Pakistan’s banks are setting global records, just not the kind we want. Government bonds and loans 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 that equation is that credit extended by Pakistani banks to the private sector is also 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, marking a clear regression in the last two decades.

The picture is even bleaker for small and medium-sized enterprises (SMEs), which receive just five percent of total private sector credit — despite making up 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 returns by investing in low-risk government securities, this is happening at the expense of small businesses, who are struggling to secure the financing they need to grow…

So, how did we get to a point where nine out of 10 businesses in Pakistan have little hope of financing their future? As with most things, it starts with the government.

Excessive State Expenditure

In the last quarter-century, the government of Pakistan has never managed to achieve a budget surplus. Not that we had one 25 years ago — there’s just no publicly available data to prove otherwise.

That means our government consistently spends more than it earns in revenue. In the last five years in particular, our budget deficit has never dropped below six percent of GDP. With our current GDP standing at around $350 billion, that means we’re borrowing roughly $20 billion each year. 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 (FY) 2024.

As a consequence, the sector has seen record profits. In the last 15 years, banks have consistently generated returns on equity of around 15 percent. In FY2023, that figure even shot up to 25 percent. And all this was achieved 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 a 15 percent return from risk-free government bonds or lend to a small business navigating a volatile economy and informal clients — what would you do?

One could even argue that domestic bank lending is preferable to our 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 associated with repayment in a currency that you cannot print.

Hence, the real solution to untangling our government-banking nexus lies in reducing public borrowing. Period.

IMF to the Rescue?

The silver lining? Public borrowing is starting to decline. Thanks to the strict conditions of the IMF programme, Pakistan’s debt-to-GDP ratio over the past year fell from 75 percent to 67 percent.

Looking ahead, the IMF projects that, by the end of the decade, the country’s budget deficit could halve from about six percent of GDP to below three percent. Under this scenario, the government’s borrowing from domestic banks could fall from 6.3 percent of GDP (or Rs5 trillion) in 2023 to 1.8 percent of GDP (or Rs3.5 trillion) by 2029, thus forcing banks to explore investments in alternative asset classes.

However, it is important to note that these projections are best-case scenarios, in that they rely on “strong policy implementation”, which isn’t exactly our strong suit. In fact, our history is littered with examples of rosy IMF projections that never quite came to pass. Instead, we find ourselves in our 24th IMF programme, something that no Fund document had ever predicted.

Near-Term Solutions

While it is tempting to rely on the IMF to fix all our problems, Pakistani entrepreneurs are already taking the lead in providing financing solutions to a private sector starved of credit.

According to local fintech start-up CreditBook, there is a $45 billion unmet financing gap for small businesses in the country, which they hope to bridge by digitising 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 digitise and finance small business supply chains in Pakistan.

Yet their scale remains modest — Haball, for instance, serves just 8,000 SMEs. And the recent layoffs at other high-profile business-to-business (B2B) start-ups such as Bazaar, Dastgyr and Retailo suggest that SME financing is far from a solved problem.

Nevertheless, such start-ups are a welcome addition to the previously anaemic financial sector. And the fact that the majority of Haball’s financing stems from Meezan Bank indicates that banks, too, are now looking 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 even more funding for innovative ventures in Pakistan’s private sector. Until then, we remain number one for all the wrong reasons.

The writer is a journalist and development consultant.
His work can be viewed at asadpabani.substack.com

Published in Dawn, EOS, April 27th, 2025