Excess Liquidity Pushes Nepal’s Interest Rates Lower

Nepal’s banking system is increasingly showing signs of excess liquidity as deposit growth continues to outpace credit demand, forcing banks and financial institutions to steadily lower both lending and deposit interest rates. Latest data published by the Nepal Rastra Bank suggest that while money is flowing strongly into the banking system, the broader economy is still struggling to generate sufficient private sector investment demand.

By the end of Chaitra in the current fiscal year 2082/83, the weighted average lending rate of commercial banks had fallen sharply to 6.77 percent, down from 8.22 percent during the same period last year. The decline of nearly 1.5 percentage points within a year reflects the growing pressure on banks to push credit into the market amid weak borrowing appetite from businesses and households.

A similar trend is visible across other financial institutions as well. The average lending rate of development banks dropped to 7.96 percent from 9.59 percent a year earlier, while finance companies reduced their average lending rate to 9.26 percent from 10.40 percent. The synchronized decline across the banking sector indicates that the issue is not institution-specific, but linked to broader macroeconomic conditions.

The fall in interest rates has not been limited to loans alone. Deposit rates have also declined significantly as banks struggle to manage excess funds sitting idle within the financial system. According to central bank figures, the weighted average deposit rate of commercial banks has dropped to 3.40 percent, compared to 4.45 percent in the previous year.

Development banks and finance companies have witnessed similar declines. Deposit rates at development banks fell to 3.77 percent from 5.22 percent, while finance companies lowered rates to 4.74 percent from 6.24 percent. The trend suggests that banks no longer face strong competition to attract fresh deposits because liquidity conditions have already become highly comfortable.

The continuous fall in deposit rates is gradually weakening returns for savers. For many households that traditionally rely on fixed deposits and savings accounts as a stable source of income, lower interest earnings are beginning to reduce real returns, especially as inflationary pressure slowly starts to rise again. At the same time, however, lower borrowing costs are creating relatively favorable conditions for individuals and businesses seeking loans.

The decline in banks’ base rates further highlights the liquidity-driven nature of the current financial environment. The average base rate of commercial banks fell to 5.06 percent by mid-April, down from 6.29 percent a year earlier. Development banks reduced their base rate to 7.36 percent from 8.34 percent, while finance companies brought theirs down to 7.48 percent from 9.17 percent.

The impact of excess liquidity is also visible in short-term money market indicators. The weighted average yield on 91-day Treasury bills declined from 3.06 percent last year to 2.61 percent this year. Similarly, the weighted average interbank rate among banks and financial institutions dropped from 3 percent to 2.75 percent. These indicators suggest that banks are holding surplus investable funds and are willing to lend money even at lower returns.

At the core of the problem lies weak credit demand from the real economy. Although deposits in the banking system continue to rise strongly, expansion in private sector borrowing has remained slower than expected. Construction activity remains subdued, industrial expansion is limited and trading businesses continue to operate cautiously amid weak market confidence and uncertain economic recovery.

According to the Nepal Rastra Bank, private sector credit expanded by 5.7 percent during the review period, increasing by Rs 311.95 billion to reach Rs 5.809 trillion. During the same period last year, private sector lending had grown by 7.1 percent, indicating that credit expansion has slowed noticeably this fiscal year.

On a year-on-year basis, private sector credit growth stood at 6.9 percent by mid-April. While the figure still indicates expansion, analysts say the pace remains below expectations considering the level of liquidity currently available within the banking system.

In contrast, deposit growth has accelerated sharply. Deposits at banks and financial institutions increased by 8.5 percent during the review period, rising by more than Rs 615 billion to reach Rs 7.879 trillion. During the same period last fiscal year, deposit growth had stood at only 5.7 percent.

The annual point-to-point growth of deposits reached 15.5 percent by the end of Chaitra, reflecting strong inflows into the formal banking system. Remittance inflows, cautious household spending behavior and limited alternative investment opportunities are believed to be among the major reasons behind the sustained rise in deposits.

The widening gap between deposit growth and credit expansion is gradually creating a liquidity-heavy banking environment. Analysts say this imbalance explains why banks are aggressively reducing lending rates in an attempt to stimulate borrowing and revive private sector activity.

Some sectors have already started to show early signs of renewed interest due to cheaper financing. Lower interest rates are gradually increasing attraction toward housing, automobiles, share market investments and business borrowing. However, economists argue that interest rate cuts alone may not be sufficient to revive broader economic momentum unless business confidence, policy stability and consumer demand improve simultaneously.

The current situation also reflects a larger transition underway within Nepal’s economy. During the high-interest-rate cycle of recent years, the banking system focused heavily on liquidity management and deposit mobilization. Now, the challenge has shifted toward effectively deploying excess capital into productive sectors without creating asset bubbles or financial instability.

For policymakers, the falling interest rate environment presents both an opportunity and a risk. On one hand, lower borrowing costs could support economic recovery and encourage investment. On the other hand, if productive sectors continue to remain weak, excess liquidity may increasingly flow toward speculative areas such as real estate and the stock market rather than long-term productive industries.

Overall, the latest central bank data suggest that Nepal’s financial system currently has money available, but lacks sufficient confidence and productive demand to absorb it efficiently. The coming months may therefore depend less on liquidity availability and more on whether the broader economy can regain enough momentum to convert cheap money into real investment and sustainable growth.