Banking inertia

PRIME Minister Shehbaz Sharif’s latest call to banks to expand lending to SMEs is nothing new. Every government over the last three decades has made a similar appeal. Ambitious targets are announced, committees are formed and banks are urged to finance sectors that generate employment and exports. However, little changes.

No doubt, raising SME lending’s share of private sector credit from 7pc to 10pc within two years and increasing the number of SME borrowers from 310,000 to 750,000 under the new Access to Finance Plan initiative are worthwhile aims. But are the banks incentivised enough to make these goals a reality?

That question lies at the centre of the chronic financing gap for SMEs. Together, Pakistan’s estimated 5m SMEs contribute nearly 40pc of GDP, a quarter of exports and around 80pc of non-agricultural employment. But barely 300,000 businesses have access to formal bank credit.

Banks often explain this failure in terms of risk. Their arguments are not without merit. Most SMEs lack audited financial statements and reliable cash-flow records. Weak legal enforcement, lengthy recovery procedures and information asymmetry further increase the cost of lending. Cash-flow-based lending requires better data, specialised underwriting, digital monitoring and relationship banking. From a commercial perspective, these concerns are legitimate.

But risk alone does not explain their exceptionally poor performance. Banks also operate in an environment where lending to the government offers attractive, virtually risk-free returns. Investing deposits in government securities requires far less effort, incurs lower operational costs and generates predictable profits without the complexities linked to financing thousands of small borrowers. When institutions earn comfortably by financing the sovereign, the motivation to develop expertise in SME or agricultural lending vanishes.

This leads to a banking culture that is comfortable with easy profits and reluctant to undertake the painstaking work of expanding financial inclusion. Recent experience reinforces that concern. Despite subsidised federal and provincial lending schemes and State Bank first-loss guarantees that reduce default risks, most commercial banks have avoided financing SMEs and agriculture. This is true even though the few participating banks have shown that technology, alternative data and cash-flow-based lending can manage risks. Banks that still stay away appear driven by inertia and easy government profits.

The issue was discussed at the Pakistan Banks’ Association’s second Banking Summit recently, where policymakers, regulators and bankers conceded that the current pattern of credit allocation was unsustainable. The finance minister urged banks to direct more financing towards sectors that generate employment, exports and productivity. Without the growth of SMEs and other priority sectors, the economy cannot sustain expansion in the long term. In that case, banks will have fewer viable borrowers. A banking system will not indefinitely prosper by recycling deposits into government securities while neglecting productive enterprise.

Published in Dawn, July 13th, 2026 ...