Financial Sector Reforms – Grey list and beyond

In Nepal, daily cleanliness often takes a backseat, with efforts to tidy up usually reserved for special occasions like Tihar or social gatherings. A similar pattern emerges when it comes to financial regulations—only in the months leading up to the Financial Action Task Force (FATF) review do we scramble to implement last-minute, symbolic reforms. By then, it’s already too late. Nepal has once again landed on the FATF gray list, marking the second time in 20 years, following its previous listing from 2008 to 2014.

The FATF, established by the G7 countries, is an “international policy-making and standard-setting body dedicated to combating money laundering and terrorist financing.” As the Kathmandu Post wrote, “Nepal’s placement on the grey list stems from its failure to fully implement necessary legal, policy, and structural reforms to combat money laundering and terrorist financing, despite some legislative progress.” Now, Nepal has two years to enact the required reforms and work its way off the list.

While I have written ad nauseum on the need for financial sector reform and adherence to global processes and standards, I provide four additional perspectives on why Nepal has come to this stage of gray listing and probable areas it needs to focus on.

First, compared to Nepal’s GDP, the country’s financial sector is relatively large. Private credit from the banking system accounts for about 90% of GDP, whereas in other South Asian countries, including India, it is less than 50%. In the stock market, Nepal’s market capitalization on a single exchange stands at 75% of GDP, while India—home to a developed stock market and the world’s fifth-largest economy—has 140%. In contrast, Bangladesh’s market capitalization is less than 10%. Additionally, real estate prices in Nepal are among the highest relative to per capita income. Given these figures, Nepal’s financial market must be recognized as a significant player. By 2040, when the country’s GDP exceeds USD 200 billion, managing and regulating financial systems will involve much larger stakes. It is thus important to reduce the tendency of patchwork and rather need a transformational legislation.

Second, Nepal receives official remittances of USD 10 billion—accounting for 25% of GDP—while an equal amount flows in through informal channels such as remittance in kind, hundi, hawala, and trade finance. Additionally, gold cannot be legally purchased in Nepal, further expanding the size and depth of informal markets. I have consistently written and advocated for allowing gold purchases through the banking system or formal channels in Nepal, as this simple legislative change could significantly curb money laundering. However, implementing such a reform requires strong political will—something difficult to find when many political leaders have been linked to gold-related scandals.

Third, there is a need to de-politicize the legislative reform process. I still remember the days of the Constituent Assembly when, in 2016, two bank promoters-turned-lawmakers served as co-chairs of the Finance Committee, overseeing amendments to the Banking and Financial Institution Act, 2017. There were many issues relating to conflict of interests and questioning the scenarios of better governance. At Nepal Economic Forum (NEF), we published a report on the complexities of collusion. Notably, one of the co-chairs was sentenced to three-year prison just a year ago. Bank promoters are powerful business-people, with some having strong political connections or direct involvement with political parties. Political meddling extends to the appointment of Chairs at the Securities Board and Insurance Board, as well as the licensing of financial institutions. Even the current Governor had to fight legal battles after being dismissed by the finance minister while justifying his educational qualifications. Nepotism and favoritism have been pushed to alarming levels, making meaningful reforms an uphill battle. However, it is time to rise above these entrenched interests and push for real change.

Finally, the authorities in the regulatory bodies are weak, and I come out harshly especially on my fellow Chartered Accountants. Here, the audit function remains a mere formality, and so do certifying projections in prospectus. The IMF had asked ten banks to be audited by the international auditors, basically passing on the clear message that Nepali audit firms are not doing their jobs well. With a headline, “A Cartel of Accountants” in The Kathmandu Post on how a profession that led the reforms in 1990s is becoming an impediment to change now. When you do not have any member penalized as per disciplinary action, it speaks volumes of the state of the profession. It is the duty of the audit firms and their fraternity to bring about transformation here.

I recall hearing someone tell me that we should not be impacted by gray listing. They exemplified how even the UAE was in the list and got out of it in 2024, so Nepal can come out of the list easily as well. However, we need to understand that the cost of gray listing is high, both financially and reputation wise. Hence, there is a need to consider this more seriously. There are no substitutes to financial reforms that will help Nepal adhere to the global practices and standards, rather than finding solace in lax rules in the name of nationalism. For political parties in Nepal that are funded by the businesspeople, one needs to figure out whether individual greed and power still remains above the interest of the nation.