Karnali Development Bank’s Road to Recovery: Analyzing the Impact of NRB’s Regulatory Actions

Karnali Development Bank, recently subjected to stringent regulatory measures by Nepal Rastra Bank (NRB), has showcased a roadmap to financial recovery. The bank has been restricted from accepting new deposits, opening new accounts, and issuing additional loans due to an alarmingly high non-performing loan (NPL) ratio of 40.85% and other financial irregularities. Despite these challenges, the bank has claimed measurable improvements in its financial metrics, signaling efforts to stabilize its operations.

NRB’s decision came after an inspection in July (Shrawan) revealed severe financial vulnerabilities. The bank's negative core capital ratio of -25.87% and NPL ratio exceeding 40% indicated a dire need for intervention. These indicators, far below the regulatory benchmarks, justified the imposition of restrictions as part of NRB's corrective action framework. By halting the bank's expansion activities, NRB aimed to pressurize its management to prioritize stability and recovery over growth.

In its latest press release, the bank reported significant strides in reducing its NPL ratio from 59.39% in FY 2079/80 to 40.85% in FY 2080/81, with further reductions to 29.49% expected by October 2024. While this improvement is noteworthy, the NPL ratio remains substantially higher than the 5% threshold prescribed for a healthy banking system. The reduction in the credit-to-deposit ratio from 66.13% to 55.02% and an increase in the liquidity-to-total-deposit ratio from 33.01% to 39.10% also reflect better risk management and liquidity positioning.

While the improvements indicate progress, they come with critical caveats. The reduction in NPLs is largely attributed to aggressive loan recovery, likely driven by short-term measures rather than structural reforms. The bank's core capital remains deeply negative, suggesting that recapitalization or external funding may be necessary to achieve long-term stability. The claim of maintaining uninterrupted banking operations and customer payments, despite restrictions, is commendable but raises questions about the sustainability of such measures without substantial capital infusion.

Karnali Development Bank’s challenges mirror systemic issues faced by Nepal’s banking sector. The COVID-19 pandemic, real estate slowdowns, and economic recession have collectively strained asset quality across banks. The situation underscores the need for robust risk management practices, prudent credit policies, and strong internal controls to withstand future shocks.

The bank's ability to lower its NPL ratio further and regain NRB’s confidence hinges on effective implementation of its recovery strategy. While short-term indicators suggest improvement, the real test will lie in its capacity to sustain these gains and rebuild trust among stakeholders. Achieving positive core capital and compliance with regulatory standards should remain the bank’s primary objectives.

In conclusion, while Karnali Development Bank’s efforts to rectify its financial health are evident, the journey ahead is fraught with challenges. The bank must demonstrate not only its capacity for immediate recovery but also its resilience to maintain long-term stability in an increasingly competitive banking landscape. For now, NRB's measures appear to have set the bank on the right path, albeit with a long road to recovery.