Supervision and Financial Stability
Purpose and approach
Supervision protects depositors and the payment system, not institutions for their own sake. NRB combines off-site surveillance with on-site inspection and is moving toward risk-based supervision and full Basel III implementation.
Core tools
- CAMELS: capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk.
- Off-site monitoring: periodic returns on capital, NPLs, liquidity, large exposures and interest spreads.
- On-site inspection: verification of loan classification, provisioning, KYC files, treasury operations and governance.
- Stress testing: single-factor and scenario shocks to credit, liquidity, interest and exchange rates.
- Macroprudential tools: countercyclical buffers, loan-to-value and debt-service caps, sectoral exposure limits.
- Crisis management: lender-of-last-resort liquidity, resolution and liquidation powers, deposit insurance, and the published Financial Stability Report.
Worked example
A stress test shocks a bank with a loan book of NPR 50,000 million and capital of NPR 4,000 million. If 2 percent of loans turn non-performing and loss given default is 40 percent, the loss = 50,000 × 0.02 × 0.40 = NPR 400 million. Post-shock capital = 3,600; with RWA of 40,000 the CAR falls from 10.0 to 9.0 percent. Follow the chain shock → NPL → loss → capital → ratio, and show each step; method marks are awarded.
Traps
Confusing microprudential safety of one bank with macroprudential system-wide risk. Equating liquidity with solvency - a bank can be liquid yet insolvent. Forgetting whether a figure is pre-provision or post-provision.