September 1, 2015 Sujeev Shakya

Financial Blues

Nepal is a wonderful country where something fascinating seems to be going on at all times. A visiting investment banker from the US recently asked me how on earth Nepal’s stock index had gone up by over 20 percent in the past one month when the world’s stock markets were tumbling and shedding value. He seemed to be baffled by the newspaper headlines about the spike in stock prices when one of the key industrial towns, Biratnagar, had been shut for 18 days in a row.

I had very few answers for him. I did my best to explain to him that Nepali stock market behaviour is completely isolated from the global markets. So, nothing that happens in other parts of the world affects Nepal and vice-versa. The rise of the stock prices were primarily based on Nepal Rastra Bank’s monetary policy that now requires banks to increase their paid up capital from Rs 2 billion to Rs 8 billon ($20 million to $80 million). The anticipation of bonus shares then raised the stock prices.

Antiquated Practices

In Nepal, we have still not been able to change with the times. So, our stock market does not attract international attention, nor would we like to change our practices to be able to attract international investors. The fundamental concept of company pricing and valuation in Nepal is antiquated. We still use the concept of paid up capital despite of the fact that the concept of capital is risk based. Successful private Nepali firms are yet to go public, as the law only allows you to list your shares a couple of times more than the paid up capital. If Google, Facebook, or any other company had started in Nepal and wanted to go public, based on our Nepali methods, they could have been listed at only a hundredth of their global prices!

Nepali stocks have a high Price-Earnings Ratio—a ratio of a company’s share price relative to its per-share earnings—which does not sync with the book values of global stock deals. In the absence of institutional investors—especially international ones that use a lot of analyses—the stock market sways with the action of a few large players, who are more speculators than analyses-backed investors. The market, since its inception, has failed a couple of times and hit small investors hard. But the gambling loving Nepali society seems to like the fact that success in the stock market is correlated to one’s luck rather than on research
and analysis.

Of capital and Capacity

The Rastra Bank’s policy, which requires banks and insurance companies to have high paid up capital, seems to have been introduced to consolidate the market. But given the performance of firms post-merger and the issues relating to human resources, the consolidation of players looks like a far cry. Therefore, it may be that banks and insurance companies would meet its capital requirements through capitalising its books. In the case of insurance companies, the requirement of Rs 5 billion of capital means that based on the Global Risk Based Capital principles, the insurance companies will need close to $1 billion to do business, whereas the current market size is itself around $ 700 million.

This means that the banks and insurance companies will have to increase profits and profitability to be able to maintain the current rate of returns to shareholders. The fall in earnings per share would mean either a drastic fall in stock prices or the bubbling of the stock prices with a high Price-Earnings Ratio.

One big question many people are raising is whether our banks and insurance companies have the right board members, management and human resource capabilities to run such highly capitalised banks and insurance companies. Others are questioning whether—apart from a few banks and insurance companies—most other companies will be able to upgrade the capacity and capability of directors and key management staff. Sanjib Subba, Chief Executive Officer of Nepal Banking Institute, discusses on social media how the training and development costs are very low compared to the revenues in Nepal, and a lot has to be done in this direction. The challenge, therefore, is not just raising the capital, but to be able to augment the increased capital with commensurate strategic, management and skilled human resource.

Time for New

The easiest thing for banks and insurance companies to do is to rent-seek on its spread. The days of taking advantage of age-old practices should be over. My craftsmen relatives were complaining about how gold was not available from banks or other sources when its prices fell. The advent of technology is ensuring that there are other industries that are competing with banks on financial services. For instance, an institution like Kiva that provides small loans is changing the landscape of low-cost lending. Similarly, telecommunication firms are making money transfer easier and cheaper. Different fund structures are replacing banks as lenders for small and medium enterprises and there are more global infrastructure funds being created to lend to businesses. Nepali institutions can keep the innovations away by working with regulators so that there is a protected space for operations, but this will change in the long run. It is important for institutions to anticipate and adopt change rather than fight it and create an oasis that benefits the few. There are many Nepali innovators and leaders in the banking and insurance fraternity that brought change when Nepal opened up these sectors in the early 90s; it is time for them to lead Change 2.0.

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