The roots of cooperative models stretch back to mid-19th century England, founded on the principles of self-governance and community-driven approaches. Recognising their transformative potential, the Constitution of Nepal, 2015 acknowledges the crucial role of cooperatives in achieving the nation’s socio-economic objectives under directive principles and state policies. Tracing the advent of cooperatives in Nepal, the Department of Cooperatives was established in 1953 under the then Ministry of Planning, Development and Agriculture. The cooperative movement in the country took momentum after the introduction of the Cooperative Act, 1992 and later geared up after the enactment of Cooperatives Act, 2017.

According to the Department of Cooperatives (2023), there are a total of 31,373 cooperatives, 68 district cooperative unions, 328 thematic cooperative unions, 20 central cooperative unions and one national cooperative union. These cooperatives engage around 28% of the population of the country and have collectively disbursed more than Rs 43 billion in loans to its members. These cooperatives are involved in diverse facets of the Nepali economy including agricultural production, dairy, manufacturing, financial services, communication, energy, education, health and consumer service businesses of many kinds.

Recent trends and issues

Cooperatives are limited liability entities designed for modest profit and socially responsible business practices. They operate based on member-driven decision-making and prioritise the welfare of all members. From an economic democracy standpoint, this structure contrasts sharply with private companies that focus on maximising profit, serve only investor interests and centralise decision-making power. However, recent trends in Nepal reveal that cooperatives are increasingly being misused as instruments for financial fraud, leading to a public perception that they are no longer a safe option in the country.

In order to prevent the snowball effect of people not trusting the cooperatives, the provisions introduced by this year’s budget, including a deposit guarantee scheme of up to Rs 500,000, could only be a short-term solution to the entirety of the problem that the recent cooperative fraud cases have shown.

Most of the cooperatives have invested excessively in unproductive sectors such as land and building. Paying interest to members from profits generated by selling these fixed assets has led to a liquidity crisis, particularly after the government-imposed restrictions on land plotting and introduced classification of land based on its usage. Furthermore, excessive bad debts, poor credit management caused due to delay in constitution of credit information bureau and debt recovery tribunal for cooperatives, involvement in conflict of interest transactions, oversight in adequacy of credit risks and liquidity of cooperatives and lack of expertise and manpower in federal, provincial and local level to regulate, inspect and supervise cooperatives within their jurisdiction, are some of the issues impeding the cooperative sector in Nepal.

Although the Cooperatives Act has empowered the Department of Cooperatives as principal regulator for cooperatives, recent amendments have classified regulation, inspection and supervision of cooperatives based on their annual transactions dividing it amongst the three tiers of government. The prudential norms and standards for those cooperatives regulated by provincial and local levels seems far-fetched considering the regulatory weaknesses evidenced by the Department of Cooperatives itself.

A decade-long observation of cooperative fraud cases in Nepal suggests that the department has failed to act as a strong, independent regulator, free from political influence. Countries with robust financial cooperative systems, such as Canada, have strong regulatory frameworks. The Central Bank in Canada serves as the primary regulator for cooperatives. In contrast, Asian countries often employ a central authority to regulate cooperatives using the CAMELS rating system, which assesses capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk.

Can NRB supervise cooperatives?

While the cooperative laws previously only permitted involvement of Nepal Rastra Bank (NRB) in the constitution and supervision of cooperative banks, the NRB’s regulatory authority was limited to licensed banks and financial institutions. This meant, NRB could not regulate and supervise financial cooperatives. To address this gap, the government, through the budget for the current fiscal year 2023/24, proposed to establish a separate regulatory body to regulate cooperatives and NRB is planning to facilitate the same. On the other hand, the recent amendment to the Cooperative Act and NRB Act, through the Act amending asset money laundering and promotion of business environment-related Nepali laws, 2022, has introduced the central bank’s supervisory powers to regulate cooperatives. Now, upon the request from the Cooperatives Department, NRB can regulate, inspect and supervise financial cooperatives with a share capital Rs 500 million or an equivalent annual transaction volume based on their financial governance and risk profile. Furthermore, the NRB is also empowered to impose fines and sanctions on these cooperatives under the provisions of the prevailing NRB Act.

Furthermore, the proposed Credit Information Reporting Bill of 2020, which has been tabled in parliament for a while now, outlines a framework for establishing a credit information bureau which could collect and transfer the credit information from the cooperatives along with the banks and financial institutions. The NRB would oversee both the reporting and governance of such a credit information bureau.

Approaches to NRB’s supervision

While direct NRB supervision of all cooperatives could potentially reduce regulatory arbitrage and enhance public trust, overseeing more than 31,000 cooperatives is a significant undertaking requiring substantial capital expenditure and public resources of the state. A more practical approach, inspired by the Latin American model, involves direct supervision of the largest cooperatives based on factors like share capital, deposits, and annual transactions, coupled with non-prudential oversight of smaller and mid-sized cooperatives.

However, this framework raises concerns about potential regulatory arbitrage, especially if the regulators (local, provincial level institutions and the Department of Cooperatives) lack the necessary prudential norms of regulation and supervisory capabilities with adequate resources. Moreover, public confidence in financial cooperatives could be undermined by confusion regarding the supervising authority.

The current Cooperative Act primarily grants regulatory authority to the Cooperative Department, with the NRB's involvement limited to supervisory oversight of large cooperatives upon request. However, the Act is insufficient to address critical areas such as capital requirements, capital adequacy, small loan servicing, non-traditional security issues, governance, credit risk management, and investment guidelines, etc. Consequently, direct NRB supervision for large cooperatives and non-prudential oversight for other financial cooperatives are essential for the sector's growth. Additionally, the Department of Cooperatives should establish norms and standards for local and provincial regulators, aligning them with the NRB's supervisory framework.

Conclusion

A lack of clear regulatory framework or excessive regulation can lead to systemic failures within the cooperative sector. Instead of establishing a dedicated regulatory authority, the NRB could supervise large cooperatives under its current non-banking and financial institutions supervision department or introduce a tiered regulatory structure specifically designed for cooperatives. Nevertheless, the NRB should ensure that its supervisory rules are tailored to the distinct nature of cooperatives, differentiating them from those applicable to licensed banks and financial institutions.

(Khatry and Singh are legal professionals.)

(This opinion article was originally published in  January 2025 issue  of New Business Age Magazine.)