Nepali Banks Shift Focus to Loan Recovery Amid Growing Bad Debt

Kathmandu, June 7, 2025 – As the current fiscal year 2081/82 nears its end, banks and financial institutions (BFIs) in Nepal have pivoted their strategy toward loan recovery rather than new lending. Despite declining interest rates, loan disbursement hasn’t picked up, and banks are under pressure to clean up their balance sheets and improve profitability by reducing non-performing loans (NPLs).

Bankers say they are now facing the dual challenge of improving annual financial statements and bringing down rising NPLs at a time when investment appetite is weak and credit defaults are rising.

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Non-Performing Loans on the Rise

According to the third-quarter report of Nepal Rastra Bank (NRB), the average NPL ratio in commercial banks rose to 5.24% in Chaitra 2081 from 3.98% in Chaitra 2080. For development banks, the NPL ratio increased to 5.56%, and finance companies experienced a sharp rise to 13.04%, from 10.40% the previous year.

Despite this, private sector credit grew to NPR 361 billion by Chaitra-end 2081, compared to NPR 222 billion during the same period the previous year. However, deposit growth has slowed significantly, rising only NPR 368 billion this year compared to NPR 409 billion last year.

Falling Interest Rates, But No Spike in Lending

Interest rates have dropped, but borrowing has not surged:

• The average base rate of commercial banks dropped from 8.51% to 6.29%

• The weighted average deposit rate declined to 4.45%

• The average lending rate fell to 8.22% from 10.55%

Despite these favorable conditions, lending hasn’t increased, largely due to low investor confidence and poor economic activity.

Why Bad Loans Are Increasing in Nepal

Multiple factors have contributed to the worsening NPL situation in Nepali banks:

1. Post-COVID Credit Boom Backfires

Banks issued aggressive loans during COVID-19 to utilize excess liquidity, often without properly assessing borrowers’ repayment capacity. Many of these loans are now defaulting.

2. Pressure to Disburse Loans

During times of excess liquidity, BFIs came under pressure to expand credit, often ignoring due diligence like borrower creditworthiness, collateral value, and repayment plans.

3. Real Estate Market Slump

A large chunk of bank loans went into real estate. However, property transactions have slowed, and borrowers are unable to repay or liquidate assets, increasing risk of foreclosure.

4. Cooperative Sector Crisis

Mismanagement and fraud in cooperatives have led to widespread defaults. As cooperatives collapse, depositors and borrowers associated with them are defaulting on bank loans too.

5. Low Capital Budget and Poor Government Spending

Nepal’s capital expenditure remains low and irregular. Delays in payment to contractors and businesses have affected cash flow, resulting in loan defaults.

6. Loans in Unproductive Sectors

Banks favored high-profit but low-productivity sectors like trading over manufacturing or industry. This has increased credit risk and failed to generate long-term cash flow.

7. Reduced Lending Capacity and Demand

With growing defaults, banks are reluctant to issue new loans. At the same time, businesses are hesitant to borrow due to uncertainty, low returns, and lack of government support.

8. Other Factors

Negative media coverage, misinformation, and lack of public financial literacy have added to public distrust. This could potentially trigger wider financial instability if not addressed.

Why Recovery is the Only Strategy Left

With NPLs rising, banks are focusing all efforts on recovering defaulted loans:

• Provisioning costs are increasing

• Profit margins are shrinking

• Capital adequacy is under stress

• Liquidity management is tightening

Recovering outstanding loans has become a survival strategy for banks.

Asset Management Company (AMC) in the Works

To address systemic NPL issues, the Government of Nepal has announced the formation of an Asset Management Company (AMC) in the FY 2082/83 federal budget.

As per Finance Minister Bishnu Prasad Paudel, the AMC will:

• Buy NPLs from banks

• Restructure loans (e.g., extending repayment periods, adjusting interest rates)

• Manage and liquidate collateral assets to recover funds

This will help banks clean up their balance sheets, restore liquidity, and regain the capacity to issue new loans.

Learning from South Korea: The KAMCO Model

After the 1997 Asian financial crisis, South Korea established KAMCO (Korea Asset Management Corporation) to acquire and manage bad loans. KAMCO’s success helped stabilize Korea’s financial system and became a global benchmark for managing distressed assets.

Nepal hopes to replicate this model with its AMC to bring long-term stability to the banking sector.

Conclusion

Nepali banks are currently navigating a delicate financial phase, caught between falling deposits, rising defaults, and slow economic activity. With loan recovery now a top priority, the success of the proposed AMC could be a game-changer in restoring confidence and enabling new investment.

But for sustainable progress, banks must improve credit assessment practices, diversify lending into productive sectors, and work closely with regulators to safeguard the financial ecosystem.