NRB's weak supervisory capacity A case in favour of FSA

DR. REWAT BAHADUR KARKI

After the adoption of partial liberalization of the financial sector in 1985, and its liberalization after the restoration of the democratic system in 1990, the trend for establishing new banks and financial institutions (BFIs) speeded up in Nepal. As a result, BFI number reached 221 including 32 commercial banks, till mid-April 2012. Similarly, the number of branches excluding micro-finance banks (MFBs) rose sharply to 2,265, which served 12 thousand people per branch. However, this is not only quantitative

development but also in terms of its structure, financial products and financial deepening.

The ratio of total assets of BFIs to GDP rose notably to more than 130 per cent during this period from its low level in 1990, increasing its capacity of raising huge domestic resources for investment. Significant developments are noticed in the modern banking services, including ATM, branchless banking, e-banking, ABBS, in addition to inflow of foreign capital and technology in this field. Even the government-owned three public commercial banks have improved and are competing with the private banks after the introduction of financial sector reform (FSR) program.

Nevertheless, this sector is passing ahead through a difficult times. Three

BFIs are already in liquidation process, while four BFIs were declared problematic. The condition of three public banks with negative net worth and high non-performing loan ratio, is still weak.

Likewise, private commercial banks’ performance is also below the satisfactory level and some development banks and finance companies are also not performing, according to the Nepal Rastra Bank (NRB) report. Strong supervisory is a pre-requisite of financial liberalization, but NRB has been issuing license for new BFIs without strengthening its supervisory capacity. New BFIs including commercial banks are coming up despite the postponement, which is inviting financial instability, and adverse effect on the economy.

Efforts were made to enhance NRB’s regulatory and supervisory capacity under its re-engineering in FSR for the last eight years. Regulatory capacity has been increased as NRB is able to issue international regulatory norms, including BASSLE-3. In order to increase supervisory system and capacity, some measures such as preparing updated supervisory manuals for all BFIs, introducing risk-based supervision, issuing guidelines for stress test and establishing four separate departments for different types of BFIs were also taken.

Why could not the supervisory capacity be enhanced despite vigorous efforts? There are six major factors responsible for this: lack of specialization due to unavailability of separate supervisory service; the current transfer within 2-5 years and overall promotion bylaws; supervision has not got special priority among the NRB’s duties as banker and economic advisor to the government, foreign exchange and domestic debt management, regulation and supervision; strong trade unionism; to work in the supervision is still an attractive opportunity; and strong political impact. Thus, specialization in

supervision was not achieved as the employees with the related training

and education in supervision departments are

transferred and promoted to other departments.

As a consequence, there is still a lack of highly skilled manpower in the supervision departments. In order to strengthen this capacity substantially, a separate supervisory service from assistant to executive level as in other countries having no supervisory authority has to be formed similar to the revenue service in the civil service. However, a separate service seems impossible in our context.

There is no doubt that supervision should be modern and of international standard as Nepal has allowed foreign bank branching policy since 2010, and is quite sensitive and high technology-oriented, but its capacity could not be strengthened even after the introduction of the FSR. Thus, instead of strengthening its capacity in NRB, it would be appropriate to establish a separate financial supervisory authority (FSA) like in the UK, Japan, South Korea, Sweden and some other Scandinavian countries. In this connection, the current four supervision departments should be brought into

subsidiary FSA through the legal provision in the NRB Act 2001.

If this reform cannot be made, with the ownership of NRB and the government, a separate FSA has to be set up putting the incumbent four departments by enacting a separate FSA Act. Notwithstanding, special attention has to be given not to make the FSA a white elephant if separate FSA is established without bringing in these departments. If any of these options are followed and adopted for structural change in the supervision arena, not only specialization in the supervision will be achieved but it will also strengthen the financial sector through check and balance of separate regulatory and supervisory authorities. This will ultimately lead to strengthening the Nepalese economy in general.

Dr. Karki is former Economic Advisor to IMF and NRB