BANKS are often cast as villains for failing to allocate credit to priority sectors — small businesses, agriculture, and housing — where, in advanced economies, lending reaches as high as 60 per cent of total bank credit. By contrast, middle- and low-income countries struggle to cross the 30pc threshold. While some of this criticism may find some grounds, much of it misdiagnoses the real problem: a financial ecosystem that undermines private sector credit growth.

Although banks can do more to extend credit to these sectors, businesses within priority sectors must also meet the system halfway. Banks can only lend where risk can be assessed and mitigated. The sectors most in need of financing remain largely undocumented. These priority sectors, which constitute over half of the GDP in Pakistan, contribute just 2.6pc to total tax revenues and a mere 5.6pc to total bank deposits. This imbalance reflects a broader economic dysfunction where informal businesses seek credit without participating in the financial system. Despite these constraints, banks still extend 13pc of the private-sector credit to these sectors, outstripping their share in the documented economy. But Pakistan’s high cash-to-GDP ratio of 42pc compared to 15pc in Bangladesh and 13pc in India exacerbates financial exclusion, making traditional credit assessments near impossible.

Where records are absent, risk skyrockets and credit markets freeze. Successful emerging economies have tackled these challenges by enhancing financial transparency and creating alternative data-driven credit assessment models. But we remain locked in a liquidity and credit assessment trap driven by two flaws. First, excessive government borrowing absorbs a disproportionate share of banking liquidity, crowding out private-sector lending. Second, financial data remains restricted. In markets where regulators, and entities with data repositories facilitate controlled data-sharing, credit access improves. In Pakistan, institutional inertia has led to a hoarding mentality towards data, stifling financial innovation.

This brings us to the ‘leaking fountainhead, dry pond’ theory. A tax system riddled with loopholes forces the state to over borrow from banks, which constrains lending to the private sector. With 52pc of the economy operating outside direct taxation, the government relies on commercial banks to finance 99.8pc of the fiscal deficit. This demand for bank liquidity — Rs10 trillion generated through OMOs, a grossly distorted form of quantitative easing on top of Rs27tr in customer deposits — leaves little capital for businesses. Hence, private investment is constrained, innovation stifled, and economic growth lethargic.

Banks can only lend where risk can be assessed and mitigated.

The recent amendment to the SBP Act, which curtailed the government’s ability to borrow directly from the central bank, has only exacerbated these distortions. Commercial banks now act as intermediaries, profiting for acting only as conduits. Yet the core impediment to private-sector credit expansion is neither bank aversion nor lack of liquidity alone; it is the absence of documentation and a restrictive approach to data-sharing. This self-reinforcing cycle — low credit penetration, weak investment, stagnant tax revenues, and rising public debt — traps the economy in a state of underperformance.

Trade policy suffers from the same structural inefficiencies. Import tariffs, instead of serving as strategic economic instruments, function primarily as revenue-generating tools. The result is a perverse market where non-competitive industries thrive under artificial protection, suppressing efficiency and innovation. Pakistan’s trade-to-GDP ratio languishes at 28.6pc against a world average of 58.5pc. High tariffs and reliance on subsidies have transformed exp­orts into a state-managed endeavour rather than a competitive market-driven proc­ess. The outcome? Weaker trade performance, constrained foreign exchange inflows, and diminished opportunities for banks to expand trade financing.

Until these leakages in the fountainhead are plugged, the pond will remain dry, and misplaced criticism of banks for credit scarcity will persist. The responsibility for reform lies not with banks alone but with policymakers, businesses, and regulators who must foster an environment conducive to financial integration.

The taxation system must be expanded equitably, tariff policies restructured to drive competitiveness rather than protectionism, and financial data accessibility frameworks modernised to facilitate responsible lending.

Critically, businesses must also take responsibility by integrating into the formal financial system by documenting themselves, contributing to tax revenues, and building credit histories. Only then can the banking sector function as a true engine of development.

The writer is chairman of the Pakistan Banks Association.

Published in Dawn, March 25th, 2025