THE IMPACT OF DEREGULATION ON COMMERCIAL BANKS AND

THEIR CUSTOMERS
INTRODUCTION

In the last quarter of the twentieth century, many industries had deregulations and reforms.
This include not only developed but also developing countries. Reasons behind this
deregulation are banking crisis, globalization and economic integration.
The purpose of this research is to see, what is the impact of deregulations on the activities of
commercial banks in Pakistan? To achieve this objective in the research, firstly it is seen what
exactly a reform means, what causes these deregulations and reforms and advantages and
disadvantages of any reforms and deregulations in the banking sector. A big change comes in
the banking sector because of reforms and deregulations. Banks have been able to maximise
their performance then before because of these reforms and deregulations. Restrictions on
banking sector have also been lifted with the help of deregulations and reforms.

SIGNIFICANCE OF BANKS

Banks get this credit of economy circulation system. The capability of financial organizations
to encourage savings and assign them to businesses in terms of loans that turn it into highly
productive capital has a great influence on economic growth. (Carba valverde et al.. 2003). If
any bank fails it highly affects the economy as the investors and depositors start withdrawing
money as they lose confidence in bank. (Dale, 1992)
For example recently a number of banks in Britain were on edge of sinking. British
government arranged a bailout package for these banks as they feared if any of the bank
sinks, investors and depositors will start withdrawing money and as a result there is going to
be liquidity problems, and it will develop into a bigger banking crisis. Most of the business
organizations in any country mainly rely on credits to carry their normal operations.
If a banking system fails to works it not only disturbs the economic growth but also
destabilises and creates uncertainties in the economy. There comes the need to bring reforms
in the banking industry. There are many organizations in the world for example IMF, the
world bank and the Basle committee, who’s role is to monitor the performance of the
financial sector and for the stability and security of a financial system bring reforms in it with
the passage of time. These organizations also help and support countries to restructure their
financial sectors.
IMF assisted Pakistan to bring reforms in the banking industry. Ratio of bringing reforms in
high income economies is higher than that of lower income economies. (Abiad, 2005)
Deregulations and reforms is believed to bring financial crisis, globalization, and economic
integration although that is not the only reason.

REFORM AND DEREGUALTION

If regulatory authorities remove restrictions on any industry it’s called deregulation, while as
reform is seen as changing the fundamental way of doing things. (Barth et al., 2004)
If reforms and deregulations bring new life in banking sectors they also bring some new
challenges for them. For example there is more competition, international standard goes high,
products and services become more complex and also they face more strict regulations and
supervisions.
There are two challenges in a reform process. First is at what stage the change is to come and
what would be the nature of the change. Second challenge is the continuous change in the
global market that needs to be taken in notice. The global interest rates and leveraged
exercised by international financial institutions also needs to be taken in notice.

REGULATION THEORIES

According to (Barth, 2001), there are two theories. First one is helping hand and second is
grabbing hand. According to helping hand, the government bring regulations to correct
failures of the market, and political constituencies are supported by the government according
to grabbing hand.
The grabbing hand theory predicts that in countries where officials or supervisors are
powerful they influence the regulation process that results in high corruption rate, without
bringing any improvement in the performance of a banking system and also affects the
stability. The grabbing hand theory was mostly observed in South Asian countries just before
the deregulation started.
It was observed that in the period of deregulation in Pakistan, government has passed on the
instructions to banks, which sector to allocate more credits that favours the government. To
control this entire situation, appointments of bank officials were politically based. (Hussain
2005)
PAKISTAN

Banking system was reformed in Pakistan over the last decade. Based in South Asia, having
land area of 778,720 square kilometres, Pakistan is sixth most populous country in the world.
Pakistan was found in 1947 after the partition of India. A countries financial sector depends
highly on the political and economic conditions especially in developing countries. Due to
this high influence political and economic condition is described in the research.

ECONOMIC CONDITION OF PAKISTAN

In the decade before last it has been seen that the economic growth is very slow because of
immense fiscal profligacy by the governments. In the early 90s GDP ratio was only 3.8
percent. It was because of low productivity in the agricultural and industrial sector. Low
revenue generation and high interest payments resulted in less investment by private sector in
financial and other sectors of the country. Just before the deregulation period, mostly deposits
in the banks were loaned to the government, and because of that government ended up with a
high fiscal deficit. (Hussain, 2005)
After the control being took over per President Musharraf the economy rebounded. Economic
growth went as high as averaging 6.1 per annum since 2003. According to world banks
reports, macroeconomic conditions in Pakistan have been rapidly improving. But in recent
years because of international commodity price, GDP decreased by 0.2% and 0.6%
respectively in 2007 and 2008. (see table 1.1)
GDP increased from 4.5% in 2003 to 5.8% in 2008. Public debt fell to 50.6 of GDP in the
year 2007-08. Unemployment rate also declined to 5.6% from 6.5%. Banks are regarded as
an important instrument in economic growth and it also benefits from economy growth.
Banking sector of Pakistan has grown not only in size but also in strength. Service sector
overall grew 8% and its overall growth contribution is more than 60%. But despite all this the
interest rate increased.
FDI investment also improved. Telecommunication sector is largest to receive FDI shares,
followed by the financial sectors. In economic growth privatization also played a vital role.
AIMS AND OBJECTIVES

All over the world modernization has changed the way of doing business. The reason behind
these changes is globalization, integration of different economical sectors and also demands
of homogeneous products and services. These changing demands let regulatory authorities
and government to design a system that meets this financial system. As a result banks and
banking systems were modernized. To stay up to date government reformed banking sector
that brought many benefits but also brought up new challenges for banks, bankers and
regulators.

RESEARCH AIMS AND OBJECTIVES

In the late 1980s, government of Pakistan initiated reforms in the banking sector. These
reforms were divided in three phases. The research aims to investigate the influence of these
reforms and deregulations on the CB’s of Pakistan. Described below are the dimensions on
which the research will mainly depend:

 What is the impact of deregulation on the efficiency and productivity of commercial

banks in Pakistan?
 What is the impact on the customers of the banks after deregulation?
 What are the challenges faced by commercial banks after reforms in the financial
sector?
LITERATURE REVIEW

REFORMS IN THE BANKING SECTOR

In order to ensure that government funding and direct bank credit to the sector of the
economy favoured by the government, all the domestic banks in Pakistan had been
nationalised in 1947. (Bonaccorsi et al., 2005)
Prior to the deregulation, banks in Pakistan were serving the needs of the government
organizations, subsidising and fiscal deficit. They were not lending anything to small or
medium enterprises. On the top of that all lending decisions and all top level management
appointments were politically influenced at that time. NPL’s proved to be a big burden for
banking industry in Pakistan. 25% of the loans get stuck, as they were issued not on merit
basis, but on political basis. (Hussain, 2005)
Banking sector reforms were initiated in the late 1980’s. Opening of foreign currency
accounts for both residents and non residents was authorised by the Pakistani authorities in
1990.
The government of Pakistan started issuing licences to private banks in 1991, when ten new
banks were given licenses and they started their operations in the country. Later on more
banks were given licenses. Two nationalised banks MCB and ABP were later privatised in
different stages.
The second phase of reforms was introduced in 1997, when new guideline to recover stuck
loans was introduced. Banking courts for recovery of bad loans was established in that time
spam. Restriction on branches was first erased in 1995, and in 2004 they were further erased.
Foreign banks were earlier allowed to open 25 branches nationwide but in 2004 the limit for
foreign banks to open their branches was increased to 50. At this time in rural areas of
Pakistan the branching network is very minimal. To tackle this SBP introduced a new
branching policy in 2008. This policy requires all commercial with 100 branches to open at
least 20 branches outside the big cities of the country, especially in the areas where there are
no branches. Capital is being reviewed by SBP consistently since 2001.
BANKING SYSTEM IN PAKISTAN
Pakistan’s banking system had 45 scheduled banks, having total branch network of 7704 at
the end of December 2006. This network has expanded by 348 branches as compared to
2005. 56 branches of foreign banks were closed during the year 2006. Banking industry in
Pakistan is constantly growing from last few years. Total assets and pre tax profits increased
tremendously and have achieved new land marks. Because of this growth Pakistan’s banking
system is ranked among top ten in terms of profit. It is placed in the top half in a group of 44
emerging economies of the world in terms of capital adequacy.

COMMERCIAL BANKS OF PAKISTAN

In any economy, commercial banks are like a backbone. Commercial banks are the main
credit providers to both house hold and corporate sector and they operate the payment
mechanism. (Casu et al., 2006)
35 out of 45 banks are commercial banks in Pakistan. Commercial banks are further divided
into three categories, public sector banks, domestic banks and foreign commercial banks. All
of these commercial banks offer a wide range of products such as debit cards, credit cards,
loans and other financial plans. (SBP, 2006)
Over the past two decades a larger number of countries deregulated their banking and
financial systems. (Bonaccorsi et al,. 2005). Reforms and deregulations in banking sector are
seen as being setup a security belt for the financial system, to avoid financial crisis. The
forces that are involved in reforms and deregulations are internal and external forces.
External drivers are, changes in the global economic environment, introduction of new
technology, global progress in banking regulation for example the Basle Committee on
banking supervision developed guide lines on capital adequacy while internal drivers are the
creation of a robust banking system, and economic growth (Yildirim et al., 2007).
The aim of deregulation and reform in the banking industry is to benefit the customers by
providing better customer service, making landing system easy, by giving competitive rates
on loans and deposits. However deregulation doesn’t always guarantee these improvements.
EFFICIENCY

A key objective of deregulation is to improve the efficiency. (Bhattacharyya et al., 1997).

Efficiency can be defined as an extent in which banks are able to improve their output
without increasing the input, or can decrease the input without affecting the output.
Efficiency is the ability of the management to control the cost involved and to use resources
in producing output.

PRODUCTIVITY

Productivity can be defined as the management operates in an efficient manner to increase the
output and by making profits using shareholder’s wealth. Efficiency and productivity are
linked to each other. If efficiency is increased productivity also gets increased and vice versa.
Reforms and deregulations involve changes of the policies and the reversal of the old
policies. These policy changes mainly incorporate amendments in six dimensions,
liberalisation of interest rates, removal of credit ceilings, privatization, relaxation in entry
barriers, removal of restriction on banking activities and currency convertibility (Abiad et al,
2005). It is commonly believed that to improve the productivity and efficiency of the
banking sector, it should be deregulated with a greater emphasis placed on monitoring banks’
risk management instead of individual transactions, removing of the interest rate ceiling and
mandatory credit allocations, and reducing restrictions on entry and the liberalisation of
branching policies (Barth, 2004).
As this research intends to investigate the impact of deregulation on the efficiency and
productivity of Commercial Banks and on their customers, the researcher isolated the
currency convertibility variable as it is not central to the study while macro economic
conditions are considered central due to their high impact on banks’ productivity.
PRIVATIZATION

Deregulation often involves privatization which is an important attribute; it significantly

affects the efficiency and productivity of banks. (Jaffry et al., 2007) pointed out that lifting
government control may enhance the efficiency of banks. (Clarke et al, 2005) included a
large panel dataset of 16 of countries (including Pakistan) of different regions to examine the
effect of privatization, acknowledged that privatization often but not always improves
performance by limiting harmful government intervention in state-owned enterprises. He also
pointed out that privatization affects the quality of management as managers in public banks
do not face a market for their skills or a credible threat of losing their job for non
performance and are less likely to receive performance related pay. They are less motivated
than managers in private banks. In addition he also unveiled in his research that the effect of
privatization depends on the nature of privatization. (Bonin et al, 2005) investigated the
impact of privatization on the banks of six countries and concluded that partial privatization
in which the state divest some of its shares but retains a controlling interest is not likely to
generate improvement in performance. Therefore a total relinquishing of control and a
transfer to strategic investors is required for the improvement of efficiency and productivity
of banks.
(Das et al, 2006) found efficiency of banks improved in the post- deregulation; they
suggested that one of the reasons for inefficiency was government ownership structure which
had an adverse impact on their efficiency. There are several reasons behind that, for example
banks were supposed to follow the government objectives like loans to the sectors favoured
by the government at below the market rate, would have ended up with a low yield return. It
is frequently acknowledged in the literature that the choice of variables used to measure
efficiency significantly affects the result. They employed the intermediation approach. This
approach includes both operating and interest expenses as inputs, where loans and other
major assets count as output and isolate the physical variables. The result may have varied if
they had employed other approach such as the production or the value added approach.
The research by The Economic Commission for Latin-America and the (Caribbean 2000)72
researched on the impact of privatization revealed that the most significant impact of
privatization on CBs in the Caribbean has been in the area of customer service and product
innovation. Most of the banks that have been privatised indicate that there has been a
considerable enhancement in customer service. This has been reflected in a better range of
products and services to customers. The banks which are still State-owned simply could not
cope with the competition in the areas of product innovation, customer service, technical
productivity and managerial competence. The result of this research clearly suggests that
privatization creates benefits for customers; however it is very possible that impact of
privatization may have different effects in different regions.

METHODOLOGY

Research methodology can be defined as extracting meaning from the data. There are two
types of research methodologies that are quantitative and qualitative.

QUANTITAIVE VS QUALITATIVE RESEARCH

A quantitative approach is used to answer questions about relationships among measured

variables with the purpose of explaining, predicting and controlling phenomena, while
qualitative research is typically used to answer questions about the complex nature of
phenomena often with the purpose of describing and understanding the phenomena from the
participant points of view (Leedy et al., 2005).
Keeping in mind the research objectives and questions, quantitative methodology is found
most suitable for this research.
JUSTIFICATION

Between qualitative and quantitative there is always a choice to go for one or another, but in
this research I’ll go for quantitative research and follow the approach to conduct structured
interviews. There are several reasons for my choice. Firstly open ended questionnaires as a
requirement of this research method increase problem of bias as compared to that of close
ended questionnaire. As mostly people won’t give negative feedback about their bank or
point out mistake in their system. While in close end questionnaires questions are compared
in different ways to get the final feedback. The second reason behind not choosing open
ended questionnaire is that it requires so much time of the participant, which indeed is not an
easy task.

Mono method technique is adopted in this research. In this technique the researcher can either
use one data collection technique and corresponding analysis procedure or use more than one
data collection techniques and analysis procedure to answer the research questions (Saunders
et al.,2006). The other techniques are Mutli-Method or Mix-Method, due to limitation of
words it is not possible to describe these techniques here however a concern reader can refer
to (Saunders et al, 2006). I will collect main data through web survey and employed Factor
analysis technique to analysis the data.

Previous researchers Leightner et al., 1998, Bonaccorsi et al., 2005, and Das et al., 2006
researched on the related topics mostly employed quantitative methodology. The researches
which employed quantitative methodology mainly used DEA, Malmquist index, logit model,
or Regression analysis etc. It is beyond the scope of this research to discuss all the available
techniques due to limitations of words and time.
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