Impact of Privatization of Banks on Profitability

Impactof Privatization of Banks on Profitability

Impactof Privatization on Profitability of Banks

Inthe recent past, more than a hundred nations have undergone economicreforms, and one of the changes taking place is the privatization ofbanks that were previously state-owned. By definition, privatizationin this context refers to the transfer of ownership from thegovernment to the private entities. The transfer can be regardingshares, asset sale or voucher privatization. Apparently, the move toprivatize banks has led to non-liability financing in the privatesector and on top of that, it has pushed for the growth of foreigncapital. It has also contributed to technology as well as theapplication of flight capital. Various countries regardless of theireconomic class have embraced one form or another of the existingprivatization strategies. This is simply because the outcomesindicate that private firms operate better than the government ownedinstitutions. Simply put, the privatization process is highlyassociated with output, efficiency, and increase revenue. Theprinciple of privatization arose from the need for the government tostrictly focus on regulation while operations are controlled by theprivate sector. The past few years have seen significantprivatization programs ensue with most explaining that it leads tohigher productivity and ultimately profitability. This is a statementthat is widely agreed upon. However, this does not mean that thestrategy is flawless. Large-sized privatization programs can haveadverse consequences if they are not monitored correctly. Countrieslike Pakistan are good examples of the effects of bank privatization.Based on the belief that private entities are more competent than thepublic ones, the desired fiscal outcomes of privatization play asignificant role in the clearance of losses in the public sector. Forprivatization to take place successfully, there must be aderegulation of the economy as well as the removal of unnecessaryrestrictions and regulations (Rizwan et al., 2015). As suchprivatization of banks significantly increases profitabilityespecially with the availability of assets and improved regulations.

Impactof Privatization on Profitability

Generallyspeaking, bank privatization has the capability of improving thestandards of service delivery, increase performance, introducehealthy competition, assures quick decision-making, develops thecapital market and most of all, it leads to increased deposits andloan security. All these elements translate to higher revenues. Threeaspects can be put together as they are the core factors affectingprofitability once privatization programs are rolled out. Theyinclude competition, political factors, and corporate governance.

Competition

Privatizationhas a tendency of improving the general operation of banks includinghow resources are allocated based on priorities. Such practices leadto better services, faster and smooth operations as well as increasedcustomer satisfaction (Nguyen et al., 2015).

PoliticalIntervention

Moreoften than not, politicians and bureaucrats cause unnecessary chaosfor their selfish gains. As such, some regulations anddecision-making processes can be significantly hindered by suchindividuals leading to reduced quality of services (Nguyen et al.,2015). For this reason, privatization improves efficiency since suchpoliticians and bureaucrats cannot interfere with the entity.

CorporateGovernance

Expertshave argued that governance is quite weak and ineffective instate-owned enterprises as compared to private ones. These issuesusually arise because of bureaucracy, agency issues as well as thelack of incentives for managers. However, private sectororganizations offer some if not all of the mentioned elements makingthem better (Nguyen et al., 2015).

Examplesof the Effects of Privatization

Pakistanis one of the countries that has seen the impact of privatization.Previously, employees were obtained based on a political platformrather than by merit. As more and more openings took place, overemployment ensued. In a short while, there was a limited number oftrained personnel, and customer loyalty was not present. As such,trade deficits, debt burdens and non-performing loans made thesituation even worse. However, things changed the tide in the year1988, and two SOE banks became privatized. The Muslim commercial bankand the Allied Bank limited were the first to undergo this process.Afterward, the permission to create other new banks as privateentities became widespread. The reforms caused significant shifts inasset system and the deposit base. This occurrence is a clearindication that privatization has significant impacts in improvingthe profitability of banks. This is mainly through the assurance ofasset quality, capital availability, profit earning and most of all,liquidity (Mubeen et al., 2014).

Althoughthe change was not instantaneous, the widening of these banks led toimprovements in the asset quality from 77.5 to 84.3. Also, the gapbetween assets and liabilities (as a measure of susceptibility tointerest rate risk) became negative over the past years for theprivatized banks. Likewise, the loans advanced by the banks showed asignificant rise in relation to their respective deposits whicheventually reached a maximum of 6.8% in the year 2000. The MCB bankalso saw an increase in the total assets of 10% between 1994 and2003. Likewise, the non-performing loans reduced from 18% to 11% inthe same period. This is a considerable improvement, especially forcredit recovery aspects. Another bank known as the united banklimited was also privatized. Similar to the first two initial banks,the deposit base increased by 16% in the year 2002 while the totalassets increased by 22% in 2006 as compared to the previous year.Habib banks privatized in 2003 saw a 12% increase in total depositsby the end of 2004 while total assets also increased. Additionally,the net revenue grew by 10%, and the non-performing loans went downby 56% (Kamaly et al., 2015).

Theseare just but a few examples of banks that became more profitable onceprivatization was done successfully. The studies done in the region,as well as other countries, seem to corroborate with the fact thatindeed. Privatization of banks has a positive impact onprofitability. This does not mean that privatization is flawless. Insome cases, challenges that may be faced include the misuse of loans,reduced competition, neglecting of small firms and also ignoringother sectors such as agriculture. Other papers have also indicatedthat privatization of banks may lead to the lack of cooperation, theaccumulation of wealth by individuals, protection of black money,provision of loans to relatives and employees, favoritism and alsoprofit-driven motives.

Conclusion

Privatizationof banks is a process that has raised considerable debate as towhether it serves its intended purposes or not. The study conductedin Pakistan provides sufficient proof that indeed, privatization canwork for the good of the banks, the customers and ultimately, thegovernment. The main reason for poor performance in state-ownedinstitutions is the presence of political issues and unnecessarybureaucracy. The findings of various studies show that there areconsiderable variations in profitability in banks before and afterthey became privatized. For this reason, it can be summarized thatafter privatizations, banks are likely to experience greaterprofitability than when operated by the government.

References

Kamaly, A., El-Ezaby, S., &amp El-Hinawy, M. (2015). Does Privatization Enhance the Performance of Banks? Evidence from Egypt. Journals of Applied Social Science Association, 1-25.

Mubeen Mujahid, Faiq Kamal Haider Hashmi, &amp Muhammad Daniyal Abbas (2014). of Banking Sector in Pakistan. Journal of Economics and Sustainable Development, 101-111.

Nguyen Hong Son, Tran Thi Thanh Tu, Dinh Xuan Cuong, Lai Anh Ngoc, &amp Pham Bao Khanh (2015). Impact of Ownership Structure and Bank Performance – An Empirical Test in Vietnamese Banks. International Journal of Financial Research, 123-133.

Rizwan, M., Pasha, S., Humera, A., &amp Siddiqui, K. (2015). Impact of Privatization in Banking Sector: A Case Study of MCB and ABL. Journal of Business and Management, 95-100.