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Chapter 3: Bank, Insurance, and Financial Institutions

3.1 Concept and Types of Banks in Nepal

A Bank is a financial institution established under prevailing law that accepts deposits from the general public (paying interest) and grants loans/advances to individuals, businesses, and productive sectors (charging interest), while performing agency, remittance, and utility services.

  • Historical Milestone: Nepal Bank Limited, established on 1994 Kartik 30 B.S. (1937 November 15 A.D.), is the first bank of Nepal.

Classification of Banks in Nepal under BAFIA, 2073

Under the Bank and Financial Institution Act (BAFIA), 2073, Nepal Rastra Bank (NRB) classifies banks and financial institutions into the Central Bank plus four licensed classes (Class A, B, C, and D) and Infrastructure Development Bank:

Institution CategoryRole and Key Examples in Nepal
1. Central BankNepal Rastra Bank (NRB), established on 2013 Baishakh 14 B.S. (1956 April 26 A.D.) under the Nepal Rastra Bank Act, 2012 (now governed by NRB Act, 2058). Supreme monetary and regulatory authority of Nepal.
2. Class ‘A’: Commercial BanksPerform full-scale commercial banking, foreign exchange, letters of credit (LC), deposits, and corporate lending. Examples: Nepal Bank Ltd., Rastriya Banijya Bank, Agriculture Development Bank, Nabil Bank, Global IME Bank.
3. Class ‘B’: Development BanksMobilize savings and provide medium/long-term credit for industrial, agricultural, and infrastructural development. Examples: Muktinath Bikas Bank, Garima Bikas Bank, Mahalaxmi Bikas Bank.
4. Class ‘C’: Finance CompaniesMobilize deposits and provide hire-purchase, housing, and consumer loans. Examples: ICFC Finance, Goodwill Finance, Manjushree Finance.
5. Class ‘D’: Microfinance Financial InstitutionsProvide collateral-free micro-credit, group savings, and self-employment loans to low-income and rural households. Examples: Chhimek Laghubitta, Sana Kisan Bikas Laghubitta, Nirdhan Utthan Laghubitta.

3.2 Functions of Central Bank — Nepal Rastra Bank

The major functions of the Central Bank are:

  1. Monopoly of Note and Coin Issue: Issues Nepalese currency notes and coins keeping minimum 100% proportional reserves of gold, silver, foreign exchange, and government securities.
  2. Banker, Advisor, and Financial Agent to the Government: Maintains government treasury accounts (TSA), manages public debt/treasury bills, and advises the Ministry of Finance on economic and fiscal policy.
  3. Banker’s Bank and Lender of Last Resort: Grants licenses to Class A, B, C, and D institutions, holds their Cash Reserve Ratio (CRR), conducts clearinghouse operations, and provides emergency liquidity loans during financial crises.
  4. Formulation and Implementation of Monetary Policy: Formulates the annual Monetary Policy to control inflation, regulate interest rates, and maintain price and balance-of-payments stability.
  5. Control of Credit: Uses quantitative and qualitative tools (Bank Rate, CRR, Statutory Liquidity Ratio - SLR, Open Market Operations) to expand or contract credit supply.
  6. Management and Custody of Foreign Exchange: Determines exchange rates (including the pegged rate with Indian currency and market rates for convertible currencies) and safeguards national foreign exchange reserves.

3.3 Functions of Commercial Banks

  1. Primary Functions:
    • Accepting Deposits: Current/Demand Deposit (no interest, unlimited withdrawals for businesses), Saving Deposit (moderate interest, limited withdrawals), and Fixed/Time Deposit (highest interest rate for a fixed maturity period).
    • Granting Loans and Advances: Overdraft, Cash Credit, Term Loans, Home/Auto/Education Loans, and discounting of bills of exchange against collateral.
  2. Secondary (Agency & Utility) Functions:
    • Remittance and Fund Transfer: Domestic and international transfer via bank draft, SWIFT, and remittance networks.
    • Opening Letters of Credit: Guarantees payment to foreign exporters in international trade.
    • Agency Services: Collection of cheques, dividends, pensions, utility payments, and locker facilities for safe custody of gold/documents.

3.4 Modern Banking Instruments

1. Cheque — Parties, Types, and Rules of Dishonor

A Cheque is an unconditional written order drawn by an account holder directing their bank to pay a specified sum of money on demand to the person named therein or to the bearer.

  • Three Parties to a Cheque:
    1. Drawer: The account holder who writes and signs the cheque.
    2. Drawee: The bank on which the cheque is drawn.
    3. Payee: The person or institution named on the cheque who receives the money.
  • Types of Cheques:
    1. Bearer Cheque: Payable over the counter to anyone who presents it at the bank (“or bearer” is not struck out). Risky if lost.
    2. Order Cheque: Payable only to the named person or someone endorsed by them after verifying identity on the back.
    3. Crossed Cheque: Has two parallel transverse lines drawn on the top-left corner (with or without “A/C Payee Only”). Cannot be encashed over the counter; must be deposited into a bank account—making it the safest cheque.
  • Causes of Dishonor of a Cheque: Insufficient balance in the account, mismatch of drawer’s signature, difference between amount in words and figures, post-dated or stale cheque (older than 6 months), overwriting without signature, or account frozen by court/NRB order.

2. Electronic Cards, Digital Banking, SWIFT, and Remittance

  • ATM / Debit Card vs. Credit Card: A Debit Card allows the account holder to withdraw cash or pay at POS/online using money already available in their bank account, whereas a Credit Card allows the cardholder to borrow funds up to a pre-approved credit limit and repay within a grace period.
  • Mobile & Internet Banking / QR Payment: 24/7 digital banking via smartphones and web portals for fund transfers (ConnectIPS, Fonepay), bill payments, and account statements.
  • SWIFT (Society for Worldwide Interbank Financial Telecommunication): Global secure messaging network using 8- or 11-character SWIFT/BIC codes to execute international wire transfers between banks worldwide.
  • Remittance: Money sent home by migrant workers employed abroad through formal banking or licensed remittance channels, forming a vital source of Nepal’s foreign exchange reserves.

3.5 Insurance: Concept, Principles, and Types

Meaning of Insurance

Insurance is a legal contract between two parties—the Insurer (Insurance Company) and the Insured (Policyholder)—under which the insurer promises to compensate the insured for financial loss caused by an uncertain future event (or pay a fixed sum upon maturity/death) in exchange for a periodic payment called Premium.

  • In Nepal, the insurance sector is regulated by the Nepal Insurance Authority (NIA) under the Insurance Act, 2079 (formerly known as Beema Samiti / Insurance Board).

Fundamental Principles of Insurance

  1. Principle of Utmost Good Faith (Uberrimae Fidei): Both insured and insurer must disclose all material facts truthfully without concealment.
  2. Principle of Insurable Interest: The insured must have a direct financial interest in the life or property insured such that its preservation benefits them and its loss causes financial harm.
  3. Principle of Indemnity: Applicable to Non-Life Insurance (not Life Insurance); the insurer compensates only the actual financial loss suffered (up to the sum insured) so the insured cannot make a profit from a disaster.
  4. Principle of Subrogation: Once the insurer pays full compensation for damaged property, ownership rights over the scrap/salvage or legal claim against a third party pass to the insurer.
  5. Principle of Proximate Cause: The insurer pays compensation only if the immediate, direct cause of loss is an insured peril named in the policy.
  6. Principle of Contribution: If a property is insured with multiple companies, all insurers share the actual loss proportionately.

Types of Insurance

Insurance is divided into Life Insurance, Non-Life (General) Insurance, and Micro-Insurance:

1. Life Insurance2. Non-Life / General Insurance
a. Whole Life Insurance: Premium is paid throughout life (or for a fixed term), and the sum assured plus bonus is paid only to the nominee after the death of the insured.a. Fire Insurance: Covers financial loss to buildings, factories, godowns, and stock caused by accidental fire, lightning, or explosion.
b. Endowment Life Insurance: Most popular policy in Nepal; sum assured + bonus is paid to the insured upon surviving a fixed maturity period (e.g., 15 or 20 years), or to the nominee if death occurs earlier.b. Marine Insurance: Covers Cargo, Hull, and Freight against perils of the sea during import/export transit.
c. Term Life Insurance: Pure risk cover for a short term (e.g., 1–5 years); sum assured is paid only if death occurs within the term; no maturity return if the insured survives.c. Motor / Vehicle Insurance: Covers Third-Party Liability (mandatory by law in Nepal) and Comprehensive vehicle damage/theft.
d. Children’s Education & Marriage Endowment: Taken by parents to fund a child’s higher education or marriage at a specified age.d. Miscellaneous & Micro Insurance: Aviation Insurance, Agriculture/Crop & Livestock Insurance, Medical/Health Insurance, Travel Insurance, Fidelity Guarantee, and Micro-Insurance for low-income citizens.

3.6 Other Financial Institutions in Nepal

  1. Employees Provident Fund (EPF): Established under the Employees Provident Fund Act, 2019 B.S. (1962 A.D.). Deducts 10% of basic salary of government/institutional employees, adds an equal 10% matching contribution from the employer (total 20%), manages social security benefits (medical, accident, maternity, funeral grants), and provides employee loans and infrastructure financing.
  2. Citizen Investment Trust (CIT): Established under the Citizen Investment Trust Act, 2047 B.S. (1991 A.D.). Operates voluntary retirement funds (Employee Growth Retirement Fund, Gratuity Fund, Investor Account Scheme, Citizen Unit Scheme), mobilizes capital market investments, and acts as an issue manager for shares.
  3. Deposit and Credit Guarantee Fund (DCGF): Established in 2031 B.S. (governed by the Deposit and Credit Guarantee Fund Act, 2073). Insures natural persons’ savings and fixed deposits in banks/financial institutions (up to the statutory guarantee limit, Rs. 5,00,000 per depositor per bank) and guarantees microfinance, agricultural, and SME loans.
  4. Financial Cooperatives: Autonomous associations of persons united voluntarily under the Cooperative Act, 2074, operating on the principle of “Each for all and all for each” to mobilize members’ savings and provide productive loans at reasonable interest rates.

3.7 CDC Textbook Exercises & SEE Practice Questions

Group A: Very Short Answer Questions (1 Mark Each)

  1. When was Nepal Rastra Bank established?
  2. Which is the first bank of Nepal and when was it established?
  3. Which regulatory body regulates insurance companies in Nepal?
  4. Write the full form of SWIFT and ATM.
  5. What percentage of basic salary is deducted for the Employees Provident Fund (EPF)?

Group B: Short Answer Questions (5 Marks Each)

  1. Explain any five major functions of the Central Bank (Nepal Rastra Bank).
  2. What is a cheque? Explain the three types of cheques used in banking transactions.
  3. Differentiate between Life Insurance and Non-Life (General) Insurance in five points.
  4. Introduce Employees Provident Fund (EPF) and Citizen Investment Trust (CIT) and state their major functions.

Worked answers to these exercises are in Chapter 3 Solutions.