Pitfalls of overregulation in banking

Even the most ardent advocates of free market capitalism have concurred that regulation of the financial system, particularly of the banks, is indispensable. The two most prominent rationales for such regulation are to prevent the banks from potential moral hazards in lending the depositors’ money to risky projects for quick profits, and to maintain the overall stability of the fanatical system of the economy concerned.

The global financial crisis of 2008-09, triggered by American subprime lending, reinforced the idea of stricter regulation of the financial sector so as to avoid similar catastrophes in future. A comprehensive study in 164 countries by the World Bank entitled ‘Bank Regulation and Supervision Ten Years after the Global Financial Crisis’ concludes, ‘bank supervision became stricter and more complex compared with the pre-global financial crisis period.’

Despite criticism, a few key neoliberal concepts on financial governance like the central bank independence and its obligation to focus on the core function of inflation targeting ‘theorised’ thorough discourses like Augmented Washington Consensus have not only survived but, generally, consolidated. However, the risk-weighted capital (adequacy) regulation has rather obsessively preoccupied the regulators. In parallel, the self-regulatory regimes designed for the bank and financial institutions primarily in compliance with the Basel III regulatory framework have come into practice, albeit to a varied extent in different countries. The overarching objectives of these developments are rooted in the principle of ‘minimal government’ where the regulator and each individual bank became robustly professional and efficient. Only then can the financial sector effectively contribute to the economy by investing in entrepreneurial and value chain ecosystems.

Compromise and arbitrage

If viewed through the lenses of global best practices, Nepal’s financial system suffers from a paradox of overregulation on the one hand and, on the other, massive regulatory arbitrage by the industry players. Every successive leadership in Nepal Rastra Bank (NRB), despite its very powerful NRB Act (2002), has failed to assert its deserved independence. The powerful political shadow of the government of the hour has persistently cast on it not only during key appointments of governors and deputy governors but also in day-to-day administration. The preference of the personal loyalty of the candidates to powerful rulers over the academic and professional qualifications, as manifested in the recent appointment of two deputy governors of the Bank, is gradually rendering the central monetary authority a toothless entity. Therefore, the compendium of NRB directives is burgeoning but effectiveness is not.

The central bank has miserably failed to timely update its outlook towards the financial industry and introduce risk-mitigating instruments. Even in this era of information technology, physical presence and paper verification of the customers is ever increasing. No substantive borrowing is possible without pledging immovable property as collateral. Although the Risk Management Guidelines of NRB states the banks would ‘analyse of borrower’s repayment history as well as current and future capacity to repay, based on historical financial trends and future cash flow projections. For commercial credits, the borrower’s business expertise and the condition of the borrower’s economic sector and its position within that sector’ needed to be reviewed.

But, all these parameters are essentially meaningless as only the value of the property with an arbitrary haircut is factored in while evaluating the creditworthiness or calculating the limit of the loans. The blacklisting provisions are applicable to only a few voiceless borrowers while about 500 large business houses never feature in the list even when their defaults amount to millions. The combined effect of such a laidback approach of the key…