THE latest report by the State Bank on the banking sector provides a glimpse of some very unhealthy trends that continue to hang over the economy. The report undoubtedly tries to downplay the negatives, but the numbers and in some places the language as well, reveal a troubled picture. For one, profitability of the banking sector “surged by 52pc [from same period last year] to reach Rs247bn in 2014; highest ever for the banking industry”.

A closer look at where these profits came from shows that the banks’ unabated appetite for government securities coupled with a rising stock market contributed the largest share of this growth. Profitable banks may be a healthy phenomenon, but if those profits are derived from risk-averse lending behaviour and inflated values of speculative assets, then they actually speak to a growing dysfunction in our banking system, which is becoming more and more a sovereign lender and less and less an intermediary between savers and borrowers.

A banking system that posts record profits while stubbornly refusing to engage in private-sector lending is not a healthy development. The performance review notes how lending to government continues to increase, while the private sector is crowded out and deposit growth is slowing down. The banks are becoming increasingly reliant on liquidity injections from the State Bank, whose daily average outstanding amounts rose by almost 400pc between the third and fourth quarters.

This means the banks are taking money from the State Bank and lending it to government, and ploughing growing amounts into public-sector commodity operations or NSS schemes, where returns are also largely risk free. It notes a growing concentration of bank advances to the power sector, most to finance the operation of the circular debt, and calls for “early liquidation measures” to contain the risks from such concentration. It notes the pressure on the fiscal framework by pointing towards an “expected shortfall in FBR revenue” even as “security-related measures may push the expenditure [sic] up”, meaning that these unhealthy developments are likely to continue, and even aggravate, before the end of the fiscal year.

The way forward is clear but not easy. Liquidity pressures at the banks need more “deposit mobilisation” effort by the banks, but the root cause of the malaise is fiscal. The growing inability to meet expenditures from revenue means the government is becoming entrenched as the banks’ single largest customer, and left to its own devices, the situation will not change since the banks have no incentive to shift away from lending to government. Couple this with the surging stock market and inflating property prices, and we have a rather dysfunctional economy, where fiscal weaknesses and the search for speculative rents are the main driving force. More needs to be done to acknowledge and remedy this state of affairs.

Published in Dawn, April 18th, 2015

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