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15/12/2017
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What banks need to become
Banks are under scrutiny and must brace for possible tectonic shifts in the banking landscape
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The Nepali banking industry has come far since the first three foreign banks entered our small, largely untapped economy three decades ago. I am fortunate to have been a part of this journey for almost a quarter of a century. These days, I occasionally get an adrenaline rush as I watch this sector. Here is my perspective on what currently ails the banking sector and a few points to ponder.

Banks are torch bearers
As a country, we have squandered the prospects for accelerated growth over and over again during the last three decades of misrule, poor governance and apathy. Our GDP has grown from $2 billion back in the 80s to $20 billion now—a small growth compared to what could have been. This growth is largely in spite of the government. The banking sector has not only been a pillar of this predominantly private sector-led growth but also a major beneficiary. On the other hand, with a lack of investments in infrastructure, absence of adequate structures and a financial system that is heavily skewed towards banking, there is no denying that banks have contributed to the creation of asset bubbles time and again, resulting in increased income disparity between the wealthy and the poor. Amidst chaos, inequality, freedom of speech and lack of investment avenues, banks are under tremendous scrutiny from all quarters and must brace for possible tectonic shifts in the banking landscape.

Private entities and individuals comprise a significant part of bank shareholders in Nepal. As the overall banking sector performance has been robust and steady over the years, not only in terms of balance sheet growth but also on the stock market, many key shareholders have become wealthier. It has helped them support and expand their business and investment portfolios to take advantage of asset bubbles and business environment rebounds that come about almost every alternate year. Most of the wealthy in Nepal are richer today than they were 30 years ago by a multiple far greater than the 10-fold GDP growth the country has witnessed.

Regulatory forbearance
Shareholders are naturally keen to ensure that their banks remain commercially oriented, which in itself is alright, as profit is an important factor in strengthening a bank. But an excessive chase for profits tends to compel professional management to take short cuts. Nepali banks have gotten away with bad behaviour on numerous occasions, usually with a little help from the Central Bank. In my opinion, there are far too many incidents of regulatory forbearance; they protect weak banks and thus disincentivise efficient, prudent practices. A recent case in point is the adjustment of credit-deposit ratio to accommodate banks that failed to meet the requirement, triggering a credit crunch owing to aggressive lending behaviour and lack of prognosis. One cannot fault the Central Bank for trying to prevent a systemic risk, but in an over-banked economy like ours, one or two banks must be allowed to fail every now and then.

Shareholders, regulators and professional managers together are responsible for ensuring that banks remain strong and the banking industry robust. Among the three actors, professional managers assume by far the largest responsibility. They not only need to self-regulate, but also need to stand up to excessive influence of key shareholders seen in a few banks.

The challenge, however, is that our banking manpower hasn’t exactly grown in terms of capability commensurate with growth in other dimensions. It is not only about training. Other than the skill transfer that occurred with the entry of the three foreign banks, there has been no major boost to the banking talent pool. The industry suffers from deep in-breeding. Almost all of the middle or senior executives today have been around for 10 to 20 years. Banks need an injection of fresh talent and experience from other markets from time to time. We are inward-focused and are not prepared to think big or in an innovate manner. Some of the new initiatives I took up during my time (such as mobile money, peer to peer lending and collateral free loans) were perceived as either being ahead of their time or lacked regulatory appreciation. But my opinion is that the banking sector as a whole should think big and continuously innovate in order to make the market responsive.

Thriving in chaos
One way to think innovatively is to expedite digitisation. Most millennials are already financially empowered, many of them drive businesses or are on the threshold of doing so. Banking habits are changing right before our eyes. The preference for digital operation is pervasive across all customer segments. Banks that don’t go digital will die. It is a pity that the mobile money ecosystem has remained painfully small even 10 years after its introduction. I will not be surprised if this space is taken over by telecom companies and bank-led models go dormant in the not too distant future.

Our banking industry is lagging behind in payments systems. Urgent effective action is required to facilitate online payment systems powered by robust payment gateways. All modern day companies have presence in the digital space with capabilities to sell online. Nationwide payment systems will not only bring in more money to the formal economy, they will also help banks to work with small businesses. Almost all banks in Nepal have Small or Medium Enterprise (SME) focus but aren’t approaching this segment any differently. A reliable payments system helps banks track cash flows of small businesses, leading to gradual departure from collateral-based lending.

Real estate and Nepali banks have a very strong linkage, mostly due to lack of transparency, thus the need for a strong second way out to cover credit risk. However, this is a key reason why very little product innovation has happened on the debt side. As a significant portion of loan books are tied to real estate, directly or as collateral, the banking industry as a whole has avoided high NPA levels for the last several years. Remittance induced liquidity, access to credit, rapid urbanisation etc are the reasons why the real estate market has historically retained a long-term positive outlook despite occasional crashes. But this deduction could be challenged by a change in government policy (for example, a revision in inheritance law) or a stable political environment prompting infra spending. As it is, banks need to be cash flow driven in their lending, hence this behaviour to lend against collateral only must change sooner rather than later.

Finally, I would urge captains of the banking industry to refrain from pointing blaming fingers at the regulators and the government when the going gets tough. The banking industry has come this far against many odds. As millions of Nepalis do on a daily basis, we need to forge alliances, innovate, and continue to thrive in chaos.

source:Joshi, Suman (2017), "What banks need to become", The kathmandu post,23 april 2017

Joshi, a former CEO of Laxmi Bank, is Founder & Chairman of True North Associates

2017-04-23

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