Where Does Pakistan's Credit Go? Understanding the Crowding Out of Private Finance

The Paradox: A Profitable Banking Sector That Does Not Lend

Pakistan has a banking sector that is, by conventional measures, healthy. Banks are well-capitalized and profitable. Yet the financial system has progressively retreated from its core function: financing productive economic activity.

The story of Pakistan's financial sector over the past fifteen years is one of structural transformation, but not the kind that promotes growth. Instead of deepening credit to businesses and households, banks have increasingly turned to lending to the government. The result is a financial system that works well for itself and for public borrowing, but fails the private economy it is meant to serve.

The Collapse of Private Sector Credit

The most striking trend in Pakistan's financial sector is the sustained decline in credit to the private sector relative to the size of the economy.

In 2008, domestic credit to the private sector reached 24.2% of GDP.^[1] This was the peak. By 2023, the figure had fallen to just 12.0% of GDP, a decline of over 12 percentage points or roughly 50% in relative terms.^[1]

To put this in perspective: in 2008, Pakistan's private credit ratio was similar to Bangladesh's (24% vs 32%). By 2023, Bangladesh had climbed to 38% while Pakistan had fallen to 12%.^[1]

The comparison with other peers is equally stark. India extended private credit equivalent to 50% of GDP in 2021.^[1] Malaysia's ratio stood at 117%.^[1] Even Egypt, which has faced its own economic challenges, maintained a ratio of 29% of GDP.^[1]

This decline was not gradual. The sharpest contraction occurred between 2008 and 2011, when the ratio fell from 24.2% to 15.4%.^[1] Multiple crises converged during this period: the global financial crisis, a severe energy shortage, security deterioration, and macroeconomic instability. Private sector credit never recovered.

Where the Deposits Go: The Advances-to-Deposit Ratio

The advances-to-deposit ratio (ADR) measures how much of their deposits banks lend out. A ratio of 100% would mean banks lend every rupee deposited with them. In practice, banks hold some deposits as reserves and invest some in securities, so ratios typically range from 70% to 100% in healthy banking systems.

Pakistan's ADR tells a story of banking sector retreat from lending.

In 2008, Pakistani banks lent out 87% of their deposits.^[2] By 2020, the ratio had fallen to 46%, and it remained at 48% in 2021.^[2] This roughly 40 percentage point decline means that for every rupee deposited, banks were lending out 40 paisa less than they had in 2008.

Among comparator countries in 2021, Pakistan's ADR of 48% was the second lowest:

Country	ADR (2021)
Malaysia	104%
Bangladesh	95%
India	72%
Pakistan	48%
Egypt	37%

Source: World Bank, GFDD.SI.04, 2021^[2]

Egypt's even lower ADR reflects a banking sector similarly oriented toward government financing. Pakistan and Egypt share a structural pattern: banking systems that collect deposits from households and businesses but deploy them overwhelmingly into government securities rather than private lending.

The Crowding Out Mechanism

Why did Pakistan's banks stop lending to the private sector? The evidence points to a single dominant factor: the government became their primary customer.

When the government runs large fiscal deficits, it must borrow to cover the gap between spending and revenue. In Pakistan, much of this borrowing occurs through the domestic banking system. Banks purchase government securities, which offer several advantages from the lender's perspective: they carry no credit risk (the government will not default on rupee-denominated debt), they require no costly credit assessment, and they generate stable returns.

For banks, this is rational behavior. For the economy, it represents a misallocation of the financial system's resources.

The World Bank's Pakistan Development Update (April 2022) reported that credit to the public sector reached 66.8% of all bank credit by end-December 2021.^[5] However, this figure requires verification against primary State Bank of Pakistan data, and should be treated with some caution until confirmed.

The same report cited research finding that a 1 percentage point increase in government borrowing from banks crowds out private sector credit by 8 basis points within four months.^[5] This means the effect is not just mechanical (banks have limited balance sheets) but also behavioral: heavy government borrowing shifts bank business models away from private lending.

The Underserved: SMEs, Agriculture, and Housing

The aggregate decline in private sector credit masks even more severe underprovision to specific segments that matter most for broad-based growth.

Small and Medium Enterprises

The World Bank's PDU reports that SME financing accounts for only 6.3% of total private sector financing in Pakistan as of June 2021.^[5] Even more strikingly, SME credit amounts to less than 1% of GDP, compared to 7.2% in India and 15% in Malaysia.^[5]

Only 6.7% of Pakistani firms surveyed reported having an outstanding loan or line of credit with a financial institution.^[4] This places Pakistan among the lowest in the world for firm-level access to formal credit. However, this data point comes from 2013 and may not reflect current conditions.

The Nature of What Credit Exists

Even the limited credit that does flow to the private sector tends to be short-term and trade-oriented rather than the long-term fixed investment financing that drives productivity growth.

According to the PDU, fixed investment financing accounts for only 33.6% of total bank financing, while working capital accounts for 41.1%.^[5] Trade finance accounts for much of the remainder. This pattern suggests that banks are financing the circulation of existing economic activity rather than the creation of new productive capacity.

Financial Exclusion: Most Pakistanis Have No Bank Account

Beyond the question of how much credit flows is the question of who participates in the formal financial system at all. The answer, for most Pakistanis, is that they do not.

According to the World Bank's Global Findex survey, only 21% of Pakistani adults had an account at a financial institution or mobile money provider in 2017.^[3] By 2021, this figure had essentially stagnated at 21%.^[3]

India's dramatic improvement, from 35% in 2011 to 78% in 2021, demonstrates that financial inclusion can be rapidly expanded through deliberate policy effort.^[3] Pakistan has not achieved comparable progress.

The Gender Gap

The exclusion is not evenly distributed. In 2017, 35% of Pakistani men had a financial account compared to just 7% of women, a gap of 28 percentage points.^[3]

By 2021, the picture had shifted somewhat: male account ownership declined to 28% while female ownership rose to 13%.^[3] The gender gap narrowed to 15 percentage points, but this occurred partly through a decline in male inclusion rather than purely through female gains.

The narrowing of the gap in 2021 should be interpreted carefully. While female account ownership nearly doubled from 7% to 13%, the decline in male ownership from 35% to 28% suggests that aggregate access may have weakened during this period.

A Structural, Not Cyclical, Problem

The patterns described here are not the result of temporary economic conditions. The decline in private sector credit began in 2008 and has persisted through multiple governments, economic cycles, and policy regimes. The low ADR has been entrenched for over a decade. Financial inclusion has barely moved in years.

This suggests structural causes: the incentive environment facing banks, the dominance of government borrowing in the financial system, and the lack of infrastructure and information systems needed to extend credit efficiently to small businesses and individuals.

Reversing these patterns would require addressing the underlying fiscal dynamics that have turned the government into the banking sector's dominant customer, as well as building the institutional infrastructure, such as credit registries, collateral frameworks, and digital identity systems, that support broader financial access.