Board directors and CEOs of banks and financial institutions (BFIs) will now be subject to a fine of up to Rs500,000 if they fail to maintain minimum regulatory capital buffer to protect cash parked by depositors in the case of defaults by borrowers and deterioration in financial health of institutions.

The Nepal Rastra Bank (NRB), the central monetary authority, has said the action will be taken against top brass of all financial institutions, including commercial banks, development banks, finance companies and microfinance institutions. This new provision has come into effect with the introduction of the new bylaw on Prompt Corrective Action for Banks and Financial Institutions.

Currently, commercial banks have to maintain minimum capital buffer, technically referred to as capital adequacy ratio (CAR), of 11 percent. This means capital fund of commercial banks must not be less than 11 percent of its total risk weighted assets. 

Risk weights are calculated on the basis of quality of assets. Risk weight for inferior real estate and housing loans, for instance, stands at as high as 150 percent of the credit amount, while risk weight for off-balance sheet assets, like letters of credit, shoots up to 200 percent of the loan amount.

However, commercial banks will not have to factor in conservation buffer while calculating CAR. This means they can maintain a CAR of 9.75 percent. This ratio will come down to 9.5 percent in mid-July, according to NRB’s Unified Directive. National-level development banks, on the other hand, have to maintain CAR of 10 percent, while other development banks and finance companies have to maintain CAR of 11 percent. Microfinance institutions have to maintain CAR of 8 percent.

If the CAR of banks and financial institutions falls short by 25 percent, the NRB will seek recapitalisation plan from them, says the bylaw. Such institutions will also be barred from declaring cash and share dividend for shareholders, opening branch offices, and raising salaries, allowances and other perks of CEO and top-level management officials.

If the CAR of banks and financial institutions squeezes by 50 percent, the NRB will put a cap on their deposit collection and loan disbursement. In the case of microfinance institutions, such a cap will be imposed on borrowings. These institutions will also be barred from conducting new business activities, extending motivation allowances to staff and raising employees’ retirement benefits. These institutions must also seek NRB’s permission before purchasing fixed assets.

If the CAR of banks and financial institutions falls short by 75 percent, they will be barred from opening new deposit accounts, extending fresh loans, raising salary, allowances and perks of staff, and recruiting new employees. 

However, these institutions can hire top-level management staff by seeking NRB’s permission, says the bylaw, adding, microfinance institutions, which have seen 75 percent shortfall in CAR, will be barred from acquiring fresh loans.

Along with these actions, banks and financial institutions that have seen their CAR erode by up to 75 percent will also have to deal with Clause 100 of the Nepal Rastra Bank Act. The clause allows the NRB to suspend top brass of banks and financial institutions, direct board of directors to sack certain directors and employees, and impose a fine of up to Rs500,000 on CEOs and board directors.

If the health of financial institutions deteriorates further, the NRB can declare those institutions problematic and initiate the liquidation process if their condition does not improve within six months.