Regulatory crisis in the Nepalese banking sector

Nepal’s banking sector is heading down a dangerously risky path, not only due to a seasonal and often recurring shortage of loanable funds, but due to a combination of factors ranging from poor regulation and oversight by the authority monetary policy to blatant compromises in corporate governance practices by banks and financial institutions. institutions themselves in their functioning and affairs.

A recent report by the International Monetary Fund (IMF) categorically pointed to the ineffectiveness of the regulatory and supervisory role of the country’s monetary authority, the Nepal Rastra Bank, resulting in a lack of “accurate assessment of the quality banks’ assets and which better reflects the risks”. He also referred to the failure of the central bank to fully implement the first phase of the supervisory information system intended for class A (commercial) banks and move to the second stage and extend it to class B (development banks) and class C (financial companies).

The lack of appropriate data to enable effective (online) supervision and methods for calculating non-performing loans were also detected by the visiting IMF delegation which finalized the IMF Extended Credit Facility (loan) of approximately $396 million in Nepal. Interestingly, fiscal and financial sector stability is one of the three components where the loan amount will be used. Such a loan with a very short repayment period of only three years should ideally have been used in more productive sectors of the economy than in reform type spending.

Regulatory gaps

Over the years, the Nepalese financial sector has grown considerably. According to the latest data from Nepal Rastra Bank, Nepal’s financial system has 27 commercial banks, 17 development banks, 17 finance companies, 67 microfinance financial institutions and one infrastructure development bank under the bank’s supervision radar. central. The number of bank branches excluding those of microfinance institutions is 6,154, or more than 50%. Prompt and efficient supervision of all, especially onsite, is indeed a herculean responsibility for an under-automated supervisor like Nepal Rastra Bank with only 50% officer-level staff among over 1,000 employees.

Apparently, the poor regulatory framework has alarmingly increased the incidences of regulatory arbitrage. These phenomena manifest themselves in different forms. The provisionally reported profit of the 27 commercial banks in the first half of the current financial year topped Rs 33 billion. The annual rate of return on the total paid-up capital of Rs 285 billion of these Class A banks will exceed 25% by the end of the financial year. The only interpretation of these high bank profits, despite the Covid-19 pandemic and the incessant complaints about a liquidity crisis, could be that the regulator of the monetary system, in essence, failed to tame them.

There are larger structural issues blunting the regulatory teeth of the Nepal Rastra Bank. The central bank as a federal entity exercises the sole implementing authority of Schedule 5(5) of the constitution with respect to money and banking, and monetary policy. The central bank currently plays a dual role of monetary authority and regulatory and supervisory authority of the country’s financial system. A monetary authority’s exercise of powers as a central bank independent (from political interference) is unquestionable and in line with global best practice. Whether the central bank of Nepal has positioned and behaved as a fully autonomous institution is, however, another matter altogether, as also indicated in the aforementioned IMF report.

But when it comes to regulatory and supervisory functions, the monetary authority messed up badly and exhibited the “I-control-everything” mentality of the pre-reform era central bankers. Many economies have split the monetary policy function and the regulatory functions and created separate dedicated institutions for each of these two distinct tasks so that monetary authorities can focus more effectively on the central bank’s core functions of targeting the economy. inflation and systemic risk analysis. This practice turns out to be more robust than the previous one, so it is rapidly gaining popularity. But, in Nepal, even a meaningful discussion has not yet started in this direction. The competent authorities seem to ignore this need. At the heart of this inertia is the reluctance of central bank mandarins to relinquish its traditional role as regulator and supervisor (as well).

It is perhaps for this reason that the Nepal Rastra Bank, while updating its laws and regulations after the restructuring of the country into a federal policy, did not even consider creating adequate legal space for provincial governments to collaborate and provide support in its regulatory functions. This would certainly have created more desirable financial governance outcomes.

Banking crisis

Despite the proud claims of industry players as the “most transparent” company in Nepal, mainly due to the fact that they are obliged to publish quarterly provisional balance sheets and reports on stock transactions, the Nepalese banking sector gradually turns into simple wear. cartel – compromising almost every standard of corporate governance. Massive insider lending, complete disregard for apparent conflicts of interest, “rigged” account books and widespread corrupt lending practices, even in private sector banks, are some of the perversions that put the entire financial architecture in imminent danger of collapse.

To cite a burning example, the current loanable funds crisis has been caused not only by the government’s level of capital spending being well below forecast (so far only 15% of the allocation), but also by lending irresponsible from the banks themselves. Their greed is evidenced by the “fantastic” level of profit made by exhausting all lending opportunities beyond self-managing liquidity risks. The true extent of their overexposure to speculative sectors like real estate remains largely unknown, even to the regulator. In the long run, the cumulative result of all of this is bound to be suicidal for the entire industry. When private companies in particular engage in unethical practices as such, the free market economy is defamed through no fault of its own. The regulator and the industry must learn at least some lessons from the crisis that the Nepalese economy has already encountered.

About Alexander Estrada

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