The International Monetary Fund (IMF) has raised concerns about the close ties between the government, the central bank, and the banking sector. The IMF states that this interconnected relationship could have negative implications for the economy and the country’s financial sector. The IMF expressed worries that this nexus could result in conflicting policies, regulatory challenges, and a trade-off between debt and inflation.
In a special chapter of the IMF’s recent report on Pakistan’s approved $7 billion Extended Fund Facility (EFF), the IMF pointed out that the country’s banking sector holds a significant proportion of government securities compared to its total assets. The IMF highlighted that banks have been financing a substantial portion of their growing securities portfolios through short-term central bank liquidity, using bonds as collateral due to limited deposit growth.
The IMF also noted that persistent high fiscal deficits, combined with recent external shocks, have had significant implications for the relationship between the government and the banking sector in Pakistan. With limited access to external funding, the government debt has increasingly been absorbed by the banking sector, resulting in banks’ holdings of domestic government debt surging to around 60 per cent of their assets, which is more than three times the average for emerging market economies.
Furthermore, the IMF emphasized that the balance sheets of the government, commercial banks, and the central bank have become highly interconnected, with government credit crowding out private lending, affecting the strength of monetary policy transmission and potentially leading to concerns about public debt sustainability.
The report also highlighted that the State Bank of Pakistan (SBP) faces potential trade-offs in fulfilling its main functions, as it has a dual responsibility for managing liquidity in the financial system and playing a regulatory and supervisory role over the banking sector. The IMF warned that the systematic shortage of liquidity in the banking system should be carefully managed by the SBP.
In addition, the report pointed out that the current banking landscape in Pakistan provides little incentive to attract depositors, as they have ample liquidity from the central bank.
