DETERMINANTS OF CAPITAL ADEQUACY RATIO OF

COMMERCIAL BANKS IN NEPAL

(With Reference to ADBL, NABIL, and NIBL)

A Proposal

Submitted By
Elina Adhikari
Caspian Valley College
T.U. Regd. No.: 7-2-0755-0005-2015
Exam Roll No.: 5160022
Campus Roll No.: 22

Submitted To
Head of Research Department
Caspian Valley College
The Faculty of Management
Tribhuvan University

In Partial Fulfilment of the Requirements for the Degree of

BACHELOR OF BUSINESS STUDIES (BBS)

Balkumari, Lalitpur
December, 2020
 TABLE OF CONTENTS

CHAPTER-I:INTRODUCTION................................................................................1
1.1 Background of the Study..........................................................................................1
1.1.1 Introduction to Sampled Commercial Banks................................................2
1.2 Problem Statement...................................................................................................5
1.3 Objectives of the Study............................................................................................5
1.4 Rationale of the study...............................................................................................5
1.5 Research Methodology.............................................................................................6
1.5.1 Research Design............................................................................................6
1.5.2 Population and Sample..................................................................................6
1.5.3 Nature and Sources of Data...........................................................................7
1.5.4 Data Collection Procedure............................................................................7
1.5.5 Data Analysis Tools......................................................................................7
1.6 Limitations of the Study.........................................................................................10
1.7 Report Structure.....................................................................................................10

Bibliography

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 CHAPTER-I
INTRODUCTION

1.1 Background of the Study

A strong and sound financial system can promote economic growth, mobilize
and allocate resources efficiently, make capital more productive and create
jobs. It lessens vulnerability to financial crisis and defrays the economic and
social costs that accompany financial disruption. Since the financial system
performs the crucial task of raising funds for, and channeling funds to
productive investment, successful financial liberalization is normally a
significant constituent of a country’s strategy for economic growth. In Nepal,
the pace of financial liberalization started in the mid-1980s when the
government allowed the entry of commercial banks in joint venture with
foreign bank. Since then, the Nepalese financial system has undergone rapid
structural changes, with a large number of financial institutions rendering an
array of financial products and services. While the increased competition has
been instrumental in enhancing efficiency in the financial sector, new
challenges have also emerged (Thapa, 2017).

These lenders can supply funds to the ultimate borrowers, who are mainly
firms, governments and households, in two ways. The first is through financial
markets, which consist of money markets, bond markets and equity markets.
The second is through banks and other financial intermediaries such as money
market funds, mutual funds, insurance companies and pension funds. It
emphasizes the importance of capital by arguing that “capital is pivotal to
everything that a bank does, and changing it... has wide-ranging implications
for bank management and bank investors.” Specifically, he suggests
that changing capital requirements has the effect of changing banks’ behaviour
towards risk because capital levels (i) constrain a key performance measure
(return on equity); (ii) influence a bank’s ability to lend and spend; and (iii)
limit dividends and capital repatriation. Capital, therefore, is the cushion that
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protects banks from insolvency. But bank failure may occur because of
illiquidity even if a bank is solvent. Is not this exactly what happened to
Northern Rock, which endured a bank run on its deposits in September 2007
A.D. Then what is so good for the bank itself about being solvent if, as a result
of a loss event, it is not in a position to resume business as usual. Solvent or
insolvent, Northern Rock could not resume business as usual, creating
significant problems for the British government and forcing the nationalization
of the bank in February 2008 (Ghimire, 2018).

The importance of banking system for financial economy, it is worthwhile to

make a detail study of capital adequacy of such financial institutions. Adequacy
is one of the most important topics for both regulatory authorities and banks. It
represents the most important element of banks stability and solidarity, in
this regard regulatory authorities have worked on introducing different
measures of adequacy, the most prominent of which was the capital
adequacy approved by Basel committee in (1983). And applied by more
than (100) countries, furthermore the application of that standard during the last
years resulted in many weaknesses that led the committee to make some
modifications on that standard and, ultimately, suggesting a new standard to
measure adequacy under the name Basel II (Basel Committee on Banking
Supervision, 1983: 4).

1.1.1 Introduction to Sampled Commercial Banks

A. Agriculture Development Bank

Agricultural Development Bank Limited (ADBL) is an autonomous

organization largely owned by Government of Nepal. The bank has been
working as a premier rural credit institution since the last three decades,
contributing a more than 67 percent of institutional credit supply in the
country. The main objective of providing institutional credit for enhancing the
production and productivity of the agricultural sector in the country, the
Agricultural Development Bank, Nepal has established in 1968 under the
ADBN Act 1967, as successor to the cooperative Bank. The Land Reform

2
Savings Corporation has merged with ADBN in 1973. Subsequent
amendments to the Act empowered the bank to extend credit to small farmers
under group liability and expand the scope of financing to promote cottage
industries. The amendments also permitted the bank to engage in commercial
banking activities for the mobilization of domestic resources. The bank
worked as a premier rural credit institution since its establishment,
contributing substantial agricultural credit supply in the country. Rural finance
has been the principal operational area of ADBN in the past. However, the
bank is also involved in commercial banking operations since 1984, to provide
commercial banking services.

The bank has 51% share of Government of Nepal and 49% of public. Most of
its shareholders are customers and employees. The enactment of Banks and
Financial Institutions Act (BAFIA) took all the banks and financial institutions
(BFIs) under its umbrella and abolished all the acts related to the BFIs
including the ADBN Act, 1967. Since then, the bank has been working as a
public limited company registered under the Companies Act, 2006 and has
licensed as "A class financial institution" by Nepal Rastra Bank from 2006.

Having glorious history of more than 52 years, the bank is one of the leading
commercial banks of the country. With its investment in agriculture, industry,
trade, commerce and households, the bank has above 1.2 million happily
satisfied customers. Just like its slogan "Sampurna Banking Suvidha sahitko
Tapai Hamro Ghar Aanganko Bank" (The bank with complete banking solution
at your own door step), it is spread all over the 7 provinces & 77 districts of the
nation with its 278 offices. The bank is committed to provide best banking
services through its widespread network and help the government from its part,
to achieve the aim of "Prosperous Nepal, Happy Nepali".

B. Nabil Bank Limited

NABIL Bank Limited, the first foreign joint venture bank of Nepal, started
operations in 12 July 1984. It is class “A” licensed commercial bank regulated

3
under the Banks and financial institutions Act 2017 A.D. NABIL Bank
Limited (“the Bank”) is a public limited company listed on the Nepal Stock
Exchange, incorporated on May 11, 1984 under the Companies Act 2006 A.D.
of Nepal, and is domiciled in Nepal. The Bank has its registered office at
‘NABIL Center’, Tindhara, Durbarmarg, Kathmandu-01, Nepal and its branch
offices are located across the Nepal. It was incorporated with the objective of
extending international standard modern banking services to various sectors of
the society. Pursuing its objective, NABIL provides a full range of
commercial banking services through its 62 points of representation. In
addition to this, NABIL has presence through over 1500 NABIL Remit agents
throughout the nation. NABIL, as a pioneer in introducing many innovative
products and marketing concepts in the domestic banking sector, represents a
milestone in the banking history of Nepal as it started an era of modern
banking with customer satisfaction measured as a focal objective while doing
business. NABIL Bank is moving forward with a mission to be “1 st Choice
Provider of Complete Financial Solutions” for all its stakeholders, Customers,
Shareholders, Regulators, and Communities & Staff. It is reflected in its
Brand Promise “Together Ahead”.

A. Nepal Investment Bank Limited

Nepal Investment Bank Limited is one of the leading commercial banks of

Nepal. Previously known as Nepal Indosuez Bank Ltd., the bank was
established in 1986 as a joint venture between Nepalese and Credit Agricole
Indosuez. The Nepalese investors bought all the shares of French company i.e.
50% in 2001. From then the Nepalese investors have raised this bank to one of
the most trusted and popular bank in the country. Till date it has 78 branches, 8
Extension Counters (98 ATM outlets) scattered throughout the country giving
modern banking services of international class from 9:30am to 7pm evening.

Nepal Investment Bank Ltd. (NIBL), previously Nepal Indosuez Bank Ltd.,
was established in 1986 as a joint venture between Nepalese and French
partners. The French partner (holding 50% of the capital of NIBL) was Credit

4
Agricole Indosuez, a subsidiary of one of the largest banking group in the
world. Later, in 2002 a group of Nepalese companies comprising of bankers,
professionals, industrialists and businessmen acquired the 50% shareholding of
Credit Agricole Indosuez in Nepal Indosuez Bank Ltd., and accordingly the
name of the Bank also changed to Nepal Investment Bank Ltd.

1.2 Problem Statement

There are different researches that have done before on capital adequacy in
different countries. Theoretical as well as empirical evidence has been
presented by the researchers there insights on capital adequacy. A brief
overview of the studies focusing on developed factors that may affect capital
adequacy. The expected losses: losses that occur frequently to any bank, and
their size is often small. The problem statement of the research study can be
stated as:
1. What is the major factor of determinants of capital adequacy ratio?
2. What is the profitability position of sample banks?

1.3 Objectives of the Study

The main objective of the study is to investigate empirically the determinants
of CAR in commercial banks in Nepal. The other objectives are:
1. To study the major determination factor of Capital Adequacy Ratio of
sample banks.
2. To analyze the profitability of sample banks.

1.4 Rationale of the study

The study is concerned with the capital adequacy ratio of banking sector.
Nepalese banking sector does not have a long history, hence, it provide a
glimpse of management of capital by nascent banking sector. Studying banking
sector of Nepal is interesting in the sense there are many banks with foreign
investment and such banks are supposed to be an efficient manager of capital.
The study makes some major contributions to the literature of capital adequacy
ratio in banking sector. Firstly, this is probably first study to analyze different

5
hypotheses related to determinants of capital adequacy for banking sector in
Nepal. Secondly, this study also examines the explanatory power of various
bank specific characteristics of two different banks to test the robustness of the
results found for the overall banking sector. Thirdly, the study also provides
various policy implications and suggestions for efficient management of
capital.

1.5 Research Methodology

Research methodology refers to the various sequential to be adopted by a
researcher in studying a problem with certain objective in view. It is a way to
systematic solve the research problem it may be understood as a science of
studying how search is done scientifically. This chapter consists of the research
methodology applied in this study for the fulfilment of the stated objectives.
The overall approach to the research has presented in this chapter. This chapter
consists of research design, sample size, sample selection, data collection
procedure, and data processing as well presentation technique and tools.

1.5.1 Research Design

In this study, this research study the determination of capital adequacy ratio of
commercial banks in Nepal. To achieve the research objective, descriptive
and analytical research design will be used. In fact, the research design is the
conceptual structure within which the research is conduct. To evaluate the
determination of capital adequacy ratio of commercial banks especially that of
ADBL, NABIL, and NIBL. This study has based on time series data extracted
from annual reports for the relevant five fiscal years (from the 2014/15 to
2018/19).

1.5.2 Population and Sample

There are 27 commercial banks in Nepal. Among them three commercial banks
will be taken for sample i.e., ADBL, NABIL and NIBL for judgmentally
sampling. Therefore, samplings have done selecting from population.

6
1.5.3 Nature and Sources of Data
This research will be based on secondary data. Secondary sources of data are
those data already gathered by others. Different secondary sources had assisted
in resolving or partly answering the research problem. The external secondary
sources include books, periodicals, articles and journals, published and other
unpublished sources. The annual reports of the sampled banks are the major
sources for secondary data.

1.5.4 Data Collection Procedure

Data has been collected from secondary sources. Likewise, data has emanated
from listed banks’ financial reports, published and unpublished books,
scholarly journals, business and financial newspapers and other magazines and
corporate journals. As the study needs historical financial data, which are from
corporate reports, accessing publicly available data has assumed as the suitable
method for the accuracy of the data. As public data is accessible to everyone,
the study made use of the financial performance data, which were of interest to
the present research. Financial reports and other relevant information of the
listed banks for the period 2014/15 to 2018/19 have retrieved from the internet,
by search engines.

1.5.5 Data Analysis Tools

The collected data has analyzed with the help of different financial and
statistical tools.

I. Financial Tools
A. Interest Rate Margin
Interest rate risks results from the fluctuation of interest rate and have effect on
bank’s capital as well as revenue as banks face these risks as part of being a
financial intermediaries. The interest rates risks might involve a big threat to its
profits and capital, which requires a good interest rate management from the
part of the bank, through maintaining acceptable levels of interest rates. Interest

7
risks as measured as ratio of interest rate sensitive assets and interest rate
sensitive liabilities as shown in Interest rate sensitive assets include all the
loans and advances whereas interest rate liabilities include deposits in local
currency.

B. Total Deposits 
Total Deposits is a term included in the balance sheet of a bank. To a common
person, the word deposit most often implies the act of placing your money in
the safety of a bank. Total Deposits from a bank's perspective, various kinds
of deposits have taken into consideration. One of the key functions of
commercial banks is to accumulate funds in the form of deposits from the
surplus sectors of the economy and make same available to the deficit sectors
of the economy. Thus, deposits constitute a significant proportion of banks
total current liabilities and as such require maintenance of adequate capital by
banks. Sharpe defined capital as a difference between assets and deposits, so
the larger the ratio of capital to assets (or the ratio of capital to deposit) the
safer the deposits. As capital was adequate, deposits were “safe enough”. His
idea was that if the value of an institution’s assets may decline in the future, its’
deposits will generally be safer, the larger the current value of assets in relation
to the value of deposits.

C. Total Loan
Total Loan: Of the total approved amount (100% amount), the amount that has
not been disbursed by the lender as of the month ending date. ... Total
Loan Amount, means the total amount the consumer will borrow, as reflected
by the face amount of the note.
There are various kinds of loans as per the financial requirements in question.
Banks can give a loan, which can be secured or unsecured. People go for
secured loans due to lower interest rates and the large sum of money available,
which can be used for purchasing a car or house. While unsecured loans are
most common in the form of personal loans, which have a higher interest rate
and are given for smaller amounts for purposes like home renovation and so on.
8
The maximum loan amount that you can avail is based on the persons’
collateral capacity and credit report. Instruments of credit like credit cards,
standard loans, line of credit.

D. Total Asset
Total Assets, most commonly used in the context of a corporation, is defined as
the assets owned by the entity that has economic value whose benefits can be
derived in the future. Assets are recorded in the balance sheet of the firm.
Assets are further classified into liquid assets and illiquid assets depending on
their liquidity. A liquid asset is that asset that can be easily converted into cash
or readily sold for cash otherwise it is called an Illiquid asset. Assets are also
classified on the balance sheet as either current assets or long-term assets. A
current asset is that asset which can be liquidated within a year, whereas, long-
term assets are those assets which are liquidated in more than a year.
Total Assets Formula = Liabilities + Owner’s Equity
E. Profitability Ratio (ROA & ROE)
The profitability ratio is proxies by two ratios namely: Return on Assets (ROA)
and Return on Equity (ROE). ROA represents all assets owned by the bank and
their ability in generating profits during a specific period. In other words, it
explains the degree to which the bank succeeds in investing its assets and its
efficiency in directing them towards profitable investment opportunities. This
ratio measures the management efficiency in using the available resources and
its ability in realizing revenues from funds or resources available from various
financing resources; therefore, it reflects the effect of the bank financial and
operation activities. ROA has measured as net profit after tax divided by total
assets.

II. Statistical Tools

The analysis could not have done without using the statistical tools. All
collected data has tabulated and appropriate statistical techniques such as mean,
standard derivation, C.V, Descriptive statistics, Correlation, Regression and

9
ANNOVA test have used to analyze the information. All the data have
calculated by using this SPSS software. Descriptive statistics is the term given
to the analysis of data that helps describe, show or summarize data in a
meaningful way such that patterns might emerge from the data. Descriptive
statistics do not however allow us to make conclusions beyond the data the
researcher have analyzed or reach conclusion regarding any hypothesis have
made. They are simply a way to describe data. The researcher used mean,
minimum, maximum, standard deviation and standard error to analyze the data.

1.6 Limitations of the Study

This study, to analyze the determinations of capital adequacy ratio of
commercial banks in Nepal. Every study has limitations due to different factors
of institutions, time-period taken, reliability of statistical data, tools and
variances. The following limitations has pointed out in this study of
profitability of banks:
1. This research covers the major determinations of capital adequacy ratio
variables are interest rate margin, total deposit, total loan, ROA, ROE,
liquidity, credit risk and bank size, it does not cover all other aspects of
the variables.
2. There are 27 banks in Nepal. Among them, this study covers only to
three commercial banks i.e., ADBL, NABIL and NIBL.
3. The study analyzes capital adequacy ratio of commercial banks only, it
may not cover the other financial institutions such as development
banks, finance companies, and cooperatives.
4. There are two types of data, primary and secondary data. This study
based on secondary data.
5. This study covers the analysis of only five years data from FY 2014/15

to FY 2018/19; hence, the conclusion drawn confirms to the above

periods only.

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1.7 Report Structure
The results and the outcomes of the whole research work have presented in
three different chapters as follows:

Chapter-I: Introduction
The first chapter of the report describes background of the study, problem
statement, objective of the study, rationale of the study, theoretical framework,
research hypothesis, conceptual review, empirical review and research gap.
research methodology, research design, population and sample, sources of data,
data collection procedures, data analysis tools, limitation of the study and
report structure.

Chapter –II: Results and Analysis

In the fourth chapter, the data and information have presented results and
discussion by the help of financial and statistical tools. This chapter is the
major finding of the study.

Chapter –III: Summary and Conclusion

Finally, in the fifth and last chapter, summary, conclusion and Implications
have made regarding the entire study. At the end bibliography and appendix
have also used.

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