What Does Nepal’s Microfinance Sector Need to Become Sustainable?

Over the past few decades, Nepal’s microfinance sector has grown significantly, from $1.8 billion as of July 2019 to $3.2 billion as of April 2025. This growth – which represents a 5-year compound annual growth rate (CAGR) of 26.5% - has been supported by the country’s broader financial sector reforms which deepened investments in microfinance and MSME finance. Financial inclusion in the country has also more than doubled since 2011, rising from only 25% account ownership in 2011 to 60% in 2024, according to the latest Global Findex Database. 

Despite this progress, the microfinance sector in Nepal faces persistent challenges. Rising non-performing loans and profitability pressures from interest rate caps threaten the sustainability of many MFIs. In order for microfinance to continue to play a vital role in expanding financial access for underserved populations in Nepal, there is a critical need for stronger risk management and capital buffers at the institution level, along with an enabling policy environment for sustainable growth in the sector.

A diversified sector in need of longer-term funding sources

As of April 2025, 49 retail MFIs operate across all 77 districts in Nepal, reaching about 6 million households. The sector is well diversified, with the largest MFI contributing 9% of the $3.2 billion retail portfolio and the top five MFIs together contributing about 33% of the market.

In terms of funding, MFIs are supported by the broader domestic financial sector, with major banks and commercial institutions serving as shareholders and lenders to MFIs. The regulatory framework for MFIs in Nepal also allows them to accept deposits from their customers, providing 40% of their funding. Although customer deposits have the advantages of being both stable by nature and cheaper than external borrowing, they can only be considered short to medium-term sources. 

Longer-term funding sources, including long-term debt and equity capital, are key to supporting new product development and sustained expansion. Concrete steps are being taken to facilitate more foreign institutional investment in the financial sector, with ecosystem initiatives such as Invest for Impact Nepal. However, raising external capital, especially institutional capital, will require Nepal’s MFIs to improve their financial performance. 

Challenges faced by retail microfinance institutions in Nepal

Nepal’s microfinance sector faces a number of challenges stemming from strict regulations on interest rate caps and an anti-microfinance movement which has brought about heightened public scrutiny. Data on asset quality, profitability and capital adequacy spread as of mid-April 2025 reveals three key challenges facing MFIs in Nepal:

Rising non-performing loans (NPLs): The anti-microfinance protests, which started in 2023, accused MFIs of discriminatory practices, high service charges and causing over-indebtedness for some customer segments. To address the increasing risk in the sector, Nepal’s central bank, Nepal Rastra Bank (NRB), announced regulatory policy changes, including limiting the number of lenders for micro-borrowers and capping MFI loans per borrower. The protests and changes in regulatory guidelines led to disruptions in disbursement and operations, with MFIs noting a sharp increase in non-performing loans (NPLs) from 2.6% as of mid-July 2022 to 7.2% as of mid-April 2025.

While disbursements have now gradually recovered, 17 MFIs contributing about 40% of the overall portfolio in the sector have NPL above 7%, indicating a need for strengthening risk assessment and delinquency management. 

Source: Author analysis, NRB, Key Financial Indicators of Microfinance Institutions, mid-Apr 2025
Note: Data is for 48 MFIs and excludes Super LBSL which is under prompt corrective action

Profitability under pressure due to interest rate caps: With a strict 15% interest rate cap, profitability is squeezed. Only three MFIs report a return on assets (RoA) above 2%, and the average is just 0.7%. Such low RoAs put stress not only on overall profitability and growth, but also on MFIs’ ability to absorb the elevated NPLs. While most MFIs are profitable, a large proportion (23 MFIs) have RoAs at less than 1% and 15 MFIs have RoA between 1% and 2%. Limited profitability also continues to impact the ability of MFIs to raise external capital.

Source: Author analysis, NRB, Key Financial Indicators of Microfinance Institutions, mid-Apr 2025
Note: Data is for 48 MFIs and excludes Super LBSL which is under prompt corrective action

Greater need for capital to fulfill credit demand: The regulatory capital adequacy threshold is set at 8%, but, given that the average NPL in the sector is 7.2%, the minimum threshold is insufficient to meet provisioning requirements for bad loans. More than 35 MFIs have a capital adequacy of less than 12%, with the average at 10.3%. Enhancing capital buffers would enable increased investment for expansion and stronger institutional capacity. 

Source: Author analysis, NRB, Key Financial Indicators of Microfinance Institutions, mid-Apr 2025
Note: Data is for 48 MFIs and excludes Super LBSL which is under prompt corrective action

Opportunities for MFIs to build sustainability and attract greater capital

The microfinance sector in Nepal now faces a pivotal moment. For it to continue to play a vital role in expanding financial access to underserved populations across all provinces, MFIs must take actions to support future sustainability and expansion. Institution-level recommendations for retail MFIs include:

• Strengthen risk management systems: MFIs need to strengthen internal audit and early warning systems to detect repayment issues and monitor disbursements in affected areas. This includes loan portfolio analysis, stress testing and delinquency management tools. Strong management information systems (MIS) also enable real-time visibility of loan performance, staff productivity and client grievances. Apart from credit and operational risk management, data can also feed into targets and planning for geographic diversification.
• Enhance collateral-based and individual lending: In addition to traditional joint liability group (JLG) models, MFIs also offer collateral-based loans for microenterprises, home improvement, agri-value chains and renewable energy solutions. Yet these remain limited in coverage.  They also require more capacity-building for MFI staff and financial literacy for clients.  To grow these offerings, MFIs can leverage basic credit scoring models and digitize borrower profiling using mobile tools to improve outreach and efficiency. Diversified product portfolios can also attract results-based funding from institutional investors at a lower cost, which can help improve profitability.
• Leverage long-term institutional funding: MFIs need to build capital adequacy buffers and take proactive steps to raise equity capital—whether through retained earnings, new investor participation or concessional funds. Doing so will help them to meet regulatory thresholds and absorb future shocks. While MFIs are listed on the Nepal stock exchange and actively mobilize public investments, improving governance and reporting standards will help attract long-term institutional investors.

Though regulatory reforms and recent policy actions have sought to stabilize Nepal’s microfinance sector, long-term resilience will depend on how MFIs adapt and strengthen their business models for future sustainability. By taking action on the recommendations listed above, MFIs can help ensure the continued progress of microfinance in bringing financial access to the underserved populations of Nepal.