Banking Khabar / As chief executive officers (CEOs) and senior executives of banks and financial institutions have increasingly come under legal scrutiny in banking offence cases, the banking sector has begun facing greater scrutiny over loan decisions and institutional accountability.
In recent cases involving lending transactions, investigations and court proceedings against senior bank officials have intensified discussions over the effectiveness of loan approval processes, risk assessment, collateral evaluation, post-disbursement monitoring and internal control systems.
Former Prabhu Bank CEO Ashok Sherchan and current CEO Suman Sharma have become involved in separate legal cases related to lending transactions. Sherchan has been remanded in custody for trial in a banking offence case, while Sharma has been released on bail. However, the courts have not yet issued final verdicts in these cases. Therefore, it would not be legally appropriate to declare either individual guilty at this stage.
The developments, however, have raised an important question in the banking sector: How far should responsibility extend when a loan goes bad?
Loan Approval Under Greater Scrutiny
Loan approval at a bank is generally not based on the decision of a single individual. A loan proposal typically moves through several layers after assessing the customer’s financial condition, nature of business, source of income, collateral, repayment capacity, past transactions and potential risks.
Depending on the size and nature of the loan, the approval process may involve the branch, concerned department, credit committee, risk management unit, senior management and, in some cases, the board of directors.
Therefore, when a loan deteriorates, the bank’s decision-making process becomes as important as the borrower’s circumstances. Questions may arise over whether adequate risk assessment was conducted, whether the collateral was properly valued, whether the borrower had sufficient repayment capacity and whether applicable regulatory requirements were followed.
Recent developments have consequently put additional pressure on senior bank management to consider legal and regulatory risks alongside business expansion and lending targets when making credit decisions.
A Bad Loan Does Not Automatically Mean Bank Officials Are Responsible
A bad loan, by itself, does not establish that a bank official made a mistake. Loans that were initially considered sound can deteriorate because of business difficulties, market fluctuations, declining customer income, natural disasters or other unforeseen circumstances.
However, the situation can become more serious if a loan was granted despite the borrower having a weak financial position, inadequate repayment capacity or without completing the necessary assessment of collateral and business activities.
Therefore, the key question is not simply whether a loan has become non-performing, but what the decision-making process looked like at the time the loan was approved. This is one of the major reasons scrutiny of lending decisions has increased in the banking sector.
Role of Internal Control Systems
Banks and financial institutions have various internal mechanisms designed to control credit risk. Risk management departments, internal audit units, compliance departments, credit committees and boards of directors are expected to monitor lending activities according to their respective responsibilities.
Supervisory reports issued by Nepal Rastra Bank have also pointed to weaknesses related to internal controls and audit systems at some banks and financial institutions.
If weaknesses identified through internal audits are not corrected on time, audit recommendations are not implemented promptly or previously identified problems continue to recur, the institution’s overall control framework can become weaker.
Therefore, when a problem arises in a loan decision, it may not be sufficient to examine only the official who made the final decision. It is equally important to assess how each level involved in the decision-making process performed its responsibilities.
Risk of Evergreening
Another major issue associated with credit quality in the banking sector is evergreening.
When a loan has already encountered problems, extending additional credit, restructuring the loan or using other measures to make the loan appear healthy instead of recognizing its actual condition can conceal the bank’s underlying risk.
Although such practices may appear to reduce non-performing loans in the short term, they can increase risks for banks over the long term.
The potential risk of evergreening in Nepal’s banking system has also drawn attention from regulators and international institutions. The International Monetary Fund has highlighted the need to control evergreening and strengthen monitoring of excessive lending to related parties in Nepal’s banking sector.
This has added pressure on banks to focus not merely on expanding credit but also on maintaining credit quality.
How Far Does a CEO’s Responsibility Extend?
As the highest level of day-to-day management, a bank’s CEO has an important role in credit and risk management. However, it would not be appropriate to assume that the CEO bears personal responsibility for every individual loan decision made by the bank.
When legal questions arise regarding a lending transaction, several factors become important: who was involved in the decision, at what level the loan was approved, whether the required documents and risk assessments were completed, and whether regulatory requirements were followed.
Senior management therefore needs to ensure not only that its own decisions are appropriate but also that the institution’s overall decision-making system is functioning effectively.
Documentation of Decisions Becomes Increasingly Important
Documentation is becoming equally important in the loan approval process.
Banks need to maintain clear records showing why a loan was approved, what factors supported the decision, how the customer’s cash flow and repayment capacity were assessed, how the collateral was valued and on what basis the relevant committee approved the facility.
If a loan later becomes problematic, such documentation provides a basis for determining whether the decision-making process complied with applicable rules and standards.
As a result, the banking sector is increasingly focusing not only on the speed of loan approval but also on the quality of the decision and the evidence supporting it.
Accountability from the Board to Employees
Credit risk management is not the sole responsibility of the CEO.
The board of directors, senior management, credit committees, risk management units, internal audit and compliance departments all have distinct responsibilities.
The board is responsible for overseeing the institution’s overall risk policies and management. Management is responsible for implementing those policies. Credit committees are responsible for assessing the risks associated with loan proposals. Risk management units must identify and control potential risks, while internal audit must identify systemic weaknesses. Compliance departments must ensure adherence to regulatory requirements.
A weakness at any one of these levels can ultimately affect the bank’s credit quality and financial health.
Pressure to Strengthen Risk Management Alongside Business Expansion
Credit expansion is a major component of banking business. As lending increases, interest income generally rises, contributing to bank profitability.
However, simply increasing the volume of lending is not enough. If credit quality deteriorates, banks may face rising non-performing loans, higher provisioning requirements and pressure on profitability.
Recent developments have therefore sent a clear message to bank management: success is not simply about increasing loans; it is about increasing quality loans.
Banks need to assess risks alongside business prospects when approving loans and continue monitoring borrowers after disbursement.
The Next Challenge: Systemic Reform, Not Just Punishment
If an individual is found guilty of a banking offence, legal action must be taken in accordance with the law. But the long-term solution for the banking system is not merely to identify and punish individuals after an incident occurs. It is to strengthen institutional systems so that such situations are prevented in the first place.
Conducting a genuine assessment of a customer’s financial condition and cash flow before approving a loan, properly valuing collateral, identifying related parties, regularly monitoring loans after disbursement and promptly identifying distressed loans can help reduce risks.
Similarly, timely implementation of internal audit recommendations, stronger compliance systems and effective board oversight of management can help reduce institutional risks in the banking sector.
Ultimately, the legal proceedings involving CEOs and senior officials should not be viewed merely as individual cases. They highlight the need to strengthen credit discipline, risk management, internal controls and institutional accountability across the banking sector.
Until a final court verdict is issued, no individual can legally be declared guilty. However, recent developments have delivered an important message to the banking sector: the greater the authority exercised at the top level of a credit decision, the greater the importance of accountability for that decision.
