NEPAL. Management Performance Indicators for. Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) (Fifth Semi-Annual Report)

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Cleared by Kenichi Ohashi, Country Director for Nepal, SAR XXX, 2006 NEPAL Management Performance Indicators for Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB) (Fifth Semi-Annual Report) 9940 Finance and Private Sector Development Unit South Asia Region November, 2006

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3 Introduction This is the fifth report on management performance indicators being submitted under the Nepal Financial Sector Restructuring Project (FSRP) as agreed with the Board of Directors of the World Bank on March 9, The report has been prepared on a semi-annual basis (twice a year) and attempts to monitor and measure the performance of the two Management Teams which have been placed at Nepal Bank Ltd (NBL) and Rastriya Banijya Bank (RBB). The primary mandate of these Management Teams is to carry out a cost and operational restructuring of these banks in order to prepare them for privatization. The indicators are computed using provisional (un-audited) data for the financial year ending mid-july Choice of Performance Indicators The performance indicators were selected on the basis of extensive discussion among the Bank, the Government of Nepal, and the Management Teams of NBL and RBB. Performance monitoring is based on pre-determined monitorable financial and operational parameters that are designed to closely address the banks efforts and progress in resolving some of the major weaknesses including excess manpower, high level of non-performing loans, low productivity, poor governance, and weak management capabilities. The indicators cover the following eight key areas. 1. Debt recovery 2. Business and revenue growth indicators, Operating efficiency 4. Profitability 5. Staff Efficiency 6. Capital Fund 7. Computerization of Branches 8. Disclosure Requirement The performance targets agreed among the stakeholders and their corresponding actual numbers for NBL and RIB are given in Table 1 and 2 respectively. Summary of Key Results: A. Nepal Bank Limited (NBL) During FY 2005/06 around Rs. 4 billion worth of Non-Performing Assets have been written-off, an achievement of Rs.500 million over the projected Rs..5 billion of uncollectible loans. This has reduced the NPA level (Rs..2 billion) to 25 percent of total loans against a target of percent. At the time of finalization of accounts it is planned that a further Rs. 1.6 billion would be written-off, bringing the NPA level down to 12 percent. All bad debts are fully provisioned for. Of the total NPA, 5 percent (Le. Rs. 172 million in principal, and billion in total including interest) relates to government exposures (impaired) out of which one third is under government guarantee. Cash recovery from NPA portfolio is ahead of schedule with Rs. 1,79 million realized against a target of Rs. 1,5-1-

4 million. On a cumulative basis, NBL has recovered almost Rs.7.5 billion since the management took over the day-to-day running of the bank in July Legal impediments and weak judicial system continues to be the major obstacle to debt recovery, though some progress has been made to increase the awareness of the judiciary to the harm being done to the country because of the stay orders issued by the high courts. Despite the country s poor economic growth (2 percent) during FY 2005/06, largely due to insurgency and political instability, NBL s business and revenue indicators are considered relatively favorable. Whilst the good loans portfolio grew by 14 percent over previous year, it fell short of target by 5 percent. Net Interest Income (Rs 1,267 million) exceeded target by 21 percent partly due to T-bill investment income where the interest rates were on an upward trend during the period under review. Although Non-Funded income (Rs. 419 million) has increased by 25 per cent over last year, it fell short of target by 17 percent. An ambitious target was set in anticipation of the return to economic recovery and political stability which, unfortunately, was not realized. Moreover, government business from a major border point (Birgunj) was taken away from NBL and given to a private bank by the central bank which resulted in revenue loss of Rs. 50 million. NBL has not been able to maximize its potential in remittance transactions due to the lack of a strong presence in major remitting countries. The bank continues to have a hold strategy on high interest-bearing deposits which resulted in a favorable deposit mix with non-interest bearing portion (17 percent) exceeding the target (14.6 percent). NBL s market share of deposits was reduced from 22 percent in FY200-4 to 12 percent as of FY 2005/06, another positive indication of progressive withdrawal from ownership of financial assets by a public-owned entity. Lending interest rates in general have declined (around 6 to 7 percent for prime corporate and 7.5 percent for individual consumer) while deposit rates have remained stable (term deposits.75 percent and savings deposits 2.5 percent) during the period under review. A better management of liabilities, especially interest-bearing deposits, have contributed to reduction in operating costs. Cost controls coupled with satisfactory revenue streams have resulted in NBL s ability to achieve favorable operating efficiency indicators. The Cost to Income ratio (55.7 percent) is better than targeted but there is further room to rationalize staff costs in order to be at par with private sector banks. Although the bank has registered an operating proft for the fourth year in a row, profitability target (Its. 2. billion) was not achieved (Itsi billion). This was due to (a) inability to write back loan loss provisions as projected for non-banking assets assumed from defaulting borrowers, (as a result of change in market regulation) and (b) restructuring efforts to regularize delinquent loans have not been successful. With lower than projected profitability, the Return on Assets (2.0 percent) is significantly below the ambitious target (4.5 percent) but is in line with the industry average (2.0 percent). A higher ROA could have been achieved if NBL did not provide an additional provision of Rs.86 million on account of retirement gratuities as per revised actuarial valuation. The best private bank achieved ROA of.6 percent. Staff strength has been reduced substantially and remains (2,960) better than target (,100). During the period under review, there was a turnover of 65 staff and hiring of

5 However, staff costs have increased dramatically primarily due to government-imposed 20 percent increment in salary, resulting in an adverse impact on staff efficiency indicators - Staff Expense to Income is 29 percent as against the target of 28.percent. The best private sector bank achieved a Staff Expense to Income ratio of 10 percent (industry average of 16 percent) over the same period. Income per Staff (Rs. 0.8 million) exceeded target (Rs million) due to achievement of higher income targets. Whilst there is a plan to reduce another 600 staff, this is unlikely to be realized under the current political situation. The Net Worth, although negative (at Rs. 6.7 billion), has improved to the extent of projits generated during the period under review after allocating bonus to stafl The target has not been achieved as cumulative targets of previous periods were not met. This year s balance sheet is cleaner after significant book write-offs of uncollectible loans. The current level of loan loss provisions fully covers NPAs. Reorganization of departments and physical space did cause delays in computerization process. As of date, 42 branches out of the targeted 44 branches are operating under live mode while two are in parallel mode but are expected to go into live mode by the end of December Computerization process benefits 75 percent of the deposit base (target 85 percent) and 85 percent of loans (target 84 percent). In order to further modernize the remaining branches, computerization of additional 6 branches on a stand alone basis is being negotiated with the vendor. Disclosure requirements: NBL published its provisional jinancials within less than 20 days, meeting the central bank s guideline (one month) but is short of its own tougher internal target of two weeks. Further improvement is expected after computerization is completed in all designated branches. Annual reports are expected to be cleared by statutory auditors by mid-november falling within target and expected to be far ahead of the central bank and other private sector banks. --

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7 B. Rastriya Banijya Bank (RBB) Recovery of cash (Xs billion) from impaired assets is close to projection (Rs billion), i.e. 97percent of target was met. Sluggish economic growth and political turmoil in the third quarter suppressed recovery efforts. NPA level, at 45 percent (target 9 percent), is expected to be reduced to 5 percent by the time the accounts are audited with a planned Rs. 4 billion write-off of uncollectible loans against full provisions. Although RBB s write-off policy has been approved by the central bank, it is yet to be cleared by the Auditor General. All bad debts have full loan loss provisions. Results for business and revenue growth indicators are mixed. The good loan portfolio (Rs. 15 billion) grew by 1 percent over last year and exceeded target by 2 percent. However, the portfolio includes exposure of Rs. 1 billion to Nepal Oil Corporation, a government undertaking, which has not been able to repay principal loan amount for more than a year due to cash crunch resulting from subsidized fuel-pricing. Major growth in assets came from consumer loans. Net Interest Income (Rs. 1,529 million) exceeded last year s performance and target by 15 percent and 6 percent respectively due principally to the growth in loan portfolio and low cost of funds. Non-Funded Income (Rs. 482 million) was less than half of the target (Rs. 975 million) because the sale of equity investments (in a private bank) could not materialize which would have added Rs. 446 million to its revenue streams. The potential buyers (promoters of the private bank) offered a price (Rs. 400 per share) which was far lower than the market price (Rs. 1,275 per share). The erosion of corporate base to competitors and less than projected government transactions have also impacted the income from fee/commission. RBB has not been able to manage a surge in deposit base which could impact NII in future. Interest-free deposits closed at almost 17.8 percent of the total deposits compared to a target of 17. percent, representing a substantially increase over last year s indicator (16. percent). Most of the operating efficiency indicators have been met. Net Spread (4.5 percent) and Net Interest Margin (4.1 percent) exceeded the target due to the growth in performing loans and low cost of funds. However, this is also indicative of high yields in an inefficient market. Net Operating Income to Total Assets (. percent) was less than target (.6 percent) due to shortfall in non-funded income and high level of average assets driven by deposit growth. The Cost to Income Ratio (5 percent) improved over last year (56 percent) and achieved target (56 percent) due to relatively higher income streams and better control over personnel costs. Despite better management of operating and personnel costs, profitability indicators are below target. A pre-tax profit of Rs. 1.7 billion is 67 percent of target (Rs.2.6 billion) owing to the (a) lower non-funded income (inability to divest equity investment as planned), (b) lower write-back of loan loss provisioning (slower debt restructuring effort), and (c) government s requirement on RBB to make provisioning for employee bonus which was earlier not required for a company with a negative net worth. Lower profitability and higher -5-

8 asset level (driven by rising deposits) has resulted in an ROA (2.9 percent) lower than target (4.9 percent) but is better than industry average (2.0 percent). Staff efficiency indicators: Roll-out of Voluntary Retirement Scheme - phase IV planned in April 2006 had to be postponed due to prolonged political turmoil. Staff strength (,01) is in excess of target (,154). Income per Staff (Rs million) indicator is favorable (target - Rs 0.84 million) due to lower profitability and higher headcount. The Staff Expenses to Income ratio (26 percent) was above target (27 percent) owing to lower operating income despite better cost controls and needs substantial improvement in order to reach industry average (16 percent). Staff expense continues to be the largest component (9 percent) of Total Operating Cost. Capital fund has improved. The negative networth has decreased from a negative Rs.20.2 billion last year to negative Rs billion during the period under review but fell short of target (negative Rs billion) owing to lower profitability. Computerization of branches is behind schedule. A combination of centralized (24 branches) and stand-alone (1 branches) IT platform covers 75 percent of the deposit base (target 85 percent) and 42 percent of loans (target 86 percent). Although RBB started off with centralizing its IT platform, their strategy has changed due to connectivity, software modification and staff readiness issues. The timeliness of disclosure requirement has not been met. RBB published its provisional annual result after one month from year end as against targeted 2 weeks. Completion of statutory audit has a target of 4 months (mid-november) from year end. However, this is highly unlikely to be achieved given that the Auditor General appointed the auditors only during the first week of September an action which should have been done a few months prior to year-end. -6-

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