Thesis(1)

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Thesis(1)

  1. 1. Nepal Rastra Bank – Capital Adequacy Norms for Commercial Banks and its impact: Case Study ofBank of Kathmandu Ltd and Himalayan Bank Ltd A THESIS REPORT By: Manoj Dumaru Shrestha Kathmandu, Nepal
  2. 2. Nepal Rastra Bank – Capital Adequacy Norms for Commercial Banks and its impact: Case Study ofBank 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
  3. 3. D ECLARATIONI hereby declare that the work reported in this thesis entitled “Nepal Rastra Bank –Capital Adequacy Norms for Commercial Banks and its impact: Case Study ofBank of Kathmandu Ltd and Himalayan Bank Ltd” submitted to Shanker DevCampus, Faculty of Management, Tribhuvan University is my original work done inthe form of partial fulfillment of the requirement for the Master’s Degree inBusiness Studies (MBS) under the supervision of Mrs. Amuda Shrestha and Mr.Shankar Prasad Khanal of Shanker Dev Campus. Manoj Dumaru ShresthaDate: TU Reg. No.: 720/93
  4. 4. A CKNOWLEDGEMENTThis thesis entitled “Nepal Rastra Bank – Capital Adequacy Norms forCommercial Banks and its impact: Case Study of Bank of Kathmandu Ltd andHimalayan Bank Ltd” has been prepared in partial fulfillment for the degree ofMasters 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 notpossible to enumerate the names of all of them. However, it will be matter ofinjustice if I forget the names of those personalities whose valuable suggestions andco-operation escorted to complete this thesis report.First and foremost, I would like to offer special thanks to Mrs. Amuda Shrestha andMr. Shankar Prasad Khanal for their proper supervision and suggestions. I wouldlike to thank Mr. Sushiel Joshi, Company Secretary and Deputy General Manager ofHimalayan Bank Limited and Mr. Binod N. Shrestha, Assistant Manager of Bank ofKathmandu Ltd for their immense co-operation during the research work of thisthesis. Also, I would like to thank Mr. Gyanendra Shrestha of Himalayan Bank Ltdand Ms. Ramila Shrestha of Bank of Kathmandu who provided relevant informationand 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 PrasadBhatta who all helped me during my study of MBS and during preparation of thisthesis report.It was a novel experience of doing a thesis work which certainly helped me to gaindeep knowledge in the subject. But accomplishment of the objective was not easy.The foremost difficulty was the scarcity of data and information, which Iexperienced 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 ShresthaDate: TU Reg. No.: 720/93 i
  5. 5. TABLE OF C ONTENTSAcknowledgement.......................................................................................................iTable of Contents.......................................................................................................iiList of Tables.............................................................................................................ivList of Figures ............................................................................................................vAbbreviations............................................................................................................viChapter 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..........................................................................11Chapter 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 .............................................................27Chapter 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 ii
  6. 6. 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......................55Chapter 5 Summary, Findings, Conclusion & Recommendation ..............................57 5.1 Summary..................................................................................................57 5.2 Findings ...................................................................................................58 5.3 Conclusion ...............................................................................................60 5.4 Recommendation .....................................................................................61Bibliography.............................................................................................................63Appendices ...............................................................................................................67Bio Data ....................................................................................................................89 iii
  7. 7. L IST OF TABLESTable 4.1 Capital Fund of BOK ................................................................................38Table 4.2 Capital Fund of HBL.................................................................................40Table 4.3 Risk Weighted Assets of BOK & HBL.....................................................42Table 4.4 Deposit Collection Trend of BOK, HBL and National Total....................43Table 4.5 Credit Trend of BOK, HBL and National Total........................................45Table 4.6 Capital Adequacy Ratios of BOK & HBL ................................................47Table 4.7 Capital to Deposit Ratios of BOK & HBL................................................48Table 4.8 Credit/Deposit Ratios of BOK & HBL .....................................................49Table 4.9 Correlation coefficients .............................................................................50Table 4.10 Hypothesis 1 ............................................................................................51Table 4.11 Hypothesis 2 ............................................................................................51Table 4.12 Hypothesis 3 ............................................................................................52Table 4.13 Hypothesis 4 ............................................................................................52Table 4.15 Changes in Capital Fund of BOK and HBL............................................53Table 4.16 Changes in Share Capital of BOK and HBL...........................................54 iv
  8. 8. L IST OF F IGURESFigure 4.1 Trend of Capital Fund of BOK ................................................................39Figure 4.2 Trend of Capital Fund of HBL.................................................................41Figure 4.3 Share of BOK & HBL on Total National Deposit Collections...............44Figure 4.4 Share of BOK & HBL on Total National Credit ....................................46 v
  9. 9. A BBREVIATIONSBOK Bank of Kathmandu LimitedFY Fiscal YearHBL Himalayan Bank LimitedHMG/N His Majesty’s Government of NepalNBBL Nepal Bangladesh Bank LimitedNGBL Nepal Grindlays Bank Limited (now SCBNL)NIBL Nepal Investment Bank Ltd (formerly Nepal Indosuez Bank Ltd)NPA Non Performing AssetsNRB Nepal Rastra BankPSA Premium Savings AccountSCBNL Standard Chartered Bank Nepal LimitedTRWA Total Risk Weighted Assets vi
  10. 10. C HAPTER 1 I NTRODUCTION1.1 BackgroundNepal, which is surrounded by China to the north and India to the east, west andsouth, is one of the least developed countries in the world which is directing herefforts in accelerating the pace of her economic development. Being landlockedhappens to be a disadvantage for the country. Nepal is located in between thelatitude 26°22’ North to 30°27’ North and longitude 80°4’ East to 88°12’ East. Theaverage 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 sectorcontributes over 60 percent to the GDP of the country. Over 80% of the populationis dependent on the agriculture. Therefore, major concentration of every governmentof Nepal has been the development and advancement of agriculture sector. But, stillthere has always been scarcity of finance in this sector. To some extent, theestablishment of Agriculture Development Bank has provided the support for thefarmers to raise the required capital. Also, various programs like microfinanceprograms, cooperative programs have been introduced in various villages of Nepalwhich 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, noorganization can exist without capital. Without capital it is not possible to set up anytype of business whether it is a general store or a big business house. Every
  11. 11. 2organization is started with a zero position and only come into existence when thepromoters, owners or shareholders finance on it as capital. Every organizationshould have enough capital to run business.Although the banks are the major source of capital, they also have to raise capital torun business. Especially, the bank capital has significant role to play as the bankshave obligations to mass people, its depositors. Thus, the banks should hold anadequate capital to secure the interest of depositors.Capital adequacy has become one of the most significant factors for assessing thesoundness of banking sector. Raise and utilization of funds are the primary functionsof commercial banks. As such, commercial banks collect a large amount of depositsfrom general public. The depositors think that depositing their money in a bank issafe and relaxing. But, what does happen if the bank does not have enough capitalfunds to provide a buffer against future, unexpected losses? Therefore, capital mustbe sufficient to protect a bank’s depositors and counterparties from the risks like,credit and market risks. Otherwise the banks will use all the money of depositors intheir own interest and depositors will have to suffer loss.After the restoration of multiparty democracy, several commercial banks make away to the business in Nepal. At present, commercial banks hold a large share ofeconomic activities of the country. Stock market has been dominated by commercialbanks since a decade. Everyday we can see trading of large amount of stocktransactions of commercial banks. Not only in the stock market, but commercialbanks have also been major contributors to the revenue of the country. They havebeen paying a large amount of tax every year. Banking sector has become amainstay of the economy of the country.Establishment of commercial banks is governed by Commercial Bank Act, 2031 BSand Company Act, 2053 BS. However, Nepal Rastra Bank (NRB), as a regulatorybody for banks and financial institutions, has right to specify the capitalrequirements, and other requirements. Being the central bank of Nepal, NRB has theresponsibility to give special attention to the interest of depositors. It is to be noted
  12. 12. 3that as per the banking and financial statistics of NRB, the commercial banks ofNepal have collected more than Rs. 185 billion money from depositors by the end offiscal year 2001/02. Such a big amount of money should have to be secured andNRB has the major responsibility to protect it.In March 2001 NRB issued various directives to be complied by all commercialbanks of the country. The directives consist of nine volumes. The NRB directive no.1 includes the capital adequacy norms for commercial banks indicating therequirement of maintaining capital fund to the prescribed ratios. The directives aresaid to be based on the internationally accepted norms of Basel Committee. TheBasel Committee on Banking Supervision is a committee of banking supervisoryauthorities which was established by the central bank Governors of the Group of Tencountries in 1975. It consists of senior representatives of bank supervisoryauthorities and central banks from Belgium, Canada, France, Germany, Italy, Japan,Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and theUnited States. It usually meets at the Bank for International Settlements in Basel,Switzerland, where its permanent Secretariat is located. The Basel Committee issuedBasel Capital Accord in 1988. The Basel Capital Accord was implementedworldwide by 1992 which is presently in practice. This Basel Accord is going to bereplaced by a new Basel Capital Accord by 2006.1.2 Focus of the StudyThe study is based on the capital funds of the banks which is supposed to beadequate as per the NRB directive no. 1, which is related with the capital adequacynorms for commercial banks. The norms basically emphasize on the basicrequirement of the capital fund that a commercial bank should possess. Thefundamental objective of the norms is to safeguard the interest of the depositors Asper these norms, bank capital has been divided into two categories which aregenerally known as Tier-1 and Tier-2.
  13. 13. 4At present, there are total 16 commercial banks in Nepal. The capital fund anddeposit 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 casestudy, analyzes the matters, issues and problems related to capital funds of Bank ofKathmandu 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 ofNepal Rastra Bank (NRB) by these commercial banks.1.2.1 Introduction to NRBNepal Rastra Bank is the central bank of Nepal. NRB was established in 1955 underthe Nepal Rastra Bank Act, 2012 BS. Now, NRB is running under a new act – NepalRastra Bank Act, 2058 BS. Before 1955, the functions of a central bank wereperformed by the government itself.NRB is the only authority to issue Nepalese Rupees currency. It has right to fixexchange rates with other convertible currencies. However, the exchange rates areextremely 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 branchesthroughout the Kingdom of Nepal including the Head Office at Baluwatar and theMain Banking Office at Thapathali in Kathmandu.NRB has been established as the regulatory body for banks and financial institutionsof Nepal. So, it has right to constitute rules and regulations to be followed by banksand financial institutions in the country. All the banks and financial institutionsoperate under the regulations of NRB. The establishment of such institutions is alsoin discretion of NRB. To regulate the operations of commercial banks, NRB hasissued various directives which include capital adequacy norms to be followed bycommercial banks.
  14. 14. 5As per the Nepal Rastra Bank Act, 2058 BS the objectives of NRB are stated asfollows: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; ande) 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 andfunctions 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 Majesty’s 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; andj) To carry out other important functions as necessary towards realizing the objectives enjoined by the Act.
  15. 15. 61.2.2 Introduction to BOKBank of Kathmandu Ltd was established in March 1995 with an authorized capitalof Rs. 240 million. The bank was established in collaboration with The SiamCommercial Bank Public Company Ltd of Thailand. But The Siam CommercialBank Public Company Ltd has sold all its shares to local promoters. BOK wasestablished with the predominant objectives of Identifying business prospects not yetcatered by then existing commercial banks and offer new banking products andservices and Introducing modern banking technology facilitating bank and businessoperations and transactions.The head office of BOK is located at Kamaladi in Kathmandu. It has branch networkof total seven branches including Head Office at Kamaladi; two branches insideKathmandu Valley: New Road Branch and Thamel Branch and four outsideKathmandu Valley: Butwal Branch, Dhangadhi Branch, Hetauda Branch, andNepalgunj Branch.BOK is committed to providing products and services of the highest standards to itscustomers by understanding their requirements best suiting the market needs. Inpursuit to deliver the products and services of the highest standards, BOK has state-of-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, correspondentbanking relationships with over 200 banks worldwide for effective and proficientexecution of international trade and remittance activities, gamut of corporate andretail banking products and services and centralized banking operations for betterrisk management, consistent service deliveries and lowering operating cost.The present share capital and ownership is shown in Appendix I. At present, BOKhas 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 themanagement of the bank in the capacity of Managing Director.
  16. 16. 71.2.3 Introduction to HBLHimalayan Bank Ltd is the first joint-venture commercial bank to be establishedafter the restoration of multiparty democracy in the country. It was established inJanuary 1993 with an authorized capital of Rs. 240 million. HBL was establishedwith 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 branchesoutside 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 aspromptly as possible. To extend more efficient services to its customers, HBL hasbeen adopting innovative and latest banking technologies like, state-of-the-arttechnology and modern banking tools. HBL has access to the worldwidecorrespondent network of Habib Bank Limited for funds transfer, letters of creditand any banking business anywhere in the world. Besides, HBL also hascorrespondent arrangements with 178 internationally renowned banks like AmericanExpress Bank, Citibank and ABN Amro.The present share capital and ownership is shown in Appendix II. At the end offiscal year 2001/02, HBL has an authorized capital of Rs. 1,000 million and issuedcapital of Rs. 650 million. Its paid-up capital stands at Rs. 390 million. Recently tofulfill is supplementary capital requirement, HBL issued short-term unsecuredsubordinated bonds: HBL Bond 2066 having face value of Rs. 1,000 and couponinterest of 8.5%. The units issued were 360 thousand totaling the amount at Rs. 360million. Mr. Shahid M. Loan, an expatriate from Pakistan, is leading themanagement as Senior General Manager.
  17. 17. 81.3 Statement of ProblemBanking and financial statistics (2002) shows that, there are more than Rs. 185billion of amount deposited in various banks of the country by the end of fiscal year2000/2001. But if the banks go bankrupted, what will happen to the depositors ofsuch money? Thus, an adequate capital fund is required to safeguard the money ofdepositors.Bhandari (2003) points out that adequacy and inadequacy of bank capital directlyaffects the banking transaction. The adequacy of bank capital is the most importantaspect of a bank. The bank should pay attention to many things for the adequacy ofcapital.In March 2001, NRB issued a new set of directives to commercial banks consistingof nine parts. NRB claims that these directives are based on the internationallyaccepted banking norms of Basel Committee. Out of nine directives, the directiveno. 1, which was later revised in September 2001, is related with the requirement ofthe 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. Thedirective no. 1 which is related to capital fund has revised the capital adequacy ratioto be maintained by commercial banks as follows: Time Table Core Capital Total Capital Fund For FY 2058/59 4.5 % 9.0 % For FY 2059/60 5.0 % 10.0 % From FY 2060/61 onwards 6.0 % 12.0 %As well as, NRB has set up to increase the paid up share capital of national levelcommercial banks to Rs. 1 billion by the year 2009.
  18. 18. 9Now, question arises, why these changes are required? While revising the capitaladequacy norms, none of the existing commercial banks meet the standard.However, they are allowed to comply with the norms, stage by stage within thespecific period.In the fiscal year 2057/58, BOK had a capital adequacy ratio of 8.6% and HBL hadthe same ratio of 8.01%. Whilst, they are able to maintain an adequate ratio in thefiscal year 2058/59 which is more than 9% as required by NRB Capital AdequacyNorms. For this compliance, they had to take various measures. Hence, the thesiswill mainly focus on the capital fund of these two commercial banks.1.4 Objectives of the studyThe 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 recommendations1.5 Significance of the studyThe study will have a significant importance in the present context of bankingbusiness in Nepal. Commercial banks have collected more than Rs. 185 million ofdeposits. We can observe that there is a lack of investment opportunity of fund. Insuch a situation, these deposits have to be protected by adequate capital fund ofrespective commercial banks. In fact, the banks should have adequate capital fundalthough there are plenty of investment opportunities.
  19. 19. 10Presently, raising capital is a tough task. The growing NPAs, being the mainheadache of commercial banks, meeting the capital adequacy is very tough, thoughit is not impossible.It has been observed that any study has not been undertaken regarding the capitaladequacy norms for commercial bank. However, studies on NRB directives havebeen 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 studiesof capital adequacy.So, this thesis is a new study in the field of banking sector. Thus, the thesis has ofcourse presented some results which will reflect the capital structure and position ofcommercial banks of Nepal.1.6 Limitation of studyThe study is limited of the capital fund and capital adequacy norms for commercialbanks. Since, it is not possible to take all commercial banks as sample, the thesiswill analyze on the data and information of BOK and HBL. The data andinformation over the period of five fiscal years commencing from the FY 1997/98till the FY 2001/02 are used in the study. For the analysis of capital fund, only twoyears’ data are available, i.e., of FY 2000/01 and FY 2001/02.Balance sheets, profit & loss accounts and other financial statements are consideredas basic source of data. Thus, the study is mainly based on the secondary datacollected from various sources. However, some primary data has also been derivedfrom the analysis of questionnaire prepared for the research study.For the literature review various newspapers, journals, unpublished thesis works andnevertheless the internet have been referred. However, the literature review has beenlimited to very few articles and research works due to unavailability of sufficientsuch matters even after very hard quest.
  20. 20. 111.7 Theoretical FrameworkThe primary and independent variable that has been considered in this researchstudy is capital fund of the selected commercials banks. The variables which aresupposed to be dependent are deposit and credit of these banks.While going through the literature review, it is found that capital and deposit arerelated. As well as capital and credit are related. The significance of the relationshipis tested in the analytical chapter i.e., Chapter 4. The positive correlations areexpected in both relations. The higher the capital fund, the higher the chance ofcollecting more deposits and flowing more credit as well.1.8 Problem HypothesisFrom the theoretical framework discussed earlier, the following hypotheses havebeen 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 reportThe structure of the thesis report comprises a total of five chapters which have beenbriefly described as follows:Chapter 1: IntroductionTo 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 thestudy, significance of the study, limitation of the study, theoretical framework, andproblem hypothesis. This chapter has been targeted to help the reader to understandget the rhythm of the subject matter of the thesis report.
  21. 21. 12Chapter 2: Review of LiteratureThis chapter includes conceptual review, review of NRB capital adequacy norms,and review of empirical works. For this purpose, various books, journals andperiodicals as well as internet have been utilized.Chapter 3: Research MethodologyResearch design, sample selection, sources of data, data collection procedure, toolsfor analysis of the study, and limitations of the methodology have been included inthis chapter.Chapter 4: Presentation and Analysis of DataThis chapter illustrates the collected data into a systematic format. The analysis ofthese data is also included in this chapter. As well as, interpretation of analysis hasalso been done in this chapter.Chapter 5: Summary, Conclusions and RecommendationsIn this chapter, the summary of the entire thesis has been comprised. This chapterfurther describes the major findings of the thesis. Conclusions of the study have alsobeen included in this chapter. As well as, possible and viable recommendations hasalso been presented in this chapter.
  22. 22. C HAPTER 2 L ITERATURE R EVIEW2.1 Conceptual Review2.1.1 Origin and Development of BanksThe economic activities existed in every civilization of mankind in all over theworld. But the modern banking practice was originated from Europe. The first bankcalled ‘Bank of Venice’ was established in Venice in 1157. Then ‘Bank ofBarcelona’ was established in 1401 and in 1407 ‘Bank of Genoa’ was established. In1694, 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 Nepalicoins to be introduced were Manank during the reign of the King Mandev andGunank during the reign of the King Gunakamdev. Afterwards the coins werereintroduced during the reign of Amshuverma. After the unification of Nepal, thegreat King Prithivi Narayan Shah started the coin Mohar. The Taksar wasestablished in 1789 to issue coins scientifically. In 1876, during Rana Regime anoffice named Tejarath Adda was established in Kathmandu to provide loans againstdeposit 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 in1937 as the first bank of the country. Nepal Bank Limited dominated the financialsector of the country for almost 30 years without any competitor. This bank played amajor role to boost up the Nepalese economy during that period. Nepal Rastra Bankwas established in 1955 as central bank of Nepal which was very essential for
  23. 23. 14Nepalese economy. The second commercial bank, Rastriya Banijya Bank wasestablished in 1965 under the Rastriya Banijya Bank Act, 2022 with full ownershipof the His Majesty’s Government.2.1.2 Development of Central BankIn 1894, the Bank of England was converted into the central bank of England. Thiswas done by establishing the Governor and the Company of the Bank of England. Atpresent, this bank is known as the Central Bank of England.Shekhar & Shekhar (1998) have stated that after the World War I and theconsequent chaotic monetary conditions brought home to many countries theimperative necessity of establishing a centralized institution capable of creating andmaintaining equilibrium in the monetary sphere.In September 1920, an International Financial Conference was held at Brussels, whichpointed out that those countries which had not yet established a central bank and weresuffered 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 BankCentral bank is the national institution that monitors all financial and monetaryprocedures and policies. Vaidya (1997) has stated that the central bank is the apexbank in a country that controls all monetary system and banking structure.Rosenberg (1982) has defined the central bank as a banker’s bank and a bankholding 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 outgovernment economic policy, influences interest and exchange rates and monitors
  24. 24. 15the activities of commercial and merchant banks. In this way it functions as thegovernment’s banker and is the lender of the last resort to the banking system.Encyclopedia Britannica (2002) defines Central Bank as an institution that is chargedwith regulating the size of a nations money supply, the availability and cost of credit,and the foreign-exchange value of its currency. Regulation of the availability and costof credit may be nonselective or may be designed to influence the distribution ofcredit among competing uses. The principal objectives of a modern central bank incarrying out these functions are to maintain monetary and credit conditions conduciveto a high level of employment and production, a reasonably stable level of domesticprices, and an adequate level of international reserves.Central bank is an institution which is charged with the responsibility of managingthe expansion and contraction of the volume of money in the interest of the generalpublic welfare. It is also a banker’s bank and holding reserves of the country andultimate reservoir of credit. Hence, central bank is the regulating authority forcommercial banks, and other banks and financial institutions.2.1.4 Importance & Functions of Central BanksIt 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 andfast rule regarding the functions of a central bank. The powers and the range offunctions of central banks vary from country to country.The most important and the earliest functions to be discharged by a central bank isthat of acting as a bank of issue. As well as it is a banker’s bank. The central bankalso acts as a lender of the last resort. In case of any problems and emergency to anyof the banks operating under it, central bank comes forward to rescue themtemporarily from such problems. It also plays the role of an agent, an advisor andbanker to the Government. Central bank is a custodian of the nation’s metallicreserves and controller of currency.
  25. 25. 16A central bank has sole right to issue national currency notes. It controls money flowin the market by imposing monetary policy. It issues notes after full analysis ofunemployment, inflation, economic growth, etc. of the country. Central bank is theholder of all the Government balances. It is the holder of all the reserves of the otherbanks and financial institutions in the country.Objectives between a central bank and other commercial banks are different. Themain objective of a central bank is to assist the government to implement economicpolicies without any profit motive, whereas the main objective of other banks is toearn profit by mobilizing funds collected from the general public. As well as thecentral 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 isthe 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 interms of implementing its policies. It can penalize the banks in case they go out ofthe central bank’s policy or the termination of the license and also can restrict theirworking dimensions to a large extent.A central bank is also important in the context to co-ordinate with differentinternational institutions such as International Monetary Fund (IMF) etc. It worksunder the supervision and guidance of such institution to develop the monetarysystem of a country.2.1.5 Meaning of Commercial BanksRosenberg (1982) has stated commercial bank as an organization chartered eitherby the Comptroller of the Currency and known as a national bank or chartered by thestate in which it will conduct the business of banking. A commercial bank generallyspecializes in demand deposits and commercial loans.
  26. 26. 17Clark (1999) has defined commercial bank as bank that concentrates on cashdeposit and transfer services to the general public, often to be found on the HighStreet. It may be joint-venture bank or a private bank.“Bank is an institution that deals in money and its substitutes and provides otherfinancial services. Banks accept deposits and make loans and derive a profit fromthe difference in the interest rates paid and charged, respectively. Some banks alsohave the power to create money. Commercial bank is a bank with the power to makeloans that, at least in part, eventually become new demand deposits. Because acommercial bank is required to hold only a fraction of its deposits as reserves, it canuse 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 depositsare thus increased until the loan is repaid. As a group, then, commercial banks areable 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 likemoney to make payments and purchase goods and services; savings accounts andtime deposits that can be used to save money for future use; loans that consumersand businesses can use to purchase goods and services; and basic cash managementservices such as check cashing and foreign currency exchange. Commercial banksspecialize in loans to commercial and industrial businesses. Commercial banks areowned by private investors, called stockholders, or by companies called bankholding companies.” (Microsoft Encarta Reference Library, 2003)The main objectives of a commercial bank are to earn profit by collecting the fundscattered around the general public, and mobilizing it. So, the main functions ofcommercial banks happen to be collecting deposits from general public and lendingloans to various economic sectors that require financing. Commercial banks makeprofit by charging a bit higher interest rate in loans than they pay to depositors. Sothe main source of income of commercial banks is interest income.
  27. 27. 182.1.6 Overview: Capital and Capital Adequacy“Capital is a stock of resources that may be employed in the production of goods andservices and the price paid for the use of credit or money, respectively.” (MicrosoftEncarta Reference Library, 2003)Rosenberg (1982) has defined capital in relation with banking as a long-term debtplus owners’ equity.The efficient functioning of markets requires participants to have confidence in eachothers stability and ability to transact business. Capital-rules help foster thisconfidence because they require each member of the financial community to have,among other things, adequate capital. This capital must be sufficient to protect afinancial organization’s depositors and counterparties from the risks of theinstitutions on-balance sheet and off-balance sheet risks. Top of the list are creditand market risks; not surprisingly, banks are required to set aside capital to coverthese two main risks. Capital standards should be designed to allow a firm to absorbits losses, and in the worst case, to allow a firm to wind down its business withoutloss to customers, counterparties and without disrupting the orderly functioning offinancial markets.Minimum capital fund standards are thus a vital tool to reducing systemic risk. Theyalso play a central role in how regulators supervise financial institutions. But capitalrequirements have so far tended to be simple mechanical rules rather thanapplications of sophisticated risk-adjusted models. Such capital standard is widelyknown as capital adequacy.Patheja (1994) has defined banks capital as common stock plus surplus plusundivided profits plus reserves for contingencies and other capital reserves. Inaddition since a bank’s loan-loss reserves also serves as a buffer for absorbinglosses, a broader definition of bank capital include this account.
  28. 28. 19Verma & Malhotra (1993) has indicated that the general public is interested in thehigher profitability and safety of the funds of a bank, because the public expects theshareholders to assume all the risks. Lower profitability of a bank fills the faith ofthe prospective depositors and all their incentive for investing in the various depositschemes.The Basel Committee sets a standard for all the banking norms, which will beaccepted by central banks of all big industrialist countries. Regarding the capitalfunds the committee has issued the Basel Capital Accord. The first Basel CapitalAccord was issued in 1988 and was implemented by 1992. The committee has nowissued New Basel Capital Accord which will be implemented by 2006 to overcomethe drawbacks of the present capital accord. Central banks of developing andunderdeveloped countries follow these standards. NRB also follows these standardsand accordingly sets standard for commercial banks in Nepal.According to the directive issued by NRB, the bank capital has been categorized intotwo parts: core capital and supplementary capital. This categorization is also knownas 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,
  29. 29. 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 adequacyratio. The capital adequacy ratio is based on total risk-weighted assets.Clark (1999) has defined capital adequacy as legal requirement that a financialinstitution (such as a bank) should have enough capital to meet all its obligations andfund the services it offers.Besis (1998) has claimed that capital adequacy aims at setting minimum level ofcapital as a function of risks. Thus capital should be risk based.Maisel (1981) “Capital is adequate either when it reduces the chances of futureinsolvency of an institution to some predetermine level of alternately when thepremium paid by the banks to an insurer is ‘fair’, that is, when it fully covers therisks borne by the insurer. Such risks, in turn, depend upon the risk in the portfolioselected by the bank, on its capital and on terms of the insurance w.r.t. wheninsolvency will be determined and what loss will be paid”.The capital adequacy ratio is yielded by the following formula: Total Capital Fund Capital Adequacy Ratio = Total risk-weighted assets × 100%2.2 Review of NRB Capital Adequacy Norms for Commercial BanksWith an objective to develop a healthy, competent and secured banking system foreconomic prosperity of the country and to safeguard the interest of depositors, NRBissued the directive no. 1 regarding minimum capital fund to be maintained bycommercial banks. NRB issued these capital adequacy norms by using the power
  30. 30. 21given by Commercial Bank Act, 2031 (with amendments) Clause 14(Ka). Thesenorms 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 ofthe risk-weighted assets. The banks are required to maintain the prescribedproportion of minimum capital fund on the basis of weighted risk assets as per thefollowing time-table: Time Table Core Capital Total Capital Fund For FY 2058/59 (2001/02) 4.5% 9.0% For FY 2059/60 (2002/03) 5.0% 10.0% From FY 2060/61 (2003/04) onwards 6.0% 12.0%As stated earlier, for the purpose of calculation of Capital Fund, the capital of thebanks is divided into two components Core Capital and Supplementary Capital.Core capital which is widely known as Tier-1 capital consists of share capital, sharepremium, non-redeemable preference shares, general reserve fund and accumulatedprofit/loss. Supplementary capital, which is also known as Tier-2 capital consists ofloan loss provision, exchange equalization reserve, assets revaluation reserve, hybridcapital instruments, unsecured subordinated term debt, interest rate fluctuation fund,and other free reserves. The sum of these two components is considered to be totalcapital fund.For the purpose of calculation of capital fund, the risk-weighted assets have beenclassified into two parts – On-Balance Sheet Risk-Weighted Assets and Off-BalanceSheet Risk-Weighted Items. The weightage of the risk assigned to them are shownin the Appendix B and Appendix C respectively. The amount of risk-weighted assetscalculated by multiplying the amount of the asset with the weightage assigned tothem and the total of which will be extracted for the purpose of calculation of capitaladequacy ratios.
  31. 31. 22As per the norms, the capital fund ratio would measure the total capital fund on thebasis of total risk-weighted assets. The capital fund ratio shall be determined asfollows: Core Capital + Supplementary Capital Capital Fund Ratio = Sum of risk-weighted assets × 100%The sum of risk-weighted assets is the sum of total on-balance sheet risk-weightedassets 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 ofCapital Fund and other relevant statements on the basis of the financial statements asper the prescribed Form No. 1 and Form No. 2 and submit to the BankingOperations Department and Inspection and Supervision Department of this bankwithin 1 (one) month from the end of each quarter. The prescribed form no. 1 and 2are illustrated in Appendix D and Appendix E respectively.In the event of non-fulfillment of Capital Fund Ratio in any quarter, the banks shallfulfill the shortfall amount within next 6 (six) months. Until the fulfillment of suchCapital Fund, the banks shall not declare or distribute dividend to its shareholdersunder Section 18 of Commercial Bank Act, 2031. The shortfall in the Capital Fundmay 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.
  32. 32. 232.3 Empirical Review2.3.1 Review of Articles and ReportsLamsal (2001) stated that that the central bank rocked the commercial banks withseven directives issued in two installments asking banks to start complying with thenew strictures by mid-July 2001 or face grave consequences. NRB claims that theseare based on the internationally accepted banking norms of Basel committee. Lamsalhas opined that banks are expected to be disparate to meet the targets of capitaladequacy norms since the consequences the banks have to face in case ofnoncompliance are very strict. And for this purpose they will have to issueadditional shares, which is not possible for them in the short-run. Or they do notprefer to go for additional share issue simply because they will also have to pay thesame dividend as the past to the holders of shares so issued. This becomes the moredifficult as the business is not going to expand commensurately. The difficulty isunderstandable now when every banker is complaining of the lack of newinvestment projects.Shah (2003) concluded that being the central bank of the nation, Nepal Rastra Bankhas to be active by playing important role for monetary and financial stability. Centralbank should always be eager to achieve the public faith towards bank and financialinstitutions enabling them being disciplined, well-organized, healthy and competentby providing effective regulation and supervision to appropriate utilization andmobilization of financial resources by increasing financial saving rate by raisingfinancial stability. Also, central bank should always be willing to safeguard theinterest of depositors and investors to accomplish the financial stability. Constantfinancial stability leads to the accomplishment of monetary stability. As the tools formonetary policy are applied through financial sector, the efficiency of monetarypolicy depends on effectiveness of financial sector. Balanced growth of financialsector helps monetizing of economy. Various drawbacks; like, managerialineffectiveness, organizational difficulty, contrary financial situation; make the long-term stability of financial sector suspicious. Failure of any one financial institution
  33. 33. 24leads the destructive impact to whole financial sector and such impact will be spreadto 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 forachieving higher economic growth rate by steadying macro economic stability hasbeen globally supported. The financial sector reform program in Nepal can also betaken in the same background. Since, it is not possible to achieve financial stabilitywithout the commanding role of regulation and supervision, new program of financialsector reform program should play role regarding structuralreformation/transformation and organizational structure in existing banks andfinancial institutions by clarifying the role of government and central bank.Khatiwada (2003) enlightened that recent financial crisis have revealed a number ofdata deficiencies, notably in pledged assets, deposits held in financially weakdomestic banks and their foreign affiliates, valuation practices leading to bankvaluation of assets being significantly different from market values and complicatingassessments of the realizable value of reserve assets. Similarly, public information islacking in many countries on the off-balance-sheet activities of the authorities thatcan affect foreign currency resources. There was a lack of information on theauthorities’ financial derivatives activities. Also observed was the inadequateinformation of actual and potential foreign liabilities of the monetary authorities andcentral government. Financial sector reform envisages for measures for mitigatingthis information and data gap problem as well.Khatiwada has further written that Nepal initiated financial sector reform back in1980s with donor initiative and assistance. In this process, some progress was madein terms of re-capitalization of the government banks, divestment, branchconsolidation, introduction of new regulatory and prudential norms and cleaning upthe balance sheets of bad loan loaded banks. But the reform process was stalled inthe later 1990s due to political instability and the government’s priority in areasother than the financial system. In between, the country observed, from very closeby, the financial crisis in the neighboring region. Keeping in mind the financial crisisand its effect in the Asian region, the Nepal Rastra Bank is now focusing its
  34. 34. 25attention on the reform measures in the financial sector as a drive towards newfinancial architecture.Khatiwada emphasized various reform majors. One of the measures was increasingcapital base and revising capital adequacy. Khatiwada stressed that experience hasshown that undercapitalized financial institutions are the ones that are first attackedby the speculators and hedgers at the time of crisis and create contagious effect onthe other institutions as well. Besides, undercapitalized financial institutions cannotgain credibility and corporate growth even in normal times. This requires thatfinancial institutions are adequately capitalized and possess resilience against attacksby dealers and customers. In this context, the capital adequacy norms are beingrevised upward as per the Basel Capital Accord. But increasing the capital base forloss making government owned financial institutions is not easy without involvingprivate sector in the equity capital.Pandey (2003) stressed that one of the main objectives of a commercial bank is tosafeguard the money of depositors. With the low capital adequacy rate, the bankswere previously lending from the money of the depositors because the capitalcomprised a very small portion of the total risk-weighted assets. However, thereturns the shareholders or promoters were reaping were quite high. The risk of thedepositors 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,NRB’s efforts in this direction are really praiseworthy.Stokes (2003) has mentioned that banks hold capital in excess of reserve requirementsto provide a buffer against future, unexpected losses. Such losses are brought about bythe credit, market, and operational risks inherent in the business of lending money.Problems created by an insolvent bank are important enough that bank regulatorsenforce minimum capital standards on banks in an effort to safeguard depositors andensure the ongoing viability of the financial system. However, from a bank’sperspective holding idle capital is an expensive safeguard against risk because thebank’s shareholders demand a return on their investment and idle capital provides no
  35. 35. 26such return. For this reason bankers and regulators can have divergent opinions aboutthe amount of capital a banks should hold making the problem of determining abank’s risk-based capital a complex and important question.Heakal (2003) has written that the central bank has been described as “the lender ofthe last resort,” which means that the central bank is responsible for providing itseconomy with funds when commercial banks cannot cover a supply shortage. Inother words, the central bank prevents the country’s banking system from failing.However, the primary goal of central banks is to provide their countries’ currencieswith price stability by controlling inflation. A central bank also acts as the regulatoryauthority of a country’s monetary policy and is the sole provide and printer of notesand coins in circulation. Time has proven that the central bank ca best function inthese capacities by remaining independent from government fiscal policy andtherefore uninfluenced by political concerns of any regime. The central bank shouldalso be completely divested of any commercial banking interests.Keijser & Haas (2001) have summarized as the Basel Capital Accord of 1988 wasan 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 offinancial collateral, is still rather limited. The same holds for the European directivesand national regulations derived from the Basel Accord. The regulatory treatment ofcollateral has recently entered a new phase, in the form of the proposed revision ofthe Basel Accord. The use of a wider range of collateral will be allowed in the newAccord and banks will be able to choose either the comprehensive or the simpleapproach for the treatment of collateral. Whereas the simple approach resembles thecurrent Basel substitution methodology in its treatment of collateral, thecomprehensive approach is more innovative. It assigns a central role to collateralhaircuts, which may be based on banks’ own internal estimates of collateralvolatility. By making a wider range of collateral available for credit risk mitigationand making the calculation of risk-weighted assets more risk-sensitive, the revisionof the Basel Accord is intended further to align regulatory capital which banks musthold and their actual economic risk structure.
  36. 36. 272.3.2 Review of Thesis WorksPandey (2002) has given conclusion regarding the capital adequacy of HBL duringhis 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 ofsupplementary capital. The total risk weighted assets of HBL is equal to Rs. 12690.6million. Therefore, the capital adequacy of the bank stands at 8.43% of total riskweighted assets. Core capital is 5.96% and the supplementary capital is 2.47% oftotal 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 supplementarycapital. 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 corecapital to compensate for the shortfall. But still the bank requires another Rs. 72.6million to meet the requirement of supplementary capital. Pandey has suggested thatHBL should increase the capital base from Rs. 1070 million by at least Rs. 115million to meet the capital adequacy ratio. For this, the bank should try to increaseits supplementary capital as it falls short by Rs. 73 million. The bank should increaseits core capital in order to expose itself to more credit risk.Karmacharya (2002) has expressed that the financial soundness as well as itsstrength of the company depends upon the large extend on the composition of thecapital structure and assets. Capital structure of the company presents its resourcecapacity and ability of its present worthiness. In the study, he has found that the allthe banks in his study follows the requirements of NRB directives regarding capitaladequacy. The capital structure of studied banks is highly leveraged. Thus,Karmacharya has recommended that the proportion of debt and equity capitalshould be decided keeping in mind the effort of tax advantages and financialdistress. The banks are required to maintain improved capital structure by increasingequity base i.e., issuing more equity capital, expanding general reserve and retainingmore earnings. With this improvement, it will compromise among the conflicting
  37. 37. 28factors of cost and risk. As mandated by NRB, for the operation in all over Nepal, acommercial bank should have capital base of Rs. 500 million. Hence, the banksshould 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 CharteredBank Nepal Ltd (SCBNL), has found that liquidity position of SCBNL was notsatisfactory. Loans & advances, cash & bank balance ratio seemed too weak thanthat of NBBL and HBL. Investment on share & debenture and interest earningpower on total working fund also seemed in weak condition than that of NBBL &HBL. Growth ratio of deposits, loans & advances, investments, net profits seemedtoo 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 outsideassets (investment and loans & advances) seemed positive. At last, Sapkotaconcluded that in overall condition SCBNL seemed in satisfactory position incomparison to NBBL & HBL. Since, SCBNL used to provide less loan & advancesin comparison to its total deposits, SCBNL Sapkota has strongly recommendedfollowing a liberal lending policy so that more percentage of deposits can beinvested to different profitable sectors as well as towards loans & advances.Because, analysis showed investment and loans & advances as a significant factorthis affects the net profit of the bank. Subsequently, a skillful administration is themust for these assets because negligence may become a reason for liquidity crisisand bankruptcy.Pathak (1999), in his thesis, has found the capital adequacy ratios of NIBL andNGBL are fluctuating in nature over the period of his study. Pathak has furtherconcluded that both the banks have been maintaining capital adequacy ratio asdirected by the central bank Nepal Rastra Bank in order to safeguard the depositors’interest. However, it is found from student’s t-test that NIBL has higher capitaladequacy ratio than that of NGBL on an average. It can be concluded that NIBL hasmaintained excess capital fund to safeguard the depositors’ interest.
  38. 38. 29Sapkota, R. (2002), in his study on capital and assets structure management ofNepal Bank of Ceylon Ltd, has found that the ratio of shareholders’ fund to totaldeposit ratio reveals that in the year 2053/054 it was highest i.e. 101.40% and hasbeen decreasing in the succeeding years. The average ratio is 35.69. Also, the ratioof shareholders’ fund in relation to total assets shows that average ratio is 21.22%. Itis concluded that its ratio are found decreasing throughout the study period.Agrawal (2002), in his study on deposit and investment position of Yeti FinanceCompany Ltd, has concluded that the major objective of financial institution is totransfer capital between saver and those who need it. Such institutions areestablished with the aim of further intensifying the participation of assistingindustries and private sector in regular supply of funds. Financial institutions serveas a financial intermediaries, transfer money and securities between firm and saverthat create a new financial product. Agrawal further commented that the majorclasses 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 financialsector, both in collecting and investing funds. They are able to tap even smalleramount of saving from public and investing in different production sectors.Shrestha (2002) has stated that in a situation when the existing financialinstitutions, especially government owned commercial banks were unable to supplycredit timely and carry capital market activities, private joint venture commercialbanks have contributed a lot. The overall performance of joint venture commercialbanks 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 (NabilBank 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 areslowly turned on hire purchase and housing financing.
  39. 39. 30Strengthening and institutionalization of the commercial banks is very important tohave a meaningful relationship between commercial banks and nationaldevelopment through shift of credit to the productive industrial sectors. At the sametime the series of reforms such as consolidation of commercial banks, directingattention to venture capital financing, appropriate risk return trade of by linkingcredit to timely repayment schedules, avoiding imperfections, allowing flexibility inlending, one window service from NRB, need of a strong supervision andmonitoring from NRB, diversity scope of activities for commercial banks,professional culture within commercial banks, etc. All these are necessary to ensurebetter future performance of commercial banks that have already been establishedand growing in Nepal.Ranjit (1989) has indicated that capital funds have positive and significant relationwith both deposits and loans. That means increase or decrease in capital fundincreases or decreases deposits as well as loans. However the degrees of relationshipwere different. But relation of capital with profit was positive and insignificant. Thatindicated less of increase or decrease in profit is due to capital fund or capital fund isleast responsible in changing profit. Bank should increase capital fund to increasethe capital fund ratio according to increase in deposits.Shivakoti (2003), in his study of capital & assets structure of Nepal IndustrialDevelopment Corporation (NIDC), has concluded that the financial soundness of acompany 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 assetstructure presents its worthiness. The composition of the capital and assets holds theutmost importance so far the successful and thriving operation of NIDC. Shivakotistated that NIDC prefers the long-term borrowing in form of capital and uses it inlong-term loan as assets. The fixed assets, investment in shares and debentures,current assets and liabilities, share capital, reserve and surplus are other componentsassociated with capital and assets structure of NIDC. Shivakoti found that thecontribution of different components of capital and assets structure in EBIT ofNIDC to be less satisfactory. The relation is positive which showed EBIT was
  40. 40. 31increasing with other variables correlated but the low degree of correlation betweenthem meant the relationship between these EBIT and other variables lacks closenessin its increasing trend.Kadel (2002), in his study on financial performance of NGBL and HBL, hasconcluded as many commercial banks have been competing with each other in theirbusiness. When the government adopted liberal policy, as a result many commercialbanks especially joint-venture banks increased rapidly i.e., Himalayan Bank Ltd,Nepal SBI Bank Ltd, Nepal Grindlays Bank Ltd, etc. These banks are mainlyconcentrated themselves on financing foreign trade, commerce and industry andother sectors. Banking helps to mobilize the small savings collectively to the hugecapital investment though the banking is considered as the platform of moneymarket.
  41. 41. C HAPTER 3 R ESEARCH M ETHODOLOGYResearch Methodology can be understood as a science of studying how research hasbeen done. This chapter looks into the research design, nature and sources of data,data collection procedure and tools & technique of analysis. For the purpose ofachieving the objectives of the study, the applied methodologies are used. Theresearch methodology used in the present study is briefly mentioned below.3.1 Research DesignThis study research attempts to analyze the capital funds of commercial banks takingthe data and information of BOK and HBL. The research design is basically focusedon analytical study. Ratio analysis, correlation analysis and testing of hypothesishave been done for analyzing the research. The research examines the relationship ofbank capital to various other stakes, like deposits, credits, etc.3.2 Population and SampleThere are total 16 commercial banks presently operating in Nepal. Collecting thedata of these entire commercial banks is not possible. Hence, Bank of KathmanduLtd (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 thesamples are BOK and HBL.
  42. 42. 33Also, through the research questionnaire, various responds of the respondents havebeen considered as sample for the study. Twelve bank officials have beeninterviewed with a questionnaire prepared as in Appendix K. There are total 72respondents of the research questionnaire for depositors as shown in Appendix L.3.3 Data collection procedureThe data and information are collected from both the primary and secondarysources. For the primary information, research interview and questionnaires areused. The research interview questionnaire, as shown in Appendix K, was set tointerview bank officials. The research questionnaire as shown in Appendix L was setfor bank account holders who are known as depositors in this thesis report.For the collection of secondary data and information, directives of Nepal RastraBank, annual reports of BOK, annual reports of HBL, various publications of NepalRastra Bank, magazines, the other publications and the internet have been used.Also, for other related information, various books and periodicals have been referredfrom library and some that the researcher self has.3.4 Data Analysis ToolsBefore analyzing the data, the data and information have been presentedsystematically in the formats of Tables, Graphs and Charts which will explain a lotabout the data and information collected.For the analysis of the research study, the following financial tools and statisticaltools are used.3.4.1 Financial ToolsRatio analysis is the best tool for financial analysis. Ratios can be taken asexpression of relationships between two items or group of items and therefore may
  43. 43. 34be calculated in any number and ways so far meaningful co-relationship isobtainable.Pandey (1995) emphasizes that a ratio is used as a benchmark for evaluating thefinancial 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 capitaladequacy of HBL and BOK.The capital adequacy ratio is based on total risk-weighted assets (TRWA) of thebank. Capital adequacy ratios are a measure of the amount of a banks capitalexpressed as a percentage of its risk weighted credit exposures. This ratio is used toexamine adequacy of total capital fund and core capital, which is yielded by thefollowing formulas:To measure the adequacy of total capital fund: Total Capital Fund TRWA × 100%To measure the adequacy of core capital: Core Capital TRWA × 100%(b) Capital to Deposit Ratio:The capital to deposit ratio is an important tool in measuring capital adequacy ratiosof 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 longestuse of any ratio devised to measure and determine capital adequacy.
  44. 44. 35The capital to deposit ratio is derived by the following formula: Total capital fund Total deposit collected × 100%(c) Credit / Deposit Ratio:The credit / deposit ratio (CD ratio) is a major tool to examine the liquidity of abank. CD ratio measures the ratio of fund that a bank has utilized in credit out of thedeposit total collected. More the CD ratio more the effectiveness of the bank toutilize the fund it collected.The CD ratio is derived by the following formula: Total Credit Total deposit collected × 100%3.4.2 Statistical ToolsThe following statistical tools are used to analyze the data:(a) Karl Pearson Correlation Analysis:The relation between two variables is correlated by Karl Pearson’s correlation co-efficient. The following is the formula proposed by Karl Pearson for calculation ofcorrelation coefficient. NΣXY - (ΣX)(ΣY) r= √[NΣX - (ΣX)2] √[NΣY2 - (ΣY)2] 2 Where, N = Numbers of pairs in observation X = Product of the first variable Y = Product of the second variable
  45. 45. 36To ease the calculation, a shortcut formula has been proposed which has been usedin to calculate correlation coefficients in this thesis report. The shortcut formula is asfollows: Σxy r= √Σx2. √Σy2 Where, x = (X-¯ ) X y = (Y-¯ ) Y(b) Test of Hypothesis:The calculated correlation coefficients have been used to test the hypothesis asproposed in Chapter 1 by using the following t-test formula: r×√n-2 t= √1-r2 Where, r = calculated correlation coefficient n = number of observationsThe hypotheses have been tested with at a 95% level of confidence.
  46. 46. C HAPTER 4 D ATA P RESENTATION AND A NALYSISThis chapter deals with the presentation, analysis and interpretation of relevant dataand information of BOK and HBL. Also, the analysis and interpretation of theinformation and data produced from questionnaire is also contained in this chapter.To obtain best result, the data and information have been analyzed according to theresearch methodology as mentioned in the Chapter 3.The main purpose of analyzing the data is to change it from an unprocessed form toan 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) RatioAnalysis, (3) Statistical Analysis, (4) Impact of Capital Adequacy Norms, (5) Studyof Perception of Depositors, and (6) Findings.4.1 Presentation of DataThe 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 hasbeen presented in most understandable format.4.1.1 Capital FundCapital fund of a bank consists of two types of components: Tier-1 capital and Tier-2 capital. Tier-1 capital is known as core capital and Tier-2 capital is known assupplementary capital. Hence, the total capital fund of a bank derived by adding
  47. 47. 38these two components of capital. The capital funds of BOK and HBL has beenillustrated hereinafter separately.4.1.1.1 Capital Fund of BOKBOK issued 30% bonus shares from the profit of FY 1999/2000 amount at Rs. 54million. 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 corecapital at Rs. 511.50 million.The capital funds of BOK have been tabulated in Table 4.1 which shows the capitalfund of the bank over the period of last five fiscal years, i.e., from FY 1997/1998 toFY 2001/2002.Table 4.1Capital Fund of BOK (amount in million) At the end of Supplementary Total Capital Core Capital Fiscal Year Capital Fund 1997/98 92.07 77.87 169.94 1998/99 95.92 75.55 171.47 1999/00 249.36 102.33 351.69 2000/01 318.70 167.36 486.06 2001/02 511.50 220.40 731.90Source: Annual Reports of BOKIn the five years period, BOK has been gradually increasing its capital base. BOKhas been increasing both components of capital simultaneously. However, the corecapital has been significantly increased over the five years period. The capital fundof 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
  48. 48. 39capital fund have been increased to Rs. 511.50 million of core capital and Rs. 220.40million of supplementary capital totaling Rs. 731.90 million at the end of FY2001/02.The same can be viewed in a chart format in Figure 4.1.Figure 4.1Trend of Capital Fund of BOK Capital Fund of BOK 800 700 Amount (Rs. in million) 600 500 Core Capital 400 Supplementary Capital 300 Total Capital Fund 200 100 0 1997/98 1998/99 1999/00 2000/01 2001/02 Fiscal YearThe Figure 4.1 shows the growing trend of capital fund of BOK during the fivefiscal 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 barof supplementary capital is increasing gradually.The increment of capital fund shows that BOK has been trying to increase its capitalbase to comply with the requirements of NRB as prescribed in capital adequacynorms for commercial banks.
  49. 49. 404.1.1.2 Capital Fund of HBLHBL also has been increasing its capital fund. The bank issued bonus shares in theFY 1998/99 by 60%, in the FY 1999/2000 by 25%, in the FY 2000/01 by 25% andin the FY 2001/02 by 30%. The bank has a plan to issue bonus shares by 10% everyyear till the paid up-capital meets the mandatory of Rs. 1 billion slab. The bankissued “HBL Bond 2066” – an unsecured subordinated term debt – in the fiscal year2001/02 amounting at Rs. 360 million to increase its supplementary capital. Theissuance of the bond was the first ever bond issued by a bank in Nepal which isbeing traded in security market.The capital funds of HBL over the period of last five fiscal years, i.e., from FY1997/1998 to FY 2001/2002 have been illustrated in Table 4.2.Table 4.2Capital Fund of HBL (amount in million) At the end of Supplementary Total Capital Core Capital Fiscal Year Capital Fund 1997/98 298.87 192.54 491.41 1998/99 388.79 258.31 647.10 1999/00 448.08 362.45 810.53 2000/01 698.70 499.61 1,198.27 2001/02 834.55 638.42 1,472.97Source: Annual Reports of HBLIn the five years period, HBL has significantly increased its capital base. HBL hasbeen increasing both form of capital simultaneously. At the end of fiscal year1997/98, HBL had core capital of Rs. 298.87 million and supplementary capital ofRs. 192.54 million totaling Rs. 491.41 million, which have been increased to Rs.
  50. 50. 41831.55 million of core capital and Rs. 638.42 million of supplementary capitaltotaling 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 achart format.Figure 4.2Trend of Capital Fund of HBL Capital Fund of HBL 1600 1400 Amount (Rs. in million) 1200 1000 Core Capital 800 Supplementary Capital Total Capital Fund 600 400 200 0 1997/98 1998/99 1999/00 2000/01 2001/02 Fiscal YearThe Figure 4.2 shows that HBL is increasing both forms of capital gradually. It canbe observed that both the bars are rising at a same pace. It can be said that HBL issuccessfully maintaining the ratio of core and supplementary capital at the samelevel.The main rationale behind the increment of the capital fund has been to comply withthe requirement of NRB capital adequacy norms for commercial.
  51. 51. 424.1.2 Risk-Weighted Assets of BOK and HBLThe risk-weighted assets are derived by calculating the amount from the respectiveon- and off-balance sheet items with the prescribed weightage. The assets arecategorized into four types while assigning weightage to them. NRB has assignedweightage of 0%, 20%, 50% and 100% according to their nature of risk bearingwhich is based on the standard of Basel Committee.The risk-weighted assets of BOK and HBL have been illustrated in Table 4.3. Thetable shows the risk-weighted assets of the two banks over the period of last twofiscal years, i.e., FY 2000/2001 and FY 2001/2002.Table 4.3Risk Weighted Assets of BOK & HBL (Amount in Rs. million) At the end of Fiscal Year BOK HBL 1997/98 1551.96 5603.31 1998/99 2586.27 7685.27 1999/00 3938.30 10093.77 2000/01 5651.95 14956.93 2001/02 5074.23 12746.17Source: Annual Reports of BOK & HBL4.1.3 Deposit Trend of BOK and HBLBeing the main function of a commercial bank, every commercial bank collectsdeposit from general public. Verma & Malhotra (1993) has mentioned that acommercial bank has usually access to three sources of fund: capital fund, depositsand borrowings.
  52. 52. 43It is clear that BOK and HBL could not remain in the business without collectingdeposits. Both banks have different policy to lure deposits from general public. Inthis matter, HBL has a scheme of Premium Saving Account (PSA), which is provedto be the most important product of HBL. PSA has helped to attract most depositsfrom 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 beviewed in figures in the Table 4.4 which also includes the national total and theshare of BOK and HBL on it.Table 4.4Deposit Collection Trend of BOK, HBL and National Total (Rs. in million) At the end of National Share of Share of BOK HBL Fiscal Year Total BOK HBL 1997/98 1,773.87 7,713.60 102,598.2 1.73 % 7.52 % 1998/99 2,564.83 9,772.74 127,201.7 2.02 % 7.68 % 1999/00 4,196.41 14,043.10 154,943.0 2.71 % 9.06 % 2000/01 5,713.49 17,636.85 181,767.0 3.14 % 9.70 % 2001/02 5,723.30 18,619.38 185,053.2 3.09 % 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 depositcollection. BOK has, however, a small share in the total national deposits than thatof HBL. HBL has more than 10% share in national deposit collections at the end offiscal year 2001/02. In the year 2001/02 BOK has collected deposits amounting atRs. 5723.30 million whereas HBL has collected deposits amounting at Rs. 18619.38million. The total deposit collections by all the banks at the end of fiscal year1997/98 amounted at Rs. 102,598.2 million which increased to Rs. 185,053.2million at the end of fiscal year 2001/02. The table 4.4 shows that HBL is far much
  53. 53. 44ahead in deposit collection. In fact, HBL is in the second position between privatesector banks in collecting deposit.The deposit collection by BOK, HBL and other remaining banks by the end of FY2001/02 are illustrated in the Figure 4.3 in a pie-chart format.Figure 4.3Share 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 depositcollection. 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 depositcollections. It is a fact that HBL is the no. 1 joint-venture bank in the country incollecting the deposits from public.

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