Was this content written or created while at IBA?

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Document Type

Conference Paper

Publication Date

11-2-2006

Conference Name

IMF High Level Seminar on Banking System Reforms

Conference Location

Spain

Conference Dates

November 2-3, 2006

Series

Faculty Research - Book Chapters and Conference Papers

First Page

1

Last Page

15

Keywords

Reforms, Banking sector, Pakistan

Abstract / Description

Pakistan has made impressive strides in reforming its banking sector and modernizing its Central Bank in the last decade or so. This paper attempts to present the rationale as to why the reforms were undertaken, the contents of reform program implemented, the outcomes and lessons learnt from Pakistan’s experience. Central bank modernization was an integral part of the banking reforms and the latter could not have been successfully implemented in the absence of the former. Financial sector reforms in Pakistan were conceptualized in the light of the experience of developing countries globally and Pakistan’s own track record of the past two decades or so. The analysis that led to these reforms had pointed to several broad conclusions: (a) Government owned banks and financial institutions distort market incentives for efficient allocation of resources and intermediation of domestic savings. These banks were being used by successive governments for political loaning with the result that almost one fourth of the portfolio was stuck up as non-performing loans raising the cost of bank borrowing for legitimate businesses. The erosion of equity base of the banks led to large injections of capital by the government out of its scarce budgetary resources. (b) Subsidized directed credit aimed at the priority sectors, underserved regions and poor households ended up benefiting the privileged and well-to-do segments of the population. For example, subsidized credit for agriculture was being pre-empted by large landowners who applied in the name of their tenants. The default rate of Agriculture Development Bank peaked at almost 70% and the bank had to be recapitalized. (c) Administered interest rates had crowded out private sector credit as bank financing for meeting government budgetary deficit took precedence in the allocation. Government’s fiscal deficit was so high that most of the deposits of the state-owned banks were lent to the government and a large part of the remaining deposits were deployed to meet the losses of the public enterprises. (d) A weak regulator controlled by the government enjoying little freedom of action was unable to prevent financial crises or enforce rules of the game or take action against those indulging in malpractices. The regulatory authority of the State Bank of Pakistan was diluted by establishing a parallel body – Pakistan Banking Council – under the direct control of the Ministry of Finance.

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