Mass Contract Cancellations Push Banking Sector Toward Deeper Stress as Government Targets Long-Pending Projects

Nepal’s banking system, already struggling under rising non-performing loans, is facing renewed pressure after the government began terminating multiple stalled infrastructure contracts. As the state enforces stricter discipline on long-delayed projects, banks that issued performance guarantees to construction firms are now preparing for a new wave of claims—an impact many bankers describe as “severe and immediate.”

Over the past three years, the economic slowdown has weakened loan recovery across the banking sector. As businesses faltered and repayment capacity shrank, banks saw a steady rise in non-performing loans, forcing them to increase loan-loss provisioning and book more non-banking assets. The cancellation of large infrastructure contracts risks accelerating this trend.

Bankers say the latest government move has created a new layer of challenges. While banks have struggled to maintain the quality of their fund-based loans, they now face growing liabilities on the non-fund side as well—particularly on performance guarantees issued to contractors handling major national projects.

A Sudden Policy Shift Adds Financial Shock

Following the political changes triggered by the GenZ unrest of Bhadra 23–24, the new administration has acted aggressively against long-pending and underperforming construction contracts. Three key ministries—Physical Infrastructure and Transport, Water Resources and Irrigation, and Urban Development—now led by Minister Kulman Ghising, have moved quickly to terminate dozens of projects that had remained stalled for years.

Officials argue that strict enforcement is essential to end chronic delays in national infrastructure development. But the ripple effect on the banking system has been immediate. Once the government cancels a contract, it automatically triggers a claim on the bank guarantees provided by the contractor. Banks must then pay the government and convert the unpaid liability into a forced loan against the construction company—an asset category that typically falls into non-performing status within 90 days.

Bankers say this process is likely to push the already fragile loan portfolio into deeper deterioration.

Large Projects, Large Guarantees, Large Losses

The government has begun terminating contracts across several flagship projects, including the Sunkoshi–Marin Diversion Multipurpose Project, the Babai Irrigation Project, and sections of the Mid-Hill and Postal highways. According to internal government estimates, more than 800 contracts worth nearly Rs 400 billion may face cancellation if the current policy continues.

Such large project volumes carry equally large bank guarantee exposures. Bankers warn that a 20 percent call on these guarantees alone could inject more than Rs 70–80 billion worth of forced loans into the system—pushing non-performing assets sharply higher.

A senior banker involved in the matter said the Sunkoshi–Marin project alone has already reached the claim stage. The government has issued letters to banks seeking payment of around Rs 3.60 billion, including Rs 2.40 billion in performance guarantees and Rs 1.20 billion in advance payment guarantees. Five major banks—Global IME, Machhapuchchhre, Prabhu, Prime Commercial, and Kumari—are among those exposed.

Once these guarantees are liquidated, banks must immediately classify the unpaid amount as a forced loan. If the contractor fails to settle the liability within 90 days, the loan must be fully provisioned, meaning banks must set aside 100 percent of the outstanding amount as a loss.

Why the Banking Sector Is Alarmed

According to bankers, the current situation is different from normal sectoral stress. In the past, construction firms primarily faced delays due to government inability to release payments or manage project logistics. That meant performance guarantees remained intact, and banks incurred no direct losses.

But this time, the government itself is initiating mass contract cancellations, creating direct liabilities for banks. With construction companies already weakened by three years of economic slowdown, their ability to settle the forced loans appears limited. Many such projects are large-scale hydropower, irrigation, and highway contracts—sectors where contractors often operate with thin margins and high cash-flow risk.

Bankers fear that if the government continues the cancellation drive without assessing sectoral impact, the banking sector could face a shock large enough to threaten broader macroeconomic stability.

Numbers That Signal a Brewing Crisis

According to Nepal Rastra Bank’s latest data, the banking sector’s non-performing loans have already reached 5.26 percent, while commercial banks alone stand at 5.03 percent. The system collectively holds nearly Rs 50 billion worth of non-banking assets and continues to write off bad loans.

With a loan portfolio of around Rs 5.6 trillion, bankers estimate that an additional Rs 70–80 billion in new non-performing loans could be added this fiscal year if forced loans begin to accumulate. When combined with existing non-banking exposures, overall impaired assets could approach 8 percent, a level many economists consider destabilizing.

Individual banks’ exposures vary, but sources say Nabil Bank holds the highest volume of non-fund liabilities—around Rs 80 billion—followed by Prime Commercial, Prabhu, Global IME, Nepal Investment Mega, Himalayan, and Kumari Bank.

Contractors Under Pressure, Banks Under Threat

Construction firms have long complained that delayed government payments, land acquisition hurdles, and bureaucratic bottlenecks have obstructed project progress. Now, with contract termination and guarantee claims occurring simultaneously, many firms may find themselves pushed into blacklisting.

Under Nepal Rastra Bank regulations, if a forced loan remains unsettled beyond 90 days, the borrower must be blacklisted. This could prevent firms from bidding for future projects, disrupting the entire construction ecosystem.

Bankers argue that without a coordinated approach, the government’s policy could trigger cascading defaults across the sector.

Economic Implications Beyond Banking

Economists warn that the consequences could go beyond balance-sheet stress in banks. Nepal’s infrastructure pipeline—already slow and underperforming—may be stalled further if contractors exit the market or become financially crippled. This would delay national development projects, slow capital expenditure and weaken the already fragile economic recovery.

Furthermore, the uncertainty surrounding bank guarantees may discourage large contractors from participating in future government tenders, reducing competition and potentially raising project costs.

Bankers have reportedly raised these concerns with senior bureaucrats in the three ministries overseeing the cancellations. Several have also urged the government to develop a risk-assessment mechanism before terminating contracts in bulk.

A Moment Requiring Prudence, Not Panic

Stakeholders acknowledge that stalled projects cannot be left unresolved indefinitely. However, they argue that mass termination—without evaluating the financial chain reaction—could do more harm than good. The banking sector, which forms the backbone of Nepal’s economic system, remains vulnerable to shocks. A sudden surge in non-performing loans would restrict banks’ lending capacity, tighten liquidity and further slow economic activity.

If the situation continues unchecked, multiple bankers warn that the combined stress of fund-based and non-fund-based exposures could push the sector into a crisis from which recovery might take years.

Nepal finds itself at a delicate juncture. The government’s determination to fix long-standing inefficiencies in public infrastructure is commendable. But the manner in which stalled contracts are being terminated—and the pace at which guarantee claims are being triggered—has created significant risks for the banking system.

Unless the government balances accountability with economic prudence, Nepal could face a destabilizing cycle: contractor failures, rising bank losses, reduced investment and slower national development. What began as an attempt to enforce discipline in the construction sector now carries the potential to reshape Nepal’s financial stability in the months ahead.