Bank domination

PAKISTAN’S financial system is heavily bank-centric. Commercial banks account for over 80 per cent of total financial-sector assets. In a ma­­t­u­­re financial system, household and corporate savings flow through multiple competing channels — capital markets, pension funds, insurance companies, asset managers and private equity. But in Pakistan, many of the institutions that should compete with banks are themselves economically and financially connected to them. What appears to be institutional diversity is, to a large extent, concentration masquerading as diversification.

Banks dominate for many reasons. They possess advantages their competitors cannot easily replicate: large capital bases, extensive branch and distribution networks, long-standing ties with government, customer trust built through decades of deposit-taking, and access to millions of small deposits through everyday transaction accounts. This gives them balance-sheet strength, scale and a low-cost funding advantage. Their established relationships with borrowers, ability to demand collateral and capacity to monitor credit also make them natural intermediaries. These advantages are barriers to entry for competing financial institutions.

But the most important explanation is the government’s persistent financing needs. Commercial banks have become the easiest channel through which government finances its fiscal deficit. Today, some 62pc of banking assets comprise government securities, while lending to the private sector accounts for a mere 22pc. Banks have become primary financiers of the state rather than intermediaries channelling savings into productive private investment.

The incentives are obvious. Government securities offer double-digit, effectively risk-free retu­rns. Lending to private businesses requires assessment of credit risk, documentation, collateral, monitoring. Why create capability to underwrite bonds, financial instruments or support new equi­­ty listings when there is an attractive return on financing government with little effort? As long as government continues to rely on banks to finance its deficit, banks will remain the dominant and highly profitable powerhouses in the financial architecture. The state reinforces this dominance. It borrows heavily from banks, operates National Savings, owns financial institutions, influences development finance, etc. An independent financial institution is not only competing against banks, it is competing against the state itself.

Commercial banks have become the easiest channel through which government finances its fiscal deficit.

The weakness of capital markets reinforces this structure. Stock-market participation is low — account holders represent less than 0.5pc of the population. Households prefer cash, bank deposits, real estate and physical gold, reflecting limited financial literacy as well as a historical mistrust of market volatility.

Corporate sector listing on the PSX or issuing corporate bonds requires compliance of SECP regulations involving extensive disclosure, auditing, corporate-governance requirements, credit ratings, which is time-consuming and expensive. Corporate debt consequently accounts for less than 3pc of Pakistan’s debt market. For most businesses, borrowing from a bank is faster and easier — secured through a bilateral relationship with a banker — than raising capital from the market. For large corporates that tend to be family-controlled businesses there is little incentive to list. A bank loan only requires a discussion with a bank official, while listing also brings exposure to tax and regulatory authorities. Retained earnings and bank borrowing therefore remain the preferred sources of corporate finance.

Institutional investors that could provide an alternative source of long-term capital are underdeveloped. Pakistan lacks a mandatory, broad-based pension system. Existing pension arrangements revolve largely around government employees and are predominantly unfunded and pay-as-you-go. Pension and insurance assets therefore remain minuscule relative to GDP. Investment restrictions further constrain them, with public-sector pension and insurance institutions required to place much of their funds in government securities or bank deposits.

Pakistan’s regulators have been reasonably successful in ensuring that banks remain solvent, liquid and systemically safe. But the same regulatory architecture has not succeeded in creating institutions capable of competing with them.

Large capital requirements may be justified for institutions taking substantial risks with other people’s money. But applying requirements designed for banks to specialist institutions creates prohibitive fixed costs. Mutual funds illustrate the problem. Non-bank financial institutions (NBFIs) are legally prohibited from taking demand or retail deposits. They must, instead, persuade savers to voluntarily invest with them or raise capital through equity or borrow from banks at commercial interest rates.

Products connecting banking and capital markets require clearances from both SBP and SECP, creating regulatory silos and slowing innovation in financial products. A process intended to protect consumers can, if poorly crafted, protect incumbents instead. Good regulation must distinguish between prudential requirements that protect customers and systemic stability, and high fixed regulatory costs that prevent new institutions from entering the market. Also, SBP’s discount window and emergency liquidity facilities are exclusively available to banks, while NBFIs operate within a fragmented and evolving framework without comparable institutional support. Banking regulation has enjoyed greater stability and predictability over decades, whereas the regulatory framework for NBFIs has been repeatedly redrafted.

Unsurprisingly, banks have responded rationally. Rather than compete with NBFIs, they have established or acquired them. The largest asset-management companies and mutual funds are not extensions of the bank’s balance sheet, they are overwhelmingly owned or controlled by banks. Their apparent independence hides their integration into the banking system. These institutions will, in the absence of sufficiently deep corporate bond markets, take corporate or household savings, invest them in Treasury bills, government-sponsored Sukuks or bank deposits-instruments that already exist — and channel much of that money back into the banking system. Ownership, distribution, funding and investment decisions remain concentrated within the same financial groups.

Pakistan’s financial system is therefore bank-dominated not simply because banks are efficient or because savers prefer them. It is bank-dominated because the state’s financing needs, corporate structures and the regulatory architecture have prevented alternative channels of financial intermediation from acquiring scale and independence.

The challenge is not to license more NBFIs while leaving these structural incentives unscat­hed. We require a function-based, competitively neutral financial system in which regulation protects risks of financial activities rather than the institutional boundaries between banks and NBFIs. Until then, Pakistan will continue to have many financial institutions but essentially one dominant player in the financial system — the banks.

The writer is a former governor of the State Bank.

Published in Dawn, September 11th, 2026