What's wrong with banks in Nepal

A recent Bank Supervision Report by the Nepal Rastra Bank has shown the numerous challenges plaguing the banking sector in Nepal. The report reveals that banks' carelessness, non-compliance with regulations, and poor risk-management practices could undermine the stability and credibility of the financial system.

One pressing concern is the excessive focus of banks' boards of directors on loan evaluation and approval while devoting little time to assessing risks associated with each loan. This imbalance has led to inadequate evaluation of borrowers' creditworthiness, increasing the risk of loan defaults. The report also raises questions about accountability and leadership within banks, as review processes for decision implementation and CEO performance appraisal are found to be lacking.

Some banks have failed to assign appropriate risk weights to their loan exposures, allowing them to overstate capital adequacy ratios and mislead investors about their true financial health. And few others are facing stress in meeting capital adequacy requirements, particularly Tier 1 capital. Excessive growth in risk assets, soaring non-performing loans, and revised risk weights have intensified the strain. A few are perilously close to the minimum regulatory threshold, while some have breached the minimum Tier 1 capital ratio, restricting them from distributing dividends. This has undercut their ability to withstand financial shocks, too.

Another issue brought to light is the misuse of funds, where loans disbursed by banks are diverted from their intended purposes and classified as pass-category loans --?against the NRB Unified Directives. This misuse includes using new loans to settle existing debts or paying interest at quarter-end. Moreover, banks' monitoring of loan utilization after disbursal is seen to be weak, exacerbating credit risks. This puts the financial health of banks at risk and erodes public confidence in the banking system.

The report also points to gaps in loan assessment practices, which have resulted in over-financing. This poses risks for both banks and borrowers, as excessive debt burdens can make repayments challenging and increase the likelihood of defaults. Banks are found providing personal loans above the specified limit without a specific purpose, too. Furthermore, errors and discrepancies in reporting loan exposures to the NRB raise concerns about data integrity and the accuracy of risk assessments of banks.

More problems abound. Liquidity risks loom large in the banking sector, as the absence of a contingency funding plan leaves banks vulnerable to unforeseen liquidity shocks. And a concentration of deposits from a limited number of depositors makes them exposed to potential liquidity stress from sudden withdrawals.

Operational risks pose yet another threat to the sector, with banks assigning trainee interns to sensitive roles with user access to the core banking system (CBS), a central software platform BFIs use to manage their banking operations, including customer accounts and transactions. Non-compliance is also evident in the opening of remittance fixed deposits without proper documentation to substantiate the source of remittance. Poor record-keeping, improper handling of ATM and PIN numbers, and mismanagement of CCTVs further compromise banks' operational efficiency and security.

As the banking business expands, fraudulent activities involving customers, staff, management, and even board members have become increasingly frequent, with many behind bars and facing trials. Fake collateral, misappropriation of client deposits and vault cash, and bribery are just a few examples of banking fraud.

Addressing these shortcomings requires strengthening their risk management frameworks, improving loan assessment practices, and ensuring compliance with regulatory guidelines. And investment in robust cybersecurity measures and heightened customer awareness will help mitigate technology-related risks. By proactively confronting these, banks can chart a course toward enhanced stability and resilience.