Nepal Rastra Bank’s decision to advise banks and financial institutions to prepare for a broader range of emerging risks has come at the right time. It reflects the reality that the financial stability of banks and financial institutions (BFIs) in a nation is increasingly linked to climate change, technology and natural disasters. The central bank’s new Risk Management Guidelines have brought climate-related risks, artificial intelligence, machine learning, cyber threats and operational risks into the same framework that has traditionally focused on credit, liquidity, market and interest rate risks. The message from the central bank is straightforward: a bank cannot be considered safe simply because its balance sheet and assets look healthy today. It needs to be prepared for unforeseen events and shocks that could hit borrowers, assets, payment systems and financial markets tomorrow. The recent Bhotekoshi flood has clearly demonstrated why this issue matters. The disaster damaged settlements, roads, bridges, hydropower projects, businesses and household assets across several districts. Many borrowers lost homes, businesses and sources of income. Hydropower companies suffered severe damage to generation facilities and access routes, while transport disruptions affected supply chains and trade. Those losses do not remain confined to the disaster-affected areas. They can eventually reach bank balance sheets through loan defaults, declining collateral values, insurance losses and weaker economic activity. That is how climate risk becomes financial risk.
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For years, nations and organizations have treated climate change mainly as an environmental issue. That view needs to change now. Disasters such as floods, landslides, droughts and other climate-related events can destroy productive assets and weaken the ability of households and businesses to repay loans. Banks with large exposures to hydropower, agriculture, tourism, construction or businesses in vulnerable locations can face heavy losses when a disaster strikes. Risk assessment, therefore, needs to look beyond a borrower’s immediate financial condition. A company may appear financially sound, but operating in a disaster-prone area, relying on a vulnerable power system or facing an erratic water supply can change the entire scenario for an otherwise sound company, as these factors can directly affect its ability to operate and repay its loans. Technology brings another set of risks. Though digital banking and artificial intelligence are making financial services more accessible and faster, they are also increasing banks’ vulnerability to cyberattacks, data breaches, system failures and manipulation. A serious disruption to payment systems could cause substantial losses and undermine public confidence. The new guidelines are helpful because they compel banks to take greater responsibility for averting unforeseen shocks and dangers. All organs of a bank, including boards, management, risk committees and internal audit units, must treat risk management as part of their business strategy. It should not be limited to paperwork.
Issuing guidelines by NRB is only the beginning. The real test will be implementation. NRB also needs to examine whether banks are actually assessing climate risks by stress-testing their loan portfolios and maintaining adequate cushions against unexpected losses. BFIs should also provide meaningful information about their exposure to climate, cyber and technology-related risks. The issue also goes beyond the banking sector. Nepal cannot build financial stability while leaving its physical infrastructure vulnerable. It must build roads, bridges, power plants, communication networks and industrial facilities that can withstand climate and disaster shocks. If they remain vulnerable, a single major disaster can push losses through businesses, households, banks and the wider economy. The Bhotekoshi flood has shown how quickly a natural disaster can turn into a broader economic shock. NRB is right to prepare the financial system before the next disaster strikes the nation. Financial stability does not mean preventing every loss, but ensuring that when the next flood, cyberattack, market shock or technology failure occurs, the banking system can absorb the damage without suffering losses that threaten its own existence. Therefore, serious supervision, better data and stronger institutional preparedness are required. Most importantly, banks and regulators need to stop treating these risks as distant possibilities. For Nepal, these risks have become a reality, compelling the central bank to issue its advisory to BFIs.
