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Improving Corporate Governance in Nepalese Financial Institutions to Promote Growth and Performance A thesis submitted in fulfilment of the requirements for the degree of Doctor of Philosophy in Finance at The University of Waikato by SANJEEV ACHARYA 2018 Abstract This study investigates the impact of corporate governance practices on the performance of commercial banks in Nepal. Specifically, the analysis focuses on the relationship between corporate governance mechanisms and financial performance. It explores the influence of corporate governance policies, guidelines and directives issued by the central bank, Nepal Rastra Bank, and self-initiatives implemented by the commercial banks. The research undertaken in this thesis is important to stimulate economic growth and to encourage a more equitable sharing of growth. The lack of proper development of corporate governance and monitoring of financial systems results in a failure to capitalise on growth opportunities when they arise. A lack of capital is a major inhibitor to development, and enhanced governance will be a major fillip in promoting investor confidence, leading to a deeper and more efficient capital market in Nepal. There are many untapped opportunities in Nepal and a well-developed capital market will attract more local and foreign investors. An improved capital market will alleviate unemployment, and the balance of payments deficit, help to restrain the brain drain and help foster financial stability, strengthen risk management and ultimately contribute to a strong financial system. A significant portion of Nepalese people, variously estimated to be around 30 per cent, do not have access to formal financial services and rely on informal service providers. There are many providers who take advantage of high interest rates, with financial frauds gaining recurring coverage in the news ii media. These issues are not specific to the informal sector; they also occur in the formal financial sector. There have been several corporate governance failures in Nepali banks including the Nepal Development Bank Limited, the first Commercial Banks of Nepal-Nepal Bank Limited, Nepal Bangladesh Bank, Lumbini Bank, Gurkha Development Bank, United Development Bank, giving rise to demands for greater transparency and accountability in the way banks are controlled and managed. Good corporate governance builds the platform for a smooth, faster, easier and reliable financial system, clarifying responsibilities, fostering transparency and fairness to encourage greater individual accountability. Although various corporate governance mechanisms have evolved in developed countries, their applicability in a low-income country such as Nepal may not be efficacious due to differences in political, cultural, social and economic factors. Hence this thesis addresses the requirement for an evidence-based study that evaluates the best fit corporate governance mechanisms applicable for the Nepalese banking sector. Panel data were collected from all commercial banks’ annual reports, central bank reports and world development indicators. The time period for the study commences in 2003, after the period of Maoist insurgency, and ends in 2012, prior to the devastating earthquake. The analysis proceeds using quantile regression, which is appropriate given the distributional properties of the data. This thesis contributes to the existing literature of corporate governance and bank performance in several ways. First, it contributes with a precis of how iii corporate governance developed in Nepal during severe political turmoil, including civil wars. Second, the method used is more robust than approaches reported in prior research and the careful diagnostics potentially provide useful guidance for other low-income country studies. Third, the present study recommends possibilities to improve corporate governance practices of financial institutions in Nepal by formulating good policies, processes and robust regulatory and supervisory systems. These improvements will ultimately lead to strengthening institutional structures, which in turn will foster various opportunities for sustainable development, not only in the banking sector but the economy as a whole. The findings indicate that corporate governance does affect the financial performance of commercial banks in Nepal. The results indicate that corporate governance structures, e.g., board size, existence of CFO, percentage of minority directors and the percentage of female directors have statistically positive effects on performance, while the percentage of external directors has a negative impact on bank performance. The findings from this study provide guidance to assist with policy formulation by highlighting the key areas that foster good governance, which in turn can improve the financial performance of the Nepali banks. The formulation and implementation of laws, regulations and policies by the government and central bank will enhance financial capability, reduce banking failures and build trust amongst depositors to help and develop more sustainable sources of financing. iv Acknowledgements I would like to express my sincere gratitude to my chief supervisor Professor Stuart Locke, who has been a tremendous mentor for me. I would like to thank him for encouraging my research and for encouraging me to grow as a researcher. His advice on both my research and career has been invaluable. I would especially like to thank my co-supervisor Dr Geeta Duppati for her helpful comments and detailed feedback. I could not have imagined having a better advisor and mentor for my PhD study. I am thankful to Dr Nirosha Hew Wellalage for guiding me with her knowledge and expertise in econometrics and STATA. Her comments and suggestions were invaluable in improving the quality of my thesis My sincere thanks to the Finance staff and postgraduate students from the School of Accounting, Finance and Economics, Faculty of Management, University of Waikato for their comments and suggestions at seminars and their collegial support. I thank our Administrator Ms. Denise Martin who organised the research facilities and assisted me with the practical things that make becoming a PhD so much easier. The support of Mr Clive Wilkinson, Management Librarian, is acknowledged with much gratitude for his prompt and patient support over a range of thesis-related issues, including database access, formatting, referencing and more. My proof reader Jennifer Buckle and Alison Robertson v painstakingly guided me in the many subtleties of English appropriate for a thesis. Special thanks to my family. Words cannot express how grateful I am to my father Professor Ram Chandra Acharya without whose motivation I would not have commenced a PhD. He is the best father, supporting me through the ups and downs of my life as a PhD student. I am similarly blessed by my mother Sita Devi Acharya for her care and concern across the geographical distances that separate us. Her prayers for me have sustained me this far. I would also like to acknowledge my siblings Sama Acharya and Dr Samir Acharya for all the motivation, support and sacrifices they made for me. It is appreciated. I would also like to thank my beloved wife Pratiksha Nepal Acharya for supporting me in everything, and especially through those sleepless nights she spent with me in my office. I can’t thank her enough for encouraging me throughout this experience. Similarly, I would also like to acknowledge the support of my local guardian, my brother Chandra Sharma for his guidance throughout my PhD journey. Finally, I thank my God Shiva, for keeping me safe and encouraged through the many travails of research and writing. Your guidance day by day brought me so far and I will keep trusting you with my future. Thank you. vi Table of Contents Title page Abstract ................................................................................................................................................ii Acknowledgements ........................................................................................................................ v List of Figures ................................................................................................................................. xv List of Tables ................................................................................................................................. xvi List of Abbreviations .............................................................................................................. xviii 1. Chapter One ..............................................................................................................................1 1.1 Introduction ....................................................................................................................1