Rich on Paper, Empty in Pocket: The Alarming Profit-Cash Gap Crippling Nepali Banks

The unpolished financial reports for the third quarter of the current fiscal year reveal a contradictory situation in Nepal's banking sector. While the net profits of most commercial banks appear to have grown, their 'free cash flow' or 'distributable profit' remains significantly low or even negative. This indicates that while banks look prosperous on paper, they are struggling with actual cash liquidity.

Data analysis shows that several major banks, such as Kumari and Himalayan Bank, have negative retained earnings. This means that despite reporting profits, they cannot distribute dividends to shareholders because their earnings are being consumed by provisioning and bad loan management.

There are three primary reasons for the shrinking free cash flow. First is 'accrued interest,' where banks record interest as profit when it is due, even if the borrower hasn't paid. Due to the economic slowdown, actual cash is not entering the banks despite being recorded as income. Second is the burden of provisioning; as non-performing loans (NPL) rise, banks must set aside large portions of their profit for safety. For example, Himalayan Bank's NPL reached 7.39%, forcing it to use its earnings to cover potential losses. Third is the increase in non-banking assets, where banks take ownership of collateral when loans aren't repaid, which increases assets on the balance sheet but does not provide liquid cash.

For investors, this growing gap means that many banks may not be able to provide dividends this year. Furthermore, low free cash flow limits a bank's ability to issue new loans, which could eventually stall business expansion. If loan recovery does not improve by the fourth quarter, the banking sector could face a significant cash crisis.