Manoj Paudel
A well-designed private equity and venture capital market could transform Nepal’s economy—if banks, insurers and regulators get the incentives right.
Nepal’s financial system has long been built around collateralized credit. Banks dominate lending, and the bulk of funds flow toward real estate, trade finance, or consumer loans. Yet, as the country aspires to diversify its economy—into agribusiness, manufacturing, digital services, and women-led enterprises—the limitations of this model are increasingly visible.
Formal credit is ill-suited to the needs of early-stage entrepreneurs, under-capitalized SMEs, and distressed but salvageable firms. What they need is long-term, risk-tolerant capital—paired with the governance discipline required to use it efficiently. That is the domain of private equity (PE) and venture capital (VC). Both are in short supply. And without urgent reform, both will remain stunted.
The good news is that change is possible. Early policy steps—such as the Specialized Investment Fund Rules and recognition of alternative investment by Nepal Rastra Bank—are encouraging. But a broader rethink is needed. Banks must move from bystanders to early backers. Institutional capital must be unlocked. And regulators must replace blanket caution with targeted, smart supervision.
Private capital, properly designed, is not a luxury. It is a necessity—one that could catalyse productivity, formalisation and growth across Nepal’s fragmented economy.
The Missing Middle: Nepal’s SMEs, Women Entrepreneurs, and the Capital Gap
Across the country, small and medium enterprises (SMEs) are the largest source of employment outside subsistence agriculture. They span furniture workshops in Bhaktapur, tea processors in Ilam, and manufacturers in Biratnagar. Many are informal, family-run, and dependent on personal savings or high-interest credit from cooperatives.
Formal banks, bound by strict collateral requirements and wary of perceived risk, lend to them sparingly. Although Nepal Rastra Bank mandates a significant allocation of bank loans to agriculture and SMEs, many institutions fall short—due to both risk aversion and a lack of structured channels for capital deployment..
Women-led businesses face even steeper barriers. While female entrepreneurship is growing, few women own titled property, making access to credit nearly impossible. Nepal has committed to gender-inclusive finance in principle. In practice, however, minimal amount of commercial loans goes to women-led enterprises.
Directed lending mandates alone are not sufficient. What is needed is a professional intermediary layer—PE funds that can evaluate SMEs beyond collateral, invest equity or quasi-equity, improve governance, and support their growth. These funds can also serve as filters: identifying viable firms for future bank lending, or helping restructure ones that have fallen behind.
This approach is not theoretical. In India, for example, several government-backed SME funds now serve precisely this role, often in partnership with banks and insurers. Nepal could benefit from a similar model—locally grounded, but globally informed.
The Venture Case: Tech Needs Capital, Not Just Talent
Nepal’s tech sector is small but vibrant. Some successful startups have shown that Nepali founders can build products for both domestic and international markets. The digital economy—spanning fintech, AI services, logistics and agritech—offers the promise of export-led growth, without the need for heavy infrastructure.
But startup ambitions quickly stall without capital. Venture capital fills this gap by backing early-stage firms that lack collateral or steady cash flow but show promise of high growth potential. It does so through equity, not loans, aligning investor incentives with founder success. Returns are lumpy and uncertain—but the potential upside is transformative.
India boasts over 100 unicorns. Nepal, so far, has none. This is not for lack of ideas. It is because the venture capital stack—seed funds, angel networks, growth-stage capital, and viable exit markets—is still under construction. And without early domestic capital, foreign funds rarely enter.
Here too, banks can play a catalytic role—not by picking startups themselves, but by investing in well-governed VC funds. Yet current regulation disincentivises such investments. Under existing Nepal Rastra Bank (NRB) rules, any investment into PE or VC funds is deducted from Tier 1 capital—reducing a bank’s lending capacity. For every NPR 100 invested, banks forego income equivalent to NPR 35.29 from traditional lending, once capital adequacy, spreads, and provisioning are factored in. The requirement to create an additional investment reserve if the fund is unlisted after three years further discourages participation.
While NRB has offered some relief by exempting investments made into fund management companies, this does not extend to the funds themselves. A more rational approach would align with international norms: allow up to 10 percent of core capital to be invested in licensed PE/VC funds without triggering reserve requirements, and assign a 150 percent risk weight under Basel III guidelines.
From Recovery to Restructuring: PE as a Tool for Turnaround
Nepal’s banking system is beginning to show signs of stress. Non-performing loans are rising—especially in the SME segment, where many firms are struggling with post-COVID demand shifts and working capital shortages. Restructuring, however, is difficult within the current credit framework.
PE funds offer an alternative. By taking equity positions in struggling but viable firms, they can recapitalise, bring in professional management, and reposition the business. In some cases, they can consolidate fragmented players into more efficient platforms—creating scale where none previously existed.
Such turnaround capital is not a panacea. But used well, it can reduce NPL burdens, preserve employment, and eventually return firms to creditworthiness. If treated as strategic partners—not just capital sources—PE funds can also introduce governance discipline, operational efficiency and market access. Nepal’s regulatory framework should recognise PE as a complementary tool in financial sector health—especially as credit stress mounts.
The Real Money: Scaling Through Insurers, Pensions and Private Wealth
Banks can help launch Nepal’s private capital ecosystem, but they cannot scale it. That requires deep, patient capital—of the sort held by life insurance firms, pension funds and high-net-worth individuals (HNWIs). In other markets, these are the main backers of PE and VC.
Nepal’s insurance and pension sectors, however, remain largely invested in government securities or term deposits. This is partly due to regulation and partly due to the lack of viable investment alternatives.
That must change. Properly structured funds—with transparent governance, periodic reporting, and clear tax treatment—can deliver attractive, long-term returns. Institutional investors should be allowed and encouraged to allocate a portion of their portfolio to such vehicles.
Policymakers could consider creating a framework similar to India’s Fund-of-Funds model, where public institutions co-invest alongside private LPs in sector-specific funds. With the right incentives, Nepal’s insurers and pensions could serve as stabilising anchors for a growing alternative asset base.
HNWIs are another potential source. Many are already investing informally—in family businesses, land, or acquaintances’ ventures. But without formal investment vehicles, this capital remains fragmented and risky. Structured PE/VC funds could channel this wealth into productive enterprise, with professional oversight and clear exit strategies.
Learning from Elsewhere: Models Worth Adapting
Nepal need not start from scratch. In the United States, the Small Business Investment Company (SBIC) programme helped banks and private investors co-invest in high-growth firms using government-backed leverage. In India, the creation of Category I and II AIFs catalysed the domestic VC industry, by enabling banks and public sector participation. In Singapore, the MAS co-invests with private VC managers, while also granting capital relief for bank investments in strategic sectors.
None of these models is perfect. But they share a common principle: early-stage risk capital is a public good worth enabling, even if privately deployed. Nepal can craft its own hybrid: one that blends catalytic bank investment, scaled institutional capital, and prudent regulatory oversight. It will require capacity-building, new legal frameworks, and patient experimentation. But the rewards are large.
A Financial System Fit for a New Economy
Nepal’s economic future will not be built on remittances and under-collateralized bank credit. It will depend on whether the country can finance and formalize the aspirations of its entrepreneurs—rural and urban, tech-savvy and traditional, male and female.
That means building a private capital market that works: one that funds ideas before balance sheets, grows SMEs beyond survival, and rescues struggling firms before they collapse. PE and VC are not silver bullets. But they are critical tools. And the time to deploy them is now.
The next phase of Nepal’s growth will require banks to lend differently, insurers to invest strategically, and policymakers to regulate boldly. It will demand risk-taking—but of the disciplined, structured kind that builds institutions and industries alike.
Nepal’s capital must be as ambitious as its entrepreneurs. Finance must do more than follow—it must lead.
(Manoj Paudel is the Founder and Chair of Aadhyanta Fund Management Limited, a domestic private equity fund licensed under SEBON. He is also the Chair of the Investment and International Affairs Committee at the FNCCI.)
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