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Pakistan has scrapped plans for a new tax on banks’ profits on government debt, just days before a critical deadline and following a backlash from lenders.
The proposed levy was intended to boost the south Asian country’s sluggish economy by encouraging banks to lend more to the private sector.
Banks would have had to raise their advances-to-deposit ratio (ADR) — a metric that measures banks’ lending as a percentage of their total deposits — to more than 50 per cent by December 31 or face an additional 10 to 15 per cent tax on investment income.
The ADR was seen as a gauge of lending to the private sector, and the measure would have pushed banks to reduce their reliance on income earned from government bonds.
But lenders launched a fightback against the regulations, mounting legal challenges and imposing fees in an attempt to reduce overall deposits.
The government published its decision to backtrack on the ADR tax on Sunday, approving instead a plan to raise the overall income tax on banks to 44 per cent, an increase of 5 percentage points, two senior government officials said. That levy will fall to 43 per cent in 2026 and 42 per cent in 2027.
The new tax will generate at least Rs60bn ($216mn) for the government for the tax year ending December 31, according to an estimate from brokerage Topline Securities, based on banks’ 2024 profitability estimates.
Zafar Masud, chair of the Pakistan Banks’ Association, an industry lobbying group, said the changes would be a way of “killing all the distortion” that had emerged as a result of the planned ADR tax.
“While the additional taxation is never an ideal situation . . . in this case the industry is most pleased to contribute towards the public exchequer in this hour of need for the government,” said Masud, who had previously called the ADR tax a blunt instrument to spur lending.
An economic contraction, soaring inflation and interest rates that touched 22 per cent have left Pakistan with one of the lowest rates of domestic credit to the private sector as a percentage of GDP, according to the World Bank.
At the same time, Pakistan’s banks have enjoyed bumper profits from returns on government-issued debt, providing them a disincentive from taking on new loans.
The ADR tax aimed to help the government claw back a greater share of those profits, as well as encourage the flow of private credit to companies.
Some lenders have already begun showing signs of attempting to meet the proposed ADR threshold in anticipation.
According to the State Bank of Pakistan, the central bank, credit to the private sector picked up by Rs1.4tn in October compared with the previous month, a 15 per cent jump. The sector’s ADR rose to 49.7 per cent by December 6, up from 38.4 per cent in August, according to Arif Habib, a brokerage.
But much of that money flowed to state-owned enterprises at artificially low rates, or through lossmaking financing to large corporates and development finance institutions that make small arbitrage gains by buying Treasury bills, according to analysts and banking executives.
Some lenders had also introduced monthly fees of about 5 per cent on their largest depositors in an attempt to push them to reduce their deposits and thereby improve the ADR ratio.
However, such fees were withdrawn after the SBP, following customer complaints, promised to advocate for lenders on tax reform in negotiations with the finance ministry, according to people familiar with talks between bankers and the central bank.
Bankers had also turned to the courts in an attempt to delay the implementation of the ADR tax. In November, the Islamabad High Court said about a dozen banks were entitled to temporary relief from the penalty while it worked through multiple petitions from lenders.
The SBP has also slashed its main policy rate — a driver of bank profits — from 22 per cent in June to 13 per cent this month. More cuts are planned as inflation falls back to the central bank’s target range of 5 to 7 per cent.
