Turning Monetary Comfort into Economic Growth Remains Nepal’s Key Test

Nepal’s formal banking journey spans nearly nine decades, but the experience of modern, customer-oriented banking is relatively recent. The transformation began in the 1980s, when foreign joint-venture banks entered the Nepali market with government backing. Institutions such as Nabil Bank, Nepal Investment Bank, and Standard Chartered Bank introduced competitive products, professional management, and international standards, setting the stage for a structural shift in financial services.

In the years that followed, Nepal’s banking sector expanded rapidly. By the late 2000s, the country had more than 30 commercial banks, alongside development banks, finance companies, and microfinance institutions. This rapid expansion created an overcrowded financial market, increasing competition but also intensifying systemic vulnerability. The global financial crisis of 2008 exposed these weaknesses, and by the early 2010s, liquidity stress and volatile interest rates emerged as recurring challenges.

The adoption of a federal structure in 2015 coincided with a major consolidation drive led by Nepal Rastra Bank. Higher capital requirements and merger policies reduced the number of commercial banks to 20, strengthening balance sheets but also limiting aggressive expansion. Despite its relatively short modern history, Nepal’s banking sector achieved notable progress in digital payments, financial inclusion, and asset quality, placing it among the stronger systems in South Asia.

A Sector Tested by Repeated Shocks

Over the past two decades, Nepal’s financial sector has navigated a series of domestic and global disruptions. Political instability, the decade-long conflict, the 2015 earthquake, the COVID-19 pandemic, and global supply chain disruptions linked to geopolitical tensions all left economic scars. During the pandemic, banks played a stabilising role, supporting businesses through refinancing and liquidity measures and preventing a deeper economic collapse.

However, the prolonged use of tight monetary policies to curb global inflation—mirrored by Nepal Rastra Bank—has constrained credit flow. While inflation control was necessary, the side effects are now visible in sluggish investment, rising stress in small businesses, and growing pressure on bank balance sheets.

Liquidity Abundance Without Lending Momentum

One of the most striking contradictions in Nepal’s economy today is the coexistence of excess liquidity and weak credit demand. Two years ago, banks struggled to lend due to liquidity shortages; today, they are holding trillions of rupees without viable lending opportunities. This volatility stems from Nepal’s narrow economic base, heavy reliance on remittance inflows, fluctuating imports, and inconsistent government spending.

Structural mismatches have aggravated the problem. Short-term deposits have financed long-term projects such as hydropower and hotels, increasing asset-liability risks. The lack of diversified foreign capital inflows—particularly foreign direct investment—has further amplified interest rate and liquidity swings, making financial stability harder to sustain.

Human Capital Drain: A Silent Risk

Beyond balance sheets, the banking sector faces a less visible but serious challenge: the loss of skilled professionals. Banking was once the preferred career for educated Nepali youth, offering stability and social mobility. Today, migration trends have shifted, with many qualified professionals seeking opportunities in Europe, the United States, and Australia.

Even experienced mid- and senior-level bankers are leaving the country, raising concerns about leadership continuity and institutional memory. While this creates openings for younger professionals, the pace of human capital outflow poses long-term risks to governance, risk management, and innovation in the financial sector.

Credit Quality Under Pressure

The economic aftershocks of COVID-19 continue to weigh on credit quality, particularly in small and medium enterprises. While refinancing and concessional loans provided temporary relief, Nepal lacked a comprehensive stimulus package focused on SME survival, unlike many countries that prioritised small businesses during the crisis.

As a result, SMEs remain the most vulnerable segment, with rising repayment difficulties. Although gross non-performing loans have reached around four percent, net NPLs remain low due to strong collateral coverage. Nevertheless, declining business confidence, reduced consumption, and weak government capital spending threaten further deterioration if economic activity does not revive.

Capital Adequacy and Profitability Concerns

Pressure on loan recovery and limited new lending have begun to affect banks’ capital buffers. Profit margins are shrinking, with average returns falling to single digits. The mismatch between historically high credit growth—nearly 20 percent annually over two decades—and modest economic expansion highlights deeper structural inefficiencies.

Credit flowed where demand existed, not necessarily where productivity gains were highest. Despite regulatory mandates requiring 40 percent lending to priority sectors, returns from agriculture, SMEs, and infrastructure have remained subdued due to policy gaps beyond the control of banks.

Sectoral Lessons from Energy, Agriculture, and Tourism

Hydropower offers a contrasting narrative. Government facilitation, private sector participation, and sustained bank financing together transformed the sector into an export-capable industry. This coordinated model demonstrates how aligned policies can convert financial investment into national economic gains.

Agriculture, however, tells a different story. Despite significant lending—over 13 percent of total credit—the sector remains import-dependent due to weak market access, open-border competition, and lack of policy protection. Similarly, tourism infrastructure has expanded rapidly, but poor connectivity and underutilised international airports have delayed returns on investment.

A Window of Opportunity

From a macroeconomic perspective, conditions are currently favourable. Foreign exchange reserves are strong, the balance of payments is in surplus, interest rates have declined, and liquidity is ample. In theory, these conditions should stimulate investment and growth.

Yet Nepal’s financial structure remains fragile, overly dependent on remittances and lacking diversified funding sources. The absence of a functional bond market, limited foreign capital mobilisation, and inconsistent fiscal execution continue to constrain long-term investment.

Why Investment Is Still Not Happening

The core issue is not the cost of credit but confidence. Private investors remain cautious due to uncertain demand, policy unpredictability, and weak government-led infrastructure development. Capacity utilisation in manufacturing and construction remains low, not because of insufficient capacity but due to lack of demand creation.

Youth migration has reduced domestic consumption, while investors perceive higher risks with unclear returns. Without credible assurances of market stability and profitability, capital remains idle despite favourable financial conditions.

Responsibility and Reform

The responsibility for the slowdown is shared. Governments have prioritised short-term fixes over structural reforms. Regulators have focused on managing immediate risks rather than guiding long-term transformation. Banks and businesses have often chased short-term gains instead of sustainable value creation.

Moving forward, structural reform is unavoidable. Investment must shift toward productive, export-oriented, and environmentally sustainable sectors. Export growth requires strategic planning, while green finance and climate-focused investment offer access to cheaper global funds.

The Way Forward

Nepal holds nearly NPR 50 trillion in banking resources capable of reshaping the economy if deployed effectively. Creating a stable policy environment, reforming tax and investment laws, easing exit barriers, and strengthening economic diplomacy are essential steps.

Investment should be viewed not merely as profit extraction but as opportunity creation. With coordinated action from government, banks, and the private sector, Nepal can convert today’s monetary comfort into lasting economic growth.

Conclusion

Nepal’s challenge is no longer financial scarcity but strategic direction. Liquidity, low interest rates, and external sector stability present a rare opportunity. Whether this moment translates into growth depends on leadership, reform, and confidence-building. The focus must now shift decisively from political debates to economic execution.