Why Banks Prefer Government Securities

In a well-functioning financial system, commercial banks serve as the arteries through which capital flows to productive enterprises, funding factories, farms, and small businesses that drive economic growth and job creation . Yet across both developed and emerging economies, a growing share of bank balance sheets is being allocated not to private sector loans, but to government securities—treasury bills and bonds issued by the state.

This phenomenon raises fundamental questions about the role of banks in modern economies. Why would institutions built to intermediate between savers and borrowers increasingly choose to lend to the government instead? The answer lies in a complex interplay of risk perceptions, regulatory incentives, macroeconomic conditions, and rational profit-seeking behaviour that, while entirely logical from a bank’s perspective, carries profound implications for economic development.

This THSB editorial examines the multifaceted reasons behind banks’ preference for government securities, exploring the structural, regulatory, and behavioural factors that make sovereign debt an irresistible refuge for commercial lenders.

The Allure of Risk-Free Returns

At the heart of banks’ preference for government securities lies the fundamental principle of risk and return. Government debt instruments—treasury bills and bonds—are universally regarded as the safest investment in any economy . They are backed by the “full faith” of the sovereign, an entity with unique powers: the authority to impose taxes and, in extreme circumstances, the ability to print money to meet its obligations .

This perceived safety creates what economists call a “gilt-edged” status—the theoretical absence of default risk. As one analyst notes, government issued debt instruments should yield the lowest interest rate precisely because they carry the lowest risk . For banks, this translates into an asset class that offers guaranteed returns without the uncertainties that plague private lending.

The contrast with private sector lending is stark. Commercial loans to businesses, particularly Small and Medium-sized Enterprises (SMEs), come with high default rates, weak collateral frameworks, and volatile market conditions . Manufacturing, agriculture, and small businesses face economic headwinds that can turn viable borrowers into default risks almost overnight. Banks must price this risk into their lending rates, but even the highest interest margins cannot eliminate the possibility of principal loss.

Government securities eliminate this uncertainty. As one banker in Bangladesh observed, with repayment behaviour among borrowers becoming increasingly concerning and non-performing loans (NPLs) continuing to rise, banks find investments in government instruments to be a more secure and stable source of earnings than traditional lending .

The Profitability Paradox: Easy Money Without Lending Risk

The preference for government securities is not merely about safety—it is also about profitability. In many markets, the returns on treasury instruments have proven highly attractive, sometimes creating what analysts describe as an “interest rate anomaly” where government securities yield higher returns than bank deposits of similar tenure .

In Nigeria, where the Central Bank consistently raised interest rates to attract foreign capital and tame inflation, yields on government securities remained highly attractive, making them an irresistible refuge for banks seeking easy profits without the burden of lending risks . The result has been a banking system where profits are driven not by productive lending but by investment securities.

The empirical evidence is striking. In the first half of 2025, United Bank for Africa (UBA) reported gross earnings of N1.61 trillion, with interest income of N1.33 trillion. Remarkably, N1.29 trillion of that interest income—nearly the entire figure—came from investment securities rather than lending . Access Holdings, GTCO, and Zenith Bank similarly confirmed that their profitability in 2024 and early 2025 was underpinned by returns from government instruments and trading gains, a model one commentator described as rewarding “financial inertia rather than developmental impact .

In Bangladesh, despite the sluggish performance of the industrial sector, overall banking industry profitability surged in 2025 as most banks shifted focus from industrial lending to treasury bills and bonds . Leading institutions like BRAC Bank, The City Bank, Eastern Bank, and Dutch-Bangla Bank all recorded remarkable profit growth, even as their net interest income from traditional lending declined .

Pakistan tells a similar story. Scheduled banks added over Rs5.8 trillion to their government securities holdings during the first nine months of 2025, with total investments reaching Rs35.85 trillion by September, a 19.3 percent increase . Meanwhile, advances to the private sector dropped by Rs1.27 trillion, underscoring weak demand for private credit that trade and industry groups attribute to persistently high borrowing costs .

The Regulatory Framework: Incentives Embedded in Rules

Bank behaviour does not occur in a regulatory vacuum. The preference for government securities is deeply embedded in the regulatory frameworks that govern banking operations.

Liquidity Requirements: Banking regulations universally require institutions to maintain a certain proportion of their assets in highly liquid, low-risk instruments. Government securities qualify for this purpose, allowing banks to meet their statutory liquidity ratios while simultaneously earning returns . As one Nigerian analyst noted, regulatory provisions permit banks to count government securities as part of their liquidity ratio, making the choice both profitable and compliant .

Capital Adequacy: Following the 2008 global financial crisis, banks in North America and Europe sharply reduced lending to strengthen their capital buffers . Bangladesh’s banking sector faced a similar capital shortfall, with many institutions under pressure to improve balance sheet health and meet regulatory requirements. Government securities offer a low-risk, capital-efficient investment option that helps stabilise bank portfolios without adding to credit risk .

Research from the Reserve Bank of India confirms this dynamic. An empirical analysis of Indian banks found that higher investment in government securities in the face of higher government borrowings indicates the operation of a “crowding-out channel,” but importantly, the crowding-out effect is lower for banks with better asset quality and higher capital adequacy . The study also found that an increase in the share of government securities in banks’ asset portfolios had a favourable impact on profitability of public sector banks, pointing towards better risk-adjusted returns from investment in government securities relative to loans .

Primary Dealer Obligations: In many jurisdictions, commercial banks serve as primary dealers in government securities markets, a role that carries both privileges and obligations. In Ghana, the Bank of Ghana recently approved a new list of 15 institutions to operate as Authorised Primary Dealers, including major banks like ABSA, CALBank, Ecobank, GCB Bank, Fidelity Bank, and Stanbic . These primary dealers play a critical role in underwriting and distributing government securities and supporting secondary market liquidity .

However, this dual role as both deposit-taker and primary dealer creates potential conflicts of interest. As one Sri Lankan analyst observed, when commercial banks serve as primary dealers while also mobilising deposits, they may lack interest in actively marketing government securities to retail investors, preferring instead to hold those securities on their own balance sheets and capture the returns for themselves .

Monetary Policy Transmission and Macroeconomic Context

Banks’ preference for government securities must also be understood as a response to monetary policy settings and broader macroeconomic conditions.

High Policy Rates: When central banks raise policy rates to combat inflation, the returns on government securities rise correspondingly. In Bangladesh, with the policy rate at 10 percent, 91-day treasury bills were yielding around 12 percent, making them economically rational investments for banks . As one analyst explained, if banks were still expanding credit rapidly at these high rates, that would actually indicate a failure of monetary policy, as the intended tightening would not be taking effect .

Inflation and Uncertainty: Macroeconomic instability, exchange rate volatility, and unpredictable fiscal direction discourage long-term private lending . In such environments, banks naturally gravitate toward assets that preserve value and provide predictable returns, even if those returns are modest.

Government Borrowing Needs: The government’s insatiable appetite for domestic borrowing creates a steady supply of securities that banks can purchase . When fiscal deficits are large and persistent, the government must borrow extensively from the domestic market, and banks are the most convenient source of funds.

The academic literature formalises these dynamics. Research from India identifies two distinct channels through which government securities influence bank behaviour:

• Portfolio Rebalancing Channel: Weak economic conditions and stressed asset quality encourage banks to increase their investments in government securities . When private sector lending becomes risky, banks rebalance their portfolios toward safer assets.

• Crowding-Out Channel: Higher investment by banks in government securities in the face of higher government borrowings indicates that public sector financing is displacing private sector credit .

The Risk That Isn’t Risk-Free: A Cautionary Tale

While government securities are considered “risk-free” in terms of default, they are not without risk. The failure of Silicon Valley Bank (SVB) in March 2023 provides a stark illustration .

Nearly 50 percent of SVB’s assets consisted of government and government-guaranteed securities—theoretically the safest assets a bank can hold. However, when interest rates rose sharply, the bank incurred significant unrealised losses in its securities portfolio. Subsequently forced to sell securities to meet deposit withdrawals, these losses suddenly became realised, leading to insolvency and closure .

This episode reveals a critical vulnerability: while government securities carry no default risk, they are exposed to interest rate risk. As rates rise, the market value of fixed-rate securities falls. If banks are forced to sell before maturity, those paper losses become real, potentially threatening solvency.

Ghana’s Domestic Debt Exchange Programme (DDEP) offered another lesson in the risks of concentrated government securities holdings. Many financial institutions struggled with liquidity issues as a result of their significant investments in government bonds . However, First Bank Ghana adopted a more prudent strategy, intentionally minimising its reliance on government bonds. As Managing Director Victor Yaw Asante explained, “Even though it became easier to, for example, buy government bonds and so on, we didn’t. We didn’t go for that temptation at all” .

The Consequences: Credit Starvation and Economic Stagnation

When banks channel funds toward government debt instead of private enterprise, the consequences extend far beyond bank balance sheets. The productive sector suffers chronic credit starvation, with measurable economic impacts.

In Nigeria, private-sector credit-to-GDP ratio hovers around 15-18 percent, compared to over 100 percent in developed economies and 45-60 percent in emerging markets  . With limited access to capital, businesses shrink, factories close, and unemployment deepens. The economy becomes trapped in a cycle of low productivity, weak growth, and worsening inequality .

Between 2020 and 2024, the Nigerian Economic Summit Group observed that banks’ exposure to government instruments grew by 20-25 percent annually, while credit to the real sector expanded by less than 10 percent . The message is clear: the banking system has become addicted to sovereign debt.

Pakistan faces similar challenges. Despite the central bank maintaining its policy rate at 11 percent, credit flow to the private sector remains limited, with advances dropping by Rs1.27 trillion during 2025 . Analysts caution that the banking sector’s growing reliance on government borrowing could crowd out private investment and hinder broader economic recovery .

In Bangladesh, private sector credit growth dwindled to 7.5 percent, prompting calls for penalties or restrictions on banks that invest heavily in treasury securities . One commentator warned that while the profit margin from government instruments is not significantly high, this trend may create substantial vulnerability in industrial growth due to reduced private sector borrowing .

The Debate: Rational Response or Systemic Failure?

The growing preference for government securities has sparked intense debate about whether this reflects rational bank behaviour or a fundamental failure of the financial system.

The Rational Response View: Proponents of this view argue that banks allocating capital to government securities under current conditions is entirely rational and even desirable . Banks have a duty to protect depositors’ funds and maintain financial stability. If policymakers want to change this behaviour, the solution lies in adjusting incentives—lowering policy rates, reducing fiscal deficits, and creating conditions for sustainable credit growth . Blaming banks for responding logically to the policy environment will not address the underlying challenges .

The Systemic Failure View: Critics contend that when banks choose government securities over productive lending, they abandon their core economic function. As one Nigerian commentator wrote, “True banking is not merely about profit maximisation but about building the foundation of national prosperity. The health of the sector depends on the strength of the economy it serves” .

This perspective emphasises that banks’ profits, while record-breaking, are increasingly disconnected from the real economy. The “risk-free banking” model may appear sound, but it is economically corrosive, fuelling short-term gains at the expense of long-term growth and exposing the system to sovereign risk . Should the government’s fiscal position deteriorate or interest rates spike further, the value of these securities could plummet, leaving banks overexposed and vulnerable .

The Path Forward: Rebalancing Incentives

Addressing banks’ preference for government securities requires coordinated action on multiple fronts.

Fiscal Discipline: Governments must reduce their borrowing appetite through fiscal consolidation and tax reforms . When the government borrows less, fewer securities are available, and banks are forced to seek alternative uses for their funds.

Monetary Policy Calibration: Central banks must carefully calibrate policy rates to balance inflation control with the need for productive credit. Lower policy rates reduce the attractiveness of government securities relative to private lending .

Regulatory Incentives: Differentiated reserve requirements, credit guarantee schemes, and risk-sharing mechanisms can make private lending more attractive . The Loan-to-Deposit Ratio directive in Nigeria, mandating that at least 65 percent of deposits be lent to the real sector, represents one attempt to rebalance incentives .

Strengthening Credit Infrastructure: Improving collateral frameworks, credit information systems, and insolvency regimes reduces the risk of private lending, making it more competitive with government securities.

Financial Literacy and Market Development: Educating retail investors about the advantages of direct investment in government securities can broaden the investor base and reduce banks’ dominance as holders of sovereign debt . In Sri Lanka, analysts have called for mandatory secondary market obligations for primary dealers and ongoing public education campaigns about treasury bill and bond investments .

Conclusion From THSB

Banks’ preference for government securities is neither inexplicable nor malicious. It is a rational response to a specific set of incentives: the perceived safety of sovereign debt, attractive yields in high-rate environments, regulatory privileges, and the genuine risks of private sector lending in unstable economic conditions.

Yet rationality at the level of individual banks does not translate into optimal outcomes for the economy as a whole. When the banking system becomes a conduit for financing government deficits rather than private enterprise, the result is credit starvation, stunted growth, and a widening gap between financial sector profitability and real economic performance.

The solution lies not in blaming banks for playing by the rules, but in changing the rules themselves. Fiscal discipline to reduce government borrowing, monetary policy calibrated to support productive credit, regulatory frameworks that reward lending to the real economy, and strengthened credit infrastructure that reduces private sector risk—these are the ingredients of a banking system that serves its fundamental purpose.

As one banker and business analyst observed, investment in government securities, though seemingly safe, is actually an unsustainable and temporary way to mitigate risk . Until the underlying incentives are addressed, banks will continue to choose the path of least resistance, and economies will continue to pay the price in forgone growth and missed opportunities.

For the businesses and entrepreneurs who depend on bank credit to grow, employ, and innovate, the stakes could not be higher. The question is whether policymakers, regulators, and bankers themselves can rise to the challenge of rebalancing incentives and restoring banking to its proper role: the engine of real economic growth, not merely a passive investor in government debt.

Frequently Asked Questions (FAQs)

1. Why do banks prefer investing in government securities rather than lending to businesses?
Banks prefer government securities because they offer risk-free returns backed by the sovereign, require no costly credit assessment, help meet regulatory liquidity requirements, and provide stable earnings without the uncertainties of private sector lending such as default risk, collateral disputes, or economic volatility .

2. Are government securities truly risk-free for banks?
While government securities carry no default risk (the government can always tax or print money to repay), they are exposed to interest rate risk. As seen in the Silicon Valley Bank failure, when interest rates rise, the market value of fixed-rate securities falls. If banks are forced to sell before maturity, these paper losses become real and can threaten solvency .

3. How do government securities affect bank profitability?
Research confirms that increased investment in government securities can have a favourable impact on bank profitability, particularly for public sector banks, pointing toward better risk-adjusted returns from government securities relative to loans . In Nigeria, several major banks reported that the bulk of their interest income in 2025 came from investment securities rather than lending .

4. What is the “crowding-out effect” in banking?
Crowding-out refers to the phenomenon where higher investment by banks in government securities reduces the flow of credit to the private sector. When the government borrows extensively from the domestic market, banks allocate more of their portfolios to sovereign debt, leaving fewer funds available for businesses, particularly SMEs .

5. Do regulatory requirements encourage banks to buy government securities?
Yes. Banking regulations require institutions to maintain a certain proportion of their assets in highly liquid, low-risk instruments. Government securities qualify for this purpose, allowing banks to meet their statutory liquidity ratios while simultaneously earning returns . They are also capital-efficient, requiring less capital to be held against them compared to private loans .

6. What role do primary dealers play in government securities markets?
Primary dealers are institutions authorised by central banks to underwrite and distribute government securities, participate in auctions, and support secondary market liquidity . In Ghana, 15 institutions including ABSA, CalBank, Ecobank, and Stanbic have been approved as Primary Dealers, with six also serving as Bond Market Specialists .

7. Does high bank investment in government securities harm economic growth?
Yes, it can. When banks channel funds toward government debt instead of private enterprise, the productive sector suffers chronic credit starvation. Nigeria’s private-sector credit-to-GDP ratio of 15-18 percent compares poorly with over 100 percent in developed economies, contributing to business contraction, factory closures, and unemployment .

8. Why do government securities sometimes offer higher returns than bank deposits?
This “interest rate anomaly” occurs when government securities yield higher returns than bank deposits of similar tenure. It can result from lack of financial literacy among retail savers, inactive secondary markets, and commercial banks’ preference to hold securities rather than market them to customers .

9. How does monetary policy influence banks’ preference for government securities?
When central banks raise policy rates to combat inflation, returns on government securities rise correspondingly. In Bangladesh, with policy rates at 10 percent, treasury bills yielded around 12 percent, making them economically rational investments . High rates make private borrowing expensive and government securities attractive.

10. What can be done to reduce banks’ preference for government securities?
Solutions include fiscal discipline to reduce government borrowing needs, lower policy rates to reduce treasury yields, differentiated reserve requirements favouring private lending, credit guarantee schemes, improved credit infrastructure, and financial literacy campaigns to broaden the investor base for government securities .

11. Is banks’ investment in government securities always bad?
Not necessarily. In contexts of high inflation, capital adequacy pressures, or economic uncertainty, investing in government securities can be a prudent way to stabilise bank portfolios and protect depositor funds . The concern arises when such investment becomes excessive and persistently crowds out productive private sector lending.

12. How have Ghanaian banks fared with government securities investments?
Ghana’s Domestic Debt Exchange Programme (DDEP) created challenges for banks heavily invested in government bonds. However, First Bank Ghana intentionally minimised its reliance on government securities, with its Managing Director stating, “Even though it became easier to buy government bonds, we didn’t go for that temptation at all” .

13. What is the difference between the portfolio rebalancing channel and crowding-out channel?
The portfolio rebalancing channel occurs when weak economic conditions and stressed asset quality encourage banks to increase government securities investments . The crowding-out channel operates when higher government borrowings force banks to allocate more funds to sovereign debt, reducing private sector credit .

14. Do banks in developed countries also prefer government securities?
Yes. In the United States, Treasury securities as a percentage of bank assets increased from 3 percent in 2013 to 11 percent in 2024 . However, the impact on private sector credit is less severe due to deeper capital markets that provide alternative funding sources for businesses.

15. Can banks be forced to lend to the private sector instead of buying government securities?
Some regulators have tried, such as Nigeria’s Loan-to-Deposit Ratio directive mandating that at least 65 percent of deposits be lent to the real sector . However, compliance has been inconsistent, and forced lending without addressing underlying risks can lead to increased non-performing loans. Sustainable solutions require aligning incentives, not imposing mandates

Source: The High Street Business