2 ways to revamp Nepal’s economy

In Nepal, a drawn-out political transition has led to a delay in the development of the financial sector, an essential part of the country’s economic growth. The sector dictates the flow of investment from public, private and foreign sources to businesses, infrastructure and development projects in both rural and urban areas; unlocking it could significantly advance entrepreneurship and foreign investment, and provide the impetus for sustainable economic growth.

Slow progress

Many people in Nepal lack basic access to financial services. The likes of the World Bank, the Asian Development Bank and the International Finance Corporation (IFC), and development agencies such as the Department for International Development (DfID) and USAID, have been actively helping Nepal’s central bank and other financial institutions to not only strengthen the financial system but bring financial services to the largely unbanked population. Progress has been sluggish, however.

In a country of 30 million people, there are 32 commercial banks, 88 development banks, 77 finance companies, 24 microfinance development banks, 36 financial non-governmental organizations, and 16 licenced saving and credit cooperatives.

There are several issues preventing the financial sector from reaching its potential:

1. Despite the high number of financial institutions, their low capital base and disproportionate balance sheets limit their ability to lend; this makes them vulnerable to shocks related to non-performing assets.
2. 51% of bank and financial-institution branches are concentrated in the Central Development Region that surrounds the capital city, Kathmandu. By contrast, the Far-Western Development Region has 8% of the branches – and 45.6% of the population living under the poverty line, according to the population census of 2011 and National Living Standards Survey 2009/10. This suggests that the area most in need of financial services is that which is most underserved.
3. The absence of financial services, among other basic facilities, has prompted millions of Nepalese people to move to urban centres such as Kathmandu. This has placed extra strain on infrastructure and resources, and made it harder for underdeveloped regions to make progress.
4. Limited availability of credit and the lack of basic financial services have prevented the private sector from expanding and has slowed down creation of new businesses, jobs, and the promotion of financial safety overall.

Revamping the system

The development of the financial sector in Nepal should follow two basic principles:

1. Develop the banking system

The central bank has taken out directives urging banking and financial institutions to increase their capital base, which has led to a positive trend in mergers, acquisitions and overall strengthening of the balance sheets. This movement can help institutions run their urban operations more efficiently and increase their ability to set up branches in remote locations.

Meanwhile, the use of technological solutions, such as mobile banking, can help institutions reach populations that are currently unbanked. Mobile technology is estimated to have penetrated 80% of the population, and this could be key. There are a few companies in Nepal, such as Finaccess and MNepal, that are developing platforms which allow banks to connect with customers. The creation of mobile bank accounts also brings in deposits that were previously not present in the banking system, and this would increase an institution’s ability to increase its credit portfolio.

The lack of critical infrastructure, as in the energy sector, has created massive electricity shortages of up to 18 hours a day. Nepal’s financial sector does not have the capital structure in place to lend to such large projects. Periodic liquidity crises within the banking system has created volatility in lending rates, and made investment unfeasible for infrastructure projects that rely on fixed rates.

Furthermore, the absence of institutions that can lend on a long-term basis, at a fixed rate of interest, is the reason why multilaterals such as the World Bank Group and Asian Development Bank step in. Nepal would benefit significantly from long-term lending institutions that can boost investment in infrastructure.

2. Raise capital

In the absence of formal financing in Nepal, entrepreneurs are faced with the following problems:

• The absence of banks and financial institutions in many parts of the country has hampered entrepreneurs’ ability to secure loans for their businesses.
• Most banks and institutions require collateral – mostly land and buildings – before a customer can qualify for a loan, thus preventing some entrepreneurs from accessing this facility.
• No system exists that connects entrepreneurs with investors of risk capital.
• Microfinance is an excellent source of capital for small businesses, but comes with high interest rates and “lending ceilings”.
• Entrepreneurs are often at the mercy of informal lenders, who can be predatory.

These issues are most pertinent to small and medium-size businesses, which form the backbone of any economy by generating employment, wealth and economic security. Here, private equity can add tremendous value by injecting the required risk capital, and strengthening company balance sheets and credit worthiness.

In recent years, the IFC, DfID and private investors have led venture funds that have raised capital of about $30 million. However, in the absence of regulatory clarity, investment vehicles like private equity funds have not been able achieve a legal status and become a legitimate asset class for private, public and foreign sectors to invest in.

Private equity can help potential entrepreneurs access capital and create the businesses and organizations that will improve the region’s economic and social health.

Through these basic developments in the financial sector, Nepal can create the systems required to obtain a favourable international credit rating. The strengthening of the banking system and private and public capital markets will boost entrepreneurship and infrastructure spending, and turn Nepal into an economic success story.

Author: Amod Rajbhandari is CEO of Mercantile Traders and a Global Shaper from Kathmandu Hub.

Image: A woman selling flower garlands waits for customers outside a temple in Kathmandu January 5, 2012. REUTERS/Navesh Chitrakar