IMF flags governance risks in Pakistan’s financial sector

November 21, 2025 (MLN): Pakistan’s financial sector remains relatively resilient, but serious governance and structural challenges persist, according to the latest IMF Technical Assistance report on “Governance and Corruption Diagnostic Assessment.”

The report highlights both regulatory achievements and vulnerabilities that could undermine financial stability, particularly as Pakistan embarks on a sweeping transition to an Islamic banking system by 2028.

The IMF assessment underscores that while the State Bank of Pakistan (SBP) has a generally strong legal and supervisory framework aligned with Basel Core Principles (BCPs), weaknesses in governance, accountability, and institutional independence could expose the sector to corruption risks.

Banks dominate, but credit remains skewed

The banking sector accounts for nearly 49% of Pakistan’s GDP, dwarfing microfinance institutions, non-bank financial institutions, and the insurance sector, according to SBP data.

Islamic banking now constitutes roughly 19% of sectoral assets, with 22 institutions operating nationwide.

Despite high returns fueled by treasury bill investments, lending to the private sector remains limited. Government credit represents more than 60% of bank assets, reflecting a “sovereign-bank nexus” that the IMF warns could escalate systemic risks.

Declining interest rates are expected to reduce bank profitability, while legal system inefficiencies continue to restrict private credit growth.

Regulatory gains tempered by governance gaps

The report praises SBP reforms, including adoption of Basel III, risk-based supervision, and the creation of SupTech tools for monitoring risk indicators.

The central bank’s active role in Pakistan’s removal from the FATF “grey list” and its licensing framework for digital banks also reflects progress.

However, governance issues persist.

The IMF notes that two Deputy Governor positions remain vacant, critical ownership conflicts exist due to SBP’s previous bank holdings, and the presence of a Ministry of Finance representative on the SBP board could compromise independence.

Moreover, there is no legal requirement to publish reasons for the removal of the Governor or Deputy Governors, raising transparency concerns.

The IMF report also highlights the need for enhanced corporate governance, particularly in relation to related-party lending and supervisory accountability.

Although the SBP has powers to sanction banks and enforce corrective measures, undercapitalized banks have historically faced delayed interventions, reflecting potential vulnerabilities to stakeholder pressures.

Islamic banking transition poses additional challenges

Pakistan’s plan to fully eliminate interest-based banking by 2028 represents a significant structural shift.

The IMF emphasizes that this transformation will require careful dialogue with banks, regulatory clarity, and robust supervision to safeguard financial stability.

The conversion of government securities and alignment of banking practices to Shariah-compliant models will demand substantial investment by banks and strong oversight by SBP.

IMF recommendations

Key recommendations include:

• Revising the SBP Act to remove the Ministry of Finance representative from the board and mandate public disclosure for senior appointments and removals.

• Filling Deputy Governor vacancies to ensure effective decision-making.

• Aligning the objective of banking supervision with Basel standards to prioritize safety and soundness of banks.

• Clarifying rules on related-party transactions and mergers to prevent ownership risks.

• Publishing supervisory objectives and annual reports to improve accountability.

• Ensuring early intervention in undercapitalized banks to reduce systemic risk.

The IMF emphasizes that the successful implementation of these reforms, combined with legal and regulatory improvements, will be critical to deepening financial inclusion, fostering private-sector credit growth, and ensuring a smooth transition to an interest-free banking system.

While Pakistan has made significant regulatory strides, governance gaps, legal inefficiencies, and state interference remain critical risks.

The ambitious 2028 Islamic banking target heightens the urgency for structural clarity, enhanced transparency, and proactive supervision to prevent destabilizing shocks in the financial sector.

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