Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 32588

IMPLEMENTATION COMPLETION REPORT(IDA-35710)

ON A

CREDIT

IN THE AMOUNT OF SDR 239.5 MILLION (US$300 MILLION EQUIVALENT)

TO THE

GOVERNMENT OF PAKISTAN

FOR A

BANKING SECTOR RESTRUCTURING AND PRIVATIZATION PROJECT

June 15, 2005

Finance and Private Sector Development UnitSouth Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective June 15, 2005)

Currency Unit = Pakistani Rupees (Rs) Rs. 1 = US$ 0.0168US$ 1 = Rs. 59.65

FISCAL YEARJuly 1 June 30

ABBREVIATIONS AND ACRONYMS

ABL Allied Bank LimitedADB Asian Development BankBSAL Banking Sector Adjustment LoanBSDP Banking Sector Development ProgramCAS Country Assistance StrategyCIRC Corporate and Industrial Restructuring CorporationDFI Development Finance InstitutionFA Financial AdvisorFCD Foreign Currency DepositFSDIP Financial Sector Deepening and Intermediation ProjectGOP Government of PakistanHBL Habib Bank LimitedMCB Muslim Commercial BankMOF Ministry of FinanceNBP National Bank of PakistanNCB Nationalized Commercial BankNDFC National Development Finance CorporationNSS National Savings SchemePC Privatization CommissionSBP State Bank of PakistanUBL United Bank LimitedABL ADB Asian Development BankBSAL Banking Sector Adjustment Loan

Vice President: Praful C. PatelCountry Director John W. Wall

Sector Director Joseph Del Mar Pernia Task Team Leader/Task Manager: Kiatchai Sophastienphong

PAKISTANBanking Sector Restructuring and Privatization Project

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 45. Major Factors Affecting Implementation and Outcome 96. Sustainability 117. Bank and Borrower Performance 128. Lessons Learned 149. Partner Comments 1510. Additional Information 16Annex 1. Key Performance Indicators/Log Frame Matrix 17Annex 2. Project Costs and Financing 18Annex 3. Economic Costs and Benefits 19Annex 4. Bank Inputs 22Annex 5. Ratings for Achievement of Objectives/Outputs of Components 23Annex 6. Ratings of Bank and Borrower Performance 24Annex 7. List of Supporting Documents 25Annex 8. Borrower's Assessment of the Project 26

Project ID: P055292 Project Name: Banking Sector Restructuring and Privatization Project

Team Leader: Kiatchai Sophastienphong TL Unit: SASFPICR Type: Core ICR Report Date: June 15, 2005

1. Project DataName: Banking Sector Restructuring and Privatization

ProjectL/C/TF Number: IDA-35710

Country/Department: PAKISTAN Region: South Asia Regional Office

Sector/subsector: Banking (100%)Theme: State enterprise/bank restructuring and privatization (P); Corporate

governance (P); Tax policy and administration (S); Law reform (S)

KEY DATES Original Revised/ActualPCD: 03/06/2001 Effective: 10/24/2001 10/24/2001

Appraisal: 04/10/2001 MTR: 08/31/2002 09/01/2002Approval: 10/23/2001 Closing: 12/31/2004 12/31/2004

Borrower/Implementing Agency: GOP/MOF; GOP/SBP; GOP/PC; GOP/NCBsOther Partners: None

STAFF Current At AppraisalVice President: Praful C. Patel Mieko NishimizuCountry Director: John Wall John WallSector Manager/Director: Joseph Del Mar Pernia Marilou Jane D.UyTeam Leader at ICR: Kiatchai Sophastienphong Joseph Del Mar PerniaICR Primary Author: Kiatchai Sophastienphong;

Isfandyar Zaman Khan; Weenarin Lulitanonda

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: SU

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:

The objective of the Project, which remained unchanged throughout the project life, was to help Pakistan continue implementation of its banking reform program started in 1997, supported by the Banking Sector Adjustment Loan (BSAL), aimed at achieving a competitive private banking system that operates under a strong regulatory framework, is supported by an effective banking court system, and intermediate resources independently of vested interests and in response to price signals. Specifically, the Project was planned to help the Government privatize Habib Bank Ltd. (HBL) and United Bank Ltd. (UBL) within a period of two to three years, get National Bank of Pakistan (NBP) ready for privatization, and divest the remaining government shareholdings in partially privatized banks. In addition, the project sought to address the problems of the specialized financial institutions by reducing their number to three (catering to small industries, housing finance and small agriculture), and amalgamating the largest Development Finance Institution (DFI) - National Development Finance Corporation (NDFC), into the National Bank of Pakistan (NBP). On the policy side, the government was expected to liberalize bank branching policy, revise the tax policy for the banking sector, reduce the level of taxation, amend the Loan Recovery Act of 1997 to facilitate the foreclosure of loan collaterals, reform the National Savings Schemes, and reform the Foreign Currency Deposit Scheme.

3.2 Revised Objective:

None

3.3 Original Components:

To achieve its objectives, the project consisted of the following components:

a) Restructuring Components • Branch rationalization of the Nationalized Commercial Banks (NCBs) • Staff rationalization of the NCBs • Amalgamation of NDFC into National Bank

b) Privatization Components • Bona fide attempt at fully divesting the government's remaining shareholding in

Muslim Commercial Bank at market prices • Sale of the government's 49% share ownership in Allied Bank to a qualified strategic investor

• Substantial progress in the sale of United Bank • Substantial progress in preparing Habib Bank for sale • Initial progress in preparing National Bank for sale

c) Policy Components • Liberalization of bank branching policy • Revision of the tax policy for the banking sector and initial reduction in the level of

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taxation • Amendment to the Loan Recovery Act of 1997 to facilitate the foreclosure of loan

collaterals • Reform of the National Savings Schemes • Reform of the Foreign Currency Deposit Scheme

3.4 Revised Components:

The project was restructured twice under which amendments were made to the Development Credit Agreement (DCA) to add new components needed to facilitate the achievement of the project development objective, even though the project development objective remained unchanged. The first amendment to the DCA was made in February 2003 to allocate $50 million, earlier earmarked for the second phase of the Voluntary Retirement Scheme (VRS) of Habib Bank Limited (HBL), for the VRS of Allied Bank Limited (ABL). The second phase of HBL's VRS was not carried out as staff retrenchment under the first phase was able to achieve the desired objective of improving the cost structure of the bank to a level that made it saleable. As a result, there was a cost saving under the project. ABL was the second bank in the public sector to be privatized. Unlike Muslim Commercial Bank (MCB), which was sold to a strategic investor, ABL was privatized through an Employee Stock Ownership Plan (ESOP). During 1991-1993, a total of 51 percent shares was sold to the Allied Management Group, which represented the employees of ABL, thus making the bank a private bank and the provisions of the Banks Nationalization Act of 1974 ceased to apply. In 1999, it transpired that one of ABL's major defaulters had purchased about 35-40 percent of ABL shares from employees. Subsequently in July 1999, the SBP imposed restrictions on the transfer of shares from employees to non-employees, except with prior approval from the SBP. The bank had also been operating at a loss with alarming levels of NPLs and its capital adequacy ratio was well below the minimum requirement. In August 2001, the SBP appointed a new Board of Directors to look after the affairs of the bank. Thus, ABL was effectively re-nationalized and taken over by the SBP because of its governance and financial problems. There was a need to re-privatize the bank and so the project was restructured to make this possible. Essentially, the DCA was amended to include ABL in the definition of NCBs so that the project money could be used to fund its VRS, which would improve its cost/income ratio and make it privatizable. However, due to strong demand for a bank presence in Pakistan and the change in the transaction structure with investors asked to pay for the shares to the bank itself rather than to the government, the authorities were able to privatize ABL without having to pay for its VRS. Given that the high cost of balance sheet restructuring to the government was not fully financed and the relevant project development objective of privatizing the NCBs had already been met, the DCA was further amended in September 2004 to allow for reimbursement against the cost of balance sheet restructuring of NCBs, which was incurred early on by the government to pave the way for their eventual privatization.

3.5 Quality at Entry:

The project was not subjected to QAG assessment of Quality at Entry.

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4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:

All the major development objectives of BSRPP, namely restructuring of the Nationalized Commercial Banks (NCB) to improve their prospects for sale to qualified strategic investors and completing the privatization of the partially privatized banks, have been fully realized. With the privatization of two of the three NCBs which accounted for nearly 25 percent of the system, nearly 80 percent of the country’s banking sector assets are now in private hands. ABL, which was taken over by the government in August 2001 because of financial and governance problems, was successfully re-privatized in August 2004. The National Development Finance Corporation (NDFC) was successfully merged with NBP. The government was able to divest its remaining 25 percent shareholding in Muslim Commercial Bank (MCB) in three market sales from November 2001 through November 2003. Necessary policy actions including reforms of the NSS and FCDS, gradual reduction of the taxation of the banking sector, and liberalization of bank branching policy were carried out. All of the key performance indicators were achieved (See Annex 1).

As a result of reforms undertaken under BSAL and BSRPP, financial soundness indicators of commercial banks have been improving in recent years. Banks’ average capital adequacy ratio—capital to risk-weighted assets—improved from 6.0 percent at end-December 1997 to 11.6 percent as of September 2004. This reflects improved profitability and fresh injections of capital, particularly in state-owned banks prior to privatization. Similarly, the aggregate NPL ratio—share of gross NPLs in total loans—for the banking system has shown a declining trend from 20.1 percent to 11.0 percent over the same period. Profitability indicators have also shown a marked improvement. After being negative in 1997 and several years thereafter, ROE turned around to about 19.9 percent and ROA increased to 1.2 percent as of September 2004. The market share of state-owned banks has declined steadily with nearly 80 percent of banking sector assets now in private hands. The improvements in the financial soundness of the banking system and the declining role of public sector banks can be demonstrated in the table below.

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Financial Indicators of the Banking System(in percent)

Before Reforms 1/

After Reforms 2/

Capital Adequacy Regulatory capital to risk-weighted assets 6.0 11.6 Tier I capital to risk-weighted assets 5.5 9.5 Capital to total assets 3.1 6.2

Asset composition and quality NPLs to gross loans 20.1 11.0 Provisions to NPLs 54.2 70.2 NPLs net of provisions to capital 10.3 3.6 Net NPLs to capital 143.6 26.5

Earnings and Profitability ROA (after tax) (1.3) 1.2 ROE (after tax) (36.2) 19.9 Net interest income to gross income 46.5 60.1 Cost/Income Ratio 85.8 53.5

Liquidity Liquid assets to total assets 41.4 42.3 Liquid assets to total deposits 49.4 53.0

Market Share of Public Sector Banks Assets 48.5 21.0 Deposits 52.6 22.9 Loans 46.9 17.1

1/ Data as of end-December 19972/ Data as of end-September 2004

Source: SBP.

4.2 Outputs by components:

a) Restructuring Components

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The first phase of restructuring the NCBs (HBL, UBL and NBP), implemented under the Banking Sector Adjustment Loan (BSAL), was achieved by bringing in professional management from outside to undertake cost restructuring by downsizing staff and closing down unprofitable branches. The NCBs underwent extensive operational restructuring with the start of the BSRPP program in 2001, a total of 11,083 staff out of a target number of 25,635 or 43 percent were separated through voluntary separation programs. Staff rationalization, de-layering, and branch rationalization (where 1,487 branches out of a target number of 1,800 branches or 83 percent were closed) reduced the high cost structure of NCBs and brought their cost/ income ratios closer to the international benchmark of 0.50. Although branch closure and staff retrenchment were below the targets, the cost reduction brought about by staff and branch rationalization enabled the banks to invest further and faster in technology, increased staff productivity, improved work culture and, improved public access to banking services. Thus, the government was able to privatize the banks well before the completion of BSRPP.

The project development objective of promoting the expansion of the healthy part of the banking system was accomplished through the liberalization of bank branching policy and with the amalgamation of NDFC with NBP under the scheme approved by the federal government, thus dissolving the largest and most chronically insolvent development finance institution.

b) Privatization Components

As a result of cost restructuring, coupled with the improving investment climate, the government was able to privatize the two NCBs (UBL and HBL) to qualified strategic investors, divest a minority equity stake through public offering in one NCB (NBP), and complete the privatization of the partially privatized banks (MCB and ABL). A qualified buyer from UAE joining hands with a local business group won the bid for a 51 percent stake in UBL with the purchase price of Rs. 12.35 billion (US$ 210 million) in September 2002. Strategic equity stake of 51 percent in HBL was sold to a qualified foreign institutional investor for a total bid price of Rs.22.40 billion (US$390 million) in February 2004. As NBP is planned to be privatized only in the medium term, the government sold a 10 percent of the bank’s shares through an initial public offering in November 2001. Further sales of 10 percent and 3.2 percent respectively in October 2002 and October 2003, brings the total to 23.2 percent. The government also successfully sold 16 percent of the remaining 24 percent shares in MCB in 2001 and the remaining 8 percent government shares in MCB were divested through the stock exchange in early 2003. In the case of ABL, the bank has operated under state appointed management and board since 2001 due to governance and financial problems. ABL was originally not included in the project but was subsequently brought under its purview at the request of the government, through amendment to the DCA in July 2003, as the government accorded it high priority and its inclusion was consistent with the original project objectives. In July 2004, SBP structured a sale of 75 percent shares with an issue of additional shares in the bank to a local finance group. The group paid for the shares and took over the control of the bank at the end of August 2004. Four out of five large nationalized commercial banks

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have now been privatized while 14 private domestic and 18 foreign banks are operating in the banking sector. State ownership of banking assets has declined from 92 per cent in 1992 to 20 percent. Moreover, the governance structure of banks has been strengthened, better disclosure and transparency standards have been introduced and credit ratings of banks have been made mandatory and disseminated widely to the public at large. Fit and proper criteria have been prescribed for the directors and senior managers.

c) Policy Components

In the area of policy reforms the project has brought about the desired outcome. Artificially high rates of return on National Savings Schemes, which were putting bank deposits at an intrinsic disadvantage and creating uneven playing field against the banks, have been gradually rationalized and aligned with market-based benchmarks so that the choice of the savers between NSS and bank deposits is less tilted than before. Foreign exchange markets have been liberalized to a significant extent, although the SBP intervenes from time to time to stabilize the currency. All current account transactions and most capital account transactions have been made convertible. Formation of exchange companies has encouraged further liberalization of capital movements. Government borrowing from the banking system is increasingly market-based and the annual volume of borrowing is limited and pre-announced. Mandatory credit allocations or subsidized interest rates have been abolished and the Central Bank does not require banks to lend to preferred sectors. Financial instruments of varying tenure such as Pakistan Investment Bonds have been introduced by the Government to serve as the benchmark enabling a corporate debt market to function. An on-line Credit Information Bureau is maintained by the Central Bank for sharing information with the commercial banks on the credit history of the borrowers, and particularly those who are not servicing their debt on time. Diversification of risks has been attempted by encouraging bank lending for agriculture, SMEs, consumer financing, mortgages etc., and widening and strengthening the customer base in place of a narrow concentration on public sector and corporate borrowers.

In terms of regulatory framework, the State Bank’s capacity to supervise and regulate banks, effectively monitor non-performing loans, enforce actions against banks found violating regulations and laws has been strengthened. In the last four years, license of one bank was revoked while appropriate intervention resulted in change of ownership and management of three banks. Several institutions were forced to liquidate or merged with strong institutions. Several development financial institutions have either been closed, wound up, privatized, converted into a bank, restructured and adequately capitalized for eventual sale to the private sector.

An independent assessment of the financial sector by a joint World Bank-IMF team has concluded that the financial soundness indicators of Pakistani banking system are robust and can withstand exogenous shocks. Observance of internationally accepted standards and codes has been found to be quite high. Stringent measures have been laid and enforced on classification of non-performing loans, loan loss provisioning, tier 1 and tier 2 capital adequacies, write off of unrecoverable debt and allocation of capital against market risk. Three different sets of

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regulations specifically tailored to manage the risk profiles of corporate, consumer and SME lending have been issued by the State Bank in consultation with the banks and businesses.

Minimum capital requirements of banks have been raised twice during the last four years to weed out weak banks and allow mergers and consolidation to take place so that fewer but stronger banks operate in the system. Banks and DFIs are now required to meet the minimum capital of Rs.1.5 billion by December 2004 and of Rs.2 billion by December 2005. In order to prepare banks/DFIs for Basel II, the State Bank has also imposed additional capital charge for market risk. Most recently the State Bank has decided formally to adopt Basel II and has issued a circular setting out the timeframe for adoption of different approaches under Basel II as follows: (i) Standardized Approach for credit risk and Basic Indicator/Standardized Approach for operational risk from 1 January 2008; (ii) Internal Ratings Based Approach (IRB) approach from 1 January 2010, with banks/DFIs given the flexibility to implement it sooner if their internal risk management systems are approved by the State Bank; and (iii) banks/DFIs will be required to adopt a parallel run of one and a half years for Standardized Approach and two years for IRB Approach starting from July 1, 2006, and January 1, 2008 respectively.

4.3 Net Present Value/Economic rate of return:

The cost restructuring program involving the introduction of VRS for staff and closure of branch offices was justified as an investment project that was expected to produce a stream of cost reductions in terms of salary savings of retrenched staff, administrative cost saving on account of branch closures, and removal of subsidy on staff loans. Applying this methodology, the EIRR was estimated to be 21 percent for UBL compared to the estimated EIRR of 21 percent at the time of appraisal. Similarly, the EIRR for NBP was found to be 16.45 percent as against the estimated figure of 38 percent due to the lower number of staff retrenched and the higher number of outsource positions post-retrenchment than anticipated at the time of appraisal. However, the EIRR is considered acceptable since it is still much higher than the cost of funds in the country. No estimate has been made for HBL as the SBP is still checking the accuracy of data received from the bank (see Annex 3).

4.4 Financial rate of return:

The payback period for NBP was found to be 3.36 years compared to the estimated payback period of 3.18 years. Similarly, the payback period for HBL was 4 years compared to the estimated payback period of 3.5 years, and for UBL the payback period was 4 years compared with the estimated payback period of 4.09 years. The actual payback periods of the VRS programs are in line with the estimates made at the time of appraisal and so are considered satisfactory (see Annex 3).

4.5 Institutional development impact:

The institutional impact has been substantial. The experience gained from implementing VRS in the NCBs would be useful for the government in trying to design a similar retrenchment program for other public sector corporations. The lessons learned from institutions restructuring

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program in NCBs could be gainfully employed for undertaking similar restructuring programs in other public sector banks.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:

The most contentious points in the design of Voluntary Retirement Scheme (VRS) were staff loans and medical benefits. Cases went to the court where it was decided that staff loans could not be deducted from the lump sum severance payment and hence these were ultimately retained in an on-going relationship with the ex-staff member. In the case of medical benefits, it was decided that early termination was problematic (especially for large families) and hence a five-year insurance coverage was offered in lieu of this prior benefit. It was discovered that to implement VRS successfully NCBs needed to have clear target groups, set the stage early, offer packages that would be accepted quickly, and close out the program quickly.

5.2 Factors generally subject to government control:

The restructuring program required endorsement by the Ministry of Finance, the SBP and the three NCBs. The plans prepared by the three NCBs were approved by the Cabinet in a timely manner and, consequently, project implementation began even before the project was approved by the Bank.

5.3 Factors generally subject to implementing agency control:

Timely processing of VRS payments and effective controls (in NCBs and SBP) in this regard assured smooth implementation of the project. The implementing agencies i.e. HBL, NBP and UBL processed VRS payments as agreed during appraisal and subsequent supervision missions. Payments were in line with their respective policies in this regard. Payments were processed by the respective Human Resource Departments and checked by the Accounts and Internal Audit Departments. External auditors’ TORs were expanded to include audit of VRS payments. Banking Policy Department and Accounts Department of the SBP efficiently processed payments to NCBs. Banking Inspection Department (BID) also test-checked VRS payments as part of their inspection that resulted in a couple of recoveries. The Bank financed the unfunded part of VRS through SBP. HBL, NBP, UBL and SBP maintained professional financial management staff throughout life of the project.

5.4 Costs and financing:

The Bank team reviewed actual project costs by components and sources of financing vis-à-vis its own estimates. The table below gives the breakdown of the figures.

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Project Costs by Components (in US$ million equivalent)

Project Component Appraisal Estimates

Actual Latest Estimates

Percentage of Appraisal

Bank GoP Bank GoP Bank GoP NCB Staff Rationalization 300 137 211 - 70 - NCB Branch Closures - 3 - - - NDFC Amalgamation - 100 - 282 - 282 Completion of MCB and ABL Privatization

- - - - - -

Other Policy Measures (capital payments)

- - 116 - 116 -

Total Baseline Cost 300 240 327 282 109 118 Physical Contingencies - - - - - - Price Contingencies - - - - - -

Total Project Cost 300 240 327 - 109 118 Total Financing Required 300 240 327 282 109 118

It was found that the total cost of the BSRPP project increased from $540 to $609 million. While the actual cost of staff rationalization dropped from $437 million to $211 million due to the less than expected number of staff being retrenched, the cost of NDFC amalgamation with NBP rose by almost two-folds from $100 million to $282 million and the whole amount was funded from GOP resources. Only 70 percent, as opposed to the entire amount, was used to finance the cost of staff rationalization. The remaining amount was used for recapitalization of NCBs (see Annex 2).

The banking reforms that were initiated in 1997 have cost the Government about US$ 2 billion, nearly 1.8 % of GDP. The costs include capital injections, voluntary separation programs for downsizing and bringing the cost structure of public sector banks in line with international norms and other outstanding claims of the banks on account of state owned enterprises and tax settlements. The costs of operational restructuring of the banks were partially supported by the Bank under BSAL, BSRPP and BSDP. The net cost to the government, after factoring in financial support from the Bank and other development partners and proceeds from the privatization of NCBs, was estimated to be about US$940 million. Details of the costs incurred over reforms carried out since 1997 are provided in the table below.

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Cost of Restructuring & Privatization (US$ in millions)

Capital Injection

VRS SOE/CIRC*Recognition

Bonds

Tax Settlements

Total Cost of Restructuring

UBL 530 105 90 91 816HBL 275 160 60 172 667NDFC 50 10 -- -- 60NBP -- 415 -- 82 497Total Cost 855 690 150 345 2,040GoP Sale Proceeds** - - - - 590

Bank Support*** 400 450 850 OECF 250 250 Sub total 1,100Net Cost 940

* HBL figures includes $39 million SOE Recognition Bonds.** Proceeds from the sale of UBL, HBL and NBP’s 23 percent shares.***Includes BSAL $250 million, BSRPP $300 million, and BSDP $300 million.

6. Sustainability

6.1 Rationale for sustainability rating:

Overall project sustainability is rated highly likely. The GOP’s final evaluation project report prepared by the SBP endorsed the mission’s main finding that the project development objective has been achieved. According to the report, Pakistan’s banking sector was on the brink of a crisis triggered by over-staffing, over-branching, poor customer services, undercapitalized banks, poorly managed and narrow product range, undue interference in lending, and huge portfolio of NPLs. The reforms implemented under BSAL were able to stabilize the financial sector while BSRPP was designed to help the Government with second level of operational restructuring of the NCBs in preparation for their privatization as well as for improving corporate governance of the partially privatized banks by divesting the remaining Government holding and allowing complete private sector ownership. The reforms introduced significantly improved soundness and efficiency of the financial system by reducing state intervention and improving the environment for banking. The prospects for the project's sustainability are good given that GOP has now embarked on a second generation of reforms including completing the process of restructuring and privatization of the remaining state-owned financial institutions, improving the environment for financial intermediation including integration of the NSS with the financial markets, improving the framework for contractual savings to further deepen capital markets and develop the long-term private debt market, improving access to finance, and strengthening of the AML/CFT regime.

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6.2 Transition arrangement to regular operations:

During the course of reforms it was recognized that the NCBs would require substantial balance sheet restructuring to attract quality investors and provide the basis for genuine privatization. The total cost of restructuring and recapitalizing the NCBs to date was about US$2 billion with net cost of about US$600 million after taking into account reimbursement by the Bank for operational restructuring and the sale proceeds received by the Government from privatization of UBL and HBL. Earlier operations have supported operational restructuring in order to facilitate privatization, however, the Bank had linked any recapitalization support to successful privatization. With the completion of privatization of UBL, HBL, and resolution of ABL, the Bank agreed in December 2004 to provide IDA credit of $100 million and IBRD loan of $200 million to support the Banking Sector Development Program (BSDP) in the context of Government’s overall banking reform strategy as spelled out in its Letter of Development Policy.

7. Bank and Borrower Performance

Bank7.1 Lending:

Satisfactory. The Bank was responsive to the special circumstances of Pakistan in preparing this operation. A Bank mission was asked by the government in September 2000 to help revive implementation of the 1997 reform program, focusing on bank privatization as the next critical set of steps in the process. The plan was to privatize HBL and UBL within the tenure of the current government and to take steps towards preparing NBP for privatization. The Bank was able to respond quickly and timely to the government's request by launching the first identification mission in January 2001, which was followed by an appraisal mission two months later. The investment operation was designed to meet the objective of improving the banks' prospects for sale while working on the sale transactions themselves. It was well designed, cost effective, and timely as the NCBs had finalized their branch closure plans in Phase I by the time of the appraisal mission. The BSRPP was approved by the Board in October 2001 (see Annex 4).

7.2 Supervision:

Satisfactory. Bank staff maintained close liaison with NCBs and SBP throughout the project period. The project benefited from inputs provided by the operational and financial management staff during supervision. The supervision mission followed up on project implementation on a regular basis and was able to identify problems hindering the achievement of project development objective. The project was restructured twice under which amendments were made to the Development Credit Agreement (DCA) to add new project components needed to facilitate the achievement of the project development objective which had remained unchanged. The first amendment was made in February 2003 to allocate $50 million, earlier earmarked for the second phase of HBL's VRS, for ABL's VRS. The second phase of HBL's VRS was not carried out as staff retrenchment under the first phase was able to achieve the desired objective of improving the cost structure of the bank to a level that made it saleable. As a result, there was a cost saving under the project. Since ABL was re-nationalized because of its governance and financial problems and needed to re-privatized, the supervision mission sought and obtained

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Bank's agreement to utilize the cost savings under the project for ABL's VRS. However, due to strong demand for a bank presence in Pakistan and the change in the transaction structure with investors asked to pay for the shares to the bank itself rather than to the government, the authorities were able to privatize ABL without having to pay for its VRS. Given that the high cost of balance sheet restructuring to the government was not fully financed and the relevant project development objective of privatizing the NCBs had already been met, the subsequent supervision mission decided to seek a second amendment to the DCA to allow for reimbursement against the cost of balance sheet restructuring of NCBs, which was incurred early on by the government to pave the way for their eventual privatization. The credit was disbursed in full on November 17, 2004, well within the closing date for fund disbursement (see Annexes 4 and 6).

7.3 Overall Bank performance:

The overall Bank's performance is rated satisfactory. (See Annexes 4 and 6).

Borrower7.4 Preparation:

Satisfactory. BSRPP was the first of its kind in the South Asia Region. It is a unique case of a loan supporting a “home-grown” program where the Borrower was in full command of program design and implementation. Decisions were made and actions were taken by the Borrower on its own. The Borrower was clear about its responsilities and knew that BSRPP would be approved after all major components of the project had been agreed on. The implementation timetable was driven solely by the Borrower. The project was well-designed. The Borrower was a willing client. Cooperation was excellent throughout preparation and implementation. The Borrower, led by the Central Bank, was convinced that the measures supported by the program were critical not only in improving the cost structure of NCBs but also in achieving an efficient and sound banking sector (see Annex 6).

7.5 Government implementation performance:

Satisfactory. Project implementation was satisfactory. The VRS supported by the project was designed mainly by the Pakistanis. Justifiably, the government claimed ownership of the reform agenda and proclaimed it to be “home-grown” program. Decisions were made and actions taken on their own volition and according to their own their timetable. The Bank’s role consisted principally of providing a global perspective, giving technical advice to enhance the bankability and market credibility of the program, and promoting the program to potential co-financiers and donors for support (see Annex 6).

7.6 Implementing Agency:

Satisfactory. The implementing agencies i.e. HBL, NBP and UBL processed VRS payments as agreed during appraisal and subsequent supervision missions. Payments were in line with their respective policies in this regard. Payments were processed by the respective Human Resource Departments and checked by the Accounts and Internal Audit Departments. External auditors’ TORs were expanded to include audit of VRS payments. Banking Policy Department

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and Accounts Department efficiently processed payments to NCBs. Banking Inspection Department (BID) also test-checked VRS payments as part of their inspection that resulted in a couple of recoveries. The Bank financed unfunded part of VRS through SBP. HBL, NBP, UBL and SBP maintained professional financial management staff throughout life of the project (see Annex 6).

7.7 Overall Borrower performance:

The overall Borrower performance is rated satisfactory (see Annex 6).

8. Lessons Learned

A number of useful lessons can be learned from Pakistan’s experience with bank restructuring and privatization including the following:

NCB reforms could not be carried out without strong government’s support and 1.commitment as reflected by the government agreeing to promulgate the Privatization Ordinance in 2000 to pave the way for privatization of the NCBs. Public sector banks must undergo cost restructuring before privatization to bring their 2.cost/income ratios in line with private banks. In Pakistan this was achieved through downsizing of staff and closure of unprofitable branch offices. In order to reduce the surplus staff in the NCBs, voluntary separation packages were offered to employees. This resulted in downsizing of the work force of the three big NCBs (HBL, NBP and UBL) by 11,083 staff out of a total of 39,277. In addition, as part of the downsizing exercise, 1,487 branches of NCBs were closed down.In order to secure a good price for a bank sale, the bank must be recapitalized so that it is 3.able to meet the minimum capital adequacy requirement. The balance sheets of public sector banks were cleaned up and their accumulated losses wiped off by the injection of new equity in HBL and UBL. A total of Rs 46.6 billion (US$ 855 million) was injected as equity in these two banks prior to their privatization.Downsizing requires bank management to identify excess manpower in the labor force. 4.There is a need to coordinate approach with other banks under SBP umbrella. Success of VRS was contingent on NCBs being able to agree on common packages and timeframe.Formula instead of subjective approach should be used to minimize contention, give 5.signals to stakeholders (staff, unions, government officials and politicians) on culture change intent, and ease legal process. The stock of NPLs must be dealt with through major amendments to loan recovery laws 6.and implementation of government-induced recovery drives. The Loan Recovery Act of 1997 was amended in 2002 through promulgation of the Financial Institutions (Recovery of Finance) Ordinance to allow foreclosure of collateral without court intervention. The SBP also issued incentives for debtors to settle their chronically overdue debts with financial institutions under its Circular No 29 dated 15 October 2002. The Circular provided debtors a one-time incentive scheme for lump sum payment. Much of the loan recoveries was achieved through these measures. The remaining uncollectible amounts were settled in the court of law or removed through a system-wide carve out of NPLs.

- 14 -

The government established the Corporate and Industrial Restructuring Corporation (CIRC) in 2000 to acquire those NPLs that NCBs found impossible to collect after exhausting all efforts including legal means. NPLs worth Rs. 47.4 billion were transferred to CIRC at a discount for rapid disposal. As a result, the government was able to clean up the balance sheets of NCBs. The government must bring in professional management teams from outside to restructure 7.and turn around the failed banks. In order to streamline the working of NCBs, the government put in place professional managers in HBL, NBP and UBL. The Board of Directors were reconstituted with private sector individuals of integrity and eminence.For privatization to succeed, the government should avoid unrealistic timelines, conduct 8.the sale transparently, lay out clear road maps, launch targeted road shows, and establish track record to widen investor interest.Restructuring of failed banks is costly but is necessary. The high costs reflect the 9.cumulative costs of misgovernance and poor management.

9. Partner Comments

(a) Borrower/implementing agency:

The banking system was on the verge of crisis in the mid 1990s with the problems of over-staffing, over-branching, poor customer services, undercapitalized banks, narrow product range, undue interference in lending, and high stock of NPLs. In early 1997, the government designed and started banking sector reforms. The first phase of these reforms was supported by BSAL. Reforms implemented under BSAL were short term in nature but were able to stabilize the financial sector by addressing some of the core issues, thus creating a platform for longer term reforms. BSRPP was designed to help the Government with the second level of operational restructuring of the NCBs in preparation for their privatization as well as for improving corporate governance of the partially privatized banks by divesting the remaining Government holding and allowing complete private sector ownership. The reforms introduced significantly improved soundness and efficiency of the financial system by reducing state intervention and improving the environment for banking. The successful implementation of reforms under BSRPP improved the overall performance of the banking system. The divestiture of state owned institutions has substantially changed the struture of the banking sector and nearly 80% of sector assets are now controlled by the private banks. The overall banking sector has now become considerably more competitive and responsive. The Financial Institutions (Recovery of Finances) Ordinance of 2001 significantly improved recoveries and, thus, helped to reduce the level of NPLs in the system. As a result, the government's debt burden was reduced and it was left with only a few minor areas to concentrate (see Annex 8).

(b) Cofinanciers:

None

(c) Other partners (NGOs/private sector):

In addition to government officials, the ICR mission also met with stakeholders in the private sector including senior bankers in private banks, foreign banks, and industrialists. Given

- 15 -

the rapid expansion of the banking sector, some people in the private sector felt strongly that there was a role to be played by an international credit rating agency. Though there are currently two credit rating agencies in Pakistan, it was felt that they lacked adequate capacity to judge the strengths of the financial institutions. Others in the private sector took the view that the existing credit rating agencies tended to give more weights to quantifiable factors such as growth and financial performance than to qualitative aspects of risk management capabilities, which are more difficult to assess. Also, doubts had been expressed about the capital and technical capacity of banks to take on increasing interest rate risks, given the current volatility of interest rates and the trend towards rising rates. Most banks doubled their loan books in the last 3-4 years with the bulk of lending going into consumer finance. As the interest rates went up, it was generally believed, there would be a need to monitor the loans more vigilantly. Since most of the loans were on a floating rate basis, the banks felt comfortable with their ability to manage these risks. However, the risk management capabilities, especially when it came to accessing credit risk of consumers, appeared to be weak and needed to be strengthened significantly. There appeared to have been a shift in the focus of the private sector from restructuring and privatizing NCBs to reaping the benefits of privatization. There was a perceived additional pressure by the new owners and the public on the privatized banks to perform better. Privatization had also led to a rethinking in the foreign banks with respect to their strategy for Pakistan. Prior to privatization, the various types of banks (public banks, local banks and foreign banks) were all catering to different segments of the market, but now the landscape had changed and with the leveling of the playing field and the growing economy, they all found themselves operating in a highly competitive environment.

10. Additional Information

None

- 16 -

Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

Reduction of the cost/income ratio of the NCBs to 0.65

Target12/31/2002HBL = 0.65; NBP = 0.55; UBL = 0.65

Actual12/31/2004HBL = 0.60; NBP = 0.43; UBL = 0.56

Rationalization of the branch network of the NCBs by reducing the number of branches by 1,800 (40%)

12/31/2002HBL = 600; NBP = 550; UBL = 650; TOTAL = 1,800

12/31/2004HBL = 503; NBP = 367; UBL = 617 TOTAL = 1,487. The closure was below the target as UBL and HBL were privatized well before completion of BSRPP.

Staff rationalization in the NCBs by reducing the headcount by 25,635 (50%)

12/31/2002HBL = 10,873; NBP = 7,430; UBL = 7,332; TOTAL = 25,635

12/31/2004HBL = 3,533; NBP = 3,048; UBL = 4,502; TOTAL = 11,083. The staff retrenchment was below the target as UBL and HBL were privatized well before completion of BSRPP

Amalgamation of NDFC into the National Bank of Pakistan

December 2001 November 2001

Full divestment of MCB and sale of 49% government shares in ABL to a qualified strategic investor.

By December 2004 Residual shares of MCB divested in three market sales from January 2001 to October 2002. ABL was reconstructed in August 2004 under Section 47 of Banking Companies Ordinance and, as a result, GOP's shareholding was reduced to 11.9%.

Bank branching policy liberalized March 2001 March 2001

Announcement of revised tax policy and regime for banking system

Gradual reduction of 5% per year Tax structure for banking sector has been gradually decreased by 7% per year from 55% to 41% and will be brought down to the normal corporate tax rate of 35% for which the schedule has already been announced.

Ordinance amending the Loan Recovery Act of 1997 promulgated.

August 2001 Amended in 2002 through promulgation of "The Financial Instituitions (Recovery of Finances) Ordinance, 2001".

Reforms of National Savings Schemes Rates are linked to market rates and other tax advantages removed

Rates are increasingly linked to market rates but some tax advantages still remain.

Discontinuance of the Foreign Currency Deposit Scheme

April 2001 Discouragement of using foreign currency deposit for balance of payments financing.

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

Initial progress in preparing NBP for sale Gradual sale through IPO 23.2% shares of NBP divested through an IPO and market sales in tranches between November 2001 and November 2003

NDFC Act revoked NDFC Act revoked NDFC Act revoked

Bad assets of NCBs transferred to CIRC Bad assets of NCBs transferred to CIRC Bad assets of NCBs transferred to CIRC

Substantial progress in the sale of HBL and UBL

Sale negotiations commenced with pre-qualified strategic buyers for HBL and UBL

Sale of 51% shares of UBL completed in October 2002. Sale of 51 % shares of HBL completed in February 2004

1 End of project

- 17 -

Annex 2. Project Costs and Financing

Project Cost by Component (in US$ million equivalent)AppraisalEstimate

Actual/Latest Estimate

Percentage of Appraisal

Component US$ million US$ millionNCB Staff Rationalization 437.00 211.24 48.33NCB Branch Closures 3.00 0.00 0NDFC Amalgamation 100.00 282.38 282.38Other Policy Measures (Capital Payments) 0.00 115.55 115.55

Total Baseline Cost 540.00 609.17Total Project Costs 540.00 609.17

Total Financing Required 540.00 609.17

Project Financing by Component (in US$ million equivalent)

Component Appraisal Estimate Actual/Latest EstimatePercentage of Appraisal

Bank Govt. CoF. Bank Govt. CoF. Bank Govt. CoF.NCB Staff Rationalization 300.00 137.00 0.00 211.24 0.00 0.00 70.4 0.0 0.0NCB Branch Closures 0.00 3.00 0.00 0.00 0.00 0.00 0.0 0.0 0.0NDFC Amalgamation 0.00 100.00 0.00 0.00 282.38 0.00 0.0 282.4 0.0Completion of MCB and ABL Privatization

0.00 0.00 0.00 0.00 0.00 0.00 0.0 0.0 0.0

Capital Payments 0.00 0.00 0.00 115.55 0.00 0.00 0.0 0.0 0.0Total Baseline Cost 300.00 240.00 0.00 326.78 282.38 0.00 108.9 117.7 0.0

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Annex 3. Economic Costs and Benefits

2001 2002 2003 2004 2005 2006 2007Present # of total employees 15163 12195 13272 13745Current Daily Waged 3800New Hires 49 159 155 80 80 80# of Employees post retrenchment 12195 13272 13745 13825 13905 13985Outsource positions post retrenchment 1345 1350 1349 1349 1349

Outflows:VHS costs of 3048 employees (6,175) Cost of outsourcing (24) (25) (26) (28) (29) Cost of New Hires (41) (137) (211) (249) (288) (326) Cost of branch closure (25) Sub total - (6,241) (161) (236) (276) (316) (355) Inflows:Salary saving of retrenched staff 1,015 1,082 1,176 1,298 1,402 1,514 Staff loan principal 1,349 Cost staff loans subsidy 54 54 27 54 67 67 Admin cost saving braches closed 108 117 126 136 147 159

Subtotal 2,526 1,253 1,329 1,488 1,616 1,740 Net Cash flows (3,715) 1,092 1,093 1,212 1,300 1,385 Payback # years 3.36IRR -30.66% -6.02% 8.03% 16.45%

Restructuring Program Projected Cash Flows of NBP

The IRR for NBP was estimated to be 16.45 percent with a payback period of 3.36 years

- 19 -

2001 2002 2003 2004 2005 2006 2007Present # of total employees 13349 8446 8815 9206Current Daily WagedNew Hires 328# of Employees post retrenchment 6345 6345 6345Outsource positions post retrenchment 4208

Outflows:VHS costs of 7,332 employees -6,133Cost of outsourcing -195 -421 -455 -491 -531 -573 -619Cost of New Hires -90 -193 -209 -225 -244 -263 -284Cost of branch closure -53Sub total -7004 -614 -664 -716 -775 -836 -903Inflows:Salary saving of retrenched staff 627 1629 1759 1900 2052 2216 2393Staff loan principal 1915 -192 -192 -192 -192 -192 -192Cost staff loans subsidy 86 172 155 138 121 103 86Admin cost saving braches closed 76 163 176 190 205 222 240

Subtotal 2704 1772 1898 2036 2186 2349 2527Net Cash flows -4300 1158 1234 1320 1411 1513 1624Payback # years 4IRR -31% -7% 7% 16% 21%Required residual for IRR of 15% 5510.91 4652.25 3609.02 2345.39 819.51 -1017.43

Restructuring Program Projected Cash Flows of United Bank Limited

The IRR for UBL was estimated to be 21 percent with a payback period of 4 years.

- 20 -

2001 2002 2003 2004 2005 2006 2007Present # of total employees 21847 19978 19733 17724Current Daily Waged 429 454 480 412New Hires 77 90 106 80# of Employees post retrenchment 19978 19733 19724 19826Outsource positions post retrenchment 342 359 444 789

Outflows:VHS costs of 3520 employees -6437 -143 -204Cost of outsourcing -55 -58 -72 -128Cost of New Hires -55 -63 -53 -85Cost of branch closure -74 -13 0 0Sub total -6621 -277 -329 -213

Inflows:Salary saving of retrenched staff 980 1058 1143 1235Staff loan principal 2225 31 1 -25Cost staff loans subsidy 89 90 90 89Admin cost saving braches closed 53 114 123 133

Subtotal 3347 1293 1357 1432Net Cash flows -3274 1016 1028 1219Payback # years 4IRR -69 -26% 0%Required residual for IRR of 15%

Restructuring Program Projected Cash Flows of HBL

The IRR has not been estimated for HBL as the SBP is still checking the accuracy of the data submitted by HBL. However, the payback period was estimated to be four years.

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Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation02/01/2001 3 TASK LEADER (1); TEAM

MEMBER (2)S S

Appraisal/Negotiation05/26/2001 3 TASK LEADER (1); TEAM

MEMBER (2)S S

07/19/2001 3 TASK LEADER (1); TEAM MEMBER (2

S S

Supervision09/01/2002 3 TASK LEADER (1); TEAM

MEMBER (2)S S

03/31/2003 3 TASK LEADER (1); TEAM MEMBER (2)

S S

10/01/2003 3 TASK LEADER (1); TEAM MEMBER (2)

S S

02/15/2004 4 SENIOR FS SPECIALIST (1); SENIOR FM SPECIALIST (1); FINANCIAL ANALYST (1); LEAD FS SPECIALIST (1)

S S

ICR04/1/2005 5 SENIOR FS SPECIALIST

(1); TEAM MEMBER (1); SENIOR FM SPECIALIST(2)FINANCIAL ANALYST (1)

S S

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 18.2 82.2Appraisal/Negotiation 42.3 173.351Supervision 39.59 159.741ICR 23.2 89.565Total 123.29 504.857

- 22 -

Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

Financial stability

- 23 -

Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

- 24 -

Annex 7. List of Supporting Documents

1. Aide-Memoire of the Implementation Completion Report Mission on BSRPP 2. Back to Office Report of the ICR Mission datedd April 30, 2005 3. A Project Completion Report prepared by the State Bank of Pakistan 4. Project Appraisal Document for the Banking Sector Restructuring and Privatization Project

dated October 1, 2001 5. Program Document for the Banking Sector Development Program dated December 13, 2004 6. Country Assistance Progress Report for the Islamic Republic of Pakistan dated Marach 26,

2004

- 25 -

Additional Annex 8. Borrower's Assessment of the Project

PROJECT: BANKING SECTOR RESTRUCTURING AND PRIVATIZATION PROJECT

a. Write up ( summary)b. Key performance indicatorsc. Impact of BSRPPd. Annexures

(I) Status of Divestment of 23.2% shares of NBP and remaining shares of MCB (9%)(II) Data on branch closure(III) Chart on cost/income ratio and number of employees (IV) Status of reimbursement of claims to NCBs/NDFC(V) Estimated/Actual Project Cost tablesa(VI) Financial Summary

e. Provided in hard copy form

i) Statement showing the position of remaining shareholding of MCB ( 9%)ii) Court order iii) Branch Licencing Policyiv) BSD Circualar on implementation of BASEL 11 in Pakistanv) BSD Circular on MCR and Capital Adequacy Ratio

- 26 -

a) Write-UpBANKING SECTOR RESTRUCTURING AND PRIVATIZATION PROJECT(BSRPP) IMPLEMENTATION COMPLETION REPORT

The World Bank approved a loan of SDR 239,500,000 ( approximately US$ 300 million) on 24th

October 2001 for Banking sector Privatization Project (BSRPP). Project appraisal document of the World Bank, laid own following plan of financing:• the staff rationalization of NCBs & NDFC• amalgamation of NDFC with NBP• Balance Sheet restructuring of NCBs (this component has been added recently to allow utilization of remaining funds under the project.

Sr. No. Financier Amount Purpose(USD million)

i) Borrower (GOP) 240 a] Partial Financing (USD 137 million) for staff rationalization of NCBs & NDFC; b] Branch Closure (USD 3 million);c] NDFC amalgamation (USD 100 million).

ii) International 300 For severance payments only.Development Association

iii) Total Project cost 540

2. Initial Schedule of Reimburesment

As per Development Credit Agreement (DCA), amount of SDR 239,500,00 (approximately USD 300 million) had to be reimbursed in four installments against the unfunded portion of the severance payments made by the NCBs/NDFC, as under:

Sl No. Initial Schedule of Reimbursement/Catetory Amount

1 Severance payment SDR 79,800,000

2 Severance payment SDR 79,800,000

3 Severance payment SDR 40,000,000

4 Severance payment SDR 39,900,000

Total SDR 239,500,000

- 27 -

3. Amendments made in the DCA ( Development Credit Agreement)

As a result of discussion with the Supervision Mission of the World Bank that visited Pakistan from February 1 to 7, 2003 amendments were made in the DCA to incoroporate the following aspects:

allocation of funds of US$50 million, earlier earmarked for Staff reduction by HBL were learmarked for VSS to be launched by ABL (however due to reconstruction of ABL this amount remained unutilized.

allowing hiring of temporary employees of NBP on permanent basis. l

Later, on 27th September 2004, in order to utilize the remaining funds available under the BSRPP, the World Bank on the request of GOP amended the agreement to allow for reimbursement against the cost incurred by the Government on balance sheet restructuring of Nationalized Commercial Banks for their Privatization. The schedule of reimbursement was amended as under:

Sl No. Amended Schedule of Reimbursement

CateogoryAmount

1 Severance payment SDR 79,505,000

2 Severance payment SDR 79,800,000

3 Severance payment SDR 3,671,000

4 Capital payment SDR 76,524,000

Total SDR 239,500,000

Reimbursement status:

Against VSS claims:

5. Total VSS claim of Rs 13.322 billion were received from the banks/NDFC. These included Rs 560.600 million representing income tax payments, which are non-reimbursable item under the bSRPP. Accordingly claims amountign to Rs 12.761 billion were submitted with the World Bank which were reimbursed in US$s. As a result , on conversation of these USDs into rupees, the claims received from the World Bank decreased by Rs 36.119 million due to exchange rate differential . Following is the postion of reimbursement against the claims submitted with the World Bank:-

- 28 -

Banks Employees Relived

USD reimbursed by the WB Amount Paid to banks or adjusted against the bridge

finance provided to the banks

( Rupees)HBL 3533 76,306,979.35 4,649,387,263

UBL 4502 25,667,201.31 1,561,004,675

NBP 3048 99,139,542 5,909,651,885

NDFC 773 10,125,449 605,726,554

Total 11,856 211,239,172 12,725,770,378

N.B Total may differ due to rounding

AgainstCapital Payments:

6. In addition , consequent upon amendments in DCA, claim of Rs 7.9 billion ( provided to UBL for equity injection in May 2002) was submitted to the World Bank for reimbursement against the Capital payments. The World Bank reimbursed the amount as given below which has already been credited to Government’s account.

Amount of Claim submitted to the WB

US D reimbursed by the WB Amount paid to GOP( Rupees)

7,900,000,000 115,54,5737.18 6,878,611,052.93

- 29 -

b) Key Performance Indicators and their outcomes:

Key Performance Indiicators Outcome1. Reduction of the cost/income ratio of the NCBs to 0.65.

By December 2003, all NCBs cost/income ratios below 0.65(Annexure-III)

2. Ratinalization of branch network of NCBs by reducing number of branches by 1,800 ( 40%).

NCBs reduced branches by 836. The closure is below the target as UBL and HBL were privatized well before completion of the BSRPP.(Annexure-II)

3. Staff retrenchment in the NCBs to reduce headcount by 35,560 (50%).

VSS programs implemented which reduced NCB staff by 11,856 (Annexure-IV).

4. Amalgamation of NDFC with NBP.

NDFC amalgamated with NBP in November, 2001.

5. Full divestiture of GOP remaining shareholding in MCB. Sale of GOP 49% shareholding in ABL.

Residual shares of MCB divested in three market sales from Jan 2001, to Oct ,2002(Annexure-I). Further, ABL was reconstructed in August, 2004, under section 47 of BCO, 1962 and GOP shareholding at present is 11.9%.

6. Substaintial progress in the sale of HBL and UBL.

Sale of 51% shares of UBL completed in October 2002. Sale of 51% shares of HBL completed on February 26, 2004.

7. Intial progress in preparing NBP for sale.

23.2% shares of NBP divested through an IPO & market sales in tranches between November 2001, and November 2003.(Annexure-I)

8. Liberalization of bank branching Policy

Bank branching policy liberalized(Provided in Hard Copy)

9. Revision of the tax policy for the banking sectorand intial reduction in the level of taxation.

Tax structure for banking sector has been gradually decrease to 41% and will be brought equivalent to Corporate Tax Rate(35%) for which schedule has already been announced.

10. Ordinance amending the loan Recovery Act of 1997

The Loan Recovery Act, 1997 amended in 2002 through promulgation of “The Financial Institutions (Recovery of Finances) Ordinance, 2001”.(A copy of one of the court order provided in Hard Copy).

- 30 -

c) Impacts of BSRPP:-

The banking system was on the verge of crisis in the mid ninetees. Over-staffing, over-branching, poor customer services, undercapitalized banks, poorly managed / narrow product range, adverse to lending to SMEs/Housing & Other Segments, undue interference in lending, huge portfolio of Non performing Loans , had all contributed to these crisis. In early 1997, the State Bank of Pakistan and Ministry of Finance designed and started Banking Sector Reforms. The first phase of these reforms were supported by BSAL. Reforms implemented under BSAL were short term in nature but were able to stabalize the financial sector by addressing some of the core issues, thus creating a platform for longer term reforms. BSRPP was planned to help the Government with second level of operational restructuring of the NCBs in preparation of their privatization as well as for improving corporate governance of the partially privatized banks by divesting the remaining Government holding and allowing complete private sector ownership. The reforms introduced under the heading of the above mentioned programs significantly improved soundness and efficiency of the financial system by reducing state intervention and improving environment for banking.

The successful implementation of Banking Sector Restructuring & Privatization program improved the overall performance of the banking system. The divestuture of state owned institutions has substantially changed the struture of the banking sector and nearly 80% of sector assets are now controlled by the private banks. The overall banking sector has now become considerably more competitive and responsive. Financial Institutions (Recovery of Finances) Ordinance, 2001, had a significant impact on reducing the overall level of NPLs and has improved recoveries. Thus continious restructuirng has reduced the burden on the government and has left it with few minor areas to concentrate.

- 31 -

d) AnnexuresAnnexure-I

STATUS OF DIVESTMENT OF 23.2% SHARES OF NBP AND REMAINING SHARES OF MCB

Date of Offer

Name of Entity

Shares Divested

Mode of DIvestment

Average Price Per Share

Total Proceeds( Rs)

November 2001

National Bank of Pakistan

37.3 million (10%)

IPO Rs 10/- (IPO)

Rs 373.039 million

October 2002

37.3 million (10%)

secondary public offer

Rs. 21/- ( in secondary offer)

Rs 783.382 million

October 2003

13.13 million (3.2%)

secondary public offer Rs 46

(secondary public offer)

Rs 604

Otober 2002

Muslim Commercial Bank

24,024,560 shares ( 9%)

Through CDC Rs 27.65 664.17 million

- 32 -

Annexure-II

STATUS ON BRANCH CLOSURE

Bank Name

Branches Closed Since July 1997

to December 2000

Branches Closed during 2001

Branches Closed during 2002

Branches Closed

during 2003

Branches Closed

during 2004

Branches Closed during

January 2001 to December 2004

Branches closed during July 1997

to December 2004

NBP 121 199 41 6 0 246 367HBL 226 233 43 1 0 277 503UBL 304 269 5 35 4 313 617

Grand Total

651 701 89 42 4 836 1487

- 33 -

Annexure-III Cost/Income Ratio and number of employees

2001* 2002* 2003* 2004**Cost Income Ratio NBP 53.6% 52.0% 39.4% 42.8%HBL 70.0% 61.8% 45.9% 59.8%UBL 65.6% 61.1% 57.9% 56.1%

Number of Employees NBP

15,163

12,195

13,272

13,745 HBL

19,212

18,911

18,714

18,536 UBL

8,906

8,453

8,815

9,206 All Banks

87,373

83,998

85,878

97,633 *Based on Annual Audited Accounts of the banks.** Based on Quarterly Reports of Conditions of the banks.

- 34 -

Annexure-IVSTATUS OF REIMBURSEMENT

(i) Against VSS claims of NCBs/NDFC

(Amount in Rupees)Bank Employe

esAmount claimed

and reimbursed by the WB

USD reimbursed by the WB

Exchange rate differential

(Rs)

Eq. PKR of USD Credited to BRSPP

A/c at SBP1 2 3 4 5 9=6-8

HBL 3,533 4,660,720,985.67

76,306,979.35

11,333,722.30

4,649,387,263.37

UBL* 4,502 1,564,840,000.00

25,667,201.31

3,835,324.97

1,561,004,675.03

NBP 3,048 5,928,834,032.00

99,139,542.21

19,182,146.53

5,909,651,885.47

NDFC 733 607,494,621.00

10,125,449.45

1,768,066.91

605,726,554.09

TOTAL 11,856 12,761,889,638.67 211,239,172.32 36,119,260.71 12,725,770,377.96

N.B Total may differ due to rounding. The payment amount differs due to tax and exchange rate differential which are both non-reimbursable items .

(ii) Against Capital Payments

Amount of Claim submitted to the WB

US D reimbursed by the WB Amount paid to GOP( Rupees)

7,900,000,000 115,54,5737.18 6,878,611,052.93

(iii)Status of Total Payments Claimed and Total Reimbursed by the World Bank

Amount of Claim submitted to the WB

USD Reimbursed by the WB Amount Paid to GOP

20,661,889,638.67 326,784,909.50 19,604,381,430.89

- 35 -

Annexure-V

Estimated/Actual Project CostsPAKISTAN : Banking Sector Restructuring and Privatization Project

Project Cost by Competent EstimatedUS $

million

Actual LocalUS $ million

ForeignUS$ million

TotalUS$ million

(1*)NCB Staff Rationalization

NCB Branch Closures

(2**)NFDC Amalgamation

Completion of MCB and ABL

Other Policy Mearues( Capital Payments)

Total Baseline Cost

Physical Components

Price Contingency

437

3

100

0

0

540

0

0

211

0.00

282

0.00

116

609

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

211

0.00

282

0.00

116

609

0.00

0.00Total Project Costs 540 609 0.00 609

N.B. Total may differ due to rounding

(1*) The captioned Project started in October 2001with a tenure of 3 years. One of the major targets of the project, was the privatization of NCBs. Accordingly, UBL was privatized in October 2002 followed by HBL which was privatized in February 2004. Further, 23.2% shares of NBP were divested through an IPO & market sales in 3 tranches between November 2001, and November 2003.

The estimated cost for staff rationalization as highlighted in the Project Appraisal document was US$ 437 million. However, US$ 326 were paid for staff rationalization of NCBs/NDFC.

Privatization of HBL and UBL before the end of the project was the main reason behind lower than the estimated cost. Since the purpose of the project was to prepare these intitution for their privatization, they were not eligible for availing the finaning after the privatization. As a result, branch and staff rationalization remained lower than estimated and consequently cost of staff rationalization remained lower than the estimated.

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(2**) As per the Project Appraisal Document, the estimated cost for NDFC’s amalgamation with NBP was US$100 million. However its actual cost came to US$282.38 million. The main reasons for higer than the estimated cost were:-

As per clause 5.04 of the scheme of amalgamation of NDFC , the outstanding claims of the lFederal Government against NDFC amount to Rs 14,431,337,063 approximately US$ 234.25 million ( @ of Rs 61.6053 per dollar as on 29th October 2001) were written-off.

As per clause 1.15 of the Scheme of Amalgamation for NDFC with NBP, the final valuation lof Assets and Liabilities was to be conducted by external auditors. As per the external auditors calculation the gap between the assets and liabilities was Rs 2.925 billion approximately US$ 48.13million (@ of Rs 60.7759 per dollar as on 21st December 2001). As per clause 5.05 of the Scheme for Amalgamation , NBP was provided an amount of Rs 2.925 billion US$ 48.13 million on 21st December 2001.

In lieu of the above developments the total cost born by the GOP on implementing the lScheme for Amalgamation of NDFC with NBP stood at US$ 282.38 million ( US$234.25 + US$ 48.13), which is higer than the estimated cost by USD 182.38 million.

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Annexure-VIEstimated/Actual Project Costs

PAKISTAN : Banking Sector Restructuring and Privatization Project

Appraisal Estimate ActualComponent Bank GOP Total Bank GOP Total

Percentage of

AppraisalNCB Staff Rationalization

300.00 137.00 437.00 211.24 0 211.24 48.34%

NCB Branch Closures

0 3.00 3.00 0 0 0 0%

NFDC Amalgamation

0 100.00 100.00 0 282.38 282.38

Completion of MCB and ABL

0 0 0 0 0 0 0

Other Policy Mearues( Capital Payments)

0 0 0 115.55 0 115.55 115.55

Total Baseline Cost

300.00 240.00 540.00 326.78 282.38 609.16 112.81

Physical Components

0 0 0 0 0 0 0

Price Contingency

0 0 0 0 0 0 0

Total Project Costs

300.00 240.00 540.00 326.78 282.38 609.16 112.81%

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Annexure-VII

Financial Summary

Year 1(2001) (US$)

Year 2(2002) (US$)

Year 3(2003) (US$)

Year 4(2004) (US$)

Total

Financing IBRD/IDA 95.46 97.65 11.51 6.62 *211.24 Government 282.38 0.00 0.00 0.00 282.38 Central 0.00 0.00 0.00 0.00 0.00 Provincial 0.00 0.00 0.00 0.00 0.00 Co-Financers 0.00 0.00 0.00 0.00 0.00 User fees/Beneficiaries 0.00 0.00 0.00 0.00 0.00 Other (Capital Payments)

0.00 0.00 0.00 115.55 *115.55

Total Project Financing

377.84 97.65 11.51 122.17 **609.16

N.B Total may differ due to rounding

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