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Study Of Domestic And Foreign Banks In Pakistan Finance Essay

This research study is conducted to compare the performance of domestic and foreign banks in Pakistan in terms of profitability. We have analyzed and compared the profitability of domestic and foreign banks working in the Pakistani market from financial period of 2003 to 2008.

The objective is to analyze the difference in profitability between domestic and foreign banks and categorize the commercial banks, a total of twenty eight Pakistani commercial banks, includes 17 domestic banks and 11 foreign banks

The Independent sample T-test is used to examine the results. We apply the t-test to observe whether the profitability of domestic banks radically different from foreign banks or not. The end result shows that there is significant differentiation between the profitability of domestic and foreign banks, which shows that profitability of domestic banks is not better than the foreign banks.

Introduction

Banking sector is measured as one of the most significant source of financing for most businesses and assessment of profitability of domestic and foreign banks is certainly difficult and convoluted, that there is no standard to gauge bank performance. The general assumption, which sustain to measures profitability of the banking sector like measuring asset management, operating efficiency, net interest margin, return on equity and return on assets Out of these prosperity performances this study is to quantify only return on equity (ROE) of domestic and foreign banking sector.

(Mazhar M. Islam, 2003) we discussed the expansion and performance of domestic banks and foreign banks in Arab gulf countries, it demonstrate that local and foreign banks in these countries to have performed well more than the past more than a few years. In addition, he added that banks is in these economies are the well capitalized and the banking sector is well developed with strong competition among the banks. (Tarawneh, 2006)

To the extent that the profitability and the effectiveness of Greek banks are anxious, Noulas (1999)we examined the ROE and ROA ratios for profitabilty, the ratios of leverage and operating efficiency of 19 Greek banks for the period 1993–1998. According to the results, there are no significant differences in the return on equity and asset diachronically.

Hardy and Simigiannis (1998) examined the competitiveness and the effectiveness of the Greek banking system. They realized that during the 1990s few banks succeeded in attaining stable high levels of profitability. This was done especially through medium-sized banks that were not state- controlled and could keep high profitability. Moreover, banks perform full financial services through the creation of suitable companies. (Spathis, Kosmidoua and Doumposa, 2001)

The point of this study is to analyze the difference in profitability between domestic and foreign bank of Pakistani commercial banks for the financial periods 2003-2008. Furthermore it measures the profitability of domestic and foreign banks based on return on equity (ROE), consequently the objective of this study to assess the profitability of domestic and foreign banks in terms of return on equity. We apply the Independent Sample t-test to observe whether the profitability of domestic banks significantly better form the foreign banks or not.

Literature Review

Generally, the concept of efficiency can be regarded as the relationship between outputs of a system and the corresponding inputs used in their production. Within the financial efficiency literature, efficiency is treated as a relative measure which reflects the deviations from maximum attainable output for a given level of input (English M. and Warng, 1992).

Levine (2001) to examine the association between financial liberalization and banking efficiency, judgment that better presence of foreign banks improve the efficiency of the domestic banking system by declining banks’ above your head costs and profits.(Janek Uiboupin, 2004)

There are more than a few other possible reasons for the enhanced profitability of foreign banks when compared to their domestic counterparts. Firstly, foreign banks take pleasure in technical compensation over domestic banks in their multitude territories. They take pleasure in economies of scale from working in more than one country within a same time. When interest rates in their habitat countries then higher interest rates within their host countries, they basically reduce their lending activities in the multitude countries and increase their lending activities in their habitat countries and vice versa. (UHOMOIBHI, 2008)

Claessens, Demirguc-Kunt, and Huizinga (1998) we analyze the effects of foreign bank entrance in the domestic banking sector. They demonstrate that in developing countries foreign banks be inclined to have greater profits, advanced interest margins, and advanced tax payments related to domestic banks. And the differing is true in urbanized countries. Another attractive conclusion is that in cooperation profitability and overhead operating cost of domestic banks drop with foreign bank entry. In this study, we apply empirical technique to a dissimilar data set. (Bayraktar & Wang, 2004)

Goldberg & Kinney (2000) on the optimistic side, foreign banks be able to also increase competition in domestic markets that be able to improve the efficiency of domestic bank operations in the market, lesser the cost of given that financial services, decrease interest rates stimulating on loans, and enlarge the interest paid going on deposits, in this manner inspiring domestic saving and investment. Foreign banks be able to also encourage improvements in government guideline and supervision of the financial system by importing business practice imitation by more stringent home country policy.

On the unenthusiastic side, foreign banks add to the instability of domestic financial markets. foreign banks come into sight more constant than domestic institutions, they may pull towards you the best domestic borrowers (higher-profit and lower-risk borrowers) put domestic banks in the more doubtful position of lending to fewer credit-worthy borrowers as well foreign banks can introduce unknown business practices that domestic regulator may find difficult to estimate and supervise rather than civilizing the regulatory or supervisory procedure, foreign banks can generate complex troubles for the domestic government.(Jeon & M. Miller 2004)

The financial concert of banks and also other financial institution have been deliberate using a mixture of financial ratios analysis, benchmarking, to measure performance alongside budget or a mix of methodologies (Avkiran, 1995).

Hardy and simmigiannis (1998) we examined the aggressive and effectual of Greek banking system. They realize that throughout the 1990s few banks succeed in attaining steady high level profitability. This was finished especially during medium-sized bank that be not state- controlled and might be keep in high profitability. furthermore, banks perform complete financial services during the creation of appropriate companies.(Spathis, kosmidon & Doumposa, 2001)

Simply stated, much of the current bank performance literature describes the objective of financial organizations as that of earning acceptable returns and minimizing the risks taken to earn this return (Hempel G. Coleman, 1986). There is a generally accepted relationship between risk and return, that is, the higher the risk the higher the expected return. Therefore, traditional measures of bank performance have measured both risks and returns.

The financial statement of corporations in Oman that available commonly contain a multiplicity of financial ratios designed to give a suggestion of the corporation's recital (Tarawneh, 2006)

Peek and Rosengren (1999) the focal point on the evolution period of foreign bank subsidiaries in the US and attempt to discover explanation for their unfortunate performance. Their results point to that target banks of foreign acquirers show lower profitability former to the acquisition, throughout the transition period and within the long run after the revise of ownership (Jurzyk, 2006).

DeYoung and Nolle (1996) to the direct investigate the affiliation between assets growth and profitability of foreign banks in the US and terminate that foreign banks might have located growth in front of profitability. This study shows that foreign banks do not do well in developing a affiliation with retail customers and consequently have to rely on highly expensive purchase funds. These results are as well confirmed for Australian market (Williams, 1998a, 1998b, 2003). on the other hand, Molyneux and Seth (1998) discover that growth has a related impact on profits of foreign banks in US. (Havrylchyk & Jurzyk, 2006)

Most developing countries have been taking different plans and strategies to their financial sectors. The financial sector in Arab countries has started recently as a part of their overall economic plans and growth. However, there is an increasing attempt to develop money capital markets in Arab world. Commercial banks are the most dominant financial institutions in any country. Therefore, local financial institutions and foreign ones have greater opportunity in economic development in to the Arab Countries.

(Mazhar M. Islam, 2003) we discussed the expansion and performance of domestic and foreign banks in the Arab gulf countries, and showed that domestic and foreign banks in these countries have perform well over the past more than a few years. Moreover, he additional that banks in these economies is well capitalized and the banking sectors are well developed with strong competition among in banks.

Tarawneh (2006) Based on the above literature, we can say that there are some studies about banks in Arab gulf countries, however, no in depth study has ever been done in sultanate of Oman because of probably lack of sufficient information, and because of their unfamiliarity with the global economy. The main contribution of this study is to make financial comparison based on return on assets, return on equity, return on deposits, and other financial banking activities as credits and deposits to determine the performance and classifications of Omani commercial banks. in the vein of any other study, this study is also not without its limitations. One of its limitations that it does not include all the commercial banks working in Oman, because the data were unavailable to the researcher.

The average ROE ratio is 12.81% for BM bank while NBO bank got negative average ROE (-9.06%) during the period ( 1999-2003 ). The ROE is net profit after taxes divided by total owners equity. It reflects the bank management's ability to generate net profits from using the owners equity as one of the financial sources.

Findings also indicate that the ranking of the banks based on their return on equity is classified Bank Dhofar to be the first, Bank Muscat is the second, Oman International Bank is the third, Alliance is the fourth, and the lowest rank is the National bank Of Oman. Based on the reported ranking, it is concluded that the bank with higher predictors of total assets, credits, deposits, or shareholder equity does not always mean that it has better profitability performance.

Since many emerging market and transition economies are more volatile than industrialized countries and consequently, greater foreign participation in the banking sector seems to be valuable because it helps insulate the banking system from domestic shocks (Claessens et al., 2000; Mashkin, 2002).

The remuneration of greater foreign bank entrance in home country’s banking system know how to be summarized into four major aspects (1) it seem likely to guide to a banking and financial system so as to is substantially fewer fragile and far few level to crisis; (2) it can give confidence adoption of most excellent practice in the banking industry for the reason that foreign banks come with know-how in areas, predominantly, risk 66 managements; (3) it increase rivalry in the banking industry in the home country and it be able to lead to improved management technique and a more well-organized banking system; and (4) it seems fewer possible that uninsured deposit and other creditor of banks resolve bailed out because it will not be opinionated popular.

In addition (1999) found that in Argentina and Mexico, the foreign banks exhibited stronger loan growth in response to economic signals as compared with domestic-owned banks, bring into being foreign bank credit activities were associated with a bolstering of overall banking sector loan growth and a lower volatility of this growth.

Claessens, Demirgüç-Kunt, and Huizinga (2001) the foreign banks, working in developing countries, usually achieve superior prosperity than domestic banks. The conflicting occurs in urbanized countries offer more than a few rationalizations for the difference between the profitability of foreign banks in well developed countries. The First tiny net-interest margins in urbanized countries may replicate participation in across-the-board rather than retail markets with slighter net-interest margins. Another technical advantages in favor of foreign banks in developed countries as well small to cover up informational disadvantages of those two explanation of low net-interest margins may overturn themselves in developed countries. (Jeon & M. Miller 2004)

Sabi (1996) we compare to the performance of foreign and domestic banks within development of evolution into a market-oriented financial system in Hungary. This research show that foreign banks are more profitable than domestic banks and had fewer exposure to liquidity and credit risk. Foreign banks provide fewer money for customer loans and were reluctant to give long-standing loans, and only 8.4% of the foreign banks’ loans are long-standing. But the entrance of foreign banks did not facilitate to improve the performance of the domestic banks.

Eichengreen and Gibson (2001) we examine bank and market precise profitability determinants for the 1993-1998 period, by means of a panel not limited to commercial banks. This study represents one of the few attempt to account for profit perseverance in banking and the empirical results suggestive of that the Greek banking sector is defectively competitive. The Market-explicit variables such as attentiveness ratios and market shares be found to have a optimistic but insignificant effect on substitute measures of the profitability to the Effect of the size of non-linear with profitability initially rising with the size and then on the way out. (Athanasoglou, Brissimis, & Delis, 2005)

CHANTAPONG (2006) Over the second half of the 1990, the return on equity for commercial banks in the United States persistently exceeded returns earned over the previous 20 years, while the provisioning expenses incurred by US banks declined significantly.5 From Table I, it can be seen that bank profitability increased whereas provisioning expenses declined in Germany, United Kingdom, Australia, Sweden and Thailand. However, it can be noted that even during the contraction period, foreign banks in Thailand experienced higher level of profitability, compared to those of banks in industrializing countries.

The main donation to the cyclical pattern in bank profitability is the cyclical nature of aggregate loan losses and that of provisioning for these losses. In excess of the second half of the 1990, the return on equity for commercial banks in the United States persistently exceeded returns earned over the previous 20 years, while the provisioning expenses incurred by US banks declined significantly. It can be noted that even during the contraction period, foreign banks in Thailand experienced higher level of profitability, compared to those of banks in industrializing countries. (CHANTAPONG, 2006)

Sturm and Williams (2004) compared the efficiency of foreign owned-banks operating in Australia with Australian domestic banks. They found that foreign banks were more input efficient than domestic banks, mainly due to superior scale efficiency; however, this did not result in superior profitability.

Detragiache and Gupta (2004) examined the experience of Malaysia during the crisis of 1997 and provided evidence on the performance of foreign banks during extreme financial fragility. They found that foreign banks (particularly those with operations not concentrated in Asia) had relatively low non-performing loans, and their profitability and capitalization even improved during the crisis. Additionally, the foreign banks lending and deposits constricted less than for domestic banks.

Molyneux and Seth (1998) modeled the determinants of foreign bank profitability in the U.S. They found that capital strength, assets composition, commercial and industrial loan growth, and U.S. GDP growth were important factors in determining foreign banks’ ROA. They found that profitability appears to be inversely related to banks’ loans-to-assets ratios, which implies that foreign banks that dedicate a larger proportion of their business to securities have relatively higher returns. For ROE, they found that capital strength was the most important factor.

Elyasiani and Mehdian (1997) deliberate the production effectiveness of domestic and foreign banks in U.S. They used the linear program techniques for the founding that foreign and domestic banks were working under dissimilar technologies; on the other hand, foreign banks were as competent as the domestic banks relative to their particular group-specific boundary.

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The most popular model for evaluating firm performance is the “return on equity Model”. Return on equity (ROE) is a measure of the rate or return flowing to the bank’s shareholders. It represents the net benefit the shareholders receive from investing their capital in the bank, i.e. placing their funds at risk in the hope of earning an appropriate profit. So ROE measures the profitability from the shareholders perspective, and it measures bank accounting profits per dollar of book equity capital. ROE is defined here as net income divided by average book value of equity. Return on assets (ROA) is an indicator of managerial efficiency and it shows how the bank’s management converted the institution’s assets under their control into earnings. ROA is defined here as net income divided by average book value of assets. ROE is linked to ROA by the equity multiplier (EM), which is equal to total assets divided by total equity (the inverse of the equity-to-asset ratio), or average assets divided by average equity. A bank’s equity multiplier compares assets with equity, where high EM ratio indicates a large amount of debt relative to equity. (Awdeh, 2005)

Awdeh (2005) The size variable has a positive and significant effect on banks’ ROE, which means that shareholders of larger banks enjoy higher returns. Off-balance sheet activities are associated with lower ROE, which may show that the income resulting from OBS is offset by the extra capital needed when engaging in such activities (according to risk-based capital rules that banks operating in Lebanon are subject to). Deposit growth shows a positive correlation with profitability. Thus the deposits (local and foreign) received by banks could be a source of increasing profits. The capitalization level has a negative association with profitability. Credit risk as expected has a negative and significant effect. IRS shows the expected sign, a positive and significant effect on ROE, so if banks have certain monopoly power, they will realize higher profits. CI and CA have a negative and significant impact on ROE and banks that are not able to control their expenses realize lower profits.

The ownership structure shows no positive impact on ROE and this variable does not have here an ability to distinguish between banks according to their ownership structure (institutional or individual). Foreign ownership shows a positive and significant effect on banks’ ROE. Foreign banks or banks with foreign control enjoy (significantly) higher ROE. Again surprisingly, concentration has a significant negative effect on ROE.

The effect of capitalization on banks’ ROE remains the same showing that domestic banks’ ROE is affected negatively by any increase in equity. LIQ does improve domestic bank’s profitability. Additionally, T-bills capture a significant effect, which suggests that investing in government securities is profitable for domestic banks.

Several factors affect the revenues that banks earn from assets and pay on liabilities and, therefore, their net income flows. The profitability and changes in profitability of a bank, regardless of its ownership are determined by two sets of variables: internal variables and external variables. The internal variables are related to the bank itself and they are planned according to the management decisions. The external variables are an outcome of the environment where the bank is operating.

Berger and Humphrey’s (1997) review locate consistent confirmation that large banks are more competent on average than small ones, but its fewer clear whether huge banks benefit appreciably from scale economies. Profitability is other likely to be improved by emulating industry most excellent practice in stipulations of technology and management structure than by escalating size(GODDARD, MOLYNEUX & WILSON, 2004)

Emilia Jurzyk (2006) illustrate that foreign banks, particularly Greenfield institutions, earn higher profits than domestic banks. This consequence is acquired, rather than present at birth, since there is confirmation that foreign banks tend to take over less profitable institutions. Profits of the foreign banks in CEECs also exceed profits of their parent banks, amplification the reasons for their entry. Domestic banks enjoy higher profits in more determined banking markets, while takeover banks suffer from diseconomies of scale due to the fact that they acquire large institutions.

Research Methodology

Sample and Data The purpose of this methodology was distinguish in Pakistani commercial banks. This study uses yearly data from financial statements of required banks independently for period of 2003-2008. We took as a sample of 28 banks in our study from which 11 are foreign banks and rest of 17 as domestic banks.

The data is taken from the balance sheet and income statements, unconsolidated financial statements form each bank’s website and state bank of Pakistan library. We used in our sample of commercial banks, and expelled investment banks, development banks and also micro-finance banks.

Therefore, the data consist of data from 11 foreign and 17 domestic banks. The domestic Pakistani banks take in the Allied Bank, Askari bank, Bank Al-Habib, Bank of Punjab, Bank of Khyber, First Women Bank, Habib Bank, Khushali Bank, KASB Bank, MyBank, MCB bank, United Bank, Meezan Bank, National Bank, Soneri Bank, Saudi Pak Bank and SME Bank.

The foreign banks are Bank Alfalah, Citi Bank NA, Deutsche Bank AG, Faysal Bank, Habib Metropolitan bank, HSBC Bank, NIB Bank, Oman International Bank, Royal Bank of Scotland formerly RBS, Standard Chartered Bank, and, Samba bank formerly Crescent Bank.

Variables and Method

The categorization of bank types of Domestic and Foreign Banks was match up to on the total Average return on Equity.

This research analyzes the determinants of banks’ profitability; accounting ratios will be used as actions of performance of this study as fit. The ratio return on average Equity (ROE) is deliberate as net profit after tax divided by average total Equity. This is most likely the important single ratio to compare the earning of performance between the domestic and foreign bank support on the total Equity.

In organize to categorize the Pakistani commercial banks, this research uses the banking behavior and is comprised independent sample test used to matchup the difference between the domestic and foreign banks variables and we took 5% confidence interval according the SPSS software.

Empirical Result

Group Statistics

Levene’s Test for Equality of Variances

In this surveillance we apply the Independent Sample t-test to observe whether the profitability of domestic banks significantly better form the foreign banks or not.

We match up to the means of domestic and foreign banks in conditions of return on average equity (ROAE), first we will seem at the variance of ROE % to find whether variances should be implicit equally or not.

H0: Profitability of domestic is significantly better than foreign banks

Independent Samples Test

First it was tested impartiality of variance, result show that significant value is 0.174 and which is > than 0.05 that means we reject the null hypothesis so we bring to a close that profitability of domestic banks is not significantly better than foreign banks.

T-test for Equality of Means

It is statistically proved that the insignificant level of 2-tailed test is P=.210 > 0.05 on the source of the result we rejected the null-hypothesis which is Profitability of domestic is significantly better than foreign banks

Confidence Interval

-16.2491 ≤ µd –µf ≤ . 3.7410

Confidence interval shows that since zero does lies in this interval; therefore Profitability of domestic is not significantly better than foreign banks and we reject null hypothesis.

Table-1 Group Statistics

Domestic and Foreign Banks

N

Mean

Std. Deviation

ROE in percent

Foreign

11

6.259909

15.3877344

Domestic

17

12.513941

10.4219274

Table-2 Independent Sample Test

Levene's Test for Equality of Variances

t-test for Equality of Means

F

Sig.

t

df

Sig. (2-tailed)

Mean Difference

95% Confidence Interval of the Difference

Lower

Upper

ROE in percent

Equal variances assumed

1.956

0.174

-1.286

26

.210

-6.2540321

-16.2491

3.7410

Conclusion

To check do domestic banks enjoy a better profitability than foreign banks, we examined the profitability on the basis of ROE differences between foreign and domestic banks operating in Pakistan from the period 2003-2008.

So the main objective of this thesis was to examine the profitability of Pakistani commercial banks. The study is based comparative analysis of domestic and foreign banks on their profitability basis.

To test that we used Independent sample T-test to analysis the result of this paper, we employ the t-test to see whether the profitability of domestic banks significantly better from those of foreign or not.

In Pakistan, the number of domestic banks exceeded the number of foreign Pakistani banks in each year of the sample, though domestic banks represent a relatively better share of the Pakistani banking sector in spite of this, it has been concluded in our results that domestic banks do not enjoy better profitability than foreign banks in Pakistan.

Discussion

It is in general acknowledged that banking systems in general are becoming increasingly global as a consequence of financial liberalization and economic integration. The performance of domestic and foreign banks has engaged researchers in recent years. As it has been conclude that Pakistan domestic banks do not enjoy better profitability than foreign banks in Pakistan, this study leave a question for researcher to find out the reason that in spite of having major share in market, why it is that domestic banks profitability in term of ROE is not better than foreign banks.

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