May 2005
Interview

Tirth Upadhyay, one of the senior most Chartered Accountants of the country is also heading the Nepal Accounting Standards Board and associated with KPMG, one of the four largest international accounting and business advisory firm. His report about the state of affairs in Rastriya Banijya Bank and Nepal Bank Limited had exposed the disastrous situation in these banks and the likely repercussions from there in the country's financial sector, thus triggering the ongoing banking sector reforms in the country. He shares his evaluation of the current status of the banking, accounting and taxation fields in the country and gives suggestions about how to go ahead. Excerpts from an interview:

What is the status of compliance of the accounting standards and code of ethics of auditors set by Institute of Chartered Accountants of Nepal (ICAN)? There are complaints of timely actions not being taken in case of non-compliance of the code.

Accounting Standards and Code of Ethics are two separate issues. The Nepal Accounting Standards Board is responsible to set the accounting standards. But it only recommends what standard should be there. It has no authority to enforce implementation or to give directives. Every country has such a Board and there also is an International Accounting Standard Board. These all are recommendatory bodies only and the national accounting body of each country is responsible for the implementation of the standards set by the Board. For example, ICAN in Nepal or Institute of Chartered Accounts of India (ICAI) in India or American Institute of Certified Public Accountants in the USA. Generally, the standards specified by the Board are mandatory and must be implemented. ICAN has been gearing itself in the implementation of the Standards, but due to paucity of resources it is not progressing the way we would like it to be. Thus far the Board has promulgated 11 standards against 44 International Standards. From the initial assessment it appears that majority of Companies in Nepal do not possess required skill and knowledge in understanding the need and usefulness of the Standards. The Board in consultation with ICAN will have to develop a mechanism that will encourage compliance across the board. As an alternative measure, in line with the Sri Lankan model, the Board is also considering to issue simplified version of Standards applicable to small and medium enterprises.

The level of knowledge of auditors, especially those of registered auditors, in understanding and interpreting the standards is another challenge area. There are about 7,000 registered auditors spread throughout the country handling around 60% of the volume of accounting and audit business. ICAN has to plan upgrading their skill and knowledge and of course, it is not an easy proposition.

The problem is not unique to Nepal only. Other SAARC nations too are going through a similar situation. The top-notch (listed) companies are better positioned in complying with the standards as they are quite resourceful, but in terms of percentage their number is insignificant. Discussion is taking place within South Asian Federation of Accountants (SAFA) Forum for developing a mechanism that would ensure compliance by small and medium enterprises as well.

What about the implementation of the Code of Ethics?

The institutes of accountants are empowered by law to prescribe code of ethics for its members and take disciplinary actions against defaulters. At times, the Institutes have been found lacking in taking prompt action against their own members. That is prompting the Government to take away some of their authority and vest the same to other agencies. The matter is expeditiously gaining ground after the Enron episode in USA when the accounting giant Arthur Anderson was sent into forced liquidation on the charges of conniving with the client and it prompted the "Sarbanes Oxley" law. A new Accounting Standards Oversight Board is established that would exercise most of the authority hitherto enjoyed by the American Institute of Certified Public Accountants.

ICAN has recently formulated a code of ethics for its members, but I must be honest in admitting that its enforcement has remained lax. ICAN has to play a pro-active role in disciplining its members failing which it may face the plight of other Institutes. For example, a debate has started in India in taking away the power of disciplinary action vested with ICAI. The government should also promptly act in legislating laws of tort that will go a long way in disciplining not only the accountants but other professionals as well, like in medicine, law and engineering. In the absence of strong legal provision, professionals are escaping prosecution and from paying compensation to victims for their professional negligence.

It is also pointed out that the standards and the codes are in English only and a large number of auditors are not able to understand the provisions.

This is just a lame excuse. All softwares that accountants and auditors use are in English. Most of the audit reports are prepared in English and all the auditors, CAs or RAs, have received their degrees by passing the exams held in English language. Moreover, in this era of globalization, English has been universally accepted as a language of business, and therefore, people should not be permitted to escape from the ambit of ethical codes merely on the ground that they did not understand the language. However, ICAN has successfully translated its code of ethics into Nepali language and the time has come that it puts greater effort to ensure its compliance.

Simply writing an ethical code would not ensure its effective implementation as it would require finer details of related issues. For example, a case was brought up against me for my regular column in a national English daily in the pretext that it was tantamount to advertising as advertisement by an accountant in public practice is prohibited. Since the ICAN has yet to publish a position paper defining the acts that would constitute an advertisement, the matter is not making any headway.

Why are the Nepali companies late in bringing out the audited financial statements? Is it because the people take time in window dressing these statements?

Window dressing can be done even when statements are prepared timely. One basic reason behind late publication of annual report is the weak regulatory mechanism. According to the Company Act, companies require submitting financial statements within six months of the completion of the FY but the default does not attract any penalty. Even many listed companies do not publish their financial reports for 4-5 years and the Stock Exchange does not delist them. Monetary considerations override the penal provision as delisting would reduce Stock Exchange's fee income.

Corruption is another factor encouraging non-compliance. Take the case of the Company Registrar who as a regulator is responsible for enforcing the provisions of the Company Act but in practice, the Office has not even maintained an inventory of companies and the filings made by them. They wait for an opportune moment for the defaulter to come to them when all scores are settled, rightly or wrongly. This relaxed attitude is also favored by the people who enjoy breaching laws as they have the means of getting away scot free.

The auditors have no incentive in delaying the audit work as they work in a fixed fee regime, implying that additional effort put in performing the audit would not result into extra remuneration, unlike in many developed countries where auditors are paid for the time they spent on the job.

Banks and other finance companies are regularly bringing out their financial reports, quarterly and half-yearly, and that has helped the retail shareholders at least to an extent. Can't the other companies be made to issue quarterly financial reports as the banks do?

Certainly it would be helpful as such reporting is required by many Stock Exchanges all over the world. But let me remind that even the banks’ periodical reportings are deceiving as they do not disclose financial performance correctly. Besides not giving any information on the expected results for the year as a whole and the earning per share, they state operating profit that does not recognize loss on non-performing assets - a significant component of costs impacting the bottom line. Such incomplete or deceptive information is hardly useful to retail investors. Security Board should prescribe comprehensive guidelines on financial reporting formats, contents and disclosure and also make mandatory for all listed companies to report their quarterly performance. It would add value if such reports are reviewed by the auditors before publication. In this electronic age, such reporting should not cause hassle to companies.

Auditors are now increasingly facing charges of complicity with the company people in a number of accounting/financial frauds. What is your comment? Is this a new trend or a normal phenomenon that started to come to the fore only recently?

Yes, previously no significant complaints had come to the fore in our country. Most of the complaints in the past were related to unfair competition among the auditors and were amicably resolved. I also read recent news published in Kantipur daily where the insurance regulator alleged two auditors of professional negligence and registered a complaint with ICAN for disciplinary action. Since I have no access to details of the case, I would not comment on the same. But it is certain that the auditors would have to be more careful with their work as the stakeholders are becoming more conscious of their rights. Time is also ripe that ICAN or some other agencies conduct a study on the magnitude of fraudulent financial statements in order to initiate corrective measures.

Some people say the scarcity of auditing jobs and low audit fees are responsible for such tendency among the auditors to help the clients in accounting maneuver. What is your opinion?

Your statement could be true partially as the competition is really fierce. The audit fee is not commensurate with the level of effort and the risk involved in certifying the accounts. But this should not give a license to the auditors to falsify the accounts and defame the profession as a whole. It should be noted that a profession is carried out for pride and not a means of getting quickly rich. As I said earlier, better enforcement of accounting standards and ethical practices would go a long way in disciplining the auditors. ICAN also has to play a role in educating the client companies that respectable audit fee would enable the auditor serve better.

You made the initial audit that led to the induction of international management team into NBL and RBB. Do you think the present management is working in the right direction?

Reforming these banks needs massive resources including human resource, government support and significant capital injection. From the information that is available, I can say that the present management team has been able to stabilize the condition of these two ailing banks. This could be considered a remarkable success within the given resources. But the conditions of these banks have remained far from satisfactory as the ultimate objective was to bring the profitability back and privatize. The reports show some profits have been earned in these years but that does not appear to be sustainable. Out of proportion non-performing assets continue to be the major concern of all stakeholders and there is no short cut for improvement. Another problem that is leaping forward is the cost of the international management team. It is believed that the donors are hesitant in continuing their support and HMG, given the present budgetary constraints, is not in a position to bridge the gap. It is time that NRB and MoF do some brain storming for dealing with the situation when the international management teams leave.

Why the interest rates gap between the lending and deposit are high? What could be done to reduce the spread?

It has been observed that the banks are very prompt in reducing the rates on deposit as compared to the time taken in reviewing the rates charged on lending. NRB Governor has asserted that they are reviewing the situation and if the need be, might intervene in fixing the minimum rate applicable on deposit. NRB should analyze whether banks are collaborating in maintaining spread and intervene only if the findings are positive. The lower rate could also be the outcome of global environment when low interest rate regime prevailed but the time is changing as the interest rates are looking up. Rates offered by our banks too have to rise in tandem; otherwise it might lead to flight of capital.

It is said capital flight is increasing from Nepal in the recent months because of the current crisis. How do you see it?

A small country like ours cannot sustain frequent spells of uncertainty. Switzerland for that reason preferred to remain neutral during the 2nd world war that enabled it to amass foreign capital contributing to reshaping the economy.

Indicators show that reverse capital flight is already taking place; i.e. inward remittance from workers abroad has significantly declined in recent months. An unconfirmed report also suggests that the banks are no longer over-liquid and interest rate is likely to move up. In the absence of major investment coming up in the country, these factors indicate capital flight. But it can not be attributed solely to the present political environment; the rising interest rate globally may be a significant contributor.

How do you comment on the ongoing practices about blacklisting borrowers and the methods reported as being considered to deal with this problem?

The blacklisting law is quite draconian and does not appear to be logical. There is no doubt that the time was ripe for NRB to act sternly in this direction but in the process they missed out to distinguish between a bad and good lender as they did for the borrowers. The present directive requires that if a bank blacklists a borrower, all other banks dealing with him require provisioning of all outstanding due from such borrower, even if his performance had remained satisfactory with other banks. The delinquent borrower needs to be punished but if the delinquency was the result of economic depression or business failure he or she should be given opportunity for expanding or diversifying the business instead of clamping down on access to resources. NRB’s view on the matter is that the directive provides for blacklisting of the borrower, not the amount borrowed, therefore, provisioning across the Board is recommended. Of course, having said that, I must add, the recommended provision is quite relevant and timely in respect of willful defaulters and person misutilizing the loan.

How do you see the sudden resurgence in the stock exchange after Feb 1?

It is said that the Stock Market is a barometer of economic performance of a country- an assertion that does not hold true in Nepali context. The market is not moving in tandem with the overall economic performance of the country and therefore, it could be characterized as speculative. Further, trading volume at the exchange floor is limited to such an extent that it cannot be considered a trend setter. My advice would be to deal cautiously in a Bull Run market.

How high are the possibilities of insider trading in Nepal's stock exchange?

It's rampant, but we just talk about insider dealing without having much knowledge of the terminology and the yardstick for measuring the damage caused by such dealing. It is a complex issue. The flip side of the coin is that if insider trading is allowed it may increase the trading volume and make the stock exchange more vibrant. If the regulators cannot define procedures for regulating the inside dealing and measures for assessing damage done, it would be preferable to make it open and transparent so that the possible harm to the retail investors are minimized as they will be better informed about the happenings.

The point to ponder here is that all the major markets of the world including Dow Jones and NASDAQ have generally recorded a loss till date of the year but NEPSE is consistently moving up without economic fundamentals backing such move.

Would you mind explaining how insider trading is going on in Nepal?

Promoters, Board of Directors, other Officials, Auditor of a company or similar other persons who have access to the information on company's performance before they are made public are in a position to use the information for their personal gain. Based on such information, they either buy or sell the securities causing upward or downward movement in prices artificially. Depending on individual's financial strength, they can arouse bullish or bearish interest in particular scrip and then buy or sell deriving unlawful gain.

Our rules governing the insider dealing is ridiculous. The Company Act, among others, prohibits the relatives (such as brothers, father-in-law etc.) of an auditor of a company buying/selling shares of a company being audited. But how can the auditor stop his father-in-law or brother from making such transaction? The matter could even be ultra vires of Constitutional provision relating to right to property. Other countries do not bar such transactions but may require disclosure of related party transactions.

What other anomalies do you see in Nepal's stock market?

Trading at the Exchange is dominated by banking and finance sector shares that should be a matter of concern to retail investors. It would be prudent for such investors to remain diversified as the saying goes "do not put all your eggs into the same basket". But outside the financial sector, there are very few good picks. The investors have already burnt their fingers by buying shares of companies like Necon Air, Taragaon Regency Hotel, Butwal Spinning Mill, Harisidhi Brick, and the list goes on. .

Misstatement of facts in the prospectus, falsifying the result of operation by not applying or misinterpreting the Generally Accepted Accounting Principles, concealment of liabilities, management deriving unlawful benefit or receiving unjust remuneration are some of the examples of on-going manipulation amongst listed companies. It has been felt that the corporate governance in significant number of listed companies is weak or non-existent.

What can be done to increase the trading in the shares of companies other than the banks and finance companies?

Encourage better performing companies to list their shares offering fiscal concessions and incentives. Prescribe corporate governance practices, implicate fraudulent management, enact provision prohibiting shareholder's rowdism in a general meeting, make falsification of accounts a criminal offence, separate ownership from management, enforce better auditing practices, constitute an audit committee in each company etc., are some of the areas that I could think right away requiring immediate correction.

What should Nepal do in view of the changes made by India in the new budget?

In recent years India has moved much ahead of us and therefore, instead of competing we should look forward to benefiting from this rising tiger economy. We should really do soul searching and identify areas of our competitive advantage and make a joint move as a good neighbor. Gone are the days when we imported goods that ultimately sneaked into the Indian market. We have natural advantage in water resources that could be harnessed for mutual advantage of both the countries. Tourism is yet another sector that we could take advantage of exodus of outbound Indian tourists. We should also liberalize our economy more rapidly than India does in order to attract direct foreign investment. Infrastructure is the other area that we must improve to facilitate trade between India and China transiting through Nepal. Our direct tax rates are no longer competitive with India.

What are the pressing problems in other taxes?

Tax administration needs to be made more efficient and tax-payer friendly, though improvements are visible in some of the areas, especially within Large Tax Payers Office. Use of discretionary powers should be discouraged. Appeal system should be simplified. Grievance handling procedures are developed independent of revenue authorities. Constitution of Advance Ruling Authority, rationalization of tax withholding rates and procedures, making timely refund etc. will encourage tax-payers to comply with the laws. Making the assessing officer accountable for willful harassment to a tax-payer will earn tremendous goodwill to the government.

Income Tax law is criticized, as it does not allow tax planning whereas the basic idea of the tax law should be to stop only tax evasion and not planning. What is your view?

Laws are not drafted with an objective that would leave a scope for planning. Tax planning is a process of saving tax by an intelligent interpretation of the legal provision. At the same time, it should not be viewed that tax is merely a source of government revenue. It should be able to promote investment, growth, export and employment generation within the country. Unfortunately, the prevailing Income Tax Act does not take cognizance of these elements.

In the context of Nepal becoming a WTO member what changes are required in Nepali accounting/auditing firms?

WTO is made a scarecrow. Nepal being a least developed country; it has sufficient time catching up with the club members. Keeping in view of our low fee structure, I don't see any professional foreign accounting firm daring to have full fledged establishment in Nepal, at least for now. However, WTO may impact government revenue by way of pressure to reduce in customs duty and VAT rates. Having said so, I must add that the accounting professional firms will have to grow in size, enhance their knowledge and skill base for advising cross border operations, implement Generally Accepted Accounting and Auditing practices and modernize service delivery mechanism to remain competitive in a liberalized economy.

WTO should not only be viewed as a threat as it will create opportunities too, both externally and internally. It will force the Government to work more efficiently, to rationalize operational policies, and to liberalize the economy faster. One may ponder: Why do we need WTO for effecting these changes that are within the jurisdiction of our sovereign Government? Remember old habits die hard! As a legacy of several years as the aid recipient, we have been habituated to act only on the instruction of foreign masters and pledge our loyalty to aid givers as it also brings fringe benefits to policy-makers.