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July 2017 Economy and Policy

Published on: 2017-07-08 14:18:12     500 times read    0  Comments
Does Financial Market Need Further Reforms?
 
Considering the size of the Nepal GDP which is about USD 25 Billion, the number of players in the Nepali financial market is too high, making it overcrowded.
 
--BY SUJIT MUNDUL
 
The Nepali financial system consists of banking and non- banking institutions. The banking sector is like a fountain headed by the Nepal Rastra Bank (NRB) as the central bank and then the commercial banks.
 
The non-banking sector, inter alia, includes financial institutions licensed by NRB like Development Banks, Finance Companies, Microfinance Development Banks, Coop financial institutions. It also includes NGOs undertaking banking activities and those under different Acts e.g. insurance companies, EPF, CIT, Nepal Stock Exchange etc. 
 
Considering the size of the Nepal GDP which is about USD 25 Billion, the number of players in the Nepali financial market is too high, making it overcrowded. The number of players is something like more than 250. One can very well appreciate the intensity of the competition amongst these players; a number of them cater to the rural and micro -finance sectors of the economy. The intense competition amongst the banks (commercial and development) and finance companies (NBFCs), representing more than 90% of the market share, has led to many problems including the burgeoning of non-performing assets in some sectors. Apart from that, another very important aspect of financial discipline, the risk-pricing policies of the players in the financial market became virtually defunct.
 
It would not be completely out of context to mention that Nepal’s inflation rate, which had been hovering around 8-10 percent for the past few years, has of late come down to the level of around 5 percent, a more tolerable one. The major reasons being better fiscal management and a substantial drop in international oil prices. It can’t be denied that historically Nepal’s inflation has had a co-relation with Indian inflation due to the Nepali rupee being pegged to the Indian rupee.
 
Way back in 2002, the Govt of Nepal and NRB had initiated financial sector reforms with the primary objective of tackling the following issues:
1. Restructuring the problem banks in the public sector; recapitalising and bringing professionalism in Nepal Bank and Rastriya Banijya Bank. 
2. Improving the governance of commercial banks and financial institutions.
3. Strengthening the autonomy of Nepal Rastra Bank and improving its supervisory capability.
 
 
 Indeed, the foregoing steps were in the right direction and have done well to improve the Nepali financial market. However, if one looks at the current state of play in the financial market of Nepal, it clearly reveals that a lot more is required to bring it to par with the progress made in the neighbouring countries and in the global financial markets.
 
An inherent problem in the Nepali financial market is lack of depth. The financial institutions (viz commercial banks and NBFCs) suffer from a perennial issue of balance sheet management. On scrutiny, it transpires that all the financial institutions are carrying long term assets being funded by short term deposits. This mismatch leads not only to pricing issues but also weakens the soundness of the financial system and may create a recipe for macro-economic instability in the time to come. 
 
The sudden drying up of liquidity or supply of excess liquidity in the market, as has been experienced by the players also causes distortion in the equilibrium of the pricing mechanism vis-à-vis risks. Most of the emerging markets have experienced the same at some points in time. One of the major causes is the absence of a secondary market, by that I mean an operative bond market which would attract long term funds and provide alternative investment options for the domestic savings. At the same time it will reduce the pressure of balance sheet mismatch as the corporates looking for term financing could directly access the bond market. The absence of a secondary market has also deprived the existing term finance providers of an appropriate pricing of the term-risk exposures, as there is no availability of yield curves for various maturities. 
 
I consider that now is an opportune time for Nepal to take a critical look at furthering the financial sector reforms, which would help support the economy to grow rapidly in the near to medium term.
 
To strengthen the process of reform the Govt/ Regulators may, inter alia, consider the following: 
  • Encourage setting up of more rating companies in collaboration with the international rating firms. This will, not only set a new direction for the assessment of various risks associated with the bonds/investments, but also assists the prospective investors in deciding the right investments for them apart from traditional shares/stocks or deposits with banks/NBFCs. These will enhance the credibility of the products in the financial markets. 
  •  Further strengthen the central bank’s (N R B) supervision capability to bring it at par with the global standard. This will assist the banks/finance companies in identifying the risks at an early stage and obviate the need to collapse the exposure with full provisioning. A more detailed instruction from central bank (NRB) towards the assessments of the underlying risks would assist the financial market players to take a better judgemental call on booking an exposure. 
  •  Disclosure norms need to be revisited for making them at par with the global standard and implemented more rigorously.
  • Accountability within the financial system needs to be more seriously understood and adopted appropriately. 
  • Serious efforts towards strengthening the corporate governance in the financial institutions would be required with a sense of urgency. This will substantially reduce the instances of “conflicting interest” within the individual entities and the overall financial markets.
Concerted efforts made by the regulators and the government can only ensure the process and the progress of further successful reforms. 
 
The writer was a Member in the Board of Directors of Standard Chartered Bank Nepal Ltd.

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