CONCEPT PAPER Thesis Topic: Merge of Banks and Financial Institution (Bank and Financial Institution Merger Bylaw,2

0 6 8 b y N R B ) is it the panacea of the all problems of Nepalese F i n a n c i a l S e c t o r Nepal??? General Background : The financial sector of Nepal can broadly be divided into two categories namely Formaland Informal Sector. The formal sector comprises of all the financial institution licensed by Nepal Rastra Bank (NRB)-the central bank of Nepal. NRB has divided the banks andfinancial institution into four classes on the basis of capital requirement, area and scopeof operation and lending criterion. The class A institutions are the Commercial Banksand there are all together 31 commercial bank operating in Nepal. Among the Class Bin s ti tu ti on a re t h e Dev e lop m en t B an k s a nd t h ey a re 7 9 in n um b ers . Th e C c la s s financial institutions under the licenses of NRB are the Finance Companies and finallyamong the class D are Microfinances and Financial NGOs. The informal sectors are beyond the control of the NRB and are dominant of in the Nepalese financial sector. Theinformal sector comprises of Provident Fund, Postal Banks, Cooperatives and InsuranceCompany. The formal sector is providing facility in the urban and semi-urban areas onlycovering the 30% of the total population. Among the institutions Financial NGOs andcooperative are the highest deposit providers from households and low income groupsan d M ic ro Fi n a n c e a nd R egi on a l Ru ra l Deve l op m en t B ank s c ollec t fe w d ep os i t s b yserving few poor and rural areas.Th e form a l fi n a n c ia l s ec t or h a s b een p rovi di n g s

a t i s fa ct ory s ervi c e t o t h e li m i t ed population and is continuously improving everyday. The activities of these institutionscan be divided into retail banking, dealing directly with individuals; business banking, providing services to mid-size business; corporate banking dealing with large businessentities; private banking, providing wealth management services to High Net Worth In d i vi d ua ls ; an d in ves t m en t ba nk in g, rela t es t o h elp i n g cu s t om ers ra i s e fu n d s i n t h eC ap it a l M a rk et s an d a d vi sin g on m ergers a n d a cq u i s i ti on s . B an k s a re n ow m ovi n gtowards Universal Banking, which is a combination of commercial banking, investment banking and various other activities including insurance. Technology has brought aboutstrategic transformation in the working of these institutions. With years, these institutionsare also adding services to their customers and are passing through a phase of customersm a r k e t . T h e c u s t o m e r s h a v e m o r e c h o i c e s i n c h o o s i n g t h e i r b a n k s a n d f i n a n c i a l institution ( BFI). With stiff competition and advancement of technolog y, the service p rovi d ed b y B F Is h a s b ec om e m ore ea s y a n d c on ven i en t . T h e B F I s o f N e p a l a r e providing the same range of products and services and their product line is same. Theyare competing for the same market with similar and homogenous products. However, b ec a u s e of la rge n u m b ers of p la ye rs s er vi n g t h e s a m e s m a ll m a rk et , t h e un h ea lt h ycompetition among these players, lack of transparency, lack of corporate governance,ma rk et an d ec on om i c c ond it i on, p oli t i c a l s c en a ri o a nd oth er a d vers e c on d i ti on s a nd factors; almost

all the BFIs of Nepal are facing a huge problems and most of them are ins ever e c on d it i on a nd s ome h a ve a lr ea d y b ei n g li qu id a t ed. Des p i t e of th e c on s t an tmonitoring, scrutiny and restrictive approach adopted by Nepal Rastra Bank (NRB)-theCentral Bank of Nepal, various problem and unhealthiness surrounds the BFI of Nepal. Nep a l R a s t ra B an k (NR B )-th e C en t ral B a nk of Nep a l, es t a b li s h ed i n 19 56 u nd er t h e Nepal Rastra Bank Act, 1955,to discharge the central banking responsibilities includingguiding the development of the embryonic domestic financial sector, plays the mosti mp ort an t role i n d eve lop i n g a s ec u re, h ea lt h y a n d effi c i ent fin an c ia l s ys t em a n d t ostabilizing the entire economy. Since its inception NRB has developed various laws,legislation, bylaws, policies, guidelines, directives and circulars in order to make thefinancial sector more smooth and prudent. It has tried to cover all the four principles of b a n k m a n a g e m e n t o f L i q u i d i t y a n d R e s e r v e M a n a g e m e n t , A s s e t s M a n a g e m e n t , Li a b i li t i es Ma n a gem en t a n d C ap it a l Ad eq u a cy M a n a gem en t t h rou gh i t s p rud en t ia lsupervision and regulations. NRB has devised and constantly upgrades its policies andregulations regarding creation, operation and liquidation of BFIs as per the need of the time. NRB has tried to cover all the three aspects of effective and prudential regulation of E ffec t i ve Li c en s i n g, R egu lat or y Norm s a n d E ffec t i ve S u p ervi s i on wi t h i t s d yn a mi cdirectives and guidelines. The licensing policy deals with provisions regarding the paidu p ca p it a l for a ll t h e fou r c la s s es of B F Is , m i n im u m in ves t m en t req ui r em en t from promoters, general public, foreign investors and employees, procedure and time period tos u b m i t a p p l i c a t i o n , f e e s a n d p a r t i a l d e p o s i t o f capital, registration provisions,qualification of promoters, expansion of working territory and

m i n i m u m c a p i t a l requirement. NRB had adopted the liberal licensing policy as the consequence there wasa t remen d ou s s u rge i n th e n um b er of B F Is fr om 2 00 4 t o 200 9; h owev er, d u e t o t h emushrooming of BFIs in small market and pressure from supra national organization likeIMF, NRB now has adopted more tighter licensing policy. NRB has issued 21 directivesfor c ov eri n g i t s p ru d en t ia l regu la t or y n orm s a n d t h e d i rec t i ves d ea li n g wi t h va ri ou s aspects like capital adequacy, loan classification and provisioning, single obligor limit,ac c oun ti n g p oli c i es a nd fi n an ci a l s t at em en t s for m a t , ri sk ma na gem en t , c orp ora t egovernance, supervisory compliance, investment policy, submission of statistical reports,sales of transfer of promoters share, consortium financing, credit information/black li s t in g, p rovi s i on on C RR / S LR , b ran ch exp a n si on , i nt eres t ra t e, fi n an ci a l res ou rc es mobilization, deprive sector lending, KYC, SLF, etc. NRB regularly reviews the process by which BFIs assesses its capital, risk position, capital levels, and quality of capital as a part of its supervisory mechanism. It evaluates the degree to which a BFIs has in place asound internal process to assess capital adequacy. NRBs supervision emphasizes on thequality of the BFIs risk management and internal controls. The process of regulatorysupervision can involve any or combination of On-site examination or inspection, Off-site review, Discussion with management, Review of work done by external auditor, and p eri od i c rep ort in g. Des p i te a ll t h es e p ru d en t i a l n orm s , regu la t i on and s up ervi s i on mechanism of NRB, the BFIs are facing the problems and are in verge of going out of the business. The adverse morale hazard has prevailed in Nepalese financial sector due torecent episodes of malpractices in a few notable financial institutions has dented the public's confidence in the banking system in

general, making the problem worst andcreating a more vicious circle. In response to these burning problems and in order to gainthe confidence of the investors in financial sector and to sustain the financial market, NRB on Thursday May 12, 2011 unveiled Banks and Financial Bylaws, 2068 withfollowing objectives: To improve the entire nations BFIs system and thus gain the public confidence inthe BFIs. To protect the interest of the depositors in order to sustain the financial sector bym a k i n g t h e B F Is s ys t em s e lf gov ern i n g, s elf d i s c ip l i n a ry, s ec u red , h ea lt h y, proficient, capable and competent. To improve the capital base of the financial sys t e m a n d t h u s d e v e l o p t h e competent capabilities. To provide the modern banking service to the general public by developing andimproving the banking, financial, human potentialities, technology and other capabilities. To protect the interest and benefit of investors. Statement of Problem: At the time when the Nepalese banking sector is going through torment and really tough phase NRB has brought a new merger bylaw believing that it will as a panacea of theentire burning problem and stated it as the need of the hour. This bylaw has been broughtinto effect by NRB to improve and develop the weak and problematic financial sector.M o s t o f t h e e x p e r t s a n d a n a l y s t s b e l i e v e t h a t t h e N e p a l e s e f i n a n c i a l s e c t o r a r e overcrowded with so many players for the small size market and if not

acted on timethese problems will worsen. Previously, NRB had adopted the liberal licensing policy ast h e c on s equ en c e t h ere wa s a t rem en d ou s s u rge i n th e n um b er of B F Is a n d n ow t h eovercrowding is hurting the financial sector. Virtually, with its new merger bylaw NRB ist r y i n g t o c o r r e c t i t s p r e v i o u s d e c i s i o n o f a d o p t i n g l i b e r a l l i c e n s i n g p o l i c y . T h e overwhelming outgrowth and the rapid surge of BFIs has not only led to the malpracticeof banking norms and unfair competition but also has created such situation where it isdifficult for NRB itself to grab the situation by the scruff of the neck, manage it andcontrol it. So, NRB has introduced Merger Bylaw 2068 in order to manage and controlthe existing BFIs effectively and efficiently. Considering these facts and the situation, the proposed thesis tries to evaluate the merger bylaw of NRB and will try to present and conclude whether the merger bylaw will act as a b a s e t o c u r e a l l t h e p r o b l e m s surrounding the Nepalese financial sector. Methodology: The proposed thesis will require more of qualitative analysis than quantitative analysis sothe following methods will be used to for the study: C a s e s t ud y of p rob lem a t i c B FIs i n Nep a les e fi n a n ci a l s ec t or n a m el y R a s t rya B a n i j ya B an k , Nep a l B an gla d e s h Ba nk , Nep a l Deve lop m en t B a nk , Gu rkh a Developmen t Bank, Samjhana Finance and Nepal Share Market Case analysis of few successful mergers to improve the financial sector in theworld

Delphi Technique as a source to collect primary data and various journals and publications will be used to access the secondary data. Findings: The intended thesis will try to conclude on the effectiveness of the merger bylaw of NRB.The thesis paper will try to figure out whether the merger program of NRB will act as ba s e t o s olv e t h e p rob lem of N ep a les e Fi n a n ci a l S ec t or. It wi l l a n a l yz e wh et h er t h emerger is really the need of hour of problematic Nepalese Financial Sector and to whatextent it will improve the financial sector of Nepal. Also, this paper will try to present the pros, cons and challenges of the merger in the Nepalese Financial Sector.