Vol. 3 :: No. 2 january, 2001 (Poush-Magh)

Sectoral

Banking Reforms

Controversial Moves

Assuming that the things move as planned, two oldest commercial banks of the country will have foreign management by the month of May 2001. That is well one month earlier than what was so far being expected. But what the Board of Directors of one the two banks (Nepal Bank Ltd. - NBL) told the Public Accounts Committee (PAC) of Parliament, and how Nepal Rastra Bank (NRB) informed PAC in later enquiry indicate that the effort is likely to see many changes by the time it is finally implemented. The NBL directors said that their Board has decided to accept technical assistance, but is not ready to grant management contract. NRB governor said, NRB has accepted all three demands of NBL. In the other two points of demand, NBL directors had said that NBL would not share the cost of the technical assistance and that the NBL board will have the final authority in all decisions.

After the Nepali central bank published an ad in The Economist magazine in September 2000 in this regard, it received Letters of Interest from 41 parties. Of them eight are short-listed – four for NBL and four for Rastriya Banijya Bank (RBB). They are now asked to send in detailed proposals by January 15, 2001, after which the proposals will be evaluated and negotiations will be held with the proposers for the financial cost. The negotiations are expected to be finalized well in time so that the World Bank Board meeting scheduled for the fourth week of April 2001 will approve the financial sector technical assistance credit. Upon the World Bank approval, the new management is to be inducted in banks.

All this is being done to restore the health of these banks that together hold over 60% of the total assets of Nepal’s banking sector. No other commercial bank in Nepal has as extensive branch network as these two. Either of them can be found present at every conceivable market or administrative centre of the country though recently they have been reducing the number of their branches. These two points are enough to indicate that if only one of these two banks goes into liquidation, the Nepali economy will find itself in similar condition (or even worse) as South Korea found itself with the failure of Daewoo Corporation. Such a doomsday was forecast by KPMG Barents, an international auditing firm, when it presented its final draft report to Nepal Rastra Bank (NRB) in April 2000 after studying

Finance Minister Acharya: Talking about reforms

about the condition of these two banks. Though still not made public officially, the report has declared both these banks "technically insolvent", a fact the authorities have publicly accepted. The negative net worth in these two banks, is estimated by KPMG in the range of Rs. 6 billion to Rs. 10 billion in NBL and Rs. 9 billion to Rs. 15 billion in RBB. The difficulty in identifying an exact figure of the loss is attributed to the primitive accounting system. For various loans, the loan documents are missing. Present NBL Board says, it also wants to restore the health of the bank, but is opposed to the way NRB is resorting to for the purpose. They complain that they were not contacted before NRB decided to advertise for the management contract.

KPMG report came at a time when demands from the private sector were being voiced for privatization of RBB. And the privatization cell in the Finance Ministry was repeatedly informing that it was ‘almost’ ready to send the bank for privatization. Though NBL was privatized already by reducing government ownership in it to about 40%, the bank’s condition worsened further after the share dilution. This experience with the "test case" was enough to stop any further development in privatization of RBB. KPMG estimated that NBL would require additional Rs. 1.1 billion and RBB
Rs. 1.5 billion to bring them up to internationally accepted norms of capital adequacy. HMG wants the consultants to achieve the objective without pumping in additional money. As a last resort, the new management team is also asked to suggest how to liquidate the banks, if everything else fails.

The government is still thinking to privatize these banks, but only after restoring their health. And the prescription being followed is to induct a new management that is being contracted. But doubts are being expressed about how this step is going to help to achieve the objective. Responding to an enquiry by the PAC in the first week of January 2001, the chairman and members of the Board of Directors of NBL from the private sector voiced their objection to NRB move. They also questioned the legality of such a step. NBL has a number of noted lawyers of the country in its Board representing the private sector shareholders.

One of the concerns in this regard is about the need to bring in foreign management. Though most of the successful private sector banks in the country are under foreign management, there also are a number of them, such as Bank of Kathmandu and Nepal Bangladesh Bank, headed by Nepali managers and doing very well. NRB governor Dipendra Purush Dhakal says, NRB has no specific intention to bring in foreign management, and it would be willing to give preference to Nepali managers. But even those Nepali managers who showed interest to the job have teamed up with one or the other foreign consultant. However, The Economist ad has been worded in such a way that Nepali consultants are deliberately barred from putting any bid.

The obsession with foreign management seems to be a very old malaise in Nepal. Recently, in a letter to the editor published in a daily, a former deputy general manager of NBL reminded that similar exercise in NBL during early 1960’s had failed after three successive expatriate GMs failed to manage the bank effectively. Apart from the problem of the official language, another trouble in that exercise was that there was another Nepali GM who was the counterpart of the foreign GM. The result was that there used to be separate and contradictory instructions issued by the two GMs. The forthcoming arrangement is to resemble that of 40 years ago. Though NBL has no general manager as of now (it is being headed by an officiating GM), RBB does have a chief executive of its own. And both these banks have their own boards of directors. The new managements are to report to the NRB and the Ministry of Finance also in addition to the boards of their respective banks. This poses a threat of dual management. In case of RBB, which is fully owned by HMG, the problem may not be so serious as in case of NBL where the majority in the board is from the private sector.

The present situation calling for management contract is created by the existing boards of the banks, at least in the case of NBL. The private sector is accused of failure to manage NBL. And, Rajendra Khetan, one of the directors in NBL Board from the private sector, accepts that the blame is well-founded, but only to an extent. "The private sector was deceived by the government", he complains. "We got the shares, but were denied representation in the board for a long time. Now we are being penalized for what we did not do." The takers of HMG shares (when they were offered to the private sector last time) had to fight in the court to gain their berths in the Board. And the bad loans of today are those granted during the period before the private sector representatives were allowed in the Board, maintain NBL’s present directors.

But the way that the bank is being managed under the Board is not much different than in the past. Khetan himself gives an example of a recent case in which one of the directors got a loan for himself approved by the board against the banking sector rule. "Though I wrote a note of dissent for that, the decision was taken as the two government representatives in the board were in support of the motion. Thus mustering a majority", says Khetan. In India, the practice requires the government representatives in a company board to abstain from voting.

Past & Future Tense of Banking Sector Reforms

March, 2000 · KPMG Barent’s report presented to NRB. April, 2000

PAC Chairman Subhash Nemband

Governor Dhakal

Ex-Governor Dr. Rawal

· Nepal Development Forum meeting at Paris with the donor countries attending. Nepal pledges fiscal, financial and governance reforms.

· Newspapers, quoting the unpublished KPMG report say that KPMG has declared NBL and RBB "technically insolvent".

· NRB Governor Dr. Tilak Rawal says the situation in NBL & RBB is not "out of control".

· The national budget speech by Finance Minister presented to the parliament is silent on KPMG report, but talks of restructuring NBL & RBB and strengthening central bank’s monitoring and supervision functions.

· HMG appoints Dipendra Purush Dhakal as Governor of Nepal Rastra Bank removing Dr. Tilak Rawal before his tenure is completed.

· Meeting with international donor agencies in Prague coinciding with the IMF – World Bank joint annual meeting. Financial sector reform high on the agenda. Donors pledge support for financial sector reform to be carried out in phases - NBL and RBB in the first phase, possibly to be followed by other public banks – Agricultural Development Bank and Nepal Industrial Development Corporation.

September 30

· Advertisement published in The Economist. Termed as "Special Procurement Notice" (SPN), the ad seeks "Expression of Interest" from international management experts to take management of "two" Nepali banks (without specifying names) for two years plus one year.

· 41 companies (including KPMG) express interest

· NBL shares revive in Nepal Stock Exchange. Speculation and manipulation by big shareholders suspected.

Nov. 30, 2000

"Request for proposal" (RFP) sent to the short listed companies. Main opposition party in the parliament, CPN –UML, opposes HMG’s banking reforms. Trade unions also opposing.

8 companies short listed

· Price Waterhouse Coopers (India)

· Ernst & Young (Sri Lanka)

· ICC Bank (UK)

·Development Partnership (Ireland)

·Arthur Anderson (UK)

·Deloitte and Touche Tomahatsu (USA)

·DFC Group (Spain)

· GMA Capitals (UK)

Interestingly KPMG does not feature in the short list. Explanation : Possible "conflict of interest"

Public Accounts Committee (PAC) of the parliament enquires.

Dec. 11, 2000

· NRB sets up one surveillance team each for NBL & RBB to monitor their activities in the meantime.

· NRB issues directive to NBL & RBB to tighten lendings.

· Deadline for submission of proposals by short listed companies.

· Appraisal of the proposals and negotiations for financial costs with the interested parties.

· World Bank’s Board scheduled to approve Financial Sector Technical Assistance Credit.

April 30, 2001

· Technical Service Agreement expected to be signed and new management to be inducted in NBL & RBB.

· The new management will submit to NRB & Ministry of Finance following document, among others, within specified period:

Pros & Cons & Concerns of Handing over NBL & RBB Management to Foreign Parties

KPMG Barents Group Recommendations

STEP 1

Government must demonstrate high-level commitment to an independent, commercially-run banking system

• Develop "All Parties" agreement or clear unilateral declaration to de-politicize and commercialize the banking system

• Provide political and financial investment in an independent Central Bank with full enforcement powers

- Skill sets needed to monitor emerging risks

- Independence and authority to effectively respond to risks

• Implement and enforce policies to foster sound banking

- Private sector banks seeking normal profits while ensuring capital not put at imprudent risk; strict controls on "self-dealing"

- Government banks penalized for squandering capital, and depositors' money (pension funds and small savers), ultimately taxpayer funds

- Improved transparency of banks' finances (required audits, etc.)

STEP 2

• Upgrade independent, professional bankers on Board and in key management positions at RBB

- International bank management experience

- Familiarity with modern "international best practices"

- Demonstrable experience in problem bank "turn-around"

• Engage reputable audit firm(s) to implement proper record keeping, accounting, reporting and investigation processes

• Lay groundwork for streamlining and institution-building programs - to be executed in Step 3

- Assess bank restructuring options

- Structure Terms of Reference for streamlining and restructuring

STEP 3

With an upgraded management team in place, design and invest in comprehensive bank restructuring programs

• Develop new, practical bank strategies and business plans

- Retarget strategy to focus on areas where RBB can perform

- Review feasibility of restructuring options: break-up into "Good Bank" vs. "Bad Bank", sale of deposit base, etc.

• Launch independent and results-driven recovery effort

- Central Asset Management Company (AMC), "Good Bank / Bad Bank" or internal bank work-out - whichever is most practical

- With any choice, implement professional methodologies and incentives as well as a proven, successful management team

• Implement approaches to rationalize and develop RBB

- Detail branching strategy with measurable criteria - and close or consolidate branches

- Draft human resource plan to rationalize and develop staff

Throughout this process, support other long-range plans to correct environmental weaknesses

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

• Support a comprehensive legal reform program that facilitates modern commercial banking

- Prioritize efforts: NRB Act, Banking Act, Bankruptcy Law, etc.

- Consider emergency legislation and "demonstration case examples" immediately, with adjustments later, after proving initial commitment to prompt action

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

Next Steps for Government, NRB and RBB

• Support government efforts to declare banking reform policies

• Support Central Bank strengthening and independence

• Upgrade Board, senior management, accounting, and other bank technical skills

• Prepare to launch comprehensive bank restructuring programs

Source :Draft Final Report of KPMG Barent Group, April, 2000

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