The recent big mergers between Global IME Bank and Bank of Kathmandu, Prabhu Bank and Prime Bank, and some in discussions have made mergers and acquisitions (M&A) issues more imperative in the Nepali financial market. It is not an overnight act, though. Nepal Rastra Bank (NRB) has for years been suggesting banks go for mergers and acquisitions. The arguments of NRB for M&A are to make financial institutions more resilient to macroeconomic shocks, strengthen their lending capacity in big projects, and reduce unhealthy competition in the market. In a recent public oration, Maha Prasad Adhikari, the incumbent governor of NRB, urged government-owned banks to engage in mergers and acquisitions. However, it seems that NRB has not fully studied the impact of such actions on the overall financial market, and their arguments for M&A seem to be based solely on the high number of banking and financial institutions in Nepal.

In a study, NRB suggested that 10 to 15 commercial banks would be optimal for the Nepalese economy. However, its study methods are questionable, and its conclusions are of limited value. Policy decisions should not be based solely on a survey. The issue is not whether banks should merge or the number of banks should be reduced; it is widely acknowledged that the number of BFIs needs to be lowered. However, the impact of mergers and acquisitions on the overall financial system and economy must be thoroughly analysed, considering both the potential benefits and drawbacks. The current focus on the number of commercial banks is misguided; what is critical is the impact of reducing the number of banks on market competition. Given the low capital base of many existing banks, they are vulnerable to macroeconomic shocks and have limited risk management capacity. Additionally, despite many BFIs and high competition in Nepal, there are still significant issues with cartel formation and syndicates in setting interest rates. For instance, the Nepal Bankers’ Association (NBA), an organisation of banks, has a long history of engaging in such practices.

A decline in the number of banks may increase the concentration ratio, which can encourage the formation of interest rate cartels. With fewer players, it becomes easier for banks to exercise their monopoly power and set higher interest rates. However, this does not mean mergers and acquisitions should not be considered, as they can help the economy access large-scale funding. Despite the potential implications, the central bank (NRB) appears to be neglecting this issue as no robust analysis has been conducted. Existing banks collude in setting interest rates, as evidenced by the agreement of the NBA to adjust deposit and loan product rates regularly.

It is not only about market concentration, but also about the existing classification of the banks. Currently, there are four categories of banking and financial institutions (BFIs) in Nepal under the supervision of the central bank and one cooperative under the National Cooperative Federation. The functions of such financial institutions seem very similar except for a few concerning import-related transactions and foreign exchange facilities. Arguments against large commercial banks have been dwarfing the issue of current BFIs categorisation. It is equally important to scrutinise the need for such classification and make necessary changes. The question is why we need this classification should their functions are identical. It not only increases the unnecessarily large number of BFIs but also increases unhealthy competition in the market: The cost of funds for such BFIs deviates significantly.

The nature of the activities performed by these institutions is also against the norms of such classifications. Micro-finances and cooperatives are to provide credit facilities to small-scale industries exclusively to reduce poverty. However, poor people pay the highest interest on their products for the current classification and high fund costs. This is because such BFIs are also allowed to collect deposits at higher rates. Therefore, the current need is not only about reducing the number of BFIs in Nepal, which is also essential, but also rethinking the need for the current classification of BFIs. Nepal needs a robust classification of BFIs with clear objectives and strong risk-bearing capacity. More importantly, the need is to rethink the responsibilities and business models for development banks, micro-finances and cooperative banks. However, this issue seems shadowed by NRB’s only quest to reduce the number of financial institutions.

Equally important is to analyse the possible impact of a small number of BFIs on consumers from the interest rate setting front. The current quest to reduce the number is no different than the careless policies of NRB during the first decade of the 2000s to allow open new BFIs, which extended substantially high numbers of banks overnight with a minimum capital base in Nepal. In hindsight, the NRB has a long history of formulating policies without robust studies and making a U-turn on policies overnight, be the case of opening new banks—during the first decade of the 2000s—or forcing banks to go for M&A in recent years or policies related to CD ratio, and many. The NRB did not remain stable in its policies because of weak policy formulation research. If these issues are not given due attention and M&A are prioritised only to reduce the number, it will not be too late to see NRB allowing new BFIs in no time to increase competition and reduce syndicate and monopoly power in the market.