Legal and Policy Framework of Banking in Nepal

Learning Objectives To know about all the Laws, Acts, Bylaws, Rules, Manuals, Guidelines, and Directives that govern Nepalese Banks and Financial sector

 

A common definition of a bank is a financial institution that accepts deposits from the public and creates credit or loans. It means the bank creates assets by its liabilities. Section 2 of the BAFIA and NRB Act has defined a bank and financial institution as follow:

What is Bank?

“Bank” means a corporate body incorporated to carry on Banking and financial transactions as referred to in Sub- Section (1) of Section 49 and the word also includes a branch office or other offices of a foreign bank located in Nepal, a branch office or other office opened outside Nepal by a bank incorporated in Nepal and an infrastructure development bank to carry out functions referred to in sub-section (5) of section 49.

What is a Financial Institution?

“Financial Institution” means a corporate body incorporated to carry on banking and financial transactions as referred to in sub-section (2), (3) or (4) of section 49, and the word also includes a branch office or other office of a development bank, finance company, microfinance development bank or a branch office or other office of a foreign finance company located in Nepal or a branch office or other office opened outside Nepal by a financial institution incorporated in Nepal.

Further, the NRB Act has stated that the objectives of a financial institution established as above may include providing loans for Agriculture, industrial, or any other specific economic purpose or for collecting deposits from the public. A “Financial Institution” also includes an institution prescribed as a financial institution by the government of Nepal by publishing the notice in the Nepal Gazette.

The Nepalese financial sector has expanded in terms of the number, type, operations, geographical spread, and other features since the mid-1980s. The growth of the financial sector accelerated during the 1990s and 2000s. This was possible with the adoption of economic liberalization policy in general and particularly financial liberalization policy. Consequently, many financial institutions came into existence in the private sector.

The financial sector reform program implemented by the Government was successful in bringing about operational efficiency turning around the delivery of services and improving the financial strength of financial institutions owned by the Government. Adoption of proactive policy, laws, regulations, and processes enlarged the capacity of the financial sector, both quantitatively and qualitatively. NRB as the regulator played a pivotal role in bringing about and sustaining favorable outcomes in the financial sector. Given the vast range of laws and regulations that the financial sector is required to be compliant with, operating in this sector requires the finest legal backing.

Available legal architecture/design, including laws as well as rules and regulations enacted at different times for governing the Nepalese financial system can be grouped into three broad areas. First, those Acts related to governing the functions of NRB, second, those Acts related to the whole banking system under the regulation of NRB and third, rules and bylaws as well as guidelines issued by NRB for operation and regulation of the banking system including its activities.

1. Acts Governing NRB

NRB was established in 1956 as per the NRB Act, 1955. In the context of the financial sector reform process, the new NRB Act, 2002 was enacted in 2002 by replacing the NRB Act, 1955 and Currency Act, 1983, to change the financial landscape and refine the role of the central bank in the economy. The NRB Act was further amended on 14 November 2016 to make the NRB more efficient and effective in the changing context of focus being given to financial consolidation rather than financial expansion with priority accorded to financial access.

According to Section 4 of the NRB Act, 2002 with the second amendment 2016, the objectives of NRB have been revised as below.

 To formulate necessary monetary and foreign exchange policies and manage them to maintain the stability of price and balance of payments for the sustainable development of economy and economic stability,

 To promote public confidence in the banking and financial system by increasing access to financial services and maintaining stability in the banking and financial sector,

 To develop a secure, healthy, and efficient system of payments.

Section 3 of the NRB Act, 2002 provides reasons for the establishment of NRB to perform the functions of the central bank. It is an autonomous corporate body, as per Section 3 (3) of the NRB Act. Section 4 (2) provides that the Bank shall, without any prejudice to its objectives, extend cooperation in the implementation of the economic policies of the GON. The NRB is governed by this Act as well as the Foreign Exchange (Regulation) Act, 1962.

The BOD of NRB must discharge the functions as listed in section 29 of the NRB Act. Once appointed, all members of the BOD remain in office for a tenure of five years. The government cannot remove the member of the BOD before the expiry of their tenure in office unless there is cause for removal as specified in Section 22 (5) of the NRB Act. The cause for removal of the member of the BOD must be established by an inquiry carried out by the Inquiry Committee instituted under the chairmanship of retired justice of Supreme Court.

2. Other Banking and Financial Acts

Before the establishment of NRB, NBL was providing banking services to the Government and public as per the mandate conferred by Nepal Bank Limited Act, 1937. Until 2004, banking institutions were governed and regulated under scattered legislations; there were separate Acts for a separate category of institutions, even separate Acts for institutions such as ADB/N, Cooperative Bank Act, NIDC, and RBB.

The Bank and Financial Institution Ordinance, 2004 was the first umbrella legislation to regulate and supervise all BFIs under a single legislation. Provision was made to classify BFIs as A, B, C, and D as per the minimum paid-up capital requirement, which was also based on the geographical areas to be covered. The Ordinance enlisted the overall functions of each category of BFIs and ensured reliable and quality banking and financial services through healthy competition among BFIs together with protecting the interest of depositors. This made provision to ensure good corporate governance and financial discipline in the BFIs and ensured professionalism in their boards and management teams. Besides, it also entrusted NRB with enough supervisory and enforcement powers. This Ordinance was later formalized as an Act - Banks and Financial Institutions Act (BAFIA), 2006. This legislation first repealed the provisions of previously scattered legislations and unified them to harmonize the banking practices.

BAFIA has been replaced by BAFIA 2017, which was enacted on 23 April 2017. The newly amended BAFIA has expanded the role and functions of NRB. It has continued the classification of BFIs into 'A', 'B', 'C', and 'D' classes. However, only the class 'A' and class 'B’ institutions are entitled to use the word 'bank' in their names.

There are some old Acts still in operation. In 1957, the Act Enhancing the Circulation of the Nepalese Currency was enacted to "enhance the circulation of the Nepalese currency throughout Nepal to consolidate and balance the economy of the country based on a single currency". Foreign Exchange (Regulation) Act was enacted in 1962 to regulate foreign exchange transactions, which made the use of foreign currencies illegal inside the domestic economy. Likewise, some other Acts like the Negotiable Instruments Act, 1977, which was enacted to "define negotiable instrument and make other arrangements relating to it to systematize the banking transaction", are in the application. Negotiable Instruments Act, 1977 controls and regulates the issues of Cheques, Drafts, Promissory Notes, Bills of Exchange, etc, and their conditions. Through appropriate directives and order, NRB prescribes for the required conditions of these instruments to ensure more secured transactions for BFIs licensed by it.

In addition to the NRB Act, 2002 and BAFIA, 2006 (now 2017), the legal architecture of Nepalese banking consists of several legislations relating to the incorporation and operation of the banking institutions. As the Nepalese legal system follows the norms of a common-law system, the precedents laid down by the Supreme Court also form part of the legal architecture. The following table presents the list of banking laws, which govern financial institutions.

Acts Governing Banking Sector Banks and Financial Institutions Act, 2006 (Recently new BAFIA 2017) Banking Offence and Punishment Act, 2008 Banks and Financial Institutions Debt Recovery Act, 2002 Act Relating to Institutions Acting as Financial Intermediary, 1999 Financial Intermediaries Rules, 1999 Negotiable Instruments Act, 1977 Act Enhancing the Circulation of the Nepalese Currency, 1957 Companies Act, 2006 Insolvency Act, 2006 Secured Transaction Act, 2006 Public Procurement Act, 2007 Foreign Investment and Technology Transfer Act, 1992 Industrial Enterprises Act, 2016

 

Besides the NRB Act and BAFIA, there are other new Acts related to financial activities enacted in the course of financial sector reform programs like Banking Offence and Punishment Act 2008, Banks and Financial Institutions Debt Recovery Act, 2002, Insolvency Act, 2006, Secured Transaction Act, 2006, Money (Asset) Laundering Prevention Act, 2008, and Money (Asset) Laundering Prevention Rules, 2016 as shown in the following box.

The Banking Offence and Punishment Act, 2008 following its first amendment in 2016 have expanded the scope of banking offenses to cooperatives and 'Dhukuti' (a practice of unauthorized informal group deposit and lending). Under this law, NRB files the First Information Report to the Nepal Police for investigation and prosecution of the offense. Based on the investigation report of Nepal Police, Government Attorney prosecutes the banking offense case before the High Court. Commercial Bench of the High Court hears the cases of Banking Offence.

Banks and Financial Institutions Debt Recovery Act, 2002 is applicable to recover the loan by BFIs for the amount exceeding Rs. 500,000 if BFIs could not recover loan under normal procedures of recovery. Based on this Act, the Debt Recovery Tribunal and Appellate Debt Recovery Tribunal have been established to facilitate debt recovery of BFIs.

AML/CFT Laws Money (Asset) Laundering Prevention Act, 2008 (second amendment, 2015) Money (Asset) Laundering Prevention Rules, 2009, new 2016 Money (Asset) Laundering Prevention (Freezing of Properties and Funds of Designated Person, Group and Organization) Rules, 2013 Proceeds of Crime and Instruments (Freezing, Seizing and Confiscation) Act, 2014 Extradition Act, 2013 Mutual Legal Assistance Act, 2014 Mutual Legal Assistance Rules, 2013 Organized Crime Prevention Act, 2013

 

In recent years, to comply with Anti-Money Laundering and Combating Financing of Terrorism (AML/CFT) requirement, various new Acts such as the Organized Crime Prevention Act, 2013; Mutual Legal Assistance Act, 2014; Proceeds of Crime and Instruments (Freezing, Seizing, and Confiscation) Act, 2014 has come into implementation. BFIs are required to put in place AML/CFT measures as per the provision of Asset (Money) Laundering Prevention Act, 2008. The second amendment of the NRB Act has included the provision of AML/CFT issues. International Anti-Money Laundering Standards set by Financial Action Task Force (FATF) have been incorporated in the Act. FIU (Financial Information Unit) as envisaged in international legal instruments and FATF standards was established on 21 April 2008 within NRB as per the provision of Asset (Money) Laundering Prevention Act, 2008.

All BFIs are established under the Company Act, 2006 as public limited companies. In case of dissolution, companies will wind up based on the provision of the Companies Act, 2006 and Insolvency Act, 2006. However, the NRB Act, 2002 (Second Amendment) has provided more power to NRB regarding the liquidation of the banking institutions. The decisions of NRB on financial matters are final whereas the liquidation of banks as a company should be allowed by a designated court.

The NRB should also follow the Public Procurement Act, 2007. However, it can formulate its bylaws without violating the provision of this Act. Foreign Investment and Technology Transfer Act, 1992 and Industrial Enterprises Act, 2016 are also relevant to NRB to the extent that the final authority of foreign investment amount in foreign currency should be approved by it.

3. Rules and Bylaws

Apart from the parliamentary enactments, the banking sector is regulated by several delegated legislations issued by NRB as per the power conferred to it by the NRB Act and BAFIA. NRB issues the prudential guidelines in the form of Directives to BFIs. Depending on the subject matter concerned, guidelines and policies have also been issued to regulate banking business. NRB has issued a few bylaws to organize its day-to-day operation to perform the legal mandate.

There are several rules, by-laws, policies, guidelines, and manuals, which have now clearly governed and guided the activities of financial institutions including NRB. Also, Unified Directives issued by NRB direct and regulate the activities of BFIs to maintain financial stability in the economy and enhance public confidence in the financial system.

NRB has been issuing directives, as per necessity, to effectively regulate the banking system. It issues unified directives as per Section 79 of the NRB Act. The NRB Directives have received judicial recognition as binding legal instruments. Separate Directives are issued for Class D microfinance institutions since 2013/14. Currently, Unified Directives of NRB, 2020 (For Class 'A' and Class 'B' Bank, and Class 'C' financial institutions) and Unified Directives of NRB, 2020 (for Class 'D' financial institutions) are in place.

Section 110 of the NRB Act, 2002 has granted the power to issue rules and bylaws on different matters. Under Section 110 (1), NRB has issued NRB Note Exchange Rules, 2003, NRB Note and Coin Rules, 2003, and NRB Note Destruction Rules, 2003. NRB has issued several bylaws under Section 110 (2) to concretize the functions of NRB and its various departments and offices. These rules, bylaws as well as manuals, and guidelines provide a clear direction for executing functions of NRB.

List of Rules Primary and Secondary Market Management of Public Debt Rules, 2004 NRB Note Exchange Rules, 2003 NRB Note and Coins Rules, 2003 NRB Note Destruction Rules, 2003 Public Debt Rules, 2003

 

List of Bylaws Merger and Acquisition of Banks and Financial Institution Bylaw, 2016 Payment and Settlement Bylaw, 2015 Prompt Corrective Actions for Banks and Financial Institutions Bylaw, 2008 (new 2017) NRB Staff Service Bylaw, 2011 NRB Procurement Bylaw, 2014 Resolution of Problem Institutions Bylaw, 2014 Open Market Operation Bylaw, 2014 NRB Publication Directives, 2011 Note Printing and Coin Minting Directives, 2009 NRB Authority Delegation Bylaw, 2008 NRB Auction Directives, 2008 NRB Function Management Bylaw, 2003 NRB Blacklisting Bylaw, 2003 NRB Inspection and Supervision Bylaw, 2013 NRB Board of Directors Meeting and Seal Bylaw, 2006 NRB Cash Bylaw, 2006 NRB Documents Shredding Bylaw, 2007 NRB Foreign Exchange License and Inspection Bylaw, 2011 NRB Money Changer Bylaw, 2010 NRB Remittance Bylaw, 2010

 

List of Procedural Manuals and Guidelines Procedural Manual of Interbank Payment System, 2016 The procedure of the Formulation of Monetary Policy, 2016 Procedure for Nepal Rastra Bank Higher Education, 2007 Risk Management Guideline, 2010 Balance of Payments (BOP) Manual, 2004 Rural Self Reliance Fund (RSRF) Credit Manual, 2012 Consumer Price Collection and Inspection Guideline, 2016 Public Debt Management Guideline, 2003 Banking Service Fee Guideline, 2010 Chief Executive’s Remuneration Guideline, 2010 CEO’s Remuneration for B, C and D Class Institutions Guideline, 2011 Stress Testing Guideline, 2012 IT Guideline, 2012 Cheque Standards and Specifications Guideline, 2012 Currency Chest Operation Guideline, 2013

 

List of NRB Directives Unified Directives, 2020 (For Class A, B, and C banks and financial institutions) Unified Directives to Microfinance 2020 Foreign Exchange Directives and Circulars on different dates

 

These are the major laws, regulations, and policy frameworks that existed in Nepal to operate the Nepalese banking and financial sector smoothly and efficiently. The NRB-Central Bank of Nepal has the authority to regulate, supervise, and control the overall financial sector through several laws, acts, bylaws, guidelines, and directives.