Effect of Privatization
SBP Research Bulletin Volume 2, Number 2, 2006
OPINIONS
The Effect of Privatization and Liberalization on Banking Sector Performance in Pakistan
Umer Khalid∗ 1. Introduction
A well functioning financial system is necessary for enhancing the efficiency of intermediation, which is achieved by mobilizing domestic savings, channeling them into productive investment by identifying and funding good business opportunities, reducing information, transaction, and monitoring costs and facilitating the diversification of risk. This results in efficient allocation of resources, contributing to a more rapid accumulation of physical and human capital, and faster technological progress, which in turn lead to higher economic growth. Anxious to achieve higher growth, policy makers in many developing countries saw public ownership of banks and other financial institutions as necessary in order to direct credit towards priority sectors. It was in this backdrop that the financial sector in Pakistan was nationalized in the early 1970s under the framework of the Banks Nationalization Act 1974. The nationalized domestic banks were consolidated into 6 major national commercial banks and several specialized credit institutions were established1. The objective of the nationalization was to direct bank credit towards specific developing sectors and to provide a source of funding to the government. By the end of the 1980s, it became, however, quite clear that the socio-economic objectives, sought through the nationalization of the banking sector were not being achieved2. Instead, the pre-dominance of the public sector in banking and Non-Bank Financial Institutions (NBFIs), coupled with the instruments of direct monetary control, were becoming increasingly responsible for financial inefficiency leading to the crowding out of private sector investment. The dominance of public sector banks
∗
The author is an Analyst in the Research Department of the State Bank of Pakistan. The author
OPINIONS
The Effect of Privatization and Liberalization on Banking Sector Performance in Pakistan
Umer Khalid∗ 1. Introduction
A well functioning financial system is necessary for enhancing the efficiency of intermediation, which is achieved by mobilizing domestic savings, channeling them into productive investment by identifying and funding good business opportunities, reducing information, transaction, and monitoring costs and facilitating the diversification of risk. This results in efficient allocation of resources, contributing to a more rapid accumulation of physical and human capital, and faster technological progress, which in turn lead to higher economic growth. Anxious to achieve higher growth, policy makers in many developing countries saw public ownership of banks and other financial institutions as necessary in order to direct credit towards priority sectors. It was in this backdrop that the financial sector in Pakistan was nationalized in the early 1970s under the framework of the Banks Nationalization Act 1974. The nationalized domestic banks were consolidated into 6 major national commercial banks and several specialized credit institutions were established1. The objective of the nationalization was to direct bank credit towards specific developing sectors and to provide a source of funding to the government. By the end of the 1980s, it became, however, quite clear that the socio-economic objectives, sought through the nationalization of the banking sector were not being achieved2. Instead, the pre-dominance of the public sector in banking and Non-Bank Financial Institutions (NBFIs), coupled with the instruments of direct monetary control, were becoming increasingly responsible for financial inefficiency leading to the crowding out of private sector investment. The dominance of public sector banks
∗
The author is an Analyst in the Research Department of the State Bank of Pakistan. The author