Non-Performing Loans (NPL) and Loan Loss Provisions in Nepali Banks

Non-Performing Loans (NPL) and Loan Loss Provisions (LLP) are two of the most critical indicators used to assess the asset quality and financial soundness of banks. In the Nepal Stock Exchange (NEPSE), where banking stocks dominate the market, understanding these concepts helps investors evaluate how efficiently a bank manages its credit risk and maintains profitability even in challenging economic conditions.

A Non-Performing Loan (NPL) is a loan on which the borrower has failed to make scheduled payments of principal or interest for 90 days or more. Such loans stop generating income for the bank and increase credit risk. When NPL levels rise, it signals potential stress in the banking system, as banks may have to write off some of those loans or recover them through legal or collateral means.

The NPL Ratio is calculated as:
NPL Ratio = (Non-Performing Loans ÷ Total Loans) × 100

A lower NPL ratio (generally below 2%) indicates strong credit control, while a higher ratio points to weak loan recovery, poor monitoring, or risky lending practices. In Nepal, Nepal Rastra Bank (NRB) regularly monitors NPL levels across banks and sets strict guidelines to ensure that they remain within acceptable limits.

To safeguard against potential loan defaults, banks create Loan Loss Provisions (LLP) — funds set aside from profits to cover expected future losses from non-performing assets. The provisioning percentage depends on the risk classification of loans:

• Pass Loans – 1% provision

• Watchlist Loans – 5% provision

• Substandard Loans – 25% provision

• Doubtful Loans – 50% provision

• Loss Loans – 100% provision

For investors, NPL and LLP directly impact profitability. As NPL rises, banks must allocate more funds to provisions, reducing net profit and Earnings Per Share (EPS). However, these provisions also make banks more resilient, ensuring they can absorb future shocks without affecting depositors.

In Nepal’s context, NPL levels tend to rise during periods of economic slowdown, high interest rates, or liquidity crises, as seen in fiscal years affected by inflation and reduced loan demand. Well-managed banks like NABIL, NMB, NIC Asia, and Global IME often maintain low NPL ratios and adequate provisioning coverage, reflecting prudent risk management.

High NPL ratios often result in reduced dividend distribution, as NRB directives restrict profit distribution until adequate provisions are maintained. Thus, investors should always review both NPL and provisioning trends before making decisions in the banking sector.

According to Sandeep Kumar Chaudhary, Nepal’s leading Technical and Fundamental Analyst and founder of the NepseTrading Training Institute, “NPL is the mirror of a bank’s loan discipline, and provisions are its shield. Together, they tell you how safely your money is managed.” With 15+ years of banking experience and 10,000+ trained investors, he teaches how analyzing NPL trends, loan recovery efficiency, and provisioning adequacy can help identify fundamentally strong banks in NEPSE.