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Pakistani Banking Sector On The Post Privatization Performance

An effective financial system needs to have an efficient system of mobilizing the domestic savings channeling them to the productive businesses or activities. The purpose of channeling the saving is to reduce the risk by diversifying the depositor’s money and transport the money across the time without losing its value. Channeling the domestic savings to the productive business and activities not only help economy to exploit opportunities to do make profit, it also leads to the progress of the economy.

Financial system through out the world ranges from simple to complex, from weak to stable. Stable banking system is an important part of the stable financial system. As the cash flows act as a blood stream of corporations and firms, Financial Institutions (FIs) (such as (i) commercial banks (ii) credit unions (iii) stock brokerage firms (iv) asset management firms (v) insurance companies (vi) finance companies) are the main sources of cash flows to corporation and firms. Major component of FIs are banks. Hence, the stability of the whole economy and FIs depends upon the effectiveness of the banking sector. If the banking sector performs ineffectively or inefficiently then the ability of the firm to acquire and generate necessary funds is affected. Performance breakdown of FIs or Banking system may lead to financial crises in the economy.

Since 1980, more than 130 countries have gone through banking sector distress which had in turn disrupted the economic development of the concerned economy. This bothersome situation led to the banking reforms by governments and other national and international FIs such as International Monetary Fund (IMF) and Word Bank (Barth, 2000). These reforms include removal of impediments to competition, privatization of public FIs and the introduction market-based securities. The aim behind these reforms was

According to Hardy & Patti (2001) aims of reforms include:

These reforms includes measures such as liberalization of interest rates, removal of quantitative control on lending, lifting barriers to competition, the privatization of public financial institutions and the introduction of market based securities. The principal aims of the reform have generally been to raise both the level of investment and efficiency of its allocation and in addition to enhance the provision of financial services to all sectors of the economy (p. 3).

In Pakistan in 1971 newly elected government decided the best way forward to economic growth and equitable wealth distribution can be achieved through nationalizing the industry, FIs, and educational institutions (Hussain, 2004). But unfortunately the desired results could not be achieved; consequently, the financial scenario was considerably changed in the 1970s (Hussain, 2004).

In Pakistan, the major reforms were initiated in banking sector privatization in 1990s, as a part of the larger economic reforms program set up by the government. The Privatization Commission (PC) was established in 1991, to provide an institutional as well as structural framework for the privatization process (Hussain, 2004).

In the study Hussain, 2004, shows that the following objectives were sought to be achieved through privatization (i) reduction in fiscal deficit ( ii) increase efficiency levels of public sector enterprises (iii) healthy competition in different sectors (iv) broad basing of equity capital (v) releasing resources for physical and social infrastructure

This study contributes to the literature by providing the evidence from Pakistani banking sector on the post privatization performance.

Literature Review

Through out history economists and researchers have debated the fact of level of government interference in the role of economy. Especially in the theory of economic privatization there is a debate of government ownership of productive resources (Meggison & Netter, 2001, p. 7). Governments usually adopt privatization programs primarily to raise revenue, and in order to improve the economic efficiency of former state-owned enterprises (SOEs) (Tanko, 2003). Privatization is defined as “transfer of ownership from public to private sector” (Naqvi & Kemal, 1991, p.105).

Interference factor comes in controlling the activities of an organization. Controlling or governing rights are executed from the corporate governance mechanism. “Corporate governance is concerned with the processes and structures through which members interested in the overall well being of the firm take measures to protect the interests of the stakeholders” (Ehikioya, 2009, p. 231). In corporate governance, the corporate control by owners is represented by the management hired by the stockholders, which separates the owners from management of the firm to reduce the agency cost. Continued employment of management is dependent on performance of the firm (Wu, 2007). However, because corporate control depends largely on the distinctiveness of the owners, public and private owners monitor the firm in different ways (Wu, 2007).

Theory of property rights suggests that state owned enterprises (SOEs) tends to be less efficient and less profitable than privately-owned enterprises (POEs). It is believed that to privatization of SOEs is done with the hope that private ownership would improve those firms' performance and the overall efficiency of the economy (Cuervo & Villalonga, 2000).

Kikeri, Nellis, & Shirley’s work (as cited in Torero, 2003) shows that in developing countries, where State-Owned Enterprises (SOEs) still account for more than 10 percent of gross domestic product, 20% of investment and about 5% of formal employment. Tatahi & Heshmati, (2009) found that there are certain benefits resulting from privatization. Because privatization reduces the role of unions, it permits firms to adopt a strict labor policy, which lowers the problems raised due to inefficient workers. This in turn leads to improvement of the company’s balance sheets i.e. a snapshot of firms’ financial performance.

In addition, govt. appointed managers i.e. public managers may act in favor of each other, causing agency problems and influence the strategic decision making process “such as wages level, capital investment strategies, debt financing and restructuring projects are assumed to be resolved by this internal relationship” (Tatahi & Heshmati, 2009, p.2-3). Privatization supposedly breaks up this relationship and introduces a more efficient process of decision-making.

Like many other developing countries Pakistan has pursued the policy of privatization. It is widely believed that to gain significant efficiency, the private sector should be fully spread across all sectors of the economy particularly in banking, education, transport, manufacturing, communication, health and energy. (Naqvi. H. & Kemal, 1991). Economic policy of privatization, generally defined as the deliberate sale of state-owned enterprises (SOEs) by the government or assets to private sector (Meggison & Netter, 2001). “Developing countries that are seeking to revitalize the SOEs, might do best to focus on privatizatizing in efficient investments” (Ramsawamay, 2001, p. 996).

The total value of proceeds gained from privatization process by the governments around the globe exceeded $1 trillion during the 1990s decade and it further added $180 billion in year 2000 (D’Souza, Megginson, & Nash, 2001).Privately owned firms achieve superior performance outcomes compared to state owned organizations (Ramsawamay, 2001). Ramaswamay, (2001) also found that SOEs does not perform as well as the privately owned counterparts.

The positive effect of privatization on the operating and financial performance of firms has been convincingly in a series of large-scale empirical studies (Gupta, 2005; D’Souza & Megginson, 1999; Meggison & Netter, 2001).

D'Souza, Meggison, & Nash, (2005) added the empirical evidence to the study of privatization i.e. privatization improves the performance of the firm. Private ownership by have positive impact on firm performance (Omran, 2009). Boubakri, Cosset, & Guedhami, (2004) study found the positive impact on of privatization on firm performance. In extant literature firm performance is measured through several determinants such as financial performance, operating efficiency, market performance, and stockholders payout.

Financial Performance


Mathur & Banchuenvijit, (2007) used ROA, ROS and ROE as the profitability measures and found that profitability increases with the privatization. D’Souza & Megginson, (1999) documented significant increases in the mean level of profitability. Corporate governance is the major source/driver of the improvement in profitability that generally follows the process of privatization. Profitability increases significantly after the firm privatization, which is also helpful to reduce the leverage of the firm (Gupta, 2005). Mathur & Banchuenvijit, (2007) found that ROS increased significantly after privatization.

“State-owned enterprises are often chronically unprofitable, at least in part because they are often charged with objectives such as maximizing employment and developing backward regions” Boycko, Shleifer, and Vishny (1993) (as cited in Megginson, Nash, & Randenborgh, 1994, p.424). Megginson, Nash, & Randenborgh, (1994) also found the significant increase in profitability of post-privatized firm. In privatization usually both control rights and cash flow rights are transferred to the new the managers who then show more interest in the profitability and efficiency as compared to SOEs management Boycko et al. (1996) (as cited in (Boubakri & Cosse, 1998). There is significantly positive impact on firms profitability after divestiture (Boubakri & Cosse, 1998).

Operating Efficiency

There is significant increase in efficiency of the firm measure by sales and net income efficiency and it supports the argument that POEs employ their human and financial resource more effectively and efficiently as compared to SOEs (Mathur & Banchuenvijit, 2007). The study of D'Souza et al., (2005) also confirms that sales per employee i.e. operating efficiency increases after privatization. Efficiency improvement is found to be highly significant (Boubakri et al., 1998). Both efficiency measures sales per employee and net income per employee showed significant increase following the privatization (Megginson et al., 1994). Results of D’Souza et al., (2001) are also consistent with other studies i.e. efficiency of the firm increases with privatization.

Market Performance

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