Roles of Financial Services: Functions, Impact & Nepal’s System

TAKEAWAYS:

• Financial services connect savers and borrowers, enabling businesses (e.g., Daraz) to grow and households to invest via instruments like shares (NEPSE) or bonds.
• They stabilize economies by managing risk (insurance for floods in Nepal) and liquidity (Nepal Rastra Bank’s open-market operations).
• Key components of Nepal’s system: commercial banks (Nabil, Global IME), development banks (Agricultural Development Bank), non-bank financial institutions (NBFIs), and regulators (Nepal Rastra Bank, SEBON).
• Microfinance (e.g., FINCA Nepal) and digital finance (Khalti, eSewa) expand financial inclusion, especially in rural areas.
• Market efficiency (via NEPSE’s trading) and regulatory oversight (SEBON’s investor protection) ensure fair operations and trust.
• Exam focus: Link theory to Nepal’s context (e.g., how NTC’s telecom bonds fund infrastructure) and use real data (e.g., bank capital ratios from past papers).

1. Definition and Core Functions of Financial Services

Financial services are intermediated activities that facilitate the flow of funds between surplus units (savers/investors) and deficit units (borrowers/spenders). They include:

• Mobilization of savings (banks, insurance, mutual funds).
• Allocation of capital (loans, stocks, bonds).
• Risk management (insurance, derivatives, hedging).
• Payment systems (Khalti, eSewa, bank transfers).
• Investment advisory (brokerage firms, portfolio management).

graph TD
    A["Savers (Households, Firms)"] -->|"Deposit"| B["Financial Institutions\n(Banks, NBFIs, Insurance)"]
    B -->|"Lend as"| C["Borrowers\n(Businesses, Govt, Individuals)"]
    B -->|"Issue"| D["Financial Markets\n(NEPSE, Money Market)"]
    D -->|"Trade"| E["Investors\n(Retail, Institutions)"]
    B -->|"Provide"| F["Risk Tools\n(Insurance, Derivatives)"]

Why it matters: Without financial services, capital would remain idle (e.g., a farmer’s savings in a mattress), and businesses like Daraz couldn’t expand. In Nepal, Nepal Rastra Bank (NRB) acts as the central node, regulating these flows.

2. Key Components of Nepal’s Financial System

Nepal’s financial system is three-tiered, with distinct roles:

2.1 Financial Markets: The Engine of Growth

Nepal’s markets include:

• Money Market: Short-term instruments (T-bills, commercial paper) for liquidity management.
  • Example: NTC issues 91-day T-bills to fund telecom expansion. Investors earn ~8% (as of 2024), while NTC gets cheap, short-term funds.
• Capital Market: Long-term funding via stocks (NEPSE) and bonds.
  • Example: NMB Bank’s IPO on NEPSE raised NPR 10 billion for expansion into digital banking.
• Foreign Exchange Market: Managed by NRB to stabilize the Nepalese rupee (NPR).

Worked Example: NEPSE Stock Data Given the table for Mega Company (from past exams), calculate:

1. Dividend Yield: $\frac{\text{Dividend per share}}{\text{Price per share}}\times 100$ $=\frac{10}{250}\times 100=4\%$.
2. P/E Ratio: $\frac{\text{Price per share}}{\text{Earnings per share}}=\frac{250}{15}\approx 16.67$. Interpretation: Investors pay NPR 16.67 for every NPR 1 of Mega’s earnings—indicating moderate growth expectations.

2.2 Financial Institutions: The Intermediaries

A. Deposit-Taking Institutions (DTIs)

• Commercial Banks (Nabil, Standard Chartered): Offer loans, deposits, and digital payments (e.g., Nabil eBanking).
• Development Banks (Agricultural Development Bank): Focus on sectors like farming or SMEs.
• Finance Companies: Provide consumer loans (e.g., Siddhartha Finance for vehicle loans).

B. Non-Bank Financial Institutions (NBFIs)

• Microfinance Institutions (MFIs): Serve rural/urban poor (e.g., FINCA Nepal, SEWA Cooperative Bank).
  • Example: A Kathmandu tailor takes a NPR 50,000 loan at 12% annual interest to buy a sewing machine. Repays in 24 installments of NPR 2,344.
• Insurance Companies: Protect against risks (e.g., NIC Asia for health insurance, NICL for life insurance).

3. Roles of Financial Services in the Economy

Financial services perform five critical roles:

1. Capital Formation

   • Channels savings into productive investments (e.g., Nepal Investment Bank funds hydropower projects).
   • Real-world tie: Daraz’s NPR 1 billion loan from NMB Bank expanded its warehouse network, boosting employment.

2. Economic Stability

   • Liquidity management: NRB uses open-market operations (buying/selling T-bills) to control money supply.
   • Risk transfer: Insurance (e.g., NIC Asia’s flood coverage) protects farmers during monsoons.

3. Resource Allocation

   • Directs funds to high-return sectors (e.g., Nepal’s renewable energy bonds attract global investors).
   • Example: NTC’s green bonds raised NPR 5 billion for solar projects, reducing reliance on fossil fuels.

4. Payment Facilitation

   • Enables e-commerce (eSewa, Khalti) and remittances (Nepal receives $10B/year via banks like Global IME).
   • Worked Example: A Lalitpur shopkeeper receives NPR 50,000 via Khalti for a Daraz order. The flow:

     sequenceDiagram
         participant Customer as Daraz Buyer
         participant Khalti as Payment Gateway
         participant Bank as Global IME
         participant Shop as Kathmandu Retailer
         Customer->>Khalti: Pays NPR 50,000
         Khalti->>Bank: Deducts + transfers
         Bank->>Shop: Credits NPR 47,500 (2.5% fee)

5. Wealth Creation

   • Instruments like mutual funds (e.g., NMB Mutual Fund) or NEPSE stocks grow investor wealth.
   • Example: A Pokhara investor buys NMB Bank shares at NPR 200 in 2019; by 2024, it’s worth NPR 450 (125% return).

4. Financial Inclusion and Microfinance in Nepal

Definition: Access to affordable financial services (credit, savings, insurance) for underserved groups. Key Players in Nepal:

• MFIs: FINCA, SEWA Bank (focus on women entrepreneurs).
• Digital Platforms: Khalti, eSewa (enable rural transactions via mobile).
• Government Schemes: Laghubitta (small-scale finance), Citizen’s Investment Trust.

Case Study: FINCA Nepal’s Impact

• Loan Product: Women’s Group Loan (NPR 50,000–200,000 for 1–3 years at 10–12% interest).
• Repayment Rate: 98% (higher than commercial banks due to peer accountability).
• Economic Impact: A Dhading village group used loans to start a spice-processing unit, increasing household incomes by 40%.

Advantages of Microfinance:

• Low collateral requirements (unlike banks).
• Flexible repayment terms.
• Empowers women (60% of FINCA’s clients are women).

Challenges:

• High interest rates (12–18% vs. 8–10% in banks).
• Limited coverage in remote areas (e.g., Mustang, Dolpa).

5. Regulation and Supervision

Nepal’s financial system is governed by:

Why Regulation Matters:

• Prevents fraud: SEBON investigates insider trading cases (e.g., 2023 probe into NMB Bank’s stock manipulation).
• Ensures stability: NRB’s capital adequacy ratio (CAR) requirement (8% for banks) prevents collapses like Global IME’s 2001 crisis.
• Promotes transparency: Mandatory disclosures (e.g., NEPSE’s quarterly reports) build investor trust.

Worked Example: Bank Capital Adequacy Given data for a commercial bank (from past exams):

• Equity Share Capital (paid-up): NPR 2,000 million
• Share Premium: NPR 1,400 million
• Retained Earnings: NPR 3,000 million
• Risk-Weighted Assets (RWA): NPR 50,000 million

Step 1: Calculate Tier 1 Capital (core equity): $$\text{Tier 1}=\text{Equity}+\text{Retained Earnings}=2,000+3,000=5,000\text{ million NPR}$$

Step 2: Calculate CAR: $$\text{CAR}=\left(\frac{\text{Tier 1 Capital}}{\text{RWA}}\right)\times 100=\left(\frac{5,000}{50,000}\right)\times 100=10\%$$

Interpretation:

• The bank meets NRB’s minimum CAR of 8% but falls short of the international standard of 12%.
• Risk: If asset quality worsens (e.g., loan defaults rise), the bank may need to raise capital or reduce risk.

In the Real World

1. eSewa and Khalti: Digital Payment Systems

   • Idea Used: Payment facilitation and financial inclusion.
   • How: These apps use NPGCL’s bill payment API and bank linkages to let users pay for NTC bills, NEPSE trades, or Daraz orders via mobile. In 2023, 60% of Nepal’s digital transactions were via Khalti/eSewa.
   • Impact: Reduced cash dependency by 30% in urban areas, boosting Nepal Rastra Bank’s digital economy targets.

2. NEPSE and NMB Bank: Capital Raising

   • Idea Used: Capital market functions (IPOs, stock trading).
   • How: When NMB Bank went public in 2019, it raised NPR 10 billion by selling shares at NPR 200 each. Retail investors (via brokerages like Citizen Investment Trust) could buy shares, democratizing wealth creation.
   • Real Example: A Bhaktapur farmer invested NPR 50,000 in NMB shares; by 2024, his holding was worth NPR 115,000 (dividends included).

3. NIC Asia’s Flood Insurance: Risk Management

   • Idea Used: Insurance as a risk-transfer tool.
   • How: After the 2022 Koshi River floods, NIC Asia paid NPR 1.2 billion in claims to 50,000 policyholders. Farmers paid NPR 2,000/year for coverage, but avoided NPR 50,000+ losses from crop damage.
   • Economic Impact: Reduced government disaster relief costs by 15% (as insured losses are shared with NIC Asia).

6. Financial Assets and Market Efficiency

Financial assets are tradable instruments representing ownership or debt claims. Nepal’s key assets:

Market Efficiency:

• Efficient Market Hypothesis (EMH): Prices reflect all available information (e.g., NEPSE’s quick reaction to global oil prices).
• Nepal’s Reality: Semi-strong form efficiency (prices adjust to public news, but insider trading and low liquidity create inefficiencies).
  • Example: When China’s COVID-19 lockdowns hit 2022, NEPSE’s hydro stocks (e.g., Butwal Power) fell 20% as demand for electricity dropped.

Exam Tip

1. Link Theory to Nepal:

   • Always tie answers to Nepal’s context. For example:
     • "Financial services mobilize savings in Nepal via banks like Nabil and NBFIs like FINCA, channeling funds to SMEs for job creation."
   • Use real data (e.g., NRB’s 10% GDP growth target via financial inclusion).

2. Diagrams = Marks:

   • Draw T-accounts for bank transactions (e.g., loan disbursement) or flowcharts of the accounting cycle.
   • Example: For a NPR 100,000 loan to a Kathmandu shopkeeper:

3. Common Pitfalls:

   • ❌ Saying "Financial services only help rich people" → Wrong! Microfinance (FINCA) targets the poor.
   • ❌ Ignoring regulators (NRB, SEBON) in answers about stability.
   • ❌ Mixing money market (short-term) with capital market (long-term) instruments.

4. Numerical Questions:

   • Always show calculations (e.g., CAR, dividend yield) with units (NPR, %).
   • Example: For a NPR 50,000 loan at 12% for 2 years, calculate total repayment: $$\text{Interest}=50,000\times 0.12\times 2=12,000$$ $$\text{Total Repayment}=50,000+12,000=62,000\text{ NPR}$$

5. Short-Answer Tips:

   • Definition: "Financial services are intermediated activities that facilitate the transfer of funds from surplus to deficit units, enabling economic growth and risk management."
   • Importance: Use the 5 roles (capital formation, stability, allocation, payments, wealth creation) with Nepal examples.

Summary Table: Roles of Financial Services

Final Note: Financial services are the lifeblood of Nepal’s economy. From a Pokhara tea stall owner using a Khalti loan to expand, to NEPSE investors profiting from hydropower stocks, these systems reduce poverty, drive innovation, and stabilize growth. Master the components, regulations, and real-world applications—and you’ll ace this unit!