ILLUSTRATION: KATMANDU JOURNAL
ON THE face of it, bankers in Nepal have reason to uncork the cheap whisky. Commercial bank assets have ballooned to Rs8.6trn ($58bn). Profits are up by a fifth in the first seven months of this fiscal year. Foreign-exchange reserves, at $22.8bn, now cover nearly two years of imports—a cushion that would make the finance ministers of Pakistan and Sri Lanka weep with envy.
The truth is uglier. The banking system is not just stronger or weaker than it was. It is being fundamentally remade by forces beyond its control. And the new model brings vulnerabilities that the old one never contemplated.
Start with the seeming strength. The surge in foreign reserves, up 23% in seven months, is real. It reflects a remittance boom: Nepalis working abroad sent home $12bn in the past year, equivalent to 28% of GDP. That money flows through commercial banks, filling their coffers. Deposit growth has followed, with individual savers—not institutions—providing nearly Rs400bn of fresh funding. The banking system is swimming in liquidity.
Yet look where that liquidity is landing. Fixed deposits, the traditional bedrock of bank funding, have collapsed by Rs232bn in seven months. Savers, earning negative real returns with deposit rates at 3.5% and inflation at similar levels, have fled to savings and call accounts. These are stickier in name only; in practice they are a funding base that can evaporate overnight when rates eventually rise. Banks are borrowing short and lending long in ways that would make a savings-and-loan executive blush.
The lending, where it happens, is not quite what it seems either. Claims on the private sector have grown by 4.7%, a respectable figure. But a growing share of the income from those loans exists only on paper. Interest accrued but not yet received ballooned by 28% in seven months, to Rs127bn. This is profit that has been booked but not collected. If borrowers cannot pay, those earnings will reverse with ugly speed. The watch-list provisions, sitting at a record Rs13bn, suggest many will not.
The wider economy explains why. Growth at 4% is a recovery from the trough of two years ago, but it is anaemic by Himalayan standards. More worrying, gross capital formation has collapsed from 41% of GDP six years ago to 27%. There are simply fewer productive projects seeking bank finance. Credit is growing because the government has leaned on banks to lend, and because refinancing existing debts at lower rates generates fees. It is not being pulled by real private-sector appetite.
The external position, for all its current strength, carries its own risks. The surge in exports—up 32%—is driven almost entirely by a single product: soybean oil re-exported to India. This is arbitrage, not industrial policy. It will last exactly as long as Indian tariffs allow. When it ends, a chunk of banking activity will end with it.
The central bank, to its credit, has noticed the liquidity glut. It has absorbed a staggering Rs31.6trn from the system in seven months, mainly through deposit facilities. It has also used another instrument, the NRB bond, to mop up more. And it has doubled its gold holdings, diversifying reserves in a way that would have been unthinkable a decade ago. These are sensible moves. They are also inadequate to address the rot.
For the rot is structural. Banks are now intermediaries of remittance flows rather than allocators of domestic capital. Their balance sheets grow but their connection to the real economy attenuates. Their profits rise but their earnings quality falls. Their reserves pile up but their core funding becomes flighty. They are, in short, becoming different animals and not necessarily fitter ones.
What is to be done? The central bank should formalise its bond auctions, giving banks a predictable instrument for managing liquidity. It should tighten norms around interest accrual, forcing earlier recognition of bad loans. And it should resist the temptation to lean on banks for politically directed lending, which only postpones the day of reckoning for unviable projects.
But the deeper remedy sits outside banking. Nepal needs to invest its remittance windfall in productive capacity, not let it slosh idly through the financial system. That means reforms to attract private capital, improve infrastructure and break the political logjams that stall projects for years. Until that happens the banks will become increasingly irrelevant warehouses for money that has nowhere else to go. ■
