The International Monetary Fund (IMF) has inserted a separate annex on savings and credit cooperatives in its staff country report, flagging a risk to Nepal’s economy that could trigger social unrest if the ongoing problems are not sorted out.

It said that several cooperatives have collapsed in the past six months, causing a loss or freezing of client savings and creating small-scale social unrest. The international financial institution released the full text of the IMF staff country report on Tuesday. It warned that problems in the savings and cooperatives sector are expanding.

The main cause of the failure is investment in illiquid and underperforming assets of cooperatives, which impact repayment capacity, combined with some cases of fraud.

The IMF said in the statement that a combination of large data gaps, weak governance, unsound credit and liquidity risk management, and a lack of licensing, effective regulation, monitoring, and supervision resulted in the failure and closure of multiple cooperatives.

On May 28, the lower house formed a seven-member parliamentary committee to investigate cooperatives fraud.

Immediate past home minister Rabi Lamichhane, who is also president of Rastriya Swatantra Party, has been accused of embezzling millions of rupees from multiple cooperatives while he headed the Gorkha Media Network before entering politics.

The IMF said that authorities need a comprehensive strategy to deal with the issues in cooperatives.

It said that over 14,000 cooperatives hold an estimated Rs478 billion of savings deposits, one-twelfth the size of banking sector deposits as of June 2023.

“There is an increasing risk of negative spillovers to other cooperatives and the smallest regulated banks,” the IMF said.

On Tuesday, a delegation of the Central Cooperatives and Poverty Alleviation Department of the ruling CPN-UML submitted a 12-point suggestion to the newly appointed minister for Land Management, Cooperatives and Poverty Alleviation, Balaram Adhikari.

“We have suggested ensuring that depositors’ money is safe in cooperatives,” said Khagraj Adhikari, chief of the department and former chief minister of Gandaki Province. “We have demanded immediate action against the people involved in the irregularities and cooperatives fraud.”

He said the cooperatives, which can be established as a strong economic pillar, need major reforms. The delegation has recommended forming a high-level, powerful task force to address the issues in the sector.

The erstwhile Pushpa Kamal Dahal-led government, on May 28, while unveiling the budget for 2024-25, had promised to return at least Rs500,000 to each depositor by recovering it from the directors’ assets. Yet doubts persist over whether depositors will get their money back.

Some economists have warned about potential mass protests if the cooperatives issue is not resolved soon.

The IMF has recommended a strategy of central coordination of the 761 district and provincial cooperatives regulators to facilitate the cleanup of the problematic cooperatives. It said that reforms in the supervisory and regulatory architecture are needed.

“Given likely limited resources, this strategy needs to ensure that the largest financially sound cooperatives remain stable and are appropriately regulated while dealing with problematic cooperatives.”

Nepal has a large and vibrant cooperative sector regulated by many agencies.

There are around 32,000 registered cooperatives. In addition to cooperatives, which focus on providing savings and loan services, cooperatives are active in areas such as agriculture, forestry and several other activities.

These non-financial cooperatives can allocate up to 30 percent of their activities to savings and loan services.

According to the IMF, there are more than 14,000 cooperatives and around 10,000 non-financial cooperatives that also provide financial services. As of June 2023, cooperatives held Rs478 billion in savings deposits and Rs426 billion in assets.

Cooperatives are regulated based on their geographical scope—at the federal, provincial, or local level. As a result, there are a maximum of 761 different regulators. If a cooperative is declared problematic, the relevant regulator must appoint a Problematic Cooperatives Asset Management Committee.

Since mid-2023, pressures in the Nepali cooperatives have been mounting.

Gauri Bahadur Karki, former chair of the Special Court and the head of an inquiry commission formed in 2013 to investigate troubled saving and credit cooperatives, told the Post last year that cooperatives were in trouble after the government halted plotting of land in 2022.

“Most cooperatives’ operation model involves investing in land and paying interest after generating profits from selling such land. With the government abruptly halting plotting, many cooperatives failed to sell the land, which resulted in their failure to pay promised interest, and the depositors who could not recover their money had to stage protests.”

According to Karki, other problems included investing in land and misappropriation of funds by the cooperatives’ promoters.

The IMF said that the Department of Land Management, Cooperatives and Poverty Alleviation, and subnational authorities are reportedly declaring an increasing number of cooperatives problematic, implying the need for decisive intervention to prevent further contagion.

The IMF has recommended three kinds of steps to deal with the issue: immediate steps, near-term steps (within one year), and medium-term steps (1-2 years).

In the immediate steps, the IMF has recommended halting the registration of new cooperatives. The current registration does not provide the same scrutiny as licensing, and adequate supervision is not currently guaranteed.

It said a temporary stop on registering new cooperatives at federal, provincial, and local levels until the issues have been addressed and the licensing and supervisory process and capacity have been improved would be appropriate.

“Resolution options in the strategy should follow the existing legal framework and could focus on liquidation combined with repayment of savings of failed cooperatives, possibly the transfer of assets and liabilities of failed cooperatives to healthy cooperatives or their continuation after restructuring.”

Near-term steps involve tightening and enforcing existing regulatory requirements. The recent crisis reveals flaws in applying the legislative and regulatory framework. The bar for cooperatives must be raised while customising the requirements to the size and nature of the businesses and a realistic supervision capacity.

Authorities could tighten existing regulatory requirements in capitalisation, liquidity, loan concentration, and governance. Cooperatives should be required to report regularly. They could be given a certain period to meet the requirements, and compliance with these needs to be closely monitored.

The medium-term step involves starting to license cooperatives. As a proper authorisation and licensing process hasn’t been established under the current regime, licensing is needed for both existing cooperatives and new entities.

The licensing regime should include a mechanism for the regulator to verify compliance and a process for treating cases of significant non-compliance (which could result in the withdrawal or suspension of the licence).

The IMF has recommended ensuring that the Cooperatives Act includes creating a debt information centre, credit tribunal, and savings and guarantee fund for cooperatives. These institutions could be aligned with existing structures, the global organisation said.

For example, the debt information centre could be set up within the Credit Information Bureau, allowing all financial institutions access to information on debtors. The savings and guarantee fund could be modelled on the Nepali Deposit Insurance System, which the country started in 2010.

Under this scheme, deposit guarantee coverage is up to Rs500,000 per individual per member institution, applicable to savings and fixed deposits.