Introduction

Corporate governance refers to the structures and processes for the direction and control of
companies. (OECD 1996) Corporate governance concerns the relationships among the
management, Board of Directors, controlling shareholders, minority shareholders and other
stakeholders. Good corporate governance contributes to sustainable economic development
by enhancing the performance of companies and increasing their access to outside capital.
The OECD Principles of Corporate Governance provide the framework for the work of the
World Bank Group in this area, identifying the key practical issues: the rights and equitable
treatment of shareholders and other financial stakeholders, the role of non-financial
stakeholders, disclosure and transparency, and the responsibilities of the Board of Directors.
Good corporate governance, in other words, is responsible and targeted management and
supervision, forms an integral part of business processes. It is designed to strengthen trust in
company, allowing for a sustained increase in value. At the same time, good corporate
governance enhances transparency for all stakeholders and firmly anchors responsible
conduct in the company. For emerging market countries like Nepal, improving corporate
governance can serve a number of important public policy objectives. Good corporate
governance reduces emerging market vulnerability to financial crises, reinforces property
rights, reduces transaction costs and the cost of capital, and leads to capital market
development.
Corporate governance is important for the success of long term development in developing,
transitional and emerging market economies. (prakash and ) The quality of a countrys
governance institutions of which those of corporate governance now constitute an integral
part matters greatly for development as a whole. Corporate governance in banks is slightly
different from other corporations in the desired level of corporate governance standards and
the scope of stakeholders to which corporate governance mechanisms should be accountable.
Banks are actually considered to be special for several reasons.
Compliance refers to all activities designed to ensure that the conduct of the company,
members of its governance bodies and its employees respect all statutory and in-house
regulations. It ensures that business activities are aligned to values and to moral and ethical
principles.

From a banking industry perspective, corporate governance involves the manner in which the
business and affairs of banks are governed by their boards of directors and senior
management, which affects how they set corporate objectives; operate the banks business on
a day-to-day basis; meet the obligation of accountability to their shareholders and take into
account the interests of other recognized stakeholders; align corporate activities and behavior
with the expectation that banks will operate in a safe and sound manner, and in compliance
with applicable laws and regulations; and protect the interests of depositors and the pivotal
object of the banking services is the trust and good faith of stakeholder and consumers.

Corporate Good Governance Directive in Nepal

The objectives of corporate Good Governance are effectiveness, efficiency, productive,
accountability, transparent and reliability. Some international agencies' standard guide on the
corporate good governance as like:

code of Good Practice & Fiscal Transparency (IMF)

International Accounting Standards (IAS)

Principle of Corporate Governance (OECD)

Basel Core Principles

Principles and Guidelines for effective inventory and creditor Right System (World
Bank)

On the basis of above standards, NRB issued the following directives to the financial
institutions:

Code of Conduct of Board of Directors: Minimum Acceptable code of conduct, noninvolvement against interest of institution, restriction in part time job, any director of one
deposit taking institution will not be director of other deposit taking institution, restriction in
custodian, abuse of Authority, complete recording & reporting, maintaining trust &
confidentiality, equal treatment, written information to NRB etc.

Duties & Responsibilities of Board of Directors

Appointment of CEO

Employees code of conduct

Provision regarding Audit Committee

Restriction on Credit facility to directors, shareholders, employees and its related

firms and companies.

Through this report I have tried to identify

Principles of Corporate Governance in Banking Sector

BIS (Bank for International Settlement) OECD (Organization of Economic Cooperation and Development) and other different financial institutions has developed and
presented the various guidelines on enhancing corporate governance in banking sector but
they do not diverge from each other, OECD focus on the following critical elements of
desirable corporate Governance for the banks.

1. Board members should be qualified for their positions, have a clear understanding of
their role in corporate governance and be able to exercise sound judgment about the
affairs of the bank.
2. The board of directors should approve and oversee the banks strategic objectives and
corporate values that are communicated throughout the banking organization.
3. The board of directors should set and enforce clear lines of responsibility throughout
the organization.
4. The board should ensure that there is appropriate oversight by senior management
consistent with board policy
5. The board and senior management should effectively utilize the work conducted by
the internal audit function, external auditors, and internal control functions.
6. The board should ensure that compensation policies and practices are consistent with
the banks corporate culture, long-term objectives and strategy, and control
environment
7. The bank should be governed in a transparent manner.
8. The board and senior management should understand the banks operational structure,
including where the bank operates in jurisdictions, or through structures, that impede
transparency (know-your structure)
Nepal and Its Compliance with OECD Principles of Corporate Governance

The following sections highlight of the principle-by-principle assessment of Nepals

compliance with the OECD Principles of Corporate Governance. (World Banks ROSC
Report 2005)
Investor protection
Equity is considered by many to be a relatively good investment in Nepal, and new issues are
regularly oversubscribed. Shareholders are also not as passive as in some other countries.
Nonetheless, there are a number of weaknesses in the corporate governance framework that
limit investor confidence.
Shareholders can and do participate in the general meeting. They have standard powers to
approve changes to companys articles, and authorize dividends, capital increases, and
mergers as well as appoint the companys auditor. They can choose directors using a
combination of proportional and cumulative voting that generally allows non-controlling
shareholders to choose at least a few directors. However, many shareholders attend
shareholder meetings not to participate in fundamental corporate decisions but instead to
receive food money or other gifts from the company. Due to shareholders spreading their
shares over a number of family members, the amount paid out in kind or cash can become
significant. There is also a cadre of VIP shareholders that demand additional special
treatment, such as dinner the night before the general meeting. These shareholder activists
will disrupt the meeting if these benefitswhich are ultimately paid for by other
shareholdersare not provided. In response, some companies especially those not making
a profit--are not holding the general meeting of shareholders. Other companies hold the AGM
at the same time and a few companies have their headquarters outside the Katmandu Valley
to limit participation by shareholders.
Companies maintain their own share registries and issue share certificates. The board must
approve any transfer of shares. While there have been few cases of abuse, the system is
cumbersome: it can take 45 days for shares certificates to reach their new owners. Companies
also normally close the register for 15 days.
Information on listed companies is often difficult to obtain. This reflects both poor
compliance with filling requirements, but also the limitations of the OCR. Certain
information provided to NEPSE is not shared with the public.

The regimes for changes in control and other major and related party transactions (RPTs) are
minimal. In practice control changes are not common. Market participants report that RPTs
are common, to the potential detriment of minority shareholders.
Disclosure
Until recently, Nepal essentially had no standards for accounting and auditing. Other
elements of disclosure are also weak. While NRB directives now ensure reporting
requirements are generally met by banks and other financial companies, many other
companies do not make required filings or issue the annual report.
Banks and other financial companies are supposed to disclose direct ownership. However,
there is at least one listed bank whose ultimate controlling shareholder is unknown. Listed
companies are required to report to NEPSE if there is a change in ownership such that a
single person has 5 percent or more of shares: this is not disclosed to the public. Shareholders
have no obligation to report their holdings, and there are no provisions in the law regarding
indirect ownership.
Since 2003 the Institute of Chartered Accountants Nepal (ICAN), through the affiliated
Accounting Standards Board and Audit Standards Board, began issuing accounting and
auditing standards. The issued standards are based on International Financial Reporting
Standards (IFRS) and International Accounting Standards (IAS), but a number of standards
remain to be issued.
Company oversight and the board
Nepal has a single tier board system. Boards normally contain some members not affiliated
with the controlling family and most companies have separate chairman and managing
directors. In practice however the controlling family remains in charge of both the board and
company management.
The law contains little on the specific duties and powers of directors. There are no duties of
loyalty and care or equivalent. Unsurprisingly, directors are not sued. Bank directors, under
NRB Directive 6, are required to have a duty of care and ensure that the bank remains within
the law.
Directive 6 also requires that boards follow a code of ethics developed by the NRB. Directors
of all companies are prohibited from offering bribes, engaging in corruption, trading in the

shares of the company, or having any conflicts of interest on appointmentthough

shareholders can waive the latter requirement. Banks and other financial companies cannot
make loans to their directors. The draft company law would extend this limit to all
companies.
While boards may have a minority of directors seen as representing smaller shareholders,
there are no formal independence requirements in the law for listed companies. Starting in
2005 banks and other financial companies are required to appoint a professional director
from a list approved by the NRB. The draft company law would also require that all
companies have one or two independent directors.
Key institutions that are mandated to oversee companies and capital markets in Nepal are
limited and play a secondary enforcement role. SEBO has limited authority, resources and
independence and undertakes few enforcement actions. The OCR, which has certain powers
under the CA, also has limited resources and a mediocre reputation with market participants.
The affiliated Company Board, a part time court like body, hears a steady stream of cases, but
these are regularly appealed. The standards developed by ICAN and the Accounting and
Auditing Standards Boards remain voluntary, and only a fraction of registered accountants
and auditors have been licensed by the body.
On the other hand the NEPSE can license its members, oversees suspicious trading, and can
suspend trading and de-list companies. It requires reporting price sensitive and ownership
information not shared with the public. The Katmandu district court and the Court of
Appeals, which hears the appeals from the Company Board, have a relatively positive
reputation. However the current law effectively limits the range of cases that will go to court.
Overall, it is the NRB that has become the driving force for corporate governance reform in
Nepal.
KATHMANDU, MAR 26 - First it was Nepal Development Bank to go into liquidation
process and then Samjhana Finance Company followed suit. And recently, Gurkha
Development Bank and United Development were declared crisis-ridden. One common
factor behind the misfortune of these institutions is bad corporate governance.
On Thursday, the Nepal Rastra Bank (NRB) decided to send Samjhana into liquidation after
seeing no possibility of recovery of the crisis-ridden company. It is the second instance since

2009 when the central bank took a bold step to initiate the liquidation process of Nepal
Development Bank.
The common reason behind the financial calamity in these three institutions is promoters and
directors vested financial interest. The biggest problem facing the banking sector currently
is bad corporate governance, said Maha Prasad Adhikari, deputy governor of NRB. The
latest Gurkha Development Bank fiasco is also because of the tussle between promoters.
Over the last two years, many instances of bad governance have appeared. A month ago, the
central bank declared United Development Bank crisis-ridden as its directors were found to
have taken loans for themselves.
A year ago, Kunja Bihari Kayal, executive chairman of Birgunj-based Public Development
Bank (PDB), in collusion of Infrastructure Development Bank (IDB) Chief Indra Humagain
was found to have taken loans from IDB by depositing his banks cheque which could not be
cashed. PDB had given loans to the men of Kayal against fake cheques.
Economists say corporate governance has appeared as the biggest challenge for the banking
sector. Even top NRB officials admit. According to them, the easy licensing policy adopted
over the last decade is the main reason behind todays 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, said a senior NRB official. Businessmen
were also allowed to open BFIs. With the easy licensing policy in place, the number of BFIs
soared to over 200. 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.
For an instance, Gurkha Development Bank Executive Chairman DB Bamjan is facing
charges over alleged irregularities while lending Rs 130 million to one Pancha Lal Maharjan.
The central bank has found that Maharjan did not actually receive the amount.
The central bank also found that the bank directors were involved in insider trading, as the
bank was in a process to purchase land of a promoter against the banking norms. According
to the NRB, the bank had sought to buy the land worth Rs 900 million which is above its

capital adequacy ratio. Such activities resulted in worsening financial situation of the bank
and the NRB was forced to declare it a crisis-ridden financial institution. Promoters think
that banks are their own property and they are free to do whatever they want, said former
governor Dipendra Bahadur Khestry.
Similar were the cases in NDB and Samjhana. In both companies, directors were involved in
insider trading. In Samjhanas case, promoters were involved in collecting deposits and
providing loans by maintaining hidden accounts even though the central bank barred it to
collect deposits and provide loans. Such loans used to go for their kin which they never
repaid.
The central bank directive bars insider trading. However, central bank officials admit that
such practice is rampant ion the banking system. They take financial benefits by lending to
third parties, said a senior NRB official.
In all these cases, the central bank has been reactive. Former governor Keshtry said the NRB
has been slow to intervene which resulted in further worsening of these BFIs.
The NRB has failed to track down bad governance practices in BFIs on time, admitted
Bishwombher Pyakuryal, an NRB board member. We should also look into the status of
trained manpower in the regulation and supervision department of NRB and whether they
sufficient in numbers to regulate and supervise the current number of BFIs.

NRB Act (Bank Supervision Report 2013)

The 2002 NRB Act, supported by the 2006 Bank and Financial Institutions Act (BAFIA)
grants supervisory authority to the Nepal Rastra Bank (NRB) and NRB is responsible for
banking supervision. Nepal Rastra Bank Act, 2002, has made NRB an autonomous institution
empowered to regulate and supervise Nepals banking industry.
As a regulator and supervisor of BFIs, NRB has been continuously issuing various policies,
guidelines and directives to the licensed institutions, adopting international practices and
norms. A dedicated department Bank and Financial Institutions Regulation Department is
set in NRB's structure to issue regulating policies, directives and guidelines.
As a supervisor, NRB supervises the activities of the banks and financial institutions based on
the existing legal framework, directives and guiding polices. To discharge the responsibilities
of supervisor, NRB has set four departments, as per the class of institution, in its structure
viz. Bank Supervision Department, Development Bank Supervision Department, Finance
Company Supervision Department and Micro Finance Promotion and Supervision
Department.

NRB and Corporate Governance

The financial crisis of 2009 has shown corporate governance as the single most important
factor that invited the crisis. Excessive risk taking in new financial instruments without
adequate risk coverage, lack of policies and procedures, noncompliance with Banks internal
approved manuals and guidelines are the major reasons that invite a bank failure.
During the review period major issues like non-compliance of Internal Policies, lack of
strategic plan and a business plan, lack of independence of Audit function, lack of board of
directors oversight banks operational activities- half of all directors at banks are involved in
various business activities with little or no banking knowledge, lack of successor plan,
Inadequate MIS system and unprofessional decisions of Board and Senior management,
insider lending, ever greening of loans etc. were noted. All of these issues were hinting a lack
of good governance in Banks in Nepalese financial sector.
While NRB issues prudential regulations on corporate governance requiring banks to
maintain minimum standards of operation, banks are expected to demonstrate robust
corporate governance based on NRB guidelines and international best practices. In view of

this, the commercial banks need to put in place a comprehensive risk management framework
to identify measure, monitor and mitigate risks.
To ensure sound practice of corporate governance, both the board of directors and senior
managers need to have adequate knowledge, competency and experience of the banking
sector. The board of directors and senior management is expected to prepare working
manuals, procedures and guidelines and strictly abide by such approved manuals.
(Bank Supervision Report 2013)