Nepal’s Banking Sector Faces Rising Credit Stress Despite Adequate Liquidity

Kathmandu — Nepal’s banking sector is facing increasing pressure from deteriorating loan quality as rising non-performing loans (NPLs) signal growing challenges in borrower repayment capacity. The latest financial results of commercial banks show that the average NPL ratio of 20 commercial banks reached 5.44 percent by the fourth quarter of fiscal year 2082/83, compared to 4.6 percent in the previous year. The increase of 0.84 percentage points within a year indicates that credit risks are rising despite relatively weak credit expansion.

The rise in bad loans has become a concern because it is occurring at a time when banks are not aggressively expanding their loan portfolios. Normally, a slowdown in lending should reduce the immediate pressure on asset quality, but the continued increase in NPLs suggests that existing borrowers are facing difficulties in generating sufficient cash flow to repay loans. This points toward deeper weaknesses in economic activity and business conditions.

However, the reported NPL figures may not fully represent the actual level of stress in the banking system. A recent assessment by ICRA Nepal suggests that the volume of stressed loans could be significantly higher than officially classified bad loans. According to the study, overdue loans that have crossed payment deadlines but have not yet been classified as NPLs may account for 15 to 25 percent of total lending. Loans that have been restructured or rescheduled also represent a considerable share, indicating that hidden risks remain within bank balance sheets.

Among commercial banks, Prabhu Bank has recorded the highest deterioration in asset quality. The bank’s NPL ratio jumped from 7.01 percent to 15.55 percent within one year, an increase of 8.54 percentage points. NIC Asia Bank followed with an NPL ratio of 9.26 percent, while Nepal Investment Mega Bank recorded 8.66 percent. Himalayan Bank and Kumari Bank reported NPL ratios of 7.96 percent and 7.46 percent respectively.

The increase in bad loans has not been limited to a few institutions. Most commercial banks experienced a rise in NPL ratios during the review period. Banks such as NIMB, Siddhartha Bank, Citizens Bank, Laxmi Sunrise Bank, NMB Bank, Prime Bank and Kumari Bank saw their asset quality weaken. However, some banks, including Nepal SBI Bank, Nepal Bank, Nabil Bank and Sanima Bank, managed to reduce their NPL levels through improved recovery and credit management.

Another indication of rising credit stress is the rapid growth of non-banking assets (NBA). When borrowers fail to repay loans, banks often take over pledged collateral, but selling those assets has become increasingly difficult due to weakness in the real estate market. According to ICRA Nepal, non-banking assets held by banks increased from around Rs 11 billion in January 2024 to Rs 54 billion by April 2026. The sharp rise suggests that banks are accumulating assets that are difficult to convert into immediate cash.

The slowdown in real estate transactions has become a major challenge for loan recovery. Since property remains one of the most common forms of collateral in Nepal’s banking system, weak demand in the housing and land market has reduced banks’ ability to recover loans through collateral sales. As a result, financial resources remain locked in non-performing assets rather than returning to productive economic activities.

Changes in working capital lending practices have also contributed to repayment pressure among some borrowers. The implementation of stricter working capital loan guidelines has improved monitoring of loan utilisation, but businesses with weak turnover and declining cash flows have struggled to adjust. Companies that previously relied on flexible credit arrangements are now facing greater pressure to maintain repayment schedules.

The impact of the cooperative sector crisis has added another layer of risk. Many individuals and businesses affected by liquidity problems in cooperatives have experienced difficulties managing their finances. Reduced cash flow among such borrowers can indirectly affect their ability to repay bank loans, creating additional pressure on the formal banking system.

Despite increasing credit risks, Nepal’s banking sector is currently not facing a liquidity shortage. Banks have sufficient investable funds, and interest rates have declined significantly. However, weak economic confidence and low private-sector investment appetite have prevented credit demand from recovering. This has created an unusual situation where banks have excess liquidity but limited opportunities for safe and productive lending.

Rising NPLs could create pressure on banks’ profitability and capital strength. As bad loans increase, banks are required to allocate more funds for loan-loss provisions, which reduces net profit and distributable earnings. If credit quality continues to deteriorate, banks with weaker capital positions may face additional pressure in maintaining regulatory requirements.

The latest banking sector data indicates that Nepal’s financial system is moving from a liquidity-focused challenge toward a credit-quality challenge. The key issue ahead will not only be increasing lending volume but improving the quality of existing loans, strengthening recovery systems and identifying hidden risks before they become larger balance-sheet problems.

For regulators and banks, the priority now will be to address the root causes behind rising defaults rather than relying on temporary measures. Improving borrowers’ cash flow, strengthening credit assessment practices, reducing dependence on collateral-based lending and maintaining adequate provisioning will be crucial to protect the stability of Nepal’s banking sector.