IMAGE VIA X
A VISITOR TO Kathmandu’s banking district might mistake the scene for a boom. At the end of July, Nepal’s 20 commercial banks held Rs 9.28trn in assets, a 13.6% increase over the previous year. Deposits alone swelled by Rs 960bn in the preceding twelve months, a 14.7% surge.
But the busy teller windows belie a strange paralysis. Of that mountain of new deposits, only about a third—some Rs 329bn—was deployed as new loans. The rest, nearly Rs 443bn, was rotated into securities. Banks are awash in cash and have nowhere meaningful to put it.
This is a crisis of stasis. The banking system has become a giant repository for household savings, much of it flowing from remittances sent home by Nepalis abroad, and a conduit for government borrowing, rather than an engine for private investment. The credit-to-deposit ratio, a standard gauge of a bank’s lending appetite, has tumbled to 69.9%, down from nearly 85% just three years ago.
At today’s deposit levels, banks could add roughly Rs 1.5trn in new loans, a 28% expansion, before even touching the regulatory ceiling. That is the time bomb: immense, idle firepower sitting on the balance sheets, earning next to nothing, while the underlying economy remains starved of productive credit.
The composition of the deposit base explains much of the paralysis. In a revolution, savings account balances have grown two-and-a-half-fold in three years, now representing 46.4% of total deposits. Fixed deposits, meanwhile, have shrunk outright, to just over a third of the mix. Households, spooked by uncertain economic prospects, are keeping their funds liquid and refusing to lock in rates that have fallen to around 4.95%.
This is a behavioural parallel to the caution suppressing credit demand from businesses. For banks, the shift has been a boon to funding costs, which have plummeted to an average of just 3.21%, but it has also created a structural mismatch. They have swapped stable, long-term funding for fickle, rate-sensitive savings that can vanish as fast as they arrived.
The consequence is seen across the asset side of the ledger. The ratio of loans to total assets has shrunk from 66.7% to 57% in three years. In their place, the banks have built a Rs 2.56trn securities portfolio, representing 27.6% of assets. The most frantic buying is in non-government instruments, which grew 76% year on year to Rs 933bn, with a massive final-month spree of Rs 170bn in the period ending mid-July. Treasury desks are aggressively accumulating these assets at yields of around 3.4% betting that rates will stay low. The sector has morphed into a quasi-bond fund with a payments franchise attached.
This rotation has kept the profit-and-loss account afloat, but only just. Net interest income has been dead flat at roughly Rs 192bn for three years, even as the balance sheet expanded by 43%. The margin is being squeezed: the spread between lending and deposit rates has narrowed to 3.34 percentage points, down from 4.6 points two years ago.
Operating profit, however, actually improved by 4.9% in the past fiscal year, a testament to cost discipline. Staff costs rose only 4.4% and office expenses were flat. The problem is what comes after. Loan-loss provisioning, after accounting for write-backs, consumed Rs 37.4bn of operating income, up 48% from the year before. The result was a net profit of Rs 69.9bn, a 2.3% decline that belies the sector’s apparent strength.
More troubling is the quality of that profit. Provision write-backs—recoveries on loans previously written off—accounted for 75% of net earnings. Foreign exchange gains, driven by remittance flows, contributed another 20%. Government-bond interest alone, at Rs 49.1bn, effectively funds 70% of the entire sector’s bottom line. Strip away these artificial props and the core earnings power is considerably weaker than the headline suggests. The return on assets has dropped to 0.80%, and return on equity is a below-par 9.6%, which is less than any reasonable estimate of the cost of equity for a developing-economy bank.
The binding constraint on the system is asset quality. The non-performing loan ratio has doubled in roughly two years to 5.56%, representing Rs 294bn of problem debt. If one adds interest in suspense—accrued interest that is overdue but not yet classified as bad—and foreclosed assets, the stressed stack rises to roughly Rs 385bn, or 7.3% of the loan book. The sector is mid-workout, with provisions climbing for four consecutive years to Rs 310bn, representing 105% coverage of NPLs.
That is adequate but not generous. With a total capital ratio of 12.61%, just over one percentage point above the regulatory minimum including buffers, there is little margin for a second wave of defaults, particularly in real estate, construction or hospitality, where collateral values remain depressed.
The paradox is that the sector is sound but handicapped. Pre-provision profit is growing 5% annually and the cost-to-income ratio is a healthy 41%. The digital infrastructure is robust, with 25.8 million mobile-banking users and a payments franchise that is deep and sticky. Yet credit penetration remains astonishingly shallow: just 1.7m loan accounts against 54.5m deposit accounts. This defines the long-run opportunity—retail lending is a white space—but also the immediate failing. Banks are not fulfilling their primary economic function.
The turning point will be a revival in private-sector credit demand. The monthly data for Asar, the final month of the fiscal year when banks traditionally push lending, showed net new private-sector credit growth of just 0.08%. Banks would rather on-lend to development banks and finance companies, which saw a 11.1% monthly increase, than take on corporate or retail borrowers. This caution is rational given slim capital buffers and a still-rising NPL curve, but it is also a self-fulfilling prophecy. Until the credit cycle turns, the sector will remain a vehicle for absorbing remittances and financing the government, its earnings held up by write-backs and bond coupons.
The risks to this equilibrium are asymmetric. A sudden rise in interest rates would inflict mark-to-market losses on the Rs 2.56trn bond book, the consequence of the liquidity rotation that currently appears safe. A second wave of NPLs, even a 150-basis-point deterioration, would consume most of the capital buffer. And a revival in equities or real estate could pull the funding rug out from under the banks just as they have become duration-heavy. The banking system is coiled like a spring: Rs 1.5trn of unused lending capacity, record-low funding costs and a consolidated industry of 20 institutions. The moment borrower risk appetite returns, the operating leverage will be ferocious. Until that moment arrives, the sector will continue to grow deposits and buy bonds, waiting for a cycle that shows no sign of turning. ■
