Banks are liquid, interest rates are low, and yet credit uptake remains weak. Policymakers are searching for ways to increase lending. From the local tea shops to the boardrooms of banks, the question is the same: Why aren’t people borrowing? The conventional answer is ‘economic distress’. But as economists, we must ask a more uncomfortable question: What if low credit uptake is not a failure but a correction? What if this slump is signalling something deeper about the structure of Nepal’s economy?

What policy has already done

Over the last year, the central bank, Nepal Rastra Bank (NRB), has adopted a more expansionary stance. It has reduced key interest rates, earlier in mid-2025 and more recently in December 2025, making it cheaper for banks to borrow money. This has translated to average base rates of commercial banks falling from over 8 percent in mid-2024 to about 6 percent a year later, and loan interest rates dropping below 8 percent.

On the banking side, total deposits across banks and financial institutions have reached Rs7,644 billion, while total credit stands at Rs5,720 billion. As a result, the credit-to-deposit ratio has fallen to about 74 percent, well below the regulatory ceiling of 90 percent, indicating ample loanable funds.

Taken together, these steps signal a clear policy intent: Credit growth should pick up. Yet, private sector credit growth has remained in the low single digits, well below the almost 20 percent average expansion seen in the last decade. This gap between policy intent and market response deserves closer scrutiny.

Over-financialised economy

In Nepal, the total amount of loans given by banks to the private sector (businesses and households) is almost as large as the country’s entire economy (90 percent of GDP). This level of lending is far higher than the South Asian average of roughly 50 percent and similar to developed countries with deeper financial systems. The relevant question, therefore, is what years of consistent credit growth actually achieved or failed to deliver.

Credit without transformation

Between the mid-2010s and early 2020s, bank credit expanded much faster than nominal GDP. If that surge had translated into productivity and capacity improvements, today, firms would be expanding, export capacity would be rising, productivity gains would be creating new jobs at home, easing the need for people to look for work overseas.

Instead, private credit growth consistently outpaced productivity growth. This disconnect is also reflected in investment outcomes. Private investment has fallen sharply from 25.5 percent of GDP in 2018–19 to just 15.7 percent in 2023–24, while public investment has remained broadly stagnant at around 8 percent of GDP.

Years of abundant credit did not build a self-sustaining investment engine. This raises a deeper question: If the last round of credit expansion didn’t transform the economy, why should we expect the same process to produce a different result now?

The land–credit loop

The slowdown in land transactions over the past two years has revealed how heavily demand for bank loans in Nepal has depended on land and real estate. As property deals declined, so did demand for large loans.

The crisis in savings and credit cooperatives reflects the same pattern. Hundreds of cooperatives have been declared problematic after failing to return depositors’ money, leaving tens of billions of rupees frozen or under recovery. In many cases, these funds were channelled into poorly managed loans linked to land and property.

In this system, land mattered more than cash flow. Rising asset prices substituted for viable projects until the property market slowed and the risks surfaced.

Banks (and their limits)

The real role of banks is that of intermediaries, channelling funds from savers to borrowers with viable projects and lending against predictable income. Their role is not to create new investment opportunities or take big risks.

With few equity or venture-funding alternatives, banks in Nepal have been made the default growth engine. Because they profit by lending, the system rewards ever-larger loan books, mistaking credit booms for economic progress even when loans chase land rather than productivity. That illusion has pushed Nepal towards over-financialisation, not sustainable growth.

Official data from the NRB indicates that non-performing loans (NPLs) in the banking sector surpassed 5 percent by mid-2025. The International Monetary Fund (IMF) and other analysts are concerned that once loan restructurings and delayed payments are fully accounted for through more realistic tests, asset quality may appear weaker. This situation implies that the previous credit boom has left behind a legacy of bad loans.

Why NRB keeps pushing

The NRB’s actions are not illogical, but they reflect a short-term bias. Central banks are designed to smooth growth, yet the risks of over-financialisation unfold over much longer horizons and are easy to overlook. Large remittance inflows, nearly a quarter of GDP, effectively mask these risks by cushioning debt servicing and making today’s high credit levels look sustainable on paper.

This is the trap. Even as the central bank looks for ways to revive lending, it has recently issued one-year bonds totalling Rs70 billion to absorb excess liquidity. This contradiction suggests that the problem is not a lack of money in the system but a lack of productive uses for it. It is a quiet admission that more loans no longer means more growth.

This is precisely when central bank independence matters the most. When growth slows, pressure to “do something” intensifies. The risk is that policymakers misread a deep structural correction as a temporary cyclical slowdown. The current lending slump is better understood as a phase of balance-sheet repair and risk re-pricing. A central bank earns its credibility not by forcing loans to flow, but by recognising when restraint is the wiser course.

Listening to the signal

The real danger today is not the credit slowdown, but the urge to reverse it at any cost. What is needed now is structural reform in how loans are assigned, not cheaper loans.

Structural change means redirecting growth at its source: From debt-led to productivity-led growth; from land speculation to income generation; from collateral-based lending to cash-flow-based investment; from bank-dominated finance to diversified capital; from remittance-backed consumption to domestic production; and from loan volume to credit quality.

Credit policy still matters, but only if it stops chasing volume. The task is not to restart lending but to lend better—away from land-backed speculation and towards activities that generate cash, exports and productivity. This requires stronger appraisal, fewer collateral shortcuts and incentives that value quality over quantity.

This will not produce a quick credit rebound but something more important: An economy that grows by producing more, not borrowing more. Forcing credit may be easier. Listening to the signal is the wiser choice.