1 90.8 101.7 47.1 51.7 152.8 2000 80.3 38.1 9.9 109.8 124.7 53.7 59.8 184.5 2001 88.3 47.7 11.4 127.9 143.6 61.5 70.2 213.8 (Annual Percentae Change) 1992 28.7 13.0 35.5 26.0 22.3 29.4 19.5 21.1 1993 40.1 23.4 -1.6 19.3 31.6 20.8 22.5 27.7 1994 24.4 0.2 -0.2 39.6 19.7 20.1 19.6 19.6 1995 2.4 7.3 6.6 41.7 16.3 16.5 15.7 16.1 1996 1.7 9.3 22.9 32.4 17.0 21.3 10.6 14.4 1997 6.6 6.2 13.2 16.5 16.2 8.9 5.4 11.9 1998 38.3 8.6 2.8 18.8 24.6 20.2 17 4 21.9 1999 17.0 10.0 26.1 18.2 25.1 4.8 13.1 20.8 2000 23.5 9.2 9.1 20.9 22.6 14.1 17 0 20.7 2001 9.9 25.0 14.9 16.5 15.1 14.5 17.5 15.9 Source Nepal Rastra Bank
Inflation. In 2001 inflation declined to 2.4 percent - its lowest rate since 1985. Inflation averaged 9.2 percent over the past decade (1991-200). More significant, however, is that (with the exception of 1996 and 1999), inflation has been decelerating since 1992 - when was 21.1 percent. The 11.4 percent increase in 1999 was largely due to a sharp increase in the price of food products - caused by poor weather conditions in the region which increased the demand for rice while also causing shortages in essential products such as edible oils and fats and vegetables. The decline in inflation in 2000 to 3.4 percent reflected a reversion to more normal seasons - leading to a fall in the price of food and beverages as a result of a good monsoon and consequent better harvest of major crops such as rice and wheat. Inflation declined further to ,2.4 percent in 2001 but is projected to increase to 5.5 percent in 2002. See Chart 1.3 below. 4
Chart 1.3: Inflation, 1985 - 2002
25 0
20 0
e 15 0
50
00 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Fiscal Years
Source. Nepal Rastra Bank.
Exchange Rate. The Nepalese rupee is pegged to the Indian rupee at NR 1.6 to INR 1.0. As trade with India, formal and informal, remains the cornerstone of the Nepalese economy, the peg has provided a useful anchor. There is free convertibility between the Indian and Nepali rupees for all current account transactions. The fixed exchange rate regime has meant that interest rates in Nepal closely mirror those of India and the scope for independent monetary policy management is limited. As a result, the focus of monetary policy has been the control of credit expansion consistent with satisfactory international reserves and projected money demand.
The underlying average depreciation of the Nepali rupee against the US$ has been about 10 percent per annum since 1986 but the depreciation has decelerated considerably since the 31 percent depreciation in 1992. The depreciation in 2000 was around 3 percent and in 2001 it was 3.2 percent reflecting a relatively robust currency in the face of a strong US dollar. Given the pegged exchange rate to the Indian rupee, the Nepali rupee's depreciation is reflective of the Indian rupee's strength against international currencies. The real effective exchange rate however has remained stable since the early nineties.
Chart 1.4: Exchange Rate of the NPR Against the USD, 1985 - 2000
70 60 C2 50
40 i 30 20 =n 10 0 1985 1986 s87 1988 1989 1990 1991 1992 s93 1994 s95 1996 1997 1998 1999 2000 Fiscal Years
Source Nepal Rastra Bank 5
Competitiveness appears to be intact as exports, remittances and, as a consequence, official reserves have all steadily increased over the period3 . Since 1993, Nepalese are permitted to hold foreign currency accounts (based on foreign exchange earnings) in Nepal, although it was not possible to obtain an estimate of the size of these holdings.
Government Domestic Borrowing. Fiscal management improved significantly in FYYI999 and 2000 mostly due to good revenue policy and improved administrative/collection measures. With revenues increasing by 34 percent in these two years, and less than anticipated developmental expenditures, the fiscal deficit was reduced to less than 5 percent of GDP in 2000 - with a subsequent lowering of the domestic financing requirement. These positive developments were, however, reversed in 2001 with wage increases on the expenditure side combined with difficulties in revenue collection, resulting in an increase in the fiscal deficit to nearly 7 percent of GDP and a sizeable increase in the domestic borrowing requirement (to 2.7 percent of GDP).
Table 1.2: Outstanding Gove;nment Domestic Borrowing, 1991 to 2001 (NR billion)
Nepal Fiscal Rastra Commercial Total Year Bank Banks Others * Borrowings
1991 9.9 7.3 3.9 21.1 1992 10.2 9.2 4.4 23.8 1993 13.9 10.0 4.9 28.7 1994 15.0 8.9 7.3 31.2 1995 17.4 8.2 7.5 33.2 1996 20.4 7.6 9.2 37.2 1997 21.9 7.8 10.1 39.8 1998 22.0 10.3 12.2 44.4 1999 22.8 12.7 14.9 50.3 2000 20.9 18.2 15.8 54.9 2001 23.6 25.4 17.6 66.6
* Individuals and institutions. Source Nepal RastraBank
Total Government domestic borrowing grew at an average rate of around 12 percent per annum over 1991 to 2001. The growth has been erratic, ranging from a high of 21 percenl in 1993 and 2001 to a low of 7.0 percent in 1997. The NRB was the largest lender to the government until 2001 and has, on average, provided around 46 percent of total government borrowings over this period. Government borrowing from the NRB grew at an annual average rate of around 9.0 percent over the period although the growth rate decelerated significantly after 1996. In 1999, a decision was taken by the NRB and His Majesty's Government of Nepal to move away from the prior practice of settling the government's overdraft position by issuing non-marketable and non- negotiable securities to the NRB. This has helped constrain NRB's lending to the Government. As a result, there has been a shift between government borrowings from the NRB and the commercial banks from 2000 onwards. Borrowing from commercial banks averaged a higher growth rate of 13.3 percent over the period - with growth accelerating in the later part of the period. There have been extremely large fluctuations in borrowings from commercial banks - as high as 40 percent in 2001 and as low as negative 11 percent in 1994. Borrowings from commercial banks as a share of total domestic borrowing was 38 percent in 2001 - but averaged
3IMF Report, March 2000. A DflD study estimates that remittance inflows are over US$500 million per annum. 6 only 29 percent over the ten year period. Government borrowings from non-bank financial institutions grew at a significantly faster rate of around 16.3 percent over the period. Such borrowings have been above commercial bank borrowings, in absolute termns, for most of the second half of the 1990s.
Banking System Credit. Banking system credit grew at 18.3 percent per annum between 1991 and 2001. However, in the four years up to 2000, credit growth slowed compared to the earlier years and has largely remained below the period average. In 2001, bank credit rebounded, growing at 18.7 percent - with the strongest growth being experienced in credit to govemment (27.5 percent).
The strongest contributor to credit growth overall was credit to the private sector which grew by around 25 percent per annum over the period. Most of these gains came in the earlier years when the political situation was more stable. Growth in credit to the private sector has been erratic - from a high of 41.7 percent in 1995 to a low of 15.9 percent in 2001. Loan recovery operations of the two largest banks and a slowdown in the economy continued to limit the expansion of credit to the private sector in the latter part of the decade. In addition, a lack of viable projects, decline in imports, and insurgency in rural areas prevented commercial banks from seeking new opportunities in the hill areas (indeed, a large number of bank branches were closed in troubled areas). In terms of the share of total banking system credit, credit to the private sector increased steadily from 40 percent in 1991 to almost 70 percent in 2000 - before falling back to 67.6 percent in 2001.
Growth in credit to the govemment averaged around 11 percent per annum over the period 1991 to 2001. After 1993, growth has been well below this average although this turned around in 1999 and, more particularly, in 2001 when it grew by 11.1 percent and 27 percent respectively. Part of the reason for this was the growth in government borrowing from NRB, non-bank financial institutions and the general public in the middle part of the 1990s. The turn around in bank lending to the central government in the late 1990s was a consequence of the change in policy after 1999 to reduce government reliance upon central bank financing and the conversion of the central government overdraft at NRB into treasury bills from March 1999. Notwithstanding this change in policy, the share of central government borrowing from the banking system has still registered a steady decline since 1991 - when it was over 49 percent - to 26 percent in 2001.
Growth in credit to public enterprises has been shrinking over the period. Its share of the total was 10.2 percent in 1991 but only 6.4 percent by 2001.
One potentially disturbing contributing factor towards credit growth, however, may well be interest capitalization on non-performing loans - which is certain to have figured prominently in the growth of credit in RBB, NBL and ADB/N - the three largest commercial banks. 7
Table 1.3: Bank Credit, 1991 to 2001 (NR billions)
Fiscal Year Central Private Public Total Government Sector Enterprises Credrit
1991 17.2 14.1 3.6 34.9 1992 19.4 17.8 4.8 42.1) 1993 23.9 21.2 4.8 49.8 1994 23.9 29.6 4.7 58.2 1995 25.6 41.9 5.1 72.65 1996 28.0 55.5 6.2 89.7 1997 29.7 64.7 7.0 101.X1 1998 32.3 76.8 7.2 116.3 1999 35.9 90.8 9.1 135.83 2000 38.2 109.4 10.3 157.9 2001 48.7 126.8 11.9 187.4 Bank Lending (annual percent change) 1992 12.2 26.0 35.5 20.2 1993 23.2 19.3 (1.6) 18.7 1994 0.3 39.6 (0.2) 17.C0 1995 7.3 41.7 6.6 24.7 1996 9.2 32.4 22.9 23.5 1997 6.0 16.5 13.2 13.0I 1998 8.7 18.8 2.8 14.8 1999 11.1 18.2 26.4 16.8 2000 6.4 20.5 13.2 17.1 2001 27.5 15.9 15.5 18.,7 Bank Lending (percentage of total) 1991 49.4 40.4 10.2 100.0 1992 46.1 42.4 11.5 100.0 1993 47.9 42.6 9.5 100.0 1994 41.0 50.8 8.1 100.0 1995 35.3 57.7 7.0 100.0 1996 31.2 61.9 6.9 100.0 1997 29.3 63.8 6.9 100.0 1998 27.7 66.0 6.2 100.0 1999 26.4 66.9 6.7 100.0 2000 24.2 69.3 6.5 100.0 2001 26.0 67.6 6.4 100.0 Source: Nepal Rastra Bank
Excess Liquidity. In Nepal, the only statutory liquidity requirement is the Cash Reserve Requirement (CRR) discussed later in this chapter. By this measure, there is considerable excess liquidity within the commercial banks. As of July 2001, there was around NR 76.D billion of liquid assets in the banking system representing 42 percent of total deposits. Of this, around NR55.0 billion was in excess above the CRR - or 25 percent of total deposits. However, over a third of total liquidity in the banking system is being held abroad and earns a rate of return - while around 6.5 percent remains as excess reserves with Nepal Rastra Bank. See Table 1.4 below. 8
Table 1.4: Liquidity of the Banking System (1990 to 2001) (NPR million)
Liquid Assets As a % of Loans and Total Fiscal Year Total Deposits' Advances 2 Cash Reserve 3 Liquid Assets 4 Deposits
1990 21,885.0 15,334.7 3,627.0 9,395.1 42.9 1991 26,687.5 17,067.4 4,836.5 15,022.1 56.3 1992 33,328.5 22,596.2 4,701.0 17,502.6 52.5 1993 43,543.1 26,223.6 7,164.8 25,111.3 57.7 1994 52,168.5 34,756.8 7,884.3 27,799.1 53.3 1995 61,045.5 46,914.7 9,509.9 25,710.7 42.1 1996 71,207.6 61,466.0 9,738.1 28,249.4 39.7 1997 81,542.4 70,765.6 12,737.4 35,450.9 43.5 1998 102,401.6 83,517.0 14,183.5 41,329.2 40.4 1999 126,773.6 99,309.7 15,860.7 50,369.3 39.7 2000 154,530.3 118,008.1 17,020.0 63,337.6 41.0 2001 181,203.4 135,526.4 20,767.5 76,036.7 42.0
'Excludes inter-bank deposits and government deposits but includes foreign deposits. 2 Excludes investments in Government securities and includes foreign bills purchased and discounted. 3Includes cash in hand, balances with Nepal Rastra Bank and foreign currency in hand. 4 Includes cash in hand, balances with NRB, foreign currency in hand, balance held abroad in transit, and government securities. Source: Quarterly Economic Bulletin, Mid-January, 2002, No I & 2, Nepal Rastra Bank
3. Overview of the Financial System Nepal has a reasonably diversified financial sector (as evidenced by the number and variety of institutions that play an active role in the sector) relative to its small and under-developed economic base. Unfortunately, the system remains unnecessarily segmented, with a negative impact upon financial system competition. As of July 2001, the financial system included 15 commercial banks4, 8 development banks, 5 regional (rural) development banks, I postal savings bank, 48 finance companies, 35 non-government cooperative societies involved in limited banking activity 5, and 30 non-government micro-credit institutions. Nepal has made significant progress in developing its financial sector since financial sector reforms began in 1984. At that time, Nepal had only two state-owned commercial banks. The structure of the Nepalese financial sector is shown in Annex One.
As of July 2001, total assets of the financial system (excluding assets of insurance firms that were not available) amounted to NR 415.2 billion or US$5.6 billion. Commercial banks comprised the largest share (55 percent), followed by Nepal Rastra Bank, (28 percent), development banks (7.5 percent), provident fund (5.1 percent), and finance companies (3.8 percent).
4 These include, Rastriya Banijya Bank, Nepal Bank Limited, Nepal Arab Bank Ltd., Indo-Suez Bank Ltd., Standard Chartered Bank, Himalayan Bank, Nepal SBI (State Bank of India) Bank Ltd., Nepal Bangladesh Bank, Everest Bank Ltd., Bank of Kathmandu, Nepal - Bank of Ceylon Ltd., Lumbini Bank Ltd., NIC Bank Ltd., Machapuchre Bank Ltd., Kumari Bank Ltd. 5There are also numerous informal (non-registered) credit cooperatives. However, as there is no data on these infornal institutions, it has not been possible to include information on them in this table. 9
Table 1.5: Total Financial System Assets, July 2001
NR million Percent Nepal Rastra Bank 114,196.1 27.5 Commercial Banks 226,219.3 54.5 Development Banks (ADBN and NIDC) 31,348.1 7.5 Provident Fund 21,000.0 5.1 Finance Companies 15,812.2 3.8 Others 6,637.4 1.6 Regional Rural Development Banks (1,996.7) (0.5) Other Development Banks (2,599.8) (0.6) Micro Finance NGOs (15.5) (0.0) Cooperatives (2,025.4) (0.5) TOTAL 415,213.1 100.0 Source. Nepal Rastra Bank
Commercial Banks. There are 15 commercial banks in Nepal (including the recently opened Macha Puchri Bank Limited and Kumari Bank Limited). Total assets of the commercial banks, as of July 2001 was NR 226.2 billion - equal to around US$3.0 billion. Of the commercial banks, Rastriya Banijya Bank (RBB) and Nepal Bank Ltd (NBL) - with shares of 28 percent and 23 percent of total commercial banking system assets respectively - were the most dominant.
The government owns the key commercial banks, including RBB, the Agricultural Development Bank of Nepal (the ADBN is Nepal's third largest bank) and, until recently, Nepal Bank Limited (NBL) where it still retains a 41 percent stake-holding. When ADB/N is also taken into account as a state-owned bank the Government's share of the total assets of the commercial banks is close to 60 percent. In contrast, the five largest joint-venture banks, some of which also have Government direct or indirect ownership - hold less than 32 percent of banking system assets.
Rastriya Banijya Bank (RBB). RBB was established in 1966 as a fully government-owned commercial bank - and is the nation's largest commercial bank. The bank currently operates a country-wide banking network, in line with the Government's policy to provide banking access to the general public, through a network of 210 branches (although as many as 70 of these have been closed as a result of the Maoist insurgency). Despite the wide branch net work, a large proportion of the bank's total banking business is conducted in Kathmandu. The bank employs around 6,000 staff. In July 2001, the bank had total assets of US$852.9 million and a total reported capital (core and supplemental) of US$47.1 million (around 5.5 percent of total assets).
Nepal Bank Limited (NBL). Nepal Bank Limited (NBL), established in 1938, is the oldest bank in Nepal and is the second largest bank after Rastriya Banijya Bank. Currently, the government owns 41 -percent of the bank after following a policy of parceling off shares of the bank to the workers as well as the general public in Nepal. In accordance with the government's policy of providing at least one banking facility for every 30,000 people, NBL also opened up many branches and sub-branches throughout the country. The bank grew to 235 branchies by 1990, which were serviced by 8,721 staff. However, a subsequent consolidation of the bank resulted in a reduction in branches to 211 and around 6,000 staff by the end of 1998. In common with RBB, the number of branches has been further reduced by the Maoist insurgency. NBL's total reported 10 assets in July 2001 amounted to around US$695.1 million, backed by reported capital (core and supplemental) of US$36.2 million (5.2 percent)6 .
Private Commercial Banks -Joint Venture and Private Nepali Commercial Banks. The private commercial banks represent 49 percent of the banking system (with approximately US$1,452.6 billion in assets). This group is dominated by three large banks - Standard Chartered Bank (9.4 percent of total commercial banking system assets), Himalayan Bank (9.3 percent) and Nabil Bank (8.5 percent). The joint venture banks are from the United Kingdom, Bangladesh, Pakistan, France, India, and Sri Lanka. The remaining 22 percent of commercial banking system assets is shared between the remaining ten smaller private banks in the system.
Development Banks. The two government-owned development banks, the Agricultural Development Bank of Nepal (ADB/N) and the Nepal Industrial Development Corporation (NIDC), control about 7.5 percent of total financial system assets. In addition, 6 private development banks have been established since 1998. Three of these have begun operations since early 1999 - and, at this stage, very little is known about their operations.
The AgriculturalDevelopment Bank of Nepal (ADB/N). The ADB/N was established in 1967 by the Agricultural Development Bank Act of the same year and was a successor institution to the Government-sponsored Cooperative Bank. It is the third largest bank in Nepal. Its mandate is to supply credit for agricultural development, small-scale irrigation projects, agriculture-based cottage and small industries, and credit for tenant farmers to purchase land. Ninety-three percent of the bank is owned by the Government through the Ministry of Finance. Other shareholders include Nepal Rastra Bank, individuals and cooperatives. The bank manages total assets of around US$227.9 million. It has branches in each of the 75 districts in Nepal, and 30 of its mainly urban branches perform commercial banking activities.
The Nepal Industrial Development Corporation (NIDC). NIDC was established in 1959 to support industrial development. It is empowered under the NIDC Act to provide credit, guarantees, underwrite shares, and hypothecate loans. The Government of Nepal is the largest shareholder in NIDC and it dominates the Board of Directors. NIDC is, however, a significantly smaller institution than the ADB/N with only around US$36 million in total assets (July 2000). Historically, NIDC's main source of funding has been from donors - the World Bank and GTZ - however, this situation has changed radically in recent years and the bank has increasingly turned to the central bank to provide it with loanable funds. In 1999, borrowings from Nepal Rastra Bank represented 35 percent of NIDC's total liabilities. Borrowings from the Ministry of Finance represented a further 8 percent. While the NIDC does not accept deposits, it is pernitted to issue negotiable certificate of deposits.
Regional Rural Development Banks. The larger scale developmental lending to agriculture and industry provided by the ADB/N and the NIDC is supplemented by a further five development banking institutions which provide micro-finance support in the five regions of Nepal. These banks control less than half of one percent of the total assets of the financial sector. They are modeled on the Grameen Bank of Bangladesh and were established between 1992 and 1996. All of these institutions aim at improving the socio-economic status of poor rural women by promoting the formnation of self-help groups and facilitating their access to formal credit. Operating autonomously in each of the five regions, each Regional Rural Development Bank (or Grameen Replicator Banks as they are also known) has a slightly different ownership pattern,
6 As discussed in the commercial banking chapter, however, both RBB and NBL have a serious problem of negative capital once adequate provisions have been made on their non-performing loans. I1 although in each case the Government and Nepal Rastra Bank dominate - with an ownership stake of 75 percent in all five institutions combined. The two state-owned banks (RBB and NRB) have a further 10 percent ownership stake in these five banks. The remaining shares of the banks are owned by the private joint venture banks - which are encouraged to participate in these institutions, with any lending funds provided counted as part of their 12 percent directed lending requirement to disadvantaged sectors.
Finance Companies. In addition to the private banks, there are 48 private finance companies operating in Nepal. These institutions have all commenced operations over the past six years since the Finance Company Act was promulgated. The Act permits these companies to offer installment credit for the purchase of vehicles, equipment, or durable household goods, for purchase or construction of residential buildings, for leasing financing, and for "operating industrial, commercial or other enterprises." As of July 2001, these 48 companies controlled around US$209.7 million in assets (representing around 3.9 percent of total financiial system assets) and are growing very rapidly.
Micro Finance Institutions. There is a plethora of organizations involved in micro finance in Nepal - formal and informal - mainly cooperatives and NGOs. Credit cooperatives first emerged in 1956 and were registered under the Cooperative Act in 1959. With a view to limiting political intervention and to institutionalizing cooperatives, a new Cooperative Act was enacted in 1992. This Act specified that a minimum of 25 persons were required to form a primary cooperative. While there is reported to be around 5,000 largely credit and multipurpose cooperatives registered under the new Act, only 35 have obtained permission from the Nepal Rastra Bank to undertake limited banking functions (although many of the others do so illegally).
Non-governmental organizations are also permitted to provide limited banking services in Nepal. To date, thirty NGOs have been licensed to conduct limited banking business of which two - Nirdhan and CSD - are Grameen replicator banks. NGOs are registered under the Societies Registration Act. As with the cooperative societies, there is little supervision and oversight of these institutions by the central bank. On the other hand, however, some of them, such as the two privately owned Grameen replicator banks, appear to be performing well.
The Nepal Stock Exchange. The history of securities market in Nepal began with the floatation of shares in a jute mill and Nepal Bank Limited in 1937. However, very little market activity occurred after this point. This was then followed by the introduction of the Company Act in 1951 and the first issue of Government bonds in 1964. The Securities Exchange Center Ltd., which was designed as a Government broker and under writer for government bonds, was established in 1976. Before its conversion into a Stock Exchange in 1993, the SEC was the only capital market institution undertaking the job of brokering, underwriting, managing public issues, market making for government bonds, and providing other ancillary services. The Nepal Stock Exchange was created in 1993 as a non-profit organization operating under the Securities Exchange Act. The Nepal Stock Exchange (NEPSE) opened its trading floor on January 13, 1994.
The NEPSE is owned by the Government (40.92 percent), the central bank (49.53), the Nepal Industrial Development Corporation (8.77 percent), and some other very small licensed members (0.78 percent). The Government had intended to sell the NEPSE to private interests within five years, however, there is not a lot of interest in investing in the Stock Exchange. The Board of Directors consists of nine members. Members of the NEPSE are permitted to act as intermediaries in buying and selling government bonds and listed corporate securities. At present there are 29 member brokers and 3 market makers, who operate on the trading floor as per the 12
Securities Exchange Act, 1983. The NEPSE had a market capitalization of US$615 million and a turn over of US$1.7 million in 2001.
The Insurance Industry. There are 13 insurance companies. The total life insurance and non-life insurance premiums collected as of July 2000 was NR 6.61 billion (US$93.89 million). Of this, life insurance accounted for around 59 percent of the total, the remainder going to non-life insurance (car insurance, fire, etc).
The largest insurance company is the National Insurance Company. It is listed on the NEPSE and the govemment is the majority shareholder - with only 12 percent of the shares being held by the general public. It has a near monopoly on govemment insurance business and its market share in 1998 was 40 percent. Other major insurance companies include the National Life and General Insurance Company (which is the only company to offer life insurance other than the National Insurance Company), Nepal Insurance, Himalayan General Insurance, and Neco Insurance. These five companies control almost 60 percent of the general insurance market. Of the 13 insurance companies, 11 are domestically owned and 2 are Indian owned. While these companies provide a variety of general insurance products, the industry still lacks the full range and sophistication of a well developed insurance business. Shortage of qualified actuaries is a particular problem.
Money Changers (Foreign Exchange Bureaus). There are currently 200 NRB licensed money changers in Nepal, although not all of these are operational. Of these, 67 are located in Kathmandu. The foreign exchange bureaus provide money changing services for foreigners only (as Nepalese can only carry out such transactions through the commercial banks). The foreign exchange bureaus provide annual reports to the NRB.
Postal Savings Bank. The Postal Savings Bank was established in 1975. It currently has branches in 121 out of a network of 3,590 post offices. The objective of the Postal Savings Bank was to cultivate a savings habit and mobilize small savings in rural areas. As such, these are mainly used by the small rural savers who earn 7 percent per annum on deposits. The funds from these schemes are re-deposited with Rastriya Banijya Bank. At present, the total postal savings are less than 5.0 million rupees (US$71,000).
Employees Provident Fund. The employees provident fund was established under the Employee's Provident Fund Act of 1962. It is an autonomous corporate body having perpetual succession. The fund had total assets of NR 21 billion (US$278.5 million) as of July 2001. It has nearly doubled in size over the past four years. Currently most of the assets of the EPF are invested in deposits with state-owned banks (65 percent) and government bonds (15 percent). The remainder is given out as loans including syndicated bank loans, with maturities of up to eight years, and member loans.
Citizens Investment Trust (Mutual Fund). The Citizen Investment Trust was created under a special Act of parliament to assist in the mobilization of savings. It offers two relatively small investment funds that help to mobilize the savings of small investors. Any employee can voluntarily participate in an investment plan sponsored by the Citizen Investment Trust called an Employee Savings Growth Scheme. Contributions of up to 10 percent of salary can be made. These contributions are tax deductible while the earnings on them are taxed at distribution. Apart from this, the Citizens Investment Trust operates two other schemes, the Citizen Unit Scheme, 1992 and the Investors Account Scheme. The total funds under the management of the Citizens Investment Trust were NR 895.8 million (US$12.1 million) as of February 2001. Around 48 13 percent of these funds are invested in fixed interest deposits, 38 percent in government bonds, 10 percent in term loans and the remainder in corporate shares and debentures. 4. Nepal Rastra Bank Background. The NRB was established as a non-profit organization fully subscribed by the government under the Nepal Rastra Bank Act, 1955 on April 26, 1956. It was established as an autonomous and corporate body having perpetual succession, although the Act allows the government to give directives to the Bank when it serves the national interest. It serves as banker to the government, maintains government deposits, and undertakes remittance and other banking services for His Majesty's Government. The NRB offers advisory services to the government for monetary and financial policies. The NRB has the authority to regulate and control foreign exchange operations and has the sole right to authorize other agencies to deal in foreign exchange. It is authorized to regulate, control and develop the banking system, license new commercial banks and financial institutions, and serves as a lender of last resort to commercial banks and financial institutions. It is mandated to supervise, regulate and monitor all commercial banks, development banks, finance companies as well as licensed NGOs and co-operatives engaged in micro-finance. In its prudential regulation and supervision task, the NRB sets norms for capital adequacy, liquidity, loan classification and provisioning, reporting requirements, and the auditing of the supervised financial institutions. It serves as a clearing house for inter-bank transactions. In addition the NRB's Development Finance Department manages the flow of credit to priority and deprived sectors. It provides capital to NGOs and the RRDBs.
Legal Position. Until early 2002, the Nepal Rastra Bank derived its authority from, the Nepal Rastra Bank Act, 1955. This legislation had been a major source of weaknesses in the Nepalese financial sector. This law has been revised and up-dated, however, with the new law coming into effect as from January 2002. With the promulgation of a new Nepal Rastra Bank Act, the NRB is expected to enjoy greater autonomy in its operation, particularly from the Ministry of Finance. Some of the important factors in the revised law that will help to ensure NRB's autonomy are (a) the governor cannot be removed without cause; (b) there has been a change in the constitution of the Board of Directors to include a number of independent directors and only a non-voting Ministry of Finance director; and (c) other provisions such as formulation of regulations and initiation of remedial steps that the NRB can take without referring to the Ministry of Finance or obtaining its approval.
Board of the Banks The NRB is currently governed by a seven member Board of Directors comprised of the Governor, four Directors nominated by His Majesty's Government I1HMG) and the two Deputy Governor's of the Bank. All the members are appointed by HMGN. The Board is the supreme policy making body of the NRB. The composition of the Board is shovm below.
NEPAL RASTRA BANK BOARD OF DIRECTORS Chairman Dr. Tilak Bahadur Rawal, Governor Members Dr. Shankar Sharma Member, National Planning Commission Dr. Bimal Prasad Koirala Secretary, Ministry of Finance Dr. Parasar Koirala Professor, Tribhuvan University Mr. Bijaya Nath Bhattarai Deputy Governor, Nepal Rastra Bank Mr. Ram Babu Pant Deputy Governor, Nepal Rastra Bank Mr. Pradeep Kumar Shrestha Chairman, Federation of Nepal Chamber of Commerce and Industries 14
Organizational Structure. The NRB is made up of 20 departments (including the Bankers Institute). These departments are grouped by functions such as the Development Finance Department that focuses on development or social banking, including support to the various development banks and organizations in which the NRB is currently engaged. The Issue Department and the Banking Department are the principal operational sub-divisions of the Bank. The NRB also has 7 branches and I sub branch located in: Biratnagar, Janakpur, Birgunj, Pokhara, Siddartha Nagar, Nepalgunj and Dhangadi and one sub-branch office in Illam. It also has an office in Bhadrapur. The Bank operates with a total staff strength of 2,719 people (2,352 permanent and 367 contract employees). The seven branch offices and one sub branch office are comprised of two main units, Issue and Banking. The only difference between the branch and sub branch is the volume of work. The branches and sub branches have a Regional Research Center that focuses its studies and analysis of the economic and banking situation in that particular region. The branches also have responsibility for revenue collection and payments on behalf of the government.
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Effective Banking Supervision, conducted in June 1999, concluded that NRB does not comply with two thirds of these Core Principles and has experienced difficulties in fulfilling its supervisory mandate. The main weaknesses point to absence of operational independence, poor internal structure, problems of hierarchy, and inadequate legal framework. Some of the reformn measures necessary to correct these deficiencies and strengthen the NRB's supervisory capacity have been identified and are now being addressed. They include, inter alia, reorganization of the departments to provide for operational autonomy; creation of an institutional development plan for supervision functions, enhancement of regulatory functions including prudential guidelines, 15
accounting and auditing practices, and expansion of supervision of non-bank financial institutions.
Table 1.6: Nepal Rastra Bank: Assets and Liabilities, 1991 - 2001 ( in NR billions)
Assets 1991 1992 1993 1994 1995 1996 1997 Ms 1999 2000 2001
FC in hand 0 9 0 4 1.2 2.6 6.5 6.8 5.7 5 3 2.3 5.6 5 6 Gold 03 03 0.3 03 0.3 04 04 0.4 0.4 04 04 Foreign Assets 13.9 19.1 26.7 320 28.1 26.6 30.4 42.1 50.9 601 701 Advances to Govemment 9.9 10.2 3.8 15.0 174 20.4 21.9 220 228 204 233 Public Enterprises 0 7 0 8 0 06 0.5 0 7 1.1 1.5 1.6 1.7 1 6 1 7 Commercial Banks 003 0.03 0.05 003 0 02 0.4 0 007 0 006 0 006 005 0 1 Private Sector 0 6 0.6 0.5 0 5 0.6 0.9 1 5 12 1 4 2 1 3 3 Other Assets 3 5 4.3 4 4 3.9 5.0 5 7 6.7 7.2 8.3 8.8 9.7 Total Assets 29.8 35.6 47.6 54.8 58.8 62.3 68.1 79.9 87.8 99.2 114.2
Liabilities 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Notes and Coins 12 6 14 8 17 7 21.5 24 5 27.5 30.2 33 8 38 3 45 7 52 6 in Circulation Deposits Govemment 0.1 ------Commercial Banks 3 5 3 1 5 5 5.6 7.0 6.7 9.3 10 5 11 9 12 8 16.0 Foreign 02 0.2 0.2 02 0.2 0.2 04 02 0 06 02 1 2 Private Sectordeposits 0.7 0.9 1.3 1 3 1 1 1 2 1.6 1.7 2 1 2 5 2 2 OtherLiabilities 47 67 122 139 11.7 101 10.4 129 131 146 156 Capital and Reserves: Capital 0 01 0 01 0 01 0 01 0 01 0.01 0.01 0.01 0 01 0 01 0.01 Reserve Funds 0 5 0.7 0 9 1.2 1 4 1.5 1.7 2.1 2.6 2.6 2 6 Other Funds 7.5 9.1 99 11.1 12.8 15 1 146 195 19.9 21.0 24.0 Total Liabilities 29.8 35.6 47.6 54.8 58.8 62.3 68.1 80.6 87.8 99.2 114.2 Source: Nepal Rastra Bank
Human Resource Management and Development. Until late 2001, the NRB was operating with 2,352 permanent employees and 367 contract employees (almost all at the assistant level). The implementation of a VRS scheme, however, has reduced total staffing levels to around 2,200 - and all contract employee positions have been eliminated. Professional staff make up only 14 percent of the total. There are 824 employees (35 percent) working in the nine branches. The ratio of assistants to professional staff is 5.3 at the center and 9.2 at the branches. Based on this high ratio of professionals to assistants, the NRB still appears to be overstaffed - and especially at the assistant level - even after the implementation of the 2001 VRS. Moreover, it appears that this problem is more severe at the branch level.
The presence of at least two staff unions (membership confined to non-professional employees) and their strong influence on personnel policies is but one explanation for the large number of low level workers in the NRB. These unions have strong political connections. As a result, they have a disproportionately large influence upon the human resource policies oi the bank, constraining hire and fire practices as well as asserting undue influence on issues o;f promotion and even automation in the workplace. While the union is also seen to have some positive impact in terms of being a watchdog over senior management, they have been counter productive and are partly to blame for the human resource problems faced by the Bank. Another reported issue is the 16 vacuum in the NRB as far as experienced professional staff are concerned. This was caused by a rule requiring mandatory retirement after 30 years of service. This rule was repealed in 1999 but the NRB still lacks an adequate cadre of professionals.
It is evident that reengineering the human resources function is key to an efficient and effective NRB. Over the short run, a policy of not replacing retirees (being enforced, particularly at the lower level) is one way to keep staff numbers from growing (currently 560 - 24 percent - of all staff are in the age group 46-58 years, 58 being the compulsory retirement age), while a longer term strategy is put into place. Given the strength of the unions as well as the large numbers of staff that are likely to be impacted by any meaningful reform, incentives will have to be carefully structured and close communication with the unions will be required.
Instruments of Monetary Policy. The main monetary policy instruments used by the NRB are the cash reserve ratio (CRR), the refinancing rate, and open market operations using treasury bills, repurchase agreements, development bonds and national savings certificates. At present, given the limited demand for credit by the private sector and the excess liquidity in the financial system, the available instruments do not provide NRB the necessary leverage to effectively conduct meaningful macro-monetary policy. In addition, there is limited range of debt instruments - although longer-term government securities were introduced in 1999 in conjunction with efforts to reduce government borrowing from the NRB. Since 1989, interest rate policy has been conducted primarily through moral suasion aimed at lowering lending rates while discouraging significant increases in yields on treasury bills. However, after observing a decade of sluggish economic growth, a high interest rate spread maintained by the commercial banks (largely the impact of the two large inefficient commercial banks), a slowdown in the growth of private sector credit, and increasing demands from the business community for lower interest rates, the NRB issued a directive on July 30, 1998 to the commercial banks to limit the interest spread to 5 percent.
Cash Reserve Ratio. This is the main monetary policy tool of the NRB. Prior to mid April 1998, the CRR was 12 percent of total domestic deposit liabilities and the total Statutory Liquidity Ratio (SLR) including CRR was 34 percent. Since then, the SLR has been removed and the CRR has been revised downward. Up to December 2001 it was calculated as 8 percent of savings and demand deposits and 6 percent of fixed deposits. Thereafter it was revised to 7 percent of savings and demand deposits and 4.5 percent of fixed deposits. Banks are also required to maintain 3 percent of total deposits as vault cash. The reduction in the CRR was expected to release additional liquidity into the market and (due to lower cost of funds) lower the lending rates of the commercial banks. Licensed cooperatives are required to maintain 10 percent of their total deposits in liquid assets.
Interest Rates. As indicated, interest rates were deregulated in 1989 with the proviso - since July 30, 1998 - that commercial banks maintain a maximum spread of 5 percent' between lending and deposit rates. Banks are also required to meet "priority sector and deprived sector" lending targets - currently set at 12 percent of their total loan portfolios, mainly targeted for agricultural loans, cottage industry loans and loans intended for the poor. A quarter of this must be allocated to the "deprived" or "hard core" poor sector (defined as those who borrow less than NR 30,000 - US$426 - per annum). While commercial banks have had difficulty in meeting this stipulation in the past (and paid penalties for the shortfall to NRB), it has become easier, with the growth of the
7The spread is calculated by the following formula - totai interest income divided by the total average loan minus total interest expense divided by total average deposits expressed as a percentage 17
RRDBs and other micro-finance institutions. The commercial banks provide these funds at between 10-15 percent.
Table 1.7 below shows interest rates in Nepal over the past six and a half years. There has been a tendency for interest rates to fall over this period. However the extent to which this reflects "market conditions" (given the dominance of the three large state owned banks within the system) is uncertain. The most notable decline has been the interest rate on Government Treasury Bills which had fallen to 4.3 percent in July 2001 from 11.7 percent in January 1997. This was mainly a result of the existing legal and operations restrictions faced by the NRB such as restrictions on selling bills acquired from conversion of overdraft in the primary markets, limits on the level of gross sales of treasury bills, as well as a regulation linking rates in the secondary markets to the average auction rate of treasury bills of the preceding three months. The reduction in T-Bill interest rates is also in line with a reduction in the rate of inflation over this period.
Table 1.7: Main Lending and Deposit Interest Rates, 1995 - 2001
Fiscal Year 1995 1996 1997 1998 1999 2000 2001
A. Government Securities Treasury Bills (3-month) 7.4 10.9 10.2 3.5 2.3 5.3 4.9 Treasury Bills (I year) - - 9.0- 12.0 5.9 - 7.3 4.7 - 7.0 5.5 -7.3 5.1 Nat'l Savings 9.0- 15.5 9.0 15.5 9.0- 13.25 9.0- 13.25 9.0- 13.25 8.5 - 13.25 8.5 - 13.25 Certificates Development Bonds 3.0- 10.5 3.0- 12.0 3.0- 12.0 3.0 - 12.0 3.0- 12.0 3.0 - 10.5 3.0- 10.5 B. Nepal Rastra Bank Refinancing Rates 11.0 11.0 9.0 9.0 9.0 6.5 - 7.5 4.0 - 6 5 C. Commercial Banks (a) Deposit Rates Savings Deposits 7.0-8.0 7.5 - 8.0 7.3 - 8.0 6.5 - 8.0 5.75 - 8.0 4.0 - 6.5 3.5 - 6.5 Time Deposits 3 Months 5.0 - 7.5 6.75 - 8.0 6.75 - 9.0 5.0 - 8.0 4.0 - 7.5 4.0 - 6.0 2.5 - 6.0 6 Months 6.0 - 8.0 7.25 - 9.0 7.25 - 9.0 6.0 - 8.5 6.0- 8.0 5.0 - 6.75 3.5 - 6.75 I Year 8.5-9.25 9.5- 11.0 9.5 - 11.0 9.0-10.5 7.25-9.5 6.0-7.75 4 5-7 75 (b) Lending Rates Industry 14.0 - 18.0 15.0- 17.5 15.0-17.5 13.5 - 17.0 11.5-17.0 10.5 - 15.5 7.0-15.0 Agnculture 13.0- 15.5 14.5 - 16.0 14.5 - 16.0 14.5 - 15.5 14.0- 15.5 12.0 - 14.5 12..5 - 14.5 ExportBills 12.0 - 16.0 13.0 - 16.0 14.5 - 16.5 12.5 - 16.0 7.5 - 15.0 7.5 - 15.0 7.0 - 125 Commercial Loans 12.0-19.0 14.5 -20.0 14.5-20.0 13.5-20.0 10.0-19.0 9.0- 18.0 7.0- 18.0 & Overdrafts Agricultural Development BankofNepal 12.0- 17.0 12.0- 17.0 12.0 - 17.0 13.0 - 18.0 13.0 - 18.0 11.0 - 16.0 10.0- 16.0 Nepal Industrial Development Corporation 15.0- 16.0 15.5- 16.0 15.0- 18.0 15.5 - 18.0 15.5 - 18.0 15.5- 18.0 13.5 - 14.5
Treasury Bills: annual weighted average. Source: Nepal Rastra Bank
Lending interest rates are reported on an industrial/segmented basis that normally reFlects a state determined system which seeks to confer preferential lending rates on priority sector activities. It is uncertain why this practice is continued - given that interest rates are theoretically deregulated (subject to conditions on interest rate spreads). Nonetheless, given the current poor financial shape and lack of competition within the banking system it is, in any case, uncertain what benefits could be derived from a totally liberalized interest rate structure. Nonetheless, the segmentation of interest rates can have serious dis-intermediation effects upon a developing financial system. 18
The entry of new banks does not appear to have injected a significant degree of competition into the interest rate structure - with the new joint venture banks playing by the existing "rules of the game" - rather than acting as "market breakers". This lack of competition, even with the entry of new banks, reflects segmentation in the banking system plus the fact that the joint venture banks are able to hide behind the inefficiencies created by RBB, NBL and ADB/N.
Lastly, most interest rates (both deposit and lending rates) have been positive in real terms, over the past two years as inflation has edged down below 5 percent. This is in marked contrast to 1999 when the dramatic increase in the rate of inflation resulted in most interest rates being, at least temporarily, negative in real terms.
Refinance Policies. NRB has completely phased out the old practice of automatically providing refinancing for commercial banks against government securities. At present, refinancing is only provided under two broad categories: (a) under the Special category, refinancing is provided at 6.5 percent - this is mainly targeted at deprived sectors; and (b) under the general category - that covers items such as export credits - refinancing is provided at 7.5 percent.
Open Market Operations. The NRB utilizes open market operations as an indirect tool for short-term liquidity management. Treasury bill sales through an auction system was first introduced in 1988. In addition to treasury bills, development bonds and national savings certificates are sold.
The government sells 91-day and 1-year Treasury Bills on a weekly basis, typically issuing around NR 600 million per week. Issues of longer dated instruments are increasingly rare. In principle, Development Bonds are auctioned 3 to 4 times a year, however the last issue was in July 2000. The government has historically issued National Savings Certificates with maturities of up to 15 years, but more recently they have been with five year maturities. National Savings Certificates are only sold, to individuals, four to five times a year9 and there is a maximum holding per person of NR I million - although an exception is made for the EPF and CIT. National Savings Certificates were historically tax exempt but this was discontinued from May 2000. The government also issues Special Bonds which are generally private placements to entities such as Nepal Rastra Bank.
While Treasury Bills are sold to the banking sector through an auction mechanism, all other bonds are sold through a fixed price re-offer, with pricing set by the Open Market Committee. The sales of bonds are generally open to all investors including foreigners (subject to the restriction on National Savings Certificates), however, some sales are made directly to entities such as the EPF for reasons of timeliness. Approximately half of all National Savings Certificates are sold through the NRB's nine regional branches and the rest by commercial banks'", a significant portion (15-25 percent) of each issue is sold outside of Kathmandu.
In 1999 treasury bills amounting to NR 2,200 million, development bonds of NR 650 million and national savings certificates of NR 1,860 million were sold through open market operations. Since March 1997, the NRB also undertook repos in Treasury Bills. During 1999, the short term cumulative liquidity injected through repos amounted to NR 16.3 billion.
The Clearing and Payments System. The main forms of payment are checks, drafts, telegraphic transfers and more recently, credit cards that are issued by a few of the newer
' This last issue was of NR 790 million of 3-year bonds with a coupon of 7 percent. 9NR I billion was sold in January 2001 with a coupon of 8.5 percent and a maturity of 5 years. " Banks are paid a fee of 0.5 percent for retail sales and 0.1 percent for institutional sales. 19 commercial banks. Cash still remains the most popular form of payment. Government payments (including salaries) are made through a combination of cash and checks.
Check clearing is undertaken through the Central Clearing House in Kathmandu and through NRB's branches. The clearing system appears to work relatively efficiently with reported clearance times of 24 hours within the Kathmandu Valley and up to a maximum of 3-4 days outside the capital. During 1999, a total of 242,697 checks for NR 129.59 billion (US$1.9 billion) were cleared. Compared to the previous year, the number of checks cleared increased by 11 percent while the amount increased by 24 percent.
Auditing and Accounting of the Central Bank's Accounts. The accounts of NRB are audited twice annually, once by internal auditors and once by external auditors. The external audit is published at the beginning of the NRB's Annual Report - as required by law. The external auditors are firms licensed by the Auditor General's office of His Majesty's Governrent and are selected (annually) by the board of directors. The audited accounts are then submitted to the governor and the board of directors as well as the Auditor General's Office. In ache event of "irregular" findings, the Auditor General's office has the right and responsibility to raLise issues in parliament.
NRB's account need to be strengthened considerably with a view to bringing them into line with internationally accepted accounting standards. Similarly, it would be worthwhile to review the panel of auditing firms eligible to carry out NRB's audit, to include more internationally reputed auditing firms.
Taxation of Financial Institutions. Currently, financial institutions pay 30 percent corporate tax - while non bank financial institutions pay 25 percent corporate tax. With respect to provisioning, 3 percent of total outstanding loans is allowed as a one time tax deduction. In subsequent years, the 3 percent deduction is only allowed on the increase in outstanding loan levels.
Economic Statistics. The NRB produces five reports along with the Annual Repolt - which is required by law. These are the Economic Report (annual), the Quarterly Economic Bulletin, the Monthly Report (main economic indicators) and the Monthly Report (economic; scenarios). There is a time lag of around one year for most information in the reports and the publications are typically produced within three months following the reporting date. The NRB also hosts a web- site where it posts, in addition to general information about its organization, the quarterly economic bulletin, economic notes and information on the development banks. 5. Linkages Between the Real and the Financial Sectors
The importance of the financial sector is in its role as a provider of essential funding support for the real sectors of the economy. Table 1.8 provides a review of banking sector lending to the real sectors of the economy over the past decade. These tables indicate that the industrial sector has traditionally been the largest recipient of credit from the banking system, followed by the commercial sector. On the other hand, agriculture has only represented a relatively small amount of bank credit - and it has been declining over this period - in contrast to lending to the service sector which has been low, but on an upward trend. In fact, over the period, the service sector has experienced the fastest rate of growth in credit outstanding - growing at over 34 percent per annum over 1990 to 2001. This compares to 26.6 percent for industry; 24.1 percent for commerce; 18.6 percent for agriculture; and 10.1 percent for the miscellaneous "other" category. 20
Table 1.8 (a): Total Credit by Sector 11(NPR millions) Fiscal Year Total Credits Agricultural Industrial Commercial Services Others2/ 1990 11798.7 1531.6 3817.6 3371.7 293.5 2784.3 1991 14009.0 1850.3 4545.6 4150.0 330.4 3132.7 1992 18797.6 2432.1 5389.3 6801.8 545.1 3629.3 1993 21477.1 3144.2 6621.1 7235.2 735.5 3741.1 1994 29339.1 3395.6 11046.9 9508.1 1271.8 4116.7 1995 40590.3 4923.8 15877.6 13305.7 1697.7 4785.5 1996 52619.8 3972.8 24212.6 17010.3 2674.4 4749.7 1997 60973.7 5599.9 26393.9 20401.0 2927.0 5651.9 1998 71244.2 6095.9 31775.2 23963.9 3439.1 5970.1 1999 84082.5 7868.5 38062.1 27654.9 4240.9 6256.1 2000 99453.8 8863.7 44885.3 32753.3 5713.6 7237.9 2001 112860.7 9999.4 51008.9 36200.2 7603.2 8049.0
Table 1.8 (b): Total Credit by Sector "(distribution - percent) Fiscal Year Total Credits Agricultural Industrial Commercial Services Others2/ 1990 100.0 13.0 32.4 28.6 2.5 23.6 1991 100.0 13.2 32.4 29.6 2.4 22.4 1992 100.0 12.9 28.7 36.2 2.9 19.3 1993 100.0 14.6 30.8 33.7 3.4 17.4 1994 100.0 11.6 37.7 32.4 4.3 14.0 1995 100.0 12.1 39.1 32.8 4.2 11.8 1996 100.0 7.6 46.0 32.3 5.1 9.0 1997 100.0 9.2 43.3 33.5 4.8 9.3 1998 100.0 8.6 44.6 33.6 4.8 8.4 1999 100.0 9.4 45.3 32.9 5.0 7.4 2000 100.0 8.9 45.1 32.9 5.7 7.3 2001 100.0 8.9 45.2 32.1 6.7 7.1
Table 1.8 (c): Total Credit by Sector (annual growth - percent) Fiscal Year Total Credits Agricultural Industrial Commercial Services Others2/ 1990 1991 18.7 20.8 19.1 23.1 12.6 12.5 1992 34.2 31.4 18.6 63.9 65.0 15.9 1993 14.3 29.3 22.9 6.4 34.9 3.1 1994 36.6 8.0 66.8 31.4 72.9 10.0 1995 38.3 45.0 43.7 39.9 33.5 16.2 1996 29.6 -19.3 52.5 27.8 57.5 -0.7 1997 15.9 41.0 9.0 19.9 9.4 19.0 1998 16.8 8.9 20.4 17.5 17.5 5.6 1999 18.0 29.1 19.8 15.4 23.3 4.8 2000 18.3 12.6 17.9 18.4 34.7 15.7 2001 13.5 12.8 13.6 10.5 33.1 11.2 V Loans, advances and overdrafts of commercial banks (excludes foreign bills purchased and discounts). 2/ Includes general use and social purpose. Source: Nepal Rastra Bank 21
6. Issues The Role of the Government in the Financial Sector. One of the main issues in the financial sector is the overwhelming role played by the Government as an owner and operator of financial institutions. Not only does it own the largest commercial bank, and hold the dominant shareholding in the second largest commercial bank, but it also owns shares in virtually every other commercial bank. In addition, it owns the two development banks (ADB/N and NIDC), insurance companies, regional rural cooperative banks, and is heavily involved in micro finance institutions. As in most developing countries, Government ownership has resulted in poor internal governance, weak management, fragile financial health, and an unhealthy politicization of these institutions. There is an urgent need for the Government to divest its ownerslhip in most of these banks and financial institutions - through either privatization or liquidation - and to replace the role which is overwhelming played by the public sector by "fit and proper" private sector owners and operators.
At the same time that the Government has played a dominant role as an owner and operator it has failed to play an adequate role as supervisor and regulator of the financial system. Consequently, weak institutions have been permitted to conduct business without adequate government or central bank oversight and sanction - and have continued to deteriorate over time. Many institutions are characterized by a weak capital base, high levels of non-performing loans, poor internal governance, and allegations of corruption and inadequate management. Hence, there is a critical need for the Government to realign its role within the financial system away from being an owner and operator of banks to being a supervisor and regulator of financial sector activity. In doing so, however, it will need to take care that it does not replace its role as art inefficient owner/operator of the state banks with that of an overly bureaucratic supervisor, thereby replacing one form of excessive public sector influence with another.
The Role of Nepal Rastra Bank. The NRB has only been partially successful in developing its core central banking functions. However, its development has been severely compromised by the inherent conflict of interest that has arisen between its role as an owner and as a regulator of the banking system. In addition, until the new central banking act was enacted, the NRB had no statutory independence from the Ministry of Finance, and was generally perceived as not having sufficient autonomy to properly perform its role, particularly with respect to the large, inefficient publicly owned banks. Also, the banking supervision system did not provide legal protection for supervisors, nor operational independence and adequate resources while on the other hand, the rapid growth in the number of financial institutions (and their technological advancement) has stretched the NRB's existing supervisory capacity. A number of additional areas need to be strengthened (after the legal reform) - including a restructuring of the bank, reform of its human resource function, and the introduction of improved incentive mechanisms. Such an exercise must include, but not be limited to, total divestment of all shareholdings in other financial institutions, withdrawal from the boards of all financial institutions, and the removal of development banking functions from NRB.
A Weak/Fragmented Legal Financial Environment. The existing legal framework is insufficiently robust to support the sort of financial sector that the government would like to see in Nepal. Nepal has a proliferation of both laws and regulations that are institution, rather than function, specific. This has resulted in a fragmented legal environment that has not been conducive to competition. In addition operating incentives are seriously distorted by government priorities such as access to credit in rural areas or concerns over the competitiveness of the local banks vis a vis foreign financial institutions. In particular, the mandatory requirement for "priority" and "deprived" sector lending by the commercial banks targeted at farmers and small 22 borrowers needs to be addressed. In addition, there is also an issue of commercial banks being required to open branches in rural areas (with a stipulated ratio of one rural branch - or two branches in semi urban areas - for every urban branch). The imposition of such directives increases costs for commercial banks while their benefits, particularly to the rural population, are questionable.
Social Dimensions of Banking. Given the large numbers of people living below the poverty line in Nepal, it is not surprising that the social dimensions of banking have been strongly emphasized. However, some of the current policies employed to achieve these objectives (directed credit, branch opening policies, and so on) are too broad and cause considerable. operational disincentives within the financial system while their impact has been minimal. There is clearly a need to revisit these policies to sharpen their focus so that any negative effects can be minimized while their impact on the poor and rural communities are maximized. Alongside these changes, there is also a need to reform the delivery mechanisms for development finance - utilizing and working with private partners wherever possible. Moreover, even if the government does decide to continue to be directly engaged in development banking in a limited fashion - it is important that the central bank withdraw from direct participation, given its supervisory role in the sector.
A Lack of Competition. A key objective of reforms in the state owned banks, and the financial system more generally, should be to reduce fragmentation and increase efficient intermediation by financial institutions through increased competition. Market oriented approaches need to be developed to enhance competitive pressures rather than mandated efforts such as those developed with respect to controls on interest rate spreads.
A Weak Accounting and Auditing Environment. The lack of a proper accounting and auditing environment - both in the financial and corporate sectors - is one reason why the problems facing the Nepalese authorities are so severe. A lack of timely and robust information, in the absence of strong enforcement, creates an ideal setting for the development of poor banking practices. Moreover, in such an environment, lending decisions become difficult for banks as they cannot be based upon good financial information. Thus a significantly strengthened accounting and auditing framework is essential for Nepal's financial system to operate in a prudentially sound and efficient manner.
Human Resource Development. An important element in the strengthening of Nepal Rastra Bank is the successful reengineering of its human resource function. Human resource policies need to be revised to ensure professional development and the retention of quality staff. Such a change will have to include significant increases in allowances and benefits essential to attract and retain quality individuals. However, such a decompression of the (seriously) compressed salary structure will need to be preceded by a substantial exercise to shed large numbers of excess staff currently employed by NRB. Such an exercise will probably require donor support and will need to be carried out on a voluntary basis to ensure union "buy-in". Finally, new human resource policies will need to be implemented which focus on merit based advancement through the institution - and a move away from the current system of "time in grade" advancement. It is only with a radical chance in HR policies, the implementation of a Voluntary Retirement Scheme (VRS), and a decompression of the salary structure, that NRB can expect to become a fully professional institution.
Other Important Issues. In addition, and in conjunction with the reforms envisaged above, it.is important to improve the functioning of the Credit Information Bureau to provide more comprehensive and easily available information about.borrowers in Nepal; the Banker's Training 23
Institute to provide for better training for participants in the financial sector; and the Banker's Association. Lastly, there is also a need to strengthen financial journalism in Nepal so that the general public is provided with better, more up-to-date, and insightful infonrnation on developments within the sector.
7. Recommendations Nepal's financial sector and its problems have been the topic of numerous discussions between the government, the donor community, (most particularly, the IMF, Asian Developmnent Bank, World Bank, DflD) and private organizations. In recognition of the fact that much needs to be done towards the establishment of an effective financial sector and to consolidate the progress already made during the 1990s, Nepal Rastra Bank issued a Financial Sector Strategy Statement (FSSS) in 2000 (see Annex Two) - laying out its vision for the future of the sector. The Financial Sector Strategy Statement provides a blue print for reform and has clearly identified the following priority areas to be addressed:
* Implement restructuring plans for the financially-troubled large banks.
* Strengthen the legal and regulatory framework covering the financial sector.
* Strengthen NRB and its supervisory function.
* Improve regulation of non-bank deposit taking institutions.
* Strengthen the legislative and institutional framework for loan recovery.
This has been a positive development and one that is necessary for reviving the health of the financial sector. Of great importance to this effort will be the further elaboration - in terms of concrete steps (including a timeframe) - for the implementation of this strategy. The following recommendations further complement the FSSS by pinpointing particular areas that should be addressed as part of the reform effort:
(a) Remove direct participation by Nepal Rastra Bank - and the Government -- from the financial sector.
(b) NRB should also rapidly move to shed its development banking functions.
(c) Privatization of the banks, occasioned by a withdrawal of the government and NRB from these institutions, should be carried out with the twin objectives of attracting strategic investors who will strengthen the institutions and increasing competition in the financial sector.
(d) Where appropriate, liquidation of bankrupt state-owned banks should also be seriously considered - particularly where successful restructuring appears to be unlikely.
(e) Strengthen the financial legal framework to create less fragmentation, and enhance transparency in the sector.
(f) Undertake a human resource reengineering exercise within NRB - including the implementation of a VRS, complete revision of existing HR policies, and a de- 24
compression of the salary structure - to encourage the development of professionalism within the bank.
(g) Replace the support of rural and micro-credit schemes using directed credit and other mandatory requirements imposed on commercial banks with more targeted and market oriented measures.
(h) Remove restrictions on foreign ownership of commercial banks to encourage the greater transfer of technology and to create enhanced competition.
(i) Establish a second tier supervisory body for micro-finance activities.
(j) Introduce internationally acceptable accounting and auditing standards.
(k) Improve the functioning of the Credit Information Bureau to provide more accurate borrower information for financial sector participants.
(I) Close cooperation and collaboration with the main donors will be critical in ensuring that the reforms, based on the NRB's Financial Sector Strategy Statement, issued in 2000, are successfully implemented. 25
CHAPTER TWO Legal Financial Environment 1. Introduction The legal system of Nepal has undergone significant change in recent years. Although the common law foundation remains, unlike other common law countries, it does not have a comprehensive set of laws or legal mechanism for the effective functioning of the corporate sector. In addition, the largely ineffectual Indian models have heavily influenced its legislation. The Government, supported by the donor community, has been introducing new legislation to fill the vacuum - and the process is ongoing.
The Nepal banking sector consists of commercial banks, finance companies, merchant banks, and development banks, cooperatives and non-governmental organizations (NGOs) that have been licensed to undertake banking business. The Commercial Bank Act 1974 (CBA) governs the banks, the Finance Companies Act 1985 (FCA) governs the finance companies and merchant banks, the Development Bank Act 1996 (DBA) governs development banks, and the Financial Intermediary Act 1998 (FIA) governs the NGOs. The Nepal Rastra Bank (NRB) is the licensing and supervisory authority under these laws and it was, in turn governed by the Nepal Rastra Bank Act 1955 - until January 2002 when a new, modern Act was promulgated. Apart from these laws related to the banking sector, the Insurance Act of 1992 and the Stock Exchange regulations also govern the financial sector. 2. Nepal Rastra Bank Act 1955 This 45-year-old law that had been amended intermittently over the years, was revamped and replaced with a new law in 2002. The previous law was essentially designed for a central bank in a government-controlled economy with a bank supervisor to supervise government-owned banks. Hence the structure, architecture and legislative framework of the NRB Act was ill-suited for a complex and modern central bank and banking system. It did not bestow sufficient powers for effective management of monetary policy, improving financial infrastructure, strengthening and improving financial markets and their supervision, and facilitating the growth of the financial sector. The major deficiencies addressed by the new law are outlined below.
Objectives and payment system. The previous law did not state the objectives of the bank. Generally, objectives should be unequivocally stated and prioritized in the law as it helps to monitor the performance of the central bank. In addition, since there is an intimate relationship between the efficiency and soundness of the payment system and soundness of the banking system, an explicit provision in the law empowering NRB to regulate the payment and settlement system was also needed. The new law addresses both these issues.
Autonomy. Under the previous law, NRB was not autonomous legally or operationally. His Majesty's Government could issue directives with which NRB had to comply as long as it was considered to be in the national interest. In addition, the Governor, Deputy Governors and Board Members could be retired by the Government if circumstances warrant. The Government also had absolute power to suspend the Board of NRB if it was of the opinion that NRB was unable to carry out its functions. The new law provides for an autonomous central bank answerable to Parliament and the members of the Board are appointed by the Government upon the recommendation of a specially constituted committee. Removal of Board members has to follow 26 due process and the new law also provides for a mechanism for coordination between the government and the central bank.
Governance. The previous law did not provide for rules for declaration of interest and avoidance of conflict of interest by Board members and bank employees. There was also no proper disclosure, transparency and consistency requirements in the activities of the central bank. The law was also silent on the decision making process at the Governor level. The new law states clearly the rules on conflict, the powers and duties of the Board and governor, the establishment of a management committee and an independent audit committee appointed by the Board and answerable to the Board.
Lending to Government This is an important issue that determines the ability of the central bank to ensure domestic price stability and the old law placed no control over the lending amount and the duration within which such loans must be repaid. Section 75 of the new law caps the lending to secured lending of 10 percent and for a duration of 180 days. This is an important improvement over the old law.
Regulation of Financial Institutions. The underlying rationale for the old law to regulate the financial system in Nepal was unclear. Various institutions were brought under the purview of the law without a clear delineation of the types of power that can be exercised over them. The new law provides clearer powers to NRB to license, regulate and supervise banks and other similar deposit taking institutions. Powers to supervise and specific powers to deal effectively with troubled bank has also been provided under the new law to address the inadequacy in the existing Commercial Banking Act of 1974.
Regulatory Burden of NRB. Notwithstanding the new law, NRB is overburdened with regulatory authority under various laws - banks, finance companies, merchant banks, deposit- taking cooperatives, development banks, regional development banks, financial intermediaries, deposit-taking NGOs, and money changers, despite its limited ability to effectively supervise even the commercial banking component of the financial system. Hopefully this will be rationalized when the new banking law is promulgated. Furthermore, since NRB has limited resources, the regulation of micro-finance institutions needs to be brought within another regime of supervision. This is justified as micro finance has only a very small share of the financial system and has limited real impact on the soundness and safety of the banking system.
Lending to specified sectors. The new law, in section 81 empowers NRB to issue directives to commercial banks and financial institutions to provide credit to sectors prescribed by NRB. Though this may not be ideal for a competitive banking sector, it not as damaging as directed lending.
Lender of Last Resort. Section 23 of the old NRB Act was too broad as it empowered NRB to grant loans and advances to banks, finance companies and other financial institutions liberally and without collateral. The current law does not contain specific provisions on the power of NRB to act as lender of last resort. However, section 86 of the new law grants general power to NRB to take actions that are deemed necessary in the case of a troubled bank.
Exchange Policy, International Reserves and Foreign Exchange Operations. The old Act was not clear on these aspects of the law. The new law specifies the role of the central bank and that of the Government in foreign exchange policy, e.g., who decides on the country's exchange regime, who determines the exchange rate, and who is responsible for foreign exchange operations and reserves management. 27
Developmental Role of the Central Bank. Although central banks in developing countries are repositories of expertise and finance and are relied on to carry-out many of the govemment's economic development aspirations, these must be limited to the development of the financial sector. The mandate and powers given to the NRB under the old law diffused the focus of the bank - which should be price stability and maintaining a sound financial system. The new law paves the path for the govemment to be weaned off this dependence.
Deposit Liability. The old Act also permitted bailouts of financial institutions and amounted to explicit government guarantees to depositor funds. The new law has rectified this. However, it does not address the guarantee under the Financial Intermediary Act. NRB is still required to assume the deposit liabilities of those institutions under the Financial Intermediary Act. This provision requires further review.
Accounts and Audit. Chapter 10 of the new law states the requirements for a proper accounting system within the NRB, the use of intemational accounting standards, the auditing of aLccounts by extemal auditors in addition to govemment auditor, and the submission of the annual report to the Govemment.
Overall Comment. The new law provides a comprehensive framework for a modem and progressive central bank law. It has also addressed most of the deficiencies in the old law. The framework is empowering, forward looking and will certainly help to strengthen NRB and improve its ability to become an effective central bank and bank supervisor. 3. Commercial Banking Act 1974 The banking sector is currently beset with numerous problems, caused in large measure by the unhealthy and ubiquitous presence of the Govemment in almost every sphere of financial sector activity. Instead of providing oversight and regulatory control, the Govemment plays an active role as owner and participant in the sector. This in turn impedes Nepal Rastra Bank's ability to properly discharge its supervisory role. In addition, the existing limitations on foreign ownership of banks has not attracted foreign banks, particularly "good name" banks, that could have fostered technology and know-how transfers beneficial to the sector.
Banks are generally poorly managed due to weak governance and lack of enforcernent. The system also suffers from cross ownership of financial institutions without proper regulatory control, lack of transparency and disclosure requirements, weak corporate governance, poor accounting and auditing standards, weak central bank supervision, and a problematic debt recovery system. These problems have been compounded by large gaps in the existing Commercial Bank Act (1974). Details of the major weaknesses are listed below.
Poor Definition. There is insufficient precision in the definition of a bank within the CBA. A clear definition of a bank, as an entity engaged in the business of accepting deposits from the public and using such funds either to make extensions of credit or investments, needs to be included. Further, the law needs to differentiate the supervision and regulation of banks and similar institutions, from other depository institutions. There is also a lack of clearly defined criteria for applications for licensing, branching, capital increases, or mergers. Excessive interference by the NRB and govemment is provided for in bank management prerogatives regarding branching, collateral, interest rates, and subsidiaries, causing inordinate delays in approvals and inconsistent decisions. 28
Prompt Corrective Action and Remedial Powers. NRB also has insufficient powers to undertake appropriate measures necessary to address infractions of laws or regulations. The law only provides for the cancellation of a banking license - which is a protracted and ineffective means of taking corrective action or imposing sanctions on errant banks. There are also inadequate provisions for addressing bank insolvency in the law. Gradual enforcement provisions in the law are needed to address regulatory violations, apart from strengthening NRB's ability to take enforcement actions in a timely manner. In addition, provisions for dealing with depository institutions with insolvency problems, including procedures for dissolving such institutions, must be included in the law.
Governance. The provisions related to governance of banks and other depository institutions with respect to NRB intervention in bank management, NRB approval of directors, credit documentation requirements, and risk management is not comprehensive in the law. Auditing requirements in the law need to be reinforced with comprehensive provisions. The existing legal framework for institutions that are not licensed as banks but still take deposits from the public also needs to be replaced. The law needs to stipulate that banks maintain their accounts in accordance with International Accounting Standards and be audited by independent external auditors.
Ownership/Mergers/Deposit Protection. Cross ownership of banks and cross directorships should be expressly prohibited in the law to avoid monopoly and misrepresentation of capital. A progressive banking law also needs to have, inter-alia, a mechanism for the reconstruction, amalgamation and takeover of banks that is expedient and cost effective. These provisions should include a short cut for take-over through court sanction and vesting order that circumvents administrative procedures and costs without compromising the interests of concerned parties. Such powers have been effectively used in other countries with a similar legal tradition and have proved to be an effective tool, especially in dealing with the restructuring of banks. Another area of concern is the safety net and depositor protection. In the absence of a deposit insurance scheme and the absence of specific provisions on speedy winding-up of banks, it may be appropriate for the law to grant priority - in the event of a liquidation - to household deposits.
Enforcement. A serious issue for the banking system is the lack of compliance by the two largest, majority government owned banks, Rastriya Banijya Bank (RBB) and Nepal Bank Limited. The NRB has been unable to effectively sanction the banks or take appropriate remedial action. The relative power of the government banks, their excessive politicization, the relationship between the central bank and the Ministry of Finance, and the weakness of the supervisory function within NRB, all impede NRB from taking action to resolve the problems in these banks. In addition, the 1974 Commercial Banking Act is outdated and does not provide an effective legislative framework for proper regulation and supervision of the banking system. The new Nepal Rastra Bank will be a major improvement on the current situation.
New Law. Prudential supervision in Nepal has not been effective under the existing legal regime, and will not be effective under the current system where a number of depository institutions are operating. There is clearly a need for new legislation aimed at strengthening the banking system. The new law should encourage and enhance competition in the financial sector by reducing restrictions on activities or mergers between different types of financial institutions. It should also limit the regulatory and supervisory burden of NRB to systemically important institutions based on their link to the payments system (banks) or size (other depositories). The new law should also seek to strengthen corporate governance and discipline by the market - the two other means by which depository institutions can be encouraged to maintain their solvency, liquidity and profitability. A new draft Banking and Financial Institutions Act, drafted by Nepal 29
Rastra Bank with assistance from the IMF and IDA, is currently ready to go before Parliament for its consideration.
Tiered Regulation. Banks and other significant depositories should be subject to comprehensive supervision and regulation in accordance with international best practices. Less significant depositories, however, should be subject to less comprehensive supervision and regulation i.e., licensing; stringent governance requirements; general prudential requirements; international accounting standards; publication of quarterly balance sheets and income statements; external audit; requirement to issue debt securities for market discipline; and a range of sanctions. Less significant depository institutions should not be required to obtain prior approval for mergers and acquisitions (unless with banks) or to have special risk management committees. Neithier should they be required to maintain specific balance sheet ratios (other than for capital and credit), to submit monthly returns, or be subject to prompt corrective action procedures narrowly defined. They should also not be subject to special trusteeship procedures in the Act for insolvency. The new draft banking and financial institution law should ensure that these important concerns are appropriately and adequately addressed. 4. Development Banks The Development Bank Act of 1996 provides for the establishment of financial institutions that have the mandate to operate in a more relaxed financial framework than the commercial banks. The banking functions of these development banks are limited to specific types of development activity to be undertaken in specified regions. The Rural Development Banks are registered under this act - which provides for regulation by NRB. It is an interesting anomaly, however, that the two largest development banks - NIDC and ADBN - are not subject to this laEw and are governed by the statutes under which they were incorporated. Consequently, in reality, these two banks are carrying on banking business without being subject to either the Developrnent Bank Act or the Commercial Banking Law. It is imperative that the regulatory arbitrage being enjoyed by these two institutions be removed and they be brought under the purview of the Commercial Banking Act as they are carrying out commercial banking activities. 5. Micro-Finance and Deposit-Taking NGOs There are no specific regulations that apply to MFIs in Nepal and, until recently, there was no single act that was pertinent to micro-finance. Instead, one or more Acts govern all institutions that are engaged in micro-finance in Nepal. Cooperatives operate under the Cooperative Act 1959 while some are licensed by the NRB for deposit taking under the NRB Act. NGOs operate under the Society Registration Act 1978, the Social Welfare Act 1991 and a few are licensed for deposit taking under the NRB Act. The degree of regulation for licensed non-bank MFIs is much lower than for banks. Since NGOs have no share capital they face no capital adequacy requirements but are directed by the NRB to limit their loans to less than NR 100,000 (IUS$1,440) per individual. They are also required to build a reserve fund through an allocation of l0 per cent of their operating profit, as a provision for loan loss. Licensed cooperatives have a minimum capital requirement for opening branches. In common with banks, they must maintain a capital adequacy ratio of 8 per cent of risk-weighted average assets. No liquidity requirements have been fixed by the NRB for NGOs involved in micro-finance. However, licensed cooperatives, such as finance companies, are nominally not allowed to collect deposits exceeding ten times their share capital.
Loan Classification Reporting Requirements. While licensed NGOs are required to create a reserve fund for loan losses consisting of 10 per cent of their profits, cooperatives have more 30 stringent loan classification and provisioning norms than even the commercial banks. NGOs and cooperatives licensed by the NRB to accept deposits and carry out limited banking activity are all obliged to submit data on their financial operations to NRB. Through instructions issued from time to time, NRB requests institutions engaged in micro-finance to submit details on loan terms and conditions, interest rates, deposit terms, balance sheet and profit and loss statements, portfolio and outreach, and loan repayment and arrears.
Auditing, Supervision and Rating. NRB also certifies auditors who audit the accounts of licensed cooperatives and specifies those who may audit NGOs. However, supervision of licensed MFIs by the Inspection and Supervision Department of NRB remains random and perfunctory at best. At worst, it is so lax as to be virtually non-existent. In this situation, the licensing of the MFIs becomes a precaution for the more responsible NGOs and a means of deluding the general public in the case of some of the cooperatives. The latter use this as a device to mobilize deposits.
NRB's Role. With its over-stretched capacity the NRB would do well to focus on the effective prudential regulation and supervision of banks and finance companies and lay down only general prudential guidelines for micro finance institutions. Performance standards, rating and other initiatives to introduce 'best practices' and supervision ought to be left to professional organizations and possibly a second tier supervisory institution. 6. The Financial Intermediary Act 1998 The Financial Intermediary Societies Act, 1998 (FIA) provides for all NGOs engaged in micro- credit to be registered with and regulated by the NRB. Rastra Bank has the power to demand information, data or other documents that it considers necessary as part of its monitoring role. It also provides for "the final obligation to meet such financial liability relating to the financial inter-mediation of the Society as cannot be met from the Society's assets [to] vest in the Bank." At the same time, the Act is silent on the issue of deposit taking/savings mobilization from members or non-members by such societies. This has been interpreted by the NRB's legal department as a ban on deposit taking by all societies registered under the Act. Thus, the FIA has not really been a tool for facilitating micro-finance.
Salient Issues. Under this Act, the NRB is empowered to issue, cancel and renew licenses, and recover its on-lent loans when NGOs are closed down. This Act prescribes accounting practices for licensed organizations and requires them to create a risk-bearing fund as a provision for possible loan losses. Another provision of this Act gives NRB the power to prescribe the level of administrative expenses to be incurred. The NRB also retains powers to issue directives to protect the interests of the ultimate borrowers if it finds, during investigation, that the licensed organization has taken some action that adversely impacts its borrowers or is misappropriating funds.
NRB's Role. It is clear that NRB has been called upon to play an important role in the promotion of micro-finance and the development of systems for regulating and monitoring institutions in the micro-finance sector. However, considerable efforts and resources are required to implement the provisions of the Act - resources that the NRB does not have. Consequently, it is unable to discharge these responsibilities properly. Moreover, there are flaws in the Financial Intermediary Societies Act, 1998 that urgently need to be corrected. Only when these are appropriately addressed will there be the envisaged legal basis for the orderly conduct of micro-finance business in Nepal. 31
7. Company Law It is well established that an adequate legal foundation is necessary to provide the essential underpinning to the development of the financial, commercial and industrial sectors. Without such an underpinning the development of a market economy is severely prejudiced. There is a general consensus amongst Nepali stakeholders and a number of international consultants, that the present Companies Act of Nepal ("the Companies Act") falls short of what is required for an effective regulatory regime. The Act suffers from a number of serious shortcomings, both in terms of what is contained in the Act and what is omitted.
Governance. The Companies Act is critically deficient in the area of corporate governance including, the separation of ownership (shareholders) and control (management board) in relation to a company and the protection of shareholder rights. In addition, the equitable treatment of all shareholders and the recognition of the rights of shareholders are absent. In addition, the board's accountability to the company and to shareholders and the requirement for the provision of timely and accurate information on all matters regarding the company is deficient.
Directors' Duties. Directors' basic duties - namely their fiduciary duties (i.e. to act honestly and in good faith and in the best interests of their company), and duties of skill and care -- need to be expressly covered in the Companies Act. Apart from that, specific provisions including declaration of interest in contracts, restraints on directors' remuneration, approval and/or disclosure of substantial property transactions, disclosure of holdings and dealings by directors, loans to directors, etc. need to be clearly defined to help regulate potential areas of abu,se.
Accounting Standards. Nepal needs to promulgate accounting and auditing requirements based on International Accounting Standards and International Auditing Standards. The Cornpanies Act should then require companies to prepare their accounts in conformity with the prescribed accounting standards.
Insider Dealing. Insider dealing is a serious but common form of market abuse in Nepal. The Companies Act does not cover insider dealing, as such, and only deals with it indirectly through a prohibition against directors and other related individuals dealing in their company's shares. This provision is defective, and does not grasp the fundamentals of insider dealing. The Securities Exchange Act attempts to deal with insider dealing but its provisions in this context are also unsatisfactory and ineffective. There is however a new draft Securities Act (developed under the auspices of the ADB) which contains satisfactory provisions to counter insider dealing. If this draft proceeds through to enactment, then the matter will be adequately covered; if however it does not, appropriate provision to counter insider dealing should be incorporated into a revised Companies Act.
Submission of Information. The Companies Act makes no provision for the use c,f electronic information technology either by companies or by the Registrar. In accordance with modrem business practice, the Registrar and companies should be permitted to maintain their records in electronic or other non-documentary form, provided that a legible copy can be produced when required.
Foreign Companies with a place of business in Nepal (as opposed to companies mierely doing business in Nepal) should be required to register with the Registrar the name and address of a person in Nepal who is authorized to accept service on behalf of the company. 32
Major Policy Issues. The Companies Act (the Registrar) and the Securities Exchange Act (SEBO) both presently regulate prospectuses for the public issue of securities. This overlapping jurisdiction involves unnecessary expense and delay. The approval of prospectuses should fall within the exclusive domain of SEBO, but with a requirement on the issuer to file a copy of the SEBO approved prospectus with the Registrar of Companies - for public access.
Disclosure Requirements. The compulsory preparation of annual audited accounts by a company, and their submission to shareholders, is a fundamental shareholder right. The Act should make clear, however, that the role of the Registrar with regard to their filing with the OCR is purely administrative and does not in any way imply "approval" by the Registrar. It is crucial that all companies (not just listed companies) be subject to a general disclosure obligation requiring them to inform shareholders of any major new developments. This includes any activity that is not public knowledge but whose information is necessary to enable shareholders to appraise their financial position, or which may materially affect the value of their securities. Similarly all major transactions, and inter-company transactions other than in the ordinary course of business, should be compulsorily disclosed to shareholders.
The Company Board. The company board is currently tasked by the Companies Act with two disparate functions - an advisory function AND a function of hearing and determining minor offences. It is recommended that the Company Board should be confined to playing an advisory role - or alternatively be completely abolished.
Registrar/Enforcement The office of Registrar is tasked with a very disparate group of functions (approval, registration, liquidation and enforcement) by the Companies Act. It is not, however, charged with the administration or enforcement of the Act. The powers of the Registrar under the Companies Act are reasonably comprehensive and adequate. Thus, the failure of the Office of the Registrar lies not in the inadequacy of its powers, but in its inability or unwillingness to enforce them. It is imperative that a revamped and professional Office of the Registrar be made statutorily responsible for the administration and enforcement of a revised and strengthened Companies Act. The Registrar's powers also need to be enhanced by the creation of automatic fixed civil penalties. He/she (or shareholder or creditor) should have the power to apply to the court for an order directing a company and its representatives to make good any default (and condemning them in costs). This needs to be coupled with a power for the court to disqualify a director in an appropriate case. The ADB is currently providing technical assistance to redraft the Companies Act and it is desirable that the issues discussed here should be addressed in this re-drafting exercise. 8. Insolvency and Liquidation An efficient insolvency law, along with efficient debt collection and security enforcement laws, helps to reinforce the responsible financial management of a corporation. If a corporation is in financial difficulty, the directors should be forced to take positive steps to deal with the problem or else suffer the consequence of action by creditors to enforce payment, to enforce securities or to liquidate the company. Both domestic and foreign investment is encouraged by the existence of an adequate corporate insolvency law regime. Lenders and investors need certainty and predictability and a good insolvency regime goes a long way in providing this. Thus, an adequate law for dealing with an insolvent corporation is important. Insolvent corporations should not be permitted to continue to trade without supervision, since it is highly likely that debts will increase or assets will be reduced. In either case, creditors of the corporation will be prejudiced. Furthermore, if there is inadequate or no laws to deal with insolvent corporations, corporate laws and regulations will lose their credibility and become ineffectual. In addition, the important goal 33 of proper corporate governance will be eroded if the management of an insolvent corporation is not required to take a responsible attitude toward the payment of corporate debts.
Current Insolvency Regime. The existing insolvency law is inadequate to deal with the insolvency of such corporate business enterprises. There is neither comprehensive rules nor adequate skills in the office of the Registrar of Companies to effectively deal with insolvency. There is also a clear need for a more adequate law in Nepal to cover personal or individual insolvency. The existing law in that regard, which is part of the Legal Code (or Muluki Ain), is out of date, inefficient and largely ineffective (there have been very few instances of the employment of this law). There is a proposal that liquidation be covered in a new discrete Insolvency Act, or in a redrafted Chapter 10 of the Companies Act. It is crucial that all forms of corporate liquidation, whether compulsory or voluntary, be covered in the same legislation. In this regard, it is noteworthy that bank insolvency is being addressed in the new Banking and Financial Institutions Law. 9. Securities Regulation The stock market that was established with the help of IRIS in 1994 is far from dynamic. Some of the major problems experienced by the securities markets include a lack of timely and transparent financial reporting and non performance of due diligence requirements prior to issuance of new listings. This is a direct result of, amongst other things, poor regulatory and supervisory control by the Securities Board and the Nepal Stock Exchange (SEBO). There have been frequent cases of infractions of rules going unpunished. Other issues, such as problems with insider trading and manipulation of markets, arise due to a lack of an effective law prohibiting such abuses, and due to ineffective enforcement of existing laws. A notable example of such weakness in the current law is the penalty of forfeiture of shares for traders who unfairly exploit their positions. This is an insufficient deterrent. Another serious deficiency in the capiital market is the complete absence of legal provisions regulating corporate commercial paper and municipal bonds. Much needs to be done to support the growth of the capital market - including, most fundamentally, the development of a more effective and comprehensive set of laws. 10. Debt Recovery Debt recovery is presently neither effective nor expedient. The court system suffers from inordinate delays and enforcement of judgment is a serious problem for banks in the process of recovery. To address this, the NRB has proposed the establishment of a debt recovery tribunal through a Debt Recovery Act, that is expected to speed up recovery of the debts owed to banks. The draft law has been modeled along the Debt Recovery Act 1993 of India, which is more substantive than the Nepal version and which has undergone significant change since 1993. The proposed law purports to establish a parallel court system to handle the debt recovery cases of financial institutions. The rationale for the new law is not entirely clear as, according to the banks, Section 47A of the Bank Companies Act 1993 has been effective in dealing with debt recovery. Section 47A, however, is not applicable to cases where collateral is not involved.
Section 47A. The Commercial Bank Act confers considerable power and privilege to a commercial bank regarding enforcement of a security. A commercial bank is afforded a power of 'self help' enforcement. Upon default by a customer in the repayment of a loan, the bank can sell any secured property and the bank does not have to obtain a court order. Further, in relation to secured property to which a registration and transfer recording system applies (for example, land), the legislation affords the bank the power to inform the appropriate office of a sale and such office is then required to record the transfer and consequent change in the registration 34 particulars. If a commercial bank is not able to sell the secured property it may require the relevant registration office to record a transfer of the property to the bank. Similar provisions are contained in the Finance Companies Act, 1986 and in the Development Bank Act, 1996.
Comment. As of now, the proposed new law would only serve the narrow category of debt recovery cases where there is no collateral. However, experiences show that a debt recovery tribunal law can definitely assist in expediting recovery, provided the procedures in the law are simple and there is sufficient funding. To complement such efforts, judges and lawyers should be trained in the new law and appropriate infrastructure - buildings, equipment, personnel and enforcement mechanisms - must be established. A more viable alternative, however, would be to create a banking bench (after providing necessary training to selected judges) in the High Court to deal exclusively with debt recovery cases related to banks. In addition, measures need to be taken to introduce arbitration and alternate dispute resolution mechanisms in Nepal, thus expanding the range of legal avenues for banks to recover loans and resolve banking disputes. 11. Secured Transactions A properly constructed secured transaction regime that makes available property as security or collateral for credit is vital for economic development. It provides for a relatively 'safe' form of financing. In doing so it will help increase the availability of credit to a wider range of individuals and generally make more finance available. It will also lessen the cost (interest charges) of finance, and improve the conditions under which finance will be made available (for example, the length of a loan, conditions of default and so forth).
Registration/Notice System in NepaL There is no system for the registration of movable property as security in Nepal. This is probably because of the almost total dependence on the possessory form of security. Registration of such a security is of little consequence since the fact of possession of the property by the creditor usually provides the needed protection. A non-bank lender who holds security is required to obtain a court order for the sale of the security and to conduct a sale of the property through the agencies of the state. This is an inefficient, time consuming and costly process.
Another relevant issue concerns differences in the enforcement of a possessory and a non- possessory security and how a modern secured transactions regime might lessen those differences. The possessory type of security provides the creditor with possession of the secured property and, thus, facilitates the enforcement of the security. The creditor does not have to take steps or action to obtain possession of the property when enforcement commences. In contrast, the enforcement of a non-possessory security requires that the creditor obtain possession of the security property as a first step toward its sale. That can be difficult. A modem secured transactions legal regime can, however, assist in overcoming these difficulties.
A final aspect of enforcement concerns protection of the debtor. Enforcement is a powerful remedy and a debtor requires some protection against possible abuse of the process. A balanced enforcement regime would require that notice of enforcement be given to a debtor and that any sale of the secured property be conducted in such a way as to ensure that a fair market price is obtained for the property. An efficient, but fair and balanced, enforcement regime should be the third aim of a secured transactions legal regime in Nepal.
Current Developments. With the technical assistance of ADB, the government is taking necessary steps to introduce a comprehensive secured transactions legal regime. 35
12. General Implementation and Enforcement There is also a real need for the regulator of the banks, the insurance industry, the capital market and others to strictly apply and enforce the laws. In the absence of proper application and enforcement, laws serve a limited role in the regulation of a market. Hence, transparent and consistent application of the laws and regulations, observance of the procedures laid out in the law, exercise of discretion within the powers of the law, and vigilant monitoring and enforcement of the laws are important for inculcating a regulatory discipline into the market. This discipline will, in the long run, pave the way toward self-regulation. Given the administrative and institutional difficulties in imposing sanctions and prosecuting serious offenders, the concept of compounding offences can be introduced in the laws with sufficient procedures and safeguards. This alternative method has helped other countries in enforcing the law and meting out appropriate sanctions for non-compliance expediently and effectively.
13. Recommendations A strong legal framework is the most important foundation for development of a healthy financial sector but its main strength lies in its enforcement. Nepal needs to clearly establish the business that can be conducted by the various financial institutions, demarcate clearly the authority of regulators, and the jurisdiction of the laws - to avoid duplication and vacuum in the financial sector regulatory framework. It must also improve the adequacy of bank exit frameworks and policies and the institutional/legal framework for corporate bankruptcy, corporate restructuring, loan recovery, corporate governance incentives and practices, court systems and procedures and other general factors affecting access to credit. Regulators must be given sufficient legal and operational autonomy so that they can perform their roles well. Policy certainty and vigilant implementation and enforcement of transparent rules are essential to the statbility and development of the financial sector.
The following are the main recommendations of this chapter:
(a) The various acts under formulation need to be enacted as soon as possible, addressing the issues raised above. They then need to be followed up with proper enforcement.
(b) NRB needs to develop a tiered regulation system in line with international best practices.
(c) All development banks must be brought under the purview of the new Banking and Financial Institutions Act.
(d) The Financial Intermediary Societies Act, 1998, should be amended to address the existing flaws that have made it ineffective.
(e) The current insolvency laws need to be strengthened in dealing with both non-corporate bodies and individuals.
(f) As the financial reform process moves forward, and the legal/judicial system starts to deal with a large case load of defaulting borrowers within the banking system - the court system will almost certainly emerge as a significant bottleneck. Hence, a bankcing bench should be established in the high court to deal exclusively with debt recovery cases related to banks.
(g) Arbitration and alternative dispute resolution mechanisms, to increase legal avenues for loan recovery and banking disputes, should be expanded. 36
1 (h) There is a need for improvement in the enforcement of laws. The concept of compounding offences could be considered for improving enforcement. 37
CHAPTER THREE Baniking Supervision 1. Introduction Underdevelopment of the financial sector infrastructure, along with excessive government intervention, has not supported the creation of a credible supervisory function in Nepal. External analysis based on international standards has confirmed that the two largest banks, Rastriya Banijya Bank (RBB) and Nepal Bank Limited (NBL), are technically bankrupt, clearly demonstrating the need for improved financial sector - and particularly bank - supervision.
For many years, the Nepalese Authorities have used the banking system as a major conduit for administering their development strategy. Although the market has been opened to foreign banks, this government policy has been essentially maintained, leading to the development of a largely inefficient banking industry.
Currently, the banking sector is characterized by a broad range of institutions, scattered across the country, and a high concentration of banking assets in a few urban banks that are largely owned or controlled by the Government. Debt and equity markets, that companies could rely on to finance large projects and development, are not sufficiently deep, nor efficient to support long term business development. 2. Regulatory, Supervisory and Other Issues Fragmentation. A major outcome of the financial reform process, that began in the mid-I 980s, was the emergence of joint-venture banks which brought modern and efficient banking techniques to Nepal. The reform also resulted in the growth of a diversified group of deposit- taking institutions, not all of which are licensed by the central bank (see Box 3. 1).
Box 3.1. Deposit-Taking Institutions in Nepal
Public Private Private Nepalese Joint-Ventures Licensed by NRB Commercial Banks 2 4 9 Finance Companies 48 Development Banks 2 Micro-Finance Institutions Regional Rural Development Banks 5 8 Savings and Credit Cooperatives 35 NGOs 13 Not Licensed by NRB Postal Savings Bank I Micro-Finance Institutions Cooperative Societies 1,575 Community-based Organizations 25,000
This expansion does not appear to be the result of a deliberate strategy. Indeed, the banking sector operates under seven different laws and suffers from an excessive segmentation that is not conducive to the development of sound competition across the country. Apart frorn the two 38 largest commercial banks, NBL and RBB, most institutions offer banking services which are restricted to some regions or limited in scope. Commercial banks essentially finance industry and trade businesses with short and medium term credits. Joint ventures" and other private banks, as well as finance companies, operate in urban areas where most of the Kingdom's business is conducted, whereas development banks and micro-finance institutions generally provide services in a limited number of rural localities or districts. The two largest banks account for around 60 percent of all deposit and lending operations.
Poor Banking Culture. A good banking culture is almost non-existent in Nepal. Prudential regulations do not require banks to define credit policies and procedures - and only a minority of banks have established satisfactory internal guidelines. Some banks are unable to provide financial statements and those that can frequently produce un-audited data - even though banks and finance companies are required to be audited annually by external auditors selected at annual general assemblies. Moreover, the Registrar of Companies is lax in requiring financial statement filing, and accessing filed statements is difficult. Due to problems of tax evasion, these figures are largely unreliable and banks reconstruct corporate accounts on the basis of client estimates. Even if some kind of financial analysis is made, credit is not extended on the basis of creditworthiness but relies heavily, instead, upon collateral. Primary collateral is always requested and, as required, secondary collateral or guarantees'2 , the value of which is assessed informally and not regularly re-evaluated. Banks are prohibited from extending credit to customers that have been black listed by the Credit Information Bureau. However, the CIB, established as a joint entity by NRB and the Bankers' Association, is not fully functional as the two largest banks do not, or are not able to, provide it with requisite data.
Loan classification and provisioning has been extremely lenient'3, as were income recognition rules that permit banks to record income on Government guaranteed non-performing loans. The legal framework for land records and bankruptcy is also inadequate. Court action against defaulters tends to be delayed and asset liquidation is rarely successful. As a result, an international audit review of NBL and RBB's July 1999 accounts confirmed that the two banks - which represent more than 50 percent of the banking assets of the country - were "technically" bankrupt and have no internal capability, nor resources to redress the situation. These problems have long been a systemic issue: real interest rate and margins spreads have been maintained at high levels to cover high operating costs and large losses, while private banks are able to follow their lead and record substantial profits. Consequently, private banks (including well managed ones) have not been forced to compete for more customers or expand their activities outside a few main cities.
Excessive Government Involvement. Development priorities are reflected in many Government directives. Access to banking services in rural areas remains a concern of the authorities and commercial banks are required to open branches in rural districts whenever they expand their urban branch network. Traditionally, the state-owned or state-controlled banks maintained a large number of branches, but on-going security problems have forced the closure of more than a hundred units. Rural areas are also serviced by a large number of generally un-licensed and even un-registered small entities that collect deposits and provide loans with little professional capacity. Thus, promoters of cooperatives have taken advantage of this new situation to apply for banking licenses, liberally granted by the central bank or, even more freely, by the Ministry of Agriculture (under which they fall).
"Full foreign ownership of banks is still prohibited in Nepal. 12 NRB guidelines request banks to maintain files on loans over NR 10,000, except for advances extended against collateral. 13For example, loans overdue up to five years were classified as doubtful and provisioned at 50 percent, until recently. 39
Regulations also constrain bank operations - although some of these restrictions have been lessened with the reduction of the cash reserve ratio, the removal of the statutory liquidity ratio, and the newly authorized ability to maintain foreign exchange positions. Although deposit and credit interest rates are now substantially determined by market forces, limits on interest rate spreads have been set since 1999 and, since 1975, commercial banks have been obliged to finance priority'4 and deprived sectors'" of the economy.
Poor Governance and Transparency Procedures. Governance principles and transparency practices are almost non-existent, leading to many cases of conflict of interest. For example, the Government maintains close control over financial institution activity and management through its own direct ownership. The Government owns the largest commercial bank, andl the two national and five regional development banks, and appoints members to the boards of most commercial banks including, in most instances, the position of chairman. Even the NRB, the authority in charge of supervisory functions, funds some development bank activities and holds shares in several banks. In addition, several NRB officials, including some involved in banking supervision, hold positions on bank boards as Government representatives. Lastly, bank boards have no leading shareholder and most directors are not professional bankers. Cross-holding of bank shares is also a major concern, as is the reported practice of insider-trading or self-dealing.
Limited public awareness of the poor financial health of the banks has caused considerable moral hazard problems in the sector. Financial accounts and annual statements, when disclosed, are neither timely nor reliable, even if audited. Moreover, accounting and auditing practices in Nepal are not to international standards. In any case, even if information was reliable, timely and "best practice", the majority of the population has limited access to information, and a proper understanding of, financial issues. Some of this is reflected in the Nepal Stock Exchange's volatile prices which do not appear to reflect the true value of a company's capital and assets. The most striking example was seen in the NBL's rising stock price during the third quarter of 2000 when its net worth was negative - and publicly declared so - based upon the work of international auditors. Implicit in this is the speculators consideration that although no deposit insurance scheme is in place, a safety net will be provided by the central bank. However, the lender of last resort's function is neither restricted, nor even defined, in terms of scope and rules of intervention.
Weak Supervision of Banks. An assessment of Nepal's compliance with the Basel Core Principles for Effective Banking Supervision was conducted in June 1999. It concluded that NRB does not fully comply with two thirds of the criteria and is unable to fulfill its supiervisory mandate. Many weaknesses confront the central bank and inhibit management from taking action against problem banks even when they are extremely serious. Moreover, almost none of the preconditions required by the Basel Committee exist in Nepal, in terms of the legal fratmework and judicial procedures, accounting principles and auditing practices, market-based banking business, exit and crisis management policies, and deposit insurance and safety net schemes.
Although recent progress has been made in the definition of a regulatory framework and the implementation of banking supervision, the supervisory system remains largely ineffective. This disquieting conclusion was substantiated by weaknesses in all aspects of supervision: a leniently applied prudential legal and regulatory framework, insufficiently qualified staff; and poor organization, tools and equipment.
14 Guaranteed by the Deposit Insurance and Credit Guarantee Corporation. I5 12 percent of the outstanding portfolio for the priority sector of which 3 percent is targeted at the deprived sector. 40
An Inadequate Legal Base. The central bank is entrusted with regulating and supervising the banks and financial institutions in Nepal but, until recently, it had no autonomy from the Ministry of Finance. The legal system needs to provide protection to supervisors, operational independence and adequate resources for supervision. Past limitations in these areas have resulted in a general inability or reluctance to enforce corrective measures necessary to prevent and resolve banking problems. Moreover, most of the old regulations allowed long delays before action, did not define financial or legal penalties, and did not mandate specific actions to be undertaken by the banking authorities. New regulations, however, were issued in the first quarter of 2001 - and these have corrected the weaknesses in the old regulations by bestowing greater regulatory powers on the central bank.
An Inadequate Organizational Structure. The supervisory functions are shared among four units placed under two different deputy-governors within Nepal Rastra Bank. The Banking Operations Department (BOD) is in charge of issuing licenses to banks and financial institutions, defining and enacting prudential regulations, and collecting statistical financial data (33 staff). The Inspection and Supervision Department (ISD) is responsible for on-site inspection, follow-up of recommendations and enforcement of sanctions, and special inspection of banks and financial institutions. Each of these units was split into two Departments in 1999, one in charge of banks and the other, non-bank financial institutions. Staff in the six branches of NRB also contribute locally to the surveillance of small financial institutions. Cooperation among the four departments is poor, and requires improvement.
The procedure for bank licensing has been put on hold since 1996, but the number of new non- bank institutions is growing. Under political pressure, NRB has had to finally accept pending applications and it liberally grants licenses to local development banks in areas where commercial bank branches have been closed or do not operate. The Ministry of Agriculture also authorizes cooperatives to conduct some banking activities.
Limited Resources. Current supervisory practices are geared toward ensuring that NRB instructions are complied with by the banks. Until recently, many of the regulations had no prudential content, and instead addressed Government policy issues such as priority and deprived sector lending, maximum spreads, liquidity, and the cash reserve requirement. Risk management processes, notably with regard to foreign exchange, were lacking in the examination procedure and no rating system of commercial banks has yet been defined. In addition, very few computers are available in the bank supervision departments and the level of computer literacy is low.
Although the Government suspended new recruitment across the central bank, the banking supervision departments have been able to hire some new staff. In general, the staff policy does ensure the recruitment of quality staff, whose education profile is a good mix of MBAs, chartered accountants and economists. However, promotion is driven by seniority, appointment criteria are not on the basis of merit and competence, and the salary scale is tied to low public sector rates. These factors have contributed to low morale and poor performance.
The rotation policy of the central bank (inter-departmental transfers) is also counter-productive for this important activity which requires stability for officers to develop skills, master techniques, acquire experience, as well as foster commitment. Training is provided mainly by the Bankers' Training Center (BTC) that caters to the needs of the NRB and the commercial banks. Courses are mostly designed for the latter group. A South East Asian bank supervision training center (SEACEN) in Malaysia is used by about twelve staff per year, but not all of the trainees remain as bank supervisors. 41
Deficient Tools and Practices. Off-site surveillance does not exist as a specific function. Information reporting is not timely nor comprehensive enough to allow full analysis - while the integrity of the figures remains do'ubtful. Financial data are mainly compiled for statistical purposes and published in the Central Bank's Bulletin. Some monitoring is conducted by ISD for individual entities - but again, these are not normally for prudential purposes (but rather for monitoring the CRR, interest rate spread and priority, and deprived sector lending).
The regular bank reporting requirement to NRB include: reports on inter-bank treasury bill transactions and loans; weekly cash reserve requirement (CRR); monthly balance sheets, statements of loan and advances by purpose (notably priority and deprived sector lending), advances to public enterprises, deposits, foreign assets, and interest rate spreads; and six-monthly statements of overdue advances sector-wise, fixed deposits by amount, period and interest rates, and large exposures. However, major prudential ratios, such as capital adequacy, are only reported on a yearly basis and the collection of prudential reports is erratic 6. Most of these reports do not come in on time and, if collected, are not analyzed. There are no sanctions for late reporting and penalties for non-compliance with regulations are not enforced, except for the CRR'7 and directed lending. In the event of a problem, the bank is requested to provide additional information, basically to cross-check the figures, within a month. If the problem remains, a penalty is finally debited from its account with the NRB.
With the exception of some joint-venture banks, financial institutions in Nepal suffer from weak organization, lack of qualified staff, insufficient equipment, and ineffective credit management and monitoring procedures. The largest commercial and development banks do not consolidate their accounts and do not centralize their operations. For that reason, on-site examinations are conducted at branch or sub-branch level, a practice which does not provide a clear understanding of a bank's overall situation"8 . Moreover, given the physical environment, transportation logistics impose a heavy constraint on the bank supervisors. Private banks and financial institutions are meant to be inspected every two years on a global basis. Time lags between the examination reference date and the time of report issue is also excessive. Consequently, it is diffictilt for NRB to use the bank examiner's findings to substantiate sanctions for non-compliance. 3. Developing Banking Supervision Banks are supervised in order to achieve both long-term financial stability and sector efficiency. This is done through the promotion of safe and efficient banking practices and institutions - to support sound private business development and meet individual bank customer needs. A weak regulatory framework and poor supervision provide grounds for inefficient and unsafe banking practices, which increase the risk of bank failure. Preventing systemic risk, protecting small depositors, and containing financial crime are concrete steps in attaining these objectives. They require that the supervisor enforce fundamental discipline in the banking system with the support of well-crafted laws and regulations and the presence of strong in-house supervisory expertise.
Strengthening the Supervisory Framework. With the support of the World Bank, the International Monetary Fund, and other donors, the Government and the central bank have to face the dual challenge of building a supervisory function and human resource capacities within NRB, while simultaneously restructuring the two largest banks.
16 It has proven difficult, sometimes impossible, to determine if some prudential reports were received from the banks. 7 However, the weekly CRR reporting, as an example, is based on the averaged positions four weeks earlier, and the report is due 15 days after the period. 18 In 1999, the first consolidated examination of NBL took almost one year to complete. 42
Prioritizing. The thrust of initial efforts should be to build up capacities in banking supervision functions that give the Central Bank management confidence and motivation to take all actions required to establish - and then preserve - the banking system's stability and soundness. This should be done by building on existing central bank supervisory activities while upgrading both the regulatory framework and supervision organization and practices to international levels.
A related issue pertains to bank licensing. The existing supervisory capacity is being outstripped by a growing number and variety of financial institutions. It is important that the central bank apply stricter technical criteria when assessing applications for a bank or a non-bank license and before granting such licenses.
It is essential that priority is given to these efforts by NRB's management. One important element of this should be the cessation of the rapid rotation of staff between central bank departments - at least those in the banking supervision area.
Meeting Pre-Conditions. A program for strengthening banking supervision cannot be built in isolation and will not be successful if the preconditions for sound banking business do not exist. There is a need for IFIs, international NGOS and donors to continue programs that aim to streamline financial, corporate and commercial legislation; implement corporate governance principles; establish international accounting standards and audit practices; build institutional mechanisms and capacity in the judicial and law enforcement systems; improve infrastructure for payments and financial services delivery; and strengthen capital regulation and supervision.
The central bank's formal bank supervisory function should, however, only cover commercial banks, finance companies, and development banks. These represent the main deposit-taking financial institutions whose failure could have systemic implications. Although it is not the central bank's function to organize the myriad of entities which operate at a micro level throughout Nepal, some micro-finance institutions take deposits, some are licensed by NRB, and some are large or weak enough to raise supervisory attention. Clear regulations for such institutions need to be provided by the central banking authorities, but supervision should be conducted by a second-tier regulatory authority answerable to NRB. 4. Creation of a New Framework for Supervision Defining Regulations. Seven new prudential regulations and guidelines were issued in March and April 2001. These include: capital adequacy, loan classification and provisioning, loans to one borrower or group of related borrowers, accounting, risk management (liquidity, interest rate, foreign exchange), enforcement, and good governance (code of ethics, duties and responsibilities of directors, prohibition of loans to directors, officers and employees). These regulations are rigorous and will be applicable to all deposit-taking institutions. A new minimum capital for banks (NR 500 million - or US$6.5 million), which was defined five years ago, came into force from July 2001.
On March 24, 2000, NRB held a "interaction program" with the banking industry to collect opinions and suggestions for improvement on draft versions of these regulations. During this one-day session, discussions were very open, showing the banking community's awareness of the need for improved regulations. However, there was also a general concern regarding their implementation, including requests for extended delays or less stringent requirements. It is important, however, that Nepal move as quickly as possible to internationally accepted norms of banking regulations - and to ensure their adequate enforcement. 43
Developing the Supervisory Capacity. Initial efforts in strengthening the supervisoly capacity have focused on a bank supervision resident expert providing assistance in implemrenting the regulations, giving comprehensive in-house training courses, developing the off-site surveillance function, participating in the on-site inspections, and formulating an inspection manual. Since the weak banking environment in Nepal requires a strong and active presence of supervisoiy teams in the bank, support of additional consultants for the ISD to participate in on-site examinations is also required. A more focused and intensified inspection process should also be developed, with the objective of shifting examinations from bank branches to head offices.
Off-site surveillance that carries out a permanent and overall assessment of banks and provides early warning indications of a bank's overall financial health, is an important aspect of bank supervision. Such off-site findings could then trigger, and better target, in-depth on-site inspections. NRB also needs to define reporting formats, to establish procedures to collate and analyze information, and to create a bank analysis function.
Building Supervisory Authority. The new regulatory framework should force banks to invest large amounts in modernizing their MIS for proper accounting and timely reporting, and to substantially enhance their capital base to meet minimum capital, loan provisioning, capital adequacy and exposure limit requirements.
Enforcement. The need for banks to significantly increase their capital is a major issue. Scaling down assets is an option, but this could reduce profitability and thus hinder intenial system upgrading. Issuing asset-backed securities cannot be considered for several years. Another alternative would be raising equity funds or issuing hybrid instruments. The latter solution could be implemented but only when new legal dispositions, which authorize and regulate such instruments, have been established. Thus, cash injections and floatation of new shares is likely to remain the only source of long-term funding for some time.
The two largest commercial banks, RBB and NBL, are expected to be put under the management of two international teams during 2002. This major change in the Nepalese banking industry will require a close, active and professional monitoring by NRB supervision teams, in the form of on- site examination and follow up on a (minimum) annual basis. The restructuring process should be piloted by the central bank. It will, defacto, foster policy definition and build capacity and experience in bank exit and restructuring.
Sanctioning. NRB must enforce the new regulations in a short period of time. Although it is important to take into account Nepalese realities, phase in periods should be as short as possible and the supervisory effort must lead to concrete results. Each inspection report should define up to five priority actions to be taken by a defaulting institution within one year. In case of a capital shortfall, or of any other regulatory inadequacy, Memorandums of Understanding (MOUs) must be drawn up with the banks which set out a short term sequenced timeframe to address the identified problems. Appropriate sanctions, including license removal, must also be taken by NRB should a bank fail to meet any of the requirements. After years of non-enforcement, more supervisory forbearance would send the wrong signal to the banking community. Nolhing must prevent the central bank from sanctioning banks that do not comply with prudential regulations. NRB's inspection teams should be able to complete on-site examinations of all private banks within two years. This will provide a precise view of their situation vis-a-vis the new regulations. 44
5. Recommendations Sustainable improvements in the banking industry will not be seen until NRB re-orients its function from directing the financial sector to acting as a regulator and supervisor in charge of preserving the soundness of banks and promoting competition among them. To achieve this, autonomy will be a key factor in ensuring freedom from political and other influences that have impeded their efficacy thus far.
Moreover, Nepal has set ambitious objectives for itself in its Ninth and Tenth Five Year Plans such as lifting restrictions on foreign bank entry, facilitating mergers and takeovers, completing privatization of banks and non-banks and supporting the development of micro-finance institutions. While most of these remain to be done, the attainment of these objectives would only be desirable if it is preceded by a strengthened central bank that is capable of regulating and supervising the sector. In its absence, further liberalization of the Nepalese financial sector is ill advised.
The specific recommendations of this chapter are:
(a) Implement and enforce the new regulations (minimum capital requirements, provisioning policy, etc) on the same basis for all banks.
(b) Given the importance of supervision (particularly at this crucial stage when the sector is undergoing significant reform), it is strongly recommended that the NRB utilize the support of experienced external consultants in the enforcement of the new regulations.
(c) Define a program to include an annual review of RBB and NBL and biennial review of all the other banks.
(d) Make inspection reports available one month after the on-site visit has been completed.
(e) Stop rotation of banking supervision staff.
(f) Apply stricter criteria in approving banking licenses.
(g) Make human resource policy changes to include improved definition of criteria for advancing staff with potential, improved staff selection and career planning, and improved systems to facilitate greater knowledge sharing. 45
CHAPTER FOUR The Commercial Banking Sector 1. Introduction Until the mid-1980s Nepal's financial sector was closed to foreign banks and was effectively controlled by two state-owned banking institutions - Nepal Bank Limited (NBL) (established in 1938) and Rastriya Banijya Bank (RBB) (established in 1966). After 1984 the Government gradually liberalized and opened up the sector - resulting in the rapid entry of three new foreign banks - Nabil Bank Limited (Nepal-Arab Bank Limited) in 1984, Nepal Indo-Suez bank in 1985, and Nepal Standard Chartered Bank in 1987. Six additional joint venture banks and four 9 Nepalese owned banks have subsequently entered the market' . However, the financial sector remains dominated by the two majority Government-owned banks, NBL and RBB.
The structure of the commercial banking sector is shown in the following chart. Total assets of the commercial banks, as of 2001, were NR 226.2 billion - equal to around US$3.0 billion. When the ADB/N is included - total commercial banking system assets increase to US$3.2 billion. The Government's direct share of banking system assets is around 50 percent - although its actual ownership is much higher than this if the state's direct and in-direct shares in the joint- venture banks are also included. The RBB and NBL (where government ownership is now 41 percent) together accounted for 52 percent of total banking system assets in 2001.
Chart 4.1: Commercial Banks: Share of Total Assets, 2001
70,000
60,000 50,000 A 40,000
I30,000
20,000 - 10,000 U _
NBL RBB NABIL NISB STB HBL NSBIB NB Bank EBL BOK NBOC ADB/N Lurrbm NICB Commercial Banks
Source: Nepal Rastra Bank
The nine joint venture banks hold around 45 percent, with approximately NR 101.1 billion in assets (US$1,341.1 million). This group is dominated by three large banks - Standari Chartered Bank (formerly Grindlays Bank, with 9 percent of total banking system assets), Nabil Bank (8 percent), and Himalayan Bank (9 percent). The joint venture banks are from the United Kingdom, Bangladesh, Pakistan, France, India, and Sri Lanka. The remaining 3.7 percent of banking system assets is held by the four domestic owned banks.
19 Rastriya Banijya Bank, Nepal Bank Limited, Nepal Arab Bank, Indo-Suez Bank, Standard Chartered Bank, Himalayan Bank, Nepal SBI (State Bank of India) Bank, Nepal Bangladesh Bank, Everest Bank, Bank of Kathmandu, Nepal, Bank of Ceylon, Lumbini Bank Ltd., NIC Bank Ltd., Machapuchre Bank Ltd., Kumari Bank Ltd. 46
There are two distinct classes of banks within this group of joint venture banks. The first includes the "good name" banks, with an international reputation, which appear to be conducting fully professional banking activities in Nepal. On the other hand, there are banks from countries whose domestic banking systems are inadequately supervised by their own central banks, and where the institutions carry out, in some cases, non-prudent banking activities. Anecdotal evidence points to some of these banks being severely over lent to a single customer and available information shows that some of them are inadequately capitalized. In this regard, it is necessary to ensure that these banks comply, as soon as possible, with the newly approved NRB regulations - which broadly comply with international norms (albeit, in many cases, with a long phase-in period). These regulations provide a framework for determining provisions, allocating adequate levels of capital, and other regulations necessary to ensure that the banking system, as a whole, operates in a prudent manner. The role of the bank supervisors has historically been made difficult by the fact that the Government's own banks - the majority of the banking system - do not operate in a safe and prudent manner. 2. Consolidated Financial Highlights of the Commercial Banks Total assets of the commercial banks grew at an annual average rate of 18.5 percent over 1994 to 2001 - from NR 73,565 million to NR 241,948 million. The highest growth was recorded in 1998 - around 24 percent and the lowest in 1995 - around 14 percent. Since 1998, growth has been around the period average (See Table 4.2 at the end of this chapter). While the growth of assets has been significant, their quality is not known but is suspected to be poor (based on the problems of the two largest banks). During the period under review, the most notable development is the gains made by the joint venture banks at the expense of the two large banks. In 1994, RBB and the NBL accounted for around 72 percent of total banking assets. The corresponding figure for 2001 was 52 percent. Detailed, bank by bank information on sources and uses of funds is given in Annex Three.
On average, deposits constituted 72 percent of total sources of funds over the review period, and grew at an average annual rate of around 19 percent. Deposit growth accelerated in 1998 and 2000 - but, in 2001, it declined to its 1997 level of around 15 percent. On average, fixed deposits accounted for 30 percent followed by savings deposits (28 percent) and current deposits (12 percent). The composition has shifted somewhat over the period with growth of savings outpacing others to constitute the largest component of total deposits in 2000 and 2001.
Chart 4.2: Commercial Banks: Breakdown of Deposits, 1994-2001
180,000 160,000- 140,000 - 120,000 - 100,000 - 80.000 60,000 -- - 40,000 - 20,000
1994 1995 1996 1997 1998 1999 2000 200 Fiscal Years
-4--Total Deposits Current Savings -X- Fixed - Call U Others 47
Capital Funds accounted for an average of 4 percent of total funds (5.5 percent in 2001) and grew at an annual rate of 26.5 percent over the seven years. The biggest contribution to capital build up over the period was not in paid up capital (which increased by 15 percent per annum) but statutory reserves (which increased by 48 percent per annum over the period). The single biggest increase in capital occurred in 2000 when the capital of the banking system increased by around 71 percent - largely in response to NRB's minimum capital regulations (although some banks still do not meet the minimum requirement of NR500 million). In addition, as a whole, the commercial banks are still not able to meet the capital adequacy ratio (8 percent of risk-weighted assets, of which 50 percent must be met from core capital ). Borrowings (from NRB, inter-bank and from abroad) remain negligible, constituting on average less than one percent of total funds. The "Other" classification - which includes provisions, sundry creditors, accounts payable, etc. - experienced an annual average growth of around 15.5 percent and constituted 21 percent of the total sources of funds in 2001.
Chart 4.3: Commercial Banks: Sources of Funds, 1994-2001
200,000 180,000 160,000 140,000 . 120,000 "___ - 100,000 _ 80,000 60,000 -A__ 40,000 20,000 *w-
1994 1995 1996 1997 1998 1999 2000 2001 Fiscal Years
-*-- Capital Fund -. Deposits 8U Borrowings Otr.,
Loans and Advances constituted, on average, 47 percent of total uses of funds. They grew by around 22 percent per annum over the seven year review period, and accounted for 45 percent of total assets in 2001. Ninety-six percent of all loans and advances was lending to the private sector - and only 2 percent was lending to the government and government enterprises. As a share of total deposits, loans and advances grew from 52 percent in 1994 to 63 percent in 2001. Loans and advances were as high as 71 percent of total deposits in 1996 and 1997. However, in general, the ratio of loans and advances to deposits is low - and appears to be symptomatic of poor intermediation within the banking system - nonetheless, the trend does appear to be positive. On the other hand, the relatively rapid growth of loans and advances could also be indicative of a poor quality loan portfolio.
Liquid funds also grew relatively rapidly - at an average rate of around 18.5 percent - and made up to almost 19 percent of total assets in 2001. Given the mandatory reserve requirements of around 10 percent, there is considerable excess liquidity in the banking system in Nepal. In 2001, 33 percent of liquid funds were comprised of balances held abroad; a further 30 percent were held in call deposits; and 25 percent were held as balances with the central bank. Balances held 48 abroad grew at around 16 percent per annum over the period, however, they grew by a significantly higher 54 percent in 2000. Limited investment alternatives in Nepal - arising from a stagnating economy - appear to have fueled this growth in liquid resources. The Other category (sundry debtors, advance payments, advances to employees, stocks of stationery, non-banking assets, expenditure to be written-off, and contra entry) grew at around 23 percent over the period, making up 22 percent of total uses of funds in 2001.
Investments were largely stagnant over the seven years under review. Investment share of total uses of funds has fallen from around 20 percent in 1994 to 6 percent in 2001. In the current environment of high excess liquidity, there is a need to introduce more and longer-term government securities to absorb some of these excess funds.
The above review demonstrates that, while the assets of the commercial banks have been growing at a relatively rapid pace, they suffer from sub-optimal investments, as evidenced by high levels of liquid fund holdings, low loan levels (whose quality is suspect), and limited investment in securities. On the other hand, most of the deposits are savings and fixed term - implying a high cost of funds. The net interest margin is therefore very low. Banks also appear to have low levels of capital adequacy - and these numbers do not reflect the "true position" with respect to un-impaired capital. Moreover, substantial assets are tied up as "interest accrued" and "unclassified" - which is not an auspicious sign for a bank - as many of these assets are generally not recoverable. Overall, it is evident that the commercial banks are not providing efficient financial intermediation.
Chart 4.4: Commercial Banks: Uses of Funds, 1994-2001
120,000
100,000
80,000
60,000
40,000
20,000
0 A 1994 1995 1996 1997 1998 1999 2000 2001 Fiscal Years
| Liquid Funds -_-- Investments A Loans & Advances - Accrued Int. - Other 49
3. The Government-Established Commercial Banks Nepal Bank Limited (NBL)
Background. Nepal Bank Limited (NBL), established in 1938, is the oldest bank in Nepal. In accordance with the government's policy of providing at least one banking facility for every 30,000 people, NBL pursued an active policy of opening up branches and sub-branches throughout the country. Although the bank had 211 branches and around 6,000 staff at the end of 1998 - by 2001, total branches numbered around 160 as many of them had been closed due to the Maoist insurgency. With total assets of NR 52.4 billion (US$695 million) - backed by a stated total capital (core and supplemental) of NR 2.9 billion (US$38 million), it accounted for 5.5 percent of total assets in 2001. Other estimates undertaken by KPMG on the 1998 accounts, however, indicate a substantial negative net worth. With a government divestment of 10 percent of its shareholding to the general public in 1998, the public share was reduced to 41 percent - making the bank a private institution in which the government is the largest single shareholder. The general public now has a majority of seats on the board. In addition, NBL holds shares in Standard Chartered Bank, the National Insurance Company, Nepal Oil Corporation, the RRDB's and NIDC.
Financial Highlights, 1994-2001. The assets of NBL grew at an annual rate of around I I percent (the slowest among the commercial banks) over 1994 to 2001. Growth has fluctuated, from a negative rate of 3 percent in 1995 to a high of 30 percent in 1998, and followed thereafter by significantly slower growth rates of 17 percent in 1999; 5 percent in 2000; and 13 percent in 2001. Deposits constituted, on average, 74 percent of total sources of funds, and grew by 10 percent per annum. This growth has been erratic, ranging from a low of 5 percent in 1995 to a high of 31 percent in 1998. In 2000, deposits grew by only 8 percent and actually declined by 0.14 percent in 2001 (possibly as a result of a growing awareness of a serious financial problem within NBL after the KPMG Report was made public). The Capital fund is purported to have grown at an average annual rate of around 26 percent over the period. However, most of this growth came from supplementary capital and largely reflects provisions for loan losses - which are still not considered sufficient to cover the non-performing assets (NPA's) within the loan portfolio of the bank.
Loans and advances constituted, on average, only 50 percent of total uses of funds over the period (44 percent in 2001) - growing at an average annual rate of around 14 percent. Liquid funds grew at an average annual rate of around 9 percent. Growth was highest in 1997 and 1998, but grew at a significantly reduced rate thereafter (minus 18 percent in 2001). They constituted 17 percent of the total funds on average, and 13 percent of total funds in 2001 - indicating that NBL was much less liquid than the banking system as a whole. Investments (in government securities, shares and debentures, and NRB bonds) shrank over the period, accounting for around 9 percent of total funds in 2001 from 27 percent in 1994. The growth rate trend has been extremely erratic, as high as 556 percent in 1998 and as low as a negative growth rate of around 66 percent the preceding year. Interest accrued grew at an annual rate of around 23 percent, growing at a faster rate since 1998 - its share of total funds was around 14 percent in 2001 compared to 7 percent in 1994. This may be indicative of a deteriorating credit porlfolio, even more so given that the average interest accrued as a share of total credit for the rest of the commercial banks - with the exception of the other troubled bank, RBB - was around 2 percent. 50
Chart 4.5: NBL: Assets, Deposits, Credit & Investment 1994-2001
60,000
50,000
0 40,000
30,000 Z 20,000
10,000
0 1994 1995 1996 1997 1998 1999 2000 2001 Fiscal Years
| Total Assets Deposits A Investments X Credit
Rastriya Banijya Bank (RBB)
Background. RBB was established in 1966 as a fully government-owned commercial bank, and it remains so today. The bank currently operates a country-wide banking network, in line with the Government's policy to provide banking access to the general public, through a network of 210 branches - of which around 70 have been closed due to Maoist activity in the country-side. Despite this, a large proportion of the bank's total banking business is conducted in Kathmandu. The bank employs around 6,000 staff. As of July 2001 it accounted for 26.6 percent of total banking system assets.
Financial Highlights, 1994-2001. Total assets of RBB grew at an annual average rate of 13 percent, from NR 27.6 billion in 1994 to NR 64.3 billion in 2001. Growth has been erratic and has slowed considerably since 1996 when it grew by 21 percent. In 1999 and 2000, growth only averaged 6.5 percent, but grew by 13 percent in 2001. Deposits constituted, on average, 58 percent of total sources of funds over the period, and grew at an annual average rate of 13 percent. Savings Deposit in particular grew relatively rapidly - an average annual rate of 22 percent over the period - to constitute 50 percent of total deposits in 2001 compared to only 29 percent in 1994. The reported Capital Fund grew at an average annual rate of around 18 percent, although its growth in 2000 was as high as 75 percent. In common with NBL, however, this does not reflect the unimpaired capital position of the bank which is also steeply negative. Nonetheless, according to this data from the NRB, it accounts for around 4 percent of total sources of funds (on average). Thus, even according to this generous interpretation of the capital position of RBB, the bank appears to still be unable to meet its minimum capital requirements. The "Other" category, which constituted around 37 percent of the total in 1994, and was as high as 44 percent in 1997, has reduced significantly over the years and comprised 34 percent of the total in 2001.
On the uses side, loans and advances constituted 46 percent of total uses of funds over the period and grew by an average annual rate of 16 percent. Growth has been erratic and, since 51
1996, it has been less than the period average. In 2000, loans grew by 12 percent and by only 3 percent in 2001. Private sector lending made up 98 percent of total lending in 2001. Investments, mainly in government securities, have declined sharply over the period and constituted less than 5 percent of the total in 2001 compared to 13 percent in 1994. Growth of Liquid Funds fluctuated widely, as high as 55 percent in 1998 and as low as a negative growth of 44 percent in 2000. They declined by a further I percent in 2001. Over the period, liquid funds grew at an average annual rate of less than I percent - the lowest among all the commercial banks. Liquid funds comprised 9 percent of all uses of funds in 2001 compared to 19 percent in 1994. Interest accrued grew at an annual rate of around 17 percent and constituted 16 percent of total credit in 2001. As with NBL, this is likely to be indicative of a low quality and deteriorating loan portfolio.
Chart 4.6: RBB: Assets, Deposits, Credit & Investment 1994-2001 70,000 60,000 50,000 E 40,000
e 30,000 20,000 10,000 0 X X X X_ 1994 1995 1996 1997 1998 1999 2000 2001 Fiscal Years
- Assets n Deposits A Credit X Investments
4. Issues in the Govemment-Established Commercial Banks According to a comprehensive assessment of NBL and RBB, carried out with the support of the World Bank in June 2000 by the KPMG Barents Group20, NBL and RBB are technically insolvent and suffer serious shortfalls in all aspects of their governance, management and operations. The conclusions of the KPMG report show that the loan assets are highly overstated, extremely risky and that as a consequence, the banks are technically insolvent. The report, based on 1998 data, estimates NBL's negative net worth between NR 6-10 billion (US$85 to $140 million) and the RBB's negative net worth between NR 14-18 billion (US$200 to $260 million). This represents around 7 to 9 percent of Nepal's GDP. The situation is certain to have deteriorated significantly over the intervening four years. This is of grave concern given that these two banks represent around half of the total assets of the commercial banking system. The report also showed that while the RBB suffers from problems almost identical to NB]L, they are greater in magnitude. The report also highlighted the following:
Severe Governance and Management Shortfalls. Years of political interference in senior appointments, lending, and operational decisions have been a major cause of poor governance
20 Nepal Banking Reform Project, Rastriya Banijya Bank (RBB) and Nepal Bank Limited (NBL), KPMG Barents Group, Kathmandu, June 2000. 52 and management. This has been exacerbated by a general lack of internationally experienced, commercially oriented, prudent bankers in Board and senior management positions. This is reflected in the absence of financial management information, a business strategy, poor board and management practices, low morale, counter-productive union activities, inadequate compensation, and so on, that have all conspired to further compound the problem (see Box 4.1).
Dysfunctional Lending Processes. Unsound banking practices have helped deteriorate the credit portfolio, evident in the absence of policies, processes and procedures that support profitable commercial banking practices. Senior management that is not concerned with taking on inappropriate and unduly high risks, a Board that is more responsive to client pressures than prudential concerns, and poor incentives and ill-trained staff, have also helped to aggravate the situation.
Primitive and Flawed Accounting Practices. Information systems, accounting, and record keeping practices are extremely poor. As a result, the banks suffer from both information gaps as well as gaps in the little information that they have. Loan files, loan ledgers, accounting records, operational statistics, and data on human resources, are ill maintained and sub-standard.
Absence of Strategic Planning and Poor Business Planning and Budgeting. There are no strategic plans, and the units responsible for this function are inadequately staffed and have very limited capacity. Budgeting process are primitive with negligible monitoring on variances and no well-defined rewards and punishment systems necessary to enhance accountability and improve performance.
Low Morale, Numerous Human Resource Issues and Active Counter-productive Unions. Poor incentives and penalties, combined with below-market pay structures and weak stafflmanagement discipline have seriously eroded employee motivation and productivity. With negligible training opportunities that could provide exposure to international best practices, staff and management skills that are already very weak, are expected to get worse. Strong counter- productive unions have aggravated the situation, resulting in an excess number of unskilled staff.
Nepal Bank Limited is Trading in Negative Equity on the Stock Exchange. In addition to the above, there is also the issue of the government's privatization policy regarding NBL holdings. The government began divestment of its holdings in NBL in 1998 through the sale of parcels of shares. The sale of shares to the public - while effectively "privatizing" the bank - has resulted in a wide dispersion of share ownership and an absence of a strong strategic banking investor. In addition, dealing with this widely owned "negative-equity" will be an important challenge for the NBL restructuring process.
Even though their financial woes are well publicized, both the banks do not appear to be suffering from these adverse findings (government ownership has been a positive factor in this respect). More recently, there has been withdrawals by some clients from RBB including a partial withdrawal by the Royal Nepal Army, one of its largest clients. The reason, however, was the more attractive rates on offer from the joint venture banks. In response, RBB increased its interest rates on deposits.
To arrest further deterioration, external teams are now being recruited to take over the management of these banks. This is expected to stem further deterioration and pave the way for their eventual recovery and possible privatization - although liquidation should also be seriously considered if successful privatization is not considered feasible. A large part of the initial efforts will be focused on recovering on the existing loan portfolio and in human resources re- 53 engineering (shedding excess workers through voluntary retirement schemes and imiproving the overall conditions for remaining and new workers). 5. The Three Largest Joint Venture Commercial Banks. There are two distinct classes of banks within the group ofjoint venture banks. The first includes the "good name" banks, with an international reputation, which appear to be conducting fully professional banking activities in Nepal. The second group includes banks from countries whose domestic banking systems are not properly supervised by their own central banks.
Table 4.1: Joint Venture Commercial Banks
Name Foreign Equity Foreign Partners
Nepal Arab Bank 50 National Bank ltd, Bangladesh Nepal Indo-Suez Bank Limited 50 Credit Agricole Indosuez, France Nepal Standard Chartered Bank Ltd. 50 Standard Chartered, UIC Himalayan Bank Limited 50 Habib Bank, Pakistan Nepal SBI Limited 50 State Bank of India, India Nepal Bangladesh Bank Limited 50 IFIC Bank, Bangladesh Everest Bank Limited 50 Punjab National Bank, India Bank of Kathmandu Limited 50 Siam Commercial Bankc, Thailand Nepal Bank of Ceylon 50 Bank of Ceylon
Source: Nepal Rastra Bank Nepal Standard Chartered BankL Nepal Standard Chartered Bank was established in 1987. With assets of NR 21.3 billion (US$280 million), representing 9 percent of total banking system assets in 2001, it is the largest (and one of the most profitable) joint venture commercial banks in Nepal. It has six branches and, as a result of its attractive remuneration (significantly higher than most of the other financial institutions), it reportedly has staff with high technical skills. It also has a higher level of computerization in the workplace. Expatriates and foreign organizations are its main source of deposits 21.
Financial Highlights 1994-2001. Total assets of Standard Chartered Bank have grown at an average annual rate of 20 percent over the past seven years. Its share of total commercial banking system assets grew from 8 percent in 1994 to 9 percent in 2001. As with most of the commercial banks in Nepal, Standard Chartered Bank has not experienced very stable growth, with reported growth rates of around 29 percent in 1997 and 9 percent the year after. Deposits grew at an average annual rate of around 17 percent - slower than the growth in total assets - and thus the share of deposits to total sources of funds declined from around 85 percent in 1994 to 71 percent in 2001. Among the various types of deposits, savings deposits grew faster than fixed or current deposits and also made up a significant proportion (54 percent) of total deposits in 2001. Fixed deposits made up around 24 percent, and current deposits 20 percent of total deposits. On average, savings deposits constituted around 49 percent of total deposits over the period, a ratio that is highest among all the banks and suggestive of a high cost of funds. Capital funds grew significantly faster, around 27 percent annually over the period. As a share of total funds, capital funds constituted around 5.5 percent in 2001 compared to 3.7 percent in 1994.
2! A Review of the Financial Sector in N.epal, DFID, November 2000 54
Chart 4.7: Standard Chartered Bank Assets, Deposits, Credit & Investment, 1994-2001
25,000
20,000
m 15,000
a 10,000
5,000
1994 1995 1996 1997 1998 1999 2000 2001 Fiscal Year
|4--Assets _ Deposits A Credit - Investment
In terms of uses of funds, liquidity has grown at an annual average rate of 29 percent, over this period. Its share in total funding increased from 23 percent in 1994 to 38 percent in 2001. This growth was mainly reflected in a high growth of balances held abroad (an average annual growth rate of around 38 percent over the period and constituting around 90 percent of total liquid funds by the end of the period). This may be a reflection of the fact that Standard Chartered's main clients are expatriates and foreign organizations. Loans and advances grew at an average annual rate of around 18 percent over the period. However, the rate of growth has been decreasing since 1995. Loans and advances constituted only 27 percent of total funds in 2001 compared to 31 percent in 1994. Investments grew at an average annual rate of 3 percent over the period.
Himalayan Bank. Himalayan Bank was established in 1993 by local businessmen in partnership with Habib Bank of Pakistan. It was the first joint venture bank under Nepalese management and with Nepalese shareholding control. It has a total of 8 branches - 7 urban and I rural. It was the first bank to introduce local credit cards, acquire the first automatic teller machines, and start tele- banking operations. In addition to commercial activities, it facilitates industrial and merchant banking activities. With total assets of NR.20.9 billion (US$280 million) in 2001, it is the fourth largest commercial bank in Nepal.
Financial Highlights 1994-2001. Total assets of Himalayan Bank grew at a significantly high average annual rate of 41 percent over the period - in part, reflecting the very small initial start- up base. In 2001, total assets grew by 25 percent. In terms of sources of funds, deposits grew at an average annual rate of 39 percent (25 percent in 2001) and constituted 84 percent of total assets in 2001, compared to 91 percent in 1994. In line with other banks, savings deposits and fixed deposits grew at faster annual average rates of around 54 percent and 42 percent, respectively. Capital funds grew at 45 percent over the period and constituted 3.8 percent of total funds in 2001. 55
Chart 4.8: Himalayan Bank Assets, Deposits, Credit & lniestment, 1994-2001 25,000 20,000
*g15,000 a 10,000 5,000
0 1994 1995 1996 1997 1998 1999 2000 200 1 Fiscal Years
|4- Assets Deposits Credit - InvestmentsJ
On the uses side, loans and advances grew at 37 percent over the period. As a shan- of total funding, loans and advances have declined from 57 percent in 1994 to 44 percent in 2001. Their average share of the total during the period was 50 percent. Liquid funds grew at 45 percent per annum over the period, and their share in total assets increased from 28 percent in 1994 to 34 percent in 2001. Within liquid funds, there was a change in composition, with call deposits accounting for 82 percent of the total in 2001 compared to only 10 percent in 1994. Investments grew at 23 percent per annum over the period. Their share in total assets shrank from 11 percent in 1994 to 4 percent in 2001.
Nepal Arab Bank Limited (NABIL). The liberalization of Nepal's financial sector began in 1984 with the establishment of the Nepal Arab Bank Limited, a joint venture with an Arab Bank. The bank operates with 12 branches - 8 urban and 4 rural (more than the other banks). NVith total assets of NR 19.2 billion in 2001 (US$250 million), its share of commercial banking system assets was around 8 percent (up from 7 percent in 1994). It is the fifth largest commercial bank in Nepal.
Financial Highlights 1994-2001. NABIL's total assets grew at an annual average nrte of 20 percent over the period. Growth has fluctuated, tapering off from 33 percent in 1996 to 9 percent in 1999 and rebounding significantly to 35 percent in 2000. They grew by 16 percent in :2001.
On average, deposits made up 78 percent of total sources of funding over this period. Growth in deposits averaged 17 percent over the period, with higher growth rates occurring in 1995-1996. Savings, fixed and current deposits made up 29 percent, 28 percent, and 26 percent, respectively, of total deposits in 2001. The capital fund grew by 29 percent on average and accounted for around 6 percent of total assets. NABIL is one of four banks that have met the minimum capital requirement.
Loans and advances constituted 43 percent of total uses of funds in 2001, and grew at an annual average rate of 19 percent over the period. In 2001, loans grew by 10 percent. Liquid funds grew at a significantly faster rate - 27 percent - over this period. Their share of total assets increased to 32 percent in 2001 from 21 percent in 1995. Among the components of liquid funds, call deposits have been the largest, accounting for 89 percent of total liquid funds in 2001. 56
Investments declined over the period, and their share of total assets has fallen from 27 percent in 1994 to 5 percent in 2001.
Chart 4.9: Nepal Arab Bank Assets, Deposits, Credit & Investment, 1994-2001
25,000 20,000 ° 15,000 e10,000 5,000 0 I 1994 1995 1996 1997 1998 1999 2000 2001
Fiscal Years
-4- Assets - Deposits + Credit -- Investment
6. The Other Joint Venture Commercial Banks, Domestic Commercial Banks, and the ADB/N
With the exception of the ADB/N, that conducts commercial banking through 30 of its mainly urban branches, and whose share of total commercial banking assets in 2001 was around 7 percent, the share of total banking assets of the remaining 9 joint venture and fully domestic commercial banks is 20 percent. A majority of these banks only began operations in the mid 1990s.
Amongst these, the two smallest commercial banks, Lumbini Bank and the Nepal Industrial and Commercial Bank - both fully Nepalese owned banks in operation for only three years - had the highest annual growth rates of 236 percent and 199 percent, respectively (the small base is the obvious reason for their significantly higher growth)'. As a result, their share of total assets of the commercial banking system has grown from less than I percent to 3 percent in 2001. The Nepal Bangladesh Bank also grew rapidly, at an annual average rate of 78 percent over this period. Although growth has been erratic, its share of total assets of the banking system increased from less than I percent in 1994 to 4 percent in 2001. Indo-Suez bank, ajoint venture with Credit Agricole-Indosuez France, had the lowest annual growth rate among the remaining commercial banks of 17 percent. Its share of total assets declined from 2.6 percent in 1994 to 2.3 percent in 2001.
Financial Highlights 1994-2001. On the sources side, the two smallest banks, Lumbini and NICB, recorded the highest deposit growth rates of 307 percent and 247 percent, respectively, in their three years of operation. The Nepal Bank of Ceylon, in operation a year longer, achieved the third fastest average annual growth rate of 105 percent. However, the deposit to total assets
22 Two even newer, and correspondingly smaller banks - Machhapu and Kumari began operations even later than this. 57 ratio was highest for the Bank of Kathmandu, 86 percent on average over the period, followed closely by Nepal Bangladesh Bank (85 percent) and Lumbini bank (84 percent).
With respect to capital funds, NICB had the highest annual growth rate during its four years of operation of 119 percent. The annual growth rate of Nepal Bangladesh Bank's capital fund was around 44 percent. Everest Bank's capital fund grew by around 38 percent per annum. NICB also had the highest capital funds to total assets ratio of around 47 percent, over the period. The next highest average capital fund to total assets ratios were those of Nepal Bank of Ceylon (20 percent) and Lumbini (13 percent).
On the uses side, the highest annual growth rates for loans and advances were recorded by the NICB (1,955 percent) followed by NBB (1,164 percent) and Lumbini (631 percent). Loans and advances as a share of total assets were on average highest for Bank of Kathmandu (65 percent), NSBIB (63 percent) and NBB (62 percent).
Liquid funds of Lumbini grew at an annual rate of around 80 percent, followed by Nepal Bank of Ceylon (61 percent) and Bank of Kathmandu (51 percent). However, NICB had the highest liquid funds to total assets ratio of 27 percent, followed by Indo-Suez Bank (22 percent) and Lumbini (24 percent). Highest annual growth rates for investments were recorded by the NBB (1,887 percent), followed by the NICB (115 percent) and NSBIB (323 percent). In keeping with the general trend, this growth was extremely erratic. Interest accrued as a proportion of total assets was less than I percent for all these banks in 2001. 7. Issues in the Joint Venture Commercial Banks. The main issues that need to be addressed for the joint venture banks in Nepal include:
Restrictions on foreign ownership of banks. Until recently, there was a 50 perceni ceiling on foreign ownership of banks - which was increased to 66 percent in the 2001 Budget. Most of the non-foreign holdings of these banks is owned by HMG/N. This has not been helpful in attracting "good name" banks. Yet, "good name" banks and their accompanying skills and technology are what the Nepalese financial sector requires. Removing this restriction altogether may help to attract more "good name" banks that could bring discipline, know-how and transfer of technology benefits to the Nepalese financial sector.
Government ownership and representation on Boards of the joint venture banks. Through its significant ownership in the large commercial banks, the government is currently represented on the boards of most joint venture banks. In several joint venture bank boards, the government is actually represented by officials from the NRB, some of whom are involved in banking supervision. Such practices help to create confusion and conflict of interest between the roles of ownership and supervision.
Government mandated directed lending schemes and branch policy. Government mandated directed lending schemes such as "priority sector lending" and "deprived sector lending" currently require that 12 percent of total loan portfolios be targeted at agricultural and cottage lending. A quarter of this must be lent to the "hard core" poor (those who borrow less than NR 30,000 per annum). These requirements place an unnecessary burden on the banks and - despite the laudable aims of these programs - they could be better achieved through other more focused interventions. 58
Branch Policy. Currently, commercial banks are required to open rural branches whenever they expand their urban branch network. This increases operational costs for the commercial banks. Meanwhile, the impact of the establishment of such branches in rural areas is doubtful.
Cross ownership of private banks by RBB, NBL and the central bank. The existing situation whereby the two large government-established banks and the central bank have substantial ownership stakes in a number of private banks is unhealthy, particularly given the weak regulatory and supervisory capability of the central bank. Such a situation creates an opening for corruption, self dealing, and other undesirable activities.
8. Recommendations Recommendations for the Government-Established Commercial Banks (a) The management teams for RBB and NBL should be put in place as soon as possible to stem further deterioration of the banks, particularly in light of the weak supervisory capacity of the central bank.
(b) Undue interference in the management team's functioning must be prevented by NRB.
(c) Human resource re-engineering must be undertaken employing voluntary retirement schemes - at a fairly early stage. Automation also needs to be significantly enhanced.
(d) Vigorous loan recovery efforts need to begin immediately.
(e) If the banks are to ultimately be privatized (and not liquidated) then the privatization must include strategic investors that bring value added skills and expertise to the banks.
(f) HMG/N should, however, seriously consider the liquidation option for the two banks - if successful and quick privatization to "fit and proper" owners is not considered a likely outcome.
(g) Close monitoring and supervision must be undertaken by the central bank during this period to ensure that looting is checked and that funds of depositors are protected. Supervision should also check insider and self dealings by opportunists.
Recommendations for the Joint Venture Commercial Banks. (a) The current restrictions on foreign ownership beyond 66 percent should be eliminated. Removing this restriction altogether may help to attract "good name" banks that could bring discipline, know-how, and technological benefits to the Nepalese financial sector.
(b) The government should move away from direct participation in banks. In particular, NRB should withdraw from direct participation in the boards of commercial banks and also disinvest any bank holdings.
(c) The Government should replace the current mandated lending requirements on commercial banks with better directed policies that result in less operating disincentives.
(d) The current policy that requires the establishment of rural branches whenever urban branches are established needs to be reviewed and removed.
(e) Cross holding in banks must be prohibited. 59
Table 4.2: Sources and Uses of Funds - Commercial Banking Sector (1994 to 2001)
1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 2,544.4 3,102.9 3,560.7 4,460.7 5,072.0 6,077.1 10,421.0 13,200. a. Paid up capital 1,774.7 2,118.5 2,271.2 2,851.6 3,082.2 3,767.0 4,067.3 4,613. b. Statutory reserve 514.2 662.7 885.1 1,091.5 1,272.0 1,596.1 6,371.2 7,842.1 c. Others 255.5 321.7 404.4 517.6 717.8 714.0 -17.5 744.5 2. Deposits 52,330.8 61,193.3 71,400.5 81,703.0 102,790.2 127,201.8 153,295.9 175,752 d a Current 9,796.9 11,629.5 13,246.4 12,819.5 16,324.2 17,709.8 20,011.0 24,504. b. Savings 17,461.1 22,765.8 25,889.4 29,697.1 36,993.7 50,154.1 64,998.5 79,945. c. Fixed 23,263.0 24,509.6 29,396.6 35,941.2 45,659.1 54,846.7 62,227.4 62,975. d. Call deposits 493.2 671.1 685.0 1,234.9 1,767.9 2,165.9 2,985.1 5,441.1 e. Others 1,316.6 1,617.3 2,183.1 2,010.3 2,045.3 2,325.3 3,073.9 2,885.6 3. Borrowings 227.8 602.9 885.3 1,629.5 887.0 1,1,'9.1 3,326.9 2,288. a Nepal Rastra Bank 40.4 424.0 230.6 362.6 381.4 429.6 408.3 365.3 b. Inter-bank 186.9 178.9 654.7 1,266.9 505.6 749.5 2,918.6 1,922. c. Foreign banks 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 18,461.6 19,072.7 24,874.9 29,928.9 36,991.0 38,010.2 35,677.1 50,707.2 TOTAL SOURCES OF FUNDS 73,564.6 83,971.8 100,721.4 117,722.1 145,740.2 172,458.2 202,720.9 241,948. 1. Liquid funds 13,700.0 17,138.8 18,206.0 22,712.6 33,381.4 39,093.1 41,258.9 45,010. a. Cash in hand 1,859.5 2,037.7 2,446.3 2,837.5 2,908.2 3,310.4 3,415.0 4,089.1 b. Foreign currency in hand 459.4 455.7 593.0 627.6 751.1 634.5 717.4 726. c. Balance with NRB 5,452.5 7,429.1 6,494.7 8,757.1 14,144.1 13,912.7 9,978.4 11,381.3 d. Balance with domestic banks 346.2 418.8 -163.2 638.3 426.3 402.1 718.9 488. e. Balances held abroad 5,153.1 6,454.9 7,803.7 7,022.9 9,279.7 9,451.7 14,564.3 14,887. f. Call deposits 429.3 342.6 1,031.5 2,829.2 5,872.0 11,381.7 11,864.9 13,437.3 2. Investments 14,821.6 9,633.8 8,585.3 8,568.9 10,877.5 14,252.4 14,151.6 14,073. a. Govemment securities 9,096.8 8,332.8 7,777.3 8,213.4 10,591.7 13,222.0 13,794.0 13,740. b Shares and debentures 76.8 95.5 127.5 355.5 285.8 1,030.4 357.6 333. c. NRB bonds 5,648.0 1,205.5 680.5 0.0 0.0 0.0 0.0 0.3 3. Loans and Advances 27,347.1 38,779.1 50,891.1 58,378.5 68,652.7 81,758.8 97,056.8 109,952. a Govemment enterprises 742.2 703.0 1,489.3 1,450.9 1,214.0 1,749.4 1,735.4 2,211. Financial 0.1 98.6 236.0 197.1 397.0 490.2 572.3 1,105. non-financial 742.1 604.4 1,253.3 1,253.8 817.0 1,259.2 1,163.1 1,106. b. Private sector 24,996.8 36,609.2 47,389.3 54,736.6 65,023.6 77,501.1 92,974.7 105,544. c. Foreign bill P&D 1,445.4 1,286.7 1,810.3 2,062.9 2,266.1 2,348.2 2,313.2 2,164. d. Foreign A.B.C. 162.7 180.2 202.2 128.1 149.0 160.1 33.5 31.3 4. Interest Accrued 5,233.9 6,202.9 7,723.2 9,074.1 10,619.2 12,932.7 15,196.2 18,810. a Govemment enterprises 517.9 692.8 861.8 545.4 221.5 299.4 597.9 742.3 b. Private sector 4,716.0 5,510.1 6,861.4 8,528.7 10,397.7 12,6-s3.3 14,598.3 18,068. 5. Others 12,462.0 12,217.2 15,315.8 18,988.0 22,209.4 24,421.2 35,057.4 54,100. TOTAL USES OF FUNDS 73,564.6 83,971.8 100,721.4 117,722.1 145,740.2 172,458.2 202,720.9 241,948. Source: Nepal Rasira Bank 60
BOX 4.1 Commercial Bank Problem Analysis and Strategy Study (CBPASS) Financial Sector Reform Programs During the 1980s Reform Measures, Performance and Lessons of Experience
Introduction: Recognizing that a healthy financial sector is a prerequisite for sustained economic growth, the Second Structural Adjustment Lending Program (SAL 11, FY89-91) of the World Bank aimed at correcting the serious portfolio problems of the two-government-owned commercial banks (RBB and NBL); initiating measures to strengthen their financial and operational performance; and improving the legal and institutional environment in the financial sector by enhancing the capacity of the central bank (NRB) to supervise the banking system and implement improved regulations and practices with regard to capital adequacy, loan classification and accounting policies.
Key reforms: The key financial sector policy reforms, which formed the centerpiece of the credit, included:
(a) Strengthen and improve the performance of the two-state-owned troubled banks (RBB and NBL), including provisioning, re-capitalization and debt recovery targets; (b) Start improving accounting, credit processes, budgeting, MIS, liquidity management and computerization by CBPASS (Commercial Bank Problem Analysis and Strategy Study); (c) Prepare an action plan to make current all government-guaranteed loans to public enterprises within three years; (d) Enact a modified Commercial Bank act, NRB Act and NIDC Act to enable NRB to exercise necessary supervisory control over financial institutions; (e) Establish an effective Credit Information Bureau, and implement TA studies to provide the basis for further improvement of the banking system.
Implementation: Following the completion of the CBPASS in 1990, the centerpiece of the reform program, the government adopted its main recommendations to strengthen the banks by:
(a) re-capitalizing them and by enabling them to make adequate provision for non-guaranteed bad debts. Consequently, in March 1991 the government introduced a Supplementary Budget to provide NR 443 million for re-capitalization of the two banks and a furnher NR 3.12 billion for provisioning and repayment of bad debts (including NR 1.2 billion for private loans and NR 1.9 billion for public enterprise debt. The total was equivalent to around US$100.0 million at prevailing exchange rates. The Government also vested the NRB with the responsibility of implementing specific measures to strengthen the two state-owned banks, and announced that itwould no longer provide loan guarantees to public enterprises. NRB proceeded to carry out this mandate and the provisioning and re- capitalization of the two banks was completed by July 1991; (b) Separate Loan Recovery Departments were established in RBB in March 1991 and in NBL in May 1991; (c) Guidelines on a new system of loan classification and accounting policies for interest suspension and provisioning (based on CBPASS methodology) were also issued to all commercial banks in May 1991; (d) A payment of government guaranteed bank loans to public enterprises of NR 400 million took place in 1990, followed by a second payment of NR 260 million in 1991; (e) UNDP technical assistance focusing on institutional development, the restructuring of the two banks, and assessing the viability of their branch net work was also initiated; (f) Technical assistance was also provided by the IMF to strengthen the banking supervision and inspection functions of the NRB; (g) Legislative changes were enacted to permit the NRB to supervise NIDC; (h) The amendments of the Commercial Bank Act and the NRB Act were both gazetted in October 1989; while the amendment of the NIDC Act was enacted in January 1990; (i) A Credit Information Bureau was set up 1989, and 100 large defaulters were blacklisted and denied further access to credits, and; 61
(j) Debt recovery targets were established for the two banks.
Problems: Despite concerted efforts, the reforms were not successful in their primary objectives of bringing about fundamental changes needed to transform the two banks into viable commercially-oriented institutions. The reforn program failed to restructure the two large banks and bring changes in the culture of their management, operational standards, and portfolio quality. No consensus was reached on what should be done with regard to the branches or how the banks themselves should be restructured. In part, this was due to the lack of clear vision on the part of the Government as to the roles of these two banks - whether they should continue undertaking a multiplicity of functions (including broader development and social objectives), or whether they should be commercially-oriented, whether they should remain in the public sector or be privatized. These issues remained unresolved and constrained the evolution of a clear strategy for restructuring. In part, the program design itself probably contributed to this inconclusiveness. Besides, there was no clear agreement at the time of the formulation of the program on how, when and what form the restructuring of the banks would take place. This was expected to fall out of the recommendations of the CBPASS and to be agreed later on. There were significant differences between the Government and the World Bank staff about what the appropriate approach to further reform/restructuring should be, and what specific commitments the program entailed for the Government in this regard. A weak and inefficient apex body, the central bank, further accentuated these problems.
Lessons Learned: The basic causes of the weakness of the financial sector reform program were: (a) Lack of commitment of the Government to change its basic attitude towards the state-owned banks, including a much stronger emphasis on commercial orientation and on preparation for eventual privatization; (b) The absence of an Action Program did not require the Government to introduce drastic changes in the managerial culture to ensure that managers were professional with autonomy and accountability; (c) There was a lack of specific fundamental reforms needed to achieve a major improvement in financial and operational performance of the banks.
Sources: (a)Project Completion Report, Nepal Second Structural Adjustment Credit, March 21, 1994, The World Elank and (b)The OED Performance Audit Report for the Second Structural Adjustment Credit, May 17, 1995. 62
CHAPTER FIVE Development Banks anid the Post Office Savings Bank 1. Introduction The two government owned development banks, the Agricultural Development Bank of Nepal (ADB/N) and the Nepal Industrial Development Corporation (NIDC), together account for about 7.5 percent of the total assets of the financial sector. These banks were established to ensure that credit was available for industrial and agricultural development, small scale irrigation projects, agriculture-based cottage and small industries, and for tenant farmers to purchase land. These banks basically target small and medium scale agricultural industries and industrial enterprise development. More recently, 5 private development banks have been established and there are more then 40 new applications currently with Nepal Rastra Bank (NRB) to establish development banking institutions. One of the reasons cited for this extraordinary interest in development banking is the restriction by NRB on the issuance of new commercial bank licenses. Furthermore, there is an expectation that the new proposed banking legislation will shortly be passed (the proposed new Banking and Financial Institutions Act) and, if passed by parliament, would bring all deposit taking institutions under one umbrella - in a universal banking concept. The new private development banks (of which three operate at the national level) belie these views, however, and engaged in industrial development activities involving lending for project finance in areas of hydro power, aviation, hospitals and education. These banks are constrained by their availability of long term funds due to legal and regulatory problems surrounding the issuance of bonds. Nonetheless, they have so far managed to generate sufficient fixed term institutional deposits and have performed reasonably well. With more private sector involvement, the face of development finance in Nepal appears to be changing for the better. 2. The Agricultural Development Bank of Nepal (ADB/N) The ADB/N was established in 1968 by the Agricultural Development Bank Act of 1967 and was a successor to the Government sponsored Cooperative Bank. It was mandated to supply credit for agricultural development, small scale irrigation projects, agriculture based cottage and small industries, and credit for tenant farmers for purchasing land. The bank is majority (93 percent) owned by the Government of Nepal through the Ministry of Finance. Other shareholders include Nepal Rastra Bank (6 percent), and small farmers who are borrowers of ADB/N. Initially borrowers could buy shares (NR 100 each) of the bank as a percentage (0.01) of their borrowings, thereby permitting the transfer of the ownership of the bank to the farmers. This scheme was later abandoned and borrowers were only allowed to purchase a single share regardless of the size of their borrowing. Currently, farmers own only I to 2 percent of the shares in ADB/N. In 1973, the Land Reforms Savings Corporation was also merged with ADB/N. Over the years, several amendments were made to the ADB/N Act allowing the bank to: finance small farmers on a group liability basis; finance cottage industry; and launch the Small Farmer Development Program (SFDP) as a pilot in 1975. The most important change, however, took place in 1984/85 when ADB/N was permitted to engage in commercial banking activities so as to access a larger and lower cost funding base.
ADB/N is the third largest bank in Nepal (after NBL and RBB) in terms of assets and deposits and largest in terms of branch network - 610 branches in all 75 districts of the country. It has an asset base of NR 28.7 billion and provides short, medium and long term loans to individual farmers, farmer groups, corporates, and village committees. The loans are intended for purchase 63 of inputs and capital items such as fertilizer, insecticides, feed, farm machinery, irrigation equipment and canal construction equipment. Loans are also provided for the purchase of livestock, construction of cold storage and ware-housing, and for marketing assistance. In addition, ADB/N provides training to its beneficiaries and its own staff through a training institute. There are different investment processes for its main activities i.e. agriculture development, SFDP and commercial loans. These are discussed below. ADB/N has access to a deposit base of NR 17.7 billion of which current and saving deposits account for 71 percent and fixed term deposits only 29 percent. This ratio has substantially skewed towards savings deposits over the last few years as until 1998 fixed deposits accounted for nearly 50 percent of the total (details of sources and uses of funds are provided in Table 5.1). Although, savings deposits are considered stable and 50 percent of ADBlN's agriculture loans are short term, its growing dependence on these short term deposits to fund a long term loan portfolio is cause for concern. ADB/N also has access to cheap long term funds from NRB through its refinance window; as well as from borrowings from commercial banks under the umbrella of priority sector lending. Until the mid 1990s it also had access to lines of credit from the Asian Development Bank which were subsequently discontinued due to weak accounting policies, low recovery rates and concerns over governance. In line with the ADB's Institutional Strengthening Program, ADB/N is focusing on improving collection rates and closing poorly performing branches. Reforms implemented over the last few years have reportedly reduced the level of non performing assets in the bank to 15 percent - although they are still above acceptable levels to maintain a viable banking institution.
Besides an agriculture development division and a commercial banking division, ADI3/N operates a small farmer development division which manages and controls the SFDP. The objective of this program is to bring deprived small farmers, landless laborers, and other disadvantaged groups, into the mainstream of development by providing loans to finance economic activities. However, during the l 980s repayments fell and operating costs of the program rose substantially. This led to a restructuring of the SFDP and, in 1987, an Institutional Development Program with the assistance of GTZ was initiated. Under the program, Sub-Project Offices (SPOs) of ADB/N were converted to Small Farmer Cooperatives Ltd. (SFCL) and to date around 100' SPOs have been converted. Due to weak management, ADB/N has only managed to reach 10 percent of the targeted small farmer population of 2 million. Given this poor performance and limited outreach it was recently decided to hive-off SFDP into a separate and independent Small Farmer Development Bank owned jointly by ADB/N, two private banks (Nepal Bank Limited and Nabil Bank) and the Small Farmer Cooperatives. ADB/N is now awaiting approval/issuance of a banking license from NRB before the SFDB can commence operations.
ADB/N's funding constraints and commencement of commercial banking activities has resulted in a reorientation of the bank away from development banking activities. ADB/N's 30 urban branches are now conducting commercial banking business and these numbers are reported to be rising. Moreover, unlike other development banks, ADB/N has its own Act and is not governed by the Development Bank or the Commercial Banking Act. As a result, it has not been regulated by NRB, despite the fact that it is an important deposit mobilizor within the economy. There has been only one formal inspection of ADB/N by NRB - carried out more than thirteen years ago. Although, some individual branches have been inspected over the past few years, a lack of supervision and absence of regular audits is a serious concern. In addition, ADB/N has not submitted its annual audited accounts to NRB for the past three years.
The management of ADB/N claims that deposits raised by commercial banking branches are lent in rural areas, however, urban credits have been increasing and now account for nearily 30 percent of the total lending portfolio. Notwithstanding this, ADB/N lending to agriculture accounts for 64
more then 70 percent of total agriculture credit from the banking system. In the agriculture sector, it lends for agricultural production, farm improvement and irrigation, agro-businesses, agro-industry, marketing and warehouse construction (see table 5.2 for details). About 70 percent of its total lending is in agriculture and micro credits. The portfolio is split 50, 40 and 10 percent between short, medium and long term loans which range from 7 to 15 years. It has recently applied for a NR 1.0 billion credit line from NRB for a period of 5 years to finance tea plantations. Commercial loans are primarily (90 percent) short term working capital loans with the remaining 10 percent mainly extended for hire-purchase of motor vehicles.
The financial performance of ADB/N appears to have improved over the last three to four years. Due to a rising deposit base (with an average cost of 4 percent) it only borrowed NR 300 million from NRB over the last 3 years from the refinance window (at 6.5 percent). Borrowing from commercial banks comes under the umbrella of mandatory priority sector lending and only costs the bank 3.5 percent. Recently, it has also been reducing the share of its more expensive fixed term deposit base and increasing short term current and savings deposits. The latter have grown substantially and now account for 71 percent of all deposits. However, the high level of administrative costs - 41 percent of total expenses - indicates that the institution requires radical restructuring to be operationally efficient.
Over the past decade, the Government has injected fresh equity into the bank to strengthen its capital base. In 2001, total paid up capital was NR 1.5 billion which is three times the minimum capital requirement for a commercial bank. In addition, the bank had general reserves of NR 107 million. Based on recommendations by PriceWaterhouse in the late 1990s, the bank has provided 7 percent in loan loss provisions based on the outstanding loan portfolio. Nonetheless, there is likely to be a shortfall in provisions given that the bank is presently reporting 15 percent in non performing loans - which, in reality, may be as high as 30 percent. In addition, ADB/N has not provided for outstanding contingent liabilities which are estimated to be about NR 1.2 billion.
ADB/N management has initiated certain reforms endorsed by the Government for viability and sustainability of the bank. Components of these reforms include; accounting transparency, the concept of 'responsibility centers' for branches (introducing transfer pricing and loan loss provisioning at the branch level), better management of financial indicators, measures to improve portfolio quality and repayment systems, and enhanced training. There is also an understanding with the Asian Development Bank that it will provide technical assistance to support ADB/N's planned restructuring. 65
Table 5.1: Assets and Liabilities of the Agricultural Development Bank of Nepal (ADB/N) - in NR's millions
Capital Reserves Deposits Borrowing Other Liabilities Total Liabilities
1990 270.1 9.2 1,770.2 1,833.1 738.3 4,620.9 1991 275.2 9.2 2,354.0 2,196.3 831.6 5,666.3 1992 292.3 9.2 3,127.9 2,218.9 764.0 (6,412.3 1993 301.5 11.0 4,227.1 2,049.9 1,570.7 S,,160.2 1994 895.3 12.3 5,319.7 3,144.4 1,301.7 10,673.4 1995 996.0 14.4 6,425.9 3,963.7 1,714.7 13,114.7 1996 1,164.4 16.2 7,495.4 4,415.2 2,178.1 15,269.3 1997 1,284.6 21.2 8,870.6 4,791.6 2,298.6 17,266.6 1998 1,285.0 31.3 10,194.8 4,773.5 4,411.1 20,695.5 1999 1,419.4 42.2 12,877.1 4,838.5 5,377.3 24,554.5 2000 1,449.6 56.1 15,456.6 4,775.1 3,661.5 25,407.9 2001 1,491.4 60.0 17,730.0 4,761.7 4,614.3 28,657.4
Agricultural Commercial Investments Cash & Other Assets Total Assets Loans Loans Bank Balances 1990 2,984.6 0.0 179.2 419.9 1,037.2 4,620.9 1991 3,328.6 32.1 242.2 522.7 1,540.7 5,666.3 1992 3,655.3 107.4 309.2 772.7 1,567.7 6,412.3 1993 4,256.7 306.4 409.5 1,152.5 2,035.1 8,160.2 1994 5,311.8 1,085.1 890.8 1,084.1 2,301.6 10,673.4 1995 6,580.5 1,877.8 969.0 1,318.2 2,369.2 13,114.7 1996 7,689.3 2,489.3 1,110.2 1,655.2 2,325.3 15,269.3 1997 8,839.6 3,067.1 1,277.6 1,592.9 2,539.4 17,266.6 1998 9,765.9 3,511.6 1,261.0 1,854.9 4,302.1 20,695.5 1999 11,094.3 3,838.9 2,410.2 2,146.0 5,065.1 24,554.5 2000 12,576.2 4,382.4 2,525.1 2,653.7 3,270.5 25,407.9 2001 14,539.0 5,549.0 2,650.6 2,885.2 3,033.6 28,657.4 SOURCE: Nepal Rastra Bank QuarterlyEconomic Bulletin (various)
Table 5.2: Total Investment in Agriculture (up to 2001)
Industry Investment Investment (NR in millions) (percent) Agricultural Production 3,204.5 21.6 Farm Improvement & Irrigation 2,733.6 18.4 Agro Business 3,136.6 21.1 Agro Ind., Mkt. & Warehouse Construction 4,989.2 33.6 Miscellaneous 791.5 5.3 TOTAL 14,855.4 100.0 66
3. The Nepal Industrial Development Corporation (NIDC) NIDC was established in 1959 with the conversion of the Industrial Development Corporation through a special charter to provide financial and technical assistance to industries in the private sector. The scope of its activities was further expanded with the enactment of the NIDC Act in 1989. While the primary objective of NIDC to facilitate private sector industrial development remained the same, the Act also empowered NIDC to extend loans against hypothecation, issue guarantees, sell and purchase shares, offer underwriting services, perform merchant banking functions, and provide banking facilities under the provision of the Commercial Banking Act. As Nepal Rastra Bank regulates development finance institutions and commercial banks under the Development Bank and the Commercial Bank Acts, NIDC - like the ADB/N - has not been properly regulated. Since its inception 43 years ago, NIDC has only been inspected by NRB once (in 1998).
NIDC is a significantly smaller institution than the ADB/N with only about US$35 million in total assets (July 2001). The Government of Nepal is the largest shareholder with 86.14 percent of the institution's shares. Other shareholders include Nepal Rastra Bank - 7.8 percent, DEG Germany - 5.2 percent and general public - 0.8 percent. Five of the seven board members are appointed by the Government, including three from the Ministry of Industry, one from the Ministry of Finance and the General Manager of NIDC. The other two members represent the general public and the NRB. Investment decisions are approved by a 3 member management committee under the Board. The committee is chaired by the General Manager/Chairman and includes the Deputy General Manager and one other Board member. Government interference in the selection of investment projects has been excessive and while NIDC has more than 100 technically qualified staff from various fields (out of a total 228 employees), interference in operations has been excessive and most lending decisions are based on Government preferences. The failure in govemance is most visible in the frequent changes of General Manager appointed by the Govemment - there have been five General Managers over the past three years.
Although, allowed to undertake various merchant and commercial banking activities, NIDC has restricted its operations primarily to long term industrial loans which account for 77 percent of its total assets. A small proportion of its activities include short term loans to industries, investment in shares and govemment securities (Table 5.3 provides details on the sources and uses of funds). NIDC's main funding comes directly from the central bank through a refinance facility. In 2001, borrowings from Nepal Rastra Bank represented 64 percent of total borrowings and 48 percent of total borrowings and deposits. Borrowing from the Govemment and the commercial banks - under the subsidized priority sector window account for 36 percent of total borrowings and 28 percent of the funding base. NIDC accepts term deposits from institutional depositors which account for 24 percent of its funding. This source of funding, however, is very limited due to the weak financial position of the Corporation. In addition, NIDC has also issued an industrial development bond to Nepal Rastra Bank and, until 1995, accessed credit lines from KFW and IDA. These extemal credit lines ceased after this date due to the weak financial position and poor govemance of NIDC. The financial difficulties of NIDC have worsened over the last few years when it has not been able to meet its current obligations to NRB. As a result, NRB has rescheduled its NR 1.0 billon loan for a 5 year period at a lower rate of interest.
NIDC's loan portfolio is mainly in long term industrial loans. Since its inception, NIDC has financed some 1,125 projects for a total investment of NR 5.6 billion (see table 5.4 for details). The largest share (about 24.2 percent) has been in the hotel and tourism industry followed by the food and allied group (23.7 percent). Other investments are in textiles, construction, health and education. Projects in the central district account for 55 percent of the total, 27 percent are in the 67
West and the remaining 18 percent are in the East, mid West and far West. Loans and advances have declined over the last 4 - 5 years as a consequence of declining financial resources. NIDC has also discontinued investments in shares and other securities due to financial problems.
It is difficult to assess the financial performance of NIDC given the absence of up-to-date and audited financial statements. Analysis is therefore based on provisional data providedi by NIDC and NRB. This information indicates that NIDC has been incurring losses for the lasi four years resulting in an erosion of its capital base. In 2001 alone, NIDC incurred an operating loss of NR 100.0 million. Overhead expenses are high and account for nearly 30 percent of total non interest costs - liquidity problems have worsened this situation further. Non-performing loans and poor collections have also rendered NIDC insolvent.
According to NIDC management, it has been following the development bank regulations of NRB for loan classification and provisioning. It is estimated that around 45 percent of the total loan portfolio, in terms of amount, and nearly 60 percent, in terms of number of projects, is not performing. Indeed, the NPAs are likely to be even higher than these levels. Hence, NIDC is operating with a substantial negative net worth - roughly estimated at NR 1.0 billion. Government interference and financing of large publicly supported projects have been the main causes of these problems. A handful of large Government projects in default account for a substantial portion of the total loan portfolio.
Three national private development banks have been established since 1998. Despite constraints with respect to access to long term funds these institutions have performed reasonably well - maintaining lean operations with low overhead costs. In a short span of time, they have managed to attract considerable term deposits and are involved in industrial financing for important sectors of the economy. As political instability and the slow down in economic activity has impacted, in particular, the textile manufacturing and hotel/tourism industry (the two key sectors in terms of their contribution to GDP - after agriculture), these development banks have started financing other potentially viable and growing sectors including; hydro power, aviation., hospitals, education, housing and information technology. One of these banks, the Developrnent Credit Bank, recently offered its shares to the general public and the offering was 14 times oversubscribed. The increasing role of the private sector in industrial financing leaves little justification for continued Government intervention in this sector.
It is important that a decision regarding NIDC be made without further delay. NIDC's financial position is constantly deteriorating and the sooner a decision is made the less costly it will be for the Government to resolve the problems of the corporation. In making a decision on NIDC's future, the following points need to be considered:
(a) the rationale for maintaining a state owned institution for industrial development (has NIDC been able to achieve the objectives for which it was established?); (b) interest by private sector institutions in industrial financing (three national level banks have been established since 1998 and there is growing interest); (c) the market and the regulators do not perceive NIDC to be playing a meaningful role; (d) if NIDC is to be retained, can it be made commercially viable; (e) what will be the cost of reviving the institution - compared to closing it down; and (f) given interest from the private sector - is the privatization of NIDC a feasible option. 68
Table 5.3: Assets and Liabilities of NIDC (NR thousands)
Capital Reserves Domestic Foreign Other Liabilities Total Liabilities Borrowing Borrowing 1990 258.4 91.8 427.7 215.5 124.1 1,117.5 1991 277.9 118.6 461.7 205.5 179.4 1,243.1 1992 277.9 98.4 492.4 206.2 128.3 1,203.2 1993 297.9 116.7 571.8 253.3 67.3 1,307.0 1994 307.9 124.8 571.4 288.8 78.5 1,371.4 1995 307.9 128.6 693.7 287.4 100.9 1,518.5 1996 312.4 173.4 785.6 285.2 530.2 2,086.7 1997 317.4 179.3 1,134.8 284.1 760.3 2,675.9 1998 317.4 131.4 1,253.9 284.1 790.6 2,777.4 1999 347.4 60.7 1,207.4 284.1 883.8 2,783.4 2000 372.4 2.7 1,170.7 281.3 711.8 2,538.9 2001 415.8 0.0 1,136.9 281.3 856.7 2,690.7
Direct Stock Investments Cash & Other Assets Total Assets Loans Participation in Govt. Bank Securities Balances 1990 838.2 95.4 0.0 66.4 27.5 1,117.5 1991 855.2 84.2 1.5 68.1 94.7 1,243.1 1992 858.7 92.6 1.5 71.5 178.9 1,203.2 1993 881.2 108.0 10.9 146.7 160.2 1,307.0 1994 961.3 104.2 7.1 119.8 179.0 1,371.4 1995 1,139.9 104.6 1.0 118.3 154.7 1,518.5 1996 1,706.8 106.3 1.0 95.9 176.7 2,086.7 1997 2,193.7 115.2 1.1 180.6 185.3 2,675.9 1998 2,254.9 115.2 1.1 203.7 202.5 2,777.4 1999 2,204.8 115.2 1.1 240.1 222.2 2,783.4 2000 2,023.9 115.2 1.1 146.1 252.6 2,538.9 2001 2,069.6 115.2 0.0 206.2 299.7 2,690.7 SOURCE: Nepal Rastra Bank, Quarterly Economic Bulletin (various)
Table 5.4: Total Investment by Industry (up to 2001) Industry No. of Projects Projects (percent) Hotel & tourism 199 17.7 Food & allied 254 22.5 Textile related 94 8.4 Construction & Development 146 13.0 Education related 73 6.5 Health related 41 3.6 Others 318 28.3 TOTAL 1,125 100.0 69
4. Sector/Institutional Issues Some of the critical sectoral and institutional issues include:
* Legal Arbitrage. One of the major issues with respect to these development banks is the potential that has been created for legal arbitrage. This has resulted in poor governance within the government owned development banks. New banking legislation is currently under discussion which, if approved, would bring all deposit taking institutions under one umbrella and, importantly, the supervision of NRB. However, if for any reason the new legislation is not approved, then both the NIDC and the ADB/N Acts should be repealed and they should be incorporated under the Development Bank Act.
* Government Interference. Government interference in lending decisions and defaults by state owned corporations is a major cause of deterioration within the two large development banks. Radical restructuring of these institutions, involving private sector participation in ownership and management as well as strict regulation, is needed to arrest the situation before it becomes an even greater liability.
* Weak regulation of commercial and non-bank financial institutions, particularly government owned development banks, is of serious concern as this has led to a deterioration within some of the public as well as some of the private financial institutions.
* Priority Lending. NRB requirements that commercial banks lend 12 percent of their assets to priority/ deprived sectors has provided a cheap source of funding to government owned development banks creating a serious distortion in the market.
* Issuance of Bonds. Legal and regulatory obstacles with respect to the issuance of bonds is constraining growth of the private sector development banks. Measures to remove these impediments will help develop a much needed long term private debt market in Nepal. 5. The Postal Savings Bank The Postal Savings Bank (PSB) was established by the Government in the mid-1970s (25 years ago) as a vehicle to provide basic financial services to the rural areas not catered by commercial banks. Rural savings are mobilized through a network of 116 Post Office Savings Banks operating in all 75 districts of Nepal. These savings were mobilized for the Government account until 1995 when HMG/N permitted the PSB to retain these deposits and allowed it to maintain its own deposit accounts. The savings collected by the Postal Savings Bank are now deposited with RBB at the local level and NRB at the center. The interest earned on these deposits is distributed to the depositors of the PSB. As the PSB pays a higher interest rate (7 percent) than it earns on its deposits (4 percent), the Government is obligated to finance the difference. Due to positive funds inflows, however, the Government has so far not had to meet this cost.
The Postal Services Act of 1963 empowers the Postal Service to provide financial services ('agency services'). The PSB operates under the framework of the Postal Savings Bank regulations. PSB is governed by a Postal Savings Bank Consultative Committee (PSEICC) under the Ministry of Information and Communications and is also responsible for making policy recommendations to the Government. The PSBCC is a five member Committee with the Secretary of the Ministry of Information and Communication as its Chairman. Other members 70 include; Chief of the Post Office Savings Bank and the Central Money Order Office, a representative of Nepal Rastra Bank, the Ministry of Finance, and the Director General of Postal Services. Under PSB regulations, the Committee is required to meet at least twice a year.
Although there are some 6,000 postal offices around the country which operate under 827 area hubs, the PSB only offers its services through 116 of these area offices. Money order services, however, are offered through 519 outlets at the area level. The PSB holds total deposits of NR 8.0 million of which NR 6.5 million are maintained at the local level and the remaining NR 1.5 million are held by the central office. In 1963 the PSB started with a minimum deposit requirement of NR 5. However, after reforms in 1999 the minimum deposit requirement was increased to NR 100 and 50 percent of the PSB's non operative accounts were closed bringing the total number of account holders down to 8,000 in 2002.
The Government is planning further reforms which are likely to commence in 2002. It also plans to allow the PSB to lend up to a maximum of NR 10,000 to its employees at market rates of interest for a period of one year. This scheme is reasonably secure and is a step toward making the PSB self sustaining. With some training, computerization, and adequate security, the PSB could reach out to a much larger population. However, these services should primarily be targeted at the more remote rural areas where normal banking services are lacking.
6. Recommendations The Agricultural Development Bank of Nepal (ADB/N)
* A radical restructuring of the Agricultural Development Bank of Nepal is long over due. In addition, it is also important to continue pursuing the reforms already initiated and those agreed to with the ADB. As the bank becomes more commercially viable, ADB/N shares could be sold to the general public. To improve performance, professionals from the private sector should be brought into management and board positions.
* Current plans to convert and separate the Small Farmer Development Program into an independent institution with participation of private banks is a step in the right direction. Eventually, it should be completely privatized.
* The commercial banking activities of ADB/N should be restricted, in particular, the mobilization of retail deposits and the issuing of bank guarantees. Separate accounts for commercial banking should be required which would help in identifying risks within each area of business and assist NRB in regulating the ADB/N.
* Given the prominence of the ADB/N within the overall banking system - it would be useful for Nepal Rastra Bank to undertake some additional brainstorming on the role and future direction of this institution in conjunction with the ADB, the IMF and the World Bank.
The Nepal Industrial Development Corporation
* Increasing private sector participation in industrial financing leaves little justification for Government intervention in the sector. In addition, existing private sector development banks are potentially interested in acquiring the NIDC. The Government can, as a first option, try selling NIDC to private investors already in the business or to new groups interested in this area. 71
* NIDC, without further delay, should be restricted from further lending and deposit taking activities.
* The staff of NIDC should focus on collection of non performing loans and monitoring of the existing portfolio. These efforts would not only help make NIDC more attractive in the event of a potential privatization/merger but would also reduce costs to the Government in the event that no private parties are interested in acquiring NIDC.
* In the event that no private parties are interested in acquiring NIDC - it should be rapidly liquidated.
Other
* Private bond markets are currently non existent in Nepal due to a number oi legal and regulatory impediments. Their development would provide an alternate funding avenue for private sector development banks and other financial institutions - as well as assisting industrial development in Nepal. Removing the impediments to the development of such markets should be immediately instigated. 72
CHAPTER SIX The Finance Companies Of Nepal 1. Introduction The first finance company, the Nepal Housing Development Finance Company Limited, began operations in 1992. Since then and, over a relatively short span of time, the number of finance companies has grown rapidly to 48 (by 2001). A detailed listing of Finance Companies is provided in Annex Four. These companies make up 6.5 percent of the total assets, 6.6 percent of the total deposits and 9.8 percent of the total credits of the banking system compared to 0.6 percent, 0.4 percent and 0.8 percent respectively in 1994 (excluding the NRB). This rapid growth in the number of finance companies has also been accompanied by a corresponding rapid increase in the level of total assets that they hold. Total assets of the finance companies rose from NR 0.4 billion in 1994 to NR 15.8 billion in 2001 - reflecting an annual average growth rate of over 68 percent over the seven year period (see Table 6.1).
Of 48 companies, 35 (73 percent) are located in the Kathmandu Valley and the remaining 13 are in other urban areas - largely ignoring rural locations for their operations. The industry is unevenly distributed with wide variations in the asset size of companies. By size of assets, in 2000, the two largest companies controlled over 13 percent of the market with total assets of over NR 1.7 billion. The top five companies controlled over 33 percent of assets - NR 4.4 billion. Three finance companies have joint ventures with foreign partners (with Young Lian Realty of Malaysia, Alpic Finance of India and the International Finance Corporation holding minority shares). At present, 18 finance companies have been listed in the NEPSE and their total market capitalization was NR 890 million (as of March 2000). To undertake merchant banking functions, these companies must be registered with the Securities Exchange Board and with the NEPSE (Nepal Stock Exchange). 2. Characteristics of Finance Companies Services and Credits. These companies offer a wide range of services. Tern loans, housing loans, hire purchase, and leasing are the main fund based services while merchant banking services - including issue management, underwriting, investment management, portfolio management services, and so on - are the main non-fund based services. Total loans outstanding by July 2001 were NR1O.9 billion from a very low base of NR 0.2 billion in 1994 - an annual average growth rate of over 75 percent over this period. Term loans represented 43 percent of the total, followed by housing loans (27 percent), hire purchase (20 percent), and leasing (3 percent). See Table 6.1.
Resource Mobilization. Finance companies have been very effective in mobilizing resources. Fixed deposits, which were NR 0.2 billion in 1994, had grown to NR 11.7 billion in 2001, an annual average growth rate of over 79 percent over seven years. In order to supplement their funds, these companies have also borrowed from commercial banks and these funds amounted to NR 215 million in FY 2001 compared to NR 83 million in 1999. Finance companies are also allowed to issue debentures with the prior approval of the NRB to supplement their financial resources - although none have issued any debentures to date.
Investment in Government Securities. Finance Company investments in government securities and NRB bonds amounted to NR 1.3 billion in 2001 compared to NR 1.3 billion in 1999 and such investments represented over 11 percent (2001) and 16 percent (1999) of total deposits mobilized. 73
Profitability. A majority of finance companies have been able to make profits. Out of 46 companies (in 2000), 42 companies made profits of about NR 261 million and 4 companies were in loss of about NR 8.8 million. Total profits of the 48 companies in operation by 2001 was NR 349 million - up from NR 252 million in 2000.
3. Regulatory and Supervisory Framework for Finance Companies Regulatory Framework. All finance companies are established under the Finance Companies Act 1985, which governs their incorporation, registration, management, and scope of activities. These companies come under the regulatory framework of Nepal Rastra Bank which sets out directives relating to the minimum liquidity ratio (8 percent of deposits), financial resource mobilization ratio (10 times core capital), term of fixed deposits allowed ( 3 months to 6 years), single borrower limit (25 percent of fund based and 50 percent of non-fund based loans), maximum interest rate spread (6 percent), sectoral lending limits (60 percent in any defined sector), rules relating to the provisioning for doubtful debts, and minimum capital requirement for the establishment of a finance company (between NR 2.5 million to NR 60 million).
Supervision and Inspection. Presently, the Non-Banking Operations Department of the NRB supervises the finance companies, as deposit takers and lenders. The NRB is undertaking both off-site and on-site supervision of these companies. Supervision is weak and long reporting lags are currently experienced (see chapter on Banking Supervision). 4. Issues Low Credibility. Many of the finance companies have low credibility in the financial markets. Weak managerial capability, family domination, lack of transparency in their transactions, poor accessibility, weak accounting and auditing practices, long delays in the publication of their financial statements, delays in the issuance of shares to the general public, lack of innovation, and poor professional background of the promoters are some of the factors that have lowered the credibility of these companies, posing constraints to their growth.
Poor Regulatory Framework One of the critical issues for the finance companies is the inappropriate, rigid and poor regulatory framework of the NRB which also constrains their growth. The present regulations, particularly relating to capital adequacy, liquidity, ceiling on deposit mobilization, single borrower limits, and sectoral lending limits have been found rigid and inappropriate and have hindered their financial resource mobilization efforts and thereby limited their capability to lend with negative impact on the sustainability of their operations. Presently, NRB is preparing comprehensive regulations for these companies against which existing directives are expected to be reviewed. Although these companies furnislh financial information to the NRB, the information is of poor quality and inadequate to provide a full picture of their true financial heath.
Financial Sustainability. Their low capital base and higher transaction costs, combined with growing competition from other financial institutions in the areas of resource mobilization and allocation, have raised the issue of the sustainability of these companies. Lack of detailed information on the operations of the finance companies, particularly information on non- performing loans, repayment rates, management costs (staff and office operation costs) have made the analysis of the sustainability of these companies extremely difficult. Given their low capital, small resource base, and an interest rate structure with relatively high rates on deposits - sustainability is an issue. Many of these companies are thought to be surviving on the strength of inflows of new deposits as opposed to their income stream. 74
Higher Concentration and Growing Competition. Since the finance companies are concentrated in urban areas, they face increasing competition from other financial institutions. While their main competitors are the commercial banks and development banks, the large and growing number of cooperatives are also beginning to affect their operations, in financial resource mobilization, allocations, as well as the cost of capital. Although these companies are focusing on areas neglected by the commercial banks and others - such as hire-purchase, leasing and housing -. the general perception is that they attract clients that have been rejected by the banks. More recently, with increasing excess liquidity and declining interest rates in the banks, these companies have become even more vulnerable.
Weak Supervision. The NRB has established a Non-Banking Supervision and Inspection Department which supervises and inspects finance companies mainly to ensure their compliance with various NRB directives and to check that operations are in line with their credit policy guidelines. However, the frequency and the comprehensiveness of the supervision - both off-site and on-site - by the NRB is low and inadequate. This lack of prudential oversight has led to a further deterioration of the financial discipline within these companies which could emerge as a problem in the future.
Self dealing. According to a study carried out for the ADB, the risk of family combines using the finance companies to obtain public deposits to fund high risk activities within their business groups (self dealing), is high, and a cause for concern. There was also a perception that some weak units were functioning like ponzi schemes, sustaining high interest payments on deposits by incoming new deposits. 5. Recommendations (a) In view of their low capital base and growing competition (in the area of resource mobilization and its allocation), as well as an increasing cost of funds, there needs to be a shake out of the sector - through mergers and acquisitions. Alternatively, some of these companies could enter into joint ventures with foreign partners so as to remain/become efficient and sustainable units.
(b) The NRB directives governing these companies need to be reviewed and amended to allow greater flexibility. The regulations could be reviewed to make it attractive for them to operate in semi-urban and rural areas, and in the sub-sectors neglected by other financial institutions, but only after proper supervision is in place.
(c) Up-graded NRB supervision will be important. The NRB should initially develop a more robust off-site supervision system, to be followed in time by a reinforcing system of on- site supervision.
(d) The NRB should undertake a complete audit of the finance companies to benchmark their current status as well as to check undesirable practices. 75
Table 6.1: Financial Performance of Finance Companies
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 No. of Companies 6 20 34 41 43 45 46 48 Millions of NR Capital Fund 1/ 97 246 515 726 900 1229 1490 1929 Of which: Paid-Up Capital 94 232 485 636 733 838 945 1221 Loan Loss Provision 2 8 21 53 117 213 286 395 Total Deposits 196 648 1731 3700 6387 8037 9749 11654 Liquid Funds 2/ 84 96 125 342 453 1134 1729 2049 Loans & Advances 217 671 1853 3667 5478 7219 9063 10865 Of which: Hire Purchase 134 302 532 680 964 1304 1640 2152 Housing Loans 30 177 505 1002 1586 2004 2340 2965 Term Loans 53 131 730 1674 2207 3105 4239 4704 Leasing 0 26 55 185 310 260 235 278 Investments 3/ 80 234 285 755 1759 1262 1129 1268 Of which: Government Securities 3 35 98 413 1441 932 843 837 Others 77 199 187 342 316 330 286 431 Profit/Loss (-) n.a n.a n.a n.a 193 159 252 349 Total Assets 4/ 411 1096 2500 5117 8429 10665 13059 15812 Growth Rates (%) No. of Companies 233.3 70.0 20.6 4.9 4.7 2.2 4.3 Capital Fund 152.2 109.9 40.9 24.0 36.5 21.2 29.5 Of which; Paid-Up Capital 147.8 109.0 31.0 15.3 14.3 12.8 29.2 Loan Loss Provision 243.5 165.8 152.9 120.0 82.5 34.1 38.1 Total Deposits 230.8 167.2 113.8 72.6 25.8 21.3 19.5 Liquid Funds 14.3 30.0 174.9 32.2 150.5 52.5 18.5 Loans & Advances 208.5 176.3 97.9 49.4 31.8 25.5 19.9 Of which: Hire Purchase 125.1 76.3 27.8 41.8 35.2 25.7 31.2 Housing Loans 481.9 185.3 98.5 58.3 26.4 16.8 26.7 Term Loans 148.1 456.9 129.4 31.9 40.7 36.4 11.0 Leasing 107.2 239.4 67.7 -16.2 -9.5 18.3 Investments 194.2 21.6 165.3 133.0 -28.2 -10.5 12.3 Of which: Government Securities 1073.3 177.3 323.4 248.7 -35.3 -9.6 -0.7 Others 159.7 -5.9 82.7 -7.6 4.5 -13.2 50.7 Profit/Loss (-) n.a n.a n.a n.a -17.7 59.0 38.5 Total Assets 167 128 105 65 27 22 21.1 Selected Ratios (%) Liquidity 44.3 20.2 12.8 20.4 29.6 25.7 26.4 Loan Loss Provision 1.1 1.2 1.1 1.4 2.1 3.0 3.2 3.6 Credit-Deposit 111.0 103.5 107.1 99.1 85.8 89.8 93.0 93.2 Total Assets/T.A of Banking System 0.6 1.3 2.4 4.1 5.4 5.7 6.0 6.5 Total Credits of FCs/ Total Credits of B.S. 0.8 1.7 3.5 5.9 7.3 8.0 8.4 9.8 Total Deposits of FCs/Total Deposits of BS. 0.4 1.0 2.4 4.3 5.8 5.9 5.9 6.6 1/ Includes paid-up capital, general reserves, retained earnings, loan loss provisions and other reserves. 2/ Includes cash in hand, balances with NRB, balance with domestic banks. 3/ Includes Government securities, NRB bonds and others. 4/ Based on total resources/uses. SOURCE. Nepal Rastra Bank 76
CHAPTER SEVEN Micro-Finance 1. Introduction
With a population of 24 million, the number of people living in poverty is estimated to be around 10 million - representing 42 percent of the population. Most of those living in poverty come from the 20 million people that live in rural areas, where the incidence of poverty is substantially higher. However, even there the incidence of poverty varies markedly across regions. Poverty is more widespread and deeper in the more remote areas of the mid- and far-western development regions and the mountain belt23, while the Terai plain and the hills appear to be slightly better-off.
An informal review conducted by the World Bank estimates that the current outreach of micro- finance activities in Nepal is around 650,000, which is only 6.5 percent of the total number of poor. A break-down of the outreach by the various formal institutions engaged in micro-finance activities is given in Table 7.1. From these data, it is clear that even after more than a decade of micro-finance in Nepal, most of the poor have not yet even been touched by these activities.
Nepal's history of community-based initiatives was promoted by the Government. As far back as 1974, Nepal Rastra Bank (NRB) directed the two government-owned commercial banks - Nepal Bank Ltd. (NBL) and Rastriya Banijya Bank (RBB) - to invest at least 5 percent of their total deposits in the "small scale sector" (agriculture, cottage industries and services) to increase the flow of credit to small farmers and businesses. This scheme was named "Priority Sector Credit" in 1976, when its mandate was extended to all banks and the amount increased to 7 percent of deposits".
In 1975, poverty alleviation activities based on community-based initiatives began with the initiation of the Small Farmer Development Program (SFDP), on a pilot basis, by the Agriculture Development Bank of Nepal (ADB/N). The success of the pilots in the Dhanusha and Nuwakot districts in the Hills encouraged policy-makers and the ADBIN to gradually expand the program. Today, it covers all 75 districts through almost 400 Sub-Project Office's (SPOs), benefiting about 200,000 small farmers scattered over 650 Village Development Committees (VDCs). To increase outreach and the pace of its coverage, with the financial assistance of GTZ, the SFDP is now being transformed into autonomous self-help organizations called Small Farmer Cooperatives Limited (SFCL), which are owned and managed by the farmers themselves.
The subsequent failure of the SFDP and other community-based organizations (CBOs), coupled with the failure of priority sector credit to make a dent in poverty alleviation, encouraged the Government in 1992 to set up the first two of five Grameen Bikas Banks (GBB) - a replication of the Bangladesh Grameen model of micro-finance delivery. The next two GBBs were established in 1995, and the fifth began operations in late 1996.
Formal micro-finance activities in Nepal have been started and dominated by the Government and even today public sector micro-finance institutions (MFIs) control 59 percent of the total outreach of around 650,000 members and have provided 62 percent of the total outstanding loans.
23 Nepal: Poverty in Nepal at the Turn of the Twenty-First Century; Report No. 18639-NEP. South Asia Region; The World Bank; December 1, 1998. Page 1. 24 In 1986, the required investment in priority sectors was raised to 12 percent of the banks' loanable funds within which 3 percent must be invested in the deprived sector (consisting of loans below NR30,000). 77
The balance (41 percent) of the outreach is divided amongst a host of private sector MFIs, cooperatives, non-government organizations (NGOs), savings and credit organizations (SCOs) and international non-government organizations (INGOs).
Table 7.1: Outreach of Micro Credit in Nepal
Loan No. of No. of Outstanding Collection Name of Institutions members borrowers (NR.) Rate
Public Sector Small Farmer's Development Program (SFDP) 180,000 180,000 - < 50% Micro Credit Project for Women (MCPW) 60,000 60,000 116,792 - Eastern Grameen Bikas Bank (GBB) 45,135 44,281 250,696 99% Production Credit for Rural Women (PCRW) 35,000 26,000 71,879 - Central Grameen Bikas Bank (GBB) 31,543 30,415 199,829 100% Western Grameen Bikas Bank (GBB) 18,846 18,150 84,190 100% Mid Western Grameen Bikas Bank (GBB) 16,971 11,895 95,765 86% Far Western Grameen Bikas Bank (GBB) 16,575 14,991 87,972 97% Public Sector Total 404,070 385,732 907,123 -
Private Sector Registered (formal) Cooperatives 90,000 81,283 243,000 Small Farmers' Cooperatives Limited (SFCL) 59,883 55,000 726,580 58% Center for Self-Help Development (CSD) 36,493 29,369 153,734 100% NIRDHAN - local NGO 31,399 26,618 120,350 100% Support Activities for Poor Producers of Nepal (SAPPROS) 13,742 12,000 5,613 - Development Project Service Center (DEPROSC) 14,000 14,000 20,026 - Other Private Sector 50,000 50,000 32,760 - Private Sector Total 295,517 268,270 1,302,062 -
Total 699,587 654,002 2,209,185
Public as%of Total 57.76% 58.98% 41.06% Private as % of Total 42.24% 41.02% 58.94%
Source: World Bank estimates. 2. Overview of Institutional Players in Micro-finance
Ever since micro-credit was introduced into Nepal in 1992, a number of formal organizations, both local and international, have become involved in this sector, in addition to the existing informal institutions that still continue to provide financial services to the poor.
Informal Institutions and Arrangements. Traditionally, the informal sector has been dominated by village money-lenders, goldsmiths and pawn-brokers who provide credit against collateral, at high interest rates ranging from 36 percent to over 100 percent per annum, and with minimal procedural complexities or delays. They have been replaced to some extent by informal 78
community-based groups or ROSCAS (Rotating Savings and Credit Associations) such as Dhikuties5, Dharam Bhakari (welfare storage grain associations) and Guthies (cultural heritage associations) which are particularly common amongst Nepal's ethnic trading communities.
The informal arrangements also include about 20,000 guided or haphazard indigenous Savings and Credit Organizations, most of which have emerged over the last eight to ten years. The proliferation of these institutions over a short period of time has been both a boon and a bane to micro-finance. The SCOs are generally small organizations of up to 25 members, entirely self- managed by members and thus operating with minimal costs. They are mostly unregistered, not affiliated with any other MFI or program, and cannot usually borrow from outside the group. Their outreach is limited to their membership, and their volume of transactions is correspondingly low. An outstanding feature of this movement is its expansion to all regions of Nepal, although a greater number are found in more accessible areas.
Formal Institutions. The formal institutions and programs operating in the micro-finance sector include government-owned and private sector-owned institutions and programs.
The government-owned formal institutions and programs (see Annex Six for a more detailed description of these institutions and programs):
The five Grameen Bikas Banks (GBBs), replications of the Grameen model, were introduced by the Government with the establishment of the Eastern and Far Western Grameen Bikas Banks in 1992, followed by the Central and Mid-Western Gramneen Bikas Banks in 1995, and finally the Western Grameen Bikas Bank in late 1996. These banks face severe problems even though their programs appear to have had a positive impact on poverty alleviation (see Annex Five).
The Agricultural Development Bank of Nepal (ADB/N) was established in 1968 by the government to specialize in agricultural and rural credit. It is the third largest bank in Nepal with a reported paid-up capital of NR 1.5 billion (US$20 million), a loan portfolio of NR 20.1 billion (US$266 million) and total deposits of NR 17.7 billion (US$235 million). It operates in all 75 districts through 610 branches and offices. Only a part of these lending activities, however, are directed at agriculture or micro finance.
The Rural Microfinance Development Center (RMDC) Limited was established in 1999 by the Government to act as an apex institution for the micro-finance sector in Nepal. It is registered under the Companies Act, 1997, with a mandate to operate as a development bank within the framework of the Development Bank Act, 1996. The authorized capital of RMDC is NR 160 million of which NR 80 million is paid up.
In addition to the above-mentioned interventions of the government, there are five major government programs in the micro-credit sector, which are implemented through commercial banks, NGOs and SCCs.
The priority sector lending program was introduced by NRB in 1974 requiring all commercial banks to lend 12 percent of their loanable funds to priority sector borrowers, of which 3 percent
25 The 20 to 30 member Dhikuties are based upon the collection from each member of an equal amount of savings (NR 5 to 50) which is then lent out to each member on rotation. At the end of the rotation, the surplus is distributed equally to the members. Although fairly common both in urban and rural areas, these groups face risks of default from borrowing members as well as the possibility of drop-out once the loan has been received. 79 must be lent either directly or indirectly as micro-credit to the hard core poor (borrowers with a maximum lending ceiling of NR.30,000 per borrower - also called deprived sector lending).
The Production Credit for Rural Women (PCRW) project is implemented by the Women's Development Division (WDD) of the Ministry of Local Development (MLD). This is specifically targeted at rural women and covers 36 districts.
The Rural Self-Reliance Fund (RSRF) was established by NRB in 1990 to provide funds (currently at 6 percent interest) to Cooperatives and NGOs registered with NREI under the Financial Intermediary Act and the Cooperative Act, for on-lending to micro-entrepreneurs.
The Micro Credit Projectfor Women (MCPW) is funded by the Asian Development flank (ADB) as an extension of the PCRW. Established in 1994 and running until 2002 - the focus is rural women. It shares the same administration (WDD of MLD) but employs NGOs and SCCs to carry out the social mobilization and to act as credit agents of the commercial banks. The scope of this project has been narrowed down to 12 districts.
The Poverty Alleviation Fund (PAF) was established by the Government to "integrate scattered poverty reduction programs of a similar nature under one umbrella and replicate and upscale successful programs." The specific objectives of PAF are to support the poverty alleviation programs implemented by Government agencies, NGOs and community based organizations, develop their institutional capabilities and encourage them to use their own resources, along with those of PAF, to implement poverty programs at the district and VDC level.
Private sector-owned institutions. The Center for Self-help Development (CSD) is the largest private sector MFI in Nepal with an outreach of around 36,000. It was established in August 1991 as an NGO by ex-employees of ADB/N with the objective of promoting sociio-economic empowerment of the poor, raising their productive capacity and income levels, and sirengthening local capacities to plan, implement and monitor development activities.
NIRDHAN is the second-largest MFI in the private sector, following closely behind C'SD, with an outreach of around 27,000 borrowers. It started functioning as a local NGO in 1991 but faced initial problems in expanding its outreach - which was overcome with the dedication and commitment of its leader and other staff. As with some other NGOs, Nirdhan has also formed a development bank called Nirdhan Utthan Bank under the Development Bank Act. It will transfer all its micro-credit activities to the new bank while carrying on the non-financial services as an NGO.
The Development ProjectService Center (DEPROSC) was also set up as an NGO in 1994 by ex- employees of ADB/N with the active support of an INGO. In common with other MFIs, its objectives include raising the living standards of the poor through credit and other credit-plus activities.
Support Activities for Poor Producers of Nepal (SAPPROS) was established in 1991 to conduct action research for poverty alleviation in the country. It is devoted to augmenting grassroots based organizational and institutional capacity in less developed rural areas.
The Centerfor Environmental and Agricultural Policy Research, Extension and Development (CEAPRED) was established in 1991 by a multi-disciplinary team of professionals to develop and institutionalize the concept of participatory economic development in Nepal. Over the last ten years its activities have been focused on three main areas: rural poverty alleviation through 80 income generation; micro-environmental action programs; and action/policy research in agriculture.
Savings and Credit Cooperatives (SCCs) started to multiply in the villages after the enactment of the Cooperatives Act in 1992, often as part of a multi-purpose cooperative.
More than 10 International Non-government Organizations (INGOs) are actively involved in the sector in various ways. While only a few provide capital for micro-credit, most of these organizations are involved in providing technical assistance, subsidies and loss financing, and assistance in social mobilization.
The membership of multi-purpose cooperatives and smaller local NGOs have swollen to more than 30,000 - mostly after the restoration of democracy in 1990. They are, however, currently inadequately monitored or supervised.
Besides the above-mentioned organizations, there are also several associations and federations of MFIs in Nepal, including:
The Micro FinanceAssociation of Nepal (MIFAN) was established in 1999 as an NGO under the Societies Registration Act of 1978, to act as the common voice of the micro-finance institutions in Nepal.
The Centerfor Micro Finance (CMF) was established in 1998, under a USAID project to act as a national focal point for the expanding micro-finance sector in Nepal.
The National Federation of Savings and Credit Co-operative Unions Ltd. (NEFSCUN) was established in 1988 to act as the apex organization for savings and credit co-operative societies and their district unions, with the objective of promoting and strengthening the credit union movement in Nepal.
The National Co-operative Federation (NCF) of Nepal was registered on June 20, 1993, under the Cooperative Act to provide leadership to the cooperative movement by promoting and developing the movement on the basis of cooperative principles - according to people's needs, own initiatives, and participation. 3. The Regulatory Framework
Micro-finance activities in Nepal are governed by at least ten acts of Parliament. These are: the Nepal Rastra Bank Act (1955); the Agriculture Development Act (1967); the Development Bank Act (1978); the Societies Registration Act (1978); the Finance Companies Act (1985); the Social Welfare Act (1991); the Co-operatives Act (1992); the Companies Act (1997); the Financial Intermediary Societies Act (1998); and the Insurance Act. Thus, micro-finance appears to be over-regulated in Nepal. However, in practice, the opposite is true. This is largely due to the fact that there is no single institution responsible for overall regulation, monitoring and supervision of MFIs in Nepal. Only development banks and NGOs, with limited banking licenses, are regulated by the NRB. All other institutions are self-regulated. Moreover, some of the laws do not achieve their purpose, while others result in perverse outcomes. An example is the Financial Intermediary Societies Act of 1998, which was enacted to regulate NGOs participating as credit agents under MCPW and to provide them legal cover. However, the Ministry of Law took away the NGOs' 81 power to mobilize savings and placed the responsibility on NRB to make up for deficiencies within the NGOs. As a consequence, very few NGOs have volunteered to register under this law. 4. Challenges in Micro-credit Delivery in Nepal
It is now acknowledged by all stakeholders that the extreme level of poverty, combined with a varied topography and early stages of economic development, has created a set of challenges for successful delivery of micro-financial services that is unique to Nepal. The three major challenges are:
- successfully extending the outreach to the hills and mountains of Nepal;
- formulating a micro-credit delivery mechanism that is better suited to the people in hills and mountains;
- redesigning existing programs of the formal MFIs to better target the poorest.
The first challenge questions the basic philosophy on which the micro-finance movement was born, namely, that the most effective way to integrate the poor with the economic activities surrounding them, and thus empower them, is by providing micro-credit through a properly designed social mobilization process. At the heart of this supply-push response is the basic assumption that economic activities abound and surround this poor excluded mass, and that they are unable to engage in profitable activities only for lack of adequate capital. Micro-credit, therefore, assumes the existence of investment opportunities as well as entrepreneurial skills and abilities necessary to engage in those activities in a productive manner. Consequently, the success of micro-credit is threatened whenever these preconditions are missing. In the inaccessible hills and mountains of Nepal (defined as areas that are more than an hour and a half away from a road head), the first of these two conditions is weak, as there is simply a dearth of profitable economic opportunities. The remedy therefore, lies in creating demand-pull conditions.
The INGOs can be more effective in creating these demand-pull conditions. They can achieve this by extending their existing social mobilization efforts: making improvements to physical infrastructure (such as roads and markets); expanding services (such as agricultural extension and veterinary services); and enhancing trade in inputs (such as seeds and fertilizer). This will be important and beneficial, given that the government's track record in meeting these non-credit requirements, particularly for the people in the hills and mountains, is far from satisfactory - with little promise of improvement. Thus, there is a need for the INGOs whose programs can be easily redesigned, to provide such assistance to community-based organizations. Such redirection is expected to have a greater impact on poverty alleviation compared to present programs that focus more on subsidizing the operations of MFIs and NGOs engaged in micro-credit.
The effective implementation of programs for creating the demand-pull conditions will then pave the way for the second-order conditions to kick in, namely, to determine the most suitable models of micro-credit for the hills and mountains. Although micro-credit was introduced to Nepal based on the Bangladesh Grameen model, the sparsely populated hills and mountains of Nepal, together with the severely limited availability of physical infrastructure and productive activities, has made the successful replication of this model difficult, especially in inaccessible areas. The second challenge, therefore, is discovering a more suitable model for delivery of financial 82
services to inaccessible areas. The co-operatives, with their self-management and low operating costs, appear to be an attractive possibility.
The third challenge concems the targeting of the existing programs of the formal MFIs. While these MFIs claim that they follow the accepted methods for identifying the poor, they do not necessarily limit their membership to the identified segment of the population. This practice has potentially given rise to three basic problems. First, it excludes the poorest of the poor who are not able to compete for these funds. Second, it leads to the extension of micro-enterprise loans in the guise of micro-credit. Third, because the cost of mobilizing the ultra-poor is much higher, there is little incentive to target this group. The last problem appears to indicate the need for recognition of the fact that servicing the poorest of the poor is comparatively more costly than servicing the not-so-poor, and that effective targeting should include explicit measures to address the higher costs involved. Such measures could consist of built-in operational subsidies to targeted programs or higher interest rates, or a combination of the two.
5. Issues
Besides the identified challenges, a number of issues have emerged from the operations of the existing MFIs in Nepal. Among the more important issues are the following:
Dominance of the government and its agencies in micro-credit. It is clear that the extension of micro-credit through the public sector in Nepal has not been satisfactory. The nearly insolvent GBBs, the limited outreach achieved by the other programs, and the exclusion of the hard-core poor support this conclusion. This is, however, not surprising in light of the fact that public institutions have failed all over the world to successfully and effectively26 deliver micro-credit to the poor. Based on the available evidence, the government should seriously consider leaving the business of micro-credit delivery to the private sector, specially the NGOs that appear to have a comparative advantage in this regard.
Restructuring of the GBBs to reduce public sector dominance. Since the GBBs are the largest micro-credit operations run by the public sector, their operational and financial efficiency is critical for the health and soundness of the micro-finance sector as a whole. A steady deterioration in their portfolio quality, combined with continuing losses, have eaten away the equity in most of these institutions, making these banks technically insolvent. Discussions with GBB management shows that they are faced with a large number of problems. Some of these are: (i) appointment of NRB staff as CEOs of the GBBs, which has resulted in lack of ownership, commitment, and management efficiency; (ii) a centralized management with very little delegation at department and staff levels; (iii) strong political influence in management and personnel decisions leading to the opening of new unprofitable branches, as well as the recruitment of excessive and incompetent staff; (iv) large average loan sizes that are determined, not on the basis of management advice, but on directives received from the Board; (v) shortage of funds, as even the equity holders (NRB and commercial banks) are unwilling to lend to the GBBs for fear of losing their money; (vi) limited borrowing avenues charging high interest rates; (vii) a lending rate (10 percent) inadequate to cover operating costs, and thus no scope to generate
26 In Bangladesh, the Rural Development Project, supported by Canadian CIDA and initially by the World Bank, and implemented by the Bangladesh Rural Development Board (BRDB), did not yield the expected results. Therefore, the entire program has been spun-off from BRDB and put under an independent Foundation. Similarly, in Philippines, the previously government supported credit cooperative has been transformed into an independent apex finance institution called the People's Credit and Finance Corporation (PCFC). 83
surpluses; (viii) union interference in the management of the institutions; and (ix) a lack of proper MIS training programs for the staff and overall career development opportunities.
The poor performnance of the GBBs has been a major cause of concern for the NRB. Consequently, in mid-2000, it created a Task Force to examine the problems of these banks. According to the NRB, the following are some of the recommendations: (a) merger of the five GBBs into either one, two or four institutions so that the reduction in the number of Board members, management and staff, can contribute to reducing overhead costs, while accelerating management decision-making and implementation; (b) privatization of the GBBs by selling shares to depositors and borrowers; (c) de-linking the GBBs from the control of NRB by creating each GBB as an autonomous institution with an independent Board and management; (d) re- capitalization of the GBBs by NRB and the Government to restore financial liquidity; (d) creation of a special committee comprising micro-finance experts to advise the GBBs as most of the GBB Board members are unable to provide the required leadership, guidance and advice.
BOX 7.1 Grameen Bikash Bank changed the life of Ms. Bhagia Devi The Lucky Mohila Samaj Group Siswani Jahada, Kotohari, Morang, Biratnagar
That micro-credit has helped to reduce poverty is quite clearfrom the micro-credit program implemented by the Grameen Bikash Bank (GBB). Baghia Devi tried hard to obtain a loanfrom many sources but she was unsuccessful. Finally, GBB provided her loans which she used productively and efficiently. She is now out of acute poverty andherfamily income has increasedalong with their quality of life. S'he says it all became possible because of micro-credit.
Bhagia Devi sought loans from door to door, including from the local banks, but was refused. She also tried moneylenders, but could not afford the exorbitant interest rates of more than 100 percent per annum. Then, one day, a staff member of Grameen Bikash Bank (GBB) visited her home and explained how she could obtain a loan from GBB. She had also learned from her frierids and members about CGrameen, but was apprehensive about it. Finally, the GBB staff changed her mind. Bhagia Devi joined the Lucky Mohila Samaj group in March 1998 and became one of a member group of 40. She believed that micro-credit would change her life. It proved to be true. Bhagia has taken four loans since she joined: NRS 5,000, 10,000, 15,000, and 16,000 respectively. Her husband has been a continuous encouragement. Her first loan of NRS 5,000 was used for her husband to purchase a rickshaw. He was able to earn NIRS 100-150 per day from rickshaw pulling. This amount was adequate to service the loan and meet family food and other expenses. Her second loan of NRS 10,000 helped her to engage in various trades which further increased her family income. With the third loan of NRS 15,000 she obtained a lease of 15 decimal of land for cultivation. Her last loan was NRS 16,000 taken on May 2000. Bhagia used this loan to purchase a pair of buffaloes for cultivating in share-cropping on a 25 decimal of land. She has never faiiled to repay her loan installments and she now makes weekly repayments of NRS 353, including NRS 32 as interest. She is cautious about how she uses her loan, always keeping in sight the maintenance ol repayment. Bhagia does not have any personal savings but contributes 5 percent of the total loan to group savings. She had six children at the time of joining GBB and decided not to have any more. All the family members are involved in making major decisions. Bhagia's family is not the poorest of the poor although they do not own any land. The family still lacks amenities such as a personal sanitary latrine, but overall, their living standard and family life has improved significantly.
It is evident that the Grameen Bikash Banks require restructuring in all areas of (a) corporate structure and management; (b) credit operations, financial management and capacity building; and (c) business policies and strategy formulation. At the corporate level, a merger may not be a 84 desirable solution. Since each GBB works under a rather unique economic environment, management and other issues are not homogenous. Moreover, operational practices and clientele have some distinct characteristics that may not be easily reconciled under one management structure. Thus, it seems more practical to maintain the GBBs as separate, independent institutions with complete autonomy, but having largely local representation at the Board and minimum representation by the Government. Such a corporate structure may also make it easier for eventual privatization, which should be the ultimate goal of the restructuring. Fresh capital will also have to be injected to clean the balance sheet and make them attractive for private ownership. The restructuring process should also ensure proper staffing through a staff rationalization program supported by well-prepared safety net measures.
At the management level, as autonomous institutions, they should have their own CEO's recruited from the market to build ownership and commitment to management and the institution as a whole. The management structure should also enhance decentralization for more efficient decision-making. The restructuring should be preceded by a complete audit of the present operational and financial management systems. An internal audit department should also be created to promote internal control and cost efficiency. Product ranges and delivery mechanisms should be examined to ensure efficiency and cost reduction. The existing GBBs have no credible plan for capacity building, and it is important to develop a comprehensive institutional development plan, incorporating MIS development, training of field staff and management and adoption of a modern HRD program. The present interest rate policy also needs to be examined in light of financial sustainability and market practices. Moreover, various policies and guidelines should be designed to promote a strong and disciplined staff with excellent portfolio management skills.
Lastly, liquidation, as an alternative to restructuring of the GBBs, must remain an option.
Limited Outreach in the Terai and hilly areas. Only about 6.5 percent of the total poor population has access to micro-credit. If this is taken to be representative of separate households, each with an assumed size of 5 people, the total outreach would be about 30 percent of the total targeted poor. This is about one-half of the outreach in Bangladesh, where more than 60 percent of the rural poor have access to micro-credit. The outreach in Nepal, however, is not the same for the Terai (plain) and the hilly areas. Of the total estimated outreach of 650,000 it is estimated that about 500,000 micro-credit borrowers are in the Terai, while the remaining 150,000 are in hilly areas. Given that about 50 percent of the hill population are poor (about 5 million people or I million households), the outreach of micro-credit is about 15 percent. The relatively greater outreach in the Terai is a result of easier accessibility, a relatively dense population, better access to markets, and higher awareness and empowerment from relatively higher education, communications and economic opportunities.
The absence of favorable conditions in the inaccessible hills and mountains makes it difficult to organize group members and the transaction cost of delivering micro-credit is correspondingly higher than in the Terai. Moreover, since NGOs find the cost of delivering micro-credit using traditional methods to be excessively high, savings and credit organizations (SCOs) have become the more prevalent channel in the hills and mountains. However, the SCOs are limited in their ability to mobilize resources, expand credit and improve the efficiency of micro-credit operations. As a result, the outreach of micro-credit in the hills and mountains continues to grow at a significantly lower rate than in the Terai. Therefore, a dual approach is needed for expanding outreach in these two areas. For the inaccessible hilly and mountainous areas, it will be necessary to improve conditions to enhance economic opportunities whereas, for accessible areas, there is a 85
need to employ a greater variety of credit delivery mechanisms that are more closely adapted to local conditions.
BOX 7.2: A Savings and Credit Group in Darichoke Fisling, Chitwan
It is evident that the capacity of the Savings and Credit Organizations (SCO) is very weak There is insufficient capacity to discharge the necessaryfunctions of a local level organization and it is clear that SCOs will take a considerable time to develop such capacity. This raisesthe issue of whether the Savings and Credit Groups can be used as a methodfor delivering micro-credit to the poor in the hills and mountains.
Darichoke Savings and Credit Organization was established in 1998. It has 21 members and total savings of NR 72,000. The SCO has a President, a Secretary General and a Treasurer. It has a community center (400 meters above the road on a hill). The members meet monthly and save NR 10 per month. The SCO is a member of the Loke Priya Multipurpose Cooperative in Fisling. SAPPROS is providing technical assistance to build the capacity of the Darichoke SCO. Discussions with the SCO clearly reflect the rudimentary nature of this kind of organization. The following observations were made: (a) the SCO does not have proper pass books for recording the savings of the members; (b) there are no proper accounts or other books that they can show; (c) it is not clear how they have accumulated savings of NR 72,000 as the total savings should be about NR 10,000 for 20 members if they save at the rate of NR 10 per month (it appears that the SCO may have received some donor funds); (c) some members of the group took loans from the organization about three years ago, but they are only paying the interest on the loans, the principal amount remains unpaid; (d) some members have taken advantage of the organization and borTowed up to NR 8,000, while a number of members have not taken any loans; (e) discussions with 5-6 members gave the impression that insufficient awareness has been built as to the purpose of the SCO and the role that the members should play; (f) very little empowerment has been achieved - although the group was established more than three years ago; and (g) the involvement of SAPPROS in building the SCO's capacity has had no visible impact so far.
Diffused focus. The overall focus of micro-credit by MFIs has not been the absolute poor. Although, there are well-established criteria to identify the absolute poor as potential borrowers, field experience shows that the selection of borrowers is based more on their repayment capacity rather than their poverty status. In fact, this has helped GBBs maintain higher repayment rates (see Annex Five).
A number of CSD borrowers were found to be engaged in micro-enterprises (Annex Five). Their loan portfolio consists mainly of loans given: (i) for activities that are mostly micro- entrepreneurial, requiring bigger loans; (ii) to borrowers that are not ultra-poor blut who are moderate to well-off poor with entrepreneurial talents; and (iii) to some better-off borrowers who re-lent the loans to earn a higher rate of interest. Overall, it seems that micro-credit programs are reaching more of the moderate poor than the absolute poor. To correct this deficiency, the absolute or hard-core poor should be grouped separately by the MFIs and treated differently from other groups.
There were also cases of proxy borrowers where the women were used as a front for obtaining the micro-credit while the funds were used by the husband - a situation that is universal in the micro- credit industry (see Annex Five).
Choice of delivery mechanism. Nepal has selected the Grameen model as its main micro-credit delivery mechanism. Almost 75 percent of micro-credit members today receive credit through 86 this method. Evidence shows that the Grameen model, adjusted to meet the specific needs of the NGOs, borrowers and the prevailing economic conditions, is largely working in the Terai regions. However, MFIs need to continue innovating and expanding the range of products on offer.
Moreover, to enhance the sustainability of their programs the NGOs should provide micro- enterprise loans that can cross-subsidize the absolute poor in the hill areas, and make the overall credit program financially viable. Since the Grameen model is not well suited for the inaccessible areas, an altemative delivery mechanism needs to be developed. It appears that many INGOs and NGOs are concentrating on local SCOs and SCCs because of their low delivery costs and the greater ownership and commitment of the members. This choice is acceptable provided the INGOs and NGOs make the effort to strengthen the SCCs sufficiently to ensure their effectiveness and sustainability. There are serious weaknesses in most of these organizations - in the areas of record keeping and MIS. The use of voluntary staff has accentuated the problem, and proper accounts are not always maintained or available. This situation is potentially risky as it is likely to lead to a misuse of funds and, if unchecked; may ultimately result in the collapse of such organizations. There are cases where the organizers of some SCOs have reportedly vanished after raising considerable amounts of savings from their members. Moreover, the SCCs should be linked vertically with intermediate groups and multi-purpose cooperatives that are involved in the creation of economic activities.
Role of INGOs, SCOs and SCCs. Most of the INGOs have a wide range of programs that include irrigation, crop development, forestry, social awareness, empowerment, and so on. In the area of micro-credit, they are interested in extending credit to the poor in the hills and mountains. Their preferred method has been to promote the SCOs and the SCCs through institution building programs - although some INGOs have direct programs with the poor in the hills and mountains.
Some INGOs believe that there is very little reason for mobilizing outside resources in the hilly and mountainous areas. This is mainly because of instances where the local SCOs have generated sizable savings but the members have not been able to use them productively. These have instead been provided to the regional cooperatives who on-lend to other SCOs. It is clear from this that the local demand for funds at SCO level is not high (supporting earlier comments about the lack of profitable investment opportunities) and that there is a greater tendency to save than use these savings for investment purposes.
Another important issue is that the SCO's operational methods do not provide much incentive for members to engage in economic activities. This needs to be addressed if they are to really benefit from their own savings.
Role of donors in the development of the sector. A number of donors are involved in this sector and it is expected that they will continue to play an important role. However, to enhance their effectiveness, there is a need for them to adjust and redesign their programs in line with an agreed strategy for the sector.
Regulatory framework The legal framework for micro-finance is complex, and further complicated by multiple laws that have been framed with particular types of MFIs in mind. There is a need to revise competing and conflicting laws as well as have a regulator appointed. The changes should ensure that all actors in the micro-credit arena are covered and regulated. A case in point is the problem of the Society Registration Act of 1978 (which does not allow NGOs to mobilize savings or provide credit) and the Financial Intermediary Act (FIA) of 1999 (which allows credit delivery but not mobilization of savings) - both of which have encouraged the formation of development banks. To stem further conversion of smaller NGOs into development 87
banks, the government is considering an amendment to the FIA. However, the usefulness of the FIA should be reviewed by RMDC and other stakeholders before it is enforced.
Another issue that has arisen with respect to cooperatives is taxation. Traditionally, tIhe surplus of cooperatives was exempt from income tax. This prompted many financial organizations in Kathmandu to register themselves as cooperative societies - so as to evade tax. In response, the Government has now imposed taxes on cooperatives, the effect of which has been to penalize "real" cooperatives that need operating surpluses to build up their capital base.
Role of NGOs/MFIs. Given their access to large numbers of clients as well as their ability to reach non-accessible areas, NGOs/MFIs can play an important role in micro-credit: delivery in Nepal. Their main weaknesses include their relatively high operating costs that alre presently funded/subsidized by INGOs and donors.
Their role is quite prominent in extending micro-credit to terai regions. In fact Nirdhan's out- reach is entirely in the terai area, while 90 percent of the CSD's borrowers are from the terai. CSD has some programs in hill areas, but even these are largely concentrated in the low hills. Given their potential, an extensive assessment was made of the of NGOs/MFIs in delivering credit to the poor in the hills and mountains. It indicated that it is quite feasible for these NGOs to extend micro-credit to low hills and mountain areas near to market localities. Such extension of outreach could result in up to 200,000 to 300,000 additional borrowers over the next five years. The expansion program would, however, require the support of soft loans, grants for capacity building to NGOs/MFIs, and the adjustment of the credit delivery method discussed earlier. In addition, while NGOs/MFls see an important role for themselves in the high hills and mountain areas, their ability to discharge that role properly will hinge on substantial changes in their existing credit operations. To start, the poor inhabitants of the high hills and mountains would have to be identified and classified as ultra-hardcore poor, and then targeted with the support of subsidies that are designed on the basis of capacity building and financial viability indicators. This could be adjusted downward based on progress and achievement of targets.
Role of Apex Wholesale Institutions. An effective apex micro-finance institution could play an important role in: (a) ensuring the effective channeling of funds to target NGOs/MFIs and borrowers at reasonable interest rates; (b) meeting the supply gap of funds available to NGOs/MFIs for extending microcredit; (c) helping NGOs/MFIs in creating sustainable institution building; and (d) ensuring a positive impact of micro-credit on poor borrowers. While it is hoped that RMDC would play the above role, early indications seem to signal a bumpy starl. Firstly, the operations of RMDC were delayed due to: (i) failure in identifying eligible NGOs/MFIs that meet the partnership criteria; (ii) the absence of proper targeting of borrowers who shoulcl have access to funds channeled through the RMDC; and (iii) inadequate analysis of the interest rate issue - resulting in delays in the RMDC making decisions on lending rates. It appears that only large NGOs/MFIs, using the Grameen model of delivery, are eligible to be partners of the RMDC. Two such institutions have already received funds from RMDC. However, there are five government sponsored Grameen Bikash Banks, representing about 33 percent of the total and 70 percent of NGO/MFI supported borrowers that are not eligible for borrowing from the RMDC. As a result, the clientele of the RMDC is constrained, thus posing a major obstacle to credit expansion. Moreover, there is no specific program targeted to provide financial services to borrowers with a different economic status, different income level, and opportunities - as found in the Terai, hills and mountains.
Secondly, the assessment of demand and sources of funds were not examined in the context of RMDC's micro-credit wholesaling. There are already a number of sources that provide funds for 88 micro-credit to the GBBs and NGOs/MFIs. For example, NRB provided funds to the GBBs directly and through its "deprived sector lending" program mandated for commercial banks, without regard to the financial performance of these institutions. Moreover, there are donors bypassing RMDC and providing funds directly to NGOs/MFIs. Although, an implicit objective in setting up the RMDC was to make it the sole channel of microcredit funds from the government, donors and other sources to MFIs, it would be difficult to attain that objective since the performance of the MFls is uneven and unlikely to meet RMDC's eligibility criteria. Therefore, the supply gap is likely to persist, while RMDC is likely to encounter difficulties in expanding its program. It would, however, be important for RMDC to maintain the quality of its partners even at the risk of limited expansion of its operations. A small but good loan portfolio is always more credible than a large portfolio of poor quality.
Third, the current lending rates of RMDC do not take account of prevailing market conditions. The initial lending rate was 10 percent irrespective of the size of the NGOs/MFls and the economic status of the borrowers. Meanwhile the commercial banks are lending to the same micro-credit institutions at 5 to 6 percent - and also participating in their equity to meet NRB's deprived sector lending targets. As a result, RMDC was not able to lend until early 2001 when it reduced the lending rate from 10 percent to 7 percent. Unlike PKSF in Bangladesh, RMDC does not consider the special needs of small and medium sized NGOs/MFIs, which can build up their equity by generating a surplus, and which require financial support for capacity building. Such small and medium MFIs obtain special lending rates from PKSF compared to the large NGOs/MFIs. Furthermore, given that poverty is acute in the hills and mountains, where the population is dispersed and transaction costs are relatively higher than in the Terai, lending rates from the RMDC could be varied to take account of these difficult conditions. This problem, however, has been recognized by RMDC and they have embarked on a special credit program funded by Australian Aid, under which funds are lent at 2 to 3 percent to small NGOs/MFIs to extend micro-credit to the hills and mountains.
Sustainability and lending interest rates. Sustainability of the micro-finance sector is important and should be the ultimate goal of any strategy to strengthen the sector. It has two dimensions: (a) the sustainability of the wholesaler (RMDC) and retailers (NGOs/MFIs) for attaining overall institutional viability; and (b) sustainability of the borrowers. The ability of the NGOs/MFIs to access the market and their institutional sustainability are closely integrated. The institutional sustainability creates the capacity to operate the micro-credit activities in a cost- effective manner. As a result, the absorption capacity of NGOs/MFIs increases to sustain higher lending costs. The borrowers' sustainability is measured by their level of income, quality of life, social awareness and empowerment.
The micro-finance industry in Nepal is attempting to attain immediate sustainability. This, however, ignores the worldwide experience that the cost of delivering micro-finance services is high because of the limited institutional capacity of NGOs/MFls and the need for close supervision of these loans. There is a perception in the government that the NGOs/MFIs can lend at lower margins despite their high financial intermediation costs and inadequate institutional capacity. Therefore, lending rates are kept artificially low and the ultimate result on the ground shows that the GBBs and the NGOs/MFIs are not able to generate a surplus. Since GBBs' operational costs are not covered by the thin spreads, their equity has been eroded. Some private NGOs are apparently generating surpluses, but only because their cost of operations are subsidized by donors or fNGOs as loss financing. It is quite apparent that the objective of attaining quick sustainability has distorted the industry's interest rate structure, while NGO/MFI losses are subsidized in the name of institutional building. As a result, there has been very little 89 institution building in these organizations as the funds given for institution building has been used to finance operating costs.
The micro-finance industry should target sustainablity as a medium and long-term strategy. This should be supported by a comprehensive institutional development program. As the objective of the micro-credit program is to alleviate poverty by ensuring access to credit by the target groups, the initial operational subsidization of NGOs/MFlIs is justified considering the high costs of providing such services. There should also be grant funding for institution building of NGOs/MFIs to enhance their absorption capacity and to reduce intermediation costs. Subsidization elements should be transparent. The practice in Bangladesh has been to channel subsidies through the interest rate rather than through loss financing. In Bangladesh, the borrowing costs of MFIs have been hardened only after an increase in their absorption capacity.
Other less pressing issues - include a shortage of credit funds, problems of overlapping memberships, lack of emphasis on capacity building, and the absence of a policy on the extension of micro-credit. 6. Recommendations
Given the focus of micro-credit, its importance in reducing poverty in general and meeting the Development Plan objectives of reducing the incidence of poverty from 42 percent to 32 percent by the end of the Plan period in particular, its role cannot be overemphasized. The micro-finance sector in Nepal needs to articulate a vision and strategy based on a consensus of all stakeholders. The vision should state what the sector would achieve in five years and in ten years in terms of outreach, the types of poor clients that it will serve, the delivery mechanism, the models, the actors and their activities.
To attain that vision a well-planned strategy would have to be developed and implemented by all stakeholders. The strategy should clearly indicate that the initial focus of the MFIs - especially the INGOs and local NGOs, in the inaccessible hills and mountains - would be assistance and facilitation for the creation of economic activities which would then create the demand for micro- credit. A two-pronged approach would be necessary to expand outreach in the accessible and inaccessible areas. For the inaccessible hills and mountains, micro-credit should be preceded by efforts to increase the opportunities for engaging in productive activities while the outreach in the accessible areas could be increased by employing various methods of credit delivery adapted to local conditions. Finally, the strategy should indicate the need for MFIs to attain financial sustainability through the adoption of a pragmatic interest rate policy.
In addition, the following are the main recommendations that flow from this; report for strengthening micro-finance in Nepal:
(a) The five GBBs should be immediately restructured. The restructuring should be preceded by an audit of the capital, portfolio and management of these banks by internationally reputed auditors. In addition to identifying the weaknesses of these banks, the audit should also lay down their baseline position. Following the restructuring of the five GBBs, they should be privatized.
(b) All micro-finance programs implemented by the government through various agencies should be handed over to private sector MFIs chosen on the basis of their performance 90
and outreach. Any subsidies to micro finance institutions should be explicit and well defined and passed through these private sector operators.
(c) The PAF should be redesigned to focus only on creating economic opportunities in the more inaccessible areas of the hills and mountains. The micro-credit component of the PAF should be removed.
(d) RMDC should make stronger efforts to assist smaller NGOs/MFIs while continuing to provide funds to the larger MFIs.
(e) Targeting of beneficiaries needs to be improved to ensure that subsidized credit is being accessed by the right people, and that misuse through proxy and other practices does not increase.
(f) A two-pronged approach should be taken to expand outreach. For the inaccessible hills and mountains, the supply of micro-credit should be preceded by efforts to increase the opportunities for engaging in productive activities while the outreach in the accessible areas should be increased by employing various methods of credit delivery adapted to local conditions.
(g) The INGOs should redesign their programs and redirect their efforts to assist communities create conditions for the profitable expansion of economic activities prior to the extension of micro-credit in the more inaccessible areas.
(h) The savings and credit co-operatives should have a supervisory body to monitor and oversee their activities.
(i) The Financial Intermediary Societies Act, 1999, should be reviewed by the RMDC and other stakeholders to determine its usefulness, and their recommendations regarding the future of this Act should be implemented.
(j) NGOs/MFI's have demonstrated ability to reach non-accessible areas and also have access to large numbers of clients. Soft loans and grants should continue to be provided to these organizations.
(k) Sustainability should be the ultimate aim of any micro finance strengthening strategy. However, given the realities on the ground, this will have to be a medium and long term strategy for Nepal. In the short term, operational subsidization is justified. This should, however, be transparent and channeled through interest rate subsidies rather than provided as loss financing.
(I) The overall regulation and supervision of all micro-credit activities needs to be improved.
(m) Donors need to weave their micro finance support around a commonly agreed strategy.
(n) The taxation of cooperatives should be reviewed so that "real cooperatives" can generate operating surpluses to build up their capital. 91
CHAPTER EIGHT Pension and Retirement Savings Schemes 1. Introduction
Pensions were first introduced into Nepal in 1934, with the launching of the Employees Provident Fund (EPF), a defined contribution scheme. The Employees Provident Fund is Nepal's largest scheme with a total membership of 350,000. This was followed by the defined contribulion Civil Service Pension Scheme in 1957. Since then pension schemes and organizations have grown in number (see Annex Seven). Life insurance in Nepal was first offered in 1968.
The public and private pensions systems in Nepal are extremely modest, both in terms of their coverage and in their importance within the financial system. Unfortunately, the token regulation and supervision of the retirement savings sector limits the availability of data on the system. However, it appears that, at best, around 550,000 workers are directly covered by at least one form of retirement savings protection. This represents only 37 percent of a formal sector workforce of 1.5 million and 5 percent of the total workforce of 10.8 million. In 1999), funded pension assets were approximately NR 24.2 billion (US$350 million) - representing 7.2 percent of GDP. This appears low against figures as high as 117 percent for Switzerland, 87 percent for the Netherlands, and 75 percent for the UK, or even 22 percent for Sri Lanka, but is substantially higher than many developing countries such as Argentina (3.3 percent), Colombia (2.9 percent) or Jordan (4.9 percent). This result is possibly a reflection of the relatively higher incomes within the formal sector in Nepal as well as the use of a provident fund system. Total financial assets associated with the various retirement savings schemes are estimated to be around NR 36 billion, or 10 percent of total financial assets2". 2. An Overview of Institutions involved in Pensions
Social Security. There is a universal pension of NR 100 per month payable to everyone over the age of 75 (of which there are 246,000 individuals - although not everybody bothers to collect). This results in an annual cost to the government of around NR 300 million per year. The pension is administered by the Ministry of Local Development and paid through the municipalities and village administrations. While not meaningful in terms of ability to support a person in retirement, anecdotal evidence from other countries suggests that these minor payments can be important in providing a modicum of independence to an older person within a family.
Provident Funds. As in other South Asian countries, provident funds which pay a lump sum at retirement represent the dominant form of organized retirement saving in Nepal. Many provident fund recipients, notably government employees, also benefit from pensions in retirement..
It is mandatory for all companies with more than 10 employees to make provident fund contributions. This can be to the Employees Provident Fund or to a privately administered fund. These are purportedly supervised by a company designated Welfare Officer who, is in turn, supervised by the Department of Labor. Employees must contribute at least 10 percent of their salary (but may contribute more) while the employer is required to contribute 10 percent..
27 Poor reporting makes this number an estimate. In addition, the large portion of retirement savings assets held in the banking system leads to double counting. 92
Private provident fund investments are restricted to bank deposits and government bonds. Bank deposits must be in a segregated account and the employer must take appropriate measures to ensure that interest and principal are protected against the possibility of corporate bankruptcy.
While the organized sector in Nepal is apparently 90 percent unionized, and this is said to provide an effective supervisory mechanism, the Ministry of Labor has only 17 inspectors for the entire country and so enforcement by government is token.
Employer contributions to provident funds are tax deductible (see Annex Nine) only to the extent that they do not exceed the contribution made by the employee (which is itself only tax exempt up to 10 percent of remuneration).
In as much as the privately administered provident funds are without any form of centralized supervision, it is extremely difficult to gather information as to their scale or importance within the financial system. However, as the private provident funds can invest only in bank deposits and government bonds, it is possible to arrive at a reasonably accurate estimate. As of 1999 total provident fund deposits represented 14 percent of total deposits2 '. As total bank deposits at that time amounted to NR 127 billion and EPF bank deposits were NR 11.4 billion, it is estimated that the private provident funds had total bank deposits of NR 6.4 billion. Given the relatively low yields on government bonds and the relative complexity of managing a fixed income portfolio, it is likely that this figure of NR 6.4 billion closely approximates the total private provident fund assets.
Total membership of private provident funds is estimated to be around 200,000. As the entire formal sector labor force in Nepal is~ 1.5 million and EPF membership is only 350,000, this would suggest that the vast majority of workers in Nepal are not covered by provident funds, despite their mandatory nature.
Employees Provident Fund ("EPF"). The single biggest retirement savings entity in Nepal, the EPF has assets of NR 22 billion and annually pays NR 1 billion in retirement payments. The Employees' Provident Fund was originally established as the Army Provident Fund in 1934. The scheme was extended in 1944 to include civil servants in the Kathmandu Valley and in 1948 to include all civil servants. Coverage was further extended in 1959 to cover all government employees (including the police), and again in 1978 to include teachers. From 1991 the sixth amendment of the EPF Act of 1962 allowed membership of private enterprises employing a minimum of ten people.
Under the 1962 Act, the EPF is an autonomous corporate body, though all seven board members including the administrator of the fund, are government appointees9. Notwithstanding its nominal autonomy, the EPF is subject to administrative direction from the government. The EPF has 30 offices countrywide and 625 employees.
All private sector companies with more than 10 employees must participate in some form of provident fund, but they can offer an alternative to the EPF. While EPF participation is not generally mandatory, enterprises may be directed to participate. All government companies must participate, including the civil service and the military. The EPF does not distribute statements of
28 According to the ADB financial Sector report of October 2000 29 Of the 7 Board members, 3 are direct government employees, I comes from the banking sector (currently the Agricultural Development Bank), and I comes from the private sector. The Board also includes a chairman, who is appointed by the government, and the EPF chief administrator. 93 account, but provides them upon request. This makes it more difficult to enforce participation on the part of employers. As of February 2001, EPF membership stood at 350,000, or only a little is responsible for more than 115t of the formal sector labor force. The Department of Labor enforcement. The Self-Employed are not offered the possibility of participation. At present 5,000 people are leaving the system annually, aged 52-58, and 34,000 new members join every year30. The 5,000 retirees received NR 450 million (or an average payment of NR 90,000). The average salary of EPF participants is NR 7,000 per month, so the average pay out is only a little more than one year's salary. Total withdrawals, including early withdrawals, are currently NR 1.0 billion per year while total collections are NR 2.5 billion per year.
Table 8.1: Breakdown of Membership of Accumulated Deposit by Industry Sector, July 1999 (in NR million)
Sector Members % Deposit
Civil Service 90,000 26 5,730 34 Army 41,000 12 1,560 9 Police 53,000 16 1,590 9 Education 96,000 28 4,720 27 Private sector 60,000 18 3,610 2i1 Total 340,000 100 17,210 100
Table 8.2: EPF Membership by Year
Year Members 1962 40,000 1974 82,000 1976 91,000 1978 148,000 1980 165,000 1985 280,000 1987 290,000 1990 300,000 1994 310,000 1996 325,000 1998 333,000 1999 340,000
Participating enterprises are required to deduct at least 10 percent of the employees' monthly salary and contribute this to the EPF. Contributions by employers are discretionary, but should at least match that of employees. Contributions are paid on basic salary plus increments but do not include allowances (housing, dearness etc.). For the private sector, allowances comprise 50 percent of total compensation. Recently, the government eliminated allowances for public sector employees after increasing wages. The public sector now only receives an approximate 10 percent dearness allowance.
30 This is despite the demographic distribution which has three times as many people aged IS to 19 as aged 55 to 59. 94
Contributors can withdraw 60 percent of their deposit after 5 years. Technically, this is an interest-free loan. Every two years thereafter, a participant can withdraw an additional 60 percent of principal and intereste'. Participants may also qualify for housing loans. Amounts withdrawn can be re-deposited. In general, however, a rate of return is specified by the EPF board, after provisions and contributions to (or drawings from) a reserve account. The employee is entitled to request full withdrawal of the accumulated deposit upon termination of service, regardless of age. Conversely, retirees may maintain their EPF deposit for 6 years after retirement.
The EPF is completely tax exempt and does not even pay withholding tax on bank deposits. Also, the government guarantees a minimum nominal rate of return on EPF deposits of 3 percent per annum (so, essentially, principal is also guaranteed). The EPF enjoys preferred creditor status in its loans and investments and has an automatic first lien over the assets of any company in which it invests in the case of bankruptcy, except in the case of consortium loans. The EPF also has the right to directly take possession of and auction pledged property without a court order.
The EPF also offers members a series of associated welfare benefits, such as accident indemnity, funeral grants, insurance, etc. These benefits are modest and non-contributory.
EPF Investments. As shown in the accompanying table and charts, the EPF has paid a return to investors which has remained largely stable and which, on aggregate, has modestly exceeded the rate of inflation. This stability of return has been achieved through the use of a reserve fund which is used to stabilize pay-outs across years, and this fund currently stands at NR 1.75 billion. The actual pay-out rate is determined by the EPF Board32.
Chart 8.1. EPF Rate of Return vs. Inflation
2 5
20
15
100. _1
5
0- 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 -5 1-*C-PI s EPF interest %
The investment promotion committee of the EPF is nominated by the government, but there is no government direction.
31 This allowance was very briefly increased to 90 percent, but has reverted to 60 percent. 32 The annual pay-out was 9 percent for 2000, versus Io percent for 1999 and I I percent for the 15 years up to 1998. 95
The investment income of the EPF is NR 1.9 billion, which, together with annual contributions of NR 2.5 billion and withdrawals of NR I billion, accounts for the rapid growth of the fund (to NR 22 billion in 2000 from NR 18 billion in 1999).
Table 8.3: EPF - Total Assets and Investment Distribution by Year (in NR million)
Bank Government Corporate Member Equities Assets Deposit Bonds Loans Loans
1963 11.0 71.0% 27.7% - 1.3% 1968 38.7 35.6% 19.0% 37.3% 8.1% 1973 113.6 58.4% 9.8% 12.2% 19.7% 1978 416.8 70.6% 3.4% 3.4% 22.5% 1983 1,303.7 72.5% 0.5% 2.5% 24.5% 1988 3,622.5 46.8% 18.3% 1.1% 33.7% 1993 6,719.8 71.0% 24.2% 1.3% 3.1% 0.4% 1998 14,842.9 59.4% 22.6% 8.1% 9.5% 0.4% 2001 approx.22,000 65.0% 15.0% 9.7% 10.0% 0.3%
The EPF has an Investment Promotion Committee comprising:
* The EPF Administrator * A government economist * Two people drawn from academia or otherwise knowledgeable in investments * One EPF employee to act as Secretary
Investments are made by the Investment Promotion Committee, supposedly without political guidance, and with a view to optimizing the rate of return. The marked changes in the investment portfolio mix over the years and the occasional foray into unusual asset classes suggests, however, that government direction is more active. Moreover, it is understood that the 33 Investment Promotion Committee has not met for the last two years .
The EPF may invest in the following assets:
* Nepal Government bonds * Bank deposits * Finance company deposits guaranteed by a bank * Corporate loans (with a government or bank guarantee, or with government consent) * Shares of banks and finance companies (subject to a maximum of 25 percent of issued capital) * Consortium (i.e., syndicated) loans
33 It is also reported that the EPF Board consists solely of the Chairman and the Administrator, rather than the designated seven members. 96
* Corporate debentures (up to 25 percent of amount issued by any one company) * Housing for sale or rent * Commercial property development
Within the classification of housing finance, the EPF provides community housing loans to groups of three or more members against their joint (adjoining) real estate collateral, and up to a maximum of 5 years of the applicants' salary.
As of February 2001, the actual distribution of investments was as follows:
* 65 percent in bank fixed deposits, both public and private, receiving 7.5 percent * 15 percent Government bonds 5-1 Oyrs * 10 percent Housing loans to members * 0.33 percent equities * 9.67 percent loans to private sector (including project finance - with an average 6 year maturity)
The EPF has no specific maximum allocation to any investment sector. The government makes special issues of debt available to certain institutions, including the EPF. The EPF buys government bonds directly from NRB, rather than through an intermediary, and the EPF is not allowed to participate in auctions or secondary markets. It receives 8.5 percent interest on government bonds. The government recently issued a special bond issue - exclusively for the EPF - with a 9.5 percent coupon and a maturity of 5 years.
EPF Pension Fund. Since 1996 the EPF has offered a non-contributory pension to its members. Using reserves generated from surplus income, the EPF pays an annual pension of 5 percent of the members EPF deposit at the time of retirement. The number of years for which this pension is paid is calculated according to the number of years over which the member has made contributions (see Table 8.4).
Table 8.4: Calculation of EPF Pension Benefits
Period of Contribution Annual Pension Period of Pension
Less than 5 years I year 5 to 10 years 5 percent of the Provident Fund 3 years IOto 15 years withdrawal at retirement 5 years 15 to 25 years 7 years Over 25 years 9 years
While there are many attractions associated with offering a pension product - and it is not known if this system has been actuarially assessed - this type of benefit is fraught with risks. As the age distribution of Nepal is still extremely youthful (see Annex Eight), the ability of the EPF to pay pensions out of a modest charge against current income will be maintained. As the population pyramid flattens, however, this will become more difficult to sustain. At the same time, the payment of this benefit to retirees for a number of years will generate a strong sense of entitlement. Moreover, the pension is payable based upon the EPF deposit at retirement, which is a function of salaries and, indirectly, of inflation. The EPF has limited capacity to protect its investment portfolio from inflation and a material shortfall could rapidly develop. Furthermore, 97 at present, EPF members have the right to withdraw and redeposit contributions, implying that members might deliberately build up their EPF deposit immediately prior to retirement.
Private Pension Funds. A small number of entities offer pensions to employees. These include the various current and prior state-owned enterprises (such as Nepal Telecoms and the Electricity Authority) and Tribhuvan University. The University pension fund works on the same principle as the govemmen't's, with a 20-year vesting period. Established in 1990, the fund has NR 20 million in assets. The pension is based on total years of service and also offers a 7-year pension as a lump sum commutation.
Both Nepal Bank Limited and Rastriya Banijya Bank offer pensions to their employees. In both cases there is believed to be a major shortfall in terms of provisioning for the pension liability - approximately NR 1.0 billion in the case of NBL and NR 1.5 billion in the case of REIB. Some Finance Companies offer a pension product which may be purchased by individuals.
Civil Service Pensions. Civil service pensions were introduced in 1957. As the government follows cash accounting practices rather than accruals, the future liability of the civil service pension scheme is unknown. In the year ending July 2000, pension costs totaled NR 1,313 million, and are estimated to be NR 2,250 million (US$30 million) for 2001 (including gratuity payments). The cost of gratuity payments in 2000 was NR 50 million.
The standard retirement age is presently 58, although most people retire at age 6034. There is no minimum age for retirement, but pensions are paid only from the age of 60. The life expectancy of a civil servant is 70 years. Those who qualify for a pension but retire before the age of 60 receive up to a maximum of 7 years' pension paid as a lump sum35. The effective replacement ratio is in the region of 60-70 percent. The pension cannot exceed the current salary of an active employee at the same grade, but is also guaranteed to be at least 50 percent of the active person's salary. Pensions are increased by 2/3 of any increase provided to active employees.
The vesting requirement for a Civil Service Pension is 20 years36, and 16 years for the Military and Police. There is no commutation option. Pension payments are tax exempt. The pension is calculated as follows:
Annual Pension = Final Year's Salary x Years of Service / 50"
People who leave before completing 20 years of service do not qualify for a pension, but do receive a gratuity if they have been employed for at least 5 years. The gratuity is paid as a lump sum and is calculated on the basis indicated in Table 8.5 below.
There are other significant benefits received at retirement. Medical benefits continue to be paid after retirement. 12 days sick leave are credited for each year employed, and the unutilized balance is cashed out at retirement, as is unused regular leave. However, a maximum of only 5 months regular leave can be cashed in at retirement. Unutilized leave benefits in total represents about a year's salary when paid at retirement.
34 The lower ranks of the military and police may retire at age 46-48. The retirement age is the same for men and women, however, less than 5 percent of govemment employees are women. 35 Hence, a person retiring at age 50 would receive 7 years' payment, as would a person retiring at 53, however a person retiring at 56 would receive only 4 years'. 36 Entitlement to disability pension after 15 years. 37 In the case of death, the spouse receives a pension reduced by 50 percent, except if death occurs prior to 7 years of retirement, in which case a full pension is paid for these years. 98
Table 8.5: Gratuity Calculation
Gratuity Years of Service (per year employed)
5 - 10 yrs 1/2 month's salary 10- 15 yrs I month's salary 15 - 20 yrs 11/2 month's salary
It is a major issue for the Civil Service Pension Scheme that the cost of pensions will increase rapidly in the immediate future38. At the present time there are 103,000 civil servants and 26,207 civil service pensioners. There are also 100,000 teachers but only 4,333 teacher pensioners. In many mature economies, these numbers have come to approximate parity and over the very long term, this should also occur in Nepal. It should be noted, however, that anyone who is not currently employed by the Civil Service will not be eligible for a pension within the next 20 years. As such, it should be relatively straightforward to estimate the pension liability for the next 20 years, although this has not been done. Moreover, the Civil Service Pension Scheme is not inherently exposed to crisis, as are many national pension schemes in other countries. The government has the power to control the pension liability, not only through the pension benefits paid, but also through the number of civil servants hired and their compensation.
This being said, there is good reason for concern as to the likely rapid escalation of pension costs. Over the last 30 years the cost of pension payments has increased at twice the rate of the cost of employee pay. This acceleration is likely to continue (or even increase) as the size of the civil service has increased very rapidly - doubling in the past ten years39. In addition, the pension benefit has been increased to pay 1/ 50'h of a salary for every year of service, from the original 1/75 'h introduced in 1957, and the scheme has been extended to include teachers from 1996. Although teachers are not credited for service prior to 1996, their large numbers (around 100,000) will add substantially to pension liabilities.
Life Insurance. Life insurance offers an alternative vehicle for retirement savings in many countries, and annuities also play an integral role in the distribution phase of the pension cycle. Only two companies offer life insurance in Nepal. The life market is dominated by the National Insurance Corporation (NIC) which has a 78 percent market share. NIC is a publicly listed company - although it is 88 percent government owned and the public share holders only participate in the non-life business. Total life insurance premia collected in the year to July 1999 totaled NR 433.3 million. Neither of the two life companies offers annuity products at the current time.
The Insurance Board has fixed the prudential standards for life insurance in Nepal based upon an actuarial analysis carried out in 1971 by Swiss Re.
There is free entry into the life insurance market from any foreign country. Indeed, it is somewhat hoped that the American Life Insurance Company and the Life Insurance Company of India will soon commence operations that would then provide additional insights as to appropriate premia rates. The arrival of LIC of India is particularly welcomed as it is presently
38 A Pension Reform Committee has been established by the govemment to review this matter. 39 In 1965 there were only 32,000 civil servants. 99 believed that Indian Life Insurance Companies collect premium income of NR 40 million per year4 through unauthorized selling of Indian policies in Nepal.
Life insurance funds must be invested 75 percent in government securities and fixed deposits with the remaining 25 percent being discretionary. Insurance companies are required to pay a levy to the Insurance Board of I percent of all premium income, including Life business. The fact that this levy applies equally to Life premia is an excessive burden, given the extent to which these funds represent contributions of savings capital.
National Insurance Corporation ("NIC"). The National Insurance Corporation hias 116,000 individual life policies outstanding as well as 75 entities covered by Group Life policies covering a further 50,000 lives4". Endowment policies represent 95 percent of all policies ouiistanding, 2 percent are anticipative or "money-back" policies, which have a final term of 15, 20 or 25 years but commence repayment in installments every 5 years. The remaining 3 percent is equally split between marriage policies (to pay for weddings), education policies (to pay for schooling) and term life policies (which are written for a term of I year only). The average maturity of an endowment policy is about 15 years. All policies pay a lump sum as there are no annuities. Most life insurance sales are carried out through an independent sales force of 1,000 commission agents, although NIC also sells some policies directly. The average individual sum assured is around NR 200,000. Group policy assured amounts are typically linked to salaries for the group and average 3-4 years' salary - or about NRI 50,000.
NIC has premium income on individual policies of NR 200 million per annum. Group insurance premium income is NR 170 million per annum. As of February 2000 the life fund stood at NR 6.0 billion. Life claims run at NR 3040 million a year, mostly from accidents. NR 30-50 million is paid out annually in endowment maturities.
The Life Fund is mostly invested in fixed term deposits in banks (NR 5 billion), mostly with maturities of 1-2 years. The NIC also purchases some shares. The NIC reports that it would like to invest more in government bonds but has had difficulty purchasing government bonds at auctions. Development bonds have not been sold for some time and restrictions on the ability of institutions to invest in Savings Certificates have closed this investment avenue. The NIC feels it inequitable that the EPF and the Citizens' Investment Trust (CIT) have continued access to Savings Certificates while it does not. NIC is also subject to withholding tax on its investments (unlike EPF and CIT). The last bonus rate declared was 62.5 per 1,000 for 1991/92 and no bonus has been set since. The next valuation of the life business was due in 1992/95, but has not yet been completed.
National Life & General Insurance("NLGI"). NLGI commenced life insurance operations in 1989 and now has 14 branches nationwide. While it has a current market share of some 22 percent, its established book of business represents a much smaller share. While not as tardy as NIC in the publishing of accounts, the most recent financial data is for 199742. NLGI is also one of the many Nepali companies listed as being in breach of Securities Exchange Board, regulations requiring annual meetings. The total number of lives insured is now around 22,000 and the life fund now totals approximately NR 500 million43. NLGI has tried to offer annuity products in
40 Which would represent a life fund value of around NR 600 million. 41 Group policies are generally for government corporations and finance companies. 42 More recent data has been provided informally by management 43 Increased markedly from 1997 published financials which show only NR 173 million. 100
Nepal but has not found a ready market for these products. The pricing for the annuity was also determined by the Insurance Board and these were perceived to be unattractive by investors.
NLGI has been more or less current in the valuation of its life business. While such valuation is due every three years, the last such valuation for NLGI was carried out using the 1997 accounts by a UK actuary. While the premium rates for insurance business are set by the Insurance Board, the bonus rates are not and NLGI has been paying a slightly higher bonus rate on profits policies than NIC (65 per 1,000 vs. 62.5 for the last three years). The NLGI life fund is now around NR 500 million, and NLGI has achieved an investment return on this fund, which has averaged a little more than 9 percent per annum over the last three years. NLGI uses the UK 1967/70 mortality tables to calculate its actuarial liability for the life book.
The bulk of NLGI's life fund is invested in bank deposits with RBB and NBL. NLGI management perceive the lack of investment opportunities to be the primary hindrance to the development of their life insurance business.
Citizens' Investment Trust ("CIT"). A savings and investment institution created in 1990 under its own Act of Parliament, the Citizens Investment Trust enjoys various privileges. The primary activities of CIT are to mobilize savings, to invest in securities and make corporate loans, to underwrite and manage public offerings and to provide trustee, escrow agent and custodian services. It is explicitly recognized in the Act that the CIT may invest in overseas securities with the approval of the NRB.
Among the most important privileges of the CIT is that it is explicitly recognized in the CIT Act that income of the Trust should be tax exempt. Income from investments in the Trust is also tax exempt, although this is, in principle, subject to revision. Interest on CIT bank deposits is paid without the withholding of taxes.
The CIT is listed on the Nepal Stock Exchange and has issued capital of NR 40 million, with 10 percent direct government ownership and a further 40 percent through the Nepal Rastra Bank, and 10 percent through the Stock Exchange. A further 20 percent is owned by banks, insurance companies and other financial institutions (including those controlled by government) and 20 percent is held by the general public. Of the 9 members of the CIT board, 5 (including the CIT Executive Director) are directly nominated by government, and the NRB and Stock Exchange also appoint one director each.
The CIT operates various schemes:
* Employees Savings Growth Scheme (ESGS) * Citizens Unit Scheme * Investment Account Scheme * Pension Scheme
The chargeable administrative expense of the Citizens Unit and the Investment Account schemes is capped by law at 3.5 percent per annum and 10 percent of income, and the management fee at 1.5 percent. The CIT accepts investments into its schemes through 120 collection centers nationwide at offices of the NRB, RBB and NBL.
The Employees' Savings Growth Scheme was originally introduced in 1991 as a mandatory scheme requiring all employees in the public and private sectors to contribute 5 percent of their 101 salaries. The scheme was successfully contested in the courts, however, after only 3 months of operation. The scheme was then converted into a voluntary program, allowing workers to contribute either 5 or 10 percent of their monthly salary by direct debit for a period of 5 years. This 5-year plan was then rolled over in 1996. Participants can join the program at any point, but the roll-over years are set. In 1998 a new scheme was announced with a 10-year duration. The intention is to ultimately move to a plan that pays only at retirement. The ESGS sends annual statements of account to its members.
The ESGS invests only in fixed income securities (including loans). The management and service charge is only 0.5 percent. Interest earned within the scheme is retained and paid out with principal at the end of the program period. Participants may not withdraw their investment prior to the end of the 5-year period (or lose all accrued interest), but they may stop making contributions without penalty. Participants may borrow against their fund assets for the sole purpose of investing in securities issues promoted by CIT. Average monthly contributions total NR 25 million, or about NR 800 per active account. The average rate of return has been 12.2 percent since 1991. The rate of return was 9 percent in 2000.
The Citizens Unit Scheme was established, by statute, in 1995. Units are continually offered and may be purchased by companies or individuals. Investments of up to NR 10,000 are tax exempt. The scheme is limited to people with salaries below NR 100,000 per annum". The CIT purchases and sells units on a daily basis. The units are always priced at par and the income is distributed periodically. Since inception, the Unit scheme has provided a rate of return of around 11 percent. Less than 25 percent of the portfolio is invested in equities, though the scheme has substantial unrecognized equity gains. The actual value of the equity portfolio is NR 30 million versus a booked value of NR 12.6 million. The bulk of the portfolio is invested in terrn deposits with maturities less than two years and a current average yield of 10.56 percent.
The Investor Account was established in 1999 as a retirement scheme receiving voluntary contributions from individuals. It is not tax exempt, but it does not pay withholding tax. Participants cannot withdraw funds prior to retirement at which point they receive a lump sum. The participants choose the investments for their own account, and the current rate of return is around 7.5 percent. At present, the CIT does not charge an administrative fee for this scheme (as a promotional gesture).
Table 8.6: Citizen Investment Trust - Total Assets & Membership by Scheme
Total Assets (in NR Million) Members as of Name of Scheme July 1998 July 1999 July 2000 Feb. 2001 February 2001 Employee Savings 29,000" Growth Scheme 127.4 219.33 342.5 611.8 20,0002' Citizens Unit Scheme 15.44 42.49 146.8 183.4 4,200 Investment Account - 20.04 56.75 58.1 12,000 Pension Scheme - - 31.92 42.5 2,000 1/ Active Members 2/ Inactive Members
The Pension scheme is also a voluntary retirement scheme but is targeted at companies. It was established in 2000. At present, there are seven or eight participating companies. It is a tax- exempt scheme. Participating companies use the fund to provide a defined benefit pension to
44It is not clear how this is verified or enforced. 102 their employees. The company takes all the risk of meeting the defined benefit liability. The current rate of return is 8.5 percent. Similar to the Investor Account, the CIT presently waives the administrative fee.
Table 8.7: Citizen Investment Trust - Asset Distribution, February 2001
Distribution by Asset Class (in NR million) Govt Fixed Corporate Share Term Name of Scheme Bonds Interest & Debenture Loans
Employee Savings Growth 320.2 215.6 27.0 49.0 Growth Citizens Unit 20.8 117.5 12.6 32.5 Investment Account - 52.1 6.0 - 42.5
3. Issues
Beyond the social protection issues raised by the limited coverage of the Nepali pension system, there are a series of further concerns for institutions involved in pensions in Nepal. If pension funds are to provide adequate retirement benefits to Nepalese, these issues will need to be addressed.
Limited investment opportunities. The business environment is generally weak and there is a scarcity of safe investment opportunities that provide the pension fund system with a reasonable long-term return. This shortfall is exacerbated by the excess liquidity which exists in the banking system, resulting in government bonds having interest rates 3 to 4 percent lower than comparable government instruments in India, notwithstanding the fixed exchange rate. In addition, the current constraints upon overseas investment not only denies savers the higher returns available overseas, but also prevents any form of risk reduction through portfolio diversification.
Poor governance. The poor standards of governance, disclosure and financial sector regulations are impeding the development of the securities markets while reducing any investment in traded securities into little more than speculation.
Concentration of investments. Partly due to restrictive legislation, but also due to the paucity of other alternatives, investments of the provident funds are heavily concentrated in the banking sector. This is of considerable concern as the two major banks are insolvent. Inevitably, efforts to reduce provident fund exposure to these banks will adversely impact the bank's liquidity positions and increase their borrowing costs relative to other banks, worsening their financial condition. Also, in the event of liquidation, while the provident funds might technically be regarded as "institutional investors" and therefore expected to take a substantial haircut, or to be "bailed in" to any workout, there will still inevitably be a high cost of any such action. -
Government influence in the EPF. The EPF is the dominant entity in the Nepal retirement savings system. However, it appears to operate largely at the direction of government and even the modest measures which were designed to provide a modicum of independence (such as the investment committee) are not functional. The current and past investment strategy of the EPF reflects an accommodation of the wishes of government rather than the fiduciary responsibility to the plan beneficiaries. 103
Introduction of defined benefit plans. The plan by the EPF to provide a pension to its members essentially converts the fund from being "defined contribution" to being, at least in part, "defined benefit". As such, the plan now runs the risk that its obligations might exceed its assets. While the demographics of the Nepali labor market imply that any shortfall will be unlikely in the distant future, this is itself problematic in that there will be a strongly ingrained sense of entitlement amongst prospective beneficiaries (who will have already contributed to the benefits enjoyed by their predecessors).
Lack of enforcement of participation. There is no real system in place to enforce participation in the provident fund system. At best only a third of those required to participate actually do so. This is exacerbated by the failure of the EPF to establish any form of direct contact with its members and to distribute, at least, annual statements of account. The absence of t-ansparent good governance has helped to undermine confidence in these programs.
Tax benefits. The tax incentives attached to provident fund contributions alongside the generous withdrawal allowances make the provident fund system as much a mechanism for sheltering income from taxation as a means to provide for old age security. This also applies to the life insurance sector, especially those products which allow early repayment of principal - and to the Citizens Investment Trust. It is understood that pending tax legislation will nrduce the attractiveness of early withdrawals from the provident funds.
Fiscal burden of the Civil Servants Pension Scheme. The Civil Servants' Pension Scheme is likely to represent an increasing fiscal burden for the government. While this is an issue related more to civil service hiring and remuneration than to pensions, the cost of pensions, currently estimated at 6 percent of government revenues, will rise rapidly and inexorably.
Lack of timely production of accounts. The National Insurance Corporation, one of Ihe largest and most significant financial institutions in the country, has not been able to produce annual financial statements (the most recent released figures are 9 years old). There is also some question as to the extent to which this organization is being run on commercial lines. Given the unfortunate experience of RBB and NBL, the government may wish to take remedial action. The only other life insurance company, National Life and General Insurance, has also been lax in publishing accounts and holding its Annual General Meeting, but with only a year's delay. 4. Recommendations
The main recommendations of this chapter are:-
(a) There is a need for improved supervision and enforcement of mandatory savings schemes in Nepal. These savings schemes (particularly defined contribution schemes that are well managed and invested) can benefit a developing country such as Nepal by providing much needed post-retirement income for the participants as well as being a good source of long term savings for domestic investment.
(b) The EPF should set clear and transparent rules for the investment of its funds. This will reduce scope for abuse, both by government and others. 104
(c) Close attention should be paid to defined benefit schemes. Actuarial valuations should be conducted annually so that appropriate measures can be taken in anticipation of developments. Proper actuarial valuations should also deter abuse of the schemes.
(d) Attracting international insurance firms would be beneficial to Nepal, as they could bring more products and wider experience in setting proper premiums that would benefit individuals and firms.
(e) The government needs to review its practice of selling bonds and certificates to targeted institutions. Such practices can be distortionary and are undesirable in the long run.
(f) The constraints on international investment by contractual savings institutions should be reconsidered in light of the absence of risk diversification and domestic investment opportunities.
(g) The EPF needs to ensure that the interests of the beneficiaries are not being subordinated to government interests. The EPF should also ensure that plan beneficiaries receive regular information on their accounts.
(h) The insurance firms should produce their annual accounts in a timely manner.
(i) A review should be carried out of the National Insurance Corporation to ensure that it is running on commercial and financially sound lines. 105
CHAPTER NINE Capital Market Development in Nepal 1. Introduction
The history of securities market activity in Nepal dates back to 1937 when the shares of the Biratnagar Jute Mill and Nepal Bank Limited were floated to the general public. The next significant development after this was the introduction of the Companies Act in 1964 and the issuance of Government bonds in the same year. Real market activity, however, did not commence until the establishment of the Securities Exchange Center (SEC) in 1976 with the objective of facilitating and promoting the growth of capital markets in Nepal.
The Securities Exchange Center was owned 51 percent by the Nepal Industrial Development Corporation (NIDC) and 49 percent by Nepal Rastra Bank (NRB) and operated with a capital of NR 1.0 million. At this time there were less than 3,000 shareholders in Nepal and there were very few publicly traded companies. In an effort to increase public awareness and public ownership of shares, the Government set aside 30 to 35 percent of all newly created government- owned companies to be sold to the public. At a later stage, the Government began to sell Government bonds on the SEC - which had predominantly been held by NRB up until this point. As a result of a pro-active advertising campaign by the SEC, the public increasingly began to purchase Government bonds such that, by 1988, 70 percent were held by the general public. The SEC also began to manage other public issues. All trading was done at and by the SEC. 2. The Nepal Stock Exchange Under a program initiated to reform the capital market in the early 1990s, the Government converted the Securities Exchange Center into the Nepal Stock Exchange (NEPSE) on June 13, 1993. As a result of this change, brokers were permitted to trade in shares. This process was supported by a USAID Economic Liberalization Project. Trading began on the new Exchange on January 14, 1994, with 62 listed companies. The Nepal Stock Exchange is a non-profit organization which operates under the Securities Exchange Act of 1983 and is owned by the Ministry of Finance (58.67 percent), Nepal Rastra Bank (34.6 percent), NIDC (6.13 percent), with the remaining shares held by a variety of brokers, market makers, and issue managers (0.6 percent). The basic objective of NEPSE is to provide free marketabity and liquidity to government and corporate securities by facilitating transactions on its trading floor through market intermediaries.
The Board of Directors of NEPSE consists of nine members in accordance with the Securities Exchange Act, (1983) with representation on the following basis:
Number of Name of Organization Directors Designation
Ministry of Finance I Chairman Securities Board 2 Director Nepal Rastra Bank 2 Director NDIC I Director Licensed Members 2 Director General Manager of NEPSE I Director 106
The authorized capital of NEPSE is NR 50.0 million, of which NR.30.41 is paid up. Members of the Nepal Stock Exchange can act as intermediaries in the buying and selling of Government bonds (although government bonds have not been transacted through NEPSE since it was established in 1993) and listed corporate securities. At present, there are 27 licensed brokers who can buy and sell on a client's behalf, and one registered market maker who can quote both buying and selling prices. In addition, there are licensed primary issue managers (11) and dealers (2). Issue managers operate as managers and underwriters to primary market issues, whereas secondary market dealers operate as portfolio managers.
Trading is restricted to listed corporate securities and government bonds. At the current time, 115 companies have listed their securities to make them eligible for trading as well as one (NCM) Mutual Fund. The rules for listing on the Stock Exchange are particularly lax - with the NEPSE accepting any financial statements provided by the company wishing to list, regardless of how poor (or good) the quality of the audited financial information may be. The listing fee and the annual fee to be paid by the listed company is based on each company's capital base as follows:
Paid-Up Capital Listing Fee Annual Fee (NR million) (NR '000) (NR)
Upto 10 0.20% or minimum of 15 15,000 Above 10-50 0.15% or minimum of 45 25,000 Above 50-100 0.10% or minimum of 75 35,000 Above 100 0.075%orminimumof 100 50,000
Source: Nepal Stock Exchange
Despite the fact that 110 companies are publicly listed, very few company shares are actively traded. Typically, the local newspapers quote trading activity in 20 to 30 companies on a daily basis. Indeed, several of the companies do not appear to even still be in operation. De-listing of companies is complicated by provisions under the Securities Exchange Act, which makes transfer of ownership difficult in the case of a de-listed company.
NEPSE trades five days a week, between 11:00 a.m. and 1:00 p.m. The NEPSE operates on an "Open Cry Out" system under which securities transactions are undertaken in open auction on the trading floor. The buying broker with the highest bid will post his price in the buying column, while the selling broker with the lowest offer will post his price in the selling column. Once bid and offer prices match - contracts are concluded on the floor of the stock exchange. Trading is normally done in lots of at least 10 shares, if the face value is NR 100 - or 100 shares, if the face value is NR 10.
Opening prices cannot be more or less than 10 percent of the previous day's closing price but, once transactions are concluded within this range, the price is permitted to change with a limit of 5 percent on each consecutive transaction. The Exchange operates with a T+5 system such that settlement of the transaction should be concluded within 5 working days of the transaction day. Settlement is carried out on the basis of paper versus payment. The rate of brokerage on equity transactions ranges from 1.0 to 1.5 percent depending upon the traded amount.
The securities market of Nepal is regulated, supervised and monitored by the Securities Board, Nepal (SEBO) established on May 26, 1993 under the Securities Exchange Act, 1983 (first amendment). It is mandatory for all capital market intermediaries to be registered with SEBO before undertaking securities business, and to report their financial and trading activities to it. It is also mandatory for the listed companies to submit their annual and semi-annual progress 107 reports to SEBO. SEBO promotes and protects the interest of the investors by regulating the issuance, sale and distribution of securities and purchase, sale or exchange of securities. It also supervises and monitors the activities of the stock exchange and of other intermediaries carrying on securities business. It registers and regulates market intermediaries involved in the primary issues as well as in the secondary trading of securities. It is also the duty of SEBO to advise the Government on issues related to the development of the capital market and the protection of investor interests. Thus, SEBO has an important role in developing the capital markets by making securities transactions fair, healthy, efficient and responsible.
SEBO is governed by a Board composed of seven members, including a Chairman who is appointed by HMG/N for a four-year tenure. Members of the Board include representaltives, one each from the Ministry of Finance, the Ministry of Law and Justice, the Ministry of' Industry, Commerce and Supplies, Nepal Rastra Bank, FNCCI and the Nepal Chartered Accountants' Association.
The key challenges confronted by SEBO today are: growing demands for stronger enforcement of corporate governance; a lack of standardization of accounting and auditing practices; the need to improve market transparency through information disclosure policy; improving market surveillance; ensuring maintenance of uniform reporting systems; and the need to expand SEBO's coverage beyond the listed companies and those eligible to list securities - to include other private and public sector companies. Unfortunately, SEBO is ill-placed to meet these challenges as it firstly needs to be strengthened as an institution, with operational and financial independence - as this is currently missing.
3. Recent Activity on the Nepal Stock Exchange Between the 1980s and 1993/94, market activity grew very rapidly. Turnover rose fromrn NR 2.0 million in 1984/85 to NR80.0 million by 1993. In January, 1994 when the Nepal Stock Exchange commenced operations, market activity increased even more rapidly as market promotion and easier access permitted a significantly greater number of players to enter the market. This initial spurt of activity - which lasted for over six months - was seemingly spurred on by spectacularly good results in a handful of companies (mainly in the banking sector where some companies were paying out dividends well in excess of 50 percent). However, when it became apparent that this was not necessarily true in all cases the public became disillusioned with the market and prices and trading volumes declined.
The market was further battered by political changes from 1995 onwards which did not appear to provide active support for capital market development. As a consequence, the stock exchange experienced heavy losses as trading volumes declined. The period from 1995 to 1997/98 was particularly difficult for the NEPSE.
This gloomy situation changed somewhat after 1997/98 as many new finance companies commenced operations, made reasonable profits, and paid out dividends to shareholders. Nonetheless, the market has never been particularly vibrant nor particularly liquid. Table 9.1 below provides some of the key comparative information on the NEPSE for 2000 and 2001. One of the most interesting features of Table 9.1 is the very heavy preponderance of trading in bank and financial institution shares. In both 2000 and 2001, around 80 percent of all trading on the NEPSE (by value) was in bank shares, while over 90 percent of trading was in banking, finance and insurance. Manufacturing and processing represented the only other significantly traded sector on the NEPSE - although shares in hotels, trading companies and others are also traded. Only around 108
half the shares on the stock exchange are actively traded. The most actively traded shares in 2000 were all commercial banking shares as shown in Table 9.2.
Table 9.1: Nepal Stock Exchange Limited Summary Sheet of Transactions, 2000 and 2001
2000 2001 Share Share Units NR Units NR ('000) Million % ('000) Million %
Turnover 7,673.7 1,157.0 100.0 4,989.2 2,335.9 100.0 Commercial Banks 1,219.6 877.7 75.9 1,623.1 1,922.3 82.3 Insurance and Finance 699.7 143.3 12.4 1,120.1 293.3 12.6 Manufacturing and Processing 5,282.2 73.8 6.4 1,786.3 67.2 2.9 Hotel 181.3 26.7 2.3 142.1 22.3 1.0 Trading 11.1 12.2 1.1 7.2 4.5 0.2 Other 279.9 23.2 2.0 310.4 26.4 1.1 Market Days 240 231 Average Daily Turn over 32.0 4.8 21.6 10.1 Number of Transactions 29,136 46,095 Number of Companies Traded 69 67 Number of Shares Traded 7,673.7 4,989.2 .- Number of Companies Listed 110 115 Number of Scripts Listed 112 115 No. of Listed Unit of Mutual Fund 5,250 52.5 5,250 52.5 Total Amount of Listed Shares 7,347.4 7,919.1 Market Capitalization of Listed 43,123.3 46,349.0 Companies % of Turn Over to Paid-Up Value _ 15.7 29.6 % of Turn Over to Market Capitalization 2.7 5.1 Number of Listed Securities 114,057 121,270 Commercial Banks 10 9.1 10 8.7 Insurance and Finance 34 30.9 39 33.9 Manufacturing and Processing 37 33.6 37 32.2 Hotels 3 2.7 3 2.6 Trading 22 20.0 22 19.1 Other 4 3.6 4 3.5 NCM Mutual Funds I
Source: Nepal Stock Exchange, Annual Report 2001 109
Table 9.2: List of Top Ten Companies Top Ten on the Basis of Amount Traded, 2001
Amount Traded Name of Companies (NR million)
Bank of Kathmandu Ltd 605.44 Nepal Bangladesh Bank Ltd 255.51 Nepal Industrial and Commercial Bank 246.29 Nepal Arab Bank Ltd. 212.65 Nepal SBI Bank Ltd. 169.32 Nepal Bank Limited 129.30 Nepal Standard Chartered Bank Ltd. 107.84 Nepal Share Markets Limited 78.39 Himalayan Bank Ltd. 75.57 Everest Bank Ltd. 61.75
Source: NEPSE Annual Report
Table 9.3 shows the growth of the Stock Exchange from 1995 to 2000. Although the market capitalization of NEPSE was only $267.4 million in 1998, this has grown rapidly since that date (particularly due to the entry of new banks and finance companies - which have powered the local market) and, according to the Stock Exchange's 2000 Annual Report, stood at around $799.8 million at the end of 2000. Although trading values and volumes have recently increased (1999 and 2000) - they are still relatively low.
Table 9.3: Nepal Stock Exchange - Basic Information, 1995 to 2000
1995 1996 1997 1998 1999 2000
Number of Listed Companies 83 90 98 104 10 110 on the NEPSE
Market Capitalization In rupees 13,681.0 11,849.0 12,650.0 18,093.0 28,782.0 59,705.0 In dollars 244.0 207.8 199.8 267.4 418.3 799.8 Trading Value In rupees 915.0 287.1 276.5 302.2 1,622.0 2,253.5 In dollars 17.6 5.1 4.8 4.6 23.8 31.7 Turnover ratio 6.9 2.2 2.3 2.0 6.9 5.1 Local Index NPSE Index 206.6 - 170.9 175.5 262.5 488.0 Change in index (%) 5.8 - - 2.7 49.6 85.9 P/E ratio 23.2 10.2 8.5 8.0 18.28 27.55 P/BV Ratio 534.6 34.9 1.2 1.6 2.38 0.123 Dividend Yield (%) 3.6 5.6 6.2 3.9 :1.71 3.1 Economic Data Gross Domestic Product (US$) 4,392.3 4,509.3 4,921.9 4,783.0 5,000 5,450 Change in Consumer Price Index (%) 7.6 9.2 4.0 10.0 I11.3 3.4 Exchange Rate (average of period) 51.8900 56.6920 58.0100 65.9760 68.2530 71.0940
Source: Emerging Stock Markets Fact book 2000 & 2001 - InternationalFinance Corporation 110
Table 9.4 provides comparative Stock Exchange information for the six main stock exchanges of the South Asia region. The comparative data is for 2000. Not surprisingly, India was by far the largest exchange with almost 5,937 listed companies and a market capitalization in that year of $148 billion. Trading volumes in India were $49.4 billion. By contrast in Nepal, there were only 110 companies listed, there was a market capitalization of $800 million, and a total trading value of only $31.7 million. Pakistan, Sri Lanka, and Bangladesh range in between the Indian and Nepali stock exchanges in terms of relative size. Pakistan, the region's second largest stock exchange has 762 companies listed (13 percent of what India does); a market capitalization of $6.6 billion (4.4 percent of India); and a trading value of $1.2 billion (2.4 percent of India). Meanwhile, Bangladesh, which has the third largest stock exchange, has 211 companies listed (twice as many as Nepal); a market capitalization of $1,186 million (fifty percent higher than that of Nepal); and a turn over of $768 million (more than 24 times that of Nepal). With only 13 listed companies (12 percent of what Nepal has and less than a quarter of a percent of what India has), a market capitalization of $38.0 million (around 5 percent of Nepal's) and a trading value of $3.5 million in 1999, Bhutan has the smallest exchange in the South Asia region.
Table 9.4: Comparative Table - South Asian Stock Exchanges - Basic Information, 2000 (currency in millions)
India Sri (BSE) Pakistan Lanka Bangladesh Bhutan* Nepal
Number of Listed Companies 5,937 762 239 221 13 110
Market Capitalization (in US$) 148,064 6,581 1,074 1,186 38.3 799.8 Trading Value (in dollars) 49,403 1,184 5.2 768 3.5 31.7 Turnover ratio 33.2 19.0 0.5 74.4 9.2 5.1 Local Index 912.8 1,507.6 698.5 642.7 - 488.0 Change in index(%) -0.9 18.1 5.3 31.8 - 85.9 P/E ratio 16.8 -117.4 5.2 12.4 - 27.55 P/BV Ratio 2.6 1.4 0.7 1.8 - 0.123 Dividend Yield (%) 1.5 6.2 8.0 5.2 - 3.1 Economic Data Gross Domestic Product (US$)* 479,404 61,673 16,402 47,864 440 5,450 Change in CPI (%)* 3.8 3.6 6.2 3.6 9.2 3.4 Exchange Rate (period average) 44.9344 53.9257 70.7055 52.1656 42.9850 71.0940
* Data pertaining to 1998 Source: Emerging Stock Markets Factbook 2000 & 2001 - InternationalFinance Corporation
4. Problems with the Nepal Stock Exchange The poor performance of the Stock Exchange can be attributed to several factors - and if the NEPSE is to develop as a reasonable market maker, these will need to be addressed as a matter of urgency.
Accounting standards and their enforcement. Perhaps the most important factor impeding the development of the NEPSE is poor accounting standards. This is a fundamental problem which will require rectification before the market can grow beyond its current incipient state. Weak accounting and auditing standards mean that many companies' financial statements are not credible. In fact, some companies which are currently listed on the NEPSE have not produced accounts for several years - Nepal Bank Limited being one case in point. Even when accounts III are prepared, they are frequently of such poor quality as to be an ineffective guide as to the true financial health of the company. In some cases company accounts are purposefully misleading and have portrayed the company as being in significantly better financial health than is actually the case. This has led to a general disillusionment of investors with respect to investing in the NEPSE.
Listing requirements. Related to the above, weak listing requirements mean that almost any company can be listed on the exchange merely by providing some accounting information. The NEPSE should enforce much more vigorous listing standards so that only good name institutions, with financial information audited to international standards, are listed on the Stock Exchange. Any company found to be in contravention of new, more stringent, listing requirements, should be warned and ultimately de-listed from the exchange if they do not comply.
Corporate governance. In the tradition of many South Asian companies, many firms in Nepal are family-owned and operated. Often inexperienced family members operate as managers, accountants, and hold other senior management positions. Companies which are listed on the exchange should have professional management and adequate checks and balances in place to protect the interests of unsophisticated investors to the maximum extent possible. There has been some discussion in Nepal about establishing a Corporate Governance Code. This may be one way of helping to ensure stronger corporate governance for the future.
Mutual funds. There is also a need to develop mutual funds in Nepal. In an effort to elicit the maximum number of Nepali shareholders, the NEPSE operates with a very low minirmum share subscription level of 10 shares. This, however, is relatively inefficient and costly. Most companies would prefer a minimum share subscription level of 100 shares -this, however, would put share purchases outside the range of most small and medium scale investors in the market. The further development of mutual funds, in conjunction with a higher share subscription level, could help address this issue.
Permifting government bonds to be traded on the NEPSE. Although historically the Securities Exchange Center used to trade in Government bonds this appears to have stopped with the establishment of the Nepal Stock Exchange in 1994. Frequently, Government paper forms the "bread and butter" of market activity and market commissions in many small stock exchanges. An active program which addresses the reas6ns why trading in public paper no longer takes place and which seeks to move secondary trading in Government securities to the Stock Exchange could have a positive impact upon both overall trading activity and the profitability of the NEPSE.
Investment by insurance, pension and provident funds in the NEPSE. At the current time, provident funds are restricted to investing only in the capital of banks and finance companies. This explains, in part, the relatively better performance in the share market of these types of institutions. In most well-developed markets, the funding held by these institutions forms a major part of an economy's investible, long-term resources, and they are thus important players in the stock exchange. Permitting these institutions to invest in a re-vamped stock exchange - where listing requirements were significantly tightened, accounting standards were at international levels, and adequate corporate governance was ensured - would have a potentially powerfully positive impact upon the development of capital market activities. However, these pension funds should not be permitted to invest in an extended range of securities prior to the above changes being made. As these funds represent the future pension benefits of many, often poorer, workers - they should not be put at risk in the current lax environment. 112
Preponderance of investment in banking stocks. As indicated above, virtually all the trading on the NEPSE is in bank stocks. As indicated in the commercial banking chapter - many of these banks (both publicly and privately owned) are in poor financial health, do not produce accounts to international standards, have high levels of non-performing assets; and in some cases, have been guilty of paying out dividends while not meeting minimum capital requirements - let alone the new, more stringent capital adequacy requirements that the central bank hopes to gradually implement within the banking sector. If there is a shake out of the commercial banking sector over the next several years - the negative impact upon stock market activity and development could be severe. Although Nepal Bank Limited is the most-glaring case in point, the same is also true of several others of the small joint venture banks, which are actively traded on the NEPSE.
Poor business environment. The business environment in Nepal is not conducive to private sector investment - either domestic or foreign. In a 2000 survey of the private sector, respondents complained about poor government policies and their implementation, weak demand for Nepali produced goods, lack of access to finance (particularly longer-term finance), and a weak infrastructure (particularly power provision) - which have, in combination, adversely impacted the ability of the private sector to operate competitively and efficiently. The difficulties faced by foreign investors are even more daunting, and concern over political instability and a generally perceived poor investment climate has resulted in a fall away in FDI in Nepal over the latter part of the 1990s. The balance of payments numbers for 2000 put FDI in Nepal, for that year, at less than US$4.0 million. This compares to official development assistance in the same year of $340 million. Unless the business environment is significantly improved - it will be difficult for the capital market to develop much beyond its current incipient state. 5. Recommendations Nepal's stock exchange is small, illiquid and in urgent need of revitalization if it is to play a meaningful and active role in financial system development in the country. The following represent the main recommendations for this sector:
(a) Accounting standards need to be improved in Nepal so that they rapidly approach internationally acceptable norms. Any company not using International Accounting Standards should not be permitted to list on the NEPSE.
(b) Other listing requirements for the NEPSE should also be tightened such that they approach the norms generally applied in other more developed markets - within a short period of time. This is important to restore investor confidence in the stock market.
(c) Any company not meeting the minimum requirements of the Nepal Stock Exchange should be de-listed. This would include many companies currently listed on the exchange.
(d) A Corporate Governance Code should be approved in Nepal.
(e) The use of mutual funds should be encouraged so that more Nepalese could benefit from market activity - while permitting an increase in the minimum number of shares traded.
(f) The Government should be encouraged to trade bonds on the stock exchange.
(g) Insurance, pension and provident funds should be permitted to invest beyond the banking and financial sectors. They are currently helping to "power" the trade in this sector - to 113
the detriment of other sectors. This should NOT be permitted to happen, howazever, until the above listing and accounting changes have been made.
(h) There is urgent need to effect reform in the commercial banking sector - so that any fall out from the sector will not have a negative impact upon capital market development in the future.
(i) The government needs to seriously address issues related to the poor business environment in Nepal in an effort to encourage rapid increases in both domestic and foreign direct investment. 114
CHAPTER TEN Summary and Main Recommendations 1. Summary Despite almost two decades of financial liberalization, Nepal's financial sector remains particularly weak and extremely fragile - largely benefiting a narrow base of users in the main urban areas and having very little impact upon the mass of Nepalis in the remainder of the economy. In its current state it is highly vulnerable to shocks and internal disruption. Restoring the financial sector to a healthy state should be the prime initial goal of policy makers. Thereafter, ensuring that the sector plays a more constructive supporting role in ensuring broad based economic development will be important.
The sector is characterized by an exceedingly high level of public involvement at virtually every level. The two largest commercial banks have a dominant public sector involvement (RBB is 100 percent owned by the state); the joint venture banks also have a high level of public sector involvement - either directly or indirectly through the involvement of other state owned institutions; the two large development banks are 100 percent owned by the Government; insurance and pension funds are also mainly the preserve of the government; and micro-finance institutions (including the Grameen Bikas Banks) reflect the same high level of public sector ownership.
Public ownership has distorted and politicized these institutions. The public does not treat state owned financial institutions in the same way as it treats private sector banks. Loans are not repaid yet deposits continue to be made - safe in the assurance that the Government implicitly stands behinds the safety of these funds (an enormous contingent liability for the Government of Nepal). The end result has been the financial de-commercialization of most of these institutions as they have run up large losses associated with both high levels of non-performing loans and high administrative and overhead expenses. In the most egregious cases - the two largest commercial banks - the potential losses may be as high as 10 percent of Nepal's GDP. These are losses which already exist and will have to be recognized. This represents a banking crisis - at the upper end of the scale - even in world terms.
Yet, the problems of the financial sector are not just confined to these two large commercial banks. The Agricultural Development Bank, the Nepal Industrial Development Corporation, the Grameen Bikas Banks, the Nepal Stock Exchange, as well as other institutions, all face considerable problems of varying degrees of severity.
In addition, the financial sector operates in a murky milieu of bad accounting, weak regulation, a poor banking culture, lack of transparency, a fragile legal environment, and a deficit of readily available information on virtually all issues that are required for a banking system to operate effectively. This environment has bred all the worst possible aspects of corruption, insider dealing, lack of accountability, and opaque operation. Rolling back these problems to create an environment for prudent and supportive financial sector operations will be a major challenge for the authorities.
Reform will need to begin at the apex of the system - Nepal Rastra Bank itself. In this regard, the January 2002 passing of the new Nepal Rastra Bank Act is an important step in the right direction in terms of providing enhanced independence of operation for the central authorities. The recent 115 issuance of new banking regulations - based upon international banking norms - also provides an important basis to move forward. Nonetheless, "enforcement" will remain the big challenge - ensuring that NRB has the capacity to guarantee that the banks operate within the norms established by this new legal and regulatory regime. To do this, NRB itself will require significant strengthening and restructuring.
Reform in the sector will take place within the framework that the Government has established through the Financial Sector Strategy Statement (FSSS) which recognizes the major problems in the sector and sets out a program to deal with issues of public ownership, conflict of interest, lack of transparency, and so on. The FSSS establishes an important policy base and vision for the way forward - which will need to be refined and made more specific as the reform process advances.
Change will, nonetheless, remain challenging. Resistance from vested interests is anticipated to be strong. Unions, boards, owners, shareholders, private business interests, and even the government itself may find that a movement to more prudent banking activity cuts across more narrow personal interests within the economy. Yet reform is crucial. This report lays out numerous reforms that are necessary in all sectors and sub-sectors of the financial system. These are listed at the end of each chapter. However, the commencement of this new phase of reform should be more narrowly (if not equally ambitiously) based upon a more limited agenda of activities. These are described below. 2. Recommendations Over the short term it is recommended that the government's financial sector reforms should center on five important principles:
(a) Withdrawing the governmentfrom ownership offinancial institutions- beginning with RBB and NBL - and bringing in 'fit andproper" bankers to replace it in this role. The reform program should begin by placing Rastriya Banijya Bank and Nepal Bank Limited under conservatorship arrangements so as to gain financial control - developing a sense of the balance sheets and profit and loss positions of the two banks as quickly as possible. The next step should be to control costs and increase profitability - by implementing a voluntary retirement scheme to downsize the two banks as rapidly as possilble, cutting back on unprofitable bank branches, and introducing stringent loan recovery programs for defaulting borrowers. Once a modicum of financial control has been achieved, long-term plans should be developed to liquidate, further downsize, split, or privatize the banks - to ensure a fundamental change in their governance. Restructuring of these two large banks should be undertaken in conjunction with a program of complimentary reform within the Agriculture Development Bank of Nepal.
(b) Significantly strengthening the central bank to make it a fully professional institution. Radical restructuring should be undertaken to transform Nepal Rastra Bank into a professional central banking institution. The reform should focus initially on developing an appropriate structure, shifting to merit-based promotion and staff advancement, implementing a voluntary retirement scheme to reduce staffing to more appropriate levels, and decompressing the salary structure. Within the central bank, the establishment of a strong bank supervisory capacity - both on-site and off-site inspection - with fully implemented enforcement powers, will be critical to the evolution of a well functioning and prudently operated banking sector. 116
(c) Restructuring the ADB/N and Closing NIDC The reforms in RBB and NBL must be undertaken in close coordination with the proposed restructuring plan within the ADB/N. With an equally large branch network and presence throughout Nepal - it is likely that important synergies will exist between the reform programs in these three institutions with respect to branch rationalization, staffing reductions, and the provision of banking services throughout the country-side. Close coordination and cooperation between these various efforts will require oversight by the central authorities within Nepal Rastra Bank. As a deposit taking institution, the ADB/N also needs to be quickly brought under the purview of the bank inspection department of the central bank. In addition, given the dire financial position of the Nepal Industrial Development Corporation, its lack of funding, its weak loan portfolio - in combination with its small size and the capacity of other financial institutions to provide industrial finance - the central authorities should give serious consideration to quickly closing NIDC and winding up its operations.
(d) Creating an appropriate environment for establishing a sound financial sector. An effective system of checks and balances needs to be established in the financial system, by:
* Implementing the provisions of the new Nepal Rastra Bank Act and finalizing the new Banking and Financial Institutions Act as soon as possible so that it can be enacted. * Strongly enforcing the new regulations on bank supervision - with no exceptions. Banks failing to comply with the regulations within the period specified should have their banking licenses revoked and/or be forced to merge with other banks. * Requiring all financial institutions to submit externally audited financial statements to the central bank within four months after the end of the year - or risk losing their license. Ideally, the auditing should conform to international accounting standards. * Requiring the central bank to dispose of shares in any institution that it supervises and developing a five-year plan for disposing of shares in all financial institutions.
(e) Supporting the development of an improved system of micro-finance. The government needs to determine how to deliver financial services to the poor more effectively as part of its poverty reduction efforts. To this end, it should investigate the immediate restructuring and privatization of the Grameen Bikas Banks and consider ways of ultimately providing sustainable micro-finance services through private sector institutions - building upon the good/sustainable micro finance examples which exist within Nepal and learning from the best practice examples which exist within the region.
These steps are only the very first that must be taken - over the short to medium term - to begin restoring credibility and soundness to the financial system in Nepal. Only after these initial - but extremely difficult - steps have been taken will it be possible to devise a more detailed strategy for the longer term. Elements of this strategy can be drawn from the other recommendations of this study (see Annex 10). Nonetheless, development of this longer term strategy for the financial sector will be an important next step in the long road towards true financial sector reform in Nepal. 117
Annexes Nepal FinancialSector Study
NEPAL
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Annex One Nepal's Financial System as of mid-July 2001
A. NEPAL RASTRA BANK - Central Bank Of Nepal (7 branches, I sub-branch)
B. COMMERCIAL BANKS (16) (comprising 511 branches)
I. Rastriya Banijya Bank (RBB) (56 urban branches & 154 rural branches) 2. Nepal Bank Limited (NBL) (61 urban branches & 145 rural branches) 3. Nepal Standard Chartered Bank Limited (NGBL) (4 urban branches & 2 rural branches) 4. Nepal Arab Bank Limited (NABIL) (8 urban branches & 4 rural branches) 5. Himalayan Bank Limited (HIMBL) (7 urban branches & I rural branch) 6. Nepal Indo-Suez Bank Limited (NIB) (2 urban branches & 2 rural branches) 7. Nepal SBI Bank (State Bank of India) Limited (NSBIB) (4 urban & 3 rural branches) 8. Bank of Kathmandu Limited (BKL) (2 urban branches) 9. Nepal Bangladesh Bank Limited (NBB) (6 urban branches & 3 rural branch) 10. Nepal Bank of Ceylon (NBOC) (2 urban branches & 2 rural branches) 11. Everest Bank Limited (EBL) (5 urban branches & 4 rural branches) 12. Nepal Industrial and Commercial Bank (I urban & I rural branch) 13. Lumbini Development Bank (I urban & I rural branch) 14. Kumari Bank 15. Macha Puchri Bank Limited Pokhara (opened in 2000) 16. Agricultural Development Bank (ADB) (Krishi Bikash Bank) (performing commercial banking activities: 30 branches: 28 urban & 2 rural branches)
C. OTHER BANKING INSTITUTIONS
Cl. DEVELOPMENT BANKS (8) Agricultural Development Bank (ADB/N) (performing development banking activities) Nepal Industrial Development Corporation (NIDC) Rural Micro Finance Development Center Nirdhan Utthan Bank Limited Apurva Bikash Bank Limited Malika Bikash Bank Limited Nepal Development Bank Limited Enterprise Development Bank Nirdhan Utthan Development Bank
C2. FINANCE COMPANIES (48)
1. Ace Investment Company Limited (ACE) 2. Alpic Everest Finance Limited (ALPIC) 3. Annapuma Finance Company Limited (AFCO) 4. Arun Finance and Saving Company Limited 5. Bhajuratna Finance and Savings Company Limited (BFSCO) 6. Butwal Finance Company Limited 7. Central Finance Company Limited 8. Cosmic Merchant Banking Finance Limited 9. General Finance Company Limited (GENERAL) 10. Goodwill Finance and Investment Company Limited (GFC) 119
11. Gorkha Finance Company Limited 12. Himalayan Finance and Savings Limited (HFSC) 13. Himalayan Securities and Finance Company Limited (HISEF) 14. International Leasing and Finance Company Limited (IFCO) 15. Investment Finance Limited (INVESTA) 16. Janaki Finance Company Limited 17. Kathmandu Finance Company Limited (KAFL) 18. Lalitpur Finance Company Limited (LALITPUR) 19. Lumbini Finance and Leasing Company Limited (LUMBINI) 20. Mahalaxmi Finance Company Limited (MAHALAXMI) 21. Mercantile Finance Company Limited (MFCO) 22. Merchant Finance Company Limited (MFCO) 23. Multipurpose Savings and Investment Company Limited 24. Narayani Finance Company Limited (NaFCO) 25. National Finance Company Limited (NFCO) 26. Nava Durga Finance Company Limited 27. Nepal Bangladesh Finance and Leasing Company Limited 28. Nepal Finance and Savings Company Limited (NEFINSCO) 29. Nepal Housing and Merchant Finance Company Limited 30. Nepal Housing Development Finance Company (NHDFCO) 31. Nepal Industrial Development Corporation Capital Markets Limited (NIDC CM) 32. Nepal Merchant Banking and Finance Limited 33. Nepal Share Markets Limited (NSMCO) 34. Nepal Sri Lanka Merchant Bank Limited (NSMB) 35. Om Finance Limited 36. Paschimanchal Finance Company Limited 37. People Finance Company Limited (PFCO) 38. Pokhara Finance Limited 39. Premier Finance Company Limited 40. Samjhana Finance Company Limited (SFCO) 41. Shree Investment and Finance Company Limited (SIFC) 42. Shrijana Finance Company 43. Siddhartha Finance Company Limited (Siddharth) 44. Standard Finance Limited (STANDARD) 45. Union Finance Company (UFCO) 46. United Finance Company Limited (UNITED) 47. Universal Finance and Capital Company Limited (UF-CMCO) 48. Yeti Finance Company Limited (YETI)
C3. RURAL DEVELOPMENT BANKS/GRAMEEN BIKAS BANKS (5) 1. Far-Western Region Rural Development Bank -- (Sudur Paschimanchal Grameen Bikas Bank) 2. Mid-Western Region Rural Development Bank - (Madhya-Paschimanchal Grameen Bikas Bank) 3. Western Regional Rural Development Bank -- (Paschimanchal Grameen Bikas flank) 4. Central Region Rural Development Bank -- (Madhyamanchal Grameen Bikas Bank) 5. Eastern Region Rural Development Bank -- (Purbanchal Grameen Bikas Bank)
C4. NON-GOVERNMENT COOPERATIVE SOCIETIES with limited Banking Activities (35) 1. Nabajiban Cooperative Society Limited 2. Na-Kshitji Cooperative Society Limited 3. Sagun Cooperative Society Limited 4. Nepal Cooperative Finance Society Limited 5. Makala Transport Cooperative Society Limited 120
6. The Sahara Loan, Savings and Investment Cooperative Society Limited 7. Bindhabasini Savings Fund Cooperative Society Limited 8. Bahumukhi Cooperative Society Limited 9. Mahila Cooperative Society Limited 10. Bahu Uddechhe Saving and Loan Cooperative Society Limited 11. Rajshree Saving and Investment Cooperative Society Limited 12. National Development Cooperative Society Limited 13. Sahakari Bittiya Cooperative Limited 14. Nepal Cooperative Society Limited 15. Sana Kisan Sahakari Cooperative Limited 16. Janaki Jeevan Jyoti Bittiya Sahakari Cooperative Limited 17. Shree Manakamana Finance Cooperative Society Limited 18. Bheri Sahakari Finance Cooperative Society Limited 19. Shree Union Cooperative Society Limited 20. Shree Biku Saving and Credit Cooperative Society Limited 21. Shree the New Shree Nepal Savings and Investment Cooperative Society Limited 22. Amarawati Multipurpose Cooperative Society Limited 23. Kisan Multipurpose Cooperative Society Limited 24. United Savings and Loans Cooperative Society Limited 25. Himal Cooperative Finance Limited 26. Star Multipurpose Savings and Loans Cooperative Society Limited 27. Sanakisan Cooperative Society Limited 28. Sanakisan Cooperative Society Limited 29. Sanakisan Cooperative Society Limited 30. Sanakisan Cooperative Society Limited 31. Sanakisan Cooperative Society Limited 32. Sanakisan Cooperative Society Limited 33. Sanakisan Cooperative Society Limited 34. Sanakisan Cooperative Society Limited 35. Yeti Saving & Credit Co-operative Society Limited
CS. NON-GOVERNMENT ORGANIZATIONS (with limited banking transactions) (30) 1. Swalalamban Bikas Kendra 2. Nirhan Society 3. Jwalamukhi Club 4. Apurba Siraha Development Society 5. Economic Development Council 6. Nepal Digo Community Development and Research Center 7. Grameen Pratisthan 8. Economic Development Group, Nepal 9. Bachward Community Research Center 10. Dhaulagiri Youth Club 11. Grameen Development Sashthan Society 12. Grameen Development Scheme 13. Diprox Nepal 14. Shanti Jana Adarsha Sewa Club 15. Naree Bikas Sangh 16. Grameen Uthan Nepal 17. Nepal Grameen Puna Nirman Sanstha 18. Aarthik Bikas Prabardhar Kosh 19. Himali Aarthik Bikas Kosh 20. Kshimek Samaj Sewa Sanstha 121
21. Rastiiya Grameen Bikas Kendra 22. Naree Uthan Tatha Balbatikas Samrakshan Sangh 23. Grameen Swabalamban Bikas Kendra 24. Mahil (Women) UdhyamiSangh (Nepal) 25. Manab Seewa 26. Janjagaran Mancha 27. Nepal Grameen Sawabalamban Sahayog Samuha 28. New Jeevan Jyoti Yuva Club 29. Nepal Ekikrit Samudaik Bikas Parishad 30. Samudaik Bikas Sastha (Community Development Society)
C6. POSTAL SAVINGS BANK (in 121 post offices)
D. NON BANK FINANCIAL INSTITUTIONS
Dl. PRIVATE AND GOVERNMENT OWNED INSURANCE COMPANIES (13) 1. Alliance Insurance Company Limited 2. Credit Guarantee Corporation 3. Everest Insurance Company Limited 4. Himalayan General Insurance Company 5. National Life & General Insurance Company Limited 6. Nepal Insurance Company Limited 7. Noco-Insurance Limited 8. Premier Insurance Company Limited 9. Rastriya Beema Sanathan (National Insurance Corporation) (Government owned) 10. Sagarmatha Insurance Company Limited I1. The Oriental Insurance Company Limited 12. United Credit Company (Nepal) Limited 13. United Insurance Company (Nepal) Limited
D2. PROVIDENT FUND (1) 1. Employee's Provident Fun (EPF)
D3. MUTUAL FUND (1) 1. Citizen Investment Trust (CIT)
D4. OTHERS 1. Securities Board 2. Nepal Stock Exchange 3. Brokers 4. Securities Dealers 5. Market Makers 6. Money Changers (Foreign Exchange Dealers) - 200 122
Annex Two Financial Sector Strategy Statement
Strategy Paper of HMG/Nepal on the Financial Sector Reform Program
Background
Nepal began financial reforms in mid-1980 with a view to enhance efficiency in financial services. Accordingly, the licensing policy for banks and other financial intermediaries have been liberalized. As a consequence, the number of banks and financial institutions have been increased substantially. Presently, 13 commercial banks, 46 finance companies, 35 cooperative institutions, 25 non-government organizations (NGOs) and postal saving banks have been in operation. Along with liberal entry policy, commercial banks and other financial institutions have been given freedom to fix interest rates on their deposit and loan portfolio. As such, the statutory liquidity ratio (SLR) has been withdrawn to enable commercial banks in allocating funds on their own discretion; foreign exchange exposure has been granted and cash reserve ratio reduced. Recently, bank rates have been revised with a view to enhancing investments in agricultural and industrial sector, including export as well as redirecting larger financial resources towards poverty alleviation in rural sector. Further prudential and regulatory norms for banks and financial institution is in the process of revision under World Bank technical assistance and the new set of prudential regulation will be implemented in a time bound manner from the beginning of the next fiscal year.
The initiation of these measures has made the need for further reform and consolidation a matter of urgency. HMG/N's own concern on the financial sector reform has found good support and backing by the multilateral donor agencies. In particular, the World Bank, the International Monetary Fund and the Asian Development Bank are prepared to support substantive and comprehensive reforms by HMG/N in its efforts and endeavors related to financial sector reform strategy and program. At a time when two large state owned banks, having nearly two-third of market share in commercial banking industry, are in serious trouble, the proposed reform program would definitely help to improve the functioning of these banks. In addition, the overall financial sector reform program is expected to make a vital contribution towards supporting private sector led economic growth through enhanced resource allocation to potential growth sectors.
Against this background, the objective of this paper is to highlight and emphasize the urgency of reform program needed for the development of a competitive, efficient and healthy financial sector. This paper also sets out the Central Bank's views on the role of the banking and non-banking financial sectors and their relationship with the government, and amplifies government's policy on some key issues affecting the performance of the financial sector. In this context, the program is expected to assist in creating a sound, prudently managed and well-supervised financial sector in Nepal that is competitive, dynamic and capable of contributing towards macro-economic stability and more rapid and sustained economic growth.
The Banking Sector
As in any other economy, the banking sector has to play a vital role in the economic development of the country through facilitating the intermediary process in between capital surplus and deficit units. The banking sector has to play dual role of mobilizing as well as allocating the limited resources towards people' needs so as to develop the economic system. 123
For the efficacy and efficiency of the banking system, all banks have to be prudent and have commercial orientation in their activities. The banking business has to be conducted on commercial basis and the responsibility and accountability of the banking sector for its activities Inas to be defined clearly. The banking activities should also be compliant with the regulations issued by Nepal Rastra Bank, and should not in general, be directed by the government and other interested parties to serve their own interest, such as assisting particular sector, borrowers or groups on a non-commercial basis and undertaking social programs.
Accordingly, Nepal Rastra Bank will have to enforce the internationally accepted standards of loan classification and provisioning requirements, liquidity and reserve requirement, capital adequacy requirement, exposure limits, single borrower limit etc. for the effective, efficient and sound banking system. Consequently, the poor lending decisions motivated by personal interest and benefit would be stopped by ensuring transparency for all stakeholders i.e. the shareholders, depositors, creditors, investors and the bank management.
A sound system of corporate governance is much demanded for the maintenance and development of a well-managed banking system. In this regard, the Nepal Rastra Bank would also come up with appropriate prudential regulations that amplify a code of governance for all banks to follow. This code will have to clearly set out the rights and duties of directors, owners as well as management and also specify the functions reserved for the board.
In the last few years, the government has undertaken general reform measures, viz. Interest Rate Deregulation, Phasing out of Statutory Liquidity Requirement (SLR), Bad Loan Provisioning, Capital Market Reforms, Foreign Exchange Liberalization, some of which were encompassecl in the CBPASS package. However, still much remains to be done, and there is now an urgent need to undertake important measures to strengthen and deepen the reform process. This will require a. concerted effort from all the concerned parties involved. In this regard, the government will need to provide an overall stable and positive macro-environment along with financial support or capital injection if needed. The Nepal Rastra Bank will have to provide effective regulatory oversight, supervision and strict enforcement. Similarly, the banking sector will have to improve its efficiency, strengthen its financial condition and undertake more prudent lending. The industrial and business sector could augment this process by providing proactive support toward reducing the NPA and instill confidence in the banking system by improving their corporate governance behavior
The Non-Banking Sector
The non-banking sector consisting of finance companies, development banks, cooperatives and non- government organizations doing limited banking business, constitutes as yet a small but ever growing component of financial sector. The non-banking sector provides ample opportunity to improve financial intermediation process in course of economic development of the country. Indeed, non-bank financial institutions can frequently generate a more competitive financial system than can the entry of additional commercial banks. Thus, this sector would be diversified for the complementary role and new areas of services they provide in relation to the commercial banks. In particular, the central bank realizes the restructuring need of the large two government owned development banks, bringing financial cooperatives under its supervisory domain, and ensuring healthy growth of the finance companies and the micro finance sector. There is a further need to bring non-bank financial institutions like The Employees Provident Fund and The Citizen Investment Trust under the regulatory and supervisory domain of the Central Bank The stock market should also be working in a transparent, predictable and stable manner to mobilize long term capital in the industrial sector. 124
The Government's Role
There is a critical need to reform, revitalize and modernize the financial sector. The government is endeavoring to achieve a privately owned and managed banking system, which provides economic, and efficient financial intermediation in the economy. The inefficiency of the banking sector stems mainly because of the problems in two state owned banks, viz., Nepal Bank Limited and Rastriya Banijya Bank. Meanwhile, the Agricultural Development Bank and Nepal Industrial Development Corporation are also facing similar type of problems. This condition provides little incentive for the other private joint venture banks to become innovative, competitive, and efficient in extending their services.
In the past, the government has played a vital role in the establishment and operation of the financial system; and that has resulted in strong political influence over the operation of most banking activities. In addition, lack of adequate supervisory and regulatory oversight in the Nepal Rastra Bank has led to structural and operational weaknesses in the financial system, which need to be urgently addressed. Thus, the government and also the central bank need to re-orient their activities from being active paticipants in the financial sector and should proceed towards being a stronger regulator and supervisor of the overall financial system. In view of these, the banking sector reform strategy would: initiate a strong corporate governance by ensuring that banks are owned and managed by private investors and professionals by implying the progressive withdrawal of HMG/N from the ownership of all financial institutions and also refraining from promoting financial institutions primarily with the equity participation of the government or government owned institutions. enhance the authority and the ability of the Nepal Rastra Bank for effective supervision of banks and non-bank financial institutions and enforce regulations as well as move towards increased autonomy of the central bank,
* improve the existing legal and judicial processes for enforcing financial contracts, * improving auditing and accountancy standards within the banking sector, and * promote financial discipline through adequate disclosure and competition.
The Role and Strategy of Nepal Rastra Bank
To enhance the role of the Nepal Rastra Bank in the overall financial system of the country, it becomes necessary to think over various models, which confers greater autonomy and independence to the Nepal Rastra Bank. Thus, the Nepal Rastra Bank will work closely with the World Bank and IMF team for the amendment of the existing Nepal Rastra Bank Act, 1955 to provide sufficient autonomy in conducting monetary policy, regulation and supervision of banking and non-banking financial sector and licensing of banks and non-banking financial institution. The central bank also recognizes the critical importance of effective supervision within an appropriate regulatory framework to ensure that the banking sector fulfills its dual responsibility of protecting depositors' savings and allocating such saving in the most productive sectors for faster economic growth. The Nepal Rastra Bank would also encourage transparency in disclosing the financial information by banks particularly through the introduction of higher auditing and accounting standards that enables depositors in making prudent decision on the selection of banks they want to deal with. The Nepal Rastra Bank would also ensure that banks adopt standard practices in their operations: mainly in their lending behavior and interest calculation methods. Besides this, the Nepal Rastra Bank would also need to develop policies encouraging the establishment of privately managed institutions, industrial financing, capital market 125 development and export financing. The establishment of credit rating agency, cooperalive bank, export import bank and investment bank could be a case in point towards this direction. The government fully supports the effort of Nepal Rastra Bank in strengthening banking supervision, enforcement and regulation. The Nepal Rastra Bank would focus on the following reform measures in the financial sector.
1. Reform in the Financial Sector Legislation
The need for financial legislative reform will involve the amendment or promulgation of a new Nepal Rastra Bank Act, Commercial Bank Act and other Financial Institutions act. Alternatively, a Financial Institutions Act, which covers both commercial banks and other deposit taking financial institutions, could be promulgated as one piece of legislation. These acts will accommodate modern and supportive regulations, especially in the area of banking supervision. Reform of ancillary financial sector legislation will also be necessary to replace the currently highly fragmented legal system. Debt Recovery Act, Bankruptcy Act, Merger and Acquisition Act would be the major output of the reform process. The promulgation of these acts will help the consolidation of the financial sector in many ways, especially on enhancement of fair and efficiency based competition. The central bank is committed to instill strict financial discipline in order to break the default trend by enhancing competitions, efficiencies and controlling the malpractice, cartelling & monopolistic: or oligopolistic behavior.
2. Strengthening Bank Supervision and Inspection
The strengthening of the supervisory capabilities of the Nepal Rastra Bank should also be initiated under the financial sector reform program. This will require the recruitment of a longer term, experienced bank supervisor to assist the implementation of strategic plan for regulatory development, on-site supervision, off-site supervision and the implementation of a human resource development plan. The program should improve on-site bank supervision capacity by recruiting more accountants, improving training and introducing risk rating (Credit Rating) system. However, it is worthwhile to explore other modalities of monitoring and supervision including independent Monitoring and Supervision body. This will also extend the supervisory capacity to cover nonbanks and development banks. This is one area where technical assistance from the International Monetary Fund and World Bank could also be sought. The entire bank examination of RBB and NBL would clearly be a priority for an initial phase of enhanced banking supervision.
3. Restructuring and Privatization of NBL and RBB
As the largest commercial bank, RBB has a potentially important role to play in the economy. However, political intervention, weak management, poor financial information system and ever growing bad loans have tremendously impacted on RBB's financial health. Recent auditing work has also revealed a high negative net worth, weak internal control and information systems, and poor internal financial management. In the same way, NBL has also suffered from the overall inefficiency, a negative net worth and low level of competition in the banking system. The government's policy of successively selling shares to the general public and increasing private sector representation on its board, was aimed at avoiding the deteriorating situation as of the RBB. Nonetheless, NBL still does not operate like a private bank, does not have a strategic banking partner amongst its private shareholders and lacks a strategic direction and medium term vision. Addressing these problems wiithin NBL will be an important component of the restructuring process. Thus, after ascertaining the true financial and operational position of RBB and NBL, it will be important to employ technical support to assist in developing a strategic plan for the implementation, such as, downsizing, privatization, splitting, merger, acquisition, etc. In the same way, technical support will also be required to, implement any 126
strengthening work identified by the reform proposal, which will be working on the financial and operational position of RBB and NBL.
4. Enhance Competition in the Banking Sector
The basic purpose of reform of the NBL and RBB should be designed to correct anomaly in the banking sector, enhance competition and increase an efficient intermediary role of the banks and non-banks. The government as well as the Nepal Rastra Bank aim to foster competitive banking and non-
banking sectors in the country so as to ensure that the banking services are provided at the lowest possible intermediation cost. In this regard, the government will not allow the banking industry to be dominated by a single bank or group of banks. Therefore, the present ownership structure of NBL and RBB will be gradually changed by their privatization and entry of new reputed, fit and proper private sector banks and financial institutions. To ensure continuing effective competition, the Nepal Rastra Bank would permit new banks to be set up only by qualified, professional and experienced promoters. Similarly, the Nepal Rastra Bank will also relax some of the provisions in providing licenses especially for the foreign banks coming in joint venture by increasing the percentage shareholding that they can retain in a bank in Nepal above the current 50 percent. The detail criteria and qualifications, following internationally accepted standard practices, uniform criteria and norms, will be re-announced publicly by the Nepal Rastra Bank and accordingly provide licenses to new banks. Furthermore establishment of branches of internationally reputed banks will be promoted under the terms and conditions and procedures set by the NRB.
5. Reform on Auditing and Accounting Capabilities
Information on operations, performance and status of banks and other financial institutions or overall transparency of the whole financial system is highly important. Publishing of financial statements, their performances and auditing reports etc. on a regular basis is also needed to make the financial sector more transparent. However, the prevailing weak accounting and auditing practice has indicated that the timelines and reliability of financial data, particularly of NBL, RBB and NIDC is extremely poor. Thus, in order to operate the financial system efficiently, the accounting and auditing status of the poorly managed banks should be strengthened. To cope with this, the phase wise introduction of internationally accepted accounting and auditing standards for the banking and non-banking financial sector should be initiated. Further in respect of bank branches which cross specified ceiling of transactions, Branch audit will be made mandatory. Moreover, an appropriate environment will be created for international accounting firms to be operated in the kingdom.
6. Broad-Based Banking
The government's emphasis on broad based banking service will be met by providing adequate mix of financial services to all the needed sectors / persons. These services should be provided through appropriate private institutions at market interest rate. Alternatively, these services could be provided through proper budgetary provisions for any subsidy to be provided in any areas. The directed and subsidized lending through banking system will ultimately be phased out with the provision of alternative private financial institutions catering such services.
7. Streamlining Ownership Structure
Appropriate policy action will also be taken to avoid undue concentration on the ownership of banks and financial institutions. As such, no single person and group will be allowed to hold a controlling stake in more than one banking institution. In the case of poorly managed banks, a reputed and strategic investor will be allowed to hold controlling shares in that bank. Cross holding of capital in the 127 commercial banking industry will be eliminated and promoters having significant shareholding will be barred from accessing financial resources from their own institutions in which they hold significant ownership.
8. Establishment of Bankers' Training Institute
In addition to the aforementioned policy goals, other financial support activities should also be initiated by the Nepal Rastra Bank jointly with the coordination of all commercial banks and the government. In this regard, the NRB will endeavor to establish a separate Bankers' Training Institute, jointly financed and managed by the NRB and other banks. The newly established institute will provide ample opportunity to up-grade the working skills and research capacity of the staff involved in the commercial banks.
9. Restructuring of Credit Information Bureau
To make the lending activities more prudent, the genuine credit information about the borrowers is required. In this regard, the present Credit Information Bureau would be revamped to lprovide effective and efficient infornation service. Essential technical support would also be given to the Bureau to restructure and improve its modus operandi.
10. Establishment of Assets Reconstruction Company
The program would also initiate an appropriate plan to improve loan recovery and reduce Non Performing Loan of banking and non banking financial institutions. Hence, efforts will be made to initiate an Assets Reconstruction Company in the coming fiscal year to improve the loan portfolio status of the banking system.
11. Revamping Research and Financial Monitoring Strength of the Central Bank
In order to keep the policy makers well abreast of the financial market condition and for facilitating prudent decision making, the research and statistical wings of the Nepal Rastra Bank would be strengthened.
12. Broadening and Deepening the Financial System in Nepal
It is also felt that there is an important need to establish an environment in which a broad range of financial institutions and financial instruments are developed. Nevertheless, the commercial banking is likely to remain the largest component of the financial system for some time, there iis also a need to develop debt and equity markets, leasing companies, venture capital facilities, further strengthen the stock market, insurance markets, micro-finance, pension and provident funds, and so on. Thus, the establishment of a broad range of instruments into which savers can deposit their funds as well as a broad range of lending instruments, involving both debt and equity, will also assist the overall development of the economy.
13. Meeting Sectoral Financing Requirements
As the country is overwhelmingly based on rural economy, it has also been envisaged to ensure that the adequate financial services are provided to support the activities of this sector. Moreover, other sectoral needs, such as industrial financing, housing finance and so on, would also be provided on the competitive cost.
14. Other Measures 128
The NRB has also envisaged to announce a specific time bound plan to restructure Agricultural Development Bank and Nepal Industrial Development Corporation in the next phase. Meanwhile, the government feels that the establishment of a sound and properly regulated banking system is the key principle and the regulation of deposit taking institution is fundamental. Thus, appropriate measures would also be introduced to regulate all deposit taking institutions as the commercial banks.
15. Establishment of Development Banks at Regional Level
Efforts will also be made to augment the flow of rural credit by giving priority to establish development banks at regional and local level. However, the general thrust of the government will be less government involvement in the financial sector.
16. Strengthening of Rural Development Banks
The NRB will also undertake organizational and financial strengthening programs for rural development banks established with the objectives of alleviating poverty in the rural areas. Recognizing the importance of rural sector and development finance, the government aims the development of rural credit and development finance via the private sector, including divestiture of such rural and development financial institutions currently owned or controlled by HMG and/or NRB.
17. Establishment of Credit Rating Agency
The NRB will also put efforts in establishing Credit Rating Agency in the coming fiscal year so as to make the debt instruments more confidential and trustworthy to the potential investors, and it is expected that it will contribute to the development of capital market in the country.
18. Timetable
The implementation of the aforesaid regulations and reform policies wil! be initiated from the next fiscal year. 129
Annex Three Commercial Banks - Sources And Uses Of Funds
Commercial Banking Sector (NR millions)
1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 2,544.4 3,102.9 3,560.7 4,460.7 5,072.0 6,077.1 10,421.0 13,200. a.Paid up capital 1,774.7 2,118.5 2,271.2 2,851.6 3,082.2 3,767.0 4,067.3 4,613. b. Statutory reserve 514.2 662.7 885.1 1,091.5 1,272.0 1,596.1 6,371.2 7,842.1 c. Others 255.5 321.7 404.4 517.6 717.8 714.0 -17.5 744.5 Deposits 52,330.8 61,193.3 71,400.5 81,703.0 102,790.2 127,201.8 153,295.9 175,752. a. Current 9,796.9 11,629.5 13,246.4 12,819.5 16,324.2 17,709.8 20,011.0 24,504.5 b. Savings 17,461.1 22,765.8 25,889.4 29,697.1 36,993.7 50,154.1 64,998.5 79,945.5 c. Fixed 23,263.0 24,509.6 29,396.6 35,941.2 45,659.1 54,846.7 62,227.4 62,975. d. Call deposits 493.2 671.1 685.0 1,234.9 1,767.9 2,165.9 2,985.1 5,441.1 e. Others 1,316.6 1,617.3 2,183.1 2,010.3 2,045.3 2,325.3 3,073.9 2,885. Borrowings 227.8 602.9 885.3 1,629.5 887.0 1,179.1 3,326.9 2,288. a. Nepal Rastra Bank 40.4 424.0 230.6 362.6 381.4 429.6 408.3 365.3 b. Inter-bank 186.9 178.9 654.7 1,266.9 505.6 749.5 2,918.6 1,922. c. Foreign banks 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.( 4. Others 18,461.6 19,072.7 24,874.9 29,928.9 36,991.0 38,000.2 35,677.1 50,707.2 TOTAL SOURCES OF FUNDS 73,564.6 83,971.8 100,721.4 117,722.1 145,740.2 172,458.2 202,720.9 241,948. 1. Liquid funds 13,700.0 17,138.8 18,206.0 22,712.6 33,381.4 39,093.1 41,258.9 45,010. a. Cash in hand 1,859.5 2,037.7 2,446.3 2,837.5 2,908.2 3,310 4 3,415.0 4,089.1 b. Foreign currency in hand 459.4 455.7 593.0 627.6 751.1 634.5 717.4 726. c. Balance with NRB 5,452.5 7,429.1 6,494.7 8,757.1 14,144.1 13,9127 9,978.4 11,381.3 d. Balance with domestic banks 346.2 418.8 -163.2 638.3 426.3 402 1 718.9 488. e. Balances held abroad 5,153.1 6,454.9 7,803.7 7,022.9 9,279.7 9,451.7 14,564.3 14,887. f Calldeposits 429.3 342.6 1,031.5 2,829.2 5,872.0 11,381,7 11,864.9 13,4373 2. Investments 14,821.6 9,633.8 8,585.3 8,568.9 10,877.5 14,252.4 14,151.6 14,073. a. Govemment securities 9,096.8 8,332.8 7,777.3 8,213.4 10,591.7 13,222.0 13,794.0 13,740. b. Shares and debentures 76.8 95.5 127.5 355.5 285.8 1,030.4 357.6 333. c. NRB bonds 5,648.0 1,205.5 680.5 0.0 0.0 0.0 0.0 0.3 Loans and Advances 27,347.1 38,779.1 50,891.1 58,378.5 68,652.7 81,758.8 97,056.8 109,952. a. Govemment enterprises 742.2 703.0 1,489.3 1,450.9 1,214.0 1,749.4 1,735.4 2,211. financial 0.1 98.6 236.0 197.1 397.0 490.2 572.3 1,105. non-financial 742.1 604.4 1,253.3 1,253.8 817.0 1,259.2 1,163.1 1,106. b. Private sector 24,996.8 36,609.2 47,389.3 54,736.6 65,023.6 77,501.1 92,974.7 105,544. c. Foreign bill P&D 1,445.4 1,286.7 1,810.3 2,062.9 2,266.1 2,348.2 2,313.2 2,164. d. Foreign A.B.C. 162.7 180.2 202.2 128.1 149.0 160.1 33.5 31.3 4. Interest Accrued 5,233.9 6,202.9 7,723.2 9,074.1 10,619.2 12,932.7 15,196.2 18,810. a. Govemment enterprises 517.9 692.8 861.8 545.4 221.5 299.4 597.9 742.3 b. Private sector 4,716.0 5,510.1 6,861.4 8,528.7 10,397.7 12,633.3 14,598.3 18,068. 5. Others 12,462.0 12,217.2 15,315.8 18,988.0 22,209.4 24,421.2 35,057.4 54,100.9 TOTAL USES OF FUNDS 73,564.6 83,971.8 100,721.4 117,722.1 145,740.2 172,458.2 202,720.9 241,948. 130
Nepal Bank Limited - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 585.8 624.7 702.9 852.5 881.9 1,015.4 2,224.7 2,901.6 a. Paid up capital 305.0 287.9 312.5 377.7 380.3 380.3 380.4 380.4 b. Statutory reserve 177.5 219.5 302.5 318.2 318.2 467.2 1,692.5 2,348.1 c. Others 103.3 117.3 87.9 156.6 183.4 167.9 151.8 173.1 2. Deposits 17,855.8 18,748.7 19,855.1 21,542.6 28,144.9 33,092.7 35,692.9 35,643. a. Current 3,143.6 3,451.5 3,850.2 3,404.8 4,400.7 4,386.5 5,016.4 4,749.1 b. Savings 6,155.7 7,610.4 8,509.3 9,365.5 11,074.7 14,214.8 17,890.4 20,654.3 c. Fixed 8,208.4 7,270.0 7,001.0 8,343.7 12,261.2 14,154.7 12,403.3 9,892. d. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0. e. Others 348.1 416.8 494.6 428.6 408.3 336.7 382.8 347.9 3. Borrowings 2.6 177.6 32.6 27.1 244.0 284.3 215.7 245.6 a. Nepal Rastra Bank 1.2 176.2 27.2 25.7 242.6 282.9 214.3 213.0 b. Inter-bank 1.4 1.4 5.4 1.4 1.4 1.4 1.4 32. c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 6,660.2 4,702.0 5,027.4 6,755.8 8,663.6 9,955.4 8,328.6 13,618.2 Total Sources of Funds 25,104.4 24,253.0 25,618.0 29,178.0 37,934.4 44,347.8 46,461.9 52,409.1
1. Liquid funds 3,806.0 4,361.5 4,001.3 5,167.8 7,166.5 8,035.2 8,508.3 7,01t1 a. Cash in hand 834.6 869.4 1,063.9 1,055.4 1,297.5 1,346.4 1,280.5 1,472.0 b. Foreign currency in hand 243.2 207.1 298.3 277.0 393.3 313.4 400.3 344.6 c. Balance with NRB 1,470.5 2,089.4 1,101.9 2,111.0 2,711.9 2,870.3 2,665.0 2,264.0 d. Balance with domestic banks 62.6 32.7 79.1 41.8 61.6 179.5 194.3 172.9 e. Balances held abroad 1,195.1 1,162.9 1,458.1 1,682.6 2,702.2 1,055.2 3,968.2 2,758.3 f. Call deposits 0.0 0.0 0.0 0.0 0.0 2,270.4 0.0 2. Investments 6,813.7 4,238.3 1,999.3 682.6 4,475.1 5,119.4 4,789.3 4,7693 a. Government securities 4,449.9 3,667.5 1,854.2 510.7 4,414.9 5,058.2 4,733.0 4,713.0 b. Shares and debentures 46.3 46.3 55.1 171.9 60.2 61.2 56.3 56.3 c. NRB bonds 2,317.5 524.5 90.0 0.0 0.0 0.0 3.Loans and Advances 9,048.6 11,848.8 14,8563 18,068.8 19,472.2 22,394.6 23,328.6 23,086. a. Government enterprises 289.8 321.4 568.7 964.2 497.8 765.4 680.4 707.3 financial 0.0 52.3 0.0 0.0 0.0 55. non-financial 289.8 269.1 568.7 964.2 497.8 765.4 680.4 652.3 b. Private sector 8,326.0 11,161.0 13,871.8 16,642.5 18,441.6 21,213.7 22,415.6 22,137.2 c. Foreign bill P&D 306.5 230.7 271.2 355.0 410.1 290.8 232.6 242.2 d. Foreign A.B.C. 126.3 135.7 144.6 107.1 122.7 124.7 0 4. Interest Accrued 1,647.5 1,811.6 2,210.9 2,677.0 3,323.6 4,287.5 5,454.1 7,192. a. Govemment enterprises 57.8 126.4 163.2 173.8 90.3 90.4 93.8 123. b. Private sector 1,589.7 1,685.2 2,047.7 2,503.2 3,233.3 4,197.1 5,360.3 7,069.2 S. Others 3,788.6 1,992.8 2,550.2 2,581.8 3,497.0 4,511.1 4,381.5 10,348. Total Uses of Funds 25,104.4 24,253.0 25,618.0 29,178.0 37,934.4 44,347.8 46,461.8 52,409.1 131
Rastriya Banijya Bank - Sources And Uses Of Funds (NFL millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 1,132.0 1,334,3 1,334.2 1,385.4 1,391.2 1,440.7 2,517.7 3,559.5 a. Paid up capital 1,022.3 1,172.3 1,172.3 1,172.3 1,172.3 1,172.3 1,172.3 1,172.3 b. Statutory reserve 42.5 42.5 42.5 42.5 42.5 45.0 2,283.9 2,380.1 c. Others 67.2 119.5 119.4 170.6 176.4 223.4 -938.5 7.1 2. Deposits 16,282.5 18,779.5 20,725.0 22,015.6 26,968.1 33,329.2 38,313.9 38,503.6 a. Current 2,508.8 3,121.9 3,680.7 3,193.0 3,790.4 3,802.8 4,051.9 4,406.6 b. Savings 4,695.6 5,932.9 6,878.8 7,802.1 9,546.2 12,297.4 15,873.7 19,249.3 c. Fixed 8,645.9 9,129.8 9,204.9 10,374.3 13,093.5 16,793.1 17,970.6 14,499.1 d. Call deposits 0.0 0.0 0.0 120.1 71.2 27.6 18.5 0.0 e. Others 432.2 594.9 960.6 526.1 466.8 408.3 399.2 348.7 3. Borrowings 39.2 247.8 203.4 213.9 264.5 272.41 151.5 146.9 a. Nepal Rastra Bank 39.2 247.8 203.4 88.2 138.8 146.7 151.5 146.9 b. Inter-bank 0.0 0.0 0.0 125.7 125.7 125.7 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.( 0.0 4.Others 10,157.3 11,628.0 16,579.5 18,839.6 21,577.3 18,745.8 16,024.7 22,101.0 Total Sources of Funds 27,611.0 31,989.6 38,842.1 42,454.5 50,201.1 53,788.11 57,007.8 64,311.0
1. Liquid funds 5,355.2 5,909.9 6,015.4 6,638.7 10,318.4 10,277.6 5,785.3 5,717.8 a. Cash in hand 579.1 582.1 730.8 795.5 682.8 792.9) 769.4 878.4 b. Foreign currency in hand 168.2 195.7 215.5 237.1 203.5 226.5 173.4 193.6 c. Balance with NRB 2,281.5 3,022.2 2,911.4 3,331.9 7,602.8 6,771.9 2,394.0 2,788.0 d. Balance with domestic banks 48.5 85.5 -419.9 234.3 -24.2 -23.2 -44.2 -42.6 e. Balances held abroad 1,977.4 2,024.4 2,577.6 2,039.9 1,853.5 2,509.5 2,342.7 1,900.4 f. Call deposits 300.5 0.0 0.0 0.0 0.0 0.0 0.0 2. Investments 3,614.0 2,798.3 1,989.6 1,442.6 2,371.7 2,784.18 3,151.6 3,001.6 a. Govemment securities 2,670.6 2,690.2 1,960.7 1,393.6 2,317.0 2,704.2 3,071.0 2,921.0 b. Shares and debentures 13.4 18.1 28.9 49.0 54.7 80.65 80.6 80.6 c NRB bonds 930.0 90.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 10,732.1 13,998.9 18,405.1 18,921.8 22,404.8 26,340.4 29,594.7 30,381.5 a. Government enterprises 447.1 318.6 534.5 147.6 128.2 162.4 26.3 26.3 financial 0.1 '0.1 0.1 0.1 0.1 0.1 0.1 0.1 non-financial 447.0 318.5 534.4 147.5 128.1 162.3 26.2 26.2 b. Private sector 9,803.4 13,225.4 17,159.9 18,081.3 21,578.6 25,676.5 28,967.0 29,830.1 c. Foreign bill P&D 445.2 410.4 653.1 671.9 671.7 466.1 569.3 493.8 d. Foreign A.B.C. 36.4 44.5 57.6 21.0 26.3 35.4 32.1 31.3 4. Interest Accrued 3,406.2 4,063.7 5,161.1 5,863.4 6,546.2 7,638.2 8,3243 10,215.1 a. Govemment enterprises 460.1 566.2 696.3 371.3 131.2 203.4 504.1 618.6 b. Private sector 2,946.1 3,497.5 4,464.8 5,492.1 6,415.0 7,434.8 7,820.2 9,596.5 Others 4,503.5 5,218.8 7,270.9 9,588.0 8,560.0 6,747.1 10,151.9 14,995.0 Total Uses of Funds 27,611.0 31,989.6 38,842.1 42,454.5 50,201.1 53,788.1 57,007.8 64,311.0 132
Nepal Arab (NABIL) Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 246.1 328.6 448.7 628.1 805.2 863.0 1,360.7 1,480.0 a. Paid up capital 65.4 130.9 130.9 261.7 261.7 392.9 392.8 392.9 b. Statutory reserve 120.0 143.0 176.2 266.7 302.2 337.1 760.5 911.5 c. Others 60.7 54.7 141.6 99.7 241.3 133.0 207.4 175.6 2. Deposits 4,420.4 5372.4 7,116.3 7,752.2 8,737.5 9,464.4 11,253.1 13,530.8 a. Current 1,529.6 1,863.4 1,808.3 1,789.2 2,334.3 2,333.3 2,944.8 3,526.5 b. Savings 1,234.3 1,589.0 1,793.6 1,942.8 2,546.7 3,352.6 3,432.2 3,980.2 c. Fixed 1,319.7 1,566.8 2,704.6 2,863.1 2,315.4 2,098.1 3,022.0 3,774.5 d. Call deposits 132.2 169.8 629.9 920.9 1,343.9 1,329.8 1,363.2 1,803.6 e. Others 204.6 183.4 179.9 236.2 197.2 350.6 490.9 446.0 3. Borrowings 90.0 0.0 0.0 136.8 0.0 190.2 285.2 0.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 90.0 0.0 0.0 136.8 0.0 190.2 285.2 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 570.3 705.1 924.6 1,1473 1,722.1 1,810.0 3,703.5 4,165.2 Total Sources of Funds 5,326.8 6,406.1 8,489.6 9,664.4 11,264.8 12,327.6 16,602.5 19,176.0
1. Liquid funds 1,133.2 1,929.7 1,990.9 2,402.0 3,725.2 3,782.7 5,538.4 6,138.1 a. Cash in hand 75.4 92.2 85.0 127.6 112.5 123.6 190.4 195.5 b. Foreign currency in hand 10.6 11.8 26.7 22.1 23.5 14.6 18.4 26.7 c. Balance with NRB 320.5 562.0 309.5 487.4 559.1 290.4 517.6 350.6 d. Balance with domestic banks 27.2 48.5 16.3 187.5 225.3 12.9 161.3 3.7 e. Balances held abroad 699.5 1,215.2 1,553.4 105.3 393.9 127.1 18.9 87.6 f. Call deposits 0.0 0.0 1,472.1 2,410.9 3,214.1 4,631.8 5,474.1 2. Investments 1,453.2 520.6 1,432.5 1,770.0 954.1 1,4203 955.1 967.8 a. Government securities 562.6 400.5 1,164.4 1,759.3 943.4 1,402.8 938.0 948.0 b. Shares and debentures 5.6 10.1 10.1 10.7 10.7 17.5 17.1 19.6 c. NRB bonds 885.0 110.0 258.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 2,388.3 3,478.5 4,305.7 4,625.0 5,294.5 5,811.7 7,428.6 8,176.5 a. Govemment enterprises 2.1 4.9 67.3 31.9 79.6 62.6 77.7 98.7 financial 0.0 0.0 20.0 20.0 50.0 50.0 50.0 48.7 non-financial 2.1 4.9 47.3 11.9 29.6 12.6 27.7 43.7 b. Private sector 2,161.0 3,300.8 4,020.0 4,349.9 5,003.4 5,432.6 6,906.0 7,720.9 c. Foreign bill P&D 225.2 172.8 218.4 243.2 211.5 316.5 444.9 356.9 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 56.8 128.5 92.8 118.7 159.6 231.6 239.3 391.5 a. Govemment enterprises 0.0 0.2 0.3 0.3 0.0 0.0 0.0 0.0 b. Private sector 56.8 128.3 92.5 118.4 159.6 231.6 239.3 391.5 .Others 295.3 348.8 667.7 748.7 1,131.4 1,081.3 2,441.1 3,502.1 otal Uses of Funds 5,326.8 6,406.1 8,489.6 9,664.4 11,264.8 12,327.6 16,602.5 19,176.0 133
Indo-Suez Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 138.0 214.4 230.8 247.6 328.2 346.6 427.9 502.0 a. Paid up capital 60.0 90.0 90.0 90.0 90.0 135.3 135.4 135.4 b. Statutory reserve 74.0 120.0 132.3 148.9 180.0 198.8 271.7 332.7 c. Others 4.0 4.4 8.5 8.7 58.2 12.5 20.8 33.9 2. Deposits 1,421.4 1,527.5 1,850.7 2,104.2 2,582.3 2,438.9 2,982.6 4,256.2 a. Current 462.5 401.5 411.3 387.7 559.0 531.5 581.1 769.0 b. Savings 392.8 485.0 477.9 522.9 562.8 751.1 997.5 1,259.6 c. Fixed 499.8 569.2 883.4 983.0 1,276.0 983.6 1,093.7 1,658.7 d. Call deposits 0.4 0.0 0.0 101.1 128.6 83.2 221.7 502.5 e. Others 65.9 71.8 78.1 109.5 55.9 89.5 88.6 66.5 3. Borrowings 0.5 50.0 120.0 58.9 100.0 50.0 140.0 120.0 a. Nepal Rastra Bank 0.0 0.0 0.0 58.9 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 50.0 120.0 0.0 100.0 50.0 140.0 120.0 c. Foreign banks 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 324.4 363.1 477.0 579.6 684.9 835.4 629.5 655.4 Total Sources of Funds 1,884.3 2,155.0 2,678.5 2,9903 3,695A 3,670.9 4,180.0 5,533.6
1. Liquid funds 515.4 555.1 603.4 797.8 1,519.5 1,46,3.0 1,533.7 446.7 a. Cash in hand 29.9 42.0 35.0 56.8 61.4 40.0 28.0 62.9 b. Foreign currency in hand 4.5 4.1 8.8 9.7 17.8 7.3 4.8 8.6 c. Balance with NRB 56.3 114.5 85.6 138.6 122.9 98.6 175.3 212.3 d. Balance with domestic banks 7.1 18.7 6.6 2.7 7.7 7.5 7.3 3.8 e. Balances held abroad 343.9 360.7 129.9 188.6 228.1 110.2 147.6 159.1 f. Call deposits 73.7 15.1 337.5 401.4 1,081.6 1,199.4 1,170.7 0.0 2. Investments 298.9 11.0 80.4 119.3 17.5 1(02.7 12.7 12.7 a. Government securities 190.9 5.0 72.9 111.8 10.0 90.0 0.0 0.0 b. Shares and debentures 3.0 6.0 7.5 7.5 7.5 12.7 12.7 12.7 c. NRB bonds 105.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 910.2 1,364.7 1,702.5 1,728.5 1,678.2 1,421.6 2,0713 2,431.4 a. Government enterprises 0.0 0.0 0.0 25.0 25.0 25.0 25.0 25.0 financial 0.0 0.0 0.0 25.0 25.0 25.0 25.0 25.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 863.9 1,287.8 1,652.1 1,666.4 1,592.9 1,329.2 1,998.9 2,360.6 c. Foreign bill P&D 46.3 76.9 50.4 37.1 60.3 657.4 47.4 45.8 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 14.0 24.7 26.4 43.7 86.6 72.8 82.7 120.6 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 14.0 24.7 26.4 43.7 86.6 72.8 82.7 120.6 5. Others 145.8 199.5 265.8 301.0 393.6 610.8 479.4 2,522.2 Total Uses of Funds 1,8843 2,155.0 2,678.5 2,9903 3,695.4 3,670.9 4,179.8 5,533.6 134
Standard Chartered Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 220.3 246.7 380.4 439.2 494.2 756.0 1,196.8 1,166.0 a Paid up capital 100.0 100.0 150.0 150.0 150.0 339.5 339.5 339.5 b. Statutory reserve 100.0 121.4 200.0 247.8 300.0 358.5 620.5 792.6 c. Others 20.31 25.3 30.4 41.4 44.2 58.0 236.8 33.9 2. Deposits 5,018.2 5,509.2 6,047.7 7,623.2 8,535.2 11,160.8 12,466.3 15,139.5 a Current 1,168.2 1,437.8 1,535.6 2,039.6 1,969.6 2,334.3 2,399.7 3,085.8 b. Savings 2,340.7 2,867.3 2,866.7 3,204.3 4,079.5 5,467.6 6,616.2 8,128.2 c. Fixed 1,379.6 1,048.6 1,493.6 2,080.1 2,148.9 3,104.7 2,854.3 3,646.8 d. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 e. Others 129.7 155.5 151.8 299.2 337.2 254.2 596.1 278.6 3. Borrowings 65.5 107.5 529.3 888.0 278.5 99.5 2,380.8 1,590.1 a Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 65.5 107.5 529.3 888.0 278.5 99.5 2,380 8 1,590.1 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 570.8 876.3 1,077.3 1,388.2 1,980.1 2,364.8 2,322.3 3,363.0 Total Sources of Funds 5,874.8 6,739.7 8,034.7 10,338.6 11,288.0 14,381.1 18,366.2 21,258.6 1. Liquid funds 1,332.1 1,992.2 2,376.4 3,456.0 3,929.3 5,239.5 8,067.4 8,078.3 a Cash in hand 88.4 89.0 86.9 116.8 109.2 125.5 106.7 152.9 b. Foreign currency in hand 13.1 10.9 18.3 16.9 18.8 10.0 15.2 15.4 c. Balance with NRB 398.8 393.3 411.8 538.8 282.4 486.4 646.6 655 7 d. Balance with domestic banks 64.5 77.4 5.3 31.9 7.6 -7.3 -1.5 4.2 e. Balances held abroad 767.3 1,421.6 1,854.1 2,751.6 3,511.3 4,624.9 7,300.4 7,250.0 f. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2. Investments 2,341.7 1,538.0 1,831.9 2,304.7 1,047.6 2,689.9 2,600.2 2,900.2 a Govemment securities 1,094.7 1,252.0 1,591.0 2,288.6 1,041.6 2,678.7 2,589.0 2,889.0 b. Shares and debentures 6.0 6.0 10.9 16.1 6.0 11.2 11.2 11.2 c. NRB bonds 1,241.0 280.0 230.0 0.0 0.0 0.0 0.0 3. Loans and Advances 1,805.4 2,626.3 3,130.7 3,581.7 4,170.6 4,693.1 4,960.4 5,790.1 a. Govemment enterprises 0.0 26.9 197.5 120.1 171.7 150.6 365.5 356.3 financial 0.0 15.0 156.5 91.1 97.5 150.6 169.3 289.7 non-financial 0.0 11.9 41.0 29.0 74.2 0.0 196.2 116.6 b. Private sector 1,498.6 2,377.3 2,713.0 3,194.2 3,763.3 4,422.8 4,376.5 5,291.6 c. Foreign bill P&D 306.8 222.1 220.2 267.4 235.6 119.7 218.4 142.1 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 44.5 39.9 49.7 73.5 80.1 87.4 138.4 191.7 a Govemment enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 44.5 39.9 49.7 73.5 80.1 87.4 138.4 191.7 5. Others 351.1 543.3 646.0 922.7 2,060.4 1,671.2 2,599.9 4,298.' Total Uses of Funds 5,874.8 6,739.7 8,034.7 10,338.6 11,288.0 14,381.1 18,366.3 21,258.6 135
Himalayan Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 60.2 76.7 152.7 179.1 205.3 3141.9 717.7 799.6 a. Paid up capital 60.0 60.0 120.0 120.0 120.0 192.0 240.0 300.0 b. Statutory reserve 0.2 16.3 30.1 54.9 82.5 10S.7 336.5 499.6 c. Others 0.0 0.4 2.6 4.2 2.8 13.2 141.2 0.0 2. Deposits 1,746.8 3,035.9 4,515.8 5,731.6 7,715.6 9,780.4 14,082.5 17,613.7 a. Current 429.8 577.0 756.8 779.5 1,175.2 1,292.2 1,772.3 2,313.7 b. Savings 446.7 1,167.7 1,500.2 2,298.3 3,175.6 5,084.4 6,844.3 9,164.2 c. Fixed 476.7 832.3 2,104.5 2,484.6 3,144.4 3,106.8 5,109.4 5,668.1 d. Call deposits 287.5 325.3 0.0 0.0 0.0 0.0 0.0 e. Others 106.1 133.6 154.3 169.2 220.4 297.0 356.5 467.7 3. Borrowings 0.0 0.0 0.0 264.8 0.0 232.7 128.7 5.4 a. Nepal Rastra Bank 0.0 0.0 0.0 189.8 0.0 0.0 42.5 5.4 b. Inter-bank 0.0 0.0 0.0 75.0 0.0 232.7 86.2 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 107.0 390.7 382.2 663.5 1,241.7 2,272.1 1,851.7 2,510.4 Total Sources of Funds 1,914.0 3,5033 5,050.7 6,839.0 9,162.6 12,600.1 16,780.6 20,929.1
1. Liquid funds 539.7 846.6 1,245.8 1,807.7 3,12333 4,787.5 5,446.4 7,192.7 a. Cash in hand 58.6 92.2 106.4 221.1 141.1 121.7 116.3 131.7 b. Foreign currency in hand 4.3 7.8 4.0 19.9 24.5 21.1 17.7 18.2 c. Balance with NRB 330.1 318.7 374.1 681.4 742.6 515.6 655.3 1,073.2 d. Balance with domestic banks 16.2 8.6 4.7 7.7 30.6 22 9 12.9 11.0 e. Balances held abroad 75.4 91.8 62.6 22.5 37.6 -19.6 -38.6 52.7 f. Call deposits 55.1 327.5 694.0 855.1 2,146.9 4,125.8 4,682.8 5,905.8 2. Investments 214.5 392.8 693.6 1,352.2 974.0 468.9 1,251.5 928.7 a. Government securities 45.0 289.8 590.6 1,349.2 970.9 459.4 1,242.0 918.0 b. Shares and debentures 0.0 3.0 3.0 3.0 3.1 9.5 9.5 10.7 c. NRB bonds 169.5 i00.0 100.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 1,086.6 2,098.9 2,891.1 3,381.9 4,275,5 5,372.0 7,423.2 9,176.9 a. Govemment enterprises 3.2 0.0 61.9 44.4 60.0 267.7 200.0 536.4 financial 0.0 0.0 0.0 0.0 60.0 60 0 200.0 536.4 non-financial 3.2 0.0 61.9 44.4 0.0 207.7 0.0 0.0 b. Private sector 982.0 1,989.1 2,739.8 3,232.1 4,025.0 5,005.5 6,896.6 8,301.0 c. Foreign bill P&D 101.4 109.8 89.4 105.4 190.5 98.8 326.6 340.3 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 14.4 14.1 26.1 49.5 85.2 117.4 144.2 115.5 a. Government enterprises 0.0 0.0 2.0 0.0 0.0 5.6 0.0 0.0 b. Private sector 14.4 14.1 24.1 49.5 85.2 111.8 144.2 115.5 Others 58.8 150.9 194.1 247.7 704.6 1,854.3 2,515.1 3,5153 Total Uses of Funds 1,914.0 3,50333 5,050.7 6,839.0 9,162.6 12,600.1 16,780.4 20,929.1 136
Nepal SBI Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 120.0 120.0 134.8 162.2 139.3 222.6 318.1 567.9 a. Paid up capital 120.0 119.9 120.0 119.9 119.9 119.9 119.9 143.9 b. Statutory reserve 0.0 1.5 9.1 18.1 29.9 136.5 189.8 c. Others o.ol 0.1 13.3 33.2 1.3 72.8 61.7 234.2 2. Deposits 295.2 715.1 1,624.3 2,360.6 3,749.1 4,362.2 4,543.2 6,618.4 a Current 64.2 131.9 421.6 438.2 761.7 1,404.2 951.0 2,359.9 b. Savings 43.0 73.8 181.7 259.5 527.2 786.7 1,094.9 1,259.5 c. Fixed 159.7 474.1 927.2 1,618.8 2,383.6 2,100.2 2,420.3 2,929.4 d. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 e. Others 28.3 35.3 93.8 44.1 76.6 71.1 77.0 69.6 3. Borrowings 30.0 20.0 0.0 0.0 0.0 0.0 0.0 0.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 30.0 20.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 11.1 39.1 99.9 122.7 267.7 336.8 399.3 316.2 Total Sources of Funds 456.3 894.2 1,859.0 2,645.5 4,156.1 4,921.6 5,260.6 7,502.5
1. Liquid funds 125.4 202.0 220.3 392.1 761.5 1,357.8 1,010.1 2,348.3 a Cash in hand 11.1 9.2 19.7 72.2 40.9 106.6 123.0 133.2 b. Foreign currency in hand 1.1 1.6 2.8 8.7 15.5 7.8 15.6 15.3 c. Balance with NRB 37.3 142.9 143.3 224.4 572.3 689.9 364.3 294.2 d. Balance with domestic banks 6.1 8.2 4.1 1.9 3.3 0.6 1.0 4.7 e. Balances held abroad 69.8 40.1 50.4 84.9 79.5 532.9 386.2 1,510.8 f. Call deposits 0.0 0.0 0.0 0.0 50.0 20.0 120.0 390.0 2. Investments 2.5 32A 374.4 396.8 681.6 202.6 208.9 208.2 a. Government securities 0.0 19.4 371.4 393.8 678.6 194.0 200.0 200.0 b. Shares and debentures 2.5 3.0 3.0 3.0 3.0 8.6 8.9 8.2 c. NRB bonds 0.0 10.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 291.9 622.0 1,176.5 1,7213 2,414.9 2,930.4 3,560.1 4,176.3 a Government enterprises 0.0 0.0 0.0 56.8 74.3 88.3 0.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 56.8 74.3 88.3 0.0 0.0 b. Private sector 277.9 617.2 1,144.2 1,623.5 2,297.3 2,801.9 3,517.1 4,091.0 c. Foreign bill P&D 14.0 4.8 32.3 41.0 43.3 40.2 43.0 85.3 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 8.0 41.4 65.8 132.0 147.8 172.8 164.6 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 8.0 41.4 65.8 132.0 147.8 172.8 164.6 S. Others 36.5 29.8 46.4 69.5 166.1 283.0 308.7 605.1 Total Uses of Funds 456.3 894.2 1,859.0 2,645.5 4,156.1 4,921.6 5,260.6 7,502.5 137
Nepal Bangladesh Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 42.0 60.0 60.5 63.1 147.1 177.4 317.2 397.4 a. Paid up capital 42.0 60.0 60.0 60.0 114.1 116.4 117.8 119.1 b. Statutory reserve 0.0 0.0 0.0 1.3 26.4 45.5 185.2 235.6 c. Others 0.0 0.0 0.5 1.8 6.6 15.5 14.2 42.7 2. Deposits 115.5 645.1 864.0 1,349.0 2,361.9 4,14512 6,455.7 8,578.8 a Current 12.6 50.9 70.8 107.4 325.2 375,2 478.2 634.1 b. Savings 18.0 104.7 154.1 209.9 358.9 684.7 1,101.9 1,694 9 c. Fixed 83.2 472.0 611.6 896.8 1,497.9 2,608.1 4,356.5 5,236.8 d. Call deposits 0.0 0.4 7.0 17.3 53.5 210.3 295.2 682 2 e. Others 1.7 17.1 20.5 117.6 126.4 266 9 223.9 330.9 3. Borrowings 0.0 0.0 0.0 20.0 0.0 0.0 25.0 0.0 a Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0,0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 20.0 0.0 0.0 25.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0 0 0.0 0.0 0.0 4. Others 22.0 8.9 44.2 75.2 214.5 466..6 668.8 1,354.5 Total Sources of Funds 179.5 714.0 968.7 1,507.3 2,723.5 4,789.2 7,466.7 10,330.7
1. Liquid funds 74.2 191.7 202.3 243.0 436.6 602..6 636.1 1,810.1 a. Cash in hand 5.7 18.2 15.8 26.7 48.8 118.0 128.6 221.5 b. Foreign currency in hand 1.1 3.2 2.3 7.4 24.1 10.6 21.3 21.3 c. Balance with NRB 41.5 99.4 132.4 145.5 211.8 374.4 401.2 634.1 d. Balance with domestic banks 1.2 1.2 3.9 1.5 7.1 9.4 23.5 22.3 e. Balances held abroad 24.7 69.7 47.9 61.9 144.8 90.2 61.5 99.8 f. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 811.2 2. Investments 74.7 3.0 54.4 6.0 6.0 708.7 350.0 425.0 a. Government securities 74.7 0.0 48.4 0.0 0.0 0.0 290.0 410.0 b. Shares and debentures 0.0 3.0 6.0 6.0 6.0 708.7 60.0 15.0 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 00 0.0 3. Loans and Advances 6.2 489.8 675.9 1,200.0 1,957.6 3,258.7 4,613.4 7,347.4 a Government enterprises 0.0 31.2 59.4 60.9 114.4 1368 260.5 462.1 financial 0.0 31.2 59.4 60.9 107.5 127.6 127.9 199.9 non-financial 0.0 0.0 0.0 0.0 6.9 9.2 132.6 262.2 b. Private sector 6.2 447.4 597.5 1,077.3 1,756.1 2,854 4 4,159.8 6,560 2 c. Foreign bill P&D 0.0 11.2 19.0 61.8 87.1 267.5 191.7 325.1 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 1.4 0.0 4. Interest Accrued 0.0 2.4 6.3 16.5 15.3 27.6 73.5 91.9 a Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 2.4 6.3 16.5 15.3 27.6 73.5 91.9 5.Others 24.4 27.1 29.8 41.8 308.0 191.6 1,793.6 656.3 Total Uses of Funds 179.5 714.0 968.7 1,507.3 2,723.5 4,789.2 7,466.6 10,330.7 138
Everest Bank - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 0.0 30.0 48.2 60.2 118.6 128.3 151.9 262.5 a. Paid up capital 0.0 30.0 48.0 60.0 117.6 118.4 119.2 197.0 b. Statutory reserve 0.0 0.0 0.0 0.0 0.0 0.1 16.7 36.2 c. Others 0.0 0.0 0.2 0.2 1.0 9.8 16.0 29.3 2. Deposits 0.0 147.3 168.6 471.7 1,124.9 1,948.9 3,057.4 4,574.5 a. Current 0.0 4.2 11.5 44.0 127.6 206.1 274.4 399.7 b. Savings 0.0 12.4 25.4 79.0 217.4 449.1 891.7 1,384.1 c. Fixed 0.0 10.7 129.2 331.1 721.8 1,180.3 1,592.7 2,470.2 d. Call deposits 0.0 120.0 0.0 8.5 17.3 47.9 185.4 225.6 e. Others 0.0 0.0 2.5 9.1 40.8 65.5 113.2 94.9 3. Borrowings 0.0 0.0 0.0 20.0 0.0 0.0 0.0 80.0 a Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 20.0 0.0 0.0 0.0 80.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 0.0 6.5 12.5 29.7 104.6 210.4 202.3 323.2 Total Sources of Funds 0.0 183.8 229.3 581.6 1,348.1 2,287.6 3,411.6 5,240.2
1. Liquid funds 0.0 44.5 43.7 49.4 187.3 460.7 278.6 824.2 a. Cash in hand 0.0 4.0 9.2 13.0 21.2 62.2 41.9 93.0 b. Foreign currency in hand 0.0 1.0 1.8 2.4 8.2 4.6 8.8 15.2 c. Balance with NRB 0.0 6.6 21.0 47.3 121.5 168.1 130.5 385.7 d. Balance with domestic banks 0.0 0.0 0.0 0.7 6.7 0.0 4.3 2.3 e. Balances held abroad 0.0 32.9 11.7 -14.0 29.7 225.8 93.1 328.3 f. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2. Investments 0.0 91.0 98.3 132.3 111.1 187.4 225.5 205.8 a. Govemment securities 0.0 0.0 95.8 132.3 111.1 184.9 223.0 203.0 b. Shares and debentures 0.0 0.0 0.0 0.0 0.0 2.5 2.5 2.6 c. NRB bonds 0.0 91.0 2.5 0.0 0.0 0.0 0.0 0.3 3. Loans and Advances 0.0 20.1 49.1 322.2 867.6 1,354.9 2,270.2 3,006.8 a. Govemment enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 20.1 48.7 314.0 801.6 1,311.9 2,238.5 3,006.0 c. Foreign bill P&D 0.0 0.0 0.4 8.2 66.0 43.0 31.7 0.0 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 0.0 0.4 2.1 31.8 46.2 76.2 94.3 a. Govemment enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.0 0.4 2.1 31.8 46.2 76.2 94.3 S. Others 0.0 28.2 37.8 75.6 150.3 238.4 561.3 1,109.1 Total Uses of Funds 0.0 183.8 229.3 581.6 1,348.1 2,287.6 3,411.8 5,240.2 139
Bank of Kathmandu - Sources and Uses of Funds (NR milliions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 0.0 67.5 67.5 93.3 93.4 96.7 262.8 332.7 a. Paid up capital 0.0 67.5 67.5 90.0 90.0 90.0 173.5 233.7 b. Statutory reserve 0.0 0.0 0.0 2.1 2.1 2.1 44.5 99.0 c. Others 0.0 0.0 0.0 1.2 1.3 4.6 44.8 0.0 2. Deposits 0.0 329.9 1,281.8 1,714.4 1,740.9 2,396.5 3,983.0 5,724.1 a. Current 0.0 73.7 184.3 154.5 211.2 242.3 437.8 681.5 b. Savings 0.0 89.3 234.5 306.4 327.6 730.3 1,161.1 1,848.9 c. Fixed 0.0 158.0 816.0 1,194.5 1,029.1 1,020.6 1,812.0 1,948.5 d. Call deposits 0.0 0.0 0.0 13.0 107.2 295.7 447.2 1,050.1 e. Others 0.0 8.9 47.0 46.0 65.8 107.6 124.9 195.1 3. Borrowings 0.0 0.0 0.0 0.0 0.0 50.0 0.0 100.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank . 0.0 0.0 0.0 0.0 0.0 50.0 0.0 100.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 5.5 72.6 90.3 200.2 454.8 225.9 362.9 Total Sources of Funds 0.0 402.9 1,421.9 1,898.0 2,034.5 2,998.0 4,471.7 6,519.7
1. Liquid funds 0.0 132.7 236.5 289.1 487.7 681.5 1,036.1 1,529.9 a. Cash in hand 0.0 8.8 32.8 85.0 47.0 46.8 81.4 157.1 b. Foreign currency in hand 0.0 1.5 3.2 12.0 4.2 3.6 13.8 14.1 c. Balance with NRB 0.0 82.6 135.4 91.5 208.4 122.0 256.9 399.9 d. Balance with domestic banks 0.0 4.2 7.1 5.9 4.5 16.0 1.7 11.3 e. Balances held abroad 0.0 35.6 58.0 94.7 176.3 112.5 167.7 561.1 f. Call deposits 0.0 0.0 0.0 0.0 47.3 380.6 514.6 386.4 2. Investments 0.0 0.0 22A 190.3 112.8 119.9 158.2 204.5 a. Government securities 0.0 0.0 19.4 187.3 94.8 111.7 150.0 180.0 b. Shares and debentures 0.0 0.0 3.0 3.0 18.0 8.2 8.2 24.6 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 0.0 219.8 1,075.3 1,336.3 1,281.8 1,811.5 2,995.3 4,327.3 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 171.8 819.4 1,064.4 1,084.6 1,239.2 2,827.9 4,275.4 c. Foreign bill P&D 0.0 48.0 255.9 271.9 197.2 572.3 167.4 51.8 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 0.9 8.4 18.8 82.0 100.8 93.9 -5.5 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.9 8.4 18.8 82.0 100.8 93.9 -5.5 Others 0.0 49.5 79.3 63.5 70.2 284.3 188.2 463.5 Total Uses of Funds 0.0 402.9 1,421.9 1,898.0 2,034.5 2,998.0 4,471.7 6,519.7 140
Nepal Bank of Ceylon - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998 1999 2000 2001 1. Capital Fund 0.0 0.0 0.0 350.0 351.3 355.5 398.6 360.5 a. Paid up capital 0.0 0.0 0.0 350.0 350.0 350.0 350.0 350.0 b. Statutory reserve 0.0 0.0 0.0 0.0 0.0 2.2 22.3 10.5 c. Others 0.0 0.0 0.0 0.0 1.3 3.3 26.3 0.0 2. Deposits 0.0 0.0 0.0 350.3 1,413.3 2,105.2 2,908.7 3,772.8 a. Current 0.0 0.0 0.0 48.3 135.3 142.7 221.9 261.3 b. Savings 0.0 0.0 0.0 54.7 155.9 258.9 393.6 600.6 c. Fixed 0.0 0.0 0.0 222.6 1,075.5 1,639.7 2,181.4 2,710.2 d. Call deposits 0.0 0.0 0.0 0.0 0.0 21.1 47.7 106.7 e. Others 0.0 0.0 0.0 24.7 46.6 42.8 64.1 94.0 3. Borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 0.0 0.0 0.0 12.2 75.5 168.1 258.6 496.4 Total Sources of Funds 0.0 0.0 0.0 712.5 1,840.1 2,628.8 3,565.9 4,629.7
1. Liquid funds 0.0 0.0 0.0 154.3 278.2 543.3 900.2 940.2 a. Cash in hand 0.0 0.0 0.0 15.7 19.5 33.4 45.6 93.6 b. Foreign currency in hand 0.0 0.0 0.0 1.3 7.9 6.8 6.3 19.5 c. Balance with NRB 0.0 0.0 0.0 31.1 103.4 288.9 191.5 249.8 d. Balance with domestic banks 0.0 0.0 0.0 0.7 9.3 22.6 24.7 32.9 e. Balances held abroad 0.0 0.0 0.0 4.9 22.8 20.2 37.1 74.6 f. Call deposits 0.0 0.0 0.0 100.6 115.3 171.4 595.0 469.8 2. Investments 0.0 0.0 0.0 158.6 106.0 346.8 294.8 301.2 a. Government securities 0.0 0.0 0.0 73.3 9.4 238.7 210.0 210.0 b. Shares and debentures 0.0 0.0 0.0 85.3 96.6 108.1 84.8 91.2 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 0.0 0.0 0.0 296.7 1,272.0 1,524.4 1,936.7 2,926.1 a. Govemment enterprises 0.0 0.0 0.0 0.0 63.0 90.6 0.0 0.0 financial 0.0 0.0 0.0 0.0 56.9 76.9 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 6.1 13.7 0.0 0.0 b. Private sector 0.0 0.0 0.0 296.7 1,116.3 1,370.9 1,902.2 2,894.3 c. Foreign bill P&D 0.0 0.0 0.0 0.0 92.7 62.9 34.5 31.8 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 0.0 0.0 6.6 4.0 27.1 185.7 0.0 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.0 0.0 6.6 4.0 27.1 185.7 0.0 . Others 0.0 0.0 0.0 96.3 179.9 187.2 248.6 462.2 Total Uses of Funds 0.0 0.0 0.0 712.5 1,840.1 2,628.8 3,566.0 4,629.7 141
Lumbini - Sources and Uses of Funds (NR millions)
Particulars 1994 1995 1996 1997 1998* 1999 2000 2001 1. Capital Fund 0.0 0.0 0.0 0.0 35.0 35.0 35.4 351.1 a. Paid up capital 0.0 0.0 0.0 0.0 35.0 35.0 35.0 350.0 b. Statutory reserve 0.0 0.0 0.0 0.0 0.0 0.0 0.4 1.0 c. Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2. Deposits 0.0 0.0 0.0 0.0 76.9 663.9 1,262.0 2,097.6 a. Current 0.0 0.0 0.0 0.0 3.4 27.3 43.8 66.7 b. Savings 0.0 0.0 0.0 0.0 25.1 95.3 269.4 435.0 c. Fixed 0.0 0.0 0.0 0.0 48.4 472.6 732.7 1,271.3 d. Call deposits 0.0 0.0 0.0 0.0 0.0 64.5 186.7 273.3 e. Others 0.0 0.0 0.0 0.0 0.0 4.2 29.4 51.3 3. Borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 0.0 0.0 0.0 0.0 1.7 19.0 27.3 95.6 Total Sources of Funds 0.0 0.0 0.0 0.0 113.6 717.9 1,324.7 2,544.3
1. Liquid funds 0.0 0.0 0.0 0.0 56.2 126.6 241.3 301.7 a. Cash in hand 0.0 0.0 0.0 0.0 7.9 20.4 36.1 56.6 b. Foreign currency in hand 0.0 0.0 0.0 0.0 0.4 1.1 6.4 7.2 c. Balance with NRB 0.0 0.0 0.0 0.0 20.4 51.8 94.3 136.3 d. Balance with domestic banks 0.0 0.0 0.0 0.0 7.5 32.8 72.3 68.0 e. Balances held abroad 0.0 0.0 0.0 0.0 0.0 20.5 32.2 33.6 f. Call deposits 0.0 0.0 0.0 0.0 20.0 0.0 0.0 0.0 2. Investments 0.0 0.0 0.0 0.0 0.0 50.6 5.8 0.8 a. Government securities 0.0 0.0 0.0 0.0 0.0 49.8 0.0 0.0 b. Shares and debentures 0.0 0.0 0.0 0.0 0.0 0.8 5.8 0.8 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 0.0 0.0 0.0 0.0 26.2 472.3 916.0 1,793.2 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.0 0.0 0.0 26.1 472.3 915.8 1,783.0 c. Foreign bill P&D 0.0 0.0 0.0 0.0 0.1 0.0 0.2 0.2 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 0.0 0.0 0.0 0.4 3.2 25.6 57.0 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.0 0.0 0.0 0.4 3.2 25.6 57.0 Others 0.0 0.0 0.0 0.0 30.8 65.2 136.1 391.6 Total Uses of Funds 0.0 0.0 0.0 0.0 113.6 717.9 1,324.8 2,544.3 *October 1998 142
Agriculture Development Bank of Nepal - Sources and Uses of Funds (NR millions) Particulars 1994 1995 1996 1997 1998 1999 2000 2001 I. Capital Fund 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 a. Paid up capital 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Statutory reserve 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.Deposits 5,175.0 6,382.7 7,351.2 8,687.6 9,524.5 11,937.2 14,269.0 16,122.7 a. Current 477.6 515.7 515.3 433.3 520.0 615.4 689.4 1,002.6 b. Savings 2,134.3 2,833.3 3,267.2 3,651.7 4,312.8 5,872.9 8,075.3 9,760.7 c. Fixed 2,490.0 2,978.1 3,520.6 4,548.6 4,646.5 5,405.6 5,504.3 5,311.7 d. Call deposits 73.1 55.6 48.1 54.0 45.2 43.3 0.0 0.0 e. Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 47.7 3. Borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 a. Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 00 4. Others 38.5 347.5 177.7 224.8 254.9 313.9 881.9 1,058.5 Total Sources of Funds 5,213.5 6,730.2 7,528.9 8,912.4 9,779.4 12,251.1 15,150.9 17,181.2
1. Liquid funds 818.8 972.9 1,270.0 1,314.7 1,250.6 1,616.1 2,055A 2,130.6 a. Cash in hand 176.7 230.6 260.8 251.7 307.7 358.8 414.9 323.4 b. Foreign currency in hand 13.3 11.0 11.3 13.1 9.3 5.9 5.0 16.9 c. Balance with NRB 516.0 597.5 868.3 928.2 864.1 1,129.7 1,376.2 1,605.6 d. Balance with domestic banks 112.8 133.8 129.6 121.7 69.5 121.7 259.3 184.7 e. Balances held abroad 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 f. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2. Investments 8.4 8.4 8.5 13.5 0.0 0.0 0.0 0.0 a. Government securities 8.4 8.4 8.5 13.5 0.0 0.0 0.0 0.0 b. Shares and debentures 0.0 0.0 0.0 -0.0 0.0 0.0 0.0 0.0 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 1,077.8 2,011.3 2,622.9 3,194.3 3,528.3 3,891.9 4,299.0 4,715.3 a. Govemment enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 1,077.8 2,011.3 2,622.9 3,194.3 3,528.3 3,891.9 4,299.0 4,715.3 c. Foreign bill P&D 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 0 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 50.5 109.1 99.7 138.5 72.2 140.8 166.3 123.6 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 50.5 109.1 99.7 138.5 72.2 140.8 166.3 123.6 5. Others 3,258.0 3,628.5 3,527.8 4,251.4 4,928.3 6,602.3 8,630.1 10,211.7 Total Uses of Funds 5,213.5 6,730.2 7,528.9 8,912.4 9,779.4 12,251.1 15,150.8 17,181.2 143
Nepal Industrial & Commercial Bank- Sources and Uses of Funds (NR millions) Particulars 1994 1995 1996 1997 1998* 1999 2000 2001 1. Capital Fund 0.0 0.0 0.0 0.0 813 325.0 491.5 519.9 a. Paid up capital 0.0 0.0 0.0 0.0 81.3 325.0 491.5 499.7 b. Statutory reserve 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.4 c Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0 14.8 2. Deposits 0.0 0.0 0.0 0.0 115.1 376.3 2.,025.6 3,575.8 a Current 0.0 0.0 0.0 0.0 10.6 16.0 148.3 248.0 b. Savings 0.0 0.0 0.0 0.0 83.3 108.3 356.3 526.0 c. Fixed 0.0 0.0 0.0 0.0 16.9 178.6 1,174.2 1,958.1 d. Call deposits 0.0 0.0 0.0 0.0 1.0 42.5 219.5 797.1 e. Others 0.0 0.0 0.0 0.0 3.3 30.9 127.3 46.7 3. Borrowings 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 a Nepal Rastra Bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Inter-bank 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 c. Foreign banks 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Others 0.0 0.0 0.0 0.0 2.2 47.1 152.7 286.7 Total Sources of Funds 0.0 0.0 0.0 0.0 198.6 748.4 2,669.8 4,382.4
1. Liquid funds 0.0 0.0 0.0 0.0 141.1 119.0 221.6 539.5 a.Cashinhand 0.0 0.0 0.0 0.0 10.7 14.1 52.2 117.2 b. Foreign currency in hand 0.0 0.0 0.0 0.0 0.1 1.2 10.4 9.9 c. Balance with NRB 0.0 0.0 0.0 0.0 20.5 54.7 109.7 331.7 d. Balance with domestic banks 0.0 0.0 0.0 0.0 9.8 6.7 2.0 9.4 e. Balances held abroad 0.0 0.0 0.0 0.0 100.0 42.3 47.3 71.3 f. Call deposits 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2. Investments 0.0 0.0 0.0 0.0 20.0 50.4 148.0 148.0 a. Government securities 0.0 0.0 0.0 0.0 0.0 49.6 148.0 148 0 b. Shares and debentures 0.0 0.0 0.0 0.0 20.0 0.8 0.0 0.0 c. NRB bonds 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 3. Loans and Advances 0.0 0.0 0.0 0.0 8.5 481.3 1,659.1 2,617. a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 100.0 0.0 financial 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 non-financial 0.0 0.0 0.0 0.0 0.0 0.0 100.0 0.0 b. Private sector 0.0 0.0 0.0 0.0 8.5 478.3 1,553.8 2,568.1 c. Foreign bill P&D 0.0 0.0 0.0 0.0 0.0 3.0 5.3 49.6 d. Foreign A.B.C. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4. Interest Accrued 0.0 0.0 0.0 0.0 0.2 4.3 19.2 57.1 a. Government enterprises 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 b. Private sector 0.0 0.0 0.0 0.0 0.2 4.3 19.2 57.1 Others 0.0 0.0 0.0 0.0 28.8 93.4 621.9 1,020.1 Total Uses of Funds 0.0 0.0 0.0 0.0 198.6 748.4 2,669.8 4,382.4 *October 1998 144
Annex Four Finance Companies in Nepal
Finance Companies Licensed Operation Head Office Total Finance CompaniesDate Date Assets* I Nepal Housing Development Finance Co. Ltd. July 1992 July 1992 Kathmandu 337.9 2 Nepal Finance and Savings Co. Ltd. Dec. 1992 Apr. 1993 Kathmandu 288.0 3 NIDC Capital Markets Ltd. Jan. 1993 Jan. 1993 Kathmandu 324.0 4 National Finance Co. Ltd. Apr. 1993 Mar. 1993 Kathmandu 752.1 5 Annapuma Finance Co. Ltd. Aug. 1993 Sep. 1993 Pokhara 313.8 6 Nepal Share Markets Ltd. Oct. 1993 Oct. 1993 Kathmandu 813.8 7 Peoples Finance Ltd. Mar. 1994 Apr. 1994 Kathmandu 246.3 8 Himalaya Finance & Savings Co. Ltd. Aug. 1994 Oct. 1994 Kathmandu 108.0 9 United Finance and Leasing Co. Sep. 1994 Jan. 1996 Kathmandu 261.8 10 Union Finance Co. Ltd. Sep. 1994 Nov. 1994 Kathmandu 232.7 11 Himalayan Securities & Finance Co. Ltd. Sep. 1994 Oct. 1994 Kathmandu 594.2 12 Mercentile Finance Co. Ltd. Oct. 1994 Oct. 1994 Birgunj 74.2 13 Kathmandu Finance Ltd. Oct. 1994 Oct. 1994 Kathmandu 193.1 14 Inbesta Finance Ltd. Feb. 1995 July 1995 Birgunj 72.1 15 Narayani Finance Ltd. Feb. 1995 Feb. 1995 Narayangadh 187.5 16 City Finance Ltd. Feb. 1995 Feb. 1995 Kathmandu 132.3 17 Nepal Housing & Merchant Finance Co. Ltd. Mar. 1995 Mar. 1995 Kathmandu 417.8 18 Paschimanchal Finance Co. Ltd. Mar. 1995 Mar. 1995 Butwal 414.0 19 Universal Finance & Capital Markets. Apr. 1995 Apr. 1995 Kathmandu 323.7 20 Samjhana Finance Co. Ltd. Apr. 1995 Apr. 1995 Banepa 148.5 21 Goodwill Finance & Investment Co. Ltd. Apr. 1995 Apr. 1995 Kathmandu 267.4 22 Shree Investment & Finance Co. Ltd. Jul. 1994 May 1995 Kathmandu 378.7 23 Siddhartha Finance Co. Ltd. May 1995 May 1995 Siddharthanagar 139.2 24 Lumbini Finance & Leasing Co. Ltd. June 1995 June 1995 Kathmandu 600.5 25 Yeti Finance Co. Ltd. June 1995 July 1995 Hetauda 201.0 26 Standard Finance Ltd. June 1995 July 1995 Kathmandu 250.6 27 ACE Finance Co. Ltd. July 1995 July 1995 Kathmandu 722.2 28 International Leasing & Finance Co. Ltd. Sept. 1995 Oct. 1995 Kathmandu 468.6 29 Mahalaxmi Finance Co. Ltd. Nov. 1995 Nov. 1995 Birgunj 309.3 30 Lalitpur Finance Co. Ltd. Nov. 1995 Nov. 1995 Kathmandu 337.7 31 Merchant Finance Co. Ltd. Dec. 1995 Feb. 1996 Kathmandu 136.3 32 Bhajuratna Finance & Saving Co. Ltd. Dec. 1995 Dec. 1995 Kathmandu 132.0 33 General Finance Ltd. Jan. 1996 Jan. 1996 Kathmandu 162.4 34 Nepal Shreelanka Merchant Bank Ltd. Jan. 1996 Jan. 1996 Kathmandu 470.6 35 Alpic Everest Finance Ltd. Jan. 1996 July 1996 Kathmandu 197.0 36 Nepal Merchant Banking & Finance Ltd. Dec. 1996 Dec. 1996 Kathmandu 952.2 37 Nava Durga Finance Co. Ltd. Dec. 1996 Dec. 1996 Bhaktapur 121.0 38 Pokhara Finance Ltd. Feb. 1997 Mar. 1997 Pokhara 206.1 39 Janaki Finance Ltd. Feb. 1997 Feb. 1997 Janakpur 117.5 40 Central Finance Co. Ltd. July 1997 July 1997 Lalitpur 142.3 41 Premier Finance Co. Ltd. July 1997 May 1997 Lalitpur 111.3 42 Arun Finance & Saving Co. Ltd. July 1997 Aug. 1997 Dharan 57.9 43 Multipurpose Saving & Investment Finance Co. Ltd. Jan. 1997 Apr. 1998 Rajbiraj 9.0 44 Butwal Finance Co. Ltd. June 1998 June 1998 Butwal 212.4 45 Nepal Bangladesh Finance & Leasing Co. Ltd. Mar. 1999 July 1999 Biratnagar 112.4 46 Srijana Finance Co. Ltd. Nov. 1998 Nov. 1998 Lahan 6.5 47 Om Finance Ltd. Sept. 2000 Sept. 2000 Pokhara 42.1** 48 Cosmic Merchant Banking Finance Ltd. Nov. 2000 Nov. 2000 Kathmandu 71.4** * As of July 2000 (in millions of NR, based on Sources and Uses of Funds). ** As of January 2001. 145
Annex Five Case Studies of Micro Finance in Nepal
Case One A Proxy Loan put to Good Use Shasun Mohila Samaj Sisbony Jahada, Kotohari, Morang, Biratnagar
Women as proxy borrowers or as conduitfor obtaining micro-credit loans have been widespreadin all countries where microcredit is playing an importantrole in poverty alleviation. It is the same in Nepal. PabaniDevi Gami, a Grameen Bikash Bank borrowerhas been a proxy borrower, actually borrowing on behalfofher husband to help thefamily improve their overallfamily income and quality of life, while she remained totally devoted to carrying out the housewife 's role.
Pabani Devi Gami is a proxy borrower and her husband actually uses her loan. She is a member of the Shasum Mahila Samaj, and does not fall in the absolute poor category. She used the GBB loan to help increase family income and improve consumption. She took two loans: NR 5,000 for purchasing a cow which provides 1kg milk for daily consumption by her family (consisting of a son and a daughter), and NR 10,000 taken for her husband to invest in a grocery shop, which is worth NR 50,000, and has been part of their family for over 8 years. Her husband runs the grocery shop while she takes care of the family. The family, however, does not own any land other than their homestead. Pabzni, although not directly involved in the running of the grocery shop, makes sure that the income from the investment is wisely used; not only to cover the household expenses but also to maintain the proper repayment of the loan. The excess income, after all expenditures, is reinvested into the grocery shop.
Case Two A Well-off Borrower of Grameen Bikash Bank Shasun Mohila Samaj Sisbony Jahada, Kotohari, Morang, Biratnagar
The focus of the Grameen Bikash Bank microcreditprogram is not entirely on the absolute poor. It appears that the ability of the borrowerto repay the loan has been an important consideration. This has enabled GBB to maintain a loan collection rate of above 95%. InarbaliDevi is an example of such a borrower. She has taken loans not to get out ofpoverty, but to enhance the totalfamily income and improve the overall quality of life.
Inarbali Devi, a member of Shasun Mohila Samaj, took two loans: NR 5,000 to purchase a cow and NR 10,000 to buy an oxen to help plough the land. She has three children, two sons and one daughter, and a husband who works in a jute factory. Her family earnings are more than NR 50,000 annually from various sources. In a year, her husband earns NR 26,000 and her son earn around NR 24,000. In the last three years, the cow produced milk only for one year; about 3kg of milk daily, which was sold for six days a week for NR 20 per kg. and earned NR 18,720. The cow was fed maize (4kg/week) which cost NR 1,248 and other expenses amounted to NR 1,200 annually. In the meantime, the cow gave birth to a calf which is worth NR 1,500 in the market. Therefore, the weekly loan payment of NR 221 was maintained without much difficulty. The family does not have any land to cultivate on other than a 3 katha land on which their homestead stands. As described by Inarbali, her family has no financial problems, the microcredit from Grameen Bikash Bank has provided her with extra family income which helped her to improve house and maintain a better quality life. 146
Case Three Successful Microenterprise Activity in Low Hills CSD Branch, Bhimphedi Makwanpur District
Although Sanua Maya Lama startedas a microcredit borrower, she has the characteristicsof an entrepreneur. This trend has been prevalent among many other borrowers living in market areas around low hills and shows greatpotential to promote microenterpriselending in low hill areas.
Sanu Maya Lama became a member of the CSD branch office in Bhimpedi three years ago (1998), because her husband's income was not sufficient to meet her needs. She runs a small hotel. She has taken three loans: NR 3,000, 8,000, and 10,000. Initially, Sanu saved NR 10 fortnightly, but her income from the hotel helped her to increase saving to NR 50-100 per fortnight. Once she was able to save NR 1,000 in a month. She has accumulated a total savings of NR 25,000 on which she earns 8 percent. When she was asked why she takes loans despite having such a large amount of savings, she answered that her savings is her own money which she would not like to use for investment. The first loan was invested in the hotel business, which was half its present size, with an initial working capital of NR 2,000 and a daily sale of NR 100-200. Now, the working capital increased to NR 9,000 and daily sales rose to NR 400-500. Not only that, the hotel has 9 regular customers who pay NR 1,200- 1,500 per month. The total expenses amounted to NR 250-300, and profit earned amounts to NR 100- 150 on a daily basis. On her last loan, she paid NR 450 as installment and NR 50 as interest every fortnight. Sanu's family consists of five children, three sons and two daughters, and a husband who is a driver. Her husband brings home income of NR 5,000 per month. Her family has a land on which she plans to build a house. In the meantime, the interesting thing that Sanu has done is that she has given out a loan of NR 2,000 at an interest rate of 36 percent p.a.. She manages her business with the help of her daughter and intends to borrow NR 30,000 for further investment.
Case Four Sunila Lama Successful Entrepreneur from the Low Hill Area
Sunila Lama is an example of a successful entrepreneurin the low hill areas. She has vision and is always aspiring to move ahead. She sees the possibility of developing the low hill areas economically and creating linkages with the high hills and mountain areas. "Unless the low hill areas are developed, it wvould be difficult to develop the high hills and mountain areas", she strongly emphasized. Sunila works part-time in a local NGO, but devotes the remaining time in the family grocery business.
Sunila Lama has been a member of CSD Bhimphedi Branch for the last three years. Her last loan from CSD Brach Office was NR 10,000 which she is currently servicing. Her husband is a carpenter. Her family has a grocery shop worth NR 50,000-60,000. Sunila has been managing this grocery shop and performing the role of a business women very successfully. She already has a contract with local schools and clinics to supply grocery on a regular basis and she has been doing that for the last one year. She expects to increase her supply business to the small local grocery shops. This is because she purchases the goods herself and has developed a good business relationship with the wholesalers of Hetauda, which is located 12 km away from Bhimpedi. She thinks that by doing her own purchases she saves about 10-15 percent on the total costs. She believes that she can offer lower prices for groceries to the Bhimphedi local shops and become competitive, as it would save the local shop owners the traveling cost to Hetauda. Her goal is to emerge as a "wholesaler" in Bhimpedi and maintain a little grocery shop as it will enable her to earn 5-10 times more than her present earnings. 147
Annex Six Institutional Plavers in Micro-Finance
Informal Institutions and Arrangements
Traditionally, the informal sector has been dominated by the village money-lenders, goldsmiths and pawn-brokers who provide credit against collateral at a high interest rate ranging from 36 percent to over 100 percent per annum, without much procedural complexities or delays. They have been replaced to some extent by community-based informal groups or ROSCAS (Rotating Savings and Credit Associations) such as Dhikuties', Dharam Bhakari (welfare storage grain associations) and Guthies (cultural heritage associations) which are particularly common amongst Nepal's ethnic trading communities.
The informal arrangements also include about 20,000 guided or haphazard indigenous Savings and Credit Organizations (SCOs) most of which have emerged over the last eight to ten years. The considerable proliferation of these institutions over a short period of time is both a boon and a bane in the micro-finance arena. The SCOs are generally small organizations of up to 25 members, that are managed by its own members without hiring any staff from outside, thus operating wir,h minimal costs. They are mostly unregistered and not affiliated with any other MFI or program, and cannot usually borrow from outside. Their outreach is limited to their membership and their volume of transactions is correspondingly low. An outstanding feature of this movement is that it has proliferated to all regions of Nepal including the Terai, hills and mountains, although a greater number is found in more accessible areas.
A survey conducted by DEPROSC in March 1997, found that "the total number of households/members participating in such institutions has been estimated at 320,000." However, a serious weakness in most of these organizations is in the area of record keeping and MAIS. The use of voluntary staff has accentuated the problem and proper accounts are not always maintained or available. In the absence of passbooks or other records, many savers are unaware of the balance in their savings account and many borrowers are unaware of their loan repayment schedules and outstanding dues. Even the proper accounting of group funds is sometimes absent and hence details are unavailable. This situation is potentially risky as it may lead to misuse of funds by a few and, if allowed to continue, may ultimately lead to a collapse of the organization. There are cases where the organizers of some SCOs have reportedly vanished after raising considerable amounts of savings from their members. An escalation of such cases will deal a severe blow to the entire SCO movement and threaten the livelihood of a number of poor who are the members of such organizations.
Formal Institutions
The formal institutions and programs operating in the micro-finance sector may again be subdivided into government-owned and private sector owned institutions and programs.
The government-owned formal institutions and programs include:
1. The five Grameen Bikas Banks (GBBs) that replicated the Grameen model for the first time in Nepal with the setting up of the Eastern and Far Western Grameen Bikas Banks in 1992, followed by the Central and Mid-Western Grameen Bikas Banks in 1995 and finally the Wlestern Grameen Bikas Bank in late 1996. These banks are registered under the Company Act and have a paid-up
'The 20 to 30 member Dhikuties are based upon the collection from each member of an equal amount of savings (NR 5 to 50) which are then lent out to each member on rotation. At the end of the rotation, the surplus is distributed equally to the members. Although fairly common both in urban and rural areas, these groups face risks of default from borrowing members as well as the possibility of drop out once the loan has been received. 148
capital of NR 60 million each provided by NRB (66.6 percent), the government (9.95 percent) and by selected commercial banks (23.45 percent). Together these five MFI have the biggest outreach consisting of 140,000 members and 127,000 borrowers and outstanding loans of NR 815 million. Although its stated policies include the provision of services to poor and marginal people having less than one bigha (0.6 ha.) of land in terai and 10 ropani (0.5 ha.) of land in hill areas, in practice this policy is not strictly followed. The organization of these banks is fairly extensive and in some areas quite superfluous. Starting from the borrowers/members who are organized into groups, about two to eight groups (consisting of 10 to 40 members) are federated to form centers at the village level. Up to a maximum of 50 centers are under the control of a Unit Office, five of which are then put under the supervision and control of an Area Office established in a centrally located area. When five Area Offices are in operation, a District Office is established to supervise and monitor the Area Offices. The District Offices finally report to the Central Office, which is the apex level policy formulating body mainly engaged in preparing policy guidelines and operational procedures, resource mobilization, training, supervision and control. The overall management and control of the five banks are vested in five separate Boards of Directors comprising five members each, and the daily operation of these banks is looked after by five different Executive Directors. The result of this bloated organization structure with around 1,100 staff is that all the five banks are burdened with huge overheads which cannot be fully covered by the narrow spread from its operations. The narrow spread is itself the result of its low interest rate of 10 percent charged to its borrowers, which is the lowest amongst all the MFIs in Nepal. The problems are further compounded by poor staff skills, lack of training and inadequate MIS. The cumulative effect of these problems is that the losses incurred by four of the five banks have eaten away the entire equity base leaving these four banks technically insolvent.
2. The Agricultural Development Bank of Nepal (ADB/N) was established in 1968 by the government to specialize in agricultural and rural credit. It is the third-largest bank in Nepal (after NBL and RBB) with a paid-up capital of NRI .4 billion (US$20 million), a loan portfolio of about NR 13.9 billion (US$199 million) and total deposits of NR billion (US$ million) and operates in all the 75 districts through 610 branches and offices. Besides the commercial operations wing and the agriculture development wing, it also operates the small farmer development wing which manages and controls the Small Farmer's Development Program (SFDP) with an outreach of 180,000 members. SFDP was introduced in 1975, to bring the deprived sector, consisting of small farmers, landless laborers, and other disadvantaged groups, in the mainstream of the development process by providing loans to finance economic activities. When repayments began to fall in the early eighties and operating costs began to rise substantially, ADB/N realized that its SFDP needed restructuring for survival. So, in 1987, an Institutional Development Program with the assistance of GTZ was initiated to convert the SFDP into cooperatives, called the Small Farmers' Cooperatives Ltd. (SFCL). Under this program, the Sub-Project Offices (SPOs) of ADB/N are to be converted to SFCLs through a laid down process. So far about 100 SPOs have been converted to SFCLs and another 75 SPOs are planned to be transformed by the year 2003. However, the transformation process has been found to be slower than planned and it appears that it will take up to the year 2010 to convert all the 400 SPOs.
3. Rural Microfinance Development Center (RMDC) Ltd. was set up in 1999 by the Government to act as the apex institution for the micro-finance sector in Nepal. It is registered under the Companies Act, 1997, with a mandate to operate as a development bank within the framework of the Development Bank Act, 1996. The authorized capital of RMDC is NR 160 million of which NR 80 million is paid up. Its main shareholders are NRB (26 percent), thirteen commercial banks (67 percent), the five Grameen Bikas Banks, the Deposit Insurance and Credit Guarantee Corporation and the NGO called NIRDHAN. It's main function is to provide wholesale credit to NGOs/MFIs for onlending to the target group (the poor and the women) so that they can undertake viable farm and off-farm economic activities. It also arranges training facilities for MFIs to 149
strengthen their institutional capacity and to build-up income-earning capacity of the ultimate borrowers. RMDC is the implementing agency for the Rural Microfinance Project under which the Asian Development Bank (ADB) has provided US$20 million to the Government for onlending to eligible MFIs for extending microfinance services to the poor. Disbursements to two MFIs by RMDC under this project, up to the end of December 2000, amounted to NR 40 million (US$0.57 million).
4. Besides the abovementioned interventions of the government, there are five major government programs in the micro-credit sector, which are implemented through commercial banks, NGOs and SCCs. These are:
a) The priority sector lending program developed by NRB in 1974 and now requiring all commercial banks, both state-owned and joint venture banks, to lend 12 percent of their loanable funds to priority sector borrowers of which 3 percent must be lent either directly or indirectly as micro-credit of up to a maximum of NR 30,000 per borrower (also called deprived sector lending).
b) The Production Credit for Rural Women (PCRW) project implemented by the Women's Development Division (WDD) of the Ministry of Local Development (MLD) which is specifically targeted to rural women covering 36 districts. The project was initiated in 1984 with IFAD funds and involved the two state-owned commercial banks (NBL and RBB) together with UNICEF as their partners. Outreach was limited to 60,000 member borrowers
c) The Rural Self-Reliance Fund (RSRF) established by NRB in 1990 to provide funds (currently at 6 percent) to Cooperatives and NGOs registered with NRB under the Financial Intermediary Act and the Cooperative Act, for onlending to micro-entrepreneurs.
d) The Micro Credit Project for Women (MCPW) funded by the Asian Development Bank (ADB) as an extension of the PCRW from 1994 to 2002 and still focused on rural women and hence under the same administration (WDD of MLD) but using NGOs and SCCs to carry out the social mobilization and to act as credit agents of the commercial banks. The scope of this project has been narrowed down to 12 districts.
e) The Poverty Alleviation Fund (PAF) set up by the Government in 1990, to "integrate scattered poverty reduction programs of a similar nature within one umbrella and replicate and upscale successful programs." Among the specific objectives of PAF are to support the poverty alleviation programs implemented by Government agencies, NGOs and CBOs, develop their institutional capabilities and encourage them to use their own resources along with that of PAF for implementing poverty programs at the district and VDC level. The PAF is an umbrella fund which will not implement any programs itself but will execute its programs through eligible partner organizations (POs). Among the various activities, PAF will also finance the building of small infrastructures that are judged to be helpful for reducing poverty. Such infrastructure may include micro-irrigation, drinking water, rural energy, agro-forestry, agriculture research and extension, market link roads, bridge and culverts. In other words, PAF would finance programs that would facilitate the creation and expansion of economic activities where such activities are currently hindered by the lack of infrastructure. Since the more inaccessible areas lack such infrastructure, PAF would be catalytic in facilitating and encouraging the creation of economic activities involving the communities in those areas. This will be the main contribution of PAF to poverty alleviation and in order not to dilute this focus the micro-credit component of PAF should be completely taken out. Another reason for taking out the micro-credit component 150
is the existence of RMDC with the mandate to do exactly that - wholesaling micro-credit to eligible MFIs.
Private sector-owned institutions include:
1. Center for Self-help Development (CSD) is the largest private sector MFI in Nepal, set up in August 1991, as an NGO by some ex-employees of ADB/N, for the objective of promoting socio- economic empowerment of the poor, raising their productive capacity and income level, and strengthening local capacity to plan, implement and monitor development activities. It became quite successful from the very beginning and has expanded its outreach to 36,000 borrowers serviced by about 300 staff in its various Unit offices, Branches, Area Offices, and Project offices. The day-to-day operations are managed by an Executive Director assisted by three Directors working in Self-help Banking Division, Community Development Division, and Administration and Finance Division. At the top of the structure is the General Assembly comprising general members and promoters and a Governing Board consisting of members elected from the general assembly to provide policy direction and set out broad goals. Besides implementing four major projects: the Self-help Banking Program (SBP); the Community Based Economic Development (CBED) project in Jumla; the Community Development Programs (CDP) in Okhaldhunga and Sankhuwasabha; it also executes training programs to upgrade skills and knowledge of personnel working in organizations that are engaged in the development of grassroots communities. To avoid the limitations on savings mobilization imposed by the FIA, CSD has floated a development bank under the Development Bank Act of 1995.
2. NIRDHAN is the second-largest MFI in the private sector following closely behind CSD with an outreach of around 27,000 borrowers. It started functioning as a local NGO in 1991, and faced initial problems in expanding its outreach which was overcome with the dedication and commitment of its leader and other staff. Like some other NGOs, Nirdhan has also formed a development bank called Nirdhan Utthan Bank under the Development Bank Act. It will transfer all its micro-credit activities to the new bank while canying on the non-financial services as an NGO.
3. Development Project Service Center (DEPROSC), Nepal was set up as an NGO in 1994 by some ex-employees of ADB/N with the active support of an INGO. Like other MFTs, its objectives include the raising of living standards of the poor through credit and other credit-plus activities. Besides lending directly to the poor in the two Terai districts of Morang and Rautahat, it also promotes SCOs in seven hill districts by providing credit funds and technical and management training. Its current outreach under both systems is 17,705 members with loan outstanding of NR 54 million. To avoid the problems linked to the FIA, it has followed the other large NGOs and registered itself under the Development Bank Act on January 12, 2001, to form the DEPROSC Bikas Bank with an authorized capital of NR 23.2 million of which NR 11.6 million has been paid- up. The DEPROSC Bank will also lend to SCOs working in rural areas.
4. Support Activities for Poor Producers of Nepal (SAPPROS) was established in 1991, to conduct action research for poverty alleviation in the country. It is devoted to augment grassroots based organizational and institutional capacity in less developed rural areas. The main thrust in SAPPROS's working modalities is to involve the socially and economically deprived population in all phases of planning, designing, implementing and benefit sharing of programs meant for themselves2. It applies a holistic model which includes: organizational development; infrastructure development; resource generation; income generation; and environmental sustenance. Under its infrastructure development component SAPPROS mobilized groups for water supply schemes, the
2 ShriKrishna Upadhyay and Govind p. Koirala. "Governance, Decentralisation and SAPPROS Experience in Poverty Alleviation in Nepal. SAPPROS Nepal, 2001. Page 5. 151
construction and improvement of trail roads and bridges which increased market access specially for transporting the farm produce to the nearest market, and micro-irrigation systems. Under the income generation component, SAPPROS provided input services to group members for introducing high value crops and high yielding variety seeds production, and for livestock development activities. These are the kind of activities that are essential in the more inaccessible areas for creating economic activities which would generate the demand for micro-finance.
5. Center for Environmental and Agricultural Policy Research, Extension and Development (CEAPRED) was set up in 1991 by a multi-disciplinary team of professionals to develop and institutionalize the concept of participatory economic development in Nepal. Over the last ten years its activities have been focused on three main areas, namely: rural poverty alleviation through income generation; micro-environmental action programs and action/policy research in agriculture.
6. Savings and Credit Cooperatives (SCCs) which have started to multiply in the villages after the enactment of the Cooperatives Act in 1992, often as a part of a multi-purpose cooperative. It should be recognized at the outset that the Multi-purpose Cooperatives were not initially set up for micro- credit. However, most of these cooperatives began to form a savings and credil cooperative for fund mobilization. According to an NRB estimate there are around 1,600 savings and credit cooperatives out of a total of around 6,000 cooperatives operating in the country. Only 34 of the 1,600 SCCs have obtained the limited banking license from NRB. The limited banking licenses allows these 34 SCCs to mobilize savings from both members and non-members and lend that money as loans to individuals and groups. Although these cooperatives are not necessarily targeting the poorest of the poor, they are encouraging savings and contributing towards the monetization of the rural economy. However, these cooperatives face some serious weaknesses which are further compounded by the lack of a regulatory body to monitor their activities. Their main weakness lies in the lack of proper accounting and auditing practices, the absence of adequate MIS, and the undue influence and even exploitation of the members by the relatively better-off and smarter individuals who are most often the leaders of the cooperatives. Moreover, the members and office-bearers lack proper training and education.
7. International Non-government Organizations (INGOs) which number more than ten and are actively involved in the sector in various ways. While only a few provide capital for micro-credit most of these organizations are involved in providing technical assistance, subsidies and loss financing and assistance in social mobilization. The INGOs usually do not need to register with the District Administation Office like the local NGOs but to implement the social programs the INGOs need to register with the Social Welfare Council.
8. Multi-purpose Cooperatives: Smaller Local NGOs, whose numbers have swelled to more than 20,000 mostly after the restoration of democracy in 1990, and are currently not adequately monitored or supervised. Although all NGOs must be registered under the Societies Registration Act, and also under the Social Welfare Council and the District Administration Office, none of these agencies have the means to monitor and supervise the work of the NGOs. The NGOs can also apply to NRB for a limited banking license which allows them to accept deposits and provide loans. Moreover, many of these NGOs also act as credit agents under micro-credit programs of commercial banks. Some of the bigger NGOs that have obtained limited banking license from NRB are: Nepal Rural Development Society Center (NRDSC); Vijaya Development Resource Center (VDRS); Center for Integrated Development (ICD); Chhimeki Sewa Samaj (CSS); Nepal Rural Development Organization (NRDO); and some others.
Besides the abovementioned organizations, there are also several associations and federations of MFIs in Nepal. Some of them are: 152
1. The Micro-Finance Association of Nepal (MIFAN) which was set up in 1999 as an NGO under the Societies Registration Act of 1978, to act as the common voice of the micro-finance institutions in Nepal. Its objective is to create a platform for micro-finance practitioners and institutions for mutual sharing and learning, to lobby for wholesale resource mobilization, to protect the rights and interests of the MFIs, to carry out advocacy programs, and to encourage the flow of information among MFIs. It has three categories of members: general members, such as, the eligible MFIs; honorary members such as INGOs and practitioners involved in the development of the micro- finance movement; and patron members, such as, the promoting agencies. Current membership is around eighty. It has a manager appointed by the Board of Directors to look after the daily activities, that include delivering training and MIS systems and dissemination of best practices.
2. The Center for Micro-Finance (CMF) which was established in 1988, under a USAID project to act as a national focal point for the rapidly expanding micro-finance sector in Nepal. In June 2000, CMF was registered as a private non-profit organization and the management of the Center passed on to a formally elected nine-member Board of Directors comprising of the pioneers and reputed personalities in the field of micro-finance. Its activities consists of: technical assistance to local practitioners on emerging issues in the sector; training and professional development programs for managers in the sector; strengthening linkages and improving communications within the sector in and outside the country; research and documentation; and the setting up of a Resource Center for materials related to micro-finance.
3. The National Federation of Savings and Credit Co-operative Unions Ltd. (NEFSCUN) which was established in 1988 to act as the apex organization of savings and credit co-operative societies and their district unions, with the objective of promoting and strengthening credit union movement in Nepal. It has the support of the Association of Asian Confederation of Credit Unions (ACCU), based in Thailand. NEFSCUN is registered as a cooperative under the Cooperative Act of Nepal and is a member of the National Cooperative Federation since 1997. Out of the more than 1,500 credit unions registered under the cooperative Act, only 331 credit unions are affiliated with NEFSCUN covering some 38,000 individual members in 40 districts. Its members are all savings and credit cooperatives. Multi-purpose cooperatives cannot be members of NEFSCUN. Its services to its members include: representation; training and education; financial services; and other services, such as lobbying agent. However, a lack of revenues and funding sources have constrained the activities and expansion plans of this organization.
4. The National Co-operative Federation (NCF) of Nepal which was registered on June 20, 1993, under the Cooperative Act to provide leadership to the cooperative movement by promoting and developing the movement on the basis of the cooperative principles according to the people's needs, their own initiative and participation. It is the apex body of all cooperatives, including the multipurpose cooperatives, and has a membership of 3 Central Cooperative Unions, 49 District Cooperative Unions, 6 Single Purpose District Level Cooperative Unions and 5 Single Purpose Cooperative Societies. It represents more than 4,768 primary cooperative societies operating throughout Nepal with approximately 1.06 million members. Its functions include: research, development and promotion of the cooperative movement and spirit; training and educational programs for developing the human resources for the leadership and management of cooperative societies and unions; supporting the planning, execution, monitoring and evaluation of programs and activities of cooperative societies and unions; business promotion activities including the operation of businesses; establishing and promoting inter-cooperative relations; and to lead and represent the cooperative movement at national and international levels. It has an authorized capital of NR 500 million consisting of 100,000 shares of NR 5,000 each. It offers full-fledged membership to all Central Cooperative Unions (CCU), District Cooperative Unions (DCU), Single Purpose District Cooperative Unions (SPCU) and financial and banking institutions. Associate membership is offered to Primary Cooperative Societies and national and international NGOs that 153 are promoting cooperative values and principles. One representative from each member organization comprises the General Assembly which then elects the Board of Directors for a 5 year term. The present Board consists of 12 members including the Registrar of Cooperative Department of the Government and the Chairmen of the Central Specialized Cooperative Unions. The management of the Federation consists of a 5 member Executive Committee chaired by the NCF Chairman and full-time Managing Director nominated by the Board among the elected members of the NCF Board. 155
Annex Seven Contractual Savings Schemes
SchemeSchme StateSbtd CoverageoeFnacnYear Membership Financing ReplacementRate AdministrationSupervision / (RA nen
Employees 1934 Formal Sector 340,000 12% Employer Lump Sum Ministry of Finance 22,000 Provident Fund Mandatory , 8% Employee 5% PF deposit EPF Pension 1996 EPF Members 340,000 Non Contributory p.a. for up to 9 Ministry of Finance N/A years Civil Service Public Sector 103,000 N Last salary x Ministry of General Pension Scheme 1957 Mandatory 26,207' Non Contnbutory YOS/50 Administration N/A
Teacher's Pension 1996 Public Sector 100,000 Non Contributory Last salary x Ministry of General N/A Scheme Mandatory 4,333' YOS/50 Administration
Old Age Pension All over 75 Universal Non Contributory Fixed payments Ministry of Local N/A ______years ______NR 100 p.m.- Development______
Citizens 1990 Private Sector 67,200 Nepal Rastra Bank 896 Investmnent Trust Voluntary
Private Provident 1962 Private Sector 200,000 10% Employer Lump Sum Department of Labor 6,400 Funds Mandatory , 10% Employee
Gratuity Private Sector Employer Lump Sum Department of Labor N/A2 ______M andatory______Various 1994Various Private Sector Employee Various ~~~~~~~~~~~~~~~Normnallyadministered,self no N/A Private Pensions Voluntary supervision.
Life Insurance 1968 Private Sector 188,000 Employer or Lump Sum Insurance Board 6,5002 Voluntary Individual Endowment 156
Annex Eight Population & Population Charts
Mid-Year Population by Age and Sex: 2000 and 2005 (population in thousands)
2000 2025 _
Age Total Male Female Total Male Female
Total 24,702 12,667 12,035 39,918 20,524 19,394
00-04 3,687 1,898 1,789 4,180 2,148 2,032
05-09 3,322 1,717 1,604 4,132 2,128 2,003
10-14 3,040 1,573 1,467 4,084 2,106 1,977
15-19 2,743 1,419 1,325 3,961 2,046 1,915
20-24 2,364 1,221 1,143 3,739 1,933 1,806
25-29 1,875 969 906 3,443 1,782 1,661
30-34 1,562 801 761 3,128 1,621 1,507
35-39 1,293 657 636 2,826 1,466 1,360
40-44 1,104 562 542 2,505 1,299 1,206
45-49 942 480' 462 2,113 1,094 1,019
50-54 756 374 383 1,627 840 787
55-59 638 314 324 1,293 658 635
60-64 526 260 265 996 497 499
65-69 388 194 194 758 373 385
70-74 247 123 124 541 262 278
75-79 135 67 68 327 150 _ 177
80+ 81 39 42 265 119 146
Source: U.S. Census Bureau, International Data Base. 157
Annex Eight Population Charts
Nepal: 2999 MALE FEMALE 80+ 75-79 70-74 65-69 60-64 1-7-7-55-59'-, 11 50-54 -- F4549
2. 0.2.0 1.5 135-390 ' 0 .0 1 . N 25-292a: .
15-19 ,
2.5 2.0 1.5 1.0 0.5 0.0 0.0 0.5 1.0 1.5 2.0 2.5 Population (in millions) Source: U.S. Census Bureau, International Data Base.
E - .~~ -. 40-141 : - l 4L ~~ i Nepal:* ~95-> 2925 -> _ T ItRLE FEMLE 17801+ , 1170-74 605-64 1-. i55-59 l^0.i;50-54 , -7 PI, -Ca45-49 , r_._we
40-4
2.5 2.0 1.5 10 0:5 0.0 0.0 0.5 1.0 1.5 2.0 2.5 Population (in millions) urce: U.S. Census Bureau, International Data Base.
7-5-79
N:l 2858 11RLE FEilRLE
1"= 65F749 \t1 14-- , , >60-64 1 &S = ~~~~55-59V f f:'v--~9 1" . 7 50-54-g ** Z - t ltV ,; t?^7 > 4 >45-49 $t'!~
>¢JViFr ^g tu l ' 430-34 '0+ "1 ;;i
Ot - . S ~~~0-14 z >
2 !5 2.0 1.5 1:0 O.:5 O. O O0 0.5 l'0 i.5 2.0 2.5 Population (isn mil lions) ~Souroe: U.S. Census Bureau, Internatioaml Data Base. 158
Annex Nine Tax Treatment of Pensions and Insuiirance
Income Tax
There are only approximately 200,000 tax-payers in Nepal, of which some 131,000 are individuals or partnerships. Total income tax revenue for fiscal year 2000 was NR 7.4 billion, of which approximately 25 percent was paid by individuals and partnerships.
Contributions made to any provident fund are tax exempt.
Income tax rates are as follows:
Individuals
Annual Income Tax Rate
Up to NR 50,000 Exempt (NR 60,000 for couples)
First NR 75,000 thereafter 15 percent
Remaining income 25 percent
FinancialInstitutions
All income 30 percent
Other Corporates and Partnerships
All income 25 percent
Taxation on Distributions
At present, provident fund lump sum distributions are tax exempt up to NR 500,000 (compared to an average EPF distribution of NR 90,000). Above NR 500,000, distributions are taxed at 25 percent. It is proposed under pending tax legislation that in future all provident fund distributions shall be taxed at a rate of 10 percent. There is no limitation to the tax-exempt status of gratuity payments or leave encashment upon leaving employment.
Exemptions
All provident fund contributions up to 10 percent of remuneration are tax exempt for the employee while allowable as an expense for the employer. This exemption also applies to pension and gratuity fund contributions.
Investment in the Citizens Investment Trust of up to 10 percent of remuneration is tax exempt for employees earning less than NR 100,000 per annum. 159
All life insurance premia are tax deductible without limit, subject to the constraint that annual contributions can not be more than 7 percent of the policy value. Contributions made by companies for insurance policies on behalf of employees are tax exempt for the employee while allowable as an expense for the employer.
All income on, and withdrawals of principal from, a provident fund or the Citizens Investment Trust are tax exempt.
Withholding Tax
Tax is withheld at the rate of 6 percent per annum on bank deposits. Interest paid to provident funds, however, is exempt. Tax is also withheld at 6 percent on most government bonds.
For life insurance companies, 5 percent of the amount remaining after meeting risks and liabilities shall be withheld as advance tax offset against the total tax payable by the insurance company.
Dividends paid to Nepali residents are subject to a 10 percent withholding tax (which can be offset against the recipient's tax liability). 160
Annex Ten Recommendations from the Report
1. Macro Monetary Policy, the Central Bank and Overview of Nepal's Financial Sector
(a) Remove direct participation by Nepal Rastra Bank - and the Government - from the financial sector.
(b) NRB should also rapidly move to shed its development banking functions.
(c) Privatization of the banks, occasioned by a withdrawal of the government and NRB from these institutions, should be carried out with the twin objectives of attracting strategic investors who will strengthen the institutions and increasing competition in the financial sector.
(d) Where appropriate, liquidation of bankrupt state-owned banks should also be seriously considered - particularly where successful restructuring appears to be unlikely.
(e) Strengthen the financial legal framework to create less fragmentation, and enhance transparency in the sector.
(f) Undertake a human resource reengineering exercise within NRB - including the implementation of a VRS, complete revision of existing HR policies, and a de- compression of the salary structure - to encourage the development of professionalism within the bank.
(g) Replace the support of rural and micro-credit schemes using directed credit and other mandatory requirements imposed on commercial banks with more targeted and market oriented measures.
(h) Remove restrictions on foreign ownership of commercial banks to encourage the greater transfer of technology and to create enhanced competition.
(i) Establish a second tier supervisory body for micro-finance activities.
0) Introduce internationally acceptable accounting and auditing standards.
(k) Improve the functioning of the Credit Information Bureau to provide more accurate borrower information for financial sector participants.
(I) Close cooperation and collaboration with the main donors will be critical in ensuring that the reforms, based on the NRB's Financial Sector Strategy Statement, issued in 2000, are successfully implemented. 2. Legal Financial Environment
(a) The various acts under formulation need to be enacted as soon as possible, adclressing the issues raised above. They then need to be followed up with proper enforcement.
(b) NRB needs to develop a tiered regulation system in line with international best practices. 161
(c) All development banks must be brought under the purview of the new Banking and Financial Institutions Act.
(d) The Financial Intermediary Societies Act, 1998, should be amended to address the existing flaws that have made it ineffective.
(e) The current insolvency laws need to be strengthened in dealing with both non-corporate bodies and individuals.
(f) As the financial reform process moves forward, and the legal/judicial system starts to deal with a large case load of defaulting borrowers within the banking system - the court system will almost certainly emerge as a significant bottleneck. Hence, a banking bench should be established in the high court to deal exclusively with debt recovery cases related to banks.
(g) Arbitration and alternative dispute resolution mechanisms, to increase legal avenues for loan recovery and banking disputes, should be expanded.
(h) There is a need for improvement in the enforcement of laws. The concept of compounding offences could be considered for improving enforcement.
3. Banking Supervision
(a) Implement and enforce the new regulations (minimum capital requirements, provisioning policy, etc) on the same basis for all banks.
(b) Given the importance of supervision (particularly at this crucial stage when the sector is undergoing significant reform), it is strongly recommended that the NRB utilize the support of experienced external consultants in the enforcement of the new regulations.
(c) Define a program to include an annual review of RBB and NBL and biennial review of all the other banks.
(d) Make inspection reports available one month after the on-site visit has been completed.
(e) Stop rotation of banking supervision staff.
(f) Apply stricter criteria in approving banking licenses.
(g) Make human resource policy changes to include improved definition of criteria for advancing staff with potential, improved staff selection and career planning, and improved systems to facilitate greater knowledge sharing. 4. The Commercial Banking Sector Recommendations for the Government-Established Commercial Banks (a) The management teams for RBB and NBL should be put in place as soon as possible to stem further deterioration of the banks, particularly in light of the weak supervisory capacity of the central bank.
(b) Undue interference in the management team's functioning must be prevented by NRB. 162
(c) Human resource re-engineering must be undertaken employing voluntary retirement schemes - at a fairly early stage. Automation also needs to be significantly enhanced.
(d) Vigorous loan recovery efforts need to begin immediately.
(e) If the banks are to ultimately be privatized (and not liquidated) then the piivatization must include strategic investors that bring value added skills and expertise to the banks.
(f) HMG/N should, however, seriously consider the liquidation option for the two banks - if successful and quick privatization to "fit and proper" owners is not considered a likely outcome.
(g) Close monitoring and supervision must be undertaken by the central bank during this period to ensure that looting is checked and that funds of depositors are protected. Supervision should also check insider and self dealings by opportunists.
Recommendations for the Joint Venture Commercial Banks. (a) The current restrictions on foreign ownership beyond 66 percent should be eliminated. Removing this restriction altogether may help to attract "good name" banks that could bring discipline, know-how, and technological benefits to the Nepalese financial sector.
(b) The government should move away from direct participation in banks. In particular, NRB should withdraw from direct participation in the boards of commercial banks and also disinvest any bank holdings.
(c) The Government should replace the current mandated lending requirements on commercial banks with better directed policies that result in less operating disincentives.
(d) The current policy that requires the establishment of rural branches whenever urban branches are established needs to be reviewed and removed.
(e) Cross holding in banks must be prohibited.
5. The Development Banks
(a) A radical restructuring of the Agricultural Development Bank of Nepal is longv over due. In addition, it is also important to continue pursuing the reforms already initiated and those agreed to with the ADB. As the bank becomes more commercially viable, ADB/N shares could be sold to the general public. To improve performance, professionals from the private sector should be brought into management and board positions.
(b) Current plans to convert and separate the Small Farmer Development Program into an independent institution with participation of private banks is a step in the right direction. Eventually, it should be completely privatized.
(c) The commercial banking activities of ADB/N should be restricted, in particular, the mobilization of retail deposits and the issuing of bank guarantees. Separate accounts for commercial banking should be required which would help in identifying risks within each area of business and assist NRB in regulating the ADB/N. 163
(d) Given the prominence of the ADBIN within the overall banking system - it would be useful for Nepal Rastra Bank to undertake some additional brainstorning on the role and future direction of this institution in conjunction with the ADB, the IMF and the World Bank.
(e) As a first option, the government should try and sell NIDC to private investors already in the business or to new groups interested in this area.
(f) NIDC should immediately cease further lending and deposit taking activities.
(g) The staff of NIDC should focus on collecting non performing loans and the monitoring of the existing portfolio.
(h) In the event that no private parties are interested in acquiring NIDC - it should be liquidated.
(i) Private bond markets are currently non existent in Nepal due to a number of legal and regulatory impediments. Their development would provide an alternate funding avenue for private sector development banks and other financial institutions - as well as assisting industrial development in Nepal. Removing the impediments to the development of such markets should be immediately instigated. 6. The Finance Companies of Nepal
(a) In view of their low capital base and growing competition (in the area of resource mobilization and its allocation), as well as an increasing cost of funds, there needs to be a shake out of the sector - through mergers and acquisitions. Alternatively, some of these companies could enter into joint ventures with foreign partners so as to remain/become efficient and sustainable units. (b) The NRB directives governing these companies need to be reviewed and amended to allow greater flexibility. The regulations could be reviewed to make it attractive for them to operate in semi-urban and rural areas, and in the sub-sectors neglected by other financial institutions, but only after proper supervision is in place. (c) Up-graded NRB supervision will be important. The NRB should initially develop a more robust off-site supervision system, to be followed in time by a reinforcing system of on- site supervision.
(d) The NRB should undertake a complete audit of the finance companies to benchmark their current status as well as to check undesirable practices. 7. Micro Finance
(a) The five GBBs should be immediately restructured. The restructuring should be preceded by an audit of the capital, portfolio and management of these banks by internationally reputed auditors. In addition to identifying the weaknesses of these banks, the audit should also lay down their baseline position. Following the restructuring of the five GBBs, they should be privatized. 164
(b) All micro-finance programs implemented by the government through various agencies should be handed over to private sector MFIs chosen on the basis of their performance and outreach. Any subsidies to micro finance institutions should be explicit and well defined and passed through these private sector operators.
(c) The PAF should be redesigned to focus only on creating economic opportunities in the more inaccessible areas of the hills and mountains. The micro-credit component of the PAF should be removed.
(d) RMDC should make stronger efforts to assist smaller NGOs/MFIs while continuing to provide funds to the larger MFIs.
(e) Targeting of beneficiaries needs to be improved to ensure that subsidized credit is being accessed by the right people, and that misuse through proxy and other practices does not increase.
(f) A two-pronged approach should be taken to expand outreach. For the inaccessible hills and mountains, the supply of micro-credit should be preceded by efforts to increase the opportunities for engaging in productive activities while the outreach in the accessible areas should be increased by employing various methods of credit delivery adapted to local conditions.
(g) The INGOs should redesign their programs and redirect their efforts to assist communities create conditions for the profitable expansion of economic activities prior to the extension of micro-credit in the more inaccessible areas.
(h) The savings and credit co-operatives should have a supervisory body to monitor and oversee their activities.
(i) The Financial Intermediary Societies Act, 1999, should be reviewed by the IRMDC and other stakeholders to determine its usefulness, and their recommendations regarding the future of this Act should be implemented.
(j) NGOs/MFI's have demonstrated ability to reach non-accessible areas ancl also have access to large numbers of clients. Soft loans and grants should continue to ]be provided to these organizations.
(k) Sustainability should be the ultimate aim of any micro finance strengthening strategy. However, given the realities on the ground, this will have to be a medium and long term strategy for Nepal. In the short term, operational subsidization is justified. This should, however, be transparent and channeled through interest rate subsidies rather than provided as loss financing.
(I) The overall regulation and supervision of all micro-credit activities needs to be improved.
(m) Donors need to weave their micro finance support around a commonly agreed strategy.
(n) The taxation of cooperatives should be reviewed so that "real cooperatives" can generate operating surpluses to build up their capital. 165
8. Pension and Retirement Savings Schemes
(a) There is a need for improved supervision and enforcement of mandatory savings schemes in Nepal. These savings schemes (particularly defined contribution schemes that are well managed and invested) can benefit a developing country such as Nepal by providing much needed post-retirement income for the participants as well as being a good source of long term savings for domestic investment.
(b) The EPF should set clear and transparent rules for the investment of its funds. This will reduce scope for abuse, both by government and others.
(c) Close attention should be paid to defined benefit schemes. Actuarial valuations should be conducted annually so that appropriate measures can be taken in anticipation of developments. Proper actuarial valuations should also deter abuse of the schemes.
(d) Attracting international insurance firms would be beneficial to Nepal, as they could bring more products and wider experience in setting proper premiums that would benefit individuals and firms.
(e) The government needs to review its practice of selling bonds and certificates to targeted institutions. Such practices can be distortionary and are undesirable in the long run.
(f) The constraints on international investment by contractual savings institutions should be reconsidered in light of the absence of risk diversification and domestic investment opportunities.
(g) The EPF needs to ensure that the interests of the beneficiaries are not being subordinated to govemment interests. The EPF should also ensure that plan beneficiaries receive regular information on their accounts.
(h) The insurance firms should produce their annual accounts in a timely manner.
(i) A review should be carried out of the National Insurance Corporation to ensure that it is running on commercial and financially sound lines. 9. Capital Market Development in Nepal
(a) Accounting standards need to be improved in Nepal so that they rapidly approach internationally acceptable norms. Any company not using International Accounting Standards should not be permitted to list on the NEPSE.
* (b) Other listing requirements for the NEPSE should also be tightened such that they approach the norms generally applied in other more developed markets - within a short period of time. This is important to restore investor confidence in the stock market.
(c) Any company not meeting the minimum requirements of the Nepal Stock Exchange should be de-listed. This would include many companies currently listed on the exchange.
(d) A Corporate Governance Code should be approved in Nepal. 166
(e) The use of mutual funds should be encouraged so that more Nepalese could benefit from market activity - while permitting an increase in the minimum number of shares traded.
(f) The Government should be encouraged to trade bonds on the stock exchange.
(g) Insurance, pension and provident funds should be permitted to invest beyond the banking and financial sectors. They are currently helping to "powere the trade in this sector - to the detriment of other sectors. This should NOT be permitted to happen, however, until the above listing and accounting changes have been made.
(h) There is urgent need to effect reform in the commercial banking sector - so that any fall out from the sector will not have a negative impact upon capital market development in the future.
(i) The government needs to seriously address issues related to the poor business environment in Nepal in an effort to encourage rapid increases in both domestic and foreign direct investment.