An internal investigation of Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) carried out early this year confirms what most suspected all along: Nepal's two oldest, biggest banks are worse off today than they were two years ago.

When international auditors from KPMG looked at the banks in 1998, they found them insolvent with losses amounting to a whopping eight percent of the country's GDP. It suggested urgent measures to set things right. Those measures were never taken. Damage control efforts by the central bank, especially to protect hundreds of thousands of depositors is caught up in red tape and political apathy.

On the surface both the banks have sound liquidity positions, thanks to their near monopoly on rural savings and public sector deposits. This has helped make up for cash shortfalls. But, said one banking source: "In real terms, both are insolvent. Trouble is, we don't know for sure how bad it is because there are many ways to hide the real position, especially when you have a weak regulator."

Pro-reform economists say the only factor that has stopped a run on the banks by panicked depositors is the lack of information available to a largely uneducated public. And for those who know, there is the fatalistic attitude that if the two banks go bankrupt, the government will bail them out.

Supporters of Nepal Bank and Banijya Bank who are against World Bank-led reforms disagree: they say the banks are actually not doing badly especially if their total assets including land and buildings are taken into account. They say the scenario has been made to look bleak because international accounting standards have been used.

But the Nepal Rastra Bank (NRB) investigation points to bad management, overstaffing, and gross interference by a powerful political-business nexus.

Rastra Bank officials told us plans for reforming the fully government-owned RBB had reached the "negotiation stage". In the case of NBL, a committee has been formed by the central bank to re-evaluate the technical proposals of bidders (disqualified in an earlier round) interested in a management contract to run the bank. The new evaluation criteria have been prepared and sent to the World Bank for approval. They will be screened and, most likely, a maximum of four bidders will be shortlisted, and one selected if all goes accordin g to plan. Realistically, NRB hopes to bring in consultants to manage the Banijya Bank no later than 1 January, since there could be delays with the process with the NBL.

The process would have been much simpler had Nepal Bank's ownership been as straightforward as that of Banijya Bank. The government owns only 41 percent shares in NBL against the private shareholders who are not very keen about getting external managers looking into their books.

"I can assure you we don't need external management consultants," says Shambu Sharan Prasad Kayastha, chairman of Nepal Bank. Kayastha says the bank had has recovered loans of up to Rs 5 billion in the past month. "At this rate we will be able to pay dividends to shareholders within a year," he told us. Kayastha's claims are different from what the Rastra Bank's investigation found in January--losses in the range of Rs 1.6 billion.

The government and the central bank have a powerful ally in the World Bank which is dangling a hefty carrot of up to $25 million in loans to get reforms going. The World Bank is in no mood to process other loans for Nepal unless the two ailing banks are out of danger. The International Monetary Fund (IMF) has also listed financial sector reform as a condition the government must meet to be able to borrow from the Fund's Poverty Reduction Growth Facility (PRGF) which is taken as endorsement by bilateral donors of a country's economic health.

The only obstacles are: the resistance of the board of Nepal Bank to reforms, delays in finding the international consultants and a serious lack of political commitment. Rastra Bank's investigation reveals that neither bank has done much to correct the shortcomings detailed in the KPMG report. The banks appear to be re-capitalising interest on loans, lending to insiders, and failing to upgrade management. Other conclusions:
. The core capital of both banks shows negative. But bad book-keeping means no one knows just how much in the red they are.
. Both banks are over-exposed to a few large (often the same) borrowers: well-known names in Nepali business with political connections.
. Non-performing loans in both banks are increasing.
. Nepal Bank, especially, has not followed central bank directives.
. Directors of Nepal Bank were found to have deferred decision on one infamous bad loan for ten consecutive board meetings. NBL swapped a loan with a finance company in which a director had interests.
. The report suspects the management is focusing on re-structuring bad, old debts rather than on recovery and not respecting single-borrower limits.
. Investigators asked Nepal Bank to furnish details of insider lending. The bank said it had no such list.


The Rastra Bank's inspection reports are incriminating enough for it to invoke Section 29 (A) and take over both banks any time it wants. The law says it can either run the banks-for which it does not have the capacity-or get someone else to do it, which is what it is trying to do with the management contract.


For their part, Nepal Bank directors smell foul play. "I think the report was leaked to the press by those wanting NRB to take over our bank because they think it will make it easy to do so," says one director, Rajendra Khetan, who insinuated that the investigators were paid to present a bleak picture.

But independent financial analysts say the government underestimates the seriousness of the banking crisis, private business interests do not care for the country or the depositors and the bureaucrats are happy to let things coast along. He warned: "If a bank's management cannot protect depositors' interests, then the central bank that should step in."