Banking Stress and it reduce Mechanism

Dibakar Bashistha, PhD 

What is Banking Stress?

 Banking stress refers to a situation where a bank or the banking system as a whole faces financial difficulties, instability or risk of failure.

This can be caused by insufficient capital or liquidity, high levels of non-performing loans, economic downturn or recession, interest rate changes or volatility, regulatory changes or no compliances, operational risks such as cyber-attacks or IT failures, reduced lending capacity, increased borrowing costs, decreased investor confidence, reduced market value of bank shares, increased risk of bank failure or consolidation. Banking stress in Nepal is a significant concern and the Nepal Rastra Bank (NRB) has taken steps to address it.

In 2012, the NRB issued Stress Testing Guidelines to help banks assess their risk exposure and resilience to potential shocks. These guidelines aim to promote financial stability and ensure that banks have sufficient capital and liquidity to withstand economic downturns.

The NRB also conducts regular stress tests to assess the banking sector’s vulnerability to various risks, including credit, market and liquidity risks.

These tests help identify potential weaknesses and inform policy decisions to mitigate risks and promote financial stability. In addition to these measures, the NRB has also implemented guidelines for Internal Capital Adequacy Assessment Process (ICAAP), which requires banks to maintain sufficient capital to cover potential losses. Some of the key stressors in the Nepalese banking sector include Credit risk, Market risk, Liquidity risks, Operational risk etc.

So overall NRB’s efforts to promote financial stability and resilience in the banking sector are crucial to mitigating the risk associated with banking stress in Nepal.

Lacking of Bankers to reduce stress

Nepalese bankers may lack several key skills, knowledge and attitudes to effectively reduce banking stress. Here are some of the potential lacking areas:

• Nepalese bankers may lack advanced risk management skills, including identification, assessment and mitigation.
• Bankers may lack strong financial analysis skills including financial modeling, forecasting and stress testing.
• Bankers may lack up to date knowledge of regularity requirements, compliance and risk management frame works.
• Bankers may lack effective communication skills including presentation, negotiation and conflict resolution.
• Senior bankers may lack strong leadership and management skills including strategic planning, team management and change management.
• Bankers may lack a collaborative mindset, including team work, stakeholder engagement and partnership development.
• Nepalese Banks may have a risk averse culture, which can hinder innovation, entrepreneurship and growth.
• Bankers may lack a customer centric approach including understanding customer needs, preferences and pain points.
• Bankers may not conduct regular stress testing and scenario planning to anticipate and prepare for potential risks and challenges.
• Nepalese banks may use outdated technology and systems which can hinder efficiency, productivity and risk management.
• Bankers may lack access to accurate, timely and relevant data which can impede informed decision making and risk management.
• Banks may lack robust cybersecurity measures, including firewalls, encryption and incident response plans which can expose them to cyber threats and data breaches.
• Nepal’s regulatory framework may inadequate which can hinder effective supervision and risk management.
• The NRB may lack sufficient supervisory capacity including skilled personnel, technology and resources to effectively oversee the banking sector.
• Regulatory bodies may lack effective enforcement mechanisms and accountability frameworks to ensure compliances with regulatory requirements.

 Responsibilities of Bank Management and Employees

Bank management and employees play a crucial role in reducing in reducing banking stress. Here are some of their key responsibilities:

Bank Management Responsibilities

• Implement effective risk management practices to identify, assess and mitigate potential risks.
• Develop and implement strategic plans to ensure the bank’s long-term sustainability and resilience.
• Ensure that the bank maintains adequate capital to absorb potential losses and meet regulatory requirements.
• Implement effective liquidity management practices to ensure that the bank has sufficient liquid assets to meet its short-term obligations.
• Ensure that the bank complies with all relevant law as, regulation and guidelines.

Bank Employees Responsibilities

• Adhere to the bank’s policies and procedures to ensure that all activities are conducted in a responsible and compliant manner.
• Identify and reporting potential risks to management and participate in risks mitigation efforts.
• Maintain customer confidence by providing excellent customer service, and ensuring that customers information is kept confidential.
• Stay up to date with regulatory requirements and industry developments to ensure that the bank remains compliant and competitive.
• Participate in training and development programs to enhance skills and knowledge and to stay current with industry developments.

Collective Responsibilities

• Foster a culture of risk awareness throughout the bank and encourage employees to identify and report potential risks.
• Promote transparency and accountability throughout the bank and ensure that all activities are conducted in a responsible and compliant manner.
• Encourage collaboration and communication among employees and between employees and management to ensure that all stakeholders are aware of potential risks and opportunities.
• Support continuous improvement efforts throughout the bank and encourage employees to identify areas for improvement and suggest solutions.
• Maintain a customer centric approach throughout the bank and ensure that all activities are conducted with the customer’s best interests in mind.

Stress Reduce Mechanisms and Remedial measures

Banking stress in Nepal can be reduced through several mechanisms. Here are some possible strategies.

Regulatory Mechanisms:

1. Capital Adequacy Ratio (CAR)
2. Liquidity requirements
3. Stress Testing

Risk Management Mechanisms

1. Credit Risk Management
2. Asset-Liability Management (ALM)
3. Market Risk Management

Institutional Mechanisms

1. Banking Supervision
2. Deposit Insurance
3. Bank Resolution Frame work

Market base Mechanisms

1. Market Discipline
2. Credit Rating Agencies
3. Financial Markets Development

These mechanisms can help reduce banking stress in Nepal by promoting financial stability, improving risk management practices and enhancing regulatory oversight.

How to reduce current banking stress?

1. Short term measures

• Banks should maintain sufficient liquidity to meet their short-term obligations.
• Banks should implement effective risk management practices to mitigate risks
• Banks should increase provisioning for potential losses to reduce the risk of insolvency.
• Banks should focus on improving asset quality by reducing non-performing loans and increasing credit to productive sectors.

2. Medium term measures

• NRB should strengthen regulatory frameworks to ensure effective supervision and risk management.
• The NRB should enhance banking supervision to ensure compliance with regulatory requirements.
• Banks should promote financial inclusion and literacy by increasing access to financial services for underserved population.
• Banks should invest in technology to improve operational efficiency, reduce costs and enhance customer service.

3. Long term measures

• The government and regulatory bodies should develop a robust financial infrastructure including a well-functioning payment system an reliable credit information system.
• Bank should foster a culture of risk management including regular risk assessments, scenario planning and stress testing.
• The government regulatory bodies should promote banking sector consolidation to reduce fragmentation and increase efficiency.
• The government and regulatory bodies should develop a comprehensive financial stability framework to ensure the stability of the financial system.

By implementing these measures, Nepal’s Banking sector can reduce current banking stress and promote financial stability.

Dr. Dibakar Bashistha, Expert Bank and Financial Institutions