Mobile Banking

Mobile Banking is a banking service that allows customers to conduct financial transactions — checking balances, transferring funds, paying bills, and making purchases — through a mobile device such as a smartphone or tablet, using a bank-provided application (mobile app), SMS, USSD, or mobile web. In Nepal, mobile banking is offered by commercial banks such as Nepal Bank Limited, Nabil Bank, and others under the regulatory framework of Nepal Rastra Bank (NRB), which permits branchless banking and mobile banking through licensed institutions.

Benefits of Mobile Banking

1. Convenience and 24/7 access: Customers can bank anytime, anywhere without visiting a branch, saving time and travel cost.
2. Cost effectiveness: Transaction costs are lower for both banks and customers compared to branch-based banking; banks save on physical infrastructure and staffing.
3. Wider financial inclusion: It reaches remote and rural areas where opening full branches is not viable, supporting NRB's financial inclusion goal.
4. Speed and efficiency: Fund transfers, bill payments (electricity, water, internet), mobile top-ups, and balance inquiries are completed instantly.
5. Reduced risk of carrying cash: Digital transactions lower the risk of theft or loss associated with handling physical cash.
6. Value-added services: Account statements, cheque book requests, fixed deposit bookings, and loan EMI payments can be managed from the app.
7. Better record keeping: Every transaction generates an instant digital receipt and statement, improving personal financial management.

Risks of Mobile Banking

1. Security and fraud risk: Phishing, SIM swapping, malware, and hacking can compromise login credentials and cause financial loss.
2. Unauthorized access: Loss or theft of the mobile device, or sharing of PIN/password, may lead to unauthorized transactions.
3. Network and connectivity issues: Poor internet or mobile network in remote areas can interrupt transactions and cause failed or duplicate debits.
4. Technical failures: App crashes, server downtime, or system errors may delay or block transactions.
5. Limited digital literacy: Many customers, especially in rural areas, lack the skill to use apps safely and may fall victim to fraud.
6. Dependence on technology: Power cuts, device malfunction, or outdated software can make banking inaccessible.
7. Regulatory and compliance risk: Banks must comply with NRB directives on KYC, AML, and transaction limits; failure invites penalties and reputational damage.
8. Dispute resolution difficulty: Proving unauthorized transactions and recovering funds can be time-consuming and complex.

Conclusion

Mobile banking is a powerful tool for expanding banking access and improving customer convenience in Nepal. However, its benefits can be fully realized only when banks invest in strong cybersecurity, customer awareness, and reliable technology infrastructure to manage the associated risks.

Main objectives, features and strategies of Nepal's Industrial Policy

1. Main objectives

• To increase industrial production and productivity and thereby raise national income and employment.
• To achieve balanced regional development by encouraging industries in less developed and remote areas.
• To promote export-oriented and import-substituting industries to improve the balance of payments.
• To develop agro-based, labour-intensive and small and cottage industries that use local raw materials.
• To attract domestic and foreign investment in industries and transfer modern technology.
• To link industry with agriculture and the service sector so that growth becomes self-sustaining.
• To create employment opportunities and reduce poverty.

2. Main features

• Priority classification: Industries are grouped into priority, relatively priority, export-promotion and other categories, with different facilities for each.
• Private-sector led: The policy accepts the private sector as the main vehicle of industrialisation, with the government acting as facilitator and regulator.
• Special facilities: Concessional loans, tax exemptions (income tax holidays, excise and customs concessions), and subsidised land and utilities for priority industries.
• One-window system: A single agency (Department of Industry / Investment Board) is used for registration, approval and service delivery.
• Special provisions for backward areas: Additional concessions for industries established in remote, undeveloped and specified districts.
• Foreign investment allowed: Foreign investment is permitted in most industries, with limits on the share in some sectors and full prohibition in a few.
• Environmental and labour standards: Industries must follow pollution-control and labour-welfare rules.
• Periodic revision: The policy is revised every few years to suit changed economic conditions (e.g. the Industrial Policy, 2067 BS (2010 AD), later supported by the Industrial Enterprises Act, 2076).

3. Main strategies

• Cluster and corridor development: Developing industrial corridors, special economic zones (SEZs) and industrial estates along highways and border points.
• Export promotion: Providing export incentives, duty drawback and cash incentives on exports, and developing export processing zones.
• Small and cottage industry promotion: Providing skill training, technology transfer and credit through institutions such as the Cottage and Small Industries Development Board.
• Technology upgradation: Encouraging research and development, technology transfer and modernisation of existing industries.
• Investment promotion: Organising investment summits, using the Investment Board Nepal to facilitate large projects, and simplifying approval procedures.
• Public–private partnership: Involving the private sector in infrastructure and industrial projects.
• Protection of national industries: Using tariffs and quality standards in a measured way to protect infant industries while respecting WTO commitments.
• Balanced regional growth: Directing new industries to backward areas through special incentive packages.

Nepal Rastra Bank — Deprived Sector Lending (DSL) Provisions and Assessment

1. Legal and policy basis

The requirement flows from the Banking and Financial Institutions Act, 2073 (2016), section 42, which empowers Nepal Rastra Bank (NRB) to direct banks and financial institutions (BFIs) to extend a certain percentage of their total loans to the deprived sector. NRB gives effect to this through its Unified Directives (currently Directive No. 10, "Deprived Sector Lending"), issued under the Monetary Policy for each fiscal year.

2. Main provisions

• Minimum lending floor: Each commercial bank must maintain deprived sector lending of at least 3 per cent of its total outstanding loans and advances as at the end of each quarter. (The floor was progressively raised from 0.5 per cent in the 1990s to 1 per cent, then 2 per cent, and 3 per cent from FY 2074/75; development banks and finance companies have lower floors, generally 2 per cent.)
• Definition of deprived sector: Loans of Rs 200,000 or less (raised from Rs 100,000 in FY 2074/75) to a single borrower/enterprise, and loans to specified target groups — landless and marginal farmers, freed bonded labourers (Kamaiya, Haliya), Dalits, indigenous nationalities (Janajati), women, persons with disabilities, conflict-affected persons, and micro-enterprises of such persons.
• Qualifying modes of lending: Direct lending by the BFI itself; lending through microfinance institutions; lending through wholesale lending to MFIs; and lending to rural development banks and cooperatives working in the deprived sector. Loans to micro-enterprises promoted by deprived households also qualify.
• Interest rate ceiling: Interest on deprived sector loans is capped (currently not more than the base rate plus 3 per cent for direct lending, and a prescribed spread for lending through MFIs).
• Reporting and monitoring: BFIs must report DSL figures in the prescribed format in their monthly and quarterly returns; NRB's Bank Supervision Department verifies compliance through off-site surveillance and on-site inspection.
• Penalty for shortfall: A BFI failing to meet the floor must deposit the shortfall amount in a non-interest-bearing account with NRB (or pay a penalty as prescribed), and the amount is not counted as lending. Persistent default attracts supervisory action.
• Incentives: BFIs meeting the target may count such lending toward priority sector requirements and may access refinance facilities from NRB at concessional rates for deprived sector lending.

3. Assessment — have the provisions produced expected results?

Positive outcomes:

• Volume: Deprived sector lending has grown substantially in absolute terms, from a few billion rupees in the early 2000s to over Rs 400 billion in recent years, with most commercial banks meeting or exceeding the 3 per cent floor.
• Institutional reach: The provision gave birth to and sustained a large microfinance sector — over 50 MFIs with thousands of branches, mostly in rural and semi-urban areas — extending small loans to millions of poor households, particularly women.
• Access and inclusion: A significant share of borrowers are women (often above 90 per cent in MFIs), and outreach has reached districts and wards that commercial banking had never touched.
• Livelihood impact: Micro-loans have financed petty trade, livestock, agriculture and micro-enterprises, contributing to income generation and, indirectly, to poverty reduction and women's empowerment.

Shortcomings:

• Targeting failure: A large part of DSL is "deprived sector lending" only by the size criterion (loans up to Rs 200,000), not by borrower identity. Better-off households often capture these loans, so the genuinely deprived are not always reached.
• Compliance without substance: Many BFIs meet the floor through wholesale lending to MFIs or by purchasing MFI loans rather than direct lending, which weakens the link between the provision and actual field-level credit delivery.
• Multiple borrowing and over-indebtedness: Weak credit information on small borrowers has led to borrowers taking loans from several MFIs, causing repayment stress and, in some cases, coercive recovery practices.
• Geographic and sectoral skew: Lending is concentrated in accessible districts and in consumption or petty-trade loans rather than productive, employment-generating enterprises.
• Weak monitoring: Verification of end-use and of the true deprived status of borrowers is difficult; penalties are modest relative to the profitability of non-compliance.
• Limited graduation: Many borrowers remain trapped in repeated small loans instead of graduating to larger, viable enterprises.

4. Conclusion

The DSL provisions have succeeded in expanding the volume and geographic reach of credit to the poor, and in building a microfinance delivery system. However, in terms of quality of targeting, end-use, and genuine poverty impact, the results are only partially satisfactory. Effectiveness can be improved by tightening the definition of deprived borrowers, requiring a minimum share of direct (non-wholesale) lending, strengthening the credit information bureau for small loans, linking refinance and supervisory incentives to verified outcomes, and promoting graduation from micro-credit to micro-enterprise finance.

Nepal Rastra Bank (NRB): objectives, duties, responsibilities and powers (Nepal Rastra Bank Act, 2058)

1. Objectives of establishing NRB

The Act establishes NRB as the central bank of Nepal, an autonomous and corporate body, to:

1. Formulate necessary monetary and foreign exchange policies to maintain price stability and the stability of the exchange rate.
2. Maintain a balance of payments position conducive to sustainable economic growth.
3. Promote the stability and liquidity needed in the banking and financial system, and develop a healthy and efficient financial system.
4. Develop a safe, healthy and efficient payment system.
5. Regulate and supervise banks and financial institutions.
6. Enhance public confidence in the banking and financial system.

2. Duties and responsibilities

• Formulate and implement monetary policy and foreign exchange policy.
• Issue notes and coins (sole right of currency issue) and manage their circulation.
• Act as banker, adviser and financial agent of the Government of Nepal, and manage public debt.
• Act as banker to banks and financial institutions; hold their cash reserves and act as lender of last resort.
• Manage the country's foreign exchange reserves and regulate foreign exchange transactions.
• License, regulate, inspect and supervise banks and financial institutions (with BAFIA).
• Develop and regulate the payment and settlement system.
• Collect, publish and maintain financial and economic statistics and conduct research.
• Promote financial access and literacy, and coordinate with international financial institutions.

3. Powers

Conclusion: NRB's objectives centre on price stability, external balance and a sound financial system. Its duties and powers (currency, monetary policy, banking regulation and supervision, forex and payments) give it the tools to achieve them.

Financial Intelligence Unit (FIU): functions, duties, powers and performance (Asset (Money) Laundering Prevention Act, 2064)

The FIU of Nepal is established within Nepal Rastra Bank as the national centre for receiving, analysing and disseminating information on suspected money laundering (ML) and terrorist financing (TF).

1. Functions and duties

1. Receive Suspicious Transaction Reports (STRs) and Threshold Transaction Reports (TTRs) from reporting entities such as banks, financial institutions, insurers, securities firms, cooperatives, casinos and dealers in precious metals.
2. Analyse the reports and other information to identify ML/TF and related offences.
3. Disseminate analysed intelligence to the Department of Money Laundering Investigation, Nepal Police, the CIAA and other investigating agencies.
4. Maintain a secure database of reports.
5. Issue directives and guidelines to reporting entities on the form, manner and timing of reports.
6. Monitor and supervise compliance by reporting entities with customer due diligence, record keeping and reporting duties.
7. Conduct typology studies and research, and publish trends.
8. Exchange information and cooperate with foreign FIUs (Egmont Group) and bodies such as APG.
9. Provide training and awareness programmes.

2. Powers

• Call for any additional information, document or record from reporting entities and government bodies.
• Issue directives and require corrective action, and recommend action against defaulting entities to the concerned regulator.
• Inspect and examine reporting entities' compliance.
• Share information with domestic and foreign counterparts under the Act.

3. Is the progress of FIU satisfactory? Analysis

Conclusion: The FIU's progress is moderately satisfactory: the legal framework and reporting system are in place, but outcomes in prosecution, asset recovery and non-bank sector supervision remain weak. More skilled staff, technology, quality STRs and inter-agency coordination are needed.

Basic Objectives of Portfolio Management

Portfolio management is the art and science of selecting, allocating and continuously reviewing a group of investments (securities, loans, deposits, treasury instruments) so that the investor or institution earns the best possible return for a given level of risk. Its basic objectives are:

1. Maximisation of return (yield) — to earn the highest possible income from the funds invested, whether through interest, dividends or capital gains. In a bank, this means earning a healthy spread between the cost of deposits and the return on loans and investments.

2. Minimisation of risk — to protect the principal and the expected return from default, market, liquidity and interest-rate risks. Return should never be chased at the cost of solvency.

3. Optimal risk–return trade-off — to build a combination of assets whose total risk is lower than the sum of individual risks, i.e. to gain the benefit of diversification. This is the core of the "efficient portfolio" concept.

4. Liquidity maintenance — to keep enough cash and near-cash assets (cash reserve, bank balance, unencumbered government securities) to meet depositors' withdrawals and loan commitments on demand. For a bank this objective is legally binding through the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

5. Safety of principal — preservation of the invested capital, which for a bank means protecting depositors' money and the bank's own capital fund.

6. Income stability and growth — a steady, predictable stream of earnings rather than volatile spikes, so that dividends and reserves can be planned.

7. Diversification of risk — spreading funds across sectors, borrowers, instruments and maturities so that failure in one area does not sink the whole portfolio.

8. Meeting regulatory and statutory requirements — compliance with Nepal Rastra Bank (NRB) directives on credit concentration, sectoral lending, capital adequacy and liquidity.

9. Matching liabilities (maturity and liquidity planning) — aligning asset maturities with the maturity profile of deposits and borrowings to control interest-rate and liquidity risk.

10. Maximisation of the institution's value — ultimately, portfolio decisions should raise the net worth and long-term sustainability of the bank.

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Risks Associated with Portfolio Management in the Nepali Banking Sector

The risks are broadly of two types — systematic (market-wide) and unsystematic (institution-specific) — and in Nepal they take the following concrete forms:

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Risks Specific to Nepal Bank Limited (NBL)

NBL is the oldest commercial bank of Nepal (established 1937) and, being partly government-owned and listed on NEPSE, faces a mix of legacy and current portfolio risks:

1. Legacy non-performing loans — NBL historically carried a very high NPL ratio (above 30% in the early 2000s) before restructuring. Even today its NPL ratio tends to be higher than the industry average, reflecting old written-off and restructured accounts.

2. High government and directed lending — As a bank with government shareholding, NBL carries large exposures to government-guaranteed and priority-sector loans (agriculture, small enterprises, deprived sectors). These carry lower yield and, in some cases, weaker credit assessment.

3. Concentration in a few large borrowers — A significant share of its loan book is held by a small number of large corporate and government-related borrowers, raising single-obligor concentration risk.

4. Deposit concentration and branch-based funding — A large portion of deposits comes from government and institutional accounts; withdrawal of such bulk deposits can create sudden liquidity pressure.

5. Interest-rate and maturity mismatch — Heavy reliance on short-term deposits to fund long-term project and term loans exposes NBL to repricing and refinancing risk.

6. Collateral and market risk — A large part of collateral is land and buildings; a slowdown in the real-estate market (as seen after the 2015 earthquake and the recent land-price correction) reduces recoverable value. Shares held as collateral lose value when NEPSE falls.

7. Operational and legacy-system risk — Older branches and legacy IT systems increase the risk of documentation errors, delayed reporting and fraud.

8. Capital adequacy pressure — High NPLs and provisioning requirements reduce the capital fund and can push NBL close to the regulatory minimum, restricting fresh lending.

Example: Suppose NBL has lent Rs 2 billion to a single hydro-power group in Karnali and holds shares of that company worth Rs 300 million as collateral. If the project is delayed and the company's share price falls 40% on NEPSE, NBL faces (i) credit risk — interest not serviced, (ii) concentration risk — one group dominates the portfolio, (iii) market risk — collateral value drops to Rs 180 million, and (iv) liquidity risk — the account must be provisioned, reducing profit and capital. A diversified portfolio spread across sectors, smaller ticket sizes and periodic revaluation of collateral would have reduced this combined risk.

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Conclusion

The basic objectives of portfolio management — return, risk control, liquidity, safety and diversification — must be balanced, not maximised individually. In the Nepali banking sector, and particularly in Nepal Bank Limited, the dominant risks are credit risk, concentration risk, liquidity risk and interest-rate risk, compounded by legacy NPLs and government-directed lending. NBL can manage these through strict credit appraisal, sectoral and single-borrower exposure limits, maturity matching, regular collateral revaluation, strong MIS and full compliance with NRB directives.

Loan classification and ECL Guidelines of Nepal Rastra Bank (NRB)

1. Classification of loans (NRB Unified Directive)

Loans are classified by how long they are overdue (principal or interest), and loan loss provision is kept on the outstanding amount.

Pass and Watchlist loans are performing; Substandard, Doubtful and Bad are non-performing loans (NPL). Loans may also be classified as Bad on grounds of the borrower's insolvency, fraud or unrecoverable security. Special rules apply to rescheduled and restructured loans, and to short-term and term loans with instalments.

2. Main provisions of the ECL Related Guidelines No. 61

NRB introduced the Expected Credit Loss (ECL) model, in line with NFRS 9, to replace the "incurred loss" approach.

• Applicability: commercial banks and other BFIs adopting NFRS.
• Three-stage approach:
  • Stage 1: performing; 12-month ECL.
  • Stage 2: significant increase in credit risk (for example, more than 30 days past due); lifetime ECL.
  • Stage 3: credit-impaired or default (more than 90 days past due); lifetime ECL.
• Formula: ECL = Probability of Default (PD) x Loss Given Default (LGD) x Exposure at Default (EAD), discounted to present value.
• Forward-looking information: macroeconomic factors and scenarios must be reflected.
• Governance: a board-approved ECL policy, model validation, documentation and use of historical data.
• Regulatory comparison: BFIs compare ECL impairment with the NRB loan loss provision and, where the NRB provision is higher, transfer the difference to a regulatory reserve from retained earnings, which cannot be distributed as dividend.
• Reporting and disclosure: periodic reporting to NRB and disclosure in the financial statements.

Conclusion: NRB's loan classes give a uniform minimum provision, and the ECL guidelines make provisioning more forward-looking and risk-sensitive.

Financial System in Nepal and Recent Challenges of the Banking Industry

1. The Prevailing Financial System in Nepal

Nepal follows a bank-dominated, mixed financial system regulated primarily by Nepal Rastra Bank (NRB), the central bank established in 1956 under the Nepal Rastra Bank Act. The system is structured in a tiered manner:

• Tier 1 – Regulatory and Monetary Authority: Nepal Rastra Bank, which conducts monetary policy, issues currency, regulates and supervises banks and financial institutions (BFIs), and acts as lender of last resort.
• Tier 2 – Commercial Banks (Class "A"): Around 20 commercial banks that dominate deposits, credit, and payment services. They hold the largest share of banking sector assets.
• Tier 3 – Development Banks (Class "B"), Finance Companies (Class "C"), and Microfinance Institutions (Class "D"): These serve specific regions, sectors, and low-income/rural clients.
• Tier 4 – Other Institutions: Insurance companies, Employees Provident Fund, Citizen Investment Trust, mutual funds, cooperatives, and capital market institutions (NEPSE, SEBON, CDSC) that complete the financial architecture.

Key features of the system include:

• Bank-centric financing: Capital markets are relatively small and shallow; most corporate financing comes from bank credit rather than equity or bond markets.
• Dominance of deposits and loans: Interest income remains the main revenue source of BFIs.
• Regulatory framework: Governed by the Nepal Rastra Bank Act, 2058; Bank and Financial Institution Act (BAFIA), 2073; and directives issued by NRB (e.g., Unified Directives, monetary policy circulars).
• Financial inclusion drive: Expansion of branch networks, mobile banking, digital wallets, and priority-sector lending (agriculture, energy, tourism, SMEs) to underserved areas.

2. Recent Challenges Faced by the Banking Industry

1. Liquidity Crunch and Credit-Deposit (CD) Ratio Pressure: Periodic shortage of loanable funds, especially in the first half of fiscal years, has pushed CD ratios near the regulatory ceiling (90% for commercial banks), forcing banks to raise deposit rates sharply and ration credit.

2. Rising Non-Performing Loans (NPLs): NPLs have climbed above 3–4% in recent years due to stressed borrowers, over-leveraged industries (construction, real estate, hydro), and weak recovery of pandemic-hit sectors. High NPLs erode profitability and capital.

3. Interest Rate Volatility and Spread Pressure: Sharp swings in deposit and lending rates, combined with NRB's spread cap (currently around 4–5%), squeeze net interest margins. High cost of funds reduces competitiveness.

4. Deposit Mobilization Constraints: Low financial literacy in rural areas, competition from cooperatives and informal channels, and remittance-driven consumption rather than savings limit deposit growth relative to credit demand.

5. Regulatory and Compliance Burden: Frequent changes in directives, Basel III implementation, anti-money laundering (AML/CFT) requirements, and increased reporting obligations raise operating costs, particularly for smaller BFIs.

6. Digital Disruption and Cybersecurity Risks: Rapid growth of mobile banking, QR payments, and fintech has increased exposure to cyberattacks, fraud, data breaches, and system failures. Many BFIs lack robust IT infrastructure and skilled manpower.

7. Concentration and Financial Access Gap: Credit is concentrated in urban and a few large borrowers, while rural, SME, and agricultural sectors remain underserved. Branchless banking has not fully translated into meaningful credit access.

8. External Sector Pressure: Depletion of foreign exchange reserves, import restrictions, and remittance volatility affect banks' foreign currency transactions and overall stability.

9. Human Resource Challenges: Shortage of skilled bankers, high employee turnover, and gaps in digital and risk-management competencies weaken institutional capacity.

10. Impact of Global Shocks: COVID-19, Russia–Ukraine war, and global monetary tightening transmitted through remittances, trade, and capital flows, affecting asset quality and credit demand.

3. Measures to Address These Challenges

A. Liquidity and Deposit Management

• Strengthen deposit mobilization through attractive savings products, financial literacy campaigns, and expansion into rural and remittance-receiving households.
• Diversify funding sources: interbank borrowing, foreign currency deposits, and issuance of debentures/bonds.
• Improve asset-liability management (ALM) to match maturity profiles and reduce dependence on short-term volatile deposits.

B. Asset Quality and NPL Resolution

• Adopt strict credit appraisal, sector-wise exposure limits, and stress testing.
• Establish specialized recovery units and use legal tools (debt restructuring, rescheduling, asset management companies).
• Promote credit guarantee schemes and blended finance for risky but priority sectors.

C. Profitability and Efficiency

• Shift toward fee-based income: digital payments, bancassurance, remittance services, and advisory.
• Digitize processes to cut operating costs and improve turnaround time.
• Rationalize branch networks and merge weak BFIs to achieve economies of scale.

D. Regulatory and Compliance Reforms

• Harmonize NRB directives with international standards while allowing proportionate regulation for smaller BFIs.
• Invest in compliance technology (RegTech) and staff training on AML/CFT.
• Strengthen coordination between NRB, SEBON, and other regulators.

E. Digitalization and Cybersecurity

• Invest in core banking upgrades, cloud infrastructure, and real-time payment systems.
• Implement strong cybersecurity frameworks: encryption, multi-factor authentication, incident response plans, and regular audits.
• Foster fintech partnerships under NRB's regulatory sandbox.

F. Financial Inclusion

• Expand priority-sector lending with subsidized interest and refinance facilities.
• Promote microfinance, branchless banking, and digital financial services in remote areas.
• Use alternative credit scoring (mobile data, remittance history) to serve the unbanked.

G. External Sector Stability

• Maintain adequate forex reserves through export promotion, remittance formalization, and prudent import management.
• Hedge foreign currency exposures and diversify correspondent banking relationships.

H. Human Capital Development

• Invest in continuous training, leadership development, and digital skills.
• Offer competitive compensation and clear career paths to retain talent.
• Build a culture of risk awareness and ethical banking.

Conclusion

Nepal's financial system is bank-dominated and regulated by NRB, but it faces significant challenges in liquidity, asset quality, digital disruption, and inclusion. Addressing these requires a coordinated effort by regulators, BFIs, and the government through prudent monetary policy, stronger risk management, digital innovation, and inclusive growth strategies. For an Assistant Manager (Level 6), understanding these dynamics is essential for effective operational and strategic decision-making.

Basel III: Key Features and Role in Capital Adequacy and Risk Management

1. Introduction

Basel III is a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision (BCBS) in response to the deficiencies in financial regulation revealed by the global financial crisis of 2007–09. It builds on Basel I (1988) and Basel II (2004) and aims to strengthen the regulation, supervision and risk management of the banking sector. In Nepal, Nepal Rastra Bank has implemented Basel III norms for commercial banks in a phased manner.

2. Key Features of Basel III

(a) Improved Quality and Quantity of Capital

• Common Equity Tier 1 (CET1) is raised to at least 4.5% of risk-weighted assets (RWA).
• Tier 1 capital must be at least 6% of RWA.
• Total capital must be at least 8% of RWA.
• Greater emphasis on loss-absorbing common equity; deductions from capital tightened.

(b) Capital Conservation Buffer (CCB)

• An additional 2.5% of CET1 above the minimum, making the effective CET1 requirement 7%.
• Designed to absorb losses during stress periods without breaching minimum requirements.

(c) Countercyclical Buffer

• Range of 0–2.5% of CET1, imposed during periods of excessive credit growth to curb pro-cyclicality.

(d) Leverage Ratio

• A non-risk-based backstop of at least 3% of Tier 1 capital to total exposure, limiting excessive leverage.

(e) Liquidity Standards

• Liquidity Coverage Ratio (LCR): High-quality liquid assets to cover 30 days of net cash outflows.
• Net Stable Funding Ratio (NSFR): Stable funding relative to required stable funding over one year.

(f) Systemically Important Financial Institutions (SIFIs)

• Additional loss absorbency (capital surcharge) for institutions whose failure could destabilize the system.

(g) Counterparty Credit Risk Reforms

• Stronger standards for derivative exposures, including Credit Valuation Adjustment (CVA) risk capital charge.

3. How Basel III Maintains Capital Adequacy

• By raising the minimum CET1 to 4.5% and adding the 2.5% conservation buffer, banks hold a larger cushion of high-quality capital to absorb unexpected losses.
• The leverage ratio prevents banks from building excessive on- and off-balance-sheet exposure even when risk weights appear low.
• The countercyclical buffer ensures capital is built up in good times and released in stress periods, smoothing the credit cycle.
• Capital planning and stress testing requirements ensure banks remain adequately capitalized under adverse scenarios.
• In Nepal, NRB prescribes minimum capital fund requirements (e.g., Rs 8 arba minimum paid-up capital for Class 'A' commercial banks) along with Basel III capital ratios.

4. Support in Managing Various Risks

(a) Credit Risk

• Higher capital charges for credit exposures, especially for unrated and high-risk borrowers.
• Stricter treatment of counterparty credit risk and large exposures.
• Encourages better credit appraisal, collateral management and diversification of loan portfolios.

(b) Market Risk

• Enhanced capital requirements for trading book exposures, including stressed Value-at-Risk (VaR) and incremental risk charges.
• CVA framework captures mark-to-market losses on derivatives due to counterparty default.
• Promotes use of hedging and limits on proprietary trading.

(c) Operational Risk

• Basic Indicator, Standardised, and Advanced Measurement Approaches link capital to operational risk.
• Encourages robust internal controls, business continuity planning, IT security and fraud prevention.
• Loss data collection and scenario analysis improve risk identification.

(d) Liquidity Risk

• LCR and NSFR ensure banks hold sufficient liquid assets and stable funding, reducing run-off risk.

5. Conclusion

Basel III addresses the weaknesses exposed by the global financial crisis by improving capital quality, introducing buffers, leverage and liquidity standards. It strengthens capital adequacy and provides a comprehensive framework for managing credit, market, operational and liquidity risks. For Nepali commercial banks, effective Basel III implementation enhances resilience, depositor confidence and overall financial stability.

Customer relationship management (CRM) is the strategy, process and technology a bank uses to build, maintain and deepen profitable relationships with customers by understanding their needs and delivering consistent, personalised service. In a bank like Nepal Bank Ltd., CRM helps improve customer satisfaction and loyalty in the following ways:

Improving customer satisfaction

1. Customer knowledge and personalisation: CRM maintains a central database of each customer's accounts, transaction history, loan products, income profile and preferences. Staff can thus offer tailored products (e.g., a suitable fixed deposit or remittance scheme) instead of a one-size-fits-all approach.
2. Faster and accurate service: With a single view of the customer across branches and digital channels, queries, cheque clearing, statement requests and loan status are handled quickly and without repeated paperwork, reducing waiting time and errors.
3. Multi-channel convenience: CRM integrates branch counters, ATMs, mobile banking, internet banking and call centres, so customers can transact and get support through the channel of their choice at any time.
4. Proactive service and complaint handling: Automated alerts (loan due dates, FD maturity, KYC renewal) and a structured grievance-redressal system ensure problems are resolved before they escalate, which directly raises satisfaction.
5. Consistent service quality: Standardised service scripts, service-level agreements and staff training ensure the same experience across all branches.

Building customer loyalty

1. Trust and emotional bonding: Repeated positive experiences build trust, making customers less likely to switch to competitors even when rates are marginally better elsewhere.
2. Loyalty and reward programmes: CRM enables tiered benefits, cashback, preferential interest rates and relationship pricing for long-standing or high-value customers, giving them a tangible reason to stay.
3. Retention and reduced churn: By identifying at-risk customers (e.g., declining balances, dormant accounts) through analytics, the bank can intervene with retention offers, protecting its existing customer base.
4. Cross-selling and up-selling: Satisfied customers who trust the bank are more willing to take additional products (insurance, mobile banking, cards), increasing share of wallet and switching costs.
5. Lifetime value and word-of-mouth: Loyal customers are more profitable over the long term and refer new customers, lowering acquisition costs.
6. Feedback-driven improvement: CRM captures customer feedback and complaints, which the bank uses to redesign products and processes, creating a continuous improvement cycle that further strengthens loyalty.

Conclusion: CRM shifts the bank from a transaction-oriented to a relationship-oriented approach. By using customer data to deliver personalised, timely and reliable service, and by rewarding continued association, CRM raises satisfaction, which in turn converts into loyalty — benefiting the bank through higher retention, greater cross-selling and a stronger, more stable deposit and customer base.

Capitalization of interest and penal interest (Nepal Bank Limited credit policy, following NRB directives)

1. Capitalization of interest

Interest is added to the loan principal (capitalized) only in limited, controlled cases:

• Interest due during the construction or gestation period of a project may be capitalized into the project loan if the sanction approves it.
• On rescheduled or restructured loans, accrued interest may be capitalized only with approval of the appropriate authority and when the borrower has a proper repayment plan.
• It is not permitted merely to hide default: interest on non-performing accounts is not capitalized to show a loan as regular (evergreening).

2. Income recognition on interest

3. Penal interest

• Charged on overdue instalments and amounts, at a rate set by the bank on top of the contractual rate, as stated in the sanction letter.
• Applied only on the overdue amount, for the overdue period, and not on the full loan.
• Recognized as income only when actually received; not accrued on non-performing accounts.
• Not compounded or added to principal, except under approved rescheduling.
• Waiver or reduction needs approval of the competent authority under the bank's policy.

Internal Control Mechanisms in NBL's Operation Manual Part I and Their Role in Minimizing Operational Risk

Context. Operation Manual Part I of Nepal Bank Limited codifies procedures for general banking — account opening and KYC, cash receipt and payment, cheque book issue, remittance, clearing, locker operation, interest posting, dormant/inoperative accounts and AML/CFT screening. The internal controls embedded in these procedures are the bank's first line of defence against operational risk, i.e. loss arising from failed processes, people, systems or external events.

Control mechanisms and their risk-mitigating role

Evaluation. These controls are largely preventive (segregation, dual custody, limits) supported by detective controls (reconciliation, surprise checks, audit). Together they reduce the likelihood of error and fraud and limit severity when it occurs, and they align NBL with NRB's directives on internal control and risk management. However, their effectiveness is conditional: controls are only as strong as their enforcement — non-compliance, override by senior staff, weak monitoring of control registers, staff shortage at branches, and manual/legacy processes create residual risk. Control cost must also be balanced against operational efficiency.

Conclusion. The internal control mechanisms in Operation Manual Part I are effective in minimizing operational risk only when they operate as a continuous, monitored system — supported by a strong compliance culture, periodic review, staff training and independent audit — rather than as documented rules alone.

Dismissal of an NBL employee with disqualification, and the process of departmental punishment (NBL Employee Service Bylaws, 2079)

1. Circumstances for dismissal with future disqualification and loss of benefits

A serious offence proved after a fair inquiry leads to dismissal from service, the employee being disqualified from future service and receiving no retirement benefits. Typical grounds are:

• Fraud, embezzlement or misappropriation of the bank's or customers' money or property.
• Forgery or falsification of records, documents or certificates, or obtaining the job by false documents.
• Corruption: taking bribes or commission, or using the post for personal gain.
• Conviction by a court for a criminal offence involving moral turpitude.
• Serious breach of trust or secrecy, such as leaking confidential customer or bank information for gain.
• Wilful and serious disobedience of lawful orders, or acts causing major loss or damage to the bank.
• Grave misconduct: violence, harassment, or acts damaging the bank's reputation.
• Repeated misconduct after earlier punishments.
• Unauthorised absence for a prolonged period.

2. Process of departmental punishment

1. Complaint or detection: misconduct is reported, or found by audit or inspection.
2. Preliminary inquiry: the competent authority decides whether a case exists and, if needed, suspends the employee, who gets a subsistence allowance.
3. Charge sheet: a written statement of the allegations with evidence is served on the employee.
4. Explanation: the employee is given a reasonable fixed period to submit a written reply.
5. Inquiry: an inquiry officer or committee examines the documents and witnesses, hears the employee and records findings.
6. Decision: the competent authority decides on punishment in proportion to the offence, after considering the report. Punishments range from warning, fine or stoppage of increment and promotion, to demotion, compulsory retirement and dismissal.
7. Notice of decision: the order is communicated in writing with reasons.
8. Appeal or review: the employee may appeal to the higher authority within the prescribed time.

The principles of natural justice apply: notice, opportunity to be heard and a reasoned decision.

The exact periods, committee composition and authorities are those fixed in the Bylaws and should be quoted from the text when known.

Annual procurement plan in Nepal Bank Limited

1. Why an annual procurement plan is prepared

• Legal requirement: the Public Procurement Act, 2063 and Public Procurement Rules, 2064 require a public body to prepare a procurement plan before procurement begins; NBL, being a government-owned bank, follows this.
• Budget linkage: it ties purchases (IT systems, ATMs, premises, vehicles, stationery, security and maintenance) to the approved annual budget, so that spending is controlled.
• Timeliness: it schedules each purchase so that goods and services are available when needed and work is not delayed.
• Economy and efficiency: grouping similar needs into packages gives better prices and avoids repeated small purchases.
• Transparency and competition: it fixes the method of procurement in advance, discourages splitting of lots and reduces favouritism and corruption.
• Monitoring and accountability: it gives a base against which progress is checked and audited.

2. Key considerations while preparing the plan

1. Approved budget: purchases must be within the budget ceiling and the available source of funds.
2. Real needs: assess needs from branches and departments, avoiding unnecessary items and duplication.
3. Packaging: divide items into suitable lots, without splitting a package to avoid a higher threshold or approval level.
4. Procurement method: select the right method (quotation, national or international bidding, direct purchase) according to the value limits in the Act and Rules.
5. Time schedule: set realistic dates for specifications, bid invitation, evaluation, contract and delivery.
6. Specifications and cost estimates: prepare clear, non-discriminatory technical specifications and reliable cost estimates.
7. Eligibility and evaluation criteria: set objective criteria in the standard bidding documents.
8. Publicity: publish the plan and notices as required for transparency.
9. Responsibility and capacity: assign officers and committees and ensure trained staff.
10. Banking factors: technology compatibility, security, after-sales service and annual maintenance for core banking and ATM systems.
11. Review: allow revision of the plan with proper approval if needs or budget change.

Part A: Major risks as per the Basel Framework and Nepal Rastra Bank Guidelines (4 marks)

The Basel Framework (Basel III) and Nepal Rastra Bank (NRB) guidelines identify the following major risks that banks face:

1. Credit Risk — the risk of loss arising when a borrower or counterparty fails to meet its contractual obligations. It is the largest risk for Nepali banks, mainly from lending.
2. Market Risk — the risk of loss from movements in market prices, covering:
   • Interest Rate Risk — adverse movement in interest rates affecting earnings and capital.
   • Foreign Exchange Risk — adverse movement in exchange rates on open foreign currency positions.
   • Equity Price Risk — loss from movements in share/security prices.
3. Operational Risk — the risk of loss from inadequate or failed internal processes, people, systems, or from external events (including fraud, cyber-attacks and legal risk).
4. Liquidity Risk — the risk that the bank cannot meet its obligations as they fall due, or can do so only at excessive cost. NRB monitors this through the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR) and Net Liquidity Gap limits.
5. Operational/Compliance and Legal Risk — risk of regulatory sanctions and legal penalties for non-compliance with laws, directives and circulars.
6. Credit Concentration Risk — excessive exposure to a single borrower, sector or related party (governed by NRB's single obligor limit and Directed/Deprived Sector lending rules).
7. Country / Transfer Risk — risk that a foreign counterparty cannot remit funds due to political or economic reasons.
8. Interest Rate Risk in the Banking Book (IRRBB) — risk to capital and earnings from rate changes on non-trading positions.
9. Strategic and Reputational Risk — risk from poor business decisions or damage to public image.

NRB's Risk Management Guidelines (2018) require banks to identify, measure, monitor and control these risks through a Board-level Risk Management Committee, an independent Risk Management Department, Internal Capital Adequacy Assessment Process (ICAAP), Stress Testing and Basel III capital/liquidity standards.

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Part B: Strategies adopted by Nepal Bank Limited to mitigate these risks (6 marks)

Nepal Bank Limited (NBL), the oldest bank of Nepal, mitigates the above risks through the following strategies:

1. Credit Risk Mitigation

• Strict compliance with NRB's single obligor limit (not exceeding 25% of core capital for a single borrower and 50% for a group) and the Deprived Sector Lending requirement.
• Credit appraisal through a Credit Risk Management Department, use of a Credit Rating/Scoring model, and independent review by the Credit Committee.
• Collateral security (land, building, fixed deposits, gold) with proper valuation and margin, plus loan-to-value (LTV) limits.
• Loan classification and provisioning as per NRB's Directive No. 2 (Pass, Watchlist, Substandard, Doubtful, Bad), with timely rescheduling/restructuring and recovery/legal action against defaulters.
• Diversification of the loan portfolio across sectors, regions and borrower groups to avoid concentration.

2. Market Risk Mitigation

• Maintaining open position limits for foreign currency as prescribed by NRB.
• Treasury mid-office independently monitors market risk; use of Value at Risk (VaR) and duration/gap analysis for interest rate risk.
• Asset-Liability Management (ALM) Committee to match rate-sensitive assets and liabilities.

3. Liquidity Risk Mitigation

• Maintaining CRR and SLR balances as required by NRB.
• Holding adequate liquid assets (cash, bank balance, government securities) and keeping LCR above 100% and NSFR above 100%.
• Contingency funding plan and periodic stress testing of liquidity.

4. Operational Risk Mitigation

• Segregation of duties, dual control, maker–checker system and rotation of staff.
• Internal Audit and Compliance Department conducting regular branch audits.
• CCTV surveillance, core banking system (CBS) controls, cyber-security policy and business continuity/disaster recovery plan.
• Staff training on AML/CFT, KYC and fraud prevention; a Whistle-blower policy.

5. Governance and Capital Mitigation

• A Board-level Risk Management Committee and independent Risk Management Department.
• ICAAP and stress testing to assess capital adequacy under adverse scenarios.
• Maintaining Capital Adequacy Ratio (Basel III) above NRB's minimum (currently 11%, including buffers).
• Anti-Money Laundering (AML) and KYC procedures to control legal and reputational risk.

Conclusion: NBL thus follows a comprehensive, Basel-aligned and NRB-compliant risk management framework — identification, measurement, monitoring, control and reporting — to protect depositors' funds, ensure capital adequacy and maintain financial stability.

Procedures for loan recovery in Nepal Bank Limited

Loan recovery follows the Bank and Financial Institutions Act (BAFIA), 2073, NRB directives and NBL's credit policy, in these stages:

1. Follow-up and reminders: as soon as an instalment or interest is overdue, the branch sends reminders and visits or calls the borrower and guarantor. The account is closely monitored (watchlist).
2. Rescheduling or restructuring: where the borrower has a genuine, temporary difficulty and the business is viable, the loan may be rescheduled (extended in tenure) or restructured on new terms, with approval of the competent authority and within NRB limits.
3. Legal notice: if the loan becomes non-performing, a formal notice (35 days) is sent to the borrower and guarantor and published in a national daily, demanding payment.
4. Collateral action: if payment is not made, the bank takes over and auctions the mortgaged property under BAFIA, after a public notice (at least 15 days), and applies the proceeds to the dues.
5. Guarantor and legal action: if the collateral is insufficient or the auction fails, the bank recovers from the guarantor and files a case with the Debt Recovery Tribunal (Rin Asuli Adalat). The bank may also take action such as blacklisting the borrower through the Credit Information Bureau.
6. Write-off: as a last resort, with Board approval and following NRB rules, the unrecoverable loan is written off from the books, while the bank continues its right to recover.

Throughout, proper documentation, time-bound recovery targets and regular NPL reporting to NRB are maintained.

Corporate Governance

Corporate governance is the system of rules, practices and processes by which a company is directed, controlled and held accountable. It defines the relationship among a company's board of directors, management, shareholders and other stakeholders, and lays down how objectives are set, how performance is monitored, and how risk is managed. In essence, it is the mechanism that ensures the company is run in the long-term interest of its shareholders and stakeholders rather than in the personal interest of managers.

Principles of Corporate Governance

1. Accountability – The board and management must be answerable for their decisions, actions and performance to shareholders and regulators.
2. Transparency – Timely, accurate and complete disclosure of financial and non-financial information (financial statements, related-party transactions, risk exposures) so that stakeholders can make informed judgements.
3. Fairness – Equitable treatment of all shareholders, including minority shareholders, with protection of their rights and equal access to information.
4. Responsibility / Integrity – Recognition of the company's responsibility towards society, employees, customers and the environment, and conduct of business with honesty and ethical standards.
5. Independence – Presence of independent directors and an independent audit function so that objective judgement is not compromised by conflicts of interest.
6. Risk management and control – Effective internal control, audit and risk-management systems to safeguard assets and ensure compliance with laws.

Status of Corporate Governance in the Banking Sector of Nepal

• Legal and regulatory framework: Corporate governance in Nepali banks is primarily governed by the Companies Act 2063, the Bank and Financial Institutions Act (BAFIA) 2073, Nepal Rastra Bank (NRB) directives, and the Securities Board of Nepal (SEBON) rules for listed banks. NRB's Unified Directives contain detailed provisions on board composition, independent directors, audit committees, risk management committees and fit-and-proper criteria for directors and senior managers.
• Board structure: Banks are required to have a board of directors with a specified number of independent directors (generally at least two, and a higher proportion in larger banks), a separate audit committee headed by an independent director, and mandatory risk-management and credit committees. The Chief Executive Officer cannot be a board member, separating ownership/oversight from executive management.
• Disclosure and reporting: Listed commercial banks must publish quarterly and annual financial statements, Basel III capital disclosures and corporate governance reports. NRB requires prompt reporting of major transactions, related-party dealings and non-performing loans. Nepal has adopted the Basel III framework, which indirectly strengthens governance through capital, liquidity and risk-disclosure requirements.
• Internal control and audit: Banks must have an internal audit department reporting to the audit committee, and external audits by NRB-approved auditors. NRB conducts on-site inspections and can impose penalties, remove directors or management, and even liquidate institutions for governance failures.
• Emerging practices: Most commercial banks now have a code of conduct, whistle-blower policy, anti-money-laundering (AML) framework and CSR programmes. Some banks have adopted international best practices such as the OECD principles and the G20/OECD corporate governance principles.
• Persisting weaknesses: Despite progress, governance in Nepali banks still suffers from promoter dominance and family control, politically influenced board appointments, weak enforcement of fit-and-proper criteria, limited genuine independence of directors, inadequate shareholder activism, and delays in punishing wrongdoers. Cases of misuse of insider information, related-party lending and weak risk culture have appeared in several banks. The problem is less of law and more of implementation and enforcement.
• Role of regulators: NRB has increasingly used prompt corrective action, restrictions on new branches, dividend caps and director disqualifications to enforce governance. SEBON and the Nepal Stock Exchange also require listed banks to comply with governance codes. However, coordination among regulators and timely judicial action remain weak.

Conclusion

Nepal's banking sector has a fairly comprehensive corporate governance framework on paper, aligned with international standards. The real challenge lies in strict enforcement, genuine independence of boards, reducing promoter dominance and building an ethical risk culture. Strengthening these areas is essential for financial stability and public confidence in the banking system.

Cybercrime is any criminal activity carried out using computers, networks or the internet, where the computer is either the target or the tool of the offence. In banking, it includes hacking of accounts and systems, phishing and vishing, identity theft, card skimming and ATM cloning, ransomware and malware attacks, business email compromise, SIM-swap fraud, insider data theft, and denial-of-service attacks. Its main features are that it is borderless, anonymous, fast, technically sophisticated and constantly evolving, so it causes direct financial loss, leakage of customer data, reputational damage and loss of public trust in the financial system. In Nepal, such offences are dealt with mainly under the Electronic Transactions Act, 2063 and the Payment Systems and Settlement Act, 2075.

Measures for banks and financial institutions to stay safe:

1. Strong technology controls — multi-factor authentication for internet and mobile banking, end-to-end encryption of data in transit and at rest, firewalls, intrusion detection and prevention systems, antivirus and patch management, and regular penetration testing and vulnerability assessment.
2. Segregation of duties and least privilege — no single employee should control a transaction end to end; access rights should be role-based, reviewed periodically, and revoked immediately on transfer or exit.
3. Customer awareness — SMS/email alerts for every transaction, warnings against sharing OTP, PIN, CVV or passwords, and education about phishing links and fake calls in the name of the bank.
4. Card and ATM security — EMV chip cards, PIN encryption, skimming detection at ATM booths, CCTV surveillance, and real-time transaction monitoring with automatic blocking of unusual patterns.
5. Cyber security policy and governance — a board-approved IT and cyber security policy, a dedicated information security function, a Chief Information Security Officer, and a Cyber Incident Response Team with a tested response plan.
6. Incident reporting and coordination — mandatory reporting of incidents to Nepal Rastra Bank and the Nepal Police Cyber Bureau within the prescribed time, plus information sharing among banks.
7. Human resource management — verification of employees before appointment, confidentiality agreements, mandatory leave, and regular training on cyber hygiene.
8. Business continuity and insurance — data backup at a separate site, disaster recovery drills, and cyber risk insurance cover.
9. Vendor and third-party risk management — due diligence of IT service providers, contractual liability clauses, and monitoring of outsourced systems.
10. Legal and regulatory compliance — strict adherence to NRB directives on IT security, KYC/AML rules, and the Electronic Transactions Act, 2063, with prompt legal action against offenders.

In short, cybercrime is a growing threat to banking stability, and safety depends on a combination of technology, trained people, aware customers, strong internal controls and effective regulation.

Profit Management and Break-Even Analysis in Loan Product Pricing — Nepal Bank, Assistant Manager (Level 6)

Introduction

A commercial bank earns its core income from the spread between the interest charged on loans and the cost of funds, minus operating costs and loan losses. When introducing a new loan product, management must know at what volume and at what price the product becomes viable. Profit management and break-even analysis are the two analytical tools that answer this question. In the Nepali context — where interest rates are volatile, the base rate is published quarterly, and competition from 20 commercial banks plus microfinance institutions is intense — these tools are not academic exercises but survival requirements.

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1. Profit Management as a Pricing Tool

Profit management for a bank rests on the following components:

a) Net Interest Margin (NIM) $\text{NIM} = \frac{\text{Interest Income} - \text{Interest Expense}}{\text{Average Earning Assets}}$ For a new loan product, the relevant measure is the loan spread: $\text{Spread} = \text{Loan Interest Rate} - \text{Cost of Funds} - \text{Expected Credit Loss Rate}$ If the spread is negative or too thin, the product destroys value no matter how much is lent. Management must therefore set the loan rate at least equal to: $\text{Minimum Rate} = \text{Cost of Funds} + \text{Expected Loss Rate} + \text{Operating Cost Rate} + \text{Target Profit Margin}$

b) Cost-Income Ratio $\text{Cost-Income Ratio} = \frac{\text{Operating Expenses}}{\text{Operating Income}}$ A product that pushes this ratio above the board-approved ceiling (typically 50–60% for Nepali commercial banks) is not sustainable.

c) Risk-Adjusted Return on Capital (RAROC) $\text{RAROC} = \frac{\text{Risk-Adjusted Return}}{\text{Economic Capital}}$ This links pricing directly to the capital consumed by the loan, ensuring the product earns above the cost of equity. Under Basel III norms adopted by Nepal Rastra Bank, capital is scarce and must be allocated to the most profitable products.

d) Cost of Funds and Base Rate NRB requires banks to publish a base rate quarterly, computed from cost of funds, operating costs, and a minimum return. A new product priced below the base rate would violate the spirit of the base rate mechanism and invite regulatory scrutiny.

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2. Break-Even Analysis as a Pricing Tool

Break-even analysis identifies the loan volume at which total revenue equals total cost.

Formula: $\text{BEP (in loan volume)} = \frac{\text{Fixed Costs}}{\text{Contribution Margin per Rs of Loan}}$

Where contribution margin per Rs of loan = Spread (as defined above).

Illustration: Suppose a bank plans a new SME loan product:

$\text{BEP} = \frac{50,00,000}{0.02} = \text{Rs 25,00,00,000 (Rs 25 crore)}$

The product must have an average outstanding loan book of at least Rs 25 crore just to cover costs. If market demand or the bank's branch capacity cannot support this volume, the product should be repriced upward or redesigned.

Sensitivity: If the cost of funds rises to 8%, the contribution margin falls to 1%, and BEP rises to Rs 50 crore — a doubling of the required volume. This shows how vulnerable thin-spread products are to interest rate movements.

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3. How These Tools Help Management

a) Pricing decisions

• They establish a floor price below which the product cannot be offered.
• They allow risk-based pricing: high-risk borrowers are charged a higher rate to cover higher expected losses, rather than cross-subsidising them from low-risk borrowers.
• They support product differentiation — a premium product (e.g., quick-disbursement SME loan) can carry a higher rate justified by higher operating costs.

b) Cost control

• Break-even analysis separates fixed from variable costs, showing management where cost reduction has the greatest impact on the BEP.
• It highlights whether high fixed costs (e.g., a dedicated credit team) are justified by the expected volume.

c) Interest rate risk management

• By computing BEP under different interest rate scenarios, management can assess whether the product remains viable if NRB tightens policy or if deposit rates rise.
• It encourages floating-rate or spread-based pricing rather than fixed-rate pricing for long-tenure loans.

d) Financial sustainability

• A product that covers its fully loaded cost — including expected credit loss and capital charge — contributes to the bank's return on equity (ROE) and long-term viability.
• It prevents "growth for growth's sake," where a bank expands its loan book at unprofitable rates and later suffers capital erosion.

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4. Limitations and Practical Considerations

• Break-even assumes costs and rates are stable; in Nepal, interest rates can shift sharply within a year.
• Expected credit loss estimates may be unreliable for a new product with no historical data; the bank may need to use proxy data from similar products.
• Cross-selling (insurance, remittance, deposits) can improve the effective contribution margin and lower the true BEP — a factor pure break-even analysis ignores.
• Regulatory caps on certain sectors (e.g., priority sector lending, deprived sector lending) may prevent fully risk-based pricing.

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Conclusion

Profit management and break-even analysis give bank management a disciplined framework for deciding whether, at what rate, and at what volume a new loan product should be launched. They convert vague profitability concerns into measurable thresholds — minimum spread, minimum loan book, and minimum RAROC — and allow the bank to test its resilience against interest rate changes. For a Nepali commercial bank operating in a competitive and rate-sensitive market, these tools are essential for pricing discipline, cost efficiency, and long-term financial sustainability.

Major Project Appraisal Techniques (5 marks)

Project appraisal techniques are the methods used to evaluate the financial viability of an investment project. They are broadly classified into two groups:

A. Non-Discounting (Traditional) Techniques

1. Payback Period (PBP): Measures the time required to recover the initial investment from cash inflows. A shorter payback period is preferred. It is simple but ignores the time value of money and cash flows after the payback period.
2. Accounting Rate of Return (ARR): Expresses average annual profit as a percentage of the average investment. It is easy to compute but is based on accounting profit, not cash flow, and ignores the time value of money.

B. Discounting (Time-Adjusted) Techniques

3. Net Present Value (NPV): Discounts all future cash inflows and outflows to present value using the cost of capital. If NPV > 0, the project is accepted; among mutually exclusive projects, the one with the highest NPV is selected. It recognises the time value of money and measures absolute wealth addition.
4. Internal Rate of Return (IRR): The discount rate at which NPV equals zero. If IRR exceeds the required rate of return (cost of capital), the project is accepted. It is useful for ranking projects but can give multiple rates when cash flows change signs.
5. Profitability Index (PI): The ratio of the present value of cash inflows to the initial investment. If PI > 1, the project is accepted. It is particularly useful when ranking projects under capital rationing.

Conclusion: Discounting techniques (NPV, IRR and PI) are considered superior to traditional techniques because they account for the time value of money and the total cash flows over the project's life. In practice, a combination of techniques is used for sound investment decisions.

Difference between Letter of Credit (LC) and Bank Guarantee (BG)

In short: An LC guarantees payment for performance of a contract, whereas a BG guarantees recovery in case of non-performance or default.

Narrow Money (M1)

Narrow money is the most liquid measure of money supply in an economy. It consists of currency held by the public and demand deposits with the banks. In Nepal, Nepal Rastra Bank defines narrow money as:

$M1 = C + DD$

where:

• $C$ = Currency held by the public (outside the banking system)
• $DD$ = Demand deposits with commercial banks

M1 is called narrow money because it includes only those assets that are directly and immediately usable as a medium of exchange. It represents the money available for immediate transactions.

Broad Money (M2)

Broad money is a wider measure of money supply that includes M1 plus other less liquid assets such as time deposits and foreign currency deposits. In Nepal:

$M2 = M1 + TD + FCD$

where:

• $TD$ = Time deposits with commercial banks
• $FCD$ = Foreign currency deposits

M2 is called broad money because it includes near-money assets that are not immediately usable for transactions but can be converted into cash with some delay. It reflects the total purchasing power in the economy.

Factors Affecting Money Supply: The Money Multiplier Theory

The money multiplier theory explains how the central bank's control over base money (reserve money) translates into the total money supply through the banking system. The relationship is:

$M = m \times B$

where:

• $M$ = Money supply
• $m$ = Money multiplier
• $B$ = Base money (reserve money)

The money multiplier is determined by the following factors:

1. Reserve Ratio (r)

The reserve ratio is the proportion of deposits that banks are required to keep as reserves. It includes the cash reserve ratio (CRR) and the statutory liquidity ratio. A higher reserve ratio means banks can lend less from each deposit, reducing the multiplier:

$m = \frac{1 + c}{r + c}$

where $c$ is the currency-deposit ratio. An increase in $r$ lowers the multiplier and hence the money supply.

2. Currency-Deposit Ratio (c)

This is the ratio of currency held by the public to their demand deposits. If people prefer to hold more cash and less in banks, the multiplier falls because fewer deposits are available for banks to create credit. A higher $c$ reduces the money multiplier.

3. Excess Reserves

Banks sometimes hold reserves above the statutory requirement. Higher excess reserves reduce the amount available for lending, lowering the multiplier and money supply.

4. Base Money (B)

Base money is directly controlled by the central bank through open market operations, discount window lending, and changes in reserve requirements. An increase in base money increases money supply proportionally, given the multiplier.

5. Public's Preference and Banking Habits

The public's confidence in the banking system, availability of banking services, and payment habits affect the currency-deposit ratio. Greater banking penetration reduces cash holding and raises the multiplier.

6. Interest Rates

Higher interest rates on deposits encourage people to hold fewer excess reserves and more deposits, increasing the multiplier. Higher lending rates encourage banks to lend more, also raising the multiplier.

Conclusion

Money supply is determined by both the central bank's control over base money and the behaviour of the public and commercial banks through the money multiplier. In Nepal, Nepal Rastra Bank manages money supply by influencing reserve requirements, conducting open market operations, and regulating the banking sector to achieve its monetary policy objectives of price stability and economic growth.

Nepal Bank — Assistant Manager (Level 6) Marks: 10

1. Main Aspects of Commercial Banking Management in Nepal

Commercial banking management in Nepal (governed mainly by the Banks and Financial Institutions Act, 2073 (2016) and directives of Nepal Rastra Bank — NRB) covers the following aspects:

(a) Regulatory and legal management

• Licensing, capital adequacy (Basel III norms), statutory reserves, and liquidity ratios prescribed by NRB.
• Compliance with the Basel III framework, Deposit and Credit Guarantee Fund, anti-money laundering (AML/CFT) rules, and NRB's Unified Directives.

(b) Financial management

• Management of capital (paid-up capital, tier-I and tier-II capital), deposits, borrowings, and reserves.
• Asset–liability management (ALM) to match maturities of assets and liabilities and control interest-rate and liquidity risk.
• Profitability management through spread (interest income – interest expense), fee-based income, and cost control.

(c) Credit (loan) management

• Formulating credit policy, sector-wise lending (agriculture, SME, energy, tourism, etc.), and priority-sector lending as directed by NRB.
• Credit appraisal, documentation, disbursement, monitoring, follow-up, and recovery.
• Maintaining loan-to-deposit ratio, single-borrower and sectoral exposure limits, and classifying loans into Pass, Watchlist, Sub-standard, Doubtful and Bad as per NRB rules.

(d) Risk management

• Identification, measurement, and control of credit risk, liquidity risk, market risk, operational risk, and reputational risk.
• Establishment of a Risk Management Committee, internal control system, and compliance function.

(e) Human resource and organizational management

• Recruitment, training, motivation, promotion, and succession planning.
• Branch network expansion, modernization (CBS, mobile banking, digital wallets), and customer service management.

(f) Corporate governance and social responsibility

• Board of Directors, Audit Committee, and independent directors as per NRB directives.
• Transparency, disclosure, and CSR activities.

2. Rising Non-Performing Credit (NPL) and Non-Banking Assets (NBA)

Present situation: In recent years, the NPL ratio of commercial banks in Nepal has crossed 4–5% (and higher in some quarters), while non-banking assets held by banks have also increased. NRB has repeatedly warned banks about the rising trend.

Causes of rising NPL:

• Over-lending during the liquidity surplus period (especially in real estate, share loans, and unproductive sectors).
• Economic slowdown, low capital expenditure, and weak demand after COVID-19.
• Poor credit appraisal, weak monitoring, and "evergreening" of loans.
• Political instability, strikes, and delay in government payments to contractors.
• Willful defaulters and lack of effective legal action.

Causes of rising NBA:

• Failure of borrowers to repay, forcing banks to take over mortgaged land, buildings, and industries.
• Difficulty in selling such assets due to legal hurdles (Land Revenue Office procedures, court cases).
• Poor valuation and lack of a secondary market for such assets.

Effects: Erosion of capital, reduced lending capacity, lower profitability, and increased risk to depositors and the whole financial system.

3. Measures to Reform the Situation

(a) Strengthen credit appraisal and monitoring

• Strict compliance with NRB's Credit Risk Management Directive; independent credit review before disbursement.
• Regular monitoring, early-warning signals, and timely restructuring only where genuinely viable.

(b) Effective recovery measures

• Use of Debt Recovery Tribunal, Asset Management Companies, and legal action against willful defaulters.
• Publication of blacklist of defaulters; denial of new loans to them.

(c) Manage non-banking assets

• Speedy disposal of NBA through auction, and simplification of legal procedures for transfer of ownership.
• Formation of a separate Asset Management Company to handle NBA.

(d) Strengthen capital and provisioning

• Maintain adequate Loan Loss Provision (Pass 1%, Sub-standard 25%, Doubtful 50%, Bad 100% as per NRB).
• Raise capital through rights issue, bonus, or FPO to absorb shocks.

(e) Improve governance and supervision

• Strong internal audit, Risk Management Committee, and NRB's on-site/off-site supervision.
• Discourage evergreening and related-party lending.

(f) Supportive macro policies

• Timely government capital expenditure, favorable monetary policy, and promotion of productive sectors to improve repayment capacity.

Conclusion: Commercial banking management in Nepal must balance profitability with prudent risk management. Controlling NPL and NBA through strict appraisal, effective recovery, and strong supervision is essential for a sound and stable banking system.

1. Background

Following the global financial crisis of 2007–09, the Basel Committee on Banking Supervision issued Basel III, which added a macro-prudential (system-wide) layer on top of the micro-prudential Basel II framework. Nepal Rastra Bank (NRB), as the regulator of Banks and Financial Institutions (BFIs), has progressively adopted Basel III through its Capital Adequacy Framework (effective from 2015, fully from 2016/17) and subsequent directives, with the aim of building loss-absorbing capacity and curbing systemic risk in the Nepali banking sector.

2. Major Basel III based macro-prudential regulations of NRB

(a) Higher and better-quality capital (Capital Conservation Buffer) NRB requires BFIs to maintain CET1 of at least 4.5%, Tier 1 of at least 6%, and Total Capital of at least 8.5% of risk-weighted assets (RWAs), plus a Capital Conservation Buffer (CCB) of 2.5% of RWAs. Thus the effective minima become CET1 7%, Tier 1 8.5%, and Total Capital 11%. The CCB restricts dividend distribution, bonus shares and staff bonuses when it is not maintained, forcing banks to conserve capital in stress periods. The CCB was phased in from 2016/17 and fully implemented by 2018/19.

(b) Countercyclical Buffer (CCyB) NRB has adopted the framework for a countercyclical capital buffer of 0–2.5% of RWAs, to be activated when credit growth is judged excessive relative to GDP growth. The buffer is to be built up in good times and released in downturns so that credit supply is not abruptly cut when the economy slows. NRB monitors the credit-to-GDP gap and other indicators to decide on activation; the buffer has not yet been activated in Nepal and remains a standby macro-prudential tool.

(c) Leverage Ratio A minimum leverage ratio of 4% (Tier 1 capital to total exposure) is prescribed as a non-risk-based backstop against excessive balance-sheet expansion and to limit the build-up of leverage that risk-weighted measures may understate. It was introduced by NRB around 2017/18.

(d) Liquidity standards — LCR and NSFR NRB has introduced the Liquidity Coverage Ratio (LCR), requiring BFIs to hold sufficient high-quality liquid assets to survive a 30-day stress scenario (phased in from 2017/18, reaching 100% within the phase-in period), and the Net Stable Funding Ratio (NSFR), requiring stable funding of long-term assets over a one-year horizon (introduced from 2018/19). These reduce systemic liquidity risk and maturity mismatch.

(e) Capital buffers for Domestic Systemically Important Banks (D-SIBs) NRB identifies D-SIBs based on size, interconnectedness, substitutability and complexity, and requires them to hold an additional Common Equity Tier 1 (CET1) buffer of RWAs (about 1%) as prescribed in the D-SIB framework. This addresses the "too-big-to-fail" problem and the disproportionate impact of large banks on financial stability.

(f) Loan classification, provisioning and stressed asset norms NRB's Directive No. 2 (Loan Classification and Loan Loss Provisioning) and related circulars require higher general and specific provisions, including a regulatory reserve, and impose stricter classification of restructured/rescheduled loans. These are macro-prudential in effect because they build collective buffers against correlated credit losses.

(g) Sectoral and concentration limits NRB imposes single obligor limits (e.g., 25% of core capital for fund-based exposure and 50% of core capital for total fund-based plus non-fund-based exposure to one borrower/group), sectoral credit caps (e.g., real estate, margin lending, share loans), and directed lending (agriculture, energy, SME, deprived sector). These curb concentration and asset-price bubbles.

(h) Stress testing and risk management NRB requires BFIs to conduct regular stress testing on credit, liquidity, interest rate and FX shocks and to submit results to the Supervision Department. Supervisory review (Pillar 2) uses these to set institution-specific capital add-ons.

(i) Macro-prudential surveillance tools NRB uses the credit-to-GDP ratio, real estate price indices, loan-to-deposit ratio, liquidity ratios, NPL ratios and exposure concentration as early-warning indicators and adjusts monetary and prudential policy (e.g., margin lending caps, loan-to-value ratios) accordingly.

3. Significance

These regulations strengthen the resilience of BFIs against shocks, reduce pro-cyclicality of credit, protect depositors and promote financial stability. They also align Nepal's banking system with international standards, improving the confidence of foreign investors and development partners.

4. Conclusion

NRB's Basel III based macro-prudential framework — covering capital buffers (CCB, CCyB, D-SIB), leverage ratio, LCR/NSFR, provisioning, concentration limits and stress testing — provides a comprehensive defence against systemic risk. Continued refinement, better data and effective supervision are essential for its full effectiveness in Nepal's evolving financial sector.

Change management is the structured process of planning, implementing, and stabilising changes in an organisation's strategy, structure, processes, technology or culture, so that the organisation moves from its current state to a desired future state with minimum resistance and maximum benefit. It involves assessing the need for change, preparing people for it, executing it in phases, and reinforcing the new way of working. Common models include Lewin's unfreeze–change–refreeze model and Kotter's eight-step model.

In the context of growing use of technology in the banking sector:

1. Need for change — Digital banking, mobile wallets, ATMs, internet banking, core banking systems, AI-based credit scoring and fintech competition have made technology unavoidable. Banks must change or lose customers and market share.

2. Process and system change — Manual ledgers and branch-based transactions are replaced by core banking solutions, digital onboarding (KYC), online loan processing and real-time payment systems such as RTGS and connectIPS.

3. People and behavioural change — Employees must be retrained to use new software, and customers must be educated and motivated to adopt digital channels. Resistance arises from fear of job loss, habit and low digital literacy.

4. Structural change — New departments such as IT, cybersecurity, digital banking and data analytics are created, and decision-making becomes more centralised and data-driven.

5. Managing resistance — Through communication, training, participation of staff, pilot testing, phased rollout and leadership support. This reduces disruption and builds trust.

6. Outcome — Faster service delivery, lower operating cost, better risk control, wider financial inclusion and improved competitiveness.

Thus, in banking, change management is not merely installing new technology; it is aligning people, processes and structure with that technology so that the change is accepted, sustained and productive.

Risks Prevailing in the Nepal Banking Sector (4 marks)

1. Credit Risk (Non-Performing Loans): The dominant risk. High concentration of lending in a few sectors — real estate, hydroelectricity, share (margin) lending, and hire-purchase — makes banks vulnerable to sectoral shocks. Directed lending (deprived sector, agriculture, SME) and weak borrower financial disclosure add to default risk. NPLs have shown sharp swings in recent years.

2. Liquidity Risk: Structural surplus liquidity alternates with tight phases. Deposit concentration in a few large institutional depositors, heavy dependence on short-term deposits to fund long-term loans (asset-liability mismatch), and sudden withdrawals during panics create liquidity stress. The interbank rate and CD ratio are key indicators.

3. Market Risk: Interest rate risk from repricing mismatches, exchange rate risk on foreign currency deposits/remittances and trade finance, and price risk on the investment (share) portfolio held as collateral and as trading assets.

4. Operational Risk: Weak internal control in some institutions, fraud and embezzlement by staff, IT system failures, cyber-attacks, ATM/branch network failures, and errors in documentation. Nepal's growing digital banking penetration has widened cyber exposure.

5. Concentration and Connected Lending Risk: Large exposure to a few borrowers/groups, insider and related-party lending, and promoter-driven lending weaken portfolio diversification.

6. Regulatory and Compliance Risk: Frequent changes in NRB directives (CD ratio, sectoral caps, base rate, spread cap), Basel III implementation, AML/CFT compliance, and risk of penalties or licence action.

7. Reputational and Strategic Risk: Loss of depositor confidence from negative publicity, liquidity crisis of cooperatives spilling over, and strategic risk from over-expansion of branches or aggressive growth targets.

8. Other Risks: Country/political risk (policy instability, strikes), climate and environmental risk (floods, landslides affecting collateral and borrowers), and pandemic/health shocks.

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Key Risk Management Techniques and Strategies (6 marks)

A. Credit Risk Mitigation

• Robust credit appraisal: Use of the 5 Cs (Character, Capacity, Capital, Collateral, Conditions), cash-flow based lending, and credit scoring models.
• Collateral management: Proper valuation, periodic revaluation, margin requirements, and legal perfection of security.
• Diversification: Sectoral, geographical and borrower-wise limits; single borrower and group exposure limits as per NRB (e.g., 25% of core capital for single borrower).
• Loan review and monitoring: Independent credit audit, early warning signals, timely rescheduling/restructuring, and prompt provisioning as per NRB directives.
• Credit derivatives/guarantees: Credit guarantee schemes (e.g., Deposit and Credit Guarantee Fund), consortium lending, and syndication to share risk.

B. Liquidity Risk Mitigation

• Asset-Liability Management (ALM): Matching maturities, gap analysis, and maintaining liquidity ratios (CRR, SLR) above NRB floors.
• Liquidity buffers: Holding of unencumbered high-quality liquid assets, standby credit lines, and access to the interbank market and NRB's Lender of Last Resort facility.
• Stress testing: Scenario analysis for deposit run-off and contingency funding plans.

C. Market Risk Mitigation

• Interest rate risk: Repricing gap limits, duration analysis, and use of interest rate swaps where available.
• Forex risk: Position limits (open position limits set by NRB), hedging through forward contracts, and natural hedging by matching assets and liabilities in the same currency.
• Investment risk: Mark-to-market valuation, stop-loss limits, and limits on share-backed lending.

D. Operational Risk Mitigation

• Internal control systems: Segregation of duties, dual custody, maker-checker, and rotation of staff.
• Internal audit and compliance: Risk-based internal audit, whistle-blower policy, and independent compliance function.
• Business continuity planning: Disaster recovery sites, data backup, and IT security (firewalls, encryption, cyber-security policy).
• Insurance: Fidelity insurance, bankers' blanket bond, and D&O insurance.

E. Enterprise-Wide Risk Management (ERM)

• Risk governance: Board-level Risk Management Committee, Chief Risk Officer (CRO), and three lines of defence model.
• Risk appetite framework: Defining risk tolerance limits and cascading them to business units.
• Integrated risk reporting: MIS dashboards, key risk indicators (KRIs), and regular reporting to the Board.

F. Regulatory and Supervisory Compliance

• Basel III adoption: Capital adequacy (CAR), leverage ratio, liquidity coverage ratio (LCR), and net stable funding ratio (NSFR).
• AML/CFT: KYC, customer due diligence, transaction monitoring, and reporting suspicious transactions to the Financial Intelligence Unit.
• Stress testing and ICAAP: Internal Capital Adequacy Assessment Process as required by NRB.

G. Strategic and Reputational Risk Mitigation

• Corporate governance: Independent directors, transparent disclosure, and whistle-blower protection.
• Reputation management: Grievance handling, prompt communication, and CSR activities.
• Contingency planning: Crisis management team and communication strategy.

H. Risk Transfer and Sharing

• Securitisation of loan portfolios, credit insurance, and participation in guarantee schemes to transfer part of the risk.

Conclusion: An effective risk management framework in Nepali banks must be proactive, integrated, and Basel III-compliant, supported by strong governance, adequate capital, robust MIS, and a risk-aware culture. This ensures stability, depositor confidence, and sustainable growth of the banking sector.

Nepal Bank Limited (NBL), established in 1937 (Vikram Samvat 1994, Kartik), is the first bank of Nepal and the oldest financial institution in the country. Its establishment marked the formal beginning of the modern banking system in Nepal. As a pioneer institution, NBL has played a foundational role in the development of the banking sector in particular and the national economy in general. Its contribution can be examined under the following headings.

1. Pioneer in Institutional Banking Before NBL, the Nepali economy depended on informal sources such as moneylenders (Sahu-Mahajan), landlords and goldsmiths who charged exorbitant interest rates. NBL introduced the concept of organized, institutional banking with a formal structure, professional management and regulated interest rates. It thus laid the foundation on which the entire modern banking system of Nepal was later built.

2. Introduction of Modern Banking Services NBL introduced a wide range of banking services for the first time in Nepal, including:

• Acceptance of deposits (savings, current and fixed deposits)
• Provision of loans and advances to trade, industry and agriculture
• Remittance and fund transfer facilities
• Foreign exchange and trade financing
• Safe deposit lockers and other ancillary services

These services familiarized the public with the habit of saving in banks and using banking channels instead of keeping money idle or with moneylenders.

3. Mobilization of Domestic Savings and Capital Formation By collecting scattered savings from households, traders and farmers and channeling them into productive sectors, NBL contributed to capital formation in a capital-scarce economy. It directed credit to agriculture, cottage and small industries, trade and commerce, thereby supporting employment generation and income growth.

4. Financing of Trade, Industry and Agriculture NBL provided credit to exporters and importers, financed agricultural development (including seasonal and term loans to farmers), and supported industrial establishments. In the early decades, it was virtually the sole source of institutional credit, and its lending helped expand domestic production, trade and entrepreneurship.

5. Role in Government Banking and Monetary Management NBL acted as banker to the government, handling government transactions, treasury operations and payments. It also served as a depository for government funds. Until the establishment of Nepal Rastra Bank in 1956, NBL performed central banking functions such as note issue (to a limited extent) and management of the country's monetary affairs. After 1956, it continued as a commercial bank and helped implement the monetary and credit policies of NRB.

6. Expansion of Banking Network and Financial Access NBL expanded its branch network across urban and rural areas, taking banking services to districts where no other bank existed. This geographical expansion improved financial access, encouraged the habit of banking among rural people and created a base of trained banking manpower. Many later banks and financial institutions drew their human resources and experience from NBL.

7. Catalyst for the Growth of the Banking Sector The success and experience of NBL demonstrated the viability of commercial banking in Nepal. It encouraged the establishment of other banks such as Rastriya Banijya Bank (1966), Agricultural Development Bank and later joint-venture and private commercial banks. NBL thus acted as a model and a training ground for the entire banking industry, contributing to competition, innovation and expansion of financial services.

8. Contribution to Economic Development NBL's contribution to the economy includes:

• Mobilization of savings and their conversion into investment
• Support to trade and balance of payments through trade financing and remittances
• Promotion of agriculture and small industries, which are the backbone of the Nepali economy
• Generation of employment in the banking sector and in enterprises financed by it
• Assistance in the development of money and capital markets by participating in the financial system

9. Social and Institutional Contribution NBL has contributed to financial literacy, promotion of the saving habit, and modernization of payment systems. As a large public-sector bank, it has also been involved in priority-sector lending, rural credit and support to government welfare and development programmes.

10. Challenges and Continuing Role Despite its pioneering contribution, NBL later faced problems of non-performing loans, weak governance and capital deficiency. Its reform and restructuring, including strategic partnership and recapitalization, reflect its continuing importance. Even today, as a large commercial bank with an extensive network, NBL contributes to deposit mobilization, credit delivery and financial inclusion.

Conclusion NBL is the foundation stone of Nepal's modern banking system. It introduced institutional banking, mobilized savings, financed trade, agriculture and industry, supported government banking and monetary management, and served as a model and training ground for other banks. Its contribution to the development of the banking sector and to capital formation, employment and overall economic growth is therefore both pioneering and enduring.

Assessment of Current Debt Recovery Practices of Banks and Financial Institutions in Nepal

1. Legal and regulatory framework. Recovery is governed mainly by the Banks and Financial Institutions Act (BAFIA) 2073, the Debt Recovery Act 2058, the Secured Transactions Act 2063, and Nepal Rastra Bank's directives on loan classification, provisioning and restructuring. Under the Debt Recovery Act, banks may refer chronic non-performing loans (generally above Rs 10 million and overdue beyond a set period) to the Debt Recovery Tribunal, which can order recovery through auction of collateral.

2. Internal recovery practices. Banks follow a graded approach: reminder letters and phone calls, personal follow-up by relationship managers, rescheduling/restructuring of viable loans, and finally legal action. Recovery cells or departments, separate from credit departments, handle stressed assets. Recovery is incentivised through staff performance targets and, in some banks, commission-based recovery agents.

3. Collateral enforcement. Non-judicial enforcement of security interests is possible under the Secured Transactions Act through the Secured Transactions Registry, which has shortened the time to seize and sell collateral compared with full court proceedings. Auction through public notice is the usual mode of realisation.

4. Write-off and sale of bad loans. Loans that are fully provisioned and deemed unrecoverable are written off, though the right to recover continues. Some banks sell or assign non-performing loans to asset management companies or other institutions, a practice still at a nascent stage in Nepal.

5. Major weaknesses. Recovery remains slow due to tribunal backlogs, delays in valuation and auction, weak borrower information, politically influenced settlements, and inadequate use of credit information (CIB) to trace defaulters. Recovery rates on written-off loans are low. Many banks rely on restructuring to avoid classifying loans as non-performing, which merely postpones the problem.

6. Emerging good practices. Use of CIB blacklisting, publication of defaulter names, one-time settlement schemes, digital reminders and SMS/email follow-up, and adoption of international practices such as early warning systems and specialised stressed-asset desks. Some banks have adopted recovery policies aligned with Basel III and NRB's prompt corrective action framework.

Conclusion. Debt recovery in Nepali banks has improved through legal reform, the Debt Recovery Tribunal and the Secured Transactions Act, but it is still constrained by judicial delays, weak enforcement and governance issues. Strengthening early detection, timely restructuring, faster collateral enforcement and strict credit discipline is essential to reduce non-performing loans and protect depositors' funds.

What is Money Laundering? (2 marks)

Money laundering is the process of disguising the source and ownership of money obtained from illegal activities (such as drug trafficking, corruption, tax evasion, smuggling, fraud and organised crime) so that the funds appear to have come from a legitimate source. It generally involves three stages: placement (introducing illegal cash into the financial system), layering (moving funds through multiple transactions to hide the trail) and integration (re-injecting the cleaned money into the economy as legitimate income). In Nepal, it is legally defined under the Prevention of Money Laundering and Promotion of Good Governance Act, 2064 (2008) as the act of acquiring, possessing, transferring or investing proceeds of crime, or assisting another person to do so.

How a Bank Can Contribute to Controlling Money Laundering (8 marks)

Banks are the main gateway through which illegal money enters the financial system, so they are the first line of defence. With reference to Nepali norms, a bank can contribute in the following ways:

1. Customer Due Diligence (CDD) / KYC: Verify the identity of every customer before opening an account or conducting a transaction, using citizenship, passport, registration certificate, PAN etc., as required by the NRB Directive on Anti-Money Laundering and the AML Act. For high-risk customers (PEPs, politically exposed persons, non-resident customers, trusts, NGOs), conduct Enhanced Due Diligence (EDD).

2. Risk-Based Approach: Classify customers and products as low, medium or high risk and apply controls proportionate to the risk. Update risk profiles periodically.

3. Record Keeping: Maintain complete records of all transactions and customer identification documents for at least five years as prescribed by NRB, so that they can be produced on demand to NRB, the Financial Information Unit (FIU) or investigating agencies.

4. Reporting Suspicious Transactions: Report suspicious transaction reports (STRs) and threshold transaction reports (TTRs) to the Financial Information Unit (FIU) under NRB without tipping off the customer. Cash transactions above the prescribed threshold must be reported.

5. Monitoring and Detection: Operate an effective transaction monitoring system to detect unusual patterns — structuring of deposits just below the threshold, sudden large cash deposits inconsistent with the customer's profile, frequent transfers to/from high-risk jurisdictions, and round-sum transactions.

6. Compliance Structure: Appoint a Compliance Officer / AML Officer at head office and compliance functions at branches, adopt a written AML policy approved by the Board, and conduct regular internal audit and independent testing of AML systems.

7. Staff Training and Awareness: Train staff at all levels on KYC, red flags, reporting duties and legal obligations so that front-line employees can identify and escalate suspicious activity.

8. Cooperation with Authorities: Cooperate fully with NRB, FIU, the Department of Money Laundering Investigation and other law-enforcement agencies; freeze accounts and assets when directed; and comply with UN Security Council sanctions lists and targeted financial sanctions.

9. Control of Alternative Channels: Apply the same AML standards to remittance, mobile banking, internet banking, card transactions and agent banking, and monitor hawala/hundi-type informal channels.

10. Promoting Financial Integrity: By doing the above, the bank protects its own reputation, avoids regulatory penalties (NRB can fine, suspend or revoke licences), and helps maintain the stability and credibility of Nepal's banking system.

Conclusion: Money laundering threatens the integrity of the financial system and the national economy. Banks in Nepal must therefore treat AML compliance not merely as a legal formality but as a core risk-management function, guided by the AML Act 2064, NRB directives and FIU reporting requirements.

Corporate governance refers to the system, principles, and practices by which a company or financial institution is directed, controlled, and held accountable. It defines the relationships among the board of directors, management, shareholders, depositors, and other stakeholders, and establishes the mechanisms for setting objectives, monitoring performance, managing risk, and ensuring compliance. In banking, corporate governance rests on four pillars: transparency, accountability, fairness, and responsibility.

Why corporate governance is pivotal in preventing operational and reputational risk:

1. Segregation of duties and accountability — separates ownership, board, and management, preventing concentration of power, fraud, and unauthorized transactions (operational risk).
2. Internal control and risk management — mandates independent risk, compliance, and internal audit functions to detect process failures, cyber threats, and control weaknesses early.
3. Sound decision-making — independent, competent boards with functioning committees discourage reckless lending and related-party dealings that lead to NPAs and capital erosion.
4. Transparency and disclosure — timely, accurate reporting builds depositor/investor confidence and protects reputation; concealment turns small problems into scandals.
5. Regulatory compliance — ensures adherence to NRB directives and laws, avoiding penalties and licence restrictions.
6. Ethical culture and whistle-blowing — codes of conduct and protected reporting channels reduce undetected misconduct, a major source of reputational damage.

Principal NRB provisions on corporate governance:

The framework comes mainly through the Bank and Financial Institutions Act (BAFIA), 2073, the Nepal Rastra Bank Act, 2058, and the NRB Unified Directives (especially the directive on corporate governance). Key provisions include:

1. Board size and composition — 5 to 13 directors; at least 25% independent directors; at least one woman director; maximum two consecutive terms of four years.
2. Fit-and-proper criteria — academic, experience, and integrity standards; no insolvency, moral turpitude conviction, or default status.
3. Independent directors — defined qualifications, tenure, shareholding limits, no conflicting business relationship.
4. Board committees — Audit, Risk Management, Credit, ALCO, and Corporate Governance Committees.
5. Separation of roles — Chairperson ≠ CEO; Chairperson not involved in day-to-day management.
6. Meetings and quorum — board meets at least 6 times a year, with no gap of more than three months between meetings.
7. CEO appointment and tenure — board-appointed with NRB approval; maximum two terms of four years.
8. Code of conduct and ethics — written code with whistle-blower protection.
9. Related-party transactions — arm's-length, disclosed, board-approved, subject to limits.
10. Disclosure and reporting — audited financials, governance compliance statement, periodic NRB reports.
11. Internal control and compliance — independent Internal Audit (reports to Audit Committee) and Compliance function.
12. Risk management framework — board-approved policy covering credit, market, liquidity, operational, reputational risks; Chief Risk Officer.
13. Remuneration and performance evaluation — board-approved policy; annual evaluation of board, committees, CEO.
14. Regulatory supervision — NRB on-site/off-site supervision; removal of directors/CEO for governance failures.

Financial Sector Reform in Nepal and Reforms in Nepal Bank Limited

1. Background

Nepal's financial sector was, until the late 1980s, a repressed, state-dominated system: interest rates were administered, credit was directed to priority sectors, and two large state-owned commercial banks — Nepal Bank Limited (NBL, established 1994 BS / 1937 AD) and Rastriya Banijya Bank (RBB, 2022 BS / 1966 AD) — dominated banking. By the mid-1980s NBL carried non-performing loans (NPLs) of roughly 60 per cent of its portfolio and had a negative net worth, i.e. its liabilities exceeded realisable assets. Reform was therefore unavoidable.

2. Phase-wise Financial Reform Programmes

Phase I — Liberalisation (mid-1980s to 1989). Interest rate deregulation began in 1986, branching policy was relaxed, and joint-venture banks (starting with Nepal Arab Bank, 1984) were allowed. The aim was competition and resource mobilisation, but prudential supervision remained weak.

Phase II — Structural Adjustment / FSRP-I (1989–1995). Under the IMF–World Bank Structural Adjustment Programme, the Financial Sector Reform Programme (FSRP) was launched in 1989/90. It covered interest rate liberalisation, removal of directed credit, introduction of prudential norms (capital adequacy, loan classification and provisioning), and a management contract for NBL with a foreign team of bankers to professionalise operations. The Nepal Rastra Bank Act, 2058 (2002) gave NRB operational autonomy and strengthened its supervisory powers.

Phase III — Deepening reforms / FSRP-II (1999–2006). NBL and RBB were by then technically insolvent. The government, with World Bank/IMF assistance, carried out financial and operational restructuring of both banks: recapitalisation, NPL write-off/recovery, branch rationalisation, voluntary retirement schemes, computerisation and MIS. Supporting institutions were created — the Debt Recovery Tribunal (2059 BS / 2002), the Credit Information Bureau, and the Secured Transactions Act, 2063 (2006) for movable collateral. The Bank and Financial Institutions Act (BAFIA), 2063 (2006) consolidated banking law and strengthened supervision.

Phase IV — Consolidation and risk-based supervision (2007–2017). Basel II was implemented from 2008 and Basel III from 2015/16; NRB moved to risk-based supervision, introduced the Prompt Corrective Action (PCA) framework (2014/15), and enforced a phased capital hike — paid-up capital of commercial banks to Rs 2 billion by mid-July 2015 and Rs 8 billion by mid-July 2017 — which triggered large-scale mergers and acquisitions.

Phase V — Current phase. Focus on consolidated supervision, stress testing, digital financial services, financial inclusion, deposit insurance (Deposit and Credit Guarantee Fund), and strategic divestment of state ownership in NBL and RBB.

3. Reforms in Nepal Bank Limited — Credit Quality and Balance Sheet

4. Ways Ahead — Expanding Quality Credit

1. Sectoral diversification: raise lending to productive sectors — agriculture, SME, tourism, hydropower, agro-processing — and cap exposure to real estate, share and import-based lending.
2. Better underwriting: cash-flow based appraisal, project viability study, realistic collateral valuation, avoidance of over-financing and multiple financing of the same borrower.
3. Credit rating and scoring: use internal rating models and the Credit Information Bureau/credit registry before sanction; price loans according to risk.
4. SME and retail focus: collateral-light products backed by the Credit Guarantee Scheme, group lending, digital micro-loans.
5. Technology: digital lending platforms, data analytics and early-warning systems to detect stress before default.
6. Capacity building: continuous training of credit officers and accountability for lending decisions.

5. Ways Ahead — Managing NPL and NBA

1. Early recognition: strict classification as per NRB norms (Pass, Watchlist, Substandard, Doubtful, Bad) and full provisioning; no evergreening by repeated rescheduling.
2. Specialised recovery: dedicated recovery department, one-time settlement, out-of-court settlement, DRT and legal action, sale of bad loans to asset reconstruction companies.
3. Restructuring with discipline: genuine restructuring only for viable borrowers, with fresh cash-flow projections and close monitoring.
4. NBA disposal: NBA arises when collateral is taken over in loan settlement. It should be valued realistically, insured, maintained and disposed of within the period prescribed by NRB (generally three years) through public auction or direct sale, so that capital is not locked in dead assets.
5. Prevention: avoid taking over-valued or illiquid collateral; obtain proper legal documentation and enforce the Secured Transactions Act.
6. Governance and supervision: independent board risk committee, strong internal audit and compliance, and NRB's risk-based supervision with PCA triggers.

6. Conclusion

Nepal's reform journey moved from liberalisation to recapitalisation, then to consolidation and risk-based supervision. NBL's turnaround shows that recapitalisation alone is not enough — professional management, sound credit policy and strict recovery are essential. Going ahead, quality credit growth must be balanced with disciplined NPL and NBA management, supported by technology, governance and effective regulation.

Main Objectives and Strategies of Nepal's Prevailing Commercial (Banking) Policy

Nepal Rastra Bank (NRB), as the central bank, formulates and implements the Commercial/Banking Policy (Monetary Policy) each fiscal year under the Nepal Rastra Bank Act, 2058 (2002) and the Banks and Financial Institutions Act (BAFIA), 2073 (2016). The prevailing policy is guided by the twin goals of price stability and financial sector stability, with supporting objectives of sustainable growth and financial inclusion.

Main Objectives

1. Price stability — Containing inflation within a targeted band (e.g., around 5–6.5%) by managing money supply, credit growth and liquidity.
2. External sector stability — Maintaining adequate foreign exchange reserves (import cover of at least 6–7 months) and a stable balance of payments, supported by remittance inflows.
3. Financial sector stability and soundness — Ensuring banks remain well-capitalised, liquid and free from excessive risk through prudential regulation and supervision.
4. Sustainable economic growth — Channeling credit toward productive sectors to support output and employment.
5. Financial inclusion and access — Expanding banking services to the unbanked, rural and remote populations.
6. Protection of depositors and depositors' confidence — Through deposit insurance, strict supervision and prompt corrective action.

Main Strategies

1. Monetary management through open market operations — Use of repo, reverse repo, outright purchase/sale of securities, and the interest rate corridor (bank rate, deposit collection rate, policy rate) to keep short-term rates within the corridor.
2. CRR and SLR adjustments — Modifying Cash Reserve Ratio and Statutory Liquidity Ratio to absorb or inject liquidity.
3. Directed/productive sector lending — Mandatory sectoral credit floors (agriculture, SMEs, energy, tourism, education, etc.) to direct credit to priority areas.
4. Interest rate spread regulation — Capping the spread between lending and deposit rates to protect borrowers and ensure fair pricing.
5. Prudential regulation and supervision — Risk-based supervision, capital adequacy (Basel III), loan classification, provisioning, and stress testing.
6. Consolidation and restructuring of BFIs — Encouraging mergers/acquisitions to build stronger, well-capitalised institutions and reduce fragmentation.
7. Digital banking and payment system development — Promoting digital transactions, QR payments, mobile banking and interoperability to deepen financial access.
8. Foreign exchange and reserve management — Managing reserves prudently and using instruments such as the NRB bond and foreign currency swap when needed.
9. Deposit insurance and consumer protection — Strengthening the Deposit and Credit Guarantee Fund and grievance-handling mechanisms.
10. Coordination with fiscal policy — Aligning monetary operations with the government's fiscal stance to avoid crowding out and to manage liquidity cycles.

Conclusion

In summary, Nepal's prevailing Commercial Policy aims at macroeconomic stability — chiefly price and external stability — while safeguarding the banking system and promoting inclusive growth. Its strategies combine market-based instruments (interest rate corridor, OMO) with regulatory tools (CRR, SLR, sectoral lending, prudential norms) to achieve these objectives in a remittance-dependent, import-heavy economy.

Five measures of liquidity adopted by banks and financial institutions

1. Cash Reserve Ratio (CRR) — The proportion of total deposits that a bank must keep as cash reserves with the central bank (Nepal Rastra Bank). It is the most direct statutory measure of liquidity. A higher CRR reduces lendable funds and tightens liquidity; a lower CRR releases funds. In Nepal, CRR is maintained on the basis of domestic deposits (currently 4 per cent for commercial banks).

2. Statutory Liquidity Ratio (SLR) — The minimum percentage of total deposits that a bank must hold in liquid assets such as cash, gold, and unencumbered government securities. Unlike CRR, these assets are held by the bank itself but must be readily convertible into cash. SLR ensures a cushion of easily realisable assets to meet depositors' demands.

3. Liquidity Ratio (Current Assets to Current Liabilities) — The ratio of a bank's liquid assets (cash, bank balances, money at call, short-term investments, bills) to its short-term liabilities (deposits and borrowings maturing within a short period). A ratio of, say, 20–30 per cent indicates the bank's capacity to honour withdrawals promptly. A very low ratio signals liquidity risk.

4. Loan-to-Deposit Ratio (Credit-to-Deposit Ratio, CD Ratio) — The proportion of loans and advances to total deposits. A high CD ratio (e.g., above 80–90 per cent) means most deposits are locked in illiquid loans, leaving little liquidity; a low ratio means excess liquidity but lower profitability. NRB prescribes a ceiling on the CD ratio for banks.

5. Cash Reserve to Total Deposits / Liquid Asset to Total Assets Ratio — The proportion of cash and near-cash assets to total deposits or total assets. It shows the percentage of deposits immediately payable and measures the bank's short-run solvency and ability to absorb sudden deposit withdrawals without distress borrowing.

Other acceptable measures: Net Stable Funding Ratio (NSFR), Liquidity Coverage Ratio (LCR), interbank borrowing position, and maturity gap analysis.

Nepal Bank Limited (NBL) was established on 30 Kartik 1994 BS (15 November 1937 AD) as the first modern commercial bank of Nepal. Its evolution can be traced as follows.

1. Background. Before NBL, credit came mainly from informal Sahu-Mahajan moneylenders and from Tejarath Adda, a state lending office founded in 1877 AD (1934 BS) under Prime Minister Ranodip Singh to lend to government employees and the public. It did not mobilise deposits like a bank, so a modern bank was needed.

2. Establishment (1937).

• Set up under the Nepal Bank Act, 1994 BS, with an authorised capital of Rs 1 million.
• Ownership was shared between the government (51%) and the public (49%), a partnership of public and private capital.
• It took over the work of Tejarath Adda and started with its head office in Kathmandu.

3. Role as banker to the government and central bank (1937-1956). Until Nepal Rastra Bank (NRB) was established in 1956, NBL acted as banker to the government, issued notes and carried out some central-bank functions. It also had a monopoly in commercial banking until Rastriya Banijya Bank was set up in 1966.

4. Period of expansion and weaknesses. NBL opened branches across the country, but it had political interference, rising non-performing loans, weak governance and poor service in the 1980s and 1990s, especially after competition from joint-venture banks.

5. Reform. A reform programme with support from the World Bank and IMF began in about 2002, with professional management, restructuring and recovery of bad loans. The bank was converted into a public limited company, and its shares were listed on NEPSE in 2017.

6. Present. NBL now operates as a Class 'A' commercial bank with a nationwide network, and it remains one of the oldest financial institutions in the country.

Bank Guarantee

1. Meaning of Bank Guarantee (2 marks)

A bank guarantee is a written undertaking issued by a bank on behalf of its customer (the applicant), whereby the bank promises to pay a specified sum of money to a named beneficiary if the applicant fails to fulfil the contractual obligation agreed upon between them. The bank's own credit standing stands behind the promise, so the beneficiary is assured of payment without having to rely on the applicant's financial strength. The bank charges a commission (guarantee fee) and normally takes a counter-guarantee, cash margin or collateral from the applicant.

2. Main Parties (Players) of a Bank Guarantee (2 marks)

1. Applicant (Principal / Account Party) — the bank's customer at whose request the guarantee is issued; the party who has the underlying contractual obligation.
2. Beneficiary — the party in whose favour the guarantee is issued and who is entitled to claim payment on default of the applicant.
3. Guarantor (Issuing Bank) — the bank that issues the guarantee and undertakes to pay the beneficiary on a valid claim.
4. Counter-Guarantor / Advising Bank (where involved) — a second bank that guarantees the issuing bank's obligation or authenticates and advises the guarantee to the beneficiary.

3. Types of Bank Guarantees (6 marks)

(a) Performance Guarantee This guarantee is issued to secure the due performance of a contract. The applicant (usually a contractor or supplier) undertakes to complete the work or supply goods as per the contract terms; if he fails to perform, the beneficiary (the project owner or buyer) can invoke the guarantee and recover the guaranteed amount. It is normally issued for 5–10% of the contract value and remains valid until the defect-liability period ends. Example: A construction company bidding for a road project furnishes a performance guarantee to the concerned government authority.

(b) Financial Guarantee This guarantee assures the beneficiary of payment of a financial obligation of the applicant. It covers loans, overdrafts, deferred payments, instalment purchases or any other monetary liability. If the applicant defaults in repayment, the bank pays the outstanding amount to the beneficiary. Example: A bank issues a financial guarantee on behalf of a borrower in favour of a supplier for purchase of machinery on credit.

(c) Advance Payment Guarantee When a buyer or project owner pays an advance to the supplier or contractor before the work begins, the payer faces the risk of non-performance. An advance payment guarantee, issued in favour of the payer, ensures refund of the advance amount along with interest if the applicant fails to execute the contract. The guarantee amount is progressively reduced as the advance is recovered from running bills. Example: A contractor receiving a 20% mobilisation advance from a government department furnishes an advance payment guarantee for the same amount.

(d) Bid Bond / Tender Guarantee Issued in favour of a tender-inviting authority, it assures that the bidder will not withdraw the bid within its validity period and will sign the contract and furnish the performance guarantee if the bid is accepted. It is typically 2–5% of the bid value. If the bidder backs out, the authority forfeits the guarantee amount.

(e) Performance Bond for Customs / Retention Money Guarantee A retention money guarantee allows the contractor to receive the retention amount withheld by the employer by substituting it with a bank guarantee, while a customs guarantee secures payment of customs duty on temporarily imported goods.

1. Performing and non-performing loans under NRB Directives

Under the NRB Unified Directives, BFIs classify loans by the period for which principal or interest remains overdue. The classification decides how much provision a bank must keep.

Performing loan: the borrower pays interest and principal on schedule, or the overdue is less than 3 months. The bank recognises interest as income and needs only a small general provision.

Non-performing loan (NPL): principal or interest remains overdue for 3 months or more. The loan is a non-earning asset: accrued interest is not taken as income, and a higher provision is charged against profit.

2. Reasons for the increase in NPLs in recent years

1. Economic slowdown after COVID-19 and tight liquidity: weak demand, business losses and a sharp rise in interest rates (2022-2023) reduced repayment capacity.
2. Over-exposure to real estate, share and hire-purchase loans: when land transactions and the stock market slowed, borrowers could not repay and collateral was hard to sell.
3. Weak credit appraisal and monitoring: loans were given on collateral, not cash flow, with weak post-disbursement follow-up.
4. End of COVID-era relief: loans restructured and rescheduled during the pandemic turned non-performing when forbearance ended.
5. Imported inflation, slow remittance growth and political uncertainty reduced business confidence.
6. Wilful default and slow legal recovery: delays in auction of collateral and expectations of relief encourage default.
7. Stress in specific sectors, such as tourism, transport, small enterprises and over-indebted microfinance borrowers.

Opinion: the rise reflects both a cyclical downturn and structural weakness in credit culture. BFIs should adopt cash-flow-based appraisal, early-warning systems and prompt recovery, while NRB should strengthen supervision, discourage wilful default and promote lending to productive sectors.

Practices of loan loss provisioning in Nepal

NRB's Unified Directives require every BFI to classify loans by overdue period and to keep provisions out of profit.

1. Classification is mainly based on days past due, with watch-list for weak but performing loans.
2. Additional provision is required for restructured and rescheduled loans and for loans to related parties.
3. Interest suspension: interest accrued on NPLs is not recognised as income until it is recovered.
4. Regulatory reserve: where the provision under NRB rules is higher than the impairment under NFRS 9, the shortfall is kept in a regulatory reserve from retained earnings.
5. Write-off is allowed only after recovery efforts are exhausted and with the required approvals, and the borrower's liability continues.
6. Monitoring: periodic returns, off-site and on-site supervision, and shortfalls must be made good from profit.

Consistency with international practice

• Consistent: the principle of graded classification, general provision on performing loans, interest suspension and prudence are in line with Basel principles and with the idea of IFRS 9.
• Different: NRB is rule-based and backward-looking (days overdue, fixed rates). IFRS 9 requires a forward-looking expected credit loss (ECL) model using probability of default, loss given default and exposure at default, with a three-stage approach (12-month ECL, then lifetime ECL). Basel and IFRS allow banks' own models and judgement; Nepal prescribes minimum rates.
• Direction: banks report under NFRS 9 for accounting, while NRB prescriptive provisioning is the floor, so the system is partly converged.

Conclusion: Nepal's rules are sound and broadly consistent in aim, but they are more prescriptive and backward-looking than international practice. Full convergence needs better data, modelling capacity and supervisory validation of ECL.

Analytical and Selection Techniques of Portfolio Management

1. Concept of Portfolio Management

A portfolio is a collection of different investment assets (shares, bonds, debentures, deposits, loans, etc.) held by an investor or institution. Portfolio management is the process of selecting, allocating, monitoring and revising these assets so as to maximise return for a given level of risk, or minimise risk for a given level of return. Its central logic rests on diversification — "not putting all eggs in one basket" — so that the poor performance of one asset is offset by the good performance of another.

2. Analytical Techniques of Portfolio Management

(a) Return analysis

• Holding period return: $R = \frac{D_t + (P_t - P_{t-1})}{P_{t-1}}$
• Expected return of a portfolio: $E(R_p) = \sum_{i=1}^{n} w_i E(R_i)$ where $w_i$ is the weight and $E(R_i)$ the expected return of asset $i$.

(b) Risk analysis

• Variance / standard deviation: $\sigma_p^2 = \sum_{i=1}^{n} w_i^2\sigma_i^2 + 2\sum_{i<j} w_i w_j \rho_{ij}\sigma_i\sigma_j$
• Covariance and correlation: $\text{Cov}_{ij} = \rho_{ij}\sigma_i\sigma_j$ — low or negative correlation reduces portfolio risk.
• Beta ($\beta$): measures systematic (market) risk; $\beta_p = \sum w_i\beta_i$.

(c) Risk–return models

• Markowitz Mean–Variance Model — identifies the efficient frontier, the set of portfolios giving maximum return for each level of risk.
• Capital Asset Pricing Model (CAPM) — $E(R_i) = R_f + \beta_i(E(R_m) - R_f)$; used to judge whether an asset is over- or under-priced.
• Sharpe's single-index model — simplifies Markowitz by relating each security's return to a market index.
• Arbitrage Pricing Theory (APT) — multi-factor extension of CAPM.

(d) Performance evaluation measures

• Sharpe ratio = $\dfrac{R_p - R_f}{\sigma_p}$ (risk-adjusted return per unit of total risk)
• Treynor ratio = $\dfrac{R_p - R_f}{\beta_p}$ (per unit of systematic risk)
• Jensen's alpha = $R_p - [R_f + \beta_p(R_m - R_f)]$ (excess return over CAPM benchmark)

3. Selection Techniques of Portfolio Management

(a) Traditional / qualitative techniques

• Diversification — spreading funds across industries, sectors, maturity and geography.
• Formula plans — constant-rupee-value plan, constant-ratio plan, variable-ratio plan; these mechanically buy when prices fall and sell when they rise.
• Investment timing — forecasting market trends (technical analysis) to decide entry/exit.
• Security analysis — fundamental analysis (economy, industry, company) and technical analysis (price charts, trends, moving averages) to identify undervalued securities.

(b) Modern quantitative techniques

• Markowitz efficient frontier — choose the optimal portfolio at the tangency of the efficient frontier with the investor's indifference curve.
• Sharpe's single-index / diagonal model — rank securities by excess return to beta and cut off at the optimal point.
• Capital market line and optimal risky portfolio — combine the risk-free asset with the market portfolio.
• Utility / indifference curve approach — match the portfolio to the investor's risk aversion.

4. Application in the Nepali Banking Industry

(a) Regulatory framework as the first selection filter Nepal Rastra Bank's Unified Directives fix exposure limits — single obligor limit, sectoral caps (e.g., agriculture, energy, tourism, SME), deprived-sector lending, and limits on share/real-estate lending. Banks therefore cannot freely optimise; the "efficient frontier" is constrained by regulation. Basel III liquidity and capital ratios (CRAR, LCR, NSFR) further restrict the asset mix.

(b) Asset-side (loan) portfolio selection

• Banks classify loans by sector, borrower, security and maturity, and use credit risk grading (internal rating models) to estimate probability of default and expected loss — a direct application of risk analysis.
• Concentration limits and sector-wise diversification are used to avoid over-exposure to a single industry such as real estate or share trading.
• Risk-adjusted return on capital (RAROC) and loan pricing models are increasingly used to select profitable borrowers.

(c) Investment-side (treasury) portfolio selection

• Banks hold government securities (T-bills, development bonds), NRB bonds, inter-bank deposits and limited shares/debentures.
• Selection is guided by maturity laddering (to manage liquidity and interest-rate risk), duration analysis, and yield comparison — a direct use of return and risk analysis.
• The treasury portfolio is managed as a liquidity buffer for LCR compliance.

(d) Asset–Liability Management (ALM)

• Banks use gap analysis, duration gap and simulation to match rate-sensitive assets and liabilities, applying portfolio theory at the balance-sheet level.
• Diversification of funding sources (deposits, borrowings, refinance) reduces liquidity risk.

(e) Performance evaluation

• Banks compute Return on Assets (ROA), Return on Equity (ROE), Net Interest Margin (NIM) and, in some cases, risk-adjusted measures, to judge portfolio performance.
• Non-Performing Loan (NPL) ratios by sector guide reallocation of the loan portfolio away from weak sectors.

5. Limitations in the Nepali Context

• Underdeveloped capital market — limited securities for diversification.
• Dominance of bank loans over marketable securities — little scope for Markowitz-type optimisation.
• Political and regulatory interference, directed lending, and weak credit information.
• Limited use of advanced quantitative models; decisions remain largely judgmental.

Conclusion

Portfolio management combines analytical tools (return, risk, beta, CAPM, Sharpe/Treynor/Jensen measures) with selection techniques (diversification, formula plans, efficient frontier, index models). In Nepal, these are applied mainly through NRB exposure limits, sector-wise loan diversification, credit-risk grading, treasury maturity laddering and ALM, though the underdeveloped market and regulatory constraints restrict full use of modern portfolio theory.

Money and Banking: Model Answers (Nepal Bank, Assistant Manager, Level 6)

2.1 Banking: history, role and functions

History of banking in Nepal

• Early period: informal lending by Sahu-Mahajans, and Tejarath Adda, founded in 1877 AD under Prime Minister Ranodip Singh to lend to government employees and the public.
• 1937: Nepal Bank Limited, the first commercial bank, under the Nepal Bank Act 1994 BS.
• 1956: Nepal Rastra Bank (NRB), the central bank, under the NRB Act 2012 BS. 1966: Rastriya Banijya Bank. 1968: Agricultural Development Bank.
• 1984 onwards: liberalisation and joint-venture banks (Nepal Arab Bank, now Nabil, 1984); the private-sector banking boom after 1990.
• After 2000: NRB Act 2058, BAFIA 2063 (2006) replaced by BAFIA 2073 (2017), and the merger drive from 2011. Today there are about 20 commercial banks (Class A), plus development banks and finance companies.

Functions of commercial banks: accept deposits, give loans and overdrafts, discount bills, remit funds and issue drafts, issue letters of credit and guarantees, deal in foreign exchange, offer ATM, card and mobile services, and act as agent for payments.

Functions of the central bank (NRB): issue currency, act as banker to the government and to banks, regulate and supervise BFIs, formulate and implement monetary policy, manage foreign exchange reserves, and act as lender of last resort and payment system overseer.

2.2 Management of a commercial bank

• Profitability vs liquidity: the two conflict, since liquid assets earn little and high-yield assets are less liquid. A bank holds CRR, SLR, cash and investments in government securities for liquidity, and loans for profit.
• Asset-liability management (ALM): matching maturities and rates of assets and liabilities, with gap analysis. A negative gap exposes the bank to rising rates.
• Lending principles: safety, liquidity, profitability, purpose, diversification, security and the 5 Cs of credit (character, capacity, capital, collateral, conditions).
• Interest-rate determination: the base rate (cost of funds, operating cost, CRR/SLR cost and return on capital) plus a premium for risk; NRB's policy rate, the interest rate corridor and the spread cap on the lending-deposit difference influence rates.

2.3 Project appraisal and financial analysis

• Appraisal techniques: payback period, accounting rate of return, net present value $NPV = \sum \frac{CF_t}{(1+r)^t} - I_0$, internal rate of return, and profitability index. Accept if $NPV > 0$ or IRR exceeds the cost of capital.
• Aspects: technical, market, financial, managerial, economic and environmental.
• Ratio analysis: liquidity (current ratio), solvency (debt-equity), profitability (ROA, ROE, net interest margin), efficiency (cost-income ratio) and bank-specific ratios (CD ratio, NPL ratio, capital adequacy).
• Cash flow analysis: operating, investing and financing flows, used to judge repayment capacity (for example, the debt service coverage ratio).

2.4 Bank marketing

• Products: deposits (current, savings, fixed), loans, cards, remittance, mobile and internet banking, bancassurance and lockers.
• Target groups: salaried people, migrant workers' families, SMEs, farmers, women, youth and corporates.
• Strategy: the 4 Ps (product, price, place, promotion), plus people, process and physical evidence for services; relationship banking, digital channels, branchless banking and agent banking, and customer service quality.
• Plan: market research, segmentation, positioning, budget, implementation and review.

2.5 Foreign exchange management in Nepal

The Foreign Exchange (Regulation) Act 2019 BS and NRB's Foreign Exchange Management Department govern the system. Nepal has a fixed peg with the Indian rupee, and the rate is INR 1 = NPR 1.60. Other currencies float against the rupee on the basis of the dollar-rupee rate. Authorised dealers (commercial banks) buy and sell foreign currency within NRB directives. Key rules cover current-account convertibility with India, restrictions on capital account transactions, limits for foreign travel and education, and reserve management. Challenges: dependence on remittances, trade deficit and the peg's loss of monetary independence.

2.6 Money supply

• Definition: narrow money $M1$ = currency with the public + demand deposits; broad money $M2$ also includes time and savings deposits.
• Factors: reserve money, the money multiplier, NRB's net foreign assets, domestic credit, government borrowing, remittance inflows, interest rates and the cash-reserve policy.
• High-powered money (reserve money) $H$:

$H = C + R$

where $C$ is currency held by the public and $R$ is bank reserves (cash in vault and deposits with NRB).

• Money multiplier:

$m = \frac{M}{H} = \frac{1 + c}{c + r}$

where $c = C/D$ is the currency-deposit ratio and $r = R/D$ is the reserve-deposit ratio. Example: $c = 0.2$ and $r = 0.1$ give $m = 1.2/0.3 = 4$. A rise in $c$ or $r$ reduces the multiplier.

2.7 Inflation

• Concept: a sustained rise in the general price level.
• Causes: demand-pull (excess demand, credit growth), cost-push (fuel and import price, wages), imported inflation (Nepal's peg means Indian inflation transfers to Nepal), and structural bottlenecks such as supply-chain disruptions.
• Measurement: Consumer Price Index $= \frac{\text{cost of basket in current year}}{\text{cost of basket in base year}} \times 100$; inflation is the percentage change in CPI. NRB publishes the national CPI each month.
• Consequences: it reduces purchasing power of fixed-income groups, discourages saving, redistributes income from creditors to debtors, hurts exports and raises interest rates.
• Trade-off: the Phillips curve suggests lower unemployment can be bought with higher inflation in the short run, but there is no long-run trade-off once expectations adjust (the long-run Phillips curve is vertical).

2.8 Risk management and Basel III

• Risks: credit, market (interest rate, exchange rate), liquidity, operational and reputational risk.
• Basel III raises the quality and quantity of capital. NRB requires a minimum CET1 of 4.5% of risk-weighted assets, Tier 1 of 6%, and total capital of 8.5% (with the capital conservation buffer and the countercyclical buffer, effectively about 11% total capital for commercial banks); other measures include the leverage ratio, liquidity coverage ratio (LCR) and net stable funding ratio (NSFR).
• The three pillars: minimum capital requirement, supervisory review (ICAAP) and market discipline (disclosure).
• NRB Directives also cover the single obligor limit, sectoral limits, CD ratio and risk management guidelines.

2.9 Trade finance

• Letter of credit (LC): a bank's undertaking to pay the exporter on presentation of compliant documents. Types: sight and usance, revocable and irrevocable, confirmed, transferable, back-to-back and stand-by LC. Parties: applicant, issuing bank, advising/confirming bank and beneficiary.
• Bank guarantee: the bank promises to pay if the customer fails to perform. Types: bid bond, performance guarantee, advance payment guarantee and financial guarantee.
• Other instruments: documentary collection, trust receipt, bills discounting and export credit.

2.10 Banking laws

NRB Unified Directives add rules on capital adequacy, loan classification, provisioning, single obligor limits, KYC/AML and consumer protection.