Fine-tuning our finances

Fine-tuning our finances
The KTP, 27-Oct-10
Rewat Bahadur Karki

Since the middle of 1980’s, Nepal, as a part of its partial liberalisation policy, started opening up its banking/financial sector (FS). Following the restoration of democratic system in 1990, a more reform-oriented policy of financial liberalisation was adopted. Since then the Nepali financial sector has witnessed rapid development. Up until 1985, there were only eight banks and financial institutions (BFIs), comprising two commercial banks, two development banks and four other financial institutions. This number went up to 15 in 1990 and after that it has steadily increased, reaching 292 by mid-July in 2010. Of the total, 263 BFIs including 27 commercial banks, 79 development banks, 79 finance companies and 18 microfinance banks are regulated by Nepal Rastra Bank (NRB), while 29 financial institutions including 25 insurance companies are regulated by the Insurance Committee, the Securities Board and the government. In recent years, ratio of total BFI assets to gross domestic product (GDP) has exceeded more than 120 percent while total deposits and credit to GDP ratio too has increased accordingly.

Nevertheless, such a high concentration of BFIs in a small economy with a GDP of Rs. 1,200 billion poses a major threat to financial stability. This is so because most of the money is now in non-productive sectors including real estate, accounting and auditing systems are weak and unreliable, the supervisory capacity of NRB has been undermined and the much-vaunted financial sector reform (FSR) has been clouded in uncertainties. Thus, crafting a stable, modern and reliable financial sector is a major challenge. But there are steps that can be taken to strengthen the sector. The first of the four steps I propose is merger and acquisition, or, in other words, unification of most BFIs, so that the number of BFIs is manageable and the financial sector is strong. Although NRB has for the

last couple of years talked up this option frequently while announcing its monetary policy, virtually no progress has been done on this front. A separate merger and acquisition act providing special tax breaks and other benefits has to be brought into effect, as in Malaysia and the Philippines in the 1990’s, where merger and acquisition policies were quite effective in bringing down and consolidating the number of commercial banks.

The process of financial sector reform in two major public banks—the Nepal Bank Limited and the Rastriya Banijya Bank—including restructuring of NRB and capacity enhancement of financial sector started in 2002. But the process has been halted as NRB cancelled the appointment process of CEOs of these two banks. Due to this cancellation, DFID and the World Bank, which were providing technical and financial support from the very beginning of FSR, have withdrawn their support from this process. These two banks are now being run on an ad hoc basis. In order to restructure or privatise the banks, the appointment of bank restructuring advisor is crucial, but the process has already been delayed. The reform process of these banks which have an important role in the Nepali economy has to be expedited without delay. In order to consolidate the progress made by these banks so far and further the reform process, it is important that they be studied and evaluated by international audit firms. Similarly, undue political interference and appointment of non-professionals in the BFIs has to stop for smooth functioning of the financial sector. This is my second suggestion.

My third suggestion is strengthening the accounting and auditing standards of BFIs. Although attempts have been made to improve BFI accounting and auditing standards, these have not met international standards and reliability mainly due to weak supervisory capacity of NRB and ineffectiveness of the government accounting and auditing boards. Questions are frequently raised about the reliability of financial and disclosure statements of BFIs. Strengthening these standards is a must to restore the credibility of the banks and financial institutions. The current system which deputes the same auditors to the BFIs for three consecutive years has rendered this system weak and unreliable. Discontinuity of year-on-year auditing by the same auditor will help issuance of real and reliable auditing reports. In order to enact this reform, the auditing and accounting boards have to be strengthened and their supervisory capacity enhanced.

My fourth suggestion concerns the supervisory capacity of NRB. The number of BFIs has increased tremendously but as the supervisory capacity of the central bank has not been enhanced accordingly. Along with the other major functions of central bank such as regulating the BFIs, managing foreign exchange and domestic currency, and advising the government, NRB’s supervisory role has also been given special importance but this role has been rather politicised too. The two supervisory departments of NRB have been rendered virtually ineffective because of frequently transfers of officials and excessive politicisation. Hence, it would be wise to set up a financial supervisory authority (FSA) including these two supervisory departments, following in the footsteps of countries like South Korea, UK, Sweden and other Scandinavian countries. As this body would specialise on supervision, there would be proper check and balance as regulatory and supervisory institutions will be separate and independent .The poorly supervised large government institutions like Employee Provident Fund and Citizen Investment Trust then can be surpervised by the FSA.

Urgent attention is needed be strengthen the financial sector through merger and acquisition, speeding up the financial sector reform, standardisation of auditing, and establishment of an independent supervisory authority. This approach will ultimately strengthen and stabilise the financial sector in particular and the economy in general.

Karki is former economic advisor to IMF and NRB as well as ex-CEO of Nepal Stock Exchange