Nepal Rastra Bank eases capital adequacy requirements to boost lending

KATHMANDU: Nepal Rastra Bank (NRB) has introduced more flexible measures regarding the mandatory capital adequacy funds that banks and financial institutions (BFIs) must maintain while issuing credits, aiming to provide relief to struggling BFIs.

Announced during the third-quarterly review of the Monetary Policy for the fiscal year 2023/24 on Friday, the central bank has permitted BFIs to adopt additional tools for managing their capital adequacy funds.

This move is expected to alleviate the pressure on several BFIs that have faced challenges in maintaining their required capital adequacy levels.

As part of the new measures, NRB has reduced the mandatory loan loss provision for credits classified under the ‘good’ category from 1.25 percent to 1.20 percent. Bankers estimate this adjustment will expand the loanable fund amount by an additional Rs 20 billion.

The provision ratio, which was less than one percent before the COVID-19 pandemic, was raised to 1.30 percent during the pandemic, with bankers advocating for it to be maintained at one percent.

Furthermore, NRB has allowed BFIs to issue perpetual preference shares or perpetual debt instruments. This is part of a broader strategy to enhance the capital adequacy framework.

In a mid-term review in February, NRB had already revised the ‘regulatory retail portfolio,’ increasing the threshold for credit to agriculture and small, cottage, and medium enterprises from Rs 10 million to Rs 20 million.

According to the Capital Adequacy Framework 2015, banks are required to maintain an 11.5 percent capital adequacy ratio (CAR), with nine percent from core (tier-1) capital and an additional 2.5 percent from supplementary (tier-2) capital. Failing to meet these levels restricts BFIs from expanding their lending activities, despite having sufficient liquidity.

NRB officials pointed out that non-compliance with capital adequacy guidelines has led to actions against several BFIs in recent months. These institutions were found to have violated rules by understating risk-weighted assets and misrepresenting their capital adequacy ratios.

In addition to capital adequacy adjustments, the central bank introduced several measures to stimulate the real estate, automotive, and stock markets.

Notably, the debt service to gross income ratio for real estate purchases was adjusted from 50 percent to 70 percent. Additionally, the risk weight for hire purchase in automotive loans over Rs 250,000 was reduced from 125 percent to 100 percent.

The NADA Automobile Association of Nepal responded cautiously to the review, acknowledging positive steps but highlighting unaddressed issues like the loan-to-value ratio and the process for opening letters of credit for vehicle imports.

The NRB’s adjustments aim to strike a balance between maintaining financial stability and promoting economic growth by enabling BFIs to lend more freely, thereby supporting various sectors of the economy.