Maha Prasad Adhikari 's tenure as the Governor of Nepal Rastra Bank has been marked by significant challenges. He has steered the central bank through the tumultuous aftermath of the Covid-19 pandemic, persistent high inflation and foreign exchange pressures. During his tenure, the central bank implemented working capital loan guidelines that sparked debate within the private sector, tightened regulations on margin and real estate lending, and faced occasional friction with the Ministry of Finance. As his term draws to a close, Adhikari engaged in an exclusive conversation with New Business Age , where he discussed the complexities of managing Nepal's financial sector, including the declining profitability of banks, the mounting challenge of non-performing loans and the evolving dynamics of regulatory framework for saving and credit cooperatives. Excerpts:

You are in the final year of your tenure as the governor of Nepal Rastra Bank. How has been your tenure so far?

The policies introduced by Nepal Rastra Bank (NRB) are grounded in globally accepted principles and supported by various economic and financial data relevant to the economy. Recently, the International Monetary Fund acknowledged in its reports that our policies have become more data-driven. Every policy introduced during this period was the result of extensive study and research. During the extreme uncertainty created by Covid-19, when central banks worldwide adopted aggressively accommodative monetary policies, we also did everything possible to support the economy. I understand this as providing significant help to prevent further economic contraction and protect businesses.

Unfortunately, similar to the challenges posed by Covid-19, we also had to contend with high inflation driven by disruptions in the global supply chain. Our foreign exchange reserve was also under pressure. In such circumstances, it was natural for the central bank, as the custodian of economic stability, to respond with concern. I believe our policy changes were made at the right time and in the right direction.

Of course, every policy change involves certain costs or trade-offs. However, the measures taken by the central bank have successfully averted economic instability and also made a significant contribution to post-Covid recovery. In this sense, I am satisfied with how the central bank has fulfilled its responsibilities. I have been taking the fluctuations that came during the fulfillment of this responsibility in a normal manner.

Banks' returns are continuously declining, and there are reports that long-time investors are looking to exit the banking sector. Why has this situation arisen, and how will it impact the banking sector?

The profitability of the banking sector has declined slightly, but we need to view this within the broader context of the country’s overall economic situation. In the past two years, Nepal’s average economic growth rate remained around 3%, while credit expansion has averaged 6%. The impact of Covid-19 and recent contractions in some sectors have added challenges to maintaining financial stability. The combined effect of these factors has impacted the profitability and returns of banks and financial institutions.

Currently, banks and financial institutions in Nepal have a return on equity (ROE) of around 11%, and a return of asset (ROA) of around 1%. Compared to other countries, this is a relatively favorable position. For instance, according to the International Monetary Fund, the ROE of banks in 49 countries in 2022 and 21 countries in 2023 was below 10%. In the coming days, as the country's economic activities improve, we can expect improvements in the banking sector's returns. Share trading is a continuous process driven by market needs and conditions. There does not seem to be any major problem in this regard.

There are rumors that the IMF is demanding changes to the process of appointing governors to make the NRB more independent. Similarly, it is said that the IMF is against having representation of the finance ministry in the board of directors of NRB. What are the positions of Nepal and the IMF on this?

The IMF provides its recommendations to strengthen the autonomy, accountability and transparency of central banks as part of its safeguards assessment framework. We have taken these suggestions positively and are committed to implementing them gradually. However, we believe that some of these suggestions need to be viewed in the context of our specific country, rather than solely through an international lens. Reforms of this nature are part of a continuous process. While it may not be feasible to implement all recommendations immediately, certain suggestions are more relevant for the future. Our approach is to implement immediately feasible suggestions now and gradually implement the remaining ones in future.

Some suggestions, though well-intentioned, may not be immediately acceptable in our context. These suggestions often seem focused on granting greater monetary management and operational autonomy to the central bank while restricting its involvement in fiscal functions. An amendment to the Bank and Financial Institutions Act (BAFIA) has been proposed to create a clear separation between bankers and businesspeople. The proposal suggests that someone holding more than 1% of a bank’s paid-up capital would be ineligible to obtain loans from other banks. How practical is this proposal?

Such issues are best resolved through discussions with all stakeholders. Additionally, determining what to include in the Act is ultimately the prerogative of the sovereign Parliament. The concern raised in the proposal highlights a problem currently being observed in the financial sector. However, measures to address such issues will be introduced during the legislative process. The proposed provision aims to strengthen institutional governance in the banking sector. Financial conflicts of interest have emerged because major borrowers and bank directors are often the same individuals. This amendment seeks to improve banking system integrity by revising the qualifications of bank founders and directors.

The Cooperatives and Nepal Rastra Bank acts have been amended to give the NRB responsibility for regulating large savings and credit cooperatives. However, the central bank seems reluctant to take this role. Why is the NRB hesitating to use its legal authority?

The NRB has long maintained that cooperatives are distinct institutions requiring a separate regulatory body. The government has already made progress toward establishing such a body. The central bank remains committed to providing technical support, if needed, during the initial stages of this new regulatory body. Additionally, the Nepal Rastra Bank Act has been amended to fulfill the responsibilities it has acquired. This includes proposing standards and seeking input from stakeholders. The necessary standards will be issued in due course.

The government is also proposing to create a second-tier regulator for the cooperative sector. What is the central bank’s perspective on the need for such a regulator?

As mentioned earlier, the NRB has long supported establishing a separate regulator for cooperatives. We are prepared to provide necessary facilitation for this purpose, which we have emphasized through monetary policy as well. Recognizing the importance of this issue, a provision for such a regulator has recently been introduced through an ordinance. For the proposed body to function effectively, it should be granted the authority to regulate and supervise cooperatives, as well as to take appropriate actions against organizations that fail to comply with established rules. Such powers would ensure the regulator can operate efficiently and uphold proper governance within the cooperative sector.

Have the problems seen in cooperatives affected any bank and financial institutions?

Since savings and credit cooperatives are a part of Nepal's financial system, problems arising in cooperatives do, to some extent, impact banks and financial institutions. However, because cooperatives operate under a distinct institutional structure and hold a relatively small share of the financial system, their problems have not directly affected banks and financial institutions. That said, the psychological impact of these issues has had an indirect effect on banks and financial institutions. More broadly, the issues in cooperatives have had a significant impact on the overall economy.

The NRB’s Financial Stability Report indicates that asset quality of financial institutions has deteriorated. Central bank data also shows increasing non-performing loans (NPLs) in banks. What is the level of risk in the banking sector, and what is the NRB doing to mitigate this risk?

There has been a slight increase in bad loans over the past couple of years. Currently, the current ratio stands at 4.42%. From an international perspective, this is not particularly alarming. International Monetary Fund data shows that in 2022, 46 countries had bad loan ratios exceeding 5%, and in 2023, the number was 41. In South Asia, the bad loan ratios in 2023 were 9.57% in Bangladesh, 8.34% in the Maldives, 6.63% in Pakistan and around 13% in Sri Lanka.

Several natural reasons have contributed to the increase in non-performing loans in Nepal in recent times. The economic slowdown over the past two years, coupled with contractions in the industrial production and construction sectors, has negatively impacted the recovery and loan quality of banks and financial institutions. The NRB is closely monitoring the health of banks and financial institutions to manage and mitigate bad loans. The supervision department is conducting on-site, off-site and risk-based supervision to track the situation.

To assess the bad loan issue independently, we have commissioned an international agency to review the loan portfolios of top 10 commercial banks. We expect external experts to further evaluate the bad loan situation. Additionally, the recently implemented Expected Credit Loss (ECL) Guidelines will encourage banks and financial institutions to adopt more prudent practices regarding bad loans.

The central bank has been implementing a tight monetary policy for the past two years to stabilize the economy. However, the private sector has opposed this policy, arguing that it is contributing to the current economic challenges. What do you say?

Nepal Rastra Bank formulates monetary policy with the primary goal of maintaining the country’s overall economic stability. The Act assigns it the key responsibility of ensuring price stability and safeguarding the external sector. Therefore, the stance of monetary policy is largely influenced by inflation trends and external sector risks.

The tight monetary policy was appropriate given the context of rising prices, a historically high current account and balance of payments deficit, and the policy measures adopted by central banks globally at that time. Thanks to this approach, the external sector has strengthened and inflation is improving. While this may have had some impact on economic activity, refraining from such measures could have resulted in a far more severe economic crisis. It is clear that the tight monetary policy has played a crucial role in fulfilling the mandate to maintain economic stability, as outlined in the Act. While the central bank continues to discharge its duties, if it causes inconvenience to any other aspect, we do not see an alternative but to bear such accusations.

The Working Capital Loan Guidelines were introduced to prevent loan abuse. What was its impact? What would have happened if it was not introduced?

The NRB introduced this guideline to ensure the appropriateness, effectiveness, and efficiency of working capital loans provided by banks and financial institutions. This has established uniformity in aspects like determining loan limits, and has made loan utilization, asset quality and loan risk management effective. We have been addressing the practical challenges that have arisen since the implementation of the guideline based on feedback from stakeholders. I believe there is no doubt among any of us about the necessity of this guideline for managing working capital loans. Nepal Rastra Bank is fully committed to its continued and effective implementation in the coming days.

Currently, 45% of loans are directed, but their impact on economic growth is not evident. Does this suggest that the loans are not being utilized effectively?

Nepal Rastra Bank has mandated that banks and financial institutions allocate a specific percentage of their loan investments to agriculture, energy and small and medium enterprises to mobilize financial sector resources towards productive sectors. In line with this provision, loan investments in these sectors are increasing. Currently, commercial banks have invested approximately 13% of their total loan portfolio in agriculture, 8.4% in energy, and 10.8% in micro, small, cottage and medium industries. This should be considered an achievement.

These investments have resulted in increased hydropower production, self-sufficiency in certain agricultural commodities, job creation through small and medium industries and benefits to the economy. Regarding economic growth, there are structural challenges in our economy. The economy remains import-dependent. In such a situation, merely redistributing financial resources from the supply side has not yielded the expected impact

There are occasional disagreements between the Governor and the Finance Minister regarding monetary policy. Why do these disputes occur?

The central bank is tasked with maintaining economic stability in the country, while the Ministry of Finance is primarily responsible for economic growth and job creation. As a result, the government's fiscal policy is generally expansionary. The central bank's policy, however, is determined based on price pressures and potential external sector impacts, which means it can sometimes be less expansionary than the government expects, considering the country's overall stability. Such differences and theoretical conflicts are normal and exist in other countries as well. The central bank works to support the government's policy while maintaining economic stability. We have consistently worked in a coordinated manner with this principle in mind.

The NRB has initiated a study on Central Bank Digital Currency (CBDC), and it has also been included in the BAFIA amendment. When can we expect the launch of CBDC in Nepal?

Following the Covid crisis, central banks have placed a greater emphasis on electronic payments. Accordingly, the NRB has also been promoting electronic payments. Additionally, we are systematically working on issuing a Central Bank Digital Currency. A separate division has been established to advance this work. The division has developed a work plan to create a suitable prototype, use case and design specifications for the CBDC within the current fiscal year.

The latest review of Nepal's anti-money laundering regime by FATF and APG has not been positive. In the meantime, there have been efforts to amend certain laws. Given this, is Nepal at risk of being placed on FATF’s grey list again?

The third round of Nepal's Mutual Evaluation Report, completed by the APG in 2022/23, highlighted both the efforts and progress, while offering some recommendations. Compared to the previous evaluations in 2005 and 2010, Nepal has made significant strides in developing legal and policy infrastructure and institutional structures. Nepal's performance is satisfactory in terms of technical compliance with the FATF’s 40 Recommendations. However, there are still areas that require improvement in terms of effectiveness, as outlined by the FATF’s Immediate Outcomes (IOs).

Recently, 19 acts related to money laundering prevention have been amended. Along with these amendments, regulations have been approved, and further amendments to regulations, instructions and procedures are underway, which will enhance technical compliance. If these amendments are fully implemented, Nepal can make progress in meeting effectiveness standards. A decision regarding this will be made by the FATF in February 2025 during its annual meeting. Generally, most countries are placed in phase one after a mutual evaluation. If this happens, Nepal will not be significantly affected, as it has already laid a solid foundation for both implementing and improving the effectiveness of its anti-money laundering efforts. Even if Nepal remains on the list, it has positioned itself well for future progress and eventual removal from the list.

Due to the commitment made to the IMF when Nepal took the ECF, the process of auditing 10 large banks by independent auditors is underway. When will this process start?

This is a priority for the central bank. But it has been delayed due to technical issues related to the procurement process. While evaluating applicant firms according to the Public Procurement Act and Nepal Rastra Bank's procurement regulations, we were unable to select a firm that met our requirements. However, we have restarted the process, and this time, we are optimistic that an independent auditor will be selected, allowing for the review of the loan portfolios of these banks to proceed.

(This interview was originally published in February 2025 issue of New Business Age Magazine.)