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Financial Stability Report
2014
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Palestine Monetary Authority (PMA) - Financial Stability Report 2014
Financial Stability
Report
2014
Research and Monetary Policy Department
September, 2015
© September, 2015
All Rights Reserved.
In the case of quotation, please refer to this publication as follows:
Palestine Monetary Authority (PMA). Financial Stability Report (FSR)
2014: June, 2015.
Ramallah – Palestine
All Correspondence shall be directed to:
Palestine Monetary Authority (PMA)
P. O. Box 452.
Ramallah, Palestine.
Tel.: (+ 970) 2-2409920
Fax: (+ 970) 2-2409922
E-mail: [email protected]
Web Page : www.pma.ps
Designed by:
Public Relations and Communications Department - PMA
ii
Foreword
On behalf of the Palestine Monetary Authority (PMA), I am honored to
present the current issue of the Financial Stability Report (FSR). Financial
stability is increasingly gaining attention, as many central banks are progressively targeting financial stability alongside monetary stability. The publication of the current FSR is consistent with the PMA’s mandate and objectives to assess potential risks threatening financial intermediaries and
the financial system and to display the capacity of this system to withstand
such risks and threats and ultimately to propose a set of recommendations
intended to bolster financial stability and avoid and reduce potential risks
and threats.
In Palestine, the focus on financial stability reflects the significance of the
financial sector as well as its capacity to deal with risks and effectively promote economic growth and sustainable development, as it is the backbone
of the Palestinian financial system and the most vulnerable to risk. The focus on financial stability also reflects the
status of the financial system’s development, a dynamic process which mirrors the progress in volume and quality
of financial services as well as the degree of the system’s adaptability and inter-linkage with the real economy.
The PMA regards financial stability as the smooth flow of funds between households, corporations and the government as well as between citizens and the rest of the world. This notion entails a sound and effective operation of
financial intermediaries within efficient financial markets, and requires that financial corporations can withstand
adverse macroeconomic and liquidity shocks and financial contagion risks. It also necessitates sufficient liquidity
and a good measure of confidence in the operation of financial markets.
In this context, the current FSR highlights the PMA’s strive to foster a stable, robust and effective financial system, and
maintain price stability with a view to ensure balanced and sustainable economic growth. As such, the publication
of financial stability analysis findings directly furthers a key objective of PMA, as the sole institution authorized to
oversee both payments services providers and sound and effective payments systems, thus ensuring financial stability.
Governor
Dr. Jihad Khalil Alwazir
iii
iv
Contents
Chapter One: Overall Assessment of Financial Stability
1
Financial stability trends in 2014
1
Israeli sanctions
2
The Crisis of the Gaza-based civil service pay
4
Israeli aggression against GS and repercussions for the banking system
5
Financial development and development indicators during 2014
6
The regulatory and supervisory framework
6
Banking system updates
6
Characteristics of the Palestinian financial system
6
Credit risks and financial soundness indicators
7
Global economy
9
Economic performance
9
9
Chapter Two: Global and Local Economic Developments
9
Global financial stability
11
Regional economy
12
Israeli economy
12
Jordanian economy
14
Local developments
15
Public finance
16
Regularity and supervisory framework
19
Chapter Three
19
Financial Sector Developments
19
Banking system updates
20
The electronic national switch
20
The public key infrastructure (PKI)
20
Standardization of the International Bank Account Number (IBAN)
21
The Automated Clearance System
21
Development of the Credit Bureau System (version III)
21
Launch of database for facilities granted to SMEs
22
Launch of online bank-charges comparison service
22
Business Continuity
23
The Palestinian Financial System Matrix
24
Characteristics of financial institutions
26
Financial depth
26
Financial access
27
Financial efficiency
32
Financial stability
32
Characteristics of financial markets
32
Financial depth
32
Financial access
33
Financial efficiency
34
Financial stability
35
v
Exposures to local sectors
37
Public sector
37
The government
37
37
Chapter Four: Banking Sector Exposure
37
Civil servants
39
Private sector companies contracted by the government
40
Private sector
41
Mortgage and housing sector
42
SMEs sector
44
Exposures to external sectors
45
Non-residents
45
Interest rates
46
Placements abroad
48
Credit gap
49
Capital adequacy indicators
53
Chapter Five: Financial Soundness Indicators
53
Regulatory capital to risk-weighted assets (capital adequacy ratio)
54
Nonperforming loans
54
(less provisions) to core capital
54
Core capital to total assets
55
Asset quality indicators
55
Non-performing loans
(NPLs) to total loans
55
Sectoral distribution of loans
57
Earning and profitability indicators
58
Return on average assets (ROAA)
58
Return on average core capital (ROAE)
58
Net interest income (interest margin) to gross income
59
Non-interest expenses to gross income
59
Liquidity indicators
59
Liquid assets to total assets
59
Liquid assets to short-term liabilities “regulatory liquidity”
60
Money changing sector
63
63
Chapter Six: Non-Banking Financial Institutions
63
Specialized lending institutions
65
Loans granted to SMEs
67
Mortgage and housing loans
68
Securities sector (Palestine Exchange-PEX)
68
Insurance sector
72
Legislative and regulatory developments
72
Operational and financial activity
72
Mortgage sector
74
Financial leasing sector
75
Stress tolerance tests
77
vi
Chapter Seven: Financial Pressure “Stress Testes”
77
Tolerance testing at the level of the banking sector
79
Testing banks’ ability to withstand macroeconomic risks
81
Figures
Figure 1-1: Palestinian financial stability risks
2
Figure 1-2: Israeli channels of pressure on the banking sector
3
Figure 1-3: Clearance revenues, 2010-2014
3
Figure 2-1: Global economic developments, 2010-2014
10
Figure 2-2: Israeli economic developments, 2010-2014
12
Figure 2-3: Bank of Israel policy rates, 2010-2014
12
Figure 2-4: Israel control channels on the Palestinian economy
13
Figure 2-5: Jordanian economic developments, 2010-2014
14
Figure 2-6: Central bank of Jordan policy rates, 2010-2014
15
Figure 2-7: Palestinian economic developments, 2010-2014
16
Figure 2-8: Weaknesses in public finances and risks to financial stability
18
Figure 3-1: Branching policy, 2010-2014
23
Figure 3-2: Concentration in the banking sector, 2010-2014
23
Key functions of financial systems
24
Figure 3-3: Credit granted to Private sector as a percent of GDP , 2013
26
Figure 3-5: Branches and offices per 100 thousand of adult population, 2013
27
Figure 3-4: Financial depth in Palestinian financial institutions, 2013-2014
27
Figure 3-6: Account ownership at banks or other financial institutions, selected countries, 2011-2014
28
Figure 3-7: Individuals with outstanding loans from banks or other financial institutions, selected countries, 2011-2014
28
Figure 3-8: Individuals with debit card, selected countries, 2011-2014
28
Figure 3-9: Individuals with credit card, selected countries, 2011-2014
29
Figure 3-10: Advanced usage of electronic services, selected countries, 2014
29
Figure 3-11: The use of ATM in cash withdrawals, selected countries, 2014
30
Figure 3-12: Interest rate margin, 2013-2014
32
Figure 3-13: Characteristics of Palestinian financial market, 2013-2014
33
Figure 3-14: Financial depth of Arabs stock exchange, 2013
33
Figure 3-15: Financial inclusion of Arabs stock exchange, 2011
34
Figure 3-16: Financial efficiency of Arabs stock exchange, 2011
34
Figure 3-17: Market rate of return volatility in PEX, 2010-2014
35
Figure 4-1: Growth rate in credit granted to the government, 2011-2014
38
Figure 4-2: Domestic credit granted to public and private sectors, 2010-2014
38
Figure 4-3: Share of domestic credit granted to public and private sectors, 2010-2014
39
Figure 4-4: Government credits as a percent of banks’ equity, 2010-2014
39
Figure 4-5: Credit granted to civil servant employees, 2013-2014
40
Figure 4-6: Government arrears accumulation, 2013-2014
40
Figure 4-7: Credits granted to private sector, 2010-2014
41
Figure 4-8: Credit granted to mortegage sector as a percent of total credits, 2013
43
vii
Figure 4-9: Outstanding loans to SMEs as a percent of GDP, 2013
44
Figure 4-10: Sectoral distribution of SMEs defaulters, 2013-2014
45
Figure 4-11: Lending and deposit rates in Palestine, 2010-2014
46
Figure 4-12: Currency composition as a percent of banks assets in Palestine, 2010-2014
46
Figure 4-13: Annual change in USD exchange rate against NIS, 2010-2014
47
Figure 4-14: Credit structure by currency, 2010-2014
47
Figure 4-15: Deposits structure by currency, 2010-2014
47
Figure 4-16: Blacements abroad as a percent of total deposits, 2010-2014
48
Figure 4-17: Blacements abroad and credit facilities, 2010-2014
49
Figure 4-18: Credit gap of the Palestinian private sector, 2010-2014
50
Figure 5-1: Capital adequacy ratio, 2010-2014
54
Figure 5-2: NPLs (less provisions) as a percent of core capital, 2010-2014
54
Figure 5-3: Core capital to total assets, 2010-2014
55
Figure 5-4: NPLs to total Loans, 2010-2014
56
Figure 5-5: The structure of NPLs in foreign banks, 2010-2014
56
Figure 5-6: The structure of NPLs in foreign banks, 2010-2014
56
Figure 5-7: Sectoral concentration of credits, 2010-2014
57
Figure 5-8: Provision coverage for bad loans, 2010-2014
57
Figure 5-10: Return on core capital (ROAE), 2010-2014
58
Figure 5-11: Net interest income to total income, 2010-2014
59
Figure 5-14: NIS cash liquidity (dollar-denominated), 2008-2014
60
Figure 5-12: Liquid assets to total assets, 2010-2014
60
Figure 5-13: Liquid assets to short-term liabilities, 2010-2014
60
Figure 6-1: Credits granted from specialized lending institutions to SMEs by sector, 2014
67
Figure 6-2: Defaults in SMEs by sector, 2014
67
Figure 6-3: General index of Palestine Stock Exchange, 2010-2014
69
Figure 6-4: Indecies of Arab Stocks Exchange, 2014
71
Figure 6-5: Turnover rates in Arab Stocks Exchange, 2014
71
Figure 6-6: Investments of insurance companies by type, 2013-2014
72
Figure 7-1: Tier 1 capital to risk weighted assets, 2013-2014
80
Figure 7-2: Forecasts of changes in loans provisions, end of 2015
81
viii
Tables
Table 1-1: Clearnace revenues, 2010-2014
4
Table 3-3: Some financial inclusion indicators, selected countries, 2014
35
Table 4-1: Credit granted to private and public sectors, 2010-2014
41
Table 4-2: Credit granted to resident private sector by beneficiary, 2010-2014
42
Table 4-3: Credit granted to private sector, 2012-2014
43
Table 4-4: Outstanding credits to SMEs by activity, 2013-2014
44
Table 4-5: Destribution of credit portfolio by beneficiary, 2010-2014
45
Table 5-1: NIS cash shipped from Palestine to Israel, 2013
61
Table 6-2: Main financial indicators of money changers, 2011-2014
64
Table 6-1: Money changers in Palestine, 2010-2014
64
Table 6-3: Outstanding loans granted to licensed specialized linding institutions, 2014
65
Table 6-3: Outstanding loans granted to licensed specialized linding institutions, 2014
66
Table 6-4: Main indicators of Palestine Stock Exchange, 2010-2014
70
Table 6-5: Sectoral indicators of Palestine Stock Exchange, 2014
70
Table 6- 6: Financial indicators of insurance sector, 2012-2014
73
Table 7-1: Potential shocks in single variable stress tessts
77
Table 7-2: Potential shocks in multivariable stress tessts
78
Table 7-3: The PMA stress tessts results, 2014
79
Table 7-4: Forecasts of changes in loans provisions, end of 2015
81
Boxes
Box 1: World Bank framework to measure financial system characteristics
24
Box 2: Crisis management during the war on Gaza Strip in 2014
50
ix
Chapter One
Overall Assessment of Financial Stability
Overview
A PMA’s primary function is to safeguard financial stability in Palestine. The PMA therefore
gives great attention to maintaining a secure, sound and effective financial system, and
closely monitoring financial developments and trends. This, in turn, contributes towards
withstanding successive crises and various risks facing the financial system and the Palestinian economy at large. For this purpose, the PMA has adopted effective and persistent
measures by issuing an array of supervisory instructions and directives. It thus exerted relentless efforts to develop a banking system in accordance with international best standards
and practices, incorporating elaborate business continuity and risk management plans.
Notwithstanding the satisfactory performance of the majority of the banking system financial indicators, the PMA remains fully cognizant of the risks threatening the system’s
stability, and the consequent need for implementing appropriate measures to mitigate
and contain their likely effects and repercussions.
Financial stability trends in 2014
During 2014, several key political, security and economic developments left a deep impact on the Palestinian economy
in general. Most prominent among these were the conclusion of the agreement on national reconciliation (between the Palestinian Authority government in the West Bank and the Hamas government in Gaza), and the ensuing
formation of a single consensus government, as of mid-year. However, internal tensions persisted largely due to the
consensus government’s suspension of salary payments for the employees of the dissolved Gaza-based government.
Assault on the banks’ branches in Gaza ensued, leading to their closure for several days, virtually bringing banking
and much of economic activity in Gaza to a standstill. Shortly afterwards, the 51-day Israeli aggression against Gaza
Strip (GS) in July caused devastating damage and loss of lives, property and general infrastructure, as well as enormous destruction to a large number of industrial and other establishments. Although bank branches in Gaza escaped
serious physical damage, they closed doors for most of the war period and banking activity in the Strip either entirely
ceased or was curtailed to a bare minimum.
Under such conditions, financial stability in Palestine remains prone to many risks, most prominently the exogenous
risks posed as a result of the Israeli occupation, blockade and economic sanctions which are adjusted to suit concomitant developments in the political and security situation. Such a risk represents a persistent and chronic condition
whose detrimental effect weighs on the overall Palestinian economy.
Chapter One: Overall Assessment of Financial Stability
1
As for endogenous risks to the Palestinian financial system, these include the constant ebb and flow of the national
reconciliation process. As a result, the banking system, which was caught in the cross fire of the conflict, was exposed
to various operational risks, credit risks and reputation risks that had unfavorable effects on the overall Palestinian
banking system. Other outstanding endogenous risks include those related to public finance developments, which
stem in essence from the exogenous risk posed by Israel through withholding clearance revenues. These transfers
constitute the major source of public revenues. Consequently, the government cannot meet its obligations steadily,
particularly its obligations to civil servants. In turn, this compromises civil servants’ ability to fulfil their obligations
to banks. Nor can the government meet, with regularity, its obligations to suppliers from the private sector, thereby
disrupting their relationship with the banking sector. Additionally, pronounced and direct risks to banks also arise
from the large volume of credit granted to the government.
Figure 1-1: Palestinian financial stability risks
External Risks
Internal Risks
Grants
instability
Economic
Irregulari-
Sanctions
ties in
by Israel
clearance
transfers
Disrupt the
Public
finance
instabiltity
Non
payment
Destabilize
develop-
financial
ment of the
stabiltity
banking
sector
Unnetralize
the
banking
sector from
Gaza
employees'
political
differences
sallaries
Internal
schisim
Political risks are regarded as the most prominent and serious risks impacting the Palestinian banking system, in specific, and the economy at large. Within this context, the banking system was subject during 2014 to three acute crises
which were linked to political and security risks that adversely affected financial stability. These crises were as follows:
• Israeli sanctions
Early June of 2014, Israel threatened to impose economic and banking punitive measures against the Palestinian
people in order to abort the reconciliation efforts and the resulting national unity government. It also resorted to
such threats as Israeli-Palestinian negotiations faltered and the State of Palestine commenced the process of joining
several international treaties, conventions and organizations. The punitive actions involved the following aspects:
• Freezing and confiscation of the clearance revenues to be paid to the Palestinian government, and settlement
of all bills owed to Israeli companies and institutions directly from these revenues without prior consultation
with the relevant Palestinian authorities.
• Cutting down the deposit ceiling for banks operating in Palestine with Israeli banks, which entails refusal of
the Israeli banking system to receive NIS cash surplus accumulated by banks operating in Palestine.
• Suspension of activity and cooperation in the marine gas fields drilling off the coast of GS.
• Interruption of trade activities from and to Israel and via Israeli ports and airports.
• Tightened restrictions on the movement and activity of Palestinian businessmen and merchants, especially in
Area C of the Palestinian Territories, which adversely affects overall activity in commerce and industry.
2
Financial Stability Report - PMA
In essence, the risk of sanctions and
Figure 1-2: Israeli channels of pressure on the banking sector
restraints imposed by the occupa-
Link channels between the Palestinian
and Israeli banking sectors
tion over the Palestinian banking
system is evident in the nature
of the relationship between that
system and its Israeli counterpart,
which is based on the economic
Corespondance
Paris Protocol regulating monetary
banking
and banking relationships between
Letter of
credits
relations
Incoming &
outgoing
transfers
Checks
clearing
Cash liquidity
& Shekel
surplus
the Palestinian and Israeli parties.
Figure (1-2) illustrates channels of overlap and interconnection between the Palestinian banking system and the
Israeli one, as the latter provides members acting as correspondent banks on behalf of those licensed in Palestine,
particularly with respect to letters of credit, transfers and all Israeli-shekel transactions. These channels are: (1) check
clearance which is carried out through the Israeli clearing house for checks drawn on Palestinian bank accounts and
paid into Israeli bank accounts and vice versa; (2) outgoing and incoming transfers to and from Israel; (3) issuance
and processing of letters of credit in Israeli shekel through Israeli banks; and (4) administration of cash liquidity
particularly in relation to the Israeli shekel (See Chapter Five – Liquidity indicators).
With the first signs of the Palestinian political schism mid-2007, Israeli measures and their ramifications started to
emerge, as Israel exploited the Palestinian division circumstances to besiege and, on 19 September 2007, declare Gaza
Strip a “hostile entity”. Israeli banks suspended operations with banks operating in the Strip, leading to the creation of
the cash liquidity crisis. The liquidity crisis soon transmitted to the West Bank (WB) in the form of large accumulated
Israeli cash surpluses as Israeli banks refused to take back these surpluses in violation of the Paris Protocol.
Yet the most hazardous economic threat in the hands of Israel is the complete control over the transfer of clearance
revenues to the Palestinian government, as they constitute the main source of public revenues. Clearance revenues
represented, on average, 70.4 percent of total domestic revenues during the period 2010 – 2014, covering an average
of 47.7 percent of total public expenditures.
Figure 1-3: Clearance revenues, 2010-2014
With the detention or the irregular transfer of
80
these revenues, the most important financial
interruption. Subsequently, the government
will be unable to cover half of its expenses. Most
importantly, the unpaid civil service pay bill may
lead the economy to grind almost to a halt, as a
general economic slump is an inevitable result of
the non-receipt of salaries that comprise the key
60
Percent
resource to the government is threatened with
40
20
0
2010
2011
2012
2013
2014
Percent of domestic revenues
Percent of total expenditures
Source: Ministry of Finance (MoF) database.
driver of demand and consumption.
It is worth mentioning that the volume of clearance revenues is related to the trade volume from and via Israel, which constitutes the second channel of Israeli pressures on the Palestinian economy. The Israeli economy remains the
mandatory key trading partner of the Palestinian economy and thus the most influential, owing to the high volume
of trade exchange and the
Chapter One: Overall Assessment of Financial Stability
3
almost complete control exercised by Israel on the movement of Palestinian goods[1]. Clearly, such a situation has
long-term ramifications on economic stability and growth.
Evidence of the Israeli heavy control over the
Table 1-1: Clearnace revenues, 2010-2014
economic activity manifests in its full control
over Palestinian crossing borders, which leaves
the Palestinian economy hostage to Israeli-im-
Year
posed measures, as the majority of basic goods
and intermediate raw materials enter through
Israel. Consequently, interruption of imports
may cripple most Palestinian industries especially that the size of foreign trade with Israel
accounts for half of the Palestinian economy.
Likewise, the cessation of export of Palestinian
goods through Israeli ports and airports will
result in the collapse of export-based industries,
Clearance revenues
(USD million)
Clearance revenues as a
percent of
Annual
values
Domestic
Public
revenues expenditures
Net
domestic
Monthly revenues*
average
2010
1,243.0
103.6
1,900.0
65.4
38.1
2011
1,487.4
124.0
2,175.8
68.4
45.7
2012
1,574.4
131.2
2,240.1
70.3
48.3
2013
1,690.5
140.9
2,230.0
72.9
49.4
2014
2,054.3
171.2
2,791.2
73.6
57.0
Ave.
1,609.9
134.2
2,285.4
70.4
47.7
*Include tax, non-tax, and clearance revenues minus tax refunds.
Source: PMA database.
as most Palestinian exports leave via Israel.
Another pressing card in the Israeli hand is the employment of Palestinian workers in the Israeli market, by which
Israel controls unemployment rates, specifically in the WB. The number of workers in Israel from the WB reached 107
thousand in 2014, comprising 11.7 percent of the Palestinian labor force, or 16.0 percent of WB workers. As a result, Israel
plays a key role in the absorption of the Palestinian labor force, which is a role it can exploit to serve Israeli interests,
considering that the loss of jobs for the aforesaid portion of Palestinian workers in Israel would translate as the loss
of USD 1.4 billion[2] pumped into the Palestinian economy each year, which in tandem would raise unemployment
and poverty rates. Moreover, any sudden decline or cessation in the flow and utilization of the income generated by
these workers will have grievous consequences on economic growth and the public budget.
• The Crisis of the Gaza-based civil service pay
One of the banking system’s major challenges during 2014 was the crisis of civil servants in GS. The crisis occurred
in the wake of the formation of the unity government and the dispute which followed between political parties as
to the inclusion of employees of the now-resigned Gaza government on the current government’s payroll. Consequently in that case, these salaries had to be disbursed and assigned to the budget of the newly-formed government.
One outcome of this disagreement and the continued non-receipt of salaries by the Gaza-based employees was that
security forces closed all bank branches in GS for 5 working days at the beginning of June. The crisis recurred shortly
at the beginning of July 2014 as bank branches in GS were attacked. The attack targeted the surveillance systems of
all bank branches in addition to bank executives. Over the course of several days, attacks were repeatedly carried out
and a number of ATMs vandalized.
In the wake of these attacks, the movement of trade came to a complete halt. Markets witnessed a sharp recession,
owing to the fact that employee salaries are the key drivers of the Gazan economic demand. In the meantime, all
[1] During 2014, imports from Israel constituted 71.0 percent of total imports, while the Israeli market received more than 81.0 percent of Palestinian exports
over the same period.
[2] It was calculated based on the formula: [average number of workers in Israel 2014] X [average daily wage for workers in Israel (NIS 187.5)] X [average
monthly working days (20.0 days)] X [12 months]. The sum was then transformed to USD at the exchange rate of NIS 3.518 per US dollar.
4
Financial Stability Report - PMA
financial and banking transactions for all groups of the public were suspended affecting in particular the merchants
who could not settle their contractual agreements. Furthermore, checks and transfers could not be cleared. As a result,
overall economic activity was adversely affected and banking and financial stability shaken.
To overcome the crisis, the PMA announced its full understanding of the humanistic dimension of the crisis of the
employees, while emphasizing that the banking system is not a party to the political dispute. In doing so, the PMA
confirmed its long-lasting neutrality policy against the political dispute, and sought to evade Israeli and international
threats to freeze funds and suspend international dealing with the banking system, which could have dangerously
undermined the economic activity in Palestine. However, with the start of the Israeli aggression against GS on 8 July
2014 the situation fundamentally changed and attacks against the banks seized.
The political and security risks resulting from the internal schism has taken their toll on financial and banking stability,
in particular in GS. Moreover, the persistence of these risks may have a myriad of unfavorable repercussions, such
as shaking public confidence in the banking system, reputation risks, day-to-day losses due to cessation of banking
operation, operational risks, in addition to a suspension of activity in the clearinghouse and the subsequent indefinite
deference of checks and other common economic risks. All of these risks will reflect on bank loan collection and their
ability to meet their obligations towards various segments of the public.
• Israeli aggression against GS and repercussions for the banking system
The third major crisis affecting the Palestinian banking system during 2014 was the Israeli war beginning of July
2014 against GS and the massive devastation, huge loss of life and property, and significant economic damages it
inflicted. The war caused long-term adverse effects on economic growth, particularly in light of the stumbling efforts
to rebuild the war-devastated Strip.
The impact of the war extended to the banking system, as to various other economic sectors of GS. Some bank branches
were damaged. Direct damages were estimated at about USD 3 million. Other Indirect losses and damages manifested
as an almost total halt of banking operations in GS and other related financial consequences for banking activity and
performance over 2014. Despite the severity of the aggression, the PMA, in cooperation with the banking system, met
its responsibilities in supporting, as much as possible, our people in GS during the war. A crisis management unit was
established working around the clock during and after the war. The unit managed the crisis with remarkable success
that earned the admiration and praise of the IMF[3] in a report prepared for the Donor Aid Liaison Committee at its
conference held in New York on 22/9/2014. The IMF report noted that despite significant losses in Gaza, the banking
sector remained healthy owing to the successful regulatory efforts of the PMA, which continued to steadily gain the
capabilities of a central bank. The report also alluded to the fact that the PMA was carefully monitoring risks related
to high credit exposure associated with loans to the Palestinian Authority and its employees.
[3] In February 2015, the World Bank asked the PMA to collaborate with its Payment System Development Group and some other central banks in the
preparation of a handbook on crisis management relating to payments systems. The Handbook will serve as a reference to monetary authorities and central
banks worldwide, in order to help protect banking systems and ensure effective management of crises. The request came following the successful and
distinguished PMA experience in developing of BURAQ settlement system to promote financial stability in Palestine, in spite of the prevailing crises and
conflicts associated with the Israeli occupation and its adverse effects on the Palestinian economy. Particularly admirable was the PMA experience in the
management of GS crisis during the latest Israeli aggression, during which the banking system managed to sustain its operations with close cooperation with
the PMA. In managing the crisis, the PMA employed macroprudential tools and procedures to protect and ensure the soundness of the banking system and
support the stability of the financial system in general.
Chapter One: Overall Assessment of Financial Stability
5
Despite an array of potential risks, the Palestinian financial system has managed to make great achievements. These
relate to promoting financial stability, risk mitigation, financial infrastructure development and the expansion of
financial inclusion, in order to secure ongoing financial development that contributes to the promotion of economic
growth and sustainable development.
Financial development and development indicators during 2014
• The regulatory and supervisory framework
The PMA continued to issue a number of supervisory instructions intended to ensure the soundness of banking
operations. The most important of which were instructions on housing loans and mortgage based on the dynamic
loan-to-value (LTV) ratio, instructions concerning membership in Real-Time Gross Settlement System (BURAQ), instructions concerning credit granted to relative parties and instructions concerning bank fees and commissions. It
also lowered risk reserve rates to 1.5 percent for net direct credit facilities instead of 2 percent, and 0.5 percent for
indirect credit facilities. Furthermore, the PMA issued instructions on deceased-clients’ account management and
on bank stress testing. On a different note, the PMA followed through with its efforts to promote financial stability
by concluding the second stage for implementing Basel II and III requirements. Full implementation of the project is
expected to conclude by end of 2015.
• Banking system updates
The year 2014 witnessed further achievement in the field of financial system infrastructure development. The PMA
pursued its efforts to accomplish the National Switch project and carried out the first step to establish the Public
Key Infrastructure (PKI) and the third stage of the IBAN project. The PMA successfully launched the new automated
clearing system, Perago Clear, and prepared for the electronic clearing system infrastructure. In addition, a number
of workshops were held to prepare for the automation of incoming transfers from the Israeli Clearing House project.
The project aims at process automation and reduction of operational risks associated with recording transfers of
officially-registered Palestinian workers from the Israeli Clearing House, as well as providing monitoring tools on
transfers from Israeli banks to banks operating in Palestine and reducing cash inflow to Palestine. As for credit registry
systems, through the year, the PMA developed the Credit Registry System (version III) and started the second stage of
standardizing credit information systems (existing and new), in addition to upgrading the credit report generated
by the Credit Registry System.
• Characteristics of the Palestinian financial system
During 2014, the Palestinian financial system manifested uneven performance, whether in financial institutions (banks
and non-banks) or the financial market, based on the new World Bank (WB) methodology; the Matrix of Financial
System Characteristics. At the level of financial institutions, an improvement was apparent in terms of financial depth
and financial efficiency, whereas a decline was noted in financial inclusion and financial stability. Yet, other financial
inclusion indicators picked up, according to data published by the WB. As for the financial market (the second financial system component of the matrix), there was an improvement in financial depth and inclusion and a decline in
financial efficiency and stability, owing to the sharp deterioration in the Palestine Exchange index in the aftermath
of the aggression against GS, in addition to the impact of other political factors that made the scene over the year.
6
Financial Stability Report - PMA
• Credit risks and financial soundness indicators
The 2014 year witnessed some slight declines in financial soundness indicators, where the capital adequacy ratio for
all banks fell to 18.9 percent compared with 20.0 percent in 2013. However this ratio remains higher by 7 percentage
points than the minimum limit set by the PMA. Profitability indicators also fell, with return on average assets reached
to 1.7 percent in 2014, compared with 1.9 percent, and return on average equity to 17.2 percent compared with 18.7
percent during the comparison period. Liquidity indicators fell as well, where the ratio of liquid assets to total assets
decreased from 39.5 percent to 35.5 percent at the end of 2014. As for the liquidity crisis in the surplus NIS, liquidity
ratio in the NIS fell to 11 percent of total banks’ assets compared to 30 percent in 2013, meaning that the ratio approaching normal levels that prevailed before the crisis.
The portfolio of housing and mortgage loans offered by banks operating in Palestine showed a rise in the ratio of
non-performing loans to total used loans from 1.8 percent in 2013 to 2.2 percent in 2014, at the level of all banks. The
default ratio in SMEs credit portfolio was around 12.3 percent of SMEs total outstanding facilities. This ratio does not
exceed 1 percent of total loans granted by the banks and represents a low and controllable ratio that does not pose
a significant risk to financial stability. Similarly, risks associated with facilities granted to non-residents remained
limited and insignificant.
On a different note, the Palestinian private sector credit gap rose significantly in 2014Q4, adversely influenced by the
aggression against GS. The private sector credit gap reached about 3.34 percent, higher than the ratio of 2 percent
specified in the requirements of Basel III. Despite the developments in 2014, non-performing loans to total loans
dropped to 2.5 percent from 2.9 percent in 2013, which is one of the lowest ratios in the MENA countries.
In a different context, the results of financial stress testing conducted by the PMA for the banking sector produced
generally positive results in view of the various scenarios and the likelihoods of exposure to political and economic
shocks. The results are an indication of the Palestinian banking system successful management capacity of various
shocks and its ability to absorb its repercussions.
Chapter One: Overall Assessment of Financial Stability
7
Chapter Two
Global and Local Economic Developments
Overview
With the growing economic and financial integration and interlinkage among and within
countries, the likelihood of contagion of risks, spreading from one country to another or
from one sector to the other, also mounts. The contagion pace depends on the degree of
the integration and interlinkage and on the nature and typology of these risks.
The financial sector is regarded as a critical sector in any economy, exerting impact on economic developments, their consequences and repercussions while also being susceptible to
them. This was evident in the wake of the recent global financial crisis which transmitted
from the financial sector to the real economy in many countries as a result of a number of
factors. The year 2014 witnessed numerous economic developments and challenges at the
international, regional and local levels, which cast their shadow on financial stability. With
greater focus on the regional and local, this chapter sheds some light on the most important
economic developments and challenges and their likely impact on the financial situation
and financial stability in Palestine.
Global economy
Economic performance
By end of 2014, the global GDP growth rate stabilized at around 3.4 percent for the second consecutive year, despite
the stumbling start of all of the world’s largest economies without exception. However, the performance gap between these economies started to widen mid-year as a result of the accelerating and inspiring growth in the U.S., and,
in contrast, the recurrent slowdown cycle in the remaining advanced countries and many emerging economies. In
summary, recovery in the U.S. lifted growth for advanced economies, accelerating to 1.8 percent against 1.4 percent
in 2013, whereas growth in emerging and developing countries decelerated to 4.6 percent from 5.0 percent over the
same period.
Despite the relative steadiness of global growth rate during 2014, global prices witnessed sharp declines, driven specifically by the falling prices of oil and food, in addition to a general weakness in demand levels. A resultant decrease
in global inflation rates was seen to about 3.4 percent down from 3.9 percent in 2013, which was more discernable
in emerging and developing countries, dropping from 5.9 percent to 5.1 percent, as opposed to advanced countries
which maintained a relatively stable rate around 1.4 percent through the same comparison period.
Chapter Tow: Global and Local Economic Developments
9
These developments prolonged the life of the expansionary monetary policies in large economies
Figure 2-1: Global economic developments, 2010-2014
6
for another year, although preliminary forecasts
mid-2014. This further endangered the stability
of the global financial system, given the growing
Percent
had earlier anticipated the termination of the
quantitative easing program in the U.S. before
se to developments that took place towards the
1
global oil prices started to fall dramatically, moderating inflationary pressures that hit the global
Inflation
3
2
economic growth appeared in the U.S. horizon and
Unemployment
4
discordance of global monetary policies in responend of the year. After early signs of accelerating
Growth
5
0
2010
2011
2012
2013
2014
Source: IMF database.
economy and the advanced economies in particular, diverging monetary paths were followed on the opposite sides of
the Ocean. While the Federal Reserve was enthusiastic about ending its asset purchase program having announced
its expectations for increased interest rates in early 2015, the European Central Bank (ECB) was initiating efforts to
kick-start a similar asset purchase program in the Eurozone. Driven by the falling prices of basic goods, the ECB plan
was intended to contain exacerbated deflation risks, amid a general weakness in demand and a limited role of any
cutback of the already low interest rates in reviving the economy.
Contrarily, Bank of Japan continued to make steady strides on the path of quantitative easing till the last quarter of
the year. It took the market by surprise by launching yet another new cycle of asset purchase, in the hope that this will
dilute the effect of tax hikes on economic growth. Meanwhile, analysts await still more signals on Chinese economic
performance. Despite the government clearly announcing that faltering growth was no cause of concern, indicators
reveal the need to stimulate Chinese demand in order to ensure desired levels of economic stability.
It is worth noting that the U.S. economic recovery, as opposed to stagnation in the Eurozone and Japan, has cemented
investor confidence in the U.S. dollar and spurred capital flows to the U.S. markets. This reflected on the dollar exchange rates against other major currencies. In consequence, the Federal Reserve predicted a delay in official interest
rate hikes, especially if inflationary pressures remained absent in the short-term. On the other hand, the drop in oil
prices is expected to positively affect Chinese and Japanese export competitiveness, with the latter being supported
by the drop in the Yen against other currencies.
These developments come with ample warning against the potential imbalances resulting from the continuous injection of easy money into the markets over prolonged periods, taking the form of bad loans and the accumulation
of high-risk assets in the balance sheets of financial institutions. Such conditions could ignite a new round of crises
in the event markets do not achieve timely return to normality. However, it is clear that such measures will not be
undertaken before the end of 2015.
These developments reflect to varying degrees on the Palestinian economy. Despite the limited impact of global economic volatility, price fluctuation of basic goods constitutes a main channel affecting local economic developments.
Likewise, currency exchange rates, particularly the US dollar, represent another channel that directly affects the cost
of borrowing in any of the major currencies and, probably to a lesser degree, the domestic demand for the purpose
10 Financial Stability Report - PMA
of saving or investment. However, the most serious impact on economic and financial stability in Palestine emanates
from regional interconnections particularly with Israel. Regional interconnections gain prominence in view of the
trade relations and the peculiar circumstances of the Palestinian banking system which is dependent in its operation
on other currencies; most importantly the Israeli shekel. As such, this peculiarity necessitates the analysis of economic
and financial regional developments in tandem with the analysis of financial stability in Palestine.
Global financial stability
After more than six years since the start of the global financial crisis, the global financial stability map[4] shows that
economic recovery around the globe continues to rely heavily on accommodative monetary policies in advanced economies to encourage demand and corporate investment and rectify public finance imbalances. These accommodative
policies entail a trade-off between achieving economic benefits that exceed expectation on, against taking the risks
of adverse developments compromising financial stability. Economic benefits that are realized are accompanied
by increased levels of market and liquidity risks endangering financial stability if left unaddressed. The best way to
safeguard financial stability and improve the balance between economic and financial risk-taking is to put in place
policies that enhance the transmission of monetary policy to the real economy and address financial excesses through
well-designed macroprudential measures.
From a different perspective, rapid credit expansion remains a source of heightened risk to global financial stability,
resulting in rising asset prices and diminishing returns. Moreover, since the start of the global meltdown, capital
markets have become a more frequented source of credit, with the risk center migrating to shadow banking. As
such, the share of credit tools in portfolios of mutual funds multiplied since 2007 and currently acquires 27 percent
of total global high-return debt. At the same time, the fund management industry is becoming highly concentrated
as the world’s top ten asset management corporations currently manage assets worth over USD 19 trillion. Since
asset concentration is linked to the expansion of investment portfolio positions and their increased valuation, the
increase in investor tendency to leave the markets and the fragility of liquidity structures, market and liquidity risks
have increased. Emerging economy markets are currently more prone to shocks than advanced economies, as they
receive a larger share of portfolio investments flows.
According to the IMF Global Financial Stability Report, policies still face the challenge of eliminating obstacles to economic risk-taking and adopting approaches that enhance the transmission of monetary policy to the real economy.
To that end, banks have come a long way since the global financial crisis, with adjustment proceeding at different
stages. The first stage focused on emergency stabilization measures. In the second stage, banks sought to adapt with
the new realities of operation and regulation, resorting to significantly raise their capital since the start of the crisis,
and strived to rectify balance sheet imbalances. Progress was uneven across banks, especially that low profitability
raises concerns with regard to the ability of some banks to build and maintain capital buffers and meet credit demand. The size and extent of this challenge is reflected in the fact that about 80 percent of the assets of the largest
institutions have a return on equity that fails to cover the cost of capital required by shareholders. Banks have entered
the third stage in which a more comprehensive and in-depth process of reform of its business models is needed. This
should include re-pricing of existing activity and the redistribution of capital across these activities in addition to
restructuring or contracting businesses.
[4] IMF, Financial Stability Report, October 2014.
Chapter Tow: Global and Local Economic Developments
11
In view of this reality which depicted by the global financial stability map, monetary policy must commit to accomplish
the mission of the central bank in safeguarding price stability, provided that macroprudential policies remain the
foremost line of defense against financial infringements that may jeopardize stability. To improve monetary policy
options and contain financial stability risks, a set of micro- and macro- prudential policy tools needs to be used to
push back expectations for interest rate hikes before they find true economic justification, help reinforce regulatory
entities, contain the dynamics of asset and credit prices which align with cyclical trends and provide a preventive
margin against the ramifications of liquidity crises in the event fluctuations recur.
In general, macroprudential measures depend on three steps: firstly, ensuring swift and accurate data to policy makers
(central banks) to monitor the accumulation of risks to financial stability; secondly, securing regulatory authority and
analytical capacity of macroprudential tools, if need arises (gaining significant importance in non- banking sectors
due to deficient regulatory framework to deal with emerging risks); and thirdly, allowing policy makers the freedom to
take action when necessary to confront developments, even if measures taken are not popular, provided an effective
and balanced relation with the public is nurtured in order to justify implemented measures.
Regional economy
Israeli economy
During 2014, the Israeli economy continued to
Figure 2-2: Israeli economic developments, 2010-2014
10
decelerate to 2.7 percent from 3.2 percent in 2013,
Growth
in the aftermath of the latest aggression against
ding and fiscal deficit and the continuous impact
of weak global demand, from the EU specifically,
Percent
GS and the resulting decline in tourism revenues,
receding export growth, heightened public spen-
on economic activity in general. Concomitant with
rates dropped to 6.0 percent and 0.5 percent, from
to stabilize the exchange rate and neutralize the
effect of natural gas discovery on the shekel and
its stability.
12 Financial Stability Report - PMA
2013
2014
3.5
3.0
below 1.0 percent; first to 0.5 percent by midyear,
by direct BoI intervention in the currency market
2012
Figure 2-3: Bank of Israel policy rates, 2010-2014
phasic lowering of its official interest rate to levels
second half of the year, which was accompanied
2011
Source: IMF database.
netary policy at the beginning of 2014, adopting
2.5
Percent
on against GS on the Israeli economy during the
4
2010
moved further towards an accommodative mo-
responded to the obvious impact of the aggressi-
6
0
6.3 percent and 1.5 percent in 2013, respectively.
then to 0.25 percent by end of the year. This policy
Inflation
2
this performance, unemployment and inflation
At the level of monetary policy, Bank of Israel (BoI)
Unemployment
8
2.0
1.5
1.0
0.5
0.0
2010
Source: BoI website.
2011
2012
2013
2014
However, Israeli economic slowdown drew attention to the extent of damage the appreciating shekel has inflicted on
export competitiveness, which stirred expectations of further intervention by the Bank. BoI measures were accompanied by assurances of the absence of any serious disruptions to the Israeli financial system structure. However, the
risks created by the housing market bubble had reached levels that raised concerns. As a result, decision makers were
forced to take measures to restrain the housing bubble incessant growth over the past few years, which, according
to BoI, have contributed to reduce the risks attributed to the housing market.
The consequences of Israeli economic performance reflected on the economy and financial stability in Palestine
in many ways. With the compulsory subjugation of the Palestinian economy to the Israeli economy, direct impact
channels are wide open at various levels. The Palestinian financial system is susceptible to Israeli monetary policy and
exchange rate stability with the shekel being a major currency of trade exchange and a key component of assets of
banks operating in Palestine. Furthermore, the Palestinian financial system is indirectly susceptible to fluctuations in
prices, the demand on Palestinian workers in the Israeli market, the imposed constraints on trade and tax transfers
(clearance revenues) and the general adverse effects inflicted on Palestinian economic performance.
In general, the most salient Israeli
Figure 2-4: Israel control channels on the Palestinian
channels of pressure on the Palestinian economy during 2014 can be
Channels of control
summed up in five main channels
(figure 2-4), over which Israel enjoys
full control. Through these channels
Israel was able to influence and
subject the economy to numerous
crises and shocks that gave rise to
Palestinian
workers in
Israel
an erratic and faltering economy,
Trade
activities
Clearing, banking
& fiancial
economy
activities
Reconstruction
and controlling
of building
materials
Natural
resources (gas)
adversely impacting the livelihoods
of an entire population.
With the persistent Israeli economic slowdown, on one hand, and the ongoing restrictions on the freedom of movement and access, on the other, the size of the Palestinian workers in Israel declined, recording a 3.8 percent drop in
the second half of the year. This followed further tightening on movement in the aftermath of the war on Gaza. By
2014Q4 the number of workers in Israel stood at approximately 105.2 thousand, which is equivalent to 11.3 percent
of total Palestinian labor force. Although this segment of workers has limited dealing with the domestic banking
system, any sudden drop or cessation in employment or the influx of income brings about detrimental consequences
for economic growth and the public budget.
Likewise, the almost-full Israeli control over the movement of goods will adversely affect Palestinian economic stability and growth on the long term, as the Israeli economy is the compulsory most influential trade partner of the
Palestinian economy. As such, imports from Israel constituted more than 70 percent of total imports during 2014,
whereas the Israeli market acquired more than 80 percent of total exports over the same period.
As for the transfer of tax revenues, and despite the fact that 2014 witnessed a somewhat steady transfer of clearance
revenues, amounting to NIS 7,317.0 million (20.6 percent higher than in 2013 and 51.0 percent of total revenues and
grants to the Palestinian government during the year), the continuous and regular flow of these revenues remains
Chapter Tow: Global and Local Economic Developments
13
contingent on political developments and the extent to which Israel will attempt to use this channel as a means of
coercion to serve its interests.
The weight of these revenues to the total Palestinian government income demonstrates the significance of the role
they play in maintaining the stability of the Palestinian banking system. Withholding these funds by the Israeli
Authorities disrupts the disbursement of civil service pay. As civil servants represent a significant portion of bank
customers, delay or stoppage of payment of bank loan instalments, if prolonged, will compromise the stability of the
banking system. The suspension of revenue flows worsens the government financing position, forcing it to resort to
banks in view of the lack of other financing alternatives. Such a development may undermine PMA effort to regulate
lending in a manner that maintains the soundness and stability of the financial system.
Jordanian economy
During 2014, the Jordanian economy witnessed several positive changes, beginning with the constant and steady
growth all through the year, to receding inflationary pressures and the recovery of foreign currency reserves levels,
and ending with contracting deficits in the public budget and the current account in the balance of payments. IMF
estimations point to an acceleration of growth in Jordan to about 3.1 percent during 2014 compared with 2.8 percent
in the previous year, driven by the influx of external aid, particularly the release of loan instalments from the IMF
to finance the program of economic reforms. The program incorporates a series of measures intended to achieve
structural economic and public spending reforms in Jordan. The growth comes as a result of many factors, most
important of which is the recession of pressures on public finances in light of a steady influx of aid, alongside the accomplishments, whether full or partial, of the economic reform program. Accompanying the success of the Jordanian
economy in absorbing the shock of the influx of thousands of Syrian refugees and the ensuing drainage of resources,
Jordan reaped the fruit of relative political stability.
It is worth mentioning that the Jordanian economy was confronted with several price shocks at the beginning of 2014.
A sharp rise in the prices of basic goods occurred
following the decision to remove general subsidy
Figure 2-5: Jordanian economic developments, 2010-2014
14
The price shock was aggravated by the rising ener-
12
gy bill as a result of the shut-off of Egyptian gas
10
supplies, forcing Jordan to buy from other markets
at higher prices. Yet, inflation continued to fall
gradually over the year to reach 2.9 percent from
Percent
on goods and replace it with targeted subsidies.
lending eased, Bank of Jordan was capable of ma-
2
intaining the official interest rate at 4.25 percent
0
percent from 12.6 percent in 2013.
Inflation
6
4
with a reduction in unemployment rates to 11.9
Unemployment
8
4.8 percent in 2013. With the burden of the cost of
during 2014. This performance was concomitant
Growth
2010
2011
2012
2013
2014
Source: IMF database.
On a different note, the current account deficit shrank by about 27.3 percent during 2014 to account for 7.0 percent
of GDP in 2014 from 10.3 percent in the previous year, thereby contributing to curb the depletion of foreign currency
14 Financial Stability Report - PMA
reserves. The inflow of aid and IMF payments led
to a rise in official reserves by about 17.3 percent to
Figure 2-6: Central bank of Jordan policy rates, 2010-2014
5.5
reach USD 14.1 billion by end of 2014. The Jordanian
government efforts to rectify its financial situatibudget deficit fell by around 7.1 percent to reach
10.0 percent of GDP. However, the public debt
increase from 83.5 percent in 2013 to 84.2 percent
5.0
Percent
on and reduce spending came to fruition as the
4.5
4.0
in 2014 remains a threat to economic stability and
signals the possibility of a rise in the value of debt
service in the future, especially after IMF financing
terminates or in the case of new future shocks.
3.5
2010
2011
2012
2013
2014
Source: Bank of Israel website.
The Jordanian economy is the second most influential economy affecting economic and financial stability in Palestine,
mainly due to interconnecting economic relations, particularly at the level of the banking system. Despite the fact
that the influence of trade with Jordan on the local economy is limited (2 percent of imports and 6 percent of exports),
the relative importance of the Jordanian dinar as a currency of savings and the importance of the Jordanian banks
in the Palestinian banking sector framework makes the stability of the Jordanian monetary and financial system a
major channel of impact on the financial stability in Palestine.
At the end of 2014 , the Jordanian dinar acquired 25.7 percent of total customer deposits in Palestine and about 11.9
percent of total credit granted. Assets of Jordanian bank branches in Palestine amounted to about 50.4 percent of
total assets of banks operating in Palestine. Moreover, the Jordanian banks’ share of total credit granted in Palestine
reached 45.9 percent, while their share of total customer deposits stood at 49.3 percent, which is an indication of the
degree of exposure of the Palestinian banking system to any unexpected development that concerns its Jordanian
counterpart.
It is worth mentioning that the absence of inflationary pressures and the maintenance of convenient levels of official
reserves over the year have bolstered the stability of the banking system in both Jordan and Palestine.
Local developments
Political developments during 2014 presented a new challenge, as they cast dark shadows on the infrastructure and
the production base of the Palestinian economy, which witnessed serious damage to growth, especially in GS. As a
result the economic gap between GS and the WB deepened, as was the gap in the standard of living between the
two regions. Following a sluggish beginning of the Palestinian economy during the first half of the year, the ensuing
Israeli aggression on GS pushed the economy down into economic contraction, recording a growth rate of -0.4 percent from 2.2 percent in 2013, after real GDP in GS declined by 15.2 percent as opposed to a growth of 5.6 percent in
2013. Despite the accelerated growth in the WB, reaching 5.1 percent up from 1.0 percent in 2013, real GDP in Palestine
stabilized around USD 7,449.0 million.
Despite the fact that price data have revealed a relatively steady inflation rate hovering around 1.7 percent for both
2013 and 2014, this consistency actually masked distinct disparities between GS and the WB. While the WB saw receding levels of inflation from 3.1 percent in 2013 to 1.2 percent in 2014, GS suffered a notable rise in prices from -0.8
Chapter Tow: Global and Local Economic Developments
15
percent to 2.9 percent. This performance was accompanied by a rise in unemployment rate to 26.9 percent of total
labor force compared with 23.4 percent in 2013. The rise came generally as a result of the alarming hike in unemployment in GS (from 32.6 percent to 43.9 percent) following the war waged by Israel against the Strip in 2014Q3 (during
which unemployment rate reached 47.4 percent). Worsening employment rates came despite a notable fall in WB
unemployment from 18.6 percent to 17.7 percent during the same period.
The disparity in the rates of growth, inflation and
unemployment between GS and the WB mirror
the differences in the economic, political and
Figure 2-7: Palestinian economic developments, 2010-2014
30
in the performance and composition of demand
20
in the two regions. Whereas final consumption in
15
the WB picked up, accompanied by a recovery in
investment and a narrowing trade deficit, the devastation in the aftermath of the war pushed back
Percent
social conditions, and subsequently, the disparity
25
Unemployment
Inflation
10
5
investment markedly and deepened trade deficit
0
in GS as a result of the suspension of exports and
5-
the mounting dependence of GS on external sour-
Growth
2010
2011
2012
2013
2014
Source: PMA database.
ces to meet its basic needs. In tandem, an increase
in demand for basic goods gave rise to an upsurge in consumption, especially during the war-period. In summary,
final consumption increased by about 5.7 percent during 2014, while investment lagged behind, dropping by more
than 17.1 percent, and trade deficit increased by about 7.5 percent since 2013.
These trends reflect an increased Palestinian economic dependence on external sources, especially on Israel, to meet
basic consumption needs. In consequence, economic stability risks grew and the Palestinian economy became more
susceptible to shocks originating from Israel in particular. Moreover, the sharp decline in most economic activities
in GS led to further structural deformation of the Palestinian economy, particularly with regard to the diminishing
contributions of production activities, like agriculture and industry, to the Palestinian GDP.
It is worth mentioning that the persistence of the years-long siege imposed on GS, in addition to the almost-continuous
closure of borders, have aggravated the already difficult conditions in GS during the second half of the year and later
impeded the restructuring process and the return of the Gazan economy to prior activity levels. The continued internal
schism further exacerbated the situation and was a cause of additional losses that strained Palestinian resources.
No doubt, the accumulation of these factors will have current and future repercussions on financial stability trends,
especially those relating to public finance, which may be eventually transmitted to the banking system.
Public finance
The analysis of public finance developments gains special attention in the study of local financial stability trends owing
to the special correlations between the two. This correlation results mainly from the influence public finance performance casts on the stability of the banking sector in specific, as the most important component of the financial sector.
16 Financial Stability Report - PMA
In this context, the public budget for 2014[5] was generally distinguished by a pronounced rise in net domestic revenues, at a rate higher than the acceleration in current expenditure. This led to a decline in current deficit by almost
one third its value in 2013 to total NIS 2.3 billion; the equivalent of 5.4 percent of GDP. Furthermore, foreign grants,
amounting to NIS 4.4 billion compared to NIS 4.9 billion in 2013, secured the full coverage of the current balance
and achieved an overall surplus of NIS 488.6 million, or 3.2 percent of GDP. This surplus was used to pay off part of
accumulated government arrears from previous years, specifically those owed to banks operating in Palestine. The
payment completely used up the surplus achieved in the overall balance after grants.
Given the lack of adequate liquidity to curtail the accumulation of arrears, a pronounced rise by 64.7 percent in arrears
occurred compared to the previous year to total NIS 2.8 billion. Non-wage arrears, specifically social transfers and
operational expenditures, accounted for about 61.6 percent of total arrears, compared to about 72.1 percent in 2013.
Additionally, wage arrears’ share was significant, reaching 20.5 percent compared to 22.4 percent in 2013.
In general, the Palestinian budgetary performance is linked to two main transmission channels. The first enjoys direct
impact and is the channel of direct credit granted by the banking sector to the public sector (particularly the central
government). The second channel reflects the indirect effect of credits offered to civil servants, on one hand, and the
accrued arrears, on the other (see chapter 4 for a complete analysis).
One of the most pronounced challenges facing public finance, and reflecting on financial stability, is likelihood of
merging about 50 thousand employees of the former government of Gaza and adding their salaries to the public
budget in light of latest reconciliation deal; their monthly wage expenditure is estimated at around USD 35 million[6].
This challenge weighs down on the already burdened salary bill, which represents in itself the heaviest expenditure.
The government has adopted several containment procedures in that regard: starting with the implementation of a
mechanism of net zero employment gain (appointment only for retiree vacancies); restricting the increase in the salary
bill to annualized inflation rates and allowances listed in the Civil Service Law and bylaws; freezing of promotions;
and placing tight restrictions on administrative and supervisory bonuses to employees and suspension of employee
remuneration which is not included in civil service regulations. Yet, despite these procedures, current available cash
inflows including foreign grants remain inadequate. The most salient underlying causes of these poor results can
be summarized in the following:
1. The financial consequences of implementing the General Retirement Law, as compared to the previously effective
retirement regulations, led to an enormous rise in the value of obligatory transfers to cover the government contribution. The real value of these transfers is expected see a further rise if the 50 thousand Gaza-based employees
of the former government are added on the government payroll.
2. As it impacts the livelihoods of employees, the normal growth of the salary bill cannot be curtailed by the go-
vernment. The normal growth requisites of the salary bill in 2014 were around 6 percent higher than in 2013,
equivalent to an increase of NIS 408.3 million in one year only. In contrast, the deficiency to cover cash payment
for salaries of existing employees was about NIS 569.7 million. This sum is almost equal to a month’s salary bill
and about 20.5 percent of total accrued government arrears, which, under the given situation, is expected to
increase. This will greatly enlarge government arrears on the medium and long terms, especially if employees
of the former Gaza-government are on the government’s payroll, unless additional resources are secured to pay
[5] According to data published by the MoF on its official website.
[6] In addition, about USD 500 million are to be added as wage and salary arrears accumulated over past years.
Chapter Tow: Global and Local Economic Developments
17
for their salaries plus the expected growth
rates, within the bare minimum.
3. The frail role of the private sector in the
employment of the Palestinian labor force
makes the government the main employer in
the economy. If the employees of the former
Gaza-government are on its payroll, the government is faced with financial expenses that
are too high to address the requirements of financial solvency and continuity in the future.
The incorporation of employees of the former
government will augment the need for donor
aid which, in itself, contradicts the objective
Figure 2-8: Weaknesses in public finances and risks to
financial stability
Revenues
Control by israel
Current
expenditures
magnitude wage bill
Current
deficit
Linked to political developments
Grants
Overall deficit
after grants
Arrears
accumilation
of improving solvency through gradual shedding of grants and a greater dependence on
domestic revenues. Conversely, the utilization
of domestic revenues to fill the anticipated
Overdraft
accumilation
Generate
a continuing
need to borrow
gap will have economic repercussions through
its expected impact on inflation.
One factor expected to have a positive impact on the fiscal position is the discovery of gas off the coast of the Gaza
Strip[7]. The discovery can prove to provide a potentially major revenue source for government coffers in the future.
Natural gas resources may decrease the reliance on foreign grants and offer vast alternatives for independent economic growth, as it is estimated the gas drilling will generate USD 150 million per year, for the coming three year
until 2017[8]. The significance of the discovered gas lies in the fact that it could offer the best solution to the problem of
energy supplies in Palestine, as natural gas has multiple uses relating to cooking, vehicles, electricity power plants and
others. It is also expected to contribute to the reduction of the expenses of energy import from Israel, thereby easing
financial pressures facing the government[9] and resolving several economic and financial issues. This will, in turn,
boost financial stability on the medium and long-run and mitigate risks and burdens confronting the banking sector.
[7] Excavation for natural gas off the coasts of GS started with the advent of the Palestinian Authority upon the instructions of the late President Yaser Arafat,
culminating in the signature of an agreement with British Gas group and CCC on the 29 November 1999 in London. Pursuant to this agreement, developers
were granted the 25-year exclusive right to dig for hydrocarbons (petrol and gas) in Palestinian waters. Two large natural gas wells were discovered: the Gaza
Marine 1, which is the larger field and entirely located in Palestinian maritime areas at a distance of 35 km off the Gazan coastline (estimated at around 28
billion cubic meters), and the borderline well, which is a field shared with the Israeli side with 67 percent falling under Palestinian sovereignty (estimated at
3 billion cubic meters).
[8] These amounts have not yet been excavated owing to marketing difficulties faced by BG Group. Every attempt by the company to reach an agreement with
successive Israeli governments to sell their product was frustrated because of the depreciated prices offered by the Israeli side in addition to its demand to pay
for the natural gas not in cash but in-kind. The discovery of gas in GS is considered one of the prominent strategic economic issues that the Israeli government
pays attention to and over which it earnestly seeks to gain control.
[9] It is estimated that the usage of natural gas in the operation of power plants instead of industrial fuel will lead to a reduction to less than half the current
fuel expenditure, thereby cutting down the electricity bill to be paid to Israel. In this context, the Palestinian government will reap two types of benefits: firstly,
make profits of more than USD 2 billion over the coming 15 years, which represent the life of the project, and, secondly, quit the import of electricity to GS and,
to a large extent, to the WB in case one or two power plants are built. This is expected to save around USD 7-9 billion during the presumptive life of the project.
In addition, saving will extend to the cooking gas bill and the fuel imports bill, as gas can be used as a source of alternative energy to run benzene-powered
automobile engines. It is worth noting that, according the Palestinian Central Bureau of Statistics (PCBS), the Palestinian citizen spends about 20 percent of
his/her income on energy sources, whereas the normal rate is around 5 percent of the income.
18 Financial Stability Report - PMA
Chapter Three
Financial Sector Developments
Overview
The financial sector’s infrastructure, primarily composed of regulatory and supervisory
frameworks and operating systems, is considered a fundamental prerequisite to financial stability. In this context, the PMA continued to carry out several projects that directly
contribute to complete the foundation of this infrastructure and upgrade its capabilities,
thereby supporting and promoting financial stability.
This chapter reviews the most outstanding developments and achievements in the area
of financial infrastructure during 2014. It also includes a description of the characteristics
matrix of the Palestinian financial system (financial institutions and financial market), as
per the new approach for global financial development adopted by the WB, as well as a
comparison with several other countries around the globe.
Regularity and supervisory framework
The PMA continued to work on the development of supervisory instructions to promote financial and banking stability.
In that context, the PMA released several instructions during 2014[10], including Instructions No. (1/2014) concerning the
transport of money, precious metals and valuable documents; Instructions No. (2/2014) concerning the regulation of
housing and mortgage loans based on the dynamic LTV ratio, whereby housing and mortgage loans are offered in a
manner that mitigates associated credit risks; and Instructions No. (3/2014) relating to membership in the Real-Time
Gross Settlement System (BURAQ), which organize the membership structure of BURAQ and put in place the rules
to carrying out various procedures by members. Furthermore, Instructions No. (4/2014) were issued to regulate fees
for BURAQ and the clearing system.
The PMA also released Instructions No. (5/2014) concerning official bank working days and hours; Instructions No.
(6/2014) concerning credit granted to relative parties, defining related parties and setting mandatory requirements
for the bank credit policy with respect to credit granted to a related party and Instructions No. (7/2014) on bank fees
and commissions, categorizing fees and commissions and setting permissible ceilings for fees charged by banks from
clients in return for the services offered.
[10] For more information, check the PMA Annual Report 2014.
Chapter Three: Financial Sector Developments
19
According to Instructions No. (8/2014), the risk reserve rates were lowered to 1.5 percent for net direct credit facilities
instead of 2 percent, and 0.5 percent for indirect credit facilities. The PMA also issued Instructions No (9/2014) on
the management of the deceased’s accounts and Instructions No. (10/2014) on bank stress testing, which specify the
bank’s duties with regard to the operating procedures and policies, as well as the kind of tests, test conditions and
test shocks including political and economic shocks required to conduct stress testing.
On a different note, PMA efforts to promote financial stability continued, as further advances in implementing the
requirements of Basel II and III were made, so as to help the banking system better withstand risks and promote good
governance and risk management in accordance to international best practices. In that context, the second stage of
the implementation project concluded in 2014. The project advocated the principles of simplicity, gradualism and
communication to achieve an ideal implementation of the Basel II requirements in a manner suited to the peculiar
Palestinian reality. It is expected that all project stages will conclude by end of 2015.
As for the development of tools to identify, measure and control risks as well as mitigate their adverse impact on the
financial positions of banks, the PMA required all banks to establish risk management departments, provide appropriate staffing and ensure the departments keep up with their designated duties to monitor, supervise, measure and
control risks posed to banks. At the same time, the PMA will be following up on risks to the banking system, for all
banks and on a case-by-case basis, by regularly conducting stress tests and evaluating financial soundness indicators
for local and foreign banks, as one tool of the early warning system.
Banking system updates
In laying down a robust and comprehensive banking infrastructure that can contribute to reduce potential risks to
the banking system, the PMA continued its strenuous efforts to build and develop banking systems in accordance
with international best practices. To that end, the PMA took further measures in 2014 to upgrade a number of existing
banking systems introduced in past years, and initiated other projects to be finalized in due course. Following are
details of the aforementioned system upgrades:
• The electronic national switch
In cooperation with the banks, the PMA pursued its efforts to accomplish the National Switch project[11], which connects all Automated Teller Machines (ATMs) and Points of Sale (PoSs) to a unified database, to meet the cash needs of
citizens anytime and anywhere. During 2014, the system’s operating rules and instructions were approved and the
by-laws, instructions and policies which organize the operation of subscribing members were issued. Additionally,
arrangements that defined the nature of operation with global payment card companies like Visa and MasterCard
were also finalized.
• The public key infrastructure (PKI)
The PMA carried out the first step to establish the Public Key Infrastructure (PKI) in 2014 as part of its pursuit to
modernize the digital environment of the Palestinian banking sector and boost the security of electronic financial
transactions, in an attempt to open new horizons to the Palestinian economy and channels of communication with
the world. This step included issuing basic certificates and basic keys to maintain the safety and independence of all
electronic transactions generated and authenticated using these keys. Transparency and high reliability have been
ensured by the creation of a unique digital user identity provided to every banking infrastructure user, which qualifies
[11] On a later date to the year of this report, the first stage of this project was launched, linking ATMs of Bank of Palestine, Cairo Amman Bank and Bank of
Jordan with the National Switch at the PMA. This will give clients of these banks the possibility to use all ATMs, regardless of the associated bank.
20 Financial Stability Report - PMA
the PMA to attain the ISO-21188 standards for the public key infrastructure for financial services.
• Standardization of the International Bank Account Number (IBAN)
In 2014, the PMA concluded the implementation of the third stage of the IBAN project, linked to regulating internal
and cross-border transfer of personal transfers. Upon the conclusion of this stage, no internal personal transfer will
be processed without carrying an IBAN (or if carrying an incorrect IBAN). In case of personal transfers from banks
abroad not carrying IBAN (or carrying a wrong IBAN), the foreign issuing bank will be duly notified via swift or any
other approved means of communication with foreign banks. While it will not be revoked, such a transfer will be
subject to a fee ranging from USD 2 to USD 5. The fee will be deducted from the transfer sum credited to the account
of the beneficiary, who should be notified of the cause of deduction. Incoming and outgoing transfers to and from
the Palestinian government and workers’ transfers from Israel are exempt from the aforesaid requirement. It is
expected that during 2015, the PMA will cooperate with the banks to automate banking activities linked to Straight
Through Processing (STP).
• The Automated Clearance System
During 2014, the PMA successfully launched the new automated clearing system, Perago Clear, which came into
operation on September 7th, 2014. Alongside BURAQ, this system represents the second component of the Automated Transfer System (ATS). The system aims at providing safe and effective processing of check-clearing and other
retail payment transactions to service the Palestinian market. The system will assure the automated execution of
check-clearing operations and other retail payment instruments, in a modern, prompt and more secure manner.
The achievement came in line with the requirements of the third pillar of the National Payment System, which supports the automation of check-clearing and other retail-payment tools through the provision of direct connection
mechanisms to members, by means of a secure infrastructure and real-time monitoring of operations. On the medium-term, it will be part of a more comprehensive system to modernize and develop retail-payment instruments,
with the possibility of including government payments within the new system in the future.
Within the same context, the PMA commenced transforming the clearing system currently in operation into a fully
automated one, in preparation for the electronic clearing system infrastructure. As a result, the check clearing period
will be cut short to (T+1), that is equal to the clearing day plus another workday for returning the check. Consequently,
check collection time and paper-use will be reduced, and the check-clearing process will synchronize with that in the
Israeli clearing house. The project is expected to be completed over the coming two years. It is worth noting that the
Presidential Decree No. (17) of 2012 on National Payments Law for the year 2012, issued on 23 November 2012, constituted the legal basis for the introduction of electronic interbank clearing systems, using optical scanning techniques, to
transfer net transactions to the automated clearing system in order to easily perform electronic settlements between
banks secured by electronic signature verification under specific conditions.
• Development of the Credit Bureau System (version III)
To preserve the efficiency and performance levels of the Credit Bureau System, the PMA carried out a comprehensive
system assessment, in line with relevant international best practices and in a manner that would best serve users
from the banking system and lending institutions, on one hand, and the effective reinforcement of bank supervisory
mechanism, on the other. As a result, various aspects of the system were upgraded, including system screens and
disclosure mechanisms. Most importantly, the borrower’s credit report was improved to provide more information
Chapter Three: Financial Sector Developments
21
about credits granted; the collaterals offered by the guarantor and the borrower’s obligations. The use of the new
report template will contribute to mitigate and manage credit risks associated with borrowers and their guarantors,
on one hand, and expand the bank credit database, on the other. The report will also reveal the main details of credits
granted by public and private companies including leasing companies, service providers, real-estate developers and
retails, in addition to the disclosure of court rulings related to banking lawsuits and the Student Loan Fund.
In the same context, and to complete the first stage of standarizing credit operation systems within a unified and
automated system, the second phase commenced in 2014 and covered the Credit Bureau System, the Bounced Checks
System, the Suspended and Lost Checks System, the Credit Reports System, the Consensual Settlement System, the
Program for Revenue and Expenditure Control of the Consumer Relations and Market Conduct Department and the
Complaints System as well as Standardizing Personal Information Databases of the Credit Bureau System.
• Launch of database for facilities granted to SMEs
To complement the efforts that the PMA previously made in support of the SME sector, the database for credits
granted to SMEs was launched. The database contains comprehensive information on SME debt finance portfolios,
in a manner which allows users to access a number of analytical and supervisory reports, which, on one hand, will
contribute to better control of the sector and, on the other, will help develop SMEs capacities and facilitate their
access to financing sources.
Furthermore, the technical committee, previously established to help enhance the capabilities of SMEs, held a number of meetings. Its efforts culminated in several achievements; most importantly the endorsement of a standard
definition for SMEs[12] and the implementation of various measures to stimulate, empower and promote SME operations. These measures took the form of instructions which exempted banks and specialized lending institutions from
setting aside the 2 percent general risk reserve on credits granted to SMEs and waived the precondition previously
required by the PMA of an advance cash payment set at 10 percent, when SME non-performing loans are rescheduled.
The committee also studied the demand and supply sides of SME financing to diagnose and treat its most pronounced
challenges. These challenges centered around: the inability of banks to access information on SMEs from the Ministry
of National Economy with regard to enterprise registration and authorized signers; the inability of banks to enquire
about post-dated checks drawn on customer accounts and presented for collection by other banks; poor quality of
financial statement preparation and presentation by SMEs; poor understanding by SME owners of the significance
of conducting economic feasibility studies, their objectives and purpose; and the absence of legislation on movable
assets rights[13].
• Launch of online bank-charges comparison service
To promote transparency, disclosure and fair competition between banks, the PMA commenced end of 2014 to design
and develop a program to disclose fees and commissions collected by banks and conduct cross-bank comparisons.
The software is expected to raise competitiveness between banks and contribute to the delivery of higher-quality
services to the public at fair and competitive prices.
[12] An enterprise with a maximum of 25 employees and a turnover that does not exceed USD 7 million.
[13] On this subject, a working paper on Palestinian expertise in enhancing the SME sector’s access to finance was reviewed by AFI’s SME Finance Working
Group. The paper was endorsed during 2014Q1 and presented as a case study to the G20 group.
22 Financial Stability Report - PMA
• Business Continuity
To enhance business continuity in critical operational activities, the business continuity program was updated with
the participation of PMA departments. The updated version of the program was endorsed (including policy, strategy
and various plans). Several in-house workshops were held for a number of PMA departments to review plans and
procedures, raise awareness of business continuity and examine PMA activities with regard to arrangements, location
and employee competencies at the alternative site, alongside periodic testing of alternate communication methods.
Some departments executed operations remotely from employee homes to test the staff’s ability to perform in a state
of emergency. In cooperation with departments involved, periodic auditing of the alternative site was carried out
and relevant reports submitted to senior management. Internal and external contact data in connection to critical
PMA operations were also updated.
Bank expansion and concentration
The number of licensed banks in Palestine stood at 17 banks by end 2014[14], out of which 7 were local and 10 were
foreign banks (8 Jordanian, one Egyptian and one foreign-HSBC) providing services through 258 bank branches and
representative offices spread across the WB and
Figure 3-1: Branching policy, 2010-2014
280
branch opened in GS. Licensing of this notably
240
high number of bank branches and offices was
200
No. of branches
branches and offices, of which 3 offices and 1
consistent with the PMA’s goal to provide banking
services to all regions in Palestine, while giving priority to remote and rural areas in order to facilitate
trade and economic activities and offer citizens
160
reduce the population density per bank branch,
10
8
6
4
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2
0
Growth rate
Figure 3-2: Concentration in the banking sector, 2010-2014
2000
Point
1800
1600
promote financial inclusion and the capability of
1400
the various segments of the society to access and
1200
reach banking and financial services.
12
Source: PMA database.
in 2014, as will be discussed later. Despite this
in all governorates in Palestine are still needed to
14
160
No. of branches (left axis)
branches per 100 thousand of adult population
improvement, efforts to reinforce bank expansion
16
80
The PMA intends through its branching policy to
in an improvement in the index of the number of
151
20
18
120
0
customers. These efforts culminated
139
258
40
easier access to all kinds of financial transactions.
and thus enhance the quality of service offered to
190
209 212
237
226 232
Percent
GS. The year saw the addition of 21 new licensed
2008
2009
2010
Private sector deposits
2011
2012
2013
2014
Total credits
Source: PMA database.
[14] In February 2015, subsequent to this report, a strategic partnership agreement was signed between The National Bank (TNB) and the Union Bank (a
foreign Jordanian bank) by which TNB acquired the assets and liabilities of the Union Bank in Palestine, while the Union Bank becomes its strategic partner
owning 10 percent of the paid-in capital. As such, the number of licensed banks in Palestine falls to 16 as of March, 1st 2015. Chapter Three: Financial Sector Developments
23
As for concentration in the banking sector, analysis using the Herfindahl index showed consistent improvement in
2014 for deposits and credits alike. The average Herfindahl Index for banks’ share of private sector deposits continued
to recede to reach 1,567 points, compared to 1,630 points in 2013. This value fell short of the internationally acceptable
critical concentration threshold (at 1,800 points). The index recorded a drop in concentration for bank market share
of total credits to 1,522 points, compared to 1,597 points in 2013, which was also below the critical concentration threshold. It can be concluded that the banking sector is taking timely paces towards improving competitiveness for
both sides of financial intermediation.
The Palestinian Financial System Matrix
According to WB methodology, the characteristics of the financial system (financial institutions and markets) in
any country relate to four fundamental dimensions that compose a matrix of financial system characteristics. The
characteristics are the following: financial depth, financial inclusion, financial efficiency and financial stability. Each
of the four dimensions is measured separately for both financial institutions and financial markets using a set of
basic indicators.
The above-mentioned four dimensions were derived from international experiences, particularly those gathered from
the recent global financial crisis. Examination of these experiences suggests that the global financial crisis resulted in
more than financial instability. In some countries, it also caused problems along other dimensions in terms of financial depth and financial inclusion, giving rise to obstacles hindering individual and firms’ access to financial services.
Box 1: World Bank framework to measure financial system characteristics
In view of the global financial crisis which broke out in 2008 and the grave ramifications which ensued to global
growth, employment rates and debt burdens, the WB, in its Global Financial Development Report 2013, emphasized on the importance of financial development across different countries, due to its marked impact on economic
development, poverty rates and economic stability in general.
Key functions of financial systems
easing the
exchange of goods,
services and
financial
instruments
produce
information about
possible
investments and
allocate capital
Key functions of
exert corporate
governance after
providing
finance
financial systems
mobilising
savings
24 Financial Stability Report - PMA
facilitating
trading,
diversification
and management
of risk
The WB defines financial development as the ability of the financial system to ease “market imperfections”. At a
broader level, financial development can be defined as improvements in the quality of five key financial functions
illustrated in the figure. Financial institutions and markets around the world differ markedly in how well they
provide these key services depending on the environment and ideology, the legal systems, the social culture, etc…
Financial development occurs when financial instruments, markets, and intermediaries mitigate—though do not
necessarily eliminate—the effects of imperfect information, limited enforcement, and transaction costs. For example,
the creation of credit systems and registries provides data about borrowers and thereby improves the allocation of
resources. Likewise, effective legal and regulatory systems have facilitated the development of financial markets
that allow investors to hold more diversified portfolios which encourages the flow of capital to higher return projects, and in turn, boosted income to higher levels than achieved in countries lacking efficient financial markets.
Against this background, the WB introduced in its Report a special framework to measure financial system characteristics in any country, for both financial institutions and financial markets. These characteristics are measured
through four key dimensions: financial depth, financial inclusion, financial efficiency, and financial stability. Characterization is carried out through measuring the four dimension categories for the two key components of the
financial system using a number of key indicators. Financial system characteristics are assembled in a 4x2 matrix
as represented in the below table:
Dimensions
Financial Institutions
Financial Markets
Stock market capitalization plus
outstanding domestic private debt
securities to GDP
Financial depth
Private sector credits to GDP
Financial access
Depositor accounts per thousand Percent of market capitalization
adults (commercial banks)
outside at top 10 largest companies
Financial efficiency
Net interest margin (Lending-depo- Turnover ratio (turnover/capitalizasits spread)
tion) for stock market
Financial stability
Volatility (standard deviation/aveCapital adequacy ratios (regulatory
rage) of stock price index, sovereign
capital to risk-weighted assets)
bond index
Source: GLOBAL FINANICAL DEVELOPMENT REPORT 2013, World Bank.
For every category in the matrix, several proxy indicators can be used, depending on the availability of data in each
country. The indicators may be complementary or substitutive, especially that financial systems vary considerably
across countries in shape and size in terms of the four dimensions. It should be noted that, as economies develop,
services provided by financial markets are becoming more important than those provided by banks.
The multi-dimensional nature of financial systems, apparent during the measurement of characteristics, is attributed to differences in the experiences of individual countries, particularly in relation to the global financial crisis,
which proved that financial crises are not the sole result of financial instability, but for some economies, concur
with significant changes in financial depth, the level of financial inclusion and impediments to access financial
services for individuals and firms. Moreover, financial depth is solely a measure of size (of financial institutions
and financial markets). It is the most conventionally employed measure of financial development, yet it does not
reflect the reality of financial development, because deep financial systems do not necessarily offer quick access to
financial services, nor do they necessarily provide inclusive financing. Also, the most efficient financial systems are
not necessarily the most stable ones. Hence, different countries have varying financial system characteristics, which
necessitate the measurement of these characteristics from multiple facets, as these characteristics are linked to
economic and social development, financial sector policies and other enabling environment variables of financing.
Chapter Three: Financial Sector Developments
25
Upon implementation of the above-mentioned matrix, in-depth analysis suggested that the Palestinian financial
system showed disparate results over 2014 that ranged between recovery and decline in comparison with the previous
year. This applies to financial institutions (banks and other financial institutions) and to the financial market alike.
Following is a detailed review of developments in the dimensions of the Palestinian financial system characteristics
matrix.
Table 3-1: The Palestinain financial system matrix, 2013-2014
Indicator
Financial institutions
2013
2014
Financial markets
Change (%)
2013
2014
Change (%)
* Financial depth
23.6%
26.3%
2.7%
improved
24.4%
25.1%
0.7%
improved
Financial inclusion
1,037.5
1,009.0
2.7% fall
back
21.5%
22.8%
1.3%
improved
Financial efficiency
7.86%
6.70%
1.16% fall
back
11.2%
11.0%
0.2% fall
back
Financial stability
20.0%
19.0%
1.0% fall
back
8.6%
26.0%
17.4%
improved
* Adjusted by CPI.
Source: Calculated according to the methodology of the global financial development report, WB, 2013.
Characteristics of financial institutions
In terms of financial depth and financial efficiency, financial institutions showed signs of recovery, whereas, in terms
of financial inclusion and financial stability, they showed signs of decline. Following is a review of the developments
in the four dimensions of the characteristics matrix for financial institutions.
• Financial depth
The financial depth indicator[15], measured by the ratio of
Figure 3-3: Credit granted to Private sector as a
percent of GDP , 2013
ence between the banking sector and economic activity,
thereby the promotion of economic growth, especially
in light of the evidence offered in many studies on the
strong correlation between credit granted to the private
sector (the main driver behind economic activity) and
economic growth.
128.4
rd
a
Eg n
y
Le pt
ba
pa no
le n
st
in
e
M
Lo
EN
w
M
A
i
Lo idd nco
w
le m
m
in e
Hi
i
c
gh ddle om
m
in e
id
c
dl om
e
in e
co
Hi
gh me
in
co
m
W e
or
ld
This is an indication of the increased degree of conflu-
150.9
160
140
98.6
98.0
120
85.8
100 72.3
25.4
80
41.5
60
27.8
27.6
24.9
40
20
0
Jo
a rise from 23.6 percent in 2013 to 26.6 percent in 2014.
Percent
private sector credit granted by banks to GDP, exhibited
Source: IFS, IMF.
Comparison with neighboring countries reveals that the ratio of private sector credit to GDP in Palestine was relatively low compared with 27.8 percent in Egypt, 72.3 percent in Jordan and 98.6 percent in Lebanon. The ratio reached
27.6 percent for the Middle East developing countries, while it recorded about and 128.4 percent globally by end of
2013. The ratio in Palestine ranked low within the group of low-income countries which registered an average of 27.6
percent. This result exposed the need for good effort to be made to foster credit granting to the private sector locally.
[15] Depth indicator was calculated according to the WB methodology that adjusted by Customer Price Index CPI.
26 Financial Stability Report - PMA
Other main indicators of financial depth presented
similar trends As all recorded an increase during
Figure 3-4: Financial depth in Palestinian financial
institutions, 2013-2014
2014 compared with the previous year. One such
100
indicator was the ratio of money supply (M2) to
2013
80
Percent
GDP[16], which surged from 75.2 percent up to 80.2
percent in 2014. The financial sector’s (financial
activities and insurance) share of GDP also increased from 3.4 percent to 3.7 percent[17]. Likewise, the
60
40
20
0
share of customers’ deposits of GDP increased from
66.6 percent to 70 percent for the same period.
This signals the positive change registered by the
Palestinian financial system (financial institutions’
2014
Financial
Private sector M2 to GDP Customer
deposits to sector value
credits to GDP
GDP
added to GDP
Source: PMA database.
side) in terms of financial depth.
• Financial access
The financial inclusion indicator, expressed as number of depositors’ accounts per 1000 adults (15 years of age and
above), showed a decline by 2.7 percent compared to 2013, dropping from 1,037.5 accounts/ 1000 adults in 2013 to
1009 accounts/ 1000 adults.
Notwithstanding this slight decline captured by one indicator, other financial inclusion indicators showed better
results than in 2013. The number of bank branches and offices per 100,000 adults rose from 9.6 in 2013 to 10.0 branch/
100,000 adults[18]. According to the latest data released by the IMF database[19], this indicator scored better for Palestine
than some other countries like Egypt, Sudan, Algeria, Iraq, Syria and Saudi Arabia, while scoring lower than in some
other Arab countries like Jordan, Morocco, Tunisia, Qatar and United Arab Emirates. In
comparison with non-Arab countries, both developing and advanced, it is apparent that the number of bank branches
and offices is rather low, as Palestine ranked 107 out of 177 countries on the basis of this indicator. The indicator recor-
On the other hand, WB data reveal that financial
inclusion indicators for Palestine have improved. Account ownership at banks and other
financial institutions increased from 19 percent
in 2011 to 24 percent in 2014. This percent was higher than the average for developing countries
in the Middle East, recording about 14.2 percent.
This percentage is, however, considered close to
Figure 3-5: Branches and offices per 100 thousand of adult
population, 2013
50
40
30
20
10
0
39
34
24
20
3 5 5
18 16
6 4
12 13
9 11
20 17
15
11 12
20
22
24
Jordan
Sudan
Egypt
Algeria
Morocco
Tunisia
Kuwait
Iraq
Syria
U.A.E
Qatar
Saudi…
Palestine
Israel
China
Malaysia
India
Germany
Turkey
USA
Sweden
France
Canada
and 20.1 in Turkey per 100,000 adult population.
Branch/100 thousand adult
ded 19.9 in Israel, 33.9 in the USA, 17.2 in China
Source: IMF database, Financial Access Survey (FAS).
[16] Check the Quarterly Monetary Developments Report at www.pma.ps, which includes an estimation of money supply in Palestine as per a specific
methodology.
[17] National accounts, PCBS.
[18] The indicator was calculated using the same methodology as the IMF: the number of bank branches per 100,000 adults = (number of bank branches and
offices + number of banks) * 100,000/ number of adult population. With regards to the number of bank branches, the data published by the PMA was used,
whereas with regard to the number of adult population, the data published by the PCBS data was used.
[19] Variations in indicator value are attributed to the differences from data sources, as the number of adult population in Palestine differs from that stated
in the IMF database.
Chapter Three: Financial Sector Developments
27
that scored by low-income countries of about 27.5
percent, as shown by WB rankings. Yet, this score is
Figure 3-6: Account ownership at banks or other financial
institutions, selected countries, 2011-2014
considered generally low compared to 42.7 percent
worldwide, which registered 61.5 percent in 2014.
80
Percent
Palestine is assigned, or compared to the percent
60
40 19
20
With regards to promoting the use of the banking
2011
loans in Palestine from 4.1 percent to 4.2 percent.
compared to some neighboring Arab countries
and developing countries in the Middle East. It is
also below the percent recorded for low-income
14
25 25
11
14
28
21
62
51
43
29
0
rise in the number of people with outstanding
This percent is considered generally low when
10
70
57
e
Eg
yp
t
Jo
rd
a
Le
n
ba
no
n
Isr
ae
l
Lo ME
w N
in A
M
co
Lo idd
m
le
w
e
in
m
co
id
Hi
gh dle me
in
m
c
id
dl om
e
in e
co
Hi
gh me
in
co
m
e
W
or
ld
of the survey conducted by the WB showed a timid
24
58
43
47
37
pa
le
st
in
system and other lending institutions, the results
91
85
90 90
100
scored by lower middle income countries, to which
2014
Source: Global financial inclusion database, WB.
Figure 3-7: Individuals with outstanding loans from banks
or other financial institutions, selected countries, 2011-2014
50
countries equal to 8.6 percent.
40.5
20
10
population. This figure was higher than for Midd-
sed on the WB survey, which is a low ratio when
50
compared to the Middle East countries and the
40
45.9
tin
le
s
pa
As for the advanced usage of electronic services, the
percentage of individuals using their accounts to
2011
9.6
40.1
8.5
6.6
an
no
n
Isr
ae
l
Lo M
E
w
N
M
Lo idd inco A
w
m
l
m e in e
id
Hi
co
d
gh
le me
in
m
c
id
dl om
e
in e
co
Hi
gh me
in
co
m
e
W
or
ld
0
e
compared to 2.4 percent in 2013, which indicated a
10.6
51.2
21.2
19.1
20
10
34.4
33.4 32.4
30
PMA showed that this ratio was 2.6 percent for 2014
relative pick-up in the credit card usage.
10.7
Le
pectively, for the same year. Data published by the
10.4 11.3
ba
60
Percent
about 1.2 percent of adult population in 2014, ba-
world average of 2.1 percent and 17.6 percent res-
7.5
Figure 3-8: Individuals with debit card, selected countries,
2011-2014
t
As for holders of credit cards, they constituted
9.1
This ratio reflects all respondents who borrowed from banks or other financial
institutions in the past 12 months out of total number of adult population (15 years
and above).
Source: Global financial inclusion database, WB.
yp
percent reported for 2013.
8.6
2014
rd
years and above) was 15.3 percent, similar to the
2011
Jo
the number of debit cards to adult population (15
5.6
in
average of 40.1 percent in 2014. It is worth mentioning that, according to data published by the PMA,
6.3
4.2
st
le
pa
respectively. However, it was lower than the world
15.6
0
le East developing countries and for low-income
countries scoring 8.5 percent and 6.6 percent
13.6
e
yp
t
Jo
rd
a
Le
n
ba
no
n
Isr
ae
l
Lo ME
w N
in A
M
co
Lo idd
m
le
w
e
in
m
co
id
Hi
gh dle me
in
m
c
id
dl om
e
in e
co
Hi
gh me
in
co
m
e
W
or
ld
cards in 2014 was about 10.6 percent of the adult
30
Eg
banking services, the percent of people with debit
Eg
With regards to access to electronic financial and
Percent
40
2014
This ratio reflects all respondents who hold debit card out of total number of adult
population (15 years and above).
Source: Global financial inclusion database, WB.
28 Financial Stability Report - PMA
pay utility bills (water and electricity), for example,
was 3 percent in Palestine, higher than figures re-
Figure 3-9: Individuals with credit card, selected countries,
2011-2014
ported for neighboring Arab countries and Middle
90
East developing countries.
80
76.2
20
10
the world average, albeit better than some Arab
0
Figure 3-10: Advanced usage of electronic services, selected
countries, 2014
20
15
10
8.1
reached 51.1 percent, albeit better than for low-income countries where the ratio was 20.2 percent.
in
ld
or
co
m
e
e
e
m
co
in
e
gh
e
co
in
e
dl
id
gh
m
dl
id
m
w
m
m
co
dl
e
in
m
e
A
EN
Lo
accounts, which is a low ratio compared to neighboring Arab countries and the world average which
co
M
Lo
cards was 32.2 percent of the adult holders of bank
in
e
in
st
pa
le
withdrawal, the percentage of adults using ATM
3.1
0.9
0.2
w
0
As for using ATMs as a basic method of cash
0.6
0.1
id
0.1
Hi
3.0
Hi
5
n
2 percent, also higher than in Egypt and Jordan.
16.7
12.3
no
East developing countries and a world average of
17.7
M
same year, compared to about 0.1 percent in Middle
Percent
0.3 percent of adult population in Palestine for the
W
personal bank accounts, this indicator was equal to
an
who used a mobile phone to pay utility bills from
This ratio reflects all respondents who hold credit card out of total number of adult
population (15 years and above).
Source: Global financial inclusion database, WB.
ba
about 1.4 percent. As for the percentage of adults
2014
Le
however, higher than in Egypt which recorded
2011
t
a world average of 16.6 percent. The figure was,
3.7
1.1
e
Eg
yp
Jo t
rd
Le an
ba
no
n
Isr
ae
l
M
Lo
EN
A
M w
Lo idd inco
w
m
l
m e in e
id
Hi
c
o
gh dle m
in e
m
c
id
dl om
e
in e
co
Hi
gh me
in
co
m
e
W
or
ld
cent of adults in Palestine compared to about 2.1
percent in Middle East developing countries and
2.1
pa
le
st
in
to shop or process payments constituted 1.6 per-
2.3
1.9
1.2
17.6
16.8
10.7
10.7
low ranks compared to developing countries and
countries. In 2014, adults who used the internet
27.8
30
rd
bills, indicators for Palestine generally occupied
40
yp
and shopping, or using mobile services to pay
50
Eg
services like the use of the internet in payment
60
Jo
With regards to the use of modern online banking
Percent
70
This ratio reflects those who used their bank accounts to pay utility bills in the past 12
months out of total number of adult population (15 years and above).
Source: Global financial inclusion database, WB.
Table 3-2: Advanced usage of electronic banking services in Palestine, 2010-2014
Finical services
2010
2011
2012
2013
2014
# ATM machines
335
378
435
488
549
# ATM cards
71,684
101,728
122,379
132,758
163,074
# Point of sales
2,314
3,658
3,926
4,646
5,579
# Debit cards
308,962
354,352
410,536
408,636
419,676
# Credit cards
37,374
47,046
56,835
62,931
70,029
# depositor accounts
2,185,779
2,545,459
2,715,338
2,748,387
2,766,635
Source: PMA database.
Chapter Three: Financial Sector Developments
29
It is worth mentioning that the number of ATM
cards increased in 2014 by 22.8 percent compared
Figure 3-11: The use of ATM in cash withdrawals, selected
countries, 2014
to the previous year. Moreover, the number of
in 2013 to 20.0 in 2014. The improvement in this
indicator is a result of PMA instructions intended
to promote the usage of electronic banking services
and ATMs. Pursuant to Instructions No. (138/2014),
banks are instructed to abstain from opening new
bank accounts (both current and saving) unless
an ATM card application is requested by the customer, with the exception of illiterate and blind
80.0
67.3
51.3
70.3
60.9
51.2
44.9
55.7
42.4
51.1
32.2
20.2
e
Eg
yp
Jo t
r
Le dan
ba
no
n
Isr
ae
l
Lo ME
N
w
M
A
Lo idd inco
w
le m
m
e
id inc
Hi
gh dle om
in e
m
c
id
dl om
e
in e
co
Hi
gh me
in
co
m
e
W
or
ld
the number of ATMs per 100,000 adults from 18.4
90
80
70
60
50
40
30
20
10
0
pa
le
st
in
different governorates, which brought about a rise
Percent
ATMs increased from 488 to 549, spread across the
Source: Global financial inclusion database, WB.
customers. Additionally, banks are instructed to
close accounts of customers who already hold ATM cards, in case they request the cancellation of the ATM services.
The PMA devotes special attention to financial inclusion. In February 2014, it signed a MoU with the PCMA to establish
the National Strategy on Financial Inclusion, with support from the AFI. This strategy aims at enabling access to and
use of various financial services and products by people from different strata of the society. With the joint effort of all
parties involved, the public will be made aware of the importance of financial services and introduced to their modes
of access and usage, to ultimately boost their capacity to advance socially and economically and achieve social and
financial stability. The strategy aims to bridge the financial literacy gap in the best possible manner by promoting
consumer protection through the formulation of policies and guidelines to introduce current and potential consumers to their rights and obligations. The formulation of this strategy comes to meet the mounting need of consumers of financial services in Palestine
for financial education and awareness-campaigns. Concerted efforts are needed to avoid redundancy in effort and
resources and eventually reach the largest segment possible of targeted groups. Together, the PMA and PCMA spearhead the formulation of the National Financial Inclusion Strategy in Palestine, in collaboration with all stakeholders
within a clear and well-developed plan. The plan is based on the main principles for enhancing financial inclusion
endorsed by the G20, WB and AFI as well as the OECD Principles on National Strategy for Financial Education.
Judging from past international experiences, the formulation of this strategy is expected to extend over a two-year
period. Due to the peculiarity of the Palestinian situation and the scarcity of resources and specialized staff, the
strategy will be divided into two phases. The first phase will last for 5 years and target financial sectors supervised
by PMA and PCMA. The second phase will be implemented over three years and will target the remaining sectors
including the private and public sectors and any other sector for which the strategy is pertinent.
The Steering Committee is presided over by both the PMA and the PCMA, while members of the Committee are: the
Association of Banks in Palestine, the Ministry of Education and Higher Education, the Banking Services Consumer
Society, the Palestinian Network for Small and Micro-Finance “Sharakeh”, the United Nations Relief and Works Agency
UNRWA, The Palestine Stock Exchange (PEX), the Palestine Union of Securities Trading Companies and the Palestinian
Insurance Federation. The committee held its first meeting in April 2014.
30 Financial Stability Report - PMA
In the same context, the PMA held the Palestine International Banking Conference 2014[20] under the title “Financial
Inclusion: A Path for Growth”. The conference was organized in partnership with the International Finance Corporation
(IFC) and the Association of Banks in Palestine (ABP), under the patronage of H.E. the Prime Minister. The conference
program included presentations of successful experiences in financial inclusion for youth and women and discussions of the appropriate mechanisms and tools to be employed to promote financial inclusion and defeat associated
impediments. On a related note, and as a sequel to the Banking Week activities, the Third Child and Youth Banking
Week, held over the period from March 16 -21, 2014, was launched in both the WB and GS.
For the purpose of promoting financial inclusion, several workshops and awareness campaigns were organized
including seminars to students in schools, universities and summer camps in the WB and GS. Furthermore, banking
awareness seminars targeting specific sectors of the society (the judiciary, merchants, and Palestinian security forces employees) were conducted. The PMA also coordinated the awareness campaign launched by Islamic banks and
financial institutions on Islamic banking services, in addition to organizing a campaign and preparing a companion
pamphlet on the risks associated with being a loan guarantor. This campaign was a result of PMA keenness to raise
awareness of members of the public to the plausible social and economic risks associated with providing guarantees
to personal loans. The main goal was to help preserve the rights of potential guarantors of loans, whether with the
banking system or the specialized lending institutions, so that they are cognizant of their legal and material obligations. Relevant statistical figures reveal a rise in the numbers of personal loan guarantors in the Palestinian society
over the past few years by about 119 percent. Oftentimes in the local community, acting as loan guarantor is regarded
from the perspective of social courtesy, despite proving to be quite costly in many instances. The campaign’s logo was
“Stop, Think Then Decide”. It introduced the public to the risks associated with acting as personal loan guarantor and
provided instructions for the guarantor-to-be to help corroborate his/her decision to provide loan guarantees to others.
Similarly, a campaign was launched to raise public awareness to the importance of abstaining from dealing with
usurers. In 2014, information was circulated to the public advising against dealing with, or entrusting them with
investment of savings. The information pointed out that such a business and its practices were unlawful, as they
implicate citizens and escape official supervision. It was also affirmed that such usurers are not licensed by any
competent authority. Another campaign was launched in 2014 in both the WB and GS to introduce all segments of
the Palestinian public to the significance and role of the Palestine Deposit Insurance Corporation (PDIC) in protecting
citizens’ deposits and maintaining financial stability. The campaign was consistent with the PDIC’s social responsibility towards citizens and depositors in licensed banks.
Despite the tangible improvement of financial inclusion indicators, there is still need to exert continuous effort to
encourage citizens to make use of the financial system. Efforts are also needed in reinforcing banking infrastructure
to promote the spread of electronic banking services, thereby expanding financial inclusion and facilitating access to
financial services for all groups of the society. The PMA takes active and well-planned steps towards achieving this goal.
[20] During the conference, three sessions were held in which Palestinian and international IFC and GIZ experts spoke. The first session was chaired by Dr.
Sabri Saidam, Former Minister of Telecommunications and IT, and was entitled “Financial Inclusion the Way Forward”. The second session was chaired by Mr.
Hayder Al-Bagdadi, the Manager of GIZ project for Promotion of the Microfinance Sector in the MENA Region. It was entitled “Initiatives and Financial Products
to Enhance Financial Inclusion”. The third session was chaired by Mr. Hermann Bender, IFC’s Program Manager at the MENA Bank Advisory Services, and was
entitled “Channels, Tools and Techniques to Enhance Financial Inclusion”. This session saw contributions from Mr. Joseph Nesnas, Mr. Florian Henrich and Ms.
Margarete Biallas.
Chapter Three: Financial Sector Developments
31
• Financial efficiency
The financial efficiency indicator for financial institutions, measured using the spread (margin) between lending
and deposit interest rates[21], improved during 2014 dropping by 1.16 percentage points to reach 6.7 percent. Despite
the relative pick-up, the spread for Palestine[22]
remained the highest in comparison with other,
8
to boost banking sector attractiveness, and hence,
the role of banks in promoting economic growth.
5.6
4.6
4.8
1.5
1.4
1.6
1.5
3.7
3.6
st
in
e
t
le
yp
pa
Eg
sia
n
ay
al
no
M
ba
ya
Le
Lib
ta
r
ge
Qa
ria
an
Al
persist, as do efforts to lower the interest margin
0
rd
the efficiency of financial brokerage in Palestine
1
l
developments. However, the efforts to improve
2014
2
Jo
the pronounced impact of political and security
3
ae
and economic environment in Palestine, owing to
4
Isr
generally heightened degree of risk in the banking
4.2
4.5
5
3.1
3.1
6
in Israel, during 2014. This can be attributed to the
Percent
cent in Egypt, 1.4 percent in Lebanon and 3.1 percent
2013
6.3
6.3
7
3.5
3.5
the spread stood at 4.5 percent in Jordan, 4.8 per-
6.9
Figure 3-12: Interest rate margin, 2013-2014
particularly neighboring, countries. For example,
Source: IMF database.
As for the remaining financial efficiency indicators like profitability and non-interest income, and despite having
shown a relative decline in 2014 compared to 2013, they remained generally satisfactory compared to neighboring
countries. (For further details, check Chapter Five on financial soundness indicators FSIs.)
• Financial stability
The financial stability indicator approximated by the bank capital adequacy ratio (the ratio of regulatory capital to
risk-weighted assets) showed a slight drop by 1 percentage point to reach 19.0 percent from 20.0 percent in 2013. This
ratio remained satisfactory and higher than the minimum limits designated by the Basel Committee of 8 percent
and the limits designated by the PMA set at 12 percent. Other financial stability indicators, whether in relation to
liquidity ratios or asset quality ratios like the ratio of non-performing loans to total facilities, showed improvement
when compared to the previous year. Non-performing loans to total loans receded to 2.5 percent from 2.9 percent in
2013. This ratio is considered low when compared to other countries as the analysis of financial soundness indicators
in Chapter Five duly demonstrates.
Characteristics of financial markets
The characteristics the financial market[23]showed an improvement in the terms of financial depth and inclusion, and
a decline in terms of financial efficiency and stability. Following is a detailed account of the development in the four
dimensions of the financial market, as per the characteristics matrix:
• Financial depth
The financial depth indicator, measured by PEX capitalization to GDP (market value of listed stocks plus outstanding
[21] Because of multi-currency lending and depositing, and subsequently the differences in associated interest rates, the margin was calculated based on a
compound interest rate index for each of loans and deposits using a currency –weighted formula.
[22] This margin was only measured for the US dollar according to the IMF database, for the purpose of inter-country comparisons.
[23] For further details on PEX developments, check Chapter Six “Development of Non-Banking Financial Institutions”.
32 Financial Stability Report - PMA
domestic private debt securities[24] to GDP), showed
an improvement in 2014 by increasing from 24.4
Figure 3-13: Characteristics of Palestinian financial market,
2013-2014
percent in 2013 to 25.1 percent in 2014.
30
According to the latest published data on Arab
Percent
countries’ GDP for 2013, and by measuring the
financial depth indicator (not adjusted by CPI),
24.4 25.1
21.5
26
22.8
20
11.2
11
8.6
10
financial depth in Palestine is considered satisfactory in comparison with several Arab stock exc-
0
Financial depth
hanges, reaching 26 percent, and exceeding that
of the stock exchanges of Dubai, Egypt, Khartoum,
Tunisia and Beirut. It edged close to the Abu Dhabi
Securities Exchange and was lower than the Am-
2013
Financial
inclusion
Financial
efficiency
Financial
stability
(volatility)
2014
Source: PCMA database.
man Stock Exchange which scored 76.6 percent. In general, taking into consideration the difficult circumstances amid
which the Palestinian economy operates, the progress accomplished with respect to financial depth in Palestine is
considered a remarkable achievement which promotes the role of the stock exchange in the local economy, making
it a significant driver of financial and economic activity.
outside of top 10 largest companies, registered an
22.7
27.3
26.0
18.2
23.4
Bahrain
Beirut
Palestine
Casablanca
Amman
Tunisia
Muscat
3.6
0
Within this context, the financial inclusion indicator, measured by percent of market capitalization
17.6
20
Kuwait
and make use of the stock exchange services.
40
56.3
52.5
46.2
Khartoum
curtailing the ability to access the financial market
61.6
Qatar
access difficulties for new or smaller firms will be,
60
76.6
75.4
62.4
Cairo
concentration and hegemony is, the greater the
80
AbuDhbi
centration and hegemony. The higher the level of
100
Dubai
the stock exchanges depends on the levels of con-
Figure 3-14: Financial depth of Arabs stock exchange, 2013
Saudi
The degree of financial access and inclusion in
Percent
• Financial access
Palestine data from PEX and PCBS.
Source: Calculated ratios based upon the data released by the IMF.
improvement of 1.3 percentage point, rising from
21.5 percent to 22.8 percent end of 2014. This reflects a drop in the concentration and hegemony levels in the stock
exchange, and a relative improvement in the significance and value of non-dominant companies. It also signals an
improvement in financial access and inclusion in PEX, and consequently, positive consequences for small or new
companies to the stock exchange.
In comparison with the financial inclusion indicator for global financial markets, based on data from the WB’s Global
Financial Development database[25], it can be deduced that the indicator for Palestine in relatively low, when compared
to neighboring Arab countries (Egypt and Jordan), or to countries across the globe. The financial inclusion indicator
in the Middle East developing countries was 29.6 percent, and 57.3 percent for middle-income countries, to which
Palestine belongs, while the global average was 46.9 percent.
[24] Private securities in the PEX are solely comprised of the Palestine Commercial Bank bonds with a value of USD 10 million. The bonds were issued on July
14, 2014, with a nominal value of USD 1000, at an interest rate of 6.5 percent. The bonds are held to maturity for five years from the issue date.
[25] For comparison purposes, it must be noted that the value of the indicator discussed here for Palestine is for 2014, whereas the comparison values for
different countries (appearing in the Figure) are for 2011, which are the most recent data issued by the WB. Despite the time gap, the comparison offers a
general indication of the degree of financial inclusion in the PEX as compared to the rest of the world.
Chapter Three: Financial Sector Developments
33
On a different note, and notwithstanding its sig-
Figure 3-15: Financial inclusion of Arabs stock exchange,
2011
nificant developments and accomplishments, the
PEX remains modest in size compared to Arab stock
Percent
exchanges, with a relative size (market capitalization/total market capitalization of Arab markets)
equal to 0.26 percent end of 2014. The listed companies in Palestine constitute 3.3 percent of the
markets, according to data released by the Arab
ge to PEX with regards to expanding its share and
companies to become incorporated with PEX.
43.4
53.6
46.1
29.6
22.8
45.5
28.8
M
Monetary Fund. This represents a serious challenpromoting financial inclusion, by encouraging
57.3
id Wo
dl
rld
Lo
e
w
in
m
co
id
m
Hi
dl
e
e
gh
i
n
m
c
om
id
dl
e
e
in
co
Hi
m
gh
e
in
co
m
e
M
EN
A
pa
le
st
in
e
Jo
rd
an
Eg
yp
t
Isr
ae
l
total number of listed companies in the Arab stock
70
52.8
60
46.9
50
40
30
20
10
0
Palestine data for 2014.
Source: Global financial development database (latest data for 2011 only), WB.
• Financial efficiency
Financial efficiency can be approximated using the turnover ratio (expressed as turnover for a certain period/market
capitalization) for a stock market. An increase in this ratio is an indication of an increase in the volume and number
of transactions in the stock exchange, and subsequently an increase in liquidity. From another perspective, an increased volume of transactions signals a higher degree of transparency and clarity with regards to stock prices and
the manner in which they change. In turn, this means a larger content and better quality of information resulting
inevitably in higher financial market efficiency.
The financial efficiency indicator for PEX[26] recorded a slight decline of 0.2 percentage points, dropping from 11.2 percent in 2013 to 11.0 percent in 2014. This suggests that the level of financial efficiency in PEX was somewhat characterized by relative consistency between 2013 and 2014.
In comparison with the financial efficiency indicator for global financial markets[27], the corresponding indicator for Palestine is comfortably posi-
Figure 3-16: Financial efficiency of Arabs stock exchange,
2011
60
tioned, as the Middle East developing countries’
ne is assigned, 6.9 percent. On the other hand, the
world indicator recorded 12.9 percent. Moreover,
the indicator in Palestine scored better than in
Lebanon, albeit lower than in Jordan and Egypt. In
general, this indicator reflects a sufficiently high
value for financial efficiency in PEX as a result of
several measures and accomplishments made by
the Exchange over the course of its operation .
[28]
Percent
of lower-middle income countries, to which Palesti-
40
33.9
30
20 12.9
10
2.6
6.9
5.4
5.4
10.9 11.0
13.9
4.9
0
W
Lo
or
w
l
M
in d
Lo idd com
le
w
e
i
Hi mid nco
gh dl
m
m e in e
id
c
dl om
e
e
i
Hi nco
gh m
in e
co
m
e
M
EN
pa
A
le
st
in
e
Jo
rd
an
Le
ba
no
n
Eg
yp
t
Isr
ae
l
indicator recorded 10.9 percent, and for the group
56.1
48.3
50
Palestine data for 2014.
Source: Global financial development database (latest data for 2011 only), WB.
[26] The financial efficiency indicator was calculated according to WB methodology adjusted by CPI.
[27] It must be considered that the comparison years are different.
[28] For further information, check the chapter on developments of non-banking financial institutions in previous Financial Stability Reports.
34 Financial Stability Report - PMA
• Financial stability
PEX financial stability is measured using a key indicator which reflects market volatility based on the stability/fluctuation of financial market earnings. This indicator is calculated in accordance with WB methodology[29] using the
40
8.6
2014
2013 to 26.0 percent in 2014. The rise may be attri-
7.9
2013
0
2011
tage points, as volatility rose from 8.6 percent in
2010
9.9
2012
19.4
10
and its repercussions on PEX and the Palestinian
26.0
20
During 2014, the PEX indicator sank by 17.4 percen-
buted to the Israeli aggression against GS in 2014
33.7
27.4
2009
of potential causes, both economic and political.
35.9
27.7
30
Percent
in financial market conditions due to a number
36.4
2008
market earnings, reflecting an overall instability
2007
with instability and high degree of fluctuation in
Figure 3-17: Market rate of return volatility in PEX, 20102014
2006
price. A high value for this indicator is associated
2005
formula: (standard deviation / average) of stock
Source: Bloomberg.
economy in general, notwithstanding the impact of other political factors over the course of the year.
Table 3-3: Some financial inclusion indicators, selected countries, 2014
Individuals with
The use of
Country
internet for
paying and
Purchasing
account for
utility bills
(Percentage)
mobile for
utility bills
ATM for cash
withdrawals
debit card
credit card
Palestine
1.6
3.0
0.3
32.2
10.6
1.2
Egypt
1.4
0.1
0.0
51.3
9.6
1.9
Jordan
2.5
0.1
0.1
67.3
19.1
2.3
Lebanon
4.4
0.6
0.3
60.9
33.4
10.7
Israel
35.7
43.5
4.5
80.0
32.4
76.2
MENA (developing
countries)
2.1
0.2
0.1
44.9
8.5
2.1
Low income
1.2
0.9
2.2
20.2
6.6
1.1
Middle income
9.4
8.1
0.8
51.2
34.4
10.7
Lower middle income
2.6
3.1
0.3
42.4
21.2
3.7
income Upper
middle
15.3
12.3
1.2
55.7
45.9
16.8
High income
21.4
17.7
1.2
70.3
51.2
27.8
World
16.6
16.7
2.0
51.1
40.1
17.6
Source: Global financial development database, World Bank.
[29] Source: Bloomberg, calculated according to the following formula: average of stock price fluctuation during the year/domestic market fluctuation.
Chapter Three: Financial Sector Developments
35
Chapter Four
Banking Sector Exposure
Overview
Like many of its counterparts in other countries, the Palestinian banking sector is prone to
risks that arise in response to the nature of ongoing changes in the economic environment,
in view of the increased degree of financial liberalization, the development of banking
mechanisms and tools, on one hand, and the increased inter-linkage between and within
countries, on the other.
These risks are likely to transmit from and to the banking sector via a number of contagion
channels affecting different activities of lending and investment, among others, as well
as the sector’s assets and key indicators, thereby compromising the safety of customers’
deposits. The risks may even threaten the stability of the entire banking sector, especially
if that sector is operating within a high-risk environment, as does the Palestinian banking
sector. Indeed the Palestinian sector is vulnerable to a number of exogenous and endogenous factors, which have given rise to several shocks, specifically in relation with public
finance and political conditions. This chapter reviews and analyzes the various risks that
surrounded the Palestinian banking sector in 2014, their main transmission channels and
their likely effects on key banking sector indicators.
Exposures to local sectors
Public sector
Developments in fiscal performance affect banking stability, both directly and indirectly. The main impact channels
are the following three channels, albeit having varying associated degrees of risk: (1) direct credit granted to the
government, its growth potentials and constraints; (2) credit granted to civil servants and associated risks; (3) accumulated arrears for the private sector and its relation to credit granted to this sector. Following is an analysis of these
channels and their associated risks:
• The government
Direct credit granted to the government represents an important form of direct risk to financial stability. This is so
because the banking sector is exposed to the effects of Palestinian budgetary crisis, especially in view of the prevailing uncertainty about the persistence of public finance state of affairs, the limited local resources and the reliance
of the budget on clearance revenues and foreign grants to cover expenditures. The situation is further aggravated
by the fact that the government has no control over these two items. In addition, other crises affecting the size and
Chapter Four: Banking Sector Exposure
37
composition of expenditures may arise due to security developments and related compulsory expenses, as was the
case in the wake of the aggression against Gaza mid-2014.
Credit granted by banks to the Palestinian government affects two main accounts: government bank balances (termed
as net domestic financing) which reflects government short-term finance needs, and domestic debt account which
constitute around half of the public debt.
At the level of net domestic financing, data point
Figure 4-1: Growth rate in credit granted to the
government, 2011-2014
to a persistent dependence of the government on
this kind of credit to manage the requirements of
50
its monthly budget. The government uses this kind
40
of facility to face the fluctuation in its monthly
10
banks, which, in turn, depletes the surpluses reali-
0
zed in the overall balance after grants in a manner
-10
injected all surplus realized in the overall balance
after grants, which totalled NIS 488.6 million, into
its overdrawn bank accounts[30].
4,000
government on domestic financing to overcome
financing shortages over the past years, albeit at a
slower pace. In this context, estimated data (calculated after neutralizing the impact of dollar/shekel
exchange rates)
[31]
point to an increase in credit
3,000
2,000
1,000
0
2010
king sector. Firstly, the ongoing dependence of the
Government
Private and public sectors (excl.govenrment)
granted to the government by about 2.4 percent in
2014 compared to 4.6 percent in the previous year.
Dollar-denominated growth
Figure 4-2: Domestic credit granted to public and private
sectors, 2010-2014
USD million
features that may affect the stability of the ban-
2014
Source: Palestine Ministry of Finance (MoF).
As for the domestic debt balance, analysis of
domestic public debt suggests three important
2013
2014
and accumulated arrears. In 2014, the government
2011
2012
-20
growth after neutralizing Fx effect
2013
that curtails control over domestic debt balance
2012
build-up of overdrawn government balances with
20
2011
revenue. Shortage in domestic revenues leads to a
30
Percent
domestic revenues, in particular the clearance
Source: PMA database.
[30] It must be noted that, in line with IMF recommendations, the MoF introduced amendments to the 2014 government financial statements, in particular
to the items of “use of goods and services” and development expenditures. These amendments devalued both items by a total of about NIS 1,003.8 million, as
both were considered outstanding arrears from previous years. When this sum was deducted from the realized surplus (NIS 1,492.4 million), the actual surplus
after grants was equal to NIS 488.6 million.
[31] Neutralizing the effect of currency exchange rates, the growth rate for credit granted to government was calculated as follows:
Computing the growth rate of credit granted to the government denominated in USD based on data from banks, as published on the official PMA website.
Computing the relative change in the exchange rate by end of each time-period (around NIS 3.47 per USD by end of 2013, opposed to NIS 3.89 per USD at end
of 2014).
The growth rate of credit granted to the government after neutralizing the effect of exchange rates= growth rate of credit granted to the government
denominated in USD ± relative change in exchange rate at the end of each period.
It is worth mentioning that the impact of dollar/ shekel exchange rate is regarded as one of restricting factors of growth of sovereign debt. Most of domestic
debt, in addition to overdrawn balances at banks, is in Israeli shekel (about 70 percent of domestic debt), subsequently, any increase in the exchange rate of the
USD against the NIS will result in a diminished USD-denominated value of this debt and vice versa.
38 Financial Stability Report - PMA
Figure 4-3: Share of domestic credit granted to public and
private sectors, 2010-2014
to a fluctuating credit demand by the government,
it relates to the degree of concentration of credit
0
granted to the government, which constituted
74.7
69.4
25.3
20
30.6
of public indebtedness. As for the third feature,
2010
2011
2012
2013
2014
Government
one quarter of total credit granted to all economic
sectors, both resident and non-resident, during
69.1
40
33.4
ments of the elements of solvency and continuity
60
30.9
absence of necessary planning to fulfil the require-
80
Percent
that characterizes the Palestinian budget and the
66.6
100
which reflects the state of constant confusion
71.5
steady flow of financing is maintained. Data point
28.5
The second feature relates to the extent to which a
Private and public sectors (excl.govenrment)
Source: PMA database.
the last year.
Despite the absence of firm evidence of competition so far, the continued borrowing of the government, in view of
the current shortcomings of the budgetary structure, may crowd out the private sector for its share of bank credit on
the medium and long run. Such a competition may adversely affect not only financial stability, but also the overall
economic performance. Public-private sector competition raises interest rates, thwarting investment (one of domestic
demand’s most important components), and subsequently, growth rates.
From a different viewpoint, risks to the banking sector arise when credit granted to the government exceed banks
equity, as this is considered the ceiling for bank credit extended to the government. Surpassing this ceiling is associ-
Figure 4-4: Government credits as a percent of banks’
equity, 2010-2014
occasions, advising the government to resolve its
120
fiscal crisis and associated liquidity shortages away
100
pushing down credit granted to the government
40
to below the maximum permissible limits, as go-
20
vernment credit to banks equity dropped from 111.6
0
percent in 2012 to 100.9 percent in 2013, ultimately
2010
reaching 84.6 percent in 2014, thereby mitigating
Source: PMA database.
2011
2012
2013
84.6
60
100.9
This policy, adopted by the PMA, was successful in
80
111.6
dermine financial stability and public confidence.
Percent
from the banking system, as that can possibly un-
92.8
alerts were raised by the PMA, on a number of
75.2
ated with heightened risks. Based on this criterion,
2014
bank risk exposure to government credit.
• Civil servants
One important aspect of public finance developments is the exposure to credit granted to civil service employees,
which constitutes a source of risk endangering the soundness and robustness of the banking sector. In this context,
data analysis shows a rise in credit extended to this segment of employees to about USD 885.6 million, or the equivalent to 18.1 percent of total credit, end of 2014 as compared to USD 727.4 million, or the equivalent to 16.2 percent
of total credit in 2013. This sum represents 40.1 percent and 46.6 percent of total wages and salaries bill for 2013 and
2014, respectively.
Chapter Four: Banking Sector Exposure
39
Despite numerous positive effects, related to multi-faceted economic and social indicators, which
Figure 4-5: Credit granted to civil servant employees, 20132014
granting credits to civil servants entail, failure of
80
the government to meet its obligations towards
its employees bounces back as the inability of
banks leading ultimately to rising default rates,
another form of dormant risk endangering finan-
Percent
employees to meet their obligations towards
40
23.7
22.2
20
cial stability.
0
It is worth noting that the impact of this kind
2013
2014
Percent of credit granted to resident private sector
Percent of credit granted to public sector
of risk is not solely restricted to exceptional instances related to political developments and the
associated consequences of clearance revenues
57.8
53.0
60
Source: PMA database.
detention and decline in foreign grants, but has a
further disturbing aspect. Data reveal that the payroll cash deficit persists even when clearance revenue transfers and
grants are resumed. The value of this deficit for 2014 totaled around NIS 569.7 million, equivalent to a full-month’s
bill, and constitutes a 50 percent increase from 2013. Therefore, in assessing the risk of government failure to meet its
employee salary obligations, this factor presents a higher risk than Israel withholding clearance revenues or foreign
grants grinding to a halt.
• Private sector companies contracted by the government
Another source of threat to financial stability is the likely credit default by private sector companies and corporations who are suppliers or contractors to the government, especially those government payments to private sector
suppliers are dependent on liquidity available. Such credit risk takes one of two forms. The first consists of pressure
that creditor private corporations put on government by coercing it to borrow from banks in order to meet at least
part of its outstanding obligations, otherwise
threatening to suspend their business with the
government. The second form relates to increased
Figure 4-6: Government arrears accumulation, 2013-2014
100
80
private sector corporations supplying government,
which will also coerce them to borrow from banks
to settle payments related to their businesses. The
end result is a vicious financing cycle encompassing banks and both the private and public sectors.
For banks to receive loan payments, private sector
Percent
potential to compromise the financial positions of
Percent of domestic pubic debt
Percent of external public debt
Percent of credit granted to other sectors (excl. government)
60
76.5
40
20
38.4
sufficient funds to pay.
40 Financial Stability Report - PMA
55.2
63.2
0
2013
suppliers must receive government payments
which in turn depend on the government having
43.9
65.4
Source: PMA database.
2014
Private sector
Credit granted to the private sector registered a rise of 17.7 percent end 2014 compared to 2013, thereby representing
74.7 percent of total credits from 69.3 percent in 2013. Total credit
granted to the private sector totaled about USD
3,655.3 million, constituting about 30.9 percent of
Figure 4-7: Credits granted to private sector, 2010-2014
40
total bank assets and 28.6 percent of nominal GDP
by end of 2014.
Percent of total asstes
Percent of GDP
10
there are no significant differences between local
and foreign banks in the ratio of public sector to
about 70.3 percent of total credit over the period
28.6
30.9
24.9
27.8
24.7
23.4
0
private sector granted credit, as the average credit
granted to the private sector by local banks was
27.8
11.6 percent increase for foreign banks. In general,
20
26.2
granted to the private sector by local banks, against
23.3
Percent
Data point to a 23.4 percent increase in credit
23.0
30
2010
2011
2012
2013
2014
Source: PMA database.
2010–2014, while that ratio was 70.0 percent for foreign banks. As such, local and foreign banks are equally exposed
to credit risks associated with the public and the private sectors.
Credit granted to the private sector
includes credit granted to companies, personal credit and credit extended through credit cards. Hence,
risks associated with private sector
Table 4-1: Credit granted to private and public sectors, 2010-2014
(Percent)
Bank
Local
credit vary according to the segment
to which the credit is extended. Risks
Foreign
associated with credit granted to
companies are linked predominantly with economic developments, the
level of economic activity and the
Total
Beneficiary
2010
2011
2012
2013
2014
Av.
Private sector
70.9
69.3
67.9
69.1
74.3
70.3
Public sector
29.1
30.7
32.1
30.9
25.7
29.7
Private sector
71.1
68.7
65.2
69.6
75.2
70.0
Public sector
28.9
31.3
34.8
30.4
24.8
30.0
Private sector
71.0
69.0
66.5
69.3
74.7
70.1
Public sector
29.0
31.0
33.5
30.7
25.3
29.3
Source: PMA database.
impact of political conditions, whereas risks associated with personal credit are predominantly linked to the stability
and steadiness in the disbursement of salaries to employees, especially that credit extended to public employees
constituted about 37.3 percent of all personal credit end of 2014. In addition, general economic conditions affect the
ability of individuals to meet outstanding payments due dates.
Credit granted to the resident private sector is distributed between corporates and personals, in addition to that
granted in the form of credit cards. Additionally, a limited portion is extended to non-profit institutions serving households and inactive overdraft facilities. Credit granted to resident corporates (including non-profit organizations)
amounted to about USD 1550.2 million, increasing by 26.5 percent over 2013 to represent about 42.7 percent of total
credit granted to resident private sector, compared with 39.9 percent in 2013. Credit granted to corporates from local
banks rose from 30.5 percent in 2013 to 33.3 percent in 2014, while credit from foreign banks rose from 24.0 percent
to 29.8 percent, for the same period. Credit granted to corporates includes investment loans and short-term loans
Chapter Four: Banking Sector Exposure
41
(overdraft). The former constituted about 77.1 percent of total credit granted to corporates, while the latter constituted the remaining 22.9 percent[32].
Credit granted to resident personals[33]
amounted to USD 1978.6 million by end of
Table 4-2: Credit granted to resident private sector by beneficiary,
2010-2014
(Percent)
2014, increasing by 13.7 percent over the
previous year and constituting 54.5 percent
of total credit granted to resident private
Beneficiary
2010
2011
2012
2013
2014
Corporate
36.8
42.9
37.3
39.9
42.7
previous year. This increase is mainly att-
Personal
56.4
52.6
58.8
56.7
54.5
ributable to the increase in personal credit
Credit cards
1.9
1.6
1.6
1.5
1.4
granted by local banks, growing by 24.6
Non-profit
institutions
0.0
1.0
0.6
0.5
0.4
Inactive overdraft
1.9
1.9
1.7
1.4
1.0
Total
100.0
100.0
100.0
100.0
100.0
sector as compared to 56.7 percent in the
percent to constitute about 38.1 percent
of local banks’ total credit portfolio, which
signals a mounting interest in personal
credit. Conversely, personal credit granted
Source: PMA database.
by foreign banks rose by 4.3 percent comprising 43.2 percent of their total credit portfolio by end of 2014.
Given its limited size within the banking sector, credit extended through credit cards (personal or corporate) does not
pose a significant risk to financial stability. Credit through credit cards totaled USD 49.3 million, representing about
1.4 percent of total credit granted by banks to resident private sector by end of 2014. It is worth mentioning that the
larger part of this credit is extended by local banks, amounting to USD 37.8 million.
Mortgage and housing sector
Credits granted to the mortgage and housing sector[34] increased by 6.5 percent in 2014 over the previous year, to reach
about USD 692.1 million. The used portion of loans was USD 548.8 million representing 11.2 percent of total credit
granted by banks operating in Palestine end of 2014, opposed to 11.8 percent in 2013.
Analysis of the mortgage and housing loan portfolio on the basis of bank nationality shows that loans granted by
local banks fell from 40.5 percent of total portfolio value in 2013 back to 39.5 percent end of 2014. This contraction
was to the advantage of foreign banks, with their share rising from 59.5 percent to 60.5 percent over the same period.
Credit extended to the Palestinian mortgage sector as percent of total credit, equal to 11.2 percent, is significantly
lower than the percentage in some neighboring countries, like Jordan where the ratio recorded around 23 percent, or
Israel where it recorded 47.9 percent end-2014. It is, nonetheless, close to figures in some other countries like Turkey,
with 10.1 percent, India with 13.2 percent, and Indonesia recording 15 percent end of 2014.
[32] It is worth mentioning that overdraft facilities entail higher risks than loans. For this reason, the PMA imposed certain supervisory controls, most
important of which is setting a bank’s maximum permissible limit for overdraft balance to total credit at 30 percent. Overdrafts granted to the government
and public sector institutions are excluded from the overdraft value for the purpose of calculating this ratio. Likewise, overdrafts granted with cash guarantee
are also excluded.
[33] Personal credit includes loans guaranteed by mortgages, car loans, educational loans and other consumption loans. These loans are granted against
multiple collaterals to reduce potential risks.
[34] These include all credits directed for housing purposes, for example building, buying, completing or refurbishing property, buying land for building and
living purposes, refinance or buying debt associated with housing.
42 Financial Stability Report - PMA
Concerning risks associated with mortgage and
housing loans, data show an increase in the ratio
Figure 4-8: Credit granted to mortegage sector as a
percent of total credits, 2013
of non-performing loans (NPLs) to total used loans
60
from 1.8 percent in 2013 to 2.2 percent in 2014 for
10
the same period.
8.1
it increased form 1.6 percent to 2.7 percent, over
15.0
20
10.1
2.0 percent to 2.8 percent, while for foreign banks
11.2
30
13.2
47.9
40
23.0
banks. The default ratio with local banks rose from
Percent
with foreign banks was higher than with local
47.2
50
all banks. It is notable that the default ratio’s rise
rate remained comparatively low and did not
ne
Uk
ra
i
US
A
In
d
ia
e
in
es
t
Tu
rk
ey
In
do
ne
sia
and housing loans portfolio, the sector’s default
Pa
l
Despite this rise in the default ratio for mortgage
Isr
ae
l
Jo
rd
a
n
0
Source: IMF database, PMA database, and Central Bank of Jordan database.
pose a significant threat to financial stability. On the other hand, provisions allocated to counter the portfolio’s NPLs
dropped from USD 3.9 million in 2013 to about USD 2.9 million in 2014, resulting in a drop in the coverage ratio to
24.2 percent NPLs value compared to about 41.9 percent in 2013.
Together with other supervisory and prudential measures implemented by the PMA
Table 4-3: Credit granted to private sector, 2012-2014
(Value
in
USD
Credit portfolio
and banks, these provisions
million)
Non-performing loans
Number
of loans
Value of
loans
As a
percent
of used
Loans
(%)
175.6
116
6.0
3.4%
play a pivotal role in mitigating risks associated with
Bank
Years
Number
of loans
Value of
loans
2012
7,508
234.0
the mortgage and housing
Used
loans
loan portfolio. The issuance
of Instructions No. (2/2014)
helped organize the process
2013
7,475
263.0
190.5
87
3.8
2.0%
of lending for mortgage and
2014
7,286
273.1
203.0
198
5.7
2.8%
housing purposes based on
2012
5,218
367.9
316.7
62
8.1
2.6%
2013
5,725
387.0
337.0
43
5.5
1.6%
2014
5,837
419.0
345.8
53
9.3
2.7%
2012
12,728
601.8
492.3
178
14.1
2.9%
2013
13,200
650.0
527.5
130
9.3
1.8%
2014
13,123
692.1
548.8
251
12.0
2.2%
the loan and the loan to the
real-estate appraised value
Local
Foreign
(LTV Ratio)[35], consequently
mitigating credit risks by linking loan conditions, namely
the term of the loan and the
loan to the real-estate app-
Total
Source: PMA database.
raised value (LTV Ratio), to the score of credit rating granted to a client following an accurate analysis of the credit
behaviour of a consumer. This has encouraged borrowers to conform to the contractual terms of the loan, since a
compliant borrower is more likely to attain a higher LTV ratio and a longer term for the loan. Indeed, a loan can be as
high as 85 percent of the LTV and for a period as long as 25 years, pursuant to certain requirements specified by the
[35] It is worth mentioning that during a meeting of the Central Banks and Monetary Authorities of the Organization of Islamic Cooperation (OIC) Member
States in 2014, the Governor of Bank of Indonesia, Agus Martowardojo, commended the role of the PMA with regards to the macro-prudential measures it
adopted and the monitoring of stability within the mortgage sector by linking borrowing capacities with the credit rating system through the Dynamic LTV
Ratio, which is a policy unique to the PMA amongst central banks in the Middle East. This policy has allowed the PMA to adopt a judicious supervisory policy
for the risk management of the mortgage loan portfolio in line with relevant international best practices.
Chapter Four: Banking Sector Exposure
43
instructions. Moreover, such instructions encourage clients with high risk credit scores to adjust their credit positions
and upgrade their scores to subsequently improve the chances of getting a loan.
Table 4-4: Outstanding credits to SMEs by activity, 2013-2014
SMEs sector
(Value in USD million)
By end 2014, bank credit
granted to SMEs amounSector
ted to USD 528.4 million, of
‫التسهيالت المتعرثة‬
Outstanding
loans
2013
which outstanding credit
2014
2013
Number
2014
value
Number
value
constituted USD 398.2 milli-
constructions
39.5
49.2
31
6.5
38
8.3
on, dropping by around 18.9
Commerce
293.4
195.2
361
38.1
250
24.1
percent from the previous
Industry
40.6
38.6
58
3.9
49
3.9
year. Moreover, outstan-
Agriculture
18.0
7.8
43
1.1
36
2.4
ding SMEs credits constitute
Public administrations
45.1
34.1
75
2.6
39
0.9
about 8.1 percent of total
Public sector
3.4
21.6
12
0.0
5
0.0
credit granted by banks by
Financial sector
2.9
0.8
6
2.2
2
0.1
end of 2014. This figure refle-
Personal & consumption 32.3
48.5
144
5.8
123
8.5
cts the modest level of credit
Tourism
16.3
2.5
16
1.7
2
0.8
extended by banks to this
Total
491.3
398.2
746
62.1
544
49.0
vital economic sector.
Source: PMA database.
Despite the modest volume, bank credit remained the main source of funding for SMEs. By end of 2014, bank credits
constituted around 87.7 percent of total credit extended to these enterprises, which amounted to USD 453.9 million.
Specialized lending institutions[36] were the second most important financier of SMEs, funding the remaining credits.
Consequently, banks are more prone to credit risks associated with SMEs lending, given that income sources for these
enterprises are irregular and, to a great measure, affected by political and security developments.
economic activity in Palestine and in other Arab
8.2
8.6
10.6
8.6
16.8
23.8
6.8
Mexico
1.9
Chile
Venezuala
Russia
Turley
G.Britain
India
Indonesia
Bangladesh
2.3
Malaysia
ries. This is so despite the fact that the majority of
Palestine
general, when compared to other foreign count-
1.6
0
Eygpt
portion of economic activity represented by GDP,
0.5
5
6.7
10
the modest levels of financing offered to SMEs as a
in Palestine specifically and in Arab countries in
12.7
15
Iraq
with 2.5 percent. These figures are an indication of
Percent
was 1.6 percent or Iraq with 0.5 percent or Sudan
22.5
20
2.3 percent[37]. Yet, Palestine is better off than some
Arab countries, like Egypt where the ratio recorded
20.8
25
as per IMF latest data which reported the ratio at
Greese
tine in comparison to many countries worldwide,
Belgium
Figure 4-9: Outstanding loans to SMEs as a percent of GDP,
2013
2.5
credit extended to SMEs as percent of GDP in Pales-
Sudan
Analysis also points to the decline in the ratio of
Source: IMF database, PMA database, and Central Bank of Jordan database.
countries is primarily dependent on SMEs. Such
[36] Check Chapter Six which includes an analysis of SMEs lending portfolio by specialized lending institutions.
[37] According to SMEs database of the PMA, this ratio was 3.1 percent, dropping from 3.9 percent in 2013. It should be taken into consideration that his ratio
is affected by the definition of SME and the classification of the lending bank.
44 Financial Stability Report - PMA
modest lending is indicative of the highly conservative bank credit policies with respect to SMEs, owing to the inadequate collaterals normally provided and the high levels of risk associating with such lending in general, especially
given the current circumstances of the Palestinian economy.
Figure 4-10: Sectoral distribution of SMEs defaulters, 20132014
Analysis of credit risks associated with SMEs loan
portfolio shows the ratio of NPLs to total outstan-
70
ding SME loans was 12.3 percent by end of 2014,
2014
50
Percent
banks. From a different perspective though, it
represented about 39.3 percent of total NPLs with
banks, amounting to USD 124.8 million by the end
40
30
20
of 2014. This indicates that SMEs-associated credit
10
risks are a significant factor that should be taken
he
rs
Ot
ism
ur
n
co
ns
To
io
pt
ice
s
Se
ric
um
tu
ul
rv
re
ry
st
In
Ag
Co
remains under control and does not represent a
Co
ns
tr
m
m
uc
the banking system. Yet, the SMEs default ratio
du
n
tio
er
ce
0
into consideration when assessing credit risks for
serious threat to financial stability.
2013
60
equivalent to 1 percent of total loans granted by
Source: PMA database.
The sectoral distribution of SMEs defaulters shows that the commerce sector acquired the highest relative importance
with 61.4 percent in 2014, compared to about 49.1 percent in 2013. Personal and consumer loans sector came second
with 9.4 percent, compared to 17.4 percent, followed by the constructions and real estate sector with 10.5 percent,
compared to 16.9 percent in 2013.
Exposures to external sectors
Non-residents
Credit granted by banks operating in Palestine is concentrated in resident sectors of the local economy. The average share of these sectors from total credit granted over the period from 2010–2014 was 98.8 percent. The share of
non-resident sectors, on the other hand, did not exceed 0.5 percent of total credit granted in 2014, and 1.2 percent of
average total credit over the aforementioned period.
This also applies to a great extent to
the nationality of the lending bank, as
credit granted by local banks to non-residents during 2014 amounted to about
USD 6.6 million, representing a mere 1.0
Table 4-5: Destribution of credit portfolio by beneficiary, 2010-2014
(Percent)
Bank
Local
percent of total credit, whereas credit
granted to non-residents by foreign
Foreign
banks amounted to USD 16.3 million, or
1.2 percent of their total credit portfolio.
It is noteworthy that credit granted
to non-residents during 2014 was the
Total
Beneficiary
2010
2011
2012
2013
2014
Average
Resident
98.4
98.7
98.9
99.4
99.8
99.0
Nonresident
1.6
1.3
1.1
0.6
0.2
1.0
Resident
97.7
99.1
98.9
99.1
99.3
98.8
Nonresident
2.3
0.9
1.1
0.9
0.7
1.2
Resident
98.0
98.4
98.9
99.2
99.5
98.8
Nonresident
2.0
1.6
1.1
0.8
0.5
1.2
Source: PMA database.
lowest in eight years.
Chapter Four: Banking Sector Exposure
45
From the discussion above, it is clear that the
degree of risk associated with credit granted to
Figure 4-11: Lending and deposit rates in Palestine, 20102014
non-residents is limited and insignificant, and
15
does not represent a source of concern to financial
stability in Palestine, particularly that supervisory
granting facilities to non-residents. Foremost
among these measures is the stipulation, according to Instructions No (5/2008), that such faci-
2012
2013
2014
5
0
lities should be deployed exclusively in Palestine
Loans
within a scheme to encourage investment. Also,
Deposits
Loans
JD
they could only be extended provided adequate
collaterals are presented and set aside, in case of
2011
10
Percent
measures govern and control the mechanism of
2010
Deposits
Loans
USD
Deposits
NIS
Source: PMA database.
cash collateral, or registered to the bank, in case of in-kind collateral. Otherwise, any credit granting will require the
PMA’s prior written approval.
Interest rates
In light of the absence of a national currency, the PMA advocated a policy of non-intervention with respect to determining interest rates, allowing rates to move with the markets, as dictated by the bank’s internal policy and inter-bank
competition. On these grounds, the Palestinian banking sector remained exposed to risks associated with exchange
rate fluctuations in the main currencies in circulation (USD, JD and NIS), specifically for the deposit rate which is
far more sensitive to interest rate cuts due to hedging policies with regard to depositing surplus liquidity in these
currencies in banks abroad, particularly in currency-issuing countries. Lending rates, on the other hand, tend to be
more sensitive to rate hikes.
Analysis of lending and deposit interest rates for
2014 showed that the spread (difference) between
Figure 4-12: Currency composition as a percent of banks
assets in Palestine, 2010-2014
the lending and deposit rates improved compared
50
to 2013, dropping from 6.9 percent to 5.6 percent
interest rate (check Chapter Three) dropped from
7.9 percent in 2013 to 6.7 percent in 2014, or by
1.2 percentage points. This reflects the relatively
enhanced efficiency of financial intermediary
within the banking system, as inter-bank competitiveness heightened in light of several measures
Percent
the NIS. In general, the spread for the compound
JD
2010
2011
NIS
Others
40
for the USD, from 7.1 percent to 7.0 percent for
the JD and from 10.3 percent to 9.5 percent for
USD
30
20
10
0
2012
2013
2014
Source: PMA database.
and policies adopted by the PMA. Some of these measures were related to bank merger processes and the creation of
larger and competing bank entities; geographical dispersion and financial inclusion as well as credit bureau which
bolstered prompt and efficient credit decisions, in addition to many other relevant policies and decisions. However,
despite the relative improvement, the net interest margin for Palestine remains the highest in comparison with other,
particularly neighboring, countries, as previously elaborated in Chapter Three.
46 Financial Stability Report - PMA
Exchange rates
Exchange rate risks are one of the major risks
threatening the Palestinian economy, in general, and the banking system, in particular, as a
Figure 4-13: Annual change in USD exchange rate against
NIS, 2010-2014
10
8
in the USD/NIS exchange rate (and likewise JD/
6
NIS rate) have a particular impact on the gover-
4
nment budget, and therefore, the economy and
financial system as a whole. This is so because
Percent
result of the multiple currency system. Changes
2
0
the government receives international grants in
2-
foreign currencies (mostly the USD and the EUR),
4-
while the bulk of its expenditures is in NIS (ma-
6-
inly wage and salary expenditures). Inevitably,
8-
exchange rate fluctuations cast their influence
Source: PMA database.
on the budget deficit.
2010
2010
borrowed from the banking system. As such, the
2014
2011
2012
2013
2014
60
Percent
domestic debt (about 70 percent) and exposed
2013
80
tes affect the value of public debt especially that
driver for public debt fluctuation, since most
2012
Figure 4-14: Credit structure by currency, 2010-2014
On the other hand, changes in the exchange ra-
USD/NIS exchange rate is regarded as a major
2011
balances with banks are in NIS, as previously
40
20
elaborated.
0
With respect to the banking industry, banks constantly attempt to align its assets and liabilities
USD
JD
NIS
Others
Source: PMA database.
with the different currencies, and take prudential
measures against exchange rate risks, especially
Figure 4-15: Deposits structure by currency, 2010-2014
that the USD accounted for about 42.4 percent
50
of total assets end of 2014, whereas assets in JD
2010
It is worth noting that, the USD/NIS exchange
rate (and likewise the JD/NIS) witnessed acute
fluctuations in the past years amidst a state of
uncertainty. Despite tending to rise markedly in
2014Q4, the USD/NIS rate recorded an average an-
Percent
26.6 percent. The remaining currencies accounted
for about 3.6 percent of total assets.
2011
2012
2013
2014
40
accounted for about 27.4 percent and in NIS about
30
20
10
0
USD
JD
NIS
Others
Source: PMA database.
nual drop of about 0.9 percent compared to 2013.
Chapter Four: Banking Sector Exposure
47
This fluctuation significantly impacted the currencies’ relative importance for both credit and deposits. Thus, credit
in NIS to total credits dropped from 33.7 percent in 2013 to 29.5 percent in 2014. This decline was for the advantage of
both the USD and JD, resulting in a rise in credit in USD from 55.0 percent to 58.0 percent, and a rise in the share of
the JD from 10.5 percent to 11.9 percent. The share of remaining currencies stood below one percent of total credits.
Likewise, customers’ deposits underwent certain changes on the grounds of exchange rate fluctuation. The relative
importance of deposits in NIS rose from 29.0 percent in 2013 to 30.8 percent in 2014. Similarly, the relative importance
of deposits in JD rose slightly from 25.4 percent to 25.7 percent. These increases were at the expense of the relative
importance of deposits in USD, which dropped from 41.7 percent to 39.7 percent, and the remaining currencies, which
dropped from 3.9 percent to 3.7 percent.
Placements abroad
The value of banks’ placements abroad[38] increased by 8.4 percent end of 2014 compared to 2013 to total USD 3,822.1
million, constituting around 39.6 percent of total deposits (customers’ deposits + bank deposits + PMA deposits)
against 38.2 percent in 2013. Despite this slight increase, this percentage remained below the maximum limit set by
the PMA at 55 percent.
In terms of nationality, local banks’ placements
abroad constituted about 29.6 percent, totalling
USD 1,402.5 million, and representing 24.9 percent
Figure 4-16: Blacements abroad as a percent of total
deposits, 2010-2014
60
of total local banks’ assets by end of 2014. On the
50
other hand, placements abroad for foreign banks
cent of their total deposits, totalling USD 2,419.6
million, or the equivalent of 40.7 percent of total
foreign banks’ assets. On one hand, these ratios
signal the mounting attractiveness of deposit
investment in the local economy to local banks,
thereby fostering economic activity. This is so to a
lesser degree for foreign banks which still prefer
40
Percent
operating in Palestine constituted about 49.2 per-
30
20
10
0
2010
2011
2012
2013
2014
Source: PMA database.
to deploy their deposits abroad. On the other hand, these ratios imply that foreign banks are more susceptible to
external threats than local banks.
As a result of diversification, risks associated with placements broad also vary, as they relate to exchange rate and
interest rate risks, country risks, or market and economic risks in general. Balances placed abroad accounted for the
largest share of total placements (74.3 percent), amounting to USD 2,839.8 million. Thus they represent the main
contagion channel of external risks, exposing the Palestinian banking sector to external banking and financial crises. The second contagion channel is banks’ investments abroad, which mainly concentrate in the form of different
securities comprising 24.2 percent, amounting to USD 926.2 million. This channel reflects the risks and fluctuations
that may face global stock exchanges and financial markets. Yet, this channel’s impact remains less hazardous than
[38] According to PMA instructions No. 5/2008, article 5/7, placements abroad are defined as “cash balances deposited with banking financial institutions
outside Palestine, in addition to investments, whether in financial markets or as credit granted to be exploited abroad and include certificates of deposit,
bonds issued by foreign governments or institutions, investment in stocks of foreign companies, foreign investment funds and syndicated loans and any other
facilities extended for the purpose of investment outside Palestine”.
48 Financial Stability Report - PMA
that of the first channel. The third contagion channel is the channel of credit extended outside Palestine, comprising
about 1.5 percent of total placements and amounting to USD 56.1 million, which is a generally modest percentage
that does not pose any grave threat to financial stability, especially in light of the controls imposed by the PMA on
credit abroad, which requires PMA pre-approval.
In general, historical data on placements abroad point to a gradual downturn, and subsequently, a decrease in the
exposure of the Palestinian banking sector to external risks, as opposed to an upturn in the exposure to local risks,
especially that the decline in placements abroad was accompanied by a rise in domestic credit as a result of PMA
policy to reinforce the banking sector’s role in economic development. On the grounds of this policy, credit as percent
of customers’ deposits followed an upward trend to reach 54.8 percent by end of 2014 from 31.1 percent in 2008, whereas placements abroad as percent of total deposits fell to 39.6 percent from about 56.1 percent over the same period.
Credit gap
The credit gap is defined as the difference
between the actual credit-to-GDP ratio and its
long-term trend[39]. Gauging this gap provides
Figure 4-17: Blacements abroad and credit facilities, 20102014
60
an early warning indicator to predict potential
55
is primarily intended to protect banks against
50
excessive lending and the associated credit and
default risks.
It is worth mentioning that the computation of
the credit gap depends on a group of factors;
most important of which is the availability of
long time-series of data, the calculation method
of average credit to GDP ratio on the long-run and
its susceptibility to economic shocks, in addition
Percent
risks of banking crises. The credit gap indicator
56.1
50.9
48.4
45
43.5
42.4
40
54.8
54.0
35
39.6
38.2
36.8
30
2010
2011
2012
Blacements/total deposits
2013
2014
Credits/customer deposits
Source: PMA database.
to measurement errors. In this context, analysis for 2014 shows a pronounced private sector credit gap increase, especially during Q4, when the gap reached about 3.34 percent compared to about 1.60 during the previous quarter[40],
against a growth of -0.10 percent from the corresponding quarter of 2013. This ratio exceeds that set in the requirements of Basel III at 2 percent.
The rise in the gap at the end of 2014Q4 is attributable to the implications of the Israeli aggression against Gaza
Strip, which resulted in the upsurge in credit granted to the Strip during that quarter by 12.5 percent over the previous quarter. Furthermore, the relative importance of credit granted in GS on annual basis rose from 11.0 percent
end of 2013 to 11.7 percent end of 2014. This hike comes on the grounds of unprecedented policies endorsed by the
PMA to alleviate the suffering of Gazans. Shortly after the cessation of the aggression, the PMA issued a circular[41]
which required banks to postpone borrowers’ due payments in all banks operating in GS. Pursuant to this circular,
[39] For further details on the computation methodology and definition of credit gap, check the following:
Bank of International Settlements, “Guidance for national authorities operating the countercyclical capital buffer”, Basel Committee on Banking Supervision,
December 2010.
[40] It must be noted that the time-series used to compute the credit gap is relatively short in the Palestinian case, which may affect the precision of the
calculations. Additionally, the value of the indicator changes with the change in period for which the indicator is computed.
[41] Circular No. (135/2014) dated August 28, 2014.
Chapter Four: Banking Sector Exposure
49
outstanding loan payments due dates (from individuals, institutions and companies) were shifted forward in time
by 6 months, starting from the beginning of the aggression in July 2014 until the end of 2014. Any fees or additional
interests accrued on delayed payments were waived. Additionally, banks were exempt from setting aside provisions
required to counter delayed payments and also from the prepayment requisite equal to 10 percent of the value of
postponed payments to be rescheduled.
Figure 4-18: Credit gap of the Palestinian private sector, 2010-2014
8
Credit gap
6
Growth rate (right)
20
4
10
2
0
0
-10
-2
-4
-20
-6
-30
2013
Q3
Q1
Q3
2012
Q1
Q3
2011
Q1
2008 2009 2010
Q3
Q1
Q3
Q1
Q3
Q1
Q3
2006 2007
Q1
Q3
Q1
Q3
2004 2005
Q1
Q3
Q1
Q3
2002 2003
Q1
Q3
Q1
Q3
Q1
Q3
Q1
2001
Percent
Percent
30
2014
Source: PMA database.
On the other hand, studies[42] suggest that a weak relation exists between the credit gap and real GDP, as the correlation
is influenced by the size of the gap and the economic and financial crises faced by relevant economies. Correlation is
negative when the credit gap is small and when no measures were implemented to alleviate the impact of shocks.
Similarly, it is negative for periods that follow economic and financial crises. For remaining cases, the relationship is
either positive, or non-existent. In the case of Palestine, available data show a weak but negative correlation between the credit gap and real GDP (correlation factor equal to -0.196). This is attributed, as illustrated in figure (4-18) to
the modest size of the credit gap in addition to the multiple economic and political crises that have impacted the
Palestinian economy, last of which was the Israeli war against GS mid-2014.
Box 2: Crisis management during the war on Gaza Strip in 2014
From the beginning of the Israeli aggression against GS commenced on July 8, 2014, the PMA set up a crisis management cell that worked around the clock, during and after the war. With full concordance and cooperation
with banks and the Association of Banks in Palestine (ABP), a number of measures were implemented during the
aggression to safeguard the soundness of the banking system’s assets and banking service continuity to citizens
during the war, paramount during periods of seize-fire. Within the context of preserving business continuity of
banking services during the war, the following measures were implemented:
• Enactment of bank business continuity plans and convening consultancy meetings on a daily basis.
• Supplying branches with necessary means to ensure business continuity (electrical generators, fuel).
• Provision of sufficient liquidity in advance of the crisis.
[42] Drehmann M. and Tsatsaronis K. “The credit to GDP gap and countercyclical capital buffers: questions and answers”. BIS Quarterly Review, March 2014.
50 Financial Stability Report - PMA
• Distributing cash across branches in case of emergency and avoiding cash concentration at near-border branches.
• Feeding ATMs with cash as required and ensuring adequate liquidity.
• Ensuring the possibility of cash withdrawal from different PoS.
• Reinforcing security and safety procedures.
• Timely decision-making (working hours and closure of branches in periods of seize-fire as agreed upon).
• Appointment of a spokesperson for each bank.
• Constant deliberations before issuing statements to the media.
• Publishing press-releases to reassure the public.
• Offering directions to customers seeking banking services, and identifying the bank branches and offices and
ATMs to be visited during the war.
• Facilitating relief operations.
On the other hand, the PMA made important decisions to organize banking with regards to clearance, payment
and settlement systems and credit rating. These were as follows:
• Suspending the collection of bounced checks fees from check issuers.
• Suspending credit rating using the bounced check system.
• Suspending credit rating for borrowers (individuals, companies and institutions).
• Waiving conditions on mortgage loans for loans obtained through credit rating based on the LTV ratio.
• Granting borrowers wider-ranging allowances by raising the ratio of monthly installments to total income from
50 percent to 65 percent.
• Postponing installments due for private, corporate and institution debtors until the end of 2014.
• Suspending the collection of delay fees on postponed installments.
• Issuing instructions to banks and money changers that specify the exchange rates for the main currencies in GS
according to the globally prevalent rate with a 100 points margin a day (1 NIS only). Otherwise the transfer is to
be paid to the beneficiary in the original transfer. The PMA warned that appropriate action will be taken against
non-compliant banks and money changers in order to protect the rights of citizens.
Once hostilities against Gaza Strip ceased, the PMA carried forward its efforts to alleviate the suffering of Gazan
citizens. Out of the deeply-rooted commitment of the PMA and the banking system to their social responsibility, an
unprecedented measure was implemented. Accordingly, based on understandings between the PMA and the banks
operating in GS and for the period extending from the beginning of the war in July 2014 until end of 2014, bank
administrations were required to delay the collection of all outstanding loan installments due or to-be-due within
the aforesaid period. This was to apply to personal, corporate or institutional loans, provided the delay is requested
by the borrower in writing. The request was to be accepted even in the case the guarantor’s written approval could
not be obtained. At the same time, no extra fees or additional interest were to be charged on the delayed loans. The
PMA also announced that it would look favorably into exempting banks from setting aside necessary provisions
to counter deferred loan instalments under the above-mentioned conditions. It also exempted banks from the
pre-requisite of a 10 percent payment for the rescheduling of delayed installments, as per the related circular issued
by the PMA to banks. To further support banks in this process, the PMA reduced the risk reserves from 2 percent to
1.5 percent in order to boost profitability of banks and help preserve their financial positions.
Chapter Four: Banking Sector Exposure
51
Additionally, the PMA issued a special circular specifying the check collection mechanisms at the clearing room in
GS for settlement by banks in accordance to maturity dates, starting from the beginning of the Israeli aggression.
The first five days of clearing room operations were dedicated solely to sort problems regarding bounced checks.
Following this period, the checks were presented for clearing according to their due dates distributed over several
clearing sessions to give branch management, the check issuer and beneficiary the appropriate time allowance
to adjust their situations and thereby evade the creation of a liquidity crisis. The PMA emphasized the need to
operate in accordance to the previously issued circulars at the beginning of the Israeli aggression which stipulated
that no bank fees were to be charged on bounced checks drawn on any customer account. The PMA also confirmed
the continued suspension of the customer rating, whether individuals, companies or institutions, by the bounced
checks system until further notice, to facilitate the return of merchants and business owners to usual business
after the aggression had ceased.
On a related note, following the recent war on GS, the PMA launched an initiative in collaboration with the World
Bank Group to establish a small enterprises loan insurance fund to help revive economic activity in GS. The initiative
takes into consideration the fact that such facilities constitute a major instrument which is capable of addressing
the SMEs financing gap through developing specifically-tailored banking instruments that help SMEs overcome
challenges brought about by war, while encouraging the banking system to assume its role as a main driver of the
economy in line with sound banking standards. It is anticipated that the initiative implementation will commence
in 2015.
52 Financial Stability Report - PMA
Chapter Five
Financial Soundness Indicators
Overview
Financial Soundness Indicators (FSIs) are regarded as tools of great prominence in macroprudential analysis of financial systems. According to IMF methodology, these indicators
are divided into two main groups: the first is the set of core indicators, and the second
is the set of encouraged indicators. FSIs are also generally divided into four sub-groups:
capital adequacy indicators, asset quality indicators, liquidity indicators, and earning and
profitability indicators. The analysis of developments in these indicators over time reflects
the health and robustness of the banking sector during the period of analysis, and allows
forecasting of some of the potential risks and taking appropriate measures.
The PMA gives particular attention to these indicators, among others. It computes their
values for the Palestinian banking sector on a regular basis, to precisely determine the level
of financial safety and identify potential risks that might surround the Palestinian banking
system. In this context, the FSIs analysis showed positive results in general, in light of the
judicious policies and regulations pursued by the PMA. However, banking sector remains
vulnerable to external risks and shocks like the rest of the economy’s sectors. This chapter
deals with the analysis of these indicators and the prominent risks surrounding Palestinian
banking sector during 2014.
Capital adequacy indicators
The PMA dedicated special attention to strengthening the financial positions of banks operating in Palestine by boosting bank capital, as the first line of defense, thus enabling financial institutions to withstand shocks. This comes as
part of a PMA plan intended to make the banking system more immune and capable of withstanding both expected
and unexpected potential risks. Such a feature becomes especially crucial in light of volatility and uncertainty that
prevail in the endogenous and exogenous environment. Clearly, the plan’s other goal is to boost bank competitiveness, both locally and abroad.
By the end of 2014, paid-up capital increased by 5.2 percent compared with 2013, to reach USD 976.0 million. This
raised its importance in the ownership equity and liabilities structures to 66.7 percent and 8.3 percent, respectively.
The strengthening of bank capital has reflected positively on the banks’ ability to absorb the expected and unexpected
losses that can extend to depositors’ and lenders’ money. In its future plans, the PMA seeks to further raise banks’
capital to reach USD 100 million, within the plan of promoting banking and financial stability and raising bank competitiveness in Palestine[43]. The most prominent indicators that measure the capital risk include:
[43] In this context, it is worth noting that the paid-up capital of two of the banks operating in Palestine has exceeded USD 100 million in 2014.
Chapter Five: Financial Soundness Indicators
53
Regulatory capital to risk-weighted assets (capital adequacy ratio)
By end 2014, the capital adequacy ratio measured
Figure 5-1: Capital adequacy ratio, 2010-2014
for all banks operating in Palestine was 18.9 per-
25
cent compared with 20.0 percent at end 2013. This
24
ratio is considered a leading indicator of financial
increase in capital base, the former growing by 15.1
19
17
16
the previous year.
ratio remained above the minimum limit set by the
21
20
18
percent and the latter by 9.1 percent compared to
Despite this marginal decline, the capital adequacy
Foreign banks
22
Percent
rease in risk-weighted assets that outpaced the
Domestic banks
23
stability in the financial system characteristics
matrix. This slight drop is attributed to an inc-
All banks
15
2010
2011
2012
2013
2014
Source: PMA database.
Basel Committee (8 percent) and the PMA (12 percent). Moreover, it stands as one of the best capital adequacy ratios
internationally, as capital ratio recorded 17.9 percent in Saudi Arabia, 15.9 percent in Turkey, 16.8 percent in China
and 14.3 percent in Israel, end of 2014[44]. As for banks it Egypt[45], it reached 13.0 percent, while for banks in Jordan, the
ratio amounted to 17.4 percent on 30 June 2014[46].
In terms of nationality, the capital adequacy ratio in Palestine continued to show disparity between local and foreign
banks by end 2014, averaging 16.3 percent for the former against 21.7 percent for the latter. It is also observed that the
aforementioned disparity between the two bank groups is constantly widening as greater risk-weights are given to
high-risk assets of local banks that fall within a risk-weighting category of 70 percent and above, hence constituting
41.0 percent of total risk-weighted assets as opposed to 32.9 percent for foreign banks. This category of high-risk
assets incorporates supervised credit, non-performing loans in addition to the fixed assets. Through raising capital
levels, encouraging mergers, and expanding reserves, the PMA continuously seeks to reinforce bank capital base, in
general, and the capital base for local banks, in specific, in a manner that bolsters their risk-withstanding capacities.
Nonperforming loans
(less provisions) to core capital
During 2014, the ratio of non-performing loans
Figure 5-2: NPLs (less provisions) as a percent of core
capital, 2010-2014
7
(less provision) to capital showed an improvement
by dropping to 4.0 percent compared to 4.7 percent
In terms of nationality, this ratio exhibited dispa-
Percent
3
2
all banks, local and foreign banks alike. By end of
1
2014, local banks registered a ratio of 5.9 percent
0
banks registered 2.3 percent, compared to 3.3 percent for the same period.
[44] International Monetary Fund, www.imf.org
[45] Central Bank of Egypt, www.cbe.org.eg
[46] Central Bank of Jordan, www.cbj.gov.jo
54 Financial Stability Report - PMA
Foreign banks
4
rate results, albeit following a downward trend for
compared to 6.5 percent in 2013, whereas foreign
Domestic ban
5
in 2013. This reflects the enhanced capacity of capital to cope with credit risk.
All banks
6
2010
Source: PMA database.
2011
2012
2013
2014
Core capital to total assets
The ratio of core capital to total assets[47] shows the extent to which a bank’s core capital covers total assets. This ratio
is set at a minimum of 3 percent by Basel standard requirements. For Palestine, this ratio registered 10.1 percent for
all banks end of 2014 compared with 10.0 percent end of 2013.
With respect to bank nationality, this ratio was 9.7 percent for local banks compared to 9.9 percent in the previous
year, whereas, for foreign banks, it was 10.5 percent compared to 10.1 percent from the same period. These figures are
considered satisfactory when it comparison with some other countries as, for example, Israel recording 7.1 percent
end of 2014, Jordan 12.5 percent end of 2014Q2, Turkey 11.3 percent end of 2014Q3 and Algeria 7.5 percent end of 2013[48].
Asset quality indicators
The assessment of asset quality is of great
Figure 5-3: Core capital to total assets, 2010-2014
significance being directly related to credit risks
13
fully meet obligations (interest, loan principal
12
or both) on time, which may result in a finan-
11
cial loss adversely affecting bank earnings and
10
capital. Asset quality can be inferred from a set
of indicators, most notably the following:
Non-performing loans
(NPLs) to total loans
This ratio is regarded as a one of the most significant asset quality indicators reflecting the risk
degree assigned to the credit portfolio, given that
Percent
that arise due to the customer’s inability to
All banks
Domestic banks
Foreign banks
9
8
7
6
5
2010
2011
2012
2013
2014
Source: PMA database.
it is normally closely linked to economic and political developments, and in the Palestinian case, to fiscal developments. In view of inconsistent government revenues,
payment of outstanding loans extended to civil servants depends on the regular payment of the civil service salary
bill. To a certain degree, payment of outstanding loans extended to private-sector commodity and service suppliers
to the government also depends on the government meeting its obligations towards these companies and suppliers.
Since government payments are, in turn, dependent on fiscal stability, any fiscal turbulence may compromise the
ability of both civil servants and private sector suppliers to meet their obligations to banks.
Despite unfavorable economic developments occurring over the year, the ratio of NPLs to total loans continued on
a downward path, declining to 2.5 percent from 2.9 percent in 2013. This figure is regarded as low when compared
to other countries, like Jordan and Egypt, for example, where the recorded ratio was 7.0 percent and 9.1 percent,
respectively, at the end of 2014Q2. In Israel the ratio was 2.2 percent by end of 2014 and reached 2.8 percent in Turkey
by end of 2014Q3, while in Algeria and Lebanon it recorded 10.6 percent and 4.0 percent, respectively, by end of 2014.
[47] This is regarded as a financial leverage ratio which was previously used to assess bank capital adequacy, prior to Basel Committee standards. One of its
disadvantages is that it does not take into account the various risks associated with the different types of assets. The capital in the numerator stands for the
core capital or Tier 1capital. According to Basel III requirements, this ratio has to equal or exceed 3 percent.
[48] Financial Stability Indicators, IMF website, www.imf.org
Chapter Five: Financial Soundness Indicators
55
This decline in the ratio of NPLs in Palestine was
Figure 5-4: NPLs to total Loans, 2010-2014
concomitant with an ongoing growth in total cre-
6.5
dit, increasing by 9.3 percent in 2014, compared
to 6.7 percent in 2013. This low figure reflects the
Percent
database established by the PMA.
Domestic banks
Foreign banks
5.5
enhanced efficiency of credit-decision making,
in view of the steady improvement in the credit
All banks
4.5
3.5
Moreover, this ratio declined for both local and
foreign banks operating in Palestine. For local
banks, it dropped from 2.3 percent in 2013 to 2.1
percent in 2014 and for foreign banks from 3.5
percent to 3.1 percent.
In a related context, structural analysis of NPLs,
based on default time periods, shows the subdu-
2.5
1.5
2010
120
hile, loans classified as losses dropped from 82.8
80
Percent
total NPLs, to reach 10.2 percent in 2014. Meanw-
culminated by end of 2014 in the launch of version
III of this system, which is characterized by wider
2010
2012
2013
2014
Figure 5-6: The structure of NPLs in foreign banks, 2010-2014
120
80
Percent
rulings related to banking lawsuits and other
leasing companies, and real-estate developers.
2011
Source: PMA database.
data disclosure, including the disclosure of court
institutions, such as retailers, utility companies,
Losses
0
100
information with regards to some private sector
Doubtful
20
to the remarkable merits of the credit informati-
PMA’s strenuous efforts to develop this system
Substandard
40
The improvement of the ratio of NPLs is attributed
and improved the credit portfolio quality. The
2014
60
compared to 7.0 percent in 2013.
on system, which markedly reduced credit risks
2013
Figure 5-5: The structure of NPLs in foreign banks, 2010-2014
100
opposed to a hike in doubtful loans to 8.4 percent
2012
Source: PMA database.
ed relative importance of substandard loans[49] to
percent in 2013 to reach 81.4 percent in 2014, as
2011
Substandard
Doubtful
Losses
60
40
20
0
2010
2011
2012
2013
2014
Source: PMA database.
[49] Based on PMA instruction No. (1/2008), loans which are 91 to 180 days overdue are classified as substandard loans and require provisions of 20 percent
of their value; loans which are 181 to 360 days overdue are classified as doubtful loans and require provisions of 50 percent of their value and loans overdue by
more than 360 days are classified as losses and require provisions of 100 percent of their value.
56 Financial Stability Report - PMA
Sectoral distribution of loans
This indicator reflects the degree of concentration in credit granted to various sectors. A high volume of credit granted to a particular sector increases the degree of risk to which the banking sector is exposed, as the ability to repay
loans is linked to economic developments and the unforeseen fluctuations and changes associated with that sector.
Figure 5-7: Sectoral concentration of credits, 2010-2014
40
ration, with the exception of the public sector,
which accounted for about 25.3 percent of total
2014
rs
he
Ot
od
s
g
Go
er
um
Co
ns
rs
fin
an
cin
ice
s
re
rv
Se
Ca
accounted for most of the credit. The ratios of
credit granted to these sectors ranged between
tu
Ag
Co
m
ric
ul
m
er
st
ce
ry
ns
In
du
or
tio
ct
se
ic
bl
Pu
land development, in addition to consumer loans
2013
0
concentration ratios shows that the sectors of
trade; services[51]; real-estate, construction and
2012
10
by related PMA instructions[50]. Analysis of sectoral
uc
ined below 20 percent of total credits as required
2011
20
tr
2013. Concentration ratios in other sectors rema-
Percent
credit granted, compared with 30.7 percent in
2010
30
ns
lestine points to the absence of sectoral concent-
Co
In general, the sectoral credit distribution in Pa-
Source: PMA database.
18.8 percent for financing of consumer goods, 17.0
percent for real estate and construction (including land development), 15.2 percent for general trade, 10.1 percent for
services, 5.3 percent for industry and 4.0 percent for other services. Meanwhile, the share of the agriculture sector
stood at around 0.9 percent of the total credit granted in 2014.
Coverage of non-performing loans
This ratio shows the extent to which NPLs are
Figure 5-8: Provision coverage for bad loans, 2010-2014
75
covered by provisions. A rise in this ratio is a sign
of the enhanced capacity of banks to withstand
70
king sector, hence a higher degree of financial
stability. Analysis of consolidated data for all
banks operating in Palestine points to a small
increase in the rate of coverage of NPLs by provisions from 58.8 percent in 2013 to 61.4 percent
end of 2014, signaling a relative improvement in
the capacity of banks to face potential losses in
the credit portfolio.
Percent
and cover credit risks that may threaten the ban-
65
60
55
50
2010
2011
2012
2013
2014
Source: PMA database.
[50] According to PMA Instructions No. (5/2008) dated 29 December 2008, article 5/6/1, the ratio of granted (outstanding) credit to any economic sector must
not exceed 20 percent of total granted (outstanding) credit.
[51] For the purposes of this analysis, the services sector includes tourism-related services, restaurants, freight transport and transportation and securities
financing.
Chapter Five: Financial Soundness Indicators
57
Earning and profitability indicators
During 2014, net income (before tax) for banks operating in Palestine recorded a decline by 2.5 percent over the previous year, to reach the level of USD 196.1 million. Several indicators are used to evaluate a bank’s ability to generate
profit, to effectively manage resources and improve utilization in order to realize profits. These indicators are directly
proportional to the degree of banking safety, as higher earnings and profitability boost the ability of equity to counter
the effects of asset risks. The most important earning and profitability indicators are the following:
Return on average assets (ROAA)
By end of 2014, the ROAA for banks operating in Palestine fell back to about 1.7 percent from 1.9 percent in the previous year. It is notable that this ratio receded for all banks, local and foreign alike, during the year as compared with
2013. The ratio dropped from 1.8 percent in 2013
to 1.6 percent in 2014 for local banks, and from
2.1 percent to 1.8 percent for foreign banks, for
Figure 5-9: Return on average assets (ROAA), 2010-2014
2.5
All banks
Despite this decline, the ROAA for Palestine remains high and satisfactory when compared with
some countries in the region. In Jordan and Egypt,
for example, the ROAA recorded 0.7 percent and
Percent
the same period.
Domestic ban
Foreign banks
2
1.5
1.0 percent by end of 2014Q2, respectively, while
ROAA for Israel was 0.8 percent and 2.5 percent
1
2010
for Saudi Arabia by end of 2014. Likewise, in Turkey, it recorded 1.7 percent end of 2014Q3 and in
2011
2012
2013
2014
Source: PMA database.
Lebanon 1.2 percent end of 2013.
Return on average core capital (ROAE)
ROAE dropped for all banks operating in Palestine
Figure 5-10: Return on core capital (ROAE), 2010-2014
from 18.7 percent in 2013 to 17.2 percent in 2014.
30
This decline affected both local and foreign banks.
While ROAE declined for local banks from 17.0
Percent
percent over the same period.
Domestic ban
Foreign banks
25
percent in 2013 to about 16.9 percent, ROAE for
foreign banks declined from 20.1 percent to 17.4
All banks
20
15
Nonetheless, these figures scored well compared to countries of the region, as for example in
10
Jordan and Egypt, where it recorded 5.8 percent
and 14.5 percent, respectively. As for Israel, it
recorded 11.7 percent and 18.2 percent for Saudi
Arabia, end of 2014. Turkey recorded 15.2 percent
end of 2014Q3, and Lebanon’s ROAE reached 14.1
percent end of 2013.
58 Financial Stability Report - PMA
5
2010
Source: PMA database.
2011
2012
2013
2014
Net interest income (interest margin) to gross income
Net interest income to gross income for banks operating in Palestine suffered a downturn, falling from 74.9 percent in
2013 to 72.2 percent in 2014, driven by an increase in net non-interest income by 8.1 percent of gross income, as opposed
to an increase in net interest income by 4.0 percent. This fallback was seen for both local and foreign banks, recording
about 69.0 percent for local banks, as opposed to
76.1 percent for foreign banks. However this ratio
Figure 5-11: Net interest income to total income, 2010-2014
80
remains high compared to some countries in the
region, reaching 58.2 percent in Israel and 66.5
70
percent in Turkey at the end of 2014Q3, and 65.0
percent in Lebanon at the end of 2013. In general,
this decline indicates the growth of
Percent
percent in Saudi Arabia at the end of 2014; 67.3
60
50
banking sector profits as a result of other secondary activities such as currency trading and fees
40
2010
and commissions earned on banking services.
2011
2012
2013
2014
Source: PMA database.
Non-interest expenses to gross income
The non-interest expenses to gross income indicator increased from 54.8 percent in 2013 to 60.1 percent in 2014. This
rise is attributed to a growth in operational expenses by 17.1 percent from 2013 to reach about USD 294.5 million. The
growth in operational expenses was due to an increase in employee-related expenses by about 11.3 percent. In spite
of this rise, employee expenses as percent of total operational expenses dropped to 52.3 percent from about 55.0
percent in 2013. As for nationality, non-interest expenses to gross income recorded about 63.1 percent for local banks
and about 57.3 percent for foreign banks in 2014.
Liquidity indicators
Liquidity indicators reflect the bank’s ability to meet expected and unexpected demands for cash or, in other words,
the availability of sufficient cash to cover depositors’ cash withdrawals and other demands for credit without being
exposed to losses resulting from the sale of any bank asset. This requires the distribution of bank resources across
diverse assets, as the main purpose of cash availability is to boost both depositor and creditor confidence. Liquidity
is also a sign of good management and an assurance of the ability of the bank to meet its obligations. The main
indicators used to gauge liquidity risks are the following:
Liquid assets to total assets
At the end of 2014, the ratio of liquid assets to total assets recorded a drop to about 35.5 percent from 39.5 percent in
2013. This slump is attributed to a rise in fund utilization in less liquid items such as credit granting and different “low
liquidity” investments with long maturity terms (exceeding one year). In spite of the fallback of this indicator, liquid
assets acquired still a satisfactory share of gross banking sector assets, in comparison with corresponding ratios for
neighboring countries. For example, it was 15.7 percent in Israel and 22.3 percent In Saudi Arabia, at the end of 2014;
49.6 percent in Turkey at the end of 2014Q3; and 22.7 percent in Lebanon at the end of 2013.
Chapter Five: Financial Soundness Indicators
59
With regards to bank nationality, a drop in this
Figure 5-12: Liquid assets to total assets, 2010-2014
ratio for both local and foreign banks can be
50
observed when compared to 2013. For foreign
All banks
Domestic ban
Foreign banks
45
banks the ratio recorded was about 36.7 percent,
Percent
compared to 42.1 percent in 2013, while for local
banks it reached about 34.0 percent in 2014,
compared with 38.6 percent a year earlier. This
analysis generally suggests that local banks are
40
35
30
more inclined to have lower liquidity balance
than their foreign counterparts, considering
25
that local banks outstripped foreign banks in
2010
credits-to-assets ratio.
2011
2012
2013
2014
Source: PMA database.
Liquid assets to short-term liabilities “regulatory liquidity”
The liquid assets to short-term liabilities ratio
Figure 5-13: Liquid assets to short-term liabilities, 2010-2014
indicates whether short-term bank liabilities
60
have maturity periods congruent to those of
All banks
Domestic ban
Foreign banks
bank liquid assets, such that a bank can meet its
obligations without being exposed to liquidity
55
Percent
crises or losses. PMA instructions require banks
to maintain a minimum of 25 percent regulatory
liquidity. This requirement reflects positively on
other liquidity ratios, pushing them within the
50
45
acceptable liquidity levels. In general, this ratio
shows a bank’s ability to cover liabilities which
40
are susceptible to rapid withdrawal at any given
2010
time and without prior notification by these
This indicator dropped during 2014 to
700
600
liquid assets. While liquid liabilities
500
USD million
increase for liquid liabilities than for
400
300
1.4 percent over the same period. With
200
respect to bank nationality, foreign and
100
respectively.
60 Financial Stability Report - PMA
Source: PMA database.
Q3
14
20
14
Q1
Q3
West Bank branches
20
Q1
20
13
13
12
Q3
20
Q1
20
3
12
20
1
11Q
20
11Q
Q3
Gaza branches
20
10
Q1
10
20
Q3
20
09
Q1
52.5 percent and 52.2 percent in 2013,
20
09
Q3
20
08
20
08
Q1
0
20
48.3 percent in 2014, compared to about
2014
800
percent in 2013 as a result of a higher
local banks recorded the same ratio of
2013
Figure 5-14: NIS cash liquidity (dollar-denominated), 2008-2014
reach 48.3 percent compared to 52.7
vious year, liquid assets increased by
2012
Source: PMA database.
liabilities’ holders
increased by 1.6 percent over the pre-
2011
On a different note, and despite defusing the liquidity crisis affecting banks operating in Palestine due to the accumulation of NIS cash surpluses, particularly in the West Bank, liquidity risks persist given Israel’s adamant violation
of signed agreements and unremitting threats of punitive economic measures against the Palestinian government.
In consequence, the liquidity crisis, which is the result of exogenous factors, remains one of many challenges facing
financial stability.
In this context, it is worth noting that during 2014, the shipment to Israel of about NIS 9 billion was authorized; of
which NIS 4.4 billion were shipped to the Bank of Israel via the Bank of Palestine and NIS 4.6 billion were shipped via
Jordanian banks operating in Palestine directly to their Israeli correspondent banks. As for GS, spoilt notes worth NIS
200 million were replaced and coins worth NIS 1.9 million were allowed into the Strip. By end of 2014, the ratio of NIS
cash liquidity to total assets of banks operating in Palestine shrank to about 11 percent, compared to about 30 percent
end of 2013; a sign that the ratio is now drawing closer to normal pre-crisis levels.
Table 5-1: NIS cash shipped from Palestine to Israel, 2013
Items
2013
2014
Banks' branches operating in WB
Direct shipping from Jordanian banks
4,740.6
4,594.9
Shipping from bank of Palestine
4,860.3
4,400.0
Total NIS surplus shipped to Israel
9,600.9
8,994.9
Shipping NIS coins to banks' branches
4.0
1.9
Replacing a damaged cash
50.0
200.0
Banks' branches operating in GS
Source: PMA.
Chapter Five: Financial Soundness Indicators
61
Chapter Six
Non-Banking Financial Institutions
Overview
One important component of the Palestinian financial system, beside the banking sector,
is the non-banking institutions, currently undergoing a process of steady development
and growth, driven by unfaltering efforts made under the supervision of the PMA and the
PCMA. The two bodies work, each within its scope of specialization, to regulate and foster
the growth of these institutions. Non-banking institutions include specialized lending
institutions and money exchange institutions, supervised by the PMA; and the Palestine
Exchange-PEX, insurance companies, mortgage companies and financial leasing companies, supervised by the PCMA. Altogether, they are considered a main creditor of various
economic sectors.
During 2014, non-banking institutions witnessed several financial and legislative developments, which had both direct and indirect effects on the financial system and economic activity in general. Examination and monitoring of these institutions is of special importance
with regards to the promotion of financial stability, as eventually banking and non-banking
institutions are interrelated, whether directly or indirectly. This chapter undertakes an
analysis of the risks associated with non-banking financial institutions during 2014 and
their impact on financial stability.
Money changing sector
By end of 2014, PMA-licensed money changers and money-changing companies rose by 3.7 percent to reach 280, of
which 237 are in the WB and 43 in GS[52]. With respect to the legal form, there were 199 money-changing companies
as opposed to 81 money changers (individuals engaging in currency exchange), with six money-changers having
rectified their legal status from individually-run businesses to companies during 2014.
At the level of regulatory development, the PMA eagerly continued to promote the soundness and stability of the
money-changing sector, as a main pillar of the Palestinian financial system during 2014. PMA efforts also extended
to raising awareness of customers, so as to safeguard them against falling victims to illegal businesses, most importantly money-laundering. To that end, the PMA issued the Anti-Money Laundering Manual for Money Changers in
line with international recommendations and
[52] In view of the expiry of the period designated to receive licensing applications as set forth in its circular released on 10 September 2013, the PMA announced
it will no longer receive applications for licensing money-changing companies or new branches starting from 10 March 2014.
Chapter Six: Non-Banking Financial Institutions
63
standards released by the Financial Action Task
Table 6-1: Money changers in Palestine, 2010-2014
Force (FATF) and the Palestinian Anti-Money Laundering Decree Law No. (9) of 2007. Additional-
Item
ly, in collaboration with the Palestinian Banking
2010
2011
2012
2013
2014
Institute (PBI) and the Financial Follow-up Unit
Corporate
95
154
173
184
199
(FFU), the specialized Palestine Anti-Money La-
Individual
165
130
103
86
81
Total
260
284
276
270
280
undering Accreditation (PAMLA) program will be
delivered to compliance officers and supervisors
in the field of the money exchange business.
Source: PMA database.
On a different note, a draft version of the instructions on compliance was prepared, incorporating the concepts of
compliance risks, procedures and conditions for the appointment and the responsibilities of the compliance officer
supervising money changers and money-changing companies. These instructions await endorsement and issuance.
Furthermore, money changers and money-changing companies were notified in Circular No. (167/2014) that they
are required to disclose any cash or unrefined precious metals that are brought into or outside the country through
crossing borders. Additionally, a new draft of the Presidential decree on the organization of the exchange profession
was prepared by the PMA and currently awaits ratification by the President.
In terms of developing tools for supervision over money changers and money-changing companies, a manual on on-site
inspections was developed to suit the nature of the money exchange business and its associated operational risks.
It included sections on the accounting systems, standard business hours instructions and instructions on detecting
counterfeit money. It is worth mentioning that a software program to activate the off-site supervision was developed.
With respect to financial developments
Table 6-2: Main financial indicators of money changers, 2011-2014
during 2014, analysis of performance indi-
Item
cators of the money-changing sector point
2011
2012
2013
2014
to a rise in the sector’s assets by about 6.7
Capital
35.9
42.7
44.5
46.4
percent compared to 2013, to reach around
Ownership equity
36.5
48.2
46.6
46.1
USD 52.9 million. Additionally, capital[53] rose
Profits
1.8
1.8
0.4
0.8-
by 4.3 percent to reach USD 46.4 million. Yet,
Total expenses
3.6
5.2
5.4
5.0
ownership equity dropped by 1.1 percent as
Current assets
35.1
46.8
47.1
49.9
a result of realized losses during 2014 which
Fixed assets
2.1
2.7
2.5
2.8
amounted to about USD 847 thousand op-
Total assets
37.0
49.4
49.6
52.9
posed to profits worth USD 394 thousand
in 2013.
Source: PMA database.
Total cash deposits and guarantees amounted to about USD 3.0 million by end of 2014, of which company insurance guarantees captured the largest share of 43.3 percent, followed by cash deposits with a 31.9 percent share. The
remaining share was divided between branching insurance guarantees with 5.4 percent, bank guarantees with 11.7
percent and transfers insurance with 7.7 percent.
[53] On 29 January 2014, the PMA board of directors made the decision to postpone until further notice the effective
raise the capital of money-changing companies (regular companies).
64 Financial Stability Report - PMA
date for the requirement to
This aforesaid review suggests
Table 6-3: Outstanding loans granted to licensed specialized linding
institutions, 2014
that financial indicators for
the money-changing sector
had an insignificant impact
and did not pose a serious risk
to financial stability, particularly in light of PMA supervisory instructions and on-site
follow-up. In contrast, the
phenomenon of unlicensed
money-changers persisted,
especially in GS. This was the
main risk associated with the
Institution
Credits
No. of
Credits value in
West Bank
Gaza Strip
FATEN
61.4
63.1
63.9
54.7
FEATAS
18.0
13.0
14.2
27.8
REEF
9.0
5.9
8.3
10.7
ACAD
5.5
5.8
6.6
2.8
ASALA
4.3
10.7
4.6
4.0
IBDAA
1.8
1.5
2.4
0.0
Total
100.0
100.0
100.0
100.0
Source: PMA database.
money-changing sector which can adversely affect financial stability, given that these money-changers engage in
practices that are deemed illegal by the PMA. Such practices include, among others, the acceptance of deposits, which
may expose citizens to crimes of fraud and deception. Therefore, to safeguard financial stability and safety, the PMA
is relentless in alerting citizens to the hazard of dealing with any unlicensed party.
Specialized lending institutions
The number of PMA-licensed specialized lending institutions[54] by end of 2014 was 5 institutions, out of 14 engaged
in the business of specialized lending. Licensed lending institutions conduct their business through a network of 63
branches (including headquarters).
At the regulatory level, the PMA carried through its work to regulate and control specialized lending institutions. In
that context, it issued in 2014 a number of new instructions intended to promote financial stability of these institutions and underpin their status within the Palestinian economy. Instructions No. (01/2014) were issued to organize
the process of granting of housing loans and mortgages using the dynamic LTV ratio, in a manner that mitigates
potential associated credit risks. This was achieved by linking the conditions of the loan or mortgage, namely the
term of the loan and the loan to the real-estate appraised value (LTV Ratio), to the credit score granted to a client.
Furthermore, the PMA issued Instructions No. (2/2014) on the classification of loans/financing and the creation
provisions. These instructions require all specialized lending institutions to create a risk reserve equal to 1 percent
of the overall credit portfolio or outstanding regular facilities. The instructions also specify different categories for
loans and nonperforming loans and the corresponding provisions to be set aside[55], as well as the procedures and
conditions of loan and facility scheduling.
On a different note, and in line with PMA efforts to reinforce supervision over specialized lending institutions and
boost their role played within the Palestinian financial system, a standardized financial and statistical report form
[54] Licensed institutions are in the process of rectifying their statuses to become either profit or non-profit organizations. The licensed institutions are: Faten,
Asala, ACAD, Reef, and Ibdaa. Later to the year of this report in January 2015, the PMA granted final license to VITAS as a specialized lending institution. In the
meantime, three other licensing applications are under examination.
[55] Based on PMA instruction No. (2/2014), non-performing loans were classified into four categories as follows: Supervised loans are loans with installments
of principal loan, interest or returns which are 31- 60 days overdue and require the allocation of provisions equal to 25 percent of the value. Substandard loans
are installments of principal loan, interest or returns which are 61-90 days overdue and require provisions of 50 percent of their value. Doubtful loans are loans
with installments of principal loan, interest or returns that are 91 – 180 days overdue and require the allocation provisions equal to 75 percent. Losses are loans
which have installments of principal loan, interest or returns more than 180 days overdue and require provisions of 100 percent of their value.
Chapter Six: Non-Banking Financial Institutions
65
(Call Report) was prepared, similar to the one used by banks. From mid-2014 onwards, the institutions began to use
this form on quarterly basis, in accordance with the manual specially compiled to facilitate and standardize the completion of financial statement preparation. Another guide on off-site analysis for the inspection of these institutions
was also developed, while a guide for on-site inspection is currently being prepared. It is expected that PMA on-site
visits to inspect the operation of specialized lending institutions will commence during 2015.
With respect to the activity of specialized lending institutions during 2014[56], the number of beneficiaries of granted
loans was about 45,517 with an outstanding loan total value of about USD 97.0 million and an average value per loan
of USD 2,141, divided between the WB, with a share of 72.3 percent, and the GS with a share of 27.7 percent. The Female
beneficiaries held a share of about 38.5 percent of this portfolio.
Faten, a licensed lending institution, captured the highest share of the activity of specialized lending institutions,
whether on the basis of number of beneficiaries, the value of loan portfolio or geographical distribution. Faten’s share of the outstanding loan portfolio was equivalent to 61.4 percent and of the number of beneficiaries 63.1 percent.
Its activity was distributed between the WB and GS, where it acquired 63.9 percent and 54.7 percent of the region’s
portfolio value, respectively. The average value of loans granted by Faten was USD 2,077. VITAS, another licensed
lending institution, ranked second and Reef third as per the ranking shown in (Table 6-3). It is worth mentioning that
Reef ranks first on the basis of the loan value, as the average loan value granted by Reef was USD 3,125, whereas the
lowest ranking was Asala with an average loan value equal to USD 882.
The credit activity distribution for specialized lending institutions points to a high degree of market concentration in
the lending business. Further to the fact that a single institution captures a 60 percent share of the institutions’ loan
market, the Herfindahl index[57] reached about 4,223 points with regard to loan value and 4,339 with regard to number of loans. Both figures strikingly exceeded the acceptable critical concentration threshold set at 1,800 points. The
index revealed weak competitiveness between the lending institutions, which calls for calculated measures to bolster
competitiveness and reduce concentration; and consequently the risk degree associated with such concentration.
Lending institutions primarily
Table 6-3: Outstanding loans granted to licensed specialized linding
institutions, 2014
depend for financing resources on domestic and external
Institution
borrowing, in addition to their
own capital. The volume of
their operations is rather small
as opposed to banking operations, rendering their impact
on financial stability relatively limited; the ratio of their
outstanding facilities to total
bank facilities did not exceed
2.0 percent by end of 2014. It
Credits
No. of
Credits value in
West Bank
Gaza Strip
FATEN
61.4
63.1
63.9
54.7
FEATAS
18.0
13.0
14.2
27.8
REEF
9.0
5.9
8.3
10.7
ACAD
5.5
5.8
6.6
2.8
ASALA
4.3
10.7
4.6
4.0
IBDAA
1.8
1.5
2.4
0.0
Total
100.0
100.0
100.0
100.0
Source: PMA database.
[56] The figures are based on the consolidated balance sheet of specialized lending institutions licensed by the PMA. Since this is the first consolidated balance
sheet, comparison with previous years was not possible.
[57] The Herfindahl Index is expressed as: H=∑i=1= (MSi)2 , where (H) is Herfindahl Index, (MSi) is bank (i)’s share of the overall variable for which concentration
is to be calculated, e.g. value of loans or number of loans. A concentration is considered high if H is > 1800 point, which is the approved threshold in the USA.
66 Financial Stability Report - PMA
is worth mentioning that the PMA encourages banks to finance specialized lending institutions through exempting
such financing from the allocation of a 9 percent required reserves.
Loans granted to SMEs
Specialized lending institutions are considered key creditors of SMEs[58], having provided around 28,050 loans with a
value of about USD 55.7 million are outstanding loans. This value represents 57.4 percent of total outstanding loans
extended by specialized lending institutions (amounting to USD 97 million by end of 2014).
The loans were diversified across different economic sectors at varying ratios. The trade sector
Figure 6-1: Credits granted from specialized lending
institutions to SMEs by sector, 2014
claimed the largest share of around 40.9 percent
of total outstanding loans to SMEs (granted by
lending institutions only), which is indicative of
Construction
1.6%
Others
1.8%
Services
& public
utilities 16.9%
a high degree of concentration conducive to a
high degree of credit risk related to that sector.
Ranking second was the agriculture sector with
Commerce
40.9%
Agriculture
22.4%
22.4 percent; public services and utilities with
16.9 percent, and industry and mining with 16.4
Industry
16.4%
percent, while construction and real-estate acquired a mere 1.6 percent and other sectors including
consumer loans and tourism 1.8 percent of total
Source: PMA database.
value of outstanding loans granted to SMEs.
On the other hand, SME non-performing loans (NPLs) amounted to USD 6.7 million by end of 2014. These loans
amounted to USD 6.7 million, representing about 12.0 percent of their SMEs outstanding loan portfolio (a ratio
close to the default ratio in the housing loans portfolio by banks equivalent to 12.3 percent). However, with respect
to total outstanding facilities granted to SMEs by banks and specialized lending institutions, the ratio of SME NPLs
constituted around 1.5 percent only, valued at USD 453.9 million by end of 2014. Subsequently, SME NPLs did not pose
a significant risk to macro financial stability, yet
they may pose risks to lending institutions, given
that about 93.5 percent of total NPLs of the SME
loan portfolio were loans granted by specialized
lending institution.
Figure 6-2: Defaults in SMEs by sector, 2014
Services &
public utilities
23.0%
Analysis of the NPL portfolio for SMEs by specialized lending institutions for 2014 showed that
the highest default ratio was by the trade sector
Commerce
46.4%
Agriculture
18.8%
at 46.4 percent owing to the high credit concentration within that sector, followed by the public
Industry
10.3%
utilities and services sector at 23.0 percent, the
agriculture sector at 18.8 percent and, ranking
Construction
0.3%
Others
1.2%
Source: PMA database.
[58] The source of information concerning credit facilities in the
PMA database for facilities granted to SMEs, which incorporates data on licensed specialized lending institutions in addition to data of UNRWA, the Palestinian
Banking Corporation and the Establishment for the Management and Development of Orphans Funds.
Chapter Six: Non-Banking Financial Institutions
67
fourth, was the industry sector at 10.3 percent. The severity of default is related to the risks associated with each
sector of the economy, which in turn is dependent on political and security developments and measures imposed
by the Israeli occupation.
Mortgage and housing loans
Compared to 2013, the value of the housing loans and mortgage portfolio granted by specialized lending institutions
rose by 8.4 percent in 2014, to reach about USD 70.9 million representing 9.3 percent of the total portfolio of banks
and lending institutions combined. The value of outstanding housing loans and mortgage portfolio was about USD
47.4 million representing 8 percent of that for banks and lending institutions combined.
Analysis of the quality of the portfolio of lending institutions shows that its NPLs constituted about 19.4 percent of
the total portfolio by end of 2014. This ratio is considered high when compared with the mortgage portfolio of banks
equal to 2.2 percent. This is indicative of the high degree of risks associated with loans granted by lending institutions
in the housing and mortgage business. This is probably attributable to the fact that borrowers dealing with these
institutions are mainly low-income borrowers. This ratio, however, does not exceed 1.5 percent, which amounted to
about USD 596.2 million by end of 2014. Being a small ratio, it has insignificant impact on financial stability in general. Apart from its minute share, the default ratio is considered insignificant because lending institutions hedge
credit risks by setting aside debt provisions with coverage of 8.9 percent of the total housing and mortgage NPLs they
provide. In comparison, the coverage is equivalent to 24.6 percent for banks.
Securities sector (Palestine Exchange-PEX)
During 2014, PEX continued to make steady progress as one fundamental cornerstone of the Palestinian financial
system and a facet of the advanced infrastructure underpinning this system. In terms of achievements that foster
financial market performance in general, PEX passed an important milestone on 2 September 2014 by securing a
place on the FTSE “Watch List”[59], having fulfilled all required criteria for promotion to a frontier market status. This
is one of many steps aimed at placing PEX on the map of global investment. The achievement helps PEX to enhanced
its competitiveness within regional and international markets and remains an important step towards a possible
promotion to FTSE’s emerging market category in the long-horizon.
This achievement was the result of PEX successfully meeting several criteria with regards to integrity and transparency, information depth and disclosure mechanisms, in the presence of an independent supervisory body monitoring
its performance (considered a key reason for this selection). PEX also benefitted from the absence of constraints on
foreign ownership and the easy market access offered to foreign investment, while at the same time, operating an
effective trading mechanism with a zero-tolerance to failed settlement of transactions. One positive aftereffect of
the addition of PEX to the FTSE Watch List is that it gives the market momentum and wider exposure on the international investment scene, thereby drawing the attention of both regional and international specialized financial
institutions and investment funds. As a result, PEX can move forward to a more advanced status that boosts regional
and international competitiveness.
[59] These are released by the indexing group “Financial Times Stock Exchange”, upon which countries are classified into groups: developed, advanced
emerging, secondary emerging and frontier. A Watch List incorporates countries nominated for promotion or demotion and is revised on annual basis.
68 Financial Stability Report - PMA
Similarly, the PCMA succeeded in securing full membership to the International Organization of Securities Commissions (IOSCO)[60], which is the supreme professional association of organizations that regulate and supervise financial
markets. The acceptance of the PCMA membership application came in a meeting held on the 21st of February 2014
in Malaysia. Having become the world’s 124th IOSCO full member, Palestine was also accepted as the 101st signatory
to the Multilateral Memorandum of Understanding (MMOU).
The admission to the IOSCO is expected to have positive consequences on the Palestinian securities sector, affecting
the investment climate in general and fostering investor confidence in the securities listed in PEX. To investors, and
-foreign ones in particular-, this membership represents an international testimonial affirming the compliance of
the Palestinian securities sector to the IOSCO international standards and principles of regulation and monitoring,
as required by all member states. Consequently, the membership is expected to contribute to boosting of investment
attractiveness of the Palestine Exchange, considering that foreign investors give great attention to the IOSCO membership of the financial market supervisory body when making their investment decisions.
On a different note, and following the delisting of the Palestine Mortgage & Housing Corporation (PMHC) due to
change in legal status to become a private shareholding company, the number of listed companies fell to 48 from
49 in 2013. PEX held 245 trading sessions during the year, during which 181,545,154 shares were traded, marking a
drop in traded shares by 10,6 percent compared to 2013. The market value of traded shares was USD 3,187.3 million,
dropping by about 1.9 percent against the previous year, executed through 41,257 trading transactions, which is 7.3
percent less than in 2013.
By end of 2014, the PEX Index (Al-Quds) closed at 511.8 points declining by 5.5 percent against the previous end-year
close. This setback came as a result of a drop in the indices of all sectors, with the exception of the insurance sector,
which rose by about 2.8 percent. The remaining sector indices fell, registering a drop for banking and financial services
by 4.2 percent; for services sector by about 5.8 percent; for the industry sector by 0.9 percent and for the investment
sector by 0.3 percent.
As for trading by sector, the investment sector
Figure 6-3: General index of Palestine Stock Exchange,
2010-2014
560
continued to rank first acquiring 40.3 percent
540
of total number of traded shares, equivalent to
capitalization. Banking and financial services
520
Point
17.1 percent of listed companies’ total market
500
came second, accounting for 36.7 percent of total
480
number of traded shares, the equivalent of 26.4
460
percent of total market capitalization. Services
sector followed accounting for 16.9 percent of
total number of traded shares, the equivalent of
440
2010
2011
2012
2013
2014
Source: PMA database.
[60] The International Organization of Securities Commissions (IOSCO) develops international and technical standards to be advocated by its members. All
financial market supervisory associations seek to join IOSCO as it provides an international endorsement that the regulatory frameworks used by those bodies
to regulate and monitor securities markets meet international standards and requirements. The approval of the IOSCO membership and the admission to the
Multilateral Memorandum of Understanding (MMoU) is a lengthy process that requires strenuous effort to meet the legal and technical requirements of the
Memorandum, including adjusting and developing the regulatory and technical framework. Membership to this Memorandum is of immense significance as
it binds members to full cooperation in the area of financial market supervision and protection of investor rights. The Memorandum requires the cooperation
and exchange of information from member states in order to prevent fraud, price manipulation, insider trading, or any manipulative practice that might
adversely impact sound trading in the financial markets of member states.
Chapter Six: Non-Banking Financial Institutions
69
44.6 percent of total market capitalization. Insurance sector claimed 3.5 percent of total number of traded shares, the
equivalent of 3.3 percent of total market capitalization. Finally, industry accounted for 2.6 percent of total number
of traded shares, the equivalent of 8.6 percent of total market capitalization.
Table 6-4: Main indicators of Palestine Stock Exchange, 2010-2014
Item
2010
2011
2012
2013
2014
Trading volume (million shares)
230.5
184.5
147.3
203.0
181.5
Traded value (USD million)
451.2
365.6
273.4
340.8
353.9
Market capitalization (USD million)
2,449.9
2,782.5
2,859.1
3,247.5
3,187.3
Value of traded shares to GDP (%)
5.1
3.5
2.4
2.7
2.8
Market capitalization to GDP (%)
27.5
26.6
25.3
26.0
25.0
Turnover ratio (%)*
18.4
12.6
9.7
10.5
11.1
Number of transactions
82,625
61,928
41,442
44,425
41,257
Number of trading sessions
249
248
249
241
245
Number of member companies
10
10
9
8
8
Number of listed companies
40
46
48
49
48
Al-Quds index (point)
489.6
476.9
477.6
541.5
511.8
• Turnover ratio = Traded value/market capitalization.
Source: PCMA database.
PEX performance has been adversely affected in the aftermath of the latest war against Gaza Strip, which lasted for
more than 50 days during the third quarter of 2014. The war inflicted severe damage on the Palestinian economy,
both directly and indirectly, reflecting directly upon the business results of the private sector. These unfavorable
results were a clear evidence of the impact of political risks and the state of instability on the investment climate in
Palestine on the whole.
Table 6-5: Sectoral indicators of Palestine Stock Exchange, 2014
Market
Sector
capitalization (USD
Number
of trading
sessions
Traded
value (USD
million)
million)
Trading
volume
(million
shares)
Number
of listed
companies
Banking & financial services
840.5
8,099
111.6
66.6
8
Insurance
105.2
1,193
4.3
6.4
7
Investment
545.3
16,552
109.5
73.1
9
Industry
273.7
2,773
9.1
4.8
12
Service
1,422.6
12,640
119.3
30.6
12
Total
3,187.3
41,257
353.9
181.5
48
Source: Palestine Stock Exchange.
70 Financial Stability Report - PMA
On a different note, the financial depth indicator, measured by the ratio of stock market capitalization to GDP, improved during 2014, rising from 24.4 percent in 2013 to 25.1 percent. This ratio is still modest when compared to other
Arab and regional stock exchanges, like for example the Amman Stock Exchange, where it recorded 75.8 percent by
end of 2014[61].
Regionally, PEX ranked fourth, after Iraq,
Figure 6-4: Indecies of Arab Stocks Exchange, 2014
Kuwait, and Muscat, among 6 other Arab
35
financial markets which witnessed a
Iraq
1.7
Kuwait
1.8
Muscat
5.6 5.6 4.8
5
Palestine
10
Amman
Dubai
-20
Casablanca
This inconsistent performance was reflec-
AbuDhbi
-15
Bahrain
disparate performance results during 2014.
Tunisia
-10
Qatar
-5
scope of Arab stock exchanges, which saw
index tracking the performance of financial
12.0
0
is not regarded exceptional within the
ted in the Arab Monetary Fund’s composite
16.2 14.2
Saudi
15
18.4
Khartoum
improvement in key indicators. It is worth
Percent
10 Arab stock exchanges which registered
Damascus
25
20
Beirut
decline in key indicators, as opposed to
mentioning that the decline of PEX
31.6
30
-0.5 -2.4 - 5.5
-7.2
-13.4
- 18.7
Source: PMA database.
Arab markets (denominated in US dollars) which recorded a drop of 14.5 percent over 2013. Likewise, the S&P AFE40
Index, which was launched by Standard & Poor’s (S&P) in partnership with the Arab Federation of Exchanges (AFE),
recorded a drop of 4.1 percent compared to 2013.
As for liquidity indicators, given their significance to financial markets, the PEX turnover rate increased from 10.5
percent to 11.1 percent, close to the average turnover rate of Arab stock exchanges, which recorded 16.5 percent for
2014[62]. This figure reflects an improvement in PEX liquidity for 2014.
in 2014, holding shares equivalent to 42.5
100
8.2
5.9
3.2
2.5
Bahrain
Damascus
11.1
Palestine
Beirut
12.5
Amman
9.4
14.9
Tunisia
Iraq
15.6
Casablanca
stability perspective.
Muscat
any associated high risks, from a financial
20.7
above-said figures do not raise concern or
Kuwait
0
23.0
shareholders, respectively. In general, the
Khartoum
20
29.5
cent, 13.7 percent and 3.0 percent of all
Qatar
40
34.8
Liberian and Saudi, constituting 12.5 per-
AbuDhbi
60
39.5
shareholders were mainly Jordanian,
80
Cairo
percent of securities market value. The
118.2
120
118.4
accounted for 4.8 percent of shareholders
Dubai
140
Percent
nership showed that foreign shareholders
audi
Figure 6-5: Turnover rates in Arab Stocks Exchange, 2014
On the other hand, analysis of shares ow-
Source: PMA database.
In fact, the entry of foreign investors to PEX has positive consequences on economic activity and the level of confidence in local investment.
[61] 16th Annual Report, Amman Stock Exchange, 2014.
[62] The figure represents the turnover rate for Arab stock exchanges over 2014, having excluded two outlier results, namely: Saudi Stock Exchange with 118.4
percent and the Dubai Stock Exchange with 118.2 percent. The remaining Arab stock exchanges’ turnover ranged from 2 percent to 40 percent.
Chapter Six: Non-Banking Financial Institutions
71
Insurance sector
Legislative and regulatory developments
During 2014, the insurance sector made advances over the course of the year, given the earnest efforts made by the
PCMA to boost the activity of this sector. To that end the PCMA issued Instructions No. (1/2014) on the professional
code of conduct for insurance companies and Instructions No. (2/2014) concerning re-insurance arrangements and
policies for insurance companies, which stipulate that insurance companies operating in Palestine shall put in place
liquidity management plans and shall withhold no less than 20 percent of the share of consensual reinsurance premiums, provided this sum is released one year from the retention date.
An advisory committee on insurance was founded, pursuant to Decree No (1/2014) to supervise and oversee insurance matters and develop insurance activity. The Committee membership includes PCMA chairman as Committee
chairman, a member of PCMA board of directors as Committee vice chairman, head of PCMA Insurance Directorate
as Committee coordinator, Director of the Palestinian Insurance Federation (PIF) as Committee member and an insurance expert appointed by PCMA board of directors.
During 2014, the PCMA released a number of circulars to regulate insurance activity. Most important among these was
Circular No. (C-2/2014), which requires companies to enclose the report of an expert actuary with their annual financial
statements as a basic condition for PCMA approval of these statements. The distribution of profits on shareholders
shall be prohibited, unless the actuarial report reveals a surplus of funds upon proper examination of the company’s
financial position, and provided PCMA approval of profit distribution is granted. Another circular was also released
in November 2014 which reinstalled the use of the Palestinian Electronic Vehicle Insurance System as of 16 November
2014. The Circular requires all insurance companies to issue vehicle insurance documents through this system only.
Operational and financial activity
By end 2014, the number of insurance companies in Palestine stood unchanged at 10 companies. The number of
branches and offices fell to 111 compared to 114 in 2013, distributed across various regions in the WB and GS. Yet, the
number of employees in the insurance sector rose by 9.3 percent to 1,175 employees by end of 2014. The number of
agents and insurance producers dropped 4.7 percent to 215, by the end of the year.
29.1
28.1
25.6
10
Investments distributed across stocks and bonds,
bank deposits and real estate, while accounts receivables constituted about 19.0 percent of total
0
Stocks
Source: PMA database.
72 Financial Stability Report - PMA
Bonds
Deposits
Properties
2.4
investments, and USD 64.5 million were foreign.
20
2.4
million of which USD 129.0 million were domestic
Percent
cent in the previous year, with a value of USD 193.5
17.3
30
constituted 50.5 percent, compared with 51 per-
2014
16.3
to USD 383.0 million. Of total assets, investment
2013
22.3
40
rose by 7.8 percent over that in 2013, to amount
29.9
during 2014, total insurance companies’ assets
Figure 6-6: Investments of insurance companies by type,
2013-2014
26.6
As to financial activity of insurance companies
Others
assets receding by 2.3 percent. Insurance contracts constituted 7.7 percent down by 6.1 percent compared to 2013 and
cash in banks and funds constituted 3.6 percent.
On the other hand, insurance companies boosted both equity rights and capital, the former rising by 14.1 percent
to USD 136.7 million by end of 2014, and the paid-in capital rising by 2.7 to USD 69.7 million. This positively affected
the companies’ business results, which showed a net profit after taxes of USD 14.0 million, recording a hike of 12.9
percent compared to 2013.
Analysis concerning insurance premiums indicated a growth in insurance premiums by 12.3 percent to reach about
USD 171.0 million by end of 2014, alongside an increase in paid-in compensations by 21.9 percent to reach USD 108.1
million. It is worth mentioning that motor insurance premiums constituted the largest share (58.8 percent) of total
premiums by end of 2014. Health insurance premiums ranked second with 18.4 percent, workers’ compensation insurance premiums with 8.7 percent, fire insurance with 4.9 percent and the remaining types of insurance premiums
with 9.2 percent[63].
With regard to the sector’s soundness
Table 6- 6: Financial indicators of insurance sector, 2012-2014
(Percent)
indicators, data show a rise in total
Indicator
written premiums to total sharehol-
2012
2013
2014
der equity to 125.1percent compared
Total insurance premiums- to-shareholder’s 132.8
to 134.4 percent in 2013. Net written
equity
premiums to total shareholder’s equ-
Insurance premiums (net)-to-shareholder’s 111.9
ity dropped from 118.3 percent in 2013
equity
to 109.5 percent. This ratio is indicative
Change in shareholder’s equity
13.8
10.1
14.1
of the build-up of capital and reserves
Holding premiums
84.3
88.1
87.5
in provision for net written premiums,
Total expenses-to-total assets
10.8
11.1
11.1
and therefore is an indication of po-
Reinsurer’s share of premiums
15.7
11.9
12.5
Reinsurer’s share of paid up claims
15.4
17.4
14.2
Average losses
tential risks to the insurance sector,
after deducting the risks transferred
to reinsurers; an increase in this ratio
signifies a heightened risk to capital.
Likewise the ratio of holding premiums receded to 87.5 percent down
from around 88.1 percent in 2013[64].
This ratio correlates positively with
the degree of reliance on reinsurance.
Moreover, administrative costs[65] also
fell to 24.9 percent from 25.7 percent.
This indicator reflects companies’
competence in the rationing of their
134.4
125.1
118.3
109.5
70.5
66.6
72.6
Shareholder’s equity-to-technical provisions 67.9
67.4
80.3
Technical provisions-to-paid up claims
181.3
200.5
157.4
Technical provisions-to-liquid assets
80.3
76.9
74.8
Liabilities and equity-to-liquid assets
170.3
158.6
168.3
Average administrative cost
25.5
25.7
24.9
Return on shareholder’s equity- ROE
11.7
13.6
13.3
Return on assets- ROA
3.7
4.4
4.7
Assets-to-GDP
3.0
2.9
3.0
Investment-to-GDP
1.6
1.5
1.5
Solvency margin
199.0
169.0
181.0
Source: PCMA database.
[63] Included civil liability insurance at 1.8 percent, other general insurances at 1.8 percent, marine insurance at 1.0 percent, engineering insurance at 2.3
percent and life insurance at 2.3 percent.
[64] This ratio represents the result of dividing net written premiums (total written premiums after excluding reinsurer share) over total written premiums.
[65] This is calculated by dividing total administrative expenses by total premiums.
Chapter Six: Non-Banking Financial Institutions
73
general expenses. Conversely, the sector’s loss rate (compensation/acquired or earned premiums[66]) rose to 72.6 percent compared to 66.6 percent in 2013. In tandem, shareholders’ equity coverage of technical provisions increased to
80.3 percent compared with about 67.4 percent in 2013.
As for liquidity indicators, they exhibited a decline from the previous year. The ratio of liabilities to liquid assets rose
to 168.3 compared to 158.6 percent in 2013. This ratio gauges the lapse in a company’s ability to settle its obligations
to insurance document holders in case of liquidation. Furthermore, the ratio of technical provisions to liquid assets
dropped to 74.8 percent from 76.9 percent, indicating a decline in liquidity available to the company against its
technical provisions.
As for profitability indicators, and despite a rise in profits before tax by 11.4 percent to reach USD 18.2 percent, the
return on shareholders’ equity dropped slightly from 13.6 percent 13.3 percent in 2014. This is attributed to an increase
in company equity rights and paid-in capital. On the other hand, an increase in return on assets, from 4.4 percent in
2013 to 4.7 percent in 2014, reflected a rise in the productivity and profitability of the sector’s assets.
Additionally, the PCMA regularly calculates the financial solvency ratio for insurance companies, which represents
the founding principle upon which the future of the industry rests. This ratio measures the availability of adequate
funds to meet the insurance company’s financial obligations, as the company’s assets must not be jeopardized to pay
off various obligations. Given normal circumstance, a company is able to face potential risks by payment of claims
from the income accrued from new premiums, without the sale of any of the company assets. The financial solvency
ratio for the entire sector rose to 181 percent in 2014 compared to 169 percent end of 2013, and is higher than the
PCMA required limit set at 150 percent. These figures indicate that the insurance companies are well equipped to
withstand the risks associated with the inadequacy of technical reserves to counter risks including company default.
Concerning the relation and risk contagion channels between the insurance and the banking sectors, the insurance
companies’ deposits with banks accounted for around 19.0 percent of their total investment by end of 2014, compared
with about 21.5 percent in 2013. These deposits did not exceed 0.4 percent of total customer deposits with banks. On the
other hand, credit granted to insurance companies by banks totaled about USD 3.6 million, constituting 0.07 percent
of total credits granted by banks by end of 2014. These ratios clearly indicate that the insurance sector’s exposure to
risks posed by the banking sector is much greater than the opposite. This is because the banking sector represents
the largest constituent of the Palestinian financial system, in comparison with the other financial institutions.
Mortgage sector
The Palestinian mortgage sector did not see any tangible developments during 2014, as the primary market for
mortgage financing continued to suffer from the absence of specialized financing companies, which restricts the
market to banks only. While some banks rely on intrinsic sources to finance mortgage loans, others resort to refinance
loans through the secondary market. However, the secondary market consists of two companies only: the Palestine
Mortgage and Housing Corporation, founded in 1999 as a public shareholding company with a capital of USD 20
million, and its subsidiary the Palestine Housing Finance Corporation. The secondary market also suffers from limited
sources of financing, as a result of the reluctance of refinancing companies to issue corporate bonds or mortgage
backed securities due to the absence of a specialized law to regulate the issue of such bonds. Mortgage loans are
refinanced by the Palestine Mortgage and Housing Corporation, and insures against borrower default risk through
the Palestine Mortgage Insurance Fund.
[66] The acquired instalments represent the written premiums after deducting reinsurer shares from the written premiums and deducting the value of
change of reserves in force and accounting reserve.
74 Financial Stability Report - PMA
On a different note, the Palestinian Mortgage Law is still awaiting approval by the relevant authorities. The draft
version of the law had been approved by the PCMA board of directors in 2012. However, the PCMA, in collaboration
with other stakeholders, concluded a review of the supervisory instructions that were formulated with the aid of
international expertise, like the instructions on capital adequacy, the instructions on provisions and credit standards
for mortgage financing companies. In tandem, the PCMA, is also working on setting a proper basis for market value
of land in Palestine in collaboration with other stakeholders.
By end of 2014Q3, the sector’s to-
Table 6-7: Financial indicators of mortgage sector, 2010-2014
tal assets amounted to USD 41.3
Item
million, down from about USD
2010
42.4 million in 2013. This drop rep-
Assets (USD million)
resents a 2.0 percent decline from
Ownership equity (USD mil-
the corresponding quarter in 2013
lion)
and a 2.3 percent drop from end
2011
2012
2013
9/2014
38.7
37.1
37.5
42.4
41.3
21.7
21
21.5
21.6
21.1
Profit of the year (USD million) 0.34
0.45
0.60
0.44
0.44
of 2013. Equity rights also fell by
Equity-to- Assets (%)
56.1
56.6
57.3
50.9
51.1
2.3 percent to reach USD 21.1 mil-
Return on assets (%)
0.9
1.2
1.6
1.0
1.1
lion over the same period. At the
Return on equity (%)
1.6
2.1
2.8
2.0
2.1
level of the sector’s performance,
Source: PCMA database.
profits (before taxes), for the first
9 months of 2014 only, amounted to around USD 0.44 million, marking a pronounced growth equivalent to 63.5
percent over the corresponding quarter in 2013. As for financing extended to banks in order to grant housing loans
under appropriate terms and conditions, long-term housing loans granted to banks in 2014 totaled USD 31.8 million,
compared with USD 31.3 million by third quarter of 2013.
It must be noted that the PMA established a special database for the financing of housing loans and mortgages in
Palestine. The database is intended to mitigate risks and evade crises that may arise in the future, in a manner similar
to the 2008 mortgage crisis in the USA. The PMA also released instructions in relation to housing loans and mortgages, regulating this kind of lending on the basis of the dynamic (LTV) ratio. These instructions were: Instructions No.
(2/2014) directed to banks and Instructions No (1/2014) directed to specialized lending institutions.
Financial leasing sector
The financial leasing sector is a new member of the financial market in Palestine, which, over the past few years,
has introduced alternative financing methods. Despite its young age, the sector is promising and can positively
contribute to economic sustainable growth given that it can offer local investment opportunities and boost the Palestinian economy. Financial leasing activity is founded on the notion that profit can in essence be realized through
asset utilization, and not necessarily through asset ownership, as the leasee can realize cash inflows by operating
the asset. Financial leasing is of special significance for SMEs and is also characterized by being Sharia- compliant.
The sector’s prevalent activity is vehicle finance, which constituted about 99 percent of its activity by end of 2014.
Available data shows that the companies[67] engaged in financial leasing numbered 10 by the end of that year.
[67] For more details on PCMA licensed companies in 2014, visit the official website www.pcma.ps
Chapter Six: Non-Banking Financial Institutions
75
The PCMA assumed the responsibility of developing this sector and establish the sound basis for its operation, starting
with seeking presidential ratification for the Law of Financial Leasing in January 2014, which was developed in line with
the best international practices of lease financing including the model law on leasing developed by the International
Institute for the Unification of Private Law (UNIDROIT) in Italy and customized to conform to Palestinian statutes and
regulations. Furthermore, the PCMA conducted a comprehensive revision of instructions on VAT imposed on lease
agreements and the instructions on the registration of immovable assets[68].
Nonetheless, the sector is still challenged by obstacles hindering its development like the high costs of leasing in
comparison with the costs of credit offered by banks, in addition to the lack of public awareness of leasing and its
significance. Currently, the Financial Leasing Administration at the PCMA seeks to develop this sector so that it can
efficiently contribute to economic growth in Palestine. Likewise, the PMA’s is making efforts to add leasing companies
to its credit information database in order to help mitigate risks to the financial leasing sector and raise the efficiency
of financing decisions, which would reflect favorably on financial stability.
[68] For the purpose of establishing proper foundations for the operation of this sector in conformance with international best practices, the instructions
on VAT on lease agreements were revised in collaboration with the VAT department in the Ministry of Finance and a Jordanian expert, contracted through the
IFC, to attain the best-possible version of the instructions and consequently, pave the way for their endorsement by the Minister of Finance. Likewise, a final
version of instructions on the registration of immovable assets was drafted in collaboration with the Lands Authority, which, as was agreed, will be released in
tandem with the issuance of the Mortgage Law.
76 Financial Stability Report - PMA
Chapter Seven
Financial Pressure “Stress Testes”
Overview
Financial stress testing is considered an important risk management tool for banks and
supervisory bodies alike and an integral part of total risk management. The PMA began
conducting several financial stress tests to assess the ability of banks operating in Palestine
to endure different risks based on simulations of economic and political reality in Palestine
and the related possible shocks. This allows the PMA to formulate suitable hedging policies
that enable banks to withstand various risks that may come true under these possible scenarios. This chapter sheds light on the most important results of financial stress testing of
the Palestinian banking sector, conducted by the PMA on regular basis.
Stress tolerance tests
Since 2011, the PMA regularly performed stress testing of the overall banking system and every bank individually. In
2014 new instructions were issued on stress testing[69]‫ و‬elaborating the sound stress testing practices and policies
that banks should adhere to in conducting stress tolerance tests. The instructions identified the types of tests to be
conducted semi-annually. Tests fall into two types: first, the single factor tests and the second, the multi factor tests.
The PMA shall be provided with the results of the two types of tests. When single factor tests are conducted, a bank
must take the following shocks into account:
Table 7-1: Potential shocks in single variable stress tessts
1.
Increase in special provisions to cover all classified facilities by 100%.
2. Increase in special provisions by 25% and 35% of the PA's outstanding facilities.
3. Increase in special provisions by 25% and 35% of the PA's employees net outstanding facilities.
4. Decrease in the price of stocks by 15% and 30% where the bank invested regardless the place of
investment.
5. Decrease in the price bonds and bills issued by government and central banks outside by 10% and 20
percent regardless of the issuing currency.
6. Decrease in the price of non-government stocks by 15% and 30% regardless the place of investment.
7. Faltering financial institution where a bank hold balances by more than 10% of his total balances
outside Palestine.
8. Decrease or increase in the dollar exchange rate against other currencies by 15%.
[69] Instructions No (10/2014) published on 5 November 2014, superseding Instructions No (5/2011).
Chapter Seven: Financial Pressure “Stress Testes”
77
9. Change in dollar interest rate by 200 basis point, decrease or increase.
10. Increase in special provisions by 100% of net outstanding facilities of the bank's three and five largest
borrowers, excluding government facilities.
11. Increase in special provisions by 25% and 50% of private sector net outstanding facilities for
mortgage, commerce, services, and consumer loans.
Source: PMA database.
When multiple factor tests are conducted, a bank must take the following shocks into account:
Table 7-2: Potential shocks in multivariable stress tessts
Scenario
1
Scenario
2
Increase in provisions from the PA's outstanding facilities
10%
20%
Increase in provisions from the PA's employees net outstanding facilities
5%
15%
Increase in provisions from private sector net outstanding facilities for financing 5%
government projects and activities.
10%
Shocks
1. Political
Increase in provisions from private sector net outstanding facilities (excluding the net
outstanding facilities for the PA's employees, and private sector outstanding facilities
for financing government projects and activities.
3%
5%
Decrease the price of investments in Palestine (stocks and bonds)
15%
25%
Increase in provisions from the private sector outstanding facilities
5%
15%
Increase in provisions from the PA's employees net outstanding facilities
3%
5%
Decrease the price of investments outside Palestine (stocks and bonds)
10%
20%
Decrease the price of investments in Palestine (stocks and bonds)
10%
20%
2. Economic
‫نقطة أساس‬
Interest rates for the main currencies (NIS, USD, JD) (Basis points)
Decline in the interest rate on loans
25
50
Decline in the interest rate on overdrafts
25
50
Increase in the interest rate on saving deposits
25
25
Increase in the interest rate on time deposits
25
25
Note: each scenario read vertically.
Source: PMA database.
Tolerance stress tests are conducted in accordance with the above-mentioned scenarios and shocks on the ratio
of Tier 1 Capital to risk-weighted assets (Tier1 Capital/RWA). This ratio must not fall below 4 percent as per Basel II
requirements (and not below 6 percent as Basel III requirements starting from 2015), and not below 8 percent as per
PMA effective instructions. In addition, the effect of shocks under the single factor test on profits and losses must
be demonstrated. The bank must also specify the effect for the following assumed shocks on its ability to meet its
short-term obligations in due date. The shocks are:
• Customers withdrawing 20 percent of their deposits during June and December of every fiscal year.
• Liquid assets falling by 25 percent.
• The top three and top five depositors withdrawing their deposits, including government deposits.
78 Financial Stability Report - PMA
The instructions also required the testing to cover the upcoming year; the test data relating to the balance sheet must
be consistent with the data as they appear on the date of the test; all collaterals must be excluded, including cash
insurances for guarantee of credits; the increase in special provisions must be calculated on net portfolio basis. The
test must also include both budget and non-budget items (for non-budget items, a conversion coefficient is used).
Tolerance testing at the level of the banking sector
Results of financial tolerance tests, which were conducted by the PMA on the financial statements of the banking
sector as they appeared on December 31, 2014, were generally favorable in light of the various hypothetical scenarios
and likely exposures to the political and economic shocks mentioned in this chapter. The results, shown in Table (7-3),
demonstrate the accomplishments and shock-absorbing abilities of the Palestinian banking system.
Table
7-3:
The
PMA
stress
tessts
results,
2014
Scenarios of political shocks nature, includes:
‫ الصدمات السياسية‬Political Shocks
Scenario 1
Scenario 2
Scenario 3
Assuming delay in the PNA payment of their outstanding loans
20%
30%
40%
Delinquency of PNA employees loans
25%
40%
50%
Delinquency of private sector loans-excluding PNA employees loans
10%
15%
20%
Decrease in the fire value of investments inside Palestine
5%
10%
15%
Withdrawal of deposits
10%
15%
20%
Result on Tier 1 capital/RWA
16%
11.6%
8%
Scenarios of economic shocks nature, includes:
Scenario 4
Scenario 5
Scenario 6
Delinquency of private sector loans-excluding PNA employees loans
10%
20%
30%
Decrease in the fire value of investments inside and outside Palestine
5%
15%
25%
Withdrawal of deposits
5%
10%
20%
Result on Tier 1 capital/RWA
18.8%
12.8%
6.6%
Scenarios of concentration shocks nature, includes:
Scenario 7
Scenario 8
Scenario 9
Delinquency of biggest 1, 3, 5 borrowers
1
3
5
Withdrawal of biggest 3, 1, 5 depositors
3
1
5
Result on Tier 1 capital/RWA
18.9%
16.4%
14.3%
Source: PMA database.
In terms of political shocks, and in ascending order of shock severity from scenario 1 (least severe) to scenario 3 (most
severe shock), the results of financial stress testing were favorable. The Tier 1 Capital to risk-weighted assets ratio
remained above the minimum limit set in the Basel requirements (not less than 4 percent pursuant to Basel II requirements, and not less than 6 percent pursuant to Basel III requirements starting from 2015). Likewise the ratio was
above the minimum limit set by the PMA at 8 percent.
The first scenario postulates potential political shocks that impact the government’s ability to meet its obligations;
whether in the form of payments to the banks, regular payment of salaries of employees, payments of outstanding
dues to its suppliers from companies and private sector institutions, and, subsequently the inability of government
employees and companies to meet their obligations to the banks. This situation is further compounded by the fall of
market value for shares in Palestine and deposit withdrawals by depositors. In light of these assumed shocks, debt
provisions to be allocated by banks are expected to grow by 70 percent (the summation of ratio increases in provisions
Chapter Seven: Financial Pressure “Stress Testes”
79
to counter each shock in accordance with the above table). This increase in provisions is expected to adversely impact
capital, pushing down the ratio of Tier 1 Capital to risk-weighted assets to 16 percent. Despite this decline, the ratio
remains high and exceeds the minimum limit as required by the Basel Committee and the PMA.
The second scenario postulated similar shocks to the one mentioned above, albeit with greater severity. Debt provisions are expected to swell by 110 percent while the Tier 1 Capital to risk-weighted assets ratio is expected to drop to 11.6
percent. Regardless of that decline, the ratio remains above the minimum limit as required by the Basel Committee
and the PMA. As for the third scenario, which postulates the most severe political shocks, debt provisions are expected to increase by 145 percent while the Tier 1 Capital to risk-weighted assets ratio is expected to drop to 8 percent.
This ratio is still higher than the Basel requirements and exactly equal to the minimum requirement set by the PMA.
As for economic shocks, it is assumed that the private sector is unable to pay off obligations to banks, that the market
value for shares in Palestine will decline, and deposits withdrawn by depositors. In light of these assumed shocks,
it is expected that debt provisions to be allocated by banks would rise by 20 percent for the scenario with the least
severity (scenario 4); by 35 percent for scenario 5 and by 75 percent for scenario 6 (the most severe stress scenario).
Test results have also shown that the Tier 1 Capital to risk-weighted assets ratio will remain above the minimum limit
requirements of both the Basel Committee and the PMA. The ratio reached 18.8 percent and 12.8 percent for scenario
4 and scenario 5, respectively, while dropping to about 6.6 percent for scenario 6, which is the most severe stress
scenario for economic shock. Although the ratio falls below the 8 percent minimum limit set by the PMA, it remains
above the minimum limit set by the Basel Committee.
In regards to scenarios that postulate concentration shocks, testing was conducted on the basis of three different
adverse scenarios: scenario 7 assumes that the largest borrower fails to meet obligations and, additionally, the three
largest depositors withdraw their deposits from the bank; scenario 8 assumes that the three largest borrowers fail
to meet their obligations to the bank and, additionally, the largest depositors withdraws his/her deposits from the
bank and finally, scenario 9 assumes the five largest borrowers fail to meet their obligations to the bank and the five
largest depositors withdraw their deposits from the bank. On the grounds of the aforesaid three scenarios, testing
results expressed as the Tier 1 Capital to risk-weighted assets ratio were as follows: 18.9 percent, 16.4 percent and
14.3 percent, respectively. All ratios are above the minimum limit set in the Basel requirements and above the limit
Figure 7-1: Tier 1 capital to risk weighted assets, 2013-2014
25
do materialize.
scenarios. Under this scenario, banks are especially
prone to the risk of fair value depreciation of investments abroad, which is indicative to the large ratio
80 Financial Stability Report - PMA
Percent
io
ar
io
9s
ts
ce
n
io
8s
ts
ce
na
r
io
7s
ts
ce
na
r
io
ts
6s
Ratio after simulation, 2013
Minimum limit
Source: PMA database.
ce
na
r
io
5s
ts
ce
na
r
io
4s
ts
ce
na
r
io
ce
na
r
ar
ts
reme stress scenario of all economic and political
3s
2014 and in 2013), which is considered the most ext-
0
io
potential scenarios except for scenario 6 (both in
5
ce
n
Banks, the tests were passed under all adverse
10
ce
na
r
the Palestinian banking sector, in general. For all
15
ts
all licensed banks demonstrates the resilience of
1s
Analysis of the results of financial stress tests for
20
ts
banks to absorb concentration shocks, in case they
2s
required by the PMA, which signals the ability of
Ratio after simulation, 2014
of foreign assets to total bank assets. Moreover, under this scenario, banks are prone to the risk of deterioration in
the quality of loans extended to the Palestinian Authority and civil servants. It is expected that, under this scenario,
Tier 1 Capital to risk-weighted assets ratio will plummet from 20 percent (the ratio before the shock) to 6.6 percent.
Testing banks’ ability to withstand macroeconomic risks
Since 2013, the PMA began to conduct a second kind of testing in order to assess the ability of banks to withstand
adverse shocks at the macro level, using Vector Autoregressive Model (VAR) methodology. The method examines
several variables at the macro- level[70] to measure the impact of respective shocks on financial stability, for the
purpose of modelling the relation between bank default and any other shocks related to macro-economic variables.
Loan provisions were used as a measure of financial default, as they are included in bank income statements and,
therefore, directly relate to net profits. Additionally, data on loan provisions are available in the form of quarterly
time series and for a sufficiently long period. This type of testing was conducted under two different scenarios: the
baseline scenario and the pessimistic (adverse) scenario; both derived from the Palestinian macroeconomic model[71].
Under the baseline scenario for
Table 7-4: Forecasts of changes in loans provisions, end of 2015
the Palestinian economy in 2015,
PMA forecasts point to an expected
Baseline scenario
improvement, albeit slight, in the
Period
from Q2, based on expectations that
Change in
loans provi-
Growth in
loans provi-
GDP (%)
sions
GDP (%)
sions
Israel resumes the regular transfer
2015Q1
1.3
1.3
4.9-
1.3
2015Q2
1.5
4.9
3.0-
6.4
2015Q3
2.7
3.6-
1.7-
0.3
2015Q4
2.0
2.2
7.5-
10.1
Source: PMA.
25
tions. These assumptions envision that political
lic finance, it is assumed that the government will
maintain its financial austerity policy of rationing
Baseline scenario
2015Q4
slightly increase from the previous year. As for pub-
2015Q3
nian workers in Israel will remain unchanged or
0
-5
2015Q2
and travel will persist and the number of Palesti-
5
2015Q1
restrictions imposed on the freedom of movement
10
2014Q3
ly to certain economic consequences; barriers and
15
2014Q4
change (impasse in peace process) to lead inevitab-
20
USD million
and security conditions will undergo no major
2014Q1
These forecasts are based on a number of assump-
Figure 7-2: Forecasts of changes in loans provisions, end of
2015
2014Q2
percent during 2015.
2013Q4
achieve a growth rate of about 1.9
18.1
2013Q3
Palestinian economy is expected to
4.3-
2013Q2
increase. Under such conditions, the
4.8
2013Q1
from abroad to the private sector
1.9
2012Q3
budget are steady and transfers
(USD million)
2015
2012Q4
and aid to support the government
(USD million)
2012Q1
of tax revenues, the levels of grants
Change in
Growth in
2012Q2
level of economic activity starting
Optimistic scenario
Optimistic scenario
Source: PMA database.
[70] These variables include: the economic growth rate, interest rates on both lending and deposit for the three currencies circulating in the Palestinian
economy, the exchange rates for the USD and the JD against the NIS, the real effective exchange rate (REER) and finally the inflation rate.
[71] For further details, check the Annual Report 2014 published by the PMA.
Chapter Seven: Financial Pressure “Stress Testes”
81
current expenditures and keep growth rates for revenues and expenditures at previous-year level. As to foreign aid,
it is expected that donor countries will continue to provide financial aid to the Palestinian Authority at the previous
year’s levels, estimated at around USD 1.0 billion.
Under the pessimistic scenario, however, the economy is exposed to an adverse shock in 2015. It is expected that the
country will suffer from a sharp deterioration in political and security conditions; a drop in the number of Palestinians
working in Israel; a tightening of restrictions on movement of people and goods; an increase in days of closure for
workers and trade; a proliferation of trade barriers; continued withholding of clearance revenues by Israeli authorities; a decline in donor countries’ foreign aid in support of both the budget and economic development and a delay
in the transfer of funds allocated to rebuild Gaza Strip. If such a shock materializes, PMA forecast point to further
deterioration in economic conditions leading to economic contraction by about 4.3 percent.
The results under the aforesaid scenarios showed that loan provisions will witness a rise under both scenarios. For
the baseline scenario, the rise will amount to USD 4.8 million during 2015, which marks an increase by USD 2.9 million
over the loan provisions for 2014. Under the pessimistic scenario, the rise is estimated at USD 18.1 million, an increase
of USD 16.2 million over loan provisions at the end of 2014.
82 Financial Stability Report - PMA