Access to financial services remains limited for most people in Nepal and has declined in recent years, according to the World Bank and DFID’s 2006 Access to Financial Services Survey report launched today.

The report examines the country’s supply of and demand for financial services, constraints to increasing access, and offers recommendations for making the financial sector work for all Nepalese, especially the poor. The report finds that about 38 percent of Nepalese households have an outstanding loan exclusively from the informal sector, 16 percent from both the informal and formal sector, and 15 percent from only the formal sector. Family and friends are by far the largest informal providers of loans to households—and, contrary to common belief, family and friends often charge interest.

“Despite efforts by the Government to address the situation, formal financial institutions do not serve the needs of most people in Nepal, especially low-income households and small businesses,” said Ken Ohashi, World Bank Country Director for Nepal. “Access to financial services plays a crucial role in poverty reduction. For example, access to savings helps poor people cope better with shocks such as health care emergencies. Through access to credit, they can invest in income-generating activities or in the future, by obtaining education or migrating. Financial services also play an important role in supporting the growth of small businesses—crucial for creating jobs for low-skill workers.”

Ohashi further said that lack of capacity among financial institutions is a key constraint. “The government urgently needs to help banks and microfinance institutions to develop appropriate products and procedures for profitable lending to small businesses and low-income households.”

Only 26 percent of Nepalese households have a bank account, and banks’ procedures are perceived as being the most cumbersome among financial institutions. Accordingly, clients prefer not to save in them. Financial NGOs and cooperatives run a close second as largest provider of deposit accounts, serving 18 percent of households. These institutions are the preferred provider for low-income households, but are also popular among the wealthier households. Microfinance and regional rural development banks are a distant third provider of deposit accounts, serving only 4 percent of households—mainly the rural poor.

“Most households who borrow from informal providers do not bother trying to borrow from financial institutions, mainly because formal institutions cannot meet their financial needs on time,” said Aurora Ferrari, World Bank Private Sector Development Specialist and author of the report. “Moreover informal providers require less or no immovable collateral. Even among the wealthiest households, half of those with a bank account prefers informal lenders because of their rapid delivery.”

“Government efforts to increase access to formal financial services have not fully achieved their goals because they have focused on the symptoms of limited access—not the root causes” says Sabin Raj Shrestha, World Bank Sr. Financial Sector Specialist and co-author of the report. “For example, the priority sector lending program, requiring banks to make loans to small businesses, has not addressed the sustainability of such lending. Similarly, the deprived sector lending program for low-income households has not addressed the microfinance sector’s capacity to extend large volumes of loans.”

Increasing financial access for small businesses and low-income households requires that financial institutions be able to serve these segments in a financially sustainable manner, the report argues. Lending profitably to small businesses requires a high level of efficiency, while operating microfinance institutions with large outreach requires specialization. By enlarge Nepal’s financial institutions do not meet these requirements.

“To serve small businesses profitably, banks need to minimize transaction costs and generate large numbers of high-quality loans. The country needs to develop an environment where small business lending is safer, cheaper, and faster,” said Ferrari.

The report proposes several approaches to increase access for small businesses and low-income households. For example to assist banks serve profitably small businesses the secured transactions law should be implemented by creating a secured transactions registry. This will allow borrowers with movable collateral (e.g. a generator or a tractor) to borrow safely against it.