Safeguarding Financial Stability: Nepal’s Experiences

1. Safeguarding Financial Stability:Nepal’s Experiences Country Paper Presentation by Nepal Rastra Bank at the SAARCFINANCE Governors’ Symposium Kumarakom, Kerala, India June 10, 2011

2. Introduction • Financial Crisis and Financial Stability • Nepal’s Economy and Financial System • Measures Initiated toward Financial Stability • Major Challenges Presentation Outline

3. Financial stability—ability of financial system to smoothly fulfill its key economic functions at all times. • Failures of financial institutions and financial crisis—implication to the economy, society and polity. • Maintaining financial stability—a core responsibility of the central bank. Introduction

4. Repercussions and lessons. • Significance of macro-prudential policy. • Appropriate regulatory structure. • South Asia better sustained financial crises—low level of market integration and conventional services. Financial Crisis and Financial Stability

5. GDP growth: 3.5% growth in 2009/10; 4% estimated for 2010/11. • Inflation: 10.6 % in mid-April 2011. • Monetary sector: M2 ↑ 3.3% and M1 ↓ 0.6% in 1st nine months of 2010/11. • Fiscal sector: budget deficit/GDP at 3.3 percent in 2009/10; budget surplus in 1st nine months of 2010/11. • External sector: BoP deficit of NRs. 3.6 billion in 2009/10; no expected improvement in 1st nine months of 2010/11. Macroeconomic Trends

6. Promoting financial stability: major objective of NRB. • Classification of banks and financial institutions: A, B, C and D. • Number of banks and financial institutions as of mid-March 2011; 31 commercial banks, 87 development banks, 80 finance companies, 21 micro finance development banks. • Banking sector problems: thinly spread institutions, liquidity shortage and credit concentration. Nepal’s Financial System

7. Conduct of monetary policy: multiple objectives and instruments—price stability, financial and external sector stability. • Approach: gradualist; foreign investment permitted in almost all sectors; portfolio investment not permitted. • Capital account transactions mostly regulated. Measures for Safeguarding Financial Stability

8. Balanced monetary policy. • Fiscal discipline—no spill over to monetary sector. • Focus on credit flow to productive sector. • Credit ceiling on real estate and housing loan, cap on margin lending. • Fixed exchange rate regime with major trading partner. Measures

9. Capital standard based on BASEL-II implemented fully for A class banks; from 2010/11, BASEL-II applicable to development banks. • Risk-based supervision system technique and risk management guideline issued. • Stress testing system: a permanent task force set up; a model stress testing exercise done. • Support from IFIs on risk based supervision. Measures

10. Contingency planning at progress. • Ensuring transparency in financial transactions—establishment of FIU. • Strengthening legislations. • Encouraging merger of banks and financial institutions • Senior Policy Group under chairmanship of Finance Minister to address issues that impact the financial system. • A Coordination Committee under Deputy Governor to deal with issues pertaining to the maintenance of financial stability. Measures

11. Enhancing competitiveness and coping with global competition, expanding financial access and ensuring credit flow to productive sectors. • Nepal’s commitment in WTO—opportunities & risks. • Ensuring adequate monitoring of banks and non-banks. • Growth of credit cooperatives. • Government owned banks and their reforms. Challenges

12. Institutional expansion and access to services. • Regulatory and supervisory architectures. • Building a financial system that is supportive to growth and sustained economic development. Conclusions