The latest central bank provision that makes it mandatory to set aside additional funds to cover potential lending risks may prompt banks and financial institutions to exert undue pressure on the private sector for credit repayments.
Such a scenario, bankers say, may further dampen the business sentiment, precipitating a decline in private sector investment, which may have a knock-on effect on the economy.
On March 13, Nepal Rastra Bank toughened its regulation on loan-loss provision, making it mandatory for banks and financial institutions to set aside five per cent of the total loan amount even if borrowers are making timely principal and interest payments.
The amount that has to be set aside is in addition to provisioning of up to 100 per cent that banks and financial institutions have to make based on the quality of loans.
Banking institutions worldwide have to set aside funds to cover lending risks. This is done to prevent banking institutions from collapsing in the event of huge loan defaults, which could destabilise the entire financial system.
Here in Nepal, banks and financial institutions have to provision one per cent of the total loan amount soon after issuing a credit. In other words, one rupee has to be booked as loss in profit-loss statement right after loan of every Rs 100 is extended. In this manner, provisioning amount goes up to 100 per cent of the loan if the borrower fails to pay instalments for over a year.
Many domestic bankers call the new regulatory provisioning requirements ‘stringent’. This is because banking institutions in neighbouring India, for instance, have to make 100 per cent provisioning only if loans are classified as ‘doubtful’ for over three years.
“We are, therefore, beginning to feel that the directive was introduced without conducting proper studies,” President of Nepal Bankers’ Association Upendra Poudyal told The Himalayan Times.
One of the conditions in the latest central bank directive — introduced six days before formal retirement of immediate past governor Yubaraj Khatiwada — is banking institutions have to set aside five per cent of the total loan amount even if borrowers miss the loan repayment deadline by a day.
Also, five per cent of the loan amount has to be provisioned if the borrower has maintained negative working capital, cash flow or networth for two consecutive years. This means banking institutions are not exempt from setting aside funds even if principal and interest payments are being made on time.
Surprisingly, banking institutions have also been told to make similar provisions if borrowers fail to clear payments of domestic raw material suppliers or if renewal process of loans, such as working capital, is delayed.
The central bank has said these measures were introduced ‘to enhance shock absorbing capacity of banking institutions’.
“This will ultimately protect interest of depositors, who have parked hard-earned money at banks and financial institutions, and prevent risks from building up in the banking system,” NRB Spokesperson Min Bahadur Shrestha said.
Bankers say the concerns of the central bank are genuine.
“But the directive has to be practical as well,” said Poudyal, who is also the CEO of NMB Bank, questioning, “How can the central bank expect us to provision five per cent of loan amount if repayments are delayed even by a day?”
The central bank, Poudyal said, should have realised payments sometimes could not be made on time because of unavoidable circumstances, like delay in delivery of cheques. “Besides, it is a normal practice here to extend a timeframe of 35 days to comply with rules.”
If such conditions, according to bankers, are to be followed profit of banks and financial institutions, which stood at over Rs 30 billion in the last fiscal year, may take a hit this fiscal.
It is not exactly known how bad the directive — introduced after eight months into the current fiscal year — would hit the balance sheets of banking institutions this fiscal. But bankers say net profit may fall by around Rs 100 million — at mid-sized commercial banks like NMB — to Rs 1 billion at bigger institutions.
If net earnings slump in this manner, share prices of banking institutions may drop, sending jitters across the secondary market, as commercial banks, development banks and finance companies make up 65 per cent of the stock market capitalisation.But the central bank does not want to buy this argument.
“Banking institutions will not face problems if they make realistic repayment schedules based on cash flow of borrowers,” Shrestha said.
What Shrestha is saying may be true. “But what is also true is that the latest directive is not investor friendly,” Citizens Bank International CEO Rajan Singh Bhandari said.
For instance, why should provisions be made for loans acquired by firms with negative working capital, cash flow or networth, Bhandari questioned.
It is known that many private firms here make deliberate efforts to show losses in balance sheets to evade taxes. Nonetheless, there are genuine reasons for not being able to maintain a healthy balance sheet.
For instance, firms engaged in production of steel, cement or electricity may not be able to produce healthy balance sheets in the initial days because of long gestation period. Also, firms, which have accumulated losses in the past due to fragile political and economic conditions, may not be able to produce a sound balance sheet at present. Yet they may be on the track to mending their books.
“Considering these circumstances, banking institutions will have to harass borrowers — even those facing genuine problems — to make loan repayments right on time or raise interest rates on credit that they have obtained. This will eventually discourage people from engaging in the productive sector,” Bhandari said.
Such a situation could have severe repercussions on the country, which is aspiring to gain competitive edge in production of commodities like cement and electricity and gradually substitute imports to bridge the bulging trade gap which stood at a whopping Rs 394.58 billion in the first seven months of the current fiscal year.
“Our intention is not to create panic in the banking sector or destabilise the economy. And we are ready to revise the directive, if institutions cannot meet some of the conditions,” Shrestha said.