Navigating Financial Headwinds

Banks and financial institutions (BFIs) are currently facing a dual challenge: high liquidity coupled with sluggish credit demand. Private sector credit growth reached only 6.95% for the first 10 months of the fiscal year. This falls significantly short of the 12.5% credit growth estimated by the 2024/25 Monetary Policy, which is deemed necessary to achieve the government’s economic growth targets. Despite banks holding an estimated Rs. 700 billion in available funds for lending, they have been unable to disburse these funds due to the prolonged economic slowdown.

Lack of credit appetite
A confluence of factors has exacerbated the disinclination of large businesses to borrow: a slump in consumption, a prolonged economic slowdown, and the enforcement of the working capital guideline by Nepal Rastra Bank (NRB), the central regulatory and monetary authority. This guideline restricts credit to 25% to 40% of a borrower’s annual transaction volume. Specifically, those seeking credit from Rs. 10 million to Rs. 20 million can obtain up to 40% based on their annual sales/transaction volume and justified credit needs. For credit exceeding Rs. 20 million, the limit is set at 25%.

The private sector’s umbrella organisations have opposed the stringent provisions of these working capital guidelines. One key provision requires working capital to be settled at least once a year for a minimum of seven days.

The NRB instructed borrowers utilising excess working capital to adjust their positions. Enforced on October 18, 2022, the working capital guideline aims to curb credit misuse. Borrowers who had availed working capital exceeding 20% of their annual turnover were permitted to convert the excess into term loans, to be settled through installments.

The compliance requirements of the working capital guidelines are quite stringent. For instance, the lending bank or financial institution must verify the borrower’s annual turnover. Furthermore, borrowers with credit exceeding Rs. 50 million must submit quarterly financial statements certified by an internal auditor, while those with credit below Rs. 50 million must self-certify and submit monthly statements to the bank or financial institution. If working capital is found to be availed beyond the prescribed limit or not utilised for its intended purpose, the NRB has directed banks to make a 100% provision, classifying the loan amount as a Non-Performing Loan (NPL).

Working capital is defined as credit utilised in a business for purposes other than the formation of fixed assets or capital. However, the central bank has permitted borrowers to avail fixed-term loans for five years, provided these funds are specifically used for the formation of fixed capital or assets.

Working capital guidelines on hold signals accommodative Monetary Policy
The Monetary Policy for Fiscal Year 2024/25 had initially put the enforcement of working capital guidelines on hold from mid-July 2024 to mid-July 2025. However, Nepal Rastra Bank has now extended this grace period for another two years, giving borrowers until mid-July 2027 to adjust any credit exceeding 25% of their annual turnover.

This recent amendment to the working capital guideline signals an expansionary or accommodative monetary policy. However, there are concerns that this additional flexibility could cause distortion, especially given ongoing recovery challenges and a rise in Non-Performing Loans. Bankers have cautioned the NRB to be mindful of the stress in the financial sector resulting from increasing NPLs and difficulties in loan recovery.

“Credit rates are moderately low and saving rates are at rock bottom,” stated Manoj Gyawali, CEO of Nabil Bank. He added, “As the budget has already announced loan rescheduling facilities, borrowers have started taking such schemes for granted. We hope the monetary policy will allow banks to make decisions based on the borrower’s specific requirements.”
Just days prior, Deputy Prime Minister and Finance Minister Bishnu Prasad Paudel affirmed that the monetary policy would support the budget’s targets, ensuring alignment between fiscal and monetary policies.

It is believed that at least 15% credit growth to the private sector is necessary to achieve the desired 6% economic growth. The recent amendments to the working capital guideline are expected to boost investor sentiment.

The budget has already announced certain moratorium schemes for borrowers, which had been discontinued in Fiscal Year 2022/23. Maha Prasad Adhikari, Former Governor of Nepal Rastra Bank, commented on this, stating, “Such facilities were provided once to help borrowers revive their businesses; they cannot be given indefinitely.”

Inflation control or drop in demand?
Banks have reduced credit rates, a consequence of being flush with liquidity from the previous fiscal year. Consequently, depositors, who previously benefited from high deposit rates without investment risks, are now compelled to accept significantly lower rates on deposit schemes. According to private sector leaders, this unusual situation stems from inconsistencies in the direction of Monetary Policy. Adding to concerns, the aggressive recovery efforts by banks and financial institutions (BFIs) have led to a worrying increase in blacklisting.

Kamlesh Kumar Agrawal, President of Nepal Chamber of Commerce, states that approximately 100,000 borrowers have been blacklisted by banks in the last three-and-a-half years, accounting for 70% of all blacklisted borrowers over the past three decades.

Consumption has sharply declined and the government’s reluctance to address this challenging situation by boosting aggregate demand has prolonged the economic slowdown. “The economy cannot bounce back without raising aggregate demand,” asserted Anjan Shrestha, Senior Vice President of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI).

While unconventional policies might address these cyclical effects, policymakers face a dilemma. Experts suggest that the frequent shifts in policies, alternating between regulatory flexibilities and restrictive measures, have undermined the predictability that the private sector considers a fundamental requirement for making investment decisions.

Inflation in the first 10 months of this fiscal year dropped to 2.77%, reflecting a lack of economic momentum and a slump in demand. It is difficult to reconcile inflation below 3% with robust market demands. As a result, the country’s foreign exchange reserves have reached a record high of $18.40 billion or Rs. 2512.95 billion. Nepal is currently enjoying a significant Balance of Payments (BoP) and current account surplus, recording Rs. 438.52 billion and Rs. 255.93 billion, respectively.

Concerns over high NPL & directed lending policy
The escalating Non-Performing Loans (NPLs) within banks and financial institutions post-COVID-19 pandemic present a severe threat to Nepal’s financial system. These non-performing assets not only restrict BFIs’ lending capacity but also significantly impair the financial health and stability of the entire system. To mitigate these risks, the International Monetary Fund (IMF), under its Extended Credit Facility programme, has urged Nepal Rastra Bank to conduct an asset quality review of 10 commercial banks by an international audit firm, however, this process remains stalled.

Alongside the increased provisioning requirements necessitated by high NPLs, banks’ profits and returns on investment have shrunk considerably as NPLs have risen significantly over the years. As of April 2025, NPLs constituted 5.05% of commercial banks’ total loan portfolio of Rs. 4,807.48 billion, a notable increase from 1.5% in FY 2022/23.

Newly appointed NRB Governor Biswo Nath Poudel has identified the directed lending policy as a contributing factor to the rise in NPLs. The NRB prioritises bank lending aligned with national priorities. Banks were previously urged to allocate at least 15% of their portfolio to agriculture and 10% to the energy sector by 2023 and 2024, respectively, building on an initial decade-old target of a combined 15% for energy and agriculture. Additionally, the central bank has now directed banks to lend at least 15% to micro, small and medium enterprises (MSMEs) by 2027.

According to NRB, commercial banks have so far lent 13.78% to agriculture, 8.8% to energy, and 10.92% to micro, cottage, small and medium industries.

The Confederation of Nepalese Industries (CNI) has advised Nepal Rastra Bank to gradually reduce directed lending, noting that approximately 45% of total credit is currently allocated to priority sectors. The CNI has also advocated for the abolition of the base rate, arguing that the central bank’s prohibition on lending below this rate hinders competitive projects.

Interplay of Fiscal and Monetary Policies
Debates persist regarding whether fiscal and monetary policies operate in tandem. While their objectives traditionally differ, recent years have seen fiscal budgets incorporate provisions typically associated with monetary policy. For instance, the Fiscal Budget 2025/26 has announced several facilities, including loan rescheduling, additional working capital provisions, and penalty waivers for borrowers. Critics argue that this encroaches upon the monetary policy’s jurisdiction, thereby limiting Nepal Rastra Bank’s scope in formulating it.

Generally, monetary policy tends to be contractionary when fiscal policy is expansionary. Given the moderate size of the current fiscal budget, the monetary policy is anticipated to be accommodative. Monetary policy, despite its limitations, was utilised by the government post-COVID-19 pandemic to incentivise the production and service sectors through various measures. This flexible monetary stance led to a remarkable 27% loan growth in Fiscal Year 2020/21, an exponential increase compared to the average annual loan growth of previous fiscal years. The monetary policy offered loan restructuring and rescheduling, along with over Rs. 150 billion in refinancing to borrowers, aiming to mitigate vulnerabilities and potential impacts on the financial sector. This high credit growth fuelled a boom in both the share and real estate markets. However, subsequent to widespread misuse of credit, the central bank implemented stringent measures in consecutive fiscal years, which, in turn, triggered an economic slowdown. Concurrently, the depletion of foreign exchange reserves prompted the central bank to tighten import credit.

“Fiscal and monetary policies can work together if macro-economic fundamentals are deteriorated, manage the crowding out effect and public debt management,” remarked Nara Bahadur Thapa, Former Executive Director of Nepal Rastra Bank.

 

FNCCI calls for economic acceleration and private sector support in monetary policy

The Federation of Nepalese Chambers of Commerce and Industry (FNCCI) has sought a monetary policy that accelerates the economy, boosts private sector morale, and addresses money laundering risks amid an economic slowdown, financial sector vulnerabilities, and a large informal sector.

Citing a lack of adequate infrastructure and governance undermining policy effectiveness, the private sector umbrella body requested Nepal Rastra Bank to adopt infrastructure-targeted monetary measures. It recommended concrete programmes to implement the budget’s loan-rescheduling and restructuring provisions for all businesses, regardless of size, and called for clear concessions on working capital flows and penalty interest.

To support productive sectors – manufacturing, tourism, construction and housing developers – FNCCI proposed granting banks and borrowers discretion over working capital loans and keeping industry lending rates 1%–2% below trade rates, given the sector’s share has fallen to 12.4%.

In light of Nepal’s graduation to the league of developing nations in 2026 and its sustainability, FNCCI called for concessional loans to micro, cottage, small and women-led export-oriented industries, an interest subsidy linked to production, and loans up to Rs. 50 million at a maximum premium of 2%.

Additional suggestions included easing the Watch List Provision, business registration through the Nagarik app, and promoting youth entrepreneurship with project loans up to Rs. 10 million, offering concessional credit to families of overseas remitters and establishing asset management companies to tackle rising non-performing assets.

In addition, FNCCI also backed raising the housing loan ceiling from Rs. 20 million to Rs. 30 million, linking KYC to the National ID for electronic access, providing free interoperable QR codes, and allowing domestic remittances of up to Rs. 100,000 through remittance firms on presentation of an identity card.

On overseas investment, it supported permitting Nepali firms to open sales outlets or processing plants abroad, invest up to 25% of their total exports overseas, and receive sweat equity for technology or specialised services. FNCCI further requested that private equity and venture capital (PE/VC) investments incur no additional capital charges and be recognised as directed sector loans.

FNCCI urged the central bank to consider the provision of barring domestic remittances in view of how low-income groups, informal sector workers, working-age people, those working out of home, and unbanked populations of rural areas can be served through remittance companies, and asked to allow transferring up to Rs. 100,000 internally. FNCCI further urged to increase the threshold of housing loan from Rs. 20 million to Rs. 30 million, integrate KYC to the national ID and make it accessible to government agencies, and execute interoperability of QR without any additional costs.

 

CNI urges central bank for monetary policy reforms to boost economy

The Confederation of Nepalese Industries (CNI) has drawn the attention of Nepal Rastra Bank to the ineffectiveness of the policy rate and advocated for lowering the Statutory Liquidity Ratio from the existing 12% for commercial banks. In its feedback for the Monetary Policy 2025/26, CNI urged the central bank to scrap the base rate and adopt the marginal cost of lending rate or an external benchmark lending rate, aligning with international banking practices. CNI argued that the base rate provision prevents banks from offering the best rates for competitive projects.

CNI also requested the removal of the provision mandating a 5% difference between saving and fixed deposit rates, stating that banks and financial institutions (BFIs) would not risk increasing their cost of funds by accepting fixed deposits at higher rates. Furthermore, CNI asked to eliminate the rule barring BFIs from reviewing interest rates by more than 10% compared to previously published rates.

Regarding macro-prudential measures, CNI asked to keep the Counter Cyclical Buffer on hold and minimise the directed sector credit requirement. CNI also suggested structural reforms, including improvements in the Board of Directors (BoD) to ensure the appointment of experts instead of relying on nepotism and favouritism. Additionally, CNI recommended forming a Monetary Policy Committee for policy formulation. CNI has also urged for BFIs to be granted authority, under the close monitoring and supervision of NRB, to implement facilities based on borrowers’ needs rather than through micro-management.

In addition, CNI urged for the deferral of the enforcement of working capital guidelines until they are prepared to address sector-specific needs through adequate future studies. CNI stated that the prevailing working capital guidelines were designed on a ‘one size fits all’ concept, undermining the complexities and nature of different businesses. Along with this, CNI urged for favourable lending policies, including deferral of the watchlist provision, enhanced access to finance for MSMEs and startups, and development in infrastructure and productive sectors to achieve the 6% growth target envisioned by the fiscal policy 2025/26.

In the context of the rising non-performing loan (NPL) rate, which reached 5.35% by mid-May 2025, CNI urged for flexible measures regarding blacklisting genuine borrowers who, despite their good intention and track record, are unable to repay loans on time.

 

“Even in favourable economic currents, stagnant credit, rising NPLs and wealth concentration threaten our collective progress”

Biswo Nath Poudel, Governor, Nepal Rastra Bank

W e are currently experiencing an opportune moment for economic advancement. Most indicators are robust: banks possess ample liquidity, interest rates are low, inflation is minimal, and foreign exchange reserves are at a record high, exceeding USD 18 billion. Crucially, stakeholders are willing to drive progress.
However, credit growth remains sluggish, with potential borrowers adopting a wait-and-see approach. The rise in non-performing loans (NPLs) is hindering overall economic development. We have established sound policies to align credit allocation with productive sectors like agriculture, energy, and small and medium enterprises. These sectors, vital for building a strong production base and fostering sustainable development, are currently facing challenges with loan repayment. This trend of NPLs will undoubtedly diminish banks’ lending capacity and requires proper attention.
Furthermore, as economists, we observe the current status and potential for wealth and asset concentration, which could lead to market instability and distortion. We discourage lending concentration and advocate for credit allocation across diverse sectors nationwide to ensure equal opportunities for enterprises to grow and thrive.

 

What should be the focus of Monetary Policy 2025/26?

Nara Bahadur Thapa, Former Executive Director, Nepal Rastra Bank

For the past four to five years, fiscal policy has been pro-cyclical rather than counter-cyclical. The upcoming fiscal budget’s size has been reduced to 24% of GDP, at a time when increased government spending is needed to address current challenges. In normal circumstances, the budget size typically expands up to 30%.

Debates in the 1990s, based on Philips curve analysis, centred on granting autonomy to the central bank, which has since established an institutional relationship with the government. The overdraft facility to the government capped at 5% and government securities holding by NRB capped at 10% of the government revenue of the preceding year. Similarly, the government cannot avail credit more than 10% of the revenue against securities.

For several years, there has been an ongoing discussion about the coordination between fiscal and monetary policies, which requires analysis from two perspectives: primarily, macro aspects, including how to increase credit access, enhance SME financing, and strengthen banks and financial institutions, among other factors. Currently, the capital formation to GDP ratio has decreased to 24% from 30%. According to the 16th plan, the informal economy accounts for nearly 50%. Both fiscal and monetary policies can collaborate on these aspects. It is challenging to make monetary and fiscal policies effective when the informal economy is so large and arguments for coordination between the two are strong.

However, there is a pervasive trend of seeking easy money and regulatory forbearance, which consistently pressures the central bank by citing poor economic performance. This leads to persistent demands for relaxations such as loan restructuring, cheaper credit, softened blacklisting criteria and deferral of working capital guidelines. Therefore, the government should refrain from pressuring the NRB.

Against this backdrop, the Monetary Policy 2025/26 must envision a long-term strategy and provide clear direction for the economy. This strategic direction should prioritise resolving the current stalemate in the financial sector and fostering its vibrancy.

Secondly, the central bank should focus on enhancing financial access. This could involve opening up bank licensing, particularly for provincial and local development banks.

Thirdly, a key objective of the monetary policy should be the promotion of green financing and a green transition. The central bank has already issued the Green Finance Taxonomy as a guideline to redirect credit allocation towards transforming the economy.

Fourthly, Nepal Rastra Bank should prioritise the corporatisation of the private sector. While large banks already implement corporate practices, they should also corporatise their borrowers who are obtaining wholesale credit. Another focus of the monetary policy should be alignment with the capital market, potentially through the promotion of alternative investment funds and Private Equity/Venture Capital (PE/VC). NRB, through Unified Directives No. 8, has permitted investment of up to 30% of Tier 1 capital into debentures and mutual funds. However, there remains a lack of clarity regarding the optimal limit for purchasing mutual funds in the secondary market and venture capital in the primary market. If the central bank allows a certain percentage of investment in PE/VC, it would create room for financing small and medium-sized enterprises (SMEs), thereby aligning monetary policy with the capital market.

Lastly, the monetary policy must include a specific objective to remove Nepal from the Financial Action Task Force’s grey list.