1 Introduction and background 1.1 Key demographic and economic data Nepal is a landlocked country and one of the least developed countries of the world. It has borders with India in the west, south and east, and with the Tibet Autonomous Region of the People’s Republic of China in the north. The nearest sea coast is 1,120 km away in India. Nepal is mainly a hilly country with about one-fourth of its total land area falling in the Terai region which has a 26–32 km wide fertile plain contiguous with India. The remainder of the land area consists of hills and the Himalayas. There are 250 peaks of which 22 peaks exceed 7,600 m in altitude including the world’s highest peak, Mt Everest (8,848 m). Only 17 per cent of the land is arable. However, Nepal is endowed with abundant water resources. Its main nine rivers are estimated to have the potential to generate 83,000 MW hydropower, about 2.27 per cent of the world’s total estimated hydropower potentiality. The actual production of electricity only amounts to 237 MW or less than 1 per cent of its potential. Nepal is estimated to have a population of 21.5 million as at end-1995, and its population growth rate of 2.5 per cent between 1990 and 1995 was higher than most South and Southeast Asian countries and second only to Pakistan. The total fertility rate in 1995, at 5.3 per cent births per woman, was the highest among all the countries under study. The population density in the same year was 152 persons per square kilometre. The Himalayan region in the north has virtually no human habitation because of perpetual snow, and population density increases as one descends into the hilly and Terai regions. The country is largely rural, with only about 14 per cent of the population living in urban areas in 1995. Nepal is still at a very low level of development, with a per capita income of only $200 in 1995, lowest among all the countries studied. It ranks 151 out of 175 countries on the human development index. Gross national product (GNP) per capita growth rate between 1965 and 1995 was 2.4. In the last three years, however, the growth rate has been about 4.6 per cent. The structure of production has changed with economic growth, with the share of agriculture falling from 50 per cent in the late 1980s to 42 per cent in 1995. The share of industry and particularly of the services sector has increased at a rapid pace. 1.2 Poverty Estimates of poverty Estimates of the poverty line or of the incidence of poverty have been made by some agencies in the past. The first of such estimates was by the National Planning Commission in 1976–77. This concluded that based on the ‘minimum income angle’, 36.2 per cent of the total population were below absolute poverty, and from the ‘minimum consumption angle’, 31.54 per cent of the total population were below the absolute poverty line. The Multi-Purpose Household Budget Survey (MPHBS) of 1984–85 (published in 1989) conducted by Nepal Rastra Bank concluded that, based on the consumption of Nepal households of both food and non-food items, the poverty line for the country was 42.6 per cent. This was taken as a guide until the National Planning Commission in its Eighth Plan (1992–97) estimated the poverty line as 49 per cent of population or about 9.2 million persons in 1992. The total population of Nepal at that time was close to 20 million. In determining the incidence of poverty, the Eighth Plan adopted calorie consumption as the basis. Accordingly, the calorie-based national poverty line was estimated at 2,250 calories per capita: 2,300 for the hills area and 2,000 for the Terai region. It was termed a Basic Need Approach (BNA). (According to FAO, the basic minimum daily human need of a person is 2,256 calories.) Nepal’s current average consumption is estimated at 2,078 calories. Due to the insufficient calorie energy available, the death rate of children at birth has exceeded 20 per cent, and nearly one million persons are rendered blind. About 60 per cent of the population are illiterate, and 62 per cent of the school age children cannot go to school due to severe poverty. It is true that sampling and methodological differences between the survey of 1984–85 and that of the Eighth Plan in 1992 do make the comparison difficult. But the estimate of the Eighth Plan (a five-year plan) is the latest authoritative estimate available. Recently, the Central Bureau of Statistics of the government of Nepal with the assistance of the World Bank launched a national survey entitled Nepal Living Standards Survey (NLSS) in July 1994. The survey was completed in July 1996 and states: On the basis of the poverty line which we have developed for Nepal, the incidence of poverty in the country as a whole is 42 per cent. In urban areas the rate is 23 per cent while in rural areas it is 44 per cent. Given that about 90 per cent of the population resides in rural areas, it is clear that poverty is overwhelmingly a rural phenomenon . . . rural poverty is both deeper and more severe than urban poverty . . . And the mountain region as a whole is poorer than the hills and Terai. In monetary terms, the survey determined Rs4500 ($82) per capita per annum as the poverty line. Regardless of the outcome of past surveys and their findings, if we were to estimate the population below the poverty line by adopting the commonly agreed upon international standard of $150 as the threshold, nearly 71 per cent of Nepal’s population would fall below the poverty line. It is difficult, however, to compare Nepal’s situation with other countries and it is safer to judge the prevalence of poverty on the most recent and reliable estimates made at the national level by the responsible institution — in this case, the Central Bureau of Statistics. Policies for poverty reduction Being one of the poorest countries in the world, the government has always placed a high priority on poverty alleviation. Among the programs implemented in the past were:
The above and many other schemes launched in the past have typically suffered from implementation weaknesses. In fact, over the years poverty may have increased both in terms of absolute numbers and as a percentage. The Eighth Plan (1992–1997) The Eighth Plan had targeted that, as a result of various programs envisaged for addressing poverty, the number of absolute poor would have been reduced to 8.7 million from the 9.2 million at the beginning of the plan period — a reduction by 1.4 million or 7 per cent during the period of the plan. The Eighth Plan included several programs ensuring that the poor would have access to social and economic sources and employment opportunities. However, realising that absence of targeting has been a shortcoming in the past, the plan for the first time proposed targeting poverty specifically. In respect of credit for poverty alleviation, the plan specifically mentioned the Small Farmers Development Program (SFDP) of the Agricultural Development Bank and the Production Credit for Rural Women (PCRW) implemented by the Ministry of Local Development and involving two large banks, the Nepal Bank Ltd and the Rastriya Banijya Bank. No evaluation of the outcome of the Eighth Plan is available so far, and so it is not yet possible to assess its impact on poverty in concrete, quantifiable terms. However, compared to the period 1987–92 during which annual GDP growth rate remained 2–3 per cent, the period of the Eighth Plan (1992–97) witnessed a GDP growth of 4–5 per cent. As such, the overall growth rate of about 3.5 per cent in the last decade must have had a positive impact on poverty reduction. However, in the absence of an impact study, this cannot be stated conclusively. In 1994 Nepal joined other SAARC (South Asian Association for Regional Cooperation) countries, namely Bangladesh, Bhutan, India, Maldives, Pakistan and Sri Lanka, in declaring its commitment to poverty alleviation in this region by adopting a strategy which lays stress on social mobilisation of the poor by providing them with:
Based on these three themes, Nepal conducted pilot testing of the concept in the district of Syangjha. The result so far has been quite encouraging according to the National Planning Commission. The government has adopted a basic document outlining the Ninth Plan beginning the fiscal year 1997–98. This provides a perspective of twenty years of development and again, poverty alleviation is a priority goal. The plan targets that in twenty years or by 2017, poverty would have reduced from the present level of 42 to 10 per cent. The reduction will be progressive in successive five-year plans as follows:
The specified targets are to be achieved through the implementation of various sectoral plans of line ministries and the work of specialised financial institutions such as the regional rural development banks and the microfinance programs of NGOs and international NGOs operating in the country. The recently adopted 20-year Prospective Agricultural Development Plan, Land Redistribution Plan, and the Development of Backward Classes, Skill and Employment Generation programs will play a contributing role. 1.3 Overview of financial system Nine private commercial banks, two state-owned commercial banks, two development banks, five regional rural development banks (RRDBs), 37 finance companies and about 17 non-bank financial institutions together with the Nepal Rastra Bank, the central bank of the country, constitute the core of the institutional financial system. They are regulated by Nepal Rastra Bank (NRB) under the NRB Act 1956 and the Commercial Bank Act 1984. In the case of RRDBs they are regulated under the Development Bank Act enacted in 1996. Among them, two state-owned commercial banks (the Nepal Bank Ltd and the Rastriya Banijya Bank) and the Agricultural Development Bank of Nepal (ADB/N) together share about two-thirds of loans and investment and 55 per cent of total deposits of all banks and finance companies. The two state-owned commercial banks also have the most extensive outreach in terms of branch network. The eleven commercial banks and the Agricultural Development Bank have a total of 700 branches all over the country providing banking services. The majority of these branches are located in rural and semi-urban centres. Additionally, 16 credit cooperatives and 23 NGOs undertake limited banking activities, mainly loans and deposits. They are licensed to undertake limited banking activities under the NRB Act 1956. Until 1984, no foreign banks were allowed to open branches and engage in banking activities in Nepal. Since 1985, as part of the open policy and to attract modern technology and management into the banking industry, foreign banks were allowed as joint ventures with local promoters on an equity-sharing basis to the extent of 50 per cent. The remaining 50 per cent of equity capital had to be owned by nationals. So far, foreign commercial banks, mostly from the neighbouring SAARC countries as well as one each from France and Australia have established themselves as joint ventures. Foreign capital investment has also gone into finance companies, a phenomenon witnessed for most of the last three years. A separate Act, the Finance Company Act 1985, regulates their operation. Despite the fact that foreign capital and management have been imported into the commercial banking field, financing of the poverty sector remains outside the consideration of joint-venture banks except where, by regulation, they are compelled to set aside a certain percentage of their loan portfolio for the priority sector (including the ‘deprived’ or hard-core poor). Commercial banks are obliged to allocate 12 per cent of their total loan portfolio to the priority sector (including the ‘deprived’ or hard-core poor). Of the 12 per cent meant for the priority sector, 0.25 per cent (in the case of newly established banks) to 3 per cent (in the case of two large state-owned commercial banks) must be lent to the ‘deprived’ or hard-core poor. Commercial banks are, however, entitled to refinance 11 per cent from NRB if they achieve a minimum of 12 per cent fixed for priority sector lending. ‘Deprived’ sector lendings are those which fall within the range Rs5,000–Rs15,000 ($91–$272) per loanee: assets, landholdings or income are not guiding factors. Whereas normal commercial interest rates for loans range from 19 to 24 per cent at present, loans for the priority sector have been between 13 and 15 per cent. This is a voluntary decision on the part of the commercial banks and without any regulatory compulsion. In so doing, commercial banks are guided more by social considerations than commercial. It is also possible that they (commercial banks) intend to achieve the 12 per cent obligatory target as soon as possible, even by lowering interest rates. In the recent past, NRB has introduced a number of changes aimed primarily at encouraging private initiative and more prudent monetary measures in the financial market, which may help achieve this objective. 1.4 Overview of microfinance The government’s commitment to microfinance is reflected in the declaration through the five-year development plans. In particular, the following programs illustrate these commitments:
Twenty credit cooperatives have so far been permitted by NRB to provide microfinance services in the rural areas. The Agricultural Development Bank of Nepal (ADB/N) has been the single largest formal credit institution in the agricultural and rural sector. Its main credit program is designed to lend to farmers, tenants and landless with per capita income of Rs2,500 ($45) under the Small Farmers Development Program (SFDP) which now operates through 322 Sub-Project Offices (SPOs) of the bank. As of mid-July 1996, it had 26,743 groups, consisting of 189,061 members (146,589 males and 42,472 females). The Intensive Banking Program (IBP) which focuses on the priority sector as defined by the Nepal Rastra Bank (that is, cottage industries, agricultural activities and the services sector) had by mid-July 1996 disbursed a cumulative total of Rs4,056 million ($74 million) to 246,439 borrowers through the network of 338 branches — Rastriya Banijya Bank (164), Nepal Bank Ltd (172) and Nepal Arab Bank Ltd (2) — in 74 out of the 75 districts of the country. The borrowers under this program consist of both poor and non-poor individuals. The poor segment within IBP are those whose maximum borrowing limit is Rs30,000 ($544) per person. No separate statistics are available for the poor categories. Production Credit for Rural Women (PCRW) under the Ministry of Local Development operates through 139 branches of Nepal Bank Ltd (NBL), Rastriya Banijya Bank (RBB) and ADB/N spread over 55 districts covering a total of 13,181 credit groups with 64,724 women members. Of these, 35,017 had borrowed Rs230 million ($4.2 million) up to mid-July 1996. The average loan size was Rs8,050 ($146). As of mid-January 1997, MCPW was operating through 31 branches of two participating banks, Nepal Bank Ltd and Rastriya Banijya Bank, covering 93 village development committees (VDCs) and ten municipalities. There were 1,885 SHGs with 11,591 women members. Rural or urban women belonging to a household with a per capita income of less than or equal to Rs2,511 ($46) are eligible to join a group. Between July 1994 and January 1997, a total of Rs69 million ($45.6 million) was disbursed to 5,708 women borrowers. Recovery so far has been nearly 100 per cent. The groups have also collected total savings of Rs37 million ($0.7 million) up to January 1997. The Banking with the Poor (BWTP) program of The Foundation for Development Cooperation has been implemented by RBB since 1992. It now covers a number of selected villages of 15 districts and is expanding gradually. All in all, 522,000 persons have received microfinance services under the poverty-focused credit programs. As has been explained, except in the case of SFDP, PCRW, MCPW and BWTP where the target groups are defined as poor, the Intensive Banking Program (IBP) does not necessarily target the poor. IBP is especially for small sectors, and only an insignificant part is devoted to those below the poverty line. The government of Nepal introduced the Rural Self-Reliance Fund in March 1991 to supplement NGO funding for rural lending. The fund started as a pilot project with a one-time contribution of Rs20 million ($0.4 million), and 45 NGOs (mostly saving and credit associations) have been given Rs15 million ($0.3 million) as loans out of the fund at 8 per cent interest. NGOs with a satisfactory performance are also given 6 per cent rebate for administrative support. Until now 3,194 families have received loans from 45 NGOs, with a repayment rate of 84.12 per cent. With regard to cooperatives, Nepal Rastra Bank estimates that there are about 3,132 cooperatives registered under the Cooperative Act 1992. Of these, 343 are savings and credit cooperatives, the others being multi-purpose. Out of these 343 savings and credit cooperatives, 214 have formed a national-level federation named Nepal Federation of Saving and Credit Cooperatives Union (NEFSCUN). With a total membership of 16,041 persons, their total cumulative savings is Rs74 million ($1.3 million) and their disbursement Rs59 million ($1.1 million). As of January 1997 their deposit was Rs203 million ($3.7 million), with loans and advances of Rs299 million ($5.4 million). According to NRB, the average loan size per borrower of the 16 cooperatives is higher than that of the cooperatives collecting savings from their members only. With the enactment of the Cooperative Act 1992, there was an upsurge of community-based informal savings and credit organisations (SCOs) trying to get themselves registered as primary societies under the Act. As of April 1995, 158 community-based SCOs were formally registered as cooperatives. It is estimated that there may be in excess of 12,158 such community-based savings and credit groups (CECI 1996). Their sources of fund are members’ share contributions, deposits from members and external borrowings. On average, an SCO has Rs58,076 ($1054) as deposits, Rs28,115 ($510) as share and Rs32,187 ($584) as loans. Their loans are for a smaller amount (less than Rs2,000) and the recovery rate is 100 per cent. All of them are operationally viable, enjoying surplus over expenditure by an average of Rs5,282 ($96). This is due to the voluntary nature of their workers with their economical operation. The Social Welfare Council estimates that about 18,000 NGOs are operating in Nepal. They are categorised mainly into three types:
Four thousand (4,000) of them are registered under the Society Registration Act 1978 as non-profit social welfare organisations. About 24 such NGOs have gained the permission of NRB to engage in limited banking activities. Of these, two — Nirdhan and CSD — are active in the rural finance market and replicate the Grameen Bank model. They have formed 2,332 groups in seven districts and 102 village development committees (VDCs) with 11,037 members (women). By January 1997, they had disbursed Rs73 million ($1.3 million) to 10,050 borrowers, with an average loan size of Rs7,230 ($131) and with 100 per cent recovery. The total savings mobilised amounts to Rs7 million ($0.1 million). With about 8 per cent cost of funds and 11 per cent service delivery cost, the total operating cost of CSD is 19 per cent against a lending rate of 20 per cent. Nirdhan has incurred an operating cost of 24 per cent (delivery cost 15 per cent and cost of funds 8 per cent). CSD has attained sustainability because of its larger outreach (CSD has 6,431 borrowers as against Nirdhan’s 3,619) and fewer staff (CSD’s 42 compared to Nirdhan’s 96). Both enjoy 100 per cent repayment with zero overdue. Both NGOs have been able to attract commercial bank loans. Nirdhan has borrowed a total of Rs2.5 million ($45,400) from five commercial banks, and CSD Rs0.7 million ($12,700) from three commercial banks. By 1996 five regional rural development banks (RRDBs) had been established in five regional development centres of the country to provide easy access to credit to ‘deprived’ sections of the society, especially women from poor rural households. These banks are capitalised by the government and NRB up to 75 per cent of the paid-up capital of Rs60 million ($1.09 million) each, the balance being subscribed by other banks and financial institutions. RRDBs replicate the Grameen Bank model. They have extended operations to 19 districts and 332 VDCs, formed 9,520 groups with 47,780 members and disbursed Rs652 million ($11.8 million) to 45,352 borrowers. They have attained 100 per cent repayment rate (as of January 1997). The Micro Credit Project for Women (MCPW) is a microcredit program funded by the Asian Development Bank (ADB) and initiated in 1994 by the Ministry of Local Development in coordination with two large commercial banks, the Nepal Bank Ltd (NBL) and Rastriya Banijya Bank (RBB). It is committed to developing and involving NGOs as financial intermediaries, and serves both urban and rural women. At present 80 per cent of the loan funds provided by ADB are channelled through NBL and RBB, 10 per cent from the two participating banks and 10 per cent by the beneficiaries of the program. The project also involves grant assistance from the Japanese Special Fund and government of Norway for institutional support to NGOs. How NGOs in Nepal can intermediate between banks and SHGs promoted by them is a subject currently under discussion. The ADB-assisted MCPW program has engaged the Canadian Center for International Studies and Cooperation (CECI) to conduct a study of issues which has produced draft legislation entitled the ‘Financial Intermediation Act’. The draft envisages a financial intermediary being licensed by a registrar specially created for this purpose. The relevant functions of the financial intermediary are to:
Other provisions of the proposed draft relate to record keeping, accounting, audit, reporting and compliance with the Act, etc. In short, the draft legislation creates an opportunity for NGOs and MFIs to act as intermediaries without being subject to the other prevailing banking and financial regulations of the NRB which are stringent. It is still in draft form and may have to undergo a range of scrutiny before it is finally enacted. 2 Arrangement for direct support 2.1 Support for specialised microfinance institutions Rural Self-Reliance Fund (RSRF) The establishment of the Rural Self-Reliance Fund (RSRF) in 1991 was a step in the right direction. It can be compared with the Palli Karma Sahayak Foundation (PKSF) of Bangladesh. The fund was established to lend to NGOs and MFIs that have otherwise had difficulty in accessing financial institutions and banks. RSRF received initial funding of Rs20 million ($0.4 million) in 1991 from government budgetary resources, but has not received additional funds since then. Up to January 1997, about 54 NGOs (mostly SCOs) had borrowed Rs17 million ($0.3 million) for on-lending to members from deprived families. Eligible NGOs are those that are registered with the relevant government body and are permitted by Nepal Rastra Bank to engage in banking transactions. Activities that can be supported by the fund are agriculture and horticulture, livestock farming, cottage industries, services and other income- and employment-generating activities. The loan conditions are:
The fund is being managed by Nepal Rastra Bank. NGOs are further required to submit to NRB returns concerning: (a) sources of income and list of assets; (b) operational results; (c) audit reports on an annual basis; (d) operational and loan procedures; (e) provision for monitoring and inspection; and (f) social mobilisation activities benefiting the targeted groups. The fund has attained a repayment rate of 84 per cent. In the past, the repayment rate has ranged from 67 to 85 per cent, indicating the weakness in supervision, monitoring and follow-up. Though it is designed to target the poorest, it has not achieved the purpose of meeting the credit needs of the poor since the lending operations of savings and credit associations in Nepal are not, in practice, poverty focused. Nevertheless, the fund has the potential to support a large number of NGOs, if it is properly managed and better resourced. Regional rural development banks (RRDBs) As noted above, five regional rural development banks (RRDBs) were established by 1996 to provide credit to ‘deprived’ sections of the society, especially poor rural women. They are owned primarily by the government, and replicate the Grameen Bank model. One of the five RRDBs, the Eastern Region Development Bank (ERDB) was the first to attain operational self-sufficiency by 1996 based upon its operating cost of 18 per cent (delivery cost 10 per cent plus cost of funds of 8 per cent, and a loan loss zero per cent) against its lending rate of 20 per cent. The other four RRDBs are yet to attain sustainability, mainly because their outreach is far below that of ERDB. RRDBs initially established under the Commercial Bank Act have now been registered under the Development Bank Act 1996 which is more appropriate for poverty-focused microfinance institutions like RRDBs. Of late, RRDBs are being increasingly plagued by political pressure and interference in their operation. Having achieved so much in such a short period of time, it is unthinkable that RRDBs may be facing a similar fate to other government-run credit programs for the poor. One way of diluting undesirable pressure from ‘above’ would be to divest the shareholdings of government, NRB and government-owned banks to borrowers and savers in the program as well as to the public generally. The total outreach of five RRDBs is 9,520 groups with 47,780 members, ERDB’s share being nearly 70 per cent of the total. Sources of lending funds are mainly equity capital, group funds and borrowings from NRB and commercial banks. Shortage of loanable funds has been a problem as the group fund and equity cannot meet the growing needs of this expanding program. NRB recently extended a line of credit of Rs100 million ($1.8 million) to ERDB to overcome its funding problem. As yet, it has not been utilised. However, the line of credit promised by NRB indicates the willingness of the central bank to fill the void created by the funds shortage and to see that a successful RRDB does not have to suffer for want of loanable funds. However, RRDBs could also mobilise deposits from the public, borrow from banks, and even try for external assistance to augment their resources, if they pay the prevailing interest rates. At this stage of their operation, RRDBs have obviously not been able to explore other potential avenues for resource augmentation. 2.2 Support through the banking system Small Farmers Development Program (SFDP) The government of Nepal has played an important role in seeing that the rural poor and those below the poverty line are given credit for income and employment generation. The move for the provision of microcredit started first in the early 1970s with the introduction of the Small Farmers Development Program (SFDP) implemented by the Agricultural Development Bank of Nepal (ADB/N) which is owned by the government. SFDP is now the single largest microcredit program encompassing about 190,000 small farmers in 74 out of the 75 districts of the country. It targets those below the per capita income of Rs2,511 ($46) per year. It should be noted, however, that the poverty line of Rs2,511 ($45.6) was fixed at the beginning of the sixth five-year development plan, or about ten years ago. It is likely to be revised shortly, to reflect inflation and exchange rate changes since then. It is possible that the revised poverty line may be fixed at or around Rs5,000 ($90). SFDP, an ongoing program, has witnessed deterioration over time in terms of its effectiveness. This is reflected in its loan repayment rates which have now fallen to 58 per cent (1995–96). Starting in the early years at subsidised interest rates, the program is not yet operationally viable despite the fact that since 1988, applicable interest rates have been near market rates which range between 16 and 18 per cent. Some grant element is provided by bilateral donors and IFAD for social mobilisation and development. However, SFDP’s transaction costs of 11 per cent combined with nearly 10 per cent of cost of funds totalling 21 per cent is far above its interest income of 16 to 18 per cent. Coupled with the program’s recovery rate of only 58 per cent, SFDP is unsustainable. Several factors account for this state of affairs. Bureaucratic handling of the program by state-owned development banks, lack of supervision, lack of motivation and training of the field staff, and interferences from above have compounded to affect SFDP adversely. Since the early 1990s, GTZ has been assisting ADB/N to restructure SFDP and salvage the once well-known microcredit program which is of far-reaching importance to Nepal’s agriculture-based economy. Accordingly, in selected districts on a pilot basis, groups of small farmers are being linked with what is now known as Small Farmers Cooperatives Ltd, owned and managed by the members themselves. ADB/N plays a supportive role. Assets and liabilities of small-farmer groups are transferred to this newly created organisation which, in turn, continues to be linked with ADB/N for funding and training inputs. So far, results are reported to be quite satisfactory. Ownership and autonomy in decision making have encouraged the active participation of members, recovery rates have improved, and some of the small-farmer cooperatives are already operationally self-sustainable. Production Credit for Rural Women (PCRW) PCRW was launched by the Ministry of Local Development in 1982 in collaboration with three public-sector banks (Nepal Bank Limited, Rastriya Banijya Bank and the Agricultural Bank of Nepal) and UNICEF. In this program, the Women Development Section (WDS) of the ministry acts as social intermediary and the participating banks provide loans directly to the group members who are developed and promoted by WDS staff. The program focuses at improving the socioeconomic status of rural women. Since 1988, 90 per cent of the loan funds have come from IFAD and been channelled through the two commercial banks and ADB/N. Participant banks contribute 10 per cent. Technical input is provided by IFAD and UNICEF on a grant basis, so that there is no cost to banks for social preparation. PCRW has been a reasonably successful program with a repayment rate of 81.85 per cent as of 1995–96. However, being a socioeconomic program, its delivery cost has been rather high at 42 per cent. With the added funds cost and bad debt cost, it will be quite high, compared to its income of 15–16 per cent interest. In the past 14 years, about 35,000 rural women have received loans and since the staff members of WDS are temporary, the program has lacked the necessary motivation to organise groups. In its present form, it is not a sustainable program, but its contribution in terms of women’s awakening has been valuable. To make the program self-sustainable, a move similar to that taken by ADB/N for SFDP under GTZ technical assistance, might be appropriate for PCRW. Micro Credit Project for Women (MCPW) The Micro Credit Project for Women (MCPW) was initiated by the government under ADB assistance in 1994, and is the second in a series of credit programs with a focus on women. The project is designed to provide three components:
The loan component consists of $4 million and technical assistance of $9 million by bilateral donors. It is committed to involving NGOs as service delivery agents in the first phase and as financial intermediaries in the second phase which is due to begin soon. Nepal Rastra Bank is the executing agency for the credit, with Nepal Bank Ltd and Rastriya Banijya Bank as participant banks. It is the first government credit program which is committed to involving NGOs as an alternative mechanism for service delivery in a cost-effective manner. MCPW serves mostly the poorest, as only women with incomes less than or equal to Rs2,511 ($45) are eligible to join a group. A mid-term review of the project is under way at present and more about its implementation will be known after the review. Available information indicates that the project has experienced 100 per cent repayment so far. Intensive Banking Program (IBP) Initiated in October 1981, IBP has been recognised as one of the poverty-focused microcredit programs. The program follows an area approach, each IBP branch covering 250 to 400 households and concentrating on loan operations within this given area. Households are categorised as ‘high income’ and ‘low income’ families. Viable projects are financed with adequate collateral for high-income families and without collateral for low-income families under group guarantee schemes. The maximum individual loan size is determined at Rs30,000 ($544) and loans are granted on an individual as well as a group basis. Commercial banks are obliged to lend 12 per cent of their loan portfolio to the priority sector. Loan sizes of Rs5,000 ($91) ranging up to Rs15,000 ($272) to individual borrowers are regarded as loans given to hard-core poor. The initiation of priority-sector lending has been the sole factor in drawing commercial banks to microfinance activities. The commercial banks are still very hesitant, and the repayment performance under IBP has declined to less than 50 per cent indicating poor loan management, political pressure on banks and lack of motivation. NRB has eased the obligation of commercial banks to some extent by allowing their loans to MFIs, two Grameen replicators and five regional rural development banks (also Grameen replicators) to be considered as part of their mandatory 12 per cent lending to the priority sector. IBP has proved non-viable commercially. The World Bank in 1993 estimated that in order for IBP to be viable, it needed to be able to charge an interest rate of 30.3 per cent against the banks’ then lending rate of 15.50 per cent. The situation in 1997 is not very different. Commercial banks perceive that lending small sums to large numbers of borrowers scattered over distant geographic areas is not operationally cost-effective, and their staff members do not possess the kind of orientation to deal with poor clients. Moreover, they argue that microfinance requires a different kind of institutional set-up, one for which commercial banks are inherently unsuitable. This may be the reason why the commercial banks’ priority sector credit as against their total loan portfolio has remained below 8 per cent. As recommended by the Nepal Rural Credit Review Report (ADB/NRB 1994), a fresh look into the future of IBP seems urgent. In its present form IBP has not well served the needs of the weaker sections. The objective can be better attained either by creating an autonomous entity or a fund which will support the activities of microfinance institutions (MFIs) which are successful in poverty lending. 3 Regulation of non-bank microfinance institutions There are no specific regulations applicable to MFIs. NGOs are normally registered as non-profit organisations under the Society Registration Act 1978 and do not have a capital base. A large number of small NGOs undertaking lending programs depend on external donor funding. To a limited extent, they also mobilise savings of the group members, although under the Nepal Rastra Bank Act 1956, no institution can engage in credit and savings activities without NRB’s prior approval. NRB has tolerated it, considering these transactions as being insignificant at this stage. Limited banking In the last three years NRB has granted ‘limited banking’ authority to 24 NGOs. This was a much discussed subject in ‘Bank Poor 1996’ in Kuala Lumpur in December 1996, and is a practice which has no parallel in other Asian countries. Under the ‘limited banking’ arrangement, NGOs/MFIs are permitted to accept savings deposits, but are not allowed to engage in other banking activities such as overdrafts, bills and foreign exchange transactions, issuance of bonds etc. NRB has issued two types of limited banking permission. In the first category, only two large NGOs, namely Nirdhan and the Center for Self-help Development (CSD), both Grameen Bank replicators, have been authorised to accept deposits from members as well as from non-members and also to lend to non-members. The second category is where NGOs have authority only to accept deposits from and lend to members. There are 380 NGOs given such authority. Nepal Rastra Bank has imposed reserve requirements similar to banks to the first category of NGOs. No such requirements exist for the second category. NRB expects that the first category of NGOs will gradually make a move towards converting themselves into a development bank where the capitalisation requirement is Rs10 million ($0.2 million) as against Rs500 million ($9.1 million) for opening a commercial bank. Nirdhan is reported to have applied to NRB for such a licence. As a development bank Nirdhan will have much more flexibility and opportunity to mobilise untapped and potential savings in the rural areas and to achieve financial self-sustainability in a relatively short period of time. Financial Intermediation Act Another new aspect of microfinance operations in Nepal is a piece of draft legislation, the Financial Intermediation Act proposed by Nepal Rastra Bank to the government for enactment. When adopted, it will legally empower qualified NGOs to act as financial intermediaries between banks and SHGs of the poor. The draft defines a financial intermediary as a society which has obtained a certificate of permission to perform the functions of financial intermediation — financial intermediation meaning ‘anything done in playing the role of an intermediary in the supply of microcredit’. Certificates of financial intermediation are to be issued by a registrar specially created for this purpose under the Act. The registrar will decide on NGO qualifications for obtaining such a licence, and strict criteria and standards are expected to be applied. Non-compliance will be subject to penalties including cancellation of the certificate. The registrar is also empowered to carry out inspections from time to time and receive reports, as well as returning to ensure compliance. It is expected that NRB itself might be designated as the registrar. The functions of the intermediary under the proposed Act include:
The intermediary is prohibited from performing any function with a commercial or profit motive. Interest rates to be charged will be decided by the intermediary itself. The above are some glimpses from the proposed Act, but it remains to be seen whether the final adoption will follow the proposed course. It is an attempt born out of the special requirements of the MCPW program, rather than an independent initiative of NRB. Its objective is to facilitate intermediation by NGOs under the MCPW program assisted by ADB. Nevertheless, it is possible that the proposed Financial Intermediation Act may eventually prove an instrument in strengthening NGOs/MFIs as effective microfinance institutions. It may be noted that the Act does not require any capitalisation for NGOs acting as intermediaries. 3.1 The broad regulatory framework Licensing Institutions engaged in microfinance are required to obtain a licence as follows. Commercial banks
Agricultural Development Bank
Cooperatives
NGOs
RRDBs
It should be noted that the Agricultural Development Bank and cooperatives are subject to registration under two pieces of legislation and the NGOs under three different pieces of legislation. There are numerous savings and credit groups and their associations all over the country, most of which operate informally. Some are incorporated under the Cooperative Act 1992. However, no statistics of their operation are readily available. According to Nepal Rastra Bank, it has so far given permission to 128 cooperatives and 20 NGOs to engage in limited banking activities, especially deposits. Generally speaking, NGOs and cooperatives which are given such authority for deposits are limited to accepting deposits from members only. Moreover, such licensed NGOs and cooperatives are subject to the following:
In addition to deposit taking, very few NGOs have asked for authority to engage in other banking activities, that is, letters of credit, foreign exchange transactions, etc. There are 343 single-purpose savings and credit cooperatives that are registered under the Cooperative Act 1992 which allows them to accept savings and deposits from their members or other persons, and to provide loans to their members. According to Article 26: ‘A Society or Union may conduct banking transactions with permission of the Nepal Rastra Bank’. This means some overlap with NRB regulation. Authorities of NRB interpret it differently and believe that all societies engaged in financial intermediation rightfully fall under the regulation of the central bank. Most savings and credit cooperatives have not bothered to obtain permission from NRB as the issue is still under debate and the scale of their operation is small. On the other hand, some of the savings and credit cooperatives whose financial operations are fairly large and expanding have applied for NRB’s permission and 128 of them have been granted such permission. Twenty (20) NGOs have also been given permission by NRB. The feeling on the part of most NGOs and community-based savings and credit organisations (SCOs) is that with formalisation they might be subjected to political and bureaucratic control with consequent loss of autonomy and flexibility. As such, they prefer to operate informally. 3.2 Interest rates and other charges Non-governmental organisations (NGOs) are restricted to charging a maximum of 15 per cent on loans. They can charge a maximum of an additional 3 per cent as a service charge. Thus, NGOs are limited to charging a maximum of 18 per cent. There is no such restriction on commercial banks and cooperatives, and there is therefore no level playing field between players in poverty lending. Although there does not seem to be any rationale for this regulation, policymakers seem to fear that if NGOs are given full freedom, they might charge an exploitative rate — an apprehension which presently stands in the way of NGOs attaining financial self-sustainability. Selected NGOs, mainly Nirdhan and CSD, have received lines of credit from the commercial banks at 6–8 per cent. The prevailing market rates charged by commercial banks on other commercial loans range between 17 and 20 per cent, though the rates may differ to some extent among institutions. Loans to individuals by banks, NGOs and cooperatives ranging up to Rs15,000 ($272) are defined as loans given to the ‘deprived’ sector or ‘hard-core’ poor, and attract an interest subsidy of 80 per cent up to the loan amount of Rs5,000 ($91) and 33 per cent for up to Rs15,000 ($272). The effective rates of interest for such loans are therefore 3 and 10 per cent respectively. Such low interest rates on small-sized loans have become controversial and it is alleged that members of SHGs and clients of RRDBs pressurise Grameen Bikas banks for loans because of these extremely low effective interest rates. It is feared that this might prove a hurdle to maintaining high loan repayment rates in the future. Observers comment that in the absence of an effective monitoring system, subsidies have led to distortions and should therefore be withdrawn.
A constraining influence for microfinance institutions in attaining operational self-sufficiency has been the two restrictions imposed by NRB regulation: that is, a ceiling of 6 per cent on ‘spread’ (uniformly applied to banks, finance companies, cooperatives and NGOs) and 15 per cent on loans. The cost of operations of NGOs at this stage is much higher, and successful microfinance institutions might need to charge at least 25 per cent loan rates for break-even. NGOs do enjoy the freedom to charge application and other service fees not exceeding 3 per cent, but the same is not allowed to the cooperatives. 3.3 Prudential regulation and supervision Capital adequacy Eight (8) per cent of risk-weighted average assets is required for commercial banks and cooperatives. Guidelines given with regard to calculation of risk are associated with the quality of loan and the assets of the organisation. For NGOs, no capital requirement has been imposed. They are, however, directed by NRB to build a reserve fund to which NGOs have to allocate 10 per cent of their operating profit as provisions for loan loss. In case of RRDBs, the Development Bank Act 1996 gives discretion to NRB to decide on the capital stock to be maintained by them. The five RRDBs now in operation have Rs60 million ($1.1 million) each as their paid-up capital. NRB regulations presently in force require that commercial banks must have Rs250–500 million ($4.5–9.1 million) as paid-up capital depending on the location of head office and geographic coverage of business, and no capital is fixed for NGOs. For saving and credit cooperatives, the requirement is a minimum of Rs2.5 million ($45,400) to open a branch within the same district and Rs10 million ($181,500) for opening a branch in another district. Liquidity For commercial banks the liquidity requirement is 12 per cent of total deposits, while for cooperatives, it is 10 per cent of total deposits. No liquidity requirements have been fixed by NRB for NGOs involved in credit and savings activities focused on the poverty sector. Limiting deposit as a ratio of share capital An NRB directive states that a society shall not collect deposits exceeding ten times its paid-up capital. A similar regulation applies to finance companies but not commercial banks. NGOs are exempt as they do not have a capital base. In their case, a loan ceiling of Rs100,000 ($1815) per group or individual has been fixed. Loan classification and provisioning An NRB directive provides an operational definition of six categories of loan classification according to which the commercial banks have to make provisions ranging from 1 to 100 per cent, based on the quality and ageing of the loan. Societies have to maintain a reserve account to cover the risk associated with four categories of loans: good (1 per cent), weak (10 per cent), doubtful (50 per cent) and bad (100 per cent). Such provisions are considered normal with the formal financial sector. With regard to the rationale for minimum capital requirements, they are simply based on policy decisions which followed Basle Accord recommendations concerning prudent banking practices. Despite these, however, the above provisions are subject to debate and interpretation. Loan documentation The regulatory authority — in this case, NRB — and the applicable legislation governing microfinance institutions (MFIs) have not laid down specific requirements for loan documentation. These have been left to the discretion of the lending institutions. In practice, the basic information required of the loan applicant generally include project cost, profitability, investment, maturity, loan amount, type of collateral etc. Adherence to documentation by borrowers at the poverty level is often facilitated by the NGO intermediaries assisting them. It is the availability of credit according to the need of such borrowers which is more important and pressing than the formalities. With group guarantees legalised as collateral in the case of low-income families under the Development Bank Act 1996, it is hoped that many of the hurdles concerning loan documentation would have been solved. It must be mentioned, however, that cooperatives, under their law and practice, require adequate collateral, and group guarantees are not applicable in their case. Rastriya Banijya Bank (RBB) became conscious of the impact of the many and lengthy documentary requirements being applied by their branches while granting loans, and early in 1992 introduced a number of modifications to make them short and simple. In this process, some of the formalities considered not so relevant were also dropped. These actions have helped RBB branches to reduce their transaction costs of lending to the rural poor under their Banking with the Poor Program. Collateral In practice in Nepal, group guarantees have been accepted for some years as loan collateral for poverty lending. This is true for all MFIs with a poverty focus. In fact, group guarantees are quite prevalent and even commercial banks involved in group lending have accepted them as a collateral substitute, traditional collateral being land and buildings. Commercial banks have also extended lines of credit to NGOs (Nirdhan and CSD) against collateral of: (a) personal guarantees of chairman and members of the board of directors; (b) physical assets and properties of NGOs; (c) track record of the NGO involved, performance and volume of loans; and (d) trustworthiness of the NGO leadership. For the first time, the Development Bank Act recognised joint liability of the group as sufficient collateral for low-income families up to a specified loan amount (Rs30,000 per borrower) given to them. Reporting requirements NGOs and cooperatives as well as MFIs licensed by NRB to accept deposits and carry out limiting banking activities are all obliged to submit data on their financial operation to NRB. In the case of RRDBs, such requirements are specified in detail in the Development Bank Act itself under which RRDBs are incorporated. By separate instructions issued from time to time, NRB has asked MFIs to submit financial information and data relating to the following areas:
Depending upon the kind of activity, information must be submitted, weekly, monthly and yearly. Returns are monthly, and balance sheet and profit and loan accounts are submitted on a yearly basis. Auditing For cooperatives, auditing must take place within five months after the end of the fiscal year. The auditor must hold at least a ‘B’ class certificate and be approved by NRB. For NGOs, auditing is required within six months after the end of the fiscal year, and at least a ‘C’ class auditor is required. NRB approval is not required. Governance The Society Registration Act 1978 under which NGOs are registered provides for an annual general meeting, board of management, duties and responsibilities of the board and of the chief executive. The Act also provides strictly for annual audit reports to be submitted to the Chief District Officer. Where such NGOs are licensed by NRB for limited banking activities, they are instructed by NRB to abide by the law strictly. This also applies for cooperatives under the Cooperative Act. As such, internal management, control and supervision are duly provided for in the respective legislation in the case of MFIs. With regard to ownership, there is no provision for capitalisation under the Society Registration Act, and accordingly NGOs are not based on the principles of ownership. In almost all cases, the private initiative of a few dedicated persons or social workers as promoters have led to the establishment of the NGO. NGOs do not have their own internal rules of governance, and boards of directors are elected from among the promoters. Cooperatives, of course, by the very nature of their operation are owned by members in the private sector. Cooperatives do have a capital structure, and voting rights consist of one vote per member. The term of office of the board varies and is decided by the general body. RRDBs are now licensed under the Development Bank Act 1996 which is quite elaborate in terms of the internal control and management of those institutions set up under it. RRDBs at present are owned by NRB and the government (75 per cent), and by banks and other financial institutions (25 per cent). Political pressure exercised by the government on RRDBs has been a matter of concern of late: chief executives have been subject to frequent transfers and there has also been interference in the appointment of staff members. Taxation No tax exemptions of any nature — on income, financial transactions, deposits or payrolls — are extended to MFIs. MFIs which are registered with the government do pay taxes, albeit not regularly. In the case of those operating on an informal basis, the government does not seem to have kept any record of their operation and does not appear to bother about it. Comment MFIs in Nepal are at an early stage of development. They do not have adequate administration and trained personnel, except in the case of Nirdhan and CSD, and therefore are not capable of adhering to stringent norms that are normally applied to formal financial institutions. This fact has been recognised by the policymakers and, accordingly, MFIs enjoy specific exemptions to some extent. Nevertheless, ceilings on the level and spread of interest rates, and possibly some reporting requirements need to be relaxed to suit the need of MFIs. 3.4. Self-regulation The Social Welfare Council estimates that there are about 18,000 NGOs operating in the country. Only 20 have been granted permission to engage in limited banking and two large NGOs, Nirdhan and CSD, have been able to receive lines of credit from commercial banks to a limited extent. On the national level, the NGO Federation which is a coalition of 800 NGOs charged with the responsibilities of reformation as well as framing and enforcing a code of conduct, capacity building and advocacy has not been effective. It is a federated body of multi-functional NGOs, not only of credit-based NGOs. Of late, it has increasingly been put under political pressure, NGOs being divided on political party loyalties. The Nepal Federation of Savings and Credit Cooperative Union (NFSCUN) is a national-level federation of credit and savings cooperative societies with a membership of more than 200 cooperatives. It is relatively free from political pressure, but it has not been effective in influencing policymakers towards reform in favour of cooperatives. Hence, at the moment, discussion about the development of a code of conduct and standards for MFIs has not come to the fore. However, credit-based NGOs might rally around to form a platform of their own (similar to CDF of Bangladesh) for developing standards for self-regulation. The initiative to frame new legislation, that is, the Financial Intermediation Act, could potentially lead to such development. 4 Regulation of banks 4.1 Licensing and minimum capital requirements Official policy permits any number of banks and non-bank financial institutions except that, in order to slow down possible over-expansion, applications for operating such banks are invited by Nepal Rastra Bank only once a year. In 1995, NRB revised the capital requirements for opening a bank, raising it from the previous Rs60 million ($1.1 million) to Rs500 million ($9.1 million) where a bank sets its headquarters in Kathmandu, and to Rs250 million ($4.5 million) if the bank is established in districts outside the valley. As a consequence and mainly because of the raised capital requirement, a recently established joint venture bank with Sri Lanka (Bank of Ceylon) was headquartered in the Lumbini District. 4.2 Interest rates Interest rates charged by the banks and non-banking finance institutions have been deregulated since 1989 as part of financial-sector reform. However, limited restrictions of a specific nature are in place. Banks and financial institutions may not have more than a 6 per cent margin between the deposit and lending rates. NGO financial intermediaries are subject to a maximum interest rate of 15 per cent in their lending rates. While commercial banks are free to fix their own interest rates, they are obliged to publish such rates and changes therein and are permitted only one percentage point variation, up or down, on these published rates for their depositors. Similarly, on the lending side, banks can deviate by 2 percentage points (positive or negative) on lendings between borrowers for the same purpose. These restrictions, it was explained, were imposed to deter banks from engaging in unhealthy competition with one another through setting arbitrary and large deviations in interest rates to attract customers. 5 Summary and recommendations With a per capita income of $200, the World Development Report 1996 categorises Nepal as among the poorest one dozen countries of the world, with ten devastated countries of sub-Saharan Africa below it. While estimates vary, the most recent suggest that in 1996, 42 per cent of the population was below the poverty line. Several programs which were launched in the past and aimed at poverty reduction have suffered due to implementation weaknesses. In fact, it is believed that poverty may have increased both in absolute and percentage terms over the years. Several microfinance programs are in operation among which the Small Farmers Development Programme (SFDP) is the largest. In addition, there are five regional rural development banks specifically catering to the credit needs of the targeted poor. In the private sector, a number of NGOs are dealing in microfinance, though the most prominent are Nirdhan and the Center for Self-help Development (CSD). The total outreach of microfinance services covers 522,000 as against 8.4 million people below the poverty line. The gap is to be met through a combination of efforts in the coming twenty years, so that by 2017, the total number of poor below the poverty line will have been reduced to 10 per cent of the total population. The government has supported microfinance for a number of years, and the Intensive Banking Program (IBP), Small Farmers Development Program (SFDP), Production Credit for Rural Women (PCRW), Micro Credit Project for Women (MCPW) are examples of such support. However, over the years these programs have lacked drive, reform and effective implementation. Consequently, their repayment rates have declined to an unacceptably low level. Moreover, they are not yet financially self-sustainable. The newly established RRDBs and private sector MFIs have been found more effective. Review IBP and introduce alternative mechanisms for greater effectiveness The government has also supported microfinance through IBP which is implemented by commercial banks as directed by Nepal Rastra Bank. However, commercial banks have generally been found reluctant and have not reached the specified target of 12 per cent to the priority sector in their total loan portfolios. There are several reasons for this. There is a need to review IBP and to introduce alternative organisational and operational mechanisms to make it effective. Policies adopted in respect of interest rates affecting this sector have also not proved helpful. The ceiling of 6 per cent on ‘spread’ and 15 per cent on loans by NGOs limits the ability of MFIs to reach self-sufficiency since their cost of operation is high especially at the beginning. Introduce one-window MFI licensing The system at present fails to provide ‘one-window’ treatment to MFIs in licensing. NGOs must obtain licenses from three different agencies (the government, NRB and the Social Welfare Council), and the cooperatives from two agencies (the government and NRB). One-window treatment would facilitate the operation of MFIs. Relax regulations for MFIs Once MFIs expand outreach and loan volumes and intend to accept deposits, they need to obtain NRB approval and abide by NRB directives for loan provisioning, reserve requirements and reporting requirements. These regulations should be relaxed in the case of MFIs which have relatively limited resources and administrative capability. References
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