Financial sector reform II Privatisation is not a solution

Devendra Pratap Shah

Financial Sector Reform (FSR) was an agenda discussed in the recently concluded pre-consultative meetings of Nepal Development Forum. A well-functioning financial service sector is essential for the country’s sustained economic development and poverty reduction. The existence of a wide and diversified set of sound, well-managed institutions and markets reduces magnitude of financial crisis. However, I am now tempted by relatively narrow but

important considerations on the second phase of FSR, which includes Agricultural Development Bank of Nepal (ADBN). The new package for ADBN’s reform is now reported to have come from Asian Development Bank (ADB). But the prescription has not been made public yet. The World Bank says the reform model is likely to be replicated in ADBN to ensure a consistency of approach.

Despite many accomplishments, ADBN is said to have failed to achieve its own sustainability. ADBN was created during the 1960s and emphasised volume of disbursements rather than quality of lending, low interest rates rather than broad based access to credit, only credit rather than integrated financial services and agricultural production rather than diversified rural activities. Governments of developing countries and donors then believed in such policies to achieve the goals of poverty reduction and income expansion in rural areas. These policies are responsible for deepening financial problems such as accumulation of non-performing assets, higher operating costs and erosion of equity capital. Another reason for such crisis has been attributed to the lack of prudential norms and regulatory standards set by the central bank. Therefore the 1980s witnessed policy changes that dramatically altered the context of banking in general and FSR in particular.

From 1987 to 1996 ADB made sincere efforts for ADBN’s reform. During this period, through provision of technical assistance and with the enforcement of stringent loan covenants, it wanted to transform ADBN from a traditional to a professional and financially viable institution. Though initially certain improvements were made, the trend quickly reversed. Repayment rates were not satisfactory, costs were shooting, default rates were on the rise and problems of liquidity were felt. In substance, ADBN did not transform itself and continued to operate more or less in the same fashion. At the same time, ADB’s Sixth Line of Credit was closed and since then no new one has been in the pipeline. Donors including ADB have started to create alternative institutions to ADBN.

On this foundation, structural reform, therefore, became inevitable. So, in October 1997, a reform programme prepared by the internal management team was introduced. It was not a complete package, but certainly made efforts to address some of the core problems then facing ADBN. This included measures including accounting transparency, concept of responsibility centre, better management of financial indicators, measures to improve portfolio and repayment system and enhanced training capability. There was a need of capital infusion but the government becomes ready for such support only when donor asks it to do so, as it never believed that Nepal could initiate bank reform on its own. So the benefit derived from the reform efforts made by ADBN was not to the extent as expected. The reform package I and II within five years, however, brought about many positive changes as per ADBN’s own study.

Giving due importance to long term viability, its primary goal, unlike commercial banks, even now should not be profit maximisation. Rural finance in Nepal is not exactly commercial banking. The complexities involved in Nepal’s rural finance are not the ones that can be addressed by the foreign management. Their professional skill as consultants, however, is important. No doubt, local management does not automatically deliver. A high level of management autonomy and performance accountability is a key to successful reform. Management autonomy in any organisation is largely determined by its ownership. Under state ownership and the present legal environment, it seems difficult to increase ADBN’s efficiency to a desired level. In view of the overall situation prevailing in the country, its immediate privatisation, however, is not a practical solution.

It seems, therefore, that a better solution could be state ownership with commercial management. This is possible in two ways: Through a management contract with a private firm and by changing the statute for management autonomy to include transparent rules for hiring and firing of chief executive. In Nepal’s context, the first alternative does not look feasible as competent local firms are hardly available and, at the same time, a management contract to a foreign firm cannot be on the agenda as a ‘local context’ is important to ADBN’s governance. In view of the above situation, the second alternative is the choice that requires a reform in ADBN Act. As it has now become clear that ADBN cannot survive with its traditional approach to rural finance, this (reform) should be given serious thought, since the new approach to rural finance suggests a minimalist and market oriented role for the government. However, the foreign management as proposed in Nepal’s FSR II is likely to be disastrous.Shah is former chairman and general manager, ADBN