A Comparative Study of the Performance of Local and Foreign Banks in Pakistan: Some

ANOVA Evidence
The paper measures the financial performance of local and foreign banks operating in
Pakistan, and secondly it investigates the causes of performance deficiencies. The performance
of the sample banks is measured by using one-way Analysis of Variance (ANOVA). The paper
uses three parameters and proxies to measure bank performance profitability, financial structure
and efficiency. The determinants used for estimation of these three parameters are Return on
Assets (ROA), Return on Equity (ROE), Net Profit Margin (NPM), Debt-to-Equity Ratio (DER),
Capital Adequacy Ratio (CAR) and Operating Expense-to-Assets (OETA) ratio. The first stage of
findings indicates that foreign banks have a sound financial structure compared to the local
banks. The second stage of findings indicates that the ROA and ROE of foreign banks are
comparatively higher than that of the local counterparts. The results at the second stage also
show that NPM of foreign banks is higher than that of local banks. Finally, the third stage of
analysis finds that local Pakistani banks are less cost-efficient than foreign banks operating in
Pakistan.
Introduction
Banking industry acts as a backbone of modern business and performs as a bridge to
provide a specialized source of financial intermediation. Banks transfigure their multiple inputs
in several financial goods. The macroeconomic stability of banks enables them to change their
overall preferences and plays a crucial role in the reinforcement of fiscal policy. Therefore, the
organized and proper allotment of banking encouraged the growth level of the economy (Galbis,
1977; Ngalande, 2003; and Hartman, 2004). Furthermore, the economic progression and fiscal
mediation have direct association. The fiscal growth and its positive associations were utilized as
an important determining factor in the growth modeling (Gurley and Shaw, 1955; and
Goldsmith, 1969). Performance assessment is crucial in the background of an effective and
successful financial sector. Varadi et al. (2006) imply that the efficiency of banking sector is very
crucial for the firmness and stability of the economy in this period of time. Moreover, measuring
banks performance using financial ratios such as net earnings, service production, assets and
fiscal management gives us better outcomes.
Khalid (2006), employing CAMELS framework of financial indicators, concluded that
the privatization process of banking sector improved the performance of banks in Pakistan. The
study further suggested that the banking sector requires proper supervision and regulation.
Usually, there are different (old and new) techniques to measure bank performance, but the most
commonly used technique is the use of financial, profitability, and liquidity ratios. Financial
ratios are used as a necessary medium for the manipulation and analysis of financial position and
performance of banking sector (Shapiro, 2000). Financial ratios represent competitiveness,
operating, financial, and investment decisiveness in comparison to the existing competitors in the
financial environment (White, 1998).
In Pakistan, there are four important constituents of monetary and fiscal system:
regulatory authorities, intermediaries in the form of banks, financial institutions and stock
exchanges. There are three regulatory authorities: State Bank of Pakistan (SBP), Pakistan
Banking Council (PBC) and the Corporate Law Authority (CLA).
Many studies have been performed by Pakistani researchers for measuring performance
and efficiency of banking industry. They used both statistical and non-statistical methods, but the
outcomes of their studies are different on the basis of methodology, sample size and models.

Important among them are Khan (1995), Shapiro (2000), Akhtar (2002), Burki and Niazi (2003),
Khalid (2006), Qayyum and Khan (2006), Ansari (2007), Bokhari et al. (2009) and Salehi and
Yousefi (2011). Previous studies did not explain the financial structure, profitability and
efficiency of local and foreign banks in the context of financial ratios.
The core points of this study that distinguish it from the above-mentioned studies are:
first, the application of one-way ANOVA for measuring performance differences; second, the
study includes the merged and the non-merged banks; third, the estimation of performance gaps
is explained through a selection of core performance measures, which play a crucial role in the
financial sustainability of the banking industry; and fourth, theoretical relevance of the results
and causes and strategic solutions for low-performance and inefficiency are provided.
Literature Review
Performance is conceptualized as a banks ability to generate transactions by effectively
utilizing its resources and efficiency and refers to the ratio of outputs to inputs. Efficiency is a
relative term and is used for the comparison of observed quantity of input and output variables
with respect to the optimal quantity of these variables. The optimal quantity is achieved through
minimization of inputs (input orientation) and maximization of outputs (output orientation). It
means to produce outputs from a given level of inputs (Wilson, 1995). The previous research
conducted in India examined the performance of liberalized banking industry and implied that
the type of the owners position has meaningful impact on undetermined performance
instruments. Furthermore, the overall extension in competition and the period of liberalized
financial industry are closely related with the contraction in mediation cost and net earnings of
the banking industry (Koeva and Hallinan, 2003). Extensive studies were conducted in Pakistan
and other countries such as India, Malaysia and Greece on the performance and efficiency of
banking sector. These studies indicated that the large-sized banks are relatively sound, with
average and small-sized banks placing themselves in small markets. Thanassoulis (1999) studied
the performance and efficiency of banks on the basis of outputs and inputs, i.e., how efficiently
a bank utilizes its resources (intermediary function) to increase its level of outputs (production
efficiency).
Shaikh and Jalbani (2009) and Majid (2010) indicate that performance measurement of
banks is significant for risk management in both Islamic and commercial banks. Moreover, the
functions of operating commercial banks as equivalent collaborator are supporting the aggregate
fiscal solidity and firmness of banking sector. In the situation of competition between
conventional and Islamic banks, the investigation of financial stability of the banks is essential
under banking regulations, i.e., Basel regulations. Lim and Randhawa (2005) measured the
efficiency of banks in Hong Kong and Singapore and found that economies of scale and type of
ownership had a huge influence on the efficient banks in both the economies. They also proved
that various financial changes in the banking environment of Hong Kong left no significant
influence upon the comparative efficiency of banks. Mukherjee et al. (2002) measured the
association between planned groups and efficiency of Indian banking industry. The study was
based on four output variables, namely, net income, deposits, loans, interest spread and noninterest income, while the input variables comprised number of branches, operating expenditures,
net worth and bank borrowings. Pandey and Bi (2011) argued that there is a significant
difference between performance of public and private banks and microfinance institutions in
India.

Efficiency of Banks
Akhtar (2002) measured the efficiency of 40 private sector banks of Pakistan and found a
strong support for the privatization process and ended up with a need for improvement in the
banking performance as well as efficiency. Attaullah et al. (2004) estimated the aggregate
efficiency of private sector banks of Pakistan and India before and after privatization. The study
implies that the efficiency of banking industry has been improved after the process of
privatization. Ansari (2007) investigated that the efficiency scores of banks are distinguished
comparatively and vary from 87% to 49%. Mostly, the public sector banks have an existence in
the smallest efficient category, while more number of foreign and less number of local
commercial banks survive in the superefficient group. Additionally, the raising rate of bad debts
results in cost inefficiency of banks. Milbourne and Cumberworth (1991), Sufian (2007) and
Wang and Lee (2008) implied that accounting ratios do not provide adequate information about
different magnitudes of a banks performance because the results of accounting ratios are always
comparative and do not give accurate results. The ratio technique failed to contemplate multiple
inputs that bank uses to carry and turnover outputs to accomplish performance due to the yearwise divergence of calculated numbers based on the fiscal records.
Patti and Hardy (2001) measured the relative efficiency of Pakistani commercial banks.
Their study found that the banking reforms remained beneficial to the bank customers. As a
result, public and private sector banks enhanced their cost efficiency. Moreover, the domestic
commercial banks have achieved success in expanding capital and recovery of profit in Pakistan.
Kiani (2005) studied the relative technological efficiency of private sector banks and
functioning of foreign banks. The findings of the study revealed that foreign banks are more
efficient compared to the domestic private Pakistani banks. Islam and Chowdhury (2009), using
ratio analysis, compared the liquidity position of commercial and Islamic banks in Bangladesh.
They found that the liquidity performance of Islamic banks is greater than that of the
conventional banks.
Profitability of the Banking Sector
Boubakri et al. (2005) studied a sample of 88 banks in 22 underdeveloped countries by
applying univariate tests and multidimensional data estimation methods. Their results indicate a
decline in the economic efficiency and rise in the credit risk disclosure of commercial banks.
Furthermore, the recently privatized banks are more profitable than pre-privatized banking
industry. Favero and Papi (1995) analyzed the efficiency of Italian banking sector. They used
both parametric and non-parametric methods for comparison and found that there was a higher
deviation in the profit and cost measures of Italian banking environment. Financial
Structure/Capital Structure of Banks Bokhari et al. (2009) indicated that the capital adequacy
ratio of Pakistani commercial banks is less than that of their foreign counterparts. They are
unable to meet the minimum capital requirement settled by the regulatory authority (State Bank
of Pakistan). The capital adequacy requirement has a great influence on the risky investment of
banks owners and management. The lower capital adequacy ratio enhances the risky behavior of
banks top management (Furlong and Keeley, 1989).
The strict regulations on banks capital requirement enable banks to control asset choices.
Furthermore, in addition to the undercapitalized banks, the capitalized banks can also face moral
hazard due to an increase in risk behavior, less lending chances and incompetent managers

(Gorton and Rosen, 1995). The risk-weighted ratios have no effect on the savings of banks as
well as volume of deposits. The study was unable to exhibit any influence of capital adequacy
ratio upon both the variables (Pausch and Welzel, 2002).
Objectives
The specific objectives of this study are threefold:
1. To investigate and contrast the fiscal performance of local and foreign banks of Pakistan;
2. To examine the fiscal structure of local and foreign banks of Pakistan; and
3. To analyze the profitability and efficiency of local and foreign banks in Pakistan.
The following hypotheses are proposed:
H0: There is no significant difference between the means of local and foreign banks.
H1: There is a significant difference between the means of local and foreign banks.