Private sector struggles as banks lend less

ISLAMABAD: Commercial banks lending to the private sector fell from 24.1 percent of the GDP in 1995 to 17.9 percent in 2019, checking the latter's economic growth and boosting the former's profitability.

These are the findings of a new report released by Policy Research Institute of Market Economy (PRIME), an independent think tank.

The report found a dramatic increase of the share of government securities in banks’ investment portfolio from 10 percent in 2010 to 46.4 percent in 2020, which indicates banks have turned to risk-free lending to the government rather than playing a role in allocation of capital to the private sector.

On the other hand, the profitability of the banking sector increased from Rs7 billion in 2000 to Rs244 billion in 2020.

These are some of the main messages from the report.

Some key messages of the PRIME report illustrate that post-privatisation, banking sector’s efficiency and profitability has improved reaching Rs244 billion in 2020 as against Rs7 billion in 2000.

According to the report, episodes of higher private sector lending and lesser exposure to government securities notwithstanding, the long-term trend of private sector lending from commercial banks after privatisation suggest a visible decline.

Declining role of Development Finance Institutions (DFIs), rising government footprint in credit market, high private credit risk, procedural complexities, low financial literacy, information asymmetries and muted demand for long-term investment have suppressed the private credit off-take, it says.

Restructuring of financial sector has been detrimental from the inclusion standpoint as banks’ disbursements are skewed towards blue-chip corporations, while SMEs remain financially deprived.

Pakistan continues to lag regional economies with respect to penetration of bank credit and private investment.

The report mentions gradual extinction of Development Finance Institutions as a factor, which was used to complement the banking sector by bridging the gaps in the supply and demand of financial services.

The report notes that after privatisation, the infection ratio that stood at 25 percent in December 2000 fell to 8 percent in 2017and then increased to 9.2 percent as of December 2020.

The report also finds that in Pakistan, the banks’ credit disbursements to private sector are heavily skewed towards large enterprises. The share of large-sized borrowers in total loans of the banking sector stands at 87 percent in Pakistan, such borrowers account for only 1.6 percent of the total borrowers, in contrast to 72.5 percent in Bangladesh.

While the privatisation has improved the efficiency and profitability of the banking sector, the state of private sector credit remains unsatisfactory. Post-reform banking sector is not effectively performing its core function of channeling depositors’ savings into loans for private businesses. While there have been episodes of higher private sector lending, these commercial funds are being increasingly geared towards government debt instruments to earn secure profits. Consequently, a large proportion of private businesses, particularly SMEs remain financially excluded and face difficulty in accessing finance.

This in turn has repercussions for private sector investment, causing the country to lag its regional competitors in terms of penetration of bank credit and private fixed investment. The large federal government footprint in the credit market is suppressing private credit off-take by reducing the funds available for private sector credit. Even within the private sector credit, the banks’ disbursements are heavily skewed towards blue-chip corporations who get priority in lending decisions, possibly, at the cost of SMEs. During these unprecedented times, increasing banks’ credit to private sector and ensuring financial inclusion is necessary for restoring the business confidence and propelling private sector activity forward that has been suppressed with the onset of Covid-19. The report recommends that as the incumbent government sits down to think about rekindling economic growth post-pandemic, sustainable measures to enhance banks’ credit to private sector should not be discounted.

In order to make banking sector conducive to private sector growth, there are certain policy measures the public and private stakeholders should consider in order to facilitate banks’ credit to private sector.

The report suggests that it is high time the government practices fiscal prudence and diversifies its borrowing sources so that the commercial banks can increasingly divert their funds to the private sector.