We have tried to reassure ourselves that Nepal is somehow insulated from the international financial crisis. Nepal's economy may not be globalised, but we depend on the global economy through our reliance on remittances,tourism and exports.

Sooner or later, this is sure to have an impact on Nepal's financial sector. But even if we come out relatively unscathed from the contagion of global meltdown, banking will soon face a domestic implosion from its own home-spun crisis.As it is, Nepal's financial sector is an enigma wrapped inside paradoxes.

The free-market policy of the past two decades led to the establishment of 25 commercial banks, 58 development banks, 78 finance companies, several micro-finance institutions and financial NGOs supervised by Nepal Rastra Bank.

Large operators like the Employees' Provident Fund and Citizen Investment Trust function as fairly unregulated entities. Some 3,000 plus cooperatives also provide financial services.

This dramatic growth was expected to deepen, diversify and reduce the cost of formal financial services to Nepalis, but in reality the financial architecture has not been able to effectively replace loan sharks even in urban areas who charge interest rates as high as 36 percent.

Interestingly, repayments of these loans are seldom deferred or defaulted, proving that there is strong demand of funds and there are honest borrowers out there.Yet our banking system suffers from bad loan portfolio with NPAs standing at 14 per cent of total banking assets. The prevalence of excess liquidity in the system and the central bank's mop-up drama through open market operations are often reported. But this simply indicates a mismatch between demand and supply, a lack of business acumen, creativity and imagination in the banking sector.

Despite the share-rush in every initial public offering for new banks and a disproportionate growth in the banking and financial sector, its cumulative capacity can barely finance a 20MW hydropower project. Last week, Citizens Bank and Bank of Asia simultaneously issued IPOs, soaking up about Rs 12 billion. This created a liquidity crisis in the banks and also pushed the inter-bank rate above 11 per cent, the highest in the last 10 years. Nepal's financial sector is therefore fragile, unsustainable and runs on a trust deficit.

To make things worse, the 120-hour-a-week power cuts have brought economic activity throughout the country to a halt. Large manufacturers have seen a huge increase in operating costs, even photocopy shop owners, furniture makers, cybercafe and call centres, fruit-juice vendors, farmers using lift-irrigation, cold-storage renters and milk chillers have shut shop.

Big and small, these businesses are beginning to default on bank repayments for loans. Most banks and financial institutions that have invested more than 80 per cent of their liquid assets are also likely to face a reduced deposit inflow and increased withdrawals.

The crisis will start manifesting itself by the third-quarter bank balance sheets of this fiscal year. There can't be a quick fix solution to a crisis that was building up for years and has been exacerbated by more recent downturns. But what is even more alarming is the gross indifference of policy-making and regulatory authorities to the impending crisis.

Coming soon: bank runs, inflation caused by government augmenting money supply, social and political anarchy. The government and the Rastra Bank have but no alternative but to consider other alternatives: keep the economic activity floating during these difficult periods. In absence of investment opportunities in productive sectors, people are either investing in real estate or in banking sector equity. A credible and commercially viable plan could pool these scattered resources into a consolidated fund, perhaps administered by a transparent autonomous body, and invested into the areas less affected by the energy shortfall. Large infrastructure investments could crank up the economy by creating jobs and spurring growth.

But, first and foremost, the government must have the willingness and sense of urgency to foresee and forestall the danger. You can't solve a problem if you don't acknowledge a problem exists.