Credit & Loan Operations: Process, Risks & Recovery

Key Concepts & Definitions

What is a Loan?

A loan is a temporary transfer of money from a lender (bank) to a borrower (customer) under a legally binding agreement, with repayment terms including principal + interest. In Nepal, loans are governed by:

• Banking Act, 2073 (2016)
• Nepal Rastra Bank (NRB) directives (e.g., Loan Classification and Provisioning Guidelines, 2075)
• Nepal Bankers’ Association (NBA) best practices

classDiagram
    class Loan {
        +Principal: NPR
        +Interest Rate: %
        +Tenor: Months/Years
        +Collateral: Asset Type
        +Risk Category: Low/Medium/High
    }
    class Borrower {
        +Credit Score: 0-1000
        +Income Proof: Required
        +Purpose: Personal/Business
    }
    class Bank {
        +Loan Limit: NPR
        +Overdue Policy: Days
        +Recovery Process: Legal/Court
    }
    Loan --> Borrower : "Issued to"
    Loan --> Bank : "Sanctioned by"
    Borrower --> Bank : "Repays"

Loan Process in Nepal: Step-by-Step

flowchart TD
    A["Customer Applies"] --> B["Bank Verifies Documents"]
    B --> C["Credit Scoring & Risk Assessment"]
    C --> D["Collateral Valuation"]
    D --> E["Loan Sanction Committee Approval"]
    E --> F["Disbursement"]
    F --> G["Repayment Schedule"]
    G -->|"Default"| H["Recovery Process"]
    G -->|"On-Time"| I["Loan Closed"]

1. Loan Application & Documentation

Required Documents (Nepal)

2. Credit Risk Assessment

Banks use 5 Cs of Credit to evaluate loan applications:

1. Character: Borrower’s credit history (e.g., CIBIL score in Nepal).
2. Capacity: Ability to repay (income vs. EMI).
3. Capital: Net worth of the borrower.
4. Collateral: Security for the loan (e.g., property, gold, fixed deposits).
5. Conditions: Economic/purpose-specific risks (e.g., agricultural loans in monsoon).

Collateral Valuation Rules (NRB)

• Maximum Loan Against Collateral:
  • Immovable Property (Land/House): 60% of market value.
  • Gold/Jewelry: 75% of market value.
  • Fixed Deposits: 90% of deposit amount.
  • Vehicles: 50% of insured value.
• Example: A Kathmandu shopkeeper pledges a Rs 50 lakh house for a loan. Loan Amount = 60% of Rs 50 lakh = Rs 30 lakh.

3. Loan Sanction & Disbursement

Loan Sanction Committee (LSC)

• Approves loans based on risk assessment.
• Composition: Branch manager, credit officer, legal advisor.
• Decision Time: 7–14 days (per NRB guidelines).

Disbursement Methods

4. Loan Repayment & Risk Management

Repayment Methods

1. Equated Monthly Installment (EMI): Fixed monthly payments (principal + interest).
   • Formula: $$EMI=P\times \frac{r(1+r{)}^n}{(1+r{)}^n-1}$$ Where:
     • $P$ = Principal (NPR)
     • $r$ = Monthly interest rate ($r=\frac{annualrate}{12}$)
     • $n$ = Tenor in months
2. Bullet Repayment: Principal repaid at maturity (common in trade finance).
3. Balloon Payment: Small EMIs + large final payment.

Loan Classification (NRB Guidelines)

Banks classify loans into 4 categories based on repayment status:

5. Loan Recovery Process

Legal Procedures (Nepal)

1. Notice of Demand: Bank issues a 30-day notice to repay.
2. Legal Notice: Served via court if no response.
3. Attachment of Property: Court orders seizure of collateral.
4. Auction/Sale: Collateral sold to recover dues.
5. Criminal Action: For fraudulent defaults (e.g., fake documents).

Worked Example: Recovery of a Defaulted Loan

Scenario: A Kathmandu shopkeeper defaults on a Rs 20 lakh loan secured by a Rs 30 lakh property (60% loan-to-value).

1. Overdue Classification:

   • After 90 days → Doubtful Asset (50% provision = Rs 10 lakh).
   • After 180 days → Loss Asset (100% provision = Rs 20 lakh).

2. Recovery Steps:

   • Bank files a Civil Suit for Recovery in the District Court.
   • Court orders attachment of the property.
   • Property sold at auction for Rs 25 lakh (market value dropped due to delay).
   • Recovery:
     • Rs 20 lakh (loan) + Rs 5 lakh (legal costs) = Rs 25 lakh (fully recovered).
     • Remaining Rs 5 lakh loss absorbed by the bank.

6. Common Loan Risks & Mitigation

7. Special Cases in Nepal

Agricultural Loans

• Purpose: Farm equipment, irrigation, seeds.
• Risk: Weather-dependent repayment.
• NRB Rule: Maximum 80% loan-to-value for agricultural land.

SME Loans (Microfinance)

• Example: Pathao Driver Loans (Rs 50,000–2 lakh).
• Collateral: Often no collateral (based on cash flow).
• Interest Rate: 12–24% p.a. (higher due to risk).

Trade Finance (Letter of Credit - LC)

• Process:
  1. Importer opens LC with their bank.
  2. Bank issues LC to exporter’s bank.
  3. Exporter ships goods; bank pays upon presentation of documents.
• Example: Daraz Importer’s LC for Chinese goods shipment.

In the Real World

1. Ncell’s Postpaid Loans

   • Idea Used: Collateral-free personal loans (up to Rs 5 lakh).
   • How: Ncell assesses creditworthiness via CIBIL score and income proof (salary slips). Defaults are recovered via salary deduction (if employed) or legal action.

2. Daraz Vendor Financing

   • Idea Used: Working capital loans for small businesses.
   • How: Vendors get Rs 50,000–5 lakh based on past sales data (collateral-free). Overdue orders trigger automatic suspension of sales until repayment.

3. Kathmandu Traffic Route Financing

   • Idea Used: Project financing for infrastructure.
   • How: Banks like NMB provide Rs 50 crore+ loans for traffic management projects (e.g., ring road). Repayment tied to toll revenue or government grants.

Exam Tip

How This Unit is Examined

1. Numerical Problems (30%):

   • Calculate EMI, loan-to-value ratio, or provisioning for doubtful assets.
   • Example Question:

     "A borrower takes a Rs 10 lakh loan at 10% p.a. for 5 years. Calculate EMI and total interest paid." Solution: $$>EMI=10,00,000\times \frac{0.10/12\times (1+0.10/12{)}^{60}}{(1+0.10/12{)}^{60}-1}=\text{Rs 22,245/month}>$$ Total Interest = (22,245 × 60) – 10,00,000 = Rs 334,700.

2. Short Notes (20%):

   • Define sub-standard asset, bullet repayment, or NRB’s loan classification.
   • Example Answer:

     "Sub-standard asset refers to a loan that is past due by 30–90 days but not yet classified as doubtful. Banks must provision 25% of the outstanding amount as per NRB guidelines."

3. Case Studies (30%):

   • Analyze loan recovery scenarios or risk management in real businesses.
   • Example:

     "A Daraz vendor defaults on a Rs 2 lakh loan. Describe the bank’s recovery process under Nepal’s Banking Act." Answer:

     1. 30-day notice sent via email/SMS.
     2. Legal notice filed in District Court if no response.
     3. Attachment of inventory (if any collateral exists).
     4. Suspension of Daraz account until repayment.

4. True/False (20%):

   • Identify myths vs. facts (e.g., "Good collateral increases the risk to banks" → False; it reduces risk).

Common Mistakes to Avoid

• Ignoring NRB Guidelines: Always refer to loan classification percentages (0%, 25%, 50%, 100%).
• Misapplying Collateral Rules: Remember 60% for property, 75% for gold.
• Skipping Legal Procedures: Recovery involves court notices, not just bank calls.
• Overcomplicating EMI Calculations: Use the formula step-by-step in exams.