Even while deliberations on federalism and its multiple aspects remain vociferous in Nepal, the state of banking in a federal structure is a topic least discussed among decision makers and experts. The economic properties of a well-functioning federalism, which have a direct relationship with banking sector development, should get serious attention. The key question of banking in a federal structure is the degree of centralization in the new banking system — the role and structure of the central bank and that of other banking and financial units.
THE CENTRAL BANK
The central bank’s mandated goal is to safeguard the currency of the country and to ensure a stable macroeconomic environment, including monitoring inflation and exchange rates. It is also required to support the general economic policy of the national or federal government. Hence, following the general pattern in nearly all federal countries, there should be a common currency that would facilitate internal trade between different states. The management of that currency and monetary policy needs to be carried out exclusively by the central bank.
Nevertheless, the central bank should also take into consideration regional concerns. Therefore, it is important that members of the central bank are chosen for both their expertise and also their regional diversity, i.e. it is important that members of the central bank represent different regions of the country. The method of appointment and organization of the central bank is important to ensure that it is representative of the country as a whole and consists of economic experts and not only political representatives and appointees. Basically, an inclusive composition of the central bank is a must.
In the federal arrangement, Nepal Rastra bank should concede its banking regulatory and supervisory role, at least partly, to a separate agency — say a ‘bank regulatory and supervisory board’— within or outside the central bank structure. The independence of the board shall be ensured in the banking and financial institution act itself. The agency, under gubernatorial chairmanship, shall be represented by monetary authorities of all states. Such an arrangement would serve two purposes. First, its independent status will allow the central banking machineries to stay away from the specialized function of banking regulation and supervision to focus exclusively on price stability and macroeconomic management. Second, it will help the country cope with the increasing internationalization of banking activities by internalizing the developments in global financial arena, like effectuating BASEL regulations, international financial reporting standards etc., into the national context.
OTHER BANKS AND FINANCIAL INSTITUTIONS
In order to reposition the banking industry as per the needs of federalism, the central bank should pursue reforms in the financial sector by strongly pushing a ‘banks consolidation’ policy. To begin with, the present four-tiered structure of Bank and Financial Institutions (BFIs) that classifies BFIs into four classes: ‘A’ class - commercial bank, ‘B’ class - development bank, ‘C’ - class finance companies and ‘D’ class - microfinance development bank, with seemingly overlapping scope of operations should be dismantled. The BFIs should be regrouped into national banks —those operating nation-wide under the national regulatory jurisdiction, and regional banks - those operating within a state under the state’s regulatory jurisdiction.
Further, the operating capital of banks should be also raised to Rs. 5 billion for a national bank and Rs. 2 billion for regional banks, which will force many banks to merge or acquire weaker ones. This will lead to a manageable number of stronger banks both at the national and regional levels. The commercial banks and national level development banks and finance companies may be grouped into the former category while the rest can be grouped into the second category. They will have distinct areas of operation and defined mandates.
The key question of banking in a federal structure is the degree of centralization in the new banking system—the roles of the central and other banks.
The national banks may generally be structured as universal banks providing a wide palette of banking services. Riding on their strong capital base, these banks can lend to large businesses and mega infrastructure and energy projects. On the other hand, regional banks may focus on helping the poorer and middle class segments of the economy by promoting the allocation of credit and banking services to the previously unbanked population in the region, something that banks have been accused of ignoring currently.
This dual banking structure allots power to both levels of government to create and control banking instruments through which their respective public policies can be effectuated, without infringing on each other’s roles. Public policy goals for the national government include promoting safety and soundness in the banking sector, ensuring the effectiveness of monetary policy, and enhancing consumer protection; whereas state governments would look towards preserving a degree of local control over the regional or local economy, promoting the supply of credit to all market segments in the state, and encouraging community reinvestment.
Additionally, the differential distribution of regulatory authority between the central government and states would promote efficient allocation of resources, improve governance, accelerate economic growth and reduce poverty by economically empowering weaker sections of society.
To conclude, the model of banking in federalism presented above is, of course, the function of various political outcomes that will unfold when the constitution is eventually drafted. It broadly depends on varying factors like the number of states, level of their autonomy and fiscal arrangement, among others. However, it is time all stakeholders start the discussion on a revised banking structure since any reform of the financial sector is a long-drawn phenomenon, and not always a straightforward one.
The author is with the Business Development Department of the Nepal SBI Bank Ltd
bishalkchalise@gmail.com
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