KARACHI: Formal credit to private sector in Pakistan has declined to one of the lowest among the emerging markets and developing economies (EMDEs), said a special report of the State Bank of Pakistan (SBP) issued on Friday.

“Formal credit to the private sector in Pakistan has declined both in absolute and relative terms over the past few decades, and is currently one of the lowest among emerging markets and developing economies (EMDEs),” said the report.

During FY21 credit to private sector was almost double than the preceding year, but the credit penetration is on the lowest side. Banks in the country are easily making profits out of huge investments in the government papers ignoring the needs of the low income segments of the economy.

“This (low credit to private sector) is despite multiple reforms aimed at deregulation and liberalisation of the financial sector since the 1990s, in a bid to reverse the impact of nationalisation of banks in the 1970s,” said the SBP report.

The special report said that various factors have contributed to low level of formal credit in Pakistan. The reforms aimed to increase access to finance by implementing measures to improve governance, supervision, and risk management of the financial institutions.

“However, while banking profitability improved as a result of these reforms, the presence of market failures in the form of information asymmetries made commercial banks generally averse to lending to underserved segments such as housing, agriculture, and small and medium enterprises (SMEs),” said the report.

“This behaviour was further fuelled by the presence of a dominant borrower in the form of the government sector, whose debt requirement increased significantly,” said the report.

Meanwhile, challenges such as high informality in the economy, faith-based considerations, and low financial and digital literacy continued to keep the demand of formal credit low in the country.

“Financial institutions place greater emphasis on serving the well-off and already well-served segments of the society and shy away from lending to low income individuals and SMEs,” said the report. Both, the government and the SBP have been emphasising for higher credits for SMEs but the banks prefer to extend loans to well-served and low risks borrowers.

“Even when such segments are extended loans, financial institutions charge higher rates to price in their risk, which negatively impacts demand for formal borrowing,” said the report, adding that this in turn hampers credit off-take and ultimately proves detrimental to economic growth and development.

In the agriculture sector, banks have limited incentives to increase their lending portfolio, said the report. Recently the SBP carried out a financing project which revealed the potential benefits of value-chain financing in overcoming adverse selection and moral hazard problems.

Credit-to-GDP is found to be 19 percentage points higher in EMDEs where credit bureaus maintain information of loans below 1pc of income per capital compared to EMDEs where such data is not maintained and used for various information needs, said the report.

“Credit bureau coverage in Pakistan is marginally better than the minimum threshold of 5pc as defined by the World Bank,” said the report, adding that in Pakistan the coverage of alternate data is currently non-existent because the data is not available.

In April 2020 the government directed all electricity and gas distribution or transmission companies to be member of credit bureau and advised to furnish information.

“Except for K-Electric, to date no other electricity and gas distribution company is providing the data to credit bureau. Even if reported, the utility data set is prone to factual inaccuracies and therefore unreliable,” said the report.

Meanwhile, telecom data, which can be a boon for nano-lending and microfinance lending, is also not available yet, despite 2019 government notification that instructed mobile operators in the country to become members of credit bureaus and furnish telecom users’ billing information.

Published in Dawn, July 18th, 2021