Commercial Bank Management

A commercial bank is a financial institution that accepts deposits from the public, grants loans and advances, and provides other banking services such as remittance, foreign exchange, guarantees and payment services, with the aim of earning profit. In Nepal it is licensed as an "A" class institution under the Bank and Financial Institutions Act (BAFIA) and supervised by Nepal Rastra Bank.

A dormant account is a bank account that has had no customer-initiated transactions (deposit, withdrawal or transfer) for a long period, usually 12 months or more under Nepal Rastra Bank practice. Interest postings and bank charges do not count as activity. Such accounts are blocked from normal use and are reactivated only after the customer submits a request with fresh identification (KYC).

Four causes of credit risk:

• Poor credit appraisal: weak analysis of the borrower's repayment capacity, character and collateral.
• Wilful default or borrower's business failure: the borrower cannot or will not repay because of losses, mismanagement or fraud.
• Economic downturn or adverse market conditions: recession, inflation, falling demand or interest-rate shocks reduce borrowers' cash flows.
• Weak monitoring and over-concentration: poor follow-up after disbursement, or lending too much to one borrower, sector or group.

Features of credit insurance:

• It protects a lender or seller against loss when a borrower or buyer fails to pay because of insolvency, default or political events.
• The insurer pays an agreed percentage of the loss (normally 75-90%) in return for a premium.
• It covers either a single transaction or a whole portfolio of receivables, for domestic or export credit.
• It improves the bank's willingness to lend, since credit risk is partly transferred to the insurer.
• It works as a risk-transfer tool and supports business expansion on credit terms.

Four responsibilities of a cashier:

• Receive cash and cheques from customers and make payments against valid cheques and withdrawal slips after verification.
• Maintain the cash book and cash balance, and tally the cash in hand with the books at the end of the day.
• Check for counterfeit or mutilated notes and keep cash securely within the prescribed limits.
• Prepare the day-end cash statement and hand over the cash to the vault or the head cashier, reporting any shortage or excess.

Four types of agency services provided by banks:

• Collection and payment of cheques, bills, drafts, dividends, interest and utility bills on behalf of customers.
• Acting as trustee, executor or administrator of wills and estates.
• Purchase and sale of shares, bonds and securities on behalf of customers (DEMAT or share-registrar services).
• Remittance and foreign exchange services, such as acting as agent for money-transfer companies, and acting as correspondent for other banks.

Features of a bank guarantee:

• It is a written promise by the bank to pay the beneficiary if the customer (applicant) fails to perform a contractual obligation.
• It is a contingent liability: the bank pays only if the applicant defaults.
• It is issued for a fixed amount and a fixed period (expiry date).
• The bank charges a commission and usually takes margin money or collateral from the customer.
• Common types are bid bond, performance guarantee, advance payment guarantee and financial guarantee.
• It is an independent undertaking, so the bank pays on a compliant demand without questioning the underlying contract.

A Vostro account (Latin for "yours") is an account that a domestic bank holds in its own currency on behalf of a foreign bank. The holding bank calls it "your account with us". It is used to settle the foreign bank's transactions in the local currency.

Example: Nabil Bank keeps a Nepali rupee account for Standard Chartered Bank, New York. For Nabil this is a Vostro account. For Standard Chartered the same account is its Nostro account ("our account with you").

Four functions of the back office:

• Process and settle transactions, such as clearing, remittance, trade finance and treasury deals.
• Maintain records, ledgers and the reconciliation of accounts, including nostro/vostro and inter-branch accounts.
• Prepare reports and regulatory returns, and handle documentation and file management.
• Support the front office through data entry, account opening formalities, loan documentation checks and compliance with internal controls.

Mobile banking is a service that lets customers use their mobile phones (through SMS, USSD, apps or a mobile browser) to carry out banking transactions. These include checking balances, transferring funds, paying bills and recharging from anywhere at any time. Nepali examples are the mobile apps of commercial banks and the SMS banking facility.

Commercial banks in Nepal operate under the Bank and Financial Institutions Act (BAFIA), 2073, and the Nepal Rastra Bank (NRB) Act, 2058. Nepal Rastra Bank is the regulatory authority, and the functions of authority are the powers and activities permitted to commercial banks.

Main functions (Class "A" licence):

• Accepting deposits: current, savings and fixed deposits from the public.
• Lending: term loans, working capital, overdraft, trade finance, hire purchase, housing and priority-sector loans.
• Foreign exchange and international trade: letters of credit, guarantees, remittance and currency exchange.
• Agency and utility services: collection and payment, safe-deposit lockers, ATM, credit/debit cards and e-banking.
• Investing in government securities, shares and other permitted instruments.

Regulatory functions of the authority (NRB over banks):

• Licensing and supervision of banks and financial institutions.
• Setting the CRR, SLR, capital adequacy, single-obligor and sectoral lending limits.
• Setting the loan-loss provisioning norms and interest-spread policy.
• Inspecting and taking action in the case of non-compliance.

Meaning: Security in a loan agreement is an asset or guarantee pledged by the borrower that the bank may realise (sell or enforce) if the borrower fails to repay. It is a secondary source of repayment. The primary source is the borrower's cash flow.

Features of good security:

• Marketability: it can be sold easily at a fair price.
• Clear and marketable title: the borrower must own it free of other claims, so the bank can enforce its charge.
• Adequate value: the value is enough to cover the loan plus interest, after a margin or haircut. Land and buildings, for example, are valued by an approved valuer.
• Stability of value: the value does not fall quickly, and perishable or rapidly depreciating assets are avoided.
• Easy transfer and control: it is easy to take possession of, to mortgage or pledge, and to register the bank's lien.
• Legal enforceability: documents (mortgage deed, pledge, hypothecation) are properly executed and registered.
• Insurability: the asset can be insured against loss.

A letter of credit (L/C) is a written undertaking by the importer's bank (issuing bank) to pay the exporter a stated amount if the exporter presents the documents that comply with the L/C terms.

Process:

1. The importer and exporter sign a sales contract that specifies payment by L/C.
2. The importer (applicant) applies to its bank for an L/C and pays the margin or gives collateral.
3. The issuing bank issues the L/C and sends it to the exporter, usually through an advising bank.
4. The advising bank verifies the authenticity of the L/C and passes it to the exporter (beneficiary).
5. The exporter ships the goods and presents the documents (invoice, bill of lading, packing list, insurance, certificate of origin) to its bank (the negotiating or confirming bank).
6. The negotiating bank checks the documents and sends them to the issuing bank. It pays the exporter if the terms are met.
7. The issuing bank examines the documents, reimburses the negotiating bank, and delivers the documents to the importer against payment or acceptance. The importer takes the goods using the documents.

Responsibilities of the parties:

• Applicant (importer): gives correct instructions, pays the margin and charges, and reimburses the bank.
• Issuing bank: issues the L/C, examines the documents carefully, and pays if they comply.
• Advising/confirming bank: authenticates the L/C and, if it confirms, adds its own payment guarantee.
• Beneficiary (exporter): ships the goods as specified and presents compliant documents on time.

Banks provide a number of agency services, acting on behalf of customers for a fee:

• Collection and payment: collecting cheques, bills of exchange, dividends, interest and rent, and paying insurance premiums, taxes, utility and loan instalments as instructed.
• Standing instructions: making regular payments from the customer's account, such as rent, subscriptions and EMIs.
• Trustee and executor services: acting as a trustee for debenture holders, as an executor of a will, or as administrator of a trust.
• Purchase and sale of securities: buying and selling shares and bonds for customers, and acting as depository participant, issue manager or registrar.
• Remittance and foreign exchange: acting as agent for international money-transfer companies, issuing drafts, and handling foreign currency.
• Correspondent services: acting as an agent for other banks in places where they have no branch.
• Other services: insurance and mutual fund distribution, and tax payment collection on behalf of government.

These services earn the bank fee income and strengthen customer relationships.

Foreign exchange risk is the risk of loss arising from adverse movements in exchange rates when a bank has assets, liabilities, or off-balance-sheet positions in foreign currencies that are not perfectly matched. It appears as transaction, translation and economic risk.

Impact on a bank's international operations:

• Trading losses: an open foreign currency position (long or short) loses value when the rate moves against it.
• Lower profit margins: depreciation of a currency reduces the rupee value of foreign income, and appreciation raises the cost of foreign obligations such as import L/Cs.
• Credit risk of customers: importers with foreign liabilities may fail to repay if the domestic currency weakens.
• Capital and liquidity pressure: large exchange losses reduce earnings and capital, and may affect the bank's ability to meet foreign currency obligations.
• Uncertain pricing: making quotations for remittance, trade finance and cross-border lending harder.
• Regulatory pressure: NRB sets net open position limits to restrict exposure.

Management: hedging with forwards, swaps and options, keeping open positions within limits, matching currencies of assets and liabilities, and daily revaluation.

The Asset Liability Management Committee (ALCO) is a senior management committee, usually chaired by the CEO or the head of treasury/finance, that manages the bank's balance sheet to balance profitability, liquidity and risk.

Roles and responsibilities:

• Liquidity management: monitor the funding gap, cash flow mismatches, the CRR/SLR, and the liquidity coverage and net stable funding ratios.
• Interest rate risk management: review the repricing gap of assets and liabilities, and decide the deposit and lending rates.
• Balance sheet planning: set the target composition of assets and liabilities, loan-to-deposit mix and maturity profile.
• Foreign exchange risk management: supervise open positions and the foreign currency liquidity.
• Capital adequacy: ensure that capital is maintained at the regulatory level in line with business growth.
• Pricing and strategy: decide on the pricing of products and funds-transfer pricing, and review investment strategy.
• Contingency funding plan: prepare and test plans for liquidity stress.
• Reporting: report to the board and risk management committee, and follow NRB guidelines.

Each ratio is expressed as a percentage of total operating income (Rs 11,473 million).

$\text{Interest expense ratio}=\frac{14{,}422}{11{,}473}\times100=125.70\%$

$\text{Impairment charge ratio}=\frac{1{,}119}{11{,}473}\times100=9.75\%$

$\text{Non-interest expense ratio}=\frac{4{,}340}{11{,}473}\times100=37.83\%$

$\text{Tax expense ratio}=\frac{2{,}031}{11{,}473}\times100=17.70\%$

Interpretation: The interest expense alone is more than 100% of total operating income, and together with the other costs it makes a heavy burden on the bank. Non-interest expense takes about 38% of income, and impairment and tax take another 9.75% and 17.70%. This shows poor cost control and weak profitability on these figures.

Meaning: Technology risk is the risk of loss from failure, misuse, or inadequacy of information and communication technology used by a bank. It covers system outages, cyber attacks, data breaches, software errors and obsolete technology. It is a part of operational risk and can cause financial loss, reputational damage and regulatory penalties.

Causes:

• Cyber attacks: hacking, malware, ransomware, phishing and card/ATM skimming.
• System failure: hardware or software faults, network downtime, power failure and poor system integration.
• Human error and insider fraud: wrong data entry, weak access control, and unauthorised use by staff.
• Outdated technology: legacy core banking systems that cannot cope with volume or new threats.
• Weak governance and policies: inadequate IT policy, audit and testing.
• Dependence on third-party vendors: outsourced services and cloud providers.
• Inadequate disaster recovery: no proper backup site or business continuity plan.
• Lack of skilled staff and customer awareness.

Measures to reduce technology risk:

• Adopt an IT security policy aligned with NRB IT guidelines, and appoint a chief information security officer.
• Use firewalls, encryption, multi-factor authentication, and intrusion detection systems.
• Control access by role, and monitor logs for unusual activity.
• Regularly upgrade the core banking system and patch software.
• Maintain a data centre and disaster recovery site with regular backups and drills.
• Conduct periodic IT audits, penetration tests and vulnerability assessments.
• Train staff and educate customers about fraud, PIN and phishing.
• Carry out due diligence on vendors and sign service-level agreements.
• Take insurance against cyber loss and set up an incident response plan.

Opening a savings account

1. Choose the bank and account type after comparing the interest rate, minimum balance and charges.
2. Collect and fill the account opening form with personal details, specimen signature and nominee details.
3. Submit KYC documents: citizenship certificate (or national ID/passport), PAN where applicable, two passport-size photographs, and proof of address. For minors, a birth certificate and guardian's documents.
4. Verification by the bank: the officer checks the documents and customer identity, screens against sanction/AML lists, and approves the account.
5. Initial deposit: the customer deposits the minimum opening balance.
6. Account activation: the bank issues an account number, passbook or statement, debit card and mobile/internet banking access.

Closing a savings account

1. The customer submits a written application (account closure form) stating the reason.
2. The customer returns the unused cheque books, passbook and debit card.
3. The bank verifies the identity and signature, and checks for pending dues, loans lien or standing instructions.
4. The bank calculates the interest up to the date and deducts any closing charges and taxes.
5. The balance is paid in cash or by a cheque/transfer, and the account is closed in the system with a closure acknowledgement.

Costs:

• Opening: usually free or a small fee, and a minimum balance requirement (for example Rs 500 to Rs 1,000 or more).
• During the life of the account: annual debit card fee, SMS banking and mobile banking charges, minimum balance penalty, cheque book charges and ATM fees beyond free limits.
• Closing: an account closing fee (often charged if the account is closed within a short period such as 6 months or 1 year), plus a fee for unreturned cards or cheques.
• Government taxes on interest: 5-6% tax at source on the interest income.

These charges vary across banks.

Fundamental role of bank credit in the financial system

• Financial intermediation: banks mobilise savings from depositors and channel them as loans to borrowers who need funds. This links surplus units with deficit units.
• Supports production and trade: working capital and term loans let firms buy inputs, expand capacity, and finance trade.
• Money creation: lending creates deposits and expands the money supply, which supports economic activity.
• Smooths consumption: consumer, housing and education loans let households spend ahead of income.
• Transmits monetary policy: the central bank's policy rate and credit controls affect the lending rate and credit availability, thereby influencing demand and inflation.
• Credit discipline and screening: banks appraise projects, so funds flow to productive uses.

Contribution to economic development

• Capital formation and investment: credit funds industries, agriculture, hydropower and infrastructure, increasing the productive capacity.
• Employment generation: new and expanding businesses create jobs, and microfinance and SME loans support self-employment.
• Entrepreneurship and innovation: credit allows start-ups to turn ideas into businesses.
• Poverty reduction and inclusion: deprived sector lending and priority sector loans reach rural and low-income groups.
• Higher GDP and tax revenue: growth of output leads to higher national income and government revenue.
• Balanced regional development: branch expansion carries credit to rural areas.

If credit is poorly allocated (excessive real estate or consumption lending), it can create inflation, bubbles and bad loans. Prudent lending is therefore essential.

Is innovation necessary for survival? Yes.

• Competition: with many banks offering similar products in Nepal, and with fintech and wallet companies entering, a bank without new products loses customers.
• Changing customer needs: customers now expect digital channels, quick service and customised products.
• Income diversification: new fee-based products reduce reliance on interest spread, which has narrowed.
• Cost efficiency: digital products such as QR payments and mobile banking lower the cost per transaction.
• Regulatory and technology changes: developments such as interoperable payments need continuous adaptation.
• Customer retention and brand image: innovative banks attract young and urban customers and build a stronger brand.

Challenges in launching innovative products

• High cost of technology, research and marketing.
• Weak technological infrastructure and legacy systems, and cyber-security risk.
• Regulatory restrictions and approval requirements of Nepal Rastra Bank, and slow approval processes.
• Shortage of skilled human resources and resistance to change from staff.
• Easy imitation by competitors, as products cannot be patented, which reduces the first-mover advantage.
• Low customer awareness and digital literacy, particularly in rural areas, and poor internet and power access.
• Risk of failure and uncertain returns.
• Fraud and operational risk from new channels.

To overcome these, banks should invest in technology and training, work with fintech firms, and educate customers.

(a) Problem in deposit collection

Yes. The deposits are mostly very short term (one to six months), so they are volatile and the bank has little stable funding. At the same time, the deposit interest rate is below the industry average, which makes deposits costly to attract and easy to lose. Funds are being collected through staff targets and incentives, which encourages quantity over stability. The bank also lends long term against short-term deposits, which creates a maturity mismatch and liquidity risk.

How to address it:

• Offer competitive interest rates and attractive long-term products (fixed deposits, recurring and savings schemes with higher rates for longer tenures).
• Build a base of core deposits through relationship banking, salary accounts and digital services.
• Diversify the depositor base (institutions, individuals, rural and urban).
• Manage asset-liability matching through ALCO, with limits on long-term lending in relation to long-term funding.

(b) Solving the problem in the lending process

The bank gives only collateral-based loans, which makes it ignore cash-flow viability, and it lends heavily long term. Staff are rewarded for loan selling, so appraisal quality suffers.

• Adopt a cash-flow based appraisal that tests repayment capacity, character, capital and conditions, not only collateral value.
• Separate the sales function from credit approval (independent credit risk unit).
• Verify collateral valuation properly and monitor it regularly.
• Follow up after disbursement, with end-use checks and early warning signals.
• Diversify the loan portfolio across sectors and cap exposure to single borrowers.
• Match loan tenure to the stable funding available.
• Train credit staff.

(c) Reasons for increasing non-performing loans (NPLs) and measures

Reasons:

• Weak credit appraisal and over-reliance on collateral.
• Staff incentives linked to loan volume, which causes aggressive and low-quality lending.
• Long-term lending in sectors such as housing, shares and cottage industries without adequate analysis.
• Poor monitoring and recovery efforts, and diversion of funds by the borrowers.
• Economic slowdown and fall in asset prices (collateral loses value, e.g. shares and real estate).
• Concentration risk and evergreening.

Measures:

• Strengthen appraisal, approval and monitoring, and use credit scoring and early warning systems.
• Set up a strong recovery unit and negotiate rescheduling and restructuring for viable borrowers.
• Take legal action and auction collateral against wilful defaulters, and use the credit information bureau.
• Link incentives to loan quality (performing portfolio), not volume.
• Maintain adequate provisioning and diversify the portfolio.

(d) Additional recommendations

• Lending: shift towards a balanced portfolio, with limits per sector, and make decisions through a credit committee; use cash-flow lending with collateral as a back-up.
• Collateral: use independent, regular valuation, apply conservative loan-to-value ratios, ensure the legal title is clear, and insure collateral; avoid over-dependence on volatile security such as shares.
• Deposit marketing: price the deposit products competitively, create long-term and customer-specific products, use digital channels and campaigns, and focus on customer satisfaction and retention rather than only target-based selling.
• Incentive system: reward on quality (low NPL, retention of deposits, tenor, customer satisfaction and profitability) instead of volume alone, with clawback or deferral for loans that turn bad.
• Strengthen ALCO and risk management, and build staff skills.