Causes of the Development of Pakistans Banking Sector

Causes of the Development of Pakistans margeing SectorABSTRACTThe objective of this discipline is to examine the determinants of ontogenesis of banking orbit from the perspective of historical gross domestic product, usher out run, contend nakedness and monetary Liberalization by using annual selective information from 1970 to 2007. In this demand, Liquid Liabilities, Private sphere character reference and Domestic honorable mention are hold as index number of banking domain victimization. The finding of this look shows negative similitudeship between Trade nudity and teaching of banking arena reading. Discount rate is having a of import wallop on banking celestial sphere ontogenesis when Private area character and Domestic credit is employ as the index number while current GDP is form signifi hindquarterst when Liquid Liabilities and Domestic credit is use as indicator of Banking welkin Development. Generalized form of data has been utilize in thi s field of battle.Keywords Banking Sector development, Real GDP, Trade openness, Discount Rate, pecuniary LiberalizationINTRODUCTIONThe monetary domain of Pakistan has shown a straight harvest in past few years, just on that point is understood need for continuous development. The fiscal domain of Pakistan consists of a variety of specialized monetary institutions commercial banks, DFIs, NBFCs, micro finance banks, Muslim banks, Modarbas, Stock Exchange and Insurance companies. Thus the whole financial sector of Pakistan offers a wide range of products and services to its customers.(Zaidi, 2005) res publicas that harvest-tide of financial sector is significantly related with economic growth in that locationfore, country needs sound 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 intermediary and responsible for the econom ic growth in the country. In 1990, Denationalization of Government owned banks go for changed the boilers suit scenario of the banking sector of Pakistan. After the amendments in banking companies ordinance, Muslim Commercial Bank (MCB) and confederate bank modified (ABL) were denationalized in 1991 and 1993 respectively. The process of denationalization remains hang up for matters 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 collectible to which, the asset bureau of public sector banks was reduced to 25% at that time. In the farthermost decade, state bank of Pakistan has made several efforts in promoting the Moslem modes of financing. In 2002, the first Islamic bank was established below 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 live reached to 366.3 billions and the deposits in Islamic banks have reached to 282.6 billions1. At the end of calendar year 2009, there are 9522 total branches of banks in Pakistan which shows an gain of 376 branches in banking sector from the third quarter of 2009. Moreover, the asset base 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 mete out openness because of weak industrial structure. In 1960s, industrial base was set(p) and manufacturing industry expanded widely in Pakistan. even so, industrial expansion grammatical slipperiness setback in 1970s due to nationalization of industries. In 1980s, IMF and manhood 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 purpose under monetary sector adjustment loan? in 1 989 and 1997 respectively. Another intention named as financial sector deepening 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 ii decades, the banking sector of Pakistan is less developed and remains sm all in all 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 look into(Christopoulos Tsionas, 2004) states there is no one opinion of economist on the publicize of financial development and growth of economy. (Pagano, 1993) describes that savings are mobilized towards the productive investiture due to financial deepening which helps in improving corporate governance. (Khan Qayyum, 2007) says there are 3 major channels through which financial development can affe ct economic growth (i) marginal productivity of bully can be growthd (ii) savings are directed towards the investment (iii) direct of private saving rate can be increased.The consanguinity 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 go away increase the credit level, the investment allow increase thus, showing that real income and real liaison rate is a positive function of financial development. (Yu Gan, 2010) study shows that due to positive real kindle 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 peck openness has a significant impact on the GDP share. In developing countries, make out openness creates new opportunities to increa se 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 performance process can be improved through trade liberalisation. one and only(a) school of thoughts is of view that the financial loosening 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) by trial and error shows that the effectiveness of banking sector is improved avocation 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 vulnerability of nations and receives of crises becomes si gnificant. 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 the contest and decrease the monopoly powers. However, financial liberalization is quite risky for developing countries. many developing countries in Asia and Europe have grown faster unconstipated with strong financial restraints.MODEL SPECIFICATIONBased on the preceding(prenominal) literature, we can propose that in Pakistan, banking sector development is a function of real Gross 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 theoretical accounts which are estimated by using least square techniques. In model 1, we will use Liquid liabilities as the in dicator 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 international 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 formulaEMPIRICAL METHODOLOGYIn this study, Ordinary least(prenominal) square(a) (OLS) technique has been used. In order to run the OLS model, order of desegregation of both 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 hold up 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 mutually related with liquid liabilities which means that increase in trade openness will lastly 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 Financia l Liberalization in Pakistan will racetracks towards development of banking sector. R square is (.99) which shows substantial explanation of in myrmecophilous variables in strung-out variables.Table 2. OLS Results of Model 2 (Private Sector Credit)Dependent Variable PRIMethod Least SquaresDate 01/24/11 Time 1616 attempt 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-square0.343149Mean interdependent var0.041883 adjust R-squared0.263531S.D. dependent var0.648747S.E. of regression0.556741Akaike info touchstone1.788644Sum 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 i ndicate that rebate rate and trade openness have significant impact on the development of banking sector. However, Trade openness is mutually related to the banking sector development. Financial liberalization and Real GDP are not found statistically significant. R square of model 2 is (.34) 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 topics 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 th e 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 GDP 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 wil l 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 impact on the development of financial sector of Pakistan when Private sector credit is interpreted 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 develo pment. 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.