Vol. 2 :: No. 07 June, 2000 (Jestha-Asadh)

Sectoral

Tea in Teething Troubles  

By Madan Lamsal

This more than century old industry of Nepal started growing only recently and is now demanding state support to cope with its teething trouble

Tea is the cheapest drink available and thus the number one selling beverage in the world. However, despite the comparative advantage that Nepal has in this sector, Nepali tea entrepreneurs find that the government is not taking necessary steps to fine tune it to face the changing global terms of competition.

While Nepali government is expediting the process to attain WTO membership, the Nepali tea entrepreneurs are getting scared of the patent problem that will crop up as its immediate impact. Despite over a 137 year long history of tea cultivation in Nepal, the country still does not have a single bush of tea patented as Nepali.

The problem is particularly of concern for orthodox tea entrepreneurs as compared to CTC tea producers. While CTC tea is primarily for home consumption and grown mainly in the Terai, the former is produced in hills and almost 100% of it is exported. Hill tea cultivation covers at present some 3000 hectare of land and yields some 350000 kg of made tea with an expected revenue of Rs. 120 million, according to Himalayan Orthodox Tea Producers Association (HOTPA).

Though CTC segment too has its own problems, the orthodox segment is getting more fidgety over the delay from the government in adopting a comprehensive tea policy, a draft of which the entrepreneurs have submitted to the government. According to Purna Kumar Sherma, Chairman of HOTPA, the policy is now learnt to be finally handed over by the cabinet to a team of four secretaries of HMG – Finace, Agriculture, Forests and Land Reforms. However, it is not clear when they will come up with their recommendations and when the government will formally announce the policy.

One of the major points of the proposed tea policy is to preserve the history of Nepali tea so that it can survive the patent invasion that is about to come under WTO regime. It also has proposed to fix a logo that the entrepreneurs can use on their export certifying it as an authentic Nepali product. According to Suraj Vaidya, Vice Chairman of HOTPA and owner of Guranse Tea Estate of Dhankuta, the Ministry of Commerce says that it would take about five years for the government to come out with such a logo. "But business people can’t wait that long", he says, and informs that HOTPA is, therefore, now preparing a logo on its own and formulating a system for the administration of the logo. "We’ll propose to the government that it be adopted as soon as possible," he says. Apart from serving as a quality certificate, the logo is expected to be a means to check leakage of tea from across the border, which would go out in the name of Nepali tea if there is no such system.

Purna Kumar Sharma

As contrasted to the earlier days when Nepali tea used to go across the border to Darjeeling of India from where it used to be exported as Darjeeling tea, now the reverse is likely to take place, tea entrepreneurs point out. Tea bushes in Nepal are younger than in Darjeeling and yielding better quality tea leaves. Thus, Nepali tea is gaining higher acceptance in the major tea markets in the world. Still, as of now, a lot of Nepali tea is finding its way to India where it is mixed with Indian tea to improve the quality of the lot.

This has resulted into an interesting development. The Germans, who are among the major buyers of orthodox tea, have become concerned about how some four million kgs of Darjeeling tea has suddenly started going to Germany while the production capacity of Darjeeling is only at around one million kg. Sunil Kumar Rai, Chairman of Rabi Sengchelengma Tea Estate Ltd. of Panchthar and a member of the management committee of HOTPA, thinks that a substantial portion of that excess Darjeeling tea is from Nepal.

Suraj Vaidya

Interestingly, while the production of such tea in Nepal has increased substantially, the Trade Promotion Center (TPC) has shown a decline in its overseas exports in 1997/98. Therefore, the entrepreneurs are also demanding with the government to develop a tea auction center in Nepal itself. At present some of the Nepali tea is exported directly overseas, but most of it is sold at Calcutta auction and the buyers in Calcutta mix it with Darjeeling tea. However, to set up an auction center is to cost an astronomical amount of investment. Realizing this, the entrepreneurs have suggested the government to rent a space in Calcutta auction exclusively for Nepali tea.

The history of tea cultivation in Nepal dates back to 1863 AD, when Gajaraj Singh Thapa, brother in-law of the first Rana Prime Minister Jang Bahadur Rana started it in Illam with saplings that Jang Bahadur received as gift from China. The garden sprawling across 120 acres of land near Illam Bazar still has a processing factory installed there in 1873 AD. And soon after the Illam garden was set up, another 150 acre tea garden was developed nearby at Soktim. Though the original bushes in the Soktim garden were later uprooted to plant new varieties of tea, the tea bushes in Illam garden and the factory there are standing as the living proof of the long heritage of Nepali tea.

The history compares well with other major tea growing countries of the world, since Sri Lanka’s history in tea dates back to 1867, Darjeeling’s to 1841 and Kenya’s to 1940. It shows that "we have been left behind in spite of an early start", as Vaidya wants to put it. It took about a century to resume further expansion of tea cultivation in Nepal, when the land reforms movement forced big landlords to look for ways to retain control over the large estates of their land holdings. And the government in 2035 BS set up Nepal Tea Development Corporation (NTDC), which managed the Illam and Soktim tea estates and also set up five other estates in Jhapa as well as in Illam district. The corporation is now being handed over to a private sector party, which will take over all the gardens as well as the factories previously being run by NTDC.

And the tea entrepreneurs are demanding that the garden as well as the factory of Illam be leased over to them. "We want to protect them as a proof of our history in tea", says Sherma who also owns North Nepal Tea Estate, Panchthar. "It should be decided early lest they (those to whom it is being handed over) demolish the factory and uproot the old plants", he cautions. Though the dilapidated factory or aged bushes now may have lost their economic value, they still have a ‘heritage value’ and HOTPA’s intention is to conserve it to show the world the proof of Nepali tea’s old history, Sherma says. And that proof will be very much helpful under the WTO regime. Moreover, the place can also have a technical school on tea by the side of the factory. "It will help to develop our own manpower in tea," he says. At present, the Nepali tea estates have been borrowing experts from India.

One of the reasons why Nepali tea sector is showing hopeful prospects is because of the growing tea demand in India where the land for expanding tea cultivation is getting scarce. Thus, entrepreneurs in Nepal feel that their time has now come. But it will be possible to take the advantage of this situation only when the government supports the sector in this teething period, the entrepreneurs think.

Entrepreneurs point out that tea has recently been attracting more and more of farmers, businessmen and people from other sectors. More so in case of hill orthodox tea and it is no longer confined to the five eastern districts (Panchthar, Dhankuta, Tehrathum, Illam and Jhapa) that the government has declared the tea zone. National Tea and Coffee Development Board (NTCDB) has recorded tea gardens also in Sankhuwasabha Sindhupalchok, Ramechap and Dolakha. HOTPA’s list shows them even in Bhojpur and Solukhumbu. And it is also being tried in places as west as Kaski. So one of the demands of the entrepreneurs is to provide the same facilities in those new areas as in the tea zone. The proposed tea policy is to remove the concept of limiting tea only in the five eastern hill districts.

Sunil Kumar Rai

The interest of the farmers in cultivating tea even in areas outside the tea zone is because tea is feasible in many places of Nepal, wherever the rainy season lasts for very long as it does in the Mechi and Koshi zones. And the small farmers have found it more profitable to plant tea than other crops. As Vaidya has calculated, one acre of land situated at the altitude of 5000-6500 feet yields the farmer only Rs. 6,450 in eight months if the crops farmed are maize and potato. The same piece of land will yield a steady monthly yield of 180 kg of tea, which translates into a monthly income of Rs. 3,241 totaling up to Rs. 25,930 in eight months. And that too without any substantial investment after the bushes have grown to maturity.

However, to reap that return, the farmer has to wait at least four years before the bushes grow to a level from where they start giving a regular income. For that reason HOTPA is advocating on behalf of the small farmers for state support to them for at least the first four years so that they can survive the teething problems. This will help make tea a viable proposition for farmers to invest, says Vaidya. This issue holds special significance in the industry also because, as HOTPA has estimated, 90% of the total orthodox tea leaves in Nepal are produced by small farmers. Since the farmers do not prefer to pool their land for large scale cultivation to be possible, the viable strategy would be to let them retain their land where they would grow tea and supply the leaves to processing factories. But many of the farmers who have been cultivating tea have no ownership over the land because some of it is under the forest area in official records, and some is missed in the geodetic survey by fluke or by design.

So HOTPA is now demanding that the land that is without forest cover but officially classified as forest be handed over, on lease, preferably to the farmers for tea cultivation and, if the farmers are not interested, to the entrepreneurs. Though, NTCDB, under the provisions of NTCDB Act, is authorized to provide land for tea and coffee cultivation, NTCDB has no land under it’s control. It is the government that has the land, under forests or as received under the land reforms. Another demand is to ease up the process for relaxing the land holding ceiling for tea cultivation, which at present takes several years to complete.

The first private sector tea estate to start producing orthodox tea in Nepal is Kanchanjungha Tea Estate (KTE) of Panchthar. As it also had a processing factory, farmers were selling their tea to this estate, but when KTE started specializing in organic tea, it had to stop buying leaves from farmers because there are no instruments in Nepal to check whether the leaves are from a plant grown in an organic manner. Another orthodox tea estate in private sector with its own processing factory is Guranse Tea Estate of Dhankuta. There are seven other orthodox tea-processing units, that have no garden of their own, thus relying on the farmers for their inputs.

Entrepreneurs have also been demanding that special fiscal and monetary incentives be provided to the processing units so that more of such units can be set up to facilitate the small farmers. This is important, they say, because it is naturally more costly to set up a processing unit in the hills than in the plains as the transportation of machines costs high, for example. Another demand is construction of roads to the tea areas, and the entrepreneurs say, they are ready to share the cost of construction of the insfrastructure.

Likewise, they also point out that the same standards, as applicable in other industries, should be made applicable in tea industry as well. For example, the land cost is taken into consideration while calculating the total fixed assets cost of an industrial unit before extending bank loan to them. But tea entrepreneurs or farmers do not get loan against the land, which takes up as much as 60% of the project cost. Similarly, the incentive of specially subsidized interest rate on loan for tea that was provided in the past has now been withdrawn. Once the rate was as low as 2% per annum, that now has gone up to 13% (12% interest and 1% service charge) as practised by Agriculture Development Bank (ADB). It has been more than two months since Nepal Rastra Bank reduced refinancing rate to ADB from earlier 9% to 7.5%. But ADB has not lowered its lending rate. As Sherma claims, only a month ago, he signed a loan agreement with ADB for a loan at 13% interest.

On bank loan, the entrepreneurs also point out many other problems. Entrepreneurs demand that the grace period on loan repayment (the day the first installment of loan falls due) be extended to 10 years from the present seven (for orthodox tea) to allow the cash flow of borrowers match the repayment schedule.

This, the entrepreneurs say, is in keeping with what the other major tea growing countries like India, China, Sri Lanka have in practice. For example, in India the rate of interest on tea is 7.5% on average, though it may vary slightly up or down between different states.

Meanwhile, apart from preparing the logo, HOTPA is undertaking various measures in marketing tea abroad and upgrading the technology here. Vaidya was recently in Hannover to attend Expo 2000 there and has arranged, with German Tea Association, to hold Nepal Tea Day in the Expo when Nepali tea will be distributed free to the visitors. He further informs that the German Tea Association has also agreed to exhibit Nepali tea in its Home Page. "We’re also coming up with our own edition of it", he says. With Japan also the work is going on at similar level. The other effort is towards gaining ISO 9002 for Nepali tea and of compiling a literature on the history of Nepali tea. Training on ISO will start by October this year, according to him.

Trend of Orthodox Tea Production in Nepal
(in '000 kg)

Source: Himalayan Orthodox Tea Producers Association (HOTPA)

Nepal's Orthodox Tea Exports to overseas
Qty in '000 kg
Value in million rupees

Source: Nepal Overseas Trade Statistics (Trade Promotion Center)

Total Exports of Nepal's Orthodox Tea
Qty in '000 kg

Source: HOTPA

Tea Outside Tea Zone

Experience of a tea enterprise outside the declared tea zone

Som Prasad Gauchan and his team did not actually have tea in mind when they were looking for a plot of land. They were thinking of some herbs, tea being only one of the possibilities. When they spotted a plot of 100 or 150 ropanis of land some 10 km north of Sankhu, Kathmandu, with a wild growth of tea (there were no bushes but trees), they decided to give tea a try, and acquired 500 ropanis of land nearby on lease for thirty years. They initially planted the saplings in around 50 ropanis, but found that the local people on the prompting of some local politicians, had uprooted all the plants within a couple of days. The locals also filed a writ against Gauchan’s company (Everest Tea Estate Pvt. Ltd.–ETE). Now after a prolonged court battle, the company, however, won the case in the Supreme Court.

As of now, ETE has no tea-processing machine, and whatever leaves are being produced are being processed by hand. "And if we’re able to convince the buyers about this fact, we hope they will like it more, as handmade is becoming a fad in western countries", Gauchan says. However, hand-processing is not going to be feasible once the volume of work becomes really big when all the plants in the garden start giving leaves, he explains. Therefore, ETE is now planning to put up a medium scale machine to process tea.

Time for Development Banking

Attracted by the opportunities offered by imperfections in the present financial market of the country, a group of bankers, professionals, businessmen and diplomats are venturing into this specialized banking business

Notwithstanding the excess liquidity within the banking system, various sectors of the Nepali economy are complaining of financial draught. That gives an ideal example of imperfection in the country’s financial market. But the situation has also presented a business opportunity, as identified by a group of professionals and businessmen, who are preparing to come out with a development bank of their own.

The promoters of Development Credit Bank Ltd. (DCBL), as the proposed entity is to be called, are still waiting for the license from Nepal Rastra Bank (NRB) which is reportedly at a very positive stage.

There are seven development banks operating in the country of which only two are of national level, according to NRB. But Sudhir Khatri, President of the proposed development bank says, his institution is going to be the first national level development bank without the equity participation of NRB. Among the existing development banks, Nepal Industrial Development Corporation (NIDC) and Agriculture Development Bank (ADB/N) are government owned while NRB has 10% equity in both Nepal Development Bank Ltd. (NDBL) and Cottage and small Industries Development Bank (CSID). Though NDBL has been in operation for just over a year and a half, CSID is still to go into full-fledged operation. Rest of such banks are regional ones or focussed only in micro-credits operating in the style of the Grameen Bank of Bangladesh. DCBL is going to operate at the national level and providing all kinds of services, which a development bank is supposed to provide, says Khatri.

According to him, his bank is going to focus on venture capital financing in IT, health, education and other new technology sectors, lending to infrastructure projects like hydropower and construction of roads, irrigation and airports and also supporting construction entrepreneurs. With the BOT (Build-Operate and Transfer) system already accepted in the country as a means to involve the private sector in developing infrastructure, there is tremendous scope for this type of business. "And I see that our bank alone will not be enough to cater to the entire demand for finance in all such projects", Khatri says indicating the need for more of such banks in the country.

Sudhir Khatri

That means a development bank requires a lot of funds, which have to be arranged from various sources. And the existing government owned development banks are said to be facing problems in their sources of fund drying out, especially from the international funding agencies. Moreover, all the financing institutions – banking as well as non-banking – are complaining that they do not find credit-worthy clients to lend to. Under such circumstances, viability of any new bank has been questionable. The problem appears more acute for a development bank as it is barred from opening saving and current deposit accounts. Such bank is also restricted from performing many of the non-funded banking activities that commercial banks make money out of. But Khatri says his group has scouted for new avenues and this is exactly where the competitive strengths of his proposed bank lie.

Elaborating further, he explain that big finances are required in projects that have long gestation period (such as hydropower) and the commercial banks are not prepared to finance such projects. The commercial banks concentrate their attention more on short-term operations, whether in collecting deposits or in providing other banking services. Consequently, they have neither capacity nor the preference to finance long-term projects with long payback period. Ironically, many of the non-performing assets (NPA) of commercial banks are in consortium financing and project lending. Even heavy collateral orientation has not helped the banks in reducing the size of their NPA. This, according to Khatri, is because the commercial banks in many cases do not fix realistic repayment schedule which could span over 10 or 15-year period and reduce it to around one to seven year period. Consequently the cash flow of the project becomes inadequate to adhere to such repayment schedule.

For financing a long-term project, a bank needs to have a long-term source of fund. To meet this requirement, the development bank will mobilize long-term deposits and issue development bank bonds. It also can have refinancing facility from NRB, which recently has announced a policy of escaping bank rate on refinancing to development banks. Khatri is also targeting to arrange credit lines from international as well as domestic banks. "The surplus liquidity available with the commercial banks will be easily attracted to us if we manage our business well. A smart development banker can also intermediate flow of credit between commercial banks", he believes.

Since the government sector development banks at present are struggling with their own peculiar problems, while the private sector ones are either not yet firmly established in the business or operating only at regional levels, the proposed bank is confident of coping to face a strong competition from them. That means, its competition is going to be more with the commercial banks and other financial institutions both in collecting deposits and in finding clients. However, Khatri says that one of the main strengths of a development bank is that it can do some operations restricted to commercial banks, such as venture capital. These factors make it possible for a development bank to offer competitive interest rates to the depositors and bondholders while charging equally competitive rates of interest to the borrower.

Generally, development banks, particularly those owned by the government, complain that they do not have opportunities for non-funded business that commercial banks do, such as L/C operation. But Khatri says, in fact development banks can create their own non-funded businesses such as of consultancy services, project identification, development and bank guarantee. "We can identify viable projects and develop them into project proposals which can be sold to the prospective clients for a fee". And unlike the commercial banks, development banks are allowed to buy land, establish a project there on their own and sell it or rent it out for profit.

That means, a development bank has to have specialist manpower. And in that DCBL is not going to have any problem, Khatri says. For this he has a valid ground. His bank will have Krishna Lal Maharjan as its Chairman. Formally associated with NIDC, Maharjan has many years of experience in financial sector. Educated in India and the UK, he taught economics in colleges as well. Presently he is also an active working director of Samjhana Finance Company in which he is the major promoter. During his three-decade association with NIDC he carried the reputation of a prudent banker. Other promoters of DCBL include two experienced bankers, Deepak Sharma and Shashi Maskey who have more than 12 years of banking experience in various commercial and development banks. Khatri himself comes with a long experience in commercial and development banking. He had started his banking career with Nepal Indosuez Bank Ltd. in 1989. Later he joined Himalayan Bank Ltd. in 1992 and was the General Manager of NDB for one year where Sharma and Maskey were the DGMs. Presently, all the three of them are running the Institute of Financial Engineering, a consultancy firm basically focussed in providing training on banking for both bankers and non-bankers. Other promoters of DCBL include the incumbent President of FNCCI, the incumbent President of Nepal Chamber of Commerce, Second Vice President of Nepal Carpet Association, General Secretary of Contractors Association of Nepal and General Secretary of the Society of Nepalese Architects "The group also has other reputed businessmen, contractors, bureaucrats, diplomats, and chartered accountants", Khatri says.

Development banking was opened to the private sector some seven years back when Development Bank Act, 2052, was enacted. But the intervening period to date has been able to attract only a few development banks. However, the coming days are to see more of them, if the present indications are to be believed. In its report on Capital Market Development submitted to Asian Development Bank (ADB) in 1998, GMA Capital Markets Ltd. had pointed out the need for establishing a number of development banks in Nepal and also suggested that Asian Development Bank (ADB) should participate in equity as well, if need be, in such banks. Moreover, as compared to Rs. 500 million needed as paid up capital for setting up a national level commercial bank, the Act requires only Rs. 160 million for a development bank to be established in Kathmandu. About the existing law governing the development bank, Khatri says he finds NRB very positive towards this sector and hopes that whatever revision may be needed in it will be introduced by the central bank as it has been doing with the Commercial Bank Act.

By Business Age Reporter

State-owned Banks

In The Red

As an independent study portrays poor state of affairs of the state-owned banks, the government is under pressure to speed up finance sector reforms

By Bhagirath Yogi

Are the two largest banks in the country really bankable? No, says a draft final report presented by KPMG Barents Group, a renowned international auditing firm, submitted to Nepal Rastra Bank in March this year. " By international standards, both Rastriya Banijya Bank (RBB) and Nepal Bank Limited (NBL) suffer serious critical shortfalls in all key areas; both are technically insolvent," said the report.

The findings of the report has come as a startling revelation of what is going on in the government-owned banks that together mobilize nearly 60 percent of the total deposits in the entire banking system in the country.

" Though there are serious problems within these banks, the situation is not as bad as it is made out to be," said Governor of NRB Dr. Tilak Rawal. But the KPMG report, commissioned by NRB itself, estimated that these two banks incurred combined losses worth between Rs 15 billion and 30 billion (US$ 220 to 435 million). These losses represent 4.5 to 8.5 percent of GDP of Nepal and between 24 and 45 percent of Nepal’s total budget in 1999.

Though belatedly, officials seem to be waking up to face the crisis. A strategy paper on financial sector reform program prepared by Nepal Rastra Bank in May this year said that both RBB and NBL suffer from negative net worth, weak internal control and information system and poor financial management. "There is an urgent need to initiate an appropriate plan to improve loan recovery and reduce non performing loans of these two banks," said the paper.

The paper has proposed the NRB to focus on about a dozen reform measures including reform in the financial sector legislation, strengthening bank supervision and inspection, restructuring and privation of NBL and RBB, and broadening and deepening financial system in Nepal.

In line with his commitment at the Nepal Development Forum meeting in Paris in April this year, Finance Minister Mahesh Acharya has—in the budget estimates for the year 2000-01— proposed, among others, restructuring of RBB and NBL with improved management, branch rationalization, improved supervision mechanisms, and privatization of the government-owned banks and non-bank financial institutions in the medium term (that is, within 24 months).

The budget has also allocated Rs 600 million to carry out institutional and structural reforms in the banking sector and improve the capital structure of the government-owned banks and set up an Asset Reconstruction Company (ARC) in joint partnership between NRB and the private sector.

While measures like setting up an ARC to reclaim collateral of the bad loans will take time, reforms in the banks should start with immediate measures, say analysts. "The first thing is the balance sheet of these banks need to be cleaned and capital should be injected to raise their level of net worth," said Satyendra Pyara Shrestha, former Governor of NRB, who hired KPMG to conduct the study during his tenure. "After this, the government can seek soft loan from multilateral agencies like the World Bank to capitalize these banks."

According to Shrestha, RBB in particular may need up to Rs 3 billion to be injected to offset its net negative worth." I don’t agree that the government-owned banks are in technically solvent positions. There is still room for their improvement by taking appropriate measures."

It is easier said than done. Over-staffing, growing trade union activities and less attention toward customer service seem to be permanent features of these government-owned banks. Both NBL and RBB have more than 200 branches and nearly 6000 staff each all over the country.

According to a latest report published by the International Monetary Fund (IMF), share of non-performing loans (as percent of total loans) stood at whopping 40 percent in 1996/97, which declined marginally to 35 percent in 1997/98. Similarly, non-performing loans of Nepal Bank Ltd. stood at 17.5 percent in 1995/96, which rose to 24.4 percent in 1997/98. In such a situation, injecting of capital alone will be tantamount to pouring water into the sand.

"Some form of recapitalization of RBB will be necessary, but should only be undertaken when the bank has been properly restructured and management improved," said the IMF report, published in February this year. "Of equal importance are the enhancement of accounting and auditing practices and strengthened regulatory and oversight functions of the central bank, including supervision of nonbanking financial institutions. A complete overhaul of the NRB Act would aid these improvements."

Former Governor Shrestha also agrees that autonomy to NRB is a crucial factor. "The supervisory mechanism of NRB needs to be strengthened and a pre-warning system needs to be developed. But the most important role in the financial sector reform is that of the government. Unless the banking system is not run in accordance with banking norms there won’t be any improvement in this sector."

Given the experience of Southeast Asian financial crisis and Indian experiences, experts argue that the speed of financial sector reforms in Nepal should be gradual. "Financial sector reforms should be speeded up only to the extent at which preparatory works are accelerated at the domestic front," said Dr. Yubaraj Khatiwada, chief economic advisor at NRB, at an IIDS seminar a few months back. "Speed of financial sector reforms must also be accompanied by proper sequencing of various reform measures. Internal liberalization and structural reforms must precede globalization of the financial system."

The KPMG report has suggested that the government should demonstrate high-level commitment to an independent commercially run banking system, institute emergency measures to limit the damage at NBL and RBB, and design and invest in bank restructuring programs to improve upon the present poor state of these banks. "Unless something is done NOW- this situation will only deteriorate even further and will, sooner or later, result in an open financial crisis," said the report.

Of course, any further delay or carelessness to address these problems will certainly invite disaster in the country’s financial sector and the whole economy. Will the officials act?

Thus Reports KPMG

Excerpts from KPMG Barents Group report on RBB and NBL: Preliminary Observations (March 2000)

It is broadly recognized that Nepal’s financial sector (RBB and NBL in particular) faces difficult systemic problems:

- Poor bank governance; political interference and private sector "self-dealing."

- Lack of rational banking strategies as well as the skills and "international banking experience" to support them.

- Lack of independent, capable supervision.

- Weak financial and management information.

- Weak legal and accounting practices.

- By international standards, both RBB and NBL suffer serious critical shortfalls in all key areas; both are technically insolvent.

- While there may have been some temporary improvement after CBPASS, the situation is now clearly worse than 1992.

What to do?

1. Demonstrate high-level commitment to an independent commercially-run banking system

- Develop "all parties" agreement or clear unilateral declaration to de-politicize, de-unionize and commercialize the banking system.

- Provide political and financial investment in an independent central bank with full enforcement powers.

- Implement and enforce policies to foster sound banking.

2. Institute emergency measures to limit the damage at NBL and RBB

- Place independent, professional bankers on Boards and in key management positions at both RBB and NBL.

- Preferably an "International Bank Management Contract."

- Otherwise, a "team" of professionals with common vision, practices, processes, systems, methods, etc.

- Engage reputable audit firms to install proper record keeping, accounting, reporting and investigation processes.

- Lay groundwork for streamlining and institution-building programs.

3. Design and invest in bank restructuring programs

- Develop new, practical bank strategies and business plans.

- Launch independent and result-driven recovery effort.

- Implement approaches to rationalize and develop the banks.

4. Develop and implement long-range plans to correct environmental weaknesses

- Raise accounting standards and overall transparency of financial information (for banks and borrowers).

- Design and implement a comprehensive legal reform program that supports modern commercial banking.

- Set clear, national standards for ancillary professional services (e.g., land registry, appraisals, etc.)

- RBB and NBL are insolvent- both are bankrupt banks.

- Sooner or later, they will become both insolvent and illiquid.

- When this happens, Nepal will experience a financial sector "melt down" or collapse, similar to the "Asia crisis" of recent years.

- Nepal can act now in the "Pre-Crisis Period"- or wait for the crisis to arrive, but losing critical room for maneuver and paying a higher price at a later stage.

- If not tangible action is taken, key donors are likely to interpret this as a lack of government commitment and resolve to deal with some of the most fundamental problems in Nepal- with potential consequences for future assistance and aid commitments.

Problems in the Banks

According to KPMG, the problems in NBL and RBB are FAR WORSE than anyone thought;

The financial problem in NBL is as worrying as the problem in RBB- both are bankrupt banks;

Management is not in control and does not appear to be particularly concerned about this fact;

Politically motivated loans to big borrowers almost always "go bad";

Union activity is disruptive and "out of control" in the banks;

The estimated losses in these two banks is somewhere between NR 15-30 billion (US$ 220 to 435 million). This is the responsibility of the shareholders of these two banks;

These losses represent 4.5 to 8.5 percent of GDP of Nepal;

These losses represent between 24 to 45 percent of Nepal’s total budget in 1999.

Addressing these problems will take political courage- and a lot of short term pain- for medium to long term gain;

Unless something is done NOW- this situation will only deteriorate even further and will, sooner or later, result in an open financial crisis.

- No more politically motivated loans;

- Need to deal with highly politicized and disruptive unions within the two banks;

- Need to deal sensitively with the issue of bank branching- particularly in rural areas;

- NBL shares are NOT an asset. The shareholders in NBL no longer "own a bank."

Immediate steps to be considered

- "All parties agreement" on the de-politicization of the banking sector. If this is not possible- a Nepali Congress commitment;

- New bank management team to be recruited to go in and take over RBB and NBL immediately;

- Send in accountancy firms to both banks to develop accounting capacities and provide internal audit;

- Declare banks "essential services" so that workers cannot strike and begin a retrenchment program.

Medium-term Actions

- Shrink RBB/NBL and "carve out" a good book from the bad bank- and privatize it;

- Bad assets turned over to an Asset Resolution Trust to make rigorous efforts at recouping funds.

What support can the donors give?

- This process will not be easy. Donors must stand prepared to support a Fully Committed Government;

- This could possibly include resources for Golden Handshakes to workers being retrenched; re-training schemes for retrenched workers; and some funding for recapitalization.

Benefits from Decisive Action

- Nepal can avoid financial crisis, instability, and starkly reduced levels of per capita national income, business failures, and loss of political and economic control (as in Korea, Thailand, and Indonesia).

- It will lead to a better performing, privately owned, banking system in Nepal which, if properly supervised, will be able to support faster, private sector led growth;

- It will send an impressive signal to both domestic and international audiences that the Government is willing to tackle very difficult governance issues;

- It may result in additional donor assistance in support of a committed Government and a stronger national economy.