Kathmandu- Questions are growing about loan quality in Nepal’s banks. Many lend without proper checks and use evergreen lending to mask risks.

Evergreening means  topping up loans to show stronger numbers and pay cash dividends, appears common at Siddhartha Bank. Nepal Rastra Bank has remained silent, which encouraged the bank to push dividends despite distorted financials.

After the slowdown that followed COVID-19 and the Gen Z protest, Siddhartha Bank still distributed about Rs 800 million in cash dividends. This hurt the bank’s core capital.

To manage capital pressure, the bank bypassed unified directives and prepared a Basel report that justified cash dividends. The bank also showed an unusual drop in non-performing loans in the fourth quarter of the last fiscal year, which inflated its distributable profit. This does not look consistent.

For most of the last fiscal year, the bank’s NPL ratio stayed above 4 percent. The annual report shows that NPLs dropped sharply by year end. This raised doubts about transparency.

The bank invested about 20 billion rupees in loans during the year. More than one third of that came in the final quarter. This indicates that large top up loans were given to reduce NPLs.

In the third quarter, the NPL ratio had reached 4.04 percent. The first and second quarters had NPLs of 3.91 percent and 4.50 percent. The fourth quarter suddenly showed a drop to 2.62 percent. By the first quarter of the current fiscal year, NPLs rose again to 3.8 percent.

A similar pattern appeared in fiscal year 2023-24. The first-quarter NPL was 3.44 percent. The second quarter was 2.56 percent. The third quarter was 2.57 percent. The year-end was 2.22 percent.

While announcing cash dividends, the bank hid the 2.22 billion rupee distributable loss from the first quarter of the current fiscal year in its Basel report. This avoided pressure on core capital and allowed higher cash dividends.

Under the Capital Adequacy Framework 2015, a bank must deduct all regulatory reserves from its unaudited profit before counting it as Tier 1 capital. These reserves include general reserve, exchange fluctuation fund, staff bonus, and regulatory adjustments. If these are not deducted, the unaudited profit cannot be counted as core capital. Siddhartha Bank did not deposit required amounts in these reserves but still showed the unaudited profit. This violates the rule.

The bank showed 1.61 billion rupees in distributable profit in the first quarter by adjusting a loss of 221.6 million rupees. This may look factual, but in the Basel report the same profit should appear as retained earnings. Instead, the bank showed 1.83 billion rupees as last year’s distributable profit and only 118.1 million rupees as unaudited profit instead of the 221.6 million rupee loss. This is a serious breach of point number 5 of the Capital Adequacy Framework.

High capital charge risk

Because the bank did not adjust the 221.6 million rupee loss and instead carried over the 1.83 billion rupee profit, the Basel report will require major corrections.

After accounting for the 780 million rupees distributed as cash dividends, the core capital adequacy ratio may fall to about 9.28 percent.

The bank has limited room for loan expansion. The cash dividends weakened core capital. The bank plans to boost profits by paying off 2.16 billion rupees in debentures maturing in Poush. This may raise distributable profit but will not boost core capital.

When the debenture matures, provisioning can be written back to profit. However, an equal reduction will occur in the capital redemption reserve, so the impact on core capital will be small.

If the economy does not recover in the second quarter, NPLs may rise and net profit may shrink. This will restrict new lending.

A rise in NPLs and a drop in profit will squeeze core capital. A capital shortfall will limit loan expansion and increase pressure on the bank.

Nepal Rastra Bank has barred banks from distributing cash dividends from debentures maturing in Poush. These must be distributed as bonus shares next year. The bank has already issued a new debenture worth 2.5 billion rupees to maintain supplementary capital. This requires a fixed amount in the redemption reserve. This raises capital charge risk.

Regulations require an 8.5 percent core capital ratio and a 2.5 percent supplementary capital ratio, totaling 11 percent capital adequacy. The countercyclical buffer is not applied due to economic slowdown.

If the bank fails to meet the 8.5 percent core capital ratio, it cannot distribute cash dividends and cannot expand lending. It must focus on recoveries or raise capital.

By prioritizing cash dividends for major shareholders, Siddhartha Bank weakened its own financial position. A bank responsible for billions in public deposits cannot operate with such policies. The regulator needs to act to protect depositors.