Market of Financial Services
BY Madan lamsal & Keshav Gautam
The government's efforts over the last four decades to increase the access of the poor to formal financial services have failed, concludes a study by The World Bank and the DFID. The reason for the failure, according to the report, is that the government focused on the symptoms of the problem rather than its root causes.
Though the government has forced the banks to maintain that a certain portion of their total lending is in the priority sector and deprived sector, its sustainability is not assured. According to the report, when NRB reduced the priority sector lending target for the commercial banks, the result was a decrease in the total lending to priority sectors. Among the 17 commercial banks covered in the study, 11 were found not meeting the target and happy paying fines for the shortfall.
Among those that met the target were state-owned Nepal Bank Ltd. and Rastriya Banijya Bank. While 85 per cent of lending from these two to the deprived sector was indirect (i.e. they lent through the microfinance institutions), this percentage was over 99 per cent in case of four other banks that met the target and avoided paying fines.
All these indicate that the financial services market has failed to reach the rural areas and small businesses - a proof that the Nepali financial market lacks the basic efficiency that is the feature of developed countries while other developing countries have already marched far ahead along the path to efficiency.
The case in point, as cited by the report, is that of Mongolia . In 1991, Mongolia had created Khan Bank from the assets of a former state bank with the goal of serving the rural areas. It was placed on receivership in 2000, recapitalised and put under a restructuring plan under which one large component was downsizing. Later in 2003, it was privatised and between December 2001 and June 2006 its loan portfolio grew from $9 million to $149 million. In June 2006, it had 410 branches, all profitable.
This success story contrasts with Rwanda 's case. After hundreds of credit cooperatives emerged in Rwanda over a decade, building a base of depositors three times that held by commercial banks, in June 2006 the central bank announced immediate closure of eight of the cooperatives citing gross mismanagement. The decision had its root in November 2005 when the government had closed a saving and credit cooperative on similar charges. The others were then issued warnings, but in vain. The result was the loss of people's confidence in the entire system.
Against this background, the question is: Which of these two examples do the Nepali authorities prefer? Clearly the present condition in Nepal is closer to that of Rwanda in view of the innumerable credit cooperatives and microfinance institutions over which the central bank is not able to exercise enough monitoring.
Among the major findings, the interesting one is that only 26 per cent of Nepali households have a bank account while only 15 per cent of Nepali households have outstanding loans from the formal sector only. And 38 per cent have loan outstanding only from the informal sector while 16 per cent have loan outstanding from both sources.
Even among the wealthiest households, half of those that have bank accounts prefer to borrow from informal sources, says the report. According to its finding, small businesses prefer informal sources for working capital loans. Among the formal sources of credit, the financial NGOs and cooperatives dominate the market for loans of sizes below Rs. 50,000.
Though the banking sector is expanding its network within and outside the country to tap remittances received from Nepali migrant workers, the report says, just six per cent of it is saved in banks.
Among the major problems with the microfinance institutions, according to the report, is a stagnating loan portfolio despite high liquidity. Capital adequacy ratio is as high as 19 per cent in some microfinance institutions against the minimum requirement of eight per cent. Clearly, they have money, but they are not lending it while people are clamouring for funds and borrowing from informal sources.
The report observes that the microfinance institutions are weak in almost all respects of management - internal control, MIS, HRM, accounting, business planning etc. More important for policymakers is the conclusion that the microfinance institutes have no incentive to expand their outreach as doing so would incur higher costs and lower revenue.
One interesting statement of the report is that microfinance is not appropriate for the poorest of the poor. It says outright grants may be more appropriate for them due to the lower cost of administration.
The stern remark of the report about the central bank is that the supervision of microfinance institutions is very impracticle - many big ones are not supervised while even tiny ones are supervised. And the consumers don't know which ones are supervised and which ones aren't. As a result, there is no incentive for the institutions to get supervision.
No loan to small businesses
The report's conclusion that the banks prefer not to lend to the small enterprises is worth noting. Though most of the causes for this as noted in the report are in a way general knowledge, some others are new and eye-opening.
Among the major causes noted by the report as to why banks have failed to increase loans to small businesses is the lengthy procedure that small borrowers find difficult to deal with. The report says, the overdraft facility is not useful for small businesses because they don't deposit the revenue in bank accounts.
More important is the conclusion that the interest rates that the banks charge small borrowers are much less than the cost to the bank. This is clearly a disincentive for the bank to lend to the small businesses. Obviously, the banks are quoting this interest rate but not providing any loan. It is done for two reasons. First, to observe the directive of the Central Bank and second, to claim that they are responsible corporate citizens. But it is for anyone to see that the teeth that bite are different from those that are visible.
As to the other cause of not lending to the small businesses, the report says, the banks require immovable asset as collateral while the small businesses have mainly movable assets. There is no registry to register immovable assets taken as collateral, hence there is a risk of lending against the same asset twice. Banks try to avoid this.
The report is critical of the banks also for their failure to use their lavish management information system to monitor loans. It is being used only to monitor its employees.
Another reason for low credit to small businesses is the fact that the credit information bureau records loans above Rs. 1 million only. Hence there is no credit information available for small borrowers so this makes it risky for the banks.
As another reason, the report cites the stringent rules that require high loan loss provisioning on loans extended against the collateral of movable assets. This discourages banks from lending to small borrowers, it adds.
Recommendations
To solve the problem, the report has suggested selecting some banks and providing them with technical support to develop their capabilities as was done in Mongolia for the Khan Bank. In this regard, the first candidates can be the Nepal Bank Ltd, Rastriya Banijya Bank and Agriculture Development Bank due to their nationwide branch network. However, the private sector banks too can be selected if they come up with viable plans for the same.
Another suggestion is to create an enabling environment for such lending. One such step is to provide a registry for collateral of immovable assets, while the other is reforming the Credit Information Bureau so that the credit information is available for all borrowers -big or small. In this regard, the report has cited examples of Albania and Romania where the creation of the registry for collateral of immovable assets has yielded very fruitful results.
Next, the report has suggested the promoting of the microfinance industry by upgrading technical skills by renergising and reforming the state-owned providers. It also suggests facilitating the entry of foreign institutional investors in the microfinance sector.
In another suggestion, it has asked the authorities to create a regulatory environment to protect microfinance consumers. It says, supervise only the big providers of microfinance and explore the possibility of auxiliary supervision of the tiny ones.
Whether the government and the central bank will really listen to these or go about trying some avoidance tactics is yet to be seen. However, the track record suggests they will go for the latter. Given the low level of education about efficient financial market among Nepalis, there is no strong pressure group to force the authorities to go for more logical steps. With the ascendancy of the Red in politics, such reforms are more likely to be stalled than expedited unless the donors really do the tail-twisting, in which case it would be another instance of donor-driven reform.
