CHAPTER 1

INTRODUCTION

Banking has evolved much since it formally took shape.

Banks are no longer a place where the client stores his
money for safe keeping. Rather they have evolved into much
complex places which offer many different financial
solutions to their customers. With the evolution of
technology, and ever expanding customer needs, banks have
broadened their customer services to include a vast area of
financial tools and instruments. For instance ATMs are
slowly replacing the need to go to the bank counter and ask
the cashier to give you money.

Background

Advances in technology, internet, satellite,

computers, telecommunications, have impacted banking and
potentially allowed for increased efficiency, lower costs,
and greater profitability. Technological advances in
general, information technology applications in particular
have had a major effect in banking and finance. The use of
IT has enabled Commercial Banks to capture more and more
customers. These banks are offering a wide range of
services. Major innovations include, ATM cards, Credit
Cards, Debit Cards, Smart Cards, Pre-loaded cards, Internet
Banking, Mobile Banking, Online Utility Payments, etc.
These innovations are creating tremendous opportunities for
the commercial banks to enhance and upgrade their service
portfolio to cope with the requirements of an IT enabled

1
world. Hence this research project seeks to examine the
innovations that have occurred in the banking sector.

Rational Of The Study

The IT revolution is evolving the Commercial Banking

sector tremendously and is opening new horizons of progress
and prosperity for both the bankers and their customers.
The major impact of IT is in the services area of
commercial banking sector. The use of IT tools have
facilitated lots of problems, enabling the bankers to offer
a wider a range of services to their clients. This is not
only allowing the commercial banks to capture a bigger
market share but is also providing the commercial bankers
an opportunity to meet requirement of globalization.

Banks today play a very vital role in the economies of

nations. Effective banking systems can help a country
excel financially. Similarly, ineffective banking systems
can help bring down a country to its knees. For instance,
with the freezing of the foreign currency accounts after
the nuclear explosions, in Pakistan, the country saw a
major flight of capital. This flight of capital led to
decrease in the foreign exchange reserves. This effect led
the country to a major financial crisis, where it was about
to default on major loans taken from international
institutions. It is therefore imperative that we study the
changes in the banking sector to see if the banks are
facilitating their customers.

2
 Problem Statement

Instead of just looking at changes in the banking

sector, the topic has been narrowed down. More
specifically, this report seeks to answer the following
question: “What have been major innovations in the
Commercial Banking Services in Pakistan?” Innovation is
widely proclaimed as being of vital importance to achieve
and maintain competitive advantage (Bátiz-Lazo &
Woldesenbet, 2002). Therefore the research looks at
innovation, rather than just changes. Moreover, the
research narrows down to the Pakistani banking sector,
since it is a much more relevant topic. The foreign
banking sector will be discussed, however, in the
literature review chapter of this thesis.

Theoretical Framework

Although many innovations have sprung up in the

commercial banking sector, this research seeks to examine
those that are relevant to Pakistan. Furthermore, this
research seeks to examine those areas that have been
affected due to the changes in technology. The factors
that affect this research are the following:

• Card Based Payment Systems

• Electronic Payment Systems

Card Based Payment Systems have many sub factors, or

services. Each of these factors has some features in

3
common, yet differs from one another. These factors
include the following innovatory services:

• ATM Cards
• Credit Cards
• Debit Cards
• Pre-loaded Cards
• Smart Cards

Electronic Payment Systems is a vast area. This area

has grown the most in the recent past. However, all of the
services being offered can be divided into three major
categories, which include the following:

• Mobile Banking
• Virtual Banking
• Internet Banking

These factors have been the major innovations in the

commercial banking services in Pakistan. Each of these
will be looked into, and examined. The study will seek to
understand how they work, and what impact they have had on
the commercial banking sector.

Objectives Of The Study

The following objectives are intended to achieve the

results of this study:

4
 1. To measure the overall impact of innovation on
the commercial banking services.
2. To determine the advantages that innovations have
added to commercial banking services.
3. To analyze the role and importance of innovation
in the enhancement of commercial banking services.

Definition Of The Terms

Internet banking refers to the use of the Internet as

a remote delivery channel for banking services. Such
services include traditional ones, such as opening a
deposit account or transferring funds among different
accounts, and new banking services, such as electronic bill
presentment and payment (allowing customers to receive and
pay bills on a bank’s Web site) (Fust, Lang, & Nolle, 2000).

Internet Banks can be of two types. One is a physical

bank that opens a web site and starts to offer various
services. Another option would be to have a branchless or
Internet-only bank. An internet bank is one where there
are no physical branches, rather a computer web server,
which performs all the functions, and gives access to the
user thorough web sites, or other electronic media.

Mobile Banking means banking carried out over the

mobile phone. This is also known as M-Banking.

ATM, refers to Automated Teller Machine. ATM machines

are machines installed by banks that a customer can use to
withdraw cash, among other facilities.

5
 Virtual Banking refers to banking over the Internet.
Banks that develop web sites and offer various
transactional facilities are said to be providing virtual
banking facilities.

6
 CHAPTER 2

LITERATURE REVIEW

Much literature is not available about the Pakistani

banking industry; however there are many papers available
on the international banking industry. The literature
review for this thesis focuses on banking past, present and
future in the international arena. Moreover this is tied
into innovation. Innovation as a whole and more
specifically in the banking sector is examined in this
section.

The Early Origins Of Banking

Banking has been around for thousands of years. Some

of the earliest evidence of banks was found in Mesopotamia
between 3000 and 2000 B.C. where temples were used to store
grain and other valuables used in trade (http://
money.zezenetwork.com). Other places where banking
flourished include Lydia, Phoenicia, China, and Greece.
For example the safe deposit vaults of today date back to
the Greece, where temples for were used for the purpose of
a safe-deposit vaults for the valuables of worshipers. The
Greeks developed coined money and developed a system of
credit. Later on, the Roman Empire had developed a highly
complex banking system, where its bankers not only accepted
deposits of money, but also made loans, and purchased
mortgages (“History of Banking,” 2000). Ancient Babylon is
credited with not only the birth of banking, but also
having developed a highly sophisticated banking system

7
which is much close to our own banking system of present
time. The basic banking system that was developed in the
ancient time era continues till this day. Goetzmann
describes the importance of the ancient banking system:

"In the centuries since the era of the Mesopotamian

and Greek financiers, the financial world has become
increasingly complex, but the fundamental principles
and tools they discovered several millennia ago have
remained the root of all investment contracts
(Goetzmann, 2002)."

Development Of Modern Banking

After the fall of Rome, banking declined in Europe.

At this time, Europe fell into its dark ages, and
elsewhere, the Muslims were having their golden era.
Banking did not flourish in the Muslims areas, since
interest is looked down upon and considered haram.
Examples of other banking functions such as safe deposits
can be found in this era. Unfortunately much information
is not available about banking of that time.

The first bank to offer most of the basic banking

functions known today was the Bank of Barcelona in Spain.
Founded by merchants in 1401, this bank held deposits,
exchanged currency, and carried out lending operations. It
also is believed to have introduced the bank check. Three
other early banks, each managed by a committee of city
officials, were the Bank of Amsterdam (1609), the Bank of
Venice (1587), and the Bank of Hamburg (1619). These

8
institutions laid the foundation for modern banks of
deposit and transaction (“History of Banking,” 2000).

Banking remained in the hands of families and powerful

men for over 300 years in Europe. National government
started taking control of banking with Napoleon. Napoleon
organized The Bank of France in 1800. The Bank of France
became the most dominant financial institution by the
middle of 1800s. In the middle of 19the century in
Germany, the banking sector flourished with the
introduction of publicly held banks, or banks that issued
stocks.

Banking in the British Isles originated with the

London goldsmiths of the 16th century. These men made loans
and held valuables for safekeeping. By the 17th century
English goldsmiths created the model for today’s modern
fractional reserve banking—that is, the practice of keeping
a fraction of depositors’ money in reserve while extending
the remainder to borrowers in the form of loans. Customers
deposited gold and silver with the goldsmiths for
safekeeping and were given deposit receipts verifying their
ownership of the gold deposited with the goldsmith. These
receipts could be used as money because they were backed by
gold. But the goldsmiths soon discovered that they could
take a chance and issue additional receipts against the
gold to other people who needed to borrow money. This
worked as long as the original depositors did not withdraw
all their gold at one time. Hence, the amount of receipts
or claims on the gold frequently exceeded the actual amount
of the gold, and the idea that bankers could create money
was born (“History of Banking,” 2000).

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 Functions Of Banks

Banking is defined as, any financial institution that

receives, collects, transfers, pays, exchanges, lends,
invests, or safeguards money for its customers.
(“Banking”, 2000). The basic functions of banks are to
provide a place for people to keep their money. They do so
by issuing checking or current accounts and savings
accounts (also known as profit and loss savings (PLS)
account in Pakistan). Current accounts are used for day to
day activities, where customers can deposit and withdraw
their money freely. Savings accounts help to save money
for a longer term for the future. As the name suggests,
savings accounts help to save money. Other services
include providing loans to consumers and businesses; and
basic cash management services. These include check
cashing and foreign currency exchange.

The most important function of banks is financial

intermediation. Financial intermediation basically means
to give money to the investor, taken from the saver. This
helps in the growth of the economy. It lets people borrow
money to build factories that produce goods and services
people need. People can borrow money to purchase things
like cars and homes. This flow of money, from those who
save, to those who invest helps the economy grow. If money
were to sit in the homes of people, there would be none
available for investors. Who in turn would not build new
factories. Factories employ people that get salaries.
They use their salaries to buy more goods and services.
This cycle continues, and helps to expand the economy.

10
 The second most important function of banks is that
they help provide a medium of exchange. This medium of
exchange can be cash, check, credit or debit cards, etc.
Without these facilities, customers would not be able to
make payments, and people would revert back to the barter
system, which is highly very inefficient as well as time
consuming.

Banks today not only provide these basic facilities,

but also provide many other functions. Some of these
include credit and debit cards, foreign currency deposits,
mortgages, leasing, and much more. Banks can be of several
types: commercial or consumer banks, industrial banks,
investment banks, etc. This report focuses on commercial
or consumer banks, which are explained below.

Commercial Banks

Commercial specifically deal with the individual.

Other banks deal specifically with small or larger
organizations and business. Commercial banks offer
consumer banking services, which all of use today.
Commercial banks have been defined by different people in
relatively similar terms. The Central Bank of Bahamas
describes commercial banks as:

A commercial bank is a bank whose main functions are

to accept demand deposits and to make short-term
loans, chiefly to business firms, thereby facilitating
the transfer of funds in the economy. In addition,

11
 commercial banks make many other kinds of loans to
private individuals, firms, government agencies or to
the Government itself. They also issue time and
savings deposits and operate trust departments. Though
commercial banks do not issue currency, they do issue
money in the form of demand deposits hence they have
the power of creating and destroying money
(www.centralbankbahamas.com).

According to Larsen, commercial banks rely heavily on

short-term sources of funds.

A commercial bank is a financial institution designed

to act as a depository and lender for many business
activities. Commercial banks rely heavily on short-
term sources of funds. Therefore, commercial banks
tend to write short-term loans in an attempt to
balance the maturity of their assets with the maturity
of their liabilities. By doing so, if their cost of
funds increases, they can cover the increase fairly
quickly by charging higher rates on new loans (Larsen,
1994).

Commercial banks have another interesting

characteristic, which is they are for-profit institutions.
The objective of commercial banks is to make a profit.
They obtain their profit by lending money to people. These
for-profit, stockholder-owned institutions buy money from
people who have more than they need (deposits) and sell it
to those who do not have enough (loans) (www.precision-
info.com). Banks then earn interest on loans. A part of
the interest is passed on to the people who deposit money

12
with the bank. The remaining is profit for the bank. The
profits either can be paid out to bank stockholders or to
the holding company in the form of dividends, or the
profits can be retained to build capital (net worth)
(“Commercial Banks,” 2000).

Some of the services of commercial banks include,

giving loans for automobiles, consumer goods, as well as
homes. Other services include: Exchange foreign currency,
Offer retirement services, credit cards, and debit cards,
Issue American depository receipts for stocks of foreign
corporations, provide a variety of accounting services to
their customers, issue letters of credit for firms involved
in international trade, and manage trust accounts for
wealthy clients (www.precision-info.com).

Innovations

After having examined banks, and banking, it is

imperative to discuss the next vital factor of the research
question, which is innovation. In order to tie up
innovation with banking, innovation’s gist needs to be
examined. Innovation was first recognized by Joseph
Schrumpter, an economist in the 1930s. Joseph had
identified five different types of innovations. These
included; new products or a substantial change to an
existing one; new methods of production; opening new
markets; new sources of factor inputs; and new
organizations (Glassop, Samson, & Terziovski, 2001).

13
 Recent managers, Porter and Stern in a paper submitted
to the council on competitiveness said that, Innovation is
the transformation of knowledge into new products,
processes, and services – involves more than just science
and technology. It involves discerning and meeting the
needs of the customers (Porter & Stern, 1999).

Our view of Innovation has changed much since the

1930s. Rothwell had developed a 5 generation model of
innovations. This model describes the 1st generation as
what people thought of innovation in the early days, to the
5th generation model, of where innovation stands today. The
five generations of the model are described below
(Rothwell, 1994).

First generation innovation – technology push. This

era of innovation was the foundation for the industrial
revolution. Innovation came with new, technologically
advanced products and means of production. Such products
were pushed onto the market (Rothwell, 1994).

Second generation innovation – need pull. Innovation

during this era shifted to a market/customer focus. A focus
where the customer determined needs and production
technology responded. Marketing took a pivotal role in
generating new ideas (Rothwell, 1994).

Third generation innovation – coupling model. This era

of innovation involved a coupling of the push and pull
models. The market might need new ideas, but production
technology refined them. Alternatively, R&D developed new

14
ideas that marketing refined with market feedback. R&D and
marketing were linked (Rothwell, 1994).

Fourth generation innovation – integrated model. An

integrated model of innovation saw a tight coupling of
marketing and R&D activity, together with strong supplier
linkages and close coupling with leading customers
(Rothwell, 1994).

Fifth generation innovation – systems integration and

networking model (SIN). This model of innovation builds on
the integrated model by including strategic partnerships
with suppliers and customers, using expert systems, and
having collaborative marketing and research arrangements.
There is an emphasis on flexibility and speed of
development with a focus on quality and other non-price
factors (Rothwell, 1994).

Some of the major characteristics of the 5th generation

in innovation include, time-based strategies (faster, more
efficient product development); a development focus on
quality and other non-price factors; an emphasis on
corporate flexibility and responsiveness; a customer focus
at the forefront of any strategy; electronic data
processing strategies, fully developed internal databases;
and an effective external data link (Glassop et al., 2001).

Although there are very few companies around the globe

which are in the 5th generation of innovations, yet most are
slowly moving towards it. They recognize the importance of
improving their innovation process as vital to growth.
Countries with the highest number of innovations are

15
currently at the top of the economic ladder. Examples
include the United States and Japan. Therefore, no
advanced economy can maintain high wages and living
standards, and hold its own in global markets, by producing
standard products using standard methods (Porter & Stern,
1999).

Innovating The Commercial Banking Sector

Innovation does not only look at one aspect, but

focuses on several factors. Some of the major of these
factors is a focus on customer satisfaction, technology,
and high quality products and services. The banking sector
too has been busy in innovating to meet the needs of its
customers. Many new products and services have come up.
Technology has been incorporated into many a function of
banking. Newer technologies have helped banks to grow and
profit despite the pressures of competition. One example
of this is US banking industry. If we are to examine the
US banking industry from 1979 to 1994 (Table 2.1) we are to
find that the number of banking organizations has in fact
decreased. This is evident of the tough competition that
banks face. However, the assets of the industry in mega
banks, or very large banks have doubled. The main cause of
this is that the better banks were able to either merge
with, or buy out the weaker banks. This had lead to the
creation of mega banks. These mega banks have been able to
survive due their competitive advantages.

16
 Table 2.1: Comparison of the US Banking Industry

Changes in the U.S. Banking Industry 1979-1994

Item 1979 1994
Total number of banking
12,463 7,926
organizations
No. of small banks 10,014 5,636
Real industry gross total assets
3.26 4.02
(Trillions of 1994 dollars)
Industry assets in 9.4% 18.8%
megabanks (percent of total)
Industry assets in small 13.9% 7.0%
banks (percent of total)
Total loans and leases 1.50 2.36
(Trillions of 1994 dollars)
Loans made to consumers 19.9% 20.6%
(percent of total)
Total number of employees 1,396,970 1,489,171
Number of automated teller
13,800 109,080
machines
Real cost (1994 dollars) of 0.0199 0.0253
processing a paper check
Real cost (1994 dollars) of an 0.0910
0.0138
electronic deposit
(Source: Frei, Harker, & Hunter, 1998)

Therefore, banks must continue to innovate in order to

meet the changing needs and desires of the consumer, while
at the same time developing new fee structures to migrate
consumers away from high-cost delivery systems. This blend
of innovation and behavior change lies at the heart of the
modern banking organization (Frei, Harker, & Hunter, 1998).

Technology plays a key role in the performance of

banks. Large banks in the United States spend approximately
20% of non-interest expense on information technology, and
this investment shows no signs of abating (Frei, Harker, &

17
Hunter, 1998). The rest of the world is also excelling in
the use of technology in Banking.

Figure 2.1: Example of Worldwide Use of E-Money

(1997)

Source: Office of the US Comptroller of the Currency using

data on Visa’s general-purpose, stored value chip cards,
from Visa (1997), Chip Card Programs around the world.

It can be concluded from Figure 2.1 that the spread of

electronic use in banking is not limited to the US. In
fact, Europe and Asia Pacific lead the United States in the
use of e-money, or money stored on an electronic chip on a
plastic card. The relationship of the use of technology
and innovation with success was further strengthened by a
recent survey of the top 500 companies of the world. The
survey of the Global Fortune 500’s, for the year 2004,
shows that in the top 10 banks of the world only three are
from the US, while seven are from Europe.

18
 Innovation in technology has been the main force
behind innovations in the banking sector. Technology has
brought about many new media, and methods of transacting.
For example, many banks have started to develop their own
web sites. These web sites give the consumer information
about the services offered by the bank. In the US alone,
the number of banks that offer internet banking is
increasing very rapidly. In the different sizes of banks,
the largest banks have taken lead, and 100% of them are
offering internet banking. Where as the smaller banks are
catching up quickly in order to provide internet banking
services. Figure 2.2 explains this phenomenon.

Figure 2.2: Percent of US Banks Offering Internet

Banking

Source: Office of the US Comptroller of Currency

19
 Moreover, many banks are moving away from simple web
sites to providing transaction facilities to their
customers on the web sites. As it is evident from figure
2.3, the number of banks with transactional web sites is
growing very rapidly. In the fourth quarter of 1997 (Q4-
97), there were 103 banks that had transactional internet
web sites. This figure has gone up by more than 10 times
in just two year. In the fourth quarter of 1999 (Q4-1999),
there were 1,100 banks offering transactional web sites.

Figure 2.3: Estimated Bank Web Sites vs.

Transactional Web Sites in the US

Besides using the internet for banking purposes, banks

are also adopting technology for other purposes.
Electronic bill payments offered by banks to their
customers is also gaining popularity. The Office of the
Comptroller of the Currency, in the US, has reported that
the number of transactions of electronic bill payments have
grown substantially. In figure 2.4 we can see that the
number of these transactions has boomed from a little over

20
100 million transactions in 1996, to well over 275 million
in 1997.

Figure 2.4: Very Rapid Growth in Number of

Electronic Bill Payment Transactions

Source: Office of the US Comptroller of the Currency.

The same types of developments have been reported by

the retail sector as well. Figure 2.5 shows the number of
electronic payment transactions versus cash payments for
the US retail sector. In 1991, approximately 80% of the
payments were carried out in checks. This percentage has
decreased steadily, and in 1996 a little less than 75% of
those transactions were carried out by check. On the other
hand, the number of electronic transactions increased from
about 18% in 1991 to about 25% in 1996. This signals the

21
fast pace with which the retail industry is embracing
innovatory payment systems in their banking transactions.

Figure 2.5: Electronic Retail Payments Growing in

Importance

(Billions of non-cash retail payments)

Source: Office of the US Comptroller of the Currency, using

data from Committee on Payment and Settlement Systems
(1997), Statistics on Payment Systems in the Group of Ten
Countries: Figures for 1996, Bank for International
Settlements, and from the National Automated Clearing House
Association (NACHA).

Consumers too are switching over to other innovatory

types of payment mechanisms. These innovatory payment

22
systems include credit cards and debit cards. Figure 2.6
shows the percent of users using various types of payment
systems in the United States between 1990 and 1994. Credit
card and debit card payment systems are slowly gaining on
check based payment systems.

Figure 2.6: Use of Various Payment Mechanisms in

the United States

(Source: Frei, Harker, & Hunter, 1998)

Innovation For Cost Savings

Interestingly, innovating to newer techniques not only

helps the consumers, but also helps banks by cutting costs.
Different agencies report different figures. However, all
of them point to the same direction that the cost per
transaction in all cases is lower for the newer
technologies. For instance, not only have ATMs helped to

23
facilitate the customers, but also they have reduced the
cost per transaction for a bank. If a customer were to
withdraw money from a teller, or an ATM machine, the cost
difference would be huge. The teller cost about $1.4 per
transaction, where as the ATM machine is much cheaper, and
only cost $0.40 per transaction. This is $ 1.00 cheaper
than the human teller.

Table 2.2: Comparison of Cost Per Transaction for

Various Delivery Channels

Distribution Channel Cost Per Transaction

Teller $1.40
Telephone (human operator) $1.00
Telephone (automated voice response unit) $0.15
ATM $0.40
(Source: Frei, Harker, & Hunter, 1998)

Moreover the cost per transaction for various types of

media has also come down much. The internet is becoming
the cheapest media possible. On the internet it costs only
1 cent ($0.01) per transaction, compared to a human teller
processing a check, which costs 95 cents ($0.95). This is
a huge increase in costs for a bank. If a bank were to
carry out 1 million transactions in a year, it could save
nine hundred and forty thousand dollars ($ 940,000) by
carrying out all of these transactions over the internet.

24
 Figure 2.7: Banks have cost incentives to
encourage electronic payments
(Cost Per Transaction)

Note: Estimated cost per transaction. For checks, figures

are for deposit by check using a bank teller.

Source: Office of the US Comptroller of the Currency, using

data from Faulkner & Gray (1997) and from the National
Automated Clearing House Association (NACHA).

Banks have been around for thousands of years. Since

their inception, their functions remain the same, but they
have offered many more services. The tools and techniques
used to offer the services, and the type of services
themselves have changed. Banks find that innovating helps

25
them to attract customers, who find it easier and more
convenient to use newer technologies and products. More
over, banks have also benefited by lower costs of using
innovatory techniques and products.

Innovations in Regional Countries

Other countries in the region are at about the same

place in terms of innovations as compared to Pakistan.
Bangladesh and Nepal are much worse off, since they have
not introduced many of the innovations that Pakistan has.
India is the most advanced of the countries compared to
Pakistan. Even India is not as advanced in some of the
areas compared to Pakistan. India does not have an
advanced debit or smart card system. However Indian banks
offer more services over the Internet as compared to
Pakistan. The major reason for this is the advanced IT
industry in India. Some Indian banks allow the user to
apply for credit cards online, a facility that no Pakistani
bank offers.

26
 CHAPTER 3

METHOD

The method for the research is survey. In order to

identify the different innovations in banks, the researcher
needed to go and visit the banks. This research examines
the current developments in the Pakistani banking sector.
To accomplish this task, information was collected from the
major Pakistani banks that are offering innovatory services
and products to their customers.

Sample

There are many banks in the country today. It is

impossible, with the time and financial constraints to
visit each of these banks for the survey. Therefore a
sample of the leading banks was taken. The sample consists
of about 10 banks that are at the forefront of innovation
in commercial banking services in Pakistan. These banks
include, Al-Falah Bank, Allied Bank, Askari Commercial
Bank, Bank Al-Habib, Bank of Punjab, Habib Bank, Muslim
Commercial Bank, National Bank, United Bank, and Union
Bank. Managers from each of the banks were contacted for
the study. Moreover, other bank official data was
accessed. This data was obtained from brochures, and the
web sites of these banks. The study is carried out in a
natural environment.

27
 Sources Of Data

The sources of data for this research consisted of

secondary sources, as well as unstructured interviews.
Secondary sources include published materials of various
banks, obtained from the banks. Also, several of the
banks’ web sites were visited for obtaining data.
Secondary sources also included research published by
others on the subject. Unstructured interviews and
telephonic interviews were also carried out to obtain
information in relation to the subject at hand.

Procedure

This study was conducted in a systematic procedure.

Initially a literature search was conducted to locate
research that has already been done related to innovations
in commercial banking services. Upon finding relevant
information and factors, visits were made to various banks.
At the banks, data was collected in the form of bank’s
print material. In some cases, unstructured interviews
were conducted with bank officials to get a better
understanding of the innovatory services being offered. In
certain cases, due to unavailability of bank officials,
telephonic unstructured interviews were conducted. Later,
web sites for a few of the banks were visited to collect
information pertaining to the research project. Finally
all of the data was collected, analyzed, and summarized in
the results section of this report.

28
 CHAPTER 4

RESULTS AND DISCUSSIONS

Innovations In Card-Based Payment Systems

Banks are slowly moving away from traditional payment

systems into newer areas. The traditional systems, such as
checks, are no longer cost efficient, nor are they user
friendly. Consumers prefer to carry cards that help them
to carry out their daily transactions. There are several
types of card based payment systems available today in
Pakistan. These include ATM cards, Credit Cards, Debit
Cards, Pre-Paid or Pre-Loaded cards, and Smart Cards. Each
of these is discussed in this section.

ATM Based Payment Systems

Although Automated Teller Machines (ATM) are not an

innovation in Pakistan, they way in which they are being
used is an innovation. An ATM is a machine, which is
operated by a plastic card. A customer is issued a card,
along with a personal identification number (PIN), or a
special password to operate that card. The user then puts
the card in the ATM machine, and enters his/her PIN code.
Upon verification, the user has complete access to his/her
bank account. For instance, the user can withdraw money,
check the balance, transfer money between various accounts,
and even deposit money into the account. The benefit of an
ATM card is that the user can access his/her account at any

29
time of the day, even if the bank itself is closed.
Moreover, banks have established ATMs all over the country.
Even in places where there are no bank branches. This lets
the user to withdraw money from almost anywhere, at any
time.

Some banks have innovated their services by offering

utility bill payment facility through their ATM network.
Askari Commercial Bank is one example of this. With the
help of the ATM card, a customer can walk up to any Askari
Commercial Bank’s ATM machine, and select the bill payment
option. The user is given choices for Phone, Electricity,
and Gas bills. Upon choosing the appropriate bill, he/she
enters the bill number, and then is able to authorize the
transfer of funds from his/her account to pay the utility
bill.

There are two main innovations in the ATM area. These

two are the development of a unified ATM network in the
country, and the way in which banks issue ATM cards. Each
of these two innovations is discussed below.

Unified ATM Network

Initially, consumers could only use the ATM machine of

the bank with which they had an account. This meant that
banks had to purchase and install ATM machines all over the
country, to help their consumers access their accounts.
More recently, a couple of networks have been developed,
which have interlinked various banks. The most popular of
these is the OneLink network, being used by banks such as

30
Habib Bank Ltd. and Union Bank. OneLink, and other
networks have developed a centralized database, with which
all of the ATM machines of various banks are connected.
This lets a customer of one bank use the ATM machine of any
of the other banks that are part of this network. For
instance, a consumer has an account with Habib Bank, and
uses Habib Bank’s ATM card. If the user is unable to find
a Habib Bank ATM nearby, or there are no Habib Bank ATMs in
a particular city, the user can still withdraw money from
his/her own account, if another bank, that is part of the
OneLink network, has an ATM machine available. The user
simply can enter his/her card in the ATM of any of the
other banks, and the ATM will recognize this as another
bank’s ATM card. The user will then be transferred to the
central database, which will allow the user to access
his/her account from Habib Bank.

With the development of this innovation, the number of

ATM machines that a single banks customer can use has
increased from hundreds to thousands. This has encouraged
many more customers to switch over from Cash based payment
mechanisms.

ATM Issuing

In the past, customers had to apply separately to get

an ATM card issued. This meant that the number of users
that had access to their account through the ATM network
was very low. However, recently many banks have changed
this policy. Askari Commercial Bank is just a few of the
banks that give an ATM application to any customer that is

31
applying for a new account. Just as banks would give an
application for the issuance of a check book when opening a
new account, banks today are doing the same with ATM. This
has led to an increase in the number of ATM card users.
Banks realize that the cost of an ATM transaction is much
lower. Furthermore, banks are encouraging their customers
to use the ATM machine for normal queries. For instance in
Allied Bank, telephone operators encourage customers to use
the ATM to get their bank balance information and other
information related to their account. Banks are using
measures such as these to encourage users to use the ATM
machines, to help save on costs.

Importance Of ATM On Commercial Banking Services

ATM serves as a dual purpose. They are beneficial to

both the customer as well as the commercial banks. The
customer benefits from ATMs, in many ways:

• Customers don’t have to stand in lines at the bank to

get money of perform other functions.
• Customers don’t have to rush to the bank, during the
bank hours, since ATMs can be used 24 hours a day, and
even on holidays.
• Customers don’t have to go to a specific bank branch,
since ATM cards can be used in a large number ATM
machines all over the country, and even outside the
country.
• ATMs are being used to deposit utility bills, which
avoids much hassle, and waiting on the part of the
customer.

32
 • The customer is more secure and safe, since he/she
does not need to carry cash around with him/her.

ATMs have also helped the banking sector. The banks

have been benefited by ATMs in the following ways:

• ATMs have helped to reduce the per transaction cost.

As discussed in the literature review section, the
cost for using ATM as compared to a teller has come
down by $1 per transaction (Frei, Harker, & Hunter,
1998).
• ATMs have helped to serve more customers. Just by
installing an ATM machine, banks can serve more
customers.
• ATMs have helped to attract more customers. Many
customers open an account with a bank that has ATMs
near the customer’s favorite locations.
• ATMs have helped to increase profitability for banks,
by increasing efficiency.

Credit Cards

Credit Cards have also been around in Pakistan for

more than 10 years. However the use of credit cards was
not very popular. Credit Cards were not popular for
several reasons. First they were expensive to obtain. The
annual fee and other charges were too high. Second, credit
cards were not accepted in too many places, and those
places that did accept them charged a certain fee. And
finally, it was a complicated procedure to obtain a credit

33
card. Banks have innovated their processes, and have done
away with these three flaws.

First, banks have cut down on the annual cost of

obtaining a credit card. Bank Al Falah now has a zero
annual fee for life on a credit card. Other banks too give
discounts, or charge very low annual joining fees. Second,
banks have spread the number of vendors that accept their
credit cards. There are many more shops today that accept
credit cards. Most of the shops that charged a percent fee
have dropped those fees. All the oil companies, such as
Shell, PSO, Caltex, etc. do not charge a fee for processing
credit cards. Moreover, banks have encouraged shops by
charging them less, to give discounts to credit card
holders. Many restaurants and other shops give discounts
to those people who use credit cards. Finally, the process
for obtaining a credit card is much easier. A person with
a monthly salary of Rs. 12,000 can now obtain a credit
card. In the past it would take many months to obtain a
credit card. Now this process has been cut short by
several weeks.

Importance Of Credit Cards On Commercial Banking

Services

Innovations in Credit Cards include the ability to pay

the mobile phone bill through credit cards. This can now
be done either over the internet, or using a mobile phone
(through Ufone only). Customers no longer have to rush to
a bank to pay their utility bills. In this fast changing
world, time is very scarce. Therefore, Credit Cards help

34
to save time of the consumer by allowing speedy
transactions. Furthermore, customers who make purchases
from other countries are facilitated by the use of credit
cards. Previously users had to issue checks, or send pay
orders, or send money through tele transfer. The first two
procedures took much longer time, since customer had to
wait for the check or the pay order to clear. The cost of
tele transfer is too high. It costs US $ 5 per transaction
for international tele transfer. With the help of credit
cards, consumers can now make payments online, and the
transaction will be processed in less than a second.
Moreover, it is a low cost method, depending upon how
quickly the user pays back the money to the bank (delay in
payment results in interest being charged).

Debit Cards

With the popularity of ATM cards, debit cards have

also gained acceptance. Many banks are simply letting
their ATM card users to use it as a debit card. This has
been enabled with the advent of a third party organization
called Orix. Orix has a network which recognizes both
credit and debit cards. Orix gives away their machines to
shop keepers, or merchants. The merchants use the machines
to charge customers’ purchases. Banks have teamed up with
Orix who allows their customers to use their ATM cards as
debit cards. Debit cards essentially differ from Credit
cards in the sense that, the user already has money
available in an account for a debit card. Whereas in the
credit card, the user does not have money, rather pays
after he/she has made purchases. Debit cards have become

35
popular because many consider it as a more Islamic medium
of purchasing goods. Moreover, merchants are happy to
accept debit cards, since the processing fee they have to
pay is much lower as compared to credit cards.

Features Of Debit Cards

Some of the salient features of debit cards are the

following:

1. There is no need to carry cash. Thus it is a much

more secure mode of payment.
2. Easier to obtain than Credit Cards
3. It is accepted in many locations in major cities of
Pakistan.
4. Payment is made directly from a user’s bank account.
5. No interest is charged on the transactions.
6. Can also do balance enquiry at the merchant outlet.
7. Payment is authorized by a user’s PIN number. Thus,
even if a Debit Card is lost, it can not be used.

Importance Of Debit Cards On Commercial Banking

Services

Debit cards have played a very important role in

commercial banking. The following are the advantages of
debit cards:

• Debit cards require no special application

process therefore the user can receive his/her
card right away.

36
 • Debit cards are an Islamic mode of transfer.
Many more people in an Islamic country are
willing to go for this mode of payment.
• Debit cards have no interest or fees, therefore
it is very affordable.
• Money is debited directly from the user’s
account. Therefore there is no chance of going
into debt.
• Debit cards are safer than cash and credit cards.
If lost, no one can use it without the secret PIN
code.
• Debit Cards help to save on costs for banks. The
per transaction cost for debit cards is the same
as ATM cards, which is $ 1 cheaper per
transaction than a human teller.
• Debit cards have helped to attract more customers
for banks.
• Debit cards are a more efficient way of
transferring money. Hence more customers are
likely to use this mode as compared to cash.
This results in more users using a particular
bank’s services.

Smart Cards

Smart Cards being currently used in Pakistan are much

similar to a debit card. In Europe smart cards are more
sophisticated. A smart card used in Europe, especially in
France, has a small chip embedded into the plastic card.
This chip stores a lot of information about the user. This
information can range from, several bank accounts, to

37
personal information such as passport and ID card numbers,
etc. However, in Pakistan the concept of a smart card is
slightly different. The difference between a debit card
and a smart card is that smart cards can be used anywhere
in the world. Banks, such as Union Bank, have made
arrangements with various organizations around the globe,
which allows a user to use his/her smart card in ATM
machines anywhere in the world. For example, Union Bank
smart cards can be used in Cirrus ATM machines all over the
world. A user can also use a Union Bank smart card
wherever MasterCard is accepted. This gives a dual use to
the smart card, where it can be used in ATM machines as
well as a replacement to credit cards.

Importance Of Smart Cards On Commercial Banking

Services

Smart cards have the same advantages as debit cards.

The major extra advantages smart cards have over debit
cards are the following:

• International users, businesspersons, and

travelers prefer smart cards since they can use
smart cards in any country of the world.
• Smart cards can be used in many more outlets,
including places where credit cards are accepted.

Preloaded Cards

Another interesting innovation found in the Pakistani

banks is a preloaded card. It has been given different

38
names by various banks; however all of them serve the same
function. Anyone can go to a bank and present the bank
with money. The Bank will then issue the customer with a
card, which has the amount of money the card user paid for.
The benefit of this system is that anyone could go and get
a card. Even if someone does not have a bank account, they
can obtain this card. While obtaining a debit, credit or
smart card requires that the user have a bank account. The
preloaded cards can be used in ATM machines or at various
merchants that accept debit cards. The main negative
aspect of this method is that if someone were to loose
their card, they loose all the money available in the card.

Importance Of Preloaded Cards On Commercial Banking

Services

Preloaded cards have several advantages for both the

user as well as the bank. These advantages are the
following:

• Preloaded cards are not traceable. They are not

attached to any person; therefore it maintains
the customer’s privacy.
• A customer can control the amount of money that
is to be spent, by purchasing the card with a
certain limit.
• Banks can attract more customers, since it
requires no identification, and a person does not
have to have an account with the bank.
• With more customers banks can earn more profits
and revenues.

39
 Innovations In Electronic Banking

Electronic banking has taken many forms, and continues

to grow at a very rapid pace. With the rapid change in
technology the services that banks offer are also
progressing. There are a number of areas where banks are
offering electronic based banking. The media of these
electronic banking solutions are either through the
Internet, or over the Cellular Mobile Network. This
section discusses the latest innovations in the electronic
banking services. These innovations are, mobile banking,
virtual banking, and internet banks.

Mobile Banking

Mobile banking is the use of the banking services

through your mobile phone, over a particular mobile
company’s connection. Mobile banking can be of two types.
A simple type, which prevails in Pakistan, is banking
through short messaging service (SMS). A more complicated
type is banking through the mobile phone using mobile
specific web pages, also known as Wireless Application
Protocol (WAP). Banking through WAP is not available in
Pakistan as yet. However, several services are being
offered for customers through SMS. Through mobile banking,
customers in Pakistan can now get balance information about
the accounts, view transactions made on their accounts, and
even pay bills for their mobile phones.

For example, MCBs mobile banking works by assigning

the user a Personal Identification Number (PIN). The user

40
then sends in his/her inquiry, through SMS, along with the
PIN code, as well as the account number to a dedicated
number. In reply, the user receives an SMS with the
desired information. The services available through SMS
mobile banking include, balance inquiry, mini statement
which displays the last 4 transactions on the account,
account blocking an account, and unblocking an account.
Other banks offer varying services.

Importance Of Mobile Banking On Commercial Banking

Services

Mobile Banking has many benefits for both the consumer

as well as the bank. These are the following:

• Mobile banking is with the customer all the time.

Since the customer carries the mobile phone
everywhere, therefore the bank travels with the
customer everywhere.
• Mobile banking helps to save on money of the
bank. The per transaction cost is very little in
mobile banking. This figure is the same as
internet bank’s cost which is 1 cent per
transaction.
• Since very few banks offer this service, it will
help to attract many customers.

Virtual / Online Banking

Virtual banking is essentially the offering of banking

services through the internet. Many banks in Pakistan have

41
web sites. However not many offer the ability to carry out
transactions over the internet. Habib Bank, was a pioneer
in this area with their E-Bank. Other banks have followed
suit, and are providing various services through the
internet. Some of these services include, balance inquiry,
account statement, transfer facility, bill payment, check
book requests, standing orders, personalized alerts, salary
payments, account transfers, payment to third party,
foreign currency payments and funds management.

A user needs to create an internet banking account

login and password. This is usually given out by the bank
through various methods. For example, National Bank asks
the client to use the ATM card, and go to the ATM machine
to get a password and Habib Bank gives the user their
information at the bank in print format. Upon getting
their login information, a user can access his/her account
over the internet from anywhere and at any time.

After logging into the account, the user can perform a

number of functions. The user is allowed to transfer funds
from one account to another. A business user can send
salary to all of its employees over the internet,
electronically. Some banks also allow their users to pay
their utility bills through internet access. Users can
also request check books, or simply view the transactions
in their accounts. Habib Bank also allows users to
authorize payments to third parties through the internet.
The type of payments include, the issuance of a demand
draft, the issuance of a pay order, making telegraphic
transfers (TT), and the issuance of a mail transfer. Banks

42
are promising many more services over the internet in the
near future.

Importance Of Virtual Banking On Commercial Banking

Services

Virtual Banks have facilitated the customer in many

ways. These include:

• While previously, a customer needed to request

the bank for a bank statement, which would
require a visit to the bank, or have to mail it
to the customer. With the help of virtual
banking, customers can obtain all that
information by clicking a few buttons.
• The customer is made much more powerful, by
giving him/her the access to create different
services, such as account fund transfers, and
making pay orders, etc. This eliminates the need
to hire workers in the banks.
• Customers have more freedom to do what they want
and when they want. They can create any type of
service they require, without having to visit any
office or spend time.
• Virtual Banking, has decreased the per
transaction cost. The cost has been reduced to
$0.01.
• Virtual Banking attracts many customers to the
bank. Especially those customers that make
frequent transactions find it much useful to

43
 switch to banks that offer virtual or online
banking.

Internet Banks

Internet Banks are those that are 100% on the

internet. Meaning they have no physical branches. All the
transactions, from establishing a bank account, to
depositing money, making transfers, etc. are done over the
internet. There are no Internet Banks in Pakistan, however
with the speed at which technology is spreading; the day
may be near when there will be 100% internet banks in
Pakistan. In the meanwhile, physical banks, or those that
have physical branches are ever increasing the services
they offer through their web sites.

Services Of Internet Transaction Banks

Many services are being offered in Pakistan by online

banks. However, these services are not up to the mark with
the international community. This point is proven by Table
4.1 which describes the services that are offered by US
transactional internet national banks. Some of the
services not being offered in Pakistan include, Credit
applications, new account setup, Brokerage, Insurance, etc.
By offering these services to their customers the
commercial banks can catch up to the level of the
international community. These services will further boost
the portfolio of a bank, as well as help to reduce costs
drastically.

44
 Table 4.1: Services Offered by US Transactional
Internet Banks
Key services offered by transactional Internet national
banks (Q3 1999)
Type of service Percent of transactional Internet banks
offering selected services
All Less $100 $1 $10
banks than million billion billion
$100 to less to less and
million than $1 than over
billion $10
billion
Balance inquiry 88.8 74.1 90.2 90.2 100.0
and funds
transfer
Bill payment 78.2 60.0 77.4 90.4 100.0

Credit 60.0 51.8 51.7 75.3 80.5

applications
New account set- 36.6 29.8 43.9 45.2 43.9
up
Brokerage 21.6 10.6 14.7 41.1 53.7

Cash management 15.7 14.1 16.2 15.1 17.1

Fiduciary 11.9 3.5 9.8 12.3 41.5

Bill presentment 10.6 7.1 7.9 16.4 24.4

Insurance 5.4 2.4 2.3 6.8 29.3

Basic1 77.6 56.5 77.4 90.4 100.0

Premium2 23.9 14.1 17.0 41.1 58.5

Source: Office of the US Comptroller of the Currency.

1
“Basic” includes balance inquiry, funds transfer, and bill
payment.
2
“Premium” includes “Basic” and at least three other
services.

45
 Non-IT Related Innovations

Non IT related innovations in the commercial banking

sector are mainly in leasing and financing. Banks today
offer various types of leasing, including car leasing and
equipment leasing. Home financing is the major financing
innovation.

Leasing

Car and equipment leasing have allowed consumers to

purchase cars and equipment which they would not have been
able to do so earlier. With the different types of leasing
schemes consumers can purchase a car or equipment with just
a fraction of the cost. For example, Bank Alfalah’s
leasing allows a customer to purchase a car or equipment
with just 20% down payment of the total cost. After the
down payment, the consumer pays monthly installments with a
certain percentage interest. The consumer can pay the
installments in a number of years ranging from 3 to 5.

Home Financing

Home financing is another non-IT innovation in the

commercial banking sector. Home financing allows consumers
to get loans to purchase, renovate, or build their own
homes. The major reason for this innovation is because
banks today have a lot of cash. This cash is then made
available to the consumer in the form of loans and lease.
A home loan usually is for a period of 20 years. This loan
can either have a fixed or floating interest. Fixed

46
interest remains fixed over the 20 year period. Floating
loans keep changing with the change in interest rates of
the country.

Reasons For Innovation

Although Banks in Pakistan have existed since the

creating of the country, many changes have occurred in the
commercial banking sector recently. The main reason is
that the number of people using the Internet has increased
substantially. Today there are over 10 million internet
users. Just 4 years ago, this number was less than
250,000. With the spread of Internet, and technology,
Banks have adopted newer technologies, which have led to
increase in innovations.

47
 CHAPTER 5

CONCLUSION AND RECOMMENDATIONS

Since the development of banks, thousands of years

ago, the banking sector has changed much. However the
basic functions of banking remain the same. With the
advent of technology, the commercial banking sector has
been able to improve upon the services it offers to
customers. This is evident from two major categories of
services, which are card based payment systems and
electronic payment systems. Although Pakistani banks have
innovated many of their services, there is still much room
for improvement. The most exciting of the areas were
Pakistani banks can truly make use of technology is the
Internet.

Globalization and increased competition are trends

that have shaped the banking industry for decades. The
expansion of Internet banking will contribute to these
trends in the same way that previous advancements in
telecommunications and data processing did – for example,
by reducing barriers associated with geography and national
boundaries. Many markets that were once highly localized
(mortgage finance in the U.S., for example) have become
national and sometimes international in scope. Not only
will competition be enhanced by the reduction of
geographical barriers, but also by the increased ability of
bank customers to search for and locate new suppliers
electronically.

48
 Internet banking will also accelerate the ongoing
process of financial deepening, i.e. the widening
applicability of more formalized financial markets in the
economy. Traditionally, small start-up firms with a limited
credit history have been unable to secure external funding
in formal credit markets, including banking. Technological
advancements in data collection, data management, and
financial engineering have improved the ability of
potential creditors to assess the creditworthiness of
potential borrowers and to price the risk associated with
those borrowers through standardized mechanisms such as
credit scoring. As a result, the range of businesses and
individuals that can obtain loans through financial
institutions is that can obtain loans through financial
institutions is information that can be entered into a
standardized database, and thus it avoids the costs
associated with customized loan products. Standardized
credit scoring is easily transferable to multiple lenders
or potential lenders, a process that eliminates any
economic rents created when credit depends on specialized
knowledge of a lender with respect to a particular
borrower. The result is greater access and lower cost for
borrowers who qualify for this type of lending.

The impact of Internet banking on the consolidation of

the banking industry is less clear-cut. The Internet can be
employed as an extremely efficient device for banks of all
sizes to collect and manage information in order to meet
the various financial needs of individuals and businesses,
particularly by integrating services or ‘bundling’ them
together. On the one hand the Internet allows financial
firms of different sizes to enter markets and reach

49
customers previously out of reach to them. On the other
hand, there are substantial economies of scale and scope in
data storage and data processing, and larger banks are
better positioned to exploit these than smaller banks. In
addition, the proliferation of Internet sites means there
may be a substantial advantage for banks able to
distinguish their products from those of other banks. This
implies a significant advantage for large firms and banks,
which possess resources to brand and market themselves.
These factors could boost both the pace and scope of
consolidation in the banking industry.

However, even if the growing use of the Internet

favors large banks, these banks must choose between
alternative Internet-based business strategies. The
Internet provides a very effective searching device for
consumers to choose the best-of-breed producers of
specialized services. Intermediaries may play a role in
helping users locate the best product given their
individual preferences for quality, convenience and price.
While economies of scale imply that information warehousing
and processing will be highly concentrated, these functions
may not necessarily be integrated into an individual
banking firm. Rather, they may be performed by third
parties that service the needs of highly specialized and
focused financial firms. Thus, it is not clear whether the
Internet will provide a larger impetus to increased focus
or to greater conglomeration. Most likely, both types of
business strategies will co-exist in the market place with
some banking customers preferring the convenience of one-
stop shopping, while others choose lower costs or higher

50
quality products produced by specialized financial service
providers.

Moreover, U.S. banks are increasingly outsourcing an

expanding range of their operations to third-party service
providers. Recent industry estimates show that outsourcing
by U.S. banks accounts for almost 20 percent of their
information technology services spending. Importantly, the
prospect of considerable cost savings and access to scarce
information processing and development resources has led a
growing number of banks to consider making greater use of
foreign-based service providers – that is, of engaging in
‘cross-border outsourcing’(Kelly & Nolle, 2003). Cross-
border outsourcing by banks is yet another area of
innovation where Pakistani Commercial Banks can excel.
Commercial banks can offer services to other banks in the
form of outsourcing work. This can help to generate a
newer revenue source for the Pakistani banks.

In conclusion, innovations have had a very significant

impact on the commercial banking services. Innovations
have helped commercial banks to develop newer, faster and
better services for their customers. These newer services
have led to increase in customer satisfaction, customer
retention, lower costs per transactions, and higher profits
for the banks. If commercial banks are to improve their
services, the only way forward would be with the help of
innovations. Through innovations, commercial banks can
offer services that will not only attract customers in
Pakistan, but from all over the world.

51
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