Financial Sector Reforms in Nepal

Financial sector is the backbone of any of the economy. It works as a facilitator for achieving sustained economic
growth through efficient financial intermediation. In market economy, it is widely accepted that following three
foundations are required to systematically function the financial sector

1. Liberalization of the financial sector- participation of private sector

2. System of prudential regulation and supervision- to prevent private sector against the interest of stakeholder
and general public.
3. Strengthening institutional infrastructure and building capacity of the system as a whole.
In this connection, economic liberalization in Nepal was initiated during 1980s by allowing financial sector to
private players. Significant growth in the number of banks and financial institutions has been observed during the
last three decades. Such growth was very rapid after the process of liberalization after mid eighties.

Financial Sector Assessment Program (FSAP) conducted by the World Bank and the IMF in various developed and
underdeveloped financial markets in 1999 highlighted that most of the developing countries were still in the
vulnerable situation, as they were not complying with the Basel core principles and International norms and Best
Practices.
The indicators of the financial sector of Nepal as well as the procedures exercised in the system had indicated that
the system was weak, vulnerable and risky. Therefore, a reform strategy was felt necessary to be launched in the
economy.
Financial Sector Reform (FSR) was adopted as a strategy aimed at making the financial system well diversified,
sound, competitive and supportive to the attainment of development objectives of the economy.
Objectives
The main objective of Financial Sector Reform Program was to support the renewed effort of the Nepal government
to improve the sector in order to bring macroeconomic stability and promote private sector-led economic growth.
The objectives of FSR can be listed as below.
o To create sound stable and healthy financial system.
o To strengthen the central bank by increasing the autonomy and capability of central bank for making its
monetary policy, supervisory and regulatory functions effective
o To build and maintain strong banking and non-banking sector,
o To improve existing legal and judicial aspects of financial system,
o To improve auditing and accounting standards within the banking sector,
o To promote financial discipline through adequate disclosure and competition,
o To initiate more focused interventions toward the programs for the upliftment of the poor,
o To re-orient the activities of Government and Nepal Rastra Bank from being active participant (owner) of the
financial institutions to a regulatory body.
o To build the capacity of staffs inside the NRB
o Reduce the level of Non Performing Asset
The Reform in the financial sector was announced in the Financial Sector Reform Strategy Paper (FSRSP) of the
government on November 22, 2000. The FSRSP of Government of Nepal has assigned an important and enhanced
role, responsibility and accountability to the central bank. NRB was assigned to focus and handle the following
reform activities in the financial sector:
o Reforming the Financial Sector Legislation
o Strengthening Bank Supervision and Inspection
o Restructuring and Privatization of NBL and RBB
o Enhancing Competition in the Banking Sector
o Reforming the Auditing and Accounting Capabilities
o Broad Based Banking
o Streamlining Ownership Structure
o Establishment of Banker's Training Institute
o Restructuring of Credit Information Bureau
o Establishment of Asset Reconstruction Company
o Revamping Research and Financial Monitoring Strength of Central Bank
o Broadening and Deepening the Financial System in Nepal
o Meeting Sectoral Financing Requirements
o Establishment of Development Banks at Regional Level
o Strengthening of Rural Development Bank
o Establishment of Credit Rating Agency
The financial sector reform program in Nepal was initiated with the financial assistance of the International
Development Association (IDA) of the World Bank group and a grant of DFID. It has provided a provision of
further enhancements depending on the progress of reforms. The approved two phases of the reform program are
 Phase I -Financial Sector Technical Assistance Project (FSTAP)
 Phase II – Financial Sector Restructuring Project (FSRP)
Financial Sector Technical Assistance Project (FSTAP)
It is the first phase project of financial sector reform program, which is focused on restructuring of the Central Bank,
initiating commercial banking reforms, and supporting financial reforms through its following three project
components.
o Re-engineering Nepal Rastra Bank
o Restructuring the Two Big Banks (NBL and RBB)
o Capacity Building in the Financial Sector
Financial Sector Restructuring Project (FSRP)
Financial Sector Restructuring Project was continuation of financial sector reform program as second phase in
Nepal. This project was centered around further strengthening of central bank of Nepal, NRB and deepening of
reform process within the two large banks, RBB and NBL so that they operate in a more commercially oriented
basis through its following four project components:
o Voluntary Retirement Schemes (VRS) in RBB and NBL
o Hiring of Sales Advisor (Restructuring Advisor)
o Phase II: NRB Re-engineering
o Management Team Support in RBB and NBL
Activities and Achievements
Following were the activities and achievements attained under comprehensive financial sector reform program.
Re-engineering of Nepal Rastra Bank
 IOS Partners, Inc., an American consulting agency was selected for the reengineering work of NRB. The IOS
Partners started work from March 2003 and submitted its report with recommendations and suggestion.
 The new corporate re-organization model based on functional activities of NRB was developed and
implemented since December, 2003 which has lead to elimination of functional duplication of works among
departments.
 Human resource functions have been restructured to enhance the professionalism, efficiency and productivity
of the staff of the NRB and staff level downsized through launching of three phases of Voluntary Retirement
Scheme. Training needs of all departments have been identified and accordingly training programs for staffs of
various departments have been / is being conducted.
 The staff compensation packages were reviewed and necessary adjustments were made and the personnel
byelaw has been reviewed and new one implemented by NRB in order to motivate, hire and retain the
experienced and skilled staffs within the organization.
 An international HR Advisor has been appointed and has been closely working with HR department of NRB.
He is doing exercise to form new HR policy as per the recommendation of IOS partners.
 In order to strengthen the inspection and supervision functions NRB Inspection and Supervision Byelaw 2059
have been implemented from March 18, 2003 and new inspection manuals on on-site inspection and offsite
supervision have been prepared.
  To develop the bank supervisory capacity of NRB and implement the recommendation of IOS Partners bank
hired consulting firm M/S IEF Inc. in association with KPMG Sri Lanka as international bank examiner. The
consulting firm submitted inception report to NRB.
 The IT/MIS were installed and improved.
Restructuring of NBL and RBB
Management
 Management Teams were placed in both NBL and RBB. ICC Bank Management Team “ICCMT” consisting of
international bankers from Bank of Scotland (Ireland) Ltd. was appointed in the NBL, initially for two years on
July 22, 2002 under the leadership of Mr. Craig McAllister. In case of RBB, the management team was
appointed on individual basis under the leadership of Mr. Bruce F. Henderson on January 16 January 2003 for
two years.
 The management team of both banks completed the financial analysis of their respective banks.
Operation
 Standardized System and procedures were prepared and implemented in both the banks.
 After loss position of several years, both the banks have turned around to a profitable position from F/Y 2003/04.
 The level of NPA were reduced in both the banks. The level of NPA of the NBL came down 60.47 percent of
Mid July 2002. Likewise, the NPA of RBB came down from 60.15 percent of Mid July 2003.
 Negative capital fund of both the banks have been reduced.
 Branch rationalization taking place in both the banks.
Credit
 New standard Credit Policy Problem Loan Guidelines, Loan Recovery Guidelines, ALM Guidelines, Inspection
manual have been prepared and implemented in both the banks.
 A continuous negotiation and dialogue with big defaulters has been initiated and around Rs. 7.49 billion of loan
categorized as NPA has been recovered in cash and Rs 2.75 billion restructured till mid July 2006 in case of
NBL. In case of RBB, the management team has established seven core teams in order to make adequate efforts
toward loan recovery and loan administration, which has been able to recover Rs 9.34 billion in cash and
restructure 2.55 billion NPA restructured till mid July 2006.
 New consumer loans introduced in both the banks.
 Cases are being filed to Debt Recovery Tribunal by both banks for recovery of NPA
Accounting and Audit
 New accounting manual, Budget manuals, charts of accounts were prepared and implemented in both the banks.
 Pending statutory audits of last several years of both the banks were completed and updated up to FY 2005/06.
 Both the banks have been able to produce and publish the quarterly financial statement in regular basis since
2003.
Human Resource
 Significant improvements were done in HR development. Organizational restructuring and functional
restructuring were completed.
 A detailed Human Resource Master Plan and Skill Enhancement Plan were prepared and implemented.
 New Staff Bye laws and reward and punishment system initiated in both the banks.
 Staff compensation package was revised and employees were imparted trainings in various fields for skill
enhancement in both the banks.
 The staff levels of both the banks have been downsized through launching of various phases of VRS scheme
under FSRP-Phase II. NBL, which had altogether 5652 employees at the end of mid-July, 2002 were reduced to
2960 at mid-January 2006 and in case of RBB which had more than 5583 employees at the end of mid-July,
2002 were reduced to 3301 at mid-July 2006.
IT/MIS
 IT/MIS plans were prepared in both the banks in order to install modern IT / MIS system in the bank. The
procurement was completed.
 NBL initiated the implementation of NEWTON software in the branches and KASSEL for Treasury operations.
RBB initiated the Integrated Banking Information System in the branches for computerization.
Capacity Building in the Financial Sector
Legislative Reforms in Financial Sector
 The new NRB Act, 2002 was enacted which provided more autonomy, authority and accountability to the central
bank. As a result of enactment of the new NRB Act, supervisory, oversight, and regulatory functions have been
strengthened substantially.
 The Debt Recovery Act, 2002 was promulgated. Accordingly, the Debt Recovery Tribunal was established on
June 19, 2003. This legislative framework is a new attempt to make loan recovery aspect more effective and
reduce the level of NPA of the banking system.
 Bank and Financial Institutions Ordinance, 2004 was enacted to consolidate the fragmented legal bases such as
Commercial Bank Act 1974, Finance Companies Act, 1985, Development Bank Act, 1996 and other laws
governing some deposit-taking financial institutions have come under the single legislation.
 Secured Transaction Act, 2005, Insolvency Ordinance 2005 was enacted.
Regulative Reforms
In order to comply with the best practices and ensure a safe, sound and efficient financial system, the NRB
formulated and issued prudential regulations/directives for banks and financial institutions.
Strengthening of Credit information center (CIC)
Reform measures were initiated to establish and strengthen the role of CIC.
Others
 Training program for financial journalists was conducted to enhance their capability.
 New training programs on FSTAP for NRB employees were processed to upgrade the skill level and central
banking professionalism
 Various seminars/workshops relating to various aspects of financial sector were conducted with the participation
of all the major stakeholders of financial sector viz. central banks, commercial banks, development banks, DRT,
Judiciary, CIC, FNCCI, Ministry of Finance, Finance companies Media persons, Multilateral agencies etc.
 List of approved Auditors and Professional Director's were prepared and updated.
Conclusion
After the implementation NRB reengineering under financial sector reform program significant improvement have
been observed in organizational structure, human resources, accounting and auditing fronts, regulatory and
supervisory functions and information technology of NRB. Similarly after initiation of restructuring of NBL and
RBB, both the banks came up with positive financial performance indicators. The progress made by NBL and RBB
on Management, Operation, Accounting and Auditing, Human Resources, Credit and IT/ MIS in the process of
restructuring was quite encouraging . The financial sector reform phased out from end of December 2011.