Impact of COVID-19 Pandemic: Government Relief Package and the Likely Mis-Allocation of Loans in Pakistan

Abstract

This study argues the likely misallocation of capital in Pakistan associated with the perverse incentives faced by banking institutions to provide additional loans to weak businesses and households. Businesses and households are more likely to receive additional bank financing if they are financially constrained, because: (a) financial intermediaries in Pakistan have an incentive to allocate funds to weaker borrowers in order to avoid the realization of non-performing loans on their financial statements; and (b) the financial regulator’s relief package for commercial banks to sidestep deleveraging that will hamper economic growth arising from COVID-19 pandemic. This study hypothesizes that a potential ‘ever-greening’ behavior would be more observable among financial institutions that have capital adequacy ratios close to regulatory minimum requirement; and the policy of forbearance on extending funds by banks will be compounded due to the existence of deposit insurance scheme. However, the evidence suggests that banking institutions in Pakistan have not adopted the policy of forbearance despite announcement of incentives by State Bank of Pakistan (the central bank) - commercial banks prefer to park their excess liquidity in government securities in the face of global pandemic. Moreover, the findings of this study are not conclusive due to the availability of aggregate commercial banks data and short sample period.