Inclusive Finance in Nepal
The Challenges of Financial Inclusion in Nepal
Nepal's financial sector is composed of a wide range of institutions, including 20 commercial banks, 17 development banks, 17 finance companies, 54 microfinance institutions, and approximately 31,000 cooperatives. Despite this diverse landscape, many people still lack access to essential financial services. Studies have shown that formal institutions meet only 40% of the demand for financial services, while cooperatives cover an additional 20%. This indicates that a significant portion of the population remains excluded from the formal financial system.
The phrase "Water, water everywhere, nor any drop to drink" aptly describes the situation in Nepal’s financial sector. There are numerous institutions, but their services often fail to reach those who need them most. This gap between availability and accessibility highlights the challenges in achieving true financial inclusion.
Regulatory Efforts and Implementation Gaps
To address these issues, the Nepal Rastra Bank (NRB) has introduced several regulatory frameworks and guidelines aimed at improving access to finance. These include the deprived sector lending program, which requires Class A, B, and C Bank and Financial Institutions (BFIs) to allocate 5%, 4.5%, and 4% of their loan portfolios to the deprived sector, respectively. Additionally, NRB mandates that each bank establish at least one branch in every municipality. Priority sector lending requirements and subsidized credit programs further support these efforts.
Despite these policies, implementation remains weak. Many banks are physically present across the country and hold excess liquidity, yet they do not effectively mobilize these resources to expand access to finance. Moreover, there is a lack of mechanisms to ensure that Microfinance Institutions (MFIs) serve the underserved and ultra-poor. Empirical evidence consistently shows that financial inclusion remains limited, especially among rural populations, women entrepreneurs, and low-income households.
Traditional Models and Their Limitations
Most BFIs rely on traditional service delivery methods and offer standardized products that may not meet the unique needs of poor households. Serving low-income clients effectively requires understanding their irregular income patterns, seasonal fluctuations, and household-level cash flows. Similarly, MSME products offered by BFIs may not be tailored to the specific needs of different types of businesses.
For example, internationally recognized agricultural banks like Rabobank provide customized financial products based on cash-flow needs. A farmer requiring a loan to purchase a cow might have a repayment period of 3-5 years, while a loan for livestock, sheds, and grazing land could extend to 20-40 years, aligned with long-term cash flow expectations. Such tailored approaches are rarely seen in Nepal.
Struggles of Microfinance Institutions
MFIs in Nepal have faced challenges in reaching the ultra-poor due to a lack of commitment to serving the most vulnerable. Many MFIs have shifted focus toward commercialization and profit maximization, moving away from their original mission of poverty alleviation. Reaching the unserved and ultra-poor requires coordinated efforts among government agencies, donors, and civil society.
The group-based lending model used by MFIs also creates barriers. Mandatory monthly meetings and the requirement to form groups often exclude the ultra-poor, whose opportunity costs are high. Many of the poorest households engage in daily wage labor, making it difficult to attend regular meetings. Additionally, some individuals struggle to find enough members to form a group or lack acceptable physical collateral.
In group-based lending, leaders often select members based on trust, proximity, and past relationships. As a result, ultra-poor individuals are frequently excluded due to perceived higher risks of default. This exclusion perpetuates the cycle of financial marginalization.
Promoting Financial Inclusion
The exclusion of many people from mainstream financial services indicates that current delivery mechanisms and products are inadequate for financially excluded communities. Barriers exist on both the demand and supply sides. People in different geographic areas and occupations require tailored financial products designed to meet local needs.
Poor households often rely on informal mechanisms because they offer flexible repayment terms and do not require physical collateral. However, these mechanisms lack the structure and security provided by formal financial services.
People living below the poverty line face significant challenges as clients for financial service providers. Their agricultural incomes are often irregular, and the risks associated with agriculture are unpredictable. They require frequent, flexible, and tailored financial products to manage risks and stabilize their livelihoods.
Those in absolute poverty—characterized by poor health, inadequate housing, and limited access to basic services—face even greater barriers. They require broader support systems, including improvements in health and sanitation, skills training, and start-up grants to initiate microenterprises. Credit can only benefit them when they possess some skills and income-generating activities that can be expanded.
The Role of Financial Literacy
Limited financial literacy is another major barrier to financial inclusion. Many clients are unable to access available financial services due to a lack of understanding. Financial education helps individuals make informed decisions, set goals, borrow and invest productively, increase income, and save for the future.
Studies suggest that individuals with a strong internal locus of control—those who believe their life outcomes are determined by their own actions—are more motivated to work hard and save for the future. Training and empowerment programs that promote livelihood skills, improve business practices, and encourage wise money management behaviors are essential for enhancing self-efficacy and overall well-being.
Data and Policy Recommendations
Accurate data on access to finance is critical for promoting financial inclusion. Many BFIs and cooperatives cannot provide information on the number of poor clients they serve or the reasons for exclusion within their operational areas. Without reliable data, it is impossible to design effective strategies to meet the financial needs of excluded populations.
Strengthened guidelines and directives from regulators, along with effective monitoring and enforcement, are necessary to address these challenges and advance financial inclusion. Only through comprehensive and inclusive financial systems can Nepal achieve its goal of universal access to financial services.
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