Public and private ownership and performance: A case study of Pakistani Commercial

banks.

Project Summary:

The main goal of this research is to determine the impact of public and private ownership of
commercial banks on the performance of commercial banks working in Pakistan to investigate
because there is a general trend of privatization in Pakistan. Government of Pakistan privatize
many banks 1990-2006, so there is a profession to research that either the banks effectively work
in publicly owned or privately owned. The central theme of this investigation is to explore the
performance of publicly owned banks as well as the privately owned banks. The comparative
study of the banking sector in the specific time period will represent the true picture of effective
performance of the banking sector. This research is useful for the Government to the
nationalization or privatization strategies better flourishing of the banking sector in Pakistan.
This research will also be a basis for 3rd world countries to increase the effectiveness of their
sector banking by adopting this type of strategies.

Proposed Goals

The major purpose of this research is checking the impact of ownership on the performance of
commercial banks working in Pakistan. The central theme of this investigation is to explore the
performance of publicly owned banks as well as the privately owned banks. The comparative
study of the banking sector in the specific time period will represent the true picture of effective
performance of the banking sector in Pakistan.

Hypothesis:

Introduction:

The term “BANK” is derived from an Italian word “BANKO” which means “Bench” that is
where people were meeting and solve their financial matters.

The term bank is being used for a long time yet it has no precise definition. The basic reason is
that the banks perform not just one but many types of functions originally the banks were
supposed to make short term loans to the traders only. The banks now not only make short term
loans to the formers, traders , industrialist etc. But also invest in a wide variety of long term
earning assets (Cornett, Guo, Khaksari, & Tehranian, 2010).

The commercial banks also undertake and execute trust, deal in stock, shares and debentures,
issue guaranties and indemnities underwrite and sell new securities, and deal in foreign exchange
etc.

History of banking sector in Pakistan

Humble beginnings, 1947 – 1970

Our financial sector evolved very differently from banks in the developed world. For nearly a
year after partition, Pakistan had no central bank. Habib Bank – established in 1941 – filled this
gap initially, until the State Bank of Pakistan (SBP) was set up in 1948 under quasi-government
ownership. The role of domestic banks was particularly limited at the time, accounting for only
25 of the total 195 bank branches in the country. Therefore, the SBP was initially mandated to
develop commercial banking channels, and maintain monetary stability so trade and commerce
could flourish in the newly-created state. Subsequently, Habib Bank, Allied Bank and National
Bank were amongst the first to start operations with strong support from the central bank.

A legacy of public control, 1970 – 1980

Commercial banking grew favourably in Pakistan until 1974. Under the nationalisation policy
implemented by Zulfikar Ali Bhutto’s government, thirteen banks were brought under full
government control, and consolidated into six nationalised banks. The Pakistan Banking Council
was set up to monitor nationalised banks, marginalising the SBP’s role as a regulator. These
measures were meant to improve lending to prioritised industries. However, while directed
lending was viewed favourably at the time, little can be said of the long-term gains that have
been achieved.

Business as usual, 1980-1990

Over time, the financial sector grew to serve primarily large corporate business, politicians and
the government. Board of Directors and CEOs were not independently appointed. Lending
decisions were not always commercially motivated, and many billions of rupees were
unsurprisingly funneled out of the financial system as “bad loans”. Banks were essentially not in
control of their destinies during this period.

Privatization, 1990 – 1997

By 1991, the Bank Nationalisation Act was amended, and 23 banks were established – of which
ten were domestically licensed. Muslim Commercial Bank was privatised in 1991 and the
majority ownership of Allied Bank was transferred to its management by 1993. By 1997, there
were still four major state-owned banks, but they now faced competition from 21 domestic banks
and 27 foreign banks. More importantly, administered interest rates were streamlined, bank-wise
credit ceilings removed and a system of auctioning government securities was established,
forcing the government to borrow at market determined rates.

Ushering in the reforms, 1997 – 2006

After privatisation, transformational reforms were pushed through. The central bank’s regulatory
powers were restored via amendments to the Banking Companies Ordinance (1962) and the State
Bank of Pakistan Act (1956). Subsequently, corporate governance, internal controls and bank
supervision was strengthened substantially. Legal impediments and delays in recovery of bad
loans were streamlined in 2001. Furthermore, the scope of prudential framework set up in 1989
was enhanced, allowing banks to venture into hitherto untapped business segments. Lending to
small and medium enterprise had previously been neglected, whereas consumer and mortgage
finance had not developed prior to reforms.

The post-reform era, 2006 – present

Buoyed by the spirit of liberalization, the sector’s landscape has changed significantly. By 2010,
there were five public commercial banks,25 domestic private banks, six foreign banks and four
specialized banks. There are now 9,348 bank branches spread throughout the country, catering to
the needs of some 28 million deposit account-holders.
Pakistan government-owned banks have undergone a remarkable privatization program that,
distinct from the experience of other transition countries, has followed an incremental approach
to change. The resulting changes in the ownership of Pakistani banks raise important questions.
In particular, what role do domestic private ownership and foreign private ownership play in
banks’ performance relative to state ownership? To address these questions we employ an
econometric methodology that builds on the literature on the performance effects of various
types of bank ownership in developing countries and apply it to a unique data set on Chinese
banks from 2009 to 2013.
In our analyses we regress banks’ performance on corporate ownership changes. Following the
methodology proposed by Berger et al. (2005), we include variables that control for static,
selection, and dynamic effects. Static effects refer to performance differences among banks that
have not observed any corporate ownership change over the sample period (i.e., domestic,
foreign, and state ownership). Selection effects refer to performance differences among banks
that have observed some corporate ownership change over the sample period. Dynamic effects
represent performance changes that are due directly to a change in ownership.
Performance of banking system:
As the performance of financial sector indicates the financial health of an economy, standard
analytical tools are used to provide a better comparative picture & gauge the performance of this
vital sector. Consolidation is provided at the beginning of the respective sector’s analysis. For
banks, consolidation is at different levels. At first level, overall consolidation of all banks
including foreign banks is given. Foreign banks are not included in this consolidation because
the information and ratios relating to number of ordinary shares, dividend earning per share and
breakup value per share are not given in this form of financial information. The level of
consolidation for banks is as follows:
1. All Banks (overall)
 Public Sector Banks
 Private Sector Banks
Stock holders will view performance in terms of the profits made on their behalf, whether or not
adjusted for risks taken. They will be mainly interested in whether financial products are not too
expensive and whether the quality is sufficient.(Bikker, 2010)
There is another kind of performance that works in the interest of consumers, but does so in the
long run. It is the reliability of a financial institution in terms of solvency and of whether
customers can be sure to get their money back. (Bikker, 2010)

Statement of Problem:

The research is focused on the effect of Public and Private Ownership on the performance of
Commercial banks working in Pakistan. Banks ownership changes in 1990-91 from state to
private partners was the good act of the government or bad by using time series analysis. If the
experience is good then Government should have reduce its role in the commercial bank working
in Pakistan.

Ownership structure is widely accepted in the finance and economics literature as an

instrumental determinant of firm performance. For example, a specific feature of ownership
structure that has received much attention is how insiders versus outsiders can affect a firm’s
performance. In addition to insider versus outsider stock ownership; another important
dimension of ownership structure is state or public ownership versus private ownership structure.

Literature Review:

Ownership structure is widely accepted in the finance and economics literature as an

instrumental determinant of firm performance. For example, a specific feature of ownership
structure that has received much attention is how insiders versus outsiders can affect a firm’s
performance. In addition to insider versus outsider stock ownership, another important
dimension of ownership structure is state or public ownership versus private ownership structure.

The government ownership and government involvement in a country’s banking system affect
bank performance. Specifically, we use cash flow and accounting based measures to examine
performance differences between privately-owned and state-owned banks. An interesting pattern
of changing performance difference between state-owned and privately-owned banks is that the
state-owned banks generally operated less profitably, held less core capital, and had greater
credit risk than privately-owned banks and the performance differences are more significant in
those countries with greater government involvement and political corruption in the banking
system. (Cornett et al., 2010)

We also take into account the deterioration in the cash flow returns, core capital, and credit
quality of state-owned banks was significantly greater than that of privately-owned banks. We
also find that state-owned banks closed the gap with privately owned banks on cash flow returns,
core capital, and nonperforming loans In addition holding of government securities corroborate
and suggest that state-owned banks finance the government to a greater degree than do privately-
owned banks in countries where the government is involved heavily in the banking
system.(Haider, Yasir, Shahzad, & Javed, 2013) The performance gap between state-owned and
privately-owned banks is greater for the countries with less economic freedom in the banking
sector, and state-owned banks finance the government to a greater degree than do privately-
owned banks in countries where the government is involved heavily in the banking system, are
more consistent with the agency-cost explanations.(Boyd & Runkle, 1993)

Hypothesis:

H1: State Ownership has no effect on performance of banks in Pakistan

H2: State Ownership has a positive effect on performance of banks in Pakistan

H3: Private Ownership has no effect on performance of banks in Pakistan

H4: Private Ownership has a positive effect on performance of banks in Pakistan

Sample size:

Major commercial bank working as public and private ownership is taken as sample. Secondary
data is collected from annual reports of respected banks. Then the results are compared with
purely private sector banks working in Pakistan.(Srinivasan, 2003).
Methodology:

Our analyses focus on the effects of a change in ownership on bank performance. Following the
methodology proposed by Berger et al. (2005), we evaluate the static effects of maintaining
different types of governance over the long term, the selection effects associated with different
types of ownership changes, and the dynamic effects of the two types of ownership changes. The
basic regression model takes the form:

Bank Performance Measure

=Constant + β1 * Static Ownership Indicators + β2 * Selection Ownership Indicators + β3 *
Dynamic Ownership Indicators Dummies + β4 * Dynamic Ownership Indicator Years Since +
β5 * Control variables + β6 * Year Fixed Effects + Error Term.

Significances:

The research is focused on the effect of Public and Private Ownership on the performance of
Commercial banks working in Pakistan. This research is also helpful for many other developing
countries to enhance the performance of their banking system by public and private ownership
There is much other research on this topic but most of them compare the performance of private
commercial banks with the foreign commercial banks working in Pakistan or other developing
and developed nations but we are going to compare the effect of ownership on the performance
of public and private ownership commercial banks working in Pakistan
References:

Ahmadi, M., & Mousavi, S. M. Application of Public Private Partnership for Developing
Metropolises’ Metro Projects in Islamic Republic of Iran.
Berger, A. N., Hasan, I., & Zhou, M. (2009). Bank ownership and efficiency in China: What will
happen in the world’s largest nation? Journal of Banking & Finance, 33(1), 113-130.
Bhatti, G. A., & Hussain, H. (2010). Evidence on structure conduct performance hypothesis in
Pakistani commercial banks. International Journal of Business and Management, 5(9),
p174.
Bikker, J. A. (2010). Measuring performance of banks: an assessment. Journal of Applied
Business and Economics, 11(4), 141-159.
Boyd, J. H., & Runkle, D. E. (1993). Size and performance of banking firms: Testing the
predictions of theory. Journal of Monetary Economics, 31(1), 47-67.
Cornett, M. M., Guo, L., Khaksari, S., & Tehranian, H. (2010). The impact of state ownership on
performance differences in privately-owned versus state-owned banks: An international
comparison. Journal of Financial Intermediation, 19(1), 74-94.
Haider, J., Yasir, M., Shahzad, F., & Javed, M. (2013). Ownership & Performance An Analysis
of Pakistani Banking Sector.
Srinivasan, T. (2003). Indian economic reforms: a stocktaking. Stanford Center for International
Development, Working Paper(190).