PAKISTAN'S banks are in for a hectic time in the coming months. State- owned banks are to be restructured and sold-off before March 1998 and the government's remaining shares in the privatised banks are to be unloaded as soon as possible. The upshot is certain to be far greater competition for all.

'The whole banking system is being changed,' says Muhammad Yaqub, governor of the State Bank of Pakistan (SBP-central bank). 'This includes lending procedures, the structure of the large banks and governance of the banking sector.'

New regulations introduced earlier this year mean that no government agency can issue directives to banks that conflict with central bank instructions. 'The changes have established state bank supremacy,' says Yaqub. But he concedes that there is still a way to go. 'We need to change the mind set, as well as the laws.'

Pakistan's banking system is dominated by five giants, all of them the product of nationalisation in the early 1970s. Two of them - Allied Bank and Muslim Commercial Bank (MCB) - were privatised in the early 1990s and are already performing better. The three remaining nationalised commercial banks (NCBs) - United Bank (UBL), Habib Bank (HBL) and National Bank of Pakistan (NBP) - are being prepared for privatisation.

'The banks have remained in the public sector for too long,' says Khawaja Mohammad Asif, chairman of the Privatisation Commission. 'The sector should be independent of government influence and run on a commercial basis.'

The failed attempt to privatise UBL in 1996 has obliged the authorities to take a different approach this time. All three banks are being restructured first and bankers have been recruited from the private sector to do the surgery. The task ahead of them is awesome. One of the new management team at HBL, Khaleeq Kayani, makes no bones about what has been found.

'Habib Bank is devoid of all the basic checks and balances,' he says. 'The basic methods of banking are just not there...the bank had no target markets and no business plan.'

The first step is to clear up the huge non-performing loan portfolios. Only HBL has put a figure on such loans, disclosing recently that it alone accounts for over a third of the country's total stock of bad debts - Rs 42,000 million ($1,050 million) out of a total of Rs 120,000 million ($3,000 million). The two recently privatised banks have already provisioned for their bad debts, although this has hit their profits hard.

As some of the leading debtors are members of the National Assembly there has been a distinct lack of political will to do anything about the problem. To force the situation, the SBP has introduced incentives to encourage defaulters to pay up. The government has also passed a foreclosure law which opens the way for banks to seize assets. When the incentive scheme expires on 5 September the banks can put the squeeze on recalcitrant debtors.

'After 5 September the banks will get tough,' says HBL's Kayani. Dedicated teams at each of the NCBs will focus on debt recovery. It is also hoped that the new regulations and procedures will prevent such a situation from arising again.

'The new foreclosure laws make the idea of assets as collateral realistic,' says Shafiq Khan, executive director at MCB. The banks are re-assessing credit policies and bringing in skilled staff to oversee future lending.

New credit procedures are just one aspect of the wider restructuring planned at the three banks. A significant innovation, being introduced at HBL by Shakut Dareen, a former country head at Citibank, is to organise internally according to function rather than region. The other NCBs will follow suit. Downsizing is also on the agenda.

As each of the NCBs has over 1,000 branches, Dareen envisages co-operation among the three banks to reduce duplication. Collective decisions are expected about closing or merging loss-making branches. The banking unions may object to closures but private sector bankers say resistance should be softened by the fact that management has been the first in the firing line.

'The changes will be a challenge for all the banks,' says Farrukh Zaman, head of corporate banking at Bank of America. 'We will have to adapt to a changing environment.' Despite the greater competition SBP governor Yaqub expects the private and foreign banks to retain certain advantages.

'They do not have the staff baggage, the dated technology and the bad loans,' he says. They also have a reputation for efficiency and have already carved out lucrative niches in corporate and investment banking.

After a difficult year in 1995, the foreign banks performed much better in 1996. High interest rates and government debt were a source of easy income. In May the yield on six month bonds rocketed to 17.5 per cent; it has since come back down to just over 15 per cent.

ANZ Grindlays Bank, for example, estimates that more than half of its lending portfolio is in government paper. It also recognises the risks. 'It's a passive way of increasing profits,' says deputy general manager Bob De Courteney. 'The situation [the high yields] could easily be reversed.'

The foreign banks have also benefited from financing private power generation projects although trade finance remains the core activity for most of them.

Optimism for 1997 is derived in part from the SBP's tentative moves to increase liquidity and make more funds available to the private sector. It has cut the statutory liquidity ratio to 20 per cent from 25 per cent, for example. 'This will help them [the banks] finance more private sector activity,' says Yaqub.

Interest in rates

At the same time, attempts to bring interest rates down and any efficiency gains at the NCBs are likely to reduce spreads. The government has withdrawn a 1 per cent excise duty on loans and SBP has made two cuts in its repo rate. As a result HBL and MCB have already cut their lending rates.

'The state bank wants interest rates to come down further,' says MCB's Shafiq Khan. 'But it is dependent on the government being able to control spending.'

Lower rates and increased liquidity may mean more potential business but everyone is aware of the dangers. 'Banks in the 1980s went for a number of big projects,' says Yaqub. 'This time they need to be prudent.'

The remaining state banks and the two newly-privatised ones have been instructed to avoid a mismatch in the maturities of their lending and deposits. As the majority of deposits are short- term priority is given to export finance, working capital for companies and trade finance. Project finance comes at the bottom of the list.

The well-managed private and foreign banks, however, are in a good position to take advantage of any upturn in activity. They are keeping their fingers crossed that the government's plans for reviving the economy will bear fruit. At the same time the new policy-makers at the NCBs are facing the challenges of restructuring head-on. The air of impending change is palpable and every banker seems to believe that things can only get better.