Over the last three decades, Nepal's financial landscape has been severely rattled by three distinct episodes of unnatural loan expansion, popularly known as ‘credit booms’.

According to a recent research paper published by Nepal Rastra Bank (NRB), the country's central bank, each of these aggressive lending cycles was followed by an economic downturn, or ‘credit bust’. The paper highlights that every boom severely weakened the country’s macroeconomic indicators, resulting in ballooning balance of payments deficits, soaring current account deficits, a sharp depletion of foreign exchange reserves, and a subsequent contraction in credit growth. Recovering from the aftermath of these three cycles has proved difficult for the country's fragile economy.

The research paper titled An Anatomy of Nepal's Credit Boom 1990–2025 by Birendra Bahadur Budha, the acting director of NRB. The research identifies the three volatile cycles as occurring between 1994 and 1996, 2008 and 2010, and 2020 and 2022. The data show that the years immediately following these periods plunged the national economy into deep institutional distress.

The study links these aggressive credit cycles to expansionary fiscal policies, prolonged periods of loose monetary regulation, and the unmanaged liberalisation of the financial sector. During these peaks, stock markets soared artificially, systemic risks for commercial banks multiplied, current account deficits widened, and foreign currency reserves plummeted, ultimately forcing the real economy into a prolonged slowdown.

Financial stakeholders acknowledge that while credit growth is essential for economic expansion, the misdirection of capital remains a historical problem. Santosh Koirala, the president of the Nepal Bankers' Association, noted that credit expansion and economic growth are meant to complement each other under normal market conditions.

"Our internal assessment indicates that a substantial portion of the credit disbursed, particularly during the post-Covid period, diverted directly into speculative areas like real estate and the secondary stock market rather than productive industrial sectors," said Koirala.

Industrialists argue that private borrowers simply reacted to the regulatory and fiscal incentives provided by successive governments. Rajesh Kumar Agrawal, the former president of the Confederation of Nepalese Industries (CNI), explained that banks expanded their credit portfolios and the private sector took loans in accordance with the prevailing state policies of those specific times.

"At those junctures, some credit undoubtedly flowed into sectors that are now classified as unproductive," said Agrawal. "However, the current financial landscape is entirely different. Both borrowers and financial institutions have become far more cautious and aware of the systemic risks associated with speculative investing."

Economists argue that regular credit growth is a healthy sign of an expanding economy. However, when the rate of credit growth vastly outpaces the actual capacity or real expansion of the GDP, it is classified as an unsustainable credit boom. While these booms temporarily stimulate retail trade and domestic consumption in their initial stages, they carry an incredibly high risk of creating long-term structural financial imbalances.

Generally, a credit boom is defined as a situation where the growth rate of the credit-to-GDP exceeds the 20 percent threshold.

Economists classify credit booms as ‘good’ if they contribute significantly to sustainable economic growth, and ‘bad’ if their contribution to actual production remains low. The central bank study concludes that all three credit booms fell into the ‘bad’ category. The report notes that following each credit boom, real economic growth fell well below the historical average, domestic production weakened, and the broader financial system had to bear the painful structural consequences for an extended period.

Prakash Kumar Shrestha, a former vice-chairman of the National Planning Commission and a former executive director of NRB, admitted that these recurring cycles of aggressive credit expansion failed to generate positive contributions to the country's structural economic transformation.

"The rapid credit expansion driven by banks and financial institutions primarily promoted imports, triggered unnatural inflation in real estate prices, and increased the consumption of private vehicles," said Shrestha. "Because a very nominal amount of credit was channeled into productive manufacturing sectors, economic growth failed to improve despite huge credit volumes." According to him, international financial studies have consistently proved that excessive credit expansion can cause an economy to overheat, even if the capital is utilised well.

"In Nepal's case, the situation was worse because the credit did not go to manufacturing, leading to a minimal contribution to GDP," said Shrestha. "The government and certain regulatory policies are highly responsible for these aggressive lending booms. Measures such as the aggressive capital hike for banks and financial institutions, alongside the post-Covid refinancing facilities, directly fueled unsustainable credit growth.” According to him, the lack of effective coordination between fiscal policy led by the Ministry of Finance and monetary policy managed by the central bank failed to balance credit demand and supply, plunging the economy into a crisis after every boom.

First credit boom

The central bank study identifies the rapid loan expansion that took place between 1994 and 1996 as the first official credit boom. According to the data, the annual credit growth rate stood at an astonishing 40.5 percent in 1994 and reached 42.1 percent in 1995. During this exact period, the growth rate of the credit-to-GDP ratio was 20.9 percent and 29.2 percent respectively. The credit-to-GDP ratio is a crucial metric that measures the widening gap between the growth of credit and the growth of the actual economy.

In comparison, the GDP growth rate stood at 8.22 percent in 1994, but quickly tumbled to 3.47 percent in 1995. Historical data confirms that the two years following this initial boom dragged the national economy into a deep recession.

By 1996, credit expansion decelerated to 32.1 percent, dropping further to 15.7 percent in 1997. During this contractionary phase, economic growth slowed down drastically, while national imports and exports suffered major contractions. Concurrently, the current account deficit widened significantly, and the country's overall balance of payments slipped into a deficit.

This initial boom was deeply rooted in the political and economic shifts of the era. Following the 1990 People's Movement and the restoration of multi-party democracy, Nepal adopted sweeping economic liberalisation policies. The government initiated comprehensive financial sector reforms, which led to the rapid opening of private commercial banks, finance companies, and industrial manufacturing units.

The research report explains that after 1991, the government actively pursued a market-oriented economy, introducing the Companies Act, establishing the Nepal Stock Exchange, reforming state-owned banks, and liberalising foreign investment and trade. This legislative overhaul triggered an exponential increase in the number of financial institutions. In 1991, Nepal had only seven banks and financial institutions. By 1994, this number grew to 40, and by 1996, it jumped to 55. Commercial banks grew from five to 11, while the number of finance companies reached 37.

To support this institutional expansion, the central bank aggressively slashed interest rates. When the 91-day treasury bill yield was dropped from 10.4 percent to 6.2 percent, cheap liquidity flooded the banking ecosystem, accelerating credit disbursement. The study concludes that this blend of financial liberalisation, loose monetary stance, and unregulated institutional growth created the perfect storm for Nepal's first unnatural credit boom.

Second credit boom

The central bank study identifies the sharp lending surge between 2008 and 2010 as the country’s second major credit boom. This aggressive loan expansion was driven by the second phase of financial sector reforms, a rapid proliferation of financial institutions, surging remittance inflows that injected massive liquidity into the banking system, and a prolonged loose monetary policy.

Data reveal that the annual credit growth rate reached 26.9 percent in 2008 and rose to 29.1 percent in 2009, while the credit-to-GDP gap grew by 13.2 percent and 6.6 percent, respectively. Meanwhile, real GDP growth stood at 6.5 percent in 2008 before slowing to 4.53 percent in 2009.

Statistics confirm that a severe economic downturn followed, with credit growth plummeting to 14.3 percent in 2010 and 13.8 percent in 2011. During this bust, economic growth contracted sharply, alongside a severe squeeze in the stock market, real estate, imports, and exports. The current account deficit widened and the balance of payments ran into a deficit. For three consecutive years after 2009, the credit-to-GDP gap growth rate remained entirely negative.

This boom was heavily fueled by post-2002 legislative overhauls, including the new Nepal Rastra Bank Act and the Bank and Financial Institutions Act (BAFIA). A liberal licensing policy caused the number of financial firms to jump from 100 in 2004 to 203 by 2010, while commercial bank branches expanded from 375 to 990.

This institutional expansion, paired with booming remittances, filled bank vaults and prompted aggressive lending. This directly triggered an unprecedented speculative bubble in the stock market. The Nepse index nearly tripled within two years before suffering a catastrophic crash that wiped out over half its value.

Third credit boom

The central bank study classifies the aggressive loan expansion between 2020 and 2022 as Nepal's third major credit boom. This particular cycle was driven by hyper-expansionary fiscal measures and ultra-loose monetary policies introduced by the state to revive economic activity during the Covid pandemic.

Data show that the credit growth rate stood at 12.6 percent in 2020 and surged to 26.4 percent in 2021, while the credit-to-GDP gap grew by 11.8 percent and 12.9 percent respectively. In terms of economic output, the country's GDP growth contracted by negative 2.37 percent in 2020 before recovering to 4.84 percent in 2021. The subsequent credit bust dragged the economy into crisis, with credit expansion plummeting to 13.2 percent in 2022 and dropping to a nominal 4.6 percent in 2023.

According to the study, the NRB extended unprecedented refinancing facilities, provided sweeping regulatory waivers, and pushed interest rates to historic lows. Between 2020 and 2021, the interbank lending rate fell below 1 percent. The central bank's total refinancing portfolio ballooned from Rs22 billion to Rs158 billion within a few years, while subsidised concessional loans were distributed aggressively. While these extraordinary measures provided immediate relief to pandemic-hit businesses, they ultimately triggered a massive injection of cheap capital. That, in turn, severely weakened the country's external economic indicators, including its foreign exchange reserves, balance of payments, and current account balances.

Economic crisis after credit booms

The central bank study concludes that all three lending spikes inevitably triggered severe external sector crises. Aggressive loan expansions consistently drove up imports, and in turn, ballooned the current account deficit, worsened the balance of payments, and depleted foreign currency reserves.

During the 1994-1996 boom, the current account deficit widened from 4 percent of GDP to 8.7 percent, while import cover fell from 7.9 to 5.4 months. Similarly, the 2008-2010 cycle saw the deficit touch 2.4 percent of GDP, as reserves slid from 9.4 to 7.4 months. The situation peaked dangerously during the 2020-2022 boom, when the deficit hit an unprecedented 12.5 percent of GDP, and foreign exchange reserves shrank to cover only 7.3 months of imports. This emergency forced the government to ban ten luxury imports and the central bank to impose strict cash margins alongside tight monetary restrictions.

Why are all credit booms ‘bad’?

The study classifies all three lending surges as ‘bad booms’ because they failed to stimulate sustainable output, leaving Nepal’s post-boom economic growth consistently below par. Although the country managed an average GDP growth rate of 4.4 percent between 1990 and 2025, the three years following the first, second, and third booms saw growth limited to just 4.2 percent, 3.87 percent, and 3.42 percent respectively. Consequently, the output gap remained persistently negative. The paper notes that while none of these spikes triggered a full systemic banking collapse, they severely crippled long-term economic productivity.

Where did the credit go?

The study reveals that capital was heavily misallocated during these cycles. While the first boom saw uneven loan distribution, the second and third spikes channeled credit overwhelmingly into non-tradable, speculative sectors like construction, financial trading, and retail consumption rather than industrial production. Consequently, when the busts occurred, these specific areas suffered severe credit contractions and sharp slowdowns, whereas the core manufacturing sector remained relatively stable but structurally underfunded.