It is hard to predict the exact number of financial institutions (FIs) our ailing economy needs. The theoretical hypothesis reveals that more the number of FIs faster the monetization and thus the acceleration in investment to achieve high economic growth rate. It is basically based on the belief that more FIs generate more resources for ordinary people by mobilizing their own deposits thus providing access to resources for individuals, community, society and the state through investments in economic activities. FIs are a part and parcel for national development in a typical developing country like Nepal.

In Nepal, FIs are mushrooming roughly more than a dozen a year. The planners, policy and decision makers believe that more FIs can beget more growth which in fact is true. With the birth of democracy in 1990 and mainly in the first decade of this century more FIs have emerged at a faster momentum. In general terms, an FI is an institution that accepts deposits and provides loans. The primary goal of FIs largely is to earn decent profit by operating banking business. Decent profit is the result of more deposits at lower rates and more loan advancement at higher possible rates. But profit is affected by competition. Higher number of FIs means greater competition which leads to the advancement of loans to sectors (real estate, imports, transportation) for profit irrespective of the credibility and reliability. Before 1990, banks and other FIs were strictly regulated so that they could not take undue advantage of any kind. After 1990 that system gradually broke down de-regularizing the FIs making them more or less autonomous regarding the decisions they make about deposits and loan advancement. De-regularization has made them master in determining their loan advancement to those sectors where they can maximize their profit in a short period of time.

To achieve a healthy progress in an economy, motives both social and profit should go together. So far as the social motive is concerned under this arrangement, FIs are not legally obligated to advance their loan to those sectors in which social values are attached-priority sector. This is the result of over deregulation of FIs. The focus of FIs has been heavily linked with profit motive rather than with the social motive. Recent liquidity crisis is said to be the result of the overcrowded FIs but detailed investigation is necessary

to know the real cause. Despite the deepening of the liquidity crisis, new banks and other FIs are still in queue to operate. Furthermore, politicians and bureaucrats have suggested that there should be more FIs for an investment environment. But in reality, the investment is being made in unproductive sectors that is more lucrative but is on the verge of collapsing. Given the situation, it can be inferred that the progress in productive activities has become slow. Result is that the contribution of FIs in achieving high economic growth is in peril. This puts that the largest service sector or rather the largest service industry’s contribution to the economic growth is a matter of question today. Without the question being answered, opening up of new institutions is being allowed without examining social and economic effect which could be the curse or even suicidal. The market is not large enough for FIs to pursue profit on the first hand and growth associated with the social welfare later - the two that must come together, are both in jeopardy. This will ultimately result in the reduction of profit and hence the confidence in the customers.

Recent experience has proved that opening of large number of FIs with the policy of de-regularization brings instability in the financial sector. Housing bubble in USA had compelled a number of large banks to go bankrupt which of course was the beginning of current global recession. In the same fashion, any down turn in the real estate market in Nepal will collapse most of the FIs quickly as a large chunk of their lending has been flowing in this sector.

Likewise, it would be too early to say that recent problem of liquidity crisis in Nepal is the outcome of financial sector deregulation. Factors such as lack of credibility in advancement of loans, investment of limited resources in unproductive sectors, dependence of FIs on the real estate sector, and focus of the FIs on the same region over and over again could be the possible reasons for the liquidity crisis. Allowing them to save their faces, we could even bring up topics such as the outflow of money to foreign banks by businessmen to import gold or other commodities to earn arbitrage profit over the price differences in various regions. However, these profit makers cannot take their advantages without the help of

FIs that allow them to open up Letter of Credit for those purposes. The greater number of banks in the economy has made it easier for the fraudulent activities to go clean. Therefore, it is still a question whether we are in need of more banks or should the existing banks be merged to better serve the economy.

By: Dr. Kamal Raj Dhungel
Dr. Dhungel is Associate Professor, Central Department of Economics, TU, email:kamal.raj.dhungel@gmail.com

courtesy: thehimalayan times