Karachi, December 13, 2024 – Banks in Pakistan are under significant pressure to meet Advance to Deposit Ratio (ADR) ratios and are now offering loans below market rates to address this challenge.
According to a research report by Insight Securities (Pvt) Limited, domestic banks have enjoyed robust profits over the past two years, driven by record-high interest rates and resilient asset quality. These factors enabled them to navigate macroeconomic challenges effectively. However, the faster-than-expected decline in inflation and subsequent reduction in the policy rate have put pressure on the sector’s Net Interest Margins (NIMs). Compounding this issue is the ADR tax, which has become a contentious topic between banks and regulators. While banks have challenged this tax in courts and secured stay orders, it continues to be levied on their balance sheets. To meet ADR targets, banks have resorted to strategies such as shedding high-cost deposits and offering loans at below-market rates, leading to market distortions rather than promoting meaningful private sector lending.
The trend is evident in the surge in advances, particularly after September 2024, which coincided with lower interest rates and a degree of economic stability. However, a significant portion of this increase appears to stem from banks’ efforts to meet year-end ADR requirements. This is further corroborated by declining deposit volumes during the same period. Such taxation measures fail to generate substantial revenue for the government or stimulate private sector growth effectively.
The formation of a committee, led by Deputy Prime Minister and Foreign Minister Ishaq Dar, underscores the importance of resolving these issues. The committee’s mandate includes reviewing the legal framework for fiscal measures related to ADR, exploring alternative taxation schemes on bank profits from government securities, and collaborating with the banking sector and the Federal Board of Revenue (FBR) to develop consensus-driven solutions.
Approximately 70% of the banking sector’s profitability is derived from government securities. Any changes in taxation on this front are likely to erode profitability further. Insight Securities suggests shifting from a year-end ADR threshold to an average basis, which would encourage systematic private sector credit flow. This approach would allow banks to base lending on strategic and risk considerations rather than year-end compliance efforts.
Tax collection challenges remain critical, especially under the IMF program where revenue targets are stringent. In this context, the government might consider directly increasing the tax rate on the banking sector, given its reliance on income from government securities. According to estimates, a 10% additional tax could reduce the sector’s profitability by approximately 19%, highlighting the delicate balance required in addressing fiscal and economic goals
