BFIs Grappling With Flushed Liquidity & Recovery Challenges

At a time when banks and financial institutions (BFIs) are awash in liquidity and credit rates have hit a floor, the weighted average lending rate sits at 7.6% with credit demand plummeting. The credit interest income of BFIs (main source of income) is projected to be adversely affected resulting in low profitability as the situation prolongs.

According to Nepal Rastra Bank (NRB) - the central regulatory and monetary authority - credit demand in the first quarter of the ongoing FY 2025/26 is a dismal 1.44%. From mid-July to mid-October 2025, the total lending volume of BFIs squeezed to just Rs 81.08 billion. The credit growth is far below the Monetary Policy 2025/26 private sector credit growth target of 12%. 

In the backdrop of the Gen Z uprising on September 8-9 that further exacerbated deteriorating business confidence, credit growth may remain flat throughout the year unless there is a seminal effort from the government.

The twin challenge of the banking sector, high liquidity with a low interest rate and marginal credit growth, is largely concerned with the country’s investment climate. “A serious effort is required from the government to create a conducive investment climate,” according to Bhuvan Dahal, former President of Nepal Bankers Association. He said, “The current challenge of the banking sector is mainly caused by low credit demand due to lack of confidence among borrowers, stemming from the prolonged economic slowdown and concerns over the security of investments.”

The 1.47% inflation recorded in the first quarter of FY 2025/26 reveals a pessimistic demand-side scenario. “Lower inflation is mainly due to plummeting aggregate demand in the economy,” said Manoj Gyawali, CEO of Nabil Bank. He added that a desirable level of inflation is also required to incentivise spending, investment and efficient labour markets.
The central bank had estimated 12% credit growth correlating with the 6% economic growth target set by the government for the ongoing FY 2025/26. However, growth may remain at 2.1% in this fiscal due to a major shock in the service sector, particularly tourism and insurance, and the loss of crops and livestock during the recent natural catastrophes, as highlighted in the recently published World Bank Group’s Nepal Development Update. 

Slow economic growth perils the credit expansion of BFIs, despite the country’s need to invest more to increase the demand for goods and services, enhance production and create more jobs to address the economic woes of its people.

The political scenario is not entirely optimistic, as the incumbent government has a mandate to hold elections on March 5, 2026. Neither investors nor the government are taking any bold decisions in such a scenario, explains Upendra Poudel, President of the Confederation of Banks and Financial Institutions Nepal (CBFIN). The consistently low dividend payouts (returns) are repelling bank promoters and many of them are planning to exit.

Status of Profit and NPL in Q1 of FY 20225/26 

In an analysis of the profit of commercial banks for the first quarter (mid-July to mid-October) of FY 2025/26, overall bank profit fell by around 19% to Rs 13.14 billion. Only five banks - Global IME Bank, Nabil Bank, Kumari Bank, Everest Bank and Prime Commercial Bank - out of the 20 commercial banks currently in operation generated a profit exceeding Rs one billion in Q1 of FY 2025/26. Many banks that enjoyed high profit growth in previous years are now witnessing only marginal profits. Notably, one commercial bank, Citizens Bank, incurred a loss of Rs 220 million in the first quarter.

Non-performing loans (NPLs) of banks have surged to 4.86% compared to 4.04% in the corresponding period of the previous fiscal year. The rise in NPL directly affects bank profits as they must comply with regulatory requirements related to loan loss provisioning. BFIs are required to provision 1% of the total loan under the ‘pass’ or ‘good’ loan category. This increases to 5% under the ‘watch list’ if credit repayment stalls for three months. It is then classified as ‘substandard’ if repayment stalls for 3-6 months, requiring 25% provisioning. If payment stalls for 6-12 months, it is classified as ‘doubtful’ requiring 50% provisioning. After one year or 12 months and above, it is classified as a ‘loss’ loan with 100% provisioning.
In view of the rising NPL, following the Covid 19 pandemic and subsequent economic shocks that adversely affected bank recovery, the government has announced the establishment of an Asset Management Company (AMC) to manage and enhance recoveries of distressed assets removed from the banking system. High NPL not only shrinks the lending capacity of the BFIs but also causes public trust in BFIs to decline, thereby imperiling financial sector stability. (See Table 1).

Ramifications in the economy

The expansion of private sector credit primarily spurs economic growth by pushing up aggregate demand which, in turn, incentivises economic actors. Marginal credit growth means economic growth will continue to be slow and retarded. This could lead to a rise in the outmigration of youth due to a lack of employment opportunities within the country. Moreover, a prolonged economic slowdown adversely affects debt servicing by borrowers. Ultimately, the financial sector would have to struggle to maintain its robustness and stability.
Till date, commercial banks alone possess over Rs 1,100 billion in loanable funds. They have parked over Rs 750 billion with Nepal Rastra Bank at the Standing Deposit Facility (SDF) rate of 2.75%.

Governor of Nepal Rastra Bank, Biswo Nath Poudel, underlined that bank resources cannot be utilised rampantly by allowing everything to be imported, even though the country holds enough foreign exchange reserves to cover imports for almost one-and-a-half years. He stated, “These precious resources must be channelised for the country’s economic development, particularly in sectors which enhance production and create jobs. The current debate is whether we allow the import of processed foods and other consumable items thereby depleting our forex reserves, or the turbines for electricity generation or any other imports that help enhancing productive capacity in the economy.”

Financial sector analysts have stated that the ongoing situation is gloomy, necessitating the government’s proactive intervention to boost investor confidence. Despite the central bank’s flexibility introduced through the Monetary Policy 2025/26 and subsequent reviews, the impact on borrowing has been insignificant, even though interest rates are at a favourable level for borrowers. This flexibility included deferring the enforcement of working capital guidelines for two years; increasing the credit facility for first home loans up to Rs 30 million with an 80% loan-to-value ratio; increasing agricultural loans to Rs 1 million (against crop collateral); and withdrawing the single obligor limit in margin lending (which was previously Rs 250 million).
Most importantly, BFIs are reluctant to accept deposits, actively minimising their costs associated with fixed deposits. Fixed deposit rates tumbled to around 3.5% in the second quarter, and the weighted average interest rate on savings until October was a mere 3.9%. Interest rates on normal saving deposits are practically zero. Banks are essentially just transferring the SDF rate paid by the central bank to their depositors. This situation in the financial sector is quite alarming, triggering concerns about safeguarding depositors. BFIs being cautious about minimising costs and reluctant to take new deposits, seeing them as a liability, could potentially lead to capital flight and the escalation of informal channels such as hundi, dhukuti and loan sharking within unregulated and semi-regulated cooperative sectors.

In addition, the huge resources held in provident funds, retirement funds, social security and life insurance pools, which largely rely on returns from BFIs’ fixed deposit schemes, now face herculean challenges in providing benefits to contributors. Reportedly, these funds have been actively seeking viable projects to invest in an effort to maximise returns, according to Kabi Raj Adhikari, Executive Director of Social Security Fund.

Potential initiation of the government

Given the challenges the financial sector faces due to the huge loanable funds in their vaults, along with recurring funds from sources like Employees Provident Fund (EPF), Citizen Investment Trust (CIT), Social Security Fund (SSF) and Life Insurance Funds, the government has been advised to issue project-specific bonds to invest in development projects. Deposits in banks and financial institutions will continue to rise as remittance inflow into the country remains robust. 

Remittance inflow in the first quarter of this FY 2025/26 accounted for Rs 553.31 billion, a significant growth of 35.4% compared to the corresponding period of the previous fiscal year. Since the central bank is offering 2.75% on the Standing Deposit Facility (SDF), the government could issue development or project bonds with a coupon rate of 6%-7% to mobilise these resources for development, according to Govinda Gurung, CEO of Agricultural Development Bank. This action would increase aggregate demand in the economy, spur growth in the near term, and yield a multiplier benefit from low-hanging fruit projects in the medium term. However, the government has not yet made any decision in this respect. 
As revenue has been slumping, the government requires resources for the reconstruction of public properties destroyed during the Gen Z protest and the rehabilitation of infrastructure, primarily roads, wiped out by the floods of October.

Experts argue that the government should make a consolidated effort, in collaboration with stakeholders in the investment ecosystem, to improve the investment climate. Bankers have indicated that credit demand will surge if the government ensures a conducive investment environment in the country. Moreover, due to the low absorption of resources in development projects stemming from weak implementation capacity, the government appears reluctant to issue project-specific development bonds.