NRB amends NFRS 9 guidelines, enforces stricter rules on credit loss provisioning and collateral valuation

KATHMANDU: Nepal Rastra Bank (NRB) has issued an amendment to the Expected Credit Loss (ECL) Guidelines, 2024 under the NFRS 9 framework, tightening several provisions related to default classification, credit risk staging, collateral valuation, and loss estimation methods. The revised provisions, published through an official regulatory notice, are aimed at enhancing consistency, transparency, and prudence in credit loss provisioning by banks and financial institutions (BFIs) across Nepal.

The amendment introduces changes in how financial institutions classify loan stages, measure credit impairment, estimate losses, and value collaterals. BFIs are now required to adopt more conservative assumptions and standardized risk assessments in line with international standards under the International Financial Reporting Standard (IFRS) 9.

Key Amendments to the Guidelines:
Revision of Credit Risk Staging:

Stage 1 Assets: Financial assets where contractual payments are not overdue or overdue by up to one month (previously 30 days).

Stage 2 Assets: Financial instruments with payments overdue for more than one month but not exceeding three months (earlier defined as 31 to 90 days).

Stage 3 Assets: Instruments with overdue payments of more than three months (previously “more than 90 days”).

BFIs are now required to adopt this updated staging mechanism for identifying and reporting expected credit losses.

Revised Definition of Default:

The amended guidelines clarify that for the purpose of ECL calculation, BFIs must define default to include at least:

Loans with payments overdue for more than three months.

Financial assets classified as Purchased or Originated Credit Impaired (POCI)—including any new loans issued during the current reporting period to borrowers already categorized in Stage 3.

Collateral Valuation and Haircut:

Under the new directive, the net realizable value of collateral must be calculated as follows:

Current fair market value less a 25% haircut is to be applied on all collateral or assets from which BFIs have a legal right to recover.

If a loan has defaulted and collateral or related assets have not been realized within five years, those assets cannot be included in calculating recoverable value.

BFIs must also maintain a valuation history and regularly conduct back-testing—comparing the last valuation before the asset was classified as Stage 3 with the final net sales price of collateral.

Computation of Loss Given Default (LGD):
The updated guidelines require BFIs to use a more structured approach for calculating LGD:

-First, use historical actual recovery rates for LGD estimation.

-If historical data is unavailable, then use valuation-based estimates applying the prudential haircut and considering disposal timelines and costs.

If neither historical recovery data nor reliable valuation inputs are available, BFIs must:

-Seek approval from their board of directors.

-Use a minimum LGD of 45% for such credit exposures.

-BFIs are also required to demonstrate through sound back-testing that assumptions used for LGD estimation are grounded in observed experience and data.

Transfer Between Stages:

Loans classified under Stage 3 cannot be upgraded to a lower-risk stage unless:

-The conditions for Stage 3 no longer exist.

-The loan undergoes a minimum probationary monitoring period of three months (previously six months).

-This probationary period must be satisfied even if repayments have resumed and conditions have improved.

Regulatory Objective:

The NRB’s amendment is aimed at improving the accuracy of expected credit loss calculations, minimizing under-provisioning, and enforcing a more consistent application of risk-based accounting. It also strengthens oversight by requiring board-level approvals when data or input limitations prevent direct LGD calculations.

The revised guidelines are binding on all commercial banks, development banks, and finance companies regulated by the central bank and must be implemented in their credit risk management and financial reporting frameworks.

BFIs must now upgrade their systems to comply with the amendments, including enhancing their data analytics, credit history tracking, and internal governance related to ECL assumptions.