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Middle EastSeptember 1 2011

Can Jordan's banks rise to the challenge?

A sharply declining growth in GDP, political and social unrest, credit rating downgrades, rising NPL ratios... To say Jordan's banks have faced a testing couple of years would be an understatement. However, there are some causes for optimism.
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Can Jordan's banks rise to the challenge?

While Jordan’s banking sector was not hit as badly as those of some of its Middle East neighbours, it has suffered at the hands of the global financial crisis.

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Background: Stable but stagnant

Over the past few years, Jordan has undergone its worst economic contraction in decades. After boasting an average growth rate of 8.1% between 2004 and 2008, the country saw the growth rate of its gross domestic product (GDP) shrink by more than two-thirds, from 7.6% in 2008 to 2.3% in 2009. It posted only marginally stronger growth of 3.1% in 2010. The International Monetary Fund’s initial 2011 GDP forecast of 4% has since been lowered to 3.3%.

Jordan was racked by weeks of anti-government protests at the start of 2011, which culminated in the country’s King Abdullah sacking the entire cabinet and the prime minister on February 1, replacing him with Marouf Bakhit, a conservative former premier known for his hostility to the private sector.

Disquiet spreads

On February 8, credit rating agency Moody’s downgraded the outlook for Jordan’s sovereign debt from 'stable' to 'negative', citing higher fiscal and economic downside risks related to the political turmoil in both Jordan and its neighbouring countries. The same day, Standard & Poor’s cut Jordan’s local long-term and short-term currency ratings from BBB-/A-3 to BB+/B and revised the outlook on its long-term foreign currency and local currency ratings from 'stable' to 'negative'.

The unrest, which has now subsided, did not reach the magnitude it did in other Middle Eastern countries. While Egypt, Tunisia and Libya all saw bloody uprisings calling for regime change, in Jordan only a small handful of protests – those which focused on corruption, government reforms and employment for the young – became violent. However, the Amman Stock Exchange (ASE), regarded as a good barometer of the overall economy, was noticeably hit by the unrest, with its share capitalisation falling by Jd1.6bn ($2.24bn) in the first quarter of 2011.

This diminished operating environment has further compounded the problems that the country’s banks were facing. In the second half of 2011, the banks are grappling with non-performing loans (NPLs), which have almost doubled over the past two years, surging from comprising 4.2% of banks’ total loans at the end of 2008 to 8.2% by the end of 2010. This has largely been fuelled by banks’ lending to commercial and residential real estate projects, where bankers say the biggest risks remain.

Property crash

Property prices have sunk by roughly 15% in Jordan’s capital Amman, and up to 50% in other areas since the onset of the crisis. “The property sector has been the hardest hit by the downturn,” says Kholoud Saqqaf, deputy governor of the Central Bank of Jordan (CBJ). “The sector was really booming and there was a big increase in prices before the recession, but people today are cautious and taking a wait-and-see approach.”

Prices have begun stabilising in Amman since the beginning of 2011 but are still falling outside the city where there is a continued slowdown in buying and selling.

Loans extended to the real estate sector comprise 12% of Jordanian banks’ total loan portfolio. Comparatively speaking, this figure is far lower than in other Middle Eastern countries, such as the United Arab Emirates, where banks’ exposure is valued at closer to 35%. Regulation introduced by the CBJ in 2000 prohibits banks from lending more than 20% of their deposits to real estate which has helped curb their exposure to this sector.  

However, Jordan is a well-diversified economy and banks have been hit by the slowdown across all sectors. The key contributors to the country’s GDP have all recorded lower growth rates since the global crisis hit. Foreign direct investment has dropped by 34%, foreign reserves fell by 8%, tourism by 5% and workers’ remittances by 0.7%.  

Tempting further growth

“Government officials were hoping we could achieve growth of 3.5% in 2011, but we have recorded growth of 2.2% in the first half of the year,” says Dr Jawad Hadid, CEO of Jordan Commercial Bank. “So we are still in a very slow economic cycle and a slow economy isn’t good for banks.”

In order to try to help stimulate growth, the CBJ has introduced a set of incentives to encourage banks to lend to small and medium-sized enterprises (SMEs), which comprise 95% of the economy, as well as the export and industrial sectors. In January 2011, the CBJ issued a circular, which states that if the banks lend to an SME at a prime interest rate of -1%, they will then release the same amount of the loan from the reserves kept with the CBJ at 0% (legal reserve requirement).

In such a case, a bank can reinvest the released money, at least by depositing it at the CBJ at the overnight window rate, which currently stands at 2.25%.

Furthermore, while Jordanian banks are usually prohibited from lending in foreign currency, the CBJ has made an exception for export or re-export financing. 

Jordan: financial indicators

Export reliance

“The problem for Jordan is it is a net oil importer,” says Philip Smith, senior director at Fitch. “It is keen to focus on generating exports to redress that.” However, exports have been falling gradually over the past few years from $7.78bn in 2008 to $6.98bn in 2009 and a further drop to $6.32m in 2010. In contrast, the price of oil has skyrocketed in 2011 – Jordan's oil import bill has been raised by no less than $1bn on an annual basis.

As for the industrial sector, the CBJ will now provide five-year fixed rate advances to banks on the condition they re-lend the money to companies operating in that sector.

Ms Saqqaf says the incentive for exports has proven to be the most popular, followed by that for small businesses. “Our incentive to get banks to lend to industries has been the least successful but that is because there are still so many obstacles facing this sector, such as the high cost of fuel,” she explains. Jordanian industry has seen its fuel and power prices climb steadily in the past few months. Prices of heavy fuel used by the country’s industries have increased to Jd505 per ton.

International prices of heavy fuel are 30% cheaper than those sold by the country’s sole oil supplier, the Jordan Petroleum Refinery Company. In addition, at the start of July 2011, the government increased electricity tariffs by 16% for customers consuming more than 750 kilowatts, as it aims to help the state-owned electricity company, National Electric Power Company, balance its books.

Helping hand for institutions

The approval of the establishment of a credit information bureau by the CBJ in June 2010, however, will hopefully play a key role in improving the country’s lending climate. The bureau will operate as a private company licensed and monitored by the central bank.

In enabling banks and companies to check the financial soundness and credit history of their clients, the bureau is aimed at increasing the efficiency of financial institutions, supporting the growth of smaller businesses and mitigating lending risks. “The bureau will help enhance credit information in the market through providing banks with data about potential clients’ aggregate numbers and mentioning if there are any past-due loans,” says Ms Saqqaf. “There were several assessments in the market that a private credit bureau was needed.”

If it performs its job correctly then the bureau should help speed up the process of providing loans and, perhaps more significantly, reduce the number of defaulted loans that financial institutions have on their books. The fact that it will enable individuals to obtain credit facilities, in addition to pricing these loans with reasonable interest rates, is also expected to play a key role in boosting lending to SMEs.

New players

In terms of other new growth areas, there have been some new entrants to the Islamic finance market over the past couple of years.

Jordan Dubai Islamic Bank opened its doors in January 2010 and listed on the ASE in May that year. It is also in the process of helping the government to issue an Islamic bond. Meanwhile, Al Rajhi Bank, Saudi Arabia’s biggest Islamic lender, opened a branch in Amman in March 2011 and is planning to open several more.

Jordanian banks are likely to have their profits squeezed further by the increased market share of foreign conventional players. National Bank of Abu Dhabi, the largest bank in the UAE by market value, entered the Jordanian market in early 2010. At the time of opening its second branch in the country in May 2011, it said that it planned to expand its branch network to six by 2015. Meanwhile, Lebanon’s Bank Audi has also set up operations in Jordan to attract depositors from neighbouring Iraq.

With the recent entries, there are now a total of 26 banks operating in Jordan, which includes 13 local banks, nine branches of foreign banks and four Islamic banks.  

Yet despite the ongoing challenges that banks have faced over the past few years, they have shown an upward growth in lending activity. Loans rose by 9%, from Jd13.3bn from year-end 2009 to Jd14.5bn by the end of 2010. They have grown by a further 6.2% in the five months to the end of May 2011 to stand at Jd15.4bn.

“If the current trend continues then we will have more active lending in 2011 than we saw in 2010,” says Mr Hadid.

Deposit growth has been more subdued, growing marginally by 2.27% from Jd22bn at the end of 2009 to Jd22.5bn at the end of 2010. It has more or less stabilised this year, coming to rest at Jd22.7bn at the end of May.

Health checks

Jordan: banking indicators

The reasonable health of Jordanian banks’ balance sheets is largely down to their careful stewardship by the CBJ. The central bank is currently in the process of strengthening capital adequacy regulations to comply with Basel II requirements, having ordered all banks to submit an Internal Capital Adequacy Assessment Process (ICAAP) by the end of 2010.

“They have all submitted their results,” says Ms Saqqaf. “We now have to validate their ICAAP’s which will take roughly one year.” However, historically speaking, Jordanian banks have very good liquidity by international standards. Today, their overall capital adequacy ratio stands at 19.5%, a slight decrease from 20.3% at the end of 2010.

In line with a directive issued by the CBJ in September 2009, banks are now also required to conduct semi-annual stress tests, examining in particular credit and concentration risk.

Banks’ future profitability depends to a large extent on whether the worst is over in terms of provisioning for NPLs. Ms Saqqaf says NPLs are now stabilising but the picture will not become clear until banks across the sector publish their half-year results. As The Banker went to press, only the Arab Bank and the Housing Bank for Trade and Finance (HBTF) had disclosed results. 

However, given these banks account for about a 40% market share in Jordan, their performance to date in 2011 is certainly encouraging. Arab Bank’s profit rose by 13% to $327m in the first half of this year over the same period in 2010, while HBTF’s profit grew by 7% to reach $101.7m.

Weakness or strength?

Bankers have said that Arab Bank has been viewed as a safe haven during the global financial crisis because its geographic diversification has helped it weather turmoil in the past. HBTF also benefited from the fact that its overseas operations continued to perform well. 

“The main obstacles to growth are that banks are still fairly cautious and there aren’t as many quality lending opportunities as they’d like,” says Laila Sadek, a director in credit rating agency Fitch’s financial institutions team. “Some of Jordan’s export markets are picking up a bit and they are definitely lending more this year, but they’re still lending less than they could be doing.”

Yet, compared to the current state of other countries’ banking sectors, the fundamentals of Jordan’s banking system are in fairly good shape. Its minimal exposure to Western markets, which has traditionally been regarded as a weakness, has helped insulate it from some of the worst effects of the downturn. 

The CBJ is also continuing to make a series of changes to protect its currency and economy in light of the slowdown. On June 1, 2011, it increased the policy interest rate by 25 basis points to 2.25 in order to increase the attractiveness of the Jordanian dinar and deal with rising inflation. This has proven effective, with Jordanian dinar deposits increasing in June and July, while inflation and foreign reserves have stabilised. Inflation stood at 4.6% as of July 2011.

Modest expectations

However, rating agency Standard & Poor’s believes the ongoing political turmoil in the region will negatively affect Jordan’s sovereign creditworthiness in two ways – through an increase in fiscal deficits and sluggish GDP growth. 

Higher subsidies for food, oil, and other staples are likely to divert spending from public capital investment, raising fiscal deficits. New social spending has been estimated at Jd320m annually – equivalent to about 1.5% of GDP. S&P forecasts general government deficits to be sustained at 5% of GDP or above out to 2014.  

Set against this macroeconomic background, the country's weak fiscal flexibility and regional security concerns, the appetite for either the continuation of or launch of new projects is likely to be depressed and all sectors will continue to feel the effects of the slowdown. Therefore, banks are expected to remain cautious and any growth in 2011 will be modest.

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Read more about:  Middle East , Jordan