Current Liquidity Situation in Nepal: Challenges and Way Forward
Current Liquidity Situation in Nepal: Challenges and Way Forward
-By CA Namuna Joshi
Executive Summary
This article is an overview of the current liquidity position in Nepal, showcasing the shift of Nepal’s situation of liquidity stress to period of ample liquidity. This article highlights that money supply is key source of liquidity in financial sector and Interest rates, Credit to Deposit ratio, Excess Reserves in central bank are some key indicators of liquidity. The article also explores the issues arising out of excess liquidity, such as the slowdown in economic growth, low credit growth, the impact on profitability and the potential for misallocation of funds. Lastly, the article discusses the policies and strategies that could be put in place to ensure that the idle funds are productively deployed, thereby promoting economic growth in Nepal.
Key Words
Liquidity, Money Supply, Credit Growth, Credit-Deposit Ratio, Banking System, Excess Liquidity
- Introduction
Liquidity, in simple words, is the capacity of an asset to be easily converted into cash. The role of liquidity in the financial system is of critical importance in maintaining financial stability in the economy.
In the banking sector, liquidity is the capacity of banks and financial institutions to meet their financial obligations. The banking system requires adequate liquidity to function efficiently. From the perspective of the macro economy, the concept of liquidity refers to the availability of money and credit in the overall economy. The availability of enough liquidity in the system is essential for the smooth operation of consumption, investment, trade, and other economic activities like production. If the liquidity level is adequate, businesses can easily access funds for expansion, and individuals can easily access credit for consumption and investment purposes. On the other hand, if the liquidity level declines, the cost of borrowing tends to rise, thereby affecting economic activities.
This article aims to present an overview of the present liquidity position in Nepal with reference to some significant indicators such as money supply growth, credit growth, interest rates, and the credit-deposit ratio. The implications of excess liquidity in the banking system and some possible measures are also discussed hereunder.
- Indicators of Liquidity in Economy
The liquidity conditions of the economy can be determined through various macroeconomic and financial indicators. Central banks, economists, and financial analysts use different indicators to measure the money and credit available in the financial system. Some of the major indicators of liquidity in the economy are money supply, credit growth, interest rates, and the credit-deposit ratio.
- Money Supply
Money supply measures how much money is circulating in the economy, i.e. cash and bank deposits. Greater money supply means high liquidity and vice versa.
Source: Current Macroeconomic and Financial Situation published by Nepal Rastra Bank
*Data as Mid-Jan for FY 2025/26
Narrow Money Supply (M1) represents the most liquid form of money. It includes cash in circulation, current account deposits and money that can be immediately withdrawn. Broad Money includes narrow money supply (M1) plus less liquid deposits, which include term deposits and saving deposits. It is the broader money supply available in the economy. It indicates the overall liquidity situation in the economy.
From the above table, we can see that money supply has grown consistently over the past seven years. We can note a sharp increase particularly in FY 2020/21 during COVID period. We can observe lower and declining money supply during FY 2021/22 and FY 2022/23, which represents tighter liquidity during the period. The period has been followed by increasing money supply and broad money in the economy representing higher liquidity in the economy. The higher liquidity during the period is driven by growing remittance inflow in the country. As of Mid-Jan FY 2025/26, year-on-year growth of broad money (M2) and money supply (M1) stands at 14.15 percent and 21.1 percent. The 21.1 percent growth is the highest in last seven years, highlighting very high and strong liquidity in the economy. Also, higher growth rate of narrow money supply than broad money suggests fixed deposits are converting to saving deposits.
- Credit Growth
Credit growth is an important measure in economy and the banking system to measure the increase in loans provided by banks and financial institutions to individuals and business entities. An increase in credit growth is considered economic expansion. Further, growth in business loans is viewed positively as it enables businesses to invest in production, operations and create employment opportunities in the country. This will ultimately increase country’s Gross Domestic Product (GDP) and per capital income of citizens. However, it is very crucial that such credit growth is sustainable.
Source: Current Macroeconomic and Financial Situation published by Nepal Rastra Bank
*Data as Mid-Jan for FY 2025/26
From the above table, we can see that credit growth pattern has been fluctuating over the past five years. The credit growth was lowest, i.e. 4.2 percent in the FY 2025/26, which was due to lower credit demand in the market. During FY 2023/24, credit growth was highest at 14.5 percent at FY 2021/22 in the last five years and then started declining and stands at 4.2% as of FY 2025/26 (up to Mid-Jan). This suggests that liquidity has improved over the past three years. From Table 1, we can also observe that money supply is increasing every year, but credit growth is not increasing at the same rate, indicating that banks have enough funds but haven’t been able to lend. It indicates low credit demand in the economy which means low economic activities.
On the other hand, we can see that deposit growth pattern has also been fluctuating in the last five years. From FY 2022/23, we can see that deposits have been increasing and the gap between deposit and credit is widening, which can also be supported by CD ratio in Table 4.
- Interest Rates
Interest Rates are another significant economic indicator. Interest Rates directly influence deposit rates, borrowing costs and overall liquidity of the economy.
Source: Monthly Banking and Financial Statistics (Mid- Jan 2026) published by Nepal Rastra Bank
*Data as Mid-Jan for FY 2025/26
The above table represents trends of weighted average interest rates on deposit and credit from FY 2021/22 to FY 2025/26, indicating change in liquidity conditions. Deposit rates increased slightly from 7.41 percent in FY 2021/22 to 7.86 percent in FY 2022/23, while credit rates also rose from 11.62 percent to 12.30 percent during the same period, indicating period of liquidity stress in the banking system, and demand of higher deposit. However, from FY 2023/24, both deposit and credit rates began to decline, showing improvement in liquidity conditions. Weighted average credit interest rate has declined from 12.30 percent in FY 2022/23 to 7.12 percent in FY 2025/26 and weighted average deposit interest rate has dropped from 7.86 percent from FY 2022/23 to 3.56 percent in FY 2025/26.
- Credit-Deposit Ratio
Credit Deposit Ratio measures the percentage of loan provided by banks out of its total deposits. A higher credit deposit ratio means the banks are lending large proportion of their deposits, which can also indicate tighter liquidity and lower credit deposit ratio means that banks are lending lower amount of their deposits and indicate excess liquidity.
Source: Monthly Banking and Financial Statistics (Mid- Jan 2026) published by Nepal Rastra Bank
*Data as Mid-Jan for FY 2025/26
The above table shows that from FY 2021/22 to FY 2025/26; the CD ratio ranged from 91.38 percent to 75 percent. The ratio was highest, i.e. 91.38 percent in FY 2021/22, indicating higher lending and tighter liquidity conditions. However, from FY 2022/23 CD ratio began to decline from 84.53 percent and dropped to 75 percent in mid-Jan of FY 2025/26. This shows improved liquidity conditions in the economy.
- Open Market Operations
Open Market Operations are monetary policy tools implemented by the central bank of any country to manage liquidity in the money market by buying or selling government securities in the market. Through these tools, the central bank of any country manages the money supply, interest rate, and stability of the money market.
In case of Nepal, Nepal Rastra Bank (NRB), manages liquidity in the market by injecting liquidity when banks face liquidity shortages and by absorbing liquidity when there is excess money in the market. Nepal Rastra Bank has absorbed NPR 28,699 billion from the banking system through Standing Deposit Facility, deposit collection and bonds.
- Current Excess Liquidity Scenario in Nepal
At present, banks have more funds available than demanded, as deposits are increasing, interest rates are decreasing, but loans are not increasing. For instance, in FY 2024/25, deposits rose by 12.4%, but loans grew by only 6.2%. This means that banks are receiving a large amount towards deposit but are unable to mobilize loans to businesses or individuals.
Another indicator of excess liquidity in Nepalese banks is their credit deposit ratio, which represents the ratio of loans provided by banks to their total deposits. Banks can provide loans up to 90% of their deposits as per the rule of Nepal Rastra Bank, but their average credit deposit ratio is at around 74 to 76 percent.
Thus, there is a paradox in the Nepalese banking sector, where banks have ample funds and interest rates are low, but businesses and individuals are not taking loans. Hence, banks are facing problems in utilizing their funds optimally, and these idle funds are not contributing to economic growth of the country. Along with the increasing remittance inflow, the recent Gen-Z protest in Nepal also seems to have driven the current situation. Due to uncertainty in the political situation, businesses and individuals are hesitant to borrow money and start new businesses.
- Challenges and Impacts of Excess Liquidity in Nepal
Nepal’s current financial system is facing situation of excess liquidity, which means that the banks are holding more money than they need, but the demand for credit remains low. There are several challenges associated with a situation of excess liquidity:
1. Low Credit Utilization and Low Economic Activity
Excess liquidity in the system means that banks have ample funds but lack the credit demand. This is because businesses and households are not interested in availing debt which might be due to uncertainties and low investment opportunities or because they are already in high debt situation. This means that the banks have large amounts of funds remaining idle rather than being used productively to grow businesses or start new ventures. This will cause the economy to grow at a slower pace even as the banks have ample unutilized funds.
2. Pressure on Profitability of Banks
When there is excess liquidity in banks, they tend to park the amounts in the hands of the central bank or in the form of low-yielding government securities. This option generates minimal returns for the banks compared to the returns generated when they lend money to businesses and individuals. Hence, the overall profitability of the banks comes down. In the long run, excess liquidity tends to make the banks more risk-averse and impacts on the number of initiatives taken by the banks.
3. Declining Interest Rates and Margin Compression
The excess liquidity tends to bring down the rates at which the banks lend and deposit money. Although the rates are favorable for the borrowers, the overall banking profitability comes down as the main source of income for the banks is the differential between the lending and deposit rates.
4. Asset Bubbles and the Misallocation of Capital
When banks face excess liquidity and low credit demand, they can invest in safer and riskier assets such as government bonds, and stocks, which can cause asset bubbles and pose systemic risks. Banks can also allocate funds to sectors that do not contribute significantly to the productivity of the economy.
- Way Forward
The current liquidity situation is posing a lot of challenges in the banking system and economy. Some of the measures to cope with the situation have been discussed below:
1. Increase loan demand
To convert the surplus liquidity into economic activities, the demand for credit should be increased. This can be achieved through targeted lending strategies to sectors with high growth potential such as agricultural sector, hydropower sector, manufacturing industry, and infrastructure development. Low-cost and subsidized loans can be provided to small and medium-scale enterprises, new industries, and individuals for housing, education, and consumption purposes. This will help increase economic activities.
2. Enhancing Bank Lending Efficiency
Banks need to utilize the excess money they have by lending it more productively. They can do this by providing more loan opportunities and bringing loan products that are attractive to different sectors of the economy. In this way, more people will borrow money, and the excess money in the banking system will be utilized for productive purposes.
3. Monetary Policy and Liquidity Management
The monetary policy of Nepal Rastra Bank also plays a key role in managing surplus liquidity in the country by using monetary policy tools to balance the liquidity in the market. However, it is also very important to monitor the market to avoid any possible bubble or investment that may be made in different sectors of the market.
4. Promoting Private Sector Growth and Financial Intermediation
The private sector is very important in utilizing surplus liquidity in the market by encouraging its growth and entrepreneurship in different sectors of the market. Therefore, public-private partnerships in different sectors of the market are very important in utilizing surplus liquidity in the market by encouraging different sectors of the market to invest in different sectors of the market, particularly in infrastructure and development projects in diverse sectors of the market. At the same time, banks should also encourage entrepreneurs to invest in different sectors of the market by providing loans to entrepreneurs at reasonable interest rates to promote economic growth in diverse sectors of the market.
- Conclusion
The liquidity scenario in Nepal has witnessed a major shift in the past few years. In FY 2021/22 and FY 2022/23, the economy was in the condition of scarce liquidity with high interest rates and low credit availability, however, the current scenario has high liquidity in the banking system with high deposit growth, a falling credit-deposit ratio, and falling interest rates.
There are huge funds in the banking system, and the cost of borrowing is low. But having excess money in the system can slow down the economy and make the profit of the banking sector very low. It can also make the monetary policy less effective because the interest rates are already very low and further decreasing interest rates may not encourage businesses and people in the country to borrow money.
To solve this problem, there are several things that need to be done. One such thing is to make the loans more attractive through specific programs. Another is to help the banking sector lend the money more efficiently. The banks can think of prioritizing short-term loans over long-term lending to minimize future cost risks. In addition, the liquidity in the system needs to be managed through the central bank. This way, the excess money in the banking system can be utilized for the growth and development of the economy.
References:
- Nepal Rastra Bank. (2026, February). Current macroeconomic and financial situation – English (based on six months data of 2025/26).
- Nepal Rastra Bank. (2026, February). Macroeconomic report: February 2026.
https://www.nrb.org.np/contents/uploads/2026/03/Macroeconomic-Report-February-2026.pdf
- Nepal Rastra Bank. (2026, February). 2082 Poush (Mid-Jan 2026) monthly banking & financial statistics [PDF].
https://www.nrb.org.np/contents/uploads/2026/02/Poush_2082_Publish.pdf