Report highlights low credit, digital gaps in Pakistan’s banking sector

KARACHI: Pakistan has significant potential for credit penetration due to low lending to the private sector as a percentage of gross domestic product, a falling advance-to-deposit ratio (ADR), and a rising investment-to-deposit ratio (IDR) in comparison to certain other economies, a report said on Wednesday.

Pakistan’s ADR stands at 37 per cent, significantly lower than Bangladesh’s 88 per cent, India’s 75 per cent, Sri Lanka’s 63 per cent, and Kenya’s 62 per cent. Conversely, Pakistan’s IDR is remarkably high at 94 per cent, compared with Bangladesh’s 22 percent, India’s 34 per cent, and Sri Lanka’s 42 per cent. These findings are part of the consulting firm AF Ferguson & Co’s (PwC Pakistan) second annual banking report for 2024, titled ‘Road to Sustainability’.

The ADR has experienced a notable decline, closing at 37 per cent in June 2024, down from 41 per cent in December 2023 and 50 per cent in 2022. This decrease may be attributed to a cautious approach by banks, as well as demand compression resulting from economic conditions and higher mark-up rates prevailing in those times.

“While historically there might have been significant focus on investments in government securities, considering tax implications on ADR, we may see some change by the end of 2024 and during the next year,” the report said.

Banks’ investments surged by 42 per cent in December 2023 and a further 19 per cent in June 2024, with more than 95 per cent concentration in government securities, according to the report.

Overall, lending to the private sector in Pakistan declined to 12 per cent of GDP in 2023 from 15 per cent in 2022, which is significantly lower compared with 38 per cent in Bangladesh and 50 per cent in India. The report suggests a more inclusive credit strategy targeted to priority sectors and segments may help elevate private sector credit to a reasonable level in the medium to long term.

Cash flow-based financing currently represents only 2.0 per cent of total loans, with various types of physical and other collateral still being the preferred choice for the majority of portfolios. “Banks may enhance their willingness to extend credit and increase cash flow-based financing to priority segments,” the report noted.

By the end of June 2024, corporate loans had decreased by 2.0 per cent compared to December 2023. Consumer finance saw a decline of 9.0 per cent in 2023, followed by an additional 2.0 per cent drop by June 2024, now accounting for 6.2 per cent of total advances. In contrast, the commodity finance portfolio grew by 12 per cent in 2023 and increased by a further 9.0 per cent by June 2024.

Despite historic importance, access to affordable growth capital remains restrictive largely due to SMEs being undocumented with insufficient collateral. Of over 5 million enterprises, currently, only 3.5 per cent have borrowed from banks. In relation to agriculture, even today, around 75 per cent of farmers rely on informal sources of credit, the report noted.

Financing to these critical sectors has been declining over the years -- currently at less than 8.0 per cent of total loans, with SMEs at 3.7 per cent and agriculture at 4.0 per cent. SME lending in other countries as a percentage of total loans is much higher such as Indonesia 20 per cent, Bangladesh 19 per cent, and India 16 per cent, the report said.

Cash poses a challenge to financial inclusion and digitisation

While there is some notable improvement in financial inclusion with Pakistan standing at 60 per cent, there is still underpenetrated space compared with regional peers and emerging economies, according to the report.

Cash continues to pose a challenge in relation to inclusion as well as digitisation with Pakistan’s cash-in-circulation ratio at 35 per cent, compared with Bangladesh’s 15 per cent, India’s 16 per cent, and Kenya’s 10 per cent.

“In the context of digital payments, while we have witnessed a steady adoption, there is still sizeable room for uptake considering only 20 per cent mobile banking enrolment and cash still comprising more than 40 per cent of the total volume of retail payments within the banking system,” it said.

Mobile banking represents untapped opportunities in Pakistan

Despite growing popularity, only 20 per cent of individual account holders have registered for mobile banking in Pakistan, representing vast untapped opportunities especially when compared to emerging economies where this ratio is around 80 per cent, the report said.

Digital payments for online purchases have increased, but as e-commerce transactions cash-on-delivery, the share of digital payments continues to hover around 20 per cent given cash-on-delivery rampant preference for cash-on- delivery further exacerbated due to certain structural and logistical challenges associated with e-commerce in Pakistan.

Banks may face challenges during conversion

Pakistan will be one of the first countries in the world with a fully Sharia-compliant banking industry, once all the conventional banks complete their conversion, as per the current deadline, according to the report.

Pakistan’s parliament passed the 26th constitutional amendment bill last month, which calls for the elimination of all forms of ‘riba’, or interest, by January 2028. Currently, the Kingdom of Saudi Arabia reports the highest Islamic banking portfolio followed by Malaysia and Bangladesh, and then Pakistan with 23 per cent deposits and 28 per cent financing portfolios.

“Islamic transformation will require significant efforts on the part of the banks and will only be possible with absolute support, ownership, and stringent monitoring by the sponsors, Board of Directors, and the senior management,” it said. “Banks will face some critical challenges during the conversion journey. It will be vital for them to devise effective mitigation strategies and action plans to address those on an on-going basis.”