Banks and Financial Institutions Act 2073 in Nepal: Complete Legal Guide

The Banks and Financial Institutions Act 2073 (2017), commonly known as BAFIA, is the principal legislation governing the establishment, operation, management, regulation, inspection, and supervision of banks and financial institutions in Nepal. Enacted pursuant to Article 296(1) of the Constitution of Nepal on Baishakh 10, 2073 BS (April 23, 2017), this Act consolidates and amends previous banking laws to strengthen the financial system, protect depositors, and maintain financial stability.

Introduction and Objectives

The Banks and Financial Institutions Act 2073 was enacted to increase public confidence in Nepal's banking and financial system, protect depositors' rights and interests, promote healthy competition among financial institutions, and maintain financial stability. The Act replaced the Banks and Financial Institutions Act 2063 (2006) with more comprehensive provisions for modern banking regulation.

Key Objectives

• Increase confidence of general public towards the banking and financial system
• Protect and promote the rights and interests of depositors
• Provide quality and reliable banking and financial services through healthy competition
• Make the national economy sustainable and strong
• Maintain financial stability
• Establish comprehensive legal provisions for establishment, operation, management, regulation, inspection, and supervision of banks and financial institutions

Classification of Banks and Financial Institutions

Section 37 of the Act empowers Nepal Rastra Bank to classify banks and financial institutions based on minimum paid-up capital, types of transactions, and working areas into four classes:

Additionally, Infrastructure Development Banks may be incorporated for infrastructure financing but are not classified into any class.

Incorporation of Banks and Financial Institutions

Basic Requirements (Section 3)

Any person desiring to incorporate a bank or financial institution must:

• Register as a public limited company under prevailing company laws
• Obtain prior approval from Nepal Rastra Bank before registration
• Meet minimum capital requirements prescribed by NRB
• Submit required documents and feasibility studies

Documents for Prior Approval (Section 4)

Application for prior approval must include:

• Memorandum of Association and Articles of Association
• Feasibility study report
• Personal details of applicants in NRB-prescribed format
• Certified copy of any pre-incorporation agreements
• Evidence of income sources and tax clearance
• Details of bankruptcy status, loan history, blacklisting status
• Self-declaration regarding criminal history
• Details of regulatory actions in Nepal or abroad
• Family member details and significant ownership information
• Written authority for NRB to conduct background inquiry
• Undertaking for deposit guarantee/insurance

Persons Ineligible for Prior Approval (Section 4(3))

Prior approval cannot be granted to persons (and firms/companies with their significant ownership) who have been:

• Subjected to regulatory actions of NRB
• Punished for banking offence
• Punished for cheating, fraud, or forgery
• Punished for money laundering or terrorist financing
• Punished for corruption
• Punished for serious offenses like human trafficking, kidnapping, hostage-taking, or rape

Foreign Investment (Section 5)

Foreign banks or financial institutions seeking to incorporate in Nepal through joint venture or within prescribed share limits must additionally submit:

• Memorandum, Articles of Association, and certificate of incorporation from home country
• Copy of license from home country for banking transactions
• Principal place of business details
• Audited financial statements for latest three years
• Proposed business plan, strategies, internal control, and risk management details
• Home country regulatory approval for operating in Nepal

Branch of Foreign Bank (Section 6)

Internationally rated foreign banks may open branch offices in Nepal with NRB approval. Additional requirements include:

• Written commitment from Board of Directors to fulfill all liabilities
• Details of proposed branch location
• Details of proposed office bearers

Licensing Provisions

Prohibition on Unlicensed Transactions (Section 31)

No one except a bank or financial institution with a license from NRB may carry on banking or financial transactions. NRB formulates and executes licensing policy for this purpose.

Use of Name (Section 32)

Without NRB approval, no person, company, or institution may use words like "bank," "banking," "finance," "financial," or similar terms in their name for carrying on banking and financial transactions.

Application for License (Section 33)

Application must include:

• Copy of Memorandum, Articles, and incorporation certificate
• Particulars of office building with required infrastructure
• Evidence of promoter share subscription deposit with NRB
• Service conditions bylaws, financial administration bylaws, and loan write-off bylaws
• Principal place of business and branch addresses
• Consent to comply with NRB terms and conditions
• Business plan with organizational structure, internal control, and risk management
• List of qualified Directors and officials
• Commitment to maintain minimum capital adequacy ratio
• Commitment for internal control system

License Issuance (Section 34)

NRB may issue license within 120 days if satisfied that:

• License will result in healthy competition and effective financial intermediation
• Institution is capable of carrying out transactions subject to Act and regulations
• Submitted documents and physical infrastructure are adequate
• Appointed officials are capable of carrying out banking transactions

License Denial Grounds (Section 35)

NRB may deny license if:

• It causes adverse effects on financial system stability, fair competition, or credibility
• It is not reasonable for depositor protection
• Infrastructure for banking transactions is incomplete
• Other conditions under the Act are not completed

Conversion to Higher Class (Section 38)

Lower class institutions (except Class D) may be converted to higher class with NRB approval if:

• Paid-up capital requirement for higher class is met
• Capital fund adequacy maintained continuously for last five years
• Profitable continuously for last five years
• Average non-performing loans within NRB-prescribed limits
• Preliminary expenses written off
• Public shares issued and allotted
• Special resolution passed by General Meeting

Share Allotment and Transactions

Public Share Allocation (Section 9)

Sale or Pledging of Securities (Section 11)

• Lock-in Period: Promoters cannot sell or pledge shares for at least 5 years from commencement of financial transactions
• After Lock-in: May sell or pledge with NRB approval, subject to shares remaining under promoter group
• Conversion: After 10 years, promoter shares may be converted to ordinary shares with NRB approval
• Exception: NRB approval not required for promoters with less than 2% shareholding

Prohibition on Securities Transactions (Section 12)

Directors, Chief Executives, Auditors, Company Secretaries, and persons directly involved in management cannot buy, sell, mortgage, transfer, or donate securities of their bank or its subsidiary while in position or for one year after leaving, except in specified circumstances like bonus shares, rights shares, or merger processes.

Buy-back of Own Shares (Section 13)

With NRB approval, banks may buy back their shares from free reserves if:

• Shares are fully paid-up and listed
• Authorized by Articles of Association
• Special resolution adopted at General Meeting
• Debt-to-capital ratio not more than double after buy-back
• Buy-back value not more than 20% of paid-up capital and general reserve
• Complies with capital fund directives

Board of Directors

Formation (Section 14)

• Size: Minimum 5 Directors, maximum 7 Directors
• Appointment: General Meeting appoints Directors subject to Act and Articles
• Professional Director: At least one must be appointed by Board from qualified persons
• Family Restriction: No more than one family member may be Director at same time
• Chairperson: Directors choose from amongst themselves by majority

Term of Office (Section 15)

• Maximum 4 years as provided in Articles; may be reappointed
• Independent Director: Single tenure only
• Executive Chairperson/Managing Director: Maximum two consecutive terms

Qualifications of Director (Section 16)

At least one of the following:

• 5 years work experience as Director or office bearer of bank/financial institution or related corporate body, or officer level in Government of Nepal
• Bachelor's degree with at least 3 years such experience
• Master's degree in prescribed related subject

Qualifications of Independent Director (Section 17)

Disqualifications (Section 18)

Following persons cannot be Directors:

• Below 25 years of age
• Unsound mind or insane
• Declared bankrupt in Nepal or abroad
• Blacklisted or declared defaulter (until 3 years after removal from list)
• Incumbent Director or employee of another deposit-taking, banking, or insurance institution
• Borrower, auditor, or advisor of the bank; person with contract or personal interest
• Stock Exchange member acting as securities broker or merchant banker
• Incumbent Director of the same bank
• Person not meeting minimum share subscription requirement
• Incumbent employee of Government, NRB, or bank/financial institution
• Tax defaulter
• Convicted of theft, cheating, forgery, fraud, corruption, moral turpitude, or banking offense (until 10 years after punishment)
• Subjected to regulatory action (until 5 years after action)
• Outstanding imprisonment or fine payment

Board Meetings (Section 21)

• Frequency: At least 12 times per year
• Gap: Not more than 60 days between meetings
• Quorum: At least 51% of total Directors
• Decision: By majority; Chairperson has casting vote in case of tie
• Minutes: Must be recorded and signed by all Directors present

Functions of Board (Section 22)

• Frame necessary bylaws, directives, and procedures
• Prepare internal control system and risk management norms
• Make necessary policy management and carry out regular monitoring
• Prepare clear organizational structure
• Submit audit report and annual progress report to General Meeting
• Carry out other functions as specified by NRB

Chief Executive

Appointment and Qualifications (Section 29)

• Tenure: Maximum 4 years; may be reappointed for one additional term
• Removal: Board may remove for unsatisfactory performance after providing opportunity to submit clarification

Qualifications:

• Master's degree in management, banking, finance, economics, commerce, accounting, statistics, mathematics, business administration, or law; OR
• At least 10 years as officer level or above in banking/finance sector, government, corporate body, university, or international organization after bachelor's degree in relevant subjects or chartered accountancy
• Not disqualified under Section 18 (except parts (i) and (n))

Functions of Chief Executive (Section 30)

• Exercise powers delegated by Board and implement Board decisions
• Prepare annual budget and action plan for Board approval
• Manage human resources per Personnel Bylaws
• Implement General Meeting decisions
• Operate institution per Act and NRB directives with effective internal control and risk management
• Submit statements and documents to NRB and other agencies on time
• Operate institution protecting interests of depositors, shareholders, and institution

Permitted Banking and Financial Transactions

Class A Banks (Section 49(1))

Commercial banks may carry out comprehensive transactions including:

• Accept deposits through various financial instruments with or without interest
• Electronic banking including payments, transactions, and fund transfers
• Lending including hire-purchase, leasing, housing, overdrafts
• Project financing and hypothecation loans
• Consortium financing with other institutions
• Issue guarantees on behalf of customers
• Refinance from NRB; lend to or borrow from other banks
• Write-off credits per bylaws
• Issue shares, debentures, bonds for capital fund
• Issue and deal in letters of credit, bills of exchange, promissory notes, cheques, travelers cheques, drafts
• Issue and manage debit/credit cards and electronic instruments
• Foreign exchange business
• Government transactions per NRB limits
• Purchase and sell treasury bills and NRB bonds
• Remittance within and outside Nepal
• Custodian services for securities
• Off-balance sheet transactions
• Deprived sector lending
• Buy and sell gold and silver bullions
• Project study, research, training, consultancy

Class B Development Banks (Section 49(2))

In addition to specified Class A functions, development banks may:

• Project financing and consortium lending
• Issue guarantees with customer collateral
• Issue and deal in bills of exchange, promissory notes, cheques
• Accept loans against movable and immovable assets
• Letters of credit and remittance with NRB prior approval
• Custodian and safe deposit services
• Fund transfer within Nepal
• Study, research, training, consultancy services

Class C Finance Companies (Section 49(3))

In addition to specified Class A functions, finance companies may:

• Hire-purchase, leasing, housing loans
• Consortium financing
• Accept loans against own assets
• Sell or rent own assets
• Deal in bills of exchange, promissory notes, cheques
• Foreign currency transactions with NRB approval
• Installment loans for vehicles, machinery, household goods
• Leasing finance for movable assets
• Issue guarantees with customer collateral

Class D Micro Finance Institutions (Section 49(4))

• Disburse micro-credit to groups or members with regular savings
• Accept loans or grants from banks, financial institutions, or domestic/foreign organizations
• Evaluate feasibility of micro-credit schemes
• Provide services and consultation on micro finance mobilization
• Recover micro credits on time
• Accept deposits with NRB approval within prescribed limits
• Issue shares, debentures, bonds for capital
• Exchange credit information with NRB and other institutions

Infrastructure Development Banks (Section 49(5))

• Disburse loans and invest in infrastructure development projects
• Finance in securities of infrastructure companies
• Open letters of credit and issue guarantees for infrastructure equipment
• Issue financial instruments in national or foreign currencies with NRB approval
• Mobilize resources through long-term deposits or debentures
• Leasing transactions with NRB approval
• Loans against foreign bank guarantees

Prohibited Acts (Section 50)

Banks and financial institutions cannot:

• Purchase and sell goods for business or purchase immovable land/construct buildings except for own purposes
• Disburse credit against own shares as security
• Provide credit to Directors, 1%+ shareholders, Chief Executive, their family members, or related firms
• Exceed per-customer credit limit prescribed by NRB
• Provide credit on guarantee of promoters, Directors, or Chief Executive
• Invest in securities of Class A, B, and C institutions
• Invest beyond NRB-prescribed limits in share capital of other institutions
• Create monopoly or restrictive practices in collusion with other institutions
• Create artificial hurdles in competitive environment for undue advantage

Capital and Capital Fund Requirements

Capital Maintenance (Section 41)

• Minimum paid-up capital as prescribed by NRB from time to time
• Must be fulfilled within NRB-prescribed timeframe
• Maximum 15% of paid-up capital investment by single person/firm/company/institution
• Investors in one institution must invest less than 1% when investing in another

Capital Fund (Section 42)

• Maintain capital fund ratio as prescribed by NRB on total assets or risk-weighted assets
• NRB may also prescribe additional capital fund ratio
• If capital fund falls short, Board must inform NRB within one month with reasons and plan to restore
• NRB may direct implementation of plan or amendments

Loan Loss Provisions (Section 43)

Banks must make provisions for potential risks concerning assets including loans and off-balance sheet liabilities as prescribed by NRB.

General Reserve Fund (Section 44)

• At least 20% of net profits until paid-up capital is doubled
• At least 10% thereafter each fiscal year
• Cannot be invested or transferred without NRB approval

Liquid Assets (Section 46)

Banks must maintain liquid assets as prescribed by NRB from time to time.

Dividend Declaration (Section 47)

NRB approval required before declaring dividends. Dividends cannot be declared until:

• Preliminary expenses and previous year losses are recovered
• Capital, capital fund, and loan loss provisioning requirements are met
• General reserve fund requirements are fulfilled
• Public shares are fully sold

Credit Disbursement and Recovery

Credit Disbursement (Section 55)

• Disburse credit only after disclosing purpose, per NRB directives and Board-determined credit policy
• Obtain acceptable collateral security or guarantee to safeguard institution and depositors
• Write to concerned office to withhold collateral property from transfer
• Collect borrower identity documents, including family members and beneficial owners
• Clearly specify repayment schedule, interest, penal interest in deed or contract

Credit Monitoring (Section 56)

Banks must prepare monitoring schedule and regularly monitor whether borrowers utilize credit for stated purposes.

Credit Recovery (Section 57)

Banks may recover principal and interest by auction sale of mortgaged assets if borrower:

• Fails to abide by credit terms
• Fails to repay within stipulated time
• Is found to have misused credit for other purposes

Additional recovery powers:

• Request additional collateral if value decreases
• Recover from borrower's movable or immovable assets if collateral insufficient
• Take property into own ownership if no auction bidders
• Request NRB to recommend passport confiscation and service deprivation for defaulters
• Write to Credit Information Bureau to blacklist non-paying borrowers
• Freeze assets in foreign countries

Accounts, Records, and Auditing

Account Maintenance (Section 58-59)

• Maintain accounts precisely using double-entry bookkeeping
• Reflect exact transaction status
• Prepare balance sheet, profit and loss account, and cash flow statement in NRB-prescribed formats
• Submit to NRB within three months of fiscal year end
• Publish audited balance sheet within nine months

Audit Committee (Section 60-61)

• Composition: 3 members under headship of one non-executive Director
• Exclusions: Chairperson, sub-committee conveners, and Chief Executive cannot be members
• Meetings: Normally once in three months

Functions:

• Ascertain appropriateness of accounts, budget, internal auditing, and internal control
• Cause internal auditing of accounts and books per law and NRB directives
• Conduct management and operation audit
• Monitor compliance with Act, Rules, Bylaws, policies, and directives
• Recommend three names for external auditor appointment

External Auditing (Section 62-68)

• Timeline: Within four months of fiscal year completion (extendable by two months)
• Auditor Appointment: By General Meeting; same auditor cannot serve more than three consecutive times
• Auditor Qualification: Chartered Accountant for Class A, B, C; Chartered Accountant or Registered Auditor for Class D
• Remuneration: As determined by appointing authority

Merger and Acquisition

Framework (Section 69)

• Banks may merge with or acquire other banks by fulfilling procedures under this Act and NRB Act
• Class D institutions may only merge with or acquire same class institutions
• Infrastructure Development Banks cannot merge with regular banks

NRB-Directed Merger (Section 69(3))

NRB may order merger if:

• Capital fund is inadequate or financial position deteriorating for three years
• Acts causing adverse effect on depositor interests
• Necessary to enhance competitive capacity for financial system stability

NRB-Directed Acquisition (Section 69(4))

NRB may order acquisition if:

• Multiple institutions of same group have unhealthy financial relations
• Depositors and shareholders cannot be protected if status quo continues
• System-based risks increased and institution cannot pay liabilities
• Shares not issued to public within prescribed time or minimum capital not met
• Rapid reforms required three or more times or frequent Board disputes

Merger/Acquisition Process

1. Board Decision: Respective Boards decide on merger/acquisition
2. Application for Theoretical Approval: Joint application to NRB with feasibility, auditor reports, creditor protection provisions, asset details, employee management plan, preliminary agreement
3. NRB Inquiry: May request discussions and additional documents
4. Theoretical Consent: If no negative impact on banking system and fair competition
5. Valuation: Appoint qualified valuator for assets, liabilities, and transactions
6. Agreement: Enter into detailed merger/acquisition agreement
7. General Meeting Approval: Special resolutions from respective General Meetings
8. Final Approval: Submit to NRB with agreement and prescribed matters

Liquidation

Voluntary Liquidation (Chapter 11)

Process:

1. Submit application with action plan to NRB
2. NRB grants theoretical consent if confident institution can pay all credits and liabilities
3. Inform Company Registrar within 7 days
4. Send notice to all depositors and creditors within 30 days
5. Publish notice in national newspapers within 30 days
6. Refund all deposits and liabilities within set time
7. Close operations; no new transactions
8. Submit auditing report to NRB
9. NRB grants final approval and revokes license

Mandatory Liquidation (Chapter 12)

Circumstances Leading to Mandatory Liquidation (Section 79):

• Matured deposits or financial liabilities not paid on time
• Capital fund is negative
• NRB recommends liquidation based on inspection report
• Shareholders or officials frequently obstruct depositor interests
• Frequent violations of Act and NRB directives
• Other situations determined by NRB

Process:

1. NRB files application to Court for mandatory liquidation
2. Court orders initiation of liquidation process
3. NRB suspends all financial transactions and may revoke license
4. Court appoints Liquidator from NRB-recommended names
5. Board of Directors automatically dissolved; employee services terminated unless otherwise ordered
6. Liquidator takes responsibility of assets, books, accounts
7. Public notice published; notice sent to depositors and creditors
8. Claims submitted and classified
9. Liquidation plan prepared and approved by Court
10. Assets sold by auction
11. Payment made in priority order
12. Court decides liquidation completion
13. Name removed from Company Registration

Priority Order for Payment (Section 94)

1. Expenses incurred for mandatory liquidation
2. Amount paid by deposit guarantee/insurance organization
3. Remaining deposits
4. Employee salaries, allowances, and liabilities
5. Amounts payable to Government of Nepal, local bodies, and NRB
6. Outstanding amounts payable to other banks/financial institutions
7. Amounts for other creditors and claims
8. Shareholders as per prevailing laws

Regulatory Actions and Offenses

Regulatory Actions (Section 99)

For violations of Act, NRB Act, Rules, Directives, or Orders, NRB may take actions against institutions:

• Written warning
• Require Board commitment for reformative steps
• Order not to violate or to take reformative steps
• Prohibit dividend distribution or bonus shares
• Limit or prohibit accepting deposits or disbursing credits
• Complete or partial ban on transactions

License Suspension/Revocation Grounds:

• Transactions not initiated within 6 months of license
• Transactions closed without NRB approval
• Operating against depositor interests or failing to repay deposits
• Violation of NRB Act, this Act, Rules, Directives, or prescribed conditions
• License obtained with false description
• Deposits not guaranteed as per law

Actions Against Individuals:

• Forfeit and freeze shares; direct Board to sell
• Stop or suspend facilities including meeting allowances
• Remove Chairperson, Director, Chief Executive, or employee not working in depositor/shareholder interests
• Recover unnatural remuneration or facilities

Fines (Section 100)

For failure to provide required information or documents:

• NPR 100,000 daily for first week after deadline
• NPR 125,000 daily for second week
• NPR 150,000 daily thereafter indefinitely

For violations by promoters, Directors, shareholders, Chief Executive, officials, employees: up to NPR 1 million depending on nature and gravity.

NRB Control (Section 102)

NRB may suspend Board of Directors for up to 3 years and take control if satisfied that institution:

• Violated Act or failed to perform obligations
• Not operating smoothly
• Acting against shareholder or depositor interests

After control, NRB may:

• Remove Board suspension and handover to same Board
• Dismiss Board and form new Board from shareholders
• Convene General Meeting to form new Board
• Initiate mandatory liquidation or settlement process

Offenses (Section 103)

• Carrying out transactions without license
• Obtaining license with false statements
• Transactions against license terms
• Unauthorized foreign currency business
• Credit disbursement against Act
• Irregularities in valuation, credit recovery, auctioning
• Irregularities in merger, acquisition, liquidation, or auditing
• Attempting or abetting above offenses

Punishment (Section 104)

Deposit Protection

Security of Deposits (Section 107)

Licensed banks must make security of deposits as prescribed by NRB in accordance with prevailing law.

Banking Secrecy (Section 108)

Customer relationship and account information cannot be disclosed except:

• To NRB as required by law or for credit information exchange
• To court in connection with litigation
• To authorized investigation or prosecution officials
• To auditor during auditing
• To foreign country under mutual legal assistance laws
• As directed by NRB on request from Ministry of Finance

Right to Claims over Deposits (Section 110)

On depositor's death, claim rights go to nominee, or in order: spouse, children, parents, grandparents, siblings, other relatives. If none exist, deposit goes to NRB Banking Development Fund.

Unclaimed Deposits (Section 111)

• Banks submit statement of accounts unclaimed for 10 years to NRB annually
• Publish notice to collect unclaimed deposits once every 5 years
• If uncollected for 20 years, deposit goes to NRB Banking Development Fund

Dispute Settlement

Section 123 provides for dispute settlement between banks and financial institutions:

• First attempt mutual settlement
• If unsuccessful, NRB settles through mediation or other dispute resolution methods
• NRB decision is final