Kathmandu – Nepal’s banks and financial (BFIs) institutions are currently holding around Rs 869 billion in investable funds. 

Despite a significant rise in deposits, credit expansion remained sluggish, which has started to destabilise the financial system.

Interest rates on both deposits and loans are decreasing abnormally.

According to the latest data from Nepal Rastra Bank (NRB), the average interest rate on loans has dropped to 8.11 percent, while the average deposit rate has fallen to 4.37 percent.

Since credit disbursement has remaining unsatisfactory, banks are now investing at base rates. 

As a result, the interest spread—the difference between lending and deposit rates—has fallen below the limit set by the central bank.

With excess liquidity in the BFIs, the interbank interest rate has started to fall below 3 percent.

In response, NRB has begun issuing short-term monetary instruments of more than two months’ maturity to mop up excess liquidity.

Currently, total deposits in the banking system have reached Rs7.082 trillion, while total credit disbursement stands at Rs 5.582 trillion. 

The average credit-to-deposit (CD) ratio of banks has dropped to 77.73 percent . 

As the fiscal year nears its end, deposits are expected to rise further, pulling the CD ratio even lower.

BFIs are also facing significant pressure from rising non-performing loans (NPLs). They have been unable to recover loans effectively.

In response, many banks have recently started aggressively offering top-up loan facilities to borrowers.

Although this strategy may reduce NPLs and temporarily show improved profits in the short term, it will undoubtedly cause problems in the long run. 

However, the central regulatory authority,NRB, has failed to pay adequate attention to this matter. 

The new leadership at the central bank appears to lack deep understanding of the issue.

Additionally, BFIs are facing structural issues with their core capital ratios. The difficulty in loan recovery has increased their provisioning costs, thereby straining their retained earnings and primary capital base. 

This has caused banks to focus more on recovering existing loans than issuing new ones.

Some banks, facing stress on their supplementary capital, have started issuing bonds to raise funds.

Meanwhile, there has been no significant rise in loan demand within the economy. The current fiscal budget also failed to promote development projects that could stimulate economic activity, and as a result, overall demand in the economy remains sluggish.

This weakness in demand has further slowed down economic activities, keeping credit demand stagnant and discouraging new investments from BFIs.

On another front, the IPO issuance process of some hydropower companies has been stalled at the Securities Board of Nepal (SEBON).

Conflicting recommendations from the Public Accounts Committee and the Finance Committee of the House of Representatives have prevented SEBON from granting approval for the IPOs. 

This deadlock has created difficulties for hydropower companies in repaying loans from BFIs.

Had these hydropower companies been able to raise funds via IPOs and used them to repay bank loans, banks would have benefitted from increased income and improved financial health. 

However, the differing opinions of parliamentary subcommittees have caused major disruptions.

Likewise, construction contractors have also struggled to repay principal and interest on their loans. 

To address this, the central bank has extended its loan restructuring facilities, even for priority sector loans of up to Rs 20 million.

This provision is expected to curb the rise in NPLs and benefit borrowers. 

However, it may erode borrowers’ repayment discipline and ultimately harm BFIs in the long term.

Further, many small and medium-sized loans issued during the COVID-19 pandemic under refinancing schemes are now facing repayment issues. 

These refinancing and subsidised loans have been cited as major contributors to current problems within BFIs.

The government has already presented the budget for the upcoming fiscal year.

Entrepreneurs appear somewhat optimistic about the new tax policies and foreign investment strategies included in the budget, which are believed to help revitalise the economy.

Economist Bishwonath Poudel has been appointed as the new Governor of Nepal Rastra Bank. He has expressed his intention to prioritise supervision over regulation. 

Under his leadership, a new Monetary Policy Recommendation Committee has been formed, chaired by former SEBON chief Rewat Bahadur Karki. The upcoming monetary policy will be drafted based on this committee’s recommendations.

If the forthcoming monetary policy fails to address the problems facing BFIs, the entire banking system may face collapse. 

Unless banks significantly boost credit disbursement, the sector could enter deep trouble in the next fiscal year.

Three commercial banks are reportedly close to triggering Prompt Corrective Action (PCA) by NRB. The central bank must find ways to protect them through the upcoming monetary policy.

Additionally, nearly a dozen commercial banks are operating at a loss. Bringing these banks back to profitability will also be a key responsibility of the new monetary policy.

If the policy fails to address rising NPLs—currently averaging 5 percent across banks—and provide mechanisms for writing back loan loss provisions, the banking sector will become even more vulnerable.

For this, Governor Poudel must hold consultations within the central bank and with CEOs and investors in the banking sector to find workable solutions.

Governor Paudel has also made some provocative and controversial remarks, which are proving counterproductive in the current banking scenario. 

However, he still has both time and resources at his disposal to engage in dialogue and introduce reforms that could strengthen the sector. 

He must use these wisely.

As some difficult decisions lie ahead for the central bank, proposals like forced loan expansion or using monetary policy to generate employment and raise production are economically counterproductive. These goals should instead be addressed via fiscal policy.

According to the Nepal Rastra Bank Act, the central bank’s primary responsibilities are to safeguard external stability—especially foreign exchange reserves—maintain interest rate stability, and ensure price stability. 

Within that mandate, it must also work toward strengthening BFIs while protecting the interests of depositors and borrowers.

Additionally, Governor Poudel must become more serious about preventing loan misuse and enforcing compliance with regulations through stronger supervisory mechanisms. 

At this time, instead of approving new banks, his priority should be to protect and stabilise the existing ones.