The Nepali banking sector is grappling with an escalating crisis of non-performing loans (NPLs), which has started to threaten the stability of the entire financial system. With defaults mounting across sectors, especially among small and medium-sized enterprises (SMEs), Nepali banks are at a critical juncture. The challenge is not only about managing the rising bad loans but also about ensuring the long-term sustainability of the banking system.

As the volume of NPLs continues to increase, experts are urging banks to adopt a mix of strategic measures to control the situation. But Nepal is not alone in facing this challenge; several countries have faced similar struggles and have adopted innovative approaches to tackle growing bad loans. Here’s how Nepali banks can manage this issue, drawing lessons from global experiences.

Loan Restructuring and Moratoriums: A Critical First Step

One of the first lines of defense against high NPLs is loan restructuring. This approach involves negotiating with distressed borrowers to revise loan terms, extend repayment periods, or even reduce interest rates. By offering temporary relief to borrowers, banks can prevent defaults and allow businesses time to recover. In cases where businesses are temporarily unable to meet their obligations, moratoriums on loan repayments can also help. Central bank had regularly issued circular to reschedule/restructure of the certain sector of loans during this difficult time. Banks need to identify business which can be revive in future and provide these relaxations for effective implementation of the policy rather than providing facilities to black net basis to entire sector.

A good example of successful loan restructuring can be seen in India. In the aftermath of the 2016 demonetization and the subsequent economic slowdown, Indian banks faced a sharp rise in NPLs, especially in sectors like construction and real estate. Banks worked with borrowers to reschedule their debts, helping many stay afloat during challenging times.

Sale of NPLs to Asset Reconstruction Companies (ARCs)

When loan restructuring is not enough, selling bad loans to Asset Reconstruction Companies (ARCs) can help clean up balance sheets. ARCs specialize in managing distressed assets and have the expertise to recover a portion of the defaulted loans. Nepal’s banks can benefit from such a strategy, which has been successfully employed by banks in South Korea and Thailand.

In South Korea, after the 1997 Asian Financial Crisis, the government owned Korea Asset Management Corporation (KAMCO) played a significant role in restructuring the Korean financial industry during the aftermath of 1997 Asian Financial Crisis. KAMCO helped to quickly resolve bad debts by either recovering the funds or liquidating collateral, giving banks the ability to focus on new, healthier loans. This strategy allowed South Korean banks to stabilize and return to profitability in a relatively short period.

Nepali Banking industry is also proposing for establishment of such assets management company as banks are struggling to manage the rising NPA level, however any decision regarding establishment of such company is yet to be initiated. Associations like NBA, DEBAN can pay pivotal role to pursue the government for formulation of assets management company as early as possible so that bank can get rid of non-banking assets. In the recent years, investors are not willing to invest in these assets so much, hence the requirement of proper assets management company has been felt more.

Strengthening Credit Risk Assessment and Monitoring

Improving credit risk assessment and loan monitoring systems is another essential strategy for managing NPLs. In Nepal, banks often extend loans without thorough monitoring or timely reassessment of a borrower’s financial health due to high pressure from the Shareholders for return. Hence most of the Nepali Banks overlook the credit risk assessment & loan monitoring system and solely focused on loan growth, consequently, quality of the loan was compromised. Further, Banks have implemented various relaxation to clients during covid period as provided by central bank without effective monitoring which has affected the health of the borrower. By implementing robust monitoring systems, banks can identify early signs of stress and intervene before loans become non-performing.

Singapore’s banking sector offers a great example of rigorous credit risk management. The Monetary Authority of Singapore (MAS) has set strict guidelines for banks on assessing and managing credit risk. Singaporean banks, such as DBS Bank and OCBC, use advanced analytics and digital tools to monitor loan performance continuously. These banks regularly assess the ability of borrowers to repay and take timely action to prevent defaults, including restructuring loans and offering financial advice to clients facing difficulties.

Banks like SCB, NSBI and EBL has relatively lower NPAs as these banks follows the standard set by their parent company or joint venture partner for risk assessment and loan monitoring.

Legal Measures and Asset Seizure: Effective Recovery

When all else fails, legal measures and seizure of assets are the last resort. Banks can resort to court proceedings to recover the dues or enforce the BAFIA or follow the recovery guidelines in countries like Nepal. This law allows banks to seize and auction off the collateral offered by borrowers. However, banks have witness various hurdle on this though first right over the mortgaged assets is ensured in the law. Defaulters have been able to delay this process through various legal channel which has affected the profitability of the Banks. Further, in the current economic conditions very few buyers can be found to invest on these assets as there is not any certainty of the over the return on investment as present. So banks NPA and NBA is constantly rising in the recent years.

The Insolvency and Bankruptcy Code (IBC), which has been successful in India, provides a mechanism for creditors to recover dues from defaulting borrowers through a formal liquidation process. Thailand has also implemented laws to facilitate the swift recovery of bad loans, making it easier for banks to take legal action and liquidate assets.

So Nepali Banks through NBA, DEBAN can pursue Nepali government and parliament for formulation of the strict laws for recovery and ask to remove these hurdles. For this NBA, DEBAN can regularly set meetings with central bank, government officials to discuss the problem faced by the Banks so that spoliations can be carved out.

Increased Provisioning and Capital Buffers

Banks need to increase provisioning for bad loans to ensure their balance sheets remain resilient. Adequate provisioning allows banks to absorb losses from NPLs and avoid negative impacts on capital adequacy ratios. Moreover, higher provisioning enhances a bank’s ability to recover from a shock, as it has already accounted for potential losses.

In Japan, after years of struggling with NPLs following the asset bubble collapse in the early 1990s, banks were required to set aside significant provisions for bad loans. The Bank of Japan and other regulatory bodies forced banks to recognize losses early and build capital buffers to prevent future crises. This helped Japan’s banking sector recover and avoid a systemic collapse, ensuring that banks remained solvent despite high levels of bad loans.

In contrast, Central Bank of Nepal has been allowing various relaxation on provisions so that profit of the Banks does not decrease. For example, recently central bank has decrease the loan loss provision to 1% on pass loan which may serve the present requirement however may hamper the banks health of loan term as economic condition is not expected to improve in near future.

Government Support and Public-Private Partnerships

Government intervention plays a crucial role when banks face widespread NPLs. In China, when the banking sector faced a significant rise in NPLs, the government intervened by providing capital injections and facilitating loan workouts. The China Asset Management Corporation (AMC) was created to handle bad debts and to restructure them. Public-private partnerships were formed to streamline recovery and reinvigorate the banking system.

In Nepal, similar government support could be instrumental in helping banks manage rising NPLs. Capital infusion into public sector banks could help stabilize them, while facilitating the creation of a dedicated body to manage bad loans could provide additional expertise and resources to deal with the situation. Further, we have witness the protest against the financial institutions and their staffs in Nepal, which needs to handled effectively and strictly by the government as Bank run on the public deposit.

Financial Literacy and Education for Borrowers

Often, high NPLs arise from borrowers not understanding the terms of their loans or overextending themselves financially. By promoting financial literacy and educating borrowers on sound financial practices, banks can reduce the likelihood of defaults. Australia offers an example here, where banks actively engage in financial education programs aimed at improving the borrowing habits of individuals and businesses. Central Bank of Nepal has already prepared a pool of experts on banking literacy, Banks can use them to educate borrowers regarding the timely repayment of loans and other factors effectively.

Conclusion: The Way Forward

The rising tide of non-performing loans in Nepal presents a serious challenge, but it is not an insurmountable one. By implementing strategies such as loan restructuring, leveraging ARCs, strengthening credit risk assessment, enhancing legal measures for recovery, and increasing provisions, Nepali banks can better manage the growing NPL crisis. Additionally, looking to global examples—such as South Korea, India, Japan, and Singapore—provides valuable insights into how banks can stabilize their operations in the face of rising bad loans.

Ultimately, a combination of proactive risk management, government support, and innovative financial solutions will be key in helping Nepal’s banking industry navigate through these turbulent times and emerge stronger. (Mr. Bhattarai is ex banker having more than 2 decade of experience in nepelease banking industry.)