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April, 2004 |
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Economy & Policy |
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Comments on Umbrella Ordinance 2004 by Tirth Upadhyay An Ordinance
relating to Bank and Financial Institution has been promulgated that has
come into force effective April 4, 2004, after a labour pain of almost
two years. Though this Ordinance may be considered one of the
achievement of financial sector reform program, it is debatable if such
an important law having far flung effect on the financial sector should
be implemented by an Ordinance that survives only six months. As the
installation of new parliament (that alone has the power to enact
permanent law) is nowhere in sight, the financial sector must go through
the uncertainty in foreseeable future. The Ordinance is popularly called an
Umbrella Act as it repeals and replaces all existing Acts relating to
Commercial Banks, NIDC, other Development Banks and Finance Companies
and brings all such institutions under the purview of a single Act. The
Ordinance is comprehensive and prescribes in detail the provisions for
licensing, incorporation, governance, and merger and dissolution
procedures for banks and financial institutions (FIs). This is a
significant improvement over the existing Acts but apprehension is
expressed about the discretionary power that the Ordinance has vested on
Nepal Rastra Bank (NRB). The Ordinance is divided into 12 chapters
and contains altogether 93 sections. The first chapter defines the
various terms used in the Ordinance but has conspicuously omitted to
define “security” and “collateral,” among some other important
terms. These words have been frequently used in relation to lending
activity but in the absence of universally acceptable definition the
ongoing anomalies owing to the ambiguity are expected to continue though
it has been clarified that the financial institutions henceforth can
lend against personal or corporate guarantees. Second chapter specifies the procedures
for establishing a bank or financial institution and has brought
transparency in licensing procedure. The authority has to either
issue the licence within 120 days of application or notify the reason of
refusal within the said period. Further, a foreign bank’s
presence in Nepal either through a joint venture or branch banking is
legally mandated. This provision will probably meet the long
outstanding demand of the donors and conforms to Nepal’s entry to WTO. Buying back of its own share by a
financial institution, a unique provision, is legislated by this
Ordinance and that could be considered progressive. But it has
failed to explain the objective of such provision and at the same time
appears to be too restrictive to implement. The Ordinance has
failed to prescribe conditions for enhancing the stake of joint venture
partner, fresh issue of shares to strategic partner, issue under
Employees Stock Option Plan and preferential issue that is vital from
the investor’s perspective. Chapter 3 deals with the constitution of
Board of Directors and appointment of CEO. Henceforth, in addition
to directors appointed by the shareholders’ meeting, the FIs must have
one independent director in its Board appointed from amongst the names
in a roster maintained by NRB. Also the academic qualification of
remaining directors has been prescribed that requires that 2/3rd of all
directors must possess required academic qualification and experience
but it has failed to describe procedures that could ensure that people
of requisite qualification are elected by the general meeting.
Similarly, academic qualification for a position of CEO is also
prescribed and his/her tenure is limited to four years. But the
intention for limiting the tenure of such paid executive remains
unexplained. It might prevent young and dynamic person from taking this
leadership position. Further, the authority and responsibility
specified are not commensurate to the position of a CEO. As vesting of
executive authority on CEO is not guaranteed by the law, it may be
played down at the hands of unscrupulous directors and might be
inconsistent with the principle of divesting management from investor to
professional managers. Chapter 4 places restriction on using
bank or FI's name or carrying out financial transactions by institutions
other than those licensed by NRB as per the Ordinance. Chapter 5
deals with capital adequacy, reserves and provisioning for NPAs. But the
more it has tried to be transparent, the more it has vested
discretionary powers with NRB. To protect the interest of
depositors, the prime concern of legislatures in drafting the law should
be continued maintenance of adequate capital and such an important
matter should not be left to the discretion of NRB. The lesson
should be learnt from the past experiences where NRB’s leniency sent
two largest banks technically bankrupt. In this regard, it may be
pertinent to remind why the Basel Committee recommendation on capital
adequacy (that is universally acceptable) is not being made mandatory in
Nepal. Further, mandatory obligation on the part of the promoters is not
created to meet the capital gap within specified time. Such an
obligation is vital for protecting the depositor’s interest. As has
been the case with the two largest banks (i.e. Nepal Bank Ltd. and
Rastriya Banijya Bank) and a few other private sector banks in Nepal,
continued flouting with NPAs has eaten away not only their equity but
the depositor’s money as well. Chapter 6 prescribes the financial
transactions that banks and FIs are empowered to undertake. It has
attempted to include all types of traditional financial transactions
hitherto undertaken by a bank or FI but has failed to visualize the
requirement of a modern banking like debt securitization, swap and hedge
transactions and dealing in other financial derivatives. The
finance company will be benefited with this Ordinance as they are now
authorized to accept interest free deposit. Regulatory, inspection and supervision
responsibility with regard to FIs continue to remain with NRB. The
new provision has enlarged the scope of NRB’s regulatory role.
Banks set up with foreign shareholding will now be required to submit to
NRB the inspection reports prepared by their headquarters. Severe
penalty including suspension of Board or taking over the management of
FIs has been prescribed if the result of NRB inspection indicates
non-compliance with its directives or if the FIs are found to be guilty
of engaging in activities that are detrimental to the interest of the
shareholders or the depositors. The deregulated interest rate regime
appears to be drifting away as the Ordinance has empowered NRB to
intervene in rate fixation but it does not specify the conditions that
would oblige NRB to do so. Looking at the current rate of interest
offered on deposit by FIs, that has gone below the inflation rate, NRB
intervention could bring relief to thousands of small depositors,
especially old, disabled and pensioners whose lifetime saving is at
stake. Loan
disbursement and its recovery procedures are covered under chapter 8
that re-establishes the NRB’s authority to regulate lending and
minimize the chances of loan going to an unscrupulous borrower or
diversion of the funds. The Ordinance has specifically provided for the
compulsory registration of all charges on assets pledged as collateral
but the agency responsible for such registration (other than real
estate) is not identified. The authority of FIs in loan recovery
has been extended and it may now reach to other assets of the borrower
in case the security for loan falls short or becomes inadequate.
The hitherto requirement of disposal of non-banking assets within seven
years has been done away with. It may result in accumulation of
significant unproductive assets in FIs' balance-sheet. The role of
Loan Recovery Tribunal has been undermined and no role is envisaged for
Asset Management Company that is in the offing. The role of the auditor of FIs has been
extended and it goes beyond the scope of expertise of accounting
profession. Auditors shall require, among others, to certify
whether FIs have acted (or failed to act) to protect the interest of
depositors or investors and whether the business of FIs has been
conducted satisfactorily. Basis of such opinion is not outlined
and, accordingly, it will serve no purpose other than becoming a ritual. Chapter
10 deals with merger that permits an FI to merge with another FI only.
This is a new provision but does not prescribe the circumstances when
such merger will be permitted. The missing part on merger is the
safeguard of interest of minority shareholders. It does not
entitle shareholders opposed to the merger to ask for compulsory
acquisition of their stake by the management group. Similarly, no
provision has been made for acquisition that is vital for promoting
foreign investment. Chapter
11 prescribes penalty for various offences that could be both civil and
criminal. Chapter 12 has laid down procedures for voluntary
winding up of FIs, arbitration and miscellaneous administrative and
operational procedures. The client confidentiality is guaranteed
but with so many restrictive sub-clauses it is doubtful if the objective
would ever be met. Similarly, depositor’s right is clearly
protected by reiterating that there would be no other claimant on
deposit kept with FIs other than the depositor himself or his nominee
but certain other provision could interfere with such right. The
state may interfere in one or other pretext defeating the intention of
law and lessening the confidence in the banking system. For the first time, the law has taken
cognisance of international terrorism and NRB is empowered to suspend
operation of account related to organization or individual associated
with such activity. But it has omitted any anti-money laundering
provision. Probably, a separate Act is being envisaged to deal with such
transaction. In
conclusion, it could be said that the Ordinance is comprehensive and
deals with significant aspect of operation of FIs. However,
attempts should be made to limit NRB’s discretionary power by framing
transparent, prudent and unambiguous policies and regulations.
Further work would be necessary to integrate the country’s financial
sector with international financial market and effort should be directed
to encourage adoption of international best practices like International
Financial Reporting Standards (IFRS), International Standards on
Auditing (ISA), Basel Committee Recommendation etc. (Upadhyay
is a partner in T R Upadhyay & Co., correspondent firm of KPMG
International and, provides accounting, taxation and business advisory
services) One Umbrella Act's Pros and Cons by Sudhir Khatri His Majesty's
Government of Nepal has finally got promulgated the much awaited
Ordinance to replace several existing laws related to the banks and
financial institutions. With this the banking system in Nepal will
switch over to universal banking from the existing specialised banking.
The new law is perceived to be helpful to protect the rights and welfare
of the depositors and the small investors. At the same time it has
reduced the legal clutter as all the banks and financial institutions
will now be governed by a single act. But unfortunately this new act is full of
even so trivial lapses that it needs amendment immediately. In section
47 (2) of this Ordinance, clause 'Ja' and 'Tha' are the same. Acts
should be released only after careful proofreading so as to avoid such
mistakes. The banks and other financial
institutions which are going to open may not face so serious problems
due to this Ordinance as the registration criteria set in this Ordinance
and the criteria are clear cut. But there is confusion for the existing
banks and financial institutions. This ordinance separates them into
'Ka', 'Kha', 'Ga', and 'Gha' categories. They will no more be known as
commercial banks, development banks or finance companies. As per the act
only "Ka" category can mention itself as a Bank, the rest
should only mention themselves as financial institutions. It will create
confusion. The Agriculture Development Bank will become Agriculture
Development Finance Company and similarly Development Credit Bank will
be Development Credit Finance Company. Such changes in the name of the
bank would lead towards panic among the depositors. Even after so
many months of the Ordinance being promulgated, NRB has not clearly
stated in which category the existing banks and finance companies fall.
Because of this reason, the banks are facing difficulties to prepare
themselves for obtaining the licence that they are required by the new
law to obtain. Among the positive aspects of this Act is
that the monopoly that the commercial banks are now enjoying will be
checked to some extent after the implementation of this Act. The
financial institutions that are going to fall under 'Kha' category will
also be allowed to carry out several financial activities that were
previously allowed to only the commercial banks, such as operating
current accounts, issuing drafts and travellers' cheques, dealing in
foreign exchange and issuing Letter of Credits. Even the financial
institutions that are going to fall under 'Ga' category will be
permitted to handle current account, savings account and, to some
extent, foreign currency transactions. Such a system will help create
competition among banks and financial institutions. The ultimate group
to benefit from such competition is the consumer. But there are chances
that commercial banks might try to resist the change that this Act aims
to bring about. Commercial banks might lobby with authorities not to
permit other financial institutions to carry out such varied activities. One debatable point in the Ordinance is
related with the qualification of the directors. Out of the total number
of directors, two-thirds have to be graduates in specified disciplines -
management, commerce, economics, accounting, finance, law, banking and
statistics. They are also required to have a five years work experience
either in banking or public limited companies or in gazetted level
government posts. But a question arises: When a law graduate can be a
director, why can't someone with an engineering degree be in the same
position? Some successful General Managers and Directors in Nepal
Industrial Development Corporation (NIDC) were engineers. There are
several engineers working in NIDC and other financial institutions even
now. Why cannot they be qualified to be the Director or CEO of NIDC and
other financial institutions? Activities like project financing and
assets valuation require engineers. Similarly why cannot mathematicians
or science graduate be allowed to be the CEOs and directors in banks?
It's good to have qualified directors but there cannot be any reason to
require them to be graduates in only some specified fields. Similar arguments can be put forward
regarding the requirement of five years work experience. In Development
Credit Bank Limited, only a few of existing directors will be able to
continue if those criteria are to be strictly followed. I think, around
60% of those who are directors in any of the financial institutions,
will not be able to continue at their positions. Only the retired
government officials, officers of public limited companies and bankers
will have to be searched to be the directors in banks irrespective of
whether they have any financial stake at the bank or not. How can we be
sure that such people be able to contribute significantly to the
financial institution? Looking at the bleak picture of the public
limited companies of Nepal, how can we expect the retired officers from
those companies to be able to efficiently lead the banks or other
financial institutions? As per the act, it shall be mandatory to appoint
in the Board a professional Director chosen from the list of
professional experts enlisted by NRB. Such directors will have no voting
rights. A director without a voting right cannot contribute
significantly towards the development of a bank or financial
institution. CEO of the 'Ka' category banks have to
have master's degree in either of the chosen few subjects. The act does
not mention the renewal of a CEO's tenure. There could be an argument
that when the governor or deputy governor of NRB or any secretary in any
HMG departments have to retire after a 4/5-year term, why shouldn't
there be the same rule for the CEOs of the banks? But this single 4-year
term rule is not sufficient for the CEO to fully apply his vision in the
bank. There should not be a fixed term for the CEO.The tenure of a CEO
should be decided by the Board or AGM of the institution. For the existing banks and other
financial institutions a two-year period has been granted to apply for
the licence. This time period is short in order to meet all the
necessary requirements before applying for the licence. The number of
directors has to be reduced to 5-7. Entirely new Memorandum of
Association and Articles of Association have to be prepared and for this
purpose a special General Meeting of the shareholders has to be
convened. If in two years period, this preparation is not completed the
organizations are threatened as they will not be getting the licence.
When NRB makes a fetish of time factor like this why could not they come
out with a circular stating which banks belong to 'Ka', 'Kha', 'Ga' and
'Gha' categories? This all should have been clearly stated when the Act
was being announced. When we don't know where we stand on, what basis
are we going to follow for the licence? Also it is not clear whether we
are to prepare Memorandum of Association and Articles of Association on
our own way or is the central bank going to provide templates on the
basis of which we are to prepare them? It will take more than a year for
the hundreds of these financial organizations to hold AGMs, prepare new
Memorandum of Association and so on. The next year when all these
organizations will submit applications for obtaining the licences, the
central bank will be in a great pressure. How will they be able to check
in detail all the documents that have been submitted there? Another interesting fact is that as the
Ordinance has to be renewed after six months, there is a chance that the
Act might come in revised format again. Banks and Financial Institutions
have to wait and see the expected amendments within six months so that
they could decide accordingly. When there will be no specialised banks
like the Industrial Development Banks or Agriculture Development Bank,
the banks will only go for the sectors that will help them generate the
highest profit. Who will take care of the development in agriculture or
the industrial sector? However, as NIDC and Agriculture Development Bank
are clearly stated in the Ordinance as belonging to the 'Kha' category
and it is also provided that these two banks can be allowed to do more
than what 'Kha' category banks will be normally allowed, it provides
some hopes. But the actual implementation of these provisions has to be
observed in the future. This Ordinance has given the full
authority to NRB for monitoring, inspection, supervision etc. NRB is
vested with the power to fix interest rates in lending and deposits and
the Act also states that NRB can also delegate this authority to the
individual banks themselves. Such delegated authorities can be taken
back. This further makes banking more risky. The Ordinance indicates the
NRB's willingness to have control over fixation of interest rates, when
required. About loan disbursement and recovery
procedures there is a separate chapter. Movable or immovable property
has to be taken as security before the disbursement of the loan. The
bank will have to register with the competent government authority its
lien on the property so taken as mortgage against the loan. Such
registration is possible in case of land and building as the Land
Revenue Office maintains such records. But how can such lien be
registered in case of current assets and machinery? It is heard that a
special law for the registration of immovable property is being drafted,
but nobody knows when it will be announced. A provision of the new law states that
for recovering its loan, the bank can claim even the personal property
of the promoters of the defaulting borrower firm. This contradicts the
concept of limited liability. For auditing the financial reports of the
bank, five months time has been provided under this new law. If in that
period it is not completed three more months can be provided. If even in
that time, the auditing is not completed, NRB will appoint an auditor on
its own will. There can be several reasons as to why the banks may not
be able to complete auditing in that period. One reason may be the
inefficiency of the auditor. Or the auditor may try to act fraudulently.
These possibilities are not addressed in this law. It is also stated in this Ordinance that
the AGM will decide the salary of the auditor. But a draft of new
Company Act is being finalised in which it is stated that the audit
committee, a committee formed with a non-executive director as the head,
will decide the salary of the auditors. Thus, this law is going to
contradict the provision of the new Company Act that is in the offing. This Act has also vested the power to NRB
to issue directives and make or change regulations by taking permission
from HMG. When the regulations keep on changing, it will have negative
repercussions. For example, previously the promoters were not allowed to
sell shares for two years. Again there came out another regulation,
which stated that the promoters would not be allowed to sell shares for
three years. Then another regulation was introduced stating that shares
can be sold only after three years of the company being listed in the
stock exchange. Now there is a rule that the shares can be sold only
after five years of the listing. Sometimes back there also was a rule
that did not allow the promoters to take loan. Also, the development
banks were once allowed to invest in private limited companies. Then
another rule was brought out stating that they can't invest in such
companies. If there is such an investment it has to be disposed
off by the year 2061 BS. As DCBL has made such investment, it is facing
problem in this regard. Such inconveniences arise as a result of the
changing rules. This Ordinance has come out following a
number of other developments related to banking business. Debt Recovery
Tribunal has been set up. Asset Management Company is soon to be set up.
But the act does not have anything about these. Moreover, it is silent
on how to write off the bad debts. It requires the accounts of the banks
to be maintained in the head office. So it neglects the branch-banking
concept. This act has also neglected the internal audit concept. This
has the concept of corporate governance and Audit Committee. This Ordinance has come up with a new
regulation supporting merger concept, which is a positive development.
But again it is silent about acquisitions. In liquidation of the banks,
this act has given priority to the depositors' money and government
money. Staff salary and their provident fund were also in priority
previously but they are given least priority by this act. NRB is to fix the management expenses of
the banks and financial institutions, as per this law. The management
expenses include the overhead expenses, staff expenses, salary,
operating expenses, expenses on entertainment, etc. It is not clear
whether NRB is going to fix everything from the staff salaries to what
should be the expenses on entertainment. One just wonders how NRB is
going to do this. On the whole, the concept of the
Ordinance to replace specialised banking concept with universal banking
concept is a positive development. This Act also will boost competition.
The inefficient banks will face difficulties. The deposits will be very
secure. Also the borrowers will benefit a lot, as the implementation of
this Act seems to reduce significantly the interest rates on lending.
This is possible because the monopoly of the commercial banks will be
ended and the cost of fund of the development banks and the finance
companies will be reduced. So the consumers are the ones who will get to
reap the maximum benefits. However, amendments are necessary to get rid
of the loopholes in the Ordinance. At the same time NRB has to be very
efficient. They have to monitor the activities of the banks very timely.
If they are not able to go the way they have promised, there may be
severe backfires. (Khatri is President/CEO of Development Credit Bank. But the views expressed in this article are his own and not necessarily reflect those of his ogranization) Lackings in Nepal-India Railway Accord by R B Rauniar At last the
Railway Services Agreement has been initialed by the bureaucrats of both
the Indian and Nepali Governments in November 2003. This will now enable
the operation and management of the Inland Clearance Depot, the DRY
PORT, constructed at Birgunj and ready for operation since December
2000. The formal signature at the ministerial level is still due.
However, the concerned authority of ICD Birgunj, Nepal Intermodal
Transport Development Board (NITDB), has already initiated the process
for operation and management of the ICD. But while going through the provisions of
the recently concluded Rail Services Agreement, one can quickly notice
that much could have been done as improvement in it if a few vital
points could have considered and included in the agreement. Of course, it is positive that there is
some thing now where there was nothing till recently. The Indian
Railways or their subsidiaries shall pick-up and deliver goods of Nepal
for international and bilateral trade from/to the Nepali territory.
International ISO containers and Indian domestic DSO containers can be
carried by the Indian Railways in and out of Nepali ICD. The covered
Indian Railway wagons can ply in and out of Nepali ICD. But there is no
provision in the agreement for plying open wagons which carry bulk cargo
like minerals, coal, gypsum, clinkers etc. This lack is conspicuous. ICD
Birgunj does have facilities to handle these types of cargo. Without the
necessary provision in this agreement, these facilities will lie
unutilized. A separate rail track has been constructed to handle these
types of cargo. Moreover, movement of third country container traffic is
permitted in the treaty only in the opening year of rail operation
though there is a provision to permit other types of cargo carrier
wagons after review at a later stage. The major volume of bilateral and
international cargo toward and from Nepal is in the form of break-bulk
and bulk. Operation of only containerized traffic from and to the ICD
will not be economically viable for the operation of ICD. One good provision made in the Rail
Services Agreement is the arrangement for review and modification of the
technical and operational aspects which is to be held at least once
every six months. This gives room to negotiate further for any expansion
of services. No provision has been made in the Rail
Services Agreement for any scheduled fixed day and minimum number of
rail operations to and from the Indian ports to the ICD. This creates
big confusion to the trade for arrival and departure of the containers
to and from Indian ports. This causes lack of confidence among the
traders about the transit time, arrival and return of empty containers
to and from Indian ports. If transit time is not assured other costs
like container detention and demurrage may be incurred. As regards the settlement of claims and
compensation, the provision made in the Rail Services Agreement is based
on the Indian Railway rule which specifies a rate of Rs. 50 per kilo.
This clause of the Rules of Claim of the Rail Services Agreement
supercedes claim payment provisions made in the Treaty of Transit in
respect to the movement of cargo by rail where the value of the claim is
stated to be as per invoice value. The signed Rail Services Agreement has
specified Kolkata and Haldia port for rail operation. These are only
feeder ports. The two governments of India and Nepal have already agreed
in other documents to make other ports like Jawaharlal Nehru Port in
Mumbai, which is now a hub port, available for Nepal’s Cargo movement
as reiterated in the joint statements published during the state visits
of the then Nepali Prime Ministers to India (i.e. during the India visit
of late Prime Minister Manmohan Adhikari and the visit of the then Prime
Minister Sher Bahadur Deuba). Moving cargo and containers from and to
‘hub port’ means reducing shipping costs. Operation through
‘feeder port’ has higher sea freight cost than through a hub port.
There will be a cost benefit of sea freight in between US Dollar 200 to
400 per container from hub port compared to feeder port and save
substantial transit time. While going through the procedures laid
down in the agreement, for movement of Nepali International Traffic –
Import and Export – it can be noticed that there is very little
difference in the customs procedure laid in the Rail Services Agreement
in comparison with the existing procedure laid in the Treaty of Transit.
The procedures in the Treaty of Transit with India are based for the
movement of traffic by road. A lot of sensitive issues have been
considered in the Treaty of Transit. In the Rail Services Agreement, the
procedures should have been made considering that the rail operation has
less sensitive issues. The Treaty of Transit was made against
the background of the situation when the trade was facing the regime of
restrictions, licensing and other trade barriers imposed for
international trade. The globalization of trade, entry into WTO,
reduction on customs duties, India’s opening up to free international
trade and de-licensing, should have been reflected in this Rail Services
Agreement in the form of simplified procedures for smooth movement of
traffic. Procedure simplification and unhindered transit transport could
further reduce transit cost and transit time. (Rauniar is the Managing Director of Interstate Multi-Modal Transport P. Ltd., Nepal) |
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