Banks do not grow faster than the economies they serve

Why Pakistan’s banking sector mirrors the country’s economic choices and how it can still become an engine of growth.

For much of modern economic history, banks have been seen as catalysts of economic growth. They mobilize savings, finance entrepreneurs, support innovation and connect capital with opportunity. Behind almost every industrial revolution, export miracle or technological breakthrough stands a financial system willing and able to transform deposits into productive investment.

Yet history tells a more nuanced story. Rarely do banks lead economies into prosperity on their own. More often, they reflect the economies they serve. Dynamic economies produce dynamic banks. Countries that industrialize, innovate and expand globally give rise to financial institutions that follow their companies across borders. Economies trapped in low growth, fiscal stress and policy uncertainty tend to produce defensive banks, more comfortable financing governments than enterprise. Banks, in other words, are less the architects of national destiny than its mirrors.

This distinction matters greatly for Pakistan. Commercial banks are often criticized for lending too much to the government, doing too little for private enterprise and failing to become regional or global institutions like those in the United States, Europe, China or India. There is truth in this criticism. But it is only part of the story. The deeper question is not why Pakistani banks did not become global or regional champions, it is why Pakistan did not produce the sustained economic expansion that naturally creates global banks.

The evolution of banking has always followed commerce. Renaissance Italian banks flourished because Venice, Florence and Genoa dominated Mediterranean trade. London’s financial institutions rose with Britain’s commercial and imperial power. American banks grew alongside American corporations. Chinese banks expanded as Chinese companies, infrastructure projects and supply chains spread across Asia, Africa and Europe. Indian banks increased their overseas presence as Indian technology, pharmaceutical and manufacturing firms became international.

Banks follow business. Business follows opportunity. Opportunity follows sound policy. Pakistan has struggled to complete this chain.

Since independence, Pakistan’s economy has experienced repeated bursts of promise interrupted by recurring crises, balance of payments pressure, fiscal deterioration, exchange rate instability, inflation and repeated recourse to international financial assistance. Chronic fiscal and current account deficits, Pakistan’s twin deficits have become structural features rather than temporary disruptions. These deficits have shaped not only economic policy but also the behaviour of banks.

When governments consistently spend more than they collect, they must borrow. In Pakistan, commercial banks have become major financiers of the sovereign. Treasury Bills and Pakistan Investment Bonds offer attractive, relatively low risk returns, especially when private sector lending is made difficult by weak enforcement, informality, volatility and uncertain policy direction. Faced with this choice, banks have behaved rationally.

The result is classic crowding out. Deposits that could finance factories, exporters, technology firms, farmers, housing and small businesses are increasingly absorbed by government borrowing. This is not simply a matter of banking preference; it is the logical outcome of Pakistan’s macroeconomic incentives.

The numbers tell the story. Pakistan’s banking system is well capitalized and profitable by regional standards. According to the State Bank of Pakistan, the sector’s capital adequacy ratio remains comfortably above regulatory requirements, while banking assets exceed Rs 60 trillion. Yet a large share of those assets sits in government securities rather than private sector credit. From a prudential standpoint, this is understandable. From a developmental standpoint, it raises serious questions about the allocation of scarce national savings.

Financial intermediation remains weak. Private sector credit as a share of GDP is modest. Mortgage finance is among the lowest in Asia. Small and medium sized enterprises, despite being central to employment, receive limited formal credit. Agriculture remains underfinanced relative to its importance. Venture capital and innovation finance are shallow. Many entrepreneurs still depend on retained earnings, family money or informal credit.

Banks deserve criticism for not doing more. They could have invested more aggressively in digital credit assessment, supply chain finance, SME lending, agricultural value chains, climate finance, Islamic finance and financial inclusion. They could have accepted more calculated risk in supporting emerging industries. But to blame banks alone is to confuse symptoms with causes.

Commercial banks operate within the incentives created by the wider economy. They cannot prudently lend at scale where legal enforcement is weak, contract recovery is slow, informality is widespread and macroeconomic volatility makes long-term planning hazardous. Nor can they ignore government securities when these offer attractive returns with minimal credit risk, especially for local rupee borrowings. Any banking system would respond similarly under comparable conditions. Pakistan’s banks also face one of the highest effective tax burdens in the country and perhaps globally, further affecting incentives.

To their credit, Pakistani banks have achieved something important, resilience. Despite repeated crises, political transitions, external shocks, and IMF programmes, the system has avoided a major collapse. Regulation has improved. Capital levels are stronger. Digital payments, branchless banking and mobile finance have expanded access for millions. These are real achievements.

The problem, therefore, is not that Pakistani banks have failed. It is that they have succeeded at survival without being given the macroeconomic environment required to become engines of transformation.

This becomes clearer when one looks at Pakistan’s corporate landscape. Global banks usually follow global companies. American banks followed American multinationals. Japanese banks followed Toyota, Sony and Mitsubishi. Chinese banks followed Huawei, Sinopec and Belt and Road infrastructure. Indian banks followed Tata, Reliance, Infosys, Wipro, Mahindra and other firms as they expanded worldwide.

Pakistan has produced talented entrepreneurs and an impressive diaspora, but few multinational companies headquartered at home. Outside textiles, cement, fertilizers and consumer goods, few Pakistani firms have built significant regional or global presence. Exports remain narrow and concentrated in relatively low value-added sectors. Participation in global value chains remains limited. As a result, Pakistani banks have had few domestic corporate champions requiring sophisticated cross-border finance, international cash management or global capital markets support.

It is difficult for banks to become international when the economy they serve remains largely domestic.

For decades, economic policy has been dominated by crisis management rather than transformation. Large portions of federal revenue are absorbed by debt servicing and other non-developmental expenditure, leaving limited space for education, healthcare, infrastructure, research and technological upgrading. This weakens long-term productivity while increasing dependence on borrowing. The consequences for banking are profound particularly when the sovereign becomes the largest borrower, private credit suffers.

Financial inclusion illustrates the paradox. Pakistan has made progress in digital wallets, branchless banking, Raast and fintech innovation. But payments have modernized faster than lending. True inclusion is not merely opening an account. It is whether families can obtain mortgages, farmers can invest in productivity, entrepreneurs can finance businesses and young innovators can turn ideas into companies.

Housing finance is a telling example. In many economies, mortgages are a major asset class and a foundation of household wealth. In Pakistan, home ownership still relies heavily on personal savings, family support and informal finance. SMEs face similar constraints with weak documentation, limited collateral, informality and slow legal recovery. Banks cannot ignore these risks, but Pakistan cannot afford an economy where its most dynamic businesses remain chronically underfinanced.

The comparison with India is instructive. Three decades ago, the gap between the two banking systems was far smaller. Since then, India has sustained higher growth, expanded its middle class, attracted investment, built globally competitive firms and integrated more deeply with the world economy. As corporate India expanded, Indian banks expanded with it. Their international presence was the consequence, not the cause, of national economic transformation. The lesson is simple, strong banks are built on strong economies. The sequence matters.

This does not absolve banks of responsibility. Pakistani banks must become more innovative partners in development. They should invest in AI-driven credit models, SME finance, green lending, agricultural modernization, export finance, venture debt, women’s financial inclusion and sustainable infrastructure. They must move beyond being efficient custodians of deposits.

But the greatest transformation must occur outside bank boardrooms.

If Pakistan sustains GDP growth of 6 to 8 per cent for the next two decades with low to moderate inflation, the operating environment for banks will change fundamentally. Higher growth will create stronger corporate balance sheets, larger household savings, better tax revenues, improved investor confidence and greater demand for private credit. Fiscal discipline will reduce government borrowing and allow banks to redirect capital toward businesses and households. Stable policies will lower risk premiums and lengthen investment horizons.

Under such conditions, banks will cease to be passive financiers of deficits. They will become financiers of national ambition.

That is the transformation Pakistan needs. Better governance with rule of law, stronger institutions, a broader tax base, export-led growth, judicial reform, energy-sector restructuring, investment in education and technology, and sustained macroeconomic stability will do more for banking than any isolated regulatory initiative.

Pakistan’s banks have shown that they can survive. The next challenge is to ensure they help the country thrive. In the end, banks do not grow faster than the economies they serve. But when an economy finally begins to run, banks become more than custodians of capital. They become the circulatory system through which national aspiration is transformed into enterprise, innovation and prosperity. That is the rightful role Pakistan’s banking sector can still play provided if Pakistan first builds the economy worthy of it.

Copyright Business Recorder, 2026