Gopal Prasad Kaphle is Deputy Governor of Nepal Rastra Bank (NRB), the central bank of Nepal. He was appointed to the post on December 26, 2010. He started his career in banking in 1955 and is devoted to this sector for more than 29 years. During this period, he worked in banking operation, branch operation, development finance, micro finance, public debt, training, and banking inspection and supervision department. He completed Master’s Degree in Economics from Tribhuvan University in 1979. He also has a Master’s Degree in Economics from the University of New England, Australia. In an interview with New Business Age, Kaphle speaks about the current situation in the banking sector and NRB’s regulatory plans for the future. Excerpts:

Total net profit of commercial banks has increased by 2.28 per cent compared to that of last year. Why is the growth so low?

The growth rate compared to a few years ago is quite low. However, there is no reason to be unhappy about the profit earned by financial institutions. There are some factors that have caused the liquidity problem such as absence of investment area and environment, turmoil in real estate, margin lending, and until last year delayed government budget. Despite these all, BFIs (bank and financial institutions) are successful in making profit and provide relief to shareholders and promoters. In the coming years, if the things change for the better like a timely budget, investment friendly environment and good corporate governance, we can be more optimistic about the high growth in profit.

Problem of liquidity is still not solved. What is the real scenario at present? How long will it take to overcome this crisis?

If we look at the liquidity inside financial system, there are not many reasons to worry about. A couple of months ago, commercial banks had Rs 22 billion surplus liquidity in the market. Prior to that, more than Rs 30 billion surplus liquidity was observed in commercial banks. Most of the commercial banks except only a few are in surplus. Among B and C class financial institutions, some have surplus while others are in deficit. Moreover, commercial banks are at ease while development banks and finance companies are not completely out of the woods. If we look at inter-bank lending rate, till date, only some finance companies are still borrowing at 15 or 16 per cent. Commercial banks were borrowing at one per cent some time back but at present they are borrowing at around 1.5 per cent. This shows, there is ease in the system but at the individual level, some bank and finance companies are still in problem. But, the liquidity problem is not completely resolved.

This time of the year is normally the period of ease. During this period, the government budget has been passed by the parliament. There have been fewer investments. Loan and interests repayment rate in the commercial banks is good. That makes the liquidity problem to look relieved. We are also in a wait and watch mode to see what the situation is after Dashain and Tihar. I believe there won’t be big problems like in previous years. At such times, we cannot deny the possibility of problems. However, we are alert because of the lessons we have learnt. Public trust has developed in the banking sector. In the coming days, NRB will take every possible measure to bring this problem under control. The government has also assured that. NRB, if required, will use any instruments like refinancing to LOR (Lender of Last Resort) to bring the situation in control. To make sure that liquidity does not remain idle, we are issuing development bonds and treating B and C class institutions can participate in such instruments. We are putting them in a separate basket. I am trying to ensure the environment to cash in on instruments whenever there is any problem of liquidity. Problem is psychological too. And, commercial banks are also optimistic that the problem will ease. I believe the problems of the past will not repeat.

The average non-performing loan out of total loans has increased to 2.41 per cent from 1.92 per cent of previous year. What is your take on this?

This may be realistic too because the biggest problem currently is real estate loans. The financial sector is not mobile. Economic activities are missing; industries are not moving on the right track, there are problems of labour and import-export. Due to unstable government, policies are not implemented. We also realise that NRB has become quite aggressive and taken tough policy measures. We tried to address the problem of good governance that has been left unaddressed over the years at once instead of treating it in a step-by-step manner. Due to the absence of investment environment to tap such opportunities, lending in industries have problems of recovery. Industries may not be running, some might have been closed down, there are labour issues. So, loans are not being paid back. Some banks and finance companies were in problem. So, we decided to liquidate some companies, and because of that, their non-performing loans must have been added. Real estate loans had the largest market share. We put a cap on lending to the real estate. The sales of real state also faltered. As developers cannot sell, they could not repay the loan. We have tried to ease it. However, market and economy as a whole has effects on business and non-performing loans increased.

On NRB’s inspection and supervision part, we have managed it. Compared to the past, we have improved our vision and efforts to solve problems, monitoring and inspections. After our effective inspection, institutions are not able to turn bad loans into good. That has also led to increase the volume of such loans. Increase in such loans does not mean banking system’s status has deteriorated than earlier. This is another side of NRB’s inspection, supervision’s smoothness and effectiveness.

NRB is planning to adopt a risk based supervision system. What will be the modality of such a system? And, how soon could this be implemented?

We have various modalities in this risk-based supervision system. There are numerous risks like subjective, managerial and operational among others. Our inspection department categorises specific risks from every sector. Based on that, we define our observation. There may be risks in one sector while others may be safe. This modality tries to take a multidimensional approach to maintaining discipline. It is a change from traditional supervision mechanism. The mechanism is envisioned to ensure that banks and financial institutions should not be in trouble because of any sector or cause. It considers not only good governance, capital base but also operation, investment portfolio among others. This modality aims to calculate and mitigate risks from any sectors. It is based on our belief that a bank must be healthy, strong and create a separate identity in the market.

Risk-based supervision is applied within NRB too. We are applying it in our departmental operations. It is already under application. We believe risks must be mitigated. We now have to take it forward effectively and give continuity to it. We have to calculate risks that may arise in the future.

IMF had suggested NRB to exercise more power. What are the new steps NRB is planning to take?

Exercise of power must be viewed considering a couple of elements. NRB exercises power based on NRB Act and BAFIA. BAFIA is in the house and discussions are going on to amend it. It must be strong. The government sector also has a role to make NRB active. We have focused on a few things like taking prompt action on the problems witnessed in financial institutions. NRB must be given right to take prompt action against any issues of good governance. For now, it takes a long time to take action against any person who is proved guilty. The process requires informing the Ministry of Finance then the Ministry of Home and finally the police. If we had power, we could have taken action against some financial criminals. So, NRB must be powerful and the government intervention should be less. NRB should be guaranteed a strong autonomous identity. For that, the status of Governor and Deputy Governor of NRB must be raised which would lead to more power. There must be such provisions that police can make arrests and take actions based on our letter. Time lag that is in existence is encouraging culprits to flee. We are demanding to increase our rights and that will help maintain discipline in banks and financial institutions.

What is NRB doing to restore public confidence in financial institutions that is said to be at a low ebb?

I don’t fully agree with it. At present, public confidence is improving. The confidence started declining when there was crisis of new notes during Dashain around two-three years back. Then, slowly public belief diminished in the entire banking system. And, it heightened with the liquidity crunch. At the same time, some companies were in problem and as a result, trust in the entire financial system eroded. If NRB had not been able to take action and correct its policies, the confidence would have fallen more. We tried hard and deposits have increased, profit has grown though a little and the people are returning to banks for deposits. People kept their money with themselves as some banks could not give loans, or even return deposits. We have moved on from this situation. The increased deposit and surplus liquidity is all because of increasing public confidence. I don’t think commercial banks should worry but this is not a siesta time. Public is so sensitive that if it does not get good service there will be shift in belief and trust. Public confidence must be won with good service, good governance and transparency.

A demand to stop issuing license to financial institution is heard. Is NRB planning to take such action?

A couple of things must be taken into consideration. Firstly, the number of financial institutions needed for Nepal with respect to our scale of economy must be clear. Another, there must be clear demarcations of public status like deprived groups, remote areas, hilly and mountainous areas and developed areas. We have already faced the consequences of rampant establishment of banks and finance companies. So, we are going for merger. One policy was formulated, companies came meeting the requirements and licence was issued. We have seen its consequences. NRB’s capacity for inspection and supervision was witnessed along with banks and finance companies’ capacity and implementation of good governance. Often question is raised whether a company can be established or not just with a certain amount of capital. The number is one question, while deepening access of service in certain geographical region and population can be another. Access and inclusion of financial and banking service to all regions must be analysed. The measures to cater to that group or region deprived of service must be pointed out. Similarly, unhealthy competition arises from increased number. The cake is shared by all institutions even as their number increases. Eventually, the size of activities will also diminish. Considering it, a suitable policy and environment must be created. It does not mean we should not issue any licenses. We had prioritised microfinance and its number has also exceeded. There are a lot of duplications. It must be analysed whether a particular area requires more companies or service. Whether to go for branch expansion or number of institutions are two options. So, whichever is feasible we must concentrate on that. Every region and every group of people must be able to access the services and share the cake of national economic development. We must devise our licensing policy accordingly so that there is no duplications and quality facilities are evenly distributed. We are making such policy. We are forming a five-year strategic plan in which we have planned to review the licensing policy. After formulation of that outline, we will have suitable licensing policy and we will bring in merger to control excess institutions and expand in areas with scarcity. That will be either by motivation, giving additional services or accelerating, we will take banking services to those areas.

Till date, a merger between two commercial banks has not happened. Do you think the mergers that are happening are satisfactory and meet the expectation of NRB?

The expectation of NRB on merger is not met. For the coming days, NRB is offering two options: merge and get incentive or be ready for forceful merger. If motivational measures do not work, we will have to go for forceful mergers. IMF and other world bodies have suggested that the number of financial institutions is exceeding the national capacity and need. Our only target is to merge the financial institutions, increase their capital base and ensure good governance. It is our continued effort. There are policy complications and we are relaxing them. We are inviting them to come for merger as soon as possible. It is obvious that some practical problems come during mergers. Nobody wants to lose anything. There can’t be two CEOs, chairmen or GMs. Problems in managerial aspects are visible. Someone must compromise something. NRB is determined and it will make mergers anyhow.

NRB is trying to correct several of its mistakes of the past like cap on CEO salary, margin lending and real estate? Why does NRB take ad-hoc decisions in the first place?

I don’t think so. While trying to manage something in an open system, ripples like in a pond hit by a stone are visible. We did not compromise even while deciding CEO’s salary. It is implemented now. We had some policy difficulties regarding B and C class institutions. There would be large variations if similar policy is applied in all financial institutions. It is difficult to manage as there are institutions confined to a district and also large national institutions. Now, we have addressed it through a new policy. We have let them decide independently on salary but based on certain backdrops.

How long will it take to improve the BoP situation to a comfortable level?

BOP has improved lately and it was in surplus in June/July. It will continue to improve in coming months too. I don’t think we will go into deficit this year but having said that we should not stay idle. It is getting positive and we are optimistic. There are countries which have deficit balance of payment and are still considered developed. In countries like ours, where there is small source of income and imports are big, some discipline must be maintained like increasing our productivity in sectors like agriculture and increased credit flow to the productive sectors. Internal production immediately helps BoP. We have requested financial institutions to invest in such areas. When the government budget flows to those areas, production increases and jobs are created. That will have multiplier effect and export will also increase. Import of luxurious goods must be discouraged while development oriented activities must continue. Other options than remittance also need to be sought to remain in safe position.