The Pakistani banking sector has become something of a national punching bag. It is accused of rent-seeking, tax dodging, ignoring the private sector, and failing to support inclusive growth. On the surface, these criticisms resonate with the public. Banks post billion-rupee profits, while small businesses struggle, farmers remain unbanked, and insurance and housing finance are virtually nonexistent.
BANKING SECTOR
The Pakistani banking sector has become something of a national punching bag. It is accused of rent-seeking, tax dodging, ignoring the private sector, and failing to support inclusive growth. On the surface, these criticisms resonate with the public. Banks post billion-rupee profits, while small businesses struggle, farmers remain unbanked, and insurance and housing finance are virtually nonexistent.
Further, the ADR remains low at 37 per cent as of June 2024, down from 74 per cent in 2007; the IDR remains high at 94 per cent, up from 33 per cent in 2007. Private investment has declined from around 12 per cent of GDP in 2008–09 to 9 per cent in 2024–25. Currently, 70 per cent of the gross public debt is domestic, and 85 per cent of the total interest payments from July to May FY25 are attributed to domestic debt. Budget 2026 suggests that nearly half of the total expenditure is again earmarked for interest payments. The entire financial landscape is beginning to feel like Murphy’s Law brought to life.
But let’s play devil’s advocate. What if we’re looking at this all wrong? What if banks aren’t the villains of Pakistan’s economic dysfunction, but rather the reluctant firefighters keeping a fragile house from burning down?
The banking sector, as it stands today, is Pakistan’s single largest taxpayer, with an effective tax rate of around 54 per cent, 1.86x higher than other sectors. In FY2024 alone, the sector contributed over Rs840 billion in taxes. Even in the case of the windfall tax, despite legal contention, the banks paid in advance. Similarly, the ADR tax was in effect but later withdrawn -- a form of taxation based on the balance sheet rather than income, which encouraged window dressing instead of genuine lending.
And with its sane removal, another layer of taxation was added: a 5.0 per cent increase, raising the bank-specific tax rate from 39 per cent to 44 per cent in Tax Year 2025. Compare this to bank tax rates in other countries: India (25 per cent), Bangladesh (37.5 per cent), and Sri Lanka (35 per cent).
The most frequent and lethal charge is that banks crowd out the private sector by lending excessively to the government. And it’s true, most of total bank deposits are parked in government securities, and banks funded nearly 100 percent of the fiscal deficit during FY24. At first glance, it seems like a symbiotic or cozy relationship: banks make risk-free profits, while the government gets easy access to credit. But perhaps it's something else: a case of causality dysmorphia.
The banking sector’s central role in government borrowing may be less a symptom of greed than of necessity, a consequence of a broken fiscal architecture. The real chain of events tells a different story. Chronic fiscal deficits persist due to a mismatch between bloated government expenditures and stagnating revenues.
Tax-to-GDP ratios hover pathetically, given our currency in circulation exceeds Rs9.4 trillion (as of 2025), with currency comprising 26–27 per cent of broad money, and the informal economy estimated at $500 billion vis-a-vis the formal economy of $411 billion. Key sectors such as agriculture, retail, and real estate remain largely outside the tax net, despite repeated solicitations by MLDAs, with no meaningful reforms introduced in the latest Finance Act. Meanwhile, tax expenditure has surged to Rs5.8 trillion, a staggering increase of Rs2 trillion.
Where taxation does exist, it is highly distortive: 46 per cent of total tax collection comes from import taxes, compared to a global average of just 5 per cent. This makes Pakistan one of the most protected economies in the world. Such a protectionist structure, often justified under the guise of import substitution, relies heavily on cascading tariffs that reduce competition, hamper growth, and discourage foreign direct investment.
Banks are far from perfect; they must improve customer service, responsible practices and support for innovation. But blaming them alone misses the point. The real issue lies in the broken economic framework: weak public finance, a vast informal economy and poor governance
It leads to inefficient resource allocation, and fuels smuggling and trade misinvoicing while encouraging rent-seeking behaviour. As a result, the economy has become increasingly stagnant and inefficient; exports now account for only around 9.0 per cent of GDP, down from 16 per cent two decades ago.
In essence, the government’s own source of liquidity is either non-existent or, where present, parochial and ultimately damaging. Given the lacunae in inflows, and under the State Bank of Pakistan (SBP) Act, the central bank is prohibited from lending directly to the government. The only available option then is to borrow from private banks. The SBP, independent on paper, uses Open Market Operations (OMOs) to inject liquidity into the banking system.
Banks then uses this excess liquidity to purchase government securities, which remain the safest and most liquid option available. So banks are strapped into a vehicle driven by a government that refuses to reform. Refusing to lend under such circumstances would mean denying the very function, though laggard and elitist, of the state apparatus itself, effectively cutting off its lifeline—a no-choice situation.
Moreover, banks are often criticised for neglecting key sectors like SMEs, housing and agriculture, receiving less than 7.0 per cent, 5.0 per cent and 1.0 per cent of private credit, respectively. While these figures are poor, they reflect deeper issues: informal operations, weak documentation and lack of collateral. Banks require verifiability. That said, change is underway. Tools like Electronic Warehouse Receipts and digital supply chain financing are expanding access. SME financing, for instance, rose 36 per cent last year to Rs641 billion, benefiting over 95,000 businesses.
Banks are also often criticised for failing to make the financial system accessible to the poor and marginalized. Yet progress here is also evident. According to the latest Karandaaz Financial Inclusion Survey, bank-based financial inclusion has risen sharply over the past decade, from just 7.0 per cent in 2014 to 17 per cent in 2024. Since 2022, bank account usage has diversified beyond wages and savings. Notably, accounts with balances under Rs25,000 have increased ninefold in five years. Per the SBP, the gender gap in financial inclusion has decreased to 34 per cent in 2023 from 47 per cent in 2018.
This suggests that the role of banks in driving economic growth has also been criticised for being too passive. But scratch the surface and a quiet transformation is underway. Notable interventions include: the Rs1.275 trillion circular debt resolution deal, negotiated by the Pakistan Banks Association (PBA), aimed at stabilising the chronically distressed power sector by retiring old loans and issuing new ones at KIBOR minus 0.9 per cent, a move that dented bank profits for national cause; the National Subsistence Farmers Support Initiative, which provides digital, cash flow–based loans of up to Rs1 million directly to smallholder wallets; and a green mobility financing program for gig workers and women that is subsidised, collateral-light and climate-conscious.
According to the PBA, a Rs200 billion disbursement under the Prime Minister’s Youth Business and Agriculture Loan Scheme is targeting MSMEs and even supporting the solarisation of diesel-powered tube wells, making green agriculture not just aspirational, but a viable policy tool.
The sector is championing fintech collaborations, promoting digital banking, and even backing initiatives for affordable housing. A Financial Data Exchange (FDX) is in the works to enable secure data-sharing for more personalised financial services. A private equity support fund is also planned to scale fintechs.
Most notably, the sector is driving Pakistan’s first outcome-based financing tool: the Pakistan Skills Impact Bond (PSIB), developed with the British Asian Trust. By linking funding to employment outcomes, it replaces cheque-book philanthropy with performance-based investment, a model that could reshape public finance in Pakistan.
Banks are far from perfect; they must improve customer service, responsible practices and support for innovation. But blaming them alone misses the point. The real issue lies in the broken economic framework: weak public finance, a vast informal economy and poor governance. Banks, prima facie flawed and profit-driven, are propping up a failing state apparatus. The question is no longer just about holding banks accountable, but about demanding a stronger state so banks can shift from enablers of dysfunction to drivers of inclusive growth.
The writer is a Peshawar-based researcher who works in the financial sector.
