When the new financial setup under the federal system was under preparation, a policy was formulated to encourage commercial banks to expand their presence in all the 753 local levels of the country. However, development banks were excluded as the Financial Comptroller General Office (FCGO) opposed the proposal to include such financial institutions despite NRB and the Ministry of Finance principally agreed on it.
At present, commercial banks in Nepal are well-protected and supported by legal and regulatory frameworks. The attention given to such financial institutions has created an environment for them to succeed. Seeing the performance and profitability of commercial banks, we adopted the concept of universal banking and the government in 2016 endorsed the Financial Sector Development Strategy. We moved further to adopt concepts such as bancassurance and allowing banks to operate stock brokerage firms as subsidiaries. Later, we asked commercial banks to establish small and medium enterprise (SME) units. However, this approach has not worked as expected.
While, different types of formal financial sources and channels such as banks, microcredit institutions and cooperative organisations, and also informal financial sources are available, borrowing money has remained difficult for those who are looking to become entrepreneurs or expand their existing businesses. The difficulties faced by SMEs and startups in their growth are mainly related to access to finance. In Nepal, such businesses do not have the ability to go for direct financing such as issuing shares and bonds and have to seek indirect financing i.e. bank loans. Also, the ongoing merger and acquisitions drive in the BFI sector is creating big financial institutions and their priority is large-scale financing than lending money to SMEs and startups.
After the government opened the banking sector for private investment in the early 1990s, there was a vibrancy in the Nepali financial sector which lasted till the early 2010s. We don’t see such exuberance in other sectors except in tourism at some point of time. Due to financial constraints, SMEs and startups are unable to come ahead with products and services to scale-up their business quickly in order to achieve noticeable growth.
We are talking about the private sector-led development of the country by fostering a vibrant environment for SMEs and startup businesses. Here, one of the responsibilities of the government is to manage appropriate financial institutions that can support the growth of such businesses in the country. Sticking to the ‘one size fits all’ notion will not help flourish an environment conducive to entrepreneurship development in the country. It is because, the financing needs of businesses of different sizes are different. And, the nature of financial institutions catering to their needs should also be different. So, we need banks in the local levels that will collect deposits and mobilise the financial resources only in their operational areas. This can be a spur to develop entrepreneurship. Establishment of such banks will also help local governments to expedite the process of budget formulation, revenue mobilisation and development activities.
We should also see this in the light of the changes that have taken place in our country. Nepal adopted a federal system of governance because it was felt that people were not getting services properly and the country’s development was uneven in the unitary system. I think it will take a long time to achieve results in entrepreneurship development moving ahead with the universal banking. So, the government and NRB should adopt the three-tier system (3TS) for development banks comprising of banks in national, provincial and local levels.
It’s been over 12 years since NRB stopped issuing licences to establish new banks. Due to M&As, the number of development banks has shrunk to 18 at present from 88 a decade ago. 70 percent of such financial institutions were operating outside the Kathmandu valley and most of them lost their existence in the process of banking consolidation. Now the central bank needs to open licences to establish development banks in the provincial and local levels. This is also important for transferring knowledge and technical know-how about investing, opening and operating banks to the new generation of investors. Having this kind of financial infrastructure is necessary for a well-balanced growth of all provinces, thus helping in the holistic economic development of Nepal.
(This article is based on a conversation with Thapa who is former Executive Director of Nepal Rastra Bank.)