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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

Transcript of 317S

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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.

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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.

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“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)

Source: Privatization Commission of Pakistan

1991 to June 2002

Jul2002 to Jun 2003

Jul 2003 to May 2004

To Date

Sector No Amount No Amount No Amount No Amount

Banking 4 5644 2 12970 1 22409 7 41023

Capital Markets Transaction

3 1300 8 8421 3 9759 14 19482

Energy 12 20898 12 20898

Telecom 2 30558 2 30558

Automobile 7 1102 7 1102

Cement 11 2 1048 13 8838

Chemical/fertilizer 16 9383 1 815 1 6 18 10204

Engineering 7 187 7 187

Gee Miles 21 768 81 22 849

Rice/Roti Plant 23 326 23 326

Textile 2 87 2 87

Newspapers 5 270 5 270

Tourism 3 594 1 1211 4 1805

Others 5 154 1 530 6 687

Total 121 79061 11 22211 10 35044 142 136316

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Source: Privatization Commission Annual Report, 2003

Source: Privatization Commission Annual Report, 2003

F igure 1.1: Sources of Proceeds

Energy19%

Telecom 28%

Industrial & O ther 20%

Banking & C apital M arket Transactions

33%

F igure 1.2: D istribution of Proceeds Rupees in B illion

16 5

5 64

R eturned to SO E Privatisation E xpenseR estructuring E xpense R eturned to G O P

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1.4 Steps In Privatization Figure 1.3

1: Identification 2: Hiring of a financial advisor 3:Due Diligence 4: Regulatory Reform

7:Post Bid Matters 6: Pre-Bid and Bid process 5: Valuation of property Source: Privatization Commission Annual Report, 2003

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Figure 1.4

Source: Privatization Commission Annual Report, 2003

1.4.1 Identification

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

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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

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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:

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(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.

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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

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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.

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• 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

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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.

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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)

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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.

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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

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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

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Figure 1.7

Figure 1.8

Source: Policy Consideration Before Bank Privatization-Country Experience by Dr. Ishrat Hussain

Governor State Bank of Pakistan

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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

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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

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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

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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:

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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

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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

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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

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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

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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

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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.

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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.

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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.

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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

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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

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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

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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

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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

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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

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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

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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.

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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

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(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

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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)

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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.

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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.

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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

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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

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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.

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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.

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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.

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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

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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

171 34.2 9.665 6.95 9.665 Table No.3.2 1997-2001 MCB after Privatization Inputs Assets (Rs.Millions)

Mean Variance Standard Deviati Estimated StandaError of mean

0.978 0.1956 0.0060 0.0778 0.00121 Efficiency = 9.665/0.00121 > 1 => MCB’s relative efficiency better after privatization than before

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Table No.3.3

1987 - 1990

ABL Before Privatization

Inputs Assets (Rs.Millions)

Mean Variance Standard Deviati Estimated StandaError of mean

72.9 18.225 15.3425 3.92 3.84 Table No.3.4 1996-1999 ABL After Privatization Inputs Assets (Rs.Millions)

Mean Variance Standard Deviati Estimated StandaError of mean

2.358 0.589 0.1182 0.34 0.03 Efficiency = 3.84/0.03 > 1 => ABL’s relative efficiency after privatization better than before

(See appendix 3.1 for calculation) Part 11.

The word “TARCSIMEL” is an acronym whose letters are defined as follows:

T=transaction cost,

A=asset quality,

R=risk exposure,

C=capital adequacy,

S=spread between deposit and borrowing rate,

I=intermediation proxies of savings and mobilization and credit allocation,

M= Management competence,

E=earning or profitability,

L=liquidity

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Figures.3.1

1:Operating cost as % of T/Income 2: Staff cost p/u of T/Income

L cash as ratio of demand deposit 3: Staff cost P/U of employee

2:liquidity fund/T.deposit 4: Staff cost P/U of Op.cost 3:Liquid funds/T.assets

1:Pro.of loan losses 1:return on assets 2:write of loans losses 2:return on equity 1:income/assets 1:Default risk 2:income/fixed assets 2:Capital risk 3:interest risk 4:liquidity risk 1:private loans/T.loans 2:public loans/T.loans 1:Demand deposit/Total deposits 3:Govt.loans/T.loans 2:quasi money/T.deposits 4:total credits/T.deposits 3:share.cont.as% T.assets Source: Sam Q. Ziorklui et al (2003) 3.3. Efficiency Gains of Two Banks MCB and ABL 3.3.1. Transaction Cost

One of the major objective of privatization of banking sector in Pakistan was to

minimize transaction cost which will attract the customers to use banking facilities.

Transaction cost can be reduced by training staff to be more productive in the delivery of

bank services and the efficient management of bank operations. Before privatization

maximum appointment in banking sector were on the basis of political affiliations and on

Banks Efficiency Model

Transaction

t Asset quality

Earning Profitability

Liquidity

Mang. Compt

Inter. Proxees

Risk exposur

Capitl Adequacy

Spread Rate

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political approach. MA Islamyate, Urdu and political sciences degree holders were

appointed as managers in the branches with out knowing the alpha bit of the banking

operation. After privatization Institute of bankers launch a program of MBA banking and

finance in different universities to produce future bankers. The efficient management may

lead to lower cost for bank customers and depositors and an increase in savings

mobilization. It will also increase the spread between the operating cost and revenue,

which may lead to higher profit. The indicators to examine the transaction cost are:

a: Operating cost as percentage of total income/revenue

b: Staff cost per unit of total income/revenue

c: Staff Cost per unit of employee

d: Staff cost per unit of operating expense.

The analysis was conducted for two periods pre- and post privatization of two banks, i.e.

MCB and ABL.

Table.3.5 Transaction Cost Period Bank Average

operating cost as % of total income/ revenue

Average staffcost % per unit of total income/ revenue

Average staff cost % per employee

Average staff cost per unit of operating cost

MCB 92.8 26.7 63381.6 28.71 Before privatization 1987-91

ABL 96.4 28.6 N.A N.A

MCB 92.78 24.68 371906 28.25 After privatization 1997-2001

ABL 99 24.47 N.A N.A

Source: See appendix 3.2

The result shows little change in operating cost as percentage of total income. The

operating cost as a percentage of total income of MCB was 92.8% before privatization

while after privatization operating cost of MCB is 92.78% remain unchanged. The data

shows that before privatization MCB was facing 92.8% cost for generation of revenue

one Rupee.

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Staff cost per unit of total income for pre-privatization period of MCB was 26.7% and

after privatization it is 24.7% showing decrease of 2%. The operating cost as percentage

of total income of ABL 96.4% before privatization, but after privatization it is 99%, mean

increase of 2.6%. The third indicator of transaction cost which is staff cost per employee

of MCB has increased for after privatization period. The fourth indicator of transaction

cost per unit of operating cost of MCB is showing no notable changes. The reasons for

Increase in staff cost per employ may be because of:

• Increase in number of private banks and competition for recruitment.

• Staff demand for higher wages

• Due to higher inflation rate; and

• Due to devaluation of the local currency

3.3.2. Asset Quality

Improvement in the asset quality is the most basic ingredient to enhance the profitability

and soundness of financial institutions. Advances and loans normally make up the largest

portion of the assets of the banks and is important source of income. One of the major

problems of the banks in Pakistan at the end of 1990 was the huge stock of Non-

performing loans (NPL), particularly of the public sector banks. Corporate and Industrial

Restructuring Corporation was established in September 2000 to deal with the historical

stuck-up portfolio of the banking sector. The study of the data’s of two banks shows that

the % of provision to total advances is decreasing from 1997 to 2000 but increase in

2001. The percentage of provision for MCB to total advances in 1997 6.2% and

decreased to 5% in 2000 showing decrease 1.2% but increased 1.35% in 2001. As whole

the stock of NPL 234.2 billion decreased by the end of 2002 from previous year for all

schedule banks of Pakistan showing sign of improvement in the asset quality. (Pakistan:

Financial Sector Assessment 2001-2002)

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Figure 3.2 Percentage of Provision for MCB to T/Advances

1997

1998

1999

2000

2001

6.2

5.955.68

5.08

7.55

Figure 3.3 Provision as % of T/Advances for ABL

1997

1998

19998.62

6.72

5.07

The study also shows that write off % before privatization for both banks is high as

compared to the post privatization period. See appendix .3.3

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3.3.3. Risk Measurement

The extent to which the banks manage the resources of depositors in order to generate

income that pays interest to depositors and shareholders is associated with various

uncertainties. Banking sector is facing different types of risks and needs proper

management. The different types of risks are:

• Default Risk. Such as inability of the borrowers to pay loans.

• Capital Risk .The inadequacy of owner to contributed capital to cover losses on

business transaction

• Liquidity risks. The inadequacy of funds availability to meet unexpected

withdrawal by depositors.

• Interest risks. The potential of unexpected changes in interest rates to have

adverse impacts on the revenue and expenses of the banks.

Risk management is one of the important requirements for financial institutions. The

default of one bank to another bank can create contagion risk, which can paralyze the

whole economy. The term liquidity for the banks refers to their ability to quickly raise the

cash at a reasonable cost. Adequate liquidity is important for the banks to pay creditors,

meet unforeseen deposit runoffs, satisfy periodic changes in loan demand, and fund loan

growth without making costly balance sheet adjustments. Absence of adequate liquidity

may affect the profitability of an otherwise sound bank and in extreme case may lead to

insolvency of a problem institution. Primarily, the liquidity risk arises due to mismatches

in the maturity profile of assets and liabilities. Banks’ ability to bridge this gap at

relatively lower cost mainly depends on the efficiency and liquidity position of inter-bank

market and the stance of monetary policy. As whole banking sector of Pakistan is

showing improvements in liquidity due to increase in deposits. The financial statements

of the two banks selected as a case study are also showing improvements in liquidity after

privatization.

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Table 3.6 Risk Measurements

Source: See appendix 3.4

3.3.4. Interest rate risk

The change in interest rate can affect the earnings of the banks. The interest rate risk

shows the extent to which changes in interest rates affect the valuation of the bank assets

and liability cost. In a competitive banking environment where interest rates are

determined by market forces, small change in interest rate will affect revenue and the cost

of the funds.

The data shows that interest rate risk of MCB has increased from 35.38 in 1987 to 55.70

in 2001, while interest rate risk of ABL decreased from 37.32 percent to 5 percent. The

main reason of higher interest rate risk in Pakistan banking sector is because of higher

spread rate. The spread rate has increased from2.4% in 1989-90 to 7.1% in1999-2000. So

still main source of revenue of banks in Pakistan is spread rate.

3.3.5. Capital Risk

The capital risk is induction of how a shareholders fund can absorb asset declines before

depositors and creditors funds are put at risk. The financial reform with prudential

regulation of adequate capital ratio is designed to ensure that depositors and creditors

funds are not put at risk. There is inverse relationship between capital risk and exposure

of depositor’s funds to risk. Thus higher the ratio of capital to advances, the less the

capital risk, the greater the protection for depositors funds and the less the risk of

exposure of depositor and creditors funds.

Bank Before privatization After Privatization 1987 1988 1989 1990 1991 1997 1998 1999 2000 2001 MCB 35.38 39.20 34.07 35.19 33.77 39.97 35.66 40.65 48.75 55.70 Year 1986 1987 1988 1989 1990 1997 1998 1999 2000 2001

%of Net interest income to Total Revenue

ABL 37.32 38.20 37.50 32.10 33.33 07.71 12.69 04.59 N.A N.A

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Table 3.7.CAPITAL RISK OF MCB & ABL BEFORE AND AFTER PRIVATIZATION

( Rs in 000)

Source: appendix 3.4

The results of study show that capital risk at sector level as well as for these two banks

remain negative. The capital risk ratio of MCB is showing decline 97.17 in 1987 to 20.67

in 2001, while the capital risk ratio of ABL was 8.27 negative in 1986 increased to 18.38

in1999. So ABL show slight improvement in management of capital risk after

privatization.

3.3.6. Capital Adequacy Measurements

The capital adequacy ratio of all banks in Pakistan is showing improvements. The capital

adequacy ratio in 2000 was 9.2 % increased to 9.7% in 2002 showing slight

improvement. To prepare the Pakistani banking sector for the emerging challenges of

globalization, it was required to have fewer institutions, but with sizable capital base.

Although a risk based capital adequacy system was already in place since 1997, the

existing system was not encouraging the small private sector banks to achieve the

economies of the scale. To address this issue the SBP doubled the minimum paid up

capital (net of losses) requirement for schedule banks to Rs.1.0 billion.

The study shows that the capital adequacy of banking sector as whole and the two banks

of case study improved. The capital adequacy ratio for MCB (before privatization) was

2.88% in 1987 while in 2001 (after privatization) the ratio is 11.81% showing increase of

9% approximately. The capital ratio of ABL was very high before privatization. It was

29.52% in 1986 but data after privatization is not available to compute the ratio for after

privatization period.

Bank Before privatization After Privatization

1987 1988 1989 1990 1991 1997 1998 1999 2000 2001 MCB 97.17 30.41 28.02 202.93 158.21 22.65 19.70 18.82 26.03 20.67

Year 1986 1987 1988 1989 1990 1997 1998 1999 2000 2001

%of total capital to total Loan

ABL 8.28 12.11 14.55 13.51 14.72 17.75 21.64 18.38 N.A N.A

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Table 3.8. CAPITAL ADEQUACY OF MCB & ABLBEFORE AND AFTER PRIVATIZATION ( Rs in 000) Bank Before privatization After Privatization

1987 1988 1989 1990 1991 1997 1998 1999 2000 2001 MCB 2.88 9.35 9.08 7.79 9.45 10.29 12.08 12.49 7.77 11.81 1986 1987 1988 1989 1990 1997 1998 1999 2000 2001

%of Share holder contribution to total Assets

ABL 29.52 23.86 26.80 25.05 20.09 0.24 0.20 0.20 N.A N.A

Source: appendix 3.5

3.3.7. Interest Rate Spread

Banking spread (or intermediation cost) is a measure of efficiency of the financial

institutions. A higher spread shows a less efficient financial system. Pakistan had a very

high spread till 2001, however, recent developments in external and monetary sector

helped the banking system to brought down the banking spread to 7.3 percent in FY03

due to a more pronounced decline in lending rates than rates on deposits. Specifically, a

sharp slide in the rate of returns on government papers made this customary investment

avenue unattractive for the banks. In fact, ample liquidity forced banks to introduce new

financial products and explore new market segments such as consumer financing.

Although lending rates fell significantly, intense competition improved the banks’

efficiency and profitability. In this background, it is expected that further improvement

would be realized in financial sector efficiency in terms of lower intermediation cost.

This is the difference between the average interest rate on their loans and the average

interest rate paid on deposits. There are several established methods of calculating

interest rate spreads (or margins). One approach is:

Interest received interest paid Interest Rate Spread=

Interest earning assets total deposit This approach shows a bank’s spread from the viewpoint of its customers. The interest

rate spread charged by institutions represents a cost imposed on their customers. The

wider the spread, the greater the cost; depositor receive a lower rate and borrowers pay a

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higher rate. Generally accepted views about privatization are that it will increase

competition and in competition between banks will decrease spread rate.

Figure 3.5 Spread Rate after Privatization

00 1997

1998

1999

2000

20014.5

5.296.76

6.2

7.83

Source: Annual report of State Bank of Pakistan (2001-2002). The data shows that spread rate before privatization was lower as compared to spread rate

after privatization. Just spread rate is not enough to draw conclusion that efficiency of the

banks are not improved. Possible reasons for the above developments are:

• Lack of active competition in the banking sector for saving.

• Large reserve requirements by the SBP that do not earn any interest rates.

• Higher spreads may be used as a hedge against inflationary pressures in Pakistan

economy.

Figure 3.4 Spread Rate Before Privatization

0 1987

1988

1989

1990

19913.37

3.062.64

2.07

3.3

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• Hedged attempts to cover interest foregone on higher reserve requirements.

• Huge value of NPLs on their Balance Sheets. • High administrative cost.

• Over staffing

• Higher risk of business default

• Increasing volume of bad loans of financial institutions.

Increase in banking spread should, however, be interpreted with caution. In pre-reform

period, interest rates were controlled from both sides, with the floors on deposit rates and

ceilings on lending rates. The widening after the reforms largely indicated the change

from a repressed to a liberalized interest rate regime. However, the interest rate spread

widened from 4% in 1990 to 4.5% in 2000 showing that the reforms did not succeeded in

increasing the efficiency of the banking sector.

General views of the researchers are that privatization increases competition and

competition increases efficiency and efficiency gives birth to new products. The data

shows that these two banks have created too many new products and services after

privatization. No doubt these products are not new on world level but totally new on

Pakistan level.

INNOVATIONS

MCB Product and Services 1. Consumer Banking

Specialized products Specialized Accounts

• Remit Expense Saving 38s • Rupees Traveler Cheque Khushali Bachat • Master Card Pak rupee • Easy Personal Loan Foreign Currency A/Cs • Car Cash • Pyara ghare

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2. Corporate Banking 3. MCB International------Dollar Khushali A/Cs

Monthly Khushali A/Cs---1. Speed Cash 2. Home remittance 3. Money Gram and Global money 4. Drawing Arrangements

4. MCB Islamic Banking MCB on Line Products

• MCB ATM Services--------- MCB ATM Bill Payment • MCB Mobile Banking MCB AM Fund

Transfer • MCB Call Center MCB ATM Cash

Card • MCB Debit Card • MCB Smart Card

ABL New Product and Services 1. All time Banking 2. Inter Branch Transactions 3.Allied Expense, Electronic Funds Transfer For Overseas Pakistani 4.Corporate Service------Trade Finance ABL Evergreen Products Saving Account Foreign Currency Accounts Lockers Travelers Cheques Seasonal Finance Term Deposits MCB On Line Branches Swat, Murree, Abbotabad, Haripur, Peshawar, Islamabad, Sialkot, Sargodha

Gujranwala, Sahiwal

MCB ATM Branches Lahore, Faisalabad, Bhawalpur, Multan, Quetta, Kamoki, Sadiq

Abad, Rahimyar Khan, Sukkur, Larkana , Hyderabad, Karachi.

On the basis of competition all banks in Pakistan have introduced different new products

and services to attract the customers, which is one important sign of improvement in

efficiency of Banking Sector.

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3.3.8. Intermediation Proxies

One of the important functions of the banks is to link lenders (surplus units) with

borrower (deficit units). The developed banking sector can accelerate the financial saving

mobilization and credit allocation to private sector. The extent to which financial

institutes intermediate between the business community and depositors, in terms of

raising financial resources for credit allocation, has been measured in term of demand

deposit/total deposits and long-term (quasi money)/total deposits. The intermediation

proxies, in terms of credit allocation, are measured by the followings:

• Private loans/total loans or advances

• Public loans/total loans

• Government loans/total loans

• Total credit/total deposit or the loan deposit ratio.

Table 3.9. Intermediation Proxies

Source: See appendix 3.5

The level of financial intermediation shows the confidence in the banking system. This

could be measured by using currency to M2 ratio or currency to deposits ratio. Currency

to M2 ratio fell marginally from 25.4 percent in FY00 to 24.6 percent in FY01 and

remained at the same level in FY02 then fell again to 23.8 in FY03. It shows higher

intermediation in FY02 that implies people preference to hold lower cash compared to

Bank Intermediation proxies Before privatization After Privatization

1987 1988 1989 1990 1991 1997 1998 1999 2000 2001 % of demand deposits to total deposits

19.60 22.14 22.69 22.95 25.40 36.66 23.25 17.10 21.37 22.02

% of long term deposits to total deposits

28.96 20.00 22.00 20.70 22.15 28.34 26.68 27.21 21.14 18.39

% of private loans to total loans 69.35 74.63 82.42 80.24 81.34 12.01 4.4 NA NA NA

MCB

% of total loans to total deposits 58.03 59.80 61.39 68.57 59.95 51.74 50.81 51.73 63.50 49.55 1986 1987 1988 1989 1990 1997 1998 1999 2000 2001

% of private loans to total loans NA 70.70 80.18 NA NA NA 91.17 95.00 NA NA % of public loans to total loans NA 19.37 07.29 NA NA NA 08.83 05.00 NA NA

ABL

% of total loans to total deposits 55.83 49.07 37.68 48.61 56.06 NA NA ,57.12 55.81 59.35

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the bank deposits. The improvement in FY03 is also attributed to increasing use of ATMs

and other means of electronic banking.

Efficient allocation of credit also requires diversification of assets portfolio.

Concentration of credit in few sectors of the economy makes the financial sector

vulnerable to the performance of these sectors. Financial reforms in Pakistan did not

appropriately address this problem. In total credit the share of large scale manufacturing

sector, which was 42 % in 1990, further increased 50.9% in 2000. The share of

manufacturing sector in real GDP is less then that of agriculture but its share in bank

credit is more then twice compared with the credit share of agriculture. (Pakistan

Financial Sector assessment 1990-2000)

The study shows that that private loan as ratio of total advances increased both at the

sector level as well as banks level selected as a case study. The ratio of private loans to

total loans of MCB was 69.35% in 1987 increased to 92.5% in 2000 and 78.05% in 2001.

While ratio of private loans to advances of ABL was 71% in 1987 increase to 95% in

1999. Slight changes are also noted in public loans measured as ratio of advances, that

are 12.05% in 1987 increased to 21.95% for MCB and 19.37% in 1987 decreased to

5.01% in 1999.

The study also shows that the ratio of demand deposits to total deposit remain stable for

sector level as well as for MCB and ABL. While ratio of quasi money to total deposit

shows increase on sector level but stable on banks level.

3.3.9. Management Competence

Although it is difficult to comment on the management performance of the banking

sector without taking qualitative factors into account, expenses to income ratio and

intermediation cost can be used to assess the overall management performance. Both

indicators have recorded notable positive changes during the years under review. So the

measure of efficiency is the extent to which management uses resources at its disposal to

generate income through the delivery of financial services to the public. Both

income/assets and income/fixed assets measured management efficiency in resources

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utilization. An efficient bank operation manifests in greater income per unit of assets

then does less efficient bank operations.

The analysis shows tremendously increases in income/t. assets of MCB after

privatization. The income/asset ratio of MCB was .97% in 1987 and 1.123% in 2001.

Similarly the ratio of income/fixed asset was 35% in 1997 and 57.41% in 2001. While the

ratio of income/assets and income /fixed asset for ABL is showing decreasing after

privatization. Result of one bank should not be interpreted as unfavorable indicator.

Table3.10 Management Competence

Source: See appendix 3.6

3.3.10. Earning and Profitability . Earnings quality for a bank generally refers to the composition, level and stability of

bank’s profits. A bank’s ability to earn adequate return on its assets has direct bearing on

its safety and soundness. The inability could lead to the failure to adequately: (1) serve

the credit need of customers, (2) provide for the losses of the bank that may arise during

its operations, and (3) build the capital to absorb any adverse shock due to macro or

micro reasons. This ultimately means that depositors are at greater risk and shareholders

Before Privatization After Privatization Bank 1987 1988 1989 1990 1991 1997 1998 1999 2000 2001

% of income to Assets

0.566 0.636 0.631 0.364 0.381 0.822 0.632 0.763 0.757 1.123 MCB

% of income to Fixed Assets

127.4 147.8 171.3 91.09 112.1 34.98 26.60 34.79 36.67 57.41

1986 1987 1988 1989 1990 1997 1998 1999 2000 2001 % of income to Assets

0.273 0.264 0.24 0.194 0.179 0.038 0.190 0.066 NA NA ABL

% of income to Fixed Assets

52.96 54.93 52.14 49.72 46.83 3.296 6.815 2.322 NA NA

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return may become inadequate. The banks in Pakistan have been finding difficulties in

earning positive profits since 1997. besides other reasons, a prime factor was the

transition cost of ongoing reform process.

Earning and profitability ratios are use to evaluate the efficiency of banks. The ratio used

to measure profitability is:

• Return on assets

• Return on equity

• Return on share.

In term of ROA is increased for MCB .57% in 1987 to 1.123% in 2001 while ROE is

increased from 1.56% 1987 to 13.27% 2001. While ROA for ABL is .27% in 1986 to

3.45% in 1999 and ROE is 8.05% 1987 decreased to .70% in 1999. As whole banking

sector has improved profitability performance. Earning per share of both banks is

increased after privatization.

Table 3.11 Earning and Profitability

Source: See appendix 3.7 3.3.11. Liquidity Management

Liquidity management serves various purposes.

• To sure the availability of funds meet withdrawal of demand

• To meet reserve requirements needs of banks.

Description Before Privatization After Privatization Bank Year 1987 1988 1989 1990 1991 1997 1998 1999 2000 2001

Return of Assets %of income to Assets

0.566 0.636 0.631 0.364 0.381 0.823 0.632 0.763 0.757 1.123 MCB

Return of equity % of income to capital

1.565 5.670 5.728 2.839 3.601 8.471 7.640 9.537 5.879 13.27

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

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• 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.

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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.

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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

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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

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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

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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%

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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.**

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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.

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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%

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Table 3.20 Financial Indicators MCB

Source: Financial Sector Assessment 2001-2002,State bank of Pakistan

Table 3.21 Financial Indicators of ABL Assets (%

of Assets of NCBs)

Deposits (% of deposits of NCBs)

Advances (% of advances of NCBs)

NPLs (% 0f total loans)

1994 9.6 9.8 10.9 16.6 1997 10.4 10.6 12.5 17.9 2000 11.7 13 14.2 29.4 2003 12.2 14.3 11.2 43.8

Source: Financial Sector Assessment 2001-2002,State bank of Pakistan

Assets (% of Assets of NCBs)

Deposits (% of deposits of NCBs)

Advances (% of advances of NCBs)

NPLs (% 0f total loans)

1994 18.1 17.6 17.7 18.1 1997 21.5 20.8 21.9 11.6 2000 18.2 18.3 21.5 14.4 2003 28.3 26.5 26.7 11.3

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3.5 Findings: Earning Assets to Total Assets According to the findings, five years average ratio of MCB is 81.20%, which is higher

then the industry average. This shows the performance of MCB is comparatively better

as compared to the average of UBL, which was working in public sector but recently

privatized. While the performance of UBL is better then ABL which was good in the

start but suffer with management problem in 1999. This indicates that UBL has also

done well its assets to work but not better then MCB.

Return on Earning Assets The Industry average of return on earning assets ratio is obtained as 0.14%. By

examining the results, it can be seen that return on earning assets ratio of MCB is

0.62%, which higher then industry average. It means that profitability of MCB was

relatively better then the industry. Where as the average ratio of ABL is 0.12% lower

then average ratio of UBL that is 0.33% lower then industry average. The analysis

clearly shows that just privatization is not enough for improvement in efficiency but

proper management is also necessary for development and efficiency. ABL is handed

over to management of the Bank, where the management remains the same when the

bank was working in the public sector.

Interest Margin To Average Earning Assets Interest margin to average earning assets ratio for the industry is calculated as 3.79%.

MCB average ratio is higher then the industry average i.e. 5.45%, where is UBL and

ABL ratio are lower then the industry i.e. 3.45% & 2.46% respectively. This indicates

the MCB profitability is higher then the industry. Whereas UBL and ABL not

performed well in terms of profitability as compare to the industry.

Loan Loss Coverage Ratio The industry average for the loan loss coverage ratio is 4.35 times. The average loan

loss ratio for MCB is 8.81 times and for UBL is .12 times. This indicates that MCB has

higher protection against loan and good quality assets. Whereas opposite is the case in

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UBL. However, for ABL this ratio is not calculated, as ABL had not made provision in

1995, and 1996 as well it had not written off its bad debt in the year 1995, 1996, 1997,

1998 and 1999.

Equity Capital to Total Assets The industry average for equity capital and total asset ratio is 1.87%, whereas five years

ratios of MCB, UBL and ABL are 2.53%, 1.52% and 1.57% respectively. The data is

showing clearly that MCB has better results then the industry and has more cushion of

equity against the risk of using debt, While opposite is the case in UBL and ABL.

Deposit Time Capital

The industry average for deposits time capital ratio is 32.35 times, whereas average ratios

for MCB, UBL and ABL are 32.13, 17.93 and 46.98 times respectively. Only ABL has

higher average ratio than the industry. The other two banks have lower ratios this shows

that they have more capital against deposits and more margin of safety.

Loan Deposits

The industry average for equity capital and total asset ratio is 53.40%, whereas five years

average ratios of MCB, UBL and ABL are 51.99, 50.59% and 57.62% respectively. By

examining the results it is clear that ABL had more risk from debt stand point as compare

to UBL and MCB.

3.6 Conclusions

State regulators not only in Pakistan but through out the world regularly assess the

financial condition of each bank and specific risk faced via on site examinations and

periodic reports. Federal regulators rate banks according to the Uniform Financial

Institutions Rating system, which now encompasses six general categories of

performance under the label CAMELS. Each letters refers to a specific category,

including:

C= for capital adequacy

A= for asset quality

M=for management quality

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E=for earnings

L=for liquidity

S=for sensitivity to market risk

Regulators numerically rate each bank in each category, ranging from the higher or the

best rating (1) to the worst or lowest (5) rating. It also assigns a composite rating for the

banks over all operation. A composite rating (1) or (2) indicates a fundamentally sound

bank. A rating of (3) indicates that bank shows some underlying weakness that should be

corrected. A rating of (4) and (5) indicates a problem bank with some near term potential

for failure. The TARCSIMEL used in this study is similar to CAMELS but with some

extra categories.

Summary of empirical studies on state versus private ownership of banking clearly

shows that private owned banks are efficient than state owned banks. Bonin, Caprio and

Paul Wachtel (2002) examine the impact of ownership structure state, private and foreign

owner ship on bank performance in six transition economies. The authors find robust

evidence that profitability ---measured by return on assets and return on equity –is higher

for fully private banks than for banks with some state-ownership. Berth, Caprio and

Levine (2003) used a new data base on bank regulation and supervision in 107 countries

to assess the relationship between specific regulatory and supervisory practices and

banking sector development, efficiency and fragility. They found that government owner

ship of banks is negatively correlated with favorable banking outcomes and positively

linked with corruption. Cornette, Guo, Khaksari and Tehranian (2003) examine

performance differences between privately owned and state owned banks in 16 Far East

countries from 1989 through 1998.They find that state owned banks are significantly less

profitable then privately owned banks. The performance differences are more acute in

those countries where government involvement in the banking system is the greatest. On

the basis of the findings of these different studies and results of my own analysis I

conclude that privatization of banks will have positive impact on efficiency of banks in

Pakistan.

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Part 1 Using DEA approach; Akhtar (2002) has conducted a preliminary study of X-

Efficiency Analysis of commercial banks with ownership forms. On similar lines but

with privatization prospective, DEA approach has been applied to Muslim

commercial bank and Allied Bank to determine the relative efficiency of

these two banks selected as a case study. Table No 3.1, 3.2, 3.3, and 3.4

shows that in both cases relative efficiency has exceeded unity implying that

the banks has improved their performance after being privatized.

Part. 1I.

Nine areas are examined in this study and 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 needs decrease to attract borrowers to

stimulate economic activities. It is hoped that with the passage of time and increase in

competition the sector will further improve efficiency.

Impact analysis of privatization (MCB)

There has been a marked improvement in the performance of MCB following its

privatization, as can be seen from its financial indicators. A healthy growth in the assets

of the bank can be observed, which by the end of 2003, represented over 28 percent of

the assets of the nationalized commercial banks. Similar growth can also be seen in the

deposits and advances of MCB, with deposits and advances standing at 26.5 and 26.7 per

cent respectively in 2003.

The non-performing loans as percentage of total advances have declined significantly

during the period under consideration, reaching 11 percent of gross advances by 2003. If

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we take the net NPL ratio for the bank, this figure comes out close to 2 percent, which

compares very favorably with net NPL ratio for the entire banking system at 5.5 percent.

Profitability of the bank has also improved significantly, while return on assets increased

from 0.2 percent in 1993 to over 0.8 percent in 2003.

Impact analysis of privatization (ABL) Unlike the case of MCB, the performance of Allied Bank does not show any

improvement after its privatization. In fact, some of its financial indicators show

considerable deterioration in the post privatization period. Assets and deposits have

shown only a marginal improvement. Advances, which had grown somewhat initially

declined in the later years.

The most alarming development has been the jump in non-performing loans of ABL.

NPLs as a proportion of total loans reached nearly 44 percent by 2003 from 16 percent in

1993. It is interesting to note that in 1994, the NPLs of MCB were slightly higher than

those of ABL. While the new management of MCB was successful in bringing down the

NPLs, the employee management group in ABL was responsible for a drastic increase in

the NPLs. As a result of the increasing NPLs, the profitability of Allied Bank has also

suffered, the bank made huge losses between 2000-02. The situation only started

improving after the SBP removed the Board of Directors in 2001, replacing it with a new

Board. The ROA has been negative since 1999, and the bank came out of the red only in

2003.

Part 111 Ratio Analysis Ratios provide a very simple and effective method for looking at the financial

performance of any business by analyzing the financial accounts of the business. Ratio

can prove to be a valuable analysis tool, but they are based on looking at accounts, which

are only true for one day in time. However, 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 of the bank. On the basis of ratio

analysis results I conclude that privatization improve efficiency.

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CHAPTER 4

Privatization of Banks and its Impact on Economy

4.1 Introduction

A well functioning financial system is a pre-requisite for the economic development of

any country. A large body of recent theoretical and empirical research has also confirmed

the view that the development of financial markets and institutions in a country is crucial

for economic growth. (Thorsten et al. (2000) & Khan and Senhadji (2000). Realizing this

importance of the financial sector in economic development, some governments in

developing countries sought to increase their ownership of banks and other financial

institutions, in order to direct credit towards priority sectors. However, the importance of

state-owned banks in many developing countries contrasts worryingly with recent

research findings, which show that the state ownership of banks has serious negative

effects on economies in developing countries. A recent study finds that state ownership is

negatively associated with bank performance and the overall development of the financial

sector. (Barth et al. (2001) A large theoretical literature shows that banks can reduce the costs of acquiring

information about firms and managers and lower the costs of conducting transactions. By

providing more accurate information about production technologies and by exerting

corporate control, better banks can enhance resource allocation and accelerate growth

[Boyd and Prescott 1986; Greenwood and Jovanovic 1990; King and Levine 1993b].

Similarly, by facilitating risk management, improving the liquidity of assets available to

savers, and reducing trading costs, banks can encourage investment in higher-return

activities [Obstfeld 1994; Bencivenga and Smith 1991; Greenwood and Smith 1997].

The government ownership of commercial banks resulted in political intervention into

credit allocation and loan recovery decisions besides other institutional inefficiencies. As

a result, infected loans increased sharply, financial institutions suffered losses and quality

of services plummeted. In order to address to these issues, a number of policy reforms

were undertaken to encourage the participation of private sector, and permitting it to open

banks and NBFIs.

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The primary stated goal of the privatization efforts was to promote the private sector as an

engine for growth and to increase efficiency and productivity in economy. In general, it

was claimed that privatization policies would improve efficiency of resource use, foster

competition, enhance the role of private sector, and obtain higher rates of domestic savings

and investment and, last but not least, attract and provide opportunities for foreign investors.

In addition, privatization would, it was said, reduce the size of the state, reduce the fiscal

deficit, provide better services and give the state immediate resources that would be used to

reduce the short-term debt and invest in social infrastructure or reduce other social

expenditures. (Ishrat Husain, 2003)

There are several important benefits that come from privatizing a state owned banks. When

banks were controlled by the government, it was primarily concerned with serving the

interest of its owner. This means that politicians and bureaucrats use the banks as a means

of patronage and corruption. The banks were overstaffed as cronies and lackeys were

thrown on to the payroll. Services were poor as the managers did not gain anything by

providing good services or expanding their business. Efficiency was lost and the banks run

at a loss to meet its bloated payroll. This results in general revenue being used to balance

the banks books and make up the losses. Precious tax receipts were flushed down the toilet

to maintain the companies. Private sector competition was stifled or constrained as it would

hurt the public sector banks and so the consumer losses out again. Without competition the

public sector banks had no incentive to shape up. When banks were privatized, all these

negatives were turned into positives. The banks had to stand on itself, so it improved its

management and pared down its staff to a more appropriate level. The job losses that were

feared were probably overstated and certainly don’t justify the current situation. One of the

first banks to be privatized has actually increased its total work force, as it became a real

business intent on expansion and growth. The difference is that its workforce is actually

there to work rather than collect a government check.

In any capitalist economy the single most important function of banks is the provision of

credit to those able to make the most productive use of it. The major strengths of United

States are its highly developed capital markets that allow anyone with a good idea to get

access to adequate financing. No modern economy can grow if capital is consistently

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wasted, and this holds doubly true for a country like Pakistan, where there is only a small

amount of capital available each year.

4.2 Privatization of Banks and its Impact on Economy

Patrick (1966), who first introduced the idea of the bi-directional relationship between

financial development (FD) and economic growth (EG), suggested two patterns in the

relationship between financial development and economic growth. In the first pattern,

which is called “supply-leading”, FD causes EG by allocating resources to more

productive sectors. Patrick explains the functions of the supply-leading phenomenon as

follows: “to transfer resources from the traditional, low-growth sectors to the modern,

high-growth sectors and stimulate an entrepreneurial response in these modern sectors”.

In the second pattern suggested by Patrick, called “demand-following”, economic growth

creates demand for developed financial institutions and services. According to Patrick,

the creation of modern financial institutions, their financial assets and liabilities and

related financial services are a response to the demand for these services by investors and

savers in the real economy. Since Patrick, a large empirical literature emerged testing the

causal relationship between FD and EG. The main finding of these studies was the strong

positive correlation between the financial structure and rate of growth of the economy.

The relevant literature can be found in the detailed surveys of Levine (1997) and Tsuru

(2000). Levine (1997), after reviewing many studies on the relationship between FD and

EG, it states that broad cross-country comparisons, individual country studies, industry-

level analyses, and firm-level investigations point in the same direction: the functioning

of financial systems is important for economic growth. According to the survey results,

countries with larger banks and more active stock markets grow faster over subsequent

decades even after controlling for many other factors underlying economic growth.

Furthermore, according to these results, industries and firms that rely heavily on external

financing grow disproportionately faster in countries with well-developed banks and

securities markets than in countries with poorly developed financial systems. Levine also

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emphasizes that there exists a less-developed theoretical literature on the influence of the

level and growth rate of the economic activity on the financial systems, and this is an area

that needs additional theoretical research.

Recently, there are mainly three approaches in testing for the correlation between FD and

EG. One approach is to test the hypothesis on a group of countries by using either cross-

section or panel data techniques (King and Levine 1993, La Porta, Lopez-de-Silanes,

Sheifer and Vishny, 1997, Levine 1998). Another approach is to present industry-level or

firm-level evidence that measures this correlation (Rajan and Zingales 1998, Demirgüç-

Kunt and Maksimovic, 1998). The third approach is to test the hypothesis for a particular

country.

To evaluate the impact of privatization of banks on economy I have considered two

systems of financial structure i.e. banks-based versus market based financial system. In

examining financial structure and economic development, historians, economists, and

policy makers have examined the relative merits of bank-based versus market-based

financial systems. For over a century, this work primarily involved careful country

studies of Germany and Japan as bank based systems and the United States and United

Kingdom as market based systems. Allen and Gale (1999) and Stulz, (2000).

Joseph Schumpeter argued in 1911 that banks play a pivotal role in economic

development because they choose which firms get to use society’s savings. According to

this view, the banking sector alters the path of economics progress by affecting the

allocation of savings and not necessarily by altering the saving rate. Thus, the

Schumpeterian view of finance and development highlights the impact of banks on

productivity growth and technological change. Recent theoretical models have carefully

documented the links between banks and economic activity. By economizing on the costs

of acquiring and processing information about firms and managers, banks can influence

resources allocation. Better banks are lower cost producers of information with

consequent ramifications for capital allocation and productivity growth. (Diamond 1984;

Boyd and Prescott 1986; Williamson 1987; Greenwood and Jovanovic 1990; and King

and Levine 1993b). Alternatively, a vast development economic literature argues that

capital accumulation is the key factor underlying economic growth. According to this

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view, better banks influence growth primarily by raising domestic saving rates and

attracting foreign capital. (See discussion and citations in King and Levine (1994),

Easterly (1998), and Easterly, Levine and Pritchett (1999).

Banks provide the raw material for a monetary production economy to work and grow.

The positive impact of finance on economic growth has received significant empirical

support during the nineties, starting with contribution by King and Levine (1993). The

research showed also that countries with developed banking system and liquid capital

markets have experienced the most rapid growth (Demirguc-Kum) and Levine,

(1996,1997). It is easy to over look the relevance of financial system when it functions

smoothly. However, its importance is evident in times of financial crises, such as during

period of hyperinflation and when financial institution collapse, inflicting losses on their

shareholders and depositors.

The role of commercial banks in a countries economic growth is substantial. Today while

the state of publicly owned institutions has been gradually improving the scars of poor

management, bad loans and inefficient hiring practices have greatly curtailed the

efficiency of institutions in the banking sector. Before we continue with our discussion

we must first realize that the terms "economic growth" and "economic development" are

two different ideas. While economic growth refers to the increase in wealth of a state

economic development refers to social indices such as those included in the HDI (Human

Development Index). In such a situation this study should have been aptly entitled "The

role of commercial banks in the economic growth of Pakistan", however the link between

the accumulation of wealth and an improvement in living standards cannot be ignored. In

any case if banks were to focus on micro-credit and agricultural loans to poor farmers

then indeed we would witness an increase in both GDP and the HDI.

This study evaluates privatization of banks and its impact on economy using the data of

schedule banks for country level as well as for two banks. I have used different

methodologies to assess the relationship between banks and economic growth work on

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 zerove 1998). I have selected the deposits, credits and advances, investments and

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GNP as sources of economic growth. I have developed two hypotheses and then the

correlation and time series between the sub hypotheses is calculated to see significance of

correlation/regression. To observe the relation between the under study variable I draw a

scatter diagrams for both hypothesis using statistical package M.S. Excel, the diagrams

reveal the linear relation between the variables. Scatter diagram, presents one time series

variable on the vertical axis with another time series on the horizontal axis. This gives the

researcher an opportunity to infer visually some casual relationship between the two

variables. To determine the extent of regression I have used the method of OLSD in time

series analysis.

I have also used the descriptive measures for the same data. We have observed that data

is not very much dispersed.

4.3 HYPOTHESIS

i) "Better the banking system, the greater will be the

economic growth"

ii) "The worse the banking system, the lesser will be the

economic growth."

Dependent Variable Economic growth

Independent Variable Better Banking System

Sub Hypothesis: i) The greater the number of deposits, the more will be

the investment.

Dependent Variable Investment

Independent Variable Number of Deposit

ii) The more the lending, more will be the GNP

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Dependent Variable GNP

Independent Variable Lending

VARIABLES

1. Investment

* Domestic Investment.

* Foreign Investment

2. Deposits

3. Loans and advances

* Lending

4. GNP

4.4 INVESTMENT The first investment bank in the country was Cress Bank, which started its operation in

1985. This was the period in which most of private sector commercial and investment

banks, Modarabas and leasing companies were also established. The fast expansion of

financial sector, as feared in the beginning, has not only resulted in unnecessary

competition, while the profit margins reduced, the economic slow down also effected the

repayment ability of the borrowers. This caused a significant increase in the quantum of

provisions against non-performing loans because of reduction in lending rates and

persistent recessionary trends in the country.

It is true that the recessionary trend in the country, spread over the last five years, is

partly responsible for the poor performance of investment banks. However a fact cannot

be ignored that to a large extent the management of these banks are responsible for their

current dismal financial condition as they attained unnecessary exposure in capital

markets. A large percentage of their income in the past was due to capital gains received

from trading of shares. As the capital market took a nosedive in post 1994 period, most of

their investment in equities reduced to about 20 to 25 percent of the original cost of

purchase.

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Investment banks initially classified this portfolio as short-term investment. As the share

prices did not improve, the portfolio was classified as long-term investment to avoid

heavy provisioning against diminution in the value of such investment. Despite this

reclassification most of investments banks would not be able to avoid 100 percent

provisioning against declining value for the year ending June 30, 1999. This is expected

to result in huge losses for the year and many of these institutions would become virtually

insolvent. As told above that there are presently 14 investment banks operating in

Pakistan. All of these banks are public limited companies and listed at Karachi, Lahore

and Islamabad stock exchanges. Most of these banks suffer from precarious financial

position.

4.4.1 Effect of Freezing of Foreign Currency Accounts (FCAs)

The problems of investment banks have aggravated further after freezing of foreign

currency accounts (FCAs). Many of these institutions are on the verge of insolvency.

There are hardly any prospects for turn around of investment banks as the economy is

expected to continue to suffer from recessionary trend. Therefore, there is a need to

explore ways and options to restore the vigour of these institutions and also minimize the

agony of the shareholders. As the GOP is trying to restructure the financial sector, it is

also necessary to decide the fate of investment banks.

4.4.2 Effects of Nuclear Tests on Investment

The annual accounts of most of the listed companies in general and financial institutions

in particular, have attributed the poor results for 1997-98 to post-nuclear situation. But

one should not ignore a fact that the nuclear tests were conducted on May 28, 1998 and

therefore, had hardly any impact on the operation of these entities. However the impact of

economic sanctions during the first half of current financial year was visible some extent,

though marginal only. The economic sanctions during the first half of 1998 financial year

were visible to some extent, though marginal only. The economic sanctions slowed down

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the undocumented economy proliferated during the sanctions period. That was the reason

no scarcity of goods was ever felt. The prices of various items went up but it was the

outcome of hoarding and profiteering practices of vendors.

The annual report of state bank of Pakistan for the year 1997-98 also said that the

recessionary trend in the country had started much before the nuclear tests and

impositions of economic sanctions only aggravated the situation. It is necessary to

examine the performance of each investment bank before making the financial decision

about the fate of these banks.

4.4.3. Role of Banks Intermediating Foreign Capital Inflows

Two Accounts are playing important role in the economic growth of each nation.

(i) Capital account

(ii) Current account.

Current Account of Maximum countries are deficit including the USA and Japan. While

Capital Account of developed countries are surplus. Surplus Capital Account plays very

important role in the economic growth. Developed banking sector can encourage foreign

investors, which increase capital inflow and make the capital account surplus. The

example of Swiss banks is enough in this regard.

4.4.4. Hesitation on the Part of Foreign Investors in Investing in Pakistan

All the investors in the world are considering two things before making decision of

investment in any project or country. How much risk is there and how much return is

possible. They are trading off between risk and return. The banking sector where

information disclosure and check on inside trading is not appropriate the investors will

hesitate to make investment decision.

4.4.5. The Pakistani Financial Market is improving its Transparency & efficiency to

cater to the needs of the Foreign Investors.

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a) The financial market in Pakistan, comprising of Commercial Banks, Development

Financial Institutions, Special Finance Institutions, Investment Banks, Leasing

Companies, Modarabas, Mutual Funds, Insurance Companies, Stock Exchanges,

Credit Rating Companies, Fund Management and Brokerage Houses etc., is fully

competent to fulfill the needs of international investors.

b) The aggregate market capitalization as on 30th June 2001-2002 was 353.9 Billion

rupees out of which the financial sector constitutes about 14.83%. (Source.

Karachi stock exchange)

c) The financial market has a very strong resource base and is fully competent even

to generate more funds from different sources in order to meet the local

component for foreign investment. The total deposits of scheduled banks, for

example, are worth about 680 Billion in addition to the resources of other players

in the market like Leasing Companies, Mudarabas & Investment Banks etc. etc.

(Annual Report of SBP, 2001-2002)

4.4.6. Liberalization in Pakistan to Ensure Inflow of Foreign Investment

a) Pakistan is passing through a phase of liberalization, deregulation and

privatization - a march towards market economy.

b) Any foreign investors including overseas Pakistanis can now invest in

Pakistan. All investments made through foreign currency coming to Pakistan

through accepted banking channels are repairable at the discretion of the

investors. Even the investment made from rupee funds can be repatriable

through indirect channel, namely to purchase and sale of FEBCs.

c) The foreign investors can also operate business in Pakistan and can also meet

their local currency financing requirements, working capital as well as long-

term capital, from local market.

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4.4.7. Modes of Financing in Pakistan and Outside

a) A wide variety of financing techniques and instruments is available in the

market including certain special Islamic Banking instruments.

b) In comparison to other countries in Asia, Pakistan has also entered into the

field of raising international corporate debt, international equity issues, cross

boarder mergers and other sources of international financing.

Figure 4.1 Inflow of foreign investment in Pakistan(in Million US $)

-500.000.00

500.001000.001500.002000.00

1984

-85

1986

-87

1988

-89

1990

-91

1992

-93

1994

-95

1996

-97

1998

-99

FDIPortfolioTotal

Source. Economic survey of Pakistan 2000-2001

4.4.8. DEPOSITS

Banking system totally depends upon the deposits. Without deposit it will have no money

to lend or invest. Deposits are the amount of money that the general public gives to the

banks for security or for earning interest. The efficient banking sector can pull saving

from the peoples to build up deposit level. The figure 4.1 clearly shows that deposit level

of the banking sector in Pakistan is improved just after privatization but later on went

down due to some Political and macroeconomic factors. However, 2002 is showing

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upward trend in the deposit of schedule banks of Pakistan.after Deposits are of many

types, their terms and conditions changes by their types.

Different types of deposits offered by banks are: i) Current Deposits

ii) Call Deposits

iii) Saving Deposits

iv) Fixed Deposits (different types by duration)

v) Other Deposits

Deposits are classified into different categories to earn more profit, as well as to have an

idea of money available for lending, for reserves and other purposes. These deposits have

differs interest rates determined by their value.

Figure 4.2 Deposits of Scheduled Banks

Source: Pakistan: Financial Sector Assessment 1990-2000, SBP, 2002.

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4.5. Test of Sub Hypothesis No.1

Correlation between Deposits and Investment (Rs in Million)

Table 4.1 Source: Banking statistics of Pakistan 2001 –2002 State Bank of Pakistan.

Years X No. Of

Deposits

Y Investment

1982 18251389 32261.8 1983 19565836 45033.5 1984 20488157 38572.3 1985 21215465 49056.1 1986 21720814 60230.4 1987 22578568 87273.6 1988 23947814 85882.1 1989 25140528 85303.9 1990 26756571 81226.1 1991 30993837 120021.0 1992 27106754 192185.5 1993 27973622 208043.1 1994 29520563 267805.2 1995 31085736 268794.3 1996 31723719 322875.8 1997 32271603 375286.2 1998 29772355 420830.2 1999 29710720 350326.2 2000 28409347 338796.6 2001 28043818 303782.4 Total 526277216 3733585.7

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Figure 4.3 Scatter diagram for hypothesis no.1

0

100000

200000

300000

400000

500000

0 10000000 20000000 30000000 40000000

Investment

Dep

osits

Series1

4.5.1. Results of Hypothesis No: 1 β = 0.0249

Sum of Deposits = 526277216

Sum of Investment = 3733585.7

Average of deposits = 26313860.8

Average of investment = 186679.285

Dispersion in deposits= 4393029.337

Dispersion in investment = 132396.601

γ = 0.8285 γ2 = 0.6864

Assuming the distribution of deposits (x) and investment (y) as being bivariate normal,

we wish to test the hypothesis that correlation coefficient of the population is greater then

0 .5 i.e.:

ΗO=ρ = 0.5 VS ΗI = ρ > 0.5

Using the test statistics Z = Zf - µz

1/√ n-3 (1)

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With n=20 period observations an x and y I test the hypothesis Ho at 5% level of

significance. The calculated value of Z is 2.61417. This leads us to reject HO at 5% level

of significance, and I conclude that population correlation coefficient between deposits

and investment is greater then 50%.

4.5.2 Findings

This means that variables "x", and "y" vary together 82.85% of the time". The coefficient

of correlation ranges in values between (-1 and +1) this is simply a measure of the degree

of Association or Covarriation that exists between variable "x" and "y"

In simple regression analysis the regression line can be used to estimate the values of

dependent variable on the basis of independent variable whose values are known. But in

correlation analysis I study the degree of closeness of relationship between the variables.

If two variables vary in such a way that changes in one variable are accompanied by

changes in the other, the variables are said to be correlated/regressed.

As my hypotheses was that deposits and investment are positively related, the hypothesis

is true because deposit and investment are very closely related the logic behind is that if

there is more money in general public they prefer to deposit it in banks thus deposits

increases Now banks have more money for credit creation thus lending will increase

resulted a high investment

Coefficient of Determination R2 is defend as the ratio of the explained variations to the

total variation

γ2 = explained variations in y / Total variation in y

As

γ = γ2

γ2= 0.6864

It shows that 68.64% of the variation in the investment is accounted for by the variation

in the deposits.

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4.6 Test of Sub Hypothesis No.2 Correlation between Lending and GNP

(Rs in million) Scheduled banks Advances by Borrowers GNP

Table 4.2

Source: Banking statistics of Pakistan 2001 –2002 State Bank of Pakistan.

Lending X GNP Y

1982 66842.3 317502 1983 80706.7 367807 1984 88941.8 413944 1985 105136.4 463375 1986 123397.5 507678 1987 121419.4 551809 1988 130012.4 630120 1989 142953.8 711143 1990 165618.7 796751 1991 189474.1 932282

1992 250283.6 1201301

1993 303623.3 1404853

1994 341114.5 1686020

1995 417198.0 1922755

1996 462415.0 2207230

1997 532340.8 2456520

1998 575069.7 2710396

1999 629659.2 2877082

2000 745719.3 3116245

2001 746610.0 3409083

Total 6218536.5 28683896

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Scatter diagram for hypothesis NO.2 Figure 4.4

4.9.1 Result from Hypothesis No: 2 β = 4.46

Sum of landings= 6218536.5

Sum of GNP = 28683896

Average of Independent Variable = 310926.825

Average of dependent Variable = 1434194.8

Dispersion in landing= 230586.3044

Dispersion in GNP = 1032937.732

γ = 0.997 γ2 = 0.994 (See the appendix 4.3)

A correlation coefficient of 0.997 is an indicator of high degree of positive correlation

between lending (x) and GNP (y). However, it stills remain to test the hypothesis of

correlation between x and y.

Assuming the population of lending and GNP as being bivariate normal. With 20

observations in pair I test……

comparison

01000000200000030000004000000

0 2E+05 4E+05 6E+05 8E+05

GNP

Land

ing

Series1

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HO = Þ = 0.9 VS HI = Þ >0.9 at 5% level of significance. The calculation of Z stated in

(1) is then 7.3317 and Ho: Þ = 0.9 is rejected at 55 level of significance. So we may

conclude that correlation between x and y is grater then 90%.

4.6.2 Findings

I see that there is a very higher degree of positive correlation is 0.997. It shows that the

GNP is positively related to the lending of the banks. The reason behind is that due to the

lending, the investments are increased and we know that an increase in investment will

result in increase in GNP.

γ = (γ2) γ2 = 0.994 so it means that 99% of variation in GNP is explained by lending

4.7. Impact of MCB and ABL on Economic Growth.

Performance before and after privatization (Rs. In Millions) Table 4.3 MCB

Years 1990 2001 Increase in % Deposit 27691 154544 82.08 Advances 18987 76586 75.21 Investment 10688 55432 80.72 No. Of A/Cs 2891659 4392164 34.16

Table 4.4 ABL

Years 1990 1999 Increases in % Deposits 19824 93107 78.7 Advances 11115 55263 80.00 Investments 72668 26774 73.00 No. Of A/Cs NA NA NA

Source: Annual reports for both banks for mentioned years.

The progress report of both banks for pre and post privatization periods clearly indicates

a huge percentage of increase in three sub- hypothesis selected for evaluation. The

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deposits of MCB before privatization were 27691 billion in Pakistani rupees that has

increased 154544 billion in Pakistani rupees showing increase 78.7% after privatization.

Advances and investment of MCB are also showing increase of 75.2% and 80.725 after

privatization of the bank.

The progress report of ABL is showing 78.7% increase in deposit base after privatization

while the other two sub hypothesis, advances and investment are also showing increase of

80% and 73% respectively after privatization. All the variables selected in hypothesis as

source of economic growth are showing increases. I conclude that injection of new

deposits; advances and investments of these two banks in economy will have positive

impact on economic growth and development.

4.8. Privatization and Fiscal Deficit

One of the main objectives of the privatization has been reduction in fiscal deficit.

Privatization is presumed to help in retiring the public debt and thus in reducing the debt

servicing. At the same time the surplus of autonomous enterprises also tends to fall. If

reduction in debt servicing exceeds the fall in surplus of autonomous bodies, budgetary

deficit tends to fall. (A.R.Kemal,1996)

Like many other developing countries fiscal profligacy has been the main underlying

cause of macroeconomic instability in Pakistan. Before the adoption of privatization

policy persistence of large fiscal deficit (on average, 7% of GDP) resulted in sharp

accumulation of public debt as it increased from 91.3 percent to 103.0 percent of GDP

during the 1990s. In 1990-1991 almost 38 percent of total revenue was consumed to

finance debt servicing but after privatization of large number of manufacturing units and

some banks, the percentage of total revenue reached almost 64% in 1999-2000.

Realizing the weaknesses of Pakistan’s tax structure a concerted effort was launched

some four years ago. The government launched a series of wide-ranging tax and tariff

reforms on the one hand and fiscal transparency on the other, the overall fiscal deficit,

which averaged almost 7.0% of GDP during the 1990s, has been reduced to 4.6% in

2002-2003. However the cumulative privatization receipt of Rs. 136316 million compare

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to a huge amount of debt in billion is rather small, but that can have a significant

influence on the fiscal deficit.

Table 4.5 Fiscal Indicators as % of GDP Years GDP real

Growth

Overall Fiscal deficit

1990-91 5.4 8.8

1991-92 7.6 7.5

1992-93 2.1 8.1

1993-94 4.4 5.9

1994-95 5.1 5.6

1995-96 6.6 6.5

1996-97 1.7 6.4

1997-98 3.5 7.7

1998-99 4.2 6.1

1999-00 3.9 6.6

2000-01 2.2 5.2

2001-02 3.4 5.2

2002-03(BE) 5.1 4.6

Source: Economic survey of Pakistan 2001-2002

Figure 4.5 Budget deficit as percent of GDP

Source: Pakistan: Financial Sector Assessment 1990-2000, SBP, 2002.

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The table 4.5 and figure 4.5 shows that over all fiscal deficit of the country before

privatization was 8.8, but after privatization the budget deficit as percentage is 4.6%. No

doubt this is not only because of privatization, other economic factors cannot be ignored.

4.9 Conclusion

In Raymond W. Goldsmith’s seminal book, “Financial Structure and Development,” he

defined “financial structure” as the mixture of financial instruments, markets, and

institutions operating in an economy. He sought to (1) trace the evolution of national

financial system’s during the process of economic development, (2) assess whether the

overall development of the financial system influences the rate of economic growth, and

(3) evaluate the impact of financial structure on the pace of economic development.

Goldsmith was largely successful in documenting the evolution of national financial

systems, particularly the evolution of financial intermediaries. Goldsmith met with more

limited success in assessing the links between the level of financial development and

economic growth. He clearly documented a positive correlation between financial and

economic development across a large number of countries.

A large theoretical literature shows that banks can reduce the costs of acquiring

information about firms and managers and lower the costs of conducting transactions. By

providing more accurate information about production technologies and by exerting

corporate control, better banks can enhance resource allocation and accelerate growth

[Boyd and Prescott 1986; Greenwood and Jovanovic 1990; King and Levine 1993b].

Similarly, by facilitating risk management, improving the liquidity of assets available to

savers, and reducing trading costs, banks can encourage investment in higher-return

activities [Obstfeld 1994; Bencivenga and Smith 1991; Greenwood and Smith 1997].

Stability of financial system has strong correlation with the economic growth and

development of any country. A glance at the recent economic history reveals that

weaknesses in the financial systems were the root cause of the economic woes of most of

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the economies. The supervisory authorities around the world are striving to ensure safety

and soundness of their respective financial systems so that they can play an active role in

the economic development of their countries. Although there has been substantial

research on the relation between financial development and economic growth, both the

finance and development literature lacks a comprehensive analysis of the effects of the

banks privatization process on economic growth.

Banks provide the raw material for a monetary production economy to work and grow

(regardless of the technological form of money). The positive impact of finance on

economic growth has received significant empirical support during the nineties, starting

with the contribution by King and Levine (1993). Research showed also that counties

with more developed banking systems and liquid capital markets have experienced the

most rapid growth (Demirgüç-Kunt and Levine, 1996). Banks support increasing

production by lending new deposit claims. Moreover, bank loan and deposit contracts are

cost-efficient in environments with poor financial infrastructure, scarce information, and

a high demand for safe and stable returns on money from savers: banks become the main

financial players. (Biagio Bossone, The World Bank)

In this study, the direction of correlation between the financial development and

economic growth is investigated for Pakistan. The study is carried through the causality

analyses, carrying out correlation/regressions and testing of the two hypotheses. The

results of both hypothesis developed for the study are giving positive results, so the study

leads to conclude that privatization of banks will increase competition, competition will

improve efficiency and efficient banking sector will develop financial system and

develop financial system of the country will contribute to economic growth. Financial

sector has still a long way to go to catch up with other countries in the region with similar

economic characteristics. However, recent structural changes, economic revival and

stronger rupee if sustained will make it possible for Pakistan to substantially improve its

position at least in relation to most of the countries with the same per capita income.

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CHAPTER 5

Privatization of Banks and its Impact on Employees

5.1 Introduction

Almost all developing countries including Pakistan have launched ambitious privatization

programs with view to improve efficiency of the state-owned enterprises, convert the

enterprises from state based economy to market based economy. Despite the extent of

privatization worldwide, little attention has yet been paid in policy and the academic

literature to its impact on labor (Oestmann, 1996). 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).

A universal concern in this process the effect privatization has on labor. Major

researchers, politicians and observers fear that privatization will cause major job losses

because the new owners/managers will reduce the workforce for improvement of

efficiency. On another side before divesting government cuts the work force to prepare

for privatization. The opponents of privatization in developing countries are labor unions

and enterprise work force, like labor unions of WAPDA and PTCL in Pakistan. They are

most vocal and organized opponents and trying to delay or block the reform.

5.2 Does privatization Affect Labor? Governments have traditionally feared the impact of privatization on employment. In

some countries, the concern about massive layoffs has led governments to side-step

privatization and tinker, without much success, with public enterprise reform.

Increasingly, however, governments realize the futility of public enterprise reform and

the opportunity costs of delaying privatization (in terms of unrealized gains from

privatization to society as a whole). Governments that have taken employment concerns

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seriously have devised labor strategies, and have been able to mitigate the adverse

consequences of privatization.

The impact of privatization on employment is multifaceted and complex. (Antonio

Estache et al.) The evidence is not clear on whether privatization has had a positive or

negative effect. First, privatization has had a different impact on labor made redundant as

a result of privatization, on labor retained within the privatized enterprise, and on labor

markets. Second, the impact of privatization on employment can be measured both

quantitatively (number of workers made unemployed, number of new jobs created, etc.)

and qualitatively (working conditions, working hours, unionization, etc.), and the two

indicators need–indeed, rarely– move in tandem. Third, the impact of privatization on

employment has depended primarily on the company’s initial labor conditions, which in

many SOEs are: overstaffing, higher wages than comparable jobs in the private sector–

especially if the SOE does not face a hard budget constraint, generous non-wage benefits,

rigid labor contracts or collective bargaining agreements, and high job security. Fourth,

the welfare impact has varied depending on the measures that governments have taken,

namely on whether they have put in place social safety nets. Fifth, the impact has varied

depending on the privatization method (Table 2-6). Sixth, the impact of privatization on

employment will vary from industry to industry and depending on the macroeconomic

conditions. Finally, the population growth rate of the country will also effect on

employment rate of the country. So, the complexity of the relationship between

privatization and employment is such that there is no standard answer. (Sunita

Kikeri,1998)

It is frequently observed that employment is reduced with privatization (either in

preparation for, or after) and the accompanying restructuring due to the overstaffing that

typically exists in many SOEs. Three large-scale studies, however, have documented

significant increases in employment. Galal et al. (1994) find that workers had a net

welfare gain in ten out of twelve cases they examined, and that even laid-off workers

were not worse off because of the social safety programs put in place (compensation

packages, discounted shares, etc.) Boubakri and Cosset (1998) calculate an employment

increase of no less than 10% in 57% of the privatized cases examined. On the other hand,

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examples of significant job losses abound. In Argentina, the privatization of the railway

enterprise, which began in 1990, involved the loss of nearly 80,000 jobs in less than five

years. But prior to privatization, the company was losing $ 800 million a year and

receiving $ 1.3 billion a year in subsidies and the company moved less than 10% of the

total traffic. In 1995, the subsidy had dropped to $ 250 million a year, productivity had

increased ten times, and urban commuter rail rider-ship increased by 45%. In Mexico,

half in the four years before privatization in 218 SOEs reduced the number of white and

blue-collar employees.

Employment implications of privatization are important issues that need to be addressed.

The issue of employment can be looked at from both static and dynamic perspectives.

From a static point of view, what happens to employment in the privatized unit is

relevant. The dynamic aspect of employment is linked to the stated objective of

increasing productivity. In the longer run, increased productivity and higher growth of the

economy may create conditions for enhanced growth of employment. The economic

environment and future growth potential of the economy, especially the private sector,

needs to be examined in this context, and the long-term employment implications need to

be analyzed? (Joshi,Gopal, ILO, SAAT. New Dalhi)

The main reason of privatizing government enterprises in developing countries was to

improve efficiency and decrease operating cost. The main cause of higher operating cost

was political appointment, employing too many peoples more then requirement of

enterprises. State owned enterprises were free and protected from competition. Peoples

were appointed with higher wages and benefits that were higher then their private sector

counterparts. These decisions led to low productivity and higher operating cost of state

owned enterprises, in turn have contributed to inefficiency and financial losses. To attain

the objectives of privatization (improvement in efficiency and decreasing operating cost)

it was necessary to restructure the work force before privatization by government and

after privatization by private owner. This restructuring will lead to reduction in labor

force. At the same, it is believed that workers will gain from privatization, because of

new investments that will create opportunities of new jobs and better terms and

conditions of services.

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5.3 Characteristics of Labor Market in Pakistan.

Pakistan is developing country with unique features of government. Changes in

governments are amazing story. A fluent change in government causes fluent changes in

policies. Political governments are in favor of appointment of the peoples having political

influence with the party, while military governments having no political agenda are in

favor of strengthening enterprises not party.

5.3.1 Overstaffing

State enterprises in developing countries including Pakistan were used as vehicles for job

creation and political patronage. Protection from competition, lack of hard budget

constraints, and security of tenure of public sector positions have led to chronic

overstaffing or larger labor forces then is efficient. 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.

Overstaffing increases operating cost of the banks that will effect net income and return

to owners. Overstaffing was not only a problem of the banking sector but also rampant in

other infrastructure sectors as well at both the national and municipal levels. Power

utilities in many countries as well as in India and Pakistan, are severely overstaffed, with

fewer then 50 customer per employee (compared with more then 200 in countries, such

as Chile, Indonesia and south Africa). (World Bank 1996b)

5.3.2 Generous Pay and benefits

The second important problem of State owned enterprises were payment of generous pay

and benefits. In the absence of hard budget constraints, many state enterprises tend to

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reward workers well often too well. These huge payments have been eroding as a result

of fiscal pressure. The banking sector of Pakistan was not safe from this practice. Un

relevant peoples were appointed in banking sector with huge package on political basis

that would impact bank profitability and efficiency negatively. In the absence of wider

social safety nets, state enterprises in many countries also provide, a great expense,

services such as housing, health care, education, and transportation. In 1980s these non-

wage benefits were equivalent to 20% of wages in Africa, 20-35 percent in Asia, and 24-

37 percent in Latin America (Banerji and sabot 1994). Among sample of 361 Mexican

state enterprises privatized between November 1983 and June 1992, fringe benefits in

many companies tripled the wage bill (Lopez-de-Silanes 1996).

5.3.3 Labor Union Influence

Rigid labor contracts or collective bargaining agreements at the enterprise level also

contribute to low efficiency/productivity and high costs. A high job security in public

sector enterprises, such contracts often place restriction on the right of employers to hire

and fire, allocate work, and subcontract activities to non-union parties. These problems

contribute not only to increased costs of doing business but also to high rates of

absenteeism and moonlighting. On the basis of above-mentioned distortions in state

enterprises labor markets, many observers fear that privatization will have a negative

effect.

5.4 Privatization’s employment impact: Initial Conditions Matter

Many observers fear that privatization will have a negative effect on labor as

governments prepare enterprises for sale and as new investors strive to raise productivity.

What does the evidence show? Labor force reductions have often accompanied the

privatization and exposure to competition of large and inefficient firms. But many

enterprises, particularly those already operating in competitive markets, have been sold

with their labor force intact. Moreover, privatization has often created new jobs as a

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result of new investments and dynamic expansion. While there are little data on what has

happened to workers retrenched during privatization, because data assessing the effects

privatization has on labor are hard to find and often poor in quality. The data do not

distinguish the labor effects of privatization from those of overall economic reform

programs. Moreover, they do not capture short-term effects of privatization relative to its

long-term effects, since many governments have downsized labor well before

privatization or imposed employment guarantees on newly privatized enterprises that

have affected employment only down the line. Tracer studies of laid off workers are

generally not available. However, employees who retained their jobs with privatized

firms gained by better terms and conditions of service and employee shares.

5.5 Labor force reductions In general, privatization has had a minimal effect on employment in countries that carried

out labor reforms well before privatization. Chile, for example, began extensive labor

market reforms in the early 1970s by rationalizing state enterprise employment and

wages and changing labor market regulations regarding the hiring and firing workers.

These reforms led to significant employment reductions by the early 1980s in both public

and private firms. As a result the second round of privatization that began in 1985 and

involved larger firms in sectors such as telecommunications and electricity resulted in no

layoffs (Hachette and Luders 1993). In fact, employment in these firms increased by 10

percent as a result of overall improvements in the economy but also of the new

investments that accompanied privatization. Privatization has also had a minimal effect

on workers in competitive enterprises. Ghana, Mexico, Morocco, Pakistan and Tunisia

are among many countries that have been able to sell such enterprises with their labor

force more or less intact. Prior exposure to competitive pressures had resulted in

relatively efficient staffing levels at the time of privatization and private buyers were

willing to take on modest amounts of surplus workers who could be absorbed by new

investments and dynamic expansion.

However, large employment reductions have often accompanied the privatization of state

enterprises that were, in the past, heavily subsidized and protected from competition. In

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steel, railways, and energy enterprises, overstaffing often has led to employment

reductions before privatization as governments prepare the companies for sale, and after

as privatized companies continue to shed labor.

The following has manifested effects of privatization in South Asia:

• Worker redundancy

• Retrenchment of workers

• Stagnation of employment in organized sector

• Growing Casualization of labor

Redundancy resulting from privatization in South Asia

a: voluntary retirement

b. ILO estimates in 1992 for a scenario of 50% redundancy

Source: Gopal Joshi , overview of privatization in South Asia

PSE Employment Redundancy Retrenchment Costs

Bangladesh 240 thousand 25% Tk 7 billion

India 9.8 million 23%a Rs. 48092 billion

Nepal 46.7 thousand 60% Rs. 9914 million b

Pakistan 34.6 thousand 63% a Rs. 3559 million

Sri lanka 120 thousand 53% b Up to 53 months

salary

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Bid Values and Payments on Golden Handshake of Selected Industries in Pakistan

Table 5.1

Average and Compound Growth Rates of GDP, Investment and Employment

Table 5.2

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Tables were taken from privatization in Pakistan (A.R kamal, 1996) is showing the total

lay off in the selected industries due to privatization. The tables show that 63.335% of the

total employees are separated from services in the selected industries after privatization.

The data about two bank is not given in the tables, however, the average compound

growth rate of employment is showing increase for post privatization period as compared

to pre privatization period of selected industries of Pakistan.

5.6 New Jobs Creation Finally, while privatization has resulted in employment cuts, it also has created new jobs

at the enterprise level (including in enterprises where labor reductions occurred before or

during privatization) and at the sartorial level. Jobs are created when private operators

used assets more productively and made new capital investments that might not have

been made in the absence of privatization. Several studies support this view:

• A comparative study of the pre- and post-privatization performance of sixty-one

companies in eighteen countries (six developing and twelve industrial) sold

through public share offerings showed that almost two-thirds of the firms

increased employment after privatization, by an average of 6 percent

(Megginson, Nash, and van Randenborgh 1996).

• A study of seventy-nine newly privatized firms in twenty-one developing

countries (including the most active privatizers) found employment increases of

10 percent for 60 percent of the sample firms; privatized firms newly exposed to

competition were more likely to reduce employment (Boubakri and Cosset 1996).

• A 1994 study examining the costs and benefits of privatization for different

groups in society (including workers) in twelve enterprises in Chile, Malaysia,

Mexico, and the United Kingdom found that workers gained in ten of the twelve

cases through the retention and expansion of jobs. Equally important, the study

found that even laid off workers were better-off, or did not suffer a welfare loss,

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because the amount of severance pay they obtained was larger than the wages

they lost during the time between losing their old job and finding a new one, and

because of the allocation of valuable shares at discounted prices (Galal and others

1994).

5.7 Factors, which will determine the extent of that impact:

1. Change of employer

2. The extent to which privatization is associated with technological

changes, organizational changes or management changes.

3. The extent and pace of organization in whole economy.

4. Changes in the country’s legal frame work concurrent with privatization.

5. Changes in the nature of agreements collective bargaining and the culture

of bargaining which invariably accompany privatization

6. Any specific agreements made between the Government, the new private

company and trade unions.

7. The industry relation’s framework and the role and recognition of trade

unions.

8. The level of competition with industry.

9. The nature of the new company.

5.8 Protection of the Interest of Workers Government signed an agreement with the All Pakistan State Enterprise Workers Action

Committee on 15th October 1991 prior to launching the privatization program. The

package had three components, viz. protection of workers, a scheme of golden handshake

and the buy-out by the workers. These packages are given below:

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Package A (i) Workers are accorded all protection available to them under the Labour Laws. As a

special measure no retrenchment of the workers is allowed during the first twelve

months.

(ii) 10 per cent of the shares of the privatized units are offered to the workers at a

mutually agreed rate.

(iii) Workers rendered surplus after the initial period of 12 Months, are entitled to the

following benefits:

(a) Priority in matters relating to the employment abroad.

(b) Availability of easy credit for facilitating their self-employment.

(c) A surplus pool of laid off workers was to be maintained by an agency appointed for

the purpose and the Privatization Commission is endeavor to find jobs for such workers.

Till such time, these workers are placed in employment; they are entitled to

unemployment benefit at the rate of Rs. 1000 per month for a maximum period of two

years. This benefit would be available to only those workers who have been rendered and

remain unemployed involuntarily.

(d) Suitable arrangements are to be made to provide training to surplus workers in new

trades and occupations.

(e) Grants are to be given for the marriage of their daughters.

(f) Scholarships are to be provided for education of their children.

Package B

(a) One month’s gratuity for each complete year of service is payable to the workers.

Wherever this gratuity is non-existent or less than one month, the gratuity is assumed to

be of one month.

(b) Four month’s last drawn basic salary for each year of service will be paid in addition

under the arrangements of the Privatization Commission.

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(c) All dues are paid only after the sale of units. However, all possible measures are

adopted to settle the dues before handing-over of the units.

(d) List of workers opting for golden handshake is to be provided by the respective

CBAs.

(e) All those including seasonal regular workers, who wish to avail the facility have their

option before the sale agreement is signed.

Package C (1) In case of employee buyout, negotiations are facilitated in consultation with the

Supreme Council of All Pakistan State Enterprises Workers’ Action Committee.

(2) Workers are provided all opportunities to purchase a unit if they make a bid. They

also have a right of negotiations on the highest bid.

(3) All bids made by the workers have to be competitive and in accordance with the bid

documents.

(4) Workers are given concessions through negotiations if they are declared successful

bidders.

(5) Wherever gratuity fund is maintained as a trust, the funds can be used for investments

as per rules.

(6) The savings in the Provident funds can also be utilized for bidding purposes subject to

Government rules and Regulations.

(7) A management plan (which should include a financial plan) is submitted by the

workers for any bid they make for a unit.

(8) Any unit owned by the Federal Government in FATA will avail the same facilities as

available to remaining units of state owned enterprises.

(9) The facility of group insurance for workers who opt for golden handshake is available

for continuation provided he subscribes from his own resources.

I have collected the data about numbers of employees, numbers of branches and total

operating expenses of two banks for pre and post privatization period. I have measured

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the impact of privatization on employment quantitatively (number of workers made

unemployed, number of new jobs created, etc.) and qualitatively (working conditions,

working hours and salaries etc.)

Table 5.3 Numbers of Employees Before and After Privatization

Muslim Commercial Bank Limited Before privatization after privatization

Years Numbers of

employees

Years Numbers of employees

1986 12817 1997 13660

1987 12885 1998 12858

1988 12685 1999 12557

1989 12890 2000 12133

1990 12904 2001 11614

Figure 5.1 Number of employees for MCB pre & post privatization periods

1050011000115001200012500130001350014000

1 2 3 4 5

Numbers ofemployees preprivatizationNumbers ofemployees postprivatization

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Table 5.4 Numbers of Branches

Muslim Commercial Bank Limited Before privatization After privatization

Years Numbers of

branches

Years Numbers of

branches

1986 1263 1997 1320

1987 1265 1998 1216

1988 1271 1999 1215

1989 1270 2000 1210

1990 1283 2001 1061

Figure 5.2 Number of Branches for MCB before and after privatization

0200400600800

100012001400

1 2 3 4 5

Numbers ofbranches

Numbers ofbranches

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Table 5.5 Annual Operating Cost per Employee Before and After Privatization of

MCB Before privatization After privatization

Source: Extracted from annual reports.

0

2000000000

4000000000

6000000000

8000000000

1 2 3 4 5

Figure 5.3 Operating Cost Before and After PrivatizationMCB

T. Operatingcost beforeprivatization

Operating costper employeebeforeprivatizationT. Operatingcost afterprivatization

Op. cost peremployee after

Years T. Operating cost

Operating cost per employee

Year T. Operating cost

Op. cost per employee

1987 951934299 74271 1997 6488460000 474994

1988 1014285192 78718 1998 7325059000 569688

1989 1117094854 86664 1999 7104200000 565756

1990 1395556135 108266 2000 7195383000 593042

1991 1596859325 123749 2001 7371770000 634731

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Table. 5.6 Numbers of Employees Before and After Privatization of

Allied Bank of Pakistan Before privatization after privatization

Years Numbers of employees

Years Numbers of employees

1986 6875 1997 NA ** 1987 7000 1998 1988 7125 1999 1989 7400 1990 7525

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

Source: Extracted from Annual Reports.

Years Number of branches Years Number of branches

1986 666 1997 1987 691 1998 929 1988 693 1999 929 1989 711 1990 747

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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

Operating costper employeebeforeprivatizationT. Operatingcost afterprivatization

Op. cost peremployee

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Table 5.9 Structure of Banking Sector for Pre and Post Privatization Period

Before privatization After privatization

Source: Banking supervision department State Bank Of Pakistan (march, 2004)

Figure 5.5

Number of Banks before privatizationand after privatization

05

1015202530354045

Fore

ign

Sta

te o

wne

d

Fore

ign

Tota

l

Ban

ks a

fter

priv

atiz

atio

n Banksbeforeprivatization No. 7 --

Banks No. No. Of employees Average

State owned 7 59706 8529

Private -- -- --

Foreign 17 NA NA

Total 24 NA NA

State owned 4

Private 20

Foreign 13

Specialized 3

Total 40

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5.9 Findings

Total number of employees in MCB decreased after privatization is 290. In 1990 the total

number of employees were 12904 while in 2001 the total numbers of employees are 11614.

This shows slight decrease in number of employees, which 2.25% of total. The data also

shows that after privatization the numbers of employees were increased from 12904 in 1990

to 13660 in 1997, showing increase of 756 as a 5.86% of total. While the Number of

employees in ABL before privatization were 7525 but data after privatization is not

available. One thing, which is most important to mentioned here is methods of privatization

of both banks are different. The impact has varied depending on the privatization method.

ABL is given to Management, so it is hoped that there will be no reduction in numbers of

employees except routine retirement etc.

The numbers of branches of MCB before privatization was 1283 in 1990 while the

number of branches are 1016 in 2001, showing decrease of 222 branches. Privatization

needs reform and decreases in number of branches are because of closing non-profitable

branches of the bank. The data also shows that numbers of branches were increased after

privatization (37) in 1997 but later on it were decreased. The numbers of branches of

ABL before privatization 1990 were 747 while after privatization the total numbers of

branches are 929 in 1999, which shows increase of 182 branches that is 24.364% of total

after privatization of the bank. Increase in numbers of branches will need to hire services

of personnel’s so it can be estimated that there is chances of increase instead of decrease

in numbers of employees.

One of the objectives of privatization of public sector banks was to decrease operating

cost. The data of MCB shows increase in operating cost per employee instead of decrease

in number of branches and number of employees. The positive aspect of this increase in

operating cost per employee is indicating increase in employee’s benefits. We cannot

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ignore the other causes of increase like inflation, increase in salaries for appointment of

well skilled personnel etc.

The operating cost in ABL is also showing increase. No doubt the number of branches

after privatization are increased 24.364% of total branches that will need further

appointments and hiring of personnel’s for operating of the branches.

The impact of privatization of banks on employees is more severe during preparation for

privatization then after privatization. In order to reduce surplus staff in the nationalized

commercial banks voluntary separation packages were offered to employees. This

resulted in the down sizing of the work force of three big NCBs (HBL, NBL and UBL)

by 11101 staffers out of 39277 which is 28.26% of total and also as a part of down sizing

exercise 1646 branches of NCBs were closed.

5.10 Conclusion

There has no labor shading in the two privatized banks. The number of employees in

MCB is showing slight decrease of 2.255 % of total employees. This may be because of

retirement etc. so 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. We have 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. I have 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

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decrease in state owned banks are approx. 12000 after or during preparation for

privatization.

While some privatizations will generate net employment as a result of expanding

production or services, employment in many privatized entities may decrease after

privatization. This is because state owned enterprises often have many more employees

than needed for efficient operation of the company. Many of the employees perform little

or no work and/or have low productivity. This implies that either taxpayers end up

subsidizing their salaries or consumers pay for it through higher prices. The extra

amounts paid by taxpayers or consumers leaves less money in the hands of people who

might otherwise spend it in a way that promotes productive employment.

In sum, the evidence shows a wide range of experiences with respect to privatization’s

effect on workers. Privatization can bring significant benefits to workers in enterprises

operating in competitive markets where overstaffing is limited and where new owners are

willing to maintain some excess staff to keep the political and social peace. More

important, privatization can bring benefits to other workers as new jobs are created with

new investments and dynamic expansion. Still, large employment losses can occur as

inefficient, insulated state enterprises are liquidated or privatized, and as privatized firms

face increasing competition. The more governments move into privatizing such firms,

and the greater the exposure to competition, the larger those losses are likely to be.

The privatization program as a whole, by injecting new investment, introducing better

management, improving competitiveness, and leaving more money in the hands of the

public, is likely to result in increased employment opportunities. At the same time, laid-

off workers are often given generous severance packages that can be used to start

business or obtain training to help them prepare for a new job. So I can conclude that

privatization of bank has no negative impact on employees but it will create new jobs.

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CHAPTER 6

Privatization of Banks and Its Impact on Customers 6.1. Introduction

In the operation of a bank, there is unique relationship between banks and customers.

Banks are borrower from customers at one place (pulling savings) and banks are lenders

to customers at second place (providing loans, advances and credits). This borrowers and

lenders relation is very important and need confidence on each other. The success of

commercial banks totally depends on satisfaction of customers, if customers are satisfied

they will use the products and services of the banks and banks can generate

revenue/profit for the owners.

The financial sector witnessed significant changes in terms of introduction of new

services, expansion in existing services and changes in the regulatory framework. During

the last few years, the banking sector expanded its menu of services aggressively by

introducing new products. In the area of consumer financing, the banks are now

competing with each other aggressively in contrast with an almost absence of these

activities in the past. Banks have also been revamping their existing services of deposit

taking and lending by introducing new instruments/schemes tailored according to the

business needs of customers. Encouragingly, these changes are being made to specifically

target the small and the medium size savers or borrowers. Consequently, lending to the

small and medium enterprises, which had been a neglected area in the past, has now re-

emerged as a strong potential investment avenue.

6.2. Characteristics of Commercial Banks in Pakistan

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

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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.

6.3. Customer’s Problems

1. Customers were needs to keep some cash in homes for emergency, because of

working hours of banks in Pakistan. Peoples having money in their accounts were

unable to withdraw from bank after 12 o’clock of afternoon. This was one of the

most important drawbacks of banking services and was caused the low rate of

mobilization of savings.

2. The second important problem of banking sector in Pakistan was no safe products

and services for fast transfer of money. Carrying huge amount in ship of cash had

become the base for looting burglary etc.

3. No proper facilities for submission of utility bills at the end and start of months.

Making of long queue to wait for own term was another problem facing by

customers, and problem of law and order for local authorities.

4. Information’s about products and services were not for all. The small deposit holders

were not aware to get benefits from bank products and services.

5. Loans, advances and credits were only for big fishes on the basis of their political

backgrounds or something else, but not for all customers.

6. No use of modern technology in banking sector was also cause of dissatisfaction of

customers.

6.4. Challenges faced by Commercial Banking in Pakistan.

There is a mini revolution in the financial sector of the economy in Pakistan. The

liberalization of exchange control, large scale privatization of state enterprises, opening

of new banks in the private sector, deregulation of credit controls, conversion to Islamic

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banking etc., etc. have brought about radical changes in the banking sector. The banks

are rapidly equipping themselves for the new role to be played in meeting the challenges

faced by commercial banking. The main competition challenges faced by commercial

Banking in Pakistan are as under: -

1. Change in Market Needs. Due to privatization of state owned enterprises,

deregulation environment, free capital flow in and out of Pakistan, the banks are

now to focus greater attention on meeting the market needs of the customers. The

banks that solve the customer’s problems for enlarging sale of the product will

receive higher reward. The traditional role of providing trade finance only is now

relegated to the background.

2. Service to Customers. The banks which can provide speedy, accurate and

standard services in the delivery of products, loans etc. to the customers will be a

success. The others will be chipped away.

3. Regulatory Challenges. The bank shall have to work within a regulatory

framework that protects the interest of the depositors and ensure the provision of

capital to the customers.

4. Consumer Banking. The banks do not adequately finance the basic needs of the

consumers such as housing, transportation, and other durable. There is a challenge

to banking sector as to how the finance could be provided to the consumers so

that they could also benefit from the advances in technology and banking.

5. Challenge to New Banks in Private Sector. The new banks in the private sector

will have to develop a sound funding base, attracting high quality management,

providing high quality services to the customers to meet the new challenges in the

banking sector.

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6.5. Emergence of New Products and Services

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 micro

finance 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.

6.5.1. Consumer Financing

Consumer financing means any financing allowed to individuals for meeting their

personal, family or household needs. Consumer financing is not a new idea, this avenue

of lending was almost entirely ignored by the banks and only the non-bank financial

institutions had been active in extending such credits. This was due to the fact that banks

were reluctant to embark on such activities owing to the longer tenures involved. It was

only after 2001, when banks were flushed with liquidity that the interest in such lending

arose among banks.

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At the moment Consumer financing is being provided by banks through credit cards, auto

loans, housing finance and personal loans for the payment of goods, services and

expenses. Banks are required to extend such loans within the broad parameters set by the

SBP.

6.5.2.Consumer Financing Products

Credit cards

Auto Loans

Housing Finance

ATM

Electronic Banking etc.

Table 6.1. Details of Consumers, Products and Services in Pakistan.

Source: Banking System review State bank of Pakistan, 2002.

Products 2000 2001 2002 2003March

Numbers of Credit Cards 220000 295000 370000 400000

Number of On Line branches 322 450 777 994

Number of ATM 206 259 399 445

Number of ATM Transactions

(000)

3624 5924 9319 6450

Value of Transactions (in Million) 12507 22108 37786 28052

Trends in Auto Loans (in Million) 0.9 3.5 4.1 N.A

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0

200000

400000

Figure 6.1 Numbers of Credit Cards

Numbers ofCreditCards

0

500

1000

Figure 6.2 Number of On Line branches

Number of On Line branches

0

200

400

600

2000 2002

Figure 6.3 Number of ATM

Number of ATM

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Table 6.2. Distribution of ATM (in Numbers)

2000 2001 2002 2003 March

Public Sector Commercial Banks 48 66 89 100

Domestic Private banks 113 146 245 278

Muslim Commercial Bank

(MCB)

75 103 151 155

Others 38 43 94 123

Foreign Banks 45 47 65 67

Total 206 259 399 445

Share of MCB in % 36.4 39.8 37.8 N.A

Source: Banking System review State bank of Pakistan, 2002.

The data clearly indicates the interest of the peoples in uses of new products and services

of banking sector in Pakistan. But still the number of users is very low when we compare

it with total numbers of accounts for the mentioned periods. The positive point is the

upward trend of the users and we hope with the passage of the time and awareness of the

customers that ratio will further increased. However, the contribution of MCB in the

provision of new products and services as a privatized bank is very encouraging. The data

about other bank (ABL) selected as a case study is not available to separately to use in

comparison.

6.6. Impact on Customers

Researcher has prepared the questioner to collect the primary data in three district of

NWFP i.e. Dera Ismail khan, Peshawar and Mardan. I failed to use questioner as a data

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collection tool because maximum customers were less educated and unable to fill the

questioner properly, so I have carried semi structure interview to collect data about

customer’s views for pre and post privatization periods of banks. A series of questions

were designed to examine the satisfaction of bank customers with bank services,

confidence on banking sector, use and knowledge of new products etc., etc. I have

interviewed 30 customers of each bank in each district and table of their response to

different questions is as under:

Table.6.3 Customers knowledge about Privatization of Banks

Figure 6.4 Custom ers know ledge about Privatization of Banks

0%20%40%60%80%

Positive Extrem elypositive

Negative Extrem elynegative

1. Do you know what isprivatization?

2. Do you feel anychange in bankservices?3. Do you know aboutnew products of thebanks?4. Do you haveconfidence on banks?

Questions Positive Extremely

positive

Negative Extremely

negative

1. Do you know what is

privatization?

3% 2% 70% 25%

2. Do you feel any change in bank

services?

7% 5% 65% 28%

3. Do you know about new

products of the banks?

10% 5% 50% 35%

4. Do you have confidence on

banks?

20% 15% 45% 20%

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Peoples of NWFP have unique culture that is not easy to change with education.

Religious factor is also considered in bank transactions. During survey I have observed

that maximum customers with enough education do not know what is privatization. Only

5% customers maximum University teachers, doctors and engineers or well-educated

businessmen were known to concept of privatization. Only 2% of total were well aware

about the privatization process. 65% did not know this term, while 28% heard the term

but did not know the real concept. So for changes in services are concerned response of

12% was positive or extremely positive. 7% of were of the views that after privatization,

the services of these two banks are improved but unable to notify. 5% were able to notify

the change in services.

I have also observed that 15% respondents are aware about the new products introduced

by these two banks after privatization. Confidence on banks ratio is still very low in

NWFP because of the problems already explained in this chapter (cultural problem). The

survey results also confirm the continued lack of confidence in the banking system as a

result of the unorthodox policies of the government in the 1999 and onward. The majority

of the respondents indicated that the lack of banking confidentiality and fear of

government probes of individual bank accounts serve as a deterrent to deposits,

especially large deposits. The amazing thing we have noted in the survey is that 65% of

total are still look like allergic from banking system while 25% have shown confidence

on banking system in Pakistan.

One positive impact is the disappearance of the long waiting time at some of the larger

banks that have introduced ATMs and computers. Some depositors still complain about

delays at banks, especially those banks that are not yet computerized.

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Table 6.4 Changes in Bank Employee’s Behavior

Figure 6.5 Employees Behavior with Customers

0%

10%

20%

30%

40%

50%

Good Very good Bad Very bad

Behavior with customers

Cooperation withcustomersDealing with customers

Provision of information

The survey reveals that employee’s behavior with customers is improved because of

change in ownership and structure of their services that is 55% where 30% is good and

25% is very good, cooperation and dealing with customers is not bad but percentage of

information is very low. This shows that low percentage of customer’s knowledge is

because of non-availability of appropriate information.

Questions Good Very good

Bad Very bad

Behavior with customers 30% 25% 23% 22% Cooperation with customers 27% 14% 29% 30% Dealing with customers 24% 10% 36% 30% Provision of information 9% 6% 45% 40%

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Table 6.5 Customer’s Awareness About the Banks New Products

Figure 6.6 Customers Awareness About Bank New Products

0%20%40%60%80%

100%120%

Positive ExtremelyPositive

Negative ExtremelyNegative

ATMOn line AccountCredit cardsEFTPOS

I have found during the survey that maximum customers in these three districts (Dera

Ismail khan, Mardan and Peshawar) used as population do not know the new products

created by these two banks after privatization. Only 5% of the total know about the ATM

stand for, while 95% do not know what is ATM and what that stands for? I have also

observed that only 8% of the customers know about on line account facility of the banks

and 92% have no knowledge of on line account. Only 12% in these three districts have

knowledge of credit cards and 88% responded in negative. So for EFTPOS is concerned

only 1% has give answer in positive while 99% don’t know what is EFTPOS?

Positive Extremely

Positive

Negative Extremely

Negative

ATM 3% 2% 80% 15%

On line Account 5% 3% 65% 27%

Credit cards 7% 5% 60% 28%

EFTPOS 1% 0% 0% 99%

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Table 6.6 Customers Views About Operation of New Products and Services

Figure 6.7 Customers Views About Operation of New Products

PositiveExtremely positiveNegativeExtremely Negative

The study also found that maximum customers did not know how to operate the new

products of the banks. The astonishing thing I have noted during interviewing the well

qualified customers like teachers including university teachers and doctors, engineers etc.

their response was totally negative about the operation of ATM, however they were

aware about uses of on line account and credit cards.

The percentage of account holders who can operate these new products are very low, just

5% can operate the ATM most them were foreign returned and 9% can operate on line

account and 11% can operate credit cards.

In terms of banking hours, the majority (76.2%) of the respondents in a survey indicated

their dissatisfaction with the current banking hours. Sixty-five percent (65%) of the

respondents indicated their preference for longer hours from 8.30 am to 4.00 p.m. The

Positive Extremely positive

Negative Extremely Negative

ATM 2% 5% 33% 60% On line account 4% 5% 51% 40% Credit cards 5% 6% 39% 49%

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study also found that maximum bank employees are not able to operate the new products

and technologies and need proper training.

6.7 Conclusion

The new economics of information, together with the advent of e- banking, deregulation,

privatization, convergence, and consolidation are reshaping the banking industry.

Autonomy can help you develop a formidable online offering to satisfy and exceed

consumers raised expectations. Around the world, banks are facing new challenges in

their battle to compete successfully. These challenges are being driven by three

interrelated factors: changing customer expectations, which has led to the "reinvention"

of retailing; innovations in technology that have permitted structural bypass, and an

evolution of regulatory policies that have led to enterprise realignment. As a result, bank

management today is facing an entirely new set of strategic issues:

• Keeping shareholders happy

• Customer loyalty and profitability

• Distribution strategy

• Flexible cost structure

• New structures for growth

• Risk management

• Keeping pace with change

Financial services providers are poised to profit from new e-business opportunities and

new legal freedom to combine industry segments-such as banking and insurance-but they

face the challenge of opening backend systems to broader audiences than ever before.

With a phenomenal growth of electronic transactions internationally, it is 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 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

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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.

We will recommend that just creation of new products are not enough but customer’s

awareness is more important. In the country like Pakistan, bank management should

develop comprehensive plan for educating customers and employees of the banking

sector about the new products and services.

We conclude that the theory, privatization will increase competition and competition

will give birth to new products, is proved in case of Pakistani banking sector. A lot of

new products and services are introduced after the privatization and reform in banking

industry of Pakistan. The introduction of computers at bank branches and the installation

of ATMs seemed to set in motion a revolution in Pakistan’s banking system. So as to

ensure that financial assistance is rendered to the potential borrowers, it is necessary for a

bank to develop adequate level of awareness about the various types of schemes and

facilities and their utility among the people. Such awareness can be developed in various

ways such as educating borrowers / potential borrowers through formal and informal

interactions. The bank branches are required to hold customer meetings once a month to

generate awareness and interaction. In addition, the branch personnel are expected to

move in field to contact existing and potential borrowers to know their requirements and

expectations from the Bank to enable the banker to tailor the schemes to suit the

requirements of the customers within the overall framework and guidelines of the Bank.

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Chapter 7

Regulatory Environment for Privatization of Banks

7.1. Introduction

Banking is sensitive industry. Unlike other corporate entities, the business of banking

requires supervision and vigilance to ensure the safety and soundness of the system and

also to protect the interest of the depositors. Ishrat Husain (2004). Commercial banks are

also among the most tightly regulated economic institutions in modern economies. There

are many justifications, including preventing contagious liquidity crisis, maintaining

financial stability, protecting small depositors and investors, enhancing efficiency, and

other social purposes (Herring and Santomero, 2000: Freixas and Rochet, 2001).

Calomiris and White (1994) attribute banking regulation to the capture of the state by

interest groups. Despite the tight regulations, banking crisis have been the sources of

economic instability during the last two decades of the 20th century. As a result,

inappropriate banking has attracted more criticisms (Caprio, 1998).

The past history of banks in Pakistan cannot be ignored. The case of Mehran Bank is still

on record. Financial institutions were opened in different nature and type, like

cooperative societies, etc. with out any proper regulation and vigilance. Huge percentage

of returned was offered to attract peoples to deposit their savings. After collection of

huge amount they run away and the Government of Pakistan is still facing to solve this

problem.

Banks are key institutions for attracting savings, in the form of short-term deposits, and

converting them into longer-term investments, in the form of loans. When private capital

is genuinely at risk, bankers have strong incentives to gather information about the credit-

worthiness of potential borrowers, which they can then use to determine how, and on what

terms, credit is allocated. This ensures that investment is directed towards the most

productive purposes and imposes a hard-budget constraint on firms. (World Bank, 1995).

However, when political pressure distorts bankers' incentives, credit may be directed

without due regard to commercial lending criteria. These pressures are likely to be especially

pronounced for state-owned banks. In theory, bank’s privatization might, therefore, have a large

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effect on financial sector performance and, in turn, on aggregate long-term growth.

(Demirguc-Kunt and Levine (1994)

7.2 Regulatory Reform

Proper regulation for corporate governance of banks received immense importance in the

aftermath of several episodes of banking crises in 1990s, some of which resulted into

banking sector collapses. In an emerging economy like Pakistan, this issue becomes even

more important. In view of rapidly developing market but slow pace of information

dissemination, it is important to reduce the adverse selection and moral hazard problems

that may arise due to new entrants in the business of banking. It is in this perspective that

the State Bank of Pakistan issued some guidelines detailing the code of corporate

governance of banks. Privatization of banks without proper regulation can create

problems. For example, Chile privatized many public banks in the early 1970s as part of

its privatization program. In 1982, the financial distress of the industrial conglomerates

caused by high interest rates and currency devaluation meant that many firms were

unable to service their loans. World Bank (1989) suggests that an inadequate regulatory

framework “allowed [the privatized banks] to be acquired by industrial groups, which

used them to make excessive loans to group firms. (Stallings and Brock, 1993)

7.3 Pre- Privatization Activities

Economic development does not take place in a vacuum. It requires an enabling

environment, which includes a proper legal and regulatory framework. To prepare the

public sector banks for privatization, following steps were taken in the Pakistani banking

sector:

1 Amendment in Banks (Nationalization) Act 1974.

This Act, under which the banking sector in the country was nationalized during

the seventies, was amended in 1990, to pave the way for privatization of the

nationalized commercial banks.

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2 Cabinet Committee on Privatization (CCOP)

Created in 1991, the CCOP has operated continuously except for the period

September 1998 to February 2000, when a Privatization Board of Pakistan headed

by the Prime Minister replaced it. Presently, this Committee of the Cabinet is

headed by the Minister for Finance and includes the Ministers for Privatization,

Industries & Production, IT & Telecom, Petroleum, Water and Power, and Labor.

It also includes the Deputy Chairman, Planning Commission. According to its

terms of reference issued in February 2000, the CCOP is to:

• Formulate the Privatization Policy for approval of the Government/Cabinet

• Approve the State Owned Enterprises to be privatized on the recommendation of

the Privatization Commission or otherwise

• Take policy decisions on inter-ministerial issues relating to the privatization

process

• Review and monitor the progress of privatization

• Instruct the Privatization Commission to submit reports/information/data relating

to the privatization process or any matter relating thereto

• Take policy decisions on matters pertaining to privatization, restructuring,

deregulation, regulatory bodies and Privatization Fund Account

• Approve the Reference Price in respect of the State Owned Enterprises being

privatized.

• Approve the successful bidders

• Consider and approve the recommendations of the Privatization Commission on

any matter

• Assign any other task relating to Privatization to the Privatization Commission.

3 Abolition of the Pakistan Banking Council

The Pakistan Banking Council, established subsequent to nationalization of the

banking sector in the seventies, was abolished in 1997.

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4 Establishment of CIRC

The Corporate and Industrial Restructuring Corporation (CIRC) was established

in 2000 for acquiring Non-performing Loans of NCBs. Non-Performing Loans

worth Rs. 47.4 billion have been transferred to CIRC at a discount so far for

disposal.

5 Protection of Economic Reforms Act, 1992.

The new Act was introduced for protection of economic reforms in the country. The

main headings of the act are:

II Act No. XII of 1992

AN ACT TO PROVIDE FOR FURTHERANCE AND PROTECTION OF

ECONOMIC REFORMS

WHEREAS it is necessary to create a liberal environment for savings and investments;

and other matters relating thereto;

AND WHEREAS a number of economic reforms have been introduced and are in the

process of being introduced to achieve the aforesaid objectives;

AND WHEREAS it is necessary to provide legal protection to these reforms in order to

create confidence in the establishment and continuity of the liberal economic

environment created thereby;

It is hereby enacted as follows:

1. Short Title, Extent And Commencement

(1). This Act, may be called the Protection of Economic Reforms Act, 1992.

(2) It extends to the whole of Pakistan.

(3) It shall come into force at once.

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2. Definitions

In this Act, unless there is anything repugnant in the subject or context:

(a) "Government" includes both the Federal Government and any Provincial----------------

--------Government;

(b)"economic reforms" means economic policies and programmes, laws and regulations

announced, promulgated or implemented by the Government on and after the seventh day

of November, 1990, relating to privatization of public sector enterprises, and nationalized

banks, promotion of savings and - investments, introduction of fiscal incentives for

industrialization and deregulation of investment, banking, finance, exchange and

payments systems, holding and transfer of currencies; and

(c) all other expressions used in this Ordinance shall have the meaning, respectively

assigned to them under the relevant laws.

3. Act To Over-ride other Laws

The provisions of this Act shall have effect notwithstanding anything contained in the

Foreign Exchange Regulation Act, 1947 (VII of 1947), the Customs Act, 1969 (IV of

1969), the Income Tax Ordinance, 1979 (XXXI of 1979), or any other law for the time

being in force.

4. Freedom to Bring, Holds, Sell And Take Out Foreign Currency

All citizens of Pakistan resident in Pakistan or outside Pakistan and all other persons shall

be entitled and free to bring, hold, sell, transfer and take out foreign exchange within or

out of Pakistan in any form and shall not be required to make a foreign currency

declaration at any stage nor shall any one be questioned in regard to the same.

5.Immunities to Foreign Currency Accounts

1. All citizens of Pakistan resident in Pakistan or outside Pakistan who hold foreign

currency accounts in Pakistan, and all other persons who hold such accounts, shall

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continue to enjoy immunity against any inquiry from the Income Tax Department or any

other taxation authority as to the source of financing of the foreign currency accounts.

2 The balances in the foreign currency accounts and income there from shall continue to

remain exempted from the levy of wealth-tax and income tax and compulsory deduction

of Zakat at source.

3 The banks shall maintain complete secrecy in respect of transactions in the foreign

currency accounts.

4 The State Bank of Pakistan or other banks shall not impose any restrictions on deposits

in and withdrawals from the foreign currency accounts and restrictions if any shall stand

withdrawn forthwith.

6. Protection of Fiscal Incentives for Setting-up of Industries

The fiscal incentives for investment provided by the Government through the statutory

orders listed in the Schedule or otherwise notified shall continue inforce for the terms

specified therein and shall not be altered to the disadvantage of the investors.

7. Protection of Transfer of Ownership to Private Sector.

The ownership, management and control of any banking, commercial, manufacturing or

other company, establishment or enterprise transferred by the Government to any person

under any law shall not again be compulsorily acquiredor taken over by the Government

for any reason whatsoever.

8. Protection of Foreign and Pakistan Investment

No foreign, industrial or commercial enterprise established or owned in any form by a

foreign or Pakistani investor for private gain in accordance with law, and no investment

in share or equity of any company, firm, or enterprise, and no commercial bank or

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financial institution established, owned or acquired by any foreign or Pakistani investor,

shall be compulsorily acquired or taken over by the Government.

9. Secrecy of Banking Transaction

Secrecy of bonafide banking transactions shall be strictly observed by all banks and

financial institutions, by whosoever owned, controlled or managed.

10. Protection of Financial Obligation.

All financial obligations incurred, including those under any instrument, or any financial

and contractual commitment made by or on behalf of the Government shall continue to

remain in force, and shall not be altered to the disadvantage of the beneficiaries.

11. Rules

The Federal Government may make rules for carrying out the purposes of this Act.

6. Promulgation of Privatization Ordinance

To further strengthen the privatization process, the government promulgated the

Privatization Ordinance in 2000. The Ordinance strives to ensure that

privatization is carried out in a fair and transparent manner.

7.4 State Bank of Pakistan (SBP)

The State Bank of Pakistan in itself is a regulatory authority, monitoring banks and

financial institutions. There is a separate department, Banking Policy and Regulation

Department specific for this purpose. In 1991-92, the financial sector reforms were going

on at a rapid speed. Privatization of the banking sector has been an important component

of these reforms. It is motivated by the intention to increase the competitiveness and

efficiency of the banking system. In 1992, SBP issued new cautious regulations to

enhance the supervision and regulation of the banking system. The new guidelines

include more strict limits on credit concentration and on conditional liabilities; rigid

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guidelines on the separation of bank ownership and management; tighter margin

requirements on equity-based advances; and a strong system of classification and

provisioning for non-performing assets. In addition, amendments were also made to the

banks Nationalization Act of 1974 aimed at enhancing the administrative and advisory

role of the Pakistan banking Council in commercial banking. In 1993, through an

amendment in the State bank Act, 1956, the State bank of Pakistan has been given

operational independence to conduct monetary policy and regulate and supervise the

banking sector. Recently, an ordinance called Financial Institutions (Recovery of

Finances) Ordinance 2001 has been promulgated. According to this ordinance a financial

institution or the customer may fill a suit in the banking court, with regard the any default

in the finances. (A.R. Kemal, et al, 2002)

7.5 Legislative Agenda for Economic Reforms

For the implementation of economic reform program, the government has as a matter of

policy, formulated an extensive legislative agenda cutting across the various sectors of

economy, including the banking and financial sector.

7.5.1 Banking and Financial Sector

Mindful of the magnitude of the defaulted loans, the Banking companies’ loan

recovery law is being strengthened to facilitate the process of mortgage,

foreclosure and expeditious settlement of banking disputes. Further more, a

banking Law Review Commission has been formed to review all the banking laws

and regulations with a view to updating, consolidating and rationalizing the same.

Legal measure to build confidence, which had eroded after the freezing of foreign

currency accounts, are also being introduced to prevent such occurrences in the

future.

Industrial finance is being revived through a restructuring of the banking and

financial sectors, Priority will be given to the needs of small and medium industry

with in export orientation. Efforts will be focused to promote small and medium

industries, having high labor intensity.

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As a follow up of its poverty alleviation program, the Government has, through an

enabling legislation, established a new bank for enhancing poor peoples’ access to

credit.

A new insurance law has been promulgated to provide for deregulated,

competitive and safe environment for insurance business.

A new law has also been framed to provide for easy mergers, acquisitions, take

over and liquidation of public listed companies.

Changes in monopoly control authority law are also under consideration.

State Bank of Pakistan, during the last decade has implemented policies to reform the

banking sector in Pakistan, as part of the overall financial sector reform package initiated

in early 1990s. Although, slow in pace until recently, the reforms have been consistent

and continuous. As a result of these reforms, the commercial banking industry in

Pakistan has taken a new shape and is working on a new vision. Part of these reforms is

also related to the issue of corporate governance of banks in Pakistan.

Corporate governance is a new phenomenon not only in Pakistan but in general. The

major reason of corporate governance is the recent episodes of banks failures in different

parts of the world especially in the aftermath of the 1997 Asian financial crisis. The issue

of corporate governance of banks in Pakistan received special attention because Pakistan

embarked on measures of banking sector restructuring and privatization at the same time

when deliberations were underway to devise some code of ethics for corporate

governance of the financial and corporate sector including banks. A major step towards

this was a joint project by the Securities and Exchange Commission of Pakistan and the

UNDP (SECP-UNDP) in collaboration with the Economic Affairs Division (EAD) of the

Ministry of Finance. The project was launched in August 2002 with the objective to

design, develop and implement a Code of Corporate Governance. Though this project

had some discussion on corporate governance for banks but its main focus was the

corporate sector in Pakistan and issued measures to create stakeholder awareness,

capacity building and networking with other emerging economies. To address the

problems of banking sector, the State Bank of Pakistan (SBP) issued a ‘Handbook of

Corporate Governance’ in 2003. The objective of this handbook is to provide guidelines

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for Board of Directors, managers and shareholders. Most of the recommendations and

guidelines stated in the handbook are directly drawn from the recommendations made by

Basel Committee on corporate governance and OECD. These guidelines cover four

important areas, namely, Board of Directors, Management, Financial Disclosure, and

Auditors. It is to be noted that this is the only document available at this point. Some

important features of this Handbook are highlighted here:

a. The Board of Directors

Basel committee places major responsibility on the board of directors and senior bank

management to fully understand the risk exposure. As such, it is recommended that the

composition of the board of directors and senior management in a bank should include

individuals who are highly skilled and experienced in determining the risk exposure

given the size and nature of the bank’s activities and should be able to take certain steps

if a need arise to reduce a high risk exposure. Regulators and supervisors have an

important responsibility to determine the adequacy of the internal control measures

including the responsibilities of the board of directors in dealing with organizational

structure, accounting principles, checks and balances and safety of investment and

compliance of abiding by the given laws and required disclosure. Another important part

of the recommendations issued by different committees such as Basel and OECD deals

with the Business ethics, specifically to make sure that the rights of shareholders

stakeholders are well protected. Accordingly, these shareholders and stakeholders have a

right to adequate and timely information and appropriate forms of participation in the

decision making process of the bank.

Appoint of Board of Director

Prior clearance of the SBP is needed for the appointment of BOD. The potential

nominee/appointee for the post of a Director should have substantial interest (no less than

20 per cent shares) and should be working in a management capacity for the bank.

Anyone holding at least 10 per cent shares can become Director subject to SBP’s

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approval. SBP requires that the incumbent should also qualify the standard ‘fit and

proper test’ for appointment. A minimum of 5 years of senior business/management

level experience for the post of directors while potential candidate for Presidents or CEO

of banks need to have spent 15 years in banking career with a minimum of 3 years in

senior level. These individuals should also have impeccable record in the their

professional capacities, should not have been involved in any bank insolvency or should

not be a defaulter of any kind and should not be a director in any other financial

institutions creating a conflict of interest.

The SBP may also ask any banking company to call a general meeting of the

shareholders to elect a new director. Banking Companies Ordinance (BCO), 1962 and

Companies Ordinance (CO), 1984 specify the procedure for the election of a director.

According to the Companies Act, 1913 the SBP may also appoint no more than one

person to be a director of a banking company. In either case, the total number of

directors should not be less than seven and the tenure of a director is restricted to be no

more than six consecutive years.

Responsibilities of the Board of Directors

The responsibilities of the BOD are specified in the SBP code of corporate governance.

Some important ones are highlighted here:

• The Board shall approve and monitor the objectives, strategies and overall

business plans of the institution and will ensure that all activities are carried out

prudently within the framework of existing laws and regulations.

• The Board shall clearly define the authorities and key responsibilities of both the

Directors and the senior management without delegating its policymaking power

to the management.

• The Board shall approve and ensure the implementation of all policies related to

audit and internal management of risk and resources and will be responsible for

the review and update of existing policies.

• The Board will ensure an effective ‘Management information system’ to cater to

the needs of changing market conditions.

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• The Board should meet frequently (preferably on a monthly basis but at least

quarterly), and the individuals directors should attend at least half of the meetings

held in a financial year. The SBP requires that all Pakistani scheduled banks in

Pakistan should not hold their ordinary BOD meetings outside the country.

Holding such meeting abroad leads to wastage of resources without any benefit to

depositors/customers.

• The Board is required to prepare a formal summary of the proceedings of the

general meetings and meeting of its directors and committee of directors for

inspection duly signed by the chairman and makes it available for inspection by

members free of charge. Under an amendment to the BCO, 1962, the SBP starting

January 2000, required all banks incorporated in Pakistan to furnish copies of the

minutes of the meeting of their respective BODs within seven days of the meeting

to the Director, BPRD, SBP.

• The activities of the Board should be transparent to the external auditors and

supervisors to form a judgment on its working and decision-making performance.

• The Board will ensure that appropriate actions are taken, in consultation with the

audit committee of the Board, to rectify any weaknesses and lack of controls with

a copy of the letter submitted to the SBP for monitoring purposes.

Further Guidelines for the Functions of the Board of Directors

The Companies Ordinance, 1984 also details the power of Directors which empowers the

Director to make important decisions on investment and human resource management as

well as capital expenditure. The SBP directive also require that member of the BOD of a

banking company should not hold any more 5 per cent of the paid-up capital of the

banking company in individual capacity or in the name of family members. The

Directors should not appointed in the bank in any capacity, shall not be paid other than

traveling and dialing allowances to attend meeting and no more than 25% of the total

directors can be paid executives of the bank.

In order to reduce the monopoly of the same family in a banking company, the SBP, in

November 2001 issued a circular to restrict the number of directors on the board from the

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same family no more than 25% (as compared to 50% allowed earlier). The BCO, 1962

also restrict a person to be a director of two companies simultaneously. To reduce

political influence, any Federal, or Provincial Minister or the Minister of State or a civil

servant cannot be appointed as the director of the banking company.

Under prudential regulation guidelines of the SBP, the banking is not allowed to make

loans or advances to any of its directors, chief executive, individuals, or their family

members or firms or companies which the banking company or any of its director is

interested as partner holding more than 5 per cent of the share capital or make loans and

advances on the guarantee of the above individuals. The banking company is also not

allowed to make loans and advances against the security of its own share. The prudential

regulation circular issued in 1992 also forbids banks to enter, without a prior approval of

the SBP, into a lease, rent or sale/purchase agreement with their directors, officers,

employees or any individual (or their family member) with ownership of 10 percent or

more of the equity of the bank

Whenever deemed necessary, the SBP has the authority to supersede the Board of

directors and may continue to do so for period determined by the SBP. The SP guidelines

also detail the procedure for the removal, retirement or prosecution of director(s) or chief

executive officers.

b. Management

The appointment criterion of the Chief Executive Officer (CEO) is the same as the

Director of the BOD. No prior approval of the SBP is required for such appointments.

However, the banks are required to adhere to the SBP’s guidelines containing the “Fit

and Proper Test” for the appointment of key executives, especially very senior level

officials non-compliance to which will result into punitive actions against the banking

company. The key criterions of the ‘Fit and Proper test’ include:

• The incumbent should have a track record of ‘Honesty, integrity and reputation’,

not convicted of any criminal offence including fraud or financial crime.

• Should be competent and capable of fulfilling his/her duties, having adequate

qualification and experience.

• Should not have been removed/dismissed from service in the capacity of an

employee, director or chairman on account of financial crime or moral conduct.

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• Should not be defaulter of payment(s) due to any financial institutions or tax

office.

• Should not supervise more than one functional area that give rise to conflict of

interest within the banking company and should not hold directorship of a

company that is a client to the bank.

c. Financial Disclosure

• Under the BCO, 1962, all banking companies incorporated in Pakistan or foreign

banks with branches in Pakistan are required to furnish a balance sheet and profit

and loss account to the SBP at the end of the calendar year.

• The CO, 1984 requires that the directors shall attach a report with the balance

sheet to report the state of the company’s affairs, the details of dividend

distribution, and details of any reserve accounts

• Disclose any material changes and commitments affecting the financial position

of the company.

• Disclosure of any observations or negative remarks made in the auditor’s report.

• State details of holding of share, earning per share, reasons for incurring loss (if

any) and any defaults (if any).

• Noncompliance to the above will result in to punitive actions by the relevant

authorities.

d. Auditors

Another principal of effective bank supervision is the effective internal audit. Internal

audit helps to identify the problem areas and to avoid a major collapse. However, to have

an effective internal audit, it is important that the bank should have sufficient resources

and qualified and an appropriate methodology to undertake this task. Again, supervisors

have to make sure that banks have an appropriate audit function and satisfy the above

criterion. Reporting of these reports in an accurate and timely manner is essential for

evaluation of the bank’s status and need for any necessary strategy. Supervisors have the

authority to hold management responsible for the release of all such information and

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reports and that these reports are accurate and produced in a timely manner. Some

recommendations from the SBP’s handbook are stated here:

• Under CO, 1984, the banking company is required to appoint an auditor in its

annual general meeting for a period of one year. The first auditor of a newly

incorporated company should be appointed within 60 days of the incorporation of

the company.

• All banking companies are required to appoint auditors from the panel of auditors

maintained by the SBP. This panel consists of auditors who satisfy certain

minimum criteria based on their qualification and experience. Any individual

who is a director of the company or has any kind of employment with the

company or any of his/her family member is employed by the company cannot be

appointed as the auditor of the same company. Any individual or his/her family

member who is appointed the external auditor is not allowed to hold, purchase, or

sale shares of the company.

• The BCO, 1962 states that the balance sheet and profit and loss account prepared

by the company shall be audited by the banking company’s auditor.

• The auditor is required to furnish an audit report stating the authenticity of the

information and extend of cooperation provided by the banking company while

conducting the company audit. These will include verification of the sources of

funds generated and investments made by the banking company during the audit

period.

The auditor shall adhere to the guidelines or any amendments to the guidelines issued by

the SBP for the audit of the banking company. The auditors will furnish a special report

to the Director, Banking Supervision Department (BSD) of the SBP and a copy to the

concerned bank. (State Bank of Pakistan (2004), Draft Guidelines on Internal Controls,

State Bank of Pakistan, Karachi.)

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Further General Developments on Corporate Governance

The State Bank of Pakistan has recently issued ‘Guidelines on Internal Controls’ further

explaining the policies, plans and processes as affected by the decion-manking process of

the BODs and senior management. As it is well established elsewhere and effective risk

management is strongly influenced by effective internal control mechanism helps reduce

the risk and probability of banking crisis. Hence, the SBP has put special emphasis to

these guidelines for internal control as part of effective risk management. The system of

internal controls includes financial, operational and compliance controls and risk

management. The guidelines ensure efficiency and effectiveness of operations, reliability,

completeness and timeliness of financial and management information and compliance

with policies, procedures, regulations and laws. An important aspect of risk management

is risk recognition and assessment as well as correcting deficiencies. Self-assessment

requires certain level of expertise and experience. It is, therefore important that senior

management and internal auditors of the banking industry are qualified to perform these

tasks. In an emerging but rapidly developing financial system such as Pakistan,

regulators can be very useful by organizing certain workshops to the senior management

to understand the mechanism to fully understand and assess different categories of risk

bank is expected to face in the changing market conditions. One can learn important

lessons from the policies implemented by the Southeast and East Asian economies in the

aftermath of the 1997 Asian financial crisis and under the new financial architecture.

Organizing workshops and courses for senior banks management and sharing information

dealing with a bank-specific problem are two important aspects of this new financial

architecture. (State Bank of Pakistan (2003), Handbook of Corporate Governance)

The existing Prudential Regulations in respect of various aspects of operations of

commercial banks been reviewed in the light of the on-going process of changes in the

financial sector. The introduction of new products and services were required new rules

and regulations. The state bank of Pakistan as a prudential supervision authority made the

following regulations about consumer financing.

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PART – A

D E F I N I T I O N S 1. Bank means a banking company as defined in the Banking Companies Ordinance,

1962.

2. Borrower means an individual to whom a bank / DFI has allowed any consumer

financing during the course of business.

3. Consumer Financing means any financing allowed to individuals for meeting their

personal, family or household needs. The facilities categorized as Consumer Financing

are given as under:

(i) Credit Cards mean cards, which allow a customer to make payments on credit.

Supplementary credit cards shall be considered part of the principal borrower for the

purposes of these regulations. Corporate Cards will not fall under this category and shall

be regulated by Prudential Regulations for Corporate / Commercial Banking or

Prudential Regulations for SMEs Financing as the case may be. The regulations for credit

cards shall also be applicable on charge cards, debit cards, stored value cards and BTF

(Balance Transfer Facility).

(ii) Auto Loans mean the loans to purchase the vehicle for personal use.

(iii) Housing Finance means loan provided to individuals for the purchase of residential

house / apartment / land. The loans availed for the purpose of making improvements in

house / apartment / land shall also fall under this category.

(iv) Personal Loans mean the loans to individuals for the payment of goods, services and

expenses and include Running Finance / Revolving Credit to individuals.

4. DFI means Development Financial Institution and includes the Pakistan Industrial

Credit and Investment Corporation (PICIC), the Saudi Pak Industrial and Agricultural

Investment Company Limited, the Pak Kuwait Investment Company Limited, the Pak

Libya Holding Company Limited, the Pak Oman Investment Company (Pvt.) Limited

and any other financial institution notified under Section 3-A of the Banking Companies

Ordinance, 1962.

5. Documents include vouchers, cheques, bills, pay-orders, promissory notes, securities

for leases / advances and claims by or against the bank / DFI or other papers supporting

entries in the books of a bank / DFI.

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6. Equity of the Bank / DFI means Tier-I Capital or Core Capital and includes paid-up

capital, general reserves, balance in share premium account, reserve for issue of bonus

shares and retained earnings / accumulated losses as disclosed in latest annual audited

financial statements. In case of branches of foreign banks operating in Pakistan, equity

will mean capital maintained, free of losses and provisions, under Section 13 of the

Banking Companies Ordinance, 1962.

7. Financial Institutions mean banks, Development Financial Institutions (DFIs) and

Non-Banking Finance Companies (NBFCs).

8. Government Securities shall include such types of Pak. Rupee obligations of the

Federal Government or a Provincial Government or of a Corporation wholly owned or

controlled, directly or indirectly, by the Federal Government or a Provincial Government

and guaranteed by the Federal Government as the Federal Government may, by

notification in the Official Gazette, declare, to the extent determined from time to time, to

be Government Securities.

9. Liquid Assets are the assets which are readily convertible into cash without recourse

to a court of law and mean encashment / realizable value of government securities, bank

deposits, certificates of deposit, shares of listed companies which are actively traded on

the stock exchange, NIT Units, certificates of mutual funds, Certificates of Investment

(COIs) issued by DFIs / NBFCs rated at least ‘A’ by a credit rating agency on the

approved panel of State Bank of Pakistan, listed TFCs rated at least ‘A’ by a credit rating

agency on the approved panel of State Bank of Pakistan and certificates of asset

management companies for which there is a book maker quoting daily offer and bid rates

and there is active secondary market trading. These assets with appropriate margins

should be in possession of the banks / DFIs with perfected lien. Guarantees issued by

domestic banks / DFIs when received as collateral by banks / DFIs will be treated at par

with liquid assets whereas, for guarantees issued by foreign banks, the issuing banks’

rating, assigned either by Standard & Poors, Moody’s or Fitch-Ibca, should be ‘A’ and

above\ or equivalent.

10. NBFC means Non-Banking Finance Company and includes a Modaraba, Leasing

Company, Housing Finance Company, Investment Bank, Discount House, Asset

Management Company and a Venture Capital Company.

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11. Secured means exposure backed by tangible security with appropriate margins (in

cases where margin has been prescribed by State Bank of Pakistan, appropriate margin

shall at least be equal to the prescribed margin). Exposure without any tangible security is

defined as clean.

12. Tangible Security means liquid assets (as defined in these Prudential Regulations),

mortgage of land and building, hypothecation or charge on vehicle, but does not include

hypothecation of household goods, etc.

PART – B MINIMUM REQUIREMENTS FOR CONSUMER FINANCING

Apart from the specific regulations given under each mode of financing separately, general

requirements laid down here should also be followed by the banks / DFIs while undertaking

consumer financing. It may be noted that these are the minimum requirements and should

not in any way be construed to restrict the role of the management of the banks / DFIs to

further strengthen the risk management processes through establishing comprehensive credit

risk management systems appropriate to their type, scope, sophistication and scale of

operations. The Board of Directors of the banks / DFIs are required to establish policies,

procedures and practices to define risks, stipulate responsibilities, specify security

requirements, design internal controls and then ensure strict compliance with them.

PRE-OPERATIONS

Before embarking upon or undertaking consumer financing, the banks / DFIs shall

implement / follow the guidelines given below. The banks / DFIs already involved in the

consumer financing will ensure compliance with these guidelines within six months of

the date of issuance of Prudential Regulations for Consumer Financing.

1. Banks / DFIs shall establish separate Risk Management capacity for the purpose of

consumer financing, which will be suitably staffed by personnel having sufficient

expertise and experience in the field of consumer finance / business.

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2. The banks / DFIs shall prepare comprehensive consumer credit policy duly approved

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.

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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.

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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

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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Agénor, P. (1996): "The labour market and economic adjustment" in IMF Staff Papers, June 1996, Vol. 43, No. 2.

Aigner, D.J., Lovell, C.A.K., and Schmidt, P., “Specification and Estimation of Frontier Production, Profit and Cost Functions,” Journal of Econometrics 6: 21–37, 1977. Aktan,Coskun Can 1987. “Public enterprises and denationalization (Turkish) Izmir Bukom Matbaasi” Aktan, Coskun Can 1991). “The Economics of Privatization” (Mimeo). Izmir, Dokuz Eylul Universities. Allen, Franklin and Douglas Gale. 1999. “Corporate Governance and Competition,” working paper, Wharton School: The University of Pennsylvania. Allison, Christine, and Dena Ringold. 1996. Labor Markets in Transition in Central and Eastern Europe 1989-1995. World Bank Technical Paper 352. Washington, D.C. Altunba(s,) Y., and S.p Chakervarty (2001) Frontier Cost Functions and Bank Efficiency. Economics letters 72:2, 233-240. Al-Yousif Y.K. (2002), “Financial Development and Economic Growth, Another Look at the Evidence from Developing Countries” Review of Financial Economics, 11, 131-150 Antonio Estache et al. Labor Redundancy, Retraining and Outplacement during Privatization: The Experience of Brazil’s Federal Railway (WBI, The World Bank) Annual Reports of Muslim Commercial Bank of Pakistan Limited for various years, 1986-1990 and 1997 to 2001. Annual Report for Allie bank of Pakistan Limited for various years, 1986 to 1990 and 1997 to 1999.

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APPENDIX

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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

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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.

2 Pakistan Industrial Credit & Investment Corporation Ltd. 2 Pak-Libya Holding Co. (Pvt) Ltd.

3 Pak-Kuwait Investment Company (Pvt) Ltd. 3 Pakistan Industrial Credit and Investment Corporation Ltd.

4 Pak-Libya Holding Co. (Pvt) Ltd. 4 Saudi Pak Industrial & Agricultural Inv. Co. (Pvt) Ltd.

5 Bankers Equity Ltd. 5 Pak-Oman Investment Company Limited

6 Regional Development Finance Corporation 6 Investment Corporation of Pakistan

7 Saudi Pak Industrial & Agricultural Inv. Co. (Pvt) Ltd. 7 SME Bank

8 Small Business Finance Corporation (SBFC)

9 Investment Corporation of Pakistan

Investment Banks Investment Banks

1 Al - Meezan Investment Bank Ltd. 1 Asset Investment Bank Ltd.

2 Al-Faysal Investment Bank Ltd. 2 Atlas Investment Bank Ltd.

3 AlTowfeek Investment Bank Ltd. 3 Crescent Investment Bank Ltd.

4 Asset Investment Bank Ltd. 4 Escorts Investment Bank Ltd.

5 Atlas Investment Bank Ltd. 5 Fidelity Investment Bank Ltd.

6 Crescent Investment Bank Ltd. 6 First international Investment Bank Ltd.

7 Escorts Investment Bank Ltd. 7 First Standard Investment Bank Limited

8 Fidelity Investment Bank Ltd. 8 Franklin Investment Bank Ltd.

9 First international Investment Bank Ltd. 9 Islamic Investment Bank Ltd.

10 Franklin Investment Bank Ltd. 10 Jahangir Siddiqui Investment bank Ltd.

11 Islamic Investment Bank Ltd. 11 Orix Investment Bank Ltd.

12 Jahangir Siddiqui Investment bank Ltd. 12 Prudential Investment Bank Ltd.

13 Orix Investment Bank Ltd. 13 Security Investment Bank Ltd.

14 Prudential Investment Bank Ltd. 14 Trust Investment Bank Ltd..

15 Security Investment Bank Ltd.

16 Trust Investment Bank Ltd..

Leasing Companies Leasing Companies 1 Asian Leasing Corporation Ltd. 1 Askari Leasing Company Ltd.

2 Askari Leasing Company Ltd. 2 Capital Assets Leasing Corporation Ltd.

3 Atlas Lease Ltd. 3 Crescent Leasing Company Ltd.

4 Capital Assets Leasing Corporation Ltd. 4 Dawood Leasing Company Ltd.

5 Crescent Leasing Company Ltd. 5 First Leasing Corporation

6 Dadabhoy Leasing Company Ltd. 6 Grays Leasing Ltd.

7 Dawood Leasing Company Ltd. 7 Ibrahim Leasing Ltd.

8 English Leasing Ltd. 8 Inter Asia Leasing Company Ltd.

9 First Leasing Corporation 9 International Multi Leasing Corporation Ltd.

10 Ghandhara Leasing Company Ltd. 10 Lease Pak Ltd.

11 Grays Leasing Ltd. 11 National Development Leasing Corporation Ltd.

12 Ibrahim Leasing Ltd. 12 Natover Lease & Refinance Ltd.

13 Inter Asia Leasing Company Ltd. 13 Network Leasing Corporation Ltd.

14 International Multi Leasing Corporation Ltd. 14 Orix Leasing Pakistan Ltd.

15 Lease Pak Ltd. 15 Pacific Leasing Corporation Ltd.

16 Mercantile Leasing Company Ltd. 16 Pak-Apex Leasing Company Ltd.

17 National Assets Leasing Corporation Ltd. 17 Pak-Gulf Leasing Ltd.

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18 National Development Leasing Corporation Ltd. 18 Pakistan Industrial & Commercial Leasing Ltd.

Appendix 1.1 Continued..

19 Natover Lease & Refinance Ltd. 19 Paramount Leasing Ltd.

20 Network Leasing Corporation Ltd. 20 Saudi Pak Leasing Company Ltd

21 Orix Leasing Pakistan Ltd. 21 Security Leasing Company Ltd.

22 Pacific Leasing Corporation Ltd. 22 Sigma Leasing Corporation Ltd.

23 Pak-Apex Leasing Company Ltd. 23 Trust Leasing Corporation Ltd.

24 Pak-Gulf Leasing Ltd. 24 Union Leasing Ltd.

25 Pakistan Industrial & Commercial Leasing Ltd. 25 Universal Leasing Corporation Ltd.

26 Pakistan Industrial Leasing Corporation Ltd 27 Paramount Leasing Ltd. 28 Saudi Pak Leasing Company Ltd. 29 Security Leasing Company Ltd. 30 Sigma Leasing Corporation Ltd. 31 Trust Leasing Corporation Ltd. 32 Union Leasing Ltd. 33 Universal Leasing Corporation Ltd.

Modarabas Modarabas 1 Al-Noor Modaraba 1 Al-Noor Modaraba 2 Allied bank Modaraba 1st 2 Allied bank Modaraba 1st 3 Al-Zamin Modaraba 3 Al-Zamin Modaraba 4 B.F. Modaraba 4 B.F. Modaraba 5 B.R.R. International Modaraba 5 B.R.R. International Modaraba 6 Confidence Modaraba 1st 6 Constellation Modaraba 1st 7 Constellation Modaraba 1st 7 Crescent Modaraba 1st 8 Crescent Modaraba 1st 8 Custodian Modaraba 1st 9 Custodian Modaraba 1st 9 Elite Capital Modaraba 1st 10 Dadabhoy Modaraba 1st 10 Equity Modaraba 1srt 11 Elite Capital Modaraba 1st 11 Fayzan Manufacturing Modaraba 12 Equity Modaraba 1srt 12 Fidelity Leasing Modaraba 1st 13 Fidelity Leasing Modaraba 1st 13 Financial Link Modaraba 14 Financial Link Modaraba 14 General leasing Modaraba 1st 15 General leasing Modaraba 1st 15 Grindlays Modaraba 1st 16 Grindlays Modaraba 1st 16 Guardian Leasing Modaraba 17 Guardian Leasing Modaraba 17 Habib Bank Modaraba 1st 18 Habib Bank Modaraba 1st 18 Habib Modaraba 1st 19 Habib Modaraba 1st 19 Hajveri Modaraba 1st 20 Hajveri Modaraba 1st 20 IBL Modaraba 1st 21 IBL Modaraba 1st 21 Imrooz Modaraba 1st 22 Ibrahim Modaraba 1st 22 Industrial Capital Modaraba 1st 23 Imrooz Modaraba 1st 23 Interfund Modaraba 1st 24 Industrial Capital Modaraba 1st 24 Islamic Modaraba 1st 25 Interfund Modaraba 1st 25 LTV Capital Modaraba 26 Islamic Modaraba 1st 26 Mehran Modaraba 1st 27 LTV Capital Modaraba 27 Modaraba Al Tijarah 28 Mehran Modaraba 1st 28 Modaraba Al-Mali 29 Modaraba Al Tijarah 29 National Modaraba 1st 30 Modaraba Al-Mali 30 Pak Modaraba 1st 31 National Modaraba 1st 31 Paramount Modaraba 1st 32 Pak Modaraba 1st 32 Professional Modaraba 1st 33 Paramount Modaraba 1st 33 Prudential Modaraba 1st 34 Professional Modaraba 1st 34 Punjab Modaraba 1st 35 Providence Modaraba 1st 35 Tri-Star Modaraba 1st 36 Prudential Modaraba 1st 36 Tri-Star Modaraba 2nd 37 Prudential Modaraba 2nd 37 Trust Modaraba 38 Prudential Modaraba 3rd 38 UDL Modaraba 1st 39 Punjab Modaraba 1st 39 Unicap Modaraba 40 Schon Modaraba 40 Unity Modaraba 41 Tri-Star Modaraba 1st 42 Tri-Star Modaraba 2nd 43 Trust Modaraba 44 UDL Modaraba 1st 45 Unicap Modaraba 46 Unity Modaraba

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

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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

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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

thru stock exchange 782.0 Nov-02 Stock Exchange

16 Attock Refinery Limited shares (CDC) 614.0 Jan-03 Stock Exchange 17 DG Khan Cement shares (CDC) 41.0 Dec-02 Stock Exchange

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

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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

32 Al-Ghazi Tractors Ltd. 105.6 Nov-91 Al-Futain Industries (Pvt) Ltd. UAE

33 National Motors Ltd. 150.4 Jan-92 Biboo Jee Services 34 Millat Tractors Ltd. 306.0 Jan-92 EMG 35 Baluchistan Wheels Ltd. 276.4 May-92 Abdul Qadir & Saleem I.

Kapoorwala

36 Pak Suzuki Co. Ltd. 172.0 Sep-92 Suzuki Motors Co. Japan 37 Naya Daur Motors Ltd. 22.3 Jan-93 Farid Tawakkal & Saleem I.

Kapoorwala

38 Bolan Castings 69.2 Jun-93 EMG Total 1,101.9 Cement

39 Maple Leaf Cement 485.7 Jan-92 Nishat Mills Ltd. 40 Pak Cement 188.9 Jan-92 Mian Jehingir Ellahi & Ass

41 White Cement 137.5 Jan-92 Mian Jehingir Ellahi & Associates

42 D.G Khan Cement 1,972.8 May-92 Tariq Sehgal & Associates 43 Dandot Cement 636.7 May-92 EMG 44 Garibwal Cement 836.3 Sep-92 Haji Saifullah & Group 45 Zeal Pak Cement 239.9 Oct-92 Sardar M. Ashraf D. Baluch

46 Kohat Cement 527.9 Oct-92 Palace Enterprises 47 Dandot Works - National Cement 110.0 Jan-95 EMG 48 General Refractories Limited 18.9 Feb-96 Shah Rukh Engineering 49 Wah Cement 2,635.5 Feb-96 EMG

Total 7,790.1 Chemical

50 National Fibres Ltd 756.6 Feb-92 Schon Group 51 Kurram Chemicals 33.8 Feb-92 Upjohn Company USA 52 Pak PVC Ltd 63.6 Jun-92 Riaz Shaffi Reysheem 53 Sind Alkalis Ltd 152.3 Oct-92 EMG 54 Antibiotics (Pvt) Ltd 24.0 Oct-92 Tesco (Pvt) Ltd. 55 Swat Elutriation 16.7 Dec-94 Sahib Sultan Enterprises 56 Nowshera PVC Co. Limited 20.7 Feb-95 Al_syed Enterprises 57 Swat Ceramics (Pvt) Limited 38.6 May-95 Empeiral Group 58 Ittehad Chemicals 399.5 Jul-95 Chemi Group 59 Pak Hye Oils 53.6 Jul-95 Tariq Siddique Associates 60 Ravi Engineering Limited 6.5 Jan-96 Petrosin Products Pte 61 Nowshera Chemicals 21.2 Apr-96 Mehboob Ali Manjee 62 National Petrocarbon 20.8 Jul-96 Happy Trading 63 National Petrocarbon (add’l 10% shares) 2.3 Mar-02 Happy Trading

1,610.2

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1.2 continued

Engineering

64 Karachi Pipe Mills 18.9 Jan-92 Jamal Pipe Industries 65 Pioneer Steel 4.4 Feb-92 M. Usman 66 Metropolitan Steel Mills Limited 66.7 May-92 Sardar M. Ashraf D. Baluch

67 Pakistan Switchgear 8.9 Jun-92 EMG 68 Quality Steel 13.2 Apr-93 Marketing Enterprises 69 Textile Machinery Co 27.9 Oct-95 Mehran Industries 70 Indus Steel Pipe 47.4 Oct-96 Hussien Industries

187.4 Fertilizer

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

96 Sheikhupura 28.0 May-92 Contrast Pvt Ld. 97 Faizabad 21.2 May-92 Packages Ltd. 98 Siranwali 16.2 Jul-92 Enkay Enterprises 1.2

Continued

99 Hafizabad 20.0 Sep-92 Pak Pearl Rice Mills 100 Eminabad 24.1 Nov-92 Pak Arab Food Industries

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222

101 Dhaunkel 79.2 Jun-93 Dhonda Pakistan Pvt Ltd. 102 Mabarikpur 14.3 Nov-93 Maktex Pvt) Ltd. 103 Shikarpur 32.5 Mar-96 Afzaal Ahmad

235.5 Roti Plants

104 Gulberg, Lahore 8.7 Jan-92 Packages Ltd. 105 Peshawar 2.6 Jan-92 Saleem Group of Ind 106 Head Office, Lahore 10.2 Jan-92 Hajra Textile Mills 107 Hyderabad 2.6 Jan-92 Utility Stores Corp. 108 Faisalabad 11.5 Jan-92 Azad Ahmad 109 Bahawalpur 1.6 Feb-92 Utility Stores Corp. 110 Multan 2.5 Feb-92 Utility Stores Corp. 111 Quetta 4.8 Feb-92 Utility Stores Corp. 112 Islamabad 3.6 Mar-92 Utility Stores Corp. 113 Taimuria, Karachi 9.2 Jun-92 Spot Light Printers 114 SITE, Karachi 5.1 Sep-92 Specialty Printers 115 Multan Road, Lahore 3.5 Dec-92 Utility Stores Corp. 116 Korangi, Karachi 4.1 Apr-93 Utility Stores Corp. 117 Mughalpura, Lahore - Jun-96 Pakistan Railways 118 Gulshan-e-Iqbal, Karachi 20.2 Mar-98 Ambreen Industries

90.2 Textile

119 Quaidabad Woollen Mills 85.5 Jan-93 Jehingir Awan Associates 120 Cotton Ginning Factory 1.2 Jun-95 Hamid Mirza

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

147.4 Newspapers

125 N.P.T Building 185.0 Oct-93 Army Welfare Trust 126 Mashriq – Peshawar 26.6 Jun-95 Syed Tajmir Shah 127 Mashriq – Quetta 6.2 Jan-96 EMG 128 Progressive Papers Ltd. 46.1 May-96 Mian Saifu-ur-Rahman 129 Mashriq – Karachi 6.5 Aug-96 EMG

270.4 Tourism

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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223

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

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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

X2 817.96+806.56+1056.25+1317.69+2043.04 = 6041.5

S2 = (6041.5 – 5×34.22 ) /4 = 48.325 V(X) = 48.325/5 = 9.665 Variances

S = 6.95 SD

1997 - 2001

MCB After Privatization

Inputs: Total Assets: X 0.150+ 0.150+ 0.159+ 0.332+ 0.187 = 0.978 X = 0.1956 Mean

X2 0.1502+ 0.1502+ 0.1592+ 0.3322+ 0.1872 = 0.215474

S2 = (0.215474 – 5×0.19562 ) /4 = 0.0060443; V(X) = 0.0060443/5 Variances = 0.00120886

S = 0.077745096 SD

Efficiency = 9.665/0.00120886 = 7995.14 = before/after > 1 => MCB relative performance better after priva than before or efficiency

1987 - 1990 ABL Before Privatization

Inputs: Total Assets: X 14.3+16.2+19.1+23.3 = 72.9 X = 72.9/4 = 18.225 Mean

X2 = 14.32+16.22+19.12+23.32 = 1374.63 S2 = (1374.63 – 4×18.2252 ) /3 = 15.3425 V(X) = 15.3425/4

= 3.84 Variances S = 3.92 SD

1996 - 1999

ABL After Privatization

Inputs: Total Assets: X 0.634+0.724+0.894+0.104 = 2.356 X = 2.356/4 = 0.589 Mean

X2 0.6342+0.7242+0.8942+0.1042 = 1.736184

S2 = (1.736184 – 4×0.5892 ) /3 = 0.1162 V(X) = 0.1162/4 = 0.03 Variances

S = 0.34 SD

Efficiency = 3.84/0.03= 128 = before/after > 1 => ABL relative performance after privatization better than before or efficiency

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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

balance 151821487 129802811 167621998 38482648 66724843

Balance brought farward 93020 273007 434318 94066 614464

151914507 130075818 168056316 38576714 67339307

Transfer to reserve 143000000 121000000 155000000 25000000 67000000

proposed dividend 8641500 8641500 12962250 12962250 nil

Profit for the year 237007 434318 94066 614464 339307

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3.2 continued Muslim Commercial bank Limited

Profit and Loss Account for after Privatization

1997 1998 1999 2000 2001

Mark up revenue 16,939,966 17,755,988 15,755,990 14,124,265 17,034,263

Mark up expense 10,267,190 11,099,850 9,420,968 7,238,680 7,544,897

Net Mark up 6,672,776 6,076,138 6,335,022 6,885,585 9,489,366

provision for diminution of investment 589,476 28,500 257,144 46,048 62,064

provision for non performing loans 806,252 144,000 601,799 1,704,944

Bad debts directly written off 153,804 120,130 39,424 483,943 448,999

Total Provision and write off 1,549,532 292,630 296,568 1,131,790 2,216,007

net Mark up after provision 5,122,088 5,808,124 6,038,454 5,753,772 7,272,321

fee commission and brokerage income 944,944 922,044 901,444 909,045 868,637

Dividend Income 31,259 24,290 40,245 158,909 243,994

Income from dealing in foreign currency 888,769 871,341 633,137 609,838 687,854

Other Income 736,188 646,263 701,459 1,085,614 400,140

Total Income 7,723,248 8,517,178 8,314,739 8,272,062 7,723,248

Administration Expenses 5933700 6004561 7038834 7130724 7331623

Other provisions 243744 9750 60570 30000 40000

Other Charges 311016 1310748 4796 36725 147

Profit Before Taxation 1234788 947003 1210539 1321795 2101176

taxation current 957720 650992 852186 1083048 655164

taxation prior years 44457 -1209758 -213126

taxation deffered 296385 674533 -210597 149200 35280

Net profit 238782 399180 568950 734729 1108176

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Appendix 3.2 (cont) Profit and Loss Account of ABL before privatization

1986 1987 1988 1989 1990

Total Interest Revenue 899898667 1020801001 1097194673 1.297E+09 1655157873

Interest Expense 564044272 630851921 685760943 880659595 1103412084

Net Interest Revenue 335854395 389949080 411433730 416386869 551745789

Other Income 20302837 25019267 39463680 29232428 72855506

Commission & Fees 87502786 123822301 163577339 249592030 315015340

Trading Securities 1127749 2526375 4728213 1706707 732799

Gain (Loss) on Foreign Exchange

Other Income 10315 68780 69790 69240 71678

Total Income 444798082 541385803 619272752 696987274 940421112

Administrative Expense 282662261 340302646 387823052 435498471 594191960

Other Charges 97131978 118024713 148277433 174482092 244054253

Provision against non-performing

Loans

Total Expense 379794239 458327359 536100485 609980563 838246213

Income before tax 65003843 83058444 83172267 87006711 102174899

Taxation 27500000 36900000 33100000 33900000 41000000

Net Income 37503843 46158444 50072267 53106711 61174899

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Appendix 3.2 Continued P/L Accounts for ABL After privatization (Rs.000)

1996 1997 1998 1999 Total Interest Revenue 4,692,220 5,026,784 6,059,060 7,287,432

Interest Expense 3,802,172 4,639,053 5,289,971 6,953,006

Net Interest Revenue 890,048 387,731 769,089 334,426

Other Income 405,746 361,322 426,229 358,997

Commission & Fees 1,185,396 1,130,242 1,033,310 1,172,024

Trading Securities 491,449 564,453 755,170 971,956

Gain (Loss) on Foreign Exchange - - - -

Other Income 795,933 1,313,718 710,238 1,081,457

Total Income 3,768,572 3,757,466 3,694,036 3,918,860

Administrative Expense 3,019,703 2,960,699 3,396,440 3,772,889

Other Charges - 32,001 128,004 128,004

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

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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

Advances 13110617022 13096086856 15548316766 18987094540 21000380355

Total Intermediate assets 22947893781 22647674290 26539755267 29674635388 34047665132

Other Assets PremisesLess depreciation 55312919 59417220 57450541 80890561 91853293Furniture and Fixture less depreciation 101160251 94206545 88275453 93511494 97991533

Other Assets including Silver 1358472917 1384889117 1767546896 2139815304 2789395113 1514946087 1538512882 1913272890 2314217359 Total Assets 28639448962 28372861417 32498907390 36293868893 45201306582

Liabilities and Equities Bills Payable 533829981 563123045 687304838 744181555 1026787023Borrowings from other banks,Agents &cos. 2493654554 2616457444 2836566755 4049496898 4294052888Other Liabilities 1775054031 1927313471 2128948269 2262969083 3237875029

Deposits and Other Accounts 22591537389 21899433139 25324893462 27690506893 35029152335

Total liabilities

Shareholders Equity 27394075955 27006327099 30977713324 34747154429 43587867275

Issed,subscribed and paid up capital 576100000 576100000 576100000 576100000 576100000Reserve funds and other Reserves 669000000 790000000 945000000 970000000 1037000000Profit brought forward 273007 434318 94066 614464 339307

Total Owner Equity 1245373007 1366534318 1521194066 1546714464 1613439307

Total Owner Equity and Liabilities 28639448962 28372861417 32498907390 36293868893 45201306582

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230

Appendix 3.2 continued MCB balance Sheets for after privatization

1997 1998 1999 2000 2001

Assets

Cash 12801142 13559218 17669913 12571424 21259900

Balance with other banks 548,219 788,081 3603458 4,757,413 3,025,689

Money at Call and short Notice 864,470 467,655 9398536

Total Current assets 14,213,831 14,814,954 30,671,907 17,328,837 24,285,589lending to Financial Institutions 10,852,094 15,470,519

Investment -net 58,094,728 57,980,746 45609297 43,110,947 55,432,235

Advances -net 64,365,285 62,920,478 67432574 86,359,139 76,585,999

Total Intermediate term Assets 122,460,013 120,901,224 113,041,871 140,322,180 147,488,753Capital work in Progress 51,677 20,467 50828

Operating Fixed Assets 3,529,980 3,559,751 3479458 3,604,356 3,659,646

Other Assets 9,839,637 10,428,361 11340754 13,203,910 11,400,906

Deffered Tax Assets 255,780 220,500

Total Assets 150,095,138 149,725,757 158584818 332,366,080 187,055,394Liabilities and Equities

Bills Payable 7,989,205 4,611,819 5292910 7,803,443 8,097,178Borrowing from Financial Institutions 9,789,998 7,562,164 8780541 16,890,675 8,946,624

Deposits and other Accounts 124,391,460 123,821,807 130336164 135,990,147 154,544,451

Other Liabilities 8,895,267 9072090 8,438,055 8,580,119

Total liabilities 145,308,743 144,891,057 153481705 169,122,320 180,168,372Share holders equity

share Capital 1,820,541 1,820,541 1820541 2,202,855 2,423,140

Reserves 1,716,773 1,796,609 2092453 2,277,630 2,278,980

Unappropriate profit 387 1,136 1161 3,185 283,940

3,537,701 3,618,286 3914155 4,483,670 4,986,060Surplus on revaluation of Assets 1248694 1,216,416 1188958 1,109,073 1,900,962

4786395 4,834,700 5,103,113 5,592,743 6,887,022 150,095,138 149,725,757 158584818 174,715,063 187,055,394

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Appendix 3.2 continued Balance sheets for ABL before Privatizations

Assets 1986 1987 1988 1989 1990 Cash on hand 876138336 989431736 1220635306 1535541904 1788480216

Balance with other banks 909345059 1067620126 912403861 1694064913 1073291193

Money at call and short notice 11400525 67268386 50000000 nil 400000000

Total Current Assets 1796883920 2124320248 2183039167 3229606817 3261771409Investment at cost 3101518341 5191386024 7237633698 6424756884 7268407105

Advances 5616120702 6054814297 5490507467 8087814754 11115241689

Premises 18477295 22431630 26387790 25224955 25653330

Furniture and Fixture 52344244 61598638 69652125 81576358 104992195

Other Assets 862905791 860267475 1203617884 1298241778 1542675683

Total fixed Assets 9651366373 12190498064 14027798964 15917614729 20056970002

Total Assets 11448250293 14314818312 16210838131 19147221546 23318741411

Liabilities

Deposit and other accounts 10058018097 12337440831 14571231598 16637511090 19824866983

Borrowing from other banks 254785209 373896644 422354421 694742342 1218670343

Bills payable 153967210 344105532 262506866 361060586 588109953

Other Liabilities 769329231 898006315 576403989 1056359560 1269371265

Total Liabilities 11236099747 13953449322 15832496874 18749673578 22901018544Capital

Issued and subscribed capitals 132267725 272227725 272227725 272227725 272227725

Reserve fund and other reserve 77800000 87100000 104100000 123300000 143500000

Reserve for issue of bonus share 1992150 1992150 1992150 1992150 1992150

Profit 90671 49115 21382 28093 2992

Total Capital 212150546 361368990 378341257 397547968 417722867

Total Liabilities and capital 11448250293 14314818312 16210838131 19147221546 23318741411

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Appendix 3.2 continued Balance sheets for ABL After privatization

1996 1997 1998 1999

ASSETS (Rs, 000) (Rs, 000) (Rs, 000) (Rs, 000)

Cash in hand and with State Bank and NBP 7,195,269 6,316,337 7,646,937 8,601,193

Balance with other banks 1,627,627 1,380,840 1,878,796 1,757,510

Money at call and short notice - 450,000 100,000 300,000

Total Investments 15,552,713 20,192,699 25,605,470 26,774,766

Total Loans and Advances (net of provisioning) 32,766,263 36,231,357 42,719,179 55,263,762

Fixed Asset 901,904 872,730 2,488,619 3,062,045

Other Assets 5,395,334 6,959,687 8,919,166 11,167,055

63,439,110 72,403,650 89,358,167 106,926,331

LIABILITIES & OWNER'S EQUITY

Total Deposits 55,896,800 63,429,709 76,541,153 93,107,291

Borrowings 4,015,193 4,914,558 6,243,517 7,144,163

Bills Payable 548,575 802,367 1,084,151 1,073,491

Other Liabilities 1,589,147 1,741,598 2,487,440 2,588,936

total liabilities 62,049,715 70,888,232 86,356,261 103,913,881

Paid up capital 950,797 1,063,156 1,063,156 1,063,156

Reserves 438,598 452,262 1,938,750 1,949,294

total owner's equity 1,389,395 1,515,418 3,001,906 3,012,450

63,439,110 72,403,650 89,358,167 106,926,331

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3.2 continued Financial Statement of UBL

UNITED BANK LIMITED RS. In, 000

1998 1999 2000 2001 2002

Earning Assets Rs. 85979751 Rs. 105247148 Rs. 117287577 Rs. 114367602 Rs. 113187063 Rs. 147130367

Total Assets Rs.101491125 Rs. 139991644 Rs. 154716101 Rs. 160572595 Rs. 160852206 Rs. 183003466

Net Income Rs. 2690949 Rs. 507058 Rs. 667092 Rs. (7477876) Rs. 1414306

Interest Margin Rs. 1710380 Rs. 2765878 Rs. 4759680 Rs. 5060183 Rs. 5778566

EBT Rs. (6600551) Rs. 1253058 Rs.1645497 Rs. (5741086) Rs. 2731308

Provision Rs. 3996700 Rs. (840317) Rs. 1526964 Rs. 1488083 Rs. 851958

Net Charge Off Rs. 786408 Rs. 352985 Rs. 555541 Rs. 511950 Rs. 865498

Average Equity Rs. (18531434) Rs. 5531202 Rs. 5866362 Rs. 6726604 Rs. 887222 Rs. 8626252 Average Deposit Rs. 106710654 Rs. 117718301 Rs. 127133204 Rs. 129679245 Rs. 134961054 Rs. 154914619

Total Loans Rs. 54222928 Rs. 48468324 Rs. 61238410 Rs. 74156421 Rs. 78492649 Rs. 74117401

Source: Annual Reports of UBL for 1997 to 2002.

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Appendix 3.3 Transaction Cost of MCB

A: MCB before privatization b Staff Cost % Transaction Cost of Allied Bank Of Pakistan

operating cost as % of Total Income/ per unit of a: ABL before privatization b: Staff Cost %

years Total Income/Revenue Revenue for Rs. 1 years t/income/Revenue operating cost as % of Total Income/ per unit of

1987 92 1 1987 24.29 years

Total Income/Revenue Revenue for Rs. 1 years t/income/Revenue

1988 91 1 1988 26 198

6 96 1 1986 28

1989 91 1 1989 26.2 198

7 96 1 1987 29

1990 95 1 1990 30.24 198

8 97 1 1988 29.72

1991 95 1 1991 26.71 198

9 97 1 1989 27.6

After privatization After privatization 199

0 96 1 1990 29.07

1997 95 1 1997 22.49 After privatization

1998 95 1 1998 22.32 199

7 99.65 1997 24.02

1999 93 1 1999 27.3 199

8 98 1998 26.14

2000 92 1 2000 27.07 199

9 99.35 1999 23.25

2001 89 1 2001 24.22 200

0 N.A 2000 N.A

MCB before privatization

2001 N.A 2001 N.A

C Staff Cost per employee No. Of Employees d Staff cost P/U of ABL before privatization

years In Rupees Per Annum Operating cost % c: Staff Cost per employee No. of employees

1987 49627 12845 1987 26.51 years In Rupees Per Annum

1988 52556 12685 1988 28.52 198

6

1989 57791 12890 1989 28.5 198

7 Data is not available in the reports

1990 76511 12904 1990 31.79 198

8

1991 80423 13031 1991 28.24 198

9

After privatization After privatization 199

0

1997 262810 13610 1997 23.47 After privatization

1998 342355 12858 1998 26.33 199

7

1999 386539 12557 1999 28.85 199

8

2000 421850 12133 2000 32.38 199

9 Dta is not available in the reports.

2001 445976 11614 2001 30.23 200

0 Source: Calculated from annual reports for the said periods.

2001

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Appendix 3.3 Particulars of provision against Non performing Advances for after privatization of MCB

(Pakistani Rupees '000)

1997 1998 1999 2000 2001

Provision Specific General Total Total Specfic General Total Specific General Total Specific General Total

Opening Balance 4306550 4E+06 4306550 3412679 566000 3978679 3497386 566000 4063386 4054778 566000 4620778

Exchange adjustment 3482 4944 3482 90452 90452 99593 99593 -14564 -14564

Change for the Year 144000 806252 144000 1024305 1024305 1704944 1704944

Amount written off -331134 -691648 -331134 -5643 -5643 -144000 -144000 -58304 -58304

Reversal -144219 -1656 -144219 -102 -102 -422506 -422506

Intertransfer -566000 566000 503702 -503702

Closing Balance 3412679 566000 4E+06 3978679 3497386 566000 4063386 4054778 566000 4620778 6190556 62298 6252854

Provision against

Advances to bank

Advances to others 4E+06 3978679 4063386

provision for advances/loans as a percentage of total loans/advances. (Rupees,000)

1997 1998 1999 2000 2001

provison T/Advances % provison T/Advances % provison T/Advances % provison T/Advances % provison T/Advances %

4306550 6.9E+07 6.27 4E+06 6.7E+07 5.95 4E+06 7.1E+07 5.68 5E+06 9.1E+07 5.08 6252854 8.3E+07 7.55

Percentage of written off against T/advances

1997 1998 1999 2000 2001

0.48 1.03 0.008 0.16 0.07

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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.

1997 1998 1999 Provision T/Advances % Provision T/Advances % Provision T/Advances % 3417099 39648456 8.62 3070768 45789947 6.72 2954519 58218281 5.07 Percentage of write off against T/advances 1997 1998 1999 0.15 0.23 0.05

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Appendix 3.4

Interest Risk Measurement

Before Privatization MCB

1987 1988 1989 1990 1991

Interest and discount or return 2247813441 2176215890 2269720109 2638307048 3192089572

Interest on deposits borrowing etc. 1452592066 1323036347 1496323415 1709808151 2114270463

Difference 795221375 853179543 773396694 928498897 1077819109

% of net interest income to T/Revenue. 35.3775523 39.204729 34.0745403 35.192981 33.7653153

After privatization

Pakistani Rupees in Millions

1997 1998 1999 2000 2001

Interest and discount or return 16938510 17197805 15755990 14124242 17033225

Interest on deposits borrowing etc. 10168048 11065063 9351947 7238680 7544897

Difference 6770462 6132742 6404043 6885562 9488328

% of net interest income to T/Revenue. 39.9708239 35.6600275 40.6451324 48.7499577 55.704824

ABL Before Privatization (In Pakistani Rupees)

1986 1987 1988 1989 1990

Interest and discount or return 899898667 1020801008 1097194637 1297046464 1655157873

Interest on deposits borrowing etc. 564044272 630851921 685760943 880659595 1103412084

Difference 335854395 389949087 411433694 416386869 551745789

% of net interest income to T/Revenue. 37.3213571 38.2003039 37.4986971 32.1026949 33.3349343

After Privatization(Pakistani Rupees in'000)

1997 1998 1999 2000 2001

Interest and discount or return 5026787 6059060 7287432Data not available

Interest on deposits borrowing etc. 4639053 5289971 6953006

Difference 387734 769089 334426

% of net interest income to T/Revenue. 7.71335646 12.6932065 4.58907884

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Appendix 3.4 continued Capital Risk of MCB Before Privatization

1987 1988 1989 1990 1991

Advances 13110617022 13096086856 15548316766 2757663780 3733992169

Capital* 12739027561 3982991762 4357760821 5596211362 5907492195

% 0f total capital to T/Loans 97.16573629 30.41360221 28.02721919 202.9330552 158.2084784

Capital Risk of MCB After Privatization (Rs.In, OOO) 1997 1998 1999 2000 2001

Advances 64365285 62920478 67432576 86359139 76585999

Capital* 14576393 12396864 12693535 22483418 15833646

% 0f total capital to T/Loans 22.6463582 19.70243138 18.82403988 26.03478712 20.674335

ABL Befor privatization (in Rupees)

1986 1987 1988 1989 1990

Advances 5616120702 6054814297 5490507467 8087814754 11115241689

Capital* 464943602 733273484 798703528 1092290310 1636393210

% 0f total capital to T/Loans 8.278732361 12.11058586 14.5469892 13.5053824 14.72206593

ABL after privatization (000)

199 1998 1999

Advances 36231357 42719179 55263762

Capital* 6429976 9245423 10156613

% 0f total capital to T/Loans 17.74699192 21.6423237 18.37843215

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239

Appendix 3.5 Capital adequacy ratios

MCB before Privatization 1987 1988 1989 1990 1991

Assets 36720602828 37235514464 39572596150 43590210123 55819696091

Shareholders contribution to T/Assets 12739027561 3982991762 4357760821 5596211362 5907492195

% of Shareholders to T/Assets 2.882527936 9.348629545 9.080947251 7.789235842 9.448966541

After Privatization (000)

1997 1998 1999 2000 2001

Assets 150095138 149725757 158584818 174715063 187055394

Shareholders contribution to T/Assets 14576393 12396864 12693535 22483418 15833646

% of Shareholders Contribution to T/Assets 10.29713853 12.07771231 12.49335335 7.770840848 11.81379159

AbL Brfore Privatization ( In rupees)

1986 1987 1988 1989 1990

Assets 13725521165 17495291259 21409793271 27372345626 34203739405

Shareholders contribution to T/Assets 464943602 733273484 798703528 1092290310 1636393210

% of Shareholders Contribution to T/Assets 29.52083028 23.85916256 26.80568261 25.05958844 20.90190744

After Privatazation(000)

1997 1998 1999 2000 2001

Assets 1569897 1937514 2063418

Shareholders contribution to T/Assets 6429976 9245423 10156613 data not avaialable.

% of Shareholders Contribution to T/Assets 0.244152855 0.209564668 0.20316005

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240

3.5 Continued

Source State bank Report for 2002

Capital Adequacy Ratios 2000 2001 2002Capital to Risk weighted assets Public sector comm.banks 10.4 9.6 12.3Domestic private banks 9.2 9.5 9.7Foreign banks 18 18.6 23.2specialized banks -3.3 -13.9 -31.7All Banks 9.7 8.8 8.8

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241

Appendix 3.5 Liquidity

Management

MCB befor

Privatization a: cash as ratio of demand deposit years 1987 1988 1989 1990 1991Cash* 2911594683 4176609094 2835323850 4031226481 6457761511Demand deposit 4428245822 4848430143 5745813777 6355700033 8896130809% of cash for demand deposit 65.75052064 86.14353452 49.34590573 63.42694684 72.5906762

After privatization

years 1997 1998 1999 2000 2001Cash 13349361 14347299 21273371 17328837 24285589Demand deposit 45613941 28791970 27293325 28858208 33859944% of cash for demand deposit 29.26596717 49.83090424 77.94349351 60.04820881 71.7236538

b:Liquid funds/total deposits Before privatization

years 1987 1988 1989 1990 1991Liquide Funds** 16220808034 16260343846 18475132958 19768408888 2.7355E+10Total Deposit 22591537389 21899433139 25324893462 27690506893 3.5029E+10% of total deposit to liquid funds 71.80037266 74.25006731 72.95246073 71.39056343 78.0932613

After privatization

years 1997 1998 1999 2000 2001

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242

Liquide Funds 177059310 176911444 165091754 142583756 190376686

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

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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

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244

Appendix 3.6 Earning and profitability

a:Return on assets Earning and Profitability for MCB before privatization

a: income/assets

MCB before privatization

Years 1987 1988 1989 1990 1991Income(before tax) 199358535 227012385 249621998 158860942 212724843

T.Assets 35205656741 35697001582 39572596150 43590210123 55819696091

% of income to assets 0.566268473 0.635942446 0.630795101 0.36444179 0.3810928

After privatization (Rs.000)

Years 1997 1998 1999 2000 2001Income(before tax) 1234788 947003 1210539 1321795 2101176

T.Assets 150095138 149725757 158584818 174715063 187055394

% of income to assets 0.822670219 0.632491709 0.763338518 0.756543241 1.123290783

b:return on equity

MCB before privatization

Years 1987 1988 1989 1990 1991Income (before tax) 199358535 227012385 249621998 158860942 212724843

Capital* 12739027561 3982991762 4357760821 5596211362 5907492195

% of income to capital 1.564943117 5.699544427 5.728217042 2.838723053 3.60093312

After privatization (Rs.000)

Years 1997 1998 1999 2000 2001Income (before tax) 1234788 947003 1210539 1321795 2101176

Capital* 14576393 12396864 12693535 22483418 15833646

% Of income to capital 8.471149207 7.639052909 9.536657834 5.87897712 13.27032321

a: income/assets ABL before privatization

Years 1986 1987 1988 1989 1990

Income (before tax) 37503843 46158444 50072267 53106711 61174899

Assets 13725521165 17495291259 21409793271 27372345626 34203739405

ROA 0.273241668 0.263833527 0.233875528 0.19401593 0.178854418

ABL after privatization

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245

Years 1997 1998 1999 2000 2001Income (before tax) 28766 169592 71098

Continued 3.6

Assets 1569897 1937514 2063418

ROA 1.832349511 8.753072236 3.445642134

b:Return on equity ABL before privatization

years 1986 1987 1988 1989 1990

income(before tax) 37503843 46158444 50072267 53106711 61174899

Capital* 464943602 733273484 798703528 1092290310 1636393210

ROE 8.066320913 6.294847012 6.269193167 4.861959363 3.738398487

After privatization

years 1997 1998 1999 2000 2001income(before tax) 28766 169592 71098

Capital* 6429976 9245423 10156613

ROE 0.447373365 1.834334676 0.700016826

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Appendix 4.1 Inflows of foreign investment in Pakistan

Source. Economic survey of Pakistan 2002-2003.

In million US $ As % of Total

years FDI Portfolio Total FDI Portfolio Total 1984-85 70.30 23.40 93.70 75.0 25.0 100.01985-86 145.20 16.00 161.20 90.1 9.9 100.01986-87 108.00 21.00 129.00 83.7 16.3 100.01987-88 162.00 10.50 172.50 93.9 6.1 100.01988-89 210.20 7.20 217.40 96.7 3.3 100.01989-90 216.20 -4.70 211.50 102.2 -2.2 100.01990-91 246.00 -9.00 237.00 103.8 -3.8 100.01991-92 335.10 218.50 553.60 60.5 39.5 100.01992-93 306.40 136.80 443.20 69.1 30.9 100.01993-94 354.10 288.60 642.70 55.1 44.9 100.01994-95 442.40 1089.90 1532.30 28.9 71.1 100.01995-96 1101.70 205.20 1306.90 84.3 15.7 100.01996-97 682.10 267.40 949.50 71.8 28.2 100.01997-98 601.30 221.30 822.60 73.1 26.9 100.01998-99 472.30 27.30 499.60 94.5 5.5 100.01999-2000 423.70 54.6 478.30 88.6 11.4 100.0

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247

Appendix No 4.2

r = ∑∑∑∑

∑ ∑ ∑−− )/)(()/)((

n / y)( x)( -xy 2222 nyynxx

β =∑∑

∑ ∑ ∑==

===

− 21

21

n1i1i1i

)(YX - XY

XXnn

ni

ni

nn

γ2=1-

nY

Y

en

ini

n

ii

i

n

i

∑∑

∑=

−=

=22

1

1

2

)1(

Years X Y X2 y2 XY

No. Of Deposits Investment

1982 18251389 32261.8 3.33113E+14 1040823739 5.88823E+11

1983 19565836 45033.5 3.82822E+14 2028016122 8.81118E+11

1984 20488157 38572.3 4.19765E+14 1487822327 7.90275E+11

1985 21215465 49056.1 4.50096E+14 2406500947 1.04075E+12

1986 21720814 60230.4 4.71794E+14 3627701084 1.30825E+12

1987 22578568 87273.6 5.09792E+14 7616681257 1.97051E+12

1988 23947814 85882.1 5.73498E+14 7375735100 2.05669E+12

1989 25140528 85303.9 6.32046E+14 7276755355 2.14459E+12

1990 26756571 81226.1 7.15914E+14 6597679321 2.17333E+12

1991 30993837 120021 9.60618E+14 14405040441 3.71991E+12

1992 27106754 192185.5 7.34776E+14 36935266410 5.20953E+12

1993 27973622 208043.1 7.82524E+14 43281931458 5.81972E+12

1994 29520563 267805.2 8.71464E+14 71719625147 7.90576E+12

1995 31085736 268794.3 9.66323E+14 72250375712 8.35567E+12

1996 31723719 322875.8 1.00639E+15 1.04249E+11 1.02428E+13

1997 32271603 375286.2 1.04146E+15 1.4084E+11 1.21111E+13

1998 29772355 420830.2 8.86393E+14 1.77098E+11 1.25291E+13

1999 29710720 350326.2 8.82727E+14 1.22728E+11 1.04084E+13

2000 28409347 338796.6 8.07091E+14 1.14783E+11 9.62499E+12

2001 28043818 303782.4 7.86456E+14 92283746550 8.51922E+12

Total 526277216 3733586.3 1.42151E+16 1.03003E+12 1.07401E+14

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248

Appendix No 4.3

r =

∑∑∑∑∑ ∑ ∑

−− )/)(()/)((

n / y)( x)( -xy 2222 nyynxx

β =∑∑

∑ ∑ ∑==

===

− 21

21

n1i1i1i

)(YX - XY

XXnn

ni

ni

nn

γ2 =1-

nY

Y

en

ini

n

ii

i

n

i

∑∑

∑=

−=

=22

1

1

2

)1(

Years X (No of Deposits) Y (Investment) X2 Y2 XY 1982 18251389 32261.8

3.33113E+14 1040823739 5.88823E+111983 19565836 45033.5

3.82822E+14 2028016122 8.81118E+111984 20488157 38572.3

4.19765E+14 1487822327 7.90275E+111985 21215465 49056.1

4.50096E+14 2406500947 1.04075E+121986 21720814 60230.4

4.71794E+14 3627701084 1.30825E+121987 22578568 87273.6

5.09792E+14 7616681257 1.97051E+121988 23947814 85882.1

5.73498E+14 7375735100 2.05669E+121989 25140528 85303.9

6.32046E+14 7276755355 2.14459E+121990 26756571 81226.1

7.15914E+14 6597679321 2.17333E+121991 30993837 120021

9.60618E+14 14405040441 3.71991E+121992 27106754 192185.5

7.34776E+14 36935266410 5.20953E+121993 27973622 208043.1

7.82524E+14 43281931458 5.81972E+121994 29520563 267805.2

8.71464E+14 71719625147 7.90576E+121995 31085736 268794.3

9.66323E+14 72250375712 8.35567E+121996 31723719 322875.8

1.00639E+15 1.04249E+11 1.02428E+131997 32271603 375286.2

1.04146E+15 1.4084E+11 1.21111E+131998 29772355 420830.2

8.86393E+14 1.77098E+11 1.25291E+131999 29710720 350326.2

8.82727E+14 1.22728E+11 1.04084E+132000 28409347 338796.6

8.07091E+14 1.14783E+11 9.62499E+122001 28043818 303782.4

7.86456E+14 92283746550 8.51922E+12

Total 526277216 3733586.3 1.42151E+16 1.03003E+12 1.07401E+14