CHAPTER I

INTRODUCTION

1.1 Background of the Study

Operational risk and management is an essential component of banking operations, ensuring the
financial stability of financial institutions by effectively managing the risks associated with
borrowers' inability to meet their debt obligations. In the case of Prabhu Bank, a leading
commercial bank in Nepal, robust Operational risk and management practices are vital to
safeguarding the bank’s financial health and ensuring its long-term sustainability. Founded in
1996, Prabhu Bank has steadily expanded its portfolio, offering a variety of financial products
and services to individual clients, businesses, and corporations. As the bank's lending activities
have grown, so too have the potential risks associated with loan defaults. Given that the banking
sector plays a crucial role in Nepal's economic development, effective operational risk and
management is paramount, particularly in the context of the challenges posed by political
instability, economic fluctuations, and external shocks (Nepal Rastra Bank, 2020).

The importance of managing operational risk effectively is widely acknowledged in the global
banking community, with frameworks such as the Basel Accords providing clear guidelines for
risk assessment, mitigation, and monitoring. According to the Basel Committee on Banking
Supervision (2000), operational risk and management involves identifying, assessing, and
mitigating the risk of borrower defaults, as well as implementing continuous monitoring systems
to ensure a sustainable loan portfolio. For Prabhu Bank, this means applying a variety of tools
and methodologies to assess the operational worthiness of potential borrowers. These include
thorough operational scoring models, risk rating systems, and in-depth analysis of borrowers’
financial conditions and repayment capabilities. Additionally, the bank ensures that it has
established prudent policies to limit exposure to high-risk sectors and borrowers, which helps
reduce the likelihood of loan defaults (Basel Committee on Banking Supervision, 2000).

In Nepal, where economic volatility, natural disasters, and political instability can influence
borrowers' ability to repay loans, operational risk and management becomes even more
challenging. A study by Shrestha (2018) indicates that banks in Nepal often face difficulties due
to inadequate operational information, a lack of standardized lending practices, and a limited
operational assessment infrastructure. This creates an environment where managing operational
risk becomes more complex. Prabhu Bank has responded to these challenges by strengthening its
operational risk and management framework, introducing advanced technology into its
operational evaluation processes, and ensuring that loan officers are well-trained in risk
assessment techniques. The bank has also invested in improving its internal risk management
policies, ensuring that there are clear guidelines for loan approvals, disbursements, and
monitoring, which help mitigate potential losses (Shrestha, 2018).

Furthermore, Prabhu Bank has made substantial efforts to align itself with international best
practices in operational risk and management, taking into account the specific risks posed by
Nepal's unique economic and regulatory environment. As part of its risk mitigation strategy, the
bank has established provisions for loan loss and regularly conducts stress tests to evaluate the
resilience of its loan portfolio against potential economic downturns (Nepal Rastra Bank, 2020).
These proactive measures help to maintain the stability of the bank's financial position, even
during times of economic uncertainty.

In conclusion, the study of operational risk and management at Prabhu Bank provides valuable
insights into how the bank navigates the complexities of loan portfolio management in a
challenging environment. It underscores the importance of having a robust risk management
framework in place to assess, mitigate, and monitor operational risks effectively. Given the
growing competition in Nepal's banking sector and the evolving risks that come with expanding
lending activities, Prabhu Bank’s continued focus on improving its operational risk and
management strategies will be crucial to maintaining its financial stability and ensuring that it
can continue to contribute to the economic growth of Nepal.

1.2 Profile of the Organization

Prabhu Bank Limited is a leading commercial bank in Nepal, providing a broad spectrum of
financial services to individuals, businesses, and institutions. The bank was originally established
as Prabhu Development Bank in 1996, primarily focused on microfinance services. However, in
2016, the bank merged with Global IME Bank, which led to its transformation into a full-service
commercial bank under the new name, Prabhu Bank (Prabhu Bank, 2023). The merger
significantly expanded the bank’s footprint, enabling it to offer a comprehensive range of
services, including retail banking, corporate banking, trade finance, remittance services, and
digital banking solutions. This transformation helped the bank solidify its position in the
competitive Nepali banking sector (Nepal Rastra Bank, 2020).

The mission of Prabhu Bank is to provide innovative, customer-centric financial solutions that
promote financial inclusion and economic development in Nepal. With a strong focus on meeting
the diverse financial needs of its customers, Prabhu Bank delivers efficient banking services
designed to foster business growth and financial well-being. The bank has positioned itself as a
key player in facilitating operational availability, supporting businesses with customized loan
products, and enabling broader access to banking services, particularly for underserved
communities (Prabhu Bank, 2023). The bank's strategy has been aligned with the regulatory
standards set by the Nepal Rastra Bank (NRB), the central regulatory authority, ensuring
compliance with banking laws, including those on risk management and financial stability
(Nepal Rastra Bank, 2020).

Prabhu Bank has demonstrated consistent financial growth, reflecting its strong asset base and
financial stability. With a broad network of branches across Nepal, the bank provides reliable
services and has earned a reputation for sound financial management. It operates in accordance
with the regulatory framework set by Nepal Rastra Bank (NRB) and maintains a robust capital
structure, which is crucial in mitigating the challenges posed by potential loan defaults and
adverse economic conditions. Additionally, the bank’s commitment to maintaining operational
transparency and adhering to prudent banking practices further bolsters its credibility in Nepal’s
banking industry (Prabhu Bank, 2023).

A key focus for Prabhu Bank has been its operational risk and management framework, which is
vital for the bank’s sustainability in a volatile economic environment. The bank has taken
proactive steps to address the growing risk of loan defaults by improving its operational
evaluation processes and monitoring systems. Prabhu Bank employs advanced risk management
tools and strategies, which are continually refined to align with international best practices. This
approach helps ensure the bank's resilience to economic fluctuations and secures the quality of its
loan portfolio (Shrestha, 2018). Moreover, the bank has also prioritized technological upgrades
to enhance its services and streamline its operations, helping it stay competitive in an
increasingly digitalized financial sector (Nepal Rastra Bank, 2020).

In addition to its core banking services, Prabhu Bank is deeply committed to corporate social
responsibility (CSR). The bank has been actively involved in initiatives that focus on education,
healthcare, and rural development. By investing in such projects, the bank not only enhances its
social impact but also strengthens its relationship with local communities. These CSR initiatives
reflect Prabhu Bank’s broader commitment to the economic and social well-being of Nepal,
positioning it as a responsible corporate entity in the country’s banking sector (Prabhu Bank,
2023).

1.3 Statement of the Problem

The efficient management of operational risk is crucial for the sustainability and growth of
Prabhu Bank, especially in Nepal’s dynamic economic environment. Despite the bank’s efforts
to mitigate operational risks, the growing number of loan defaults, fluctuating economic
conditions, and limited access to comprehensive operational information continue to pose
significant challenges. These factors may lead to a deterioration of the bank's loan portfolio and
potentially undermine its financial stability. Therefore, a detailed investigation into the
operational risk and management practices of Prabhu Bank is necessary to evaluate their
effectiveness and identify areas for improvement.

Research Questions
 How effective are the current operational risk assessment procedures at Prabhu Bank in
minimizing loan defaults ?
 What tools and techniques does Prabhu Bank employ to mitigate operational risk, and
how do they align with global best practices ?
 What are the main challenges faced by Prabhu Bank in managing operational risk, and
how can these challenges be addressed to improve financial stability ?
1.4 Objective of the Study
The objective of this study is to evaluate the operational risk management practices of Prabhu
Bank and assess how effectively they contribute to maintaining a stable and healthy loan
portfolio. The study seeks to explore the various strategies and processes employed by the bank
in assessing and managing operational risk, focusing on the tools and techniques utilized to
mitigate potential defaults and financial losses. Additionally, the research aims to identify the
challenges faced by the bank in managing operational risk, particularly in a volatile economic
environment, and propose actionable recommendations to strengthen its risk management
framework. This will provide valuable insights into how Prabhu Bank can enhance its overall
financial stability and competitiveness in the Nepalese banking sector.The specific objectives
of the study are as follows.
 To assess the effectiveness of Prabhu Bank's operational risk assessment procedures in
reducing loan defaults.
 To examine the tools and techniques used by the bank to mitigate operational risk and
their alignment with global best practices.
 To identify challenges in operational risk and management and propose improvements
for enhancing financial stability.

1.5 Rationale of the Study

This study is important as it addresses the growing concerns around operational risk and
management in Prabhu Bank, which plays a significant role in Nepal’s financial sector. With the
increasing number of loan defaults and the challenges posed by economic fluctuations, it is
crucial to evaluate the bank’s current risk management practices. Understanding how the bank
manages operational risk will provide valuable insights into its operational strengths and areas
that require improvement. Furthermore, the findings could help strengthen Prabhu Bank's
financial stability, ensuring it remains competitive and resilient in an increasingly complex
banking environment. This research will also serve as a reference for other banks in Nepal,
offering practical recommendations for improving operational risk management practices.
1.6 Literature Review
Operational risk and management is a critical aspect of banking operations, as it directly
influences the stability and profitability of financial institutions. Effective operational risk
management ensures that a bank can minimize losses associated with borrower defaults while
maintaining a healthy loan portfolio. Various studies have examined the importance of sound
operational risk and management practices and their impact on bank performance. The Basel
Committee on Banking (2000), a well-structured operational risk and management framework
should involve identifying, assessing, and mitigating risks associated with operational exposures.
Banks are encouraged to employ risk rating systems, set lending limits, and regularly monitor
borrower behavior to avoid potential defaults. The Committee also emphasizes the need for
stress-testing models to assess the resilience of banks' loan portfolios under different economic
scenarios.

Shrestha (2018) explores the credit risk management practices of Nepali banks and highlights the
challenges faced by financial institutions, such as inadequate credit information, underdeveloped
credit evaluation systems, and high default rates in certain sectors. Shrestha’s study emphasizes
the importance of enhancing operational assessment frameworks to manage risks effectively.
This aligns with findings from Nepal Rastra Bank (2020), which reports that banks in Nepal
need to adopt more robust risk management tools to deal with the growing complexities of
operational risk.

Further, Prabhu Bank has also been recognized for its efforts in improving operational risk and
management through better risk evaluation systems. The bank applies various strategies to
reduce defaults, including rigorous borrower background checks and regular monitoring of loan
repayment patterns. However, studies such as Khadka (2019) suggest that despite these efforts,
challenges such as economic instability, limited access to operational information, and a lack of
advanced technology still affect the bank's ability to manage operational risk effectively.

Jorfi et al. (2017) stress that banks worldwide are increasingly relying on technology to enhance
their operational risk and management practices. This includes the use of operational scoring
models, automated risk assessment systems, and data analytics to predict loan defaults more
accurately. The study indicates that integrating technology into risk management processes
significantly improves efficiency and reduces human error.

In summary, existing literature underscores the importance of strong operational risk and
management frameworks in mitigating defaults and ensuring financial stability. While Prabhu
Bank has implemented various risk management measures, there is still a need for further
improvements to address challenges such as economic volatility, limited access to
comprehensive operational information, and technological advancements in risk evaluation
systems. This study seeks to build on these insights by analyzing the effectiveness of Prabhu
Bank's current practices and offering recommendations for future improvements.

1.7 Research Methodology

A systematic research study requires following a proper methodology to achieve the set of
objectives. Research Methodology is a systematic approach of finding solution of a particular
problem. It is systematic collection, recording, analysis, interpretation and reporting of data and
information. This chapter aims to present a basic framework of the research work. Research
methodology is a way of explaining how a researcher intends to carry out their research. It's a
logical, systematic plan to resolve a research problem. A methodology details a researcher's
approach to the research to ensure reliable, valid results that address their aims and objectives.
This chapter contains the research design, sample size, time frame, instrument of data collection,
validity and reliability, data processing tools and techniques, variables etc.

1.7.1 Research Design

This research is based on recent historical data of last five years. The study range is from
2076/2077 to 2080/2081. This research is mainly focused on of the Prabhu bank. To achieve
objective of the study, descriptive and analytical research design has been adopted.

1.7.2 Data Collection

In this study, data used in the research are secondary sources i.e. published/unpublished written
document, e.g. books, journals and annual reports of selected banks, trading reports of NEPSE,
website of NEPSE, NRB and other banks are used as a secondary data.
1.7.3 Population and Sample
In Nepal, there are a total of 20 commercial banks operating within the financial sector. These
banks collectively serve a wide range of customers, from individuals to large corporations, and
are integral to the country’s economic development. For the purpose of this study, Prabhu Bank
has been selected as one of the banks to assess operational risk and management practices.
Alongside Prabhu Bank, another commercial bank is also chosen, making the sample size two
commercial banks in total.

The selection of only two banks as the sample is intended to provide a focused analysis, allowing
for a detailed comparison of the operational risk and management strategies and practices of each
bank. While the findings may not be generalized to all commercial banks in Nepal, the study will
offer valuable insights into the effectiveness of operational risk and management in these
institutions. The small sample size allows for an in-depth investigation, which is essential for
understanding the specific challenges and strategies employed by these banks in managing
operational risk.

1.8 Limitation of the Study

This study is limited by several factors. First, the sample size is restricted to only two
commercial banks, which may not fully represent the broader banking sector in Nepal.
Additionally, data availability could be a challenge, as comprehensive and up-to-date
information on operational risk and management practices may not be readily accessible. Time
constraints also limit the depth of analysis, preventing a long-term view of the banks' risk
management strategies. The study may also be influenced by subjective political instability,
which can affect operational risk and management, are not considered in this research.

Some of the limitations of the study are as follows:

 The study mainly based on secondary data collected from the different sources.
 The study is simply cannot cover all the dimension of the subject matter and time period
is also limited.
 The study focuses on only two commercial banks, limiting broader applicability.
 The study’s duration limits the depth and scope of the analysis.