Major financial sector reforms crucial to realising 13th Plan goals

Thukten Zangpo

Sweeping reforms in the financial sector are essential for the country to achieve the ambitious goals of its 13th Plan, say experts.

According to Sonam Lhendup, Economics Officer at the Asian Development Bank (ADB)’s Bhutan Resident Mission, financial deepening is critical to sustaining economic growth, reducing borrowing costs, and unlocking private sector potential.

Financial deepening involves a multifaceted process to enhance the size and complexity of the finance sector and its liquidity, efficiency, and overall volume.

He cautioned that a limited financial depth raises risk premiums and borrowing costs, restricts access to higher-return investments, and undermines countercyclical policies, as budget deficits and increased government borrowings crowd out private sector investment.

Conversely, a deeper financial market fosters stability, provides more affordable financing options, strengthens government funding, and promotes fiscal consolidation by ensuring a sustainable equilibrium between public and private sector investments.

“Bhutan’s financial market deeping has stagnated, evidenced by stagnant private sector credit growth,” Sonam Lhendup said.

Net claims on the private sector have averaged around 60 percent of the country’s gross domestic product between 2016 and 2024, significantly lower than comparable economies like Nepal, which boasts a figure exceeding 80 percent.

At the same time, post-pandemic private credit growth remains highly volatile and is showing signs of slowing. Domestic banks rely heavily on fixed asset-backed loans due to limited capacity for proper appraisal and financing based on cash flow.

“A significant portion of credit is concentrated in the tourism and housing sectors, with housing accounting for 30 percent of all lending, thereby limiting funds for other enterprises and creating a risk of credit concentration,” Sonam Lhendup said.

While the non-performing loan (NPL) ratio declined from 14.6 percent in 2020 to 7.4 percent in 2024, this drop may not reflect actual sectoral health. Much of it, the ADB economist said, is linked to deferred repayments under pandemic-era relief measures that are now nearing expiration.

The ADB also warned that once these relief measures end, it could expose underlying weaknesses in the financial sector.

Bhutan’s financial market development also lacks diversification with banks providing collateral-based loans. Public sector banks dominate the sector, accounting for over 82 percent of the banking system’s credit to the economy, starkly contrasting with the South Asian average of 25 percent.

“This dominance stifles competition and innovation, reduces the efficiency of the banking sector, and hinders both financial deepening and the effective transmission of monetary policy,” Sonam Lhendup said.

Financial sector reforms

The ADB recommends a wide-ranging financial sector reform agenda to reverse these trends.

Key recommendations include strengthening regulatory framework and implementing a risk-based supervisory model, crucial to address existing vulnerabilities.

The ADB recommends reversing pandemic-era relaxations in prudential regulations, increasing risk weights for overexposed sectors like tourism and housing, and prioritising the integrated supervision of financial conglomerates.

In addition, to develop robust financial infrastructure, the ADB suggests establishing effective credit information systems, diverse collateral registries, an accessible insolvency framework for smaller businesses, enhanced inter-agency coordination for crisis management, and a thorough assessment of climate-related risks.

Sonam Lhendup said that the financial institutions should be encouraged to adopt risk-based pricing strategies that assess borrower viability, rather than rely solely on collateral, which would also promote more equitable lending practices.

The ADB also recommends promoting digital finance to enhance payment systems and stimulate innovation in financing.

The Royal Monetary Authority’s establishment of the Fintech Regulatory Sandbox and the development of cybersecurity supervisory practices are positive steps in this direction.

Since implementing this ambitious broad reform plan for financial deepening will take time, the ADB recommends developing a detailed action plan, allocating adequate human resources and funds to conduct appropriate studies, develop the required rules and regulations, and establish procedures for needed supervisory actions.