The banks' favourite borrower

Pakistan’s FY27 budget, presented on June 12, allocated Rs8.054 trillion to interest payments. That is about 43% of the total outlay of Rs18.77 trillion, and the single largest head of expenditure in the budget. Of this, Rs6.983 trillion is owed on domestic debt and Rs1.071 trillion on foreign debt. Much of this interest does not leave the financial system. It returns to the commercial banks and other holders of government paper that now treat the state as their most reliable source of income. For all its language of transformation, the budget did little to disturb this arrangement.

Pakistan’s banks have found their safest customer in the government. T-bills and other government securities now form a major share of assets on bank balance sheets, which means the banking sector is earning more from financing the state than from financing businesses, exporters, SMEs, households or new firms. If the government has become the banking sector’s largest and safest customer, the logical question follows: who is funding growth?

The State Bank’s latest Financial Stability Review confirms this observation. The banking sector’s balance sheet expanded by 17.8% in CY25, but the SBP was explicit that the growth was driven primarily by investments in government securities. The share of investments in the asset mix rose to 62%, from 55.5% a year earlier, with treasury securities alone accounting for 58.6% of the asset base. Advances, meanwhile, actually declined year-on-year by December 2025. A banking system that relies so heavily on government paper links its strength to the state’s borrowing needs, instead of the private economy’s expansion.

A banking system that earns comfortably from the state while private firms struggle for credit may look stable, but it cannot create the scale of investment, jobs and exports Pakistan needs.

Banks historically exist to redistribute funds: they transfer savings from savers to borrowers, ideally to businesses that invest, expand and create jobs. In Pakistan, however, bankers can bypass the harder route, which requires due diligence, default-risk assessment and long-term confidence in the borrower. They lend instead to the borrower least likely to default: the government. The saver still places money in the bank, the bank still earns a return, but the final borrower is the state rather than the firm. This results in SMEs, exporters, manufacturers, homebuyers and new businesses competing for credit against the government itself.

The mismatch between access to credit and banks’ profitability is further exposed by internationally published statistics. According to the World Bank, domestic credit extended by banks to the private sector made up only 11.34% of gross domestic product (GDP) in 2024. SBP’s latest SME finance tables show SME financing at just 7.63% of domestic private-sector financing by March 2026.

This partly explains why exporters complain about liquidity, refund delays and expensive short-term borrowing. It also helps us understand why new businesses in Pakistan often depend on family capital, supplier credit or informal lending before a bank finally takes them seriously. A banking system that earns comfortably from the state while private firms struggle for credit may look stable, but it cannot create the scale of investment, jobs and exports Pakistan needs.

The problem, it seems, runs deeper than weak credit to businesses. Over the past decade, government domestic debt has increased from Rs12.19 trillion in FY15 to Rs57.57 trillion by March 2026. Scheduled banks have occupied a central role as the main financiers of the government’s fiscal deficit. The money used to service this debt, however, does not fall from the sky. Interest payments on domestic debt, paid back to commercial banks and other holders of government paper, come from the tax pool, built through petroleum levy, GST, customs duties, withholding taxes, utility bills, mobile usage, documented salaries and inflation. The public first pays into the state through everyday transactions, and the state then uses that pool to service the debt it owes. The FY27 budget does little to change this.

Every round of short-term domestic borrowing increases rollover pressure and gives banks another reason to prefer the state over the economy.

The salaried class received some relief through revised slabs and the removal of the income surcharge, but the burden shifts within the same documented base rather than moving onto wealth held in land, property, agriculture and informal assets, which remains far harder to tax.

Also read: Govt debt stock surges to Rs82trn by May

Recent T-bill auctions show that this loop is tightening rather than easing. On June 23, the government raised Rs1.243 trillion through treasury bills in a single session, while rejecting all bids for 10-year floating-rate bonds. Combined participation across the two auctions exceeded Rs3.39 trillion, with demand concentrated in the 12-month tenor. Even with the policy rate held at 11.5%, banks continue to prefer short-term government paper over lending to the economy. Every round of short-term domestic borrowing increases rollover pressure and gives banks another reason to prefer the state over the economy.

Banks have thus made phenomenal profits since 2023, much of it from interest on government securities. This is most visible in the stock market, where the past year’s Pakistan Stock Exchange rally has partly been a bank-profit rally. Out of the Rs491 billion in combined earnings posted by KSE-100 Index companies in 3QFY26, banks alone contributed Rs169.7 billion, around 34.6% of the total. They also paid Rs74 billion in dividends out of total KSE-100 dividends of Rs139.5 billion. The pattern continued after the budget. When the KSE-100 crossed 180,000 in the days that followed, banking stocks again contributed the most to the benchmark’s weekly gains, adding 2,047 points.

Retail participation is also rising along with public sentiment. PSX added 25,114 new investor accounts in April 2026. The harder question to ask is what these investors are really entering into. Much of the index’s gain over the past year has been driven by banks, with a single large bank accounting for a sizeable share of the rise on its own.

This distinction matters because not all profits inside the index tell the same story. A bank earning interest on government securities is not the same as a technology exporter earning dollars from foreign clients. A fertiliser company benefiting from gas allocation and pricing policy is not the same as a new manufacturer expanding output. In many cases, what appears as corporate profitability is really state policy passing through a company’s balance sheet. Taxes, tariffs, subsidies, regulated margins and government borrowing become revenue streams, and once they reach the listed company, they are recorded as earnings.

This is where the middle-class retail investor enters the same cycle four times. As a taxpayer, they help fill the fiscal pool through GST, petroleum levy, withholding taxes, electricity bills, mobile usage and inflation. As a depositor, their savings help fund bank balance sheets that are increasingly built around government paper. As a borrower, they face high rates, collateral demands and selective lending when they need credit for a home, business or working capital. Finally, as investor, they enter the PSX through shares, mutual funds or apps, hoping to participate in profits generated partly by the same structure they already fund. They pay into the system with certainty, lend to it cheaply, borrow from it expensively and then enter the market hoping to recover some upside.

This begins to look less like broad-based wealth creation and more like a quiet game of musical chairs. The music is the rally. The chairs are the concentrated profit pools. Banks, sponsors, institutions, mutual funds, pension funds and asset managers sit closest to them. Retail investors enter as the music gets louder. But the structure remains uneven: the public funds the fiscal pool broadly, while the market upside is owned narrowly.

A rising PSX is welcome, but a stronger economy would show up when the market celebrates productive risk as much as fiscal intermediation.

The budget had an opportunity to begin addressing this and largely declined. It abolished super tax for companies earning up to Rs500 million and reduced the top super-tax slab, but excluded banks, E&P and fertiliser from the relief. A higher tax on bank profits, however, only allows the state to recover a portion of the interest it has already paid them. It does not alter why those profits exist in the first place. The NFC Award was again left unchanged, leaving the centre to carry debt servicing while provinces still have far more room to raise revenue from agriculture, property and services. Development spending remains squeezed, another sign that debt servicing is crowding out the kind of expenditure that should support future growth.

Reform is possible, but it must begin at the source. The fiscal deficit must be treated as the root of the sovereign-bank loop. The state cannot keep asking banks to absorb its borrowing while also expecting them to finance private growth.

Debt management also matters. Pakistan should reduce reliance on short-term domestic borrowing, lengthen maturities, and diversify through sukuk, non-bank investors and external local-currency instruments. The debut Panda bond, issued in May, raised RMB1.75 billion (about $250 million) within a larger $1 billion programme. It was oversubscribed more than five times and priced at a 2.5% coupon, showing that alternative external local-currency financing can reduce pressure on domestic borrowing. It is small, but it points toward diversification. The recent T-bill auction shows the opposite pressure at home: the state is still paying more to keep domestic money inside government paper, while private borrowers remain crowded out.

Banks are simply responding to incentives. What needs to change are the incentives themselves, so that financing a new firm, an exporter, an SME or a manufacturer becomes as rewarding as financing the state. A rising PSX is welcome, but a stronger economy would show up when the market celebrates productive risk as much as fiscal intermediation.