Banks are generally called financial intermediaries because they mobilise savings from depositors for onward lending to borrowers/investors, thereby taking an important part in the country’s economic development.

The deployment of savings into prudent lending is considered a more difficult job for banks. It is therefore usually said that the art of banking lies in lending.

In the early sixties, the country had a robust banking system catering to credit needs of commerce and industry. In the seventies, banks were inducted in financing agriculture and small business in a big way.

Till the end of the 20th century, earning assets of banks largely consisted of advances and bills purchased and discounted along with a small amount of investment in government securities just to meet the statutory liquidity requirement (SLR) imposed by the central bank. Rates of return on government securities were deliberately kept much lower so as to make private sector the chief beneficiary of the available bank credit.

Until the 1990s, banks had no appetite for investing in government securities more than the SLR because the rate of return on such placements remained fixed at 6pc as against the conventional lending rate of 14pc. Under this regime, success or otherwise of a bank was directly linked with its Advance to Deposit Ratio (ADR) which used to be above 75pc in normal situations.

At the start of the 21st century, Pakistan opted for a market-based banking system with a major policy shift on the auction of short term and long term government papers at market rates. Since the main objective of banks is to maximise their profit, they found it more worthwhile to invest in government securities at market rates.

For the last ten years, commercial banks have been parking the bulk of their cash balances in both short term and long term government securities making the private sector — the engine of growth and employment in a country — a residual borrower of banks.

According to the latest SBP Financial Stability Review, 2015, the government remained the major user of banking funds while commercial banks increased by 31.7pc their investments in government papers by December 2015, bringing the ADR of banks to 46.4pc compared to 75.9pc as of end December 2008.

Very recently, Islamic banks have also followed the footsteps of their conventional counterparts. As per SBP Islamic Banking Bulletin, Islamic bank iInvestments (net) increased by Rs155bn to reach Rs586.9bn by the end March 2016, compared to Rs431.9bn by end December 2015. As a result, their investments to deposits ratio (IDR) — the newly found benchmark of bank performance — reached 43.9pc by the end March 2016 compared to 31.4pc by end December 2015.

The insatiable hunger of banks for investing in risk-free areas has changed the shape of the banking industry in the country. In addition to government papers, another such area relates to selling third party products (insurance, etc) where both Islamic and conventional banks are working with the same zeal.

It was feared that with the drastic decrease in rates of government papers, bank profits would also fall. However this has not taken place because of the availability of a number of non-fund based avenues of income for banks. Globally, there is a great deal of criticism on banks working in a way that has resulted in the ‘financialisation of the economy’ — a phenomenon of ‘profiting without producing’.

Obviously the above situation is not desirable for a country like Pakistan where strategically important sectors viz. agriculture and SMEs are highly credit starved. Despite hectic efforts of the SBP, banks are catering for less than one third of the total agricultural credit requirements. SMEs and the corporate sector are now facing the same issue due to the reasons mentioned above.

In order to bring back traditional banking wisdom, SBP needs to play an effective role in this regard. Since the government is not going to enter another agreement with the IMF, all government requirements for funds should be met by the SBP. Investment of banks in government securities should be allowed equivalent to twice their SLR level; or such investments should be allowed at 2/3pc as was done in the past.

All these initiatives would force banks to revert back to lending to the private sector. If such steps are not taken soon, we can expect the third segment of banking — microfinance banks- placing their funds in risk free government papers.

The writer is the president of the Institute of Banking and Business Learning — IBBL .

munir9511@outlook.com

Published in Dawn, Business & Finance weekly, August 1st, 2016