Due to low capital base and high risk of exposure to the real sector lending has eroded the commercial banks’ capacity to absorb market shocks.
A recent stress test by central bank revealed that a standard credit shock would cause capital adequacy ratio (CAR) of 28 commercial banks, or around 90 per cent of class ‘A’ financial institutions, to fall below the minimum regulatory requirement of 10 per cent.
Some 28 commercial banks’ CAR was susceptible to standard credit shocks in mid-January, 2013, whereas decreased to 27 in mid-July 2013, according to the central bank’s Financial Stability Report published here recently.
Capital adequacy ratio measures a bank’s strength to absorb shocks and ability to extend loans. The central bank has mandated to maintain CAR at 10. The central bank will take prompt corrective action, if the CAR falls below minimum regulatory requirement. The central bank will also declare such banks and financial institutions as ‘troubled’.
The report also revealed increasing risk for banks as they are exposed to real estate and housing sector. It also indicated that ‘credit quality of banks is deteriorating’ and ‘they are likely to face a difficult situation in case of slowdown in recovery, downgrade of loans to loss category and loan loss provisioning increases’.
The stress test in mid-January also revealed that nine banks’ CAR would fall below the minimum regulatory level, if 25 per cent of loans extended to real estate and housing sector turned into bad debts. “A stress test conducted in mid-July last year had revealed that only five banks would see their CAR fall below 10 per cent level, if 25 per cent of their performing loans turned sour.
Though two-thirds of loans are collaterised by real estate sector, the slowdown in the prices and recovery also would hit the banking sector, it said, adding that some 22 commercial banks may find themselves in a high risk, if 15 per cent or more of their deposits are withdrawn. “Likewise, some 16 banks – against five in mid-July 2013 – may find it difficult, if two per cent, five per cent and 10 per cent of their deposits are withdrawn in one, two and three days.”
It also indicated, according to the report, that liquidity position of commercial banks has not improved much since mid-July 2013, despite popular belief of excess liquidity in them.
The report has also suggested banks and financial institutions to raise capital base to make them financially strong, as many of them are not adequately capitalised to absorb shocks. “But banks seem better equipped to cushion market shocks including shocks from fluctuation in interest rate, exchange rate and equity prices as all commercial banks – except state-owned Rastriya Banijya Bank and Nepal Bank – could maintain CAR of above 10 per cent in case they face market risks, the report added.