Challenges in Loan Recovery Procedures of Banks

Term Paper in the Subject of Banking and Insurance Law

B.A. LL. B, 4th year

Business Law Group

April 10th 2020

3250 words

Rejina Paudyal

Kathmandu School of Law (KSL)

Purbanchal University
Introduction

Bank and Financial Institutions are organized institutions that collect deposits from their clients
and lend the deposited money to the needy persons so providing loan is the core business of the
bank. A loan is a liability for the individual or corporation receiving it, but an asset for a bank,
because it provides income to the bank1. Banks provide loans to the public or companies in the
form of cash credit, short term loans, overdraft, etc. out of the deposits they receive from its
customers hence, they must be very alert while granting loans. A banks primary function is to
provide loan and accept deposits. Banks and financial institutions provide loan to its customers
or borrowers on certain rate of interests by keeping something valuable in collateral and the
burrower is obliged to pay back the loan in stipulated time. However, sometimes, the burrower
might not be able to pay back the loan, invest it in proper field or just act opposite to what the
parties have agreed upon. In such a situation, it is the liability of the debtor to pay the principal
and interest of the debt, within stipulate time and it is the right of the bank or financial institution
to initiate a legal action to recover its amount and interest 2. Hence, this paper deals with the legal
provisions regarding loan recovery in Nepal and challenges associated.

Provisions regarding loan recovery procedures

Section 57 of the Bank and Financial Institution Act, 2073 provides the procedures regarding
loan recovery. Besides this, there are other statutes like Recovery of Debts of Banks and
Financial Institution Act, 2058, Banking Offence and Punishment Act, 2064, Insolvency Act,
2063, Secured Transaction Act, 2063, etc. that are related with recovery of loans. The Debt
Recovery Tribunal (DRT) has also been established under the Recovery of Debts of Banks and
Financial Institution Act, 2058 to settle disputes regarding bank loans. The mechanisms under
these statutes are discussed below:

1) BAFIA 2073

1
Frederic S. Mishkin & Stanley G. Eakins, Financial Markets and Institutions, 7th ed., United States of America:
Pearson Education Inc., 2012, p. 402.
2
Sitaram Tamang v. NIDC Kathmandu, NKP 2063.
 Bank and Financial Institution Act 2073 regulates entire banks and financial institutions, it
provides rights, duties, functions and responsibilities of these institutions. Section 49 provides
a power to the banks to grant different kinds of loans by different classes of banks whereas
section 50 limits these powers of banks. Section 56 provides that a bank may grant credits to
burrowers but only by fulfilling certain criteria such as by knowing the real purpose of
burrowing the loan, by keeping something as collateral, etc. This ensures that the loan so
provided wouldn’t be misused by the burrowers. Section 57 of the Act makes elaborate
provision relating to recovery of loan. It provides that it is the duty of the burrower to abide by
the terms and conditions, if not, the bank may recover the loan from the collateral. This
particular section provides the following ways to recover the loans:

 By auctioning or disposing the collateral

According to Section 57(1), the licensed institution may recover its principal and interests
having sold by auction the assets taken or put as mortgaged by the borrower in the name
of the institution. This maybe done if:
- the borrower fails to abide by the terms of the credit as mentioned in the deed or
agreement or any terms and covenants made with the licensed institution,
- the borrower fails to repay credit to the bank or financial institution within the time-
limit stipulated in the deed,
- the licensed institution, through the monitoring conducted finds out that it has
misused the credit by using it for the purpose other than the purpose for which it was
disbursed.

 By recovering from any other property owned by the borrower

The licensed institution may ask the borrower to place more assets as collateral security if
the borrower gives off the title over the assets mortgaged collateral security or the value
of assets mortgaged as collateral security to the licensed institution is decreased 3 and if
3
See, section 57(2) of BAFIA 2073, Nepal, ‘in case the borrower gives off the title in any manner whatsoever over
the assets mortgaged collateral security or the value of assets mortgaged as collateral security to the bank or
 the borrower didn’t do so, the institution may recover its principal and interests from the
movable or immovable assets under title of the borrower according to the prevailing
laws4.
 By blacklisting the borrowers
According to Section 57(11), the bank or financial institution shall have to write to the
Credit Information Bureau Limited to blacklist the borrowers according to the prevailing
laws if:
- in case a borrower does not repay the credit from a bank or financial institution and the
interests accrued thereto and penal interests within the time limit stipulated.

 By freezing the assets

According to Section 57(12) of the Act, if the loan is not recovered from any of the above
process, the licensed institution may even freeze any assets of the borrower located in a
foreign land.

 By withholding or confiscating the passport

According to Section 57(13), if the credit could not be recovered even after taking all
actions mentioned above, the institution may request the Rastra Bank for making
necessary provisions to withhold or confiscate the passport/s of the concerned borrowers
and to deprive the concerned borrower from availing the services to be made available by
the state. Rastra Bank then, should forward the request to the Government to take
necessary actions.

Hence, we can see that the BAFIA 2073 has the full authority to recover the loan if in
case the borrower is not cooperating as per the terms and conditions signed between the
borrower and the licensed institution.

financial institution is decreased’.

4
See, section 57(3) of BAFIA 2073, Nepal, ‘In case the borrower fails to place more assets as collateral within the
time limit pursuant to Sub-Section (2) or the principal and interests could not be recovered from the collateral
security so mortgaged, the bank or financial 59 institution may recover its principal and interests from the movable
or immovable assets under the ownership or title of the borrower according to the prevailing laws.’
 2) Recovery of Debts of Banks and Financial Institution Act, 2058
Under this Act, a Debt Recovery Tribunal (DRT) has been established and also a
supplementary legislation called Recovery of Debts of Banks and Financial Institutions
2059. This Act came into existence as an expedient to make provisions for the recovery
of principal and interest of debts recoverable from borrowers by trying and settling cases
relating to recovery of debts of banks and financial institutions in a speedy and prompt
manner. The Recovery of Debts of Banks and Financial Institutions 2059 on the other
hand provide detailed procedures regarding the adjudication of cases in the tribunal. The
DRT was established on 2060 in order to originally try and settle cases relating to
recovery of debts of banks and financial institutions.

Before filing a petition, it is essential for any licensed institution to have completed the
prior duties. The borrowers must have been reminded of monthly interest payment where
first second and third reminder letters must be sent to the borrowers. The implementation
of recovery actions might take place when a 35 day notice is published in media but
before that, the institutions must make sure that that the bank has provided all previous
reminder letters to the customer and he/she has received it.

Moving onto DRT, it is a three-member judicial body which consists of chairperson from
legal expert, one member from banking expert and other from account expert. 5 All
commercial banks, Agricultural Development Bank, Nepal Industrial Development
Corporation and other financial institutions as specified by Nepal Rastra Bank are eligible
lending agencies to file cases into DRT6. These agencies can file a petition if the principal
recoverable amount is N.Rs 500,000 or more. 7 Time limitation for filing the case is 4
years from the date of maturity of the loan. 8 The tribunal not only gives decision, it also

5
See section 4(3) of Recovery of Debts of Banks and Financial Institution Act, 2058, Nepal.
6
See section 3 of Recovery of Debts of Banks and Financial Institution Act, 2058, Nepal.
7
Ibid.
8
See section 15(1) of Recovery of Debts of Banks and Financial Institution Act, 2058, Nepal.
 implements it9 through a debt recovery officer. In recovering the principal and interest of
a debt, the debt recovery officer has to follow the following procedures:
a) To take possession of, or auction, the borrower's other movable or immovable property
whether furnished as security or not,
b) To take possession of, or auction, the guarantor's movable or immovable property,
c) Where any individual is a borrower or guarantor, to arrest such individual and detain
him/her pursuant to the prevailing law.

The DRT has power, functions and duties to see the cases regarding loan recovery and it
has been efficiently performing its functions. In the economic year 2075/2076 only, 104
cases have been decided out of 505 cases 10. However, the rate of implementation seems
pretty low if we see the data11.

3) Other relevant laws

Even though there are no other laws except above two which directly mentions about the
procedures of debt recovery, there are other relevant laws that indirectly support the idea.
For example, Banking Offence and Punishment Act, 2064 has defined various banking
offences which are relevant to disbursement and recovery of loan. The Act has defined
providing loan in unauthorized manner12, unlawful lending and burrowing of the loan,
misuse of loan facility13, false valuation of the collateral14, etc. as the banking offences
and has prescribed the respective punishment15.
Another relevant example would be of Secured Transaction Act, 2063 which was brought
to make provisions to secure obligations with movable and intangible property by making
9
See Section 21 of Recovery of Debts of Banks and Financial Institution Act, 2058, Nepal.
10
Yearly report, Debt Recovery Tribunal, 2075/2076, available on,
http://drtribunal.gov.np/wp-content/uploads/2019/07/%E0%A4%B5%E0%A4%BE%E0%A4%B0%E0%A5%8D
%E0%A4%B7%E0%A4%BF%E0%A4%95-%E0%A4%AA%E0%A5%8D
%E0%A4%B0%E0%A4%A4%E0%A4%BF%E0%A4%B5%E0%A5%87%E0%A4%A6%E0%A4%A8-
%E0%A5%A6%E0%A5%AD%E0%A5%AB-%E0%A5%A6%E0%A5%AD%E0%A5%AC.pdf accessed on 3rd of
April 2020.
11
Ibid.
12
Section 7 of Banking Offence and Punishment Act, 2064, Nepal.
13
Section 8 of Banking Offence and Punishment Act, 2064, Nepal.
14
Section 7(b) of Banking Offence and Punishment Act, 2064, Nepal.
15
See section 15 of Banking Offence and Punishment Act, 2064, Nepal.
 consolidated legal provisions in relation to secured transactions for the maximum
promotion of economic activities for the economic development of the country. It has laid
down provisions for the creation of security interest, priority of creditors claim, publicity
of creation and enforcement of security interest by the creditors in case of default by
debaters16.
Also, the directive published by Rastra Bank is another relevant law that helps in
systematizing the procedures of debt recovery.

Supreme Court of Nepal on debt recovery

The Supreme Court has delivered some of the landmark judgments regarding debt
recovery, some of which has even been incorporated in the laws by legislators. For
example, in the case of Rastra Banijya Bank, Janakpur v. Jhawarmal Goyanka17, the
court had given the power to the bank’s authority to recover its loan from the property of
the debtor, which is not in security which has now been incorporated in section 57(3) of
the Bank and Financial Institution Act 2073.

In the case of Narayan Bahadur Karki v Krishna Bahadur Karki 18, the Supreme Court
held that loan take for family purpose should be borne by all family members and lending
institution has right to recover its debt from the common family property. In lack of
substantial written evidence to show that there is division of parental property, the court
enforced the right of Bank over the collateral. The court has laid down similar principle
in the case of Narayan Prasad Tharu v Maharani Tharuni and others 19 where the court
held that in absence of any evidence establishing that parental property had already been
divided at the time of giving collateral, the property should be considered common family
property and lending institution has right to recover its debt from sale of common family
property.

16
See Section 46 of Secured Transaction Act, 2063, Nepal.
17
Rastra Banijya Bank, Janakpur v. Jhawarmal Goyanka, NKP 2045, D.N. 3386.
18
Narayan Bahadur Karki v Krishna Bahadur Karki, NKP 2053, D.N. 6131, p. 65.
19
Narayan Prasad Tharu v Maharani Tharuni and others, NKP 2060, D.N. 7204, p. 288.
 The court has also established the principle that blacklisting of the borrower should not
be a regular practice by the banks, it should be used as a last resort. This principle has
been set in the case of Indra Jungam v Nepal Rastra Bank and others20 and also in the
case of Krishna Gopal Tandan and others v. Nepal Rastra Bank and others21.

In case of Sitaram Tamang v Nepal Industrial Development Corporation and others 22,
where land and building constructed in land was kept in collateral for loan of seven years,
the debtor could not pay the full amount within the period. Debtor the petitioner claimed
notice of auction to be unlawful and prejudicial to interest of the petitioner. The court
held that borrower should pay back the loan in stipulated time; otherwise the lender
institution has absolute right to auction the collateral to recover its amount.

Challenges on debt recovery procedures

There might be various challenges in the debt recovery procedures, some of them are:

1) Consequences of black listing:

Blacklist is as discussed earlier is used as a coercive weapon by regulator to the willful
defaulter of bank due. In Nepal, this is a list maintained by the Credit Information Bureau
on the basis of information provided by the bank and financial institution under the
provision of directives issued by NRB and the NRB Act. The objective of the list is to
pressure the defaulter for payment of due debt and provide for the information to the
needy person about the default for payment of due debt. However, it has certain
consequences which are:
a) Social Consequences:
Blacklisting might reduce the image and credibility of a person, firm or company. It
may also reduce the reputation of such person’s firm or company and their social
status which not only harms personally but also reduce the demand of their product.
Black listed persons, firms or companies also lose their business image and
credibility.

20
Indra Jungam v Nepal Rastra Bank and others, NKP 2058, D.N. 7027.
21
Krishna Gopal Tandan and others v. Nepal Rastra Bank and others, NKP 2060, D.N. 7295, p. 918.
22
Sitaram Tamang v Nepal Industrial Development Corporation and others, NKP 2059, D.N. 7075.
 b) Legal Consequence:
Any person, company or firm who is blacklisted will not receive further loan,
advance or any other facilities from respective bank. Government can withhold the
passport or confiscate it by which their movement is curtailed. Such blacklisted
borrowers are not appointed or nominated in any public position by the government.

c) Political consequence:
A person who is blacklisted as such is declared to be disqualified to become a
candidate in election23.

Because of these consequences, Supreme Court has also suggested to blacklist the
borrowers only on last resort.

2) Unhealthy competition between banks and financial institution is another problem.

Because of this, the banks have normally have the tendency to provide loan by keeping
low collateral or grant higher amount of loans to borrowers who are not credible enough.

3) Another problem is the inadequate collateral valuation system. Most of the banking
institutions lack corporate governance. The malpractice in valuation and proper scrutiny
of the collateral by responsible staffs creates difficulty in the recovery of loan which
might be due to undue influence. The property valuation system of banks is subjective,
obscure and unpredictable24. The pre-valuation, valuation and re-valuation system by
banks is not scientific nor is transparent25.
4) Sometimes, the collaterals kept are either insufficient to recover the loan granted 26 or they
are of very low quality which generally happens due to the negligence of banks.
5) The property kept as collateral might sometimes be a disputed property because of which
the coparceners’ counter claims can create hurdles in recovering the loan.
6) While keeping a property for auction, there might be no buyer available. In situations as
such, banks must take the ownership of the property in its own name as non-banking
23
See section 19(e), Election to the Members of the Constituent Assembly Act, 2064 (2007), Nepal.
24
Yearly Report, Debt Recovery Tribunal, 2068/069, p. 20.
25
Ramesh Rijal, Lending Business of Banks in Nepal: A Legal Perspective, p. 170.
26
Debt Recovery Tribunal, (n 24), p. 18.
 assets which should be converted into cash within stipulated time period. This also
creates a hurdle.
7) Because of the lengthy procedures of DRT, the lending institutions might have to bear a
heavy loss.
8) Lack of skilled professionals, no monitoring and timely supervision of the collateral also
is a great challenge in this field.
9) There are loopholes in the laws as well. The existing laws are not sufficient to address all
of these problems. Moreover, if we see the annual report of the DRT then the
implementation rate of the cases is very low.
10) Another challenge seen is the bad corporate practices. There is lack of enough human
resource that is skilled and ethical as well. The BAFIA restricts the BoD to take loan
from their own company similarly, it restricts the board members to provide collateral for
loan purpose for own or for others. However, these are being practiced directly or
indirectly and there is no proper supervision.
11) Political intervention, insider lending, lack of skilled manpower, institutional set ups and
management system are some other challenges faced by the banks in recovery of loans.

Analysis and Conclusion

Providing loan and accepting deposits are the two major functions of the banks. The
sustainability of bank is possible only through the success in business for which the customer
took loan and increase in loan repaying capacity of the customer and payment of principal and
interest of loan taken by the customer in specified time. From the above information, it is clear
that sometimes, there might be borrowers who are reluctant to pay back the principal and interest
amount which creates a tension inside the banks. However, there are sufficient laws established
that provide banks and financial institution with adequate amount of power to recover back the
loans so provided. But, the fact that power comes with many responsibilities cannot be
neglected. Power can always be misused, which banks should never.
Banks and the financial institutions, before providing loan to the borrowers should always be
very alert and there must be sufficient homework done. The lender always lends money with a
trust that the amount will later be paid. However, banks must always screen out the incompetent
borrowers. With all the powers provided by the laws to these institutions, it is ensured that there
are measures to recover the loans so provided. Nonetheless, with good corporate governance,
scientific collateral valuation system, reform of regulations according to the international
instruments, effective credit risk management mechanism, skilled human resources, effective and
appropriate supervision and inspection, compliance of the existing laws and directives of NRB
and effective implementation of the decisions of DRT, a good banking system can be established
in Nepal.