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Government is taxing banks at higher rates for overly investing in government securities. The Finance Act says that banking income is higher for those banks having ‘asset to deposits ratio’ of below 50 percent. However, FBR has changed that to banks having ‘advances to deposits’ below 50 percent. One legal question is that can FBR change the definition of law in its regulation. And the economic question is why the government is treating investment in private instruments equivalent to investment in government papers. Not to mention that with such a high fiscal deficit and a prohibition of government borrowing from SBP, the government has no option but to knock on banks’ doors.

The first question is more important, and its implication is to discourage banks to invest in private papers – like TFCs, corporate Sukuks and commercial papers. Since FBR is finding it hard to do calculations on additional investment and additional earnings, it is simply taking any asset – beyond advances, to be treated for higher taxation. The change came in the last budget (effective from 1st July,2021), and it is to be treated for tax year 2022, which starts from 1st January for banks. Here the banks would have a disadvantage of six months.

Without giving any credit to bankers for being lazy and busy in generating low-cost CASA and investing in government securities to earn decent spreads, it is pertinent to note that the government is also responsible for banks’ indulgence in this risk-free behavior. The government must curtail its deficit to push banks to divert their deposits in deploying towards advances.

Coming to higher tax on income on low assets to deposits ratio, banks would reduce their investment in equities and private papers, and they would start charging higher spreads on government lending to compensate for higher taxes. Since government is running big deficits with fewer avenues (outside commercial banks) to borrow, it must accept whatever rates banks charge. This will increase the government’s debt servicing cost to nullify any increase in tax revenues for higher taxes. The causality is the private sector to issue papers.

After the deregulation and privatization of banks in early 2000s, the advances to deposits ratio of banks reached in high 70s with some banks hovering in 90s. There were two reasons for it. One was low government reliance on bank borrowing due to its curtailed deficit. And the other reason was low interest rates – that again was dependent upon lower demand from the government.

At that time there was no interest rate corridor; the market rates went down to 1-2 percent while the discount rate was at 7.5 percent. Banks went aggressively into lending to the private sector with focus on SMEs and consumers. Later, there was a case of higher NPLs due to economic downturn. The speed of NPLs grew due to higher discount rate with economic slowdown which was due to growing twin-fiscal and current account-deficits.

Since the foreclosure laws were effectively absent, banks burned their hands badly and swayed away from lending to the private sector. Concurrently, government borrowing has kept growing since 2008 and there is no stopping to the steep growth till today. Banks habits of risk aversion towards private lending is becoming a permanent feature'.

Now the government is trying to correct this through distortion such as lowering the tax rates on SME and housing lending, and SBP’s offerings of a plethora of subsidized schemes for private lending. The whole structure is lopsided and distorted.

Such taxes would have limited efficacy. For meaningful lending to the private sector, overall interest rates need to come down and the foreclosure laws have to be implemented in letter and spirt – something that does not fall in federal government’s or SBP’s jurisdiction; it’s the judiciary that is independent, and experts claim that it is not at all business friendly.


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