Since the 2008 global financial crisis, countries around the world have worked hard to strengthen their financial regulations to better withstand future economic shocks. Pakistan, despite facing its own economic hurdles, has managed to protect its financial system from the worst of global turmoil, thanks to timely reforms led by the State Bank of Pakistan (SBP). These efforts, aimed at both stability and innovation, have made Pakistan’s banking sector stronger. However, the country still faces challenges in finding the right balance between keeping the system stable and embracing modernization to stay competitive on the global stage.
After the crisis, major economies like the United States, the United Kingdom, and the European Union implemented stricter regulations. The U.S., for instance, introduced the Dodd-Frank Wall Street Reform, with stress tests and higher capital requirements, while the European Union adopted Basel III rules to make their banks more resilient. Pakistan took inspiration from these reforms but applied them in a way that fits its own needs. For example, while Europe adopted a 7% capital adequacy ratio, Pakistan’s banking sector surpassed this, reaching 18% in 2023, showing its cautious and proactive approach to avoid crises. By tailoring global standards to its local realities, Pakistan has managed to strike a careful balance between regulation and growth.
Emerging economies like India and Brazil have also taken steps to clean up their banking systems. In India, the Reserve Bank focused on reducing bad loans and improving asset quality. In comparison, Pakistan still has a long way to go with its own non-performing loans (NPLs). As of 2023, more than PKR 1 trillion in bad loans were still unresolved, putting a strain on the financial sector’s efficiency. Looking at how India managed to address similar issues, Pakistan could benefit from adopting some of their strategies to improve its banking system and boost competitiveness.
Pakistan’s financial reforms began back in the 1990s, focusing on privatizing state-owned banks, deregulating interest rates, and encouraging foreign investment. Over the years, this led to a banking sector that is now a cornerstone of the financial system, with total deposits exceeding PKR 25 trillion as of 2023. Foreign investment and ownership have added to its competitiveness and global reach. But unlike countries like the U.S. or China, where capital markets play a huge role in financing, Pakistan still heavily relies on bank lending. While this reliance has shielded Pakistan from global financial shocks, the country’s underdeveloped capital markets accounting for less than 20% of GDP in 2023 limit its ability to innovate and diversify.
Pakistan has also made significant strides in Islamic banking, similar to what we see in Malaysia and Indonesia. As of 2023, Islamic banks in Pakistan held over PKR 5 trillion in assets, representing more than 20% of the country’s banking sector. The SBP has actively supported the development of Sharia-compliant financial products, positioning Pakistan as a regional leader in Islamic finance. This focus on Islamic banking not only caters to local needs but also drives innovation and growth in the sector, much like the path Malaysia has taken.
On the issue of financial inclusion, Pakistan has made impressive progress. Taking inspiration from Kenya’s M-Pesa mobile banking revolution, Pakistan’s digital financial ecosystem has grown rapidly. Between 2021 and 2023, mobile banking transactions surged by 56%, reaching PKR 5 trillion. The number of active mobile wallets also jumped to over 50 million, bringing banking services to millions who were previously underserved. This mirrors similar success stories in countries like Bangladesh, where microfinance has played a key role in expanding access to financial services. By pushing digital banking and microfinance, Pakistan is working to bridge the urban-rural divide.
However, significant challenges still loom. The government’s heavy borrowing from domestic banks to finance its budget deficits similar to issues seen in Greece and Italy has limited credit available for the private sector. In 2023, government borrowing made up nearly 30% of the total banking sector’s assets, squeezing out private investment. Pakistan’s fiscal imbalance is made worse by inefficiencies in its legal system, particularly the slow resolution of banking disputes, which weakens creditor rights and complicates loan recovery. The legal backlog has left over PKR 1 trillion in non-performing loans unresolved. Countries like India have improved their situation with legal reforms such as the Insolvency and Bankruptcy Code, and Pakistan could take notes from these reforms to speed up loan recovery and strengthen its banking sector.
To strengthen Pakistan’s financial system and keep up with global trends, several key areas need attention. Reducing the government’s reliance on borrowing from domestic banks is critical to freeing up credit for the private sector. Countries like South Korea and China have shown how developing capital markets can provide an alternative source of financing, and Pakistan should consider similar paths. Reforms in the legal system, aimed at quicker resolution of disputes and better creditor protection, are also essential. Examples from Brazil and India show how such reforms can improve efficiency and boost investor confidence. Encouraging innovation, particularly through non-bank financial institutions, fintech, and Islamic finance, will further diversify the financial system and help drive economic growth.
In conclusion, Pakistan’s financial regulatory framework has proven to be resilient, helping the country navigate through global financial instability. The SBP’s cautious but forward-thinking approach has successfully maintained stability while encouraging innovation in key areas like Islamic banking and mobile financial services. Yet, the challenges of fiscal imbalance, legal inefficiencies, and underdeveloped capital markets still hold the system back. By learning from global experiences and applying these lessons locally, Pakistan can continue to strengthen its financial sector and support long-term economic growth.
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