The Nepal Rastra Bank (NRB) recently introduced a new directive blacklisting big loan defaulters. The way in which the edict was issued smacks of the lack of due process and rule of law. There is no transparency and inclusiveness in the law-making process, there is no consultation with stakeholders and the public.

The central bank's argument is that the directive is a prudential norm to safeguard the financial system. However, the regulator should have known that any law that is based on exceptions is bound to be a bad law. Aside from questions about its legality, the directive is also badly timed.
Nepal's business community is currently under siege from all sides.

ales are at an all-time low due to the insurgency and the knock on effects of a slump in tourism has hurt everyone. Businesses pay a double tax: one to the state and one to the Maoists. Now, the regulator is further squeezing them.

For any provision to be effective as a law, it has to withstand three main tests: legality, constitutionality and rationality. The directive fails all three. Legally, the bank has no authority to impose a directive of this nature under the Nepal Rastra Bank Act 2058. Even assuming that the directive had legal basis, it would require the approval of the NRB board, which was not done.

Under the guideline, banks and financial institutions are prohibited from extending credit to businessmen and their relatives blacklisted by the directive. If a mother is blacklisted, her son or daughter cannot borrow from banks. If a private company is blacklisted, all its shareholders are automatically blacklisted too. A shareholder holding more than 10 percent share in a public company which has defaulted a bank loan is also blacklisted, whether or not such person is involved in the management of the company. It seems that the NRB, with its newfound autonomy, feels that it is above the Constitution of Nepal which guarantees the right to profession, trade and occupation as a fundamental right.

If there is a rational basis for the directive, we don't see it. There can't be any good reason to blacklist businesses just because one of their projects fails out of, say, 10 successful ventures. If the rationale was to force the businessman to divert cash from other successful projects to bail out the concerned unsuccessful project, then that would be ignoring other creditors and investors of the successful projects who have invested because of their financial strength.

If this directive is implemented by the letter, Nepali banks and financial institutions would not have any one left to do business with. The directive also creates a moral hazard as it takes all the risk off the banks and financial institutions and lets them enjoy their profit without having to take any risks. This would make our financial institutions more incompetent, because their ineptitude will be rewarded while entrepreneurship is punished.

There appears to be pressure on NRB from donor agencies to clean up non-performing assets (NPA) to reform the banking sector. The Rastra Bank may well have thought that the directive would be a shortcut to achieve that goal, but in doing so it has cut the branch of a tree on which it is sitting.

Moreover, the directive fails to address the real reasons for the accumulation of non-performing assets. Government-owned banks have the biggest defaulters because of political lending, corrupt lending because of involvement of security valuators and managers of the banks, virtually no effective supervision of loan utilisation, and unaccountable and inefficient management. Unfortunately, the directive, still exempts the directors of government- owned corporate bodies from its ambit.

It is also common knowledge that the NRB itself has been involved in shady lending transactions in the past, and may have designed this directive as a face-saving drive or to grant itself immunity. The contents of the directive also suggest that the NRB lacks necessary leadership and dynamism to use prudence in decision-making on matters having longterm impact on the economy.

The first order of business is to immediately suspend the directive. If it can't do that, NRB should make it applicable only in cases where fraudulent lending and misuse of the banking fund has occurred, and even then only as a temporary measure.

The system of Credit Information Bureau (CIB) incorporated by the Directive should, however, be encouraged and this institution should be strengthened. Its role should be restricted to information on credit-worthiness of individuals or companies. The provision should be made mandatory for banks to consult the information kept by the CIB before granting any credit facility notwithstanding the amount involved.

We need a system where the honest are rewarded and culprits are punished. To deal with the latter category of debtors, a law focusing on financial crime should be introduced as a priority. Under the existing law, banks and financial institutions are given a great deal of protection, but there are no standards to measure the quality of their services. There is need for self-discipline and to establish a banking code that sets standards of service. Bankers' Association of Nepal could take a lead in this.

Bharat Upreti is an advocate, and senior partner in Pioneer Law Associates. bharat@pioneerlaw.com