Nepal’s Banks Show Income Stability, but Profit Quality Signals Deeper Stress

Kathmandu — Financial results released by Nepal’s commercial banks for the second quarter of the current fiscal year reveal a cautiously improving headline picture, but a closer examination exposes persistent structural weaknesses within the banking system. While net interest income—the core revenue stream for banks—has shown modest growth, rising dependence on unrealized interest income and an increase in bad loans continue to cast doubt on the sector’s underlying financial strength.

By mid-January, the country’s 20 operating commercial banks had collectively generated net interest income of approximately NPR 96 billion, marking a year-on-year increase of 3.72 percent. This improvement, though positive, remains relatively subdued given the scale of excess liquidity in the banking system. The data suggest that banks are earning slightly more from their lending activities, but not enough to indicate a strong revival in credit demand or economic activity.

Performance across banks, however, has been uneven. Larger institutions continued to dominate in absolute terms, while several mid-sized banks posted stronger growth rates. This divergence highlights differing risk exposures and recovery trajectories within the sector. Banks with relatively healthier loan portfolios and lower stress in interest recovery were able to expand margins, while others struggled under rising repayment challenges.

Government-owned banks emerged as notable performers in percentage terms, reflecting a rebound from previously subdued earnings. In contrast, some of the largest private banks reported declines in net interest income, pointing to pressure from loan repricing, higher funding costs, or weakening interest collections. These mixed outcomes indicate that the sector’s recovery is selective rather than systemic.

While income trends appear mildly encouraging, profitability tells a more complicated story. During the second quarter, commercial banks collectively reported net profits exceeding NPR 30 billion, representing double-digit growth compared to the same period last year. At first glance, this suggests improved operational performance. However, a significant portion of these profits—nearly one-third—was generated from interest that has accrued but not actually been received in cash.

Under existing accounting standards, banks are allowed to recognize such accrued interest as income, even when borrowers have not made payments. Although regulatory adjustments may later reverse these figures, the growing share of unrealized interest in profits raises concerns about earnings quality. In practical terms, this means that reported profits may not fully reflect banks’ cash-flow reality.

The increasing reliance on unrealized interest income signals ongoing stress in loan recovery. Compared to the previous fiscal year, when unpaid interest played a smaller role in profitability, the current trend suggests that more borrowers are struggling to service their debt on time. This pattern is consistent across almost all commercial banks, indicating system-wide pressure rather than isolated issues.

These challenges are further reflected in the rise of non-performing loans. By mid-January, the average bad-loan ratio of Nepal’s commercial banks had crossed the 5 percent mark. This level is widely viewed as a psychological and regulatory threshold, beyond which asset quality concerns become more pronounced. Banking analysts attribute the increase to lingering effects of the post-pandemic slowdown, coupled with recent social and economic disruptions that weakened business cash flows.

In response, banks have accelerated collateral enforcement, leading to a growing stock of non-banking assets on their balance sheets. However, sluggish activity in the real estate market has made it difficult to liquidate these assets, limiting banks’ ability to convert collateral into recoverable cash. This has added another layer of risk to balance-sheet management.

Overall, the second-quarter data suggest that Nepal’s banking sector is stabilizing at the surface level but remains vulnerable beneath. Modest growth in net interest income provides short-term relief, yet rising bad loans, dependence on unrealized interest, and growing non-banking assets point to unresolved structural challenges. Without stronger credit recovery and broader economic momentum, improvements in headline figures may prove fragile rather than sustainable.