DISCLOSURE REQUIREMENTS for Banks:

Banks should at minimum, disclose the following information at the stipulated time intervals. At
the same time, banks shall be free to disclose any other information they consider important for
its stakeholders as and when they consider necessary, beyond the prescribed requirements.
a. Banks should provide the following disclosures as at the end of each financial year along
with the annual financial statements.
1. Capital structure and capital adequacy
 Tier 1 capital and a breakdown of its components;
 Tier 2 capital and a breakdown of its components;
 Detailed information about the Subordinated Term Debts with information
on the outstanding amount, maturity, and amount raised during the year
and amount eligible to be reckoned as capital funds.
 Deductions from capital;
 Total qualifying capital;
 Capital adequacy ratio;
 Summary of the bank’s internal approach to assess the adequacy of its
capital to support current and future activities, if applicable; and
 Summary of the terms, conditions and main features of all capital
instruments, especially in case of subordinated term debts including hybrid
capital instruments.
2. Risk exposures o Risk weighted exposures for Credit Risk, Market Risk and
Operational Risk;
 Risk Weighted Exposures under each of 11 categories of Credit Risk;
 Total risk weighted exposure calculation table;
 Amount of NPAs (both Gross and Net)
 Restructure/Reschedule Loan
 Substandard Loan
 Doubtful Loan
 Loss Loan
 NPA ratios
 Gross NPA to gross advances
 Net NPA to net advances
 Movement of Non-Performing Assets
 Write off of Loans and Interest Suspense
 Movements in Loan Loss Provisions and Interest Suspense
 Details of additional Loan Loss Provisions
 Segregation of investment portfolio into Held for trading, Held to maturity
and Available for sale category
3. Risk Management Function
 For each separate risk area (Credit, Market and Operational risk), banks
must describe their risk management objectives and policies, including:
  Strategies and processes;
 The structure and organization of the relevant risk management
function;
 The scope and nature of risk reporting and/or measurement
systems; and
 Policies for hedging and/or mitigating risk and strategies, and
processes for monitoring the continuing effectiveness of
hedges/mitigants.
 Types of eligible credit risk mitigants used and the benefits availed under
CRM.

b. All commercial banks should make following disclosures on a quarterly basis on their
respective websites.
o Tier 1 capital and a breakdown of its components;
o Tier 2 capital and a breakdown of its components;
o Detailed information about the Subordinated Term Debts with information on the
outstanding amount, maturity, and amount raised during the year and amount
eligible to be reckoned as capital funds.
o Deductions from capital;
o Total qualifying capital;
o Capital adequacy ratio;
o Risk weighted exposures for Credit Risk, Market Risk and Operational Risk;
o Risk Weighted Exposures under each of 11 categories of Credit Risk; o Total risk
weighted exposure calculation table;
o Amount of NPAs (both Gross and Net)
 Restructure/Reschedule Loan
 Substandard Loan
 Doubtful Loan
 Loss Loan
o NPA ratios
 Gross NPA to gross advances
 Net NPA to net advances
o Movement of Non-Performing Assets
o Write off of Loans and Interest Suspense
o Movements in Loan Loss Provisions and Interest Suspense
o Details of Additional Loan Loss Provisions
o Segregation of investment portfolio into Held for trading, Held to maturity and
Available for sale category
o Summary of the bank’s internal approach to assess the adequacy of its capital to
support current and future activities, if applicable; and
o Summary of the terms, conditions and main features of all capital instruments,
especially in case of subordinated term debts including hybrid capital instruments.
 c. Disclosure requirements under this framework should also be published in the respective
websites of the banks. Such disclosures of the banks should also be updated to reflect the
capital adequacy position of the banks after the supervisory adjustments under the review
process. Banks that do not host a website yet are required to make the necessary
arrangements to host a website immediately.
d. Banks are required to report to NRB their capital adequacy computations, according to
the format as specified in Annexure of this framework on a monthly basis within one
month after the end of the month or as required by NRB from time to time. All such
returns has to be validated by the internal auditor of the bank. If the monthly internal
audit could not be carried out, it should be disclosed on the monthly returns. But, such
returns at the end of the quarter must be submitted with the validation from the internal
auditor of the bank. Besides the returns specified above, a bank must inform NRB within
30 days of:
1. Any breach of the minimum capital adequacy requirements set out in this framework
together with an explanation of the reasons for the breach and the remedial measures
it has taken to address those breaches.
2. Any concerns it has about its capital adequacy, along with proposed measures to
address these concerns.

e. Full compliance of these disclosure requirements is a pre-requisite before banks can

obtain any capital relief (i.e., adjustments in the risk weights of collateralized or
guaranteed exposures) in respect of any credit risk mitigation techniques.

Non-Performing Assets? (Imp)

What is 'Non-Performing Assets?'
 Non-Performing Assets (NPA) means the amount of loan that the individual commercial banks
had provided and the customer has not paid in until the time already matured. The distributed
loan is not returned timely by clients and becomes overdue then, it is known as Non-Performing
assets for the banks.
 Among the different types of risk which are faced by banks, credit risk seems to have more
impact on bank’s profitability because bank’s revenue are generate from loans from which
interest is derived.
  NRB directives categories into sub-standard, doubtful and loss. The circular further says a NPA is
a credit facility in respect of which interest has remained unpaid for two quarters.
 Non- performing loan reflects the performance standard of the banks. A high level of NPL
reflects the high probability of loss and net worth get affected due to large number of credit
defaults and similarly low level of NPL reflects the high probability of profit due to low credit
default.
In the fiscal year 2078/79 BS, the average Non-Performing Loans (NPL) has dropped to 1.15%
as compared to 1.36% of the previous fiscal year.

Negative consequences of increase in NPA:

NPA increase means bad condition of bank and no one like to disclose their bad condition as to
avoid LLP. As when there is increase in LLP, profit decreases by which share price decreases.
NPA effect on the return on assets in several ways:
 They erode current profits through provisioning requirements
 They result in reduced interest income
 Increase pressure on net interest margin, thereby reducing competitiveness. So, interest
will decrease as a result no depositor will deposit. And if interest increase, borrower will
not borrow.
 Steady erosion of Capital Resources. When capital decreases, standard solution is to
increase capital, but no shareholder will come as NPA is increasing, so bank will be at a
difficult position.
 When NPA increases, bank reputation decreases.

Factors of Accumulating NPA in Nepal:

A. Internal Factors:
 Diversion of Funds (Main Problem in Nepal)
After taking loan for one purpose, borrower invest in other things.
 Time/Cost Overrun during the project overrun Stage.
Not calculating the exact project duration. Loan for 3 years is extend to 5 years.
Uppertamakosi was supposed to be completed with 35 billion however, it took 65 billion.
 Business (Product, Marketing Failure)
When bank give loan for business and if the business fails, there is high chance to have
NPL.
 Inefficient Management: Poor labor Relation. Surya Garment collapsed due to labor issue
even if it was profitable.
B. External Factors:
 Recession: When there is recession in any country, no borrower will be able to return
money to banks.
 Natural Calamities
 Change in Government Policies
  Price Escalation

Stress Testing: (Imp)

Q1: What does it mean to stress test a bank?

A: Stress tests are an important risk management tool that has been used for a number of years
now, both by banks as part of their internal risk management practices and by supervisors to
assess the resilience of banks and of financial systems in general to possible shocks.

Stress tests assess adverse and unexpected outcomes related to a variety of risks, and provide an
indication of how much capital might be needed to absorb losses would the shocks that have
been assumed actually occur. Usually stress tests envisage a set of hypothetical "what if"
scenarios with different degrees of severity.

Stress tests do not provide forecasts of expected outcomes: the adverse scenarios are designed as
"what-if" scenarios reflecting severe assumptions which are therefore not very likely to
materialise.

Stress testing is a critical tool used by banks as part of their internal risk management and capital
planning. A stress test is also used as a tool to analyze how a bank would cope with an economic crisis.
The test involves the simulation of various unfavorable financial conditions to determine whether a bank
has enough capital to handle whatever scenario comes its way. The results are then studied from
quantitative and qualitative perspectives to predict whether the bank will pass or fail. 

Stress testing also serves as a key component of the supervisory assessment process to identify
vulnerabilities and assess the capital adequacy of banks. Banks have taken this regulatory requirement
and used it for business planning, growth policy, dividend policy, and setting of risk appetite as well as
limits or threshold setting.
Elements for Stress Testing:

• The first element of a stress test is the selection of the initial shock, or indeed
combination of shocks.
• Each shock comprises a change in some specific risk factor.
• One key issue is how large a shock to consider. Because systemic stress tests aim to
highlight vulnerabilities to stresses, the shock should be extreme.
 • But, for any policy conclusions to be meaningful, it should not be so extreme as to be
implausible.
• So, for example, there is no real value in considering the impact of simultaneous default
by all borrowers.
Stress Test Scenarios as Being Applied In Nepal
Relevant Risks Being Applied In Nepal for Conducting Stress Tests:
i. Credit Risk
 What Happens If:
 Certain Percentage of performing loans deteriorated to substandard.
 Certain Percentage of Substandard loans deteriorated to doubtful loans.
 Certain Percentage of Doubtful loans deteriorated to loss loans.
 All NPLs under substandard category downgraded to doubtful.
 All NPLs under doubtful category downgraded to loss.
 Certain Percentage of performing loan of Real Estate & Housing sector loan
directly downgraded to Doubtful category of NPLs.
 Certain Percentage of performing loan of Real Estate & Housing sector loan
directly downgraded to Loss category of NPLs.
 Large exposures downgraded:
• From Performing to Substandard.
• From Performing To Loss
ii. Market Risk
Interest Rate Shocks
• What happens if, there is a change in market interest rate.
Exchange Rate Shocks
• What happens if, there is a change in exchange rate.
Equity Price Shocks
• What happens if there is an adverse movement in the prices of equity exposures
iii. Liquidity Risk
What happens if?
• Withdrawal of deposits in percentage for number of days.
• Deposits withdraw: No. of top depositors.
Stress Testing of Commercial Banks in Nepal
i. Credit Shock
 Stress test results show that there is growing risk in credit among commercial
banks. Stress testing results based on data of mid - July 2016 obtained from 28
commercial bank revealed that a combined credit shock of
o 15 percent of performing loans degraded to substandard,
o 15 percent of substandard loans deteriorated to doubtful loans
o 25 percent of doubtful loans degraded to loss loans and
o 5 percent of performing loans deteriorated to loss loans categories
 Would push the capital adequacy ratio of 27 commercial banks below the
minimum regulatory requirements of 10 percent. The numbers of such banks
were28 in mid July 2015.
 ii. Market Shock
 Commercial banks found to be safe from exchange rate risks as the net open
position to foreign currency was lower for 28 of them.
 Furthermore, since commercial banks have nominal equity investments, the
impact of fluctuation in equity price is near to Zero.

iii. Liquidity Shock

 The stress test under scenario of withdrawal of customer deposits by 2, 5, 10, 10
and 10 percent for five consecutive days' results showed that 22 of 28 commercial
banks are vulnerable towards liquidity crisis.
Additional Content FROM NRB:
Stress Testing Guideline was issued in 2012 requiring BFIs to undergo regular stress tests. As the
first step in stress testing, these guidelines cover simple sensitivity tests in different areas of risk
management. There are simple shocks, which provide the minimum standards for stress testing
in Nepalese banking. All commercial banks are required to conduct stress test on a regular basis.
As per the regulatory provision, board level committee for risk management of commercial
banks should review the stress test results. Likewise, BFIs are encouraged to develop institution
specific scenarios and shocks, along with more advanced techniques of stress testing to improve
their own internal risk management practices. Based on the nature, size and complexities of the
business activities, the techniques for stress testing could vary. The guideline aims to establish
link between our current banking practices and the Basel principles and international best
practices. BFIs are required to conduct stress test on a quarterly basis and the result should be
reported to respective Supervision Departments.
NRB has developed various scenarios for stress testing related to three major risk categories such
as credit, market and liquidity risk. The following are the what-if scenarios that are considered
for stress testing related to credit risk:
o certain percentage of performing loans deteriorated to substandard,
o certain percentage of substandard loans deteriorated to doubtful loans,
o certain percentage of doubtful loans deteriorated to loss loans,
o all NPLs under substandard category downgraded to doubtful,
o all NPLs under doubtful category downgraded to loss,
o certain percentage of performing loan of real estate and housing sector loan directly
downgraded to doubtful category of NPLs,
o certain percentage of performing loan of real estate and housing sector loan directly
downgraded to loss category of NPLs,
o Large exposures downgraded: from performing to substandard and from performing to
loss.

Open Market Operations (Imp)

NRB Act, 2002 made a provision of Open Market Operation (OMO):

 to control excess/under-liquidity in the financial system

 to ensure monetary stability
 to provide confidence in the monetary operations
1. Standing Liquidity Facility (SLF):
 NRB introduced the SLF in order to provide fully collateralized liquidity facility for
commercial banks.
 Currently, SLF is provided to the BFIs in order to assist them meet short-term liquidity
requirements for a period of maximum five days during normal times.
 The amount of loan provided is up to 90 percent of the face value of the collateral.
2. Deposit Collection Auction
 introduced in 2015
 The multiple rate auction procedure is adopted for the issuance of deposits.
 The minimum auctioned amount for 3 months deposit collection auction is Rs. 50 million
and, above that, the amount must be divisible by Rs. 50 million.

How NRB does it?

On the basis of nature, the OMO Bylaw, 2014 divides the OMOs into regular, fine tuning and structural
OMOs. Regular OMOs are conducted Wednesday with a maximum maturity of seven days in order to
manage the general type of shortage/excess liquidity in the system. Fine-tuning OMOs can be conducted
for a maximum maturity period of three months using repo/reverse repo in case of substantial liquidity
fluctuation with high volatility in short-term interest rates. Finally, the operation of structural OMOs is
for the maximum period of six months for the purpose of long-term liquidity management. The
collateral in OMOs includes government securities (such as T-bills, development bonds), NRB bond (if it
exists) and other specified securities. The cap for individual auction is limited to the maximum of two
percent of overall domestic deposit liabilities of the BFIs. Currently, the counterparties in OMOs are 'A'
class, 'B' class and 'C' class financial institutions.

Repo and Reverse Repo:

In a repo, one party sells an asset (usually fixed-income securities) to another party at one price at the
start of the transaction and commits to repurchase the asset from the second party at a different price
at a future date. If the seller defaults during the life of the repo, the buyer (as the new owner) can sell
the asset to a third party to offset his loss. The asset therefore acts as collateral and mitigates the credit
risk that the buyer has on the seller. Thus, although repo is structured legally as a sale and repurchase of
securities, it behaves economically like a secured deposit. The difference between the price paid by the
buyer at the start of a repo and the price he receives at the end is his return on the cash that he is
effectively lending to the seller. In repurchase agreements, this return is quoted as a percentage per
annum rate and is called the repo rate. Although not legally correct, the return is usually referred to as
repo interest.

 Under a repurchase agreement ("RP" or "repo"), NRB buys government securities

from a dealer who agrees to buy them back, typically within one to seven days; a
 reverse repo is the opposite.

 NRB uses these two types of transactions to offset temporary swings in bank
reserves.

 RPs initially add reserves to the banking system and then withdraw them; reverse
repos initially drain reserves and later add them back.

Among the tools used by NRB to achieve its monetary objectives is the temporary purchase and
sale of Government securities in the open market.

In conducting these operations, NRB uses "repurchase agreements" ("RPs" or "repos") and
"reverse repurchase agreements" transactions which have a short-term, self-reversing effect on
bank reserves.

Repurchase agreements are made at the initiative of the NRB. NRB uses these techniques in
open market operations as a supplement to outright purchases or sales.

RPs and reverse repurchase transactions are particularly useful in offsetting temporary swings
in the level of bank reserves caused by such volatile factors as float, currency held by the public
and Treasury deposits at NRB.

When doing an RP, NRB, which conducts open market operations, buys a government security
from commercial bank who agrees to repurchase the obligation within a specified period up to 45
business days (usually 1 to 7 days). When repurchasing the obligation, the commercial bank pays
the original price, plus an agreed-upon return to NRB as payment for use of the funds acquired in
the first part of the transaction.

NRB awards the agreements on a competitive basis. Each commercial bank is requested to
present the rates the bank is willing to pay for the agreements. NRB selects the best bids
presented, ending when the total accepted is approximately equal to the volume of reserves to be
added to the banking system.

NRB makes payment for the securities by directly crediting the account of the commercial bank.
As a result, new bank reserves are created by NRB.

When the transaction is reversed as agreed and the commercial bank repurchases the securities,
funds are withdrawn from bank accounts to pay NRB, thus reducing reserves in the banking
system. The Federal Reserve doesn't pay for its repurchase of the issue until the agreed upon
delivery date. When payment is made, reserves are returned to the banking system.

The proceeds of the RP are slightly less than the full value of the securities purchased. This
difference in value is referred to as margin and serves as protection for the initial purchaser
should security prices decline.

Reverse repurchase transactions have the opposite effect on bank reserves to that of RPs. They
withdraw reserves initially and later return them to the banking system. In an RRP agreement,
NRB sells securities to the commercial banks and agrees to buy them back on a specified date at
a specified price. NRB arranges the transactions competitively, starting with the best terms
proposed.

Prompt Corrective Action (PCA) (Imp)

It is essential that corrective action is taken well in time when the BFI still has adequate cushion of
capital so as to minimize the cost of failure and its spillover effects on the real economy through
financial system.

NRB issued bylaw for PCA based upon the capital adequacy as PCA Bylaw, 2008 (later updated in 2017).
PCA is intended to resolve the problems of BFIs with inadequate capital at the least possible long-term
cost by earlier intervention in the BFIs through mandatory dividend restriction, prohibition on
acceptance of deposits and in several other ways, depending on the triggers. PCA is a regulatory
provision mandating progressive penalties against BFIs that exhibit deteriorating capital ratios. At the
lower extreme, a critically undercapitalized BFI (i.e., one with a ratio of total capital/risk weighted assets
below 2 percent) is required to be declared as problematic in order to minimize long-term losses. NRB
has put in place some trigger points to assess, monitor, control and take corrective actions on weak BFIs.

NRB had set five trigger points on the basis of CAR in PCA Bylaw, 2008. Based on each trigger point, the
BFIs would have to follow certain corrective actions ranging from the submission of the action plans to
the delicensing. As part of its action plan, the BFI is required to develop a detailed capital and operating
plan showing how the BFI's capital will be restored. The plan must show the BFI's projections for its
income, dividends, assets, liabilities, capital, liquidity, NPA, and loan charge-offs, assessed in a
conservative manner. A key factor in determining whether the action plan will be successful is the
commitment of the Board of Directors and, ultimately, of the major shareholders of the BFI.

The Bylaw has been revised in 2017, with some refinements, after introduction of new capital adequacy
framework. The new Bylaw, which has been in effect since 2 May 2017, has reduced existing levels of
PCAs from five to four with introduction of some stringent measures. Unlike previous modality, which
focused on shortfall in capital adequacy in percentage points, the new Bylaw has calculated the existing
capital adequacy of BFIs as a percentage of total required capital adequacy. The first level of PCAs starts
if the capital adequacy defined by NRB falls from minimum level to 25 percent of that level. The second
level of actions triggers when capital adequacy falls from 25 percent to 50 percent of minimum level,
third level from 50 percent to 75 percent of minimum level, while fourth level of PCAs is triggered when
capital deficiency level crosses 75 percent of minimum requirement. The new Bylaw has delegated
authority to take PCAs from department level to the BOD of the NRB.

Capital Adequacy Ratio: (Imp)

NRB issued New Capital Adequacy Framework in 2007 for class ‘A’ banks (commercial bank) in line with
Basel II implemented since 2007/08. Under the new provision, minimum CAR was 10 percent, out of
which at least 6 percent comprised the core capital, consisting of paid-up capital, statutory reserves and
accumulated profits or losses. Core capital is also known as Tier-I capital. Similarly, Tier-II
(supplementary) capital consists of general loan loss provision, revaluation reserve, exchange
equalization reserve, investments adjustment reserve, other reserves, redeemable preference share and
subordinated term debt. The new provision stated that Tier-II capital would not exceed the total Tier-I
capital, with the sum of Tier-I and Tier-II capital constituting the total capital fund.

A new capital adequacy framework based on Basel–III has been applied 2017 onwards. The new
framework has given more emphasis on improving the quality of capital in banks.

Basel I vs. Basel II

Basel I

o Pillar : only minimum capital requirement so than banks can minimize the capital risk
o Risk: Only Credit Risk
o Approach: Standard approach of measurement and capital calculation.

Basel II
o Three Pillars:
i. Pillar I: Minimum capital requirement as of Basel I
ii. Pillar II: Supervisory Role and Review – It is as good as regulatory body of
the country looking at BFI’s financial practices.
iii. Pillar III: Market Discipline and disclosure – Submitting different reports to
the market so that investors and shareholders the entire industry understand
the risk associated and improve the practices.
o Risk:
i. Credit Risk
ii. Operational Risk
iii. Market Risk
o Approach: Multiple approach for measurement of each of the risk and then capital
calculation.
 Tier I Capitals: Common Shares, Share Premium, retained earnings, preferential share,
and different types of reserve.
o Can be converted to cash in short period

Tier II Capital: Bond, Debentures, Loan Loss Provisions, other hybrid capitals
CCD Ratio:
o Credit to Core Capital Plus Deposit
o Maintain 85%
o This means, if a bank has NRs. 100 as capital then the bank can give loan of NRs. 85.

CD Ratio:
o Credit to Deposit
o Maintain 90%

This created liquidity in banks and as a result bank increased interest rates to attract more
deposits. However, due to increased interest rate, the share market started falling.
Base Rate:
o It is the minimum rate below which banks are not allowed to lend to its customers.
CRR, SLR, CCD

When CRR increases, money to be kept at NRB

increases and as a result the money that has to be
floated in market remains freeze at NRB as a result
money supply decreases and when money supply
decreases, economy activity too decreases.

SLR refers to reserve to be maintained at NRB apart

from cash i.e. liquid assets. This leads to decrease of
money supply.
at least 3%