NRB's latest policy to make lending expensive for construction sector

KATHMANDU, July 16: Credit for the construction sector is likely to become more expensive as the Nepal Rastra Bank has directed all banks and financial institutions to manage additional 20 percent loan loss provision for credit extended on the back of collateral pledged by a third party.



Since half of the loans secured by the construction companies are backed by assets pawned by person or firms other than the borrower, the instruction generally means that extra cost to mitigate risk generated by such credit will be passed on to the borrower.



"This could raise interest rate on such loans by around 0.5 percentage point," Surendra Man Pradhan, CEO of Sunrise Bank, told Republica.

The construction sector, which develops physical infrastructure from roads and bridges to commercial complexes, has so far secured over Rs 60 billion in loans from commercial banks alone, of which Rs 8.5 billion was acquired in the first 10 months of fiscal year 2011/12.



"Since the nature of business generally requires credit line to the tune of hundreds of millions of rupees, the new instruction on third-party collateral is expected to significantly raise debt servicing cost of construction firms," said Jaya Ram Lamichhane, the president of the Federation of Contractors´ Associations of Nepal. He, however, said the federation would come up with an official view after thoroughly reviewing the provision.



The central bank has defined third party collateral as security provided by person or firms other than the lender (bank) and borrower. This means all loans secured by a person on the back of collateral pledged by spouse, children, or extended family members such as in laws, would require additional provisioning of 20 percent, according to Nepal Rastra Bank Spokesperson Bhaskar Mani Gyawali. This is also expected to affect corporate loans as firms that wish to secure credit backed by assets belonging to company´s promoters would be subjected to higher loan loss provisioning.



The central bank has classified credit, or loans, into four categories: pass (good), substandard, doubtful and loss (bad). Loans are considered good when borrowers make installment payments regularly or when they stop paying the installment for a period of up to three months.



Loans on which installment payments are not made for a period of between three to six months are classified as substandard loans, while loans, on which installment payments are not made for six months to up to a year are known as doubtful loans. Likewise, loans whose installment payments have not been made for more than a year are labeled bad loans.



Based on this classification, banks and financial institutions have to allocate certain amount to ensure they do not land in trouble in case the borrower fails to return the money.



For instance, in normal case, banks have to provision one percent of the due principal amount even if loans fall under ´good´ category. In case, these loans downgrade to ´substandard´ and ´doubtful´ categories, financial institutions have to allocate 25 percent and 50 percent of the outstanding principal amount for loan loss provisioning, respectively. In this manner, loans that fall under ´bad´ category require provisioning of 100 percent of the due principal amount.



The central bank instruction on third-party collateral issued last Friday implies that loans extended under third-party collateral will now entail loan loss provisioning of at least 21 percent - including one percent normal rate and 20 percent additional rate - even if they fall in ´good´ category. Similarly, loan loss provisioning of 45 percent and 70 percent have to be made in case the loans turn to ´substandard´ and ´doubtful´, respectively. But since a central bank directive says loan loss provisioning need not exceed 100 percent of the principal amount, banks and financial institutions will not have to keep aside 120 percent of the principal amount in case the credit extended on collateral pledged by third party falls in ´bad´ category.



However, most of the leading banks are not worried by the new provision as they are not exposed to such credit and discourage extension of such loans.

"Such loans entails higher risk and create legal complications as well," said Sashin Joshi, CEO of NIC Bank, whose bank has exposure of 0.1 percent of the total credit portfolio to such loans. Similar comments were expressed by Ashoke Shumsher Rana, CEO of Himalayan Bank.



Nepal Rastra Bank Spokesperson Gyawali, on the other hand, said the central bank had introduced the provision to protect the interest of depositors. "We are more concerned about depositors than billionaires who secure credit lines beyond their capacity," he said.

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