Jordanian Capital Market

"Present and Future Outlook"

Presented to a Seminar on

"Asset and Liability Management"

Held at

The Institute of Banking Studies

November, 1996

Jordanian Capital Market

"Present and Future Outlook"

   Capital markets are the outcome of centuries of development of business financing, providing an evolving and increasingly efficient means by which governments and corporations have access to different maturities of funding, both in debt and in equity.

   Borrowers, lenders and investors within the market are all very diverse in terms of needs and requirements. They, therefore, have different preferences and conceptions for risk and reward. This, in fact, has led to the evolution of new instruments and products diversified enough to meet different needs of all parties. Evolution and innovation of other instruments will continue in the future to cover all requirements.

   Capital markets consist of a group of units or institutions, which facilitate the process of intermediation between centers of both monetary surpluses and deficits. By performing such a task, the financial markets play a vital role in availing needed finance within national economies to enhance investments and maintain sustained economic growth. The linking of international capital markets has added further importance to the role played by these markets and facilitated capital mobility across national borders.

   The importance of capital markets stems from the functions they carry out, which include:

-         Setting up of a proper mechanism for allocating funds between savors and investors.

-         Preserving and maintaining domestic savings by providing investment opportunities.

-         Facilitating the accumulation of capital for short as well as for long-term investments.

-         Constituting a mechanism, which both buyers and sellers can use, to determine the real value of traded securities.

-         Representing an organized system, through which financial papers can be exchanged for money and vice versa.

-         Providing an important indicator of the state of the economy through the movements in the prices of securities.

   Capital markets are to be further enhanced by the availability of a stable and favorable investment climate, the existence of an integral financial system (banks and financial institutions) together with specialized technical expertise, the awareness of the role played by capital markets, and the existence of an advanced network of communication.

    My presentation will focus on the current status of the Jordanian capital market and its future outlook. In this respect, I will first touch upon the importance of capital markets and their role in availing financial resources needed by deficit sectors of the economy. This will be preceded by a quick review of the historical development of the market, the financial institutions operating in it, and the financial tools available. Afterwards, I shall try to evaluate the conditions of the Jordanian capital market, recent trends taking place and the obstacles facing its evolution into an advanced market.

1. Introduction:

   For the past 20 years, the international financial markets have been witnessing an enormous wave of development, which was the direct result of various factors, the most important of which are the computer revolution, the increasing globalization of these markets and the trends of disintermediation.

   Prior to 1975, the task of financial intermediation was undertaken by four major kinds of institutions, which dominated the market at the time:

-         Commercial banks: which used to collect savers' deposits and re-lend them again to investors at a suitable margin.

-         Insurance Companies: these companies collect money by selling insurance policies to customers and employing proceeds in relatively save investments, such as medium and long-term government treasury bonds. By doing so, the insurance companies were capable of playing the financial intermediation role.

-         Brokers: besides common brokerage activities, brokers are engaged in the process of issuing, underwriting and trading in financial papers against certain brokerage fees.

-         Investment banks: such banks used to provide their customers with financial consultancy services needed to find suitable cost effective sources of finance.

    Sources of finance were limited to loans from commercial banks or insurance companies, issuance of bonds and other financial papers to be sold in the financial markets.

    Competition, among companies trading in commercial papers, was notable limited, and their income was safely secured by pre-fixed fees. The risk factor was almost absent because the main activity of these companies concentrated on brokerage. Even in certain cases where these companies used to carry a stock of inventory, their risk remained minimal due to the stability of interest rate environment.

    However, this simple system has been replaced during the past couple of decades by an extremely advanced and competitive one. This replacement came as a result of the excessive pressures created by the vast changes still taking place in the world financial markets at present.

    In addition to the boom experienced by the financial markets in the field of technology, information and financial products introduced into the market, the so-called financial engineers were capable of introducing new instruments, the most important of which may be referred to as the securitization of loans (turning loans into financial papers that can be traded and liquidated quickly). These new developments enabled investors to borrow directly from the market at a cost significantly lower than the cost charged by the banks.

    However, the deregulation of the banking industry and allowing banks to deal in commercial papers and undertake brokerage activities have worked effectively in eliminating distinctions between financial institutions and commercial banks. Banks were able to undertake securitization activities and pass lending risks to bearers of financial papers, which enabled these banks eventually to lower their costs.

    Nowadays, the international financial markets stand to represent extremely complicated systems in terms of the variety of financial institutions, segmentation of markets and the instruments and products provided to customers.

   Financial markets are divided into money and capital markets. Money markets are designed for making short-term loans, where individuals and institutions with temporary surpluses of funds meet others who have temporary shortages of funds, thus helping both parties to manage their liquidity.

   Financing working capital needs for business and temporary needs of government, until taxis collected, is the main function of money markets. In contrast, capital markets are designed for long-term investment by both business and government. Availability of funds in capital markets made the construction of factories, highways, industries and schools possible.

    The usual distinction between money and capital markets is the maturity of the credit instruments in which they deal. By common consent, money market instruments are those with maturities of one year or less; capital market instruments lie beyond that range. This leaves a wide range for capital market instruments. In addition, capital markets include financial instruments with no maturity, such as stocks.

   Money market instruments, which are characterized by their high liquidity and short-term maturity (less than one year), consist of the following:

1-        Treasury bills.

2-        Commercial papers.

3-        Bankers acceptances.

4-        Dealers loans and repurchase agreements (Repos).

5-        Negotiable certificates of deposits.

6-        Surplus reserve funds.

7-        Treasury notes.

   The most significant function of money markets is to provide economic units with financial facilities needed for adjusting their liquidity positions.

   Capital markets, on the other hand, can be divided into two major segments:

-         Debt market: the part of the market where dealings are in instruments issued to raise funds by borrowing.

Securities traded in this market usually fall within the following generic categories:

·         Government bonds.

·         Government agencies bonds.

·         Local government bonds.

·         Corporate bonds.

-         Equity market: the part of the market where dealings are in instruments issued to raise funds for business ventures. The variety of instruments under this category is limited, and restricted to the following:

·         Ordinary shares (Common Stock).

·         Preferred Stocks and Share Warrants.

·         Convertible Preferred Stokes.

2. The Jordanian Financial Market:

   Despite the fact that our subject is about the capital market, I shall attempt to review the two parts of the Jordanian financial market, the capital market as well as the money market, due to the significant role of the money market in availing finance compared with limited role of the capital market.

A. Historical Overview:

   Until 1964, the financial market in Jordan mainly consisted of (9) commercial banks working under very conservative policies due to the lack of a central bank. The monetary authority was in the hands of Jordan Money Council, whose only duty was to issue the Jordanian currency against the full coverage of the British Pound.

   The establishment of the CBJ was the first serious step to develop an organized financial market in Jordan because this market is necessary to secure the success of monetary policies.

   In 1966, a number of financial regulations were issued among which was the public Dept Law, permitting the government to borrow internally through the issuance of treasury bills and bonds. The first such issue was done in January 1969 representing the cornerstone of the Jordanian financial market.

   In 1971, medium-term government bonds were issued heralding the advent of an organized capital market. This was followed by the establishment of Amman Financial Market (AFM) in 1978 as well as the creation of many investment banks and financial companies.

   These developments, that Jordan witnessed in the past two decades, especially in the second half of the 1970s, were the most important among all developments that the Jordanian economy has undergone. The more significant of these were the promulgation of banking and financial regulations, establishment of many institutions, creation of a variety of financing instruments and the substantial growth in the assets of the banking system and in the size of its operations. This enabled it to play an ever-growing role in accumulating savings and directing them into investments in different economic sectors.

    In general, the evolution of the Jordanian capital market passed through three distinguished stages, namely:

-         First Stage:

      This stage, extended from 1984 until 1978, was 

   characterized by the existence of a limited variety of

   financial papers, which were not commonly  

   widespread. Legal reforms accomplished during the  

   period of the 1960s did not affect the capital market,

   which remained notably unorganized.

     During this period, the private sector depended, in  

   financing its investments, on its own resources    

   together with the government participation in the

   establishment of a few public shareholding

   companies.

-         Second Stage:

   This stage, extended from 1978 until 1992, started with the establishment of Amman Financial Market. AFM was created to organize and supervise the issuing and trading of financial papers (i.e. stocks and bonds). This market has succeeded in achieving most of its targets, and has helped to a great extent in the establishment of several projects vital for the Jordanian economy. It is worth mentioning that the total number of companies listed in the market has increased significantly over the past few years.     

-         Third Stage:

      This stage started during the year 1992 and     

   extends to present days. It is characterized by the  

   introduction of major structural reforms. In this

   respect, the government has been working very hard

   to amend laws related to the operation of the

   financial market, the most important of which is the

      Amman Financial Market Law, where a new law for

       financial papers will be issued shortly.

B. Foundations of the Jordanian Financial Market:

    The financial market in Jordan relies on three major elements or factors:

a)        The variety and number of financial institutions necessary to create a modern sophisticated financial market including:

1-        the Central Bank of Jordan.

2-        14 commercial banks including the Housing and Islamic banks, which have many branches covering Jordan.

3-        6 investment banks.

4-        Special Lending Institutions including:

·         Agricultural credit institutions including Agricultural Lending Corp. and the Co-operative Organization.

·         The Industrial Development Bank specializing in industrial lending.

·         Institutions specializing in housing credit including the Housing Bank and the Corporation for Housing and Urban Development.

·         Cities and Villages Development Bank.

5-        Government and semi-government investment institutions, including the following:

·         Social Security Corporation.

·         Jordan Investment Corporation.

·         Postal Savings Fund.

6-        20 insurance companies.

7-        Amman Financial Market (AFM).

8-        27 stock brokerage firms.

b)        The Suitability of the Investment Environment:

Jordan enjoys an excellent investment environment for the following reasons:

1-        Political stability.

2-        Good relations between employer and employee in the society.

3-        An increasingly liberal economic system.

4-        A highly qualified work force.

5-        The stability of the exchange rate for the national currency.

6-        The availability of tax and tariff duty exemptions.

7-        Protection against nationalization and confiscation.

c)        The Availability of Different Instruments:

A good and reasonable number of financial instruments do exist within the Jordanian financial market. This fact was the result of the variety of issuers and specialized financial institutions undertaking the role of intermediating between borrowers and lenders.

C. Instruments in the Jordanian Financial Market:

    Financial market instruments are the products issued and exchanged in this market. They include money market instruments and capital market instruments. Among the most important instruments used in Jordan are the following:

1-                 Deposits:

  No specific financial instrument is issued in this case, and as such there is no secondary market for these deposits. However, the development of the primary deposit market allows the development of a secondary market for interbank deposits, despite the limitedness of this market at present.

2-                 Banker Acceptances:

          Banker acceptances are time drafts, that are   

       bank-accepted or guaranteed. This instrument is

       the outcome of internal or external trade

       transactions. Such acceptances are used as a

       money market instrument and are usually traded

       at a discount from their par value. It is however,

           worth noting that no secondary market exists for

           this instrument in Jordan.

3-                 Commercial Paper:

  The only type of commercial papers known in Jordan is short-term notes issued by borrowers in favor of banks, which buy them at discount, at specified amounts for a short period of time. The usage of this instrument is very limited and no secondary market is known to exist for it.

4-                 Certificates of Deposits:

  It is relatively a new instrument in the Jordanian money market. These certificates are usually issued either through public offering or upon request. CD's have not had much success in both secondary and primary markets due to the lack of sufficient marketing to the public. No statistics are available as to their size relevant to other deposits at the current time.

  In undertaking its monetary policy, the Central Bank of Jordan replaced the issuance of treasury bonds by certificates of deposit carrying high interest. However, despite the high volume of these CD's (outstanding balance of about 550 million JD), no secondary market has developed for them.

5-                 Stocks:

  The creation of AFM in 1987 had a great impact on increasing the number of shares offered for public subscription. Shares traded at AFM are common stocks because the Jordanian Companies Law does not permit the issuance of preferred stocks. Nevertheless, preferred stock is well-known in the Jordanian market because two companies were allowed to issue such shares by special decree (the Housing Bank and Industrial Development Bank).

  It is expected that the new Companies Law will provide for the issuance of preferred stock by any company adding a new instrument to the financial market.

6-                 Government Bonds:

  These bonds are issued by power of the Public Debt Law enacted in 1966 for the purpose of creating a cornerstone for the capital market and as an arm for monetary policy. This law provided for two methods of public borrowing (i.e. treasury bills and treasury bonds). The Jordanian market contains four types of government bonds:

a.       Treasury Bills:

  The first such issuance was made on January 1969, constituting the core of the money market in Jordan. These bills are issued every 3 months and are sold at a discount by public subscription at an interest rate of 4.5%. interest on T-bills is 50% tax-exempted.

  The Public Debt Law set a maximum limit for issuing T-bills so that it does not exceed 25% of the average value of the revenues of the last 3 fiscal years, or from the total value of currency in use, whichever is greater.

b.       Treasury Bonds:

  Treasury bonds (T-bonds) were first issued in 1986 with a maturity of two years. Such bonds are sold at a discount, mainly to commercial banks.   

c.        Public Corporation Bonds:

  These are government bonds issued to finance independent government corporations at interest rates comparable to those charged on development bonds. Most of these bonds are held by commercial banks.

d.       Government Bonds:

  These bonds were basically issued for development purposes starting year 1961. a good share of these bonds are held by commercial banks. Trading in government bonds was first initiated at Amman Financial Market back in 1979, however, with limited activity. Because of the good features these bonds exhibit (reasonably high return, tax exemption and high liquidity), commercial banks and other financial institutions acquired the larger portion of government bond issues.

7-                 Corporate Bonds:

  Public corporations started issuing this kind of bonds back in 1978. However, the financial market was not active enough with regards to these bonds due to the high competitiveness of other debt instruments available within the market.

  The total outstanding balance of corporate bonds stood at JD8.2 million by the end of 1995, and the total volume of trading in these bonds did not exceed JD 319 thousands during 1995.

8-                 Syndicated Loans:

  These loans are considered one of the most important developments in the Jordanian financial market that took place at the end of the 1970s in the field of large and medium-term financing. This instrument provided a good and effective financing alternative to satisfy the increasing needs of large borrowers.

3. Amman Stock Exchange:

   Due to the relative weakness and limitedness of other aspects of the Jordanian capital market, the Amman Financial Market (ATM) will be exposed and analyzed as the main representative of the capital market in Jordan.

    When Amman Financial Market commenced its activity in 1978, the total number of listed companies was 57 with a total authorized share capital of JD 246 million. By September 1996, this number increased to 98 companies (in addition to 34 companies traded in the parallel market) with authorized capital of JD 1860 million. The total market value of these shares stood at JD 3111 million as of 30/9/1996.