Banking sector in Nepal

reogma|Banking sector in Nepal
4 mins read

High growth in credits with slow growth in deposits leads to pressure in the liquidity position of the Nepalese banking industry.

It also resulted in unhealthy competition on the interest rate. In order to overcome this problem, the banking industry should focus on the mobilization of rural deposits rather do throat-cut competition.

Definition / Scope

Banking industry is one major part of financial system. The group of Institutions which accept deposits, supply loans, issue guarantees on behalf of its customers, carry out foreign exchange business, remit or transmit amount to different places, purchases, sell or accept treasury bill/bond issued by central bank and doing other activities as prescribed by act is called banking industry.

The banking industry in Nepal is classified in four classes

  • Class A includes the commercial banks
  • Class B includes the development bank
  • Class C includes the finance companies
  • Class D includes micro-finance companies

These all banks are regularized by Bank and Financial Institution Act, 2073. Nepal Rastra Bank, the central bank of Nepal, has a legal authority to monitor, supervise and regulate the industry.

Market Overview

Due to the financial liberalization policy adopted after the mid of 1980s, Nepal observed the proliferation in the number of BFIs in the last couple of decades and the growth has moderated as NRB has imposed moratorium on licensing.

Nepal Rastra Bank stopped issuing new licenses for banking and financial institutions from 2012 and encouraged Banking and Financing Institutions (BFIs) for merger through regulatory easing and tax benefits. The process of merger between BFIs accelerated after NRB directed to increase the paid-up capital requirement through monetary policy in July 2015.

The capital increment plan along with the merger and acquisition policy has induced 162 BFIs to undergo a merger and acquisition process. In this process, the license of 121 institutions has been revoked thereby forming 41 institutions (Monetary Policy for 2018/19). However, the industry has remained concentrated in urban areas.

Market Risks

Mainly there are seven types of risk in the banking industry of Nepal. They are:

  1. Credit Risk
  2. Operation Risk
  3. Liquidity Risk
  4. Market Risk
  5. Interest Rate Risk
  6. Foreign Exchange Risk
  7. Other Risks

In order to the effective management of these risk, the central bank has issued strong directives, which should be strongly followed by all banks. Some major provisions are CCD ratio, CRR, SLR, interest rate corridor, stress testing, Capital adequacy ratio, loan loss provision, priority sector lending, single borrower limit, corporate governance, Basel III adaptation, etc.

Top Market Opportunities

  • Since the central bank and government focus on financial access and inclusion strategies, there is a large opportunity for business expansion.
  • As there is no limit on deposit collection for the commercial bank, the bank can mobilize sufficient deposit and can earn a profit.
  • As the country focuses on economic development and prosperity after the promulgation of the new constitution, there is vital roles and opportunities for banking expansion and earn a profit.
  • Since central bank adopts a liberal policy to mobilize external borrowing by BFIs (25 % of core capital), there is ease to BFIs to manage liquidity profile and overall profitability.
  • Still, about 60 percent of the population is not directly connected in the banking industry, it shows that the banking industry can adopt Blue ocean strategy.

Market Trends

A large part of BFIs lending is concentrated in thirteen sectors. The concentration of lending to a few sectors would expose the bank to credit risk.

The banking industry in Nepal is still behind as expected to lend in the productive sector despite the mandatory provision of lending in agriculture and productive sector to support the economy. The details are shown in the following figure.

Industry Challenges

  • The increased capital base created return pressure on bank management and set a background for aggressive credit growth.
  • High credit growth (because of capital increment) without adequate improvement in the fundamentals of the economy could lead to an unwarranted impact on the assets quality of the banks as well as the general economy.
  • With most of the major business houses of Nepal involved directly in the banking business, there is a lack of clear demarcation between borrowers (members of the business community) and banks, which could give rise to the potential conflict of interest situation.
  • Concentration in an urban area and sometimes unhealthy completion among the banks resulted from the unnecessary fluctuation in the interest rate and arises liquidity problem in the sector.

Regulatory Trends

The banking industry in Nepal is governed by the Bank and Financial Institution Act, 2073 and Nepal Rastra Bank is apex regulatory/supervisory body for this industry. There are strong regulatory rules for the industry in order to ensure good corporate governance and thereby enhance public confidence on and maintain banking and financial stability.

As Bank and Financial Institution Act, 2073, a bank should have a Board of Directors comprising of at least five Directors and not exceeding seven Directors. All functions, duties, and powers that are exercised by the bank, except those function performed by the general meeting, are vested in the Board of Directors.

The term of office of a Directors is of four years in maximum and he/she may be reappointed or re-nominated. The meeting of the Board of Directors has to be at least 12 times in a year and the gap between two meetings should not be more than sixty.

Some major acts related to the banking industry in Nepal are:

  • Bank and Financial Institution Act, 2017
  • Nepal Rastra Bank Act,2002
  • Banking Offence and Punishment Act, 2064
  • Company Act, 2063
  • Money Laundering Prevention Act, 2063

Strategic Conclusion

The banking industry has a dominant role in the financial system of Nepal. There is a significant expansion on the balance sheet of BFIs mainly due to an increase in deposits and credits. Despite the mandatory provision of lending in the productive sector to support the economy, lending is concentrated on a few sectors.

Which may expose the bank to credit risk. The shortage of lending fund compared to deposit in the last two years has pushed interest rate at a higher level.

Which arises the liquidity shortage in the banking industry. However, the higher rate of credit flow (as evidenced by rising CCD ratio), has a positive impact on the profit level of the banks.

Further Reading

Appendix

  • BFIs: Bank and Financial Institutions
  • CCD: Credit to Core Capital and Deposit
  • CRR: Cash Reserve Ratio
  • FY: Fiscal Year
  • NIMs: Net Interest Margins
  • NPA: Non-performance Assets
  • NRB: Nepal Rastra Bank
  • ROA: Return on Assets
  • SLR: Statutory Liquidity Ratio
  • SME: Small and Medium Enterprises

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