Financial Sector Stability DPC2

Start & End Date: 2015-2020

Country/Countries: Nepal

Multilateral Institution(s) Involved: World Bank

The FSAP diagnostics and recommendations for Nepal were triggered by the liquidity crisis of 2011 when the real estate and stock market bubbles burst and remained the relevant challenge through to the disaster in 2015 when an earthquake damaged the central bank's physical facilities, threatened banks with capital erosion, stressed the balance sheets of insurance companies, and resulted in the insolvency of many microfinance institutions and financial cooperatives.

The program development objective of the Second Post Disaster Financial Sector Stability Development Policy Credit Project for Nepal is to support the medium-term reform program for the financial sector initiated by the Nepalese authorities to reduce the vulnerability of the banking sector and increase its transparency. The present operation is also intended to provide emergency support to the Government of Nepal (GoN) following the April 25 earthquake. Although this operation was designed prior to the April 2015 earthquake, the magnitude of the devastation that ensued, the associated financial needs of GoN, as well as the heightened vulnerabilities of the financial sector as a result of the disaster - only make the rationale for the reforms and further financial support even stronger. Therefore an additional objective is to provide the GoN with much needed short term financial support to expedite and scale up relief and recovery efforts while mitigating new emerging financial sector weaknesses and allowing it to play its role in the broader post-disaster recovery effort. The presented credit is composed of four policy areas: first pillar, enhancing financial sector development; second pillar, restructuring and consolidating the financial system; third pillar, strengthening the legal and regulatory framework for crisis management, banking supervision, and payment systems; and fourth pillar, enhancing the governance and transparency of the banking system.

The target for a strengthened coordination framework for the design and implementation of financial sector reforms was met with the approval by the Cabinet of the Nepal Financial Sector Development Strategy (FSDS) in January 2017; the appointment of a high level Financial Sector Coordination Committee; and the formation of two committees to monitor progress with the FSDS recommendations, one headed by the Governor of the NRB and the other by the Minister of Finance. The capital adequacy ratio of the Rastriya Banijya Bank (RBB) was raised to 13.15 percent by the second quarter of FY2020, exceeding the target of 11 percent. In the baseline, the bank had been under-capitalized, with a capital adequacy ratio of 5.6 percent, lower than the regulatory norm of 11 percent. The capital adequacy ratio of the Nepal Bank Limited (NBL) was raised to 17.4 percent by the second quarter of FY2020, meeting the target of 10 percent. The bank had been under-capitalized, with a capital adequacy ratio of 5.26 percent in the baseline, lower than the regulatory norm of 11 percent. All banks in Nepal met the minimum capital adequacy ratio of 10 percent in FY2020 --- an average 13.7 percent at commercial banks (Class A), 15.3 percent at development banks (Class B), 19.4 percent at finance companies (Class C), and 13.9 percent at all finance institutions. Following 47 mergers, 53 acquisitions and 16 corrective actions involving 108 banks and 120 financial institutions, the total number of banking and financial institutions was reduced to 72 in FY2020, meeting the target that the number of banking and financial institutions be reduced to 130 or less by the program closing date. All authorized financial NGOs were converted to microfinance institutions (Class D) by March 2020, meeting the target. The new Cooperatives Act, passed in 2018 (part of the prior actions), assigns supervisory and resolution powers over cooperatives to the Department of Cooperatives, acting as Registrar of Cooperatives. In the baseline, the Nepal Rastra Bank (NRB) supervised only 15 financial cooperatives out of 17,000 that were operating in the country. The Registrar of Cooperatives licensed the remainder, but did not have any supervisory authority or resolution power over the cooperatives. The NRB had also licensed 47 financial NGOs. The target that all insurance companies are adequately capitalized --- the new capital requirements are NPR 2 billion for life insurance companies and NPR 1 billion for non-life insurance companies --- or are subject to a PCA or resolution program was met.