Salman Ahmad

Performance of Commercial Banks in

Pakistan:
A Study in Risk Analysis
Salman Ahmad
*
Introduction
The nanca sector n Pakstan has evoved over the
years n response to the growth of the economy and the
governments pans for the growth and deveopment of
the country. The sector as on 31 March 2002 comprses the
State Bank of Pakstan, 4 state-owned banks, 2 newy
prvatsed banks, 4 specased banks, 14 prvate
schedued banks, about 30 easng companes, 45
Modarabas, 14 nvestment banks, 3 stock exchanges, 58
nsurance companes, and Government Savng Centers.
Commerca banks were natonased n 1974 and are
now n the process of beng prvatsed. Two natonased
commerca banks have been prvatsed snce 1990:
Musm Commerca Bank was sod by aucton/ negotaton,
whe Aed Bank was sod to ts empoyees .The market
share of the natonased commerca banks has been
decnng wth the ntroducton of new prvate banks.
The three natonased commerca banks n Pakstan
-Habb Bank Lmted, Unted Bank Lmted, and Natona
Bank of Pakstan-have a arge branch network that aows
them to expand and compete wth the prvate banks n
depost mobsaton. The newy prvatsed banks have
acqured the branch network that w aow them to
expand and compete wth the state-owned banks. Whe
these nsttutons pay an mportant roe n nancng short-
term credt requrements, ther success n rasng deposts
ensures that they have a sgncant surpus of funds that
can be ent or nvested n government securtes.
*
The author is Professor of Economics, Lahore School of Economics.

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The Lahore Journal of Economics, Vol.6, No.2
There are 19 foregn banks whch have been
estabshed from tme to tme. The foregn banks n Pakstan
are branch operatons; they are not separate ega enttes.
Much of ther success can be attrbuted to ther superor
management sks and better access to nternatona
nanca markets. A arge fracton of foregn currency
deposts are wth foregn banks, party because of ther
marketng ehorts and party because of ther credbty as
nternatona banks. Foregn banks are ony aowed four
branches wthn the country.
In recent years, as externa credt ows to
deveopng countres have decned, the need for an
emcent and vabe nanca sector has grown. An emcent
nanca system coects domestc savngs and aocates
the coectve resources to the best possbe nvestment
opportuntes, aowng for better domestc resource
mobsaton and utsaton, and reducng the reance on
externa nancng.
Throughout the 1980s, Pakstan was abe to acheve
strong growth wth ow naton. The bankng sector
operated nemcenty because of natonasaton.
1
Fnanca
ntermedaton was geared towards the nancng needs of
the government and those of the targeted sectors of the
economy to whch credt was omcay drected. Athough
Pakstans economy opened up nternatonay n 1990, the
government had a tght hod on entry to nanca markets.
The stuaton changed durng the 90s wth the entry of
prvate banks n the country and subsequent competton.
Fnanca reforms were ntated wth a strong commtment
to market-orented deveopment of the nanca sector.
These reforms are st underway and w need to be
strengthened substantay f modern, compettve nanca
markets are to be deveoped.
Foregn banks have shown the hghest growth rate n
terms of deposts n the ast three years. State-owned
banks averaged an annua growth of 12.7 per cent over the
1
Khan Bashir Ahmad, Financial Markets and Economic e!elo"ment in Pakistan#
1$%&'1$$(, ".))%
66
Salman Ahmad
three-year perod 1998-2001, whe the recenty prvatsed
natonased commerca banks averaged 18.2 per cent and
foregn banks, 31.4 per cent. Foregn banks are aso more
emcent n terms of controng admnstratve costs per
branch. For exampe, growth of admnstratve costs
averaged 19.7 per cent for state-owned banks, 18.3 per
cent for the recenty prvatsed banks, and 17.6 per cent for
foregn banks. As a percentage of assets, admnstratve
costs are the owest for foregn banks.
The gross revenues of foregn banks have grown at a
much faster pace than the rate of growth of ther costs.
For Pakstan banks, the dherence n the growth rates s
extremey narrow, f not negatve. Bank deposts have
grown sgncanty n recent years prmary because of the
rapd growth of money suppy, whch ncreased by around
18 per cent and 20.6 per cent durng 1999-2000. Money
has aso owed nto the bankng system from the nforma
economy wth the change n ncentves foowng the
recent sde of the stock market and the sgncant sump
n the rea estate market. Demand deposts consttute
about 47-50 per cent of tota bank deposts whch s much
hgher than other countres. Ths aso expans why the
cost of funds have been ow for commerca banks.
Proftability and Productivity of Commercial Banks
The prot earned by the commerca banks s the
dherence between the depost rate and the endng rate,
caed the spread. In nomna terms, the spread has rsen
steady from 5 per cent n 1986-87 to 6.2 per cent n
1992-93, but then fe to 2.8 per cent n 1997 and
ncreased to 3.3 per cent n 2000. In rea terms, the
weghted average yed on deposts fe from 3.9 per cent
n 1986-87 to -4.6 per cent n 1990-91, and -1.1 per cent
n 1992-93.The weghted average yed on oans aso
decned; after decnng from 8.9 per cent n 1986-87 to
1.1 per cent n 1990-91.Thereafter, t cmbed rapdy to
5.14 per cent by 1992-93.
2
)
*l +a,ue, -adeem, and Shahid Kardar, 1$$( . e!elo"ment of the Financial Sector in
Pakistan., ". %%/.

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The Lahore Journal of Economics, Vol.6, No.2
Foregn banks seem to be the man benecares of
the reatvey arge spreads, especay as the natonased
banks have to dea wth probems of arge overheads,
ncreasng nemcences and nonperformng oans.
The three-year (1998-2001) averages of the
protabty ndcators for natonased commerca banks
and prvate commerca banks are umnatng. In the case
of natonased commerca banks, tota admnstratve
costs were 2 per cent of tota assets compared wth 0.85
per cent n the case of foregn banks, 0.6 per cent n the
case of prvate banks. Pre-tax prots as a percentage of
deposts are 0.6 per cent for natonased commerca
banks, 5 per cent for foregn, and 2.5 per cent for new
prvate banks.
Over the years, the capta base of natonased
commerca banks has been severey ahected by the poor
quaty of bank oans made on potca and uneconomc
grounds. As a resut, the snge most formdabe probem
facng the banks s the heavy burden of nonperformng
oans. Pakstan ntroduced Prudenta Reguatons n 1993
to ensure that credt s not msused and the nfected
portfoo was mnmum. However, the nfected portfoo
has ncreased to sgncant proportons ( see Tabe 1
beow). On |une 30, 2001, the Non-Performng Loans
(NPLs) amounted to Rs. 279 bon, .e., 8.2 per cent of
GDP, 18.6 per cent of domestc assets, and 32.5 per cent
of tota credt made avaabe to the prvate sector and
pubc enterprses. Non-Performng Loans of the
Commerca Bankng sector were Rs. 221 bon,.e, 6.5 per
cent of GDP and 22.1 per cent of tota deposts. Out of
NPLs, the defauted oans of the nanca nsttutons and
the commerca bankng sector were Rs. 172 bon and Rs.
141 bon respectvey. Because of such a arge nfected
portfoo, the spread between endng and depost rate has
remaned hgh. Though reschedung of oans s common,
the tota advances of natonased commerca banks
categorsed as bad and doubtfu debts are Rs. 56 bon of
whch Rs.46 bon are cassed as advances reated to
the prvate sector. |ust under 23 per cent of the prvate
68
Salman Ahmad
sectors cassed debt pertans to advances under
mandatory targets and concessona credt schemes. In
1998, the State Bank of Pakstan estmated that around
14.2 per cent of the oan portfoo of natonased
commerca banks were made up of nonperformng oans.
Table : !on"Performin# and $efaulted %oans &Rs'
billion(
!on"Performin#
%oans
$efaulted
%oans
)une **+ 207.9 146.1
)une *** 212.1 143.1
)une ,--- 239.5 148.1
)une ,-- 279.1 172.4
.ebruary ,--, 278.6 168.1
Source: Unpubshed data, cted n Pakstan Human
Condtons Report 2002
The probem of debt recovery s not smpy a
technca ssue. Not ony have potca pressures ahected
the quaty of the oan portfoo of banks, they have aso
been nstrumenta n preventng banks to proceed aganst
persstent defauters and have ressted attempts to
mprove the enforcement mechansm.
/easures of Performance
. A tota of 16 natonased, prvatsed, prvate, and
foregn banks were seected for the study. The standard
tests used to measure the performance of commerca
banks are apped. There are four ratos used n Rsk
anayss.
These are:
' Ca0ital Risk
Capta base of nanca nsttutons factates
depostors n formng ther rsk percepton about the

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The Lahore Journal of Economics, Vol.6, No.2
nsttuton. Aso, t s the key parameter for nanca
managers to mantan adequate eves of captasaton.
Besdes absorbng unantcpated shocks, t sgnas that the
nsttuton w contnue to honour ts obgatons. In order
to protect the nterest of depostors and sharehoders of
commerca banks, the State Bank of Pakstan ntroduced
the rsk-based system for capta adequacy n November
1998 and asked banks to mantan 8 percent Capta to
Rsk Weghted Assets (CRWA) rato. Ths s the benchmark
set by the BASLE (Bank Supervson Reguaton
Commttee) of Bank for Internatona Settements.
Addtonay, banks are requred to acheve a mnmum
pad-up capta of Rs. 1 bon vde BSD crcuar No. 31
dated December 6, 2000.
Capta Rsk s measured by the rato of Equty
Capta to Tota Assets. Ths rato for our sampe of 16
banks s shown n Tabe 2. A hgher percentage means that
the bank s safer because t can wthstand a sharper
decne n the vaue of ts assets. The tabe shows that ths
rato has mproved for most banks over the year 2000 to
2001. However, t s beow the target of 8 per cent for a
except Faysa bank, Prme Commerca bank, and Emrates
Bank. The rato has been ow for natonased commerca
banks and foregn banks. Ths suggests a hgh degree of
capta rsk or nadequate captasaton for the exstng
eve of endng. Ony four banks, Faysa Bank, Prme
Commerca bank, the Bank of Pun|ab, and Emrates Bank
had ths rato greater than 8 per cent. Ths ower rato can
be attrbuted to a fa n yed of government securtes,
and hence fa n returns on banks nvestment. Beng zero-
rsk weghted, dsnvestment of government securtes
nevtaby ed to a sght fa n the capta adequacy rato.
In addton, hgher provsonng aganst Non-Performng
Loans (NPL), whch ahects the capta base through
prot/oss accounts, has further contrbuted to the decne
of ths rato.
Ths had three mpcatons. Frst, endng rates
probaby dd not adequatey reect the prevang rsk
premums n the market and ahected the spreads between
7
Salman Ahmad
endng and borrowng rates. Second, oan recovery was
poor and the rate of defaut hgh wth a correspondng
wrte-oh of osses and ower earnngs. Thrd, voume
growth dd not adequatey compensate for the reduced
spreads over the ong run.

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The Lahore Journal of Economics, Vol.6, No.2
Table ,: Ca0ital Ade1uacy of Commercial Banks in
Pakistan
Ca0ital Risk & 0er cent(
,--- ,--

1. Habb Bank Lmted 3.81 3.84

2. Unted Bank Lmted 3.79 4.33
3. Musm commerca Bank Ltd. 3.20 3.68
4. Askar Commerca Bank Ltd. 5.06 5.05
5. Bank A-Faah Ltd. 4.0 3.27
6. Boan Bank Ltd. 1.5 1.6
7. Faysa Bank Ltd. 9.64 9.38
8. Patnum Commerca Bank Ltd. 5.65 1.14
9. Prme Commerca Bank Ltd. 9 10.3
10. Soner Bank Ltd. 6.21 7.57
11. The Bank of Pun|ab 10 11
12. Unon Bank Ltd. 3.65 3.78
13. ABN AMRO Bank NV 2.14 1.4
14. Ct Bank NA 1.37 0.24
15. Emrates Bank Internatona
Ltd.
9.6 10.2
16. Standard Chartered Grndays
Bank Ltd.
2 1
Source: Cacuated from nanca statements as on
31.12.2001.
,' Credit Risk
Asset quaty determnes the robustness of nanca
nsttutons aganst oss of vaue n the assets. The
deteroratng vaue of assets, beng the prme source of
bankng probems, drecty pour nto other areas, as osses
are eventuay wrtten -oh aganst capta, whch utmatey
|eopardses the earnng capacty of the nsttuton. Wth
ths backdrop, the asset quaty s gauged n reaton to the
eve and severty of non-performng assets, adequacy of
72
Salman Ahmad
provsons for bad oans, recoveres of oans, dstrbuton of
assets, etc. Athough the bankng system s nfected wth a
arge voume of Non-Performng Loans (NPLs), the severty
of ths probem has stabsed to some extent. Ths s not to
say that the probem of NPLs has taken a secondary
poston. Unfortunatey, t st remans the most domnant
factor ahectng the earnng capacty of banks. Popuar
ndcators ncude non-performng oans to advances, oan
defaut to tota advances, and recoveres to oan defaut
ratos. We have used tota oans to assets rato to |udge
credt rsk. It shows what percentage of assets are more
rsky because oans are the most rsky assets on whch
defaut occurs. For a ess rsky bank, ths rato shoud be
ow and must decne overtme. The resuts for the years
2000 and 2001 are gven n Tabe 3.The tabe shows that
a the banks had above average credt rsk, rangng from
30 to 60 per cent. Techncay, a hgh credt rsk shoud be
assocated wth hgher returns.
In the case of natonased commerca banks, ths
rato has decned for Habb Bank. It fe from 53.19 n
2000 to 50.10 n 2001. Ths shows that fresh oans are
beng extended much more prudenty than was the case
earer. In other words, the percentage of oans out of tota
assets gven to cents has faen. In the case of prvate
and prvatsed banks, ths rato has ncreased. The rato for
UBL ncreased from 39.95 to 47.77. For MCB, t ncreased
from 42.5 to 52.73. For Bank A-Faah, t ncreased from
49.13 to 55.27. Smary, for Prme Commerca Bank, ths
rato ncreased from 47.07 to 57.35. The same s the
stuaton for Emrates Bank and Standard Chartered Bank.
Ths rato was very hgh for Patnum Bank, ABN-Amro, and
Ct bank, athough t has decned over the year 2000 to
2001.Ths mprovement s much more pronounced gven
ther share n tota NPLs. It shows a marked mprovement
n recovery ehorts by the prvate banks. The rato s owest
for Bank of Pun|ab and Boan Bank ndcatng that the
banks are rsk averse.

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The Lahore Journal of Economics, Vol.6, No.2
Table 2: Asset 3uality of Commercial Banks in
Pakistan
Credit Risk & 0er cent(
,--- ,--
1. Habb Bank Lmted 53.19 50.10
2. Unted Bank Lmted 39.95 47.10
3. Musm commerca Bank Ltd. 42.5 52.73
4. Askar Commerca Bank Ltd. 46.53 45.69
5. Bank A-Faah Ltd. 49.13 55.27
6. Boan Bank Ltd. 33.91 35.55
7. Faysa Bank Ltd. 52.10 56.75
8. Patnum Commerca Bank
Ltd.
65.35 39.71
9. Prme Commerca Bank Ltd. 47.07 57.35
10. Soner Bank Ltd. 54.34 49.65
11. The Bank of Pun|ab 33.77 30.43
12. Unon Bank Ltd. 49.27 46.03
13. ABN AMRO Bank NV 61 57.37
14. Ct Bank NA 49.56 44.04
15. Emrates Bank Internatona
Ltd.
48.60 52.13
16. Standard Chartered Grndays
Bank Ltd.
49.04 53.14
Source: Cacuated from nanca statements as on
31.12.2001
2' %i1uidity Risk
An adequate qudty poston refers to a stuaton
where the nsttuton can obtan sumcent funds, ether by
ncreasng abtes or by convertng ts assets qucky at a
reasonabe cost. It s, therefore, generay assessed n terms
of overa assets and abty management, as msmatchng
of maturtes of assets and abtes gves rse to qudty
rsk. Emcent fund management refers to a stuaton where a
spread between rate senstve assets (RSA) and rate
senstve abtes ( RSL) s mantaned. The most commony
7#
Salman Ahmad
used too to evauate nterest rate exposure s the gap
between RSA and RSL, whe qudty s gauged by qud
assets to tota asset rato. We have used nvestment n
short-term securtes to deposts as a measure of qudty
rsk. A hgher rato shows that the bank has qud assets
avaabe to meet depost wthdrawas. However, there s a
tradeoh between qudty and protabty. A bank that
mantans hgher qudty s not nvestng ts funds n ong-
term and rsky pro|ects. Ths s shown n Tabe 4. Foregn
Banks have the owest qudty rsk. For Standard Chartered,
the qudty rato ncreased from 41.4 to 50.95, for Ctbank,
t ncreased from 12.9 to 19.75, for ABN AMRO, t ncreased
from 15 to 25. The rato decreased for prvate commerca
banks showng ncreased qudty rsk. For Bank Afaah the
rato fe from 32 to 28.6. For Boan Bank the rato fe fram
48 to 32. For Prme Commerca Bank the rato aso fe from
34 to 26.5. However t ncreased for Bank of Pun|ab from 19
to 33. For the bankng sector as a whoe, the rato s qute
ow due to the after ehects of freezng of Foregn Currency
Accounts as the banks had ess resources to nvest n qud
funds. An aternatve expanaton s decreasng yeds on
short-term securtes whch render nvestment n such
securtes unattractve. Generay, decnng rato woud
mpy that a smaer percentage of deposts are nvested n
qud assets, thus rasng the qudty rsk.
Table 4: %i1uidity of Commercial Banks in
Pakistan
%i1uidity Risk & 0er cent(
,--- ,--

1. Habb Bank Lmted 16 16

2. Unted Bank Lmted 9.47 8.54
3. Musm commerca Bank Ltd. 12 14
4. Askar Commerca Bank Ltd. 18.6 21.1
5. Bank A-Faah Ltd. 32 28.6
6. Boan Bank Ltd. 48 32
7. Faysa Bank Ltd. 13.66 13.4
5

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The Lahore Journal of Economics, Vol.6, No.2
8. Patnum Commerca Bank Ltd. 11 27
9. Prme Commerca Bank Ltd. 34 26.5
10. Soner Bank Ltd. 49.27 50.0
5
11. The Bank of Pun|ab 19 33
12. Unon Bank Ltd. 12.6 18.3
9
13. ABN AMRO Bank NV 15 28
14. CtBank NA 12.9 19.7
5
15. Emrates Bank Internatona
Ltd.
38.9 32.5
16. Standard Chartered Grndays
Bank Ltd.
41.4 50.9
5
Source: Cacuated from nanca statements as on
31.12.2001
4' Interest Rate Risk
The dversed nature of bank operatons makes them
vunerabe to varous knds of nanca rsks. Senstvty
anayss reects the nsttutons exposure to nterest rate
rsk, foregn exchange voatty and equty prce rsk. Rsk
senstvty s mosty evauated n terms of the
managements abty to montor and contro market rsk. For
nterest rsk we have used a rato of nterest senstve assets
to nterest senstve abtes. Ths s shown n Tabe 5. RSAs
has dverged from RSLs, n absoute terms. Hgher nterest
rate senstvty of spread s reected n ess than 100 vaue
of rato between RSA and RSL. For most of the banks, ths
rato decned between 2000 and 2001 ndcatng a rse n
nterest rate senstvty. Ony three banks had a rato of more
than 100. The hghest s 588 per cent for Askar Commerca
Bank durng 2001. Faysa Bank had 200 per cent durng
2000, the Bank of Pun|ab had 100 per cent durng 2001 and
Soner Bank had 111 per cent durng 2000.
Table 5: /arket Risk of Commercial Banks in
Pakistan
Interest Rate Risk & 0er cent(
76
Salman Ahmad
,--- ,--
1. Habb Bank Lmted 93 89
2. Unted Bank Lmted 94.7 85.4
3. Musm commerca Bank Ltd. 95 85
4. Askar Commerca Bank Ltd. 534.6 588
5. Bank A-Faah Ltd. 87.98 89.37
6. Boan Bank Ltd. 83 71
7. Faysa Bank Ltd. 200 114
8. Patnum Commerca Bank
Ltd.
81 72
9. Prme Commerca Bank Ltd. 82.9 89
10. Soner Bank Ltd. 111 107
11. The Bank of Pun|ab 95 100
12. Unon Bank Ltd. 34.49 28.49
13. ABN AMRO Bank NV 81 86
14. Ct Bank NA 82.21 88
15. Emrates Bank Internatona
Ltd.
68 67
16. Standard Chartered Grndays
Bank Ltd.
63 80
Source: Cacuated from nanca statements as on
31.12.2001
A dscusson of a the four rsk ratos for the 16
banks shows that the Bank of Pun|ab s performng we as
far as the rsk dmenson s concerned.

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The Lahore Journal of Economics, Vol.6, No.2
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