The aim of this project is to assess the level of non-performing assets and its repercussions in overall financial stability of commercial bank in Nepal through the comparison between proper Nepali bank and the joint venture bank.
The specific objectives are :
- To determine the extent to which commercial banks face potential financial instability because of non-performing assets.
- To identify the mechanisms by which commercial banks control non-performing assets.
- To identify successful and unsuccessful measures in relation to recover and mobilization of non-performing assets of commercial bank.
- To find out Whether or not Nepalese Commercial Banks are following rules and regulations of NRB (Nepal Rastra Bank) regarding their lending, especially to maintain the provision for NPA?
- To enumerate and examine the level of NPA to total assets, total lending and total deposit of these two commercial banks.
- To identify the internal and external factors affecting on the growth of NPA?
- To identify the effects of Non-Performing Assets on ROA and ROE of these two commercial banks.
- To identify which bank has high level of non- performing assets
- To make recommendations as to how commercial banks might improve their efforts in relation to minimization of non-performing assets.
These objectives will be achieved by addressing the following research questions:
Which bank, proper nepali bank or joint venture bank, is actively seeking to minimize risks of non-performing assets?
When did non-performing assets start showing impacts in the bank?
What resources do the banks devote to control non-performing assets?
Who decides on this resource allocation?
How do banks seek to control non-performing assets?
Is non-performing asset increasing amongst banks? What is the degree of increment of non-performing asset in proper Nepali commercial bank and joint venture bank?
What percentage of total assets and total lending is occupying by NPAs of Nepalese commercial banks?
How does non-performing assets effects on return on total assets (ROA) and shareholders’ equity (ROE)?
What are major internal factors, external factors and other main causes to growth of NPA?
To compare the percentage of non-performing assets of these commercial banks in different time period.
Which measure (or measures) in particular has been effective in curbing non-performing assets of commercial banks?
What factors contribute to a successful management of non-performing assets?
Are increased non-performing assets retaining provisions considered to be good news for all banks or only for particular banks?
Do the valuation implications of non-performing assets vary across banks?
The Context and Background of the Proposal:
The proposal is to concentrate on two commercial banks of Nepal: Rastriya Banijya Bank (a proper Nepali bank) and Everest Bank Limited (a joint venture bank); RBB and EBL respectively in acronyms. These are the two main banks operating in the banking industry in the expanding economy of Nepal.
Rastriya Banijya Bank (RBB) is fully government owned, and the largest commercial bank in Nepal. RBB was established on January 23, 1966 (2022 Magh 10 BS) under the RBB Act. Now, the bank is running under bank and financial institute act 2063. RBB has been contributing to socio-economic development of the country for the last four and half decades. The Bank has currently entered into 46 years of service. RBB provides various banking services to a wide range of customers; they include elite to poor individuals, institutional customers, and the customers from industry / business communities. RBB has many correspondent arrangements with major international banks all over the world that facilitate trade finance, bank-originated personal funds transfers and interbank funds transfer. The bank has played crucial role for the development of financial sector i.e. bank, insurance companies through its promoter’s role. As a second commercial bank of the country, the bank has been contributing in the trade, industry and agricultural sector of the country. The bank has also contributed in the hydropower sector. Health and Education sector are also benefitted through its disbursement. As a government owned bank the bank is also contributing towards achieving national goals as per the government directives. The bank has made significant contribution in the development of private sector either by loan disbursement or by active participation in the fairs organized by industrial and business communities.
A leading commercial bank of Nepal established in the year 1994 in joint venture with Punjab National Bank, India, Everest Bank Limited (EBL) started its operation with a view and objective of extending professionalized and efficient banking services to various segments of the society. Punjab National Bank (PNB), EBL’s joint venture partner (holding 20% equity in the bank) is the largest nationalized bank in India. With its presence virtually in all the important centres at Nepal, EBL offers a wide variety of banking services which include corporate and personal banking, industrial finance, agricultural finance, financing of trade and international banking. The large presence and vast resource base have helped the Bank to build strong links with trade and industry.
These two banks make for an interesting comparison since they are both leading commercial banks with large number of clients, covering a diverse range of commercial sectors. They both share the bad news associated with increased provisions, preempted by loan default and increases in non-performing loans. The bad news in loan loss provisions is most likely to occur when fourth quarter audits correct under-provisioning relative to increases in non-performing loans during the first three quarters of the fiscal year which found the common victim in RBB and EBL. In contrast to EBL, the bad news stems from management exercising power over loan-loss provisions and their engagement in protection of larger numbers of defaulters in RBB. The disclosure of RBB as having more potential threats of increase in non-performing assets to EBL is hugely credited to the flexibility for efficient contracting provisions. At the time when economic activities are growing rapidly throughout the country, it is most uphill task for the banks to manage and curb non-performing assets. Moreover, political instability has resulted in more cases of commercial loans defaulting. Interestingly, consumer loans are hardly non-performing given to the rise of middleclass and service industry. But this trend differs in both EBL and RBB. This study purposes to underscore the importance of management of non-performing assets of RBB and EBL while comparing the provisions and their outcome in banking sector.
Preliminary Literature Review
Investment theory defines non-performing asset as “a debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The non-performing asset is therefore not yielding any income to the lender in the form of principal and interest payments. Non-performing asset has become the major problem in investment banking since the inception of banking service itself.
Literature devoted to the cause and effect of non-performing assets of banks concentrates mainly over the consequence and overall impact on the systematic wellbeing of bank due to the rise of non-performing assets. In the article “Differential Valuation Implications of Loan Loss Provisions across Banks and Fiscal Quarters Chi-Chun Liu(1997) concentrates over the impact of loan loss provisions in market: “Prior research finds that, on average, the market reacts positively to loan loss provisions conditional on less discretionary information about loan default, such as non-performing loans and loan write-offs (133). Liu’s finding holds across different model specifications and study periods, despite radical changes in the banking industry over time. Liu finds that loan loss provisions are good news only for banks with loan portfolios that contain a high proportion of loans for which loss provisions require judgment and discretion on a loan-by-loan basis (e.g., commercial loans) rather than using statistical methods (e.g., consumer loans).
A substantial body of research sought to confirm management’s role regarding loan default. James M. Wahlen’s(1994) study in “The Nature of Information in Commercial Bank Loan Loss Disclosures suggests that loan loss provisions are to be “maintained at levels considered adequate to reflect management’s expectations of future losses because “managers have private information regarding default risks inherent in the loan portfolio (455). Wahlen finds that manager’s judgment is necessary in estimating the loan loss provision each period. Wahlen further contends, “It is prohibitively costly for investors and monitors to obtain all of management’s information about the loan portfolio each period . . . [Thus] bank managers can exercise discretion over the timing of provisions for certain loan losses (456). Wahlen examines the relations between unexpected loan loss provisions and both stock returns and changes in future cash flows, and the role of managers in handling non-performing assets, in his study.
Similarly, Iftekhar Hasan and Stephen D. Smith (1997) have argued that traditional view in profitability of banking institutions does not comprehend recently developing market trends. The duo has empirically investigated the alternative hypothesis using overall profit measures: “the negative price-concentration relationship does not hold over the entire range of observed market concentration (47). They have focused on the impact of concentration and efficiency measures using price data for individual products and services. Jackson (1992) suggests that any generalization of such statements since price-concentration measures may vary substantially across time periods. Recently, in a comprehensive study, Berger and Hannan (1993) found more support for the structure-conduct-performance hypothesis than for the relative-market-power and/or efficient structure hypothesis.
While concentrating over the role of banking sector in fetching the great depression of 1930s in America, Adam B. Ashcraft(2005) analyses the implication of non-performing assets in overall macroeconomic scenario in the article “Are Banks Really Special? New Evidence from the FDIC-Induced Failure of Healthy Banks. Ashcraft contends that severe contraction in banks results from uncontrolled lending. He writes:
While there is some disagreement in the literature over the precise mechanism through which failure affects real activity it is hard to walk away without the conclusion that bank failures played an important macroeconomic role in the severity of the economic downturn. What are the possible mechanisms? The most direct effect is through the loss of real wealth by uninsured depositors and other creditors. Even in the absence of a wealth effect, however, the creditors of a failed bank lose liquidity while they wait for assets to be liquidated, which in turn affects real spending in the presence of borrowing constraints. (1712)
Ashcraft observes that when a bank fails, some long-standing relationships with its customers are disrupted, if not destroyed. If customers are unable to replace these relationships with other lenders on equal terms, this contraction in the supply of bank credit has an effect on real activity. And finally, there is the threat of contagion, where the failure of one institution prompts a run on other banks, spreading the effect of failure throughout the economy.
Literature related to non-performing assets and the Indian experience provides the glimpse of Asian economy and challenges of banking industry. Prashanth K Reddy(2002) makes a comparative study of Asian banking industry in “A comparative study of Non Performing Assets in India in the Global context – similarities and dissimilarities, remedial measures. Reddy stresses the importance of a sound understanding of the macro economic variables and systemic issues pertaining to banks and the economy for solving the NPA problem along with the criticality of a strong legal framework and legislative framework. Reddy contends:
Concerns have been raised about their relevance to India. A significant percentage of the NPAs of the PSB’s are in the priority sector. Loans in rural areas are difficult to collect and banks by virtue of their sheer reach are better placed to recover these loans. Lok Adalats and Debt Recovery Tribunals are other effective mechanism to handle this task. ARCs should focus on the larger borrowers. Further, there is a need for private sector and foreign participation in the ARC. Private parties will look to active resolution of the problem and not merely regard it as a book transaction. Moving NPAs to an ARC doesn’t get rid of the problem. Actions and measures have to be taken to build investor confidence. (12)
Reddy stresses on the need to analyze foreign experiences that must be utilized along with a clear understanding of the local conditions to create a tailor made solution which is transparent and fair to all stakeholders.
Reducing systemic risk potential that the non-performing assets create in banks is probably the strongest economic rationale for supervision of any economic system. In that context all over the world capital adequacy has become a core instrument of effective supervision of banking system. But the lack of research in Nepali commercial banking sectors has further prompted to economic instability. This research proposes to study the variables behind non-performing assets and its implication in commercial banking through the comparison between EBL and RBB. Consequently, the researcher hopes in treading into new avenue of research and its make recommendations for the reform process to be initiated in the Nepali banking industry as apart of the liberalisation of the economy in general and the financial stability in particular.
Methodology / Sources of Data
Researching NPAs of commercial banks is a sensitive topic. Several parties contribute to the “dynamics of the situation. These parties are:
- Bank employees and their representative from portfolios of credit (loan) department.
- Perspective clients of consumer loan and commercial loan investment from EBL and RBB
- Post-graduate students of finance and investment from various universities
- Law professionals handling the cases of NPAs.
- Journalists active in featuring economic beat across different prominent newspapers and magazines.
- A comprehensive investigation of this topics should attempt to collect data from each of these parties.
It is proposed that the following methods of data collection be deployed:
A content analysis of literature produced by these commercial banks, particularly their investment literature. Much of this literature is prepared for public consumption and hence will be readily available.
Interviews with a representative sample from each of the parties identified above. Resource constraints do not allow for national coverage, hence these interviews will be conducted in one region of the country, which will be selected on the basis of convenience for the researcher. This could well limit the generalisations that can be made from the data.
The researcher will “pose as a prospective client and will write a letter to each banks requesting guidance for loans. This raises ethical issues since a certain amount of “deception is involved. However, it is felt that it is a legitimate approach and doesn’t cause personal harm to any party.
The researcher will dispatch questionnaire selecting and identifying representative information provider from each party who in turn will provide with necessary information for the research.
This work is essentially a comparative analysis since the issuance of loans and the state of recovery of two commercial banks are being compared. For the comparison to be meaningful and objective it is essential that a standard framework be adopted. It is proposed to structure the data collection and also the comparison and analysis using a distribution framework of:
- Public Sector Units
- Large Industries
- Medium Industries
- Other non priority Sectors
- Small scale industries
- Other Priority sectors
Hence in simple terms the results of the project could be presented in the following dummy table:
Borrowing Segment-wise NPA
Percentage of Total NPA
Percentage of Total NPA
Public Sector Units
Other non priority Sectors
Small scale industry
Other Priority sectors
It is envisaged that this will provide a degree of originality because the application of a distribution framework to an investment relations issue is novel.
On the basis of the comparison of the activities of the two banks some recommendations can be made regarding the relative success of investment initiatives in this context.