Effects of Access to Finance on Business Formation in Nepal

Introduction

This paper looks at the role of access to finance in Nepal, as measured by number of bank branches and volumes of MFI loans, in formation of new businesses. It does so using time-series data and hopes to share policy implications that could move the country forward economically. Nepal is a landlocked developing country in South-East Asia that has been struggling to keep up with the development spurts of its prosperous neighbors India and China. Subject to monarchy until 2008 and a devastating civil war, 1996-2006, Nepal has undergone a process of democratization in the past years and is looking to unleash its economic potential.

Closely tied to the British after the Anglo-Nepalese War (1815-16), Nepal may have experienced a form of reversed fortune that is a movement from relative prosperity pre-colonization to relative poverty post-colonization. Acemoglu et. al (2001) investigated this phenomenon and found that populations in India, Southeast Asia and Meso America, amongst others were relatively richer pre-colonization around 1500 and presently are relatively poorer. The key explanation for this reversal of fortune is found in placement of extractive institutions in formerly wealthy areas, such as heavy taxation systems and exploitation of local labor, and placement of commerce and industry friendly institutions that asserted property rights. I argue that present relative poverty may again be reversed with establishment of commerce and industry friendly improved access to finance.

Prior to the design of this paper I interviewed a set of 44 Nirdhan Utthan, one of Nepal’s largest micro finance lenders, clients in the Mugling area and found strong ties between people’s micro finance uptake and business activity. Clients were almost evenly split into groups of livestock farmers, shopkeepers and hotel and restaurant owners.  Loans taken out went almost exclusively into and new existing business ventures, with only a few loans used for coping with shocks and for educational purposes. Returns on investments were almost always sufficient for the repayment process. There was considerable variation in satisfaction with loan size however, with several clients dissatisfied with the upper ceiling of 125,000 rps. This disagreement amongst clients prompted me to look at the quantitative effects of access to finance, both in commercial, “A” class, and micro finance, “D” class lending.

The remainder of this paper is divided into five sections. The Literature Review section provides a brief review of the literature on access to finance. The Data section describes data used and the Model section describes the regression models used to study quantitative effects. The Results section discusses regression results. The last two section share policy implications and conclude.