56753 . July 2010 Number 27 THE ROLE OF STATE BANKS IN THE MENA REGION Roberto Rocha1 banks started circumscribing credit, state banks stepped in. The impact of this counter-cyclical Introduction: The MENA region was generally role has been widely acknowledged. For less affected by the global financial crisis than example, a recent issue in The Economist other regions, though some sub-regions and contained a lengthy article on emerging countries were impacted more than others. country banking, acknowledging how state banks had played an important counter-cyclical GCC countries, for example, were more role in many emerging countries. Given this impacted because GCC banks were more over- recent experience, some MENA countries may extended compared to non-GCC banks. They decide to retain an important role for state had higher loan-to-deposit ratios and were banks, including reformist countries such as borrowing abroad to sustain a very high rate of Egypt and Tunisia that had been privatizing credit growth. Moreover, they were also much state banks and allowing the entry of foreign more exposed to the real estate sector. Thus, banks over the last decade. when wholesale markets worldwide froze, the funding of GCC banks was immediately The importance of state banks in MENA: affected, while the bursting of the real estate Regarding the role of state banks in the bubble also affected the quality of their assets. financial system, we can classify MENA In the case of non-GCC countries, banking countries into three broad groups. In the first systems are generally less globally integrated group of countries, state banks lead the banking and less dependent on external funding. system and the financial sector. These countries Therefore, the effects were milder. include Algeria, Libya, Iran, Iraq, and Syria. It is worth noting that the role of state banks has Now, three years later, the crisis has subsided declined in the past four years in some and there are signs that credit growth is countries like Syria, but they still represent beginning to recover in many emerging more than 70% of the banking system. countries. Similarly, we have witnessed a recovery of credit growth in most MENA A second group of countries include those countries in the last few months, in both the where the state banks no longer lead, but still non-GCC and GCC countries. The question is play an important role in the financial system. whether state banks played any role in this These countries include Egypt and Tunisia recovery. where state banks still make up a significant portion of the financial sector, accounting for Role of state banks in the global economic approximately 45% of the banking system in recovery: In MENA, state banks played a less Egypt, and about 33% in Tunisia. In these two important role in the recovery as compared to countries, a decision was made that state banks several countries in Latin America and South will continue to play an important role. And as Asia, as well as China, where state banks we saw with the recent crisis, those played a counter-cyclical role. When private governments now may feel that their decision to retain an import role for state banks has been 1 vindicated. In some respects, Morocco falls into Robert Rocha, Senior Advisor, MNSED. This Fast Brief was cleared by acting MNA Chief Economist Farrukh Iqbal. the second grouping, though state banks it is still a poor market in terms of the quality of account for a smaller share of the system. the buyers and in terms of prices. Finally, a third group of countries are those The role of the World Bank in a post-crisis where private banks lead and the state banks world: It is important for the World Bank to play little or no meaningful role in the financial remain engaged in the post-crisis world. While system. Countries in this group include Bahrain, state banks may have played a counter-cyclical Kuwait, Jordan, Lebanon, Oman, and Qatar. role and may also have contributed to the achievement of some access objectives, their The financial crisis has not resulted in historical performance in most countries has fundamental changes in MENA: While the been generally weak. Since many state banks in crisis led to some reconsideration of the role of MENA are expected to remain state-owned for state banks in some MENA countries, we have some time, we need to assist governments to not seen a fundamental change in paradigms in ensure that they are well governed, especially the sense of a fundamental revision of the role in cases where there was a very important of the state in the financial system. For public investment made in these banks to example, countries in the second group like ensure their solvency. In this regard, our Egypt or Tunisia, have not determined that engagement has taken several forms. previous reforms should be reversed and that state banks should now take the lead. In fact, FSAPs2 provide a basic vehicle for diagnostic Tunisia considers that the ownership structure and policy dialogue. The issue of governance of of its banking system is balanced and should be state banks in MENA has been recently maintained: i.e. one third state banks, one third addressed in several FSAPs, including Egypt, private domestic banks, and one third foreign Morocco, and Syria, for example. The FSAP banks. Likewise, with countries in the third allows for an initial diagnostic of the situation group where the banking systems are privately in this area, although it frequently cannot dig dominated, we do not see a movement to deeper, because the team is expected to cover reintroduce state banks. the whole financial sector. The situation in MENA contrasts with other Bank governance assessments provide a much regions like Latin America and countries like more focused diagnostic of the quality of bank India where state banks have increased their governance. Where state banks are present, the share because of the crisis. In these cases, state assessment makes an effort to examine the banks increased their share for two reasons: (i) special governance challenges affecting these they continued extending credit whereas the banks. Recent bank governance assessments in private banks contracted lending, and (ii) in MENA have included Kuwait, Morocco, and some countries, state banks bought insolvent Syria. In the last two countries, the team private banks to protect the financial system. examined the particular governance challenges of state banks. This is a good diagnostic tool, In MENA, we do not see any significant change and the Bank has been making an effort to in market shares between state banks and conduct this type of exercise in other MENA private banks. At the same time, it is also true countries. that state banks will probably continue to play an role in several MENA countries, not only in the countries in the first group (where they lead the financial sector), but also in the second 2 The Financial Sector Assessment Program (FSAP) is a group (where they do not lead but still retain a IMF-World Bank initiative launched in 1999, which significant market share). This situation will provides in-depth examinations of countries' financial sectors. FSAPs assess both the stability of the financial not change in the near future, not only because system and its potential contribution to growth and some countries may have decided to retain an development, and provide recommendations to strengthen important role for state banks, but also because the former and maximize the latter. Assessments are done the crisis has frozen the privatization market, or jointly by World Bank and IMF staff in developing and emerging market countries (IBRD countries) and by the IMF alone in advanced economies. July 2010 · Number 27· 2 In addition to diagnostic work, the Bank has Contact MNA K&L: also made an effort to improve state bank Emmanuel Mbi, Director, Strategy and Operations, governance and performance by supporting Middle East and North Africa region key reforms and policy actions in Development David Steel, Manager, Operations, Middle East Policy Loans (DPLs), such as the 2005 Morocco and North Africa region DPL, and the more recent DPLs in Egypt and Iraq. Regional Quick Notes Team: Omer Karasapan, Roby Fields, Najat Yamouri, and Aliya Jalloh The role of state banks and the associated Tel #: (202) 473 8177 governance challenges are issues that are being addressed by other regions as well, and this is The MNA Quick Notes are intended to summarize motivating more analytical efforts inside the lessons learned from MNA and other Bank Knowledge World Bank. The financial sector network has and Learning activities. The Notes do not necessarily recently created a working group that is reflect the views of the World Bank, its board or its member countries. making an effort to understand what the participation of state banks is today: whether it has increased, what it implies for the future, and what the governance challenges are. The finance team in MENA is part of this working group and is not only benefitting from the experiences of other regions, but also contributing to the body of knowledge by sharing its experiences in MENA. July 2010 · Number 27· 3