CORPORATE WINDOW: Building better banking practices

Banks play a crucial role in the economy. If they align their goals with the broader goals of economic stability, growth and development their contribution to the economy becomes vital. If they don’t, the economy suffers from instability, low or slow growth and unsustainable development in the country.

The State Bank of Pakistan (SBP), being the chief regulator of the banking industry, carries the responsibility of ensuring that banks behave in the larger national economic interest. The government of the day, under the guidance of the parliament, is supposed to work with banks in a manner to pursue its broader economic policies without hurting the key interests of the banking industry.

However, this required cooperation has remained elusive for decades in Pakistan not only in economic affairs but often in every department of national life. Pakistan’s economy, particularly its external sector has historically remained vulnerable to numerous internal and external shocks and managing it well requires lots of balancing acts in local politics as well as in economic affairs.

The current hybrid regime has somehow managed to stabilise the economy under a strict International Monetary Fund (IMF) reforms programme thanks to the support of friendly countries like China, Saudi Arabia, United Arab Emirates and Qatar. Now, moving from economic stability to growth requires increased willingness and grit on the part of the hybrid rulers and greater maturity on the part of the entire political class.

In the coming months, banks are expected to play a more positive role in economic growth and development, balancing their natural urge to boost profits and the need to lend more to the private sector businesses, especially in energy, technology and agriculture sectors that have the potential to transform the economy.

Bank also need to remain focussed on weaker segments of the private sector like micro, small, and medium enterprises and women-led businesses on whose growth hinges job creation and the overall well-being of the society. How well they do this will determine how soon the economy gets ready for long-term sustainable growth.

According to a recent Dawn report based on the findings of Topline Securities, the banking sector’s gross advances to deposit ratio (ADR) shot up to 44pc as of Oct 25 from 39pc on Sept 27 this year. This happened apparently because some banks that had their ADR running below 50pc began lending aggressively to avoid a 15pc incremental tax at the year’s end.

This is one classic example of how key contributors to the economy behave. Instead of keeping their ADRs at a not-so-high level of 50pc on their own realising the importance of lending to the private sector, banks are moving towards achieving this goal just to avoid additional taxation. This betrays a typical mindset that we often see in the works everywhere in Pakistan where institutes mostly do the right thing under compulsion.

The government began power sector reforms only when the IMF flagged it as a condition for lending funds. But by the time it moved to do this circular debt of the power sector due to massive corruption, mismanagement and inefficiencies had soared to unmanageable levels over the past three decades. The result: today, the total circular debt of the power sector stands above Rs2.4 trillion, and Rs1.8tr worth of these debts also carry interest equal to Karachi Interbank Offered Rate plus three per cent to 4.5pc.

On the one hand, the government keeps lamenting about resource paucity and often cruelly taxes people and businesses while failing to cut costs where they are due. Why, for example, did the total cost of power thefts (plus low recoveries) exceed Rs590bn in the last fiscal year? If nothing concrete is done to address this issue, this cost is projected to increase to Rs637bn, according to recent credible media reports.

Whereas the recent rise in banks’ ADR, regardless of the motive driving it, is a welcome move, the fact remains that the root cause of it, ie banks’ romance with the government bills and bonds, is not waning. According to a recent Topline Securities report, the investment-to-deposit ratio (IDR) of banks gradually rose from only 33pc in 2007 to 88pc in 2023 and then skyrocketed to 94pc in June 2024.

While looking at this absurdly high IDR, one can understand what prompted the government to impose an additional tax on banks whose ADRs remain below 50pc in July. Had the government taken this decision back in 2023 when the average IDR of the banking industry was still below 90pc, banks would have become more disciplined a bit earlier.

But sadly, since 2007, all successive governments have themselves been responsible for encouraging banks to invest more in risk-free treasury bills and bonds, neglecting the credit requirements of the private sector.

After all, it’s the government’s growing need to finance the fiscal gaps that creates greater demand for their bills and bonds in the interbank market and allows banks to continue making huge profits by offering loans to the government.

Published in Dawn, The Business and Finance Weekly, November 25th, 2024