Attachment 01

[kIVA1I2A1ICN AND NCN-LkICkMING LCANS] CcLober 29, 2009
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Has privatization reduced the proportion Has privatization reduced the proportion Has privatization reduced the proportion Has privatization reduced the proportion
of Non of Non of Non of Non- -- -Performing Loans and increased Performing Loans and increased Performing Loans and increased Performing Loans and increased
Bank performance in Pakistan? Bank performance in Pakistan? Bank performance in Pakistan? Bank performance in Pakistan?

Moslim Commerciul Bunk und Allied Bunk Limited
(re-pr|vat|zat|on and ost-pr|vat|zat|on compar|son)
Authors: Imran kar|m Saroh|, Muhammad 1ar|q
Superv|sor: Cather|ne L|ons
SLudenL umea School of 8uslness
AuLumn SemesLer 2009
MasLer Lhesls, one-year, 13 hp

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Serial
Number
Table of Contents Page
No
Copyright Notice 1
Acknowledgement 2
Preface 3
Abstract 4-5
1 Introduction 6
1.1 Background 6-8
1.1.1 Pakistan Banking Evolution System 8
1.1.2 Dominance of Nationalized Commercial Banks (NCB) 8-9
1.1.3 History of Non-Performing Loans (Snapshot) 9
1.2 Research Question 9
1.3 Purpose of the Research 9
1.4 Definitions 10
1.4.1 What is privatization? Different Views 10
1.4.2 Types of privatization 10-11
1.4.3 Non-Performing Loans 11-12
1.4.4 Definition of Banks 12
1.4.5 Performance 12
1.5 Limitations 12
1.5.1 Limitations of the Data 13
1.5.2 Limitations of Research 13
1.6 Disposition 14

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2 Theoretical Framework 15
2.1 Pakistan Economy and Lending Market 15
2.1.1 Pakistan and the World (2008) 15
2.1.2 Economy Overview 16
2.1.3 History of Pakistani lending market and Non-Performing
Loans
16-17
2.2 Privatization as an Economic Instrument 18
2.2.1 Why Privatization 18
2.2.2 Different views on effect of Privatization 19
2.2.3 Efficiency of Privatization 19
2.2.4 Views on the effect of Privatization on Customers 19
2.2.5 Privatization Impact on NPLs and banks performance (IMF
Analysis)
20-21
2.3 Performance of the Banking Sector in Pakistan from (1980s to
now)
22
2.3.1 The role of the Central Bank 22
Regulatory Authority 22
Reform Measures taken by State Bank of Pakistan 22
Recent trends in banking sector 22
2.3.2 Introducing Major Reforms and Prudential Regulations in late
1980s
23
2.3.3 Analysis of Financial Sector Reforms 24
Interest Rate 24
Performance and Efficiency of Financial Institutions 25
Privatization 25
2.3.4 Conditions before privatization in Banking Sector
performance
26
2.3.5 Main problems before privatization took place in banking
sector
26

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2.3.6 Financial sector reforms 1990 26-28
2.3.7 Banking Law Reforms 28
2.3.8 Post-privatization activities 28-29
2.3.9 Banks privatized just after privatization 29-30
2.4 Non-Performing Loans and Classification 31
2.4.1 Treatment of Non-Performing Loans 31
2.4.2 Classification of Non-Performing Loans 31
2.4.3 Facts regarding Non-Performing Loans 32-33
2.4.4 Impact of NPLs on Banking sector 33-34
2.4.5 Causes of Non-Performing Loans in different countries 34-35
2.4.6 Different Views and Analysis on Non-Performing Loans 35-36
2.4.7 Steps taken by State Bank of Pakistan to overcome NPLs in
future
36-37
Conclusion on NPLs 38
2.4.8 Short review of MCB and ABL 38
MCB Privatization Impact Analysis 39
ABL Privatization Impact Analysis 39
MCB and ABL Comparison after Privatization 39
3 Research Methodology 40
3.1 Statement of the problem 40
3.2 Scope of the study 40
3.3 Research Philosophy 40
3.3.1 Positivism 41
3.3.2 Phenomenal 41
3.4 Research Approach 41

v

3.4.1 Inductive Approach 41
3.4.2 Deductive Approach 41
3.5 Research Methods 42
3.6 Research Design 42
3.7 Research Criteria 42
3.8 Sample and Sample Size 43
3.8.1 Population 43
3.8.2 Sample 43
3.9 Hypothesis 43
Hypothesis Model 44
3.9.1 Null Hypothesis Model 44
3.9.2 Hypothesis Model 44
3.10 Dependent and Independent Variables 44
3.10.1 Variable 1 44
3.10.2 Variable 2 45
3.11 Analysis Format 45
3.11.1 Percentages of Non-Performing Loans of Muslim
Commercial Bank
45
3.11.1 Percentages of Non-Performing Loans of Allied Bank
Limited
45-46
Short review of NPL percentages 46
Short Description of Chapter 4 47
4 Our Analysis and Outcome 48
Levene s test for equality of variances 48
Independent sample test 48
T-test for equality of means 49

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Confidence interval 49
Observations 49
Observation No: 1 (Muslim Commercial Bank) 49-51
Observation No: 2 (Allied Bank Limited) 51-53
5 Conclusions and Recommendations 53-54
Recommendation for further Research 54
6 Truth Criteria 55
Reliability 55
Validity 55-56
Generalization 56
References 57-60
7 Glossary 61
8 Appendices 62-68
9 Index 69-72


1

Copyright Notice
Copyright @ Muhammad Tariq, Imran Karim Sirohi 2009
All Rights Reserved. No part of this thesis may be reproduced, stored in or introduced into a
retrieval system or transmitted, in any form or by any means (electronic, mechanical,
photocopying, recording or otherwise).
Students and academicians can take the advantage from this Thesis Report. If any individual
wants to take reference from this report he/she can use it for the reference of his/her academic
thesis.

Printed in Umea University, 2009


2

Acknowledgement

First of all we are grateful to Allah Almighty, the most beneficent and ever merciful who gave us
courage to complete our Thesis Report.

It has been half year we have started our thesis entitled Has privatization reduced the proportion
of non-performing loans and increased bank performance in Pakistan During this period, many
people have contributed to the success of this thesis.

We wish to express our gratitude to the supervisor Miss. Catherine Lions for the advice that she
provided us throughout the study period, in particular the discussions that we had during our stay
at the University of Umea. Her maximum effort contributed to the success of this project. We
want to acknowledge the help that we have received from Mr. Ghulam Abbas (Assistant
Professor, University of Iqra, Pakistan). He helped us to acquire an in depth knowledge of the
statistics part.

We are grateful for the support and co-operation that we have received from department of
Business Administration of the University of the Umea, in particular the support of Miss. Gisela
Taube Lyxzen.

The support of our family was also invaluable in completing this thesis. They all have been on
our side through prayer, moral and support. Finally, we wish to express our gratitude to all our
teachers in the university education that provided us with a good background for completing this
thesis.

________________
Imran Karim Sirohi
Student, Umea University

_____________________
Muhammad Tariq
Student, Umea University


3

Preface

The study of Finance has always been interesting and full of complexities. Think of today major
economic sectors of Pakistan, Industrial, Textile, Agricultural, Banking, Telecom, Media and
Government and Semi Government Sectors and many more, question is which sector has played
an important role in making the economy of the country strong. Of course Banking Sector that
has contributed a major part in the economy of the country after the privatization has taken place.
Other sectors like Telecom and Media have done a great job for the last seven to eight years but
Banking has overcome other sectors because of the high stream of privatization process. So it is
therefore necessary to study the measures of banking sectors and to find out the problems which
have been affecting the economy of the country.


4

Abstract

Privatization has become an important aspect all over the world especially in developing
countries of the world. Pakistan has also embarked on privatization program for the state-owned
financial sector. As this report is limited to banks so we have selected banks which were
privatized in the decade of 1990-2002 and the topic on which we have emphasized is Non-
Performing Loans.

This thesis is based on the two main things, firstly privatization of government owned banks and
secondly Non-Performing Loans proportion with respect to the effect of privatization.
Privatization of government owned banks in Pakistan was the main reason behind the overcome
of weak banking sector and as part of this policy, for the very first time in 1991, two government
owned banks of Pakistan Muslim Commercial Bank (MCB) and Allied Bank Limited (ABL)
were converted into private entities.

In first step authors have tried to collect data regarding the history of Pakistan as an economic
instrument, why privatization in banking sector was important, review of banking sector and its
performance in Pakistan and Non-Performing Loans and its classification with respect to
privatization in the banking sector.

Banking sector is considered as one of the most important sector of every country and there are
so many measures to gauge the performance of the banking sector. There are many measures
utilized to gauge the performance of the banking sector like measuring asset quality, capital
adequacy, earning, profitability, liquidity. Out of these performance measures this study is
targeted towards gauging the operating performance of banks keeping in view the global
performance. We have taken one specific measure that is Non-Performing Loans of selective
banks to find out the operating performance of the banking sector and impact of privatization has
been kept in mind to find out the results. So the scope of the study is to find out the impact of
privatization on performance of banking sector and the area of the study is Non-Performing
Loans.

The nature of the topic puts on view that that it cannot be studied in artificial environment. The
topic has been analyzed in natural environment without any involvement, so the research is more
of exploratory research and as well as descriptive. The purpose of the study is Exploratory in
nature, as it aimed to collect and create appropriate information related to the topic. The method
of conducting this research is based on secondary data. We have adopted the secondary data
collection method, for that we have gone through the newspapers, internet, books, magazines,
annual reports, articles and different libraries have been investigated.

For the empirical studies, we have taken observations from two different banks: Muslim
Commercial Bank (MCB) and Allied Bank Limited (ABL) and we have done the comparison of
means between their pre-privatization period and post-privatization period respectively to assess

3

the impact of privatization on Non-Performing Loans. To compare the means we have use SPSS
software.

We looked at the Group Statistics in which we compared Levenes Test for Equality of
Variances to find out the variance result. Secondly we looked at the Independent Samples T-Test
to compare means and finally to prove the hypothesis we looked at Confidence Interval of both
the observations. We can conclude that Banks performance has improved on the basis of results
of only one factor that is Non-Performing Loans and has a positive impact on NPLs overall and
performance of banks have gone upward due to decrease in Non-Performing Loans percentages.
We cant say that banking sector performance has improved overall, because there are so many
factors from which we can have different results but as our research is limited to only one factor
that is NPL, hence on the basis of that we conclude that privatization has a positive impact on
Non-Performing Loans of two banks of Pakistan which we have studied.


6

Chapter 1 (INTRODUCTION)
First chapter of our thesis is Introduction part which will cover the major aspects of this essay.
First one is Background of the report. Second thing is Research Question for what this
research is happening and Purpose of the Research and some main Definitions related to our
research topic. Finally we will present limitations and disposition of the thesis. Applied terms
will be used throughout this part
(1.1) Background
Non-Performing Loans or we call it a bad loan has been a big problem for not only developing
countries but also for developed countries. Many countries have adopted the formula of
privatization in order to strengthen the banking performance and until now most of the developed
countries have converted their state owned banks to private banks. According to the different
studies privatization has played a major role in Banking Sector to develop it in a more efficient
manner but issue of Non-Performing Loans is still debatable all over the world, especially in
developing countries.
Researchers have found that most of the banks were merged or were closed in order to avoid the
bankruptcy and main reason which was disclosed was high non performing loans and their high
cost.
All countries in the world consider banking sector as a backbone of any developed country and
to make the financial sector strong and stable, governments involve actively. Pakistani
government has also worked actively in making the banking sector efficient and no doubt that
after privatization Pakistani banking sector has performed very well in the global market, but the
main problem in Pakistan which is still held there, is the problem of Non-Performing Loans.
The ongoing Non-Performing Loans has created a complex environment for banking sectors
throughout the world but the most affecting one are developing countries whose banking sector
has not really showed a vast improvement compare to developed countries. The main problem is
the balance sheet which never figures out the true essence of Non-Performing loans. Pakistan
Non-Performing Loans might be considered as a problem in the same way but there are so many
reasons which compelled Pakistan to revive their banking sector and to expose the true picture of
Non-Performing Loans.
Privatization impact has shown a vast improvement but still banking sectors never really come
up with comprehensive reports on Non-Performing Loans. So there is a need of looking at the
impact of privatization on banking sector and to see whether privatization was really the main
solution to wipe out the Non-Performing Loans in different ways.
Before discussing the main Pakistan banking evolution system we need to know the main
reasons of why financial institutions lost control on their money and how did they spread their
loans without investigating in a true manner.
The main reasons which can be seen here are:

Poor management with bad quality banking services

7

Large number loss incurring branches
High percentage of non-performing loans
High influence of political bodies in public financial institutions
Inadequate market capitalization.

These are the problems which occurred before privatization and the main of them was Non-
Performing Loans which affected the financial institutions very badly.

Non-Performing Loans as major problem in foreign key financial markets

Here we will discuss about some economies that are developed but still suffered from Non-
Performing Loans. Just to provide the basic theoretical information in order to know how Non-
Performing Loans have created problem in different foreign financial markets and then we will
discuss about Pakistani banking system.

US Market

US market has been fixed in the loan crisis from 1989 to 1994 and the main reason which author
address here is real estate and consider it as a biggest banking crisis. The FDIC Corporation
(Federal Deposit Insurance Corporation) has probably given the enhanced information about the
saving and loans crisis and concerned about debt emergence problem.

Berger and DeYoung (1997) has analyzed the main link between cost efficiency and Non-
Performing Loans in a complicated way. According to if Non-Performing Loans are higher in
volume then the efficiency cost will be lower. Author further also explain that mismanagement
of funds also one of the main reason of increasing Non-Performing Loans.

Some authors have different opinion from US financial market and they talk mainly about
political connections which is why Non-Performing Loans proportion is going up. Remember,
privatization is very old in US economy but still Non-Performing Loans are going up. We cannot
compare Pakistani economy with American economy as both are in different ways.

China Market

Peiser and Wang (2000) have discussed the motion approach of concerned debts in China by the
means of lay out of state-owned asset management companies for Chinese biggest state-owned
banks. They compare their financial economy with US where (RTC) Resolution Trust
Corporation was introduced to promote quick workout for Non-Performing Loans.

Another study was examined by Chen (2004). Chens main execution was to examine the legal
and economical framework concerning securitization of Non-Performing Loans performance
with respect to government involvement to check whether adjustments and debt restructuring
plans are important for long term securitization.

Japan Market


8

Herr and Miyazaki (1999) discuss about Non-Performing Loans problems and also favor
securitization as a main proper solution in order to achieve a positive balance sheet for the
financial markets. Authors further mention about the need of political involvement which can
promote the idea of securitization especially for the private banks. Japanese market has mainly
focused on privatization and it really worked for them but they also need a support of
government to reduce Non-Performing Loans.

Barseghyan (2002/2004) has come up with the problem of Japanese lack of government
interference in order to solve Non-Performing Loans and economic downturn. Barseghyan
further says that government need to support and interfere more in privatization banks to create a
suitable environment for financial markets and that will also increase the chances to overcome
Non-Performing Loans.

Pakistani financial market is totally different from the above mentioned market and their nature
of problems of Non-Performing Loans is totally different. High interference of so many sectors
without privatization made it more complex. Privatization came late in Pakistan, so the main
problem of Non-Performing Loans proportion need to be discussed.

(1.1.1) Pakistani Banking Evolution System

In Pakistan the activities involved in the financial sector are mostly in the hands of Government
and the main reason behind control of government is to implement its own development
strategy.
1

In 1974 all domestic banks were nationalized and all banks were spitted into six main national
banks. Other than the National Banks some credit institutions and House Hold Savings were also
established. The main purpose behind the nationalization was to ensure bank credit towards
government sectors and their funding, and this was one of the main reasons why Non-Performing
Loans percentage in pre-privatization period was very high.

High interference of the government
enforced banks to hold 30% of their deposits as government securities and 5% as a cash reserve
requirement which led to financial repression and banks could not hold their high returns on
portfolios. This was yet another reason why Non-Performing Loans went up.
2

(1.1.2) Dominance of Nationalized Commercial Banks (NCB)
From 1970s till 1991 Nationalized Commercial Banks had a strong influence on the banking
sector due to highly strict restrictions imposed on opening of private banks; they worked as per
the policies of government because State Bank of Pakistan was sharing a power with Pakistan
Banking Council who did not allow the central bank to enjoy the freedom of decision making.
Hence politicians of Pakistan who had a strong influence over the main sectors of Pakistan
especially financial sectors, kept on taking loans from the banks without realizing the outcome of
financial repression which swelled the portfolio of Non-Performing Loans.
3

The banking sector was in jeopardy when clear picture came in 1990, the banking sector was
unable to provide a level of competition because of the higher ratio of National Commercial
Banks. Till 1990 there were 8 state owned banks and there percentage was 92% in total banking
assets, while other foreign banks which were 31 in number had only 8% of the total sector.
4


9

Government never realized the importance of Non-Performing Loans till 1990s when most of the
banks were in a pathetic position and they were unable to maintain the 30% of government
securities .Politicians kept on taking loans without realizing of giving it back to the banks, while
on the other side top management of banks enjoyed a healthy cash along with government
people.
(1.1.3) History of Non-Performing Loans
First time Non-Performing Loans issue was raised in America when very serious financial crisis
jolt American Stock Exchange in a very bad manner. (Morgan Stanley, 2004). In order to
overcome these crisis American Government introduced the corporation known as Federal
Saving and Loans Insurance Cooperation to work for the primary reasons of defaulted loans,
but due to the high cost and cash problems this cooperation itself went into huge loss and it can
clearly be seen that Non-Performing Loans are one of the major issues all over the world.
5

Pakistani Financial Sector had also faced the same problem and still government and different
financial companies trying to overcome this major problem. Banking Nationalization Act and
Pakistan Banking Council should be stood as responsible for all this, but without having strong
evidence one cannot blame them.

Non-performing loans have compelled many countries to establish Asset Management
Companies that fix the problems of Non-Performing Loans.
6

(1.2) Research Question

The Research question that we have formulated for our research is:
Has Privatization Reduced the Proportion of Non-Performing
Loans and Increased Bank Performance in Pakistan?

(1.3) Purpose of the Research

The main aim of this research is to assess the impact of privatization on Non-Performing Loans,
that how privatization helped Pakistani Banks to reduce the percentage of Non-Performing Loans
and whether bank efficiency or performance has improved after privatization or not. The
research will focus on the measurement of Non-Performing Loans and authors will find the
problems or constraints which banks encountered at the time of privatization of state owned
banks and what major post-privatization steps were taken by the authorities to reduce the
proportion of Non-Performing Loans.
1

1

1
Emilia Bonaccorsi Di Patti and Daniel C. Hardy, (2005) Effects of Banking System Reforms in Pakistan, The
journal of banking and finance, IMF Monetary and Financial Systems Department, April 20, page 4-5.
2
Abid A. Burki and Ghulam Shabbir Khan Niazi, (2003) Effects of Privatization, Competition and Regulation on
Banking Efficiency in Pakistan, 1991-2000, November 12, page 2-3
3
Ebit,
4
Ebit

10

(1.4) Definitions
(1.4.1) What is privatization? Different views
Privatization (1)
Privatization is a pure conversion of productive items from public to private ownership and
change in control of the firm. Privatization has also been considered as a major player to improve
the economy of any country. Firstly privatization started in United Kingdom and then slowly and
gradually started to take place in other parts of the world, especially industrial countries, but the
motion of privatization started slowly in developing countries because of high influence and
involvement of government authorities. Afterwards the pace went up and 1990s showed the
major impact of privatizations all over the world.
7

According to the author more than 15,000 state owned enterprises privatized. According to
researchers, in next twenty years, $6 trillion of privatization assets will be sold of which 3 trillion
has been sold in last ten years, majority coming from Eastern Europe and China.
8

Privatization (2)
Different authors define privatization in different ways. According to Chowdhury F.L,
privatization is a pure process of ownership transfer from public to private or in short words
transfer of ownership of any government based company to private company.
9

(1.4.2) Types of Privatization

There are three main different methods of privatization and they are:

Share Issue Privatization: In this method of privatization management of the company with the
consent of their share holders sell shares to the stock market and this method is the most
common method of privatization. This method is very useful in enhancing the liquidity and
economic growth but it totally depends upon the strength of capital markets, if they are not
sufficient enough then it is very difficult for the firm to find out the potential buyers and this
could lead to higher transaction cost. Asset Sale Privatization: In this method of privatization
one firm acquires other firm assets. Voucher Privatization: In this method of privatization
shares of the owner are distributed among people at a very low price. This method is mostly used
in Transition economies, like Central and Eastern Europe. Citizens can buy a voucher from the
state owned institution which represents their shares in those institutions.
10

2

5
Jessica Peterson, Isac Wadman, (2004), Non-Performing Loans, The markets of Italy and Sweden, Bachelor Thesis
Uppsala University Department of Business Studies, page 5
6
Ebit
7
Robel Netserab Debassay, (2004) The Impact of Privatization on firm efficiency, labor and budget of government,
University of the Western Cape, Bellville, page 1-2
8
Ebit
9
Chowdhury F. L (2006) Corrupt Bureaucracies and Privatization of Tax Enforcement, Article on Dhaka Studies
10
www.en.wikipedia.org/wiki/privatization

11

Privatization (3)

To convert publicly owned companies into privatization is to increase the efficiency of the firms;
because private owners tend to work more on profit maximization as compared to the
government based owners who are not really interested in profits of the firm.
11

Governments have implemented the method of privatization hoping that new private owners will
increase the efficiency of the firms and reduce the demands of State Owned Enterprises. Further
philosophers think that converting public enterprises to private enterprises would lead them to
enhance their overall efficiency. (Richard and Mansoor, 1998).

With privatization another thing
like financial and technological resources will be planned more accurately in order to increase
the chances of lucratively and reduction of government subsidies.
12

(1.4.3) Non-Performing Loans:

When loan goes default for more than 3 months then that loan is considered to be as Non-Performing
Loan. This can also be depending on the terms of loan contracts.
13

Central Bank of Pakistan classifies Non-Performing Loans into following categories
14

Other Assets Especially Mentioned: NPL type in which amount which has been recovered is
less than 75% of the amount receivable and has been over due by more than 180 days.
(Provisioning)This is the type in which no provisioning is required.

Substandard: NPL type in which amount has been recovered is less than 60% of the amount
receivable and has been overdue by more than 1 year. (Provisioning) of 20% of the difference
resulting from the outstanding balance of principal less the realizable value of liquid assets.

Doubtful: NPL type in which amount has been recovered is less than 40% of the amount
receivable and has been overdue by more than 2 years.(Provisioning) Provision of 50% of the
difference resulting from the outstanding balance of principal less the realizable value of liquid
assets.

Loss: NPL type in which amount has been recovered is less than 20% of the amount receivable
and has been overdue by more than 3 years. (Provisioning) provision of 100% of the difference

3

11
www.answers.com/topic/privatization
12
University of the Western Cape, Bellville, page 1-2
13
www.en.wikipedia.org/wiki/non-performing
14
State Bank Report (2008), Guidelines for Infrastructure Projects Financing, page 21, State Bank of Pakistan


12

Banks definition of Non-Performing Loans consists of 2 different types:

Loan which was executed and has been passed for more than 90 days and still accruing
interest.
Loans for which interest is not accrued.
15

Impaired Loans:

Loans which are not expired but it is not sure whether debtor would be able to repay the debts.
Because of this uncertainty banks and other financial institutions dont consider this loan as Non-
Performing Loans. In other words this loan is a no loss provision for them.
16

(1.4.4) Definition of Banks

Bank
Bank is financial institution where people keep their extra money for saving and safe custody
purposes. Institutions also deposit money in bank for interest earning purposes. Banks lend these
deposits to other individuals and institutions in the form of a loan to earn profit and pay interest
to their depositors.
17

Commercial Bank
Commercial banks are those institutions where individual and institutions keep their money for
saving and safe custody purposes. Commercial banks lend these deposits\savings to individuals,
institutions in the form of loans for commercial business to earn profit and pay interest to their
depositors.
18

Private Bank
Private Banks are those financial institutions which are totally owned by private people. The
percentage of shares in ownership in institution is more than 51%.For example: MCB Bank Ltd,
Allied Bank Ltd, Bank Alfalah Ltd etc.

State Owned Bank
State owned banks are those financial institutions whose supervision is under the control of the
government. The percentage of shares in ownership in institution is more than 51%... For
example: National Bank Of Pakistan, State Bank of Pakistan.

(1.4.5) Performance

In terms of finance, performance of the firm refers to the profitability, stability, and validity of
business. If firm profitability is increasing in both short and long term in constant way, means
firm performance is improving. The firm with strong solvency position means ability to pay its
long term obligations to the creditors, shows firm performing well. Performance of the firm also
assessed through its liquidity position.
19


13

(1.5) Limitations

(1.5.1) Limitations of the Data

As this report is limited to banks so we will look at some banks which were privatized in the
decade of 1990-2002. The banks which we have chosen for our Thesis Report are: Muslim
Commercial Bank and Allied Bank Limited. Before privatization there were 6 banks which were
nationalized their pre-privatize data was available but their post-privatize data was not that
sufficient, and out of 6 nationalized banks 3 banks were privatized in 1997. Another problem
was time constraint and access of banks which was difficult for us to cover all 6 banks that is
why we limited our research to two banks. It was the hope that the banks might be restructured
into more efficient, profitable, competent and value creating private enterprises. This thesis,
therefore, assesses the impact of privatization on non-performing loans of banks.

(1.5.2) Limitations of Research

This research is to assess the performance of banks. There are so many factors from where we
can assess the performance of banks, but as our research is limited to only one factor that is non-
performing loans, so all the results of performance of banks is on the basis of percentages of non-
performing loans of total loans to see whether from non-performing loans point of view banking
performance has improved or not. If we combine other measures of assessing performance of
banks along with the measure that we have taken, then the results are liable to change.

4

15
www.en.wikipedia.org/wiki/non-performingloans
16
Jessica Peterson, Isac Wadman, (2004) Non-performing Loans, The markets of Italy and Sweden, Bachelor Thesis
Uppsala University Department of Business Studies, page 5
17
www.google.com.pk
18
www.investorwords.com/955/commercialbanks

14

(1.6) DISPOSITION

This section will tell you the step by step chapters which will be covered at the later stage of the
research, keeping in view the guidelines, which are necessary to follow.

(2) Theoretical Framework

A chapter which contains a deep study of the research papers, articles, newspapers, journals and
academic source, solely related to the subject area. This chapter will guide reader to the proper
reaching of research methodology and conclusion part. Topic related theories will be explained
in this section with simple and appropriate explanations.

(3) Research Methodologies

This chapter will provide reader the methodological approach of the researcher as to how
researchers have formulated the methodology of their subject and work order.

(4) Our Outcome and Analysis

This chapter will provide the depth description of the outcome of the topic. This chapter will also
cover the results which will produce by applying some statistical tools and concepts.

(5) Conclusions and Recommendations

Finally on the basis of the results which will be given by the tools in the methodological chapter
reader will get to know the conclusion of the topic and researcher will also come up with some
recommendations.

(6) Truth Criteria

This chapter will show the reliability and validity of the report.

(7) Glossary

(8) Appendices

This chapter will show the tables and graphs which have been used in this report.

(9) Index

19
www.answers.yahoo.com


13

Chapter 2 (Theoretical Framework)

This chapter is organized into following sections:
Section 2.1 will review history of Pakistan related to its economy and Non-
Performing Loans
Section 2.2 will review privatization and why privatization is important in Pakistan
Section 2.3 will review banking sector and its performance in Pakistan
Section 2.4 will review Non-Performing Loans and its classification

(Section 2.1)
The features and characteristics of non-performing loans all over the world can be varying from
sector to sector. In Pakistan the financial sector and especially the banking sector is the highly
affected sector from the Non-Performing Loans and therefore it is useful to find out whether
after privatization Non-Performing Loans proportion has been reduced or not. This is the main
theme of the research and keeping in the view it will be discussed in this chapter of literature
review.
(2.1) Pakistan Economy and Lending Market
When Pakistan came into being in 1947 there was not a single industry in Pakistan and almost
whole economy of Pakistan was based on Agriculture and 75% of Pakistan population was living
in rural areas. Culture of Landlord, one can say a gift of God since independence but
unfortunately high interference of landlords in the politics and good relationship with the
government officials came out in the clear picture of Non-Performing Loans. Landlords took
loans but they never paid back and this worsened situation of non-performing loans ran till 1990.
The country Pakistan is located in South Asia with total population is around 160 million. Gross
Domestic Product of Pakistan grows by 5% to 6% every year.
20

(2.1.1) Pakistan and the World (2008)
21

Nominal GDP in $ 126.8M
GDP Rank 44/185
Per Capita (GNI) in $ 800
Per Capita GNI Rank 162/209
Population Rank 6/224
Geographical Area Rank 35/250
Global Competitiveness 92/131
Economic Freedom Index 93/157
Human Development Index Rank 136/177

16

5

(2.1.2) Economy Overview

Initially after independence people from India and Pakistan displaced due to the Hindu-Muslim
disputes and country economy was mainly based on Agriculture sector which could not produce
large amount of employment in the country, however slowly and gradually growth rate was
increasing as time was passing. Pakistan average growth was 6.8% in 1960s, 4.5% in 1970s,
6.5% in 1980s and 4.8% in 1990s.In 21 century growth picked up a speed and today after China
and India, Pakistan growth rate is the third fastest. The countrys GDP in 2006 was 128.8 Billion.
Services had a major share of 52.9% contributing in a Pakistans economy; Industry contributed
26.7% and Agriculture contributed 20%. Growth rate from 2003-2007 was 7.5% which was
record in Pakistans whole economy history, the main reason behind this impressive growth was
increase in domestic demand. The major problem facing the economy of Pakistan is the inflation
rate, which was 17.2% in April 2008. Quarter of the Gross domestic product is contributed by
manufacturing sector and two large industries in Pakistan are manufacturing and cotton textile
production. Other than these industries, revolve around construction, paper, food, fertilizer,
sugar, electric goods, beverages and shipbuilding. The Government of Pakistan has taken steps to
encourage privatization of these public sectors through the help of privatization committee which
was established in 1990. Until now committee has privatized around 143 public sectors including
seven banks, one major telecommunication company, 12 energy sector units, five newspapers,
five hotels and around 100 industrial units. In recent years, services which are the main
contributor to GDP are mainly consisting of construction, trade, transportation and
communications. These sectors have increased the flow of foreign direct investments
(FDI).Further, there is a wide improved change in the financial system and problem of
supervisory and inadequate governance, due to which Non-performing Loans were touching the
sky for a longer period of time, has been corrected through a series of government backed
reforms.
22

(2.1.3) History of Pakistani lending market and Non-Performing Loans
Pakistans history of Non-Performing Loans is based on the following characteristics, which has
been discussed in one of the research reports written by Salman A. Shaikh. We would like to
discuss those issues in this report.
Concentrated in the large scale manufacturing sector: According to the author, sector which
was affected more by the Non-Performing Loans was the large-scale manufacturing sector and
the sectors which were affected are textiles, sugar, cement and public sector companies. He
further mentioned that SME Non-Performing Loans do not have so much impact on (SMEs)
Small and Medium Enterprises it was mainly due to the debt aversion/low leverage in the SME
sector and high leverage in the manufacturing sector.
23

Concentrated in the public sector banks and financial institutions: According to the author,
most of the time Pakistans Non-Performing Loans were man-made and avoidable. 90% of the
Non-Performing Loans were mostly situated in banks and financial institutions which play an

20
www.privatization.gov.pk/finance/finance.htm
21
www.thomaswhite.com/explore-the-world/pakistan.aspx

17

important role in the economy of the country. Non-Performing Loans were mainly in public
sector banks. In private sector and foreign banks, Non-Performing Loans were very low except
in 1990s when economic and industrial growth was not up to the mark as it was working
previously. The other main reasons behind low Non-Performing Loans % in private banking
sector was due to the protection from overseas competition through tariffs on import-substitution
industries and below market interest rates.
24

Zero Equity Projects in 1980s and 1990s: Easy policies on finance projects, collusive lending,
pathetic corporate governance and bureaucratic style were also one of the reasons of an increase
in Non-Performing Loans of Pakistan. In this period so many projects which were set up, under
capitalization and high gearing became of the norm of every project and paid up capitals went
up.
25

Amateur Entrepreneurs: According to the author, another main reason behind the increase in
the Non-Performing Loans was business groups without knowing anything about the projects.
Groups like agriculturists, bureaucrats, military officers and judges who never understood the
meaning of business took loans and their main motive was to continue the tradition of Non-
Performing Loans that is to take loans and never give back. These influential defaulters taking
the advantage of their reputable statuses blocked efforts at enlightened NPL reform.
26

Direct Lending: People in the upper top management of public sector banks and enterprises
were solely selected by politicians and military officials without having professional competency
and capability inside them. These individuals were also satisfying their well wishers by giving
them loans and never took back from them. (Non-Performing Loans were at birth). Bankers
did whatever instructions came from them and public money was deteriorated.
27

6

22
LblL
23
Salman A. Shaikh, (2003) Maximizing Value of Non-performing Assets, Pakistan Experience, 1999-2003, 10-11
November, Seoul, Korea

18

(Section 2.2) Privatization as an Economic Instrument

(2.2.1) Why Privatization?

Privatization, till 1978 there was no such thing to implement; it was first time in 1979 when
British Thatcher Government introduced a word privatization with so many modern policies. For
the first twenty years not so many countries believe in this thing but slowly and gradually
countries understood the importance of Privatization and now all over the world Private
Companies Ratio is more than State Owned Firms. [Megginson, Price and Netter, 1998]
28

A strong favor in privatization can be proved when in early 1990s more than 15000 state-owned
firms turned privatized. [Kikeri, Nellis and Shirley, 1994]. According to Drucker in 1960s,
Government is a poor manager means companies which are owned by the government are good
in making plans but poor at spitting them out.
29

The main question arises from the privatization that whether privatization has improved firm
performances or companies just following successful company trends. We will focus more on
banking Non-Performing Loans.

In Pakistan when Banking Sector was state owned, banking sector was suffering from huge
losses and banks were unable to meet the requirements. Main reasons which can be seen to adopt
the policy of privatization by the state owned banks were competition, political intervention and
corporate governance.

Competition

According to the analysts, a greater competition will take place when privatization will improve
the operations and allocation of resources in the economy.
30

Political Intervention
Another main advantage of privatization is that it could help in improving firm efficiency
without changing the face of market monopolies if it stops interference of political bureaucrats
who since independence of Pakistan took loans and never returned to banks.

Corporate Governance

Another main point which strengthens favor in privatization is weak corporate governance in
State Owned Banks in Pakistan. No doubt that Pakistani State Owned Banks had multiple aims
and objectives and planned it in an accurate way but problem with them is that due to weak
corporate governance they never executed it in a professional way.
31

24
LblL
23
LblL
26
LblL,
27
LblL

19

(2.2.2) Different views on effect of Privatization
According Clarke et al (2003), country and cross country studies, he found that privatization put
the banks performance in positive node. He further analyzed that where the institutions setup is
weak, the ownership transfer to strategic investors through direct sales has more positive effect
on banks performance than ownership transfer through public offering.
32

According to Otchere (2003), study of privatized banks of low and middle income countries. He
found that after privatization the bad loans proportion increases and also banks were overstaffed
which affects the banks performance in negative way. On the other hand he found that privatized
banks were more responsible for their underperformance and more professional managers were
there to manage the activities in effective manner.
33

According to Boehmer et al. (2003) he examines those 101 countries from database that whether
political and economic factors affect the government decisions regarding privatization. He took
both developed and developing countries for the analysis. From his study, he found that banks
privatization weakens the banking sector in developing countries where government is more
accountable to its people.
34

(2.2.3) Efficiency of Privatization

Property Rights Theory

According to this theory, privatization is necessary for productive activities in the government
sector because individual or group showing no interest in government enterprise. The reason of
lack of interest of these groups is that they have no own stakes/property rights in the government
enterprises which is the main reason of inefficiency of state enterprises in productive activities.
35

(2.2.4) Views on the effect of privatization on Customers

From different research studies, we found that privatization of firms affects the customers
positively as well as negatively. But commonly the negative impact of privatization on customers
is increased prices of product and services etc. For Example: Bunn and Vlahos (1989), after
detailed analysis of effect of privatization in electricity industry, argue those twenty five years
ahead, the prices will increase in the range of 40 to 90%.
36
7

28
University of the Western Cape, Bellville, page 12
29
Ebit
30
Umer Khalid, (2006) The effect of privatization and liberalization on banking sector performance in Pakistan, SBP
Research Bulletin, Volume 2, Number 2, page 406
31
Ebit
32
Umer Khalid, (2006) The effect of privatization and liberalization on banking sector performance in Pakistan,
SBP Research Bulletin, Volume 2, Number 2, page 406-407
33
Ebit,
34
Ebit
35
George R.G Clarke, Robert Cull, Mary Shirley, Empirical studies of Bank Privatization, some lessons ,page 3
36
Ebit


20

Privatization vs. Competition

From study drawn by Shirley and Walsh 2003, According to their analysis privatization brings
competition in the market which pushes the firms performance in positive trend. Due to
privatization, operations and allocation of resources improve which makes the industry and
economy competitive. From their study they found that state owned enterprises are less
competitive because politicians use them for their self interest purposes i.e more higher of
personal without any need or giving more different incentives to their known private institution
which puts extra burden on firm budget to achieve their political goals, due to these reasons state
owned enterprises not perform efficiently and effectively. State owned enterprises are less
competitive because they dont have enough problems in generating funds, incentives etc
because in any worse situation government supports them by different incentives. On the other
hand private firms are more competitive because they need profit and performance to remain in
the market.
37

Privatization vs. Political Intervention

From the studies of (Shleifer and Vishny 1994, Gaal 1991: Shirley and Nellis 1991, World Bank
1995), concludes that after privatization the firm performance normally improves because
politicians are unable to use the firm resources for their own interest. The reason is that in private
sector the management is more capable to handle any intervention.

For example, in private banks, the managers are more independent in decision making regarding
their branch operations i.e decisions regarding loans and cost minimizing etc as compare to state
own banks. So he makes the decisions according to their bank policies and goals etc.
38

Privatization vs. Corporate Governance

According to studies of these researchers (Berglof and Roland 1998, Dewaripont and Maskin
1995, Schmidt 1996, Lopez-calva 1999, Vickers and Yarrow 1989, 1991), privatization improves
the corporate governance structure in firm by giving more incentives to their employees in order
to use their skills in efficient and effective manner which in result improves the firm
performance. On the other hand, in state own enterprises is weak due to less incentives to
employees, no worry of loss of job, lack of interest etc which results in bad performance of
employees. Bad performance of employees affects the firm performance in negative way.
39

According to Adam, Cavendish, and Mistry 1992, Caves 1990, Commander Killick 1988, Cook
and Kirkpatrick 1988, 1997, Stiglitz 1999, that mostly in developing countries firm performance
is not good even after privatization because of weak court system, weak policies for bankruptcy
problem, weak capital markets and weak banking systems etc.
40

(2.2.5) Privatization impact on NPLs and banks performance (IMF Analysis)

According to the IMF report privatization has helped commercial banks to maintain their NPL
issues and records shows that NPL trend is going downward. Write off guidelines were issues in

21

October 2002, which enabled banks to clean the stock of Non-Performing Loans more quickly.
Banks were expecting these guidelines for a long term period because they have kept NPL on
their balance sheet for a longer period of time even after 100% provisioning.
41

According to the IMF report, after privatization the ratio of Non-Performing Loans starts from
0.4% to 35% on average across all the banks. If you look at the overall position Asset Quality in
five largest banks of Pakistan is generally poorer than other small banks especially foreign
banks. Five largest banks gross loans to total NPL starts from 15 to 35%.Foreign banks ratio of
provision of NPL is 79.5% and overall its 63%.
42

8

37
George R.G Clarke, Robert Cull, Mary Shirley, Empirical studies of Bank Privatization, Some lessons, page 5-8
38
Ebit
39
Ebit,
40
Ebit
41
IMF report, (2005) Condition of the banking system, Pakistan Financial Sector Assessment Program, (Technical
Note), IMF Report No 05/157, Publication services 700, 19
th
street, Washington DC, page 7-8
42
Ebit

22

(Section 2.3) Performance of the Banking Sector in Pakistan (1980 to now)
(2.3.1) The role of the Central Bank
Regulatory Authority
The Regulatory Authority in Banking Sector of Pakistan is the Central Bank which is known as
the State Bank of Pakistan. According to the new prudential regulations in 1989 Central bank
was able to increase the capacity of its supervisory because Pakistan Banking Council was no
more in charge after the prudential regulations. Other than State Bank of Pakistan SECP also
supervises the banks which are related to public shareholding matters
43

Main Responsibilities of State Bank is
1. Licensing
2. Directing
3. Supervising
4. Controlling
5. Inspecting Banks
6. Exercising Monetary Control Policy Measures.
Reform Measures Taken by State Bank of Pakistan
44

To make the Prudential Regulations more mature and powerful
Liberalization in increase or decrease bank branches
Exchange Rate with free-floating rate has been introduced and buying and selling of
foreign currency from the bank has been lifted.
Banking Companies Act 1997, introduced in order to look into the issues of Non-
Performing Loans of different banks and financial institutions, which has been pending
since years.
Corporation with name Corporate Industrial Restructuring Corporation (CIRC) has been
established by the government with certain terms and conditions. The main aim of this
corporation is to takeover NPL portfolios of nationalized banks and instead of that issue
them government guaranteed bonds in order to earn market rates of return.
Minimum capital of banks has been enhanced to Rs 1Billion.
Credit Rating has been made mandatory for all the banks

23

Requirement of good corporate governance in order to avoid non-performing loans in the
future.
Relaxation in Merger and Acquisition
Recent Trends in Banking Sector
45

Relaxation in Merger and Acquisitions has helped local private banks to connect with
several domestic acquisitions.
Expansion in banks branch network
More committed to consumer finance and customer service
Reduction in NPLs due to good corporate governance.
(2.3.2) Introducing Major Reforms and Prudential Regulations in Late 1980s

Major financial reforms were introduced at the end of 1980s, by introduction of these reforms the
interest rates slope went from upward trend to downward trend and credit ceiling was also
eliminated till 1992.In 1989 new prudential regulations came into the market and these
regulations helped Central Bank of Pakistan to increase its capacity of supervisory. Pakistan
Banking Council was no more in position of to disturb central bank leading authority. Another
system for the government securities was established that this system of auctioning government
securities and regular auctions for six months bills began in 1991 (Hardy 2000).
46

The breakthrough in the Pakistani Banking Sector came at that time when Privatization
Commission took place in 1991 and liberalization of authorities gave chance to banks to get
privatized. For the very first time in Pakistan two state-owned banks were privatized named as:

Muslim Commercial Bank
Allied Bank Limited

Other than this, 10 other new banks started their operations and this shows the major positive
effect of reforms and regulations. Still there were 4 state owned banks in 1997 but great numbers
of domestic banks gave them a very intense competition.

Branching policy, reduction in employees, departments to overcome the recovery of Non-
Performing Loans and defaulters, and closing of unprofitable branches were one of the major
advantages that industry had.
47

The main step which State Bank of Pakistan took in order to clean the problem of Non-
Performing Loans was that it made a plan for how to recover Non-Performing Loans and
reformed the guidelines for loan classification. Because of these State-owned banks non-
performing loans further went up.
48


24

(2.3.3) Analysis of Financial Sector Reforms
49

As we above discussed the history of Pakistan economy and financial sector reforms specially
banking sector in deep. Prior to 1990, Pakistan financial institutions were in jeopardy due to
following major factors:
Poor management with bad quality banking services.
Large number loss incurring branches.
High percentage of Non-Performing Loans (NPL).
High influence of political bodies in public financial institutions.
Inadequate market capitalization.

These factors very badly affected Pakistan economic growth in between 1970-1980. In order to
improve and strengthen the economic system of country, Government of Pakistan undertook
financial restructuring reforms in early 1990 as we discussed above.

Strong banking system is necessary for the economic development of any country. The
objectives of these financial reforms are to strengthen the banking system in country. As
Shamshad Akhtar (Governor State Bank of Pakistan) said that:

We can improve and can make our financial institutions affective by high effective
resource mobilization and transferring these resources to improve economic growth.
More strengthen the financial institutions performance.
Promote and extend the financial to every sector of society especially poor.

Here we discuss the impact of these financial reforms in different terms.

Interest Rate

Prior to reform interest rate were set administratively and on average it was negative in real
terms. Due to negative trade investors or savers were encouraged to deposit money with financial
institutions. This situation is not good for any economy where people not take interest to
strengthen country financial institution which is very important for economic development.
50

After these reforms the price of financial services was determined by banks on a competitive
basis. In june2005, SBP reports show that lending rates decrease 8.81% from 15.6% as in 1998.
But real interest rate increase from 3.6% (1996) to 10.9% (2000). The decline trend in lending
rate shows the profitability of banks but in actual it is ad hoc not due liberalization. On the other
hand the deposit rate also reduced for 6.8 %( 1998) to 1.37% (2005) which further reduce the
saving in the economy.

The interest rate spread play very important role for profitability, competitiveness and efficiency
but after SBP reforms bring competition in economy but still there is high interest rate spread
which reached 7,44% in 2005 which discourage investment and saving in the economy but SBP
taking different measures to take down the interest rate spread.
51


23

9

Performance and Efficiency of Financial Institutions

We can analyze the performance and efficiency of financial institutions after reforms in two
aspects i.e. Insolvency and sustainable profitability. We take Non-Performing Loans (NPL) to
measure the performance of financial institution after reforms of 1990. As from history we know
that NPL was big hurdle in economic development before 1990. Even after SBP reforms its
percentage is on upward trend i.e. National commercial banks (NCBs) and DFIs in Pakistan are
facing great problem of high NPL i.e. Rs.25 billion in 1989 which increased to Rs.128 billion in
June 1998, 4% of GDP. Further it increased from Rs 230.7 billion (Dec.1999) to Rs.240, 1
billion in (DEC, 2000). But since 2001, NPL percentage was on declining trend which improves
the performance of financial institution and this resulted of significant reforms and effort of SBP
and Government of Pakistan policies. Due to the fact that effective measures NPL went down
from 25% to 8.3% of the total advance of banks and DFIs at the end of 2005. The net NPLs ratio
was 2.1%. These all indicators show that performance of banking sector improved because 1996
the banking system was near to default and 1/3 of its assets stuck in form NPLs but now it seems
stable.
52

Privatization

Before 1990 all banks in Pakistan were public owned in which the problem of overstaffing, no
market competition, high NPLs ratio etc were big hurdles in the growth of banking sector. After
1990 financial reforms, Government adopted the policy of privatization. In start only two banks
were privatized i.e. Muslim Commercial Bank (MCB) and Allied Bank Limited (ABL) which
brought little market competition but then process was delayed for several years. In 2002,
Government privatized another largest bank of the country United Bank Limited (UBL). Then
the asset share of domestic private banks was 47% and Public owned banks share was 41%.
Currently, only one bank is state owned bank. The privatization reform affects the economy and
brings more competition in market which result good services to people etc. The government
also more facilities to banks in restructuring process by recapitalization of bank through equity
injection of Rs 46billion in some of public sectors banks and write offs to Rs.51 billion and also
close of 2000 branches which were in loss. In overall, financial restructuring is a continuous
process not an event for one time. Before 1990 financial sector reforms, Pakistan economy were
faced different problem i.e. weak prudential regulation, weak banking system, lack of accounting
standards etc. But due to financial sector restructuring (1990 to 2004), Pakistan financial sector
improved then before 1990 era. Specially banking sector showed good performance but still
improvement and measure are required to more stabilize the economic development.

43
www.privatisation.gov.pk/finance/finance.htm, source State Bank of Pakistan (Report)
44
LblL,
43
LblL
46
journal of Banking and Finance, April 20, page 4-5, IMF Monetary and Financial Systems Department.
47
LblL,
48
LblL
49
Muhammad Arshad Khan and Sajawal Khan, (2007) Financial sector restructuring in Pakistan, The Lahore journal
of economics, special edition, September 2007, page 107-131
50
Ebit,
51
Ebit

26

Furthermore the capital market also needs more measures to contribute in economy of country in
well mannered. However, due to reforms, financial sector of Pakistan improved enough in this
short period of time.
53

(2.3.4) Conditions before Privatization in Banking Sector Performance

Domination of the public sector or we call it a state owned sector and government made (NBFIs)
Non Banking Financial Institutions, and Direct Monetary Control were all involved in making
the banking sector inefficient from all corners. Percentage of public sector banks in early 1990s
was 92% amazingly in total assets of banking sector. Not even a single percent was belonged to
domestic private banks as there was not such bank exist at that time. Competition and growth
was not there in banking sector as due to the 92% was in the hand of government.
54

The main problem in banking sector was Pakistan Banking Council who played an important
role in spreading its financial network all over Pakistan without realizing concern about financial
repression in the country. State bank was in no power to stop these activities as policies
regarding credits to political people were so lean that Non-performing Loans were swelling with
the period of time.
55

(2.3.5) Main Problems before Privatization took place in Banking Sector

High Intermediation Costs
Over-staffing and over-branching
Huge portfolio of Non-Performing Loans
Poor Customer Services
Under-capitalization
Poor Management / Narrow Product Range
Averse to Lending to SMEs/housing & other segments
Undue Interference in Lending, Loan Recovery & Personnel issue

To overcome these problems and to avoid the further swelling in Non-Performing Loans
Pakistan produced there Financial Sector Reforms of 1990s with the hope that banking sector
performance will go up and sector will work in an efficient way
56

(2.3.6) Financial Sector Reforms 1990

It was quite clear that BNA and PBC Banking Nationalization Act and Pakistan Banking Council
were not at all efficient and there were so many problems which they created for the Banking
sector, it was a time to call up for something which can bring banking sector back on the track.

Institutional Reforms

In order to address issues like political intervention into credit allocation, loan recovery and other
inefficiencies from financial institutions, steps of policy reforms were taken to increase the
participation of private sector. Things like autonomous power to the Central Bank and NBFIs

27

control to the private sector etc. These measures were designed in order to increase growth,
competition and of course the main problem of Non-Performing Loans.
57

Privatization Process (A very First Time in Pakistan)

The Banking Nationalization Act was amended in 1990, and given powers to the Federal
Government to sell shares of NCBs (National Commercialized Banks)

For the very first time 26% of MCB Muslim Commercial Bank was sold to private sector in
1991. Just after two years of it another 49% were sold to the buyer and automatically
management shifted in the hand of buyers who were now 75% share owner.

Another bank known as Allied Bank Limited: 26% shares were sold to disinvest under Employee
Stock Ownership and automatically control was taken over by the group. Further 25% shares
were sold later to the private sector that is in August 1993.
58

Revival in Self-Governance

Lot of amendments took place in the Banking Companies Ordinance of 1962. The two main
amendments were one the empowerment of State bank of Pakistan to create stable and potential
guidelines for the recovery of bad or doubtful loans by giving huge incentives to borrowers so
that they can repay within time. Central Bank was also ask to disclose a list of defaulters
including political people who were directly involved in taking loans never paid it back.
59

Strengthening of Loan Recovery Process
State bank categorized loans into three different types
Sub-standard
Doubtful
Loss
State bank made these categories on the basis of assessment of risk which was faced by different
banks. In 1989 SBP issued guidelines for the classification of loans and advances to the banks
and best thing about these classifications was that these classifications were strengthened in 1992
in order to overcome Banks Non-Performing Loans.Just two years after the privatization State
Bank was working actively in getting the bank Non-Performing Loans back and to improve them
Central bank ordered banks to set quarterly recovery targets. Other than that a main condition
was also created to ensure that those who are defaulters will not be entertained with the fresh
loans no matter what. All banks were also supposed to provide a list of those defaulters whose
borrowing was more than Rs 1 Million or above. Banks were helped properly by the Credit
Information Bureau of Central Bank; one can see the difference of empowerment before this
Pakistan Banking Council never allowed them to do so.
60

10

52
Ebit,
53
Ebit

28

In 1993 government played an important role by increasing the number of banking tribunals
from three to eleven for non-interest bearing loans also known as mark-up based loans where as
for interest bears it was raised to 14.

(2.3.7) Banking Law Reforms

A number of changes took place in the banking sector during 1990s, main changes like The State
Bank of Pakistan Act 1956, The Banking Companies (Recovery of Loans) Ordinance, The
Banking Tribunals Ordinance 1984. The main and key reasons behind these changes were to
pave the way for privatization of Nationalize Commercial Bans, to increase competition, to
increase the power of SBP in making the policies like monetary policy and to strengthen its
overall governance and last but not the least the improvement of skeleton for the recovery of
loans.
61

Banking Companies (Recovery of Loans, Advances, Credits and Finances Act
1997)

The main aim of this act was to revise the policies of recovery of loans ordonance 1979 and Banking
Tribunal Ordinance 1984. The main purpose was to expedite recovery process for loans which were stuck
for a longer period of time.
62

(2.3.8) Post Privatization Activities
63

To prepare the public sector banks for privatization, the following steps were taken in the
Pakistani banking sector.
Amendment in Banks (Nationalization) Act 1974: This Act, under which the banking
sector in the country was nationalized during the seventies, was amended in 1990, to
pave the way for privatization of the nationalized commercial banks.

Abolition of the Pakistan Banking Council: The Pakistan Banking Council,
established subsequent to nationalization of the banking sector in the seventies, was
abolished in 1997.

Downsizing in NCBs: In order to reduce the surplus staff in the nationalized
commercial banks, voluntary separation packages were offered to employees. This

54
journal of Banking and Finance, April 20, page 4-5, IMF Monetary and Financial Systems Department.
55
Abid A. Burki and Ghulam Shabbir Khan Niazi, (2003) Effects of Privatization, Competition and Regulation on
Banking Efficiency in Pakistan, 1991-2000, November 12, 2003, page 3
56
Ebit
57
Financial Sector Reforms 1990, source State Bank of Pakistan, www.sbp.org.pk
58
Ebit,
59
Ebit
60 Financial Sector Reforms 1990, strengthening of loan recovery process, source State Bank of Pakistan,
www.sbp.org.pk


29

resulted in downsizing of the work force of the three big Nationalize Commercial Banks
(NCBs), (HBL, NBP and UBL) by 11,101 staffers out of a total of 39,277.

Closing Of Unprofitable Branches: As part of the downsizing exercise, 1,646 branches
of National Commercialize Banks were closed down.

Recapitalization of National Commercial Banks: The balance sheets of public sector
banks were cleaned up and their accumulated losses wiped off by the injection of new
equity in Habib Bank and United Bank. A total of Rs46.6 billion was injected as equity
in these two banks prior to their privatization.

Establishment of CIRC: The Corporate and Industrial Restructuring Corporation
(CIRC) was established in 2000 for acquiring Non-Performing Loans of NCBs. NPLs
worth Rs 47.4 billion have been transferred to CIRC at a discount so far for disposal.

Resolution Of Non-Performing Loans Problem: An incentive scheme for settling long
outstanding Non-Performing Loans was designed under the guidelines of SBP to clean
up the balance sheets of NCBs..

Installation of Professional Management in NCBs: In order to streamline the working
of NCBs, the State Bank put in place professional management in HBL, NBP and UBL.
The Boards of Directors were reconstituted with private sector individuals of integrity
and eminence.

Promulgation of Privatization Ordinance: To further strengthen the privatization
process, the government promulgated the Privatization Ordinance in 2000. The
Ordinance strives to ensure that privatization is carried out in a fair and transparent
manner.

Committee for Revival of Sick Units: The Committee for the Revival of Sick Industrial
Units (CRSIU) was formed by the Government of Pakistan. The purpose of this
committee was to restructure loans of sick industrial units, in order to make them
viable. It is illustrative to understand the political economy considerations.

(2.3.9) Banks privatized just after Privatization
64

Muslim Commercial Bank Limited:
26% shares were sold at the National group in April 1991 for Rs. 838.8 million. Another 25%
shares were offered for subscription to the public in February 1992. Remaining shares have been
divested in January, 2001, November 2001, and October 2002, for proceeds of Rs 1287.2
million.

Allied Bank of Pakistan Limited:
26% shares sold to Allied Management Group (AMG) representing employees of ABL, in 1991.
Another 25% sold in 1993, resulting in transfer of ownership from government to AMG.


30

Bankers Equity Limited:
In June 1996, 51% shares were sold to LTV Consortium for Rs 618.73 million.

Bank Alfalah Limited:
Highest Bid of Rs. 1.64 Billion received for sale of 70% shares of Highest Credit and Exchange
Bank Limited. (Presently Bank Alfalah) in June 1997, .2% shares were meant for the employees,
28% shares sold in block for Rs. 1226.0 million. The shares not taken up by the employees were
also sold. Sale Purchase agreement was signed on 13
th
December, 2002.

United Bank Limited:
51% shares sold in October, 2002. Payment of US$ 176,907,858 and Rs 1,852,500,000 received.

Habib Bank Limited:
Highest bid of Rs 22.409 billion received from Aga Khan Fund for Economic Development, for
sale of 51% shares on 29
th
December, 2003. Transfers to the new owners took place on February
26, 2004.

National Bank of Pakistan:
23.2% shares have been divested through IPO/POs in November, 2001, February, 2002 (Rs 373
million) November, 2002 (Rs. 782 million), November, 2003 (Rs 604 million).
34


31

11

(Section 2.4) Non-Performing Loans and its Classification

(2.4.1) Treatment of Non-Performing Loans

Financial crisis in mid 1990s raised the consequences of serious question that is how
macroeconomics statistics should account for Non-Performing Loans. The treatment in the
system of National Accounts 1993 (SNA) which is based on very important considerations
proved that there is no sound basis in observable transactions, so there was a need for 3 main
things. First the need for accounting practices in order to proper comparisons between economic
agents and countries. Second the need for valuation of loans to be consistent with debtors legal
obligations and third proper suggestions and advices which can be useful in measures of
solvency. The main problem which is still there is that the national accounts do not reflect the
existence of Non-Performing Loans in either flow accounts or balance sheets.
65

So many countries have come up with different rules and regulations in order to clarify the
problems of Non-Performing Loans. These regulations have prompted several banking and
accounting institutions like Basel Committee on behalf of banking supervision BCBS and IASB
and so many other effective private financial organizations.
66

The main issues in Non-Performing Loans are
67

The criteria for identifying Non-Performing Loans.
The value of such loans
Cancellations of write offs on such bad loans
Interest on bad loans.

These points in Non-Performing Loans needs a proper treatment and require further adjustments.
Privatization will tell us the performance of banks by testing the instruments later but still Non-
Performing Loans needs a treatment in this areas.
68

According to the different studies Non-Performing Loans can affect all the sectors which are the
pillars of economy but the sector which can be affected most by the Non-Performing Loans is a
financial sector such as commercial banks which tend to have large loan portfolios.

(2.4.2) Classification of Non-Performing Loans

Central Bank of Pakistan classifies Non-Performing Loans into following categories
69

61
Banking law reforms 1990, source State bank of Pakistan
62
Banking law reforms (1997), (Recovery of Loans and Credits Act 1997)
63
Dr Ishrat Hussain, (Former Governor SBP), (2004) Policy Considerations before Bank Privatization, Case Study
64
Dr Ishrat Hussain, (Former Governor SBP) (2004), Policy Considerations before Bank Privatization, Case study

32

When loan goes default for more than 3 months then that loan is considered to be as Non-Performing
Loan. This can also be depending on the terms of loan contracts

Other Assets Especially Mentioned: NPL type in which amount which has been recovered is
less than 75% of the amount receivable and has been over due by more than 180 days.
(Provisioning)This is the type in which no provisioning is required.

Substandard: NPL type in which amount has been recovered is less than 60% of the amount
receivable and has been overdue by more than 1 year. (Provisioning) of 20% of the difference

Doubtful: NPL type in which amount has been recovered is less than 40% of the amount
receivable and has been overdue by more than 2 years.(Provisioning) Provision of 50% of the
difference resulting from the outstanding balance of principal less the realizable value of liquid
assets.

Loss: NPL type in which amount has been recovered is less than 20% of the amount receivable
and has been overdue by more than 3 years.(Provisioning) Provision of 100% of the difference

(2.4.3) Facts Regarding Non-Performing Loans
70

There are some important facts related to the Non-Performing Loans issues are as follows:

The proportion of Non-Performing Loans went up by Rs 107 Billion in 2008 due to increase in
interest rates, economic slowdown, and high inflation rate and power breakouts.

Due to the economic global recession, the banking sector posted huge rise in the NPLS and
increasing the defaulters risk once again.

The NPLs of banks has gone down during the last six years from the year 2001 to 2006 but they
started surging in 2007, and same trends shown by the analysts in 2008. During the year 2007
NPLs increased by Rs 30 Billion that is 17% that is from 175.5 Billion in 2006 to 206.1 Billion
in 2007.

An increase of about 52% was witnessed in all banks; NPLs during the year 2008 were Rs.
313.657 Billion from Rs 206.1 Billion in the year 2007.It was a record increase in the history of
banking industry.

Non-Performing Loans Figures in Last 8 years:

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008
Total
NPLs
240B 244B 231B 211B 200B 177B 175B 206B 313B

33

12

Main reasons behind increase in NPL in 2008

The policy rate was raised from 10% to 15% during last year, which automatically affected the
lending cost of industrial loans, which resulted in slow recoveries and automatically increase in
NPLs. The major problem is that the policy rate has been on the upward trend for the last 2 years
and it is keep on increasing which proved high NPLs in 2008.
71

Comparison among Bank different categories

There was an increase of about 64% during the year 2008 in the commercial banks from Rs
173.5 B in 2007 to Rs 284.515 B in 2008 an increase of about 111 B in one year. In public sector
banks NPLs increased from Rs 44.1 B in 2007 to Rs 77.6 B in 2008.Specialized Banks were on
the better side of Non-Performing Loans and NPLs went down from 32.5 B to 29.143 B. Foreign
Banks also suffered a major blow in NPLs when their NPLs increased from Rs 1.4 B to Rs 3 B.

Non-Performing Loans minus provision for loan losses in banking sector also went up in 2008.A
net amount of Rs 79.427 Billion was shown in the statistics. Similarly net NPLs to Net Loan
Ratio also went up to 2.56% in 2008.

Increase in NPLs figures in the year 2008 was mainly due to the high spread and high portfolio
of loans which weakened the internal control of banking sector and raised the NPLs. Banks were
also facing NPLs recovery problems in advances against shares due to downward trends in
stocks.
72

Sector wide Comparison

In different sectors of the economy analysis shows that NPLs ratios have been increased for all
the sectors except the agriculture sector. Sectors like sugar, textile and auto NPLs ratios
increased from 10.74, 7.12 and 6.05 in 2007 to 14.60, 9.06 and 7.49 in 2008 respectively.
73

(2.4.4) Impact of NPLs on Banking Sector

Banks in Pakistan especially the Commercial Banks are going though transitory period and
avoiding the transition easily is not really possible. The main factors behind this reason are
growing liquidity, declining interest rates and shrinking spreads. Before the incident of 9/11
Government of Pakistan was the biggest borrower but after that it has been reduced and also
yields on government securities also went down. Commercial banks were actually surviving
because of the government securities. Due to lack in growth in private sectors banks especially

65
International Monetary Fund, (2002) Statistics Directorate, page 3
66
2009, Rise in Non-Performing Loans, Dawn Daily Newspaper, April 20
67
International Monetary Fund, (2002) Statistics Directorate, page 3
68
Ebit
69
State Bank Report (2008), Guidelines for Infrastructure Projects Financing, page 21, State Bank of Pakistan
70
Shamim Ahmed Rizvi, Alarming Rise in NPLs, Pakistan and Gulf Economist, April 6-12, page 39

34

commercial banks have no options but to go or new business in order to face their declining
trend of profitability
74

Overall banking sector is experiencing changes. SBP has been kept on working on its rules and
regulations and instructions so that banks especially commercial banks improve their solvency
and to increase their competitive feature. Banks are also given the free hand to make their own
policies regarding the credit policies but with some restrictions which have to follow them while
giving credits.
75

(2.4.5) Causes of Non-Performing Loans in different countries

Real Estate Market

In 1980, the percentage of Non-Performing Loans in Italian market increased rapidly. The main
reason behind that was high speculation in real estate market. Due to good economic
environment at that time, investors made high speculation and increased the demand of both
commercial and residential properties. Investor took more loans from banks in order to earn
profit because high speculation increased the real estate market prices. Banks also followed easy
lending policy due to good economic condition. Furthermore, the bubble of high speculation
burst and investor lost big money which effected the banks badly because debtor have no money
to pay back their loans to banks. Italian banks Non-Performing Loans were over 50 billion at that
time. The big proportion of Non-Performing Loans was contributed in real estate market in
Italy.
76

In 1980, high inflation and credit deregulation made the Swedish market profitable and investor
took loans from banks and increased the prices of real estate and other assets. Due to some poor
lending decision in the decade of 1990s, the balloons of real estate market burst and prices came
down, which resulted in great credit losses to banks.
77

Weak Lending Policies (Banks)

The main reason of increased Non-Performing Loans in Italian market in 1980 was not only real
state market but also weak lending policies in Italian banks. The government laws had made
hurdles in banking policies for recovery of loans. Also bankers had less capability to reduce the
Non-Performing Loans. In order to reduce the Non-Performing Loans ratio local banks took help
from other banks and also activated new laws in 1998, due to which percentage of Non-
Performing Loans little decreased.
78

In 1980, the poor lending policies in Swedish financial market was another big reason of
financial crisis, because Swedish bankers focused only on increasing volume of loans and did not
pay attention to the cash flow process.
79

13

71
Ebit,
72
Ebit
73
2009, Rise in Non-Performing Loans, Dawn Daily Newspaper, April 20
74
Shabbir H. Kazmi, (2003) Commercial Banks, April 28 May 04, source: www.ya-hussain.com

33

Strong Lenders Relationship

Bankers and lenders relationship is also reason of increase in Non-Performing Loans. In Italy,
bankers and lenders relationship is very strong, due to which Italian credit control system is
weak. Banks give loans easily to borrower without any detail investigation. These strong
relationships between banks and borrowers make the repayment process of loan slow and also
increase percentage of Non-Performing Loans. To control Non-Performing Loans ratio, Italian
banker should switch from friendly lender to debt collector. In Pakistan, rich people and
politicians have strong relationship with bankers due to which Non-Performing Loans percentage
increased. Due to these relationships they return the loans slowly and even some times did not
pay.
80

Impaired Loans on Hold

Another cause of Non-Performing Loans in Italian market is that banks hold the
defaulted/impaired loans in its system. These problems occur because most bankers are not very
professional and reason for the weak regulation for financial institution in Italy. According to
Mr. Aaronson, banks should acknowledge the defaulted loans in its annual results otherwise
Non-Performing Loans issue will not solve.
81

According to Mr. Aaronson, financial crisis is not only the main reason of Non-Performing
Loans but also the different events occurs in borrower life that is unemployment, death, divorce
etc.
82

(2.4.6) Different Views and Analysis on Non-Performing Loans

According to Syed Iqbal Ahmed, policy of introducing (CRSIU) committee for revival of sick
industrial units was a positive step to overcome the increasing trend of Non-Performing loans but
unfortunately committee worked more towards in just recovering the bad loans instead of
searching the main cause of increasing bad loans and revival of sick industrial units. The
members of the committee did not went in depth of studies of NPLs but on the other hand
government kept on increasing guidelines as to how to achieve the main cause behind NPLs.
Other problem which has been found out regarding this committee is that in many cases they
have sold out the assets of sick units with the help of banking courts who has shown trust on this
committee, and with this, committee also closed so many sick units without investigating the
matters correctly. Another problem which has been discussed by this author is harsh conditions
set by State Bank of Pakistan regarding the Non-Performing Loans. He thinks that with this
attitude Pakistan cannot overcome the problem of Non-Performing Loans even privatization has
taken place 11 year ago.
83

According to the World Bank report Non-Performing Loans of Nationalized Commercial Banks
have been a major issue in banks because of high political interference and issuing huge amount

75
Ebit
76
Jessica Petersson and Isac Wadman, (2004) The markets of Italy and Sweden, Uppsala University, Department of
Business studies, bachelor thesis, page no: 11-17
77
Ebit,
78
Ebit,
79
Ebit

36

of credits to the individuals without verifying their accounts and previous histories, it has also led
government to increase 7 to 8 percentage points between deposit and lending rates. There was a
reduction in Non-Performing Loans percentages especially after privatization but once again
raise in new default cases have increased to Rs 300 Billion. Despite some geo political crisis
banking sector in 1990 was stronger than in 1997 and the main reason behind the success was a
private management in the banks and central bank independence. According to the report, once
again interference in the banking sector in 1999 loan recovery went down and banks rules were
loosen. Another main problem behind this was that the banks which were privatized were still
not fully privatized like Muslims Commercial Bank, Allied Bank etc.
84

In 2004, State Bank of Pakistan once again made some amendments in Non-Performing Loans
and Development Finance Institutions policies in order to produce some fruitful results and to
wipe of the huge portfolios of banks bad loans, keeping in mind the best international practices
that have been practiced by other countries of the world. State bank went on supervising the
banks procedures and reporting of loans and advances, accrued mark up and Non-Performing
Loans, especially in Non-Performing Loans when selective banks started to charge mark up on
mark up which was totally unacceptable as per the rules of State Bank. In some cases selective
banks with respect to overseas operations did not report the current market value of their foreign
currency NPLs. After investigation, the real problem came out when banks did not mention the
total amount in NPLs. In order to overcome the above mention problems, State Bank of Pakistan
after consulting with some institutions like (CAP) Chartered Accountants of Pakistan and
Pakistan Banks Association, issued guidelines for NPLs reporting.
85

According to the article, the actions which have been taken so far by State Bank of Pakistan
regarding non-performing loans are:
86

Accelerating the pace of recovery
The increased loan loss provisions
Realizing the forced sale value of circumstantial defaulted loans in loss category for last
three years and waiving of the difference.
Referring the cases of willful defaulters to National Accountability Bureau.

(2.4.7) Steps taken by State bank of Pakistan to overcome NPLs in future
87

In 2008 Non-Performing Loans once again increased as compared to previous years. To
overcome this problem and to minimize the ratio of Non-Performing Loans State Bank of
Pakistan established some new rules and regulations.
14

80
Ebit,
81
Ebit,
82
Ebit
83
Syed Iqbal Ahmed, (2002) Banks Non-Performing Loans, Dawn, November 13, (letters section)
84
Ehtasham ul Haq, (2002) Non-Performing loans of NCBs, major problem, World Bank Report, Dawn May 5
85
Article by State Bank of Pakistan, (2004) Non-Performing Loans of the banking sector decline sharply, March 17
86
Ebit
87
State Bank Report, (2008) Guidelines for Infrastructure Projects Financing, page 19, State Bank of Pakistan


37

Project Description

Proposed ownership structure
Legal status of projects and government approvals
Projects anticipated economic contributions (example in the generation of foreign
exchange, employment, technology etc.)

Capital Investment

Project site
Legal agreements for land rights
Project Management
Pre-operating requirements and costs
Initial working capital requirements
Project Schedules

Startup, operations
Expenditures
Funding

Financing

Total cost of the project
Capital structure
Proposed debt/equity structure
Shareholder structure
Debt
Long-term debt/working capital
Overrun/stand by arrangements
Projected Financial statements including cash flows
Clear statement of all assumptions

Legal Documentation

Joint ventures agreements
Articles of association
Government approval docs
Mortgages
Loan agreements
Off take agreements
Supply agreements


38

Conclusion

The operating environment of banking sector in 2003 came up with a great challenge when
declining trend and shrinking spread took place in the economy. Due to these reasons banks were
compelled to take new steps to boost up their competitive strength and to avoid losses. Though
the economy is set to grow, the banking sector after these problems is largely depend upon
private sector demand, that is why privatization is an important feature in every sector of
economy especially in banking sector.
88

So many complicated issues have been created by the several authors in identifying the true
picture of Non-Performing Loans. What they have done in the past papers is that they took the
absolute amount of such Non-Performing Loans in 1999 and then created a complex situation
by telling that situation has gone worst after the privatization and State Bank of Pakistan and
the government of Pakistan has not done anything in overcome the upward trend of Non-
Performing Loans.
89

The State Bank of Pakistan (SBP) is dealing with the NPL issue in a classified manner and 4
main steps have been taken by the State Bank of Pakistan.
90

They are:
Improvement in coverage and reporting of NPLs
A pro-active treatment of the existing stock of NPLS
Stemming flow of new NPLs
Improving the policy and regulatory environment

As per the nature of Non-Performing Loans it will always grow over time. This will happen
because the amount is consisting of principal and markup. So if the loan is not serviced and went
up by 90 days then the unrealized markup will continue to increase up to the total amount of
NPLs.
91

(2.4.8) Short review of Muslim Commercial Bank and Allied Bank Limited

Before going into the chapter of analysis and findings, we would like to present the short review
of Muslim Commercial Bank and Allied Bank Limited. Statistics tables are available in the
appendix part.


First bank in the history of Pakistan which was privatized, after the privatization commission
established in 1991.On April 6 1991 first MCB shares were sold out to the National Group and
total percentage which was sold out was 26%. Just after nine months of this deal another 25%
shares were declared for the IPO on February 1992.Nine months after IPO further shares were
sold out in January 2001 and October 2002 of Rs 13 Billion. When 51% shares were sold out the
MCB application was released from the Banking Nationalization Act 1974.
92


39

MCB Privatization Impact Analysis
93

Total assets of Muslim commercial bank with an impact of privatization went up from
18% in 1994 to 28% in 2003, shows 10% increase in upward trend.
Total deposits of Muslim Commercial Bank with an impact of privatization went up from
17.6% in 1994 to 26.5% in 2003, shows 9% increase in upward trend.
Total advances in 1990 were 17.7% and in 2003 they were 26.7%.
Non-Performing Loans % of total loans were went down from 18.6% in 1993 to 11% in
2004 which shows a vast improvement in recovery of loans.
Allied Bank Limited

After privatization Allied Bank Limited was the second bank to be privatized and first time in
September 1991 26% of Allied shares were sold out to the Allied Management Group. After two
years another 25% shares were sold out to the same Allied group, which resulted in replacement
of ownership from public to private.
94

ABL Privatization Impact Analysis

Total assets of Allied Bank Limited with an impact of privatization went up from 9.6% in
1995 to 12% in 2002, shows 2.4% increase in upward trend.
Total deposits of Allied Bank Limited with an impact of privatization went up from 9.8%
in 1995 to 14.3% in 2003, shows 4.5% increase in upward trend.
Total advances went down from 15.5% in 1999 to 11.2% in 2003
Non-Performing Loans went up from 16.1% in 1993 to 43% in 2003 which shows a
worst outcome of Non-Performing Loans.
95

MCB and ABL Comparison after privatization

Allied bank was not transferred to strategic investors in fact the owner ship was given to the
employees which resulted in even worse condition than it was in public sector ownership. State
Bank after this condition realizing the situation of the bank when in 2003 NPL moved up to 43%
from 16.1% in 1993, disclosed a bid for this bank to the private sector.
96

On the other hand Muslim Commercial Bank was prominently sold to private strategic investors
which showed a positive sign of improvement throughout the bank and this can be shown by
looking at the percentage of Non-Performing Loans which went down from 18% in 1993 to 11%
in 2003. Other indicators like customer services, technology up gradation and cost efficiency
were also improved.
97

15

88
Shabbir H. Kazmi, (2003) Commercial Banks, April 28 May 04, source: www.ya-hussain.com
89
Dr. Ishrat Hussain, (2002) Dealing with Non-Performing Loans of the Banks, article by former governor of state
bank of Pakistan page 1-3
90
Ebit,
91
Ebit
92
Dr Ishrat Hussain (Former Governor SBP), Policy Considerations before Bank Privatization, case study, 2004
93
Ebit,
94
Ebit

95
Ebit,
96
Ebit

40

Chapter 3 (Research Methodology)
(3.1) Statement of the Problem
The effectiveness of privatization all over the world has been a mixed blessing or is inconclusive.
Pakistan has also embarked on privatization program for the state owned banks, in the hope that
the banks might be restructured into more efficient, profitable, competent, and value-creating
private enterprises and last but not the least performance of the banks. To date, there is very less
work done to assess the post privatization performance of Pakistani Banks in terms of Non-
Performing loans. There is lack of sufficient studies on the performance of the privatized banks
with respect to Non-Performing Loans. Abstracting form this deficiency, this study intends to
bridge the research gap by assessing the banks performance, and to check that whether Non-
Performing Loans proportion has gone down after privatization and performance of banks
privatized banks has improved or not.

(3.2) Scope of the Study

Banking sector is considered as one of the most important sector of every country and there are
so many measures to test the performance of the banking sector. There are many measures
utilized to gauge the performance of the banking sector like measuring asset quality, capital
adequacy, earning, profitability, liquidity. Out of these performance measures this study is
targeted towards gauging the operating performance of banks keeping in view the
performance. We have taken only one measure that is Non-Performing Loans of selective
banks to find out the operating performance of the banking sector and impact of privatization has
been kept in mind to find out the results. So the scope of the study is to find out the impact of
privatization on performance of banking sector and the area of the study is Non-Performing
Loans. Bankers, academicians, students and those who want to pursue career in banking industry
can take the advantage from this research.

We Imran Karim Sirohi and Muhammad Tariq, both are a student of MSc Finance at Umea
University. We both are from Pakistan and our educational background is of Finance. We have
worked in different banks in Pakistan before coming to Sweden. We have taken this wide range
banking topic that is related with the Non-Performing Loans of Pakistan because we thought that
Pakistani banking sector is efficient and is working effectively all over the world but the main
problem they faced since the independence is of Non-Performing Loans, so we decided to look at
the position on Non-Performing Loans with respect to the effectiveness of Privatization. Another
main reason of choosing this topic is that very few studies has been done in Pakistan before, so
we hope that this research will help professional researchers to find out more in a proper way.

(3.3) Research Philosophy

According to the Remenyi, Williams, Money and Swartz, there are two kinds of research
philosophies which researchers implement on their research work. They are positivism and
phenomenology.

97
Ebit

41

(3.3.1) Positivism

The philosophy of positivism defines that research which is been done by researcher is all
independent and subject will not affect him at any step. In positivism, researcher works as an
object analyzer and methods which has been conducted are highly structured and later it has been
finalized in quantitative form.
98

(3.3.2) Phenomenal

On the other hand phenomenal research is totally based on realistic approach which defines the
realistic situation.
98

(3.4) Research Approach

Two main approaches in the research area are Inductive approach and Deductive approach.

(3.4.1) Inductive Approach

This approach uses to further work on the research which has already been done. This approach
is useful by taking the small sample of any research which has been done and then define the
problem.
99

According to the Bryman/Bell, in this approach first data is collected and then researcher tries to
find relationship between the observations.
100

(3.4.2) Deductive Approach

According to Bryman/Bell, in this approach first of all the hypothesis is established which has
been structured by certain field of the study. This hypothesis is tested by finding the results that
this hypothesis is a null hypothesis or a positive hypothesis. After the finding researchers give
feedbacks on the basis of the results.
101

We have chosen deductive approach because we think that the main problem is to find out the
impact of privatization on Non-Performing Loans proportion and to see whether bank
performance has been improved after privatization or not from Non-Performing Loans point of
view. We think that, to come up with the conclusion first of all we need to make some hypothesis
and based on our research question we will test our hypothesis. Deductive approach seems to be
right choice for this report as we are basically not looking for small sample, but 40% of our total
population and for that hypothesis is necessary.

The structure of this report is also based on the deductive approach, as first the hypothesis will be
structured and then to test that hypothesis, (Independent sample t-test) for both pre privatized

42

period that is from 1981 to 1991 and post-privatized period 1993-2003 will be conducted and
then on the basis of the results conclusion will be drawn.

(3.5) Research Methods

There are three main research methods which have been widely used by researchers for a longer
period of time in their research work. They are qualitative, quantitative and pluralistic research
methods. Qualitative research method used when researchers try to get a clear picture of research
problem, by analyzing and interpreting what people execute or say. In qualitative research
observations are all in non-standardized form. Qualitative studies can be done in the form of case
studies, observations, biographical method, and experience survey etc.
102

Quantitative method is the method in which the data which has been gathered is in the form of
numerical value. It could be numbers, digits or any other data which is measurable. In this
method outcome will be always in the form of numbers.
103

Pluralistic method is the method which is a mixture of both qualitative and quantitative method.
In this method qualitative method is a foundation to quantitative method.
104

The research method which has been used in this research study is the quantitative research
method and the software to analyze the data later will be SPSS software.

(3.6) Research Design
The research has been designed such that it fulfills the entire requirement and also does justice to
the cause. While designing the research it has been considered that it should serve the cause
properly and should be in line the purpose of the study. It is also kept in mind that the research
work is done to add or contribute in the existing knowledge about the issue. Research design is
Exploratory in nature, in order to develop a clear understanding of the topic. Secondary data
that is the actual figures of Non-Performing Loans will be gathered. After gathering the data
from the selected sample, it will be analyzed using SPSS software to study the performance of
banks on the basis of Non Performing Loans as a percentage of total loans over a specified
period of 21 years.

(3.7) Research Criteria
The nature of the topic puts on view that that it cannot be studied in artificial environment. The
topic has been analyzed in natural environment without any involvement, so the research is more
of exploratory research and descriptive consist of longitudinal. The purpose of the study is
Exploratory in nature, as it aimed to collect more appropriate information related to the topic.
The method of conducting this research is based on secondary data. We have adopted the
secondary approach for that we have gone through the newspaper, internet books, magazines,
annual reports, co articles and different libraries has been considered.

43

16

(3.8) Sample and Sample Size

Initially it was decided to cover all the banks which were privatized, but due to time constraints
and inconvenience and difficulty to access all the banks, it was decided to go for limited banks.
Criteria for the sample are banks which were state-owned and later they were privatized. Data in
percentage was taken of Banks NPLs as this thesis is limited to NPLs.

(3.8.1) Population
Habib Bank Limited
Alfalah Bank Limited
United Bank Limited
Allied Bank Limited
National Bank of Pakistan

(3.8.2) Sample

Banks which have been taken for the research and sample of the report are:

Allied Bank Limited
The total population is consisting of six privatized banks and out six we have chosen 2 banks that
is Allied Bank and Muslim Commercial Bank. The reason behind choosing very short sample is
non-availability of data and time constraint. As just two banks were privatized in the decade of
1990 so it was inappropriate to choose those banks which have been privatized late. We cant
take other two banks which were privatized that are HBL, UBL, because their data is not
sufficient enough to study the hypothesis.
(3.9) Hypothesis
(Banks Non-Performing Loans have decreased on average after privatization)

To test this hypothesis we will look at the percentages of pre-privatization 10 years that is from
1981-1990 and 11 years post-privatization from 19993-2003 of two banks. We will compare
both pre and post period and find out whether situation has improved or is it null?

We will take 2 privatized banks
Muslim Commercial Bank.
Allied Bank Limited.

98
Remenyi, Williams, Money and Swartz, (1998) Doing Research in Business and Management: An international
process and method, London, page 94
99
Saunders M. Lewis and Thorn Hill, (2000) Research Methods for Business Students, 2
nd
Edition, page 92-93
100
Bryman, Alan Bell. Emma, Business Research Methods, 2
nd
Edition, Oxford University Press, page 13-14
101
nd
Edition, Oxford University Press, page 11-12


44

17

Hypothesis Model
To test the Hypothesis model has been developed. This model is based on Non-Performing
Loans improvement.
(3.9.1) Null Hypothesis Model
H
o
: H
bp
H
ap
= 0

Here the null hypothesis has been defined as per the statistics rules and this means that there is
no significant difference between the percentage of pre-privatization period percentages and
post-privatization percentages and no improvement has taken place after privatization.

This model interprets that according to the mathematics if H
bp
mean is equal to H
ap
mean then
there is no change in Non-Performing Loans and the hypothesis is said to be null hypothesis.

(3.9.2) Hypothesis Model
H
1
: H
bp
H
ap
> 0

This model interprets that according to the mathematics if H
bp
is greater than Hap then there is an
improvement in Non-Performing Loans and privatization has a positive effect on Non-
Performing Loans

Where:

bp stands for: Pre-privatization period
ap stands for: Post-privatization period
H: Hypothesis Model

(3.10) Dependent and Independent Variables
Two variables will be used in this research
(3.10.1) Variable 1 (Nominal Scale)
Category
Privatization
In this research privatization is the independent variable because it shows the impact of
privatization on the variable which has been effected or not. In this report privatization has been
split into two variables Pre-Privatization Period and Post-Privatization Period to compare the
performance of banks in terms of Non-Performing Loans.

102
nd
Edition, Oxford University Press, page 14
103
Ebit,
104
Ebit

43

(3.10.2) Variable 2

Non-Performing Loans in % of total loans (Dependent Variable)

Non-Performing Loans is a dependent variable in this research as we are looking at the impact of
privatization on Non-Performing Loans of banks, and to check whether bank performance has
been improved with respect to Non-Performing Loans proportion. As we are limited to only one
factor that is NPL so privatization impact is going to tell the result whether bank performance in
terms of Non-Performing Loans has improved or not.

Years (Pre 10 years and Post 11 years of privatization with respect to Non-Performing
Loans)

(3.11) Analysis Format

We will take two observations of two different banks and we will do the comparison of means
between their pre-privatization period and post-privatization period respectively to assess the
impact of privatization on Non-Performing Loans. To compare the means we will use SPSS
software. We cannot judge orally on the basis of percentages of pre and post years, we have to
compare them mathematically. We will look at the Group Statistics in which we will compare
Levenes Test for Equality of Variances to find out the variance result. Secondly we will look at
the Independent Samples T-Test to compare means and finally to prove the hypothesis we will
look at Confidence Interval of both the observations.

(3.11.1) Banks Percentages of Non-Performing Loans of total loans
57


Pre-privatization per ivatization period Post-privatization period
Year Percentages Year Percentages
1981 25% 1993 18%
1982 23% 1994 17%
1983 22% 1995 11%
1984 25% 1996 10%
1985 24% 1997 12%
1986 19% 1998 13%
1987 22% 1999 18%
1988 29% 2000 14%
1989 19% 2001 17%
1990 18% 2002 15%
2003 12%


46

Allied Bank Limited

Pre-privatization per ivatization period Post-privatization period
Year Percentages Year Percentages
1981 51% 1993 17%
1982 47% 1994 18%
1983 40% 1995 12%
1984 50% 1996 18%
1985 48% 1997 18%
1986 43% 1998 20%
1987 35% 1999 20%
1988 32% 2000 30%
1989 36% 2001 31%
1990 32% 2002 40%
2003 42%

Short review of above mention Non-Performing Loans percentages tables

The percentages which have been mention in the tables of both banks shows huge variations in
it. This is because of the management setup and different ways of organizing it.

Muslim Commercial Bank percentages review

If you look at the percentages of Muslims Commercial Bank Non-Performing Loans, bank was
solely sold to the private strategic investors which enable bank to improve its percentages of
Non-Performing Loans of total loans from pre-privatization period to post privatization period.
Other main indicators which helped bank to improve its performance in terms of Non-
Performing Loans were positive attitude to customer services, better value chain facilities, up
gradation of advanced technology and cost efficiency. In real, percentages still shows huge up
and down fluctuations because of some of economic and political situations which have jolted
the country all over. Non-Performing Loans % of total loans went down from 18.6% in
1993 to 11% in 2004 which shows a vast improvement in recovery of loans.

Allied Bank Limited percentages review

If you look at the percentages of Allied Bank Limited Non-Performing Loans, it has more
fluctuations and bigger margins in percentages, it is because bank shares was not transferred to
strategic investors as MCB did, and the owner ship was transferred to the employees which
resulted in even more worse condition than it was in public sector owner ship. But overall
improvement in terms of Non-Performing Loans has been shown in most of the years after
privatization but not as it was in Muslim Commercial Bank. Performing Loans went up from
16.1% in 1993 to 43% in 2003 which shows a worst outcome of Non-Performing Loans.


47

(Short description of chapter 4)

Chapter 3 has provided in-depth information about the research methodology and this
methodology will further be tested in chapter 4. As mentioned earlier that two banks have been
taken for the testing of the hypothesis that are Muslim Commercial Bank an Allied Bank
Limited. Group statistics will be consist of

1) Levenes Test for Equality of Variances
2) Independent Sample test
3) t-test for equality of mean
4) Confidence interval

Why we used Independent Sample T-Test

Before going into the depth of these terminologies we must explain why we have chosen
Independent Sample T-Test. We have used this measurement because T-Test is the best model to
find out the comparison of means of two independent groups and this model is always based on
the variances of population. We think that by using this model we can identify the real mean of
percentages which has been mention for the Non-Performing Loans and then based on our
statistics we can come up with proper analysis.

All tests will be observed by using SPSS software and proper data will be used to identify the
main results for the research and on the basis of analysis and outcome conclusion will be drawn.
Data is consisting of 21 years for both banks starting from 1981-2003.


48

18

(Chapter 4) Our Analysis and Outcome
Before going into the observational analysis first of all we would like to define some main
statistical tools which have been used in this thesis hypothesis model assumption.

1) Levenes Test for Equality of Variances
2) Independent Sample test
3) t-test for equality of mean
4) Confidence interval

Levenes Test for Equality of Variances

Levenes test equality tells us that if we have met our second assumption or not. Second
assumption of Hypothesis model that is (H
1
: H
bp
H
ap
> 0). In levenes equality of variances we
check that whether population variances are equal or not. If significant value is less than 0.05
than population variances are not equal and if significant value is greater than 0.05 then
population variances are equal. In case if variances equal are not equal than further research in
that case is useless because it proves null hypothesis which is the first model that (H
o
: H
bp
H
ap

= 0).

P >
Rejected Area
P < P <

Accepted area which is greater than 0.05 Rejected Area which is less than 0.05
High probability values fail to reject

Independent Sample Test

This statistical tool involves the means of normal populations with anonymous standard
deviation. It also tells us the comparison of mean scores of two different groups with a given
variable. The dependent variable is normally distributed. In order to conduct this test, variances
should be equal.

In this hypothesis can be tested like:

Null in which both different groups are not significantly different.

Alternate or Positive in which both different groups are significantly different.

105
Annual Reports, Muslim Commercial Bank and Allied Bank Limited, source library State Bank of Pakistan


49

T-test for equality of means
In this statistical test there are three main points:
First of all null hypothesis in which both tested groups mean are equal and positive
hypothesis or null hypothesis in which both mean are not equal (one or other may greater
or less).
The test which is conducted in this statistical tool is t-statistic.
P-value is determined by looking at the t-distribution.
Confidence Interval

Confidence interval is an interval estimate of a population parameter. An interval is given in this
tool instead of single parameter values. This tool is used to know the reliability of an estimation
that has been done in any statistical part.
Observations

As discussed earlier, we have assumed model, and we have observed two observations to find
out whether which model is accepted.

Null Hypothesis Model

H
o
: H
bp
H
ap
= 0

Hypothesis Model

H
1
: H
bp
H
ap
> 0

Where

bp stands for = Pre-Privatization period

ap stands for = Post-Privatization Period

Observation No: 1

Group Statistics


Pre-Post N Mean Std. Deviation
Std. Error
Mean
1
10 22.6000 3.37310 1.06667
NPLS
2
11 14.2727 2.90141 .87481

30

In first observation of MCB we have taken percentages of NPLs of 21 years to prove the
hypothesis, whether bank NPLs has improved on average after privatization. First of all we will
look at the variance of NPLs percentages to find whether variances should be assumed equally or
not.

In variance there are two cases:

Case No: 1

S
1
2
=

S
2
2
This means population variances are equal

Case No: 2

S
1
2
S
2
2

This means population variances are not equal

MCB Levenes test for Equality of Variances and t-test for Equality of Means
Follow this arrow on next page

Independent Samples Test

Variance Result

Result shows that significant value is .868 which is greater than .05, which means if we reject we
will make an error of 86%. So first observation of Non-Performing Loans % declares that
population variances are equal.

Hence case No: 1 is accepted

t-test for Equality of Means

Levene's Test for
Equality of Variances t-test for Equality of Means
F Sig. T Df
Sig. (2-
tailed)
Mean
Difference
Std. Error
Difference
95% Confidence
Interval of the
Difference
Lower Upper Lower Upper Lower Upper Lower Upper Lower
N
P
L
S
Equal variances
assumed
.028
.868
6.082 19
.000
8.32727 1.36921
5.46148 11.19307
Equal variances
not assumed
6.036 17.893 .000 8.32727 1.37952 5.42777 11.22677

31

As equal variances are assumed and also mathematically proved, we will not look at unequal
variances. In equality of means significant results show that significant 2 tailed test is < 0.05
which is rejected area, which means we will reject our null-hypothesis model that is H
o
, because
it says H
o
: H
bp
H
ap
= 0 no improvement in Non-Performing Loans. Here mean are not equal,
now since they are not equal situation has improved mathematically and H
1
model is accepted.

Confidence Interval

5.461 < H
bp
H
ap
< 11.193

Confidence interval shows that situation has improved a lot after the privatization and Non-
Performing Loans has a downward trend in the banking industry.

According to the first observation it is mathematically proved that

H
1
: H
bp
H
ap
> 0

Hence it is mathematically proved that in the case of Muslim Commercial Bank NPLs situation
has improved and performance of MCB in terms of NPLs is going in a positive way.

Observation No: 2
Group Statistics


In second observation of ABL we have taken percentages of NPLs of 21 years to prove the
hypothesis, whether bank NPLs has improved on average after privatization. First of all we will
look at the variance of NPLs percentages to find whether variances should be assumed equally or
not.

In variance there are two cases:

Case No: 1

S
1
2
=

S
2
2
This means population variances are equal.

Case No: 2

S
1
2
S
2
2

Std. Error
Mean
1
10 41.4000 7.39670 2.33904
NPLS
2
11 24.1818 9.98817 3.01155

32

This means population variances are not equal.

ABL Levenes test for Equality of Variances and t-test for Equality of Means


Variance Result

Result shows that significant value is .255 which is greater than .05, which means if we reject we
will make an error of 25%. So second observation of Non-Performing Loans % also declares that
population variances are equal.

Hence case No: 1 is accepted also in 2nd observation

t-test for Equality of Means

As equal variances are assumed and also mathematically proved, we will not look at unequal
variances. In equality of means significant results show that significant 2 tailed test is < 0.05
which is rejected area, which means we will reject our null-hypothesis model that is H
o
, because
it says H
o
: H
bp
H
ap
= 0 no improvement in Non-performing Loans. Here means are not equal;
now since they are not equal situation has improved mathematically and H
1
model is accepted.

Confidence Interval

9.148 < H
bp
H
ap
< 25.300

Confidence interval shows that situation has improved a lot after the privatization and Non-
Performing Loans has a downward trend in the banking industry.

According to the second observation also it is mathematically proved that

H
1
: H
bp
H
ap
> 0

Levene's Test for
Equality of
Variances t-test for Equality of Means
F Sig. t Df Sig. (2-tailed) Mean Difference
Std. Error
Difference
95% Confidence
Interval of the
Difference
N
P
L
S
Equal variances
assumed
1.336
.262
4.450 19
.000
17.21818 3.86932
9.11960 25.31677
Equal variances
not assumed
4.515 18.303 .000 17.21818 3.81321 9.21644 25.21992

33

Hence it is mathematically proved that in the case of Allied Bank Limited also Bank NPLs
situation has improved and performance of ABL in terms of NPLs is going in a positive way.

(Chapter 5) Conclusions and Recommendations

In this thesis, two series of observations of two different privatized banks were measured to
determine the performance of NPLs of Banks in Pakistan. NPLs % of 21 years of both the banks
were taken, and 1 dependent variable that is Non-Performing Loan and 1 independent variable
that is privatization were measured.

The result shows that variances are equal in both the cases and NPLs situation has improved a lot
after privatization took place. In case of ABL if we look at the last four years there is an
increasing trend in NPLs but if we compare it with pre-privatization period then it is very
positive.

We can conclude that Banks performance has improved on the basis of results of only one factor
that is NPL and has a positive impact on NPLs overall and performance of banks have gone
upward due to decrease in NPLs percentages. We cant say that banking sector performance has
improved overall, because there are so many factors from which we can have different results but
as our research is limited to only one factor that is Non-Performing Loans hence on the basis of
that we conclude that privatization has a positive impact on non-performing loans of banks in
Pakistan.

If we combine measures, other than the Non-Performing Loans of the banks like measuring asset
quality, profitability, liquidity, capital adequacy and earning of the banks to assess performance
of banking sector along with the measure that researcher have taken, the results are liable to
change.

The overall study proves that privatization has a positive impact on Non-Performing Loans
keeping in view the two privatized banks, which were privatized earlier in 1990s. Other banks
were not taken because of insufficient data.

All over the world so many reports and research have been done on this topic and every country
has its own nature of the problem. In Pakistan before that not enough research has been done and
no doubt that keeping in view the above statistics which has been released from this research we
can conclude that banking sector is improving in terms of Non-Performing Loans but with
respect to only one variable that is privatization and we can also combine other measures to
make more comprehensive report but due to time constraints and limitations only one limited
variables have been taken to prove the hypothesis.

Pakistani banks must take some steps to overcome this problem in the future, the main problem
in Pakistan for the banking sector is the dominance of politicians on the financial institutions and
monopoly of the government in banking policies. Every government has its own State Bank
governor and he/she applies policies according to the desire of the government and government
delegates enjoy lucratively from the banks by taking huge amount of loans from the banks. No

34

doubt that after the privatization and strong media influence things has been changed but still
there is a lot of things that should be noticed and to stop defaulters in the near future.

Another main thing that we would like to conclude that it was difficult to get the whole
information in the proper way because all information was based on the Non-Performing Loans
of Pakistan and as we are in Sweden it was bit difficult for us to collect all the data but still we
have tried our level best to give the maximum output from our side and to produce a high class
and reliable results from this thesis. All data which has been used in this research is appropriate
and conclusion has been drawn by using an appropriate data in the analysis and outcome section.
All references have been given properly and links has been used according to the requirement of
theory and literature.

Recommendation for further Research
The limitations of this study by itself are leading to the new researcher for further research in this
field of study. As mentioned in generalization part, we know that our study is very limited, that is
we took only one variable of Non-Performing Loans in order to analyze the bank performance in
term of privatization. Therefore other researchers could analyze the performance of banks by
taking other variables i.e. return on assets, return on equity and other important measures related
to the banking sector. All this research recommendation aims the deeper study of effect of
privatization on bank performance.

From Pakistan point of view, if any writer wants to have some information about this thesis
he/she is more than welcome to get the information.


33

(Chapter 6) Truth Criteria

This chapter reflects the criteria of reliability and validity. The measure which has been used in
this research is Non-Performing Loans. To prove the reliability and validity of this measure,
proper statistics data has been taken from the State Bank of Pakistan in terms of percentage of
Non-Performing Loans of total loans and we read this measure by doing the Independent Sample
T-Testing with the help of SPSS software. It has been kept in mind that no data is misleading
towards the wrong outcome of the measure.

Reliability

The term reliability shows how much the concept of measure is consistent through the research
work. In another words if any other author want to work on this data he will get the same
outcome. In this research authors believes that the measure which has been used is reliable and
further measure has been checked within proper analysis by doing Independent Sample T-
Testing.

Another prove of the reliable data is that all data has been taken from the State Bank library
which is of course the proper place to get measurement information for any type of Bank. We
have thoroughly checked every single figure which has been used in the data and this show the
reliability of the data. Researchers who want to work on this topic, if they use the same data they
can get the same result provided what models will be used.

All data is available in the annual reports of the banks which can be taken by the Library State
Bank of Pakistan.

Validity

The term validity says that the data which has been used for the research is appropriate and
sounds good support to the outcome of the research. The data which has been taken in this
research is all appropriate and shows the proper guidance to the outcome and analysis. The
percentages of Non-Performing Loans of total loans which has been taken, supports the total
research report by looking at the affect of privatization, which is the main theme of this research.
No data is invalid throughout the research and proper references have been cited for the readers.

Data in this report proves the validity of its existence in this report. We took this data because we
thought that pre-privatization period comparison of percentages with post privatization
percentages can justify this report as per the requirement of an author. As we mentioned in our
research question that whether privatization has reduced the proportion of Non-Performing loans
of banks in Pakistan, for that these percentages were necessary to be tested. So this proves our
data to be valid according to the requirement of report. The source from where this data was
taken is definitely the perfect source to grab up all percentages. State Bank library and website
was used to get those percentages.


36

We also tried to contact the two given banks in this report MCB and ABL for the proof reading
of our data but as banks do not have their past information because structure of banking sector
has been changed and data is available to the State Bank of Pakistan.

Overall this research is reliable and valid enough to support all the foundations of the report and
data are used in a proper way to avoid misleads to the readers.

Generalization

The term generalization in the research refers to be general from specific. This research is more
towards the specific way. Total 5 banks are in population and 2 banks have been selected and out
of so many measures only 1 measure that is Non-Performing Loans has been selected. The main
purpose behind the selection of only two banks out of 5 was basically the time and non-
availability of data. We could have taken all the banks into an account for this research but as
post-privatization data of other three banks was not enough to test the hypothesis so we thought
that first two privatized banks were fully enough to test them. Another reason behind the non-
availability of data is that other three banks were privatized late and there percentages were not
enough to support them with the percentages of pre-privatized period. So this shows that the
generalization of our report is all accurate and appropriate.


37

References
1. Emilia Bonaccorsi Di Patti and Daniel C. Hardy (2005), Effects of Banking System
Reforms in Pakistan, the Journal of Banking and Finance, April 20, IMF Monetary and
Financial Systems Department.

2. Abid A. Burki and Ghulam Shabbir Khan Niazi (2003), Effects of Privatization,
Competition and Regulation on Banking Efficiency in Pakistan, 1991-2000, November
12,

3. Robel Netserab Debassay, (2004) The Impact of Privatization on firm efficiency, labor
and budget of government, University of the Western Cape, Bellville,

4. Chowdhury F. L, (2006) Corrupt Bureaucracy and Privatization of Tax Enforcement,
Article on Dhaka Studies,

5. Salman A. Shaikh, (2003) Maximizing Value of Non-Performing Assets, Pakistan
Experience, 1999-2003, November, Seoul, Korea

6. Umer Khalid, (2006) The effect of privatization and liberalization on banking sector
performance in Pakistan, SBP Research Bulletin, Volume 2, Number 2

7. George R.G Clarke, Robert Cull, and Mary Shirley, Empirical studies of Bank
Privatization, Some lessons, page 3

8. Condition of the banking system, Pakistan Financial Sector Assessment Program,
(Technical Note), IMF Report No 05/157, Publication services 700, 19
th
street,
Washington DC

9. Muhammad Arshad Khan and Sajawal Khan, (2007) Financial sector restructuring in
Pakistan, The Lahore journal of economics, special edition, September

10. Financial Sector Reforms 1990, strengthening of loan recovery process, source State
Bank of Pakistan

11. Banking law reforms 1990, source State bank of Pakistan


38

12. Banking law reforms (1997) (Recovery of Loans and Credits Act )

13. Financial Sector Assessment 1990-2000, source state bank of Pakistan

14. Dr Ishrat Hussain, (2004) (Former Governor SBP), Policy Considerations before Bank
Privatizations, Case Study,

15. Banking Supervision Department, source: State Bank of Pakistan

16. International Monetary Fund, (2002) Statistics Directorate,

17. Guidelines for Infrastructure Projects Financing, 2008,State Bank of Pakistan

18. Kay Ellen Herr & Geo Miyazaki (1999), The Japanese Non-Performing Loans problem:
Securitization as a Solution, Bankruptcy and Reorganization, April 14.

19. Allen N.Burger, George R.G, Clarke, Robert Cull, Leora Klapper, Gregory F. Udell,
(2005), Corporate Governance and Bank Performance. A joint analysis of the static,
selection and dynamic effects of domestic, foreign and state ownership, Journal of
Banking and Finance, 29, April 20.

20. Lahcen Achy, Mongi Boughzala, Hanaa Kheir-El-Din, and Sbidey Togan, (2005)
Bilkent university centre for international economics Turquie, Impact of liberalization of
trade and services: Banking, Telecommunications and Maritime transport in Egypt
Morocco, Tunisia and Turkey, December

21. Prof Dr. Nico Rottke Workout Management of Non-Performing Loans (a formula model
based on transaction cost economies) Working Paper Series # 06- 003 (Real Estate
Management Institute (European Business School). European Business School
(International University- Schloss Reichartshausen)

Articles:

Syed Iqbal Ahmed, (2002) Banks Non-Performing Loans, Dawn, November 13, (letters
section)


39

Ehtasham ul haq, (2002) Non-Performing Loans of NCBs, major problem, World Bank
Report, Dawn May 5

Article by State Bank of Pakistan (2004), Non-Performing Loans of the banking sector
decline sharply, March 17,

Shamim Ahmed Rizvi, Alarming Rise in NPLs, Pakistan and Gulf Economist, April 6-
12

Rise in Non-Performing Loans, (2009) Dawn Daily Newspaper, April 20

Shabbir H. Kazmi, (2003) Commercial Banks, April 28 May 04

BS reporter,(2006) Bad loans are stare at India and Pakistan, Mumbai Newspaper,
October 23

Websites
www.ebscohost.com
www.sbp.org.pk
www.en.wikipedia.org
www.answers.com
www.google.com.pk
www.investorswords.com
www.wisegeek.com
www.privatization.gov.pk
www.thomaswhite.com
www.ya-hussain.com
www.yahoo.com
www.businessrecorder.com


60

Books
Remenyi, Williams, Money and Swartz, (1998) Doing Research in Business and
Management: An international process and method, London.
Saunders M. Lewis and Thorn Hill,(2000) Research Methods for Business Students, 2
nd

Edition.
nd
Edition, Oxford University
Press.
Annual Reports
Muslim Commercial Bank (1981-2003)
Allied Bank Limited (1981-2003)
Libraries
Library State Bank of Pakistan, Karachi, Pakistan
Library, University of Umea, USBE, Sweden
Thesis
Jessica Peterson, Isac Wadman,(2004) Non-Performing Loans, The markets of Italy and
Sweden, Bachelor Thesis Uppsala University Department of Business Studies.


61

GLOSSARY

NCB: National Commercial Banks
NPL: Non-Performing Loans
SBP: State Bank of Pakistan
GDP: Gross Domestic Product
GNI: Gross National Income
FDI: Foreign Direct Investment
SME: Small Medium Enterprises
IMF: International Monetary Fund
% : Percentage
SECP: Security Exchange Commission of Pakistan
CIRC: Corporate Industrial Restructuring Corporation
Rs: Rupees
MCB: Muslim Commercial Bank
ABL: Allied Bank Limited
UBL: United Bank Limited
NBFI: National Banking Financial Institution
BNA: Banking Nationalization Act
PBC: Pakistan Banking Council
HBL: Habib Bank Limited
NBP: National Bank of Pakistan
CRSIU: Committee for the Revival Sick Industrial Unit
AMG: Allied Management Group
IPO: Initial Public Offer
SNA: System of National Accounts
BCBS: Basel Committee on behalf of Banking Supervision
CAP: Chartered Accountants of Pakistan
Hbp: Hypothesis before privatization
Hap: Hypothesis after privatization
$: Dollar
US: United States
PO: Public Offering
IAS: International Accounting Standards
B: Billion
H: Hypothesis Model


62

Appendices

Muslim Commercial Bank Statistics (MCB)

0
5
10
15
20
25
30
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
Assets (% of assets of NCBs)
%
0
5
10
15
20
25
30
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
Advances (% of advances of NCBs)
%
0
5
10
15
20
25
30
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
Deposits (% of deposits of NCBs)
%

63

Muslim Commercial Bank (Non-Performing Loans 1993- 2003)

Muslim Commercial Bank (Return on Assets 1993- 2003)

0
5
10
15
20
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
%
0.0
0.2
0.4
0.6
0.8
1.0
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
%

64

Allied Bank Limited Statistics (ABL)

0
2
4
6
8
10
12
14
1995 1996 1997 1998 1999 2000 2001 2002 2003
Assets (% of assets of NCBs)
%
0
5
10
15
20
1995 1996 1997 1998 1999 2000 2001 2002 2003
Deposits (% of deposits of NCBs)
%
0
5
10
15
20
1995 1996 1997 1998 1999 2000 2001 2002 2003
Advances (% of advances of NCBs)
%

63

Allied Bank Limited (Non-Performing Loans 1993- 2003)

Allied Bank Limited (Return on Assets 1993- 2003)

0
10
20
30
40
50
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
%
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
1
9
9
3
1
9
9
4
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
%

66

Pre Privatization Structure of Banking Sector 1990

Post Privatization Structure of Banking Sector

Banks No. Assets Deposits Equity
Amount
(Rs.
Billions)
Share
(%)
Amount
(Rs.
Billions)
Share
(%)
Amount
Rs.
Billions)
Share
(%)
State-owned 7 392.3 92.15 329.7 93 14.9 85.6
Private - - - - - -
Foreign 17 33.4 7.84 24.9 7 2.5 14.4
Total 24 425.6 100 354.6 100 17.4 100
Banks No. Assets Deposits Equity
Amount
(Rs.
Billions)
Share
(%)
Amount
(Rs.
Billions)
Share
(%)
Amount
(Rs.
Billions)
Share
(%)
State-owned
1
4 518.8 18.6 379.3 20.1 22.5 17.2
Private 20 1840.3 66.0 1292.3 68.5 92.8 70.9
Foreign 13 278.4 10.0 198.0 10.5 26.7 20.4
Specialized
banks
2

3 149.8 5.4 16.1 0.9 -11.1 -8.5
Total 40 2787.2 100 1885.6 100 130.9 100

67

References for Appendix
Dr Ishrat Hussain, (2002), Case Study, Financial Sector Assessment (1990-2000), State
Bank of Pakistan.(Reference number 58).
Dr Ishrat Hussain, (2004), (Former Governor SBP), Policy Considerations before Bank
Privatization, case study. (Reference number 59).
Financial Sector Assessment (1990-2000), source state bank of Pakistan (Reference
number 60).
Banking Supervision Department, Source State Bank of Pakistan (Reference number 61).

All tables and statistics inside the tables have been taken from the library State Bank of Pakistan
and tables and figures have been quoted exactly as they have been mentioned in their respective
original files.


68

Statistics Tables
MCB (Muslim Commercial Bank Statistics Tables)

Group Statistics

Std. Error
Mean
1
10 22.6000 3.37310 1.06667
NPLS
2
11 14.2727 2.90141 .87481


ABL (ALLIED BANK LIMITED BANK STATISTICS TABLES)
Group Statistics
Group Statistics

Levene's Test for
Equality of Variances t-test for Equality of Means
F Sig. T Df
Sig. (2-
tailed)
Mean
Difference
Std. Error
Difference
95% Confidence
Interval of the
Difference
N
P
L
S
Equal variances
assumed
.028 .868 6.082 19 .000 8.32727 1.36921 5.46148 11.19307
Equal variances
not assumed
6.036 17.893 .000 8.32727 1.37952 5.42777 11.22677
Std. Error
Mean
1
10 41.4000 7.39670 2.33904
NPLS
2
11 24.1818 9.98817 3.01155

Levene's Test for
Equality of
Variances t-test for Equality of Means
F Sig. t Df Sig. (2-tailed) Mean Difference
Std. Error
Difference
95% Confidence
Interval of the
Difference
N
P
L
S
Equal variances
assumed
1.336 .262 4.450 19 .000 17.21818 3.86932 9.11960 25.31677
Equal variances
not assumed
4.515 18.303 .000 17.21818 3.81321 9.21644 25.21992

69

Index
Background
Pakistani Banking System Evolution
Dominance of Nationalized Commercial Banks
History of Non-Performing Loans
Research Question
Purpose of Research
Definition of Privatization
Privatization
Types of Privatization
Non-performing Loans
Definition of Banks
Commercial Banks
Private Banks
State Owned Banks
Performance
Efficiency
Limitation
Limitation of Data
Limitation of Research
Disposition
Theoretical Framework
Research Methodology
Case Studies
Outcomes and Results
Conclusions
Theoretical Framework
Pakistan Economy and Lending Market
Pakistan and World
Economic Overview
History of Pakistani Lending Market and Non-Performing
Concentrated in the Large Scale Manufacturing Sector
Concentrated in the Public Sector Banks and Financial Institution
Zero Equity Projects in 1980s and 1990s
Amateur Entrepreneurs
Direct lending
Privatization as an Economic Instrument
Why Privatization
Competition
Political Intervention
Corporate Governance
Different Views on Effect of Privatization
Efficiency of Privatization
Property Right Theory
Public Choice Theory

70

Views on Effect of Privatization on Customers
Privatization vs Competition
Privatization vs Political Intervention
Privatization vs Corporate Governance
Privatization Impact on NPL and Banks Performance
Performance of the banking sector in Pakistan
Role of the Central Bank
Regulatory Authority
Reform Measure Taken by State Bank of Pakistan
Recent Trends in Banking Sector
Introducing Major Reforms and Prudential Regulation in Late 1980s
Analysis of Financial Sector Reforms
Interest rate
Performance and Efficiency of Financial Institutions
Privatization
Condition before Privatization in Banking Sector Performance
Main Problem Before Privatization Took Place in Banking Sector
Financial Sector Reforms 1990
Institutional Reforms
Privatization Process
Revival in Self Governance
Strengthening of Loan Recovery Process
Banking Reforms
Banking companies
Pre Privatization Structure of Banking Sector 1990
Post Privatization Activities
Amendments in Banks
Abolition of the Pakistan Banking Council
Downsizing in NCB
Closing of Unprofitable Branches
Recapitalization of National Commercialize Banks
Establish of CIRC
Resolution of Non Performing Loan Problem
Installation of Professional Management in NCBs
Promulgation of Privatization Ordinance
Committee for Revival of Sick Unitntr
Banks Privatized Just After Privatization
Allied Bank Limited
Bankers Equity Limited
Bank Alfalah Limited
United Bank Limited
Habib Bank Limited
National Bank of Pakistan
Post Privatization Structure of Banking Sector
Treatment of Non Performing Loans
Classification of Non Performing Loans

71

Different Views and Analysis on Non Performing Loans
Causes of NPL in different countries
Steps Taken by State Bank of Pakistan to Overcome NPL in Future
Project Description
Capital Investment
Project Schedule
Financing
Legal documentation
Facts Regarding Non Performing Loans
Main Reasons behind Increase in NPL in 2008
Comparison among Bank Different Categories
Sector Wise Comparison
Impact of NPL on Banking Sector
Outlook
Research Methodology
Statement of Problem
Scope of Study
Research Philosophy
Positivism
Phenomenal
Research Approach
Inductive Approach
Deductive Approach
Research Methods
Research Design
Research Criteria
Sample and Sample Size
Population
Sample
Hypothesis
Hypothesis Model
Null Hypothesis Model
Hypothesis Model
Dependent and Independent Variables
Variable 1
Variable 2
Analysis Format
Percentage of NPL of MCB Post Privatization
Percentage of NPL of MCB Pre Privatization
Percentage of NPL of ABL Post Privatization
Percentage of NPL of ABL Pre Privatization
Muslim Commercial Bank (MCB)
MCB Privatization Impact Analysis
Allied Bank Limited (ABL)
ABL Privatization Impact Analysis
ABL and MCB Comparison after Privatization

72

Analysis and Outcome
Observation 1
Group Statistics
Levene Test for Equality of Variances
T test for Equality of Means
Confidence Interval,
Observation 2
Group Statistics
Levene Test for Equality of Variances
Variance Result
T test for Equality of Means
Confidence Interval
Conclusion and Recommendation
Truth Criteria

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[kIVA1I2A1ICN AND NCN-LkICkMING LCANS] CcLober 29, 2009

(Banks Non-Performing Loans have decreased on average after privatization)

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