Corporate Ownership & Control / Volume 6, Issue 2, Winter 2008 – Continued – 3 POLITICAL MOTIVATIONS: THE NATIONALIZATION OF THE PAKISTANI BANKING SECTOR Hussain Gulzar Rammal* Abstract The sixth most populated country in the world, Pakistan has faced political instability since her independence. The Pakistani banking sector, which had experienced rapid growth, faced an unexpected move in 1974 when through a parliamentary act; the Government of Pakistan nationalized the industry and seized control of all assets. The purpose of this paper is to highlight the events leading to the nationalization and the impact of the decision on the banking sector in Pakistan. The findings of the paper reveal that the decision to take control of the banking sector was a politically motivated one which failed to achieve the objectives that were set out during the nationalization. Keywords: nationalization; privatization; Pakistan; banking. *The University of Adelaide Business SChool, Australia [email protected] 1. Introduction countries via its Eastern border with India (Dunung 1999). Since her independence in 1947, the Pakistani The demand for a new country in South Asia Banking sector has faced numerous challenges. From called Pakistan was first put forth in a resolution in laying the foundations of a financial regulatory Lahore by the All India Muslim League on 23 March system to establishing indigenous banks to compete 1940 (Ahmad 1997). This new proposed country with foreign owned entities, Pakistani banks worked would be the homeland for the Muslims of South Asia hard to make their presence felt both nationally and and on 14 August 1947 Pakistan was created. globally. But these efforts received a jolt in 1974 Pakistan’s population consists of people from different when the Pakistani Government nationalized the ethnic backgrounds such as Punjabis, Sindhis, banking industry and took over control of the Balochs, Pathans, Bengalis and Mohajirs (those who operations and assets of Pakistani banks both at home migrated to the newly independent state of Pakistan and abroad. This paper provides a critical account of after the partition) who came together as a nation on the events that led to the nationalization and the basis of the common religious belief of Islam subsequent privatization of the Pakistani banking (Khan 2007). The differences in the ethnic background sector. were exposed in 1970-1971, when the then Eastern This paper is divided into six sections. The part of Pakistan broke away from the Western part to following section provides a brief profile of Pakistan form the independent nation of Bangladesh (Memon and its economy. Section three provides the history of 1996; Ziring 1971). the Pakistani banking sector from the time before the Pakistan was the first country in the world to partition from India till the end of the 1960s. Section declare herself an Islamic Republic on 23 March 1956 four details the events that led to the nationalization of (Constitution of Pakistan 2008). More than 97 per cent the Pakistani banking sector, followed by section five of Pakistan’s population belongs to the Islamic faith, which discusses the steps taken by the government in making it the second most populated nation in the 1980s and 1990s to privatize the banking industry and Muslim world after Indonesia. As such, religious the current market situation. The final section beliefs heavily influence the national and business provides core findings and conclusions of this paper. culture of Pakistan (Karim 2008). For the majority of Pakistan’s existence, the military has ruled the country 2. Profile of Pakistan (Dunung 1999) and many of the state owned enterprises, and a few financial institutions, are With a population of more than 172 million people managed by active and retired military personnel. (2008 estimate), Pakistan is the sixth most populated country in the world (Population Reference Bureau 3. The banking sector (pre-partition – 2008). Situated in South Asia, Pakistan borders the 1974) Middle East via Iran, Central Asia via Afghanistan and Tajikistan, East Asia via China and other South Asian Prior to the partition of India, the financial sector was in the hands of foreign banks some of which were 342 Corporate Ownership & Control / Volume 6, Issue 2, Winter 2008 – Continued – 3 British by origin. Commencing their operations in reason for the separation of Eastern wing of Pakistan 1883, the oldest banks operating in India were the which came to be known as Bangladesh. Politically Chartered Bank and the Grindlays Banks (Baig 1999; this economic disparity saw the increase in popularity Baig 2000; Khalid and Hanif 2005). Among the of the alternative socialist system. Pakistan had since indigenous banks, the Imperial Bank of India was the independence allied herself politically to the United largest Indian Bank and performed the dual roles of a States and followed a relatively liberal capitalist commercial bank as well as the Central Bank for economic system. In 1971, the elected Government India. In 1935 the Reserve Bank of India was led by Zulfiqar Ali Bhutto came to power on a established as the independent central bank. However, platform of promotion of socialist economy in the due to its large network, the Imperial Bank continued country (Karim 2008). The new government motto to play the role of a subsidiary of the Reserve Bank of was to provide food, shelter and clothing to the India (Khalid and Hanif 2005). masses. The role of the government increased sharply The role of the Muslim population in the banking with both direct as well as indirect controls over the sector prior to the independence of Pakistan was economy. Direct controls took the form of price limited. The only bank in pre-partition India that was regulation; restriction to entry and exit; allocation of owned by Muslims was the Habib Bank, which was resources, services and credit; issuing licenses for new established in 1941 (Khalid and Hanif 2005). To investment; and regulation of monopolies to prevent improve and strengthen the banking sector for the inefficiencies in economic transactions. Indirectly, the future Muslim State of Pakistan, the leader of the Government intervened in the economy through Muslim League, Muhammad Ali Jinnah, expressed taxation, provision of subsidies and incentives in the his desire that another Muslim bank be established form of protection, tax exemptions, infrastructure and before partition. In 1947, a few months before the social services (Baig 1999). The Bhutto-led creation of Pakistan, the Muslim Commercial Bank government decided that the best way for achieving was established (Baig 1999). After the creation of equitable growth in Pakistan was by nationalizing Pakistan, both Habib Bank and Muslim Commercial banks, insurance, educational institutions, utilities and Bank shifted their headquarters to Karachi, the then other industries. Thus, the public sector became capital city of Pakistan. Pakistan did not have its own responsible for the provision of all infrastructures central bank until 1948, a year after independence including energy and communications and financial (Khalid and Hanif 2005). In May 1948, the founder of services but it also participated in the manufacturing Pakistan, Muhammad Ali Jinnah, took steps for the activities as well. establishment of a central bank. These steps were The action to nationalize the banking sector was implemented in June 1948, and the State Bank of first promulgated as an Ordinance on 1 January 1974 Pakistan commenced operation on 1 July 1948. Under by the President of Pakistan as ‘The Banks the State Bank of Pakistan Order 1948, the Bank of (Nationalization) Ordinance, 1974’. The Bill of the Pakistan was charged with the duty to regulate the Act was introduced in the National Assembly on 23 issue of bank notes and keeping of reserves with a January 1974 with the following statement of objects view to securing monetary stability in Pakistan and and reasons: generally to operate the currency and credit system of "In order to provide the directing the country to its advantage (State Bank of Pakistan banking activities towards national 2008). socio-economic objectives, co- From 1947 the banking sector grew rapidly. The ordinating banking policy and co- private sector invested in the establishment of operation in various areas of feasible commercial banks with a network of branches across joint activity without eliminating healthy the country. At the same time, the State Bank of competition in various fields of Pakistan granted licenses to certain foreign banks to operation, and ensuring complete operate in Pakistan. But in 1974, the banking industry security of depositors' funds, the Banks fell into chaos when the government decided to (Nationalization) Ordinance, 1974 (I of nationalize the banking sector (Husain 2004). 1974), was promulgated on the 1 January, 1974. This Bill, which contains 4. The banks (nationalization) certain additional provisions relating to ordinance, 1974 the management and administration of the banks, seeks to replace the said The growth of the banking sector was accompanied Ordinance by an Act of Parliament". by rapid growth of the Pakistani economy. This is (State Bank of Pakistan 1974, p.2) evident from the fact that in 1969 the exports of Pursuant to the Rules of Procedure and conduct Pakistan were higher than the combined exports of of business in the National Assembly, 1973, the Bill Indonesia, Malaysia, Philippines and Thailand was referred to the Standing Committee on Finance, (Husain 2004). But in Pakistan a perception had Planning and Development, Economic Affairs and developed that income and regional disparities has Statistics. The Committee considered the Bill at its widened resulting in concentration of wealth in a few meeting held on the 28th January, 1974 unanimously hands. Many critics blame this inequality is the core recommended introduction of the Bill in the National 343 Corporate Ownership & Control / Volume 6, Issue 2, Winter 2008 – Continued – 3 Assembly. On 29 January 1974 the Bill was accused by many of nepotism when it came to introduced in the National Assembly and received the promotions.