To explore this one has to look at the shift in paradigm in Pakistan's commercial banking sector. The process was initiated in early nineties with the privatization of Muslim Commercial Bank (MCB) and Allied Bank of Pakistan (ABL) and establishment of a dozen banks in the private sector. This was followed by the first phase of financial sector reforms. Now the consultations with banks is going on to initiate the second phase . The local banks have been asked to: raise their paid-up capital to one billion rupee, follow maximum disclosure requirement and make full provisions against non-performing loans (NPLs). Efforts are also being made to restructure NCBs for their ultimate privatization. All these measures have changed the working environment. The local banks have emerged strong competitor of foreign banks. Have the foreign banks lost the zeal to compete or do they find themselves inadequate to compete with the local banks?

Foreign banks operating in Pakistan have thrived in the past mainly due to selective clientele, better standard of services and virtually no burden of NPLs. Their biggest strength was the ability to mobilize foreign currency deposits and to swap these deposits. As they were mobilizing dollar deposits, they were also considered blue-eyed kids of the Government of Pakistan (GoP). Then came freezing of foreign currency accounts (FCAs) in May 1998. Though, there was restriction on withdrawal of money in foreign exchange, foreign banks experienced, initially, large erosion in deposits. They also found mobilizing local currency deposit difficult due to limited branch network.

Foreign banks were, and still, competing mainly with the five big banks. The private banks have intruded, to a large extent, into their niche market. They also realized the fact that they could not put up effective resistance against the local banks due to their limited number of branches. Opening more branches was not only an expensive proposal but also not enough to compete with the five big banks and to face the ambitious branch expansion plan of the private banks. To overcome this limitation, foreign banks are making huge investment in technology, i.e. on-line banking, ATMs, credit cards, etc. However, these services could only be used in urban areas, mostly. With the gradual increase in the paid-up capital of private banks and depositors' confidence in them, branch rationalization programme followed by the NCBs and privatized banks, the feeling of inadequacy among the foreign banks further intensified.

Some of the foreign banks have either already sold their Pakistan operations to local banks or are actively involved in the negotiations. The two banks which have already taken an exit are Bank of America and Societe Generale of France (SG). Earlier, a very important feature was conversion of Pakistan branch network of foreign banks into locally incorporated banks followed by acquiring of large equity stakes by foreign groups, particularly from the Middle East, in the local banks. Faysal Bank of Bahrain was the first to convert its Pakistan operations into a locally incorporated bank— Faysal Bank. A foreign investors' group acquired Habib Credit & Exchange Banks (previously branch network of BCCI) and renamed it, Bank Alfalah. Schon Bank was bought by some foreign investors from the Middle East and given the name, Gulf Commercial Bank. This was subsequently takenover by Pakistan Industrial Credit and Investment Corporation (PICIC) and became PICIC Commercial Bank.

As a result of merger ANZ Grindlays Bank of Australia and Standard Chartered Bank of UK, now the two banks are operating under Standard Chartered banner. The majority shares of Union Bank were acquired by another group from the Middle East. Union Bank has also acquired Pakistan operations of Bank of America and some business of American Express in Pakistan. It has also acquired Pakistan operations of Emirates Bank International of UAE.

It is very important to explore the motives behind the above mentioned transactions, but first the SG deal. Al-Meezan Investment Bank, established by Pakistan Kuwait Investment Company, recently acquired commercial banking licence and the name was changed to Meezan Bank. The new bank also acquired Pakistan operations of SG. An interesting point is that SG sold its Pakistan's operations to Meezan Bank but also acquired substantial stake in the bank. The point which makes it further interesting is the declaration of Meezan Bank to undertake commercial banking activities on the basis of Riba free transactions only. It is rather unusual that a European bank has become a partner in a bank which promises Riba free banking.

There has been no official announcement about the takeover of Emirates Bank's Pakistan operations by Union Bank. However, the sources in banking sector say that the deal has been concluded at a substantial cost and formal approval from the shareholders of Union Bank was acquired at a recently held extraordinary general meeting. It may look a bit strange that Emirates Bank, which has been going strong in Pakistan, makes such a decision. However, banking sector experts say that Emirates Bank's decision is due to the shift in its policy which envisages making the bank a strong domestic bank. It has already sold its operations in the UK and India and it was expected they would also pull out of Pakistan.

It is also important to look at the recently held bidding for the sale of 51 per cent shares alongwith transfer of management of United Bank Limited (UBL). Muslim Commercial Bank (MCB) submitted the highest bid, almost double the amount offered by other participants. Though, State Bank of Pakistan (SBP) has suggested to the Privatization Commission to ask the bidders to raise the bids further, it seems that MCB will ultimately takeover UBL. A question was raised, why did MCB offered such a high price? The sector experts say, "MCB has most probably submitted such a bid to make it difficult for others to match the price."

Why should MCB be so keen in taking over UBL? The sector experts say, "The biggest attraction for MCB, in UBL, is its overseas operations. MCB has already attained the status of the largest private sector bank in Pakistan and now intends to make its presence felt in the global market. Whereas Union Bank should be keen in consolidating its operations after the takeover of Pakistan operations of Bank of America, American Express and Emirates Bank." It must be kept in mind that UBL's ultimate handing over to any bidder is largely dependent on the formal clearance of the buyer by the Bank of England. Therefore, the transfer of ownership and management of UBL to MCB seems most likely.

It may be of some interest to compare MCB with Union Bank in slightly more detail. MCB has a long history of operations and successful restructuring after its privatization. It also enjoys extensive and intensive branch network. Lately it has invested heavily in technology to improve quality and range of its services which include on-line banking, ATMs and MNET. Under the new management efforts were made to recover NPLs and full provisioning against such loans.

Compared to MCB, Union Bank has a rather bumpy track record. The initial sponsors, Saigol Group, relinquished their stake in the bank under a distressed sale. The new management, mostly comprising of zealous and ambitious bankers, have yet to make a mark. It is true that the bank is making a lot of investment to become the preferred bank but has little control on expenditures. According to the annual report for year 2001, bulk or almost total income was eaten up by operating expenses and the bank posted a meager profit of around Rs 10 million for the year.

It is often said that most of the banks listed in Pakistan follow orthodox or conservative approach and they must come out of this syndrome. However, the critics are often not able to differentiate between orthodox and prudent approach in banking. It is still the better to be a little conservative and make stable profit rather than being adventurous and posting marginal profit or incurring loss. Ensuring decent return to depositors and shareholders should always be the key objective of the management of any bank.

ELIMINATION OF RIBA

According to an order by the Supreme Court of Pakistan local financial institutions were required to eliminate Riba from the system by June 30, 2001. However, taking into consideration the quantum of work, the deadline was extended for one more year, to June 30, 2002. While the intellectual deliberations continued, the battle in the court of law became more focused. Now, the court has ordered for determination afresh in the light of contentions of the parties and the observations. The financial institutions may no longer face the pressure to re-engineer the system, at least for the time being. However, one may raise a question, Is the court order more important or the Islamic injunctions demanding elimination of Riba ?

The future deliberations must address key issues like: 1) what is the real definition of Riba ? 2) Does the prevailing system provides assurance against exploitation of borrowers by the lenders? 3) Are the borrowers paying market-based rates? 4) Are the fixed lending and borrowing rates only notional? There are host of other issues which have to be dealt with. However, both the sides, religious scholars and economists, must not enter into due diligence with rigid stands. This is an academic discussion of the highest importance — it deals with the basic teaching of Islam, Rizzaq-e-Halal.

PRIVATIZATION

The present government is making efforts to ensure swift and smooth privatization of NCBs. This includes two tier strategy, sale of remaining shares of GoP in already privatized banks and sale of majority shares alongwith transfer of management of remaining NCBs. There was plan to list the NCBs on stock exchanges first and then off-load part of GoP holding, according to the market appetite. Following this policy, National Bank of Pakistan was listed on local stock exchanges and 5 per cent shares were offered to general public. As the issue was heavily over-subscribed, the GoP decided to exercise 'green-shoe option' and off-loaded its 10 per cent shares.

As regards UBL, the GoP decided to sell 51 per cent shares alongwith transfer of management. The bidding was held and MCB submitted the highest bid of Rs 8.5 billion. The next major transaction on agenda is sale of majority shares of Habib Bank Limited (HBL) alongwith transfer of management. Initially the GoP had the plan to first enlist HBL on local stock exchanges and sell part of its holding to general public. However, the plan has been changed. Now the GoP wishes to make outright sale of the bank. The GoP has also offered to sell its holding in Bank Alfalah.

KEY PLAYERS

Askari Commercial Bank posted over one billion rupee profit before tax and improved its payout for the year 2001 compared to dividend paid for the previous year. The Board of Directors approved payment of 20 per cent dividend and issue of 5 per cent bonus shares.

Bank Alfalah may rightly term year 2001, 'another year of remarkable performance and another year of consistent growth'. This is evident from a 47 per cent growth in deposits, 24 per cent increase in advances, 31 per cent growth in profit before tax and 44 per cent hike in profit after tax as compared to the previous year. At the end of the year equity of the bank also stood at Rs 1.361 billion, a growth of 51 per cent over the previous year.

Faysal Bank was able to wipe out its accumulated losses. Over the last couple of years the bank not only managed to clean its slate but to also pay 10 per cent dividend. There was improvement in mark-up as well as non-mark up income. The management was able to control expenses, though there was slight increase in administrative expenses. There was also improvement in basic earning per share — from Rs 1.53 to Rs 1.82.

Habib Bank posted Rs 2.2 billion profit before tax for the year, almost double the amount posted for the previous year. This was despite the fact that the bank made provisions amounting to Rs 2.6 billion as compared to Rs 1.2 for the year 2000. Profit after tax of Rs 1.1 billion was more than double the amount posted for the previous year. The bank managed to curtail administrative expenses. There was a reduction in non-performing loans. The bank has increased lending to SMEs. There was improvement in overseas operations which contributed towards higher profit. Another improvement was the increase in number of ATMS — 61 of its own and over 100 machines through sharing with other banks.

Metropolitan Bank posted Rs 742.7 million profit before tax as compared to Rs 567.9 million profit for the year 2000. Out of Rs 338 million profit after tax, Rs 200 million were appropriated for issue of bonus shares. Rs 175 million bonus shares were also issued in year 2000.

Muslim Commercial Bank is the largest private sector bank and the third largest bank of Pakistan. The year 2001 was yet another year of achievements. The bank posted over Rs 2.1 billion profit before tax and total dividend payout for the year 2001 was 25 per cent.

PICIC Commercial Bank (formally Gulf Commercial Bank) completed the first successful year of operations since the acquisition of the bank by Pakistan Industrial Credit and Investment Corporation (PICIC). The various structural and financial changes introduced, yielded positive results. Some of the indicators of improvement were, a hefty 153 per cent growth in profit before tax and 79 per cent increase in deposits. The Board of Directors approved issue of 25 per cent bonus shares and 40 per cent right shares to further improve the balance sheet footing.

Prime Commercial Bank was able to improve its earnings per share due to higher income, though there was also increase in expenses. The bank posted Rs 241 million profit before tax as compared to a profit of Rs 158.6 million for the previous year. Out of Rs 152.6 million profit after tax Rs 122 million were transferred to revenue reserve and the Board of Directors preferred to skip dividend payment.

The Bank of Khyber posted Rs 231 million profit after tax for the year 2001 as compared to a loss of Rs 157 million for the previous year. One of the reasons foe posting loss last year was the provision of Rs 310 million against NPLs. By making such a provision the bank has cleaned its slate and the step would augur well in the future performance.

Union Bank posted a meager Rs 9.95 million profit before tax for the year 2001. A closer look at the financial results reveals that out of an interest income of Rs 597.5 million, provision against non-performing loans and advances amounted to Rs 197.6 million. While interest income amounted to Rs 597.5 million, non-interest income amounted to over one billion rupee. An interesting observation was that as against a total income of Rs 1,064.6 million for the year, administrative expenses were as high as Rs 1,040 million.

The financial results of commercial banks for the year 2001 seem good despite economic slow down, barring a few. However, analysts say that the earnings for the year 2002 may come under pressure due to shrinking spread. The central bank has been not only lowering discount rate but also persuading the commercial banks to curtail average lending rates. Since the demand for funds has not picked up significantly, shrinking spread is adversely affecting profitability of the banks. Meeting the enhanced capital requirement of one billion rupee may not pose any serious problem for most of the banks.

DEPOSITS (Rs in million)
Name	2001	2000
Askari Commercial Bank	41,200	30,359
Bank Alfalah	30,207	20,482
Bank Al Habib	24,697	17,823
Metropolitan Bank	17,902	13,136
Platinum Commercial Bank	3,991	6,416
Prime Commercial Bank	10,367	8,264
PICIC Commercial Bank	9,619	5,371
Soneri Bank	16,054	14,030
Union Bank	20,721	17,171

 

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ADVANCES (Rs in million)
Name	2001	2000
Askari Commercial Bank	23,291	17,893
Bank Alfalah	19,131	15,242
Bank Al Habib	15,902	14,722
Metropolitan Bank	12,988	11,367
Platinum Commercial Bank	2,147	6,355
Prime Commercial Bank	6,853	6,794
PICIC Commercial Bank	6,330	4,746
Soneri Bank	10,199	10,931
Union Bank	13,869	13,346

OUTLOOK

Most of the banks have been able to make full provisions against NPLs. The impact of September 11 incident did not appear in first quarter reports. The real impact can only be quantified after half-year results are announced.

The demand for funds by the private sector has not increased despite reduction in lending rates. State Bank of Pakistan has been consistently reducing T-Bill yields and discounting rates which have reduced the spread. Therefore, profits of banks are expected to remain under pressure despite reduction in corporate tax rate.

While further reduction in lending rates seems improbable. The analysts forecast for slow and gradual increase in interest rates during October-December quarter this year. That is the time when funds are needed the most by textile and sugar industries.

Analysts hint towards more foreign banks leaving Pakistan. These include Doha Bank, Mashriq Bank, IFIC and Rupali Bank. Operations of some of these banks may be taken over by local financial institutions and closure of a couple of banks seems certain, if local buyers do not come forward. The three foreign banks, namely Standard Chartered, Citibank and ABN AMRO are expected to get further strength mainly because of the diversified range of their products and services.