ARE BANKS FACING A CRISIS OF TRUST
Nepal’s banking sector is navigating a moment of unusual strain and many of the big questions being raised today point to deeper issues beneath the surface. Rising non-performing loans have triggered debate on whether the problem comes from weak credit assessment and risk practices or if it is simply the latest shock in an economy that has struggled to gain momentum. At the same time, the broader economic environment has made it hard for banks and businesses alike to find their footing. Slow capital spending, unpredictable policies and a long period of stagnant growth have left the financial system carrying much of the burden with limited support from elsewhere.
Even with excess liquidity in the system, private investment remains hesitant. Borrowers are holding back, investors are unsure and the environment for new business is still difficult. Questions are now being asked about whether banks should be doing more to innovate or whether the problem lies in an investment climate weighed down by regulatory uncertainty, weak institutional support and policy shifts that make long-term planning difficult. These concerns come alongside growing pressure on banks to maintain profitability and dividends even as provisioning costs rise, sparking discussion on whether short-term expectations are undermining long-term stability.
All of this has sharpened the debate on what needs to change. How can incentives be reset so banks are better aligned with productive sectors? What will it take to restore confidence among borrowers and the public? And how should regulators and financial institutions respond when economic fundamentals, rather than isolated decisions, are driving current challenges?
Business 360 spoke to Ashoke SJB Rana, CEO of Himalayan Bank and Ganesh Raj Pokharel, CEO, Citizens Bank to explore these questions in depth.
There are many policy and political provisions for banks that are slowly eroding their profitability and long-term stability. Banks have had to take on a role as an instrument of social support. Directed lending, a hangover from the days of state planning still persists in the banking sector. Banks are restricted through policies like interest spread and service charges and therefore cannot price in the cost and risk associated with loans and services.
– Ashoke SJB Rana
CEO, Himalayan Bank
With NPLs steadily climbing, are Nepali banks facing a deeper structural problem in credit assessment and risk management, or is this merely a cyclical reflection of broader economic stagnation?
Ashoke SJB Rana: I think it is both. Nepali banks have not fully developed an overall risk management framework and have relied on collateral and market assumptions to assess credit. This is why we have faced difficulties time and again during times of cyclical downturns and policy issues resulting in stagnant economic growth. It is surprising that donors and multilateral agencies have forecasted robust growth scenarios despite the dismal economic performance of the government for such a long time. The structure of the economy that is so dependent on import duties (tariffs) to fund budgetary operations have left it vulnerable to external shocks and natural disasters.
The lack of capital spending has constrained development and is evidenced by the dismal progress of the so called ‘National Pride’ projects. The private sector has taken up most of the lead in economic growth and very often Nepal Rastra Bank has had to step in and use Monetary Policy for growth incentives in the absence of any fiscal stimulus from the government. Private sector lending reached over 90% of GDP in Nepal, whereas in South Asia it averages around 40%.
Therefore, banks have had to follow monetary policy directives and policies to foster growth and respond to economic headwinds like the blockade, earthquake and Covid, while facing an uncertain and arbitrary tax regime. The last change in government before the Gen Z upheaval created an environment where there was hardly any economic activity as market sentiment was in a wait and see mode knowing that there was a deal among the ruling coalition that leadership would change hands midway through the government’s tenure. In this environment, banks suddenly found themselves with borrowers who could not service their debt sobligations as economic activity came to a standstill.
Ganesh Raj Pokharel: Nepal’s recent macroeconomic landscape, marked by subdued investment, weak credit demand and slower activity in key sectors like tourism, construction and parts of industry has strained borrower cash flows, making previously viable loans difficult to service. This has led to a recent rise in Non-Performing Loans (NPLs), even in cases where the banks’ underwriting processes were reasonable. Consequently, the rising NPLs in Nepal appear to reflect cyclical stress rather than a structural weakness in how banks underwrite, monitor and recover loans.
The 2015 earthquake delivered a massive blow causing devastating economic damage initially estimated at nearly half of the country’s GDP at the time. The disaster resulted in immense losses to housing, agriculture and infrastructure, significantly harming sectors like tourism and triggering widespread unemployment and food insecurity. Key economic consequences included the destruction of physical assets, severe disruption to the tourism industry and a long-term setback to GDP growth and poverty reduction goals.
Just as the country stood on the verge of recovery and reconstruction from the devastating earthquake’s aftermath, the Covid 19 pandemic struck the nation and the world. This crisis plunged Nepal into its worst-ever recession, inflicting even more devastating impacts, profoundly transforming the nation for years to come and leaving lasting scars on its economy.
As the economy was recovering from the pandemic’s effects, floods across various regions of Nepal again caused significant economic damage. The economic losses were concentrated in infrastructure, agriculture, and health and education sectors. Key impacts included infrastructure damage, crop and livestock losses, business disruptions and long-term threats to food security and economic stability due to climate change and increasing disaster frequency.
Lastly, ongoing political unrest, weak capital expenditure, and recent Gen Z protests that escalated to widespread violence have inflicted further significant damage on the country’s economy. The collateral damage from this recent movement was so severe that the economy has again been hit with severe infrastructure damages, supply chain disruptions and a sharp drop in investor and consumer confidence.
While banks maintain a robust structure in credit assessment and risk management, cyclical impacts, economic stagnation and stringent regulatory guidelines remain the primary drivers for the recent surge in NPLs.
Despite having surplus liquidity, credit growth remains weak, does this indicate a crisis of confidence among borrowers, a failure of banks to innovate lending products, or deeper weaknesses in the country’s investment environment?
Nepal’s recent macroeconomic landscape, marked by subdued investment, weak credit demand and slower activity in key sectors like tourism, construction and parts of industry has strained borrower cash flows, making previously viable loans difficult to service. This has led to a recent rise in Non-Performing Loans (NPLs), even in cases where the banks’ underwriting processes were reasonable. Consequently, the rising NPLs in Nepal appear to reflect cyclical stress rather than a structural weakness in how banks underwrite, monitor and recover loans.
– Ganesh Raj Pokharel
CEO, Citizens Bank
Ashoke SJB Rana: It is more of a case that excess liquidity exists due to the weakness in the country’s investment environment rather than the failure of banks to innovate and lend. No investor likes uncertainty and the situation we are in is very unpredictable. In the rankings of ease of doing business, overall Nepal was 94th and 135th for starting a business. For Foreign Direct Investment (FDI), the environment is even more difficult with outright ownership limited and the requirement to have a local partner a prerequisite for many investments. Also, the visa rule is very restrictive for expats and therefore limits the appetite to invest.
For FDI, the whole infrastructure of support services like accounting and legal firms should be allowed. We need to upskill these services to give comfort to those investing from abroad. Tax laws are opaque and the government seems to be guided by public sentiment rather than upholding the legal provisions that allowed the investments to come in.
Ganesh Raj Pokharel: Nepali banks currently offer innovative lending products, suggesting that weak credit growth is attributable to a lack of borrower confidence and innovation in the private sector rather than the banks’ failure to innovate their offerings.
A crisis of confidence among borrowers is a significant factor hindering credit growth. Many individuals and businesses are reluctant to borrow due to slow economic activity, sluggish demand and political instability in the country which has made entrepreneurs hesitant to expand. Furthermore, frequent regulatory changes imposed by the regulator, tax uncertainties and inconsistent government decisions have collectively diminished the risk-taking appetite of both individuals and businesses. Lastly, weak post-recovery from the damages the country endured following natural calamities and the pandemic still poses a vulnerability, leading businesses to actively avoid long-term liabilities.
The root cause for the lack of private sector confidence lies in the structure of the country’s investment environment. Key contributing factors include the lack of a stable long-term investment environment where economic growth remains consumption-driven rather than investment-driven along with bureaucratic hurdles that reduce investment appetite, declining productivity sectors, and the failure of capital flight and remittance to convert into productive investment. These elements remain the deepest and most influential reasons for the lack of credit growth.
As profit margins narrow and dividend expectations persist, are banks compromising their long-term stability for short-term shareholder satisfaction and how sustainable is this pressure in the face of rising provisioning costs?
Ashoke SJB Rana: There are many policy and political provisions for banks that are slowly eroding their profitability and long-term stability. Banks have had to take on a role as an instrument of social support. Directed lending, a hangover from the days of state planning still persists in the banking sector. Banks are restricted through policies like interest spread and service charges and therefore cannot price in the cost and risk associated with loans and services. Because of this, banks have had to rely increasingly on interest income for a major source of its revenue. Even though with the partnership of Nepal Rastra Bank, the banking sector has invested and facilitated the cheque clearing and payments system, they have not been able to pass on or price in the cost of the risk involved on the digital transactions.
This means that any rise in bad loans and provisioning will erode their ability to give dividends and fulfil shareholder expectations and the stock market. Also, the market and the economy cannot absorb or take on the magnitude of loans mandated by the directed lending requirements further putting a strain on the risk portfolio of banks and subsequent NPL levels now being seen in those sectors.
Ganesh Raj Pokharel: The banking business is fundamentally long-term, not short-term. While profit margins in the Nepali banking industry are currently tightening due to high competition in lending, increased operating expenses, weak credit demand, low private sector investment and limited fee-based income streams, banks are not compromising their long-term sustainability. The persistent rise in provisioning costs is directly linked to strengthened rules on loan loss provisioning and the adoption of the NFRS 9 Expected Credit Loss (ECL) calculation model.
Even with provisioning costs on the higher side and given the current economic situation, there might be a short-term risk of default. If this pattern continues, banks face the challenge of a weakened balance sheet due to delayed recovery of stressed loans. However, thanks to strong credit structure, credit assessment, credit monitoring and stringent regulatory norms, coupled with the anticipation of cyclical effects on the economy, the overall performance of the banking sector is sound. Banks are not compromising their long-term stability and the current spike in NPLs does not equate to an actual loss risk to the bank, as they maintain enough cushion when originating loans.
How can Nepal’s banking sector realign its incentives to support economic productivity and job creation?
Ashoke SJB Rana: Banks cannot operate in the long run without more depth in the financial markets. The economy needs to open up and allow a bond market to take hold. Banks need to diversify its expertise and revenue from interest income to investment income and service revenue.
We are moving to a newer accounting regime in NFRS and the ECL model for loan loss. Banks are ready to invest in any sector and venture that is viable and have been doing so. The investment environment and reform in government services to facilitate business and job creation is needed. A major issue is the tax and duty structure that needs to be aligned to incentivise entrepreneurs to open and run business. Trying to get banks to forcibly lend to borrowers that do not have the entrepreneurial aptitude or knowledge just adds to the list of social problems that the policy is trying to alleviate.
Ganesh Raj Pokharel: Nepali banks have consistently designed innovative products to support genuine economic productivity and creation, moving beyond mere asset growth. Banks have extended loans to small-scale startups, farmers and MSMEs as well as to large-scale industries like cement, hydropower and infrastructure, all of which have created jobs and increased economic turnover.
The core issue lies not with the banks but with the ongoing political instability, frequent policy changes and shifts in regulatory guidelines, resulting in a weak confidence level among borrowers. Nepal Rastra Bank has set specific thresholds for priority sector lending for banks and financial institutions, however, the funds provided by banks for these priority sectors often appear to be used for consumption rather than for the intended sectors.
One point is very clear and that is banks are always ready to support genuine borrowers. Nevertheless, the intensity and confidence of the borrower remain crucial factors for achieving productivity and creation. The government’s launch of the Startup Loan 2082 Programme allows startups to borrow between Rs 5 lakhs and Rs 20 lakhs at 3% without collateral. This initiative will certainly boost the banks’ efforts, provided the borrowers utilise the fund for its intended purpose.
Given mounting concerns about regulatory oversight and governance lapses, what will it take for the central bank and financial institutions to restore public confidence?
Ashoke SJB Rana: In an economy that is stagnant and not growing, banks reflect the business environment that they are operating in. Rather than try to see it as a lack of regulatory oversight or governance lapses it would be better to scrutinise the role, policies and politics of the government and the conduct of fiscal policy that is the root of all the problems. The dialogue should shift to the government that has systemically failed to implement its capital budget and revenue target for more than five years.
The central bank and monetary policy can only do as much as it can to augment and align with the government budget performance to make a difference in economic growth. It cannot be the lead. It can however make sure that financial institutions are well regulated, capitalised and insulated from political interference.
Ganesh Raj Pokharel: Restoring public confidence requires structural, transparent and consistent actions supported by self-governance, not merely small fixes. Currently, key concerns in Nepal centre on political instability, frequent changes in policies and guidelines, rising NPLs, weak corporate governance and inconsistent enforcement. While banks and financial institutions have a role in ensuring transaction-level transparency and self-governance to rebuild public trust, the government and the central bank bear the major responsibility for formulating stable, structural policies and guidelines, moving away from temporary, ad-hoc remedies. Furthermore, the financial literacy activities currently undertaken by the central bank and BFIs appear insufficient, which is also a major factor hindering the restoration of public confidence.
