Middle East Economic Survey

VOL. L

No 29

16-July-2007

GENERAL 

Banks In The Middle East: Catalysts For Economic Growth Or Forces To Preserve The Economic Status Quo? To Find Out, “Follow The Money”

By Andrew Cunningham

Andrew Cunningham is Managing Director, Head of Middle East and Balkan Programs at the Financial Services Volunteer Corps, a US-based not-for-profit company which works to strengthen financial sectors in transitioning and emerging markets. He can be contacted at acunningham@fsvc.org

Private sector companies in the Middle East’s most impoverished nations are being starved of credit because their banks continue to place more money with their governments or with banks and clients abroad. In some of these countries, the proportion of private sector deposits being recycled into private sector credit has been falling, despite government efforts to promote private sector enterprise and reduce the role of state-owned companies in their economies. Ironically, it is banks in the wealthier nations of the GCC which are showing greatest efficiency in recycling private deposits into private sector credit, and in reducing, in proportional terms, the amount of money they extend to their home governments or place abroad.

According to central bank statistics, commercial banks in nine of the Middle East’s developing countries extended $144bn in domestic credit at the end of June 2006, while $132bn was placed with their home governments and government-owned institutions, and a further $52bn in foreign assets. In contrast, banks in the six GCC states had extended $286bn in credit to the private sector, with only $73bn being placed with their governments or government-owned institutions, and a further $113bn held in foreign assets (see Table 1).

Table 1

Domestic Credit Vs Credit To Government And Foreign Assets

*     Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

**   Algeria, Egypt, Jordan, Morocco, Syria, Lebanon, Libya, Tunisia, Yemen. Statistics published by the central banks of Palestine and Iraq are insufficiently granular to be included in this table. Foreign asset figures for Oman, Egypt and Libya refer only to deposits with foreign banks. For further information on how the figures have been compiled, please refer to the “Notes on Methodology,” on Page 33.

Libya provides the most striking example of a banking system which continues to channel its resources to its own government or to foreign banks, rather into its domestic economy. High oil prices led deposits in the banking system to increase by 68% in the two-and-a-half years to the end of June 2006, yet bank credit actually fell during that time. Effectively all of the additional resources which the banks collected were directed either into Central Bank securities, or into foreign bank deposits. Looked at another way, at the end of 2003, 71% of deposits were being recycled into bank credit, but by June 2006 the figure had fallen to 39%.¹

Table 2

Private Sector Credit % Private Sector Deposits*

*     Care must be taken when comparing the ratios, since Central Banks report in different ways and it is not always possible to reach a common basis for calculation – see “Notes on Methodology” on Page 33.  Such differences are important to note, but do not compromise the general picture which emerges in this table.

Egypt tells a similar story. In the five years to the end of 2006, private sector deposits more than doubled, but private sector credit increased by only 44%. The majority of the additional resources which the banks received from private sector deposits were placed abroad with foreign banks.

Saudi banks show the opposite trend. Private sector domestic deposits doubled in the five years to December 2006, but loans to the private sector increased by 161%. Whereas in December 2001 the banks were lending out 61% of their private sector deposits in the form of loans to the private sector, five years later the percentage had risen to 80%.

Clearly, care must be taken when comparing such different economies. In the Gulf, consumer lending is well established and accounts for a large part of private sector credit. Recent statistics indicate that around 40% of private sector credit is classified as some form of personal loan in each of the Gulf states, and that the percentage has generally, though not uniformly, been rising. Much of this finances cars and consumer goods, and the financing of share purchases was also a major factor in 2004 and 2005. (Bank credit in Saudi Arabia rose by 37% and 39% in 2004 and 2005 – when IPO activity was at its height – but only 10% in 2006, when the market collapsed.) But not all personal lending is for consumer goods and other personal items. Some is used to finance small businesses and family enterprises. The Central Bank of the UAE breaks down personal loans into two categories – “for business purposes” and “for consumption purposes” – with business loans now accounting for nearly three quarters of the total.

As for the developing countries of the Middle East, most have a history of socialist-style state ownership which they are still trying to shed – the public sector still accounts for a huge proportion of economic activity so it is natural that much of the available bank credit will be directed there.² 

But despite these qualifications, the underlying picture is clear. In many of the Middle Eastern economies where the private sector is most in need of credit, the nation’s banks are directing an increasing proportion of private sector deposits to their government (usually their central bank) or to foreign banks.

Banks would argue that good local lending opportunities do not exist: that the local legal system will not support them if a borrower reneges; that private sector companies do not produce proper accounts; that there is no credit registry where they can check a potential borrower’s payment record; and that there is no system of collateral registration. Given all that, and the fact that their own staff would need considerable re-training to be able to make sound credit judgments on private sector companies, as opposed to state-owned monoliths which “never” fail, it is hardly surprising that banks leap at the chance to place money in government securities.

Yet the cost to their local economies is considerable.

Take the example of Lebanon, where only about one third of private sector deposits are recycled into private sector credit. If the Lebanese banks were able to increase the private sector loan/deposit ratio to 50% – still a rather modest proportion – the increased credit available to the private sector would be equivalent to about one third of a single year’s gross domestic product. Increasing the same ratio to 50% in Yemen would result in the injection of $0.5bn into the private economy, equivalent to about 3.5% of one year’s GDP. ³

At the end of June 2006, Lebanese banks had placed 53% of their assets either with the central bank in the form of reserves or in treasury bills. In Yemen, the equivalent figure was 42% at the end of 2005.

In Libya, the amount of additional money which the banks placed with their government in 2005 was equivalent to about 6% of GDP. The picture was repeated in first half of 2006, where incremental lending to the government amounted to about 3% of annual GDP.

Do banks have sufficient capital to support switching assets away from their home governments and foreign banks, and into private sector credit? Bald statistics would suggest not. Unweighted equity-to-asset ratios for systems as whole at the end of June 2006 were 5.3% in Egypt, 7.3% in Lebanon, 5.2% in Libya and 6.8% in Yemen. In Algeria it was 4% at the end of 2005. (Syria showed a robust 15.8% after a capital injection at the end of 2005.) But these statistics do not capture the specific circumstances in each of these countries. Internal capital generation by Lebanese banks tends to be strong. Egypt and Yemen have broader issues of bank capitalization to address – a comprehensive government-sponsored solution to the problem of long-standing non-performing loans would dwarf the effects on risk-weighted capital of a change in asset allocation. Algeria, an oil and gas economy with more than $100bn in reserves, could easily finance capital increases to the state-owned banks, which together account for over 90% of the country’s banking activity. In short, capital is not an obstacle to greater private sector lending in these countries.

In the developing countries of the Middle East, the banks, and the legal and accounting environment in which they operate, hold the key to an expansion of private sector enterprise and to faster economic growth. Capital market development has a role to play in developing other sources of finance such as private wealth and overseas investors, and is often an effective catalyst for better transparency and governance throughout the financial sector. But more effective recycling by national banks of existing, domestic, private sector deposits would have an immediate impact on economic performance and wider social issues such as employment and economic inclusion.

The Gulf Vs The Rest: A Widening Gap

Any review of financial statistics in the Middle East highlights a widening gap between the size of the banking systems in the six Gulf states and those in the rest of the Middle East. The GCC accounted for 55% of all private sector deposits in the Middle East in June 2006 – a proportion which has been increasing in recent years. Saudi Arabia alone accounts for one quarter of the total. The widening gap is even more marked for private sector credit, although the role played by consumer lending – well developed in the Gulf and generally less so elsewhere – should be recognized. 

Outside the GCC, three countries dominate: Egypt, Lebanon and Morocco together accounted for about two thirds of private sector credit and deposits in the nine non-GCC counties analyzed (see Table 3).

Table 3

Distribution Of Credit And Provenance Of Deposits: Middle East 15

The fall in Egypt’s share of deposits is entirely attributable to a weaker exchange rate – absent this and the proportion would have increased. The fall in its share of credit would have been reduced, though far from eliminated without the exchange rate movement. In contrast, without its strengthening exchange rate, Morocco would have shown a fall in its share of deposits, and a larger fall in its share of credit.

In the absence of official statistics, June 2006 figures were estimated for Yemen (credit and deposits) and Algeria (deposits only).

Some totals may not add due to rounding.

Please refer to the Notes on Methodology, on Page 33.

The biggest six banking systems in the region together account for about 80% of private sector credit and deposits.

A final observation: at the end of 2006, the UAE banking system was bigger than that of Saudi Arabia in terms of asset size, although the Saudi system remains the largest in terms of private sector credit and private sector deposits. The larger asset size of the UAE system is attributable mainly to larger amounts of foreign liabilities.

Notes:

1.   Here, deposits and credit refer to total deposits and total credit since figures published by the Libyan central bank figures do not permit a precise breakdown into private sector deposits and private sector credit.

2.   The oil industries in the Gulf – which dominate economic activity in those countries – are also overwhelmingly state-owned, but not all require debt financing, and much of the debt which they do assume is provided by international banks.

3.   These estimates are based on end-2005 figures, the most recent point for which internationally comparable GDP figures are available.

Notes On Methodology

Statistics were compiled from publicly-available Central Bank reports for the six GCC states, Algeria, Egypt, Jordan, Lebanon, Libya, Morocco, Syria, Tunisia and Yemen. Comprehensive statistics are not available for Iraq or Palestine.

The granularity of central bank statistics is not uniform so the composition of indicators differs from some countries to others. The notes below give a sense of what the differences are.

Bahrain: Figures are those for “Retail Banks.”

Egypt: Figures refer to end of June not end of December, unless otherwise specified. Credit refers to loans and discounts, but not securities.

Jordan: Foreign Assets exclude claims on non-resident private sector and foreign currency cash held in vaults.

Kuwait: Private sector credit comprises credit facilities to residents and not “other local investments”. Government securities exclude Debt Purchase Bonds, though these are included in the total figure for Claims on Government. Foreign assets include credit facilities to non-residents.

Libya: Figures for credit to the private sector refers to total credit, including social loans, housing loans, and loans to economic and services activities – in other words it includes loans to the government as well as to the private sector. Deposit figures are similarly aggregated for public and private sources. As a result, Libya’s figures provide a picture of total intermediation by the banking system rather than of the intermediation of private depositors to private borrowers.

Morocco: Figures for private sector deposits include comptes crediteurs a vue en dirhams de la clientele, comptes sur carnets, comptes a terms et bons a echeance fixe less souscriptions des entreprises non financieres et des particuliers.

Qatar: Private sector credit excludes credit made outside Qatar. Deposit figures exclude non-resident deposits.

Saudi Arabia: Claims on private sector include bills discounted but not investments in private sector securities.

Syria: Figures are for local banks, public and private. Foreign assets include foreign currency in vaults. Deposit figures exclude “other deposits” and take no account of import deposits.

Tunisia: Private sector deposits are those for entreprises et particuliers.

UAE: Private sector credit excludes commercial papers and includes real estate mortgage loans. Foreign assets include credit to non-residents.

Yemen: The figure for deposits is total deposits, including a small amount of “Government” deposits and any deposits from state-owned enterprises.