The reformed trio
Pakistan's nationalised banks are being privatised and are providing better service. They are also mounting a strong challenge to foreign banks.
Even though Pakistan's economy remains tangled in a web of low industrial activity, slack domestic investment and low GDP growth, structural reform is beginning to show results in some areas. The bloated and politicised nationalised banking industry has long been a drag on the financial sector and the economy as a whole but the effects of aggressive restructuring during the last two years are now making themselves felt in the broader economy. Indeed the financial sector as a whole has undergone a process of streamlining and consolidation, which promises to yield substantive macroeconomic gains in the future.
Perhaps the most obvious strides have been made by the three nationalised banks in the country, which are also the three biggest players in the banking industry; National Bank of Pakistan (NBP), Habib Bank Limited (HBL) and United Bank Limited (UBL) together control two-thirds of total deposits and credit in the country. These have now become formidable forces of competition for the traditionally more efficient foreign and private banks operating in the country. And with the strategic sale of UBL to a domestic banking group in June this year, as part of Islamabad's privatisation programme, the situation can only be expected to improve further. Among the gains, consumers and corporate customers have greater options to choose from. And the improved processes and cleaner balance sheets in these three banks has meant Pakistan's industry is now supported by a streamlined and reliable banking system.
Pakistan started restructuring its deeply troubled banks in 1997 and the process of reform has been bumpy and turbulent. NBP was formed in 1949 as a government-owned entity while HBL and UBL were taken over by the state during the mass nationalisation of the 1970s. Over the years a corrupt civil bureaucracy undermined the efficacy of these banks, as political considerations, which ruled lending and employment, led to huge losses, enormous inefficiency, and regressive functioning. Bad loans swelled at the three banks and they grew into unmanageable behemoths employing a total of 76,500 people and operating 4,800 branches nationwide and several hundred through overseas franchises as well. Even though the banks were fast approaching financial collapse, political interference continued in full swing.
Under pressure from the International Monetary Fund, the government began instituting economic reforms in 1997 and the financial sector came under close scrutiny. The World Bank approved a USD 250 million loan for banking sector reform under which defaulted loans were recovered and operating losses stemmed. A new system of banking courts was set up to process loan recovery cases which had piled up in regular courts. The three banks shed thousands of workers and shut down hundreds of branches to curb spiralling costs. More importantly, the banks were given new structures and placed under professional management and independent boards. Under the same package of reforms, the State Bank of Pakistan (SBP), the country's central bank, was made autonomous. The management of UBL was taken over by the central bank since the bank had collapsed and required a fresh infusion of capital. The operation of the other two banks was put through rigorous analysis.
The reform process slowed in 1998 when the Nawaz Sharif government lost interest in it. And the reform initiative was stagnating until two years ago when General Pervez Musharraf's government gave it new life. A new set of professional managers, mainly top bankers from foreign banks, were brought to the helm of the three banks and they moved swiftly to streamline operations and improve balance sheets. This second round of restructuring was supported by a USD 300 million World Bank loan for restructuring and privatisation.
In the last two years, restructuring has proceeded a pace. The three banks have closed down more loss-making branches, retrenched more employees and worked to widen product offerings and improve internal systems. In order to lure a greater share of fee-based income away from the foreign and private banks, the three giants have hired several foreign bankers at the top and middle levels of management. New products such as debit cards, kiosk bill payment and fund-management services are also in the pipeline. And the banks have focused more intently on enhancing the earnings base, upgrading technology, and training staff. All three have come back into the black from multi-million losses in 1996 to strong profits in 2001.
Certainly, the competitive dynamic within the banking sector has undergone a dramatic shift. The 19 foreign banks operating in Pakistan have long operated within the limited niche of high-end consumer banking and the top-tier corporate market. In recent months, three of these banks have announced plans to pull out of Pakistan with Societe Generale selling out to local bank Al-Meezan, Emirates International passing on its local operations to the domestic Union Bank, and Doha Bank announcing plans to wind up. The three big nationalised banks had traditionally served the middle markets in both consumer and corporate banking, taking advantage of their extensive branch networks and rural reach but were unable to compete with the professional expertise of foreign banks at the upper end of the market.
In recent months, foreign bankers have begun to feel the heat from the reformed nationalised banks that have gradually been chipping away at the banking pie they had so far been excluded from. These three banks have geared up to rake in a large chunk of the corporate debt business that will be generated through the several large infrastructure projects General Musharraf has promised to initiate. The chief of NBP says Pakistan's corporate debt market is likely to grow from its current PNR 10 billion to PNR 100-150 billion within the next three years. In fact, in the first quarter of this year, the three jointly signed a memorandum of understanding with the Pak-Arab Pipeline Company for financing the USD 480 million White Oil Pipeline Project. This project will involve PNR 10 billion in term finance certificates.
Yet, the black spot on these revitalised banks still remains the growing non-performing loan portfolios. Despite the fact that the economy has shown improvements over the last 12 months, progress has slowed on the collection of bad loans. Total gross non-performing loans (NPLs) in the banking system add up to PNR 308 billion. As of 31 March, total NPLs accounted for almost 20 percent of advances in the banking system. For nationalised banks alone, this figure was 28 percent, while for private banks it was 11 percent and for foreign banks 6 percent.
In May 2001, the government set up the Corporate and Industrial Restructuring Corporation (CIRC) to help banks and other state-owned institutions clean out their nonperforming loan portfolios. CIRC has already restructured PNR 28 billion worth of NPLs. But, between July last year and February this year, loan defaults reported by commercial banks also rose from PNR 121.1 billion to PNR 126.6 billion. Even so, it is significant that the three banks have attained profitability. NBP, which suffered massive losses in the past, particularly in 1996, posted USD 17.7 million in pre-tax profits in 2000 and doubled this figure in 2001. UBL, which had to be bailed out by the central bank in 1997, turned around to register USD 18.3 million in profits in 2001. And HBL more than doubled profits in 2001 to PNR 2.2 billion.
The next step is privatisation. After three failed attempts to sell UBL, the Privatisation Commission finally managed to have the Muslim Commercial Bank buy it in early June for PNR 8.4 billion. Meanwhile, 10 percent of NBP's shares were issued on the capital markets recently and were oversubscribed by seven times. The stock has become one of the most sought-after among investors today. Although no date has yet been set for the privatisation of the bank, given the response the stock has received, the government may opt for the listing route rather than the strategic investor route to sell the bank. The government has already approved the listing of 5 percent of HBL's shares in the market and the bank is to be privatised before October, according to the government's schedule. But given Islamabad's abject failure in sticking to its plan to privatise state assets and generate USD 1 billion in 2001, it is unlikely that the HBL transaction will close this year.
The three big banks have a host of challenges ahead. For one, foreign banks are gearing up to forcefully counter this new competition from the reformed trio. And with the former's distinct edge in technology and processes, the nationalised banks will have to stay on their toes, particularly since the economic environment is likely to become increasingly difficult for banking companies. The central bank has, in the last 12 months, embarked on an aggressive round of interest rate cuts to spur economic growth. As a result, the rate of return offered on government treasury bills has plummeted from 10.5 percent last year to just 6.5 percent currently. And since the three nationalised banks have traditionally been obliged to hold large amounts of government bonds and have billions of rupees parked in these investments, the dramatic losses incurred on account of lower interest rates will hit these three banks harder than the rest. Also, lending rates, although slow to respond to SIP persuasion thus far, are bound to continue to decline throughout this year, and thereby tighten the screws more on the big banks. So far, private sector credit demand has been 50 percent lower than in the previous year but this should pick up as the year progresses and industrialists slowly begin to make investments. A four percent cut in the tax rate on banks from 50 percent to 46 percent, announced in this year's federal budget, will also provide some relief.
But while re-energised competition, residual bad loans and lower interest rates will make this a tough year, the major cleanup at these banks is indication enough that they are being prepared for privatisation. And Islamabad realises that the only way to sustain reform is to move ahead with privatisation, which will eventually make for an efficient, reliable banking system and thereby an economy with a stronger base to stand on.