Explain the issue and challenges of Banking sector in Developing Countores like Nepal?
Issues:
Shortage of Loanable Fund
In recent years, the Nepalese financial sector has frequently experienced episodes of shortage of loanable fund. The major reason behind such situation is mismatch in lending and deposit growth. While the demand for credit is soaring, the stock of deposit of banking institutions has not increased much. Further, increased pressure on balance of payment, maturity mismatches, high concentration in deposits, and delayed government expenditure have aggravated the issue. It has been noted that almost all banks are having tight credit to core capital plus deposit (CCD) ratio, which is hindering them from further lending The funding problem has also resulted in volatility in long-term interest rates in loan and deposit.
Multiple Banking
A large number of loans are provided under multiple financing. Banks are required to execute pari-passu agreement in case of loans higher than Rs.10 million and those loan exposures above Rs.1 billion must be provided under consortium financing. The onsite inspection teams have observed that for loans lower than Rs.1 billion, even if pari-passu agreements have been done, there is no adequate information sharing among financing banks about the stock positions and outstanding loans. Chances of over-financing and crossing the drawing power remain, which can adversely affect the repayment capacity and collateral adequacy. Likewise, the issues of setting interest rates and common stock monitoring are observed in case of consortium financing.
AML/CFT Compliance
Anti-money laundering and combating financing of terrorism (AML/CFT) has been a major issue that banks are not adequately dealing with. Failure to abide by rules and regulations concerning AML can result in various kinds of risks. NRB has issued AML/CFT related onsite inspections reveal that most staff, especially the front-line staff, are not adequately directive (Directive No.19), which act as supplement to the laws related to the topic. The trained and taught to identify and monitor AML/CFT related risks. Further, the board level AML Committee members and senior management lack capabilities to oversee AML/CFT risks effectively. There has been under-reporting of suspicious transactions (STR) and ineffective risk profiling of customers. Banks need to strengthen their internal policies and procedures regarding appropriate assessment of these risks, and ensure that the criminal activities related to these risks are not conducted using the banking channels. They need train the concerned staff adequately and encourage staff at all levels to be vigilant regarding such activities.
Ever-greening of Risk Assets
Ever-greening of the risk assets has been another major issue in the Nepalese banking industry with regard to regulation and supervision. The major chunk of the total risk assets of the industry is of revolving nature. On the other hand, banks have the practice of lending some short term loans on ad-hoc basis as well as extending the maturity dates and renewing the facilities that ultimately help in meeting the debt-service need of the borrower. Nepalese banking industry has no practice of clean-ups for the revolving loans due to which the problems such as: maturity mismatch and ever-greening are still prevalent in the banks.
Risk Management Culture of Banks
BSD has already fully implemented Risk Based Supervision for the Commercial banks. The risk profiles of the banks are being prepared and updated. The onsite inspection reports reveal that banks are not adopting the provisions of the Risk Management Guidelines issued by NRB. Most of the risk management practices are found to be traditional, and effective risk management mechanisms are in early stages of development. While most banks have now formulated risk-related policies, their implementation has been weak because of poor risk culture. The tone of risk culture starts from the top level, which includes the board and the senior management. However, board and senior management's oversight over risk management is noted to be weak and initiatives to develop and promote risk management culture in banks are still inadequate:
Control Environment in the Banks
With the adoption of RBS, BSD has been reviewing the control environment of the banks. It has been found that the control environment is not robust. Board and senior management oversight is not adequate. There are not sufficient policies and procedures in place, and adherence to these documents is not properly monitored. In some banks, risk management function is not independent of the business function. This shows a poor segregation of duties and responsibilities to ascertain checks and balances. Furthermore, in some cases, the same individual is made responsible for business and control functions, which shows conflict of interest with respect to assigned roles. These findings reveal that the control environment in the banks needs to be strengthened.
Internal Capital Adequacy Assessment Process (ICAAP) With the issuance of ICAAP Guidelines 2012, NRB has encouraged banks to strengthen their capital adequacy assessment process under pillar-2 considering all material risks inherent in their operations. NRB believes that a well thought out execution of ICAAP is crucial for banks to manage their capital level for adequate solvency. The guideline provides some principles and components of Supervisory Review Process and ICAAP established for the best practices. Banks are required to develop their own internal policy, procedures and structures to manage the risk inherent in their business, and link risks with capital. However, upon onsite examinations, it is found that ICAAP is being considered a mere document in most of the cases without adequate methodology to measure risk level and make appropriate linkage to capital. Need of appropriate ICAAP has been continuously reiterated during onsite inspections as well as via inspection reports to the concerned banks.
Quality of Human Resource
Now the Nepalese banking industry has become more complex with the development of new products and adoption of advanced information and communication technology (ICT). Additionally, the international and national prudential norms, regulatory standards as well as risk management practices are also demanding proactive efforts in the bank management. Definitely, this leads to the need for a competent skill set in the industry. However, almost every time the dearth of such skill-sets are encountered during onsite inspection and supervision.
Recognition of Asset Quality
Prevalent measures to recognise quality of the risk assets are mainly found to be based on ageing of the loan defaults, which is mandated by the regulatory provision. Beyond this, banks are not following other prudential measures to recognise the asset quality. They are not taking qualitative as well as other quantitative measures to check the impairment in such assets and recognise their quality prudently for the proper classification and adequate provisioning for the loss given default on such assets.
Limits and Indicators
Limits and indicators play crucial role in monitoring and controlling of risks. The indicators enable the managers to assess direction of risk and expect the risk events. The responsible officials need to act timely in response to the indicators so as to minimize losses from risks. Likewise, risk limits help the management to keep the risk levels within the risk appetite set by the board. While regulatory limits act as safety valves and breach of such limits may invite penalty, the banks own limits act as cushion to remain within banks" own tolerance level. The observations from onsite inspections reveal that not enough limits and indicators are put in place by banks for effective monitoring and control.
Challenges:
Financial Access and Inclusion
The last few decades saw a rapid increase in the number of financial institutions and their branch network. However, degree of financial access and inclusion is still not satisfactory. A survey done for National Financial Inclusion Roadmap a few years back revealed tha 't only around 40% of adults are formally banked and another 21% use other formal products. Poor financial and other infrastructural facilities, lack of financial literacy and general awareness, viability and sustainability of microfinance financial institutions, and lack of coordinated efforts among the stakeholders are the major causes for low level of financial inclusion.
Productive Sector Lending
As financial intermediaries, BFIs provide funds for entrepreneurs and other needy individuals and firms, thereby contributing to the country's economic growth. However, a large portion of the banks' credit has been channelled to unproductive sectors like real estate and trading business. While directed lending policies introduced by NRB have led to some increase in funding toward productive sectors, it is a challenge to significantly change the banks' loan portfolio as banks are attracted toward lending to unproductive sectors for quicker and higher returns.
Good Governance and Risk Management
Good governance is key for success of any organization. The failures of some financial institutions during the real estate bubble collapse of 2009/10 were primarily due to poor governance and risk management in banks. In order to address the issue of governance and risk management, efforts have been made to improve legislation and regulation related to the issues. The key issues such as composition and qualifications of the board members, term of the chief executive are addressed through amendment in BAFIA.
RBS has been recently introduced and supervisors are not experienced enough to take this approach effectively. However, manual has been developed to assist supervisors and provide uniformity in report preparation. Supervisory resources have also been hampered by transfer of experienced supervisors to other departments. Since most of the international trainings a supply driven and domestic trainings have several limitations such as: time constraint, budgetary constraint, limited scope of training and lack of trainers' skills in the required field, capacity development of supervisors has been a challenge.
Capacity Building of Supervisors
Efficient Use of Supervisory Resources NRB has limited supervisory resources compared to increasing exposure of banks. Under RBS approach, along with compliance, all the major risk areas are to be properly assessed and issues are to be properly identified. Likewise, in addition to full scope and targeted inspections, special inspections need to be performed as necessary. Hence, it is a challenge for NRB to utilize its limited available supervisory resources efficiently for maximum benefit to the organization and the banking industry.
Time Lag in Offsite Surveillance Offsite surveillance is a crucial part of overall supervision function. However, effective offsite supervision requires timely data compilation, processing and analysis are mostly performed manually by the Offsite Unit. As a result, there is an inevitable lag in the offsite surveillance. Delay in the submission of bank returns and manual compilation process coupled with the unavailability of properly mechanised data analysis system is making offsite process delayed and lax. This has led to surveillance and monitoring function of the supervisor less effective. To overcome this challenge, NRB is in the process of implementing Supervisory Information System (SIS) with the support of DFID (Department of International Development, UK).
Effective Enforcement of Supervisory Directions Effective enforcement function is important to ensure that banks are complying with the supervisory directions and are making necessary changes. Sometimes, banks make commitments to make corrections in some later date. It has been challenge for the department to follow up on all the commitments made by banks and ensure that appropriate corrections are made on time, especially because of limited supervisory resources. Onsite and Offsite Integration
The department conducts supervision of the commercial banks through both onsite inspections and offsite surveillance. However, there hasn't been adequate integration between the two functions. As a result, there is redundancy in supervisory functions. Same analyses are being performed by the offsite analysts and onsite inspectors. Further, inputs from offsite are not considered while developing the risk profile of individual banks. Currently, Offsite Manual is being prepared to facilitate integration which could help with more efficient use of supervisory resources. But full integration is still a challenge. Coordination with other Regulators
Ensuring effective coordination between banking supervisors and other regulators of the financial sector still remains a challenge. Supervisory effectiveness can be further enhanced through proper coordination among different regulators and the concerned authorities such as Ministry of Finance (Government), Securities Board of Nepal (SEBON), Insurance Board. Credit Information Bureau (CIB), Debt Recovery Tribunal (DRT), and Credit Rating Agencies. With the growing complexity in the financial system, systemic risks are also building up due to which the need of coordination among regulators and policy makers is becoming a must.
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