A Brief History of Financial System of Nepal

Suman Raj Subedi

Faculty of Management, Everest College
Ex- Banker

A financial system is an economic arrangement wherein financial institutions facilitate the transfer
of funds and assets between borrowers, lenders, and investors. Its goal is to efficiently distribute
economic resources to promote economic growth and generate a return on investment (ROI) for
market participants. A financial system is a set of institutions, such as banks, insurance companies,
and stock exchanges, that permit the exchange of funds. The financial system of Nepal is largely
dominated by the banking system. When we go through the history of Nepal, we can witness the
gradual development of financial system in Nepal across time. Ancient Nepal used to be the center
for trade with Tibet, it means Nepal had a practice of limited banking functions from the very
beginning of Lichchhibi dynasty but not in an institutional way. It has written that then king
Gunakamadev had taken loan to rebuild the Kathmandu once and Sankha Dhar Sakhwa, a
philanthropist, had paid off the loans of poor people of Kathmandu and this special day is still being
remembered as the beginning of Newa Sambat. These are the historical facts evidencing the
existence of limited banking practices in ancient Nepal. Even though, start of the institutional
banking could be found in the year 1933 BS only as Tejarath Adda was established by Ranodeep
Singh, the next Rana prime minister after Janga Bahadur Rana. Tejarath Adda used to lend funds
against gold and silver to then landlord, government employees etc and deposit to this entity used
to come from the Government. This entity used to conduct limited banking functions but it was
beyond the reach of general public. The first milestone in the history of institutionalized modern
banking in Nepal had been achieved in the year 1994 BS only at the establishment of Nepal Bank
Limited. Nepal Bank Limited was the first commercial bank established for the mobilization of
deposits and extending loans to the general public as well as providing various other financial
services and solutions to them. Sadar Muluki Khana (Taksar) was established in the year 2002 BS in
order to issue coin and currency notes as well as to maintain the Government’s account, later,
Taksar has been taken over by Nepal Rastra Bank.

After few years from the end of Rana Regime, the country started to take a pace in the economic
development and soon realized the necessity of the separate central bank to look after the
monetary policy and foreign exchange regulation issues, currency publishing and managing, working
for price stability and the control of inflation rate and also to supervise and regulate the banking
sector to let it flourish ahead. NRB Act 2012 BS was first prepared and enacted and the separate
entity named Nepal Rastra Bank was established as the central bank of Nepal in the year 2013 BS
under the same act.

The cooperative movement in Nepal began with the establishment of the first cooperative - Bakhan
Multi-purpose Cooperative Institute - in Chitwan district way back in 2014 BS. Afterwards, the first
Cooperative Act was enacted in 2017 BS. The cooperative movement, however, did not pick up
momentum until 2037 BS, when a large number of community-based savings and credit
cooperatives came up across Nepal. In fact, liberalization and open market economy adopted in the
year 2046 BS further helped the emergence and development of cooperatives in the country. As the
cooperative movement spread to every nook and cranny of the country, several problems have also
emerged in this sector as this sector is fundamentally on the principle of self-regulation rather than
being in control of a dedicated regulator. The Cooperative Department of the Government is the
regulatory authority of this sector but the regulation style is an administrative as well as educational
process rather than direct controlling with continuous supervision. Major problems of cooperative
development in Nepal are dominance of few influential members and misuse the fund, other
dormant members, weak governance and management, untrained human resources, lack of
business plans and strategies, weak monitoring and MIS reporting, no adequately set performance
standard, weak portfolio management etc. Even though, there are plenty of problems in this sector,
this sector is one of fundamental bases of our economy which need to be carried forward for the
economic development of the nation.

In the year 2016BS, a separate entity named Nepal Industrial Development Corporation (NIDC) was
established in order to arrange funding as well as technical assistance for the development of
industries in the country. Despite of its noble objectives of establishment, NIDC after being operated
for decades as a chronic institution, finally got merged with Rastriya Banijya Bank (RBB) in the year
2075 BS. In the year 2019BS, an institution named Employee Provident Fund (EPF) was established
as the financial intermediary of nonbanking nature with the purpose of collecting and mobilizing
provident fund contributions of Government and other sector’s employees. EPF, today, has a
significant role in the financial system as a biggest non-banking financial institution and contributing
the system by investing its fund in various big projects, infrastructure projects, promoting various
other financial institutions, taking part in number of consortiums as well as providing institutional
deposits to the number of banking institutions.

Two different entities were first established as Cooperative Bank and Land Reform and Saving
Corporation (LRSC) in the years 2021BS and 2023BS respectively and the both are later merged to
form Agriculture Development Bank in the year 2024 BS to work for the development of agriculture
sector of Nepal by providing cheaper loans as well as technical knowhow. Later, from the year 2031
BS, ADB obtained the license also to work as a commercial bank and started to work as a full phase
commercial bank thereafter. Before establishment of ADB as a merged entity, Rastriya Banijya Bank
was established as the second commercial bank of Nepal in the year 2022 BS. After it, altogether
four banks consisting of two commercial and two development banks but all entities completely
owned by the Government remained in existence creating monopolistic like situation until the
establishment of Nepal Arab Bank Limited (Now called Nabil Bank Limited) as the first private sector
joint venture bank in the year 0f 2041 BS. In the meantime, two separate entities named National
Insurance Corporation (2024BS) and Nepal Insurance Corporation (2025BS) were established in the
first two entities under the insurance sector. Soon, Insurance Board (Beema Samiti) was established
in the year 2026 BS as the separate Regulator of the Insurance Sector which with the enactment of
Insurance Act, 2079 BS is converted into Nepal Insurance Authority. Another separate entity Credit
Guarantee Corporation (now called DCGF) was established in the year 2031 BS. to provide insurance
coverage to loans and deposits within certain limits extended by the banks and financial institutions.
These developments in financial sector had been obtained when the Government and the policy
makers realized the factor that further economic development of the nation won’t be possible
unless more players in financial and banking systems were added. For it, the Government
promulgated separate acts for commercial banks, finance companies and development banks first in
the years 2031 BS, 2042 BS and 2052 BS respectively. As a result of opting such liberal policy by the
Government, NABIL bank was established in the year 2041 BS in joint venture with Dubai Bank
Limited, Dubai.

Soon in the year 2046 BS, our country became free from the single party autocratic panchayat
system and multiparty monarchial democratic system was restored in the country. The Governments
formed after this historic event opened new dimensions to support the further flourishment of
financial system through their financial liberalization policies. As a result, various players in the
financial system like several banks, development banks, finance companies as well as micro finance
or rural development banks were established in the nation with separate objectives. Meantime, the
financial health of two large Government owned commercial banks (RBB and NBL) became chronic
due to weak credit management and the lack of corporate governance. Government had to put
extra capital along with taking assistance of foreign management and foreign aid then only the both
banks could have been revived at the present level with a lot of hard works and difficulties. While
assessing the various reasons of failure of country’s two largest banks, it was found that a prominent
reason was the poor regulation and supervision of NRB. Such situation was the outcome of various
shortcomings of NRB like structural problem, inefficiency of then staffs and legal incapability and
complications due to the old and inadequate act of 2012BS. Realizing the same, NRB act was
amended as NRB act 2058 BS which first provided the legal foundation for the structural reform of
NRB itself as well as established NRB as the strongest authority for regulating banking system.
Meantime, the secondary capital market took its final shape as Nepal Stock Exchange Limited in the
year 2049BS from its separate evolution from Securities Marketing Center (2034) through Securities
Exchange Center (2041BS). Security Board of Nepal (SEBON) was later established in the year 2050
BS as the regulator of capital and bond market. Citizen Investment Trust (CIT) was founded in 2047
BS with the objective of ensuring broader participation of general public in economic development,
encouraging the citizens to save, enhancing investment opportunities for raising capital, opening up
employment opportunities and thus bringing dynamism in the capital market.

From the year 2050BS, it was quite unfortunate for the country as start of civil war in the name of
Maoist Movement took place which remained for a period of more than a decade. This unfortunate
event has been understood as the main cause of derailing of economic development of the nation
even though several political achievements have been obtained as outcomes of the struggle. Almost
all sector of economy got badly affected from this movement but the banking sector still managed
to develop and perform but probably in a reduced pace. Many nations which were like us in terms
of financial strength at that time have developed themselves leaving us far behind until a relief from
the insurgency was obtained when the Maoist joined hand with other parties and came into main
line politics in the year 2062 BS.
The other alarming problem creating obstacles for the effective regularization of the banking sector
at that time was the existence of three separate acts governing all four types of banking institutions.
Due to separate acts for separate types of banking institutions, supervision and regulation functions
were being full of legal complexities and NRB even needed to issue separate directives to regulate
various banking institutions with the functioning of similar nature. In the year 2063, BAFIA (Bank
and Financial Institution Act) was promulagated by the parliament and enacted as a single unified
umbrella act to regulate all types of banking institutions replacing the earlier separate acts. BAFIA
was later amended in the year 2073 BS and the current active act to govern the banking institutions
has been BAFIA 2073 BS till now. Being a member of WTO (World Trade Organization), someday
Nepal needs to be opened for the branches of the foreign banks as well and we can find the legal
provisions to open such branch in current BAFIA but with some restricted provisos of doing banking
business here. To compete with the international banks and remain in the international banking,
NRB took tougher steps to implement Basel standards for Nepalese banking sector. As a result,
minimum capital requirements to operate banking institutions have been increased to enhance the
risk absorption capacity of Nepalese banks and financial institutions. The minimum capital
requirement for operating commercial bank was first raised to 2 billion and later to 8 billion. During
these periods, many case and problems came to challenge the banking system and NRB
continuously addressed the remedial solutions and always ensured not to let repeat such
problematic situation again in banking through the issuance of various directives. NRB has emerged
as a better regulator in the course of time through various trial and error efforts in dealing with
banking problems.

It was then necessity of time to increase the number of players in the financial system to break the
monopolistic like situation of Government banks and entities and also to flourish the economic
development of the country. But the Government and NRB failed to trace out the upcoming
negative implications in the economy due to the existence of larger number of financial players in
the small economy like ours and let more institutions to be opened than actually required by the
economy. By the end of Ashad, 2069, the number of commercial banks reached to 32 with same
type of substantial increase in other type of banking institutions also. This situation created many
unethical practices in banking and later NRB realized that the reduction of number of institutions in
the financial system through merger and acquisition has become quite necessary. In the same line,
NRB has offered various incentives promoting the mergers and acquisitions as a result of which the
number of banking institutions has been decreased substantially. Now the number of commercial
banks as on end of Ashad, 2080 has dropped down to 20.

The remaining undealt important issues that should be addressed in the coming period for the
betterment of the financial system of Nepal are to modernize all establishments with the
applications of latest best practices found throughout the world and dilute the stake of business
people in banks and other institutions of financial system. To establish ethical financial and banking
system like we find in studying books, a country must make its financial system free from the
dominance of certain business groups.