Vol. 2 :: No. 12 November, 2000 (Kartik-Mangsir)

Economy

Banking the Future on Competition

By Bhaskar Sharma

Nepali financial sector, especially the banking sector, has undergone drastic changes in the past one and half decade. The opening up of the financial market to foreign joint venture banks in the mid-80s, ending the monopoly of the two state-owned banks (one fully and other partially), namely, Rastriya Banijya Bank (RBB) and Nepal Bank Ltd. (NBL), is a notable step after which a number of private and foreign affiliated joint venture banks emerged. Though the two state-owned banks still continue to hold over 50 percent share in total domestic banking transaction, yet they are challenged by the more innovative and efficient private banks. Presently, there are thirteen commercial banks in operation.

One of the most important achievements as a result of the growth in the number of commercial banks in the post liberalization period is in the area of domestic savings. Quantitative growth of the banking sector has positively contributed in raising domestic banking savings, which crossed the 152 billion mark in mid-August, 2000. In addition, deposit-GDP ratio, one of the major economic parameters widely employed to analyze the efficiency of the banking system, as substantiated by empirical data, also rose from 0.128 before reforms to 0.199 after the reforms. This would directly make more funds available for investment.

Given that efficiency of the financial sector is the backbone of the economy, the advent of joint venture commercial banks has contributed much to this direction. The opening of the financial sector for free entry of commercial banks has added more to the efficiency of funds flow into the economy, which surely would not have been possible had the government maintained a conservative and inward looking policy restricting free competition.

A laudable contribution by the banking sector growth, and the resulting competition, in the past one-decade is the diversion of banking sector resources to the industrial sector. Post liberalization era competition has forced commercial banks to broaden their lending portfolio that has resulted in the expansion of loan extension from the trading sector to the industrial sector. This is particularly important due to the fact that Nepalese trading sector is dominated by transit trade. Empirical data shows that lending to the industrial sector has increased significantly from 15 percent of the total loan portfolio in the pre-liberalization era to about 35 percent presently.

In addition, competing joint venture commercial banks have played a crucial role in modernizing, though only to an extent, the banking system. The recent introduction of 24-hour service facilities through the installation of Automatic Teller Machines (ATMs) by some banks and initiation of innovative schemes for granting credit facilities to consumers is a notable achievement. However, the fact that only a few banks have really followed suit, and the usual rush of customers seen in almost all banks for withdrawing their accounts during times of festivals, only puts a question mark on the correlation between quantitative growth of the banking sector and the quality of services, and hence casts doubt over the existence of so called stiff competition in the banking sector.

Most bank officials on their part, however, claim of tight market situations and maintain that the banking sector is already saturated with an excess number of commercial banks. They assert that banks are presently operating at minimal margin and are of the view that if lending continues under the present circumstances, commercial banks would be in a precarious position within the next five years.

Says Rajendra Shrestha, manager of Nepal Bangladesh Bank, New Road Branch, "About 60-70 percent of the total deposits of banks are interest bearing. Due to the lack of investment avenues, banks are tempted to invest without proper credit appraisal and on personal guarantee, whose negative side-effects would show colors only after four or five years."

Though the quality of services offered to all beneficiaries and the contribution of the banking sector to the economy as a whole has seen a quantum leap after the advent of the private banks, thereby opening up larger avenues for all investors, depositors as well as entrepreneurs, there still exist ample rooms for improvement. And, despite all alluring developments, it would be but naive to paint a rosy picture of the banking sector.

Firstly, there still exist anomalies in the banking sector in spite of the claim of stiff competition. The rate of interest offered by banks to depositors still varies widely from bank to bank. For example, Grindlays Bank, one of the most successful joint venture banks, offers only 3.5 percent interest on savings deposit, while Nepal Bangladesh Bank, another joint venture, offers 6 percent. This only suggests independence of the operation from bank to bank directly contradicting the principles of competition.

Another issue needing special mention is the system of making interest payment by the banks. Most banks still make interest payment on the minimum monthly balance of a depositor’s account, wherein it is credited only at the end of 6 months. This indicates lack of competition in the banking sector, which otherwise would have been forced to shift from making interest payment on a monthly minimum balance basis to calculating the payments on the daily balance.

Moreover, private commercial banks have mushroomed only in the urban areas where banking transaction in large volumes is possible. The rural and sub-urban areas mostly remain unattended to, and which is likely to prevail till competition takes its full rein in the urban sector.

For an investor, commercial banks themselves have grown as the most lucrative sector for investment. Investors’ confidence into the banking sector is easily exemplified by the recent over subscription of shares of Nepal Industrial and Commercial Bank by over eight folds. Moreover, continued high performance by the stocks of commercial banks, reflected in the charts of Nepal Stock Exchange (NESPE), where banks dominate 90 percent of the total share transaction, is another reason luring investors to invest readily into the banking sector.

As a whole, increasing credit flow to both trading and industrial sector and channeling domestic savings into capital investments, towards which the contribution of the banking sector cannot be questioned, will ultimately bolster the country’s rate of economic growth. In addition, the sector has actually done more than just providing mere safety to small investors’ capital. Yet, the sector will become prudent and successful only when the banking sector ‘interest rate’ will draw the interests of both depositors and creditors.

(Sejon-Platform Feature Service)

Ratio of total bank loan to industrial loan

(in %)

Note:* provisional data

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