Until some years ago, everyone in Nepal wanted to run a private bank. They modernised banking, made customer service more efficient, and a booming economy ensured business. Until a year ago deposits and investments were growing at 15 percent annually. Bankers profited and so did the shareholders. But things have changed: growth has plummeted due to the economic downturn, especially in tourism, where where almost 15 percent of all commercial bank loans are. Finally, the Nepal Rastra Bank (NRB) issued 10 directives to govern the industry, including guidelines on capital adequacy, single borrower limits, accounting standards, etc.

Last week Himalmedia invited heads of major private banks and the central bank to a discussion on the state of banking and the impact of the NRB directives. Narendra Bhattarai, CEO Nepal Bangladesh Bank, CP Khetan, director, Laxmi Bank, Manoj Goyal, CEO Bank of Kathmandu, Maheshwar Shrestha, manager audit and inspection at Himalayan Bank and Tirtha Prasad Upadhaya, a chartered accountant, attended. Standard Chartered Bank Nepal, the Nepal Investment Bank, Kumari Bank and the Nepal Rastra Bank confirmed participation but did not attend. Excerpts from the two-hour discussion:

Narendra Bhattarai: The regulations are well intentioned but not very practical. The state of the economy should be used to assess whether the timing of the directives was appropriate. Given that the economy nearing zero growth, following the guidelines would be near impossible. This year, 2002/03, our capital adequacy requirement is 10 percent, next year it has to be 12. The definition of supplementary capital has become more stringent. Effectively our capacity to do business has shrunk. Will it be possible to raise capital to Rs 1 billion without reasonable economic growth? The average non-performing assets (NPA) at all banks, including two government banks, was 16 percent last year. The NPA of Nepal Bank Limited (NBL) and the Rastriya Banijya Bank (RBB) was estimated to be about 24-25 percent. Now that is said to have grown to about 48 percent. At private banks last year it was about seven percent, now it is up to 11-12 percent. The directives are a reason for this, another is the quality of investments, still another, the state of the economy.

CP Khetan: The new capital requirements have made it easier for small banks to enter into a market that used to be dominated by seven or eight major banks. In a market economy we talk of healthy competition where consumers benefit, which may not have been the case with our banking. There has not been much competition among banks but (because they had high profits) investing in one became very attractive. The profits earned might have been because the institutions were doing very good banking, or because they weren't following international accounting principles. The NRB directives are aimed to end that, but they come at a time when the economy isn't doing well, and even the medium term outlook is also not very good. The mindset of bank owners and shareholders is such that they don't want to shoulder any loss, although there is no rule that must always make profits. They seem to be competing not to increase profitability but to increase book profits. We need more flexibility in the implementation of the NRB guidelines.

Only a few banks have adequate provisioning for loans. Now all banks have agreed to meet the provisioning requirements in three years. But bank owners and shareholders also need mechanisms to help them recover their loans. We have been talking about an assets reconstruction company for some time now. We have a loan recovery act, but I do not know which court to go to for settlements. The NRB is pressuring banks to enforce prudential norms from which ordinary shareholders and depositors stand to benefit, but what about the other investors? They want to see the NPAs being recovered. The NRB needs to facilitate loan recovery.

Manoj Goyal: The NRB is being directed by the conditions of the World Bank and the IMF and has been told that we won't get foreign assistance if we don't take reforms forward. The 12 percent capital adequacy, for example, would be acceptable if our economy were doing well. But what are the economic parameters on which we are basing that number? Where is the flexibility needed to make adjustments to our economic situation? Does the central bank have authority to relax the directives if things go really bad? We don't argue that the banking sector has to be strengthened, but what about the environment in which the banks are operating? To be able to fulfil the norms banks are putting undue pressure on businesses. Will they still be motivated to invest? The cost of capital grows when we raise capital adequacy because we also have to earn returns for shareholders, which means that the price of banking products will rise. But we don't have an economy ready to use those products.

Tirth Upadhyaya: Until recently banks did not even ask borrowers for financial statements and the NRB had to step in to get them to. The large hotel projects that are now suffering, is it because of today's slow economic growth? It is the fault of the banks that the hotels they financed are now in trouble. Everybody knew tourism numbers were not growing fast enough. I don't fault the government or the central bank for bringing in the directives. Until now the banks operated freely, without licensing. Now the central bank has become smarter.

Goyal: Banks invest based on future prospects, and the possibilities looked good, based on the information we had. If there were adequate flights there could still be a shortage of hotel beds. And then you would have blamed us saying that the shortage resulted because the banks didn't invest enough in hotels.

Bhattarai: Even those who advise us (government) on policy have invested in the equity of some of the hotels that are talked about as having bad loans. There are risks in every business. We did not invest expecting the economic growth rate to be 0.8 percent, but 5-10 percent.

Upadhyaya: So why blame the central bank for everything? The 12 percent CAR was not fixed by the central bank, but by the Basel Committee. The directives also cover other very crucial issues.

Goyal: We aren't blaming NRB for what it is, but for the manner in which its hands have been tied (by donors). If we were a rich country our central bank would have been run how we wanted and we could have determined what level of health we wanted to achieve and then decided on how to get there. But suddenly we had external advice that moved too fast. Then the economy began faltering. We have certain needs and the central bank needs to be flexible to address those needs.

Khetan: We are asking for more flexibility on the NRB's part and greater inputs from it to tackle problems resulting from other sections of the economy.

Maheshwar Shrestha: Four years ago the Maoist problem was not as intense as it is today. Both pashmina and tourism were doing well. The growth and profits in banking were visible. But what do we have left? The pashmina industry is gone and so has the carpet industry. The garment business has changed after 11 September, and tourism is down. Then the NRB directives came. They were initially very stringent but were changed at the request of bankers.

But certain problematic issues remain. For example, earlier any overdue loan became bad only after five years, now they have to be classified 'bad' in a year. The methods of counting capital adequacy have also changed, not to mention the increase from 8 to 12 percent. The single borrower limit has also been lowered and pegged to a lower base. It was 35 percent of total capital earlier, now it is 25 percent of core capital. We can prevent major trouble at the banks by deferring certain directives and imposing them when the economy turns around.

Then there are overlapping and problematic taxation laws. We don't get deductions for loan loss provisioning. I have to count the interest due from clients even if I don't actually get it, and pay tax on that. All this is in addition to the already high 30 percent corporate taxes we pay. Delay in litigation can go on for 10 years. The central bank says it has taken certain measures because some banks have not functioned properly. Why must the entire sector be penalised for the mistakes of a few?

Upadhyaya: What are banks for? We have a $300 million hydroelectric project built with foreign investment and now we have problems paying for the power in convertible currency. Do private banks see a role for themselves in such projects? If banks are run well and if their portfolios are okay, they can start making money in a year, despite the directives.