Cipcommunity

Failure of Nepal Development Bank Ltd.

Failure of Nepal Development Bank Ltd.

Chapter I Introduction 1. Background 1. 1. History Nepal Development Bank Limited (NDBL) was established under the Company Act, 2053(1997) in Chaitra 6, 2054 (March 19, 1998). It was the first national level development bank established by the private sector in Nepal. It had commenced its operation since Magh 17, 2055(January 31, 1999) as per Development Bank Act, 2052 (1996). Since Baisakh 21, 2063(May 4, 2006), it had imparted its services in accordance with Bank and Financial Institution Act, 2063. It had entered into the subscription and services agreement with Industrial Development Bank of India Ltd. IDBI), the most leading development bank of India on 7th July 2003. It had been honored with ADFIAP (Association of Development Financing Institution in Asia and the Pacific and foreign countries) Development Awards 2004 Infrastructure Development Category for its significant contribution towards infrastructure development in the country. The main objective of NDBL was to cater the demand of medium and long term finance for the industrial, commercial, agricultural, tourism, infrastructure sectors and other services by offering various banking facilities.

It mobilized its sources in the form of fixed, saving and other short-term deposits with competitive interest rates. 1. 2. Bank Failure: Bank (depository institutions) failures are widely perceived to have greater adverse effects on the economy and thus are considered more important than the failure of other types of business firms. In part, bank failures are viewed to be more damaging than other failures because of a fear that they may spread in domino fashion throughout the banking system, felling solvent as well as insolvent banks.

Thus, the failure of an individual bank introduces the possibility of system wide failures. This perception is widespread. It appears to exist in almost every country at almost every point in time regardless of the existing economic or political structure. As a result, bank failures have been and continue to be a major public policy concern in all countries and a major reason that banks are regulated more rigorously than other firms. A bank fails economically when the market value of its assets declines below the market value of its liabilities, so that the market value of its capital (net worth) becomes negative.

At such times, the bank cannot expect to pay all of its depositors in full and on time. The bank, or indeed any firm, should be resolved as quickly as possible in order to treat all depositors (creditors) fairly and not allow a run by depositors holding demand and short-dated deposits. The longer an insolvent bank is permitted to operate, the more time such informed depositors have to withdraw their funds at par value and effectively strip the bank of its valuable assets. The entire loss will then be borne by less informed depositors and holders of longer-dated deposits.

Moreover, because banks are closely intertwined financially with each other through lending to and borrowing from each other, holding deposit balances with each other, and the payments clearing system, a failure of any one bank is believed to be more likely to spill over to other banks and to do so more quickly. Thus, the banking system is seen as more susceptible to systemic risk, because there is probability that cumulative losses will occur from an event that ignites a series of successive losses along a chain of institutions or markets comprising a system. Live Chart . 3. Objective of the study: The main objectives of our study are: * To identify the causes of failure of Nepal Development Bank Limited * To study the impact of its failure on different stakeholders and depositors * To study the impact of its failure in the financial system * To identify different measures to be taken by Central Bank and other BFIs to avoid similar failure. * To develop the critical and conceptual skills 1. 4. Research methodology: Since Nepal Development Bank is already liquidated, only secondhand data were available for our study.

All the information presented in the study is collected from different secondary sources as magazines, websites and journals. 1. 5. Limitation of the study: While conducting our study, we faced several limitations. They are: * Limitation of time for completing the project * Actual facts and figures for the failure of NDBL were not available * The degree of truth is fully dependent on the information received from concern sources * Due to the class hours, other projects and events we couldn’t dedicate our full time towards the study

Chapter II 1. Analysis and Interpretation 2. 1. Reasons for failure of Nepal Development Bank Banks fail when they are no longer able to meet their obligations. They might be unable to pay the bills, or a bank failure may arise because they can’t provide cash when depositors demand it. Nepal Development Bank Limited (NDBL) which aspired to enter the new millennium with profitability, size and efficiency on par with the best of the banks in the world is one of the banks that have been a victim of its own irresponsible acts.

One factor behind the misfortune of Nepal Development Bank Limited is bad corporate governance. Economists say corporate governance has appeared as the biggest challenge for the banking sector. According to them, the easy licensing policy adopted over the last decade is the main reason behind today’s problems, as everybody with certain income could open BFIs. Because of the easy licensing policy, nobody failed in the fit and proper test. This allowed those seeking windfall gains in the banking sector.

However, the supervisory capacity of the central bank remained same. Now, BFIs, one after another, are being found involved in fraudulent activities which has hampered the credibility of the banking sector. Another reason behind the financial calamity in Nepal Development Bank Limited is promoters and directors vested financial interest. Directors were involved in insider trading. Most of them were found to be involved in taking loans from their own financial institution in the name of their family members and also in the name of fake companies.

As the bank’s financial status deteriorated severely with double cumulative loss against capital, the central bank had asked the court to liquidate it. Nepal Development Bank Limited was finally liquidated as its promoters could not pull it out of its crisis and put it back in business. According to media reports, the central bank estimated that NDBL had bank deposits and cash worth Rs 196. 20 million and its cumulative loss amounted to Rs 690. 2 million (the bank management did not even know the full scale of its losses and claimed it amounted to Rs 640 million only).

The non performing loans (NPL) comprised over 50 percent of its loan portfolio. The negative capital adequacy ratio of 48. 31 percent was far less than 11 percent allowed by the central bank. In its decision, the central bank has accused NDBL of not being able to fulfill a set of directives that it had issued to the management of the bank while declaring the NDBL a problematic bank in October 2007. The NRB has argued that the whopping negative capital fund, worst internal governance and repeated violation of the central bank? s directives are the major factors that compelled the central bank to take the decision. . 2. Impact of failure of Nepal development bank on different stakeholders The failure of few of the banks to correctly assess their own capacity and ability to fulfill the interests of depositors and investors has created an environment where the public is questioning soundness of the entire banking industry. This has impeded efforts to foster healthy competition, ensure market confidence, and promote a bankable banking industry where a run on one bank would not become a contagion and drag the whole industry down. NDB had Rs. 720 million in deposit of general public and institutional depositors.

But there was less possibility that depositors and share holders would be receiving the money they had invested. The banking industry had just begun in Nepal and the depositors faced the condition of the failure in no time. This of course had a very negative impact on the depositors. The banking industry is the industry of faith. The collapse of one bank leads to the decreased faith towards the whole banking industry. People deposit their savings for future use. The deposits made in the banks are also the portion separated for the time of crisis.

The major impacts on shareholders and depositors due to the failure of NDBP are: * Shareholder had to lose their investment as well as return on investment * Depositors had to lose their deposit as well as interest on their deposit * This may also affect the mental health * Further new investment was not made by investor in the fear that same event may reoccur * Credibility of shareholders also decreases * Shareholders may not able to pay their utility bills and finance other basic needs as education for children, good health and sanitation and fulfill other social obligations 2. 3. Major Depositors and Borrowers

The main institutional depositors of Nepal Development Bank Limited were Employment Provident Fund (EPF) and Nepal Army (NA) while there were 3,391 small depositors. NDBL had total outstanding deposits liability of over Rs 720 million, including Rs 320 million of EPF, Rs 170 million of NA and rest of small depositors. It had cash deposit worth Rs 105 million in Nepal Cooperatives Bank, loans worth Rs 400 million and non-banking assets worth Rs 140 million. Bank had also invested Rs 10 million at Gorkha Hydro and other assets worth Rs 2. 5 million. 2. 4. Lesson Learned By the failure of Nepal Development Bank Ltd.

Time and again, there are issues of banks and finance companies failure. First it was Nepal Development Bank to go into liquidation process and then Samjhana Finance Company followed it. And recently, Gurkha Development Bank, United Development Bank, Vibor Development Bank and Nepal Share market Financial Institute were declared crisis-ridden. Some might say this is bound to happen given the crowd of 272 banks and financial institutions but this is not something that cannot be controlled. The closure or failure of a bank is not comparable to the closure of a retail shop on a street corner.

A financial institution’s closure leaves a huge negative impact on the entire economy. The banking sector is said to be highly regulated. However, despite such regulation and strong monitoring by the Nepal Rastra Bank, incidences of failure occur time and again. Such incidents repeating illustrates central bank regulations are rather unfortunate. Most of the time, failure of corporate governance has resulted into such mishaps. Probably, some of the banks owners or the management teams do not take their institutions and the depositors seriously enough. In some cases, they themselves manage to lead the company on the verge of collapse.

They take huge amount of loans behind the scene which later proves to be non performing loans or show investment in areas that does not give any returns. Such practices bear the potential to eventually lead the company towards bankruptcy. In the bargain, it’s the depositors in particular and the economy in general which stands to suffer. This is a ticking time bomb that may explode any time. So, the regulations may not prove to be successful every time. Companies must maintain self- discipline, good corporate governance and realize the importance of their respective financial institutions.

They must not forget banks are not a business house only. There is tremendous responsibility on their shoulders that they must fulfill. The NDB episode has taught the following lesson: * Depositors and the shareholders have to be aware while depositing or buying shares of financial institutions. * One has to be careful while depositing or investing. * Banks will collapse if not handled properly. * Banking rules and regulations should be reviewed time and again to make adjustment as required by the changing scenario. There must be high requirements regarding the formation of BFIs so that proper test of concerned parties can be made. * Good corporate governance must be maintained by the Board of Directors. * The concentration of loans and deposits must not be made in one sector. The loan and deposit portfolio must be diverse. Chapter III 3. 1. Conclusion and Recommendation Nepal Development Bank Limited failed because of bad corporate governance, promoters and directors vested financial interest and repeated violation of the central bank’s directives. A financial institution’s closure leaves a huge negative impact on the entire economy.

So companies must maintain self-discipline, good corporate governance and realize the importance of their respective financial institutions. The NRB also needs to send a strong signal to the market that it is a responsible and strict watchdog of the banking industry. The NRB, despite regulatory and institutional weaknesses, has to show that it is tough and capable of reigning in banks that taint the image of the otherwise healthy banking industry. References * archives. myrepublica. com * www. nepalsharemarket. com * sapkotac. blogspot. com