Taskforce Recommends Classifying Banks Based on Good Governance Indicators

A high-level taskforce has recommended classifying banks and financial institutions based on good governance indicators and introducing incentive schemes alongside regulation to improve the banking sector.

The recommendations of the Banking Sector Reform Recommendation Taskforce, led by former chair of SEBON Dr Rewat Bahadur Karki, made public by the Nepal Rastra Bank on Tuesday proposes implementing the concept of “basic regulation with enhanced supervision” by categorising banks according to prescribed standards and regulating and incentivising them accordingly.

Under the proposal, banks would be classified into first, second and third categories based on indicators such as customer service, overall risk management assessments conducted by NRB’s Supervision Department, regulatory actions taken by the central bank, and financial health indicators including capital adequacy, asset quality, earnings and liquidity. Separate directives and circulars would be issued for each category, reads the report adding that institutions placed in the first category would be encouraged through greater self-regulatory space and various forms of recognition.

The taskforce has suggested forming a committee, chaired by a former governor or a respected banking-sector expert, to carry out the classification using data from the past five years. The classification would be conducted annually in mid-July and published on the NRB website. Regulation and supervision would then be applied through category-specific circulars and directives. The report also recommends imposing financial penalties that are 10 percent higher on third-category institutions than on first-category ones for similar violations.

For first-category institutions, the taskforce has proposed policy incentives such as exemption from the interest rate spread cap and the freedom to set fees for all services other than basic banking services. Additional incentives include formal recognition of bank chairs, directors and chief executive officers at NRB’s annual programme, special interaction opportunities, and facilitation for study visits to reputed institutions such as the IMF and the World Bank.

Taskforce member and former president of the Nepal Bankers’ Association, Bhuwan Kumar Dahal, said the current practice of issuing uniform directives to all banks fails to reward good performers.

“Institutions that do not comply may face action, but there is no provision to encourage those that perform well. That incentive mechanism is necessary,” he said.

In recent times, bankers have criticised the central bank for excessive micro-level intervention. The taskforce has also noted that some policy directives amount to micro-management and run counter to liberal economic principles.

Non-merged banks perform better

The Banking Sector Reform Recommendation Taskforce Report, 2082 concludes that banks which have not undergone mergers have generally performed better than those that have. Citing weaker performance among merged institutions, the taskforce has advised banks to approach mergers cautiously and only after adequate preparation.

“Mergers and acquisitions should not be rushed. They require careful integration of operations, software, products and, importantly, human resources—from the board level to lower tiers. Institutions that have paid due attention to these aspects have been relatively successful,” the report states, adding that most non-merged institutions currently show better overall performance.

The taskforce has also suggested studying the option of appointing new individuals as board chair and chief executive officer to improve post-merger performance.

In addition, the report proposes granting merging institutions the authority to decide on swap ratios and other procedural matters in line with prevailing laws, while urging NRB to facilitate the timely completion of such processes. It also recommends encouraging institutions with cross-holdings to move towards mergers.