Green Finance and Credit Risk in Nepalese Banking Industry

Abstract The primary focus of this study is to analyze the effect of green loans on credit risk in Nepalese banks. To achieve this objective, this study follows a quantitative approach considering the objective reality and uses the quarterly secondary data, sourced from the website of Nepal Rastra Bank [NRB] over the period starting from 2021Q2 to ending with 2025Q2. The fixed-effect model (FEM) and the random-effect model (REM) are used to estimate results. The best model is selected using the Hausman and Breusch-Pagan LM tests. The result demonstrated that green loans, as measured by hydroelectricity loans, increase credit risk in the Nepalese banking sector. This unexpected result is also robust, shown by the REM. This indicates that a 1 percent increase in green loans is associated with a 0.384 percent increase in credit risk. Conversely, the capital adequacy ratio (CAR) reduces credit risk. The credit-to-deposit ratio (CD ratio) stimulates credit risk in the Nepalese banking sector. Similarly, holding more liquid assets and a larger size, as measured by deposit volume, increases credit risk in the Nepalese banking sector. The positive impact of green loans on credit risk indicates that the regulator (or NRB) should give financial incentives, such as concessional loans, to banks, by which banks grant green loans at a concessional rate, which increases borrowers’ debt-paying capability and thus reduces credit risk. Similarly, bankers should enhance their own capacity for credit evaluation and develop a monitoring mechanism to help reduce credit risk in the Nepalese banking sector.