Deputy Governor, Nepal Rastra Bank
“Small banks can't withstand even small shocks”
Why did the central bank decide to raise the mandatory minimum paid-up capital for BFIs?
We took the step so that the capital base of banks widens and small shocks and risks do not affect them. We also want banks to be able to finance big projects on their own without having to seek co-financers; when the paid-up capital increases a bank’s single obligor limit (SOL) is also raised. This will enable banks to invest in big projects.
On the other hand, we found that in the SAARC region, Nepali banks have the lowest paid-up capital, even when they have the capacity to raise more capital. For example in India, the minimum paid-up capital required to open a branch is Rs 5 billion; but in Nepal you could open a bank with just Rs 2 billion. When a bank does not have capital, it cannot secure the trust of the people.
Wasn’t the policy introduced to forcefully merge BFIs that cannot increase their capital?
Forceful merger is not the main objective of the policy, but it definitely has helped mergers. If we had wanted forceful mergers, we could have told banks that they would not be allowed to inject new capital. But we haven’t said that. If a bank can find more investment, and comply with the new provisions on its own, we have no problems with that. Those who have the capacity to issue bonus or right shares or further public offerings, they can do so.
There are small BFIs who operate in one or two districts and they are prone to collapsing even when a single borrower defaults. When the borrower defaults, the loan has to be provisioned, and when the loan is provisioned, they fall short on this capital. When this happens, we need to declare the bank as a troubled bank and this triggers a bank run.
As I told you earlier, the main reason we came up with this policy was to make banks resistant to such small shocks.
There are reports that the policy was introduced to diversify the boards of BFIs, and to reduce the dominance of one or two particular groups in particular banks. Is that so?
That could be one of the implications of the policy. But even without the new policy, the central bank had been looking into the matter—take the case of NIC and BoA or NB and NCC.
There have also been reports that the new policy was brought in because of the central bank’s strategy to move towards universal banking.
I was part of a committee that came up with a five-year strategy for the banking sector. In our report, we have envisaged universal banking. Under such a system, banks have a big network. Today we have banks of several categories (A,B,C..), but the work they do is more or less the same. But when we implement universal banking, the categories will no longer exist. The banks will have their specialised area of operation; they will also work in areas other than their specialisation area, but their focus will be on their specialisation area.
When we implement universal banking, the banks may not be able to reach every nook and corner of the country, but they will cater to the needs of big industrial houses. We will have micro finance, regulated by a different entity, to work on financial inclusion.
There may be doubt that the banks’ recent work to promote financial inclusion may be undone by this, but the big banks can acquire these small banks that have a very strong local presence. This will save the big banks resources they would otherwise have to spend on setting up new branches.
We have seen that small banks are able to give more returns than big banks. So when big banks acquire small banks, the small bank’s returns will diminish.
The small banks are not going anywhere; they will be where they are. Big banks based in Kathmandu can acquire these small banks (say a bank in Surkhet). The big bank can make good use of their local expertise, and invest in agriculture—the big banks have not been able to invest in agriculture to the extent we want them to, but the development banks have been able to do that. One thing that will change is that the profit that used to be distributed among a small bank’s shareholders will have to go to the centre. But even then, the promoters won’t lose much as they will get shares of the big bank. To add to that, the small bank will be better prepared to handle shocks.
The monetary policy also talked about an infrastructure development bank. What is happening on that front?
As of today, we are not yet clear about it. My suggestion is to incorporate the concept in the new BAFIA (Banks and Financial Institutions Act), instead of preparing another legislation for it. If we incorporate it in BAFIA, NRB would get clear authority to monitor and supervise such banks.
If NIDC can raise its capital to the said Rs 20 billion, we could come up with a policy to establish an infrastructure bank as was declared in the monetary policy.
For an infrastructure bank, the capital of Rs 20 billion is not very big. The minimum capital we have set could be spent in one single project. If we get one infrastructure bank, we may get more, if the promoters can justify their business plan. We want such a bank to do more than just collect deposits
The bankers have said that the decision to increase the capital was unexpected, the time they have been given is too short, and the capital they have to raise is too big.
We introduced the policy after several rounds of deliberations and calculations. Banks that have their operation limited to just one district will have to increase their capital by as much as 25 times. Will they be able to do that? For them, the policy’s indirect message is to go for a merger, downgrade to micro finance or get acquired by a big bank.
When the banks become big, their operations will also have to expand. Do we have the human resources capable of handling such an expansion?
Let’s say after the mergers, the number of commercial banks goes down to 10-15. What will then happen is that the supply of skilled people will increase, and those people who go around changing banks every six months will not be able to continue doing that. They will have to compete. On the other hand, all CEOs will not be able to keep their jobs. It should not be about individuals; we do not make policies to suit individuals.
Is the central bank thinking of allowing new banks to open?
As the central bank has put a stay on opening new banks, many people might have thought that the central bank is negative towards new banks coming into the market. We are open to giving permits to new banks that have big capital and a specialised business plan—the infrastructure bank provision is one way for new banks to enter the market.
So the new permits will be limited only to these types of banks?
We might raise the required capital further for new commercial banks to come into the market. But looking at the size of the economy, the number of exiting banks looks quite enough. We do not want a lot of banks in the country. We want big banks that can withstand shocks.
How have the JV banks responded to the new policy?
The JVs were worried that if their capital base increases, they would have to increase their business to give returns to investors. I have told them not to worry. The reason I have said this is that for example, there are 30 banks right now, after sometime it might drop to 10. So the business that three banks were handling would now have to be handled by a single bank.
The other thing I have told them is that there is a lot of scope for new infrastructure in Nepal, and when their banks are big, they can finance big projects without looking for partner financers. They should get more investment from their JV partner so that they would be able to bring in new technology. If they do not do this, and raise capital domestically, they will turn into a local bank. That we don’t want.
None of the JVs are in a mood to wind up operations here. I don’t see any problems with the JVs.
The volume of Nepal’s trade with China has been increasing. Chinese tourist arrivals are on the rise and many Chinese contractors work in Nepal. In view of all these things, a Chinese bank is what we need. Has the central bank done anything in this regard?
We have raised the issue at the governor and deputy governor levels. We have urged the Chinese central bank to open a branch in Nepal so that it becomes easier to carry out transactions through the banking channel. The Chinese central bank has told us that it is positive about opening a branch in Nepal.
The presence of Indian JVs in Nepal has helped us a lot, but we don’t have Chinese banks in Nepal. I think the main reason for this is that the level of communication we have with India is higher compared to China. In addition to this, we have observed that the members of the financial sector in China are not aware of the conditions in Nepal—may be this is because we have not been able to approach them.
One reason the people mostly point out for Chinese banks not coming to Nepal is that Nepal’s economy is very small compared to China’s, and it would not make sense for them to have a presence in Nepal. The same can be said about India, but Indian JVs have a good presence in Nepal.
So, as the banks become big, will they be allowed to open branches outside Nepal?
If a bank decides to open a branch outside Nepal, we would be more than happy if they have the capacity to do so. There are no obstacles from our side. But we should also not forget that in India a bank needs Rs 5 billion paid up capital to open a single branch.
Many bankers have also raised the issue of liquidity in the market. What is the situation now?
For the last 4-5 months we have had a lot of liquidity in the banking sector. At one time we had Rs 100 billion in the system. Due to this, the rate fell. We wanted the rate to rise, but the government was not issuing bonds in time. So NRB decided to collect deposits from the banks. This was the first time we did it, not many central banks around the world do this. After that, the rates have improved.