Four Problems in Credit Market of Nepal

Every year, the Canada-based think tank, Fraser Institute, publishes the Economic Freedom of the World Report. Samriddhi, The Prosperity Foundation releases the report in Nepal as the country partner. This time around, Samriddhi Foundation also undertook a Country Audit process to test how truly the numbers in the Index reflect the attributes of the economic sector of Nepal. The process further studies how the economic freedom of the Nepalese people has been restrained.

Out of the five major components and forty-two sub-components of economic freedom, Nepal score a 7.28 (out of 10) in the Credit Market Regulation sub-category under the category “Regulation”. The country audit process has identified the following 4 problems in the credit market sector as the major challenges to instating economic freedom in Nepal.

  1. The first major problem in Nepalese banking sector is low public participation. A large proportion of the people do not have access to banking. In real 1984/85 terms, the per capita cash deposit in the banks and financial institutions was as less as Rs. 20 in the year 2007. This figure depicts that a large number of people are deprived of banking services, and consequently, of credit as well. This deprivation is one of the main hindrances for capital accumulation and formation, and thus, higher economic growth.
  2. The direct control of the government over the banks has added more problems. The government has pressured banks to provide collateral-free loans at low interest rates to some ‘deprived/marginalized’ groups. This has compelled banks to make riskier investments in order to increase revenue generation from alternative sources. Also, there is a provision in the monetary policy of 2012/13 that prohibits banks and financial institutions from charging interest of more than 9 percent for refinancing in the productive sector. Such interest caps can also been seen in some other sectors too. It is true that these sectors may get loans at cheaper interest rates; but only at the cost of interest expenses of other sectors, meaning, banks will charge higher interests in other sectors to cover up the loss.
  3. The Central Bank has also regulated the spread. In July 2014, the Central Bank issued a directive that restricted the spread rate –the difference between interest charged to borrowers and that paid to the depositors –at 5 percent. These controls over the credit market, in the pretext of benefitting some groups, have hampered the growth of a free credit market.
  4. Another problem in the credit market is lack of alternative channels of investment. There are inadequacies of the entities like hedge fund, mutual fund and venture capital. These alternative forms of investment provide opportunity to the people to invest in various forms and gain higher returns instead of saving in the banks and earning negative real interests or investing in the physical assets. Development of these alternatives will lead to more choices to the investors and will induce more investments.

Hence, the regulatory control of the authority over banks seems to be the main reason behind the underdevelopment of the credit market. Freeing the credit market may help boost up the financial system and thus yield higher levels of growth. Although the regulator had not set forth any regulation over the specific interest rates since liberalisation started in Nepal in the early 1990s, the 2014 directives of Nepal Rastra Bank (the Central Bank of Nepal) instructing commercial banks to keep the spread rate within 5 percent is against the principle of liberalisation and economic freedom. This has shown the Central Bank’s duality in its commitments and actions. The end of this control seems more justifiable to resolve the problems of the credit market.

Another potential solution could be pooling up the various government funds such as Youth and Small Enterprise Self-Employment Fund into a single larger fund and mobilizing it through a private party. Similarly, in order to increase the banking habits of the people, the provision of the bill-payment of the various public utilities through banks should be executed. Another requirement for an improved Nepalese banking sector is competitiveness. Allowing the foreign financial institutions to enter the Nepalese market freely can promote competition, lead to innovation, increase choices to the consumers and thus improve the whole financial market.

Along with the free entry of foreign banks, a liberal Foreign Direct Investment (FDI) policy should also be implemented for an easy inflow of capital. Allowing FDI would also help local banks, enhancing their client base.

In addition to these, a liberal financial policy that will foster alternative channels of investment such as hedge funds, mutual funds, and venture capitals may provide capital owners with choices beyond conventional banking and real estate.

For more details on the 2015 Economic Freedom Country Audit Report Nepal, please click here

Ashesh Shrestha

Ashesh Shrestha is an independent researcher. He has an Economics background and is interested in Monetary economics and Public finance.

One thought on “Four Problems in Credit Market of Nepal

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