Privatization: Pakistan’s Banking Sector

5081 words (20 pages) Essay in Economics

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The topic of the research is “The impact of the privatization on the banking sector of Pakistan”. “Privatization is the process of the transferring of the business, enterprise, agency or public service form the public sector (government) to the private sector (business).” The nationalization of the assets and the businesses was done in the 1970’s, when Zulfikar Ali Bhutto was the prime minister. This nationalization did not achieve the desired goals; rather much more issues of corruption were reported. So again in 1990’s in the period of the prime minister ship of Nawaz Sharif, reforms were made to privatize the businesses including the banks. This privatization was done in order to reduce the administrative costs and to lessen the layers of the bureaucracy. Thus due to the privatization, the banks were able to shift their focus from the political goals to the economic goals, leading to the efficiency of the market economy as a whole.

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The banking sector of Pakistan forms the basic financial sector of Pakistan, which is necessary for the progress of the country. So, the growth and the progress of the banking sector is essential for the growth of the real economy. The policies of the liberalization and privatization favor the working and the efficiency of the banking sector. Since the privatization of the banks, the performance of these banks had improved dramatically, savings have shown an upward trend in privatization other than the period of nationalization.

Back ground of the problem

The banks in Pakistan under the state ownership were basically catering to the needs of the Government organizations, serving a few large corporations and engaging in trade financing. There was no lending to small and medium enterprises, to the housing sector or to the agricultural sector, which create most of the growth and employment in Pakistan or lending to the poor through microfinance and SME finance. Most important, the financial system suffered from political interference in lending decisions and also in the appointment of managers and staff. The middle class which is the backbone of any economy and those who had no connections to influential individuals were almost excluded by the banking sector.

The government’s fiscal deficit was so high that most of the deposits the banks used to get were loaned to the government and government corporations.This was safe lending which fetched good returns and the banks made good profit out of it. Naturally, there was little incentive for them to do anything else except lend to the Government which was both risk free and reaped high returns.In the government banks the staff worked like typical government employees, coming to office at 9:00 a.m., checking files; having nothing important to do and leaving at 5.00 p.m. without doing much work. These banks suffered from a high bureaucratic approach, overstaffing, unprofitable branches and poor customer service. Administrative costs were also high. The recovery rate was so low that almost 25% of the loans were stuck up as a large number of loans to the private sector borrowers were not given on the merit of the proposal but on political considerations. These influential borrowers hardly repaid their loans. The banking industry faced a high tax rate of 58 percent while the rest of the corporate sector paid only 35 percent. This high rate along with the burden of stuck loans and inefficiency of the staff was passed on to the customers in form of high lending rates and low deposit rates. The banking industry was not attractive for new entrants who could foster competition and improve efficiency.The Government injected Rs.41 billion to offset the losses incurred by these nationalized commercial banks and recapitalize them. Because of these factors, i.e. high administrative costs, burden of stuck-up loans and excessive tax rates, the average interest rate for lending was about 21% per annum. The genuine businesses and middle class borrowers could not afford to get credit on such high interest rates and pay it back. Banking sector reforms were thus needed badly to address these and other constraints so that the banks could play their due role in the economic development of the country.

The basic objectives of bringing about the change were:

Reform the banking structure in such a way that the banking system is subjected only to the government

Make the institution free from external pressures including political pressure and of influential individuals

Increase the efficiency and eradicate the beurocratic culture prevailing in the banks

Improve the quality of service to the customers

Encourage the private sector to step forward hence flourish competition

Research Questions

The objectives of research are as follows:

To analyze the impact of the privatization of the banking sector of Pakistan

What changes it brings to the efficiency and performance of banks?

How has competition grown as a result of privatization?

The analyze evidence of corruption before and after privatization

Have technological advancement taken place after privatization or not?

Is soundness of management a result of privatization?

Has political intervention increased or decreased after privatization?

Has privatization lead to job insecurity?



The Effects of Privatization, Competition and Regulation on Banking Efficiency in

Pakistan 1991 – 2000

The Banking sector of Pakistan has been through major reforms since 1990 such as liberalization, privatization and extensive change of policies. The banking sector of Pakistan has faced a lot of changes in its structure like structure of ownership; level of competition has also played a big difference in the banking sector. The methodology used to measure the total cost of efficiency is input price vector. [1] Data has been collected by the balance sheet of respected banks. State owned, private, and commercial banks are under observation. Through empirical results we get to know that privatization and competition may have influenced the whole technology of banking sector. Continuous time frame has told us about the performance of banks. Central bank independency showed the improved quality of regulation and supervision in Pakistan. For concluding analytically banks were divided into three parts Government owned banks, private and foreign banks. Non parameter DEA method was used to measure the performance by cost efficiency. Highest efficiency was found in 1991 and lowest was in 1996, in achieving highest efficiency foreign banks were on the top level followed by private and then state owned. Unbalanced panel data was used to investigate variables of efficiency. The results specify that efficiency of banks cannot be differentiated on the source of policy reform of privatization. Furthermore, individual reforms promoting competition led to a turn down in average performance of banks in postre form period. Complete liberalization was also a source of decline. Independent regulator played a positive role in banking sector, helpful in enhancing the supervisory role of central banks.

One likely clarification for the unpleasant effects of reforms on banking efficiency appears to be critical macroeconomic environment in the country established during most part of 1990s. whilst GDP growth rates in 1990s were much lower than those experienced in 1980s. Not surprisingly, because slower growth is frequently associated with feeble debt servicing of borrowers, it leads to more loan defaults and superior credit risks. This is exactly what had happened in Pakistan where due to poor economic growth evidence in 1990s loan default rates grew extremely during the period. Therefore, we may hypothesize that individual policy reforms would bear fruit where economic growth environment is also favorable, which seems to provide improved support to the reform process.


Initially the banking sector of Pakistan was dominated by public sector and was the main reason for banking inefficiency. The biggest challenge was to formulate the suitable regulatory frame work which can uplift the banking efficiency. Restructuring programs was started to regulate the banking sector. The government of Pakistan has started banking sector restructuring and privatization project. The main objective of this project was to privatization of banks and mainly to uplift this sector in Pakistan. Amendments were made in banking act to promote the privatization of banks. Banking performance was measured in terms of CAMELS frame work and CAELS. Dynamism and financial strength and control were gained through privatization. Banks capital adequacy was rising gradually. Input oriented and output oriented results have been included in the report. [2] Through the analysis we can say that commercial banks can improve their efficiency by increasing profits, assets, markup interest earnings and non-markup interest earning and decreasing liabilities, markup interest expenditures and non-markup interest expenditures among the bank specific variables. Financial structure reforming in simple words in meant to changing the ownership and it has great influence on the banking sector of any country.

The Impact of Financial Restructuring On the Performance of Pakistani Banks A DEA Approach

Privatization is known as one of the appropriate approach to improve the financial structure of banks. The importance of financial growth in the economy cannot be deprived of. Evaluation of financial structure of banks has gained a major importance in the recent years. For establishment of better internal control and financial importance of banks, restructuring of banks have been taken place. The biggest example of this reform is privatization of banks it means transferring the ownership from state to private ones. In early days banks efficiency was measured through traditional ways but now technology has improved many other techniques have been discovered. Efficiency of banks can be measured either by operating or intermediation approach.

In operating approach, the bank is measured as creator of services, and efficiency is premeditated in terms of cost/revenue side. On the other side, in intermediation approach, the bank is known as a manufacturing unit and efficiency is measured in conditions of outputs such as loans, deposits, and investments (Akhter, 2002). In this study, the banking efficiency is measured through operating approach. Banking literature recommends that operating efficiency of banks can be ratio of non interest expense to profits. Relative efficiency is calculated by the DEA approach. The DEA model enables firms and banks to analyze the performance of other banks and their efficiencies. Ratio analyses have been executed in this paper. [3] Administrative and operating efficiencies have also been calculated [4] . Results of DEA model have also been included in the article [5] . We can conclude this article by saying that privatization is very important technique to improve the efficiencies of banking sector of Pakistan as it had bring a lot of positive results in total quality management. Commercial banks needs to improve their operating efficiency as compared to state owned banks. Banks’ performance can be evaluated by estimating the technical, apportion, pure technical, scale and by and large technical efficiency.

Impact of Financial Liberalization and Deregulation on Banking Sector

In Pakistan

Survey approach has been used to carry out the results for the impact of financial liberalization and deregulation on banking sector in Pakistan. 15 banks have been taken for analyses out of 35 institutions. Some key banking reforms were success full in diminishing the flaws of banking sector in Pakistan. From the analyses it has been found that privatization of banks in Pakistan was helpful in reducing the flaws. During the period of 1996-2000 the cost inefficiency has improved. Ranking from group wise efficiency foreign banks are on the top, subsequently private and commercial banks. Banking sector is a major industry for mobilizing of monetary benefits all over the country, regulation of money and transfer of wealth, saving function and lot of others. Now coming towards the role of banking sector in an economy it plays three major functions facilitation of banking system, mobilization of saving and allocation of funds [6] . There are always some indicators, some standards which shows the poor performance of banks such as adverse changes in policies and rules and regulations. Performance of banks can be affected by rigidity of bureaucratic system and too much state intervention. Pre reform tells us about the changing structure of banking industry in Pakistan. The methodology used was feedbackinputresponses. The restructuring plan of banks was helpful in improving the financial health of banks. The average relative competence of top 5 most excellent banks is 96.6

% parallel to 60.5 percent for 5 least proficient banks. The overall average efficiency level of commercial banks is found to be 80 percent which depicts that there is enough room to minimize the cost by reducing role of factors causing inefficiencies in banking’ operations. The results of the current study are also consistent with efficiency estimates of the study conducted by Ansari (2005) for Pakistani banks

The Effect of Privatization and Liberalization on Banking Sector Performance in Pakistan

A sound performance financial system is essential for boosting the efficiency of intermediation. Privatization of state owned banks and other liberalization measures Introduced were the foundations of the financial sector reforms started in the early nineties in order to regenerate the financial system of Pakistan. Initially the MCB and Allied bank became privatized and later the state gave permission for more privatization of banking industry. Gradually the number of private banks and financial institutions was increasing day by day started from nil. CAMEL framework has been used to understand the impact of privatization in banking sector. Development and political view has been discussed in this article. Political view states that government can intervene through financial institutions to the direct savings of people for the development of country whereas political view states that state intervention results in lower economic efficiency as state become dishonest while using the direct saving of people.

Camels framework describe about capital adequacy this tells us how the financial institution is capable of absorbing the risk obviously depending upon the capital structure of financial institution. Now coming towards asset quality it is very important tool in banking sector as it helps in recovering from major liabilities and serve as a shock absorber. Management soundness is also very important regarding performance of capital adequacy, asset quality and liabilities. Earning and profitability shows the financial position of an institution. Liquidity tells the state where institutions can obtain sufficient funds. Sensitivity to market risk refers to the exposure of institution towards market risk interest rate and exchange rate etc. the banking system of Pakistan is operating in four forms public , private , domestic and foreign banking system. Privatization of banking in Pakistan shows little substantiation in improvement of financial health of banking industry. It is an long process and the results are changing with the passage of time , the CAMELS frame work is a useful to measure the performance of financial institutions.

Does privatization improve efficiency?

As the business world is becoming dynamic day by day, there is a need to recognize the importance of the privatization and the impact of deregulation on the business world, specifically on the financial services sector. This dynamic environment in the business sector has increased the competition and efficiency between the firms. The larger the degree of completion between the firms, the greater the firms tend to be efficient.

Specifically talking about the banks, the changes in the structures and regulatory environment of banks have a great impact on the policy makers, investors, managers and regulators. A large number of the developing countries are involved in making some kind of reforms in their financial institutions as well as the financial systems on the whole, to see the impact of these reforms on the efficiency of these institutions. The performances of these are measured according to 3 criteria: allocative efficiency, operational efficiency and dynamic efficiency.

The modern banking industry is extremely important to the trade and commerce because it provides the major portion of the financial intermediation to the businesses. A lot of studies have been carried out about the performances and efficiency of the banks throughout the world but in context of Pakistan such studies and publications have been conducted on a massive scale. Study of x-efficiency is also important in the banking sector as the x-inefficiencies account for about 20% of the total bank costs. X-efficiency includes two components of efficiency, technical efficiency and the allocative efficiency. The public sector banks in the Pakistan have performed poorly and their after-tax profitability have been much lower than the private banks.

A study conducted in Pakistan supports the idea that improvement should be made in the banking sector by the efforts of the banking sector as well as the authorized government agencies. The results of that study also support that notion that privatization of public banks should be continued. The start of the privatization process was done through the two state owned banks Muslim Commercial Bank limited (MCB) and Allied Bank of Pakistan (ABL ltd) in 1991.

The previously published data is used in the research paper and the data is taken from the annual reports published by these banks. The result of this study shows that the efficiency of these banks has increased after the privatization of the banks. So, the researcher concludes that the privatization process should be continued in order to increase the efficiency of the banks, which in return will increase the competitive environment of the entire financial system.

MCB with regard to privatization

This research paper attempts to explain the relationship between the bank privatization and the efficiency of the bank marketing strategies. In this research paper MCB have been selected as a case study. privatization become popular in the 1980’s and the government of Pakistan recognized its importance in the late 80’s and thus started privatization, as a social and an economic reform, of the state institutions that included the banks as well.

In this research paper, the author has tried to prove that the bank privatization and the bank marketing are similar in their meaning. They have the same basic objective of creating a competitive environment to maximize the growth and the profits of the bank and thus due to the privatization, competition is increased manifold which results in the increasing of the profits as well.

The research paper is written in a descriptive way and is based on the secondary data. MCB’s first five years of privatization are analyzed in this research paper to formulate the result about how is the privatization and the marketing strategies directly related. Further, it explains the relationship between the privatization and the effects of it on the efficiency and effectiveness of the bank.

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Under the first five years of the privatization, MCB started various schemes to involve people in the bank and make the bank credible. These include the strategic planning of the bank, Mahana (monthly) Khushali Scheme, Capital Growth Certificate Scheme, Constancy services, Self – Supporting Scheme, FAX Press, Night – Banking Services, Utility – bills collection. These services increased the customers of the bank, as well as there profits.

The results that are accumulated from the study include the increased profits of the bank due to the promotional and marketing strategies after the privatization of the bank. The main idea of this paper is that through the privatization process the country’s resources are better utilized and the bank becomes more effective than before. In 1995, the bank’s deposits increased by 184 %, advances by 143 %, investments by 237 % and profit after tax by 455%. This shows the effective working of the MCB after the privatization of the ban



There is a very strong and a close relationship between the banks and the customers of the bank. At the first place the bank is the borrower from the customers in the form of collecting the deposits on the other hand the bank acts as a lender to the customers who need loans or other types of leasing.

So, in this context the banks need to be very reliable to accomplish the trust between the customers and to attract the new ally of the customers. Thus the banks performance should be extraordinary. The efficiency and effectiveness of the bank comes into play when the bank is privatized so it is analyzed that how the privatization of the bank helps to attract and retain the customers.

Due to the changing in the banking system there are huge array of the new services being introduced in the banks, these services include issuing credit cards, debit cards, various saving schemes, and online banking etc. but the weak and inefficient banking system of Pakistan has inculcated problems for the customers. These problems can be listed as no safe and secure way to transfer the money, no proper way of submitting of the treasury bills, loans and the advances are only for the reputable and approachable individuals.(hussain, 2003) so the banks when not privatized create problems in working efficiently.

The data gathered in this analysis the primary data which is based on the semi structured interviews. The customer’s view is taken in the surveys about the privatization of the banks. The samples of the account holders were taken. It is explicitly shown that customers tend to be more secured when the banks are privatized.

The results showed that the customers increased the credit cards transactions, the ATM transactions, and the auto loans in much greater value then they were used when the banks were not privatized. So, the more the banks are privatized the better they perform thus, they become credible for the customers and the better is the chance of attracting the new customers and of retaining the old ones.



In the decade of the 1970’s massive nationalization of the private business was done in order to attain a higher level of the profits, achieve better efficiency and to gain the ample effectiveness in operating the businesses. These businesses included the banks as well. After around two decade later it was seen that all the objectives of the nationalization were badly eroded and the country was deemed in the deep rotted corruption and worsened the economic conditions of the country. The poor in the country started to worsen. The managers and the employees neither had the competence nor where they effective in maintaining the relations with the customers and the clients. They were engaged in looting the common people and the government was not there to put a check on it.

So in 1991, Nawaz Sharif the prime minister of that time revised the policies and he made quite extensive and diverse reforms. These reforms could be called in three words namely- deregulation, privatization and liberalization. These reforms were very important in the in the economic and the social sphere of Pakistan. So, there was a consensus that privatization is beneficial for the working of the nation effectively.

For this concept to be proved, the author has taken the case studies of the various banks. At the beginning of the 1990’s there were a total of 24 commercial banks. These commercial banks were characterized by high costs, over staffing, lower profits, poor management and under capitalization of resources. for the elimination of these problems, privatization was done.

As mentioned earlier the privatization process was started in the in the 1990’s and it bore splendid results. The main achievements of the privatization were the reduction in the fiscal deficit of the budget, it increased the efficiency levels of the bank, it insured the competition between the banks, which in return created the customer services much better. Further broad basing of the equity capital was done and the resources were managed much better than before. More new physical and social infrastructures were purchased.

These were huge benefits that the country gained due to the privatization of the banks and the other financial institutions as well. From this case study of the banks it is evident that privatization is extremely important for the institutions to perform effectively and efficiently.

The Effect of Privatization and Liberalization on Banking Sector Performance in Pakistan

By Umer Khalid

A well functioning financial institution is extremely important for the working of the economy of the country. A sound financial sys tem results in the fine allocation of the resources of the country, there by improving the efficiency and increasing the effectiveness of these institutions. It was in the 1970’s that the nationalization of the assets and the institutions was done. It induced much of the problems of the corruption and looting from the customers.

The privatization was done in the 1990’s by the Prime Minister Nawaz Sharif. These laid the most important reforms in the financial sector and thus the country improved its financial position, its economy and finally the efficiency of the banks.

In this paper the author attempts to investigate the impact of the privatization or the liberalization on the financial performance of the banks. For this process the author had used the CAMELS ratio of the financial analysis of the banks after the privatization process. CAMELS include the six factors on the measuring is done. These include the Capital adequacy, Asset quality, Management soundness, Earnings and profitability, Liquidity and Sensitivity to market risk.

Each of these elements is measured for the banks both before the privatization and after the privatization of those banks. These elements provide the complete analysis of the banks and thus the analysis indicates that the banks performances improved dramatically after the privatization process.

The results do show a marked difference in the pre and post privatization eras. However that difference is still low for the economy to prosper. The number of the privatized banks have increased and a lot of foreign banks have opened there branches in the country still more of the efforts are needed to ensure complete efficiency in the prevailing banking sector.

I did the analysis to see whether the selected independent variables; efficiency, competition, corruption, management soundness, job insecurity. Political intervention and technology are important in the variability of measuring the impact of privatization on the banking sector of Pakistan. I performed a multiple regression test using StatGraphics Plus to examine the impact of the above mentioned independent variables on the dependent variable. The related statistics used for the interpretation of results are R squared, t-statistic and the p-value. T-statistic is a measure that tells that the actual value of the parameter is not equal to zero. The larger the absolute value of t-statistic means that it is the less likely that the actual value of the parameter could be zero. The R-squared of the regression describes how well the independent variable explains the variation in the dependent variable. T-statistic and P-values show the nature and significance of relationship among the dependent and independent variables. All the three statistics will help in proving the hypothesis of this research paper and giving a complete analysis of the impact of privatization on the banking sector of Pakistan.

The output shows the results of fitting a multiple linear regression model to describe the relationship between the impact of privatization and 7 independent variables Since the P-value in the ANOVA table is less than 0.05, there is a statistically significant relationship between the variables at the 95.0% confidence level.

The R-Squared statistic indicates that the model as fitted explains 79.3864% of the variability in dependant variable. The adjusted R-squared statistic, which is more suitable for comparing models with different numbers of independent variables, is 72.8275%. The standard error of the estimate shows the standard deviation of the residuals to be 0.278872. This value can be used to construct prediction limits for new observations. The mean absolute error (MAE) of 0.15427 is the average value of the residuals. The Durbin-Watson (DW) statistic tests the residuals to determine if there is any significant correlation based on the order in which they occur. Since the P-value is greater than 0.05, there is no indication of serial autocorrelation in the residuals at the 95.0% confidence level.

In determining whether the model can be simplified, the highest P-value on the independent variables is 0.8154, belonging to political intervention. Since the P-value is greater or equal to 0.05, that term is not statistically significant at the 95.0% or higher confidence level.


H0 Efficency of the banking sector has not increased as a result of privatization

H1 Efficency of the banking sector has increased as a result of privatization

Here we see that if the value of probability (P-value) is less than 0.05 and is 0.02 we reject H0 and accept H1. This shows that the efficiency of banking sector has increased as a result of privatization.

H0 competition in the banking sector is not due to privatization

H1 competition in the banking sector is because of privatization

In the second test, if the value of probability (P-value) is less than 0.05 (one-tailed) we reject H0 and accept H1. The P-value is 0.006 we reject Ho and accept H1. This shows that the competition in the banking sector has increased as a result of privatization.

H0 privatization of banks has no impact on job insecurity

H1 privatization of banks creates job insecurity

In the third test the P-value is greater than 0.05 and is 0.22 hence we do not reject Ho. Thus privatization of banks has no impact on job insecurity

H0 corruption had increased as a result of privatization

H1 corruption di

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