IMF Recommends Gradual Phasing Out of Priority Sector Lending in Nepal

The International Monetary Fund (IMF) has advised Nepal to gradually phase out its priority sector lending policy, under which banks and financial institutions are required to allocate a certain percentage of their credit to sectors such as agriculture, small and medium enterprises (SMEs), and low-income households.

Nepal Rastra Bank (NRB) has long implemented the priority sector lending policy to ensure financial resources reach productive sectors and marginalized groups. However, in its October 2025 consultation report, the IMF highlighted that the policy has increased risks for banks and contributed to a rise in non-performing loans. The report recommended revising the policy in the short term to make it more targeted and, in the long term, phasing it out entirely.

“The requirements for lending to vulnerable sectors, such as agriculture and SMEs, have complicated banks’ efforts to manage non-performing loans,” the IMF report noted. “Refining the policy and gradually removing it will reduce the rate of lending to impractical borrowers.” The IMF also urged Nepal to shift toward a market- and risk-based credit allocation system, which it said would strengthen the stability of the banking sector.

Current Priority Sector Lending Requirements

Currently, NRB mandates that commercial banks allocate 40% of their total loans to priority sectors: 15% each to agriculture and small, domestic, and medium enterprises, and 10% to the energy sector. Additionally, banks must allocate at least 5% of their loans to low-income households. Development banks and finance companies are required to allocate a minimum of 15% to agriculture, small enterprises, energy, and tourism, and 5% to low-income households.

According to NRB spokesperson Kiran Pandit, the priority sector lending policy was designed to channel credit to productive sectors while ensuring access for poor and disadvantaged groups. NRB plans to review the limits on such loans in its monetary policy for the current fiscal year.

Policy Adjustments and Past Recommendations

The government has recently tightened regulations on subsidized loans after instances of misuse. A banking sector reform task force chaired by Dr. Rewat Bahadur Karki had also recently recommended phasing out priority sector lending. Bhuwan Dahal, a former banker and member of the task force, acknowledged that while priority sector lending is still necessary in a country like Nepal, banks should be incentivized rather than compelled to lend. He suggested that creating specialized banks for agriculture and SMEs could enhance the policy’s effectiveness.

Cooperative Sector Recommendations

The IMF report also recommended establishing provincial and local committees to manage problematic cooperatives. With the establishment of the National Cooperative Regulation Authority, cooperative registration and regulation are underway. The report emphasized the need to quickly implement a deposit protection program for cooperatives.

Additionally, the IMF suggested maintaining NRB’s current accommodative monetary policy while operating the interest rate corridor more effectively. It urged banks to closely monitor growing risks, complete stress tests on the loan portfolios of large commercial banks, and exercise caution when establishing asset management companies to manage non-banking assets.