Pakistan’s economic state is no secret today: We are undergoing a massive financial recession. News of unemployment hikes, inflationary bursts, and rising budget deficits pepper bulletins every day.
The pandemic bears the brunt of the blame for the economy-wide crisis, whether it be in the form of textile industry giants mourning the loss of raw material imports, or small and medium-sized enterprises (SMEs) undergoing cashflow constrictions.
In any case, the average Pakistani has set their foot down: COVID-19 to is blame, and that’s that. However, our myopic view of the economy doesn’t cloak a reality we often seem to ignore: The banking sector of Pakistan is inadequate and highly responsible for the financial misfortunes of the country.
It is not a new story. Instead, it’s been going on for quite a while.
To understand why let’s refresh some macroeconomic basics:
THE FUNCTIONS OF THE BANKING SECTOR
Banks are part of a larger umbrella of financial institutions known as ‘Financial Intermediaries.’ These institutions are responsible for transferring excess funds (or savings) from businesses, the government, and ordinary households to those who can appropriately invest them in productive opportunities.
Due to their specialization in this expertise, they can cut transaction costs, and reduce fraud and market failures. Thus, these sectors are crucial for the efficient functioning of an economy and its markets.
An often-overlooked purpose of such entities is to meet the borrowing requirements of the private sector of the economy, namely business owners and consumers like you and me, before providing for government borrowing. In Pakistan, the banking sector does the exact opposite.
REVEALED: THE BANKING SECTOR’S GOVERNMENT BIAS
The State Bank of Pakistan (SBP) regulates Pakistan’s banking sector. It is an autonomous body that restricts government influence on monetary policy implementation. Ironically, Pakistan’s majorly private banking sector pays no heed to such technicalities, investing heavily in government bonds at the expense of private lending.
In 2019, 56% of lending was concentrated in the public sector, with a subpar 44% allocation to the private sector. High-interest rates in the economy enticed saving attitudes from the masses, with a 12% year-on-year boost in bank deposits. Yet, the loan to deposit ratio fell, from 56% in June 2019 to 51% a year later.
Where did the money go?
It was invested in low-risk government bonds to facilitate government borrowing. Surprise, surprise.
Also, of the funds allocated to the private sector, a whopping 60% is fed to corporate giants, leaving meager amounts for SMEs, agriculture, and consumer sector loans. This is proving to be detrimental, with small enterprises collapsing due to a lack of resources, and ordinary citizens experiencing major blows to living standards. They have no last resort to fall back to.
Haroon Sharif, economic counsel to the Prime Minister, sums the grappling situation of small business owners: “They have little savings, and much of their business is in cash. So, they have little to no support from the banking system.”
That’s not all.
Banking sector inefficiencies probe beyond the scope of logical risk and return models, into the realm of illogical politics. As such, it often fails to fulfill another vital financial intermediary function: Preventing information asymmetry.
REVEALED: THE POLITICAL PLAY
Information asymmetry is the inequality of knowledge between both parties in a transaction. Financial institutions should conduct extensive background and credit checks and consistent monitoring of borrowers to ensure they don’t default on their loans.
Unfortunately, banks in Pakistan fail to conform to such standards adequately. Instead, they often adopt the old notion of ‘optimistic favoritism,’ namely providing loans to well-known, affiliated political entities with the hope that they will pay back the dues in time. It is a notorious practice, strictly against SBP’s Know-Your-Customer (KYC) regime. This means that when they do lend in the private sector, it may not be based on the ‘access to productive opportunities’ criteria.
The waiving off of Rs. 50 Billion to private companies in the last 34 years, gives evidence of banks’ lenient stance against such entities. This signifies a very high proportion of Non-Performing Loans (NPLs) plaguing bank balance sheets.
So, as this large ratio of deposits funnel to the government and corporate giants, where does the average consumer lie?
In Pakistan, the issue transcends the banks’ reluctance to lend. There is also a trudge in the consumers’ steps: They are reluctant to borrow. This is because of the lack of general awareness of and access to financial institutions’ benefits.
Is the banking sector to blame for this? Technically, yes.
REVEALED: THE BANKING SECTOR’S SHEER UNADAPTIBILITY
If you live in a big city, like Karachi or Islamabad, you must see an endless row of bank branches taking up real estate in the city’s bustling areas. Moreover, you must have witnessed the same bank’s familiar logo multiple times during just a short car journey. Now, that isn’t really a problem. Heavily urbanized populations require easy and instantaneous access to financial services.
The problem is the inaccessibility of these services throughout the rest of the country. These include inner towns of Sindh and Punjab and remote areas of KPK and Balochistan.
Pakistan’s financial inclusion ratio stands at just 14% – one of the lowest in the region. Only 21% of the population had an active bank account in 2019, of which just 7% were women. However, not having a bank in the locality isn’t the only reason for this tragically low percentage.
Many Pakistanis are opposed to modern commercial banking – steering clear of their maneuverings involving interest in the give and take. Islamic banking is a relatively new concept. Such banks comprised of only 14.4% of the banking industry’s asset size last year.
Of course, commercial banks have hopped onto the trend. HBL, UBL, and other big names in the industry offer separate Islamic banking services and mainstream interest-inclusive operations. However, the public is wary and slow to trust.
These systematic dysfunctionalities blend into a tale of financial woes. The had been afflicting the country since way before the ‘COVID factor’ came into play.
But there is another angle to the story – one which a typical Pakistani rarely ignores: The Government Factor.
RESTATED: THE GOVERNMENT’S FAR-REACHING HAND
Of course, we cannot pretend that the government has no role to play in the banking sector’s inefficiencies. It always seems to lean back on these institutions, requesting bailouts to keep its drowning industries afloat.
The proof is in the pudding: The PTI Government approved an Rs. 17 billion bailout package with funds to be borrowed from commercial banks in November 2018. And there have been many more bailouts since.
Such actions’ crowd out’ the private sector, as banks scramble to invest in low-yielding albeit low-risk assets backed by the government’s finance ministry, ensuring returns not guaranteed by private-sector loans.
Moreover, the low financial accessibility is also attributed to administrative holdups in the process – financial technology or ‘fintech’ innovations are strictly regulated, and physical infrastructure is often nonexistent. This makes it nearly impossible for banks to extend the financial arm of the country.
Thus, like in any other mixed economy throughout the world, the Pakistani government can dig its nails into various segments of the state. A closer view of its banking sector shows why this reality raises alarms – a prosperous state-bank relationship thrives at the expense of the ordinary public.
Pakistan’s banks need to be held liable. They need to be held to the rigorous standards boasted by the SBP. They need to ensure transparency in transactions and undergo a reshuffling of lending attitudes, especially now – when even thriving businesses are questioning their ability as a going concern.
As we buckle in for the oncoming financial slump, let’s hope that the banking sector, the most crucial cog in the economy’s machine, can help soften the blow.
