In the process of evolution of the banking system, the first means of exchange, which is loosely called money, was developed. Later on, individuals started to provide payment services and elementary banking services such as accepting deposits and granting loans. States started to issue currency notes and mint the metals coins. Institutions were evolved to provide banking services. So, in the evolution process of the regulatory framework, regulation to regulate the currency note and coins was evolved. In the U.S.A, the National Currency Act was introduced in 1863.
In Nepal, Sadar Muluki Adda (Government Treasury) issued the currency note for the first time in 1945. Before the issue of currency notes, Nepalese coins and Indian currency was used as a means of payment in Nepal. At that time, there was no single act to establish and regulate the banks. Two commercial banks—Nepal Bank Limited and Rashtriya Banijya Bank, were established under special charters: Nepal Bank Act, 1936 and Rashtriya Banijya Bank Act, 1964.
The banking industry in Nepal started with the establishment of Nepal Bank Limited in 1937 under the Nepal Bank Act, 1937 (1994 B.S.). It was followed by the establishment of the Nepal Rastra Bank in 1956 to promote and regulate the banking system in Nepal. The then His Majesty’s Government brought the Nepalese Currency Circulation Act, 1958, and the Foreign Exchange Regulation Act, 1963 in effect to enforce the circulation of Nepalese currency and control and manage the foreign currencies. There was no competition in the banking industry due to the restriction on the entry of new banks, and banking services were not efficiently provided to the customers.
In 1974, both Nepal Bank Act, 1937 and Rashtriya Banijya Bank Act, 1964 were repelled by Commercial Bank Act, 1974 which brought two public sector commercial banks under the commercial bank act. But, the regulatory framework for deposit insurance was not framed. The then His Majesty’s Government did not realize the need for any regulatory framework to protect the money of the general public. This was natural since the banking sector was completely under the public sector, and there was no case of bank failure in Nepal. However, the regulatory framework for the protection of loans provided to the priority sector was introduced. As a result of this, Credit Guarantee Corporation was established to provide banks a guarantee for the priority sector loans.
The regulatory framework of the banking industry was stringent after the great wave of bank failures and the Great Depression. Restrictions on the pricing of deposits, restrictions on entry and geographical expansion, restrictions on scope and nature of activities, and minimum capital requirements were common phenomena in the banking industry.
The development of information and communication technology (ICT) brought about innovation in the financial sector. By the late 1970s, many sets of restrictions put on the banks were inconsistent with the innovations brought by the development of ICT in the banking industry. So, the deregulatory framework was introduced in many countries in the early 1980s. In many countries, the government opened the banking industry to private and foreign investors also. Government in many countries liberalized the entry, branching, product, and pricing of products and services of banks. In the U.S.A, the Depository Institutions Deregulation and Monetary Control Act were passed in 1980. This act deregulated many aspects of banks in the U.S.A. This act eliminated the interest ceiling on time and saving deposit accounts and lifted the restriction on paying the explicit interest on transaction accounts. Many banking services such as offering interest-bearing transactions accounts and granting consumer loans services were under the scope of the commercial banks. This act also opened these services to other depository institutions and brought about a competitive environment in the banking industry.
In Nepal, the then His Majesty’s Government amended the Commercial Bank Act, 1974, and opened the banking sector to foreign banks with a view to promoting competition, encourage innovations and expand services to the general public. The pricing policy of banking products was also liberalized. It became more liberal in the expansion of branches; banks were allowed to open branches on their own on the basis of the financial sustainability of branches. After liberalization and deregulation of the banking industry, banks turned into department stores of financial products in Nepal.
In the process of liberalizing the banking and services, the government enacted the Finance Company Act, 1985 Development Bank Act, 1996, and allowed finance companies and development banks to offer a wide range of banking services. Further, it also amended Agricultural Development Bank Act, 1967, brought the new Nepal Industrial Development Corporation Act, 1990, and allowed them to offer commercial banking services. But in 2006, the Parliament of Nepal unified all these Acts and enacted the Banks and Financial Institutions Act 2006 (BAFIA) to regulate and operate the banks and financial institutions and repelled the Commercial Bank Act, 1974, the Agricultural Development Bank Act, 1967, the Finance Company Act, 1985, the Nepal Industrial Development Corporation Act, 1990 and the Development Bank Act, 1996.
The number of banks and financial institutions grew rapidly after the liberalization and deregulation of financial sectors. It promoted competition in the markets, but at the time, brewed unfair practices among the banks and financial institutions. To curb these unhealthy practices and gain public confidence in the banking and financial system of the country, Nepal Government brought the Banks and Financial Institutions Act, 2016. The Act is expected to promote and protect the interest of depositors, bring about healthy competition among banks and other financial institutions and provide reliable and qualitative services, and maintain financial stability in the country.