LocationsEnhancing Credit Access for Pakistan’s Private Sector
By Muhammad Abbas Taqi | Data & Analytics Officer, Development Policy Unit, UNDP Pakistan
The lack of private sector investment in Pakistan has hindered growth of small and medium enterprises, limiting broader economic diversification, innovation and job creation.
Introduction
Pakistan’s banking sector has undergone significant reform and modernization over the past two decades. Deregulation, privatization, and the development of a more competitive banking landscape have made Pakistan’s financial system more sophisticated, stable, and inclusive. Pakistan’s banking sector has demonstrated resilience in the face of significant macroeconomic challenges in the recent past. The sector recorded an impressive 90 percent growth in net profit despite double-digit inflation and soaring policy rates.1 However, despite relative stability in the banking sector, credit growth to businesses and the private sector has remained muted. This situation has stifled private sector investment, hindered the growth of Small and Medium Enterprises (SMEs), and limited broader economic diversification, innovation, job creation, and productivity for the country and its people.
Declining Private Sector Credit Growth
Pakistan’s private sector credit growth has significantly underperformed relative to historical trends and peer economies. According to data from the World Bank, domestic credit to the private sector as a percentage of GDP was only 12 percent in 2023, down from 15 percent in 2021 and 16 percent in 2019. In comparison, during the same period, Indian banks’ domestic credit to the private sector amounted to 50 percent of the GDP (2021), Bangladesh 40 percent, while the aggregate for South Asia stood at 46 percent. Pakistan’s stark slowdown is a major concern, as it suggests a structural issue in the financial system’s ability to support the private sector.
Factors Behind the Decline in Private Sector Credit Growth
1. Macroeconomic Instability (2018–20)
Macroeconomic instability has been the most significant factor driving the decline in private sector financing. Since 2018, Pakistan has faced recurring economic crises marked by high inflation, currency depreciation, fiscal imbalances, and persistent external debt challenges. These pressures have created a volatile business environment, prompting banks to adopt a cautious approach to lending. For instance, from 2019 to 2020, double-digit inflation and a sharp devaluation of the Pakistani rupee undermined consumer demand and created heightened uncertainty for businesses. The State Bank of Pakistan (SBP) raised interest rates to curb inflation, making borrowing prohibitively expensive for many enterprises. Consequently, banks redirected their focus toward government securities, which offered safer and more stable returns amid the economic turbulence. The COVID-19 pandemic compounded these issues by introducing structural challenges such as supply chain disruptions, decreased consumer spending, and a sharp contraction in export performance. These factors further eroded the creditworthiness of many businesses, particularly SMEs, causing lending to the private sector to slow significantly.
2. The Banking Sector’s Shift towards Government Debt
In recent years, banks have shifted their investments towards government-backed securities rather than private sector loans. With heightened economic uncertainty, rather than extending credit to businesses, many banks have found it more attractive to invest in low-risk government securities, including long-term options such as Sukuks and Pakistan Investment Bonds and shorter-term instruments such as the Treasury Bill. By 2024, 38.3 percent, around PKR 27.4 trillion, of the government’s total debt was with domestic banks’ portfolios2, concentrated in different government debt instruments. In comparison, emerging markets and developing economies, on average, had a much lower exposure of 16 percent to government debt.3 For Pakistan, this shift has led to a crowding out of private sector financing, particularly for long-term investment projects and growth-oriented ventures. Instead of supporting innovation and expansion, banks have prioritized safer, more liquid assets in response to domestic economic challenges and global financial pressures including rising commodity prices and tightened global monetary policy.
3. Challenges in the Small Medium Enterprise Financing Ecosystem
SMEs make up over 90 percent of businesses in Pakistan and employ a significant proportion of the workforce; they have long struggled with limited access to credit.4 The situation has worsened in recent years as banking practices have become more stringent, making it more difficult for small businesses to access financing. Banks have reinforced barriers by implementing rigid credit manuals and risk acceptance criteria requiring either substantial collateral or pre-existing borrowing relationships with other banks. This “you first” approach has created a cycle of inaction, where no bank takes meaningful steps to lend to SMEs because others do not. The data speaks volumes: between June 2019 and June 2024, lending to SMEs increased by a mere PKR 25 billion, compared to a staggering PKR 2.65 trillion increase in advances to corporate customers—a multiple of 106 times. Notably, PKR 700 billion of this corporate lending, or 26 percent, was concentrated in just the 10 largest exposures of the banking sector.5
This stagnation in SME credit cannot simply be attributed to historically high markup rates. Even during the COVID-19 pandemic, when the State Bank of Pakistan (SBP) extended refinance schemes to cushion the economic impact of lockdowns, lending to SMEs declined between June 2019 and June 2021. The introduction of the SME Asaan Finance Scheme in 2021–22, which aimed to incentivize lending through loss guarantees and credit risk-sharing mechanisms, yielded underwhelming results. SME credit grew by just 3 percent annually during this period, while corporate lending rose by 17 percent year-on-year.4
4. Impact of Global and Domestic Shocks
The global economic environment, including the aftermath of the COVID-19 pandemic, rising commodity prices, and geopolitical instability, has placed additional stress on Pakistan’s economy. Combined with the domestic fiscal deficit and inflationary pressures, these shocks have heightened the perceived risk for both domestic and international lenders, leading to further caution in extending credit to businesses. Furthermore, global capital outflows and the tightening of global monetary policy have made it more difficult for Pakistan to attract foreign investment, further limiting the available pool of financing for private sector enterprises.
Recommendations
The decline in private sector credit in Pakistan stems from a mix of macroeconomic instability, structural flaws in the financial system, and banks’ increasing preference for low-risk government securities. While the banking sector remains stable, its limited engagement with the private sector—especially SMEs—has stifled innovation, job creation, and broader socio-economic progress. This financing gap is more than a financial constraint; it’s a developmental bottleneck with serious implications for poverty reduction, resilience, and long-term prosperity. Encouragingly, initiatives like the SDGs Innovative Financing Challenge Cup, launched by UNDP in collaboration with JS Bank, offer a blueprint for change. By mobilizing a blended finance instrument of $0.27 million—combining a UNDP grant with a JS Bank loan—the program supported SDG-aligned, climate-resilient SME projects, attracting over 120 applicants and providing capacity-building to 30 shortlisted ventures. Such efforts demonstrate how targeted interventions, including credit guarantee schemes, blended finance models, and incentives for private banks, can unlock financing for the private sector and SMEs. Additionally, leveraging AI, digitalization, and financial innovation will aid the way for a more inclusive and sustainable economic future.
1. KPMG in Pakistan, Pakistan Banking Perspective 2024, KPMG in Pakistan, 2024, Available at: https://assets.kpmg.com/content/dam/kpmg/pk/pdf/2024/05/Pakistan-BankingPerspective-2024.pdf
2. Pakistan Credit Rating Agency, Commercial Banks: PACRA Research – May 2025, Pakistan Credit Rating Agency, 2024, Available at: https://www.pacra.com/view/storage/app/PACRA%20Research%20-%20Commercial%20Banks%20-%20May%2725_1749028726.pdf
3. Dunz , Nepomuk, et al. “The Rise of Sovereign–Bank Nexus Risks in Developing Economies.” World Bank Blogs, World Bank Group, 23 Oct. 2024, Available at: blogs.worldbank.org/en/psd/the-rise-of-sovereign-bank-nexus-risks-in-developing-economies#:~:text=Note:%20Panel%20a:%20Sample%20consisting,IMF%20International%20Financial%20Statistics%20data. &text=The%20results%20of%20this%20surge,(Grande%20and%20Angelini%202014).
4. Abbas, Ghulam. “SMEs Propel Economy with 40% GDP Contribution, Senate Committee.” Profit by Pakistan Today, Pakistan Today, 11 Jan. 2024, profit.pakistantoday.com.pk/2024/01/11/smes-propel-economy-with-40-gdp-contribution-senate-committee/.
5. BR Research, ‘SME financing: “he’s just not that into you!”’, Business Recorder, 25 November 2024, Available at: https://www.brecorder.com/news/40334268/sme-financing-hes-just-not-that-into-you