Financing the state, starving growth

Three recent interventions have opened one of Pakistan’s most important economic debates. Shahid Kardar argues that banks dominate because alternative financial institutions have never acquired comparable scale.

Zafar Masud replies that banks operate on a very different playing field from their regional peers: an undocumented economy, excessive cash use and a sovereign that absorbs a large part of their balance sheets.

Nadeem Ul Haque goes further, arguing that a bank-based economy is not necessarily a growth economy. Read together, these positions expose something larger than a disagreement over whether bankers are lazy, protected or rational.

The central problem is the structure through which Pakistan mobilises savings, allocates credit and manages macroeconomic adjustment. It rewards financing the State more readily than financing economic transformation. It also encourages policymakers to treat symptoms—interest rates, exchange rates, import controls or temporary liquidity—as if they were substitutes for productivity, exports, investment and institutional reform.

Shahid Kardar’s numbers are stark. Commercial banks account for more than 80 percent of financial-sector assets. Around 62 percent of banking assets comprise government securities, while lending to the private sector is only about 22 percent. Corporate debt remains tiny and participation in the stock market is exceptionally narrow. What appears to be a diversified financial sector is still overwhelmingly bank-centred.

Zafar Masud is right, however, that these outcomes cannot simply be attributed to bankers’ preferences. Banks lend against information. Large parts of Pakistan’s economy remain undocumented; businesses conceal turnover; cash remains dominant; audited accounts are often unreliable; collateral substitutes for information.

Meanwhile, government offers banks enormous volumes of comparatively low-risk securities. Under such incentives, a banker choosing sovereign paper over a poorly documented enterprise is behaving rationally and prudently (sic).

Rational behaviour by individual institutions can nevertheless produce an irrational outcome for the economy. State Bank of Pakistan’s data show private-sector credit at only 8.7 percent of GDP in fiscal year (FY) ending on June 30, 2025. The advances-to-deposits ratio fell to 36.3 percent as deposits grew faster than advances and banks remained heavily invested in government securities.

‘Pakistan Economic Survey 2025-26’ records investment at only 14.38 percent of GDP and national savings at 14.13 percent. Real GDP growth recovered to 3.7 percent, but these ratios are far too low for sustained structural transformation. This is the real issue: Pakistan does not merely suffer from inadequate finance; it suffers from misdirected finance.

Citizens place savings in banks. Banks lend heavily to government. Government services its obligations through taxation and further borrowing. Productive businesses then confront expensive credit, short maturities, collateral demands and weak access to equity. The system intermediates savings, but too often towards fiscal consumption rather than future productive capacity.

Nadeem Ul Haque’s separate intervention on the language of ‘devaluation’ helps explain why the same intellectual problem appears in macroeconomic policy. He argues that Pakistan continues to speak as if the exchange rate were an administrative knob to be turned by government, whereas under a flexible system it is largely an endogenous price reflecting inflation, productivity, external balances, reserves, capital flows and expectations. Suppressing the rupee may temporarily change the displayed number; it does not repair the underlying economy.

This insight is at the centre of the banking debate. A weak rupee and weak private investment are not independent accidents. Both reflect low productivity, narrow exports, fiscal dominance, exorbitant tax rates, inadequate savings, poor governance and shallow financial markets. Pakistan repeatedly tries to stabilise the exchange rate without reforming the economy that determines it, just as it tries to stimulate growth without reforming the financial structure that determines where savings go.

An overvalued currency can subsidise imports and punish exporters; an abrupt correction can raise inflation and debt-servicing costs. Neither outcome creates productivity. Competitive exchange rates become durable only when accompanied by fiscal discipline, export expansion, lower regulatory costs, reliable energy, better logistics and rising productivity. Similarly, lower policy rates alone cannot create investment where government pre-empts bank balance sheets and entrepreneurs lack access to risk capital.

That is why Nadeem Ul Haque’s argument for financial diversity is persuasive. A young economy needs more than bank credit. It needs corporate bonds, independent asset managers, pension funds, venture capital, private equity, credit unions, cooperatives and functioning equity markets. Debt naturally favours established borrowers with collateral. Equity and risk-sharing finance can support ideas, innovation and first-generation entrepreneurs whose principal asset is future productivity rather than inherited property.

Digitisation can help. Zafar Masud correctly points to the transaction trails being created through Raast, 1Link and formal payment systems. Used with appropriate privacy safeguards, digital histories can make previously invisible borrowers assessable through cash flows rather than land or buildings but digitalisation improves information available to finance; it does not by itself create competing sources of capital.

The debate also has immediate importance because Pakistan is constitutionally committed to eliminate riba completely before January 1, 2028. That transition can either become an opportunity to redesign financial intermediation or degenerate into relabelling. If conventional government securities merely become economically equivalent to Sukuk, if banks’ balance sheets remain dominated by sovereign financing and if guaranteed returns survive behind altered contractual forms.

Our recent series on reconstruction of a just financial order argued for a wider approach. Transaction money should be distinguished from investment capital. Productive finance should be linked with ownership, trade, leasing, enterprise and genuine risk.

Cooperative finance can mobilise community savings. Capital markets should provide long-term and risk-bearing funds. Bait-ul-Maal, public waqf and qarz-i-hasana should address social needs that should never become opportunities for financial extraction.

None of this can succeed unless government reduces its own appetite for national savings. Fiscal dominance is the common thread running through the Shahid Kardar-Zafar Masud-Nadeem Ul Haque debate.

A State perpetually seeking finance will shape the entire financial system around that requirement. Banks will buy its paper, pension funds will hold its securities, Islamic institutions will structure Sukuk around public borrowing and monetary policy will remain preoccupied with managing the consequences.

The policy response should be structural. Government securities should be accessible directly to households and genuinely independent institutional investors. Corporate debt markets must be made cheaper and simpler without sacrificing disclosure.

Equity financing should receive tax neutrality with debt. Bank ownership of ostensibly competing financial institutions deserves competition scrutiny. Cooperative and regional institutions should be encouraged under proportionate regulation. Most importantly, fiscal reform must release financial capacity for the private economy.

Pakistan also needs to abandon the comforting belief that exchange-rate management can compensate for these failures. The rupee is ultimately a messenger. If productivity stagnates, exports remain narrow, fiscal deficits persist and investment stays weak, no administratively preferred exchange rate can permanently conceal the imbalance.

The same is true of banking: profitable and well-capitalised banks cannot by themselves constitute a growth-oriented financial system.

The present debate should not end with deciding whether Shahid Kardar, Zafar Masud or Nadeem Ul Haque is right. Shahid Kardar is right about concentration. Zafar Masud is right about the field on which banks operate. Nadeem Ul Haque is right that the field itself has been designed badly for growth—and that manipulating visible prices cannot substitute for changing fundamentals.

Pakistan’s test is simple. Do national savings finance greater productive capacity, exports, entrepreneurship, technological change and employment, or do they continue circulating principally between depositors, banks and government? Until that answer changes, periodic exchange-rate crises will remain mirrors of the same structural weakness. Pakistan may have profitable banks and temporary stabilisation. It will still lack a financial system capable of underwriting sustained growth.

Copyright Business Recorder, 2026