Capital Pressure Mounts on Eight Commercial Banks Despite Excess Liquidity

Nepal’s banking sector is facing a growing capital adequacy challenge, even as liquidity remains abundant across the system. According to the Nepal Rastra Bank’s (NRB) financial report up to mid-January (Poush), eight commercial banks are currently under pressure due to weakening capital buffers, limiting their ability to expand lending despite having sufficient funds.

The data reveals a structural imbalance within the banking system. While deposit growth has outpaced credit demand, leading to excess liquidity, several banks are constrained by declining primary capital adequacy ratios. This means that even though banks have money to lend, regulatory capital limitations are preventing them from doing so. The issue highlights a shift from liquidity-driven constraints in previous years to capital-driven constraints in the current environment.

Among the affected institutions, Himalayan Bank appears to be under the most significant pressure, with its primary capital adequacy ratio dropping to 8.19 percent—below the regulatory minimum threshold of 8.5 percent. Similarly, Prabhu Bank and Citizens Bank are hovering just above the minimum requirement, with ratios of 8.68 percent and 8.69 percent respectively. Other banks, including NIC Asia Bank, NMB Bank, Kumari Bank, Machhapuchchhre Bank, and Rastriya Banijya Bank, are also operating close to the regulatory floor, leaving little room for aggressive credit expansion.

At a system-wide level, the average primary capital adequacy ratio of 20 commercial banks has declined to 9.48 percent, down from 9.68 percent a year earlier. Although the decline of 0.20 percentage points may appear modest, it signals a consistent erosion of capital strength across the sector. Government-owned banks are relatively better positioned, with an average ratio of 9.78 percent, compared to 9.44 percent among private sector banks.

Regulatory provisions require commercial banks to maintain at least 8.5 percent primary capital and 11 percent total capital adequacy ratios. Falling below these thresholds not only restricts lending capacity but also prohibits dividend distribution for that fiscal year. Based on current figures, Himalayan Bank is likely to be barred from distributing dividends from its earnings this year, reflecting the tangible impact of capital stress on shareholders.

The underlying causes of this pressure are closely tied to asset quality deterioration and rising non-performing loans (NPLs). As bad loans increase, banks are required to allocate higher provisions, which directly reduce profitability and, consequently, capital reserves. This cycle has intensified the strain on capital adequacy, even in a low-credit-growth environment.

Interestingly, the capital pressure persists despite weak credit demand. Economic slowdown, limited expansion in business activities, and subdued investor confidence have all contributed to reduced borrowing appetite. As a result, banks are currently holding an estimated Rs 1.1 trillion in excess lendable funds. The average credit-to-deposit ratio stands at around 73.86 percent, well below the regulatory ceiling of 90 percent, indicating that liquidity is not the primary constraint.

However, stricter lending standards imposed by banks themselves—largely due to rising credit risk—have further dampened credit expansion. With average non-performing loans exceeding 5 percent, banks are becoming increasingly cautious in issuing new loans, creating a feedback loop where low lending reduces income while provisioning requirements continue to rise.

To address capital shortfalls, the central bank has allowed banks to issue perpetual preference shares as an additional capital instrument. Some banks have already utilized this provision, while others are in the process of doing so. Nevertheless, experts argue that without a meaningful reduction in bad loans or fresh capital injections, the pressure on capital adequacy is unlikely to ease in the near term.

In essence, Nepal’s banking sector is currently navigating a complex phase where liquidity abundance contrasts sharply with capital constraints. The situation underscores a deeper structural challenge: restoring asset quality and strengthening capital buffers will be crucial for reviving credit growth and sustaining financial stability in the coming months.