Banking System and Monetary Policy
A bank is a financial institution that accepts deposits, grants loans, and creates credit. Nepal's banking system has four layers — central bank (NRB, established 2013 BS), commercial banks (Nabil, NIC Asia, RBB), development banks (NDBL, ADBL), and microfinance institutions. NRB issues currency, acts as banker to the government, and controls credit through monetary policy. Commercial banks create credit through the money-multiplier process. The money market deals in short-term funds (T-bills, call money); the capital market deals in long-term funds (shares, bonds). Monetary policy is expansionary (to boost growth) or contractionary (to control inflation).
In this chapter
Banking System — Meaning & Role
- mobilising savings — turning idle household savings (e.g. a teacher's salary in Pokhara) into productive investment
- credit creation — multiplying money supply through lending
- facilitating payments — cheque, NEFT, ConnectIPS, FonePay, QR payments
- implementing monetary policy — passing on NRB's policy rate to the public
Classification of Banks in Nepal
Classification of banks in Nepal with examples
| Type of Bank | Main Function | Nepal Examples |
|---|---|---|
| Central Bank | Issues currency, controls credit, banker to govt | Nepal Rastra Bank (NRB) |
| Commercial Bank (Class "A") | Accepts deposits, grants loans, credit creation | Nabil, NIC Asia, RBB, Global IME |
| Development Bank (Class "B") | Long-term finance for industry/agriculture | ADBL, NDBL, Excel Development Bank |
| Finance Company (Class "C") | Hire purchase, housing finance | Nepal Finance, GUFC |
| Microfinance (Class "D") | Small loans to poor without collateral | Chhimek, Deprosc, Nirdhan Utthan |
The central bank (NRB) is the apex — it does not deal with the public directly but regulates all other banks. Commercial banks are the workhorses of the system; they accept demand deposits (chequable) and create credit. Development banks provide long-term loans for agriculture, industry and infrastructure (e.g. Agricultural Development Bank finances tractor purchase in Terai). Microfinance institutions lend small amounts (Rs 10,000–Rs 200,000) to poor women's groups without collateral, following the Grameen Bank model — e.g. Chhimek Laghubitta lends to women in Bhaktapur.
Nepal Rastra Bank (NRB)
Nepal Rastra Bank (NRB) was established on Baisakh 14, 2013 BS (26 April 1956 AD) as the central bank of Nepal under the Nepal Rastra Bank Act, 2012 BS. It was nationalised in 2021 BS and a new NRB Act, 2058 BS was passed to make it autonomous. NRB is the sole authority to issue Nepali currency notes and coins, regulate all banks and financial institutions, and conduct monetary policy. Its head office is in Baluwatar, Kathmandu, with branches in all seven provinces. The Governor (currently Dr. Biswanath Paudel as acting Governor in 2025) is the chief executive appointed for a five-year term.
Functions of NRB
- Issue of currency — sole right to issue Nepali rupee notes and coins (note-issue department).
- Banker to the government — maintains govt accounts, issues treasury bills, manages public debt.
- Banker's bank & supervisor — keeps deposits of commercial banks, lender of last resort, licenses & inspects all BFIs.
- Credit control — uses monetary policy (CRR, bank rate, open market operations, moral suasion) to expand or contract credit.
- Custodian of foreign exchange — manages foreign exchange reserve, fixes exchange rate policy, regulates remittances.
- Publication of monetary statistics — publishes quarterly Economic Bulletin, Banking & Financial Statistics.
NRB monetary policy instruments and their effects
| Instrument | Expansionary (Boost Credit) | Contractionary (Reduce Credit) |
|---|---|---|
| Bank Rate / Policy Rate | Lower the rate | Raise the rate |
| Cash Reserve Ratio (CRR) | Reduce CRR (e.g. 3%) | Increase CRR (e.g. 4%) |
| Open Market Operation (OMO) | Buy T-bills from banks | Sell T-bills to banks |
| Statutory Liquidity Ratio (SLR) | Reduce SLR | Increase SLR |
| Moral Suasion | Request banks to lend more | Request banks to lend less |
| Margin Requirement | Lower margin (lend more) | Raise margin (lend less) |
Commercial Banks — Functions & Credit Creation
Commercial banks (Class "A" institutions licensed by NRB) perform two categories of functions — primary functions and secondary functions. Primary functions include (i) accepting deposits in four types of accounts — current account (no interest, chequable, used by businesses), savings account (moderate interest, limited withdrawals, used by households), fixed deposit (highest interest, locked for a period, e.g. Nabil Fixed Deposit 1-year at 9% in 2024), and recurring deposit (regular monthly saving); (ii) granting loans and advances — overdraft, cash credit, term loans, and discounting bills of exchange. Secondary functions include agency services (collecting cheques, paying bills, portfolio management), general utility services (lockers, traveller's cheques, foreign exchange, letters of credit), and credit creation through the money multiplier.
Credit / money multiplier (depends on Cash Reserve Ratio r)
Types of bank deposits and their key features
| Deposit Type | Interest | Withdrawal | Typical User |
|---|---|---|---|
| Current Account | No interest | Any time, chequable | Business firms, companies |
| Savings Account | Moderate (3-5%) | Limited per month | Households, students |
| Fixed Deposit (FD) | Highest (8-10%) | Only after maturity | Retirees, savers |
| Recurring Deposit | Moderate-high | After fixed period | Small regular savers |
| Call Deposit | Variable | On short notice | Banks, large firms |
Money Market vs Capital Market
The money market deals in short-term funds (up to 1 year) — instruments include Treasury bills (91-day, 182-day issued by NRB), call money (overnight lending between banks), commercial paper, and banker's acceptances. Participants are NRB, commercial banks, and large corporations. The capital market deals in long-term funds (more than 1 year) — instruments include equity shares (NEPSE-listed companies like Nabil Bank, NIC Asia), debentures, and government bonds (e.g. 5-year, 10-year Citizen Saving Bonds). Nepal's capital market is regulated by SEBON (Securities Board of Nepal), and NEPSE (Nepal Stock Exchange) is the only secondary market — located in Singha Durbar Plaza, Kathmandu.
Monetary Policy — Types & Tools
- Expansionary (cheap-money) policy — used during recession; NRB lowers bank rate, reduces CRR, buys T-bills through OMO, so banks can lend more and economic activity rises.
- Contractionary (dear-money) policy** — used during inflation; NRB raises bank rate, increases CRR, sells T-bills through OMO, so banks lend less and prices fall. In 2023/24 (2080/81 BS), NRB pursued a contractionary stance to control inflation that had crossed 8% — raising the policy rate to 7% and CRR to 4%
Money-supply equation with money multiplier
Remember the Multiplier
If NRB injects Rs 100 crore of new high-powered money and CRR is 5%, then the total money supply that commercial banks can create is Rs 100 × (1/0.05) = Rs 2,000 crore — a 20-times multiplier. Lower CRR ⇒ higher multiplier ⇒ more credit ⇒ more growth (but possibly more inflation).
Practice Problem
NIC Asia Bank receives a fresh deposit of Rs 50 lakh. The NRB has fixed CRR at 5% (i.e. banks must keep 5% of every deposit as reserve). (a) How much can the bank lend in the first round? (b) Using the credit multiplier, calculate the total credit created in the banking system. (c) If NRB raises CRR to 10%, what is the new total credit?
Practice Problem
Nepal Rastra Bank wants to inject Rs 1,000 crore of new money into the banking system through open-market purchase of Treasury bills. The CRR is 4%. (a) Calculate the total money supply that can be created (use the money multiplier). (b) If instead NRB sells Rs 500 crore of T-bills from its portfolio (contractionary OMO) and CRR remains 4%, what is the reduction in money supply?