Effects of Reserve Requirements on Priority Sector Lending by Commercial Banks in Nepal

Abstract

The Nepal Rastra Bank, the central bank of Nepal, has directed commercial banks to make loans to the so-called priority sector which includes agriculture and small industries within the rural areas of Nepal. The commercial banks have done this reluctantly because loans to the priority sector are viewed as being less profitable than other types of loans given reserve requirements and other factors. This study examines the extent to which reserve requirements and other factors discourage commercial bank lending to the priority sector. Simple algebraic models and time series data for the period 1981 to 1992 are used for this purpose. For the 12 year-period it was found that reserve requirements increased the cost of lending to the priority sector. It is concluded that the government of Nepal will need to provide additional incentives to commercial banks in order to develop the rural areas. Some suggestions are made in this regard.