Learn how the World Bank Group is helping countries with COVID-19 (coronavirus). Find Out

Speeches & Transcripts

The Future of the Middle East and North Africa Region: Impact on the Global Economy

June 23, 2011

Dr. Shamshad Akhtar, Vice President, Middle East and North Africa, The World Bank International Arab Banking Summit 2011: “The Future of MENA: Impact on the Global Economy” Rome, Italy

As Prepared for Delivery

1. Thank you to His Excellency the Minister of Jordan, Governors, and other distinguished guests. I would like to thank the Union of Arab Banks (UAB) for hosting this event. The UAB and the World Bank have strengthened their partnership over the past two years. We collaborated on joint forums on bank governance and SME finance. The stage is set for further fostering this relationship.

2. The future of MENA depends on how effectively the Region is able to unleash its resources, including its economic and human potential. MENA’s contribution to global output is confined to 3.5% (or 2.5% excluding oil) and its contribution to trade to 6% (2% excluding oil). Though the region is not well integrated, MENA’s inter-linkages with the global economy are quite visible. For instance, the global crisis resulted in a 3 percentage point fall in MENA’s growth. The recent round of events not only has geopolitical repercussions, but has triggered another round of oil price volatility that has global and regional implications. Oil prices are now in the range where they put upward pressure on interest rates, and contribute to rising food prices, which have become a global concern. The growing youth bulge with very high rates of unemployment, and the high levels of exclusion of many segments of society from the benefits of growth, also poses both domestic and global risks.

3. Recognition of challenges and internally generated momentum for a change by the public offers an opportunity for all stakeholders to reflect more deeply on how to support MENA’s transformation. In this spirit, substantial consultations have been underway. Greater consultation across the region, and deliberations among the G8 and key International Financial Institutions have facilitated newer partnerships. There is a broad agreement to adopting a coordinated approach and strategy that encourages (i) governance, transparency and accountability, (ii) social and economic inclusion, (iii) job creation, and, (iv) accelerated private sector led growth. A G8 Joint Action Plan has been put together to implement this agenda. Bilateral and multilateral assistance are being mobilized to support the countries undergoing transition.  

4. A well functioning and efficient financial system that is broad based and inclusive is critical to support the economic transformation of the Region. Performance of the region’s financial sector reveals a mixed story. Growth of financial assets to GDP ratio over the past decade or so has been impressive in most countries. Notwithstanding, the contribution of MENA’s financial systems, predominantly bank based systems, to economic development is less than the potential of the sector.

5. Performance, judged by profitability indicators, has been good, except for a few years of downturn. The credit-to-GDP ratio and market caps have been generally high. Banking systems are generally well capitalized, except for some non-GCC countries that need to strengthen their capital buffers to sustain future credit expansion. However, the Region’s financial systems reveal interesting trends. While bank assets and credit to GDP ratio’s are high, the financial systems across most countries lack breadth and penetration.

6. MENA has the highest average loan concentration ratio in the world, as measured by the ratio of the top 20 exposures to total equity. This concentration ratio is somewhat lower in GCC, indicating the region’s progress in developing consumer lending and the larger equity base. High loan concentration ratios in MENA reflect deep connections between large banks and large enterprises. Not only does financial system report high degree of asset concentration, it lacks access to alternative sources of financing or innovation for risk diversification. These characteristics have held back sector and product diversification. Some newer trends are worth noting. Thus far MENA banks continue to enjoy cheap and stable funding from sizeable customer deposits that lacked alternative investment opportunities. Residential housing finance has started to develop in the MENA region, at least as a market-based activity. Mortgage loans account for about 10 percent of the loan portfolio, though it remains a low share by international comparison. MENA banks seem to be increasingly involved in long-term lending and becoming exposed to growing maturity mismatches, requiring more supervisory monitoring. The increase in housing and investment finance will require well-articulated Asset and Liability Management frameworks to avoid excessive liquidity, interest rate and counterparty risks.

7. In recent years, as MENA’s financial system has, grown a few steps have been taken to strengthen macro-prudential regulatory framework. Several GCC countries now use a number of macro-prudential tools that are being advocated for others, such as limits on loan-to-value ratios, debt-service-to-income ratios, loan-to-deposit ratios, and sector concentration ratios. Given the overreliance of these economies on hydrocarbon revenues leading to strong cycles, GCC countries could complement these initiatives by introducing dynamic provisioning, limiting dividend payments in good times to build up capital buffers, and increasing capital requirements for particular exposures such as real estate. Non-GCC countries would also benefit from a more active use of macro-prudential tools. Although many non-GCC countries are not yet ready to adopt more sophisticated risk management methodologies, a gradual increase in capital buffers and the adoption of more basic macro-prudential instruments with adequate provisioning would help them contain the buildup of systemic risk.

8. Even where equity markets are large, the market capitalization can be deceptive. There are only a few non-financial companies listed in stock markets and banks, and large infrastructure companies account for 80% of market cap. The non bank financial institutions sector is less developed. Some countries have been steadily encouraging insurance companies, private pension funds, and mutual funds or alternative finance institutions to support leasing and factoring, but at the same time,  access for SMEs has been weak.

9. Private fixed income markets and instruments are limited. Issuance of corporate bonds, mortgage bonds and mortgage backed securities are negligible. Companies are deprived of alternative sources of finance, and the banks are deprived of efficient funding instruments for long-term lending. The lack of a private debt market reflects to some extent the low level of development of a public debt market that is constituted largely of treasury bills that end up preempting bank and depositor funds for fiscal deficit financing such as in Egypt, Lebanon, and others. Some countries are now preparing the framework for public debt law, and development of securities auctioning systems and trading platforms. Bond issuance at the federal level will be important for providing benchmarks for pricing private debt. Absence of a sound enabling legislation for debt instruments such as corporate bonds, mortgage covered bonds, and mortgage backed securities and liquidity constraints are few other factors impeding growth of private debt market.

10. Publicly sponsored funds have been set up to perform financial intermediation functions in social and housing areas. A number of these funds have not made an effective contribution to market development, due to the lack of adequate governance structure, investment policies, insufficient disclosure and especially insufficient outsourcing and decentralization of asset management.

11. Generally, access to finance is limited as the banking sector, which accounts for the bulk of the financial system, has limited penetration. Relative to developed markets, deposit and loan accounts per adult are low. Only 20% of SMEs have access to finance – this is confirmed further as the bank’s lending to SME barely constitutes 8% of their total loans in the non-GCC bloc and 13% in the GCC. Lack of access to finance has been one of the reasons for the small contribution of SMEs to the economy, including job creation. The bulk of the SME sector relies on internal resources or higher priced informal sources to finance their requirements and their growth has been affected by lack of alternatives, such as equity, leasing, and factoring.

12. Bank competition in MENA is weak as evident from the high loan concentration and the restricted access to finance.  The reduction in the share of state banks in most countries has not been sufficient to increase competition in the main credit markets. Recent research shows that MENA banking systems remain less competitive than other regions, due to stricter entry requirements and procedures, weak credit information systems, and lack of competition from capital markets and non-banking institutions.

13. The recent round of events provides a sobering lesson of how the objectives of access and stability have to be pursued closely and jointly. Finance promotes growth and access and if today the financial sector is part of the problem, tomorrow it has to be a part of the solution. The financial development agenda has to be inclusive and uphold a high degree of governance to allow for balanced and shared growth.

14. Access to financial systems will foster balanced growth of the financial system itself, which is key to its stability, while helping the underprivileged and underserved sectors. Prerequisites for achieving this are strengthening financial infrastructure by creation of complementary private bureaus or at least a substantial upgrading of public registries.  Regulators must also make efforts to increase the depth of credit information encouraging the engagement of microfinance institutions, retailers and utilities. Bureaus or registries should also be encouraged to produce value added services such as credit scores and SME ratings. Collateral regimes should be subject to a legal and institutional overhaul that will strengthen all the components of the chain of secured lending.

15. Bank competition will be highly beneficial. Where needed, the role of state banks should be evaluated as they have produced mixed results. The share of state banks should be reduced in some countries, their mandates should be clarified, and governance structures strengthened, including risk governance. There should be a review of licensing procedures that would not deny the entry of reputable banks, a review of the supervisory approach to large exposures and connected lending, the introduction of a competition policy preferably managed by an independent competition agency (as in the EU), and the development of alternative to bank finance (corporate bonds, leasing, and factoring).

16. The development of non banking institutions, markets and instruments. NBFIs, instruments, and markets have been slower to take off. Absence or gaps in legislation or weak supervision and enforcement have prevented the faster growth of many sectors such as insurance, mutual funds, leasing, and factoring.

17. Moreover, the financial development agenda needs to be complemented by a financial stability agenda to ensure that financial systems remains resilient and stable, as access is expanded and new risks emerge. Implementing effective risk-based supervision remains a challenge in MENA. A transition from compliance to risk-based supervision needs to be completed in the most advanced countries and initiated in others. Risk based supervision requires a “cultural” transition from focusing on regulatory compliance to understanding and assessing banking group risk profiles and strategies.

18. Credit concentration needs to be gradually reduced to ensure banks’ resiliency. Although the largest borrowers are often considered to be well-known and low risk (often leading to “name lending”), there have been failures of large groups in the recent crisis. Disclosure in MENA is at best limited to some of groups’ entities, which makes it difficult to identify all group members and monitor their linkages on an ongoing basis. A stricter definition the large exposure and related party regime is a first step towards reducing credit concentration.

19. Crisis simulation exercises should be undertaken to identify weaknesses in crisis management and foster cooperation among financial authorities. Such simulations expose key public decision makers to a plausible crisis scenario and identify areas where improvements are needed. Only two MENA countries have gone through such exercises, which are now a key component of financial stability frameworks in the European Union and the United States.

20. MENA countries are encouraged to conduct regular macro-prudential assessments and to publish Financial Stability Reports. Only two MENA countries currently publish financial stability reports (Bahrain and Qatar). These reports could improve the transparency of risk recognition in the financial system and facilitate broad communication with the financial community. Stress testing should also become an integral part of systemic surveillance. These activities could best be achieved by setting up well staffed macro-prudential units within the supervisory agencies.

21. In conclusion, development of an inclusive and well governed financial system and its stability is quite critical post political developments. The World Bank can provide financial and technical assistance to MENA countries, helping them implement the proposed financial development and stability agendas. This includes:

  • Policy Lending Supporting Systemic Financial Reforms;
  • Investment Lending Providing Finance to Key Sectors (Housing finance, SME finance);
  • Diagnostic/Technical Assistance in Key Areas (Financial Infrastructure, Housing and SME finance, Corporate Governance of Listed Firms, Corporate Governance of Banks, Crisis Preparedness/Crisis management;
  • Seminars/Training for Financial Supervisors;
  • Capacity Building for Financial Regulatory Agencies.

22. It is not only MDBs who are quite focused in supporting this sector, international financial sector players hold quite an interest in MENA on account of:

  1. wealth management opportunities of the GCC,
  2. the promising retail market given the growing population that will reach about 430 million, including the  growing ranks of youth,
  3. the high level of urbanization expected to rise to about 68%,
  4. the scope for enhancing access to finance for both individuals and small businesses and
  5. the growing infrastructure requirements – according to one estimate infrastructure financing requirements could be more than $100 billion or so.