International markets have been shaken by the recent bank failures in the United States, Switzerland, and Lebanon. The economic situation in Pakistan is also uncertain, which raises concerns about the stability of its banking system.
However, the answer to whether we should be worried about our banking system is not a straightforward one – it’s both yes and no.
To start with, it is important to acknowledge that there are certain structural problems with Pakistani banks that have played a part in the difficulties experienced by the banking industry.
One of the structural issues with Pakistani banks is their high concentration risk. This is due to the fact that a few large banks hold a significant percentage of assets in the banking system.
This poses a concentration risk as the failure of one or more of these banks could have a severe impact on the entire financial system.
The second structural issue is the high rate of non-performing loans (NPLs). This is a significant problem as it means that a large proportion of loans given out by banks are not being repaid, resulting in a liquidity crisis in the banking sector. Furthermore, many of these NPLs are questionable and may appear to have been used to benefit certain individuals through collusion.
It is imperative to increase transparency in the banking system by making financial reports more accessible to the public and by encouraging whistle-blowers to come forward with information about corruption and fraud, particularly in relation to loan write-offs.
The third challenge is the lack of transparency and accountability in the banking system, which has resulted in widespread corruption, money laundering, and fraudulent activities. This has led to a loss of public trust in the banking sector and contributed to the lack of confidence from both domestic and foreign investors.
As for the fourth challenge, the legal and regulatory frameworks governing the banking system are inadequate, and enforcement is often weak, despite recent efforts to improve through the Financial Action Task Force (FATF)-oriented reforms. Fifth, Pakistan’s banking system suffers from a limited level of financial inclusion. A significant portion of the country’s population remains unbanked or underbanked, with limited access to formal financial services.
This has resulted in a lower level of financial literacy and restricted availability of credit to smaller businesses, which contribute significantly to the country’s economic activity. As a result, the full potential of deposits remains unutilised, leading to a scarcity of funds available for lending to businesses and individuals, ultimately hampering economic growth and job creation.
To build a strong and stable banking system, it is essential to tackle these underlying challenges. This requires implementing policies and reforms aimed at establishing a transparent, accountable, and competitive financial sector.
This may include increasing the independence and bolstering regulatory authorities, improving financial inclusion, and establishing appropriate legal and regulatory frameworks. Shifting the focus to why the Pakistani baking sector is not at risk, the primary reason is its relatively secure lending portfolio, which mainly consists of public debt and high-yield consumer lending.
The government is one of the biggest borrowers from the banking system. It obtains funds by issuing Treasury Bills, Pakistan Investment Bonds (PIBs), and other short and long-term instruments, which are utilised to finance budget deficits and other government expenses.
The State Bank of Pakistan’s most recent data as of February 2023 shows that the government borrowed Rs21.74 trillion out of the total credits or loans.
Meanwhile, public sector enterprises that are not part of the government borrowed Rs11.24 trillion, and the private sector borrowed a comparatively smaller amount of Rs8.6 trillion. Within the private sector loans, personal loans accounted for Rs1.2 trillion.
Looking at this credit portfolio from an economic policy perspective, it could be considered highly inefficient. However, from a banking perspective, it is quite secure since the risk of default by the state is much lower than that of the private sector. It’s worth noting that the government’s borrowing from the banking system has increased significantly in recent years. This is mainly due to higher budget deficits and increased expenditures, such as Covid-19 relief measures.
While borrowing can help finance vital public services and infrastructure, excessive borrowing may lead to higher inflation, put upward pressure on interest rates, and cause macroeconomic instability. Hence, it’s crucial for the government to manage its borrowing carefully and maintain fiscal discipline to ensure macroeconomic stability.
In recent years, there hasn’t been any significant bank failure in Pakistan, with the exception of one odd case attributed to mismanagement. This can be attributed to the secure lending portfolio mentioned earlier, along with a high lending-deposit spread and relatively lax regulatory oversight that has allowed some banks to cross certain red lines. However, this does not necessarily guarantee that all is good.
The concentration and composition of the lending portfolio, along with structural issues, an economic slowdown, and external shocks, are all cause for concern. It’s important to remain alert and cautious. Banking and financial meltdowns spread quicker than fire.
The writer is an international economist
Published in The Express Tribune, April 10th, 2023.
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