Hit by an earthquake and trade blockade with India, Nepal has endured a tough few years. However, despite these events its banks have remained profitable, though much of this is explained by what many deem to be an over-reliance on remittances. Peter Janssen reports.

IME Nepal embedded

The morning after the 7.8 magnitude earthquake of April 25, 2015, Nepalese bank executive Sashin Joshi got a call from a customer asking when the bank was opening. “He said ‘I’ve got Nrs30m [$285,000] at home and I want to deposit it in the bank’,” recalls Mr Joshi, the chief executive of Nabil Bank, Nepal’s biggest private bank measured by profits.

One might wonder why a Nepali businessman would have Nrs30m stashed away at home when there are plenty of reputable banks in the country. “The reason was that the parallel economy in this country is huge,” says Mr Joshi. Nepal’s parallel economy is an estimated 30% to 40% of gross domestic product (GDP), with many business transactions kept off the books to avoid taxes and excess scrutiny.

In 2015, the country suffered a double whammy. First, a devastating earthquake and its aftershocks in April, which killed more than 8000 people and caused about $5bn of damage. Then came a 135-day trade blockade with India – which accounts for about 65% of Nepal’s total trade – that caused even more damage to the formal economy than the earthquake.

Rise in profits

As a result, Nepal’s GDP grew a disappointing 0.7% in fiscal year 2015/16 (ending July 15, 2016), the lowest rate in 14 years. Yet its 28 commercial banks notched up an average 25% to 26% rise in profits during the same period. This seeming incongruity says a lot about Nepal.

One reason for banks’ unexpected profitability can be attributed to the central bank, Nepal Rastra Bank (NRB), which was quick to introduce forbearance measures on earthquake-affected bank loans. This allowed banks to avoid heavy provisioning for non-performing loans after the usual 90-day cut-off period. But that was only part of the story, according to private bankers.

“That was not the main reason [for the profitability],” says Upendra Poudyal, president of the Nepal Bankers’ Association and CEO of Kathmandu-based NMB Bank. For starters, the banks and their customers did not suffer unduly from the earthquake. “Imagine a situation where 800,000 homes were fully or partly damaged, but overall there was insurance coverage on just 17,000 of them. That means there was minimal impact on the banking system,” adds Mr Poudyal.

In fact, the banks benefited from an immediate surge in deposits in the post-earthquake period. According to a study by the UN Capital Development Fund (UNCDF), the percentage of banked adults rose 3 percentage points after the earthquake, from 47% to 50%.

The same report notes that the proportion of financially excluded adults rose 4 percentage points from 14% to 18%, as hard-hit low-income groups were excluded from even informal mechanisms. Most of the destroyed houses belonged to the poor.

The World Bank estimates that 700,000 to 1 million Nepali may have been pushed below the poverty line ($1.90 a day) because of the earthquake and subsequent trade blockade with India, although the real impact will not be known until the government updates its Living Standard Survey, maybe by 2018.  

But for the banks, the earthquake did not bring with it a financial hit. Deposits went up 20.6% from Nrs1500bn to Nrs1800bn, according to central bank figures. Another unexpected boost from the earthquake came from remittances from Nepali workers overseas, the backbone of the economy in more ways than one.

Remittance reliance   

Over the past two decades, Nepal – one of the world’s least developed countries – has graduated from aid dependence (aid accounted for 10% of GDP in 1990) to having a reliance on remittances. In fiscal year 2015/16, official remittances from some 4.5 million Nepali working in 120 different countries amounted to an estimated $6.5bn, accounting for about 30% of GDP.

This amount far exceeds the $4bn pledged by donors to Nepal over the four to five years following the earthquake. Nepal’s economy has been relying on people exports since the early 2000s, turning the government’s failure to create employment at home into a gold mine for the domestic economy.

“The big transformative gorilla in the room is remittances,” says Damir Cosic, country economist for Nepal at the World Bank. “Remittances are 10 times larger than foreign aid, 2.5 times larger than exports and two times the budget, so they dwarf everything.”

Remittances are also big business for the banks, and were their salvation in the 2015/16 fiscal year. “The earthquake and trade blockade hurt the economy, and the poor, but the banks were not affected because the remittances were flooding in in a big way,” says Ratna Raj Bajracharya, CEO of Kathmandu-based Sunrise Bank.  

Remittances rose dramatically after the April earthquake, as Nepali workers in Malaysia, Saudi Arabia and elsewhere worked hard to send money home to their families devastated by the disaster. While the remittance flow to India (the world’s leading remittance-receiving nation) decreased by 2.1% in the last calendar year (ending December 31, 2015) they were up 20.9% to Nepal in the corresponding period, according to a World Bank report.

Slowing flows

The remittance flow in 2016 shows signs of slowing, especially as Malaysian and Saudi Arabian demand for Nepali workers faltered on weak oil prices. In July 15 to August 15, the first month of fiscal year 2016/17, remittance inflows declined 2.5% year on year, although the jury is still out on whether the downward trend will continue.

“The growth rate [of remittances] is going down but with the festival season coming up, it could go up again,” says Tara Manandhar, deputy CEO of Prabhu Bank. The banks are waiting to see if remittances jump in October, the time of the Dashain Hindu festival, when the Nepali diaspora traditionally remit more money home to assure a prosperous year for themselves and their relatives.

The Prabhu Bank group includes Prabhu Money Transfer, one of the two leaders of the money transfer services for the millions of Nepali remitters. The lead remittance company in Nepal is IME, which claims to handle $1bn in remittances a year. Both IME and Prabhu base their operational models on that of the globally dominant Western Union.

According to Suman Pokharel, CEO of IME: “Western Union is synonymous with remittance everywhere. But in Nepal, IME is synonymous with remittance.” Prabhu might disagree, as it also claims to handle $1bn in remittances a year.

Targeting the unbanked

Now, both IME and Prabhu have branched out into banking and other financial services. “In fiscal 2016/17, we are looking to bring more deposits in digitally,” says Kusum Lama, a director at Prabhu Money Transfer. The bank has issued 22,000 pre-paid remittance swipe cards, which can be used to deposit money abroad, and then utilised as a debit card by recipients of remittances in Nepal. Prabhu remittance cardholders can also get cash from the company’s 7000 money transfer agents nationwide. “Most of the people sending remittances from abroad are unbanked, so they may not have access to a bank branch in their village,” says Ms Lama.

Another bank showing innovation in addressing the needs of the poor is commercial lender Mega Bank, under CEO Anil Shah, who says: “Our vision statement is ‘from plow to power’. I want to give banking services to all Nepali.” Besides innovating small loan schemes to thousands of sugarcane farmers and village shareholder investors in hydro-power schemes, Mega Bank has also launched speaking IT tablets to enable illiterate farmers to make deposits, withdrawals and payments as part of its branchless banking scheme. “I want Mega Bank to be the Coca-Cola of Nepalese banking – wherever you go, you can access a Mega Bank,” says Mr Shah.      

Financial inclusion is a government priority. The banking system in Nepal, a land-locked, mountainous country, is only about 30 years old (the first three commercial bank licences were handed out in 1984). The 28 commercial banks (down from 32 three years ago), have about 1869 branches nationwide to serve 30 million people.

Besides the 'class A' commercial banks, there are 67 'class B' development banks (852 branches), 42 'class C' finance companies (175 branches) and 42 microfinance companies (1378 branches.) According to the UNCDF, Nepal’s financial access is better than that of Laos, Myanmar and Pakistan, with 61% of the adult population having some access to formal financial services and only 18% being financial excluded.      

With so many players in the market, better supervision may be necessary to make the financial inclusion work. “I don’t see an overarching vision on the ways and means, [as there are] different and alternative channels that they can use in order to increase financial inclusion,” says Ujjwal Pokhrel, national programme coordinator at the UNCDF. “That [vision] needs to come from the central bank of Nepal, by being a little bit more liberal.”

Tightening system

The NRB is focused on tightening up the financial system, after arguably giving out too many banking and other financial licences in the 1990s. The central bank is encouraging the existing commercial banks to merge by forcing them to raise their paid-up capital bases fourfold from Nrs2bn now, to Nrs8bn by the end of fiscal year 2016/17.

If anything, the push is fuelling a stock market bubble as banks issue new shares to boost their capital. “The entire bank system is floating about Nrs50bn in new share issues,” says Sunrise’s Mr Bajracharya. The rights to the new shares go to existing shareholders first, meaning that a huge number of people are buying bank shares now, creating a stock bubble that many fear is about to burst. “The index is now above 800. Five years ago it was below 300, and fundamentally nothing has changed in the country. It’s gotten worse,” said Nabil’s Mr Joshi.  

While, in theory, raising capital makes the banking system more stable, the strategy depends partly on banks being able to increase their lending. Unfortunately, in Nepal, there is very little to lend to, barring the stock market, real estate and to a lesser extent hydro-power and cement plants. Total foreign direct investment (FDI) in fiscal year 2015/16 was Nrs15.1bn, down 77.5% year on year. Nepal’s FDI inflows have consistently been one of the lowest in the south Asian region, with domestic investment not much better.  

Nepal has suffered from two decades of political instability on its rocky transition from Hindu kingdom to democratic federal state, and most observers anticipate another two to three years of adjustments as politicians thrash out amendments to the September 2015 constitution. Controversial clauses in the charter sparked the trade blockade with India.

Until Nepal gets its political house in order, private investment may prove difficult to attract. The economy lacks public investment in infrastructure such as irrigation, roads, airports and power stations. But these require consistent, investment-friendly policies.

In the meantime, Nepal’s banks are likely to come under increasing pressure to lend, given the fourfold increase in their capital requirements. “What happens if there is an overcapitalised bank and a very aggressive board, and in Nepal all the boards are run by the big business houses?” asks Joseph Silvanus, CEO of Standard Chartered Bank Nepal, which is 75% owned by Standard Chartered Group. “The poor CEOs and management teams would take short-cuts to create business to increase revenues, and the unintended consequences will be asset bubbles.”

The National Banking Institute’s CEO, Sanjib Subba, estimates that 95% of the current bank board members have no banking experience.

Innovation needed

Of course, with only 61% of the adult population currently using the formal financial sector, there is arguably plenty of room for growth in innovative banking in Nepal. One challenge is that nearly all of the country's leading bank chief executives are graduates from the Standard Chartered school of banking (the UK bank has had a presence in Nepal since 1984) but there are few other global players on the market, although they are – at least in theory – welcome.

“The only way to make the system more competitive is if tomorrow there is Citibank, Bank of America, HSBC and others here. That would iron out the market, because currently the banks are just a platform for trading,” says Sujeev Shakya, founder of Kathmandu-based Beed Consult and author of the book Unleashing Nepal.

With few industries and small export volumes, Nepal’s private sector is principally driven by rent-seeking and trade, with a lot of that trade being off the books, or in the parallel economy. Traders tend to be experts at making money from all economic developments, including even trade blockades. During the September to January trade embargo, smuggling took off and prices skyrocketed. “Unscrupulous people made a lot of money off the embargo,” says Mr Joshi. He believes a lot of these unscrupulous people are close to the politicians. “They play the system. There is a lot of crony capitalism here,” he adds.

The crunch for the system may come if Nepal’s remittance flows start to dry up. “Remittances are a transformative flow, but not something you want to build into your growth model for a country,” warns the World Bank’s Mr Cosic.

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