Two years ago, I was on a trip to Dubai. When I reached the hotel, a Nepali staff picked up my luggage. I asked him how long he had been working in the country. He said it was his second stint there. He previously worked there, earned a decent amount, returned to Nepal and started a business. However, over time, he suffered huge losses that drained all the money he had earned in Dubai. He had no choice but to give up the business and fly again to Dubai. I asked him how he failed. He said he bought everything in cash and sold it in udharo (credit). He added that many people didn’t pay; some gave him money after a long time, which bore him huge interest. 

This story has become one of the chronic problems in the Nepali market. Even though there is a demand and supply of goods, the absence of contracts to enforce payments has resulted in bankruptcies. One incident came to light recently but in a more pronounced and tragic way: Prem Acharya perished due to self-immolation as he couldn’t bear losses caused by long credit dues and bad debts. Who is to blame here? It is the choice of the business person to take risks—sell their products and services on credit. But anyone who works in the market knows that market structure and practice compel business people to take such risks. 

Credit days

These risk-taking practices are more prevalent in competitive product markets, where the product is less differentiated, and there are fewer customers. It is now more of a rivalry between producers. You can’t compete directly in prices as prices are just above your marginal cost, so you can only attract customers by giving them credit days. In a well-functioning market, credit days are fixed. When credit days are fixed, you know the interest cost of the credit supply. Usually, for large corporations, these transactions are facilitated by banks and financial institutions. But in unorganised markets, there is no facilitation of the financial institutions. Coupled with high interest rate loans taken from unorganised markets and long credit dues, it creates pressure for the solvency of the firm. As credit days are extended, you bleed out more money. Sales are registered, books full of assets, but the cash cycle is abrupt. This bleeds out the money in terms of interest.

For most large corporations, even though it entails the cost of facilitation from the bank, transaction volume is enormous, so the operational cost is low for such facilitation. Financial products such as a letter of credit (L/C) or a bank guarantee ensure payments as the product is sold. Small businesses usually sell products on verbal credibility rather than legal contracts because they cost more in operational costs. Lengthy legal contracts are not feasible solutions for product selling on a small scale. That’s where financial institutions as intermediatory come into play. But for small businesses, reluctance arises from both banks and small enterprises, as the process is lengthy and costly for small businesses that don’t have substantial business volumes. Additionally, banks in Nepal require the bondage of collateral for such a process which might not be feasible for small enterprises. 

What is the solution?

Currently, most of the financial intermediatory products are handled by commercial banks. They have successfully done it for international and large-sum local transactions. It is imperative for a market like ours to now extensively include development banks and finance companies to work on financial products for the facilitation of local transactions. Even microfinance can make tailored facilitations for petty businesses and intermediate more and more transactions and financial contracts. 

At first, we can start the compulsion of purchase of products by big companies whose annual turnover exceeds a certain value to enter such financial contracts with small sellers also facilitated by banks. Transactions through such intermediaries will enable small sellers to know exact payment terms and credit period days and enforce payments on a stipulated day. But to accomplish that, the cost of transactions should be very low. At present, such intermediations by commercial banks are very costly and lengthy. For example, while opening a letter of credit, one has to pay charges for opening a letter of credit, document handling, document acceptance, and so on. 

At present, these facilities used by a tiny proportion of the business community pay a hefty price for each transaction. It will be financially expensive to use this for small-volume transactions. Our main target will be to reduce these charges and make it financially feasible even for small enterprises and individual sellers. The competition will reduce costs as we allow and equip development banks and finance companies. Mass transactions will create economies of scale. The central bank and Finance Ministry must play a pivotal role in incentivising financial institutions to develop new financial products to facilitate the intermediation process. These new financial products must be less cumbersome and cost-effective. 

This enables us to estimate the cost correctly and stop bullying and bargaining from big institutions for extended credit periods beyond the previously agreed stipulated time. This can also be extended to small individuals like farmers who can earn a guaranteed sum as their farm products are sold. No more sugarcane farmers will have to leave their fields and gather in Maitighar Mandala to ask for their hard-earned money. Once the product is sold, payment terms are agreed upon, and interest will be borne only by those who hold the inventory.

Many corporations will try to circumvent the process and favour those who don’t enter such contracts through financial intermediaries. That’s why the government should make such institutions purchase products only through financial contracts and must be well audited by the tax office to purchase items. What this creates is not only proper cost estimation for small firms and individuals but also allows them to enter organised money markets. This assures them of proper cash cycles and upholds their financial credibility which will later easily translate into credit expansion for small firms and individuals which might even reduce the bank’s dependency on the collateral model of loan disbursement to cash cycles and financial credibility loans based on credit score appraisal. In the long run, this will decrease the influence of the wealthy few and their appropriation of much-needed credit and loans available in the market, as loans might not be fully tied up to collateral. This can be a significant tool to reduce inequality and create a new entrepreneurial class. The dichotomy of the organised credit market and cheap access to capital for the wealthy few and the unorganised market and high-cost access to capital for the poor will gradually decrease. 

Ensuring the working of this policy will impact government policies as well. As all transactions will be bank-facilitated, avoidance of taxation will be a difficult process. Money now being circulated in the organised money market ensures monetary policies are more effective. Moreover, such financial product innovation will establish credibility in the market which is one of the core components in the functioning of a market. Even small businesses will have the same enforcing mechanisms as large corporations and create a level playing field. These contracts enforcing financial products will create a sustainable business environment for the business firms working in the Nepali market and prevent bankruptcies due to bad debts and high-interest costs despite having good sales.