Trust sermon to banks

Kathmandu, October 22:

Nepal Rastra Bank (NRB) has introduced Prompt Corrective Action (PCA) — a new directive effective from October 17 — if financial institutions do not maintain minimum Capital Adequacy Ratio (CAR) every month, unlike the previous three-month duration earlier. CAR — an indicator of financial capital strength — is a measure of the amount of a bank’s capital expressed as a percentage of its risk weighted credit exposure.

All financial institutions — in A, B and C classes — licenced by NRB will have to mandatorily maintain minimum CAR every month prescribed by it, said acting NRB governor Krishna Bahadur Manandhar.

Under Basel II, commercial banks have to maintain a minimum of 10 per cent CAR while development banks and finance companies — financial institutions in B and C classes — will have to maintain 11 per cent CAR, under Basel I.

“If any institution falls short of the prescribed CAR any month, the central bank will immediately take action against it,” Manandhar said, adding that this new regulation will make financial institutions more disciplined and stabilise the financial market.

“NRB defines and monitors CAR to protect depositors, thereby creating confidence in the banking system,” he added.

There are various actions that the regulatory authority of the financial market would take against institutions failing to maintain the minimum CAR. “If an institution falls short of maintaining CAR by upto two per cent, it cannot announce its dividends and bonus shares,” states the NRB directive.

Similarly, if a financial institution’s CAR is less than two to four per cent, NRB will put a cap on its lending capacity. If CAR falls short from four to six per cent, it will not be allowed to open a deposit account and will suspend its lending activities.

If the institution has less than six to eight per cent shortfall in its minimum CAR, it will not be allowed to pay salary, allowance or any kind of benefit to its staff . It also cannot promote or recruit new employees.

However, if the minimum CAR is less than eight per cent and over, the financial institution will be declared ‘problematic’ and action taken against it according to section 86 of the NRB Act. “If the financial institution cannot maintain its minimum CAR within six months of being declared ‘problematic’ also, its licence will be terminated and the company marked for liquidation,” says the NRB directive.

CAR is the ratio, which determines the capacity of the bank in terms of meeting time liabilities and other risks such as credit and operational risks. In the most simple formulation, a bank’s capital is the ‘cushion’ for potential losses, and which will protect the bank’s depositors or other lenders.