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VOL. 03, NO. 03, July 01, 2009 (Ashadh 17 2066)
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Crisis @ NDB
Shivanth Pande` & Santosh Pokharel
Research and Development Department, Nepal Investment Bank Limited
The Nepal Rastra Bank’s (NRB) recent decision to liquidate the Nepal Development Bank – the first private sector development bank in Nepal – has put an end to the prevailing myth that banking sector in Nepal is perpetually a profitable enterprise. The current crisis at the NDB has underlined that without competent management team, adequate capital base, prudent risk management and strong corporate governance, financial institutions cannot survive in the long run. Moreover, the NDB’s debacle will have long term implications for the overall financial sector of Nepal.
Implications for banking sector:
Prudent risk management:
The major problem with the NDB was their high Non-Performing-Assets (NPA). By offering high deposit rate, the development bank was able to attract depositors, however, due to lack of investment opportunities and to cover their high cost of funds, the bank was lending out money to questionable and risky enterprises. Over the long run, these risky lending practices led to high accumulation of NPA and consequently led to the downfall of this development bank. Financial institutions need to learn important lesson from this recent banking crisis.
Currently, many of the new commercial banks and other financial institutions are also offering high deposit rate to attract depositors. Similarly, many of these new financial institutions have heavy exposure to real estate sector. Over the past few years, the domestic real estate sector has witnessed an unprecedented boom and many institutions as well as individuals have benefitted from this explosive trend in real estate market. However, the larger question is how sustainable is this boom? Going forward, if the real estate market goes down or even stagnates, then it will put billions of rupees of investment in real estate sector in serious jeopardy. And because many of these new financial institutions have significant exposure to the real estate sector, they will have to face the music. The sub-prime mortgage crisis in the United States is testament of the fact that too much exposure to risky assets can led to severe losses when there is adverse market movement.
Competent Management Team:
While the banking sector has seen tremendous growth in recent years, the talent pool of qualified human resources in banking sector is still very limited. Because of this mismatch between demand and supply, there is high attrition rate of staffs in banks and other financial institutions as there is a tendency among banks to lure staffs from rivals’ banks by offering higher positions and salaries. Moreover, also due to the supply demand mismatch, individuals without adequate experience and qualifications are being assigned higher-up position.
However, running a bank or financial institutions is not an easy job. Strong professional experience coupled with adequate educational background is a perquisite for any managerial position in a financial institution. Financial institutions are in the business of risk management – they seek returns commensurate with their risk taking ability. Qualified and experienced bankers are in better position to understand and mitigate risk factors while seeking higher returns.
Strong corporate governance:
A corporation primary objective is to maximize their shareholder’s return. In a public corporation there are multiple owners (shareholders) who play little or no role in the corporation’s business decisions and these decisions are left in the hand of professional management. This separation between the owners and management creates a potential conflict of interests whereby the management may decide to put their interest first instead of the general shareholder (this problem is known as the principal – agent problem). Because of this principal-agent problem, strong corporate governance is imperative to minimize the conflict of interests.
Recently a wave of problems in the domestic financial institutions and life insurance companies (e.g. Bank of Kathmandu, Nepal Development Bank, National Life insurance Company ) has once again underscored the need for strong corporate governance system to promote the interests of general shareholders. Management of many public corporations in Nepal put their interests first when making business decisions because the corporate governance practice employed by public companies don’t have enough check and balances to ensure that general shareholders’ interests are being taken care of. However, as the recent corporate scandals (both domestic and international such as Satyam) have demonstrated, the current practice of corporate governance in many of the domestic corporation cannot be sustainable in the long run.
Implications for the domestic equity market
Over the past decade, investments in the stock of financial institutions have provided good returns. As such, most of the individual investors in Nepal are attracted towards investing in the stocks of financial institutions. However times have changed. Due to lack of competition in the past, many of these financial institutions were able to generate good profit. But with the entry of so many new commercial banks and other financial institutions, competition will be stiff and bottom line will be thin. Hence it’s now necessary for investor to analyze the basic fundamentals such as price-to-earning (P/E) ratio, price-to-book (P/B) ratio, and dividend yield, among others, of any company before investing their savings in the stock market. Just blindly putting money in stocks of any financial institutions without even analyzing their true fundamental picture can lead to financial ruin, as many of the investors in the NDB can testify.
Moreover, particularly when investing in financial institutions, investors need to be aware of their capital base because strong capital base indicates ability to withstand adverse market movement.
