78479 FOR OFFICIAL USE O N L Y FINANCIAL SECTOR ASSESSMENT TUNIA SI JULY 2006 MIDDLEEAST AND NORTH AFRICA REGIONVICE PRESIDENCY FINANCIALSECTOR VICE PRESIDENCY ON THE J BASED O N I T IMF-WORLD BANKFINANCIALSECTOR ASSESSMENT PROGRAM UPDATE OVERVIEW 1. The Tunisian economy registered a strong performance over the past decade. With average real growth rates o f 5 percent since 2000, real per capita income increased b y n a context o f macroeconomic stability. 20 percent i 2. The banking sector plays a predominant role in financing the economy. New equity issues remain modest (TD 204 million in 2004, equivalent to 0.8 percent o f GDP and 3.7 percent o f private investment), in line with low stock market capitalization (about 9 percent o f GDP i n 2004). Asset growth o f venture capital companies (SICAR) in 2004 was lackluster (approximately TD 40 million) with their total assets (TD 550 million) equal to 1.5 percent o f GDP. However, leasing has developed successfully, with assets growing 50 percent between 2000 and 2004, reaching 11 percent o f private investment financing. 3. The authorities are aware that pursuit o f growth, necessary to create employment, requires strong banking sector support. Presently, the banking sector i s burdened b y a high level o f non-performing loans (21 percent o f total loans at end-2005, compared to 24 percent at end-2004) with a l o w provisioning ratio o f 46 percent. 4. T o strengthen the banking sector the authorities have established a provisioning ratio target o f 70 percent by 2009. Building o n their awareness that a reduction in the NPL level i s essential to restore the effectiveness o f the banking sector, the mission has recommended that they adopt a second objective o f reaching a NPL target o f 10 percent b y 2009. 5. Attainment o f this latter goal would yield significant savings in provisioning and could reduce the need for capital increases, particularly in state-owned institutions. A set o f regulatory, judicial, and tax measures have to be designed to create appropriate incentives for banks to attain this goal. The principal regulatory, tax and judicial measures* should aim at: ' Box 1 on page 14 summarizes the main policy recommendations. -2- e Improving the quality o f new loans so as to ensure that the stock o f nonperforming loans (NPLs) does not increase again. For new loans, no more than 30 percent o f the loan loss provisioning should be met through collateral, consistently with the goal o f achieving at least 70 percent provisioning o f all non-performing loans b y 2009. e Eliminating the legal and tax obstacles currently preventing a reduction in the non- performing loan burden, particularly through partial write-offs. These measures should also encourage recourse to out-of-court settlements. 6. The mission estimates that these measures should encourage vigorous prosecution o f recalcitrant debtors and restructuring arrangements that are fair to both creditors and debtors and thus help reduce the moral hazard resulting from total or partial nonpayment o f loans. 7. In order to achieve the proposed strategy, it i s important that regulatory authorities monitor closely the implementation b y banks o f the new measures taken to promote the restructuring o f N P L s , including their compliance with the new provisioning rules. Authorities should monitor the effectiveness o f the instruments deployed to reduce the N P L stock and, if necessary, quickly adapt quickly the regulatory incentives to support them. I. INTRODUCTIONAND RECENT MEASURES 8. The joint International Monetary Fund/World Bank mission’ that visited Tunis from January 16 - 31 and March 27 - 31,2006 as part o f the Financial Sector Assessment Program (FSAP) update for Tunisia carried out a detailed analysis o f the ability o f the Tunisian banking sector to support the country’s development objectives. Upon invitation o f the Governor o f the Central Bank o f Tunisia (BCT), the mission organized three well- attended workshops on: the restructuring o f nonperforming loans; management o f public banks; and the use o f information for financing S M E s and individuals. 9. The Tunisian economy registered a strong performance over the past decade. With average real growth rates o f 5 percent since 2000, real per capita income increased by 20 percent in a context o f macroeconomic stability. In 2005, the rate o f inflation declined to 2 percent and the fiscal deficit was brought down to around 3 percent. The current account deficit o n the balance o f payments narrowed considerably since 2000, to reach 1.3 percent o f GDP in 2005 in spite o f further progress in trade liberalization. 10. The authorities acknowledge that the continued economic growth hinges on improved effectiveness of the banking system and this, in turn, requires a reduction o f non-performing loans in the banks’ portfolio (20.9 percent o f total loans at end-2005). This burden increased between 2000 and 2003, mainly as a result o f the decline i n tourist sector activity following *The mission was co-led by Luigi Passamonti (WB, FSE) and Emilio Sacerdoti (IMF, MFD). Mission members were: Guillaume Almeras (WB, S M E Lending consultant), Pauline Aranda (WB-LEG), Marie-Therese Camilleri (IMF-MFD), Jean-Philippe Couetoux (Banque de France), Didier Debals (WB-MNISF),Marianne El- Khoury (IMF, MFD), Eric Haythorne (WB-LEG), Oscar Madeddu (IFC), Rodolfo Maino (IMF-MFD), Cedric Mousset (WB-FSE), Jean Pesme (WB-FSE), Michael Pomerleano (WB-FSE), Isabelle Schoonwater (WB-FSE), Emile Van der Does (WB-FSE), David Welch (IFC retiree). Sadok Rouai (IMF),Senior Advisor to Executive Director for Tunisia, has attended a l l meetings. -3- the events o f September 11, 2001 and in Djerba in 2002. Although a marked decrease in the non-performing loans ratio took place in 2005, it remains high and considerably above the level o f comparable countries. 11. n a comprehensive T o address these challenges, the authorities have embarked i strategy which i s based on the following regulatory actions: Strengthening of the credit culture and good governance e A major element i s the law 2005-96 o f October 18,2005 o n the security o f financial relations. This law strengthens companies’ financial governance through improved allocation o f responsibilities among corporate officials and control structures, and ensures more transparency through communication to the markets o f credible financial data. e n 2001 bank regulations have imposed stricter requirements I t i s also to be noted that i on banks regarding financial information on their clients, i n particular the obligation to obtain financial statements certified b y the external auditors if total exposure on a client exceeds TD 5 million, and a recent rating from a rating agency if exposure exceeds TD 25 million. Addressing the stock of nonperformingloans e Within the framework o f the efforts under way to limit the risks arising from the nonperforming loans, the tax deductibility o f provisions has been gradually increased to attain 100 percent o f profits starting in 2005. e In addition, since 2004 the central bank has forced banks that record inadequate provisions to allocate the totality o f their operating income to the coverage o f this shortfall (and foregoing dividends, if necessary), until it i s fully reabsorbed. e Other measures aim to facilitating the judicial recovery o f bank credits, in particular n difficulty, so as to prevent the reform concerning the rehabilitation o f enterprises i recalcitrant debtors from using the law for delays, and the law which facilitates the n the recovery o f claims. judicial sales o f goods, and limits undue delays i Restructuring of the banking system e Restructuring has taken mainly the form o f the privatization o f two banks, the Union Internationale des Banques (UIB) and the Banque du Sud (BS), which account for 13.5 percent o f banking system assets. These two sales have led to a reduction o f government equity participation in the banking system from 36 percent at end-2004 to 32.5 percent at end 2005 and to an increase in foreign participation to 34 percent in 2005. Reform of the regulatory framework e In the context o f the modernization o f the banking sector, the authorities have revised the law on the central bank and the law on credit institutions. -4- 12. Regarding the insurance sector, the legal and prudential framework was strengthened by amending the insurance code, which aligns prudential rules with international standards, triples minimum capital requirements, establishes new supervisory arrangements, and broadens the scope of off-site and on-site inspections 13. A summary o f recommendations of the 2002 FSAP, and the status of their implementation i s presented in Table 1. 14. Although this set o f measures represents an important regulatory effort to strengthen the banking and financial system, and although headway was made in 2005 in reducing and provisioning nonperforming loans, the FSAP mission has recommended additional measures to reduce the NP L stock. I t s present high level hampers the ability o f the banking system to contribute effectively to the financing of the economy and weakens the image o f the Tunisian economy with foreign investors. 11. OBJECTIVES, STRATEGIES, AND INSTRUMENTS FOR STRENGTHENINGTHE FINANCIAL SECTOR A. Main features of the strategy 15. The Tunisian banking system has reached a watershed i n i t s long strengthening process. In order to withstand the shocks to which an outward-oriented economy i s inevitably exposed while financing new growth-oriented activities-particularly those involving intangible assets-the banking system must strengthen i t s efforts to reduce the stock of nonperforming loans. 16. Today, a sizable proportion of the equity base of the banking system i s earmarked for covering under-provisioned NPL risks. If a meaningful reduction i n NPLs i s achieved, it would be possible to allocate the largest part of the system’s equity base to protect against unexpected losses, thereby bolstering the financial system’s support for economic growth. 17. The mission conveyed the opinion to the authorities that the banking system should focus on achieving an NPL target level of 10 percent or less by 2009. This would put Tunisia on a par with other emerging countries. Attainment of this target would allow for substantial loan loss provision savings, and could minimize the need for potential equity capital injections, particularly from public shareholders. A package o f regulatory, judicial, and tax- related measures to provide banks with appropriate incentives should be assembled. 18. A powerful tool for scaling back NPLs-and the related provisioning requirement- would involve restructuring loans to debtors, whose situation might be sustainably improved, including through partial debt cancellation. This strategy could be much less costly in terms of provision build-up than that presently pursued by the authorities which i s to reach 70 percent provisioning target on presently outstanding NPLs. 19. However, a prerequisite for any partial restructuring i s to reduce moral hazard resulting from full or partial nonpayment of debt. This can be achieved through vigorous enforcement action against defaulting debtors. I t i s to be noted that NPLs older than one year have a high concentration o f large debtors, and that only 1/3 o f N P L s older than 5 years are -5- in litigation based o n end-2003 data. Moral hazard results not only from the partial write-off o f claims, but also from delayed payments o n a temporary basis. 20. T o limit moral hazard, partial debt cancellation should be accompanied by a dilution o f control by the borrower through debt-equity swaps. Banks could then transfer these equity participations to investment companies such as the SICARs. Debt restructuring operations (extension o f terms, extended grace period, stepped-up amortization) should be conducted o n the basis o f a rigorous analysis of actual ability to repay, to ensure that restructured loans can rapidly be reclassified as performing (which i s seldom the case today). 21. A 25 percent reduction o f the present NPL stock would be sufficient to put Tunisia o n a par with other emerging countries that is, achieving an NPL ratio below 10 percent3 and a provisioning rate, in line with the authorities' objectives, o f 70 percent. T o achieve this goal, the banking system should reduce i t s NPL stock by 300 million dinars per year for three years. Mission estimates show that this target could be achieved with the following indicative modalities: (i)full collection o f about 100 million dinars (equivalent to 3 percent o f NPLs older than 1 year); (ii)partial write-offs (average 25 percent o f face value) o f about 300 million dinars (equivalent to 8 percent respectively), and ( iii) total write-offs o f about 400 million dinars (12 percent respectively). 22. I t i s to be noted that this dynamic strategy, which associates a provisioning effort with a reduction o f NPLs, would imply, if successful, a provisioning cost for the banking system substantially lower than that resulting from the provisioning-only strategy currently pursued by the authorities. The Table below indicates that the cost savings would be in the order o f '500 million, ie about one third o f the provisioning cost. A detailed worksheet has been made available to the BCT. COST OF 70 % PROVISIONING STRATEGY Millions A) Without NPL Stock Reduction I 1,550 B) With NPL Stock Reduction I 1,000 I ) FinancingN P L write-offs 490 Full Write-offs 420 Partial Write-offs 70 11) To reach 70% on outstanding NPLs 510 Saving (B-A) 550 (% A Strategy) 35% 23. Presently, debt restructuring i s penalized b y the absence o f tax deductibility for partial write-offs. I t i s important that the fiscal treatment be neutral in relation to the amount o f write-off provided, and that the rules for eligibility o f tax exemption for write-offs be simplified. In fact, write-offs have accounted for just TD 287 million over the past six years. As calculated, according to international standards, net of non-accrual interest which.Bankof Tunisia presently adds to the NPL stock. -6- 24. With respect to the recovery o f claims through judicial channels, although reforms n favor o f creditors were made in 2003, major delays in court-ordered payment procedures i are s t i l l encountered. Thus, it will be important to develop extrajudicial procedures. 25. In the area o f prudential regulations, incentives for rapid recovery o f non-performing claims need to be strengthened. Thus, in accordance with the government’s strategy to raise the provisioning rate for nonperforming claims to at least 70 percent b y 2009, the regulatory authorities should take steps to ensure that, for new NPLs, no more than 30 percent o f the provisioning requirement i s met b y eligible ~ o l l a t e r a l . ~ B. Financial restructuringin the tourism sector 26. The tourism sector, o f which 40 percent o f claims are classified, could be the pilot case for this renewed effort to reduce NPLs. Indeed, this sector has some favorable features: the number o f operators i s relatively limited (800 hotels), economic prospects for the latter are favorable, except in isolated segments, cash flow projections are expected to pick up, foreign investors are interested i n bringing in considerable amounts o f capital and skills, and an investment restructuring program i s underway. The Minister o f Tourism has expressed interest in preparing a comprehensive financial restructuring plan that could provide a reference for the Tunisian banking sector as it considers funding requests from individual hotel operators. This plan should quantify the overall resources needed by the tourism sector from existing and new shareholders and the banking system i n order to successfully complete i t s restructuring. I t should provide an estimate o f how much equity i s required to reduce the level o f indebtedness and the new financing from international and local banks and include quantification o f possible extensions o f terms and loan write-offs. I t should also include plans for stock exchange listing o f tourism real estate firms and the establishment o f dedicated institutional investors. 27. I f it were to be successful, a more disciplined financial restructuring o f the tourism sector would enable the largest public bank to significantly reduce i t s non performing portfolio, to strengthen i t s financial base while limiting potential equity increases from i t s main shareholder. Ministry o f Finance data indicate that out o f 235 tourism projects that benefited from the provisions o f the 2004 Budget (cancellation o f late interest, transfer to principal o f part o f the unpaid obligations, restructuring o f the debt over 25 years, tax exemption for efforts to write-off debts), no recovery was effected for 77 o f the projects, for 33 the rate o f recovery was less than 50 percent and only the remaining 125 projects were recovered by more than 50 percent. T h i s would imply that the average provisions for class 2 and class 3 NPLs (older respectively o f 90 and 180 days) would not be less than 14 and 35 percent, respectively, so as to penalize the accumulation of new NPLs. In 2004, the corresponding data were 7 and 21 percent respectively. -7- C. Strengthening the management of public banks 28. The share o f the public banks in the system (42.9 percent o f total assets5 end-2005) remains high. I t i s crucial that their operating results remain at least as good as those o f their private sector competitors so as to avoid the establishment o f a banking system with differentiated performance capabilities along ownership lines. In 2004-05 the bank specialized i n housing financing seems to have reached performance levels comparable to those o f the private sector banks. For the other public banks, a broad strengthening program (strategic, financial, operational and institutional) w i l l have to be drawn up to ensure that their performance does not weaken further, which would be costly for the government. This program should include action plans directed, above all, towards improving risk management (loan procedures, information o n borrowers, and risk appraisal), the handling o f nonperforming loans, and rationalization o f activities and personnel. 29. The reference shareholder should formalize a contract program with management o f the public banks based o n achieving a certain number o f quantitatively defined and precisely scheduled targets (NPL ratios, cost income ratios, claims recovery, write-offs, fees and commissions as a percentage o f operating income, evolution o f interest margins, etc.). Implementation o f this plan should be periodically verified by the B C T and the government. I t should be complemented by a series o f measures related to governance, transparency, and human resource management: T o make the Board o f Directors free from external influence, ensuring it i s partly composed o f non-executive members, to implement the strategic plan; Appointment o f internationally recognized auditing firms; Insistence o n all loans being granted solely on the basis o f strict financial criteria; Judicious management o f human resources, including appropriate mandates for senior managers; Prompt estimates o f prospects for recovery nonperforming loans based on financial n terms o f provisioning audits, drawing appropriate conclusions from the latter i requirements and capital injections from shareholders. A commitment to a dynamic policy o f N PL resolution, with quantitative targets for their reduction and deadlines to limit potential capital increases. 111. CONSTRAINTS, CHALLENGES, AND VULNERABILITY OF THE BANKING SECTOR A. Credit quality 30. Loan portfolio quality has declined across all commercial banks since 2000, as a n 2002 and 2003), result o f the combined impact o f the crisis in the tourism sector (mainly i drought, and business cycle difficulties in the distribution sector. Thus, N P L s as a ratio o f total lending rose from 21.6 percent i n 2000 to 23.7 percent i n 2004. However, a significant decline to 20.9 percent was registered in 2005. Tunisia falls short o f other countries’ The government share in the total equity of the system i s 32.5% because of private sector minority interests in public banks (para 11). -8- performance i n terms o f NPLs, compared with ratios o f 19.6 percent in Morocco, 15.5 percent in Poland, 7 percent in Greece, and 6 percent in Turkey (end-2004 data). 3 1. The provisioning rate for NPLs was 46.4 percent at end-2005 (36.2 percent net o f interest in suspense), compared to 40.2 percent at end-2000. Other comparable countries fared better: the provisioning rates at end- 2004 were 59 percent for Morocco, 58 percent for Poland, 88 percent for Turkey, and 51 percent for Greece. The balance, corresponding to non-provisioned NPLs, i s covered by collateral, 85 percent o f which i s real estate. Due to the high ratio o f NP L to total loans, this low level o f provisioning leads to a ratio o f non- provisioned NPLs to capital that is greater than 100 percent. B. Solvency ratios 32. The solvency o f commercial banks, as measured by the reported risk-weighted capital adequacy ratio (CAR), has weakened since 2000 to reach 10.7 percent in 2005. It seems low given the risks the sector i s exposed to, most notably as classified claims are covered by guarantees the value o f which i s subject to fluctuations. 33. The high ratio o f non provisioned NPLs to capital, which increased from 114.2 percent in 2000 to 124.1 percent in 2005, i s worrisome. These non-provisioned loans, which represent the implicit value o f the (especially real estate) collateral, pose a high risk o f vulnerability for the banking sector. Achieving the 70 provisioning goal by 2009 would bring the share o f these claims down to approximately 80 percent o f 2004 regulatory capital, which would be a more acceptable ratio, while s t i l l high b y international standards. 34. The B C T allows banks to reduce provisioning needs by taking the value o f collateral into account. In 2005, real estate collateral accounted for nearly 85 percent o f commercial banks’ admissible guarantees. Taking real estate collateral into consideration on insufficiently prudent terms (over-optimistic appraisals, especially in illiquid markets) could lead to under-provisioning o f nonperforming loans. International best practice suggests that higher provisions against N P L s should be constituted than those currently in place in Tunisia. C. Profitability and liquidity 35. The spread between average lending and deposit rates declined from 4.6 percent in 2000 to 3.1 percent in 2004. This development stems from the decline i n interest rates and n the interest-bearing claims portfolio i partly from the decline i n view o f the increase in NPLs. 36. B The second trend affecting the rofitability o f the banking system as a whole, i s the marked deterioration in operating cost -income ratios (including amortization), from 54.5 percent in 2000 to 61.4 percent in 2005. The difference between banks i s significant, since two public banks registered a ratio o f approximately 70 percent, while two private Depreciation of fixed assets i s included in operating costs. -9- banks had rates o f 40 and 50 percent, respectively, comparing favorably with international standards. Reversing the trend for banks suffering from high ratios requires (apart from increasing income) a meticulous cost control. However, the strategy o f most banks to open new branches and the resulting need for completely overhauling their information systems to cope with the development o f new market segments, such as consumer credit, and risk management will increase overheads and amortization costs. D. The former development banks 37. The five former development banks (the shareholding o f which held jointly b y the government o f Tunisia, and the governments o f four Gulf states and Libya) have restructured n 2002 and 2004 b y making provisions and transferring claims to their their loan portfolios i asset recovery companies. After acquiring universal bank status in 2005, they w i l l henceforth be required to compete in what i s increasingly appearing to be an over-banked system. I t would thus be beneficial to consider associations or mergers. E. Financing SMEs and individuals: opportunities and risks 38. The Tunisian productive sector w i l l be undergoing major transformations as it will face increasing international competition. T o support new or fast-growth enterprises, the banks w i l l need to rely less on historical relations and traditional collateral. The mission considers that further improvements i n banks’ organizational and lending practices are required. In parallel, competitive pressures may push banks to engage i n new product and client segments without adequate instruments for assessing risks and appropriate control systems. I t i s important to underscore that the establishment o f a credit bureau would be an essential instrument for improving the quality o f credit extended to small- and medium scale enterprises and households. 39. The development o f electronic banking i s likely to bring about changes i n forms o f financing which, are currently based mainly on collateral and available for a small share o f the potential client base. Guarantees w i l l become less important for evaluating risks in favor o f more sophisticated techniques, based on beneficiaries’ repayment capacity. The B C T could greatly contribute to this new development phase by making the data collected for the consumer credit module o f i t s centralized information service available to a private credit bureau which, under i t s oversight, would provide a service to banks by giving them data adapted to their needs in terms o f retail lending (credit scoring). 40. While broadening access to finance hinges on a better understanding o f the client base, the B C T will also need to ensure that banks increasing their exposure to new markets have internal systems that allow them to identify, measure and manage risk properly. Weaker banks, and particularly those without access to international expertise, will be those more exposed to an increase in default risk. As in the case o f S M E lending, the B C T w i l l play a n promoting the upgrading o f banks’ technological and professional capabilities. crucial role i F. Improvements in the prudential framework 41. Since the 2002 FSAP several regulations o f relevance to bank supervision were adopted, most notably the banking law that has established new rules on licensing and investment, N e w regulations have also been adopted to strengthen the compilation o f - 10- financial information prior to the extension o f credit to enterprises. As at early 2006, the banking law was under revision and a draft circular o n internal control reached i t s final stages; their enactment w i l l strengthen the legal and prudential frameworks, a task for which the BCT has devoted considerable efforts. The BCT has also refined i t s analytical approach, developed the expertise o f i t s inspectors and reinforced i t s supervision o f the banking system, particularly the monitoring o f credit risk. 42. The weaknesses highlighted by the assessment lie essentially in the management o f credit risk and provisioning, the absence o f prudential ratios o n a consolidated basis, sanction procedures, and rules for connected lending. 43. With regard to the rehabilitation o f the non performing portfolio o f the banking sector, it would be beneficial for the BCT to closely monitor the classified claims o f each bank, particularly those with high NPL ratios, as well as progress in terms o f recovery. Regular studies should be carried out, such as those o f end-2001 and 2003 on claims classified in category 4, to follow up on the situation in the banking sector and ensure that the objectives o f reducing classified claims and increasing the rate o f provisioning can be achieved. G. Scenarios through to 2009 and vulnerability analysis 44. The mission developed a commercial bank performance simulation model, distinguishing between private and public banks, in order to assess the ability to reach the target o f 70 percent provisioning by 2009. Baseline scenario 45. This scenario i s based o n maintenance o f the current situation. The results o f this exercise confirm a split i n the Tunisian banking system between private and public banks. Whereas private banks achieve the 70 percent provisioning target and observe the standard C A R o f 8 percent, public banks achieve only 58 percent provisioning i n 2009. Pessimistic scenario 46. This scenario i s based o n continued deterioration o f the current situation (average spread between lending and deposit rates would further shrink7 and the cost income ratio would increase). The whole o f the banking system fails to reach the 70 percent provisioning target by 2009 because the overall provisioning coefficient i s 54.5 percent. In this scenario, private banks do better (60.5 percent) than public banks (46.4 percent). A lower interest rate spread would adversely affect the stability of an under-capitalized banking system while representing a benefit to financial service users from an efficiency perspective. -11- Iv. LEGAL AND JUDICIAL ENVIRONMENT FOR CREDIT 47. The legal and judicial framework for credit in Tunisia has recently undergone a series o f reforms designed to facilitate the recovery o f nonperforming loans. However, these changes do not appear to have altered the behavior o f economic actors, nor have they led to a significant improvement i n the s t i l l low rate o f recovery, particularly o f loans in litigation. 48. Because o f that, special attention needs to be paid to the rehabilitation and liquidation n difficulties, to claims recovery procedures, to execution o f collateral, and to o f enterprises i guarantees in the form o f securities and real estate. 49. I t i s generally recognized, internationally, that the restructuring o f enterprises i s more effective "in the shadow o f the law", that i s to say, especially when there i s market discipline, a reliable judicial system, and effective liquidation procedures. Opinions differ regarding the extent to which these conditions exist in Tunisia today. 50. The recovery o f claims and execution o f guarantees have been commented upon b y financial institutions, particularly in connection with the privileges accorded certain creditors. I t i s essential that the existence and amount o f the "super privileges" enjoyed b y the Treasury, the National Social Security Fund (CNSS), and, albeit to a lesser extent, by employees, be published to enable banks to gauge their risks and the advisability o f filing a collection action to preclude challenges from third parties. 51. n the courts i s variously described as "lengthy" or The time it takes to recover claims i "reasonable." The mission was told that there i s no control over requests for adjournment o f hearings. Hence the importance, in this context, o f amicable and discreet proceedings, which could be handled by professional mediators and supported by business information bureaus. 52. The establishment, reporting, and execution o f guarantees i n Tunisia i s somewhat precarious, a state o f affairs that impairs banks' ability to recover their loans as well as the possibility and terms of access to credit. The scope for collateral in the form o f securities i s limited, in particular, b y a restrictive l i s t o f assets that can qualify as collateral without dispossession. In more advanced guarantees systems, any security can be put up as collateral, with no major restrictions. Furthermore, existing mechanisms are particularly restrictive.' The rules governing the constitution, reporting, and execution o f guarantees are specific to each guarantee, with no regard for a harmonized system. 53. Certain gaps in the system make it more difficult to constitute and register mortgages on real estate property. A sizeable portion o f Tunisian territory i s not registered and, despite the political will to expedite this process, proceedings before the real estate tribunals are especially long-drawn-out (three to five years), Financial institutions are also conscious o f the long time it takes to obtain title deeds, be they for land, lots in Tunisia's industrial zones, or city apartments (operations involving misappropriation o f the title deed). Registering transfers and mortgages with the land registry--which affects the ranking assigned to For instance, the pledging of equipment (without dispossession) i s only allowed in connection with i t s purchase, not in other circumstances. - 12- mortgage-holder creditors--is criticized for i t s slowness and excessive protocols, which leads to numerous rejections o f applications.’ OF AMLEFT V. ASSESSMENT 54. In December 2003 Tunisia adopted a comprehensive A M L - C F T Law, which goes a long way towards meeting international standards. Criminalization o f money laundering and the financing o f terrorism in particular are generally in line with current international standards. Key remaining weaknesses in the legal framework include the absence o f a legal basis for freezing funds in accordance with United Nations Security Council Resolution 1267 and 1373, the inability o f the financial sector supervisors to engage i n international cooperation, too limited requirements for identification o f beneficial owners, and significant ambiguities in the suspicious transaction report (STR) system and i n the coverage o f Designated Non-Financial Businesses and Professions (DNFBPs). The Tunisian authorities should quickly address these weaknesses, particularly those related to their UN-related obligations and to the STR system, as these are central to an effective AML-CFT system. 55. Overall, the implementation o f the A M U C F T law i s s t i l l at an initial phase. The prosecutorial authorities have begun using the CFT component o f the law, but o n a limited basis. Beyond this, the Tunisian authorities should lay out a criminal policy o n their fight against money-laundering, based o n a more comprehensive risk-assessment and analysis o f criminal patterns in the country. A Financial Intelligence Unit (FIU) has been formally set up within the Central Bank o f Tunisia, but i s not yet operational in i t s core functions. Only a handful o f STRs have been filed with the FIU in more than two years. The key challenge going forward lies therefore i n implementation and enforcement, in particular through a more active supervision o f compliance o f the financial sector with their A M L - C F T requirements. The adoption o f two directives i n April 2006 by the FIU i s in that regard a welcome step forward. While the first directive deals with the STR template, the second one details requirements o n due diligence, internal controls, and suspicious transactions reporting obligations for credit institutions, off-shore banks and the Postal Office. However, it needs to be complemented i n the short term by circulars to be issued by the central bank. Approximately 30 percent of requests for registration are rejected. - 13- Box 1. Main FSAP Update Recommendations Main recommendations (by area) Timefr ame A. Banking sector issues Establish prudential ratios on a consolidated basis ST Enter in information sharing agreements with other Tunisian financial supervisors and ST foreirm suuervisors 0 Review the superseniority o f tax authorities and social security agency claims ST E. Collateral registration and realization 0 Standardize rules for movable collateral ST 0 Speed- up real estate titles registration, registration of changes in property, and ST registration of mortgages 3T= Short Term; MT=Medium Term - 14- L) 3 - 15- - 16- - 17- I I 8 L 4 3 - 18- a .- 19- Table 1. Tunisia: Selected Macroeconomic Indicators, 2000-2005 2000 2001 2002 2003 2004 2005 (prov) Production and income (percent change) Nominal GDP 8.2 7.8 4.1 7.6 8.8 6.2 Real GDP 4.7 4.9 1.7 5.6 6.0 4.3 GDP deflator 3.3 2.7 2.4 2.0 2.6 1.9 Consumer price index (CPI), average 3.0 1.9 2.8 2.8 3.6 2.0 Gross national savings (inpercent o f GDP) 23.1 23.7 22.2 22.0 21.9 22.1 Gross investment (in percent o f GDP) 27.3 27.9 25.7 25.1 24.2 23.9 External sector (percent change) Trade balance (in percent o f GDP) -11.6 -11.8 -10.1 -9.1 -8.7 -7.9 Current accounr excl. grants (in percent o f GDP) -4.2 -4.2 -3.5 -2.9 -2.0 -1.8 Foreign direct investment (percent o f GDP) 2.2 3.8 2.2 2.2 2.3 Terms o f trade (deterioration -) -2.1 0.1 -0.7 -1.5 -0.5 Real effective exchange rate (depreciation -) I / -1.7 -2.4 -1.1 -4.1 -3.9 Central government (percent o f GDP, unless otherwise indicated) 2/ Central government balance, incl. grants, excl. privatization -3.7 -3.5 -3.1 -3.2 -2.6 -2.9 Total government debt (foreign and domestic) 60.8 62.7 61.5 60.4 59.7 60.3 Foreign currency public debt (percent o f toial debt) 62.4 63.5 64.4 63.2 64.2 Money and credit (percent change) Credit to the economy 8.0 10.3 6.7 4.6 5.3 7.5 Broad money (M3) 3/ 13.2 11.3 5.2 6.3 10.3 9.2 Velocity o f circulation (GDPhI3, deposit money banks) 1.88 1.84 1.83 1.85 1.81 Liquidity aggregate (M4) 4.47 6.41 3.92 5.64 9.5 Velocity o f circulation (GDPhI3) 1.71 1.65 1.64 1.66 1.64 1.6 Interest rate (money market rate, in percenr e.0.p) 5.88 5.94 5.91 5.00 5.00 5.00 Official reserves Gross official resews (US$ billions, e.0.p) 1.8 2.0 2.3 3.0 4.0 4.4 In months o f imports o f goods & services, c.i.f. 2.4 2.3 2.7 3.0 3.5 3.6 Total external debt External debt (US$ billions) 11.4 11.6 13.7 17.9 19.8 19.2 External debt (in percent o f GDP) 58.4 58.1 65.1 67.2 67.8 69.5 Debt service ratio (percent o f exports o f GNFS) 22.6 15.6 17.2 15.1 16.2 15.6 Financial market indicators Stock market index 4/ 1443 1,267 1,119 1,250 1,332 Memorandum items: GDP at current prices (TD millions) 26685 28,757 29,933 32,212 35,035 37,202 GDP at current prices (US$ billions) 19.5 20.0 21.1 25.0 28.1 28.8 GDP per capita (US$) 2036 2,068 2.152 2,53 1 2,833 2,867 Unemployment rate ( in percent) 15.9 15.3 15.5 14.7 14.2 Population (millions) 9.6 9.7 9.8 9.9 9.9 10.1 Exchange rate: dinarms$ (average) 1.37 1.44 1.42 1.29 1.25 Sources: Tunisian authorities and staff estimates and projections I/Information Notice System. 2/ Excludes the social security accounts. 3/ Financial system (Deposit money banks and Development banks) 4/ TUNINDEX. (1000 = 4/1/1998). 2005 data from November 1,2005 - 29 - Table 2. Tunisia Financial System Structure, 2000 and 2004 2000 2004 Type of Institution Institutions Assets (MD) % of GDP Institutions Assets (MD) % of GDP Commercial banks 13 19,613 73.5 16 31,138 88.9 State-controlled 5 11,676 43.8 3 ... ... Private 8 7,936 29.7 13 ... ... Development Banks 6 1,119 4.2 2 407 1.2 Offshore Banks 8 1,961 7.3 8 2,080 5.9 Centres de Cheques Postaux (CCP) 1/ 1 1,000 3.7 1 1,150 3.3 Caisse dEpargne Nationale Tunisienne (CENT) 1/ 1 800 3.0 1 920 2.6 Leasing companies 9 861 3.2 11 1,275 3.6 Factoring companies 2 30 0.1 3 72 0.2 SociCtC d’hvestissement B Capital Variable (SICAV) 28 1,398 5.2 34 1,998 5.7 SociCte d’Investissement B Capital Fixe (SICAF) 85 469 1.8 92 490 1.4 Societe d’hvestissement B Capital Risque (SICAR) 26 207 0.8 38 547 1.6 Insurance companies 1/ 16 1,300 4.9 16 1,508 4.3 Pension funds 1/ 2 2,500 9.4 2 2,900 8.3 Banque Tunisienne de Solidarite (BTS) 1/ 1 143 0.5 1 180 0.5 Total 198 31,399 117.7 225 44,665 127.5 Sources: BCT 1/ Estimates for 2004 - 21 - Table 3 - Tunisia - Commercial Banks- Financial Soundness Indicators, 2000-2005 (In percent, unless otherwise indicated) 2000 2001 2002 2003 2004 2005 Capital adequucy Regulatory capital to risk-weightedassets 11.3 11.1 10.2 9.9 10.5 10.7 Regulatory tier Icapital to risk-weighted assets 10.8 10.7 9.9 9,s 9.8 10.0 Capital to assets 8.1 7.5 7.7 7.6 7.5 7.7 Asset quulity N o n p e r f o h g loans to total gross loans 21.6 19.2 20.9 24.0 23.7 20.9 Nonperfonning loans net of provisions to capital 114.2 105.3 132.6 161.5 143.6 124.1 Provisioning ratio 49.2 47.4 43.9 43.1 45.8 46.4 Provisioning ratio (net of interest in suspense) 36.2 35.5 31.8 32.7 35.5 36.2 Foreign currency loans to total loans I/ 3.1 3 .O 2.7 3.2 2.4 2.8 Large exposures to capital 21 79.2 53.0 70.6 124.2 84.7 ... Sectoriul distribution of totul loans Total loans to residents 98.6 98.8 98.9 98.9 99.2 99.0 Loans to private sector 89.4 92.4 93.3 92.8 93.0 92.7 Households3/ ... ... 12.9 13.3 14.8 17.3 of which housing loans ... ... 8.3 9.1 9.3 9.9 Enterprises 85.5 88.2 76.0 75.8 75.3 73.3 Financial institutions 3.9 4.3 4.4 3.7 3.0 2. I Loans to public sector 9.2 6.4 5.7 6.0 6.1 6.3 Government 0.0 0 .o 0.0 0.0 0.0 0.0 Public enterprises 9.2 6.4 5.7 6.0 6.1 6.3 Total loans to non-residents 1.4 1.2 1.1 1.1 0.8 1.0 Distribution of private sector iouns by sector of economic activity Agriculture 7.9 7.1 6.6 6.9 6.3 6.0 Industry 40.6 38.4 37.0 36.6 36.6 35.6 Real estate 41 11.4 11.8 14.0 15.0 14.8 15.6 Services 40.1 42.7 42.4 41.5 42.2 42.8 Tourism 13.8 13.3 13.5 13.7 13.2 11.9 Comrce 15.7 15.9 15.5 15.8 15.8 15.8 Other 10.6 13.5 13.4 12.0 13.2 15.1 Distribution of Nonpe$orming loans by sector of economic activity Agriculture 7.0 7.4 7.3 6.2 6.5 5.8 Industry 43.2 42.0 41.6 40.8 38.4 40.0 Real estate 3.0 4.2 4.9 5.8 6.1 5.8 Services 46.8 46.4 46.2 47.1 49.0 48.4 Tourism 28.4 24.1 23.2 24.2 26.1 21.9 Comrce 6.2 8.1 9.9 10.8 12.3 13.6 Other 12.2 14.3 13.1 12.2 10.5 12.9 Earnings and Profitability Retum on Average Assets (ROAA) 5/ 6/ 1.3 1.1 0.7 0.6 0.4 0.6 Return on Average Equity (ROAE)S/ 61 14.5 13.2 7.6 7.3 5.1 6.9 Interest margin to gross income 7/ 62.9 61.8 60.5 59.3 56.3 56.7 Noninterest expenses to gross income 7/ 54.5 56.0 60.7 64.1 64.7 61.4 Personnel expenses to noninterest expenses 63.6 63.7 62.8 64.5 65.3 64.2 Net gains on bond portfolio and other financial instruments to gross income 7/ 14.7 13.8 13.2 13.5 15.7 16.3 Average lendingdeposit spreads 4.6 4.3 3.9 3.5 3.1 ... Liquidity Liquid awets to total assets 8/ ... 31.0 27.8 27.5 28.3 29.3 Liquid assets to short-term liabilities ... 97.2 103.1 104.9 113.2 117.8 Customer deposits to total (noninterbank) loans 46.4 46.4 46.5 47.0 47.6 46.4 Foreign currency liabilities to total liabilities 8.2 I .3 7.6 6.8 7.3 8.5 Sensitivity to market risk Net open position in foreign exchange to capital 0.1 0.4 0.4 0.7 0.8 0.9 Source: Banque Centrale de Tunisie 11Total disbursed loans(exc1uding off- balance sheet commitments). W Defined as total exposures greater than 25% of bank capital. 3IData on household loans are not available for 2000 and 2001. They are included in loans toenterprises. 4/ Excluding credit for social housing in 2000 and 2001. 5/ After tax 61 Quarterly averages: average assets net of provisioning and interest in suspense. 7/ The calculation of gross income i s made according to the accounting principle 21 on the presentation of banks published accounts. I t i s defined as interest income minus interest expenses plus net commissions ad fees plus net gains on bond portfolio and other financial inshuments. 8/ Liquid assets and short term liabilites as defined in the BCT liquidity ratio regulation.