More lending to private sector for economic growth

Written By Mohiuddin Aazim

Commercial banks’ appetite for the private sector lending risk is drying up in the wake of excessive government borrowings. In its second quarterly report, the State Bank of Pakistan has noted that the banks “appear almost to have given up their role as financial intermediaries.”

The central bank is unhappy with this trend and wants banks to facilitate the private sector in playing its primary role in economic growth. Financial intermediation is all about establishing and deepening financial links between those who want to part with surplus money for adequate gains and those who need money to run existing or start new business.

“In the long run it is in banks’ own interest to cater to the requirements of the private sector instead of relying excessively on zero-risk lending to the government,” said a senior central banker.

“Individual banks with over-exposure in government securities carry the risk of losing the share in private sector credit market as left-out borrowers establish relationship with others.”

This sounds logical. But what happens when a majority of banks continue to ignore private sector borrowers? What percentage of such borrowers can be catered to by a minority of banks that are prudent enough to have a right mix of government-private sector lending?

“Well, that’s a tricky question,” conceded the central banker adding: “that is exactly what has happening now and we are brainstorming on how to correct the situation.”

Central bankers say, the SBP can prescribe a ceiling on holding of government securities to compel banks to lend more to the private sector. Or, it can find ways to limit their access to the central bank as a lender of the last resort so that they have to accelerate the pace of their own deposit mobilisation by offering reasonable rates of return to their depositors.

If this approach is adopted, the banks will also have to narrow down their unusually large banking spreads of well over 700 basis points and will have to cut their non-essential expenses besides focusing more on banking services to boost non-interest incomes.

Also, the government can use taxation tools to make holding of treasury bills and Pakistan Investment Bonds less attractive for commercial banks. But that seems a remote possibility unless the government becomes doubly sure that its ongoing efforts to borrow more through non-bank sources will really reduce its bank borrowing requirements substantially.

“We are pretty sure our non-bank borrowings would continue to rise but not to the extent that we can think of discouraging banks from investing handsomely in T-bills and PIBs through taxation measures,” said a senior official of the ministry of finance.

“What we can do instead is to make some careful and gradual cuts in T-bills rates signalling to the market that our borrowing needs are not as large as before and thus prompt banks to focus more on lending to the private sector.”

Central bankers mention two specific measures taken in the recent past to encourage financial intermediation by banks. Banks are required to offer a minimum return on five per cent per annum on deposits and introduction of interest rates corridor that has made banks’ borrowing from the central bank three percentage points costlier than their placement of surplus funds with it. Senior bankers say, it is naïve to expect banks to minimise their lending to the government when the government sets huge targets for borrowing from banks through T-bills and PIBs. They also say that lending to the private sector had slowed down in FY09 because of lower domestic growth in the wake of the global recession but it picked up in FY10 as recovery started.

And in the current fiscal year, banks have been lending still larger amounts of money to private sector after a spike in commodity prices. They, however, admit that lending to the agriculture sector has not been enough despite a faster-than-expected recovery in farming activities after July-September 2010 floods and that small and medium enterprises also have limited access to bank finances.

“The post-flood recovery has provided us a chance to make fatter loans to farmers, particularly for development purposes. But except for large local banks (who participate in the SBPs’ mandatory agricultural lending programme), most banks do not have sizable branch networks in rural areas and they also lack expertise required for the risk assessment and recovery of farm loans,” said head of agricultural credit division in one of the five major local banks.

“As for the SMEs, banks still confront the issue of securing repayment of loans as most of the SMEs are less-documented and least aware of the homework they should do to get bank financing.” But businessmen do not buy this line of argument.

They say that banks are averse to developing expertise for risk assessment and prefer to stay out of those potential areas of lending where assessing credit risk requires special skills. They also say that recovery of agricultural loans becomes troublesome when banks overexpose themselves to politically influential owners.

“Again, lending to small farmers, from whom recovery of loans is not an issue, is ignored because bankers do not reach out to them,” remarked an office-bearer of Sindh Abadgar Board.

Central bankers say, banks’ financial intermediation is weakening because of some structural flaws. These include their short-term approach to maintain banking spreads high, lack of enthusiasm to broaden deposit and credit portfolios, less effective regulatory controls over skewed expansion in the banking system and emergence of financial conglomerates.

Some top bankers admit that high banking spreads are weakening banks’ ability to raise quality deposits and also leading to tenure-mismatch in banks’ assets and liabilities. This, in turn, is making it difficult for them to employ funds in new or neglected businesses that, over some time, can generate quality deposits besides consuming bank credit.

Depositors who get paltry returns on banks deposits, when discouraged beyond a certain point start withdrawing money from banks and are often tricked into scandalous saving schemes. More often than not, humiliatingly low returns on bank deposits inflate currency in circulation and leads to expansion in parallel economy.

Expansion in parallel economy affects tax collection and compounds fiscal issues which, in turn, again increase the government borrowings from banks.

“In recent years, huge government borrowings from banks have been accompanied by cuts in development spending. That means lesser avenues for banks to employ deposits. This complicates the issue all the more,” said a senior SBP official and admitted that both the government and the central bank should take immediate corrective actions.

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