Nepal Central Bank Allows Interest Capitalization for Long-Term Projects

Kathmandu. The path to capitalizing interest on all long-term projects has been opened. The Nepal Rastra Bank has made this provision by amending the unified directive issued to banks and financial institutions. This move has provided relief to investors in projects that remain in the construction phase for a long time and yield returns slowly.

Previously, after the grace period set by the bank expired, the borrower was compelled to pay interest even if the project had not started production. Now, the central bank has made a provision to capitalize the interest for the period until cash flow from commercial production or operation begins, by adding it to the loan.

For clarity, the central bank has also defined long-term projects as those that take at least 2 years to start cash flow from commercial operation or production.

Key Provisions as Amended

• What was before?

Limited Exceptions: Interest accrued during the grace period was generally not allowed to be capitalized. There was a provision to capitalize interest on a case-by-case basis only in certain priority sectors such as hydropower, cement, agriculture, and hotels.

Compulsion to Pay Interest: Even if the project was still under construction and had not started production after the grace period given by the bank, the borrower was compelled to pay the interest out of pocket.

Pressure on Investors: Investors in long-term projects faced extreme financial pressure due to the obligation to pay interest before income began.

• What is now?

Open to All Long-Term Projects: By mentioning it in the loan agreement, interest capitalization will be allowed for loans disbursed for any long-term projects that require at least 2 years for construction.

Relief Until Production: Interest accrued during the grace period until cash flow (income) from the commercial operation or production of the project begins can be capitalized (converting interest into principal).

Separate Accounting: Banks will have to account for such capitalized interest separately under the heading 'Interest Capitalized Periodic Loan'. Borrowers will not have to face the stress of installments and interest until income begins.

Conditions and Procedures for Interest Capitalization

Although the central bank has provided the facility of interest capitalization, it has made a provision that banks must mandatorily create a working procedure to prevent its misuse. Banks must get a working procedure passed by the board of directors, including the sectors for which interest will be capitalized, a realistic analysis of the project's cash flow, the terms of repayment of capitalized interest, and the proposed loan-to-equity ratio. The decision to capitalize such interest must be made by the board of directors.

Additional Concessions for Hydropower and Natural Disaster Victims

The directive states that extending the grace period and capitalizing interest will be considered loan restructuring, requiring 25% loan loss provisioning. However, in cases where hydropower projects are completed but cannot operate at full capacity due to the lack of transmission lines, interest up to the extent not covered by income can be partially capitalized. This will not be considered restructuring.

Similarly, in cases of damage due to natural disasters or riots, where it takes more than 2 years to resume operation, overdue principal and interest can be collected, and an additional grace period can be given, allowing for the capitalization of interest for that period. Although this will be considered restructuring, a concession has been given to maintain only 12.5% loan loss provisioning.