Banks credit to private sector declines 20 percent

KARACHI: Despite the policy rate touch 42-year level, the credit to private sector failed to pick up, instead declining 20 percent from July to mid of November.

It now stands at Rs 78 billion in the current financial year. The unexpected trend was reported due to decline in the running financing of different corporations, lowers values of imports in major sectors and reluctance of banks and consumers to avail banking system. Commercial banks’ credit to the private sector, in terms of GDP, in Pakistan has witnessed a noticeable decline since financial year 2007-18, plunging from 27 percent in FY08 to just 13 percent in 2014-15, and it continued to increase in the current financial year.

The long-term analysis also shows that after witnessing a credit boom from 2005-2008, credit-to-GDP ratio has reached historic lows. Unfortunately, the ratio is among the lowest in selected developing economies despite of the fact commercial banks’ balance sheet reflected double-digit growth in bottom lines. On the other hand, the ratio surpassed the level of 2007 in other countries, which is the year before the global financial crisis, when credit activities were at their peak.

It is expected that sectors that contribute most to GDP would receive greater share in credit, this does not hold true for many countries included in Pakistan. Pakistan stands out the most because of the highest share of manufacturing in overall credit allocation; the services sector (which contributes over 55 percent of the GDP) gets less than 20 percent of the total credit. According to SBP, the share of large sized borrowers (Rs 10 million and higher) in total loans of the banking sector is more than 80 percent, while such borrowers are less than 2 percent of total borrowers.

In simple words, only 1.8 percent of borrowers are getting more than 80 percent of the total loans. The share of private sector in gross fixed capital formation is also low in Pakistan. Gross fixed capital formation by private sector (as percent of GDP) is only 9.6 percent in Pakistan, compared to more than 20 percent in Bangladesh, Sri Lanka and India. Most of the firms in Pakistan have excess capacity that inhibits investment and leads to low credit off take.

Real cost of borrowing is an important factor that discourages private sector to borrow from the banking system. Lending rate adjusted for inflation shows that the three-year average real cost of borrowing in Pakistan, barring Bangladesh, is highest in the group. This suggests that bank credit is heavily skewed towards big corporations, while consumers and SMEs are underserved sectors. This skewed distribution of credit has not changed considerably over the period of past 10 years.

By limiting the pool of funds in the banking system, the dominant borrower (i.e., the government) marginalises the credit for private sector activities. A, mirror image of private sector credit-to-GDP ratio, shows that the central government borrowing (as percent of GDP) from the banking system has remained highest in Pakistan among selected countries. Facing a persistently large fiscal deficit over the years, the government has relied on financing from the domestic banking system.

The overall credit extended by the banking system in Pakistan has increased, its composition has shifted in favour of risk-free government lending. Nonetheless, cognisant of its impact on the supply of loanable funds for the private sector, SBP stepped up its liquidity injections through open market operations (OMOs) to ensure adequate supply of credit. The hefty demand for credit from government is the most important factor that weighs heavily on banks’ incentive to extend credit to private sector.

Since large government borrowings also limits the supply of loanable funds to private sector, only the blue-chip corporate gets priority in banks’ loaning decisions. It is clear that unless the government diversifies its borrowing sources, banks would not get a meaningful push for extending credit to the private sector. Banks also need to diversify their portfolio as excessive exposure on government debt is hampering financial intermediation in the economy and eroding the effectiveness of monetary policy.

Furthermore, any sudden decline in credit demand from dominant borrower (for example, due to positive external shock) would only stash banks with ample liquidity. Hence, banks should go beyond blue-chip corporate, particularly to SMEs and household consumers – both are severely underserved segments. Banks are usually hesitant in providing finance to SME and consumer sectors due to inadequate information (preference to remain undocumented). This makes it difficult for banks to evaluate the underlying risks of their business.

SBP has taken initiatives for promotion and development of SME banking and consumer financing. Banks should exhibit a concerted effort to understand the market and develop demand based financial products that cater to the unmet requirement of low and middle-income masses of the country. Furthermore, they should explore viable collateral free lending products. The financial literacy programmes are also critical to reduce the demand side bottlenecks and facilitate awareness of formal financing opportunities.

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