Every few months a chart makes the rounds.  It shows bank credit to the private sector as a share of GDP: Pakistan at about 11%, Sri Lanka at 30%, Bangladesh at 34%, India at 44%, Vietnam at around 125%. The verdict comes before the evidence. Pakistani banks, we are told, are lazy, rent-seeking and risk-averse. They park depositors' money in treasury bills and leave the farmer, the shopkeeper, the homebuyer, and the exporter to fend for themselves.

The regional chart compares outcomes but says nothing about the conditions under which they were produced.  A 100-metre time tells you very little if one runner was on a track and the other in sand.

So this piece asks a different question: how much of the gap is the banks, and how much is the field they are made to play on?  Put in numbers, how much of the 33-point gap with India is explained by the environment, and how much is left over?  The answer, worked through below with the arithmetic shown, is that all but about two points of it is environmental.  The residual — small enterprises and low-cost housing — is where policy should be aimed.

A counterfactual, not a complaint

The method is a simple thought experiment.  Take India's and Bangladesh's actual lending ratios and recalculate them as if both countries operated under three structural constraints Pakistan lives with every day: a cash-heavy money supply, a half-documented economy, and a sovereign that, having no other option, pre-empts more than half of the banking system's balance sheet. 

This is proportional scaling on sourced inputs, deliberately kept simple.  It is not an econometric model and captures no second-order effects.  It is an order-of-magnitude answer to a fair question — and, as I will argue, its simplicity works against my own case rather than for it.  SME and housing, already on the radar of the government, the central bank, the banks, and the other stakeholders, have shown significant progress in recent months; but there is still a long walk ahead.

Constraint one: cash is deposits foregone

Deposits are the raw material of lending.  Every rupee under a mattress or in a shop till is a rupee no bank can lend.  In Pakistan, Rs 11.9 trillion of currency circulates outside the banking system — about 28% of broad money, a ratio otherwise seen mainly in conflict economies.  In India and Bangladesh the share is around 13%, and adjusting this to Pakistan’s level shrinks the deposit base by 72 over 87, a factor of 0.83.  A sixth of lending capacity is gone before a single credit decision has been made.

Constraint two: banks lend against income they can see

Banks lend against evidence of repayment capacity: tax returns, filed accounts, transaction trails.  In Pakistan, more than half of GDP pays little or no tax and is, for practical purposes, invisible to the credit system.  The World Bank's informality estimates put informal output at about 18% of GDP in India and 30% in Bangladesh — documented economies of roughly 82% and 70%.  Shrinking each to Pakistan's 50% applies a factor of 0.61 to India and 0.71 to Bangladesh.  This is the largest single adjustment, and rightly so: documentation is the precondition for lending at all.

Constraint three: the sovereign eats first

The third constraint is the one bankers are most often blamed for, and the one over which they have the least control.  Pakistan's government finances more than 90% of its fiscal deficit domestically, and government securities now absorb about 55% of banking assets.  The IMF, counting all sovereign exposure, puts the figure at close to 60% — the highest in the world and roughly four times the global median.  This is not a preference; it is a consequence.  When the state must borrow and the only deep pool of domestic savings is the banking system, banks will hold government paper whether they want to or not.  Imagine, hypothetically, that the banks decided to stop financing the government's deficit in order to divert the balance sheet to the private sector.  What would happen?  The sovereign would default on its commitments, and there would be precious little private sector left to lend to.

In........

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