One statistic has become increasingly prominent in the financial reports of banks and financial institutions (BFIs) since the third quarter of FY 2024/25—a figure central banks worldwide dread: bad loans. In some Nepali banks, bad loans now account for nearly 8% of their loan portfolios.

The rise in non-performing loans (NPLs) reflects a growing inability of borrowers to repay their debts. If left unchecked, widespread defaults and payment delays could jeopardize the long-term stability of BFIs and send ripples through the broader economy. Loan recovery has become increasingly difficult for banks in recent months. This has led to higher provisions for loan losses. The challenge is compounded by the inability to liquidate mortgaged assets. The ongoing economic slowdown has not only led to more loan defaults but also reduced the value of collateral, making asset recovery even more difficult.

According to unaudited third-quarter reports for fiscal year 2024/25, nearly half of the country’s 20 commercial banks have reported NPL ratios exceeding 5%—a level experts consider unhealthy for the sector. As of mid-April 2025, the average NPL ratio among commercial banks stood at 4.78%, up from 3.65% during the same period of the last fiscal year. Some banks, such as Himalayan Bank, Kumari Bank and Nepal Investment Mega Bank, have seen NPL levels spike to 7.86%, 6.98% and 6.06%, respectively. Bad loans now make up nearly 8% of total loan portfolios of some banks, a trend that has caught the attention of regulators and international watchdogs alike. The International Monetary Fund (IMF), in its recent report, raised concerns about the accuracy of NPL reporting in Nepal, suggesting that some banks may be “evergreening”—issuing new loans to help borrowers repay old ones to mask underlying defaults.

As a condition under its Extended Credit Facility (ECF) program, the IMF has mandated an independent audit of loan books from 10 major banks. In response, the Nepal Rastra Bank (NRB) has begun the process of hiring an international consultant to oversee the audit. The NPL ratio is a critical indicator of the banking sector's health. A high ratio means more bad loans, cutting into banks’ interest income and increasing the risk of losses. This erodes their financial strength and, if unchecked, could destabilize the entire banking system.

The current spike in NPLs is driven by a combination of structural and cyclical factors. Following the COVID-19 pandemic, commercial banks lent aggressively under accommodative policies introduced by the NRB. The central bank slashed interest rates, lowered reserve requirements and extended repayment periods to stimulate credit flow. Many of these loans, however, flowed into speculative sectors like real estate. “As long as real estate prices were rising, these loans appeared sound,” said Sudesh Khaling, CEO of Everest Bank Limited. “But when the market stagnated, the underlying vulnerabilities surfaced.”

Data from the Department of Land Management and Archive shows property transactions have declined sharply since FY 2021/22, and land prices, which peaked in 2022, have been on a downward trajectory. Land and building transactions across the country fell from 1.8 million in 2021/22 to 1.3 million in 2022/23, followed by a modest recovery to 1.6 million in 2023/24. With just 700,000 million transactions recorded in the first half of the current fiscal year, the full-year total for 2024/25 will likely match or fall short of the 2021/22 level. Bankers attribute this trend to two key factors: some borrowers are unable to sell properties—even at discounted prices—to repay loans, while others are waiting for a market rebound. Ultimately, the trajectory of real estate prices will be a key determinant of financial health and profitability of banks. Economist Biswash Gauchan is skeptical about a near-term recovery. "The old playbook—holding property for a few years, selling at a profit, and settling debts—no longer applies," he wrote on Facebook. "That era has passed. Since peaking in 2022, land prices have nowhere to go but down." Gauchan warned that the days of flipping property for quick profits are over. Declining land prices are eroding the value of collateral backing many loans, leaving borrowers unable to sell even at reduced prices to repay their loans. This has put additional stress on banks, especially those with significant exposure to the real estate, construction and tourism sectors.

Construction firms, in particular, are suffering from delayed government payments for completed infrastructure projects. According to the Financial Comptroller General's Office (FCGO), only about half of the government’s revenue target had been collected by the third quarter of the current fiscal year. Low revenue collection has limited the government’s ability to pay contractors. “These delays have directly affected the ability of contractors to repay loans,” said Santosh Koirala, president of the Nepal Bankers' Association (NBA).

Tourism businesses are facing similar challenges despite a rebound in visitor numbers. Many hotels and resorts expanded aggressively during the pandemic years which led to oversupply of rooms and services. As a result, many establishments are now struggling with low profitability and high debt servicing costs. The deteriorating loan quality has also begun affecting bank profits. Six commercial banks—Rastriya Banijya Bank, Nepal Investment Mega Bank, Prabhu Bank, NIC Asia Bank, Kumari Bank and Himalayan Bank—have reported negative distributable profits, limiting their ability to pay dividends to their shareholders.

Not all banks are in a difficult situation though. Everest Bank has maintained the second-lowest NPL ratio at 0.64 percent, attributed to its minimal exposure to vulnerable sectors. “Our focus on safer lending practices has helped us avoid the worst of this downturn,” Khaling said. NRB officials have sought to downplay the panic. Guru Prasad Poudel, Executive Director of the central bank’s Supervision Department, acknowledged the rising NPL levels but maintained that the overall banking system is resilient. “Banks are still well-capitalized and liquid. The situation is not alarming yet,” he said. However, he admitted that negligence by some banks and sector-specific slowdowns have contributed to the surge in defaults. Despite a modest 1.4% increase in overall net profits for the commercial banking sector—reaching over Rs 41.25 billion by the third quarter—experts warn that unless NPLs are brought under control, long-term profitability and financial stability could be at risk.

With economic growth projected to remain below 5% in 2024/25, pressure on banks and borrowers is expected to persist. As concerns grow both at home and abroad, policymakers and regulators face growing urgency to address underlying risks in the financial system before they escalate further.

(This news report was originally published in  May 2025  issue of New Business Age Magazine.)