Services Trade in Nepal: A Comparative Case Study of Banking and Insurance Sectors

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Services Trade in Nepal: A Comparative Case

Study of Banking and Insurance Sectors

D. R. Khanal

Institute for Policy Research and Development



Scope of the Study

„ Briefly assess the liberalization policies perused in the banking and insurance sectors especially since 1990s,

„ Examine the strengths and weaknesses of the banking and insurance sector liberalization in the light of their contribution in raising efficiency and competitiveness,

„ Make comparative assessment on the role of joint venture, private and government owned banks and insurance companies promoting business and enhancing access to credit with special focus on gender dimension,

„ Explore the possibility of enhancing the role of banking and insurance services in the Nepalese economy and chalk out strategies to be appropriate in the preferential trade agreements especially to the LDC countries like Nepal.




an analytical approach for examining the features of

banking and insurance sector liberalization and reviewing

their strengths and weaknesses,


quantitative analysis for assessing the efficiency of

banking and insurance sectors as well as examining the

effect on access to services and employment creation,


a case study of banking sector (one each from government

owned, domestically private sector owned and joint

venture banks) to look into the impact on efficiency,

access to credit and employment in a comparative way.


Financial Sector Liberalization: Driving

Forces and Present Status

„ Driving Forces

„ Unilateral

„ Regional Commitments

„ Multilateral Routes (WTO)

„ Although, prior to the accession to the WTO in April 2004, Nepal’s financial liberalization was carried out by the government unilaterally, donors were mainly instrumental. The first phase of financial liberalization which began in mid 1980 was influenced by the conditions laid down in the Structural Adjustment Program (SAP) of the WB and IMF. The second phase of wide ranging liberalization which began in the early 1990s was driven by the conditions incorporated in the Enhanced Structural Adjustment Facility (ESAF) Program of the IMF. Wave of liberalization including liberalization in India also contributed to the liberalization drive in Nepal.



Some of the major reforms carried out before accession

to the WTO include

„ Interest rate deregulation

„ Permission to establish banks and insurance companies in the

private sector including foreign equity participation up to 66 percent in banks and 100 percent in insurance sector in a case by case basis.

„ Phasing out of private sector lending by 2007.

„ Enactment of various laws including Nepal Rastra Bank Act

2002, Debt Recovery Act 2002 and now Bank and Financial Institutions Act 2006 aimed primarily at enhancing prudential rules and regulations in the financial institutions and raising competitive strength.



So far no major commitments under SAFTA

and BIMESTC. However, SAARC member

countries have decided to include service trade

within the free trading framework and a decision

on this respect is expected in coming month.


More importantly, Nepal has made certain

commitments under WTO membership

obligation having far reaching implications on

further opening up the banking and insurance

sector. Accordingly, Nepal must allow foreign

wholesale banking and insurance by 1





Some Specific Policy Measures

„ Rules on Ownership

„ In general, at least 51 percent ownership should be occupied by promoters to establish any bank and financial institutions. At least 30 percent shares of total paid up capital should be allocated for general public.

„ Rules on Location

„ To establish a commercial bank operating all over Nepal, the paid up capital must be at least Rs 1 billion. For outside the Kathamdnu paid up capital must be Rs. 320 million.

„ Legal Forms

„ Banks to be established with foreign promoters' participation have also to be registered fulfilling all the legal processes prescribed by the prevalent Nepal laws. For the establishment of Joint Venture Bank, the share capital of foreign joint venture bank should be at least 20 percent and it can't exceed 75 percent ( banks which are already operating in Nepal, otherwise two third at the most) of total paid up capital.


„ Branching

„ The Commercial banks established with a head office in Kathmandu are authorized to open a main branch office in the Valley initially and thereafter one more branch in Kathmandu Valley and then only branches outside Kathmandu Valley.

„ Rules on Employment

„ There are no specific rules and regulations that are required to be incorporated in the rules of employment. For employment to the foreigners separate technical agreement is required.

„ Prudential Regulations

„ Rules and regulation directives of the central bank. Which include (I) Maintenance of capital adequacy, (ii) Loan classification & loan loss provisioning, (iii) Limit of credit exposure and facilities to single borrower, group of related borrowers and single sector of the economy, (iv) Accounting policies and formats of financial statements, (v) Minimization of risk, (vi) Corporate governance, (vii) Time-frame for implementation of regulatory directives issued in connection with inspection & supervision of the banks, (viii) Investment in shares & securities, (ix) Statistical reporting by commercial banks to NRB and (x) Sale and transfer of promoters share (xi) Provision related with Consortium financing (xii) Provision for blacklisting (xiii) Maintenance of Cash reserve ratio (xiv) Provisions for bank branches (xv) Provisions relating interest rate (xvi) Provisions related with financial resource collection.

„ Off-Site Inspection

„ Special Inspection




„ The Insurance Act, 1992 and Insurance Regulation, 1993 are the main guidelines for the administration of the insurance industry in Nepal.

„ There is no restriction on pattern of ownership, location of business inside the country and in legal forms. However, in case of foreign joint venture, 20 percent of the share should be issued to the public for general subscription. The insurer is not allowed to operate life insurance and non-life insurance business side by side through the same organization.

„ There is a provision in the Insurance Act, 1992 that the Insurance Board may cancel the registration of an insurance company in the circumstances if the head office of the insurance business of any foreign insurer is situated out side Nepal, and in case it is felt that Nepalese insurer has not obtained equal facilities while operating in the foreign countries as enjoyed by the foreign insurer pursuant to the prevailing law of such country.





The insurer may operate life insurance business

under (a) whole life insurance (b) endowment

life insurance and (c) term life insurance


The foreign investor making an investment in

foreign currency shall be entitled to repatriate

share of equity, profit or dividend, and also

principal and interest on foreign loan.


The Insurance Board formulates policies for

systematizing, regulating, developing and

controlling insurance business.



Exchange Rate Policy


Nepal constantly is following two sets of policies

regarding the exchange rate-one for the IC and another

for convertible currencies.


The liberalization of the exchange rate gained momentum

after India introduced partial convertibility of the current

account in 1993. Nepal accepted the Article VIII of the

IMF in 1993 and thereby fully liberalized the current

account. Now convertible currency rate is market



However, Nepal has not been able to liberalize exchange

rate with India despite misalignment of the prices hurting

business competitiveness of Nepal.


An Overview of Financial Sector


0 10 20 30 40 50 60 Number 1980 1985 1990 1995 2000 2005 Fi sc a l Y ea r

Growth of Financial Institutions


Total Assets of Financial Institutions (Mid- July 2005) CB 87% Others(Cooperativ es and NGOs) 1% MCDB 1% DB 5% 6%FC


0 10 20 30 40 50 60 70 80 90 100 Percentage of Participation NBL RBB NABIL NIBL SCBNL HBL NSBIBL NBBL EBL BKL NCCBL NICBL LB MBL KBL LXBL SBL Ba n k

Commercial Banks and Their Ownership Pattern



Total Assets, Deposit and Credit in the Bank ing System (Mid July 2005)




0 5 10 15 20 25 30 35 40 45 50 Share in Percentage 1990 1992 1994 1996 1998 2000 F is cal y e ar s

Lending Portfolio of the Comercial Banks


0 10 20 30 40 50 60 70 Percentage HHB Banks BRELATIVES BM LEND PPQABB PRQABB Bo rr o w in g

Household Borrowing and Access to bank Credit


0 5000 10000 15000 20000

Total Number of Employees

1991 1995 2000 2001 2005 F iscal Y e ar


0 2 4 6 8 10 12 14 16 Number Government Owned Private Sector Foreign Joint Venture Total T yp es o f O w n er sh ip

Ownership Structure at a Glance (Insurance)


0 5 10 15 20 25 30 35 Percentage 1996 1997 1998 1999 2000 2001 2002 2003 Fi sc a l y e a rs

Sectorwise Collection of Premium of Non Life Insurance


Investment Portfolio of Insurance Business






















Rs in million












Number of Employement












Status of Employment


Case Studies of Three Banks

0.0 5.0 10.0 15.0 20.0 25.0 30.0 Ratio 2000 2001 2002 2003 2004 2005 Fi scal Year

Loans to Staff Ratio


0 10 20 30 40 50 60 70 Percentage 2000 2001 2002 2003 2004 2005 Ye a r

Percentage of Non-performing Loan


0 20 40 60 80 100 2000 2001 2002 2003 2004 2005 F is cal Year

Fee Based Income to Total Income


0 1 2 3 4 2000 2001 2002 2003 2004 2005 F iscal Y ear

Net Interest Income to Total Assets


0 5 10 15 20 25 30 35 40 45 50 2001 2003 2005 F is c al y ear

Distribution of Loans by Business types of RBB


0 5 10 15 20 25 30 35 40 45 Share 2001 2003 2005 Fi sc al y ear

Distribution of Loans by Business Types of SCBNL


0 10 20 30 40 50 60 70 Share 2001 2003 2005 F is cal Y ear

Distribution of Loans by Business Types of NIB




„ Banks are engaged in developing new products and services. Most of the banks now use swift and Epabx for speedy banking transactions. Banks are also providing limited Internet banking facilities. Further extension will take place after the introduction of Cyber law in Nepal. Auto loan, home loan, education loan, employment loan, debit card, VISA and Master Card are increasingly becoming popular products of the commercial banks.


Internet Transactions vs Other the Counter

„ Banks have started to make certain banking transactions through internet banking. Mobile banking is used for balance enquiry, statement of transactions, alert notice etc. In general more than 98 percent of banking transactions are made over the counter. Now banks have started providing services of ATM, payment of electricity bill, telephone bill etc.



Risk Management in Commercial Bank


Very few banks have developed consumer scoring

model on their own but it is not a major criteria for

the purpose of providing loans or provisioning the

loan losses. The advanced form of loan grading and

credit portfolio management models are not used in

the commercial banks. Only very few banks do have

their internal risk based provisioning model. The risk

based provisioning model is not used in Nepal.


Conclusions and Implication for

Managing Change



„ Both industry and trade have been beneficiary of banking and insurance sector liberalization. Profitability ratio, margins, spread rate, fee based income to total income ratio, interest

income to total assets ratio and labor productivity in the form of loan to labor ratio indicate that efficiency of the private and

joint venture banks has greatly enhanced. They have employed a large number of people overtime.

„ However, an assessment of the entire banking system by including two government owned banks gives completely a different but disappointing picture. Studies show that these two banks became technically insolvent in 2002 as the share of non-performing assets in these banks reached about 60 percent of the total assets. The huge negative net worth and profitability has had very severe adverse effect on the entire financial system.



Although after contracting out the two banks to the foreign

companies some improvements in their performance has taken

place, adverse employment implication has been very large.

The deepening crisis in these banks has undermined the good

performance demonstrated by the private domestic and joint

venture banks. Access to the credit among the rural populous

has decreased over times. Similarly, the private domestic and

foreign joint venture banks have almost confined their

investment in the urban center with priority on lucrative

business. As a result, despite huge expansion in their

investment the productive areas have been least benefited.

This is true in case of insurance companies also. The

investment portfolio of such companies reveals that most of

their funds are kept in fixed deposit.



Implications for Policy Design and Implementation

„ Unilateral move under the external influence without rigorous domestic analysis examining the pros and cons would have very adverse effect on enhancing competition and ensuring healthy

development of the financial sector. Particularly, enactment of laws, development of institutional capacity both in central and concerned banks in terms of strengthening regulatory system would be a key in this respect.

„ One important implication from the policy design perspective is that unless excessive influence of the state in government run banks or insurance companies is stopped and restructuring is started

simultaneously that would have negative spill over effect on the entire financial system.

„ As the multilateral route through WTO compels to introduce various acts in the course of meeting WTO obligations, it would help

enhancing institutional and technical capacity. Hence, the multilateral route could be more viable and effective.



Managing Change


Strong curative as well as preventive measures for

improving the performance of the two banks is warranted.

While introducing measures, restructuring of two

commercial banks at a faster pace along with strong steps

to reduce NPAs will need top most priority. Likewise,

bank capitalization, implementation of regulations

effectively, improvement in risk management, better

governance including rules to promote transparency and

strengthening the capacity of the supervisory authority

would be essential. Accountability, transparency and

strict financial discipline are critically important in the

whole reform and or restructuring process.


Introduction of new products and diversification of

financial services will also be essential to improve the

financial health of the banking system.



Reduction of transaction cost is necessary. For this

efficiency not only in business service but also in the

physical infrastructure and other support services

would be essential.


There is a necessity of timely fulfillment of the WTO

commitments. Strengthening of financial laws by

promulgating bank rules, banking fraud control laws,

Asset Securitization law and Trustee law, among

others would be essential.


Nepal has to allow foreign wholesale banking by

2010. On the other; the problems are magnifying in

the banking system. Therefore, Nepal’s experience so

far indicates that either review of deadline or some

support measures would be essential.



In view of access to credit among the rural populous

decreasing on the one hand and restructuring of banks making

very adverse effects on employment on the other,

consideration of some safeguard measures in the international

trade forums for the LDCs like Nepal would be essential.


WTO obligations insurance sector needs various reforms like;

(i) strengthening of legal, regulatory and supervisory

frameworks, (2) maintenance of soundness in operational and

management of insurance institutions, (3) introduction of

dispute settlement mechanism and strengthening of capital

base, (4) exploration of reinsurance business (5) deepening of

service reach to the general masses, (6) capacity enhancement

and integration among the insurance companies and (7)

reforms in activities of state owned insurance institutions.