Health of banks and deposit protection

This article discusses the two major indices for measuring the health of banks, capital adequacy ratio and asset quality.

Capital Adequacy Ratio

Banking business basically involves credit, operational, market and liquidity risks. Because of these risks, Nepal Rastra Bank has arranged that each bank should keep capital based on risk so that the bank does not go into losses and sink the deposits of the general public. The National Bank has issued detailed instructions on how to calculate the above risk and how much capital should be kept as a minimum. It is called 'Pillar 1' in the banking world. In simple terms, a bank that takes more risk should hold more capital, while a bank that takes less risk should hold less. So that the capital held on the basis of risk is adequate and the depositor's money is safe. The above guidelines of the National Bank are based on the good banking practices prepared by the Basel Committee for Banking Supervision, which is a group of central banks of the developed countries of the world. The secretariat of the Basel Committee is in the city of Basel, Switzerland.

Nepal Rastra Bank does not just issue instructions. It usually conducts on-site inspection of the banks once a year to check whether the work is done as per the instructions, whether the banks have taken additional risks. During the inspection, apart from the policy issues, the performance system, customer's business, customer service and protection, policy compliance level, institutional governance etc. are also studied. Apart from the on-site inspection, the National Bank is also studying the various details submitted by the banks periodically (daily, fortnightly, monthly, quarterly, annually etc.).

There is hardly any organization without mistakes/weaknesses. When it comes to Standard Chartered Bank Nepal, apart from Nepal Rastra Bank, it has to follow the rules of its mother institution (parent company). Being an international bank, the rules of its parent company are generally considered to be stricter than those of Nepal Rastra Bank. We think that the risk management of a bank working under such strict rules should be much higher than what the National Bank expects, but the National Bank also found its weakness. In December 2080, Rastra Bank instructed all 20 commercial banks, including Standard Chartered, to keep additional capital by classifying them based on the level of increased risk. In this way, after studying the overall aspect of the bank, the process of instructing to put more capital on the basis of risk classification is called 'Pillar 2' (Supervisory Review and Response). All banks must maintain the minimum capital fund ratio as prescribed by the National Bank on a daily basis. At present, there is a rule that all banks must maintain a minimum of 11 percent of the total capital fund (the sum of primary and supplementary capital) of the sum of Pillar 1 and Pillar 2 after calculating the risk-weighted assets as per the instructions of Nepal Rastra Bank. According to Basel rules, 10.5 percent is enough.

The National Bank can change the rule to keep 11 percent capital according to the situation. The rule to maintain an additional 0.5 percent capital fund by the end of June 2081 was released some time ago. In simple words, if a bank has taken a risk equal to 100 rupees, it should currently hold at least 11 rupees in capital. This means that even if the bank loses perhaps 11 more rupees these days, the depositor will not lose a penny. If there is a loss of more than 11 rupees, the depositor may also have to lose.

Asset quality

Banks lend a large portion of the money taken from depositors. A loan is an amount that is given to be returned with interest at a specified time. If the non-performing loans increase excessively, the net interest income of the bank will be negative and the loan loss arrangement will increase and the bank will incur losses. If the amount of loss exceeds the capital fund with the bank, the bank goes bankrupt, in which case the depositor may also have to lose.

Since it is not possible for all depositors to be careful, the government has established Nepal Rastra Bank as a central bank by making a law to look after the interest of the depositors. In order to maintain the stability of the banking sector, the National Bank has made various rules including capital fund adequacy, credit risk management and monitors whether the actions have been carried out accordingly. Banks that do not comply with the rules are subject to various fines, including financial ones, depending on the level of the offense. If it comes to the conclusion that the interest of the depositor is not from that institution, then the license of that institution will be revoked.

According to the rules of the National Bank, the banks should keep the loans in active and inactive categories, even if there is no profit, they should allocate the amount of the loan loss provision in the profit and loss account. Since more than 1.25 percent loss provision should be kept on a loan, since the loan may incur a loss (currently the maximum limit of the interest rate difference is only 4 percent), the maximum effort of the banks is to ensure that no loan falls below the good level.

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