Financial sector liberalisation, partially initiated in mid-1980s, is being pursued vigorously with aggressive policies. It has gone hand in hand with a sharp increase in the number of new urban centres since the economic liberalisation of 1990s. The substantial increase in the number of transactions in the financial sector, a direct impact of liberalisation, has been continuing in the urban centres, even during conflict owing to migration and inflow of remittance.

The mushrooming growth in the number of new financial establishments shows the urban concentration, whereas closing and merging of the rural branch offices of big banks reveals the effects of conflict in these areas. It is natural that the Nepali financial sector is urban-centric despite pro-rural policy. The difficulty of financial service accessibility in rural areas hints that restoration of peace will not suffice for these centres to grow. It rather calls for positive discrimination for pro-rural approach, with flexible and micro finance cooperative mechanism, backed by independent and prudent regulation and supervision.

Surprisingly, empirically well-established feedback relationship of cause and effect between economic growth and financial sector development, respectively, could not be validated in Nepal, where the financial sector’s booming growth can be, in large measures, attributed to sluggish economic growth.

Given the capital base, among other factors, bank/financial institutions are easier to establish and operate in comparison to other institutions. But, it is difficult to measure the saturation of the banks and financial institutions that fulfil the mandatory norms and conditions for their establishment. The potential size of the economy can be used as a better proxy to estimate the tentative size of financial sector.

The beauty of liberal economic regime is that individuals/groups are free to enter

the market if there is room for higher return. Nonetheless, the option of free exit may not be easily available as compared to other sectors since the financial sector deals with public deposits. Mergers and acquisitions are the types of exits in financial sector. However, they might not be applicable due to the problems of matching and marking.

Looking at the mounting performance based on non-performing asset levels of banks/financial institutions, among other bodies, it is difficult to expect fast recovery of bad loans despite window dressing through mandatory book write off and lack of support of Asset Management Company. Similarly, the seizure of the collaterals of big defaulters has not been easy due to physical hassles and threats from them. The Debt Recovery Tribunal is an ideal concept for recovering the debts. But because of lack of competent and sufficient manpower and resources, the actual recovery is difficult.

Moreover, one can easily imagine the likely consequences of WTO commitment by the year 2010, if foreign banks with their proven track record of maintaining spread rate of about two per cent enter Nepal. It might prove to be a big challenge not only for the banks/financial institutions that have struggled to maintain the weighted average spread rate of 5-6 per cent, but also for their regulators and planners.

Given the improved capital base, among other factors, more and more new banks/financial institutions are being opened, an early signal to review the criteria for urban-centric banks/financial institutions.

A cursory survey of the financial markets reveals that most of the big borrowers have either defaulted or the banks/financial institutions have had to attract the genuine ones by offering lower interest rates, exempting service/processing charges, along with offering efficient and quality services. The increased tendency of swapping either the loans between banks or the repayments of loans through loan from other banks, obviously at lower rate(s), clearly indicates the unsound mentality of the borrowers.

Since the historically low interest rate cannot be sustained for a long time, one can easily foresee how the urban financial system with high spread rate — and if the remittance flows back to rural areas — will compete with the more efficient ones. The takeovers and mergers, if they become endemic practices, will make it difficult to manage financial sector prudentially. Moreover, light actions taken against the culpable bank(s) by the regulator (as has happened in the recent past) might lead to a serious moral hazard.

It is time for rigorous review of the urban sector finance system in order to make it competitive and at par with the international level. Along with this, stern actions should be taken against the wrongdoers. The existing rural financial model is difficult to implement in areas where people have barely enough to survive. With the likely restoration of peace, a viable rural financial model is essential for the stability of peace and national development.

Dr Paudel is a member of RBB Board