KARACHI, Jan 6: Banks made record advances during 2008 which was highest since 2002, the State Bank of Pakistan reported on Tuesday.

Bank advances grew by Rs457 billion during 2008 calendar year as against Rs280 billion during 2007 which was 61 per cent higher than last year.

Official figures showed that commercial banks slashed their investment in treasury bills and capital market and diverted money to public and private sectors.

Experts said advances also increased because of circular debt. “Banks provide debt on government guarantees for public sector enterprises which attracted a good sum of money from commercial banks,” said an analyst.

The circular debt is a new phenomenon in the country. When a company does not clear its debt to other company, it creates a chain of debt or circular debt and the process goes on.

When the government assures banks that it will return the debt, banks once again lend to a company. The circular debt accumulated to around Rs220 billion.

Public sector advances in just five months reached over Rs60 billion, an obvious reason for higher advances of banks.

On the other hand, banks investment, mainly on security papers and stocks, fell by 52 per cent during the year.

The low investment is a serious concern for both the State Bank and the government.

Since banks are not investing in security papers, the government had to borrow a record sum of Rs688 billion from the State Bank during the fiscal year 2007-08 which escalated inflation to push it to 24 per cent.

The State Bank accelerated its effort to attract banks investment and gradually started increasing policy interest rate which reached as high as 15 per cent in November 2008.

The SBP has now set an auction target of Rs565 billion for January-March and is hopeful of achieving the target.

According to the data, banks made an investment of Rs220 billion during 2008 compared to Rs416.5 billion in 2007.

However, most shocking is the sharp decline in deposit growth during 2008, which is reflecting the real cause of liquidity crunch in the banking sector.

Deposits of commercial banks fell by 61 per cent during 2008 compared to the preceding year. The amount mobilised by banks during the year was Rs226.6 billion compared to the last year’s Rs590 billion.

The fall in deposit growth vastly impacted the banking industry and destabilised the entire system while small banks were hit by the poor growth.

The State Bank provided some incentives for growth of deposits but it did not work.

The other negative impact of small deposit growth was an unhealthy competition among banks to raise funds by offering better returns to depositors.

Banks are offering 15 to 20 per cent returns to attract deposits.

The deposits are highly risky as they are prone to default. The default rate has already started rising. “If default rate increases, it will be a real threat to banking in Pakistan,” said the analyst.