Karnali Development Bank, with its headquarters in Nepalgunj, published its financial statement for the first quarter of Fiscal Year 2024/25 on October 28. The statement reported a capital adequacy ratio of 10.05% and non-performing loans (NPLs) at 7.27% as of mid-October. However, less than two months later, Nepal Rastra Bank (NRB) declared the bank problematic on December 25, citing that its bad loans had surged to 40.85%, while its capital adequacy ratio had fallen below 4%. Subsequently, the central bank formed a three-member committee, led by Deputy Director Tikaram Khatiwada, to oversee the bank's management.
The drastic deterioration of Karnali Development Bank’s financial health has raised questions about the credibility of financial statements published by banks. Former NRB Executive Director Nara Bahadur Thapa expressed concern, stating, "It is alarming that the bank's management needed intervention just two months after reporting seemingly stable financial conditions. This casts doubt on the reliability of the data shared by banks and financial institutions."
This skepticism aligns with recent concerns from the International Monetary Fund (IMF). The IMF has questioned the quality of bank loans in Nepal, suspecting a practice known as "evergreening," where additional loans are issued to repay existing ones, thus concealing bad loans. As part of its Extended Credit Facility (ECF) program, the IMF mandated a credit quality assessment for Nepal’s 10 largest commercial banks by an international consultant. Despite initiating the process in March 2024, the selection of consultants was delayed after the initial bids were rejected.
Regulatory and Oversight Challenges
The situation at Karnali Development Bank highlights weaknesses in Nepal's banking supervision. Former Executive Director Thapa criticized the ineffectiveness of NRB's on-site and off-site monitoring. He also cited the tendency of some bankers to exploit regulatory loopholes, contributing to the sector's instability.
Karnali Development Bank had been under NRB’s scrutiny for a year, with a special on-site inspection conducted during the first quarter of Fiscal Year 2023/24. Based on this inspection, then-Chairman Rajendra Bir Raya and CEO Dinesh Kumar Rawat were fined Rs 500,000 each for non-compliance with directives and misuse of loans. Despite these interventions, the bank continued to present a misleading picture of its financial health, prompting NRB to take control of its management.
An NRB official revealed, "Our special inspection uncovered discrepancies in the bank’s published financial statements. The NRB had issued instruction to implement corrective measures on November 26 but as the situation did not improve, the board of directors themselves requested intervention. The decision to take over was based on the bank’s inability to address these issues and operate effectively."
Historically, NRB has intervened in troubled institutions like Nepal Bangladesh Bank and NCC Bank, as well as a dozen others, including Nepal Bikas Bank and Gorkha Bikas Bank. To address the rising number of problematic institutions, NRB established the Troubled Institution Resolution Division in March 2014. Although the division was dissolved in 2018 after resolving most cases, Nepal Share Market and Finance remains unresolved.
Partial Deposit Refunds to Begin
Karnali Development Bank will begin partial deposit refunds to its customers starting Tuesday. The bank had suspended withdrawals after NRB assumed management last Thursday. A central bank official stated, "We are prioritizing liquidity management and will begin refunding deposits to customers facing urgent financial difficulties."
As of mid-October, the bank had collected Rs 5.21 billion in deposits and disbursed Rs 3.81 billion in loans. However, only Rs 30 million deposits remained when NRB took over.
"An initial review shows that 45,000 out of 90,000 accounts are active, holding deposits worth Rs 3 billion," an NRB official said.
NRB has directed the new management to prioritize deposit refunds, recover misused loans, and conduct a due diligence audit of the institution. Preliminary investigations suggest collusion between the former chairman and CEO in loan misappropriation. Despite these irregularities, NRB assured depositors that their funds are not at risk of being lost.
