The Impact of Privatization on Banks Profitability

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Privatization as an economic reform has swept the globe during the past two decades, as more than one hundred countries of all economic and political persuasions have launched motivated programs to privatize once state-owned enterprises (Megginson and Netter, 2001). Privatization programs have contributed to non liability financing of the public sector. It has attracted foreign capital and technology, and encouraged the return of flight capital (Perotti and Guney, 1993). Since the Thatcher government in the United Kingdom executed a privatization program during the late 1970s, privatization has developed into a global event. Countries in different stages of development and of different principles and sizes have all accepted, in one form or another, privatization strategies as a key element of their economic policies. It has become an acknowledged insight that privatized firms are better than state-owned enterprises (SOEs). As D’Souza and Megginson (1999) put it, results of scholastic studies jointly speak with a consistent voice: privatization persuades output, efficiency, and profitability improvements.

The philosophy of privatization comes out from the role of state in economic life. The philosophy of the international financial institutions and free market economists is that, as in USA, the state should detain itself to regulation only and the procedure and ownership of industrial enterprises and utilities should be left to the private sector.

Large privatization programs have happened in the recent decades equally in developed and developing countries. The key explanation has been that privatization guides to increased productivity and profitability, an agreement view which an enormous empirical literature has established.’ However, the large size of several privatization programs proposes they have important economic and political consequences.

Like the developing countries, the private sector is introverted, inexperienced and not prepared to embark on quick industrialization. Pakistan beside with other developing countries follows the campaigner role for the state in industrialization and the pace of industrial development in Pakistan has been very high.

The main thrust for privatization is the faith that private sector units are more competent than public sector units. The positive fiscal impact of privatization is estimated from the sale proceeds being used to retire national liability, as well as removal of losses of the public sector units as the losses were being financed from the budget. Necessary condition for the achievement of privatization is that the economy should be deregulated and needless restrictions and measures for industrial enterprises should be done away with. Privatization should consequently be part of a process to reinforce private sector by giving it assets as well as improving regulatory structure for their operation.


The decade of 1970s in Pakistan observed a massive redeployment of national assets from the private owners to the state. The motive underlying the then Government’s thoughts for this enormously radical action was that the national assets were being concerted in the hands of few families and the rich were getting richer and the poor getting poorer. It was stated by the proponents of this tactic that the state manage over allocation of the resources would endorse the best interests of the poor. The scholar support for this approach was drawn from the achievement of the Soviet Union and the socialist economic model experienced in that part of the world.

Two decades later it turned out that these statements and assumptions that drove this exacting line of action i.e. nationalization was not only impractical and defective but the consequences were precisely opposite to what the aims were. The fall down of the Soviet Union and the bankruptcy of the socialist model battered the ideological foundation of this approach and the actual results on the ground in Pakistan and approximately all the developing countries devastated the ideal and utopian dreams of the proponents of this thinking. Pakistan’s public enterprises including banks became an exhaust on the country’s finances through continuous bleeding and leakages and a draw on the economic growth impulses.

These public enterprises became the medium for employing thousands of supporters of political parties that implicit power in the country in rapid succession and a source of support, perks and privileges for the ministers and the favored bureaucrats appointed to manage these enterprises. These employees and managers had neither the managerial skill nor technical capability to carry out the job.


The nationalization policy of the early 70s enlarged the size of the public sector to an uncontrollable extent. The nationalization process also unsuccessful to deliver what was projected from it. In July 1977, the new government commenced the policies of denationalization, disinvestment and decentralization to refurbish the confidence of private investors. As a part of these policies, the government declared denationalization of about 2000 Agro-based industries, in September, 1977. Distant from that, the government presented a number of SOEs on Management Contract and introduced concert signaling system, in order to advance their performance and bring competence in operation and management.


The privatization of State Owned Enterprises (SOE) became a significant tool of economic policy of the government in late 80s. However, it was in 1991 that privatization process in Pakistan became efficient.

Privatization of SOEs is a versatile, complex as well as politically and socially receptive process. A well-devised privatization plan of SOEs fundamentally takes care of all the stakeholders, which comprise labor, customers, investors, government and the economy. It helps to encourage capital, goods and labor markets in the country. The privatization procedure in Pakistan has passed through different stages and it has been very influential to redefine the association of private and public business with the government institutions.


Privatization in Pakistan comprises of two tides. The first tide is from 1992 to 1994 and the second tide from July 2001 to October 15, 2002. In the opening period assets worth Rs.120 billion were striped and in the second period assets worth Rs.65 billion were striped.

As a first pace towards privatization, a Committee on Disinvestment and Deregulation was created. The Committee in its introductory report, submitted to the government in January 1991, suggested the disinvestment of 118 industrial units, which incorporated 45 nationalized units taken over during the phased 1972-74. The government permitted this disinvestment plan and announced the formation of a Privatization Commission on 22nd January 1991 to execute the disinvestment programmed within the shortest promising time. The birth of Privatization Commission institutionalized privatization efforts in Pakistan. By the similar time, a Cabinet Committee on Privatization (CCOP), with the Minister for Finance and Economic Affairs as its Chairman, was constituted to agree the recommendations of Privatization Commission.


On the whole results of the privatization process in Pakistan are varied. In certain sectors like power generation, cement, financial institutions and automobile the performance of the privatized units is acceptable and the new management has succeeded in improving the quality of product and service as well as financial health of the units. The workers have also advantaged in terms of higher salaries and improved working conditions. In other sectors like edible oil plants privatization has not been very successful.


In 1991 when the banking sector started in repeal direction when government privatized two sector banks. First Muslim Commercial Bank (MCB) secondly was the Allied Bank (ABL). The facts and figures specify that the privatized banks have shown enhanced performance. The better performance shown by the privatized banks are recognized to their aggressive marketing and banking policies.


Determine the impact of privatization of banks in profitability.


What are the performance differences of pre-post privatization of banks in terms of profitability?



World Bank study by (Kikeri, 1992) states that, “more than 80 countries have commenced motivated efforts to privatize their nationalized enterprises. Since 1980, more than 2000 SOEs have been privatized in developing countries, 6,800 global.” Furthermore, (Goodman, 1992) states that, by 1990, the value of universal sales of state enterprises had topped $185 billion and shows no sign of slowing. The hypothetical work of (Boycko M. A., 1993) shows that privatization will guide to effective reorganizing of SOEs-that are currently creating at incompetently high levels in order to capitalize on employment only if both cash flow rights and management rights go by the government into private hands. Boardman, 1989 analyzed the comparative performance of the 500 biggest non-U.S. mining and manufacturing companies in 1983 to decide whether privately owned firms outperform state-owned and assorted state and privately-owned companies (labeled mixed enterprises, MEs). After controlling for the aggressive environment in which each firm functions, they present very strong indication that private corporations are both more profitable and more efficient than either SOEs or MEs. Megginson (1994) examined 61 privatized firms from 18 countries and 32 industries above the period 1961-1990. They evaluate these firms’ financial and operating performance for the three years pre-post privatization. Their Wilcox on and proportion tests show statistically positively increases in profitability, output, capital investment spending, employment, operating efficiency, , and dividend payout, and a reduce in leverage. They feel the most possible explanation for these alters is that (even partial) private ownership allows the internalization of the benefits of performance enhancements, and publicly listed shares permit these benefits to be capitalized into the price of the firm’s stock. Changes in administrative and employee compensation policies may give inducement for the firm’s workers to be more productive.(Bernal, 1999)In developing countries the studies illustrate that the privatized firm performs better than the SOE. Current study made by (Fischer, 2003), made an important review of 37 Chilean SOES that were privatized during 1981-2001. They find out that privatized firms attained a important improvement in competency, but this development is no different from the change experienced by other private firms in their particular economic sectors. This means that the assessed Chileans SOES were competent before privatization. According to Djankov (1999) foreign ownership is positively related with enterprise reforming at high ownership levels. So far, ownership by external local investors or the state is not considerably correlated with effective restructuring. According to Djankov S. a., (2000) in common, privatization letting ownership by foreigners, block holders, or investment funds is more than a few times as creative as privatization to insiders.D’Souza J. W., (2000) concerted shareholdings produce better effects than disperse shareholdings. From cross-sectional regression outcome on a sample of 119 firms privatized between 1961 and 1995, show that stronger profitability gains are linked with lesser employee ownership and upper state ownership.

D’Souza (1999) verifies these results in a modernized study era of 1990 to 1996 for 85 privatized firms in 28 developed countries. Boubakri, 1998 discovered similar results in analysis on 79 privatized firms in 21 developing countries for the era 1980 to 1992.

In detail, the 15 privatization studies evaluated in Megginson and Netter (2001) show that firms classically perform superior after privatization.

Frydman (1999) study the Czech Republic, Hungary, and Poland, and discover that privatization has no positive effects on the performance of firms restricted by insider owners (managers or employees), but does have definite effects on firms restricted by outsider owners. In a Ukrainian study, Akimova (2000) as well show that concerted outside ownership has an important positive impact on firm performance. Using analysis data from Kazakhstan, Georgia, the Kyrgyz Republic, Russia, Moldova, and Ukraine, Anderson, 2000 also show that, in a number of cases of Mongolian privatization, state ownership is linked with considerably higher efficiency than private ownership. In the primary ample study on privatization in Malaysia, study 24 SIPs in Malaysia throughout the era 1983 through 1997. Tong (2002) verifies that the Malaysian privatization plan has been flourishing, study shows that, post privatization, SIP firms boost their absolute levels of total profits. They more than twice their real sales; they raise their dividend payouts; and they appreciably reduce their leverage. At last, there is proof that privatization works enhanced for firms that were completely owned by the government pre privatizations.

Laffont and Tirole (2002) showed that a public venture is a firm whose assets are, in the bulk, possesses by the government who therefore perform equally internal and external control.

Accroding to Hinds (1991) property rights theory states that the shareholders of a private firm can organize the administrative team in order to boost profits as the public firms cannot. For the cause the performance of public firms is by classification less than the privates. Pollitt (1997) showed the potential owners, competent of rising profits by falling costs, would be concerned in obtaining the private utility through stock market takeover.

More latest economic literature has taken a much fewer flattering sight of SOEs and a more positive sight of privatization. This literature highlights agency differences as the source of the incompetence of SOEs. There are two corresponding strands of the literature according to whether the serious agency divergence is with the politician or with the manager. Vickers (1988) argues that SOE managers can lack high powered inducement or proper supervising. In turn, Shleifer, (1994)stats taht strain that political interfering in the firm results in unnecessary employment, poor selections of product and location, short of investments, and ill-defined inducement for managers. Clarke Normally, the case for privatization of SOEs can be grouped about three main themes, i.e., political intervention, competition, and corporate governance. The competition argument states that privatization will develop the operation of the firm and the provision of resources in the economy, if it outcome in better competition. Privatization can develop competence even without varying market structure if it hinders interferences by bureaucrats and politicians who would like to employ the SOEs to additional their political or personal gains. It is also quarreled that corporate governance is weaker in state SOEs than in private firms because of organization problems. “SOEs have numerous objectives and numerous principals who have no obvious responsibility of observing”. One more cause for SOEs to have inferior corporate governance is the weak inducement structure for managers to perform competently. They do not look a market for their ability or the hazard of losing their jobs for non-performance. Thus, “fewer competition, better political interference and weaker corporate governance are strong hypothetical arguments against state ownership. Roth, 1987Privatization policies assume that private enterprises are more efficient than either central or local governments in the delivery of many goods and services for which people can pay, such as public transportation, electric power, piped water, or housing. Otchere (2003) presents a comprehensive analysis of the pre and post privatization performance of privatized banks and their rival banks in low and middle-income countries. The author does not find any significant evidence of improvements in the privatized banks’ post privatization performance. In fact, the privatized banks have a higher proportion of bad loans and appear to be overstaffed relative to their rivals, in the post privatization period. The continued government ownership of privatized banks is found to be responsible for their underperformance, as it hinders managers’ ability to restructure them efficiently. Accoridng to Levine (1997) governments usually adopt privatization programs primarily to raise revenue and in order to improve the economic efficiency of former state-owned enterprises, most also hope that privatizations implemented through public share offerings will develop their national stock market. Recent economic research has given added impetus to this objective by conclusively documenting a direct link between capital market development and economic growth. Bortolotti (2000) examine governments’ choices between selling privatization share offerings domestically versus externally. While both of these studies examine the impact of privatization issues on subsequent external financing, and the Bortolotti, paper indirectly measures privatization’s impact on stock market development, the current study focuses much more directly on privatization’s role in market development and patterns of stock ownership and the result is positively. Megginson M. K. (2000) examines the effect privatizations have had on the pattern of share ownership by individuals and institutional investors and find that privatizations have dramatically increased the number of shareholders in many countries. William L. Megginson (2004)examine the impact of political, institutional, and economic factors on the choice between selling a state-owned enterprise in the public capital market through a share issue privatization (SIP) and selling it in the private capital market in an asset sale. Researchers find that the nature of the capital market in the privatizing country is key to the privatization decision-SIPs are more likely to occur in countries with less developed capital markets, perhaps resulting from the government’s need and desire to use SIPs to develop the national market’s liquidity and absorptive capacity. SIPs are more likely when income is more equal throughout the country, providing more potential investors and avoiding the need for extensive under pricing of offerings

According to a study by Feng (2004) the Singapore government still maintains controlling power over privatized SOEs (called government-linked corporations) but these firms seem to operate quite efficiently. Bortolotti (2002)also found more improvements in efficiency and output for firms in countries where stock markets are more developed and where property rights are better protected and enforced.

Schmidt (2000) who shows that mass privatization reduces the political support for redistributive economic policies. Perotti (2001) find that privatization reduces perceived political risk and increases stock market capitalization, which is consistent with a positive impact on political support for market-oriented policies.

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