When Sehara Khatun needed Rs150,000 to cover her household expenses, the only person willing to lend her money was a local moneylender.

Seven years later, the 40-year-old from Jayanagar in Garuda Municipality-1, Rautahat, is still trapped in debt after the loan document she signed showed an amount four times what she actually received.

Her husband, a mason, had an irregular income that barely supported the family. Mahato agreed to lend her the money for a year at an annual interest rate of 36 percent. But claiming the loan involved high risk, he made Khatun sign a tamasuk, a traditional promissory note, by placing her thumbprint on a document that inflated the loan amount fourfold to Rs600,000.

More than seven years later, despite having repaid over Rs200,000, Khatun’s debt remains legally unsettled.

“I borrowed Rs150,000, but the paper showed a much higher amount. I have already paid more than the amount I received. Yet the debt has not cleared,” she said.

In another part of Rautahat, Shivashankar Mahato of Brindaban Municipality-5 borrowed Rs2.7 million from Shivaprasad Ray Yadav of Gujara Municipality-8 in 2015 to build a house.

The agreement required him to repay the loan within a year at a monthly interest rate of three percent, or 36 percent annually. As collateral, Shivashankar was compelled to transfer the deeds of 1 bigha and 4 kattha (approximately two acres) of land to Yadav.

Unable to clear the debt within a year, Shivashankar paid Yadav Rs2.5 million six years later. By then, however, Yadav had already sold the land to a third party for Rs8.4 million.

“I have already paid Rs2.5 million, yet they are demanding millions more,” said a distressed Shivashankar. “They sold my land without my consent. What am I supposed to do now?”

A crisis rooted in financial exclusion

Khatun and Shivashankar represent thousands of Nepalis trapped in the country’s long-running loan sharking crisis. They are among the victims who reached a nine-point agreement with the government last Friday after years of protests and negotiations.

Across the country, more than 24,000 borrowers have filed formal complaints against moneylenders who allegedly charged exorbitant interest rates and added accumulated interest to principal amounts.

In 2022, a high-level commission was formed under the leadership of then deputy prime minister and home minister Narayan Kaji Shrestha to address the grievances of loan shark victims. The commission, chaired by former judge Gauri Bahadur Karki, collected complaints from April 30 to May 28, 2023, receiving around 24,000 petitions through district administration offices across the 77 districts.

Despite repeated protests, government negotiations and agreements, the problem has persisted.

Economists say the continuing crisis exposes a major gap in Nepal’s financial inclusion efforts. While the country has expanded its formal banking network, the system has failed to provide accessible credit to many low-income and marginalised citizens.

Over the past three decades, Nepal’s commercial credit market has experienced significant interest rate increases only a few times. For most periods, market rates have remained relatively low. Yet access to formal credit has remained difficult for ordinary citizens.

Economists argue that while Nepal adopted federalism, its financial system remained largely centralised, limiting the ability of institutions to respond to local credit needs.

The missing link in financial federalism

Nara Bahadur Thapa, an economist and former executive director of Nepal Rastra Bank (NRB), says financial sector reforms have not kept pace with political decentralisation.

“The country adopted fiscal federalism, and commercial bank branches have reached all 753 local units,” Thapa said. “But while branches have arrived, actual financial services have not. There is a complete disconnect between our financial structure and federalism. The central bank must overhaul the institutional framework to bridge this gap.”

Thapa said district-level and region-specific development banks and finance companies previously played an important role in providing credit to small entrepreneurs and low-income borrowers.

However, after NRB pushed consolidation and reduced the number of development banks and finance companies, the groups they served were left without adequate alternatives. Commercial banks and microfinance institutions failed to fill the gap, leaving vulnerable borrowers dependent on informal lenders.

“Had our financial system mirrored our three-tier governance structure, with dedicated provincial and local banking licences, rural citizens would have had better access to credit,” Thapa said.

The scale of financial exclusion is also reflected in the NRB’s own data.

The central bank’s Financial Literacy Baseline Survey, published in January 2023, found that nearly 72 percent of adults relied on informal sources, including moneylenders, family and friends, to meet their savings or credit needs.

The survey showed that 71.83 percent of adults depended on informal financial channels, while 45.54 percent actively used community-based savings and credit groups. Nepal’s overall financial literacy rate stood at 57.9 percent.

Experts say the figure has not improved significantly since, despite government claims that financial literacy has increased and commercial banks’ branches have expanded across almost all local units.

Red tape and the collateral trap

Santosh Koirala, president of the Nepal Bankers’ Association, acknowledged that commercial banks have failed to develop financial products tailored to low-income groups.

“Relying on local moneylenders is an age-old practice. The numbers may have declined over time, but the practice has not disappeared,” Koirala said. “Borrowing from formal financial institutions requires lengthy procedures and extensive documentation that many people are unfamiliar with. For them, dealing with a local lender feels easier. Perhaps banks have also failed to publicise their services effectively.”

Koirala said the conventional lending criteria of banks often exclude the poorest sections of society.

“The formal banking system operates on strict requirements, which means the poorest are often left behind. The financial literacy programmes we have conducted so far have clearly not been enough,” he said.

In the past, microfinance institutions and cooperatives helped meet the credit needs of rural communities. But after the Nepal Rastra Bank tightened regulations on microfinance institutions to address widespread irregularities, followed by the recent collapse of many cooperatives, a large section of the population lost access to formal credit.

The twin setbacks pushed many borrowers back towards informal lenders, even for small financial needs.

Central bank officials also acknowledge that expanding physical access to banks alone has not ensured financial inclusion.

Guru Prasad Poudel, spokesperson for the central bank, said the presence of bank branches is only the first step.

“Physical presence is a prerequisite, but it is not enough,” Poudel said. “We ensured commercial bank branches reached all 753 local units, but providing customised financial tools based on customer demand remains a challenge.”

Poudel said the central bank has changed its approach over the years.

“In the 1980s and 1990s, the financial sector reform programme focused on increasing the number of institutions. That expanded branches but did not necessarily improve the quality of services. We later shifted towards strengthening institutions through mergers while also promoting financial literacy,” he said.

The central bank is now focusing on digital access, he added. In the current fiscal year’s monetary policy, the regulator introduced frameworks for peer-to-peer lending through non-banking institutions and digital banking models.

“True inclusion is not just about opening a bank account. It is about giving citizens the ability, security and confidence to use those accounts to improve their economic condition,” Poudel said.

The paradox of excess cash

The lack of access to credit comes at a time when Nepal’s banking sector is sitting on an unprecedented pile of deposits.

Driven by weak domestic credit demand and a steady flow of remittances, banks have accumulated massive amounts of loanable funds that sit idle.

According to NRB data, excess liquidity held by commercial banks stood at Rs1.56 trillion as of July 9.

The surplus remained a persistent feature throughout the last fiscal year. Excess liquidity stood at Rs1.01 trillion in August, Rs1.04 trillion in September, Rs1.16 trillion in October, Rs1.09 trillion in November, Rs1.21 trillion in December, Rs1.224 trillion in January, Rs1.222 trillion in February, Rs1.25 trillion in March, Rs1.283 trillion in April, Rs1.365 trillion in May and Rs1.388 trillion in June.

Yet, despite this historic accumulation of cheap loanable funds, many ordinary citizens remain unable to access formal credit.

In the villages of Madhesh Province, the consequences of this exclusion are severe.

The District Administration Office (DAO) in Gaur says many complaints filed by loan shark victims involve loans taken for basic “household expenses”. Victims say they turn to informal lenders because they lack the income documents and collateral required by banks.

To obtain a bank loan, borrowers must generally provide proof of a stable income. For daily wage workers and small vendors, such documentation is often unavailable, says 32-year-old Shyam Kumari Thakur of Dhanushadham-2, Mangalpur, Dhanusha.

In August 2011, her husband Bhojendra Thakur borrowed Rs350,000 from local lender Shivaji Yadav to start a small business. As security, he transferred a 2-kattha homestead plot to the lender.

“Banks demand reliable collateral. The poor, the landless and those living on unregistered public land have nothing that banks accept,” Thakur said. “Even when someone owns land, dealing with the valuation process at land revenue and survey offices is another major hurdle.”

Shivashankar Mahato, who has been leading the movement for loan shark victims, said government-subsidised credit programmes meant for small businesses often fail to reach those who need them most.

“Until the banking system is simplified for low-income groups, predatory lenders will continue to thrive,” Mahato said. “Banks need to provide small, collateral-free loans based on simple recommendations from locally elected representatives. Many borrowers are illiterate, and lenders exploit them by inserting clauses they cannot understand.”

According to Mahato, lenders often mention the actual principal amount and legal interest rate in tiny letters at the bottom of promissory notes. When disputes reach courts, he claimed, lenders remove that portion and present the inflated amount written prominently on the document as evidence.

From a legal perspective, loan sharking or predatory lending involves financial transactions designed to charge interest beyond the 10 percent ceiling allowed under Nepal’s law.

Advocate Bipin Gautam said such practices violate the National Penal Code (Second Amendment) Act, 2023.

“Lenders exploit borrowers’ desperation by inflating the principal amount on paper, sometimes doubling or tripling the actual loan amount,” Gautam said. “They add unpaid interest to the principal every few months, creating a cycle of compound debt that eventually leaves borrowers without homes or property.”

Officials at the DAO Gaur said many complaints involve lenders refusing to return land deeds even after borrowers have cleared loans.

In other cases, lenders allegedly force borrowers to sign blank cheques and later fill them with arbitrary amounts to threaten them with cheque-bounce cases.