The investment situation of banks and financial institutions in Nepal’s energy sector is gradually increasing and positive. According to the latest statistics of Nepal Rastra Bank, the total loan from commercial banks in the energy sector stood at Rs 504.43 billion as of mid-October 2022.

Out of this, the loan disbursement in the renewable energy sector was Rs 445.63 billion, which is about 7.86 percent of the total credit of commercial banks during the period. However, according to the regulatory provision, this share is 9.07 percent of the total credit of commercial banks.

Most of the commercial banks have completed the provision of directed sector lending in the renewable energy sector. Lending to the sector has been found to be safe and reliable as the banks have very low non-performing loans related to this sector.

Depending on the size of the project, the loan is disbursed in a phased manner for 2 to 5 years, depending on the size and functionality of the project, and then repays only for 10 to 15 years after operation.TAG_OPEN_strong_83

Investment Returns in Energy Sector

Looking at the current situation, the payback situation of the investments made by banks and financial institutions in Nepal, especially in the energy sector, especially hydropower, is overall mixed but with long-term potential.

Although the construction and management of the project takes time, there is a tendency to pay the principal and interest of the loan on time as the hydropower and renewable energy projects generate regular income once they come into operation.

Although some of the projects that have already come into operation are at risk due to problems like transmission line, lack of assurance of power consumption, the sector as a whole seems to be doing well till date.

It cannot be denied that some of the ongoing and delayed projects have faced problems in loan repayment and interest payment. At a time when the country’s economy is becoming problematic due to various reasons, it is natural that this sector will also be adversely affected. If the political and economic sphere of the country is stable, there is a lot of potential in this area.

The increase in construction cost, delay in completion of projects on time, natural calamities, electricity exports and lack of growth in domestic demand have affected the income period. Therefore, some loans have to be restructured and rescheduled. However, in the long run, with the increase in electricity demand, export potentials and policy reforms, the bank’s investment in the energy sector will be secured and the pay-back situation will gradually improve.

Long-term investments in the energy sector have an impact on bank liquidity. Since energy is a long-term investment sector, there is little chance of immediate payback from the investment, which is sure to have some impact on the liquidity of the banks. It is not a sector like other business sectors where you can invest today and get returns tomorrow.

Depending on the size of the project, the loan flows in a phased manner throughout the construction period, usually for 2 to 5 years, depending on the size and performance of the project, and after that, the loan is repaid only for 10 to 15 years after operation.

At present, when there is sufficient liquidity in the banking system, investing in such projects does not have much negative impact on liquidity. However, long-term investments in the energy sector are likely to have a direct impact on banks’ liquidity if there is a liquidity crunch like the one seen in the past. In addition, long time taken in infrastructure construction, projects sometimes affected due to natural disasters and debt restructuring have a direct or indirect impact on liquidity management.

However, as the energy sector is a high-potential sector, Nepal Rastra Bank (NRB) has been trying to reduce the liquidity risk of the banks by raising investment in the sector through long-term refinance, energy bonds, and foreign green funding. Therefore, although there are some challenges in managing liquidity in the short term, we can be optimistic that in the long run, the investment in the energy sector will yield good and stable returns.

Resources with banks in the construction of ambitious projects

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The government has come up with an ambitious plan to increase generation, transmission, distribution and consumption in the energy sector. The Energy Development Roadmap and Action Plan, 2081 aims to attract investment of Rs 446 billion, export 15,000 MW and consume 13,500 MW within the country by 2035. For this, the government has adopted a strategy to encourage the private sector, expand transmission lines to increase domestic demand and increase electricity exports to India and Bangladesh.

According to the long-term plan set by the government in the energy sector, there is a need to construct hydropower and other energy projects on a large scale, for which the resources of Nepali banks and financial institutions alone are not enough. Since the power projects are capital-intensive, have long construction periods and give returns only after a long time, the limited capital of the banks, the short-term deposit structure and the ability to bear the credit risk are not enough to sustain all the projects alone.

Billions of rupees needed to invest in large projects will put pressure on the liquidity of banks, single credit limits and sectoral credit limits. Therefore, to develop energy as per the government’s target, resources including foreign direct investment (FDI) are needed along with the resources of domestic banks. Overall, although Nepali banks play an important role in energy development, their resources alone are not enough to meet the government’s ambitious plans.

Current investments in the energy sector

The situation of investment in the energy sector has been gradually increasing in the last few years. The latest data from Nepal Rastra Bank (NRB) also shows that the lending by commercial banks in the energy (electricity and renewable energy) sector has been steadily increasing in recent years. As of the end of October 2002, the total credit of commercial banks in the energy sector has increased significantly to more than Rs 445 billion, which is higher than the previous year. In the previous fiscal year, the flow of credit to the energy sector has been gradually increasing, which means that the energy sector is under the priority area of the bank.

The energy sector is becoming attractive for bank credit due to long-term infrastructure development, safe returns, low non-performing loans and regulatory policy concessions. However, although the instability in the political and economic situation of the country has a natural impact on the sector, the investment opportunities are increasing overall.

Strategic role of banks and financial institutions to increase investment in energy sector

To increase investment in the energy sector in the coming days, banks and financial institutions should play the role of strategic development partners and not just general loan providers. First, banks need to develop a long-term financial architecture based on the nature of their energy projects, including consortium lending, phased lending, and flexible payback schedules. Second, to reduce the risks associated with project construction and operation, it is necessary to strengthen risk assessment capacity and project monitoring system so that loans are disbursed only to feasible and sustainable projects. Third, banks should coordinate with Nepal Rastra Bank, the government and energy regulatory bodies to ensure policy clarity that boosts investor confidence.

In addition, banks and financial institutions need to mobilize long-term resources by developing alternative financial instruments such as green finance, bonds, and energy funds, and collaborate with foreign banks and multilateral institutions to share risk. It is also necessary to strengthen the deposit structure internally, attract long-term savings and institutional deposits, and adopt digital and transparent lending processes.

Risk Management

It is imperative for banks to adopt various risk management measures when investing in long-term energy projects. First, it is necessary to make a detailed assessment of the technical capacity of the project, construction cost, potential delays, and cash flow. Consortium lending can be mutually agreed with other banks or financial institutions to share the risk on large projects, while it is advisable to keep the debt structure in a long-term, phased loan and flexible payback schedule that matches the duration of the project. The use of insurance and government÷multilateral guarantees is necessary to mitigate the risk of natural calamities, loss of production or PPA.

It is becoming increasingly difficult to obtain insurance coverage for energy and infrastructure projects, which has increased the overall risk.TAG_OPEN_em_84 In the past, insurance was seen as an important way to reduce risk. However, in the current situation, insurance itself has become a source of risk as it is uncertain, expensive and claims settlement are becoming complex.

It has become increasingly difficult to obtain insurance coverage for energy and infrastructure projects, which has increased the overall risk. In the past, insurance was seen as an important way to reduce risk. However, in the current situation, insurance itself has become a source of risk as it is uncertain, expensive and claims settlement are becoming complex. The lack of adequate insurance coverage has created a situation where banks and projects have to bear natural disasters, construction risks, and operational risks, which has made investments in the energy sector more vulnerable.

Investment interest in alternative energy

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In recent years, the interest of banks and financial institutions in solar and other alternative energy sources other than hydropower has been gradually increasing in Nepal. Previously, banks were focused on hydropower projects, as cash flow was expected through large projects and assured PPAs. However, banks are expanding their role in alternative energy as the environment and policy incentives to increase investment in solar energy, biogas and small micro-hydro projects increase. Particularly, in the solar energy sector, the flow of loans to individual, community and low-capacity projects has also increased. Some banks have introduced special loan packages for solar panel÷solar farms, green finance and long-term loan facilities. There is also a possibility of an increase in investment in biogas.

Desirable policy reforms

Although credit investment in the sector has been gradually increasing in the last few years due to the mutual understanding between banks and projects, there is also a need for policy reforms by the government to increase investment in the energy sector overall. Currently, although banks and financial institutions are willing to invest in energy projects in Nepal, credit flow is limited due to long-term projects, capital intensive structure, PPA instability, liquidity challenges, risk management, and political and economic instability. In such a situation, banks and private investors will not be able to invest adequately in long-term projects without clear, stable and investment-friendly policies.

In particular, clarity and long-term guarantees on power purchase agreements and power pricing, which play a key role in boosting investor confidence. Similarly, investment in energy sector is likely to increase if there is some change in policy issues such as timely development of electricity distribution and transmission infrastructure, tax exemption and incentives in various other sectors, risk sharing structure, etc. There have been voices for a long time that the private sector should be given the responsibility of electricity trade, but no policy decision has been taken on this issue yet. In the current situation, the purchase agreement with the Electricity Authority alone is not enough to ensure additional investment in the energy sector. If these policy reforms are implemented, there is a possibility of increasing the participation of both banks and private investment in the energy sector.

Policy Implications

The directives given by the Nepal Rastra Bank at different times, sectoral credit limits and other policy provisions have had both positive and controlling impact on the investment capacity of the banks. Lately, Nepal Rastra Bank (NRB) has introduced mandatory minimum loan, interest capitalization permit until the project is commercially operational, proportionate general credit loss allowance during the construction period, management that can be divided during the construction period, reschedule and restructuring on the condition. The repayment of loans will start only after the project is operational, whether there is a delay in the construction of the project or the construction of the transmission line; In this case, the extension of the moratorium period is not considered as a reschedule, and if the loan is inactive, the loan loss can be managed only according to the installment and not in the entire loan amount.

It has systematized the investment capacity of banks, long-term, and reduced risk. Particularly, the provision of interest capitalization permission before the project operation, proportionate credit loss allowance during the construction period, and the provision of rescheduling and restructuring have made it easier for the bank to invest in long-term projects. In this way, banks will be able to invest in long-term infrastructure and energy projects without the pressure of immediate cash flow.

Collaborative Template

Although the collaboration between private sector and banks in Nepal’s energy sector is gradually increasing, it still seems challenging. The private sector needs financing to operate hydropower, solar, wind and other alternative energy projects, while banks provide loans based on the terms and conditions of investment in long-term, capital-intensive projects.

The collaboration between project directors and banks has increased through consortium lending, co-financing model and project finance. This has created an environment for risk-sharing in projects, enabling large investments and providing long-term loans. However, delays in project construction, instability, liquidity management, lack of infrastructure, and regulatory complexities are some of the reasons for the problems. However, a new roadmap of collaboration is inevitable as the private sector and banks complement each other.

Role of the banking sector in the coming years

There is a lot of hope that the role of the banking sector will become more strategic and effective in Nepal’s energy sector in the next 5-10 years. Banks will not only be limited as lenders but will also be established as partners in long-term energy development. Similarly, consortium lending on hydropower, solar and other alternative energy projects will be expanded, refinancing, green finance and long-term loan packages will be expanded.

Overall, in the next decade, the banking sector is expected to emerge as a key financial pillar, risk partner and innovative investor in the energy sector. Likewise, the proactive and strategic role of the banks in the long term is believed to play a key role in making Nepal self-reliant in the energy sector and establishing it as a test to take the country on the path of economic prosperity by making it the main sector of export.

(From the article ‘Energy Prosperity Souvenir’ 2082 by Nepal Bankers’ Association President Koirala)