THE banking sector reforms in Pakistan did not lead to a rise in the overall profitability which was held down by a combination of rising deposit rates and intensified competition, says a latest IMF study.
“Nor did it lead to a strong convergence in all aspects of efficiency, because, it seems, in the liberalised environment strong banks were generally able to keep ahead of those trying to catch up”, it further said.
The IMF report, “Bank Reform and Bank Efficiency in Pakistan”, conducted jointly by Mr Daniel C. Hardy and Ms. Emilia Bonaccorsi di Patti, pointed out that the public sector banks and the privatised banks made progress in improving cost efficiency, and their relative profitability improved noticeably, if from a lower base. The reforms did not allow all banks, including the public sector banks to improve their underlying revenue performance, and especially the privatized banks seem to have succeeded in expanding their revenue base and in the way regaining profitability.
Financial market deregulation and liberalization has transformed the banking systems of a large number of countries over the last two decades. The reforms are sure to have a profound effect on the development of the financial system in these countries, and their overall macroeconomic performances. The transformation has been perhaps most in some developing countries where previously a ‘dirigiste’ approach to the financial sector prevailed and where there was little scope for competition, the allocation of resources according to commercial criteria, or the introduction of new products and services.
“Pakistan was one such country, which between 1988 and 1992, very substantially de-regulated interest rates and the allocation of credit, liberalised entry into the sector and privatized major state-owned banks, and introduced modern prudential de-regulated interest rates and the allocation of credit, liberalised entry into the sector and privatized major state-owned banks, and introduce modern prudential regulation and supervision”.
Nevertheless the report believes that the new banks could adopt the most up-to-date practices and specialise in the most profitable market segments, whereas existing banks and in particular the public sector banks may have been burdened by outdated practices and commitments to less profitable activities. But there was market “catching up” in terms of cost efficiency. “It seems on balance that deregulation increased the penalty for being inefficient”.
The report also said that public sector banks tended to suffer both cost and revenue inefficiencies. The banks that were eventually privatized seem to have been relatively efficient in terms of revenue performance even before reform, and increased their lead over the banks that remained in the public sector after they were privatized, but their cost efficiency was somewhat worse. Possibly, both the preparation for privatization, and new incentives and scope for profit maximisation thereafter induced them to seek higher revenues, but they could do little about their cost structure. The private domestic banks and the foreign banks seem to have been about equally profitable. The private banks tended to have lower revenues and especially lower costs, which may reflect differences in specialization.
Talking about effect of structural factors and market conditions, the report said that the net results provided an indication of the gains and losses in relatives efficiency achieved by various group of banks across time. “The evolution of all performance will depend not only on such gains and losses, but also on changes in structural features of the banking system, such as technological developments, the opening of new markets, and degree of competitiveness of the sector, and on changes in market conditions, such as interest rates”.
The report said that for all banks, average profitability improved only modestly but the improvement for the public sector banks was slightly greater. Changes in structural features tended to raise profitability, whereas changes in market conditions lowered it, but when looking at public sector banks alone the evidence is mixed. “The transformation of Pakistan’s financial system was profound, but the role of the state remained important, not only through the national commercial banks, but also the specialised credit institutions and sundry measures promoting the allocation of credit to certain favoured sectors and facilitating the financing of the government. Further, significant non-prudential regulations remained in force, notably in relation to foreign exchange and external transactions”, the report added.
The State Bank Annual Report for 2000 says that the banking sector has been undergoing a complex, painful but comprehensive phase of restructuring since 1997 with a view to make it sound, efficient at the same time forging its links firmly with the real sector for promotion of savings, investment and growth. Although a complete turnaround in banking sector performance is not expected till the completion of reform, signs of improvements are visible. Furthermore this improvement has to be seen in the context, not only of restructuring undertaken so far, but also the negative fallout of freezing Foreign Currency Accounts (FCAs) in May 1998. The report concedes that banks have taken the hit on their profitability from almost every side. After the freezing of FCAs, long term federal investment bonds (FIBs) became highly attractive due to sharp decline in short term yields. Net interest margins also declined across the board, except for NCBs, which rose from 1.5 per cent in 1997 to 3.3 per cent in 1998.