Palestine Monetary Authority (PMA)

Transcription

1 Palestine Monetary Authority (PMA) Financial Stability Report (FSR) 2010 Research and Monetary Policy Department July, 2011

2 Vision To be a full-fledged and a modern central bank for an independent and sovereign Palestinian state, capable of conducting sound monetary policy and issuing and managing a national currency. In doing so, the PMA will always aim at achieving both, financial and monetary stability, and thus contribute to sustainable economic growth in Palestine. Furthermore, the PMA seeks to practice the role of economic and financial advisor to the Palestinian government. Mission Ensuring monetary stability and keeping inflation under control, as well as contributing to financial stability in a way that underpins further development in the financial sector in Palestine, promote integration into the regional and global economy, and ultimately, foster high rates of sustainable economic growth in Palestine.

3 Palestine Monetary Authority (PMA) Ramallah - Al Bireh, P. O. Box 452 Tel.: Fax: Gaza- P. O. Box 4026 Tel.: Fax: info@pma.ps Web page:

4 Palestine Monetary Authority Board of Directors Dr. Jihad Al Wazir Governor and Chairman Dr. Shehadah Hussein Deputy Governor Dr. Ismail El Zabri Dr. Mahmoud El Jafari Mr. Mohammad Abu Ramadan Mrs. Mona al Masri Dr. Nabeel Kassis Dr. Said Haifa Dr. Samir Abdullah

5 Introduction The issuing of the Financial Stability Report (FSR) for 2010 came in light of global interest in financial stability issues, specifically after the negative consequences of the global financial crisis, and the extension of its influence to the real economy. The FSR is considered one of the new reports, which the PMA has decided to issue regularly. This version comes to being while the global financial system is still representing a key weak point in the process of economic recovery, despite the actions taken by many developed countries in order to restore stability to financial markets. The atmosphere of uncertainty has surrounded the market as a result of budgets weakness and the disorders suffered by the recent sovereign market debt in Europe. Moreover, the banking system was influenced as a result of the intensive sales of sovereign debt due to the weak economies in the euro area, which led to raised concerns about the sustainability of recovery, and falling stock prices on a large scale, especially in the last quarter of the year. However, on the Palestinian front, despite its limited connection to the global economy and its compulsory association to the Israeli one, the Palestinian economy has achieved positive results during 2010, thus contributing to strengthening performance of the banking sector and promoting financial stability. The real GDP growth rate was increased, unemployment rate decreased, procedures undertaken by the government led to decreasing overall budget deficit, and hence reducing reliance on foreign aid in an attempt to reach financial independence as an essential component of building the Palestinian state. As to the banking performance level, bank assets have increased and customers deposit improved signaling the citizens continuous and increasing confidence in the Palestinian banking system. Furthermore, credit granted has increased, mostly towards private sector residing in Palestine. That has led to an increased proportion of loans to customer deposits, and to the reduction of placements abroad to total deposits. This comes in the context of a PMA plan aimed at fostering and deepening ties between the banking sector and real economy in order to promote economic growth. The above developments in the consolidated balance sheet of banks were reflected positively in the financial soundness indicators of the banking sector in general, whether those of the capital adequacy, asset quality, profitability or liquidity. Non-performing loans decreased to

6 total loans, an indication of the extent of improvement in the quality of the assets of the Palestinian banking sector. These positive outcomes are a result of developing electronic banking systems that have contributed to enhance the stability of the banking sector in parallel with both electronic bounced-checks and credit-scoring systems. Moreover, in the framework of developing payment systems in Palestine, the Real-Time Gross Settlement System BURAQ was launched in accordance with the basic principles of payment systems issued by the Bank for International Settlements. Also, the Palestinian National Council of Payments was established, to undertake the task of formulating national policies and strategies for developing of payment systems and stimulate the continuous cooperation and coordination across all players in this sector. On the other hand, the PMA has paid special attention to sort out the conditions of money changers and specialized lending institutions in Palestine. To this end, it has completed all the regulatory and supervisory aspects relating to money changers. It also obliged money changers to use accounting systems that make it possible to extract a number of financial and monitoring reports to ensure the control of this business. In this context, the PMA has adopted a set of programs that are consistent with its regulating requirements in order to ensure transparency and accuracy in money changers operations, enable the extraction of financial reports compliant with the PMA instructions, and to combat any attempts to launder money or use this business for purposes outside its dominion, which ensures the safety of the financial system in Palestine. As to specialized lending institutions, the final draft of licensing and supervisory system of specialized lending institutions has been completed, as part of the reorganizing, and supervising such institutions to ensure their effectiveness, maintain the stability in the financial system, and ensuring their contribution to sustainable economic development. As for the other non-banking financial institutions, they sill suffer from many obstacles and constraints, which limited their role in the economy, and its contribution in the Palestinian financial system. In this regards, the Palestine Stock Exchange is the most modernized and organized. However, despite the fluctuation in the performance of the stock exchange, it has marked a remarkable development in its ability to mobilize funds and promote investment locally, in a manner that complements the banking role. The insurance sector has witnessed remarkable performance advances, and its database started to develop its shape systematically and accurately. As for the sectors of lease financing and mortgage, they are still under the completion of the legislative and regulatory frameworks governing them. The financial stability has been reviewed as a situation where the financial sector in general, and the banking sector in particular, are able to operate and cope with any risks or undesirable effects (whether in present or in future) on economic growth and development, thereby ensuring that this sector functions effectively and efficiently. This definition is based on the fact that the stability of the financial and banking sector can be exposed to risks, as a result of the existence of the inherent vulnerability, or as a result of its inability to absorb the effects of financial and economic shocks, whether local or global, or as a result of the growing risk in the borrowing sectors, as well as the risks of economic and financial policies.

7 In issuing this report, the PMA aimed to increase awareness and understanding of various issues and developments pertaining to the financial stability in Palestine. The PMA assessment covers the risks surrounding the banking system and the tools used to improve performance. In addition, this report aims to review developments pertaining to the legislative environment of the banking and non-banking financial institutions, Palestinian payment system, and regulatory initiatives that promote financial stability. The contents of this report fall into four main chapters. In the first chapter, the initial part reviews the most important developments within the international economic environment and their impact on global financial stability, especially with regard to sovereign debt crisis in Europe, as well as issues relating to credit rating and the corrective actions taken at the international level to reduce credit risk. The remainder of the chapter, reviews the local economic environment and its implications on financial stability in general and banking in particular, especially in light of the PNA orientation towards relying on domestic borrowing from the banking system, to reduce the degree of dependence on external sources of funding. Chapter two discusses the infrastructure of the Palestinian banking system, through a review of the most important developments in the payment systems, banking regulations, and the developed electronic systems, in addition to the impact of these on strengthening banking stability and elevating banks efficiency. The chapter also included some assessments released by some local, regional and international institutions about the PMA and its achievements. The third chapter deals with the various developments witnessed by the Palestinian banking sector, along with an analysis of the financial soundness indicators according to the manual of financial soundness indicators of the International Monetary Fund, this is undertaken in order to determine the degree of risk that the Palestinian banking system might be exposed to, and its ability to adapt. The chapter also focuses on the payable and receivable interest rates and their trends and impacts on funds available for the local economy. The fourth chapter deals with the most recent developments in non-banking financial institutions, and its impact on promoting financial stability. In the end, I would like to thank the members of the PMA board of directors, and all of its employees, for their considerable efforts to achieve the objectives of the PMA, and our future aspirations to become a full-fledged central bank for the sovereign and independent State of Palestine. In addition, I would like to express my appreciation and gratitude to all Arab, regional and international institutions for their contributions in the ongoing development of the PMA, banking and financial system, thereby serving the process of sustainable development in Palestine. Governor Dr. Jihad Khalil Al Wazir

8 Monetary Stability Group Research and Monetary Policy Department Monetary Operations Department Research and Analysis Division Reserve Management Division Statistics Division Risk Management Division Forecasting Division Open Market Operations Division Ethics Office Supervision and Inspection Department Licensing Division Local Banks Supervision Division Non-Bank Financial Institutions Division MacroPrudentiaI Analysis Division Foreign Banks Supervision Division Organization Structure of The PMA Board of Directors Governor Deputy Governor Ombudsman Office Internal Audit Office Independent Offices Financial Stability Group Consumer`s Relations and Market Conduct Department Payment System Department Security and Public Safety Office Finance Department Human Resources Department Credit Bureau Systems Division Clearing and Banking Settlements Devesion Accounting and Financial Reporting Division Operations and Staff Relations Division Analysis and Technical Support Division Swift & Payment Systems Technical Support Division Budgeting and Expenses Division Training and Development Division Awareness Complaints Division Real Time Gross Settlements Division Back Office and Account Management Division Legal Counsel Office Administration Group Information Systems and Technology Department Governor`s Office Operations and Control Division Project Management Unit Applications and Development Division Management of Business Continuity Plan Unit Technical Support Division Secretarial Archive Unit External Relations and Communications Department Protocol and Public Relations Division Publications and Media Division General Services Department Procurement Division Administrative Services Division Currency Division

9 Institutions of the Palestinian banking system as at the end of 2010 Palestine Monetary Authority Local Banks Foreign Banks 1960 Bank of Palestine P.L.C Cairo Amman Bank Palestine Commercial Bank Arab Bank Palestine Investment Bank Bank of Jordan Arab Islamic Bank Egyptian Arab Land Bank Palestine Islamic Bank Jordan Commercial Bank Al Quds Bank Jordan Ahli Bank Arab Palestinian Investment Bank Housing Bank for Trade and Finance Al Rafah Microfinance Bank Jordan Kuwait Bank Union Bank HSBC Bank Middle East Limited 1 Money Changers Microfinance Institutions 154 Individuals 106 Companies Year of establishment for local banks, or re-opening of the first branch for foreign banks. Number of branches.

10

11 Executive Summary The global economy remains in the process of recovery from the effects of the financial crisis, and in this context, the year 2010 came better than its predecessor in terms of global real GDP, as it recorded a growth rate of 5%, compared with a decline by 0.5% in Despite this improvement, the recovery achieved remained fragile, and the global financial stability is still uncertain. Although the improvement in financial position by virtue of the strong action initiated by many developed countries, which had helped to stabilize the financial markets and reduce the risk, the uncertainty continued to surround the market. The global financial system remained a major weakness in the process of economic recovery due to fragilities in sovereign budgets and disturbances of the sovereign debt market in Europe. This resulted in market turmoil, weak investor confidence, and a worsening performance of global stock markets. The banking system was affected, especially following the intensive sale of sovereign debt bonds of the weak economies in the euro area. This led to increased concerns about the sustainability of recovery, and the fall of stock prices on a large scale, particularly in the last quarter of the year. In contrast, emerging economies in general have shown great ability to withstand the sovereign and banking pressures facing developed countries, and most of them were able to access international capital markets. Yet, in light of the slow growth in developed countries, emerging markets in general have become an increasingly attractive destination for investors due to their strong growth compared to other economies. However, the potential of accumulated macro-financial risks arising from the strength of capital flows, including risks of excessive demand in local markets and the possibility of increasing volatility, remains a source of concern for those countries receiving such flows. Locally, the Palestinian economy was not affected much by fluctuations in the global economy due to its limited relations to the outside. The influence over it by global economic developments stems mainly from its mandatory association to the Israeli economy, and the high ratio of imports to GDP, which forces the local economy to import external inflation. On the financial front, there is no doubt that the Palestine Stock Exchange was relatively affected by the events in regional and global stock markets, especially as the result of fluctuations in the dollar exchange rate, which is determined by price changes and global interest rates. The influence on the Palestinian banking and financial sector in general stems from the absence Executive Summary I

12 of a national currency, and the associated loss of ability to take advantage of monetary policy tools in achieving price stability. In addition, there is the inability to control the crossing borders, and to establish foreign economic relations in line with circumstances, conditions, and structure of the local economy, which is kept hostage to the economic conditions in Israel. Despite these forced constraints, all major economic indicators achieved positive results in The real GDP growth rate increased to about 9.3%, accompanied by a rise in the inflation rate of about 3.7%, a rise that is not considered a worrying sign economically. In addition, the unemployment rate fell to 23.7% of total workforce, compared to 24.6% in the previous year. Moreover, in light of the increase of the total local net revenues by about 24.5%, and the reduced public expenditure by about 3.5%, the overall deficit of the Palestinian National Authority (PNA) s budget declined (without external support) to 17.8% of GDP compared with Despite this improvement, however, the freedom and the ability of the local economy to achieve sustained growth remain restricted under Israeli occupation. This opens the door to more sources of financial instability that affect, directly and indirectly, the performance of the local economy. Some of these sources are: the current multi-currency monetary system, fluctuations in exchange rates, inflation, fluctuations in foreign aid, and political instability. Fluctuations in the exchange rates of currencies used in Palestinian Territory (US dollar, Jordan dinar, Israel shekel) are considered the most significant source of concern, especially if the PMA is unable to control these currencies exchange rate, in addition to affecting various economic sectors. The fluctuations in exchange rates of the US dollar and Jordanian dinar versus the Israel shekel have affected the performance of Palestinian stock exchange significantly. Additionally, the PNA general budget has been affected by such fluctuations due to its dependence on foreign aid (provided in currencies other than the Israeli shekelthe currency used for expenditures) which finances a large percentage of the overall deficit in the budget (about 96% in 2010). In addition there is the effect of the exchange rate on the purchasing power of citizens who earn their wages in US dollar and Jordanian dinar and spend in shekel. Thus, the use of multi-currencies has a direct impact on people s standards of living and ultimately on poverty rates (particularly on those receiving low wages). Risks associated with the inflation rate stems from the fact that a large part of inflation in the Palestinian Territory results from high prices in Israel (imported inflation). This also makes the forecasting of future inflation rates highly difficult in the Palestinian Territory (unanticipated inflation). This is also negatively reflected in some economic and social indicators, especially the cost of living, real wages and real interest rate. With regard to foreign aid, the associated danger stems from the possible halting or decreasing of such aid. The declining pace of foreign aid during 2010 by 8.9% resulted in increasing public debt owed by the PNA by almost the same percentage (8.7%) compared to the previous year. This debt was distributed between domestic debt (44.6%) and external debt (55.4%). On one hand, this indicates a weakness in local revenues, and on the other, the importance of foreign aid; both are considered sources of threat to financial stability. This is particularly so since such aid finances wages and salaries of public sector employees, and covers some II Executive Summary

13 operational, transfer and developmental expenses. Poverty data released by the Palestinian Central Bureau of Statistics (PCBS) showed a decline in poverty rate from about 30.9% before receiving aid to approximately 25.7% after aid during In order to reinforce financial stability, and reduce the risk of sources of threat, the PMA was keen to establish a strong infrastructure to support such stability. The PMA has attained many achievements in this regard during In the forefront of such achievements came the new legislative framework for the banking sector, namely the Banking Law number (9) for the year 2010, which dealt with all the shortcomings of the previous law. Moreover, the PMA has completed the final draft of the Palestinian Central Bank Law, which lays down the legal bases to empower the PMA to manage monetary policy, issue currency, and carry out its duty as a financial agent and economic adviser to government. In addition, it continued issuing banking regulatory instructions in accordance with the international standards. Furthermore, the PMA has made many advances at developing electronic banking systems that contributed to the banking sector stability. The most prominent of these was the Real Time Gross Settlement System BURAQ, which allows the immediate settlement of payments commensurate with modern payment systems. The system is based on giving large transactions higher importance, and transacting them at a desirable speed and according to well considered risk management procedures, thereby alleviating liquidity and credit risks. Likewise, the PMA has launched the credit Bureau system which aims to build a modern and advanced database based on three electronic systems: the credit registry system, bounced checks system, and credit scoring system. These systems represent a distinct addition to tools to reduce credit risks and then take the right decision about credit. The PMA seeks to create an appropriate legislative environment to govern the payments system procedures in accordance with the law and the basic principles issued by Bank for International Settlements. In this regard, the Palestinian National Payments Council (NPC) was established by the decree number (62/2010) issued by the Governor of the PMA on 16/6/2010. The responsibility of the NPC is limited to putting in place the national policies and strategies to develop the payments system and encouraging continuous cooperation and coordination between all parties (banks, financial institutions, technology companies, government institutions and any other related entity). However, work has been underway to develop many electronic systems to enhance the level of financial stability in Palestine. The above-mentioned developments, in addition to a good economic performance of the Palestinian economy during 2010, have been reflected positively in banking performance. The total banks assets increased by 9%, thereby reaching USD million. This increase comes as a reflection of growth and improvement in key items of assets and liabilities of banks, as customers deposit achieved a growth rate of 8% thereby reaching USD million. This growth was reflected positively in the total value of granted credit facilities amounting to USD million, achieving a growth rate of 29.2%, mostly directed towards the private sector residing in Palestine. This led to an increased ratio of loans to customers deposit during 2010, reaching 42.4% versus 35.5% in In contrast, the ratio of placements abroad to total deposits decreased from 51.1% in 2009 to 48.4% in Executive Summary III

14 That enhanced the impact of the banking sector on the real economy by increasing liquidity in the latter. This comes in the context of the PMA s plan aimed at fostering ties between the banking sector and the sectors of the real economy in order to promote economic growth. On the other hand, banks have maintained their tendency to invest in different securities (certificates of deposit, stocks and bonds) due to the persistently very low global interest rates (at zero level) on deposits, which led to an increase in investment abroad by 71.8%, after hitting a record increase in These increases have led to a steady rise in the relative importance of foreign investment from 14% to 23.5% of total placements abroad in In contrast, stocks abroad (the largest component of placements abroad) have retreated by 9.4%, resulting in a decline in their relative importance from 85% of total foreign placements to 75.2% during the same period. In general, the degree of risk associated with foreign investments is not considered disturbing due to their high liquidity on one hand, and low investments concentrated in nonbank institutions on the other. The latter amounted to 16.6% of the total foreign investments for 2010, of which 7.4% were placed in guaranteed government securities. As to the self-funding sources of finance for banks, equity (net) recorded an increase by 13.9% in 2010, compared to the previous year. That enhanced their relative importance in total liabilities to 12.7%. This increase came for two reasons: first, the increase in paid-up capital by 10.9% in 2010 in line with instructions of the PMA aimed to raise the minimum capital for banks operating in Palestine; and second, the USD million worth of profits made by banks in 2010, which enabled the banks to enhance their various reserves with the objective of facing any possible risks. In this context, a new reserve was instituted in 2011, under the name (counter-cyclical reserve); the PMA s instructions in this regard obliged banks to deduct 15% of their net profit after tax in order to augment their capital and counter risks surrounding the banking business. This reserve will also be reflected in 2010 banking data. The degree of competitiveness of the Palestinian banking sector continued to improve in 2010, as a result of policies and actions taken by the PMA in dealing with weak banks, and restructuring of banks subject to special supervisory conditions by liquidation or merger. Thus, the Aqsa Islamic Bank was dissolved through voluntary liquidation under the direct supervision of the PMA, where, its portfolio has been sold to Palestine Islamic Bank. Furthermore, the Palestine International Bank was dissolved through compulsory liquidation by a decision of the Board of Directors of the PMA on 28/11/2010; its good banking portfolio was sold to Al-Quds Bank. The previous developments in the banks consolidated balance sheet have positively impacted the financial soundness indicators for the banking sector. Despite the modest retreat in the capital adequacy of local banks, from 22% in 2009 to 21.5% in 2010, this ratio remained at good level, and higher than both the minimum ratio specified by the PMA (12%) and the minimum level imposed by the instructions of Basel Committee (8%). Furthermore, the enhancement of the paid-up capital by 10.9% has contributed to raising the indicator of capital to total assets to 12.8%. This is in addition to enhancing the ability of banks to absorb losses resulting from non-performing loans. In terms of the assets quality indicators, the indicator of non-performing loans to total loans decreased to 3.1%, compared with 4.1% in In addition, the indicator of provisions for non- IV Executive Summary

15 performing loans decreased to 70.4% in 2010 compared with 82.7% in the last year. Generally, this indicator reflects the adequacy of financial resources to face default risks by borrowers. With regard to concentrations of credit, the facilities granted to the public sector in 2010 were increased by 31.3% over the previous year, reaching USD million. That had led to an increase to their relative importance to 29% compared with 28.5% of total facilities in the past year. The latter percentage was high indicating a possible negative impact on banking stability in the event that the public sector faced any financial or political crises, especially in light of the instability of financial resources of the PNA general budget, and its heavy reliance on external support to cover the overall deficit. In that context, the Palestinian government aims to shift from direct borrowing from banks to borrowing through the government bonds issued by the Ministry of Finance, and managed by the PMA, as part of a government plan to reduce dependence on external funding, and shifting towards local resources in financing the economic development process. As to the distribution of credit facilities to various economic sectors, it is noted that despite the disparate increases in the size of facilities granted to various economic sectors 2010, there is no indication of dangerous concentration of the facilities granted to a given sector. However, there is a discrepancy between sectors share of facilities, and their contribution to GDP, as is especially the case in the sectors of trade, services and agriculture. As for profitability indicators, the net current profit (after taxes) has increased for all banks at a rate of 35.8% amounting to USD million in That was reflected positively in the profitability indicators, where the return on average equity ROAE rose to 17.5% and the return on average assets ROAA increased to 2.1%. These figures reflect the good improvement in the banking sector s efficiency in the use of its assets. A contributing factor to this improvement was the decline of the non-interest expenses to total income in 2010 by 9.9 points to 55.1%, indicating a high operational efficiency of the administrative expenses of banks. In comparison, the index of net interest income to average assets increased from 2.6% in 2009 to 2.7% in 2010, reflecting a slight improvement in assets profitability of banking sector. However, the index of net interest income to total income has declined from 65.4% in 2009 to 59.4% in 2010, due to an increase in gross income by USD 65 million or by 21.4%, which is higher than the percentage increase in net income from interest. This was due to high bank profits resulting from sub-activities, such as currency trading processes, fees and commissions earned on bank services. This is reinforced by the index of non-interest income to total income, which rose from 34.6% to 40.6% in 2010, indicating a greater diversity in sources of income for banks. As to liquidity indicators, the index of liquid assets to total assets retreated to 40.9% in 2010, compared with 43.2% in the previous year. The decline in this indicator is attributed to the high degree of capital investment in less liquid components such as granted credit, and various low liquidity investments with a maturity greater than one year. The index of the liquid assets to short-term obligations decreased from 55.1% in 2009 to 52.5% in However, with regard to the adequacy of liquid assets to meet withdrawals of deposits, the index of liquid assets to total deposits decreased from 52.3% in 2009 to 49.8% in Despite the decline in liquidity indicators, liquid assets continued to represent a good percentage of total assets in the banking sector, enabling it to meet its obligations, without suffering any liquidity hardship. Executive Summary V

16 As for developments witnessed in other non-banking financial institutions (insurance companies, finance companies, mortgage, lease financing, and the Palestine Stock Exchange), subject to the control of the Palestine Capital Market Authority (PCMA), the Palestinian stock market has experienced a limited drop in performance during 2010, where Al-quds general index declined at the end of the year by around 0.7% over the previous year to reach the level of points following the decline of the index of banks, financial services and insurance. Additionally, the number of shares traded decreased about 3.5% amounting to million shares, with a decline in value of these shares by about 9.8% to USD million. In contrast, the market value of listed companies increased by about 3.1% over the previous year, to around USD 2450 million. However, the Palestinian insurance sector has suffered for long time from the absence of legislations, oversight and control mechanisms, and poor insurance culture, until the Capital Market Authority was founded and became the legally authorized entity supervising, controlling and organizing this sector in late In 2010, this sector has improved its performance, despite the continued setback suffered due to the weak activity in Gaza Strip, where the number of insurance companies operating in the Palestinian Territory amounted to ten local and foreign companies operating in various types of insurance, and providing their services through a network of 103 branches. In addition, the number of insurance agencies increased to 265, compared with 225 agencies in the previous year. At the end of 2010, gross assets of insurance companies fell to about USD million, or by 0.7%, compared with a growth of about 7.5% in the previous year. While shareholders equity increased to USD 95.6 million, or by 13.2%, compared to 11.7% in 2009, the paid-up capital rose to USD 62.2 million, or by about 12%, compared with 4.3% in the previous year. Furthermore, the operational performance indicators for the insurance sector witnessed a remarkable development during 2010, with total insurance premiums rising by 20.6% reaching USD million. The activities of the Palestinian insurance sector were focused mainly in vehicle insurance, which accounted for 59.5% of the total activities carried out by insurance companies during As for the sectors of lease financing and mortgage, although they are significant in increasing domestic investment and boosting economic growth and stability, the weakness of the legislative and regulatory environment, as well as the absence of laws governing them remain one of the most important obstacles to the spread of their services. It should be noted that all other non-banking financial institutions have a modest contribution in the overall Palestinian financial sector, when compared to the banking sector that constitutes the largest share. Given the importance of the banking sector in influencing financial stability, the PMA has recently undertaken a number of technical steps to stresstesting of banks operating in Palestine. This involved an analysis of the ability of the banking sector to cope with political or economic shocks, with a range of scenarios that vary in intensity, to measure their impact on financial stability and the real economy. These tests revealed the capacity of the core capital in the banking system to absorb the toughest of the proposed scenarios, as the capital adequacy ratio remained higher than the minimum prescribed by the Basel Committee on Banking Supervision. VI Executive Summary

17 Contents Chapter 1: Global and Local Economic Environment Overview 1 Part I: The Global Economic Environment 1 1) Economic Performance 1 2) Financial Stability 3 3) Systematic Liquidity 5 4) Credit Rating Agencies 6 5) European Sovereign Debt 7 Part II: Local Economic Environment 9 1) Indicators of Economic Performance and Growth Trends 9 2) Variables Affecting the Financial Stability 10 A. Exchange Rates 10 B. Prices and Inflation 12 C. Foreign Aid 15 D. Political Stability 16 3) Orientations of the PMA for Issuance of Public Bonds 17 Chapter 2: Infrastructure for Financial Stability in Palestine Overview 19 1) Legislative and Regulatory Environment 19 A. Banking Sector New Banking Law The PMA Law Anti-Money Laundering Law The PMA s Instructions 22 B. Money Changers 23 C. Specialized Lending Institutions 24 2) Developed Banking Systems 25 A. Credit Bureau Credit Registry Bounced Checks System 26 Contents VII

18 3. Credit Scoring System 26 B. Real Time Gross Settlements System BURAQ 27 3) What they Said about the PMA 29 A. PMA is Eligible to Become a Central Bank 29 B. PMA, A Unique Success Story 31 Chapter 3: Palestinian Financial System Preview 33 Part I: Banking Developments 34 1) Degree of Competitiveness (Concentration Ratio) 34 2) Consolidated Balance Sheet of Banks Operating in Palestine 36 A. Liabilities Side (Funds Sources) Equity Customers deposit 39 - Distribution of Customers Deposit by Region 39 - Distribution of Customers Deposit by Source 40 - Distribution of Customers Deposit by Type 41 - Distribution of Customers Deposit by Currency 42 a- Deposits in US dolars 43 b- Deposits in Jordanian Dinars 44 c- Deposits in Israeli Shekels 44 d- Deposits in Other Currencies Bank Deposits (Balances of the PMA and Banks) 46 B Assets Side (Funds Uses) Direct Credit Facilities (Loans) 46 - Distribution of Direct Credit Facilities by Region Distribution of Direct Credit Facilities by Borrowing Sectors 48 - Distribution of Direct Credit Facilities by Type 50 - Distribution of Direct Credit Facilities by Currency 52 - Distribution of Direct Credit Facilities by Economic Activity Ratio of Loans to Customers Deposit Placements Abroad Balances with the PMA and Banks (in Palestine) 58 VIII Contents

19 5. Investments in Company Shares (subsidiaries,associates and minority stakes) 58 3) Interest Rates in the Palestinian Banking Sector 59 Part II: Financial Soundness Indicators 60 1) Capital adequacy 61 2) Asset quality 63 3) Income and profitability 65 4) Liquidity 67 Chapter 4: Non-banking Financial Institutions, Developments and Achievements Preview Securities Sector Insurance Sector Lease Financing Sector Mortgage Sector Money Changers Specialized Lending Institutions 78 Contents IX

20 Figures Chapter I: Global Economic Environment 1-1 Some Palestinian macroeconomic indicators, Overall deficit as a percentage of nominal GDP, Palestinian stock market index and exchange rate, Imports and exchange rate of dollar against the Israeli shekel, Average exchange rate, inflation rate and purchasing power, Inflation rates in the Palestinian territory and Israel, Real interest rate for deposit and lending, Foreign aid impact on budget deficit, Foreign aid, wages and non-wages expenses, Growth rate and foreign direct investment, Number of Unemploymed and Palestinian employed in Israel, Chapter 3: Palestinian Financial System 3-1 Hervndal index for customers deposit and credit, Palestinian banking system, end of Branches and offices of banks operating in Palestine, Net assets for banking system, Banks liabilities during 2009 and Banks assets during 2009 and Banks equity (net) during 2009 and Customers deposit, Customers deposit by region, Customers deposit by type, Customers deposit by currency, Relative importance of type of deposits in USD, Relative importance of type of deposits in JD, Relative importance of type of deposits in NIS, Bank deposits during 2009 and Direct credit facilities, Credit facilities by region, X Contents

21 3-18 Credit facilities by borrowing Sectors, Credit facilities by type, Provisions for defaulting loans and overdrafts, Overdrafts by type of currency, Loans by type of currency, Relative importance of Credit facilities by currency, Credit facilities by economic activity, Credits and placement abroad as a percentage of deposits, Placements abroad components during 2009 and Defaulted loans before guarantees, Net equity as a percentage of net assets, Capital adequacy ratio for local banks, Non-performing loans as a percentage of total loans, Non-performing loans by period of default, Net Income (after abnormal tax and profit or loss), Return on average equity and return on average assets, Non-interest expenses as a percentage of total income, Liquid assets as a percentage of total assets, Liquid assets as a percentage of short-term obligations, Chapter 4: Non-Banking Financial Institutions, Developments and Achievements 4-1 Palestinian Exchange Index, Trading in the PEX by sectors, Rates of change in the indicators of Arab financial markets in Insurance sector by activity, Contents XI

22 Tables 1-1 Position of the World s Sovereign Debt in Indicators of securities firms, Palestinian Stock Exchange Performance, Financial indicators and operational performance of insurance sector, XII Contents

23 CHAPTER 1 Global and Local Economic Environment Preview After nearly four years into the biggest financial crisis since the great depression, the global financial stability remains uncertain. Dispite improvements in financial position by virtue of actions of many developed countries to stabilize financial markets and reduce risk, uncertainty continued to surround global market. The global financial system remained a major weakness in the process of economic recovery, due to fragilities in the sovereign budgets and the disturbances that have recently befallen the sovereign debt market in Europe. In addition, the conditions in the real estate markets are still a cause of deep concern, especially in the United States and some euro area economies. Locally, although the Palestinian economy has achieved in recent years accelerated growth rates that are higher than those of many neighboring countries, the special nature of the Palestinian economy has posed its own challenges, which threaten this recovery. The high rates of unemployment and poverty remain as major challenges facing the Palestinian economy. It seems that the growth rates achieved are not sufficient to induce structural changes in the economy capable of overcoming these risks. In addition, the current multicurrency monetary system has added more risks due to fluctuations in the exchange rate of currencies in circulation, and the inability to employ monetary policy instruments, or even use these to stimulate the economy. These, in addition to other risks, are arising from the absence of political certainty. Part I: The Global Economic Environment 1) Economic Performance Although the global economic recovery was in line with expectations, vulnerability remained an attribute of this recovery, particularly as developed countries grew at a slower pace than the rest of the world. Available data suggest that global growth reached around 5% in 2010, compared with negative growth of 0.5% in driven by strong growth achieved in the emerging economies in particular. (1) World Economic Outlook (WEO), International Monetary Fund (IMF), April, Global and Local Economic Environment 1

24 Developed countries grew by 3%, compared with negative growth of about 3.4% in the previous year. Yet this growth rate remained low (given that these countries had just emerged from a recession, the deepest ever since World War II) due to the fact that consumption in many countries of this group remained subdued because of low consumer confidence, and the decline in both incomes and wealth of the household sector. It is expected that the recovery remains fragile in this group unless it is translated into improvement in investment and increased employment, especially as unemployment remains high in these countries, up to about 8.3% of the total workforce, compared with about 8% in In contrast, the group of emerging and developing countries grew by 7.3%, as a result of improved household spending in many countries of this group and the positive contribution of investment in creating new jobs. However, this growth has coincided with an increase in inflationary pressures, due to the high rate of inflation of 6.2%, compared with 5.2% in 2009, as a result of high prices of commodities, especially the prices of oil and food, which account for a significant share of the consumption basket in these countries, in addition to the demand for higher wages due to price developments. This double-track growth has posed a challenge to implementing policies that encourage re-balancing internal demand by moving focus from the public to the private sector, and externally by moving focus from the deficit to the surplus economies. One of the most pressing challenges for developed economies is to strengthen sovereign budgets, achieve sustainable financial conditions, stabilize increasing public debt and then reduce it at a later stage to provide more mobility and face the changing conditions in sovereign debt markets. This is particularly so since the monetary policy, which is considered the first line of defense against any expected weakness in economic activity, might not be solely able to address this weakness. As base interest rates were close to zero in developed countries (about 0.30% in the United States, 0.38% in Japan, and about 0.81% in the euro area) 2, these countries may have to use more measures to counter unexpected weak demand resulting from a decline in financial support. In this area, the growth-enhancing structural policies can contribute to restoring macroeconomic policies to their normal role. For example, labor market policies can contribute to promote growth, create new jobs and reduce unemployment. In addition, some complementary reforms in products and services markets may increase the demand for labor. In contrast, many emerging and developing economies were successful in accomplishing a large part of reforms, which resulted in an improvement of the macroeconomic policy framework, thus enhancing the robustness of these economies in facing macroeconomic shocks. Although many of the countries in this group resumed achievement of high growth rates, they are still relying heavily on demand from advanced economies, which is expected to remain below the levels that prevailed before the crisis. Such a matter forces these countries to rely more on endogenous sources of growth to achieve growth rates close to those recorded before the crisis. They should also work on strengthening human capital and infrastructure, which would help to absorb the capital flows that are expected to increase with (i) continued improvement in performance of these countries compared with developed countries that are characterized by low returns, and (ii) with the desire of emerging economies to diversify (2) OCED Database, short-term interest rate, percent per annum. 2 Financial Stability Report

25 the portfolios of their investment institutions. However, these flows remain vulnerable to fluctuations and may once again outflow from these countries following a rise in key interest rates in developed countries beyond their present exceptional low levels. 2) Financial Stability Developed countries have faced several challenges that slowed achieving financial stability, due to the correlation between slow economic recovery, high levels of indebtedness and debt renewal processes, the continued weakness of the financial sector and the turmoil in European sovereign debt markets. It is noted that market fluctuations increased, confidence of investors decreased, prices declined in many stock exchanges beginning with European markets, and the banking system was shaken following the intensive sales of sovereign debt of weak economies in the euro area, resulting in a systemic crisis. This led to increased concerns about the sustainability of recovery, and caused a drop in stock prices on a large scale, especially in the last quarter of the year 3. In addition, risk premiums on corporate bonds increased, and companies issuances slowed down. On the other hand, concern grew in markets along with the increasing weaknesses in sovereign budgets. Some countries in the euro area fell under financing pressures arising from current challenges relating to the sustainability of sovereign debt, renewal of short-term debt, and lack of diversity in the investor base. There were implications for these pressures on the banking sector, as credit contracted, growth slowed down and banks balance sheet weakened further. Although the unprecedented initiatives taken via European policies have contributed to risk reduction, basic weaknesses of both sovereigns and the banking system continued to pose a major challenge amid fears of risks that threatened the global recovery. It is noteworthy in this regard that the European Central Bank has developed the Securities Markets Program, while member governments in the euro area established the European Stability Mechanism. These programs have helped in coordinating efforts and ambitious reforms announced by European countries that were most vulnerable to funding difficulties to contain the unrest in the euro area after its rapid escalation, particularly in May However, significant sovereign risks remained as markets continued to focus on the burden of public debt, the increasing risk of renewed debt, and links with the banking system. Access to financing markets remained limited and financing costs continued to increase especially for banks operating in countries that still have yield differences on their sovereign bonds under pressure. In the United States, financial stability has improved within an extremly cautious atmosphere. Although banks were successful in providing a great deal of capital, there was a need for more funds to prevent a decrease in financial leverage rates and ensure commitment to regulatory reforms. There was also need to address the weaknesses in the real estate sector that remained an additional challenge. It should be noted that the seemingly modest US (3) The Dow Jones Euro Stoxx 50 index in the euro area decreased by 1.7% in October, 1.2% in November 1.2%, and by 2.8% in December. Over the year, this indicator has increased by 12%, compared with the decline by about 20.5% in While Standard & Poor s 500 index in the United States increased by 21.8%, compared with a decline by about 18.9% in Nikkei 225 index in Japan increased at around 8.8% compared with a decline of about 19.7% in See ECB, Statistics Pocket Book, March, Global and Local Economic Environment 3