Nepal: Rural Finance Sector Development Cluster Program (Subprogram 2)

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Lessons

Careful thought should be given to investing in sector development programs in countries in political transition.

The Asian Development Bank (ADB) should carefully think about investing in sector development programs that require policy changes in countries undergoing political transition. The highly volatile political situation in such countries can pose risks that may not be foreseeable during the design stage but can seriously impede implementation. This was highlighted by this program’s experience in Nepal where, due to successive short−lived governments and the protracted process of drafting a constitution, the passage of the microfinance authority act had not been acted upon until program completion. Policy actions that depended on the passage of the act consequently have also remained pending until now.

It is not prudent to undertake bank privatization in a politically unstable environment.

ADB should carefully evaluate supporting bank privatization in an environment of political instability. The plan of the state−owned Agricultural Development Bank Limited (ADBL) to divest to a strategic investor did not materialize due largely to the country’s unstable political and investment climate. Additionally, investors were reluctant to commit equity to an institution influenced by politically active labor unions. In contrast, the success of the privatization and merger of all the 5 Grameen Bikash banks may be attributable to the largest bloc of shares held by the employees and/or staff of the new bank. Furthermore, no strategic investor was invited to commit equity to the new bank.

Policy actions should be realistic and within program control.

It is imperative to ensure that policy actions are within program control. For example, when pursuing privatization, an appropriate policy action would be to bring an institution to the point of sale, as opposed to selling an institution. The policy action regarding ADBL privatization should thus have reflected the process to the point of sale, which can be reasonably controlled.

Limiting the number of policy measures can enhance program monitoring and implementation.

The Rural Finance Sector Development Cluster Program, with 2 subprograms, consisted of many policy actions, and this made monitoring and implementation a challenge. Subprogram 2 alone comprised 34 policy actions—16 for the first tranche and 18 for the second. Limiting the number of policy measures may be considered to ensure effective monitoring and implementation of future similar programs.

Background

The macroeconomic environment in Nepal became upbeat, as peace set in after a decade−long conflict. Gross domestic product grew by 4.7% in 2008. Poverty incidence fell from 42% in 1996 to 31% in 2004. Nevertheless, until subprogram 2 preparation in 2009, severe poverty had persisted in various parts of the country and economic growth had been uneven. With poverty in Nepal largely a rural phenomenon and rural poverty associated with limited access to finance, increased financial intermediation was deemed vital to improving the flow of resources to the rural sector and enabling the poor to invest in productive activities and improve their incomes.

Against this backdrop, the Asian Development Bank (ADB) approved in June 2010 a 2-tranche, $60.4 million−loan and $12.1 million−grant for subprogram 2 of the Rural Finance Sector Development Cluster Program (RFSDCP). Subprogram 2 aimed to complete the rural finance sector reforms started under subprogram 1, which was approved together with RFSDCP in October 2006 and completed in December 2009. As with subprogram 1, it supported the attainment of RFSDCP’s intended impact of economic growth and poverty reduction in the rural areas and intended outcome of establishing an inclusive rural finance system that is sound, efficient, and has wider outreach. It had 4 key outputs: (i) an enabling legal and regulatory framework; (ii) reform of the Agricultural Development Bank Limited (ADBL), Small Farmers Development Bank (SFDB), and Grameen Bikash banks (GBBs); (iii) capacity building; and (iv) rural finance infrastructure.

Through 34 policy actions, subprogram 2 achieved most of its output targets. The draft microfinance authority act had been submitted to the Ministry of Law and Justice for endorsement to the Parliament. A government divestment plan from ADBL had been formulated and an initial public offering resulted in an additional 229,000 general public shareholders. Expansion of SFDB microfinance services to 9 districts in the hills and mountain areas led to the development of 75 new credit cooperatives and the first−time inclusion in microfinance services of 142,514 small farmer households, well above RFSDCP’s original target of 30,000 small farmer borrowers. Of the new borrowers, 63% were women.

The 5 GBBs, established by the government as regional rural development banks, were merged, with the Nepal Rastra Bank (NRB) holding only 5% of the merged bank’s equity. The National Banking Training Institute (NBTI), formed and incorporated under subprogram 1, became operational in 2010 and raised professional standards by training a wide range of institutions and bank staff. A microfinance credit information system was established, and capacity development of the Debt Recovery Tribunal was assisted.

Despite the challenging political and policy implementation environment, subprogram 2 thus effectively supported the government’s bid to implement structural reforms that enhanced the efficiency and soundness of the rural finance system and expanded its outreach. However, due to the shift from small borrowers to larger and/or commercial accounts at ADBL, formal banking credit outreach decreased from 200,000 accounts in 2010 to 174,000 in 2016, 34,800 of which were owned by women. The credit outreach of SFDB, on the other hand, increased from 140,000 accounts in 2008 to 512,765 in 2016. 381,074 of the new accounts were women−owned. Finally, with the registration of microfinance institutions with the Credit Information Bureau, a more viable rural credit culture is in the offing.

The program, executed by the Ministry of Finance, was rated successful by ADB’s South Asia Department.

Project Information

Project Name:

Rural Finance Sector Development Cluster Program (Subprogram 2)

Report Date:

August, 2016

Main Sector:

Finance

Country:

Nepal

Project Number:

36169-023