Banking sector reforms in a challenging environment: An emerging financial market experience

Abstract

The long-lasting impact of reforms on financial institutions in the presence of country level risks and uncertainties may be unclear but has been rarely investigated. By using more than two decades of Pakistani banking industry data covering a period of uncertain policies and volatile political and economic environment alongside severe security threats due to terrorism, this study examines technical change, scale effect, and total factor productivity growth. Our estimates show that despite deep economic and regulatory reforms spreading over a decade, country level risks and uncertainties led to no longer run technological progress and productivity growth. This made the long-run outcome of broader reforms in the presence of a number of uncertainties less satisfactory and did not help materialize the true benefits of reforms. Change of ownership through privatization contributed positively in achieving technological progress and productivity growth, but this limited positive effect faded subsequently. Interestingly, the negative impact of risks and uncertainties is more severe for domestic privately owned and foreign-owned banking firms with parent institutions based in other than Western and developed countries. More specific analysis of the individual uncertainties and related risks shows that although economic, legal, and security-related risks and uncertainties are important for all firms in determining the outcome of reforms, increased uncertainty with corruption perception, law & order conditions, and investment climate in particular impacts more domestically owned firms.