Chapter 1 Financial System in Nepal

The Nepali financial system consists of banking and non banking sector. Banking sector consists of Nepal Rastra Bank (NRB) as the Central Bank and the Commercial Banks. The non banking sector includes, financial institutions licensed by NRB like Development Banks, Finance Companies, Microfinance Development Banks, Coop Financial Institutions, NGOs undertaking banking activities and those under different Acts like Insurance Companies, Citizens Investment Trust, Postal Savings Offices, Employees Provident Fund, Nepal Stock Exchange and Commodity Markets. History The origin of the modern Nepali Financial System can be traced to the establishing of Nepal Bank Ltd as the first commercial bank of the country. It was established under Nepal Bank Act, 1994 B.S. The Government of Nepal owned 52% and general public 48%. It started the banking system in the country and also public private partnership in financial sector. In addition to commercial banking operations, it was also permitted to function as banker to the Government. Establishment of Nepal Rastra Bank under the NRB Act 2012 was another important milestone for the development of banking system in Nepal. Nepal Industrial Development Corporation was established in 2016 B.S. and it brought in the concept of development banking in the country. Its objectives were to provide technical and financial assistance to industries. Though it was licensed to undertake banking transactions, its activities are subdued.
1

Thereafter Cooperative Bank was established, which commenced the compulsory savings scheme for farmers. Later, this was merged with Agricultural Development Bank Ltd. The latter was primarily for Development of Agricultural Sector. It has wide reach in both urban and rural areas and in addition to development banking is actively involved in Commercial Banking also. Rastriya Banijya Bank was established as a fully government owned entity in 2022 B.S. for Development of Commercial Banking Activities. It has a wide branch network all over the country. A savings institution established as a fully government owned entity in 2022 B.S. for Development of Commercial Banking activities and has a wide branch network all over the country. In the aftermath of liberalization of economy, Nepal Arab Bank (presently NABIL Bank) was established in 2041 B.S as a first foreign joint venture bank. This was followed by other banks like Nepal Indosuez, Nepal Grindlays etc. A number of Commercial Banks were also established by Nepali Investors leading to an emergence of a growing and competitive commercial banking sector in the country. In the last decade there was phenomenal growth of Financial Service Industry and the present position of various participants including their share of business is indicated below: Number Share of Business

Commercial Banks 32 Development 87 Banks Finance 79

80.8% 8.0% 9.6% 1.6%

Companies Micro Finance 21 Development Banks Savings Credits Cooperatives NGOs Rural Development Banks Total 254 38 and 16

Nepal Rastra Bank Under the provisions of Nepal Rastra Bank Act 2012, Nepal Rastra Bank (NRB) was established in 2012 B.S. as Central Bank of the Country. It played a crucial role for Development Banking Industry and has effectively circulated Nepali Currency. NRB Act 2058 replaced the earlier act. This has made NRB a more autonomous and responsible regulator as well as supervisor of Financial Sector. Section 4 of NRB Act 2058 spells out the following as its objectives: i) To formulate necessary monetary and foreign exchange policies in order to maintain the stability of the price and balance of payment for sustainable development of economy and manage it. ii) To promote stability and liquidity required in banking and financial sector. iii) To develop a secure healthy and efficient system of payment. iv) To regulate, inspect, supervise and monitor the banking and financial system. v) To promote entire banking and financial system of Nepal and to enhance its public credibility. To achieve these objectives the functions, duties and rights of the bank have been details as under: i) To issue bank notes and coins. ii) To formulate and implement monetary and foreign exchange policies. iii) To determine the system of foreign exchange rate iv) To manage and operate the foreign exchange reserves.
4

v) To issue license to banks and financial institutions and to regulate, inspect, supervise and monitor their transactions. vi) To act as a banker, advisor and agent of Government of Nepal. vii) To act as banker to banks and financial institutions and to act as a lender of last resort. viii) To establish and promote a system of payment, clearing and settlement and to regulate these activities.

As mentioned above Nepal's Financial System consists of banking and non banking sectors. The banking sector includes NRB and A class Commercial Banks. Non Banking sector consists of B category Development Banks, C category Finance Companies, D category Microcredit Development Banks (including Grameena Bikas Banks), Savings and Credits Co-operatives (SACCOS) with limited banking license, and FINGOS with limited banking activities and other financial institutions like Insurance companies, Employees Provident Fund Organization, Citizens' Investment Trust, Postal Savings Offices, Nepal Stock Exchange and the Commodity Exchange.

The semi formal sector consists of savings, credit or other cooperatives registered with registrar of cooperatives. The informal sector consists of informal groups like Dhukuti groups who pool their savings and extend credit to members, moneylenders and individual.

RMDC

The Rural Microfinance Development Centre is an apex wholesale lender and capacity building institutions for promotions and development of Nepal's microfinance sector. It was established with ADB support in 1998. It is promoted by NRB and Commercial Banks. Major activities include providing wholesale loans, institutional capacity building support to partner institutions, training support to end users in areas like adult literacy, entrepreneurial and skills development, group development etc.

Centre for Microfinance Ltd.

The Centre for Microfinance Ltd. was registered under Companies Act in July 2000, and is promoted by Canadian Centre for International Co-operation. It provides training, technical assistance and consultancy service for microfinance sector. Its mission is to promote and strengthen Microfinance Services through capacity building, training, knowledge management, research, policy lobbying, consultancy and networking with mutual trust and co operation among service receivers, practitioners and stakeholders.

In addition to the aforementioned institutions the following institutions have helped in formulating standards and ensuring compliance of the member institutions:
6

i) Nepal Bankers' Association ii) Microfinance Bankers' Association of Nepal iii) Microfinance Institutions' Association of Nepal iv) Nepali Federation of Savings and Credit cooperatives Union Ltd. v) Insurance Board- the regulator for Insurance industry vi) SEBON vii) Development Bankers Association viii) Nepal Finance Companies Association Further, National Banking Training Institute functions as an apex training institute for the entire financial sector. Financial Sector Reforms Nepal's inflation rate has been hovering around 10% for the last three years; the food inflation has been higher than non food inflation. Historically, its inflation had correlation with inflation in India due to a fixed peg of Nepali Rupee to the Indian Rupee, the trend has changed to the lag in pass through of international oil prices and increase in real interest rate. Financial Sector Reforms (FSR) initiated from 2002 onwards has tackled the following main issues: a) Strengthening the autonomy of Nepal Rastra Bank and improving its supervisory capability. This has been achieved by passing of new Nepal
7

Rastra Bank Act and divesting of ownership of NRB in institutions where it has supervisory responsibility. b) Improving the governance of Commercial Banks and Financial Institutions: Banks and Financial Institutions Act and Debt Recovery Act were passed to give a legal framework for improving Assets quality and Governance issues. c) Restructuring the Problem Banks in the Public Sector; recapitalizing and bringing professionalism in Nepal Bank and Rastriya Banijya Bank action initiated. Monetary Policy The framework of the monetary policy of the country and the instruments of the policy are given in the following table: Instrument Cash Reserve Ratio Policy Rates Direct Operating Target Short Intermediate Target Term Monetary Aggregates Interest Rate Goals Price Stability Economic Growth Employment

Interest Rate Monetary Base

Control Excess reserve Exchange Rate

(interest setting and of Commercial credit control) Banks Open Market Domestic Credit Inflation Operations Moral Suasion Exchange Rate Stability BOP Surplus

The monetary policy is administered by Nepal Rastra Bank through the above instruments. The position is reviewed periodically at least once in a year and the necessary actions to achieve the goals, including course corrections are taken. Capital Market The history of Securities market began in Nepal with the issue of shares by Biratnagar Jute Mills and Nepal Bank Ltd. in 1937. Introduction of Companies Act, issue of Government Bond in 1964 and established of Securities Exchange Centre in 1976 were other important milestones. The latter was established with the objective of growth and development of capital markets. SEC was later converted into Nepal Stock Exchange (NEPSE) in 1993. The basic objective of NEPSE is to impart free marketability and liquidity to government and corporate securities by facilitating transactions through its trading floor through members and market intermediaries like brokers, market makers etc. Government of Nepal, NRB, NIDC and members are the shareholders of NEPSE. It has introduced fully automated trading system from 2007. It has adopted a T+3 settlement system. A provision for Blank transfer is also available with T+5 as the maximum permissible time. The shares, preference shares, Government bonds and corporate securities are traded in the above Exchange.