Financial crisis, financial stability,

macro prudential policies and

financial sector reforms in nepal.
 Financial Crisis
• A state where asset prices see a steep decline
in value, businesses and consumers are
unable to pay their debts and financial
institutions experience liquidity shortages
• Often associated with panic or a bank run -
where investors sell off assets or withdraw
money from savings accounts because they
fear that assets value will drop
 Types of Financial Crisis
• Asset Bubble
– Housing Bubble of 2008-9
• Banking Crisis
– Banking crisis of USA, 1993
• Currency Crisis
Asian Financial Crisis-It began as a currency crisis when Bangkok
unpegged the Thai baht from the U.S. dollar, setting off a series
of currency devaluations and massive flights of capital.

• Stock Market Crashes

– The Great Depression(1920)
*Severity of FC measured in Price Fluctuations in S&P500
 Causes of Financial Crisis
• Overvaluation of institutions or assets
(2008-09 FC)
• Irrational investor behavior
(.com bust)
• A rapid string of selloffs can further result in lower asset
prices or more savings withdrawals

• If left unchecked, a crisis can cause an economy to go

into a recession or even depression
(The great Depression of 1930s)
 GFC and Nepal
• Our country and its financial market are not highly integrated
with the global economy.
• The capital account is partially liberalized and portfolio
investment is not allowed to foreign investors. The likelihood
of direct effects of the global financial crisis, thus, was very
low.
• However, the economy was vulnerable to indirect effects
emanating from the crisis which may be felt in the changes in
the tourism receipts, remittances, foreign aid, FDI, debt
servicing, exports, and foreign employment.
• The rural economy and vulnerable groups of Nepal might
were affected more since foreign employment, remittances
and foreign aid has been playing crucial role in the
development process especially reducing the rural poverty of
Nepal.
 GFC and Financial Stability
• The importance of financial stability was heightened
after the global financial crisis (GFC) of 2008.
• Financial stability was generally understood with the
prudential regulation and supervision of individual
institutions
• Nevertheless, the understanding on the financial
stability mandate and strategies has been redefined post
GFC.
• The lessons of GFC have pushed many central banks to
develop a comprehensive framework of policy that
focuses on containing systemic risks for addressing the
stability of the whole financial system through
formulation of macro-prudential policy.
Objectives of Macro-prudential Policy
• Primary objective : limiting financial system risk such that
financial systems function smoothly without seriously
affecting the real economy.
• Other Objectives:
 controlling on the build-up of financial imbalances;
 set the mechanisms that contain the speed and
sharpness of any financial turmoil and its impact to
economy
 identify and address the factors of financial instability
such as exposures, risk concentrations,
interconnectedness as well as interdependencies. Thus,
the mandates for macro-prudential policies are being
heightened substantially in the growing range of
financial jurisdictions
 GFC and NRB
• Prior to the global financial crisis of 2007-09,
Nepal Rastra Bank had accorded more focus on
micro-prudential policies.
• As the financial crisis exposed the gaps in existing
supervisory and regulatory framework, regulators
worldwide hastened to embrace macro-
prudential policies
• NRB also followed suit and issued a host of macro
prudential measures to make BFIs more resilient.
 Impact of GFC, NRB and MPP
• The increased importance of macro-prudential policy is felt after 2009
in Nepal.
• Despite the low impact of GFC (due to the low global financial
integration and closed capital accounts), NRB issued a set of prudential
measures aimed at containing credit and liquidity risks in the licensed
Banks and Financial Institutions (BFIs) between 2009 and 2011.
• For instance, NRB imposed a moratorium on bank license in July 2009,
and it was partially lifted in April 2010 only for the class D microfinance
banks.
• Similarly, Single obligor limit and real estate loan exposure limits was
enforced, loan to value ratio was lowered and credit to deposit ratio
was introduced. Likewise, the paid-up capital needed for the BFIs was
increased.
 NRB and Macro-prudential Policy
• NRB has fully enforced BASEL III simplified
standardized approach since July 2016 to all the
commercial banks, which will gradually be
implemented till 2019.
• Likewise, in 2015 July, NRB increased the minimum
paid-up capital requirement for BFIs by at least
four fold to be completed in 2017 July.
• Besides the regulatory framework, stress testing,
prompt corrective actions (PCA), consolidated
supervision and risk based supervisory mechanism
are some of the key tools put in place by NRB
• The strengthening of legal capacity is a key area of reform to
enforce the macro-prudential policy. Thus, recent amendment
in the NRB Act 2002 (2nd Amendment 2016) has mandated NRB
on maintaining financial stability, enhanced the existing
supervisory power to banking resolution and also provisioned
measures for strengthening governance in the financial system.
• Likewise, the issuance of the new Bank and Financial
Institutions Act (BAFIA) - 2017 has further cleared the mandate
of the NRB on banking resolution, introduced additional
measures for the board of directors and CEOs of the BFIs to
ensure the corporate governance, among others. These all
measures are expected to ensure the financial stability.
• Besides these all, the merger and acquisitions process is expedited further
with many smaller and problem banks being either merged and/or
acquired by stronger ones.
• As a part of strengthening financial infrastructure, a separate "Payment
Systems Department" has been formed and establishment for "state of the
art" payment and settlement infrastructure are under way.
• Furthermore, credit rating, credit information and debt recovery processes
are being streamlined and strengthened further. In addition, a
comprehensive "Financial Sector Development Strategy (FSDS) 2017-2021"
was formulated recently.
• The vision of FSDS is "An Effective, efficient, inclusive and stable financial
sector contributing to broader economic growth". The due implementation
of such strategy would help in policy coordination with various financial
regulators, thereby increasing the effectiveness of macro-prudential policy.
• The NRB is applying a framework for monitoring systematic
risk and assess whether there is build-up of excessive risk
taking behaviors in the Nepalese financial sector.
• The framework consists of many tasks including:
• (a) monetary survey compilation;
• (b) Balance of Payments statistics compilation;
• (c) price indices (CPI, WPI, SWRI) preparation;
• (d) liquidity monitoring and forecasting; e) close watch into
the short-term and long-term interest rates; (f) monitoring of
sector-wise and product-wise credit flow; and (g) onsite and
offsite supervision of BFIs
• The framework helps to assess the build-up of risksand
closely monitor number of areas such as: (a) the contagion
effect of growth on total credit or asset prices to overall
economy; (b) sectoral vulnerabilities arising from growth of
excessive credit to certain sector, for example, from growing
credit to real estate, households sector, corporate sector;
(c) vulnerabilities from changes in theremittance flow; (d)
vulnerabilities from growing trade deficit; (e) vulnerabilities
from excessive government savings, among others. A
number of early warning indicators are observed to assess
vulnerabilities well before the emergence of stresses
 Macro-prudential = ‘Macro’ + ‘Prudence’

• ‘So, macro-prudential policies help ensure that

everyone takes a cautious approach to risks
that could become systemic i.e. risks related
to whole financial system.
• Examples of risks that could lead to systemic
risk
– The building-up of asset price bubbles
– Excessive risk-taking by banks
– Excessive corporate or household debt
 Financial stability
• Financial stability can be defined as a condition in
which the financial system – which comprises
financial intermediaries, markets and market
infrastructures – is capable of withstanding shocks
and the unraveling of financial imbalances.
• This mitigates the prospect of disruptions in the
financial intermediation process that are severe
enough to adversely impact real economic activity.
 Financial stability and macro-prudential policy

• Financial Stability is the ability of the financial system to smoothly

fulfill its key economic functions at all times, including in stress
situations and periods of structural upheaval.
• FS maintains efficient allocation of financial resources and risks
along with the provision of a well functioning financial
infrastructure.
• The primary aim of financial stability is to attain macroeconomic
and monetary stability along with attaining sustainable growth
• The emergence of possible systemic risks in the financial system is
addressed through macro-prudential policies by maintaining
financial stability in the economy.
• Thus the overarching goal of macro-prudential policy is to
preserve financial stability.
 Macro-prudential policies aim to:

• prevent the excessive build-up of risk, resulting

from external factors and market failures, to
smoothen the financial cycle (time dimension)
• make the financial sector more resilient and limit
contagion effects (cross-section dimension)
• encourage a system-wide perspective in financial
regulation to create the right set of incentives for
market participants (structural dimension)
 The principal macro-prudential policies
implemented by NRB are related to

strengthening the capital of banks and

financial institutions,
implementing risk based supervision,
making necessary arrangement for system
audit,
and enhancing corporate governance in BFIs.
Ideally, a sound macro-prudential policy needs
to be based on
– the determination of the economic cycles,
assessment
– measurement of the build-up of systemic risk
– the impact of the stance of other public policies
on the risk taking behavior of the financial sector.
Issues with regard to the implementation
of Macro-prudential policies

a) constructing an appropriate tool kit to tackle

with systemic risk
b) evolving an optimal mix of rules and
discretion while using macro-prudential
policies
c) extending the perimeter for macro-
prudential instruments to encompass the
shadow banking system.
 Some core elements of macro-
prudential regulation
risk management guidelines to banks,
stress testing guidelines,
liquidity monitoring,
fixation of credit to core capital and deposit
(CCD) ratio,
loan to value ratio,
and single borrower limit, among others.