This article was originally published in www.nepallivetoday.com on April 19, 2023 by Nabin Kafle. Mr. Kafle is a researcher at Samriddhi Foundation, an economic policy think tank based in Kathmandu. The views expressed in this article are the author’s own and do not represent the views of the organization. Author can be reached at [email protected]
Non-Performing Loans (NPL) have been one of the key factors along with other macroeconomic indicators of the countries in a banking crisis. According to research carried out in various regions by the International Monetary Fund (IMF), the signs of a banking crisis become stronger as the NPL ratios (ratio of NPL to total loans) start to surpass the threshold of seven percent. Since the loan loss provision to cover losses due to NPLs reduces the capital to provide subsequent loans, NPLs negatively impact a Bank’s profitability and sustainability. A significant amount of NPL over a period of time also indicates a riskier portfolio of assets of the BFIs that limits liquidity and growth. Doubtful of the current status of NPLs of the banks in Nepal, an international audit is to be carried out by the IMF. Does the audit hint at a crisis in Nepal?
Nepal Rastra Bank’s (NRB) rules stipulate that loans whose scheduled payment has not been received for three months or more be treated as Non-Performing Loans (NPL). In order to minimize the risk associated with every loan, NRB has instructed the BFIs to set aside a loan loss provision based on the non-performing asset quality. After Covid, NRB changed the provision amount for ‘Pass’ loans or performing one from one to 1.3 percent, keeping provisions for other loans unchanged. The provision amount for other categories such as ‘Watchlist’ loans, ‘Sub-standard’ loans, ‘Doubtful’ loans, and ‘Loss’ loans stands at five, 25, 50, and 100 percent, respectively. The latter three fall under the NPL category. These categories of loans are based on the duration of delay in debt servicing. According to new requirements, a lender has to classify loans that have not been serviced for three months as ‘pass’ loans. ‘Watch List’ includes loans that have not been serviced for three months. But ‘Watch List’ also includes loans whose principal and interest have not been paid within the repayment period. Non-performing loans not serviced for three to six months will have to be classified as ‘Sub-standard’ loans. Similarly, loans not serviced for six months to one year will have to be classified as ‘Doubtful’ loans. The ‘Loss’ loans are those whose interest and/or installment of principle has not been paid for more than one year.
(Source: Nepal Rastra Bank)
According to the annual reports for commercial banks published by the NRB, the NPL ratios for state-owned banks (Agriculture Development Bank Ltd, Nepal Bank Ltd and Rastriya Banijya Bank Ltd combined) are comparatively higher than that of privately-owned banks. NPL ratios for the state-owned banks have gradually decreased from 8.31 percent in the fiscal year 2010/11 to a mere 1.86 percent in 2021/22 mid-July. We can clearly see that NPL ratios for the state-owned banks were resolved gradually after the fiscal year 2010/11. The NPL ratios for privately owned banks have ranged between one and 2.5 percent over the years. Total annual NPL amount for the privately-owned banks has increased gradually until fiscal year 2016/17. From then on, it has sharply increased from NPR 16.85 billion to NPR 40.33 billion in 2020/21, which is almost a 150 percent increase in four years. On the other hand, the total annual NPL amount for the state-owned bank remains consistent over the years. This must be the scenario brought up by the credit growth that started a few years back because of the relaxed policies on lending. Most commercial banks are invested to limits on real estate loans and recent changes in the land use act has halted the transaction of land. These shocks in the real estate market are expected to be vulnerable to the NPL. But surprisingly, the NPL ratios for individual commercial banks as reported by NRB seem well below the risk threshold.
As of February 28, 2023, IMF staff and the Nepal authorities have reached a staff-level agreement on the policies needed to complete the combined first and second reviews of the extended credit facility (ECF) arrangement for the economic recovery due to the pandemic and external shocks as of present. Nepal would have access to about US$52 million of the total in financing once the review is formally approved by the Executive Board. The IMF is concerned about the deteriorating bank asset quality in Nepal with a recent decline in borrowers’ capacity to repay debt as a result of higher lending rates. Despite the overall weaker macroeconomic scenario, the NPL ratio of banks and financial institutions remains comfortable on paper. However, the article IV mission of the IMF has set the conditions that an audit of 10 large commercial banks through an international auditing firm is mandatory for approval of the ECF facilities. As per the IMF, this audit is aimed to verify the true picture of the financial health of the banks in Nepal.
There has been extensive research on behalf of the IMF on the dynamics of NPL during various banking crises around the world. According to these working papers, NPL ratios during the crises have almost doubled in most cases and recovery has been justified based on pre-crisis status of macroeconomic determinants. On an average the time to peak for the NPL has been three years whereas the post-crisis recovery period has been seven years. If we are to relate to the findings of the paper and if Nepal faces a banking crisis, we might fall in the category of delayed recovery because of the higher government debt and credit growth at the moment.
To put it in a nutshell, apart from the audit, Nepal Rastra Bank always needs to ensure appropriate reclassification of loans and close monitoring of the impact of a potential deterioration in repayment capacity of borrowers. Also, Monetary Policy should focus on maintaining a cautious and data-driven approach to prevent large boom-bust credit cycles that can create financial sector instability and hinder sustainable growth.