KATHMANDU: Nepal’s banking sector is facing mounting challenges as overdue interest on loans has more than doubled over the past two years, raising alarms about financial stability and profitability. According to data from Nepal Rastra Bank (NRB), the outstanding interest that banks failed to collect reached NPR 135.83 billion by the end of Ashwin 2081 (October 2024), a significant increase from NPR 61.35 billion in Ashar 2079 (July 2022).
This 121.40% surge in overdue interest reflects worsening credit recovery issues within Nepal’s financial institutions. Over the past year alone, outstanding interest increased by 12.8%, rising from NPR 120.38 billion in Ashwin 2080 (October 2023). Notably, while banks intensified loan recovery efforts during the fiscal year-end in Ashar 2081 (July 2024), temporarily reducing the overdue interest to NPR 119.59 billion, the figure climbed sharply by over NPR 16 billion within three months.
Uncollected Interest and Financial Accounting Practices
Nepal’s financial accounting standards mandate banks to prepare their financial statements on an accrual basis, which requires recording accrued interest as income even if it remains unpaid. However, such practices often inflate the profit figures, potentially misleading stakeholders.
If the accrued interest remains uncollected, NRB regulations stipulate that banks must allocate the amount to regulatory reserves after deducting taxes and employee bonuses. From the current fiscal year, banks are permitted to include deductions for general reserves and Corporate Social Responsibility (CSR) funds before transferring the remaining balance to regulatory reserves.
This regulatory adjustment aims to ease the burden on banks; however, uncollected interest continues to rise. By Ashwin 2081, uncollected interest income had reached NPR 135.83 billion, up from NPR 99 billion in Ashar 2080, significantly straining banks’ balance sheets.
Non-Banking Assets and Capital Pressure
In parallel with the rise in overdue interest, non-banking assets (NBAs) of commercial banks have also increased. These assets typically include foreclosed properties and other collateral that banks acquire when borrowers default on their loans. As of Ashwin 2081, the NBA value for commercial banks stood at NPR 37 billion, a significant rise from NPR 30 billion in Ashar 2081.
These developments indicate that banks are struggling to liquidate foreclosed properties, further exacerbating capital pressure. A senior banker noted that the accumulation of NBAs and overdue interest is adversely affecting banks’ profitability and putting pressure on their capital reserves.
Impact on Dividend Distribution and Profitability
The surge in overdue interest and non-performing loans (NPLs) is eroding banks’ ability to distribute dividends. Currently, four commercial banks are operating at an accumulated loss. In addition, nearly half of Nepal’s commercial banks are unlikely to distribute dividends to their shareholders this year.
Banks previously allocated around 63% of uncollected interest to regulatory reserves after accounting for taxes and employee bonuses. Under the revised regulations, approximately 50% of overdue interest must now be allocated to reserves after including CSR and general reserves.
Non-Performing Loans on the Rise
The ratio of NPLs in Nepal’s banking sector has surged dramatically, reaching 4.42% by Ashwin 2081, up from 1.31% in Ashar 2079. This 237.40% increase over 27 months is a clear indication of deteriorating credit quality.
Commercial banks reported NPR 112.82 billion in overdue interest by Ashwin 2081, with an average NPL ratio of 4.28%. Development banks and finance companies are also grappling with similar issues. Development banks’ overdue interest has risen to NPR 10.89 billion, with an NPL ratio of 4.37%, while finance companies reported NPR 12.13 billion in overdue interest, with an NPL ratio of 10.84%.
Concerns for Financial Stability
The rising overdue interest and NPLs highlight deeper structural challenges within Nepal’s financial system. The private sector’s total loan liabilities to banks and financial institutions have grown by 2.79% in the last three months, reaching NPR 5.338 trillion by Ashwin 2081, despite subdued credit expansion.
Experts warn that the banking sector’s growing uncollected interest and non-performing loans could have long-term implications for financial stability. Banks must focus on improving loan recovery mechanisms and reducing exposure to high-risk borrowers to ensure sustainable growth.
The current trends, if left unchecked, could significantly impact profitability, capital adequacy, and the overall health of Nepal’s banking system.