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TRANSCRIPT
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Document of
The World Bank
FOR OFFICIAL USE ONLY
Report No. 77660-NP
INTERNATIONAL DEVELOPMENT ASSOCIATION
PROGRAM DOCUMENT
ON A PROPOSED DEVELOPMENT POLICY CREDIT
IN THE AMOUNT OF SDR19.9 MILLION (US$30 MILLION EQUIVALENT)
TO
NEPAL
FOR A
FINANCIAL SECTOR STABILITY CREDIT
June 6, 2013
Finance and Private Sector Development (SASFP) Nepal Country Unit (SACNP) South Asia Region (SAR) This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization
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NEPAL—GOVERNMENT FISCAL YEAR July 16 - July 15
CURRENCY EQUIVALENTS
(Exchange Rate Effective as of June 1st, 2013)
Currency Unit: Nepalese Rupee US$1.00: NPR 88.82
WEIGHTS AND MEASURES
Metric System
ABBREVIATIONS AND ACRONYMS
ADB Asian Development Bank ADBL Agricultural Development Bank Limited AML/CFT Anti-Money Laundering / Counter Financing of Terrorism BAFIA Bank and Financial Institutions Act BFI Bank and financial institutions (Class A, B and C institutions) CAR Capital Adequacy Ratio CPS Country Partnership Strategy CDR Credit to Deposit Ratio CPIA Country Policy and Institutional Assessment DCGC Deposit and Credit Guarantee Corporation DCGT Deposit and Credit Guarantee Trust DPC Development Policy Credit DFID Department for International Development EPAD Economic Affairs and Policy Analysis Division FATF Financial Action Task Force FDI Foreign Direct Investment FSAP Financial Sector Assessment Program FSMD Financial Sector Management Division FSTA Financial Sector Technical Assistance Project FY Financial Year GDP Gross Domestic Product GNFS Goods and Non Financial Services GNP Gross National Product GNI Gross National Income GoN Government of Nepal
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ICAN Institute of Chartered Accountants of Nepal ICR Implementation Completion Report IDA International Development Association IFC International Finance Corporation IFRS International Financial Reporting Standards IMF International Monetary Fund ISN Interim Strategy Note LCY Local Currency MDGs Millennium Development Goals MDTF Multi-Donor Trust Fund MoF Ministry of Finance MoLJ Ministry of Law and Justice MTEF Medium-Term Expenditure Framework NBL Nepal Bank Limited NEA Nepal Electricity Authority NIDC Nepal Industrial Development Corporation NLSS National Living Standards Survey NOC Nepal Oil Corporation NPL Non-Performing Loan NRB Nepal Rastra Bank PEFA Public Expenditure Financial Accountability PCA Prompt Corrective Action PDO Project Development Objective PFM Public Financial Management PFMRP Public Financial Management Reform Program RBB Rastriya Banijya Bank SDR Special Drawing Rights VRS Voluntary Retirement Scheme
Vice President: Isabel M. Guerrero Country Director: Johannes Zutt
Sector Director: Sujata Nitin Lamba Sector Manager: Henry Bagazonzya
Task Team Leader: Guillemette Jaffrin
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NEPAL
FINANCIAL SECTOR STABILITY CREDIT
Contents I. INTRODUCTION ............................................................................................................................................. 8
II. COUNTRY CONTEXT ................................................................................................................................... 9
A. Recent Political Developments ............................................................................................................ 9
B. Recent Economic Developments ....................................................................................................... 10
C. Macroeconomic Outlook and Debt Sustainability ............................................................................. 16
D. Recent Financial Sector Developments ............................................................................................. 18
III. THE GOVERNMENT PROGRAM AND PARTICIPATORY PROCESSES ............................................ 29
IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM .................................................................... 34
A. Link to Interim Strategy Note (ISN) and Country Partnership Strategy (CPS) Under Preparation ... 34
B. Collaboration with IMF and Other Donors ........................................................................................ 34
C. Relationship to Other Bank Operations ............................................................................................. 35
D. Lessons Learned ................................................................................................................................ 36
E. Analytical Underpinnings .................................................................................................................. 37
V. THE PROPOSED OPERATION ................................................................................................................... 41
A. Operation Description ........................................................................................................................ 41
B. Policy Areas ....................................................................................................................................... 42
VI. OPERATION IMPLEMENTATION ........................................................................................................... 47
A. Poverty and Social Impact ................................................................................................................. 47
B. Environmental Aspects ...................................................................................................................... 48
C. Implementation, Monitoring and Evaluation ..................................................................................... 49
D. Fiduciary Aspects .............................................................................................................................. 49
E. Disbursement and Auditing ............................................................................................................... 51
F. Risks and Risk Mitigation .................................................................................................................. 52
ANNEX 1: LETTER OF DEVELOPMENT POLICY ....................................................................................... 54
ANNEX 2: DPC POLICY MATRIX ................................................................................................................. 60
ANNEX 3: SHORT- AND MEDIUM-TERM GOVERNMENT PROGRAM .................................................. 62
ANNEX 4: RISK ANALYSIS OF FINANCIAL SECTOR REFORM PROGRAM ......................................... 69
ANNEX 5: FUND RELATIONS NOTE ............................................................................................................ 74
ANNEX 6: NEPAL AT A GLANCE ................................................................................................................. 76
The Financial Sector Stability Credit was prepared by an IDA team comprising: Guillemette Jaffrin (Task Team Leader, SASFP), Michael Markels, Sabin Raj Shrestha, Suran Kc Shrestha (SASFP), Roshan Darshan Bajracharya, Salman Zaidi, Aurélien Kruse, Hisanobu Shishido (SASEP), Bigyan B. Pradhan (SARFM); and Andrew Lovegrove, David Bufton, Djurdjica Ognjenovic (DFID consultants)
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CREDIT AND PROGRAM SUMMARY
NEPAL
FINANCIAL SECTOR STABILITY CREDIT
Borrower Nepal Implementing Agency Ministry of Finance Financing Data IDA Credit
Terms: Regular (40 years, with 10 years grace period) Amount: US$30 million equivalent
Operation Type The proposed Financial Sector Stability Credit is a standalone single tranche development policy operation that supports the broader Government of Nepal reform program to address financial sector vulnerability. The IDA credit is expected to be withdrawn in a single tranche of US$30 million equivalent.
Main Policy Areas Although the current Government of Nepal’s monetary and fiscal policy stance is sound, enhancing financial sector stability is critical. A financial sector crisis could have a devastating impact on Nepal’s economy. As such, the Financial Sector Stability Credit will support the following areas:
(i) Formulation of a financial sector development strategy (ii) Restructuring of two state-controlled banks: Nepal Bank
Limited (NBL) and Rastriya Banijya Bank (RBB) (iii) Assessment of the condition of class A, B and C financial
institutions and potential restructuring (iv) Strengthening institutional arrangements to support the bank
restructuring process (v) Strengthening the legal and regulatory framework for effective
bank resolution (vi) Increasing the transparency of the financial system
Key Outcome Indicators (By December 2013)
• The Capital Adequacy Ratio (CAR) of RBB is positive and RBB’s performance (including governance) is monitored by the Ministry of Finance’s (MoF’s) Financial Sector Management Division
• The Capital Adequacy Ratio (CAR) of NBL is positive and NBL’s performance (including governance) is monitored by MoF Financial Sector Management Division
• The Nepal Rastra Bank (NRB) program of in-depth diagnostics has been initiated to provide comprehensive information on problem institutions
• The NRB Bank Resolution Unit operates and undertakes bank resolution
• Consolidation of the financial sector underway through a decrease
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in number of financial institutions (down to 175 institutions) • The legal and operational framework for deposit insurance is ready
for implementation (pending legislative approval) • The legal framework for effective bank resolution is finalized
(pending legislative approval) • Nepal retains grey or better Financial Action Task Force (FATF)
classification which allows normal external financial relations (trade finance, remittance inflows and Foreign Direct Investment)
Program Development Objective(s) and Contribution to ISN / CAS
The objective of the credit is to support the implementation of the financial sector reform program initiated by the Nepalese authorities to reduce the vulnerability of the banking sector and increase its transparency. The proposed credit recognizes the important progress made so far by the Nepalese authorities to tackle financial sector vulnerability and supports the acceleration of a medium term reform strategy which commenced implementation in 2011. The current Nepal Interim Strategy Note (ISN) for FY12/13 notes the vulnerability of the financial sector. At the time of the Board presentation of the ISN, World Bank Executive Directors noted the emerging weaknesses in the financial sector and urged the Bank to assist the Government of Nepal (GoN) in addressing them inter alia through the potential use of development policy lending. The new Nepal Country Assistance Strategy (FY14-17) currently under preparation underlines persistent financial sector weakness and the risk this poses to macroeconomic stability and economic growth, as illustrated by the liquidity crisis in 2011. It recognizes the efforts undertaken by the authorities to address the root causes of the financial sector difficulties and makes the case for the use of Development Policy Credits to support those reform efforts.
Risks and Risk Mitigation
The main risks identified are political instability and reform implementation risks. Continued political uncertainty has become the norm in post-conflict Nepal characterized by frequent changes in government. The dissolution of the Constituent Assembly in May 2012 has brought additional uncertainty. However, on March 13, 2014, political parties agreed to form an Interim Election Government with the Chief Justice as Chairman (Prime Minister) and consisting exclusively of former secretaries, ending a 10 month political impasse. The Interim Election Government is charged with holding new Constituent Assembly elections by December 2013. It should be noted that Nepal stands out as a country that has achieved stable economic performance and good development results despite these political uncertainties.
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To continue to mitigate political uncertainty to the extent this is possible, the Bank actively engages with leaders across the political spectrum to confirm bipartisan support for sound economic policies and continuing financial sector reforms. Delivery of the prior actions for the proposed operation was agreed with the economic leadership of all major political parties. Reform implementation risks are high in the present environment. The financial sector reform program initiated by the Government and supported by the Development Policy Credit affects vested interests, which may trigger resistance. Capacity to implement reforms is low and will therefore be supported by intensive technical assistance. The present political environment in Nepal complicates the reform process, in particular for legal reforms given the absence of a Parliament. Implementation risks for this Development Policy Credit have been mitigated through the choice of the instrument: i.e. stand-alone single tranche DPC, with prior actions completed ahead of DPC approval. In addition, during the preparation of the DPC, starting in November 2011, the DPC team worked closely with key technical counterparts, who have played a critical role in the delivery of the prior actions and who have also provided continuity in the policy dialogue. This close collaboration has also created a strong momentum for further reforms in the Government’s medium term program. Furthermore, close alignment with the International Monetary Fund (IMF) and the United Kingdom’s Department for International Development (DFID) – which is providing technical assistance to both the preparation and implementation of the DPC – has ensured a consistent message from development partners on how best to address financial sector vulnerability in Nepal.
Operation ID P129929
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IDA PROGRAM DOCUMENT FOR A PROPOSED
FINANCIAL SECTOR STABILITY CREDIT
TO NEPAL
I. INTRODUCTION 1. In mid-2011, a financial sector crisis was about to unfold in Nepal. Withdrawals of deposits from smaller financial institutions and severe liquidity constraints across the banking sector exposed the vulnerabilities of the financial system and required urgent intervention by Nepal’s central bank and bank regulator, the Nepal Rastra Bank (NRB). The World Bank, together with the International Monetary Fund (IMF), was called on by NRB and the Government of Nepal (GoN) to provide assistance, both technical and financial, to support efforts to contain the developing crisis and to provide longer-term support for institutional and regulatory changes that would contribute over time to a more robust system. Due to quick and effective intervention by NRB, with technical assistance from the Bank and the IMF, and thanks to a favorable environment (notably continuing large flows of remittances which contributed liquidity to the system), the development of a full-blown financial crisis was averted. In this process, a strong dialogue between the authorities and the Bank developed, leading to the articulation of a medium-term program to address the underlying vulnerabilities of the financial sector, including the insolvency and governance challenges posed by the two largest state-controlled commercial banks, the excessive number of small financial institutions with weak governance and supervision, the nascent bank restructuring and resolution frameworks, and issues of transparency in the financial system. In the context of the presentation of the Interim Strategy for Nepal in the fall of 2011, the Bank’s Board was informed of the troubled status of the financial sector and of the Bank’s readiness to provide support through development policy lending and other means as necessary to help stabilize the situation. 2. This program document describes a stand-alone, single tranche, Financial Sector Stability Credit of US$30 million to support the Government’s efforts to address financial sector vulnerabilities that remain critical to macroeconomic stability and economic growth. The actions supported under the proposed Development Policy Credit (DPC) form part of a broader, medium-term Government program aimed at reinforcing banking sector stability and paving the way for the development of a robust and more inclusive financial sector. The key components of this medium-term program are also described in detail in the document. Sufficient overall progress towards the objectives of the medium-term program would allow the Bank to provide additional support in the form of a second DPC within about 18 months. Given the depth of the Bank’s dialogue with the authorities, the detailed elaboration and mutual understanding of the medium-term Government program, as well as commitment by key stakeholders, this operation could have been designed as the first phase of a programmatic series of DPCs supporting financial sector stability and reform. However, the fluidity of the political situation and the current lack of a Parliament argue for a two-stage approach. This allows the timely acknowledgment of the important steps already taken by the Government to preempt a possible financial crisis and strengthen financial sector stability, and the continuation of a deepening
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dialogue on further reforms that could be supported by a follow-up operation when conditions warrant. 3. The objective of the credit is to help reduce the vulnerability and increase the transparency of the banking sector. The credit will support the following policy areas:
(a) Formulation of a financial sector development strategy. (b) Restructuring of two state-controlled banks, Nepal Bank Limited (NBL) and Rastriya
Banijya Bank (RBB). (c) Assessment of the condition of class A, B and C financial institutions and potential
restructuring. (d) Strengthening of the institutional arrangements to support the bank restructuring process. (e) Strengthening of the legal and regulatory framework for effective bank resolution. (f) Increasing the transparency of the financial system
II. COUNTRY CONTEXT
A. Recent Political Developments 4. While there have been setbacks in the path towards a stable democracy, Nepal is making progress on consolidating peace and building a new political system. Still emerging from a-ten year armed conflict that ended in 2006, the country is currently passing through a prolonged political transition. This transition entails two interrelated processes: promulgation of a new constitution and the completion of the ongoing peace process. Nepal has made good progress on the peace process—notably by formally concluding integration of former ex-combatants into the armed forces in August 2012—but the country’s political transition is taking longer than expected. The Constituent Assembly, in session since 2008 and tasked with drafting Nepal’s new constitution, was dissolved in May 2012 without completing the constitution. Deeply-rooted differences between and among the existing political parties, and the rise of ‘ethnic identity politics’ are making consensus building complicated and leading to political instability. The Constituent Assembly was disbanded due to irreconcilable differences between the political parties and within cross-party caucuses on key issues such as state restructuring and the extent of federalism. Since then, the country has been facing various constitutional, legal and administrative uncertainties, exacerbated by the absence of a political consensus between the leading political parties to address them.
5. The 10-month political impasse that followed the dissolution of the Constituent Assembly in May 2012 ended on March 14, 2013, when the Chief Justice was sworn in as Chairman (Prime Minister) of the Interim Election Government. The Interim Election Government is charged with holding new Constituent Assembly elections by December 2013. The Chairman appointed an 11 member Council of Ministers exclusively from retired government secretaries. 6. In spite of the political uncertainty of recent years, Nepal has demonstrated a remarkable ability to achieve development results. Paradoxically, in light of the 10-year conflict and the post-conflict challenges of reaching consensus on the future shape of the state,
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Nepal has experienced economic stability and surprisingly strong results, especially in poverty reduction and human development. Political instability is bound to remain a concern for the foreseeable future, but Nepal’s track record shows its ability to accomplish development outcomes at a reasonably fast pace notwithstanding the uncertain environment. As a fragile state, Nepal stands out for its relatively stable economic performance and good development results even during the height of the conflict. 7. The progress achieved to date by the Nepalese authorities in addressing financial sector vulnerabilities has demonstrated the capacity of GoN to implement critical reforms despite political uncertainty. It has also demonstrated a strong willingness to engage and respond to assistance provided by external partners, and provides a compelling basis in pursuing the Bank’s engagement in the financial sector. The formation of an Interim Election Government and the forthcoming Constituent Assembly elections will allow for an acceleration and deepening of reforms.
B. Recent Economic Developments 8. Notwithstanding the difficult and uncertain political transition, economic performance has continued to be good during the past few years. The economy grew by an estimated 4.6 percent in FY 2012 (Table 1), and is projected to grow by three to 3.6 percent in FY 2013 despite the lower-than-expected growth in India and a shortfall in public spending.1 Higher growth in FY 2012 reflected stronger agricultural performance (up 4.9 percent), a rebound in the service sector (up 5.1 percent) and a positive but slow turn-around in the industrial sector (2.7 percent). Good monsoon rains and strong inflows of remittances and tourists contributed to the good performance. Consumption , fueled by the surge in remittance inflows, continued to be the main driver of growth, (Figures 1 and 2). The expected growth slowdown in FY 2013 is due to a combination of exogenous shocks and domestic factors. A poor monsoon has depressed agricultural output. Likewise slower growth in India, whose economy is now projected to grow at 4.5 percent in FY 2013, is affecting Nepal via exports, Foreign Direct Investment (FDI) and remittance channels.2 Growth has also been dampened by significant shortfalls in public spending, reflecting the shortcomings of the FY 2013 budgetary framework.
1 These growth rates are well above Nepal’s population growth of 1.35 percent per annum. 2 India accounts for 60 percent of Nepal’s exports, 50 percent of its FDI, and about 20 percent of its remittance inflows.
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Table 1: Selected Macroeconomic Indicators (FY 2008-FY 2012)
2007-08 2008-09 2009-10 2010-11 2011-12 Output and prices
Real GDP growth (%) 6.1 4.5 4.8 3.4 4.6 Gross investment (% of GDP) 27.9 31.5 37.1 33.2 33.5 CPI inflation (average) 6.7 12.6 9.5 9.6 8.3
Public Finance % of GDP Total revenue (excl. grants) 13.0 14.2 14.8 14.4 15.7 Total expenditures 17.4 19.8 19.8 19.7 20.5 Overall balance (before grants) -4.5 -5.7 -5.0 -5.2 -4.8 Net lending/borrowing -3.0 -2.6 -0.8 -1 -0.6 Public debt 41.0 39.0 35.4 33.1 33.6
External accounts Exports (f.o.b) (US$ million) 900 904 849 961 1,008 Annual % change -4.6 0.5 -6.1 13.2 5 Imports (f.o.b) (US$ million) 3,164 3,611 4,927 5,430 5,613 Annual % change 8.4 14.1 36.4 10.2 3.4 Remittances (US$ million) 2,072 2,712 3,113 3,545 4,414 Annual % change 34.9 30.9 14.8 13.9 24.5 Current account balance (incl. off. transfers) (% GDP) 2.7 4.2 -2.4 -1.0 4.7 Gross official reserves (US$ million) 2473 2,907 2,844 3,074 4,307 In months of GNFS imports 6.7 6.0 5.4 5.8 6.8
Money and credit 12 month % change Private sector credit 24.3 29.0 14.2 13.9 11.3 Broad Money (M2) 25.3 27.3 14.1 12.3 22.7 Source: Nepalese authorities and IMF estimates
Figure 1: Drivers of Growth
Source: Nepalese authorities and staff calculation
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Figure 2: Remittances at a Historic High
Source: Nepalese authorities and staff calculation 9. While still high and heavily dependent on price movements in India, inflation has declined. Because of the fixed peg of the Nepalese rupee to the Indian rupee and the fact that around two thirds of the country’s imports come from India, inflation in Nepal is closely linked to that in India. For FY 2012, average inflation is estimated at 8.3 percent, down from 9.6 percent the previous year. This is mainly because of lower food prices due to good harvests in Nepal and India, counterbalancing the effect of persistently high core inflation (averaging 9 percent). Non-food inflation was driven by higher (administered) fuel prices, continued pressure on wages and the exchange rate depreciation triggered by the depreciation of the Indian rupee. Given the currency peg, Nepal has only limited ability to carry out independent monetary policy and use it to control inflation. Nepal Rashtriya Bank (NRB) – the central bank of Nepal – has pursued an accommodative monetary policy stance (with remittances inflows only partly sterilized) to allow banks to rebuild liquidity. In FY 2012, broad money grew by 22.7 percent, well above nominal GDP growth (14 percent). However, the NRB shifted policy in July 2012 signaling its intent to bring broad money growth down to 15 percent, as the pressure to keep liquidity high to support the financial sector eased. Inflation is projected at 10.2 percent for FY 2013 but is expected to decline further subsequently. 10. Despite the large trade deficit, high remittance inflows have led to a substantial current account surplus. In FY 2012, the balance of payments surplus reached an all-time high, largely due to surging remittances inflows. Remittances rose by 25 percent compared to the previous year to reach a record 23 percent of GDP. The current account surplus (including grants) reached an historic high of 4.7 percent of GDP, up 5.7 percentage points from the previous year (Figure 3 and Table 1). Gross official reserves rose to more than US$4.3 billion in FY 2012, equivalent to 6.8 months of total imports (up from 5.8 months in FY 2011). High remittances have been more than sufficient to offset the large trade gap (imports accounting for 28.9 percent of GDP and exports 5.2 percent of GDP). While for some countries a high trade deficit may signal an unsustainable external balance, for Nepal the risk is low. Worker remittances are quite stable as migration destinations are diversified among both oil and non-oil
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producing countries. Moreover, a drop in remittance inflows (or more likely slower growth rate of remittances) would ultimately be “self-corrected” by a commensurate decline in imports.
Figure 3: The Current Account Moved to a Surplus in FY12
Source: Nepalese authorities and staff calculation
11. Nepal has made important inroads in reducing poverty and improving human development outcomes. In 1996, 68 percent of the country’s population lived under US$1.25 per day (in Purchasing Power Parity); by 2011 the rate had fallen to 24.8 percent. The pace of poverty reduction accelerated sharply in recent times – from 1.5 percentage points per year during the 1996-2004 period, to 2.5 percentage points during the 2004-2011 period.3 Nepal has progressed from being the poorest nation in South Asia in 1990 to being the third-poorest today, having overtaken India and Bangladesh. Both growth and reduced inequality contributed to the large observed decline in poverty between 2004 and 2011, with most of the observed poverty reduction having occurred in rural areas. Nepal has already achieved the first Millennium Development Goal (MDG): its poverty headcount rate in 2010 was well below the corresponding rate in 1990 (Figure 4). If poverty reduction is maintained at this pace, poverty may be eradicated within the next decade. In addition, Nepal has already met the target on improved access to water, and it stands out as the only fragile and conflict-affected state to have already reached the target on reducing maternal mortality.4 For women in Nepal, the chances of dying in childbirth have been cut in half since 1996.
3 This amounts to a 40 percent higher rate of poverty reduction than that achieved by another remarkable performer, Bangladesh (1.78 percentage point reduction per year from 2005-2010). 4 World Bank: Stop Conflict, Reduce Fragility and End Poverty: Doing Things Differently in Fragile and Conflict-affected Situations
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Figure 4: Nepal has Already Achieved the MDG of Halving the Incidence of Poverty Relative to 1990
Source: Nepal Living Standards Survey (NLSS)
12. Nepal’s good growth performance in recent years is partly due to external factors. Given the current structure of its economy, Nepal’s economic fortunes are largely determined by exogenous factors, including rainfall, remittances, and India’s economic situation. Good monsoon rains resulted in the agricultural sector growing by nearly 5 percent in FY 2012. Remittances have more than doubled as a share of GDP over the past decade (Figure 3). Nepal’s economy has also benefited from strong economic growth in neighboring India, and total exports have increased rapidly in recent years. 13. However, the government’s prudent policy stance has also been an important contributing factor. Fiscal balances improved in FY 2012 from an already strong position (Table 2). Revenue collection was particularly buoyant with tax and non-tax revenues increasing 23.8 percent from the previous year, a sign that tax administration reform is bearing fruit. On the expenditure side, total spending grew at a slower pace (18.3 percent) though mostly on account of restrained growth in capital expenditure (16 percent). Overall, the GoN was able to contain the fiscal deficit: the overall balance before grants improved by 0.4 percentage points of GDP, from -5.2 percent to -4.8 percent (Table 1). At around 33 percent of GDP, public debt remains low; it has fallen steadily from over 40 percent of GDP in FY 2008. The year 2012/13 was exceptional from a fiscal point of view because of prolonged political uncertainties (Box 1). The supplementary budget recently announced by GoN is aligned with poverty reduction objectives, and is consistent with macroeconomic stability and debt sustainability. In line with past practice, the supplementary budget is available – in full red book – on the Government’s website.
-
10
20
30
40
50
60
70
80
1995-96 2003-04 2010-11
% P
oor
NLSS Survey Year NLSS I-II poverty estimates NLSS III poverty estimateTrend based on 2010-11 PL $1.25, PPP
201
0-11
Po
v L
ine
199
5-96
Pov
Li
ne
199
5-96
Po
v Li
ne
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Table 2: Government Operations (Percent of GDP, FY 2008-FY 2012)
Actual Est. FY08 FY09 FY10 FY11 FY12
Overall revenues and grants 15.5 16.8 18.0 17.7 18.3 Total revenues 13 14.2 14.8 14.4 15.7 of which Tax revenues 10.6 11.8 13.0 12.6 13.3 Non tax revenues 2.4 2.3 1.8 1.9 2.4 Grants 2.5 2.7 3.2 3.3 2.6 Total expenditure and net lending 17.4 19.8 19.8 19.7 20.5 Expenses 11.2 16.3 15.6 15.2 15.6 of which Interest payments 0.8 0.8 0.8 0.9 1.0 Salaries and allowances 3.4 3.5 3.5 3.3 3.4 Net Acquisition of Nonfinancial Assets 2 3.1 3.2 3.4 3.3 Net lending/borrowing -2.1 -2.6 -0.8 -1.0 -0.6 Memorandum item: Public debt 41.2 39.3 35.4 33.1 33.6 Public external debt 28 26.3 22.1 18.7 20.4
Source: Nepalese authorities and IMF estimates.
Box 1: Nepal’s FY 2013 Budget
The failure of political parties to reach agreement over a consensus government in 2012 meant that the caretaker government was unable to propose a full-fledged budget for FY 2013. Instead, the President approved two ordinances authorizing public spending up to the actual levels spent in FY 2012. The combination of (i) lower overall ceilings, (ii) adoption in phases, and (iii) inefficient arrangements for implementation resulted in significantly lower-than-planned budget execution and led to the first eight months of FY 2013 being quite exceptional from a fiscal point of view. However, the formation of a new consensus government has opened the way for the adoption of a supplementary budget for FY 2013 (announced on April 9, 2013), which is expected to boost spending in the last trimester of the year. GoN has also announced its intention to prepare a full-fledged budget for FY 2014.
The proposed ‘full adjusted budget’ for FY 2013 foresees a significant increase in overall revenues and expenditures. Overall expenditure is expected to rise from NPRs 359 billion budgeted in FY 2012 to NPRs 405 billion; this 13 percent increase is almost exactly equivalent to the combined rate of growth of economic activity and prices (that is a real increase in spending of 3.5 percent). Executing the full budgeted amount will most likely not be possible given that (i) it includes an appropriation of NPRs 14 billion for election-related spending (in the event that a June date could be kept to hold the elections), (ii) actual spending was 89 percent of budgeted expenditure in FY 2012, and (iii) spending has been particularly low in the first eight months of the fiscal year (NPRs 155 billion). On the revenue side, financing would come from domestic revenue (about NPRs 290 billion), repayment receipts (NPRs 4.4 billion) and foreign grants (NPRs 47 billion) leaving a balance of NPRs 64 billion to be covered by foreign and domestic borrowing.
The proposed FY 2013 budget appears consistent with macro stability, even at the proposed relatively high level of spending. With the proposed levels of expenditure and expected revenue and grants, the required level of domestic financing would be equivalent to 1.4 percent of GDP. Given that expenditure targets are ambitious, while revenue objectives are likely to be met, domestic financing needs are very unlikely to be above two percent of GDP, even if grants are lower than anticipated—that is the proposed budget is very unlikely to negatively affect macro-stability or overall debt sustainability dynamics. The revised budget partially addresses the shortfalls in social sector allocations under the previous ordinances. Under the proposed adjusted budget, social sector allocations – including education, health, drinking water, local development amount and other social sectors – amount to over 32 percent of the total (7.6 percent of GDP) with education and health jointly making up 20.6 percent of the total. Moreover, the proposed budget foresees an increase in ‘economic’ expenditures including irrigation, road and power expansion.
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C. Macroeconomic Outlook and Debt Sustainability 14. Despite expected headwinds in FY 2013, Nepal’s medium-term growth prospects remain good. Real GDP growth is expected to slow to 3.6 percent in 2012/13, reflecting a forecasted weak monsoon and lower growth in India (Table 3). A slowdown in public expenditure has also depressed aggregate demand. However, Nepal is expected to grow on average at 4.1 percent per year over the next five years. It could overshoot these targets if it achieved greater political stability, enhanced private sector engagement, and invested in new and better infrastructure. Fiscal revenue is expected to increase further, reflecting continued reform momentum in tax administration,5 while expenditure is expected to grow moderately as a share of GDP.
Table 3: Medium Term Macroeconomic Outlook (FY 2013-FY 2017)
2012-13 2013-14 2014-15 2015-16 2016-17
Real GDP growth (%) 3.6 4.0 4.0 4.1 4.1 CPI (period average) 10.2 8.3 7.3 6.9 6.1 Tot. revenue & grants (% of GDP) 19.0 18.2 17.9 18.0 18.3 Expenditure (% of GDP) 18.1 18.8 19.0 19.2 19.6 Net lending / borrow. (% GDP) 0.9 -0.6 -1.1 -1.2 -1.3 Current account balance (% of GDP) -0.3 -1.5 -2.1 -2.3 -2.6 Reserves (in months of GNFS imports) 6.6 5.7 5.1 4.9 4.5 Public debt (% of GDP) 30.9 33.5 33.6 33.5 33.5 Remittances year on year growth (%) 8.9 6.0 6.0 6.0 6.0
Source: Nepalese authorities and staff calculation 15. The joint IMF-WB Debt Sustainability Analysis shows a moderate risk of debt distress. Under baseline projections, Nepal’s debt indicators remain below the indicative sustainability thresholds. In the baseline scenario, the present value of public debt decreases moderately as a share of GDP from 31 percent in 2012 to 26 percent at the end of the projection period (corresponding, respectively, to 171 and 190 percent of revenue and grants). Moreover, debt dynamics also remain generally sound under standard stress tests, including shocks to GDP growth, exports, non-debt creating flows, and a one-time 30 percent exchange rate depreciation. Nepal’s debt indicators are below the sustainability thresholds under all but the most severe of these stress test scenarios (specifically a substantial slowdown in remittances6 would cause the present value of the ‘external debt to exports and remittances’ ratio to exceed the indicative threshold by 10 percentage points in 2014). 16. Nepal’s key macroeconomic vulnerability remains its financial sector. Non-standard debt sustainability scenarios show that in case of financial stress, three debt ratios would cross the threshold7.A financial crisis could cause a loss of 30 percent of Nepal’s GDP and result in
5 Reforms undertaken by the Inland Revenue Department include (i) e-filing of tax returns (now representing over 90 percent of returns), (ii) skills and capacity upgrading resulting in increased investigations and assessment amounts, and (iii) outreach to taxpayers (with the establishment of 26 ‘Taxpayer Service Offices’ throughout Nepal). 6 Reflected in a one standard deviation below average growth of non-debt creating flows in 2013 and 2014. 7 The ratio of ‘Present value of external debt-to-GDP and remittances’, the ‘Present value of external debt-to-revenue’ ratio and the ‘Debt service-to-revenue’ ratio.
17
severe fiscal distress (Box 2)8. Consequently it is important for GoN to assess and address the risks posed by the financial sector, and also for it to develop good estimates of the magnitude of its quasi-fiscal liabilities.9 These non-standard scenarios call for a continued prudence on the fiscal side, with a fine balance of expenditure reduction and revenue enhancement, and resolute actions to address financial sector weaknesses.
Box 2: Financial Sector Risk in Nepal
A recent middle range estimate by the IMF suggests that real GDP loss could reach 30 percent in the first four years of a financial crisis before growth recovers to the baseline trend.10 Reserves would fall by half in the first two quarters of the crisis through the widening current account balance11 and capital flight, though foreign borrowing could reverse partially the reserve losses later. The fiscal cost would be about 25 percent of GDP, leading to rapid deterioration of debt dynamics. Even though the fiscal cost could be largely assumed domestically at the onset of the crisis (for bank resolution and deposit coverage), net domestic financing has to be gradually brought down to 2.75 percent of GDP in outer years considering the capacity of the domestic financial system, and foreign borrowing would be heavy over the long run.
Baseline Financial Stress Medium-term Output loss compared to baseline 1/ -- 30% Current account balance by 2016/2017 (% GDP) -1.2% -1,6% Gross international reserves by 2016/17 US$5.0 bn (5.3 months) US$3.9 bn (4.1 months) Net domestic financing, 2013-17 average (%GDP) 2.3% 6.9% Public Debt/GDP ratio by 2016/17 30.4% 97.2%
1/ Calculated as cumulative losses of real GDP as a percent of baseline real GDP over the medium term Source: IMF, Nepal, December 2012, Article IV Consultation, IMF Country Report
17. Nepal’s macroeconomic policy framework is adequate for the proposed operation, which will help mitigate significant risks to macro-stability and growth. GoN has pursued prudent fiscal and monetary policies. Following IMF and World Bank advice, its economic policy agenda is centered on two main pillars (i) continued prudent fiscal policy and a return to a normal budgetary framework, together with ongoing Public Financial Management reform, and (ii) tighter monetary policy coupled with financial sector strengthening.
8 The IMF assessed the potential fiscal costs of a scenario where an escalating financial crisis initially afflicts smaller and weaker banks, causing deposit runs, and then spreads to larger banks. This represents an extreme loss of confidence, given past history of deposit flight to Class A institutions during times of distress. If all banks including large Class A institutions were affected, initial fiscal costs could rise to as high as 23 percent of GDP with a medium term output loss of 30 percent of GDP. 9 These include the potential fiscal burden of financing the losses of Nepal Oil Corporation (NOC) and Nepal Energy Authority (NEA). The authorities appear committed to restructuring the NEA and moving to an automatic adjustment mechanism for fuel prices, which would contribute to bringing NOC gradually back to financial health. 10 The assumption of output loss is based on the average level of crisis episodes in the past few decades in a sample of countries. In low income countries, macro-financial linkages tend to be lower compared to more advanced economies, and therefore output loss may be smaller. However, Nepal’s financial sector is relatively large, standing at 70 percent of GDP, which is comparable to many emerging economies. 11 The widening of the current account balance is consistent with recent experience in Nepal. Remittances appear to decline in times of uncertainty. Further, when there is ‘flight to safety’ the general population tends to import gold as a store of value – increasing imports.
18
D. Recent Financial Sector Developments The 2011 liquidity crisis 18. By mid-2011 a financial sector crisis was about to unfold in Nepal, due to acute liquidity stress. A number of the smaller development banks (‘Class B institutions12’) and finance companies (‘Class C institutions’) came under severe liquidity stress. Several institutions requiring emergency liquidity assistance from NRB, which in some cases was accompanied by corrective action directives and intensified supervision. The institutions’ underlying liquidity problems derived mainly from the rolling over of loans to mask the inability of borrowers to repay, especially in the real estate sector (a practice known as ‘ever-greening’). Liquidity problems were made worse by falling profitability and increased competition for deposits – factors which were reinforced by a loss of depositor confidence as these problems became public knowledge. The underlying structural problems were most evident in class B and C financial institutions, which together hold approximately 22 percent of total banking sector assets. Despite their capital insolvency, the two large state controlled banks (NBL and RBB) did not suffer from the liquidity crisis, because they were perceived by the population at large as enjoying an implicit state guarantee on deposits. 19. The 2011 liquidity crisis was a symptom of significant underlying weaknesses affecting the banking sector. The liquidity stress faced by numerous institutions can be mostly attributed to weak risk management practices, including a mismanagement of deposit-to-loan ratios, mismatches between deposit and loan terms, and a high concentration of liabilities in the largest 10 depositors. Violations of NRB circulars and directives -including under-reporting of Non-Performing Loans (NPLs), rolling over of loans and over-exposure to the real estate sector- also played an important role in the liquidity crisis. As a result, financial institutions became highly vulnerable to shocks, such as delays in Government expenditures or a downturn in remittances. The liquidity difficulties of a number of institutions were further compounded by the loss of interbank funding, as banks protected their own financial positions by withdrawing wholesale funding from those institutions identified (or rumored) to be in trouble. 20. The liquidity crisis was also the symptom of potentially deeper solvency issues in financial institutions. The real financial condition of banks is not yet known as a result of lending growth concentrated in real estate loans, practices of ‘ever-greening’ or using overdraft facilities to hide problem assets. Factors contributing to possible solvency issues include poor management practices13, with weaknesses relating to the governance structure of financial institutions (which can lead to conflicts of interest and insider transactions) and weak risk management systems and practices (use of institutional depositors without a sufficient base of long term retail depositors, portfolio concentrations in the largest 10 borrowers, sectoral concentration of portfolios, rapid loan growth without attention to potential asset bubbles, hiding potential problem assets through ever-greening, or inappropriate use of overdraft facilities).
12 The banking system in Nepal consists of Class A financial institutions (commercial banks), Class B institutions (development banks) and Class C institutions (finance companies). In effect, other than different capital adequacy requirements, there is little operational difference between these three classes. 13 Onsite inspections of institutions applying for liquidity assistance revealed serious governance failures, impaired assets, and financial interconnectedness.
19
Weaknesses in the quality and effectiveness of banking supervision can also be identified, with a lack of adequate (human and technological) resources, an outdated approach to bank examination, weak supervisory enforcement, and unreliable data being provided by financial institutions to supervisors. 21. Thanks to quick and effective interventions by NRB, with technical assistance from the Bank and IMF, a full-blown financial crisis was averted. These interventions were also supported by a relatively favorable environment, notably continuing large flows of remittances which contributed liquidity to the system. The NRB took a series of quick actions14 to tackle the liquidity crisis, including: (i) daily monitoring of liquidity ratios, (ii) capping of the allowable Credit to Deposit Ratio (CDR) at 80 percent, (iii) introducing deposit insurance (up to NPR 200,000), (iv) capping of allowable exposure to real estate (25 percent), (v) activation of a lender of last resort facility and special refinancing window (both facilities provided liquidity funding to financial institutions experiencing liquidity stress), (vi) reduction in the required cash reserve ratio from 5.5 percent to five percent, (vii) allowing foreign investors to make fixed deposits, (vii) changes in AML declaration forms to encourage use of formal financial institutions, and (viii) discouraging gold imports to reduce the conversion of deposits into gold. Coming back from the brink 22. The quick actions of the Nepalese authorities have led to stabilization of the financial sector. In 2011 and 2012, NRB (with support from the IMF) conducted stress tests for Class A institutions (see Box 3) which highlighted the credit and liquidity risks facing commercial banks. The 2012 stress tests show that the vulnerability of commercial banks (Class A institutions) had decreased compared to the previous year. In addition, the overall liquidity of the financial sector has also improved since mid-2011 (see Figure 5).
14 The majority of these measures are still in place.
20
Box 3: NRB Stress Testing Results
The latest stress tests conducted by the authorities for commercial banks show some improvement compared to the previous year’s results, but weaknesses persist. Among the 32 existing commercial banks, a standard credit shock would push capital below the regulatory minimum in 20 banks, and a third of commercial banks would be under-capitalized if real estate and housing loans are downgraded15. Sustained deposit withdrawals over five consecutive days would render 14 banks illiquid, and liquidity ratios at a number of banks would fall below 20 percent in the event of sudden large withdrawals, or withdrawals by institutions.
2012 2011 Credit shocks No. of banks with CAR < 10% regulatory minimum Standard credit shock 1/ 20 22 25 percent of performing loans of real estate and housing sector downgraded to losses loans
11 15
Liquidity shocks No. of banks illiquid after 5 days Standard withdrawal shock 2/ 14 19 No. of banks with liquid assets to deposit ratio < 20% Withdrawal of deposits by 20% 26 27 Withdrawal of deposits by top 3 institutional depositors 18 27 Withdrawal of deposits by top 5 institutional depositors 1 6
1/ 15 percent performing loans deteriorated to substandard, 15 percent substandard loans deteriorated to doubtful, 25 percent of doubtful loans deteriorated to loss, five percent of preforming loans deteriorated to loss. 2/ Withdrawal of customer deposits by two percent, five percent, 10 percent, 10 percent and 10 percent for five consecutive days, respectively. Source: IMF, Nepal, December 2012, Article IV Consultation, IMF Country Report 23. While the overall liquidity situation of the banking sector has improved, this improvement hides significant variation between institutions. In the second quarter of FY 2013 (mid-January 2013), the overall Credit to Deposit Ratio (CDR) in local currency for commercial banks stood at 82.2 percent. However, 27 of 32 banks recorded a CDR above 80 percent (with 11 of these exceeding 90 percent). The average CDRs for development banks and finance companies were reported at, respectively, 84 percent and 89 percent as of mid-January 2013. Financial institutions with CDRs above 90 percent are considered vulnerable to liquidity shocks.
15 This refers to the scenario in which 25 percent of performing loans of real estate and housing are directly downgraded to loss loans.
21
Figure 5: Credit to Deposit Ratio (FY 2007-FY 2013Q2, NRB data), in Percentage
Source: NRB
24. Liquidity pressures are more intense for Class B and C institutions. During and after the 2011 liquidity stress, interbank lending was cut and deposits moved from Class B and C institutions to the perceived safety of Class A banks, amidst concerns over balance sheet weaknesses and governance. Class B and C institutions now have to pay significantly higher rates for deposits as compared to Class A, which places additional pressure on earnings already suffering from the deterioration in real estate lending portfolios. A changing structure of the financial sector 25. Since 2005, the number of Class A banks has almost doubled (with a total of 17 commercial banks licensed in 2005 and 32 in 2012) and the total assets of Class A banks have almost tripled. Private commercial banks accounted for the vast majority of this growth, while the combined assets of the two large state-controlled banks (Rastriya Banijya Bank (RBB) and Nepal Bank Limited (NBL)), as a share of the sector’s total assets, declined to 15.2 percent. Nonetheless, RBB is still the largest bank in Nepal, representing 9.3 percent of total commercial bank assets and NBL is the fifth largest bank, with 5.9 percent of total assets. As of February 2013, the nine largest banks accounted for 54.9 percent of commercial banks assets (Table 4). At the same date, the banking system comprised 32 Class A (commercial banks), 90 Class B (development banks), and 66 Class C (finance companies) institutions, accounting for 79, 13 and eight percent of banking system assets, respectively (see Figure 6). Nepal’s banking sector16 has expanded rapidly in recent years, with domestic credit to the private sector jumping from 28
16 The ‘banking system’ refers to commercial banks (Class A), development banks (Class B), and finance companies (Class C). Other than different capital adequacy requirements and some operational restrictions on Class B and Class C institutions (foreign exchange and international transactions), there is little operational difference between these three classes. In addition, there are 25 Class D micro-credit institutions that report to the NRB and thousands of rural credit cooperatives that are under the purview of the Ministry of Agriculture. Other financial services are available through insurance companies and the Nepal Stock Exchange. There are 24 insurance companies and 225 listed companies, of which 80 percent are banks or nonbank financial institutions. NRB’s foreign exchange department oversees more than 50 remittance agencies.
50
60
70
80
90
CD Ratio LCY CD Ratio
22
percent of GDP in 2005 to 53 percent in 2011, overtaking the South Asia regional average (46 percent in 2011), as illustrated by Figure 7.
Figure 6: Composition of Banking System, Number of Institutions
Source: NRB (data as at mid-July except for 2013)
Figure 7: Domestic Credit to the Private Sector (as Percent of GDP, FY 2000-FY 2011)
Source: World Bank, World Development Indicators
26. The rate of credit growth has contracted since 2009, as the effects of a build-up of nonperforming loans began to be felt, but despite this, the banking system has continued to grow in the 2009-2013 period. During this period, the assets of Class A institutions expanded by 37 percent and those of Class B and C institutions grew by 172 percent and 34 percent, respectively (see Figure 8). However, the growth of Class C institutions significantly slowed down following the 2011 liquidity crisis.
13 17 18 20 25 26 27 31 32 32
7 26 28 38 58 63 79 87 88 90 45
60 70 74 78 77 79 79 70 66
0%
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40%
60%
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100%
2000 2005 2006 2007 2008 2009 2010 2011 2012 Feb. 2013
Commercial Banks (A) Development Banks (B) Finance Companies (C )
0%
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20%
30%
40%
50%
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Nepal South Asia
23
Figure 8: Composition of Banking System, Assets of Institutions
Source: NRB (data as at mid-July except Feb. 2013, assets in NPR million)
27. All of the Class A banks now meet NRB’s minimum Capital Adequacy Ratio (CAR) of 10 percent except the two state-controlled banks17. Overall CAR is estimated at 11.7 percent in FY 2013 Q2 (that is, mid-Jan 2013), a slight deterioration from 12.1 percent as of end FY 2012, but up from 11.1 percent computed as of end FY 2011 and 9.5 percent as of end FY 2010. The improvement in FY 2012 is primarily due to GoN injecting capital into NBL and RBB as part of the two banks’ recapitalization programs. Excluding these two banks, CAR is computed as 14.3 percent as of end FY 2012 which does not vary significantly from 14.2 percent as of end FY 2011 and 14.3 percent as of end FY 2010.
Table 4: Main Commercial Banks: Assets (as percent of total) and Capital Adequacy Ratios
Assets (%) (Mid Feb.2013)
CAR (%) (Mid Jan. 2013)
RBB Rastriya Banijiya Bank 9.33 -2.4418 ADBL Agriculture Development Bank 7.86 18.92
NABIL Nabil Bank Limited 6.30 12.05 NIBL Nepal Investment Bank Limited 6.18 11.51 NBL Nepal Bank Limited 5.87 -5.3919 NSBI Nepal SBI Bank Limited 5.29 11.51
EBL Everest Bank Limited 5.14 11.09
HBL Himalayan Bank Limited 4.98 10.80
SCBNL Standard Chartered Bank Limited 3.97 14.30 Source: NRB
28. Commercial banks posted a net profit of NPR 7.9 billion in FY 2013 Q2, against NPR 5.4 billion recorded in the same period last financial year—which represents a year-on-year
17 As of mid-January 2013, RBB CAR was -2.44 percent and NBL CAR was -5.39 percent. To be compared with -20.46 percent and -7.72 percent for RBB and NBL respectively as of mid-June 2012 (before the Government’s capital injection). As of mid-February 2013, RBB’s CAR had become positive. 18 This figure reflects the implementation of the recapitalization plan. RBB CAR was – 20.46 percent as of mid-June 2012. 19 This figure reflects the implementation of the recapitalization plan. NBL CAR was – 7.72 percent as of June 2012.
- 200,000 400,000 600,000 800,000
1,000,000 1,200,000 1,400,000 1,600,000
2009 2010 2011 2012 2013
Banking system
Commercial banks (A)
Development banks (B)
Finance companies (C)
24
growth of 46 percent. Seven large banks (representing 43 percent of the system) registered profits in excess of NPR 500 million by end FY 2013 Q2. Their total profits amounted to NPR 4.9 billion, which represents around 61 percent of the total profits earned by commercial banks. All three state controlled commercial banks (RBB, NBL and Agricultural Development Bank Limited) registered net profits (totaling NPR 1.2 billion). 29. Reported data may however overstate the strength of the system because of underreporting of Non-Performing Loans – and hence under-provisioning and overstatement of income – and collateral valuation uncertainties. Underreporting of NPLs, as well as real estate exposure, is further discussed in the section below. Financial sector risks 30. While Nepal’s macroeconomic framework remains relatively sound, current and potential problems in the financial sector could severely undermine macroeconomic stability and economic growth. Stress testing (Box 3) conducted by NRB with IMF assistance has identified significant risks to the solvency of financial institutions from the potential impact of declining real estate prices and from a potential loss of depositor confidence. 31. Most observers agree that the risk of a credit quality driven systemic problem is largely concealed by what is believed to be widespread under-reporting of NPLs. Based on reported data, the asset quality of the financial sector appears to have improved at the end of FY 2012, with the NPL ratio for the commercial banking industry improving to 2.8 percent as of first quarter FY 2013 (but increased to 3.1 percent in the second quarter of FY 2013) from 3.7 percent reported as of first quarter FY 2012 (Figure 9). In absolute terms, NPLs have increased by NPR 5 billion since last FY end and by NPR 3 billion in the last quarter. Most banks report NPLs below 2 percent. Such NPL ratios—given banks’ high level of exposure to a rapidly declining real estate market—strongly suggest significant under-reporting of NPLs and ever-greening of loan portfolios. Some banks have also benefited from NRB’s adoption of regulatory forbearance that allowed banks a grace period of 15 additional days from FY 2012 to recover overdue loans/interest, which helped prevent loans from having to be disclosed as NPLs in year-end reports.
25
Figure 9: Non-Performing Loans of Commercial Banks (FY 2007-FY 2013 Q2)
Source: NRB & provisional financial statements published by individual banks 32. The true level of banks’ total exposure to the real estate sector is also likely under-reported. NRB regulations only require commercial real estate loans and large residential mortgages (above NPR 10 million) to be reported as real estate exposures, resulting in significant under-reporting of the true total exposure of financial institutions to real estate. Reported total real estate exposures of commercial banks as of Q1 FY 2013 (mid-October 2012) reduced to 16.3 percent of total loans from 19.0 percent reported the previous year. Reported real estate exposure further decreased to 15.1 percent as of Q2 FY 2013 (mid-January 2013). Development banks and finance companies reported exposures of 21 percent and 24 percent respectively as of mid-October 2012. Seven commercial banks (18 percent of total assets) reported exposures exceeding 20 percent of their portfolio as at end Q2 FY 2013. None of the banks reported real estate exposure in excess of 25 percent compared to four banks (with a market share of 9.5 percent) a year ago. 33. The real estate sector is showing signs of increasing difficulties. Prior to 2012, notices of auctions of foreclosed land parcels and/or developed property by financial institutions rarely exceeded 12 per month, but by the fourth quarter of FY 2012 this number had reached about 300 per month. It is also reported that very few bidders participate in these auctions due to lack of financing and, if financing is available, interest rates are considered unaffordable by investors. Together this means that most auctions fail. Based on an internal study, NRB concluded that real estate is overpriced by 30 percent and that there is a need for sellers to adjust prices to stimulate the market. Market participants suggest that this estimated decline may be understated in major markets (such as Kathmandu and Pokhara) where the level of speculative investment has been highest. 34. The real estate crisis is not the only cause of banking sector vulnerability. A number of additional factors have contributed to the fragility of the sector, including the rapid credit growth seen during the FY 2008-2010 period, weak supervision and enforcement of prudential regulations, and a liberal bank licensing policy. Inadequate governance and risk management in
17.33%
14.08% 12.41%
10.99% 10.36% 8.99% 8.71%
6.18% 5.89% 5.61% 5.06%
3.82% 3.57% 3.21% 3.11% 2.54%
3.15% 3.15% 3.31%
3.12% 3.70% 3.72%
3.49%
2.62% 2.79%
3.06%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
FY07Q1
FY07Q2
FY07Q3
FY07Q4
FY 08Q1
FY 08Q2
FY 08Q3
FY 08Q4
FY 09Q1
FY 09Q2
FY 09Q3
FY 09Q4
FY 10Q1
FY 10Q2
FY 10Q3
FY 10Q4
FY 11Q1
FY 11Q2
FY 11Q3
FY 11Q4
FY 12Q1
FY 12Q2
FY 12Q3
FY 12Q4
FY 13Q1
FY 13Q2
26
banks has heightened systemic fragility and financial interconnectedness, including through connected lending, and possible cross shareholding among banks arising from pledging of equity shares as loan collateral. 35. There are signs of renewed liquidity stress starting to develop in early 2013. The overall CDR in local currency (LCY) stood at 82.2 percent in FY 2013 Q2 (mid-January 2013), compared to 78.4 a year ago and 76.2 as of mid-July 2012. During the first half of this financial year, banks’ deposit grew by 4.4 percent (NPR 38 billion), compared to a credit growth of 12.3 percent (NPR 76 billion). This is a reverse trend from the corresponding period in 2011 when deposits grew by 10.7 percent (NPR 74 billion) and credit by 6.2 percent (NPR 32 billion). Eleven commercial banks, representing 30 percent of the market, recorded a CDR (in LCY) in excess of 90 percent. This tightening of liquidity is mainly due to two factors: (i) lower Government expenditure reducing liquidity by restricting the flow of funds into the economy (as explained in Box 1), and (ii) growth in lending higher than the growth in deposits—as banks aim to maintain or increase their level of profitability20. The reform agenda ahead 36. Addressing underlying banking sector vulnerabilities by building on the reforms efforts already undertaken by the Nepalese authorities since the 2011 liquidity crisis is a critical priority. Nepal already has a relatively comprehensive financial sector supervision framework that needs to be further strengthened. NRB licenses, regulates and supervises deposit-taking institutions. The Ministry of Finance (MoF) contributes to policy formulation for the financial sector through the Economic Affairs and Policy Analysis and Financial Sector Management Divisions. The High Level Financial Sector Coordination Committee (HLFSCC), consisting of representatives of financial sector regulators, chaired by the Minister of Finance, is tasked with coordinating regulators—NRB, the Securities and Exchange Board of Nepal (SEBON, which oversees stock brokers, merchant banks, and other capital market participants) and the Insurance Board under MoF (which supervises and regulates insurance companies)—and policy formulation. 37. The authorities have responded to the identification of weaknesses in the regulatory and supervisory frameworks and the emergence of new and potential problems by commencing implementation of a multi-faceted program directed at the early identification and effective management of financial system risks21.
i. First, the HLFSCC was established in 2011 to monitor progress and recommend policy actions to promote financial sector stability.
ii. Second, NRB has strengthened the regulatory and supervisory frameworks (see Table 5) by issuing new regulations, circulars, directives and notices covering required CARs,
20 Following the liquidity crisis, commercial (Class A) banks became more conservative and reduced their lending. At the same time, their deposit base increased (because commercial banks were perceived as safer than development banks and finance companies). As commercial banks were not able – due to competition – to reduce interest rates on deposits, their profitability started to decline. As a result, commercial banks have now started to resume lending in a more aggressive manner, to maintain profitability, which is in turn affecting their liquidity. 21 Technical assistance to support implementation of this program has already been secured from Department for International Development, DFID (see Appendix to Annex 3).
27
credit risk management, insider lending, collateral, and operational risks. Loan classification and provisioning regulation have been improved; new risk management guidelines have been issued and a Liquidity Monitoring Framework adopted.
iii. Third, a single department supervising both Class B and C institutions was split into two dedicated departments. On-site inspection practices have been strengthened through IMF technical assistance. Regular stress testing of commercial banks is being undertaken. Macro-prudential monitoring has been strengthened by the creation of a Financial Sector Stability Unit in NRB, which will create semi-annual financial stability reports.
iv. Fourth, NRB has provided a degree of forbearance by relaxing three requirements relating to the real estate sector, following pressure from banks and real estate developers: (i) the deadline for banks to meet a real estate exposure cap of 25 percent of total loans has been extended by a year to July 2013; (ii) home mortgage loans of up to NPR 10 million are excluded when computing real estate exposure; and (iii) allowing financial institutions a grace period of 30 days from the end FY 2011 and 15 days from the end of FY 2012 to recover overdue loans/interest, especially from real estate borrowers.
v. Fifth, the NRB has established a Prompt Corrective Action framework and a bank resolutions desk to implement the framework. The NRB has also approved a Bank Resolution Manual and amendments to the NRB Act which strengthen and expand NRB’s bank resolution powers.
vi. Sixth, the MoF has approved a Deposit and Credit Guarantee Trust Bill which would provide a sound legal basis for the deposit insurance system in line with international practice.
vii. Seventh, with IMF support, in 2012 NRB commenced a program of diagnostics of 20 financial institutions to better identify institution-specific and potential systemic risks. In 2013, with Department for International Development (DFID) support, this program will be widened to cover up to 60 financial institutions, and the scope of diagnostics—which will be carried out by consortia led by international auditing firms—significantly expanded to allow an in-depth assessment (‘deep dive’) of all aspects of each institution’s condition.
viii. Eighth, NRB has initiated the consolidation of the financial sector through maintaining a licensing moratorium on new financial institutions22, tightening eligibility criteria for licensing upgrades (between Classes A, B and C) and issuing a new bylaw to facilitate mergers between institutions.
22 However NRB does not restrict up-graduation (through increased capital or merger, for example) subject to meeting NRB conditions for up-graduation.
28
Table 5: NRB Actions to Strengthen the Regulatory and Supervisory Framework (2011-13)
Document Issued
POLICY: Merger By Law May 2011 GUIDELINES: Stress Testing Guidelines January 2012 Internal Capital Adequacy Assessment Process August 2012 IT Risk Management Guidelines August 2012 NOTICES: Amendment in Merger By Law October 2012 NRB Credit Information By Law October 2012 SUPERVISION-ISSUED FRAMEWORK: Liquidity Monitoring Framework October 2012 CIRCULARS: #32 – Amendments to Directives for year 2067 for upcoming year 2068. (This circular explains changes made to previously issued Directives for the upcoming year.)
July 2011
#5 – Shareholding Limit, Margin Lending, Interbank Lending, Provision, Directive 9 Amendment to Risk Weight
September 2011
#4 – Restructuring and Provisioning, CRR Penalty September 2011 #14 – Repeal of Liquidity Management Refinance November 2011 #12 – withdrawal of Action Against a Willful Debtor November 2011 #17 – Limit for Promoter Share, Self-Declaration by directors December 2011 #21 – Stress Testing January 2012 #19 – House & Real Estate Loan January 2012 #18 – Credit Purchase Against Interbank Lending January 2012 #24 – Revised Directive Number 19 for AML CFT February 2012 # 23 – Withdrawal of Action Against a Willful Defaulter February 2012 #28 – Share investment in Class D Institutions April 2012 #27 – Loan Repayment Schedule D, Sector Lending, Promoter Share in D, Black Listing, Relief of Fine and Mortgage Release
April 2012
#29 – Withdrawal of Action Against Willful Debtor May 2012 #31 – Margin Type Loan against Shares June 2012 #30 – Term Loan, Deprived Sector Loan, Prepayment Charge June 2012 #33 – Amendments in Unified Directives of 2068 for upcoming year 2069. (This circular explains changes made to previously issued Directives for the upcoming year.)
July 2012
#3 – Third Party Collateral, Interest Recognition August 2012 # 5 – No approval to treat Tier 2 Capital for Debt Instrument, Loan by Non-National level financial institutions.
September 2012
#4 – Loan to individual risk taker, Loan to private Company, Restriction to Shareholder September 2012 #9 – Credit Information November 2012 #15 – Capital Change, RWA for Operational Risk, Disqualification to be a Director & SMEs Definition
February 2013
Source: NRB
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III. THE GOVERNMENT PROGRAM AND PARTICIPATORY PROCESSES 38. As highlighted previously, notwithstanding the difficult and uncertain political transition, Nepal economic performance has continued to be good during the past few years. The economy grew by an estimated 4.6 percent in FY 2012 and is projected to grow by three to 3.5 percent in FY 2013, despite the lower-than-expected growth in India and shortfall in public spending. Nepal has also made important inroads in reducing poverty and improving human development outcomes (with 68 percent of the country’s population lived under US$1.25 per day in 1996, down to 24.8 percent in 2011). In April 2013, the newly formed consensus Government approved a supplementary budget, which should boost public funding in the last trimester of the year and also announced its intention to prepare a full-fledged budget for FY 2014. In addition, the newly formed Government fully recognizes the need to further accelerate reforms to address financial sector vulnerabilities, which are a key threat to macroeconomic stability in Nepal. 39. Despite the complex political environment, the Government, acting through NRB and MoF, has taken a number of important steps to address financial sector vulnerabilities. As described in the previous section, starting in 2011, the Government implemented a series of regulatory and supervisory measures designed to provide a first response to the weaknesses in the financial sector and begin the process of identifying systemic and institution-specific risks. Building on the foundation of these actions, the Government has now begun implementing a comprehensive medium-term reform program to complete the identification of emerging risks that could threaten stability, and to initiate broader financial sector restructuring. 40. The authorities have initiated the consultative process to prepare a Financial Sector Development Strategy. The process is led by NRB. Initial rounds of discussions with stakeholders began in early 2013 on issues to be tackled by the Strategy. The authorities intend that the Strategy will have an important focus on financial inclusion and financial literacy. As part of this process, the authorities have also made an official request for a Financial Sector Assessment Program (FSAP) to be carried out by IMF and the World Bank, and DFID will provide support for coordination of the preparation of the Strategy and for its dissemination. 41. In 2012/13, the Government commenced restructuring of state-controlled banks. The Government’s policy is to retain RBB as the sole state controlled financial institution. RBB will have a development focus but on a commercially self-sustaining basis. All other state-controlled institutions are to have control either divested (ADBL and NBL) or be merged into RBB (Nepal Industrial Development Corporation, NIDC). By end-January 2013, the recapitalization program for RBB had progressed very rapidly with its Capital Adequacy Ratio becoming positive (up from -21.79 percent a year earlier)23. RBB is already profitable, and the additional capital will provide it with long-term viability. NBL is operating under NRB control, and an initial capital injection by the Government of NPR 1.37 billion (of a total of NPR 6 billion needed) was made in July 2012. NBL expects to raise the balance of the amount required from private sources (through a rights offering) and by selling non-banking assets24, half of which were tendered to the public in February 2013 with the remainder to be offered starting in 23 See Box 4 for further details of the RBB and NBL recapitalization programs. 24 See Box 4.
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April 2013. As a result, NBL expects to have a positive CAR by mid-July 2013. Significant progress has also been made on RBB and NBL governance. Both banks: (i) have professional top management appointed by NRB (NBL) or competitively recruited (RBB); (ii) no longer issue politically motivated loans; (iii) follow standard procedures for credit approval; (iv) have staff performance evaluation and promotions standards; (v) have made the internal audit function independent of management and reporting directly to the Board; (vi) give the CEO and management targets and are expected to maintain corporate governance standards with ex-post review by the Board; and (vii) achieved a higher compliance rating of central bank prudential norms. ADBL is now in the process of preparing for divestiture of state control with assistance from the Asian Development Bank (ADB). Lastly, in 2012 MoF also took an important step to improve its ability to provide governance for state-controlled financial institutions and any future Government interventions in the sector by establishing a Financial Sector Management Division (FSMD), which will work in close coordination with the Economic Affairs and Policy Analysis Division (EPAD). The capacity of FSMD and EPAD will be built up in 2013-2015 with intensive DFID support.
Box 4: NBL and RBB Recapitalization Plans
NBL’s recapitalization plan was approved by NRB in January 2012. The plan calls for the Bank to be recapitalized by increasing its capital by approximately NPR 8.2 billion in stages over three years by the following actions: • Purchase of NPR 1.3 billion of new shares by the Government as its share of an NPR 3.6 billion rights offering
(completed). • Sale of five percentage points of the Government’s shares to the staff of NBL as a condition of NBL’s unions’
agreement to the bank’s restructuring (completed – NBL staff purchased about 2 percentage points). • Purchase of a further NPR 2.3 billion of shares by private investors, representing the remainder of the NPR 3.6
billion rights offering (rights offering subscription launched in May 2013). The rights offering (9.5 shares for one share) is expected to close in mid-June 2013 and be completed in July 2013 (underway).
• Sale of non-banking real estate assets to generate approximately NPR 1.3 billion of after-tax profits (first NPR one billion estimated value of assets, involving eight properties, was offered for sale to the public in February 2013, the remainder to be sold before end-December 2013) (underway).
• Government exchange of NPR 670 million of income tax liability arising from profits on the sale of non-banking assets for NBL shares (MoF has agreed in principal but a binding agreement between NBL and the Government has not yet been signed – the exact amount will be determined by the total profits realized from sales of non-banking assets).
• Net income to generate retained earnings of NPR 2.6 billion (Provisional data indicate NPR 406 of Net Income for FY 2012).
As of October 15, 2012, NBL had negative equity of NPR 2.65 billion. NBL management projects that the capital position will become positive by mid-July 2013 as a result of: (i) injection of NPR 2.3 billion from the rights offering; (ii) NPR 600 million in after-tax profits from non-banking asset sales; (iii) NPR 300 million in conversion of income tax liability on non-banking asset sales; and (iv) retained earnings for FY 2012/13. Sale of the remaining non-banking assets and retained earnings would then increase NBL’s capital to comply with regulatory requirements by mid-July 2016. In mid-July 2011, the Government’s stake in NBL was 40.59 percent. As a result of the sale of Government shares to NBL staff, this stake fell to 38.6 percent by end-December 2012. The Government has fully subscribed its share of the rights offering, with the result that its ownership share will not change when the rights offering is completed. However, as a result of the projected conversion of NPR 670 million of income tax liabilities arising from the sale of non-banking assets, NBL management projects that the Government could rise again to approximately 48 percent. The Government’s medium-term strategy calls for the divestiture of this stake. RBB’s capital plan was approved by NRB in July 2012. The Bank is 100 percent Government-owned and would remain so after implementation of the capital plan is completed. The Government’s medium-term strategy calls for
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RBB to remain as the sole state-owned bank. The recapitalization plan calls for RBB to meet regulatory capital requirements by mid-July 2016 as a result of the following actions: • Government purchase of NPR 4.32 billion in new shares (completed). • Assumption of liability by the Government for on-lent World Bank funds25 resulting in new equity in the
amount of NPR 3 billion (completed). • Conversion of NPR 787 million of Government-owned preference shares to common shares increasing the
capital weight of this amount to 100 percent (completed). • Conversion of NPR 87 million preference share dividend payable to the Government to equity (completed). As a result of the completion of these four actions injecting NPR 7.7 billion of common equity, RBB’s capital ratio improved from -9.35 percent (a figure which reflects the Government injection of NPR 4.3 billion to purchase new shares) to become positive as of January 15, 2013. In the period from July 2012-July 2016, RBB’s capital plan projects that the Bank’s capital ratio will increase to 11.42 percent (regulatory requirement 10 percent) as a result of the following: • Capital increase of NPR 416 million as a result of merger with NIDC Development Bank (underway, completion
expected by mid-July 2013). • Retention of earnings of approximately NPR 3.5 billion. • Issuance of supplementary capital (subordinated debt) in the amount of NPR 4.25 billion.
42. Building on the important measures taken in 2011/12 to alleviate the liquidity crisis, the authorities are now addressing the root causes of the crisis with World Bank, DFID, and IMF support. These root causes include the importance of detecting and taking action to address emerging risks to the stability of the financial system and individual institutions, which is one focus of the proposed DPC. In 2012, NRB moved to address these issues by launching a pilot program (supported by IMF) of special inspections focused on risk management practices and real estate lending of 20 financial institutions. By May 2013, 14 of these diagnostics had been completed. NRB has also made a decision to expand the diagnostics program by launching in-depth diagnostics of up to 60 institutions representing about 65 percent of financial system assets. These diagnostics (supported by DFID) will be carried out by consortia led by international accounting firms working under terms of reference aligned with international practice. 43. NRB has been supporting the consolidation of the financial system by encouraging mergers of Class C institutions in difficulty with stronger institutions where such mergers can provide long-term viability26. In 2012, NRB issued an amended bylaw to facilitate mergers and has maintained its moratorium on new licenses for institutions (see Table 5). NRB recognizes the need to review the overall structure of the financial sector (in particular the number of institutions and their classifications). The financial sector strategy under development—complemented by FSAP (requested by the Nepalese authorities)—aims at building a consensus on the most appropriate structure to ensure that the Nepalese financial sector is both inclusive and a motor for economic growth in the years to come.
44. The Government has also completed preparation of important enhancements to the financial sector safety net and to the legal framework for bank resolution. MoF has
25 The World Bank funded Financial Sector Restructuring Project financed the Voluntary Retirement Schemes (VRS) at NBL and RBB. The GoN on-lent the funds allocated for the RBB VRS to RBB. As part of RBB restructuring plan, GoN agreed to convert its loan to RBB into capital. 26 Between January 2012 and January 2013, 11 Class B and C institutions completed mergers, one Class C institution completed a voluntary liquidation, and one Class C institution completed a forced liquidation.
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approved a Deposit and Credit Guarantee Corporation (DCGT) Bill to place the deposit insurance system on a sound legal footing. With DFID support, a program is also underway to strengthen the capacity of DCGC to provide depositors with speedy and accurate repayment of insured deposits and to build DCGC’s operational capacities. Both the NRB Act and the Banking and Financial Institutions Act (BAFIA, revisions to which have been under Parliamentary consideration for some years) provide NRB with legal tools to intervene in troubled financial institutions, and underpin the PCA framework. However, overlaps, gaps, and conflicts raise uncertainty. With technical assistance from IMF, NRB has prepared amendments to the NRB Act to allow for more efficient bank resolution through modernization and strengthening of NRB’s bank resolution powers. NRB has also established a Bank Resolution Unit and has prepared, with technical assistance from FIRST27 and DFID, two bank resolution manuals: one that can be used in the current legal framework (with the current version of NRB Act and BAFIA) and one that will be used once the amendments to NRB Act are approved. 45. The authorities have also taken steps to promote the transparency of the financial sector. In order to improve transparency and in parallel improve the ability of supervisors to detect emerging risks in the financial system, the Institute of Chartered Accountants of Nepal (ICAN—the legal decision maker for all accounting issues in Nepal) has decided to require the implementation of IFRS28-compliant Nepal Accounting Standards29 by listed financial institutions starting in FY 2015/16. In consultation with the NRB it has been decided to stagger the implementation process over three years, allowing additional time for lower capacity institutions (primarily Class B and C institutions) to prepare themselves. DFID and World Bank support will be utilized over the 2013-2015 period to build regulatory, audit industry, and financial statement preparer capacity to work in an IFRS-compliant environment, and to adjust regulatory frameworks to IFRS.
46. Decisive steps have been taken by the Government to act against money laundering and terrorist financing. In 2012, ordinances were approved by the President, which enacted the Mutual Legal Assistance Bill and Extradition Bill. These pieces of legislation (ordinances have the force of law but will have to be submitted for approval within six months of a Parliament being elected), along with the Organized Crime Bill approved by ordinance in February 2103, are expected to be enacted once a Parliament is in place and, along with the already enacted ‘Asset (Money) Laundering Prevention Act (2008)’, will provide a legal framework in line with international standards. The authorities have also put in place the institutional infrastructure required, with dedicated units at NRB and MoF, and establishment of a special court and prosecutors to handle Anti Money Laundering / Counter Financing of Terrorism (AML/CFT) cases. However, to avoid the Financial Action Task Force30 (FATF) ‘dark list’ (also referred to
27 Financial Sector Reform and Strengthening (FIRST) Initiative (http://www.firstinitiative.org/) 28 International Financial Reporting Standards 29 For convenience these have been referred to as IFRS. 30 The Financial Action Task Force (FATF) is an inter-governmental body established in 1989. The objectives of FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. FATF has developed a series of Recommendations that are recognised as the international standard for combating of money laundering and the financing of terrorism and proliferation of weapons of mass destruction. FATF monitors the progress of its members in implementing necessary measures, reviews money laundering and terrorist financing techniques and counter-measures, and promotes the adoption and implementation of appropriate
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as a ‘public statement’), the following additional measures have to be completed by the issuance of ordinances by end June 2013 enacting: (i) amendments to AML/CFT laws which incorporate FATF recommendations, and (ii) the Proceeds of Crime Bill. 47. The Government’s medium-term program for the financial sector focuses on reforms designed, over a three-year period, to place the financial sector on a sound foundation for the future. This program encompasses:
i. Completion of a financial sector strategy based on wide consultation with stakeholders.
ii. Completion of restructuring of three state-controlled banks through recapitalizations and a merger, and divestiture of control over two out of the three remaining institutions after completion of the merger31. Only one bank with 100 percent state ownership, RBB, will remain with a commercial banking license but following a development focused strategy.
iii. Completion of the program of in depth diagnostics of all at-risk and systemic banks, followed by appropriate measures to ensure that all banks are in regulatory compliance within two years.
iv. Approval of a modernized bank resolution process and appropriate capacity within NRB to undertake bank resolution.
v. Putting in place a functioning financial sector safety net through enactment of the DCGT Bill and operationalization of the deposit insurance system.
vi. Adoption of amendments to NRB Act and BAFIA to give supervisors stronger legal tools for bank resolution.
vii. Improvements to the transparency of the financial system through a staged adoption of IFRS.
viii. Enactment of further measures to support the fight against money laundering and terrorist financing.
48. The participatory process has been enhanced as a result of NRB stepping up the consultative process with stakeholders in recent months to keep pace with the changing environment and to make appropriate amendments to the existing rules and regulations in the financial sector. Regulatory changes are drafted by relevant departments before being reviewed and endorsed by the Regulations Committee. The draft amendments are then shared with relevant stakeholders—such as the associations of banks and financial institutions— for their feedback before they are finalized and submitted to NRB management for approval. The High Level Financial Sector Coordination Committee headed by the Finance Minister takes key decisions on major financial sector reforms (such as RBB and NBL restructuring) and facilitates consultations with key Government stakeholders (that is, MoF, NRB, Insurance Board, Securities Board).
measures globally. FATF currently comprises 34 member jurisdictions and 2 regional organizations representing most major financial centers in all parts of the globe. The World Bank has the status of observer. 31 The four state controlled financial institutions are NBL, RBB, ADBL (where the GoN divestiture process is supported by ADB) and NIDC (which will be merged with RBB, as per the RBB recapitalization plan).
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IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM
A. Link to Interim Strategy Note (ISN) and Country Partnership Strategy (CPS) Under Preparation
49. The current Nepal ISN (FY 2012-FY 2013) notes the vulnerability of the financial sector and its potential adverse impact on growth. The ISN32 is built around three pillars: (i) enhancing connectivity and productivity for growth; (ii) reducing vulnerabilities and improving resilience; and (iii) promoting access to better quality services—with two crosscutting themes (i) governance and accountability, and (ii) gender equality and social inclusion. At the time of the Board presentation of the ISN, World Bank Executive Directors took note of the emerging weaknesses in the financial sector and urged the Bank to assist the Government in addressing them inter alia through the potential use of development policy lending.
50. A new Country Partnership Strategy (CPS) for FY 2014-FY 2017 is under preparation. The proposed CPS would be centered on four pillars aimed at: (i) increasing accessibility and growth; (ii) promoting growth in human potential; (iii) enhancing governance, accountability and citizen’s empowerment; and (iv) strengthening resilience and social equity. The Concept Note for the proposed CPS underlines persistent financial sector weakness and the risk this poses to macroeconomic stability and economic growth, as illustrated by a liquidity crisis in 2011. It recognizes the efforts undertaken by the authorities to address the root causes of the financial sector difficulties and the support provided by the World Bank, IMF and DFID. The CPS Concept Note makes the case for the use of Development Policy Credits to support the reform efforts of the authorities.
B. Collaboration with IMF and Other Donors 51. This proposed development policy credit has been prepared in close collaboration with IMF and DFID. As a result of the vulnerability of the financial sector, the World Bank (mostly through FIRST), IMF, and DFID have been providing technical assistance to the Nepalese authorities, and in particular to NRB and DCGC. The focus of these efforts was: to establish a framework for bank resolution, undertake initial diagnostics of some financial institutions, prepare a prompt corrective action framework, and to finalize amendments to NRB Act and prepare the Deposit and Credit Guarantee Trust (DCGT) Bill. 52. The World Bank and IMF share the same concerns regarding the vulnerability of the financial sector and the need to take urgent actions—as highlighted in IMF Article IV consultation report (December 2012). The two institutions have therefore agreed to collaborate closely on activities to address financial sector vulnerability.
53. DFID is working closely with the World Bank on financial sector issues. Notably, DFID co-financed the World Bank Financial Sector Technical Assistance Project (P071291, closed on December 31, 2011). DFID is now providing technical assistance support to both the World Bank and the Government for the preparation of the proposed Development Policy Credit
32 Report number 63381; Board date September 15, 2011.
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and DFID has also recently approved a US$7.5 million equivalent technical assistance package for 2013-2015 designed in coordination with the World Bank to support the implementation of the broader Government financial sector reform program (see Annex 3 Appendix, below).
54. This operation also complements the activities of IFC (Investment and Advisory Services) to develop the Nepalese financial sector. IFC has invested in several financial institutions in Nepal (Bank of Kathmandu, Nirdhan—a microfinance institution, Nepal Ventures—a Small and Medium Enterprise venture capital fund, Rural Microfinance Development Centre (RMDC)—an apex microfinance wholesale lending institution, and International Leasing and Finance Company). IFC’s Financial Markets and Access to Finance advisory work focuses on financial infrastructure, sustainable energy financing and SME lending, microfinance, credit information bureaus, secured transaction registries, and support to long-term lending institutions.
C. Relationship to Other Bank Operations 55. This proposed Development Policy Credit builds on the lessons from the World Bank financed US$16 million Financial Sector Technical Assistance Project (P071291, approved in 2002 and closed in 2011) and the US$75.5 million Financial Sector Restructuring Project (P084219, approved in 2004 and closed in 2009)33. 56. The Financial Sector Technical Assistance (FSTA) Project focused on three broad objectives: (a) helping to restructure and re-engineer NRB, so that it can effectively perform its key central banking functions; (b) commencing commercial banking reform in the two large state-controlled commercial banks that dominate the sector (RBB and NBL) by introducing stronger bank management to protect the financial integrity of the two banks and prepare the banks for the next steps of restructuring; and (c) supporting a better environment for financial sector reform in areas such as enhanced credit information, better financial news reporting, and better training for staff in financial institutions. The FSTA Project closed in December 2011 and the recently completed Implementation Completion Report (ICR) evaluated the project outcome as Moderately Unsatisfactory and the Bank Performance, as well as Borrower Performance, were rated Moderately Unsatisfactory. The ICR of the FSTA project (as well as the ICR of the Financial Sector Restructuring Project described below) recognizes that important reforms—in particular with regard to RBB and NBL—took place during the initial stages of the project, but that the reform momentum then disappeared, hence the rating of the projects. 57. Similarly, the objectives of the Financial Sector Restructuring Project were to: (a) improve corporate governance through provision of management support to the two large commercial banks (NBL and RBB), to substantially improve their operating capacity and commercial viability; to move them as swiftly as possible into the private sector; and, thereafter, develop the Government's oversight and supervisory capacity over them and other banking institutions; (b) improve market structure by reducing the size of the state-owned segment of the banking system; (c) sustain and deepen banking sector reforms, which entailed further strengthening of NRB through a program of bank supervision strengthening; accounting and
33 Both projects were IDA credits. The US$75.5 million Financial Sector Restructuring Project included a US$7 million grant component.
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auditing development, human resource re-engineering, information technology up-grading, and other support. This project represented the second phase of a larger financial sector reform effort that began with the FSTA Project. The project closed in 2009 and the ICR evaluated the project outcome as Moderately Unsatisfactory. Bank Performance, as well as Borrower Performance, were rated Moderately Unsatisfactory. 58. These projects initially managed to implement a number of reforms, notably with the two largest state controlled banks (such as the implementation of a Voluntary Retirement Scheme (VRS) and the implementation of management contracts within the banks). However, they then suffered from the political instability in Nepal during project implementation, from shifting commitment from the frequently changing governments regarding the restructuring of the two largest state owned banks, and from a blocked procurement process that derailed further implementation34.
59. More recently, the World Bank has provided technical assistance to NRB and DCGC on contingency planning, crisis management, bank resolution and deposit insurance through the FIRST Initiative and in coordination with DFID technical assistance. The design of the proposed Development Policy Credit relies on the recommendations of this technical assistance. Section E below provides further detail on the technical assistance and analytical work undertaken by the World Bank, IMF and DFID.
D. Lessons Learned 60. In 2008, the Bank undertook a comprehensive review, both in its operations and research areas, of its responses to earlier financial crises35. Notably, the largest Bank crisis-response programs for South Korea, Argentina, Turkey, Thailand, Indonesia, and Russia have been reviewed and critically assessed. The main generic lessons from Bank responses to previous crises stressed the importance of an early response: the fiscal cost of interventions can be quite large but the cost of inaction can be even larger. 61. Experience during the 1990s financial crisis points to three broad areas requiring close attention:
• Focus and selectivity. The speed and focus of Bank response are both crucial for good outcomes during and after crises. Past crisis support was much more successful when it was nested in a results framework (explicit or implicit) that incorporated selective coverage and focused on the Bank’s comparative strengths. The proposed operation incorporates this lesson by focusing on policy actions that address directly the immediate needs of stabilizing the financial sector.
• Financing modalities and organizational arrangements. Development Policy loans/credits can usefully address crisis needs, as they can support incremental reforms.
• Coordination with partners. Coordination among key partners, particularly with IMF, is critical, as differences of view surface quickly during crises and are potentially damaging.
34 See Footnote 35. 35 IEG, Evaluation Brief 6, Lessons from World Bank Group Responses to Past Financial Crises, 2008.
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As mentioned in section B above, this proposed Development Policy Credit is prepared in close coordination with IMF and DFID.
62. A number of lessons have also emerged from the more recent global financial sector crisis (which started in 2008), as highlighted by the 2012 Independent Evaluation Group (IEG) report36 on the “World Bank Group’s Response to the Global Economic Crisis.” This report has provided useful guidance for the development of this proposed intervention. In a situation like Nepal, where the financial sector problems are chronic rather than acute, the report advocates a phased program of intervention that sets forward-looking targets through a broad and medium-term reform program. Finally, the report also highlights the key role of World Bank analytical work to inform the policy dialogue and the reform program. 63. In addition, the proposed operation takes into account the lessons from the Financial Sector Technical Assistance and Financial Sector Restructuring Projects. While these two projects initially achieved notable results with regard to NBL and RBB restructuring, the results of both were ultimately disappointing. They have shown the limits of stand-alone technical assistance projects when it comes to achieving politically sensitive reforms, especially in the complex Nepalese political environment37. Learning from the lessons from these two projects, a different approach to supporting financial sector reform has been adopted, combining intense policy dialogue in the context of the preparation of a Development Policy Credit with technical assistance provided by FIRST and DFID. The policy dialogue on financial sector reform was restarted following the mid-2011 liquidity crisis and through this intensive dialogue, the Nepalese authorities and the World Bank have agreed on a financial sector reform roadmap, whose initial steps would be supported by the proposed Development Policy Credit. Technical assistance provided by FIRST and DFID has also proved critical, providing just-in-time policy guidance to the authorities on issues such as NBL and RBB restructuring, bank resolution, and deposit insurance.
E. Analytical Underpinnings 64. The design of this operation has relied on technical assistance financed by DFID, the FIRST Initiative, US Treasury, and IMF. In particular, the design of this operation has been informed by IMF on-going technical assistance to NRB, analytical work and on-site work on the condition of the banking sector performed by DFID and IMF, and the recommendations of IMF Article IV consultations. As highlighted in Figure 10, the reform program supported by DPC is fully aligned with the IMF roadmap for financial sector reform. Boxes 5, 6 and 7 provide a summary of the main recommendations of the various technical assistance reports.
36 IEG, The World Bank Group’s Response to the Global Economic Crisis—Phase II, 2012. 37 Following allegations of mis-procurement from the Commission for the Investigation of the Abuse of Authority (CIAA) under the Financial Sector Restructuring Project, the Governor of NRB was dismissed in July 2007 and the Governor position remained vacant for one year and half. The Appellate Court absolved the former Governor from all charges of corruption and reinstated him in July 2009. These events had a detrimental impact on the projects and put a halt to all reform efforts. In addition, NRB has since then been extremely reluctant to undertake any procurement under World Bank financed projects.
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Box 5: Responding to Issue Facing the Financial Sector of Nepal: Summary of Key Recommendations
A. Near-Term (as soon as possible) Supervision
• Conduct ‘deep dive’ diagnostics of banks to determine their real financial positions. This will help to identify any weaknesses not currently identified and afford a better opportunity to address them. The order of banks to be reviewed should be based upon the current identification of those thought to be the weakest and those that are most strategic to the system.
Resolution of troubled financial institutions • Consideration should be given to allowing a small institution to fail and be taken over by NRB, sold or
liquidated.
B. Medium- and Longer-Term (will require more time to address, but need to be started soon) Structure of the banking system
• The number of bank classes should be reduced to two. Clear distinctions should be drawn between the two types of licenses in such areas as: required capital, the types of funds which can be mobilized and the term of the funds mobilized as well as the level of supervision applicable to each type of bank.
Supervision • Improve supervision: review structure of NRB supervision departments for class A, B and C; strengthen
training of supervision staff and limit staff rotation; identify and closely monitor systemic banks. Liquidity/solvency
• Liquidity support should not be a substitute for addressing fundamental weaknesses of an institution. Care must be given to ensure liquidity support is not provided to an otherwise insolvent institution.
• Undertake thorough review of loan portfolios, in terms of borrower repayment capacity, valuation of collateral, loan classification and provisioning to more adequately estimate the true capital position of banks.
Resolution of troubled financial institutions • Create a framework for effective bank resolution • Amend the law (BAFIA and/or NRB Act) to give sole discretion to NRB to determine a bank’s viability
and its need for liquidation/insolvency and to act thereupon. Source: Adapted from “Responding to Issue facing the Financial Sector of Nepal: Background and Options – Summary of Key Recommendations” (August 2011), FIRST Technical Assistance Report
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Figure 10: IMF Financial Sector Reform Roadmap
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Box 6: Nepal Problem Bank Resolution Framework: Key Recommendations
• Harmonize the NRB Act, Banks and Financial Institutions Act (BAFIA), and the proposed law on the Deposit Credit and Guarantee Trust (DCGT). NRB should have the authority to determine the fate of the bank / financial institution (BFI), not a court, and DCGT needs clear depositor preference status for its claims. • Determine the extent to which the real estate downturn has affected BFIs by performing ‘deep dive’ diagnostics of as many Class A, B & C institutions as possible. • Establish a Problem Bank Resolution Unit at NRB, independent of but working closely with the BFI Supervision Departments. The size of this unit would depend upon the extent of the problems disclosed by diagnostics and the number of BFIs in distress as a result. The Unit will make recommendations for resolution methods as well as supervise the Conservators and Receivers appointed over the non-state owned entities. The Conservators appointed to operate institutions until a resolution is accomplished should not be employees of NRB, they should be professionals hired as such. NRB as regulator and supervisor of BFIs in Nepal should not also be directly managing a BFI due to conflicts of interest. • If the real estate problem proves to be significant, it may be necessary to consider some open bank resolution alternatives in addition to the traditional methods of conservatorship or receivership. It is hard at this time to recommend one specific approach until the extent of the problem is known. One option used by other countries—and which has been discussed in Nepal in similar situation—is to establish an Asset Management Company (AMC) to acquire NPLs from problem institutions. Who will bear the cost to capitalize the AMC, at what price would the assets be purchased out of the institutions and how will the institutions recapitalize? The use of AMCs has not been universally successful and great care needs to be taken in designing an AMC to avoid it becoming a mechanism for bank shareholders to avoid losses by shifting costs to the taxpayer. These are questions that would have to be answered and highlight the need for working with MoF to develop a coordinated strategy for dealing with potential widespread insolvency. It is important that the role of NRB as the supervisor become clearly separated from the use of budget funds to finance the restructuring and recapitalization of financial institutions. • Work with DCGT to develop procedures for insuring depositors receive their insured deposits in a reasonable period of time; procedures are developed to insure the DCGT is reimbursed by the Receivership as appropriate under applicable law and that the public is aware of deposit insurance and what it means. • Consider relaxing the cross holding limitations under BAFIA to allow institutions to acquire other institutions. Source: Nepal Problem Bank Resolution Framework, Executive Summary, June 2012, FIRST Technical Assistance Report
Box 7: Nepal Bank Resolution Legal Framework: Key IMF Recommendations
IMF technical assistance (TA) analyzed the current legal regime under the Nepal Rastra Bank Act and provided specific drafting suggestions based upon international good practices. IMF TA recommended that a new Chapter 9A of the Nepal Rastra Bank Act (“the NRB Act”) substitute its existing sections relevant to bank resolution. Chapter 9 of the NRB Act currently provides for corrective actions against problematic banks and contains several provisions for restructuring banks under official control. It has some useful provisions for restructuring banks, including: (i) the quantitative and qualitative triggers of taking control over banks, and (ii) the full control of an ‘Appointed Officer’ over bank’s general meeting and management. However, the existing legal framework for bank resolution is not effective. The weaknesses in the existing Chapter 9 of the NRB Act include: (i) the lack of safeguards to creditors and shareholders, (ii) the complicated procedural requirements for each step of the official control, (iii) the provisions to allow releasing a bank from the official control without conducting any restructuring measure, and (iv) the power of an appellate committee to set-aside resolution transactions. Furthermore, there is no liquidation procedure specifically aiming at liquidating banks in
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an orderly manner. Under the absence of a bank specific liquidations procedure, only the general insolvency procedures under the Insolvency Act are available, but they are not suitable for orderly bank liquidation. IMF TA also reviewed the Bill for the Amendment and Consolidation of Legislation regarding Banks and Financial Institutions, which is under review at the Parliament. The Bill contains provisions very similar to those under Chapter 9 of the NRB Act. In order to eliminate possible overlap and inconsistency between the recommended Chapter 9A of the NRB Act and the Bill, IMF TA recommended deleting these relevant provisions under the Bill, if it continues to be under review at the Parliament. Source: IMF Technical Assistance Report on Improvements to Legal Framework for Bank Resolution (June 2012)
V. THE PROPOSED OPERATION
A. Operation Description 65. A standalone single tranche operation, supporting part of the medium-term Government financial reform program, is proposed. The DPC will focus on putting in place building blocks for banking sector stability, while the medium-term Government reform program aims at consolidating banking sector stability and paving the way for the development of a robust and inclusive financial sector. Given the depth of the Bank’s dialogue with the authorities, the detailed elaboration and mutual understanding of the medium-term Government program, as well as commitment by key stakeholders, this operation could have been designed as the first phase of a programmatic series of development policy credits supporting financial sector stability and reform. However, the fluidity of the political situation and the current lack of a Parliament argue for a two-stage approach. This allows the timely acknowledgment of the important steps already taken by the Government to preempt a possible financial crisis and strengthen financial sector stability. It also allows the continuation of a deepening dialogue on broader reforms that could be supported by a follow-up operation when conditions warrant. 66. The proposed DPC builds on the authorities’ reform efforts and would allow a deeper dialogue. As already outlined above, the policy dialogue on financial sector reform re-initiated since the liquidity crisis in mid-2011 is bearing fruit and the Nepalese authorities have commenced implementation of key steps in an ambitious financial sector reform program, with the support of the World Bank, DFID and IMF. The authorities have demonstrated that despite the complex political environment, they are able to implement important reform efforts such as the approval and implementation of the recapitalization plans for NBL and RBB and the issuance of Presidential ordinances (which have the force of law) on AML/CFT. The proposed DPC—coupled with technical assistance from DFID and IMF—would play a key role in maintaining a close and constructive dialogue. It would maintain this close policy dialogue, moving forward, to ensure implementation of the longer-term Government financial sector reform program. 67. The proposed prior policy actions for the Development Policy Credit are summarized in the Box 8. The Policy Matrix is included in Annex 2. The articulation between the proposed DPC and the medium-term Government financial sector reform program is presented in Annex 3.
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Box 8: Prior Actions for Development Policy Credit
The following constitute the prior actions for presentation of the Development Policy Credit to the World Bank’s Board.
1. The first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital.
2. The first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (i) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (ii) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of NPR 1 billion; and (iii) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion.
3. NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50 percent of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed.
4. NRB has established a bank resolution desk and approved a bank resolution manual.
5. NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector.
6. The moratorium on new license applications for Class A, B and C financial institutions, as defined in BAFIA, and evidenced by no acceptance of banking license applications in 2012, has been maintained
7. The draft Bill on Deposit and Credit Guarantee Trust has been endorsed by MoF for submission to the Cabinet.
8. Amendments to the NRB Act providing NRB with modernized tools for bank resolution have been approved by NRB Board and further endorsed by MoF
9. The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Ordinance and Organized Crime Ordinance.
B. Policy Areas 68. The DPC supports six main policy areas: (i) formulation of a financial sector development strategy; (ii) restructuring of NBL and RBB; (iii) assessment of the condition of Class A, B and C financial institutions and potential restructuring; (iv) strengthening institutional arrangements to support the bank restructuring process; (v) strengthening the legal and regulatory framework for effective bank resolution; and (vi) increasing the transparency of the financial system. Formulation of a financial sector development strategy 69. The DPC supports the decision of GoN to prepare a comprehensive strategy to support the development of an inclusive financial sector. The preparation of a financial sector development strategy would help the authorities look beyond the short-term need to stabilize the financial sector and help the authorities and the financial sector stakeholders come to a consensus on a vision for the Nepalese financial sector in five to ten years and on the steps required to transform this vision into reality. This strategy exercise will also undertake a review of the current structure of the financial sector (Class A, B, C and D institutions, as well as cooperatives) and to assess whether this structure is still relevant to Nepal’s needs because there is a growing recognition that a consolidation of the financial sector is required (moving towards fewer
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categories of financial institutions more sharply differentiated by required capital, with increased minimum capital requirements and more stringent licensing regulations; the types of funds which can be mobilized and the term of the funds mobilized; as well as the level of supervision applicable). As explained in paragraph 40, this exercise is led by NRB. By December 2013, NRB and MoF will have initiated technical consultations with stakeholders for the elaboration of the financial sector development strategy for Nepal and a roadmap for strategy preparation would have been developed. The medium-term Government program will ensure that the financial sector development strategy has been approved and that the strategy is under implementation, as per its action plan. Restructuring of NBL and RBB 70. These two undercapitalized state controlled banks38 represent 15.3 percent of total commercial banks assets (as of mid-October 2012). It is critical for the Nepalese authorities to establish a level playing field and to require that all banks (public as well as private) meet prudential norms and, in particular, capital adequacy requirements. Allowing state-owned banks to remain insolvent indefinitely sends a negative message to the overall financial sector, indicating that lack of compliance with prudential regulation is acceptable. It also significantly reduces the authorities’ credibility to tackle problem banks. 71. As discussed above, the authorities have initiated the restructuring of NBL and RBB. The prior actions for the DPC read as follows: (i) the first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital and (ii) the first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (a) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (b) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of NPR 1 billion; and (c) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion. The recapitalization plans are described in Box 4, in Section III. The medium-term Government reform program aims at ensuring that, following diagnostic audits, RBB and NBL remain in compliance with their approved recapitalization plans. In addition, while RBB will remain a fully state-owned bank, the Nepalese authorities intend to transfer control of NBL to a reputable strategic investor, which will be critical to ensure the continued sound governance of NBL. NBL is currently under the direct control of NRB, which ensures appropriate governance. As discussed in paragraph 41, in 2012, MoF took an important first step to improve its ability to provide governance for state-controlled financial institutions and any future Government interventions in the sector by establishing a Financial Sector Management Division (FSMD), which will work in close coordination with the Economic Affairs and Policy Analysis Division. By December 2013, both RBB and NBL CARs will be positive (RBB CAR stood at -21.79 percent in Mid-January 2012, while NBL CAR stood at -8.53 percent at the same date). 72. The medium-term Government reform program will focus on completing the restructuring and full recapitalization of NBL and RBB. The approved recapitalization plans 38 While GoN only owns 38.6 percent of NBL, NBL is still perceived by the public as a state-owned bank.
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for NBL and RBB include several phases that should ensure that NBL and RBB exceed minimum CAR requirements by FY 2016. The first phases of NBL and RBB recapitalization plans have been completed; however it will be important to ensure timely and effective implementation of the remaining phases of the recapitalization plans. In addition, to ensure that the recapitalization (that is, financial restructuring) of the institutions is sustainable, it is indeed critical to ensure that the errors of the past (which led to the insolvency of both banks, that is, poor governance) do not re-occur and to pursue the institutional restructuring of the banks—as spelled out in NBL and RBB business plans. NBL and RBB have prepared—building on the approved recapitalization plan—business plans which demonstrate how the two institutions aim to improve their operations and facilitate access to financial services to the Nepalese population. MoF has indicated that it intends—with support from the recently approved DFID long-term technical assistance package—to closely monitor the performance of the two state-controlled institutions through the new established FSMD. In recent years, both MoF and NRB have demonstrated a strong commitment to ensure good governance within RBB and NBL, as well as compliance with prudential regulations.
Assessment of the condition of Class A, B and C financial institutions and potential restructuring
73. NRB has recognized the need to undertake an in-depth assessment of financial institutions which are either considered to be at risk or systemic. As highlighted in paragraph 42, to better understand the true situation of the financial sector, NRB has launched a pilot program (supported by IMF) of diagnostics focused on risk management and real estate lending of 20 financial institutions. Considering the lack of reliability of reported financial information (notably with regard to NPLs and exposure to real estate), it is important to deepen this exercise and NRB has taken the decision to undertake comprehensive diagnostic audits of financial institutions (A, B and C class) representing at least 50 percent of total banking assets. The World Bank, DFID and NRB have agreed on Terms of Reference (including selection criteria for up to 60 institutions) for these in-depth diagnostics. The prior action for the DPC therefore reads as follows: NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50 percent of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed. By December 2013, the in-depth diagnostic program will have been initiated, to provide comprehensive information on problem institutions. 74. The medium-term Government reform program will ensure that the diagnostic audits of financial institutions will be completed; and that corrective action programs are implemented for undercapitalized institutions. If the diagnostics identify undercapitalized banks, the authorities will develop and implement appropriate resolution processes, which would involve restructuring and recapitalization from private sources for viable banks or financial institutions and orderly liquidation for non-viable banks or financial institutions. In the case of undercapitalized systemic institutions, if insufficient private capital is available, then state intervention may be necessary. Strengthening of banking supervision and resolution capacities will be critical to ensure that corrective action programs are implemented for undercapitalized institutions.
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Strengthening institutional arrangements to support the bank restructuring process 75. The Nepalese authorities have initiated key reforms to strengthen the bank restructuring process with, in particular, the issuance of regulations to facilitate mergers of financial institutions, continuation of the moratorium on new licenses, preparation of a bank resolution manual, and preparation of a Bill to transform the Deposit and Credit Guarantee Corporation (DCGC) into the Deposit and Credit Guarantee Trust (DCGT). Such steps are critical before receiving the results of in-depth diagnostics, which might lead to the need to resolve a number of problem financial institutions. The prior actions for the DPC therefore read as follows: (i) NRB has established a Bank Resolution Unit and approved a bank resolution manual; (ii) NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector; (iii) the moratorium on new license applications for Class A, B and C financial institutions, as defined in BAFIA, and evidenced by no acceptance of banking license applications in 2012, has been maintained; and (iv) the draft Bill on DCGT has been endorsed by MoF for submission to the Cabinet. The Bank Resolution Desk for Class A financial institutions has been established, and this Desk will also become responsible for the resolution of Class B and C institutions, in order to ensure consistency and better utilization of resources. The Bank Resolution Manual—which can be used with the current version of the NRB Act—was approved in May 2013 by NRB. A second version of the Bank Resolution Manual, to be used once the amendments to the NRB Act have been enacted, has also been developed. As illustrated in Table 5, NRB has issued regulations in 2012 to facilitate mergers of financial institutions and NRB has maintained the moratorium on new licenses for class A, B and C institutions39. As a result, the consolidation of the sector has been initiated and as of January 2013, the sector consisted of 187 institutions in Classes A, B and C, reduced from 199 in January 2012. By end-2013, the sector is expected to be reduced to 175 institutions. MoF has finalized the draft DCGT bill with DFID assistance, taking into account international practice and new senior management has been appointed. The following results are therefore expected by December 2013: (i) NRB Bank Resolution Desk is operational and undertakes bank resolutions; (ii) consolidation of the financial sector is underway through a decrease in the number of financial institutions; and (iii) the legal and operational framework for deposit insurance is ready for implementation (pending legislative approval). 76. The medium-term Government reform program supports the development of DCGT as an efficient and effective deposit insurance mechanism. Once the Constituent Assembly is in place, the DCGT Act will be submitted for Parliamentary approval40. The DCGT Act will be complemented by the issuance of several key documents: (i) regulations on criteria for setting deposit insurance coverage and the annual guarantee fee; (ii) payout procedures for effective deposit compensation; (iii) Deposit Insurance Institutional Development Plan; and (iv) DCGT organizational structure (with competitive recruitment of staff). Starting in the second quarter of 2013, the DFID technical assistance package will provide DCGC with the information
39 A new class B institution has been established in 2012—as it had received an in-principle approval from NRB before the moratorium was put in place. 40 However, should a financial crisis break out, it would be possible for the DCGT Act to be approved by Presidential ordinance.
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systems required to execute deposit pay-out operations and to build the capacity of DCGT staff. This will ensure that the legal and operational framework for deposit insurance is in place. Strengthening the legal and regulatory framework for effective bank resolution
77. The legal framework for bank resolution (notably the NRB Act and BAFIA) overlaps and conflicts, which creates legal uncertainty. Moreover, declaring a bank insolvent is complex, lengthy, and subject to interference by creditors and shareholders. As a result, the prior action for the DPC is as follows: amendments to the NRB Act providing NRB with modernized tools for bank resolution have been approved by NRB Board and further endorsed by MoF. By December 2013, the legal framework for effective bank resolution should be finalized (pending legislative approval41). The NRB Board approved the amendments to the NRB Act on May 22, 2013. A review by the IMF and World Bank of the NRB Act amendments on bank resolution approved by NRB Board showed that while the amendments relating to bank resolution were conceptually satisfactory, further precisions and revisions to ensure clarity were needed in the text. Following the NRB Board approval, these amendments have been forwarded, for endorsement, to the Ministry of Finance. The Ministry of Finance, in close coordination with NRB, further revised the amendments (in light of the IMF and World Bank comments) and endorsed the revised amendments on bank resolution for further transmission to the Ministry of Law, Justice, and Parliamentary Affairs. 78. Under the medium-term Government program, MoF will ensure that the amendments to the NRB Act and the conforming amendments to other legislation (including BAFIA) have been submitted to Parliament and necessary directives for their implementation have been finalized. This would ensure that the legal framework for bank resolution has been modernized to allow effective bank resolution. Following a request from the Nepalese authorities, IMF and DFID will provide technical assistance to revise BAFIA (starting in FY 2014). Increasing the transparency of the financial system 79. The authorities have taken important steps to promote the transparency of the financial sector. In particular, the authorities have demonstrated their commitment to act against money laundering and terrorist financing with the approval of three key ordinances (Legal Assistance Bill, Extradition Bill and Organized Crime Bill). The authorities have also decided to adopt—with support from the recently approved DFID technical assistance program—IFRS-compliant accounting standards, which will allow a more accurate picture of the performance of financial institutions and, thus, more effective supervision. 80. The prior action for the DPC reads as follows: The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Ordinance and Organized Crime Ordinance. This prior action is complemented by the following policy action under the DPC: the Institute of Chartered Accountants of Nepal (ICAN) has taken the decision to adopt IFRS in July 2015 for the financial sector. By December 2013, it is expected that Nepal retains
41 However, should a financial crisis break out it would be possible for the NRB Act amendments to be approved by Presidential ordinance.
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grey (or better) classification from FATF, and therefore avoids being on the FATF dark list that would have dire consequences for Nepal (that is, cut off from the international financial system42). The medium-term Government program will support the submission to Parliament of the three ordinances on Mutual Legal Assistance, Extradition and Organized Crime.
VI. OPERATION IMPLEMENTATION
A. Poverty and Social Impact 81. Nepal attained the first Millennium Development Goal (MDG), to halve extreme poverty, ahead of time. The percentage of people living below the international line for extreme poverty (people earning less than US$1.25 per day) has halved in only seven years. At this measure of poverty, the percentage of poor people declined from 53.1 percent in 2003/2004 to 24.8 percent in 2010/2011. With a higher poverty line (people earning less than US$2 per day), poverty declined by one quarter to currently 57.3 percent. Nepal's overall Gini coefficient has simultaneously declined from 0.41 to 0.35, a measure that shows poor segments of the population have been able to increase household incomes in relation to higher income groups. While general increases in household incomes were largely driven by remittances, a recent poverty diagnostic suggests that remittances had only a relatively small effect on the decline in absolute poverty, which was mainly driven by internal migration. The link between remittances and poverty reduction and Nepal’s drivers of poverty reduction in general still require further analysis, which is ongoing. Despite the progress in poverty reduction, Gross National Income (GNI) per capita remains low at US$742 (2012) and Nepal remains among the poorest countries in the world. 82. A potential financial sector crisis would have serious negative impacts on poverty and social development. The specific measures supported by this operation, and the medium-term Government program, are targeted at mitigating the impact of a potential financial sector crisis, in particular for households. They are therefore considered to have a substantial positive social impact. The proposed operation supports initial measures that safeguard banking system stability and give priority to individual depositors in the process of bank resolution. At the same time, it is well known that banking crises have large direct fiscal costs and even larger indirect costs in terms of foregone economic growth—costs that increase significantly as a result of non-action. As highlighted in the IMF Article IV report for 2012, the potential impacts of a financial crisis on Nepal could include fiscal costs of 23 percent of GDP and an output loss of 30 percent of GDP. DFID has calculated that a financial crisis of the potential magnitude in Nepal projected by IMF would result in about an additional two million people remaining below the poverty line over 10 years43. The financial sector reform program supported by this proposed operation is
42 If Nepal were to be blacklisted by FATF, Nepalese financial institutions would lose their credibility in the international financial system and, for example, commercial banks might not be able to approve letters of credit issued by Nepalese banks. This could sharply restrict Nepal’s international trade finance transactions, especially imports (which would have to be paid for in physical foreign currencies). In turn this would cripple economic activity and deprive the country of basic or essential commodities. It would also have a devastating impact on FDI and remittances, which would have to switch to informal channels. 43 DFID Nepal Business Case & Intervention Summary, Macroeconomic Reform Project, January 2013
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designed based on the principle of least cost solutions to addressing banking sector stress, with private shareholders and unsecured creditors bearing the brunt of the costs of bank failures. 83. Maintaining the stability of the weakened financial sector, a central aim of the proposed operation, is critical to safeguard household deposits. As highlighted by Figure 11, total deposits in commercial banks have more than doubled since 2007, from NPR 352 billion in FY 2007 to NPR 898 in January 2013. To safeguard these deposits and preserve the trust in the financial sector, the authorities decided to establish DCGT, protecting deposits up to NPR 200,000.
Figure 11: Total Credit and Deposits of Commercial Banks, FY 2007-FY 2013 Q2, NRB Data
Source: NRB
84. In addition, if Nepal were to be blacklisted by FATF, the impact on remittances inflows—and thus poverty—could be dramatic. Nepalese financial institutions would lose their credibility in the international financial system, which would likely severely curtail Nepal’s international financial transactions. It would have, in particular, a devastating impact on remittances, which would have to switch to informal channels. 85. Overall, the proposed measures would strengthen the performance of financial institutions, as well as increase the capacity of NRB to supervise the financial sector and resolve problematic financial institutions. In the medium-term, the poor and the vulnerable would benefit substantially as the health of financial institutions is regained, and growth would likely be accelerated with a more stable and efficient financial sector. At the same time, the poor’s access to financial services is expected to improve, again, benefitting the poor.
B. Environmental Aspects 86. Actions proposed under this operation (and the medium-term Government program) are not expected to have any negative effect on the environment.
190
290
390
490
590
690
790
890
NPR billions
Total Deposit Total Credit
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C. Implementation, Monitoring and Evaluation 87. The Ministry of Finance will be responsible for overall implementation, in close coordination with NRB. Progress towards the proposed outcome indicators is monitored regularly. The HLFSCC (chaired by the Minister of Finance and composed of NRB Governor, Chairman of the Insurance Board, Chairman of the Securities Board of Nepal, Finance Secretary, Deputy Governors, and the Executive Director of NRB Regulations Department—who acts as the Coordinator) has played a key role in the implementation and monitoring of reforms. MoF has recently strengthened its capacity to oversee the financial sector by forming the Financial Sector Management Division to complement and expand the capacity already in place in the Economic Affairs and Policy Analysis Division. 88. This development policy credit, which supports initial financial sector reforms and paves the way for the medium-term Government reform program, will be complemented by significant technical assistance. The appendix to the policy matrix in Annex 3 identifies the areas where technical assistance will be provided. DFID has provided short-term technical assistance to the preparation of the DPC and has recently approved a US$7.5 million equivalent technical assistance package to support the implementation of the medium-term Government financial sector program from 2013-2015. This DFID technical assistance, along with support from other donors, is critical for the implementation of the financial sector reform program initiated by the Government and supported by the Development Policy Credit.
D. Fiduciary Aspects 89. Public Expenditure Financial Accountability (PEFA) assessment. In 2007, the assessment of Nepal’s performance in Public Finance Management (PFM) was concluded. GoN initiated the process with the support of the World Bank and in collaboration with other development partners that assessed the performance of the country’s PFM systems in comparison with internationally accepted benchmarks. This assessment followed the Public Financial Management Performance Measurement Framework prepared by Public Expenditure Working Group44. The methodology examined the soundness of the PFM framework by rating 28+3 indicators (the three are related to donor practices) using specific criteria provided by the guidelines. The scope of the assessment covered fiscal and debt management, budget formulation, budget execution, internal controls, procurement, accounting and reporting, auditing, transparency, and external scrutiny based on specific criteria for ratings for each indicator provided in the methodological document contained in the Public Financial Management Performance Measurement Framework referred above, known as the Public Expenditure Financial Accountability (PEFA) Framework. 90. The assessment concluded that the financial management system has been well designed but unevenly implemented. It specified that the budget has become a credible policy tool, clearly linked to policies in some sectors, with a solid control of aggregate outturns and a reasonable control framework at the transaction level (notably for payroll). However, it noted
44 World Bank, IMF and Joint Donor Public Expenditure and Financial Accountability Unit, available at http://www.pefa.org/Documents.htm
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that there are many gaps in the control framework as well as significant implementation constraints, and large fiscal activities remain outside the scope of the central budget. Several weaknesses originate in the weak demand (from both Government and external stakeholders) for better budget information (financial and physical) and management. It further stated that the performance in terms of fiscal discipline is generally positive but remains threatened by four main weaknesses: (i) lack of monitoring of fiscal risks (including those related to donor funding) is creating significant uncertainties; (ii) poor capital budget preparation and implementation weakens GoN’s capacity to make the best use of existing fiscal space; (iii) weak sector strategies prevent GoN from managing the Medium Term Expenditure Framework (MTEF); and (iv) weak reconciliation of revenue accounts reduces available resources. 91. Public Financial Management Strategy, Phase I and follow up actions. Following the 2007 PEFA assessment, GoN (in collaboration with development partners) formulated a Development Action Plan that described the menu of actions for strengthening PFM systems and processes. In 2008, GoN formed a PFM Steering Committee (chaired by the Finance Secretary) and set up a PEFA Secretariat to drive the reform initiatives and coordinate PFM reform efforts. In 2009, with the support of the World Bank and DFID, GoN formulated a Public Financial Management Reform Program (PFMRP) Strategy, Phase I (2010-2013), with the objective of adopting a holistic Government-wide approach to PFM reforms encompassing both the institutional and technical aspects. The PFMRP strategy has two key priorities for the short term: (i) to deliver actions that yield effective results in strengthening the PFM system, in general, but, more specifically, on the ex-post side of PFM institutional and process strengthening; and (ii) to build the capacity of the PEFA Secretariat to lead the PEFA agenda and institutionalize the reform process. The PEFA Secretariat is now driving the PFM Reform Agenda. 92. As a result of continuing political instability, the Country Policy and Institutional Assessment (CPIA) score has been low, especially in sections dealing with public financial management and governance. While there are limits under the given political situation on how much the reform agenda can be accelerated, at the bureaucratic and technical level, a number of the core reforms are currently taking place under the support of Multi-Donor Trust Fund (MDTF) for Public Financial Management. Implementation of single treasury system of accounts has been a success story for Nepal, with the roll-out of the Treasury Single Account (TSA) in 60 districts covering almost 95 percent of expenditures and 98 percent of revenue, thus ensuring better cash management and timely reporting. The government plans to roll out the TSA in all 75 districts by the end of FY 2012/13. Similarly, the intervention at the Office of the Auditor General through the support of MDTF is also expected to improve the quality of audits focusing on risk-based auditing and performance auditing. The Bank is also working with the civil society organizations to create demand for better accountability. Regular dialogue is taking place between the Bank and the government on PFM agenda, discussed during the recently concluded Nepal Portfolio Performance Review and at PFM Steering Committees chaired by the Finance Secretary. Development partners have formed a PFM Thematic Group at the technical level to discuss and share knowledge and experiences with the objective of harmonizing development assistance to areas related to PFM. The Government also has committed to carry out the Repeater PEFA Assessment this financial year with the aim to complete the assessment in 2014. All these are likely to affect the result of the relevant CPIA score in the years to come.
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93. Budget information is available to the public as soon as the Finance Minister tables the fiscal year budget proposal for Parliament’s approval. The information available on the Ministry’s website represents aggregate budget numbers for the proposed year and includes budget numbers of the two previous years’ expenditures, as well as forward budget estimates for the next two years, along with functional and program/project budget lines. Upon Parliament’s approval of the budget, fiscal year budget numbers by geographical region are made available to the public. It should however be noted that this information is relatively technical and the population at large might not be able to effectively use the available information.
94. Increased demand for improved PFM from civil society. In addition to the Government’s focus on strengthening government public expenditure and financial management systems, there has also been an increasing interest in recent years on the part of non-executive branch state actors, civil society organizations and development partners to strengthen financial accountability, with the goal of improving use of public resources and obtaining value for money. With regard to transparency and information sharing, GoN promulgated the Right to Information Act in 2007, mandating the need for information sharing and transparency. GoN has been working closely with development partners in the design and implementation of PFM reforms initiatives at the country and sector level, particularly in two sector wide programs in the education and health sectors. Regular stakeholder meetings are held to review activity budgets, implementation status reports, and output flash reports.
E. Disbursement and Auditing 95. Disbursements. This operation is a standalone single-tranche credit of US$30 million equivalent. The credit proceeds will be made available to the Government upon credit effectiveness. Upon approval of the credit and notification by the World Bank of credit effectiveness, the Government will submit a request to the World Bank to withdraw the funds. The World Bank will disburse the proceeds of the credit into a treasury account at the request of MoF, which will be deposited in the Nepal Rastra Bank. The Government will transfer an amount in local currency but equivalent to amount disbursed by the World Bank to the budget (the general fund). GoN will confirm to the Bank, within 30 days, receipt of the tranche proceeds and its credit in the general fund. If after deposit in the NRB account, the proceeds of the credit are used for ineligible purposes (for example, to finance goods or services on the World Bank’s standard negative list), the World Bank will require the Government to return that amount to the account for use of eligible purposes. 96. IMF conducted an update in 2010 of a safeguards assessment that was carried out in 2002 of the Nepal Rastra Bank and concluded that NRB had made progress in recent years to strengthen its safeguards framework. However, it suggested that further improvements could be made in some areas, notably the involvement of an audit partner or firm with experience in auditing central banks or larger financial institutions for the external audit; enhancement of transparency by resolving matters raised by the auditors; improving financial reporting and control systems; and modernization in areas such as reserves and currency management. The update assessment noted that most recommendations made in the 2002 assessment have been complied with. However, the following actions remain outstanding and require serious consideration: (i) enhance the role of the Audit Committee and its independence by changes to the composition of the Audit Committee and indicate appropriate requirements for
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membership of the Audit Committee (this could be addressed through the amendment of the NRB Act); (ii) strengthen the internal controls, accounting procedures, and internal auditing practices by forming a task force chaired by the Audit Committee Chair; and (iii) prepare a written reconciliation of program data with accounting records for all test dates under the Poverty Reduction and Growth Facility arrangement. NRB is currently addressing these recommendations in the context of the amendments to the NRB Act. While amending the NRB Act to allow more effective bank resolution, NRB is also making broader amendments to strengthen the Act. 97. The latest audit report of NRB for FY 2011/12 was a qualified report, and all preceding audit reports were also qualified. Key audit observations are related to the following: (i) non-compliance with NRB Act 2002, and (ii) non-compliance with IFRS. NRB has indicated that it is fully committed to address the observations included in the audit reports. 98. No audit will be required under DPC. The Government will maintain accounts and records showing that loan disbursements were made in accordance with provisions of the Credit Agreement. Within thirty days of remittance of funds by the World Bank, the Government will provide a confirmation to the World Bank that the funds have been received by NRB and that these funds are available for financing budget expenditures. The IMF Safeguard Assessment of NRB indicates that there are no strong reasons for the World Bank to request an audit of the deposit account or to require additional safeguard measures, as permitted under Operational Policy (OP) 8.60. As such, no audit will be required under the DPC.
F. Risks and Risk Mitigation 99. The main risks identified are political instability and reform implementation risks. Political uncertainty has become the norm in post-conflict Nepal, characterized by frequent changes in Government. The dissolution of the Constituent Assembly in May 2012 has brought additional uncertainty although the recent formation of the pre-election Government augurs well for the orderly conduct of elections and formation of a democratically elected Government by end-2013. It should be noted that Nepal stands out as a country that has achieved stable economic performance and good development results despite these political uncertainties. The speed of implementation of the medium-term Government reform program could be slowed down depending on the prevailing political environment. However, Nepal has proven in the past that it can generate consensus on financial sector issues at critical times as in the case of the recent approval on three key ordinances on AML/CFT. 100. Changes in Government might affect policy dialogue continuity. To mitigate this situation, to the extent possible, delivery of prior actions was discussed with economic leadership across the major political parties so that there is wide ownership and continuity of policy agreement even if there is Government change (as has recently happened). While political risks to implementation of the Government’s medium-term program for the financial sector are substantial, this operation takes the view that such risks are best managed through continued active engagement, coupled with a strong technical assistance program (to be mostly supported by DFID).
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101. Reform implementation risks are high in the present environment, but mostly affect the medium-term Government program. The financial sector reform program initiated by the Government, whose initial steps are supported by the Development Policy Credit, may affect vested interests, which could trigger resistance. Capacity to implement reforms is low and will therefore be supported by intensive technical assistance. The medium-term Government reform program includes complex and sensitive reforms. The diagnostics will provide information on the exact financial situation of the institutions under review. If the diagnostics identify under-capitalized institutions, NRB will need to request shareholders to recapitalize their respective institutions or to initiate liquidation. It will be critical for NRB to be able to enforce resolution actions. While the authorities have stressed their commitment to divest from NBL and find a reputable strategic partner (while maintaining RBB as a fully state-owned bank), it is also likely that this decision will face resistance, notably from the powerful NBL unions and/or some NBL shareholders. A detailed risk analysis for each policy action of the financial sector reform program is included in Annex 4. 102. It is recognized that the present political environment in Nepal complicates the reform process (in particular for legal reforms, given the absence of a Parliament). However, the vulnerability of the financial sector is such that urgent measures need to be taken. In addition, the Nepalese authorities have demonstrated during the preparation of the DPC that they are able to take critical decisions in an uncertain political environment (such as the approval of the recapitalization plans for NBL and RBB and subsequently making large capital injections into the two banks, as well as the closure of distressed financial institutions, and the decision to proceed with in-depth diagnostics). Implementation risks for this DPC are mitigated through demonstrated commitment at the highest levels of the Government and bureaucracy, and through close alignment with IMF and DFID, as well as through an extended preparation phase with continued policy dialogue, which has allowed the authorities to complete the prior actions.
103. The proposed operation (stand-alone, single tranche DPC) has been designed in such a way to mitigate political instability and reform implementation risks. As explained in paragraph 2, the actions supported under the proposed DPC form part of a broader, medium-term Government financial sector reform program. Sufficient overall progress towards the objectives of the medium-term program would allow the Bank to provide additional support in the form of a second DPC within the next 18 months or so. This two-stage approach allows the timely acknowledgment of the important steps already taken by the Government to preempt a possible financial crisis and strengthen financial sector stability. It also allows the continuation of a deepening dialogue on broader reforms that could be supported by a follow-up operation when conditions warrant.
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ANNEX 1: LETTER OF DEVELOPMENT POLICY
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56
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58
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ANNEX 2: DPC POLICY MATRIX
Development Policy Credit Policy actions Prior actions are bolded45
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
Formulation of a financial sector development strategy The Government has taken a decision to prepare a comprehensive strategy to support the development of an inclusive financial sector
No comprehensive financial sector development strategy
NRB and MoF have initiated technical consultations with stakeholders for the elaboration of the financial sector development strategy for Nepal and a roadmap has been developed
Restructuring of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) The first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital
RBB CAR: - 21.79 percent (Mid-January 2012)
RBB CAR is positive and RBB’s performance (including governance) is monitored by MoF Financial Sector Management Division and NRB
The first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (i) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (ii) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of NPR 1 billion; and (iii) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion
NBL CAR: - 8.53 percent (Mid-January 2012)
NBL CAR is positive and NBL’s performance (including governance) is monitored by the MoF Financial Sector Management Division and NRB
Assessment of the condition of class A, B and C financial institutions and potential restructuring NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50% of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed
Comprehensive information on number of problem institutions not available
The NRB program of in-depth diagnostics has been initiated to provide comprehensive information on problem institutions
Strengthening institutional arrangements to support the bank restructuring process NRB has established a Bank Resolution Unit and approved a No bank resolution The NRB Bank Resolution Unit operates and
45 The disbursement of the DPC is based on the completion of the prior actions (in bold).
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Development Policy Credit Policy actions Prior actions are bolded45
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
bank resolution manual unit and no bank resolution manual
undertakes bank resolution
NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector The moratorium on new license applications for Class A, B and C financial institutions, as defined in BAFIA, and evidenced by no acceptance of banking license applications in 2012, has been maintained
199 financial institutions (Class A, B and C) in January 2012
Consolidation of the financial sector underway through a decrease in number of financial institutions (down to 175 institutions, for Class A, B and C) See above indicator
The draft Bill on Deposit and Credit Guarantee Trust (DCGT) has been endorsed by the Ministry of Finance for submission to Cabinet
No legal and operational framework for deposit insurance
The legal and operational framework for deposit insurance is ready for implementation (pending legislative approval)
Strengthening the legal and regulatory framework for effective bank resolution Amendments to the NRB Act providing NRB with modernized tools for bank resolution have been approved by NRB Board and further endorsed by Ministry of Finance
Incomplete legal framework for bank resolution
The legal framework for effective bank resolution is finalized (pending legislative approval)
Increasing transparency of the financial system ICAN has taken the decision to adopt IFRS in July 2015 for the financial sector
Decision to adopt IFRS for the financial sector in 2013—which is premature (no capacity)
The date agreed to adopt IFRS for the financial sector reflects the time required to build the capacity of the stakeholders to implement IFRS
The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Bill Ordinance and Organized Crime Ordinance
Nepal threatened with dark grey (or worse) classification by FATF
Nepal retains grey or better FATF classification which allows normal external financial relations (trade finance, remittance inflows and Foreign Direct Investment)
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ANNEX 3: SHORT- AND MEDIUM-TERM GOVERNMENT PROGRAM
Development Policy Credit Policy actions Prior actions are bolded46
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
Medium-Term Government Reform Program
Medium-Term Government Program: Expected Outcomes
Formulation of a financial sector development strategy Formulation of a financial sector development strategy The Government has taken a decision to prepare a comprehensive strategy to support the development of an inclusive financial sector
No comprehensive financial sector development strategy
NRB and MoF have initiated technical consultations with stakeholders for the elaboration of the financial sector development strategy for Nepal and a roadmap has been developed
The Government has approved the financial sector development strategy
Financial sector development strategy under implementation as per its action plan
Restructuring of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) Restructuring of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB)
The first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital
RBB CAR: - 21.79 percent (Mid-January 2012)
RBB CAR is positive and RBB’s performance (including governance) is monitored by MoF Financial Sector Management Division and NRB
Following a diagnostic audit, RBB remains in compliance with its approved recapitalization plan
RBB is close to compliance with regulatory capital adequacy requirements
The first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (i) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (ii) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of
NBL CAR: - 8.53 percent (Mid-January 2012)
NBL CAR is positive and NBL’s performance (including governance) is monitored by MoF Financial Sector Management Division and NRB
Following a diagnostic audit, NBL remains in compliance with its approved recapitalization plan The Government has launched the tender process to transfer control of NBL to a reputable strategic investor
NBL CAR is close to compliance with regulatory capital adequacy requirements A reputable strategic investor has been identified to acquire control of NBL
46 The disbursement of the DPC is based on the completion of the prior actions (in bold).
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Development Policy Credit Policy actions Prior actions are bolded46
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
Medium-Term Government Reform Program
Medium-Term Government Program: Expected Outcomes
NPR 1 billion; and (iii) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion Assessment of the condition of class A, B and C financial institutions and potential restructuring
Assessment of the condition of class A, B and C financial institutions and potential restructuring
NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50% of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed
Comprehensive information on number of problem institutions not available
The NRB program of in-depth diagnostics has been initiated to provide comprehensive information on problem institutions
Diagnostic audits of selected financial institutions have been completed; and, resolution program implemented for undercapitalized institutions, if any
The problem institutions identified as a result of the diagnostic audits are either fully recapitalized or being resolved using supervisory powers
Strengthening institutional arrangements to support the bank restructuring process Strengthening institutional arrangements to support the bank restructuring process
NRB has established a Bank Resolution Unit and approved a bank resolution manual
No bank resolution unit and no bank resolution manual
The NRB Bank Resolution Unit operates and undertakes bank resolution
NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector The moratorium on new license
199 financial institutions in January 2012 (Class A, B and C)
Consolidation of the financial sector underway through a decrease in number of financial institutions (down to 175 institutions, for Class A, B and C)
The moratorium on new licenses for class A, B and C institutions is maintained
The consolidation of the financial sector has progressed significantly, with an important decrease in the number of financial institutions.
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Development Policy Credit Policy actions Prior actions are bolded46
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
Medium-Term Government Reform Program
Medium-Term Government Program: Expected Outcomes
applications for Class A, B and C financial institutions, as defined in BAFIA, and evidenced by no acceptance of banking license applications in 2012, has been maintained The draft Bill on Deposit and Credit Guarantee Trust (DCGT) has been endorsed by the Ministry of Finance for submission to Cabinet
No legal and operational framework for deposit insurance
The legal and operational framework for deposit insurance is ready for implementation (pending legislative approval)
DCGT Act submitted to Parliament Regulations on criteria for setting the deposit insurance coverage and the annual guarantee fee have been issued The DCGT Board has developed payout procedures for effective deposit compensation. The DCGT Board has approved the Deposit Insurance Institutional Development Plan, as well as its organizational structure (with competitive recruitment of staff)
The legal and operational framework for deposit insurance is in place
Strengthening the legal and regulatory framework for effective bank resolution Strengthening the legal and regulatory framework for effective bank resolution
Amendments to the NRB Act providing NRB with modernized tools for bank
Incomplete legal framework for bank resolution
The legal framework for effective bank resolution is finalized (pending legislative
The amendments to the NRB Act and conforming amendments to other
The legal framework for bank resolution has been modernized to allow effective
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Development Policy Credit Policy actions Prior actions are bolded46
Baseline Indicator 2012
Outcome Indicators for DPC (End of Program: December 2013)
Medium-Term Government Reform Program
Medium-Term Government Program: Expected Outcomes
resolution have been approved by NRB Board and further endorsed by the Ministry of Finance
approval)
legislation have been submitted to Parliament and necessary directives for their implementation have been finalized
bank resolution
Increasing transparency of the financial system Increasing transparency of the financial system ICAN has taken the decision to adopt IFRS in July 2015 for the financial sector
Decision to adopt IFRS for the financial sector in 2013 – which is premature (no capacity)
The date agreed to adopt IFRS for the financial sector reflects the time required to build the capacity of the stakeholders to implement IFRS
The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Ordinance and Organized Crime Ordinance
Nepal threatened with dark grey (or worse) classification by FATF
Nepal retains grey or better FATF classification which allows normal external financial relations (trade finance, remittance inflows and Foreign Direct Investment)
Submission to Parliament of the three ordinances on Mutual Legal Assistance, Extradition and Organized Crime
Nepal retrains grey or better FATF classification
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Appendix: Technical Assistance Program to Short- and Medium-Term Government Program
Development Policy Credit Policy actions Prior actions are bolded
Medium-Term Government Reform Program Technical Assistance
Formulation of a financial sector development strategy The Government has taken a decision to prepare a comprehensive strategy to support the development of an inclusive financial sector
The Government has approved the financial sector development strategy.
Technical assistance to finance sub-sectoral experts and DFID assistance to provide coordination support for preparation of the strategy.
Restructuring of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) The first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital
Following a diagnostic audit, RBB remains in compliance with its approved recapitalization plan
Diagnostic audit financed under DFID assistance program for NRB.
The first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (i) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (ii) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of NPR 1 billion; and (iii) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion
Following a diagnostic audit, NBL remains in compliance with its approved recapitalization plan The Government has launched the tender process to transfer control of NBL to a reputable strategic investor
Diagnostic audit financed under DFID assistance program for NRB. Financial and legal advisers to assist with divestiture under DFID assistance program for MoF.
Assessment of the condition of class A, B and C financial institutions and potential restructuring NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50% of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed
Diagnostic audits of selected financial institutions have been completed; and, resolution program implemented for undercapitalized institutions, if any
Diagnostic audits for up to 60 FIs financed under DFID assistance program for NRB. Technical assistance to strengthen capacity of bank resolution at NRB.
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Development Policy Credit Policy actions Prior actions are bolded
Medium-Term Government Reform Program Technical Assistance
Strengthening institutional arrangements to support the bank restructuring process NRB has established a Bank Resolution Unit and approved a bank resolution manual
FIRST and DFID technical assistance to support implementation of bank resolution manual and DFID technical assistance for capacity building for the Bank Resolution Unit.
NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector The moratorium on new license applications for Class A, B and C financial institutions, as defined in BAFIA, and evidenced by no acceptance of banking license applications in 2012, has been maintained
The moratorium on new licenses for class A, B and C institutions is maintained
The draft Bill on Deposit and Credit Guarantee Trust (DCGT) has been endorsed by the Ministry of Finance for submission to Cabinet
DCGT Act submitted to Parliament Regulations on criteria for setting the deposit insurance coverage and the annual guarantee fee have been issued The DCGT Board has developed payout procedures for effective deposit compensation. The DCGT Board has approved the Deposit Insurance Institutional Development Plan, as well as its organizational structure (with competitive recruitment of staff)
DFID technical assistance for the development of relevant regulations, procedures and institutional development plan. DFID technical assistance for DCGC capacity building and to finance design and purchase of insured deposit payout hardware and software.
Strengthening the legal and regulatory framework for effective bank resolution Amendments to the NRB Act providing NRB The amendments to the NRB Act and conforming Technical assistance to undertake comprehensive
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Development Policy Credit Policy actions Prior actions are bolded
Medium-Term Government Reform Program Technical Assistance
with modernized tools for bank resolution have been approved by NRB Board and further endorsed by the Ministry of Finance
amendments to other legislation have been submitted to Parliament and necessary directives for their implementation have been finalized
review of legal framework for bank resolution to ensure consistency DFID technical assistance to prepare/amend implementing regulations. In coordination with IMF Technical Assistance to NRB
Increasing the transparency of the financial system ICAN has taken the decision to adopt IFRS in July 2015 for the financial sector
DFID technical assistance and financing to provide IFRS training for regulators and CPAs and for the adaption of regulations and systems for transition to IFRS
The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Ordinance and Organized Crime Ordinance
Submission to Parliament of the ordinances on Mutual Legal Assistance, Extradition and Organized Crime
Technical assistance to strengthen capacity of Financial Intelligence Unit at NRB and Department of Money Laundering Investigation at MoF
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ANNEX 4: RISK ANALYSIS OF FINANCIAL SECTOR REFORM PROGRAM
Development Policy Credit Policy actions Prior actions are bolded47
Medium-Term Government Reform Program
Risks Mitigation Strategy
Formulation of a financial sector development strategy The Government has taken a decision to prepare a comprehensive strategy to support the development of an inclusive financial sector
The Government has approved the financial sector development strategy
The risks relate to the medium term Government program.
The two main risks are: (i) the strategy is developed with limited inputs from non-Government stakeholders (that is, financial sector institutions) which could affect its strategic relevance and negatively impact its implementation, and (ii) the strategy is developed hastily with limited background analysis which would affect its overall quality and relevance
The mitigation strategy is twofold: (i) technical assistance will be provided (by DFID and possibly FIRST) to help ensure broad consultation and participation, as well as background analysis on key issues. In addition, the FSAP request by the authorities should also ensure a strong analytical background to the strategy.
Risk rating = Moderate
Restructuring of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) The first phase of a time bound recapitalization plan for RBB has been approved by NRB and completed, including a cash injection from GoN of NPR 4.32 billion and the conversion of a loan of NPR 3 billion from GoN into capital
Following a diagnostic audit, RBB remains in compliance with its approved recapitalization plan
The risks relate to the medium term Government program. The two main risks are (i) lower than expected retained earnings, which would delay RBB reaching CAR regulatory compliance, and (ii) poor governance which would affect the operational and financial performance of RBB.
The implementation of RBB recapitalization plan will be closely monitored by the Nepalese authorities (NRB and MOF) as well as by development partners (World Bank, DFID and IMF) to ensure that the plan is on track. In addition, DFID will provide technical assistance to the Ministry of Finance Financial Sector Management Division to strengthen its capacity to monitor state controlled banks performance (including their governance).
The governance of state controlled banks has
47 The disbursement of the DPC is based on the completion of the prior actions (in bold).
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Development Policy Credit Policy actions Prior actions are bolded47
Medium-Term Government Reform Program
Risks Mitigation Strategy
markedly improved since 2003. The oversight of MoF (as owner) and NRB (as supervisor) over RBB should ensure that sound governance is maintained. Risk rating = Substantial
The first phase of a time bound recapitalization plan for NBL has been approved by NRB and completed, including: (i) a cash subscription from GoN of NPR 1.37 billion in advance payment for rights offering shares, (ii) the publication of a notice for tenders from the public for the sale of non-banking assets of NBL with an estimated value of NPR 1 billion; and (iii) the initiation of a rights offering for private shareholders to purchase NBL shares with a value of up to NPR 2.2 billion
Following a diagnostic audit, NBL remains in compliance with its approved recapitalization plan The Government has launched the tender process to transfer control of NBL to a reputable strategic investor
The risks relate to the medium term Government program. The two main risks are: (i) lower than expected profits from sale of Non Banking Assets and retained earnings, which would delay NBL reaching CAR regulatory compliance, and (ii) delays in identifying a strategic investor for NBL which could affect NBL governance and performance
The mitigation strategy described above for RBB also applies to NBL.
In addition, DFID will provide technical assistance for the identification of a reputable strategic investor for NBL. Progress towards identification of the strategic investor for NBL could be a critical prior action for a follow up DPC. Risk rating = High
Assessment of the condition of class A, B and C financial institutions and potential restructuring NRB has approved a program of in-depth diagnostics for a list of financial institutions whose aggregate assets represent over 50% of the total banking assets in Nepal, including approval of the terms of reference of the diagnostic and the initial list of the institutions on which diagnostics will be performed
Diagnostic audits of selected financial institutions have been completed; and, resolution program implemented for undercapitalized institutions, if any
The risks relate to the medium term Government program. The main risks are the following: (i) poor audit quality and/or collusion between auditors and financial institutions, and (ii) delays in implementing resolution program for undercapitalized institutions because of political interference, and (iii) public cost of recapitalizing financial institutions
The mitigation strategy is as follows: (i) The Terms of Reference for the audits have been agreed between NRB, the World Bank and DFID. The TOR include the requirement for a certification from internationally recognized auditing firms. The procurement of the auditors will be undertaken by DFID. (ii) Implementation of resolution programs for under-capitalized institutions will be closely monitored by the World Bank, DFID (which will provide technical
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Development Policy Credit Policy actions Prior actions are bolded47
Medium-Term Government Reform Program
Risks Mitigation Strategy
deemed systemic assistance on bank resolution) and IMF (which provides technical assistance on banking supervision). (iii) If public recapitalization of systemic banks is deemed necessary, the World Bank, DFID and IMF will closely analyze the costs and devise a financing strategy with the Nepalese authorities.
Risk rating = Substantial
Strengthening institutional arrangements to support the bank restructuring process NRB has established a Bank Resolution Unit and approved a bank resolution manual
Achieved.
[An associated risk relates to the approval of the NRB Act amendments and the revision of BAFIA to allow for more effective bank resolution—see below]
Risk rating = Low
NRB has, in May 2011 and October 2012, issued, respectively, a bylaw and amendments to the bylaw, as provided for under the NRB Act, to facilitate mergers of financial institutions so as to consolidate and strengthen the financial sector The moratorium on new license applications for Class A, B and C financial institutions, as defined in BAFIA, and
The moratorium on new licenses for class A, B and C institutions is maintained
The risk would be that the Nepalese authorities no longer support the consolidation of the financial sector, which is unlikely. There is a consensus within the authorities and financial sector stakeholders that the sector needs to be consolidated and that its structure needs to be reviewed.
The financial sector strategy (with inputs from the FSAP) will provide a roadmap on how to consolidate the financial sector, as well as review its structure.
Risk rating = Low
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Development Policy Credit Policy actions Prior actions are bolded47
Medium-Term Government Reform Program
Risks Mitigation Strategy
evidenced by no acceptance of banking license applications in 2012, has been maintained The draft Bill on Deposit and Credit Guarantee Trust (DCGT) has been endorsed by the Ministry of Finance for submission to Cabinet
DCGT Act submitted to Parliament Regulations on criteria for setting the deposit insurance coverage and the annual guarantee fee have been issued The DCGT Board has developed payout procedures for effective deposit compensation. The DCGT Board has approved the Deposit Insurance Institutional Development Plan, as well as its organizational structure (with competitive recruitment of staff)
The risks relate to the medium term Government program.
The main risks relate to: (i) the approval of the DCGT Act by the Parliament, (ii) the current limited capacity of DCGC, and (iii) potential political interference in the governance and operations of DCGC (with interference, for example, in the recruitment of staff). Another risk relates to delays in organizing elections for the Constituent Assembly. The recently appointed Government committed to organize the elections before December 2013.
The DCGT bill is not controversial and Parliament approval should be straightforward. DFID will provide technical assistance to strengthen the capacity of DCGC/DCGT and to develop the required regulations/operational procedures, as well as software and hardware. Technical assistance will also be provided to the MOF Financial Sector Management Division to monitor the performance and governance of DCGC/DCGT. The main risk, following the mitigation measures, relates to the governance of DCGC/DCGT.
There is no mitigation strategy, under this operation, for possible delays to organize the elections for the Constituent Assembly. Risk rating = Substantial
Strengthening the legal and regulatory framework for effective bank resolution Amendments to the NRB Act providing NRB with modernized tools for bank resolution have been approved by NRB Board and further endorsed by Ministry of Finance
The amendments to the NRB Act and conforming amendments to other legislation have been submitted to Parliament and necessary directives for their implementation have been finalized
The risks relate to the medium-term Government program.
The main risks relate to: (i) the approval of the amendments to the NRB Act by Parliament, and (ii) the revisions of BAFIA
The amendments to the NRB Act are not controversial and Parliament approval should be straightforward. The revision of BAFIA is more controversial, as it could also affect the structure of the financial sector (a possible revision of the current classifications of financial institutions). The financial sector development strategy should help build a consensus on the future structure of the Nepalese financial sector, and therefore on
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Development Policy Credit Policy actions Prior actions are bolded47
Medium-Term Government Reform Program
Risks Mitigation Strategy
The risk described above of delays in organizing elections for the Constituent Assembly also applies.
the required revisions to BAFIA.
Risk rating = Substantial
Increasing transparency of the financial system ICAN has taken the decision to adopt IFRS in July 2015 for the financial sector
Achieved. Risk rating = Low
The President of Nepal has promulgated the Mutual Legal Assistance Ordinance, Extradition Ordinance and Organized Crime Ordinance
Submission to Parliament of the ordinances on Mutual Legal Assistance, Extradition and Organized Crime
The risks relate to the medium-term Government program.
The risk relates to the approval by Parliament of the three ordinances. The risk described above of delays in organizing elections for the Constituent Assembly also applies.
The importance of avoiding a dark grey or black listing of Nepal by the Financial Action Task Force (FATF) is recognized by all political parties and financial stakeholders in Nepal—as such dark grey/blacklisting would cut Nepal from the international financial system. It is therefore expected that the Parliament will approve the three ordinances.
Risk rating = Moderate
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ANNEX 5: IMF ASSESSMENT LETTER
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ANNEX 6: NEPAL AT A GLANCE
Key Development Indicators South Low
Nepal Asia income(2010)
Population, mid-year (millions) 30.0 1,633 796Surface area (thousand sq. km) 147 5,131 15,551Population growth (%) 1.8 1.4 2.1Urban population (% of total population) 18 30 28
GNI (Atlas method, US$ billions) 14.5 1,920 421GNI per capita (Atlas method, US$) 490 1,176 528GNI per capita (PPP, international $) 1,210 3,124 1,307
GDP growth (%) 4.6 8.1 5.9GDP per capita growth (%) 2.7 6.6 3.7
(most recent estimate, 2004–2010)
Poverty headcount ratio at $1.25 a day (PPP, %) 25 36 ..Poverty headcount ratio at $2.00 a day (PPP, %) 57 71 ..Life expectancy at birth (years) 68 65 59Infant mortality (per 1,000 live births) 41 52 70Child malnutrition (% of children under 5) 39 33 23
Adult literacy, male (% of ages 15 and older) 72 73 69Adult literacy, female (% of ages 15 and older) 47 50 54Gross primary enrollment, male (% of age group) .. 113 108Gross primary enrollment, female (% of age group) .. 107 101
Access to an improved water source (% of population) 89 90 65Access to improved sanitation facilities (% of population) 31 38 37
Net Aid Flows 1980 1990 2000 2010
(US$ millions)Net ODA and official aid 160 423 386 821Top 3 donors (in 2010): United Kingdom 16 26 23 105 Japan 24 55 100 81 United States 8 17 16 52
Aid (% of GNI) 8.2 11.6 7.0 5.2Aid per capita (US$) 11 22 16 27
Long-Term Economic Trends
Consumer prices (annual % change) 9.6 9.9 3.3 9.6GDP implicit deflator (annual % change) 7.6 10.7 4.5 13.4
Exchange rate (annual average, local per US$) 12.0 28.5 69.1 74.5Terms of trade index (2000 = 100) .. .. .. ..
1980–90 1990–2000 2000–10
Population, mid-year (millions) 15.0 19.1 24.4 30.0 2.4 2.5 2.1GDP (US$ millions) 1,946 3,628 5,494 15,722 4.6 4.9 3.8
Agriculture 61.8 51.6 40.8 36.1 4.0 2.5 3.2Industry 11.9 16.2 22.1 15.4 8.7 7.1 2.5 Manufacturing 4.3 6.1 9.4 6.6 9.3 8.9 0.7Services 26.3 32.1 37.0 48.5 3.9 6.2 4.4
Household final consumption expenditure 82.2 84.3 75.9 82.0 .. .. 4.3General gov't final consumption expenditure 6.7 8.7 8.9 10.6 .. .. 5.7Gross capital formation 18.3 18.1 24.3 34.7 .. .. 10.2
Exports of goods and services 11.5 10.5 23.3 9.8 .. .. -1.6Imports of goods and services 18.7 21.7 32.4 37.1 .. .. 6.1Gross savings 13.6 10.1 30.0 23.3
Note: Figures in italics are for years other than those specified. .. indicates data are not available.
Development Economics, Development Data Group (DECDG).
(average annual growth %)
(% of GDP)
10 5 0 5 100-4
15-19
30-34
45-49
60-64
75-79
percent of total population
Age distribution, 2010
Male Female
0
50
100
150
1990 1995 2000 2010
Nepa l South Asia
Under-5 mortality rate (per 1,000)
-4
-2
0
2
4
6
8
10
95 05
GDP GDP per capita
Growth of GDP and GDP per capita (%)
77
Balance of Payments and Trade 2000 2010
(US$ millions)Total merchandise exports (fob) 971 820Total merchandise imports (cif) 1,713 5,082Net trade in goods and services -658 7,481
Current account balance 173 11,273 as a % of GDP 3.2 71.7
Workers' remittances and compensation of employees (receipts) 111 3,468
Reserves, including gold 953 2,287
Central Government Finance
(% of GDP)Current revenue (including grants) 12.2 0.0 Tax revenue 8.7 0.0Current expenditure 9.4 0.0
Technology and Infrastructure 2000 2010Overall surplus/deficit -3.3 0.0
Paved roads (% of total) .. 53.9Highest marginal tax rate (%) Fixed line and mobile phone Individual .. .. subscribers (per 100 people) 1 34 Corporate .. .. High technology exports
(% of manufactured exports) 0.0 0.6External Debt and Resource Flows
Environment(US$ millions)Total debt outstanding and disbursed 2,867 3,702 Agricultural land (% of land area) 29 30Total debt service 102 187 Forest area (% of land area) 27.2 25.4Debt relief (HIPC, MDRI) – – Terrestrial protected areas (% of land area) 17.0 17.0
Total debt (% of GDP) 52.2 23.5 Freshwater resources per capita (cu. meters) 7,754 6,734Total debt service (% of exports) 5.4 3.6 Freshwater withdrawal (% of internal resources) 5.1 4.7
Foreign direct investment (net inflows) 0 88 CO2 emissions per capita (mt) 0.13 0.12Portfolio equity (net inflows) 0 0
GDP per unit of energy use (2005 PPP $ per kg of oil equivalent) 2.7 3.1
Energy use per capita (kg of oil equivalent) 332 338
World Bank Group portfolio 2000 2010
(US$ millions)
IBRD Total debt outstanding and disbursed 0 0 Disbursements 0 0 Principal repayments 0 0 Interest payments 0 0
IDA Total debt outstanding and disbursed 1,132 1,426 Disbursements 49 11
Private Sector Development 2000 2011 Total debt service 24 54
Time required to start a business (days) – 29 IFC (fiscal year)Cost to start a business (% of GNI per capita) – 37.4 Total disbursed and outstanding portfolio 75 32Time required to register property (days) – 5 of which IFC own account 50 28
Disbursements for IFC own account 12 0Ranked as a major constraint to business 2000 2010 Portfolio sales, prepayments and (% of managers surveyed who agreed) repayments for IFC own account 0 7 n.a. .. .. n.a. .. .. MIGA
Gross exposure 33 29Stock market capitalization (% of GDP) 14.4 30.8 New guarantees 0 0Bank capital to asset ratio (%) .. ..
Note: Figures in italics are for years other than those specified. 4/5/12.. indicates data are not available. – indicates observation is not applicable.
Development Economics, Development Data Group (DECDG).
0 25 50 75 100
Control of corruption
Rule of law
Regulatory quality
Polit ical stability andabsence of violence
Voice and accountability
Country's percentile rank (0-100)higher values imply better ratings
2010
2000
Governance indicators, 2000 and 2010
Source: Worldw ide Governance Indicators (www.govindicators.org)
IBRD, 0
IDA, 1,426
IMF, 114
Other multi-lateral, 1,724
Bilateral, 374
Private, 3Short-term, 61
Composition of total external debt, 2010
US$ millions
78
Millennium Development Goals Nepal
With selected targets to achieve between 1990 and 2015(estimate closest to date shown, +/- 2 years)
Goal 1: halve the rates for extreme poverty and malnutrition 1990 1995 2000 2010 Poverty headcount ratio at $1.25 a day (PPP, % of population) .. 68.0 .. 24.8 Poverty headcount ratio at national poverty line (% of population) .. 41.8 .. .. Share of income or consumption to the poorest qunitile (%) .. 7.9 .. 8.3 Prevalence of malnutrition (% of children under 5) .. 44.1 43.0 38.8
Goal 2: ensure that children are able to complete primary schooling Primary school enrollment (net, %) 65 .. 71 .. Primary completion rate (% of relevant age group) 51 .. 66 .. Secondary school enrollment (gross, %) 32 40 35 44 Youth literacy rate (% of people ages 15-24) 50 .. 70 82
Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education (%) 57 68 77 .. Women employed in the nonagricultural sector (% of nonagricultural employment) .. .. 14 .. Proportion of seats held by women in national parliament (%) 6 3 6 33
Goal 4: reduce under-5 mortality by two-thirds Under-5 mortality rate (per 1,000) 141 110 84 50 Infant mortality rate (per 1,000 live births) 97 79 64 41 Measles immunization (proportion of one-year olds immunized, %) 57 56 77 86
Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio (modeled estimate, per 100,000 live births) 870 700 550 380 Births attended by skilled health staff (% of total) 7 9 12 19 Contraceptive prevalence (% of women ages 15-49) 24 29 37 48
Goal 6: halt and begin to reverse the spread of HIV/AIDS and other major diseases Prevalence of HIV (% of population ages 15-49) 0.2 0.4 0.5 0.4 Incidence of tuberculosis (per 100,000 people) 163 163 163 163 Tuberculosis case detection rate (%, all forms) 33 56 74 72
Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source (% of population) 76 80 83 89 Access to improved sanitation facilities (% of population) 10 15 20 31 Forest area (% of total land area) 33.7 .. 27.2 25.4 Terrestrial protected areas (% of land area) 7.7 14.0 17.0 17.0 CO2 emissions (metric tons per capita) 0.0 0.1 0.1 0.1 GDP per unit of energy use (constant 2005 PPP $ per kg of oil equivalent) 2.3 2.6 2.7 3.1
Goal 8: develop a global partnership for development Telephone mainlines (per 100 people) 0.3 0.4 1.1 2.8 Mobile phone subscribers (per 100 people) 0.0 0.0 0.0 30.7 Internet users (per 100 people) 0.0 0.0 0.2 7.9 Computer users (per 100 people) .. .. .. ..
Note: Figures in italics are for years other than those specified. .. indicates data are not available. 4/5/12
Development Economics, Development Data Group (DECDG).
Nepal
0
25
50
75
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2000 2005 2010
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Nepa l South Asia
Measles immunization (% of 1-year olds)
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NEPAL
This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.
0 25 50 75
0 25 50 75 Miles
100 Kilometers
IBRD 33455
SEPTEMBER 2004
NEPALSELECTED CITIES AND TOWNS
ZONE CAPITALS
NATIONAL CAPITAL
RIVERS
MAIN ROADS
RAILROADS
ZONE BOUNDARIES
INTERNATIONAL BOUNDARIES