Tax Fueled Lending Reversal, Pakistan Banking Sector Struggles with Credit Flow

The government’s bold move to impose a hefty tax of up to 15% on banks with an advance-to-deposit ratio (ADR) under 50% by December 31, 2024, has sparked a dramatic reversal in private-sector borrowing trends. What initially fueled a sharp surge in borrowing, driven by the fear of the tax, is now rapidly unwinding as banks have already met the new ADR requirement.

The numbers tell the story: conventional banks have seen their lending to the private sector plummet from a staggering Rs722.6 billion on January 17 to just Rs325 billion by month-end.

Meanwhile, Islamic banks experienced a similar decline, with lending dropping from Rs625.5 billion to Rs559.5 billion during the same period. In contrast, Islamic branches of conventional banks managed to slightly boost their lending by Rs23.5 billion, bringing their total to Rs73.5 billion.

Experts had previously linked the rise in credit flows to a drastic reduction in the policy rate, which plummeted by 1,000 basis points from 22% in June 2024 to just 12%. But the sharp decline in private-sector credit outflows is now challenging the idea that merely lowering interest rates would be enough to drive borrowing.