“Outside interferences in central bank will increase if the governor doesn't stand strong.”

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“Outside interferences in central bank will increase if the governor doesn't stand strong.”

Himalaya Sumsher JB Rana With the problems growing in the country’s financial system, Nepal Rastra Bank (NRB) is finding it difficult to play its role as the banking sector regulator. From the recurring short supply of investment-grade liquidity in the banking system to achieving the objective of bank mergers, NRB has been coping with several issues all at once. Also, there are concerns over the growing friction between the central bank and the Ministry of Finance in recent months. 
 
Now 90, Himalaya Sumsher JB Rana, the first governor of NRB from 1956 to 1961, is still in good health and spirits. The veteran central banker contemplates and suggests ways for the betterment of the central bank and the entire Nepali banking sector.
 
Policymakers consider his keen observations as valuable suggestions. In an interview with Madan Lamsal, editor-in-chief of New Business Age, Rana talked about the importance of maintaining a harmonious relationship between the central bank and the government, the current role of NRB in resolving the problems in the banking sector and economic situation of the country, among other issues. Excerpts:
 
There is a notion that the finance ministry’s interference into the affairs of the Nepal Rastra Bank (NRB) has increased beyond reasonable limit. How is your observation? 
As the former governor, it is obvious for the finance minister to have concerns with the operations of the central bank. I do not have knowledge about him interfering in NRB’s affairs. If there has been any, it might be related to the appointment and posting of staff, which I am not aware of. Talking about interferences, the governor of Reserve Bank of India (RBI) resigned because of principle disagreement between RBI and the Indian finance minister. I don’t feel there are such tussles between the government and the central bank in our context. 
 
How independent was the central bank during your tenure as the first governor?
During the initial years, it was hard to establish the independency of the central bank. The country’s administrative centre Singha Durbar was so powerful that its officials and secretaries felt that they held all the state powers. Despite the fact that NRB was instituted under the Nepal Rastra Bank Act which gave it an autonomous status, the officials treated the central bank as a department of the Ministry of Finance for the first couple of years. They wanted us to get approval from the ministry in every step. I have struggled quite a lot to make the central bank an autonomous body. The last six decades have seen 16 governors. Some of them were unable to complete their tenures. Basically, they were replaced due to the changes in the government. However, NRB’s status has been relatively independent in the last few years. It is also because The World Bank and International Monetary Fund have been stressing on making the central bank more autonomous. The amendments in the Banks and Financial Institutions Act (BAFIA) have been focused towards this end. The relationship between the ministry of finance and NRB is a very complex one, which at times depends on the personal equations between the top officials of the two institutions. If the governor is outstanding, there will be less interference. Outside interferences will increase if the governor will not stand strong in his/her work.
 
Can we learn anything from Urjit Patel’s resignation from the post of governor of the Reserve Bank of India (RBI)? 
The resignation of Patel from the post of RBI governor is a very classical case. One of the key responsibilities and primary roles of a central bank is to stabilise the value of a country’s currency. In order to keep the international value of the currency stable, the central bank increases the interest rate from time to time if it deems it necessary. But if there is a populist government, it wants the central bank to lower interest rates so as to add momentum to the country’s economic activities. This has resulted in conflicts between the government and the central bank in many countries. The tussle between the government and central banks has happened not only in India, but also in some East European countries too. Similarly, there can be friction if the personalities of the finance minister and the governor do not match. If both of them are sensible, the central bank will cooperate to achieve the government’s economic desires. On the other hand, the government will also understand the limitations of the central bank to become flexible due to its key role in stabilising the value of the currency and make compromises accordingly. 
 
Given that there is a much more stringent regulatory regime post-2008 in the banking sector worldwide, how can NRB play its role as an efficient regulator?
After the restoration of multi-party democracy in 1990, the number of Banks and Financial Institutions (BFIs) grew significantly due to the relaxed licensing regime. An environment of disorder was fostered leading to systematic problems in the financial sector. Strong supervision in the BFI sector was deemed necessary. After the appointment of Dr Yuba Raj Khatiwada as the NRB governor, the central bank’s supervisory role started to become more managed. It has helped to make the Nepali financial sector healthier compared to countries like India, Sri Lanka and Bangladesh. 
 
In recent years, the responsibilities of NRB have increased due to the high number of BFIs in the country. It takes a lot of time for the central bank to make decisions. During his tenure as the governor, Satyendra Pyara Shrestha started a good practice which was to resolve every single issue by discussing it in a committee comprising of the departments heads of the central bank. Such a committee has dominated the decision making process of NRB. In those days when the central bank's workload was low, it was fine. But now the central bank's work load has increased. Due to this, the governor or the deputy governor is unable to make decision on his/her own. It has been seen that the decisions are deferred due to the lack of a quorum as some members have either gone out of the country or are on district visits. It is quite ironical that the central bank, which constitutes individuals with high levels of knowledge, takes a lot of time in decision making. Similarly, the pressure from employee unions is also contributing to this. These two factors have been affecting the efficacy of the supervisory role of NRB. For instance, it seems that decisions related to the financial performance of some banks for the first quarter of the current fiscal year will be deferred as some banks are yet to submit their balance sheets. 
 
It is said that the difficulties for BFIs to submit their financial reports is due to  the Nepal Financing Reporting Standards (NFRS) which is too complicated to comply. How do you view this?
The previous NRB rules for BFIs to submit their balance sheets were good enough. The introduction of NFRS was basically due to the pressure of the Institute of Chartered Accountants of Nepal (ICAN) and a director of NRB, who is also a chartered accountant. The balance sheets prepared in the NFRS format show an increase in the profit of banks. NRB had problems with it and the banking regulator mandated banks to submit two balance sheets; one prepared in the old format and the other in the NFRS format. This has created confusion and problems for banks. The central bank should have decided and stood firm on which financial reporting format to use. 
 
The introduction of the International Financing Reporting Standards (IFRS) was indeed a stepping stone to add transparency, accountability and economic efficiency in the financial reports of institutions. It has also helped to strengthen the international financial regulations. However, there should have been adequate discussions about the pros and cons of NFRS prior to its introduction. We always want to give the impression that we are progressive. The implementation of NFRS is indicative of this. No other country in the South Asia region has made a rush to start practicing the new financial reporting standard. 
 
Many people think that banks in Nepal are earning unnaturally high windfall profits in the current economic situation where sectors such as manufacturing and agriculture are too weak. Do you think this is so?
It is not an easy question to answer. From the prolonged political instability, increased trade unionism to shortage of electricity, several reasons are behind the underdevelopment of the Nepali manufacturing sector and low level of profitability of industries here. Similarly, the higher labour cost is also a contributing factor in this regard. We have been hearing the grievances of industrialists who feel they have fallen into a trap as it is hard to run businesses and there is no policy for an exit to shut down the industries. I view the importance of these factors over the bank interest rates for industries. 
 
At the same time, banks have been distributing dividends 30-40 percent from the profits to their shareholders. Also, their stock prices are much higher compared to other companies listed in the stock exchange. These factors are what makes the banking sector a profitable business in the eyes of many people. The newly introduced regulations have pulled down the profit of commercial banks to 15 to 20 percent.  Only large banks like Nabil and Nepal Investment Bank Limited have been able to maintain their annual profits at 30 to 40 percent. Given the central bank’s recent intervention to curb the rising interest rates and regulatory tightening, the profits of banks might further decrease and the banking sector could gradually become unattractive to investors if the spread rate is lowered from present level.  
 
Likewise, the banks also need to be aware in determining the interest rates. If there are changes in the demand for loans and deposits, the banks should fix interest rates for a quarter or two by properly reviewing the situation. Immediately hiking the predetermined interest rates on loans can be unbearable to many borrowers. 
 
The central bank is preparing to bring in the ‘Fit and Proper Test’ while appointing CEOs in the commercial banks. What is your take on this?
This will be the start of a wrong practice. Such a move is likely to tarnish the image of the central bank. The officials of NRB may be blamed for appointing bank CEOs for their personal benefits.  The promoters and investors have the right to appoint CEOs in their banks. They do not need to seek approval from the central bank. I think the idea to introduce ‘Fit and Proper Test’ might have come by looking into similar practices in some other countries.
 
How do you evaluate the current situation of the country’s banking sector?
Till now, the banking sector has been in sound health. However, it has undergone a lot of problems in the last few years. With good intentions, NRB in 2015 asked the banks to raise their paid-up capital levels. What was problematic was that the banks were given a relatively short deadline of two years to change their capital structure. I think four years could have been a comfortable period for BFIs in this regard. The paid-up capital hike of BFIs should have gone along the tempo of the country’s economic growth, enabling banks to evaluate the growth of loans and deposits properly and plan accordingly. Many promoters and investors of BFIs were forced to sell their properties so as to meet the new capital requirements. So it became obvious for them to ask for higher returns for their investments. As a result, bankers opted for aggressive lending but were unable to collect deposits as expected. The collection of deposits and extension of loans are governed by certain tempos in the market. I have heard bankers stating the sluggishness in the government’s capital expenditure as one of the major factors hindering the deposit collection of banks. This is not actually true because the pace of the government’s capital expenditure has always been disappointing.  The fact is that the target for banks to collect deposits has exceeded the natural growth rate of deposit collection.  
 
What prospects of business and profitability are there for Nepali banks in terms of expanding their presence across the country in the federal system? What challenges do you observe for them in this regard?
Nothing can be predicted at the moment as we have entered into an unchartered territory. We are yet to see the preferences and interests of the provincial governments in terms of allowing the operation of financial institutions and regulation of their branches. Similarly, there should be a legal basis for the operation of such institutions in the provincial and local levels. I think the provincial and local governments should properly understand the role of the banks in the development of their regions. There should not be any interference in operating the branches and the financial institutions; they need to be under the purview of the central banking authority.   
    
Are the banks playing their roles accordingly in the changed economic and financial contexts?
Banks are yet to enhance their capabilities in several aspects. With the changes in the economy, there is a huge demand for capital. But banks are unable to finance the investment needs for the country’s higher economic growth. It is also very difficult to attract foreign direct investment (FDI) in Nepal. With all the bureaucratic hurdles and corruption, very few foreigners are actually interested in investing here. Nepal may receive some amount of money from neighbouring China and India through government-to-government arrangements. But it is very difficult to work in Nepal. Even the established banks find it quite hard to operate here. 
 
How do you see the argument for less number of banks with high capacity? How do you view the push for bank mergers by NRB in the last few years?
In the national politics, the unity between the two largest leftist parties last year signaled some amazing results. We have hoped for similar things in the banking sector. Nevertheless, NRB’s good intention to merge the BFIs to reduce the number has not worked for commercial banks. There were some acquisitions, but the major target of mergers was not realised. I think the main reason behind this has been the longing of bank promoters and bankers to stick to their current positions, which they might have to lose if the banks are merged. 
 
The International Monetary Fund (IMF) in its recent Article (IV) consultation has suggested NRB to again hike the paid-up capital of banks. Would such a move be viable at present?
IMF always suggests increasing the paid-up capital of banks so as to strengthen the financial capacity of the institutions. The recommendations of IMF are implemented considering the need and the economic situation of the countries. The last three years have clearly showed that it has been quite tough for BFIs to meet the new capital requirement in the last three years, and to bring another change in the capital structure so soon will not be viable.  
 
The shortage of investible funds in the Nepali banking sector has been recurring on a cyclical basis for the last few years. What could be the long- term solution for this problem?
This particular issue also used to exist as a minor problem in our banking system in the past. Over the last few years, the short supply of investment-grade liquidity has become a major headache for banks. The relatively short deadline for BFIs to raise their paid-up capital levels is the main reason behind this. The aggressive expansion of the loan portfolio of banks did not match their deposit collection leading to the depletion of investible funds in the banking system. The hassles in following the Anti-money Laundering (AML)/ Counter Financing of Terrorism (CFT) compliances are the other contributing factors in this context. For instance, just to deposit a sum of Rs one million in the banks, the depositors are required to show their income sources. Hassles like these create difficulties for banks to collect deposits. The rules and regulations related to AML/CFT compliance need to be made more pragmatic. The situation of the availability of money has become quite distressing in Nepal. The sprawling activities in consumption clearly indicate that people have a lot of money with them. On the other hand, it is very hard even to borrow Rs 40-50 million to invest in a business. 
 
The government needs to take a pro-active approach to resolve this particular issue. The government has deposited billions of rupees, collected as revenue, in its account at NRB. I have suggested bringing the money to the banking system in order to provide some breathing space for private banks. After studying my suggestion, officials at the legal department of the Ministry of Finance said that the existing legal provisions do not allow the government to provide its money to commercial banks. Likewise, the government also needs to work for the interest rate stability in the financial market. It should direct large institutional depositors like the Nepal Army and the Employees Provident Fund not to engage in bargaining with the commercial bank to hike interest rates on deposits. 
 
The country’s forex reserve is dwindling, the trade deficit is sky rocketing and Balance of Payment deficit is widening fast. How can these challenges be faced? 
The inflow of remittances has been the major supporting factor for day-to-day economic activities in the country. Talking about the trade deficit, a sizeable gap between export and import has always existed which has widened significantly in the recent years. The government needs to control the import of products. There is a need to start a national campaign to narrow the gap. Restricting imports of luxury goods can help to lower the trade imbalance. Similarly, curbing imports like poultry and dairy items, in which we are self-reliant, can be another important step. Subsidies for the domestic producers need to be increased to encourage them. Instead of pulling the anti-corruption departments under the authority of the Prime Minister, establishing units to promote domestic production and export at the Prime Minister’s Office could have been more fruitful. I don’t think limiting the amount of US Dollars Nepalis can exchange when travelling abroad can check the depleting forex reserve. It will only add to the hassles of business people and ordinary citizens. 
 
What is your take on the government’s decision to ban higher denomination Indian currency notes? 
This decision is actually influenced by the actions of the Indian government. Our southern neighbour went through the demonitisation drive in 2016 and the government there thinks Pakistanis print fake Indian currencies in Nepal to supply to India. But our government should have well assessed the situation before taking such a decision. It will hit the people hard, particularly those living in the Terai region where the use of Indian currency is common, and the migrant workers returning to Nepal from India will also face a lot of difficulties.
 
There have been calls for abolishing the peg between the Nepali and Indian currencies due to the changing trade patterns. Can the free flotation of currency ease Nepal’s trade problems?
I don’t think the free floatation will be of any help. The issues related to trade deficit were not looked at when the Nepali currency was pegged with the Indian currency 60 years ago. It took us three years to study and research every aspect of the demand and supply of the currencies of the two countries. The current pegged rate INR 100 = NPR 160 was determined in 1994 and has remained unchanged since then. Now the time has come to review the currency peg. Each and every aspect and issues related to the Nepal-India trade relationship and demand and supply of the currencies need to be studied in-depth before determining the new pegged exchange rate. Also, there should be a political consensus in this respect. Looking at our trade deficit with India, I think, the new pegged exchange rate should be set at INR100 = NPR 170. 
 

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