Despite the efforts made by the government of Nepal to improve the business environment, promote and attract foreign investment, it has been placed on the negative list (grey list) of the Financial Action Task Force (FATF), an international organization that monitors money laundering. It indicates that there are some weaknesses in the investors, banks and financial institutions and the financial system of Nepal. This is likely to lead to decline in domestic, foreign investment and trade.

Professors Daron Acemo Glue, Simon Johnson and James Robinson received the Nobel Prize in 2024 for their significant work on the role of institutions in economic prosperity. Financially competent institutions play an important role in economic growth by instilling confidence in the market through ensuring a stable environment for investment, effective promotion of capital and access to finance. However, confidence in Nepal's financial and banking sector is currently the lowest in history.

Nepal was placed on the gray list by FATF in February 2025, showing weakness in Anti-Money Laundering (AML) and Counter-Terrorism Financing (CFT) standards. The FATF is an independent intergovernmental body that develops and promotes policies to protect the global financial system and monitors global money laundering.

Nepal has been placed on the gray list due to lax regulation of the sector including cooperatives, inadequate implementation of the AML/CFT legal system, lack of effective monitoring of financial transactions related to corruption, tax evasion and illegal money movement. 

With the new declaration of FATF, Nepal has been placed under more stringent monitoring and regulation. Any country placed on this list is given a two-year time frame to implement legal reforms, implement them and take steps against illegal money and money laundering to withdraw from the list. 

Earlier, Nepal was on FATF's 'grey list' from 2008 to 2014. It seems that Nepal needs to improve its financial sector within two years to get out of the 'grey list'. Otherwise, FATF may blacklist Nepal and if that happens, Nepal will have to face more international pressure and sanctions. Nepal has not fully complied with some of the FATF standards. Nepal's inclusion in the gray list is due to its failure to fully implement the necessary legal, policy and structural reforms to combat money laundering and financing of terrorism. According to FATF, it was initially given a deadline of July 2023 and again extended to October 2024 to bring Nepal out of the gray list.

Finance Minister Bishnu Paudel said in the meeting of the House of Representatives that the Nepal government will prepare a white paper to remove the country from the gray list and take all necessary steps to create an environment of trust in the financial and banking system.  Only through

legal measures and policy pronouncements, but effective enforcement of laws and courts free from politicization, can private businesses expect a fair hearing. Whatever laws are made, if they are applied differently to different people, we cannot build the strong institutions needed for strong economic growth.

Excessive debt, loose standards

During the time of Covid-19, Nepal had to face excessive lending (credit boom). By the end of 2021, credit growth has reached 30 percent. The ratio of credit growth to gross domestic product (GDP) was very high. The ratio to GDP in 2022 was 102.3 percent, higher than South Asian and other low-income countries.

Rapid credit expansion poses a policy dilemma. It was expected that investment and economic growth would also increase as access to finance would increase due to more credit. When credit expansion is excessive, its credit standards can lead to over-indebtedness and vulnerability to asset price increases. Professor Carmen Rinehart and Professor Kenneth Rosoff have linked aggressive credit expansion to the financial crisis. Excessive credit expansion is likely to cause financial crisis.

High credit expansion cannot sustain sustainable economic growth. My former professors, Ugo Panizza and Jean-Louis Arcande, in a report from the Graduate Institute for International and Development Studies in Geneva, Switzerland, showed that increasing financial depth when credit to the private sector ranges from 80 to 100 percent of GDP leads to negative output growth limits. The total debt of Nepal from 2019 to 5 years is more than the size of the GDP at that time. 

Financialization is a situation in which financial markets and institutions (ie, workers, entrepreneurs, and businessmen) play an increasing role in the operation of the real economy. Out of 272 companies listed on Nepal Stock Exchange (NEPSE), 134 are banks and financial institutions, 91 hydropower companies, 22 manufacturing and processing companies and 7 hotels. Banks, financial institutions and insurance companies account for nearly 60 percent of the stock market capitalization. The share of hydropower company is 14.4 percent. The share of manufacturing and processing industries is 7 percent. Financialization can reduce the scope of development of the real economy while finance enables the proper functioning of the real economy. This can create instability and cause major negative shocks to economic output as well as general well-being. 

With the growing size and impact of the financial sector on the real economy come benefits and costs. The private value of the actions performed by the financial sector does not always match the social value and the role of the government is important in reconciling this. Understanding the limits of finance, the actors and institutions that run our financial system, is an important step. 

Renowned economist Hyamin Minsky has shown in his works two possible reasons why large financial systems can have a negative effect on economic growth. First economic instability. This is linked to an increased likelihood of a major financial crash. Professor James Tobin notes that a second negative effect is the potential for misallocation of financial resources. Similarly, Raghuram Rajan, the former Governor of India, presented a very important perspective on the dangers of excessive financial development in the context of the Global Financial Crisis of 2007-09. In Rajan's book 'Fault Lines', he has shown a direct link between excessive credit growth and financial crisis. 

Excessive credit growth does not only lead to financial crisis. It also undermines our values ​​and beliefs. Banks are excited about making and receiving loans. Money is cheaper and surveillance is less. If laws and regulations are not enforced, money laundering is more likely to spread. Corruption, tax evasion and weak legal system are the main causes of money laundering in a country like Nepal. 

Economic reforms such as liberalization and market economies can create opportunities for money laundering when there is much corruption, tax evasion and weak legal systems. High tax rates on business also encourage companies to engage in money laundering. The flow of remittances through informal channels has created an opportunity to increase the practice of money laundering.

central bank independence 

The Governor of Nepal Rastra Bank plays an important role in regulating the banking system and promoting financial stability. Governors, governments and other stakeholders have an important role to play in building trust in the financial sector.

In the current perspective, central bank independence is considered a key factor in good monetary policy practice. The independence of the central bank in formulating economic policy is not often questioned. Even in the United States in 1961, central bank independence was not considered a key factor in sound monetary policy practice. Two prominent economists, James Tobin and Milton Friedman, disagreed on everything else but agreed that the Federal Reserve should not be independent. This thinking changed after Paul Volcker led the Federal Reserve from 1979 to 1987, which was given the freedom to fight inflation. He adopted an aggressive anti-inflationary policy, which led to a deep recession in the US economy. But this event established central bank independence as a good practice. In the 1980s central bank independence was not yet established, with the exception of the Federal Reserve, the Deutsche Bundesbank, and the Swiss National Bank.

A new study by David Romelli attempts to measure the relationship between central bank independence and fiscal outcomes in 155 countries from 1923 to 2023. During this period, Romeli identified a total of 370 improvements in central bank design. Which prominently reveals a global change to increase the independence of monetary authorities. 

This change is particularly important in the context of recent challenges such as the global financial crisis of 2008, the Covid-19 pandemic and the resurgence of inflation in high-income countries after 2021. Which has brought the debate about the role and scope of central banks back into the limelight. 

The lessons from this historical analysis emphasize the point that central bank independence is not just an academic concept but an important component in formulating economic policies. 

In recent years, many central banks have changed their mandates to include government priorities. For example, New Zealand, Hungary, Sri Lanka and Rwanda. Professor Allen Blinder, who teaches at Princeton University in the US, has written an excellent book entitled 'Monetary and Economic History of the United States of America, 1961-2021'. In this book, Professor Blinder discusses the highs and lows of monetary and economic policy in the United States. He has written about the cooperation and confrontation between monetary and economic authorities during several economic recessions and booms. This book provides many useful lessons for economic policy making even for a country like Nepal. 

For example, when the United States economy was on fire after the Kennedy-Johnson tax cuts, President Johnson was advised to raise taxes. He refused to raise taxes. Because, it is often very unpleasant. In fact, the 1960s was the period when Keynesianism began to be associated with hyperinflation (which I believe is wrong). Monetarism had a profound effect on academic and policy circles. At the time, Federal Reserve Chairman William McChesney Martin was at the center of the fight against inflation. He felt that the central bank needed to counter the inflationary flow from tax cuts. President Johnson wanted to fire him but couldn't. 

Clashes between monetary and fiscal policies are common. But interestingly, world experience has turned this confrontation into established knowledge about the importance of central bank independence. According to the World Bank's Enterprise Survey 2023, 41 percent of all enterprises reported political instability as a major obstacle to their growth. What is this political instability? Interestingly, this shows that there is instability in long-term policy. Policy instability has a negative impact on economic growth and job creation. Monetary policy in Nepal is comparatively more stable than fiscal policy. Hence, there is pressure on monetary policy to not only stabilize financial markets, control inflation, maintain a peg with the Indian rupee, but provide a monetary policy that is close to, if not relevant.

When Nepal Rastra Bank abandons its caution and compromises on independence, lending standards may weaken. Therefore, the role of Rashtra Bank is very important. If the government wants to get out of FATF's gray list in the next two years, Nepal Rastra Bank's leadership will be crucial. 

First, the governor must work with the government to pass the necessary laws and regulations. Second, the governor of the National Bank should act carefully in the implementation of these laws. Third, the governor should be able to communicate with international parties such as FATF and the International Monetary Fund about the progress made in creating an environment of confidence in Nepal's banking system. Stair-BREAK Economic Estitutions The Phrye-Break Philippines have been implemented by implementing their AML / CFT legal reforms by the increase of legislative amendments. & nbsp;

was found to the Philippines in a gray list, when the international surveillance organization had identified the government's 18 weaknesses, to resolve the government weaknesses. Weakness involved in the regulation of the Filiphinohar Geming Operator (gambling operator) and weakness in the implementation of financial restrictions and delay in the implementation of anti-2020. The main steps that the Philippines go out of the gray lists are as are as follows: & NBSP;