The Regulation Muddle in Nepal

Transcription

1 ESSAYS ON REGULATION AND SUPERVISION The Regulation Muddle in Nepal SANJAY SINHA SWETAN SAGAR MICRO-CREDIT RATINGS INTERNATIONAL LIMITED (M-CRIL) October 2007

2 ESSAYS ON REGULATION AND SUPERVISION No. 24 The Regulation Muddle in Nepal ABOUT THE AUTHORS Sanjay Sinha is Managing Director of Micro-Credit Ratings International Limited (M-CRIL) a company established to carry out professional assessments (ratings) of microfinance institutions (MFIs) and provide research and other services designed to promote the flow of investments into microfinance. He has 29 years of economic and development research experience in South and Southeast Asia. He has specialized in sub-sector analysis of activities of relevance to the livelihoods of poor people, microenterprise promotion and BDS, agriculture and livestock production as well as forestry in addition to microfinance. Sanjay Sinha has an M.Phil. in Economics from Oxford University, UK. In 1983, he co-founded EDA Rural Systems, which is now one of the premier development consulting companies in Asia. Over the past 24 years, EDA has worked for all the major international development institutions active in Asia. The idea of M-CRIL emerged out of EDA s experience with MFIs and from undertaking policy studies in the field of microfinance. Sanjay Sinha has written hundreds of reports during his career and has published extensively in major journals as well as in the print media. Sanjay Sinha is currently a Member of the UN Advisors Group on Inclusive Financial Sectors. Swetan Sagar is a graduate from the Indian Institute of Forest Management (IIFM), Bhopal, and has more than 8 years of experience in working on microfinance programs, enterprise promotion, and business development services (BDS) in India and South Asia. His key skills in microfinance include: capacity and risk assessment/rating of microfinance institutions; developing business plans for microfinance operations and establishment of MFIs; and undertaking research studies related to regulatory aspects and capacity building requirements of the sector. In enterprise promotion and BDS, he was involved in undertaking several subsectoral studies (including apiculture, leather, handicrafts, fruit & vegetable processing, hosiery, and sporting goods) that included value chain analysis, mapping of sub-sector, and BDS market assessment. He also has significant experience in imparting training to enterprise promotion and microfinance professionals and in monitoring, evaluating, and assessing impact of enterprise promotion and BDS programs. Some of his recent assignments include: documenting SDC Delhi s thirty years of experience in promoting rural finance in India; a study on the State of Microfinance Sector in Tamil Nadu for IFC Mumbai; financial assessment/credit rating of MFIs in India and South East Asia; and developing and delivering a training course entitled Appraisal and Portfolio Management of SME Loans. ABOUT THE SERIES The Essays on Regulation and Supervision series has been commissioned for the Microfinance Regulation and Supervision Resource Center, funded by the Consultative Group to Assist the Poor (CGAP) and implemented by the IRIS Center. These essays are intended to provide additional insights and perspectives on the experiences of microfinance institutions, regulators, donors, and others regarding specific microfinance legal and regulatory environments. DISCLAIMER The views and opinions expressed in these essays are those of each author and do not necessarily reflect the opinions of CGAP or the IRIS Center. THE MICROFINANCE REGULATION AND SUPERVISION RESOURCE CENTER You may find this and other essays in this series at the Microfinance Regulation and Supervision Resource Center: CONTACT IRIS IRIS Center University of Maryland Department of Economics 3106 Morrill Hall College Park, MD USA info@iris.econ.umd.edu Phone: Fax: Web:

3 INTRODUCTION NEPAL IS ONE of the poorest countries in the world. In 2006, Nepal ranked 68th among 102 developing countries on the Human Poverty Index, 1 with 38.1% of its population living on less than $1 per day. The main reasons for this low HDI are: (i) low per-capita income; (ii) economic growth concentrated in urban areas; and (iii) a high population growth rate. Most of the poor live in rural areas and have limited opportunities. Microfinance could help poor families who have no collateral (but would like to undertake enterprise activities) to obtain employment and earn income. Additionally, microfinance can have important consumption smoothening effects for poor families, particularly during the low point of the seasonal employment cycle. Although many development programs have been implemented in Nepal, microfinance programs are among the few that are seen as targeted directly at the rural poor. 2 A TYPOLOGY OF MICROFINANCE INSTITUTIONS (MFIS) IN NEPAL There are four types of institutions offering microfinance services in Nepal. These are: Co-operative societies established under the Cooperative Act, Cooperative societies that are focused on providing microfinance services are known in Nepal as finance cooperatives. 1. UNDP, Human Development Report. The Human Poverty Index is a composite index that measures the average achievements in a country in three basic dimensions of human development: a long and healthy life, as measured by life expectancy at birth; knowledge, as measured by the adult literacy rate and the combined gross enrolment ratio for primary, secondary and tertiary schools; and a decent standard of living, as measured by gross domestic product (GDP) per capita in purchasing power parity (PPP) US dollars. The index is constructed from indicators that are available globally using a methodology that is simple and transparent. See fs/report/hdr06-complete.pdf. 2. CMF 2003, An Overview of the Micro-Finance Sector in Nepal. Kathmandu: Centre for Micro Finance (available at Non-Government Organizations (NGOs) established under the Society Registration Act, 1978 and the Social Welfare Act, The Financial Intermediary Societies Act 1998 (FISA) enables qualified NGOs to offer microfinance services to their group members. These are known in Nepal as Financial Intermediary NGOs or FINGOs. Micro-Credit Development Banks (MCDBs) established under the Company Act, 1964 and registered with the Nepal Rastra Bank (NRB) Nepal s central bank under the Development Banks Act, Regional Rural Development Banks (RRDBs) established under the Company Act, 1964 and then registered with the NRB under the Commercial Banks Act, 1984 or the Development Banks Act, In order to operate as a financial intermediary, an organization has to be registered first as an institutional entity society, cooperative society, or company under the above acts and then apply for a license from the central bank to undertake operations 3

4 under the NRB Act, 2002 (for banks) or FISA (in the case of societies). (i) Finance Cooperatives The origins of microfinance in Nepal lie in the credit cooperatives and later some of the welfare-oriented rural development programs of the government. The first credit cooperatives in Nepal were created in the 1950s primarily to provide credit to the agricultural sector. To address the cooperatives shortfall in funds for agricultural lending, the Agricultural Development Bank of Nepal (ADBN) was created. In 1975, the ADBN established the Small Farmer Development Program to provide further impetus to agricultural lending by providing credit to small groups of farmers on a group guarantee basis. In the 1990s, these farmers groups evolved into the Small Farmer Cooperatives Limited (SFCLs). The cooperative movement also became the first vehicle of general microfinance in Nepal in the early 1960s, as 13 cooperatives provided flood victims access to financial services adapted to their specific needs. Though a number of initiatives targeted towards providing credit to the rural population of Nepal were subsequently introduced such as the genderfocused Production Credit for Rural Women it was only in the 1990s that the cooperative sector received significant attention, when it began to receive support from the German Agency for Technical Cooperation (GTZ). The Co-operative Act was introduced in 1992, and the sub-project offices of ADBN under the Small Farmer Development Program were reorganized into federations of SFCLs; each SFCL operated as an autonomous cooperative. In 2001, the Small Farmer Development Bank (SFDB) was established under the Development Banks Act to provide wholesale funds to SFCLs. 3 As of January 2006, there were about 184 SFCLs providing microfinance services to over 120,000 households. 4 The Savings and Credit Cooperative Societies (SCCSs), first established in the 1950s, were created through different processes. Most commonly, SCCSs evolved first from informal self-help groups into registered societies, after which they graduated to become formal Savings and Credit Cooperative Societies. Generally, SCCSs emerged spontaneously but were sometimes assisted by local or international NGOs. These cooperatives usually comprise around 25 to 200 members, while the largest has been able to reach 9,000 members. In 2004, there were approximately 2,300 registered SCCSs. Currently, 19 SCCSs have been granted limited banking licenses by the NRB under the Financial Intermediary Societies Act (FISA, see below) Based on BWTP, Nepal Country Profile. Brisbane: Banking with the Poor Network, Asia Resource Centre for Microfinance (available at al/i_country_profile/nepal_mf_ Country_Profile.htm). 4. NRB, Jan Banking and Financial Statistics (available at stics/banking_and_financial_st atistics-- No_46_January_2006.pdf). 5. Id. (ii) Financial Intermediary NGOs The concept of NGOs as social welfare and not-for-profit entities in Nepal can be traced as far back as the Lichhavi period, almost 10,000 years ago, through the practice of panchali pratha a 4

5 community effort at local governance. During the nineteenth and twentieth centuries, the concept of social service through charity and welfare was manifested by the provision of shelter for the needy, construction of resting places (chautaris) for weary travelers, planting of fruit trees for providing food and shade, and the construction of simple wooden bridges over mountain streams. Since the early 1980s, the Government of Nepal has regarded the role of NGOs as that of facilitators of change whose contributions are essential to the achievement of its developmental goals (as reflected through one of the major thrusts of the 1983 National Population Strategy of mobilizing NGOs and community-based organizations in population and fertility reduction programs). The introduction of democracy in Nepal in the early 1990s set the stage for an increasingly significant role for NGOs. In the past, NGOs in Nepal were not permitted to undertake profit-oriented activities such as financial intermediation. However, the rapidly growing role of NGOs in social development had created a need to permit them to extend some basic financial services such as microfinance. The decision to license NGOs to provide financial services was made largely in response to the closing of a significant number of rural branches of the two government-owned commercial banks, Nepal Bank Ltd. and Rastriya Banijya Bank, which together accounted for about 95% of Nepal s rural commercial bank branches. 6 To address the lack of institutions providing microfinance services in many areas of the country, the Central Bank of Nepal (NRB) provided a mechanism by which select NGOs could legitimately engage in financial intermediation activities: the Financial Intermediary Societies Act (FISA). The enactment of FISA in 1999 legitimized for the first time the provision of microcredit to their group members by NGOs licensed by the central bank (dubbed FINGOs). In 2002, Parliament approved changes in FISA to allow FINGOs to collect savings from the members of their groups as well. 7 FINGOs can receive preferential loans from the government s NRB-managed Rural Self-Reliance Fund and from commercial banks for on-lending to low-income groups. FINGOs mobilize foreign financial resources such as grants and soft loans and other support, including technical assistance and capacity building. Currently, there are 47 FINGOs, which provide financial services to approximately 40,000 clients. 8 (iii) Development Banks 6. These closings occurred due to local conflict and growing pressure from the restructuring program supported by the World Bank. See BWTP, 2004, op cit. 7. CMF 2003, op cit. 8. NRB, Jan Banking and Financial Statistics, op cit. The enactment of the Development Banks Act (DBA) in 1996 was a major event in the history of development finance in Nepal. This Act provided for the establishment of financial institutions that had the mandate to operate under more relaxed prudential regulations than the commercial banks. The banking functions of these development banks were limited to specific types of lending and deposit mobilization activity to be undertaken in 5

6 specified operating areas. All development banks are first registered as limited companies under the Nepal Companies Act and then licensed by the central bank to operate as development banks. 9 The DBA was repealed upon passage of an umbrella Act called the Banks and Financial Institutions Ordinance (BFIO) in Nepal s development banks can be broadly categorized into: Regional Rural Development Banks (RRDB); 9. World Bank 2002, Nepal Financial Sector Study. Kathmandu: The World Bank. 10. Pradhan, K. K. 2005, Development Finance and Nepal Rastra Bank. Kathmandu: Nepal Rastra Bank. Micro-Credit Development Banks (MCDB); and Other development banks. 11 In 1992, the Government of Nepal, following a recommendation from the NRB, initiated the establishment of Regional Rural Development Banks (RRDBs) in each of the five development regions of Nepal (listed below), modeled on the Grameen Bank (Bangladesh) methodology. The Grameen Bank methodology based on peer groups of five members incorporated into centers of up to ten groups has been adapted by a large number of organizations (apart from the RRDBs), mostly operating in the terai (plains) region, where the population is dense and road, market, and other infrastructure are comparatively more developed than in the hills and mountains. The five RRDBs are located in the five geographical development regions of the country and named accordingly: Eastern (Purbanchal), Central (Madhyamanchal), Western (Pashchimanchal), Mid-Western (Madhya-Pashchimanchal), and Far-Western (Sudur- Pashchimanchal). The first four RRDBs were established under the Commercial Banks Act, 1984, while the fifth was registered under the Development Banks Act, All of these institutions aim at improving the socio-economic status of poor rural women by promoting the formation of self-help groups and facilitating their access to formal credit. Operating autonomously in each of the five regions, each RRDB had a slightly different ownership pattern, although in each case the public sector had traditionally controlled at least 85%: 75% by the Government and Nepal Rastra Bank, and another 10% by two state-owned commercial banks (Rastriya Banijya Bank and Nepal Bank Limited). The remaining shares of the banks were owned by private, joint-venture commercial banks operating in Nepal. The NRB encourages these latter banks to participate by accepting funds lent to the RRDBs towards the requirement that commercial banks lend at least 3% of their loan portfolios to the deprived sector. 12 Despite easy access to funding sources and impressive outreach in the Nepal context, these organizations have not been successful in terms of sustainability and portfolio quality; three have even accumulated substantial losses. The RRDBs are currently going through an NRB-led restructuring process that will ultimately result in their privatization. Indeed, this has already reduced the NRB s stake in the Western RRDB (PGBB) 11. Other development banks include Nepal Industrial Development Corporation (NIDC), Agriculture Development Bank (ADB), Nepal Development Bank Ltd (NDB), and others. These are meant for specific development purposes, not necessarily microfinance. 12. World Bank 2002, op cit. This is based on the logic that the funds are to be used by RRDBs for on-lending to clients who are, virtually by definition, part of the deprived sector. 6

7 from 61% to 10%. In addition, the Eastern RRDB, which is the most successful Grameen Bikas Bank, is currently in the final stages of complete privatization BWTP, 2004, op cit. Of the six organizations registered as MCDBs, two are apex wholesale finance institutions Rural Microfinance Development Centre (RMDC) and the Small Farmer Development Bank (SFDB) while the remaining 4 are privatesector providers of retail microfinance services. Following the promulgation of the Development Banks Act, Nirdhan an existing NGO functioning since 1991 became the first organization to transfer its microfinance portfolio into an autonomous microfinance bank (Nirdhan Utthan Bikas Bank) in July In the following years, three other microfinance rural banks followed suit. Thus, DEPROSC transferred its portfolio to DEPROSC Development Bank in January 2001; NSSC transferred its portfolio to Chhimek Bikas Bank in November 2001; and the Centre for Self-help Development (CSD) transferred part of its portfolio to Swabalamban Bikas Bank Ltd. in January In addition, the Rural Microfinance Development Centre (RMDC) was established in October 1998 to act as an apex institution for the micro-finance sector in Nepal, and the Small Farmer Development Bank (SFDB) was established in March 2002 to provide wholesale funds and development support to Small Farmers Cooperatives Ltd. (SFCLs). As of July 2004, the 5 RRDBs were providing financial services to approximately 167,000 members. As of July 2005, the 4 retail MCDBs were providing financial services to approximately 130,000 members NRB, Jan Banking and Financial Statistics, op cit. THE REGULATORY MUDDLE At first glance, the four-pronged framework described above appears to enable the provision of financial services to lowincome families in Nepal through a variety of institutional types. In practice, however, its piecemeal introduction has created a situation that is confusing for regulators, microfinance practitioners, and the public alike. Overlapping and Conflicting Laws and Regulations Financial Intermediary Societies Act (FISA) The introduction of the limited banking license provided by the central bank under FISA to a select group of better-performing cooperatives and FINGOs has created much confusion. This license authorizes these primary institutions to collect deposits and provide credit services to clients in their areas of operation, but it does not permit them to provide any other banking services. In a country where access to infrastructure is difficult at best, this ought to have provided a major impetus to financial 7

8 inclusion. What it achieved, however, was the introduction of the first level of muddle in the microfinance regulatory framework. Though the measure provides for licensed cooperatives and FINGOs to be regulated by the NRB, licensed cooperatives continue to be regulated by the Cooperatives Department as well. In certain areas, the requirements of the two regulatory bodies are contradictory. For instance: The Cooperatives Department requires the maintenance of accounts on an accrual basis, while the NRB prescribes recording of interest income on a cash basis. The Cooperatives Department suggests low idle cash, while the NRB requires maintenance of a minimum liquidity of 10% of savings mobilized. The NRB encourages a write-off policy, while the Cooperative Department does not allow this. In addition, FISA originally did not provide any guidance as to whether deposit-taking from either members or non-members of societies was permitted. Furthermore, it assigned responsibility to the NRB to act as guarantor of loans provided to licensed societies. 15 In response to a strong protest from the central bank, the Act was amended in 2002 to eliminate this last responsibility. The 2002 amendments also clarified that licensed societies could only accept deposits from members. 15. Sinha, Sanjay, Nepal in The Role of Central Banks in Microfinance in Asia and the Pacific. Manila: Asian Development Bank. Banks and Financial Institutions Ordinance (BFIO) Further confusion was added by the BFIO, 16 which was passed in 2003 and applied in 2004 as an umbrella ordinance. The BFIO provided that all institutions licensed to perform banking transactions (which include FINGOs, licensed cooperatives, MCDBs, and RRDBs) may accept public deposits. 17 Under both the Cooperative Act and the Directives Issued to Limited Banking Transaction License Holder Cooperative Society, however, cooperatives are not permitted to mobilize deposits from nonmembers. 18 In late 2006, the umbrella ordinance was replaced by a Banking and Financial Institutions Act (BFIA) passed by the re-assembled Parliament. The BFIA contains all the provisions of the old BFIO but clarifies that Class D (or microfinance) institutions may not accept deposits from the public, only from members broadly defined as borrowing clients. Other Regulatory Concerns Disparate Regulatory Treatment of RRDBs and MCDBs 16. Banks and Financial Institutions Ordinance Published in the Nepal Gazette on 4 February Kathmandu: Government of Nepal. 17. See BFIO, 2003, Section 47(4)(j). The BFIO defines deposits as amounts placed in current, savings, or fixed accounts of a bank or financial institution; the term includes amounts to be accepted by a bank or financial institution through various financial instruments prescribed by the NRB. 18. See Directives Issued by NRB to Limited Banking Transaction License Holder Cooperative Society 2002, Section 2. The only practical difference between RRDBs and MCDBs is that the former have been government institutions (not considering current privatization efforts), whereas the latter are owned by NGOs and private banks. Contrary to expectations, however, this has not resulted in more relaxed prudential norms for the former 8

9 relative to the latter. RRDBs are required to maintain 7% of deposit liabilities in liquid assets of which 2% must be in the form of cash, while MCDBs must maintain only 2.5% of deposit liabilities in liquid assets (including a 0.5% cash reserve). Similarly, the capital adequacy requirements of MCDBs are more relaxed at 8% of risk-weighted assets, as compared to 12% for RRDBs. Compliance with the Letter (but not the Spirit) of the Deprived Sector Requirement A further anomaly is created by the directed credit requirement of the central bank, which mandates that 3% of the outstanding portfolios of commercial banks be lent to the deprived sector. 19 The regulations allow banks to include lending to MFIs in their deprived sector portfolios, but these regulations do not require the funds to be on-lent by MFIs to eligible clients. As a result, banks place substantial funds with MCDBs and FINGOs, but the deprived sector gains relatively little. Thus, only 40% of the total funds of FINGOs (in financial year ) were utilized for their microfinance portfolios. Meanwhile, 4% were invested in government bonds, 5% in fixed assets, and nearly 23% in other uses. 20 In practice, other uses consists mainly of investments by the FINGOs in conventional finance companies as directed by their lender banks. These banks provide FINGOs with deprived sector funds on the condition that the money is invested only with institutions selected by them. As a result, some of the leading FINGOs have borrowings that are 2.5 to 3.5 times larger than their loan portfolios (as of financial year ). Similarly, in the case of MCDBs, the proportion of funds deployed as investments in government securities and shares and debentures was 22% 21 indicating that, like FINGOs, MCDBs were also parking deprived sector funds in safe options. As a result, 3 out of 4 MCDBs had borrowings that exceeded their outstanding portfolios in financial year The deprived sector chiefly consists of loans of up to Rs. 40,000 (approx. USD 900) to the poorest, weak and deprived people of society (although income and net worth limitations are not specified). Investment in the equity of MCDBs is also included in this category, as are loans to all forms of MFIs. 20. M-CRIL, Nepal Access to Finance Study: Microfinance Sector Report. Gurgaon, India: Micro-Credit Ratings International Limited for the World Bank. 21. Id. The above discussion suggests that there is scope for rationalizing the legal framework for microfinance. Deposittaking eligibility requirements and the guidelines for limited banking transactions for various organizations undertaking microfinance need to be clarified and rationalized. Directives issued by the NRB for limited banking transactions under the NRB Act, 2002 and BFIO, 2003 should be modified to achieve this goal, though BFIA, 2006 has now clarified the issue of deposit taking from the public (as indicated earlier). Furthermore, RRDBs and MCDBs should be subject to similar regulatory treatment. Finally, regulations governing deprived sector lending need to be revised to ensure that qualifying funds received by MFIs are on-lent to microfinance clients. RATIONALIZING THE FRAMEWORK Some degree of regulation is always good for institutions involved in providing financial services, irrespective of their legal forms. At the same time, considering the total number of 9

10 institutions providing microfinance services and the related cost implications, it is not possible to undertake prudential regulation of all institutions engaged in microfinance. Since the main purpose of prudential regulation is to protect small depositors, on the one hand, and to prevent the breakdown of the financial system, on the other, two broad yardsticks are generally used to decide what types of institutions should be subject to it: Whether the institution uses public money/deposits for financial operations, and/or Whether the institution borrows from other regulated institutions for financial operations. 22 However, regulation is appropriate only in situations where it will be effective. The regulator should have sufficient capacity in terms of the number of competent staff available to undertake adequate supervision of the regulated institutions. In the absence of such capacity, regulation would become a mirage for the unsuspecting public or clientele of the regulated financial institutions, leading to a false sense of security when making deposits in these institutions. Failure of the recipient institutions to safeguard these deposits would undermine the public s confidence in the efficacy of the regulator in the short term and could, thereby, affect the stability of the entire financial system in the long term. Therefore, coverage should be limited to the number of institutions that the regulator is able to supervise effectively. 22. In the latter situation, the lender should be responsible for due diligence. The regulator becomes important in a situation where the financial system is in a relatively early stage of development and the lending institutions would not have the capacity to undertake due diligence to an appropriate level of quality. In Nepal, the responsibility for prudential regulation lies with the central bank, the Nepal Rastra Bank. Currently, only those microfinance institutions that are licensed by the NRB to perform banking transactions are regulated. These include around 47 FINGOs, 19 Savings and Credit Cooperatives, 6 MCDBs, and 5 RRDBs. A large number of NGOs and cooperatives that utilize member savings for microfinance operations are, therefore, not covered by prudential regulations. However, even the 75 or so institutions currently covered are not adequately regulated, largely due to the lack of staff capacity within the NRB s Supervision Department. As a result, inspections take place every 2-3 years and are, in any case, handicapped by the on-site inspectors inadequate level of understanding and limited experience with microfinance. This situation is compounded by the culture of transfers supervisors are transferred every 3-4 years or sooner that is intended to stem corruption but (damagingly) prevents specialization and development of supervisory expertise. In such a situation, it would be more appropriate to limit the number of institutions covered by such regulation. There is no reason, for instance, for the NRB to provide direct regulatory oversight to cooperative societies that have already functioned for decades without it. Regulation does no more than enhance the confidence of the cooperatives members in the capacity of their institutions. Strengthening the capacity of the 10

11 government s Cooperatives Department could address this issue, rather than burdening the central bank with the task. Secondly, NGOs (societies), with their loose governance and lack of an ownership structure, are institutionally inappropriate for providing large-scale financial services. It is on account of the lack of owners capital that the present regulations do not even specify any minimum capital requirement for such institutions. Further, there is no provisioning norm for NGOs; there is simply a requirement to set aside 10% of profits, and many such societies are not profitable. This situation masks the actual performance of their financial services activity and could delay the demise of inefficient institutions. Ideally, FINGOs should be allowed to continue to provide financial services to a limited clientele perhaps up to 5,000 clients but should be kept outside the ambit of prudential regulation. To the extent that either cooperatives or FINGOs would like the public respectability conferred by prudential regulation, they should be required to convert to MCDBs, starting in one or 3 districts (if they are able to raise the required amount of minimum capital). FINGOs would find the ownership issue to be difficult, but (in theory) they could raise the funds from the public (or donors) that are willing to place their faith in the original governing board of the FINGO to operate the institution as a development bank. In the case of cooperatives, the ownership issue would be easier, since members could simply be allotted capital in lieu of the shares held by them in the cooperative. Thirdly, with the ongoing moves to privatize the RRDBs, there is no longer any rationale for maintaining a distinction between these and MCDBs. Since there is no difference between the objectives and functions of the two types of institution, the categories should simply be merged. After accounting for the expected transformation of the more accomplished FINGOs and SACCOs into development banks, the decision to stop prudentially regulating FINGOs and SACCOs would likely result in a drop from 75 regulated institutions to approximately 25 regulated development banks. The effect of such a decrease on the central bank s task of supervision is apparent: The ~25 institutions remaining could be inspected every months, and a small team of specialist inspectors could be developed to ensure that the remaining regulated MFIs strictly comply with all regulatory norms. Clearly, the directed credit anomaly also needs to be resolved by placing a limit on the average proportion and tenure of funds placed by MFIs in investments with other institutions. COMPOUNDING THE MUDDLE Recent thinking on the regulation issue within the central bank, however, has not been encouraging. In early 2006, the draft of a 11

12 new ordinance for microfinance was floated. This draft Micro- Finance and Cooperative Transactions Ordinance proposed the establishment of a second-tier institution that would act as a combination of facilitator, finance wholesaler, and regulator of all microfinance activities in Nepal. This proposal totally ignores the clear conflict of interest inherent in an institution s being both facilitator and regulator at the same time. Serious debate on the matter was overtaken by the momentous political developments that engulfed the country in April Despite the passing of some limited legislation in late 2006 (the BFIA), the next chapter of this muddled tale awaits the restoration of orderly governance in the country after the promulgation of a new constitution. 23. General strikes and street protests occurred in early 2006 in response to the King s decision to take control of the government and army. Bowing to both local and international pressure, the King restored democracy on April 27, For more information, see M-CRIL, Micro-Finance Rating Risk Assessment: Swabalamban Bikas Bank Ltd (SB Bank) (available at gs_completed.aspx). 12