Nepal's licence to bank

Chiranjivi Nepal, who took over as governor of Nepal Rastra Bank in 2015

For a poor country with a tiny economy, however it is measured, Nepal certainly has a lot of banks and financial institutions.

By some estimates there are as many as 250 financial institutions of some description, including remittance houses, licensed under Kathmandu’s central Nepal Rastra Bank. 

In one of Asia’s poorest countries, which has had 15 prime ministers and six central bank governors in the last 15 years, and where the state struggles for adequate capacity in its official institutions, that means the already stretched central bank has 250 separate corporate entities to regulate.

At its last update in March this year, Nepal Rastra Bank had licensed 28 so-called Class A commercial banks to operate in the country. 

Even that might seem more than enough for an economy that generated just $24 billion in gross domestic product last year. Zambia and Papua New Guinea, economies of a similar size, get by with just 19 and four licensed commercial banks respectively. And middle-income Malaysia, with an economy almost 10 times the size of Nepal’s, has a more-realistic 27 licensed commercial banks.

Many of Nepal’s senior bankers admit the country is overbanked.

“There are far too many banks here, unfortunately,” says Anil Keshary Shah, officiating chief executive of Nabil Bank. “The Rastra Bank felt: ‘No, the more the merrier, because it will enhance competition’.”

At Himalayan Bank, one of Nepal’s biggest, privately owned commercial banks, in which HBL of Pakistan is a 20% shareholder, chief executive Ashoke Shumsher Rana agrees.

“There’s too many financial institutions,” he says. “Even at the top tier of 28 banks, there’s too many.” Rana thinks just 10 to 15 main banks would more than suffice in this market.

Yet that’s not even the half of it. The central bank has licensed 36 Class B development banks to service 30 million Nepalis – 60% of whom are designated as unbanked – and 25 Class C finance companies. In addition, there are 63 microfinance banks, and if that were not enough financial institutions, the central bank lists a further 14 credit cooperatives, 25 licensed non-government organizations and 10 companies that defy bureaucratic description and which are gathered into a basket labelled ‘other institutions,’ most of which seem to be hire-purchase providers. 

That still doesn’t include the 49 firms licensed by the central bank to operate in Nepal’s near-$7 billion-a-year remittance sector, the biggest single contributor to its GDP.

You would be forgiven for thinking that a thorough consolidation of Nepal’s banking and finance sector by the central bank must be long overdue. After all, both the World Bank and the IMF have repeatedly advised Nepal to cut the number of banks and strengthen its financial licensing regime.

It’s already happened, says Chiranjivi Nepal, who took over as governor of Nepal Rastra Bank in 2015.

“Many banks have merged,” he tells Asiamoney. “When I came here there were almost 300 banks and financial institutions.”

By his reckoning, 158 banks and financial institutions have been subsumed by other banks in the last three years, after he raised statutory capital requirements across the sector in order to weed out the weak. 

“I asked them to increase their paid-up capital within two years,” he says, with evident satisfaction, adding that there are 150 banks and financial institutions registered with his central bank, less than the 201 that the bank’s own official site lists.

But isn’t there a need for further consolidation, or perhaps another capital increase to weed out even more also-rans?

“No, now is not the time,” the governor says. “It is very hard. You need the support from the government.”

And with so many unbanked Nepalis, “we need banks in every corner of the country,” he says. “You don’t know the depth of the economy. This is a growing economy; our GDP is under-estimated…it’s more than $30 billion.” 

One reason for the proliferation of financial houses in Nepal is politics. In late 2007, after a long civil war, Nepal abolished its monarchy to become a federal republic. Communists, both Maoist and Marxist-Leninist in ideological orientation, have led seven of the 10 governments since then, including prime minister Khadga Prasad Oli’s current administration. They have divided the country into an unwieldy 753 local municipalities, the new federal bureaucracy demanding a bank presence of some description in each of them, ostensibly to aid development.

“A bank has to be open (present) in 753 units, in each corner of the country,” says governor Nepal.

The result is an oft-heard mantra among Kathmandu bankers who complain that they are obliged to open and run unprofitable branches in far-flung locations.

“They have to do it for the nation,” governor Nepal insists. “As part of their corporate and social responsibility they have to go there (so) people can become more conscious about the financial sector. This is an opportunity for them. I tell them you have to go otherwise we will send you there forcefully. It’s their national duty, of course.”

Asked how independent he is, the governor laughs, and points out that he is now serving in a government that has had five prime ministers during his three years at the central bank. He says he has a good relationship with the finance minister, “but it doesn’t mean I do everything he says.”

Nepal is one of the most remittance-dependent economies in the world. Households receive nearly $7 billion a year from the Nepali diaspora, working, for example, in the Gulf and southeast Asia; that is equivalent to about a quarter of GDP.

Remittances are not only crucial for keeping the economy afloat but also for the central bank to build reserves. Governor Nepal says the bank has reserves of almost $10 billion, which would cover imports for around 10 or 11 months, and $2 billion more than when he joined.

Queues to collect remittances from abroad

He insists that the country’s banking system is healthy and he boasts of an industry-wide non-performing loan ratio of less than 3%, which he says is one of the lowest in south Asia. 

He assures Asiamoney that he has enough qualified staff to regulate Nepal’s financial sector, detailing plans to add another 300 employees to the central bank’s current headcount of 1,150.

Shah at Nabil Bank agrees that the central bank has the capacity to adequately regulate Nepal’s top tier and development banks. But he has concerns for the “totally unregulated” lower layers of Nepal’s financial system.

“They have no AML (anti-money laundering) and KYC (know-your-customer) rules,” Shah says. The Class A banks are very strict on AML and KYC regulations, but the “playing field is not level,” he adds.

“Our fear is that if there’s a problem in any financial institution, people will say: ‘Oh my god! I want to take my money out’,” Shah says. “No bank can sustain 10% to 15% of deposits going out the gate.”

Nepal saw an example of systemic choking in December when Axiata – the Malaysian government-controlled telco that owns Nepal’s leading mobile carrier Ncell – received court approval to repatriate to Malaysia around 10% of the $660 million it had accrued in profits since 2013.

As Axiata withdrew funds from accounts across a range of banks, governor Nepal admits that “liquidity became a bit tight for one or two banks… and we helped.”

Local press reports of the crisis describe a rather more pressing drama, as banks were forced to ratchet up fixed deposit rates from 8% to 13% to attract cash lest they breach central bank capital adequacy levels.

Rana at Himalayan Bank says Nepal’s liquidity pinches are partly a result of stricter central bank regulations on handling cash. That has discouraged banks’ deposit growth as credit demand surges, leading to periodic liquidity shortages. 

Other bankers say problems such as the December liquidity choke reflect what they charitably describe as “policy misalignment” in government. One banker described it as “the left hand not knowing what the right hand is doing.”

Malaysia’s purchase of Ncell in 2015 for $1.36 billion was the biggest business deal in Nepali history. In the government’s eagerness – one banker described it as desperation – to attract foreign investment, authorities make policy on the hoof to placate investors, without making the much-need reforms necessary in an under-developed financial system.

Governor Nepal admits as much, but points the finger at banks’ management. 

“When you ask for foreign direct investment, the rules and regulations allow (profit) repatriation. But in Nepal, it’s a bit different, and this is the problem with the [local] banking sector,” he says. “When you start regulating them, give them new directives and new policy, they say: ‘Look, we are a less-developed country, we can’t do all these things, we can’t move ahead like this, we can’t do these rules, FATF (Financial Action Task Force), KYC, IFRS (International Financial Reporting Standards)…we have traditional ways, we can’t do this, we need time’…This is the problem with these people. 

“When you talk with them, (they have) very big talk, (but they are) always complaining. Definitely. They always blame us, we can’t satisfy the people, this is the situation.”

Like many Nepali government officials, governor Nepal studied in India, securing a PhD from Banaras Hindu University in Varanasi, and studied for a time at Charles Sturt University in the Australian outback town of Wagga Wagga.

As a long-time economics lecturer at Kathmandu’s Tribhuvan University, he has also advised the prime minister’s department and was chief economic adviser to the finance ministry. During the mid 2000s, he was chairman of the Securities Board of Nepal, regulating the stock exchange. He says he modernized Nepal’s securities market.

A month after he became governor, the country was struck by a massive earthquake, which killed almost 9,000 people and made 3.5 million homeless. The tragedy, Nepal’s worst natural disaster in 80 years, provided the governor with his most memorable moment while running the central bank.

“The very next day, we asked banks to open their accounts wherever they were,” he recalls. What was remarkable, governor Nepal says, was that in the month after the earthquake, deposits into the banking system rose by around $460 million.

“Everywhere was demolished but people’s trust (in banks) went up.” 

He believes that security was a big factor, because after so many homes and buildings were demolished, people knew their rescued savings would be safer in a bank, away from the looters. 

“We instructed banks to open, if people wanted to take money or deposit money, let them do it,” he says. “And all the banks were open. Usually it takes months and years to open banks in other places (that have suffered disasters). It was fantastic. We are a good example to others.”

The governor has had plenty of other problems to tackle on his watch.

Nepal is one of only two countries – the other is Bhutan – to peg its currency to India’s rupee. 

Nepal Rastra Bank maintains a peg of 160 Nepalese rupees to 100 rupees: that level has been in place since 1994 when it was adjusted from 145. India is Nepal’s biggest commercial partner and its currency has been widely accepted in Nepal for many years, particularly among traders along the border areas. It has also traditionally been a stored-value savings instrument for Nepalis.

But that familiarity led to problems between the two traditional allies with India’s demonetization of its 500-rupee and 1,000-rupee notes in 2016. Thousands of Nepali individuals and traders had built up stockpiles of Indian rupees, which were reportedly worth around $150 million – but which some estimates have put as high as $1 billion.

Nepal’s new finance minister, Dr Yuba Raj Khatiwada, and the central bank governor have embarked on thorny negotiations with the Indian authorities to persuade Delhi to make good on exchanging the hangover Indian notes held by Nepalis.

As for the Nepalese rupee, the governor says he can see a time when it may float free, but only after Kathmandu’s large trade imbalance with India is corrected and diversified. 

But that may be some time away: Nepal has long borne a very large trade deficit with its regional superpower neighbour to the south, accounting for 66% of its international trade.

Nepal’s official Trade and Export Promotion Centre tallied that in the nine months to March 31 this year, Nepal imported goods worth NRs576 billion ($5.3 billion) from India while exporting just NRs34.2 billion to India. 

Bankers say one move that would fortify the economy is the awarding of a sovereign credit rating, which would raise Nepal’s international profile, help bring down borrowing costs and make the market more efficient.

Of the eight members of the South Asian Association for Regional Cooperation grouping, Nepal is one of three – and the largest – member economies without a sovereign credit rating (the other two are Afghanistan and Bhutan).

Joseph Silvanus, chief executive of Standard Chartered’s operation in Nepal, says it is high time that changed.

“The government of Nepal should study the emerging situation, assess horizon risks and decide the appropriate time and approach to commence the process of getting a sovereign credit rating.”