Pakistan Private Sector Assistance Evaluation, 1985–2004

8/3/2019 Pakistan Private Sector Assistance Evaluation, 19852004

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A Report to the Operations Evaluation DepartmentAsian Development Bank

For the Country Assistance Program Evaluation for Pakistan

Pakistan Private Sector AssistanceEvaluation, 19852004

by

Jayyad MalikLloyd Powell

July 2006


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CURRENCY EQUIVALENTS(as of 1 November 2005)

Currency Unit Pakistan rupee/s (PRe/PRs)PRe1.00 = $0.0167

$1.00 = PRs59.73

ABBREVIATIONSADB Asian Development BankBCO Banking Companies Ordinance 1962CSP country strategy and programFYP five-year planMFI microfinance institutionNBFI non-bank financial institutionNGO nongovernment organizationPCR project completion reportPRM Pakistan Resident MissionSBP State Bank of Pakistan

SECP Securities and Exchange Commission of PakistanSME small and medium enterpriseTA technical assistanceZTBL Zarai Tarqiati Bank Limited

NOTES

(i) In this report, $ refers to US dollars.


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CONTENTS

EXECUTIVE SUMMARY iii

I. INTRODUCTION 1

A. Background 1B. Scope and Objectives of the Evaluation 2C. Evaluation Methodology 2D. Report Content 3

II. PRIVATE SECTOR PERFORMANCE AND CONSTRAINTS 3A. Private Sector Overview 3B. Private Sector Constraints 4

III. FINANCE SECTOR PERFORMANCE AND ISSUES 6A. Introduction 6B. Banking Sector 6

C. Non-Bank Financial Institutions 15

IV. STRATEGIES AND POLICIES 22A. Government Strategies and Policies 23B. ADBs Country Strategies 25

V. DESCRIPTION OF ADBS PRIVATE SECTOR OPERATIONS 30A. Finance Sector Development (Public Sector Loans) 30B. Private Sector Transactions 34C. Other Operational Activities 37

VI. CONCLUSIONS AND RECOMMENDATIONS 38

A. Overall Conclusions 38B. Recommendations 43

APPENDIXES1. Pakistan Public Sector Loans 19842004 452. Pakistan Private Sector Loans/Equity 199842004 463. Securities and Exchange Commission of Pakistan Ordinance 1997 474. Individuals Interviewed for Private Sector Evaluation Mission 76

This report is a working paper for the Country Assistance Program Evaluation for Pakistan.OED Working Papers are an informal series to present the findings of work in progress in

evaluation. They are circulated to encourage discussion and elicit comment. The viewsexpressed in this report are those of the author(s) and do not necessarily reflect the viewsand policies of the Asian Development Bank, or its Board of Governors or the governmentsthey represent.

The Asian Development Bank does not guarantee the accuracy of the data included in thisreport and accepts no responsibility for any consequences of their use. Use of the termcountry does not imply any judgment by the author(s) or the Asian Development Bank as tothe legal or other status of any territorial entity.


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EXECUTIVE SUMMARY

This report evaluates 20 years (19852004) of Asian Development Banks (ADB)support to the private sector in Pakistan. During this timeframe, ADB has formulated fivestrategy documents to guide its operations in Pakistan (plus two annual updates) and hasapproved $2,241 million in public and private sector facilities of which around 79% or $1,774

million was for 16 public sector projects.1 The remainder, 21% or $467 million was allocatedacross 38 private sector facilities.2 Over the same period, ADB approved 18 technicalassistance (TA) grants for the finance sector for a total of $7.038 million.

Pakistan has undergone significant economic changes over the last 20 years. Thesechanges have had (and in many cases continue to have) an immediate and far-reaching impacton the scope as well as scale of private sector activities within the country. Similarly, the natureof support provided by ADB in order to enhance private sector participation has also evolvedover the last two decades. Overall, ADB pursued two main strategies for assisting private sectorin Pakistan. The first strategy was followed up until the mid-1990s and involved ADB providingmuch needed capital to private sector entities through its private sector operations window.Under this strategy, ADB approved $467 million for 38 projects. These projects accounted for

21% of the total ADB private sector assistance and involved ADB providing loans to privatesector entities and/or taking equity positions in these businesses. Such interventions madesense at the time given the difficulties the private sector faced in their attempts to accessfinancial resources due to a highly regulated and state controlled economy. However, the maindrawback with this strategy was that these interventions were not material in the context of thesize of the economy and, as such, did not bring about sustainable reforms. Of the total 38private sector transactions, 13 occurred during the 1980s, 23 during the 1990s, and 2 in 2000s.The spike in the number of transactions coincides with the time (during the 1980s and the1990s) that Pakistans economy was mired in economic problems and ADB decided to step inand provide the much needed financial support directly to the private sector. Overall, theseprivate sector interventions appear to be well intentioned, commercial, and effective.3

In the mid-1990s, after the Government signed up for the most recent StructuralAdjustment Program (macroeconomic stabilization of the International Monetary Fund and theWorld Bank) and committed to a broad set of reforms, ADB stepped up its efforts and quicklyshifted its private sector assistance strategy by working directly with the Government in order toeffect meaningful and sustainable financial sector reforms. This strategy shift was co-coordinated with the World Bank and was based on the assumption that a robust financialinfrastructure was a prerequisite for establishing a thriving private sector that would enable thecountry to achieve both its economic growth as well as its poverty alleviation objectives. Underthis strategy ADB approved $1,774 million for 16 public sector projects that were gearedtowards strengthening the countrys financial systems. These finance sector reform projectsmake up a major portion (79%) of ADBs private sector assistance activities over the last 20years.

Some key accomplishments associated with ADBs private sector assistance include (i)bringing about policy reform, (ii) developing the countrys capital markets, (iii) kick-starting thecountrys microfinance sector, (iv) supporting private sector entities through ADBs private

1Details on ADBs public sector interventions between 1984 and 2004 are provided as Appendix 1.

2Details on ADBs private sector interventions between 1984 and 2004 are provided as Appendix 2.

3Currently, ADBs Private sector operation is considering investing in an existing mineral sector public privatepartnership venture in Balochistan.


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sector operations window, (v) delivering TA for conducting critical analysis across a broad rangeof finance subsectors, and (vi) assisting the Governments efforts towards restructuringfinancialinstitutions (such as Zarai Tarqiati Bank Limited [ZTBL] and SME Bank). However, there aresome finance sector development projects that are raising questions and concerns becauseeither they are not delivering anticipated results (e.g., large amounts spent on restructuringpublic sector organizationsZTBL and SME Bank), or they are seen to provide an unfair

subsidy (e.g., continued ADB funding of Government-sponsored microfinance bankKhushaliBank).

Private sector transactions undertaken under the first strategy were more effective butwere not able to bring about any meaningful reform primarily due to their (smaller) size and(narrow) focus. On the other hand, finance sector development projects carried out in thesecond strategy were much larger in scale and scope as well as more sustainable. However,these projects appear to be much less effective due to (i) insufficient understanding of thesector/subsector as witnessed by low levels of TA resource allocation prior to loan approval, (ii)over-reliance on ability to transform (almost bankrupt) public sector agencies into viablecommercial entities, and (iii) simultaneously supporting multiple subsectors (e.g., rural finance,microfinance, small and medium enterprise, capital markets, etc.). From an operational

standpoint, initial parts of these projects (project planning and approval) went smoothly, but thensome projects encountered problems during implementation. These problems were caused by(i) limited capacity within the Pakistan Resident Mission (PRM) to effectively implement projectsand/or maintain relationship with key stakeholders, (ii) high staff turnover (both at PRM andheadquarters) which raised confusion with regards to accountability, and (iii) Governmentsresponsiveness in implementing reforms and/or regulatory frameworks.

More recent government plans (such as the Ten-Year Perspective Plan and the MediumTerm Development Framework 20052010) indicate that the Government is more confident andis taking the lead in establishing what and how it plans to develop its economy. The followingprincipal recommendations are made:

Recommendations Responsibility

For Government Consideration1. Immediate Action. The Ministry of Finance, for the

Government, should commission an assessment thatprovides a gap-analysis (i.e., what support does thefinancial sector need to evolve into a mature/developedfinancial sector) and a series of recommendations based oninternational financial market standards and a fully-costedand time bound action plan to get there. It is vital thatinternational and local financial market operators are utilizedfor this assignment.

Coordination by Ministry ofFinance

For ADB (and Government) Consideration2. ADB should conduct a review of its finance sector

development projects and develop an action plan forunfinished business, such as, enhancing Securities andExchange Commission of Pakistans (SECPs) capacity as aregulator, development of the bond market, etc. (ashighlighted in this evaluation as well as by findings of 1above).

South Asia Finance Divisionand the Pakistan ResidentMission (PRM)


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Recommendations Responsibility

3. ADB should consider reducing, if possible, the high turnoverof its finance personnel at PRM. In addition, a specialty

support unit for supporting ongoing projects/programs andother Government and private sector stakeholders should becreated in PRM as soon as possible.

4. ADB should be more stringent in evaluating its ongoingprojects (especially, finance sector development programs) inorder to pragmatically assess their ability to achieve theirstated objectives.

5. ADB should increase timely TA resource allocation, especiallyfor finance sector development programs.

6. ADB should maintain strategic focus (applies to both ongoingand future projects) so as not to spread itself too thin bysimultaneously supporting a relatively large number ofsectors.

7. In the next country strategy and program (CSP),consideration should be given to increasing the number oftransactions developed through ADBs private sectoroperations window.

8. In the next CSP, a more selective approach should beadopted for new finance sector development projects given

that private entities already dominate finance sector activitiesin Pakistan. Large-scale public finance sector developmentprojects will continue to diminish as the financial systems inthe country mature.

9. Provision should be made in the next CSP to utilizeinnovative financing modalities when developing privatesector assistance interventions (such as those offered underADBs Innovation and Efficiency Initiative).

10. ADB needs to reassess its existing strategy of supportinginstitutions (e.g., ZTBL, SME Bank, Khushali Bank, etc.). If

the Government wants to continue with these initiatives, thenaccountabilities should be documented so that ADB and theGovernment understand who is carrying what risks.

PRM Country Director/South Asia Department

Operations EvaluationsDepartment/South AsiaFinance Division

South Asia Finance Division

South Asia FinanceDivision/PRM

Private SectorOperation/PRM

South Asia FinanceDivision/PRM/Government

South Asia FinanceDivision/PRM/Government

South Asia Finance Division/Operations Evaluation

Department/PRM


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I. INTRODUCTION

A. Background

1. This report is prepared by the Operations Evaluation Department of the AsianDevelopment Bank (ADB) and presents an evaluation of ADBs private sector assistance in

Pakistan over 19852004. This evaluation will contribute in preparation of a Pakistan CountryAssistance Program Evaluation, which, in turn, will support the formulation of a new PakistanCountry Strategy and Program (CSP) to be approved in 2006.

2. Pakistan has undergone significant economic changes over the last 20 years. Thesechanges have had (and in many cases continue to have) an immediate and far-reaching impacton the scope as well as scale of private sector activities within the country. Similarly, the natureof support provided by ADB in order to enhance private sector participation has also evolvedover the last two decades. During this time, ADB assisted the private sector in Pakistan eitherby delivering support directly to the private sector (through its private sector operations window),or, by working with the Government to develop large-scale finance sector reform programs.

3. Overall, ADB approved $2,241 million in facilities to assist with the development ofprivate sector enterprise in Pakistan and pursued two main strategies to this end. The firststrategy was followed up until the mid-1990s and involved ADB providing much needed capitalto private entities through its private sector operations window. Under this strategy, ADBapproved $467 million for 38 projects. These projects accounted for 21% of the total ADBprivate sector assistance and involved ADB providing loans to private sector entities and/ortaking equity positions in these businesses. Such interventions made sense at the time giventhe difficulties the private sector faced in their attempts to access financial resources due to ahighly regulated and state controlled economy. The main drawback with this strategy was thatthese interventions were entity specific and, as such, did not attempt to bring about sustainablereforms.

Figure 1: Pattern of ADBs Private Sector Assistance

0

100

200

300

400

500

600

1985-89 1990-94 1995-99 2000-04Time Period

$Million

Finance Sector Development Programs Private Sector Transactions

4. In the mid-1990s, after the Government signed up for the Structural Adjustment Programand committed to a broad set of reforms, ADB stepped up its efforts and quickly shifted its


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private sector assistance strategy by working with the Government to catalyze more meaningfuland sustainable financial sector reforms. This strategy shift was based on the assumption that arobust financial infrastructure was a prerequisite for establishing a private sector that wouldenable the country to achieve both its economic growth as well as its poverty alleviationobjectives. Under this strategy, ADB approved $1,774 million for 16 public sector projects thatwere geared towards strengthening Pakistans financial systems. Interventions carried out under

this strategy constitute a major portion (79%) of ADBs private sector assistance to Pakistan andfor this reason a major portion of this evaluation involves discussion, evaluation, andassessment of the countrys financial systems.

B. Scope and Objectives of the Evaluation

5. This report provides an assessment of ADBs activities in support of private sectorassistance in Pakistan over the last two decades. It is hoped that in addition to past and presentassistance flow, this report will also aid in developing recommendations for future assistanceefforts. In order to develop an assessment of ADBs support for the private sector in Pakistan,this evaluation will attempt to answer the following set of questions:

(i) How has the private sector evolved over the last 20 years and what are theprimary constraints it currently faces?

(ii) What strategies and policies have successive governments pursued?(iii) How has ADB assisted the private sector as per its formal country strategies?(iv) How effective have ADBs projects been in assisting the private sector in

Pakistan?(v) What strategies were pursued for using ADB resources?(vi) What drove these strategic choices?(vii) What was the quality of ADBs formal country strategies?(viii) Irrespective of quality, what was the quality and performance of ADBs program?(ix) Was the program well managed?(x) How did ADB resources contribute to sector outcomes?

(xi) Was there effective synergy between ADB resources and those of others?(xii) Did ADB do the right things?(xiii) How can choice selection and decision-making processes be improved in future?

C. Evaluation Methodology

6. This report was developed by following the methodology provided below:

(i) assessment of private sector enterprise in Pakistan;(ii) description and review of finance sector and subsector performance to identify

issues and needs;(iii) description of government strategies and policies, and assessment of their

implementation and achievements;(iv) evaluation of ADB sector strategies within country strategy documents; and(v) ADBs program was then reviewed to determine the relationship between

strategy and program.

7. In order to understand the effectiveness of ADBs private sector assistance strategiesand programs the following approach was followed:


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(i) all relevant design and evaluation/review documents for loan and TA projectswere reviewed;

(ii) performance of ADBs strategies, projects, and operations were assessed byinterviewing senior officials in the Government and holding discussions with anumber of private sector organizations and other development partners;1 and

(iii) performance, strategies, and (current/future) expectations of the Government

were assessed by holding discussions with key decision and policy makers inPakistan.

D. Report Content

8. Subsequent chapters cover private sector performance and constraints; finance sectorperformance and issues; government strategies and policies; ADBs strategies and policies; adescription and review of ADBs operations in support of private sector; and conclusions andrecommendations.

II. PRIVATE SECTOR PERFORMANCE AND CONSTRAINTS

9. This chapter aims to provide a high-level overview of Pakistans economic environmentover the last two decades as well as information on key constraints to private sectorparticipation in the country.

A. Private Sector Overview

10. For the most part, during the 1980s, a state-led model of industrialization was followed inPakistan. At the time, the Government was only focused on encouraging development of largescale manufacturing concerns. This fact was apparent from the way in which large firms wereallowed to obtain licenses, official exchange rates for imports, and tariff rebates. Suchpreferential treatment was not extended to smaller firms and these firms found it much harder tosecure financing2 and complying with regulatory requirements (e.g., tax regulations, labor laws,

licensing and price controls, etc.).

11. During the 1990s, Pakistan committed and signed up for the macroeconomicstabilization and structural adjustment programs of the International Monetary Fund and theWorld Bank. The Government committed itself to these programs in order to lower macro-instability, remove distortions prevalent in trade and industry structures, and enhance economicgrowth. For the most part, growth rates slowed across most of the main economic sectorsduring this decade as the country braced for sweeping reform measures. Political instability wasa mainstay and peaked towards the end of this decade when Pakistan conducted nuclear tests.Economic sanctions and other fall out from the countrys nuclear experiments also affected thecountrys business climate significantly.

12. Pakistans economy has improved in 2000s. In 20042005, for the third consecutiveyear, the countrys economy expanded and registered a real gross domestic product (GDP)growth of 8.4%, surpassing the 6.6% target set for the year and improving upon the GDP growthfor the previous year (6.4%).3 There are a number of reasons fueling the countrys economic

1See Appendix 4 for list of individuals met for the Private Sector Assistance Evaluation Mission.

2Due to the controlled interest rate environment banks were unable to compensate for the higher transaction costsassociated with lending to smaller businesses

3Ministry of Finance. 2005. Economic Survey 20042005. Pakistan.


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recovery, such as, actualization of government reforms aimed at deregulating and liberalizingkey sectors of the economy, improvements in countrys infrastructure (physical, financial, andtelecommunication), increasing demand for goods and services within the domestic markets,etc. Provided in Table 1 (below) is information on average growth rates that illustrate the trendsdiscussed in this section.

Table 1: Average (Annual) Growth Rates

Indicators1980s 1999

200020002001

20012002

20022003 R

20032004 P

GDP 6.45 3.91 1.8 3.1 5.1 6.4Agriculture 5.44 6.09 -2.2 0.1 4.1 2.6Manufacturing 8.21 1.53 9.3 4.5 6.9 13.4Commodity Producing Sector 6.49 3.02 0.5 1.3 4.9 7.7Services Sector 6.65 4.79 3.1 4.8 5.3 5.2R = Revised, P = Provisional.GDP = gross domestic product.Source: Ministry of Finance. Economic Survey of Pakistan(various issues). Pakistan.

B. Private Sector Constraints

13. Provided below are some of the main issues and challenges that have (and in mostcases still continue to) hampered private sector participation in the countrys economic reality.4

1. Financial Constraints

14. Access to finance is one of the main hurdles discouraging increased private sectorparticipation in the countrys economy. Even though opportunities to secure financing haveincreased over the years, there is still considerable shortfall in demand and supply for credit-related resources and services. Some of the main issues and challenges faced by the privatesector in this regard include:

(i) lack of access to credit,(ii) stringent collateral requirements,(iii) procedural delays in loan disbursement,(iv) corrupt system for obtaining credit,(v) high cost for securing credit, and(vi) high interest rates.

15. Detailed analysis for this topic is provided in Chapter III.

2. Regulatory Constraints

16. Uneven and unpredictable enforcement of regulations (tax laws, tariffs, and exportregulations) serve as a constraint for private sector participation.

17. Some of the main tax-related constraints include:

(i) high rates of income tax,

4The constraint-related information is based on the findings of ADBs Pakistan Resident Mission 2005 report titledSME Development in Pakistan, Analyzing the Constraints to Growth.


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(ii) high rates of sales tax,(iii) lengthy procedures for submitting income tax statements,(iv) uncertainty with regards to income and sales tax policies, and(v) slow pace and cost associated with resolving tax disputes.

18. Some of the main tariff-related constraints include

(i) high tariff rates on import of raw materials and intermediate goods, and(ii) unpredictable changes in tariff rates.

19. Some of the main export regulation-related constraints include

(i) cost of delay in obtaining duty drawbacks and sales tax refunds, and(ii) uncertainty of sales tax refund.

3. Infrastructure Constraints

20. Lack of adequate infrastructure facilities serve as a major impediment to private sector

growth. Main constraints faced by the private sector in the country include

(i) high cost, poor quality of service, and unreliable supply of power;(ii) inefficient, unreliable, and costly transport network;(iii) widespread corruption within utilities providers; and(iv) high cost of establishing back up power.

4. Human Resources Constraints

21. Finding appropriate human resource capacity also serves as a constraint for the privatesector. Provided below are the main human resources-related constraints faced by the privatesector:

(i) workers are not educated enough;(ii) personnel are not adequately trained;(iii) lower and middle-level personnel lack requisite skills;(iv) even where workers had degrees or certificates, the quality of training and

education they had received was substandard; and(v) there is a significant mismatch between skills required by employers and the

training provided by educational/training institutions.

5. Market Constraints

22. Market constraints refer to issues and challenges faced by the private sector as a direct

consequence of high degree of state control and inefficient regulation. Provided below are someof the main market constraints:

(i) lack of trust between suppliers and manufacturers/retailers significantly increasetransaction costs,

(ii) high cost of contract repudiation increases cost of doing business for firms,(iii) competition from smuggled goods and the informal economy significantly affects

private sector participation for manufacturer as well as retailers, and(iv) rule of law.


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III. FINANCE SECTOR PERFORMANCE AND ISSUES

A. Introduction

23. ADBs finance sector reform interventions constitute a major portion (79%) of its privatesector assistance to Pakistan over the last 20 years. This emphasis on the financial sector was

based on the assumption that a robust financial infrastructure was a prerequisite for establishinga private sector that would enable the country to achieve both its economic growth as well as itspoverty alleviation objectives.

24. Pakistans finance sector can be broadly rationalized in two main categoriesthebanking sector and the non-bank financial institutions (NBFIs). The banking sector refers to anumber of subsectors, such as commercial and retail banking, rural finance (agricultural andmicrofinance), and small and medium enterprise (SME) lending. As the name suggests, NBFIsrefers to financial institutions other than banks, such as stock markets, leasing companies,insurance companies, etc. The remainder of this chapter provides information and analysis onthe countrys key financial sectors and subsectors.

B. Banking Sector

25. Information on the regulatory framework as well as the main sub-sectors of the bankingsector is provided below.

1. Regulatory Framework

26. The regulator of the banking sector is the State Bank of Pakistan (SBP). BankingCompanies Ordinance (BCO) 1962 is the main law governing the establishment and operationsof commercial banking institutions and is administered by SBP. This law sets out certain keyrequirements for those entities interested in developing and/or operating commercial bankingentities in Pakistan that include:

(i) Capital and Reserve Requirements. As of December 2004, all scheduledbanks operating in Pakistan are required to maintain a minimum paid up capital(net of losses) of PRs1,500 million. This requirement will increase to PRs2,000million by December 2005. In addition, banks are also required to maintaincapital and unencumbered general reserves, the value of which is not less than8% of their risk weighted assets (on both consolidated as well as stand alonebasis)

(ii) Cash Reserves. The banks are required to maintain a cash reserve of apercentage of their demand and time liabilities excluding the paid up capital,reserves and balance in the profit and loss account with the SBP. This ratio is

changed from time to time in accordance with the demands of the monetarypolicy. No interest and/or profit is paid by SBP on these funds.

(iii) Liquid Assets. Banks are required to maintain liquid assets of not less than 80%of the total time and demand liabilities in Pakistan.

(iv) Annual Accounts and Audits. As per the BCO, a bank is required to maintainthe calendar year as its financial year, and its financial statements are required tobe audited in accordance with 2nd Schedule of the BCO. Under this ordinance,


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31. Up until the recent past, the retail banks were primarily focused on delivering financialservices and support to the corporate sector and the needs of the households typically wentunmet. Lending to individuals was mostly done in the form of fully secured loans againsttangible liquid securities (usually, government securities, bank deposits, etc.). Consumerfinancing was untapped until a few years ago when surplus liquidity and slow credit growth fromthe corporate sector forced the retail banks to seek other avenues to enhance their asset base

and profitability.

32. As shown in Table 2, consumer finance has been growing at a rapid pace. The Otherscategory, which accounts for the largest share of consumer finance consists of personal loans(both secured and unsecured) as well as financing for consumer durables. Auto financingaccounts for the second largest share in consumer financing followed in third place by creditcards. Mortgages have not gained a foothold in Pakistans financial markets and it is an areathat will experience significant expansion in the short to medium term.7 This rapid expansion indemand for consumer finance has resulted in banks actively entering into other financialmarkets, such as leasing, etc.8

Table 2: Consumer Finance (PRs Billion)

Source: State Bank of Pakistan. 2003. Pakistan Financial Sector Assessment 2003. Research Department: Pakistan.

Item Jun-03 Sep-03 Dec-03 Mar-04 Jun-04Credit Cards 6.7 8.0 8.9 9.7 11.2House Loans 3.8 3.4 4.1 5.5 8.3Auto Loans 15.8 16.9 22.2 27.6 33.1Others 18.7 25.6 30.3 40.2 50.0Total Consumer Finance 45.0 53.9 65.5 83.0 202.6Growth Rate (%) 69.8 19.8 21.5 26.7 23.6Total Loans 1,043.1 1,040.2 1,152.0 1,205.4 1,350.9

Consumer Finance as % of Total 4.3 5.2 5.7 6.9 7.6

33. Another interesting development in the countrys banking system has been the rising

popularity of Islamic banking. In 2002, SBP exempted Islamic commercial banks from themoratorium on the establishment of new banks, and the first full-fledged Islamic bank, MeezanBank, was licensed. Since then, several conventional banks have also opened branches thatprovide only Islamic financial services. The size of these Islamic banking institutions remainsvery small.9 Given the present administrations and SBPs commitment towards encouragingIslamic mode of financing, there is likely to be a rise in the number and type of Islamic financialinstitutions and services in the coming few years.

34. In order to provide the required regulatory support for consumer finance, SBP hasdeveloped and put in place regulations that provide for

(i) facilities to related persons,

(ii) exposure against total consumer financing,(iii) total financing facilities to be commensurate with income,(iv) general reserve against consumer finance,

7Problems with land title records are a major hurdle that needs to be overcome in order to realize increases inmortgage transactions in the country.

8Existing leasing companies were of the opinion that commercial banks entering the leasing market have created anon-level playing field because they (banks) are not subject to the same (stringent) capital adequacy requirementsas are the leasing companies.

9According to SBP estimates Islamic banking assets account for around one percent of the total bank assets.


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(v) bar on transfer of facilities from one category to another to avoid classification,(vi) margin requirements, and(vii) credit cards.

35. Additional detailed regulations have also been issued by SBP for auto loans, housingfinance, and personal loans including loans for purchase of durables.

3. Rural Finance and Microfinance

36. There is widespread acceptance among decision and policy makers as to the need fordeveloping credit products tailored for meeting the needs of the poor in Pakistan. Driving this isthe fact that despite favorable macroeconomic circumstances within the countrypoverty andinequality have been on the rise. For instance, 80% of the 14.3 million rural households earnedless than $1 a day during 19981999.10 Moreover, the head count for rural and urban povertyfor the same time period was 36.3% and 24.3%, respectively (footnote 13).

37. During the year ended June 2001, the formal sources jointly disbursed a total of 786,000loans amounting to PRs56 billion ($0.94 billion), i.e., an average loan size of PRs71,246 or

$1192.8 (footnote 13). Nongovernment organizations (NGOs) have disbursed about 100,000loans. The nominal interest rates charged ranged between 13% and 22%. The outreach ismerely 6% of the total rural households and the amount disbursed is 21% of the estimateddemand (footnote 13). These numbers clearly suggest that the demand for micro/rural financewas not met and that a sustainable solution would need to be developed.

38. The SBP established a Rural Finance Committee (RFC) that, among other things, wastasked with coming up with a definition for rural finance. In their report, the RFC defined ruralfinance as

(i) credit requirements for agricultural activities,(ii) mobilization of rural savings,

(iii) access to insurance services for risk mitigation, and(iv) payment systems that will allow flow of funds to and from the rural areas.

39. Realizing the importance of developing capacity to deliver rural finance support, over thelast few years, the Government has been following a two-pronged strategy. The two maincomponents of this strategy are:

a. Easing access to agricultural credit

40. According to the Governments current development frameworkthe Medium TermDevelopment Framework 20052010 (MTDF)over the next 5 years, i.e., up until 2010, theagricultural credit requirements in the country has been estimated to reach PRs1,665 billion

($27.88 billion). Table 3 shows the distribution of the agricultural credit requirement.

10ADB. 2000. Report and Recommendation of the President to the Board of Directors on Proposed Loans to theIslamic Republic of Pakistan for the Microfinance Sector Development Program. Manila.


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Table 3: Agricultural Credit Requirement

Year Production Development Total (PRs billion)

20052006 205 70 27520062007 220 80 30020072008 240 90 330

20082009 260 100 36020092010 290 110 400

Total 1,215 450 1,665

Source: Planning Commission. May 2005. Medium Term Development Framework 20052010.Pakistan.

41. According to SBP, the total agriculture credit disbursement during 2003 was PRs58.9billion ($.99 billion) to a total of 814,737 individual borrowers. It can be inferred from theinformation provided here that a major portion of agricultural credit requirement demand goesunmet, especially given that amount disbursed during 2003 is less than 22% of the projecteddemand for agricultural credit in 20052006 (Table 3). More information in this regard isprovided in Tables 4 and 5.

Table 4: Credit to Agriculture Sector, Disbursements (PRs billion)

ZTBL = Zarai Tarqiati Bank Limited.

Financial Institution 2000 2001 2002 20032004

(JulDec)Annual

Growth RateZTBL 24.4 27.6 29.1 29.3 13.4 6.4Commercial Banks 9.3 12.1 17.5 22.7 15.1 34.8New Private CommercialBanks

- - 0.6 1.4 1.3 133.3

Cooperatives 6 5.1 5.3 5.5 3.0 -2.4Total 39.7 44.8 52.5 58.9 32.8 14.1

Source: State Bank of Pakistan. February 2004. Financial Sector Reforms and Pro-Poor Growth: Case Study ofPakistan. Pakistan.

Table 5: Total Number of Borrowers of Agricultural Credit (Excluding Cooperatives)

ZTBL = Zarai Tarqiati Bank Limited.

Financial Institution 2000 2001 2002 2003% Increase

(FY 20002003)ZTBL 374,243 427,124 462,639 458,238 6.4Commercial Banks 290,572 309,022 353,610 345,731 19.0New Private CommercialBanks

- - 4,751 10,765 -

Total 664,815 736,146 821,000 814,737 22.5


42. In order to address the growing demand for agricultural credit, the Government in itsMTDF commits to enhancing agricultural productivity by taking the following measures:

(i) In addition to ZTBL and provincial cooperative banks, major commercial andprivate banks will also provide agricultural credit.


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(ii) Mark-up rates on agricultural credit will be reviewed by banks and reducedreasonably on the basis of market mechanisms.

(iii) One-window operation facilities will be further enhanced to make it more effectivein meeting the farmers needs.

(iv) Special trainings will be developed for farmers and will be delivered by banks tocreate awareness and knowledge amongst them (farmers).

(v) Institutional credit will also be extended to rural non-farm sector including ruralpoor, tenants, agricultural artisans, women, and other disadvantaged groups byorganizing rural communities.

43. It appears that one of the more tangible measures undertaken by the Government (andADB) to address the shortfall in agricultural credit is the revitalization of ZTBL. TheGovernments plans for ZTBL, previously known as the Agricultural Development Bank ofPakistan, involve cleaning up its balance sheet (high nonperforming loans portfolio) as well asits operations (commercializing the public sector organization) and then privatizing theinstitution. It appears that the Governments continued support for ZTBL stems from its beliefthat ZTBL is ideally suited for serving as the key supplier of credit to the rural communities. TheGovernment has invested quite heavily in trying to turn this organization around and the results

have been mixed at best.11

b. Development of the Microfinance Industry

44. The second component of the Governments strategy for addressing the shortfall in thecountrys rural finance demand is by encouraging microfinance lending. The Governmentsenthusiasm towards developing the microfinance industry lies in its belief that microfinance is aviable means for directly linking finance with poverty reduction. Currently, there are twospecialized microfinance banks operating in the country (First Micro Finance Bank Limited andKhushali Bank). According to SBP, two other microfinance banks have been granted licensesand they became operational in 2005. Table 5 provides information on the microfinance sectorin Pakistan.

11 ZTBL Chairman indicated that the organization was facing a number of serious problems, some of which arediscussed below:(i) ZTBL Board. As per the restructuring plan, ZTBLs Board would be from the private sector. However, at the

moment, three members of the seven-member Board are secretaries from the federal government. Two of theremaining four are presidents of competing banks. The Chairman suggested that this situation, at the veryleast, poses as a conflict of interest.

(ii) Lending Rate Cap. ZTBL secures funds from SBP at 8% and it has a lending rate cap (announced by thePresident of Pakistan) of 8.5%. Chairman of ZTBL said that the bank will need at least a 6.5% spread in orderto turn a profit.

(iii) Operational Issues. The bank faces formidable challenges such as, human resource capacity, operationalinefficiency, technology, etc., and there is very little that has been done to address any of these issues.


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Table 5: Micro Finance Sector in Pakistan(in PRs millions)

KB = Khushali Bank, FMFB = First Micro Finance Bank.

Item Sep-02 Dec-02 Mar-03 Jun-03 Sep-03Advances Net of ProvisionKB 413.8 475.5 565.8 662.2 778.9FMFB 4.38 17.61 31.0 49.8 58.2

Total Advances 418.2 493.1 596.8 712.0 837.1% Change 17.9 21.0 19.3 17.6Number of BorrowersKB 45,930 56,324 69,584 83,109 100,228FMFB 169 713 1657 2,608 3,112Total Advances 46,099 57,037 71,241 85,717 103,340% Change 23.7 24.9 20.3 20.6Number of New Borrowers During QuarterKB 16,827 10,394 13,260 13,525 17,119FMFB 101 544 944 951 504Total Advances 16,928 10,938 14,204 14,476 17,623% Change -35.4 29.9 1.9 21.7Average Loan SizeKB 10,786.2 8,795.7 8,471.4 8,300.1 8,183.6FMFB 25,662.7 24,697.1 20,304.8 19,406.1 16,263.2Number of BranchesKB 27 31 31 35 35FMFB 3 8 9 10 11Total No. of Branches 30 39 40 45 46


45. In order to provide the required regulatory support to microfinance institutions (MFIs),SBP has developed and put in place legislations that provide for

(i) minimum capital requirements,(ii) exposure against contingent liabilities,

(iii) maintenance of cash reserves and liquidity,(iv) statutory reserves,(v) depositors protection fund,(vi) restriction on certain types of transactions,(vii) maximum loan size,(viii) maximum exposure of a borrower from MFIs/other financial institutions/NGOs,(ix) rescheduling/restructuring of loans,(x) writing off of nonperforming loans,(xi) pricing of microfinance products and services,(xii) investment in shares of any body corporate,(xiii) undertaking of cash payments outside the MFIs authorized place of business,(xiv) prevention of criminal use of MFI channels for the purposes of money laundering

and other unlawful management trade,(xv) audit and submission of accounts,(xvi) internal audit,(xvii) operational policies, and(xviii) restriction on election and appointment of directors.

46. Governments efforts towards developing the countrys microfinance industry haveyielded promising results. Initially, ADB assisted the Government in establishing the KhushaliBankthe first microfinance bank in Pakistan. Since then, microfinance has been gaining


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ground in the country and a number of new players have started providing microfinanceservices. Unlike in the past when most institutions geared towards delivering rural finance reliefwere government owned and/or controlled, for the first time a new business model was utilizedthat was committed to establishing microfinance banks as commercially viable entities.However, since the microfinance industry has taken off, the Governments (and ADBs)continued support (financial and otherwise) for Khushali Bank is questioned and criticized by

other microfinance providers.12 So far, it remains unclear whether or not developing acommercially viable microfinance business model is a sustainable proposition or not.13

4. Small and Medium Enterprise Finance

47. SME refers to those business organizations that employ no more than 250 persons or 50persons depending on whether the organization is a manufacturing concern or a trading/serviceconcern, respectively.14 In addition, the organization in question will also need to fulfill thefollowing conditions:

(i) A manufacturing concern with total assets (excluding land) valued up to PRs100million ($1.67 million) and net sales not exceeding PRs300 million ($5.02 million)

as per the latest financial statement(ii) A trading/service concern with total assets (excluding land) valued up to PRs50

million ($0.84 million) and net sales not exceeding PRs300 million ($5.02 million)as per the latest financial statement

48. Table 6 (below) provides additional information on how small and medium enterprisesare defined.

Table 6: Definition of SMEs

Factor Small Enterprise Medium EnterpriseNumber of

Employeesa

Up to 50 for manufacturing 3699 for manufacturing

Up to 20 for services 2150 for services

Total Asset Valueb

PRs220 million for manufacturing Rs21100 million for manufacturingPRs210 million for services Rs1150 million for services

Gross Salesc

PRs220 million for manufacturing Rs21100 million for manufacturingPRs210 million for services Rs1150 million for services

aFulltime employees with at least six months employment prior to evaluation.

bAs per latest evaluations, and includes building and technical non-physical capital.

cAs per latest financial statements .

Source: Medium Term Development Framework 20052010.

49. SMEs play a vital role in the economic reality of Pakistan as they constitute 99% of thenearly 2.3 million enterprises in the country and contribute 30% to the manufacturing sector andgenerate 25% of manufactured exports.15 Importance of SMEs in Pakistan is also driven by the

12The continued support for Khushali Bank is viewed as an unfair advantage. It is interesting to note that KhushaliBank is not a member of the apex microfinance organization in Pakistan, i.e., The Micro Finance Network.

13According to the President of Khushali Bank results to date were on track. However, the bank needed to establisha track record of commercial viability in the medium term.

14SME Bank website (www.smebank.org)

15Source: Planning Commission. May 2005. Medium Term Development Framework 20052010. Pakistan.


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fact that increasing the number of SMEs can increase employment more than growth in large-scale firms.16 There is a growing realization in Pakistan that SMEs can play a vital role inenabling the countrys drive towards sustainable development. Among the many issues thatconstrain growth of SMEs (as discussed in Chapter III) by far the greatest impediment faced bythese organizations is lack of financing.17 In order to provide financing support to the SMEcommunity, the Government in its MTDF plans to facilitate SME financing by:

(i) Encouraging venture capital for new SME start-ups (especially for those engagedin export oriented contract-manufacturing and designing, or electronic services).

(ii) Offering incentive schemes in order to streamline taxation and businessregistration for SMEs.

(iii) Improving weightage for skill levels, technology and export potential, andlinkages with prime contractor, in addition to the usual evaluation schemes thatare based upon physical assets and turnover.

50. Since January 2004, SBP has enforced SME-friendly regulations so as to provide betterfinancing opportunities and options for such entities. According to these regulations, banks donot have to require collateral and instead can take into consideration asset conversion cycle and

cash flow generation as the basis for loan approval.

51. ADB has been supporting the development of the SME sector in Pakistan through itsSME Sector Development program. In addition to providing capacity building support to theSME sector, this program is also providing financing for the establishment and restructuring ofthe SME Bank (discussed below).

52. In 2002, the SME Bank was established and its primary purpose was stated asfacilitation of credit to SMEs. This bank was created by combining two state-owned DFIs thatwere on the brink of collapse due to exceptionally high nonperforming loans portfolios. Since itscreation, the SME Bank has been primarily preoccupied with cleaning up its books andoperations. It is also in the process of developing prototypes for a range of SME banking

functions, such as, lending programs, credit appraisals and delivery methodologies,standardized documentation, monitoring mechanisms, etc. The next step is for the SME Bank tobe privatizedhowever, the timing, terms, and mode of this privatization remain unclear. 18

5. Other

a. Human Capital

53. Availability of appropriate human capital resources is a prerequisite for establishment ofmature financial markets in Pakistan. Requirements for human resources differ significantlyacross the different banking subsectors. Provided below is a discussion on the various aspectsof the human resources situation across different aspects of Pakistans banking system.

16SME Financing: Issues & Strategies. Welcome address given at the SME Conference by the Governor State Bankof Pakistan in Lahore on 10 May 2005.

17According to a recently conducted World Business Environment Survey that covered 4,000 firms in 54 countriesfound that SMEs cited inadequate access to financing as their primary constraint to growth.

18The President of SME Bank and the Governor of the State Bank of Pakistan were not sure when this entity wouldbe privatized. They both talked about 2006 but with vagueness about what was going to be privatized. Whenpressed they talked about the banking license and the Mission team got the impression that the turn around andSME Banks penetration into the SME sector to meet the MTDF 20052010 intentions was less of a focus for them.


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(i) Regulatory. SBP enjoys a high level of confidence within the banking sector. Inaddition to attracting and retaining the right skill mix to carry out its regulatoryresponsibilities, SBP has also instituted training programs for youngprofessionals. So far, according to Governor SBP, the organization has trained400 Graduate students who are then either absorbed by SBP itself or elseseconded to other financial institution.19

(ii) Commercial Banks. There do not appear to be any issues associated with thecommercial banks sourcing talent from the local markets.

(iii) Microfinance/Rural Finance/SME. Both SME and microfinance banking arecommercially untested models. These organizations are investing heavily intechnology and hiring/training fresh graduates for their respective marketsegments.20 ZTBL, too, is investing heavily in technology; however, theorganization does not appear to have a coherent strategy towards addressing allof its human resources related issues.21

C. Non-Bank Financial Institutions

1. Regulatory Framework

54. The Securities and Exchange Commission of Pakistan (SECP) Act 1997 dissolved theold corporate sector regulator the Corporate Law Authority (CLA), which was a departmentwithin the Ministry of Finance, and replaced it with the SECP. On 1 January 1999, through agazette notification, the Securities and Exchange Commission Act was enforced making theSECP fully operational.

55. In accordance with the requirements of the SECP Act, a commission and a board (theSecurities and Exchange Policy Board) were established within the SECP. The Commissionconsists of commissioners some of whom are appointed by the federal government. However, amajority of them are from the private sector. Likewise, the Board consists of seven members, ofwhich four are appointed by the federal government and the rest from the private sector.

56. Power to make regulations is shared between the Board and the Commission. Whereasthe Board can make regulations on its own, the Commission can only "recommend" proposedregulations to the Board for their approval. All the powers and functions previously enjoyed by

19The Governor SBP indicated that some of these graduates had been deputed to fill human capacity gaps at otherinstitutions such as the SECP and ZTBL.

20Khushali Bank has put in place an aggressive recruitment strategy whereby the organization trains Graduatestudents. According to the Bank the only downside is the high rate of turnover of these new recruits.

21Correcting its human resources problems provides an interesting window into the broader issues faced by ZTBL,some of these are detailed below:1. Golden Hand Shake Scheme (GHS). As part of its restructuring efforts, ZTBL implemented a GHS Scheme

before it developed an understanding of what the organizations human resource-related needs were. Theobvious unintended outcome of this exercise was that most of the competent employees left the organization.Whereas in the past, one ZTBL field officer was required to cater to 300 clientsnow, after the GHS, one fieldofficer is required to meet the demands of 1,200 cl ients.

2. Technology. According to ZTBLs Chairman, there are no computers in any of the organizations field offices.In order to correct this deficiency the organization is investing substantially in developing technologies it canuse; however, it remains unclear whether the organization has thought about how its personnel will be able toutilize these technologies.

3. Management and Culture. ZTBL is having problems in recruiting a management team that can help turn thisorganization around. One of the main issues that the new management will grapple with is the organization-wide operational inefficiency and lack of motivation.


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CLA were transferred to the Commission with the exception of the powers to create regulations.Provided below are some of SECPs main responsibilities:

(i) regulating issue of securities;(ii) regulating business in stock exchanges and any other securities markets;(iii) registering and regulating workings of stock brokers, sub-brokers, share transfer

agents, bankers to an issue, trustees of trust deeds, registrars to an issue,underwriters, portfolio managers, investment advisers and such otherintermediaries who may be associated with the securities markets in any manner;

(iv) proposing regulations for the registration and workings of collective investmentschemes, including unit trust schemes;

(v) promoting and regulating self-regulatory organizations in the securities industryand related fields such as stock exchanges and associations of mutual funds,leasing companies and other non bank financial institutions;

(vi) prohibiting fraudulent and unfair trade practices relating to securities markets;and

(vii) regulating substantial acquisition of shares and the merger and takeover ofcompanies.

57. SECP Act clearly states that the Commission will regulate the NBFIs, which includedevelopment finance institutions, insurance companies, leasing companies, housing financecompanies and investment banks. Certain activities of the NBFIs are, however, regulated by theSBP. There is no clear distinction in Pakistan with regard to the scope of activity of theinvestment and commercial banks with the result that the investment banks can perform almostall the functions of a commercial bank and vice versa. Full text of the SECP Act 1997 isprovided as Appendix 3.

2. Stock Exchanges

58. The three registered stock exchanges in Pakistan are located in Karachi, Lahore, and

Islamabad. Karachi Stock Exchange (KSE) is the biggest and most liquid stock exchange in thecountry. As of 31 October 2004, 661 companies were listed with a market capitalization ofPRs1,478.6 billion ($24.75 billion) and with a listed capital of PRs396.4 billion ($6.64 billion). 22

59. Membership of KSE is capped at 200 and the only way to secure membership is topurchase a seat from an existing member. Since June 1990, corporate entities can also becomemembers of KSE and currently there are 106 such corporate members (nine of which arepublicly traded companies).23 KSE is run by a 10-member board of directors that consists of fiveelected directors (elected from amongst the 200 members of KSE), four non-member directors(elected from various trade and/or professional bodies), and the Managing Director of the stockexchange. The Chairman is elected by the Board from amongst the elected directors. Theoperational and administrative activities of the stock exchange are managed by the Managing

Director who also is the full time Chief Executive of the exchange.

60. According to the KSE classification, stock market consists of 34 sectors. In terms ofmarket capitalization, oil and gas exploration, communication, commercial banks, and oil andgas generation and distribution are the largest sectors investment-wise that between them

22Information secured from Karachi Stock Exchange.

23Corporate members are required to satisfy certain minimum requirements, such as minimum paid up capital ofthese entities should be PRs20 million.


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account for over PRs100 billion ($1.67 billion). Also counted among the largest sectors arepower generation and fertilizers. Table 7 provides more detailed information on KSE marketactivity.

61. The other major stock exchange is the Lahore Stock Exchange, which accounts foraround twenty percent of the transactional volume but appears to be more technologically savvy

and innovative than the KSE.24

62. Regulation of the stock market and securities business in Pakistan is principallygoverned by the Securities and Exchange Ordinance 1969, and the rules prescribed pursuantto it. The regulatory body entrusted with the powers conferred on the government under this lawis the SECP. The SECP is responsible for supervising stock exchanges and their members. Italso licenses investment advisers, regulates the contents of the prospectuses and enforceslegislation pertaining to companies and corporate securities. Stock exchanges are alsoexpected to self-regulate and to establish standards for listing and dealing in securities,regulating the conduct of stock exchange members, and organizing the smooth clearing andsettlement of trades executed.

24According to LSE management they have plans to open stock exchange field offices in various major cities ofPunjab. They believe that having access to trading floors will go along way in winning over investors from thosecities to invest and trade on the LSE.


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3. Insurance

63. Pakistans insurance industry is relatively small as compared with the insurance marketsof other countries with more developed and/or mature financial markets. As is the case in theinsurance markets of other developing countries, Pakistans insurance industry is small inproportion to its gross domestic product (Table 8).

Table 8: Cross-Country Comparison of Insurance Sectors(% Insurance Contributions to GDP)

Countries Non-Life Life Total

USA 4.3 4.5 8.8Brazil 1.8 0.4 2.2Mexico 0.9 0.9 1.8UK 3.1 12.7 15.8China 0.7 1.1 1.8India 0.6 1.7 2.3Malaysia 1.6 2.1 3.7Indonesia 0.6 0.6 1.2Nigeria 0.6 0.1 0.7Kenya 1.9 0.7 2.6Pakistan 0.3 0.2 0.5

Source: Pakistan Financial Sector Assessment 2003, State Bank of Pakistan.

64. The largest influence and activities generated within Pakistans insurance market (bothlife and non-life) are by the state-owned companies. The state-owned companies NationalInsurance Company Limited (NICL), Pakistan Reinsurance Company Limited (PRCL) and StateLife Insurance Company (SLIC) are, like private sector insurers, subject to the provisions of the

Insurance Ordinance and therefore to the jurisdiction of the SECP.

65. The insurance sector in Pakistan can broadly be rationalized into two main classeslifeinsurance and non-life insurance. The country only has one reinsurance company that carriesout reinsurance activity. Details for the two main classes are provided below.

4. The Life Insurance Sector

66. Life insurance sector activity in Pakistan currently accounts for approximately 0.2% ofGDP, which is far below any expected saturation level, and appears to have great scope forexpansion.

67. Even though a major portioni.e., 76% of the premium incomeof the sector isdominated by the state owned/run SLIC there are also four private sector companies.28 Inaddition, life insurance is also provided by Postal Life, a service under the control of the Ministryof Communications, and short term life insurance may be offered by non-life companies.

28Ernst & Young. 2005. Pakistan Insurance SectorA Report to the Asian Development Bank under TA 4033-PAK.United Kingdom.


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68. According to the Insurance Ordinance, effective 31 December 2004, the minimum paid-up capital requirement for life insurance providers was set at PRs150 million ($2.51 million).Failure of any insurer in complying with these requirements would lead to the insurer in questionbeing prevented from operating in this sector.

69. The overall structure of this sector is such that the activities appear to be concentrated

within the public sector. There appears to be a significant role that the private sector can play inshaping the future of this market, considering that there are plans to privatize the state ownedcorporations, such as SLIC, etc.

5. The Non-Life Insurance Sector

70. The non-life insurance sector activity in Pakistan currently represents 0.3% of thecountrys GDP. This represents a level of penetration that is, as for life insurance, well belowlevels that would be considered as saturation; this has been estimated at approximately 5%(footnote 32).

71. An increasing popularity of leased motor vehicles explains this sectors dependence on

motor insurancethis type of insurance accounted for 35% of net premium revenue in 2002and 42% in 2003 (footnote 32). However, this class of business generated underwriting lossesin both years. Profit was mostly generated in the two other largest classes (after motorinsurance), such as fire and marine, and aviation and transport (mostly marine cargo) business.

72. An important aspect of the sector to consider involves the difficulties faced by marketparticipants due to the aftermath of 11 September 2001. The reinsurance rates increased as aconsequence of these events and in some cases terrorism cover was only available on aselective basis.29

73. Overall, the non-life sector has undergone significant growth and consolidation over thepast few years. Consolidation has been driven in part by the increased capital requirements

introduced by the Insurance Ordinance, which reached their most recent minimum equity levelof PRs80 million ($1.34 million) with effect from 31 December 2004. Further importantdevelopments within this sector involve aggressive strategies by banks to provide theseinsurance services. Such strategies can involve banks either acquiring insurance companies orestablishing separate in-house departments. Some examples of this trend include AdamjeeInsurance being acquired by Muslim Commercial Bank, and Agha Khan Foundation forEconomic Development, the owner of New Jubilee Insurance and New Jubilee Life, hasacquired Habib Bank Limited. Another established retailer, Pakistan Industrial Credit &Investment Corporation, has established a non-life insurer and is in the process of trying to setup a life insurance company.

6. Leasing

74. Since the creation of the first leasing company in Pakistan in the mid-80s, leasing hasremained an important segment within the countrys financial markets. As was the case withretail banks, initially, the focus of these leasing companies was on catering to the needs of the

29Under the Financial (Non-Bank) Markets and Governance Programme Loan, ADB will provide a political riskguarantee with counter-guarantee from the Government of Pakistan for political violence related risks (includingterrorism and sabotage) for which insurance in Pakistan is not readily available. The counter guarantee has yet tobe signed by the Government.


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corporate sector. However, slow economic growth and a slump in profitability forced theseleasing organizations to broaden their business focus and offer services to individualconsumers.

75. As of December 2003, the leasing industry was made up of 27 companies and their totalassets stood at PRs45.8 billion ($0.77 billion). Table 9 provides a breakdown of the leasing

industry assets in 2003.

Table 9: Breakout of Lease Finance

Asset Type 2002 2003Plant and Machinery 54% 54%Vehicles 32% 35%Equipment 10% 8%Other 4% 3%

Total 100% 100%Source: State Bank of Pakistan.

76. The comparison for the 2 years (Table 9) suggests that the asset composition over thistime frame remained largely unchanged. Plant and machinery was unchanged and accountedfor the largest share of the leasing industry assets. The 3% rise in vehicles can be attributed tothe intense competition between commercial banks and leasing companies to deliver leasingservices for vehicles.30

77. Since the development of the SECP, leasing companies have been categorized as non-bank financial companies and are regulated by the SECP in accordance with the 2003 Non-Banking Finance (Establishment and Regulations) Rules. Last 3 years have witnessedincreased consolidation across the industry as smaller companies merge their resources inorder to satisfy the increased minimum paid-up capital requirements prescribed by the SECP.

7. Other

78. Provided in this section are important issues as they relate to the development of the NBFIsector.

a. Badla Phaseout

79. Badla is a facility for financing share purchases and is extended by brokerages andbanks, which allows buyers to obtain highly leveraged positions in the market. The extent ofleverage through such non-bank financing is not transparent and underlying securitytransactions are typically speculative. This directly results in market manipulation and increasessystemic risk. The need to phase out Badla is obvious and is seen as a growing pain that many

other financial markets in different countries have also had to overcome in order to realizemature and well-functioning capital markets. However, so far SECP failed in its efforts to phase

30The leasing companies interviewed during the Evaluation Mission stated that provision of leasing services bycommercial banks was a major cause for concern for them as it gave the commercial banks an unfair advantage,stemming from the fact that leasing companies, as non-bank financial intermediaries, have to comply with morestringent requirements of the SECP; whereas, the commercial banks are regulated by the State Bank of Pakistanand are not subject to any such restrictive requirements.


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out Badla trading.31 The drop in liquidity that occurred as a result of the proposed phase outserved as the deterrent for the regulator (SECP) and it quickly reversed its decision.32 Theunavailability of a viable alternative to replace Badla has been identified as the primarydeficiency of the failed phaseout plan.33 The Badla debacle contains interesting insight into theeffectiveness of SECP as the regulator for the NBFI market.

b. Futures and Commodities Market

80. Developing the futures and commodities markets in Pakistan appear to be a prerequisitefor the Badla phase out, as well as for broadening and deepening the countrys financialmarkets. Progress in developing these markets has so far been limited. Currently, the onlysolution available for futures trading is a 30-day forward contract. On the other hand, thedevelopment of the commodities market in Pakistan is currently on hold pending the draftingand implementation of the Futures Act. According to the National Commodities ExchangeLimited, the company has been ready to go live since mid-2004; however, it has been told towait till the Futures Act is instituted.34

8. Human Capital

81. Unlike the banking sector institutions, the non-bank side of the financial industry facesan uphill task as it tries to develop its human resource capacity. This matter is furthercomplicated by the fact that most of these institutions are relatively new and they have toconstantly adjust to the changing regulatory and other requirements of a growing market. Thisappears to ring true for both the regulator as well as the market players. There is broad-basedconsensus in the market that SECP is finding it hard to effectively regulate the NBFI market.Many attribute SECPs deficiency in enforcement powers to it (SECP) not having the breadth ofexpertise that an effective regulator is required to have. On the other hand, market playerssuggested that it would be useful to develop certification and training modules that will educatemarket players and investors about the risks associated with their investments.

IV. STRATEGIES AND POLICIES

82. This chapter discusses Government and ADB strategies and policies that were gearedtowards enhancing private sector participation in the countrys economy.35

31According to the SECP Chairman, he had worked on the proposed Badla phase out for over a year and hadsecured agreement from all the key stakeholders.

32India has also undergone a similar exercise whereby plans to phase out speculative trading were rolled back andthen later implemented.

33

Stock Market Review Task Force. June 2005. Report on the Review of Stock Market Situation, March 2005.Pakistan.

34According to the Managing Director of the National Commodities Exchange Limited, instead of drafting andimplementing a new Futures Act, a more effective option would be to modify and/or amend the existing SecuritiesAct and pointed to efforts in India, where an existing Securities Act was modified and implemented. He also addedthat Pakistans rural farmers would benefit much like the farmers in India, where the farmers can get indicativeprices for their commodities off of monitors placed in rural post offices.

35As is the case with most public sector planning documents, the Governments planning documents representpolitical aspirations more than the operational realities. The articulated what is planned tends to be tuned tocurrent political and donor themes while the how is most often not stated.


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A. Government Strategies and Policies

83. Table 10 gives the highlights from the strategies and policies followed by theGovernment from 19852004.

Table 10: Government of Pakistans Strategy Documents

Title Period Covered

Sixth Five-Year Plan 19831988

Seventh Five-Year Plan 19881993

Eighth Five-Year Plan 19931998

Ninth Five-Year Plan 19982003

Ten-Year Perspective Development Plan(2001 11)

20012011

Medium Term Development Framework 20052010

Source: Ministry of Planning & Development, Government of Pakistan

1. Sixth Five-Year Plan (19831988)

84. The main objective of this development plan was to achieve equitable developmentwithin the country, i.e., development should be shared amongst the masses. The plan employedthe following strategy in order to achieve its primary objective:

(i) Establish and maintain high growth rates by increasing productivity within theagricultural sector and by developing the service sector.

(ii) Encourage rural transformation by providing infrastructure facilities to the ruralfarmers.

(iii) Create four million new jobs in small-scale production sectors in agriculture and

industry.(iv) Increase share of provincial governments in public sector development programs(v) Allocate funds for the development of economic backwards areas such as

Balochistan.(vi) Continue import substitution and export promotion in order to decrease reliance

on foreign aid.

2. Seventh Five-Year Plan (19881993)

85. This plan focused on some of the same issues highlighted in the sixth five-year plan.The main national objectives, as stated, were:

(i) Promote national solidarity through fundamental restructuring of education andinformation policy, which should be based on a well-defined concept of naturalculture.

(ii) Implement a concrete program of poverty alleviation, especially in the ruralareas, to attain full employment and to ensure continued growth and stability.

(iii) Prepare uplift programs for advancement of all sections of the society.(iv) Formulate specific, monitorable targets for increasing economic self-reliance,

supported by legislative safeguards.


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86. An interesting development that took place during this plan period was that sectors thatused to be reserved for the public sector were opened to the private sector. During this planperiod two banks and 63 industrial units were privatized.

3. Eighth Five-Year Plan (19931998)

87. This plan was released by the Government in June 1994. Unlike the previous plans, thisplan outlined private sector led investment as a priority. Provided below are some of the mainobjectives as stated in this plan.

(i) Improve enabling environment bya. providing adequate services and physical infrastructure,b. providing education and training,c. providing better health coverage,d. strengthening capital markets, ande. deregulation and privatization.

(ii) Develop supportive policies for fiscal, monetary, foreign exchange, and trade

regimes.

88. The development and articulation of a private sector led investment agenda by theGovernment constituted an important milestone in the Governments planning process. Also,this signaled the public sectors continued commitment to deregulating and liberalizing thecountrys financial sector.

4. Ninth Five-Year Plan (19982003)

89. This plan was not officially announced and/or implemented by the Government. Thereason for this was because the Government was dealing with the fallout from its nuclear testing(e.g., international sanctions, etc.). During this timeframe, the Government was mostly

concentrating on achieving short term economic stabilization by tightening its fiscal andmonetary policies.

5. Ten-Year Perspective Development Plan (20012011)

90. This plan laid out Governments intentions to bolster the countrys financial sector byarticulating a wide variety of measures. Provided below is information on the Governmentsstated intentions as per this plan.

(i) New financial products will be introduced in order to cater to the varying needs ofdepositors.

(ii) Continue to auction investment bonds for those institutional investors who are

interested in investing in government securities.(iii) Forge ahead with privatization plans for commercial banks, and Corporate

Industrial Restructuring Corporation was set up to deal with nonperforming loans.(iv) Promulgate bankruptcy laws in order to streamline dispute resolution

mechanism.(v) Strengthen capital markets by supporting development of regulatory frameworks

for different financial products (such as pensions) by the SECP.


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(vi) Microfinance initiatives, such as Khushali Bank, would encourage savings at thegrassroots level (i.e., microfinance banks would only lend if the applicant hasalready been saving).

(vii) Special measures were being taken to extend credit to SMEscredit of PRs2billion ($0.03 billion) would be made available for development of SMEs in prioritysectors.

91. This plan was the first time that the Government realized and articulated reforms not justfor the financial markets but also for the various subsectors (both banking sector and NBFIs).This was a significant departure from past practices, when the financial markets were statecontrolled/run and financial sector priorities were either left out of the planning process and/orignored.

6. Medium Term Development Framework (20052010)

92. The MTDF reflects the adoption of a new approach towards planning by theGovernment. For the first time, the Government has developed a framework, rather than aplan, for establishing and articulating its economic and other priorities. This framework is built

over a collaborative system that assumes extensive consultations across different ministries.Moreover, this level of inclusiveness reflects a maturing government capability that could beused to drive the donor community rather than the Government being driven by donors.

93. The MTDF outlines a range of financial sector issues and opportunities that theGovernment plans to consider during the current planning cycle. Included here are:

(i) Recommendations that the Government plans to follow in order to develop thecountrys capital markets, such as strengthening capital markets by increasingmarket capitalization, developing bond markets, and encouraging institutionalinvestments

(ii) Develop an enabling environment for the private sector by encouraging banks

and other organizations to deliver financial and other support required by theSMEs. The MTDF also states that specialized technical and financial capacitybuilding support will be provided to those evaluating SME financing opportunities.

(iii) Encourage Micro Finance for Poverty AlleviationMTDF underscores theGovernments commitment to encourage provision of micro finance services tothe poor. According to the plan, the Government will support establishment of anextensive rural network for microfinance services provision through ZTBL,Khushali Bank, etc.

B. ADBs Country Strategies

94. Discussed in this section are ADBs country strategies and, more importantly, their

relevance towards assisting the private sector in Pakistan over the last two decades. Since1985, ADB has produced five main strategy documents to guide its operations in Pakistanin1985, 1990, 1995, 1999 and 2002two CSP updates, and an interim operational framework.Nuclear tests carried out by Pakistan triggered international sanctions in 1998, effectivelysuspending implementation of the 1995 strategy. A country operational framework wasprepared to cover a reduced level of operations over 19992000. Preparation of a new countrystrategy was somewhat delayed due, in part, to the need to take into account dramaticallychanged circumstances following the 11 September 2001 terrorist attack on the United States.A country assistance plan for 20012003 (approved in December 2000) provided some


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strategic direction pending preparation of a new strategy. Table 11 lists the various strategiesfollowed by ADB from 19852004.

Table 11:ADBs Country Strategy Documents for Pakistan Operations

Title Period Covered

Strategies for Economic Growth and Development: TheBanks Role in Pakistan

19851989

The Banks Operational Strategy in Pakistan 19901994

Country Operational Strategy Study for Pakistan 19951998

Country Operational Framework 19992000

Country Strategy and Program: Pakistan 20022006

Country Strategy and Program Update 20042006

Country Strategy and Program Update 20052006

Source: Asian Development Bank database.

1. Strategies for Economic Growth and Development (19851989)

95. According to this strategy document, ADBs primary objective in its support to Pakistanwould be balanced growth through policies that can bring about structural change. The strategydoes not directly address financial sector development. The strategy discusses providingsupport to private sector entities as well as those public sector entities that can be privatized.Realizing difficulties associated with conventional lending the strategy proposes to diversifyfinancial support ADB offers to the private sector, such as equity investment, leasing, directlending, etc.

2. ADBs Operational Strategy in Pakistan (19901994)

96. This strategy document states that ADB will (i) promote growth of exports and/orconserve foreign exchange; (ii) mobilize domestic resources; (iii) increase private sectorparticipation; (iv) improve efficiency of existing investment and optimize resource mobilization;and (v) satisfy basic needs, poverty alleviation, and human resource mobilization. In order toenhance private sector participation (as in [ii]), ADB would support reforms to increase domesticresource mobilization through financial sector (with special emphasis on reducing segmentationin financial markets and developing capital markets). In addition, the strategy documents statesthat ADB will develop an expanding portfolio of private sector investments in order to play acatalytic role in increasing private sectors role in the countrys economy.

3. Country Operational Strategy for Pakistan (19951998)

97. During this time, Pakistans economy was suffering low growth, high macroeconomicimbalances, growing public sector indebtedness, high inflation rates, and underlying structuralweaknesses that aggravated socioeconomic stability. Given these adverse circumstances,ADBs priorities were to assist the country to increase capital accumulation, upgrade humancapital development, enhance economic efficiency, improve social/macroeconomic stability, andprotect environment and natural resources. However, details on how ADB actually planned toprovide this assistance were not included in this document.


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4. Country Assistance Plan (19992001)

98. Human development (including education, health, population welfare, and water supplyand sanitation) was the primary focus of this ADBs Country Operational Framework. Forfinance, strategy discussed its ongoing programCapital Market Development Programwhichwas aimed at development of a diversified and competitive capital market in the country. The

strategy suggested that in view of the high magnitude of ADBs ongoing investments in thissector, no new investment was being considered and/or proposed for that operational cycle.

5. Country Strategy and Program (20022006)

99. Poverty reduction, pro-poor growth, social development, and governance emerge as theover-riding concerns for this strategy. According to this strategy, ADB planned to support privatesector development by supporting initiatives for development of SMEs, rural finance, andagribusiness; and assisting in capital market development, and restructuring and privatizingselected state-owned financial institutions. Further, ADBs efforts will provide assistance tocomplete its capital markets reform agenda to (i) develop bond and sound contractual savinginstitutions and instruments, and (ii) restructuring and privatizing of selected state-owned

financial institutions.

6. Country Strategy and Program Update (20042006)

100. This strategy update discusses the ongoing assistance that was being provided for thedevelopment of the MF sector (primarily to Khushali Bank). The document also highlighted theplanned assistance for development of the SME sector.

7. Country Strategy and Program Update (20052006)

101. The overarching concerns (as articulated in the CSP 2002 Strategy) remainedunchanged i.e., poverty alleviation. ADBs assistance within the financial sector included its

ongoing assistance for microfinance and rural finance entities such as Khushali Bank and ZTBL.The strategy also highlighted ADBs commitment to developing SME sector in the country (asSME growth could serve to catalyze pro-poor growth) by supporting Governments efforts aimedat privatizing SME bank.

102. Table 12 summarizes information and analysis presented in this chapter with regards tostrategies and policies pursued by GOP and ADB in order to aid private sector activity.


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V. DESCRIPTION OF ADBS PRIVATE SECTOR OPERATIONS

103. This chapter provides information and analysis on ADBs assistance to the private sectorin Pakistan over the last two decades. As mentioned earlier, ADB assisted the private sector inPakistan either through finance sector reform programs or through direct private sectortransactions. Whereas the finance sector reform projects involve large-scale programs

developed to strengthen the financial systems and regulatory framework in the country, theprivate sector transactions refers to those projects undertaken by ADBs private sectoroperations window. The remainder of this chapter will be dedicated to discussing these types ofmodalities employed by ADB to further the private sector in Pakistan.

A. Finance Sector Development (Public Sector Loans)

104. Over the last two decades, two thirds of ADBs assistance to the private sector inPakistan was provided in the form of finance sector development projects and delivered througha series of large-scale public sector loans. Next, provided below is information and analysis oneach of these finance sector development projects.

1. Financial Sector Intermediation Loan

105. In June 1995, ADB approved the $100 million Financial Sector Intermediation Loan(FSIL) in order to promote development of Pakistans capital markets. FSILs primary objectivesincluded (i) supporting the Governments financial sector and capital market reforms, (ii)providing an efficient and broader range of services to the private sector, and (iii) supportingprivate sector development. The FSIL was designed to provide funds that could then be re-lentto qualified public and private financial institutions in order to finance private sector investments.In addition, FSIL was also accompanied by relevant policy reform measures for the financial andcapital market sectors1 as well as a TA component worth $865,000.

106. According to FSILs Project Completion Report (PCR) and Project Performance Audit

Report, the project received an overall rating of partly successful and unsuccessful,respectively. The Evaluation Mission agrees with FSILs PCRs rating because the project hashad a minimal impact on private sector development2 and its contribution to financial sector andcapital market reform has also been limited primarily due to project design deficiencies.3Inconsistency between the project rationale and objective, excessively broad project objectives,weak linkages among expected project outputs, and lack of a viable monitoring mechanismwere cited as the main reasons for the underperformance of this project. 4

2. Capital Markets Development Program

107. In November 1997, ADB approved the Capital Markets Development Program (CMDP)for $250 million from ADBs ordinary capital resources and a TA loan amounting to $5 million

1To make FSIL more effective, the FSIL was cofinanced by the World Banks Financial Sector Deepening andIntermediation Project (FSDIP). However, after 4 years, the loan remained unused, and the FSDIP was canceledand reformulated as a TA project for $28 million. The cancellation was due to (i) lack of long-term foreign exchangerisk cover, (ii) uncertainties and high cost of short-term risk