Saturday, August 30, 2014

Financial stability in Nepal – 2014 v.1

The Nepal Rastra Bank (NRB) biannually publishes financial stability report (FSR), which comes out with a lag of about six months. The latest FSR reports developments up to mid-January 2014.

Below are key highlights of the report.

Financial system:

  • The financial system in Nepal consists of banking and non-banking systems. Banking system includes commercial banks, development banks, finance companies, and micro-finance financial institutions, and NRB permitted cooperatives and FINGOs. Non-banking system includes CIT, EPF, postal saving bank, insurance companies, cooperatives, Nepse, and merchant banking institutions.
  • These together total 285 BFIs and other financial institutions. BFIs total 211 and represent 88.7% of total assets and liabilities.
  • Total assets and liabilities of NBL, RBB and ADB— the three state-owned commercial banks— are equivalent to 15.9% of GDP. They serve 26% of total deposit account holders and 44% of total borrowers. Their combined branch network cover 33.9% of total commercial bank branches. However, they just have 80 ATMs.


  • Excess liquidity due to a surge in remittance inflows and the sluggish growth in private sector credit. It suggests a general lack of favorable investment climate.
  • Excess liquidity adding costs as banks have to pay interest on deposits, and hence are disinclined to lower lending interest rates.
  • Liquid assets to deposit ratio is higher than the regulatory requirement.
  • Repeated OMO through reverse repos and outright sale auction to mop-up excess liquidity not effective to resolve the issue beyond the short-term.
  • All BFIs restricted from accepting institutional deposit over 60% of their total deposit.
  • Prompt Corrective Action (PCA) now based on capital adequacy and liquidity situation. Liquidity Monitoring and Forecasting Framework (LMFF) covers class A, B, and C BFIs.

Non-performing loan (NPL):

  • Overall, NPL level is about 4.3%, but there are significant variations within BFIs. Total NPL of commercial banks and development banks stood at 2.6% and 4.6%, respectively by mid-July 2013. NPL of finance companies stood at 15.7%.
  • Real estate concentration is still high even though it is coming down as old real estate investments are gradually maturing. Residential housing loan is expanding.
  • 44.5% of total loan is backed by actual real estate.

Capital adequacy ratio (CAR):

  • Regulatory CAR for commercial banks, development banks and finance companies is 11%, 10% and 10%, respectively.
  • Regulatory requirement of paid-up capital is NRs2 billion, NRs640 million and NRs200 million for commercial banks, development banks and finance companies, respectively.
  • CAR of commercial bank stands around 11.3%. CAR of development banks and finance companies stand at 15.4% and 15.9%, respectively. It suggests that these are well capitalized.
  • Commercial banks and development banks are reporting under Basel II framework. Finance companies are following Base I format for reporting.

Financial stability:

  • BFIs are not adequately capitalized to absorb the shocks— hold higher percentage of deposits on their total liabilities portfolio.
  • Low business volume, rising funding costs, increased regulatory costs of higher capital requirements and liquidity buffers have become normal features.
  • Paid-up capital and total capital increased due to mergers, IPO issuance by new banks, and further increment in paid-up capital by banks.
  • As a share of GDP, total deposit and total credit have expanded. So has total credit to total deposit ratio, but this is still below the regulatory requirement, suggesting more room for BFIs to extend further credit for economic activities. But, credit to deposit ratio of B and C class institutions in totality exceeds the regulatory provision.
  • 22 commercial banks remain vulnerable in case of deposit withdrawal by 15% and more. Overall vulnerability test suggests that commercial banks are in less vulnerable position than other types of BFIs.
  • Only foreign banks and financial institutions can invest in shares of Nepalese banking sector. Foreign non-BFIs have to sell shares to Nepalese citizen or institution by mid-July 2015.


  • Lack of sound corporate governance practices, strong interconnectedness among financial institutions and promoters
  • Poor assessment of risks (credit, liquidity, foreign exchange and operation)
  • Growing risk from shadow banking activities.
  • BFIs failing to establish a sound link between risk management, capital structure and lending.
  • Lack of professional management, increasing unproductive assets, loan recovery problems, discouraging pay incentives, unsustainable profit targets, inadequate risk management practices, etc.
  • Sound regulatory and supervisory authority needed to control malpractices of cooperatives.
  • Stress testing mandatory for class A, B and C BFIs. It has to be reported back to the NRB.
  • BFIs need to audit their information system and submit audit report by January 2015.
  • No concrete provision to address interconnectedness so far. Interconnectedness occurring through inter-bank deposits and lending, investment by single promoter in more than one BFI, private placements, consortium lending, investment in government bonds, debentures, national certificate of savings, national debentures, etc.

Consolidation of BFIs:

  • Small and financially poor BFIs merging with stronger ones.
  • Moratorium on licensing of new Class A, B and C BFIs.
  • Merger promoted to lower operating costs, bring about economies of scale, and diversify market share. Following the merger bylaws, 55 financial institutions have merged with each other and formed 23 institutions.

Interest rates:

  • BFIs need to bring interest spread rate to 5% by FY2014. Base rate need to be reported by class A, B and C BFIs.
  • Inflation is eating up, on an average, 4% return on deposits, i.e. real interest rates have fallen.
  • The repo rate, 91-day T-bill rate, and inter-bank rate— important measure of short-term money market rate and indicate liquidity situation— remained low.