Pakistani borrowers can now secure loans at interest rates far below the benchmark, as banks scramble to disburse approximately PKR 3.6 trillion ($128.5 billion) by the end of the year to avoid additional taxation.

This unusual scenario has developed as banks try to meet the required Gross Advances to Deposit Ratio (ADR) mandated by the government.

Currently, banks in Pakistan are offering loans at rates as low as 4%, which is 12% below the inter-bank rates. This aggressive rate slashing is driven by the necessity to meet a 50% ADR by December 2024 to avoid a hefty tax penalty.

If banks fail to reach this target, they face a 10% tax for an ADR between 40-50%, or a 16% additional tax if their ADR falls below 40%. The average ADR stood at 38.6% as of June 2024, with only 3 of the 19 listed banks meeting the required threshold.

This tax regulation, introduced in 2022 to stimulate business and lending activities, had been temporarily suspended in 2023. However, with the exemption now lifted, banks must increase their lending or face significant tax repercussions.

An analyst from Topline Securities reported, “Approximately PKR 3.6 trillion would be required to be disbursed by the listed banks in total to reach the target.”

The urgency of the situation is reflected in the recent financing activity of the Trading Corporation of Pakistan (TCP), which secured PKR 360 billion ($1.29 billion) in loans from banks at a rate 11.9% below the Karachi Interbank Offered Rate (KIBOR).

With KIBOR hovering around 16%, this translates to an effective interest rate of just 4% for the TCP.

Banks have traditionally been heavily invested in government securities, but the pressure to improve their ADR has pushed them to expand their lending activities.

The deposit base of Pakistani banks has also seen substantial growth, reaching PKR 31.1 trillion as of June 2024. Nevertheless, achieving the 50% ADR target remains a challenging task.

As an analyst from Arif Habib Limited observed, banks would need to either shrink their deposit base or significantly ramp up lending in a short timeframe to meet the requirement.

The effects of this aggressive lending strategy are already visible in the auto financing sector. Outstanding auto loans fell to PKR 227 billion in August 2024, down from a peak of PKR 368 billion in June 2022.

Banks are now offering fixed rates as low as 14-15%, compared to last year’s 20-24%, which is expected to boost market liquidity.

Additionally, the reduction in KIBOR by 140 basis points over the last week will lower interest expenses for leveraged listed companies, further enhancing cash flow within the economy.

Despite these efforts, analysts are skeptical about the banks’ ability to meet the stringent ADR targets. They caution that banks might end up provisioning for higher taxes if they fail to achieve the required advances.

On the flip side, if banks do meet the 50% target, the government could face a revenue shortfall of approximately PKR 157 billion, based on current estimates.

Reports suggest that some banks are exploring legal avenues to challenge the tax regulation. However, even if they secure a stay order, higher tax provisions will likely be recorded based on prudent accounting principles.

In conclusion, the race to disburse PKR 3.6 trillion highlights the challenges and strategic maneuvers of Pakistani banks as they navigate regulatory pressures. While the immediate impact may boost liquidity and reduce financing costs, the long-term implications for the banking sector and broader economy remain uncertain.