The Pakistani government and banks are in a toxic relationship: the former has sort of an addiction to spending way more than it earns, which the latter is more than happy to feed off. At this point, both seem to have become pretty content with their incompetence and need each other to survive — for they know no other way.

The government has no idea, or at least the guts, on how to increase its revenue base or bring more people into the tax net, so it needs domestic financial institutions to fund its extravaganza.

Meanwhile, banks have become so dependent on riskless securities that they have forgotten to do anything else. Amidst all this toxicity, it’s the kids (the economy) who have to bear the consequence more than anyone else.

One effect of this entire situation has been how Pakistan’s private sector credit offtake has plunged over the years to just around 15 per cent of the gross domestic product. This is well below other emerging markets, such as Egypt’s 27pc, Indonesia’s 37.7pc, Bangladesh’s 39.2pc, and the Philippines’ 52pc.

Bank loans to non-banking financial institutions surged to Rs514.3bn, up 233.9pc year-on-year

There are very few categories of borrowers in Pakistan that get much (meaningful) credit. Unsurprisingly, textiles lead on this front as they rake in almost a fifth of all loans to private sector credit, while personal financing accounts for a somewhat similar share.

The point is when interest rates go up and the economy slows down (or crashes, as is currently the case), you can see the private sector credit nosedive. At least the components that are not based on refinancing schemes.

So if a particular category witnesses a spike in credit offtake in such a monetary outlook, it’s bound to stand out. That’s what happened to bank loans to non-banking financial institutions (NBFI), which surged to Rs514.3 billion, up 162.4pc month-on-month and 233.9pc year-on-year.

The spike stands out for a couple of reasons. For starters, the outstanding credit to this particular category had previously never even touched Rs200bn but somehow, within a month, jumped by over Rs318bn. To put in context, the maximum month–on–month and year-on-year increase in loans to NBFIs before this was 21.6pc in December 2021 and 56.7pc in May 2022, respectively. Since then, the amount has eased a bit to reach Rs481.8bn by the outgoing February.

Now the question is, why are banks suddenly doling out so much money to NBFIs, who are essentially credit institutions that should be lending it ahead? Who in their right mind would be borrowing from them in such an interest-rate environment after all? Plus, NBFIs — at least excluding development financial institutions and asset management companies — can’t really absorb so much liquidity.

So what happened? Well, the answer is way more boring than the data or charts show because, well, we are talking about Pakistani banks. Back in September 2021, the government decided to impose an incremental tax on banks that had advances-to-deposit ratio (ADR) below particular benchmarks: 2.5 percentage points additional if the ratio was between 40pc and 50pc, and five percentage points if it was lower than 40pc. All so that banks could start doing some lending.

Over the last decade, the average monthly ADR ratio of the banking sector has stood at 52.5pc and largely trended downwards. In contrast, the investment-to-deposits during the comparable period was 70.6pc. Some of the biggest banks found themselves ill-equipped to meet this “lofty” target because, you know, that requires actually doing work.

To avoid paying additional taxes, banks turned to window dressing — something they have a rich history in, for it earns the senior management the bragging rights with their other bald friends while they all pretend to play golf. Instead of actually giving out loans, they chose to pump up their ADR by “lending” to their buddies in the non-banking space, who then buy government securities with this money.

As a result, the overall banking ADR rose sharply to 53.02pc in December 2022, from 48.8pc in November. That’s a 423 basis point jump in a single month — the biggest increase on record since at least 2002. To be fair, this is not surprising from banks, even if the magnitude is unique.

But it does raise some questions as to how long this culture of window dressing will keep masking the underlying rot in the Pakistani financial services space. And how much longer will the State Bank let it all slide in an attempt to be the champion of the industry instead of a regulator?

The writer is the co-founder of Data Darbar. He can be reached at
mutaher@datadarbar.io

Published in Dawn, The Business and Finance Weekly, April 17th, 2023