The banks in Pakistan have remained under severe criticism for routing a major portion of their liabilities towards government securities and leaving the private credit market dry. The banks are not social organizations but businesses. There is no logical incentive for the banks to extend risky lending to the private sector for a few hundred bps more when the government is willing to offer sky high returns for no risk.
The policy makers have been trying to push the banks towards private sector lending through regulatory interventions; however, they have failed so far due to the lack of a conducive environment. Let’s take a look at some interesting regulatory contradictions:
A policy rate below the discount rate was introduced in 2015, at which banks could borrow from the SBP discount window. As a result, banks could earn a risk-free spread by borrowing from the SBP discount window and lending to the government. Seems like it was created to evade IMF’s restriction on the government’s borrowing from SBP.
While the spread has fluctuated between positive and negative due to movement in the yield curve, the average has been a positive 0.4% since it was introduced. No wonder large banks like UBL are excited to borrow from this discount window. As per its latest financial statements, UBL’s repo borrowings stand close to PKR 4 trillion vs a total deposit base of PKR 2.9 trillion.
Amid large fiscal deficits, it’s the government that’s crowding out the private sector by creating an abnormally large demand for money. Despite such a high concentration of banking deposits in government securities, OMO injection stands at an all-time high of PKR 12 trillion (more than 10% of GDP), reflecting the liquidity crisis in the system. In addition, there is an outstanding net budgetary borrowing of PKR 4.4 trillion from SBP.
Moreover, there is an additional income tax on banks that are unable to maintain an advance to deposit ratio (ADR) of 50%. Private sector lending is M2 expansionary whereas the central bank is running a tight monetary policy, owing to an external account crisis, at the same time.
Regulatory interventions would not help as long as the government remains the largest borrower in the system. In 2003-04, T-Bill yields had dropped under 3% (despite a discount rate of 7.5%) because the government was running a very low budget deficit. Lowering the fiscal deficit is not going to help much at this stage; the government must run large primary surpluses in order to lower its borrowings relative to GDP and leave room for private credit expansion at the same time.