Impact of Government Policy

and Regulations in Banking

“I sincerely believe that banking
establishments are more dangerous
than standing armies”

- Thomas Jefferson
(3rd President of USA)
 Banking Regulation
Significance
 Money is the sensitive assets of bank
 Banks involve only in monetary transaction
 Finance ministry and Central bank are know as the
prime regulatory agencies for banking sector
 Government provide permission for establishing
new Bank in country
 Bank examines carefully and review the quality of a
bank loan.

S.B.Khatri
Regulations generally related
with:
 Operations
 Service offerings
 Credit quality and quantity
 Capital positions
 Manner in which they grow and expand
 Banking Regulations
 Climate of extensive regulations
 Designed primarily to protect the public interest
 Eg. FDIC – Forever Demanding Increased Capital
(sarcastically put)
 More capital, more reserves, more public service,
more reports
 Extreme – bank owners cant even choose to close
its doors and leave industry unless they obtain
explicit approval
 Banks are in essence the “kids” with the
strictest parents on the block.
 Why banks are Heavily
Regulated: Pros and Cons
1. Banks are among the leading repositories of
the public’s savings – esp of families and
individuals
2. Loss of these funds due to bank failure or
bank crime would be catastrophic to many
individuals or families
3. Savers and Depositors lack the expertise
and depth of information needed to
correctly evaluate the riskiness of a bank.
 Regulatory Agencies are charged
with the responsibility of
gathering and evaluating the
information needed to assess the
true condition of banks and other
financial institutions to protect the
public against loss
 ……..
4. Because of their power to create money in
the form of readily spendable deposits by
extending credits.
 Changes in volume of money created by
banks appear to be closely correlated with
economic conditions, especially the growth of
jobs and the presence or absence of inflation.
5. They support consumption and investment
spending.
However, the fact that banks and many of
their nearest competitors create money,
which impacts the vitality of the economy
is not necessarily a valid excuse fo
regulating them.

As long as government policymakers can

control a nation’s money supply, the
volume of money that individual financial
firms create should be of no great concern
to the regulatory authorities or to the
public.
 ………..
6. Discrimination (in granting credit) can
create obstacle in personal and business
well-being.

7. Banks have long history of involvement with

government – federal, state and local.
 Historically banks have been first resort of credit
for governments.
 Perhaps, the government could eliminate
discrimination in providing services to the
public, simply by promoting more
competition among providers of financial
services to the public simply by promoting
more competition among providers of
financial services, such as by vigorous
enforcement of the antitrust laws, rather
than enough regulation.
 The Principal reasons banks are
subject to government regulations
1. To protect the safety of public’s savings
2. To control the supply of money and credit in order to achieve a
nation’s broad economic goals
3. To ensure equal opportunity and fairness in the public’s access to
credit and other financial services
4. To promote public confidence in financial system, so that savings flow
smoothly into productive investment, and payments for goods and
services are made speedily and efficiently.
5. To avoid concentrations of financial power in the hands of a few
individuals and institutions
6. To provide the government with credit, tax revenues, and other
services
7. To help sectors of the economy that have special credit needs
In the US, banks are regulated through a dual
banking system

Both federal and state authorities have

significant regulatory powers.

This system was designed to give the states

closer control over industries operating within
their borders, but also, through federal
regulations, to ensure that banks would be
treated fairly by individual states and local
communities as their activities expended across
state lines.
 US: Principal Regulatory
Agencies
 Federal Reserve System
 Comptroller of the currency
 Federal Deposit Insurance Corporation
(FDIC)
 Department of Justice
 Securities and Exchange Commission (SEC)
 State Banking Boards or Commissions
 US: Major Banking Laws
 Laws limiting bank lending and loan risk
 Laws restricting the services banks can offer
 Laws expanding the services banks can offer
 Laws prohibiting the discrimination in offering banking
services
 Laws mandating increased information to the consumer of
banking services
 Laws related to branch banking
 Laws regulating bank holding company activity
 Laws regulating bank mergers.
 Laws assisting federal agencies in dealing with failing banks
 Meet the “Parents”
 National Currency and Bank Acts (1863-64)
 Federal Reserve Act (1913)
 The Banking Act (1933) – Glass Steagall
 FDIC under the Glass Steagall Act
 FDIC Involvement Act (1991)
 Social Responsibility Laws
 The Riegle-Neal Interstate Banking Law (1994)
 The gramm-Leach-Bliley Act (1999)
Strict Rule Vs. Lenient Rules
 Possible impacts of regulation on the
banking and financial services industry
are in dispute.

 Earliest Theories about regulation by

“George Stigler” “Samuel Petzman” and
“Edward Kane”
Cont…
1. “George Stigler”, argues that firm in
regulated industries actually seek out
regulation because it bring benefits in the
form of monopolistic rents due to the fact
that regulation often block entry into the
regulated industry.
2. Thus some banks may lose money if
regulation are lifted because they will no
longer enjoy protected monopoly rents that
increase their earning
S.B.Khatri
Cont…
2. “Samuel Petzman” contends that
regulation shelters a firm from changes
in demand and cost, lowering its risk.
If it is true, this implies that the lifting
of regulation in banking world subject
individual bank to greater risk and
eventually result in more bank failures.

S.B.Khatri
Cont…
3. “Edward Kane” agreed that adequate
regulating can increase customer confidences
in bank. Kane believe that regulators actually
compete with each other in offering
regulatory services in an attempt to broaden
their influences among regulated bank. He
also argues that there is an ongoing struggle
between regulated bank and regulators.
(regulatory dialectic)

S.B.Khatri
 Once regulations are set in place, financial
service managers will inevitably search to
find ways around the new rules in order to
reduce costs and allow innovation to occur.
 If they are successful in skirting existing
rules, then new regulations will be created,
encouraging financial managers to further
innovate to relieve the burden of the new
rules.
 Thus, the struggle between regulated firms
and regulators go on indefinitely.
 Kane also believes that regulations provide
an incentive for less regulated businesses to
try to win customers away from more
regulated firms, something that appears to
have happened in banking in recent years,
as mutual funds, financial conglomerates
and other less regulated financial firms have
stolen away many of banking’s best
customers.
 IMPACT OF GOVERNMENT POLICY &
REGULATION ON BANKING

Banking Regulations in Nepalese Context:

Nepal Rastra Bank issues various regulations

in the form of Directives to improve the
safety, soundness and efficiency of the
financial system and banking sector.
 Why Regulations

• For the safety of the depositors

• To control the supply of loans and advances
• To ensure equal opportunity and fairness in the public’s
access to credit and other financial services
• For maintaining sound corporate governance
• To maintain discipline (financial and operating)
• To provide the government with credit and other services
• To facilitate Nepal Rastra Bank (NRB) and its policy
implementations
 BANKING REGULATIONS IN NEPALESE CONTEXT

DIRECTIVES RELATED TO THE FOLLOWING

1. Capital Adequacy
2. Loan Classification and Provisioning
3. Credit Concentration and Single Obligor Limit
4. Accounting Policy and Formats For Financial Statements
5. Management and Minimization of Risk
6. Good Corporate Governance
7. Compliance with the Directives issued in connection with Inspection and
Supervision
8. Provision related to Investment in Shares and Investments
9. Reporting Requirements
10. Provision related to Purchase & Sale of Promoter Shares
11. Others: Branch Expansion, Profitability, Dividends etc.
DIRECTIVES RELATED TO THE FOLLOWING

1. Capital Adequacy
From FY 2068/ 69
Minimum Capital Adequacy Requirement
• Core Capital: 6%
• Capital Fund: 10%
DIRECTIVES RELATED TO THE FOLLOWING

Core Capital:
• Paid-up capital
• Share Premium
• Non Redeemable Preference Share
• Statutory Reserve
• Retained Earnings
DIRECTIVES RELATED TO THE FOLLOWING

Supplementary Capital:
• General Loan Loss Provisioning
• Exchange Equalization Reserve
• Assets Revaluation Reserve
• Hybrid Capital Instruments
• Subordinated Term Debt
• Free Reserve
• Additional Loan Loss Provision
DIRECTIVES RELATED TO THE FOLLOWING

Total Capital Fund = Core Capital + Supplementary Capital

Capital Adequacy = Total Capital Fund x 100

Risk Weighted Asset
< OR = 10%
Examples Of Risk Weighted Assets
(Get Updated with recent NRB Directives)
www.nrb.org.np
DIRECTIVES RELATED TO THE FOLLOWING

2. Loan Classification & Provisioning for Loan

Loss:
• Good Loan : < 3 months principal due
• Substandard Loan : >3 months < 6 months due
• Doubtful Loan : >6 months < 1 year due
• Bad Loan : >1 year due
DIRECTIVES RELATED TO THE FOLLOWING

3. Credit Concentration & Single Obligor Limit:

Fund based : 25% of the Core Capital

Non Fund based : 50% of the Core Capital

• L/C and T/R (Trust Receipt)

 DIRECTIVES RELATED TO THE FOLLOWING

4. Accounting Policies & Formats of Financial

Statements
4.1. Road Map on Financials:
Fiscal Year - Shrawan 1 - Ashad End
Statutory Forms of Nepal Rastra Bank
DIRECTIVES RELATED TO THE FOLLOWING

4.2. Major Accounting Policies

• Cash Flow Analysis
• Depreciation Method
• Provision for Corporate Tax
• Provision of Investment
• Provision for Foreign Exchange Fluctuation
• Non Banking Asset
• Non Capitalized Items
• Cash Basis
• Loan Loss Provision
• Interest Suspense
DIRECTIVES RELATED TO THE FOLLOWING

4.3. Notes on Accounts

4.4. Assets & Liability

4.5. Income Statement

DIRECTIVES RELATED TO THE FOLLOWING

5. Management & Minimizing of Risks

5.1. Risk Classifications
• Liquidity Risk
• Interest Rate Risk
• Foreign Exchange Risk
• Credit Risk
 DIRECTIVES RELATED TO THE FOLLOWING

6. Good Corporate Governance

6.1. Directors / Promoters
6.2. Duties & Responsibilities of the Board of Directors
6.3. Chief Executive Officer
6.4. Employees
6.5. Audit Committee
6.6.Prohibited to provide credit to the Promoters/major
Shareholders
DIRECTIVES RELATED TO THE FOLLOWING

7. Compliance with the Directives issued in connection with

Inspection & Supervision
• Credit Operation
• Loan Loss Provision
• Loan Portfolio
• Credit Policy
• Capital Adequacy
• Asset Liability Management
• Internal Audit
• Quarterly Progress Report
• Planning
 DIRECTIVES RELATED TO THE FOLLOWING

8. Provisions relating to Investment in Shares &

Investments
Investment Policy:
• Venture Capital
• Investment on Shares
 DIRECTIVES RELATED TO THE FOLLOWING

9. Reporting Requirements
•13 different forms to be filled
10. Provisions relating to purchase & sales of
Promoters Share
• 5 years restriction Clause
11. Others :
• Branch expansions, profitability,dividends etc.
 Impact of Deregulation on Banks Performance &
Growth

• Perfect Competition among the banks

• Innovation of new products and services
• Sales and Profit growth
• Deposit base shifted to expensive customer accounts
• Bank risk increased – esp interest rate risk
• Rising operating costs
• Increase in fees
• Higher returns to depositors
ARE ANY BANK REGULATIONS REALLY
NECESSARY?

YES
But Efficiently, Exact Adequatey
 George Benston
 It is time we recognize that financial
institutions are simply businesses with only
a few special features that require
regulation
 Depository institutions, for e.g., should be
regulated no differently from any other
corporation with no subsidies or other
special privileges.
 He contends that the historical reasons for
regulating the financial sector – taxation of
monopolies in supplying money, prevention of
centralized power, preservation of solvency to
mitigate the adverse impact of financial firm
failures on the economy, and the pursuit of social
goals are no longer relevant today.
 Moreover, regulations are not free: they impose
real costs in the form of taxes on money users,
production inefficiencies and reduced competition.
 The trend under way today all over the
globe is to free financial service firms
from the rigid boundaries of regulation;
however, much still remains to be done
if we wish to enhance the benefits of
free competition to financial institutions
and the public they serve.
 Regulation must be balanced
and limited so that:
a) Banks can develop new services that the
public demands
b) Competition in financial services remains
strong enough to ensure reasonable prices
and an adequate quantity and quality of
service to the public
c) Private sector decisions are not distorted in
ways that misallocate and waste scarce
resources
 Impact of Regulations on
Banks
 Brings benefits in terms of monopolistic rents,
because, regulations block entry into the regulated
industry.
 Regulations shelters a firm from changes in
demand and cost, lowering its risk.
 Regulations increase public confidence in banks
 Provide incentive to less regulated businesses to
try to win customers away from regulated
businesses.
 Regulatory Dialectic
 Ongoing struggle between regulated firms and the
regulators
 Once regulations are drafted and set in place,
banks will inevitably search to find ways around the
new rules through innovation in order to maximize
the value of each banking firm.
 If bankers are successful in skirting around existing
regulations, then new rules will be created,
encouraging banks to seek future innovations in
services and methods.
 The Central Banking System
 Central bank is the supreme monetary
institution
 It control, supervise and regulate other
banks
 It manages the currency and credit policy of

the country
“Central Bank is the lender of last resort”
by: Hawtre
Cont…
 “Central Bank is a bank which
constitutes the apex of the monetary
and banking structure of the country”
By: De kock
 “The Central Bank stands to the
member banks in exactly the same
relation as the member banks
themselves to the public”
By: Crowther
S.B.Khatri
Major Function of Central
Bank
 Issue of notes
 Manage foreign currency
 Developing banking and financial system
 Lender at last resort
 Mobilizing capital
 Government banker
 Banker’s bank
 Implementation of policy and development
S.B.Khatri
Main objectives of NRB
 Promote efficiency of commercial bank
to operate in profit
 Ensure adequate fund to meet all cash
demand
 Maintain clear and fraud free financial
transaction
 Record all financial transcation as per
the banking rules
S.B.Khatri
 Impact of Central bank
 Bank and Financial system are the
backbone for development of country
 Monitoring system is a check and follow up
system
 NRB monitors bank & financial institution
 Bank & financial institution are involved in
deposit and loan process
 NRB also provide advices and instruction
S.B.Khatri
Procedures of supervisory and
monitoring system
 Off-site supervision
 On-site supervision
 Special supervision

S.B.Khatri
Principal tasks of Central bank
 Issue of note
 Bankers’ bank
 Banker, Agent and Adviser to the government
 Lender at Last Resort
 Clearing Agent
 Custodian of Foreign Exchange Reserves
 Controller of Credit

S.B.Khatri
Cont…
 Development Role
 Control and Supervise Financial
Institution
 Other miscellaneous function

S.B.Khatri
Role and Need of central bank
in Economy
 Traditional Role
 Economic Growth
 Price stability
 Development of Banking System
 Branch Expansion
 Development of Financial Institution
 Promoting the Banking habits
 Training Facilities
S.B.Khatri
Cont…
 Proper Interest rate structure
 National Debts Management
 Balance of payment
 Credit control
 Monetization of economy
 Implementation of monetary
 Other promotional roles
S.B.Khatri