IMAGE VIA FACEBOOK
THE BANKER’S dilemma, in its purest form, is a simple one: take in money cheaply, lend it out dearly and pocket the difference. For most of Nepal’s commercial banks, that ancient formula has turned inside out. Deposits have swollen to Rs7.26trn, a 43% leap over three years. Loans have crept up by only 22%. The credit-deposit ratio has slumped to 72%. The system is so awash with cash that banks have parked nearly Rs763bn in “other investments”—a forty-fold increase from three years ago. This is not prudence, meaning this is panic.
The conventional narrative, beloved of central bankers and finance ministry officials, holds that Nepal’s banking sector is a success story. Capital ratios top regulatory minimums. Digital penetration is impressive: 26m mobile banking customers in a country of 30m. Branches dot the remotest hills. But beneath that glossy surface, the sector is undergoing a slow-motion identity crisis. Its traditional business — ie lending — has become a low-margin slog. Its new business — treasury management — is a bet on markets it does not fully understand. And its profits are slumping.
The problem begins with the deposit base. Savings deposits have exploded by 144% over three years, now accounting for 46% of all deposits. Fixed deposits have shrunk by 7%. This is a rational response to collapsing interest rates: why lock in a paltry yield when you can keep your money at call? But for banks, it is a nightmare. Savings deposits are rate-sensitive, flighty and short-dated. Yet the loans they are funding — hydropower projects, term lending, real estate — are illiquid and often fixed-rate. The maturity mismatch is glaring.
That mismatch would matter less if lending were profitable. It is not. Interest income has fallen by a quarter over three years, even as the loan book has grown by a fifth. The weighted average credit rate now stands at 6.64%. Deposit rates have fallen further, to 3.29%, but the spread is being squeezed from both ends. Banks are lending more and earning less. The result: net interest income has declined in nominal terms, and profits are down by nearly 8%.
So where are banks making money? Fees and foreign exchange. Commission income is up by 30%. Forex income has more than doubled. This is a healthier business model — less capital-intensive, more diversified — but it cannot replace the sheer scale of traditional lending margins.
And it exposes banks to risks they are ill-equipped to manage. A sudden shift in the rupee’s exchange rate, or a regulatory change in fee structures, could wipe out a big chunk of earnings.
The most alarming development is the explosion in “other investments”. Three years ago, this category stood at R19bn. Today it is Rs763bn. The Nepal Rastra Bank’s data does not break down what these investments are. But they almost certainly include corporate bonds, debentures as well as possibly related-party exposures. This is, rather than diversification, desperation. Banks are chasing yield in unfamiliar territory, and they are doing so with depositors’ money.
The sector’s capital position is adequate on paper — core capital at 9.6% of risk-weighted assets, total capital at 12.5%. But the quality of that capital is eroding. Retained earnings have plunged from negative Rs1.2bn to negative Rs25.5bn. In plain English the banking system has accumulated losses that top its cumulative profits. Several large institutions are distributing dividends they have not really earned. This is not a sustainable path. If the economy turns south, or if asset quality deteriorates further, those capital buffers will prove thinner than they appear.
And already asset quality is a big concern. Non-performing loans stand at 5.41%. That is manageable, but provisions have jumped by 32%. The banks are preparing for worse. The real test will come as the hydropower loans — which have grown by 65% over three years — begin to mature. These are long-gestation projects, often with cost overruns and regulatory delays. A few high-profile defaults could cascade through the system.
The sectoral lending data shows missed opportunities. Credit to agriculture has fallen by 7.4%, even as the government preaches farm-sector priority. Banks perceive higher risk and weaker collateral in agriculture, and they are voting with their balance sheets. Meanwhile consumption loans have grown by 43%, now topping Rs1.1trn. This is profitable short-term business, but it raises systemic retail-credit risk. If unemployment rises or wage growth stalls, those personal loans will sour fast.
What is to be done? The Nepal Rastra Bank faces a delicate balancing act. It cannot force banks to lend if they see no creditworthy borrowers. But it can and should scrutinise the “other investments” category. If those investments include related-party transactions or opaque corporate debt, the regulator must act. Transparency is the first line of defence.
The government for its part needs to address the barriers to private investment. The hydropower boom is welcome, but it is one sector among many. Agriculture, manufacturing and tourism all need credit, but they are held back by policy uncertainty, infrastructure gaps and a cumbersome regulatory environment. Banks are not lending because they see few attractive projects. Fix the investment climate and the credit will follow.
For the banks themselves, the path forward is difficult but obvious. They must accept that the era of easy margins is over. That means cutting costs aggressively, boosting fee income and managing their treasury exposures with more discipline. It also means rethinking their deposit strategies. The current bias towards savings deposits is a rational response to market conditions, but it leaves them exposed to interest-rate risk. They need to offer more attractive fixed-term products even if that means paying a bit more for stable funding.
The bigger truth is that the banking sector is a mirror of the economy it serves. It is liquid but not dynamic, well-capitalised but not resilient, digitally advanced but structurally fragile. The liquidity glut is a symptom of an economy that cannot absorb the savings it generates. Until that changes, bankers will continue to drown in deposits, searching for yield in all the wrong places. ■
