In recent times, you might have heard the news of Nepali commercial banks' profits decreasing due to an unhealthy increase in non-performing loans in the latest fiscal quarters. Unless you're familiar with banking, not many know that banking and financial institutions classify and label loans as good and bad.
They undergo loan classification as it helps them make proper lending decisions, assess risks, and manage loan portfolios. In this guide, we’ll break down Nepal’s current loan classification system in a simple, easy-to-understand way.
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Loan classification is a risk assessment tool that banks and financial institutions use to classify loans into different categories based on their repayment status. The main goal of loan classification is to assess risks, identify potential defaults, and ensure financial stability.
It helps banks set aside enough reserves, also known as loan loss provisions, in compliance with Nepal Rastra Bank (NRB) regulations to cover potential losses from defaults. In addition, a proper loan classification allows banks to make an informed decision about their lending practices, pricing, and capital management.
As per the latest Nepal Rastra Bank regulations, loans are classified into two major categories, each with its own subcategories.
A performing loan is a loan where the borrower is making on-time repayments as agreed in the loan contract. In simpler terms, it means there are no overdue payments, so banks consider this type of loan as healthy, low-risk loans.
NRB has classified performing loans into two further subcategories:
A pass loan is a performing loan that is either not overdue or overdue by less than 30 days. It is considered a very low-risk loan, indicating the borrower's strong repayment history. For Pass Loans, Nepal Rastra Bank (NRB) has set a minimal loan loss provision of 1.1%.
Apart from the overdue duration, here are the other conditions for pass loans.
Banks consider loans against fixed deposits, government and NRB securities, and gold/silver as secured loans due to their higher security, which ensures complete recovery.
A watchlist loan is also a performing loan that has been overdue for up to three months. Banks and financial institutions consider this type of loan as a potential risk, but it is not yet classified as problematic.
Here are the conditions for watchlist loans.
A non-performing loan is a loan that is in default as the borrower has failed to make any payments of principal or interest for a specified period (more than three months).
After the loan is nonperforming, the likelihood of the debtor repaying in full becomes very low, so banks consider this type of loan a very high-risk one. The non-performing loans are further classified into three subcategories.
Sub-standard loans are those loans with repayment overdue for over three to six months.
Doubtful loans are those loans with repayment overdue for over six months to one year.
Loss loans are those loans with repayment overdue for over one year and are unlikely to be recovered. Besides the repayment overdue duration, loans that fall under the following conditions are categorized as loss loans.
According to the latest Unified Directives, 2081, issued by Nepal Rastra Bank on Poush 29, 2081, banking and financial institutions are required to set aside the following provisions for loan loss recovery.
| Loan Classification | Minimum Loan Loss Provision | |
| Performing Loan | Pass | 1.10% |
| WatchList | 5% | |
| Non-Performing Loan | Sub-standard | 25% |
| Doubtful | 50% | |
| Loss | 100% | |
For loans that have undergone restructuring or rescheduling, the following loan loss provisions must be made:
| Loan Classification | Minimum Loan Loss Provision | |
| Performing Loan | Pass | 12.5% |
| Non-Performing Loan | Sub-standard | 25% |
| Doubtful | 50% | |
| Loss | 100% | |
For detailed rules and regulations, you can refer to the Unified Directives, 2081, available at Nepal Rastra Bank.
Loan classification is an important part of Nepal’s banking system that helps banks manage risks while ensuring responsible borrowing. Understanding these classifications can help you navigate loans more effectively and avoid financial setbacks.
If you are planning to take a loan or manage existing debt, always ensure timely repayments so that your loan remains classified as a performing loan. This helps you maintain a clean loan history, boosting your credibility and making banks and financial institutions more willing to lend to you in the future. After all, a performing loan benefits you, your bank, and Nepal’s economy!
