One integral aspect of Nepalese society is the existence of the Hindu caste system, modeled after the ancient and orthodox Brahmanic system of the Indian plains. The caste system came with the arrival of Indo-Aryans. Its establishment became the basis of the emergence of the feudalistic economic structure of Nepal: the high-caste Hindus began to appropriate lands-- particularly lowlands that were more easily accessible, more cultivatable, and more productive--including those belonging to the existing tribal people, and introduced the system of individual ownership. Even though the cultural and religious rigidity of the caste system slowly has been eroding, its introduction into Nepal was one of the most significant influences stemming from the migration of the Indo-Aryan people into the hills. The migrants from the north later were incorporated into the Hindu caste system, as defined by Indo-Aryan migrants, who quickly controlled the positions of power and authority. Tibetan migrants did not practice private ownership; their system was based on communal ownership.

No single, widely acceptable definition can be advanced for the caste system. Bishop and others, however, view caste as a multifaceted status hierarchy composed of all members of society, with each individual ranked within the broad, fourfold Hindu class (varna, or color) divisions, or within the fifth class of untouchables--outcastes and the socially polluted. The fourfold caste divisions are Brahman (priests and scholars), Kshatriya or Chhetri (rulers and warriors), Vaisya (or Vaisaya, merchants and traders), and Sudra (farmers, artisans, and laborers). These Pahari caste divisions based on the Hindu system are not strictly upheld by the Newars. They have their own caste hierarchy, which, they claim, is parallel in caste divisions to the Pahari Hindu system. In each system, each caste (jati) is ideally an endogamous group in which membership is both hereditary and permanent. The only way to change caste status is to undergo Sanskritization. Sanskritization can be achieved by migrating to a new area and by changing one's caste status and/or marrying across the caste line, which can lead to the upgrading or downgrading of caste, depending on the spouse's caste. However, given the rigidity of the caste system, intercaste marriage carries a social stigma, especially when it takes place between two castes at the extreme ends of the social spectrum.

As Bishop further asserts, at the core of the caste structure is a rank order of values bound up in concepts of ritual status, purity, and pollution. Furthermore, caste determines an individual's behaviour, obligations, and expectations. All the social, economic, religious, legal, and political activities of a caste society are prescribed by sanctions that determine and limit access to land, position of political power, and command of human labour. Within such a constrictive system, wealth, political power, high rank, and privilege converge; hereditary occupational specialization is a common feature. Nevertheless, caste is functionally significant only when viewed in a regional or local context and at a particular time. The assumed correlation between the caste hierarchy and the socioeconomic class hierarchy does not always hold. Because of numerous institutional changes over the years and increased dilution (or expansion) of the caste hierarchy stemming from intercaste marriages, many poor high-caste and rich low-caste households could be found in the society.

Although Paharis, especially those in rural areas, were generally quite conscious of their caste status, the question of caste did not usually arise for Tibeto-Nepalese communities unless they were aware of the Hindu caste status arbitrarily assigned to them. Insofar as they accepted caste-based notions of social rank, the Tibeto-Nepalese tended not only to see themselves at a higher level than did the Hindu Pahari and Newar, but also differed as to ranking among themselves. Thus, it was doubtful that the reported Rai caste's assumption of rank superiority over the Magar and Gurung castes was accepted by the two latter groups. Moreover, the status of a particular group was apt to vary from place to place, depending on its relative demographic size, wealth, and local power.