Financial Sector Stability and Credit Growth in Nepal: A Case Study

Nepal’s financial system has undergone waves of credit booms, especially in the pre- and post-COVID-19 pandemic periods, which raises questions about the health of the banking sector. This paper examines the association between credit growth and banking sector health using secondary data from Nepal Rastra Bank and the International Monetary Fund. The World Bank for fiscal years 2016/17-2023/24. It is found that private sector credit grew at nearly 29 percent in 2016/17 and more than 27 percent in 2020/21, which far exceeded the overall economy’s growth rates. Credit boomed due to large remittance inflows, low real interest rates, and rapid expansion of bank outlets and digital products. Heavy lending to real estate, housing, construction, and import sectors. Consequently, the quality of banks’ assets declined as credit growth slowed down sharply in 2021/22. The non-performing loan ratio, which averaged between 1.2 and 1.8 percent during the boom years, rose to about 2.6 percent in 2022/23 and 3.7 percent in 2023/24. The capital adequacy ratio of banks dipped from 14.5 percent in 2016/17 to 12.8 percent in 2023/24. The study concludes that rapid credit growth, albeit beneficial for a short time, may pose significant financial stability risks if the lending environment worsens and credit becomes concentrated in a few sectors. The paper recommends enhanced risk-based supervision, countercyclical capital buffers, diversification of credit to productive sectors, improved governance, and enhanced capital markets to complement bank lending