Financial sector reform:Pitfalls of partial adoption

Financial sector reform is a continuous process of moving towards liberal regime from a directed and control regime. Nepal adopted a partial liberal policy in the banking sector in particular and overall financial sector in general during the mid-1980s, which was further widened throughout the1990s. Such efforts include opening up of financial institutions, deregulation of interest rates, withdrawal of statutory liquidity requirement, prudent regulation and supervision, strengthening prudential measures towards international standard together with adoption of Basel core principles, phasing out of directed credit, operational autonomy to management of banks/ financial institutions, etc., resulting in fast numerical growth in the financial sector.

Obviously, the banking sector within the financial sector and the public sector banks within the banking sector have been more problematic because of aging factors, inappropriate operational procedure, mismanagement and imprudent credit policy decisions. This situation has raised questions about the efficiency of the regulatory and supervisory role of the Nepal Rastra Bank (NRB). It is but natural that NRB should also be made accountable looking at the theme of regulation and supervision philosophy and the practice in other countries. The financial sector reform programme (FSRP) was the outcome of a study of KPMG, an International Auditors’ Group, in 2000, which was an extension of the study of National Auditors in 1999 under the reconciliation project of NRB. The major findings were negative net worth and technically insolvent position of the two big banks namely Rastriya Banijya Bank (RBB) and Nepal Bank Ltd.(NBL) with more than half of the total banking assets and dominating shares in the branch network.

Nepal persuaded the World Bank to finance a comprehensive FSRP. In response, World Bank through IDA window together with the support of DFID approved a two- phase financial sector technical assistance project (FSTAP) in 2003 with a closing date of 2007 and in 2004 with a closing date of 2009. The cost for first and second phases has been funded by IDA credit ($ 16 million), DFID grant ($ 10 million) and government grant ($ 4.1 million), and IDA credit ($68.5 million) and IDA grant assistance ($7 million) respectively, which amount to the total cost to $105.6 million (currently equivalent to Rs.7800 million), thus adding more than Rs. 300 per capita debt burden to the Nepalis at the cost of inefficiency of those banks. The overall assistance has been used for covering the cost of management contracts of RBB and NBL together with reengineering of NRB and capacity building of the financial system. NBL and RBB have been contracted to foreign management since 2002 and 2003 respectively. However, the performance of both banks has remained unsatisfactory. Judging in terms of cost, there has been no concrete revelation except to renew the contract to please a donor agency. It is a fact that the high remuneration not only to foreigners but also to local ‘experts’ has been creating obstacles to the employees’ efficiency. Despite reforms in the regulations, prudential norms and structural setting, irresponsible and ill-intended impulse responses of the authorities are against the spirit of FSRP.

The establishment of Asset Management Company (AMC) for dealing with the NPA as a precondition for reform was rigorously exercised prior to the implementation of FSRP. The AMC has been successfully practiced in many countries as the core of reform agenda which is yet to materialise in Nepal, which raises doubts about the authorities’ intention to make the programme successful. The time has been delayed for creating a conducive environment and for evaluating cost. The donor agencies’ intention is obvious because they are not aggressive enough to enhance the programme’s effectiveness. Similarly, it is ridiculous that the action against willful defaulters as recommended by Shankar Sharma Committee has been shelved, though the apex authority time and again endorsed implementation. Similarly, it is dubious why NRB has been continuing a compulsory TSA for national level commercial banks. There is need to honour civil rights and expertise.

Lastly, NRB should be more professional in reengineering and capacity building. The NRB and World Bank had agreed about ways to deal with overstaffing. Had the voluntary retirement scheme (VRS) been targeted in reducing officer/supporting staff ratio to the ideal size of 1:2, NRB would not have to face the structural problems and depletion of professional manpower through its repeated non-targeted VRS against the spirit of the reform agenda. The scheme benefited VRS employees but who would take the responsibility for increased short and long-term liability obligations of NRB at the cost of early retirement. How will the alternate measures work in the Nepali context as suggested by donors in recruiting high calibre professionals? It is a matter of ‘wait and see’.

Dr Paudel is ex-economic advisor, NRB