KARACHI: Banking statistics show the amount of loans extended by commercial banks to the private sector is shrinking.

In fact, its quantum as a percentage of the gross domestic product (GDP) has shrunk by more than half: from 27% in 2007-08, commercial banks’ credit to the private sector fell to 13% in 2014-15.

Some people may blame the banks’ reluctance to lend after the financial crisis that shook the banking industry in 2008. But the fact remains that Pakistan’s credit-to-GDP ratio today is substantially smaller than what it used to be back in 1999-2000.

So what exactly is keeping the private-sector demand suppressed? The answer depends on who you ask.

Bank CEOs put the blame on the private sector. In the absence of equity that comes directly from businessmen, bank CEOs say they can’t finance new projects solely with debt. In contrast, private-sector representatives claim a high cost of borrowing is hindering new investments.

Credit (mis)allocation

Given that the services sector contributes in excess of 55% to GDP, it would be natural to assume that its share in the total banking credit would also be the highest among other major sectors of the economy.

However, the manufacturing sector happens to be the most dominant (private-sector) borrower in Pakistan. Its share in private-sector credit is almost two-thirds, although its contribution to the economy is roughly one-fifth of GDP.

A breakdown of loans by size shows big borrowers (Rs10 million and higher) hold more than 80% share in total loans of the banking sector.

According to the annual report of the State Bank of Pakistan (SBP), big borrowers constitute less than 2% of total borrowers. This means only 1.8% of the borrowers are getting over 80% of the total loans in the country.

“This suggests that bank credit is heavily skewed towards big corporations while consumers and small and medium enterprises (SMEs) are underserved sectors,” the SBP said.

Govt borrowing

Government borrowing as a percentage of GDP in Pakistan is the highest among regional economies, including India, Bangladesh, Sri Lanka, Malaysia and the Philippines. Its result is obvious: the share of credit to the private sector in GDP was greater than that of government borrowing back in 2002 – a trend that has changed over the last few years.

While overall banking credit has grown in Pakistan, its composition is heavily tilted towards risk-free government lending. In other words, banks have fewer loanable funds available for the private sector now that the government has become the singularly dominant borrower.

Avoiding riskier lending

Pakistani banks face greater risk than their counterparts in regional economies when it comes to lending to the private sector. Data shows Pakistan has the highest infection ratio among Bangladesh, India, Sri Lanka, the Philippines and Malaysia.

Infection ratio is the share of non-performing loans in the total loans extended by banks. As a consequence of the relatively high infection ratio, banks tend to stay away from risky lending to the private sector while readily meeting the government’s risk-free credit demand.

Demand-side issues

Businesses find it difficult to borrow simply because the cost of borrowing is too high. While a record low benchmark interest rate may suggest otherwise, the fact remains that the three-year (2012-14) average real cost of borrowing in Pakistan was the highest among regional economies, with the exception of Bangladesh.

A lack of “financial deepening” has also resulted in the low penetration of the banking sector. Less than 10% of registered firms in Pakistan opt for bank financing, which is the lowest in all regional economies, the SBP says.

Other factors like structural flaws (energy shortages) and political instability also hamper the demand for credit from the private sector. According to the Worldwide Governance Indicators, Pakistan is in the first percentile: 99% of countries are better than Pakistan in terms of political stability and law and order.

Calling the government’s hefty demand for credit the “most important factor” that weighs heavily on the banks’ incentive to extend credit to the private sector, the SBP says banks must diversify their portfolio.

“Banks should (also) go beyond blue-chip corporates, particularly to SMEs and household consumers (because) both are severely underserved segments,” the SBP said.

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