Impact of privatization on profitability of banks

MB-13-64 Aqsa Seher Mb-13-26 Farah Latif

Privatization Privatization is the transfer of

ownership of government owned institutions to the private sector. It may be share issue privatization, asset sale privatization, voucher privatization.

Objectives Better standard of service Improvement in performance Promote healthy competition Quick decisions Development of capital market Increase in deposits Security of loan

How privatization can improve performance

There are three themes in which privatization can be grouped

1. Competition 2. Political interventions 3. Corporate governance

Competition The competition argument states thatprivatization will improve the operation of the firm and the allocation of resources in the economy, if it results in greater competition.

Political intervention Privatization can improve efficiency even without changing market structure if it hinders interventions by politicians and bureaucrats who would like to use the SOEs to further their political or personal gains

Corporate governance It is also argued that corporate governance is weaker instate owned enterprises than in private firms because of agency problems and weak incentive system for managers.

Privatization in Pakistan Privatization efforts in Pakistan began in Pakistan in 1988 when

. Employers were hired on the political bases instead of on the merit bases

More and more branches were opened causing over employment

There were no trained professionals

No customer loyalty

Low customer loyalty

budget deficit,

trade deficit,

foreign debt burden

disequilibrium in the balance of payments

increasing non-performing loans.

Establishment of privatization commission

As effort was started in 1988 and the establishment of privatization commission was done in 1991. As a part of this two public sector banks were privatized

• Muslim commercial bank (MCB)• Allied bank limited (ABL)

After that permission was granted for setting up of new banks in the private sector with 10 new banks getting licenses to commence their operations in 1991. and by this reform Share of public sector bank In asset system es to 41% in 2002 Which was 94% in 1990.In deposit base es to 43.5% in 2002 from 93% in 1990.

Privatization has shown improvements in such areas of banking system • Asset quality, • capital adequacy, • earning profitability• liquidity.

Asset qualityThe asset quality of the privatized banks as measured by the ratio of earning assets to total assets is seen to have improved 77.5 to 84.3

Capital adequacy As the deposit base of these banks widened in subsequent years, their capital toliability ratio started declining from 12.6 percent in 1992 to less than half of that by 1998 at 6.1 percent. However, after 2000 this ratio began rising again reaching nearly 8 percent by 2002.

Earnings and profitability

Liquidity The gap between the rate sensitive assets and rate sensitive liabilities measuringthe susceptibility to interest rate risk is found to be negative and rising over theyears for this group of banks. The ratio shows a rising trend during the years as the loans advanced by these banks increased relative to their deposits, the loans to deposit ratio peaked at 6.8 percent in 2000.

In order to overcome the problems of banking sector privatization was done.We have selected four banks for evaluation of privatization on performance. We have specified their performance to the non performing loans (NPL).

1. Muslim commercial bank (MCB)2. Allied bank limited (ABL)3. United bank limited (UBL)4. Habib bank limited (HBl)

Non performing loans Non-performing loan is the defaulted loan which is the sum of borrowed money upon which the debtor has not made the scheduled payment for at least 90 days. Non-performing loan is either default or closed to being in default Muslim commercial bank (MCB)It was incorporated by Adamjee group on july9, 1947. Muslim commercial was first bank which was privatized in pakistan in 1991 with 26% share sold to national group at price of Rs.56 per share that amounts for total Rs.2.4 billion. further 25% shares were offered for subscription to public on Feb 19, 1992.

Selected banks

The growth of MCB after privatization can be observed by some indicators as total assets of MCB which were 18% in 1994 to es to 28% in 2003. A 10% increase in upward trend was seen. Total deposits were 17.6 in 1994 and es to 26.5% in 2003 thus 9% increase in upward trend. Total advances in 1990 were 17.7% which es to 26.7% in 2003. Non-performing loans to total loans percentage was 18.6% in 1993 which es to 11% in 2004 which is a great improvement in recovery of loans.

Allied bank After MCB, Allied Bank was the second bank in the public sector to be privatized. In September 1991 ABL was privatized through an Employee Stock Ownership Plan (ESOP). On September 9, 1991, 26% shares were sold to the Allied Management Group. On August 23, 1993, another 25% shares were sold to AMG at a price of Rs.70 per share. Allied Bank registered an unprecedented growth. Allied Bank’s capital and reserves were Rs.1.525 Billion and assets amounted to Rs.87.536 Billion and deposits were Rs.76.038 Billion

United bank limited (UBL)In 2002, the Government of Pakistan sold it in an open auction to a consortium of Abu Dhabi Group and Best way Group. Abu Dhabi Group has given Rs.12.3 billion each acquiring 25.5% shares and management control in the bank. during 2006, deposit base increased by 16% and that was Rs.335.1 billion. Net advances increased from Rs.204.b billion to Rs.247.3 billion during 2006 NPLs Although there has been growth in NPLs overall portfolio quality indicators have improved with net infection reducing to 1.1%. Profit before tax from these international operations increased by 31% to Rs.2.48 billion during 2006. Total assets of UBL also increased by 22% that is Rs.423.3 billion in 2006 from Rs.347.1 billion at the end of previous year.

Habib bank limited (HBL)Privatization of HBL was done by Dr. Abdul Hafiz on 29th Dec 2003 and as a result of that biding the management was given to Agha Khan Funds for Economic Development by 51% shares for Rs.22.409billion. Total Deposits of the bank increased by 12% during the years of 2003-2004. Total Assets also increased which reduces the risk of liquidity. Net Income also increased by 10%. Non-Performing loans were decreased by 56%. Almost 46 branches were closed that were non-profitable.

• Misuse of loans• Unhealthy competition• Neglecting small industries• Neglecting agriculture sector• Lack of co-operation• Concentration of wealth in few hands• Protection of black money• Advances to relatives and employees• Favoritism• Profit motive

Disadvantages of privatization of banks