Pakistan's banks are earning record profits by lending to their own government rather than to the economy, parking almost two-thirds of their assets in state debt.

It is the defining feature of one of the world's more lopsided banking systems. Rather than financing factories, farms and households, the country's lenders have grown fat on a simple carry trade: take in deposits, buy the treasury bills and bonds a cash-hungry state issues in bulk, and pocket the spread. The more Islamabad borrows, the more the banks earn, and the less credit reaches the private economy that is supposed to generate growth and jobs.

Economists call it a sovereign-bank 'doom loop': lenders and the government lean on each other so heavily that the health of one is inseparable from the other. Moody's, which in February cut its outlook on the sector to 'stable' from 'positive', pointed to the banks' significant holdings of sovereign debt securities and the resultant high interlinkages between the banks' credit profiles and that of the government.

Lending to the state, not the economy

The numbers are stark. Banks held around PKR39.1 trillion ($108bn) of government securities by March, up 20.8% year on year, against just PKR14.6 trillion of loans to the private sector, a book that grew a feeble 8.1%. Put differently, the sector's investment-to-deposit ratio has climbed above 104%, while its advance-to-deposit ratio has slid to under 39% from 49% two years ago.

Government paper now makes up 62% of banking-system assets, up from 55.5%, according to the State Bank of Pakistan's (SBP) latest financial stability review. Advances actually shrank 6% over calendar 2025. Private-sector credit had withered to barely 11% of GDP in 2024, among the lowest ratios in Asia. By June of 2026, outstanding private-sector credit had risen to PKR 11.38 trillion.

The crowding-out is not subtle. The government borrowed more than PKR4.9 trillion from banks in a single financial year to plug its deficit, and debt servicing now swallows more than half the federal budget. With so much capital diverted to the state, Pakistan's domestic savings rate has fallen to a 28-year low, a warning from the Pakistan Institute of Development Economics that the country is hollowing out its own investment base.

Record profits, a thinning carry

For the banks, the arrangement has been a licence to print money. Listed lenders booked combined profits of about PKR671bn in 2025, up 11% on the year and a fresh record, even as the SBP's easing cycle dragged its policy rate down from 22% in 2023 and 2024 to the low teens. Cheaper deposits fell faster than lending yields, so margins held up.

That cushion is wearing thin. The central bank held the rate at 11.5% in July, after a surprise 100-basis-point rise in April, its first increase in a year, which points to a more grudging environment for the easy carry that has flattered earnings. The state is also clawing back a bigger share: the effective tax charge on bank profits rose to 54.3% of pre-tax income in 2025, and Fitch Ratings notes the FY27 budget leans on reduced profit transfers from the SBP itself, all under a $7bn International Monetary Fund (IMF) programme that demands ever-tighter fiscal discipline.

A sound-looking system

On the surface, the sector looks in rude health. The balance sheet expanded 17.8% in 2025 and deposits grew 24.7%. Capital is ample, with the aggregate capital adequacy ratio at 20.8%, roughly double the regulatory floor. Return on equity ran at close to 20%, and the non-performing loan ratio held at 6.1%, more than fully covered by provisions.

The ratings agencies have taken note. Moody's last year upgraded five of the largest banks to 'Caa2' in lockstep with a sovereign upgrade, precisely because their fortunes are welded to the state's. That is the paradox: what looks like strength is really a bet that Islamabad keeps paying its bills. Should the sovereign wobble, the banks wobble with it.

The big lenders

Habib Bank (PSX: HBL), Pakistan's largest lender by assets, sits at the centre of the system with a deposit base of around PKR5.5 trillion. United Bank (PSX: UBL) posted the sector's highest-ever annual profit of PKR130bn, up 73%, on a deposit book that nearly doubled. State-owned National Bank of Pakistan (NBP), the government's own lender and a workhorse of the treasury market, saw earnings jump 227% to PKR85bn, flattered by a prior-year pension charge.

MCB Bank (PSX: MCB) and Allied Bank (PSX: ABL) round out the old-guard conventional lenders, both rewarding shareholders with heavy dividends off the same government-paper carry. Bank Alfalah, Askari Bank, Bank of Punjab, Standard Chartered Pakistan, Faysal Bank and JS Bank make up a crowded second tier chasing the same trade. All of them clear through the Pakistan Stock Exchange (PSX), itself a listed company and one of Asia's better-performing bourses of the past two years.

The Islamic pivot

One structural shift cuts across the picture. Islamic banking has swelled to 23% of system assets, growing 30.7% in 2025 and outpacing conventional banks for a second year. The rush has a hard deadline: a constitutional amendment obliges Pakistan to eliminate riba, or interest, by January 1, 2028, forcing the whole system towards Sharia-compliant models.

Meezan Bank (PSX: MEBL), the country's biggest Islamic bank, has ridden that wave to profits of PKR90.7bn ($326mn), second only to UBL, on deposits up 28%. Faysal Bank has already completed its conversion to a full Islamic lender, and others are being pushed the same way. Yet the 2028 target looks ambitious while the sovereign itself still funds trillions of rupees of its debt through conventional, interest-bearing instruments the banks are so keen to hold.

A costly comfort

The comfort of the carry trade masks a deeper fragility. A banking system that lends to its government instead of its economy is a symptom of a state that borrows too much and an economy that invests too little. Record profits and 20% returns on equity look less like success than like rent extracted from a captive fiscal position.

For now, healthy remittances, a record $41.6bn in the last financial year, and an IMF anchor are keeping the machine turning. But until Pakistan's banks rediscover the unglamorous business of lending to businesses, the country will keep generating handsome financial-sector earnings and precious little of the private investment that would let it grow its way out of the trap.