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Sunday, January 23, 2011

COMMERCIAL BANKING IN NEPAL

History of Nepalese banking system
The initiation of formal banking system in Nepal commenced with the establishment in 1937 of Nepal Bank Limited (NBL), the first Nepalese commercial bank.The oldest bank of Nepal, Nepal Bank Ltd (NBL) was inaugurated by Late King Tribhuvan Bir Bikaram Shah Dev on 1994 B.S. Kartik 30, Monday 5:15 pm (1938 A.D.). NBL's authorized capital was Rs. 10 million (1 crore) & issued capital Rs. 2.5 million (25 lakh) of which paid-up capital Rs. 842 thousand with 10 shareholders, most of them Ranas. Out of 25000 equity shares of Rs.100 face value, 40% was subscribed by the government & balance was offered for sale to the private sector. The preliminary expenses of Rs.20,000 was occurred. The total deposit in the first year was Rs.17,02,025 divided into current account Rs.12,98,898, fixed account Rs.3,88,964 & saving account Rs.14,163. The total assets at the end of the first year was Rs.28,40,000 with net profit of Rs. 99,000 & the loan disbursed & outstanding at the end of the first year was Rs.19,85,000.There were only 12 employees & the first director was Commanding General Bahadur Shumsher Jung Bahadur Rana(1994/7/30-1996/3/25). The first chief manager was, Mr. Thakur Singh Kathayat.The logo of the bank was prepared by Late Balkrishan Sama. The first branch of NBL was Kathmandu Banking Office.
The country’s central bank, Nepal Rastra Bank (NRB) was established in 1956 by Act of 1955, after nearly two decades of NBL having been in existence. A decade after the establishment of NRB, Rastriya Banijya Bank (RBB), a commercial bank under the ownership of Government of Nepal (G/N) was established. Thereafter, G/N adopted open and liberalized policies in the mid 1980s reflected by the structural adjustment process, which included privatization, tariff adjustments, liberalization of industrial licensing, easing of terms of foreign investment and more liberal trade and foreign exchange regime was initiated. With the adoption of liberalization policy, there has been rapid development of the domestic financial system both in terms of number of financial institutions and as ratio of financial assets to the GDP. As of July 2005, the number of commercial banks has reached 17 and their branches numbered 375. A total of 60 finance companies and other Development Banks and numerous credit cooperatives have also been established. Total financial assets in 2004/2005 reached around 54.09 percent of GDP and the M2/GDP ratio, which shows the financial sector development or financial deepening increased from in 12.4 percent in 1975 to 50.9 percent in 2000.
In the context of banking development, the 1980s saw a major structural change in financial sector policies, regulations and institutional developments. G/N emphasized the role of the private sector for the investment in the financial sector. The financial sector liberalization, started already in the early eighties with the liberalization of the interest rates, encompassed further deregulation of interest rates, relaxation of entry barriers for domestic and foreign banks, restructuring of public sector commercial banks and withdrawal of central bank control over their portfolio management (Acharya et al, 2003). These policies opened the doors for foreigners to enter into banking sector under joint venture. Consequently, the third commercial bank in Nepal, or the first foreign joint venture bank, was set up as Nepal Arab Bank Ltd( now called as NABIL Bank Ltd ). in 1984.
There after, two foreign joint venture banks, Nepal Indosuez Bank Ltd. (now called as Nepal Investment Bank) and Nepal Grindlays Bank Ltd (now called as Standard Chartered Bank Nepal Ltd.) was established in 1986 and 1987 respectively. There after, another 12 commercial banks have been established within the period of 12 years. Nepalese banking system has now a wide geographic reach and institutional diversification. Although, Nepalese financial sector is dynamic, a lot of scope for development of this sector exists. This is because the banking and non-banking sectors have not been able to capture all the potentialities of business till this time. It is evident from the Rural Credit Survey Report that the majority of rural credit is supplied by the unorganized sector at a very high cost – perhaps being at two or three time of the formal sector - suggesting that the financial sector is still in the path of gradual development. Overdue loans and inefficiency of the older and the larger of commercial banks have aggravated and have been made to compete with the new trim banks with no rural operations. Also, the commercial banks, domestic or joint venture have shown little innovation and positive attitude in identifying new areas of saving and investment opportunities.
Existing scenario of banking sector
As mentioned in the previous section, there are 28 commercial banks presently in operation. Among these banks some are established under joint venture with foreign banks while some are fully domestic bank. Out of total commercial banks, 6 commercial banks are with foreign joint venture and 21 are fully domestic banks.
I. Capital Structure of Banks:
The current regulation of NRB prescribes that all the new commercial banks are to be established in Kathmandu at national level should have minimum paid up capital Rs. 1 billion; the existing banks in operation are required to enhance the capital level to Rs. 1 billion by the end of FY 2065/66 BS. For this purpose and objective all the commercial banks have furnished their plans to enhance the level of capital accordingly. In the mean time, there are separate provisions on capital requirements for the national level banks to be operated outside the Kathmandu. Banks to be established out side the Kathmandu valley are required to have a minimum paid up capital of Rs. 250 million.10 The total paid up capital of 17 banks as at July 2005 has reached at Rs 9.423million. The paid up capital of commercial banks operating in Nepal is on an average of Rs. 554 million
II. Banks under Foreign Participation:
All together nine banks were established under foreign participation in Nepal but three of these have divested their stake to Nepalese promoters. Six banks still have foreign joint ventures. The banks operating under foreign participation are NABIL Bank Ltd, Standard Chartered Bank Nepal Ltd, Himalayan Bank Limited, Nepal SBI Bank Ltd, Everest Bank Limited and Nepal Bangladesh Bank Ltd. Initially, Bank of Kathmandu, Nepal Credit and Commerce Bank and Nepal Investment Bank were also established under foreign joint venture.
III. Assets of Banks under Foreign Participation:
The banking asset with the foreign joint venture banks is gradually increasing. As of July 2005, the commercial banks under foreign participation hold 37.54 percent of total banking assets. The deposits and credits are still of greater proportion. Foreign joint venture banks possess 39.65 percent of total deposits and 38.45 percent of total credit of the banking system.
Existing rules and regulations relating to the banking sector
Followings are the requirements for establishing a new commercial bank in Nepal
I. Regarding Paid up capital Requirements
1. To establish a new commercial bank of national level, the paid up capital of such bank must be at Rs. 1000 million.
2. To have an office in Kathmandu, the bank is required to have either joint venture with foreign banks and financial institutions or a technical service agreement (TSA) at least for three years with such institutions.
3. In general, the share capital of commercial banks will be available for the promoters up to 70 percent and 30 percent to general public. The foreign banks and financial institutions could have a maximum of 75 percent share investment on the commercial banks of national level. In order to provide adequate opportunity for investment to Nepali promoters in National level banks, only 20 percent of total share capital will be made available to general public on the condition that the foreign bank and financial institution are going to acquire 50 percent of total share.
4. Banks that are already in operation and those who have already obtained letter of intent before the enforcement of these provisions have to bring their capital level within seven years, i.e., by 16 July 2009 as per this recently declared provision. In order to increase in the capital such increase should be at a rate of 10 percent per annum at the minimum.
5. Banks to be established with foreign promoters’ participation have also to be registered fulfilling all the legal processes prescribed by the prevalent Nepal laws.
6. To establish the commercial banks in all the places in the kingdom other than in the Kathmandu valley, the paid up capital must be Rs. 250 million. In this case, the commercial banks to be established outside Kathmandu Valley, share investment of promoters and general public should stand at 70 percent and 30 percent respectively.
7. Banks to be established outside Kathmandu Valley could be allowed to operate throughout the kingdom including Kathmandu Valley only on the condition that they have operated satisfactorily at least for a period of three years and they have brought their paid up capital level up to Rs. 1000 million and also fulfilled other prescribed conditions. Unless and until such banks do not get license to operate throughout the kingdom, they will not be allowed to open any office in Kathmandu Valley.
8. Of the total committed share capital, the promoters has to deposit in NRB an amount equal to 20 percent along with the application and another 30 percent at the time of receiving the letter of intent on the interest free basis. The bank should put into operation within one year of receiving the letter of intent. The promoters have to pay fully the remaining balance of committed total share capital before the banks comes into operation. Normally, within 4 months from the date of filing of the application, NRB should give its decision on the establishment of the bank whether it is in favor or against it. If it declines to issue license, it has to inform in writing with reasons to the concern body.
II. Regarding Promoters Qualification
1. Action on the promoters’ application will not be initiated by the Nepal Rasta Bank if it is proved that their collateral has been put on auction by the bank and financial institution as a result of non-payment of loans in the past, who have not cleared such loans or those in the black list of the Credit Information Bureau and five years have not elapsed from the date of removal of their name from such list. The application will be deemed automatically cancelled irrespective of it being on any stage of process of license issuance if the above events are proved.
2. Of the total promoters, one-third should be its Chartered accountants or at least a graduate of Tribhuvan University or recognized institutions with major in economics or accountancy, finance, law, banking or statistics. Likewise, at least 25 percent of promoters group should have the work experience of the bank or financial institution or similar professional experience.
3. An individual, who is already serving as a director in one of the bank and financial institutions licensed by Nepal Rastra Bank, cannot be considered eligible to become the director in other banks or financial institutions.
4. Stockbrokers, market makers, or any individual/institution - involved as an auditor of the bank and institution carrying on financial transactions - cannot be a director.
III. Regarding the Sale of Promoters’ Share
1. Promoter group’s share can be disposed or transferred only on the condition that the bank has been brought in operation, the share allotted to the general public has been floated in the market and after completion of three year from the date it has been registered in the Stock Exchange. Prior to the disposal of such shares, it is mandatory to get approval from the Nepal Rastra Bank.
2. The share allotted to the general public has to be issued and sold within three years from the date the bank has come into operation. Failing to fulfill such provisions, the bank cannot issue bonus share or declare and distribute dividends.
3. Shareholders of the promoters group and their family members cannot have access to loans or facilities from the same institution. For this purpose, the meaning of the family members will comprise of husband, wife, son, daughter, adopted-son, adopted-daughter, father, mother, step-mother and depended brother and sister.
IV. Regarding Branch Expansion Policy
The Commercial banks established with a head office in Kathmandu will initially be authorized to open a main branch office in the Valley and thereafter, they will be authorized to open one more branch in Kathmandu Valley only after they have opened two branches outside Kathmandu Valley.
Existing Supervision relating to the Banking Sector:
Promotion of financial stability, development of safe and efficient payment systems, regulation and supervision of banking and financial system and the promotion of healthy and competitive financial system are some of the objectives of functioning of Nepal Rastra Bank.
To attain the above objectives Section 84 of the Nepal Rastra Bank Act 2002 has entrusted Nepal Rastra Bank with the necessary powers to perform inspection and examination of any commercial banks or obtain necessary information for the purpose of supervision of the commercial banks.
Currently the Bank Supervision Department in Nepal Rastra Bank carries out the function of supervision of all commercial banks in Nepal. Since foreign banks have their presence only in the form of Joint Venture establishments – that is in collaboration with the local entrepreneurs – Nepal Rastra Bank supervises foreign establishes in the same manner as it supervises other local banks. For the purpose of supervision, the department is required to prepare annual supervision plan for onsite examinations as well off site surveillance of the commercial banks. The same is to be approved by the Governor of the Bank.
The Bank Supervision Department carries out both onsite examinations as well as off site surveillance of the commercial banks as per its annual supervision plan.
I. on site Examination
The Bank Supervision Department can carry out onsite examination of commercial banks in Nepal by sending examination team to the commercial banks. Onsite examination can be corporate level inspection covering all aspects of functioning of commercial banks or can be targeted branch level inspection.
The Department also performs follow up of the earlier examination reports by visiting the branches to ensure necessary compliance of the NRB instructions. If information as to functioning of commercial banks against the interest of depositors’ or some serious irregularity is received, the Department can perform special on site examination in such cases. The Bank Supervision Department is required to carry out corporate level examination of all commercial banks at least once in a year as per its annual plan but the gap between two inspections at any time should not exceed two years. As per current policy of the Department, corporate examination of all commercial banks is carried out once in a year. For the guidance of the onsite examination, an “On site inspection manual” is in force. On completion of the onsite examination examiners perform CAMELS rating of the bank which is exclusively used for the supervisory purpose and is not revealed to general public.
II. Off site supervision
Off site supervision is a supplement to the onsite examination and is designed to act as an early warning system to identify banks with potential problems so that appropriate policies and action can be determined. Off site division of the Bank Supervision Department is carried out in a quarterly frequency as well as annual off site review based on the reports and returns submitted by the commercial banks
III. Quarterly offsite review
Off site division reviews performance of all commercial banks on quarterly basis which is submitted to the Governor of Nepal Rastra Bank. Such review involves assessment of the financial information as well as compliance of applicable rules regulations and legal provisions including NRB directives. Based on the review internal rating which is called CAELS Offsite Rating (COR) is also assigned to the banks.
IV. Annual Balance sheet review
The Department’s off site division reviews the balance sheet of the commercial banks at the end of each financial year and issues necessary instructions based on such review; this is then published in their annual report. In the course of such review the auditor’s report, audited financial statements, long form audit report preliminary, audit report and banks reply thereon are studied. Based on the review of above report consisting of the review of financial performance, compliance with Nepal Rastra Banks directives and applicable legal provisions, adverse observations of the auditors and other significant findings is prepared and necessary instructions are issued to the bank thereon.
For the guidance of the offsite surveillance off site supervision manual is in force. Till now there is no difference in the supervision methods used for the banks with foreign investment and other commercial banks.
Foreign bank branch:
The fifth Ministerial Conference at Cancun, Mexico which took place on 10 – 14 September 2003 approved the membership of the Kingdom of Nepal into the World Trade Organization (WTO) on 11 September 2003 (WTO, 2003), with Nepal subsequently becoming the 147th member of the organization on April 23, 2004 (WTO, 2004). Membership in the WTO entails a whole range of commitments along with their implementation time frames.
Presently, Nepal has not yet allowed foreign bank branches in the country and only permits commercial presence by a foreign financial institution – presently this is limited to a maximum equity of 75% (seventy five percent). However, during the course of accession negotiation for membership in WTO and at the request of some WTO members, Nepal has committed to allow foreign bank branches in the context of wholesale banking, only after 1 January 2010 (i.e. the transition period). In the mean time, the new Bank and Financial Institution Ordinance has been enforced from 2004, which has also incorporated a provision under section 4(3) that allows incorporating a bank and financial institution in Nepal, fully owned as a subsidiary of a Foreign Bank or a Financial Institution.
The commitment on WTO for foreign bank branches in Nepal is of particular interest to the Nepal Rastra Bank (NRB) – the central bank of the country—since it touches on the health and stability of the domestic financial system (NRB, 2002). That is, foreign bank branches have a direct impact on the health and stability of the domestic financial system through greater domestic competition in the financial sector from different corners like: financial intermediation in the domestic economy, technological transfer, greater level of service-choices to the consumers, higher levels of financial flows through the access to foreign capital, interlink of domestic financial system with global financial intermediation etc. Further, stability of the domestic financial system is important since it facilitates capital formation and assists in domestic economic growth and development.
Given the above description and necessity, it is essential to forward necessary rules and regulations to maximize the benefits from the commitment of allowing the presence of foreign bank branches in the country.
Commitments to allow the foreign bank branches in Nepal in the context of WTO membership:
During the course of negotiating for accession to WTO, Nepal made commitments for bank branches. However, three aspects are worth mentioning. First, there is a transition period where foreign bank branches are only allowed as of January 1, 2010. Second, entry of financial institutions is limited to a rating of at least “B” by Credit Rating Agency e.g. MOODI, Standard & Poor etc. Lastly, establishment of foreign bank branches are subject to the domestic laws, rules and regulations and terms and conditions of the Nepal Rastra Bank.
Special provision for Foreign Bank or Financial Institution to open their office:
A foreign Bank or Financial Institution desiring to open its office within the Kingdom of Nepal must submit an application to NRB in the form as prescribed along with the fees and particulars as prescribed. The NRB may issue a license to foreign Bank or Financial Institution to carry on financial transaction by allowing them to open a office within the Kingdom of Nepal taking into account the situation of competition existing in the banking sector, the contribution that could be rendered in the Nepalese banking sector and the reputation of such foreign Bank or Financial Institution.
The NRB may specify necessary terms and conditions in the course of granting transaction license and it shall be the duty of the Foreign Bank or Financial Institution to comply with such terms and conditions. The section 34(4) of the ordinance reiterates that the provisions of the ordinance are to be complied by such foreign Bank or Financial Institution. The foreign Bank or Financial Institution, which has been issued license to operate financial transaction by opening its office within the Kingdom of Nepal, can not open another Bank or Financial Institution in Joint Venture within the Kingdom of Nepal. However, the provision for the contact or representative office of any foreign Bank or Financial Institution will be as prescribed by Nepal Rastra Bank.
Conclusion
Financial institutions play an important role in financial intermediation to efficiently allocate scarce funds – this will spurt economic growth and development. That is why the multilateral commitment by the Kingdom of Nepal for allowing foreign (wholesale) bank branches “as of” 1 January 2010 is of great interest to the Nepal Rastra Bank since it will facilitate sustainable economic development of the country. To ensure that the Bank is fully prepared to provide appropriate rules and regulations in this regard, the Bank’s High Level Committee of WTO matters established the interdepartmental taskforce entitled - “Foreign Bank Branches and the Health and Stability of Nepal’s Financial system
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