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September 12, 2019

Financial inclusion in Pakistan


September 12, 2019

One of the most common mismatches in life is that between income and consumption. It’s good when income exceeds consumption, but explains all the downsides of poverty when it is the other way round. The art of dealing with this mismatch is called ‘consumption smoothing’, and most of us do it throughout our lives.

Modern banking and finance has largely evolved to facilitate humanity’s struggles with consumption smoothing; the financial losses from an unexpected car crash can be mitigated with insurance, a sudden rise in business expenses can be met with a loan, and savings apportioned for the future can earn interest if kept in a savings account rather than at home.

There is a term for those who can avail the benefits of formal banking and finance; they are called the ‘financially included’. These are individuals with a formal financial account, be it a bank account or a mobile money account. As per World Bank estimates, for 2017, 69 percent of the world population is thought to be financially included. However, for Pakistan, financial inclusion is quite exclusive as the World Bank estimates only 21 percent of the Pakistanis to be financially included.

Pakistan’s financial inclusion strategy has a very ambitious goal for its Vision 2020, as it aims at 50 percent of its adult population to have a bank or mobile money account by next year. The efforts so far have mainly been focused on relevant issues such as lack of financial awareness and financial literacy, the complications of account registration, as well as financial infrastructure issues etc.

While these are valid constraints, in my opinion, limited access to loans might be the most crucial constraint that is resulting in low financial inclusion levels in Pakistan. Loans are a crucial lifeline in cases where expenditure exceeds income, and their availability can mean that households don’t have to choose between essential expenses, such as the education of a child and the health of a parent. It is this availability of financial loans that incentivizes formal financial behaviour; paying for goods through a credit card or a mobile wallet might mean more than convenience if the transaction adds to one’s credit score.

This incentive is inbuilt into the concept of banking, where individuals can choose to be just depositors or depositors and borrowers as per their financial circumstances. A bank account then becomes more than just a vault for cash or an option of money transfer, the possibility of loans makes it a source of financial security. Therefore, it is very likely that the lending priorities of commercial banks play a role in convincing the financially excluded to become financially included.

The latest figures from the State Bank of Pakistan show that our commercial banks have invested approximately Rs7 trillion in government securities. This constitutes around 50 percent of our overall banking deposits. For India, the same is at 28 percent. The government’s direct borrowing from commercial banks is at Rs0.8 trillion, which is another six percent of deposits. Meanwhile, ‘personal loans’ – loans given to households – stand at a mere five percent of deposits, compared to 16 percent in India and even higher in more advanced countries.

The net effect of this massive borrowing by the government is a crowding out of the private sector; a relevant indicator that captures loans for household and private businesses is the amount of domestic credit as a percentage of the GDP. On this measure, Pakistan is at a mere 19 percent, comparable to countries such as Haiti and Lesotho. Meanwhile, for India the same is at 50 percent and for Bangladesh at 47 percent.

The prime responsibility of a bank is to maintain its profitability and in the current scenario, lending to government is perhaps a better alternative than considering households as a potential market. When seen in this context, all the excitement about the use of technology in finance, for increasing financial inclusion, seems a bit misplaced. One of the biggest advantages that modern data processing technology can provide is to enable banks to sift low-risk borrowers from high-risk ones by analyzing massive datasets, like those of cellphone usage patterns etc. However, for banks to invest in more innovative credit risk assessments they need to be looking to earn money through more risky lending. What incentive do banks have in developing more rigorous screening abilities when the government is offering a much safer alternative?

It would be easy to simply say that the government should reduce borrowing from the banking sector. However, Pakistan is faced with a massive income and expenditure mismatch at our national level as well. Consider the fact that our direct tax collections are approximately equal to our defence spending, and our indirect tax collections are almost the same as our debt servicing payments, both amounting to around 72 percent of our revenues. How exactly will the country run, if the government doesn’t borrow?

The debate on financial inclusion in Pakistan and its targets have to be linked to our fiscal realities. It is easy to categorize the financially excluded masses as being unaware of the promises of formal finance, but would the current offering of financial products incentivize them to register for a formal account even after they become aware?

The mere registration of a bank or mobile money account shouldn’t be seen as an end. Innovations such as digitally submitting utility bills or electronic remittance payments are great but these mostly provide convenience, not financial security. For our less privileged and mostly financially excluded masses, consumption smoothing means a constant search for loans of small amounts and short duration. That is one pain point that our formal financial sector should be able to relieve, for formal account-holders to be truly considered as financially included.

However, for that to happen, our poor have to become profitable for our banks. And that won’t be possible as long as our banks have to ‘choose’ between the low collateral of the poor and the sovereign guarantee of the state of Pakistan.

The writer is a freelance contributor.

He blogs at

Email: [email protected]

Twitter: @iopyne