Banks Hide Bad Loans by Issuing New Loans to Repay Old Ones; CEO Provided Domestic Worker Benefits

May 14, Kathmandu – It has become evident that the practice of issuing new loans to repay old debts in banks and financial institutions obscures the actual scale of bad loans. Nepal Rastra Bank’s supervision process has found that banks grant new loans specifically to conceal bad debts and repay previous loans.

According to the central bank, the true extent of bad loans in commercial banks is not reflected accurately, confirmed during their supervision. The latest fiscal year supervision report states that non-performing loans stand at NPR 220.33 billion.

This amount has increased by 22.40 percent compared to fiscal year 2023/24. In fiscal year 2024/25, bad loans comprise 4.4 percent of the total loans of banks.

Field inspections by the central bank revealed that, when borrowers fail to repay old loans, banks approve new loans at the end of the quarter or fiscal month to show repayment of old loans. The main objective behind providing loans to repay loans has been to hide bad debts, the report concludes. The supervision report states, ‘The practice of extending loans to repay existing loans has concealed bad debts. The bad loan figures currently visible are not the actual numbers.’

Additionally, inspections found that some loans are being misused. The report states, ‘Loans granted for specific purposes are being diverted by borrowers to other activities, and banks have ignored such discrepancies. A majority of loan amounts were found transferred to accounts of directors or their related persons.’

Banks and financial institutions have been negligent in collateral valuation as well. Field inspections discovered some files under auction because of non-repayment were not classified as bad loans. The report also highlights weaknesses in internal auditing within banks.

The internal audit department chief is evaluated by the Chief Executive Officer (CEO), undermining the independence of the audit process, according to the central bank. Under CEO leadership, auditors cannot effectively point out errors committed by the CEO.

Furthermore, weaknesses were found in the boards of directors and senior management of banks. The central bank’s monitoring revealed non-compliance with its regulations regarding the appointment and benefits of CEOs. The supervision report notes, ‘Certain banks have provided CEOs with benefits not allowed by regulations, such as multiple security guards and domestic workers.’

The boards of directors, instead of focusing on policy-making, interfered in minor management tasks. It was also found that some meetings included over 100 agenda items with decisions made without proper discussions. Senior-level positions in banks have been vacant for over three months with lack of inclusivity.

Independent and female director appointments, mandated by official regulations, have not been made timely, according to monitoring findings.

The central bank also concluded that banks keep more CA trainees than permanent staff in audit departments, failing to conduct thorough inspections. Banks have also neglected to conduct timely security audits of software and technology.

Many banks still operate ATMs and branches using outdated and insecure software such as Windows 7. ATM cards and their PINs are kept insecurely in the same room; CCTV backups are not maintained for the required 90 days, and vault keys are not stored under dual supervision. In some cases, cash is transported by motorcycle without security guards.

Banks’ contingency plans for liquidity crises exist only on paper and have not been activated when crises arise, the central bank reported. Heavily relying on a few large institutional depositors poses a risk if they withdraw funds, potentially impacting the banks’ stability.

The rise in bad loans has increased provisioning requirements, placing significant pressure on banks’ capital. Discrepancies have been detected between reports submitted to Nepal Rastra Bank and the actual data in banks’ software. Borrowers’ PAN numbers and names have also been recorded inaccurately.

Commercial banks hold 83.87 percent of total banking sector assets and 87.09 percent of total deposits. The central bank has introduced a procedure to identify systemically important banks.

Since problems in these banks could trigger economic instability, they will face stricter regulation. The central bank also mandated that at least 10 percent of corporate social responsibility funds be spent in each province.

Preparations are underway to modernize supervision by incorporating artificial intelligence and machine learning techniques. Eliminating the problematic practice of issuing loans to repay loans remains a key challenge.

Banks have been classifying high-risk loans as low risk to maintain their capital adequacy ratios within regulatory thresholds; detecting such accounting manipulations is challenging.

The CEO also evaluates the risk management officers and internal audit chiefs, limiting their ability to work independently without pressure.

Ensuring independence from management influence remains a challenge for the central bank. Field inspections for assessing loan utilization are also challenging. The report recommends adopting technology-based modern supervision methods.