Over the past two and a half decades, bank loans to creditworthy private businesses and individuals as a ratio of GDP have been shrinking.

This has prompted two central bank researchers to revaluate the worth of both financial market reforms as well as state-directed bank lending in the light of private ownership of the banking industry.

In their study labelled as SBP Staff Notes, intended to initiate an internal debate within the central bank, authors Asma Khalid and Talha Nadeem, raise questions about the efficacy of the reforms initiated in the 1990s.

In a critical review of bank credit they note that the reforms ‘fell short of their objective’ and that ‘the efficiency of the banking industry improved inter alia at the cost of (financial and social) inclusion.’

And the systemic risks to the banking system has been heightened by concentration of credit in 20 big business groups with an exposure of 30pc of the total bank loans; of which the corporate sector took the lion’s share at close to 70pc.

It was the concentration of credit within 22 families, apart from political considerations, that led to the ill-fated nationalisation in the early 1970s.

The study explores the various possible factors for the reforms falling short of their objectives: was there a problem in their design, or implementation?

Was their success marred by unhelpful macroeconomic environment; or did the delay in reforms in other sectors of the economy (for instance fiscal, debt) prove unhelpful?

Currently, banks are not effectively performing their core function: channelling depositors’ savings into loans for creditworthy businesses and individuals.

Branchless banking and information and communication technologies offer banks the means to attract and serve niche clientele and their disruptive potential can reshape the banking ecosystem

The overall credit growth also remained subdued as a number of big cash-rich conglomerates have increasingly begun using their own surplus funds for growth rather than borrowing from commercial banks

Helped by reforms from FY2000 onwards, the banking industry did significantly expand the menu of its services and lending to the neglected sectors.

In the researchers’ view, however, the financing of ‘non-traditional’ sectors of the economy was quite likely the outcome of a huge influx of liquidity in the system in the aftermath of 9/11, subdued appetite for budgetary funding and an easy monetary policy.

But things began to change from 2008 onwards owing to the balance of payments crisis of 2008 followed by the IMF stability programme and the persistent energy shortage and security situation.

‘Countercyclical macroeconomic policies could not be deployed as vulnerabilities in the external sector had morphed into a full bloom balance of payments crisis.’ For the next five years, interest rates remained in double digits contributing to an anaemic growth rate.

In such situations, ‘a subsequent recourse to demand contraction and stabilisation policies over the years has time and again undermined the envisaged market-based interest rate determination.’

Had the macroeconomic environment remained favourable, banks would have consolidated upon their initial gains in the post-reform credit market.

Rationalisation of the profit structure of the National Savings Scheme in line with the banking sector did lead to intermediation of bank deposits, but its impact on private credit was sizably offset by increased government borrowing from the banking system.

If the fiscal and/or domestic debt market reforms were previously (or even simultaneously) rolled out, the government’s appetite for bank borrowing would have been contained.

In the context of finance-growth nexus, the foremost fallout of the financial sector reforms was that development financial institutions, which were integrated with the country’s growth, faded into the background. The void created by this contraction was not adequately filled.

The reforms were primarily focused on strengthening the regulatory framework and improving overall stability of the banking industry. What was initially missing from the agenda was a deliberate policy to ensure access of individuals and businesses to useful and affordable products and services.

Financial inclusion was repeatedly ignored as regulators were sceptical due to higher credit risks and lack of documentation of small businesses.

Pakistan has one of the lowest proportions of adult population with access to a transactional account and one of the highest ratios of currency to deposits.

People’s savings are mostly in the form of physical assets like livestock, gold, hard cash and real estate.

In the pre-reform era, banks were directed to lend not on the basis of project viability but for social returns. Not all the credit was being lent for productive investment and some element of politically connected lending could not be ruled out.

Under directed credit management, 65pc of the outstanding credit was mandatory and/or concessionary at the end of 1980s. This led to subsequent worsening of the asset quality that restricted the earning capacity and heightened the solvency risk of banks.

Then came the early 1990’s financial sector reforms. The idea was that credit allocation would improve if left to market forces.

In the post-reform era, Pakistan withdrew from the directed credit while it was still in place in various forms in a number of Asian countries.

Admitting that there was a possibility that Pakistan might have achieved greater credit depth if it had continued with direct state intervention, the study points out doing so would have been a compromise on overall financial stability.

The research stresses that there is no need to roll back reform measures; what is required is fine-tuning. The task now is to make it conducive for banks to lend to currently neglected sectors. The drive for financial inclusion is premised on underlying, favourable economics.

The suggested way forward: branchless banking and information and communication technologies offer banks the means to attract and serve niche clientele in a cost effective manner and their disruptive potential can reshape the banking ecosystem.

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