The International Monetary Fund (IMF) has increased concerns about the “complex tripartite relationship” involving the federal government, commercial banks, and the State Bank of Pakistan (SBP). In its latest report, titled “2024 Article IV Consultation and Request for an Extended Arrangement under The Extended Fund Facility,” the IMF highlighted that Pakistan’s growing financial reliance on these 3 entities is damaging the economy. This tight relationship, known as the sovereign-bank nexus, could lead to policy conflicts, regulatory challenges, and instability in the financial system.
The IMF liquidity warning points to the fact that with limited access to external funding, the government has increasingly relied on domestic banks to cover its debt. As a result, banks now hold around 60% of their assets in government debt, which is three times higher than the average in other Emerging Market Economies.
This heavy government dependence on banks is difficult because it takes away resources from private sector lending, stifling private investment.
Moreover, with a limited base of depositors, commercial banks have been funding the government’s needs through liquidity provided by the SBP. This has led to further SBP liquidity risks, as banks prefer lending to the government instead of offering credit to private businesses.
The IMF notes that the balance sheets of the government, commercial banks, and the SBP have become highly connected, making the entire financial system vulnerable.
The IMF suggests several actions to lower this reliance. Addressing fiscal imbalances is essential to breaking the cycle of dependence between the government and banks. Better cash and debt management should guarantee that idle public sector funds are put to good use, while also balancing the banks’ interests and the government’s medium-term goals. Monitoring the health of the banking sector is also important, and authorities should prepare for potential risks in the system.
In the medium term, the IMF recommends addressing the structural challenges within the financial sector, including dealing with the informal economy and encouraging the development of the capital market to support the financial system.
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