Excess Liquidity Deepens in Nepal’s Banking System as Credit Growth Remains Stagnant

Nepal’s banking sector is witnessing a growing imbalance between deposits and lending, with excess liquidity continuing to pile up inside the financial system. While remittance inflows and savings deposits have pushed bank liquidity to record levels, weak credit demand and subdued private sector confidence have prevented that money from circulating into the broader economy. The trend is increasingly being viewed not as a sign of financial strength, but as an indicator of slowing economic momentum.

Latest figures released by the Nepal Rastra Bank show that banks and financial institutions currently possess more than NPR 13 trillion in lendable resources. Yet, instead of flowing into industries, businesses, infrastructure, or consumer spending, a significant portion of that money has returned to the central bank itself. Commercial banks and financial institutions have parked over NPR 10.40 trillion through liquidity absorption tools introduced by the regulator.

The data reflects a widening disconnect between liquidity availability and actual economic activity. In a healthy economy, rising deposits are typically followed by higher investment, expanding industrial activity, and stronger credit growth. In Nepal’s case, however, deposits are rising while lending appetite remains weak. This has created a situation where banks have abundant cash but limited borrowers willing or capable of taking fresh loans.

To absorb the growing liquidity pressure, the central bank has intensified the use of monetary instruments. Of the total absorbed amount, more than NPR 7.21 trillion has been collected through deposit collection instruments, while NPR 1.18 trillion has been parked under the Standing Deposit Facility (SDF). An additional NPR 2 trillion has been absorbed through Nepal Rastra Bank bonds. The repeated use of these tools highlights the central bank’s struggle to maintain stability in short-term interest rates amid excessive cash in the banking system.

Despite the banking rate remaining at 6 percent, banks are earning only around 2.63 to 3 percent returns on funds parked at the central bank. Analysts say this mismatch is gradually squeezing banking profitability. Normally, banks rely on lending activities for sustainable income generation. But when loans fail to expand, banks are forced to settle for lower-yield and short-term parking facilities, reducing their earnings potential over time.

One of the major drivers behind the surge in liquidity has been Nepal’s strong remittance inflow. Over the past year, remittance earnings have continued to rise, injecting large volumes of cash into the banking system. As a result, total deposits have climbed to nearly NPR 79.79 trillion. However, total credit expansion stands at only NPR 58.76 trillion, meaning banks have lent out just 72.95 percent of their deposits. Under existing regulatory provisions, banks are allowed to lend up to 90 percent of their deposits, indicating that substantial lending capacity still remains unused.

The structure of the banking sector also reveals where liquidity is concentrated. Commercial banks alone account for deposits worth nearly NPR 71.97 trillion and loans worth NPR 52.28 trillion. Development banks and finance companies collectively hold around NPR 7.83 trillion in deposits, with loans totaling approximately NPR 6.48 trillion. The numbers suggest that the liquidity burden is particularly concentrated among larger commercial banks, which continue to face difficulty deploying capital into productive sectors.

Bankers argue that lower interest rates alone are no longer enough to stimulate borrowing. Over the last one and a half years, lending rates have dropped significantly, yet demand for fresh loans has remained sluggish. According to banking officials, businesses are currently more focused on surviving financial pressure and repaying existing liabilities rather than expanding operations. Weak consumer demand, slower real estate activity, and declining business turnover have reduced the appetite for new investments.

Another factor contributing to weak credit growth is rising uncertainty within the private sector. Ongoing anti-money laundering investigations, tighter tax scrutiny, and increasing regulatory oversight have created caution among entrepreneurs and investors. Many businesses now prefer delaying expansion decisions until policy conditions become more predictable. Bankers say that despite repeated commitments from the government to support private sector growth, confidence has yet to fully recover.

The central bank attempted to address the slowdown through its mid-term monetary policy review by introducing several relaxation measures. These included reducing liquidity facility rates, increasing the overdraft ceiling for individuals, lowering risk weights for small and medium enterprise loans, and allowing restructuring facilities for borrowers affected by floods and landslides. However, the impact of these measures on overall credit growth has remained limited.

Economists warn that excessive liquidity should not automatically be interpreted as a positive macroeconomic signal. If funds remain trapped within the banking system instead of reaching productive sectors, economic growth could weaken further. Industries, construction, manufacturing, and trade sectors all depend heavily on credit expansion to sustain activity. Weak lending therefore directly affects employment creation, business confidence, and government revenue generation.

The situation has also put pressure on interbank interest rates. With too much cash circulating among banks, interbank borrowing rates have repeatedly fallen below the lower bound of the interest rate corridor. This has forced the central bank to continuously absorb liquidity to maintain monetary stability. Analysts believe the trend clearly reflects weak demand conditions in the broader economy rather than a shortage of financial resources.

Still, banking sector officials remain cautiously optimistic about long-term recovery. They argue that the current liquidity surplus could eventually become a positive foundation for future economic expansion if investor confidence improves and economic activity regains momentum. For now, however, Nepal’s banking system appears trapped in a paradox where money is abundant, but meaningful economic circulation remains limited.