ILLUSTRATION: KJ
IN THE summer of 1995 Nepal’s commercial banks held just over Rs 100bn in deposits. Thirty-one years later they hold seventy-five times that. It is a staggering accumulation of financial mass for a country of 30m people; and it has arrived with unusual speed. Over the past three years alone, deposits have grown by nearly 50 per cent.
Yet here is the puzzle. As the pile of rupees has swelled, the share of those rupees flowing out again as loans has fallen from two-thirds of assets to barely half. Banks have become collectors of savings and buyers of bonds rather than lenders to the real economy.
This is a pathology of remittance-fed growth as well as risk aversion and a credit cycle that has yet to turn.
The numbers are arresting. Deposits at twenty commercial banks grew by 14.7 per cent in the fiscal year to mid-July, striking Rs 7.5trn. Loan growth, meanwhile, limped in at 6.6 per cent. The resulting sum is being parked in government securities and other paper: investments jumped by 27.7 per cent, and non-government instruments—predominantly NRB bonds and corporate debentures—rose by an eye-watering 76 per cent. The system’s credit-to-deposit ratio stands at 70 per cent, a full twenty percentage points below the regulatory ceiling. That implies roughly Rs 1.5trn of idle lending capacity, waiting for a borrower who does not seem to exist.
The conventional explanation blames monetary policy. The central bank has cut rates aggressively; the weighted average lending rate has fallen to 6.55 per cent, a record low, with deposit rates below 3.25 per cent. Cheap money, the story goes, has failed to stimulate credit. But that gets the causality backwards.
Rates are low because demand is weak, not the other way round. Nepali households and firms are deleveraging. Non-performing loans have doubled in three years to 5.56 per cent of the book; collateral values are depressed; and bankers, their capital buffers thinner than they would like, are in no mood to extend fresh risk. The transmission mechanism has simply run into a wall of caution.
The main cause is structural and behavioural. Remittances, which amount to over a quarter of GDP, continue to flood in; and households park the proceeds in savings accounts yielding 2.8 per cent.
Over the past three years, savings deposits have grown two and a half times while fixed deposits have shrunk outright. This is precautionary: families keep funds liquid because they have no better-performing asset and because the future feels uncertain. The same anxiety that keeps cash in the bank also suppresses the appetite for borrowing. The savings glut and the credit drought are the same phenomenon.
The consequences are seen in the sector’s profit-and-loss account. Net interest income has been flat at around Rs 190bn for three years, even as assets have expanded by 43 per cent. Operating profit is growing—up 4.9 per cent in the last fiscal year—but provisioning costs consumed the entire gain. Reported net profit of Rs 70bn would have been far lower without Rs 52.5bn of provision write-backs and Rs 14bn of foreign-exchange gains. Strip those out, and underlying earnings are perhaps Rs 20bn weaker. Banks are being propped up by their own past provisions and by a remittance-driven currency flow that could reverse as easily as it arrived.
The policy response has been to exhort bankers to lend. That is worse than useless. The problem is a shortage of creditworthy borrowers and a banking system whose capital is thin where it matters. Total capital stands at 12.6 per cent of risk-weighted assets, barely a percentage point above the regulatory minimum. With a cumulative retained-earnings deficit of Rs 22bn, internal capital generation is negative. Banks cannot grow their loan books at 12 per cent without raising fresh equity. The central bank would do better to ease macroprudential constraints on loan-to-value ratios and collateral treatment, allowing banks to price risk more freely and unlock the construction and real-estate sectors that are currently frozen.
There is a larger truth here about the nature of financial intermediation in remittance-dependent economies. Nepal’s banks have become fiscal intermediaries by default, underwriting the government’s deficit through bond purchases while private-sector intermediation stalls. The bond book now accounts for 28 per cent of assets, and the government-bond interest alone funds roughly 70 per cent of banking profit. That is a fine business model in a low-yield, no-growth environment.
But it is also a trap. When the credit cycle eventually turns—and it will—banks will face a choice: hold the bonds and miss the lending opportunity, or sell them and eat the duration losses. The central bank will manage any rate normalisation carefully because the system cannot afford a bond-market shock. But the vulnerability is real.
So the question is not whether banks are healthy. It is when the credit cycle will turn. Watch the credit-to-deposit ratio: a sustained rise above 73 per cent will signal that borrowing appetite is reviving. Watch fixed-deposit share: a reversal upward means households are locking in rates again, a sign of stabilising confidence. And watch monthly private-credit growth: sustained above 1 per cent will tell you the wait is over.
For the moment, however, the banks will keep collecting savings and buying bonds. They have more firepower than ever. They just need someone to lend it to. ■
