Nepal Rastra Bank’s regulatory approach raises red flags for economic stability

File image: Nepal Rastra Bank (NRB)
File image: Nepal Rastra Bank (NRB)

Nepal Rastra Bank (NRB), Nepal’s central bank, has negligently failed to implement prudent risk management policies to oversee lending practices by Nepal’s Banks and Financial Institutions (BFIs) including Microfinance Institutions (MFIs). This regulatory gap has allowed excessive borrowing, masked the true risk exposure on loans, and permitted loan concentration among a few large clients. 

Without reform, Nepal Rastra Bank’s inaction threatens the solvency of individual households along with the stability of banks and the overall financial system.  As the severity of the problem grows to a level that is already unstable, the clock is ticking for the country’s central bank authority to come up with a policy implementation plan.

This article aims to provide an overview of the severity of Nepal’s risky debt issues, call out Nepal Rastra Bank’s shortcomings in risk regulations and appeal for more assertive reforms based on hard facts.

The severity of debt trap

Nepal currently faces a severe and growing household debt crisis that Nepal Rastra Bank has miserably failed to address. According to the Nepal Financial Inclusion Report 2023, 38 per cent of Nepali households are now over-indebted and can no longer afford additional borrowing. 

The persistent economic slowdown, two years of Covid pandemic and an exodus of youths afterwards for foreign employment have exacerbated the severity of indebtedness.  Acknowledging the facts, the Monetary Policy Statement of Nepal Rastra Bank states that the private sector credit to GDP ratio is the highest in Nepal compared to the South Asian region. The report explicitly mentioned that Nepali private sector is over-indebted and is contributing to a drastic increase in non-performing loans of the BFIs in recent years. 

Another report by the central bank itself ominously warned that 49 per cent of Nepalis earning less than Rs 25,000 monthly had overdue loans (NRB, 2021), which is making default all but inevitable for nearly half the poorest borrowers. Yet despite these clear red flags signaling an unfolding household debt crisis, Nepal Rastra Bank still refuses to intervene with protective policy action and effective regulations.  This failure to check excessive borrowing is sinking untold families into poverty and hardship from debts they cannot repay.

Allowing debt exposure across multiple lenders

Representational sketch: A bank merger
Representational sketch: A bank merger

Worsening this household debt problem, Nepal’s Financial Stability Report notes banks have “no clear picture of borrowers’ total debt exposure” across different institutions, while a significant percentage of borrowers take multiple loans (NRB, 2022). 

Nepal’s newly established Karja Suchana Kendra (Credit Information Bureau) either does not cover retail loans or does not have a proper mechanism established yet for the lending institutions to share the borrowers’ information that can help a BFI to determine the borrowers’ affordability. 

This casts doubt on lenders’ advertised capital adequacy and non-performing loan (NPL) ratios if total owed debts per client remain unknown.  NRB admits their supervisory guidelines still await implementation (NRB, 2022), allowing banks and MFIs to keep extending additional loans without evaluating borrowers’ hidden outside liabilities.  This perpetuates an alarming Ponzi-like scheme where new loans fund interest payments on old ones – until the inevitable collapse.

Concentrated loans raise contagion risk 

Besides over-lending to households, Nepal’s Financial Stability Report also shows its banks heavily concentrate larger corporate loans with just a few big conglomerates, which makes them prime vectors for contagion if any fail. The 25 largest institutional borrowers accounted for 16.8 per cent of all outstanding lending as of mid-2021, with the top 100 biggest clients owing 1/3 of all credit (NRB, 2022). Additionally, the central bank’s data shows that Nepal’s largest commercial bank Nabil alone had 9.8 per cent of its lending tied up with just 10 institutional customers last year (NRB, 2022). 

The allocation of a substantial portion of lending portfolios to specific clients makes the entire system vulnerable to shocks emanating from concentrated exposures. This situation raises contagion risk, posing a potential threat to the stability of the whole financial system. One bankruptcy could devastate such exposed banks under NRB’s neglectful watch.

No Stress Testing for economic shocks

stock market - global economy
Photo by Markus Spiske on Unsplash

Another glaring oversight is Nepal Rastra Bank’s failure to mandate periodic stress testing of major lenders’ credit risk exposure based on economic shock scenarios. Although credit in Nepal’s banking system expanded by over 25 per cent annually from 2016 to 2020 (NRB, 2021), Nepal Rastra Bank does not require evaluations of whether banks or MFIs could withstand stressed conditions like rising job losses, deposit runs, or mass loan defaults from a downturn.  International standards expect “Stress Tests” as a routine risk practice. 

The Bank for International Settlements advises financial firms to perform Stress Testing on their portfolios against “exceptional but plausible” events (BIS, 2013). Yet Nepal Rastra Bank maintains no such expectation locally, blinding both the regulator and institutions to real risks they may soon face.

Insufficient regulatory authority hindering progress

Nepal Rastra Bank NRB monetary policy - margin lending
File: Nepal Rastra Bank

NRB has attempted to address these lending risks through initiatives like its upper threshold on banks’ capital adequacy ratios, requiring loan loss provisioning, or announcing future consolidated credit reporting rules (NRB, 2022). However, such measures still lend too much discretion to the banks, with comfortable buffers before triggering action. They offer warning flags at best rather than firm red lines.  And timetables for improved reporting systems remain aspirational without real accountability to deliver.  

For less influential household borrowers, Nepal Rastra Bank mainly offers pointers and consumer education to borrow prudently and wisely – passing the buck rather than limiting banks from over-extending debt in the first place (NRB, 2022).   Until regulators can match their diagnoses of the problem with binding prescriptions on the industry, needed reforms will continue to stall halfway.  And the debt party will continue to rage on.

Final thoughts and the path forward

Nepal Rastra Bank seems afraid to challenge the big commercial lenders or politically tied industrial groups driving this risky debt bubble.  While Nepal Rastra Bank officials often voice concerns about rising household debt or weaknesses in risk regulations, they shy away from actual confrontational steps like binding loan-to-value ratios, transparency rules, or growth limits that could raise industry objections. 

Instead, they play a delicate balancing act to avoid angering either borrower lobbies or bank executives.  But in doing so, Nepal Rastra Bank fails in its core duty as the regulator to restrain dangerous excess and mitigate risks.  This political timidity comes at a real economic cost.

As the country’s central financial governing authority, Nepal Rastra Bank ultimately must transition from a fearful enabler to an active intervenor applying tough love on commercial lenders to contain risky debt growth spiralling out of control.

Whether outdated norms limit Nepal Rastra Bank’s perceived authority over banks, or political pressure ties their hands, policymakers cannot wait any longer. Numerous danger signs flash warnings across households and banks alike from entangled balance sheets sinking deeper into the red.  If NRB persists paralyzed by indecision and inaction, they may end up holding the blame when the inevitable crisis comes crashing down. The struggling Nepalese population deserves better oversight than this from their central fiduciary authority.

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Paudel is a Financial Economist and has a keen interest in economic and financial policy matters.

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