Salman Ahmad

Performance of Commerci al Banks in

Pakistan:
A Study in Risk Analysi s
Salman Ahmad
*
Introducti on
The financial sector in Pakistan has evolved over the
years in response to the growth of the economy and the
governments plans for the growth and development of
the country. The sector as on 31 March 2002 comprises
the tate !ank of Pakistan" # state$owned %anks" 2 newly
privatised %anks" # specialised %anks" 1# private
scheduled %anks" a%out 30 leasing companies" #&
Modara%as" 1# investment %anks" 3 stock e'changes" &(
insurance companies" and )overnment aving *enters.
*ommercial %anks were nationalised in 1+,# and are
now in the process of %eing privatised. Two nationalised
commercial %anks have %een privatised since 1++0-
Muslim *ommercial !ank was sold %y auction. negotiation"
while /llied !ank was sold to its employees .The market
share of the nationalised commercial %anks has %een
declining with the introduction of new private %anks.
The three nationalised commercial %anks in Pakistan
01a%i% !ank 2imited" 3nited !ank 2imited" and 4ational
!ank of Pakistan0have a large %ranch network that allows
them to e'pand and compete with the private %anks in
deposit mo%ilisation. The newly privatised %anks have
ac5uired the %ranch network that will allow them to
e'pand and compete with the state$owned %anks. 6hile
these institutions play an important role in financing short$
term credit re5uirements" their success in raising deposits
ensures that they have a significant surplus of funds that
can %e lent or invested in government securities.
*
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 1+ foreign %anks which have %een
esta%lished from time to time. The foreign %anks in Pakistan
are %ranch operations7 they are not separate legal entities.
Much of their success can %e attri%uted to their superior
management skills and %etter access to international
financial markets. / large fraction of foreign currency
deposits are with foreign %anks" partly %ecause of their
marketing efforts and partly %ecause of their credi%ility as
international %anks. 8oreign %anks are only allowed four
%ranches within the country.
9n recent years" as e'ternal credit flows to
developing countries have declined" the need for an
efficient and via%le financial sector has grown. /n efficient
financial system collects domestic savings and allocates
the collective resources to the %est possi%le investment
opportunities" allowing for %etter domestic resource
mo%ilisation and utilsation" and reducing the reliance on
e'ternal financing.
Throughout the 1+(0s" Pakistan was a%le to achieve
strong growth with low inflation. The %anking sector
operated inefficiently %ecause of nationalisation.
1
8inancial
intermediation was geared towards the financing needs of
the government and those of the targeted sectors of the
economy to which credit was officially directed. /lthough
Pakistans economy opened up internationally in 1++0" the
government had a tight hold on entry to financial markets.
The situation changed during the +0s with the entry of
private %anks in the country and su%se5uent competition.
8inancial reforms were initiated with a strong commitment
to market$oriented development of the financial sector.
These reforms are still underway and will need to %e
strengthened su%stantially if modern" competitive financial
markets are to %e developed.
8oreign %anks have shown the highest growth rate in
terms of deposits in the last three years. tate$owned
%anks averaged an annual growth of 12., per cent over the
1
Khan Bashir Ahmad, Financial Markets and Economic e!elo"ment in Pakistan#
1$%&'1$$(, ".))%
66
Salman Ahmad
three$year period 1++($2001" while the recently privatised
nationalised commercial %anks averaged 1(.2 per cent and
foreign %anks" 31.# per cent. 8oreign %anks are also more
efficient in terms of controlling administrative costs per
%ranch. 8or e'ample" growth of administrative costs
averaged 1+., per cent for state$owned %anks" 1(.3 per
cent for the recently privatised %anks" and 1,.: per cent for
foreign %anks. /s a percentage of assets" administrative
costs are the lowest for foreign %anks.
The gross revenues of foreign %anks have grown at a
much faster pace than the rate of growth of their costs.
8or Pakistani %anks" the difference in the growth rates is
e'tremely narrow" if not negative. !ank deposits have
grown significantly in recent years primarily %ecause of
the rapid growth of money supply" which increased %y
around 1( per cent and 20.: per cent during 1+++$2000.
Money has also flowed into the %anking system from the
informal economy with the change in incentives following
the recent slide of the stock market and the significant
slump in the real estate market. ;emand deposits
constitute a%out #,$&0 per cent of total %ank deposits
which is much higher than other countries. This also
e'plains why the cost of funds have %een low for
commercial %anks.
Profitability and Producti vi ty of Commerci al Banks
The profit earned %y the commercial %anks is the
difference %etween the deposit rate and the lending rate"
called the spread. 9n nominal terms" the spread has risen
steadily from & per cent in 1+(:$(, to :.2 per cent in
1++2$+3" %ut then fell to 2.( per cent in 1++, and
increased to 3.3 per cent in 2000. 9n real terms" the
weighted average yield on deposits fell from 3.+ per cent
in 1+(:$(, to <#.: per cent in 1++0$+1" and <1.1 per cent
in 1++2$+3.The weighted average yield on loans also
declined7 after declining from (.+ per cent in 1+(:$(, to

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The Lahore Journal of Economics, Vol.6, No.2
1.1 per cent in 1++0$+1.Thereafter" it clim%ed rapidly to
&.1# per cent %y 1++2$+3.
2
8oreign %anks seem to %e the main %eneficiaries of
the relatively large spreads" especially as the nationalised
%anks have to deal with pro%lems of large overheads"
increasing inefficiencies and nonperforming loans.
The three$year =1++($2001> averages of the
profita%ility indicators for nationalised commercial %anks
and private commercial %anks are illuminating. 9n the case
of nationalised commercial %anks" total administrative
costs were 2 per cent of total assets compared with 0.(&
per cent in the case of foreign %anks" 0.: per cent in the
case of private %anks. Pre$ta' profits as a percentage of
deposits are 0.: per cent for nationalised commercial
%anks" & per cent for foreign" and 2.& per cent for new
private %anks.
?ver the years" the capital %ase of nationalised
commercial %anks has %een severely affected %y the poor
5uality of %ank loans made on political and uneconomic
grounds. /s a result" the single most formida%le pro%lem
facing the %anks is the heavy %urden of nonperforming
loans. Pakistan introduced Prudential @egulations in 1++3
to ensure that credit is not misused and the infected
portfolio was minimum. 1owever" the infected portfolio
has increased to significant proportions = see Ta%le 1
%elow>. ?n Aune 30" 2001" the 4on$Performing 2oans
=4P2s> amounted to @s. 2,+ %illion" i.e." (.2 per cent of
);P" 1(.: per cent of domestic assets" and 32.& per cent
of total credit made availa%le to the private sector and
pu%lic enterprises. 4on$Performing 2oans of the
*ommercial !anking sector were @s. 221 %illion"i.e" :.& per
cent of );P and 22.1 per cent of total deposits. ?ut of
4P2s" the defaulted loans of the financial institutions and
the commercial %anking sector were @s. 1,2 %illion and @s.
1#1 %illion respectively. !ecause of such a large infected
portfolio" the spread %etween lending and deposit rate has
)
*l +a,ue, -adeem, and Shahid Kardar, 1$$( . e!elo"ment of the Financial Sector in
Pakistan., ". %%/.
68
Salman Ahmad
remained high. Though rescheduling of loans is common"
the total advances of nationalised commercial %anks
categorised as %ad and dou%tful de%ts are @s. &: %illion of
which @s.#: %illion are classified as advances related to
the private sector. Aust under 23 per cent of the private
sectors classified de%t pertains to advances under
mandatory targets and concessional credit schemes. 9n
1++(" the tate !ank of Pakistan estimated that around
1#.2 per cent of the loan portfolio of nationalised
commercial %anks were made up of nonperforming loans.
Tabl e 1: on! Performi n" and #efaul ted $oans %Rs&
billion'
on! Performi n"
$oans
#efaul ted
$oans
(une 1))* 20,.+ 1#:.1
(une 1))) 212.1 1#3.1
(une +,,, 23+.& 1#(.1
(une +,,1 2,+.1 1,2.#
-ebruary +,,+ 2,(.: 1:(.1
Source: 3npu%lished data" cited in Pakistan 1uman
*onditions @eport 2002
The pro%lem of de%t recovery is not simply a
technical issue. 4ot only have political pressures affected
the 5uality of the loan portfolio of %anks" they have also
%een instrumental in preventing %anks to proceed against
persistent defaulters and have resisted attempts to
improve the enforcement mechanism.
.easures of Performance
. / total of 1: nationalised" privatised" private" and
foreign %anks were selected for the study. The standard
tests used to measure the performance of commercial
%anks are applied. There are four ratios used in @isk
analysis.

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The Lahore Journal of Economics, Vol.6, No.2
These are-
1& Ca/ital Risk
*apital %ase of financial institutions facilitates
depositors in forming their risk perception a%out the
institution. /lso" it is the key parameter for financial
managers to maintain ade5uate levels of capitalisation.
!esides a%sor%ing unanticipated shocks" it signals that the
institution will continue to honour its o%ligations. 9n order
to protect the interest of depositors and shareholders of
commercial %anks" the tate !ank of Pakistan introduced
the risk$%ased system for capital ade5uacy in 4ovem%er
1++( and asked %anks to maintain ( percent *apital to
@isk 6eighted /ssets =*@6/> ratio. This is the %enchmark
set %y the !/2B =!ank upervision @egulation
*ommittee> of !ank for 9nternational ettlements.
/dditionally" %anks are re5uired to achieve a minimum
paid$up capital of @s. 1 %illion vide !; circular 4o. 31
dated ;ecem%er :" 2000.
*apital @isk is measured %y the ratio of B5uity
*apital to Total /ssets. This ratio for our sample of 1:
%anks is shown in Ta%le 2. / higher percentage means
that the %ank is safer %ecause it can withstand a sharper
decline in the value of its assets. The ta%le shows that this
ratio has improved for most %anks over the year 2000 to
2001. 1owever" it is %elow the target of ( per cent for all
e'cept 8aysal %ank" Prime *ommercial %ank" and Bmirates
!ank. The ratio has %een low for nationalised commercial
%anks and foreign %anks. This suggests a high degree of
capital risk or inade5uate capitalisation for the e'isting
level of lending. ?nly four %anks" 8aysal !ank" Prime
*ommercial %ank" the !ank of PunCa%" and Bmirates !ank
had this ratio greater than ( per cent. This lower ratio can
%e attri%uted to a fall in yield of government securities"
and hence fall in returns on %anks investment. !eing Dero$
risk weighted" disinvestment of government securities
inevita%ly led to a slight fall in the capital ade5uacy ratio.
9n addition" higher provisioning against 4on$Performing
2oans =4P2>" which affects the capital %ase through
7
Salman Ahmad
profit.loss accounts" has further contri%uted to the decline
of this ratio.
This had three implications. 8irst" lending rates
pro%a%ly did not ade5uately reflect the prevailing risk
premiums in the market and affected the spreads %etween
lending and %orrowing rates. econd" loan recovery was
poor and the rate of default high with a corresponding
write$off of losses and lower earnings. Third" volume
growth did not ade5uately compensate for the reduced
spreads over the long run.

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The Lahore Journal of Economics, Vol.6, No.2
Tabl e +: Ca/ital Ade0uacy of Commerci al Banks in
Pakistan
Ca/ital Risk % /er cent'
+,,, +,,
1
1. 1a%i% !ank 2imited 3.(1 3.(#
2. 3nited !ank 2imited 3.,+ #.33
3. Muslim commercial !ank 2td. 3.20 3.:(
#. /skari *ommercial !ank 2td. &.0: &.0&
&. !ank /l$8alah 2td. #.0 3.2,
:. !olan !ank 2td. 1.& 1.:
,. 8aysal !ank 2td. +.:# +.3(
(. Platinum *ommercial !ank 2td. &.:& 1.1#
+. Prime *ommercial !ank 2td. + 10.3
10. oneri !ank 2td. :.21 ,.&,
11. The !ank of PunCa% 10 11
12. 3nion !ank 2td. 3.:& 3.,(
13. /!4 /M@? !ank 4E 2.1# 1.#
1#. *iti !ank 4/ 1.3, 0.2#
1&. Bmirates !ank 9nternational
2td.
+.: 10.2
1:. tandard *hartered )rindlays
!ank 2td.
2 1
Source: *alculated from financial statements as on
31.12.2001.
+& Credit Risk
/sset 5uality determines the ro%ustness of financial
institutions against loss of value in the assets. The
deteriorating value of assets" %eing the prime source of
%anking pro%lems" directly pour into other areas" as losses
are eventually written <off against capital" which
ultimately Ceopardises the earning capacity of the
institution. 6ith this %ackdrop" the asset 5uality is gauged
in relation to the level and severity of non$performing
72
Salman Ahmad
assets" ade5uacy of provisions for %ad loans" recoveries of
loans" distri%ution of assets" etc. /lthough the %anking
system is infected with a large volume of 4on$Performing
2oans =4P2s>" the severity of this pro%lem has sta%ilised to
some e'tent. This is not to say that the pro%lem of 4P2s
has taken a secondary position. 3nfortunately" it still
remains the most dominant factor affecting the earning
capacity of %anks. Popular indicators include non$
performing loans to advances" loan default to total
advances" and recoveries to loan default ratios. 6e have
used total loans to assets ratio to Cudge credit risk. 9t
shows what percentage of assets are more risky %ecause
loans are the most risky assets on which default occurs.
8or a less risky %ank" this ratio should %e low and must
decline overtime. The results for the years 2000 and 2001
are given in Ta%le 3.The ta%le shows that all the %anks had
a%ove average credit risk" ranging from 30 to :0 per cent.
Technically" a high credit risk should %e associated with
higher returns.
9n the case of nationalised commercial %anks" this
ratio has declined for 1a%i% !ank. 9t fell from &3.1+ in
2000 to &0.10 in 2001. This shows that fresh loans are
%eing e'tended much more prudently than was the case
earlier. 9n other words" the percentage of loans out of total
assets given to clients has fallen. 9n the case of private
and privatised %anks" this ratio has increased. The ratio for
3!2 increased from 3+.+& to #,.,,. 8or M*!" it increased
from #2.& to &2.,3. 8or !ank /l$8alah" it increased from
#+.13 to &&.2,. imilarly" for Prime *ommercial !ank" this
ratio increased from #,.0, to &,.3&. The same is the
situation for Bmirates !ank and tandard *hartered !ank.
This ratio was very high for Platinum !ank" /!4$/mro" and
*iti %ank" although it has declined over the year 2000 to
2001.This improvement is much more pronounced given
their share in total 4P2s. 9t shows a marked improvement
in recovery efforts %y the private %anks. The ratio is lowest
for !ank of PunCa% and !olan !ank indicating that the
%anks are risk averse.

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The Lahore Journal of Economics, Vol.6, No.2
Table 1: Asset 2uality of Commerci al Banks in
Pakistan
Credi t Risk % /er cent'
+,,, +,,1
1. 1a%i% !ank 2imited &3.1+ &0.10
2. 3nited !ank 2imited 3+.+& #,.10
3. Muslim commercial !ank 2td. #2.& &2.,3
#. /skari *ommercial !ank 2td. #:.&3 #&.:+
&. !ank /l$8alah 2td. #+.13 &&.2,
:. !olan !ank 2td. 33.+1 3&.&&
,. 8aysal !ank 2td. &2.10 &:.,&
(. Platinum *ommercial !ank
2td.
:&.3& 3+.,1
+. Prime *ommercial !ank 2td. #,.0, &,.3&
10. oneri !ank 2td. &#.3# #+.:&
11. The !ank of PunCa% 33.,, 30.#3
12. 3nion !ank 2td. #+.2, #:.03
13. /!4 /M@? !ank 4E :1 &,.3,
1#. *iti !ank 4/ #+.&: ##.0#
1&. Bmirates !ank 9nternational
2td.
#(.:0 &2.13
1:. tandard *hartered )rindlays
!ank 2td.
#+.0# &3.1#
Source: *alculated from financial statements as on
31.12.2001
1& $i0uidity Risk
/n ade5uate li5uidity position refers to a situation
where the institution can o%tain sufficient funds" either %y
increasing lia%ilities or %y converting its assets 5uickly at a
reasona%le cost. 9t is" therefore" generally assessed in terms
of overall assets and lia%ility management" as mismatching
of maturities of assets and lia%ilities gives rise to li5uidity
risk. Bfficient fund management refers to a situation where a
spread %etween rate sensitive assets =@/> and rate
sensitive lia%ilities = @2> is maintained. The most commonly
7#
Salman Ahmad
used tool to evaluate interest rate e'posure is the gap
%etween @/ and @2" while li5uidity is gauged %y li5uid
assets to total asset ratio. 6e have used investment in
short$term securities to deposits as a measure of li5uidity
risk. / higher ratio shows that the %ank has li5uid assets
availa%le to meet deposit withdrawals. 1owever" there is a
tradeoff %etween li5uidity and profita%ility. / %ank that
maintains higher li5uidity is not investing its funds in long$
term and risky proCects. This is shown in Ta%le #. 8oreign
!anks have the lowest li5uidity risk. 8or tandard *hartered"
the li5uidity ratio increased from #1.# to &0.+&" for *iti%ank"
it increased from 12.+ to 1+.,&" for /!4 /M@?" it increased
from 1& to 2&. The ratio decreased for private commercial
%anks showing increased li5uidity risk. 8or !ank /lfalah the
ratio fell from 32 to 2(.:. 8or !olan !ank the ratio fell fram
#( to 32. 8or Prime *ommercial !ank the ratio also fell from
3# to 2:.&. 1owever it increased for !ank of PunCa% from 1+
to 33. 8or the %anking sector as a whole" the ratio is 5uite
low due to the after effects of freeDing of 8oreign *urrency
/ccounts as the %anks had less resources to invest in li5uid
funds. /n alternative e'planation is decreasing yields on
short$term securities which render investment in such
securities unattractive. )enerally" declining ratio would
imply that a smaller percentage of deposits are invested in
li5uid assets" thus raising the li5uidity risk.
Tabl e 3: $i0uidity of Commerci al Banks in
Pakistan
$i0uidity Risk % /er cent'
+,,, +,,
1
1. 1a%i% !ank 2imited 1: 1:
2. 3nited !ank 2imited +.#, (.&#
3. Muslim commercial !ank 2td. 12 1#
#. /skari *ommercial !ank 2td. 1(.: 21.1
&. !ank /l$8alah 2td. 32 2(.:
:. !olan !ank 2td. #( 32
,. 8aysal !ank 2td. 13.:: 13.#
&

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The Lahore Journal of Economics, Vol.6, No.2
(. Platinum *ommercial !ank 2td. 11 2,
+. Prime *ommercial !ank 2td. 3# 2:.&
10. oneri !ank 2td. #+.2, &0.0
&
11. The !ank of PunCa% 1+ 33
12. 3nion !ank 2td. 12.: 1(.3
+
13. /!4 /M@? !ank 4E 1& 2(
1#. *iti!ank 4/ 12.+ 1+.,
&
1&. Bmirates !ank 9nternational
2td.
3(.+ 32.&
1:. tandard *hartered )rindlays
!ank 2td.
#1.# &0.+
&
Source: *alculated from financial statements as on
31.12.2001
3& Interest Rate Risk
The diversified nature of %ank operations makes them
vulnera%le to various kinds of financial risks. ensitivity
analysis reflects the institutions e'posure to interest rate
risk" foreign e'change volatility and e5uity price risk. @isk
sensitivity is mostly evaluated in terms of the
managements a%ility to monitor and control market risk.
8or interest risk we have used a ratio of interest sensitive
assets to interest sensitive lia%ilities. This is shown in Ta%le
&. @/s has diverged from @2s" in a%solute terms. 1igher
interest rate sensitivity of spread is reflected in less than
100 value of ratio %etween @/ and @2. 8or most of the
%anks" this ratio declined %etween 2000 and 2001 indicating
a rise in interest rate sensitivity. ?nly three %anks had a
ratio of more than 100. The highest is &(( per cent for
/skari *ommercial !ank during 2001. 8aysal !ank had 200
per cent during 2000" the !ank of PunCa% had 100 per cent
during 2001 and oneri !ank had 111 per cent during 2000.
Table 4: .arket Risk of Commerci al Banks in
Pakistan
Interest Rate Risk % /er cent'
76
Salman Ahmad
+,,, +,,1
1. 1a%i% !ank 2imited +3 (+
2. 3nited !ank 2imited +#., (&.#
3. Muslim commercial !ank 2td. +& (&
#. /skari *ommercial !ank 2td. &3#.: &((
&. !ank /l$8alah 2td. (,.+( (+.3,
:. !olan !ank 2td. (3 ,1
,. 8aysal !ank 2td. 200 11#
(. Platinum *ommercial !ank
2td.
(1 ,2
+. Prime *ommercial !ank 2td. (2.+ (+
10. oneri !ank 2td. 111 10,
11. The !ank of PunCa% +& 100
12. 3nion !ank 2td. 3#.#+ 2(.#+
13. /!4 /M@? !ank 4E (1 (:
1#. *iti !ank 4/ (2.21 ((
1&. Bmirates !ank 9nternational
2td.
:( :,
1:. tandard *hartered )rindlays
!ank 2td.
:3 (0
Source: *alculated from financial statements as on
31.12.2001
/ discussion of all the four risk ratios for the 1:
%anks shows that the !ank of PunCa% is performing well as
far as the risk dimension is concerned.

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