Every banker becomes a reluctant landlord eventually. The transition is never welcome. It happens when a borrower defaults, the collateral pledged against the loan—usually a plot of land or a building—fails to sell at auction and the deed lands irrevocably on the bank’s own ledger. These properties are classified, with dryness, as “non-banking assets”. For Nepal’s commercial banks, they are becoming a defining problem. Their combined stock has swollen to more than Rs 43bn ($260m). This heap of unsellable brick and mortar is the physical manifestation of a financial malaise: a storm of bad loans and a paralysed property market, locked in a vicious embrace.
An economic slowdown after the pandemic slammed into the world has left many borrowers struggling. Loans are therefore turning sour. The bank’s remedy is to seize the collateral and auction it. But the property market has stagnated: auctions increasingly yield no bidders. The bank is then compelled to adopt the asset. This does not only freeze capital that could be used for new lending. It forces the bank to set aside yet more money to cover the possible loss on its new, unwanted property. The process starves profitability and weakens the institution’s foundations. A slow-moving doom loop is now evident across the sector.
Consider the numbers from the first quarter of this fiscal year. The total net profit for commercial banks fell by nearly a fifth. This was not for want of business. It was devoured by a surge in impairment charges, the money earmarked to cover future loan losses. Banks set aside over Rs 20bn. That sum alone was bigger than the sector’s entire net profit of Rs 13bn. For some, the damage approaches existential. Nepal Investment Mega Bank’s profit collapsed by roughly 95%. Citizens Bank tumbled into a net loss. In each case, the cause was provisioning more than Rs 1.7bn against bad debts.
That provisioning surge says two things. First is it is a necessary accounting response to deteriorating assets. Second, it is a symptom of a deeper sickness. In a healthy system, non-performing loans (NPLs) typically sit below 3% of the total. In Nepal nine of the 20 commercial banks have ratios above 5%, a level that usually triggers regulatory scrutiny. Himalayan Bank’s NPL ratio is 7.39%. It holds nearly Rs6bn in non-banking assets and its accumulated losses surpass Rs 8bn. The case of NIC Asia Bank is perhaps more revealing. It has been deliberately shrinking its loan book for 15 months. Yet its NPL ratio has still climbed to 6.99%, suggesting that the ghosts of past lending are finally coming home to roost.
The pile-up of property acts as a dead weight. These assets generate no income, and necessitate provisions that gut profits. A growing number of banks now show negative retained earnings, meaning accumulated losses have eaten into their capital base. This restricts dividend payments and corrodes their buffer against future shocks. The sector’s aggregate capital remains adequate, notes one analyst in Kathmandu, but the cracks in individual foundations are widening.
The authorities in Kathmandu are not blind to the danger. The government recently relaxed rules that had previously barred banks from holding large tracts of land, granting them a three-year window to sit on these properties. But this is a cosmetic fix for an underlying problem. The issue is not that the banks are forbidden from holding land: it is that they cannot get rid of it. This has revived the long-dormant debate over a “bad bank”—a state-sponsored asset management company that would buy toxic loans and property from commercial banks, allowing them to clean their books and start fresh.
The idea has floated through budgets and policy papers for years, stuck in legislative limbo. Its absence is a critical failure, argues a consultant who has advised the central bank. Without a functional outlet, the toxic assets simply fester within the system. Almost every commercial bank now carries non-banking assets; the collective provision for loan losses outstrips Rs 300bn. Standard Chartered Bank is a rare exception, its foreign ownership and conservative underwriting having spared it the fate of becoming a property magnate.
The crisis is not, however, universal. A few banks have managed to stay islands of stability in a rising sea of defaults. Everest Bank, with an NPL ratio of just 0.74%, and Standard Chartered, at 1.71%, suggest that conservative underwriting and a refusal to join the property-lending frenzy of previous years can provide a powerful shield. Their relative prosperity is a rebuke to their more aggressive peers. For the likes of Himalayan Bank and Kumari Bank, the road back to health will be a long and arduous one, likely involving painful capital raises or big restructuring.
The spike in provisions is a painful but necessary cleanse. Yet without buyers or a proper way to complete the disposal, banks will remain distracted by their unwanted roles as landlords. Bankers would be well advised to keep their walking boots by their desks; they may be inspecting a lot more fields before the year is out. ■
