Loan Ko Khel – How Banks Lend, Take Security, Price Loans and Handle Bad Loans

Banking Taiyari Nepal: From Zero to Expert

Banking Taiyari Nepal, Part 3 of 5

A plain-language guide for Nepal banking job preparation. Every term comes with its meaning and the reason banks use it. Figures and limits change often, so confirm current numbers on the NRB website.

Sita Wants a Second Outlet

Sita's momo shop is now famous in her neighbourhood. People queue at lunchtime. She dreams of a second outlet near the college, a bigger steamer and a delivery bike. She needs about Rs 12,00,000. Her own savings cover only a third of it.

She walks into the bank and says, "I want a loan."

The credit officer smiles and asks six questions in a row: How much? For what? How will you repay? What is your income? What can you offer as security? What if the business fails?

Sita feels like she is in an exam. She is. And so will you be, because lending is the heart of banking and also its biggest danger. A bank earns most of its profit from loans, and loses most of its money from bad loans. A banker who understands lending understands the bank.

The Golden Rule of Lending

Before any formula, remember one sentence:

"A good loan is repaid from cash flow, not from collateral."

What does this mean? When Sita repays her loan, she will do it from her daily momo sales, not by selling her house. Collateral (security) is only the second way out. If the bank must sell the collateral, something has already gone wrong. So the first question is always: Will this business or this person earn enough to repay? The second question is: If not, what can the bank fall back on?

Beginners often reverse this. They love land and ignore income. Experienced bankers do the opposite.

The Journey of a Loan: Eight Stations

Every loan travels through the same stations, whether it is a Rs 2 lakh personal loan or a Rs 200 crore project loan.

1. Application. The customer submits a request with purpose, amount and documents.

2. KYC and screening. The bank checks identity and also checks the CIB report (credit history, explained below). It also checks whether the borrower is blacklisted.

3. Credit analysis / appraisal. The officer studies the borrower's income, business, cash flows, existing debts and character. For bigger loans, the officer prepares a Credit Appraisal Memorandum (CAM), a written file that explains why the bank should lend.

4. Security valuation. If collateral is offered, an approved valuator estimates its value. Banks look at both fair market value and a lower distress value (what the asset might fetch in a forced sale).

5. Approval. Depending on the amount, a branch manager, a credit committee or the board approves it. This is another example of authority limits.

6. Documentation. Loan agreement, mortgage deed, promissory notes, guarantees and insurance papers are signed and registered where required.

7. Disbursement. Money is released, sometimes in parts (for example, for a house under construction), after checking progress.

8. Monitoring and recovery. The bank follows how the money is used and collects instalments. If trouble appears, it acts early.

Why so many stations? Because a mistake at any station can create a bad loan. Think of these stations as filters; each one catches a different kind of problem.

The 5 Cs of Credit: How Bankers Judge a Borrower

This is a favourite exam and interview topic. Memorise it in your own words.

Character: Is the borrower honest and willing to repay? Past repayment history and reputation matter. Example: Sita always paid her suppliers on time and never bounced a cheque.
Capacity: Can the borrower repay from income? This is cash flow analysis.
Capital: How much of their own money is the borrower putting in? A person who invests their own money has "skin in the game" and is more careful.
Collateral: What security is offered?
Conditions: What are the business and economic conditions? A momo shop near a college is fine; the same loan during a long college closure is riskier.

Some banks add more Cs (for example Coverage, meaning insurance) but these five are the classic base.

Taiyari Tip: In an interview, never say "I will give a loan if the collateral is good." Say, "I will first check character and capacity, and then use collateral as a second line of defence."

Types of Loans You Must Know

Banks name products in many ways. Group them like this to avoid confusion.

By purpose and period

Term loan: Fixed amount, fixed period, repaid in instalments (EMIs). Example: a loan for a machine or a vehicle.
Working capital loan: Money for daily business needs such as buying raw materials or paying wages.
Overdraft (OD): Allows the customer to withdraw more than the balance up to a limit, with interest only on the amount used. Why bankers like it: it is flexible for businesses with irregular cash flow. Why bankers fear it: it can stay unpaid for long.
Demand loan: Repayable on demand or within a short period, often against fixed deposits or shares.
Trust receipt loan: Short-term funding for imported goods, repaid when the goods are sold.
Bills purchase / discounting: The bank pays the exporter or seller early against a bill and collects later.

By customer

Home loan (housing loan): For buying or building a house. Long tenure, collateral is the property.
Hire purchase / vehicle loan: The vehicle itself is the security.
Education loan: For studies in Nepal or abroad.
Personal loan: For personal needs, often with higher interest because the risk is higher.
Margin lending: Loans against shares for investing in the stock market, regulated tightly by NRB because share prices can fall suddenly.
SME loans: For small and medium enterprises like Sita's shop.
Corporate loans: For large companies, often with syndication (several banks sharing one big loan).

By national priority

Priority sector / deprived sector lending: NRB requires banks to give a share of loans to sectors such as agriculture, energy, tourism, small business and underprivileged groups. Why? Because without a push, banks may lend only to big cities and safe sectors, leaving farmers and small entrepreneurs without funds. Exact percentages change in monetary policy, so check the latest.
Productive sector lending: NRB also encourages lending to production (industry, agriculture, services) rather than only to trading or real estate.

Collateral: Pledge, Mortgage, Hypothecation, Lien

These four words confuse everyone. Learn the difference with simple examples.

Mortgage: The borrower keeps using an immovable property (like land or a building), but the bank gets a legal charge on it. In Nepal, this is done through the land's lalpurja (ownership certificate) and registration of the mortgage at the land revenue office. Why use it? Immovable property is hard to hide or move.
Pledge: The borrower hands over the possession of a movable item (like gold or goods) to the bank. The bank holds it until the loan is repaid.
Hypothecation: The borrower keeps the movable goods (like stock or machinery), but the bank has a charge on them. Sita's stock of flour, chicken and steamers can be hypothecated.
Lien: The bank's right to retain money or assets already with the bank (like a fixed deposit) until the loan is cleared.

Other security forms

Personal guarantee: Someone promises to repay if the borrower fails.
Corporate guarantee: A company stands behind a borrower.
Assignment of receivables: The borrower assigns money they will receive from customers to the bank.

Loan-to-Value (LTV). The bank rarely lends the full value of the collateral. If a property is valued at Rs 1 crore and the LTV is 60%, the maximum loan is Rs 60 lakh. Why? Property prices can fall, and selling takes time and money. The gap is a safety cushion. NRB sets LTV limits for some loan types (like real estate and housing), so check current rules.

Haircut. When a bank counts only part of the collateral value, that deduction is called a haircut. It is just another word for the cushion.

How Interest Rates on Loans Are Built

Why does Sita pay 12% while someone else pays 9% or 15%? The rate is built like a cake with layers.

Lending rate = Base rate + Premium (risk spread)

Base rate: The bank's minimum rate, roughly reflecting its cost of funds (what it pays depositors and other lenders), the cost of keeping reserves, and its operating cost. NRB asks banks to publish their base rate.
Premium: Extra percentage added for the borrower's risk, loan type and tenure. A safe customer pays a smaller premium; a risky one pays more.

Interest spread. NRB has also limited the spread (lending rate minus deposit rate) that banks can keep, so that banks do not overcharge borrowers. The cap number is revised from time to time.

Fixed vs floating rates.

Fixed rate: Stays the same for an agreed period.
Floating rate: Changes when the bank's base rate changes. Most Nepali loans are floating, because deposit rates move with the market.

Effective rate. The real cost to the borrower after adding fees and charges. Banks must be transparent about it.

EMI (Equated Monthly Instalment). Sita's loan of Rs 10,00,000 at 12% per year for 5 years has a monthly payment calculated as:

EMI = P × r × (1 + r)^n ÷ [(1 + r)^n − 1]

Where P = loan amount, r = monthly rate (12% ÷ 12 = 1% = 0.01), n = number of months (60).

(1.01)^60 ≈ 1.8167, so EMI ≈ 1,000,000 × 0.01 × 1.8167 ÷ 0.8167 ≈ Rs 22,244 per month.

The total she repays is about 60 × 22,244 ≈ Rs 13,34,640. So the interest cost is about Rs 3,34,640. In early instalments, most of the EMI is interest; later, most is principal. This is called the amortisation pattern. Bankers are expected to explain this in simple words.

The Dark Side: Non-Performing Loans (NPL / NPA)

Now the serious part. When a customer stops paying, the loan becomes overdue. If it stays overdue for long, it becomes a non-performing loan (NPL), sometimes called non-performing asset (NPA). Why "non-performing"? Because an asset that should earn interest is earning nothing.

NRB classifies loans by how long they are overdue and how risky they are. A simplified picture (always verify against the current NRB directive):

Class	Meaning (approx.)	Typical provision
Pass	Regular or lightly overdue	1%
Watchlist	Early stress, repayment slipping	5%
Substandard	Overdue around 3–6 months	25%
Doubtful	Overdue around 6–12 months	50%
Loss	Overdue beyond a year or very unlikely to recover	100%

Provisioning means setting aside part of the bank's profit as a reserve against expected loss. The worse the loan, the bigger the provision. Why? Because it is honest accounting: if a loan will probably not return, the bank must show that cost now, not hide it.

The first two groups, Pass and Watchlist, are performing and the last three are non-performing. Remember: Substandard, Doubtful, Loss are the NPL group.

NPL ratio = NPLs ÷ Total loans. A lower number is better. Regulators watch this figure carefully.

Why do loans go bad? Common reasons are weak appraisal, fake documents, overvalued collateral, business failure, economic slowdown, diversion of funds (borrower uses the money for something else), fraud, and poor follow-up by the bank.

Early warning signs bankers watch: irregular instalments, frequent overdraft usage at the limit, delayed financial statements, falling sales, change of management, cheque bounces and rumours about the business.

What Happens When Repayment Stops

Banks follow a ladder:

Reminders and follow-up: calls, visits, notices.
Restructuring / rescheduling: If the borrower's problem is genuine and temporary, the bank may adjust the schedule or terms, under NRB's rules. This is not a free gift; it is a business decision to avoid a bigger loss.
Legal notice and enforcement: The bank can start the process to sell the collateral (an auction process with notices) following the law.
Debt Recovery Tribunal: A special forum for disputes about recovery of dues by banks and financial institutions.
Write-off: When recovery looks nearly impossible, the loan is removed from the balance sheet (while recovery efforts may continue). It is an accounting action, not forgiveness.
Blacklisting: A defaulter can be reported to the Credit Information Bureau (CIB), which affects future borrowing from every bank.

Credit Information Bureau (CIB). Think of it as a character certificate for money. It stores credit information of borrowers, so that a customer cannot take loans from many banks without anyone noticing. Why useful? It reduces double borrowing and fraud. A banker checks CIB before every loan.

Lending Limits That Keep Banks Safe

NRB sets limits so that one mistake cannot kill a bank.

Single Obligor Limit (SOL): A bank cannot lend more than a set percentage of its core capital to a single borrower or group. Why? "Do not put all your eggs in one basket."
Sectoral limits: Caps on exposure to risky sectors like real estate or share margin lending.
Credit-to-Deposit type ratios: NRB uses ratios like the CCD ratio (Credit to Core Capital plus Deposit) to stop banks from lending more than they can safely fund. Why? If a bank lends too much compared to deposits, it may run short of cash and fall into a liquidity crisis.
Insider lending limits: Banks cannot freely lend to their own directors or related parties, because of conflict of interest.

Ethics: The Quiet Part of Lending

In Nepali banking, lending also has a human side. Pressure from powerful people, political connections or personal friendships can push staff to approve a weak loan. A good banker follows three habits:

Judge the file, not the face.
Document every decision, so that the reason is visible later.
Say no politely, with a clear reason, and suggest a fix if possible.

This is why interview panels often ask, "What would you do if a senior or a powerful person asks you to approve a weak loan?" The best answers talk about following policy, escalating properly and protecting the bank and customer interests.

Term Box: Post 3 Glossary

Credit / Loan – Money lent with an agreement to repay with interest. Why "credit": from Latin for "belief"; the bank believes you will pay.
Principal – The original loan amount. Why separate: Interest is calculated on it.
Tenure – Loan period. Why important: Longer tenure means smaller EMI but more total interest and more bank risk.
EMI – Fixed monthly payment of principal and interest. Why used: Easy for customers to plan.
Collateral / Security – Asset offered as backup. Why: A second source of repayment.
LTV – Loan as a percentage of collateral value. Why: Keeps a safety cushion.
Mortgage / Pledge / Hypothecation / Lien – Different ways of taking a charge on assets. Why different: Depends on who holds the asset and whether it is movable.
Guarantor – Person who promises to pay if the borrower fails. Why: Adds another source of repayment.
Base rate – Minimum lending rate based on cost. Why: Transparency and fair pricing.
Spread / Premium – Extra rate for risk. Why: Pays for expected losses.
Overdue – Payment not made on the due date. Why watched: The first signal of trouble.
NPL / NPA – Non-performing loan or asset. Why: Earns nothing and may cause loss.
Provisioning – Setting aside profit for expected loan loss. Why: Honest accounting and safety.
Restructuring / Rescheduling – Changing the terms of a troubled loan. Why: Better than a total loss when the problem is temporary.
Write-off – Removing a loan from the books as unrecoverable. Why: The balance sheet should show reality.
CIB – Credit Information Bureau. Why: Stops double borrowing and tracks defaulters.
Single Obligor Limit – Cap on exposure to one borrower. Why: Avoid concentration risk.
Disbursement – Releasing loan money. Why a separate stage: Conditions must be met first.
CAM – Credit Appraisal Memorandum. Why: The written reason for lending.

Taiyari Tip: Practise Like a Credit Officer

Take any small business around you (a tea shop, a tailor, a hardware store). Ask: What would I check before lending to it? Write your answer using the 5 Cs.
Practise EMI calculation by hand with two or three examples until it feels natural.
Make a flashcard set for mortgage vs pledge vs hypothecation vs lien.
Memorise the loan classification table, including approximate provision percentages.
Learn two sentences about CIB, SOL and CCD each.

Interview Corner

Q1. What is the most important thing in giving a loan?
Model answer: "The borrower's ability and willingness to repay, which means character and cash flow. Collateral is a backup, not the main reason for lending."

Q2. Why does the bank take collateral if cash flow is most important?
Model answer: "Because even good businesses can fail. Collateral gives the bank a second way to recover its money and also makes the borrower more serious about repayment."

Q3. What is the difference between pledge and hypothecation?
Model answer: "In pledge, the bank takes possession of the movable asset. In hypothecation, the borrower keeps possession and the bank only has a charge on it."

Q4. What is NPL and why does NRB want banks to keep provisions?
Model answer: "NPL is a loan that is overdue for a long time or has a high chance of default. Provisioning forces banks to recognise expected losses early, so profits are not overstated and the bank stays safe."

Q5. What will you do if a borrower asks to restructure the loan?
Model answer: "I will first understand why the problem occurred and whether it is temporary. Then I will check cash flow projections, collateral coverage and NRB's restructuring rules, and recommend only if the borrower can realistically repay under the new schedule."

Q6. Why does NRB limit exposure to a single borrower?
Model answer: "To avoid concentration risk. If one big borrower fails, the bank should not collapse."

Q7. A senior person asks you to approve a weak loan. What do you do?
Model answer: "I will respectfully explain the policy gaps, document my concerns and escalate through the proper channel. I will not approve something that breaks policy or exposes the bank to unnecessary risk."

Quick Recap of Post 3

Good lending depends on cash flow first, collateral second.
A loan passes through application, KYC, appraisal, valuation, approval, documentation, disbursement and monitoring.
5 Cs: Character, Capacity, Capital, Collateral, Conditions.
Loan pricing = base rate + premium; EMI gives the monthly payment; early instalments are mostly interest.
NPLs are divided into substandard, doubtful and loss, with rising provisions.
CIB, single obligor limit and CCD-type ratios are safety tools.

Sita gets her loan, opens her second outlet and sleeps better. But something bigger is watching over her bank and every bank in Nepal. In Post 4, we climb up to the control tower: Nepal Rastra Bank, monetary policy, capital rules and the fight against money laundering.

Next in the series: Post 4, Nepal Rastra Bank Ko Chhata: Monetary Policy, Capital Rules and the Fight Against Money Laundering

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