The sovereign-bank nexus and its pitfalls

Every few days there is a lament in newspapers and on TV that the cash economy must be killed, and that Pakistanis hold more cash than desired.

There is a part of the cash story that gets remarkably little attention: Pakistan has spent decades protecting and feeding banks while doing far too little to develop finance. The distinction matters. Banking is not the same thing as financial development. A developed financial system connects savers with entrepreneurs, finances mortgages and consumer credit, discovers new businesses, deepens bond and equity markets, and gives households a real menu of financial assets. Pakistan instead has built an extraordinarily comfortable relationship between government and commercial banks.

The IMF’s numbers are stark.

• By 2023, Pakistani banks’ exposure to government had increased to about 60 percent of assets — more than three times the emerging-market average, and about three times their exposure to the private sector.

• The Fund describes treasury operations as having become profit centers for banks: government securities require no underwriting of a private borrower’s risk, and they double as collateral for liquidity from the State Bank.

Think about what that does to incentives. Why search for a promising young entrepreneur? Why build expertise in small-business lending? Why evaluate a new factory, a technology firm, an exporter? Why compete hard for millions of small depositors? Government is standing there, borrowing enormous sums, every week. The IMF reaches the same conclusion from a different angle: the system has provided too little incentive to attract depositors, with some banks drifting toward current accounts and Islamic deposit products that require paying savers less — discouraging exactly the small savers a shallow, under-penetrated banking system needs. This is not financial development. It is a sovereign-bank nexus in which government deficits sustain bank profitability while private finance stays shallow. Then we act surprised that Pakistanis keep cash.

It’s worth pausing on what a deposit actually is. It is a depositor’s money, held in trust — not a banker’s capital to deploy as he pleases. When banks park the bulk of it in one instrument, sovereign paper, because it is comfortable and riskless for them, they are making a portfolio decision with other people’s savings, not their own. A depositor who wanted all his money in government bonds could buy them directly. He put it in a bank instead, presumably expecting the bank to do something more useful with it. Fiscal dominance has quietly converted the banking system from a manager of other people’s risk into a passive conduit for the sovereigns, and the depositor has had no say in the trade.

Where are the customers?

Here is perhaps the most striking statistic in this entire debate. The World Bank’s Global Findex 2025 survey put Pakistan’s adult population (15 and above) at 155.8 million in 2024. Of these, 113.3 million had no account — roughly 73 percent of Pakistani adults unbanked, by the most current comparable measure. Pakistan is one of just eight countries — with Bangladesh, China, Egypt, India, Indonesia, Mexico and Nigeria — that together hold more than half the world’s 1.3 billion unbanked adults. Read that first number again: 113 million people.

In an economy where nearly three-quarters of adults lack an account, treating the persistence of cash as a mystery gets the causality backwards. Where are these people supposed to put their money? How is a domestic worker paid? How does a daily-wage labourer receive wages, or a farmhand pay another farmhand, when neither has an account? Cash isn’t an ideological preference here. It’s infrastructure — arguably the country’s most functional payment system, filling a gap the formal one has left open for decades.

Try opening and keeping an account

There is also a gap between possessing an account and having a useful banking relationship. Opening one can require identification, biometric verification, employment and income details, and ongoing customer due diligence. These safeguards serve real purposes — Pakistan must meet anti-money-laundering and counter-terrorist-financing standards. But regulation has costs too, and SBP itself seems to know it: its 2025 Consolidated Customer On-boarding Framework was explicitly designed to streamline account opening and improve customer experience, which only makes sense if the existing process needed streamlining.

It’s worth being precise rather than overstating the case: banks do not have an unrestricted right to simply close a customer’s account. SBP rules constrain how accounts are handled, and current regulation requires banks to notify a customer when an account is blocked and to explain how it can be regularized. But that correction doesn’t weaken the argument — it sharpens it.

The everyday reality is that a depositor can be asked, repeatedly, to re-establish identity, source of income, and the purpose of a transaction; dormant accounts can have debit transactions stopped until reactivated; accounts lacking updated documentation can be blocked from withdrawal until requirements are met. For a salaried professional this is an occasional nuisance. For someone with irregular income, incomplete paperwork, or limited ability to navigate bureaucracy, it can tip the balance entirely. Cash never asks for another document. It doesn’t ask why you moved Rs 200,000. It doesn’t go dormant, and it never needs reactivating.

Then try getting credit

The paradox deepens the moment a customer asks the system for something back. Credit cards are far from a mass-market instrument in Pakistan; income documentation, credit assessment, fees and financing charges keep most people out. Small businesses fare worse still. We have made it remarkably easy for government to borrow and remarkably hard for citizens and firms to do the same.

The IMF supplies the macro counterpart: Pakistani banks have long lagged regional peers in private-sector lending, and rising government borrowing has crowded private credit out further. Government occupies both sides of this problem at once — borrowing so heavily that its own paper becomes irresistible to banks, while regulation makes ordinary customer relationships compliance-intensive. Banks, quite rationally, have little reason to chase small depositors or risky private borrowers when the sovereign offers a vast, safe alternative. The result should surprise no one: government gets credit, banks get profit, large established firms get service, and millions of Pakistanis get cash.

Stop blaming the Rs 5,000 note

This is why the fixation on the Rs 5,000 note is so misplaced. At roughly Rs 280 to the dollar that note is worth about USD 18. Eliminating it eliminates nothing — a legitimate Rs 1 million cash payment simply needs a thousand Rs 1,000 notes instead of two hundred Rs 5,000 ones. We would not have built financial development. We would have required bigger bags. Cash can certainly facilitate evasion and concealment — that isn’t in dispute — but policymakers must separate the criminal demand for anonymity from the entirely rational demand for a transaction medium that actually works where 113 million adults have no account.

Develop finance, not just banking

Pakistan needs to rethink what financial reform means. The goal is not more banks, and certainly not more government borrowing from them. Government should shrink its enormous absorption of banking resources and let banks rediscover their real function: managing other people’s risk, not recycling their deposits into the safest trade available. Deposit competition should rise; opening a basic account should be nearly effortless; compliance should scale with actual risk rather than blanket suspicion; customers should have clear rights and fast appeal when access is restricted.

Nor should development be measured mainly by how much credit flows. Credit is one instrument for moving savings into productive use — useful, but narrow, and the wrong one to lean on exclusively for a young, growing economy that needs risk capital more than it needs more debt. Credit demands fixed repayment regardless of outcome and rewards collateral over ideas; it will always favour the established borrower over the new one.

What Pakistan actually lacks is the fuller menu: mortgages as an ordinary product, small-business lending that is genuinely competitive, deep corporate bond markets, an equity market broad enough to let a business raise capital by selling a share of its upside rather than pledging its assets, and pension and insurance funds supplying long-term capital instead of leaving government and a handful of banks at the center of nearly every financial relationship in the country. A saver who wants to share in a firm’s growth, not merely lend it money at fixed interest, currently has almost nowhere to do that in Pakistan. That absence is itself a form of underdevelopment, distinct from and prior to the credit gap everyone argues about.

The IMF’s description of Pakistan’s sovereign-bank nexus should be read as a warning, not a footnote. Pakistanis holding Rs 11 trillion outside the banking system are not behaving irrationally. They are making portfolio and transaction choices inside the financial system we built for them — one where their deposits get treated as free capital for a captive bond trade, and where no comparable instrument exists to let their savings back an idea rather than a government deficit. Cash is telling us something about our institutions. We should listen to it, rather than trying to legislate it away.

Copyright Business Recorder, 2026