Pitfalls of overregulation in bankingA regulatory regime is essential only if the banking system moves beyond the obsession of fully collateralised lending.
Even the most ardent advocates of free market capitalism have concurred that regulation of the financial system, particularly of the banks, is indispensable. The two most prominent rationales for such regulation are to prevent the banks from potential moral hazards in lending the depositors' money to risky projects for quick profits, and to maintain the overall stability of the fanatical system of the economy concerned.
The global financial crisis of 2008-09, triggered by American subprime lending, reinforced the idea of stricter regulation of the financial sector so as to avoid similar catastrophes in future. A comprehensive study in 164 countries by the World Bank entitled 'Bank Regulation and Supervision Ten Years after the Global Financial Crisis' concludes, 'bank supervision became stricter and more complex compared with the pre-global financial crisis period.'
Despite criticism, a few key neoliberal concepts on financial governance like the central bank independence and its obligation to focus on the core function of inflation targeting 'theorised' thorough discourses like Augmented Washington Consensus have not only survived but, generally, consolidated. However, the risk-weighted capital (adequacy) regulation has rather obsessively preoccupied the regulators. In parallel, the self-regulatory regimes designed for the bank and financial institutions primarily in compliance with the Basel III regulatory framework have come into practice, albeit to a varied extent in different countries. The overarching objectives of these developments are rooted in the principle of 'minimal government' where the regulator and each individual bank became robustly professional and efficient. Only then can the financial sector effectively contribute to the economy by investing in entrepreneurial and value chain ecosystems.
Compromise and arbitrage
If viewed through the lenses of global best practices, Nepal's financial system suffers from a paradox of overregulation on the one hand and, on the other, massive regulatory arbitrage by the industry players. Every successive leadership in Nepal Rastra Bank (NRB), despite its very powerful NRB Act (2002), has failed to assert its deserved independence. The powerful political shadow of the government of the hour has persistently cast on it not only during key appointments of governors and deputy governors but also in day-to-day administration. The preference of the personal loyalty of the candidates to powerful rulers over the academic and professional qualifications, as manifested in the recent appointment of two deputy governors of the Bank, is gradually rendering the central monetary authority a toothless entity. Therefore, the compendium of NRB directives is burgeoning but effectiveness is not.
The central bank has miserably failed to timely update its outlook towards the financial industry and introduce risk-mitigating instruments. Even in this era of information technology, physical presence and paper verification of the customers is ever increasing. No substantive borrowing is possible without pledging immovable property as collateral. Although the Risk Management Guidelines of NRB states the banks would 'analyse of borrower’s repayment history as well as current and future capacity to repay, based on historical financial trends and future cash flow projections. For commercial credits, the borrower’s business expertise and the condition of the borrower’s economic sector and its position within that sector' needed to be reviewed.
But, all these parameters are essentially meaningless as only the value of the property with an arbitrary haircut is factored in while evaluating the creditworthiness or calculating the limit of the loans. The blacklisting provisions are applicable to only a few voiceless borrowers while about 500 large business houses never feature in the list even when their defaults amount to millions. The combined effect of such a laidback approach of the key regulator and volumes of regulations of very vague nature without the real prospect of implementation, in fact, have provided a wide room for regulatory arbitrage to the players in the banking sector.
For example, what is the extent banks can intrude into the private information of a customer; particularly the borrower? It is not specifically clear in any NRB guidelines. The unified directive says, 'information about customers is often confidential, in that it is provided under the terms of a legal agreement or counterparty relationship.' But this has not stopped the banks from asking very personal financial details of bank accounts and employment agreements, beyond legally valid tax return certificates, of the family members who are not necessarily responsible for the repayment of personal type loans. It is clear that banks have found it easier to securitise the loans in this easy fashion of bullying than dwelling on financial and credit history analyses of the client.
The apparent causal effect of overregulation, as if designed to facilitate only to the landlords of the feudal era, is evident in the historically low level of entrepreneurship. It is due to the extremely low level of access to bank credit. It is evidenced by the NRB data itself that the total number of deposit accounts has crossed 31 million while the total number of loan accounts is barely 1.5 million. Young innovative minds with entrepreneurial intentions and, often, with relevant academic degrees have become the primary victim of the conservative regulatory regime that constricts people who do not own the immovable property (on top of this requirement, banks only accept property with access to a motorable road) from accessing loans directly from banks.
A large number of women with business acumen, who for various reasons of deprivation do not own any immovable property, are also deprived of the opportunity. The symbolism of small-ticket 'collateral free' or 'targeted loans' has very little or no impact on economic output. These are the reasons Nepal's import dependency is horrifically increasing on every passing day, productivity is declining and potential young entrepreneurs are leaving the country in hordes.
As a matter of fact, a regulatory regime is essential only if the banking system moves beyond the obsession of fully collateralised lending where creditworthiness and project-worthiness become the major basis for investment. Then, the regulators and market players will also be forced to leave behind the 'logistic management' and embark on the domain of statistical and technical risk analyses of the entire financial system and, individually, of their own. Nothing should have stopped the NRB to depart from this conservative mindset and to devise appropriate formulae and risk-hedging instruments that address the emerging market needs.