The Banking Sector In Jordan

Performance and Challenges

            During the past few decades , Jordan has witnessed a remarkable growth , that dominated all economic sectors of the country , the result of which was a widespread economic and social prosperity . However , the progress , that the Jordanian banking sector experienced , was the most prominent and explicit compared to other sectors . The banking sector in Jordan momentarily stands as a highly developed body , which comprises various financial institutions managing a considerable volume of financial assets, which are gainfully employed within all economic sectors of the country .

            For the purpose of this paper, the Jordanian banking sector is defined as the financial body, comprising the Central Bank, commercial banks , investment banks, real estate saving institutions, specialized lending institutions, insurance companies, Amman Financial Market and financial intermediaries which represent together the financial system of Jordan .

            My presentation will primarily focus on the Jordanian banking sector and the developments that are taking place in this sector . In this paper, I shall first present a historical background for the Jordanian banking sector . The banking sector’s current conditions, its structure, performance and development will be overviewed  . Then, I shall attempt to pinpoint the problems and challenges that are facing the banking sector in Jordan . Ultimately, I will outline and agitate the reforms of the financial sector that Jordan is currently undertaking and adopting in order to modernize this important sector .

I.       A Historical Background  :

                The first beginnings of the Jordanian banking sector go back to the year 1925, when the Ottoman Bank commenced its operations in the country as the first commercial bank, followed by Arab Bank in 1934 and the British Bank of the Middle East in 1949 . The banking sector remained limited to these three banks until 1955 ,when three new commercial banks were incorporated during the period 1955 - 1960, namely, Jordan National Bank, Jordan Bank, Cairo - Amman Bank in addition to Rafidein Bank, which opened its first branch in Jordan in 1957 .

              The banking sector did not experience any major developments during the period of the 1960s since no other banks, either local or foreign, emerged . However, with the beginning of 1970s, the banking sector in Jordan started to undergo a major transformation, both in quality and quantity . Several Jordanian commercial banks were opened (Jordan Kuwait Bank, Jordan & Gulf Bank, Petra Bank, and Syrian Jordanian Bank) . In addition, several foreign banks opened new branches in the country since then (CitiBank, Chase Manhattan, and Credit & Commerce Bank) . Other financial institutions, specialized banks and investment banks commenced operations in Jordan, which eventually led to the integration of the Jordanian financial market, in terms of the variousness of its units and financial tools available .

                  In this regard, the following table may clarify more the historical development of the Jordanian banking system during the period 1965 - 1955 .

    Development of

       The Jordanian Banking Sector

JD Million

                 The development of the Jordanian banking sector passed through six main stages, which can be outlined as follows :

1. First Stage ( 1925 - 1967 )  :

               This stage, which extended from the starting of the banking sector until 1967, was characterized by the limitation of the banking sector in terms of number of operating banks, total assets and functioning in addition to the absence of the Central Bank, which was established in 1964  .

               Lending policies of banks during this period were limited to short - term lending, represented by discounting short - term commercial papers and extending overdraft accounts . The total volume of credit at the end of this stage did not exceed J.D. 39 million and the volume of banks’ domestic investment amounted to less than J.D. 0.9 million  .

2. Second Stage ( 1968 - 1973 )  :

               This stage did not witness any significant developments within the banking sector in Jordan, and this sector concentrated mainly to maintain its achievements and credibility within the local market due to the economic and political circumstances dominated then , which exerted some pressures on liquidity .

3.  Third Stage ( 1974 - 1981 )  :

               This stage was characterized by the major accomplishments achieved by the Jordanian economy in general, and the banking sector in particular, which witnessed a huge expansion in terms of operating units, total assets and variousness of financial tools used .

               The total number of banks increased to 17 banks , with a total of 174 branches and assets of J.D. 1330 million in addition to credit facilities amounting to 721 million . This period witnessed the early emergence of the capital market when the first corporate bonds were issued and the first syndicated loan was arranged . This period witnessed also the establishment of Amman Financial Market  .

4.  Fourth Stage ( 1982 - 1990 ) :

               This period can be considered as the most difficult stage and the longest as well, that the banking sector has experienced . The main factors that negatively affected the banking sector during this stage were the withdrawal in the performance of the Jordanian economy, the outburst of the public debt and foreign exchange crisis, and the resulting devaluation of the Jordanian dinar .

               Despite the difficult conditions encountered by Jordanian banks during this period and the continuous efforts of banks to reorganize their internal administrative structures, the banking sector managed to increase total deposits in local currency to J.D. 1811 million and in foreign currencies to J.D. 535 million, and increase total credit facilities to J.D. 1630 million by the end of 1988 .

               The end of this stage was an opportunity for monetary authorities to overview the whole banking system in order to reorganize it and ensure its safety .

5.  Fifth Stage ( 1990 - 1993 )  :

               This stage was dominated by the Gulf crisis and the resulting consequences , the most important of which were the influx of huge numbers of Jordanian returnees from Kuwait and other Gulf states , deprivation of Jordan from its traditional markets in Iraq and Gulf states and the suspension of foreign aid and grants to Jordan .

               In return , this event  availed to the banking sector unprecedented amounts of liquidity , which resulted in a significant increase in banking deposits .

6.  Sixth Stage ( 1994 - Present )  :

               This stage coincided with the conclusion of peaceful talks between Jordan and Israel and the signing of a peace treaty between both parties , the outcome of which did not directly materialize to the Jordanian society . This fact contributed to the spread of a state of unclear vision and uncertainty to businessmen and industrialists in the country , which led to a state of economic recession .

               In addition , the tight fiscal policy adopted by the Central Bank of Jordan led to a shrinkage in liquidity within the domestic market , which in turn led to a minor growth of deposits in local currency , a fact which limited the lending capabilities of commercial banks in the country .

               Nevertheless , licensed banks in Jordan have managed to increase their assets to a total of J.D. 8430.4 million , their deposits to J.D. 5788 million and their credit facilities to 3705.7 million by the end of 1995 .

II.      Structure of The Banking Sector  :

                 The banking sector in Jordan is one of the economy’s most active and sophisticated sectors . It continues to achieve impressive growth and improvements in the quality of services, while providing Jordan’s growing economy with adequate financial and banking services .

                  In addition to the Central Bank of Jordan , the Jordanian banking sector comprises the following units and institutions  :

1.  Fourteen commercial banks, with a total of 430 branches throughout the kingdom, an average of a branch for every 10,000 people .

2.  Six investment banks  .

3.  Four specialized credit institutions (Agricultural Credit Corporation, Cities and Villages Development Bank, Industrial Development Bank, and Housing Bank) .

       In addition to these banks, there are some institutions, which comprise, together with banks, the financial system in Jordan . These financial institutions can be outlined as follows  :

-    Amman Financial Market - Stock Exchange  .

-    Pension funds : There are several pension funds , the largest of which is the Social Security Fund . It is worth mentioning that pension funds are supposed to be sources for long - term funds; However, due to the market structure and the unavailability of quality long - term investments , a major portion of the pension funds’ resources are invested in money market short - term instruments or in real estate where the return has been reasonably high .

                 This structure is a result , in part , of the government policy of creating special institutions to provide subsidized credit to certain sectors of the economy . The government in Jordan believed that commercial financial institutions may not provide enough finance to certain specific sectors such as agro-business and housing .

III.     Current Conditions of The Banking Sector  :

                  During the past few years , the Jordanian banking sector has witnessed several major developments in the fields of both banking policies and systems . In the field of banking policies , the main developments can be stated as follows  :

-    Expansion in long - term lending , which came as a result of the foundation of investment departments , with high technical and marketing abilities , within some banks . These departments aimed at identifying potential investment opportunities within the local market , which motivated banks to venture more aggressively into the market for long - term financing .

-    The banking institutions in Jordan started to accept the notion of social responsibility , and henceforth , cases of economic growth and job creation started to gain more attention and weight for banks when evaluating financing decisions .

-    Banks in Jordan have actively entered into the market for direct investments . Banks in Jordan showed , during recent years , a strong trend towards subscribing in almost all newly established companies.

            This newly emerging role can be viewed as a qualitative development in the investment philosophy of Jordanian banks and an abandonment of their traditional role , based on financing working capital requirements . This new philosophy resembles the German philosophy in banking practices , which gave Germany the momentum that enabled it from catching with the industrial revolution .

      In this regard, the prominent role, that German banks played in most sectors of industry can not be denied . It can be safely said that the rapid growth of the German industrial sectors since late 1800s could be attributed to the contribution of German banking in its mixed form : one which combined short - term and long - term financing and established close ties between individual industrial firms and banking institutions . On the other hand, the commercial supremacy of Germany was, to a large extent , due to the spread of German exports in the world market accompanied with the German manufacturers’ readiness to give several months credit to buyers , which , in turn , could be attributed to the way these exports were credited and financed .

      On the other hand , the developments witnessed by the Jordanian banking sector in the field of banking systems can be stated as follows :

-    Solving the profitability problem as a result of floating interest rates and the economic prosperity witnessed by the country .

-    Solving the capital adequacy ratio due to improving profitability and increasing capital and reserves and the application of international capital adequacy measures .

-    A massive expansion in local and foreign assets .

       These developments in both fields of banking policies and systems have led banks in Jordan to undertake a more aggressive lending policies . Credit extended to various sectors of the economy grew during the period 1989 - 1995 by more than J.D. 1975 million ( from J.D. 1729 million in 1989 to J.D. 3706 in 1995 ) .However , this growth in banking credit did not allow banks in Jordan to exploit liquidity surpluses available within the system . The rise in banking credit during that period represented 62.5% of the total increase in deposits , which can be attributed to the inability of banks to lend their foreign deposits as banking credit extended in foreign currency did not exceed 4.3% of the total foreign deposits amounting to J.D. 2372 million by the end of 1995 .

IV.     Challenges Facing The Banking Sector  :

                  Jordan’s banking system was plagued in the 1980’s with problems in the quality of assets and the failure of a medium - size bank . The Central Bank of Jordan took charge of bank reforms in order to remedy the problems of the sector . The reforms included the reinforcement of owners equity by limiting dividends , applying capital equity measures , tightening control , and introducing loan concentration regulations in addition to forcing a capital increase .

                  The success of the reform policies was aided by the success of the macroeconomic reforms and the liberalization program adopted by the Jordanian government to stabilize the economy. The successful application of the economic re-adjustment program and the unexpected inflow of funds into the country in the early 1990’s led to a boom in the Jordanian economy .

                   The economic boom resulted in a significant improvement in the quality of bank assets and to the overall increase in the profitability of financial institutions . With all the problems facing the financial sector in the 1980’s overcome , banks in Jordan faced a new set of challenges in the newly-liberalized competitive markets . The most serious of these challenges are  :

1.    The development of the new attitudes towards risk , and the creation of new institution to cope with risk as a result of economic liberalization .

2.    Improving the profitability and the quality of investments by developing better risk management skills .

3.    Integration with the world market in products and services .

               Commercial banks continue to dominate other financial institutions in Jordan both in the size of deposits and the size of total assets . Commercial banks also continue to remain the main source of credit in the market due to the absence of competition from other institutions or lenders . The lack of a market to pair lenders and borrowers outside the banking system in Jordan is not expected to continue for a long time . Eventually , other investors will enter the market and draw depositors away from commercial banks .

                 Additionally , borrowers will learn to seek lenders directly , thus avoiding the costs of intermediation . This will lead to a rise in the cost of  banks’ liabilities and to a decrease in the yield on banks’ assets . This will result in the erosion of the profit margins of banks and will force bank managers to seek other sources of revenue to improve income .

                  Moreover , one of the major problems facing the Jordanian financial market is fragmentation . The market is divided into several “compartments” functioning individually and in isolation from each other by laws , regulations , and special privileges extended to some institutions . This fragmentation negatively affects the market efficiency and competition and limits the growth potential for financial institutions . As mentioned earlier , this fragmentation is the result of the establishment of specialized financial institutions by the government to meet certain credit needs that the market will not be able to fulfill otherwise .

               On the other hand , The capital and money markets of LDC’s will experience leaps of growth during the next few years . There is a move towards the liberalization and globalization of the financial and banking services in accordance with the provisions of the GATT agreements . This will create new business opportunities , which , if cultivated , could yield banks adequate returns and improve their competitiveness in the world market . Without capitalizing on these opportunities , the Jordanian banking system will miss the chance to materialize these opportunities into added revenues and income , and continue to function at a modest and continuously declining share of the global market .

               Against the opportunities created as a result of the previous changes and the expected transformation of the financial system, new challenges arised and are now encountering Jordanian banking institutions . These new challenges can be stated as follows  :

*     The capital and scale challenge .

*     Creating competencies .

*     Adopting modern Balance-Sheet-Management techniques .

*     Coping with changing structure of income .

*     Facing shrinking profit margins .

*     Developing capital and money markets .

*     Investing in telecommunication and information technology.

*     Providing the latest financial products .

*     The challenge of globalization and deregulation .

V.    Reforms Undertaken  :

                 In addition to the reforms taking place in the financial market since 1989 , the market will be subject to additional reforms during the period 1996 - 1998 . The aim of future reforms will be to increase the efficiency of the market in the mobilization of funds and to enhance its ability to interact with the world’s financial markets . The reforms will focus on increasing competition by creating a level playing - field for all institutions .

                 The reforms in the Jordanian financial market will mainly affect specialized lending institutions such as the Housing Bank and the Industrial Development Bank . The expected reform will include provisions to phase out the special privileges that those institutions enjoy at present . The second phase of reforms in 1997 and 1998 will bring about the privatization of both institutions , while ensuring that they will continue to provide the medium and long - term financing for housing and industry .

                  Commercial banks will be subject to closer supervision and stricter regulation . As of 1997 , banks will be required to increase their capital to a minimum of JD 20 million . The banks will be subject to stricter disclosure requirements that will be comparable to the acceptable international standards .

                   Provisions will be made for the establishment of a secondary market for short and long term papers . The availability of medium and long - term saving instruments will be expanded during the period 1996 - 1998 through the development of pension and Social Security funds , mutual funds , and insurance companies .

                 In addition , to develop the Jordanian capital market and promote international investments , the following reforms in the structure of the stock market are still needed  :

*     Separation of the supervisory functions from the operational functions .

*     A complete overhaul of the trading , clearing , settlement , and depository systems .

*     Improvement of financial disclosure .

            The continuing rapid change in the economic , technological , regulatory and competitive factors have , and seem likely to continue making banks subject to ongoing dynamic changes . Henceforth , the management of commercial banks will continue to be increasingly challenging . Concepts and techniques used few years ago are now conceived as obsolete . The environment , in which banks raise funds , has dramatically changed in the last few years . The regulatory and the geographic protection from competition has all but disappeared . To some managers , the increase in the complexity of banking decision is an added burden , but others view it as an opportunity to reward good management .