COMMERCIAL banks have been busy lending large amounts of money at below-the-market rates these last few weeks. They aren’t doing so because they suddenly find themselves flushed with excess liquidity. Nor has the economy turned a page, spurring demand for credit for investments in productivity. There is a method to this madness.

The banks are on a lending spree to increase their advance-to-deposit ratio (ADR) — a measure of the proportion of a bank’s total deposits that are given as loans or advances — above 50 per cent to avoid a punitive FBR tax of up to 16pc on the lenders with an ADR under 50pc.

The banks are lending to both large public and private entities at discounted rates, which are then investing this money in government debt, earning a spread of 2-4pc. This allows the lenders to avoid the ADR tax but only after forgoing a significant portion of their revenues to the borrowers. The entire lending is for the short term, and the money will return to banks after Dec 31, the tax deadline.

The banking industry sources claim that most lenders have already managed to achieve the targeted ADR of above 50pc. Overall, the industry ADR is said to have already shot up to 44pc from 39pc on Sept 27. Banks’ lending surged by Rs1.1 trillion in October, marking a record-breaking increase.

Critics argue the policy fails to boost private-sector lending and undermines savings

However, heavy, short-term cheaper lending is not the only strategy being pursued by the banks to avoid the ADR tax; they are also discouraging deposits to ensure that those don’t bring down their advance-to-deposit ratios, exposing them to the tax payment they have painstakingly been striving to dodge the FBR.

Most banks have notified their clients that they will charge a monthly fee of 5pc on high-balance accounts ranging from Rs1bn to Rs5bn and above, with each bank setting its own minimum threshold according to their respective customer profiles, to hedge against incoming large deposits and upending the ADR before the tax deadline.

This applies to both rupee and foreign currency accounts and has led the bank deposits to fall from Rs31.14tr on Sept 30 to Rs30.4tr by Oct 25. Some banks have also app­lied maximum daily credit balance limits on the checking accounts.

“The bank has the right to refuse and/or to return the amount over and above the said limit,” according to a notice sent out by an Islamic bank to its customers.

“This signals growing tensions between regulatory policies aimed at encouraging lending to the private sector and operational strategies of the banks seeking to safeguard their profitability,” an analyst wrote recently.

Media reports suggest the amount of cash deposits could be further slashed in case the ADR remains below 50pc at the end of the calendar year.

Thwarting FBR

That’s not the only strategy being adopted by the banks to thwart the FBR. Several banks have already sought and received court injunctions preventing the FBR from collecting this levy unless the cases are decided. Banks have taken the stand that it’s beyond the FBR’s mandate to dictate how banks deploy their deposits or how their balance sheets should look, as it is the prerogative of the industry regulator: the State Bank of Pakistan.

A petition highlights that the FBR is seeking to tax the income earned by banking companies from investments made in government securities by prescribing the tax rate based on the gross advance-to-deposit ratio.

“In doing so, the FBR is seeking to regulate the banking business, which falls beyond the scope of a Money Bill and is consequently ultra vires (beyond the scope of) Article 73 of the Constitution,” reads the petition filed with the Islamabad High Court.

The ADR-linked tax was levied ostensibly to encourage banks to provide financing to the private sector borrowers to spur growth rather than “funnelling liquidity only into government debt to make easy bucks”.

The SBP report in 2022, however, indicated that banks’ incentive to enhance deposit mobilisation and asset and liabilities management strategy could also have been affected by the ADR-linked tax policy.

“This forced lending approach significantly impairs and undermines the credit underwriting standards of banks,” the CFO of a major bank argues.

ADR tax in totality is meaningless, he argues. The way it is structured “is flawed when you talk about ADR taxation… You are taking refuge behind that you want to encourage private sector lending, but this needle has not moved even an inch,” he says.

“The banks can at the end of the year move deposits to ensure their ADR remains above the tax threshold, and public sector companies, etc., are also part of the private sector lending for ADR calculation,” he adds.

‘Market distortions’

Speaking with Dawn, Pakistan Banks’ Association Chairman Zafar Masud highlights several market distortions created by the contentious tax. “The lenders are ready to pay their taxes; in fact, they are already in the highest tax bracket in the country, and in the region. The problem arises when you start charging us for something not related to income,” he says.

“The ADR tax is proposed to be imposed on banks’ balance sheet items and not income. It is very much possible that a bank is making losses but will have to pay this tax because of lower ADR. This is unjustified.

The bankers are willing to sit across the table with the government to contribute to the public exchequer in the largest interest and benefit of the economy as long as it’s related to their income but not on the balance sheet,” Mr Masud says.

Moreover, he explains that since it is calculated at the end of the year, the banks discourage deposits or increase their lending assets through pyramiding by giving money to large firms at below-the-market rates to maintain their ADRs to avoid this tax. “This benefits the borrowers while banks take losses.

This does not serve the purpose as it doesn’t increase private sector borrowing,” he says.

Mr Masud points out that it’s not just the ADR calculation but what constitutes ‘private sector lending’. “The public sector entities, microfinance institutions, asset managers, state-owned enterprises, and so on also fall in this category. In fact, banks manage their ADR through lending to these big borrowers. If the objective was to prompt banks to boost private credit, the policy is clearly not working.”

This year, a new problem has arisen for banks due to excessive government borrowings, reducing their ADRs. On top of that, the implementation of the MDR (Minimum Deposit Rate) condition — implemented by the SBP in 2008 to encourage private savings — is restricting the lenders from deploying their assets due to higher returns than interest rates. “Consequently, banks are refusing deposits, so your objective of increasing savings is also defeated,” Mr Masud adds.

Lack of reliable data

Mr Masud also contends that systemic issues hinder private-sector lending. With over half of the economy undocumented, banks lack reliable data to assess borrowers’ creditworthiness. “Proxy data from telcos and utilities also doesn’t exist to help us assess incomes of borrowers,” he says. “First, businesses must be prepared to document themselves, and then we will see a massive shift in financing, perhaps.”

Responding to banks’ appetite for risk-free lending to the government, he replies that nearly 85pc of the budget deficit is being financed by banks. “Actually, this is a big service we are doing… Instead of appreciating us, you are penalising us. The day the government fixes its deficit problem, banks will automatically be forced to lend to the private sector.”

An official of a multinational bank argues that “banks are not trying to be cute” by demanding the removal of the ADR tax. “We want to pay taxes. But it should be on our income. We are very happy to sit with the government and discuss the issue so that its side effects and distortions in the market are removed.”

Banks say they are not asking to revoke MDR altogether but want it to be rationalised by taking corporates, state-owned enterprises, and financial institutions out of its regime to force them to reinvest their liquidity rather than take advantage of MDR rules to earn profits.

“The banks are totally in favour of keeping MDR on individuals to promote a culture of savings and investment in the country.

While hedging against incoming deposits, the banks have taken care that only large customers — government and public and private corporations — are levied fee while small savers are kept protected,” the CFO quoted above argues.

Bankers say that at the end of the day, the government will be unable to collect tax, increase savings or boost private lending. But it will end up distorting the market, choking the balance sheets of banks and pushing up borrowing costs through such regulatory measures as ADR and MDR.

Published in Dawn, November 24th, 2024