Financial frauds add to Nepal’s economic woes

Considering its small size Nepal has a significantly large number of banks and financial institutions (BFIs) – thanks to the boom the sector witnessed following economic liberalisation in the 1980s.

Commercial banking and lending saw another spurt after end of the civil war in 2006 because of the optimism that prevailed. Due to lack of investment opportunities, real estate, primarily in Kathmandu Valley, attracted a large chunk of investments.

But the good times ended within a couple of years due to several factors including negative balance of payments, tightening of liquidity, slower deposit growth and possible capital flight.

New directives by Nepal Rastra Bank, the country’s central bank, and the bleak scenario led to BFIs stopping or imposing strict restrictions on doling housing loans to the real estate sector.

Suddenly there were not many buyers for Kathmandu’s high-rise apartments. The sector came to a near halt and housing companies that had taken huge loans started defaulting on payments.

A new study published by Nepal Economic Forum, an economic policy and research organization, says this scenario led to a sharp rise in financial frauds in the Nepal’s banking sector.

As inadequate risk management system and poor corporate governance practices landed many BFIs in trouble, the first cases of banking frauds started getting reported.

“The intensity and number of fraud cases experienced after the severe liquidity crisis indicate that the frauds were planned,” the study says. Till date nine banks have been found to have indulged in various kinds of frauds by the Nepal Rastra Bank.

“The problems have not arisen due to systematic risk, but from individual risk and fraudulent actions undertaken by the management, promoters or board of directors of these BFIs. Fraud cases especially in such a highly regulated sector like banking is alarming,” it adds.

The total amount of the financial bungling indulged in by the BFIs is estimated to be over $94 million (the cost to the Nepali economy is $57 million) and the types of frauds indulged in commonly are misappropriation of assets, financial statement frauds and corruption.

More specifically the study found embezzlement by employees, misappropriation by senior staff and directors, lack of internal control and corporate governance, loans against weak collateral and even theft of personal identification numbers (PIN) of customers.

Though Nepal has laws to stop financial frauds, lapses and loopholes within the internal control system, weak regulatory supervision, people abusing positions, changing lifestyle and availability of easy money are said to be the major reasons for increase in banking frauds.

“With the country’s poor technological infrastructure, limited knowledge and monitoring mechanisms, the Nepali financial system is fraught with immense possibilities in regard to the occurrence of financial scams and frauds,” the study states.

More frauds of different nature like capital and commodity market scams and Ponzi schemes and network marketing could pose a significant risk to the financial sector of the country in future.

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