THE current discussion about under-capitalised banks in Pakistan is really subordinate to a more substantive issue surrounding our banking sector — its consistently flagging contribution to production and growth. Our banking system, as a whole, has effectively subordinated financing productive activity to funding fiscal and public-sector deficits.
A situation where, incrementally, banks run down private sector lending in favour of credit to government would normally be associated with dictation by government, ie, with ‘fiscal dominance’, or ‘financial repression’ — were it not for the fact that our banks are largely privately owned, and that this diversion of lending by banks is voluntary, profitable and with few exceptions, enthusiastically embraced.
Also read: SBP and bank regulation
Incontrovertibly, this deprivation of credit to the private sector damages prospects for longer-term growth. Between 2007 and 2014, banks’ exposure to government/public sector increased from Rs1 trillion to Rs5tr or by 500pc, while lending to the private sector grew from Rs2.1tr to Rs3tr, or by 50pc. Of all the domestic credit creation over the period, government thus took 82pc. (Source: SBP Credit/Loans classified by borrower)
Lending has to go back to, primarily, serving national development.
In 2007, the private sector had a 67pc share in bank credit; by 2014, this had fallen to 37pc. Government’s share rose from 33pc in 2007 to the present 63pc — breaking down as 51pc in government securities, and 6pc each to public sector enterprises (PSE) and commodity operations.
Over this period, the small and medium enterprises share dropped from 17pc to under 6pc, and lending to the personal sector from 19pc to 8pc, of private sector/PSE loans. Agriculture remained around 7pc.
National investment fell almost to half its 2007 level, from about 22pc per annum of GDP, to 12pc. GDP growth declined to 3pc-4pc per annum.
The smaller provinces also suffer quite dramatic credit-deprivation. KP, Azad Kashmir and Balochistan, together with Gilgit-Baltistan have about Rs1tr in bank deposits, with loans amounting to only Rs72bn, or 7pc of their deposits. In effect, they transfer almost a trillion rupees of their banked savings to the federal government, and to business activity around Karachi and central Punjab. Job-creation elsewhere sets up steady migration by their labour force, and imperils future prospects for shared national prosperity.
The near doubling of bank exposure to government has not, overall, been development oriented or job-creating. It is increasingly directed to filling gaps in the federal budget, created by rapidly rising national debt servicing, circular debt and PSE/commodity operation losses — together more than three times government development expenditure Banks and their shareholders have benefited from this redirection of credit. Where government is the borrower/guarantor, lending is classified as ‘riskless’ and does not require any capital allocation (the 6pc PSE exposure would require capital, but the 57pc in government securities/commodity loans would not). Expense associated with putting on and monitoring government exposure is negligible, compared with commercial lending. So the entire profit from government exposure thus augments return on equity (ROE) — an exceptional 25pc-plus for the six largest banks, and also for some of the 12 mid-size banks.
‘Riskless’ government securities should attract the lowest interest rate in the market. Ironically, this is not the case. Government securities need to pay significantly higher rates than banks, for matching period funds, and, in instances, even more than leading local corporates. This is owed both to the unformed and shallow state of our debt capital markets, and to the fact that the banks are the dominant purchasers of government paper — making the government a price-taker, rather than the price-maker, which it would be, in any reasonably developed market.
This state of affairs needs rapid remedy. Banks have to be reminded that their public purpose — fostering national productive capacity — is what grants them special, official, privilege (high leverage, lender-of-last-resort support etc), and they are simply not working only for optimising shareholder return. Lending has to go back to, primarily, serving national development.
The mandate for directing this would be a collaborative one. While the planning and execution of growth goals is the work of the elected government and private sector, realignment of credit institutions to nurture economic growth would be an agency responsibility of the State Bank of Pakistan.
It could be more than simply an agency responsibility. Central banks can also, in their charters, share the national mandate for development.
For example, the US Fed has a dual ‘mandate’. In addition to responsibility for price and financial stability, the US Fed is also charged with managing monetary policy “commensurate with the economy’s long-term potential to increase development”, with ‘maximum employment’ taken as a proxy for development.
The SBP Act, too, requires that it manage monetary policy “with a view to ensuring financial stability and fuller utilisation of the country’s productive resources” ie, the financial system the State Bank supervises should have the capacity and commitment for ensuring “fuller utilisation of the country’s productive resources”.
Specific action to revitalise the development role of the financial sector is a separate subject for which this writer has made suggestions in other articles.
A banking sector that is notably reluctant to focus on private sector exposure is only part of the problem. We are, as well, missing critical specialised lending and advisory capacity in our financial institutions. Government debt management needs professionalisation, to reduce rates paid. Where our private banks will not lead the way, it becomes incumbent upon the government to do so, preferably through public/private initiatives, under private management.
Finally, to preserve competition, increase financial depth and galvanise inclusion, it is necessary that Pakistan’s banking sector development emerges in a mix of different business models. The biggest six banks have, per capita average, more than 12 times the capital of the 15 smallest banks. Only higher ROEs from new business strategies will provide sustainability to the smaller banks. Eschewing this challenge, the smaller banks will have to merge and consolidate, to match the scale advantages of the biggest banks. That would diminish competition and reduce innovation, an undesirable outcome.
The writer is a former governor of the State Bank of Pakistan.
Published in Dawn, December 15th, 2014