Policy consideration

Policy Considerations before Bank Privatization – Country Experience

Dr. Ishrat Husain

Governor

State Bank of Pakistan

Presentation made at the World Bank, International Monetary Fund and Brookings Institution Conference on

“The Role of State-Owned Financial Institutions: Policy and Practice” held at Washington D.C., on April 27, 2004.

Outline• Background• Rationale• Modalities• Pre-Privatization Activities• Case Studies

Privatization of Banking Sector in Pakistan

Background

Financial sector significantly altered in early 1970s with

nationalization of domestic banks under the Banks

Nationalization Act 1974.

The Pakistan Banking Council was set up to act as

holding company of nationalized commercial banks and

to exercise supervisory control over them.


By end of 1980s, the pre dominance of public sector in

banking and non bank financial institutions together with

instruments of direct monetary control was contributing

to financial repression, financial sector inefficiency,

crowding out of private sector and deteriorating quality of

assets.

SBP’s role as a central bank had been considerably

weakened due to the presence of Pakistan Banking

Council. Duplication of supervisory role was diluting

SBP’s enforcement of its regulations over nationalized

commercial banks

Pre-privatization structure of Banking Sector (1990)

Banks No. Assets Deposits Equity

Amount

(Rs. Billions)

Share

(%)

Amount

(Rs. Billions)

Share

(%)

Amount

Rs. Billions)

Share

(%)

State-owned

7 392.3 92.15 329.7 93 14.9 85.6

Private - - - - - -

Foreign 17 33.4 7.84 24.9 7 2.5 14.4

Total 24 425.6 100 354.6 100 17.4 100

Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan


At the onset of the 90s, the Banking Sector in Pakistan was dominated by the public sector banks which were characterized by

• High Intermediation Costs• Over-staffing and Over-branching• Huge portfolio of Non performing Loans• Poor Customer Services• Undercapitalized• Poorly Managed / Narrow Product Range• Averse to Lending to SMEs/Housing & Other Segments• Undue Interference in Lending, Loan Recovery & Personnel

Rationale for Privatization in Pakistan Privatization process initiated in the early 1990s as part of

economic reforms programme

Establishment of Privatization Commission in 1991 for

disposing state owned enterprisesMission statement of Privatization Commission

“Privatization is envisaged to foster competition, ensuring

greater capital investment, competitiveness and

modernisation, resulting in enhancement of employment

and provision of improved quality of products and services

to the consumers and reduction in the fiscal burden”.

Privatization Policy announced in 1998

Rationale for Privatization in Pakistan

1. Reduction in fiscal deficitFiscal deficit reached a high of 8.5 percent of GDP in 1987-88. Loss making making public sector enterprises were a burden on the national exchequer.

2. Increase in the efficiency levelsEfficiency levels of public sector enterprises were low. Production costs of public enterprises were high as a result of political interference.

3. To foster competitionState owned units when sold to different parties would result in healthy competition in different sectors of the economy.

Rationale for Privatization in Pakistan

4. Broad basing of equity capital

Privatization would result in strengthening and deepening of capital market when some percentage of shares of public enterprises are sold to the public through stock exchange.

5. Releasing resources for physical and social infrastructure

More funds available for development projects. Privatization of loss making enterprises would give govt. more fiscal space

Modes of Privatization adopted in Pakistan

The Privatization Policy of 1998 outlined the following modes of privatization:• Total disinvestment through competitive bidding• Partial disinvestment with management control • Partial disinvestment without management

control • Sales/ Lease of assets and property

The Privatization Process

1. Identification

2. Hiring of a Financial Advisor

3. Due Diligence

4. Enacting Regulatory and Sectoral Reforms

5. Valuation of Property

6. Pre-Bid and Bid Process

7. Post-Bid Matters

Steps taken for preparing banks for privatization

1. Amendment in Banks (Nationalization) Act 1974 in 1990.

2. 11,101 workers out of 39,277 were relieved from HBL, NBP and UBL.

3. 1646 branches of NCBs allowed to be closed.4. Rs. 46.6 billion injected as equity to recapitalize the

banks.5. NPLs worth Rs. 47.4 billion transferred to CIRC1 at

discount for disposal.6. Tax refund bonds issued to NCBs amounting to Rs.

6.5 billion issued1 Corporate and Industrial Restructuring Corporation established in 2000 for acquisition of NPLs.

Steps taken for preparing banks for privatization

7. Professional management installed in HBL, NBP and UBL.

8. Boards of Directors reconstituted with private sector individuals of integrity and eminence.

9. Promulgation of Privatization Ordinance in 200010. Introduction of incentive scheme for loan defaulters11. Committee for Revival of Sick Units

Role of State Bank in Privatization

1. Analysis of issues, design of restructuring plan of nationalized commercial banks (NCBs), monitoring and implementation follow up.

2. Voluntary Separation Schemes for excess labor designed and implemented with the financial assistance of the World Bank.

3. Approval of the Chief Executives and Boards of Directors of newly privatized banks according to the ‘Fit and Proper’ test

Role of State Bank in Privatization

4. Meaningful input on documentation viz-a-viz Advertisement, Statement of Qualification (SOQ) and Agreement for sale of shares and transfer of management.

5. Screening and evaluation of the Strategic Investors for clearance of purchase of 5% or more shares of NCBs in order to ensure quality and competence of buyer.

6. Resolution of the issues raised by the strategic investors during the process of privatization.

7. Evaluation of bids

Banks privatized so far

1. Muslim Commercial Bank Limited

26 % shares were sold to the National Group in April 1991 for Rs. 838.8 million. Another 25 % shares were offered for subscription to the public in February 1992. Remaining shares have been divested in January, 2001, November, 2001 and October, 2002 for proceeds of Rs.1,287.2 million.

2. Allied Bank of Pakistan Limited

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

3. Bankers Equity Limited

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


4. Bank Alfalah LimitedHighest bid of Rs. 1.64 billion received for sale of 70 % shares of Habib Credit & Exchange Bank Limited (presently Bank Alfalah) in June 1997. 2% shares were meant for the employees 28% shares sold in block for Rs.1,226.0 million. The shares not taken up by the employees were also sold. Sale Purchase Agreement was signed on 13th December, 2002

5. United Bank Limited

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

6. Habib Bank Limited

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


7. National Bank of Pakistan

23.2% shares have been divested through IPO/POs in November, 2001, February, 2002 (Rs.373.0 million) November, 2002 (Rs.782.0 million), November, 2003 (Rs.604.0 million).


Units privatized to date

(Rupees in Billion) 1991 to Jun

2002 Jul 2002 to Jun 2003

Jul 2003 to Jan15, 2004

To Date

Sector

No.

Amount

No.

Amount

No.

Amount

No.

Amount

Banking 4 5.6 2 12.9 1 22.4 7 41.0

US $ 710 million

Source: Privatisation Commission

Post-privatization Structure of Banking Sector (March 2004)

Banks No. Assets Deposits EquityAmount

(Rs. Billions)

Share

(%)

Amount

(Rs. Billions)

Share

(%)

Amount

(Rs. Billions)

Share

(%)

State-owned1

4 518.8 18.6 379.3 20.1 22.5 17.2

Private 20 1840.3 66.0 1292.3 68.5 92.8 70.9

Foreign 13 278.4 10.0 198.0 10.5 26.7 20.4

Specialized banks2

3 149.8 5.4 16.1 0.9 -11.1 -8.5

Total 40 2787.2 100 1885.6 100 130.9 100

Source: Banking Supervision Department, State Bank of Pakistan

1 Three small new banks were set up in the public sector during the 90s. These included the First Women Bank, set up

to provide credit to women entrepreneurs; and two provincial banks; the Bank of Punjab and the Bank of Khyber.

2 These include: Zari Tarqiati Bank Ltd, Industrial Development Bank of Pakistan and Punjab Provincial Co- operative

Bank Limited


Case Studies

1. Muslim Commercial Bank

2. Allied Bank Limited

Muslim Commercial Bank

First bank in the public sector to be privatized

On 6th April 1991, 26 % shares of MCB were sold to National Group at a price of Rs. 56 per share, for a total amount of Rs. 2.4 billion.

As part of the Sale Agreement, a further 25 % of shares were offered for subscription to the public on 19th February 1992.

Further shares were sold in January, 2001, November, 2001 and October, 2002 for proceeds of Rs.1.3 billion.

Upon completion of disinvestments of 51 % shares, the application of Banks Nationalization Act 1974 ceased on MCB


Financial Indicators (1994-2003)

Source: Financial Sector Assessment 2001-02, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

051015202530

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Assets (% of assets of NCBs)

%

051015202530

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Deposits (% of deposits of NCBs)

%

051015202530

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Advances (% of advances of NCBs)

%


Non Performing Loans as % of Total Loans (1993-2003)


Banking Supervision Department, State Bank of Pakistan

0

5

10

15

20

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003%


Return on Assets (1993-2003)



0.0

0.2

0.4

0.6

0.8

1.0

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003%


Impact Analysis of Privatization

• Assets as a proportion of total assets of the nationalized banks grew from 18 percent in 1994 to over 28 percent by 2003 – an increase of 10 percentage points.

• Deposits as a proportion of total deposits of the nationalized banks increased from 17.6 percent in 1994 to 26.5 percent in 2003.

• Advances as a percentage of total advances of nationalized banks were 17.7 percent in 1990 which had grown to 26.7 percent by 2003.

• NPLs as percentage of total loans varied between a low of 11 percent in 1997 to a high of 18.6 percent in 1993.

Allied Bank Limited

Second bank to be privatized in the public sector

On 9th September 1991, 26 % shares were sold to the

Allied Management Group, which represented the

employees of ABL at a price of Rs. 70 per share

On 23rd August 1993, another 25 % shares were sold to

AMG at price of Rs. 70 per share

This resulted in transfer of ownership from Government

of Pakistan to AMG

Allied Bank Limited

• In 1999, it transpired that one of ABL’s major defaulters had purchased about 35-40 % of ABL shares from employees.

• In July 1999, SBP imposed restriction on transfer of shares from employees to non-employees except on prior approval from SBP.

• On August 3, 2001, the SBP removed the Chairman and three Directors on the Board of ABL as they were found to be working against the interests of ABL and its depositors and appointed new Board.

Allied Bank Limited

ABL was excluded from list of privatization and the

strategic sale of the remaining 49 % govt. share was

transferred to the SBP.

In February 2004, 6 parties were pre qualified for bidding

Allied Bank Limited

Financial Indicators (1995-2003)

Source: Financial Sector Assessment 2001-02, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

02468101214

1995 1996 1997 1998 1999 2000 2001 2002 2003

Assets (% of assets of NCBs)

%

0

5

10

15

20

1995 1996 1997 1998 1999 2000 2001 2002 2003

Deposits (% of deposits of NCBs)

%

0

5

10

15

20

1995 1996 1997 1998 1999 2000 2001 2002 2003

Advances (% of advances of NCBs)

%

Allied Bank Limited

Non performing Loans as % of Total Loans (1993-2003)



0

10

20

30

40

50

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003%

Allied Bank Limited

Return on Assets (1993-2003)



-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003%

Allied Bank Limited

Impact analysis of privatization

• Assets as a percentage of total assets of nationalized banks increased from 9.6 percent in 1995 to 12 percent by 2002.

• Deposits as a proportion of total deposits of nationalized banks grew from 9.8 percent in 1995 to 14.3 percent in 2003.

• Advances as percentage of total advances of nationalized banks peaked at 15.5 percent in 1999 but declined to 11.2 percent by 2003.

• NPLs as a proportion of total loans jumped from 16.1 percent in 1993 to 43.8 percent by 2003

Lessons Learnt

The Allied Bank was not transferred to a strategic

investor but employees. This approach proved to be even

worse than public sector ownership. Efforts are underway

to transfer the majority share to a private sector financial

institution through competitive bidding process.

In contrast, MCB was sold to a group of private

strategic investors who have turned around the bank and

improved all indicators including improved service to

customers, technology upgradation and cost efficiency.

Thank You

Economy & Finance

Policy consideration