Causes of the Development of Pakistans Banking Sector

Causes of the Development of Pakistans deposeing SectorABSTRACTThe objective of this paper is to examine the determinants of study of banking firmament from the perspective of literal GDP, Discount score, wiliness nudity and Financial Liberalization by using annual data from 1970 to 2007. In this study, Liquid Liabilities, privy field assent and home(prenominal) credit be use as exponent of banking arena development. The finding of this research shows negative birth between Trade openness and development of banking sector development. Discount point is having a signifi stinkpott shock on banking sector development when Private sector credit and Domestic credit is utilise as the indicant while Real GDP is ready evidential when Liquid Liabilities and Domestic credit is used as indicator of Banking sector Development. Generalized form of data has been used in this study.Keywords Banking Sector development, Real GDP, Trade openness, Discount Rate, Financial Liberaliza tionINTRODUCTIONThe pecuniary sector of Pakistan has shown a substantial ontogenesis in past few years, however there is still need for continuous development. The fiscal sector of Pakistan consists of a build of specialized financial institutions commercial banks, DFIs, NBFCs, micro finance banks, Islamic banks, Modarbas, Stock Exchange and Insurance companies. Thus the whole financial sector of Pakistan offers a wide of the mark range of products and services to its customers.(Zaidi, 2005) demesnes that growth of financial sector is significantly related with economic growth therefore, country needs well developed financial sector in order to fully utilize the financial resources. Banking system has a significant importance in financial market.Banking Sector of Pakistan is an important financial intermediator and responsible for the economic growth in the country. In 1990, De nationalisation of Government owned banks expect changed the overall scenario of the banking sec tor of Pakistan. After the amendments in banking companies ordinance, Muslim commercialised Bank (MCB) and Allied bank Limited (ABL) were denationalized in 1991 and 1993 respectively. The process of denationalization remains suspended for numbers of years and was restarted in early 2000s, when United Bank Limited (UBL) was privatized. In 2004, Habib Bank Limited (HBL) was also denationalized and due to which, the asset share of public sector banks was reduced to 25% at that time. In the utmost(a) decade, state bank of Pakistan has made several efforts in promoting the Islamic modes of financing. In 2002, the first Islamic bank was established under the name of Meezan bank. Since then, the number of Islamic banks has been opened. Various traditional banks are now opening Islamic specialized branches. At the end of 2009, total assets of the Islamic banking acquit reached to 366.3 billions and the deposits in Islamic banks suck in reached to 282.6 billions1. At the end of calendar year 2009, there are 9522 total branches of banks in Pakistan which shows an accession of 376 branches in banking sector from the 3rd quarter of 2009. Moreover, the asset basis of banking sector has shown a growth of 7 percent over the last quarter.(Yasmin, Jehan, Chaudhary, 2006) explains that after independence in 1947, Pakistan avoided trade openness because of weak industrial structure. In 1960s, industrial base was laid and manufacturing industry expanded widely in Pakistan. even so, industrial expansion face setback in 1970s due to nationalization of industries. In 1980s, IMF and World Bank provided facilities to the Pakistan in order to initiate the financial restructuring in country. A loan of $150 million and $200 Million was provided for this finding under Financial sector adjustment loan? in 1989 and 1997 respectively. An other(a) project named as financial sector compound and Intermediation project was initiated in 1995. The estimated worth of that project was $216 million. (Hanif, 2002)Despite of the remarkable performance since last two decades, the banking sector of Pakistan is less developed and remains small in relation to the economy, when it is compared to the other banking sectors of the world. This shows that a number of financial and banking needs are still ignored and that much of the economic potential of Pakistan is not achieved yet.LITERATURE REVIEW(Christopoulos Tsionas, 2004) states there is no one opinion of economist on the issue of financial development and growth of economy. (Pagano, 1993) describes that savings are mobilized towards the productive investment due to financial deepening which helps in improving corporate governance. (Khan Qayyum, 2007) says there are three major channels through which financial development can affect economic growth (i) marginal productivity of capital can be amplificationd (ii) savings are directed towards the investment (iii) level of private saving rate can be increased.The relationsh ip of economic growth and financial development was first discussed by (Goldsmith, 1969), (McKinnon, 1973) and (Shaw, 1973). Their study shows that there is a positive relationship between financial development and the level of output i.e. when the financial market will increase the credit level, the investment will increase thus, showing that real income and real affaire rate is a positive function of financial development. (Yu Gan, 2010) study shows that due to positive real interest rate, the mobilization of savings of banks increases and it also increases the growth with the increase in volume and productivity of capital.(Yanikkaya, 2003) argues that trade openness has a significant impact on the GDP share. In developing countries, trade openness creates recent opportunities to increase the growth process and hence the unemployment level decrease. (Jin, 2000) states that trade openness facilitates in establishing the development process. Moreover, local technology and product ion process can be improved through trade relaxation.One school of thoughts is of view that the financial liberalization is also a major contributor towards the financial development in developing countries. Financial liberalization means the deregulation of domestic financial markets and liberalization of the capital account.? (Attaullah, Cockerill, Le, 2004) empirically shows that the effectiveness of banking sector is improved following the financial liberalization. (Bekaert, Harvey, Lundblad, 2005) Suggests that there is a significant relationship between financial liberalization and economic growth. However, (Stiglitz, 2000) argues that increase in financial liberalization enhances the macro economic photo of nations and chances of crises becomes significant. The study of (Gong, Lee, Chen, 2004) supported the fact that increase in financial liberalization can cause crisis. (Wyplosz, 2001) suggested that financial liberalization is effective if the objective is to increase t he emulation and decrease the monopoly powers. However, financial liberalization is quite risky for developing countries. Many developing countries in Asia and Europe have grown faster even with hefty financial restraints.MODEL SPECIFICATIONBased on the above literature, we can propose that in Pakistan, banking sector development is a function of real unrefined Domestic Products (RGDP), Discount date (DR) and Trade openness (TO) and Financial Liberalization (FL). This can also be shown asBSD Pak = f (RGDP, RI, TO, FL)Where, BSD Pak = Banking Sector Development of PakistanIn this study, we have used following models which are estimated by using least square techniques. In model 1, we will use Liquid liabilities as the indicator of banking sector development. In model 2, Private Sector Credit will be used as the indicator of banking sector development where as in model 3, domestic credit will be used as the indicator of banking sector development. (Yu Gan, 2010)ln LL= o+1ln RGDP+ 2 DR + 3TO+ 4FL + eln PRI= o+ 1ln RGDP+ 2 DR + 3 TO+ 4FL+ eln DC= o+1ln RGDP+ 2 DR + 3 TO+ 4FL+ ewhere,ln LL= Natural logarithm of liquid liabilitiesln PRI= Natural logarithm of Private sector Creditln DC= Natural logarithm of Domestic CreditData sourceWe have used annual data from 1970 to 2007 in this study. The data is obtained from the World Bank database and planetary financial statistics. However, Financial Liberalization Index of Pakistan, constructed by (Waliullah, 2010) is used in this study. Real GDP (RGDP) is calculated by using following formula semiempirical METHODOLOGYIn this study, Ordinary Least Square (OLS) technique has been used. In order to run the OLS model, order of integration of every variable is determined. There are two methods to examine the order of integration i.e. Augmented Dickey-Fuller (ADF) test and Phillps-Perron test. In this study, we will use ADF test for examining weather the data is stationary or non-stationary. We will run co-integration test when all variables becomes stationary at same level. The generalized form of data has been used in this study.In model 1, liquid liabilities have been used as an indicator of banking sector development. Table 1 show that Real GDP, Financial Liberalization and Trade openness are statistically significant and Discount rate is not statistically significant to the development of banking sector in Pakistan. However, Trade openness is inversely related with liquid liabilities which means that increase in trade openness will eventually affects the development of banking sector. While, Real GDP and Financial liberalization have a significant impact on the banking sector development i.e. higher Real GDP and Financial Liberalization in Pakistan will leads towards development of banking sector. R square is (.99) which shows substantial explanation of strong-minded variables in dependent variables.Table 2. OLS Results of Model 2 (Private Sector Credit)Dependent Variable PRIMethod Least Squares exit 01/24/11 Time 1616Sample 1970 2007Included observations 38VariableCoefficientStd. Errort-StatisticProb.RGDP-7.6846145.715274-1.3445750.1879TO-7.5251193.603842-2.0880820.0446DR25.877139.2228092.8057750.0084FL-0.2040281.108112-0.1841220.8550C0.0331180.0905510.3657390.7169R-squared0.343149Mean dependent var0.041883 modify R-squared0.263531S.D. dependent var0.648747S.E. of regression0.556741Akaike information criterion1.788644Sum squared resid10.22868Schwarz criterion2.004116Log likelihood-28.98424F-statistic4.309923Durbin-Watson stat1.880175Prob(F-statistic)0.006483In model 2, we have used Private sector credit as an indicator of development of banking sector in Pakistan. Results of table 2 indicate that discount rate and trade openness have significant impact on the development of banking sector. However, Trade openness is inversely related to the banking sector development. Financial liberalization and Real GDP are not found statistically significant. R square of model 2 is (.3 4) which shows that independent variables are explaining 34 % of the dependent variable.OLS Results of Model 3 (Domestic Credit)Dependent Variable DCMethod Least SquaresDate 01/24/11 Time 1620Sample 1970 2007Included observations 38VariableCoefficientStd. Errort-StatisticProb.RGDP0.2894000.002316124.97550.0000TO-0.0071900.001983-3.6265260.0010DR0.0140200.0052402.6754960.0115FL0.0012110.0003073.9384390.0004C-6.23E-064.61E-06-1.3516920.1857R-squared0.999939Mean dependent var-1.15E-05Adjusted R-squared0.999931S.D. dependent var0.003380S.E. of regression2.80E-05Akaike info criterion-18.00387Sum squared resid2.59E-08Schwarz criterion-17.78840Log likelihood347.0735F-statistic134392.7Durbin-Watson stat1.559156Prob(F-statistic)0.000000In model 3, we have used domestic credit as an indicator of banking sector development. Results of table 3 indicate that all variables are statistically significant to the development of banking sector of Pakistan. R square of model 3 is (.99) which shows that independent variables have a significant impact on the dependent variable. (Goldsmith, 1969)As mentioned above, generalized form of data has been used in this study and numbers of tests have been applied on these three models and there is no serial correlation, heteroscedasticity.CONCLUSION AND DISCUSSIONThe results of this study shows that Trade openness is inversely related to the development of banking sector in Pakistan in all three models which validates the findings of (Siddiqui Iqbal, 2005) that Trade openness negatively affects the economic growth of a country. However these results are not according to the findings of (Miller Upadhyay, 2000) which states that trade openness leads to the development of financial sector. Moreover this study also does not support the findings of (Yu Gan, 2010) which states that trade openness have no impact on the development of banking sector.In case of Liquid liabilities as indicator of banking sector development, it is clear that Real G DP and Financial liberalization have the significant impact on the development of banking sector of Pakistan. This result is according to the findings of (Yu Gan, 2010) and (Attaullah et al, 2004) which show that Real GDP and Financial Liberalization significantly impact the banking sector development. It means that increase in Real GDP and Financial Liberalization will lead the banking sector of Pakistan towards prosperity.In case of Private sector credit as the indicator of banking sector development, it is found that discount rate is statistically significant to the banking sector development. It means that increase in discount rate will lead towards increase in private sector credit which will eventually results in financial sector development. However, financial liberalization was found inversely related to the banking sector development and Real GDP was not found significant which is against the findings of (Yu Gan, 2010) which identifies that Real GDP has a significant impa ct on the development of financial sector of Pakistan when Private sector credit is taken as indicator of banking sector development.In case of Domestic credit as indicator of development of banking sector, results shows that all four variables are statistically significant to the financial sector development which are according to the findings of (Rajan Zingales, 1998), (Cetorelli Gambera, 2001) which states that Financial Liberalization and Real GDP significantly impact the development of financial sector.PRACTICAL IMPLEMENTATIONS FOR BANKING SECTOROn the basis of the findings of this study, we can conclude that trade openness is having inverse relationship with the banking sector development. As a result of Trade openness, the less developed banking sector of Pakistan faces tough competition from the developed financial sector of other countries. Moreover, increase in trade openness increases the countrys exposure to international shocks i.e. if any economy faces will suffer a crisis, there will be more chance of transferring crisis in Pakistan.Discount rate is also found significant in this study when Private sector credit and Domestic credit was used as an indicator of banking sector development. When the discount rate will be high, financial institutions will be encouraged to get loan from state bank of Pakistan. Banks usually uses discount rate as benchmark interest rate when they further lend the money to borrowers. So increasing the discount rate will eventually lead the banking sector to development.