ILLUSTRATION: D. JURMAN
NEPAL’S BANKS have a sick problem. Banks are awash with money to lend as interest rates fall and credit picks up. Yet the quality of their existing loans is rotting. The borrowers who should terrify them most are often the ones who looked safest when the cash was handed over: property owners, builders and businesses whose loans lean heavily on collateral rather than reliable cash flow.
By mid-July 2026 the gross non-performing loan ratio across Nepal’s financial sector had hit 5.7%, a record, according to the World Bank. Capital buffers stayed above regulatory requirements, and the banking system was liquid. Those facts offer comfort but they describe a system that can swallow losses today, rather than one guaranteed to dodge worse losses tomorrow.
The latest credit figures sharpen the contradiction. Between mid-July and October 11th, banks and financial institutions extended an additional Rs133bn in credit, more than four times the increase during the same period a year earlier. Yet around Rs1.56trn in lendable funds remained in surplus. Annual credit growth was about 7% by the end of the second month of the fiscal year, well below the central bank’s ambition for faster lending. Deposits, fuelled by remittances, were growing faster than banks could find borrowers they considered worth the risk.
The first danger is property. Land and buildings account for nearly 63% of outstanding credit across Nepal’s financial institutions, according to central-bank data for mid-July. Property makes an attractive form of collateral because it is tangible and can, in principle, be auctioned after a borrower defaults. But land prices can crash, sales can dry up and auctions can drag on for months. A bank may hold a valuable plot on paper while struggling to recover the cash it lent against it.
Nepal’s property market has also depended heavily on credit, remittances and expectations of rising land values. When transactions slow, developers can struggle to sell completed apartments or plots. Businesses that borrowed against property may find refinancing gruesome, even when the underlying land remains valuable. The danger grows when several borrowers rely on the same market to repay their loans. A downturn then weakens the collateral behind many loans at once.
Construction is especially exposed. The sector recorded rapid credit growth in fiscal 2025-26, while construction-related loans were among the sources of soaring bad debt. Builders face a brutal combination: weak demand for some properties, delayed payments and financing costs that remain burdensome despite lower interest rates. A project can be technically complete yet financially distressed if buyers vanish or contractors wait for money.
Agriculture poses a different risk. It accounted for 23.5% of accumulated bad loans in the sector breakdown reported in July, ahead of construction at 10.5% and trade at 10%. Farming is vulnerable to, say, crop losses and expensive inputs. Small borrowers often have limited savings to absorb a bad season. Their loan problems can spread through rural lenders and banks, particularly when lending targets encourage rapid expansion without enough attention to repayment capacity.
Small businesses deserve closer scrutiny, too. Shops, traders and manufacturers face subdued domestic demand and uncertain investment. Many borrow for working capital, expecting sales to replenish their cash. When customers spend less or suppliers demand faster payment, the cycle breaks. A borrower may have inventory and a functioning business but lack the cash to meet a scheduled instalment. For banks, the key question is how much genuine income a business produces after costs, rather than how impressive its collateral looks.
The danger is easy to miss in headline profit figures. Commercial banks earned combined net profits of Rs64.56bn in the first eleven months of fiscal 2025-26, up by nearly 20% from the same period a year earlier, according to central-bank data reported in July. Higher profits can coexist with deteriorating loans because banks recognise credit losses over time and set aside provisions according to regulatory rules. The bill for today’s weak borrowers may arrive across several reporting periods.
Regulatory forbearance also deserves attention. It can prevent temporary distress from turning into needless business failures, especially when the wider economy is weak. But repeated extensions and relaxed classification rules can blur the difference between a viable borrower who needs time and a borrower whose business model has broken down. The longer a bad loan sits unresolved, the tougher it becomes to judge the real condition of a bank’s balance sheet.
The Nepal Rastra Bank faces a delicate task. Forcing banks to recognise losses and strengthen provisioning may hurt profits in the short term: yet hiding the problem would leave lenders weaker when conditions worsen. The regulator should demand credible cash-flow assessments, transparent loan classification and realistic collateral valuations. Banks should also be pushed to recover viable loans through restructuring while recognising losses promptly where repayment has become implausible.
The answer is hardly to stop lending. Nepal needs credit for productive businesses, new factories, expanding exporters, etc. With growth slowing to 3.9% in fiscal 2025-26, an indiscriminate credit squeeze could make the economy weaker and create more defaults. The challenge is to direct money towards borrowers who can generate income, rather than those who can offer land as security.
Banks are unlikely to run out of deposits soon. Their main problem is deciding who deserves them. The borrowers to fear are those whose repayment plans depend on, say, rising property prices or another loan. A bank can survive a bad year. It has a much more difficult time when, say, its borrowers grow poorer and its profits conceal the damage. ■
