The government’s strategy of using tax penalties to encourage banks to increase lending to businesses has failed to produce the desired results, with banks opting to absorb higher taxes rather than expand credit to small businesses and other higher-risk borrowers.
According to a report by the Karachi School of Business and Leadership, policymakers introduced a tax mechanism linked to the Advances-to-Deposits Ratio (ADR) to push banks toward greater private sector lending. The policy imposed higher taxes on banks with an ADR below 50 percent, aiming to discourage excessive investment in government securities.
However, the report found that the measure had limited impact on lending behavior. Following strong resistance from the banking industry, the government eventually replaced the ADR-linked tax structure with a higher tax rate of 44 percent.
The study noted that banks viewed lending to small and medium-sized enterprises (SMEs) as significantly riskier than paying additional taxes. SME financing often involves weak financial documentation, limited collateral, higher default risks, and greater recovery challenges, making such lending less attractive for financial institutions.
In contrast, government securities such as treasury bills, Pakistan Investment Bonds, and sukuk continued to offer secure returns with lower operational costs and minimal risk exposure. As a result, banks maintained a strong preference for investing in government debt rather than extending credit to the private sector.
The report highlighted that Pakistan’s banking sector continues to exhibit weak private-sector credit growth. ADR levels remained below 40 percent, while SMEs accounted for less than 10 percent of total bank lending.
Despite the introduction of additional taxes, including super taxes and windfall levies, banks did not significantly alter their investment strategies or lending patterns.
The report concluded that taxation alone is insufficient to drive meaningful increases in business financing. It emphasized that structural issues such as credit risk management, documentation requirements, collateral constraints, and loan recovery mechanisms must be addressed before banks are likely to expand lending to SMEs and other underserved sectors of the economy.
Experts believe that improving the overall business environment and reducing lending risks will be critical to increasing private sector credit and supporting sustainable economic growth.
