KATHMANDU: Nepal’s banking sector is facing growing financial pressure despite abundant liquidity, as weak credit demand, rising bad loans and deteriorating borrower cash flows weigh on banks’ asset quality and capital position, according to a report by credit rating agency ICRA Nepal.

ICRA said the sector’s immediate challenge is no longer a shortage of liquidity but weak demand for loans and declining repayment capacity among borrowers. While credit growth has begun to recover, asset quality and capitalisation are expected to remain under pressure in the near and medium term.

Bad loans climb to 5.6%

Gross non-performing loans (NPLs) across the banking sector have risen sharply, from 1.20% in mid-2022 to 5.41% by mid-April 2026, with the latest figure reaching about 5.6%.

ICRA estimates that 15% to 25% of banks’ loan portfolios are showing some form of repayment delinquency, while around 4% to 8% of loans at many banks have been restructured or rescheduled. The agency warned that some of these loans could eventually migrate into the NPL category.

The deterioration has been linked to weak market demand, slowdown in construction and manufacturing, tighter working-capital rules and the continuing crisis in the cooperative sector.

Deposits rise, but loan demand remains weak

Credit growth has not completely stalled. Bank lending grew at an annualised rate of around 8% during the first nine months of 2025/26, supported by investment in energy, tourism and infrastructure and some recovery in retail credit following lower interest rates.

However, remittance-driven deposit growth has outpaced lending, leaving banks with excess liquidity. The average credit-to-deposit (CD) ratio of commercial banks fell to around 73% by mid-April 2026, from about 80% in mid-January 2024, well below the regulatory ceiling of 90%.

ICRA said the figures show that banks have sufficient capacity to lend, but the private sector remains reluctant to borrow and invest.

Lower interest rates fail to revive investment

Commercial banks’ weighted average fixed-deposit rate has fallen from around 11% in mid-January 2023 to about 5% by mid-April 2026.

Despite cheaper borrowing costs, weak business revenues, subdued economic activity and pressure to repay existing loans have kept private-sector investment cautious.

Capital buffers under pressure

Rising NPLs and provisioning costs are also weakening banks’ ability to build capital internally. The banking sector’s core capital-to-risk-weighted-assets ratio stood at around 9.72%, compared with the regulatory minimum of 8.5%, while the total capital adequacy ratio was about 12.62%, against a minimum requirement of 11%.

ICRA warned that continued provisioning could put further pressure on Tier-1 capital.

The agency also noted that banks’ heavy reliance on real estate collateral may limit losses from defaults, but weak property-market liquidity is making it increasingly difficult to sell collateral and recover loans.

Non-banking assets reached about 0.9% of total loans by mid-April 2026. Adjusted for NBA, the NPL ratio stood at around 6.46%, indicating continued difficulties in loan recovery.

Cooperative crisis adds pressure

The crisis in Nepal’s cooperative sector is also creating indirect risks for banks. ICRA estimates that around Rs87 billion in cooperative deposits remain frozen.

Cooperatives had traditionally provided credit to small and informal businesses and bridge financing to larger borrowers, but their weakened financial condition has reduced that capacity.

Bank profits also under strain

Excess liquidity and weak loan demand are squeezing banks’ interest income and profitability. Lower net interest margins, higher provisioning expenses and limited investment opportunities have further constrained earnings.

The weighted average interest rate on 364-day Treasury bills, for example, fell from 11.92% in mid-January 2023 to 2.47% by mid-April 2026, reducing returns on banks’ excess liquidity.

ICRA said the banking sector’s recovery ultimately depends on stronger borrower cash flows, a revival in real economic demand and renewed private-sector investment.

The agency expects asset quality and capitalisation pressures to persist in the near and medium term, although the pace of deterioration could gradually moderate. Economic reforms by the government and Nepal Rastra Bank, stronger private-sector investment and a recovery in domestic demand will be critical to easing pressure on the banking system.