Pakistan’s banks are setting global records, just not the kind we want. Government bonds and loans now comprise 60 percent of our banking sector’s assets, the highest of any country in the world.
The closest comparisons are Egypt and Algeria — nations with long histories of authoritarianism and economic dysfunction. In emerging markets, the average is just 20 percent, meaning Pakistani banks hold three times more government debt than their developing-country peers.
The flip side of this equation is that credit extended by Pakistani banks to the private sector is the lowest among emerging economies, standing at 8.4 percent of GDP in 2024, according to the governor of the State Bank of Pakistan. For comparison, this figure was twice as high in 2004, highlighting a clear regression over the last two decades.
The situation is even bleaker for small and medium-sized enterprises (SMEs), which receive just 5 percent of total private sector credit, despite comprising 90 percent of all businesses, employing 80 percent of the non-agriculture workforce, and contributing 40 percent to GDP.
Even as Pakistani banks earn record profits from investing in low-risk government securities, this comes at the expense of small businesses, which are struggling to secure the financing they need to grow.
How Did We Get Here?
So, how did we arrive at a point where nine out of 10 businesses in Pakistan have little hope of financing their future? As with most issues in the country, it starts with the government.
Excessive State Expenditure
In the past 25 years, the government of Pakistan has never managed to achieve a budget surplus. Not that we had one 25 years ago — there’s simply no publicly available data to prove otherwise.
This means the government consistently spends more than it earns. In the last five years, our budget deficit has never fallen below 6 percent of GDP. With our current GDP standing at around $350 billion, this means we are borrowing approximately $20 billion annually. In other words, about a third of the budget is financed through borrowing.
And guess who’s lending the money? Banks. According to Zafar Masud, chairman of the Pakistan Banks Association, commercial banks financed 99.8 percent of the budget deficit in fiscal year 2024.
As a result, the banking sector has seen record profits. Over the last 15 years, banks have consistently generated returns on equity around 15 percent. In FY2023, this figure soared to 25 percent, primarily through the purchase of hassle-free, low-risk government securities.
Honestly, it’s hard to blame them. If you were running a Pakistani bank and had two choices — earn 15 percent return from risk-free government bonds or lend to a small business in a volatile economy with informal clients — what would you do?
One could even argue that domestic bank lending is preferable to the government borrowing from external creditors, as that would have to be repaid in US dollars. Indeed, the International Monetary Fund (IMF) recommends that foreign currency borrowing should not comprise more than 35 percent of a country’s debt burden, due to the risks of repayment in a currency that cannot be printed.
Thus, the real solution to unraveling the government-banking nexus lies in reducing public borrowing. Period.
IMF to the Rescue?
The silver lining? Public borrowing is beginning to decline. Thanks to the strict conditions of the IMF program, Pakistan’s debt-to-GDP ratio has fallen from 75 percent to 67 percent over the past year.
Looking ahead, the IMF projects that by the end of the decade, Pakistan’s budget deficit could be halved from about 6 percent of GDP to below 3 percent. If this scenario holds, the government’s borrowing from domestic banks could drop from 6.3 percent of GDP (or Rs5 trillion) in 2023 to 1.8 percent of GDP (or Rs3.5 trillion) by 2029, forcing banks to explore investments in alternative asset classes.
However, it’s important to note that these projections rely on “strong policy implementation”, which isn’t exactly our strong suit. In fact, our history is filled with examples of overly optimistic IMF projections that never materialized. Instead, we find ourselves in our 24th IMF program, a fact no previous IMF document had ever predicted.
Near-Term Solutions
While it may be tempting to rely on the IMF to fix all our problems, Pakistani entrepreneurs are already leading the charge in providing financing solutions to the private sector, which is starved for credit.
According to local fintech start-up CreditBook, there is a $45 billion unmet financing gap for small businesses, which they hope to bridge by digitizing transaction records and using that data to lend financing to SMEs.
CreditBook claims to have impacted more than one million businesses to date. Earlier this month, another local start-up, Haball, raised $52 million in financing, based on a similar promise to digitize and finance small business supply chains in Pakistan.
However, their scale remains modest — Haball, for example, serves just 8,000 SMEs. And recent layoffs at other high-profile business-to-business (B2B) start-ups like Bazaar, Dastgyr, and Retailo suggest that SME financing is far from a solved problem.
Nevertheless, such start-ups are a welcome addition to an otherwise anaemic financial sector. The fact that most of Haball’s financing stems from Meezan Bank shows that banks are beginning to invest in the SME sector, even if indirectly.
One can hope that as the government gradually reduces its chokehold over the financial sector, it will unlock more funding for innovative ventures in Pakistan’s private sector. Until then, we remain number one for all the wrong reasons.
