Financial Stability Report 2013

Research and Monetary Policy DepartmentSeptember, 2014

Financial Stability Report

2013

© September, 2014All Rights Reserved.

In the case of quotation, please refer to this publication as follows:Palestine Monetary Authority (PMA), Financial Stability Report (FSR) 2013: September, 2014. Ramallah – Palestine

All Correspondence shall be directed to:Palestine Monetary Authority (PMA)P. O. Box 452.Ramallah, Palestine.

Tel.: (+ 970) 2-2415250Fax: (+ 970) 2-2409922E-mail: [email protected] Page : www.pma.ps

Foreword

Foreword

Although a relatively young field compared to monetary and economic stability analysis, study of financial stability is increasingly gaining attention, as many central banks are progressively targeting financial stability alongside monetary stability. In Palestine, focus on financial stability reflects the importance of the financial sector and its capacity to deal with risks, and promote economic growth and sustainable development. As such, the financial sector is the backbone of the Palestinian financial system and most vulnerable to risk.

The Palestine Monetary Authority (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. On one hand, this entails a sound and effective operation of financial intermediaries within efficient financial markets. On the other, it requires that financial corporations are able to 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.

Thus, financial instability may involve bank failure, excessive credit growth -whether at the macro level or by sector or debtor category- poor quality loans, asset price bubbles, insufficient liquidity and the fading of confidence in the financial system.

In this context, the current Financial Stability Report represents PMA’s contribution to foster a stable, robust and effective financial system, and maintain price stability in a manner that ensures balanced and sustainable economic growth. Publication of financial stability analysis findings contributes directly to accomplishing a key objective of PMA, as the sole institution authorized to oversee payments service providers, promote a sound and effectives payments systems, and ultimately ensure financial stability.

With this Financial Stability Report, the PMA seeks to assess the potential risks and threats to financial intermediaries and the financial system and consequently evaluate the system’s capacity to withstand such risks and threats. The report also contains PMA recommendations to enhance financial stability and prevent or appropriately respond to potential risks and threats.

GovernorDr. Jihad Khalil Alwazir

iii

Contents v

Contents

Foreword iii

Chapter One: Overall Assessment of Financial Stability 1

Overview 1

Financial stability trends in 2013 1

The Palestinian Authority (PA) and its employees 1

Consumer loans within credit portfolio 2

Placements abroad 2

Exchange and interest rates 3

Relations with Israeli correspondent banks 3

Internal schism 4

Chapter Two: Global and Regional Economic Developments 5

Overview 5

Global economy 5

Regional economy 6

Israeli economy 6

Jordanian economy 9

Chapter Three: Financial Sector Developments 11

Overview 11

Legal and regulatory framework 11

Palestine Deposit Insurance Corporation 11

Reinforcing supervisory instructions 13

Reinforcing governance 13

Fostering small and medium enterprises (SMEs) 13

Establishment of SMEs database 14

Developing banking systems 14

The implementation of the International Bank Account Number (IBAN) 14

Establishment of payments systems oversight unit 14

Opening Ministry of Finance account with the PMA 15

Upgrading the credit information bureau system 15

Reinforcing business continuity procedures 15

Development indicators in the financial sector 15

Banking expansion and concentration 15

Financial depth indicators 17

Palestine Monetary Authority (PMA) - Financial Stability Report 2013vi

Chapter Four: Credit Risks in the Banking Sector 19

Overview 19

Exposures to local sectors 19

Public sector (public finance) 19

Exposures to private sector 23

Non-performing loans (NPLs) 28

Credit gap of the Palestinian banking sector 29

Exposure to external sectors 30

Exchange rate channel 30

Interest rate channel 31

Banks’ placements abroad channel 33

Chapter Five: Financial Soundness Indicators 35

Overview 35

Capital indicators 35

Regulatory capital to risk weighted assets (capital adequacy ratio) 35

Nonperforming loans (less provisions) to core capital 36

Core capital to total assets 36

Asset quality indicators 37

Large-exposures to core capital 37

Nonperforming loans to total loans 37

Total loans to total assets 38

Earning and profitability indicators 39

Return on average assets (ROAA) 39

Return on average core capital (ROAE) 39

Liquidity indicators 40

Liquid assets to total assets 40

Liquid assets to short-term liabilities 40

Chapter Six: Non-Banking Financial Institutions 43

Overview 43

Money changers 43

Specialized lending institutions 44

Securities sector 46

Insurance sector 48

Contents vii

Mortgage sector 50

Financial leasing sector 51

Chapter Seven: Financial Pressure “Stress Tests” in Banking Sector 53

Overview 53

Stress tolerance tests 53

Tests for banks’ resilience to the collapse of one of the banks operating in Palestine 55

Macroeconomic stress tests 57

Tables

Table 3- 1: Improving banking services, 2009-2013 17

Table 4- 1: Distribution of credit portfolio by sector, 2009-2013 23

Table 4- 2: Private sector credit portfolio by beneficiary, 2009-2013 24

Table 4- 3: Mortgage and housing loans, 2012-2013 24

Table 4- 4: Credits granted by banks to SMEs by activity, 2012-2013 25

Table 4- 5: Destribution of credit portfolio by beneficiary, 2009-2013 27

Table 4- 6: Private sector credit portfolio by economic activity, 2012-2013 27

Table 5- 1: Soundness indicators of Palestinian banking system, 2009-2013 41

Table 5- 2: NIS surplus cash shipped from Palestine to Israel, 2013 42

Table 6- 1: Money changers in Palestine, 2010-2013 44

Table 6- 2: Main financial indicators of money changers, 2011-2013 44

Table 6- 3: PEX main indicators, 2009-2013 46

Table 6- 4: Financial indicators of insurance sector, 2012-2013 49

Table 6- 5: Performing indicators of mortgage sector, 2009-2013 51

Table 7- 1: PMA stress tests results, 2012-2013 54

Table 7- 2: Capital adequacy ratios (CAR), 2013 55

Table 7- 3: Matrix of inter-bank stress tests, 2013 56

Palestine Monetary Authority (PMA) - Financial Stability Report 2013viii

Boxes

Box 1: The role of Palestine Deposit Insurance Corporation in promoting financial stability 12

Figures

Figure 2- 1: Israeli channels of controlling Palestinian economy and its risks 7

Figure 2- 2: Policy rate in Israel (period average), 2009-2013 9

Figure 2- 3: Policy rate in Jordan (period average), 2009-2013 10

Figure 3- 1: Banking expansion (branching policy), 2009-2013 16

Figure 3- 2: Banking concentration (Herfindahl index), 2009-2013 16

Figure 3- 3: Credit portfolio as percent of GDP, 2009-2013 17

Figure 3- 4: GDP and credit portfolio, 1996-2013 17

Figure 3- 5: Private sector credit portfolio as percent of GDP, 2009-2013 18

Figure 3- 6: Private sector deposits as percent of customer deposits, 2009-2013 18

Figure 3- 7: Credit portfolio as percent of customer deposits, 2009-2013 18

Figure 4- 1: Government public debt, 2009-2013 19

Figure 4- 2: Government public debt as percent of GDP, 2013 20

Figure 4- 3: Fiscal vulnerabilities and their impact on financial stability, 2013 20

Figure 4- 4: Distribution of credit portfolio by sector, 2009-2013 21

Figure 4- 5: credit granted to the PA employees, 2012-2013 22

Figure 4- 6: Private sector credit portfolio as percent of total assets, 2009-2013 22

Figure 4- 7: NPLs in mortgage and housing sector, 2013 25

Figure 4- 8: NPLs in SMEs by activity, 2013 26

Figure 4- 9: NPLs structure in foreign banks, 2009-2013 28

Figure 4- 10: NPLs structure in local banks, 2009-2013 29

Figure 4- 11: Credit gap in the Palestinian private sector, 2000-2013 29

Figure 4- 12: Changes in USD against NIS (period average), 2009-2013 30

Figure 4- 13: Currency composition of total assets, 2009-2013 30

Figure 4- 14: Distribution of credit portfolio by currency, 2009-2013 31

Figure 4- 15: Distribution of deposits by currency, 2009-2013 31

Contents ix

Figure 4- 16: Lending and deposit rates in USD (period average), 2013 31

Figure 4- 17: Lending and deposit rates in JD (period average), 2013 32

Figure 4- 18: Lending and deposit rates in NIS (period average), 2013 32

Figure 4- 19: Placements abroad structure, 2013 33

Figure 5- 1: Capital adequacy ratio, 2009-2013 35

Figure 5- 2: (NPLs-provisions) as percent of core capital, 2009-2013 36

Figure 5- 3: Core capital as percent of total assets, 2009-2013 36

Figure 5- 4: Large-exposures as percent of core capital, 2009-2013 37

Figure 5- 5: NPLs as percent of total loans, 2009-2013 38

Figure 5- 6: Total loans as percent of total assets, 2009-2013 38

Figure 5- 7: Return on average assets (ROAA), 2009-2013 39

Figure 5- 8: Return on average core capital (ROAE), 2009-2013 39

Figure 5- 9: Liquid assets as percent of total assets, 2009-2013 40

Figure 5- 10: Liquid assets as percent of short-term liabilities, 2009-2013 40

Figure 5- 11: NIS cash liquidity (in USD) in Palestinian banking sector, 2006-2013 41

Figure 5- 12: NIS cash liquidity as percent of total assets, 2006-2013 42

Figure 6- 1: Credits granted by specialized lending institutions to SMEs by sector, 2013 45

Figure 6- 2: NPLs of credit granted by specialised lending institutions to SMEs by sector, 2013 45

Figure 6- 3: Mortgage and housing loans by sector, 2013 46

Figure 6- 4: Al-Quds index, 2009-2013 47

Figure 6- 5: Linkages between insurance and banking sector, 2009-2013 50

Figure 7- 1: Tier 1 capital to risk weighted assets, 2012-2013 54

Figure 7- 2: Effect of different scenarios on capital adequacy ratios, 2013 56

Figure 7- 3: Provisions according to different scenarios, 2014 57

Chapter One: Overall Assessment of Financial Stability

1

OverviewOne of PMA’s primary functions is to maintain a secure, sound and effective financial system. For that purpose, the PMA has put in place tight regulatory, legislative and organizational frameworks, in line with relevant international best standards and practices. As a result, most of the banking system’s financial indicators showed good performance and notable improvement.

Nevertheless, the PMA is well aware of the risks threatening the system’s stability, which are mainly associated with the peculiarities of the Palestinian situation. The risks stem in particular from the absence of a national currency and monetary policy, and, consequently, PMA’s inability to play the role of lender of last resort. Risks additionally result from Israeli restrictions on the freedom of movement and access, and PNA’s inability to implement and enforce law over a large area of Palestine (Area C and Jerusalem). Such circumstances undoubtedly constrain banking activities, including credit granting.

Financial stability trends in 2013

The banking sector has become a most efficient and influential sector of the Palestinian economy, contributing both directly and indirectly to maximizing economic value added. As a financial intermediary, it also plays a significant role in boosting economic growth and promoting sustainable development.

Several banking developments attest to PMA’s success in enabling banks to assume their role in a highly risky environment. The enabling measures and prudential arrangements PMA undertook included: developing the banking infrastructure, reinforcing the financial safety-net, upgrading supervisory procedures and instructions in accordance with best international practices, addressing the problem of weak banks, building up the national payments system, establishing the Palestine Deposit Insurance Corporation, and fostering customer confidence.

PMA’s enabling role was attested to by banks’ good performance. This in turn was clearly indicated by various banking sector financial indices, like the enhanced value and quality of assets and the heightened bank capacity to deal with expected and unexpected risks. Notwithstanding the good performance, robustness, and steadiness of the banking system, the PMA has observed a number of potential risks to financial stability, particularly in the following areas:

The Palestinian Authority (PA) and its employees

In view of its financial distress, the irregular flow of both clearance revenues and foreign aid, and its need to meet its financial obligations, the PA has recently shifted towards greater reliance on domestic resources of

Chapter OneOverall Assessment of Financial Stability

Palestine Monetary Authority (PMA) - Financial Stability Report 20132

financing. Combined with credit given to public employees, the proportion of credit granted to the government and its employees may have well surpassed 48 percent of total bank credit extended in 2013.

This rise in credit granted to the PA has raised credit concentration risk and adversely affected banks’ capacity to lend to the private sector. Moreover, the growing direct and indirect bank exposure to the PA (including government, public sector employees and private sector corporations supplying goods and services to government) can seriously compromise banking system’s soundness, especially if indebtedness rises above a certain limit and PA’s fiscal position deteriorates.

Hence, the PMA continues to carefully monitor the abovementioned risks through conducting quarterly stress testing using banks’ consolidated balance sheets. Results reveal that the ratio of banks’ core capital to their risk-weighted assets continues to exceed the percentage set by the PMA (12 percent) and by the Basel Committee (8 percent). However, this percentage can drop below the level designated by the PMA in case of severe political or economic shock. This may happen when, for example, fair values of investments abroad drop (which may be indicative of a high ratio of foreign assets to total assets) or the quality of loans granted to the PA and its employees declines.

It is noteworthy that government borrowing from the banking system does not comply with Article (21) of the Palestinian Public Debt Law, which states that government domestic loans shall be restricted to borrowing by issuing government bonds. In this context, and pursuant to the provisions of the aforementioned Law, the Cabinet has recently decreed to restructure part of outstanding sovereign debt to local banks by issuing government bonds to be traded solely by banks.

Consumer loans within credit portfolio

The PMA closely monitors possible risks of credit concentration in consumption and real estate. The PMA encourages banks to diversify loan portfolios by allocating additional credit for investment, SMEs, and productive sectors like industry and agriculture.

Keenly aware of SMEs’ role in generating economic growth, promoting sustainable development and alleviating poverty and unemployment, the PMA has offered support to such enterprises. Thus, the PMA has facilitated SMEs’ access to sources of financing and credit, a key determinant of these enterprises’ growth and prosperity. To that end, the PMA has adopted several stimulating measures, including the waiver of the requirement of an advance cash payment of 10 percent of the SME outstanding debt balance, when rescheduling a non-performing loan. Another measure was exempting banks from the 2 percent risk reserve requirement on their facilities granted to SMEs. This measure is anticipated to motivate banks to expand such financing.

On a different note, and for the purpose of improving lending conditions, the PMA accords particular importance to the ratification of the Law on Pledges on Movable Property and the reinforcement of creditor rights , including through acceleration of judicial procedures.

Placements abroad

By end 2013, the value of placements abroad reached USD 3.5 billion, of which 76 percent were balances placed abroad and 23 percent were investments in the form of securities, stocks and bonds and other financial Islamic tools. Credit facilities granted abroad accounted for a mere 1.0 percent of total placements abroad and were diversified across countries and financial institutions.

Chapter One: Overall Assessment of Financial Stability 3

These placements are often only marginally influenced by developments affecting the global financial system. Hence repercussions on the Palestinian financial system remain limited in view of the weak association between the financial institutions of the global and Palestinian markets. Furthermore, PMA has issued supervisory instructions to the Palestinian banking system insulating it from the adverse effects that afflicted the global banking and financial markets. Overall, the recent global financial crisis, which had pronounced and far-reaching effects on many countries had only a very limited effect on the Palestinian banking system.

However, Palestinian foreign placements remain susceptible to external risks, due to the high concentration of some of them in specific countries that could suffer from inflationary pressures, high sovereign debt or declining official reserves. The PMA continues to closely monitor these investments and is always ready to take measures to limit their concentration.

Also the Palestinian financial system may be impacted by global financial developments via the channel of the Palestine Exchange (PEX). This is so since PEX has important inter-linkages with some regional financial markets, which, in turn, are clearly influenced by global international markets. Nonetheless, such developments pose limited risks, since the majority of companies listed with PEX are local companies, which are more susceptible to domestic than global developments.

Exchange and interest rates

The exchange rate channel exerts a direct influence on the value of financial assets. In view of the absence of a national currency and the use of three currencies, the Palestinian banking sector’s environment remains unfavorable and rife with risks arising from exchange rate fluctuations. These fluctuations adversely affect the banking sector’s assets, heighten exchange risks and make risk management and settlement of various transactions unduly difficult. Obviously, the severity of these risks increases with the increasing fluctuation in exchange rates.

Such a situation implies that the value of banks’ assets is inevitably prone to the various economic risks affecting the countries whose national currencies are circulating in Palestine (namely, USA, Israel and Jordan), as these risks impinge on the respective currencies’ exchange rates.

Furthermore, the absence of a national currency restricts PMA’s ability to implement necessary measures to influence money supply and interest rates by means of conventional monetary policy instruments; this also poses risks to the banking sector.

Relations with Israeli correspondent banks

Pursuant to the Paris Protocol on Israeli-Palestinian economic relations, the relation with Israeli banks is confined to four main channels of largely imposed trade transactions. These channels are: check clearing through the Israeli clearinghouse for checks drawn on Palestinian banks to be paid into Israeli banks and vice versa; inflow and outflow of transfers to and from Israel; issuing and executing letters of credit in Israeli shekel (NIS) through Israeli banks; and the management of cash liquidity particularly in the Israeli shekel.

The abovementioned channels are often time subject to the vagaries of Israeli politics and thus pose potential risks to financial and banking stability. A good example is the case in mid-2007, when Israel suspended check clearance with Israeli banks for all Gaza’s bank branches, and fully halted all outflow and inflow of transfers.


Likewise in 2009, massive cash surpluses in NIS started to accumulate in West Bank (WB) banks due to Israeli-imposed barriers to the transfer of these surpluses to Israeli banks, in violation of the Paris Protocol principles.

Undoubtedly, the situation portrayed above increases the difficulty of the liquidity management process for Palestinian banks, and heightens liquidity-associated risks.

Internal schism

The persistent West Bank-Gaza schism exacerbates the conflicts and contradictions of laws and regulations that apply in the two parts of the Palestinian homeland. This is particularly true of legislation in the economic sphere and the consequent serious distortion of both the economic structure and the financial system. For despite the continued and effective enforcement of the Palestinian Law No. (9) of 2010 on Banking and the Law No. (9) on Anti-Money Laundering in both regions of Palestine, the measures that the Gazan authorities adopted in GS and the waning of the official business sector have adversely affected the economy, specially the financial system. The PMA firmly believes that overcoming such risks necessities conclusion of the reconciliation process as soon as possible.

5Chapter Two: Global and Regional Economic Developments

OverviewThis chapter analyses developments in the global economy and in some neighboring countries’ economies linked to the Palestinian economy. The analysis aims to better assess the risks that these developments pose to the financial stability in Palestine. In the event, much stress has been laid on developments in the Jordanian economy since Jordanian banks operating in Palestine constitute a very significant component of the Palestinian banking sector. Subsequently, the risks facing the Jordanian economy will inevitably impinge, both directly and indirectly, on the financial stability in Palestine. Likewise, developments in the Israeli economy have a direct impact on the Palestinian banking sector, considering that the NIS is the main circulating currency in Palestine. It is therefore important to appraise regional and international economic and financial developments so as to gauge their potential impact on domestic financial and banking stability and the Palestinian economy at large.

The Palestinian economy in considered exceptional among other economies, in view of the ongoing Israeli occupation and the heavy dependence on the Israeli economy. Other special considerations include: (i) the absence of a Palestinian currency and the use of three different currencies in trading, financial and banking transactions, and (ii) an excessive dependence on foreign aid.

Global economy

The global economy suffered from a slight slowdown during 2013 compared to the previous year. Real GDP growth declined to 3.0 percent, compared to 3.2 percent in 2012. The slowdown in 2013 is attributable to a general decline affecting the economies of both advanced countries, and emerging and developing countries (EDCs), with the growth of advanced countries falling back from 1.4 percent to 1.3 percent, and EDCs’ growth dropping to 4.7 percent from 5.0 percent in the previous year.

This slowdown took place amidst several challenges facing the global financial system, as it headed back to financial stability. Certain advanced countries adopted several monetary policy emergency measures in response to the global financial crisis and the euro-area sovereign debt problem. When eventually these countries returned to conventional monetary policies, the global financial system had not yet attained the desired stability, and advanced countries continued to provide financial markets with monetary liquidity on concessional financing terms.

Chapter TwoGlobal and Regional Economic Developments


To achieve global financial stability, advanced countries’ and EDCs’ implemented policies had to shift from financing back to development. This especially applies to the USA, which should revert to conventional monetary policies in order to evade financial stability risks. EDCs should also restore financial balance to their monetary policies in order to eschew external financial risks. Moreover, the euro area (EU) should achieve advances in financial integration and improve financial assets’ quality, particularly for the distressed countries[1]. In Japan, a sound execution of Abenomics[2] is necessary to achieve sustainable growth and stabilize inflation rates, based upon the so-called three “arrows” of government economic policy. These arrows refer to: intensified fiscal stimulus; radical expansionist monetary policy; and structural reforms that reinforce the private sector, stimulate local demand and revive Japan’s industrial competitiveness.

Global economic developments inevitably affect the Palestinian economy in several ways. Prices and inflation rates in Palestine are influenced by global trends since the bulk of Palestinian economic needs are imported, mainly from Israel. Israel, in turn, is evidently influenced by global economic developments given its intricate international financial and trade relations, especially with the USA and the EU. Most strikingly, prices of fuel and basic food products in Palestine are highly susceptible to global price fluctuations.

However, developments in the global financial system have exerted only limited effect on the Palestinian financial system, since both systems’ financial institutions are loosely interconnected. Furthermore, the PMA has issued several supervisory instructions that have effectively shielded the Palestinian banking system from the adverse effects that afflicted global banking and financial markets. Overall, the recent global financial crisis has hardly affected the Palestinian banking system, despite its severity and far-reaching world-wide effects. Nevertheless, the Palestinian economy remains susceptible to developments in the PEX, which is closely interlinked with regional financial markets and hence with international markets. However, risks posed by global financial developments remain limited as the majority of PEX-listed companies are local businesses, which are more vulnerable to domestic than global developments.

Regional economy

Israeli economy

The Palestinian economy is significantly influenced by the economies of neighboring countries, particularly Israel and Jordan. The Palestinian economy’s essentially forced dependence on its Israeli counterpart makes it highly vulnerable to economic developments in Israel. Financial changes, in particular, have a direct effect on the Palestinian financial system, since the NIS is the main currency in use in Palestine (alongside the US dollar and the Jordanian dinar). Therefore, the Bank of Israel’s monetary policies regarding interest rates and the shekel/dollar exchange rate directly impact the Palestinian economy and citizen’s income and standard of living. In general, the Palestinian economy is linked to the Israeli economy through four main channels that are illustrated in the figure (2-1).

[1] These countries are: Cyprus, Greece, Ireland, Italy, Spain and Slovenia.[2] Economic policies proposed by the Prime Minister of Japan since December 2012, Shinzo Abe, who is considered the leader of Japan’s

new economic expansionist reforms.


The most prominent risks that heavy dependence on the Israeli economy pose include: Israel’s occasional disruption of the transfer of clearance revenues to the PA, Israeli hindrance of Palestinian external trade, close control over Palestinian workforce in Israel, and Israeli restrictions on Palestinian banking sector’s activities[3]. Thus, risks to the financial and banking stability in Palestine derive from mainly external sources. In particular, fiscal risks and the associated exposure of the banking system stem from Israeli full control over clearance revenues and the fluctuation of foreign aid.

On the macroeconomic level, a main risk is posed by the employment of Palestinian workers in the Israeli market. This applies specifically to the WB, since all workers in Israel are West Bankers. This has been the case ever since Israel denied entry to Gazan workers following its withdrawal from the Strip in 2005. Palestinian workers in Israel during 2013 numbered 99 thousand, constituting 16.1 percent of the total number of WB workers[4]. It should be noted that this percentage has been on the rise over recent years.

Thus Israel plays a key role in absorbing a significant part of the Palestinian workforce, and can exploit this to put economic pressure on the Palestinians. In fact, the size of the Palestinian labor force in Israel (99,000) assumes increased importance given the number of families dependent on these workers’ income. For if Israel decides to deny entry to these workers, a dangerous surge in unemployment and poverty levels in the WB will ensue. This in turn increases financial pressure on the PA and significantly worsens its budget deficit.

[3] Chapter Four addresses fiscal exposure as well as external risks with regard to interest and exchange rates, which are expected to directly and indirectly impact banking and financial stability in the form of shocks affecting various sectors of the Palestinian economy. Likewise, Chapter Seven presents various impact scenarios on the banking sector using financial risk tolerance tests.

[4] PCBS, Palestinian Workforce Survey: 2013, April 2014.

• NIS Liquidity management& other currencies, checks

clearance , transfers & letters of credit

• Control number ofPalestinian workers in

Israel

• Clearance revenue as a

major component ofpublic financesustanability

• Restrictions on trade and

crossing points (freemovements & access)

ForeignTrade

PublicFinance

BankingSystem

LaborMarket

Figure 2- 1: Israeli channels of controlling Palestinian economy and its risks


Risks to the Palestinian financial and banking system largely emanate from the relation with the Israeli banking system. Under the Paris Protocol, this relation involves the following four main channels:

1. Check clearing through the Israeli clearing house for checks drawn on Palestinian banks to be paid into Israeli banks, and vice versa,

2. Inflow and outflow of transfers to and from Israel[5],

3. Issuing and executing letters of credit in NIS through Israeli banks,

4. Management of cash liquidity particularly for the NIS.

The risks these channels pose to financial and banking stability have intensified since mid-2007, when Israel used the Palestinian split to impose a siege on GS and declare it a hostile entity on September 19, 2007. This declaration was used by Israeli banks as a pretext to terminate banking relations with bank branches operating in GS. As a result, on September 25, 2007 one of Israel’s largest banks, Bank Hapoalim, severed ties with bank branches operating in GS. Other Israeli banks soon followed suit.

Since then, all banking transactions between Israeli banks and bank branches operating in GS, regardless of their origins, came to a halt. All check-clearing with Israeli banks ceased, as well as the processing of outflow and inflow of transfers. In the meantime, dealing with banks operating in the WB continued, amid mounting Israeli pressures and the prohibition to supply cash required by bank branches in GS[6] in both dollar and dinar. The dollar in particular was specifically banned, being the main currency used in Gaza’s tunnel trade with Egypt. Meanwhile, a very limited amount of NIS was allowed into GS. The amount was sufficient to cover public employees’ wages only, following extreme and hard-bargaining negotiations the PMA conducted with all parties involved (the Quartet Representative, Tony Blair, the Bank of Israel, the IMF and the WB).

Come 2009, the crisis spread to banks operating in the WB. The crisis was the result of the accumulation of large cash surpluses in NIS, as Israel imposed restrictions on the transport of these surpluses to Israeli banks. By doing so, Israel violated the Paris Protocol stipulated principles that “Both sides will allow correspondent relations between each- others’ banks”.

It is noteworthy that the Palestinian monetary system relies on currency diversity, with the NIS as the most important currency in circulation. According to Article IV (10-a) in Annex IV of the Protocol on Economic Relations, signed in Paris on April 29, 1994, “The New Israeli Shekel (NIS) will be one of the circulating currencies in the Areas and will legally serve there as means of payment for all purposes including official transactions. Any circulating currency, including the NIS, will be accepted by the Palestinian Authority and by all its institutions, local authorities and banks, when offered as a means of payment for any transaction”. With this virtually forced monetary subordination, the Palestinian economy is denied use of a fundamental economic policy, namely monetary policy and its associated instruments, which could promote growth and employment rates.

In this context, the Bank of Israel adopts a policy which targets an inflation rate between 1 and 3 percent as a yearly average. Such a policy directly impacts the inflation rate in Palestine particularly as the major part of Palestinian trade exchange is with Israel. As such, officially-registered external trade (exports plus imports) between the PA and Israel amounted to USD 3,457.7 million during the period (2006 – 2012), constituting 87.3 percent of total trade registered with the PA, and around 49.6 percent of nominal GDP for the same period, i.e. external trade with Israel constituted half of the Palestinian economy.

[5] It is worth mentioning that only part of inflow transfers to banks operating in Palestine are directed through the Israeli banking system, namely transfers relating to commercial transactions with Israel.

[6] See Chapter Five for details on the cash liquidity crisis under indicators of financial soundness relating to liquidity.


Mostly, external trade takes the form of imports from Israel, which have been continuously growing. For the aforementioned period, imports from Israel recorded an average value of around USD 2,822.7 million, the equivalent of 81.7 percent of Palestinian trade. To a large degree, Israel controls Palestinian economic activity, since it has the upper hand over PA crossings, constricting the Palestinian economy by means of the cumbersome procedures it imposes. As a result of these procedures, most of the basic commodities and raw and intermediate materials are imported through Israel. This poses a serious threat to the Palestinian economy, as the suspension of import activities will effectively cripple most of Palestinian industries. Likewise, the suspension of the export of Palestinian goods through Israeli seaports and airports will result in the collapse of export industries, since most of Palestinian exports leave through Israel. These risks definitely impinge on the financial and banking stability in Palestine.

Data shows that the Israeli economy witnessed a slight slowdown during 2013, in conformance with global performance rates. The growth rate declined to 3.3 percent as compared to 3.4 percent and the inflation rate averaged 1.5 percent as compared to 1.7 percent in the previous year. Thus, inflation rates, real interest rates and the purchasing power of the NIS in Palestine were all directly affected by economic developments in Israel.

As to interest rates, the Central Bank of Israel gradually reduced the policy interest rate from 2 percent by end 2012 to 1 percent by end 2013. Following the climax reached by policy interest rate during 2011, average interest rate receded during 2012 and 2013, under a policy aimed to stabilize prices, motivate the market and stimulate the economy. Official reserves of foreign cur-rencies rose by around 7.3 percent during 2013, compared to 1.2 percent in 2012. It is worth noting that interest rate changes in Israel have not had a noticeable and statis-tically significant impact on the interest rates in the Palestinian banking sector, as revealed by PMA-conducted studies.

Jordanian economy

The interconnection between the Jordanian and the Palestinian economies, particularly in the banking sphere, is vitally important to the two countries. Eight Jordanian banks operate in Palestine, accounting for a large share of the market in terms of deposits and credit facilities alike. Assets of Jordanian bank branches in Palestine constituted around 52.4 percent of total assets of banks operating in Palestine by end 2013. Similarly, Jordanian banks accounted for 55.9 percent of total customer deposits and 46.5 percent of total credit facilities granted by banks operating in Palestine by end 2013.

The Jordanian dinar is one of the three currencies circulating in Palestine, and therefore, the Jordanian currency and banking activities are major factors affecting the performance of the Palestinian banking system and economy at large. Obviously, risks to the Jordanian economy will directly impinge on financial stability and economic performance in Palestine.

Figure 2- 2: Policy rate in Israel (period average), 2009-2013

Source: Bank of Israel.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2009 2010 2011 2012 2013

Perc

ent


As to economic performance, the Jordanian economy registered a 3.3 percent real growth during 2013, compared to 2.7 percent during 2012; the inflation rate averaged 5.5 percent compared to 4.8 percent in the previous year.

It is worth noting that the Central Bank of Jordan (CBJ) pursues a fixed exchange rate regime versus the US dollar; this restricts its ability to utilize monetary policy instru-ments. In this context, the policy interest rate in Jordan fell to 3.5 percent from 4.0 percent in 2012, whereas CBJ’s official reserves rose by 65 percent compared to a decline of 30.1 percent in 2012.

Figure 2- 3: Policy rate in Jordan (period average), 2009-2013

Source: Central Bank of Jordan.

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2009 2010 2011 2012 2013

Perc

ent

11Chapter Three: Financial Sector Developments

OverviewThis chapter presents the most significant developments and enhancements to the financial and banking sector’s infrastructure in 2013, including legal and supervisory frameworks and systems underpinning financial stability. The PMA continued its efforts to develop and upgrade this infrastructure and enhance the financial sector’s efficiency in various areas. Thus several significant accomplishments were made with regard to: legislations, instructions and supervisory systems, completion of several major projects, upgrading banking supervisory systems, promoting financial and banking inclusion, and implementing the various phases of the Basel Committee on Banking Supervision guidelines.

These achievements served to meet the requirements for transforming the PMA into a modern and full-fledged central bank. Perhaps the most prominent accomplishment in 2013 was the establishment of the Palestine Deposit Insurance Corporation (PDIC). Actually, PDIC constituted a fundamental component of the financial safety-net, without which financial stability would have remained vulnerable to financial and banking challenges and crises, as international experience has clearly shown.

Legal and regulatory framework

In 2013, the PMA pressed with its efforts to lay out and enhance the legal and legislative framework regulating banking in accordance with international best practices. The framework developed sets a resilient and comprehensive infrastructure that would mitigate risks to the banking system and financial sector at large. In particular, the PMA completed its updates to some of the banking systems introduced in the previous years, and initiated new projects to be wrapped up in the near future. The following are the major achievements made:

Palestine Deposit Insurance Corporation

The issuance of the Law on the Palestine Deposit Insurance Corporation No. (7) of 2013 [7] was followed on September 17, 2013 by Presidential Decree No. (68) of 2013 which established PDIC’s Board of Directors, composed of seven members and chaired by PMA’s Governor[8].

[7] The Law issued by Presidential Decree on May 29, 2013 was published in the Palestinian Gazette, issue (101), on August 20, 2013.[8] Members of the Board are: Dr. Jihad Al-Wazir, Governor of the PMA and Chairman of the Board of Directors as per the Law, Mr. Ahmad Al Sabah

(representative of the Ministry of Finance and nominated by the Minister), Mr. Hatem Sarhan (Companies Controller as per the Law), Dr. Basem Khoury, Mr. Ali Safarini, Dr. Said Haifa and Mr. Mohammad Al Aidi.

Chapter ThreeFinancial Sector Developments


Box 1: The role of PDIC in promoting financial stability

The Palestine Deposit Insurance Corporation (PDIC) was legally founded by Presidential Decree, putting in place a main component of the financial safety-net and a major determinant of financial and banking stability in Palestine. The PDIC aims to protect depositors in accordance with a deposit insurance ceiling set forth by law, thereby reinforcing confidence in the Palestinian banking system.

According to the Law, the PDIC’s equity consists of (i) a government capital contribution of USD 20 million, (ii) a non-refundable one-time subscription of USD 100 thousand per bank, and (iii) banks’ annual fees of a minimum of 0.003 of total insurable deposits (paid quarterly). Thus pursuant to the Law, sources of funds to PDIC consist of:

• Annual subscription fees paid by licensed banks, ranging from 0.003 to 0.008 of the value of total insurable deposits;

• Investment revenues of the deposit insurance system’s funds;

• Loans acquired by PDIC;

• Grants acquired by PDIC subject to BoD approval.

As indicated above, the PDIC includes all banks licensed in Palestine, whether commercial or Islamic; hence two funds were established: the first to manage funds from commercial banks’ subscriptions and their revenues; the second to manage funds from Islamic banks’ subscriptions and their revenues as per the Islamic Sharia’ Law.

It is noteworthy that deposits in all currencies with banks licensed in Palestine are eligible for protection, except where the law requires otherwise. Thus excluded deposits include: deposits of the government and public institutions, PMA deposits, interbank deposits and deposits between other financial institutions, cash margins within the limits of arranged overdraft facilities, bank stakeholders’ deposits as stipulated by the effective banking law, bank auditors’ deposits, deposits of members of Sharia’ Supervisory Board for Islamic banks, and restricted investment deposits as designated by the PDIC’s BoD.

The PMA has obtained membership in the International Association of Deposit Insurers (IADI) in November 2013; this will allow PDIC to take advantage of IADI members’ practical expertise; IADI has 75 member deposit insurance corporations worldwide. It is to be noted that during the donor countries’ meeting held in New York on September 26, 2013, the IMF commended the establishment of the PDIC, pointing to its positive role in reinforcing the financial safety-net and financial stability in Palestine. The establishment of PDIC comes at a time when the banking system enjoys robustness, creditworthiness and capital adequacy, the latter at a level well higher than that specified by international standards.

It is to be noted that deposit accounts in banks licensed in Palestine numbered 2,748,387 by end 2013. Customers’ deposits value exceeded USD 8.3 billion, of which USD 6.1 billion were individual deposits and USD 1.6 billion were corporate deposits. Hence, it was imperative that an institution is established which ensures security of deposits and promotes confidence in the banking system. By law, the PDIC is responsible for immediate payment to depositors within the designated insurance cap limit (USD 10,000 per account) in case of the liquidation of a bank; other appropriate procedures would be applied to honor other monetary obligations, in accordance with the law on liquidating procedures. It is worth noting that all deposits of


a single individual in branches of the bank are handled as a single account, whereas his/her deposits in a different bank are handled independently.

In its first meeting on September 26, 2013, the PDIC’s Board of Directors approved the corporation’s work strategy and commenced its activities. It stipulated a USD 10,000 coverage ceiling for every bank account and set banks’ annual contribution to the PDIC reserve fund at 0.003 of the value of eligible deposits, to be paid on quarterly basis. The above-mentioned insurance ceiling covers around 93 percent of depositors in licensed banks. PDIC is expected to mobilize savings, promote economic growth, enhance financial stability, and bolster confidence in the Palestinian financial and banking systems.

Reinforcing supervisory instructions

In light of Law No. (9) of 2010 on Banking, the PMA in 2013 conducted a full review of all previously issued supervisory instructions. In addition, it released new supervisory instructions [9] aimed to regulate and control banking business in view of recent local and international supervisory and legal developments. New supervisory instructions include Instructions No. (1/2013) on risk reserve, by which the risk reserve ratio on net direct credit facilities was amended to 2 percent from 1.5 percent, while the 0.5 percent ratio on indirect credit facilities remained unchanged. New instructions also included Instructions No (4/2013) on liquidity ratios and Instructions No (6/2013) on American citizens’ accounts under the Foreign Account Tax Compliance Act (FATCA). The latter instructions were intended to safeguard the soundness and stability of the Palestinian banking system against any reputational risks. These instructions specify measures that banks could implement without compromising banking secrecy rules or risking non-compliance with FATCA.

Reinforcing governance

The PMA issued Instructions No. (9/2013) on a Guide to Bank Governance Codes of Best Practices in Palestine, pursuant to which a new Guide to Bank Governance has been issued in place of a 2009-published Guide. The issue of the new Guide comes under PMA’s policy to ensure continued compliance with banking best international practices. It is believed that the implementation of the new Guide, including both the obligatory and the optional guidelines, will enhance governance and ensure that banks function in a smooth and sustainable manner.

Fostering small and medium enterprises (SMEs)

During 2013, the PMA issued several circulars regulating banks’ new procedures and routines. Among these was Circular No. (53/2013), encouraging banks to extend facilities to SMEs on stimulating terms. These included waiving the requirement of an advance 10 percent cash payment on SME’s outstanding loan balance, when rescheduling debt, under certain conditions. Another PMA measure exempted banks from holding a risk reserve on facilities extended to SMEs. In addition, the PMA issued Circular (123/2013) approving the Palestinian Capital Market Authority’s (PCMA’s) instruction permitting banks, upon prior PMA authorization, to engage in insurance business as insurance companies’ brokers or agents, in accordance with pertinent terms and provisions.

[9] Further details on supervisory instructions issued in 2013 are available in PMA’s Annual Report, 2013.


Establishment of SMEs database

Under Circular (113/2013), the PMA established a database for loans granted to SMEs, with a view to bolster these enterprises and facilitate their access to funding sources. On February 4, 2013 and in partnership with the International Finance Corporation (IFC) and the Association of Banks in Palestine (ABP), the PMA organized the Palestine International Banking Conference, 2013 in the city of Jericho, under the theme ‘Empowering Small and Medium Enterprises in Palestine through Enhancing Access to Finance’. The conference’s major focus was to arouse interest in the SME sector and promote awareness of its significance as a major contributor to sustainable economic and social development. The conference also sought to encourage dialogue and partnership with institutions of the public and private sectors on SME issues, including tackling major obstacles and easing terms of bank lending to such enterprises.

Developing banking systems

To reinforce the financial and banking infrastructure, the PMA continued its strenuous efforts to build and develop banking systems[10], which comply with best international practices and mitigate risks threatening both the banking sector and financial system. To that end, the PMA in 2013 made several improvements to some banking systems launched in past years and initiated new projects to be concluded in the near future.

The implementation of the International Bank Account Number (IBAN)

In May 2013, the PMA launched phase two of the IBAN project, which purports to enhance the financial payments system’s efficiency through standardizing the identification system of account numbers between banks in various countries around the world. Besides, the successful launch in February 2013 of the project for the settlement of financial trade transactions through (BURAQ) boosted financial stability in Palestine through safeguarding the clearing and settlement of large-value financial transactions. It is worth mentioning that the implementation of the procedure linking the settlement of financial market operations to BURAQ raised the classification of PEX Counterparty Risk to “A” by the international company, Thomas Miri.

Establishment of payments systems oversight unit

The PMA has founded the important Payments Systems Oversight Unit in order to: ensure the soundness and effectiveness of existing and planned payments systems in Palestine, establish cooperation mechanisms with local bodies involved in oversight, and reinforce financial stability at large. In the meantime, work got underway to launch the National Switch project. The project aims to develop electronic payment instruments in Palestine, encourage banks to issue ATM debit and credit cards at relatively low costs, increase Points of Sale (PoS), and promote prepaid cards and foster their use. This project is a chief requirement to develop retail payments, and is therefore considered a major cornerstone of PMA’s plan to upgrade and develop a national payments system. Furthermore, the Automated Transfer System (ATS) being developed will provide an alternate and secure platform for operations of the clearing session inward and outward files.

[10] Further information on banking system developments in 2013 is available in PMA’s Annual Report, 2013.


Opening Ministry of Finance account with the PMA

Opening an account for the Ministry of Finance with PMA aims to mitigate risks associated with government transactions, promote PMA’s role as the government’s bank and financial advisor, and further PMA’s strategic plan to transform to a full-fledged central bank. To that end, an agreement to open a Ministry of Finance account with the PMA was signed, stipulating that the account will receive all external transfers paid to the Palestinian government. The account can also be used to facilitate the issuance of government bonds. It is noteworthy that the PMA is a member of the team commissioned with supervising bond issuance, for which draft instructions have already been prepared.

Upgrading the credit information bureau system

As part of its continuous updating of Credit Information Bureau systems, the PMA in 2013 completed arrangements for the first phase of the standardization of the credit information systems within a single automated platform. Moreover, the PMA developed a Unified Query System which allows private sector member companies which had joined the Credit Information System through a MoU to enjoy five key features of the system. These include the capability to: check customer’s score on the Bounced Checks System, request details of the customer’s rating, know whether the customer is a loan grantee of banks or lending institutions, establish whether the customer has unpaid due installments, and finally check the customer’s overall credit history with the banking system. These features enable companies to make a more informed decision concerning their relations with customers and accordingly set the terms, strategy and policies that apply to each specific category. This will impinge positively on financial stability and reduce risks to economic and financial institutions. Besides, the Unified Query service will be made available to citizens (individuals and corporations who are officially not members in the Credit Information System) and enabling them to verify a customer’s score on the Bounced Checks System. The service, which is likely to be launched late in 2014, will allow the verification of the conduct of a check-issuing individual or corporation before accepting a check.

Reinforcing business continuity procedures

To ensure the continuity of banking operations in emergency situations -as an effective trust-building measure - and to improve financial stability, the PMA intensified its efforts to develop and enhance the Business Continuity Project in 2013. Accordingly, in coordination with the departments involved, the PMA checked and regularly inspected the alternative site, as well as the disaster recovery center. Moreover, the PMA compiled important internal and external contact data for the respective departments in special booklets, to be regularly reviewed and updated.

Development indicators in the financial sector

Banking expansion and concentration

Licensed banks by end 2013 numbered 17, of which 7 were local and 10 were foreign banks (8 Jordanian, one Egyptian and another foreign). The banks operated through a network of branches and offices spread across different regions, constituting a total of 237 branches and offices, of which 125 belonged to local banks and 112


related to foreign banks; five new branches and offices opened during 2013: A branch for each of Al-Quds Bank, Palestine Islamic Bank, the National Bank, and an office for each of Palestine Commercial Bank, and Bank of Jordan.

The PMA was keen to make banking services available across Palestinian regions, while giving priority to rural and distant areas in order to facilitate trade and economic activities, and provide financial services to all citizens.

The PMA branching policy aims at reducing the population per bank branch, with the purpose of enhancing the quality of service offered to customers on one hand, and approaching international standards of branch densities of 10,000 individuals per branch, on the other. The branch density in Palestine stood at around 16.9 thousand per branch or office (or 9.9 thousand adults above 18 years per branch or office).

The banking sector’s concentration level can be measured by the Herfindahl Index[11]. During 2013, progress in monitoring concentration level continued with respect to both deposits and facilities. The Herfindahl Index Average for bank share of private sector deposits continued to recede to reach 1,630 points, compared to 1,738 points in 2012. This value falls 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 direct credit facilities to 1,597 points, compared to 1716 points in 2012, which is also below the critical concentration threshold. It can be concluded that the banking sector is heading in the right direction and at a good pace to improve competitiveness for both sides of financial intermediation: savings and facilities.

[11] Herfindahl Index is expressed as: , where (H) is Herfindahl Index, (MSi) is the bank (i) share of the overall variable whose concentration is to be calculated, e.g. total bank assets, bank total deposits, etc… The reciprocal of the index shows the number of banks dominating the market to any fixed value of H, calculated as N= 1

H, where (N) is the number of banks of equal share that can be

potentially contained by the market, for any fixed value H. The value of H can range between 1000-10000 points; with 10000 indicating single monopolistic bank. The correlation between H and competition in an inverse one, meaning that an increase in H indicates high banking sector concentration and high disparity between banks and therefore poor competition; and vice versa. A concentration is considered high if H is > 1800 point, which is the approved threshold in the USA.

Figure 3- 1: Banking expansion (branching policy), 2009-2013

Source: PMA.

16500

16700

16900

17100

17300

17500

200

210

220

230

240

2009 2010 2011 2012 2013

Popu

latio

n/Br

anch

Num

ber o

f bra

nche

s

# branches (left axis) Population/branch (right axis)

Figure 3- 2: Banking concentration (Herfindahl index), 2009-2013

Source: PMA.

1400

1600

1800

2000

2009 2010 2011 2012 2013

Poin

t

For private sector deposits For credits

Critical line


The aforementioned developments in the banking sector have contributed to improve the delivery and quality of financial services offered to the public. Subsequently, the number of ATMs increased by 12.2 percent in 2013, compared to the previous year, while the number of bank cards increased by 8.5 percent. Likewise, the number of electronic points of sale rose by 18.4 percent, for the same period, and the number of credit cards by 10.7 percent, promoting the use of electronic payment instruments. As a result, money circulation velocity would increase and economic growth would rise, thus enhancing overall financial stability.

Financial depth indicators

Credit facilities relevant to nominal GDP dropped to 37.5 percent during 2013, compared to 40.2 percent in 2012.This decline is attributed to the fact that nominal GDP growth (16.5 percent) exceeded the rate of increase in credit facilities (6.7 percent). In general, this ratio appears modest compared to some neighboring countries, where it reached 78.4 percent in Jordan and 178.5 percent in Lebanon; but it was higher than in Egypt where it stood at 34.1 percent.

Naturally, PMA aims at boosting local credit, through reducing bank placements abroad and developing credit and other supervisory systems at home, with a view to enhance banks’ competence and capability to make credit decisions. It thus encourages credit granting locally and fosters a stronger relation between the banking sector and various other economic sectors.

PMA’s efforts in that regard were successful. In evidence, the general trend of total credit facilities became better correlated with the economic trend (represented by nominal GDP) during the period of the PMA’s strategic transformation plan (2006-2013) than in 1996-2005. The linear correlation co-efficient of this trend calculated for the two periods was

Figure 3- 4: GDP and credit portfolio, 1996-2013

Source: PMA.

02468

101214

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

USD

mill

ion

GDP Credit portfolio

Figure 3- 3: Credit portfolio as percent of GDP, 2009-2013

Source: PMA.

0

50

100

150

200

2009 2010 2011 2012 2013

Perc

ent

Palestine Jordan Eygpt Lebanon

Table 3- 1: Improving banking services, 2009-2013(In numbers)

2009 2010 2011 2012 2013

ATM machines 305 335 378 435 488

ATM cards 68,185 71,684 101,728 122,379 132,758

Points of sale 1,745 2,314 3,658 3,926 4,646

Debit cards 285,228 308,962 354,352 410,536 408,636

Credit cards 29,082 37,374 47,046 56,835 62,931

Source: PMA.


96.9 percent during 2006-2013, compared to 83.3 percent for 1996-2005.

Another indicator of financial depth is the ratio of facilities granted to the private sector to total facilities; this ratio rose to 69.3 percent, compared to 66.5 percent in 2012. It is noteworthy that this ratio was 91.8 percent in Jordan, 85.7 percent in Egypt and 52.4 percent in Lebanon in 2013.

Another financial depth indicator measuring the public’s propensity for bank saving is the ratio of customer deposits to GDP, which dropped from 73 percent in 2012 to 69.4 percent in 2013. This ratio is moderate compared to some neighbouring countries, like Jordan where it averaged 115.7 percent by end 2013. Only little country differences can be spotted when comparing the private sector’s propensity to deposit as measured by private sector deposits to total customer deposits; in 2013, this ratio reached 91.8 percent in Palestine, compared to 92.7 percent in Jordan, 86.6 percent in Egypt and 97.8 percent in Lebanon.

In general, as figure (3-7) shows, despite the drop in the ratio of facilities to deposits during 2013 to 54.0 percent from 56.1 percent in 2012, the role of financial intermediation in Palestine has gained ground over time. The facilities to deposits ratio is about average in Palestine compared with neighbouring countries, where it was 68.6 percent in Jordan, 46.3 percent in Egypt and 57.0 percent in Lebanon in the year 2013.

Figure 3- 5: Private sector credit portfolio as percent of GDP, 2009-2013

Source: PMA.

0

20

40

60

80

100

120

2009 2010 2011 2012 2013

Perc

ent


Figure 3- 6: Private sector deposits as percent of customer deposits, 2009-2013

Source: PMA.

75

80

85

90

95

100

105

2009 2010 2011 2012 2013

Perc

ent


Figure 3- 7: Credit portfolio as percent of customer deposits, 2009-2013

Source: PMA.

0

20

40

60

80

2009 2010 2011 2012 2013

Perc

ent


19

OverviewThe Palestinian economy operates in an environment subject to the influence of several exogenous factors, which have caused a number of shocks and led to noticeable fluctuations in economic performance. These shocks and risks can readily spread to the banking sector and adversely impact many of its key indicators.

This chapter analyses various risks posed to the Palestinian banking sector, including their impact on the size and trend of the non-performing loans (NPLs). Risks include exposure to local sectors, both governmental and private. Exposure to the government poses a most serious credit risk to the banking sector, particularly in view of an instable and precarious fiscal stance. Exposure to the private sector reflects risks posed by its various constituents, most particularly the family-owned businesses and companies, the housing and mortgage sector, and SMEs funding. The chapter also deals with external sector’s risks to the Palestinian banking sector and their likely transmission channels, namely the exchange rates, interest rates and bank placements abroad.

Exposures to local sectors

Public sector (public finance)

Undoubtedly, fiscal performance[12] affects financial and banking stability, both directly and indirectly. During 2013, public finance witnessed a noticeable decline in net local revenues, while current expenditure remained roughly unchanged, leading to a rise in current account deficit to NIS 3.4 billion (or the equivalent of 7 percent of GDP), compared to around NIS 3.1 billion in 2012. However, cash inflows into the budget, particularly from foreign aid [13], have

[12] Data on the performance of public finance are based on data posted on the Ministry of Finance official website. [13] The value of foreign aid given in 2013 to the PA to directly support the budget reached around NIS 4.9 billion, the highest since 2011

(NIS 3.5 billion in 2012 and a similar amount in 2011).

Chapter Four: Credit Risks in the Banking Sector

Chapter FourCredit Risks in the Banking Sector

Figure 4- 1: Government public debt, 2009-2013

Source: Palestine Ministry of Finance (MoF).

1087

1071

1115

1098

1109

649

876

1099

1385

1268

0200

400

600

800

1000

1200

1400

1600

2009 2010 2011 2012 2013

USD

mill

ion

Foreign Domestic


managed not only to fully offset the current balance deficit but also to produce a surplus in the overall balance (after grants) equal to NIS 933.3 million. The government used this surplus to pay off a large portion of its sovereign debt, particularly dues to banks. As a result, domestic debt receded by 14.3 percent in 2013, with outstanding government debt to banks amounting to NIS 4.4 billion (USD 1.3 billion, or 10.6 percent of GDP).

Also, external public debt decreased by 5 percent compared to 2012, to reach around NIS 3.9 billion (USD 1.1 billion, or 9.3 percent of GDP).

Overall, the ratio of government public debt to nominal GDP dropped to 19.9 percent in 2013 from 24.2 percent in the previous year[14]. These ratios remained within the permissible threshold of 40 percent of nominal GDP set by the Palestinian Public Debt Law. They are also lower than in other Arab countries including Jordan, Egypt and Lebanon.

In general, risks to financial stability arising from budgetary performance vulnerabilities derive from three main sources:

a) Credit granted to the government, particularly in view of its recently increased dependence on local funding sources;

b) Credit granted to the PA employees, with their wages and salaries as the main repayment means, and the consequence that salary payment delays will adversely affect their creditor banks;

c) Credit granted to private sector corporations which supply basic goods and services to government, as credit repayment depends on the extent to which the government pays its accrued obligations to the private sector.

[14] The significant drop in this percentage reflects to a large degree the upward changes in GDP value as a result of the PCBS new calculation method for GDP.

Figure 4- 2: Government public debt as percent of GDP, 2013

Source: PMA, and related central banks.

61.1

82.7

11.4

76.8

30.2

49.5

9.3 10.6

0

20

40

60

80

100

Domestic Foreign

Perc

ent

Lebanon Eygpt Jordan Palestine

Figure 4- 3: Fiscal vulnerabilities and their impact on financial stability, 2013

Current balance(current deficit)

Developmental expensesGrants for budget support

(affected by politicalsituation & conditions)

Generalbudget

Current expenditurewages is the most important

RevenueClearance is the most important

control by Israel

Overall balanceafter grants

Surplus(Decrease public debt & arrears) Deficit

A continuous need to borrow from banks& further accumulation of arrears


Obviously the abovementioned budget vulnerabilities and associated risks largely fall outside PA’s control. In particular, they stem from (i) Israeli occasional withholding or delaying transfer of clearance revenues due to the PA, and (ii) the irregular flow of foreign aid due either to donor-related factors, or to political developments in the Palestinian/Israeli relations. Figure (4-3) demonstrates basic public budget vulnerabilities.

Risks associated with credit granted to government

Government’s reliance on local alternatives to bridge the budget funding gap has increased the relative significance of government indebtedness to banks in relation to total government debt. Thus while government indebtedness to banks increased by 19.8 percent since 2008; external debt remained almost unchanged over the same period[15].

Credit granted to government constituted 30.7 percent of total bank facilities by end 2013. This is a relatively high percentage, given the serious challenges facing the public budget and the high sensitivity of its most significant revenue sources to exogenous factors.

The aforementioned ratio reveals the financial stress facing the public budget in view of the fragile local revenues. It also exposes the government’s dire need to continually borrow from banks, thus endangering the stability of the banking sector and the financial system at large. For government’s constant reliance on banks to fill in the budget gap increases the uncertainty surrounding public finances, thus pushing interest rates up and so escalating the cost of public debt service.

The main source of uncertainty regarding the sustainability of the fiscal stance relate to government’s heavy dependence on the two items of clearance revenues and foreign aid. Government’s inability to control the time-schedules and cash flow mechanisms of these two items seriously compromises its solvency. Such possible insolvency poses grave potential risk to banking sector stability.

Another potential risk is that high govern-ment demand for bank loans heightens competition with the private sector for bank credit. Actually, the relative distribution of bank credit between the two sectors clearly shows that a higher government share of total facilities consists with a decline in the private sector’s share, and vice versa. During 2012, for example, the government share of total facilities rose by 1.6 percent over 2011, while the private sector share dropped by an equal percentage. In 2013, the government share of total facilities receded by 0.2 percent (as a result of the high volume of foreign aid received), while the private sector share saw a similar percent increase.

It is noteworthy that government borrowing from the banking system does not comply with Article (21) of the Palestinian Public Debt Law[16]. Hence, to better comply with the provisions of the aforementioned Law, the Palestinian Cabinet recently approved a decision to restructure part of its sovereign debt due to banks operating

[15] Domestic public debt constituted 53.3 percent of total government public debt, mostly owed to the banking system. [16] The Law states that government domestic loans shall be restricted to borrowing by issuing government bonds.

Figure 4- 4: Distribution of credit portfolio by sector, 2009-2013

Source: PMA.

28.5

29.0

31.0

33.5

30.7

71.5

71.0

69.0

66.5

69.3

0

1020304050607080

2009 2010 2011 2012 2013

Perc

ent

Public sector Private sector


in Palestine by issuing government bonds[17] to be sold solely to banks. This measure will provide government with a legal cover for local funding, which will now be made via legally sanctioned channels and with limits and terms specified by the securitization process. Also, its buying of the bonds will (i) increase a bank’s flexibility, by diversifying its credit portfolio, and (ii) mitigate its liquidity risks by allowing it to sell government debt to other banks. The initial offering of government bonds, the first of its kind in Palestine, will have important repercussions on the financial sector. If the issue proves successful and trading expands to the secondary market, it will significantly invigorate the financial market, contribute to risk diversification and reduce the banking sector’s risk concentration.

Risks associated with credit granted to PA employees

Government’s occasional inability to pay wages and salaries on a regular basis poses risks to financial stability by raising the possibility for default on loans granted to the PA employees, who rely on wages and salaries for repayment of their bank loans. Facilities granted to the PA employees amounted to USD 727.4 million in 2013, compared to USD 683.4 million in 2012. This sum represented around 16.6 percent of total credit facilities, compared to 16.3 percent in 2012.

Government employees’ wages and salaries constitute a significant expenditure item that affects fiscal budget performance, and consequently financial stability. In 2013, average monthly wage and salary expenditure totaled NIS 545.7 million, or the equivalent of 53 percent of total public expenditure. In comparison, credit granted to public employees constituted 41 percent of the wage and salary bill in 2013, compared to 44 percent in the previous year. These figures reflect the size of risks associated with credit to the PA employees. Risks to financial and banking sector stability also include those associated with inflows of clearance revenue and foreign aid, both of which are governed by exogenous factors that fall outside government control.

Risks associated with credit granted to private sector institutions doing business with government

Total government arrears accrued by end 2013 reached NIS 1,694 million compared to NIS 2,225.7 million by end 2012. The major part of these arrears relates to non-wage expenditure, particularly transfer and operational expenditures accrued mostly to the private sector; these constituted around 72 percent of total arrears compared to 47

[17] On April 8, 2014, the Cabinet approved the restructuring of part of government debt to banks by securitization through the issuance of government bonds; however as of the time of writing this report, this decision has not been carried out.

Figure 4- 5: credit granted to the PA employees, 2012-2013

Source: PMA.

16.3

24.5

48.6

16.6

23.9

54.0

0

10

20

30

40

50

60

As a percent of totalloans

As a percent ofprivate sector loans

As a percent of publicsector loans

Perc

ent

2012 2013

Figure 4- 6: Private sector credit portfolio as percent of total assets, 2009-2013

Source: PMA.

19.8

23.3

26.2

27.8

27.7

0

5

10

15

20

25

30

2009 2010 2011 2012 2013

Perc

ent


percent in 2012. Meanwhile, wage and salary arrears constituted around 22 percent of total arrears by end 2013 compared to 36.7 percent in 2012.

Risks associated with private sector corporations supplying goods and services to government take 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. This will tend to increase sovereign debt to banks, and thus heightens risks of credit granted to government. The second form relates to increased potential for insolvency of private sector corporations supplying government, since they depend on government meeting its outstanding obligations in order to pay back their bank facilities. In short, delayed payment of government obligations to private sector corporations will aggravate banking sector credit risks.

Exposures to private sector

By end 2013, total credit granted to the private sector grew by 11.3 percent (18.0 percent for credit from local banks and 5.1 percent for credit from foreign banks) to a total of USD 3107.0 million. The private sector share of total credit was 69.3 percent in 2013 compared to 66.5 percent in the previous year.

In comparison, the private sector share of total bank assets stood at 27.7 percent by end 2013 compared to 19.8 percent in 2009, while the ratio of private sector facilities to GDP dropped to around 26 percent in 2013 compared to 30 percent in 2009.

Analysis reveals that local and foreign banks granted similar percentages of their total credit to the private sector in recent years. Thus in 2009-2013, the ratio of facilities granted to the private sector to total facilities stood at 69.9 percent for local banks as compared to 69.1 percent for foreign banks.

Risks associated with credit granted to households and family-owned businesses

Personal credit facilities [18] granted by banks in Palestine grew by around 7.4 percent in 2013, to reach USD 740.7 million, constituting 38.9 percent of total credit. Personal credit facilities granted by foreign banks grew by 1.6 percent to constitute around 42.8 percent of their total credit in 2013; in comparison, they grew by 15.2 percent for local banks, dropping slightly from 35.4 percent to 35.1 percent of total credit granted by these banks. Personal credit facilities include loans guaranteed by mortgages, car loans, educational loans and other consumption loans. These loans are granted against multiple collaterals to reduce potential risks

Meanwhile, credit granted to companies reached USD 1,225.7 million, growing by 20 percent to constitute 27.4 percent of total credit compared to 24.3 in 2012. The ratio of credit extended to companies by local banks increased from 28.5 percent in 2012 to 30.5 percent in 2013, and by foreign banks from 20.6 percent to 24 percent for the same period. Credit extended to companies is predominantly in the form of investment loans

[18] Does not include facilities granted to non-residents.

Table 4- 1: Distribution of credit portfolio by sector, 2009-2013(Percent)

Bank Beneficiary 2009 2010 2011 2012 2013 Average

LocalPrivate sector 72.4 70.9 69.3 67.9 69.1 69.9

Public sector 27.6 29.1 30.7 32.1 30.9 30.1

ForeignPrivate sector 70.9 71.1 68.7 65.2 69.6 69.1

Public sector 29.1 28.9 31.3 34.8 30.4 30.9

TotalPrivate sector 71.5 71.0 69.0 66.5 69.3 69.5

Public sector 28.5 29.0 31.0 33.5 30.7 30.5

Source: PMA.


(around 78 percent) or short-term loans or overdrafts (around 22 percent). It should be noted that overdrafts carry relatively higher risks than loans. For this reason, the PMA imposed supervisory control by setting a bank’s maximum permissible limit for overdraft balance to total credit at 30 percent[19].

Given its limited use, credit extended through credit cards does not pose a significant risk to financial stability. Credit through credit cards (granted to individuals or corporations) accounted for 1.1 percent of total credit granted by banks in 2013, a sum of USD 47.3 million, mostly extended by local banks (USD 35.7 million). It is noticeable that the relative significance of such type of credit to total credit granted by local banks has receded slightly during 2013 to 1.6 percent from 1.7 percent in the previous year. For foreign banks, the corresponding ratio remained unchanged at 0.5 percent for both years.

Risks associated with credit granted to mortgage and housing sector

In 2013, loans granted to mortgages and housing [20] grew by 8 percent over 2012 to reach USD 650 million, of which the used portion was USD 527.5 million. As such, the relative significance of the portfolio of “used” portion of mortgage and housing credit to total credit increased to 11.8 percent in 2013 compared to 11.7 percent for the previous year.

Local banks accounted for 40.5 percent of total mortgage and housing loans portfolio compared to 39.0 percent in 2012; foreign banks granted the remaining share. Loans granted to individuals from the private sector accounted for the largest share (34.0 percent) of the total portfolio for both local and foreign banks, followed by loans to individuals from the public sector, with 31.0 percent.

[19] Overdrafts granted to the government and public sector institutions are excluded from the overdraft value for the purpose of calculating this ratio. Likewise, it also excludes those granted as cash guarantee.

[20] All the figures and ratios presented here are based on the mortgage and housing database from the PMA and includes all loans directed for housing purposes , for example building, buying, completing or refurbishing property, or, buying land for living purposes, refinance or buying debt associated with housing.

Table 4- 2: Private sector credit portfolio by beneficiary, 2009-2013

(Percent)

Bank Beneficiary 2009 2010 2011 2012 2013

Local

Personal 42.2 47.2 32.3 35.4 35.1

Corporate 23.9 18.2 31.7 28.5 30.5

Debit cards 2.3 2.5 1.8 1.7 1.6

Foreign

Personal 24.0 36.4 37.9 41.5 42.8

Corporate 35.4 30.5 26.7 20.6 24.0

Debit cards 0.4 0.5 0.5 0.5 0.5

Total

Personal 31.1 40.9 35.5 38.6 38.9

Corporate 30.9 25.4 28.9 24.3 27.4

Debit cards 1.2 1.3 1.1 1.1 1.1

Source: PMA.

Table 4- 3: Mortgage and housing loans, 2012-2013(Value in USD million)

Bank Year

Credit portfolio Nonperforming loans

Number of loans

Value of loans

Used loans

Number of loans

Value of

loans

As percent of used Loans

Local2012 7,510 234.0 175.6 116 6.0 3.4

2013 7,475 263.0 190.5 87 3.8 2.0

Foreign2012 5,218 367.8 316.7 62 8.1 2.6

2013 5,725 387.0 337.0 43 5.5 1.6

Total2012 12,728 601.8 492.3 178 14.1 2.9

2013 13,200 650.0 527.5 130 9.3 1.8

Source: PMA.


The total mortgage portfolio default rate dropped to 1.8 percent in 2013 compared to 2.9 percent in the previous year, declining for foreign banks from 2.6 percent to 1.6 percent and for local banks from 3.4 percent to 2 percent, for the same period.

The highest default ratio recorded in the mortgage loan portfolio was for the category of self-employed individuals, this was 55 percent of total value of NPLs in 2013. This is because the monthly income of this category of borrowers is subject to occasional irregularities and fluctuations, affected largely by political developments.

The default ratio for non-profit organizations and societies ranked second with 28 percent, while that for private sector individuals ranked third with 9.4 percent, and that for companies ranked fourth with 5.8 percent. Public sector default ratio was 1.8 percent of total NPLs, with salaries of guarantor employees serving as loan collaterals. However, the low public sector default ratio remains subject to government’s ability to sustain regular payment of public sector employees’ salaries.

It is worth noting that total provisions for NPLs amounted to USD 3.9 million in 2013, compared to USD 3.6 million in the previous year. These provisions constituted around 41.9 percent of the total value of NPLs of real-estate portfolio. Together with other supervisory and prudential measures implemented by the PMA and the banks, these provisions are considered adequate to mitigate mortgage risks as much as possible.

Risks associated with credit granted to SMEs

SMEs [21] are a key agent of economic growth and a major contributor to sustainable development and to the alleviation of unemployment and poverty rates. By end 2013, SMEs numbered 150 thousand enterprises, constituting around 90 percent of total economic enterprises in Palestine, with a labor force of 119 thousand employees.

Since funding is a paramount determinant of growth and prosperity of these

[21] According to the PCBS, enterprises with 1-4 employees are considered small, while enterprises with 5-20 employees are considered medium-sized and enterprises with more than 20 employees are considered large. See PCBS, Establishment Census, 2012, Table 5, p. 53.

Table 4- 4: Credits granted by banks to SMEs by activity, 2012-2013

(Value in USD million)

Credit granted by banks Defaults (%)

Sector number Value Percentage share (%) number Value

Construction 669 55 8.7 4.2 10.5

Commerce 5,082 362 57.4 48.4 61.5

Industry 699 52 8.2 7.8 6.3

Agriculture 309 24 3.8 5.8 1.8

Public administrations 1,789 58 9.2 10.1 4.2

Public sector 52 5 0.8 1.6 0.1

Financial sector 51 3 0. 0.8 3.6

Personal & consumption 1,780 48 7.6 19.3 9.4

Tourism 260 24 3.8 2.1 2.7

Total 10,691 631 100.0 100.0 100.0

Source: PMA.

Figure 4- 7: NPLs in mortgage and housing sector, 2013

Source: PMA.

0

20

40

60

80

100

Perc

ent

Local banks Foreign Banks Total banks


enterprises, the PMA[22] sought to help them gain access to sources of financing and credit using several stimulating measures. These included: (i) waiving the precondition of a 10 percent advance cash payment when rescheduling SME non-performing loans; and (ii) exempting banks from the 2 percent general risk reserve requirement on facilities granted to SMEs.

By end 2013, bank facilities granted to SMEs numbered 10,691 valued at USD 631 million, of which used facilities amounted to USD 491 million, constituting around 11 percent of total bank facilities. The trade sector held the highest share (57.4 percent) of total bank credit extended to SMEs, followed by the utilities and public services sector at 9.2 percent.

It is worth noting that bank credit is the main source of funding for SMEs. Thus in 2013, bank facilities constituted around 88.3 percent of total facilities extended to these enterprises, while specialized lending institutions[23] funded the remaining facilities. Consequently, banks are more prone to credit risks associated with SME business, particularly as these enterprises’ income sources are irregular and, in great measure, affected by political and security developments.

In this context, it is noteworthy that the default ratio for credit granted to SMEs was 9.8 percent of total credit granted to these enterprises by end 2013. Non-performing banking facilities numbered 746 loans valued at USD 62 million, constituting 48 percent of total NPLs for all banks. These figures affirm the significance of risks associated with credit granted to SMEs, as they constitute around half of the banking system’s credit risks.

The highest default ratio was recorded for the trade sector at 61.5 percent of total NPLs of SMEs, followed by construction and real-estate sector at 10.5 percent, and consumption and personal loans at 9.4 percent.

Risks associated with credit granted to non-residents

During 2009 – 2013, the great majority of bank credit facilities were extended to residents, at an average of 97.7 percent, against 2.3 percent to non-residents. In 2013, the relative significance of facilities granted to residents rose to 99.2 percent, while the remaining 0.8 percent went to nonresidents. The value of credit facilities extended to residents by local banks during 2013 amounted to USD 2.3 billion compared to USD 14.2 million granted to non-residents. Foreign banks operating in Palestine extended around USD 2.1 billion to residents and USD 20.3 million to non-residents. The ratio of facilities granted to non-residents by foreign banks (3 percent) exceeded the corresponding ratio granted by local banks (1.4 percent).

[22] In this context, the PMA organized its fourth Palestine International Banking Conference in Jericho on February 4, 2013, entitled “Empowering Small and Medium Enterprises in Palestine through Enhancing Access to Finance”. Details on this conference are available in PMA’s Annual Report, 2013.

[23] Discussion and analysis of SME loan portfolio extended by specialized lending institutions will be presented in Chapter 6 of this report.

Figure 4- 8: NPLs in SMEs by activity, 2013

Source: PMA.

0

10

20

30

40

50

60

70

Perc

ent

Value Number


In light of the above, risk associated with facilities granted to non-residents is quite limited, and does not constitute a source of concern, particularly in view of the supervisory measures that regulate such credit. Foremost among these measures is the stipulation (according to Instructions 5/2008) that these facilities should be deployed exclusively in Palestine within a scheme to encourage investment. Also, they could only be extended provided adequate collaterals are presented and set aside in case of cash collateral, or registered in the name of the bank in case of credit-in-kind. Otherwise, any credit granting will require PMA’s prior written approval.

Risks associated with credit granted to various economic sectors

Naturally, credit facilities extended in 2013 varied in value across different economic sectors, with the net balance increasing for all sectors except for three. These were facilities granted to the freight and transportation sector, which declined by 4 percent, to the services sector which dropped by 9.4 percent, and to financing of investment in stocks and financial tools which fell by 18 percent, all in comparison with 2012.

Credit granted to finance consumer commodities ranked first with a share of 28.5 percent of credit facilities extended to the private sector[24]. It is worth noting that these facilities have assumed an upward trend in recent years, starting with a 4.8 percent share in 2009 to a 28.5 percent share in 2013, at the expense of productive economic sectors, especially services sectors.

The construction and real-estate sector ranked second, accounting for 22.8 percent of facilities (including facilities extended for land development), with a large portion directed at house building and improvement; the external and internal trade sector followed with a share of 19.7 percent, and the services sector with a share of 7.8 percent, all in relation to total facilities granted to the private sector.

[24] It is worth mentioning that loans granted to finance consumer commodities via credit cards accounted for a mere 6 percent of facilities. This is attributed to the limited spread of banking and consumerist literacy in the use of credit cards in the Palestinian economy, although this is being encouraged as more attention is paid to banking awareness.

Table 4- 5: Destribution of credit portfolio by beneficiary, 2009-2013

(Percent)

Bank Beneficiary 2009 2010 2011 2012 2013 Average

LocalResident 97.5 98.4 98.7 98.9 99.4 98.6

Nonresident 2.5 1.6 1.3 1.1 0.6 1.4

ForeignResident 90.7 97.7 99.1 98.9 99.1 97.1

Nonresident 9.3 2.3 0.9 1.1 0.9 2.9

TotalResident 93.4 98.0 98.9 98.9 99.2 97.7

Nonresident 6.6 2.0 1.1 1.1 0.8 2.3

Source: PMA.

Table 4- 6: Private sector credit portfolio by economic activity, 2012-2013

(Percent)

Sector 2009 2010 2011 2012 2013

Construction 13.9 16.2 16.8 21.1 22.8

Land development 2.8 3.7 1.2 1.5 1.8

Industry 11.6 12.6 12.4 6.2 7.2

Commerce 21.4 19.1 20.0 18.0 19.7

Agriculture 2.4 2.2 1.4 1.3 1.2

Tourism 2.5 2.3 2.0 2.1 1.9

Transportation 1.6 0.9 0.9 0.8 0.7

Services 25.1 22.3 12.1 9.6 7.8

Stocks & other financial instruments

3.5 2.6 2.7 2.2 1.6

Cars financing 3.6 4.2 4.5 4.1 4.2

Consumption 4.8 7.0 16.9 28.0 28.5

Others 6.9 6.7 9.0 5.1 4.4

Total (USD million) 1,596.5 2,048.6 2,449.6 2,791.8 3,106.4

Source: PMA.


Despite their significance to the Palestinian economy and the high hopes attached to them to foster development and sustainable growth, the two sectors of industry, and agriculture received respectively only 7.2 percent and 1.2 percent of total facilities granted to the private sector. The low relative significance for both sectors is attributed to: their association with a high credit risk grade; their declining relative contribution to GDP; and their heavy reliance on non-banking sources for funding, which is particularly true for the agriculture sector.

Despite banks’ efforts to diversify their credit portfolios, facilities granted to the sectors of consumer commodity financing, construction and real estate and internal and external trade accounted for about 70 percent of total credit facilities extended to the private sector. This is so because such facilities are usually granted against collaterals that reduce risk grade. To the PMA, a credit portfolio that is diversified and shows no signs of concentration is favourably regarded by way of control, due to its positive effect on risk diversification and reduction of portfolio default. To this end, PMA instructions stipulated that concentration of credit granted to any economic activity should not exceed 20 percent of total granted credit.

Non-performing loans (NPLs)

The ratio of NPLs to total credit granted by all banks was 2.9 percent in 2013, dropping by around 0.2 percent from 2012, to a total value of USD 129.1 million.

It is worth noting that the default ratio for foreign banks operating in Palestine declined to 3.5 percent of total direct credit in 2013 from 3.7 percent in 2012. Similarly, the ratio dropped for local banks to 2.3 percent from 2.4 percent over the same period. This indicates that in recent years default ratios for foreign banks have exceeded those for their local counterparts.

Generally, default ratios in the Palestinian banking system are quite low compared to other countries; for instance, the default ratio in the Middle East has averaged around 6.5 percent. This signals the relatively very low default risk posed to financial stability in Palestine.

Analysis of default periods [25]shows that facilities classified as losses accounted for 82.8 percent of total NPLs for all banks in 2013, compared to 75.1 percent in 2012. In comparison, doubtful facilities fell from 14.6 percent to 7.0 percent, while substandard facilities hovered around 10.2 percent for the same period. These figures indicate a rise in the value of mean severity of default in NPLs portfolio, which necessitates the exertion of additional efforts to monitor and tackle the causes for default in order to curb the rise in NPLs classified as losses.

With default ratios declining, provisions required against NPLs dropped from USD 77.6 million by end 2012 to USD 76.0 million, covering 58.8 percent of total NPLs for all banks by end 2013.

[25] Based on the PMA instruction No. (1/2008), facilities overdue by more than 360 days are classified as losses and require provisions of 100 percent of their value. Facilities which are 181 to 360 days overdue are classified as doubtful facilities and require provisions of 50 percent of their value. Credits which are 91 to 180 days overdue are classified as substandard facilities and require provisions of 20 percent of their value.

Figure 4- 9: NPLs structure in foreign banks, 2009-2013

Source: PMA.

0

20

40

60

80

100

Perc

ent

Substandard Doubtful Losses


These provisions were shared between foreign banks at a value of USD 55.6 million covering 50.0 percent of total NPLs and local banks at USD 20.4 million covering around 27.0 percent of total NPLs by end 2013.

It is worth noting that the PMA has implemented several measures and released various instructions to limit credit risks to the Palestinian banking system and reduce default ratios. In this context, the PMA issued Instructions No. (1/2013) on risk reserve, i.e. the reserve created to face unidentified risks. These instructions raised the risk reserve ratio to 2 percent for net direct credit facilities, instead of 1.5 percent stated in Instructions No. (5/2008), and maintained the 0.5 percent reserve ratio for indirect credit facilities, as of January 1, 2013.

Credit gap of the Palestinian banking sector

Credit gap [26]is defined as the difference between the actual credit-to-GDP ratio and its long-term trend. Gauging this gap provides an early warning indicator to crisis that potentially threatens banks as a result of excessive credit growth. The Palestinian private sector credit gap during Q4 of 2013 was around - 0.55 percent[27], compared to 0.81 percent in Q3 and 1.24 percent in the corresponding quarter of 2012. It is noteworthy that all the above ratios fall below the

[26] The first to notice this ratio were two economists: Borio and Lowe, 2002-2004. The indicator was later adopted by the Basel Committee to become one of the standards and controls to be calculated and studied in the analysis of bank positions as a Basel III requirement. The requirement sets a buffer as 2 percent the maximum limit of the credit gap directed at the private sector. The calculation methodology was performed in the following steps: • Compiling the nominal GDP data at the quarterly level for the period starting from Q1 of 2000 until Q4 of 2013. However, since quarterly

nominal GDP figures are available from Q1 2011 onwards only, the quarterly values for real GDP were used instead and a quarterly GDP deflator was estimated through the calculation of annual GDP deflator using the Quadratic-Match Average method. By multiplying the data-series of quarterly real GDP values with the GDP deflator, it is possible to obtain the missing data to complete the nominal GDP series.

• Calculating the ratio of facilities to the sum of GDPs for the first three quarters of a given year plus the quarterly value for the fourth quarter of the previous year.

• Drawing the general-trend curve for the ratio of credit growth to the nominal GDP using the Hedrick-Prescott Filter method, where λ = 400,000, as per Basel III recommendation.

• Credit gap is measured by the difference between the credit-to-GDP ratio and its long-term trend.[27] Negative values for credit gaps are of no consequence to risks.

Figure 4- 10: NPLs structure in local banks, 2009-2013

Source: PMA.

0

20

40

60

80

100

Perc

ent

Substandard Doubtful Losses

Figure 4- 11: Credit gap in the Palestinian private sector, 2000-2013

Source: PMA.

-6

-4

-2

0

2

4

6

8

2000

Q4

2001

Q2

2001

Q4

2002

Q2

2002

Q4

2003

Q2

2003

Q4

2004

Q2

2004

Q4

2005

Q2

2005

Q4

2006

Q2

2006

Q4

2007

Q2

2007

Q4

2008

Q2

2008

Q4

2009

Q2

2009

Q4

2010

Q2

2010

Q4

2011

Q2

2011

Q4

2012

Q2

2012

Q4

2013

Q2

2013

Q4

Perc

ent


maximum permissible level fixed at 2 percent by the Basel III resolutions, (based on the observation that a credit gap above this level has featured in all countries, which faced later severe financial crises).

It is noted that the Palestinian private sector’s credit gap has constantly fallen below the 2 percent barrier over the period from end-2007 to end-2013. This implies that the Palestinian banking system has been spared exposure to risks associated with growth of credit granted to the private sector over that period. In contrast, the period between 2006 and 2007 witnessed a widening of the credit gap to nearly record levels, which indicates that the Palestinian banking system has been affected by the political and economic events of that period.

Exposure to external sectors

Both the Palestinian economy and financial sector operate within an environment subject to several exogenous factors and influences that pose various risks with contagion effects. Three key external channels are discussed below.

Exchange rate channel

The exchange rate is one channel which can directly impact financial assets’ value. The absence of a national currency and the use of three foreign currencies by the Palestinian banking sector have made bank assets especially vulnerable to exchange rate fluctuations. These vulnerabilities have intensified in the past few years with the sharp fluctuation of currency exchange rates especially between the Israeli shekel and the US dollar, as monthly exchange reports clearly indicate. It is noteworthy that the combined share of the two aforementioned currencies in banks’ total assets reached 69 percent in 2013. However, this does not mean that the remaining share is risk free. In fact, the Israeli shekel/US dollar exchange rate fluctuations apply almost fully to the Jordanian dinar, which accounts for the remaining share of bank assets. Naturally, exchange rates and therefore bank assets’ value are highly vulnerable to the various risks affecting the economies of the countries whose currencies circulate in Palestine (USA, Israel and Jordan).

It is noteworthy that the total assets of banks operating in Palestine by end 2013 reached around USD 11.2 billion,

Figure 4- 12: Changes in USD against NIS (period average), 2009-2013

Source: PMA.

9.53

-4.97 -3.73

7.24

-6.33 -8-6-4-202468

1012

2009 2010 2011 2012 2013

Perc

ent

Figure 4- 13: Currency composition of total assets, 2009-2013

Source: PMA.

0

10

20

30

40

50

2009 2010 2011 2012 2013

Perc

ent

USD JD NIS Others


distributed in varying shares among the three currencies in use in Palestine, with the US dollar accounting for the largest share. The currency composition of banks’ assets reveals an instable distribution that consists with the changes in the respective exchange rates of the three constituent currencies.

Historical data on bank assets’ structure clearly point to certain fundamental but gradual changes in these assets’ currency blend, particularly regarding the US dollar. During 2006- 2013, the US dollar lost 12 percentage points of its share to the Israeli shekel, whose share increased by 14 percentage points.

The decline of the exchange rates of both the dollar and the dinar against the Israeli shekel significantly affected credit currency distribution. Thus, credit facilities in the shekel to total facilities rose from 25.9 percent in 2009 to 33.7 percent in 2013; correspondingly, the dollar and dinar credit share diminished.

As for customer deposits, the share in Israeli shekel grew from 23.3 percent in 2009 to 29 percent in 2013. This showed that depositors were keenly aware of the effect of exchange rate on the value of their savings; in effect, this tended to ameliorate the adverse effects of exchange rate fluctuations.

Overall, changes in the shekel/dollar exchange rates, which largely moved in favor of the former, have impinged on banking activity indicators, whether in terms of liabilities or assets.

Interest rate channel

Risks posed to the banking sector by this channel relate to the differentials and fluctuations of interest rates on the three currencies circulating in Palestine. These fluctuations, in turn, partly reflect relevant interest rate developments in the currencies’ economies of origin. Such fluctuations may conflict with the credit orientations of the Palestinian market. For example, it is illogical to lower interest rates on shekel loans in Palestine, when dictated by economic necessity, when such rates increase in Israel, and vice versa. This also applies to the other two circulating currencies. Additionally, an

Figure 4- 14: Distribution of credit portfolio by currency, 2009-2013

Source: PMA.

0

10

20

30

40

50

60

70

2009 2010 2011 2012 2013

Perc

ent

USD JD NIS Others

Figure 4- 15: Distribution of deposits by currency, 2009-2013

Source: PMA.

0

10

20

30

40

50

2009 2010 2011 2012 2013

Perc

ent

UDS JD NIS Others

Figure 4- 16: Lending and deposit rates in USD (period average), 2013

Source: PMA.

Deposits in USA

Credits in USA

Deposits in Pales ne

Credits in Pales ne

0

1

2

3

4

5

6

7

8

9

Q1 Q2 Q3 Q4

Perc

ent


imbalance may develop between supply and demand for loans and deposits in different currencies as a result of the variation in their interest rates.

It is noteworthy that the absence of a national currency has constrained PMA’s ability to take necessary measures to influence money supply and interest rates, through the use of conventional monetary policy tools. This may expose the banking sector to risks associated with certain second-best policies that may not support a strong economy or banking sector.

However, a PMA-conducted study[28] has shown that interest rates on currencies circulating in Palestine (US dollar, Jordanian dinar and Israeli shekel) are only marginally sensitive to the interest rates on these currencies in their original countries. The study has thus revealed a distinct disparity in the prevailing interest rates between Palestine and these countries. The adjacent graphs depict this structural misalignment in interest rates during 2013[29]. Data also show a large gap between lending and deposit rates for all currencies, albeit more pronounced in the case of the NIS. The lending/deposit rate spread in 2013 was 6.90 percent for the dollar, 7.09 percent for the dinar, and 10.25 percent for the shekel. The wider lending/deposit rate spread in Palestine compared to the corresponding spread in that currency’s original country reflect several factors, but mainly the relatively higher lending risks in Palestine due largely to Israeli measures detrimental to borrowers’ repayment capacity.

In general, interest rates in Palestine were higher in 2013 than in 2012 for all currencies circulating in Palestine. Compared to 2012, interest rate on dollar deposits rose by around 16 basis points to reach 0.62 percent, whereas the dollar lending rate rose by 54 basis points to 7.51 percent. Likewise, the interest rate on dinar deposits increased by 38 basis points to 2.08 percent, whereas the dinar lending rate went up by 106 basis points to 9.17 percent. The interest rate on the NIS deposits and loans also rose by 10 and 29 basis points to reach 1.32 percent and 11.58 percent, respectively.

[28] See paper on “Macroprudential policies: used and available to the PMA”, February 2014, www.pma.ps . [29] Vertical blue dashed lines graphs (4-16, 4-17 and 4-18) show the margin between deposit and loan interest rates for the different

currencies used in Palestine, whereas the gold vertical arrows show the margin between deposit and loan interest rates for the different currencies in their country of origin.

Figure 4- 17: Lending and deposit rates in JD (period average), 2013

Source: PMA.

Deposits in

Credits in Jordan

JordanDeposits in

Credits in Palestine

Palestine

0123456789

10

Q1 Q2 Q3 Q4

Perc

ent

Figure 4- 18: Lending and deposit rates in NIS (period average), 2013

Source: PMA.

Deposits in Israel

Credits in Israel

Deposits in Palestine

Credits in Pales�ne

0123456789

10111213

Q1 Q2 Q3 Q4

Perc

ent


Banks’ placements abroad channel

Placements abroad constitute a channel that banks can use to deploy their assets outside Palestine. Nonetheless, these placements pose risks to the Palestinian banking sector stemming from the conditions of recipient countries or economic sectors. Also, they would deprive the national economy and constituent economic sectors from the benefits of the foregone funds deployed abroad.

The value of banks’ placements abroad totaled USD 3514.5 million, constituting around 32.2 percent of total bank assets by end 2013. These placements included balances with banks abroad at USD 2754.7 million, placements in investment tools at USD 723.0 million and facilities granted abroad at USD 36.9 million.

Obviously, placements abroad were distributed between local banks and foreign banks operating in Palestine. Local banks’ placements abroad totaled USD 1074.4 million, constituting 21.4 percent of total local banks’ assets; placements abroad for foreign banks operating in Palestine reached USD 2440.2 million, or the equivalent of 41.3 percent of total foreign banks’ assets. This means that foreign banks are more exposed than local banks to external risks transmitted through this channel to the Palestinian banking sector. It is noteworthy that PMA instructions had set the threshold limit on the ratio of placements abroad to total deposits at 55 percent. In the event, this ratio averaged 25.4 percent for local banks and 49 percent for foreign banks operating in Palestine in 2013.

Figure 4- 19: Placements abroad structure, 2013

Source: PMA.

Credits 1.0 %

Investments 22.7 %

Balances 76.3 %

35Chapter Five: Financial Soundness Indicators

OverviewThis chapter deals with the banking sector’s financial soundness indicators (FSIs), considered as key measures of financial institutions’ health and soundness. These indicators highlight the macroprudential status of the banking sector, assess and monitor strengths and weaknesses of the financial system in order to promote financial stability and limit the possibility of banking system failure.

These indicators are analysed here in order to gauge the Palestinian banking sector’s soundness and robustness and forecast potential threats. This will allow supervisory authorities to take appropriate relevant measures in accordance with prevailing international guidelines and applications in the field.

FSIs fall into four groups: capital indicators, asset quality indicators, liquidity indicators and earning and profitability indicators.

Capital indicators

Regulatory capital to risk weighted assets (capital adequacy ratio)

This indicator measures the ratio of regulatory capital to risk weighted assets, or the capital adequacy ratio (CAR). This ratio is considered a leading capital indicator. In Palestine by end 2013, the capital adequacy ratio measured for all banks combined was 20 percent compared with 20.3 percent at end 2012. This slight drop is attributed to an increase in risk weighted assets that outpaced the increase in capital base, the former growing by 8.7 percent and the latter by 6.5 percent. Despite this marginal

Chapter FiveFinancial Soundness Indicators

Figure 5- 1: Capital adequacy ratio, 2009-2013

Source: PMA.

1516171819202122232425

2009 2010 2011 2012 2013

Perc

ent

Total banks Local Banks Foreign Banks


decline, the capital adequacy ratio remained above the minimum limit set by the Basel Committee (8 percent) or by the PMA (12 percent).

On bank nationality basis, the capital adequacy ratio for local banks and foreign banks operating in Palestine continued to show disparity by end 2013, averaging 17.8 percent for the former against 21.9 percent for the latter. It is also observed that the aforementioned disparity between the two bank groups was constantly widening as a result of a higher facilities-to-assets ratio for local banks than for foreign banks.

Nonperforming loans (less provisions) to core capital

This ratio reflects the capacity of capital to cope with credit risk; it averaged 4.8 percent for all banks combined compared to 4.9 percent at end 2012. The slight drop in this ratio is considered a positive indication as it signals a shrinkage of bad assets compared to capital.

The ratio of non-performing loans less provisions to core capital in Palestine is considered modest compared to neighbouring countries, where it registered 19.6 percent[30] in Israel and 6.1 percent in Lebanon at end 2013. A disparity in this ratio between local and foreign banks operating in Palestine is noticed, with 5.6 percent for the former and 3.3 percent for the latter.

Core capital to total assets

This ratio shows the extent to which a bank’s core capital could cover its total assets; it is set at a minimum of 3 percent by Basel standard requirements. Generally, this ratio fluctuates from one year to the other due to both constant increases in banks’ capital items and changes to their total assets, especially facilities. Facilities constitute the most important item on the assets side and have tended to rise constantly over time.

Banks’ core capital-to-total assets ratio averaged 10.0 percent, compared to 10.6 percent at end 2012. This slight decline is attributed to a growth in banks’ total assets

[30] According to 2013 Q3 data.

Figure 5- 2: (NPLs-provisions) as percent of core capital, 2009-2013

Source: PMA.

0

1

2

3

4

5

6

7

2009 2010 2011 2012 2013

Perc

ent

Total banks Local banks Foreign banks

Figure 5- 3: Core capital as percent of total assets, 2009-2013

Source: PMA.

5

6

7

8

9

10

11

12

13

2009 2010 2011 2012 2013

Perc

ent



that outstripped the growth in their core capital; the former grew by 11.4 percent while the latter rose by 5.7 percent in 2013. On bank nationality basis, this ratio dropped to 9.9 percent in 2013 from 11.3 percent in 2012 for local banks, and to 10.1 percent from 10.5 percent in 2012 for foreign banks operating in Palestine.

Asset quality indicators

Large-exposures to core capital

An individual bank’s financial position plays a key role in determining its large-borrowers ratio (large exposure or credit concentration risk). The PMA instructions classify large borrowers as those whose loans equal or exceed USD 100,000; banks are requested to disclose such loans to PMA. The instructions also limit the single loan value to a maximum of 10 percent of the bank’s capital; otherwise PMA’s pre-approval is necessary, pursuant to Article (16) of Banking Law (9) for 2010[31].

By end 2013, the ratio of large borrowers to core capital for all banks combined averaged 276.1 percent, a 9.5 percent rise compared to the previous year. The continuous rise in this ratio signals escalation of credit concentration, or an upsurge in the number of loans which exceed USD 100,000. This means that exposure risks posed by specific individuals or entities have continued to escalate over time. It is noteworthy that this ratio is commonly inversely proportional to the size of economy and the degree of economic development, since it is frequently high in developing and small countries and low in advanced countries.

This large-borrowers ratio of the Palestinian banking business is considered high by regional and international standards alike. For example, it was 68.6 percent in Algeria, 116.9 percent in Cyprus, 52.6 percent in Austria, and 354.3 percent in Cameron, the latter the highest ratio in the world according to IMF data

Nonperforming loans to total loans

This ratio reflects the quality of bank assets, with credit facilities being the key component of such assets. The ratio is closely linked to developments in the local economy and its various sectors, being inversely proportional to the economic health of these sectors. A low ratio is therefore an indication of a sector’s assured commitment and ability to repay debt, and vice versa.

[31] The Law considers the total exposure as the total exposure per individual or a group of individuals working together and brought together by a common interest or kingship to the second degree. Exposure is defined as all forms of direct and indirect credit granted per person, along with bonds and debt instruments issued by the same person and purchased by the bank. This is in addition to the bank’s investments in this person, whether in the form of equity or any other investments.

Figure 5- 4: Large-exposures as percent of core capital, 2009-2013

Source: PMA.

215.9 225.2 236.3

266.6 276.1

0

50

100

150

200

250

300

350

2009 2010 2011 2012 2013

Perc

ent


Banking data demonstrate a downward trend in this ratio, which dropped to 2.9 percent in 2013 compared to 3.1 percent in 2012. This is one of the lowest ratios in the region, as the average ratio in the Middle East averaged 6.5 percent.

The persistent decline in this ratio in Palestine, amid constant growth of credit facilities, implies that banks are deploying funds in the local economy with increasing competence and efficiency. To a great extent, this also points to the efficacy of PMA undertakings in the area of banking system infrastructure over the past years

This ratio averaged 2.3 percent for local banks and 3.5 percent for foreign banks operating in Palestine by end 2013, a drop for both bank groups compared with end 2012. This reflects a relative improvement in asset quality for both groups especially that the decline concurred with growth in credit facilities.

Total loans to total assets

This ratio is a measure of banks’ efficiency as a financial intermediary between economic sectors with surplus funds and those with a deficit. It is also an indication of financial depth and the banking sector’s contribution to growth and development. Total credits to total assets averaged 40 percent at end 2013 compared to 41.8 percent at end 2012. Given that historical data have shown a generally upward trend, the decrease in this ratio by end 2013 was not the result of a decline in facilities, but rather the result of an increase in bank assets that outpaced the increase in credit facilities. For while the former increased by 11.4 percent, the latter rose by 6.7 percent. Generally, the credits-to-assets ratio for the Palestinian banking sector is modest compared to the Arab World, where it averaged 58 percent by end 2012[32].

A large disparity in this ratio between local and foreign banks operating in Palestine can be observed in favor of the former, where it averaged 45.4 percent, compared to 36 percent for foreign banks. This reflects the greater inclination of local banks to deploy funds in the local economy, contrary to foreign banks which prefer placements abroad.

[32] According to data published by the Union of Arab Banks

Figure 5- 5: NPLs as percent of total loans, 2009-2013

Source: PMA.

0

1

2

3

4

5

6

2009 2010 2011 2012 2013

Perc

ent


Figure 5- 6: Total loans as percent of total assets, 2009-2013

Source: PMA.

20

25

30

35

40

45

50

2009 2010 2011 2012 2013

Perc

ent



Earning and profitability indicators

These indicators gauge the outcome of banking activity and the value added by banks during a given period. They also demonstrate the efficiency and productivity of banks for that period. In analysing bank profitability, the return[33] on average assets and the return on average core capital are usually viewed as indicators of financial stability; however these two are not the only measures of profitability and productivity.

Return on average assets (ROAA)

This indicator reflects the efficiency of both cost monitoring and the use of assets. The increase in ROAA is usually results from better monitoring and reduction of costs or more efficient and effective deployment of bank assets in available investment channels.

For banks in Palestine, ROAA averaged 1.9 percent compared to 1.8 percent in 2012. This is considered one of the best ratios among neighboring countries. Israel, for example, recorded 0.9 percent and Lebanon 1.2 percent by end 2013. On a bank nationality basis, this ratio averaged 1.8 percent for local banks and 2.1 percent for foreign banks operating in Palestine in 2013. It is noticeable that, for the past two years, this ratio has seen a drop for local banks as opposed to a steadfast increase for foreign banks.

Return on average core capital (ROAE)

By end 2013, the ROAE for all banks combined increased to 18.7 percent or by 2.4 percent over 2012. This increase reflected a surge in bank profits by 15.0 percent, valued at USD 18.6 million, compared to 2012. In general, this ratio has stabilized in the last three years to 2013, as opposed to a sharp fluctuation in previous periods, especially at the level of bank groups.

In Palestine, ROAE is regarded as favorable compared to other neighboring countries, where it averaged 14.1 percent in Lebanon and 13.8 percent in Israel by end 2013.

[33] Return represents net profit before extraordinary profits and losses and tax.

Figure 5- 8: Return on average core capital (ROAE), 2009-2013

Source: PMA.

5

10

15

20

25

30

2009 2010 2011 2012 2013

Perc

ent


Figure 5- 7: Return on average assets (ROAA), 2009-2013

Source: PMA.

1

1.5

2

2.5

2009 2010 2011 2012 2013

Perc

ent



At a bank nationality basis, the ratio for local banks rose to 17.0 percent compared to 15.2 percent in 2012, against 20.1 percent for foreign banks compared to 17.1 percent in 2012.

Liquidity indicators

Liquid assets to total assets

The ratio of liquid assets to total assets for all banks combined averaged 38.3 percent compared to 36.4 percent in 2012. This ratio has tended to settle, particularly during the last few years, showing a fluctuation that did not exceed a single percentage point, up or down, since 2011. When compared to corresponding ratios for neighboring countries, this ratio for Palestine approaches the region’s average, as it was 60.7 percent in Israel and 22.7 percent in Lebanon at end 2013.

On a bank nationality basis, a higher ratio is observed for foreign banks than for local banks during 2013, as against nearly the same ratio for the two groups in 2012. As illustrated by the adjacent figure, local banks have maintained lower liquidity ratios than foreign banks over time, as expected considering that local banks outstripped foreign banks in credits-to-assets ratio.

Liquid assets to short-term liabilities

This ratio shows a bank’s ability to cover liabilities susceptible to rapid withdrawal, any time and without prior notification, by these liabilities’ holders. A rise in this ratio is therefore a wholesome change, as it reflects the bank’s ability to cope with any unexpected short-term withdrawals. Yet, such a rise may possibly adversely affect the return and profitability indicators, as it implies the presence of non-deployed profitless assets, causing the bank to incur the additional costs of management and maintenance of these idle assets. Liquid assets to short-term liabilities ratio is also linked to the economic cycle, rising in times of economic slowdown and diminishing in times of recovery or relative improvement. This ratio for all banks combined averaged 52.6 percent at end 2013, at 52.4 percent for local banks and 52.7 percent for foreign banks.

Figure 5- 9: Liquid assets as percent of total assets, 2009-2013

Source: PMA.

25

30

35

40

45

50

2009 2010 2011 2012 2013

Perc

ent


Figure 5- 10: Liquid assets as percent of short-term liabilities, 2009-2013

Source: PMA.

40

45

50

55

60

2009 2010 2011 2012 2013

Perc

ent



On a related note, banks operating in Palestine continued to suffer from cash liquidity crisis, particularly in the WB. The crisis started when Israel prohibited the shipment of surplus cash in Israeli shekel to correspondent Israeli banks, which led to the accumulation of shekel cash surplus in banks in the WB. The aforesaid Israeli measure infringe on the economic Paris Protocol provisions, which stated that “Both sides will allow correspondential relations between each other’s banks”.

The figure illustrates the spiraling trend of cash liquidity in WB banks, which worsened since March 2009, as Israel began to hamper the shipment of shekel surpluses from banks operating in the WB to banks in Israel. The crisis drastically exacerbated since 2012, compelling the PMA to exert strenuous efforts to have Israel honor the terms of the Paris Protocol. These efforts were rewarded with an agreement with the Central Bank of Israel which permitted the monthly shipment of NIS 120 million from banks in the WB. However, the agreement which remained effective until July 2013 did not provide a fundamental solution to the crisis. Hence, the PMA pressed with its efforts to raise the permissible ceiling on the shekel transfer and managed to increase it to a monthly NIS 300 million as of July 2013. Additionally, a special arrangement allowed the shipment of NIS 1 billion for the months of September, October and November of 2013. The agreement allowing monthly shipment of NIS 300 million remained in effect until the early months of 2014. The last such transfer was made on April 9, 2014.

Table (5-2) reveals that the surplus transferred from banks in the WB reached NIS 9.6 billion in 2013. Meanwhile, Israel continued to bar the ship of the shekel surplus from Gazan bank branches, a punitive boycott measure. Nonetheless in 2013, Israel agreed to ship NIS 200 million from branches in GS to their banks in the WB, and to replace with coins some NIS 54 million worth of spoiled notes.

It is worth noting that the shekel shipment was usually carried out through two channels. The first was through the Bank of Palestine which had acted as the PMA special correspondent bank for the shekel currency, transferring the sums stated in the aforementioned agreement with the Bank of Israel. The second channel was through certain

Figure 5- 11: NIS cash liquidity (in USD) in Palestinian banking sector, 2006-2013

Source: PMA.

0

100

200

300

400

500

600

700

800

Mar

-06

Sept

.

Mar

-07

Sept

.

Mar

-08

Sept

.

Mar

-09

Sept

.

Mar

-10

Sept

.

Mar

-11

Sept

.

Mar

-12

Sept

.

Mar

-13

Sept

.

USD

mill

ion

Branches in GS Branches in WB

Table 5- 1: Soundness indicators of Palestinian banking system, 2009-2013

(Percent)

Indicator 2009 2010 2011 2012 2013

Capital Indicators

Capital adequacy ratio 20.3 21.4 21.1 20.3 20.0

NPLs to core capital 2.1 2.9 3.8 4.9 4.8

Core capital to total assets 9.7 10.7 11.2 12.4 10.3

Asset Quality Indicators

Large-borrowers to core capital 215.9 225.2 236.3 266.6 276.1

NPLs to total loans 4.1 3.1 2.8 3.1 2.9

Profitability Indicators

Return on average assets 1.8 2.1 1.9 1.8 1.9

Return on core capital 20.3 21.1 17.0 16.3 18.7

Liquidity Indicators

Liquid assets to total assets 43.3 40.3 38.2 36.4 38.3

Liquid assets to short-term liabilities

55.1 51.7 49.2 49.6 52.4

Source: PMA.


Jordanian banks operating in Palestine. These banks transferred shekel surpluses under direct bilateral agreements and MoUs with Israeli banks; these banks were favorably treated as foreign banks of a country (Jordan) that has diplomatic and political ties with Israel. These banks were: the Arab Bank, Cairo Amman Bank, Bank of Jordan, Jordan Ahli Bank and the Housing Bank for Trade and Finance.

PMA instructions on cash liquidity required parent banks to maintain a 3 percent liquidity ratio for the Israeli shekel, the Jordanian dinar and other currencies; a corresponding 2 percent ratio was required for bank branches. For all currencies combined, a minimum of 6 percent is required for parent banks and 4 percent for branches. As for the dollar as of May 1, 2013, a 4.5 percent has to be maintained for parent banks and 3 percent for branches, pursuant to PMA Instructions No. (4/2013).

However, as clearly illustrated by figure (5-12), a sharp rise is noted in liquidity ratios in the shekel to total assets (denominated in dollars) of banks operating in the WB and GS. In comparison, this ratio remained around 10 percent during the period from March 2006 until March 2009 (except for a distinct hike in December 2007). Thereafter, due to the aforementioned Israeli restrictions on the shekel surplus transfer, this ratio soared to more than 20 percent, especially after 2012, reaching 30 percent in September 2013. It then declined to around 22 percent in December 2013, reflecting the PMA/Bank of Israel special arrangement to allow the shipment of NIS 1 billion during the months of September, October and November 2013. However despite the shipments, the ratio remained high, at around 22 percent.

It can therefore be concluded that the disruption of the shipment of shekel surpluses to Israeli banks has led to a sharp accumulation of the shekel at banks in Palestine. Assuming that the normally moderate liquidity ratio for the shekel in total assets is around 10 percent (as suggested by the historical data for the period before the imposition of the Israeli restrictions), it can be deduced that banks in Palestine are currently choking on an idle surplus equivalent to 10 percent to 20 percent of assets in shekel. This surplus is idle and subsequently elevates bank overhead expenses.

In case Israel carries out its unrelenting threat to impose the economic punitive measure of lowering the deposit ceiling with Israeli banks, additional shekel surpluses are bound to accumulate in banks in Palestine. Such a situation may prompt these banks to cease receiving shekels from the public, and subsequently cause problems in the settlement of check and transfer in this currency. This will inevitably exacerbate risks to financial stability and to the economy at large.

Table 5- 2: NIS surplus cash shipped from Palestine to Israel, 2013

(NIS million)

Item 2013

Direct shipping from Jordanian banks in WB 4,740.6

Shipping from bank of Palestine in WB 4,860.3

Total NIS surplus shipped from banks in WB to Israel 9,600.9

NIS surplus shipped from branches in GS to banks in WB 200.0

Replacing damaged cash (NIS 50 million) and shipping coins (NIS 4 million) to GS

54.0

Source: PMA.

Figure 5- 12: NIS cash liquidity as percent of total assets, 2006-2013

Source: PMA.

0

5

10

15

20

25

30

35

Mar

-06

Sept

.

Mar

-07

Sept

.

Mar

-08

Sept

.

Mar

-09

Sept

.

Mar

-10

Sept

.

Mar

-11

Sept

.

Mar

-12

Sept

.

Mar

-13

Sept

.

Perc

ent

43Chapter Six: Non-Banking Financial Institutions

OverviewThis chapter analyses risks associated with non-banking financial institutions, whether subject to PMA supervision (the specialized lending institutions and money exchange institutions), or under the supervision of the Palestine Capital Market Authority, PCMA (the Palestine Exchange-PEX, insurance companies, mortgage companies and financial leasing companies).

Although most of these institutions are still in the development stage (except for the relatively developed PEX), it remains crucial to monitor developments in these institutions, as they constitute an important component of the financial system and a major contributor to the finances of various economic sectors. Besides, they are connected both directly and indirectly to the Palestinian banking sector and may pose potential risks to this sector and to the financial system at large.

Money changers

At end 2013, PMA-licensed money changers numbered 270, of which 232 in the WB and 38 in GS. There were 184 money changing firms as opposed to 86 money changers (individuals engaging in currency exchange). Work is currently underway to rectify the legal status of individually-run establishments, pursuant to the provisions of the aforementioned licensing regulation No (13) for 2008.

Regulations on the License and Control of the Exchange Profession No (13) of 2008 constitute the regulatory framework organizing money changing activity in Palestine; they elaborate the capital required for money changing firms, and the permissible activities and penalties enforceable in case of violating the law provisions. Based on this law, the PMA has issued several relevant instructions and resolutions aimed at organizing activity of the sector. In 2013, the PMA issued three sets of instructions. Instructions No (1/2013) define standard working hours and official holidays. Instructions No (2/2013) set controls on activity in the area of agent and sub-agent fast transfers, specifying requirements to be fulfilled by a wire transfer company, before money changing firm acquires its agency. The instructions also require the money changing firm to obtain PMA’s pre-approval as a condition to acquire the agency. Moreover, the instructions set out the controls for wire transfer activity, as well as the eligibility requirements to acquire such agencies, confining the agent money changer to a maximum of 5 subagents. Instructions No (3/2013) deal with processing customer complaints, and require money changers and money changing firms to provide an on-site complaint box for the use of the public. Each complaint shall be stamped by the firm or money changer stamp and a copy of the complaint handed to the complainant, who should receive a reply in writing within 10 days of the date of the complaint. A quarterly complaints report is to be submitted to the PMA of all complaints and the corrective actions taken.

Chapter Six Non-Banking Financial Institutions


During 2013, the money changing sector witnessed some financial developments, which reflected the general economic situation. As such, performance indicators of financial activity show that this sector’s total assets rose by around 0.5 percent to USD 49.6 million by end 2013. Likewise, capital rose by 4.2 percent to reach USD 44.5 million, compared to USD 42.7 million in the previous year. However, equity rights dropped by 3.5 percent for the same period, as a result of closure and going out of business of a number of money changing firms/money changers. Profit realized by the sector fell sharply to USD 394 thousand from USD 1.8 million in 2012, dropping by around 78 percent.

The money changing sector’s financial indicators point to a relatively small industry, which does not represent any significant risk to financial stability. This is also ascribed to the supervisory instructions the PMA implemented and the field visits it conducts to ensure money-changers’ compliance with effective instructions; these helped mitigate potential risks. Nonetheless, money changers who operate illegally and outside PMA’s direct control are a source of concern. In particular, these money changers engage in practices prohibited by the PMA such as receipt of deposits and safe keeping, thereby exposing involved citizens to exploitation, deception and fraud.

Specialized lending institutions

Specialized lending institutions are subject to the supervision and inspection of the PMA, pursuant to the provisions of Regulation No (132) 2011. Prior to 2011, the statutory position of these institutions was extremely complicated, as some functioned as companies and others as associations; some operated under the Ministry of Interior and others under the Ministry of Economy’s Companies’ Controller, or the Ministry of Labor, etc… The PMA sought to regulate and organize these institutions, in order to ensure their contribution to foster development and promote financial stability. For that purpose, the PMA issued supervisory systems and instructions that ensure the creation of a mature and sustainable sector that operates within a standardized legal environment. In particular, it issued instructions that define and elaborate these institutions’ licensing mechanism, their management procedures and governance processes, and their permissible and prohibited activities. In 2013, the PMA also released instructions that allowed these institutions to practice both conventional and Islamic lending, in accordance with relevant controls and restrictions. In the near future, the PMA will issue instructions requiring these institutions to observe fair lending, including disclosure, transparency and customer banking awareness.

During 2013, six out of thirteen specialized lending institutions and programs[34] were granted initial licensing, and are currently working on rectifying their statuses to transform into profit or non-profit

[34] The institutions, granted initial PMA approval, are: Faten, Asala, ACAD, Reef, CHF, and Al-Ibdaa.

Table 6- 1: Money changers in Palestine, 2010-2013

Item 2010 2011 2011 2013

Corporate 95 154 173 184

Individual 165 130 103 86

Total 260 284 276 270

Source: PMA.

Table 6- 2: Main financial indicators of money changers, 2011-2013

(USD million)

Item 2011 2012 2013

Capital 35.9 42.7 44.5

Ownership equity 36.5 48.2 46.6

Profits 1.8 1.8 0.4

Total expenses 3.6 5.2 5.4

Current assets 35.1 46.8 47.1

Fixed assets 2.1 2.7 2.5

Source: PMA.


companies. The PMA encourages banks to lend to specialized lending institutions by exempting these loans from the 9 percent reserve requirement.

By end 2013, specialized lending institutions, that are members in Sharakeh network, were operating through a network of 61 branches and 509 employees; They had granted around USD 84 million to more than 54 thousand borrowers, half of whom (50.4 percent) were female borrowers. The value of the average loan was USD 1,934.2 as opposed to USD 1,715.0 in 2012. It is worth to note that a single institution – Faten- accounts for the majority share (57.1 percent) of total loans granted by these institutions[35].

For their funding, specialized lending institutions primarily depend on internal and external lending, in addition to their capital. The volume of business they operate is small compared to banks; therefore their impact on financial stability is extremely limited. This is evident from their share in total bank credit, which was only 1.9 percent by end 2013.

It is noteworthy that specialized lending institutions are a key source of funding for SMEs. By end 2013, these institutions had granted SMEs 25,494 loans valued at USD 84 million, of which USD 49 million were outstanding facilities.

These loans were distributed to SMEs operating in various economic sectors, with the trade sector claiming the largest share (38.5 percent), followed by the agriculture sector with 25.3 percent, and industry and mining with 18.1 percent.

Specialized lending institutions loans portfolio to SMEs shows that by end 2013, non-

[35] The data for this paragraph relate to lending institutions which are members in Sharakeh; namely: Asala, ACAD, Faten, Reef, CHF and UNRWA.

Figure 6- 1: Credits granted by specialized lending institutions to SMEs by sector, 2013

Source: PMA.

Constructions 1.1 %

Financial sector 0.2%

Personal & Consumption

1.1 %

Tourism 1.2 %

Public Admin. 14.5 %

Agriculture 25.3 %

Commerce 38.5 %

Industry 18.1 %

Figure 6- 2: NPLs of credit granted by specialised lending institutions to SMEs by sector, 2013

Source: PMA.

Constructions1.1 % Personal &

consumption 0.2%

Tourism 2.2 %

Public admin. 23.3 %

Commerce 33.1 %

Industry 27.4 %

Agriculture 12.7 %


performing loans (NPLs) totalled USD 8.2 million, i.e. around 10 percent of the total loans these institutions granted to SMEs; this is almost equivalent to the ratio of NPLs of banks’ total loans to SMEs. This affirms the high credit risk that SMEs pose, which is heightened by their excessive sensitivity to the political and economic situation in Palestine. This places at risk SMEs’ main sources of income they use to repay debt, due to banks or specialized lending institutions.

Default ratios within specialized lending institutions’ loan portfolio differ for different economic sectors, with the trade sector loans showing the highest default ratio (33.1 percent) of total NPLs, followed by the industrial sector with 27.4 percent, and the public utilities and services sector with 23.3 percent.

In this context, it is worthy to note that housing and mortgage loans, whether from banks or specialized lending institutions, witnessed steady growth over time. The housing and mortgage loans that specialized lending institutions granted, numbered 7,566, with a value of USD 65.4 million by end 2013, rising by around 38 percent in number and 100 percent in value, compared to 2012. Public sector employees acquired the largest share (36.7 percent) of total loans special lending institutions granted to this sector, followed by the self-employed professionals at 29.1 percent, and private sector employees at 24.5 percent. Yet, most defaulters were self-employed professionals, affected by the irregularity of their monthly income. Hence, there is dire need to closely assess risks associated with such loans, and to take corrective measures to safeguard financial stability and prevent contagion to other sectors.

It is noteworthy that specialized lending institutions have been included in the PMA’s credit information database. This will help these institutions evade customers with poor credit rating, mitigate credit risks, enhance the competence of credit-granting decisions, and thus promote financial stability.

Securities sector

Following the listing of an industrial company in 2013, the number of listed companies on the Palestine stock exchange (PEX) increased to 49, constituting a market capitalization of USD 3.2 billion; of these companies, 9 came from the banking and financial services sector, 12 from the industrial sector, 13 from the services sector, 8 investment companies and 7 insurance companies.

To foster financial stability and promote confidence building in

Figure 6- 3: Mortgage and housing loans by sector, 2013

Source: PMA.

05

10152025303540

Perc

ent

Number Value

Table 6- 3: PEX main indicators, 2009-2013Item 2009 2010 2011 2012 2013

Volume of traded shares (million) 238.9 230.5 184.5 147.3 203.0

Value of traded shares (USD million) 500.4 451.2 365.6 273.4 340.8

Market capitalization (USD million) 2,375.4 2,449.9 2,782.5 2,859.1 3,247.5

Market capitalization to GDP (%) 32.9 29.4 27.8 27.9 27.3

Turnover ratio (%) 22.09 20.48 12.62 9.67 12.98

No. of transactions 88,838 82,625 61,928 41,442 44,425

No. of trading sessions 246 249 248 249 241

No. of companies 39 40 46 48 49

Al-Quds index 493.0 489.6 476.9 477.6 541.5

Source: PEX.


the Palestinian financial system, PMA took an important measure in 2013 which allowed the PEX to execute settlement of financial trading transactions through PMA’s real-time gross settlement system (BURAQ). This development was made possible by the signature of a MoU between PEX and the PMA in February 2013. The Clearing, Depository and Settlement Center at PEX was approved as a clearing agent for financial settlement. This is considered a quality development, which enhances the integral relation between the banking sector and the securities industry, and reinforces crosslinking and interconnection between various components of the financial system.

This MoU will significantly promote financial stability in line with best international standards through improving competence of settlements and mitigating risks associated with trading transactions. Additionally, it will enable PEX to formulate future plans that boost cash circulation in association with stock trading. The MoU will also enhance the banking system’s competence through fostering competition between banks, to benefit securities companies and investors alike.

Additionally in 2013 the implementation of a new companies-listing system commenced, featuring a two-tier securities market to enhance market competence. The system lists large companies on the primary market, while relatively small companies are listed on a secondary market[36]. It also allows moving the listing of companies from the first to the second market, and vice versa, in accordance with certain conditions specified in the system. In effect, differentiation between companies offers a clearer and more transparent picture to investors, providing them with better protection. Thus an investor will be better informed of the nature of the companies with which he/she is investing money and the associated risks; this will help mitigate potential risks to the PEX at large.

The PCMA issued several instructions and circulars to promote various aspects of governance and effective management, and reinforce and better organize technical aspects of the PEX operation. The most important instructions related to margin finance[37]; other Instructions tackled management and audit in securities companies, including clarifying the board of directors’ duties and the objectives and responsibilities of internal and external audits.

By end 2013, Al-Quds Index closed at 541.5 points, a growth of 13.4 percent compared to 2012. This growth encompassed indices of all sectors (except for the insurance sector), with the banking and financial sector index rising by 18.6 percent, and the services sector index increasing by 4.7 percent. Likewise, indices rose for the investment sector by 33.7 percent, and the manufacturing sector by 6.9 percent; however, the insurance sector index dropped by 4.1 percent to close at 45.5 points.

[36] Large companies are companies with a subscribed share capital not less than USD 10 million, a number of shareholders not less than 150 shareholders and the Free Float share not less than 25 percent of the subscribed share capital, among other requirements. Small companies have a capital not less than USD 0.5 million, a number of shareholders not less than 50 shareholders and the Free Float not less than 10 percent of capital, among other requirements.

[37] Margin Finance: is the financing provided by a listed member securities company to buy on margin by offering a percentage of the current market value of the securities held in a margin account as collateral and/or any other financial collateral, as stated in the PCMA instructions.

Figure 6- 4: Al-Quds index, 2009-2013

Source: PMA.

493 489.6 476.9 477.6

541.5

440

460

480

500

520

540

560

2009 2010 2011 2012 2013

Poin

t


At the regional level, PEX ranked 11 out of 12 Arab financial markets which showed growth during 2013; the Dubai market came first, with an index hike of 107.7 percent; while Libya came last, with its index dropping by 17.1 percent.

Analysis of shares ownership showed that in 2013 the Palestinian shareholders accounted for 87.4 percent of share value and 89.2 percent of share number. Jordanians owned 6.3 percent of share value, followed by investors from Luxembourg, Kuwait, USA and other nationalities. This is a clear indication of foreign investors’ confidence in PEX, despite the peculiarity of the Palestinian situation. Nonetheless, the growing ratio of foreign investments in PEX should be viewed with caution, as it may increase associated potential risks, which could spill into the Palestinian financial system and adversely affect financial stability. These risks mainly arise from an increased foreign investors’ propensity to rapidly withdraw their investments in the event of local or regional political or economic turmoil or various other disturbances.

As for risks posed to the banking sector, it is noted that facilities granted for the purpose of investment in securities constituted only 1.1 percent of total bank facilities, at a value of USD 50.2 million by end 2013. This ratio is evidently quite limited and does not pose any fundamental risk to financial stability in case of default. Also, PMA actively restrains risks associated with bank financing of securities trading by setting specific controls on financing for that purpose.

Insurance sector

During 2013, the PCMA issued several statutes and instructions to organize and develop the insurance sector’s technical and financial environment, all in line with best international practices; its main aim was to develop an insurance market which matches peer international markets. The key instructions and statutes issued related to (i) developing a system for setting the fees (the tariff) for vehicles’ and workers’ insurance; (ii) specifying directions on granting banking insurance certificate and the related organization and supervision procedures; and (III) and enacting a resolution requiring an insurance company to appoint an actuary charged with the compilation of an annual report, articulating his/her professional opinion regarding the financial and technical position of the company.

By end 2013, insurance companies in Palestine numbered 10, working through 114 branches and 225 insurance producers covering various regions of the WB and the GS, offering various insurance and associated support services[38], and engaging 1,075 employees working in company headquarters and branches.

Noteworthy in this context is that vehicle insurance premiums constituted the largest share (58.3 percent) of total premiums, followed by health insurance premiums with 17.3 percent, general and engineering insurance premiums[39] with 15.0 percent, and the remaining types of insurance premiums[40] with 9.4 percent.

As to financial activity, total insurance companies’ assets rose by 7.9 percent over 2012, to around USD 367 million. Of total assets, investment constituted 51.0 percent with a value of USD 187 million (of which 67.3

[38] These comprise the services of insurance damage assessors, insurance agents, reinsurance agents and insurance investigators, in addition to two management companies of medical expenses and insurance services and an approved bank (the Palestine Islamic Bank) for banking insurance represented by Al-Takaful Palestinian Insurance Co.

[39] Divided between premiums for worker insurance with a share of 8.7 percent, engineering insurance with 2.6 percent, civil liability with 1.7 percent and other insurances with 2.0 percent

[40] Including fire insurance with 5.8 percent, life insurance with 2.4 percent, marine insurance with 1.2 percent of total value of insurance premiums.


percent were domestic investments, and 32.7 percent foreign investments, distributed as 44 percent in shares and bonds, 25.6 percent as bank deposits, 28.1 percent as real estate, and 2.3 percent as loans to stakeholders). Other assets included accounts receivable at 20.2 percent and with a value of USD 74.2 million, insurance contracts assets at 8.5 percent, and cash in banks and funds at 4.2 percent with a value of USD 15.6 million.

Insurance companies’ equity rights rose by 10.1 percent to USD 119.8 million, while paid-up capital increased by 1 percent to USD 67.9 million. This positively affected these companies’ operation results, which showed a net profit after taxes of USD 12.4 million, of which USD 8.6 million were net profit on insurance technical operations.

The insurance sector’s financial indicators reveal a rise in total written premiums to total shareholder equity to 134.4 percent compared to 132.8 percent in 2012. Net written premiums to total shareholder’s equity increased to 118.3 percent compared to 112 percent in 2012, signalling a build-up of capital and reserves in provision for net written premiums. This ratio reflects the 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 increased to around 88.1 percent compared to 84.3 percent in the previous year[41], which indicates an increased reliance on reinsurance, and a consequent rise in administrative costs[42], to 25.7 percent compared to 25.5 percent in 2012. This points to a slight deterioration in companies’ competence in the rationing of their general expenses. Overall, the sector’s loss rate (compensation/acquired or earned premiums[43]) fell by 4 percentage points to 66.6 percent. Moreover, shareholders’ equity coverage of technical provisions receded by 0.5 percentage point to 67.4 percent, while technical provisions covered almost double the paid-in compensations.

As for liquidity indicators, the ratio of liabilities to liquid assets dropped to 158.6 percent from 170.3 percent in 2012, indicating a 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 76.9 percent

[41] This ratio represents the result of dividing net written premiums (total written premiums after excluding reinsurer share) over total written premiums.

[42] This is calculated by dividing total administrative expenses by total premiums[43] 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.

Table 6- 4: Financial indicators of insurance sector, 2012-2013(Percent)

Indicator 2012 2013

Total insurance premiums- to-shareholders equity 132.8 134.4

Insurance premiums (net)-to-shareholders equity 111.9 118.3

Change in shareholders equity 13.8 10.1

Holding premiums 84.3 88.1

Total expenses-to-total assets 10.8 11.1

Reinsurers share of premiums 15.7 11.9

Reinsurers share of paid up claims 15.4 17.4

Average losses 70.5 66.6

Shareholders equity-to-technical provisions 67.9 67.4

Technical provisions-to-paid up claims 181.3 200.5

Technical provisions-to-liquid assets 80.3 76.9

Liabilities- to- liquid assets 170.3 158.6

Average administrative cost 25.5 25.7

Return on shareholders equity 6.7 10.4

Return on assets 2.1 3.4

Assets-to-GDP 3.3 3.1

Investment-to-GDP 1.8 1.6

Solvency margin 199 169

Source: PCMA.


from 80.3 percent in 2012, indicating a decline in liquidity available to the company against its technical provisions.

Profitability indicators point to a rise in return on shareholders’ equity to 10.4 percent from 6.7 percent in 2012. Analysis also shows a rise in return on assets to 3.4 percent from 2.1 percent in 2012, and a drop in the insurance sector’s financial solvency ratio[44] by round 30 points to 169 percent, down from 199 percent in 2012. The PCMA calculates this ratio for each insurance company, in order to determine its ability to face potential risks resulting from the inadequacy of technical reserves to counter risks including company default.

On a different note, the insurance sector’s deposits with banks accounted for around 12.6 percent of the constituent companies’ total assets, and 24.8 percent of their total investments. It is worthy to note these do not exceed 0.6 percent of total customer deposits with banks. This indicates that the insurance sector’s exposure to risks posed by the banking sector is much greater than the banking sector’s exposure to risks posed by the insurance sector. This is because the banking sector represents the largest component of the Palestinian financial system, in contrast to other financial institutions, which are still in their early foundation or development stages. In comparison, banks’ outstanding balances with insurance companies comprise only 0.2 percent of these companies’ total liabilities. Moreover, bank internal investments in all financial companies[45] (subsidiaries, associates companies and minority equity) are less than 7 percent of total bank investments. Overall, these ratios reflect the limited exposure of the banking sector to risks posed by the insurance sector.

Mortgage sector

The Palestinian mortgage sector is subject to PCMA’s supervision and inspection. It consists of two companies, complimenting each other and cooperating with a number of banks[46], and 44 PCMA-licensed appraisers. The Palestine Mortgage and Housing Corporation specializes in refinancing mortgage loans, and the Palestine Housing Finance Corporation insures banks against mortgage borrowers’ defaults.

[44] The excess company assets over liabilities, which allow it to meet its obligations and reimburse compensations immediately when due, thereby avoiding insolvency of the company

[45] Data on bank investments in insurance companies as a separate sector are unavailable.[46] Eight banks participate in mortgage financing programs (4 local banks and four foreign banks) in addition to the Palestine Banking

Institute.

Figure 6- 5: Linkages between insurance and banking sector, 2009-2013

Source: PMA.

0

0.5

1

1.5

2

2.5

2009 2010 2011 2012 2013

Perc

ent

Insurance deposits as a percent of total deposits in banks

Banks balances as a percent of total insurance liabilities


By end 2013, this sector’s total assets amounted to USD 42.4 million, a 13.0 percent increase over 2012. The sector realized a profit of around USD 216 thousand, a dropping by 49 percent from 2012. Also this sector offer financing to banks in order to grant housing loans under appropriate terms and conditions. Long-term housing loans granted to banks in 2013 totalled USD 30.8 million, a 14 percent rise over 2012.

In order to closely monitor the development of the mortgage sector and avoid the creation of a real-estate bubble in the banking sector, the PMA initiated experimental operation of a housing and mortgage loans database in Palestine in 2011. The main aim of this database is to mitigate risks and evade any likely future crisis, similar to the mortgage crisis which occurred in the USA in 2008.

Financial leasing sector

Financial leasing is a relatively new financing method that was introduced into the Palestinian market in the past few years. By end 2013, financial leasing companies numbered six, working mainly in the field of vehicle finance. PCMA’s Mortgages and Financial Leasing Administration seeks to develop this sector so that it can efficiently contribute to economic growth in Palestine. Companies of the sector are subject to the Law of Financial Leasing which was recently ratified[47].

The PMA seeks to include financial leasing companies within its Credit Registry System, in order to assist the sector in mitigating risks and enhance financing decision-making, thereby contributing to financial stability.

[47] The Law on Financial Leasing was issued by Presidential Decree in January 2014.

Table 6- 5: Performing indicators of mortgage sector, 2009-2013Item 2009 2010 2011 2012 2013

Assets (USD million) 37.9 38.7 37.1 37.5 42.4

Ownership equity (USD million) 21.1 21.7 21.0 21.5 21.6

Profit of the year (USD million) 0.44 0.34 0.35 0.45 0.22

Equity-to- assets (%) 55.7 56.1 56.6 57.3 50.9

Return on assets (%) 1.2 0.8 0.9 1.2 0.5

Return on equity (%) 2.1 1.6 1.7 2.1 1.0

Assets-to-credit (net, %) 1.7 1.4 1.1 0.9 1.0

Source: PCMA.

53Chapter One: Overall Assessment of Financial Stability

OverviewThis chapter presents the results of financial stress testing of the Palestinian banking sector; such testing constitutes a key tool of risk management available to both banks and supervisory authorities. As crucial prudential tools to be used at both the macro- and micro- levels, these tests offer a view of the bank’s ability to respond to various shock scenarios, and allow supervisory authorities to undertake necessary measures to cope with imminent risks. The PMA has started conducting several stress tests with a view to assess Palestinian banks’ ability to survive in face of various risks and shocks that simulate the economic and political reality in Palestine. These tests will enable PMA to formulate prudential policies that assist banks to withstand various risks under several possible scenarios.

Stress tolerance tests

Since 2011, the PMA has regularly performed stress testing of the overall banking system and of every bank individually. For that purpose, the PMA issued instructions on stress testing that conform to prevailing international standards, particularly the Principles for Sound Stress Testing Practices and Supervision issued by the Basel Committee in 2009.

Stress tests are part of PMA’s efforts to develop and promote a financial supervisory approach underpinned by analysis of potential risks and banks’ ability to confront them. In particular, PMA seeks to develop appropriate policies to counter potential risks including by designing recovery plans in case of disaster, advising banks on need for capital base expansion, and commending diversification of credit portfolios including foreign investment.

For this purpose, nine scenarios have been developed in relation to credit, liquidity, market, and operation risks. These are tested under three types of shocks: political shocks, economic shocks and other shocks related to concentration. These scenarios vary from the least to the most severe, as follows:

Chapter SevenFinancial Pressure “Stress Tests” in Banking Sector


Table 7- 1: PMA stress tests results, 2012-2013Scenarios of political shocks nature, includes:

Scenario 1 Scenario 2 Scenario 3

Assuming delay in the PNA payment of their outstanding loans 10% 15% 20%

Delinquency of PNA employees loans 25% 40% 50%

Delinquency of private sector loans-excluding PNA employees loans 20% 30% 40%

Decrease in the investments fair value inside Palestine 5% 10% 15%

Withdrawal of deposits 10% 15% 20%

Result: Tier 1 capital/RWA 2012 15.9% 11.7% 8.2%

2013 15.9% 11.6% 8.1%

Scenarios of economic shock nature, includes:


Delinquency of private sector loans-excluding PNA employees loans 10% 20% 30%

Decrease in the investments fair value inside and outside Palestine 5% 15% 25%

Withdrawal of deposits 5% 10% 20%


2013 19.2% 13.3% 7.3%

Scenarios of concentration shock nature, includes:


Delinquency of biggest 1, 3, 5 borrowers 1 3 5

Withdrawal of biggest 3, 1, 5 depositors 3 1 5


2013 20.3% 17.4% 15.4%

Source: PMA.

To determine the success criteria for these scenarios, the PMA assessed the effect under each scenario on the bank’s post-stress tier 1 capital, i.e. on core capital capacity to absorb shocks. In specific, the success criterion was couched in terms of the bank’s post-stress tier 1 capital ratio to risk- weighted assets: a bank passes the test if this ratio does not fall below 8 percent. It is to be noted that the 8 percent boundary is equivalent to the minimum limit of the ratio of tier 1 capital to risk-weighted assets, which was fixed at 12 percent by the PMA Instructions No (7/2009), released on December 6, 2009.

By conducting stress testing based on banks’ financial statements as of end 2012 and 2013, it is possible to gauge the impact of the simulation scenarios on these banks’ financial data. Results for all banks (combined) affirm the resilience of the Palestinian banking sector in general, as it passed all the scenarios’ tests except for scenario No. 6, (especially in 2013), the most difficult among all the political and

Figure 7- 1: Tier 1 capital to risk weighted assets, 2012-2013

Source: PMA.

0

5

10

15

20

25

Perc

ent

Ratio after simulation, 2013Ratio after simulation, 2012Minimum limit


economic scenarios tested. Under this scenario banks are especially prone to: (i) the risk of reduction of fair value of investments abroad (indicating an unduly large ratio of net foreign assets to total assets) and (ii) the risk of a decline in the credit quality of loans granted to the PA and its employees. Under this scenario, the ratio of tier 1 capital to risk-weighted assets dropped after simulation from 21.1 percent to 8.1 percent in 2012 and from 21.5 percent to 7.0 percent in 2013.

Tests for banks’ resilience to the collapse of one of the banks operating in Palestine

At end 2013, the PMA conducted the second test for banks’ resilience to the default of one of the banks, including its loss of its entire core capital. The test is based on the inter-banks data matrix (inter-bank deposits) at a specific point in time, which, in this case, was end 2013.

Assuming the scenario of default of any of the banks in Palestine, whether local or foreign, the results for the remaining banks will be as follows:

Individual bank level

1. The default of Bank No (1) will adversely affect Bank No (6), causing the drop of the latter’s capital adequacy from 19.3 percent to 6.5 percent.

2. The default of Bank No (4) will adversely affect Bank No (1), causing the drop of the latter’s capital adequacy from 16.6 percent to 7.6 percent.

3. The default of Bank No (13) will adversely affect Bank No (1) leading to a drop in the latter’s capital adequacy from 16.6 percent to 9.2 percent, and will adversely affect Bank No (3) leading to a drop in the latter’s capital adequacy from 16.3 percent to 9.0 percent

4. The default of either Bank No (9) or Bank No (16) will adversely affect Bank No (11) causing the latter’s capital adequacy to drop from 11.4 percent to 10.8 percent and 10.4 percent, respectively. It should be noted that the capital adequacy ratio for Bank No (11) was below the 12 percent level prior to the shock, which violates PMA’s pertinent instructions.

Aggregate bank level

The default of any of the banks in Palestine will have the following adverse effect:

1. The decline of the aggregate capital adequacy ratio by a rate ranging between 1.2 percent and 3.6 percent, while remaining above the level of 12 percent fixed by the PMA.

2. The decline of capital adequacy ratio for local banks at a rate ranging between 0 percent and 7.1 percent, while remaining above the level set by the PMA, except for the case of Bank No (5), which, in case of default, will bring down the capital adequacy ratio for local banks to 10.7 percent.

Table 7- 2: Capital adequacy ratios (CAR), 2013Bank* CAR Bank* CAR

1 16.6 10 36.8

2 35.3 11 11.4

3 16.3 12 101.2

4 24 13 74.8

5 14 14 16.1

6 19.3 15 101.1

7 20.9 16 18.4

8 52.2 17 23

9 125.7

* From 1-7 are local banks, and from 8-17 are foreign banks.Source: PMA.


3. The capital adequacy ratio for foreign banks will decline by a rate ranging from 0 percent to 6.4 percent, while remaining above the level set by the PMA.

In general, the previous results demonstrate robustness of capital adequacy ratios for banks operating in Palestine, both at the individual and aggregate bank levels. In the event of a bank’s collapse, the capital adequacy ratio will remain above the 8 percent limit set by the Basel Committee, but with a risk to drop below the PMA-set ratio of 12 percent for certain individual banks, and for the local banks group in one case.

Table 7- 3: Matrix of inter-bank stress tests, 2013Banks operating in Palestine Local

BanksForeign Banks

Total Banks1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

16.6 35.3 16.3 24.0 14.0 19.3 20.9 52.2 125.7 36.8 11.4 101.2 74.8 16.1 101.1 18.4 23.0 17.8 21.9 20.0

35.3 14.3 18.3 13.0 19.3 20.9 52.2 125.7 36.8 11.4 101.2 60.6 14.3 101.1 18.4 21.4 15.7 21.2 18.6

16.6 13.5 24.0 13.5 6.5 14.0 52.2 125.7 36.8 11.4 101.2 74.8 12.3 101.1 18.4 23.0 13.0 21.4 17.5

16.6 35.3 22.3 12.3 19.3 20.1 52.2 125.7 36.8 11.4 101.2 71.8 16.0 101.1 18.4 23.0 15.0 21.8 18.6

7.6 35.3 14.6 14.0 19.3 20.9 52.2 125.7 36.8 11.3 101.2 70.4 16.1 101.1 18.4 23.0 15.0 21.7 18.6

16.6 35.3 13.3 24.0 19.3 20.9 52.2 125.7 36.8 11.4 101.2 74.8 13.2 101.1 18.4 23.0 10.7 21.5 16.4

16.6 25.2 16.3 24.0 12.4 20.9 52.2 125.7 36.8 11.4 101.2 74.8 16.1 101.1 18.4 23.0 14.4 21.9 18.4

16.6 25.5 15.7 24.0 14.0 19.3 52.2 125.7 36.8 11.4 91.9 71.2 16.1 101.1 18.4 23.0 15.1 21.7 18.6

16.6 35.3 16.3 24.0 14.0 19.3 20.9 125.7 36.8 11.4 101.2 74.8 16.1 101.1 18.4 23.0 17.8 21.6 19.8

16.6 35.3 16.3 24.0 14.0 19.3 20.9 52.2 36.8 10.8 101.2 74.8 13.5 101.1 16.1 19.1 17.8 18.7 18.3

16.6 35.3 16.3 24.0 14.0 19.3 20.9 52.2 125.7 11.4 101.2 74.8 16.1 101.1 18.4 22.4 17.8 19.8 18.9

16.6 35.3 16.3 23.3 14.0 19.3 20.9 52.2 125.7 34.0 101.2 74.8 16.1 101.1 18.4 19.8 17.7 15.5 16.6

16.6 35.3 16.3 24.0 14.0 19.3 20.0 52.2 125.7 36.8 11.4 74.8 16.1 101.1 18.4 23.0 17.7 20.0 18.9

9.2 35.3 9.0 22.3 13.7 19.3 20.0 52.2 125.7 36.8 11.4 101.2 16.1 101.1 18.4 23.0 16.3 20.0 18.2

16.6 35.3 16.3 24.0 12.7 19.3 20.9 52.2 125.7 36.8 11.4 101.2 74.8 101.1 18.4 22.0 17.2 19.6 18.4

16.2 35.3 16.3 24.0 14.0 19.3 20.9 52.2 125.7 34.1 11.2 101.2 74.8 16.1 18.4 20.1 17.8 19.9 18.9

16.6 35.3 16.3 24.0 14.0 19.3 20.9 52.2 125.7 35.8 10.4 101.2 74.8 15.3 101.1 17.5 17.8 18.7 18.3

12.5 35.3 15.8 24.0 13.4 19.3 20.9 52.2 113.2 36.8 11.4 101.2 69.3 16.1 101.1 18.4 17.3 19.4 18.4

Source: PMA.

Figure 7- 2: Effect of different scenarios on capital adequacy ratios, 2013

Source: PMA.


Perc

ent

Before shock High ratio after shock Low ratio after shock

0

4

8

12

16

20


Macroeconomic stress tests

Testing banks’ ability to withstand negative shocks on the macroeconomic level was conducted, based on the Vector Autoregressive Model (VAR). Several variables were examined at the macro- level[48] to measure the impact of respective shocks on financial fragility, using loan provisions as a measure of fragility.

The tests were conducted under two different scenarios: the baseline scenario and the pessimistic scenario; both scenarios were derived from the structural forecast model for the Palestinian economy[49]. The baseline scenario is based on the assumptions that (i) no major change in current peace talks will take place; (ii) restrictions imposed on the movement of people and goods will persist; (iii) barriers and obstacles constraining imports and exports in the West Bank will continue; (iv) the rate of closure of crossings to Gaza will remain the same as in the previous year; and (v) the number of Palestinian workers in Israel will stay unchanged from the previous year. As for public finances, it is assumed that the government will (i) maintain its financial austerity policy of rationing current expenditure; (ii) keep government investment at its previous-year level; (iii) effect a slight growth in public revenue as a result of improved tax collection and increased non-tax revenues. As to foreign aid, it is expected that donor countries will continue to provide financial aid to the PA at the previous year’s levels, estimated at around USD 1.0 billion. According to this scenario, GDP is expected to grow during 2014 at a rate of 2.6 percent compared with 2.1 percent in 2013.

The pessimistic scenario assumes that a negative shock of a sharp deterioration in political conditions will adversely affect key economic variables. In particular, it is assumed that economic activity will plummet, including a decrease 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, Israeli withholding of clearance revenues, and a decline in donor countries’ foreign aid in support of both the budget and economic development. The scenario predicted that GDP growth would decelerate to -2.7 percent during 2014.

The model’s forecasts for loan provisions indicated a rise in the value of these provisions for the year 2014 as compared to 2013. The rise is estimated at USD 0.8 million under the baseline scenario, and USD 6.1 million in the pessimistic scenario.

[48] These variables include: growth rate, interest rates on lending and deposit for the three currencies circulating in the Palestinian economy, the exchange rates for the USD, JD and the NIS, real effective exchange rate (REEF) and finally the inflation rate.

[49] For more details, check PMA Annual Report 2013.

Figure 7- 3: Provisions according to different scenarios, 2014

Source: PMA.

0.2

5.7 8.3

2.1 3.1

11.8

19.4 19.8

1.6

6.4 7.6 9.1

1.6

5.5

1.5

9.9

4.6 6.2

2.3

15.1

0

5

10

15

20

25

USD

mill

ion

Base scenario Optimistic scenario

Financial Stability Report 2013

Documents

Transcript of Financial Stability Report 2013