Despite some progress on regulatory oversight and the strengthening of regional banks’ core capital ratios, there is still some way to go to ensure that the Gulf’s financial system is truly world class. Progress needs to be made on transparency and structural reforms. The World Bank has carried out a series of in-depth studies on these aspects. Sometimes it is worth noting what others have to recommend, as local commentators can often become afflicted with a “group think bias,” making it difficult to think outside the box due to collective ingrained biases.
According to the World Bank, while the quality of credit reporting in the Middle East has improved in recent years due to the introduction of new credit bureaus, these are far from satisfying the needs of a growing, demanding modern credit industry as different legal frameworks and reluctance of lenders to share data can create industry wide difficulty. It is to the advantage of regulators to also collaborate to promote the establishment of a complete, efficient and reliable information sharing system across borders.
During periods of financial contagion, all financial institutions are at risk, and the establishment of uniform credit reporting standards can constitute a great opportunity to promote regional harmonization.
A second area with the potential for generating growth and employment generation is the Small and Medium Sized Enterprises (SME) sector its relationship with increased access to credit through what is termed “Reformed Secured Transactions.” Most Middle East countries require substantial collateral requirements from firms requesting loans, which limits the growth of SME’s in particular.
Establishing a more efficient secure transaction system can lead to an increase in private sector credit to GDP, and fewer defaults. The focus should be on the creation of modern transaction laws and electronic movable collateral registries in addition to improving enforcement mechanisms for security interests in movable property.
Enforcement and collection of debt upon defaulted loans is possibly a major impediment, according to the World Bank for increasing access to credit in the Middle East North Africa (MENA) region.
The loan repayment standstills of Dubai world’s Nakheel is one glaring example of the confusion that followed on who owned what of the underlying Nakheel assets.
This leads to another important financial market mechanism: the existence or not of an efficient “insolvency regime.”
No MENA country, according to the World Bank, can claim an efficient liquidation process by international standards, with huge delays in the pace of debt recovery and the time it takes to close a business.
While it is good for potential inward foreign direct investors to know that businesses can be set up in record time, they would also like to know how long it would take to wind down a business, and whether a country has laws that do not criminalize insolvency and allows for a fresh start after bankruptcy- something akin to the US’ Chapter 11- and which could be a key measure in improving insolvency regimes in the region.
This requires significant and serious investment in training commercial court judges in bankruptcy procedures and nurturing a “culture of reorganization”, by developing expertise among professionals in restructuring and economics of financial distress.
In countries which have such bankruptcy protection, one is amazed at the turnaround of once insolvent companies following restructuring, and society does not permanently lose the skills, knowledge and market experience of the company under insolvency protection, unlike the Middle East where all these elements are permanently lost due to a complete bankruptcy shutdown , with no chance of a turnaround.
Another area of needed reform and regulatory oversight according to the World Bank is in bank competition. There is extensive literature that has shown that higher levels of bank competition are associated with lower prices for banking products, increased access to finance, and greater bank efficiency.
Having the banking sector dominated by a few banks can also cause a major problem — the so-called “too big to fail” theory, whereby governments are obliged to bail out large financial institutions, given the potential damage to the overall financial system by not intervening to support them.
In Saudi Arabia, the three largest financial institutions of the eleven licensed banks, account for over 55 percent of the total banking sector’s assets, deposits and branch network. This in part explains the region’s worse credit information sharing environment and lower market contesting.
A further wish list for the New Year is deepening the market for leasing in the region. Leasing is fairly active in MENA, but still remains fairly under developed by international comparison, with a lot of potential for growth. Leasing can grow if a more effective legal framework can be introduced that reduces ambiguities and introduces clear definitions of leasing and clear rights and responsibilities of the parties to a lease, the lack of registries for leased assets, and ineffective legal mechanisms for repossessing these assets. The limited access to long term fixed rate funding has also restricted lease operators ability to reduce their operating risk according to the World Bank.
Given the boom in infrastructure in several GCC countries, leasing could be a viable instrument to meet operator's flexible equipment demand and create a liquid pool of movable assets across the region. Financial restructuring takes a while and, as noted, some progress has been made, but let’s hopes that some of the above wish list for the region turns to reality to add depth and maturity to an important sector.
— Professor Mohamed A. Ramady is a former banker and currently visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals