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A NOTE ON DEVELOPMENT FINANCE INSTITUTIONS IN

PAKISTAN: A FRAMEWORK FOR REFORM AND RESTRUCTURING

INTRODUCTION AND BACKGROUND

The privatization programme has been on the agenda of many successive governments since
1985. The market based reform agenda was not just limited to privatizing state owned
enterprises, it also envisaged liberalization and deregulation of the economy and opening it up
to competitive forces. This ambitious reform agenda has had limited success. In the early
1990s the financial sector showed the most potential as a result of the liberalization
programme with the government lifting many obstacles such as foreign exchange restrictions,
free flow of funds, privatizing a few financial institutions and upgrading skills in the sector. It
is in this context that the Development Financial Institutions (DFIs) and their problems were
brought to the forefront of the government’s agenda.

The reform agenda for the DFIs required analysis of the following two major factors: (a)
assessing the current status of these DFIs; and (b) developing a framework for their possible
reforms and restructuring. This analysis was required so that the reform of the financial sector
could be undertaken. Agreed upon in the year 2000, the reform package was part of the Capital
Market Development Programme of the Government of Pakistan and the Asian Development
Bank. For the purposes of this work, the DFIs included are all those non-bank financial
institutions that were engaged in, or mandated to engage in development oriented term
financing activities, and in which the government had substantial financial exposure through
equity holdings as well as various kinds of loans and advances. Specifically, the following
eleven DFIs were included:

1. National Development Finance Corporation (NDFC)

2. Bankers’ Equity Limited (BEL)
3. Investment Corporation of Pakistan (ICP)
4. National Investment Trust (NIT)
5. Small Business Finance Corporation (SBFC)
6. Regional Development Finance Corporation (RDFC)
7. Federal Bank for Cooperatives (FBC)
8. House Building Finance Corporation (HBFC)
9. Pakistan Industrial Credit & Investment Corporation (PICIC)
10. Agricultural Development Bank of Pakistan (ADBP)
11. Industrial Development Bank of Pakistan (IDBP)

This Note was written by Natasha Malik under the supervision of Associate Professor Syed Mubashir Ali to
serve as a basis for class discussion rather than to illustrate either effective or ineffective handling of an
administrative situation. This material may not be quoted photocopied or reproduced in any form without the
written consent of the Lahore University of Management Sciences.

2003 Lahore University of Management Sciences

 02-601-2003-2

The exercise required development of a framework to identify the broader issues and to
analyze the current issues and challenges faced by these institutions. Based on this analysis,
guidelines for possible remedial action for the revival of DFIs would be needed. This might
include privatizing some or all of them.

An Overview of DFIs

The eleven DFIs included in the sample represented a significant but not an overwhelming
part of the country’s financial sector. As of 2000, their total assets amounted to Rs 220 billion,
which accounted for 9% of the total assets of the financial sector excluding State Bank of
Pakistan, (SBP) (see Table 1).

Table 1
TOTAL ASSETS OF DFIs: YEAR 2000

Name of DFI Total Assets (Rs billions)

IDBP 23
NDFC 32
ADBP 78
ICP 3
NIT 39
BEL 16
PICIC 16
FBC 4
HBFC, RDFC and SBFC 8
Total 219

Source: State Bank of Pakistan Statistics 1999/2000.

The portfolio of loans and advances for the DFIs totalled 17% of the financial sector. The
Government of Pakistan held equity investment in the DFIs amounting to Rs 4.4 billion. The
combined exposure of SBP and the government in the form of loans and advances to the DFIs
amounted to Rs 87.3 billion. The DFIs employed about 13,000 staff (12% of total
employment in the financial sector) and had a modest branch network of 648 (7% of total
branches in the financial sector). Except for PICIC which was formally in the private sector,
all other DFIs were controlled and managed by the government. The salient features of each
institution reviewed are provided in Appendix A.

It was the general belief that all the eleven DFIs were in a distressed state and were facing
serious liquidity problems. Financial distress of the DFIs in Pakistan could be characterized
by a number of factors. The more prominent ones included a low liquidity level, high
intermediation and financing costs, a high ratio of non performing loans, frequent
management changes and a general lack of certainty regarding the future. Since all DFIs were
fully or partially owned by the government, several of the ‘distressed state’ characteristics
were common to all of them. Many of the DFIs were technically bankrupt with negative
equity and had either suspended or significantly curtailed the scale of their operations.
Broadly, the DFIs were characterized by a common set of problems. These included:
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(a) A very high ratio of non-performing loans (NPL) and infected portfolios. The ratio of
NPLs to total portfolio ranged from 30% to 80%. Most of these NPL had been advanced
to projects with dubious feasibility and ran into problems almost from inception. In the
past two years, most DFIs had given a very high priority to loan collections and had
succeeded in increasing the loan collections and reducing the ratio of infected portfolios.
While these efforts resulted in better loan recovery rates in almost all DFIs, collection
rates still fell far short of levels that would ensure the financial sustainability of the DFIs.
Only PICIC and IDBP management were hopeful of resolving this problem within the
next two years. However, since NPLs represented only the actual amount in default, the
proportion of the portfolios of DFIs infected by bad and doubtful loans and potential
losses were likely to be much higher than the current numbers indicated. Table 2 shows
the ratio of non-performing loans (NPL) of the DFIs.

Table 2
NON PERFORMING LOANS OF SELECTED DFIs

NAME of DFI Ratio of NPL to Total Portfolio

NDFC 50
IDBP 40
ADBP 60
SBFC 57
RDFC 50
BEL 36
PICIC 80
ICP 46

Source: State Bank of Pakistan Statistics, 1999/2000.

(b) The portfolio non-performance of DFIs had adversely affected their financial
performance and position. Some DFIs (BEL, ICP, SBFC, FBC) were already in a state of
insolvency having lost their entire equity. Moreover, it was also felt that some DFIs (e.g.,
ADBP, NDFC) might have had a much higher ratio of NPL if a detailed audit of their
portfolios had been conducted and internationally accepted accounting principles had been
applied. The remaining institutions, which might not have lost all their equity, still had
very weak financial positions. These DFIs had survived because the government and the
State Bank of Pakistan (SBP) had supported them, mainly by rescheduling of servicing of
their loans and advances. However, based solely on the NPL figure, it was difficult to
categorize which DFIs were in greater financial distress than others. From Table 2 it is
clear that PICIC had the highest share of NPL but the analysts gave this DFI a higher than
average chance of survival compared to NDFC.

(c) Serious shortage of new financial resources. Virtually all the DFIs faced this serious
problem and had no new resources available to finance their normal activities. A serious
challenge to the management of the DFIs was to find viable sources of new financing,
preferably long term in nature to generate new business and to conduct oversight of
businesses already undertaken. However, many were able to undertake new business
(particularly, ADBP, HBFC) by recycling past government and SBP funding. Even if they
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were to service these debts to the government and SBP they too would have to
substantially curtail their current already reduced levels of business.

(d) A very low level of institutional efficiency. Generally, all the DFIs had a very low level of
efficiency. This was evident from the fact that intermediation costs for some of them were
as high as 20%. Internationally, the rule of thumb is that DFIs should not have
intermediation cost above 2%, a threshold far exceeded by all DFIs in Pakistan. Moreover,
these institutions also carried a very unfavo urable reputation within the business circles.
As a result businessmen shied away from dealing with the m given their bureaucratic and
highly inefficient working.

(e) Overstaffing with a high level of demoralization. Even though many DFIs (e.g., PICIC,
IDBP, ICP) had implemented downsizing programmes, there was still an impression that
these organizations were highly overstaffed. This was particularly so for institutions that
had suspended or significantly curtailed new business. As a consequence, staff morale was
generally low because of low volume of work, uncertainty about the future, adverse
publicity of the respective institutions, and perceptions about the high level of
politicization of these institutions.

(f) Business and institutional uncertainty. In principle, all DFIs represented government
intervention in the financial markets and were created to fill a perceived market failure.
The early success stories associated with these institutions demonstrated that there was a
need for such institutions and they were able to play a significant role. However, the DFIs
in Pakistan had not performed according to their expected potential to justify their
creation. This raised doubts in the minds of many including the management and staff of
DFIs, policy makers, and the public as to their viability and therefore the desirability of
maintaining and sustaining these institutions at a high national cost.

Various researchers had pointed out factors that had contributed to the current distressed state
of DFIs. It should be noted that Pakistan’s experience with DFIs is not unique. Many
developing countries have had an equally serious problem with their DFIs and have had to
substantially restructure or liquidate them. In the past decade, Japan, Korea, and New Zealand
had to restructure or close down some DFIs. This is discussed below. It is also interesting to
note that all DFIs in Pakistan also had been affected adversely by the same set of factors as
identified in other economies. These included:

(a) High level of politicization. Pakistan experienced a very blatant politicization of public
institutions which had gone unchecked for a very long time. Financial institutions in the
public sector in general and DFIs in particular, were the most visible manifestation of this
phenomenon. Political interference could be classified as formal and informal. The formal
interference was in the form of directed credit programmes imposed on DFIs. These were
designed without much regard to business and economic rationale. This interference
affected the sound management of these institutions and impacted such policies as credit
discipline, loan forgiveness and forced opening of uneconomic branches. The informal
interventions also took a variety of forms, such as pressure to provide financial assistance
to certain individuals or groups, writing off loans, or ordering staff postings at favo ured
positions. A very peculiar, but not uncommon, problem was also the rapid and forced
turnover of Chief Executive Officers of the DFIs.
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The success of any institution, particularly a financial institution, depends largely on

professionalism and continuity of management. This factor had been conspicuous by its
absence in Pakistan. The average tenure of CEOs of the DFIs under discussion was one
year in the past 10 years. Some DFIs had been even worse off as the average tenure of
their CEO’s had not been more then 10 months (some of the CEOs also ended up behind
bars). It was alleged that many CEOs were appointed to curry favo ur and to fulfill the
agenda of their masters and were not qualified for the job.

(b) Economic slowdown. The economic slowdown in Pakistan in the 1990s was perhaps
unprecedented in terms of its severity and persistence. This resulted in a much reduced
demand for financial services and products; it even adversely affected the financial
performance of the beneficiary enterprises leading to loan defaults and a high ratio of non
performing loans (NPLs).

(c) Financial sector evolution. Since the 1980s, the financial markets had undergone a
significant transformation as a result of deregulation and liberalization policies of the
governments. This was a worldwide phenomenon and entailed a heightened level of
competition amongst different categories of financial institutions for resource mobilization
and project financing. In Pakistan, some DFIs had to compete with commercial banks and
other types of financial institutions for deposit mobilization (though not always on an
equal footing). There was also some competition in the business that was considered the
exclusive domain of DFIs, such as term and project financing. Both commercial, as well
as investment banks, albeit at a relatively smaller level, entered this segment of business.
Thus, the rationale for the establishment and maintenance of some DFIs became blurred.
This was evident from the fact that some DFIs had engaged in lines of business (leasing,
money market operations, share trading) not included in their original mandate. This
activity was at the expense of their core operations. There was also overlap of business
among DFIs. For example, PICIC, IDBP, NDFC, ICP and BEL were all engaged in
project financing business while there were at least four DFIs (IDBP, SBFC, RDFC,
ADBP) that were, or had been, in the business of financing small and medium scale
enterprises in urban and rural sectors.

(d) Limited resource raising capability. At present, the DFIs relied on three major sources of
funding which included equity capital, SBP funding under various schemes and deposit
mobilization. In addition, prior to 1990s, some DFIs (NDFC, PICIC, IDBP, ADBP, BEL)
had access to external funded lines of credit provided by international lenders such as the
World Bank and the Asian Development Bank. However, such lines of credit ceased to
exist after the nuclear blast of May 1998 and the military coup in October 1999. SBP
loans and advances, accounted for almost 70% of their resources, and were the most
dominant source of funding. The rest of the resources came from the government (capital
contributions and loans), and deposits of around 29%. There were clear limitations on the
additional funding available from these sources. Given the resource and budgetary
constraint of the government, it became clear that long-term sources of funding for DFIs
were rapidly drying up.

Additionally there were also some serious constraints on deposit mobilization capability
of these DFIs. First, given their precarious financial position, they were at a definite
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disadvantage vis-à-vis commercial banks in attracting deposits at competitive rates. Only

IDBP, a scheduled bank, had a relatively successful deposit mobilization programme.
Second, many of the DFIs did not have a commercial banking license, and could not go
for only high cost term deposits and Certificates of Investments. By and large, DFIs had
not paid much attention to, nor were they designed to develop innovative and independent
sources of funding and were constrained in this area by their corporate constitution.
However, many in the industry felt that this may ha ve been a blessing in disguise as given
their seriously impaired financial positions, a high level of deposit mobilization by them
would have created a high level of risk and instability in the financial sector.

The International DFI Experience

In the 1950s and 1960s, many developing countries (about 50-60) established specialized
DFIs dedicated to providing long-term finance for the development of certain priority sectors.
The establishment of these specialized financial institutions was predicated upon the
recognition of a perceived market failure. The failure of commercial banks, which dominated
the financial markets of most developing countries, to provide long term lending for these
project and their leaning towards the short end of the money market necessitated the creation
of specialized DFIs. This was due to a variety of reasons includ ing economic rationale such as
maturity matching due to short maturity of deposit base, lack of interest and skills in long-
term lending, and legal and regulatory restrictions. The vast majority of such DFIs were
government owned, though a few were also privately owned.

The international experience of DFIs had been mixed. With the exception of a few, all DFIs
faced problems similar to those experienced by DFIs in Pakistan, i.e., an unsustainable ratio
of non-performing loan portfolio, poor financial performance and position, liquidity problems,
and low profitability or financial losses and doubtful financial viability and sustainability.
Many such institutions had to be closed or transformed into a different kind of entity. Some of
the common reasons for these problems were:

(a) In the late 1970s and early 1980s many developing countries underwent major structural
economic changes which had a direct adverse impact on the loan portfolios of DFIs. The
exposure of these institutions was largely to enterprises operating under protected markets
and prices. With liberalization and deregulation the market structures came under
increasing pressure and the financial viability of their projects was seriously undermined.

(b) With increasing liberalization of financial markets, commercial banks also started to
encroach on the long-term end of the markets that had been perceived as the exclusive
domain of DFIs. This shift was made possible by increasing amounts of longer-term
savings mobilized by banks and the adoption of sophisticated term-transformation
techniques.

(c) DFIs were largely in the single product business of long-term loans, and thus, they were
exposed to a very high degree of business risk. Consequently they were not in a position
to adopt appropriate risk management techniques. On the other hand, the commercial
banks with access to cheaper deposits and a wider range of products and services were
much better positioned to manage their risks more effectively.

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(d) The government owned DFIs were invariably subjected to political pressures resulting in
lending to borrowers who otherwise would not be eligible for credit.

(e) Government ownership and control also resulted in lack of operational autonomy,
frequent changes in institutional leadership and management, and inadequate development
of management and staff skills. These were due to inadequate human resource policies
and poor compensatio n and benefit structure.

However, there were also examples of some successful DFIs – both government and privately
owned around the world but they were few. Some of the successful DFIs worth noting
included The Industrial Credit & Investment Corporation of India (ICICI), the ICC Bank of
Ireland (ICC), Banco Portugues de Investimento, SA of Portugal (BPI) and Corporation
Financiera Del Valle of Colombia (CFDV) 1 . In addition, DFIs in Sri Lanka, Thailand and
Malaysia had performed reasonably well. While the economic and business circumstances of
each country and institution had been distinctly different, some common success factors were
also very evident as follows:

(a) The successful DFIs enjoyed relatively stable macroeconomic conditions in their
respective countries and were able to operate within predictable business conditions.

(b) They were either privately owned or managed, or they enjoyed a very high degree of
operational autonomy. In addition, they all had competent professional leadership and
manage ment with significant stability. In most cases the tenure of the CEOs was between
10-15 years; there were no frequent and unsettling leadership changes and there was a low
level of political interference.

(c) At a very early stage of their establishment, all successful DFIs realized that in order to
manage the high risks of business, they had to diversify their assets and sources of
income. Thus they operated like a non-specialized institution and did not rely on a single
product, i.e., long-term loans. They branched off in many innovative but related areas of
business such as leasing, venture capital, mutual fund, commercial banking, trust
operations and stock brokerage.

(d) Similarly, they also diversified their funding sources, relying increasingly on self-
mobilized resources and did not rely on state funding.

(e) In the pursuit of their businesses they always gave high priority to maintaining a
reasonable level of profitability. In other words they avoided taking risks that were not
commercially feasib le.

Countries around the globe also adopted different approaches to resolve issues in the DFI
sector. Peru, Colombia, Kenya, Uganda, Indonesia and the Philippines chose to significantly
downsize their DFIs and consolidate them into one or two institutions with limited functions.
Peru in 1993-94 merged four public sector DFIs into one and assigned it the role of a second-
tier institution, i.e., wholesaling of longer-term funds to retailing financial institutions, mainly

1
Until very recently the list also included The Korea Long-term Credit Bank (KLB) and the Development Bank of Singapore (DBS). These
institutions were hard hit by the financial crisis in East Asia and were bailed out through merger with another bank (KLB) and direct
government assistance (DBS).
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commercial banks. Similarly, in the Philippines, the government DFI was downsized by about
70-80% and given a full banking license to enable it to operate as a countryside bank and a
second-tier institution to provide longer maturity resources to a variety of financial
institutions. In addition, one private DFI in the Philippines was liquidated and another private
DFI was converted into a thrift bank. In Indonesia, a large government owned DFI was
merged with three commercial banks to form a new commercial bank. These actions were
based on the premise that the DFI sector needed a new direction and reorientation of its
activities so that the new issues and challenges could be better managed. At the same time, the
large scale dependence on limited governmental resources was also minimized and the tax
payers in the country benefited from the closure or merger of financially inefficient
organizations.

Another approach had been to cut the losses of the state and liquidate its holding in problem
DFIs. This way the losses were contained and problem institutions were not allowed to be a
burden on the national exchequer. This process was adopted in China and New Zealand. A
DFI set up in the early 1980s in China later developed serious problems and was subsequently
liquidated. In the late 1980s, New Zeala nd also resolved the problems of its DFIs by
liquidating them.

The DFIs in India were facing severe competition from commercial banks both in terms of
business as well as resources. The future of Indian DFIs was debated and a recent inter-
agency report recommended that the DFIs should be allowed to compete with commercial
banks on an equal footing, meaning that the regulatory distinctions between banks and DFIs
should be removed. This approach would allow the DFIs to actively compete for resources
and bus iness.

The Rationale for Government Intervention

Any framework for the restructuring of DFIs in Pakistan should be within the context of a
strategy for the evolution and development of the country’s financial sector. After all,
specialized financial institutions represent a market intervention by the government and the
rationale for their existence can only be established when it is determined that market forces
will not fulfill the perceived gap in services. However, an economically sound system would
be one where such intervention is not needed and private or private-public partnership
arrangements would meet the requirements. Hence, the intervention by the government
through establishment of DFIs should be a transitional arrangement, while the financial
markets develop fully.

Pakistan’s financial sector has been evolving during the past two decades. The major players
in the financial markets include 25 domestic banks, branches of 20 foreign banks, 18
specialized DFIs/NBFIs/SBFIs, 57 life and general insurance companies, and about 40
different types of mutual funds. In addition, there are about 11 main stockbrokers operating at
three stock exchanges in the country. For a low- income country, Pakistan has a fairly
elaborate and extensive financial system, which if it works effectively and efficiently should
serve the financial needs of all the players in the economy, business, household and the
government.

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However, there were indications that the country’s financial sector was not serving the
business sector at an optimum level of efficiency, both in terms of the range of products and
services and quality. This was attributed largely to structural weaknesses in the sector. The
government still held a substantial portion of the financial system, including banks, despite
efforts to privatize the nationalized banks. The banking sector was saddled with relatively low
levels of efficiency and a large hangover of NPLs which was taking much of the
management’s time.

Another major issue was the existence of a large number of relatively smaller banks and
investment banks, which could not compete effectively in the market with the larger banks.
Similar issues related to capital also existed in the leasing, modaraba and the insurance sector.

The international trends in financial markets saw a shift away from smaller and specialized
banks towards financial supermarkets whereby clients had access to a wide range of financial
services. This “one stop shopping” required huge financial resources and expertise over a
diversified product range. However, at the same time specialized intermediaries with a very
focused product range, but with a substantial capital base, also emerged. It was felt that the
Pakistani financial institutions would have to decide the strategic shifts required to compete in
the international arena.

Some of the banks in Pakistan were already debating such issues, and under emerging
scenarios many of the functions for which the DFIs had been created would be taken over by
the various components of the banking system. However, there was a need for continuing
reforms and consolidation of the financial system for this to materialize and this would be a
long-term process. At the minimum, reforms in this respect would require (a) resolution of the
banking sector NPLs; (b) completion of the banks’ privatization plan; (c) further
professionalization of banks by continuation of the current efforts; and (d) policy and
regulatory measures to encourage consolidation and mergers of smaller commercial and
investment banks.

It was obvious that if the rest of the financial sector developed further, the rationale and the
need for government intervention in the financial markets through DFIs would come under
scrutiny. However, the question was what should be the strategy in the transition period
whose length was undeterminable at present. The strategy also required significant changes in
practice, culture and management of large sections of the society.

Considering the current economic and financial environment in the country, it was argued that
there was a case for government intervention in three broad areas: (a) the financial needs of
the SME sector; (b) the rural and agriculture sector; and (c) the housing sector for the low
income segment of the population. These sectors were likely to be under-served by the
financial sector for some time and yet they were critical in order to achieve a higher rate of
economic growth and to generate employment. It was felt that with the emergence of
investment banks and leasing companies as well as strengthening of the stock markets and
entry by the banking sector in project financing, DFIs operating in these areas faced
increasing competition and the basic rationale for their existence was under question.

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The DFI Restructuring Fra mework for Pakistan

The international DFI experiences suggested that DFIs could be run successfully and make a
positive contribution to the country’s economic development, provided they were soundly
conceived and professionally managed. Based on this generalization and the experience of
DFIs in Pakistan the following guiding principles were considered to form the basis of
restructuring the framework for DFIs in Pakistan:

(a) Consolidation and streamlining - As discussed above there were a number of DFIs with
overlapping functions. If the purpose of government intervention was to fill the market
gap then there was little justification for government DFIs to compete with each other or
have duplicating or overlapping roles.

(b) Autonomy and professionalism - The international experience suggested that successful
DFIs had professional management, and enjoyed significant autonomy. Their boards of
directors comprised persons of proven competence and integrity drawn mainly from the
private sector and academia. The CEOs were appointed on merit and once appointed had
full freedom to manage the institution based on business considerations. Since
management stability and ability was a major factor for the success of DFIs the
government was advised to take appropriate action in this regard. A minimum term to
CEOs; an open evaluation and fair compensation structure; and non interference should be
the cornerstone of new policies. In this, the government may set up a Performance
Evaluation Board for the review of the DFIs.

(c) A catalysts role - The DFIs should play a complementary role in the financial sector such
that over time the private financial sector would be encouraged through demonstration of
the success of DFI operations to start undertaking such hitherto neglected business.

(d) Commercial orientation - Successful DFIs around the world had always protected their
financial interest. The prime function of DFIs was to provide financial services to sectors
and enterprises, which despite being inherently viable and bankable were not served by
the financial sector. Thus DFIs should be able to pursue their mandate and at the same
time be financially prudent.

(e) Partnership with private sector - DFIs should work, as far as possible, in partnership with
the private sector to minimize their credit risks and achieve a higher level of private sector
involvement with their clients.

(f) Independent resource mobilization - Once DFIs are placed on sound financial
foundations and they start developing a sound portfolio and financial performance, they
should be able to mobilize a substantial portion of their resources on their own without
government support.

(g) Minimize subsidies - Subsidies can be a very effective vehicle to achieve certain socio-
economic and development objectives provided they are thoughtfully targeted where they
are needed and provided only in as much quantum as needed. Many financing
programmes currently managed by DFIs carry subsidized interest rates, but due to the
inefficiencies in the system the effective cost to the intended beneficiaries is much higher
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than the nominal interest/mark up rates. Also, many small borrowers, specially in the rural
sector, borrow from informal sources where the actual effective cost is well over 50% per
annum. Thus, it is suggested that in the future all subsidies related to DFIs and their
clients should be targeted and transparent. They should be periodically reviewed, and
minimized to the extent possible, and delivered through the most efficient vehicles (i.e.,
through subsidized financing or through non- financial inputs). Interest/mark up rate
subsidies are not necessarily the best vehicles for assisting the deprived classes.

(h) Non-financial support - Financial assistance alone does not lead to the development of
SMEs and rural (farm as well as non-farm) sectors. Non- financial inputs/support are
equally, if not more, important. For example, in 1998-99, agricultural credit increased by
almost 30% while the actual growth in the sector was a meagre 0.4%. Therefore, the credit
to the agricultural sector will lead to productivity gains and higher production and income
of farmers only if accompanied by coordinated efforts to provide the farmers with all
other necessary inputs such as seed, water, pesticides and marketing support. Similarly, in
the SME sector, access to technology, vocational training, access to government contracts,
and opportunities for subcontracting are as important ingredients for the growth of this
sector as finance. The government may want to develop institutional mechanisms to
ensure the delivery of non-financial support where use of subsidies will be much more
productive and controllable. 2

A Restructuring Proposal

The current DFIs, considering the markets they serve and the above guiding principles,
indicate that they fall into three broad categories. The first category DFIs are engaged in the
industrial and business sector including small scale firms and individuals (NDFC, IDBP,
PICIC, BEL, ICP, NIT, SBFC, and RDFC). The second category is involved in agriculture
and the rural sector (ADBP and FBC) and the third category is involved in the housing sector
(HBFC). The proposal for the reform would require taking into account the needs of the
country and the sectors and the relative strengths and shortcomings of the DFIs.

Next Steps

The proposed framework will need to be formally approved by the government after due
discussions with various stakeholders. The implementation of the above framework will
require a careful assessment of the fiscal implications for the government and an analysis of
the implications for each concerned institution. Detailed legal work, preparation of detailed
institutional closure and development plans, implementation, and monitoring will also be
required. This is a very complicated task and therefore the government may want to appoint
one senior official full time in charge of this task, with adequate resources to hire the
necessary expertise. This would also be a time bound assignment.

2
SMEDA represent a beginning in this direction, but care should be taken to ensure that its professionalism is not compromised and that it
does not get involved directly or indirectly in SME financing.
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Appendix A
DEVELOPMENT FINANCE INSTITUTIONS IN PAKISTAN:
A FRAMEWORK FOR REFORMS AND RESTRUCTURING

National Development Finance Corporation (NDFC)

NDFC was established in 1973 under an Act of Parliament as a specialized institution for
purposes of financing investment and working capital needs of public sector enterprises. Its
role with changing priorities of the government was later also modified to include private
sector. NDFC is owned 100% by the government, employs 650 staff and operates through 40-
branch offices spread nationwide.

NDFC has suffered due to political instability in the last ten years with changes in top
management which averaged a tenure of less then one year. These frequent changes caused
deterioration in operations and lending activities that were conducted for considerations other
then project viability and merit, and low recoveries. This led to growing inefficiencies in the
organization, poor quality of lending portfolio and un-profitable operations. NDFC’s total
loan portfolio of Rs. 23 billion is 50% classified. The total provisions against these are Rs. 5.8
billion with a substantial shortfall. It also has accumulated losses of around Rs. 2 billion by
far exceeding the capital base of Rs. 390 million.

In the past, NDFC relied on foreign credit lines for its long term financing which over the
years have dried and are no longer available. The present outstanding of these credit lines
amount to Rs. 3 billion, guaranteed or received through the government. NDFC also relies on
SBP concessional financing under LMM scheme and deposit mobilization to meet their
financing requirements. Due to uncertainty regarding its future, there has been no term
lending activity and NDFC has merely been raising short term deposits at high cost, around
17%, to maintain its liquidity and meet its expenses. NDFC also lost a number of qualified
staff in its Golden Handshake Scheme earlier offered due to deteriorating conditions.

Industrial Development Bank of Pakistan (IDBP)

IDBP was established in 1961 under a special statute for catering to term financing needs of
the small and medium scale manufacturing sector. It is owned 100% by the government,
about 57% directly and the remaining through public sector institutions. After operational
restructuring over the last two years, IDBP now has 19 branches and employs 507 people. The
focus in the last few years has primarily been on consolidation and recovery which has been
relatively successful. This, however, does not mean that there are any fewer problems at
IDBP.

IDBP’s problems also stem from political interference, frequent changes in management,
unclear focus and lack of good quality and professional staff. This in addition to uncertainty
of its future operations caused considerable damage to deposit holders, employee morale and
recovery effo rts. IDBP has managed to bring down its non-performing portfolio from about
80% of its advances in 1995-96 to about 40% in 1998-99 of Rs 23 billion. However, with
further on-going recovery efforts this figure is already showing an improved position. IDBP’s
total capital is only Rs 157 million. Due to its shortfall SBP had issued a directive for raising
IDBP’s capital to Rs 500 million by December 1998. This has not been achieved as
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government being the owner has not injected new capital into the institution. IDBP has also
incurred losses in the past several years adding further to its shortfall.

IDBP has still not finalized its 1998 and 1999 accounts due to change in the reporting
requirements of SBP. Therefore, the figures quoted are those provided by the management
and are subject to change. IDBP despite its earlier problems has managed to increase its
deposit base which is around Rs 12 billion up from Rs 8 billion the year befo re and are
targeted to reach Rs 13.5 billion by year end FY2000. These additional deposits are
essentially being used for liquidity purposes.

Agriculture Development Bank of Pakistan (ADBP)

ADBP was established in 1961 to assist small farmers and agriculture businesses for their
financing requirements and to assist in development and modernization of agriculture. It is
owned more then 99% by the government while the remaining shares are held by the
provincial governments and has a setup of 349 branches and 49 regional offices. ADBP has a
large employee base of about 7,800 people including some 1450 mobile credit officers. It is a
scheduled bank and takes regular deposits, however, these have remained a marginal source
and ADBP has mainly relied on funding from SBP, about 75% as well as funds from
multilateral institutions, guaranteed by the government.

Due to directed credit programmes of successive government’s for agriculture sector, ADBP
has remained a recipient of high political interference. As a result, no Chairman in the last ten
years survived for more the 10 months in the institution. The bank’s financial position has
been weak already carrying accumulated losses on its books and a loss of Rs 6 billion (revised
this year to Rs 3.8 billion) declared last year with a share capital of Rs 3.2 billion. In addition,
the existing portfolio is also infected to the extent of 60%, which likely is understated and a
full audit is required for an actual assessment.

ADBP’s main source of funding of SBP credit lines closed in 1997, and the outstanding funds
are merely being recycled as SBP has agreed to a repayment over 15 years. Loan
disbursements have substantially increased over the past 3-4 years increasing by 150% from
about Rs 12 billion in 1997 to Rs 30 billion in 1999. However, ADBP has achieved this
mainly through recoveries while there has been some ad hoc funding from SBP on an annual
basis of about Rs 2 billion and some borrowing from commercial banks. ADBP has not
managed to attract much deposits despite it being a scheduled bank; deposits are Rs 1.7
billion, about 2.5% of adva nces.

Small Business Finance Corporation (SBFC)

SBFC was created through an Act of Parliament in 1972 to provide financial assistance to
small business enterprises, individual small businessmen and entrepreneurs in the private
sector for development and promotion of small enterprise sector. SBFC’s source of funds
included credit lines from SBP and its own capital and it does not take deposits acting merely
as a government agent for disbursement of loans. It is 95% owned directly and indirectly
through nationalized commercial banks and by the government; the remaining 5% is owned
by the two privatized banks. It has 94 branches and 17 regional offices and employs 1,425
people.
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SBFC has a total of Rs 13.7 billion outstanding in loans with Rs 7.8 billion or 57% classified
as non-performing. This is a result of various self employment programs – which are 98% of
total SBFC’s loan portfolio, introduced by political governments with lax criteria. These
politically motivated lending programmes have also adversely affected recovery performance
due to their inadequate collateral requirements which have been below 20% and for the
current year (4.5 months) is as low as only about 6% of the recoverable. With a total capital
and reserves of Rs 435 million, SBFC has a sub stantial shortfall. SBP which provided credit
lines to SBFC on profit and loss sharing basis, and has at present an outstanding Rs 9.6
billion, also stopped its funding of SBFC in 1997. However, through an agreement with SBP
these funds are being rolled over. Under the PLS scheme SBFC passed on 10% of its profits
on provisional basis to SBP which was also considered to be their final payment.

Youth Investment Programme of the government which earlier operated as an extension/

processing agent of SBFC was also acquired in a consolidation drive. Nothing was disbursed
by SBFC against YIPs program in the last year while the present outstanding loans include
their share Rs 4 billion. With the current recovery trend it seems unlikely that even this
arrangement would last long and SBFC would not be in a position to lend any further unless
new capital is injected.

Regional Development Finance Corporation (RDFC)

RDFC was established in 1985 through an ordinance to finance projects in less developed
areas. Mining sector was given a particular focus for financing under its original charter. Fifty
percent of RDFC’s equity is held by NDFC and the remaining is also with the government
(16.7% direct) and the rest through SBP and IDBP. RDFC largely has operations in NWFP
(65% of portfolio) and Balochistan with some exposure in parts of Sindh, Punjab and AJK. It
employs 170 staff and has 12 branch offices.

RDFC’s sources of funds included its capital, credit line from ADB, GOP and SBP lines as
well as deposits of some Rs 700 million. RDFC has a significant negative equity with present
on the books paid-up capital of Rs. 172 million whereas losses incurred by it only in the last
two years amounted to more than Rs 335 million. The current portfolio is also non-performing
to the extent about 50% of its total advances of Rs. 2.6 billion.

With no new credit line, RDFC has essentially stopped lending apart from some selective
working capital finance and all the focus has been on recoveries. RDFC has also entered into
new lines of businesses by taking position in the money and equity markets. The new
management has also revived the industrial credit programme for rural women, a retail micro-
credit operation outside its balance sheet with Rs 50 million grant funding received from the
government.

Bankers Equity Limited (BEL)

BEL was established in 1980 to undertake project financing business, by providing term
financing to the manufacturing sector mainly through Islamic modes of financing. In 1996,
BEL was privatized through block sale of government shares to a local group. Following its
privatization BEL underwent operational restructuring with Golden Handshake reducing its
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employee strength to 230 people. BEL’s role also was narrowed to merchant/investment
banking activities in the private sector and permission to undertake commercial banking was
not granted by SBP.

BEL, post privatization was subject to resource constraints and non-availability of foreign
credit lines. Also, immediately after privatization public corporations and local bodies
contributed to the liquidity problems by withdrawals of their funds placed with BEL. It then
relied on deposit mobilization through Certificates of Investment (COIs) and borrowing from
banks and financial institutions of which State Bank of Pakistan (SBP) accounts for 62%.
However, BEL continued to face problems with drag of its bad debts and limited new
business.

BEL’s no n-performing loans are about Rs 5 billion as of September this year which is roughly
about 36% of its portfolio. BEL has been subject to mal-practices, fraud and corruption as a
result of which the management was removed in August this year with SBP take over. Due to
siphoning off of funds most likely no cash or other reserves would be available leaving it
substantially undercapitalized and technically bankrupt. As all accounts and reporting had
also been fraudulent the figures might not be fully representative of its actual position which
could be far worse. Since the take over by the SBP, the interim management has only been
pursuing recoveries and finalization of on-going special audit.

Investment Corporation of Pakistan (ICP)

ICP was established in 1966, with the objective of broadening investment base in the country
and development of capital markets. ICP is essentially under state control directly but through
the governments holdings in the public sector banks which account for 73% of the total shares
outstanding. ICP has a total of 3 branches employing 200 people.

ICP has two departments, the mutual fund department – operating 26 mutual funds invested in
178 companies of 125,000 shareholders with aggregate net asset value of Rs 3.2 billion and
aggregate ma rket value of these funds of Rs 2.2 billion a discount of 30% as of Dec. 1998.
The second is the merchant banking department. While not part of its charter ICP provided
loans to new companies in Pakistan, initially by providing bridge financing for initial public
offering and then expanding into project financing. The company stopped making new loans
in 1994, but there remains Rs 1.8 billion in principal outstanding of which Rs 800 million or
about 46% is classified as non-performing. Provision of Rs. 595 million have been made
against these NPLs.

The total capital of ICP is Rs 200 million on the books. With no new capital forthcoming
from the government ICP indulged in heavy borrowing and now has accumulated losses of
over Rs 1 billion. ICP also offered a golden handshake scheme in which a number of qualified
employees left the institution for better opportunities in the private sector.

National Investment Trust (NIT)

NIT established in 1962, is the largest open-end mutual fund in Pakistan. The Government
directly owns 8.33% of the outstanding shares and indirectly 66%, the rest of the 25% are

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owned by the private sector. NIT has a total of 24 branches with 180 staff.

NIT thorugh its Trus t Account has investments of Rs 18 billion in 600 listed companies. Unit
price (NAV based) is now about Rs 9.3 which had earlier touched a low of about Rs 6. The
unit trust is managed by NITL which charges a management fee of 1% per annum. Apart from
units NIT also has about 5% of its portfolio in projects under Islamic modes of finance.

In 1995-97 the government had guaranteed redemption price of its units at Rs 13.70 and about
Rs 700 million under this guarantee scheme were redeemed. While this guarantee was later
removed in 1997, the government provided a letter of comfort (put option) at Rs 13.70 to its
major unit holders after a holding period of 5 years. The general lack of liquid ity in the
market and low trading volumes of NIT holdings have placed the trust de facto in moratorium
as the current income from sale of these securities is not sufficient to meet redemptions.

House Building Finance Corporation (HBFC)

HBFC was established in 1952 to cater to the needs of the housing finance sector. Its main
functions include providing assistance for construction and purchase of houses. HBFC is
100% state-owned. It has a total of 69 branches and employs a total of 1593 staff.

HBFC, classified as a non-bank financial institution by SBP, has operated as a disbursement

agent for government. Its role has remained confined to borrowings from SBP (99%) and it
did not develop a resource base by mobilizing outside deposits though it sold debentures for a
total of Rs 272 million in the 1960s which have all been redeemed. SBP credit lines also
stopped in 1994, and since then HBFC has relied on roll-over of these funds through
recoveries. It has been meeting its expenses through income generated from operations and
has accumulated profits of around Rs 2 billion. HBFC’s level of lending has also declined
which it blames on the lack of demand for housing.

As of October 31, 1999, HBFC had disbursed 29.1 billion and has outstanding recoverable of
Rs 38.2 billion of which Rs 30.4 billion was recovered as of October this year and the
remaining Rs 7.8 billion is in default. About Rs 1 billion has also been absorbed by the
government in remissions and relief packages – for widows, retired persons and orphans, of
which only Rs 233 million has actually been received by HBFC.

HBFC lacks qualified staff, although there has been an improvement in the package being
offered there has been ban on recruitment since June 1997. The management appointed has
lacked vision and there is a lot of room for improvement and development of the housing
finance market in Pakistan.

Federal Bank for Cooperatives (FBC)

FBC was established in 1976 to provide credit to the Provincial Cooperative Banks for the
development of agriculture and rural sectors. It is also 100% owned by the government, 10%
directly and the rest through SBP and the provincial governments with a total capital of Rs
200 million. FBC has 4 regional offices and provides employment to around 280 individuals.

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FBC like most of the other DFIs is confined to passing on SBP funds to the provincial
cooperatives and also performs some regulatory functions on behalf of SBP for monitoring of
their credit lines. FBC due to the political interference at the federal and provincial has not
been able to contribute towards the intended development. The loans of cooperatives are
passed to the societies in the provinces generally formed on political motives.

Sanctions of SBP lines are on an annual basis against which Rs 5.4 billion were disbursed
during 1998-99. This year Rs 6 billion have been sanctioned. 95% of the lending has been to
the Punjab Provincial Cooperative, which has over 100 branches. There remaining funds have
gone to Sindh and NWFP which have 30 branches each while there has no lending for the last
several years to Balochistan due to their default. Total disbursement since inception is about
Rs 52 billion with present outstanding loan portfolio of Rs 4.4 billion as of June 1999. The
recoveries on average have been about 84% and the present defaulted loan amount is Rs 3
billion.

The funds are provided by SBP to FBC at 0.5% which are passed on to the Provincial
Cooperative Banks, with a 1.84% charge which are passed on to the societies at 10% and
finally on-lent to the farmers at 14%. This entire intermediation process appears to be highly
inefficient given the fact that none of the intermediaries are able to be profitable.

Pakistan Industrial Credit and Investment Corporation Ltd. (PICIC)

PICIC was established in 1958 with the aim of providing project finance to the industrial
sector. At present PICIC has a total of 19 branches employing around 381 people. PICIC went
through downsizing in 1997 laying-off 221 people – a reduction of 37%. Shareholding of
PCIC is 54% with the private sector and 46% is held indirectly by the government through
State Life Insurance Corporation – 22% and NIT – 18% and remaining is with ICP and PIC.
The Board of Directors have 16 members of which 7 are from these institutions including 1
from the Ministry of Finance.

PICIC unlike the other DFIs is not entirely dependent on SBP borrowing which accounts for
only 17% of total borrowing. PICIC’s main source of funding was credit lines from
international lending agencies which accounted for 73% of its borrowings. However, such
lines of credit are no longer available and PICIC has launched some new and innovative
deposit schemes, one with free life insurance coverage in their deposit mobilization efforts.

The current management focus also remains on recoveries due to their portfolio problems
with Rs. 11.5 billion in non-performing loans accounting for about 80% of its total advances.
PICIC is trying to diversify into other businesses to improve its financial position and has
recently also obtained permission from the Securities & Exchange Commission to start
leasing.

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