ARAB BANKING

INTO 2000

Arab Banking Summit

New York

May 20-22,1996

ARAB BANKING INTO 2000

    I would like to thank the Union of Arab Banks, represented by its chairman Mr. Mahmoud Abdul Aziz and its Secretary Dr. Adnan Al-Hindi, for their invitation to participate in this panel session "Arab Banking Into 2000".

    As requested, my representation will mainly focus on the Jordanian market and the developments that are taking place there. In this presentation, I will first touch on the Jordanian market's  current situation, with special focus on the capital and mortgage markets. Then I will discuss the reforms of the financial sector that Jordan is adopting to modernize this important sector. Finally, I will discuss the development in the financial markets, success factors in the financial services industry, and the various challenges facing the Arab banks in the next century.

     The financial system in Jordan is one of the economy's most active and sophisticated sectors. The financial sector continues to achieve impressive growth and improvements in the quality of services, while providing the Kingdom's growing economy with adequate financial services. The financial system in Jordan comprises of the following:

1-        fourteen commercial banks with a total of 410 branches throughout the Kingdom, or 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).

4-        Amman Financial Market-Stock Exchange.

5-        Pension funds: there are several pension funds, the Social Security fund being the largest. Pension funds are supposed to be sources for long-term funds. 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 good. This structure is a result, in part, to the government policy of creating special institutions to provide subsidized credit to certain sectors of the economy. The government believed that commercial financial institutions may not provide enough finance to some specific sectors such as agri-business and housing.

   Jordan's banking system was plagued in the 80'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 to remedy the problems of the sector. These reforms included the reinforcement of owners' quality by limiting dividends, applying capital adequacy 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 macro-economic reforms and the liberalization program adopted by the Jordanian government to stabilize the economy. The stabilization program and the unexpected inflow of funds into the country in the early 90'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 profitability of financial institutions. With all the problems facing the financial sector in the 80's overcome, banks in Jordan faces a new set of challenges in the newly liberalized competitive markets, the most serious of which are:

1-        The development of new attitudes towards risk, and the creation of new institutions 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 n Jordan in terms of the size of deposits and total assets. Commercial banks also continue to remain the main source of credit in market due to the absence of competition from other institutions of lenders. The lack of a market to pair lenders and borrows in Jordan outside the banking system is not expected to continue for a long time. Eventually, other investors will enter the market and draw deposits away from commercial banks. Additionally, borrowers will learn to seek lenders directly, thus avoiding the cost of intermediation. This will lead to a rise in the cost of the 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 revenues to improve income.

Structural Problems:

    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, 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.

Consumer Lending:

     Consumer lending in Jordan is available to private individuals for the purposes of financing the purchase of automobiles, house repairs, appliances and other durable goods. The market for consumer credit has grown steadily over the years, because of the increase of the income and the employment as well as job security and stability for middle class households in Jordan. Growing and secure future personal income is vital for the extension of consumer credit because it allows consumers to acquire goods and services today based on their future income.

     Jordanian banks are aggressive in marketing consumer credit because of its security and high returns. The short-term nature of consumer-credit facilities is another factor that encourages banks to be active in this field of lending.

    The types of consumer loans available with in the Jordanian market place are as follows:

     - Automobile loans.

     - Home improvement loans.

     - Single payment loans.

     - Installment loans.

     - Checking revolving overdraft line of credit.

     - Credit cards.

Mortgage Market In Jordan:

    The real estate mortgage lending market in Jordan is limited to the activity of the Housing Bank and the Housing Corporation, in addition to some limited activities by commercial banks. The Housing Bank provides long-term loans to individuals, institutions, and housing co-operatives, while the Housing Corporation provides financing for large scale community housing projects.

    The mortgage lending market in Jordan is limited. It only represents about 10% of the total lending volume in the Jordanian market. This is mainly due to the limited resources available for such kind of activities. The specialized lending institutions are limited by their own resources, and by their capacity to borrow from the Central Bank for these purposes, which is also limited.

     Another factor that limits the activity in the mortgage market is the lack of a secondary market. The absence of such a market limits the liquidity for these loans, and thus the ability of the specialized credit institutions to provide more loans. This also makes commercial banks hesitant to be active in this market for matching purposes. To overcome this serious problem, a mortgage company is in the process of formation, where it will undertake the role of facilitating the creation of a secondary market for mortgage loans.

Capital Market:

     The stoke market has experienced impressive development since its establishment in 1987. however, it is yet to become a major force in financing investments in Jordan. The majority of financing comes from direct loans, syndicated loans and from specialized credit institutions. This problem is a result of the way the market is functioning and the limited sources of long-term funds.

     The major issues in the functioning of the capital markets are:

1-       Disclosure issues:

   There are efforts towards improving the accuracy and the timeliness of the financial information available from publicly held corporations.

2-       The lack of depth in the market:

   The Jordanian market lacks the necessary depth to provide the necessary liquidity and to smooth market fluctuations.

3-       Lack of government regulation:

   There is a need for a regulatory body to supervise the transparency of the transactions.

4-       Dilution of ownership:

   The Jordanian law imposes the dilution of ownership rights through limitations on the original's promoter's share in newly-floated equity. The law stipulates that the share of the promoter is not to exceed 10% of the capital. The pre-emptive rights for new stocks issues is limited to 50%.

5-       Government interventions:

   Through the action of the Government Issuing Committee, the government establishes the issue price for new equity issues or quoted corporations.

6-       Taxation:

   The capitalized retained earnings are double-taxed at the rate of 15%.

7-       Information:

   There is a lack of timely and accurate information about financials and the key ratios for bonds traded.

8-       Benchmarking:

       There is a lack of a benchmark rate to price bonds.

9-       Limitations on investments:

   There are limitations on long-term funds enabling institutions to invest their resources in long0term investments to generate extra yields and to stabilize income. This limitation comes through an obligation to extend subsidized loans to their participants, such as housing loans. Another limitation is the obligation to deposit substantial portions of the institutions' funds at semi-government-owned institutions.

Financial reform:

   In addition to the reforms in the financial market since 1989, the market will be subject to additional reforms during 1996-1998. the aim for 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 Jordanian financial market will mainly affect specialized lending institutions, such as the Housing Bank and the Industrial Development Bank. The 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 medium and long-term financing for housing and industrial purposes.

    Commercial banks will be subject to a closer supervision and stricter regulations. 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 1996-98 through the development of pension and social security funds, mutual funds, and insurance companies.

    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.

Trends in the financial markets:

    The world financial institutions and markets have been going through a period of fundamental change, these changes are due to technological developments in addition to trends of deregulation and globalization. Those factors have resulted in several new innovations in financial markets, among which are securitization, currency and interest swaps, international investments funds, and various forms of mortgages. These are only part of the huge outcome of the lending financial innovation and financial engineering that is taking place in the financial markets of the world.

     These new developments in the financial markets resulted in increased freedom in pricing and risk tolerance. In addition, larger banks moved away from the traditional role of commercial banking that ranges from accepting deposits and making loans to dealing in commercial papers, market making, investment banking, the provision of liquid reserves to other financial institutions, and credit support activities. In addition, some of the traditional balance sheet activities of the bank were moved off the balanced sheet.

     The liberalization and deregulation of financial markets world-wide have resulted in an unprecedented increase in financial innovation. Deregulation placed banks all over the world in direct competition for business. The overwhelming changes in all aspects of the industry cover several areas of operations and management. They include:

1-        An increase in the variety of financial products and increased focus on marketing.

2-        The deregulation of financial services and the decline of the role of government in the economy.

3-        The erosion of barriers between the international financial service markets.

4-        Increased coordination and cooperation between regulatory agencies world-wide, and the increased integration between the financial markets.

5-        The intensifying of competition in the provision and distribution of financial products and the expansion of potential markets.

6-        Large borrowers, such as government and large corporations are bypassing the traditional sources of financing, and raising funds in the commercial papers market, or through direct borrowing from the money market.

7-        An increase in the mergers of financial institutions to provide diverse financial services.

8-        The tremendous developments in telecommunications and data processing resulted in an expansion in the financial markets. These developments increased the capabilities of the financial institutions to expand their markets and increase the number of their customers.

9-        An increase of the threat of bank failure.

     10-   An increased attention to the operation and distribution costs & quality management.

11-The increased need for highly qualified human resources in the areas of marketing, information, and communication technology.

    Traditionally, local financial markets are moving increasingly towards a regional and global focus. In addition, the increased competition and liberalization of financial markets will lead to the creation of new forms of financial institutions that are characterized by large scale and diverse products and markets.

Success factors in banking:

    In an era dominated by a focus on customer services and changes in the environment, the success drivers in banking are defined as follows:

1-        focusing on marketing and selling and increased attention to customers' needs.

2-        Searching for strategic alliances to compensate for areas of weakness in the institution and to facilitate specialization.

3-        Continuous improvement to the managerial and organizational structure to expedite and enhance the decision making ability of the institution.

4-        Increased attention to social responsibility and the ethics of banking, because banks, which focus on the bottom line only, will find it difficult to survive the competition.

5-        Improving and intensifying R&D efforts to continuously create innovative products that will give the bank a competitive advantage.

6-        Focusing on customer services.

7-        Controlling marginal cost at both the bank and the branch levels.

8-        Improving risk management.

    Achieving the success drivers listed above, requires the management to be more open to new ideas and to the continuous and constructive changing of the organization.

    Achieving adequate return means survival sine in a highly competitive place, only the best will survive. While some may view the changes in the market as threats, they can also be viewed as opportunities. Those who develop their services and control their costs will survive and flourish.

Challenges Facing Jordanian and Arab Fin. Institutions:

    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 deregulation of financial and bank services in accordance with the provisions of the GATT agreements, which will create new business opportunities. If cultivated, these opportunities could yield banks adequate returns and improve their competitiveness in the world market. Without capitalizing on these opportunities, the Jordanian and Arab banking systems will miss the chance of benefiting from these opportunities and continue to function at a modest and continuously declining share of the global market.

     The following challenges and threats stand to face the Jordanian as well as Arab banking:

1-        the capital and scale challenge.

2-        Creating competencies.

3-        Adopting modern-balance-sheet-management techniques.

4-        Coping with changing structure of income.

5-        Facing shrinking profit margins.

6-        Developing capital and money markets.

7-        Investing in telecommunication and information technology.

8-        Providing the latest financial products.

9-        The challenge of globalization deregulation.

    The continuing rapid change in the economic, technological, regulatory, and competitive factors have, and seem likely to continue to, make banks subject to ongoing dynamic changes. It can be concluded that successful bank managers cannot set back and let the future pass without actively participating in making it.

    The management of a commercial bank is increasingly challenging. Concepts and techniques used a few years ago are now seen as obsolete. The environment in which banks raise funds has changed dramatically in the last few years. The regulatory and the geographic protection from competition has all 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.