Policy Considerations before Bank Privatization – Country Experience

1. Policy Considerations before Bank Privatization – Country Experience Dr. Ishrat Husain Governor State Bank of Pakistan

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

3. Privatization of Banking Sector in Pakistan Background Financial sector significantly altered in early 1970s with nationalization of domestic banksunder 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.

4. Privatization of Banking Sector in Pakistan 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

5. Pre-privatization structure of Banking Sector (1990) Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan

6. Privatization of Banking Sector in 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

7. 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 enterprises Mission 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

8. Rationale for Privatization in Pakistan • Reduction in fiscal deficit Fiscal 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. • Increase in the efficiency levels Efficiency levels of public sector enterprises were low. Production costs of public enterprises were high as a result of political interference. • To foster competition State owned units when sold to different parties would result in healthy competition in different sectors of the economy.

9. 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

10. 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

11. The Privatization Process • Identification • Hiring of a Financial Advisor • Due Diligence • Enacting Regulatory and Sectoral Reforms • Valuation of Property • Pre-Bid and Bid Process • Post-Bid Matters

12. Steps taken for preparing banks for privatization • Amendment in Banks (Nationalization) Act 1974 in 1990. • 11,101 workers out of 39,277 were relieved from HBL, NBP and UBL. • 1646 branches of NCBs allowed to be closed. • Rs. 46.6 billion injected as equity to recapitalize the banks. • NPLs worth Rs. 47.4 billion transferred to CIRC1 at discount for disposal. • Tax refund bonds issued to NCBs amounting to Rs. 6.5 billion issued 1 Corporate and Industrial Restructuring Corporation established in 2000 for acquisition of NPLs.

13. Steps taken for preparing banks for privatization • Professional management installed in HBL, NBP and UBL. • Boards of Directors reconstituted with private sector individuals of integrity and eminence. • Promulgation of Privatization Ordinance in 2000 • Introduction of incentive scheme for loan defaulters • Committee for Revival of Sick Units

14. Role of State Bank in Privatization • Analysis of issues, design of restructuring plan of nationalized commercial banks (NCBs), monitoring and implementation follow up. • Voluntary Separation Schemes for excess labor designed and implemented with the financial assistance of the World Bank. • Approval of the Chief Executives and Boards of Directors of newly privatized banks according to the ‘Fit and Proper’ test

15. Role of State Bank in Privatization • Meaningful input on documentation viz-a-viz Advertisement, Statement of Qualification (SOQ) and Agreement for sale of shares and transfer of management. • 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. • Resolution of the issues raised by the strategic investors during the process of privatization. • Evaluation of bids

16. Banks privatized so far • 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

17. Banks privatized so far 4. Bank Alfalah Limited Highest 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.

18. Banks privatized so far • 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). 

19. Privatization of Banking Sector in PakistanUnits privatized to date

20. Post-privatization Structure of Banking Sector (March 2004) 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

21. Privatization of Banking Sector in Pakistan Case Studies • Muslim Commercial Bank • Allied Bank Limited

22. 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

23. Muslim Commercial BankFinancial Indicators (1994-2003) Source: Financial Sector Assessment 2001-02, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

24. Muslim Commercial BankNon Performing Loans as % of Total Loans (1993-2003) Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

25. Muslim Commercial BankReturn on Assets (1993-2003) Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

26. Muslim Commercial BankImpact 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.

27. 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

28. 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.

29. 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

30. Allied Bank LimitedFinancial Indicators (1995-2003) Source: Financial Sector Assessment 2001-02, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

31. Allied Bank LimitedNon performing Loans as % of Total Loans (1993-2003) Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

32. Allied Bank LimitedReturn on Assets (1993-2003) Source: Financial Sector Assessment 1990-2000, State Bank of Pakistan Banking Supervision Department, State Bank of Pakistan

33. 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

34. 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.

35. Thank You