Privatization of Banking Sector in Pakistan (A Case Study of MCB & ABL) Ph.D. Dissertation Submitted to Researcher Prof. Dr. Bahadar Shah Bakhtiar Khan Supervisor Department of Public Administration Gomal University, Dera Ismail Khan N.W.F.P. Pakistan
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Privatization of Banking Sector in Pakistan
(A Case Study of MCB & ABL)
Ph.D. Dissertation Submitted to Researcher Prof. Dr. Bahadar Shah Bakhtiar Khan Supervisor
Department of Public Administration Gomal University, Dera Ismail Khan
N.W.F.P. Pakistan
Table of Contents Page No Abstract i Acknowledgements ii List of Tables iii List of Figures v Appendix List vi Introduction viii Chapter: 1 Introduction 1. Description of the Study 1 1.1 Privatization 1 1.2. Types and Techniques of Privatization 3 1.3. Privatization process in Pakistan 4 1.4. Steps in Privatization in Pakistan 8 1.4.1 Identification 10 1.4.2 Hiring of Financial Advisor 10 1.4.3 Due Diligence 10 1.4.4 Enacting any needed regulatory a sectoral reform 11 1.4.5 Valuation of property 11 1.4.6 Pre-Bid and Bid Process 12 1.4.7 Post-Bid Matters 12 1.5 General Objectives of Privatization 13 1.6. Modalities of Privatization in Pakistan 14 1.7. Implications of Bank Privatization 15 1.8. Privatization of Banks 17 1.9. Privatization of Banks in Pakistan 18 1.9.1 Muslim Commercial Bank Limited. 20 1.9.2. Allied Bank Limited 21 1.9.3 Overview 24 1.9.4 Historical Background 24 1.9.4.1 Pre- Nationalization Stage 24 1.9.4.2 Nationalization Stage 26 1.9.4.3 Privatization Stage 28 1.10. Objectives of Privatization of Banks 33 1.11. Scope of the Study 34 1.12 Objectives of Study 35 1.13. Methodology 36 Chapter: 2 Literature Review 2.1 Introduction 42 2.2 Privatization of Banks and its Efficiency 42 2.3 Privatization of Banks and its impact on Economy 45 2.4 Privatization of Banks and its impact on Employees 46 2.5 Privatization of Banks and its impact on Customers 48 2.6 Privatization of Banks and Regulation 48
Chapter 3: Privatization of Banks and Its Impact on Efficiency 3.1 Introduction 49 3.2 Data Envelope Analysis 54 3.3 Efficiency gains of two banks, MCB & ABL 57 3.3.1 Transaction Cost 57 3.3.2 Asset Quality 59 3.3.3 Risk Measurement 61 3.3.4 Interest Rate Risk 62 3.3.5 Capital Risk 62 3.3.6 Capital Adequacy Measurement 63 3.3.7 Interest Rate Spread 64 3.3.8 Intermediation Proxies 68 3.3.9 Management Competence 69 3.3.10 Earning and Profitability 70 3.3.11 Liquidity Management 71 3.4. Comparative study of Private vs. Public Bank 73 3.4.1 Introduction 73 3.4.2 Ratio used in Analysis 74 3.4.3 Earning Assets to Total Assets 74 3.4.4 Return on Earning Assets 74 3.4.5 Interest Margin to Total Assets 74 3.4.6 Loan Loss Coverage Ratio 75 3.4.7 Equity Capital to Total Assets 75 3.4.8 Deposit Time Capital 76 3.4.9 Loans to Deposits 76 3.5 Findings 83 3.6 Conclusion 84 Chapter 4: Privatization and its Impact on Economy 4.1 Introduction 89 4.2 Privatization of Banks and its Impact on Economy 91 4.3 Hypotheses 94 4.4 Investment 95 4.4.1 Effect of Freezing of Foreign Currency Accounts 96 4.4.2 Effects of Nuclear Tests on Investment 96 4.4.3 Role of Banks Intermediating Foreign Capital Inflows 97 4.4.4 Hesitation on the Part of Foreign Investors 97 4.4.5 Pakistan Financial Markets Efficiency 97 4.4.6 Liberalization in Pakistan to Ensure Inflow of FDI 98 4.4.7 Modes of Financing in Pakistan 99 4.4.8 Deposits 99 4.5 Test of Sub-hypothesis No 1 101 4.5.1 Results of Sub-hypothesis No. 1 102 4.5.2 Findings 103 4.6 Test of Sub-hypothesis No. 2 104 4.6.1 Results of Sub-hypothesis No. 2 105 4.6.2 Findings 106
4.7 Impact of MCB & AQBL on Economic Growth 106 4.8 Privatization and Fiscal Deficit 107 4.9 Conclusion 109 Chapter 5: Privatization of Banks and its Impact on Employment 5.1 Introduction 111 5.2 Does Privatization Affect Labor? 111 5.3 Characteristics of Labor Market in Pakistan 114 5.3.1 Overstaffing 114 5.3.2 Generous Pay and Benefits 114 5.3.3 Labors Union Influence 115 5.4 Privatization Employment Impact 115 5.5 Labor Force Reduction 116 5.6 New Jobs Creations 119 5.7 Factors, which will determine the extent of that impact 120 5.8 Protection of the Interest of the Workers 120 5.9 Findings 129 5.10 Conclusion 130 Chapter 6: Privatization of Banks and its Impact on Customers 6.1 Introduction 132 6.2 Characteristics of Commercial Banks in Pakistan 132 6.3 Customer’s Problems 133 6.4 Challenges faced by Commercial Banking in Pakistan 133 6.5 Emergence of New Products 135 6.5.1 Consumer Financing 135 6.5.2 Consumer Financing Products 136 6.6 Impact on Customers 138 6.7 Conclusion 144 Chapter 7: Regulatory Environment for Privatization of Banks 7.1 Introduction 146 7.2 Regulatory Reforms 147 7.3 Pre-Privatization Activities 147 7.4 State Bank of Pakistan 152 7.5 Legislative Agenda 153 7.5.1 Banking and Financial Sector 153 7.6 Conclusion 177 Chapter 8: Summary and Conclusion 8.1 Summary and Conclusion 179 8.2 Bank Privatized so far 183 8.3 Achievements of the Study 184 8.4 Conclusion 187 8.5 Implications of the Study 191 8.6 Recommendations 192 8.7 Suggestions for Further Research 193
Bibliography
Appendixes
List of Tables Page No Chapter 1: 1.1 Number of Privatized Transactions in Pakistan 6 1.2 Pre privatization Structure of Banking Sector 19 1.3 Information on Banking Privatization 32 1.4 Information on Banking Privatization, Classified by Offering Types 33 1.5 Research Paradigm 41 Chapter 3: 3.1 Summary measures for Efficiency MCB Before Privatization 55 3.2 MCB After Privatization 55 3.3 ABL Before Privatization 56 3.4 ABL After Privatization 56 3.5 Transaction Cost 58 3.6 Risk Management 62 3.7 Capital Risks 63 3.8 Capital Adequacies 64 3.9 Intermediation Proxies 68 3.10 Management Competency 70 3.11 Earning and Profitability 71 3.12 Liquidity Indicators 72 3.13 Ratios for MCB 77 3.14 Percentage Change in Ratios 77 3.15 Ratios for ABL 78 3.16 Percentage Change in Ratios 78 3.17 Ratios for UBL 79 3.18 Percentage Change in Ratios 79 3.19 Comparisons 81 3.20 Financial Indicators of MCB 82 3.21 Financial Indicators of ABL 82 Chapter 4: 4.1 Data for Sub-hypothesis No. 1 101 4.2 Data for Sub- hypothesis No. 2 104 4.3 Performance of MCB for Pre and Post Privatization Periods 106 4.4 Performance of ABL for Pre and Post Privatization Periods 106 4.5 Fiscal Indicators 108 Chapter 5: 5.1 Bid Values and Payments on Gold Handshake Scheme 118 5.2 Growth Rate of GDP, Investment and Employment 118 5.3 Number of Employees, Pre and Post Privatization of MCB 123
5.4 Number of Branches Pre and Post Privatization of MCB 124 5.5 Annual Operating Cost Pre and Post Privatization of MCB 125 5.6 Number of Employees, Pre and Post Privatization of ABL 126 5.7 Number of Branches, Pre and Post Privatization of ABL 126 5.8 Annual Operating Cost Pre, and Post Privatization of ABL 127 5.9 Structure of Banking Sector in Pakistan, Pre and Post Privatization 128 Chapter 6: 6.1 Details of Consumer’s Products 136 6.2 Distribution of ATM (in numbers) 138 6.3 Consumer’s Knowledge about privatization of Banks 139 6.4 Changes in Bank Employees’ Behavior 141 6.5 Consumer Awareness about Bank’s New Products and Services 142 6.6 Costumer Views about Operation of New Products and Services 143 Chapter 7: 7.1 Classification of Credit Cards Advances 171 7.2 Classification of Auto Loans 173 7.3 Classification of Mortgage Loans 175 7.4 Classification of Personal Loans 177
List of Figures Page No Chapter: 1: 1.1 Source of Proceeds 7 1.2 Distribution of Precedes 7 1.3 Steps in Privatization (Pakistan) 8 1.4 Steps in Transaction 9 1.5 MCB 21 1.6 ABL 22 1.7 ABL 23 1.8 ABL 23 1.9 Pre -privatization Structure of Banking Sector 27 1.10 Global Privatization Proceeds 29 1.11 Privatization Proceeds by Region 29 1.12 Post Privatization Structure of Banking Sector 30 Chapter 3: 3.1 Bank’s Efficiency Model 57 3.2 Percentage of Provision for MCB to Total Advances 60 3.3 Percentage of Provision for ABL to Total Advances 60 3.4 Spread Rate Before Privatization 65 3.5 Spread Rate after Privatization 65 Chapter 4: 4.1 Inflow of Foreign Investment in Pakistan 99 4.2 Deposits of Schedule Banks 100 4.3 Scatter Diagram for Hypothesis No. 1 102 4.4 Scatter Diagram for Hypothesis No. 2 105 4.5 Budget Deficit 108 Chapter 5: 5.1 Number of Employees for MCB Before and After Privatization 123 5.2 Number of Branches for MCB Before and After Privatization 124 5.3 Operating Cost of MCB Before and After Privatization 125 5.4 Operating Cost of ABL 127 5.5 Number of Banks Before and After Privatization 128 Chapter 6: 6.1 Number of Credit Cards 137 6.2 Number of Online Accounts 137 6.3 Number of ATM 137 6.4 Customer knowledge about Privatization of Banks 139 6.5 Employees Behavior with Customers 141 6.6 Customers Awareness about Bank New Products 142 6.7 Customers Views about Operation of New Products 143
List of Appendix
Page No 1.1 Financial Sector of Pakistan 218 1.2 List of Privatization Proceeds in Pakistan 222 1.3 List of Up Coming Transactions 226 3.1 DEA Calculation 227 3.2 Financial Statement of Both Banks for Both Periods 228 3.2 Transaction Cost 237 3.3 Particulars of the Provision Against NPLs 238 3.4 Risk Measurement 240 3.5 Capital Adequacy Ratios 241 3.6 Liquidity Management 246 3.7 Earning and Profitability 247 4.1 Foreign Investment Inflow in Pakistan 249 4.2 Test of sub Hypothesis No 1 251 4.3 Test of sub hypothesis No 2 252
Acronyms ABL Allied Bank of Pakistan Limited ADB Asian Development Bank ATM Automated Teller Machine BOOT Build-Own-Operate and Transfer BOO Build-Own-Operate CCOP Cabinet Committee on Privatization DEA Data Envelopment Analysis DFIs Depository Financial Institutions EOI Expression of Interest FA Financial Advisor MCB Muslim Commercial Bank NPAs Non Performing Assets NPLs Non Performing Loans PC Privatization Commission of Pakistan RFP Request for Proposal SBP State Bank of Pakistan SOEs States Owned Enterprises SOQ Statement of Qualification UBL United Bank Limited
Privatization of Banking Sector in Pakistan
Case Study of MCB & ABL
By Bakhtiar Khan
ABSTRACT
The present study aims at examining the privatization of banking sector in Pakistan, its
impact on efficiency, economy, employment and new products and services as well as on
legal environment. For this purpose economic model was used to judge efficiency of
banking sector for pre-and- post period of privatization.
The model shows that banking sector in Pakistan after privatization of few banks improved
its efficiency. Liquidity ratios of the banks have improved. Numbers and values of deposits
have increased. Profitability of the banks increased. Value of non-performing loans is
controlled. However, spread rate is still higher as compared to pre-privatization period. New
products and services have been created to facilitate the customers.
Impact on economy, in the sense of mobilization of savings, increase in loan advances and
credit, as well as investment have shown an upward trend. Quality of assets of all banks has
improved.
The study shows that the numbers of employees have decreased in banking sector but this
decrease is not alarming. The salary and remuneration to management / employees show
increase; meaning better return to services of employees.
For a new vision of the banking sector and to prevent financial mishaps in future, the State
Bank of Pakistan and Government of Pakistan are required to develop a new regulatory
system for privatized banks.
Acknowledgements
First of all, the scholar offers his most humble gratitude to ALMIGHTY ALLAH, Who is
the Omnipresent, the Omnipotent and the Omniscient, created the universe and bestowed the
mankind with knowledge and wisdom to search for secrets. I earnestly bow before His
Compassionate Endowment.
I am deeply indebted to my supervisor, Dr. Bahadar Shah, for his guidance, encouragement
and sustained interest in my study. I must express my gratitude to Dr. Gohar Zaman and
Prof. Gul Nawaz for helping me in model development and research methodology.
My special thanks are due to my friends, Dr. Saeed Anwar, Dr. Azim and Haji Saadullah Jan
for encouraging and supporting me during this research.
I would like to take the opportunity to express my gratitude to my wife whose support made
this goal possible.
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INTRODUCTION
The economic history has witnessed waves of nationalization and privatizations,
both being defended on similar social and efficiency grounds. Theoretical models
can hardly distinguish between efficiency superiority of different ownership
arrangements. It is generally accepted that it is competition and effectiveness of
regulation, not ownership that makes difference from an efficiency point of view
(Vickers and Yarrow, 1988; Adaman, 1993).
The concept of "privatization" has not been yet clarified in both theory and practice
(Bailey, 1987; Kay and Thompson, 1986). As noted by R.W. Bailey, "one of the
concepts in vogue is privatization. Although the concepts itself is unclear, it might
be tentatively defined as a general effort to relieve the disincentives toward
efficiency in public organizations by subjecting them to the incentives of the private
market. There are in fact several different concepts of privatization" (Bailey, 1987;
138). J.A. Kay and D.J. Thompson also agree with Bailey by noting, "privatization
is a term which is used to cover several distinct, and possibly alternative means of
changing the relationships between the government and private sector" (Kay and
Thompson, 1986; 18).
Privatization is frequently used referring to the sale of a publicly owned enterprise
(POE)'s asset or shares to the individuals or private firms. However, this definition
gives only a narrow meaning of privatization. In broader meaning, it refers to
restrict government's role and to put forward some methods or policies in order to
strengthen free market economy. The former meaning of privatization, i.e. the sale
of a POE's assets or shares to the private sector is mostly called "denationalization".
These two terms -privatization and denationalization- are mostly confused and
sometimes used interchangeably in the literature, As a matter of fact;
denationalization is just one method of privatization. Government's role and
functions can also be reduced or can be wholly terminated by implementing some
other methods. The broad meaning of privatization is which encompasses the
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methods or policies, which aims to strengthen free market economy and to reduce
the role of the government in the national economy.
The recent past has seen fundamental changes in the government’s role in
economy. With the defeat of socialism and the worldwide onslaught of
privatization a new scenario is emerging. The direct role of government is shrinking
and its indirect role is increasing. Arguably, privatization does not necessarily
means “no government,” but rather “better government, Web Site, “ Islam On Line”
(The role of government in the economy) Downloaded from internet 5, Jan., 2002.
The globalization and deregulation of financial markets and privatization of
banking sector will play major role in increasing efficiency, cost effectiveness and
innovation of new products due to competition. See Stigler (1975); Wolf (1979);
Baumol (1996), and Kamal (1996). Even small improvements in efficiency
generate significant gains in the sector it self. More important, improved provision
of financial services allows greater efficiency in nearly all other sectors: by
expending the rang and quality of financial services; by allowing transactions that
would otherwise not occur; by facilitating firm entry and competition in other
sectors; and by improving export competitiveness. It can encourage savings, and
can lead to more efficient use of savings. The empirical evidence strongly shows
that an efficient financial services sector enhances economic growth (see Levine
1997). It also gives financial firms access to new technologies and ideas to help
them raise efficiency.
The existence of an efficient and well functioning financial sector is important for
the effective operation of all economies. The borrowing and lending activities of
this sector ensure that corporations in the real sector of economy have access to
fund they needed for investments and generate output, exports and jobs. The
process of financial deregulation and privatization has the prime objective of
making the financial sector work more effectively in meeting the needs of the real
sector of economy. “Privatization will encourage higher production, improve
service coverage and quality, promote market-based prices, attract capital and better
management, reduce fiscal hemorrhaging, use proceeds to retire national debts,
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strengthen domestic capital markets, broaden ownership base and reduce
opportunities for corruption. In other words the GOP aims at fostering competition
to allow the customers/consumers to enjoy the benefit of the privatization.” (
Shabbir A KAZMI, 2001). Privatization of government enterprises has taken place
nearly 100 countries; the United Kingdom has established a clear reputation as the
leading source of expertise in the fields. ( Bishop, Matthew. R and kay, John A.
1989).
Privatization efforts in Pakistan began in 1988, with the floatation of 10% shares of
Pakistan International Airlines (PIA). Between 1988 to 1990, privatization was
pursued with view to divest 14 loss making units and raise funds by selling shares
of profit making manufacturing units for retiring public debts and reducing debt
servicing. Process of privatization picked up only after setting up of the
Privatization Commission in 1991.
The problems of Pakistan’s banking sector were rooted in a failure of governance
and lack of financial discipline owing to undue political interference in the financial
intermediation process, especially in the NCBs and DFIs. NCDs and DFIs were the
major source of bad loans accounting for the 90% of the bad loans in the entire
system and were the main loss makers. Pakistan banking reforms were aimed to
strengthen the sources of governance and financial discipline for banking sector,
namely bank regulators, markets, the courts and bank owners, by enhancing the
authority and ability of the central bank to supervise banks and enforce regulations,
promoting market integration and competition, improving the legal and judicial
processes for enforcing financial contracts, and initiating corporate governance
reforms in the NCBs and DFIs. Two banks, namely MCB and ABL were privatized
in 1991, which was start of privatization process of the financial sector of the
country
The study will review the political, ideological, economic arguments and
considerations concerning privatization. It will provide theoretical background on
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the process of privatization, incentive and efficiency in the public and privatized
banks and its impact on economy.
The study aims to explore answers to the questions:
Does Privatization Improve Efficiency and gives birth to New Products?
What will its Impact on Economy?
Impact on Employee’s Welfare.
Impact on Customer Services.
Regulation with Changing Environment
Research Outlines:
Chapter First
Chapter first describes the pilot review of the present research work
consists on introduction, overview, methodology and objectives of the
study. Overview is divided into three parts. Banking sector at the time of
independence, nationalization and privatization.
Chapter Two
Chapter two is based on literature review about the research issues.
Chapter Three.
Chapter three is based on analysis of efficiency using theoretical
framework called “TARSCIMAL”. Different operating ratios are used to
evaluate efficiency of two banks selected as a case study. DEA is used
for two banks for pre and post privatization period.
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Chapter Four
In chapter four of the study we have examined the economic impact of
privatization of banks. Two main hypotheses and some sub hypothesis
were developed to evaluate the privatization of banks and its impact on
economic growth.
Chapter Five
Chapter five is based on staff welfare. We have analyzed the number of
staff before privatization and after privatization of two banks and their
salaries and the service environment.
Chapter Six
Chapter six is based on primary data about the views of customers for
both pre-and post periods of the privatization of these two banks. Semi
structure interviews were taken from different customers of these two
banks in different areas to collect their change in views with changing
structure of these two banks.
Chapter Seven:
Chapter seven provides the legal framework adopted by the Pakistan
government for privatization of banks along with its pros and cons.
Chapter Eight
Summary and conclusion of the study is narrated in this chapter.
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CHAPTER 1
1. Description of The Study
1.1 Privatization
Nationalization was common during the immediate post World War 2 period, but
privatization became a more dominant economic trend (especially with in the United
States and the United Kingdom during the 1980s and 90s). The trend of privatization has
often been characterized as part of wave of neoliberal policies, and some observers argue
that this was greatly influenced by the policies of Reagan and Thatcher. (William L.
Megginson, 2000). The term “privatization” was coined in 1948 and is thought to have
been popularized by the economist during the 80s; perhaps the most discussed
privatization case has been the privatization of British Railways. (Downloaded from
www.E-paranoids.com. Feb.10, 2002).
Privatization of state-owned enterprises (SOEs) has been an essential part of the
economic reform process that started in the 1980s in both the developed and developing
countries. It was related to the changing role of government in economic development
process. The rationale for privatization emanated from the experience that in many
countries, SOEs had not lived up to their development expectation. Due to many inherent
problems, scarce resources were being less efficiently used, and their fiscal implications
were mounting. In response to these problems, government increasingly recognized the
need to get out of economic activities that competitive markets do best than government
interventions. The privatization and deregulation policy is a key component of the
economic reforms with a view to creating a liberal economic environment for rapid
industrialization and accelerating the pace of economic development.
Privatization in general means transfer of ownership of a state-owned enterprise (SOEs)
to private enterprise along with control over its management. Privatization is a very broad
term—but simply means the transfer of assets or service delivery from the government to
the private sector. Privatization runs a very broad range, sometimes leaving very little
government involvement, and at other times creating partnership between government
and private service providers where government is still the dominant player.
2
“Privatization (sometimes: denationalization, privatization or- especially in India-
disinvestments) is the economic process of transferring property, from public ownership
to private owner ship. An opposite process is nationalization. In theory, privatization
helps establish a “free market” as well as fostering capitalist competition, which its
supporters argue will give the public better choices. Conversely, socialists view
privatization negatively, arguing that entrusting private businesses with control of
essential services reduces the public’s control over them, and will result in
unemployment and corruption.” (Downloaded from www.E-paranoids.com. Feb.10
2002).
Some important definitions given by different authors or agencies are as under: -
In the sense of government executives the meaning of privatization has the
following shades. According to, Elaine Kamarck “When we talk about
privatization, we do not mean contracting out, we mean purely divesting the
Government function.” (.Paul Starr, 1989, “The meaning of Privatization,”).
Most definitions of privatization, though, are more extensive, covering virtually
any actions that involve exposing the operations of the government to the
pressures of the commercial marketplace. That would include every thing from
contracting out janitorial services. (ADB, 1999)
The boarder definition of privatization also includes a wide range of public-
private partnerships, such as voucher systems. Even the creation of federal
corporations, quasi government organizations and government–sponsored
enterprises is often filed under the general category of privatization. In such
organizations, though it is often difficult to tell where government ends and
Private sector begins. (Kazmi. H. Bashir 2001)
In broad meaning, privatization refers to the transfer of functions previously
performed exclusively by the public sector, to the private sector. In other words,
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privatization is an umbrella term, which encompasses all methods or policies
implemented to increase the role of market forces within the national economy. In
this context, the concept of privatization covers several arrangements to deliver
goods and services by private sector. In the following, these arrangements are
explored. (Prof.Dr.Coşkun Can Aktan, 1987)
Broadly defined, privatization is the abolition of barriers to private sector
provision of services or the infrastructure necessary for their delivery. The broad
definition refers to privatization at sector level (e.g., telecommunication,
electricity, social security, etc.). It is more complex than enterprise level
privatization as it often involves restructuring of a whole sector and not just one
firm. It involves giving the private sector the right to use or access the public
domain (radio spectrum, land, right of way, etc.) to build and operate a network
industry. It also involves defining the “public service” dimension and licensing
the private sector to deliver such services. The broad definition of privatization
requires putting in place legal and regulatory mechanisms to ensure that private
providers do not overlook the public dimension of the services they are licensed
to deliver and do not fail to meet pre-announced policy objectives (coverage,
access, etc.) (Kamal S. Shehadi, 2002).
1.2: Types and Techniques of Privatization
Management Privatization means corporatization and commercialization of public
services. Corporatization refers to changes in the legal form of utilities by
incorporation under the different legal and accounting code to that of the public
service. It may be linked to or precede the sale of assets. Commercialization is a
boarder term referring to the importation of accounting and management practices
devised in private companies into public organizations including, for example, moves
to transfer a greater responsibility for payment of services from government to service
users.
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Capital privatization through the sale of whole operating units, or industries; or
partial sale of a utility, usually by selling a proportion of its shares.
Contracting out Including concession and leasing contracts. The state normally
retains ownership of the assets and continues to fund the services, but the operation
utility is transferred to private operator or contractor, with the result that labor is the
main factor privatized.
Finance privatization private funding of public infrastructure through such schemes
as Build-Own-Operate-and-Transfer (BOOT) and Build-Own-Operate (BOO). Under
BOOT schemes the private developer/consortium funds, builds, owns, operates, and
maintains a facility. It operates the facility over a fixed term, during which it can
charge users through fees or other appropriate means. At the end of the fixed term the
facility is transferred to the government or agency. BOO schemes are similar, with
the exception that the facility is not transferred back to the government at the end of
the contract.
Deregulation through removal of regulations governing entry to, or operations
within, an industry. Whereby state regulations governing or limiting the terms of
entry to or operation within an industry are removed or reduced. (Oestmann, 1994,
Rondinelli, Dennis and Max Iacono. 1996).
1.3: Privatization Process in Pakistan
Privatization efforts began in earnest after the creation of Privatization Commission (PC)
on January 22, 1991. Although the Privatization Commission mandate initially restricted
to industrial transactions, by 1993 it had expended to include power, oil and gas,
transport (aviation, railway, ports and shipping), telecommunications and banking and
insurance. The privatization process, which is aimed at selling government property in an
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open and transparent manner with a view to obtaining the best possible price, varies
somewhat depending on the nature of the asset being privatised, on the proportion of
shares being offered for Privatization, and on whether a transfer of management is
involved. The Board of the Privatization Commission decides what kind of process will
be followed.
The question at the present situation is not whether or not to privatize; it is rather how the
privatization should take place providing adequate safeguard of the interests of all parties
- workers, employers and the general public. Interests of the public and the workers
would be safeguarded only when there is periodic examination of the methods of
privatization and when there is a greater degree of discussion on the ways in which social
consequences are to be dealt with.
Public consensus as far as possible on the methods of privatization would ensure not only
the success in privatization but also equitable distribution of the fruits of such success.
Such equitable distribution can take place only when the restructuring of the public
enterprises before or after privatizations takes into consideration the social effect and
proceeds with the approach and mechanism that will ensure that adverse effects on the
interests of the workers are handled through discussion and consensus.
During January 1991 to June 2002 the Commission completed 121 transactions for Rs.
79.061 billion. Table 1.1 is giving privatization transactions in Pakistan. Then Table is
divided in three different periods, i.e. 1991-June 2002, July 2002 –June 2003 and July
2003 – May 2004. The table also shows total number of transactions in all sectors with
their values in rupees in millions.
Figure 1.1 shows total proceeds in percentage and Figure 1.2 shows distribution of total
proceeds in rupees in billions. (See appendix 1.2 for total proceeds including name of
purchaser and value of transaction etc).
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Table.1.1 Number of Privatized Transactions in Pakistan (Rs. In Million)
Steps in a Transaction with Transfer or Management or Sale of Asset or Business
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The first step is the identification of the entity or list of entities to be privatised. In a
typical transaction, the Privatization Commission, in consultation with the relevant
ministry, submits a Summary of the proposed transaction to its Board. The Summary
justifies the need for privatizing the property, outlines the likely mode of privatization,
and sometimes seeks guidance on issues relating to such matters as pricing, restructuring,
legal considerations, and the regulatory framework. Once endorsed by the Board, it is
submitted to the Cabinet or its subcommittee, the Cabinet Committee on Privatization,
(CCOP) for approval.
1.4.2 Hiring of a Financial Advisor
In major transactions, the process to hire a financial advisor (FA) is carried out by the
transaction manager with the approval of the Board. Terms of reference for the financial
advisor are finalized; expressions of interest from prospective FAs are solicited, an
evaluation team is constituted, and short listed firms are invited to submit technical and
financial proposals in a common format. The evaluation team scores the technical
proposals and the highest ranked firm based on both technical and financial scores is
invited for contract negotiations and signing. In November 2001, the Board approved
regulations for hiring a financial advisor in order to make more transparent the
procedures that were largely being followed over the last decade.
1.4.3 Due Diligence
The next step is to carry out the legal, technical, and financial due diligence. This is
aimed at identifying any legal encumbrances, evaluating the condition of the assets, and
examining the accounts of the company in order to place a value on the company. For
most industrial units and some small transactions, this is done using in-house transaction
managers and staff, or by sub-contracting out part of the work to a domestic legal,
technical, or accounting firm. However, for major privatizations in banking,
infrastructure, or utilities, the FA carries out this function. Following due diligence, the
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FA finalizes the privatization plan. This may include recommendations on any needed
restructuring, in addition to specifying the amount of shares or assets to be privatised.
For major privatizations or when the proposed privatization mode is different from the
initial plan, the plan is then submitted to the Board, the Cabinet Committee on
Privatization (CCOP) or the full Cabinet for approval.
1.4.4 Enacting any Needed Regulatory and Sectoral Reforms
For many major transactions, the ability to privatize and the amount of proceeds
realizable depend critically on the level of regulated prices for the public enterprise’s
inputs or outputs and other sectoral or regulatory policies. For many monopolies or
quasi-monopolies, the “rules of the game” specifying the competition framework post-
privatization, the manner and type of regulation, and the institutions regulating them are
key to investor interest. In addition to rules determining prices or tariffs, there may be
rules determining standards, penalties for non-compliance, the extent, form and timing of
any proposed deregulation, and the evolving structure of the market following
liberalization. Clarification of these rules and passage of needed laws and regulations
will often be necessary before taking the transaction to market.
1.4.5 Valuation of Property
In order to obtain an independent assessment of the value of the property being
privatised, the Commission relies primarily on external firms. The Financial Advisor,
where engaged, carries out the valuation to obtain a “reference price” for the property. In
other cases, the Commission contracts with an external valuation firm or accounting firm
as specified in the rules on the valuation of property, which can be obtained from the PC
website. The methods used for the valuation vary with the type of business and often
more than one method is used in determining the value. These include the discounted
cash flow method, asset valuation at book or market value, and stock market valuation.
Despite using scientific methods, valuation remains more an art than a science. The true
12
value is dependent on many difficult to quantify variables such as country risk, corporate
psychology and strategy, investor specific synergies and perceptions of future
macroeconomic performance. Only the market can determine the true value. Therefore
it is important to focus on designing appropriate transaction structures, on advertising in
relevant media, in choosing and implementing appropriate pre-qualification criteria for
bidders, and in following an appropriate bidding process to obtain a fair price for the
privatization.
1.4.6 Pre-bid and Bid Process
Expressions of Interest (EOI) are invited by advertising in the relevant media. The PC
Ordinance 2000 spells out some of the advertising procedures. Depending on the kind of
transaction, the EOI describes the broad qualifications that potential bidders must
possess. Those submitting an EOI and meeting the broad qualifications are provided with
the Request for Proposal (RFP) package, where required, containing the detailed pre-
qualification criteria, instructions to bidders, draft sale agreement, and other relevant
documents. Interested parties then submit a Statement of Qualifications (SOQ), which is
evaluated to determine whether an interested party meets the requisite qualifications.
Pre-qualified bidders are then given a specified period to conduct their own due
diligence, following which they are invited to pre-bid meeting(s) where their questions
and concerns can be addressed. The meetings are useful in determining the bidding
procedure to be followed (for example, open auction, sealed bids, or some combination)
and could even determine the proportion of shares that the Government may want to
offload. The bidding itself is done openly, with all bidders and media invited.
1.4.7 Post-bid Matters
Following bidding and identification of the highest bidder, the Board of the PC makes a
recommendation to the CCOP as to whether or not to accept the bid. The reference price
is a major determinant in the recommendation, although the Board may recommend the
13
sale even if the offer price is below the reference price. Once the bid price and bidder are
approved, the PC issues a letter of acceptance or a letter of intent to the successful bidder,
indicating the terms and conditions of the sale. Following negotiations with the bidder,
the PC then finalizes the sale purchase agreement, collects the sale proceeds, and
transfers the property. Under PC’s current policy, privatization proceeds are generally
required to be paid upfront rather than over time, however, transaction specific
exceptions are possible as had been the case for many earlier transactions. Within 30 days
of the sale, the PC is required to publish the summary details of the transaction in the
official gazette.
In summary, the privatization process is lengthy for major transactions, mainly to assure
transparency in the process. After receiving CCOP approval for the privatization, it
typically takes about 18 months to close a major transaction, even when no major
restructuring of the company is required. This includes about six or seven months to
appoint a Financial Advisor and another three or four months for the FA to complete its
legal, technical and financial due diligence and to propose a privatization strategy.
Following approval of the strategy, the marketing and bidding process may take five or
six months (valuation efforts proceed in parallel), while it may take another two months
after bidding to obtain approvals, finalize sale documents, and close the transaction.
Delays in Privatization are often caused by waiting for the necessary regulatory
framework and sectoral policies to be put in place and for any needed restructuring to
occur. In addition, resolution of transactional and interministerial issues often results in
causing delays in the bidding process. (Privatization Commission annual report,1998).
1.5 General Objectives of Privatization The stated objectives of the privatization process can be broadly categorized in three main groups: -
Economic objectives:
14
(1) Improve the overall efficiency of the economy
(2) Improve the efficiency, productivity and profitability of firms;
(3) Improve the quality of products and services; and
(4) Attract foreign investors.
Fiscal objectives:
(1) Reduce government subsidies to public enterprises;
(2) Raise money from the sale of public enterprises; and
(3) Increase tax revenue from private enterprises.
Social and political objectives:
(1) Improve the welfare of the society;
(2) Promote the ownership of private enterprises by nationals;
(3) Create a property-owning middle class;
(4) Increase total employment in the economy; and
(5) Reduce corruption and the abuse of public office.
1.6: Modalities of Privatization in Pakistan
The privatization policy of 1998 outlined the following four modes of privatization to be
adopted for public sector enterprises.
1. Total Disinvestments Through Competitive Bidding.
This involves the sale of 100 percent shares of a public sector enterprise to a strategic
investor through process of competitive bidding.
2. Partial Disinvestments with Management Control.
15
In this method, a percentage of the shares of a public sector enterprise are sold to a
private investor or group of investors and management control is also transferred to
the party.
3. Partial Disinvestments Without Management Control.
This entails the sale of a percentage of the shares of a public sector enterprise to
private investors, while the government retains management control.
4. Sales/Lease of Assets and Property.
The assets/properties are sold or leased out to any party.
1.7. Implications of Bank Privatization
There are two views about privatization of government owned enterprises. The arguments
against privatization are that selling assets of the state are not wise decision. However, it
is now common, in developing countries, that the IMF and World Bank make
privatization of economic enterprises a pre-condition for balance of payments support,
and for development aid. This withdrawal of government ownership and control of
economic enterprises is what is here meant by the term 'privatization'. This demand for
the state to withdraw from economic enterprise, and to hand over to public or private
companies, has even extended to public utilities such as companies concerned with water
and electricity supply, telephones and banking. The same is the case with Pakistan.
Government of Pakistan is compelled to start privatization of state owned enterprises
including banks to obey the order of the lenders i.e. IMF, World Bank etc. etc. (Sara
Hupekile Logwe. 2003)
The rationale behind this IMF demand is three-fold. Firstly, it is said that the
administration of parastatal companies is more bureaucratic and inefficient, because they
operate like government bureaucracies, and are protected by government from having to
adapt to competition and market forces. Secondly, they are more likely to be internally
corrupt, for example by having inflated payrolls to provide employment to relatives and
placement of government officials. Thirdly, their revenues and assets are likely to be
16
diverted by corrupt government officials who gain external control over company
decision making. All three of these factors lead to parastatals that provide services and
commodities at uncompetitive prices, and also lead to low productivity and loss making,
and to the ultimate collapse of the enterprise if exposed to competition in a free market.
( Sara Hlupekile Longwe, 2003)
Opponent of privatization dispute the claims made by proponents of the privatization,
especially the one concerning the alleged lack of incentive for government to ensure that
the enterprises they own are well run, on the basis of the claim that government must
answer to the people. It is argued that a government runs nationalized enterprises poorly
will lose public support and votes, while a government that runs those enterprises well
will gain public support and votes. Thus, democratic governments, under the argument,
do have incentive to maximize efficiency in nationalized enterprises, due to the pressure
of future election.
The opponents of the privatization are giving following arguments against the
privatization.
• Private Companies do not have any goal other than to maximize profit.
• The public does not have any control or over sight of private company.
• A centralized enterprise is generally more cost effective than multiple smaller
ones. Therefore, splitting up of company into smaller private chunks will reduce
efficiency.
• Privatization will not result in true competition if a natural monopoly exists.
• Profits from successful enterprises end up in private pockets instead of being
available for the common good.
• Nationalized institutions are usually granted against bankruptcy by the state, they
can therefore borrow money at lower interest rate to reflect the lower risk of loan
default to the lender.
17
• In case where public services or utilities are privatized it can create a conflict of
interest between profit and maintaining a sufficient service. A private company
may be tempted to cut back on maintenance or staff training etc. to maximize
profit.
• A public service may provide public goods that, while important, of little market
value, such as the cultural goods produced by public television and radio.
1.8: Privatization of Banks
In the last fifteen years privatization has become a central element of the structural reform
agenda in developed and developing countries alike. Indeed, it is now quite difficult to find a
country that has not embarked on a program to divest some or all of its state-owned
enterprises (SOEs) or to involve the private sector in their management, ownership, and
financing.
During the past 15 years, over 250 commercial banks have been fully or partially privatized
by governments of 59 countries either publicly through a public offerings of shares, or
privately through an asset sales. In almost every case, this represented a fundamental break
with a national past that emphasized the strategic role of commercial banking in funding the
nation’s economic development, and the national government ‘s key role in planning and
directing that development. (William L. Megginson, 2003). See Table 1.3 for summary
information on banking privatizations (1980-2003) in OECD and developing countries and
table 1.4 for summary information on banking privatization, classified by offering type for
(1985-2003).
1.9. Privatization of Banking Sector in Pakistan
Financial sector significantly altered in early 1970s with nationalization of domestic banks
under the Banks Nationalization Act 1974. The Pakistan Banking Council was set up to act
18
as holding company of nationalized commercial banks and to exercise supervisory control
over them. By end of 1980s, the pre-dominance of public sector in banking and non-bank
financial institutions together with instruments of direct monetary control was contributing
to financial repression, financial sector inefficiency, crowing out of private sector and
deteriorating quality of assets. State Bank of Pakistan role as a central bank had been
considerably weakened due to presence of Pakistan Banking Council. Duplication of
supervisory role was diluting SBP’s enforcement of regulations over nationalized
commercial banks. At the onset of 90s, the Banking Sector in Pakistan was dominated by
the public sector banks, which were characterized by: -
• High intermediation Costs
• Over-staffing and over-branching
• Huge portfolio of non performing loans
• Poor Customer Services
• Undercapitalized
• Poorly Managed/Narrow product range
• Averse to lending to SMEs/ Housing and other segments
• Undue interference in Lending, Loan recovery and personnel issues.
The dominance of public sector banks at the beginning of the nineties was apparent with
a share of 92.2 percent in total assets (See Table 1.4) of the banking sector. The
remainder belonged to foreign banks, as domestic private banks did not exist at that
time. Similarly, high shares existed for deposits and equity of the public sector banks.
With these characteristics, the banking sector at the end of FY90 did not provide a level
playing field for competition and growth.
19
Table 1. 2 Pre-Privatization Structure of Banking Sector in Pakistan
“The Government of Pakistan has decided to privatize the public sector banks because of
lack of financial discipline owing to undue political interference in the financial
intermediation process. The public sector banks were the major sources of bad loans,
accounting of 90% of bad loans in the entire system, and were the main loss makers.”
(Ishrat Hussain, 2003). Public sector banks were used for politically motivated retribution
and game of horse-trading on national and provincial level.
The privatization process initiated in the early 1990s as part of economic reforms
programme and in 1991, Privatization Commission was established for disposing state
owned enterprises. The mission statement of Privatization Commission of Pakistan clearly
shows the objectives of privatization.
“Privatization is envisaged to foster competition, ensuring greater capital investment,
competitiveness, and modernization, resulting in enhancement of employment and provision
of improved quality of products and services to the consumers and reduction in the fiscal
burden.” (PC Annual report, 1998)
20
Government of Pakistan has divested two banks in 1991 namely Muslim Commercial
Bank and Allied Bank of Pakistan Limited. Privatization of banks was aimed to
strengthen the sources of governance and financial discipline and minimize the political
interference through an amendment in law.
In the light of mission statement of Privatization Commission, I have selected these two
banks as a case study to evaluate, whether the objective of privatization was achieved or
not. I have examined the efficiency, impact on economy, employees welfare and products
and services of these two banks for pre- and post privatization period. I have also studied
some legal aspects of the privatization process in Pakistan.
1.9.1. Muslim Commercial Bank
This was the first bank in the public sector to be privatized. On April 6, 1991, 26 percent
shares of MCB were sold to the National Group at a price of Rs56 per share for an
amount of Rs838.8 million on an “as is where is” basis. As a result of this transaction, the
Federal Government suspended the application of the provisions of the Banks
(Nationalization) Act, 1974 except for the section 5(6)(a) to the Bank for a period of six
months.
As part of the Sale Agreement between the Government of Pakistan and the National
Group, a further 25 percent of shares were offered for subscription to the public on
February 19, 1992. Consequent upon completion of divestment of 51 percent shares of
MCB, the application of Banks (Nationalization) Act, 1974, ceased on MCB. Later
National Group purchased additional 24 percent shares of MCB on December 31, 1992,
at a price of Rs56.15 per share thereby increasing their shareholding to 50 percent of the
total shares of the bank. Further shares of the bank were sold in January 2001, November
2001 and October 2002, for proceeds of Rs1.3 billion.
21
Figure.1.5
Source: Policy Consideration Before Bank Privatization-Country Experience by Dr. Ishrat Hussain Governor
State Bank of Pakistan
1.9.2. Allied Bank Limited
The Allied Bank was the second bank in the public sector to be privatized. Unlike MCB,
which was sold to a strategic buyer, ABL was privatized through an Employee Stock
Ownership Plan (ESOP). On September 9, 1991, 26 percent shares were sold to the
Allied Management Group, which represented the employees of ABL at a price of Rs70
per share. On August 23, 1993, another 25 percent shares were sold to AMG at a price of
Rs70 per share. This resulted in transfer of ownership from the Government of Pakistan
to AMG and the application of Banks Nationalization Act 1974 ceased to be applicable.
In 1999, it transpired that one of ABL’s major defaulters had purchased about 35-40 % of
ABL shares from employees. Subsequently in July 1999, the State Bank imposed
restrictions on the transfer of shares from employees to non-employees except with prior
approval from the SBP. On August 3, 2001, the SBP removed the Chairman and three
Directors from the Board of ABL, who were also employees of ABL, as they were found
22
to be working against the interests of ABL and its depositors and appointed a new Board
to look after the affairs of the bank.
In the backdrop of this situation, the State Bank proposed to the Privatization
Commission to exclude the name of ABL from the list of privatization and transfer the
strategic sale of ABL to the State Bank of Pakistan. Consequently, ABL was excluded
from the list of privatization and the strategic sale of the remaining 49 percent
government share was transferred to the SBP in April 2003. The State Bank initiated the
process of reconstruction of the bank and transfer of its ownership to one of the existing
financial institutions in the private sector that will acquire strategic shareholding. In
February 2004, 6 parties were pre qualified by the State Bank for bidding for the 49
percent shares of ABL.
Figure 1.6
23
Figure 1.7
Figure 1.8
Source: Policy Consideration Before Bank Privatization-Country Experience by Dr. Ishrat Hussain
Governor State Bank of Pakistan
24
1.9.3. Overview
The pace of banking development in Pakistan has perhaps very few parallels in the world.
Starting from virtual scratch in 1947, the country today possesses a full range of banking
and financial institutions to cope with the multifarious needs of growing economy.
(.Meenai. S.A)
1.9.4. Historical Background
Historical background of the Pakistan banks may be divided in tree stages.
Since 1947 to 1974 ----Pre Nationalization Stage
Since 1974 to 1991----- Nationalization Stage.
Since 1991 onward---- Privatization Stage.
1.9.4.1: Pre Nationalization Stage
The partition plan was announced on 3rd June 1947; and the 15 of August were fixed as
the date on which the independence was to take effect. In March 1947; there were 3496
offices of Indian scheduled banks in which 487 offices were in the area constituted
Pakistan. The Reserve Bank of India being the central banking authority in India, it was
decided that in the interest of smooth transition it should continue to function in the new
dominion of Pakistan until 30th September, 1948.the decision was taken to help Pakistan
facing administrative and technical difficulties involved in immediately establishment
and operation of central bank.
The events immediately after independence seriously strained the political relations of the
two dominions, and point was reached when it become evident that with out control on its
currency and banking the newly established state of Pakistan would remain exposed to
grave dangers. The banking services in Pakistan were seriously impaired and drastically
curtailed. The banks that had their registered offices in Pakistan transferred them to
25
India. In an effort to bring about collapse of the new state by pursuing a deliberate policy
of withdrawal, the Indian bank offices closed quickly. (Hussain Zahid 1955). Those
banks, which stayed, operated only in name pending the winding up of their business.
Therefore, the number of scheduled bank offices thus declined from 487 before
independence to only 195 by 30th June 1948.
Pakistan banking system at that time consisted of 19 non-Indian foreign bank’s small
branches whose policies and operations were controlled from their head offices. These
banks were not interested in the economic fortune of newly born state. There were just
two Pakistani banks the Habib Bank that has transferred his office from Bombay and
Australasia Bank, which had been functioning in Pakistan territories prior to June 1947.
Government of Pakistan has provided different facilities to restore their confidence.
Finally under banking companies Pakistan Ordinance 1947, a moratorium of three
months was offered to any bank facing difficulty on account of the panicky withdrawal of
deposits. The situation, however, showed no sign of improvement. The Imperial Bank of
India, which, as the agent of the Reserve Bank of India had been designated as the agent
to the Government of Pakistan for their business, closed down most of its offices. The
few offices, which remained were unable even to discharge the routine function of
accepting deposits and cashing cheques (Ibid). Moreover, the bank declined to purchase
even token amounts of Governments of Pakistan securities on the plea that these
securities were not marketable (Baqai. M.1953). The reserve bank of India refused to
assist the Pakistan Government with an advance against ad hoc securities to enable them
to make essential disbursements such as salaries and other obligations (Hussain .Zahid.
1955). Its conditions for granting accommodation to the Government of Pakistan were
extremely stringent. Further to appreciate its difficulties, it withheld Pakistan’s share of
Rs. 75 crore in cash balance held by the undivided Indian Government at the time of
partition (Ibid). On the basis of above mentioned problems Government of Pakistan felt
to set up own central bank and take control of banking in its own hands. A committee
was immediately set up to formulate a scheme of central banking legislation for Pakistan.
The committee was of view due to shortage of trained personnel it would be difficult to
run central bank properly so it was recommended that currency board should be
26
established till to cover the trained personnel to operate the state bank of the country.
However, Government of Pakistan took bold step about setting up of full-fledged central
banking authority. Among other factors, which led to this decision, there was the fact that
banking facilities in the country had been totally disrupted and there was urgent need for
their rehabilitation, which a central bank alone could meet. A Banking Companies
(Control) Act was passed in December 1948, specifically empowering the State Bank to
control the operation of banking companies in Pakistan.
An equally urgent task to which the new central bank had to address itself was the
creation of the national banking system. The state bank recommended to government
that anew banking institution be set up to serve as an agent of the state bank. A
scheme was prepared for the setting up of the National Bank of Pakistan and bank
was set up under an ordinance in November 1949. Governor of State Bank was
appointed to head the Board of Directors in 1950. Under the fostering care of State
Bank and with the support of the Government, the new institution developed rapidly.
In 1952 the national bank became sufficiently strong to take over the agency function
from the Imperial Bank of India. The State Bank of Pakistan Ordinance took form of
an act of legislature on 18th April 1956. A major step taken in 1962 was the enactment
of a comprehensive banking law to ensure development of banking in the country on
sound lines and safe guard the interests of the depositors. Following the loss of East
Pakistan, and the assumption of office of new government in 1971, bank reforms were
introduced in may 1972. In 1974 the Government Nationalized the State Bank and all
commercial Banks incorporated in or out side Pakistan and were brought under
Government ownership.
1.9.4.2. Nationalization Stage
The People’s Party Government led by late Mr. Zulfiqar Ali Bhutto nationalized
fourteen commercial banks and the State Bank of Pakistan under the Nationalization
Act 1974 on January 1, 1974. Up to December 31,1973 there were fourteen Pakistani
commercial banks which were functioning all over the country and some foreign
27
countries through the network of branches. These were joint stock banking companies
incorporated under the Banking Company Act. The financially weaker banks were
merged with the banks, which were on strong footings. As result of merger of banks,
the following five major banking companies were formed. (Saddiqi, H. Asrar. 1978)
• Habib Bank Limited
• United Bank Limited
• National Bank Of Pakistan
• Muslim Commercial Bank Limited
• Allied Bank Limited.
Figure1.9
Source: Policy Consideration Before Bank Privatization-Country Experience by Dr. Ishrat Hussain
Governor State Bank of Pakistan
The objective of the nationalization was to stop the accumulation of wealth in few
hands. Since the banks have been nationalized, the merits and demerits of the public
ownership of banks continue to be a subject of controversary. The main
considerations behind the nationalization of banks were as under:
28
Concentration of banks credit in few hands.
• Fair distribution of credit.
• Financing of agriculture.
• Credit needs of small industrialist.
• Mobilization of resources.
• Service motive.
• Improvement in efficiency.
• Holding of the price Line.
• Increase in the rate of economic growth.
• Abolition of malpractice.
• Security to the depositors. (Nasir. M. Saeed 1979)
With the passage of time it was proved that the decision of nationalization banks was
wrong. The area that was severely criticized was the falling standard of banking
services and political misuse of credit policy, management and utilization of banks
resources for stabilization of governments. So in 1990 it was decided to divest the
nationalized banks to create competition and improve the efficiency of banking sector
in Pakistan.
1.9.4.3: Post Privatization Stage
Privatization activity has grown in the past ten years, both in terms of number and value
of transactions. In the 1980s there were only a few transactions on average per year, but
by the late 1990s the annual average rose to about 500. Between 1990 and 1999, total
global proceeds amounted to US$850 billion, growing from $30 billion in 1990 to $145
billion in 1999. Developed countries account for the bulk of the proceeds, mainly from
public offerings of large firms in countries of the European Union (Mahboobi, 2000).
See Figure 1.5 for details of global privatization proceeds since 1990-1999(US $ in
29
Billions) and Figure 1.6 for privatization proceeds by region, 1990-2000 (US $ in
Billions).
Figure 1.10: Global Privatization Proceeds (US$ billion)
0
50
100
150
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Non-OECD Countries OECD Countries Total
Source: Mahboobi, 2000.
Figure 1.11 Privatization Proceeds by Region,1990-2000 (US$billion)
55%
21%
14%
3% 4%3%
South Asia
Middle East andNorth Africa
Eastern Europeand CentralAsiaLatin Americaand theCaribbeanEast Asia and
Source: World Bank (2001b)
Large segments of the global banking system have been transferred from state to
private hands over two decades, and much more is poised to be sold in the near future.
Pakistan has to follow the global changes, decided to transfer their public sector
banks to move from state to market economy. The reasons for transfer from state to
30
market economy, two factors stand out as especially important. First, compelling and
overwhelming evidence began to accumulate showing that state ownership was not as
working as planned. The second factor was a dawning realization that this really
mattered—that financial system development promoted economic growth. Pakistan
has already divested two bank namely Muslim commercial Bank and Allied Bank of
Pakistan and is in the process to divest other state owned banks. Rational for
privatization are different in different countries. Some are common for both
developed and developing countries while some are special for developing countries
facing some special problems like fiscal deficit and instructions of world donors.
Pakistan was facing a problem of huge fiscal deficit. Fiscal deficit reached a high of
8.5 percent of GDP in 1987-88. Loss making public sector enterprises were a burden
on the national exchequer. To reduce the fiscal deficit of the country and to obey the
order of the lenders it was decided to privatize the public sector banks in Pakistan.
Figure 1.12
31
Common Reasons for launching bank privatization not only in Pakistan but
worldwide were:
SOE manager will have weaker and/or more adverse incentives than managers of
privately owned firms, and thus will be less diligent in maximizing revenues and
especially minimizing cost.
State enterprise will be subject to less intense monitoring by owners, both because
of collective action problems—potential monitors have less incentives to careful
observe managerial performance because they bear all the cost of doing so but
reap only a fraction of the rewards—and because there are few effective methods
of effectively disciplining SOE managers in the event that sub-par performance is
detected.
The politicians who oversee SOE operations cannot credibly commit to
bankrupting poorly performing SOEs, or even to withholding additional
subsidized funding, so state enterprises inevitably face soft budget constraints. It
bears repeating that these criticisms of state ownership are valid even if one grants
that the politicians who create and supervise public enterprises have benevolent
intentions.
The final and in many ways most compelling, critique of state ownership is that
SOEs will be inefficient by design, since they are created specifically so that
politicians can use them to benefit their own supporters at the expense of another
group in society. Numerous researchers –including Vickers and Yarrow
(1988,1991), Stiglitz (1994), Nellis (1994) and Boyko, Shleifer and Vishny,
(1996a,b), Shleifer (1998), Sappington and Sidak (1999) and Shirley and Walsh
(2000)—note that state enterprises can be remarkably effective tools of
redistributive politics. Since state firms answer to political masters, rather than
the market, wide divergences from profit-maximizing behavior are not only
32
possible, they are in fact desired. Even in fully competitive markets, Shleifer and
Vishny (1994) show that SOEs will be inefficient because politician force them to
pursue non-economic objectives, such as maintaining excess employment,
building factories in politically (but not economically) desirable locations and
pricing out puts at below market clearing prices. The case of Mehran Bank and
Gadoon industrial state is best example of political interference in state owned
enterprises in Pakistan.
Table: 1.3 Summary Information on Banking Privatizations, 1980-2003
in OECD and Developing Countries.
Source: Boehmer, Nash and Netter (2001)
Variables All
countries
OECD
Countries
Non-OECD
Countries
Number of countries 51 33 18
Number of Transactions 270 156 114
Average (median) size per Transaction in US$ Millions
482.66
(44)
247
(85)
710
(376)
Average (median) percent of Enterprise sold in transaction
59.1
(55.0)
46.3
(40.0)
49.6
(41.7)
Percent of transactions through Public share offering
37.9 43.6 50.1
Total value of all transactions in
US$ millions
1161558 38473 80897
33
Table: 1.4
Summary information on banking privatizations, classified by Offering Type,
1985-2003
Methods of sale Number of
transactions
Value (US$ Million)
Share issue privatization 144 76187.85
Asset sale 139 66714.74
Total 283 142902.59
Source: Megginson (2003)
1.10. Objective of Privatization of Banks in Pakistan
To undertake restructuring of financially distressed banks.
Reduction in fiscal deficit
To foster competition
Broad basing of equity capital
To improve saving mobilization and enhance the efficiency of credit
allocation.
To enhance the soundness of the banking system through an improved
regulatory and supervisory framework.
To develop money and capital markets.
To minimize the ratio of non-performing loans.
34
The objectives of privatization of banks can be achieved if the following principles
are adopted for privatization process in Pakistan:-
• Privatization should be viewed as good governance reforms.
• Privatization program must be an integral part of a country’s economic policy.
• Privatization program must include a strong institutional and regulatory
framework.
• The environment must be competitive, regulated and transparent.
• Deregulation of the financial system should precede privatization.
• Regulation is required only where restructuring unable to ensure a fully
competitive industry.
• Rehabilitation prior to privatization should be avoided.
• Privatization programs should be accompanied by extensive public awareness
campaigns.
• Privatization programs should be complemented by comprehensive social
welfare programs.
1.11 Scope of the Study
The study relates to two banks (MCB and ABL) previously working as a public sector
banks and later on privatized. The reason for selection of these two bank was availability
of data for both pre and post privatization period. In some areas banking sector as whole
is taken as per requirement of the study. The maximum portion of the study is based on
secondary data (published data) while in some portion primary data is used.
The study covers 30 customers of each bank in three districts representing 30% of entire
population, which are mentioned in the methodology. The sample consisted 10 % of
higher educated customers, 10% businessman and 10% of common customers. The
sample has also categorized on the nature of the area, 70% of customers were located in
the urban area, 30 % were in semi urban areas of these three district.
35
1.12. Objectives of the Study
Bank privatizations are among the biggest challenges facing many governments
around the world. Government of Pakistan is facing the same challenge. The claim of
the government about privatization of banks is to establish a more efficient and
market-oriented economy, reducing the influence of the state on credit allocation,
appointment and managerial policies of the banking sector.
The study at hand surveyed the efficiency after privatization of two banks selected as
a case study, its impact on economy, impact on employees and customer’s welfare.
Other issues and questions that are addressed in this study are legal framework for
privatization of banks in Pakistan. Main Objectives of the study include: -
First, most assessments of privatization have looked at financial and operational
performance at the bank level, comparing efficiency and profitability before and
after privatization, changes in performance, investments, capacity utilization, and
the like. The study provides ample evidence that, when done right, privatization
improves performance in many different settings in many different ways.
Second, there is a limited but growing body of work about the fiscal and
macroeconomic effects of privatization showing positive fiscal benefits and a high
correlation between privatization and growth.
Third, growing analysis of the employment and broader labor market impacts
shows that privatization does not always lead to unemployment, but that the
outcomes are mixed, reflecting country and industry differences. When evaluated
against the counterfactual, privatization has often led to employment increases at
both the enterprise and industry level.
36
Fourth, the broader welfare and economic consequences of privatization of banks
are not as widely studied, though the few rigorous evaluations show that
privatization of banks has done well, and that the customers welfare effects when
compared to realistic counterfactuals have been positive, often substantially so.
Fifth, the legal effects of privatization of banks on the banking law of the country
are the least studied aspects of privatization⎯though considerable work on these
questions is now in progress.
1.13 Methodology The proposed research is intended to survey the process of privatization of banks in
Pakistan and assess its impact on the efficiency of two banks selected as a case study.
The central issue I have addressed is the impact of privatization that has taken place so
far on profitability and performance of privatized banks. Going beyond this, I attempted
to understand what explains the impact of privatization on performance. The study also
addressed the impact of privatization of banks on economy, employment, customers and
regulation.
The research out put will comprise the following.
1. Introduction of the study
2. A survey of the literature on privatization banks, particularly with respect to less
developed countries.
3. Impact of privatization on firm performance
4. A review of the role of the banking sector in the Pakistan economy
5. Explanation for the impact of privatization of banks on employment
6. Customer views about privatization of banks in selected districts for the study
7.Assessment of mechanisms of corporate governance in Pakistan
8. Conclusion and summary of the study
37
Methodology is a set of procedures that enables researcher to observe the deduced
theoretical relationship between different variables qualitatively or quantitatively.
Methodology in this research work hinges upon two lines, one qualitative and the other
quantitative. The qualitative aspect is based on the theoretical background of
privatization of banks, reasons and causes of privatization, targets and objectives as well
as the methods and techniques of privatization of banks used in different countries and
their results.
I have also used semi structure interview to collect information about customers’ views
and opinions of both banks selected as a case study for both periods (pre- and post
privatization periods). Questions prepared and asked during interview were based on
performance, services and products of the banks before and after privatization.
In qualitative aspect we have also analyzed privatization of banks and its impact on
employees on the basis of numbers of employees and branches. Legal impact is also
touched in this aspect.
In case of quantitative, DEA, theoretical framework, ratios, regression, correlation,
coefficient determination and statistics z test have been calculated.
1: Published data (Secondary Data) is used to analyze the performance with
following financial tools and techniques.
To investigate the efficiency of two banks Muslim Commercial Bank of Pakistan
Limited (MCB) and Allied Bank of Pakistan Limited (ABL) because the data on
these two banks was available for both pre- and post privatization period. A
researcher has used published date taken from annual reports of both banks for
analysis. A researcher has also analyzed the banking sector of Pakistan as a whole
selected banks specifically. I have used Data Envelope Approach, theoretical
38
framework and financial ratios, used by Sam Q. Ziorkklui et al Howard
University (2003). They have developed a comprehensive index of banking
efficiency and performance that is expressed as the word “TARCSIMEL”, used
for analyzing efficiency and general performance of banking institution in Ghana.
I have also calculated the different ratios for three banks MCB, ABL, and UBL as
a cooperative study between public and private sector banks in Pakistan. Financial
ratios are calculated for five years pre- and post privatization period of UBL,
ABL, and MCB (19986 to 1990 and 1996 to 2001). The analysis of financial
statements are consisted the study of relationships and trends to determine
whether or not the financial position and financial progress of the banks are
satisfactory or unsatisfactory.
Analytical methods and techniques which were used in financial statements, include
the following
Comparative balance sheets, income statements, and other statements showing: -
Absolute data (In rupees amounts)
Increase and decrease in absolute data (in rupees amounts.)
Increase and decrease in absolute data (percentages)
Comparison expressed in ratios.
Percentages of totals
39
2:Overall cost and benefit analysis
I have evaluated the privatization of banks and its impact on economy using the
data of schedule banks at country level as well as for two banks. I have used
different methodologies to assess the relationship between banks and economic
growth. Work of assessment of connection between banking sector development
and sources of economic growth are available in the economic literature. (See
king and Levine 1993b; and Levine and Zerovs 1998). I have selected the
deposits, credits and advances, investment and GNP as sources of economic
growth. We have developed two hypotheses and then the correlation and time
series between the sub hypotheses were calculated to see significance of
correlation/regression.
I have collected the data about the numbers of employees, numbers of branches
and total operating expenses of two banks for pre-and post privatization period. I
have measured the impact of privatization on employees quantitatively (numbers
of workers unemployed, numbers of new jobs created etc.)
3: Primary data is used in research
To evaluate the privatization of the banks and its impact on customers, I have carried a
semi structure interview to collect data about customer’s views about privatization of
banks in Pakistan. A series of questions were designed to examine the customers
satisfaction with bank services, confidence on banking sector in Pakistan, use and
40
knowledge of bank’s new products etc. etc. The sample selection of bank account
holders was based on random selection of bank account holders at bank premises during
the normal business hours of the bank.
The procedure used for collection of primary data
Thirty accounts holders of the selected banks were used as sample in the three
districts of NWFP where as the population was all accounts holders of MCB
and ABL.
Semi structured interview schedule was prepared to collect data of customers
views about these two banks for pre- and post privatization period.
District selected, as sample areas were Peshawar, Mardan and D.I Khan.
The reason for selection of three district of NWFP was: -
The three districts were easily accessible.
Customers of both types were available, i.e. business and non-business
accounts holders.
4: Legal and political effects of privatization of banks were analyzed.
Table 1.5
41
Research Paradigm
Efficiency
Economic Impact Impact on Eco. Development t Impact Customer Impact Summary &
Conclusion
Overall Introduction of the Study
Secondary / Published Data is Used
Introduction
DPA/Theoretical Framework /
Ratio Analysis
Findings
Conclusion
Introduction
Secondary / Published Data is used
Hypothesis are developed
Statistical Methods are used
Findings
Introduction
Secondary / Published Data is Used
Hypothesis are developed
Findings
Conclusion Conclusion
Introduction
Primary Data is used
Semi Structured Interviews
Findings
Conclusion
Conclusion
Recommendat
Points for further Research
Privatization of Banking Sector in Pakistan A Case Study of MCB and ABL
Legal Impact
Introduction
Secondary Data is
Findings
Conclusion
42
CHAPTER: 2
LITRATURE REVIEW 2.1 Introduction Financial sector reforms and liberalization was set in motion in mid-eighties and its pace
was accelerated in 1990 when the economy suffered from a precariously low foreign
exchange reserve, burgeoning imbalance on the external account, declining industrial
production, galloping inflation and a raising fiscal deficit. Financial sector in the next
millennium reforms, being integrated process, including deregulation of industry,
liberalization of trade, exchange rate and tax policies, partial/complete disinvestments of
government holding in public sector companies and financial sector reforms. The
problems of Pakistan’s banking sector were rooted in a failure of governance and lack of
financial discipline owing to undo political interference in the financial intermediation
process, especially in the NCBs and DFIs. The NCBs and DFIs were the major sources of
bad loans, accounting for 90% of bad loans in the entire system, and were the main loss
makers. The objective of the banking sector restructuring and privatization is to achieve
competitive banking system, strong regulatory framework and an effective count banking
system.
2.2 Privatization of Banks and its Impact on Efficiency
Within the banking sector, efficiency is the core concern of both academics and bank
officials. A number of studies have sought to measure the efficiency of financial
institutions, to identify the factors that contribute to efficiency of financial system, and to
recommend the ways to attain the peer group efficiency levels (Berg, (1993); Leaven,
(1999); Berger and Mester, (1997); Miller and Noulas, (1996). Abid A. Burki and
Ghulam Shabir Khan Niazi (2003)
Efficiency of financial service firms and the strategy being followed by them is largely
reflected through the information condensed in their balance sheets and profit and loss
43
accounts. Oral and Yolalan (1990) have discussed the critical issues in efficiency of
service organizations like banks using the DEA approach. They have studied the
efficiency of 20 banks in Turkey. They used number of bank transactions as output of
banks while labour, number of accounts and credit applications were considered to be the
inputs.
Megginson, Nash, and Van randenborgh (1994) compare three years average post-
privatization financial and operating performance ratios to the three years pre-privation
value for 61 firms from 18 countries and 32 industries from 1961- 1989. Tests
significance of median changes in post versus pre-privatization period. They found that
economically and statistically post privatization increases in output, operating efficiency,
and profitability. Boubarki and Cosset (1998) compare three years average post
privatization financial and operating performance ratios to the three years pre-
privatization value for 79 companies from 21 developing countries giving the same result
that post privatization operating efficiency and profitability is improved. D’ Souza and
megginson (1999) carried a study 78 companies 10 from developing and 15 from
developed countries over the period of 1990-94. The findings of the study are showing
improvement in the post-privatization period.
Verbrugge, megginson and lee (1999) study 65 banks fully or partially privatized from
1981-to 1996. Then compare pre and post privatization performance for 32 banks in
OECD countries and 5 in developing countries. The result of the study is showing
moderate performance improvements.
Beck, Cull and Jerome (2003). Examine the effect of privatization on performance using
an unbalanced panel of 69 banks with annual data for the period of 1990-2001. Finding of
the study is showing positive impact on efficiency due to privatization.
Chen and Yeh (1998), where operating efficiency of 33 banks in Taiwan is measured.
They have used the DEA approach to measure such efficiency using the factors like loan
services, portfolio investment, interest income and non- interest income as banking
output while factors like staff employed, bank assets, number of bank branches, operating
costs and deposits as inputs.
44
Sathye (2001) provides an extensive account of x-efficiency analysis of 29 Australian
Banks. He has used two outputs and three inputs with their respective prices as well in his
quest for x-efficiency analysis. The outputs included loans and demand deposits while
inputs represented labour, capital and loan able funds. Per capita expenditure on
employees, per capita expenditure on premises and fixed assets and average interest
expense on deposits were treated as input prices.
Mukherjee, et al. (2002) has investigated the relationship between strategic groups and
firm performance in terms of efficiency for 68 Indian Banks. They have used the
financial variables like net profits, deposits, advances, non- interest income and interest
spread as output of banks. Inputs include net worth, borrowing of the banks, operating
expenses, number of employees and number of bank branches. Jemric and Vujcic (2002)
have used the DEA approach to estimate the efficiency of 48 Croatian commercial banks.
They have used three inputs, which include fixed assets and software, number of
employees and deposits. The two outputs used were total loans extended and short-term
securities.
These empirical findings suggest a healthy competitive financial market pave the way for
efficient market participants that lead to overall efficiency of the system and improve
performance and productivity. Some empirical tests have been carried out to measure
effects of liberalization and deregulation of financial institutions on efficiency and
productivity of banking sector. The results of these studies were across the countries.
Berger, Hunter and timme (1993) and Kaparakis, Miller and Noulas (1994).
After liberalization of seventies in United States, many studies have sought to measure
banking efficiency, Miller and Noulas (1996); Kaparakis, Miller and Noulas (1994); and
Elyasiani and Mehdian (1990); Humphrey and pulley (1997); Berger and Humphrey
(1991) Drake (2000).
In Turkish Banking industry, after financial liberalization, efficiency regress has been
reported. Moreover private and foreign owned banks did not perform better than the state
owned banks, Denizer, Dinc and Tarmcilar (2000). In Tunisian banking sector after
liberalization no significant efficiency improvement have been observed but private
owned banks were efficient than the public sector banks, Cook, Hababon and Roberts
45
(2001). In China, the efficiency gains have been observed, Bhattacharyya, Bhattacharyya
and Kubbhakar (1997). Recently Hardy and Patti, (2001) came up with the findings that
some efficiency improvements have been recorded in case of Pakistan.
2.3 Privatization of Banks and its Impact on Economic Growth
It has been long debated in economic literature whether financial markets play a
significant role in the economic growth and development. Gertler (1988); and Levine
(1997). Findings of some recent empirical literature show that well functioning financial
system plays an instrumental role in economic growth, and causality runs from finance to
growth, for cross country evidence see king and Levine (1993, 1993a); Levine and
Zervos (1998), Levine, Loayza and Beck (1999); Beck, Levine and Loayza (1999).
LaPorta, Lopez-deSilanes,Shleifer(2000a) Using data from 92 countries, examines
whether government ownership of banks impacts level of financial system development,
rate of economic growth, and growth rate of productivity. Find that government
ownership is extensive, especially in poorest countries, that these holding retard financial
system development, and restrict economic growth rates, mostly due to impact on
productivity.
There is now little doubt that financial sector in general, and banking in
particular, plays an important role in fostering the economic development of
a nation. Developed banking system is indispensable for modern commerce
and modern commerce is necessary for economic development. Rajan and
Zingales (1998)
Important recent papers in this literature are Demirguc-Kunt and
Maksimovic (1996,1998), Levine (1997), Demirguc-Kunt and huizinga (1998),
Wurgler (2000), Cetorelli and Gambera (2001) and Beck,Demirguc-Kunt and
Levine (2003). Related papers stress the importance of the creating the
proper legal and regulatory framework for encouraging the development of
efficient, liquid banking and capital markets. This literature is largely
46
encompassed in a series of articles by La Porta and Lopez-de-Silanes (1999)
and La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1997,1998,2002).
The basic themes that emerge from these research streams are that an
efficient financial system is vital.
Economic reform/privatization in broad sense can be defined as the
transformation of the economic system as a result of actions of the
government (Bruno, 1989), which alter the institutions that regulate
economic interactions and behavior (North, 1990, Scott, 1995).
Economic reforms have in general taken in three forms depending on the
initial condition of the country.
Movement from high state intervention to low state intervention in the
economy, which advanced capitalist countries such as the UK and Spain
underwent in the 1980s and 1990s (Baily, 1986, Peltzman, 1989, Winston,
1993,1998).
Transformation of communist based or command-based economic systems
towards capitalist-based or market based ones as the case of former Soviet
Block (Aslunde, Boone, and Johnson, 1996; Blanchard, 1997; Brada, 1996,
Peng, 2000; Sachs, 1996; Svenjar, 2002)
Replacement of import-substitution policies with more open market models of
economic models of economic development, as took place in much of Latin
America and South Asia during 1990s. (Bruton, 1998; Dornbusch, 1992;
Edwards 1993; Reinhardt and Peres, 2000; Sachs and Warner, 1995).
In these all three types of reforms the basic objective is to reduce the
government intervention in the economy. Three forms of reforms were taken
for reduction in tendency of government intervention in economy were:
• Privatization (Vickers & 1988; Zahra et al., 2000)
• Deregulation (Winston, 1993, 1998).
• Liberalization (Cooper, 1982; Norman & Thisse, 1996)
47
2.4 Privatization of Banks and its Impact on Employees Despite the extent of privatization worldwide, little attention has yet been paid in policy
and the academic literature to its impact on labor (Beck, Johanson and Fretwell 1995;
Hess 1994; Svejnar and Terrel 1991; Van der Hoeven and Sziracki 1997). In India
Pakistan and Turkey, public enterprises were estimated to be overstaffed by nearly 35%
in the early 1990.(Banerji and sabot, 1994). Overstaffing is most pervasive in enterprises
that have operated monopolies with heavy government subsidies and other form of
protection.
Galal, Jones, Tandon,and Vogelsang, (1994) compare actual post-privatization
performance of 12 large firms mostly airlines regulated utilities in Britain,Chile,
Malaysia and maxico. Find no case where workers were workers were made worse off,
and three where workers were better off.
Loretta de Luca (ed.): International Labor Organization, Geneva, November, (1997)
giving details of privatization and restructuring experience of infrastructure utilities in
Africa, the Americas, Asia and Europe, examining the impact of privatization and
restructuring on employment levels and employment conditions, and identifying factors
that facilitate successful reform.
Sunita Kikeri, World Bank Technical Paper No. 396. World Bank, Washington, D.C.,
February (1998) in her paper examining the effects of privatization on labor, and
analyzing the mechanisms that government can use to minimize the political and social
costs of labor restructuring in privatization. Robin Johnson, E-brief 112. Reason Public Policy Institute, Los Angeles, March (2001) In his paper examines evidence from the United States that privatization does not
necessarily require massive public-sector layoffs, citing several studies where
privatization has resulted in few, if any, layoffs, and suggesting that public employees
can actually benefit in the long term from private-sector management.
48
Gopal Joshi (ed) International Labour Organization, Geneva, (2000) using five countries,
(Bangladesh, India, Nepal, Pakistan and Sri Lanka) as examples, this paper looks at how
the rationale for privatization and preparations for privatization affect social costs and
worker dislocation – arguing that the success of privatization depends on the
effectiveness of mechanisms for social dialogue between workers and employers.
Patrick Belser and Martin Rama Policy Research Working Paper 2599. World Bank,
Development Research Group, Washington, D.C., April (2001) are in a view that
privatizing or restructuring state-owned enterprises may lead to mass layoffs, but the
number of redundant workers is usually unknown beforehand. This paper estimates labor
redundancy by comparing employment levels across enterprises with different degrees of
state ownership.
2.5 Privatization of Banks and its Impact on Customers
The focus of most studies is efficiency and profitability of the privatized business and, to
lesser extent, the quality of the services it delivers (Hodge, 1996). No direct work is done
in this area except the Sam Q. Ziorkui etal, Howard University Discussion paper No 81
February (2001). He interviewed the customers about changes in banking services and
products after privatization of banks in Ghana.
2.6 Privatization Bank and Regulation
Government has changed the legal environment with change in banking environment in
Pakistan.
49
Chapter 3
The Impact of Privatization on Efficiency of Banks
3.1. Introduction
The emergence of fast paced dynamic environment in business world in general and
financial services sector in particular, has highlighted the significance of competition and
efficiency. The need for deregulation has become a touchstone of success in fostering
both competition and efficiency especially in the economies, which are exposed to
structural reforms. In addition to that, intense competition both among domestic and
foreign banks, rapid speed of innovations and introduction of new financial instruments,
changing consumer’s demands and desire for product augmentation have changed the
way a bank conducts business and services its customers. Larger the degree of
competition, it is perceived that the firms would become more efficient. However, when
the structure of an industry is product of the government regulations, the degree of
competition is impaired markedly implying that the efficiency suffers negatively. (Hanif
.M. Akhtar, 2002)
Analysis of financial institutions in developing countries in the light of changes taking
place in their structures and regulatory environment has immense value for regulators,
policy makers, managers and investors. In particular, how these policy reforms affect
efficiency of banks in developing countries has a wider appeal. Over the past decade a
number of developing countries have embarked on a reform path and have witnessed
improvements in their financial systems while others are contemplating on doing so. But
there is no reason to expect that impact of reforms on performance would be positive and
uniform across countries. In particular, it is not obvious how the reform process is
influenced if economic growth environment in the country is not conducive. (Burki
.A.Abid et al, 2003)
In fact, there are many previous studies discussing the efficiency and economies of scale
in the banking industry. For example, Berger, Leusner and Mingo (1997) investigate the
50
branch efficiency of U.S. large commercial banks from 1989 to 1991, by separately
estimating frontier-flexible and translog cost functions for several years. Their evidence
shows that banks are likely to over-branch twice as many as the possible cost minimizing
level, and technical inefficiency, namely X-inefficiency, amounts to about 20% of their
operation costs. Berger and Hannan (1998) also in part examine the U.S. bank efficiency,
concluding that the efficiency cost (i.e. X-inefficiency) resulting from a lack of market
discipline is much larger than the deadweight welfare loss due to misallocation by
monopoly power. (Saunders, Scalise and Udell (1998)
Battese, Heshmati and Hjalmarsson (1998) examine the efficiency of labor utilization in
the Swedish banking industry, using the stochastic frontier analysis (SFA). Regressing
the labor input on the outputs of financial services such as loans, guarantees, and
deposits, and the quasi-fixed input such as branches, given one-sided stochastic
inefficiency and idiosyncratic noise, they show that technical inefficiency of the banks in
their use of labor is on the average 12% above the stochastic frontier. Further, the
technical inefficiency increased immediately after the reform in the banking industry in
the mid-1980s, and then has decreased due to the reform effect since 1991. Adams,
Berger and Sickles (1999) perform stochastic panel distance frontier estimation, using the
data of over 2500 U.S. banks over 10 years. The estimation of the Cobb-Douglas
production functions indicate that technical efficiency scores normalized by the most
efficient bank are quite small and range from 53.5% to 54.3%. (Atsushi Iimi, 2002)
Banking industry acts as life-blood of modern trade and commerce acting as a bridge to
provide a major source of financial intermediation. Thus, appraisal of its efficiency is
vital in context of an efficient and competitive financial system. Study of x-efficiency is
believed to be important in particular as Berger et al. (1993) found that x-inefficiencies
account for around 20% or more of banking costs. Similarly, recent drive among banks
towards downsizing, rightsizing and rationalization of banking costs also implicates for
the assessment of x-efficiency analysis of banks. It becomes vital in Pakistani context, as
there appears to be no study in literature on efficiency or x-efficiency analysis of banks in
Pakistan. “A great deal more work is needed on x-efficiency research in banking.
Managerial efficiency, the concept of x-efficiency, appears to be a much more important
51
strategic and policy consideration” (Molyneux et al., 1996.) Given the significance of x-
efficiency analysis, a study on Pakistan would be relevant and useful both to the
executives of banks and policy makers in the economy.
The concept of x-efficiency consists of two components: technical efficiency, which
reflects the ability of a firm to obtain maximum output from a given set of inputs, and
allocative efficiency, which indicates the ability of a firm to use the inputs in optimal
proportions, given their respective prices. The study carried by Hanif. M. Akhtar, (2002)
calls for the improvement in efficiency of Pakistani banks through combined efforts of
banking sector and the government to be at par with the best world practice. The results also
support the on going process of privatization of public sector banks in Pakistan.
Burki.A.Abid et al, (2003) have investigated the impact of policy reforms on performance
of commercial banks with a unique panel data from Pakistan’s banking sector over the
period 1991– 2000. For analytical purposes, banks were divided into three categories,
namely: state-owned, private and foreign banks. They have applied the non-parametric
DEA method to measure performance by cost efficiency and isolate the contribution to
cost efficiency of allocative efficiency, technical efficiency, and pure technical efficiency
and scale efficiency. They found that banking efficiency has varied over the study period
from highest efficiency in 1991 to lowest efficiency in 1996. Investigating the source of
mean cost inefficiency they found that allocative inefficiency contributes more than
technical inefficiency. The highest levels of efficiency were achieved by foreign banks
followed by private banks while state-owned banks achieved least cost efficiency. In
second-stage regressions, they also used unbalanced panel data to find determinants of
efficiency. The nature of sampling of banks and econometric tests indicated preference
for the fixed effects model. They have regressed bank-specific efficiency measures for
cost, allocative and technical efficiency on a set of control and policy variables to single
out the impact of policy reforms on banking efficiency. Their results indicate that
efficiency of banks cannot be differentiated on the basis of policy reform of privatization.
Moreover, individual reforms promoting competition led to a decline in average
performance of banks in post-reform period.
52
Realizing the inherent weaknesses of the financial structure that emerged after
nationalization, Government of Pakistan initiated a broad based program of reforms in
the financial sector. Objective of reforms were to create a level playing field for financial
institutions and market for instilling competition, strengthening their governance and
supervision, and adopting a market based-indirect system of monetary, exchange and
credit management for better allocation of financial resources (Ishrat Husain: 2003
Washington DC). The public sector banks in Pakistan have performed poorly: Its after-
tax profitability was much lower than that of the private sector. Its losses contribute to
Pakistan's fiscal deficit. In order to improve the competition and the performance of these
banks, Government of Pakistan has decided to privatize banks in public sector. It is aimed
at making these institutions financially sound and forging their links firmly with real
sector for promotion of savings, investment of growth.
In contrast to its objective of stoppage of accumulation of wealth in few hands, the 1974
nationalization of banks by so called socialist government give birth to institutional
corruption due to political influence, which in turn brought tremendous economic cost to
the national exchequer and eroded organizational efficiency of the sector.
The banking industry in Pakistan has experienced change in its ownership structure, level
of competition, regulatory environment, instruments of market discipline and greater
supervision since 1990. The start was taken from the privatization of two state owned
banks Muslim Commercial Bank limited (MCB) and Allied Bank of Pakistan (ABL ltd)
in 1991.
One major issue facing by researchers and policy makers in developing countries is how
to measure changes in bank efficiency associated with privatization/reform of banks.
Various approaches to defining bank output and input in measuring bank efficiency have
been adopted. In literature, there are two techniques to measure efficiency frontier. One is
econometric based parametric frontier technique proposed by Aigner, et al. The other is
mathematical non-parametric linear programming technique, called Data Envelopment
Analysis (DEA). Burki. A. Abid, Ghulam shabir Khan Niazi and Dr. Muhammad Hanif
Akhtar and syed Fawad Ali razvi for analysis of efficiency of banking sector in Pakistan
after reform/privatization, used these two approaches.
53
This study investigates the efficiency of two banks Muslim Commercial Bank of Pakistan
Limited (MCB) and Allied Bank of Pakistan Limited (ABL) because data on these two
banks are available for both pre- and post privatization periods. (See appendix 3.1) I have
used DEA approach, theoretical framework and financial ratios, used by “Charnes et
al”(1978), to measure the relative efficiency and management performance in the presence
of incomparable multiple inputs and outputs, and Sam Q. Ziorklui et al Howard University
Sam Q.Ziorklui” The Impact of Financial Reform on Bank Efficiency and Financial
Deeping for Savings Mobilization In Ghana (2003) respectively. They have developed a
comprehensive index of banking efficiency and performance that is expressed as the word
“TARCSIMEL” used for efficiency and general performance of banking institutions in
Ghana. I have also calculated the different ratios for three banks MCB, ABL and UBL as a
comparative study between public and private sector banks.
Besides, the application of regression techniques, it would be of interest to use alternative
methods to see the performance level before and after the privatization in banking sector
of Pakistan.
Many researchers conducted efficiency measurement studies. Berger & Humphrey
(1997) gives an account of such studies conducted in twenty-one countries. The traditional
approach towards the efficiency measurement is Financial Ratio Analysis, but this has
remained under attack since long because of relative importance of various types of input
or output used in this method as has been pointed out by Chen & Yeh (1998). Besides, the
method of Financial Ratio Analysis also ignores the ‘value of management actions’ and
‘investment decisions’, which certainly affect future against the current performance.
Mukerjee et al (2002) specifically pointed out the pitfalls of this method. So, other
approaches were developed which include Stochastic Frontier Analysis, Free Disposal
Hull, Thick Frontier and Distribution Free, all based on parametric ideas, while Data
Envelopment Analysis (DEA) approach is a non-parametric based. The DEA approach was
developed by Charnes et al (1978) to measure the relative efficiency and management
performance in the presence of incomparable multiple inputs or outputs.
54
Study is divided in three parts:
i) Data Envelopment Analysis
ii) Theoretical framework used by Sam Q. Ziorklui et al is to
evaluate the efficiency of both banks.
iii) Financial ratios are calculated for both banks and compared
with one public sector bank for evaluation of efficiency.
3.2 Part.1 Data Envelopment Analysis
Hanif. M. Akhtar has used DEA for all banks of Pakistan including foreign banks. The
results of the study are showing improvement in efficiency of private banks.
Source: Hanif M. Akhtar 2002, X-E efficiency analysis of commercial banks in Pakistan: A preliminary investigation. Pakistani banks are found to be utilizing the inputs (deposits and capital) and outputs
(portfolio investment and loans & advances) in an optimum manner as the allocative
efficiency appeared to be very high. The banks need to be consistent in this drive and
share the benefit of increased efficiency with their clients.
Private banks in Pakistan emerged as efficient on both fronts i.e. technical efficiency and
55
allocative efficiency, compared to their counterparts, the public and foreign banks. Result
on the foreign banks is converse to expectat ions. An implication of the results might be
the fact that most of the foreign banks in Pakistan often target a niche market that is
corporate sector, which is more volatile and might make them inefficient. The high
efficiency of private banks can be attributed to the fact that these banks have an extensive
branch network, distribution power and a stable retail market size. Relatively lower
efficiency of publicly owned banks alludes to the common perception that these banks are
less efficient due to lack of motivation and performance-based earnings among employees of
these banks. This supports the latest drift towards denationalization and privatization of
public sector banks in Pakistan. (Hanif. M. Akhtar, 2002)
On the same pattern DEA analysis of two banks selected as a case study is calculated. Both
are showing efficiency improvements.
Table No. 3.1 Summary Measures For Efficiency Calculations
1987 - 1991
MCB Before Privatization
Inputs Assets (Rs.Millions)
Mean Variance Standard Deviation Estimated Standard Error of mean
year 1986 1987 1988 1989 1990 1997 1998 1999 2000 2001 Return of Assets % of income to Assets
0.273 0.264 0.234 0.194 0.179 1.832 8.753 3.445 NA NA ABL
Return of equity % of income to capital
8.076 6.295 6.269 4.862 3.738 0.477 1.834 0.700 NA NA
72
• To meet short term expenses of the banks
Researcher examined the following proxies:
• Cash as ratio of demand deposits
• Liquid funds/total deposits
• Liquid funds as ratio of total assets.
The study shows that cash ratio of demand deposit for MCB remain stable while for ABL
there has been slight decrease.
Liquid funds for total assets of MCB are increased from 70.80% in 1987 to 123.19% in
2001but ratio for ABL is showing higher fluctuation. Liquid funds as ratio for total assets
is concerned are showing improvement for MCB i.e. 44.17 in 1987 and 101.78 in 2001.
The same ratio for ABL is also showing increase that is 42.50 in 1986 and 52.02 in 1999.
The liquidity ratio for banking sector is also showing improvement due to SBP prudential
rules. (See appendix 3.5)
Table. 3.12
Source: Annual Report of State Bank of Pakistan.
73
Part 111
Ratio Analysis
3.4 Comparative Study of Private VS Public Sector Banks
3.4.1 Introduction
Pakistan undertook ambitious financial reforms in the early 1990s in an effort to establish a
more market-based system of monetary management. These reforms have included such
measures as the liberalization of interest rates, the removal of quantitative controls on
lending, the lifting barriers to competition, the privatization of public financial institutions,
and the introduction of market based securities. The principal aims of the reforms have
generally been to raise both the level of investment and the efficiency of its allocation and to
enhance provision of financial services to all sectors of the economy. MCB and ABL are
privatized with the same consideration. In this paper we have analyzed performance of the
MCB and ABL to make comparison with similar bank but working in Public Sector.
Privatization of UBL is announced but due to some reasons the bank is still working under
control of Government.
Different techniques can be used to make comparison between different firms or different
divisions of the firm. We have selected Ratio analysis technique for comparative study of
three banks one in public sector and other two in private sector. Ratio analysis is age-old
technique of financial analysis and helpful in deciding about the efficiency and performance
in the past and likely in the future but suffer from some serious limitations. Three Banks, two
privatized and one of Public sector banks were selected for the study are Muslim commercial
bank limited, Allied Bank Limited (Privatized) and United bank Limited (Public Bank).
Financial statements of three banks are taken for ratio analysis to evaluate the efficiency and
performance of Privatized and public sector banks.
74
3.4.2. Ratios Used In Analysis is
3.4.3: Earning Assets to Total Assets
Earning assets includes loans, investment in securities, and money market assets. It excludes
cash and non-earning deposits plus fixed assets. This ratio shows how well bank management
put bank assets to work. High performance banks have a high ratio. Earning assets to total
assets ratio can be calculated by dividing average earning assets by average total assets.
3.4.4: Return on Earning Assets Return on earning assets, computed by dividing net income after taxes by average earning
assets, is a profitability measure to be viewed in conjunction return on assets and return on
equity.
3.4.5. Interest Margin To Total Assets This is a key determinant of bank profitability, for it provides an indication of management
ability to control the spread between interest income and interest expense. This ratio can be
determined by interest margin by average interest earning assets.
Earning Assets To Total Assets = Average earning Assets Average Total Assets
Return on earning Assets = Net Income After Tax Average earning Assets
Interest margin to average earning assets= Interest margin Average earning Assets
75
3.4.6. Loan loss coverage Ratio The loan loss coverage Ratio, computed by dividing pre tax income plus provision for loan
losses by net charge offs, helps determine the asset quality and the level of protection of
loans.
3.4.7. Equity Capital To Total Assets This ratio is also called funds to total assets, measure the extent of equity ownership in the
bank. This ownership provides the cushion against the risk of debt and leverage. This ratio
is computed by dividing shareholders equity by total assets.
3.4.8. Deposit Time Capital The ratio of deposit time ratio concerns both depositors and stockholders. To some
extent, it is a type of debt/ equity ratio, indicating a bank’s debt position. More capital
implies a greater margin of safety, while a larger deposit base gives a prospect of higher
return to shareholders, since more money is available for investment purposes. This ratio
is computed by dividing average total deposits by average equity.
Loan loss coverage ratio= EBT+Provision for loan losses Net charge offs
Equity capital to Total assets = Average Equity Average Total assets
76
3.4.9. Loans to Deposits Average total loans to average total deposits is a type of assets to liability ratio. Loans
make up a large portion of the bank’s assets, and principal obligations are the deposits
that can be withdrawn on the request—with in time limitations. This is the type of debt
coverage ratio and it measures the position of the bank w with regard to taking risks.
This ratio is computed by dividing average total loans by average total deposit.
Deposit time capital= Average total deposit Average equity
Loans to deposits ratio = Average total loans Average total deposits
77
Table 3.13 Ratios for the MCB
Source. Ratios are calculated from annual reports of MCB * Ratios are calculated on actual figures; therefore, there may be little bit difference.
Table 3.14 Percentage Changes in the Ratios
Years 1998 1999 2000 2001 2002Earning Assets to Total Assets * 100% -3.86 4.28 1.76% 3.3%Earning Assets to Total Assets ** 100% -3.11% -2.66% -1.28% 2.32%Return on Earning Assets * 100% 43.06% 18.90% 37.01% 29.71%Return on Earning Assets ** 100% 43.06% 70.09% 133.05% 202.28%Interest Margin to Average earning Assets * 100% 4.81% -1.00% 25.18% -18.87%Interest Margin to Average earning Assets ** 100% 4.81% 3.76% 29.88% 5.37%Equity capital To Total Assets * 100% 2.36% 3.13% 3.89% 2.25%Equity capital To Total Assets ** 100% 2.36% 5.57% 9.67% 12.14%Loans to Deposits* 100% -0.51 22.79% -21.97% -12.83%Loans to Deposits** 100% -0.51 22.16% -4.67% -16.90%* Ratios are calculated by taking last year with respect to each year as a base year. ** Ratios are calculated by taking 1998 as a base year for each year.
1998 1999 2000 2001 2002 AverageEarning Assets to Total Assets 81.06% 77.20% 81.48% 79.72% 86.52% 81.20%Return on Earning Assets 0.33% 0.47% 0.55% 0.76% 0.99% 0.62%Interest margin to Average Earning Assets 5.015 5.25% 5.20% 6.51% 5.28% 5.45%Loan Loss Coverage Ratio (times Per Year) 2.42% 26.86% 3.06% 7.50% 4.21% 8.81%Equity Capital To Total Assets 2.39% 2.44% 2.52% 2.62% 2.68% 2.53%Deposit Time Capital (Time Per Year) 34.69% 33.74% 31.71% 30.68% 29.85% 32.13%Loans to Deposits 51.98% 51.72% 63.50% 49.55% 43.20% 51.99%
78
Table 3.15 Ratios for ABL
Source: Annual Reports of Allied bank Of Pakistan Limited for 1994 to 1999. * Ratios are calculated on actual figures; therefore, there may be little bit difference. Table 3.16 Percentage Change in Ratios
1995 1996 1997 1998 1999 AverageEarnings Assets to Total Assets 51.59% 52.53% 78.61% 76.63% 77.04% 67.2 8%Return on Earning Assets 0.32% 0.15% 0.03% 0.03% 0.01% 0.11%Interest Margin to Average Earning Assets 5.74% 4.16% 0.74% 1.23% 0.44% 2.46%Loans Loss Coverage Ratio - - - - - - Equity Capital to Total Assets 1.21% 1.40% 1.77% 1.89% 1.57% 1.57%Deposit Times Capital 50.12% 42.76% 41.08% 45.89% 55.07% 46.98%Loans to Deposits 57.80% 58.03% 57.12% 55.81% 59.35% 57.62%
1995 1996 1997 1998 1999Earning to Total Assets * 100% -2.52% 23.03% 21.02% -0.86%Earning to Total Assets ** 100% -2.52% 19.93% 45.14% 43.89%Return on Total Assets* 100% -57.89% -82.63% 19.98% -55.26%Return on Total Assets** 100% -57.89% -92.68% -91.22% -96.07%Interest Margin to Average Earning Assets* 100% -27.52% -82.25% 65.98% -63.85%Interest Margin to Average Earning Assets** 100% -27.52% -87.13% -78.65% -92.28%Equity capital To Total Assets* 100% 15.85% 26.84% 6.35% -16.77%Equity capital To Total Assets** 100% 15.85% 46.94% 56.27% 30.06%Loans to Deposits* 100% 0.39% -1.57% -2.29% 6.35%Loans to Deposits** 100% 0.39% -1.18% -3.45% 2.68% Figures are calculated by taking last year with respect to each year as a base year.* Figures are calculated by taking 1995 as abase year for each year.**
79
Table 3.17 Ratios for UBL
Source. Ratios are calculated from the annual reports of UBL Table 3.18 Percentage Changes in Ratios (UBL)
1998 1999 2000 2001 2002 Average Earning Assets to Total Assets 79.19% 75.51% 73.24% 70.58% 75.71% 74.84%Return on Earning Assets 2.81% 0.46% 0.58% -6.57% 1.09% -0.33%Interest margin to Average Earning Assets 1.79% 2.49% 4.11% 4.45% 4.44% 3.45%Loan Loss Coverage Ratio -3.31% 1.17% 5.17% -8.31% 4.14% -0.12%Equity Capital To Total Assets -5.38% 3.87% 3.98% 2.36% 2.77% 1.52%Deposit Time Capital -17.26% 21.48% 20.31% 34.63% 30.47% 17.93%Loans to Deposits 41.17% 48.17% 57.63% 58.16% 47.84% 50.59%
1998 1999 2000 2001 2002
Earning Assets to Total Assets * 100% -4.65% -3.00% -3.64% 7.27%
Earning Assets to Total Assets ** 100% -4.65% -7.51% -10.88% -4.40%
Return on Earning Assets * 100% -83.81% 26.38% -1241.17%-
116.53%
Return on Earning Assets ** 100% -83.81% -79.54% -333.53% -61.39%
Interest Margin to Average earning Assets * 100% 38.96% 65.31% 8.23% -0.18%
Interest Margin to Average earning Assets ** 100% 38.96% 129.72% 148.62% 148.18%
Equity capital To Total Assets * 100% -171.84% 2.95% -40.69% 17.16%
Equity capital To Total Assets ** 100% -171.84%-
173.96% -143.86%-
151.39%
Loans to Deposits* 100% 16.99% 19.64% 0.92% 17.74%
Loans to Deposits** 100% 16.99% 39.97% 41.26% 16.20%
* Ratios are calculated by taking last year with respect to each year as a base year.
** Ratios are calculated by taking 1998 as a base year for each year.
80
Table 3.19 Comparison
MCB (Average)
UBL (Average)
ABL (Average)
Industry Average
Earning assets to total assets 81.20% 74.84% 67.28% 73.49%
Return on earning assets 0.62% -0.33% .12% 0.14%
Interest margin to average earning assets
5.45% 3.45% 2.46% 3.79%
Loan Loss coverage Ratio 8.81 (.12) - 4.35
Equity Capital To Total Assets
2.53% 1.52% 1.57% 1.87%
Deposit Time Capital 32.13 17.93 46.98 32.35
Loans to Deposits 51.99% 50.59% 57.62% 53.40%
81
Table 3.20 Financial Indicators MCB
Source: Financial Sector Assessment 2001-2002,State bank of Pakistan
Source: Extracted from Annual Reports. ** ABL was transferred to the management group of the workers employed in the bank so there is no reduction in the employment. Table. 5.7 Number of Branches of Allied bank of Pakistan limited
Allied bank of Pakistan Before Privatization After Privatization
Table 5. 8 Annual Operating Cost per Employee Before and After privatization of
ABL Before privatization After privatization
Years T. Operating cost
Operating cost per employee
Year T. Operating cost
Op. cost per employee *
1986 971338511 141285 1997 3696699000 491255
1987 1126079280 160868 1998 3396440000 451354
1988 1254961428 176134 1999 3719758000 494320
1989 1524540158 206018
1990 1982658297 263476 Source: Calculated from Annual reports of ABL *The numbers of employees after privatization is not available. We have assumed the numbers of 1990 to calculate operating cost per employee for post privatization of the bank.
Figure 5.4
0
1000000000
2000000000
3000000000
4000000000
1 2 3 4 5
Operating Cost of ABL Before and After PrivatizationT. Operatingcost beforeprivatization
by their Board of Directors (in case of foreign banks, by Country Head and Executive /
Management Committee), which shall interalia cover loan administration, including
documentation, disbursement and appropriate monitoring mechanism. The policy shall
explicitly specify the functions, responsibilities and various staff positions’ powers /
authority relating to approval / sanction of consumer financing facility.
3. For every type of consumer finance activity, the bank / DFI shall develop a specific
program. The program shall include the objective / quantitative parameters for the
eligibility of the borrower and determining the maximum permissible limit per borrower.
4. Banks / DFIs shall put in place an efficient computer based MIS for the purpose of
consumer finance, which should be able to effectively cater to the needs of consumer
financing portfolio and should be flexible enough to generate necessary information
reports used by the management for effective monitoring of the bank’s / DFI’s exposure
in the area. The MIS is expected to generate the following periodical reports:
i. Delinquency reports (for 30, 60, 90, 180 & 360 days and above) on monthly basis.
ii Reports interrelating delinquencies with various types of customers or various
attributes of the customers to enable the management to take important policy decisions
and make appropriate modifications in the lending program.
iii Quarterly product wise profit and loss account duly adjusted with the provisions on
account of classified accounts. These profit and loss statements should be placed before
the Board of Directors in the immediate next Board Meeting. The branches of foreign
banks in order to comply with this condition shall place the reports before a committee
comprising of CEO / Country Manager, CFO and Head of Consumer Business.
5. The banks / DFIs shall develop comprehensive recovery procedures for the delinquent
consumer loans. The recovery procedures may vary from product to product. However,
distinct and objective triggers should be prescribed for taking pre-planned enforcement /
recovery measures.
6. The banks / DFIs desirous of undertaking consumer finance will become a member of at
least one Consumer Credit Information Bureau. Moreover, the banks / DFIs may share
information / data among themselves or subscribe to other databases as they deem fit and
appropriate.
164
7. The financial institutions starting consumer financing are encouraged to impart sufficient
training on an ongoing basis to their staff to raise their capability regarding various aspects
of consumer finance.
8. The banks / DFIs shall prepare standardized set of borrowing and recourse documents
(duly cleared by their legal counsels) for each type of consumer\financing.
OPERATIONS:
1. Consumer financing, like other credit facilities, must be subject to the bank’s / DFI’s
risk management process setup for this particular business. The process may include,
identifying source of repayment and assessing customers’ ability to repay, his / her past
dealings with the bank / DFI, the net worth and information obtained from a Consumer
Credit Information Bureau.
2. At the time of granting facility under various modes of consumer financing, banks /
DFIs shall obtain a written declaration from the borrower divulging details of various
facilities already obtained from other financial institutions. The banks / DFIs should
carefully study the details given in the statement and allow fresh finance / limit only after
ensuring that the total exposure in relation to the repayment capacity of the customer does
not exceed the reasonable limits as laid down in the approved policies of the banks /
DFIs. The declaration will also help banks / DFIs to avoid exposure against a person
having multiple facilities from different financial institutions on the strength of an
individual source of repayment.
3. Before allowing any facility, the banks / DFIs shall preferably obtain credit report from
the Consumer Credit Information Bureau of which they are a member. The report will be
given due weightage while making credit decision.
4. Internal audit and control function of the bank / DFI, apart from other things, should be
designed and strengthened so that it can efficiently undertake an objective review of the
consumer finance portfolio from time to time to assess various risks and possible
weaknesses. The internal audit should also assess the adequacy of the internal controls
and ensure that the required policies and standards are developed and practiced. Internal
audit should also comment on the steps taken by the management to rectify the
weaknesses pointed out by them in their previous reports for reducing the level of risk.
165
5. The banks / DFIs shall ensure that their accounting and computer systems are well
equipped to avoid charging of mark-up on mark-up. For this purpose, it should be
ensured that the mark-up charged on the outstanding amount is kept separate from the
principal.
6. The banks / DFIs shall ensure that any repayment made by the borrower is accounted
for before applying mark-up on the outstanding amount.
DISCLOSURE / ETHICS
The banks / DFIs must clearly disclose, all the important terms, conditions, fees, charges
and penalties, which interalia include Annualized Percentage Rate, prepayment penalties
and the conditions under which they apply. For ease of reference and guidance of their
customers, banks / DFIs are encouraged to publish brochures regarding frequently asked
questions. For the purposes of this regulation, Annualized Percentage Rate means as
follows:
Mark-up paid for the period x 360 x 100 Outstanding Principal Amount No. of Days
PART – C R E G U L A T I O N S
REGULATION R-1
FACILITIES TO RELATED PERSONS
The consumer finance facilities extended by banks / DFIs to their directors, major
shareholders, employees and family members of these persons shall be at arms length
basis and on normal terms and conditions applicable for other customers of the banks /
DFIs. The banks / DFIs shall ensure that the appraisal standards are not compromised in
such cases and market rates are used for these persons. The facilities extended to the
employees of the banks / DFIs as a part of their compensation package under Employees
Service Rules shall not fall in this category.
REGULATION R-2
LIMIT ON EXPOSURE AGAINST
TOTAL CONSUMER FINANCING
Banks / DFIs shall ensure that the aggregate exposure under all consumer financing
facilities at the end of first year and second year of the start of their consumer financing
166
does not exceed 2 times and 4 times of their equity respectively. For subsequent years,
following limits are placed on the total consumer financing facilities:
PERCENTAGE OF CLASSIFIED CONSUMER
FINANCING TO TOTAL CONSUMER FINANCING
MAXIMUM LIMIT a) Below 3% 10 times of the equity
b) Below 5% 6 times of the equity
c) Below 10% 4 times of the equity
d) Upto and above 10% 2 times of the equity
REGULATION R-3
TOTAL FINANCING FACILITIES TO BE COMMENSURATE WITH THE
INCOME
While extending financing facilities to their customers, the banks / DFIs should ensure
that the total installment of the loans extended by the financial institutions is
commensurate with monthly income and repayment capacity of the borrower. This
measure would be in addition to banks’ / DFIs’ usual evaluations of each proposal
concerning credit worthiness of the borrowers, to ensure that the banks’ / DFIs’ portfolio
under consumer finance fulfills the prudential norms and instructions issued by the State
Bank of Pakistan and does not impair the soundness and safety of the bank / DFI itself.
REGULATION R-4
GENERAL RESERVE AGAINST CONSUMER FINANCE
The banks / DFIs shall maintain a general reserve at least equivalent to 1.5% of the
consumer portfolio which is fully secured and 5% of the consumer portfolio which is
unsecured, to protect them from the risks associated with the economic cyclical nature of
this business.
167
REGULATION R-5
BAR ON TRANSFER OF FACILITIES FROM ONE
CATEGORY TO ANOTHER TO AVOID CLASSIFICATION
The banks / DFIs shall not transfer any loan or facility to be classified, from one category
of consumer finance to another, to avoid classification.
REGULATION R-6 MARGIN REQUIREMENTS
Banks / DFIs are free to determine the margin requirements on consumer facilities
provided by them to their clients taking into account the risk profile of the borrower(s) in
order to secure their interests. However, this relaxation shall not apply in case of items,
import of which are banned by the Government. Banks / DFIs will continue to observe
margin restrictions on shares / TFCs as per existing instructions under Prudential
Regulations for Corporate / Commercial Banking (R-6). Further, the restrictions
prescribed under paragraph 1.A of Regulation R-6 of the Prudential Regulations for
Corporate / Commercial Banking will also be applicable in case of Consumer Financing.
State Bank of Pakistan shall continue to exercise its powers for fixation / reinstatement of
margin requirements on financing facilities being provided by banks/DFIs for various
purposes, as and when required.
REGULATIONS FOR CREDIT CARDS
REGULATION O-1
The banks / DFIs should take reasonable steps to satisfy themselves that cardholders have
received the cards, whether personally or by mail. The banks / DFIs should advise the
card holders of the need to take reasonable steps to keep the card safe and the PIN secret
so that frauds are avoided.
REGULATION O-2
Banks / DFIs shall provide to the credit card holders, the statement of account at monthly
intervals, unless there has been no transaction or no outstanding balance on the account
since last statement.
168
REGULATION O-3
Banks / DFIs shall be liable for all transactions not authorized by the credit card holders
after they have been properly served with a notice that the card has been lost / stolen.
However, the bank’s / DFI’s liability shall be limited to those amounts wrongly charged
to the credit card holder’s account. In order to mitigate the risks in this respect, the banks
/ DFIs are encouraged to take insurance cover against wrongly charged amounts, frauds,
etc.
REGULATION O-4
In case the cardholders make partial payment, the banks / DFIs should take into account the
partial payment before charging service fee / mark-up amount on the outstanding / billed
amount so that the possibility of charging excess amount ofmark-up could be avoided.
REGULATION O-5
Due date for payment must be specifically mentioned on the accounts statement. If fine /
penalty is agreed to be charged in case the payment is not made by the due date, it should
be clearly mentioned in the agreement.
REGULATION R-7
MAXIMUM CARD LIMIT
Maximum unsecured limit under credit card to a borrower (supplementary cards shall be
considered part of the principal borrower) shall not exceed Rs 500,000/. The banks / DFIs
may allow financing under the credit card scheme in excess of the limit of Rs 500,000/-
(up to Rs 2 million), provided the excess amount is secured appropriately. All credit card
limits in excess of Rs 2 million should be secured against liquid assets. For Charge Cards,
pre-set spending limits generated by the standardized systems, as is the global practice,
shall be allowed.
169
REGULATION R-8
CLASSIFICATION AND PROVISIONING
Table 7.1 The credit card advances shall be classified and provided for in the following manner:
1.Classification 2. Department 3.Tretment of
Income
4.Provision to be
made.
1. Loss Where
Markup/interest or
principal is over due
(past due) by 180
days from the due
date.
Unrealized
Markup/Interest to
be put in suspense
and not to be
credited to income
account except
when realized in
cash
Provision of 100%
of the principal
amount less the
amount of liquid
securities with the
Bank/DFI.
*This specific provision will be in addition to general reserve maintained under Regulation R.4 It is clarified that the lenders are allowed to follow more conservative policies. Further,
provisioning may be created and maintained by the bank / DFI on a portfolio basis
provided that the provision maintained by the bank / DFI shall not be less than the level
required under this Regulation.
REGULATIONS FOR AUTO LOANS
REGULATION R-9
The vehicles to be utilized for commercial purposes shall not be covered under the
Prudential Regulations for Consumer Financing. Any such financing shall ensure
compliance with Prudential Regulations for Corporate / Commercial Banking or
Prudential Regulations for SMEs Financing. These regulations shall only apply for
financing vehicles for personal use including light commercial vehicles also used for
personal purposes.
170
REGULATION R-10
The maximum tenure of the auto loan finance shall not exceed seven years.
REGULATION R-11
While allowing auto loans, the banks / DFIs shall ensure that the minimum down
payment does not fall below 10% of the value of vehicle.
REGULATION R-12
In addition to any other security arrangement on the discretion of the banks / DFIs, the
vehicles financed by the banks / DFIs shall be properly secured by way of hypothecation.
Payments against the sale orders issued by the manufacturers are allowed till the time of
delivery of the vehicle subject to the condition that payment will directly be made to the
manufacturer / authorized dealer by the bank / DFI and upon delivery, the vehicle will
immediately be hypothecated to the bank / DFI.
REGULATION R-13 The tenure of the banks / DFIs shall ensure that the vehicle remains properly insured at
all times during the loan.
REGULATION O-6
The clause of repossession in case of default should be clearly stated in the loan
agreement mentioning specific default period after which the repossession can be
initiated. The repossession expenses charged to the borrower shall not be more than
actual incurred by the bank / DFI. However, the maximum amount of repossession
charges shall be listed in the schedule of charges provided to customers. The banks / DFIs
shall develop an appropriate procedure for repossession of the vehicles and shall ensure
that the procedure is strictly in accordance with law.
REGULATION O-7
A detailed repayment schedule should be provided to the borrower at the outset. Where
alterations become imminent because of late payments or prepayments and the
installment amount or period changes significantly, the revised schedule should be
provided to the borrower at the earliest convenience of the bank / DFI but not later than
15 days of the change. Further, even in case of insignificant changes, upon the request of
the customer, the bank / DFI shall provide him revised repayment schedule free of cost.
171
REGULATION O-8
The banks / DFIs desirous of financing the purchase of used cars shall prepare uniform
guidelines for determining the value of the used vehicles. However, in no case the bank /
DFI shall finance the cars older than five years.
REGULATION O-9
The banks / DFIs should ensure that a good number of authorized auto dealers are placed
at their panel to eliminate the chances of collusion or other unethical practices.
REGULATION R-14
Table 7.2 The auto loans shall be classified and provided for in the following manner: 1.Classification 2. Department 3.Tretment of Income 4.Provision to be made.
1. Substandard. Where Markup/interest
or principal is over due
(past due) by 90 days
from the due date.
Unrealized
Markup/Interest to be
put in suspense and not
to be credited to income
account except when
realized in cash
No provision is
required.
2. Doubtful Where Markup/interest
or principal is over due
by 180 days from the
due date.
As above Provision of 50% of the
principal amount less
the amount of liquid
securities with the
Bank/DFI.
3. Loss Where Markup/interest
or principal is over due
by one year or more
days from the due date.
As above Provision of 100% of
the principal amount
less the amount of liquid
securities with the
Bank/DFI. * These specific provisions will be in addition to general reserve maintained under Regulation R.4
REGULATIONS FOR HOUSING FINANCE
REGULATION R-15
The maximum per party limit in respect of housing finance by the banks / DFIs will be
Rs 10 million.
REGULATION R-16
The housing finance facility shall be provided at a maximum debt-equity ratio of 85:15.
172
REGULATION R-17
Banks / DFIs shall ensure that at no time their total exposure under house financing
exceeds 10% of their net advances.
REGULATION R-18
Banks / DFIs are free to extend mortgage loans for housing, for a period not exceeding
twenty years. Banks / DFIs should be mindful of adequate asset liability matching.
REGULATION R-19
The house financed by the bank / DFI shall be mortgaged in bank’s / DFI’s favour by
way of equitable or registered mortgage.
REGULATION R-20
Banks / DFIs shall either engage professional expertise or arrange sufficient training for
their concerned officials to evaluate the property, assess the genuineness and integrity of
the title documents, etc.
REGULATION R-21
The bank’s / DFI’s management should put in place a mechanism to monitor conditions
in the real estate market (or other product market) at least on quarterly basis to ensure that
its policies are aligned to current market conditions.
REGULATION R-22
Banks / DFIs are encouraged to develop floating rate products for extending housing
finance, thereby managing interest rate risk to avoid its adverse effects. Banks / DFIs are
also encouraged to develop in-house system to stress test their housing portfolio against
adverse movements in interest rates as also maturity mismatches.
173
REGULATION R-23 The mortgage loans shall be classified and provided for in the following manner:
* These specific provisions will be in addition to general reserve maintained under Regulation R.4
1.Classification 2. Department 3.Tretment of Income 4.Provision to be made.
1.OAEM (other Assets
specially mentioned
Where Markup/interest
or principal is over due
(past due) by 90 days
from the due date.
Unrealized
Markup/Interest to be put
in suspense and not to be
credited to income account
except when realized in
cash
No provision is required.
2. Substandard Where Markup/interest
or principal is over due
by 180 days from the
due date.
As above Provision of 20% of the
difference resulting from
outstanding balance principal
less the amount of liquid
securities and forced sale
value of mortgage property as
valued by valuers on the
Panel of PBA.
3. Doubtful Where Markup/interest
or principal is over due
by one year or more
days from the due date.
As above Provision of 50% of the
difference resulting from
outstanding balance principal
less the amount of liquid
securities and forced sale
value of mortgage property as
valued by valuers on the
Panel of PBA.
4.Loss. Where Markup/interest
or principal is over due
by two year or more
from the due date
As above Provision of 100% of the
difference resulting from
outstanding balance principal
less the amount of liquid
securities and forced sale
value of mortgage property as
valued by valuers on the
Panel of PBA.
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REGULATIONS FOR PERSONAL LOANS INCLUDING
LOANS FOR THE PURCHASE OF CONSUMER DURABLES
REGULATION R-24
The clean limit per person for personal loans will be Rs 500,000/-. However, the banks /
DFIs may lend higher amounts provided the loan is secured appropriately. But, in no
case, the loan amount will be allowed to exceed Rs 1,000,000/-. The loan secured against
liquid securities shall, however, be exempt from this limit. The loans against the
securities issued by Central Directorate of National Saving (CDNS) shall be subject to
such limits as are prescribed by CDNS / Federal Government / State Bank of Pakistan
from time to time.
REGULATION R-25
In cases, where the loan has been extended to purchase some durable goods / items, the
same will be hypothecated with the bank / DFI besides other securities, which the bank /
DFI may require on its own.
REGULATION R-26
The maximum tenure of the loan shall not exceed 5 years.
REGULATION R-27
In case of Running Finance / Revolving Finance, it shall be ensured that at least 15% of
the maximum utilization of the loan during the year is cleaned up by the borrower for a
minimum period of one week. In case the clean up is not made by the borrower, the loan
will be appropriately classified. However, banks / DFIs who require their customers to
repay a minimum amount each month, will be considered compliant with this regulation
subject to the condition that the aggregate cumulative monthly installments exceed the
15% clean up requirement and accordingly the loans where the specified minimum
repayments are being made by the borrowers regularly, will not require classification
under this regulation.
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REGULATION R-28
The personal loans shall be classified and provided for in the following manner: These specific provisions will be in addition to general reserve maintained under Regulation R.47.5
7.6 Conclusion:
Pakistan ‘s banking sector experienced significant changes during the last few years
moving from nationalized commercial banks to private banks. Given that the banking
sector is the most important channel of resource allocation and mobilization in an
emerging economy like Pakistan, a bank failure or banking sector collapse may have
devastating effects on the economy. Therefore it is important for supervisors to take
necessary steps to provide a safe banking sector and ensure its stability. Besides some
organizational changes in the SBP itself which makes the supervision and monitoring
1.Classification 2. Department 3.Tretment of Income 4.Provision to be made.
1. Substandard Where Markup/interest
or principal is over due
by 180 days from the
due date.
As above No provision is required.
2. Doubtful Where Markup/interest
or principal is over due
by 180 days or more
from the due date.
As above Provision of 50% of the
principal less the amount of
liquid securities with the
Bank.
4.Loss. Where Markup/interest
or principal is over due
by one year or more
from the due date
As above Provision of 100% of the
principal less the amount of
liquid securities with the
Bank/DFI.
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more effective, it also issued some guidelines for corporate governance of banks in
Pakistan. These guidelines, in general, are drawn from the recommendations made by the
international agencies but modified according to domestic economic environment and
rules and regulations.
In the banking sector new reforms program should aim at a positive about the dire need to
launch of Internet Banking and for this purpose add new acts and evolve new regulations
to seriously implement electronic banking. It is imperative to have greater co-ordination
between the GOP, SBP and PTCL to make things happen and above all the innovative
attitude of the GOP, to rewrite banking policies, develop new regulatory system, to
prevent financial mis-hops which may occur due to electronic banking system in future.
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CHAPTER 8
Summary and Conclusions 8.1 Introduction Despite the rigorous reforms of the financial sector during the 1990s, there was a dearth
of financial services offered by the financial institutions in the country. Banks and the
non-bank financial institutions were largely involved only in the provision of traditional
services like deposit mobilization and credit extension mainly for working capital or
project financing needs of industry. Services like personal financing, credit cards or
ATM facility were negligible and there was no concept of online banking, phone banking
or even housing finance by the banks. The situation, however, started turning around in
the 2000s when significant progress was made in improving the health and soundness of
the financial sector.
The privatization of public sector financial institutions, relaxation in the licensing and
regulatory environment for micro and rural credit institutions, mandatory requirements
for banks to get themselves evaluated by credit rating agencies, measures to improve
corporate governance, removal of restrictions on consumer financing by nationalized
banks, incentives to provide mortgage finance, improvement in the legal framework for
defaulted loans recovery, changes in the prudential regulations enabling banks to expand
their scope of lending and customer network, reduction in the corporate tax rates on
banks, mandating the banks to join ATM networks and the initiation of the development
of Real Time Gross Settlement (RTGS) system all helped in bringing about a sea change
in the financial services offered by various financial institutions.
Significant progress was made during 2001 and 2002 in terms of expansion of
microfinance activities, emergence of new financial products and services, automation of
retail banking transactions, modernization of payment system and Islamization of
financial services. Financial services commitments under General Agreement on Trade
and Services (GATS) under WTO have also impacted the financial sector in recent past.
Financial services landscape of future will also be influenced by GATS.
Given the fact that our formal financial institutions were unable to cater to the credit
needs of micro and small enterprises, the role of Microfinance Institutions (MFIs) could
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hardly be over emphasized in overall development of our economy. These institutions are
more important in our country, where around 70 percent of population is still living in the
rural areas and the agriculture sector constitutes approximately 25 percent of GDP.
Moreover, considerable rise in poverty incidence during 1990s also called for a greater
role of these institutions. The establishment of Pakistan Poverty Alleviation Fund (PPAF)
in 1999 as an autonomous private company is one of the significant developments in
microfinance sector. The fund operates with a promise to alleviate poverty, improve
access of communities to financial services and enhance investments in infrastructure
projects. With these clear commitments, the PPAF aims at the strengthening of
microfinance sector through: (1) providing a reliable source of funds to well functioning
NGOs; (2) creating public awareness, particularly on the issues related to the outreach of
financial services to the poor and its links to the poverty alleviation; (3) encouraging
innovative products and improving the quality of existing services offered to MF sector;
and (4) acting as bridge between the government and the NGOs. Moreover, the fund may
ultimately act as a regulator of MFIs in the Pakistan.
The privatization of public sector enterprises (PSEs) has been a recurrent theme on the
international development agenda since the early 1980s. Assistance for this purpose from
international aid agencies has been cautious, placing priority first on supporting
stabilization programs and improving existing operational efficiencies. Assistance has
also taken the form of technical and financial support for institutional strengthening,
enhancing autonomy, and price reforms. Although international aid has been successful
in promoting economic and social development that would not have been supported by
commercial funding, international aid agencies and governments have been unable to
keep pace with funding requirements and technology advances. Supply constraints have
been in evidence, particularly in non-urban areas, and technical innovation and economic
growth have been curtailed. These situations contrast with the evidence from reform-
minded economies where more conducive operating environments exist, and privatization
reforms have led to higher national levels of investment, higher economic growth,
increased outputs, and improved availability and quality of goods and services. Economic
benefits of privatization are now widely acceptable. It not only works better and yields
quick rewards, but also it brings efficiency, higher out put increasing profitability and
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developing competitive industry, which serve consumer well. The recent past has seen
fundamental changes in the government’s role in economy. With the defeat of socialism
and the worldwide onslaught of privatization a new scenario is emerging.
There have been two tides of privatization in Pakistan. The first tide is from 1992 to 1994
and the second tide from July 2001 to October 15, 2002. In the first period assets worth
Rs.120 billion were divested and in the second period assets worth Rs.65 billion were
divested. The consultants engaged by Asian Development Bank have conducted a
thorough study of the first period. It is a detailed report but the following table sums up
their findings with respect to the overall assessment of the privatization process.
Better Same Worse Total PMEs * 9 13 16 38 Misc. 3 10 1 14 Ghee Mills 2 12 5 19 Rice Mills 2 - 6 8 Banks 2 2 - 4 Total 18 37 28 83 Percentage 22 44 34 100% Source: Impact and Analysis of Privatization in Pakistan: ADB Report October 1998. * Public Manufacturing Enterprises.
The above table clearly indicates that only 22% of the privatized units were performing
well than in the pre-privatization period, 44% approximately the same and about the third
i.e 34% worse than before. It is quite clear that the compelling reason for privatization
that of improving the efficiency of the units, was only attained by about 1/5 of the units,
whereas the rest were working with the same efficiency or worse than before. No wonder
in the article* quoted above the authors had reached the conclusion that, “in Pakistan
there is nothing hardly good or bad about public sector or even the private sector for that
matter”. On the whole, operational efficiency deteriorated after privatization. So for
privatization of banks is concerned the author his reported the improvement in the
efficiency of both banks. “Of the three privatized banks MCB is reported to be running
better. Same is the case of ABL.”
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Bank privatizations are among the biggest challenges facing many governments around
the world. The reluctance of states to remove themselves from the banking and credit
systems is well documented, and the overall impact of state ownership on banking has
been disastrous in almost every country where government ownership of banks has been
pervasive. However, if the objective of a country is to establish a more efficient and
market-oriented economy, reducing the influence of the state on credit allocation
decisions is critically important.
Broadly speaking, reforms in the financial sector are aimed at making Pakistani banks
conform to the international prudential standards and also making the financial system
more competitive. The competition will improve efficiency and efficiency will give birth
to new products and services.
Privatization policy needs to be pursued with the main objective of improving efficiency
in the economy. The study of the efficiency of the financial system and particular banks
has gained a lot of popularity in recent times for several reasons. The efficiency of banks
is directly linked to the productivity of economy. Banking system assets constitutes
substantial proportion of total output. Banks provide liquidity, payments and safekeeping
for depositors and channel these funds into investment and working capital requirements.
A basic benefit of enhanced efficiency is reduction in spreads between lending and
deposit rates. This is likely to stimulate both greater loan demands for industrial
investment (and thus contribute to higher economic growth) and greater mobilization of
savings through the banking system. Banks in most developing countries operates with
relatively wide spreads. Although government policies and regulations are considered a
major causes of such wide spreads, studies on banking efficiency has pointed at operating
efficiencies as one other possible source that needs to be investigated. Wide spreads
affect intermediation and distort prices thus impairing the role of financial system in
contributing to rapid economic growth. (Fields, Murphy, and Tirtiroglu 1993).
The solvency of banks and the strength and soundness of the banking system is germane
to the performance of the entire economy. Without a sound and efficiently functioning
banking system, the economy cannot function. Solvency of the banks as an enterprise
extends beyond solvency consideration for all most all enterprises. When banks fail, the
whole of a nations’ payments system is thrown into jeopardy. Therefore, banking
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supervisors place a lot of emphasis on banks operating efficiency. Today the banks are
the most important financial institutions, which play a vital role through out the world’s
economic system. Developed banking system is indispensable for development of trade
and commerce.
Banking sector in Pakistan has very short history. Prior to pre-partition entire banking
sector was dominated by Hindus, which created the great financial vacuum after shifting
of their business to India. The private banking sector in Pakistan is not new experiment.
There were some private banks in Pakistan before and after the partition of subcontinent.
Habib Bank Ltd., which was functioning in Bombay, shifted to Pakistan in the year 1947
and extended its net working through out the country with its head office at Karachi. The
Australasia Bank Ltd. has already been in operation in Pakistan since 1942. The first two
banks, which were established in private sector, were the Muslim commercial bank ltd.
founded by Mr. Adamjee and the bank of Bahawalpur in the year 1948. In the year 1949
National bank of Pakistan came into operation to act as a semi government treasury in the
country. In the year of 1959, the Saigal group of companies established United Bank ltd.
According to the policy of the then government (Peoples Party Government claiming
social democrats) all the banks were nationalized through an act called the Bank
(nationalization) Act 1974. Nationalization policy adversely affected the progress of
different areas of the banking system, which exposed to government; influences were
misused in the domestic as well as the overseas operations. This resulted the great
setback to the prevailing economic system. (Banking and Trade Management by Syed
Agha Husain, 1978)
8.2 Banks Privatized So For
Realizing the fact, the first two banks, which were immediately dis-invested and handed
over to private sector, were Muslim Commercial Bank and Allied bank of Pakistan Ltd.
MCB has acquired by private investor and Allied bank was taken over by management
group of the workers employed in the bank. The new set up proved its worth, through
high quality of service in the market. So for 6 banks have been privatized while shares of
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National Banks of Pakistan have been floated through an initial public offering. Details of
privatized banks are as under: -
Muslim Commercial Bank Ltd. Fully divested and now owned and controlled
by a domestic private group.
Allied Bank of Pakistan Ltd. 51 % shares sold to the Allied Management
Group (AMG) representing employees of the ABL.
Banker Equity Ltd. 51 percent shares were sold to a domestic private
consortium but eventually the entity was forced into liquidation. An
unsuccessful privatization episode.
Bank Al-Falah Ltd. Fully divested, controlled and owned by a foreign group.
United Bank Ltd. 51 percent shares sold and management transferred to a
group of private investor and expatriate Pakistani.
National Bank of Pakistan 23.2 percent shares divested through stock
exchange.
8.3 Achievements of the Study
The principal objective of this study, therefore, is to provide answers to some of the
issues investigating the efficiency of commercial banks operating in Pakistan. The
study is divided into six parts. In the first part of the study we have utilized the
different financial tools to judge the efficiency of the banks after privatization.
Moreover, the study has attempted to provide empirical evidence on the efficiency of
similar banks in Pakistan. The main criteria for judging performance of the financial
system are: -
Allocative efficiency. Which depends on the system’s ability to arrange
financing that is mutually beneficial to potential supplier and user of capital.
Operational efficiency. Which depends on the cost-effectiveness and
reliability of the system.
Dynamic efficiency. Which depends on the innovativeness of the system and
on the resulting benefits to the system users.
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In part-1 of the study researcher has examined various areas of efficiency using
theoretical model TARCSIMEL, most of them are showing improvement. The main
problem of Pakistani banking sector was failure of governance due to government and
political influence and non-performing loans. The study shows that both problems were
controlled through State Bank prudential rules. Profitability and liquidity of the two
banks selected as case study also improved. Because of competition new products are
invented but the spread rate is still high and need decrease to attract borrowers to
stimulate economic activities.
Researcher has also carried comparative study using ratio analysis technique for looking
at the financial performance of the two banks and its comparison with similar bank
working in public sector (recently privatized). The ratio analysis of three banks clearly
shows that performance of MCB (privatized bank) is better then performance of UBL
(public sector bank). The performance of ABL is lower in rank from UBL not because of
privatization but because of management problems and method of privatization of the
bank. On the basis of ratio analysis results and the list of new products and services it is
conclude that privatization improve efficiency.
In section two the study has examined the impact of privatization of banks on economy.
Commercial banks and financial institutions have historically played an important role in
economic growth. The financial sector in Pakistan needs to establish itself as an engine of
growth. Economic growth and development of a country depends on the health of its
financial sector. Financial sector includes banking sector. Banking sector provides a very
vital input viz., finance to the economy. It also performs the function of mobilization of
savings its role become important for capital formation, which in turn influences the
country’s growth and development.
In this study researcher have developed two hypotheses, "Better the banking system the
greater will be the economic Growth.” and "Worse the banking system the lesser will be
the economic growth.” Researcher has used simple statistics calculating correlation
among the sub hypotheses i.e. deposits, investment, GNP and lending etc. It is found
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there is significant correlation among the sub hypotheses that proves that banks play
important role in economic growth.
The section three of the study also surveyed the employment impact of privatization of
banks in Pakistan. Researcher has used the secondary data collected from various annual
reports of the two banks and State bank of Pakistan. It is found that there has no labor
shading in the two privatized banks. The number of employees in MCB is showing slight
decrease of 2.25% of total employees. This may be because of retirement etc. so far ABL
is concerned the exact data about employees for post privatization period is not available
but numbers of branches are increased and it is hoped that there will no negative impact
on numbers of employees. Operating cost per employee is showing increase in both
banks, it indicates the sharp increase in wage rates in banking sector. It has also observed
that the cause of higher operating cost is that numbers of employees reduced are field
force while the upper management is still more then requirement and getting huge
amount of benefits. Researcher also observed that the maximum employees took gold
handshake are readjusted in the new private banks. In 1990 the total number of banks in
Pakistan was 24 where 7 banks were state owned and 17 were foreign banks, while in
2004 the total numbers of the banks in Pakistan is 40, that include 4 state owned banks,
20 domestic private banks and 13 foreign banks and 3 specialized banks. The average
employees before privatization in the state owned banks were 8529 while there was no
private bank The net increase in numbers of banks are 16 and using mean as new
employment in the sector the banking sector can adjust more then one lack. But total
decrease in state owned banks are approx. 12000 after or during preparation for
privatization. So it can be concluded that privatization of bank has no negative impact on
employees but it will create new jobs.
In part four of the study researcher has also studied the impact of privatization of banks
on customers. It is found that two many new products and services especially about
consumer financing are introduced by both banks after privatization. These new products
and services have positive impact on customer’s services. With a phenomenal growth of
electronic transactions internationally, it was crucial for Pakistan to develop its e-
commerce infrastructure to be the part of global economy. But due to the capital-
intensive nature of such operations, Pakistani banks have been lagging behind in offering
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e-commerce services in the past. It is only during last couple of years, when the e-
banking witnessed some growth in the country. Banks are now investing heavily to bring
their operations on modern technological grounds. To facilitate their customers, each
bank is now maintaining its website to provide a comprehensive information regarding
the services that they offer. Wide-ranging services like Automated Teller Machines,
credit cards, debit cards and phone banking are now common among most of the banks.
In part five of the study is based on legal environment in the country after privatization of
banks. The basic objective of the law is to protect the rights of the peoples. It is found
that with change in working environment of the banks the legal environment is changed.
A new consumer financing products and services required new rules and regulation for
proper monitoring and management State Bank of Pakistan as a prudential authority and
Government of Pakistan has changed the regulatory environment as required.
8.4 Conclusion
This study reveals the following among other important conclusions:
(a) The bank deposits have increased from Rs.354.6 billions in 1990 to Rs. 1885.6
billions in 2004. This means an average increase of about 37%. That is the reason why
the banks have started having a commanding position over the nation's economy in
general and financial resources in particular.
(b) In 1990, there were 24 banks (both domestic public banks and foreign banks and there
was no single private bank in Pakistan). In 2004 there are 40 banks including 20 banks in
private sector. In 1990 there were 7 banks in public sector while in 2004 there are just
four banks in public sector but all are in pipe for privatization.
(c) The total asset of banking sector in Pakistan including foreign banks were Rs. 425.6
billions and 92.2% of the total share was under government control and 7.8% share was
under control of foreign banks. After privatization total assets of banking sector are Rs.
2787.2 billion while government has only Rs. 518.8 billion share in total but private
banks have Rs.1840.3 billion.
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(d) The total equity of all the Pakistani banks including foreign banks before
privatization (numbering24) was Rs. 17.4 billion but total equity of banking sector in
Pakistan after privatization is Rs. 130.9 billion.
(e) Before Privatization the banking sector was providing routine customer services
using old tools and techniques. There was no single bank providing ATM, Credit Card
and on line facilities, While after privatization most of banks are providing ATM, credit
cards and on line facility to customers. Too many new products are introduced by
banking sector including public and private banks.
(f) The Non-performing loan of nationalized commercial banks in Pakistan Rs. 82063
millions which is 1341 of net advances, while in privatized banks the ratio is 9.83 and in
the ratio of private bank is 4.05 of net advances. The data clearly shows that privatized
and private banks ratios of NPL are less as compared to nationalized banks in Pakistan
after privatization.
(g) The numbers of employees are decreased after privatization. Employees are properly
paid in shape of gold handshake program. The maximum of employees were laid off
before privatization during preparation process.
The results of the study and studying privatization literature lead me to conclude that The
first lesson of the past two decades of privatization is that privatization can work.
Privatization has had, for the most part, a positive impact on the countries that have
implemented it. This study shows the impact of privatization on banks performance, on
economic growth, fiscal adjustment, on foreign investment (both direct and portfolio),
customer’s welfare effect, on employment and on regulations. In a landmark study, Galal
et al. (1994) found that the welfare impact of privatization in eleven out of twelve cases
studied was positive, i.e., that there was a net welfare gain from privatization. The cross-
country study chose three companies in each of four countries (United Kingdom, Chile,
Mexico, and Malaysia) privatized between 1982 and 1990. According to the study, the
positive welfare effect of privatization resulted from productivity improvements, from
optimizing investments, from efficiency pricing, and from increased flexibility in hiring.
The study also shows that the key determinants of the success of privatization are
competition in the marketplace into which the enterprise is being divested, effective
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regulation of non-competitive sectors, the credibility of government commitments,
efficient capital markets, the relinquishing of control to the private sector, and
transparency in the privatization process.
A study funded by the Asian Development Bank in 1998 found that the 92 privatizations
carried out between 1991 and 1997 were an overall success. The privatization programme
achieved, at least partially, most of its objectives, including improving the efficiency of
enterprises and the economy, improving state finances, widening and deepening capital
ownership, and protecting the interests of employees. In a detailed analysis of 21
enterprises, the study concluded that there had been economic benefits in 10, poorer
performance in 5, and in 6, the position was roughly neutral.
Study also shows that privatization contributes to economic growth through productivity
gains, efficient utilization of resources, better governance and expansion in output and
employment. Profit making enterprises under the public sector may be making profits due to
the unique market structure such as monopoly or other privileges or concessions conferred
upon them by the government but it does so at the expense of the consumer who has to pay
higher than market price for the product or the services. The example of National Bank of
Pakistan and some state owned banks in other countries showing more profit as compared to
private banks because of some privileges and concessions from government sides. The
ordinary consumer gets a benefit only through competition among private sector firms in
form of lower prices and better services as has been demonstrated in the cases of banking,
telecommunications and, more recently, air travel. In a deregulated market environment,
public ownership becomes a serious constraint as the rule – bound procedures and the rigidity
in the structure do not allow public sector companies the flexibility to respond promptly to
dynamic market conditions. Furthermore, the government’s role as a regulator and neutral
umpire becomes questionable once it is itself a participant in the game through its own
company. This stifles competition and subverts expansion and growth by the private sector
companies.
Privatization and its effect on employees is concerned the implications for privatization of
this framework are mixed. Privatization is accepted as part of a necessary shift in public
sector activity towards a more enabling, rather than direct employment creation approach
(Cameron and Irfan 1992). But it is also important to recognize that the scale and breadth of
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the unemployment challenge in the 1990s is such that privatization cannot be regarded as
sufficient as the core of employment policy. The markets for various types of labour in
Pakistan are as imbalanced and complex as any in the world and unlikely to produce
satisfactory economic or political outcomes simply through government withdrawal - notably
for women.
Pakistan's labour force is currently growing at more than three percent per annum, which
will mean more than one and a quarter million new people wishing to be economically
active each and every year in addition to those already unemployed. An annual real GNP
growth rate of about eight percent on the current sectoral pattern and estimated
employment elasticities would be just about sufficient to provide this quantity of new
work opportunities. Employees in thousands are separated on gold hand shake
programme in privatization of banking sector, but due to establishment of new private
banks in the country maximum of them are accommodated.
As result of the privatization of the banking sector in Pakistan, only 18.6 percent of
banking sector assets now remains with the public sector. Prior to the initiation of the
privatization process, public sector banks controlled more then 92 percent of banking
sector assets, while the rest were in the hands of foreign banks which were playing only
marginal role. At that time, there were no banks owned by the domestic private sector.
Now more then 80% of banking assets, deposit and equity are with the private sector
banks. The basic objective of privatization to increase competition in the banking sector
has intensified so much that the average lending rates have come down from 21 percent
to 5 percent with in a span of few years. The intermediation cost, inflation rate and real
interest rate of have come down significantly.
The two banks selected as a case study, Allied bank was not transferred to a strategic
investor but instead management control was given to its employees. This approach
proved even worse then the experience with public ownership. Efforts are now to
underway to transfer the majority share to private sector financial institution through a
competitive bidding process. In contrast MCB was sold to a group of private strategic
investor who have turned around the bank and improved all indicators, including
improved service to customers, technology up gradation and cost efficiency. It can be
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therefore, concluded that for privatization to bring about tangible results, it must be done
the right way.
8.5 Implications of the study
So for implications of privatization are concerned, no doubt, there are many pitfalls to
privatization. Privatization has rarely worked out ideally because it is so intertwined with
political concerns, in post-communist economies or in developing nations like Pakistan
where corruption endemic. Privatization programme is very politically sensitive, raising
many legitimate political debates. Setting values of the assets, privatization methods,
allowing foreigners to buy privatized enterprises and other relevant matters are also under
fire in Pakistan. It is also cleared to all that the start of privatization in Pakistan was to
obey the order of the donor’s agencies similarly to other developing countries always
looking for financial aid.
Published financial statement is the only publicly available report on financial condition
of a banks operating in Pakistan. Published data is used in research taken from annual
reports of two banks and annual report of State Bank of Pakistan. So data used in
research is recorded facts refers to the data drawn from the accounting records. It should
be clear, therefore, that recorded facts (accounting record) does not show the financial
position of the bank in terms of current economic conditions because historical costs
rather than current costs are given for most of the items in the financial statements used
for analysis. The certain factors that may affect the financial position of business may not
be recorded in the accounting record. Therefore, there are many limitations of financial
statements. First, they are essentially interim reports and cannot be final because the
actual gain and loss can be determined only when it is sold or liquidated. Secondly, the
financial statements show exact dollar amounts, which give an impression of finality and
precision. The reader may ascribe to these amounts his own concept of value, whereas the
statements may have set up on the basis of quite different value standards. Third, both the
balance sheet and the income statement reflect transactions that involve dollar values of
many dates. Forth, financial statements do not reflect many factors, which affect financial
condition and operating results because they cannot be stated in terms of money.
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One another serious problem researcher has faced during collection of data were non-
cooperation of banks management and other relevant agencies. Bank is sensitive business
and asking queries and questions are not replied. Access to data of banking sector is not
easy in country like Pakistan.
8.6 Recommendations
The studies surveyed in this thesis leaded us to conclude that there are a series of very
important issues and questions that must be addressed in order for bank privatization to
be successful. Some, if not most, of these issues do not come into the equation in non-
financial privatizations. For bank privatization to be successful in any country, a set of
conditions must be achieved that ensure the greatest likelihood for the establishment of a
viable banking system. The researcher suggests that the following conditions represent
the minimum conditions for achieving this goal.
• The first and the foremost strategy should be that NPA should be brought down to
zero.
• There should be no recurrence of NPAs in future.
• The banks, which have reduced the NPAs, should be rewarded by State bank of
Pakistan/Government of Pakistan.
• A bank regulatory system must be developed that is sufficiently independent from
political influence. This is essential for effective bank examination, supervision
and monitoring.
• Financial reporting systems must be developed that allow for transparency,
especially with regard to asset quality and true profitability.
• Effective methods of dealing with bad loans prior to and/or during the
privatization process are essential. This problem is especially severe in situations
where uncollectable loans are outstanding to state-owned enterprises (SOEs).
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• It is essential to eliminate the culture and propensity of banks to lend to these
SOEs after privatization is critical, especially in economies with large remaining
concentrations of SOEs, and in transition economies
• There must be assurances that if the government does retain partial ownership; it
acts only as a passive investor. This is essential to prevent the continuation of past
credit-allocation decisions made by the government, usually on some political or
central-planning basis.
• Process of privatization must be transparent
8.7 Suggestions for Further Research
The present day environment is so dynamic and fast changing thus making it very
difficult for any modern business enterprise to operate. Because of uncertainties, threats
and constraints, the banking sector in Pakistan is under great pressure and is trying to find
out the ways and means for their healthy survival. Consequent upon adoption of policy of
economic liberalization all over the world leading to tumbling of trade barriers, free flow
of capital, globalization of markets, increased economic interdependencies and foray of
transnational in every conceivable sector, business milieu in every part of the globe has,
of late, become highly competitive and complex. Commercial banks need to become
conscious that they are entering a challenging environment and will have to redefine their
position within the financial industry. New ways and methods will have to be determined
in order to successfully respond to the new challenges particularly, the growing demand
from customers from high quality service.
Autonomy of financial institutions, prudential regulations and vigilant supervision is
more important than privatization of financial institutions. Policies will have to have
some target of minimum unavoidable inflation rate. Monetary and fiscal policies should
be consistent with the target prices objectives. The structure of interest rate must be left to
market forces. Exchange rate should be market determined. Nominal wages rates should
be linked to the average rate of inflation and productivity of labor. The regulatory
framework must be tightened; increasing liberalization will require effective monitoring,
supervision and regulation.
192
The history of new products of Pakistan Tele Communication Limited should not be
ignored. Telephones booths were installed in public places like hospitals, universities and
markets to facilitate customers. Most of booths were broken and misused by the peoples.
In the result this facility is withdrawn by PTCL and also faced a huge losses. Peoples can
repeat the history in connection of installation of ATM and other new products of the
banking sector. The government of Pakistan in this regard also requires proper planning
and supervision.
For Purposeful and Effective Research it is suggested that:
1. The Government of Pakistan should give first priority to regulatory framework for
privatization of banks. The new products and services introduced by the banking
sector after reform need proper regulations, especially consumer financing is one
of the most difficult task for banking sector not only in Pakistan but also
throughout the world. How to perform it properly need further research.
2. In the new millennium the banks and financial institutions will get transformed
into universal banks. The traditional working capital financing is no longer the
banks major lending area while the financial institutions are no longer dominated
in term lending. Both of them have realized the risk of one product dominance
and they need to diversify their portfolio. Universal banking aims at fulfilling all
the financial needs of the customers under one roof. How Pakistani banking
sector can do this need further research.
3. Finally, what role can privatization play in equipping banking and countries to
meet the challenges posed by major economic forces such as globalization and the
rapid growth of information based business? How can developing countries
structure privatization programs to most effectively attract the foreign direct
investment from multi national companies? All of these are questions, which can,
and should, be answered using the tool of economic analysis.
193
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APPENDIX
215
Appendix 1.1: List of Scheduled Banks Operating in Pakistan As on 30th June 2000 As on 31st December 2002 Public sector commercial banks Public sector commercial banks 1 First Women Bank Ltd. 1 First Women Bank Ltd. 2 Habib Bank Ltd. 2 Habib Bank Ltd. 3 National Bank of Pakistan 3 National Bank of Pakistan 4 United Bank Ltd. 4 The Bank of Khyber 5 The Bank of Khyber 5 The Bank of Punjab 6 The Bank of Punjab Domestic private banks Domestic private banks 1 Muslim Commercial Bank Ltd 1 Muslim Commercial Bank Ltd 2 Allied Bank of Pakistan Ltd. 2 Allied Bank of Pakistan Ltd. 3 Askari Commercial Bank Ltd. 3 United Bank Ltd. 4 Bank Al-Falah Ltd. 4 Askari Commercial Bank Ltd. 5 Bank Al-Habib Ltd. 5 Bank Al-Falah Ltd. 6 Bolan Bank Ltd. 6 Bank Al-Habib Ltd. 7 Faysal Bank Ltd. 7 Bolan Bank Ltd. 8 Gulf Commercial Bank Ltd. 8 Faysal Bank Ltd. 9 Metropolitan Bank Ltd. 9 Metropolitan Bank Ltd. 10 Platinum Commercial Bank Ltd. 10 KASB Bank Ltd. 11 Prime Commercial Bank Ltd. 11 Prime Commercial Bank Ltd. 12 Prudential Commercial Bank Ltd. 12 Saudi Pak Commercial Bank Ltd. 13 Soneri Bank Ltd. 13 Soneri Bank Ltd. 14 Union Bank Ltd. 14 Union Bank Ltd. 15 Meezan Bank Ltd 16 PICIC Commercial Bank Ltd Foreign Banks Foreign Banks 1 ABN AMRO Bank N.V. 1 ABN AMRO Bank N.V. 2 Al- Baraka Islamic Bank B.S.C. (EC) 2 Al- Baraka Islamic Bank B.S.C. (EC) 3 American Express Bank Ltd. 3 American Express Bank Ltd. 4 Bank of Ceylon 4 Bank of Ceylon 5 Citibank N.A. 5 Citibank N.A. 6 Credit Agricole Indosuez 6 Credit Agricole Indosuez 7 Deutsche Bank AG 7 Deutsche Bank AG 8 Doha Bank 8 Doha Bank 9 Emirates Bank International PJSC 9 Habib Bank AG Zurich 10 Habib Bank AG Zurich 10 International Finance Investment and
Commerce Bank Ltd. 11 International Finance Investment and Commerce 11 Mashreq Bank psc 12 Mashreq Bank psc 12 Oman International Bank S.A.O.G. 13 Oman International Bank S.A.O.G. 13 Rupali Bank Ltd. 14 Rupali Bank Ltd. 14 Standard Chartered Bank 15 Societe Generale, The French and International Bank 15 The Bank of Tokyo-Mitsubishi Ltd. 16 Standard Chartered Bank 16 The Hong Kong and Shanghai Banking
Corporation Ltd. 17 Standard Chartered Grindlays Bank Ltd. 18 The Bank of Tokyo-Mitsubishi Ltd. 19 The Hong Kong and Shanghai Banking Corporation Specialized banks Specialized banks 1 Agricultural Development Bank of Pakistan 1 Zari Taraqiati Bank Ltd. (old ADBP) 2 Punjab Provincial Cooperative Bank 2 Punjab Provincial Cooperative Bank 3 Federal Bank for Cooperatives 3 Industrial Development Bank of Pakistan 4 Industrial Development Bank of Pakistan Micro Finance Banks 1 Khushhali Bank Micro Finance Banks 2 The First Micro Finance Bank Ltd
216
Appendices 1.1Continued List of NBFIs Operating in Pakistan As on 30th June 2000 As on 31st December 2002
Development Finance Institutions Development Finance Institutions
1 National Development Finance Corporation 1 Pakistan Kuwait Investment Company (Pvt) Ltd.
Housing Finance Companies Housing Finance Companies 1 Citibank Housing Finance Co. Ltd. 1 Citibank Housing Finance Co. Ltd. 2 House Building Finance Corporation 2 House Building Finance Corporation
218
3 International Housing Finance Ltd. 3 International Housing Finance Ltd. 4 LTV Housing Finance Ltd. 4 LTV Housing Finance Ltd.
1.1 continued Mutual Funds Mutual Funds 1 1st ICP Mutual Fund 1 1st ICP Mutual Fund 2 2nd ICP Mutual Fund 2 2nd ICP Mutual Fund 3 3rd ICP Mutual Fund 3 3rd ICP Mutual Fund 4 4th ICP Mutual Fund 4 4th ICP Mutual Fund 5 5th ICP Mutual Fund 5 5th ICP Mutual Fund 6 6th ICP Mutual Fund 6 6th ICP Mutual Fund 7 7th ICP Mutual Fund 7 7th ICP Mutual Fund 8 8th ICP Mutual Fund 8 8th ICP Mutual Fund 9 9th ICP Mutual Fund 9 9th ICP Mutual Fund 10 10th ICP Mutual Fund 10 10th ICP Mutual Fund 11 11th ICP Mutual Fund 11 11th ICP Mutual Fund 12 12th ICP Mutual Fund 12 12th ICP Mutual Fund 13 13th ICP Mutual Fund 13 13th ICP Mutual Fund 14 14th ICP Mutual Fund 14 14th ICP Mutual Fund 15 15th ICP Mutual Fund 15 15th ICP Mutual Fund 16 16th ICP Mutual Fund 16 16th ICP Mutual Fund 17 17th ICP Mutual Fund 17 17th ICP Mutual Fund 18 18th ICP Mutual Fund 18 18th ICP Mutual Fund 19 19th ICP Mutual Fund 19 19th ICP Mutual Fund 20 20th ICP Mutual Fund 20 20th ICP Mutual Fund 21 21st ICP Mutual Fund 21 21st ICP Mutual Fund 22 22nd ICP Mutual Fund 22 22nd ICP Mutual Fund 23 23rd ICP Mutual Fund 23 23rd ICP Mutual Fund 24 24th ICP Mutual Fund 24 24th ICP Mutual Fund 25 25th ICP Mutual Fund 25 25th ICP Mutual Fund 26 ICP SEMF 26 ICP SEMF 27 Investment Corporation Of Pakistan (Mutual Funds only) 27 Investment Corporation Of Pakistan (Mutual Funds Only) 28 National Investment Trust Ltd. 28 National Investment Trust Ltd. 29 Golden Arrow Selected Stock Fund 29 Golden Arrow Selected Stock Fund 30 Tri-Star Mutual Fund 30 Tri-Star Mutual Fund 31 Growth Mutual Fund 31 Growth Mutual Fund 32 Security Stock Fund 32 Asian Stock Fund 33 Asian Stock Fund 33 Prudential Stock Fund 34 Prudential Stock Fund 34 KASB Premier Fund 35 KASB Premier Fund 35 Safeway Mutual Fund 36 Safeway Mutual Fund 36 First Capital Mutual Fund 37 First Capital Mutual Fund 37 Dominion Stock Fund 38 Confidence Mutual Fund 38 Al-Meezan Mutual Fund 39 Dominion Stock Fund 40 Al-Meezan Mutual Fund
Discount Houses Discount Houses 1 First Credit & Discount Corporation (Pvt) Ltd. 1 First Credit & Discount Corporation (Pvt) Ltd. 2 National Discounting Services Ltd. 2 National Discounting Services Ltd. 3 Prudential Discount & Guarantee House Ltd. 3 Prudential Discount & Guarantee House Ltd. 4 Speedway Fondmetal (Pakistan) Limited 4 Speedway Fondmetal (Pakistan) Limited
Venture Capital Companies Venture Capital Companies 1 Pakistan Emerging Ventures Ltd. 1 Pakistan Emerging Ventures Ltd. 2 Pakistan Venture Capital Ltd. 2 Pakistan Venture Capital Ltd. 3 TMT Venture Limited 4 TRG Pakistan Limited
219
Appendix 1.2 Privatization Proceeds From I Transactions
From 1991 to June 30, 2003 Rs (in million)
Sr. No Unit Name Sale Proceeds
Date of Transfer
Buyer Name
Banking and Finance
Bank 1 Allied Bank Limited (51%) 971.6 Feb-91 EMG 2 Muslim Commercial Bank (75%) 2,420.0 Apr-91 National Group 3 Bankers Equity (26%) 618.7 Jun-96 LTV Group 4 Habib Credit & Exchange (70 %) 1,633.9 Jul-97 Sh. Nahyan bin Mubarik Al-
Nahyan
5 United Bank Ltd. (51%) 12,350.0 Oct-02 Consortium of Bestway & Abu Dhabi Group
6 Bank Alfalah 620.0 Dec-02 Abu Dhabi Group 18,614.2 Capital Market Transaction
7 Muslim Commercial Bank (6.8%) 563.2 Jan-01 MCB Employees-PF & Pension Fund
8 Muslim Commercial Bank (4.4%) 364.0 Nov-01 MCB Employees-PF & Pension Fund
9 NBP (37.3 million shares) 373.0 Feb-02 Listing/Public Offer 10 Muslim Commercial Bank (CDC) 664.0 Oct-02 Stock Exchange 11 Pakistan Oil Fields Limited shares (CDC) 5,055.0 Oct-02 Stock Exchange 12 ICP Lot – A 175.0 Sep-02 ABAMCO 13 ICP Lot – B 303.0 Oct-02 PICIC 14 ICP – SEMF 787.0 Apr-03 PICIC 15 National Bank of Pakistan 10% shares
Total 9,721.2 Total Banking & Finance: 28,335.4 Energy Sector
18 Mari Gas (20%) 102.4 Apr-94 Mari Gas Company Ltd. 19 Kot Addu Power Company (26%) 6,707.6 Jun-96 National Power 20 Kot Addu Power Company (10%) 2,370.7 Nov-96 National Power 21 Kot Addu (Escrow A/c) 1,033.0 Apr-02 National Power 22 SSGC LPG business 369.0 Aug-00 Caltex Oil Pak.(Pvt) Ltd. 23 SNGPL LPG business 142.0 Oct-01 Shell Gas LPG Pakistan 24 Badin II (Revised) 516.1 25-06-02 BP Pakistan & Occidental
Pakistan
25 Adhi 681.4 04-05-02 Pakistan Oil Field 26 Dhurnal 230.7 04-05-02 Western Acquisition 27 Ratana 32.0 04-05-02 Western Acquisition 28 Badin I 8,599.1 25-06-02 BP Pakistan & Occidental
Pakistan
29 Turkwal 120.3 25-06-02 Attock Oil Company Total 20,904.3
1.2 Continued
220
Telecommunications
30 PTCL (2%) 3,032.5 Aug-94 Through Local Stock Exchange
31 PTCL (10%) 27,525.9 Sep-94 Through DR form Total 30,558.4 Industrial Units Automobile
71 Pak China Fertilizers Company Limited 435.4 May-92 Schon Group 72 Pak Saudi Fertilizers Ltd. 7,335.9 May & Sep-02 Fauji Fertilizers 73 Pak Saudi Fertilizers Ltd. (10%) 815.0 Sep-02 Fauji Fertilizers Ltd.
Total 8,586.3 Ghee
74 Fazal Vegetable Ghee 21.2 Sep-91 Mian Mohammad Shah 75 Associated Industries 152.0 Feb-92 Mehmoob Abu-er-Rub 76 Sh Fazal Rehman 64.3 Apr-92 Rose Ghee Mills 77 Kakakhel Industries 55.3 May-92 Mehmoob Abu-er-Rub 78 United Industries 15.5 May-92 A. Akbar Muggo 79 Haripur Vegetable Oil 30.1 Jul-92 Malik Naseer & Assoc. 80 Bara Ghee Mills 27.8 Jul-92 Dawood Khan 81 Hydari Industries - Aug-92 EMG 82 Chiltan Ghee Mills 47.5 Sep-92 Baluchistan Trading Co. 83 Wazir Ali Industries 31.9 Dec-92 Treat Corporation 84 Asaf Industries (Pvt) Limited 23.8 Jan-93 Muzafar Ali Isani 85 Khyber Vegetable 8.0 Jan-93 Haji A. Majid & Co. 86 Suraj Vegetable Ghee Industries 10.2 Jan-93 Trade Lines 87 Crescent Factories Vegetable Ghee Mills 46.0 Jan-93 S. J. Industries 88 Bengal Vegetable 19.1 Mar-93 EMG 89 A & B Oil Industries Limited 28.5 Mar-93 Al-Hashmi Brothers 90 Dargai Vegetable Ghee Industries 26.2 Nov-97 Gul Cooking Oil Industries 91 Punjab Veg. Ghee 18.7 May-99 Canal Associates 92 Burma Oil 20.1 Dec-96 Home Products Intl 93 E&M Oil Mills 94.0 Jul-02 Star Cotton Corp. Ltd. 94 Maqbool Oil Company Ltd. 27.6 Jul-02 Madina Enterprises
767.8 Mineral
95 Makerwal Collieries 6.1 Jul-95 Ghani Group of Industries Rice
86.7 Total (all Industrial Units) 20,462.2 Miscellaneous
121 National Tubewell Const Corpn 18.6 Sep-99 Through Auction 122 Duty Free Shops 12.5 Sep-99 Weitnaur Holding Ltd. 123 Republic Motors (Plot) 6.3 Nov-99 Muhammad Mushtaq 124 Al Haroon Building Karachi 110.0 Sep-02 LG Group
130 Cecil's Hotel 190.9 Jun-98 Imperial Builders 131 Federal Lodges - 1- 4 39.2 Jan-99 Hussain Global Assoc. 132 Dean's Hotel 364.0 Dec-99 Shahid Gul & Partners
Total 594.1 Total 1,011.9
Total upto 30-6-2003 101,272.0
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Appendix 1.3
List of Upcoming Transactions
Company Type of Sale Envisaged Telecommunications
Pakistan Telecom Co Ltd (PTCL) 26% strategic sale
Oil and Gas
Pakistan State Oil (PSO)
51% strategic sale Sui Southern Gas Corp Ltd (SSGCL) 5% Public Offer Pakistan Petroleum Ltd (PPL) 51% strategic sale National Refinery Ltd (NRL) 51% strategic sale Banking and Finance
Habib Bank Limited (HBL)
51% strategic sale
National Investment Trust (NIT) Under review Power
Karachi Electric Supply Corp (KESC) 51-74% shares Faisalabad Electric Supply Co (FESCO) 56% shares Genco 1 (Jamshoro) 51% strategic sale
Industry and Real Estate
Pakarab Fertilizer Ltd. 90% sale Pakamerican Fertilizer Ltd. 90% sale Faletti’s Hotel Asset sale Malam Jabba Asset sale National Construction Ltd. (NCL) Sale of shares Koh-e-Noor Oil Mills Asset sale
224
Appendix 3.1 1987 - 1991 MCB Before Privatization
Inputs: Total Assets: X 28.6+28.4+32.5+36.3+45.2 = 171 X = 171/5 = 34.2 Mean
Efficiency = 3.84/0.03= 128 = before/after > 1 => ABL relative performance after privatization better than before or efficiency
225
Appendix 3.2 profit and Loss Account of MCB before Privatization (In rupees)
1987 1988 1989 1990 1991
Mark up/return/interest earned 2247813441 2176215890 2269720109 2638307048 3192089572
Mark up/return/interest expense 1452592066 1323036347 1496323415 1709808151 2114270463
Net mark up/interest 795221375 853179543 773396694 928498897 1077819109Fee commission exchange and brokerage income 325688688 355654427 564964067 581449453 659943826
Income from rent 1950212 2812918 4222321 4497900 5087622
Income from sale of investment 11632271 12177438 5238291 5154139 25948582
Dividend income
Other income 16800288 17473251 18895479 34816688 40785029
Total Income 1151292834 1241297577 1366716852 1554417077 1809584168
Expenses Salaries,allowances,and provident fund 637460521 666670339 744930735 987299939 1048004206
Rent ,taxes,insurance,lighting etc. 74645231 88796728 95169453 95133899 137050212
Law charges 5869566 9270198 10401559 7387179 11738725
Postages, telegrams and stamps. 23881320 24940754 30237294 35416944 39964353
Auditors' fee 150000 180000 180000 180000 180000Depreciation on and repairs to the banking company's property 27463718 25535284 25797395 28794140 32755206Stationary printing, advertisment etc. 19664853 18305468 22135940 22007213 42405567
Other expenditures 152246790 168252921 175079578 210947421 266627640
Donations 52300 433500 22900 28400 6936416
Contribution to staff welfare fund 10500000 11900000 13140000 8361000 11197000
Total expenses 951934299 1014285192 1117094854 1395556135 1596859325Profit for the year before taxation. 199358535 227012385 249621998 158860942 212724843
provision for taxation
Current 99200000 106000000 109120593 100000000 146000000
prior year -51662952 -8790426 -27120593 -20378294 nil
Provision (write backs) against non-performing 515,000 736,000 - (53,131)
Loans
Total Expense 3,534,703 3,728,700 3,524,444 3,847,762 Income before tax 233,869 28,766 169,592 71,098 Taxation 164,000 15,102 150,000 60,554 Net Income 69,869 13,664 19,592 10,544
229
Appendix 3.2 Continued Balance Sheets MCB Before Privatization (Rs.000) 1987 1988 1989 1990 1991 cash at hand, state bankand national bank 2465981998 2417589203 2596318960 3191937581 5657745448Balance with other banks 445612685 393587553 239004890 839288900 800016063
Money at call and short Notice 1265014411 1375497489 1210555383 273789665 1716640000Total current Assets 4176609094 4186674245 4045879233 4305016146 8174401511
Investments ( at cost less provisions) 9837276759 9551587434 10991438501 10687540848 13047284777
Appendix 3.3 Continued Particulars of provision of non-performing advances after privatization of ABL (Pakistani Rupees '000) 1997 1998 1999 2577429 3417099 3070768 1815 1301 2652 712492 -59949 -103244 -30275 -254985 -53131 185312 10597 -35495 3417099 3070768 2954519 3417099 3070768 2954519 provision for advances/loans as a percentage of total loans/advances.
Total Deposit 124391460 123821807 130336164 135990147 154544451% of total deposit to liquid funds 142.3404066 142.8758377 126.6661139 104.8485932 123.185714
c:liquid funds/total assets Before privatization
years 1987 1988 1989 1990 1991Liquide Funds 16220808034 16260343846 18475132958 19768408888 2.7355E+10Totl Asseta 36720602828 37235514464 39572596150 43590210123 5.582E+10% of total assets to liquid assets. 44.17358863 43.66891147 46.68668411 45.35057031 49.0067295
After privatization
years 1997 1998 1999 2000 2001Liquide Funds 177059310 176911444 165091754 142583756 190376686Totl Asseta 150095138 149725757 158584818 174715063 187055394% of total assets to liquid assets. 117.9647205 118.1569875 104.1031267 81.60930921 101.775566
243
Annexure 3.5 continued. Liquidity
Management
ABL befor
Privatization a: cash as ratio of demand deposit years 1986 1987 1988 1989 1990Cash* 1785483395 2057051862 2133239167 3229606817 2861771409Demand deposit 2269242718 2908723717 3626813967 4412722328 5198435940% of cash for demand deposit 78.6819048 70.7200842 58.81854395 73.1885348 55.05062373
After privatization years 1997 1998 1999 Cash* 7697177 9525733 14240438 Demand deposit 28053561 24882487 36615111 % of cash for demand deposit 27.43743299 38.2828814 38.89224315
b:Liquid funds/total deposits Before privatization
years 1986 1987 1988 1989 1990Liquide Funds** 5831488410 2.8047E+10 20832769682 2.1864E+10 24357915814Total Deposit 10058018097 1.2337E+10 14571231598 1.6214E+10 19824866983% of total deposit to liquid funds 57.97850385 227.332936 142.9719207 134.845435 122.8654691 After privatization years 1997 1998 1999 Liquide Funds** 40036918 98251294 55620179 Total Deposit 63429709 76541153 93107291 % of total deposit to liquid funds 63.12013508 128.364011 59.73772666 c:liquid funds/total assets Before privatization years 1986 1987 1988 1989 1990Liquide Funds 5831488410 2.8047E+10 20832769682 2.1864E+10 24357915814Totl Asseta 13725521165 1.7495E+10 21409793271 1.7742E+10 21645420203% of total assets to liquid assets. 42.48646255 160.312086 97.30486146 123.233983 112.531499 After privatization years 1997 1998 1999 Liquide Funds** 40036918 98251294 55620179
Totl Asseta 72403560 89358167 106926331Data is not available
% of total deposit to liquid funds 55.29689148 109.952226 52.01728936
244
Appendix 3.6 Earning and profitability
a:Return on assets Earning and Profitability for MCB before privatization