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Government’s New Taxation Strategy Puts Banks in the Crosshairs

In a bold move, the federal government has shifted its focus from battling inflation to targeting banks with a new taxation strategy. Under this scheme, banks whose lending to the private sector falls below 50 percent of total deposits will face higher taxes. The aim? To spur riskier investments and quicker returns.

Government's New Taxation Strategy Puts Banks in the Crosshairs

The announcement has sent ripples of concern throughout the banking sector. An Islamabad-based banker, speaking to Pako, warned of potential judicial intervention to enforce this new directive. “The government aims to increase bank leverage and claim a larger share of profits. If legal definitions can’t be altered, courts may be leveraged to extract funds. While it might yield short-term gains, banks will retaliate,” the banker expressed.

The government’s pivot isn’t unfounded, given the recent surge in bad loans following the State Bank of Pakistan’s key interest rate hike to 22 percent last year. Defaults on loan repayments by businesses and households spiked, totaling a staggering Rs. 60 billion.

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However, concerns loom over the effectiveness of this taxation strategy. Banks facing higher taxes for failing to meet lending targets may opt to return deposits instead of risking further tax burdens. The government’s rationale is to push banks towards lending to riskier customers, diversifying from safe but less stimulating investments in government debt.

Yet, critics warn of potential repercussions, particularly for small and medium-sized enterprises (SMEs) already struggling in the current economic climate. The tax scheme, based on banks’ advance-to-deposit ratios (ADR), could inadvertently stifle private-sector lending.

Under this system, banks with ADRs below 40 percent face a hefty 16 percent tax on income from government debt securities, while those with ADRs between 40-50 percent will be taxed at 10 percent. Banks exceeding a 50 percent ADR threshold will be exempt from this tax.

The reintroduction of this tax measure might lead banks to restrict high deposits from clients to meet ADR requirements, potentially hindering private-sector lending. Interestingly, low deposits in December 2023 had propelled private sector advances, ensuring ADR compliance and exempting banks from the tax for 2022.

Critics argue that instead of singling out a sector already burdened with significant taxes, the government should explore alternatives. Suggestions include lowering interest rates, broadening the tax base by delving into agriculture and property, promoting export growth, and tackling inflation.

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As the banking sector braces for these changes, the implications of this taxation strategy remain to be seen, with stakeholders closely monitoring its effects on economic growth and stability.

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