The State Bank of Pakistan was established in 1948 and remains the country's central bank and financial adviser to the government. It is the sole bank of issue, holder of gold and currency reserves, banker to the government, lender of last resort to other banks, supervisor of other banks, and overseer of national credit policy. In October 1993, legislation reduced government control of the bank, but without giving it complete autonomy.

From 1974, when all Pakistani banks were nationalized, until 1991, all local banks were in the state sector. In 1991, as part of the government's general program of economic liberalization and the privatization of state enterprises, two small banks--the Muslim Commercial Bank and the Allied Bank--were privatized. In 1991 the government also instructed the State Bank of Pakistan to approve proposals for new private commercial banks. In early 1994, there were twenty-four commercial banks, including ten private banks that had opened since 1991, two privatized banks, and twelve banks that remained in the state sector. One of the new private banks, Mehran Bank, was closed down in early 1994 amidst allegations of massive fraud. The number of new private banks was expected to increase in 1994. In March 1993, the total assets of all Pakistani banks amounted to Rs1,090 billion. Pakistani banks had 119 foreign branches and operated joint banking ventures in Malaysia, Oman, Saudi Arabia, and the United Arab Emirates.

Twenty-one foreign banks operated in Pakistan in 1994. They had sixty-one branches, most of which were located in Karachi. United States banks with branches in Pakistan included Citibank, Chase Manhattan Bank, American Express Bank, and Bank of America.

In the 1970s and 1980s, the Bank of Credit and Commerce International (BCCI) was an important foreign bank in Pakistan. The bank had many close links with the Pakistani political and commercial elite. It was founded in 1972 by Agha Hasan Abedi, a leading Pakistani banker. Prime Minister Nawaz Sharif's family company, Ittefaq Industries, was a major borrower. BCCI's international operations were run from London, but there were three important branches in Pakistan. Abedi resigned as president of BCCI in 1990, when the ruling Al Nuhayyan family of Abu Dhabi obtained a majority share in the company. BCCI collapsed in July 1991 when the Bank of England closed BCCI's operations amid allegations of massive losses, fraud, racketeering, and laundering of drug money. The Pakistani branches continued to operate for some time after BCCI had been closed elsewhere, and there were many allegations that Pakistani businessmen and politicians had profited from the bank's illegal activities. Abedi was later indicted in the United States for fraud and racketeering. In 1992 Pakistani operations of BCCI were amalgamated with Habib Bank.

In 1991 four Punjab-based financial cooperatives, together known as the Pakistan Cooperative Societies, failed amidst allegations of misappropriation of public funds. Estimates of money lost by depositors ranged from Rs10 billion to Rs23 billion, with up to 2.6 million accounts af 1a6a ffected. Two of the four cooperatives were owned by relatives of then Prime Minister Nawaz Sharif, but an official inquiry cleared him and his family of any wrongdoing.

From independence until the mid-1970s, the commercial banks were poor providers of long-term capital because the interest rate structure favored short-term over long-term financing and long-term deposits over long-term loans. As a result, the government encouraged the growth of nonbanking financial institutions to act as sources of long-term credit and equity finance. These institutions continued to play an important role in the early 1990s.

The Industrial Development Bank, established in 1961, provides medium- and long-term credit primarily to smalland medium-sized firms in the private sector, while the Pakistan Industrial Credit and Investment Corporation provides long-term assistance in local or foreign currency to private companies in the industrial sector, arranging foreign loans for large projects. The National Development Finance Corporation, founded in 1973, provides similar services for the public sector and in the early 1990s also began to provide financing for the private sector. The Agricultural Development Bank gives credit to agriculture and to cottage industries, while the House Building Finance Corporation provides interest-free housing finance, taking a percentage of the property's rental income. Other specialized financial institutions include the Investment Corporation of Pakistan, the Small Business Finance Corporation, the National Investment Trust, and Bankers Equity. All these organizations, with the exception of the Pakistan Industrial Credit Corporation, which is 35 percent foreign owned, are government owned, although they often act as channels for foreign aid.

In the 1980s, three new financing corporations-- Pakistan-Libya Holding, Pakistan-Kuwait Investment, and Saudi-Pak Industrial and Agricultural Investment--were established. These three institutions are jointly owned by the Pakistan government and the respective foreign governments most of their funding comes from the foreign governments.

The adoption of Zia's policy of Islamization led to changes in the practices of financial institutions because of the Islamic prohibition against usury. In July 1979, the Investment Corporation of Pakistan, the National Investment Trust, and the House Building Finance Corporation opened interest-free accounts that operate on a profit-and-loss-sharing basis. In 1981 the commercial banks followed suit. Under this system, profits and losses on projects financed with deposit sums are shared in an agreed-on proportion between lender and borrower. In 1985 regulations prohibited new interest-bearing loans and interest-bearing rupee deposits. These regulations cover rupee deposits in foreign banks but not deposits made in foreign currencies. In 1990 more than 63 percent of funds on deposit were held in profit-and-loss-sharing schemes.

In addition to the profit-and-loss-sharing system, lending takes two other forms: interest-free loans on which banks make service charges at rates determined by the State Bank of Pakistan, and approving finance for purchasing goods or real estate under which the bank purchases the item and agrees to resell it to the client at an increased price. All these modes of finance are subject to criticism by some advocates of Islamization on the grounds that they contain a provision for a guaranteed rate of return that can be construed as the equivalent of interest.

In November 1991, the Federal Shariat Court declared all laws pertaining to the payment or receipt of interest and markup contrary to Islam. It also ruled against the indexation of financial assets for inflation. The federal and provincial governments were ordered to amend all relevant laws by June 30, 1992, but appeals by banks and the central government rendered the deadline inoperative. As of early 1994, no higher court decision had been announced (see Politicized Islam , ch. 2).

The National Credit Consultative Council formulates annual credit plans. The council includes members from government, financial institutions, and the private sector. The credit plan sets a limit on the expansion of the money supply, taking into account the targets of the development plan and the government's fiscal objectives, as well as prevailing rates of growth and projections for GDP. In the late 1980s and early 1990s, money growth tended to run well ahead of plan targets. (OTR EIU 1992-93, 41)

Rapid expansion of the money supply, coupled with the impact of the 1991 Persian Gulf War on domestic energy prices, pushed up the consumer price index by 13 percent during FY 1991. Although energy prices fell in FY 1992, heavy government borrowing from the central bank kept inflation relatively high in FY 1992 and FY 1993, at around 9 percent. Some independent observers, including the World Bank, believed that the official inflation statistics understated the real rate in FY 1993, which they put at about 13 percent.

The principal stock market is the Karachi Stock Exchange, although there are also small stock markets in Lahore and Islamabad. The stock market expanded greatly during the 1980s. In 1991 there were almost 550 companies listed, with a market capitalization of US$4.3 billion. The turnover ratio was 12.6 percent, which represented a traded value of US$542 million. In 1991, as part of the government's deregulation policies, restrictions on foreign investment in shares of listed Pakistani companies were lifted, as were constraints on the repatriation of investment proceeds, gains, and dividends. Initially, most foreign investment was carried out by portfolio managers and institutional investors based in Hong Kong and Singapore.

Data as of April 1994