Government efforts to shift bank lending toward the private sector through punitive taxation have largely fallen short, as banks appear more willing to pay higher taxes than expand exposure to small businesses and higher-risk borrowers.
For several years, policymakers have criticized the banking sector for preferring investment in government securities over financing private economic activity. To address this imbalance, authorities introduced a tiered tax regime targeting banks with an Advances-to-Deposits Ratio (ADR) below 50 percent, aiming to push institutions toward greater lending to businesses and consumers.
However, a policy brief by the Karachi School of Business and Leadership finds the measure delivered limited behavioral change. After pushback from the banking industry, the government eventually replaced the ADR-linked tax penalty with a higher flat tax rate of 44 percent.
The report suggests this outcome highlights a clear preference among banks: avoiding the risks and operational burdens of private lending is often seen as more important than minimizing tax liabilities.
Bank lending decisions are driven by cost and risk considerations. Extending credit to businesses—especially SMEs—requires detailed credit assessments, higher capital allocation, and exposes banks to default risk, provisioning costs, and slow recovery processes. Smaller firms are particularly challenging due to weak documentation, limited collateral, and short credit histories.
In contrast, government securities such as Treasury bills, Pakistan Investment Bonds, and sovereign sukuk offer predictable returns, minimal risk weight under regulatory frameworks, and far lower administrative complexity.
The report notes that Pakistan’s banking sector has increasingly concentrated its portfolios in government debt, while private sector credit remains weak compared to regional peers. With ADR levels staying below 40 percent in recent years, SME access to formal credit remains limited, accounting for less than 10 percent of total private lending.
Despite multiple fiscal pressures—including the super tax and a one-time windfall levy that raised Rs. 23 billion from 16 banks—the effective tax burden on the sector has risen to around 55 percent. Yet, according to the report, these measures have not significantly shifted banks’ lending behavior.
The findings conclude that taxation alone is unlikely to change credit allocation patterns. Meaningful expansion in SME lending, it argues, will require structural improvements in credit information systems, collateral enforcement, and loan recovery mechanisms rather than further tax-based pressure.
