Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank

k of Kathmandu Ltd and Himalayan Bank Ltd

A THESIS REPORT

By: Manoj Dumaru Shrestha Kathmandu, Nepal

Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank of Kathmandu Ltd and Himalayan Bank Ltd

By: Manoj Dumaru Shrestha Shanker Dev Campus TU Registration Number: 720/93

A Thesis Submitted to:

Office of the Dean Faculty of Management

Tribhuvan University

In partial fulfillment of the requirement of the degree of

Master of Business Studies (MBS)

Putalisadak, Kathmandu October 2003

D ECLARATION

I hereby declare that the work reported in this thesis entitled Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank of Kathmandu Ltd and Himalayan Bank Ltd submitted to Shanker Dev Campus, Faculty of Management, Tribhuvan University is my original work done in the form of partial fulfillment of the requirement for the Masters Degree in Business Studies (MBS) under the supervision of Mrs. Amuda Shrestha and Mr. Shankar Prasad Khanal of Shanker Dev Campus.

Manoj Dumaru Shrestha Date: TU Reg. No.: 720/93

A CKNOWLEDGEMENT

This thesis entitled Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank of Kathmandu Ltd and Himalayan Bank Ltd has been prepared in partial fulfillment for the degree of Masters of Business Studies (MBS) under the supervision of Mrs. Amuda Shrestha, Campus Chief and Mr. Shankar Prasad Khanal, Lecturer, Shanker Dev Campus. It is my privilege of getting helps and co-operation from different persons. It is not possible to enumerate the names of all of them. However, it will be matter of injustice if I forget the names of those personalities whose valuable suggestions and co-operation escorted to complete this thesis report. First and foremost, I would like to offer special thanks to Mrs. Amuda Shrestha and Mr. Shankar Prasad Khanal for their proper supervision and suggestions. I would like to thank Mr. Sushiel Joshi, Company Secretary and Deputy General Manager of Himalayan Bank Limited and Mr. Binod N. Shrestha, Assistant Manager of Bank of Kathmandu Ltd for their immense co-operation during the research work of this thesis. Also, I would like to thank Mr. Gyanendra Shrestha of Himalayan Bank Ltd and Ms. Ramila Shrestha of Bank of Kathmandu who provided relevant information and data, which helped me in preparing this thesis report. Thanks to all of them. I could not remain without thanking to my teachers and lecturers, especially to Dr. Gita Pradhan, Mr. Rishi Raj Gautam, Mr. Puspa Raj Joshi and Mr. Gopal Prasad Bhatta who all helped me during my study of MBS and during preparation of this thesis report. It was a novel experience of doing a thesis work which certainly helped me to gain deep knowledge in the subject. But accomplishment of the objective was not easy. The foremost difficulty was the scarcity of data and information, which I experienced as the most difficult work during any type of research study in Nepal. Nevertheless, it was a pleasant feeling to accomplish the thesis report finally.

Manoj Dumaru Shrestha Date: TU Reg. No.: 720/93

TABLE OF C ONTENTS

Acknowledgement.......................................................................................................i Table of Contents.......................................................................................................ii List of Tables.............................................................................................................iv List of Figures ............................................................................................................v Abbreviations............................................................................................................vi Chapter 1 Introduction .............................................................................................1 1.1 Background................................................................................................1 1.2 Focus of the Study .....................................................................................3 1.2.1 Introduction to NRB ......................................................................4 1.2.2 Introduction to BOK......................................................................6 1.2.3 Introduction to HBL ......................................................................7 1.3 Statement of Problem ................................................................................8 1.4 Objectives of the study ..............................................................................9 1.5 Significance of the study ...........................................................................9 1.6 Limitation of study ..................................................................................10 1.7 Theoretical Framework ...........................................................................11 1.8 Problem Hypothesis.................................................................................11 1.9 Structure of study report..........................................................................11 Chapter 2 Literature Review..................................................................................13 2.1 Conceptual Review..................................................................................13 2.1.1 Origin and Development of Banks ..............................................13 2.1.2 Development of Central Bank .....................................................14 2.1.3 Meaning of Central Bank ............................................................14 2.1.4 Importance & Functions of Central Banks ..................................15 2.1.5 Meaning of Commercial Banks...................................................16 2.1.6 Overview: Capital and Capital Adequacy ...................................18 2.2 Review of NRB Capital Adequacy Norms for Commercial Banks ........20 2.3 Empirical Review ....................................................................................23 2.3.1 Review of Articles and Reports...................................................23 2.3.2 Review of Thesis Works .............................................................27 Chapter 3 Research Methodology..........................................................................32 3.1 Research Design ......................................................................................32 3.2 Population and Sample ............................................................................32 3.3 Data collection procedure........................................................................33 3.4 Data Analysis Tools ................................................................................33 3.4.1 Financial Tools ............................................................................33 3.4.2 Statistical Tools ...........................................................................35

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Chapter 4 Data Presentation and Analysis ...........................................................37 4.1 Presentation of Data ................................................................................37 4.1.1 Capital Fund ................................................................................37
4.1.1.1 Capital Fund of BOK............................................................... 38 4.1.1.2 Capital Fund of HBL ............................................................... 40

4.1.2 Risk-Weighted Assets of BOK and HBL ....................................42 4.1.3 Deposit Trend of BOK and HBL.................................................42 4.1.4 Credit Trend of BOK and HBL ...................................................45 4.2 Ratio Analysis .........................................................................................47 4.2.1 Capital Adequacy Ratios of BOK and HBL................................47 4.2.2 Capital to Deposit Ratios of BOK and HBL ...............................48 4.2.3 Credit / Deposit Ratios of BOK and HBL...................................49 4.3 Statistical Analysis ..................................................................................50 4.3.1 Correlation co-efficient ...............................................................50 4.3.2 Test of Hypothesis.......................................................................51 4.4 Impact of Capital Adequacy Norms on BOK and HBL..........................53 4.4.1 Study of Changes in Capital Fund of BOK and HBL .................53 4.4.2 Study of Changes in Share Capital of BOK and HBL ................54 4.4.3 Study of Response of Officials of BOK and HBL ......................55 4.5 Study of Perception of Depositors on Commercial Banks......................55 Chapter 5 Summary, Findings, Conclusion & Recommendation ..............................57 5.1 Summary..................................................................................................57 5.2 Findings ...................................................................................................58 5.3 Conclusion ...............................................................................................60 5.4 Recommendation .....................................................................................61 Bibliography.............................................................................................................63 Appendices ...............................................................................................................67 Bio Data ....................................................................................................................89

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L IST OF TABLES

Table 4.1 Capital Fund of BOK ................................................................................38 Table 4.2 Capital Fund of HBL.................................................................................40 Table 4.3 Risk Weighted Assets of BOK & HBL.....................................................42 Table 4.4 Deposit Collection Trend of BOK, HBL and National Total....................43 Table 4.5 Credit Trend of BOK, HBL and National Total........................................45 Table 4.6 Capital Adequacy Ratios of BOK & HBL ................................................47 Table 4.7 Capital to Deposit Ratios of BOK & HBL................................................48 Table 4.8 Credit/Deposit Ratios of BOK & HBL .....................................................49 Table 4.9 Correlation coefficients .............................................................................50 Table 4.10 Hypothesis 1 ............................................................................................51 Table 4.11 Hypothesis 2 ............................................................................................51 Table 4.12 Hypothesis 3 ............................................................................................52 Table 4.13 Hypothesis 4 ............................................................................................52 Table 4.15 Changes in Capital Fund of BOK and HBL............................................53 Table 4.16 Changes in Share Capital of BOK and HBL...........................................54

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L IST OF F IGURES

Figure 4.1 Trend of Capital Fund of BOK ................................................................39 Figure 4.2 Trend of Capital Fund of HBL.................................................................41 Figure 4.3 Share of BOK & HBL on Total National Deposit Collections...............44 Figure 4.4 Share of BOK & HBL on Total National Credit ....................................46

A BBREVIATIONS

BOK FY HBL HMG/N NBBL NGBL NIBL NPA NRB PSA SCBNL TRWA

Bank of Kathmandu Limited Fiscal Year Himalayan Bank Limited His Majestys Government of Nepal Nepal Bangladesh Bank Limited Nepal Grindlays Bank Limited (now SCBNL) Nepal Investment Bank Ltd (formerly Nepal Indosuez Bank Ltd) Non Performing Assets Nepal Rastra Bank Premium Savings Account Standard Chartered Bank Nepal Limited Total Risk Weighted Assets

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C HAPTER 1 I NTRODUCTION

1.1

Background

Nepal, which is surrounded by China to the north and India to the east, west and south, is one of the least developed countries in the world which is directing her efforts in accelerating the pace of her economic development. Being landlocked happens to be a disadvantage for the country. Nepal is located in between the latitude 2622 North to 3027 North and longitude 804 East to 8812 East. The average length being 885 km. east to west and average breadth is about 193 km. north to south and area is 147,181 sq. km. The economy of Nepal is survived by agricultural sector. The agriculture sector contributes over 60 percent to the GDP of the country. Over 80% of the population is dependent on the agriculture. Therefore, major concentration of every government of Nepal has been the development and advancement of agriculture sector. But, still there has always been scarcity of finance in this sector. To some extent, the establishment of Agriculture Development Bank has provided the support for the farmers to raise the required capital. Also, various programs like microfinance programs, cooperative programs have been introduced in various villages of Nepal which has definitely helped local people to finance them. While talking about the capital formation, commercial banks play a major role on it. Capital is one of the most important components for an organization. Actually, no organization can exist without capital. Without capital it is not possible to set up any type of business whether it is a general store or a big business house. Every

organization is started with a zero position and only come into existence when the promoters, owners or shareholders finance on it as capital. Every organization should have enough capital to run business. Although the banks are the major source of capital, they also have to raise capital to run business. Especially, the bank capital has significant role to play as the banks have obligations to mass people, its depositors. Thus, the banks should hold an adequate capital to secure the interest of depositors. Capital adequacy has become one of the most significant factors for assessing the soundness of banking sector. Raise and utilization of funds are the primary functions of commercial banks. As such, commercial banks collect a large amount of deposits from general public. The depositors think that depositing their money in a bank is safe and relaxing. But, what does happen if the bank does not have enough capital funds to provide a buffer against future, unexpected losses? Therefore, capital must be sufficient to protect a banks depositors and counterparties from the risks like, credit and market risks. Otherwise the banks will use all the money of depositors in their own interest and depositors will have to suffer loss. After the restoration of multiparty democracy, several commercial banks make a way to the business in Nepal. At present, commercial banks hold a large share of economic activities of the country. Stock market has been dominated by commercial banks since a decade. Everyday we can see trading of large amount of stock transactions of commercial banks. Not only in the stock market, but commercial banks have also been major contributors to the revenue of the country. They have been paying a large amount of tax every year. Banking sector has become a mainstay of the economy of the country. Establishment of commercial banks is governed by Commercial Bank Act, 2031 BS and Company Act, 2053 BS. However, Nepal Rastra Bank (NRB), as a regulatory body for banks and financial institutions, has right to specify the capital requirements, and other requirements. Being the central bank of Nepal, NRB has the responsibility to give special attention to the interest of depositors. It is to be noted

that as per the banking and financial statistics of NRB, the commercial banks of Nepal have collected more than Rs. 185 billion money from depositors by the end of fiscal year 2001/02. Such a big amount of money should have to be secured and NRB has the major responsibility to protect it. In March 2001 NRB issued various directives to be complied by all commercial banks of the country. The directives consist of nine volumes. The NRB directive no. 1 includes the capital adequacy norms for commercial banks indicating the requirement of maintaining capital fund to the prescribed ratios. The directives are said to be based on the internationally accepted norms of Basel Committee. The Basel Committee on Banking Supervision is a committee of banking supervisory authorities which was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States. It usually meets at the Bank for International Settlements in Basel, Switzerland, where its permanent Secretariat is located. The Basel Committee issued Basel Capital Accord in 1988. The Basel Capital Accord was implemented worldwide by 1992 which is presently in practice. This Basel Accord is going to be replaced by a new Basel Capital Accord by 2006.

1.2

Focus of the Study

The study is based on the capital funds of the banks which is supposed to be adequate as per the NRB directive no. 1, which is related with the capital adequacy norms for commercial banks. The norms basically emphasize on the basic requirement of the capital fund that a commercial bank should possess. The fundamental objective of the norms is to safeguard the interest of the depositors As per these norms, bank capital has been divided into two categories which are generally known as Tier-1 and Tier-2.

At present, there are total 16 commercial banks in Nepal. The capital fund and deposit collection up to the end of fiscal year 2001/02 are shown in Appendix I. Keeping in the view of the striving commercial banks, the thesis report, as case study, analyzes the matters, issues and problems related to capital funds of Bank of Kathmandu Ltd (BOK) which is struggling to incline and Himalayan Bank Ltd (HBL) which is believed to be one of the strong joint-venture banks of the country. The thesis report is mainly focused on accordance of the capital adequacy norms of Nepal Rastra Bank (NRB) by these commercial banks. 1.2.1 Introduction to NRB Nepal Rastra Bank is the central bank of Nepal. NRB was established in 1955 under the Nepal Rastra Bank Act, 2012 BS. Now, NRB is running under a new act Nepal Rastra Bank Act, 2058 BS. Before 1955, the functions of a central bank were performed by the government itself. NRB is the only authority to issue Nepalese Rupees currency. It has right to fix exchange rates with other convertible currencies. However, the exchange rates are extremely depended upon the Indian currency. Being the central bank of the country, the ownership of NRB is with HMG/N. But, the management of NRB is not controlled by HMG/N. NRB has 12 branches throughout the Kingdom of Nepal including the Head Office at Baluwatar and the Main Banking Office at Thapathali in Kathmandu. NRB has been established as the regulatory body for banks and financial institutions of Nepal. So, it has right to constitute rules and regulations to be followed by banks and financial institutions in the country. All the banks and financial institutions operate under the regulations of NRB. The establishment of such institutions is also in discretion of NRB. To regulate the operations of commercial banks, NRB has issued various directives which include capital adequacy norms to be followed by commercial banks.

As per the Nepal Rastra Bank Act, 2058 BS the objectives of NRB are stated as follows:
a) To formulate and maintain appropriate monetary and foreign exchange policy for stable price and balance of payments situation required for sustainable economic development; b) To manage the required liquidity and stability of banking and financial sectors; c) To develop secure, healthy, and efficient payment system; d) To monitor, supervise and evaluate banking and financial system; and e) To enhance trust of citizens in overall banking and financial system within the country.

As well as, Nepal Rastra Bank Act, 2058 BS has prescribed the rights, duties and functions of NRB as follows: a) To issue currency notes and coins in the market; b) To formulate and implement necessary monetary policy for price stability; c) To formulate and implement foreign exchange policy; d) To determine the foreign exchange rate adjustment regime; e) To operate and manage foreign exchange reserves; f) To issue license to commercial banks and financial companies for carrying out financial transactions and regulate, inspect, supervise and monitor such transactions; g) To function as the banker, advisor and fiscal agent of His Majestys Government; h) To function as a bank of commercial banks and financial institutions, and as a lender of last resort; i) To establish, promote and regulate the systems of payments, clearing and settlements; and j) To carry out other important functions as necessary towards realizing the objectives enjoined by the Act.

1.2.2 Introduction to BOK Bank of Kathmandu Ltd was established in March 1995 with an authorized capital of Rs. 240 million. The bank was established in collaboration with The Siam Commercial Bank Public Company Ltd of Thailand. But The Siam Commercial Bank Public Company Ltd has sold all its shares to local promoters. BOK was established with the predominant objectives of Identifying business prospects not yet catered by then existing commercial banks and offer new banking products and services and Introducing modern banking technology facilitating bank and business operations and transactions. The head office of BOK is located at Kamaladi in Kathmandu. It has branch network of total seven branches including Head Office at Kamaladi; two branches inside Kathmandu Valley: New Road Branch and Thamel Branch and four outside Kathmandu Valley: Butwal Branch, Dhangadhi Branch, Hetauda Branch, and Nepalgunj Branch. BOK is committed to providing products and services of the highest standards to its customers by understanding their requirements best suiting the market needs. In pursuit to deliver the products and services of the highest standards, BOK has stateof-the-art technology for appropriate and efficient Management Information System (MIS) and rendering quality services, VSAT and Radio Modem for networking, SWIFT for international trade and transfer of funds around the world, correspondent banking relationships with over 200 banks worldwide for effective and proficient execution of international trade and remittance activities, gamut of corporate and retail banking products and services and centralized banking operations for better risk management, consistent service deliveries and lowering operating cost. The present share capital and ownership is shown in Appendix I. At present, BOK has an authorized capital of Rs. 1,000 million and issued capital of Rs. 500 million. Its paid-up capital stands at Rs. 463.58 million. Mr. Radhesh Pant is leading the management of the bank in the capacity of Managing Director.

1.2.3 Introduction to HBL Himalayan Bank Ltd is the first joint-venture commercial bank to be established after the restoration of multiparty democracy in the country. It was established in January 1993 with an authorized capital of Rs. 240 million. HBL was established with the joint-venture of Pakistan based bank Habib Bank Ltd. The head office of HBL is at Karmachari Sanchayakosh Building, Tridevi Marg, Thamel. HBL has four other branches in Kathmandu Valley: New Road Branch, Maharajgunj Branch, Patan Branch, and Nagarkot Branch. It has seven branches outside Kathmandu Valley: Bharatpur Branch, Tandi Branch, Birgunj Branch, Biratnagar Branch, Hetauda Branch, Bhairahawa Branch, and Banepa Branch. Besides, HBL has a separate Credit Card Center at Hariharbhawan, Pulchowk, Lalitpur at the premises of Patan Branch. The policy of HBL is to extend quality and personalized service to its customers as promptly as possible. To extend more efficient services to its customers, HBL has been adopting innovative and latest banking technologies like, state-of-the-art technology and modern banking tools. HBL has access to the worldwide correspondent network of Habib Bank Limited for funds transfer, letters of credit and any banking business anywhere in the world. Besides, HBL also has correspondent arrangements with 178 internationally renowned banks like American Express Bank, Citibank and ABN Amro. The present share capital and ownership is shown in Appendix II. At the end of fiscal year 2001/02, HBL has an authorized capital of Rs. 1,000 million and issued capital of Rs. 650 million. Its paid-up capital stands at Rs. 390 million. Recently to fulfill is supplementary capital requirement, HBL issued short-term unsecured subordinated bonds: HBL Bond 2066 having face value of Rs. 1,000 and coupon interest of 8.5%. The units issued were 360 thousand totaling the amount at Rs. 360 million. Mr. Shahid M. Loan, an expatriate from Pakistan, is leading the management as Senior General Manager.

1.3

Statement of Problem

Banking and financial statistics (2002) shows that, there are more than Rs. 185 billion of amount deposited in various banks of the country by the end of fiscal year 2000/2001. But if the banks go bankrupted, what will happen to the depositors of such money? Thus, an adequate capital fund is required to safeguard the money of depositors. Bhandari (2003) points out that adequacy and inadequacy of bank capital directly affects the banking transaction. The adequacy of bank capital is the most important aspect of a bank. The bank should pay attention to many things for the adequacy of capital. In March 2001, NRB issued a new set of directives to commercial banks consisting of nine parts. NRB claims that these directives are based on the internationally accepted banking norms of Basel Committee. Out of nine directives, the directive no. 1, which was later revised in September 2001, is related with the requirement of the maintenance of capital fund by commercial banks. The capital adequacy ratio is derived on the basis of total risk weighted assets (TRWA). Earlier, the capital adequacy ratio was prescribed as 8% of TRWA. The directive no. 1 which is related to capital fund has revised the capital adequacy ratio to be maintained by commercial banks as follows: Time Table For FY 2058/59 For FY 2059/60 From FY 2060/61 onwards Core Capital 4.5 % 5.0 % 6.0 % Total Capital Fund 9.0 % 10.0 % 12.0 %

As well as, NRB has set up to increase the paid up share capital of national level commercial banks to Rs. 1 billion by the year 2009.

Now, question arises, why these changes are required? While revising the capital adequacy norms, none of the existing commercial banks meet the standard. However, they are allowed to comply with the norms, stage by stage within the specific period. In the fiscal year 2057/58, BOK had a capital adequacy ratio of 8.6% and HBL had the same ratio of 8.01%. Whilst, they are able to maintain an adequate ratio in the fiscal year 2058/59 which is more than 9% as required by NRB Capital Adequacy Norms. For this compliance, they had to take various measures. Hence, the thesis will mainly focus on the capital fund of these two commercial banks.

1.4

Objectives of the study

The main objectives of the study are as follows: To analyze the significance and impact of NRB capital adequacy norms on commercial banks; To examine the capital adequacy of Bank of Kathmandu and Himalayan Bank Ltd; To examine the relation of capital fund to the other stakes of bank To analyze the steps taken by commercial banks to fulfill the requirements as per these norms; and To make necessary suggestions and recommendations

1.5

Significance of the study

The study will have a significant importance in the present context of banking business in Nepal. Commercial banks have collected more than Rs. 185 million of deposits. We can observe that there is a lack of investment opportunity of fund. In such a situation, these deposits have to be protected by adequate capital fund of respective commercial banks. In fact, the banks should have adequate capital fund although there are plenty of investment opportunities.

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Presently, raising capital is a tough task. The growing NPAs, being the main headache of commercial banks, meeting the capital adequacy is very tough, though it is not impossible. It has been observed that any study has not been undertaken regarding the capital adequacy norms for commercial bank. However, studies on NRB directives have been undertaken by Pandey (2002), an MBS student of TU and Karmacharya (2002), an MBA student of TU. In both studies, in course of study come the studies of capital adequacy. So, this thesis is a new study in the field of banking sector. Thus, the thesis has of course presented some results which will reflect the capital structure and position of commercial banks of Nepal.

1.6

Limitation of study

The study is limited of the capital fund and capital adequacy norms for commercial banks. Since, it is not possible to take all commercial banks as sample, the thesis will analyze on the data and information of BOK and HBL. The data and information over the period of five fiscal years commencing from the FY 1997/98 till the FY 2001/02 are used in the study. For the analysis of capital fund, only two years data are available, i.e., of FY 2000/01 and FY 2001/02. Balance sheets, profit & loss accounts and other financial statements are considered as basic source of data. Thus, the study is mainly based on the secondary data collected from various sources. However, some primary data has also been derived from the analysis of questionnaire prepared for the research study. For the literature review various newspapers, journals, unpublished thesis works and nevertheless the internet have been referred. However, the literature review has been limited to very few articles and research works due to unavailability of sufficient such matters even after very hard quest.

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1.7

Theoretical Framework

The primary and independent variable that has been considered in this research study is capital fund of the selected commercials banks. The variables which are supposed to be dependent are deposit and credit of these banks. While going through the literature review, it is found that capital and deposit are related. As well as capital and credit are related. The significance of the relationship is tested in the analytical chapter i.e., Chapter 4. The positive correlations are expected in both relations. The higher the capital fund, the higher the chance of collecting more deposits and flowing more credit as well.

1.8

Problem Hypothesis

From the theoretical framework discussed earlier, the following hypotheses have been developed which have been thoroughly tested in the Chapter 4. 1. The capital fund and deposits are correlated. 2. The capital fund and credits are correlated.

1.9

Structure of study report

The structure of the thesis report comprises a total of five chapters which have been briefly described as follows: Chapter 1: Introduction To start the thesis report, this chapter includes the background of the study, meaning, functions and importance of a central bank, introduction to NRB, introduction to BOK, introduction to HBL, statement of problem, objective of the study, significance of the study, limitation of the study, theoretical framework, and problem hypothesis. This chapter has been targeted to help the reader to understand get the rhythm of the subject matter of the thesis report.

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Chapter 2: Review of Literature This chapter includes conceptual review, review of NRB capital adequacy norms, and review of empirical works. For this purpose, various books, journals and periodicals as well as internet have been utilized. Chapter 3: Research Methodology Research design, sample selection, sources of data, data collection procedure, tools for analysis of the study, and limitations of the methodology have been included in this chapter. Chapter 4: Presentation and Analysis of Data This chapter illustrates the collected data into a systematic format. The analysis of these data is also included in this chapter. As well as, interpretation of analysis has also been done in this chapter. Chapter 5: Summary, Conclusions and Recommendations In this chapter, the summary of the entire thesis has been comprised. This chapter further describes the major findings of the thesis. Conclusions of the study have also been included in this chapter. As well as, possible and viable recommendations has also been presented in this chapter.

C HAPTER 2 L ITERATURE R EVIEW

2.1

Conceptual Review

2.1.1 Origin and Development of Banks The economic activities existed in every civilization of mankind in all over the world. But the modern banking practice was originated from Europe. The first bank called Bank of Venice was established in Venice in 1157. Then Bank of Barcelona was established in 1401 and in 1407 Bank of Genoa was established. In 1694, the Bank of England was established as a joint stock bank. Nepal has a long history of using of money. History unveils that the first Nepali coins to be introduced were Manank during the reign of the King Mandev and Gunank during the reign of the King Gunakamdev. Afterwards the coins were reintroduced during the reign of Amshuverma. After the unification of Nepal, the great King Prithivi Narayan Shah started the coin Mohar. The Taksar was established in 1789 to issue coins scientifically. In 1876, during Rana Regime an office named Tejarath Adda was established in Kathmandu to provide loans against deposit of gold and silver. But the office did not have right to accept deposits. To begin to the modern banking system, Nepal Bank Limited was established in 1937 as the first bank of the country. Nepal Bank Limited dominated the financial sector of the country for almost 30 years without any competitor. This bank played a major role to boost up the Nepalese economy during that period. Nepal Rastra Bank was established in 1955 as central bank of Nepal which was very essential for

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Nepalese economy. The second commercial bank, Rastriya Banijya Bank was established in 1965 under the Rastriya Banijya Bank Act, 2022 with full ownership of the His Majestys Government. 2.1.2 Development of Central Bank In 1894, the Bank of England was converted into the central bank of England. This was done by establishing the Governor and the Company of the Bank of England. At present, this bank is known as the Central Bank of England. Shekhar & Shekhar (1998) have stated that after the World War I and the consequent chaotic monetary conditions brought home to many countries the imperative necessity of establishing a centralized institution capable of creating and maintaining equilibrium in the monetary sphere. In September 1920, an International Financial Conference was held at Brussels, which pointed out that those countries which had not yet established a central bank and were suffered from the World War I and the consequences should establish a central bank. In the spring of 1922, the Genoa Conference also indicated the need of central bank. Then after, there came a wave of establishing central banks by several countries. 2.1.3 Meaning of Central Bank Central bank is the national institution that monitors all financial and monetary procedures and policies. Vaidya (1997) has stated that the central bank is the apex bank in a country that controls all monetary system and banking structure. Rosenberg (1982) has defined the central bank as a bankers bank and a bank holding the main body of bank reserves of a nation and the prime reservoir of credit. (e.g., Bank of England, Bank of France) Clark (1999) has expressed the central bank as bank that often carries out government economic policy, influences interest and exchange rates and monitors

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the activities of commercial and merchant banks. In this way it functions as the governments banker and is the lender of the last resort to the banking system. Encyclopedia Britannica (2002) defines Central Bank as an institution that is charged with regulating the size of a nation's money supply, the availability and cost of credit, and the foreign-exchange value of its currency. Regulation of the availability and cost of credit may be nonselective or may be designed to influence the distribution of credit among competing uses. The principal objectives of a modern central bank in carrying out these functions are to maintain monetary and credit conditions conducive to a high level of employment and production, a reasonably stable level of domestic prices, and an adequate level of international reserves. Central bank is an institution which is charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of the general public welfare. It is also a bankers bank and holding reserves of the country and ultimate reservoir of credit. Hence, central bank is the regulating authority for commercial banks, and other banks and financial institutions. 2.1.4 Importance & Functions of Central Banks It is a difficult task to put aside the importance and functions of a central bank. Shekhar & Shekhar (1998) comments that it is difficult to lay down any hard and fast rule regarding the functions of a central bank. The powers and the range of functions of central banks vary from country to country. The most important and the earliest functions to be discharged by a central bank is that of acting as a bank of issue. As well as it is a bankers bank. The central bank also acts as a lender of the last resort. In case of any problems and emergency to any of the banks operating under it, central bank comes forward to rescue them temporarily from such problems. It also plays the role of an agent, an advisor and banker to the Government. Central bank is a custodian of the nations metallic reserves and controller of currency.

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A central bank has sole right to issue national currency notes. It controls money flow in the market by imposing monetary policy. It issues notes after full analysis of unemployment, inflation, economic growth, etc. of the country. Central bank is the holder of all the Government balances. It is the holder of all the reserves of the other banks and financial institutions in the country. Objectives between a central bank and other commercial banks are different. The main objective of a central bank is to assist the government to implement economic policies without any profit motive, whereas the main objective of other banks is to earn profit by mobilizing funds collected from the general public. As well as the central bank plays the role of guardian and parents to other commercial banks. As a regulatory body of all other banks and financial institutions, a central bank is the origin of all banking policies under which all the banks are suppose to operate. Therefore, a central bank guides and assists in operating banking system as a whole. A central bank has full authority to interfere in the banking market i.e. to all banks in terms of implementing its policies. It can penalize the banks in case they go out of the central banks policy or the termination of the license and also can restrict their working dimensions to a large extent. A central bank is also important in the context to co-ordinate with different international institutions such as International Monetary Fund (IMF) etc. It works under the supervision and guidance of such institution to develop the monetary system of a country. 2.1.5 Meaning of Commercial Banks Rosenberg (1982) has stated commercial bank as an organization chartered either by the Comptroller of the Currency and known as a national bank or chartered by the state in which it will conduct the business of banking. A commercial bank generally specializes in demand deposits and commercial loans.

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Clark (1999) has defined commercial bank as bank that concentrates on cash deposit and transfer services to the general public, often to be found on the High Street. It may be joint-venture bank or a private bank. Bank is an institution that deals in money and its substitutes and provides other financial services. Banks accept deposits and make loans and derive a profit from the difference in the interest rates paid and charged, respectively. Some banks also have the power to create money. Commercial bank is a bank with the power to make loans that, at least in part, eventually become new demand deposits. Because a commercial bank is required to hold only a fraction of its deposits as reserves, it can use some of the money on deposit to extend loans. When a borrower receives a loan, his checking account is credited with the amount of the loan; total demand deposits are thus increased until the loan is repaid. As a group, then, commercial banks are able to expand or contract the money supply by creating new demand deposits. (Encyclopedia Britannica, 2002) Banking, the business of providing financial services to consumers and businesses. The basic services a bank provides are checking accounts, which can be used like money to make payments and purchase goods and services; savings accounts and time deposits that can be used to save money for future use; loans that consumers and businesses can use to purchase goods and services; and basic cash management services such as check cashing and foreign currency exchange. Commercial banks specialize in loans to commercial and industrial businesses. Commercial banks are owned by private investors, called stockholders, or by companies called bank holding companies. (Microsoft Encarta Reference Library, 2003) The main objectives of a commercial bank are to earn profit by collecting the fund scattered around the general public, and mobilizing it. So, the main functions of commercial banks happen to be collecting deposits from general public and lending loans to various economic sectors that require financing. Commercial banks make profit by charging a bit higher interest rate in loans than they pay to depositors. So the main source of income of commercial banks is interest income.

18

2.1.6 Overview: Capital and Capital Adequacy Capital is a stock of resources that may be employed in the production of goods and services and the price paid for the use of credit or money, respectively. (Microsoft Encarta Reference Library, 2003) Rosenberg (1982) has defined capital in relation with banking as a long-term debt plus owners equity. The efficient functioning of markets requires participants to have confidence in each other's stability and ability to transact business. Capital-rules help foster this confidence because they require each member of the financial community to have, among other things, adequate capital. This capital must be sufficient to protect a financial organizations depositors and counterparties from the risks of the institution's on-balance sheet and off-balance sheet risks. Top of the list are credit and market risks; not surprisingly, banks are required to set aside capital to cover these two main risks. Capital standards should be designed to allow a firm to absorb its losses, and in the worst case, to allow a firm to wind down its business without loss to customers, counterparties and without disrupting the orderly functioning of financial markets. Minimum capital fund standards are thus a vital tool to reducing systemic risk. They also play a central role in how regulators supervise financial institutions. But capital requirements have so far tended to be simple mechanical rules rather than applications of sophisticated risk-adjusted models. Such capital standard is widely known as capital adequacy. Patheja (1994) has defined banks capital as common stock plus surplus plus undivided profits plus reserves for contingencies and other capital reserves. In addition since a banks loan-loss reserves also serves as a buffer for absorbing losses, a broader definition of bank capital include this account.

19

Verma & Malhotra (1993) has indicated that the general public is interested in the higher profitability and safety of the funds of a bank, because the public expects the shareholders to assume all the risks. Lower profitability of a bank fills the faith of the prospective depositors and all their incentive for investing in the various deposit schemes. The Basel Committee sets a standard for all the banking norms, which will be accepted by central banks of all big industrialist countries. Regarding the capital funds the committee has issued the Basel Capital Accord. The first Basel Capital Accord was issued in 1988 and was implemented by 1992. The committee has now issued New Basel Capital Accord which will be implemented by 2006 to overcome the drawbacks of the present capital accord. Central banks of developing and underdeveloped countries follow these standards. NRB also follows these standards and accordingly sets standard for commercial banks in Nepal. According to the directive issued by NRB, the bank capital has been categorized into two parts: core capital and supplementary capital. This categorization is also known as Tier-1 capital for core capital and Tier-2 capital for supplementary capital. The Tier-1 capital consists of the following components of capital: 1. Share Capital, 2. Share Premium, 3. Non-Redeemable Preference Shares, 4. General Reserve Fund, 5. Cumulative Profit/Loss (up to previous FY), and 6. Current Year Profit/Loss (as per Balance Sheet). The Tier-2 capital consists of the following components: 1. Loan Loss Provision, 2. Exchange Equalization Reserve, 3. Assets Revaluation Reserve, 4. Hybrid Capital Instruments,

20

5. Unsecured Subordinated Term Debt, 6. Interest Rate Fluctuation Fund, and 7. Other Free Reserves. The total of Tier-1 and Tier-2 capital is considered for calculating capital adequacy ratio. The capital adequacy ratio is based on total risk-weighted assets. Clark (1999) has defined capital adequacy as legal requirement that a financial institution (such as a bank) should have enough capital to meet all its obligations and fund the services it offers. Besis (1998) has claimed that capital adequacy aims at setting minimum level of capital as a function of risks. Thus capital should be risk based. Maisel (1981) Capital is adequate either when it reduces the chances of future insolvency of an institution to some predetermine level of alternately when the premium paid by the banks to an insurer is fair, that is, when it fully covers the risks borne by the insurer. Such risks, in turn, depend upon the risk in the portfolio selected by the bank, on its capital and on terms of the insurance w.r.t. when insolvency will be determined and what loss will be paid. The capital adequacy ratio is yielded by the following formula: Capital Adequacy Ratio = Total Capital Fund 100% Total risk-weighted assets

2.2

Review of NRB Capital Adequacy Norms for Commercial Banks

With an objective to develop a healthy, competent and secured banking system for economic prosperity of the country and to safeguard the interest of depositors, NRB issued the directive no. 1 regarding minimum capital fund to be maintained by commercial banks. NRB issued these capital adequacy norms by using the power

21

given by Commercial Bank Act, 2031 (with amendments) Clause 14(Ka). These norms were issued under the Nepal Rastra Bank Act, 2012 (with amendments) Clause 23 Sub-clause 1 Provision for developing and regulating banking system. The norms have prescribed the minimum capital fund requirement, on the basis of the risk-weighted assets. The banks are required to maintain the prescribed proportion of minimum capital fund on the basis of weighted risk assets as per the following time-table: Time Table For FY 2058/59 (2001/02) For FY 2059/60 (2002/03) From FY 2060/61 (2003/04) onwards Core Capital 4.5% 5.0% 6.0% Total Capital Fund 9.0% 10.0% 12.0%

As stated earlier, for the purpose of calculation of Capital Fund, the capital of the banks is divided into two components Core Capital and Supplementary Capital. Core capital which is widely known as Tier-1 capital consists of share capital, share premium, non-redeemable preference shares, general reserve fund and accumulated profit/loss. Supplementary capital, which is also known as Tier-2 capital consists of loan loss provision, exchange equalization reserve, assets revaluation reserve, hybrid capital instruments, unsecured subordinated term debt, interest rate fluctuation fund, and other free reserves. The sum of these two components is considered to be total capital fund. For the purpose of calculation of capital fund, the risk-weighted assets have been classified into two parts On-Balance Sheet Risk-Weighted Assets and Off-Balance Sheet Risk-Weighted Items. The weightage of the risk assigned to them are shown in the Appendix B and Appendix C respectively. The amount of risk-weighted assets calculated by multiplying the amount of the asset with the weightage assigned to them and the total of which will be extracted for the purpose of calculation of capital adequacy ratios.

22

As per the norms, the capital fund ratio would measure the total capital fund on the basis of total risk-weighted assets. The capital fund ratio shall be determined as follows: Capital Fund Ratio = Core Capital + Supplementary Capital 100% Sum of risk-weighted assets

The sum of risk-weighted assets is the sum of total on-balance sheet risk-weighted assets and total off-balance sheet risk-weighted items. The banks shall, at the end of Ashoj (mid October), Poush (mid January), Chaitra (mid April) and Ashad (mid July) of each fiscal year, prepare the Statements of Capital Fund and other relevant statements on the basis of the financial statements as per the prescribed Form No. 1 and Form No. 2 and submit to the Banking Operations Department and Inspection and Supervision Department of this bank within 1 (one) month from the end of each quarter. The prescribed form no. 1 and 2 are illustrated in Appendix D and Appendix E respectively. In the event of non-fulfillment of Capital Fund Ratio in any quarter, the banks shall fulfill the shortfall amount within next 6 (six) months. Until the fulfillment of such Capital Fund, the banks shall not declare or distribute dividend to its shareholders under Section 18 of Commercial Bank Act, 2031. The shortfall in the Capital Fund may be rectified by issuing new shares and/or reallocating assets. If any bank does not fulfill the minimum Capital Fund within the specified period, NRB may initiate any of the following actions: a) Suspension of declaration / distribution of dividend (including bonus shares). b) Suspension of opening new branch. c) Suspension of access to refinancing facilities of Nepal Rastra Bank. d) Restriction on lending activities of the bank. e) Restriction on accepting new deposits. f) Initiation of any other actions by exercising the authority under Section 32 of Nepal Rastra Bank Act, 2012.

23

2.3

Empirical Review

2.3.1 Review of Articles and Reports Lamsal (2001) stated that that the central bank rocked the commercial banks with seven directives issued in two installments asking banks to start complying with the new strictures by mid-July 2001 or face grave consequences. NRB claims that these are based on the internationally accepted banking norms of Basel committee. Lamsal has opined that banks are expected to be disparate to meet the targets of capital adequacy norms since the consequences the banks have to face in case of noncompliance are very strict. And for this purpose they will have to issue additional shares, which is not possible for them in the short-run. Or they do not prefer to go for additional share issue simply because they will also have to pay the same dividend as the past to the holders of shares so issued. This becomes the more difficult as the business is not going to expand commensurately. The difficulty is understandable now when every banker is complaining of the lack of new investment projects. Shah (2003) concluded that being the central bank of the nation, Nepal Rastra Bank has to be active by playing important role for monetary and financial stability. Central bank should always be eager to achieve the public faith towards bank and financial institutions enabling them being disciplined, well-organized, healthy and competent by providing effective regulation and supervision to appropriate utilization and mobilization of financial resources by increasing financial saving rate by raising financial stability. Also, central bank should always be willing to safeguard the interest of depositors and investors to accomplish the financial stability. Constant financial stability leads to the accomplishment of monetary stability. As the tools for monetary policy are applied through financial sector, the efficiency of monetary policy depends on effectiveness of financial sector. Balanced growth of financial sector helps monetizing of economy. Various drawbacks; like, managerial ineffectiveness, organizational difficulty, contrary financial situation; make the longterm stability of financial sector suspicious. Failure of any one financial institution

24

leads the destructive impact to whole financial sector and such impact will be spread to other countries from the countries where capital accounts are fully convertible. So, the concept of financial system of the country should be boosting and healthy for achieving higher economic growth rate by steadying macro economic stability has been globally supported. The financial sector reform program in Nepal can also be taken in the same background. Since, it is not possible to achieve financial stability without the commanding role of regulation and supervision, new program of financial sector reform program should play role regarding structural reformation/transformation and organizational structure in existing banks and financial institutions by clarifying the role of government and central bank. Khatiwada (2003) enlightened that recent financial crisis have revealed a number of data deficiencies, notably in pledged assets, deposits held in financially weak domestic banks and their foreign affiliates, valuation practices leading to bank valuation of assets being significantly different from market values and complicating assessments of the realizable value of reserve assets. Similarly, public information is lacking in many countries on the off-balance-sheet activities of the authorities that can affect foreign currency resources. There was a lack of information on the authorities financial derivatives activities. Also observed was the inadequate information of actual and potential foreign liabilities of the monetary authorities and central government. Financial sector reform envisages for measures for mitigating this information and data gap problem as well. Khatiwada has further written that Nepal initiated financial sector reform back in 1980s with donor initiative and assistance. In this process, some progress was made in terms of re-capitalization of the government banks, divestment, branch consolidation, introduction of new regulatory and prudential norms and cleaning up the balance sheets of bad loan loaded banks. But the reform process was stalled in the later 1990s due to political instability and the governments priority in areas other than the financial system. In between, the country observed, from very close by, the financial crisis in the neighboring region. Keeping in mind the financial crisis and its effect in the Asian region, the Nepal Rastra Bank is now focusing its

25

attention on the reform measures in the financial sector as a drive towards new financial architecture. Khatiwada emphasized various reform majors. One of the measures was increasing capital base and revising capital adequacy. Khatiwada stressed that experience has shown that undercapitalized financial institutions are the ones that are first attacked by the speculators and hedgers at the time of crisis and create contagious effect on the other institutions as well. Besides, undercapitalized financial institutions cannot gain credibility and corporate growth even in normal times. This requires that financial institutions are adequately capitalized and possess resilience against attacks by dealers and customers. In this context, the capital adequacy norms are being revised upward as per the Basel Capital Accord. But increasing the capital base for loss making government owned financial institutions is not easy without involving private sector in the equity capital. Pandey (2003) stressed that one of the main objectives of a commercial bank is to safeguard the money of depositors. With the low capital adequacy rate, the banks were previously lending from the money of the depositors because the capital comprised a very small portion of the total risk-weighted assets. However, the returns the shareholders or promoters were reaping were quite high. The risk of the depositors was too high. Pandey further put forward that a good banking system is, therefore, a sine qua non for maintaining financial equilibrium in the country. And, NRBs efforts in this direction are really praiseworthy. Stokes (2003) has mentioned that banks hold capital in excess of reserve requirements to provide a buffer against future, unexpected losses. Such losses are brought about by the credit, market, and operational risks inherent in the business of lending money. Problems created by an insolvent bank are important enough that bank regulators enforce minimum capital standards on banks in an effort to safeguard depositors and ensure the ongoing viability of the financial system. However, from a banks perspective holding idle capital is an expensive safeguard against risk because the banks shareholders demand a return on their investment and idle capital provides no

26

such return. For this reason bankers and regulators can have divergent opinions about the amount of capital a banks should hold making the problem of determining a banks risk-based capital a complex and important question. Heakal (2003) has written that the central bank has been described as the lender of the last resort, which means that the central bank is responsible for providing its economy with funds when commercial banks cannot cover a supply shortage. In other words, the central bank prevents the countrys banking system from failing. However, the primary goal of central banks is to provide their countries currencies with price stability by controlling inflation. A central bank also acts as the regulatory authority of a countrys monetary policy and is the sole provide and printer of notes and coins in circulation. Time has proven that the central bank ca best function in these capacities by remaining independent from government fiscal policy and therefore uninfluenced by political concerns of any regime. The central bank should also be completely divested of any commercial banking interests. Keijser & Haas (2001) have summarized as the Basel Capital Accord of 1988 was an important first milestone in the regulatory treatment of collateralized transactions. However, the role played by risk mitigating factors in this Accord, such as the use of financial collateral, is still rather limited. The same holds for the European directives and national regulations derived from the Basel Accord. The regulatory treatment of collateral has recently entered a new phase, in the form of the proposed revision of the Basel Accord. The use of a wider range of collateral will be allowed in the new Accord and banks will be able to choose either the comprehensive or the simple approach for the treatment of collateral. Whereas the simple approach resembles the current Basel substitution methodology in its treatment of collateral, the comprehensive approach is more innovative. It assigns a central role to collateral haircuts, which may be based on banks own internal estimates of collateral volatility. By making a wider range of collateral available for credit risk mitigation and making the calculation of risk-weighted assets more risk-sensitive, the revision of the Basel Accord is intended further to align regulatory capital which banks must hold and their actual economic risk structure.

27

2.3.2 Review of Thesis Works Pandey (2002) has given conclusion regarding the capital adequacy of HBL during his study period, i.e., as of Poush end 2058 as the capital fund of HBL stands at Rs. 1070 million comprising of Rs. 756 million core capital and Rs. 314 million of supplementary capital. The total risk weighted assets of HBL is equal to Rs. 12690.6 million. Therefore, the capital adequacy of the bank stands at 8.43% of total risk weighted assets. Core capital is 5.96% and the supplementary capital is 2.47% of total risk weighted assets. Hence, Pandey has concluded that HBL has surplus of Rs. 184.92 million of core capital and a shortfall of Rs. 257.08 million of supplementary capital. The standard required to be maintained by HBL as per NRB by July 16, 2002 is 4.5% in each case totaling at 9% in all. However, according to the directives, a shortfall in the supplementary capital can be fulfilled by the surplus in core capital. Therefore, in case of HBL, the bank can use the excess of Rs. 184.92 million core capital to compensate for the shortfall. But still the bank requires another Rs. 72.6 million to meet the requirement of supplementary capital. Pandey has suggested that HBL should increase the capital base from Rs. 1070 million by at least Rs. 115 million to meet the capital adequacy ratio. For this, the bank should try to increase its supplementary capital as it falls short by Rs. 73 million. The bank should increase its core capital in order to expose itself to more credit risk. Karmacharya (2002) has expressed that the financial soundness as well as its strength of the company depends upon the large extend on the composition of the capital structure and assets. Capital structure of the company presents its resource capacity and ability of its present worthiness. In the study, he has found that the all the banks in his study follows the requirements of NRB directives regarding capital adequacy. The capital structure of studied banks is highly leveraged. Thus, Karmacharya has recommended that the proportion of debt and equity capital should be decided keeping in mind the effort of tax advantages and financial distress. The banks are required to maintain improved capital structure by increasing equity base i.e., issuing more equity capital, expanding general reserve and retaining more earnings. With this improvement, it will compromise among the conflicting

28

factors of cost and risk. As mandated by NRB, for the operation in all over Nepal, a commercial bank should have capital base of Rs. 500 million. Hence, the banks should raise its paid-up capital to Rs. 500 million as soon as possible. Sapkota, U.P. (2002), in his study on fund mobilizing policy of Standard Chartered Bank Nepal Ltd (SCBNL), has found that liquidity position of SCBNL was not satisfactory. Loans & advances, cash & bank balance ratio seemed too weak than that of NBBL and HBL. Investment on share & debenture and interest earning power on total working fund also seemed in weak condition than that of NBBL & HBL. Growth ratio of deposits, loans & advances, investments, net profits seemed too weak in comparison to NBBL and HBL. The relation of investment and loans & advances with deposits seems positive and the relation of net profit with outside assets (investment and loans & advances) seemed positive. At last, Sapkota concluded that in overall condition SCBNL seemed in satisfactory position in comparison to NBBL & HBL. Since, SCBNL used to provide less loan & advances in comparison to its total deposits, SCBNL Sapkota has strongly recommended following a liberal lending policy so that more percentage of deposits can be invested to different profitable sectors as well as towards loans & advances. Because, analysis showed investment and loans & advances as a significant factor this affects the net profit of the bank. Subsequently, a skillful administration is the must for these assets because negligence may become a reason for liquidity crisis and bankruptcy. Pathak (1999), in his thesis, has found the capital adequacy ratios of NIBL and NGBL are fluctuating in nature over the period of his study. Pathak has further concluded that both the banks have been maintaining capital adequacy ratio as directed by the central bank Nepal Rastra Bank in order to safeguard the depositors interest. However, it is found from students t-test that NIBL has higher capital adequacy ratio than that of NGBL on an average. It can be concluded that NIBL has maintained excess capital fund to safeguard the depositors interest.

29

Sapkota, R. (2002), in his study on capital and assets structure management of Nepal Bank of Ceylon Ltd, has found that the ratio of shareholders fund to total deposit ratio reveals that in the year 2053/054 it was highest i.e. 101.40% and has been decreasing in the succeeding years. The average ratio is 35.69. Also, the ratio of shareholders fund in relation to total assets shows that average ratio is 21.22%. It is concluded that its ratio are found decreasing throughout the study period. Agrawal (2002), in his study on deposit and investment position of Yeti Finance Company Ltd, has concluded that the major objective of financial institution is to transfer capital between saver and those who need it. Such institutions are established with the aim of further intensifying the participation of assisting industries and private sector in regular supply of funds. Financial institutions serve as a financial intermediaries, transfer money and securities between firm and saver that create a new financial product. Agrawal further commented that the major classes of financial intermediaries are commercial banks, mutual saving bonds, credit unions and pension funds, life insurance companies and finance companies. Within a short span of time they are showing encouraging trend in the financial sector, both in collecting and investing funds. They are able to tap even smaller amount of saving from public and investing in different production sectors. Shrestha (2002) has stated that in a situation when the existing financial institutions, especially government owned commercial banks were unable to supply credit timely and carry capital market activities, private joint venture commercial banks have contributed a lot. The overall performance of joint venture commercial banks is satisfactory and NRB has to play more active role to enhance the operation. The analysis of liquidity position of sample joint venture commercial banks (Nabil Bank Ltd, Standard Chartered Bank Ltd and Nepal SBI Bank Ltd) have satisfactory. Initially the major part of these banks was consisting of business and industrial loan; this is the indication of investment on productive sector. Nowadays, these banks are slowly turned on hire purchase and housing financing.

30

Strengthening and institutionalization of the commercial banks is very important to have a meaningful relationship between commercial banks and national development through shift of credit to the productive industrial sectors. At the same time the series of reforms such as consolidation of commercial banks, directing attention to venture capital financing, appropriate risk return trade of by linking credit to timely repayment schedules, avoiding imperfections, allowing flexibility in lending, one window service from NRB, need of a strong supervision and monitoring from NRB, diversity scope of activities for commercial banks, professional culture within commercial banks, etc. All these are necessary to ensure better future performance of commercial banks that have already been established and growing in Nepal. Ranjit (1989) has indicated that capital funds have positive and significant relation with both deposits and loans. That means increase or decrease in capital fund increases or decreases deposits as well as loans. However the degrees of relationship were different. But relation of capital with profit was positive and insignificant. That indicated less of increase or decrease in profit is due to capital fund or capital fund is least responsible in changing profit. Bank should increase capital fund to increase the capital fund ratio according to increase in deposits. Shivakoti (2003), in his study of capital & assets structure of Nepal Industrial Development Corporation (NIDC), has concluded that the financial soundness of a company as well as its strength depends largely on the capital and assets structure. The capital structure presents its resource capacity and viability where as the asset structure presents its worthiness. The composition of the capital and assets holds the utmost importance so far the successful and thriving operation of NIDC. Shivakoti stated that NIDC prefers the long-term borrowing in form of capital and uses it in long-term loan as assets. The fixed assets, investment in shares and debentures, current assets and liabilities, share capital, reserve and surplus are other components associated with capital and assets structure of NIDC. Shivakoti found that the contribution of different components of capital and assets structure in EBIT of NIDC to be less satisfactory. The relation is positive which showed EBIT was

31

increasing with other variables correlated but the low degree of correlation between them meant the relationship between these EBIT and other variables lacks closeness in its increasing trend. Kadel (2002), in his study on financial performance of NGBL and HBL, has concluded as many commercial banks have been competing with each other in their business. When the government adopted liberal policy, as a result many commercial banks especially joint-venture banks increased rapidly i.e., Himalayan Bank Ltd, Nepal SBI Bank Ltd, Nepal Grindlays Bank Ltd, etc. These banks are mainly concentrated themselves on financing foreign trade, commerce and industry and other sectors. Banking helps to mobilize the small savings collectively to the huge capital investment though the banking is considered as the platform of money market.

C HAPTER 3 R ESEARCH M ETHODOLOGY

Research Methodology can be understood as a science of studying how research has been done. This chapter looks into the research design, nature and sources of data, data collection procedure and tools & technique of analysis. For the purpose of achieving the objectives of the study, the applied methodologies are used. The research methodology used in the present study is briefly mentioned below.

3.1

Research Design

This study research attempts to analyze the capital funds of commercial banks taking the data and information of BOK and HBL. The research design is basically focused on analytical study. Ratio analysis, correlation analysis and testing of hypothesis have been done for analyzing the research. The research examines the relationship of bank capital to various other stakes, like deposits, credits, etc.

3.2

Population and Sample

There are total 16 commercial banks presently operating in Nepal. Collecting the data of these entire commercial banks is not possible. Hence, Bank of Kathmandu Ltd (BOK) and Himalayan Bank Ltd (HBL) have been selected for the case study. Thus, the population of the study comprises of all these commercial banks and the samples are BOK and HBL.

33

Also, through the research questionnaire, various responds of the respondents have been considered as sample for the study. Twelve bank officials have been interviewed with a questionnaire prepared as in Appendix K. There are total 72 respondents of the research questionnaire for depositors as shown in Appendix L.

3.3

Data collection procedure

The data and information are collected from both the primary and secondary sources. For the primary information, research interview and questionnaires are used. The research interview questionnaire, as shown in Appendix K, was set to interview bank officials. The research questionnaire as shown in Appendix L was set for bank account holders who are known as depositors in this thesis report. For the collection of secondary data and information, directives of Nepal Rastra Bank, annual reports of BOK, annual reports of HBL, various publications of Nepal Rastra Bank, magazines, the other publications and the internet have been used. Also, for other related information, various books and periodicals have been referred from library and some that the researcher self has.

3.4

Data Analysis Tools

Before analyzing the data, the data and information have been presented systematically in the formats of Tables, Graphs and Charts which will explain a lot about the data and information collected. For the analysis of the research study, the following financial tools and statistical tools are used. 3.4.1 Financial Tools Ratio analysis is the best tool for financial analysis. Ratios can be taken as expression of relationships between two items or group of items and therefore may

34

be calculated in any number and ways so far meaningful co-relationship is obtainable. Pandey (1995) emphasizes that a ratio is used as a benchmark for evaluating the financial position and performance of a firm. The following ratios related to the banks are used to analyze the data: (a) Capital Adequacy Ratio:

Capital adequacy ratio is the foremost tool to analyze the capital fund of a bank. Actually, the fundamental objective of this research study is to examine capital adequacy of HBL and BOK. The capital adequacy ratio is based on total risk-weighted assets (TRWA) of the bank. Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. This ratio is used to examine adequacy of total capital fund and core capital, which is yielded by the following formulas: To measure the adequacy of total capital fund: Total Capital Fund 100% TRWA To measure the adequacy of core capital: Core Capital 100% TRWA (b) Capital to Deposit Ratio:

The capital to deposit ratio is an important tool in measuring capital adequacy ratios of banks. But, this ratio can not reflect the capital adequacy of a bank. Patheja (1994) has stressed that the capital to deposit ratio has enjoyed the longest use of any ratio devised to measure and determine capital adequacy.

35

The capital to deposit ratio is derived by the following formula: Total capital fund 100% Total deposit collected (c) Credit / Deposit Ratio:

The credit / deposit ratio (CD ratio) is a major tool to examine the liquidity of a bank. CD ratio measures the ratio of fund that a bank has utilized in credit out of the deposit total collected. More the CD ratio more the effectiveness of the bank to utilize the fund it collected. The CD ratio is derived by the following formula: Total Credit 100% Total deposit collected

3.4.2 Statistical Tools The following statistical tools are used to analyze the data: (a) Karl Pearson Correlation Analysis:

The relation between two variables is correlated by Karl Pearsons correlation coefficient. The following is the formula proposed by Karl Pearson for calculation of correlation coefficient.

r=

NXY - (X)(Y) [NX - (X)2] [NY2 - (Y)2]

2

Where, N = Numbers of pairs in observation X = Product of the first variable Y = Product of the second variable

36

To ease the calculation, a shortcut formula has been proposed which has been used in to calculate correlation coefficients in this thesis report. The shortcut formula is as follows: xy x2. y2

r=

Where,

x = (X- ) X y = (Y- ) Y
(b) Test of Hypothesis:

The calculated correlation coefficients have been used to test the hypothesis as proposed in Chapter 1 by using the following t-test formula:

t=

rn-2 1-r2

Where,

r = calculated correlation coefficient n = number of observations

The hypotheses have been tested with at a 95% level of confidence.

C HAPTER 4 D ATA P RESENTATION AND A NALYSIS

This chapter deals with the presentation, analysis and interpretation of relevant data and information of BOK and HBL. Also, the analysis and interpretation of the information and data produced from questionnaire is also contained in this chapter. To obtain best result, the data and information have been analyzed according to the research methodology as mentioned in the Chapter 3. The main purpose of analyzing the data is to change it from an unprocessed form to an understandable presentation. The analysis of data consists of organizing, tabulating, and performing statistical analysis. (Wolff & Pant, 1999) This chapter is partitioned into the sections of (1) Presentation of Data, (2) Ratio Analysis, (3) Statistical Analysis, (4) Impact of Capital Adequacy Norms, (5) Study of Perception of Depositors, and (6) Findings.

4.1

Presentation of Data

The collected data and information are presented in this section. Various tables, charts and graphs are used to best present the data. The data and information has been presented in most understandable format. 4.1.1 Capital Fund Capital fund of a bank consists of two types of components: Tier-1 capital and Tier2 capital. Tier-1 capital is known as core capital and Tier-2 capital is known as supplementary capital. Hence, the total capital fund of a bank derived by adding

38

these two components of capital. The capital funds of BOK and HBL has been illustrated hereinafter separately. 4.1.1.1 Capital Fund of BOK

BOK issued 30% bonus shares from the profit of FY 1999/2000 amount at Rs. 54 million. The bank also issued right shares with the right of 1:1 in the FY 2001/2002. In this way BOK increased its share capital to Rs. 464 million totaling the core capital at Rs. 511.50 million. The capital funds of BOK have been tabulated in Table 4.1 which shows the capital fund of the bank over the period of last five fiscal years, i.e., from FY 1997/1998 to FY 2001/2002.

Table 4.1 Capital Fund of BOK

(amount in million)

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Core Capital 92.07 95.92 249.36 318.70 511.50

Supplementary Capital 77.87 75.55 102.33 167.36 220.40

Total Capital Fund 169.94 171.47 351.69 486.06 731.90

Source: Annual Reports of BOK

In the five years period, BOK has been gradually increasing its capital base. BOK has been increasing both components of capital simultaneously. However, the core capital has been significantly increased over the five years period. The capital fund of BOK consisted core capital of Rs. 92.07 million and supplementary capital of Rs. 77.87 million totaling Rs. 169.94 million at the end of fiscal year 1997/98. The

39

capital fund have been increased to Rs. 511.50 million of core capital and Rs. 220.40 million of supplementary capital totaling Rs. 731.90 million at the end of FY 2001/02. The same can be viewed in a chart format in Figure 4.1.

Figure 4.1 Trend of Capital Fund of BOK

Capital Fund of BOK

800 Amount (Rs. in million) 700 600 500 400 300 200 100 0 1997/98 1998/99 1999/00 2000/01 2001/02 Fiscal Year Core Capital Supplementary Capital Total Capital Fund

The Figure 4.1 shows the growing trend of capital fund of BOK during the five fiscal years. The trend shows that both forms of capital are in increasing trend. However, the bar of core capital has been significantly rising higher whereas the bar of supplementary capital is increasing gradually. The increment of capital fund shows that BOK has been trying to increase its capital base to comply with the requirements of NRB as prescribed in capital adequacy norms for commercial banks.

40

4.1.1.2

Capital Fund of HBL

HBL also has been increasing its capital fund. The bank issued bonus shares in the FY 1998/99 by 60%, in the FY 1999/2000 by 25%, in the FY 2000/01 by 25% and in the FY 2001/02 by 30%. The bank has a plan to issue bonus shares by 10% every year till the paid up-capital meets the mandatory of Rs. 1 billion slab. The bank issued HBL Bond 2066 an unsecured subordinated term debt in the fiscal year 2001/02 amounting at Rs. 360 million to increase its supplementary capital. The issuance of the bond was the first ever bond issued by a bank in Nepal which is being traded in security market. The capital funds of HBL over the period of last five fiscal years, i.e., from FY 1997/1998 to FY 2001/2002 have been illustrated in Table 4.2.

Table 4.2 Capital Fund of HBL

(amount in million)

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Core Capital 298.87 388.79 448.08 698.70 834.55

Supplementary Capital 192.54 258.31 362.45 499.61 638.42

Total Capital Fund 491.41 647.10 810.53 1,198.27 1,472.97

Source: Annual Reports of HBL

In the five years period, HBL has significantly increased its capital base. HBL has been increasing both form of capital simultaneously. At the end of fiscal year 1997/98, HBL had core capital of Rs. 298.87 million and supplementary capital of Rs. 192.54 million totaling Rs. 491.41 million, which have been increased to Rs.

41

831.55 million of core capital and Rs. 638.42 million of supplementary capital totaling Rs. 1,472.97 million by the end of fiscal year 2001/02. The increasing trend of capital fund of HBL can be viewed in the Figure 4.2 in a chart format.

Figure 4.2 Trend of Capital Fund of HBL

Capital Fund of HBL

1600 1400 Amount (Rs. in million) 1200 1000 800 600 400 200 0 1997/98 1998/99 1999/00 2000/01 2001/02 Fiscal Year Core Capital Supplementary Capital Total Capital Fund

The Figure 4.2 shows that HBL is increasing both forms of capital gradually. It can be observed that both the bars are rising at a same pace. It can be said that HBL is successfully maintaining the ratio of core and supplementary capital at the same level. The main rationale behind the increment of the capital fund has been to comply with the requirement of NRB capital adequacy norms for commercial.

42

4.1.2 Risk-Weighted Assets of BOK and HBL The risk-weighted assets are derived by calculating the amount from the respective on- and off-balance sheet items with the prescribed weightage. The assets are categorized into four types while assigning weightage to them. NRB has assigned weightage of 0%, 20%, 50% and 100% according to their nature of risk bearing which is based on the standard of Basel Committee. The risk-weighted assets of BOK and HBL have been illustrated in Table 4.3. The table shows the risk-weighted assets of the two banks over the period of last two fiscal years, i.e., FY 2000/2001 and FY 2001/2002.

Table 4.3 Risk Weighted Assets of BOK & HBL

(Amount in Rs. million)

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Source: Annual Reports of BOK & HBL

BOK 1551.96 2586.27 3938.30 5651.95 5074.23

HBL 5603.31 7685.27 10093.77 14956.93 12746.17

4.1.3 Deposit Trend of BOK and HBL Being the main function of a commercial bank, every commercial bank collects deposit from general public. Verma & Malhotra (1993) has mentioned that a commercial bank has usually access to three sources of fund: capital fund, deposits and borrowings.

43

It is clear that BOK and HBL could not remain in the business without collecting deposits. Both banks have different policy to lure deposits from general public. In this matter, HBL has a scheme of Premium Saving Account (PSA), which is proved to be the most important product of HBL. PSA has helped to attract most deposits from general public. BOK is also planning to introduce similar type of product. The deposit collection trends of BOK and HBL for last five fiscal years can be viewed in figures in the Table 4.4 which also includes the national total and the share of BOK and HBL on it.

Table 4.4 Deposit Collection Trend of BOK, HBL and National Total
(Rs. in million)

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 1,773.87 2,564.83 4,196.41 5,713.49 5,723.30

HBL 7,713.60 9,772.74 14,043.10 17,636.85 18,619.38

National Total 102,598.2 127,201.7 154,943.0 181,767.0 185,053.2

Share of BOK 1.73 % 2.02 % 2.71 % 3.14 % 3.09 %

Share of HBL 7.52 % 7.68 % 9.06 % 9.70 % 10.06 %

Source: Annual Reports of BOK, HBL & Banking & Financial Statistics (2002)

The Table 4.4 shows that BOK and HBL have been gradually increasing the deposit collection. BOK has, however, a small share in the total national deposits than that of HBL. HBL has more than 10% share in national deposit collections at the end of fiscal year 2001/02. In the year 2001/02 BOK has collected deposits amounting at Rs. 5723.30 million whereas HBL has collected deposits amounting at Rs. 18619.38 million. The total deposit collections by all the banks at the end of fiscal year 1997/98 amounted at Rs. 102,598.2 million which increased to Rs. 185,053.2 million at the end of fiscal year 2001/02. The table 4.4 shows that HBL is far much

44

ahead in deposit collection. In fact, HBL is in the second position between private sector banks in collecting deposit. The deposit collection by BOK, HBL and other remaining banks by the end of FY 2001/02 are illustrated in the Figure 4.3 in a pie-chart format.

Figure 4.3 Share of BOK & HBL on Total National Deposit Collections

Share of BOK & HBL on Total National Deposits by the end of Fiscal Year 2001/2002
BOK 3% HBL 10%

Others 87%

The Figure 4.3 shows the share of BOK and HBL on total national deposit collection. BOK has a less share in deposit collection therefore it has a small pie. But HBL has a big pie, as it has more than 10% share in total national deposit collections. It is a fact that HBL is the no. 1 joint-venture bank in the country in collecting the deposits from public.

45

4.1.4 Credit Trend of BOK and HBL The main source of income of a bank is interest income from credit. Most of the amounts of deposit collected are used for credit lending. Bhandari (2003) believes that the commercial banks are inspired wit the motive of gaining profit. To fulfill this objective, they should widely manage and improve banking sector. They must pay much more attention to the flow of loan. Being commercial banks, one of the prime functions of BOK and HBL is credit lending. The credit lending trends of BOK and HBL for last five fiscal years have been illustrated in the Table 4.5 including the national total and their share on it.

Table 4.5 Credit Trend of BOK, HBL and National Total

(amount in million)

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 1,177.87 1,863.40 3,087.63 4,285.93 4,890.07

HBL 4,223.07 5,245.98 7,224.73 9,015.35 9,557.14

National Total 68,618.0 81,757.7 96,324.8 109,151.2 114,852.2

% Share of BOK 1.72 2.28 3.21 3.93 4.26

% Share of HBL 6.15 6.42 7.50 8.26 8.32

Source: Annual Reports of BOK, HBL & Banking & Financial Statistics (2002)

The Table 4.5 shows that BOK and HBL both are very much eager to flow loan. This is very much clear by the statistics of their credit trend for last five fiscal years. Both the banks are growing there share of credit in the market. BOK had credit of Rs. 1,177.87 million at the end of FY 1997/98 making the total market share of 1.72% where as, the bank increased its share up to 4.26% at the end of FY 2001/02 total amounting at Rs. 4,890.07 million. HBL had its share of credit in the market

46

was 6.15% at the end of FY 1997/98 amounting at Rs. 4,223.07 million. The amount is increased at Rs. 9,557.14 million at the end of FY 2001/02 making the market share of HBL at 8.32%. The credit flow of BOK, HBL and other remaining banks by the end of FY 2001/02 are illustrated in the Figure 4.4 in a pie-chart format.

Figure 4.4 Share of BOK & HBL on Total National Credit

Share of BOK & HBL on Total National Credit by the end of Fiscal Year 2001/2002
BOK 4%

HBL 8%

Others 88%

In the Figure 4.4, the share of BOK and HBL on total national credit can be viewed. Since BOK has a lesser share of 4% in credit therefore it has a small pie, where as HBL has a bigger pie as it has a share of more than 8%.

47

4.2

Ratio Analysis

The following ratios are used to evaluate the financial statements of HBL and BOK in regard of the capital adequacy and capital fund. 4.2.1 Capital Adequacy Ratios of BOK and HBL Capital adequacy ratio shows the strength of a bank. The calculation of capital adequacy ratios of BOK and HBL has been presented in Appendix F. The calculated capital adequacy ratios are shown in the Table 4.6 for the year FY 1997/98 to FY 2001/02:

Table 4.6 Capital Adequacy Ratios of BOK & HBL BOK At the end of Fiscal Year: Percentage of Total Capital: 10.95 % 6.63 % 8.93 % 8.60 % 14.42 % Percentage of Core Capital: 5.93 % 3.71 % 6.33 % 5.64 % 10.08 % HBL Percentage of Total Capital: 8.77 % 8.42 % 8.03 % 8.01 % 11.56 % Percentage of Core Capital: 5.33 % 5.06 % 4.44 % 4.67 % 6.55 %

1997/1998 1998/1999 1999/2000 2000/2001 2001/2002

Detail calculations shown in Appendix F.

The capital adequacy ratios of BOK and HBL show that the both banks are able to comply with the requirements of NRB. The minimum requirements of NRB for the two FY were total capital at 8% and 9% and core capital at 4% and 4.5% on total risk-weighted assets.

48

In the FY 2000/01, has a total capital fund at 8.60% and core capital at 5.64% of total risk-weighted assets. BOK has significantly increased the ratio in FY 2001/02 at 14.42% and 10.08% respectively. In the FY 2000/01, HBL has maintained the total capital fund at 8.01% and core capital at 4.67% of total risk-weighted assets. The same ratio in FY 2001/02 was at 11.56% and 6.55% respectively. 4.2.2 Capital to Deposit Ratios of BOK and HBL The capital to deposit ratio has a significant role in measuring capital adequacy ratios of banks. Calculation of capital to deposit ratios of BOK and HBL are shown in Appendix G. The Table 4.7 shows the capital to deposit ratios for the period of five fiscal years starting from FY 1997/98 to FY 2001/02.

Table 4.7 Capital to Deposit Ratios of BOK & HBL At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02
Detail calculations shown in Appendix G.

BOK 9.58 % 6.69 % 8.38 % 8.51 % 12.79 %

HBL 6.37 % 6.62 % 5.77 % 6.79 % 7.91 %

As per the Table 4.7, the capital to deposit ratios of the both banks seems to be inadequate. It is assumed that the capital to deposit ratio should be 10%. However, the ratios of BOK can be considered OK as 8% ratio is also accepted to be adequate.

49

The capital-to-deposit ratios of BOK are at around 6% to 9% till the end of fiscal year 2000/01. However, BOK has been able to overcome and maintained the ratio at 12.79%. The capital-to-deposit ratios of HBL are in between 5% to 8%. 4.2.3 Credit / Deposit Ratios of BOK and HBL The credit / deposit ratio (CD ratio) is a major tool to examine the liquidity of a bank. Calculation of CD ratios of BOK and HBL are shown in Appendix H. The Table 4.8 shows the CD ratios for the period of five fiscal years starting from FY 1997/98 to FY 2001/02.

Table 4.8 Credit/Deposit Ratios of BOK & HBL At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02
Detail calculations shown in Appendix H.

BOK 66.40 % 72.65 % 73.58 % 75.01 % 85.44 %

HBL 54.75 % 53.68 % 51.45 % 51.12 % 51.33 %

As per the Table 4.8, the CD ratios of the both banks shows that their liquidity position is quite sound. However, BOK is seems to more efficient to utilize the funds collected as deposit. The CD ratio of BOK was 66.40% at the end of fiscal year 1997/98 which is in increasing trend and reached at 85.44% at the end of fiscal year 2001/02. But the CD ratio of HBL is persistent to 51% to 54%. Although there is not any standard for CD Ratios in Nepal, a ratio of 75% can be accepted to be adequate. As such BOK is somehow nearer to this standard, but HBL has very low CD ratios.

50

4.3

Statistical Analysis

Statistical analysis is carried out for better understanding of the collected data and information. The result of the statistical analysis is enumerated in the following section. 4.3.1 Correlation co-efficient To test the relationship between deposit and capital and between credit and capital, the correlation coefficients have been calculated by using Karl Pearsons correlation coefficient. A detail calculation has been illustrated in Appendix I. The calculated values of correlation coefficients are presented below in the Table 4.9.

Table 4.9 Correlation coefficients Correlation between Capital & Deposit Capital & Credit
Detail calculations shown in Appendix I.

BOK 0.911 0.957

HBL 0.962 0.967

The calculated correlation coefficients between Deposit and Capital and correlation coefficients between Credit and Capital are positive. Therefore, it can be said that Deposit and Credit components of a bank are positively correlated with the banks capital fund. Here, we can see that all the coefficients are near to 1 which indicates that the correlations seem to be nearly perfectly positive. We can say that the increase in capital causes the increase in Deposit. Also increase in capital causes increase in credit.

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4.3.2 Test of Hypothesis As proposed in the first chapter, the calculated values of correlation coefficients presented in Table 4.9 are tested by using t-test. The tests are shown in the Appendix J. The results of the tests are presented in Table 4.10, Table 4.11, Table 4.12 and Table 4.13.

Table 4.10 Hypothesis 1 Hypothesis (H0) Hypothesis (H1) Correlation coefficients (r) Calculated Value (tcal) Tabulated Value (ttab) Degree of Freedom (d.f.) Level of significance () Decision Capital and Deposit of BOK are not correlated. Capital and Deposit of BOK are correlated. 0.911 3.827 3.18 3 5% H0 rejected i.e.; Capital and Deposit of BOK are correlated.

Calculations are shown in Appendix J-1.

Table 4.11 Hypothesis 2 Hypothesis (H0) Hypothesis (H1) Correlation coefficients (r) Calculated Value (tcal) Tabulated Value (ttab) Degree of Freedom (d.f.) Level of significance () Decision Capital and Deposit of HBL are not correlated. Capital and Deposit of HBL are correlated. 0.962 6.102 3.18 3 5% H0 rejected i.e.; Capital and Deposit of HBL are correlated.

Calculations are shown in Appendix J-2.

52

Table 4.12 Hypothesis 3 Hypothesis (H0) Hypothesis (H1) Correlation coefficients (r) Calculated Value (tcal) Tabulated Value (ttab) Degree of Freedom (d.f.) Level of significance () Decision Capital and Credit of BOK are not correlated. Capital and Credit of BOK are correlated. 0.957 5.714 3.18 3 5% H0 rejected i.e.; Capital and Credit of BOK are correlated.

Calculations are shown in Appendix J-2.

Table 4.13 Hypothesis 4 Hypothesis (H0) Hypothesis (H1) Correlation coefficients (r) Calculated Value (tcal) Tabulated Value (ttab) Degree of Freedom (d.f.) Level of significance () Decision Capital and Credit of HBL are not correlated. Capital and Credit of HBL are correlated. 0.967 6.574 3.18 3 5% H0 rejected i.e.; Capital and Credit of HBL are correlated.

Calculations are shown in Appendix J-4.

The test of hypothesis as above showed the existence of relationship between capital & deposit and capital & credit of both BOK and HBL. Therefore, it has been concluded that capital & deposit and capital & credit of both banks are correlated which indicates that increase in capital causes increase in deposit. As well as increase in capital causes increase in credit. The same phenomenon is expected in case of both the banks.

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4.4

Impact of Capital Adequacy Norms on BOK and HBL

4.4.1 Study of Changes in Capital Fund of BOK and HBL The capital adequacy norms have greater impact on changes in capital fund of commercial banks. Table 4.1 and Table 4.2 have already presented the components of capital that are included in capital funds of BOK and HBL respectively. The Table 4.15 shows the raise of capital funds of both banks in the form of amount and percentage.

Table 4.15 Changes in Capital Fund of BOK and HBL

(Rs. in million)

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 169.94 171.47 351.69 486.06 731.90

Amount Percentage Increased Increment -1.53 180.22 134.37 245.84 -0.90 % 105.10 % 38.21 % 50.58 %

HBL 491.41 647.10 810.53 1,198.27 1,472.97

Amount Percentage Increased Increment -155.69 163.43 387.74 274.70 -31.68 % 25.26 % 47.84 % 22.92 %

In the beginning of the study period BOK had total capital fund of Rs. 164.94 million which has been increased up to Rs. 245.84 million by the end of FY 2001/02 being annual increment of 0.90%, 105.10%, 38.21% and 50.58%. As well as HBL had capital fund of Rs. 491.41 million in the beginning of the study period. HBL increased its capital fund up to Rs. 274.70 million by the end of FY 2001/02 being annual increment by 31.68%, 25.26%, 47.84% and 22.92%. Therefore the capital adequacy norms have impact on commercial banks making them increase their capital fund every year.

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4.4.2 Study of Changes in Share Capital of BOK and HBL It has been observed in Table 4.10 that the capital base of both BOK and HBL has been increased. Since, the capital adequacy norms require that the core capital be at least 50% of the total capital base, the banks has been increasing the core capital accordingly. The Table 4.16 shows that the raise of new capital of both banks.

Table 4.16 Changes in Share Capital of BOK and HBL

(Rs. in million)

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 90.00 90.00 173.63 233.65 463.58

Amount Percentage Increased Increment 83.63 60.02 229.93 92.92 % 34.57 % 98.41 %

HBL 120.00 192.00 240.00 300.00 390.00

Amount Percentage Increased Increment 72.00 48.00 60.00 90.00 60.00 % 25.00 % 25.00 % 30.00 %

In the beginning of the study period BOK had paid-up capital of Rs. 90 million which has increased to Rs. 173.63 million by the end of FY 1999/00, to Rs. 233.65 million by the end of FY 2000/01 and to Rs. 463.58 million by the end of FY 2001/02. As well as HBL had paid-up capital of Rs. 120 million in the beginning of the study period. HBL increased it capital to Rs. 192 million by the end of FY 1998/99, to Rs. 240 million by the end of FY 1999/00, to Rs. 300 Million by the end of FY 2000/01 and to Rs. 390 million by the end of FY 2001/02. In addition to comply with the norms, HBL has issued bonds amounting at Rs. 360 million in the fiscal year 2001/02. The impact of the norms thus caused the increment of the paid-up capital of both the banks.

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4.4.3 Study of Response of Officials of BOK and HBL Regarding the impact of capital adequacy norms a questionnaire was developed as shown in Appendix K. A total number of twelve officials of BOK and HBL participated in the quarries. The questionnaire revealed opinions of the bank officials towards the capital and capital adequacy. All the officials agreed unanimously that the central bank should issue Capital Adequacy Norms for commercial banks. All the respondents answered that an adequate capital fund will always safeguard the interest of depositors. However, in some questions the officials found to be disagreeable. Out of twelve, seven respondents answered that the capital adequacy ratio prescribed by NRB is perfect while remaining answered that it is high. It seemed that the officials are not quite satisfied with the prescribed capital adequacy ratios. As well as, seven respondents said that the changes brought in by NRB are necessary while the remaining said that it is not at all necessary. Seven respondents answered that the weightage on risk-weighted assets prescribed by NRB are just OK while other officials said that it should be revised. Officials of BOK opine that they can increase both components of capital to cope up with the NRB requirements. However, officials of HBL believe that at present it is not necessary to increase capital but in future they can increase both components of capital.

4.5

Study of Perception of Depositors on Commercial Banks

To study the perception of depositors a questionnaire was developed as shown in Appendix L. A total number of 72 depositors responded to this questionnaire. While responding to the why they deposit their money in a bank, 75% respondents answered that they deposit their money in a bank for security reason. 29% said that

56

to earn interest. 12.5% deposits money to meet the official purpose. 4.17% said that they deposit money in a bank for social status. And 8.33% referred to other reasons. Out of the 72 respondents, 41.67% said that physical security arrangement of a bank is most important to make a depositors money safe. 25% agreed that an adequate capital is required to make a depositors money safe. 20.83% said that profitability of the bank is important whereas 12.5% referred to the status of the bank as most important. 75% respondents think that a bank should pay an attractive interest rate to attract more deposits. 29.17% urged to arrange proper security. 25% insist on to achieve a good profit. Only 20.83% advised to maintain adequate capital fund. The remaining 12.5% referred to other reasons that attract deposits to a bank.

C HAPTER 5
SUMMARY, FINDINGS, CONCLUSION & RECOMMENDATION

5.1

Summary

This research aimed at studying capital adequacy norms for commercial banks set by NRB with case study of BOK and HBL. Raise and utilization of funds are the primary functions of commercial banks. As such, commercial banks collect a large amount of deposits from general public. Capital must be sufficient to protect a banks depositors and counterparties from the risks like, credit and market risks. Otherwise the banks will use all the money of depositors in their own interest and depositors will have to suffer loss. Being the central bank of Nepal, NRB has the responsibility to give special attention to the interest of depositors. NRB has issued various directives to regulate commercial banks. The directive no. 1 has been issued for norms on capital adequacy to be followed by commercial banks. The thesis report has been prepared with the study of capital funds of BOK and HBL. The study showed that the capital fund of BOK and HBL meet the requirements of the norms. Capital Adequacy Ratios have been calculated to check the adequacy as per the norms. Capital-to-deposit ratios and CD ratios, which are key ratios of commercial banks, have also been checked. Analyses have been done to check the relationship of capital fund with deposit and credit. Four test of hypothesis have been done to check the existence of the relationship of these components.

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The thesis also studies the responses of 12 bank officials has also been done through research interview. Also, the perception of 72 depositors has also been studied through the questionnaire.

5.2

Findings

The thesis has been concentrated on the capital and capital related items of BOK and HBL. The findings of the study are as follows: Capital Fund: Capital fund of BOK is less than that of HBL. Over the study period, capital fund of HBL seems to be consistently growing whereas capital fund of BOK does not seem to be growing consistently. BOK has total capital fund of Rs. 169.94 million in FY 1997/98 which has been increased by 0.90% in the next year. The capital fund has been increased by 105.10%, 38.21% and 50.58% in the succeeding years making a total capital fund of Rs. 791.90 million by the end of FY 2001/02. HBL had a total capital fund of Rs. 491.41 million at the end of FY 1997/98. HBL increased its capital fund by 31.68 %, 25.26%, 47.84% and 22.92% in the succeeding years making a total capital fund of Rs. 1,472.97 million by the end of FY 2001/02. It has been learnt that HBL has nearly a double capital fund than that of BOK. The capital funds of both banks are largely depend upon share capital. Capital Adequacy: It is found that both the banks are quite successful in maintaining capital adequacy as prescribed by NRB. But BOK had a capital adequacy ratio of 6.63% in FY 1998/99 which seems inadequate as NRB had prescribed it to be at least 8%. In other years both banks have meet the requirement. In the last year of the study i.e., in FY 2001/02, both banks have quite higher capital adequacy ratio than prescribed ratio. In FY 2001/02 BOK has capital adequacy ratio of 14.42 % and HBL has the same ratio of 11.56 % while the requirement of norms directed by NRB is only 9%. Risk-weighted Assets: While studying the capital adequacy the most significant component is risk-weighted assets. BOK had risk-weighted assets of Rs. 1,551.96

59

million in the year 1997/98 which is increased to Rs. 2,586.27 million, Rs. 3,938.30 million and Rs. 5,651.95 million in the succeeding years. But in FY 2001/02 it has been decreased to Rs. 5,074.23 million. HBL has obviously larger amount of riskweighted assets than that of BOK. HBL had risk-weighted assets of Rs. 5,603.31 million in FY 1997/98 which has been increased to Rs. 7,685.27 million, Rs. 10,093.77 million and Rs. 14,956.93 million in succeeding years. But same as BOK, the risk-weighted assets of HBL has also been decreased by Rs. 12,746.17 in FY 2001/02. The cause for decrease in amount of risk-weighted assets is the new provisions made by NRB effective from this FY. This is the reason for both banks to have higher capital adequacy ratio in this FY. Capital to Deposit Ratio: The capital to deposit ratios of BOK and HBL have been found unsatisfactory. The capital to deposit ratios of BOK are at around 6% to 9% till the end of FY 2000/01 which has been increased to 12.79% in FY 2001/02. The capital to deposit ratios of HBL are in between 5% to 8%. It is accepted worldwide that an 8% to 10 % capital to deposit ratio is safe. But in Nepal there are no such norms or standards to regularize this requirement. Still, it can be said that the capital to deposit ratios that the commercial banks presently maintaining are not sufficient. CD Ratio: The Credit / Deposit Ratio (CD Ratio) is one of the most important ratios for commercial banks. This ratio shows how effectively the banks have been using the fund they collected from depositors. In this regard, BOK seems to be ahead of HBL. BOK has been maintaining CD Ratio around 66% to 85% whereas HBL has constant CD ratios between 51% and 55%. The percentage of CD ratio indicates the percentage of the fund used in credits by the bank. It is learnt that the CD ratios of BOK is satisfactory and the same of HBL is scant. Statistical Analysis: The correlation coefficients between capital and deposit and correlation coefficients between capital and credit of both the banks showed that they are correlated. All coefficients are more than 0.9 which is near to 1. The coefficients nearest to 1 show the relationship to be more perfect. Also, the test of hypothesis proved the existence of their relationship.

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Impact Analysis: It is observed that both the banks have been complying with the requirement of the capital adequacy norms of NRB. Both the banks have been increasing their capital funds to meet the capital adequacy requirement. The officials of both the banks feel that NRB, as a central bank, should set the capital adequacy norms. They all agree that these norms are required to safeguard the interest of depositors. The officials are not quite convinced with the prescribed ratios. Some of them say that the ratios are reasonable and some say that it is not perfect. However, the majority opine that these norms are acceptable. Perception of Depositors: It has been found that majority of the depositors deposit their money in a bank for security of their money. But they are not seemed to be aware of the capital fund of the commercial bank where they are depositing their money. Only 25% of the respondents are aware of the fact of the necessity of adequate capital to safeguard their money. Also majority of the respondents say that attractive interest is required to attract deposits to commercial banks. It has been studied that the depositors in Nepal are not aware of the fact of capital adequacy of a bank which is necessary to safeguard their deposit.

5.3

Conclusion

Commercial banks of Nepal are bound by the directives of NRB. The directive no. 1 has set norms on capital adequacy for commercial banks. Every commercial bank has to meet the requirement of capital adequacy as stated by the directive. Capital adequacy is the portion of capital fund in regard of risk-weighted assets that a commercial bank holds. Capital adequacy is required to safeguard the money of the depositors as the banks are playing with the money they collected from the depositors. The banks under study, BOK and HBL, are found to be successful to comply with requirement of capital adequacy norms. Anyhow the banks are meeting the requirements. However some bank officials are not satisfied with the provisions.

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The capital-to-deposit ratio of both banks seems to be inadequate. The CD ratio of HBL is very much low which needs to be improved immediately. The CD ratio of BOK is satisfactory. Although the banks are successful to meet the capital adequacy requirement, they seem to be ineffective to fulfill other capital and deposit ratios which are also very much important in regard of safeguarding the money of the depositors. The lack of policy in regard of these types of ratios caused to the relaxation of the banks not to meet the adequate ratios. The correlation coefficients between capital and deposit and between capital and credit are found to be positive and near to perfect correlation. The test of hypothesis revealed that the capital and deposit and correlated. Also, the test brought to light that capital and credit are also correlated. The research questionnaire revealed that although the depositors are depositing their money for safety reason, they are not aware of the fact of necessity of adequate capital to safeguard their money. It is seemed that they are not attracted by the capital fund of a bank but the position and status of the bank has been luring them to deposit their money in any such bank.

5.4

Recommendation

After the thorough study of the research, the following recommendations have been proposed for consideration by the concerns: The capital funds of both commercial banks under study are highly depending upon share capital. It is recommended to the commercial banks to follow optimal capital structure which maximizes the market value of the firm. The banks should use some sort of debt financing also depending upon its viability. It is notable that HBL has already started the debt financing. But still debt financing is an unaccustomed source of financing for commercial banks in Nepal. Capital-to-deposit ratios of commercial banks under study are seemed to be less than what actually required. There is lack of standard on such type of ratio.

62

Therefore, NRB should set appropriate standard for capital-to-deposit ratio to be maintained by commercial banks. An 8% to 10% ratio is appropriate for the ratio of capital-to-deposit. CD ratios of HBL are comparatively less than that of BOK. This showed that HBL has not been effectively using the funds collected from depositors. It is recommended to HBL that it should concentrate more on credit and investment. The bank shall expand its branches in rural areas of Nepal and search investment opportunities there. BOK too cannot relax with such CD ratios. More credit flows are required to verge on the optimum CD ratio. The commercial banks should try to maintain appropriate capital-to-deposit ratios and CD ratios as stated above. They can no way escape pointing on to the lack of the policy. While lending loans and advances, banks should keep in account that the fund they are going to lend is collected from public and hence should be carefully treated on behalf of the depositors to protect their interest. NRB should consult to the various bank officials before setting or resetting standards on capital adequacy norms. The complaints and criticisms of bank officials should be considered accordingly. Consequently, an optimal standard will ensue which will satisfy almost everyone. It has been found that the depositors are not aware of the fact of the necessity of adequate capital fund to safeguard their deposits. They deposit their money to any banks regardless of adequate capital fund which may endanger safety of their money. Therefore, NRB should initiate awareness programs to make the depositors aware of such fact and think before depositing money in any commercial banks.

63

B IBLIOGRAPHY

Books: Besis, J. (1998). Risk management in banking. Chichester: John Wiley & Sons Ltd. Bhandari, D.R. (2003). Banking & insurance: Principle & practice. Kathmandu: Aayush Publications. Clark, J. (1999). International dictionary of banking and finance. New York: Glenlake Publishing Co Ltd and AMACOM American Management Association. Maisel, S.J. (1982). Risk and capital adequacy in commercial banks. Chicago: The University of Chicago Press. Pandey, I. M. (Eds.). (1995). Financial Management. New Delhi: Vikash Publishing House Pvt. Ltd. Patheja, A. (1994). Financial management of commercial banks. Delhi: South Asia Publications. Rosenberg, J. M., Ph.D. (1982). Dictionary of banking and finance. New York: John Wiley & Sons. Shekhar, K.C. & Shekhar, L. (1998). Banking theory and practice (Rev. ed.). New Delhi: Vikash Publishing House Pvt. Ltd. Vaidya, S. (1997). Money and banking. Kathmandu: Pratibha Joshi. Verma, H.L. & Malhotra, A.K. (1993). Funds management in commercial banks. New Delhi: Deep & Deep Publications. Wollf, H.K. & Pant, P.R. (Eds.). (1999). A handbook for social science research and thesis writing. Kathmandu: Buddha Academic Enterprises Pvt. Ltd.

64

Journals: Lamsal, M. (2001, July). NRB directives: Bankers plea for lighter strictures. New Business Age, 1(3), pp.31-35. Shah, R.B. (2003, January). Financial sector reform program: Issues and challenges. Banking Pravarddan, 15, pp.8-19. Khatiwada, Y. R. (2003, April 30 and May 7). Banking sector reforms in Nepal I & II: Implications for corporate governance. The Telegraph Weekly, p.2. Pandey, S. (2003, June 10). NRBs effort to reform commercial banks. The Rising Nepal, p.4. Unpublished Thesis: Agrawal, A. (2002). A study on deposit and investment position of Yeti Finance Company Limited. Unpublished Masters Degree (MBS) thesis, Tribhuvan University, Shanker Dev Campus. Kadel, G. (2002). A comparative study on financial performance of NGBL & HBL. Unpublished Masters Degree (MBA) thesis, Tribhuvan University, Nepal Commerce Campus. Karmacharya, B. (2002). Study on capital structure of joint-venture commercial banks and NRB directives issued in regards to there-of. Unpublished Masters Degree (MBA) thesis, Tribhuvan University, Shanker Dev Campus. Pandey, S. (2002). Nepal Rastra Bank directives, their implementation & impact on the commercial banks a case study of Himalayan Bank Ltd (HBL). Unpublished Masters Degree (MBS) thesis, Tribhuvan University, Shanker Dev Campus. Pathak, K. R. (1999). Capital structure and profitability: a comparative case study between Nepal Indosuez Bank Ltd (NIBL) and Nepal Grindlays Bank Ltd (NGBL). Unpublished Masters Degree (MBA) thesis, Tribhuvan University, Shanker Dev Campus.

65

Ranjit, R. P. (1989). A study of creation of reserves in respect of capital management if Nepal Bank Limited. Unpublished Masters Degree (MBA) thesis, Tribhuvan University, Shanker Dev Campus. Sapkota, R. (2002). A study of capital and assets structure management of Nepal Bank of Ceylon Limited. Unpublished Masters Degree (MBA) thesis, Tribhuvan University, Shanker Dev Campus. Sapkota, U. P. (2002). A study on fund mobilizing policy of Standard Chartered Bank Nepal Limited. Unpublished Masters Degree (MBS) thesis, Tribhuvan University, Shanker Dev Campus. Shivakoti, A. R. (2003). Capital and assets structure of Nepal Industrial Development Corporation (NIDC). Unpublished Masters Degree (MBS) thesis, Tribhuvan University, Nepal Commerce Campus. Shrestha, D. (2002). A comparative study on investment practice of joint-venture commercial banks. Unpublished Masters Degree (MBS) thesis, Tribhuvan University, Shanker Dev Campus. Reports and Directories: Banking and financial statistics, 39. (2002). Kathmandu: Nepal Rastra Bank, Bank & Financial Institution Regulation Department. Directives for commercial banks: Directive no. 1 to 9. (2001). Kathmandu: Nepal Rastra Bank, Banking Operation Department. Annual Reports of Bank of Kathmandu Ltd Annual Reports of Himalayan Bank Ltd Internet: Keijser, T. & Haas R., (2001, October). Financial collateral and capital adequacy requirements. Retrieved August 5, 2003 from http://econwpa.wustl.edu/eps/fin/papers/0209/0209002.pdf

66

Strokes, J.R., (2003, April 25 & 26). Using simulation to determine bank capital adequacy. In Financial Engineering News. Retrieved August 5, 2003 from http://fenews.com/fen28/siminfe.html Heakal, R., (2003, May 7). What are central banks? Retrieved June 10, 2003 from http://www.investopedia.com/articles/03/050703.asp CD-ROM: Encyclopedia Britannica 2002: Encyclopedia Britannica, Inc., CD-ROM Microsoft Encarta Reference Library 2003: Microsoft Corporation., CD-ROM

67

A PPENDIX A
Commercial Bank Statistics on Capital Fund and Deposits
(amount in million)

Name of the Bank 1. Nepal Bank Ltd. 2. Rastriya Banijya Bank 3. Nabil Bank Ltd 4. Nepal Investment Bank Ltd. 5. Standard Chartered Bank Nepal Ltd. 6. Himalayan Bank Ltd. 7. Nepal SBI Bank Ltd. 8. Nepal Bangladesh Bank Ltd. 9. Everest Bank Ltd. 10. Bank of Kathmandu Ltd. 11. Nepal Credit & Commerce Bank Ltd. 12. Nepal Industrial & Commercial Bank Ltd. 13. Lumbini Bank Ltd. 14. Machhapuchchhre Bank Ltd. 15. Kumari Bank Ltd. 16. Laxmi Bank Ltd. Source: Banking & Financial Statistics (2002)

Capital Fund 2728.5 3581.2 1464.3 514.7 1258.0 927.7 619.4 547.1 455.0 578.0 367.0 519.5 351.4 137.3 350.2 275.0

Total Deposits 36502.4 40294.7 15370.7 4216.3 15835.7 18595.2 5595.6 9514.5 5461.0 5735.9 3709.0 3165.3 2646.1 994.8 1179.9 112.6

68

A PPENDIX B
Risk-Weightage on On-Balance Sheet Assets On-Balance Sheet Assets Cash Balance Gold (tradable) Balance with Nepal Rastra Bank Investment in Govt. Securities Investment in NRB Bonds Fully secured loan against own Fixed Deposit Receipt Fully secured loan against Govt. Securities Balance with domestic banks and financial institutions Fully secured loan against Fixed Deposit Receipt of other banks Balance with foreign banks Money at call Loan against the guarantee of internationally rated*/foreign banks Other investments with internationally rated*/foreign banks Investments in shares, debentures and bonds Other investments Loan, advances and bills purchased/discounted** Fixed assets All other assets */ Risk Weightage % 0 0 0 0 0 0 0 20 20 20 20 20 20 100 100 100 100 100

Internationally rated bank having rating of at least A+ by reputed Rating Agency or Banks specified as First Class Bank by Nepal Rastra Bank from time to time. Except Loan and Advances provided against Fixed Deposit Receipt and Government Securities.

**

69

A PPENDIX C
Risk-Weightage on Off-Balance Sheet Items Off-Balance Sheet Assets Bills collection Forward foreign exchange contract L/Cs with maturity of less than 6 months (full value) Guarantees provided against counter guarantee of internationally rated*/foreign banks L/Cs with maturity of more than 6 months (full value) Bid bond Performance bond Advance payment guarantee Financial guarantee Other guarantee Irrevocable loan commitment Contingent liability in respect of Income Tax All other contingent liabilities */ Risk Weightage % 0 10 20 20 50 50 50 100 100 100 100 100 100

Internationally rated bank having rating of at least A+ by reputed Rating Agency or Banks specified as First Class Bank by Nepal Rastra Bank from time to time.

70

A PPENDIX D
Directives Form No. 1 Table of Capital Fund Particulars A) Core Capital 1) Paid-up Capital 2) Share Premium 3) Non-redeemable Preference Shares 4) General Reserve Fund 5) Cumulative Profit/Loss (up to previous FY) 6) Current Year Profit & Loss (as per Balance Sheet) B) Supplementary Capital 1) Loan Loss Provision 2) Exchange Equalization Reserve 3) Assets Revaluation Reserve 4) Hybrid Capital Instruments 5) Unsecured Subordinated Term Debt 6) Interest Rate Fluctuation Fund 7) Other Free Reserves C) Total Capital Fund (A + B) D) Minimum Capital Fund required to be maintained on the basis of Risk Weighted Assets Capital Fund (by Percent) Core Capital (by Percent) Capital Fund (excess/short) (by Percent) Core Capital (excess/short) (by Percent) Previous Quarter Current Quarter

71

A PPENDIX E
Directives Form No. 2 Statement Table of Risk Weighted Assets
On-Balance Sheet Assets
Cash Balance Gold (tradable) Balance with Nepal Rastra Bank Investment in Govt. Securities Investment in NRB Bond Fully secured Fixed Deposit Receipt Loan against own Fixed Deposit Receipt Fully secured loan against Govt. Securities Balance with domestic banks and financial institutions Fully secured Fixed Deposit Receipt Loan against Fixed Deposit Receipt of other banks Balance with foreign banks Money at call Loan against guarantee of internationally rated banks Other investments with internationally rated banks Investment in Share, Debentures and Bonds Other investments Loan, Advances and Bills purchased/discounted Fixed assets All other assets
Risk Weightage Amount Previous Quarter Current Quarter Risk Weighted Risk Weighted Amount Assets Assets

(A) Total Off-Balance Sheet Items

Bills Collection Forward foreign exchange contract L/Cs with maturity of less than 6 months (full value) Guarantees provided against counter guarantee of internationally rated*/foreign banks L/Cs with maturity of more than 6 months (full value) Bid bond Performance bond Advance payment guarantee Financial guarantee Other guarantee Irrevocable loan commitment Contingent liability in respect of Income Tax All other contingent liabilities

(B) Total

Total Risk Weighted Assets

72

A PPENDIX F
Calculation of Capital Adequacy Ratios of BOK:
(Rs. in million)

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02 We have;

Total Capital Fund 169.94 171.47 351.69 486.06 731.90

Core Capital 92.07 95.92 249.36 318.70 511.50

Risk-weighted Assets 1551.96 2586.27 3938.30 5651.95 5074.23

Ratio of Total Capital Fund as: Total Capital Fund 100% TRWA Ratio of Core Capital Fund as: Core Capital 100% TRWA where, TRWA = Total Risk-weighted Assets By using above formulas we get the ratios as: Fiscal Year 1997/1998 1998/1999 1999/2000 2000/2001 2001/2002 Total Capital Fund 10.95 % 6.63 % 8.93 % 8.60 % 14.42 % Core Capital 5.93 % 3.71 % 6.33 % 5.64 % 10.08 %

73

Calculation of Capital Adequacy Ratios of HBL:

(Rs. in million)

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02 We have;

Total Capital Fund 491.41 647.10 810.53 1,198.27 1,472.97

Core Capital 298.87 388.79 448.08 698.70 834.55

Risk-weighted Assets 5603.31 7685.27 10093.77 14956.93 12746.17

Ratio of Total Capital Fund as: Total Capital Fund 100% TRWA Ratio of Core Capital Fund as: Core Capital 100% TRWA where, TRWA = Total Risk-weighted Assets By using above formulas we get the ratios as: Fiscal Year 1997/1998 1998/1999 1999/2000 2000/2001 2001/2002 Total Capital Fund 8.77 % 8.42 % 8.03 % 8.01 % 11.56 % Core Capital 5.33 % 5.06 % 4.44 % 4.67 % 6.55 %

74

A PPENDIX G
Calculation of Ratio of Capital to Deposit:
(Rs. in million)

BOK Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02 We have; Ratio of Capita to Deposit as: Total capital fund 100% Total deposit collected Total Capital Fund 169.94 171.47 351.69 486.06 731.90 Deposit 1,773.87 2,564.83 4,196.41 5,713.49 5,723.30

HBL Total Capital Fund 491.41 647.10 810.53 1,198.27 1,472.97 Deposit 7,713.60 9,772.74 14,043.10 17,636.85 18,619.38

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 9.58 % 6.69 % 8.38 % 8.51 % 12.79 %

HBL 6.37 % 6.62 % 5.77 % 6.79 % 7.91 %

75

A PPENDIX H
Calculation of Credit / Deposit Ratio:
(Rs. in million)

Fiscal Year Credit 1997/98 1998/99 1999/00 2000/01 2001/02 We have; Ratio of Capita to Deposit as: 1,177.87 1,863.40 3,087.63 4,285.93 4,890.07

BOK Deposit 1,773.87 2,564.83 4,196.41 5,713.49 5,723.30 Credit 4,223.07 5,245.98 7,224.73 9,015.35 9,557.14

HBL Deposit 7,713.60 9,772.74 14,043.10 17,636.85 18,619.38

Total capital fund 100% Total deposit collected

At the end of Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

BOK 66.40 % 72.65 % 73.58 % 75.01 % 85.44 %

HBL 54.75 % 53.68 % 51.45 % 51.12 % 51.33 %

76

A PPENDIX I-1
Calculation of Correlation Co-efficient of Deposit on Capital of BOK: Capital (Rs. in million) 169.94 171.47 351.69 486.06 731.90 Deposit (Rs. in million) 1,773.87 2,564.83 4,196.41 5,713.49 5,723.30

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Let the variables Capital be X and Deposit be Y X 169.94 171.47 351.69 486.06 731.90 Y 1773.87 2564.83 4196.41 5713.49 5723.30

x= (X- ) y= (Y- ) X Y
-212.27 -2220.51 -210.74 -1429.55 -30.52 103.85 349.69 202.03 1719.11 1728.92

xy
471352.10 301266.23 -6166.36 178526.14

x2
45059.40 44412.19 931.59 10784.41

y2
4930664.66 2043613.20 40816.12 2955339.19 2989164.37

604582.58 122281.70

= 1911.06 19971.90 X = N Y N = 1911.06 5

- 1549560.68 223469.29 12959597.54

X = Y = Now,

= 382.21

19971.90 = 3994.38 5

r=

xy x2. y2 1549560.68 223469.29. 12959597.54 = 1549560.68 472.73 3559.94 = 0.911

Correlation co-efficient of Deposit on Capital of BOK, r1 = 0.911

77

A PPENDIX I-2
Calculation of Correlation Co-efficient of Deposit on Capital of HBL: Capital (Rs. in million) 491.41 647.10 810.53 1,198.27 1,472.97 Deposit (Rs. in million) 7,713.60 9,772.74 14,043.10 17,636.85 18,619.38

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Let the variables Capital be X and Deposit be Y X 491.41 647.10 Y 7713.60 9772.74

x= (X- ) y= (Y- ) X Y

xy

x2

y2

-432.65 -5843.53 2528181.61 187182.56 34146889.61 -276.96 -3784.39 1048110.62 -113.53 274.21 548.91 485.97 -55169.78 4079.72 1118715.24 76704.63 14321637.95 12888.15 236162.95 75193.32 16644082.64

810.53 14043.10 1198.27 17636.85 1472.97 18619.38 = 4620.28 67785.67 X = N Y N = 4620.28 5 67785.67 5

5062.25 2778737.70 301306.58 25626334.56 - 7418575.40 653275.24 90975107.71

X = Y = Now,

= 924.06 = 13557.13

r=

xy x2. y2 7418575.40 653275.24. 90975107.71 = 7418575.40 808.25 9538.09 = 0.962

Correlation co-efficient of Deposit on Capital of HBL, r2 = 0.962

78

A PPENDIX I-3
Calculation of Correlation Co-efficient of Credit on Capital of BOK: Capital (Rs. in million) 169.94 171.47 351.69 486.06 731.90 Credit (Rs. in million) 1,177.87 1,863.40 3,087.63 4,285.93 4,890.07

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Let the variables Capital be X and Credit be Y X 169.94 171.47 351.69 486.06 731.90 Y 1177.87 1863.40 3087.63 4285.93 4890.07

x= (X- ) y= (Y- ) X Y
-212.27 -1883.11 -210.74 -1197.58 -30.52 103.85 349.69 26.65 1224.95 1829.09

xy
399731.53 252380.40 -813.41 127208.61

x2
45059.40 44412.19 931.59 10784.41

y2
3546103.27 1434197.86 710.22 1500502.50 3345570.23 9827084.08

639610.82 122281.70

= 1911.06 15304.90 X = N Y N = 1911.06 5 15304.90 5

- 1418117.95 223469.29

X = Y = Now,

= 382.21 = 3060.98

r=

xy x2. y2 1418117.95 = 223469.29. 9827084.08 7418575.40 472.73 3134.82 = 0.957

Correlation co-efficient of Credit on Capital of BOK, r3 = 0.962

79

A PPENDIX I-4
Calculation of Correlation Co-efficient of Credit on Capital of HBL: Capital (Rs. in million) 491.41 647.10 810.53 1,198.27 1,472.97 Credit (Rs. in million) 4,223.07 5,245.98 7,224.73 9,015.35 9,557.14

Fiscal Year 1997/98 1998/99 1999/00 2000/01 2001/02

Let the variables Capital be X and Credit be Y X 491.41 647.10 810.53 1198.27 1472.97 Y 4223.07 5245.98 7224.73 9015.35 9557.14

x= (X- ) y= (Y- ) X Y
-276.96 -1807.27 -113.53 274.21 548.91 171.48 1962.10

xy
500535.38 -19466.98 538034.19

x2
76704.63 12888.15 75193.32

y2
8009941.47 3266239.31 29404.02 3849820.71 6269445.10

-432.65 -2830.18 1224467.79 187182.56

2503.89 1374418.08 301306.58

= 4620.28 35266.27 X = N Y N = 4620.28 5 35266.27 5

- 3617988.45 653275.24 21424850.62

X = Y = Now,

= 924.06 = 7053.25

r=

xy x2. y2 3617988.45 653275.24. 21424850.62 = 7418575.40 808.25 4628.70 = 0.967

Correlation co-efficient of Credit on Capital of HBL, r3 = 0.962

80

A PPENDIX J-1
Test of Hypothesis 1 For Capital and Deposit of BOK, we have; Null Hypothesis: Capital and deposit of BOK are not correlated. Alternate Hypothesis: Capital and deposit of BOK are correlated. Number of observations (n) = 5 Correlation (r) = 0.911 H0 : =0, i.e., Capital and deposit of BOK are not correlated. H1 : 0 (two-tailed), i.e., Capital and deposit of BOK are correlated. Level of Significance () = 5% = 0.05 Test Statistics under null hypothesis is t= rn-2 1-r2 0.9115-2 1-0.9112 = 0.9113 0.17 = 0.9111.732 = 3.827 0.412

t=

Degree of freedom (d.f.) = n-2 = 5-2 = 3 Table Value, at 5% level of significance and at degree of freedom at 3:

t0.05 = 3.18 tcal = 3.827 > t0.05 = 3.18

Since calculated t is greater than the table value, H0 is rejected. Thus, it is concluded that capital and deposit of BOK are correlated.

81

A PPENDIX J-2
Test of Hypothesis 2 For Capital and Deposit of HBL, we have; Null Hypothesis: Capital and deposit of HBL are not correlated. Alternate Hypothesis: Capital and deposit of HBL are correlated. Number of observations (n) = 5 Correlation (r) = 0.962 H0 : =0, i.e., Capital and deposit of HBL are not correlated. H1 : 0 (two-tailed), i.e., Capital and deposit of HBL are correlated. Level of Significance () = 5% = 0.05 Test Statistics under null hypothesis is t= rn-2 1-r2 0.9625-2 1-0.9622 = 0.9623 0.075 = 0.9621.732 = 6.102 0.273

t=

Degree of freedom (d.f.) = n-2 = 5-2 = 3 Table Value, at 5% level of significance and at degree of freedom at 3:

t0.05 = 3.18 tcal = 6.102 > t0.05 = 3.18

Since calculated t is greater than the table value, H0 is rejected. Thus, it is concluded that capital and deposit of HBL are correlated.

82

A PPENDIX J-3
Test of Hypothesis 3 For Capital and Credit of BOK, we have; Null Hypothesis: Capital and credit of BOK are not correlated. Alternate Hypothesis: Capital and credit of BOK are correlated. Number of observations (n) = 5 Correlation (r) = 0.957 H0 : =0, i.e., Capital and credit of BOK are not correlated. H1 : 0 (two-tailed), i.e., Capital and credit of BOK are correlated. Level of Significance () = 5% = 0.05 Test Statistics under null hypothesis is t= rn-2 1-r2 0.9575-2 1-0.9572 = 0.9573 0.084 = 0.9571.732 = 5.714 0.290

t=

Degree of freedom (d.f.) = n-2 = 5-2 = 3 Table Value, at 5% level of significance and at degree of freedom at 3:

t0.05 = 3.18 tcal = 5.714 > t0.05 = 3.18

Since calculated t is greater than the table value, H0 is rejected. Thus, it is concluded that capital and deposit of HBL are correlated.

83

A PPENDIX J-4
Test of Hypothesis 4 For Capital and Credit of HBL, we have; Null Hypothesis: Capital and credit of HBL are not correlated. Alternate Hypothesis: Capital and credit of HBL are correlated. Number of observations (n) = 5 Correlation (r) = 0.967 H0 : =0, i.e., Capital and credit of HBL are not correlated. H1 : 0 (two-tailed), i.e., Capital and credit of HBL are correlated. Level of Significance () = 5% = 0.05 Test Statistics under null hypothesis is t= rn-2 1-r2 0.9675-2 1-0.9672 = 0.9673 0.065 = 0.9671.732 = 6.574 0.255

t=

Degree of freedom (d.f.) = n-2 = 5-2 = 3 Table Value, at 5% level of significance and at degree of freedom at 3:

t0.05 = 3.18 tcal = 6.574 > t0.05 = 3.18

Since calculated t is greater than the table value, H0 is rejected. Thus, it is concluded that capital and deposit of HBL are related.

84

A PPENDIX K
Tribhuvan University

Faculty of Management

Shanker Dev Campus

Putalisadak, Kathmandu

Study on Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank of Kathmandu Ltd and Himalayan Bank Ltd. INTERVIEW QUESTIONNAIRE FOR BANK OFFICIALS 1) Nepal Rastra Bank has prescribed capital adequacy ratio in its directive no. 1 for commercial banks. Do you think it is necessary that a central bank should issue Capital Adequacy norms for commercial banks? Yes Depositors interest Employees interest No Shareholders interest Others ___________________________ 2) Which stakeholders interest will be safeguarded most by an adequate capital fund?

3) Do you think the present capital adequacy ratio i.e., 9% for FY 2058/59, 10% for FY 2059/60 and 12% from FY 2060/61 onwards; prescribed by Nepal Rastra Bank is justified? Yes, it is perfect No, it is high No, it is not adequate 4) Do you think the change in capital adequacy ratio as stated above is necessary in the present context? Yes, it is necessary Not at all 5) The capital adequacy ratio is based on risk-weighted assets. Do you think the weightage prescribed by NRB on the on- and off-balance sheet items are appropriate? Yes, it is perfect Just OK No, it should be revised 6) In your opinion, which of the following steps is appropriate for your bank to follow to cope with the above changes in capital adequacy ratio? We can increase core capital. We can increase supplementary capital. We can increase both components of capital. It is not necessary to increase capital for us, it is adequate. Name of Interviewee: Designation

85

A PPENDIX K-1
Analysis of Interview Questionnaire for Bank Officials: Question No. 1 a) Yes b) No No. of Responses 12 0 Percentage 100 % -

Question No. 2 a) Depositors interest b) Shareholders interest c) Employees interest d) Others

No. of Responses 12 0 0 0

Percentage 100 % -

Question No. 3 a) Yes, it is perfect b) No, it is high c) No, it is not adequate

No. of Responses 7 5 0

Percentage 58.33 % 41.67 % -

Question No. 4 a) Yes, it is necessary b) Not at all

No. of Responses 7 5

Percentage 58.33 % 41.67 %

86

Question No. 5 a) Yes, it is perfect b) Just OK c) No, it should be revised

No. of Responses 0 7 5

Percentage 58.33 % 41.67 %

Question No. 6 a) We can increase core capital. b) We can increase supplementary capital. c) We can increase both components of capital. d) It is not necessary to increase capital for us, it is adequate.

No. of Responses for present

Percentage

No. of Responses for future

Percentage

0 0 6 6

50 % 50 %

0 0 12 0

100 % -

87

A PPENDIX L
Tribhuvan University

Faculty of Management

Shanker Dev Campus

Putalisadak, Kathmandu

Study on Nepal Rastra Bank Capital Adequacy Norms for Commercial Banks and its impact: Case Study of Bank of Kathmandu Ltd and Himalayan Bank Ltd. QUESTIONNAIRE FOR BANK ACCOUNT HOLDERS I would be most grateful if you could spare 5 minutes to answer this questionnaire. Tick one box per question, unless otherwise indicated. 1) Why do you deposit your money in a bank? For Security of Money For Social Status For Interest Earning For Official Purpose

Others (please specify) 2) Which aspect of the bank do you think is the most important one to make a depositors money safe? Physical Security Arrangements Status Capital Fund Profitability

Others (please specify) 3) What do you think a bank should do in order to attract more deposits? Arrange the proper security Achieve a good profit Name: Address: Email: Occupation: Education: Thank you for taking the time to complete this questionnaire. Manoj Dumaru Shrestha MBS Student Tribhuvan University, Shanker Dev Campus Putalisadak, Kathmandu Maintain the adequate capital fund Pay an attractive interest rate

Others (please specify)

88

A PPENDIX L-1
Analysis of Questionnaire for Bank Account Holders: Question No. 1 a) For Security of Money b) For Interest Earning c) For Social Status d) For Official Purpose e) Others No. of Responses 42 16 2 7 5 Percentage 58.33 % 22.22 % 2.78 % 9.72 % 6.94 %

Question No. 2 a) Physical Security Arrangements b) Capital Fund c) Status d) Profitability e) Others

No. of Responses 30 18 9 15 0

Percentage 41.67 % 25.00 % 12.50 % 20.83 % -

Question No. 3 a) Arrange the proper security b) Maintain the adequate capital fund c) Achieve a good profit d) Pay an attractive interest rate e) Others

No. of Responses 13 9 11 33 6

Percentage 18.06 % 12.50 % 15.28 % 45.83 % 8.33 %

89

B IO D ATA

Manoj Dumaru Shrestha

Personal Details
Date of Birth: Marital Status: Sex: Nationality: Address: Contact Phone No.: E-mail Address: Postal Address: December 27, 1977 (Poush 12, 2034 BS) Sin gle Male Nepali Ikhapokhari Marg 30, Kshetrapati, Kathmandu, Nepal (R): 4253800; (O): 4227749 Ext -124 manojds@hotmail.com P.O. Box: 20590, Kathmandu, Nepal

Academic Qualifications
Masters Degree in Business Studies (MBS) 2001 2003 Major subjects: Investment, Capital Structure & Financial Management First Division Tribhuvan University, Shanker Dev Campus Putalisadak, Kathmandu Bachelors Degree in Business Studies (BBS) Second Division Tribhuvan University, Public Youth Campus Dhobichour, Kathmandu Proficiency Certificate in Business Administration Second Division Tribhuvan University, Peoples Campus Pakanajol, Kathmandu School Leaving Certificate (SLC) First Division HMG/N Board, Vishwa Niketan High School Tripureshwar, Kathmandu 1996 1999

1993 1995

1993

Work Experience
Himalayan Bank Limited July 1997 onwards Head Office & Main Branch, Tridevi Marg, Thamel, Kathmandu

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Languages Known
Written Nepali English Newari Very Good Very Good Good Spoken Very Good Good Mother Tongue

Trainings
Advanced Level Training on Accounting MAC Consultants (P) Ltd, Kathmandu Beginners Level Training on Practical Accounting MAC Consultants (P) Ltd, Kathmandu Training Program on International Banking Conducted by Himalayan Bank Limited Inventory Management Training Program Management Association of Nepal, Kathmandu Comprehensive Banking Course Conducted by Himalayan Bank Limited Computer Course (MS-Windows, MS-Word & MS-Excel) Wit Computer Center, Kathmandu June 16 Aug 8, 2003

Feb 10 May 2, 2003

June 2001

December 1999

August September 1997

January April 1997

Skills
Excellent commanding in MS-Word, MS-Excel, MS-PowerPoint, Adobe PageMaker & Adobe Photoshop Good knowledge of graphic designing and spreadsheet environments Basic knowledge of desktop publishing Typing fluency in English and Nepali

Extra Curricular Activities

Member of editorial board of Info Himalayan bimonthly newsletter of Himalayan Bank Ltd.

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