Polycentric Governance for Nepal’s Banks: Lessons from Hierarchical Models

Abstract

Nepal’s banking industry plays a vital role in supporting its developing economy. For years, it’s been run through a centralized system led by the Nepal Rastra Bank (NRB), which oversees regulations, monitoring, and monetary strategies. This approach has had some real wins, like ensuring stability with tough inspections, requiring at least 11% total capital and following Basel III guidelines for managing risks. As of 2025, there are 20 commercial banks operating, adding roughly 5-6% to the nation’s GDP and helping achieve financial access for adults, estimated around 61% based on recent surveys. Recent policies have pushed for more digital tools and recovery efforts after the pandemic (Nepal Rastra Bank, 2022).

This centralized setup has shown some serious cracks, such as common insider misconduct, lack of clear reporting, shaky internal checks, poor board effectiveness, and often combining the roles of chairperson and CEO, which sparks conflicts and erodes confidence (Bhatta, 2023; Ghimire, 2023). Take the 2023 cooperative meltdown, for example—it revealed how lax oversight let poor management and scams spread, causing embezzlement of around Rs. 87 billion across about 40 cooperatives, hurting depositors and sparking demands for official probes. These problems get worse with Nepal’s move to federalism back in 2015, dividing power among seven provinces and 753 local bodies, but keeping banking mostly under central control, which doesn’t match local economic differences or credit demands (World Bank, 2024).

Learning from these issues, this paper pushes for a shift to polycentric governance. In this model, various interconnected groups, like the NRB, regional regulators, independent bank directors, local cooperatives, and private players—team up to build a more robust, efficient, and flexible system (Ostrom, 2010). Drawing from Elinor Ostrom’s ideas on handling shared resources, polycentric setups encourage self-management and healthy competition among participants (Ostrom, 1990). History shows this worked in places like Scotland and Canada during their free banking periods, where banks formed voluntary networks to handle crises and keep things stable without a single dominant authority (Hendrickson et al., 2017; Boettke & Coyne, 2016). In Nepal, similar ideas have succeeded in other areas, such as coordinating relief after the 2015 earthquake, where local, provincial, and national teams worked together for better results than a strictly top-down effort (Poudel, 2023). It’s also helped with renewable energy initiatives, where community groups and businesses have boosted access in remote spots like Karnali Province (Bushley, 2014).

By pulling together insights from various studies, this work explores how polycentric methods can fix the flaws in centralized systems by sharing information, aligning motivations, and allowing quick adaptations to challenges like recessions or disasters (Cole & McGinnis, 2014). It covers potential hurdles, such as coordination snags or skill shortages at lower levels, and suggests layered structures where the NRB still handles big-picture stability. The upsides include steadier overall economy, fewer widespread risks, and better access to finance in rural areas. This paper offers practical steps for testing polycentric ideas, stressing the need for real-world assessments to shape a more responsive banking framework amid Nepal’s federal changes.

Keywords: polycentric governance, hierarchical models, Nepal banking sector, corporate governance, financial stability, federalism.

Introduction

Managing financial institutions well is crucial for steady growth and fairness in countries like Nepal, where banks are essential for distributing funds, reducing poverty, and fostering long-term progress. The Nepal Rastra Bank (NRB), set up in 1956, has been the backbone of Nepal’s centralized banking oversight, controlling everything from monetary decisions to rules and checks (Nepal Rastra Bank, 2020). Reforms in the 1980s and 1990s shifted things from government-heavy control to a more open market with private involvement, leading to 20 commercial banks, 17 development banks, and many microfinance outfits by 2025. This expansion has boosted access to finance for around 61% of adults, contributed around 5-6% to GDP, and managed remittances topping Rs. 1.7 trillion yearly (about $12.8 billion), which are key for family spending and investments. The NRB’s top-down style enforces consistent rules, including Basel III standards for capital, liquidity, and buffers against downturns, keeping bad loans around 4-6% and supporting rebound from events like COVID-19. In 2025, the monetary policy highlights flexible lending caps (up to NPR 250 million for loans backed by shares) and a new Digital Finance Innovation Hub to modernize amid expected GDP growth of about 4.6%.

However, this centralized method has some major downsides. Governance problems, like heavy control by founding owners, limited board independence, and dual chairperson-CEO positions, have led to insider deals and interest clashes (Gautam, 2021; Thapa, 2024). For example, recent issues at banks like Nepal Bank have highlighted missing funds worth billions, damaging trust and requiring central fixes. More broadly, the 2023 cooperative troubles exposed oversight gaps, with dozens of groups failing due to mismanagement, impacting thousands of savers and leading to estimated losses of around Rs. 87 billion. Reporting shortfalls and weak audits add to the dangers, especially with inflation around 2-4% and varying remittances in 2025. The 2015 federal setup created tiers at federal, provincial, and local levels with shared finances, but banking’s central focus creates mismatches, for instance, one-size-fits-all credit rules overlook farming needs in Province 2 or tourism boosts in Bagmati, fueling uneven progress and local strains (World Bank, 2024).

These challenges point to the need for fresh ideas. Centralized rigidity blocks local tweaks, creating info gaps and mismatched incentives (Liberti & Mian, 2019). Polycentric governance offers a promising path, with multiple linked authorities organizing themselves to tackle shared problems (Ostrom, 2010). Ostrom’s guidelines, including nested layers and scaled penalties, have worked in global banking like Australia’s community finance groups and in Nepal’s crisis responses (Cole & McGinnis, 2014; Poudel, 2023). After the 2015 quake, mixed-level teamwork among locals, NGOs, and officials sped up rebuilding in districts like Gorkha (Poudel, 2023). Applying this to banking could let provinces customize rules, tying into 2025 strategies for economic shifts from groups like the ADB (World Bank, 2024).

This paper aims to unpack lessons from centralized systems, outline polycentric options with real-world examples, and suggest blended approaches for Nepal. By blending research and cases, it seeks to guide leaders toward tougher financial management.

Theoretical Framework

Polycentric governance, developed by Vincent and Elinor Ostrom, features independent yet connected decision hubs linked by common guidelines and mutual oversight (Ostrom, 2010). Unlike top-heavy systems that bottleneck info and flexibility, this spreads power (Cole & McGinnis, 2014). Ostrom’s eight core principles offer a roadmap: defined roles, balanced costs and benefits, group rule-making, shared monitoring, tiered consequences, easy dispute fixes, self-organizing freedoms, and multi-level nesting (Ostrom, 1990). For banking, it views the sector as a shared asset where threats like cash shortages demand joint handling to avoid overuse, such as reckless lending (Salter, 2021).

Real history backs this up. In 18th-19th century Scotland, banks created optional alliances for reserve checks and crisis aid, leading to fewer collapses than England’s single-center model (Hendrickson et al., 2017). Canada’s pre-1935 setup with widespread branches and pacts also promoted balance (Boettke & Coyne, 2016). These handled scattered risk knowledge and bailout temptations better than rigid hierarchies (Liberti & Mian, 2019). In Nepal, it matches the federal structure, allowing stacked layers: NRB for nationwide norms, provinces for area-specific watches, and communities for grassroots finance (World Bank, 2024).

Literature Review

Centralized Governance in Nepal’s Banks

Nepal’s banking relies on NRB’s top-down control for monitoring and policies (Nepal Rastra Bank, 2020). Research highlights shortcomings in board setups and risk handling (Bhatta, 2023; Ghimire, 2023). A 2024 NRB update noted many banks lag on best practices, lacking solid policies (Nepal Rastra Bank, 2024). The cooperative fallout shows how weak checks fueled fraud (Adhikari, 2023). Federal changes make these rigidities even tougher (World Bank, 2024).

Worldwide Centralized Shortcomings and Takeaways

Around the globe, centralized banking leads to slowdowns, as seen in the 2008 meltdown where regulators overlooked dangers (Liberti & Mian, 2019). In Nepal, similar owner dominance threatens steadiness (Gautam, 2021; Upreti, 2025).

Polycentric Governance: Ideas and Uses

Polycentrism means layered authorities working together (Ostrom, 2010). In finance, open systems like Scotland’s proved tough (Hendrickson et al., 2017). In Nepal, post-quake disaster handling used multi-tier collaboration (Poudel, 2023). REDD+ and energy projects highlight advantages (Bushley, 2014). Internationally, Caribbean seaweed management shows multi-group wins (Poudel, 2023).

Method

This is a qualitative study blending ideas from secondary materials, like NRB documents and scholarly works (Nepal Rastra Bank, 2022; Koirala, 2023). It links centralized flaws to polycentric fixes through case comparisons. Drawbacks include the need for hands-on data checks later.

Discussion: Insights from Centralized Approaches and Polycentric Options

Centralized governance provides basic security but struggles with inflexibility. Key takeaways involve bolstering boards to curb misuse, as in the cooperative troubles (Adhikari, 2023). Polycentric styles decentralize power, sparking creativity (Ostrom, 2010).

Key Insights from Centralized Flaws

In Nepal, the 2023 crisis underlined monitoring lapses (Adhikari, 2023). Similar global patterns appear in 2008 breakdowns (Liberti & Mian, 2019).

Polycentric Options with Cases

Scotland’s network curbed panics (Hendrickson et al., 2017). In Nepal, quake recovery polycentrism rebuilt communities quicker (Poudel, 2023). Energy efforts in Nepal and Indonesia demonstrate decentralized perks (Bushley, 2014).

Rollout Challenges and Fixes

Issues like teamwork hurdles can be tackled with training (Cole & McGinnis, 2014). Try pilot local committees, weaving in 2025 green bonds (Timilsina, 2025).

Aspect	Centralized Challenges	Polycentric Options
Decision-Making	Slow central processes (e.g., NRB delays in cooperative issues) (Adhikari, 2023)	Local adjustments (e.g., community aid in disasters) (Poudel, 2023)
Transparency	Reporting shortfalls (e.g., insider deal scandals) (Shrestha, 2024)	Reporting shortfalls (e.g., insider deal scandals) (Shrestha, 2024)
Risk Management	Blanket rules miss local needs (e.g., rural lending gaps) (Gautam, 2021)	Customized handling (e.g., province energy schemes) (Bushley, 2014)
Accountability	Overlapping roles (e.g., chairperson-CEO clashes) (Bhatta, 2023)	Separate balances (e.g., bank networks in Scotland) (Hendrickson et al., 2017)
Resilience	Broad weaknesses (e.g., 2008-like global risks) (Liberti & Mian, 2019)	Broad weaknesses (e.g., 2008-like global risks) (Liberti & Mian, 2019)
Innovation	Stiff limits (e.g., delayed tech uptake) (Nepal Rastra Bank, 2022)	Independent drives (e.g., 2025 digital pilots) (Nepal Rastra Bank, 2024)

Ostrom’s Principles Applied to Banking

Principle	How It Applies	Example in Nepal
Clear Boundaries	Set roles clearly	Province banking zones (World Bank, 2024)
Proportional Costs	Even incentives	Shares for stakeholders in green bonds (Timilsina, 2025)
Collective Choice	Rules with input from all	Local say in cooperatives (Adhikari, 2023)
Monitoring	Reviews by peers	Nonprofit audits in relief funds (Poudel, 2023)
Sanctions	Step-by-step penalties	Step-by-step penalties
Conflict Resolution	Simple mediation	Simple mediation
Self-Organization	Freedom to act	Community energy projects (Bushley, 2014)
Nested Enterprises	Levels that overlap	NRB and province links (Nepal Rastra Bank, 2022)

Conclusion

Moving to polycentric governance could transform Nepal’s banks, overcoming centralized weaknesses with more adaptable setups (Ostrom, 2010). Suggestions include starting small trials, building skills, and using data to evaluate (Cole & McGinnis, 2014). This aligns with 2025 trends for greener, lasting expansion (Nepal Rastra Bank, 2024).

References

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