Last year, international auditors discovered some fishy goings-on in two of Nepal's foremost banks. Now, it's not just fishy any more: Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) are on the verge of collapse. Almost half their assets are non-performing, loan recovery is down to a catastrophic 25 percent, and their cash ratios (adequacy) are billions of rupees short of the mandatory minimum.

"There's no doubt that the two banks are ailing and failing," admitted Bimal Koirala, secretary at the Ministry of Finance. He told the parliament's Public Accounts Committee last week that only major reforms can ensure that some Rs 45 billion worth of depositors' savings are not lost. This was a shocking admission by a senior government official, and one that could trigger a run on the banks. But it was also an indication of just how serious the situation is.

Every politician present at the hearing seemed to agree. But their statements showed more myopic partisan grandstanding and blame throwing than desire to address the crisis itself. Leftist politicians are neither convinced about the government's reform plan, nor are they offering alternatives. The PAC is meeting again on 19 January to review a crucial sub-committee report on the issue.

That NBL and RBB are in bad shape is not news. The Commercial Bank Problem Analysis Strategic Study (CBPASS) in 1992 had already warned of a crisis. But nothing was done, and last year international auditors KMPG estimated the negative net worth of the two banks to be anywhere between Rs 20 and 25 billion (depending on who's counting) and declared them "technically insolvent". It blamed bad management, bad accounting, bad supervision and excessive political interference in the past seven years for the woes.

There are ways to resolve the crisis, like handing the banks over to external management, but politicians have an unspoken worry that skeletons are going to topple out of their closet if outsiders are let in. For the opposition, it has been just too tempting to flog the government by opposing "externally-dictated" reforms. The interests of some 40 major defaulters (a literal Who's Who of Nepal's business elite) is also delaying a decision. Nepal Bank's board members, who know very well that the value of their equity is in the negative, want the government to pay for the new management team but still want to call the shots even after the new managers arrive.

In case the banks do collapse, losses will be staggering. The collective assets of NBL and RBB run up to Rs 80 billion and the two control over 60 percent of all banking transactions in Nepal. Because the government doesn't have the money needed to rescue the banks, small and big depositors stand to lose their savings. And the 10,000 employees of both banks will not just lose their money, but also their jobs and pensions. It is a nightmare scenario and the money involved is so staggering that the government doesn't even seem to want to think about it. We're told that some major depositors are beginning to show signs of panic: the Royal Nepal Army and the Employees' Provident Fund have already withdrawn about Rs 2 billion of their mature deposits from one of the two banks under various pretexts after the KPMG report became public.

The crisis did not come overnight. The banks lent unwisely, often under political pressure, pouring good money after bad into moribund sectors like textiles, sugar and steel. Worse, they waited two years after the firms defaulted to begin taking action to get their money back. Most loans were secured against property, often over-valued, which are now not worth much because of a real estate crash. Now the largest borrowers are the biggest defaulters. Financial analysts say the situation is now much worse than it was depicted in the KPMG report last year. "If that was the macro-picture, imagine what things could be like on the ground," says a foreign economist who has studied Nepal closely over 10 years. "The hole is getting bigger every day we fail to do something."

Part of the blame for today's mess is the Nepal Rastra Bank which has always acted like a government department rather than an independent regulator. All it can do now is hope things will work out. Governor of Nepal Rastra Bank, Dipendra Purush Dhakal, told us: "A turnaround is possible. If that can be done with the smallest effort today, why not do it and take a chance to make the banks profitable again?"

That effort would cost $25 million, and the World Bank may be agreeable to lending the amount but only if the government comes up with an acceptable reform plan. Other donors and creditors will be watching those reforms keenly. Acceptable financial sector reforms are also a pre-requisite for Nepal to qualify to use money from the IMF's Poverty Reduction and Growth Facility.

The financial reform agenda at present hinges on amending the laws to make the Nepal Rastra Bank independent, and more capable of supervision and monitoring. A bill to that effect is to be tabled in parliament in the upcoming session. NBL and RBB reform plan also includes:

Selecting and appointing external management teams;
The teams take over day-to-day bank management;
Work on a time-bound plan to address issues such as the high default rate; and
Have them function as real banks in two years.

There's a sense of urgency about seeing these reforms through. According to the timeline, the deadline for management contract proposals is next week, and they will be evaluated by mid-February. Negotiations with selected teams is to begin in March, and the new management team is expected in Nepal by the Nepali New Year. Whether or not it will be a happy 2058 will depend on how well the negotiations go and how much political interference there is.