Regulatory Failure: How weak supervision by NRB pushed the banking system to the brink

KATHMANDU: The growing crisis in Nepal’s banking sector is no longer just about individual banks, rogue executives, or bad loans. At its core, it has become a story of regulatory fatigue, delayed intervention, and declining supervisory capacity at Nepal Rastra Bank (NRB)—a failure that experts say has allowed risks to accumulate unchecked until they exploded into public scandal.

The Prabhu Bank case, which saw senior executives dragged into criminal investigation, has exposed not merely corporate misgovernance but a far deeper institutional breakdown. It has raised an uncomfortable yet unavoidable question: where was the central bank when all the warning signs were already visible?

A Crisis Years in the Making

Banking experts argue that the current turmoil did not emerge overnight. Irregular lending practices, excessive exposure to connected borrowers, weak internal controls, and management override of credit risk frameworks were visible for years across sections of the banking system. These were not hidden problems. They appeared in financial statements, audit observations, credit concentration data, and risk indicators regularly submitted to the regulator.

Yet decisive regulatory action remained missing.

NRB has long possessed the tools—on-site inspections, off-site surveillance, early warning indicators, and enforcement powers. What it lacked, critics say, was the institutional will to intervene early and forcefully. Instead, supervision often remained procedural, corrective actions were delayed, and enforcement appeared selective and cautious.

“As long as the system looked stable on the surface, deeper structural risks were allowed to grow,” said a former senior banker. “By the time law-enforcement stepped in, the regulator had already lost control of the narrative—and the damage.”

Delayed Action, Escalating Damage

The central bank’s most damaging failure, analysts say, lies in its habitual delay. Problems were acknowledged internally but not acted upon decisively. By the time corrective steps were taken, risks had already crossed from supervisory concern into criminal territory.

This delay converted what could have been a contained regulatory correction into a full-blown credibility crisis—triggering police interventions, depositors’ fear, investor anxiety, and reputational damage to the entire financial system.

In effect, NRB arrived at the scene after the fire had already spread.

An Unsettling Official Defense

What has further fueled public anger is how the regulator has attempted to explain away its failure.

Responding to criticism, an NRB spokesperson defended the institution’s record by saying:

“We were monitoring continuously, but despite our ongoing efforts, such an incident occurred and could not be prevented.”

While meant as a clarification, the statement has done precisely the opposite. To bankers, investors, and policy analysts, it sounded less like accountability and more like an admission of helplessness—an alarming stance for a central bank entrusted with safeguarding financial stability.

“If monitoring was ongoing and the incident still couldn’t be prevented, then monitoring itself was either ineffective or meaningless,” one former regulator remarked. “That is not a defense—it is an indictment of regulatory capacity.”

Erosion of Confidence and Systemic Risk

The consequences of this regulatory failure extend far beyond one institution. Confidence— the invisible currency of banking—has taken a direct hit. Depositors have begun asking hard questions. Shareholders are pricing risk differently. International correspondent banks and foreign investors are quietly reassessing Nepal’s financial governance standards.

Nepal’s banking system, though relatively small, is tightly interconnected. Weak oversight at the center increases the risk that distress in one institution could spill into others. In such an environment, regulatory credibility matters as much as capital adequacy—and both are now under scrutiny.

Capacity Constraints Inside the Central Bank

Insiders acknowledge that NRB itself is under strain. Years of rising complexity in banking—digital channels, fintech partnerships, sophisticated credit products, and now AI-driven systems—have not been matched by equivalent upgrades in supervisory capability.

A shortage of specialized human resources, bureaucratic inertia, political pressure, and risk-averse decision-making have steadily weakened the regulator’s effectiveness. Supervisory action, once proactive, has increasingly become reactive.

The irony is stark: just as the banking system grows more complex, the regulator appears less equipped to stay ahead of it.

Draft Policies Cannot Mask Operational Weakness

NRB’s recent stream of draft guidelines on governance, cyber resilience, IT systems, and artificial intelligence may appear progressive on paper. But documents alone do not regulate banks—decisions do.

Without strong enforcement, real-time supervision, and the courage to act early, even the most advanced policy frameworks risk becoming decorative paperwork. Nepal’s banking crisis has demonstrated that the problem is no longer a lack of rules, but a failure to enforce them when it mattered most.

A Moment of Reckoning

The Prabhu Bank saga should not be reduced to a single criminal case. It is a stress test—of Nepal Rastra Bank itself.

Blaming individual banks while ignoring supervisory failure will only guarantee repetition. The central bank must confront uncomfortable truths: that oversight weakened, intervention came too late, and accountability was diluted.

This is no longer just about reforming banks. It is about rebuilding the credibility, competence, and authority of the regulator.

If NRB fails to learn from this moment, Nepal risks heading toward a future where financial crises are investigated by the police instead of prevented by the regulator. And by then, the damage—to trust, stability, and the economy—may already be irreversible.