History of Bank in Nepal

COMMERCIAL BANKING IN NEPAL

 HISTORY OF NEPALESE BANKING SYSTEM

The initiation of formal banking system in Nepal commenced with the establishment in 1937 of Nepal Bank Limited (NBL), the first Nepalese commercial bank. The country's central bank, Nepal Rastra Bank (NRB) was established in 1956 by Act of 1955, after nearly two decades of NBL having been in existence. A decade after the establishment of NRB, Rastriya Banijya Bank (RBB), a commercial bank under the ownership of His Majesty’s Government of Nepal (HMG/N) was established. Thereafter, HMG/N adopted open and liberalized policies in the mid 1980s reflected by the structural adjustment process, which included privatization, tariff adjustments, liberalization of industrial licensing, easing of terms of foreign investment and more liberal trade and foreign exchange regime was initiated. With the adoption of liberalization policy, there has been rapid development of the domestic financial system both in terms of number of financial institutions and as ratio of financial assets to the GDP. As of July 2005, the number of commercial banks has reached 17 and their branches numbered 375. A total of 60 finance companies and other Development Banks and numerous credit cooperatives have also been established. Total financial assets in 2004/2005 reached around 54.09 percent of GDP and the M2/GDP ratio, which shows the financial sector development or financial deepening increased from in 12.4 percent in 1975 to 50.9 percent in 2000.

In the context of banking development, the 1980s saw a major structural change in financial sector policies, regulations and institutional developments. HMG/N emphasized the role of the private sector for the investment in the financial sector. The financial sector liberalization, started already in the early eighties with the liberalization of the interest rates, encompassed further deregulation of interest rates, relaxation of entry barriers for domestic and foreign banks, restructuring of public sector commercial banks and withdrawal of central bank control over their portfolio management (Acharya et al, 2003). These policies opened the doors for foreigners to enter into banking sector under joint venture. Consequently, the third commercial bank in Nepal, or the first foreign joint venture bank, was set up as Nepal Arab Bank Ltd( now called as NABIL Bank Ltd ). in 1984.

There after, two foreign joint venture banks, Nepal Indosuez Bank Ltd. (now called as Nepal Investment Bank) and Nepal Grindlays Bank Ltd (now called as Standard Chartered Bank Nepal Ltd.) was established in 1986 and 1987 respectively. There after, another 12 commercial banks have been established within the period of 12 years. Nepalese banking system has now a wide geographic reach and institutional diversification. Although, Nepalese financial sector is dynamic, a lot of scope for development of this sector exists. This is because the banking and non-banking sectors have not been able to capture all the potentialities of business till this time. It is evident from the Rural Credit Survey Report that the majority of rural credit is supplied by the unorganized sector at a very high cost – perhaps being at two or three time of the formal sector - suggesting that the financial sector is still in the path of gradual development. Overdue loans and inefficiency of the older and the larger of commercial banks have aggravated and have been made to compete with the new trim banks with no rural operations. Also, the commercial banks, domestic or joint venture have shown little innovation and positive attitude in identifying new areas of saving and investment opportunities. Following table reflects the present development of commercial banking institutions in Nepal.

 EXISTING SCENARIO OF BANKING SECTOR

As mentioned in the previous section, there are 17 commercial banks presently in operation. Among these banks some are established under joint venture with foreign banks while some are fully domestic bank. Out of total commercial banks, 6 commercial banks are with foreign joint venture and 11 are fully domestic banks. ABOVE TABLE ABOVE exhibits the position of capital structure and foreign participation towards these banks.

Capital Structure of Banks: The current regulation of NRB prescribes that all the new commercial banks are to be established in Kathmandu at national level should have minimum paid up capital Rs. 1 billion; the existing banks in operation are required to enhance the capital level to Rs. 1 billion by the end of FY 2065/66 BS. For this purpose and objective all the commercial banks have furnished their plans to enhance the level of capital accordingly. In the mean time, there are separate provisions on capital requirements for the national level banks to be operated outside the Kathmandu. Banks to be established out side the Kathmandu valley are required to have a minimum paid up capital of Rs. 250 million.10 The total paid up capital of 17 banks as at July 2005 has reached at Rs 9.423million. The paid up capital of commercial banks operating in Nepal is on an average of Rs. 554 million

Banks Under Foreign Participation: All together nine banks were established under foreign participation in Nepal but three of these have divested their stake to Nepalese promoters. Six banks still have foreign joint ventures. The banks operating under foreign participation are NABIL Bank Ltd, Standard Chartered Bank Nepal Ltd, Himalayan Bank Limited, Nepal SBI Bank Ltd, Everest Bank Limited and Nepal Bangladesh Bank Ltd. Initially, Bank of Kathmandu, Nepal Credit and Commerce Bank and Nepal Investment Bank were also established under foreign joint venture.

Assets of Banks Under Foreign Participation: The banking asset with the foreign joint venture banks is gradually increasing. As of July 2005, the commercial banks under foreign participation hold 37.54 percent of total banking assets. The deposits and credits are still of greater proportion. Foreign joint venture banks possess 39.65 percent of total deposits and 38.45 percent of total credit of the banking system.

DOMESTIC LEGAL PROVISIONS REGARDING BANKING SECTOR

Nepal Rastra Bank Act, 2002 has given full authority to the Nepal Rastra Bank regarding regulation, inspection and supervision of the banks and financial institutions. Bank and Financial Institution Ordinance, 2060, which is popularly known as Umbrella Act, has recently been enacted in unified form. Agricultural Development Bank Act, 1967, Commercial Bank Act, 1974, Finance Company Act, 1986, Nepal Industrial Development Corporation Act, 1990 and Development Bank Act 1996 have been repealed with the promulgation of this ordinance. The ordinance governs the functional aspect of banks and financial institutions. Some of the important provisions in the ordinance regarding the banking sector have been analyzed in this chapter as follows:

Any person wishing to incorporate a bank or financial institution to carry on financial transactions should incorporate a bank or financial institution as a registered public limited company under the prevailing law of Nepal with prior approval of NRB by fulfilling the conditions prescribed in section 4 of the ordinance. The individual desiring for the incorporation of such entity is required to submit an application to NRB for prior approval with the prescribed documents. The NRB is required to conduct necessary investigation and grant permission to establish a bank or financial institution with or without terms or conditions if all the criteria are met and information of disapproval with reason is also to be given to the concerned person in case the application is denied. Similarly, any foreign bank or financial institution wishing to establish a bank or financial institution by making joint venture investment with a corporate body incorporated in Nepal or with a Nepali citizen or as a subsidiary company with 100% share is eligible to furnish the application to establish a bank or financial institution. However, the ordinance is silent about the percentage of equity investment in joint venture, such foreign corporate body can invest. It has been regulated by regulation till now as 75%.

The ordinance prohibits anybody to conduct financial transaction except an established bank or financial institution and no bank or financial institution can use the proposed name for the purpose of carrying financial transaction without obtaining license from NRB. The bank or financial institution desiring to conduct financial transaction must submit an application for license to the NRB in the prescribed form including the prescribed fees, documents and description. NRB will grant license if it is satisfied with the basic physical infrastructure of the bank or financial institution; if the issuance of license for operating financial transaction will promote healthy and competitive financial intermediary and protect the interest of the depositors, the applicant is competent to operate financial transaction in accordance with the provision of this ordinance and its regulation, directives, order or provisions of Memorandum and Article of Association and there are sufficient grounds to believe that the entity is competent to operate financial transaction.

The NRB will classify the institutions into "A" "B" "C" "D" groups on the basis of the minimum paid-up capital and provide the suitable license to the bank or financial institution.. The authorized, issued and paid up capital of a license holder institution will be as prescribed by NRB from time to time. The NRB can issue directives to the license holder entity to increase its authorized, issued and paid-up capital if it deems necessary. Similarly, the license holder entity must maintain a capital fund according to ratio prescribed by NRB based on the basis of its total asset or risk weighted assets, and other transactions. At the same time, the license holder entity must maintain a risk fund according to ratio prescribed by NRB based on the basis of liability relating to its total asset and the other risk to be borne from off balance sheet transaction. The license holder entity must maintain general reserve fund regularly every year till the amount becomes double of the paid up capital of such entity.

The bank or financial institution can be upgraded if the authorized capital is enough for upper class, the institution has been able to make profit for last five years and the non-performing asset is within the prescribed limit. Similarly, the bank or financial institution can be degraded if it fails to meet prescribed capital within the time period, it has been making loss for last five years, it has violated the directives of Rastra Bank time and again and it fails to maintain Risk Management Fund as prescribed by it. The NRB will make necessary investigation and avail opportunity to clarify before taking such decisions.

The NRB is in full power to deny license for financial transaction if the conditions stipulated in ordinance are not met and it is also authorized to impose necessary conditions taking into account the existing financial position of the bank or financial institution, the interest of depositors and healthy operation of financial transaction. Similarly, it may increase, decrease or modify the terms and conditions time to time. The NRB can suspend the license of the license holder for a specific period of time issued for the purpose of carrying financial activities or it may order the bank or financial institution to close the operation of their office partially or fully if such a license holder acts against the provisions of the Nepal Rastra Bank Act, 2002, or the regulation made there under or fails to act in accordance with the order or directives issued by it or fails to act for the welfare and in the interest of the depositors. The NRB may cancel the license issued under this ordinance to carry on the financial transactions of the license holder under the certain circumstances as stipulated in the ordinance.

A foreign bank or financial institution desiring to open its office within the Kingdom of Nepal must submit an application to NRB in the form as prescribed along with the fees and particulars as prescribed. The NRB may issue a license to foreign bank or financial institution to carry on financial transaction by allowing them to open a office within the Kingdom of Nepal taking into account the situation of competition existing in the banking sector, the contribution that could be rendered in the Nepalese banking sector and the reputation of such foreign bank or financial institution. The NRB may specify necessary terms and conditions in the course of granting transaction license and it shall be the duty of the foreign bank or financial institution to comply with such terms and conditions. The section 34(4) of the ordinance reiterates that the provisions of the ordinance are to be complied by such foreign bank or financial institution. The foreign bank or financial institution, which has been issued license to operate financial transaction by opening its office within the Kingdom of Nepal, can not open another bank or financial institution in joint venture within the Kingdom of Nepal. However, the provision for the contact or representative office of any foreign bank or financial institution will be as prescribed by NRB. Some of the important issues such as relationship with parent bank in case of liquidation and supervisory role of the different institutions (parent bank and parent bank's supervisory authority) have not been adequately addressed in this ordinance. Provisions relating to capital requirement are also silent in ordinance. However, it can be fixed by regulation.

The section 47 of the ordinance prescribes functions of the bank or financial institutions. The entities functioning under sub-section (1) only can keep their name as bank of class "A" category. The functions of such bank are incorporated in subsection (1) (A) – (AF) which are in very detail. As per Nepal's commitments foreign bank branches are only allowed for wholesale banking functions. So all of the provisions stipulated in subsection (1) will not be relevant to the foreign bank branches. According to the ordinance, NRB has authority to make necessary regulation in this aspect. See Attached annex (technical) 1.1 for details

EXISTING RULES AND REGULATIONS RELATING TO THE BANKING SECTOR

Followings are the requirements for establishing a new commercial bank in Nepal

Regarding Paid up capital Requirements

1 To establish a new commercial bank of national level, the paid up capital of such bank must be at Rs. 1000 million.

2 To have an office in Kathmandu, the bank is required to have either joint venture with foreign banks and financial institutions or a technical service agreement (TSA) at least for three years with such institutions.

3 In general, the share capital of commercial banks will be available for the promoters up to 70 percent and 30 percent to general public. The foreign banks and financial institutions could have a maximum of 75 percent share investment on the commercial banks of national level. In order to provide adequate opportunity for investment to Nepali promoters in National level banks, only 20 percent of total share capital will be made available to general public on the condition that the foreign bank and financial institution are going to acquire 50 percent of total share.

4 Banks that are already in operation and those who have already obtained letter of intent before the enforcement of these provisions have to bring their capital level within seven years, i.e., by 16 July 2009 as per this recently declared provision. In order to increase in the capital such increase should be at a rate of 10 percent per annum at the minimum.

5 Banks to be established with foreign promoters' participation have also to be registered fulfilling all the legal processes prescribed by the prevalent Nepal laws.

6 To establish the commercial banks in all the places in the kingdom other than in the Kathmandu valley, the paid up capital must be Rs. 250 million. In this case, the commercial banks to be established outside Kathmandu Valley, share investment of promoters and general public should stand at 70 percent and 30 percent respectively.

7 Banks to be established outside Kathmandu Valley could be allowed to operate throughout the kingdom including Kathmandu Valley only on the condition that they have operated satisfactorily at least for a period of three years and they have brought their paid up capital level up to Rs. 1000 million and also fulfilled other prescribed conditions. Unless and until such banks do not get licence to operate throughout the kingdom, they will not be allowed to open any office in Kathmandu Valley.

8 Of the total committed share capital, the promoters has to deposit in NRB an amount equal to 20 percent along with the application and another 30 percent at the time of receiving the letter of intent on the interest free basis. The bank should put into operation within one year of receiving the letter of intent. The promoters have to pay fully the remaining balance of committed total share capital before the banks comes into operation. Normally, within 4 months from the date of filing of the application, NRB should give its decision on the establishment of the bank whether it is in favor or against it. If it declines to issue license, it has to inform in writing with reasons to the concern body.

 Regarding Promoters Qualification

1 Action on the promoters' application will not be initiated by the Nepal Rasta Bank if it is proved that their collateral has been put on auction by the bank and financial institution as a result of non-payment of loans in the past, who have not cleared such loans or those in the black list of the Credit Information Bureau and five years have not elapsed from the date of removal of their name from such list. The application will be deemed automatically cancelled irrespective of it being on any stage of process of license issuance if the above events are proved.

2 Of the total promoters, one-third should be its Chartered accountants or at least a graduate of Tribhuvan University or recognized institutions with major in economics or accountancy, finance, law, banking or statistics. Likewise, at least 25 percent of promoters group should have the work experience of the bank or financial institution or similar professional experience.

3 An individual, who is already serving as a director in one of the bank and financial institutions licensed by Nepal Rastra Bank, cannot be considered eligible to become the director in other banks or financial institutions.

4 Stockbrokers, market makers, or any individual/institution - involved as an auditor of the bank and institution carrying on financial transactions - cannot be a director.

 Regarding the Sale of Promoters' Share

1 Promoter group's share can be disposed or transferred only on the condition that the bank has been brought in operation, the share allotted to the general public has been floated in the market and after completion of three year from the date it has been registered in the Stock Exchange. Prior to the disposal of such shares, it is mandatory to get approval from the Nepal Rastra Bank.

2 The share allotted to the general public has to be issued and sold within three years from the date the bank has come into operation. Failing to fulfill such provisions, the bank cannot issue bonus share or declare and distribute dividends.

3 Shareholders of the promoters group and their family members cannot have access to loans or facilities from the same institution. For this purpose, the meaning of the family members will comprise of husband, wife, son, daughter, adopted-son, adopted-daughter, father, mother, step-mother and depended brother and sister.

Regarding Branch Expansion Policy

The Commercial banks established with a head office in Kathmandu will initially be authorized to open a main branch office in the Valley and thereafter, they will be authorised to open one more branch in Kathmandu Valley only after they have opened two branches outside Kathmandu Valley.

PROCEDURAL ASPECTS FOR ESTABLISHING A COMMERCIAL BANK

The following documents should be submitted sequentially while applying for the establishment of a Commercial Bank.

1. Following documents are required to be submitted along with the application to establish a commercial bank: -

1.1. Application

1.2. Bio-data of promoters

1.3. Feasibility Study Report on the proposed commercial bank in the format prescribed by the Nepal Rasta Bank.

1.4. Attested photocopies of the minutes within the promoters to organize the bank.

1.5. Promoters agreement relating to operation of the bank

1.6. Copies of Articles of Association and Memorandum in the prescribed format in the Company Act, 1996. The memorandum should compulsorily include, inter alia, the provision that no person, firm, company and related group of company will be allowed to hold beyond the 10 percent stake on the issued capital in one bank and altogether 15 percent stake in all the commercial banks.

2. Requirements in the case of participation of the firm established in Nepal:

2.1. Photocopy of firm registration certificate

2.2. Broad resolution stating the amount to be invested in the proposed bank

2.3. Certified photocopies of Articles of Association and Memorandum of the investing firm.

2.4. List of Directors and proportion of their share ownership

2.5. Tax clearance Certificate of the firm and its directors

3. Certified documents on prescribed amount deposited in the Nepal Rastra Bank

4. Commitment document of the collaborating foreign bank and financial institutions providing Technical Service Agreement in the case of proposed national level commercial bank to be established in the Kathmandu valley.

5. Additional requirements in the case of joint venture of foreign banks:

5.1 Certified minute of the board of directors of the foreign bank with a commitment of the amount to invest on the proposed bank establishing in Nepal.

5.2 Clearance letter from the regulatory authority or the central bank of the collaborating foreign bank.

5.3 Last three year's audited balance sheet, profit and loss statement and cash flow statements.

5.4 Certified copies of joint venture agreement with Nepalese promoters to invest in the proposed bank

5.5 A statement, in the case of the joint venture foreign bank has a holding bank and financial institution or a branch office or a representative office or liaison office in Nepal.

5.6 A justification, in the case of the joint venture foreign bank already has a joint venture in any bank or financial institution in Nepal.

Nepal Rasta bank will provide the letter of intent to the applicants to establish a bank within the four months of period the promoters of the proposed commercial banks have had submitted all the necessary documents and after the study and analysis of such documents only if it would be appropriate to incorporate the bank.

For this, to obtain a the Letter of Intent form the Nepal Rasta Bank, the certified document stating that the prescribed amount has been deposited, should be produced. If the bank is not appropriate to establish, the applicant will be notified by such information. The Nepal Rastra Bank will also provide the required period to make the bank operation while granting the letter of Intent. If the bank will not come into the operation within such time period, it can cancel the letter of intent provided to such bank.

Providing of letter of intent shall not be regarded as the approval to conduct the banking transactions.

After obtaining the letter of intent, following additional documents should be produced to the Nepal Rastra Bank seeking the approval to conduct banking transactions:

1. An Application

2. Technical service agreement in case of foreign joint venture

3. Certified documents stating that the committed amount by promoters has been deposited fully in the Nepal Rastra Bank.

4. The agreement document, if the bank premises are in rent, and the site plan of the bank building along with necessary layout required for bank operation.

5. Information on recruitments of Staffs

6. Statements on Software Application

7. Credit Policy Guidelines (CPG) of the Bank

8. Employees by-laws

9. Information on all the physical infrastructure that are required to operate a bank

The operating license will be provided only after the conformation that all the statements and documents are complete and on the basis of physical infrastructure inspection report submitted by physical inspection team comprising of members from Bank Operations Department, Inspection and supervision Department and Information Technology Department of this Bank.

Existing Supervision relating to the Banking Sector:

Promotion of financial stability, development of safe and efficient payment systems, regulation and supervision of banking and financial system and the promotion of healthy and competitive financial system are some of the objectives of functioning of Nepal Rastra Bank.

To attain the above objectives Section 84 of the Nepal Rastra Bank Act 2002 has entrusted Nepal Rastra Bank with the necessary powers to perform inspection and examination of any commercial banks or obtain necessary information for the purpose of supervision of the commercial banks.

Currently the Bank Supervision Department in Nepal Rastra Bank carries out the function of supervision of all commercial banks in Nepal. Since foreign banks have their presence only in the form of Joint Venture establishments – that is in collaboration with the local entrepreneurs – Nepal Rastra Bank supervises foreign establishes in the same manner as it supervises other local banks. For the purpose of supervision, the department is required to prepare annual supervision plan for onsite examinations as well off site surveillance of the commercial banks. The same is to be approved by the Governor of the Bank.

The Bank Supervision Department carries out both onsite examinations as well as off site surveillance of the commercial banks as per its annual supervision plan.

On site Examination

The Bank Supervision Department can carry out onsite examination of commercial banks in Nepal by sending examination team to the commercial banks. Onsite examination can be corporate level inspection covering all aspects of functioning of commercial banks or can be targeted branch level inspection.

The Department also performs follow up of the earlier examination reports by visiting the branches to ensure necessary compliance of the NRB instructions. If information as to functioning of commercial banks against the interest of depositors' or some serious irregularity is received, the Department can perform special on site examination in such cases. The Bank Supervision Department is required to carry out corporate level examination of all commercial banks at least once in a year as per its annual plan but the gap between two inspections at any time should not exceed two years. As per current policy of the Department, corporate examination of all commercial banks is carried out once in a year. For the guidance of the onsite examination, an "On site inspection manual" is in force. On completion of the onsite examination examiners perform CAMELS rating of the bank which is exclusively used for the supervisory purpose and is not revealed to general public.

Off site supervision

Off site supervision is a supplement to the onsite examination and is designed to act as an early warning system to identify banks with potential problems so that appropriate policies and action can be determined. Off site division of the Bank Supervision Department is carried out in a quarterly frequency as well as annual off site review based on the reports and returns submitted by the commercial banks

Quarterly offsite review

Off site division reviews performance of all commercial banks on quarterly basis which is submitted to the Governor of Nepal Rastra Bank. Such review involves assessment of the financial information as well as compliance of applicable rules regulations and legal provisions including NRB directives. Based on the review internal rating which is called CAELS Offsite Rating (COR) is also assigned to the banks.

Annual Balance sheet review

The Department's off site division reviews the balance sheet of the commercial banks at the end of each financial year and issues necessary instructions based on such review; this is then published in their annual report. In the course of such review the auditor's report, audited financial statements, long form audit report preliminary, audit report and banks reply thereon are studied. Based on the review of above report consisting of the review of financial performance, compliance with Nepal Rastra Banks directives and applicable legal provisions, adverse observations of the auditors and other significant findings is prepared and necessary instructions are issued to the bank thereon.

For the guidance of the offsite surveillance off site supervision manual is in force. Till now there is no difference in the supervision methods used for the banks with foreign investment and other commercial banks

FORAIGN BANK BRANCH:

The fifth Ministerial Conference at Cancun, Mexico which took place on 10 – 14 September 2003 approved the membership of the Kingdom of Nepal into the World Trade Organization (WTO) on 11 September 2003 (WTO, 2003), with Nepal subsequently becoming the 147th member of the organization on April 23, 2004 (WTO, 2004). Membership in the WTO entails a whole range of commitments along with their implementation time frames.

Financial services are the backbone of the modern economy. Financial services are crucial for savings and efficient resource allocation which facilitate economic growth. Internationalization can help countries build more robust and efficient financial systems by introducing international practices and standards; by improving quality, efficiency, and breadth of financial services; and by allowing more stable sources of funds. Realizing the enormous potential benefits that could be derived from the liberalization of financial services, countries have committed multilaterally under the GATS (Maskay et al forthcoming).

Presently, Nepal has not yet allowed foreign bank branches in the country and only permits commercial presence by a foreign financial institution – presently this is limited to a maximum equity of 75% (seventy five percent). However, during the course of accession negotiation for membership in WTO and at the request of some WTO members, Nepal has committed to allow foreign bank branches in the context of wholesale banking, only after 1 January 2010 (i.e. the transition period). In the mean time, the new Bank and Financial Institution Ordinance has been enforced from 2004, which has also incorporated a provision under section 4(3) that allows to incorporate a bank and financial institution in Nepal, fully owned as a subsidiary of a Foreign Bank or a Financial Institution.

The commitment on WTO for foreign bank branches in Nepal is of particular interest to the Nepal Rastra Bank (NRB) – the central bank of the country -- since it touches on the health and stability of the domestic financial system (NRB, 2002). That is, foreign bank branches have a direct impact on the health and stability of the domestic financial system through greater domestic competition in the financial sector from different corners like: financial intermediation in the domestic economy, technological transfer, greater level of service-choices to the consumers, higher levels of financial flows through the access to foreign capital, interlink of domestic financial system with global financial intermediation etc. Further, stability of the domestic financial system is important since it facilitates capital formation and assists in domestic economic growth and development.

Given the above description and necessity, it is essential to forward necessary rules and regulations to maximize the benefits from the commitment of allowing the presence of foreign bank branches in the country.

Definition and Concept of Bank Branches

The general definition for bank branches is “a system of banking in which a banking institution conducts branches or offices at locations other than that of the main or head office” (Woelfel, 1994, p.150). This is elaborated further, as stated in Woelfel (1994, p.150), by the Board of Governors of the Federal Reserve System defines bank branching as “a type of multiple-office banking under which a bank as a single entity operates more than one bank office.” That is, a  bank branch will not have a separate entity from the foreign bank implying there is no equity participating with the board of directors of the foreign bank who may not necessarily reside in the country of the bank branch2; this is also consistent with the definition put forward in the Basle Concordat which classifies a bank branch as “operating entities which do not have a separate legal status and are thus integral parts of the foreign parent bank.” However the bank branch can fulfill many functions of the head office; for example, in the January 1998 information pamphlet for establishment of a foreign commercial bank’s branch in Lebanon, it states that “the main activity of a foreign commercial bank branch is to carry out, on its behalf, credit operations from funds received from the public. Its main activity can be fiduciary operations and portfolio management on behalf of other parties. The branch can carry out brokerage activities and can perform all operations related or complementing its main activities”.3 Likewise, the branch may have access to the financial strength of the parent bank as well as access to the capital of the parent bank – it is important to note that this function will touch on the capital account.

In Nepal, a similar definition applies which is set forth in the existing framework for bank branches as conveyed in the Banking and Financial Institutions Ordinance 2062 (BAFIO 2062), whose relevant portions are discussed later and provided in a annex (technical) 1.1. In that Act, the terms and conditions of bank branches will be determined by the Nepal Rastra Bank after taking into consideration a number of factors (Article 34, BAFIO 2062). Nonetheless, it has clearly stated that foreign “offices”, such as branches, must be established according to the terms and conditions prescribed by the NRB (Article 34, BAFIO 2062).

However, limitations in the activities of bank branches are prevalent, especially at the operational level. For example in Canada, full-service bank branches are not allowed to take retail deposits, but will be able to take deposits above $150,000 while a lending branch will not be permitted to take deposits, large or small, or borrow from the Canadian public; the primary business is to make loans (Canada, 1999). Similarly, Nepal has committed only to wholesale banking reflected in the negotiations in the accession for WTO membership (WTO, 2004). Further, in USA, state authorization of branch banking varies according to a determined broad range of categories, as put forward in Woefel (1994, pp. 150 – 151). Likewise, Indonesia has limited to opening based on geographical locations while in India and Pakistan, there are limitations to access of parent bank capital, which may be due to implications on financial flows and consistency with their respective policy on the capital account. The list, of course, goes on.

The important aspect for bank branches and financial stability is in regard to their monitoring and supervision. In most countries, these institutions would be subject to the same prudential regulation as regard to domestic financial institutions. For example, in the Indian “Foreign Bank Branch/Subsidiary Policy”, foreign financial institutions have to undergo on-site as well as off-site inspection, which is equal to that of domestic financial institutions. Interestingly, for Canada, foreign bank branches face “lighter Canadian regulatory requirements” since they do not take foreign deposits; further it is stated “in addition, satisfactory regulation by the home country regulator will be one of the conditions of allowing individual foreign banks to set up branches in Canada” suggesting that part of the monitoring will also be done by the home country. Likewise in the Nepal case, in the above-mentioned Act, the regulation stipulates that such “offices” would come under the supervision of the NRB (Article 52, BAFIO 2062) although supervision from the home country parent bank is also allowed with approval from NRB (Article 53, BAFIO 2062). An important issue concerning the supervision of foreign bank’s branches is the coordinated roles of parent authority, parent bank and host authority. Adequate supervision of banks’ foreign establishments calls not only for an appropriate allocation of responsibilities between parent and host supervisory authorities but also for contact and cooperation between them (Principles for the Supervision of Banks Foreign Establishments, May 1983).

Commitments to allow the foreign bank branches in Nepal in the context of WTO membership:

During the course of negotiating for accession to WTO, Nepal made commitments for bank branches. However, three aspects are worth mentioning. First, there is a transition period where foreign bank branches are only allowed as of January 1, 2010. Second, entry of financial institutions are limited to a rating of at least “B” by Credit Rating Agency e.g. MOODI, Standard & Poor etc. Lastly, establishment of foreign bank branches are subject to the domestic laws, rules and regulations and terms and conditions of the Nepal Rastra Bank.

Special provision for Foreign Bank or Financial Institution to open their office:

A foreign Bank or Financial Institution desiring to open its office within the Kingdom of Nepal must submit an application to NRB in the form as prescribed along with the fees and particulars as prescribed. The NRB may issue a license to foreign Bank or Financial Institution to carry on financial transaction by allowing them to open a office within the Kingdom of Nepal taking into account the situation of competition existing in the banking sector, the contribution that could be rendered in the Nepalese banking sector and the reputation of such foreign Bank or Financial Institution.

The NRB may specify necessary terms and conditions in the course of granting transaction license and it shall be the duty of the Foreign Bank or Financial Institution to comply with such terms and conditions. The section 34(4) of the ordinance reiterates that the provisions of the ordinance are to be complied by such foreign Bank or Financial Institution. The foreign Bank or Financial Institution, which has been issued license to operate financial transaction by opening its office within the Kingdom of Nepal, can not open another Bank or Financial Institution in Joint Venture within the Kingdom of Nepal. However, the provision for the contact or representative office of any foreign Bank or Financial Institution will be as prescribed by Nepal Rastra Bank.

CONCLUSION

Financial institutions play an important role in financial intermediation to efficiently allocate scarce funds – this will spurt economic growth and development. That is why the multilateral commitment by the Kingdom of Nepal for allowing foreign (wholesale) bank branches "as of" 1 January 2010 is of great interest to the Nepal Rastra Bank since it will facilitate sustainable economic development of the country. To ensure that the Bank is fully prepared to provide appropriate rules and regulations in this regard, the Bank's High Level Committee of WTO matters established the interdepartmental taskforce entitled - “Foreign Bank Branches and the Health and Stability of Nepal's Financial System".