Financial Stability Report Annual Report 2015 2014...2 Palestine Monetary Authority (PMA), Financial Stability Report 2015 The Israeli correspondent banks Pursuant to the Paris Protocol,

Research and Monetary Policy DepartmentOctober, 2016

Annual Report2014

Financial StabilityReport

2015

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© October, 2016All Rights Reserved.

In the case of quotation, please refer to this publication as follows:Palestine Monetary Authority (PMA), 2016. Financial Stability Report (FSR) 2015: October. Ramallah – Palestine

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

Tel.: (+ 970) 2-2409920Fax: (+ 970) 2-2409922E-mail: [email protected] Page : www.pma.ps

Designed by:Public Relations and Communications Department - PMA

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Foreword

On behalf of the Palestine Monetary Authority, I am pleased to present to you this new issue of the Financial Stability Report. Financial stability is increasingly gaining attention, as many central banks are progressively targeting financial stability alongside monetary stability. The publication of the current FSR is in line with PMA’s mandate and a key instrument to achieve its goals. The latter include assessing potential risks threatening the financial system, evaluating its ability to withstand such risks, and ultimately, instating regulations intended to manage risks and bolster financial stability.

In Palestine, the interest in financial stability stems from the essential role the financial sector plays in promoting economic growth and sustainable development. This is particularly true in light of rapid growth in the size, quality and complexity of financial services. The inherent political and economic risks within the Palestinian context and the associated systemic vulnerabilities further underscore the need to ensure financial stability.

From the PMA’s point of view, financial stability would ensure that funds flow smoothly between households, corporations and the government as well as between citizens and the rest of the world. This notion entails a sound and effective financial intermediation within efficient financial markets. It also requires that financial institutions can withstand adverse macroeconomic and liquidity shocks and financial contagion risks. These guidelines provide that sufficient liquidity and a good measure of confidence in the operation of financial markets materialize. The PMA is particularly bent on identifying sources of instability abiding in bank failures, over-lending, excessive credit concentration, bad quality loans, asset price bubbles, liquidity shortages, and waning confidence in the financial system at large.

In this context, the FSR calls for fostering a stable, robust and effective financial system and maintaining price stability to underpin balanced and sustainable economic growth. As such, the FSR conducts comprehensive financial stability analysis, including elaborate scenario simulations, graduated stress testing (both for individual banks and for the banking system at large). And as the sole institution responsible for ensuring financial stability, the PMA oversees and develops an efficient payments system.

Governor

Azzam Shawwa

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ContentsChapter One: Overall Assessment of Financial Stability

Financial stability trends in 2015 1

The Israeli occupation 1

The Israeli correspondent banks 2

The Palestinian government and its employees 2

Consumption and real estate loans 3

Placements abroad 3

Exchange and interest rates 4

Chapter Two: Global and Local Economic Developments

Global developments 7

Global economy 7

Global financial stability map 9

Regional developments 10

Israeli economy 10

Jordanian economy 11

Local developments 13

The impact of Israeli pressures on financial stability in Palestine 14

Chapter Three: Financial Sector Developments

The regularity and supervisory framework 19

Banking system updates 21

Bank dispersion and concentration 24

Characteristics of the Palestinian Financial System 26

Financial institutions 26

Financial markets 31

Chapter Four: Banking Sector Exposure

Exposures to local sectors 35

Public sector (government) 35

Private sector 39

Mortgage and housing sector 42

SMEs sector 43

Exposures to external sectors 45

Non-residents 45

Interest rates 45

Exchange rates 46

Placements abroad 48

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Chapter Five: Financial Soundness Indicators

Capital adequacy indicators 51

Asset quality indicators 53

Earning and profitability indicators 56

Liquidity indicators 58

Chapter Six: Non-Banking Financial Institutions

Money changing sector 61

Specialized lending institutions 63

Securities sector (Palestine Exchange-PEX) 67

Insurance sector 69

Mortgage sector 71

Financial leasing sector 72

Chapter Seven: Financial Pressure “Stress Tests”

Stress tolerance tests 75

Macroeconomic stress testing 84

Chapter One: Overall Assessment of Financial Stability 1

Chapter OneOverall Assessment of Financial Stability

OverviewThe PMA devotes great attention to maintaining financial stability and fostering a stable, secure and effective banking system through the continual monitoring and follow-up of risks that threaten this system and undermine its stability. In that vein, the PMA adopts the appropriate measures to mitigate the effects and contain the ramifications of these risks.In spite of good banking system performance, as reflected by its financial indicators during 2015, the PMA is well aware of the risks that threaten its stability, which are broadly associated with the peculiarity of the Palestinian condition. Such a situation calls upon continuous monitoring and follow-up and necessitates the implementation of suitable risk-mitigating measures.

Financial stability trends in 2015

The year 2015 witnessed several important political and economic developments, which significantly impacted the Palestinian economy in general, and the banking sector in specific. In view of these prevailing conditions, financial stability in Palestine continues to face several risks, both internal and external. Following is a review of the most significant risks:

The Israeli occupation The Israeli occupation is one of the most significant challenges facing the overall of Palestinian economic activity, including banking. The occupation is the main culprit of political instability through imposing a tight blockade on Gaza Strip; the control over vast areas of Palestinian territory in the West Bank including Area “C” and East Jerusalem; the construction of the Separation Wall; and the confiscation of land and attempts to isolate East Jerusalem and Judaize its holy sites. Moreover, the Israeli occupation continues to hold control over Palestinian resources, including borders, agricultural land, natural resources and air and sea space. The occupation continues to tear the Palestinian people apart, restricting trade and movement, hence deeply entrenching Palestinian economic subordination to the Israeli economy.

Within this context, the PMA assumes the responsibility of supervision and follow-up on the implications of potential risks to the banking sector that arise from the occupation. Moreover, it constantly seeks to mitigate their impact on the stability and soundness of the sector’s business. Several international institutions, most prominently the International Monetary Fund and the World Bank, have commended the PMA on several occasions on its judicious management in this regard.

Palestine Monetary Authority (PMA), Financial Stability Report 20152

The Israeli correspondent banksPursuant to the Paris Protocol, banking correspondece with Israeli banks is confined to four main channels closely linked to coercive trade transactions. These channels are: check clearing through the Israeli clearing house for checks drawn on Palestinian banks to be paid into Israeli banks and vice versa; incoming and outgoing transfers to and from Israel; issuing and executing letters of credit in Israeli shekel through Israeli banks and the management of cash liquidity, particularly in Israeli shekel.

Although originally explicitly sanctioned by the Paris Economic Protocol, the correspondece between Palestinian banks and their Israeli counterparts is subject, at times and for purely political reasons, to threats of suspension or severance by Israeli banks. Moreover, occasionally, Israeli banks refuse to receive all or part of the NIS cash surplus accumulated with the Palestinian banks. The potential risk posed by such a relationship to financial and banking stability stems from the heightened liquidity management difficulties that face banks operating in Palestine and the subsequent rise in liquidity-associated risks.

It is worth noting here that the PMA applies regulations aligned with best international standards and practices to regulate and supervise the sectors subject to its oversight. The international society holds to high esteem the efforts made by the PMA and its achievements in this respect.

However, measures implemented by some Israeli banks which interrupt the regular and smooth receipt of Israeli shekel surplus shipments result in the accumulation of millions of Israeli shekels in bank vaults. As a result, Palestinian banks incur large losses and are denied the returns from alternative opportunities. The PMA constantly endeavors to coordinate with all involved parties in order to find a suitable solution to this problem.

The PMA ascertains that, on several occasions, it had invited international parties (the IMF, the World Bank, the International Quartet and the Bank of Israel), to put pressure and secure Israeli commitment to refrain from impeding free movement of cash between banks in the West Bank and Gaza Strip, to replace damaged banknotes and to accept shipments of Israeli shekel, in compliance with international agreements. In this regard, the PMA assured that the refusal of Israeli monetary authority or any entities subject to its authority to accept any excess amounts of its legal tender (NIS) is a clear breach of one of the most important articles of the Convention binding held between the IMF and its member states. In addition, any obstruction from the Israeli side to repatriate surplus shekel from Palestinian banks is a clear violation of provisions of Para. 15 of Article IV of the Paris Protocol, which states that «the Palestinian monetary authority has the right to transfer excess shekels from banks operating in the Palestinian territories to the Bank of Israel to be exchanged by the Bank of Israel by any foreign currency in the local banking market and up to an amount to be determined periodically».

The Palestinian government and its employeesIn the past few years, the Palestinian government suffered financial distress due to the suspended and irregular transfers of clearance revenues, at times, and to the marked fluctuation and decline of foreign aid against the continuous rise in spending, at others. In order to address this problem, the government intensified dependence on local financing sources and direct borrowing from the banking sector[1]. It is worth noting that government credit combined with credit extended to public employees surpassed 48 percent of total credit granted in 2015.

[1] It is worth mentioning that government direct borrowing from the banking system does not comply with the provisions of Article (21) of the Palestinian Public Debt Law, which states that the government domestic loans shall be restricted to borrowing by issuing government bonds.


The rise in credit granted to the Palestinian government may well lead to the increase in credit concentration risks, restricting them to a certain sector, which affects the banks’ capacity to lend the private sector. On the other hand, the growing bank exposure, both directly and indirectly, to the Palestinian Authority (including the government, public sector employees, and private sector corporations supplying goods and services to the government) can seriously compromise the banking system’s soundness, if indebtedness exceeds a certain limit and the government’s fiscal position further deteriorates.

The PMA devotes special attention to these risks and closely monitors them to assess their potential impact on individual banks, in specific, and on the banking sector, in general. For that purpose, the PMA has subjected the banks, since 2012, to a set of stress tests conducted on quarterly basis to measure banks’ capacity to withstand stress under specific scenarios of increasing severity, starting from the least to the most severe. Despite results indicating that the ratio of banks’ capital to their risk-weighted assets remains comfortably higher than the minimum limit set by the PMA (12 percent) and by the Basel Committee (8 percent), at both the individual and aggregate bank levels, this ratio may fall below PMA threshold in case of severe political or economic shock, as may occur if, for example, the quality of loans extended to the Palestinian government and its employees deteriorates.

Consumption and real estate loansThe PMA closely monitors possible risks to the banking sector that may arise due to the increased relative importance of consumption and real estate loans. Concurrently, the PMA encourages the banks to diversify loan portfolios by allocating additional credit for investment, SMEs, and other productive sectors like industry and agriculture, owing to their prominent role in supporting economic growth, bringing about sustainable development and reducing unemployment and poverty.

To that end, the PMA made efforts to support SMEs by facilitating their access to financing and credit sources; a key determinant of their growth and prosperity. Consequently, the PMA adopted several incentivizing measures, including the waiver of the requirement of an advance cash payment of 10 percent of SME outstanding debt balance when rescheduling a non-performing loan.

Another measure consisted of the exemption of banks from the 2 percent risk reserve requirement on facilities granted to SMEs, to motivate banks to expand SME financing. On a different note, and for the purpose of improving lending conditions, the PMA accords particular importance to the reinforcement of creditor rights through the acceleration of judicial procedures, for example.

Placements abroadPlacements abroad represent the second most important source for the utilization of funds available to banks operating in Palestine after the credit portfolio. By end of 2015, the value of placements abroad reached about USD 3.3 billion, dropping by 13.1 percent from their value in 2014. Placements abroad are comprised of balances placed with banks abroad which constitute about 71.6 percent of the total placements; investment in some financial instruments (in the form of securities, stocks, bonds and other Islamic financial instruments) which constitute about 27.1 percent and the rest (1.3 percent) represent credit facilities granted abroad.

These placements are 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 global financial institutions and the Palestinian market. Furthermore, the supervisory instructions issued by the PMA to the banking system insulate it from the adverse effects that may impact the global banking and financial markets.

Palestine Monetary Authority (PMA), Financial Stability Report 20154

It is worth mentioning that bank investments abroad in all types of securities is bound by PMA approval and limited to investments that have high credit ratings, while taking into account the degree of concentration per institution and also per country, pursuant to Instructions No. (5/2008, clause 5/7).

Yet, Palestinian foreign placements remain susceptible to external risks, in case some manifest high concentration in specific countries, particularly if these countries suffer from inflationary pressures, high sovereign debt or declining official reserves. In general, the PMA monitors these investments closely and is always prepared to take preventive measures to limit their concentration.

From a different angle, the Palestine Exchange (PEX) represents a major channel of transmission of developments in the global system to the Palestinian financial system, owing to its connectedness to a number of regional financial markets, which, in turn, are clearly influenced by global international markets. Nonetheless, such developments do not pose significant risks, since the majority of companies listed with PEX are local companies, more susceptible to domestic developments than to global ones.

Exchange and interest ratesSince it was founded, the PMA adopted a policy of non-intervention with respect to interest rates (floating interest rates), allowing the rates to move with the market and inter-bank competition, on the grounds of the absence of a national currency and, on the other hand, because competitiveness forces banks to reduce interest rates on lending. Additionally, these rates are linked to the current rates in countries issuing currencies in circulation in the Palestinian market (US dollar, Jordanian dinar and Israeli shekel).

However, such a situation puts the Palestinian banking sector under constant exposure to risks associated with exchange rate fluctuations of these main currencies. 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 of these currencies. Such a situation implies that the value of assets of banks operating in Palestine is inevitably prone to the various economic risks affecting any of the economies whose national currencies are circulating in Palestine (namely, the USA, Israel and Jordan), in case these risks impinge on the respective currencies’ exchange rates. Nevertheless, the PMA continues to closely monitor the potential risks that affect banks through these channels and endeavors to mitigate their consequences, through the issuance of instructions that regulate currency position (article 5/10 instructions No. 5/2008).

In general, the PMA devotes great attention to banking sector stability, through continuous assessment of the risks that undermine it and the mitigation of the effects of these risks and their implications. Within this context, the PMA put in place a set of measures and arrangements, currently being implemented, which include: (1) fostering the use of stress testing at the level of individual banks and the entire banking sector as a an integral part of risk management; (2) boosting business continuity and disaster recovery arrangements; (3) raising minimum capital to USD 75 million and obliging banks to hold adequate countercyclical reserves; (4) tightening restrictions to bank placements abroad, with greater focus on concentration, counterparty and country risks; (5) promoting the use of credit registry to help banks better assess the credit worthiness of borrowers.

In addition, the PMA has carried out a series of reforms in the past few years, expanding its mandate to functions normally tasked with central banks. These specifically include tasks related to effective risk-based banking supervision


within a modern regulatory framework; provision of a robust payment and credit infrastructure; monitoring of compliance to laws and regulations, particularly to instructions on governance and the Law on Anti-Money Laundering/Combating of Financing of Terrorism; reinforcement of the oversight and regulatory frameworks to implement Basel II standards; introduction of a broad range of prudential limits and ceilings including the required reserves ratios and the requirement for minimum capital and liquidity ratios; application of restrictions to credit concentration, investment abroad and currency fluctuation and the issuance of instructions aligned to Basel Committee principles and recommendations, corporate governance and best practices of mergers and acquisitions.

Chapter Two: Global and Local Economic Developments 7

OverviewThe year 2015 witnessed numerous economic and financial developments; marked most importantly by the sharp decline in the prices of oil and primary commodities which impacted the global financial stability map; albeit not without inter-country variations based on whether a country’s economy was advanced or emerging. Global economy continued to waver under contradictory influences and enduring threats to global financial stability, particularly in light of China’s recession and economic woes. Conversely, economic and financial interrelation between Palestine and its neighbors persisted, while at the same time the Israeli economy continued to present threats and economic pressure channels to the Palestinian economy in general and public finances in specific. Subsequently, the follow-up and analysis of global, regional and local economic developments becomes mandatory when analyzing financial stability trends in Palestine during 2015.

Global developments

Global economyThe year 2015 has ended with a moderate global growth that did not exceed 3.1 percent, compared to 3.4 percent growth rate in the past year, amidst a greater degree of convergence in economic growth rates of countries of advanced and emerging and developing economies, largely heading towards gradual slowdown. This is especially the case given the poor economic performance in emerging countries such as China and Brazil, along with the lack of prompt recovery in the USA, and other advanced countries.

With respect to advanced countries, the USA faced undesirably stable growth rates for the second year respectively, where growth rates reached 2.4 percent, whereas relative improvement in the euro area and Japan failed to push growth rates to surpass 2.0 percent, as growth rate in the euro area reached 1.6 percent during 2015, compared to 0.9 percent in the past year. In Japan, growth rate reached 0.5 percent compared to a slight retraction of 0.03 percent in the past year. Subsequently, this led to a slight rise in growth rate for advanced countries to 1.9 percent compared to 1.8 percent in 2014.

On the other hand, the Chinese slowdown has become the focus of interest and analysis during 2015 in the light of growing fears from its dire consequences that may affect global economy, starting from overthrowing the efforts to support economic growth in the countries that depend on exports, such as Germany, Japan, as well as many Asian countries, and stretching to its results on the markets of basic goods, and the countries that export these goods, such as Brazil, Russia and Venezuela. These countries represent economies that suffered from tangible shrinkage in real GDP during 2015.

Chapter TwoGlobal and Local Economic Developments

8 Palestine Monetary Authority (PMA), Financial Stability Report 2015

It’s worth mentioning that the prices of oil and food, along with many minerals, have witnessed a severe decrease in this year, driven by marked changes on both sides of supply and demand. Some of these changes might be seen as a natural reflection of the global economic slowdown and trade recession, while other changes might reflect efforts to impose an “obligatory» correction of the markets, as was the case in the crude oil. This global market witnessed surplus of oil production during 2015, reflecting the desires by many producers to control supply and expel high-cost producers out of the market. The increasing cases of the bankruptcy of oil corporations depending on shale oil in the beginning of 2016, particularly in the USA, have been the main factor of success for this policy, which extremely affected the USA and international stock markets.

In the midst of such developments; 2015 has witnessed more discrepancy in monetary policies adopted by major economies, which by the end of the same year, led to widening the gap between, on one hand, the US economy, heading towards more tightening in monetary policy with interest rate rising in December, and, on the other hand, the economies of Europe and Japan adopting expansionary monetary policies which attempt to stimulate relatively-poor local consumption. These developments occur amidst growing concerns in the markets about chronic disorders in stock markets at the international level. These disorders were the resultant of years-long liquidity injection into the financial sector, accompanied by asset price bubbles, especially in China, where private sector continued to be burdened by increasing levels of indebtedness, making this sector prone to corrective waves in the light of poor production and exports, as well as the increased vulnerability of the sector’s external debts to the decline in Yuan exchange rate against the US dollar.

It’s quite clear that, after many years following the worst financial crisis since the Great Depression, not much has changed concerning the sensitivity of global financial stability to similar shocks or the high speed of contagion from one country to the other. The challenge to policymakers in the USA and Europe remains pending, whether concerning the break-up of large financial institutions which pose systematic risks, or the regulation of non-banking financial sector to conform with financial stability requirements given the current challenges. This keeps these economies susceptible to a new wave of shocks arising from stock markets and assets.

In the light of what has been mentioned above; the features of the ensuing stage are still somehow obscure, awaiting prognosis in emerging and developing economies, with the possibility of the outbreak of other new crises in Asian markets, on one hand, and the sudden developments affecting advanced economies and their monetary policies on medium term, on the other hand. However, attention will continue to focus on the US economy in the near future as a basic driver of global growth, and to the Chinese economy as a primary stimulator of markets of basic goods and of external trade in many countries. In the meantime, markets are still waiting for oil markets to regain balance, when this stage completes drawing the new map of production centers in the near future.

Such changes and developments occurring to global economy inevitably affect the Palestinian economy to varying degrees. Despite the limited effect of sudden changes that occurred to global growth, trade movement, or even crises that have been erupted at international level, the swings in basic goods markets create a main channel of influence on price changes in the Palestinian market, as well as the changes in exchange rates of main currencies, and interest rates which fundamentally determine the cost of borrowing in these currencies in the local market. However, the most influential factor affecting the Palestinian economy lies in the fact that it is closely connected to its regional milieu, particularly Israel, given the regional concentration of trade and the deep dependence, in the absence of a national Palestinian currency, on a multi-currency monetary system in bank dealings. This mandates analysis of regional economic and financial developments within the context of analyzing the financial stability in Palestine.


Global financial stability map[2]

Global economic and financial developments and the fall in oil prices and other basic commodities in 2015 have affected many countries to varying degrees. While oil-importing countries have benefited from this situation, oil-exporting countries have been negatively affected, as these changes had multiple consequences on the global financial stability map. It is expected that the fall in oil prices and other basic commodities coupled with lower interest rates following the expansion of monetary easing will support growth by the end of 2016. This has contributed to boost financial stability in advanced economies, given the emergence of a stronger macro-financial environment, as the scope of recovery widens; trust in the monetary policy deepens and deflationary risks recede to some extent in the euro zone, especially that trust in the policies of the European Central Bank is considered one of the reasons behind credit recovery and the revival of credit demand.

The Federal Reserve has also become sufficiently prepared to increase the interest rates with the imminent availability of the prerequisites of this increase, which is expected to help in curb the irregularities accompanying growing risk appetites. Moreover, there are also signs of improvements in the corporate sector which could result in a rise in investments and risk taking.

Whereas some progress has affected the advanced economies, risks facing emerging markets remain high, despite the fact that many emerging market economies have set out to reinforce policy frameworks and promote their capacity to withstand external shocks. Nonetheless, many major economies are facing significant domestic imbalances and diminishing growth, especially those countries that implemented a fast-paced credit granting policy. As a result, over borrowing gave rise to a sharp escalation in the leverage of the private sector in many economies, associated with rising foreign exchange exposures. Between 2003 and 2014, the debt of non-financial companies in major emerging economies quadrupled, as these debts transformed from loans to bonds. Notwithstanding its role in promoting investment and subsequently growth, the increased leverage’s upward trend in recent years has aggravated concerns, since many financial crises that hit emerging markets were preceded by rapid growth in leverage.

As the emerging market economies approach the final phase of the credit cycle, the prudential bank capital grew weaker, while a rise in non-performing loans is expected as a result of diminishing corporate profits and deteriorating asset quality. In China, for example, banks have only recently begun to address the growing challenges of deteriorating asset quality coupled with expanding vulnerabilities in key areas of the corporate sector. These developments seen in the banking system in emerging markets are contrary to those seen in advanced economies, where banks spent the last few years in reducing leverage, repairing balance sheets, raising capital and reinforcing financing arrangements.

Generally, three major challenges overshadow the global financial outlook, at the policy level. These are:

• Risks in emerging markets: decline in growth of the emerging markets and developing economies is expected, for the fifth consecutive year. It is worth mentioning that many emerging markets have gained greater resilience in confronting external shocks with the increase in exchange rate flexibility, the rise in foreign currency reserves, the mounting reliance on foreign direct investment flows, and external financing in local currency. Additionally, policy frameworks have generally become more robust. Yet, in spite of these positive developments affecting public sectors, many of the companies and banks in emerging markets have become burdened with obligations, increasing the likelihood that they experience financial pressure, economic activity slowdown and capital outflows.

[2] IMF, Financial Stability Report, October 2015.


• Problems created by the crisis in advanced economies: The problems of high public and private indebtedness in advanced economies must be addressed. Moreover, the surviving gaps in the euro area structure must be closed in order to enhance financial stability and avert political tensions and adverse effects on confidence and growth, especially in the euro area which is still facing the challenge to remedy the remaining vulnerabilities, both at the sovereign and the banking levels.

• Systemic market liquidity shortages: Market players in advanced economies and emerging market economies have become concerned about the possibility of shortages in market liquidity in terms of the level and adaptability, in particular with regard to bonds. This leads to fears from the rise in risks associated with liquidity-related shocks. It is crucial that an abundance of market liquidity exists ( meaning the ability to rapidly buy or sell a significant bulk of the share at a low cost and with a limited impact on prices) in order to transfer funds efficiently from depositors to borrowers and hence trigger economic growth. As such, market liquidity is a prerequisite of financial stability.

Regional developments

Israeli economyThe Israeli economy began the year 2015 with unsatisfactory performance, largely reflecting the negative impact of several economic and political developments in the local and regional arena. The decline was evident in foreign trade and investment, owing to weak global demand, from the EU and China in specific. This comes along with the decline of investors’ confidence in light of the growing political tensions; plunging export competitiveness and fears from the consequences of deterioration of global economic conditions. Additionally, consumer spending, both public and private, continued to slowdown in the first half of the year, due to declining consumer confidence and limited government spending caused by the belated adoption of the government budget.

Nevertheless, the second half of the year witnessed a relative improvement in performance in the light of positive developments, albeit briefly, in private demand, imports, and government spending, which safeguarded the Israeli economy against further slowdown, at the annual level. As such, real GDP growth rate stood at 2.6 percent for the second consecutive year, while unemployment rate dropped from 6.0 percent to 5.3 percent in 2015, and prices deflated at the annual level for the first time since 2004 by 0.6 percent, compared to an increase of 0.5 percent in the past year.

These developments appear on the grounds of significant exchange rate fluctuations of the shekel against major currencies, and a significant rise against the euro in particular, amidst anticipation concerning the initiation of natural gas production and the consequences associated with the gas production agreement that the government is trying to pass, despite the protests by the opposition, the antitrust Commissioner, along with a number of activist groups. Accordingly, the shekel exchange rate rose against the euro, which is the currency of the most important trading

Figure 2-1: Israeli economic performance, 2011-2015

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Growth Inflation Unemplyment

Source: IMF database.


partner for Israel, by about 12.4 percent during 2015, pursuant to relatively high financial flows and the limited ability displayed by the Bank of Israel to control the currency. Contrarily, shekel fluctuations resulted in a decrease by about 8.6 percent against the US dollar, which continued to rise steadily since the second half of 2015.

Despite the above mentioned changes, Bank of Israel maintained a relatively stable monetary policy during that year, contented with reducing interest rates only once, from 0.25 percent to 0.1 percent earlier in the year. Concurrently, and in spite of frequent speculation about a significant change in monetary policy, the Israeli central bank refrained from intervening in the markets, with the exception of quick and limited interventions in the currency market. This stability may likely reflect the limited margin for action available to the Bank of Israel, given the low interest rates and high pressure on the shekel, in addition to the uncertainty about the global economic developments in the near future; which increases the Bank’s reticence regarding the use of all tools currently at its disposal.

It should also be mentioned that the government has reduced the value added tax (VAT) and corporate tax from 18.0 percent and 26.5 percent respectively to 17.0 percent, and 25.0 percent during the second half 2015, in order to encourage private consumption and investment. Despite the government’s attempt to market these policies as a supporting measure for economic growth, it was widely criticized, especially by the Bank of Israel, which expressed concern at the continued expansion of government deficits and the irrationality of this decision, given the present circumstances. On a related note, the VAT in Palestine remained constant at 16.0 percent in 2015, despite having dropped in Israel, which may reflect the government’s need to maintain the scarce sources of income available locally.

In many ways, the consequences of the Israeli economic performance have reflected on the economy and financial stability in Palestine. In view of the compulsory subordination of the Palestinian economy to the Israeli economy, several channels remain became wide open for direct influence on Palestinian economic performance at various levels. The Palestinian financial system continues to be susceptible to the Israeli monetary policy and the Israeli shekel stability, being a major currency of trade exchange and a key component of assets of banks operating in Palestine. Furthermore, the Palestinian financial system is indirectly susceptible to fluctuation of prices; demand on Palestinian labor force in the Israeli market; Israeli-imposed constraints on trade and tax transfers (clearance revenues) and the associated adverse ramifications on Palestinian economic performance.

The Jordanian economyThe year 2015 did not carry any signs of a sustainable economic recovery in Jordan, as the growth rate fell to 2.5 percent, compared to 3.1 percent in 2014, following a slowdown of most productive sectors and a significant decline in the construction sector, as well as hotels and restaurants sector. In contrast, the activities of transport, electricity and financial services revealed better signs of growth. These developments come within a context of political and regional turmoil and heightening security tensions at the Syrian-Iraqi borders, concomitant with the government efforts aimed to restructure the economy and government spending, especially approaching the final stages of the economic reform program which ended in late 2015 and was funded by the IMF.

Figure 2-2: Bank of Israel policy rates, 2011-2015

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Source: BoI website.


These developments also resulted in a rise in the unemployment rates to around 13.1 percent in 2015, compared to 11.9 percent in the previous year. Inflation fell significantly, in light of the continuing decline in oil and basic goods prices worldwide. Consumer prices contracted by about 0.9 percent in 2015, compared to positive inflation of 2.9 percent in the previous year. This temporary price deflation eased the pressures felt by the Central Bank of Jordan, which succeeded in reducing the official interest rates on the Jordanian dinar twice during the first half of the year, to reach 3.75 percent, compared to 4.25 percent by the end of the previous year. The Central Bank of Jordan also maintained stable levels of foreign currency reserves amounting to USD 14,153.3 million by end of 2015, which is equivalent to around 8.8 months of total imports of goods and services during that year.

The sharp decline in oil prices has helped ease the government’s burden of energy subsidy, while the government sustained its efforts towards the liberalization of this sector and the coverage of part of the deficit in the fuel import bill. The steady rise in the exchange rate of the US dollar contributed to similar rise in the Jordanian dinar, which partially eased the cost of imports.

In spite of the above-mentioned developments, the current account deficit has increased substantially during the year to reach about 8.8 percent of Jordan’s GDP, compared to 6.6 percent in the previous year, due to the significant decline in current transfers. Indebtedness levels have continued to rise through 2015, where the total government debt reached around 91.7 percent of GDP, compared to 89.0 percent in the previous year, according to IMF data. The debt increase threatens economic stability and signals the possibility of a rise in the value of the cost of borrowing in the future, especially following the suspension of IMF funding and in case new shocks occur in the future.

The Jordanian economy is the second most influential economy affecting economic and financial stability in Palestine. As a result of the interconnecting economic relations, several significant consequences appear especially at the level of the banking system, given the relative importance of the Jordanian dinar as a currency of savings and the position of the Jordanian banks in the structure of the Palestinian banking sector. By end of 2015, the Jordanian dinar acquired 25.7 percent of total customer deposits in Palestine and about 14.8 percent of total facilities granted. While Jordanian banks’ share of total customer deposits amounted to 46.5 percent, its share of total facilities stood at 42.6 percent, which is an indication of the degree of exposure of the Palestinian banking system to its Jordanian counterpart.

Figure 2-3: Jordanian economic performance, 2011-2015

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Source: Central Bank of Jordan database.

Figure 2-4: Central bank of Jordan policy rates, 2011-2015

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Source: Central Bank of Jordan database.


It is worth mentioning that the relative stability in levels of foreign reserves and the low inflation have contributed to reinforce financial stability in both Jordan and Palestine. However, the pronounced build-up of public debt and the deterioration in the current account, in light of the cessation of flow of aid, threaten to exacerbate pressures on the dinar, if the economy is faced with economic or political shocks in the near future.

Local developments

The Palestinian economy has gradually returned to a trajectory of growth in 2015, following the end of the last Israeli war against Gaza Strip a year ago. GDP has recorded a rise of 3.5 percent compared to a decline of 0.2 percent in 2014. From a geographical point of view, GS achieved 6.8 percent growth rate in 2015, compared with a sharp plunge by 15.1 percent in the past year in the aftermath of the last aggression that caused huge damages to the infrastructure and production bases. This growth was fundamentally driven by relative revival of the construction sector, the delivery of construction and building materials into GS was again permitted and the reconstruction process commenced following a delay of approximate a year from the end of the war. However, the level of activity of several sectors remains below the level realized in the past year, which could be indicative of further economic slowdown once the construction boom in GS fades away in the next period.

Conversely, the growth of real GDP in the West Bank has reached 2.5 percent, compared to 5.3 percent in 2014. This slowdown in growth rate can be attributed to the suspension of clearance revenue transfers and its impact on economic performance during the first quarter of 2015, in addition to a marked rise in Israeli violations and restrictions imposed on movement in the last quarter of the same year.

On the other hand, price developments have been more consistent during 2015, following the decrease in inflation rate to reach 1.4 percent compared to 1.7 percent in the previous year, as a resultant of price inflation rate reaching 1.3 percent in the WB and 1.8 percent in GS. Conversely, there were deeper discrepancies in 2015 for labor market performance in both regions. The drop of unemployment rate in Palestine from 26.9 percent to 25.9 percent was the result of receding unemployment from 43.9 percent to 41.1 percent in GS alongside a slight decline in the WB from 17.7 percent to 17.3 percent during the same period.

Despite the disparity in growth, prices and unemployment between the WB and GS, the economic performance generally revealed more consistency in 2015 in comparison with the previous year. This reflects a similar inclination in terms of composition and structure of expenditure. The WB has witnessed significant growth in final consumption, particularly in private consumption, in addition to a relative improvement in fixed capital formation, basically concentrated in the area of construction. Conversely, the WB saw a marked increase in trade deficit due to a faster pace of expansion in imports compared to the exports. As for GS, final consumption witnessed growth to a lesser degree due to the rising government expenditure,in spite of a decline in household expenditure, whereas capital

Figure 2-5: Palestinian economic performance, 2011-2015

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formation witnessed a relative improvement that led to a less severe contraction during the same yea, driven by an marked upsurge in investment in the area of building. At the same time, the trade deficit in GS increased considerably, as was the case in the WB, driven by an increase in imports as opposed to a decrease in exports.

Consequently, poor performance, which marred several economic activities in GS, in addition to the lack of sustainability of the construction boom, are both ominous of the persistence of the structural disorders that were created over the course of the long-lasting siege imposed on the Strip and exacerbated due to the devastation caused by the most recent war. These disorders, along with the frequent shocks seen in the WB, continue to pose a threat endangering Palestinian economic stability in general, and financial stability in particular, especially in relation to government finances and the ability of the public sector to continue to underpin the economy and its resilience in the face of various obligations.

At the level of public finance, the Palestinian government has succeeded in lowering the current deficit and the overall deficit before grants. Public revenues have noticeably increased and although total expenditure has also increased, the increase in public revenues was greater than in public expenditure. As for overall balance after grants, it realized a surplus in 2015, which was, however much lower than the surplus in the past year due to an acute decline in grants.

Despite the distinct improvement in fiscal performance in 2015, the year witnessed a marked increase in government public debt (denominated in USD) by about 14.5 percent over the previous year to USD 2,537.2 million (about NIS 9,908.1 million), or the equivalent of 20 percent of GDP. This upsurge can be attributed to the marked increase of government local debt by 30 percent compared to the previous year to USD 1,466.5 million, as opposed to a drop in external government debt by 1.7 percent compared to the past year to USD 1,070.7 million.

Government arrears witnessed an increase of 1.8 percent to NIS 2,828.3 million in 2015. The largest portion of these arrears is payable to the private sector (as non-wage arrears). These arrears amounted to NIS 1,591.6 million, accounting for 56.3 percent of government arrears during the same year. In the meantime, wage and salary arrears increased by 5.8 percent compared to the past year, to NIS 602.7 million, accounting for about 21.3 percent of total arrears in 2015. It’s worth mentioning here that government accrued arrears have reached NIS 12,928.1 million shekels by the end of 2015, or equivalent to 27.4 percent of GDP, compared to 21.6 percent in 2014.

The aforesaid developments show the growing dependency on other countries, particularly Israel, in supplying the needs of local markets, which increases the exposure of the Palestinian economy and makes it more prone to shocks originating from Israel.

The impact of Israeli pressures on financial stability in Palestine The Israeli occupation continues to exert economic and financial pressure over the Palestinian economy in general, and Palestinian government in particular. This pressure is generated through four strategic channels presenting a multitude of economic crises that generally impact all aspects of Palestinian’s and lead to ongoing economic retrogression. These channels are: clearance revenues, export and import, Palestinian workers in Israel, the banking sector and control over cash liquidity. Three economic procedures can be added to these four channels that relate specifically to GS, which continues to suffer from stifling and complete siege since many years. The first represents the process of reconstruction, as Israel enjoys complete control over entry of construction materials. The second is the channel of natural resources and gas discovered near the shores of the Strip, which Israel attempts to seize. The third is the financial and monetary siege over banking system and the repeated creation of cash in GS.


Clearance revenues collected by Palestinian Ministry of Finance via the Israeli side constitute a main source of revenue for the government budget. These revenues serve as the most perilous means of pressure available for use by Israel, as it directly impacts the Palestinian government capacity. In 2015, these revenues amounted to about USD 2,046.9 million, representing 70.7 percent of net domestic revenues, and about 56.5 percent of total public expenditures. This means that these revenues cover more than half of the budget expenditure, which is mainly directed to wages and salaries; also constituting around half of the budget[3]. Thus, any interruption in the transfer of clearance revenues means a suspension of flow of revenues from the most important financial resource available to the government, meaning it will fail to cover half of its expenditures; most importantly public sector salaries.

The vulnerability of the financial position of the Palestinian government to Israeli pressures was quite evident in the beginning of 2015, after Israeli authorities suspended the transfer of clearance revenue funds as a punitive measure against the Palestinian government for applying to join several international organizations and agencies, in particular the request to join the International Criminal Court at that time. This procedure culminated in the Palestinian government’s failure to pay salaries of public service employees in full, disbursing only 60 percent of salaries. At the same time, the government failed to meet payment dates of its obligations to private sector companies, which, in turn, affected the companies’ ability to pay amounts due to the banking sector. It is worth mentioning that, starting from 1997, Israel withheld clearance revenues on six occasions, for periods that in total equal to four years and one month. The total sum of withheld revenues amounted to USD 3 billion, keeping in mind that Israel does not pay back any interest on the withheld revenues, which is estimated to be equal to millions of dollars[4]. However, the occupation government collects high fines and interest rates on the Palestinian authority for any delay in payments of electricity, water or sanitary services bills which doubles the pressure on the public budget.

Although regular clearance revenue transfer was restored, starting from April 2015, yet data available from the Ministry of Finance shows that salary and wage arrears amounted to NIS 602.7 million by the end of 2015, which is indicative of the cash shortage preventing full payment of the salary bill. Subsequently, it becomes more likely that the government will fail to pay the salary bill under extraordinary circumstances when the funds from clearance tax revenues and grants come to a halt. This represents another significant form of dormant threats that might affect banking sector stability, and stability of the financial sector in general as a result. On a different note, estimates suggest that about 25 to 35 percent of imported goods arriving through Israel are smuggled into the Palestinian territories. This is attributable to the lack of border control and Palestinian government inability to keep areas B and C under surveillance. The value of revenues lost due to smuggling is estimated at no less than USD 300 million each year[5].

Undoubtedly, the fiscal performance, which takes the form of the management of public funds and the setting of relevant fiscal policy, has a considerable impact on the achievement of financial stability. Therefore, The analysis of public finance developments gains special attention in the study of local financial stability trends owing to the important and special correlation with the stability of the financial sector, which relates to budgetary performance through two main channels[6]: the first is the channel of direct credit extended by the banking sector specifically to the public sector (the central government), while the second is the channel of facilities extended to public sector employees and private sector suppliers to the government, especially in view of accumulation of accrued arrears to this sector.

[3] The percentage of average wages and salaries to average total public expenditures was equal to 47.6 percent between 1996-2015, whereas the average of clearance revenues to the average of total public expenditures was equal to about 40.5 percent, for the same period. [4] United Nations Conference on Trade and Development, Trade and Development Board. Report on UNCTAD assistance to the Palestinian people: Developments in the economy of the Occupied Palestinian Territory. Sixty-second session, Geneva, 14-25 September 2015.[5] United Nations Conference on Trade and Development, Ibid.[6] Analysis of these two channels will be presented in Chapter Four in this report.


The financial fragility of Palestinian governments forced them into increased dependency on one of two financing sources, whenever Israel halts the transfer of clearance revenues. These are: using foreign grants and seeking help from the Arab World (Arab safety net), or forcibly resorting to borrow from banking sector. This is clearly illustrated by the increasingly rising levels of local government debt which reached USD 1,466.5 million by the end of 2015, while the sum of local debt and external debt reached USD 2,537.3 million, compared to USD 2,212.8 million in 2011, and about USD 863 million in 2000.

The significance of foreign grants in covering the public expenditures of the successive Palestinian governments is quite remarkable. Over the period from 2011- 2015, foreign grants contributed to finance an average of approximately 31.0 percent of public expenditure. It goes without saying that these grants are totally linked with the political orientation. As such, Palestinian public finances are ambushed between the trap of clearance revenues and the trap of foreign grants , as the sum of the two items over the course of the aforesaid period recorded an annual average of USD 2,780.3 million, accounting for about 79.8 percent of the Palestinian government’s net public revenues and grants and covering about 82.5 percent of public expenditure for the same period. It is noteworthy that the latter figure has increased considerably in the last few years reaching about 91 percent of total expenditure in 2014 and dropping to 79 percent in 2015.

This reality is indicative of the intensity of risks facing the public finances of the Palestinian government, in a manner that threatens its ability to achieve financial sustainability, in the broad sense of the word which encompasses operational sustainability, which secures government ability to finance its current expenditures without any need to resort to borrowing, and its ability to honor its financial obligations and fulfill debt service commitments without delay. Indeed, financial sustainability will safeguard the government against bankruptcy risk and prevent the ratio of public debt to GDP from deterioration.

Financial sustainability is also linked to the ability of the government to continue to provide public services to citizens, while concurrently taking into account that prices match the financial capabilities of individuals (this means that sustainable public service delivery is associated with fiscal sustainability), as the lack of sustainability of public finances weakens its ability to provide any public services. This is evidenced by the government adoption of austerity policies at times when the financing gap deepened. Consequently, the government has failed on several occasions to implement the successive Palestinian development plans, intended to reduce dependency on foreign financing and enhance self-reliance.

The situation is aggravated by the intrinsic characteristics of the Palestinian economy, in terms of its saving capacity to achieve self-reliance. As clear from Figure (2-7), local saving rates as percent of GDP are negative, averaging around -19.6 percent between the years 2011-2014, compared to about 39.6 percent in the Arab World, and 22.5 percent globally. Even the worst off countries (classified as low-income economies) are doing better than Palestine achieving

Figure 2-6: Clearance and grants as a percent of public revenues and expenditures, 2011-2015

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9.2 percent, for the same comparison period. It becomes obvious then that occupation policies have resorted over the course of many years on systematic destruction of the forces of local production that made the Palestinian economy unable to satisfy the needs of local consumption. This reflects the significant structural deformity affecting the Palestinian economy.

On the other hand, the ratio of average wages and salaries to average total public expenditures is noticeably higher than in other countries around the world. The ratio for Palestine reached 48.6 percent in 2015, and about 50.7 percent on average between 2011-2015.

Within the same context, a high government final consumption to GDP ratio is also noticeable. In Palestine, this ratio reached on average 27.1 percent in 2014[7], compared to about 18.2 percent in the Arab World, and 17.5 percent worldwide, and 11.4 percent for the category of low-income countries. This figure reveals the expansionary policy in public spending, which is known to impose additional burdens on the government and its financial resilience and maneuvering abilities.

It is worth mentioning here that the value of clearance revenues is connected to external trade from and via Israel, which represents the second main pressure channel used by Israel to economically strangle the Palestinian economy. The Israeli economy remains the most important “compulsory” trading partner to the Palestinian economy, and the most influential, owing to the huge volume of trade between the two economies and the full control by Israel over the movement of goods from and to the Palestinian cities. Such a situation has adversely affected Palestinian economic stability and growth on the long run. Accordingly, imports from Israel accounted for over 70 percent of total Palestinian imports in 2015, while the Israeli markets captured over 80 percent of total Palestinian exports over the same period.

The third pressure channel is the Palestinian workers working in the Israeli economy. Despite the slowdown in the Israeli economy during the first half of the year, the numbers of Palestinian workers have saw a quick and significant recovery, since it declined following the most recent Israeli war on Gaza Strip. The number of workers rose by 9.5 percent by end of 2015, compared to the previous year, to reach 115.2 thousand workers (all of them from the West Bank), or 11.8 percent of the total of Palestinian workers. Despite the fact that this category of workers may represent

[7] Based on the data provided by Palestinian Central Bureau of Statistics, wherein the ratio of government final consumption to real GDP has reached about 27.1 percent in 2015, compared to about 27.2 percent in 2014.

Figure 2-7: Domestic saving as a percent of GDP, selected countries, 2011-2014

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Figure 2-8: Government consumption as a percent of GDP, selected countries, 2011-2014

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Source: World Bank Database. global development indicators.


the least effective users of services offered by the Palestinian banking system, the sudden fluctuations in the number of workers within this category and their ability to access to the Israeli market carries significant impact on the overall performance of the Palestinian economy. The fourth pressure channel will be discuss in depth in chapter 5.

Chapter Three: Financial Sector Developments 19

OverviewThe year 2015 witnessed tangible developments across all areas and domains. The PMA carried through its endeavors to foster the infrastructure (legal, regulatory and supervisory) of the Palestinian financial system and promote banking dispersion, financial inclusion and banking awareness, alongside the introduction of new systems and programs that contribute to promoting financial stability in Palestine in general. This progress generally reflected on the financial system’s performance, as demonstrated by the Matrix of Financial System Characteristics constructed as per World Bank methodology. This chapter presents a detailed description of the most outstanding developments and achievements that were realized over the course of the year. It also includes a review of the components and dimensions of the Palestinian financial system characteristics matrix (indicators of financial depth, financial inclusion, financial efficiency and financial stability for financial institutions and financial market).

The regularity and supervisory framework

The PMA continued to collaborate with the Financial Follow-Up Unit (FFU) in the area of money laundering. As a result, the Palestinian Anti-Money Laundering/Combating Financing of Terrorism (AML/CFT) Decree Law No. (20) for 2015[8] was issued, as well as the issue of the Presidential Decree No. (14) for the year 2015 on the implementation of the resolutions of the UN Security Council. Pursuant to this Law, a committee for the implementation of UN Security Council resolutions was established. The new AML/CFT Law introduced fundamental additions, especially in relation to the financing of terrorism and added five predicate crimes the proceeds from which shall be regarded as proceeds of the crime of money laundering[9]. On a related note, Palestine upgraded its status in the MENA Financial Action Task Force (MENAFATF) from observer to that of full member, becoming the group’s 19th member[10].

Thus, Palestine has become in compliance with the international instructions and procedures related to Anti-Money Laundering and Combating of Financing of Terrorism (AML/CFT), where it was until mid-2015 in compliance with the instructions of money laundering only, according to the former Anti-Money Laundering Law No. (9) of 2007.

[8] The new Law on anti-money laundering makes void the Decree Law No. (9) for 2007. [9] These crimes consist of tax crimes; selling or transfer of land deemed an illegal transaction by virtue of the laws in force in Palestine, also to include mediation or any other action intended to illegally transfer land, or part thereof, to become part of another foreign country; criminal misappropriation; crimes stated in the Antiquities Law of Palestine and the crime of terrorist financing. The new Law aggravated the punishment of by an accessory to crime making it equal to that received by the actual perpetrator, instead of half the punishment as was stipulated in the former Law. [10] The task force main goal is to secure the adoption and implementation of the 40 recommendations of the FATF to counter money laundering, terrorist financing and proliferation of weapons of mass destruction, as well as other related UN agreements and Security Council resolutions. Members also aim to cooperate with other regional and international institutions to promote compliance internationally to FATF standards; make concerted efforts to address regional issues related to money laundering and terrorist financing; exchange expertise; develop solutions to deal with these issues and take measures across the region to effectively counter money laundering and terrorist financing, in a manner that does not contradict the cultural values of member countries, their constitutional frameworks or legislature.

Chapter ThreeFinancial Sector Developments


Pursuant to the Banking Law No (9) of 2010, and global and local banking developments, the PMA continued to make efforts to upgrade supervisory instructions that promote financial and banking stability. In this respect, it issued several instructions[11], including the Instructions No. (1/2015) on weather conditions, which address the importance of sustaining bank operations and taking appropriate measures and arrangements during severe weather conditions, and Instructions No. (2/2015) on determinants and controls for credit granting, which oblige banks to observe clarity and transparency in the terms and conditions of agreements with customers[12].

Further, the PMA issued Instructions No. (3/2015) and Instructions No. (7/2015) on the appointment of Anti-Money Laundering Liaison Officer in local and foreign banks. These instructions are part of PMA’s efforts to safeguard the banking system against the crime of money laundering.

In addition, the PMA issued Instructions No. (5/2015)[13] on the National Switch fees, which specify the national switch fees for cash withdrawal and balance enquiry to be charged by member banks. Moreover, The PMA issued Instructions No. (6/2015) concerning capital requirements, reserves and shareholders’ equity. These instructions clarify capital requirement from the banks. Paid-up capital or capital allocated to engage in banking in Palestine should not be less than USD 75 million. The instructions also define additional capital requirements; requirements for foreign banks and capital adequacy requirements, which should not drop below 12 percent. Moreover, the instructions define owner’s equity and related terms and conditions and additionally outline the structure of reserve requirements to be allocated by banks as statutory reserves, risk reserves and countercyclical reserves.

Over the course of the year, the PMA published numerous circulars aimed at the regulation and follow-up of the situation of banks. One such circular was a circular on disclosure requirements in annual reports for local banks and closing statements for foreign banks. The compliance of banks to this circular was later verified. In addition, a circular was published on the fees and the commissions charged by banks in line with (IFRS-18). Efforts are underway to ensure bank compliance to requirements.

As for supervisory follow-up, the PMA carried through its efforts to promote bank corporate governance, through requiring banks to, firstly, appoint independent members and members representing minority shareholders within the board and, secondly, establish board committees, in particular the governance and remuneration committee, alongside the other designated committees. It also required banks operating in Palestine to expand their capital by raising the minimum capital requirements from USD 50 million to USD 75 million, according to a 3-year time schedule (ends on July 15, 2018), and to promote compliance to international best standards and practices relating to anti-money laundering and to USA’s Foreign Account Tax Compliance Act (FATCA).

On a different note, in order to secure financial and operational sustainability of the financial sector, the PMA enhanced the role of supervisory departments in the banking system through the upgrade of off-site and on-site supervisory tools used. Upgrading aimed to maintain a safe and sustainable financial sector; intensify the control over risks associated with banking through bolstering business continuity measures and improving the technical environment at banks; and sustain the implementation of prudential supervisory measures to control risks facing the Palestinian banking system. In this context, the general framework for domestic systemically important banks was developed and endorsed by PMA’s board of directors. The banks that were classified as systemically important banks

[11] For more details, please check PMA’s Annual Report for 2015. [12] These instructions were amended by Instructions No. (8/2015), amending specifically the controls over financing of vehicle purchase and the granting of consumer credit.[13] Instructions No. (4/2015) concerning the business hours for banks during vacation and public holidays.


were duly notified of the decision and meetings were arranged each bank’s management requiring it to provide a time frame for the implementation of the supervisory procedures required, as per the approved general framework. Additionally, a working paper on procedures for De-risking of correspondent banks was prepared and adopted by the Arab Monetary Fund (AMF).

As for PMA efforts to implement the requirements of Basel II and III, steps III, IV and V of the second phase[14], which commenced in 2014, were completed. The third step focused on the risk assessment system (RAS); the fourth step focused on the laying the ground to apply more sophisticated approaches (Internal-Rating Based Approaches) and the fifth focused on monitoring of the parallel run period during the implementation.

The remaining sixth step focuses on the preparation of the final regulatory framework, which relates to the issuance of instructions for the implementation of Basel II requirements. In this context, the template for the consolidated financial statement of banks was revised and amended, whereby all items on risk-weighted assets and capital adequacy became aligned to Basel II requirements. It is anticipated that this phase will be closed during 2016. It is worth mentioning that, in order to guarantee an exemplary implementation of the Basel II requirements, the implementation process advocates simplicity, gradual application and good communication, in a manner suited to the unique Palestinian situation.

With regard to periodic inspection of banks, several comprehensive audit visits to a number of banks were conducted, in addition to many follow-up visits to examine bank compliance with rules and regulations aimed at maintaining a safe, healthy and secure banking system. Likewise, the compliance of banks to IT controls, intended to mitigate operational risks, was followed up. It is noteworthy that the PMA is currently working on the compilation of on-site and off-site inspection guide that applies a risk-based supervisory approach, in line with an ambitious plan to maximize prudential supervisory risk-based tools and modernize the fundamentals of supervisory work as per the latest related developments, On the other hand, periodic testing of all banks was conducted, during which the alternative site, post–disaster recovery site and evacuation preparedness were examined in order to verify bank preparedness to cope with emergency situations.

Banking system updates The PMA continued to make strenuous efforts to build and develop banking and financial systems in accordance with international best practices. These systems are meant to lay down a robust and comprehensive banking infrastructure to contribute to the reduction of potential risks to the banking system, in specific, and the financial system in general. To that end, the PMA took numerous steps in 2015 to upgrade existing banking systems which were introduced in past years and initiated new projects, to be finalized in due course. Following are detailed descriptions of these developments:

Standardization of the International Bank Account Number (IBAN)In 2015, the PMA sustained its endeavors to upgrade the International Bank Account Number (IBAN) system, in collaboration with the banks with the objective to automate bank transactions related to the processing of transfers (Straight Through Processing-STP). On a related note, in order to adopt the IBAN system as a format for all its accounts, the Ministry of Finance is working in collaboration with the PMA to develop its bylaws to meet the requirements of

[14] This phase is comprised of six steps, the first two of which have been completed. The first step involved the preparation of working papers in the area of credit, market and operational risks. The second step involved the preparation of the final version of the Quantitative Impact Study (QIS) Form with the explanatory instructions that were distributed to banks in 2014.


this project, such that ultimately all the accounts used by the Ministry, estimated at 450 thousand, will be identifiable using the IBAN.

National Switch 194 SystemThe PMA launched the electronic national switch in May 2015[15]. The system links all bank ATMs and electronic Points of Sale (PoS) operating in Palestine to a unified database network, enabling ATM card-holders in anywhere in Palestine and at anytime to access point-of-sale service and ATM services from any machine belonging to any bank, regardless of the card’s originating bank.

The system aims at developing retail payment in Palestine by expanding the use of modern electronic methods of transfer and gradually shifting away from conventional payment methods such as cash, checks and other paper-based payment methods. This transition will result in the mitigation of risks and negative effects resulting from the application of these traditional instruments, on one hand, and keeping abreast with the most up-to-date technical advances in the area of electronic payment methods, on the other. The system also strengthens the management of cash liquidity by making cash available to citizens and SMEs, whenever and wherever needed. It ultimately lowers the cost incurred by individuals seeking bank services by limiting demand on conventional services. Moreover, the system saves individuals’ time and effort spent in long waiting periods at bank premises and facilitates easy and smooth access to and use of electronic banking services for all segments of the society, thereby promoting financial inclusion.

In addition, the system contributes to the reduction of bank operational and administrative expenses as the phenomenon of customer overcrowding in bank reception halls will be better controlled. At the same time, the bank operating ATMs (acquirer bank) can redeem its operational costs and realize profit. The system contributes to ensure fair and competitive banking, based on equal opportunity as fees are collected from the card-issuing member (issuer bank) in cash withdrawals only[16].

Work is well underway to secure the membership of all banks operating in Palestine as well as to define the nature of the relationship of the national switch with the global payment card companies like Visa and MasterCard, in a manner that accomplishes PMA’s strategic objectives from the project. Work is also underway to issue the regulations and instructions that regulate the operation of member banks and is expected to consummate in 2016.

Automation of the incoming transfers from the Israeli clearing houseThe PMA sustained efforts aimed at process automation and reduction of the operational risks that arise while posting incoming wage transfers of officially registered Palestinian labor force from the Israeli Clearing House. This project will also provide the appropriate oversight tools for incoming transfers from Israeli banks to banks operating in Palestine. It will also reduce cash inflow to Palestine by transferring the transfers from the Israeli Clearing House to the accounts of banks with correspondent Israeli banks, rather than pay the wages in cash. Consequently, licensed banks will to some degree be relieved from the burden of accumulated Israeli shekel.

In taking the steps to complete this project, a meeting and workshop were held during 2015 with the Bank of Israel, in addition to another workshop and introductory discussion with banks operating in Palestine, to determine the technical prerequisites, the standard procedures to complete the connection with the Bank of Israel as well as properties

[15] The PMA launched a media campaign on 29/11/2015 to introduce the National Switch 194 titled “We have made it easy for you; your account is close at hand”, which included advertisements in newspapers, radio and television and print-outs that describe the method of operation of the system. [16] A nominal fee was set at NIS 1, or the equivalent in other currencies, for ATM cash withdrawal and at NIS 0.5 for balance enquiry, pursuant to the Instructions No. (5/2015).


of the electronic file and connection mechanisms, upon coordination with the banks involved. It is anticipated that the project will conclude in the first half of 2016[17].

Electronic Clearing SystemThe PMA initiated preparations for the transition from the clearing system currently operated to a fully automated system (in preparation for the Electronic Check Clearing (ECC) system infrastructure). As a result, the check clearing period will be to cut short to become (T+1) in the future, that is equal to the clearing day plus another work day for returning the check; thereby accelerating check collection. Additionally, check clearing will synchronize with check clearing in the Israeli clearing house. The project is expected to be concluded within the next two years.

PMA’s Geographic Information System (GIS)In 2015 the PMA Geographic Information System (GIS) was launched to offer integrated solutions that achieve linkage between descriptive data and location information through new and advanced services. The system is considered an important tool to be utilized by the PMA and the banking system for the purposes of decision-making and strategic planning related to branching policies and provision of various banking services, in line with PMA regulations and instructions. The system will provide information that supports better geographical distribution of bank branches, ATMs, money changers and specialized lending institutions depending on statistical data on population density in each region and geographic location, whether in a city, village or refugee camp. It will also contribute to the promotion of financial inclusion in Palestine and the provision of quality analytical services, as well as other various services, to the PMA and the banking system.

In the near future, citizens will be able to use this system to obtain information on the geographical distribution of bank branches, ATMs, money changers and specialized lending institutions through the website tailored to host this service. It is worth mentioning that the system was constructed and developed using state-of-the-art technology systems that are specialized in GIS. The system uses an Oracle data-base and an Esri (Environmental Systems Research Institute) GIS software, which establish high system reliability and sustainability.

Launch of version III of the Credit Information SystemThe PMA continued its efforts to upgrade the credit information system which resulted in the launch of the upgraded version III at the beginning of the year 2015. The new version featured improvements of several aspects of the system including system entry and usage screens, the credit report, the financial file structure and the disclosure mechanisms. It also included the amendment of the borrower credit report extracted from the credit information system to contain the identification document number (ID No.) of guarantors, the collaterals presented by every guarantor for each facility and the disclosure of the main details of facilities granted by public-sector entities and private-sector companies, including leasing companies, service providers, real-estate developers and retail tradesmen, in addition to the disclosure of court rulings related to banking lawsuits.

Furthermore, the credit scoring system was upgraded following a full review of the entire range of risk-grade determinants, in a manner that suits the Palestinian banking environment. This upgrade was conducted within the frame of management and mitigation of credit risks associated with borrowers and guarantors, through the provision of precise, comprehensive and up-to-date information about all facilities, collaterals and liabilities of customers. As such, it is possible to maintain a low-risk facilities portfolio, on one hand, and expand the banking loan base and

[17] It is worth mentioning that the project had been previously suspended by the Israeli side, having decided to halt coordination with the Palestinian side. As such, the project’s success will depend on the progress allowed by the Israeli side.


subsequently the banking system’s role in economic development, on the other. It is worth mentioning that the PMA dedicated special attention[18] to the credit information system, owing to its fundamental role in establishing financial stability and mitigating risks facing the banking system, in particular credit risks.

In the same context, to further pursue the efforts made to standardize Credit Bureau systems, both existing and novel, in a unified automated platform and to follow on the second phase commenced in 2014, the PMA continued to make efforts in 2015 to officially launch these systems within a unified system forthcoming in 2016. These systems were: the Credit Registry System, the Bounced Checks System, the Suspended and Lost Checks System, the Credit Reports System, the Consensual Settlement System, the Program for the Control of Revenue and Expenditure received by the Credit Registry System and the Complaints System, the harmonization of personal information databases for both the Credit Registry System and the Bounced Checks Systems.

It is worth mentioning that the PMA is always desirous that the private sector reaps the benefits of the credit information system. Several memoranda of understanding (MoUs) have been signed with private sector companies enabling them to use the unified query system or the credit registry system. During 2015, MoUs were signed with the Union of Palestinian Real Estate Developers and the Student Loan Fund in Palestine to connect to the Unified Query System, while MoUs were signed with the Palestinian Company for Rental and Leasing “PalLease” and Ritz Leasing Co., by which they were authorized to use the services of the Credit Registry System. The signing of such MoUs expands the credit base available to the leasing sector; fosters its activity as an emerging sector and safeguards it against potential credit risks. Such cooperation helps strengthen the Palestinian economy in general, and the financial system in specific, since the MoU enables the beneficiary company to make credit decisions that are distant from risks, and, subsequently provide its range of services to all segments of the society across Palestine.

Bank fees comparison Web-serviceA special software program was developed to enable citizens to compare the different fees charged by banks. Users sign into the service on the PMA website and select the type of fee, the bank or banks and the type of currency they want to enquire about, in order to choose what best suits them[19]. This new service is part of PMA efforts designed to protect the rights of banking service consumers, promote transparency, disclosure and fair interbank competition so that banks provide good quality services to the public at affordable costs.

In addition, work is underway to develop the Annual Percentage Rate (APR) calculation program and related instructions, using the special APR calculation equation. The APR calculation program is intended to protect the rights of borrowers, ensure transparency in the disclosure of the actual cost of lending and encourage competition between the different loan providers.

Bank dispersion and concentration The PMA sustained its rigorous efforts to promote bank dispersion, as part of a basic strategy aimed at promoting financial inclusion across all segments of the society. In the follow-up of its branching policy adopted in 2007, the PMA granted licenses to a number of bank branches and representative offices, with the aim to secure the provision of banking services across all territories in Palestine, while giving priority to rural and distant areas in order to facilitate trade and economic activities and help citizens conclude all kinds of financial transactions.

[18] It is worth noting that the first version of the system was launched in the beginning of 2008. Version IV was launched in March 2016, following the organization of several training workshops for the various involved parties to show its upgraded features and additionally conduct pilot inspection with the help of a sample of users from banks and lending institutions to verify the system’s performance before launch.[19] The service was launched on PMA’s website on June 1, 2016.


Within this context and despite the fact that the number of licensed banks in Palestine fell to 16 banks by the end of 2015, seven of which were local and nine were foreign banks (seven Jordanian, one Egyptian and one foreign), the network of bank branches and offices expanded to 274 compared to 258 in the previous year. It is worth mentioning that in February 2015, a strategic partnership agreement was signed between The National Bank (TNB), which is a local bank, and the Union Bank, a Jordan-based bank, by which TNB acquired the assets and liabilities of the Union Bank in Palestine, while the Union Bank became its strategic partner owning 10 percent of the paid-up capital. As such the number of licensed banks in Palestine fell to 16 as of March 1, 2015[20].

In line with its strategy aimed at paving the way for a competent and advanced banking sector that contributes effectively to economic development in Palestine; offers and delivers banking services that are commensurate with real demand in the Palestinian market and meets needs of citizens from the diverse range of banking services and products, the PMA granted pre-approval for Cairo Amman Bank to found a new Islamic bank with a capital of USD 75 million under the name Al Safa Islamic Bank. The bank will provide new Islamic banking services and additionally encourage Palestinian and foreign investors to invest in the banking sector.

The PMA branching policy aims at promoting financial inclusion and making banking services available to all areas in Palestine. As a result of this policy, the population per bank branch drops approaching international standards of branch densities of 10,000 individuals per branch, while the quality of service offered to customers improves. Consequently, the branch density in Palestine dropped from 16.0 thousand per branch or office in 2014 to 15.6 thousand per branch or office in 2015.

As for concentration in the banking sector, analysis using the Herfindahl index showed that the year 2015 saw consistent improvement compared to the previous year, especially with respect to deposits. The Herfindahl Index average for bank share of private sector deposits continued to drop to reach 1,513 compared to 1,567 points in 2014. This figure falls below the internationally acceptable critical concentration threshold set at 1,800 points.

In contrast, the index recorded a slight rise in the concentration of bank market share of total direct credit facilities to 1,529 points, compared to 1,522 points in 2014, remaining still below the critical concentration threshold. It can thus be concluded that the banking sector is heading in the right direction at a reasonable pace to improve competitiveness for both sides of financial intermediation: savings and facilities.

[20] In March 25, 2016 and subsequent to this report, the Palestine Commercial Bank (PCB), a local commercial bank, merged with the Bank of Palestine; upon prior approval of the PMA and the General Assembly for Bank of Palestine in its extra-ordinary meeting, whereby a share swap of 3:1 in favor of the Bank of Palestine share was finalized. On a different note, HSBC Ramallah branch terminated at the beginning of 2016 its operation in Palestine. As such, the number of licensed banks in Palestine dropped to 14 in 2016.

Figure 3-1: Branching policy, 2011-2015

15000

16000

17000

18000

200

220

240

260

280

2011 2012 2013 2014 2015

Branches (left) Population/branch (right)

No.

of b

ranc

hes

Popu

latio

n pe

r bra

nch

Source: PMA database.

Figure 3-2: Concentration in the banking sector, 2011-2015

1200

1400

1600

1800

2000

2011 2012 2013 2014 2015

Private sector deposits Loans

Poin

t



Characteristics of the Palestinian Financial System

According to the World Bank, the characteristics of the financial system (financial institutions and the financial markets) in any country relate to four fundamental dimensions that compose a matrix of financial system characteristics[21]. The characteristics are financial depth, financial inclusion, financial efficiency and financial stability. Each of the four dimensions is measured separately for both financial institutions and financial markets using a set of basic indicators. The matrix of financial system characteristics constructed according to the World Bank methodology showed disparate results ranging between recovery and decline compared to 2014, at the levels of financial institutions (banks and other financial institutions) and financial market alike.

Table 3-1: Matrix of the Palestinain financial system, 2014-2015

IndicatorFinancial institutions Financial markets

2014 2015 Change (%) 2014 2015 Change (%)

Financial depth* 26.3% 31.6% 5.3% improved 25.1% 25.7% 0.6%

improved

Financial inclusion 1,009.0 1,036.9 2.8% improved 22.8% 23.5% 0.7%

improved

Financial efficiency 6.70% 6.79% 0.09% fall back 11.0% 9.6% 1.5%

fall back

Financial stability 18.8% 18.0% 0.9% fall back 13.0% 10.1% 2.9%

improved

* Adjusted by CPI.Source: Calculated according to the methodology of the global financial development report, WB, 2013.

Financial institutions Data from the matrix of Palestinian financial system characteristics for financial institutions showed signs of recovery in terms of financial depth and financial inclusion, while showing signs of decline in terms of financial efficiency and financial stability. Following is a review of the developments in the four dimensions of the characteristics matrix for financial institutions.

• Financial depthThe financial depth indicator[22], measured by the ratio of private sector credit granted by banks to GDP, showed a rise from 26.3 percent in 2014 to 31.6 percent in 2015. This is an indication of the increased degree of confluence between the Palestinian banking sector and the various economic sectors, to support economic growth, especially in light of the evidence provided by many studies of the powerful correlation between credit granted to the private sector (the main driver behind economic activity) and economic growth.

[21] For additional information, please see Financial Stability Report for 2014. Published on PMA website www.pma.ps[22] The depth indicator was calculated according to the World Bank methodology and adjusted to Customer Price Index CPI.

Figure 3-3: Financial depth indicators for financial institutions as a percent of GDP , 2014-2015

26.3

80.270.0

3.7

31.6

87.976.2

4.0

0

20

40

60

80

100 2014 2015

Perc

ent

Privatesector loans

Moneysupply (M2)

Customerdeposists Value added



Other main indicators of financial depth presented results in the same direction. All recorded an increase during 2015 compared with the previous year. One such indicator was the ratio of Money Supply (M2) to GDP[23], which surged from 80.2 percent in 2014 up to 87.9 percent in 2015. The financial sector (financial activities and insurance) share of GDP also increased from 3.7 percent to 4.0 percent[24]. Likewise, the share of customers’ deposits of GDP increased from 70 percent to 76.2 percent over the same period. This is indicative of the positive change accomplished by the Palestinian financial system (financial institutions’ side) in terms of financial depth.

• Financial inclusionThe year 2015 showed several posit ive developments with respect to a number of financial inclusion indicators. The number of depositors’ accounts per 1000 adults (15 years of age and above) showed an increase by 2.8 percent compared to the year 2014, rising from 1,009 account/ 1000 adult in 2014 to 1,036.9 account/ 1000 adult in 2015. Within the same context, other financial inclusion indicators also picked up. The number of bank branches and offices per 100,000 adults rose from 10.0 branch/ 100,000 adults in 2014 to 10.6 branch/100,000 adults in 2015[25].

Table 3-2: Advanced usage of electronic banking services in Palestine, 2011-2015

Banking services 2011 2012 2013 2014 2015

ATM machines 378 435 488 549 592

ATM cards 101,728 122,379 132,758 163,074 189,414

Point of sales 3,658 3,926 4,646 5,579 5,987

Debit cards 354,352 410,536 408,636 419,676 466,789

Credit cards 47,046 56,835 62,931 70,029 82,830

depositor accounts 2,545,459 2,715,338 2,748,387 2,766,635 2,940,575


According to the latest data available from the IMF database for the year 2014[26], the number of bank branches and offices in Palestine recorded better results than some other countries like Egypt, Sudan, Algeria, Iraq and Saudi Arabia, while scoring lower than in some other Arab countries like Jordan, Lebanon, Morocco, Oman, Kuwait, Qatar and United Arab Emirates. In comparison with non-Arab countries around the globe, both developing and advanced, Palestine’s rank was generally low standing at 107 out of 177 countries listed in this indicator. Israel, for example, recorded 19.1; USA recorded 32.4; Germany 14.5 and Turkey 19.8 branches per 100,000 adult population.

[23] Check Quarterly Monetary Developments Report at PMA website www.pma.ps which includes an estimation of money supply in Palestine as per a specific methodology. [24] The source: Palestinian Central Bureau of Statistics (PCBS). [25] The indicator was calculated using the same methodology as the IMF, as follows: the number of bank branches per 100,000 adults = (number of bank branches and offices + number of banks) * 100000/ number of adult population. With regards to the number of bank branches, the data published by the PMA was used, whereas with regard to the number of adult population, the data published by the PCBS data was used. [26] The different indicator value is attributed to the differences from data sources, as the number of adult population in Palestine differs from that stated in the IMF database.

Figure 3-4: Branches per 100 thousand adults, selected countries, 2015

20

30

3 5 5

25

16 17

6 12 14

9 11 19

11 13 15 20

32

21

38

24

05

1015

2025303540

Jord

an

Leba

non

Suda

n

Eygp

t

Alge

ria

Mor

occo

Om

an Iraq

UAE

Qat

er

S,Ar

abia

Pale

stin

e

Isra

el

Mal

eysi

a

Indi

a

Paki

stan

Turk

ey

USA

Swed

en

Fran

ce

Cana

da

Bran

ch p

er 10

0 th

ousa

nd a

dults

Source: IMF database, Financial Access Survey: FAS.


With regards to the use of electronic financial and banking services, the year 2015 saw a notable increase across the range of electronic banking services. The number of debit cards rose by 11.2 percent and the number of debit cards to adult population (15 years and above) rose from 15.3 percent in 2014 to reach 16.5 percent in 2015. The number of credit cards grew by 18.3 percent compared to 2014, with the percentage of adult card holders rising from 2.6 percent of adult population in 2014 to 2.9 percent in 2015. Moreover, the number of points of sale (PoS) grew by 7.3 percent to reach 5,987 PoSs; which effectively contributes to boost citizens’ use of electronic cards to carry out purchases.

Also ATMs recorded an increase in number by 7.8 percent to reach 592 machines in 2015 spread across the various governorates, leading to a hike in the number of ATMS (per 100,000 adult individuals) from 20 in 2014 to 20.9 in 2015, according to PMA data.

From the point of view of ATM geographical dispersion, Palestine secured a rather advanced rank compared to other countries, recording 91.2 ATMs\1000 square kilometer in 2014. According to the most recent data available from IMF sources, Palestine realized the second best result in the Arab World after Lebanon. In 2015, the number of ATM cards increased by 16.2 percent compared to

the previous year.

In 2015, a significant achievement was recorded for Palestine as it acquired a high score in credit information depth measured according to the methodology used by the World Bank. Palestine attained the score (8), the maximum possible score for credit information system effectiveness, from (7) in 2014. This high-ranking score by Palestine becomes more meaningful when compared with other countries around the world. In 2015, the Arab World scored (4), falling mid-way on the scale, while high-income countries scored (6), Israel (7) and the world average was (4).

This achievement was made possible thanks to the credit information system established by the PMA, and continuously upgraded ever since making it one of the most advanced credit information systems in the region. These systems represent a modern and advanced database available for the use of banks and specialized lending institutions through the data portal, to support the judicious selection of customers with a high degree of credibility and professionalism, and subsequently support the management of credit portfolios and the mitigation of associated risks. The database hinges on four electronic systems: the credit registry, credit scoring system, the automated bounced checks system and the lost and suspended checks system.

It is worth noting that, out of a long-term strategic perspective, the PMA devotes special attention to financial inclusion. Within this context, it carried through its efforts in the area of financial inclusion and banking awareness

Figure 3-5: ATM per 100 thousand adults, selected countries, 2014

32 44

4 13 7 26

61 61 74

21

126

52

18 7

77 52

40 49

020406080

100120140

Jord

an

Leba

non

Suda

n

Eygp

t

Alge

ria

Mor

occo

UAE

Qat

er

S,Ar

abia

Pale

stin

e

Isra

el

Mal

eysi

a

Indi

a

Paki

stan

Turk

ey

USA

Swed

en

Mex

icoAT

M p

er 10

0 th

ousa

n d

Palestine data represents 2015.Source: IMF database, Financial Access Survey: FAS.

Figure 3-6: ATM per 1000 square kilometer, selected countries, 2014

16.0

156.1

0.4 7.3 0.9 14.0 58.0 103.5

7.2 91.2

345.3

35.4 54.9 11.7 56.7

8.0 7.9 22.5 0

100

200

300

400

Jord

an

Leba

non

Suda

n

Eygp

t

Alge

ria

Mor

occo

UAE

Qat

er

S,Ar

abia

Pale

stin

e

Isra

el

Mal

eysi

a

Indi

a

Paki

stan

Turk

ey

USA

Swed

en

Mex

icoAT

M p

er sq

uare

d ki

lom

ete

Source: IMF database, Financial Access Survey: FAS.


over the course of 2015. Since the onset of 2014, the PMA and the Palestine Capital Market Authority (PCMA) spearheaded the establishment of the National Strategy on Financial Inclusion, in partnership with other stakeholders. During 2015, a field survey was conducted of both the supply side and the demand side across all segments of the society. This study was executed by the Palestine Economic Policy Research Institute –MAS and work is underway to create the various working sub-committees and assign the related to the preparation of the strategy. Moreover, both the Steering Committee and the Technical Committee held their meetings according to the terms of reference and tasks assigned to each.

It is worth mentioning that the Steering Committee for the Establishment of the National Strategy on Financial Inclusion in Palestine was established at the beginning of 2014 to supervise and guide all participants in the formulation of the strategy. The strategy aims to promote access to and use of financial services and products by people from different social strata in a fair and transparent manner and at affordable prices. With the financial support of the Alliance for Financial Inclusion (AFI) which has its headquarters in Malaysia, the strategy is being put into effect.

By harmonizing the efforts of all stakeholders, this strategy is intended to secure access to and use of the various financial services and products by people from different social strata. Objectives include introducing the public to the importance and the modes of access and usage of financial services, thus enhancing the capacity of individuals to improve their social and economic situation and achieve social and financial stability. With the collaboration of the various stakeholders, the strategy seeks to bridge the financial literacy gap in the best possible manner by promoting consumer protection through the formulation of policies and guidelines to acquaint current and potential consumers with their rights and obligations.

Furthermore, within the frame of its participation in the AMF-affiliated regional team for the promotion of financial inclusion in the Arab countries, the PMA prepared two working papers: one discussing the subject of requirements for the establishment of a national strategy on financial inclusion and the other discussing PMA’s experience in organizing the Child and Youth Banking Week. The former paper was adopted by the Council of Governors of the Arab Central Banks and Monetary Agencies during its meeting in Cairo in September 2015.

On a different note, in continuation of the annual banking week event, the Fourth Child and Youth Banking Week was held on March 16-21, 2015 in the WB and GS. The participants were comprised of the banks, the Ministry of Education and Higher Education (MoE), UNRWA and the Association of Banks in Palestine (ABP). During the week, employees from bank branches visited around 1,141 schools in order to reach 60,000 eight-graders, representing the targeted segment. The visits aimed at distributing around 140 thousand standard informative pamphlets that present a description of the various financial and banking services and their significance. The pamphlets aim to harness saving and investment inclinations and awareness within the target segment and answer students’ enquiries. Moreover, bank branches received young and child guests who were accompanied by their teachers and parents. Using a number

Figure 3-7: Credit information depth, selected countries, 2014-2015

7

34

1

45

6

78

44

1

45

67

0123456789

2014 2015

Pale

stin

e

Arab

wor

ld

Wor

ld

Low

inco

me

Low

mid

dle

inco

me

Hig

h m

iddl

e in

com

e

Hig

h in

com

e

Isra

el

Poin

t

Source: World Bank database, global development indicators.


of entertaining methods including “learn through play”, guests were introduced to banking operations and services offered, including ATMs, deposit and withdrawal, opening an account, advantages of the various types of accounts, in particular the savings account and to an introduction to the safety deposit box services.

Since it launched its initiative in 2012, the PMA has devoted special attention to the Banking Week, which coincides with the activities of the Global Child and Youth Week on March 16 of every year. In view of its success in promoting financial literacy and awareness of the targeted segments, the PMA is contemplating extending greater support to the event in the coming years. A day within the Banking Week will be designated as National Savings Day, during which banks will encourage saving and investment activities by the targeted segment. To this year’s activities, the PMA added the reception of a group of its employees’ children aged 10 years and above in Ramallah and Gaza, with the aim of promoting the children’s financial and banking awareness, considering they fall within the targeted segment.

• Financial efficiencyThe financial efficiency indicator for financial institutions, measured using the the spread (difference) between lending and deposit interest rate[27], dropped slightly during 2015 as the margin rose by about 0.09 percentage points to reach 6.79 percent from 6.7 percent in the previous year.

The interest margin (interest spread) for Palestine is considered relatively high when compared with some of the countries worldwide. During 2015, in Jordan, for example, the interest margin recorded 5.0 percent, in Egypt 4.7 percent, in Lebanon 1.1 percent. This can be attributed to the generally heightened degree of risk surrounding the banking and economic environment in Palestine, owing to the pronounced impact of political and security conditions. However, the efforts to introduce measures that improve the efficiency of financial brokerage in Palestine persist, as do efforts to lower the margin between lending and deposit rates in order to boost the banking sector attractiveness and hence the role of banks in economic activity and growth, hence promote financial stability in general.

An analysis of the remaining financial efficiency indicators like profitability and non-interest income will appear in Chapter Five on Financial Soundness Indicators.

• Financial stabilityThe financial stability indicator for financial institutions measured by bank capital adequacy ratio (the ratio of regulatory capital to risk-weighted assets) showed a slight drop by 0.9 percentage point to reach 18.0 percent in the year 2015. Yet, the ratio remained higher than the minimum limits designated by the Basel Committee of 8 percent and the limits designated by the PMA set at 12 percent.

[27] Because of multi-currency lending and depositing and subsequently the differences in associated interest rates, the margin was calculated based on a compound interest rate index for each of loans and deposits using a currency –weighted formula.

Figure 3-8: Interest rate margin, selected countries, 2014-2015

6.3

4.8

4.5

1.4 3.

1

3.6

6.7

2.7

1.5

5.1

2.5

6.3

4.7

5.0

1.1

2.8

2.8

6.8

2.8

1.5

6.5

2.7

0

2

4

6

8

2014 2015

Alge

ria

Eygp

t

Jord

an

Leba

non

Om

an

Qat

er

Pale

stin

e

Mex

ico

Mal

eysi

a

Russ

ia

Cana

da

perc

ent

Source: IMF database, IFS.


Other financial stability indicators, in relation to liquidity ratios or to asset quality ratios like the ratio of NPLs to total loans, showed improvement when compared to the previous year. NPLs to total loans receded to 2.1 percent from 2.5 percent in 2014. This ratio is considered low when compared to some countries, such as Algeria with 9.4 percent; Lebanon with 4.2 percent; India with 5.9 percent and Turkey with 3 percent in 2015.

Financial marketsThe second component of the financial system characteristics matrix, namely the financial market, showed an improvement in all the dimensions except the dimension of financial efficiency. Following is a detailed account of the development in the four dimensions of the characteristics matrix of the financial market:

• Financial depthThe financial depth indicator for Palestine stock market (PEX), measured using the World Bank methodology by the ratio of market capitalization (market value of listed stocks plus outstanding domestic private debt securities[28]) to GDP, showed an improvement in the year 2015 by 0.6 percentage points increasing from 25.1 percent in 2014 to 25.7 percent in 2015.

Despite this pickup, the indicator of financial depth in Palestine is considered modest when compared to other countries worldwide. This indicator recorded 55.8 percent for the Arab World, 55.7 percent for lower middle-income countries, to which Palestine belongs, and 65.6 percent for Israel in 2014. This drop in the PEX financial depth indicator can be attributed to the limited number of listed companies as well as the low volumes of company capital in comparison with capital of companies listed in global stock markets.

[28] Private securities in the Palestine Exchange are solely comprised of the Palestine Commercial Bank bonds with a value of USD 10 million. The bonds were issued on July 14, 2014, with a nominal value of USD 1000, at an interest rate of 6.5 percent. The bonds are held to maturity for five years from the issue date.

Figure 3-9: NPLs, selected countries, 2014-2015

9.2

4.0

1.1

2.5 2.9 4.

3

3.0

2.7

0.5 1.2

9.4

4.2

1.2

2.1 3.

3

5.9

2.5 3.

0

0.5 1.2

0

2

4

6

8

10

2014 2015

Alge

ria

Leba

non

S,Ar

abia

Pale

stin

e

Braz

il

Indi

a

Mex

ico

Turk

ey

Swed

en

Cana

da

perc

ent

Source: IMF database, IFS.

Figure 3-10: Characteristics of Palestinian financial market, 2014-2015

25.122.8

1113

25.7 23.5

9.8 10.1

0

10

20

302014 2015

Financial depth Financialinclusion

Financialeffeciency

Financialvolatility

perc

ent

Source: PCMA database.

Figure 3-11: Stock exchange depth, selected countries 2014

25.7

55.8 52.4 55.7 56.7

108.0

65.6

0

20

40

60

80

100

120

Pale

stin

e

Arab

wor

ld

MEN

A

Low

mid

dle

inco

me

Hig

h m

iddl

e in

com

e

Hig

h in

com

e

Isra

el

perc

ent

Palestine data for 2015.Source: World Bank, global development indicators (recent data available only for 2014).


• Financial inclusion The degree of financial access and inclusion in stock exchanges depends on the levels of concentration and hegemony. The higher the level of concentration and hegemony of a few number of companies in the stock exchange, the more difficult the access for new or smaller firms. This curtails the ability of small companies to access the financial market and make use of the stock exchange services.

Within this context, the financial inclusion indicator, measured by percent of market capitalization outside of top 10 largest companies, registered an improvement of 0.7 percentage point, rising from 22.8 percent to 23.5 percent by end of 2015. This reflects a drop in the concentration and hegemony levels in the stock exchange, and a relative improvement in the significance and value of other companies (excluding the top 10 largest companies). It also signals an improvement in financial access and inclusion in PEX, and consequently, positive consequences for small or new companies to the stock exchange.

In comparison with global financial markets and based on most recent data available from the World Bank database for the development of global financial systems in 2013, it can be noticed that the indicator for Palestine is relatively low at 21.5 percent, as this indicator registered 33.6 percent for developing Middle Eastern countries; 54.8 percent for lower middle-income countries to which Palestine belongs whereas the global average recorded 49.6 percent and in Israel 49.3 percent. This signals a persistently high degree of concentration in comparison with other countries worldwide, requiring additional efforts to promote financial inclusion in the Palestine Stock Exchange.

• Financial efficiencyFinancial efficiency is approximated using the turnover ratio expressed as turnover for a certain period/market capitalization. An increase in this ratio is an indication of an increase in the volume and number of transactions in the stock exchange, and subsequently an increase in liquidity. An increased volume of transactions signals a higher degree of transparency and clarity with regards to stock prices and the manner in which they change, raising the content and quality of information on pricing and ultimately leading to higher financial market efficiency.

Within this context, the financial efficiency indicator for Palestine Exchange recorded a decline of 1.5 percentage points, dropping from 11.1 percent in 2014 to 9.6 percent in 2015.

Figure 3-12: Financial inclusion in the stock exchange, selected countries 2013

0

10

20

30

40

50

60

21.5

33.6

54.846.5 49.8 49.6 49.3

Pale

stin

e

MEN

A

Low

mid

dle

inco

me

Hig

h m

iddl

e in

com

e

Hig

h in

com

e

Wor

ld

Isra

el

perc

ent

Palestine data from PEX for 2015.Source: World Bank, global development indicators (recent data available only for 2013).

Figure 3-13: Efficiency of the stock exchange, selected countries, 2014-2015

9.6 57.4 47.9 39.1

344.8

128.4 162.9

23.1 0

50

100

150

200

250

300

350

400

2014 2015

Pale

stin

e

Arab

wor

ld

MEN

A

Low

mid

dle

inco

me

Hig

h m

iddl

e in

com

e

Hig

h in

com

e

Wor

ld

Isra

el

perc

ent

Palestine data from PCMA for 2015.Source: World Bank, global development indicators (recent data available only for 2014).


In comparison with the financial efficiency indicator for global financial markets, the corresponding indicator for Palestine is relatively low, as the indicator recorded 57.4 percent in the Arab World; 39.1 percent for lower middle-income countries to which Palestine belongs; 162.9 percent globally and 23.1 percent in Israel. This decline in financial efficiency indicator can be attributed to several factors including the limited size of the market, the limited number listed companies, the modest size of the national economy in general and the unstable political and economic conditions. In addition, PEX is prone to instabilities experienced by a number of global financial markets, in particular neighboring ones.

• Financial stabilityFinancial stability is measured, according to the World Bank methodology, using a key indicator which reflects market volatility based on the stability/fluctuation of the financial market earnings. A high value for this indicator is associated with instability and high degree of fluctuation of market earnings, reflecting an overall instability of the financial market conditions due to several economic and political reasons.

During the year 2015, the PEX indicator picked up by 2.9 percentage points, as the volatility level dropped from 13.0 percent in 2014 to 10.1 percent in 2015, influenced by the measures and ceaseless effort made by PEX to make strides forwards. In consequence, the PEX indicator was the only Arab stock exchange indicator to record growth, as opposed to a drop in the performance indicators of all the remaining Arab financial markets. In addition, a number of incentivizing resolutions were published in 2015. One example, as will become clear in Chapter Six of this report, was the government’s decision to freeze taxes imposed on capital profits and dividends, which enabled listed companies to distribute satisfactory cash dividends to shareholders.

In comparing the financial stability indicator for PEX with that for other countries, it can be noticed that the indicator in Palestine displays satisfactory results, being somewhat greater than in developing Middle Eastern countries (7.8 percent), whereas that indicator recorded 9.4 percent for lower middle-income countries, to which Palestine belongs, 15.2 percent globally and 14.0 percent in Israel.

Figure 3-14: Volatility of PEX (market rate of return), 2011-2015

9.9 7.9 8.6

13.0

10.1

0

2

4

6

8

10

12

14

2011

2012

2013

2014

2015

Perc

ent

Source: Bloomberg.

Figure 3-15: Market rate of return volatility, selected countries, 2013

8.6 7.8 9.4

16.2 14.0 16.1

15.2 14.0

02468

1012141618

Pale

stin

e

MEN

A

Low

inco

me

Low

mid

dle

inco

me

hig

h m

iddl

ein

com

e

Hig

h in

com

e

Wor

ld

Isra

el

perc

ent

Palestine data from PCMA for 2015.Source: World Bank, global development indicators (recent data available only for 2014).

Chapter Four: Banking Sector Exposure 35

OverviewThe Palestinian banking sector operates amidst a high-risk environment, coming under the influence of a host of endogenous and exogenous factors that can give rise to numerous shocks and cause significant fluctuation in the performance of various economic activities and sectors. Like other economic sectors, the Palestinian banking sector is not immune to these challenges and risks imposed by the constantly changing nature of the economic environment. These risks may be transmitted to the banking sector through several channels that influence its different financing and investment activities, as well as its assets, key indicators and the soundness of depositors’ funds and possibly undermine the stability of the sector as a whole. This chapter reviews and analyses the various risks that surrounded the Palestinian banking sector over the course of 2015, the main transmission channels and the potential effects on key banking sector indicators.

Exposures to local sectors

Public sector (government) Developments in public finances affect banking sector stability, both directly and indirectly, through three channels, which have varying degrees of risk associated to each. These channels are: (1) direct credit granted to the government, its growth potentials and constraints; (2) credit granted to public employees and associated risks; (3) accumulated arrears for the private sector and its relation to credit granted to this sector. Following is an analysis of these channels and their associated risks:

• Credit granted to governmentDirect credit granted to the government represents one of the most important inherent risk to financial stability. This is so because the banking sector is exposed to the effects of the crises of the Palestinian budget, given the prevailing uncertainties concerning the fiscal sustainability, the limited local resources and the reliance of the budget on the items of clearance revenues and foreign grants to cover expenditure; particularly that the government has no control over both these items. In addition, other crises affecting the expenditure side may arise due to security developments and related compulsory expenses.

Credit granted by banks to the Palestinian government affects two main accounts: overdrawn government bank accounts (termed as net domestic financing), which reflect government short-term finance needs, and domestic debt account, which constitutes approximately half of the public debt. Regarding net domestic financing, data point to a

Chapter FourBanking Sector Exposure


persistent dependence of the government on this kind of credit to manage its monthly budgetary needs. The government uses these facilities to face the monthly fluctuation in its domestic revenues, in particular the clearance revenue. Shortage in domestic revenues leads to a build-up of government bank overdraft accounts, which, in turn, depletes the surpluses realized in the overall balance after grants and thwarts any chance of curbing domestic debt balance and accumulated arrears. In 2015, the government used all surplus realized in the overall balance after grants, which totalled NIS 342 million, or the equivalent of about USD 87 million, in the repayment of its bank overdraft account.

As for the domestic debt balance, analysis of domestic public debt suggests three risks that can potentially threaten the stability of the banking sector; firstly, the increasingly rising government dependence over the years on domestic sources to overcome financing shortages; particularly so in the past year. In this context, estimated data (calculated on the basis of neutralized impact of dollar/shekel exchange rates) [29]point to an increase in credit granted by the banks to the government by about 17.1 percent compared to a drop by about 21.7 percent during the previous year.

The second risk relates to both financing uniformity and financing stability. Data show fluctuation in government demand for credit, characteristic of continuous confusion and absence of necessary planning that inflict on the budget, as well as the absence of planning necessary to meet the requirements of solvency and debt sustanability.

[29] Having offset the effect of currency exchange rate, the growth rate for facilities granted to government was calculated as follows: • Computing the growth rate of facilities granted to the government denominated in USD based on data from banks as published on the official PMA website.• Computing the relative change in the exchange rate by end of each time-period (reaching by end of 2014 around NIS 3.889 per USD as opposed to NIS 3.902

per USD end of 2015).• The growth rate of facilities granted to the government after neutralizing the effect of exchange rates= growth rate of facilities granted to the government

denominated in USD ± relative change in exchange rate at the end of each period. It is worth mentioning that the impact of dollar/shekel exchange rate is regarded as one of determinants of growth of government debt. Most of domestic debt, in addition to overdrawn bank accounts, is in Israeli shekel (about 70 percent of domestic debt). Subsequently, any increase in the rate of US dollar against the Israeli shekel will diminish US dollar-denominated value of this debt and vice versa.

Figure 4-1: Government loans growth rates, 2011-2015

30-

20-

10-

0

10

20

30

40

2011 2012 2013

2014

2015

Growth after neutralizing FX effects Doll-denominated growth

perc

ent


Figure 4-2: Loans granted to goverment, 2011-2015

0

1,000

2,000

3,000

4,000

5,000

2011

2012

2013

2014

2015

USD

mill

ion

Government Other sectorsSource: PMA database.

Figure 4-3: Relative importance of the government loans, 2011-2015

30.9

33.4

30.6

25.3

24.9

69.1

66.6

69.4

74.7

75.1

0

20

40

60

80

100

2011 2012 2013 2014 2015Government Other sectors

Perc

ent



The third risk relates to concentration of credit granted to the government, which constituted during the last year 24.9 percent of total facilities granted to all economic sectors by end of 2015.

Despite the absence of evidence of competition (Crowding out) so far, the continuous borrowing of the government, given the structural imperfections of the budget, may lead to competition with the private sector for bank credit, on the medium and long run. Such a competition can adversely affect not only financial stability, but also the entire economic performance. Public and private sector competition raises interest rates and thwarts investment (one of local demand’s most important components) and subsequently growth rates.

On the other hand, despite the swelling in credit granted to the government in 2015, it continues to fall below the ceiling of bank ownership equity, as this is considered the maximum limit possible for bank facilities extended to the government, particularly that exceeding this ceiling is associated with heightened risks to the banking sector. As such and based on this criterion, the PMA has, on more than one occasion, issued alerts advising the government to address the fiscal crisis and related liquidity shortages away from the banking system, as that may compromise financial stability and public confidence in the banking sector. The PMA’s approach succeeded in pushing down credit granted to the government to levels below the maximum permissible limit, as government credit to bank ownership equity dropped from 111.7 percent in 2012 to 100.9 percent in 2013, ultimately reaching 84.6 percent in 2014, thereby mitigating bank risk exposure to government credit. However, during 2015, government credit rose again to 99.2 percent of ownership equity owing to the government’s financial distress, particularly in the first quarter of the year following the suspension of the transfer of clearance revenues by the Israeli side to the government. As a result, bank exposure to government credit deepened.

• Credit granted to public employeesExposure to credit granted to public employees relates directly to the developments in public finances, being a source of risks that can endanger the soundness of the banking sector. In this context, data analysis shows a rise in credit extended to this segment of employees to about USD 1,022.8 million, or the equivalent to 17.6 percent of total credit facilities and 23.5 percent of facilities granted to the resident private sector by end of 2015, compared to about USD 885.6 million in 2014, or the equivalent to 18.1 percent of total credit facilities and 24.4 percent of facilities

Figure 4-4: Government loans as a percent of banks' equity, 2011-2015

92.8

111.7

100.

9

84.6

99.2

0

20

40

60

80

100

120

2011 2012 2013 2014 2015

Perc

ent


Figure 4-5: Loans granted to civil servant employees, 2013-2015

23.7

24.4

23.5

53.0

71.5

70.3

0

20

40

60

80

2013 2014 2015

Percent of resident rpivate sector Percent of government loans

Perc

ent



granted to the resident private sector. This sum represents 58.1 percent and 46.6 percent of the total wages and salaries bill for the years 2014 and 2015, respectively.

Despite the many advantages and benefits culminating from facilities granted to civil servants, relating to multiple aspects of economic and social indicators, the failure of the government to meet its obligations towards its employees bounces back in the form of civil servant inability to meet their obligations towards banks, leading ultimately to rising default rates. In turn, this creates another kind of dormant risk that endangers financial stability.

In spite of the fact that default levels relating to this kind of credit are currently extremely low and do not pose a real threat to Palestinian financial stability, the PMA, however, continues to closely monitor this kind of credit, especially that its impact is not solely restricted to exceptional instances related to political developments and consequences of clearance revenues detention and decline in foreign grants. Data reveal that the payroll cash deficit in 2015 reached about USD 151.8 million, equivalent to a full-month’s bill, compared to about USD 153.2 million in 2014. Taking into account the possibility of government non-payment of salaries to its employees, whether terminally or over a period of several months, the aforementioned factor is regarded more dangerous than the suspension by Israel of transfers of clearance revenues or the termination of foreign grants by donors.

• Credit granted to private sector companies contracted by the governmentAnother channel of inherent threat to financial stability is the credit default by private sector companies and companies who are suppliers or contractors to the government, especially that the regular government payment to private sector suppliers is mainly dependent on available liquidity. Such a risk takes one of two forms. Firstly, creditor private companies exert pressures on the government forcing it to borrow from banks in order to meet (at least partially) its outstanding arrears and sustain its operational activities. Secondly, government inability to pay can undermine the financial positions of private sector companies supplying government, which forces these companies to borrow from banks to settle payments related to their businesses. The end result is a vicious financing cycle encompassing banks and both the private and public sectors. For banks, debt collection hinges on the supplier outstanding payments being paid by the government, which in turn depends on the government having sufficient funds to pay.

Driven by the aforementioned threats, the PMA follows up closely the developments in public finances, in particular regarding liquidity shortages and related implications on the banking system. On the other hand, it follows up and monitors theses risks through stress testing conducted on regualer basis to measure bank capacity to withstand such pressures (see Chapter Seven of this Report). Results reveal that the ratio of banks’ capital to their risk-weighted assets remains higher than the minimum limit set by the PMA (12 percent) and by the Basel Committee (8 percent), as elaborated earlier.

Figure 4-6: Government arrears accumulation, 2011-201545

.6

52.0 60

.9

70.9

70.3

37.6

53.7

63.5 75

.1

79.4

0

20

40

60

80

100

2011 2012 2013 2014 2015

Percent of local gevernment debt Percent of other sector debt

Perc

ent



Private sectorThe private sector credit portfolio registered an increase by 19.6 percent by end of 2015 over the previous year. Consequently, the portfolio’s relative importance rose to 75.1 percent of total credit portfolio, compared to 74.7 percent in the previous year. Total facilities granted to the private sector amounted to about USD 4,372.2 million, constituting about 34.7 percent of total bank assets and 34.5 percent of nominal GDP by end of 2015

Data reveal an increase by 31.1 percent in facilities granted to the private sector by the local banks against 5.6 percent increase for the foreign banks. In general, these changes have culminated in a significant discrepancies between local and foreign banks in the ratios of credit granted to the public and private sectors, as the average credit granted to the private sector (as percent of total credit) by local banks rose to about 78.2 percent, while that ratio fell to 71.0 percent for foreign banks, compared with 74.3 percent and 75.2 percent by end of 2014, respectively. As such, local banks have become more exposed to risks of private sector credit than foreign banks, whereas foreign banks are more exposed to risks of credit granted to the public sector than local banks, for the same period.

Credit granted to the private sector includes credit granted to companies; individuals who are not public employees and credit extended through credit cards, and additionally, to a limited extent, to non-profit institutions serving households and dormant overdraft accounts. Hence, risks associated with private sector credit vary according to the segment to which credit is extended. Risks associated with credit granted to companies are linked predominantly with economic developments, the level of economic activity and the impact of political conditions, whereas risks associated with personal credit are predominantly linked to economic conditions in general and the related impact on the individual’s ability to meet the obligations of payments due. It also depends on the stability and steadiness in disbursing salaries to employees, especially that credit extended to public employees constituted about 42.4 percent of all personal credit by end of 2015.

In general, loans granted to the private sector were predominantly personal loans. By the end of 2015, loans granted to resident individuals[30] totaled approximately USD 2,414.2 million, rising by 22.0 percent compared to the previous year

[30] These loans include mortgage loans, vehicle loans, educational loans and other consumption loans, which are granted against various collaterals to mitigate potential risks.

Figure 4-7: Loans granted to private sector, 2011-2015

26.2

27.8

27.8 30

.9 34.7

23.4 24

.7

24.9 28

.7

34.5

0

10

20

30

40

2011 2012 2013 2014 2015

Percent of total assets Percent of GDP

Perc

ent


Table 4-1: Loans granted to private and public sectors, 2011-2015 (Percent)

Bank Beneficiary 2011 2012 2013 2014 2015 Average

Local Private sector 69.3 67.9 69.1 74.3 78.2 71.8

Public sector 30.7 32.1 30.9 25.7 21.8 28.2

Foreign Private sector 68.7 65.2 69.6 75.2 71.0 69.9

Public sector 31.3 34.8 30.4 24.8 29.0 30.1

TotalPrivate sector 69.0 66.5 69.3 74.7 75.1 70.9

Public sector 31.0 33.5 30.7 25.3 24.9 29.1



and comprising 55.5 percent of total credit granted to the resident private sector compared with 54.5 in the previous year. Local banks financed the major part of this increase (33.3 percent) in the form of credit granted to individuals, constituting about 40.6 percent of these banks’ credit portfolio; a signal of growing interest in personal credit. In the meantime, foreign banks financed 10.4 percent of credit granted to individuals, constituting 42.6 percent of these banks’ credit portfolio by end of 2015. As such in 2015, local and foreign banks have become almost equally exposed to the risks associated with credit granted to individuals.

Concurrently, credit granted to resident companies reached about USD 1,821.2 million, rising by 17.5 percent over the previous year, to constitute about 41.8 percent of total credit granted to the resident private sector compared with 42.7 percent in the previous year. Credit financed by local banks increased by 29.7 percent compared to the previous year, as opposed to a rise by 1.5 percent in credit granted to companies by foreign banks, over the same period. Credit granted to companies includes investment loans and short-term loans (overdraft facilities). Investment loans acquired three quarters of the credit portfolio granted to companies, while the rest was acquired by overdraft facilities[31]. Generally, the relative importance of credit granted to companies for local banks increased as opposed to a decline for foreign banks. As such, the relative importance for local bank increased from 33.3 percent of total credit granted to the resident private sector in 2014 to 34.5 percent in 2015. Conversely, the relative importance for foreign banks fell from 29.8 percent to 27.0 percent, over the same period. This indicates growing risks associated with this kind of credit to local banks, as opposed to a decline in such risks to foreign banks.

Given its limited size within the banking sector, credit extended through credit cards (personal or corporate) does not pose a significant risk to financial stability. Credit through credit cards reached USD 63.1 million, representing about 1.5 percent of total credit granted by banks to resident private sector by end of 2015. It is worth mentioning that the larger part of this credit is extended by local banks amounting to USD 51.7 million.

Similarly, credit granted to non-profit organizations and dormant overdraft is generally modest acquiring about 0.5 percent and 0.7 percent of total credit portfolio granted to the private sector, respectively. Consequently, it does not pose a real threat to financial stability.

In spite of this expansion in credit it receives, the private sector continues to suffer from a gap in available financing (credit gap[32]), which is regarded as an early warning indicator to diagnose potential risks of banking crises. The credit gap indicator is primarily intended to protect banks against unjustifiable expansion in lending and the risks likely [31] It is worth mentioning that overdraft facilities entail higher risks than loans. For this reason, the PMA imposes specific supervisory controls, most important of which is setting a bank’s maximum permissible limit for overdraft balance to total credit at 30 percent. Overdrafts granted to the government and public sector institutions are excluded from the overdraft value for the purpose of calculating this ratio. Likewise, overdrafts granted with cash guarantee are also excluded.[32] The credit gap is defined as the difference between the private credit-to-GDP ratio and its long-term trend (over past periods of time). For further details on the computation methodology and definition of credit gap, check the following: Bank of International Settlements, “Guidance for National Authorities Operating the Countercyclical Capital Buffer”, Basel Committee on Banking Supervision, December 2010.

Table 4-2: Loans granted to resident private sector by beneficiary, 2011-2015

(Percent)

Beneficiary 2011 2012 2013 2014 2015

Corporate 42.9 37.3 39.9 42.7 41.8

Personal 52.6 58.8 56.7 54.5 55.5

Credit cards 1.6 1.6 1.5 1.4 1.5

Non-profit institutions 1.0 0.6 0.5 0.4 0.5

Inactive overdraft 1.9 1.7 1.4 1.0 0.7

Total 100.0 100.0 100.0 100.0 100.0



to arise as a result of non-payment and other credit risks. It also aims at protecting the banking system against any future losses that are likely to occur as a result of over-borrowing and related risks.

It is worth mentioning that the computation of the credit gap is dependent on a group of factors; most important of which is the availability of long time-series of data, the calculation method of average credit to GDP ratio on the long-run and its susceptibility to economic shocks, in addition to measurement errors. In this context, analysis for 2015 showed that the performances of the national economy, in general, and of the banking sector, in specific, were affected by a number of political developments. The year commenced with the suspension by Israel of the transfers of clearance revenues to government coffers and concluded with the popular unrest “Al-Quds Intifada”. As a result, economic and political uncertainty prevailed leading to greater risks to the Palestinian economy. These developments led to the deterioration in economic performance during 2015 by about 0.3 percent (nominal growth rate) compared with 2014[33]. Contrarily, credit facilities extended to the private sector witnessed an increase over the same period by about 19.6 percent to constitute 34.5 percent of nominal GDP and about 60.3 percent of customer deposits by end of 2015. Rather than being met with a similar increase in nominal GDP, this growth in facilities was met with a decline, which is indicative of the fact that these facilities (or the larger portion of them) were directed towards service sectors or non-productive sectors. Subsequently, it is necessary to assess the risks to the Palestinian economy in general and the banking system in specific through the computation of the credit gap.

In this context, data show a swelling in private sector credit gap during 2015, which exceeded 6 percent during the second, third and fourth quarters of 2015 and about 3.4 percent during the first quarter of the same year, compared with 1.6 percent during the fourth quarter of 2014. This ratio is much higher than that designated by the requirements of Basel III at 2 percent. Conversely, it must be noted that this pronounced expansion started off from a modest base, especially that the economy’s financial depth indicators (facilities granted to the private sector as percent of GDP) are regarded as low in comparison with countries worldwide, having reached 34.5 percent by the end of 2015. On the other hand, this expansion came as a result of a series of measures taken by the PMA to promote and reinforce the banking system infrastructure, including the launch of the national strategy on financial inclusion, the national switch, the anticipated amendment of the Banking Law to better meet the needs of SMEs and the issue of the circular on responsible lending which contributes to regulating consumption loans and facilitating investment loans. Yet, from another and third perspective, this expansion points to a credit boom associated with flexible lending criteria, over-borrowing and asset bubbles, especially that it coincided with a decline in economic activity during 2015.

The correlation between the credit gap and real growth rate hinges upon a number of factors, most importantly the size of the credit gap and the economic and financial crises faced by relevant economies. The correlation is negative when the credit gap is small and when no measures are implemented to alleviate the impact of shocks. Similarly,

[33] It is worth noting that the real growth rate for 2015 was about 3.5 percent compared to a decline of about 0.2 percent in 2014.

Figure 4-8: Credit gap of the Palestinian private sector, 2004-2015

-15-

10-

5-

0

5

10

15

20

8-

6-

4-

2-

0

2

4

6

8

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

Q1

Q4

Q3

Q2

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Credit gap Real growth rate (right axis)

Perc

ent

Perc

ent



it is negative for periods that follow economic and financial crises. For remaining cases, the relationship is either positive, or non-existent[34].

In the case of Palestine, available data show a weak but negative correlation between the credit gap and real growth rate (correlation factor equal to -0.203). This is attributed, as illustrated in Figure (4-8) to the modest size of the credit gap in addition to the multiple economic and political crises that have impacted the Palestinian economy, namely the suspension of the transfers of clearance revenues at the onset of the year and the popular uprising and associated political and economic instabilities at the end of that same year.

Mortgage and housing sectorThe year 2015 witnessed an increase in loans granted to the mortgage and housing sector[35] by 30.1 percent over the previous year to reach about USD 1,081.0 million, representing about 18.8 percent of total credit granted by banks operating in Palestine, compared with 16.8 percent in the previous year. The portion of loans used from total real estate loans portfolio was about 79.6 percent compared with 82.7 percent in 2014.

Analysis of the mortgage and housing loan portfolio on the basis of bank nationality shows that both local and foreign banks have contributed to this credit rise, albeit to varying degrees. The share of local banks in the rise in real estate credit portfolio was 45.0 percent as opposed to 27.5 percent for foreign banks. Consequently, the contribution of local banks to real-estate financing rose from 32.0 percent in 2014 to 34.9 percent in 2015, whereas the contribution of foreign banks dropped from 68.0 percent to 65.1 percent over the same comparison period.

Concerning risks associated with housing and mortgage loans, despite the swelling in the real-estate loan portfolio during 2015, the ratio of non-performing loans (NPLs) to total used loans

Table 4-3: Credit granted to mortgage sector, 2012-2015 (Value in USD million)

Bank Years

Credit portfolio Non-performing loans

Number of loans

Value of loans Used loans Number of

loansValue of

loans

As a percent of used

Loans (%)

Local

2012 7,508 234.0 175.6 116 6.0 3.4

2013 7,475 263.0 190.5 87 3.8 2.0

2014 7,286 273.1 203.0 198 5.7 2.8

2015 8,264 382.5 291.5 140 3.9 1.3

Foreign

2012 5,218 367.9 316.7 62 8.1 2.6

2013 5,725 387.0 337.0 43 5.5 1.6

2014 5,837 419.0 345.8 53 9.3 2.7

2015 9,050 714.5 582.1 89 6.5 1.1

Total

2012 12,728 601.8 492.3 178 14.1 2.9

2013 13,200 650.0 527.5 130 9.3 1.8

2014 13,123 692.1 548.8 251 12.0 2.2

2015 17,314 1,097.0 873.5 229 10.3 1.2


[34] Drehmann M. and Tsatsaronis K. “The credit to GDP gap and countercyclical capital buffers: questions and answers”. BIS quarterly Review, March 2014.[35] These include all loans for construction and real estate purposes, for example building or refurbishing property for residence, or commercial and investment property, and land for private ownership or investment purposes.


dropped from 1.5 percent in 2014 to 1.2 percent in 2015 for all the banks, local and foreign alike. For local banks, the default ratio fell from 1.7 percent in 2014 to 1.3 in 2015, while dropping for foreign banks from 1.4 percent to 1.1 percent over the same period. Yet, local banks remain more susceptible to credit risks of the mortgage and housing sector than foreign banks.

Credit extended to the Palestinian mortgage sector as percent of total credit, equal to 11.2 percent, is significantly lower than the percentage in some neighboring countries, like Jordan where the ratio recorded around 23 percent, or Israel where it recorded 47.9 percent end-2014. It is, nonetheless, close to figures in some other countries like Turkey, with 10.1 percent, India with 13.2 percent, and Indonesia recording 15 percent end of 2014.

In general, the default ratio for housing and mortgage loans portfolio remained comparatively low and did not pose a significant threat to financial stability. This can be attributed to the supervisory and prudential measures implemented by the PMA, which played a pivotal role in mitigating risks associated with this loan portfolio, especially following the issuance of Instructions No. (2/2014). These instructions regulate lending for the housing and mortgages sector based on the dynamic loan to the real-estate appraised value (dynamic LTV Ratio), which played a role in mitigating credit risks by linking loan conditions, namely the term of the loan and the loan to the real-estate appraised value (LTV Ratio), to the credit score granted to a customer following an accurate analysis of his/her credit behaviour. Such a measure encourages borrowers to conform to the contractual terms of the loan, since a compliant borrower is more likely to attain a higher LTV ratio and a longer term of the loan. Indeed, a loan can be as high as 85 percent of the appraised real-estate value and for a period as long as 25 years, pursuant to certain requirements specified by the instructions. Moreover, such instructions encourage customers with low credit scores to meet their outstanding obligations to upgrade their scores and subsequently improve the chances of getting a loan.

SMEs sectorBy end 2015, the credit portfolio granted to SMEs by banks and specialized lending institutions saw a hike by 17.4 percent over the previous year to USD 1,072.5 million, distributed between credit granted by the banks, accounting for 92.7 percent of total SME credit portfolio and equal to USD 994.7 million, and credit granted by specialized lending institutions accounting for 7.3 percent and equal to USD 77.8 million.

It is noteworthy that the credit portfolio extended by the banks to SMEs rose by 15.9 percent, compared to the end of 2014, to constitute 17.1 percent of total facilities granted by the banks by end of that year. This is indicative of the growing interest of the banks in this vital sector, especially following the launch of PMA’s SME database which incorporates comprehensive information on SME debt finance portfolios. The launch came as part of PMA efforts streamline activities in the SMEs sector, on one hand, and to support and enhance its abilities to access sources of financing, on the other, owing its economic significance and given that the banks are its key financier.

Figure 4-9: NPLs in mortegage sector, 2012-2015

3.4

2.6

2.9

2.0

1.6

1.8

1.7

1.4

1.5

1.3

1.1

1.2

0

1

2

3

42012 2013 2014 2015

Local banks Foreigh banks All banks

Perc

ent

Source: IMF database, PMA database, and Central Bank of Jordan database.


Table 4-4: Outstanding credits to SMEs by activity, 2013-2015 (Value in USD million)

SectorOutstanding loans

NPLs

2014 2015

2013 2014 2015 Number value Number valueConstructions 39.5 92.9 121.1 97 11.5 104 11.8Commerce 293.4 433.7 476.3 572 39.9 652 28.4Industry 40.6 116.9 133.9 154 13.9 139 15.7Agriculture 18.0 215.5 19.6 55 1.2 61 1.7Public administrations 45.1 100.3 109.2 82 3.7 143 6.0Public sector 3.4 5.7 10.4 13 0.1 18 0.4Financial sector 2.9 17.7 14.2 11 1.1 12 2.6Personal & consumption 32.3 74.2 105.0 310 18.3 198 11.2Tourism 16.3 11.1 4.9 8 1.6 7 1.3Total 491.5 857.9 994.7 1,302 91.4 1,334 79.2


Despite the growth in their portfolio, credit granted to SMEs did not exceed 7.8 percent of GDP in Palestine in 2015, compared to 6.7 percent in 2014. This demonstrates the modest size of facilities granted to SMEs by banks, despite the fact that the main part of economic activity in Palestine depends primarily on this type of enterprises. The conservative bank credit policies with respect to SME reflect the poor quality of collaterals provided by SMEs and the heightened risks associated with SME lending in general, especially given current economic conditions in Palestine.

Within this context, analysis of credit risks associated with SME loan portfolio shows that, during 2015, non-performing loans (NPLs) dropped by about 13.3 percent in comparison to the previous year to USD 79.2 million, or the equivalent of 8.0 percent of total outstanding facilities for SMEs, compared to 10.6 percent in 2014. Despite the fact that the rate of default in this sector constitutes about 1.4 percent of total facilities granted by banks in 2015, compared with 1.9 percent in 2014, it however constitutes about 63.5 percent of non-performing bank credit which amounted to USD 124.8 million by end of 2015, compared with 73.2 percent in 2014. This is indicative of the fact that credit risks associated with SMEs are indeed significant when analyzing credit risks at the aggregate level for banks. Therefore, they must be monitored and any related changes tracked, specifically at the levels of activities and sectors.

Analysis of SME defaulters by sector shows variations in NPLs from year to the other and from one sector to the other, while continuing to concentrate within certain sectors, especially within the trade sector. Default was dominant in the trade sector registering 35.9 percent compared with 43.7 percent in 2014, followed by the industry sector with 19.9 percent compared with 15.2 percent, the construction sector with 14.9 percent compared with 12.6 percent, personal and consumer loans sector with 14.1 percent compared with 20.0 percent and services and public facilities

Figure 4-10: Sectoral distribution of SMEs defaulters, 2014-2015

0

10

20

30

40

502014 2015

Cons

truc

tion

Com

mer

ce

Indu

stry

Agric

ultu

re

Serv

ices

Cons

umpt

ion

Tour

ism

Oth

ers



sector with 6.7 percent compared with 4.1 percent, over the same comparison period for all. Payment default in the remaining sectors remained less severs.

Exposures to external sectors

Non-residentsCredit granted by banks operating in Palestine is heavily directed towards resident sectors in the local economy. These sectors’ average share of total facilities granted over the period (2011–2015) was 98.9 percent as opposed to an average 1.1 percent for non-resident sectors, over the same period. During 2015, the credit portfolio granted to residents constituted 99.6 percent of total credit portfolio as opposed to 0.4 percent for non-residents.

To a large extent, this also applies to the nationality of the lending bank. Facilities granted by local banks to non-residents during 2015 amounted to about USD 12.0 million, marking an 82.8 percent rise in comparison with 2014 and constituting a mere 0.5 percent of the total credit portfolio of local banks. On the other side, facilities granted to non-residents by foreign banks amounted to USD 7.2 million, marking a drop by 58.6 percent compared with 2014 and constituting 0.4 percent of foreign banks’ total credit portfolio. This is indicative of the greater degree of exposure facing local banks as compared with foreign banks, with respect non-resident sectors.

In general, the degree of risk associated with facilities granted to non-residents is regarded as limited and insignificant, and does not represent a source of concern to financial stability in Palestine, particularly that supervisory measures govern and control the mechanism of granting facilities to non-residents. Foremost among these measures is the stipulation, according to Instructions No (5/2008), that such 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.

Interest ratesDespite the fact that it has advocated a policy of non-intervention with respect to the determining of interest rates (floating interest rates), allowing the rates to move with the markets as dictated by the bank’s internal policy and inter-bank competition, the PMA nevertheless follows up and monitors developments in lending and deposit rates, at banking system level. Within this context, analysis of credit and debit interest rates over the course of 2015 reveals that the interest rate spread (margin) has picked up compared to 2014. For the Jordanian dinar, the interest rate spread dropped from 6.95 percent to 6.85 percent and for the Israeli shekel from 9.5 percent to 8.61 percent, whereas for the US dollar, the interest rate spread swelled from 5.58 percent to 5.84 percent. This reflects a relative improvement in the efficiency of financial intermediation in the Palestinian banking system, indicating an improvement in interbank

Table 4-5: Destribution of credit portfolio by beneficiary, 2011-2015 (Percent)

Bank Beneficiary 2011 2012 2013 2014 2015 Average

LocalResident 98.7 98.9 99.4 99.7 99.5 99.2

Nonresident 1.3 1.1 0.6 0.3 0.5 0.8

ForeignResident 99.1 98.9 99.1 99.0 99.6 99.1

Nonresident 0.9 1.1 0.9 1.0 0.4 0.9

TotalResident 97.7 98.8 99.2 99.3 99.6 98.9

Nonresident 2.3 1.2 0.8 0.7 0.4 1.1



competitiveness in light of PMA-adopted measures and policies aimed at promoting the efficiency and competitiveness of the banking system in Palestine. The numerous measures adopted concerned aspects like banking mergers and the creation of larger more competitive banking entities; geographical dispersion and financial inclusion; credit information systems which boosted the pace and competence of bank credit decisions in addition to several related policies and decisions.

However, despite the relative improvement, the interest rate spread for Palestine remains the highest in comparison with other, particularly neighbouring, countries, as previously elaborated in Chapter Three. In general, developments on the interest rates in countries issuing the currencies in circulation in the Palestinian banking system continue to pose threats to the Palestinian banking sector. In the Palestinian market, interest rates are more prone to drop than to climb, in particular in the case of deposits, because of bank hedging policies with regard to employment of surplus liquidity in these currencies in banks abroad, particularly in currency-issuing countries. At the same time, rates are more prone to rise in the case of lending.

Exchange ratesOver the course of 2015, a state of uncertainly loomed driven by the predictions over the date on which the Federal Reserve will raise the official interest rate on the US dollar and the resultant threats to investors and financial market customers. Exchange rate risks are one of the major risks which threaten the Palestinian economy, in general, and the banking system, in specific, as a result of the usage of three different currencies: the dollar, the dinar and the shekel. The changes in the exchange rate of the dollar against the shekel (and likewise the dinar against the shekel) impact the Palestinian economy and the financial system, in particular the government budget. This is so because the government budget receives international grants in foreign currencies (mostly the dollar and the euro), while the major part of its expenditure is in shekel (mainly wage and salary expenditure). Inevitably, the changes in the exchange rates will reflect on the budget deficit.

On the other hand, the value of public debt is also affected by changes in the exchange rates, especially regarding borrowing from the banking system, since most domestic debt (about 70 percent) and overdraft balances with banks is in Israeli shekel.

Similarly, exchange rate fluctuations impact the banking sector’s assets, making the management of exchange and settlement risks in all currencies more difficult. These risks deepen as fluctuations in exchange rates increase. Therefore, banks

Figure 4-11: Lending and deposit rates in Palestine, 2014-2015

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Figure 4-12: Annual change in USD exchange rate against NIS, 2011-2015

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constantly attempt to align bank assets and liabilities with the different currencies, and take prudential measures against exchange rate risks, especially that the US dollar accounted for about 39.7 percent of total bank assets by end of 2015, whereas assets in dinar accounted for about 26.8 percent and in shekel about 30.1 percent. The remaining currencies accounted for about 3.4 percent of total bank assets.

It is worth noting that, the exchange rate of the US dollar against the Israeli shekel (and likewise the dinar against the shekel) witnessed acute fluctuations in the past years, giving rise to a state of uncertainty. Despite being inclined to pick up in 2015, the dollar against shekel exchange rate recorded an average hike over the whole year of about 8.6 percent compared to 2014.

The fluctuation in exchange rates reflected on the relative significance for the currency of both credit facilities and customers’ deposits. As such, credit facilities in the dollar dropped to 50.3 percent compared to about 58.0 percent in 2014. This decline came to the advantage of the shekel, the dinar and the other currencies. Facilities in shekel rose from 29.5 percent to 34.1 percent; in the dinar from 11.9 percent to 14.8 percent and in the remaining currencies from 0.6 percent to 0.8 percent, over the same comparison period.

With respect to deposits, the relative importance of deposits in US dollar dropped from 39.7 percent in 2014 to 37.1 in 2015. This decline came to the advantage of deposits in shekel which rose from 30.8 percent to 33.5 percent, while deposits in the dinar stood at the previous year’s level of 25.7 percent and, similarly, deposits in other currencies stood at 3.8 percent, over the same comparison period.

Figure 4-13: Currency composition as a percent of banks assets in Palestine, 2011-2015

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Figure 4-14: Credit structure by currency, 2014-2015

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Figure 4-15: Deposits structure by currency, 2014-2015

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Placements abroadThe value of banks’ placements abroad[36] shrank by end of 2015 by 13.2 percent compared to the previous year to total USD 3,307.1 million, constituting around 31.5 percent of total deposits (customers’ deposits + bank deposits + PMA deposits) compared to 39.4 percent in 2014, keeping in mind that the maximum limit set by the PMA for placements abroad is 55 percent of total deposits. Thus, the relative importance of these placements dropped to about 26.3 percent of total bank assets from 32.2 percent in the previous year.

Local banks’ placements abroad constituted 35.9 percent of total placements abroad, totalling USD 1,189.2 million, representing 18.4 percent of total local banks’ assets and 21.8 percent of total local banks’ deposits. On the other hand, placements abroad for foreign banks constituted about 64.1 percent of total placements abroad totalling USD 2,117.9 million, or the equivalent of 34.7 percent of total foreign banks’ assets and about 42.1 percent of total deposits.

On one hand, these ratios signal the mounting attractiveness of deposit inveted in the local economy to local banks, which contributes to foster economic activity. This is so to a lesser degree for foreign banks which still prefer to deploy their deposits abroad. On the other hand, these ratios imply that foreign banks are more susceptible to external threats than local banks.

Various risks are associated with placements abroad, as they spread across exchange rate and interest rate risks, country risks, market and general economic instability risks. Balances placed abroad accounted for the largest share of total placements amounting to USD 2,370.6 million, representing the main contagion channel of external risks, keeping the Palestinian banking sector exposed to external banking and financial crises.

The second contagion channel is the banks’ investments abroad, which mainly takes the form of different securities and comprise 27.1 percent with a value of USD 895.5 million. This channel reflects the risks and fluctuations that may face global stock exchanges and financial markets. Yet, this channel’s impact remains less hazardous than that of the first channel, as this kind of investment requires prior PMA approval and is restricted to investments that have high credit ratings, while taking into account the degree of concentration per institution and per country, pursuant to Instructions No. (5/2008, clause 5/7).

The third contagion channel is the channel of credit extended outside Palestine, comprising about 1.2 percent of total placements and amount to USD 41.0 million. This is a generally modest percentage that does not pose any grave threat to financial stability, especially in light of PMA-imposed controls on credit granting outside Palestine, which requires PMA pre-approval.

[36] According to PMA instructions No. 5/2008, article 5/7, placements abroad are defined as “cash balances deposited with banking financial institutions outside Palestine, in addition to investments, whether in financial markets or as facilities granted to be deployed abroad and include certificates of deposit, bonds issued by foreign governments or institutions, investment in stocks of foreign companies, foreign investment funds and syndicated loans and any other facilities extended for the purpose of investment outside Palestine”.

Figure 4-16: Placements abroad as a percent of total deposits, 2011-2015

43.5

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In general, historical data on placements abroad point to a gradual downturn, and subsequently a decrease in the exposure degree of the Palestinian banking sector to external risks, as opposed to an upturn in the exposure degree to local risks, especially that the decline in placements abroad was accompanied by a rise domestic credit. This rise was a result of PMA policies advocated in order to reinforce the interconnections between the banking sector and the local economy. On the grounds of this policy, credit facilities as percent of customers’ deposits followed an upward trend to reach 60.3 percent by end of 2015, while placements abroad as percent of total deposits fell to 31.5 during the comparison period.

Figure 4-17: Placements abroad and credit facilities, 2011-2015

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Palcements abroad Credit portfolio


Chapter Five: Financial Soundness Indicators 51

OverviewThe PMA employs a set of diverse macro-prudential tools[37] to help determine the level of financial soundness and the likely risks that may threaten the Palestinian banking system. The financial soundness indicators, (FSIs) both core and encouraged, are regarded as the most prominent tools used in macro-prudential analysis and assessment of financial stability. According to the IMF methodology, these indicators are divided into four sub-groups: capital adequacy indicators, asset quality indicators, liquidity indicators, and earning and profitability indicators. The PMA gives particular attention to these indicators, which are calculated on regular basis. In light of the judicious policies and regulations implemented by the PMA, analysis of banking sector FSIs showed positive results in general. Yet, the banking sector remains extremely vulnerable to risks and external shocks like the rest of the Palestinian economic sectors. This chapter presents an analysis of these indicators of the Palestinian banking sector during 2015, in order to assess its soundness and robustness and identify some of the risks that surround it and, subsequently, adopt the appropriate respective measures.

Capital adequacy indicators

The PMA dedicated special attention to strengthening the solvency and capital adequacy of banks operating in Palestine by raising bank capital (being the first line of defense), so that banks are able to better absorb losses and withstand expected and unexpected risks. This becomes especially crucial in light of growing presence of risk-generating circumstances and supporting factors within the external and internal environment. Concurrently, PMA aims to boost bank competitiveness, both locally and abroad.

Within this context, PMA issued Instructions No. (6/2015) concerning capital requirements, reserves and shareholders’ equity. These instructions clarify bank capital requirements and stipulate that paid-up capital allotted to engage in banking in Palestine should not fall below USD 75 million. The instructions also specify additional capital requirements; foreign bank requirements and the capital adequacy ratio, which should not drop below 12 percent[38]. Moreover, the instructions define owner’s equity and related terms and conditions and outline the structure of the reserve requirements to be allocated by banks as legal reserves, risk reserves and countercyclical reserves. The instructions also prescribe tighter restrictions on dividend distributions, the issuance of debt instruments and investment including controls on the creation or acquisition of subsidiary company/companies or real estate.

[37] Comprised of tolerance test and financial soundness indicators, among others.[38] According to these instructions, capital adequacy ratio of a local bank which has banking presence abroad in the form of a representative office must not fall below 12 percent; in the form of offices and branches not less than 15 percent and in the form of a subsidiary banking entity not less than 18 percent. In the event a bank decides to conduct leasing business through creating a subsidiary it must observe a capital adequacy ratio not less than 14 percent.

Chapter FiveFinancial Soundness Indicators


It is worth mentioning within this context, the PMA plans to raise bank capital to reach USD 100 million in the future, with the objective to further reinforce banking and financial stability in Palestine and boost bank competitiveness[39].

The year 2015 witnessed a shrinkage in bank paid-up capital by 1.5 percent, compared with 2014, to USD 961.3 million[40], which resulted in a drop in relative importance of paid-up capital on the structure of equity and structure of liabilities to about 65.8 percent and 7.6 percent from 66.7 percent and 8.3 percent in 2014 respectively. However, this modest decline did not have a considerable impact on the ability of the banks to cope with expected and unexpected risks. The most prominent indicators that measure the capital risk include:

Regulatory capital to risk-weighted assets (capital adequacy ratio)This ratio is considered one of the most salient indicators of financial stability in the financial system characteristics matrix. By end 2015, the capital adequacy ratio (CAR) was 18.0 percent in Palestine measured for all banks combined, compared with 18.9 percent by the end of 2014. This slight drop is attributed to a rise in risk weighted assets that outpaced the growth in capital base; the former having increased by 10.1 percent and the latter by 4.8 percent compared to the previous year.

Despite this marginal decline, the capital adequacy ratio remained above the minimum limit set by the Basel Committee at 8 percent and by the PMA at 12 percent.

Comparing CAR in Palestine with similar ratios for other countries, Palestine’s position is relatively comfortable, given that CAR in Egypt recorded 13.7 percent, in Algeria 17.0 percent, in Turkey 15.6 percent and in Israel 14.0 percent, by end of 2015. In Jordan, CAR recorded about 18.5 percent, by end of June 2015.

At the level of the nationality of banks operating in Palestine, analysis reveals a persistent disparity in capital adequacy ratios between local banks and foreign banks. This disparity is indicative of disparate utilization of available funds by each group of banks, which subsequently leads to a disparity in risk-weighted assets and capital base between local and foreign banks. By end 2015, capital adequacy ratio for local banks was 15.4 percent, as opposed to 21.4 percent for foreign banks. It can also be well observed that the aforementioned gap between the two bank

[39] It is worth mentioning that paid –up capital for two of the banks operating in Palestine has surpassed USD 100 million, since the year 2014. [40] The drop in capital came on the grounds of the conclusion of a strategic partnership agreement signed in February 2015 between The National Bank (TNB), which is a local bank, and Union Bank , a Jordan-based bank, by which TNB acquired the assets and liabilities of Union Bank in Palestine, while Union Bank became its strategic partner owning 10 percent of the paid-up capital.

Figure 5-1: Capital adequacy ratio in Palestine, 2011-2015

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Figure 5-2: Capital adequacy ratio, selected countries, 2015

18.1

1512.7

1718 18.5

13.715.6

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Source: IMF database.


groups is constantly widening as relative weight for high-risk assets that fall within a risk weighting category of 70 percent is greater for local banks than for their foreign counterparts. This category of high-risk assets includes supervised credit facilities, non-performing loans in addition to the value of fixed assets.

Core capital to total assetsThe ratio of core capital to total assets shows the extent to which a bank’s core capital covers its total assets. This is considered a financial leverage ratio which, according Basel III recommendations, must equal to or exceed 3 percent.

For the banks operating in Palestine, this ratio registered 9.5 percent by end of 2015 for all banks combined, compared with 10.1 percent by end of the previous year. With respect to bank nationality, this ratio for local banks was 9.3 percent compared to 9.7 percent in the previous year, whereas, for foreign banks, it was 9.7 percent compared to 10.5 percent from the same period. The ratio of capital to total assets is higher than the limit set by the Basel instructions, for both individual banks and the banks combined.

Asset quality indicators

The significance of the assessment of asset quality emanates from its direct relation to the credit risks that arise due to the customer’s inability to fully meet obligations (interest or loan principal or both) on time, which may cause financial loss that adversely affects bank revenues and capital. Asset quality can be inferred from a set of indicators, most notably the following:

Irregular (nonperforming) loans to total loansThis ratio is regarded as a one of the most significant asset quality indicators which reflect the direction of risk degrees assigned to a credit portfolio, especially that the direction of this ratio unfolds in close harmony with economic and political developments in general. Despite the various economic developments that occurred during 2015, this ratio continued to follow a downward trend, falling from 2.5 percent in 2014 down to 2.1 percent in 2015. This drop in the ratio of NPLs was accompanied by a persistent growth over the year in total facilities by 19.0 percent. The drop was experienced by both local and foreign

Figure 5-3: Core capital to total assets, 2011-2015

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Figure 5-4: NPLs to total Loans, 2011-2015

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banks, with irregular loans to total loans dropping from 2.1 percent in 2014 down to 1.6 percent in 2015 for local banks and from 3.1 percent to 2.8 percent for foreign banks, over the same period.

The ratio of NPLs to total loans in Palestine is regarded as low when compared to other countries around the world, as was previously mentioned in Chapter Three. This low value is a reflection of the high competence with which the credit-decision is being made, especially in view of the implementation of risk-based effective bank supervision and the steady development of the credit information system established by the PMA, which played a significant role in lowering credit risks and improving credit portfolio quality.

In a related context, structural analysis of NPLs, based on default time periods, shows the subdued relative importance of substandard facilities[41] to total non-performing facilities, which dropped from 10.5 percent in 2014 to 9.1 percent in 2015. In fact, this ratio increased for local banks from 16.7 percent to 16.8 percent, while decrease for foreign banks from 5.1 percent to 3.4 percent. Meanwhile, doubtful facilities dropped from 8.4 percent to 8.3 percent; rising for local banks from 11.8 percent to 15.6 percent and dropping for foreign banks from 5.6 percent to 2.9 percent. Conversely, facilities classified as losses increased from 81.1 percent to 82.6 percent by end of 2015, falling for local banks from 71.4 percent down to 67.7 percent and rising for foreign banks from 89.2 percent to 93.7 percent.

Non-performing loans (NPLs) less provisions to capitalThe ratio of irregular loans after provisions to capital reflects the ability of capital to face up credit risks. This ratio improved in 2015 by dropping from 4.0 percent in 2014 to 3.4 percent in 2015. However, this ratio revealed a disparity at the level of nationality for banks operating in Palestine, albeit inclined to follow a downward trend for both alike. By end of 2015, this ratio for local banks was 4.6 percent compared to 5.9 percent in the previous year and for foreign banks 2.1 percent compared with 2.3 percent over the same period.

[41] Pursuant to PMA instruction No. (1/2008) facilities which are 91 to 180 days overdue are classified as substandard facilities and require provisions of 20 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 and facilities overdue by more than 360 days are classified as losses and require provisions of 100 percent of their value.

Figure 5-5: Structure of NPLs in local and foreign banks, 2011-2015

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LossesDoubtfulSubstandard

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Figure 5-6: NPLs (less provisions) as a percent of capital, 2011-2015

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Coverage of non-performing loans (NPLs) The ratio shows the extent to which NOLs are covered by provisions. A rise in this ratio is a sign of the enhanced capacity of banks to withstand and cover credit risks; hence establishing a higher degree of financial stability. Analysis of consolidated data for all banks operating in Palestine points to an increase in the ratio of coverage of NPLs from 61.4 percent by end of 2014 to 67.3 percent by end of 2015. This increase signals a relative pick-up in the capacity of banks to face potential losses in the credit facilities portfolio. From a bank nationality perspective, this ratio increased for local banks from 40.5 percent in 2014 to 47.5 percent in 2015 and for foreign banks from 84.9 percent to 119.7 percent, over the same period.

Sectoral distribution of loansThis indicator reflects the degree of concentration in facilities granted to various sectors. A high volume of facilities granted to a particular sector increases the risk degree to which the banking sector is exposed, as the ability to repay loans is linked to both economic developments and the unforeseen fluctuations and changes experienced by that specific sector.

In general, the credit distribution by economic sector in Palestine points to the absence of concentration of facilities within a specific sector, with the exception of the public sector which accounted for about 25.0 percent of total facilities granted as compared with 25.3 percent in 2014. Concentration ratios in the remaining sectors continued to fall below 20 percent of total facilities as required by related PMA instructions[42].

Analysis of sectoral concentration ratios shows that the productive sectors combined acquired 24.4 percent of the total credit portfolio in 2015 (with agriculture acquiring 1.3 percent, industry 4.5 percent and construction including land development 18.6 percent) compared with 23.2 percent in 2014. As for service sectors, combined they acquired about 75.6 percent compared with 76.8 percent in the previous year. At the forefront came consumption goods financing with 18.7 percent of total credit portfolio compared with 18.8 percent by end of 2014, followed by general trade sector which acquired 16.2 percent compared

[42] According to PMA Instructions No. (5/2008) dated 29 December 2008, article 5/6/1, the ratio of granted (outstanding) credit to any economic sector must not exceed 20 percent of total granted (outstanding) credit.

Figure 5-7: Provision coverage for bad loans, 2011-2015

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Figure 5-8: Sectoral concentration of credits, 2013-2015

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with 15.2 percent; financial services and public services around 6.9 percent compared to 7.6 percent and vehicle purchase financing about 3.4 percent for the second consecutive year. All remaining services sectors acquired 5.4 percent compared with 6.5 percent of the total credit portfolio by end of 2014.

However, the credit channel continues to be susceptible to the substantial impact placed by security and political circumstances current in Palestine upon the entire economic activity and the implication thereof on the current investment climate, as apparent for example during the first and last quarters of 2015. Despite the fact that this did not have pronounced adverse effects on the quality of the credit portfolio, it however pushed banks to observe greater caution and prudence. While non-performing facilities continued to hover around the level of USD 124.8 million for 2014 and 2015, (equivalent to 2.1 percent of total facilities in 2015 and 2.5 percent in 2014), yet banks increased the provisions for non-performing facilities to cover around 67.3 percent of facilities, compared with 61.4 percent by end of 2014.

Earning and profitability indicators

During 2015, net income (before tax) for banks operating in Palestine recorded a decline by 9.7 percent over the previous year, to USD 177.1 million. The decline was seen despite an increase by 3.9 percent in net interest income, equal to USD 13.9 million, owing to the marked rise in credit by 19.0 percent and a 4.0 percent increase in net non-interest income (equal to USD 5.3 million) in the same period. Net non-interest income distributed between net income realized from foreign exchange transaction fees and currency valuation fees totaling USD 5.2 million; commission[43] with USD 4.3 million; securities with USD 1.1 million; extra-budgetary transactions with USD 0.4 million as opposed to a drop in other operating income by about USD 5.7 million.

Furthermore, total expenditure registered an upsurge by 12.9 percent compared to the previous year to USD 334.8 million, influenced by an increase in operational expenditure by USD 25.8 percent, equivalent to an 8.8 percent rise, and an increase in provisions by USD 12.4 million equivalent to a 9.8 percent rise over the previous year to USD 14.5 million.

The decline in net income affected earning and profitability indicators negatively. These indicators measure the ability of a bank to realize profit and are suggestive of a bank’s capacity to effectively manage and utilize the resources at its disposal. The most important earning and profitability indicators are the following:

Return on average assets (ROA)By end of 2015, the ROA for banks operating in Palestine registered a decline to around 1.5 percent from 1.7 percent in the previous year. Yet, this ratio remains superior to other countries, like Jordan for example which registered 1.4 percent by end of June 2015; Egypt with 1.3 percent and Israel with 1 percent by end of 2015.

This ratio receded for both local and foreign banks, dropping for local banks from 1.6 percent in 2014 to 1.3 percent in 2015 and for foreign banks from 1.8 percent to 1.7 percent over the same period.

[43] These include commissions charged on loans, overdraft accounts, extra-budgetary items and fees charged on accounts, in addition to any other type of commission.

Figure 5-9: Return on average assets (ROA), 2011-2015

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Return on average equity (ROE)ROE dropped for all banks operating in Palestine from 17.2 percent in 2014 to 15.0 percent in 2015. Nonetheless, this ratio remains superior to ratio recorded in other countries, as for example in Jordan where it recorded 11.1 percent (by end of June 2015) and 14.4 percent in Israel. At the same time, this ratio is lower in Palestine than in other countries like Egypt which recorded a ratio of 18.9 percent by the end of 2015.

However, results for ROE were not similar for local and foreign banks. Analysis shows that ROAE increased for local banks from 16.6 percent in 2014 to about 17.1 percent in 2015, whereas it decreased for foreign banks from 17.4 percent to about 13.1 percent over the same period.

Net interest income (interest margin) to gross incomeNet interest income to gross income for all banks operating in Palestine in 2015 fell back, albeit slightly, from 72.7 percent in 2014 to 72.2 percent in 2015, dispite the increase in net non-interest income by 4 percent and in net interest income by 3.9 percent. This ratio remains satisfactory when compared to some countries, as it scored 74.6 in Jordan (by end of June 2015) and in Israel 56.5 percent by end of 2015.

The decrease in net income was driven by foreign banks, were this ratio increased from 76.1 percent in 2014 to 75.6 percent, while increasing for local banks from 69 percent to 69.2 percent.

Non-interest expenses to gross incomeNon-interest expenses to gross income indicator increased from 60.1 percent in 2014 to 63.0 percent in 2015. This rise is attributed to the growth in operational expenses by 8.8 percent compared to the previous year to about USD 320.3 million. At the level of bank nationality, non-interest expenses to gross income increased for local banks from about 63.1 percent in 2014 to 63.8 percent in 2015 and for foreign banks from about 57.3 percent to 62.1 percent over the same period.

Figure 5-10: Return on average equity (ROE), 2011-2015

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Figure 5-11: Net interest income to total income, 2011-2015

71.7 72.4 74.9 72.7 72.2

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Liquidity indicators

Liquidity indicators reflect a bank’s ability to meet expected and unexpected demands for financial obligations in general, or in other words the availability of sufficient cash to cover depositors’ cash withdrawals and other demands for credit, without being exposed to losses resulting from the sale of any of the bank’s assets. This requires the distribution of bank resources diversely across maturity dates, while also attuned to maturity dates of liabilities. Liquidity indicators also signal good management and an assurance of the ability of the bank to meet its obligations. The main indicators used to gauge liquidity risks are the following:

Liquid assets to total assetsAt the end of 2015, the ratio of liquid assets to total assets recorded a drop by about half a percentage point to about 35.0 percent from 35.5 percent in the previous year. This drop is attributed to a rise in fund utilization in less-liquid items such as credit granting and different “low liquidity” investments with long maturity terms (exceeding one year).

This decline is attributed to local banks, where this ratio dropped from 34.0 percent in 2014 to about 31.2 percent in 2015, as opposed to a rise in foreign banks from 36.7 percent to 38.9 percent, over the same period. These results generally suggest that local banks are more inclined to hold lower liquidity ratios than their foreign counterparts, considering that local banks outstripped foreign banks in the facilities to assets ratio.

In spite of this fallback, the ratio for Palestine is satisfactory when compared to other countries. In Saudi Arabia, for example, this ratio recorded 20.4 percent, in UAE 22.2 percent, while Turkey recorded 49.6 percent, India 9.9 percent and in USA 14.7 percent, by the end of the third quarter of 2014. In Israel, the ratio was 15.1 percent by end of the first quarter of 2015.

Liquid assets to short-term liabilities The liquid assets to short-term liabilities ratio indicates the degree of congruence between short-term bank liabilities and their liquid assets, such that a bank can meet its obligations without being exposed to liquidity crises or losses. PMA instructions require banks to maintain a minimum of 25 percent regulatory liquidity[44], which reflects positively on other liquidity ratios, keeping them in line with acceptable liquidity levels. In general, this ratio reveals a bank’s ability to cover liabilities which are susceptible to rapid withdrawal, at any time and without prior notification by these liabilities’ holders

[44] Taking into account some differences between this ratio and the ratio of regulatory liquidity.

Figure 5-12: Liquid assets to total assets, 2011-2015

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Figure 5-13: Liquid assets to short-term liabilities, 2011-2015

40

45

50

55

60

2011 2012 2013 2014 2015


Perc

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This indicator dropped during 2015 to 45.6 percent, compared with 48.3 percent in the previous year, as a result of a higher increase in liquid liabilities than in liquid assets. With respect to bank nationality, this ratio fell back for local banks to 42.8 percent from 48.3 percent in 2014, while remaining unchanged for foreign banks at 48.3 percent, for the same comparison period.

This ratio is regarded as satisfactory for Palestine, when compared with other countries, as it reached 150.6 percent in Jordan; 31.9 percent in Saudi Arabia, 30.1 percent in UAE, 66.5 percent in Turkey, 28.8 percent in India and 93.2 percent in USA, by end of the third quarter of 2014, while recording 26.5 percent by end of the first quarter in Israel.

On a different note, the year 2015 saw the resurgence of the liquidity crisis affecting banks operating in Palestine. The crisis, generated by exogenous factors, occurred as a result of the accumulation of shekel cash surpluses, pushing up the ratio of liquidity surplus in shekel to total assets of banks operating in Palestine to about 20.6 percent, compared to 10.9 percent in 2014. The difference shows how distant this ratio stands from its normal pre-crisis levels. The root cause for the crisis goes back to several measures taken by Israel (also in line with the Locker Committee recommendations to decrease the use of cash in the Israeli economy and increased cash issuance) which culminated in the accumulation of large sums in the Israeli currency within Palestine.

The accumulation of cash surpluses in the Israeli shekel represents one of the menacing challenges to financial stability, especially in the WB, as the Israeli occupation continues to reject and stall the resolution of this problem, refusing any collaboration and coordination with the PMA. Instead, the Israeli side continues to resort to threats of tightening its punitive economic measures against the Palestinian government.

Table 5-1: NIS cash shipped from Palestine to Israel, 2013-2015(NIS million)

Items 2013 2014 2015

Banks' branches operating in WB

Direct shipping from Jordanian banks 4,740.6 4,594.9 3,455.9

Shipping from bank of Palestine 4,860.3 4,400.0 5,300.0

Total NIS surplus shipped to Israel 9,600.9 8,994.9 8,755.9

Banks' branches operating in GS

Shipping NIS coins to banks' branches 4.0 1.9 5.0

Replacing unfit cash 50.0 200.0 51.0

Source: PMA.

Figure 5-14: NIS cash liquidity (dollar-denominated), 2008-2015

0

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Gaza branches West bank branches



In this context, it is worth noting that the shipment to Israel of about NIS 8.8 billion shekels was carried out in 2015. Of this sum, NIS 5.3 billion were shipped to the Bank of Israel via the Bank of Palestine, representing Palestinian banks and some Jordanian banks, while around NIS 3.5 billion were shipped directly by large Jordanian banks operating in Palestine to their Israeli correspondent banks. Moreover, NIS 51 million worth of spoilt notes were replaced and NIS 5.0 million worth in coins were allowed into the Gaza Strip.

Table 5-2: Financial soundness indicators for banks operating in Palestine, 2011-2015(percent)

Items 2011 2012 2013 2014 2015

Capital Adequacy Indicators

Regulatory capital to risk weighted assets (capital adequacy ratio) 21.1 20.3 20.0 18.9 18.0

Paid up capital to total assets 11.2 10.2 10.3 10.1 9.5

Assets Quality indicators

NPLs to total loans 2.7 3.1 2.9 2.5 2.1

NPLs (net of provisions) to capital 3.8 4.9 4.7 4.0 3.4

Provision coverage to NPLs 60.9 60.1 59.1 61.4 67.3

Return and profitability indicators

Return on average assets 1.9 1.8 1.9 1.7 1.5

Return on average capital 17.0 16.3 18.7 17.2 15.0

Interest income to total income 71.7 72.4 74.9 72.2 72.2

Non-interest income to total income 57.2 55.4 57.8 60.1 63.0Operational expenses to non-interest expenses 55.5 53.8 53.4 51.5 51.3

Liquidity indicators

Liquid assets to total assets 38.2 37.5 40.5 35.5 35.0

Liquid assets to short-term liabilities 49.2 49.3 52.4 48.3 45.6

Liquid assets to total deposits 46.9 45.8 48.1 43.2 41.0

Source: PMA.

Chapter Six: Non-Banking Financial Institutions 61

OverviewThis chapter undertakes the analysis of risks surrounding non-banking financial institutions. These institutions incorporate specialized lending institutions and money changers, supervised by the PMA, and the Palestine Exchange-PEX, insurance companies, mortgage companies and financial leasing companies, supervised by the PCMA. Over the course of 2015, they have experienced several financial and legislative developments, which were in concordance with prevailing economic conditions in Palestine. Although non-banking financial institutions are still set on a course of evolution and growth, with the exception of the Palestine Exchange which achieved remarkable progress over the past few years, it is however important to examine and monitor them, given their interrelations, whether directly or indirectly, with the Palestinian banking sector, on one hand, and considering that they constitute key components of the financial system alongside the banking sector, on the other. These institutions showed remarkable development and growth in terms of financial indicators and at the legal and supervisory levels. Moreover, they are considered a main creditor of the various economic sectors.

Money changing sector

Regulation No. (13) of 2008 on Money Changer Licensing and Supervision constitutes the legislative and legal framework that regulates the money changing activity in Palestine and provides the legal basis for the issuance of regulatory instructions to this vital economic sector. These instructions address, for example, the determination of required capital, prohibited and permissible activity, mechanisms and prerequisites to engage in the transfers business, the punitive measures in case of breach or violation of the law or the instructions. By taking appropriate and necessary measures and preventive actions, the PMA has made tangible progress in comparison with neighboring countries regarding the regulation of the money changing sector and linking it with the Palestinian economic reality, being a fundamental component of the financial system in Palestine.

In 2015, the PMA issued the Instructions No. (1/2015), which regulate the engagement of money changers with internal transfers (within Palestine), setting out relevant checks and controls. The instructions require money changers to register these transfers using the PMA-approved software; deliver the transferred amount in the same currency stated in the transfer –unless otherwise requested by the beneficiary- and provide customers with necessary documentation, taking into consideration the requirement to observe AML regulations, policies and procedures. These instructions also stipulate the requirement to publish the fees charged on these transfers in a way where they can be easily spotted, in addition to other measures.

Chapter Six Non-Banking Financial Institutions


Furthermore, the PMA concluded the compilation of the criteria used to examine applications for the transfer of money-changing companies and the compilation of the first draft of the standards for temporary closure and the change of legal form, while work in underway to duly approve them. It is worth mentioning that, in light of the decision by PMA’s board of directors to open the door to license money-changing businesses in Gaza Strip, the countryside and the refugee camps, the PMA completed the compilation of criteria to be used in the examination of licensing and branching applications.

With respect to instructions on the compliance control of money-changing companies, 46 compliance officers received approval to work in companies dealing with regular and quick transfers. On another note, approval was renewed for 20 money-changing companies offering international transfers services, while renewals were also granted to 32 companies offering quick transfers services as sub-agents and to 9 money-changing companies which offer quick

transfers services as principal agents.

Within the context of continued efforts to automate and upgrade the database on money-changing companies, the names and numbers of employees in each of these companies were incorporated, while work is underway to complete the e-licensing and monitoring of money changers project.

During 2015, the number of money changers and money-changing companies rose by 4.3 percent compared to 2014 to 292, out of which 238 are in the WB and 54 in GS. With respect to the legal form, there were 222 money-changing companies as opposed to 70 money changers (individuals engaging in currency exchange), as seven money-changers rectified their legal status from individually-run businesses to companies during 2015, whereas one company adjusted its legal form from a private shareholding company to partnership.

The increase in the number of money changing businesses reflected positively on the financial indicators of the money changing sector. Accordingly, total assets of money changers rose by around 26.3 percent, as compared to 2014, to USD 66.8 million. The sector’s capital rose by 33.2 percent to 61.8 USD million and ownership equity rose by 35.8 percent to USD 62.6 million. The sector realized a net profit of USD 579 thousand during 2015 compared with losses equal to USD 847 thousand in the previous year.

Despite these developments with respect to the financial performance of the money changing

Table 6-1: Money changers in Palestine, 2011-2015

Item 2011 2012 2013 2014 2015

Region

West bank 240 234 232 237 238

Gaza Strip 44 42 38 43 54

Legal framework

Corporate 154 173 184 199 222

Individual 130 103 86 81 70

Total 284 276 270 280 292


Table 6-2: Main financial indicators of money changers, 2011-2015

(USD million)

Item 2011 2012 2013 2014 2015

Capital 35.9 42.7 44.5 46.4 61.8

Ownership equity 36.5 48.2 46.6 46.1 62.6

Profits 1.8 1.8 0.8 -0.8 6.0

Total expenses 3.6 5.2 5.4 5.0 6.0

Current assets 35.1 46.8 47.1 49.9 62.7

Fixed assets 2.1 2.7 2.5 2.8 4.1

Total assets 37.0 49.4 49.6 52.9 66.8



sector, they remain relatively insignificant and do not pose any threat to financial stability, particularly in view of the supervisory instructions and the field inspection conducted by the PMA of money changers and money-changing companies, to ensure their commitment to the approved instructions and thereby mitigate potential risks to these businesses. Perhaps the basic vulnerabilities within the money changing sector lie in two aspects:

The first takes the form of money-changers who illegally engage in money changing activities, away from the direct supervision of the PMA, which gives them a leeway to practice activities prohibited by the PMA, such as acceptance of deposits and safe deposits. These activities may expose citizens to exploitation or to fraud and deception. The PMA seeks to reduce these risks through ongoing cooperation and coordination with the Attorney General to take legal action against operating companies for which business licenses were revoked and unlicensed money changers. Additionally, the PMA continues to follow up on previous related correspondence with the public prosecution to take legal action against unlicensed money changers, including filing lawsuits, charging of fines, imprisonment and closure of businesses.

The second lies in the risk of exploiting the money changing sector in suspicious and money-laundering operations. In that respect, the PMA took several preventive measures to limit these risks through continuous effort to promote awareness of money exchange customers to the risks of money laundering and protect them against falling victims to illegal activities. An Anti-Money Laundering Manual for Money Changers has been compiled and issued, while workshops were held for moneychangers in all governorates to introduce them to this manual. Work continued during 2015 to conduct the Palestine Anti-Money Laundering Accreditation (PAMLA) courses for compliance officers and supervisors in the field of the money changing business, in collaboration with the Palestinian Banking Institute (PBI) and PMA’s Financial Follow-up Unit.

Specialized lending institutions

The PMA carried through its efforts to organize and control conditions of specialized lending institutions, through implementing risk-based supervision and developing operation manuals and both off-site and on-site supervisory tools, consistent with the international best practices in the specialized lending business. A preliminary assessment form was developed based on CAEL off-site rating system and was provided for the use of these institutions, while work in underway to prepare a manual on on-site inspection of these institutions, in line with risk-based supervision.

With respect to strengthening governance and supervision over specialized lending institutions, an automated program for external auditor assessment was designed for use by these institutions. Work is underway to prepare relevant circulars and supervisory instructions, including instructions concerning the provision to abide with the requirement for external audit and instructions on Shari‘a–based supervision over these institutions.

Several on-site inspection visits to specialized lending institutions were conducted to ensure their commitment to observe relative regulations and instructions and work to remedy violations. Additionally, the PMA maintained communication with the Palestinian Network for Small & Microfinance (Sharakeh), which culminated in the development of two vocational high diploma programs for lending and internal audit supervisors and for risk management in specialized lending institutions, with support from international parties. Additionally, PMA helped these institutions assess the automated system and seek funding for the development a new automated program.

By end of 2015, the number of specialized lending institutions which attained PMA licensing was six companies. These are comprised of four profit companies, namely, ACAD for Development and Finance, Ibdaa for Microfinance and


Asala for Development and Lending in addition to Vitas Palestine, and two non-profit companies, namely Palestine for Credit and Development “Faten” and Reef Finance. The companies conduct their business and provide services to the public through a network of 64 branches and representative offices operated by a staff of 754 employees.

Operational data on specialized lending institutions indicate that, by end of 2015, there were about 51,589 beneficiaries who received 51,952 loans, of whom 3,346 were first-time borrowers and around 39.1 percent were female beneficiaries. The outstanding loan portfolio totaled USD 136.7 million, of which females acquired about 39.2 percent. The loans were distributed between WB and GS; the former receiving 73.3 percent and the latter 26.7 percent of total loans.

Geographically, credit granted by these companies concentrated in Nablus, Ramallah and Al Bireh and Gaza Governorates; the three combined acquiring 43.8 percent of the total loan portfolio.

The specialized lending institutions’ loan portfolio was divided into commercial and Islamic loans. Commercial loans accounted for about 78.9 percent of the total loan portfolio with a value of USD 107.8 million, whereas Islamic loans accounted for 21.1 percent of the portfolio, amounting to USD 28.9 million.

The housing sector acquired the largest share of 27.9 percent of the loan portfolio of specialized lending companies, followed by the trade sector with 24.1 percent, the agriculture sector with 14.9 percent, consumption loans with 13.1 percent and the services sector with 9.9 percent, while industry and tourism sectors acquired about 5 percent each.

Lending institutions primarily rely for financing resources on domestic and external borrowing, in addition to their own capital. However, the volume of their operations is rather small as opposed to banking operations, rendering their impact on financial stability relatively limited. By the end of 2015, the ratio of outstanding facilities to total bank facilities for specialized lending companies did not exceed 2.3 percent.

Figure 6-1: Geographical distribution of Credits granted by specialized lending institutions to SMEs by branch, 2015

0.6

14.916.5

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Dor

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Figure 6-2: Credits granted by specialized lending institutions to SMEs by type, 2015

82.378.9

17.7 21.1

0

50

100

Commercial loans Islamic loan

Perc

ent

Number of loans

Value of laons


Figure 6-3: Credits granted by specialized lending institutions by economic activities, 2015

Industry 5.0%

Housing 27.9%

Commerce24.1%

Agriculture14.9%

Consumption13.1%

Tourism 5.1% Services9.9%



Loans granted to SMEsSpecialized lending institutions provided around 32,628 loans during 2015 to finance micro, small and medium-sized enterprises (MSMEs)[45], with a total value of USD 116.7 million, marking a rise of about 29.4 percent over the previous year. These loans accounted for about 8.5 percent of total bank loans extended to SMEs, which reached USD 1,373.7 million by end of the year. As such, specialized lending institutions are regarded as key SME creditors.

The specialized lending institution extending the largest share of granted facilities was Faten, which captured 45.1 percent of the total SME portfolio, followed by the UNRWA with 12.3 percent, then ACAD for Development and Finance with 10.3 percent. The distribution of credit activity across specialized lending institutions points to a high degree of lending market concentration and to poor competitiveness between the lending institutions, which calls for the implementation of specific measures to boost competitiveness and reduce concentration; and consequently reduce the risks associated with such concentration to financial stability of the specialized lending sector, in specific, and the financial sector, in general.

On the other hand, analysis points to the acquisition of the trade sector of the largest share of total loans solely granted to SMEs by lending institutions equal to 38.7 percent, followed by the agriculture sector with 22.8 percent; public facilities and services with 17.2 percent, and industry and mining with 10.7 percent, while tourism acquired 7.0 percent and other remaining sectors (including construction, real estate, the public sector, the financial sector in addition to personal consumption loans) acquired 3.5 percent of total value of loans granted to SMEs.

Analysis of the SME loan portfolio granted by specialized lending companies for 2015 shows that SME non-performing loans (NPLs) reached USD 5.4 million, constituting around 4.6 percent of total loans granted to the SMEs. As for default in terms of economic activity for 2015, analysis showed that the highest default ratio was by the trade sector with 53.8 percent owing to the high credit concentration within that sector (equal to 38.7 percent), followed by the public facilities and services sector with 25.1 percent, the agriculture sector with 11.9 percent and, ranking fourth, was the industry sector at 7.1 percent. The severity of risks associated with each economic sector is linked to the prevalent political and economic conditions in Palestine.

[45] The information was provided by the PMA database for facilities granted to SMEs, which incorporates data on licensed specialized lending institutions in addition to data of UNRWA, the Palestinian Banking Corporation and the Establishment for the Management and Development of Orphans Funds.

Figure 6-4: Credits granted from specialized lending institutions to SMEs by instituition, 2015

Orphan fund 0.4% Palestinian bankingcorporation 9.0%

Reef6.5%

Fitas9.2%

ACAD10.3%

UNRWA12.3%

Asala7.2%

Faten 45.1%


Figure 6-5: Defaults in SMEs by sector, 2015

Commerce53.8%

Tourism 0.8% Others 1.3%

Agriculture11.9%

Services & publicutilities 25.1%

Industry 7.1%



Housing loans and mortgage Housing loans and mortgage have witnessed steady growth whether financed by banks or specialized lending institutions. Data show that, by end of 2015, the number of housing loans and mortgages granted by specialized lending institutions reached 10,241 loans totaling USD 76.5 million, which represents an increase by 19.3 percent in number and by 11.9 percent in value over the previous year. Professionals, craftsmen and merchants[46] acquired the largest share of mortgage loans by 41.6 percent, followed by public sector personnel[47] by 25.7 percent and private sector employees[48] by about 23.8 percent. Yet, borrowers employed with the private sector registered the highest default rate with 38.7 percent, whereas the default rate amongst public sector personnel was 32.6 percent and amongst professionals, craftsmen and merchants 28.2 percent.

Table 6-3: Defualts in motgage loans granted by specialized lending instituitions, 2014-2015

Item2014 2015

No. loans value of loans No. loans value of

loans

Corporates 0 0 0 0

Public entities 0 0 0 0

Persons from gov. sector 215 2,947,488 231 2,881,800

Persons from police 4 47,129 4 28,995

Persons from security 3 36,921 4 38,199

Persons from other forces 11 22,083 14 21,202

Persons from civil defense 4 29,741 4 24,741

Persons from intelligence 3 40,066 5 43,815

Persons from internal security 0 0 0 0

Persons from Private sector 265 3,728,834 291 3,615,817

Institutions and associations 0 0 0 0

Owners prosession, vactions and traders 281 2,652,841 401 2,633,690

Total 786 9,505,203 954 9,332,074Source: PMA database.

Geographically, loans granted by specialized lending companies distributed across the different governorates in varying shares. The governorate of Hebron captured the largest share with 16.4 percent of total housing and mortgage loans granted, followed by the Governorate of Nablus with 16.1 percent and the Governorate of Ramallah with 11.3 percent.

It is worth mentioning that information on borrowers from specialized lending institutions has been uploaded to the credit information database. This helped these companies reduce their credit risks and raise the competence of credit-granting decisions, reflecting positively on financial stability.

[46] Includes private sector personnel who are craftsmen professionals, merchants, doctors, engineers, lawyers, housewives or students. [47] Includes public sector employees and employees in the General Directorate of Police, Preventative Security, Civil Defense, Intelligence in addition to Palestinian National Security Forces[48] Includes private sector employees


Securities sector (Palestine Exchange-PEX)

The securities sector is a multi-party sector overseen and supervised by the Palestine Capital Market Authority (PCMA) in accordance with the Securities Law No. (12) of 2004 and the Capital Market Authority Law No. (13) of 2004. The parties comprising the sector are the following: the Palestine Exchange and the centre of depository and settlement, public-shareholding companies, securities companies which are members of PEX, financial professionals and investment funds

During 2015, the e-disclosure system was launched to streamline the disclosure process of financial statements and non-financial information by listed companies. This achievement comes as part of PEX efforts to keep up with international best practice and make use of advanced applications on disclosure used globally, as these applications instrumental in boosting the investment climate and fostering investor confidence, through raising the transparency levels of disclosure operations.

The disclosure system aims at developing the work environment and providing a transparent and fair trading environment, as well as organizing the process of financial disclosure by listed companies and streamlining the disclosure process to better serve the interests of all traders and other stakeholders including investors, analysts, auditors, listed companies and capital market regulators. It is also intended to competently implement the International Financial Reporting standards (IFRS), achieve consistency, allow comparison to meet the needs of all users of these financial statements and put an end to human error.

Table 6-4: Main indicators of Palestine Stock Exchange, 2011-2015

Item 2011 2012 2013 2014 2015

Number of member companies 10 9 8 8 8

Number of listed companies 46 48 49 48 49

Trading volume (million shares) 184.5 147.3 203.0 181.5 175.2

Traded value (USD million) 365.6 273.4 340.8 353.9 320.4

Market capitalization (USD million) 2,782.5 2,859.1 3,247.5 3,187.3 3,339.2

Value of traded shares to GDP (%) 3.74 2.66 2.85 2.77 2.53

Market capitalization to GDP (%) 27.8 27.9 27.3 25.0 26.3

Turnover ratio (%)* 12.6 9.7 10.5 11.1 9.6

Number of transactions 61,928 41,442 44,425 41,257 31,014

Number of trading sessions 248 249 241 245 246

Al-Quds index (point) 476.9 477.6 541.5 511.8 532.7

* Turnover ratio = Traded value/market capitalization.Source: PCMA database.

The Palestine Exchange is listed under most of the major world indices. Morgan Stanley and Standard and Poor’s created a standalone index for Palestine and the Financial Times (FTSE) added it to its watch list. In 2015 PEX index was removed by FTSE and added to their frontier market indices as of September 2016. In addition, the Palestinian Exchange is also engaged in training on “investor relations best practices” in collaboration with Finance Talking-UK and has executed several investor educations programs.


By the end of 2015, the number of PEX listed companies was 49 companies, after Beit-Jala Pharmaceutical Company (BJP) became a listed company. Listed companies include 8 companies operating in banking and financial services, 13 in industry and 12 in the services sector, 9 in investment, and 7 in the insurance business.

At the level of PEX developments during 2015, the Palestine Exchange held 246 exchange sessions during which 175,229,463 shares were traded, marking a drop by 3.5 percent compared to the previous year. The market value of these shares amounted to around USD 3,339.2 million, rising by approximately 4.8 percent, over the same comparison period. The shares were traded through 31,014 deals, marking a drop by 24.8 percent from 2014, with trading volume in some sessions not exceeding USD 0.5 million.

By end of 2015, the PEX Index (Al-Quds) closed at 532.7 points rising by about 20.9 percentage points, which marks a rise by 4.1 percent from the previous end-year close, as result of the rise in the indices of all sectors, with the exception of the investment and service sectors, which slumped by 6.0 percent and 1.6 percent, respectively. In contrast, the banking and financial services sector index soared by 20.0 percent, the insurance sector index increased by 4.9 percent and the industry sector index by 3.2 percent.

Despite the general political and economic instability which prevailed in Palestine during 2015, the PEX Index (Al-Quds) recorded a pickup by about 4.1 percent compared to the previous year, influenced by the government’s decision to freeze the imposition of taxes on capital profits and dividends, which enabled listed companies to distribute satisfactory cash dividends to shareholders, amounting to about USD 150 million, and additionally distribute USD 21 million worth of bonus shares.

As for trading by sector, the banking and financial services sector ranked first having captured 53.4 percent of all traded shares, equivalent to 30.3 percent of listed companies’ t o t a l m a r k e t capitalization. The investment sector c a m e s e c o n d , accounting for 28.8 percent of total number of traded shares, which were equivalent to 15.3 percent of total market capitalization. The services sector followed accounting for 11.9 percent of total number of traded shares, the equivalent of 42.2 percent of total market capitalization. The insurance sector claimed 3.6 percent of total number of traded shares, the equivalent of 3.3 percent of total market capitalization. Finally, the industry sector accounted for 2.3 percent of total number of traded shares, the equivalent of 8.9 percent of total market capitalization.

Figure 6-6: General index of Palestine Stock Exchange, 2011-2015

440

460

480

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560

2011 2012 2013 2014 2015

Poin

t


Table 6-5: Sectoral indicators of Palestine Stock Exchange, 2015

SectorMarket

capitalization (USD million)

Number of trading sessions

Traded value (USD million)

Number of trading shares (million share)

Number of listed

companies

Banking & financial services

840.5 8,099 111.6 66.6 8

Insurance 105.2 1,193 4.3 6.4 7

Investment 545.3 16,552 109.5 73.1 9

Industry 273.7 2,773 9.1 4.8 12

Service 1,422.6 12,640 119.3 30.6 12

Total 3,187.3 41,257 353.9 181.5 48

Source: PCMA.


As for trading by nationality (local versus foreign), investment was predominantly Palestinian capturing about 64.3 percent of traded shares and about 59.9 percent of the share value, whereas non-Palestinian investment captured 35.7 percent of traded shares and 40.1 percent of the share value.

In general, PEX was faced with liquidity shortage during 2015, as illustrated by trading indices. The value of traded shares during 2015 totaled USD 320.4 million, plummeting by 9.5 percent compared to the previous year. Consequently, PEX turnover rate dropped from 11.1 percent in 2014 to 9.6 percent in 2015. This figure reflects a decline in the financial efficiency indicator for the Palestine Exchange. In comparison with the financial efficiency indicator for global financial

markets, the corresponding indicator for Palestine is relatively low (as previously elaborated in Chapter Three).

Regionally, during 2015 PEX ranked first in terms of index growth, as all Arab stock markets witnessed a decline in all major indices, at varying degrees. The retreat was affected by the sharp and overwhelming decrease (by more than 50 percent) in the global price of oil. The ongoing slide in global oil prices led to a contraction of liquidity and took its toll on investor confidence and economic outlooks for these markets. Furthermore, the increase in US interest rate adversely affected the performance of financial markets in developing and emerging market economies, including the economies of Arab countries. The situation was aggravated by political tensions in the Middle East which eventually reflected on the Arab Monetary Fund’s composite index tracking the performance of all financial Arab markets which in 2015 recorded a drop of 14.1 percent over the previous year.

Insurance sector

By end of 2015, the number of licensed insurance companies was nine[49]operating through a network of 116 branches and representative offices spread across the various areas in the WB and GS. The companies manage business and offer insurance services through 1,156 employees working in company headquarters and branches. Additionally by end of the same year, supporting insurance services are offered by 206 PCMA-licensed agents and insurance producers, alongside seven insurance intermediaries and

three reinsurance intermediaries.

In 2015, most of indicators and financial activities of insurance companies retreated. Accordingly, insurance companies’ total assets dropped by 8.0

[49] During 2015, the Arab Insurance Company was closed.

Figure 6-7: Indecies of Arab Stocks Exchange, 2015

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Source: www.arab-exchanges.org .

Figure 6-8: Investments of insurance companies by type, 2014-2015

29.9

16.3

22.3

29.1

2.3

26.6

15.9

24.3

31.7

1.5

0

10

20

30

4020142015

Perc

ent

Shares Bonds Deposits Real estate Others

Source: PMCA database.


percent to USD 352.4 million, compared to a growth by 7.8 percent in 2014. Of total assets, investment constituted 50.1 percent with a value of USD 176.7 million of which 67.2 percent were domestic investments, and 32.8 percent were foreign investments. Investments were diversified across a range of investment options including real estate with 31.7 percent, followed by shares with 26.6 percent, bank deposits with 24.3 percent and investment in bonds with about 15.9 percent. Finally, the share of investment in the form of loans stakeholders was equal to 1.5 percent of total investment. Accounts receivable constituted about 17.7 percent of total assets with a value of USD 60.4 million, followed by insurance contracts which constituted 7.7 percent of assets, while cash in banks and funds constituted 3.3 percent of total assets with a value of USD 11.5 million.

Additionally, shareholder equity dropped by 8.8 percent during 2015 to USD 124.6 million, compared with USD 136.7 million in 2014, as paid-up capital plunged by 15.8 percent to total USD 58.7 million. The decline came on the grounds of the closure of an insurance company that exited the market, affecting insurance companies’ net results which realized net profit after taxes of USD 7.3 million marking a decline by about 48.2 percent compared to 2014.

Table 6- 6: Financial indicators of insurance sector, 2012-2015(Percent)

Indicator 2012 2013 2014 2015

Total insurance premiums- to-shareholder’s equity 132.8 134.4 125.1 132.3

Insurance premiums (net)-to-shareholder’s equity 111.9 118.3 109.5 116.0

Change in shareholder’s equity 13.8 10.1 14.1 8.8

Holding premiums 84.3 88.1 87.5 87.7

Total expenses-to-total assets 10.8 11.1 11.1 11.1

Reinsurer’s share of premiums 15.7 11.9 12.5 12.3

Reinsurer’s share of paid up claims 15.4 17.4 14.2 9.4

Average losses 70.5 66.6 72.6 70.9

Shareholder’s equity-to-technical provisions 67.9 67.4 80.3 75.9

Technical provisions-to-paid up claims 181.3 200.5 157.4 167.7

Technical provisions-to-liquid assets 80.3 76.9 74.8 78.6

Liabilities and equity-to-liquid assets 170.3 158.6 168.3 168.6

Average administrative cost 25.5 25.7 24.9 23.7

Return on shareholder’s equity- ROE 11.7 13.6 13.3 7.7

Return on assets- ROA 3.7 4.4 4.7 2.7

Assets-to-GDP 3.0 2.9 3.0 2.8

Investment-to-GDP 1.6 1.5 1.5 1.4

Solvency margin 199.0 169.0 181.0 169.0

Source: PCMA database.

With regard to the sector’s financial soundness indicators in 2015, total written premiums to total shareholder equity was 132.3 percent compared to 125.1 percent in 2014, while net written premiums to total shareholder’s equity equal to about 116.0 percent compared to 109.5 percent in the previous year. This ratio expresses net written premiums and the build-up of capital and reserves against these premiums, and is therefore an indication of potential risks to the insurance sector, after deducting the risks transferred to reinsurers. As such, an increase in this ratio signifies a heightened risk to capital.


Likewise the ratio of holding premiums increased by about 0.2 percentage point to 87.7 percent from around 87.5 percent in the previous year[50]. This ratio correlates positively with the degree of reliance on reinsurance. Conversely, administrative cost rate, which is a figure that reflects the competence of companies in the rationing of general expenses, also fell to 23.7 percent compared to 24.9 percent in the previous year. The sector’s loss rate (compensation/acquired or earned premiums[51]) fell by about 1.9 percentage points to reach 70.9 percent. Analysis also shows that shareholders’ equity coverage of technical provisions recorded 75.9 percent, while technical provisions covered about 167.7 percent of paid compensations during 2015.

With respect to liquidity indicators, the ratio of liabilities to liquid assets recorded 168.6 compared to 168.3 percent from in 2014. This ratio gauges the company’s ability to settle its obligations to insurance document holders in case of liquidation. Furthermore, the ratio of technical provisions to liquid assets was 78.6 percent. This ratio is a measure of the liquidity available to the company against its technical provisions.

As for profitability indicators, the return on shareholders’ equity was 7.7 percent, while the return on total assets was 2.7 percent. The financial solvency ratio for the entire sector recorded 169 percent[52] by end of 2015, compared with 181 percent in 2014. The PCMA assumes the task of computing the financial solvency margin[53] for each company separately, as this figure indicates that the insurance company is well equipped to withstand the risks associated with the inadequacy of technical reserves to counter risks including company default. In spite of dropping during 2015, the financial solvency ratio for the insurance sector continued to be higher than the minimum limit set by the PCMA at 150 percent.

With respect to financial depth indicators, which measure the effectiveness and impact of the insurance sector on the Palestinian economy as a whole, the ratio of insurance sector assets to GDP was 2.8 percent, while the sector’s investments to GDP was about 1.5 percent in 2015. These figures are regarded as modest and unsubstantial, owing to the relatively small size of the sector within the financial sector as a whole.

Mortgage sector

The mortgage sector is subject to the oversight and supervision of the PCMA. It is comprised of a primary and a secondary market. The primary market suffers from the absence of specialized mortgage financing companies, which restricts the market to banks only. While some banks rely on intrinsic sources to finance mortgage loans, others resort to refinance loans through the secondary mortgage market. The secondary market consists of two companies: the Palestine Mortgage and Housing Corporation (PMHC), which was founded as a public shareholding company in 1999, and its subsidiary the Palestinian Housing Finance Corporation.

The secondary market also suffers from limited sources of financing, as a result of the reluctance of refinancing companies to issue corporate bonds or bonds backed by real estate holdings due to the absence of a specialized law to regulate the issue of bonds backed by real estate.

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

[51] The acquired installments represent the written premiums after deducting reinsurer shares from the written premiums and deducting the value of change of effective reserves and accounting reserve.[52] Excluding Ahliea Insurance Group, which was under examination by the PCMA at the time this report was compiled.[53] The value of company assets surpassing required amounts, which allows it to meet its financial obligations fully, and pay compensations in time without exposing the company to default.


The year 2015 witnessed the exit of The Affordable Mortgage and Loan Corporation (AMAL) from the mortgage market, leaving PMHC, with its financing arm the Palestinian Housing Finance Corporation, as the sole company operating in the mortgage company, specifically in the secondary market. It should be noted that the company’s capital was reduced and its legal form changed to a private shareholding company, and therefore was delisted from the financial market. At the legal level, the year 2015 did not see any significant development of the legal environment or the Palestinian Mortgage Law, which still awaits ratification by the Palestinian Cabinet.

With respect to real-estate appraisal, and given the importance of this profession in determining the values of real-estate guarantees against which loans are granted which subsequently reduces risks to lending parties, the PCMA seeks to license qualified real estate appraisers. In that respect, PCMA in cooperation with the Palestinian Banking Institute organized a training course in real estate appraisal in order to grant licenses, in a manner that conforms to the real estate appraisal licensing instructions No. (3) of 2012.

During 2015, three new real estate appraisers obtained business licenses raising the total number of licensed real estate appraisers to 44; out of whom four reside in GS, as PCMA register showed on December 31, 2015.

Financial leasing sector

Leasing is defined as asset-based financing method used to buy fixed assets, by which the lessor (the leasing company) acquires the asset selected by the lessee from the supplier, then grants the lessee the right to exclusive possession and use (economic possession) of the leased asset for a specific period in return for specified rental or lease payments, while retaining legal ownership of that asset.

The main difference between leasing and other financing tools (credit facilities) hinges on ownership and the manner with which it is transferred. A lease agreement does not require concrete guarantees and approval terms whether with respect to a long-term credit history or a valuable asset base to be used as guarantees, since it is built on the basis that profit comes from the use of assets not their acquisition, as well as the lessee’s ability to achieve cash flows resulting from the asset’s operation. Thus leasing becomes of particular importance to small and medium-sized industrial enterprises. A feature of leasing is that it conforms to the provisions of Islamic Sharia.

The financial leasing sector is a new member of the financial market in Palestine, which, despite its young age, is positively contributing to economic growth and stability. It is a vital sector that could offer local investment opportunities and boost the Palestinian economy. The services of this sector are considered complementary to bank credit, with the potential to increase financial depth and speed up economic development, by increasing cash inflows to the productive economic sectors. In turn, this provides support to local production and improves enterprise profitability, especially for SMEs.

The predominant leasing activity is vehicle leasing, which constituted about 99 percent of the sector’s activity by end of 2015. Available data shows that the companies engaged in financial leasing numbered 11 by end of that year[54].

From the legal and legislative perspective, the issue of the Decree Law No (6) of 2014 On Financial Leasing helped establish a clear and effective legal framework that can regulate the relationship between the parties to the lease agreement. All leasing companies have managed to rectify their conditions in accordance with the provisions of this law and are all licensed and operating as independent and specialized leasing companies.

[54] Leasing companies licensed by PCMA by 2015 are: the Palestinian Leasing and finance leasing company (PalLease), the Palestinian Motor Vehicle Company (Hyundai), Ritz Leasing, Arabic Motor Vehicle Company (KIA), Mena Investment Company (Nissan), Palestinian Lease Company, Murad leasing and finance leasing Company, Lease and Go Company, Goodluck Cars Company for Car Rental, Easy Car Finance Leasing Company and White Stone for Leasing.


Nonetheless, the sector is still challenged by obstacles hindering its development like the high costs of leasing in comparison with the costs of credit facilities offered by banks, in addition to the lack of public awareness about leasing as an activity. Currently, the Financial Leasing Administration at the PCMA seeks to develop this sector so that it can efficiently contribute to economic growth in Palestine. Likewise, the PMA’s is making efforts so that leasing companies join its credit information database in order to help mitigate risks to this sector and raise the efficiency of financing decisions, which would reflect favorably on financial stability.

Chapter Seven: Financial Pressure “Stress Tests” 75

OverviewFinancial stress testing is considered an important risk management tool for banks and supervisory bodies alike and an integral part of total risk management. The PMA is keen on conducting these tolerance tests to assess the ability of banks operating in Palestine to endure different risks based on different scenarios that simulate economic and political reality in PalestineTolerance testing contribute to the strengthening of PMA ability to formulate suitable prudential policies that enable banks to overcome various risks that appear under these scenarios in the event any comes true. The PMA advocated the performance of these tests as part of its efforts to maintain financial stability. In spite of the stress test results, revealed divergent results corresponding to the severity of presumed shocks and the number of factors for each shock, yet the results demonstrated that the banking system that was in general adequately robust to survive shocks, and capital and reserves held with the banks able to absorb the repercussions of these shocks.

Stress tolerance tests

Since 2011, the PMA began to conduct stress testing of the overall banking system and every bank individually, on regular basis. For that purpose, the PMA issued in 2014 instructions on stress testing elaborating the sound stress testing practices and policies that banks should observe while conducting stress tolerance tests. The instructions identified two types of tests, to be conducted twice each fiscal year: the single variable test and the multi variables tests. The PMA must be provided with the results of the two types of tests[55].

Tolerance stress tests are conducted in accordance with the scenarios and shocks specified in PMA instructions concerning the impact on the ratio of Tier 1 Capital to risk-weighted assets (Tier1 Capital/RWA). This ratio must not fall below 4 percent as per Basel II requirements; and not below 6 percent as per Basel III requirements and not below 8 percent as per PMA effective instructions.

Results of financial stress testing conducted by the PMA at the level of the banking sector revealed generally favorable results under the various scenarios, for single and multiple variables testing alike. Following is the analysis of the test results according to the number of factors associated with each of the potential shocks.

[55] For further information check Instructions No (10/2014) published on 5 November 2014 or the 2014 Financial Stability Report.

Chapter SevenFinancial Pressure “Stress Tests”


Tabl

e 7-

1: Po

tent

ial s

hock

s in

sing

le-v

aria

ble

stre

ss te

sts,

Dec

. 201

5

1. Si

ngle

Sh

ocks

Shoc

k D

etai

ls

Num

ber o

f Ban

ks w

ith

CAR

Tota

l*

(T1 C

apit

al/

RWA)

< 4

%

4% ≤

(T1

Capi

tal/

RWA)

< 6

%

6% ≤

(T1

Capi

tal/

RWA)

< 8

%

(T1 C

apit

al/

RWA)

≤ 8

%

Pre-

Shoc

k Po

siti

on0

00

1414

Und

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api-

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edAd

equa

tely

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pita

lized

Wel

l-Cap

i-ta

lized

#Po

st-S

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Pos

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1 Cap

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/RW

A) <

ص

4%

4% ≤

(T1

Capi

tal/

RWA)

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%

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Capi

tal/

RWA)

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%

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apit

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data

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.


Test results in case of a single-variable Financial stress testing was conducted for licensed banks assuming single-variable shocks take place, and in accordance with the percentages of likelihood of occurrence as shown in (Table 7-1). The tests showed different results for single-variable shocks for the ratio of Tier 1 Capital to risk-weighted assets (Tier1 Capital/RWA) of banks as follows:

Comparative tolerance testing results for the banks at the level of 4 percent of Tier 1 Capital/ RWA, as per Basel II:

Results showed that the majority of licensed banks passed the tests and were able to attain a ratio greater than 4 percent of Tier1 capital/RWA, as per Basel II requirements, in case they faced any of the shocks outlined in the table, with the exception of few banks which failed in tests simulating four shocks, as follows:

• Faltering of a financial institution with which the banks holds more than 10 percent of its total balances utilized abroad: Results showed that the ratio of Tier1/RWA dropped below 4 percent for two banks.

• Increase in special provisions by 50 percent of private sector net outstanding facilities for housing and mortgage sector: Results showed that the ratio of Tier1/RWA dropped below 4 percent for three banks.

• Increase in special provisions by 50 percent of private sector net outstanding facilities for the trade sector: Results showed that the ratio of Tier1/RWA dropped below 4 percent for two banks.

• Increase in special provisions by 50 percent of private sector net outstanding facilities for the consumption loans sector: Results showed that the ratio of Tier1/RWA dropped below 4 percent for one bank.

Comparative tolerance testing results for the banks at 6 percent Tier 1 Capital/ RWA, as per Basel III:

Results showed that the majority of licensed banks passed the tests and were able to attain a ratio greater than 6 percent of Tier1 capital/RWA, as per Basel III requirements since 2015, in case they faced any of the shocks outlined in the table, with the exception of few banks which failed in tests simulating five shocks, as follows:

• Increase in special provisions by of the government outstanding facilities: Results showed that the ratio of Tier1/RWA dropped below 6 percent for one bank.

• Faltering of a financial institution with which the banks holds more than 10 percent of its total balances utilized abroad: Results showed that the ratio of Tier1/RWA dropped below 6 percent for two banks.

• Increase in special provisions by 100 percent of net outstanding facilities of the bank’s five largest borrowers, excluding government facilities: Results showed that the ratio of Tier1/RWA dropped below 6 percent for one bank.

• Increase in special provisions by 25 percent of private sector net outstanding facilities for housing and mortgage sector: Results showed that the ratio of Tier1/RWA dropped below 6 percent for one bank.

• Increase in special provisions by 50 percent of private sector net outstanding facilities for the trade sector: Results showed that the ratio of Tier1/RWA dropped below 6 percent for one bank.

• Despite dropping below 6 percent in case of experiencing one of the above-mentioned shocks, the Tier1/RWA ratio remains for the banks above 4 percent, as per Basel II requirements.

Comparative tolerance testing results for the banks at level of 8 percent Tier 1 Capital/ RWA, as per PMA instructions:

Results showed that the majority of licensed banks passed the tests and were able to attain a ratio greater than 8 percent of Tier1 capital/RWA, as per effective PMA instructions in case they faced any of the shocks outlined in the table, with the exception of few banks which failed in tests simulating six shocks, as follows:


• Increase in special provisions by 25 percent and 35 percent of the government’s outstanding facilities: Results showed that the ratio of Tier1/RWA dropped below 8 percent for one bank under both scenarios; 25 percent and 35 percent.

• Increase in special provisions by 35 percent of the public sector employees net outstanding facilities: Results showed that the ratio of Tier1/RWA dropped below 8 percent for one bank.

• Increase in special provisions by 100 percent of net outstanding facilities of the bank’s largest three and five borrowers, excluding government facilities: Results showed that the ratio of Tier1/RWA dropped below 8 percent for one bank under the three borrowers scenario, and for four banks under the five borrowers scenario.

• Increase in special provisions by 25 percent of private sector net outstanding facilities for housing and mortgage sector: Results showed that the ratio of Tier1/RWA dropped below 8 percent for one bank.

• Increase in special provisions by 25 percent and 50 percent of private sector net outstanding facilities for trade sector: Results showed that the ratio of Tier1/RWA dropped below 8 percent for two banks under the 25 percent scenario and one bank under the 50 percent scenario.

• Increase in special provisions by 50 percent of private sector net outstanding facilities for consumption loans sector: Results showed that the ratio of Tier1/RWA dropped below 8 percent for two banks

• Despite dropping below 8 percent in case of experiencing one of the six above-mentioned shocks, the Tier1/RWA ratio remains above 6 percent, as per Basel III requirements.

Based on the aforementioned result, it is clear that the banks in general have shown an ability to withstand single-variable shocks, as the number of banks which failed the test and recorded the ratio of Tier1/RWA below 8 percent as per PMA instructions ranged between one bank and five banks. This means that failure rate in tolerance tests reached 35.7 percent of the total number of banks, under the worst drawn scenario Increase in special provisions by 100 percent of net outstanding facilities of the bank’s largest five borrowers, excluding government facilities.

Test results in case of a multiple-variables Financial stress testing was conducted for licensed banks assuming the occurrence of two major shocks, and taking two scenarios for each into account: a mild level of stress and a severe level of stress. Results shown in (Table 7-2) demonstrate the ability of banks in general to absorb shocks, as the majority of banks maintained the Tier1/RWA ratio above the minimum limit set by the Basel requirements (not less than 4 percent by Basel II requirements, and not less than 6 percent by the Basel II requirements starting from 2015). However, banks demonstrated a lesser ability to maintain Tier1/RWA ratio above the minimum limit set by PMA instructions at 8 percent. Following is a review of these results:

Table 7-2: Potential shocks in multi-variable stress tests, D

ec. 2015

2. Multiple Shocks

Shock Details

(T1 Capital/RWA) < 4%

4% ≤ (T1 Capital/RW

A) < 6%

Num

ber of Banks with CAR

Total*6%

≤ (T1 Capital/

RWA) < 8%

(T1 Capital/RW

A) ≤ 8%

Pre-Shock Position0

00

1414

Under-capi-

talizedAdequately- Capitalized

Well-Capi-talized

Post-Shock Position(T1 Capital/RW

A) < 4%

4% ≤ (T1

Capital/RW

A) < 6%

6% ≤ (T1

Capital/RW

A) < 8%

(T1 Capital/RW

A) ≤ 8%Total

4.a.1

Increase in provision by … from

the PA’s outstanding facilities. .10%

00

014

14


the PNA em

ployees net outstand-ing facilities.

5%

Increase in provision by …of the private sector outstanding net

facilities for the purpose of financing government projects and

activities.5%


facilities (excluding the net outstanding facilities for PNA em

ploy-ees , and private sector outstanding facilities for the purpose of financing governm

ent projects and activities).

3%

Decrease the price of investm

ents in Palestine (stocks and bonds)15%

4.a.2



11

57

14


the PNA em


15%



activities.10%





5%




Table 7-2: Potential shocks in multi-variable stress tests, D

ec. 2015

2. Multiple Shocks

Shock Details

(T1 Capital/RWA) < 4%

4% ≤ (T1 Capital/RW

A) < 6%

Num

ber of Banks with CAR

Total*6%

≤ (T1 Capital/

RWA) < 8%

(T1 Capital/RW

A) ≤ 8%

Pre-Shock Position0

00

1414

Under-capi-

talizedAdequately- Capitalized

Well-Capi-talized

Post-Shock Position(T1 Capital/RW

A) < 4%

4% ≤ (T1

Capital/RW

A) < 6%

6% ≤ (T1

Capital/RW

A) < 8%

(T1 Capital/RW

A) ≤ 8%Total

4.a.1



00

014

14


the PNA em


5%



activities.5%





3%



4.a.2



11

57

14


the PNA em


15%



activities.10%





5%




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• Test Results for banks in case of first multiple-variables shockTolerance test results for banks in case of first multiple-variables shock under the mild scenario, by increasing percentage of provisions for each factor, as shown in (Table 7-2) showed that all banks passed the test. Tier1/RWA ratio remained above 4 percent for all banks (14 in number), which maintained a higher ratio than the minimum limit set by Basel and that set by the PMA. This is proof of the robustness of the banking system and the ability of bank capital to withstand composite shock.

However, tolerance test results for banks in case of first multiple-variables shock under the severe scenario, by increasing percentage of provisions for each factor, as shown in (Table 7-2), showed that none of the banks recorded Tier1/RWA ratio below 4 percent as per Basel II requirements except for one bank (success rate in this case in 92.9 percent), while another bank recorded a Tier1/RWA ratio lower than 6 percent as per Basel III requirements, while maintaining a 4 percent ratio.

When examining the ability of banks to comply with PMA instructions, results for tests under the severe scenario showed a success rate for banks of only 50 percent, as Tier1/RWA ratio dropped below 8 percent in the case of seven banks. Subsequently, half the licensed banks (seven banks) failed to comply to PMA instructions, keeping in mind that for five of these banks the ratio is higher than 6 percent; for one bank higher than 4 percent and lower than 6 percent and for another bank lower than 4 percent (less than the limit set by Basel II). These results show that the capital held by the licensed banks is robust and the banks can survive shocks, as per Basel requirements, however, the banks still need to expand their capital, as per PMA instructions, which are considered more conservative and prudent in order to safeguard financial stability and banking system robustness, especially in light of political and economic volatility in Palestine.

• Test Results for banks in case of second multiple-variables shockTolerance test results for banks in case of second multiple-variables shock under the mild scenario that the success was 92.9 percent, as all banks (numbering 14) maintained a Tier1/RWA ratio above the limit designated by the Basel Committee and also by the PMA, with the exception of one bank which recorded less than 8 percent (lower than limit designated by the PMA), albeit maintaining a ratio above 6 percent. This represents evidence of the robustness of the banking system and the ability of bank capital to withstand composite shock.

However, tolerance test results for banks in case of second multiple-variables shock under the severe scenario were similar to results attained for first composite shock under the severe scenario, showing a success rate for banks of only 50 percent. Subsequently, half the licensed banks (seven banks) failed to comply to PMA instructions, keeping in mind that for two out of the seven banks attained a ratio greater than 6 percent; three banks attained a ratio higher than 4 percent and lower than 6 percent and for two banks attained less than 4 percent (less than the limit set by Basel II). The success rate rises to 64.3 percent of banks when compared to the minimum limit of 6 percent set by Basel III, and to 85.7 percent when compared with 4 percent; the minimum limit set by Basel II. Yet, these seven banks need to expand their capital pursuant to PMA instructions, which are considered more conservative and prudent in order to fulfill its strategic objective of maintaining financial stability and banking system robustness, especially in light of political and economic volatility in Palestine. To that end, the PMA issued Instructions No. (6/2015) concerning capital requirements, reserves and shareholders’ equity, which required that paid-up capital allotted to engage in banking in Palestine be no less than USD 75 million. Furthermore, the PMA plans to expand the capital requirements from the banking system to USD 100 million in the future.


Liquidity stress test resultsLiquidity stress testing of the Palestinian banking system was conducted, assuming four types scenario shocks with various severity levels shown in Table (7-3). The impact of these shocks on Liquid Assets/Short term liabilities within 1 month was analyzed. Despite being disparate, the results remain in all the cases greater than 25 percent (the minimum liquidity requirement set by the PMA). Although discrepancies between the two percentages exist, they both measure the exposure of banks to short-term liquidity risks. Table (7-3) outlines the test results, as follows:

Table 7-3: The PMA stress tessts results, 2014

Liquidity stress test

50% > (liquid assets/short term

Liabilities within 1 month)

100% > (liquid assets/short term

Liabilities within 1 month) ≥ 50%

100% ≤ liquid as-sets/short term

Liabilities within 1 month)

Total*

Pre-shock position 4 6 4 14Post-shock position

A gradual withdrawal of 20% customer deposits during the month

9 4 1 14

Withdrawal of three largest depositors, including of the Palestinian Authority

4 7 3 14

Withdrawal of five largest depositors, including of the Palestinian Authority

5 8 1 14

A decline in liquid assets of 25% 7 6 1 14


• First stress test results: Customers withdrawing 20 percent of their deposits within one month

Results for test assuming the occurrence of the first shock, taking the form of customers withdrawing 20 percent of their deposits within one month, showed a failure rate equal to 64.3 percent, with nine banks failing to retain a liquidity ratio greater than 50 percent, as opposed to five banks who passed the stress test. All the same, it should be taken into consideration that four banks already suffer from low liquidity ratios prior to experiencing the assumed shock, meaning that the assumed shock increased the number of banks from four (pre-shock) to nine banks (post-shock). At the same time, the number of banks falling within the second category (with liquidity ratios between 50 percent and 100 percent) dropped from six banks (per-shock) to four banks (post-shock), while the number of banks in the third category (liquidity ratio greater than 100 percent) dropped from four banks (pre-shock) to one bank (post-shock). The decline comes as a result of the negative impact of the scenario shock on certain banks in the second and third category, resulting in the movement of these banks to the first category (liquidity ratio less than 50 percent). However, the liquidity ratio remains above 25 percent for all banks.

• Second stress test results: The top three depositors withdrawing their deposits, including government deposits

Contrary to the first stress test result, the second stress test results, which takes the form of the three top depositors withdrawing their deposits, including government deposits, showed no impact whatsoever on the banks. The number of banks which failed to attain a liquidity ratio above 50 percent remained unchanged at four banks, both prior and


after the shock scenario. Results showed a slight negative impact of the shock on few banks within the second and third category, as the number of banks within the third category (liquidity ratio above 100 percent) fell from four banks to three banks, whereas the number of banks within the second category (with liquidity ratios between 50 percent and 100 percent) increased from six to seven banks.

• Third stress test results: The top five depositors withdrawing their deposits, including government deposits

Results for the third stress test, which takes the form of the five top depositors withdrawing their deposits, including government deposits, showed slight impact on the banks. The number of banks which failed to attain a liquidity ratio above 50 percent rose from four banks, prior to the test, to five banks, after the test. Results showed a greater adverse impact on banks within the second and third category, as the number of banks within the third category (liquidity ratio above 100 percent) fell from four banks to one bank only, whereas the number of banks within the second category (with liquidity ratios between 50 percent and 100 percent) increased from six to eight banks.

Based on the above analysis, it becomes clear from the results of the stress tests of the first three simulated shocks related to depositor conduct that there are no significant risks arising from deposit concentration in a limited number of depositors (less than five), as demonstrated by the results of the second and third shocks. Nonetheless, liquidity risks heighten in case 20 percent of deposits are withdrawn, regardless of the number of depositors, as demonstrated by the results of the first shock. It is noteworthy that the PMA makes remarkable effort to promote depositor confidence in the banking system. One of the most effective measures taken was the establishment of the Palestine Deposit Insurance Corporation (PDIC), in order to finalize the creation of the financial safety net scheme and assure depositors. PDIC provides an insurance coverage ceiling for every bank account of USD 10,000, which covers more than 93 percent of all depositors with banks, since the majority of depositors are small depositors.

• Fourth stress test results: Liquid assets falling by 25 percent

Results for the fourth stress test, which takes the form of the decline in liquid assets by 25 percent, showed that 50 percent of banks (seven banks) failed to attain a liquidity ratio above 50 percent, as opposed to seven banks who passed the stress test, taking into account that there were four banks which suffered low liquidity ratios prior to conducting the stress test. This means that the simulated shock resulted in the rise of the number from four banks, prior to the test, to seven banks, after the test.

Results also showed a notable adverse impact of the simulated shock on banks within the third category (liquidity ratio above 100 percent), as the number of banks fell from four banks to one bank only, whereas the number of banks within the second category (with liquidity ratios between 50 percent and 100 percent) stood unchanged at six banks.

Despite the fact the liquidity ratio remains greater than 25 percent for all the banks, the results of the fourth stress test signals a high degree of liquidity risk which may endanger the banking system in the event of decline in liquid assets. This necessitates the monitoring of placements of bank assets to assure they are adequately liquid in order to mitigate potential risks and ensure that banks are capable of meeting their short-term obligations without being exposed to losses.


Macroeconomic stress testing

The resilience of banks to withstand adverse shocks at the macro level was tested using Vector Autoregressive Model (VAR) methodology. The method examines several variables at the macro- level[56] to measure the impact of respective shocks on financial fragility. Loan provisions were used as a measure of financial default, as they are available in the form of quarterly time series and explicitly appear on bank income statements and therefore directly related to net profits. The ultimate objective was to develop modeling approach for the relationship between bank financial default and the various macro-economic shocks.

Testing was conducted according to two different scenarios: the baseline scenario and the pessimistic (adverse) scenario; both derived from the Palestinian macroeconomic model[57]. Based on the baseline scenario, PMA predictions point to a rise in real GDP during 2016 by about 3.3 percent compared with 3.5 percent in 2015. This growth is assumed to be mainly driven by an increase in private consumption, financed by a rise in granted bank credit, and the accumulation of arrears, alongside a hike in total investment arising from the implementation of investment projects and the continuation of reconstruction process in GS.

The forecasts for Palestinian economic growth in 2016 were founded on a series of basic assumptions (the baseline scenario) and their economic repercussions. These basic assumptions includes that the political and economic conditions in Palestine will remain unchanged especially with regard to restrictions imposed on crossings, freedom of movement, transport and access. It is also assumed that the number on Palestinian workers in Israel will remain unchanged from 2015. Additionally, it is assumed that the government will continue to implement the fiscal austerity policy and rationalize its current expenditures, while growth in government revenues and expenditures stand at previous-year levels. Moreover, it is also assumed that aid from donor countries will continue to flow into the Palestinian government treasury to a value of around USD 1 billion, and a fund equivalent to USD 1.2 billion will flow in the form of remittances to the private sector, while credit facilities are assumed to grow by around 17.0 percent compared to the previous year.

In contrast to this scenario, the economy remains prone to negative shocks (pessimistic scenario) in which political and security conditions further deteriorate, the number of Palestinians working in Israel declines, restrictions on movement of individuals and goods tighten, number of closure,s days facing workers and trade movement increase and Israel suspends transfers of tax revenues. Additionally, this scenario assumes that foreign aid

[56] These variables include: growth rate, interest rates on both lending and deposit, for the three currencies circulating in the Palestinian economy, the exchange rates for the USD and the JD against the NIS, the real effective exchange rate (REEF) and finally the inflation rate.[57] For further details, check the Annual Report 2015 published by the PMA.

Table 7-4: Forecasts of changes in loans provisions, end of 2016

Period

Baseline scenario Pessimistic scenario

Growth in GDP (%)

Change in loans

provisions (USD

million)

Growth in GDP (%)

Change in loans

provisions (USD

million)

2016 3.3 9.9 -4.2 21.9

2016Q1 2.9 4.3 -6.0 5.2

2016Q2 3.1 9.1 -4.5 8.5

2016Q3 3.5 7.0 -9.1 2.1

2016Q4 1.7 9.3 -1.4 6.1

Source: PMA.


from donor countries in support of the budget and development projects declines and that the reconstruction of Gaza grinds to a halt. Under such a scenario, it is estimated that real GDP will fall by 2.4 percent.

When the above-mentioned scenarios are applied to the banks and impact on financial default examined, results suggest that net loan provisions will rise by USD 9.9 million during 2016 based on the baseline scenario, whereas, on the basis of the pessimistic scenario, they will rise by USD 21.9 million, in the same year.

Figure 7-1: Forecasts of changes in loans provisions, end of 2016

0

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20

2013

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2013

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2013

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2013

Q4

2014

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USD

mill

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Documents

Financial Stability Report Annual Report 2015 2014...2 Palestine Monetary Authority (PMA), Financial Stability Report 2015 The Israeli correspondent banks Pursuant to the Paris Protocol,