Evolution of Non-Performing Loans (NPL) in Nepal; Addressing the Current Situation of Growing NPL
Non-Performing Loans in Nepal
The Banking sector is considered an important component of the economy and sound financial health of these institutions is imperative to support the economic growth of the economy. However, due to various endogenous factors as well as exogenous shocks, there can be disequilibria in the banking system and normally the outcome is first and foremost reflected in the rising NPLs of the BFIs. Previous studies pertaining to the Nepalese context, have highlighted the various factors that have affected NPLs in the past. There are various interesting findings from these past studies, which hint at the pressure of persistent levels of high inflation on nominal interest rates, and as these interest rates follow inflation rates, increasing cost of borrowed funds put pressure on the financial health of the borrowers and ultimately, they start to surrender which in turn leads to rising NPLs. From the above figure, we can see that normally, the NPLs have come down in the final quarter of the fiscal year which is quite in line with the normal banking practice where banks are focused much more on the recovery activities in the third and fourth quarter. However, there are two instances in the above graph, where we can see that the final quarter of the fiscal year has witnessed higher NPLs and both these instances have one thing in common and that is these are events that were caused by exogenous shock. I leave my readers with the task of guessing these two events and the period where such anomalies were observed.
The time series of the Non-performing loans as seen above tells us that non-performing loans in general and that of the government banks have come down substantially in the past decade. NRB’s strong supervision and implementation of different phases of BASEL to ensure that BFIs are well equipped to deal with the burgeoning risk as the BFIs increase their access to the different parts of the country could be some of the major reasons for downward trend in the NPLs. NPLs are considered to be one of the major indicators to gauge the health of BFIs and NPLs above 1% are considered to be preliminary signals of ominous events to follow. BFIs operate as an intermediary between the supply and demand of loanable funds. For customers to have blind faith in the banking system, it is quite essential that the BFIs follow different protocols which are already in place and demanded by NRB. Furthermore, to ensure such faith, BFIs need to make sure that NPLs are kept below the 1% level. However, due to the nature of the business, banks and financial institutions do tend to have high NPLs in times of economic recession and then seem to recover these NPLs once the period of the slump is over. The history of over 13 years do suggest that the total NPL levels of commercial banks in Nepal till date haven’t been able to stay below the 1% level. Also, the highlighted part in the above graph suggests that NPLs by their nature do tend to decline once the market interest rates fall.
Although history may repeat itself, there are some distinct differences in the current situation compared to the past, i.e. credit to GDP ratio has reached an alarming figure of around 100.8% which is quite high compared to the levels of 46.42% (in the year 2011) more than a decade earlier. There seems to be very little room for credit to grow with exacerbation in the growth of deposits and market currently hit by stagflation. Furthermore, the condition of real estate also seems to have hit its ceiling with prices at an alarmingly high level with transactions declining at such prices. As the majority of the loans issued by BFIs are collateral-backed, stagnation in the real estate sector will only add to the plight of the banking sector. If history does repeat itself, we can see that the fourth quarter will witness improvement in the non-performing loans figures which is normally backed by strong recovery actions by the BFIs to ensure good profitability for their shareholders. Furthermore, the situation is also supported by declining interest rates, which as seen in the graph above, will lead to an ease in the cost of funds of borrowers and their ability to pay back the loans. However, the current predicament seems to be a culmination of the expansionary policies issued in support of the COVID period which led to excessive bubbles in the stock as well as real estate market which put in undue pressure on the external sector of the Nepalese economy. A lot of the recovery in the non-performing loans does seem to rest on how the real estate sector will recover as the overall economy heads toward recovery. Addressing the current situation of growing Nonperforming loans seems to be imperative on the part of the policymakers as non-performing loans issue that are left unaddressed tend to be sticky and this, in turn, discourages further credit creation process and extends the overall recession phase which seems to be quite detrimental for the overall economy.
Raunak Karanjit
M.Sc. Economics, M.Phil System Dynamics
