NRB introduces stringent directives for non-performing loan categorisation

The central bank has introduced stringent rules to minimise credit risk and ensure a sound financial system.

“Any non-performing loans (NPLs) can be recategorised under pass loan only if the borrower repays both principal and interest for six consecutive months after settling their previous outstanding dues,” the NRB said Monday revising its rules relating to NPLs in a move to enhance banking credit practices. The new rule would come into effect from the third quarter of the current fiscal year (2023/24). 

Read here: What are ‘Non-performing loans’ and ‘loan loss provision’?

This marks a departure from the previous practice, wherein financial institutions could reclassify NPLs as performing once overdue amounts were settled. 

This earlier approach had the potential to obscure the genuine extent of underlying credit risk and raised concerns about the integrity of loan portfolios. 

Additionally, it had the undesirable effect of encouraging the evergreening of loans among BFIs — a practice of extending additional loans to non-performing borrowers to settle their outstanding payments with a view to reducing NPL ratio in their balance sheets. 

Furthermore, the directive also mandates that if a borrower (individual or entity) has availed loans under different categories, their all loans shall be included in the ‘watchlist’ if any of their loans turn non-performing. A watchlist is a loan classification under the performance loan category necessitating a loan loss provision of 5%.

Similarly, a loan categorised as non-performing for one borrower will lead to an obligation for the BFIs to evaluate the non-performer direct business impact on other partners in the same institution or group of borrowers. BFIs will have to include them under the same sub-category of the non-performing loan classification even if their loans are categorised as performing.