Bankers fear loan misuse ruling could shake confidence in lending

The Supreme Court ruled that diverting loan money from its approved purpose can amount to a banking offence. This applies even when the borrower has paid principal, interest and instalments on time. The ruling matters because repayment alone may not end questions about how the money was used.

The court did not say every borrower is automatically guilty. Authorities must investigate the allegation using evidence, and the case must be tested through judicial proceedings. It also said a bank’s complaint or prior repayment demand is not required before an investigation begins.

The ruling came in Shashidhar Sharma’s case and was issued on July 30, 2026. Bankers fear it could affect older loans, especially those made before working capital lending guidelines. They warn that criminal risk could discourage borrowers and banks, further weakening lending in a market already facing excess liquidity and weak credit demand.

Loan diversion occurs when a borrower uses loan funds for a purpose different from the one stated in the application or approval. Nepal’s banking rules already prohibit this practice. The Supreme Court said it can be more than a private disagreement about repayment because the Banking Offence and Punishment Act provides grounds for investigation.

The key mechanism is public enforcement. The government is the plaintiff in a loan-misuse case, so the lending bank does not have to complain first. Nor must it previously demand repayment. Evidence must still establish what happened, and the allegation must pass through judicial proceedings before guilt is determined.

The issue is significant because banks and borrowers have often treated diversion as routine when repayments continued. Nepal Rastra Bank also tended to overlook such cases in those circumstances. The ruling could therefore bring old lending practices under sharper legal scrutiny, although the supplied article does not define every form of diversion.

Shashidhar Sharma’s loan was Rs480 million, borrowed from Prabhu Bank on January 17, 2025. He stated that the money would be used to purchase land, but the supplied article ends mid-sentence after the words “for a r”. It therefore does not provide the complete stated purpose or a complete account of the alleged use.

The article does give two inspection findings. Nepal Rastra Bank’s regulatory inspection report found that Prabhu Bank had failed to secure adequate collateral. It also found that the bank had disbursed the loan in breach of its own internal guidelines. Those findings supported the court’s view that investigation could continue without a complaint from the bank.

Because the source text is incomplete at this point, it would be unsafe to identify exactly how Sharma used the money. The clear facts are the Rs480 million amount, the land-purchase statement, and the inspection findings about collateral and internal procedures.

The article identifies Nepal Rastra Bank as the banking regulator responsible for inspecting and supervising banks and financial institutions. It can forward findings from an inspection to an agency authorised to investigate suspected loan misuse. The court ruled that doing so was within the central bank’s legal role.

The supplied text does not specifically identify the police or describe their exact procedure. It refers more generally to an authorised investigating agency. The investigation can begin without a complaint from the lending bank or a prior repayment demand. The government is the plaintiff in a loan-misuse case.

Courts provide the judicial stage. They test allegations and evidence before deciding guilt. In Sharma’s case, the Supreme Court also considered the bank’s inadequate collateral and breach of internal guidelines. The ruling therefore separates regulatory inspection, investigation and judicial determination, rather than treating repayment as the end of the process.

If the ruling reaches older loans, borrowers who diverted funds in the past could face criminal investigation despite regular repayments. Bankers say this would expose people to legal risk after a practice that had often been treated as routine. The court’s interpretation could therefore change expectations around previously issued credit.

Banks could also face pressure because many older loans were used for purposes other than those approved, especially before Nepal Rastra Bank’s working capital lending guidelines. Santosh Koirala warned that much of that money remains tied up in investments. The article also notes that the court found one bank had failed to secure adequate collateral and had breached internal guidelines.

The wider effect could be less lending. Nepal’s banking system already has excess liquidity, historically low interest rates and weak credit demand. Bankers fear criminal exposure would make lenders more cautious and borrowers less willing to seek credit. The article does not state whether older loans will ultimately be prosecuted.

Before this ruling, loan misuse was commonly handled as a banking or recovery matter when borrowers continued making payments. Banks and borrowers had often treated use of funds for another purpose as routine. The article says Nepal Rastra Bank also tended to overlook such cases when repayments remained regular.

The available responses focused on financial remedies. Nepal Rastra Bank could direct banks to recover loans used for unauthorised purposes. Banks could make provisions, while borrowers were expected to repay. Rajesh Upadhyay said these measures should normally address misuse without criminal prosecution.

The ruling changes the possible legal framing. It says misuse can be investigated as a criminal offence even without a complaint from the lending bank. Bankers distinguish loans issued after working capital lending guidelines from earlier loans, but they fear uncertainty over the past. The article does not say that older borrowers were routinely prosecuted before this ruling.

Banks approve a stated purpose so they can assess whether a proposed use fits the loan and its risks. Requiring that purpose also gives the lender a basis for monitoring the money. The article says Nepal’s regulations prohibit borrowers from using loans for purposes other than those approved by the lending institution.

Collateral gives a bank security if repayment fails. A repayment schedule provides a clear way to return principal and interest over time. These are standard banking safeguards; the article does not explain their underlying rationale in detail. In Sharma’s case, an inspection found that Prabhu Bank had not secured adequate collateral.

The rules matter because misuse can weaken the lender’s control over its funds. The court also noted that Prabhu Bank had disbursed the loan in breach of its internal guidelines. At the same time, the case shows that regular repayment does not necessarily erase concerns about approved use under the Supreme Court’s interpretation.