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Asia-PacificJuly 29 2022

Nepal’s banks battle isolationism

Nepal’s banks appear resilient to the worst shocks of the pandemic, with strong balance sheets and low non-performing loan ratios. Beneath this, there is discontent over a slow to change regulatory system, which is stifling growth. Kimberley Long reports. 
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Nepal’s banks battle isolationism

Nepal’s banking sector is, on the surface, exhibiting a strong performance among its regional peers. In contrast to the economic slowdown facing regional powerhouse China and the unfolding crisis in Sri Lanka, Nepal looks buoyant. 

Ratna Raj Bajracharya, CEO at Global IME Bank, says the Covid-19 pandemic left few marks on the banks. “Covid had an impact, but it was not felt that strongly on the balance sheet. Last year the bank saw record growth, with a 25% deposit increase to NPR75bn ($590m). Much of this came from slowing discretionary spending.” 

Suman Sharma, CEO at Sunrise Bank, backs this up, saying the bank saw its deposits grow by 32% year on year to January 2022.  

The outlook for the economy as a whole looks bright. Mr Bajracharya forecasts the economy will grow by 2.7%, to 5.5%, during 2022, although he acknowledges the International Monetary Fund has predicted growth below 4%.  

In response to the ongoing difficulties faced by some sectors due to the Covid-19 pandemic, the central bank, Nepal Rastra Bank, instructed banks to support their customers in December 2021. “Banks were supported to provide stimulus loans to customers,” says Mr Bajracharya. “These came as a 20% working capital loan, with a high focus on supporting affected companies, such as the tourism sector. Companies were also allowed to restructure their debts and pay accrued debt back in four instalments over two years.” 

The non-performing loan (NPL) ratio has remained low for the banking sector, due to the nature of Nepalese borrowers. Sunrise Bank reported seeing NPLs at 1.18% to mid-October 2021. However, without the concession of the central bank on loan classifications due to Covid-19, the figure would have been closer to 2.29%. 

“The low level of NPLs in the country is mainly due to availability of secondary collateral security, such as real estate, besides primary security like stocks, receivables and movable fixed assets, as borrowers usually dispose of their fixed assets if needed to repay overdue loans or settle loans,” says Mr Sharma. 

The low NPLs may also be down to the restricted nature of lending. Sailesh Subedi, head of the rating division at credit rating agency ICRA Nepal, says banks have not seen major systemic asset quality concerns from the trading, manufacturing or consumption loan segment so far. Most of the loan portfolio is comprised of short-term revolving loans, which are used to finance working capital. Because of this, even external shocks like the 2015 earthquake and the Covid-19 pandemic have caused little impact on asset quality. 

It is the changing nature of loans and borrowers which are most likely to impact NPLs. “Lately the proportion of banks’ exposure to long-tailed projects, such as hydropower and the hotel sectors, are rising,” says Mr Subedi. “Now that the banks are increasing their stake in longer term projects, the asset quality of banks could be affected by such externalities. Moreover, overleveraging of the borrowers following high credit growth by the banking sector players after 2015 have lowered the financial flexibility of many borrowers, as well as their resilience towards sudden liquidity and interest rate shocks.” 

SME backbone  

Providing support to small and medium-sized enterprises (SMEs) is the backbone of the offering for several banks and the focus of their lending. At Sunrise Bank, the microfinance portfolio comprises 8.7% of total loans, compared with the statutory minimum of 5%, and 23% to SMEs. 

In order for borrowers to get the most from the bank, additional services are included. Mr Sharma says: “SMEs are provided with financial support in the form of interest subsidies from the government and educational programmes as part of our corporate social responsibility initiative.” 

Sunil Babu Khatri, senior deputy CEO of Citizens Bank, says the bank is introducing innovative products to meet the needs of customers outside of urban areas. “We look to support micro, small and medium-sized enterprises (MSMEs) in undeveloped sectors, and have a practice of opening ATMs in underserved areas,” he says. “We have developed products to support agriculture, such as providing loans and mortgages against paddy fields, for example, for customers without property to put up as collateral. There is a lack of modernisation in the agricultural space, which needs to be addressed to expand the sector.” 

Other banks are expanding their reach beyond the cities by taking over another bank’s business. Sunil KC, CEO at NMB Bank, says: “The bank conducted a merger during the pandemic, which has given us greater reach in rural areas to focus on financial inclusion and supporting MSMEs. Greater decentralisation of the sector will help rural areas get access to greater opportunities.” 

Roshan Kumar Neupane, CEO, NIC Asia Bank, believes it makes economic sense to provide services beyond the large urban areas. “SMEs are hampered by the lack of credit access. Banks in the metro areas don’t see the advantages of supporting rural customers. Customers need to be able to bank remotely and through user-friendly services. There needs to be a focus on improving customer service. This would help banks to be more profitable.” 

While the regulated banks may be moving into the rural areas for the first time, there are existing banking services in these areas. Due in part to the lack of banking services in some parts of the country, Nepal has a thriving informal banking network. Sujeev Shakya, founder and CEO of management consultancy Beed, says there are underlying issues for the country due to the size of the informal sector, but customers are unlikely to stop using informal services. “Many people bank with their local co-operatives as they can access high levels of interest up to 24% on their deposits.” 

Monopoly on digital 

The size of the informal banking sector, and the impact that has on remittances (see page 70), is one of the causes of frustration felt within the country’s finance sector. 

Digital banking is one space which has been slow to grow. Rajib Maharjan, assistant vice-president at ICRA Nepal, says: “Covid-19 boosted the number of users on digital platforms, but before there was not much interest. Investment is now coming, so we see the evolution of products like e-wallets. Banks are starting to target their corporate customers as a method of future business growth.”

Financial software provider F1Soft International seemingly provides most of the country’s digital banking and payment services, ranging from white labelling the online banking software for the country’s banks, to mobile wallets and QR code payments. Biswas Dhakal, president of F1Soft, says licensing and maintaining bank software is one of the main revenue streams for the company. 

F1Soft CEO Subash Sharma explains that the company operates multiple systems to squeeze value from the market. “We provide bank technology, servicing the local market. It is a very small market, and it is not always enough to sustain a business. But businesses which want to explore new ideas are restricted by law against investing and operating businesses outside of Nepal.”

He continues: “Our eSewa wallet has hit 70% market share. eSewa is unable to explore opportunities outside Nepal due to legal restrictions, so it might hit a growth ceiling very soon.” 

The company has a touchpoint across a payment lifecycle. “F1Soft runs both ends of the transaction, operating for the merchant and the customer,” Mr Sharma adds. “We run the mobile wallet and process QR code payments. The wallet is funded directly from bank accounts.” 

Mr Dhakal adds: “The QR codes are used for both low- and high-end transactions. There is no charge to the vendor to accept payments in this way. The economy is still very cash-based and vendors are often reluctant to move away from this, as it would disrupt their own supply chains. But as a company, we want to position ourselves as the market leaders when the wholesale movement to digital happens.” 

While this has produced several revenue streams for one company, there are feelings of dissatisfaction at how Nepal is allowing its financial sector to operate. Mr Shakya is critical in his views, believing there is a lack of aspiration for growth, with complacency and collusion between banks preventing real modernisation in the sector. 

“The population of Nepal wants modern, digital banking,” Mr Shakya says. “But bank board members and CEOs are from an older generation who are not using much tech. Therefore, banks have not been able to push digitisation of services, like digital signatures, and do away with physical documents. There is no impetus for the banks and the central bank to modernise. The banks are not operating to Basel III or IFRS standards, which alienates the banks from the global markets.” 

To operate at this level would require significant commitment. Anirvan Ghosh Dastidar, CEO, Standard Chartered Nepal, says: “Any move from the current level to Basel III would require considerable change to how capital is allocated. The central bank needs to move faster. Its needs to develop new sorts of mechanisms and facilitate a highly regulated capital market.” 

Local mindset 

There is a lingering frustration at the insular nature of the Nepalese market and how restrictions on banking and business are preventing international expansion. 

“There is low bank interoperability due to unsophisticated software,” Mr Shakya says. “Banks are still using pirated software. There is little in place to protect banks from cyber attacks.” 

Mr Shakya points to issues which he says stems from the “closed mindedness” in the country, which makes doing business difficult. These include a lack of solid economic data from the banks, as they do not have research or economic departments. He also says there is negligible support for think tanks and research institutes that work with data. 

He believes the issues stem from the top. “The central bank makes it difficult to work with overseas companies. They have the mindset that everything needs to be built locally. Nepal is located between the two huge markets of China and India and could learn a lot about increasing foreign investment from them.” 

This view is echoed by Prithvi Pande, chairman of Nepal Investment Bank. “There is a lot of potential if Nepal could operate more with India. In the provinces bordering Nepal there are 350 million people — 10 times Nepal’s population,” he points out.

Capital markets 

Nepal’s banking sector is hampered by underdeveloped capital markets. The Nepal Stock Exchange was founded in 1993, and as of May 2022, the equity market capitalisation of the listed companies was $27bn. As of June 2022, there are 184 active companies listed. 

In the bond market, issuance is mostly concentrated on government bonds. Mr Sharma says: “The bond market is not in the developed stage in the country, hence there is little opportunity for banks to generate income by investing in the money market. The banks have the opportunity to invest only in government bonds and treasury bills, the yield of which normally remains at the lower side of the normal liquidity situation. Furthermore, investment outside the country is restricted to euro money market deposits and sovereign bonds, as issued by financial institutions.” 

Some banks are looking to move forward, especially with external assistance. Mr KC says: “NMB Bank has issued local currency energy bonds for the first time. The bank also secured International Finance Corporation (IFC) financing to fund green projects. It is the second deal with the IFC and there are a lot of projects to support in the local market.” 

Even with the offering, the majority of the interest in the bonds is still focused on the financial sector. “The other local banks are the main investors in the bonds,” Mr KC says. “Liquidity is tight, but they look to get 70% to 80% subscribed, at $30m.” 

“In the absence of corporate bonds in the market, banks have little choice of investment in fixed income securities, which are exclusively treasury bills and government bonds,” Mr Sharma adds. 

Mr KC remains optimistic that the capital markets will take off. “The secondary bond market is not strong, and trading is not done very often. Hopefully going forward, we will see greater levels of credit and liquidity in the market,” he says. 

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Read more about:  Asia-Pacific , Nepal , Regulations
Kimberley Long is the Asia editor at The Banker. She joined from Euromoney, where she spent four years as transaction services editor. She has a BA in English Language and Literature from the University of Liverpool, and an MA in Print Journalism from the University of Sheffield. Between degrees she spent a year teaching English in Japan as part of the JET Programme.
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