Turkey’s Central Bank has pledged to maintain tight monetary policy to meet inflation targets, warning that, despite predicted continuation of recent disinflation, the risk of inflation is far more serious. Despite monetary control, the banking sector remains dynamic. External demand and the growth of housing and consumer spending loans have partly offset a cooling of domestic demand, and several banks have recently cut rates, giving incentive to borrow further. The implementation of a new mortgage law is expected further to boost demand for credit, albeit in the medium- to long-term.

At the end of May, the monetary policy committee of Turkey’s Central Bank announced that short-term interest rates would not be cut, despite the trend of disinflation. The committee said that high levels of consumer spending and investment, high oil prices, an uncertain political environment and service price inflation all combined to make a cut in rates unwise. The bank operates on a policy of inflation-targeting.

“The committee assessed that meeting the medium-term inflation targets requires the maintenance of the tight policy stance,” the committee reported. The report, issued on May 14, noted that sound fiscal policies and structural reform were important tools for restraining inflation, and that monetary policy alone was not enough to rein in prices.

“The recently elevated prices of crude oil and commodities add to the inflationary pressures via imported input costs and thus curb the disinflation process,” the report added.

Managing inflation

Consumer price inflation of 1.21% in April brought annual inflation down to 10.72%, within the annual uncertainty band set by TCMB. A rise in clothing prices offset some of the decrease in consumer durable and service inflation, local press reported. The first-quarter year-on-year inflation rate was 10.86%, partly attributable to an increase in food and tobacco prices.

The central bank stated that disinflation would be a continuing trend, but counselled caution, due to the existence of inflationary risk. “Against this background, disinflation is expected to become more significant in the upcoming period. However, there are some remaining risks to the inflation outlook,” the report said, announcing that the central bank was prepared to act swiftly should economic shocks change the economic outlook.

Despite inflationary pressures, both current and potential, year-end inflation will be likely to fall between 4.5 and 7.1%, with a midpoint of 5.8%, according to the central bank’s second 2007 inflation report. The outlook was for inflation to continue to fall to 1.3% to 5.0% in 2008, with a midpoint of 3.2%. Bank Governor Durmufl Yilmaz said that this was due to bank policy since June last year, following the market correction in May. Yilmaz announced that “the tight stance for monetary policy and the ongoing perceptions of uncertainty continue to restrain the demand for credit.” He noted that demand for durable goods and machinery had weakened. Yilmaz said that there would be little scope for monetary relaxation if the medium-term goal of 4% was to be met.

However, the impact of tight monetary policy on inflation has been smaller than predicted. While there has been a cooling in domestic demand recently, exports have flourished, boosting industrial production and offsetting the internal slowdown to an extent. Recent increases in public spending also look set to lessen the effectiveness of the interest rate freeze, hence perhaps the Central Bank’s warning that fiscal caution and economic reform were also needed to bring inflation down to target levels. However, in the midst of a tough election campaign, it is unlikely that the government will back off from spending until the third quarter.

Another issue has been inflation expectations, which have stalled over the past three months after dropping for some time, affecting price and wage setting behavior. Yilmaz said that he expected inflation expectations to start dropping again as headline inflation falls.

The central bank noted that the trend of late has been for banks to ease interest rates due to an increase in lira bond issues and the proceeds of privatization. In May, HSBC dropped its monthly TRY consumer loan and TRY consumer loan at interest. Home financing interest rates have gradually been fallen to 1.49% per month. Vehicle loans have backed down at 12 month terms to 1.67%, at 36 month terms from 1.69% to 1.65% and at 48 to 60 month terms from 1.69% to 1.59. Even though home financing loan has been set on interest rate of 1.67%, the rate has backed down by 0.89%.

Garanti Bank also moved to decrease its lending rates. The monthly mortgage rate which, was initially set up at 1.53% has now been cut to 1.44%. According to Garanti Bank General Manager, Ali Fuat Erbil, the bank is not expecting further decrease in interest rates, stating that any forecasts should be put aside until the end of the general elections.

While automobile loan growth has slowed, housing and consumer spending loan growth continues.

New mortgage law

One factor set to increase the rate of housing loans is the new mortgage law, which was implemented in February. For several decades, due to inflation, high interest rates, poor securitization and cultural traditions, Turkey has had a relatively small mortgage market. This was already beginning to change due to interest falling below the psychologically important benchmark of 20% in 2005. By mid-2006, interest on housing loans accounted for 10.7% of banking assets, up from 1.3%.

The new provisions create a secondary market in securitized mortgages, which should increase the number of mortgages with maturities of 10 years or more. It reinstates a 2% early payback or break charge and gives the green light to floating-rate mortgages, as well as cutting lender liability to one year for defaults and giving lenders more powers to repossess property, for example in the case of three consecutive non-payments.

The law also makes possible the formation of non-bank financing organizations working with floating mortgage-backed securities and, at implementation, converted all housing loans into mortgages unless specific requests are made by the debtor.

Deeper problems

However, despite widespread praise for the reforms, it may take some time for the new law to boost mortgage take-up significantly. One issue is that many banks do not have the administrative infrastructure for large-scale mortgage transactions. They will need property assessment divisions that can evaluate mortgage applications. Insurance companies will also have to be equipped to investigate the properties and provide guarantees for the lenders.

Perhaps a bigger problem is the fact that, at conservative estimate, half the housing in Turkey is illegal and therefore not eligible for mortgages. Earthquake standards will also eliminate many of the legal buildings.

While it will doubtless take time for the new systems to be fully operational, the emergence of the legal provision for a proper mortgage market is a positive step.

Overall, careful monetary policy seems set to support confidence in a maturing banking sector and the economy as a whole in a time of underlying inflation risk. It does not seem to have deterred banks from cutting lending rates further, and the reforms of the mortgage sector not offer a real prospect for loan growth in a relatively under-banked market. However, with the election coming up in July, the policy of the Central Bank may come under review depending on the victor.

As Jordan’s financial services industry comes of age, the banking sector has been shaping itself into one of the major contributors to the country’s increasing economic power. The sector may also be experiencing what is equal to its Sturm und Drang period, brimming with ambitions, growth instincts, and sometimes conflicting impulses.

In recent reports, analysts credited increased purchasing power of consumers along with liberal attitudes towards personal debt with driving Jordan’s explosive banking sector growth. Deeper rooted drivers of development included increased investment from the GCC, improved regulations, and focus on the development of retail business.

A variable helping the sector sustain its growth is trade and banking services activities originating from neighboring Iraq, which has provided significant fee income for local and foreign banks. Observers also say that the sector appears to have benefited from the ongoing political instability in Lebanon where certain capital inflows make it to Jordan in search of a safer environment for investment.

Banking sector deposits, which last year reached $20.6 billion and equaled 1.4 times Jordan’s nominal GDP, have grown at a slightly faster rate than GDP – supporting the notion that the country’s financial culture has left its underbanked past firmly behind and that banks are reaching the customers. However, in spite of the highly competitive environment, the market remains concentrated, with the top three banks dominating the market.

Good asset

Jordan sports 13 local commercial banks plus eight foreign owned, two Islamic banks and five investment banks for a population of 5.9 million. There is no state ownership in the sector. But one of the significant features of Jordan’s banking sector is its high concentration. The leading bank is the Arab Bank, which holds approximately 60% of overall banking assets. Observers agree that size matters when it comes to the performance of banks and Arab Bank demonstrates the accuracy of this theory.

Research shows the strength of Arab Bank is such that the bank’s 40% increase in profits in 2006 reflected very positively on total sector results, which rose for all banks to $773 million (JD547.35 million; JD1 buys $1.41) in 2006 from JD 500.77 million in 2005, representing a 9.3% increase. According to research firm Amwal Invest, only Arab Bank and four other banks experienced growth in their bottom line in 2006. 

In any case, the sector’s 2006 growth is paltry when compared to the 80% increase in 2005. But nevertheless, experts say the sector’s prospects for 2007 are promising, specially the sector’s performance on the Amman Stock Exchange.

In 2006, the sector’s consolidated assets grew by 14.9% to reach JD 24.24 billion. Figures from the Central Bank of Jordan (CBJ) showed that 25.6% of the total assets at the end of 2006 comprise foreign assets, with balances held at foreign banks making up the bulk. The remainder represents local assets, with the lion’s share claimed by facilities given to the private sector, constituting 39.31% of total assets. The largest increase in assets in absolute terms was for the Arab Bank, which grew by JD1.624 billion.

The International Monetary Fund said it expects Jordan’s economy to keep growing at around 6% in 2007 on the back of 6.5% real GDP growth in 2006. Expecting a bumper year in 2007, a number of the local and foreign bankers are willing to expand their business in the kingdom.

The IMF encouraged the increasing role of the banking sector, but issued a warning on credit growth. “Particular care is required with new forms of lending, which carry greater risks, such as margin and non-collateralized loans that have been growing rapidly,” the international watchdog admonished, arguing that the profitability of banks and, implicitly, the health of loan portfolios have yet to withstand tests of a slowing economy. 

The stats

Figures by Amwal Invest show 2006 saw the consolidated credit facilities offered to the private sector grow by 26.1% to reach JD9.7 billion. “Facilities extended to public entities increased by 18% to JD423.2 million, while those to financial institutions declined by 63.4% from JD20.5 million in 2005 to JD7.5 million.”

Amwal did note two distinct changes in the sector between 2005 and 2006. “In 2006, net interest income made a more significant contribution to total operating income at almost 70%, pursuant to a refocusing on core operations, while gains from investments played a much smaller role, making up only 3%.” When compared to 2005, interest income contributed 55% to total operating revenue, and gains from investments around 13%. “The average increase of net income for all the banks was 27%, the most significant being Jordan Commercial Bank, rising by 62.9% from JD 9.66 million to JD 15.74 million,” Amwal’s report said.

Property financing increased to meet the expansion in the real estate sector in Amman and other tourist areas. Similarly, other kinds of financing, such as personal loans, holiday loans, marriage loans, car loans, and business loans also thrived. These developments trickled down to fee-income and thus, the bottom line.

Both the Arab Bank and the Housing Bank for Trade and Finance (HBTF) posted profit increases of over 20% in the first quarter of 2007. Arab Bank announced first quarter profits of $187 million after taxes and provisions, which was a year-on-year increase of 24.6%. HBTF reported even a better increase of 36% with profits standing at $51.7 million for the first quarter of 2007.  These robust results to a certain extent were also achieved by other banks with Jordan Kuwait Bank reporting profits of $15.7 million in the first quarter of 2007 or a 5% increase when compared to the same period in 2006.

Despite rapid growth and high levels of profitability, the banking sector still requires further development, including long-term strategies to diversify sources of income, innovations in product and service delivery, greater choices for customers and investing more on staff training.

Charging ahead

Experts agree that the upcoming three years hold considerable challenges for the banking sector, as well as for policy makers who determine aspects of the environment in which the sector operates. Banks will be looking for sources of growth and to maintain the high profit rates that they become accustomed to, while competition intensifies, and technological changes impact on the way that banking operations are carried out.

Banks must also introduce new strategies aimed at the most efficient utilization of capital in line with capital adequacy requirements. Large banks must accelerate efforts to penetrate new markets regionally and internationally. The CBJ must also encourage a consolidation phase in the next two years as the market is saturated. Consolidation should first start in acquisitions between local banks, especially smaller ones. This move would encourage the introduction of new products and services and enhance the quality of those already existing, allowing effective competition on a regional and international level.

Another challenge local banks must face is the entry of foreign banks. Foreign banks have many advantages over their local counterparts and could eat away at their profits if additional reforms and development of the sector fails to materialize.

Although experts warn of the potential shortfalls in the sector, the report by Amwal Invest acknowledges that most “Jordanian banks enjoy a higher capital adequacy requirement ratio than the 12% set by the CBJ, which is also higher than the 8% ratio set by Basel II Committee.” After the CBJ raised the minimum paid-up capital for Jordanian banks last year, “most banks went about increasing their capital through the distribution of stock dividends or through private placements. The step helped banks secure sufficient funds to seize investment opportunities locally, regionally and globally.”

In non-fiscal aspects, Jordan’s financial services industry has a number of governance and cultural issues to master. The sector’s evolution recently showed some large-scale employee migrations and shifts in personnel that seemed indicative of challenges in the management of highly skilled human banking resources, which are somewhat scarce in the country. In one recent banking conference in Amman, a sector critic asked the president of a smaller bank outright why his institution was lambasted by so many people for “loan sharking”. In other instances, industry insiders still frequently clam up when asked about the dominance of Arab Bank and its impact on the entire sector, virtually forcing further questions on transparency and the authenticity of all facets in the country’s banking picture.

Although the economy and leading sectors are showing consistent growth, the government in Amman is tasked to have strong strategies to mitigate potentially even higher oil prices, address unemployment and control inflation in order to remedy the country’s trade and current account deficits. As more foreign investment is flowing in and alternative financing means gain in popularity in the broadening financial industry, supervision of the Jordanian banking sector through the CBJ will be existential for the further sound development, believes the IMF. But, the government must also assist in establishing a central credit bureau to help banks make better risk assessment. And implementation of the Basel II accords by the end of 2007 is a move that cannot be avoided. Market forces will drive mature banks to excel – with a little helping hand from the regulator. 

Just five years ago changing dollars in Syria was a tricky process – either wade through mounds of paperwork and bureaucracy at a state bank to change foreign currency at an exceedingly bad rate or wander the streets waiting for a man to idle up to you and whisper, “change money.” Back then, any Syrian seen with greenbacks poking out of his wallet would have been paying a trip to the local police station.

Today, it is another story. You can change money pretty much anywhere, withdraw from an ATM or go to one of the numerous private banks newly established in the last three years.

Syria’s banking reforms, kicked off in 2001 with amendments to the law allowing the entry of foreign banks, has been the harbinger of this change, boosting the private sector and slowly altering attitudes to banking and financial services.

“We are moving in the right direction, setting up private banks and the stock market,” said Dr Nabil Sukkar, Managing Director of the Syrian Consulting Bureau for Development and Investment.

Role reversal: Enter the Lebanese

Lebanese banks were the first to enter this essentially virgin market, which had seen no private banks since nationalization took place in the 1960s. This had forced Syrians to either operate through the moribund state banks, bank in Lebanon, the Gulf and elsewhere, or adopt the seemingly highly popular option of shoving money under the floorboards.

“After nearly 50 years of public banks, people are gradually starting to trust banks, taking money from their cushions. This will bring liquidity into the market, and act as a different cushion for the economy,” said Jean Bassil, Assistant General Manager of Byblos Bank Syria.

A lot of money seems to have been pulled out of cushions and from under the floorboards, with banks doubling assets in the first two years of operations. That initial surge is not likely to be as impressive this year however. “We won’t double assets this year. The number of private banks has increased tremendously – seven banks now, two Islamic banks and the third on its way. But the cake is so big in Syria that whoever comes to operate will have enough cake,” said Georges Sayegh, General Manager of the Bank of Syria and Overseas (BSO), part of Lebanon’s BLOM group.

The growth of private banks in Syria is evident not only in deposits and credits doubling year on year, but the number of branches mushrooming around the country – from 25 in 2005 to 43 last year (BEMO Saudi Fransi, BSO, International Bank for Trade and Finance, Audi, Arab Bank, and Byblos). By comparison there are only 271 branches for the country’s six state-owned banks, roughly one branch for 432,000 people according to Bassel Hamwi, Deputy Chairman and General Manager of Bank Audi Syria.

“I hope to see it come down to 10,000,” said Hamwi.

Byblos plans to open new branches in Tartus, Latakia, Hama and the north over the next three years, while BSO plans to open three to four branches this year.

Meanwhile, other Lebanese banks are gagging at the bit to enter Syria, with Bank Libano-Francaise and Fransabank recently granted licenses, and First National Bank to enter with an 8% stake in the Syria Gulf Bank in June. The Lebanese Canadian Bank is also reportedly in talks about entering the fledgling market, and the Bank of Beirut has applied for a license in partnership with the Qatar National Bank and the Emirates Bank of Dubai. BLC’s Shadi Karam said they were waiting for a change in the law to open a subsidiary. “The law is still not friendly enough for me,” he said.

An increasingly diverse sector

Bankers are enthusiastic about the entrance of Islamic banks into Syria, believing the globally growing Islamic financial sector will help diversify the sector and attract deposits from Syrians that have been hesitant to deal with commercial banks.

“Product differentiation is key. I was happy that Islamic banks are coming in, as they are not trying to take market share but broaden the market,” said Hamwi.

The two Islamic banks currently in operation – one Kuwaiti, the other Qatari – are to be joined by Bahrain’s Global House Group, which has launched a new Islamic bank with a capital of $500 million, and the Dubai Islamic Bank, which has also received approval to launch. Three other Islamic banks are reportedly in the pipeline.

“I think a lot of people will move money to these banks,” said Sukkar. “Deposits will grow fast, but to make money will be difficult until people learn about Islamic financing. Islamic banks will do well, but not at the beginning,” he added.

There is also a draft law under review to increase capital requirements for Islamic banks from the current $100 million to $200 million. This same draft law, if passed, will raise maximum foreign ownership from its current 49% to 60% to attract international banks.

The government, however, is dragging its feet to implement the law, adopting a wait and see approach to monitor how the current banks fair, and of equal importance, how state-run banks adapt to the new banking environment.

If passed, the government would likely raise the capital requirement from the current $30 million to $100 million, which would ward off smaller regional players and potentially attract the big players.

However, international banks might hesitate before entering the Syrian market, concerned about Damascus’ politics, the US ban on the Commercial Bank of Syria along with economic sanctions, and due to overly rapid expansion by top players in recent years. Indeed, a Citibank manager admitted as much last month, saying the bank had become too unwieldy in its worldwide operations.

Regardless of whether the law will change, the 51% ownership of banks by Syrians is widely viewed as a façade, with the foreign banks handling overall management. This is reflected in one of the biggest challenges for banks: manning new branches. “We are targeting Syrians educated outside, and then repatriating them,” said Bassil. Top management at the Lebanese banks is typically Lebanese, with middle to lower management a mix of Lebanese and Syrian.

A few more bridges to cross

Attracting new talent is not the only concern of private banks. Attracting suitable clients is equally problematic.

“Approaching a client is difficult as financial education is minimal, as well as transparency and auditing. Few companies have financial managers, and it is difficult for banks to lend due to the risk,” said Bassil. The same applies to attracting foreign investment.

The Gulf is keen to utilize its high liquidity by investing in the likes of Syria, but legislation still needs to be amended to improve the free flows of capital.

An amendment to the law in February – allowing the export of capital by foreign firms – has eased some of these concerns, but the modernization of the legal system is still moving at a snail’s pace. Legal issues over ownership still need to be addressed, taxation needs to be overhauled, and a culture of transparency needs to be introduced. There is also a noticeable gap in the market for investment and merchant banks, alongside other financial institutions to cover all the financial bases for Syria to really excel.

The Central Bank is working to address these issues however, currently taking on two advisors from the Bank of England, and the European Union funding reform of the Finance Ministry.

But most pressing for the sector is what to do with the deposits flooding into their vaults.

“Banks are awash with money and need new products [to sell], but don’t know much about the economy, market and society,” said Sukkar.

However, that said, banks are offering mortgages, credit cards and car loans, as well as altering more traditional approaches to banking to appeal to more clients. “Before, Byblos was into trade finance, but we now offer medium- to long-term facilities,” said Bassil. “We are also trying to gradually bring retail products to Syria as we believe it is a lucrative market,” he added. Indeed, if governmental statistics are accurate, Syria’s exports spiked from $6 billion in 2005 to $10 billion last year. As this rise is attributed to the growth of the private sector – Syria’s oil sales are rapidly dwindling – further money could enter the system.

Nonetheless with more money entering the system, and inevitably the banking sector, banks are appealing for alternative outlets for their deposits.

“We first and foremost need some kind of liquid investment, a treasury bill of some sort to ease distortion in the sector – bank institutions take rates fixed by the regulator but have no place to deposit on a short term basis,” said Hamwi.

Liquidity was originally deposited in a bank-specific colored vault at the Central Bank at 0%, and as of December raised to 1%. Banks want that rate to be raised.

“At least give us a chance to get pennies on our liquidity,” said Sayegh.

The problem of what to do with such inflows of cash could be addressed in the next six months with the launch of the Securities Exchange and the issuance of treasury bills.

Stock market dreams

The securities exchange, slated to open by year end in Yarfour, is being financed by a Syrian investor in the UAE as a gift to the government. Sukkar thinks the bourse will not be opened to foreigners initially, despite regulations that allows foreigners to do so, as the system will take time to adequately handle flows of capital in and out of the country – factors that led, in part, to the financial meltdown in South-East Asia in 1997.

The prospects for Syrian investors looks good, however, with bank IPOs heavily subscribed when released over the last few years.

More compelling for the banks will be the introduction of treasury bills sometime in the next year. “We certainly need it, as a non-inflationary way of providing for the budget,” said Sukkar. “But I hope banks don’t do what they did in Lebanon by buying the bulk of treasury bills as a way to make money. This is possibly why the government is postponing it, to make banks fund the real economy.”

Hamwi thought this wasn’t necessarily the case, however. “This is unlikely given a number of things, such as the ability to borrow multi- and unilaterally as Syria has low international debt and no rating.”

Ultimately, no matter how much the financial sector is reformed and all the corresponding knock-on benefits boost the economy, other sectors need serious investment for there to be viable economic progress.

“We’ve done more on tourism and reform of the financial sector than agriculture and manufacturing – there is a lopsided focus. We shouldn’t forget these sectors need to be restructured in parallel,” suggested Sukkar.