While the banks in Pakistan may appear financially healthy on paper, the reality is more complex. It would be foolhardy to merely glance at their financial statements and assume these institutions are in good health and ready to handle unexpected challenges. Although such risks are not often discussed in the press, the excessive influence of the government is putting the financial sector at grave risk. The easy business model of simply lending to the government at market rates—seemingly a low-risk sovereign lending exercise, especially in a high-interest-rate environment—may appear to yield unprecedented profits for these mostly privately owned commercial banks. However, this practice has serious repercussions for the banks themselves and, more importantly, for the Pakistani economy.
The resultant complacency within these financial institutions, due to such effortless profit-taking (bordering on rent-seeking), makes them weak and leaves them with few alternative financial products to rely on should these two-way transactions falter. Innovations in seeking new or diverse financial instruments are virtually absent. It is no surprise that the financial statements of the main borrower, the government, do not paint a rosy picture and would fail to secure borrowings at merit-oriented conditions in international markets. The tough conditions imposed by the IMF only attest to this reality. Moreover, the pattern of sovereign borrowings over the last decade indicates a brewing cash flow crunch on the part of the government, which repeatedly covers its shortfall by increasing borrowing merely to service its domestic loans. This has reached a point where the principal amounts are assumed to be mandatory rollovers.
The concern is, what if the government decides to renege on its principal repayments (not an unprecedented event in the history of sovereign lending) or if the banks, adhering to international compliance, are unable to re-roll these loans? What if the banks are asked to take a massive haircut on their sovereign lending? Such eventualities could push these lending institutions into a tailspin. Given these institutions’ over-dependence on the government’s borrowings, this situation is bound to lead to a run on the banks or even a collapse of the entire financial industry. This unhealthy relationship between the state and commercial banks not only leads to imminent disaster but also crowds out the private sector, where capital is most efficient and productive. Alarmingly, the latest figures released a couple of weeks ago put the government’s borrowing appetite for 2024-25 at Rs. 7.70 trillion, compared to a paltry Rs. 124 billion from the private sector—a mere 1.60%, a figure that should raise serious concerns.
The lack of imaginative behaviour among banking leaders raises questions about their ability to innovate. Interestingly, we are now relying on the innovative skills of one such leader to steer Pakistan’s economy out of its current economic impasse!
Scepticism about banking management leadership is not confined to Pakistan. As we mark the first anniversary of Silicon Valley Bank’s collapse, the Pollyannas on Wall Street and the leaders of large global banking institutions are already celebrating how the global banking system has avoided the systemic crisis that seemed imminent a year ago. Silicon Valley Bank’s bankruptcy in early March last year was the largest bank failure in the U.S. since the Great Depression and was closely followed by the collapse of Silvergate Bank and Signature Bank. Switzerland’s Credit Suisse also failed in March 2023, igniting fears of the crisis spreading to other countries’ banking systems.
Independent analysts, however, warn that it is premature to celebrate and point out that in the financial industry, things are not always as they seem on the surface. They caution against ignoring potentially systemic risks. For example, New York Community Bancorp (NYCB), which took over Signature Bank, is now in trouble itself, with its stock worth less than half of its value at the beginning of the year. Many banks are suffering from the same issues that caused last year’s failures—higher interest rates. Stanford University finance professor Amit Seru advises that banks can overlook toxic lending or unrealised losses due to artificial interest rates and not-so-risk-free sovereign lending.
Another source of concern is the knee-jerk policy measures by governments, which can trigger another collapse. Shutting down real estate markets or rapid economic contractions can quickly boomerang on financial institutions before they even have time to react—familiar scenarios in Pakistan. Additionally, there are concerns about what banking regulators are doing versus what they are saying, or effectively stalling what the market truly requires.
While all this may seem distant to us at the moment, if we do not take corrective action now, like in other economic areas, the chickens will soon come home to roost.
Dr Kamal Monnoo
The writer is an entrepreneur and economic analyst. Email: kamal.monnoo@gmail.com