02-07-2025
- Business
- Business Recorder
Why doesn't credit flow?
It is often suggested that Pakistan's credit problem is a policy oversight, a bug in the system; a legacy issue. Anything but, what it actually is: the intended outcome of a financial architecture built to say no.
Across Pakistan, small businesses without land, or a name that do not already signal comfort to lenders, are routinely excluded from formal credit channels. Not because they are unviable, but because they are invisible. Pakistan's credit market is not broken; it is functioning exactly as designed. Risk averse, asset-obsessed, and allergic to novelty.
Consider the numbers most often overlooked: Small and Medium Enterprises (SMEs) account for roughly 40 percent of the GDP and 78 percent of non-agricultural employment in Pakistan. Yet they receive less than 7 percent of private sector credit. The unmet credit demand for SMEs is estimated at over Rs 1.7 trillion.
This is not merely a gap. It is deliberate exclusion, crafted under rules that reward financial institutions to avoid complexity; and guarded by a regulatory framework that penalizes risk-taking more than complacency.
Within Pakistan's banking system, collateral has become the entire underwriting process. SMEs are not assessed on cash flow or operational viability. They are judged on their ability to mortgage a building. This makes sense only if you believe that every growth enterprise starts with inherited property. Banks finance land, not commercial viability. Ironically, many of these small enterprises are profitable, with better margins than large corporates. But good ideas, strong margins, and resilient cash cycles do not weigh much in a credit committee meeting if the borrower lacks fixed assets or a recognizable name that banks already trust, regardless of the business's fundamentals or cash flows.
And; then there is refinance, the usual policy analgesic for credit policy headaches.
In the past, whenever SME targets were missed or when signals of policy support were needed, the central bank would open a refinance window. Unfortunately, lending under refinance schemes only injects cheap liquidity into the system. At worst, it becomes an accounting trick to show off credit expansion without altering risk behavior. Banks lend more to those they already lend but Just cheaper.
Under the legacy design of SBP refinance schemes, banks received 100 percent of the loan liquidity from the central bank yet retained full credit risk on their books. This created a regulatory asymmetry: while the risk-weighted asset (RWA) treatment remained unchanged, as banks had to still provision against potential default, the effective exposure under Regulation R-1 (which governs single and group obligor limits) was substantially reduced, as refinance loans often benefited from concessional treatment.
In effect, loans made under refinance carried concessional exposure weightings, or even excluded entirely, allowing banks to lend far more to those already 'banked' clients than would have been permissible had they relied solely on their own funding. By design, then, these schemes did not mitigate credit risk; they only amplified the incentive to deepen exposures to clients already deemed credit worthy, rather than diversify or expand credit access to new borrowers.
The risky borrower, the one who needs liquidity support the most, stayed out again.
This is where the distinction between liquidity and risk becomes critical. Liquidity can be manufactured. Risk tolerance cannot. Banks are not irrational; they are simply responding to incentives. Capital adequacy rules, provisioning requirements, credit rating downgrades, all scream: do not touch anything without collateral or history. That is why banks are deeply rational in being risk-averse, even if that rationality results in collective stagnation.
The solution is to start pricing risk differently. Not ignoring it. Not subsidizing it blindly, but sharing it. That is what a credit guarantee does when it is done properly. It does not eliminate risk; it redistributes it. In fact, well-designed guarantee schemes offer far more accountability than refinance schemes because the guarantee has to be called. It is real money, tied to real performance, governed by real contracts.
Globally, credit guarantees are not exotic. They are institutionalized. In Jordan, for example, credit guarantees enabled the financial sector to support over 270,000 SMEs, while maintaining low default rates and driving credit graduation. In Turkey, Korea, and Colombia, similar models have been central to expanding formal finance without moral hazard.
And now, quietly but credibly, Pakistan has its own such institution: a dedicated credit guarantee company with a long-term AAA rating from PACRA, one of fewer than a dozen financial institutions in the country to receive this distinction. And to be clear: this is not a token gesture. Under SBP's Prudential Regulation R-1 (Clause 1.C), guarantees issued by highly rated institutions are recognized for capital deduction up to 85 percent. AAA rated guarantees reduce regulatory charges for banks, enabling real relief, not just reputational comfort.
Credit guarantees are not your usual policy stunt. They are neither a time-bound political scheme nor a subsidy designed to support favored industrial segments. They are permanent institutional instruments designed to absorb credit risk so that banks do not have to take blind leaps into unfamiliar markets. Guarantees typically cover 40 to 60 percent of the principal. That gives lenders enough comfort to enter unfamiliar segments without letting go of underwriting discipline. No lender is bailed out. But no viable borrower is locked out either.
Most importantly, credit guarantees are not meant to permanently carry the risk for banks. They are structured as risk-familiarization instruments, transition tools, not crutches. The explicit mandate of credit guarantees is to enable lenders to enter high-risk segments with partial comfort, develop credit track records and repayment behavior, and then gradually taper off that risk coverage over time. As lenders build comfort through data, repayment experience, and credit history, the guarantees shall exit and migrate to the next underserved market. They do not exist to underwrite inertia but to create momentum and then move on.
This institutional framework reflects real capital, real governance, enforceable obligations, and audited recovery mechanisms. The institution's equity base of Rs 7.3 billion is eligible for multiple rounds of leverage under NBFC rules. That means one rupee of guarantee capital can support several rupees of private lending. Not donor grants. Not headline schemes but actual lending to real businesses.
Crucially, it does not distort loan pricing. It does not override credit policies. It does not create artificial incentives. What it does is offer lenders a reason to say yes, when every rule in the book pushes them to say no.
Of course, it is still new and still being tested. And like every reform-minded initiative, it remains vulnerable to mission creep, bureaucratic interference, and political repurposing. But the architecture is sound. The math works. And the logic is unassailable: credit will not flow until risk is shared.
This calls for a shift in framing. Rather than asking why banks avoid SME lending, the more important question to ask is: why does the system penalize institutions that attempt it? The answer likely lies not in cheaper liquidity, but in institutional mechanisms that enable confident, risk-informed lending.
And if that confidence must be underwritten by public capital, then let it be underwritten well.
Copyright Business Recorder, 2025
