For developing countries it is necessary to have a sound banking system in the growth framework since banking system has tremendous influence on the growth in the early stages. Pakistan initiated its banking reforms in the 1990s and allowed many foreign banks to open their branches in the different cities. Foreign banks entry in the financial markets of Pakistan had a positive and healthy influence on the performance and profitability of the domestic banking sector. Some researchers have compared the performance of domestic and foreign banks from 1988-1995 in the context of developed and developing countries. In developing countries, not adequate research has been conducted but a lot has been written about the effect of financial reforms conducted in various capacities. Keywords: Profitability Efficiency, Domestic Banks, Foreign Banks, Economic Developmen

Khan, Hafiz Muhammad Ismail

English

International Institute for Science, Technology and Education (IISTE): E-Journals

Research Journal of Finance and Accounting                                                                                                                                    www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.6, No.5, 2015  8 The Profitability and Efficiency of Foreign and Domestic Banks: A Mode of Economic Development  Hafiz Muhammad Ismail Khan1      Irfanullah Khan2      Muhammad Saqib Khan3      Rahim Ullah Jan4 Rashad Khattak4      Kashif Naveed4 1.Deputy Director Finance, Khushal Khan Khattak University, Karak, Khyber Pakhtunkhwa, Pakistan 2.Department of Public Administration, Gomal University, Khyber Pakhtunkhwa, Pakistan 3.Department of Business Administration, Gomal University, Khyber Pakhtunkhwa, Pakistan 4.Khushal Khan Khattak University, Khyber Pakhtunkhwa, Pakistan  Abstract  For developing countries it is necessary to have a sound banking system in the growth framework since banking system has tremendous influence on the growth in the early stages. Pakistan initiated its banking reforms in the 1990s and allowed many foreign banks to open their branches in the different cities. Foreign banks entry in the financial markets of Pakistan had a positive and healthy influence on the performance and profitability of the domestic banking sector. Some researchers have compared the performance of domestic and foreign banks from 1988-1995 in the context of developed and developing countries. In developing countries, not adequate research has been conducted but a lot has been written about the effect of financial reforms conducted in various capacities. Keywords: Profitability Efficiency, Domestic Banks, Foreign Banks, Economic Development  1. INTRODUCTION  Banking sector is considered as one of the key sectors that plays a very crucial role in economic development and fiscal stability (Ryu, Piao & Nam, 2012). A country can’t show a sustainable growth and stability if it has an unhealthy banking sector. According to Karacaoglan (2011), foreign banks are playing major role in Turkey and other developing countries. While Demireli (2010) says that performance measurement is very necessary to assess the banking sector’s success in terms of international and national context. The development of financial services and restructuring of domestic financial sector are both interlinked processes meant for facilitating economic growth through efficient and aggressive financial system. Due to these factors, the foreign banks’ presence increased in south East Asia from about 1.6 % to 6 % during 1990s. In Latin America foreign bank control of domestic financial market rose from 7.5 per cent to 25 % during the same period. The share of foreign banks in domestic financial sector in Eastern Europe was dramatically increased from 8 percent to 52 percent in 1990s (IMF, 2000). A study was conducted to compare the financial performance of public, foreign and private banks working in Nepal from 2005-2011. This study found that effectiveness of foreign and domestic is better than the state owned banks (Jha & Hui, 2012). Foreign and domestic banks were found to have equal efficiencies according to the study. Similarly, a same study was conducted in Ghana to compare the domestic and foreign banks between the years 2005-2011. They compared the banks in terms of size, profitability, asset quality, liquidity and capital adequacy. Foreign banks showed to have better size, liquidity, asset quality and capital adequacy while domestic banks showed a higher return on equities and assets when these were compared with foreign banks (Mathew & Esther, 2012). Some researchers have studied the financial performance of banks working in the developing and developed countries. They studied the data from 1988-1995 and found that the performance of foreign banks to be higher than domestic one (Kunt & Huizinga, 1999). Similarly Chantapong (2003) compared the foreign and domestic banks in terms of financial performance in Thailand between the years 1995-2000. This study found domestic banks to be less profitable than the foreign banks.  2. THE BANKING SECTOR Banking sector of Pakistan saw many phases of reforms in accordance with the needs of time. The first phase of reforms started in the late 1980s. In this stage, a policy to liberalize the state owned banks took place. Some state owned banks like ABL (Allied Bank Limited) and MCB (Muslim Commercial Bank) were partially privatized. Another hallmark of this stage was the granting of full autonomy of full autonomy to State Bank of Pakistan, national regulatory bank of Pakistan. Previously it was working under the umbrella of Ministry of Finance. Later on, it was independent of all constraints. It is significant to note here that  during  this  tenure  of  liberalization  policy initiation,  all  these  steps  were  taken  by the government to solely focus on increasing the efficiency in the banking sector of Pakistan to ensure the competition base market system.  An environment ridden with competition always brings within it efficient methods of operations to maximize profits in Domestic hands. The state is less concerned with profit and more with power. It resulted into Research Journal of Finance and Accounting                                                                                                                                    www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.6, No.5, 2015  9 inefficiency of the financial sector as this section will be perused in the literature review. Its priorities are based on power- structure not on market-oriented stages of economic growth. In this regard, some of the considerable effort had been taken such as an increase in asset quality, improve the managerial structure, reducing control on credits and leading the market environment (Rehman & Roaf, 2010). Second stage of reformation of banking sector took place in 1990s; the main intention was to totally finalize the privatization and liberalization policy. In this phase:  Firstly, the capital structure of the banks was modified.  Secondly, partially privatized banks were fully privatized.  Thirdly, the ownership of the State Bank of Pakistan was decreased by 93% to 34% (SBP). Some beneficial outcomes were noticed in the second phase of reformation, which are as under:  At least ten private banks were given licenses to enter into the market in 1991.  The  residual  share  value  was  covered  by  25  foreign  banks  including  some of international banks.  Banks were given detailed instruction regarding the credit policy for specific sectors, expansion of the branches and also the given administration of interest rates.  At the end of 2010, the number of banks was 46, which includes 33 private banks and 13 as foreign bank (SBP). The net-effect of all of these reformative phases of the financial sector came in early 2000 and within the short span of 5 years in the banking industry in Pakistan was of worth 4 trillion rupees in 2005. The total share of the banking sector assets to GDP ratio increased from 47.2% to 55.6% during 2000 to 2005. These facts show the tectonic, but hopeful changes in Pakistan GDP with compare to later years of 1990.  All these achievements were due to the liberalization, privatization and transformation of banking sectors from public to private sector. Another interesting factor was the return on the banking asset which was uplifted up to 2.6% and return on equity was in 25.4%. According to the World Bank, Pakistani banking sector has been ranked second amongst the South Asian countries. The profitability and the capital structure were improved and it reached at exorbitant levels of 11.91%. Inefficient loan was reduced significantly to 2.1% which was almost close to international standards. The payback ratio of loan is now at 70% (Rehman & Roaf, 2010).  3. DISCUSSIONS  Nimalathasa (2008) compared the financial performances of foreign, domestic, state owned and private banks working in Bangladesh from 1999-2006. He found the foreign banks should have higher performance than domestic banks with respect to profitability, interest income and liquidity.” Researchers have concluded that banks profitability is function of many factors i.e. internal and external. Internal factors are bank specific and external factors are macro-economic and industry specific. Bank specific indicators are capital risk, profitability, asset quality, growth in bank assets and operational efficiency. Industry specific indicators are bank concentration index, ownership and bank size; while macroeconomic factors are interest rate, inflation, interest rate spread, growth in GDP and per-capita income (Millon and Tehania (1992), Mercia, et al. (2002), Toddard, et al. (2004), Guru et al.(2001) and Panayiotis et al.(2006).” Varadi et al. (2006) have examined the efficiency of banks and used four indicators productivity, probability, financial management and asset quality for private, public and foreign banks for period of 1999-2003. According to results, Public banks were more efficient while private banks were highly inefficient, but foreign banks were in a better position as compared to private banks in terms of efficiency. Guru and Staunton (2000) conducted research about the commercial banks in Malaysia to find out the determinants of profitability and concluded that managing the market interest rate and expenses of banks plays an important role to determine the profitability of commercial banks. They concluded that banks must increase the current account deposits on which no interest is payable in order to increase profits and reduce expenses. Moreover, banks must be vigilant and careful while advancing loans in order to reduce risk indicators.  4. CONCLUSION  The findings of this research are mixed. In some cases domestic banks outperformed the foreign banks while in other cases foreign banks performance was above the mark. However, the overall picture shows that foreign banks seems to perform better as compared to the domestic banks as a whole, due to their efficient risk management and high investment in technology. Although, domestic banks inherited a high ratio of assets and longevity than foreign banks, domestic banks face the highest loan loss provision ratio.”  Foreign banks have better ROE than domestic ones, which shows the better capability, efficiency and profitability of foreign banks. But on the other hand a good level of ROE may either reflect a good level of profitability or more limited equity capital. So we can’t say for sure that foreign banks are more efficient. Whereas domestic banks have higher return in ROA which shows that domestic banks have more efficient management in utilizing its asset base.”   Research Journal of Finance and Accounting                                                                                                                                    www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.6, No.5, 2015  10 5. SUGGESTIONS  This research has enabled the researcher to put forward some useful suggestions for future research: 1. This study used six performance indicators to evaluate and compare the profitability and efficiency of domestic and foreign banks. By taking some more indicators, a clear picture may emerge regarding the profitability of these banks. 2. This research may also be extended to other countries to study the profitability of foreign banks in other countries of the region. A research to study the performance of foreign banks in Pakistan compared to foreign banks in Muslim countries in particular and non-Muslim countries in general can be carried out. 3. Another research to compare the performance of Islamic banks with foreign banks in Pakistan may also be conducted. 4. For future studies, with the passage of time when there will more foreign banks to study and longer time period, a similar study would generate better insight on the issue of performance comparison.” 5. In this research, bank specific variables have been used to determine the efficiency of banks. Future researchers are advised to use macro-environment variables such as bank type, ownership, regulatory and geographical region. 6. In this research, 5 years period was used. Future research may include longer period to determine the more accurate measure of efficiency and reliability.  References  1. Demirgüç-Kunt, A., Laeven, L., & Levine, R. (2004). Regulations, Market Structure, Institutions, and the Cost of Financial Intermediation. Journal of Money, Credit, and Banking, 36(3), 593-622. 2. Demirguc-Kunt, A., Levine, R., & Min, H. (1998). Opening to Foreign Banks: Issues of Stability, Efficiency, and Growth. In Proceedings of the Bank of Korea Conference on the Implications of Globalization of World Financial Markets (December). 3. Denizer, C. A. (2000). Foreign Entry in Turkey’s Banking Sector: 1980-97. The World Bank WP No: 2462 (October). 4. Denizer, C.A. (2000). Foreign entry in Turkeys banking sector, 1980-97. World Bank Working Paper (2462), Washington D.C. 5. Doğan, M. (2013). Comparison of Financial Performances of Domestic and Foreign Banks: The Case of Turkey. International Journal of Business and Social Science, 4(1), 233-240. 6. Flamini V., McDonald, C., & Schumacher, L. (2009). The Determinants of Commercial Bank Profitability in Sub-Saharan Africa. IMF Working Paper, 09/15. 7. FSA (2009). Financial statements analysis of financial sectors 2006-2010. State Bank of Pakistan.  8. Goldberg, L., Dages, B. G., & Kinney, D. (2000). Foreign and Domestic Bank Participation in Emerging Markets: Lessons from Mexico and Argentina,” NBER Working Paper No. 7714 (May). 9. Goldsmith, R. W. (1969) Financial Structure and Development. New Haven, CT: Yale University Press. 10. Golin, J. (2001). The Bank Credit Analysis handbook: A Guide for Analysts, Bankers and Investors. (John Wiley & Sons (Asia) Pre Ltd). 11. Guru, B. K., Staunton, J. et al. (2000). Determinants of commercial bank profitability in Malaysia. Asian Academy of Management Journal 5(2): 1-22. 12. Guru, B., Staunton, J., & Balalashanmugam. (2002). Determinants of Commercial Bank Profitability in Malaysia. University of Multimedia Working Papers.  13. Guru, B.K., Staunton, J., & Balashanmugam, B. (1999). Determinants of Commercial Bank Profitability in Malaysia, Paper presented at the 12th Annual Australian Finance and Banking Conference, Sydney, Australia, 16-17 December. 14. Hasan, I. & Marton, K. (2000). Development and Efficiency of the Banking Sector in a Transitional Economy: Hungarian Experience. Bank of Finland Institute for Economies in Transition BOFIT Discussion Papers No.7. 15. Havrylchyk, O. & Jurzyk, E. (2011). Inherited or earned? Performance of foreign banks in Central and Eastern Europe. Journal of Banking & Finance, 35, 1291-1302. 16. Havrylchyk, O. (2006). Efficiency of the Polish banking industry: Foreign versus domestic banks. Journal of Banking and Finance, 30, 1975-96. 17. Hellmann, T., Murdock, K., & Stiglitz, J. (2000). Liberalization, Moral Hazard in Banking and Prudential Regulation: Are Capital Requirements Enough? American Economic Review, 90 (1), 147-165. 18. Ho, T. S., & Saunders, A. (1981). The Determinants of Bank Interest Margins: Theory and Empirical Evidence. Journal of Financial and Quantitative Analysis, 16, 581–600. 19. Iimi, A. (2004). Banking sector reforms in Pakistan: economies of scale and scope, and cost complementarities: Japan Bank for International Cooperation (JBIC) Institute, 4-1 Ohtemachi 1 Chome, Chiyoda-ku, Tokyo 100-8144, Japan. Research Journal of Finance and Accounting                                                                                                                                    www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.6, No.5, 2015  11 20. Imad, Z., Ramadan, Qais, A., Thair, A., Kaddumi (2011). Determinants of Bank Profitability: Evidence from Jordan. International Journal of Academic Research, 3(4). 21. IMF. (2000). International Capital Markets: Developments, Prospects, and Key Policy Issues. Washington, D.C. 22. Indranarain, R. (2009). Bank-Specific, Industry-Specific and Macroeconomic Determinants of Profitability in Taiwanese Banking System: Under Panel Data Estimation. International Research Journal of Finance and Economics, Issue 34. © EuroJournals Publishing, Inc. 2009. 23. Jha, S. & Hui, X. (2012). A comparison of financial performance of commercial banks: A case study of Nepal. African Journal of Business Management, 6(25), 7601-7611. 24. Kasekende, L. A., & Sebudde, R. K. (2002). The Impact of Foreign Ownership and Financial Growth in Uganda's Financial Sector. Bank of Uganda mimeo. 25. King, R. G., and Levine, R. (1993). Finance entrepreneurship, and growth: theory and evidence, Journal of Monetary Economics 32:3, 513 – 542. doi:10.1016/0304-3932(93)90028-E, http://dx.doi.org/10.1016/0304-3932(93)90028-E 26. Lensink, R., & Hermes, N. (2004). The short-term effects of foreign bank entry on domestic bank behaviour: Does economic development matter? Journal of Banking and Finance 28, 553-568. The IISTE is a pioneer in the Open-Access hosting service and academic event management.  The aim of the firm is Accelerating Global Knowledge Sharing.  More information about the firm can be found on the homepage:  http://www.iiste.org  CALL FOR JOURNAL PAPERS There are more than 30 peer-reviewed academic journals hosted under the hosting platform.   Prospective authors of journals can find the submission instruction on the following page: http://www.iiste.org/journals/  All the journals articles are available online to the readers all over the world without financial, legal, or technical barriers other than those inseparable from gaining access to the internet itself.  Paper version of the journals is also available upon request of readers and authors.   MORE RESOURCES Book publication information: http://www.iiste.org/book/ Academic conference: http://www.iiste.org/conference/upcoming-conferences-call-for-paper/   IISTE Knowledge Sharing Partners EBSCO, Index Copernicus, Ulrich's Periodicals Directory, JournalTOCS, PKP Open Archives Harvester, Bielefeld Academic Search Engine, Elektronische Zeitschriftenbibliothek EZB, Open J-Gate, OCLC WorldCat, Universe Digtial Library , NewJour, Google Scholar   

The Profitability and Efficiency of Foreign and Domestic Banks: A Mode of Economic Development

https://www.iiste.org/Journals/index.php/RJFA/article/download/20766/21357

The Profitability and Efficiency of Foreign and Domestic Banks: A Mode of Economic Development

Abstract

Similar works

Full text

Available Versions

International Institute for Science, Technology and Education (IISTE): E-Journals