Final study report for publication december 17, 2009

Microfinance Policy and Regulatory Framework
Diagnostic of Nepal: Recommendations

Tejhari Ghimire and Tulasi Prasad Uprety

Center for Microfinance (CMF)

2009 Bahtbhateni, Kathmandu, Nepal
Tel: 977 1 4434041, 4443984
Email: cmf@cmfnepal.org
Internet: www.cmfnepal.org

Copy rights

2008 Center for Microfinance (CMF), Kathmandu

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, without the prior written permission of the Center for
Microfinance (CMF). CMF does not guarantee the accuracy of the data included in this publication
and accepts no responsibility for any consequences in their use.

This publication Microfinance Policy and Regulatory Framework Diagnostic of Nepal:
Recommendations was published with the financial support of The Asia Foundation. The study was
conducted by the following team:

Tejhari Ghimire, Team Leader
Tulasi Prasad Upreti, Microfinance Consultant;
Sushila Gautam, Naresh Nepal, Ganesh Bista, Ruchi Bhagat, and Mimu Raghubamshi, Field
Researchers

The views expressed in this publication are those of the authors and do not necessarily reflect the
views of the CMF and The Asia Foundation.

Center for Microfinance (CMF)
Bahtbhateni, Kathmandu, Nepal
Tel: 977 1 4434041, 4443984
Email: cmf@cmfnepal.org
Internet: www.cmfnepal.org

i

ABSTRACTS

The objectives of the study were to review the current legal and regulatory frameworks related
to microfinance institutions in Nepal; to identify stakeholder policy and regulatory framework
issues; and to suggest measures required for MF sustainability and growth. The study team
reviewed the regulatory frameworks of other countries; held group and individual discussions
with MF industry representatives; and held a national seminar to share the outcome results
before finalizing the study.

Many MF practitioners believe that the “Market is the best regulator”. They also realize the
need to have some form of government regulation. The possibility of a stakeholder(investor)
panic ‘run’ on an MFI due to lack of information; the public’s concern regarding the
opportunistic and risky behavior of agents; the need for consumer protection; and the
requirement to ensure stability and protection of wholesale lenders are often put forward as
the reasons for having appropriate regulation and supervision. In addition, the building of an MF
database; facilitating the acquisition of a legal identity; ensuring a healthy development of the
sector i.e. performance standards; and facilitating the linkages that enable banks to become
involved in direct micro-finance are considered some of the other important areas that help to
establish need.

Nepal has experimented with different types of MF models i.e. Grameen replication, Savings &
Credit Cooperatives (SACCOs), Financial Intermediary NGOs (FINGOs) as well as project/
program based models. These models are apart from any informal MF practices.

Many of the MFDBs and FINGOs regulations are acceptable to MFIs but there are areas where
reform is required to ensure the growth and sustainability of the sector. The co-operative MF
sector lacks regulation. Unfortunately, the policy and legal framework now under discussion at
the Central Bank lacks the required direction. Consequently, MF industry stakeholders are
committed to draft an appropriate policy and framework using a participatory approach. The
multi agency regulations for different types of MFIs (current model) are appropriate but a
number of provisions required revision.

Rather than applying the Basel Framework of regulations, the Government should use the
PEARLS rating system to regulate and supervise MFIs. The Pearls rating system is simpler, more
realistic and comparable to the worldwide MF database. It is also recognized that setting
performance standards, self-regulatory norms and promoting best practices can be enhanced
through appropriate policy and regulation application.

An outcome of this study was the model Microfinance Act of 2009. Its’ adoption by
Government is expected to set a level playing field for all MFIs, aid the growth of the sector,
widen MFI outreach and help to reduce poverty.

ii

TABLE OF CONTENTS
Abstracts...................................................................................................................................ii
Acronyms .................................................................................................................................v
List of Tables...........................................................................................................................vii
1 Introduction............................................................................................................................1
1.1 Context................................................................................................................................. 1
1.2 Methodology ....................................................................................................................... 3
1.3 Limitations ........................................................................................................................... 3
2 Microfinance Market Environment ........................................................................................4
2.1.1 Outreach Growth........................................................................................................... 4
2.1.2 Market Penetration........................................................................................................ 5
3 Policy and regulatory environment.........................................................................................8
3.1 Defining Microfinance.......................................................................................................... 8
3.2 Principles and Characteristics .............................................................................................. 9
3.3 Best Practices ....................................................................................................................... 9
3.4 Why Enabling Regulatory Environment.............................................................................. 10
3.5 Principles of Enabling Environment.................................................................................... 11
3.6 The role of Government and the Central Bank................................................................... 12
3.7 Impact of Micro- finance in Nepal...................................................................................... 12
3.8 Regulations for Microfinance Institutions ........................................................................... 13
3.9 Establishment Criterion...................................................................................................... 13
3.9.1 General......................................................................................................................... 13
3.9.2 Licensing Norms for FINGOs......................................................................................... 15
3.9.3 Registration Norms and SACCOs.................................................................................. 16
3.10 Regulations for Micro Finance Development Bank (MFDB) .............................................. 16
3.11 Regulations to Savings and Credit Co-operative Societies (SACCOs) .................................20
3.12 Regulations for FINGOs..................................................................................................... 22
4 Micro-Finance Policy, 2065 (2008).........................................................................................22
5 Survey findings.....................................................................................................................24
5.1 Survey Coverage................................................................................................................. 24
5.2 Policy Issues Awareness...................................................................................................... 24

iii

5.3 Policy Issues raised by the Actors....................................................................................... 25
5.3.1 Co-operatives.............................................................................................................. 25
5.3.2 FINGOs ........................................................................................................................ 26
5.3.3 MFDBs.......................................................................................................................... 27
5.3.4 Policy Organizations..................................................................................................... 27
5.3.5 Donor Agencies / INGOs............................................................................................... 28
6 Recommendations................................................................................................................30
6.1 Legal/Regulatory Framework.............................................................................................. 30
6.2 Performance Standards/Indicators..................................................................................... 35
6.3 Model Microfinance Regulation Act 2009.......................................................................... 36
6.4 Other Suggestions .............................................................................................................. 36
Annexes..................................................................................................................................37
Bibliography............................................................................................................................60

iv

ACRONYMS

ACCION ACCION International - a Latin American MFI system
ADB Asian Development Bank, Manila
ADB/N Agriculture Development Banks, Nepal
ASA Association for Social Advancement, Bangladesh
BASEL Basel Committee for Banking Supervision, Bank for International Settlement,
Switzerland, BASEL
BFI Bank and Financial Institutions
GBB Grameen Bank Bangladesh
BRAC Bangladesh Rural Advancement Committee
CAMELS ‘Capital Adequacy, Asset Quality, Management, Earning, Liquidity and
Sensitivity’ to Market Risk
CAR Capital Adequacy Ratio
CMF Center for Micro- Finance, Kathmandu, Nepal
CBs Commercial Banks
CBOs Community Based Organizations
CEO Chief Executive Officer
CRR Cash Reserve Ratio
CSD Center for Self Help Development, FINGO
CGAP Consultative Group to Assist the Poorest
CGISP Community Ground Water Irrigation Sector Project
DDB Deprosc Development Bank
DLGSP Decentralized Local Governance Support Program.
DSL Deprived Sector Lending
FCs Finance Companies
FD Fixed Deposit
FGD Focus Group Discussion
FI Financial Institution
FINGO Financial Intermediary Non-Government Organization
FSS Financial Self-Sufficiency
FWGB Far Western GB
GB Grameen Bank
INAFI International Network of Alternative Financial Institutions
LLP Loans Loss Provision
LOI Letter of Intent
MCPW Micro-Credit Project for Women
MCR Minimum Capital Requirement
MEDEP Micro Enterprise Development Program
MDGs Millennium Development Goals
MF Micro-finance
MFDB Micro Finance Development Bank

v

MFI Microfinance Institution
MGB Madhyamanchal GB
MWGB Madhya Paschimanchal GB
MIS Management Information System
NCDB National Co-operative Development Board
NCF National Co-operatives Federation
NEFSCUN National Federation of Saving and Credit Co-operatives
NGO Non-Government Organization
NRB Nepal Rastra Bank
NUBL Nirdhan Utthan Bank Limited
OSS Operational Self-Sufficiency
PAF Poverty Alleviation Fund
PCRW Productive Credit for Rural Women
PEARLS Protection, Effective financial structure, Asset Quality, Rates of return and costs,
Liquidity, Sign of growth
PGB Paschimanchal GB
PuGB Purbanchal GB
RFP Rural Finance Project
RMDC Rural Micro-Finance Development Centre
RSRF Rural Self-Reliance Fund
SACCOS Savings and Credit Co-operative Societies
SFCL Small Farmer Co- operative Ltd
SFDP Small Farmer Development Project
SHGs Self-Help Groups
SKBB Sana Kishan Bikash Bank
SBB Swabalamban Bikas Bank
SOL Single Obligor Limit
SPOs Sub Project Offices (SFDP)
STI Second Tier Institution
TLDP Third Livestock Development Program
UN United Nations.
VICCU Vijaya SACCOS, Nawalparasi
WOCCU World Co-operative Union

vi

LIST OF TABLES

Table 1: MFI Categories and Client base

Table 2: Current Microfinance Market size and penetration

Table 3: Microfinance Market breakdown by regional type

Table 4: Market Concentration in thirteen ( 13) districts

Table 5: Minimum Capital Requirement in Nepalese Rs in Millions

Table 6: MFIs and Organizations Surveyed during policy diagnostic

vii

Introduction

1 INTRODUCTION
1.1 CONTEXT
Microfinance has been one of the few effective tools for poverty reduction. As a result of the
creation of sound microfinance institutions and systems, poor people can safely deposit money
and accumulate funds for future investments or emergencies as well as access loans for
productive purposes leading to higher incomes. Additionally, microfinance has produced an
impact in other areas including good governance, participation in the political process, women
empowerment, social inclusion and conflict transformation.1
Currently, more than 1.6 million individuals in the rural population have access to microfinance
services. This figure represents approximately 7 percent of the population and approximately
22.7 percent of the people living below the poverty line. The outreach of sustainable and sound
microfinance institutions to the rural and urban poor still needs, however, to be increased in
order to further diminish poverty. Despite ongoing development efforts, poverty remains
widespread with approximately 31 percent of the population living below the poverty line. The
incidence of poverty is highest in rural areas, particularly in the remote hill and mountain areas.
The Microfinance Summit Nepal held from February 14 to 16, 2008 discussed the major issues in
the microfinance sector. These issues included:

• Lack of an enabling microfinance policy based on a broad consensus among
policymakers and stakeholders;

• Lack of coordination among microfinance stakeholders (including the international
donor community) which has lead to market distortions and overlapping interventions;

• Lack of appropriate strategies to build a strong and inclusive microfinance sector which
responds to the needs of all segments of society, and actively contributes to creating a
peaceful and socially equitable society;

• Lack of microfinance sector baseline data on key stakeholders and customers which
hinders the development of targeted and tailor-made support strategies for different
client groups (i.e. how to bring microfinance services to hill areas? How to better access
dalit and janajati communities?);

• Lack of information sharing on innovations, new technologies and strategies which
impedes increased outreach, particularly to the less accessible areas.

Delegates (838) of private, government and public microfinance stakeholders together with the
international donor community attempted to address these issues at the Summit. Microfinance

1
Microfinance Summit Nepal 2008

CMF Nepal 60

Introduction

stakeholders shared their experiences with microfinance issues and jointly decide on the future
direction of microfinance in Nepal. The Summit promulgated the ‘21 Point Kathmandu
Declaration’ and established goals for Nepal only after recalling national and global
commitments.

• The national development plan; and the United Nations Millennium Development Goals
(MDGs) call for reducing international poverty by half by the Year 2015, thereby globally
reaching 175 million poor families;

• Bearing in mind that the Global Microcredit Summit held in Halifax, Canada declared a
goal of ensuring that 100 million of the world’s poorest families move from below USD 1
day earnings to an adjusted purchasing power parity above USD 1 a day;

• Recognizing that adopting an inclusive approach for poverty reduction through
appropriate financial services contributes to ensuring a peaceful, democratic future for
Nepal.
The Summit set as its goal:
• Reaching 2 million of the ‘poorest of the poor’ with microfinance services for their
sustainable income by 2010;
• Reaching a total of 3 million of the ‘poorest of the poor’ by 2015

The Summit also formulated a two year action plan to meet this goal. The most important step
was to form a fifteen (15) member Taskforce to lobby for the formulation of a microfinance
policy and the creation of an enabling regulatory environment. The Summit recognized that an
enabling policy and regulatory environment was a necessary pre condition to meeting its goal. In
the course of this action, a review of new policy, regulations and regulatory provisions was felt
to be necessary. This recognition prompted CMF and The Asia Foundation to implement the
project “Advocacy for Enabling Microfinance Policy Environment in Nepal” (May 10, 2008 to
January 31, 2009).
The partnership conducted primary and secondary research to diagnose the current regulatory
gaps and ambiguities in Nepal’s microfinance policy in close coordination with the Summit’s
Taskforce. This diagnostic report is the outcome of the primary and secondary research, and the
in-depth discussions held with the Microfinance Policy Taskforce formed at the Summit.

Rationale:

Microfinance in Nepal is emerging and transforming itself from a directed public sector
environment to a market led private effort. This does not mean, however, that the
Government, the Central Bank and donor institutions are not giving it the necessary attention.
Their role is recognized as systematizing, regulating, supervising, promoting and facilitating the
systems, methods and institutions.

Nepal's Central Bank (Nepal Rastra Bank) is considered the prominent regulator. It is always in
support of poverty reduction strategies through the provision of development finance especially
microfinance. In this mission it has created not only laws and regulations but also institutions at
various points in time. In recent years it has concentrated on regulatory reforms in the banking

CMF Nepal 2

Introduction

and financial system in line with Basel II for creating a safe and sound financial system. This is
the basic requirement of sound macroeconomic stability. Currently, NRB is in the process of
strengthening microfinance systems, regulations and regulatory frameworks.

Objectives

This diagnostic study on the policy and regulatory framework for microfinance in Nepal had the
following objectives:

1. To review the existing policy, legal and regulatory frameworks for different models of
micro finance institutions;

2. To identify issues related to policy and regulatory framework from the perspective of
stakeholders; and

3. To suggest measures and a regulatory framework for MFIs with the aim of enhancing
their sustainability and growth.

1.2 METHODOLOGY
• The study reviewed the policy and regulatory framework of the microfinance sector.
Available literature on principles, issues and practices of regulation and policy
framework of several countries were also reviewed.

• Individual consultations were held with forty-four microfinance institutions, policy
making organizations, donor agencies and INGOs.

• The national Microfinance Summit held in February 2008 in Kathmandu proposed a
national Taskforce Committee be formed to prepare and suggest policy and regulatory
issues in micro-finance to the next Summit to be held in February 2010. The
Microfinance Secretariat formally constituted the Taskforce and conducted a series of
nine meetings with members, the NRB governor, and NRB officials. The outcome results
of a desk-top audit and field review were submitted to this Committee. The final
comments of the Committee including final draft recommendations were then
submitted at a wider stakeholders meeting including the National Steering Committee
members on January 26, 2009. The model draft Microfinance Act and stakeholder
suggestions on it are attached as Annex-1-2.

1.3 LIMITATIONS
The study focused on the regulatory environment, reviewing current practices and
recommending how to reform them. It did not focus on the depth of outreach, sustainability
factors and probability of sector growth. This was due to the availability of resources. As a
consequence, there exists further scope for study in each of these areas.

CMF Nepal 3

Microfinance Market Environment

2 MICROFINANCE MARKET ENVIRONMENT
An unstructured form of microfinance service started in the 1950s when several saving and
credit co-operative societies were formed in Chitwan district. Available study data indicates that
while this informal financial system (SACCOs) remains dominant the microfinance sector has
undergone many changes. The sector has experienced a rapid growth of institutions (MFIs) and
significant progress has been made in terms of client out-reach, savings and credit management
services. The number and outreach of microfinance institutions in Nepal has increased
substantially over the last 13 years.

Market Outreach

The table below shows the microfinance market in Nepal by category of financial model. The
number of institutions in each category, the number of clients served per institution, and the
total client base are shown. This information was gathered mostly from secondary sources.

Table 1: MFI Categories and Clients

MFI Categories Number Number of Clients (Range) Client Base
of MFIs

MFDBs 10 20,000-96,000 455,782

SACCOs 4,432 100-5,000 686,453

FINGOs 47 5,000-40,000 343,596

SFCLs 219 500-1,500 139,368

Sources: NRB (2008), CMF (2008), Department of Cooperative (2008), SKBBL (2008).

SACCOs account for 42 percent
of the market. The 10 MFDBs
account for 28 percent and the
47 FINGOs for 21 percent of
the microfinance customer
base. The rest of the market is
covered by SFCLs.

Figure 1: Market share

2.1.1 OUTREACH GROWTH
Figure 2 below shows the annual microfinance outreach growth from 2004 to 2008 of each MFI
category. The FINGO category has the highest growth rate but has had a declining rate since
2006. SFCLs have a positive growth rate in comparison to other categories from 2006 to 2007.

CMF Nepal 60


The aggregate annual average growth rate of all MFIs is nearly 23 percent. The unexpected
growth of SACCO clients in 2008 was due to the growth in the number of SACCOs. There was
only limited growth in 2007, however, among the other MFI categories. This indicates the need
exists for an enabling policy and regulatory environment to boost outreach

MFI Outreach (2004-2008)

75%
70% 70% 70%
65%
62% 62%
60%
55%
50% 51%
Outreach growth

45%
40%
37%
35%
33%
30%
25%
22% 21%
20% 19% 19%
17% 16%
15% 15% 15%
12% 11%
10%
8%
5%
2%
0% 0%
2005 2006 2007 2008

Fiscal Year

MFDBs SACCOs FINGOs SFCLs Aggregate outreach

Figure 2: Outreach growth

2.1.2 MARKET PENETRATION
As discussed earlier, the potential microfinance market comprises the 31 percent of the
population that live below the poverty line. The table below shows the current outreach and
market potential of each development region. The data used to estimate the market potential
and the coverage of MFIs came from CMF reports.

CMF Nepal 5


Table 2: Current Microfinance Market Size and Penetration

Development Number of Microfinance Percent of

Regions Clients Market Penetration

Eastern 306,388 2,543,536 12%

Central 472,810 2,806,561 17%

Mid-West 117,126 1,043,790 11%

Western 237,772 1,518,415 16%

Far Western 49,657 766,722 6%

Total 1,183,753 8,679,024 14%

Sources: CBS (2007), CMF (2008). Note: Market penetration is based on 2007 client base data.

Table 2 shows that a small percent of the microfinance market is being reached. It also shows
that those that are being reached come from the Eastern, Mid-Western, and Central regions.

The vast majority of microfinance recipients live in the Terai as indicated in Table 3. However,
Table 3 also indicates that the hills and the mountain areas have a high number of possible
needy clients.

Table 3: Microfinance Market by regional type

Eco-zone Number of Microfinance Market Percent of Market

Clients Size Penetration

Terai (plain 743,423 3,153,752 24

areas)

Hills and 440,330 5,525,272 8

mountains

Total 1,183,753 8,679,024 14

Sources: CBS (2007), CMF (2008).

Table 4 shows that the majority of microfinance clients live in only 13 districts primarily
centered in the Central and Eastern regions.

CMF Nepal 6


Table 4: Market Concentration in 13 districts

Microfinance
Concentration of Market ( 31% of
SN Districts clients Total Pop) Total Population Regions
1 Morang 88,795 291,900 941,614 E
2 Sunsari 60,200 220,361 710,842 E
3 Rupandehi 55,026 249,755 805,662 W
4 Bara 55,046 196,708 634,542 C
5 Jhapa 54,484 234,203 755,494 E
6 Kathmandu 43,823 395,794 1,276,754 C
7 Chitwan 43,765 165,694 534,496 C
8 Sarlahi 40,627 221,499 714,513 C
9 Dang 35,985 161,674 521,528 MW
10 Parsa 35,604 174,627 563,312 C
11 Nawalparasi 33,800 196,220 632,969 W
12 Dhanusa 32,441 231,695 747,402 C
13 Bake 27,468 135,968 438,608 MW
Total 607,064 2,876,098 9,277,736
51 % share of total market penetration by 13 districts
21% penetration in the microfinance market of 13 districts

The policy and regulatory measures that are to be formulated must be able to encourage MFIs
to expand their services to the underserved target groups and into other districts. In addition,
support in reducing operational cost through innovation, research and ICT infrastructure can
also help MFIs expand their services beyond these 13 Terai and hill districts.

CMF Nepal 7

Policy and regulatory environment

3 POLICY AND REGULATORY ENVIRONMENT
3.1 DEFINING MICROFINANCE
Micro-finance has emerged as a powerful tool for poverty reduction. Historically, different
forms of intermediation and development strategies have not been able to trigger poverty
reduction economic activities. This has caused policy makers and practitioners to re-think
microfinance as an emerging tool for poverty reduction. This re-thinking reflects the paradigm
shift in rural development attitudes world -wide.

Microfinance has been defined in different ways to suit both academics as well as MF
practitioners. Its origin, however, can be traced back 50 years when development focused on a
planned approach. As a consequence of this approach, rural development programs, especially
those lending to agricultural, agro business and related businesses had the objective of attaining
growth with social justice.

The Asian Development Bank (ADB) defines micro-finance as “the provision of a broad range of
financial services such as deposits, loans, payment services, money transfers and insurances to
the poor and low income households and enterprises.”

The World Bank defines it as “the provision of financial services to low income clients, including
the self employed. It includes both financial and social intermediation. It is not simply banking, it
is a development tool.”

Similarly, Rachel Rock defines it as the “development of small amounts of short term working
capital and in some cases, long term investment loans and provision of deposit facility to small
scale business and households.”

“Microfinance is the supply of loans, savings, and other basic financial services to the poor"
(CGAP).

A microfinance institution (MFI) is defined as an organization that provides microfinance
services, ranging from small non-profit organizations to large commercial banks. CGAP broadly
defines an MFI as any organization—credit union, downscaled commercial bank, financial NGO,
or credit cooperative that provides financial services to the poor.

Nepal’s National Microfinance Policy 2008 defines microfinance as the financial services that
help poor communities develop their professional skill and become involved in income related
activities by offering self employment opportunities through micro saving, micro credit, and
micro credit insurance/micro credit security activities.

CMF Nepal 60


3.2 PRINCIPLES AND CHARACTERISTICS
Microfinance encompasses key principles that have evolved over the years through the
interaction of stakeholders, researchers and academicians. These principles clearly demonstrate
that MF has created its own development and academic identity.

Key Microfinance Principles: 2

1. “Poor people need a variety of financial services, not just loans.
2. Poor people are bankable, can pay loans and can also save.
3. It is a powerful tool to fight poverty.
4. It means building financial systems that serve the poor.
5. It can pay for itself, and must do so if it is to reach very large numbers of poor people.
6. It is about building permanent local financial institutions.
7. Micro-credit is not always the only answer.
8. Interest rate ceilings hurt poor people by making it harder for them to get credit.
9. The role of government is to enable financial services, not to provide them directly.
10. Donor funds should complement private capital, not compete with it.
11. The key bottleneck is the shortage of strong institutions and managers.
12. Micro-finance works best when it measures and discloses its performance.”

Characteristics of Microfinance: Microfinance possesses characteristics which separates it from
other forms of finance. Some of these characteristics include:

1. MF is mostly collateral free
1. MFIs go to clients rather than clients go to MFIs
2. Simplified savings and loan procedures
3. Small size of loans and savings
4. Repeat Loans
5. Loan sizes increases when there are repeated loans or in subsequent cycles
6. Interest rate is usually between that charged by money lenders and formal banks
7. Free use of loans (no restrictions on specified purpose)
8. Loan repayment considers incomes from business as well as other sources
9. Loan and saving products within manageable numbers

3.3 BEST PRACTICES
Initiatives to develop microfinance have attracted the attention of development agencies, i.e.
the United Nation proclaimed 2005 as the “Year of Micro-credit”. From the various
development agency initiatives a number of MF models have been developed and practiced
over the years. As a consequence of this experience, a large knowledge base has developed
which in turn has led to the development of guiding principles, often termed ‘best practices’,
which can help MFIs achieve sustainable operations for longer periods of time.

International ‘best practices’ include: building effective management information systems
(MIS); offering outreach services to attract a larger number of clients (vision of growth);

2
CGAP

CMF Nepal 60


promoting and diversifying savings services; offering services that fit client needs; diversifying
loan products; and simplifying loan procedures. In addition, there exists the need to motivate
clients to repay loans which focus on high repayments; attain operational self sufficiency (OSS)
and financial self sufficiency (OSS) by charging adequate and appropriate interest rates and fees;
involve clients when designing services; promoting effective governance characterized by
democratic and transparent decision-making; and properly targeting clients..

‘Best practices’ also includes a focus on financial services (provision of business development
services as a separate but parallel intervention not as a part of, or, condition of finance);
development of institutional linkages; implementation of incentives systems that promote
efficiency and maintain quality; and implementation of an internal control system that
minimizes financial and credit liquidity, interest rate charges, transactional and operational risks
and the risk of fraud. It is regrettable that the majority of MFIs in Nepal can not follow these
‘best practices’ due to the absence of a proper infrastructure, regulatory environment and
market standards.

3.4 WHY ENABLING REGULATORY ENVIRONMENT
There is no unanimous opinion among MF practitioners and regulators on the issue of
regulation for microfinance operations. Some say the “Market is the best regulator” while
others argue that MF should be left outside the purview of formal regulation. The later envisions
a scenario where MF works are viewed as noble social work versus as a professional financial
activity.

The general consensus that has emerged, however, is that some conducive, facilitative or
growth oriented regulation could boost the MF sector. According to Fukaya and Shadagopan
(2001) “The motivation for regulatory intervention is based on the assumption that an
asymmetry of information exists between the lender and the borrower.” They argue that
regulation has to match the actions of the institutions (Agent) and the clients (Principal) in such
a way that the actions of the agents are controlled, decision making power of the agents are
restricted and provide incentives in doing so by harmonizing the benefits to principal and the
agents. In summary, the reasons for an enabling regulatory environment are:

• The possibility of a ‘run’ on an MFI due to a lack of information to the stakeholders
(investors).

• The opportunistic and risky behavior of an agent even for MFIs that do not take deposits
may pose a serious threat to the functioning of the MFI.

• The need for consumer protection in order to ensure stability.

• The protection of wholesale lenders (some could be banks in which case public funds
are involved, others could be bilateral or multilateral agencies where returnable funds
may have as a condition the requirement for appropriate regulation and supervision
before disbursement to the MFI).

CMF Nepal 10


• The need to ensure a healthy development of the sector through performance
standards

• The need to facilitate linkages with commercial sources of finance.

• The need for the prudential regulation of savings

• The opportunity for banks to become involved in direct microfinance.

Once microfinance activities start various needs emerge according to changes in the market.
The enabling regulatory environment creates a competitive market for microfinance. It
determines the size of the micro enterprise sector, the supply of credit, the assessment of the
credit gap, the interest rate setting, the number and types of institutions, the capital
requirement, the product design, etc. It also protects the quality of a portfolio through
documentation requirements, group guarantees, insurances, and either the CAMEL or PEARLS
rating systems. In addition, the enabling environment builds the institutional capacity of an
agency, obtains timely and adequate financial information and establishes effective off and
onsite supervisory mechanisms and handles potential insolvencies.

Nepalese experience and studies suggest that building an enabling and sound regulatory
environment is very important for an efficient and effective microfinance industry. The enabling
environment in the Nepalese context consists of creating a legal framework; developing self
regulatory norms; ensuring good management practices and governance; developing
appropriate internal control and institutional rating systems; and public disclosure of norms,
deposits and credit insurance schemes as well as the development of performance standards.

Generally, non bank MFIs are not subjected to prudential regulation when they do not accept
public deposits (McGuire and Conroy 1999). This study suggests that for most non-bank MFIs,
prudential regulation is not always effective in preserving financial health. Suggestions arise
from observation that leads one to find ways for developing institutions that are sustainable,
self regulated and governed with sound performance management systems. Additionally, these
actions can be supported by the use of independent credit rating systems and the disclosure of
financial and social performance information. If these actions are taken, it will facilitate
wholesale funds, and better enable commercial banks and foreign financial institutions to
provide funding to MFIs. Ultimately, this will lead to self-led supervision under performance
criterion and strong loan repayment performance.

3.5 PRINCIPLES OF ENABLING ENVIRONMENT
Globally practiced enabling regulatory environment principles include:

1. Competitive neutrality: The regulatory environment needs that all types of MFIs play
on a level field. There should not be any discriminatory policies for any type of MFI
(Government owned/ Private/ Cooperatives/ Banks/ FINGOs, etc.).

2. Negative effect of regulation: Regulations that effect efficiency should be minimized to
allow for reducing the cost of intermediation.

3. Do not mix social objective (political agenda): Avoid self-interest in promoting financial
markets.

CMF Nepal 11


4. Avoid institutional failure: The purpose of regulation and supervision should be to do
this.

5. Provide competition: Regulation must rely, as much as possible on the self-interest of
the economic agent.

6. Regulatory framework should not be static: Markets always innovate and find ways to
avoid regulation. Therefore, there must be a strong will on the part of regulators to
discover changes.

The regulatory framework should be flexible enough to regulate different intermediaries in
different manners as required.

3.6 THE ROLE OF GOVERNMENT AND THE CENTRAL BANK
The role of Government and Central Bank has been discussed earlier. From the 1950s until the
1980s most countries pursued a guided rural, small or micro- financial approach. The aim was to
provide funds to poor rural people at concessional rates, sometimes together with other
interventions to replace the traditional informal sector, which was considered as exploitative.
Consequently, many governments and central banks launched directed credit programs. During
the 1990s this approach was criticized as financial repression.

Rapid outreach was not considered possible due to a lack of funds. Ultimately, the poor did not
benefit due to the non availability of funds at the required time. (Uprety, 2005) The success of
Grameen Bank Bangladesh model in reaching a large number of poor people without a
government subsidy and intervention has led many policy makers and practitioners to rethink
and act in different ways. Today, MF theorists have the view that role of the government and
the central bank should only be to facilitate and not control. This will be discussed more in the
section on the Analysis of the Nepal MF Policy Framework.

3.7 IMPACT OF MICRO- FINANCE IN NEPAL
There are only a few studies available on the generic impact of microfinance services in Nepal.
Generally, however, it has been found that MFs can contribute to poverty reduction by
encouraging the acquisition of new assets, income growth, women empowerment, better
health care and better education for the client’s children. Some specific observations made by
Dhakal and Uprety, 2005 include:

 MF services are not very diversified.

 Micro- credit has been used for both production (66 percent) and consumption (36
per cent) activities.

 MF contributes to a reduction in a client’s household poverty (56 percent reported an
increase in their income after participation).

 MF has served to lessen the dependency on moneylenders by reducing the average
interest rate.

CMF Nepal 12


 Participation in income generating micro- enterprise activities has increased income
and employment as well as created more employment in the ratio of 1:1.28.

 Access to financial services has had a significant impact on clients for a wide range of
economic and social indicators including: increased income, improved nutrition,
higher quality food and clothing, better housing, lower child mortality, lower birth
rate, higher family planning practices adoption, better health care, better education
for their children, women empowerment and participation in social and political
activities. Thus, MF is directly helping Nepal to attain its MDG goals.

3.8 REGULATIONS FOR MICROFINANCE INSTITUTIONS
The term regulation is understood differently by organizations depending on their place in
society. Broadly, regulation in banking and finance can be referred to as "binding rules
governing the conduct of legal entities and individuals, whether they are adapted by a legislative
body (laws) or an executive body (regulations)” (CGAP, 2003). Regulations can be further
described as: 1. Self-Regulation; 2. Prudential Regulation; 3. Non-prudential Regulation; and 4.
Enabling. Regulation.

Self-Regulation: Regulation and/ or supervision by a body that is effectively controlled by the
entities being regulated or supervised based on predetermined performance criterions or rating
system (PEARLS rating system is applied by many MFIs as self-regulation norms in many
countries).

Prudential Regulation: Regulations aimed at protecting the financial system as a whole as well
as protecting the safety of small deposits in individual institutions. Many such regulations stem
from the BASEL principles and CAMELS rating, which may be a burden to some smaller MFIs to
adhere to especially for those who do not take public deposits and to regulators.

Non-Prudential Regulation: Outside of a central banks purview there are regulations covering
"fit and proper", "dos and don'ts" maintained by various government bodies, industry
associations, audit firms, rating tools, etc. Many believe that an MF portfolio covering 2 percent
(on average) of total financial asset does not pose a safety soundness risk to the financial system
and thus does not require prudential regulation.

Enabling Regulation: Regulation having a positive outlook that allows MFIs easy entry and
involvement in new activities is considered as an enabling or promoting regulation.

The worldwide issues in regulation and supervision are: the movement of deposit vs. on-
deposit taking; small vs. large outreach volume; donor funded vs. commercial fund accessed
MFIs; and rating services availability etc.

3.9 ESTABLISHMENT CRITERION
3.9.1 GENERAL
Based on the above theoretical understanding of regulation and supervision, an analysis of
the existing MFI regulations in Nepal is possible. MFIs in Nepal are subject to many

CMF Nepal 13


different types of regulations including the establishment of criterion, prudential and non-
prudential regulation (a few regulations could even be termed enabling).

Minimum Capital Requirement

The minimum capital requirements to establish a Banking Finance Institution (BFI) are
determined based on the category type and functional area. The establishment norm for MFIs
is considered as facilitative and promotional but does not reflect on the future return to the
equity holders.

Table 5: Minimum Capital Requirement: NRs in Millions

Category of Central Regional From 4-10 From 1-3 Priority
Financial Level Level* Districts* Districts* Areas ***
Institution
Commercial Bank 2,000 - - - -
Development Bank 640* - 300** 300** 20
200 100
Finance Company 300** - - 300** 10
200 100
Microfinance 100 60 20 10 -
Development Bank
+ 5 Hill
districts
*Outside Kathmandu Valley only
*Includes leasing business
***Priority areas where there are less than 5 bank branches / VDCs or municipalities having
no banking services.

Facts
1. Promoters must invest at least 51 percent of the required equity, while 30 percent can be
set-aside for the general public (of which 5 percent can be allocated to staff members).

2. Joint venture partners can invest up to 85 percent in the equity of a bank or financial
institution. If Joint venture partners invest less than 50 percent, 30 percent needs to be set-
aside for the general public. If they invest 50 percent or more than 15 percent needs to be
set-aside for the general public.

3. Individual, firms or companies must submit their latest tax clearance certificates, source of
fund and for a company their audited balance sheet for the last 2 years as well as a record of
their retained profit. In the case of micro-finance development bank companies are required
to submit at least one-year’s balance sheet.

CMF Nepal 14


4. Promoters of a bank or financial Institutions need to deposit 5 percent of paid-up equity at
the time of application; 45 percent at the time of receiving the Letter of Intent (LOI); and the
remainder at the time of receiving the operating license from Nepal Rastra Bank (NRB).

5. Promoters of a bank or and financial institution must have a clear financial record. If they
were blacklisted in the past they need to have completed at least 3 years after their names
were deleted from the black list by the Credit Information Center.

6. At least one third of the promoters should have a bachelor’s degree.

7. The investment limit for a single person, their family or firm is a maximum of 15 percent of
the paid-up equity. A type 'D' or Micro-Finance Development Banks is set at a maximum of
25 percent.

8. Banks and financial Institutions in various categories (type A, B, C and D) have a maximum
establishment expense limit of 0.5; 1.0; 1.5 and 2 percent respectively. Banks and financial
institutions must submit 0.01 percent of their issued capital as a licensing fee at the time of
application (non refundable).

9. Banks and financial Institutions must start operations within 6 months from the date of
approval of the NRB license. If they do not, their license will automatically be cancelled.

10. Microfinance Development Banks (MFDBs) can expand branches at a cost in the ratio of NRs
2.5 million in capital per branch.

Other conditions can be found in the licensing norms, Bank and Finance Institution Act and NRB
regulations relating to the incorporation, corporate governance and other topics that need to be
followed as a precondition. Banks and MFIs are also required to disclose other matters as
mentioned in the laws, regulation and policies.

3.9.2 LICENSING NORMS FOR FINGO S
Facts:

1. The minimum capital requirement is NRs. 100,000. The capital of Non-Government
Organizations (NGOs) is defined as membership fees, reserves and capital grants.

2. NGOs must have at least 500 members in the Kathmandu Valley and Terai and 300 in other
districts (with at least 50 percent women member) to apply for a financial intermediation
license.

3. At least 2 working committee members must have a Bachelor’s degree and 50 percent SLC
level qualifications.

4. At least 2 members of working committee must be trained in micro-finance.

5. Working committee members should not have been blacklisted by any bank or finance
institutions and also have no criminal offences.

6. NGOs must have at least 3 years of continuous experience in the social sector.

CMF Nepal 15


7. Priority will be given to NGOs having worked in PCRW, MCPW and having functioned as the
credit agent of a commercial bank or as a borrower from RSRF with satisfactory results.
NGOs also targeting dalits and disadvantaged ethnic group will also be given priority.

8. A business plan and other documents need to be submitted as required by the NRB together
with the application for a license.

9. NRB has suspended taking any application for a FINGO license since 2004.

3.9.3 REGISTRATION NORMS AND SACCOS
Facts:

1. There should be at least 25 persons to organize a co-operative society. All corporative
societies are not necessarily MFIs as they may focus on micro-finance for a targeted group.
In either case, the registration requirement is the same.

2. Members of a co-operative society can be individuals, firms, and international co-operative
alliance member institutions (maximum 20 percent of paid-up share).

3. Single shareholder limit is a maximum of 20 percent.

4. Voting right is "one member, one vote" and not on the basis of number of share owned, as
per the principles of co-operatives.

5. SACCOs can issue and sell shares to members on the basis of 'open to all' principle at any
time.

6. Working area can be 5 VDCs or all the wards of a municipality or the 5 adjoined wards of a
greater / sub greater municipality.

7. Branches can not be opened without the prior permission of the Department of
Cooperatives (DOC).

3.10 REGULATIONS FOR MICRO FINANCE DEVELOPMENT BANK (MFDB)
Micro Finance Development Banks are type 'D' financial institution as defined in the Banking and
Financial Institutions Act, 2006, and are regulated by NRB. Therefore, they are regulated by the
Bank and Financial Institution Act, 2006, Nepal Rastra Bank Act, 2003 and other regulations
issued by the Nepal Rastra Bank from time to time. Some of the major regulations affecting
performance are:

1. Board of Directors

Micro Finance Development Bank, like all other banks and finance institutions are required to
organize a management board having 5 to 9 directors. One member should be a professional
director appointed from the list of professionals published by NRB. A professional director
requires a master's degree qualification and 5 years of experience at the executive level.
Unfortunately, these qualifications make it difficult to find sufficient interested professionals.

CMF Nepal 16


2. Permissible Activities
• Lending as per NRB directives
• Micro-credit provision in accordance with NRB directives
• Borrowing from local and/or foreign institutions for micro lending or strengthening micro-
finance systems
• Providing services to promote microfinance i.e., training and conducting seminars.
• Taking deposits (with or without interest) from the public as per the conditions stated by
the NRB.
3. Capital Adequacy Ratio (CAR)

The CAR is set at a lower rate for MFDBs than other BFIs. CAR - primary capital 4% and total
capital fund 8 percent of risk weighted asset. [For commercial banks, development banks, and
finance companies the CAR is 5.5 and 11 percent. Recent changes for type A, B and C BFIs
require a minimum CAR of 8 percent and additional capital provision as per BASEL II regulations]
Risk Weights applicable to Micro Finance Development Banks (MFDBs) %

Cash 0
Balance held at Nepal Rastra Bank 0
Nepal Government/Nepal Rastra Bank securities
Balance with other Banks and FIs 20
Loans against govt. securities 0
Accrued interest to be received (Government securities) 0
Loans against other Bank and Finance institutions FDs 20
Balance held with Foreign Banks 20
Money at call 20
Investment in shares/debenture 100
Loans 100
Fixed assets 100
Other assets 100

4. Loan Loss Provision

Categories LLP %

Pass - Principle not overdue or due up to 3 months 1%

Sub-standard - Principle overdue from 3 to 6 months 25%

Doubtful - Principle overdue from 6 to 12 months 50%

Loss - Principle overdue from more than a year 100%

A term loan (more than one year) installment due is counted as the total due and provision
need to be made accordingly. A loan to a missing borrower and a miss-utilized loan are
counted in the loss category whether overdue or not .

CMF Nepal 17


5. Single Borrower Limit

The loan limit of a Micro Finance Development Banks (MFDB) involved in wholesale lending is
the same as for a commercial bank and financial Institution - that is a maximum of 25% of core
capital to a single borrower (MFI). The loan limits for an MFDB at retail is:

• Maximum of NRs. 60,000/- per person (group member) - Group guarantee and collateral
free.

• Micro-enterprise (Income generating occupation having less than 10 persons involved) loan
to group members (graduated) up to NRs. 150,000/- (with collateral).

• Micro Finance Development Bank (MFDB) can invest only up to 25% of their total lending in
a micro-enterprise portfolio.

6. Accounting Policy and Financial Returns

Accounting and reporting formats for MFDBs have not been issued separately. Informally they
were advised to use the same format (prescribed for commercial banks, development banks and
finance companies) that process is complicated, lengthy and basically unnecessary for them to
complete. Even so, this does not facilitate nor provide the required information for an MF
comparative database.

7. Regulation for Minimizing Transaction Risk

This is a common regulation for all types of banks and financial Institutions. Many of the
provisions under this regulation may not be applicable to MFIs i.e. gap analysis.

8. Regulations on Corporate Governance

Duties of the Board of Directors:

Maintain Minimum Acceptable Behavior: To commit to compliance to Nepal Rastra Bank
guidelines; not to interfere in the day to day operations; and to disclose any involvement in the
transaction of the concerned MFI.

Not to be involved against the MFI's Interest: The Board of Directors of a bank or a financial
institution cannot be a Director of another bank or financial institution (Bank and Finance
Institution Act, 2006).

Appointment of Chief Executive Officer (CEO)

A qualified, experienced and capable person must be appointed as CEO.

CEO/Staff Discipline: Maintenance of confidentiality, CEO is not to abuse the position and
information received; maintains trustworthiness; does not act against the interests of the
institution; and needs permission for part-time work to be approved in advance.

CMF Nepal 18


Shareholders: (with more than 1% of shares), Board of Directors and staff are restricted from
borrowing from the bank (except loans) as per staff rules and in pledging collateral for others in
the bank.

9. Regulations on Investment

• Investments can be made according to the investment policy approved by the MFDBs Board
of Directors.

• There is no restriction to invest in Government and Nepal Rastra Bank (NRB) securities.

• Banks and financial institutions can only invest in listed companies, and only up to a
maximum of 10 percent in a single company and in total 30 percent of its own primary
capital. Banks and financial institutions can invest up to 20 percent in a related company
but that amount needs to be deducted from its primary capital for calculation purposes.

• The valuation of an equity investment or debenture has to be made on the basis of the
purchase price or market price whichever is less. If the market price is less, then a provision
has to be made for the purchase price in the same amount. A bank or a financial institution
can not invest in the equity, debenture or hybrid capital instruments of another BFI. Banks
and financial institutions in type 'A', 'B' and 'C' categories can, however, invest in type 'D'
(Micro Finance Development Bank) securities

10. Regulations on Compulsory Reserve (Liquidity)

• MFDBs are required to maintain 2.5 percent of their deposit liability in the form of liquid
assets. Liquid assets are defined as cash in the vault, investments in Government and Nepal
Rastra Bank securities, and deposits in commercial banks.

• MFDB’s are required to maintain a compulsory reserve with the Nepal Rastra Bank, and
where there is no Nepal Rastra Bank branch with a commercial banks in a current account
for 0.5 percent of their member’s deposit and borrowed fund

• Liquidity is calculated monthly on a daily average basis.

• There is a limited penalty provision for non-compliance.

11. Branch Expansion

MFDBs are allowed to open, close or merge their branches within approved geographical areas.
They are required to inform Nepal Rastra Bank, however, within 15 days of doing so. Three to
ten district MFDBs can expand their branches into an additional 5 hill districts with the same
capital. They can also expand branches at the additional capital ratio of NRs 2.5 million per one
district.

12. Interest Rate

MFDBs are not restricted to a fix flat rate. They can fix interest rates at any time by placing an
announcement on their notice board. Like other banks and financial institutions, they are not

CMF Nepal 19


required to publish a change in the national newspaper, but only need to inform the Nepal
Rastra Bank after the change.

13. Financial Resource Mobilization

• MFDBs can mobilize financial resources (deposits, borrowings and debentures) up to 30
times their core capital (subject to maintaining a CAR of 8 percent)

• MFDBs are not permitted to collect deposits from non-members.

• Borrowing from foreign sources requires the approval of the Nepal Rastra Bank (NRB).

• The Issuance of debentures and debt instruments is conditional. Banks and financial
institutions must have completed 5 years of operation, public shares must have been issued
and their listing has occurred at least 3 years before. In addition, any initial operating loss
has already been recovered.

• If excess resources have been mobilized, they should be brought within limits within 3
months time. Until this happens the bank or financial institution cannot announce or
distribute a dividend or mobilize further resources.

3.11 REGULATIONS TO SAVINGS AND CREDIT CO-OPERATIVE SOCIETIES (SACCOS)

SACCOs are registered in accordance with the Co-operative Act, 1992 and operate according to
the Acts, rules and bylaws. All SACCOs are not Micro Finance Institutions. Many of them have,
however, adopted micro finance principles and practices in their operations. There are no
separate regulations for such co-operatives. Some of the SACCOs (16 out of 3000) have also
received limited banking licenses from the Nepal Rastra Bank but only a few are involved in
microfinance. Even so, the Nepal Rastra Bank regulations are also not specific regarding
microfinance formicrofinance for SACCOS.

SACCOS, worldwide, are governed by the ‘Seven (7) Principles’ of co-operatives and the
international practices of credit unions. Each SACCO is an autonomous institution governed
democratically by its member.

Nepal has had some bitter experience in the co-operative field. During the past 5 years more
than 100 co-operatives have lost member's money. There are also co-operatives abusing the co-
operative principles and acting as financial institutions without appropriate regulation and the
absence of prudential supervision. This has created a negative image for the functioning of
financially sound co-operatives.

According to the Co-operative Act certain general regulations govern co-operatives. These
regulations include:

1. Registration: At least 25 persons residing in the described geographical area and agreeing to
apply co-operatives principles can apply for registration.

2. Bylaws must be in accordance with Cooperative Act and its rules.

CMF Nepal 20


3. The annual general meeting (AGM) for shareholders must be conducted within 6 month of
the end of the fiscal year.

4. The Board of Director must be appointed for a maximum of 5 years by the AGM (members 5
to 11); an audit committee (1 co-coordinator and 2 members); and other sub-committees
must also be formed based on the approved bylaws.

5. SACCOS can generate resources by issuing shares to individuals, members and other
agencies, and foreign co-operatives (international co-operation alliance) up to a maximum
of 20 percent for all categories; accept savings from members (individuals only); and issue
debt instruments with the approval of Government.

6. The principle of one member one vote applies as opposed to the normal company practice
of one share one vote.

7. Co-operatives can accept savings and provide loans to members and also conduct other
banking activities with members with NRB approval.

8. Co-operatives must transfer 25 percent of their surplus (annual profit) to a reserve fund as
per their bylaws. They can only distribute a maximum of 15 percent in dividends to
shareholders from the net surplus.

9. Co-operatives can merge or separate in accordance with the law.

10. Co-operatives are subject to supervision by either a registrar or another designated person.

11. Co-operatives should follow the PEARLS rating system while supervising co-operative
societies.

12. Co-operatives can not discriminate by categorizing members as promoters, general
members and share only members.

13. Co-operatives can fix interest rate spreads of not more than 6 per cent.

14. Co-operatives can mobilize member deposit up to 10 times the cooperatives share capital. If
the co-operative‘s capital has eroded, however, it can still collect (receive) deposits.

15. Co-operatives can lend up to 5, 10 or 20 percent of their capital to an individual for the first,
second and third loan respectively. They can also take collateral and can lend based on a
group guarantee. They can not lend, however, to more than 49 percent of their members at
any time. Lastly, they need to maintain a minimum debt equity ratio of 80:20 while lending.

16. Co-operatives should maintain at least a10 percent liquidity in relationship to their total
savings. This does not take into consideration borrowing, however, which may cause them
to fall into a liquidity trap. At least 2 per cent of any liquid asset should be cash in the vault
or cash at a commercial bank. Liquidity data should be published monthly and must be
submitted quarterly to the concerned district co-operative offices.

CMF Nepal 21


17. NRB regulated SACCOS can mobilize resources up to 10 times their share capital but must
maintain a cash reserve of 0.5 percent and liquid assets of 7 percent which are subject to a
single obligatory limit of 10 percent. A loan loss provision also exists with similar bank and
financial institutions and corporate governance regulations.

18. NRB has barred co-operative from purchasing each other's share. This was done after
finding artificially created amounts equal to the amount of share transactions without cash
being involved with the aim of deceiving regulators. The 1, 25, 50 and 100 percent loan loss
provisions also apply to ‘pass loan’ when they are: 6 months, 12 month and more than 12
months over due.

3.12 REGULATIONS FOR FINGOS
The Act for Financial Intermediation by societies was promulgated in 1998. Under the provisions
of this Act, forty-seven (47) FINGOs provide their memberships with microfinance services.

There are only a few regulations for the operations of a FINGO. The legal licensing requirement,
the NRB conditions mentioned earlier and performance regulations which include:

1. FINGOs can only work with groups of poor people. Poor people are defined as those who
do not posses more than 6 Ana or 10 dhur in a municipality and 20 ropani or 1.5 bigha in
another area. Poor people also do not have permanent employment, have no access to the
loan facilities of commercial banks and financial Institutions and have annual incomes of less
than NRs. 5,500.00 per year.

2. The lending limit for group members is NRs. 60,000.

3. A FINGO must prepare and implement rules and bylaws approved by the NRB.

4. The geographical working area of a FINGO is determined by the NRB in accordance with the
recent regulations that they can only work in one district.

5. FINGOs must avoid client duplication with other MFIs.

6. Reporting formats and the frequency of need to be set by the NRB.

7. The NRB has introduced the PEARLS rating system into its inspection and supervision
manual for FINGOs. It has not yet, however, directed the use of PEARLS as a rating tool or
asked for any disclosures.

4 MICRO-FINANCE POLICY, 2065 (2008)
The Government announced a National Microfinance Policy 2008 after the conclusion of
Microfinance Summit 2008. Briefly, the major points of this policy are (see Annex-2 for more
details):

• Availability of microfinance services will be made simpler as per geographical diversity and
for rural and urban poor. Standards will be set for identification of the poor and MF
services flow system will be strengthened.

CMF Nepal 22


• Support will be made available to MFIs for their strengthening, institutional development
and wholesale financing from the public and private sectors

• Programs addressing poverty will be implemented in a co-ordinate manner.

• Micro enterprise and similar skills will be promoted.

• Local community institutions and saving credit groups involved in MF will be legally
recognized and linked to other MFIs.

• Micro saving will be encouraged.

• A second tier institution (STI) will be established under the NRB for effective regulation,
supervision, monitoring and evaluation of MFIs.

• A Micro Finance Development Fund will be established and funds available from domestic
and donor agencies will be mobilized through this Fund.

• A survey will be conducted to gather information on MFI outreach and activities.

• Capacity building of MFI practitioners will be done through training.

• A simplified policy will be adopted for MFI deposit mobilization depending on their services
and share capital.

• A flexible policy will be adopted on the corporate and deposit tax system for MFIs.

Most microfinance experts view this new policy as a way for the Government to orient,
emphasize and dominate policy. The role of Government, the private sector and donor agencies
has not been clearly mentioned in this policy. Large scale micro finance outreach can only be
achieved by strengthening private initiatives, i.e. the expansion of micro finance in Bangladesh
(Grameen, ASA, BRAC and many other micro finance institutions/programs) has been mainly
due to private initiatives with limited regulation.

CMF Nepal 23

Survey Findings

5 SURVEY FINDINGS
A rapid assessment survey based on qualitative interviews and using a checklist was conducted
to gauge market participant’s perception of microfinance policy and regulatory issues. The
survey also identified suggestions for the improvement and practical implementation of an
enabling microfinance policy and regulatory environment for Nepal.

5.1 SURVEY COVERAGE
The survey was conducted in forty-four (44) organizations including various types of MFIs, policy
formulating agencies, donors and INGOs.

Table 6: MFIs and Organizations surveyed during Policy Diagnostic

Organizational Type No of MFIs Percentage

MFDBs 7 15.9

FINGOs 6 13.6

Co-operatives 16 36.4

SFCLs 4 9.1

Policy Organizations 6 13.6

Donor Agencies / INGOs 5 11.4

Total 44 100

5.2 POLICY ISSUES AWARENESS
Eighty percent of the respondents said that they were aware of microfinance policy issues. The
awareness level on policy issues was found to be sufficiently high to meet the needs of the
survey.

.

CMF Nepal 60

Survey Findings

Table 6: Level of Awareness

Awareness MFDBs Co-operatives SFCLs FINGOs Policy Donors/
Organizations INGOs

No % No % No % No % No % No %

Yes 6 86.0 9 56 4 100 6 100 6 100 4 80

No 1 14.0 7 44 100 0 0 0 0 1 20

Total 7 100 16 100 4 100 6 100 6 100 5 100

5.3 POLICY ISSUES RAISED BY THE ACTORS
5.3.1 CO-OPERATIVES
Co-operatives responded on various issues of concerns including:

• Currently, the minimum number of persons required to form a co-operative is 25. Fifty-six
percent expressed this as adequate while 44 percent believed this is too low and proposed
that at least 100 people should form a co-operative society.

• Most of the respondents opined that the minimum paid-up capital should be at least NRs.
1000 per person while the remaining stated that it should be left to the members. In terms
of the area of operation, 69 percent stated that the existing area policy was appropriate.

• The interest rate spread of 6 percent that was recently introduced by the Department of Co-
operatives was view as suitable by 50 percent of respondents while 31 percent do not see
any reason behind it and 13 percent believe that there should be no regulation at all.

• The Loan Structure ratio with a maximum of 80 for the cooperative and a minimum of 20 for
an individual was also thought to be correct, but many of the respondents felt that it should
be 70: 30 or even 60:40.

• Eighty-seven percent stated the PEARLS system introduction should use selected indicators
instead of all 44 ratios.

• Sixty-three percent expressed a strong opinion that co-operatives should not be taxed, 31
percent suggested to have a 5 to 10 percent tax rate and 6 percent felt it should be in the
range of 10 to20 percent.

• Most of the respondents were in favor of audit uniformity (similarity of formats), easy of
access to wholesale, improvements in accounting systems (4 Ledgers), and showed concern
regarding duplication, and emphasized the need to have a system of credit information and
insurance.

CMF Nepal 25

Survey Findings

• Regulatory restriction on dividend payment to members (not exceeding 15 per cent)
invoked a mixed response. Some were happy with the current regulation while others
suggested it should not be regulated.

Other suggestions included:

• Transactions with non members should be allowed within the rules and regulations
• Loans should be available at low interest rates.
• If more than 10% of cooperative members want, this should be the quorum necessary
to convene an AGM
• Priority should be given to selecting women for decision making position
• Co-operative categorization should be done according to the tax rate; and be regulated
• The NRB should be more flexible in regulating cooperatives.
• Unhealthy competition should be removed
• Permission should be required to open a branch

SFCLs, a special category of small farmer co-operative, have almost similar views. On taxation
issues 100 percent of the SFCL respondents suggested that there should not be tax on co-
operatives. Other suggestions given by SFCLs included:

• Corporate governance should be strengthened in cooperatives
• Government should have a concrete policy towards cooperatives
• There should b a flexible environment for the smooth operation of cooperatives
• Farmers should be given ownership
• Flexible policy is needed to introduce new products in the cooperative
• Frequent monitoring is required
• The Central SFCL Federation should be more active

5.3.2 FINGO S
Most FINGOs selected were well aware of the policy and regulatory issues. They showed
concern on the geographical area restriction (recent NRB circular), the licensing restriction for
an unknown period, taxation and most argued for a new approach in provisioning. Almost all (83
percent) were against board member’s personal guarantee for obtaining wholesale funds. Some
also expressed that the MF loan limit of NRs. 60,000 should be raised to NRs. 100,000. Others
suggestions given were:

• According to their progress and performance FINGOs should be given permission to
expand their working area, especially in the hill areas,
• While paying down a loan an IC note should be allowed
• Should be reachable for the poorest of the poor
• No Tax on MFIs

CMF Nepal 26

Survey Findings

5.3.3 MFDBS
Most of the MFDBs interviewed believed that the capital requirement was sufficient for
establishment purposes. They also believed that the capital adequacy ratio was acceptable. In
term of liquidity requirement 50 percent of the respondents said it was acceptable. On resource
mobilization all opined that NRB should allow them to have access to public deposits with some
conditions attached.

Some suggestions provided by MFDBs were:

• The NRB should give permission to collect deposits
• The corporate tax rate (31.5%) should be zero
• Government should scrap the deposit tax rate for MFIs
• Establish a Microfinance Department and unit related to microfinance in the Ministry of
Finance
• The NRB Microfinance Department should be strengthened and have more specific
terms of reference
• Development Banks, FINGOs and cooperatives should act together for the betterment
of MF policy
• Transactions with non members should be permitted
• Some accounting procedures not related to MFDBs should be removed
• The MF Act should be formulated and further monitoring and regulation should be
strengthened
• In Grameen banks the board of director’s structure should be supported by the NRB as
board members are located in Kathmandu. As it is very difficult to conduct a board
meeting outside the Valley, NRB should manage to depute members from the local
level.

5.3.4 POLICY ORGANIZATIONS
Policy organizations refer to organizations that make and implement policy and
regulations on financial services. They are the NPC, Ministry of Finance, NRB,
Beema Samiti and Women development division. All of them are well aware of
the MF policy environment. Most of them agree on the non involvement of the
Government in financial services to the poor. Rather, they stress the need to
provide funds and capacity building services to MFIs using a systematic
approach. All agree that donor organizations should work with local partners
rather than provide the financial services themselves.

Some of their suggestions include:

• NRB’s monitoring, policy making, amendments and linkage development should be
strong,
• Buildup capacity of MFIs,
• A free Interest rate regime is very necessary
• Wholesale fund organizations should make funds available on demand
• Research on product diversification

CMF Nepal 27

Survey Findings

• Enterprise development should be encouraged
• Micro insurance products need to be developed. MFIs, MFI networks, Government, the
NRB and Beema Samiti should have the necessary discussions
• CMF and NRB should have close linkages in the area of research, training, policy
development and study
• Cooperatives, MFIs, and small enterprises should be structured in one form for
development
• Monitoring, supervision, tools development, financing should be done by NEFSCUN for
financial co-operatives
• Identify enterprises for the poor should be prioritized
• Business and market linkages are necessary for microfinance promotion
• Other federation should meet their members needs, provide advocacy & support to
strengthen them and integrate MFIs
• On the spot training/capacity building should be provided
• Associations should act as good network for sustainable MF and also for benchmarking,
monitoring and supervision
• Suggestions can also be expected for developing implementation mechanisms
• Facilitation on development work with network and associations i.e. CMF

5.3.5 DONOR AGENCIES / INGOS
Most donor agencies and INGOs (80 per cent) are aware of the policy environment. They are in
favor of an enabling and regulatory role for Government. In their own programs they also have
given an emphasis on providing MF services in the hills and mountains areas, the necessity of an
MFI tax rebate facility, embedding micro-insurance and health insurance services within the
services provided by MFIs and MFI capacity building. They also believe that MF wholesale funds
and programs need to be restructured.

High operating costs, dispersed populations, lack of economic opportunities and infrastructure,
a rigid MF model, the absence of a clear cut MF policy, lack of coordination between donors,
lack of an appropriate microfinance act and the absence of BDS services at the community level
are considered some of the hindrances to MF sector growth.

Some of their suggestions include:

•Services should reach into the hill areas
•Private social investment should serve as a good indicator rather than public social
investment
•Only the deprived sector should get microfinance services
•There should be more awareness program based on local development
•Plans for community awareness building should be linked
•The National Planning Commission (NPC) and Ministry of Finance (MOF) should help
develop new plans for microfinance
•The Microfinance Act should be promulgated soon
•Government should only play an enabling role

CMF Nepal 28

Survey Findings

•Existing MFIs need strengthening
•Promote increasing the number of MFIs
•Coordination with the Poverty Alleviation Fund (PAF)

Overall, stakeholders in the micro-finance sector are interested in the development of the
sector in Nepal. Therefore, it is time for stakeholders to implement suitable strategies, policies,
plans and programs to support the sector.

CMF Nepal 29

Recommendations

6 RECOMMENDATIONS

The study team incorporated the issues raised by the Taskforce and made recommendations to
the various stakeholders including: Government, the NRB (Central Bank), apex funds (wholesale
lending micro-finance institutions and programs), microfinance institutions and others.

6.1 LEGAL/REGULATORY FRAMEWORK
• The current legal arrangement for regulation and supervision of banks and financial
institutions appears to be acceptable to MFDBs and FINGOs.

• Most MFDBs viewed the proposed Micro-Finance Act (earlier draft) as not suitable for
the growth of the sector. It was also found not suitable for regulation and supervision
purposes. The main reason was a mix-up of MFIs and non-MFIs, equity based and non-
equity based organizations in the same legal framework. MFDBs, FINGOs, SACCOS and
even CBOs need to have different legal identities to better address their separate
activities If there is commonality in some areas of activities, they can be addressed by
the reform of regulations for each. Therefore, it is important that each type of MFI have
its own required legal framework reviewed separately to accommodate ‘best practices’.

• There could be an STI established for supervision purposes only for the various types
of microfinance institutions. This STI would be subject to the regulation and supervision
of the NRB. The supervision of SACCOS, other than NRB licensed ones is an issue that
must be dealt with separately.

• Access to Public Deposit: The Bank and Financial Institution Act, 2006 has a provision
that MFDBs can access public deposit with Nepal Rastra Bank approval. This provision
needs to be activated but not for everyone at this time. Nepal Rastra Bank could set
conditions and based on fulfilling such conditions MFDBs could be permitted to have
access to non-member deposits. This is also necessary for future MFI growth in
outreach, expected phasing out of the deprived sector credit directives, shrinkage in
donor funds, wholesale fund not being expended as expected and providing financial
services to local residents who are not members of MFDBs but poor villagers. Some
conditions that could be set include:

- Experience of at least …. years.
- Having a net profit in the last….. years.
- Having a capital base of NRs. …. million
- Having written off all pre-operational expenses.
- Can provide only saving services in the program area and cannot access current
(demand) deposits.
- Subject to higher liquidity requirement as other DBs and FCs for non member
deposit.

CMF Nepal 60

Recommendations

- Subject to fund management policy approved by the board of directors.
- Not exceeding a percentage of total resources

- MFDB has not been penalized by NRB.

• Establishment and Expansion: The MCR regulations required for the establishment of
MFDBs is reasonable except for the expansion provisions, which needs to be updated.

• The BASEL principles on capital and supervision may not be suitable for MFDBs, FINGOs,
and SACCOS. Their use would also be burdensome to the Central Bank or other
designated bodies. Therefore, drawing on CGAP, ACCION and WOCCU practices and
experiences, it would be better to use the PEARLS rating system.

• Loan Loss Provision: Currently, the loan loss provision is similar for all banks and
financial institutions based on due date periods (0 to 3 month, 3 to 6, 6 to12 and above
12 months for the overdue category). Better methods for micro finance institutions
exist i.e. minimum of 1 percent and adding as per PAR. (Portfolio at Risk) Some
microfinance institutions have the provision that if the due date is more than 6
installments (GBB's own regulation) or 2 percent flat with an evaluation at the end of
every year. If some microfinance institutions are comfortable with the higher
percentage for LLP (within 5 percent limit), it should be agreeable to the tax authorities.

• Micro-enterprise Loan: Nepal Rastra Bank accommodates micro-enterprise loans not
exceeding NRs. 150,000 to members using the ‘ladder’ model (enhancement approach)
with collateral. This approach appears to be abused by some MFIs. Instead, ladder
model loans could be restricted to graduated members only (new member needs)
otherwise MF may face a crisis after some time. If it is strictly for graduated members,
collateral could be considered as optional with appropriate risk management tools
adopted (Insurance, marketing network, guarantee, etc.).

• MFIs having experience over X years would be allowed to enter into a micro enterprise
loan at a higher limit (i.e. 500,000) within their working area if the enterprise focused on
local employment generation.

• Lending methodologies: There is the need to develop innovative individual lending
methods apart from the traditional group lending methods. The focus on women is well
understood but single men in rural or urban areas should not be excluded. Another
important area for reform is in the lending methodology applied, i.e. MFIs should be
allowed to lend to local, community-based SACCOS, SCOs, SHGs, CBOs, and user groups
of different types and village banking units. This will reduce MFIs operational costs
dramatically and allow them to increase outreach more quickly. It also ensures that
more MF services will reach the hilly districts. (Uprety, 2002) MFIs need to develop their
loan assessment guidelines for this to ensure safety and soundness.

• Regulations on Corporate Governance: The regulation that restricts any bank or
financial institution Board member from being on the Board of Directors of another
bank or financial institution has affected MFDBs and FINGOs. The Board of member of
any bank or financial institution could be allowed to be on the Board of at least one

CMF Nepal 31

Final study report for publication december 17, 2009

Final study report for publication december 17, 2009

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Final study report for publication december 17, 2009