Banking Sector Recovery Begins? ICRA Says Nepal’s Toughest Phase May Be Over

Nepal’s banking sector is gradually showing signs of recovery after years of pressure from rising non-performing loans, liquidity imbalances and weak capital adequacy, according to ICRA Nepal’s latest report, “Nepalese Banking Sector: Performance Update and Outlook.” Based primarily on data from 20 Class ‘A’ commercial banks, the report states that although the sector’s underlying problems have not been fully resolved, the pace of new risks is slowing and the banking industry appears to have moved past its most difficult phase. Loan growth increased by around 8% during the first nine months of fiscal years 2025 and 2026, with demand improving in sectors such as energy, tourism and retail lending. Borrowers have also received relief from a sharp decline in lending rates, which have fallen by around 40% over the past 12–18 months, improving their financial position. ICRA noted a significant improvement in company ratings as well, with only 6% of rated companies receiving upgrades in FY 2080/81, compared with 37% by the first half of FY 2026. However, the report cautions that around 77% of borrowers remain in a risky category. Asset quality continues to be a major concern, with the average non-performing loan ratio of commercial banks rising from 1.20% in Ashar 2079 to 5.60% by the third quarter of FY 2082/83, while the adjusted NPL ratio, including non-banking assets, reached 6.46%. Meanwhile, loan-to-deposit ratios have fallen to around 73% amid strong deposit growth and weak credit demand, creating excess liquidity in the banking system. The weighted average fixed deposit rate has dropped from around 11% in Poush 2079 to about 5% by Chaitra 2082, while government bond yields have also fallen toward the 2% level, putting pressure on banks’ investment returns and net interest margins. ICRA identifies the central bank’s Working Capital Loan Directive, introduced in Shrawan 2079, as one of the policies that had the strongest impact on businesses and banks, contributing to liquidity stress and rising bad loans, although its negative effects are now gradually easing as the policy has become more flexible. The report also highlights challenges arising from the sluggish real estate market, which has made loan recovery and collateral auctions difficult, with banks’ repossessed assets rising from 0.5% at the end of Poush 2080 to 0.9% by Chaitra 2082. The troubled cooperative sector has added further pressure by disrupting cash flows to businesses and the broader market. On the positive side, the report notes that companies increasingly turning to IPOs and other capital-market instruments to raise funds and repay bank loans could support banking-sector stability. Measures allowing banks to raise capital through instruments such as redeemable preference shares and rights shares are also expected to ease capital adequacy pressures. ICRA further expects the government’s emphasis on good governance and economic development to improve market confidence, although geopolitical tensions in West Asia remain a key external risk to Nepal’s banking and economic outlook.