In a turbulent region, the local banking sector has become a safe haven

Over the past year, Jordan’s local banking sector has shown a robust performance, with aggregate lending on the rise and net profits generally maintained across the board. Improvements in asset quality indicators suggest that the industry has turned a corner regarding the troublesome loans that have persisted since the global financial crisis, and a relatively upbeat assessment of the economy’s growth prospects by the IMF and others has brought an air of optimism to the sector in 2014. Though risks and challenges remain – the chief ones being external shocks from regional turbulence and the question of regulatory compliance – Jordan’s bankers have good reasons to look forward to another solid performance in fiscal year 2014/15.

Historical Background

The emergence of Amman as a regional banking centre coincides with the withdrawal of the British Mandate Authority from Palestine in 1948, when Arab Bank moved its headquarters from Jerusalem to the Jordanian capital. Since then, banking in Jordan has grown on the back of rapid economic expansion, kickstarted by a tripling of the population in 1948-50. The new arrivals, most of them displaced Palestinians, brought with them their savings and enterprising spirit, and banks like Egyptian Arab Land Bank and Jordan Ahli Bank soon entered the market to claim a share of the increasing financial activity.

During the 1950s and 1960s, Jordan’s GDP grew by 8-9% a year, driven by its booming construction and infrastructure sectors. Those decades saw the arrival of significant players such as Bank of Jordan and Standard Chartered, and the establishment of the Central Bank of Jordan (CBJ), which began operations in 1964 and replaced the Currency Board as the body in charge of monetary stability. Regional conflict in 1967 and a civil war in 1970-71 put a pause on economic expansion, but by the mid-1970s the nation was enjoying the highest growth rates in its history, reaching a peak of 24% in 1976, according to the World Bank. This economic uptick attracted yet more banks, the most significant of these being the Housing Bank for Trade and Finance.

The 1980s brought fresh challenges to the sector. As the region’s oil boom ended, Jordanian workers flooded back from the Gulf and the government began to run sustained fiscal deficits. Liberalisation of the interest rate regime nudged the sector toward crisis, and the high-profile collapse of Petra Bank in 1989 undermined confidence in the entire industry. A period of austerity and fiscal restructuring followed, during which time the government sought to balance financial probity against the threat of popular unrest – a process interrupted by the Gulf War of 1990-91.

A second wave of economic reforms in the 1990s brought mixed results, but succeeded in setting the economy on a path to steady growth. Over the last decade, the banking sector continued to expand on the back of this: in 2003 the CBJ had licensed 20 banks operating a total of 443 branches; by 2013 this had grown to 26 licensed lenders and 739 branches.

Present State

Today, Jordan’s banking sector is home to a diverse array of institutions. These include national players, all but one listed on the Amman Stock Exchange; regionally based institutions, such as National Bank of Abu Dhabi; and global banks such as Citibank and Standard Chartered. Three of the national lenders – Jordan Islamic Bank, Islamic International Arab Bank and Jordan Dubai Islamic Bank – provide only sharia-compliant financing. Saudi Arabia’s Al Rajhi Bank, which does the same, has also entered the local market, significantly boosting the Islamic segment.

So far, Jordan’s Islamic banks have focused their attention on the retail segment, but they have increasingly sought business from small and medium-sized enterprises (SMEs). The Islamic International Arab Bank, for example, has become the first sharia-compliant lender to sign on to the state-backed kafala “sponsorship” programme, which aims to increase the amount of such financing available to the nation’s businesses. Besides the national and foreign lenders licensed by the CBJ, there are three publicly owned credit institutions: the Agricultural Credit Corporation, the Housing and Urban Development Corporation, and the Cities and Villages Development Bank.

Market Concentration

Though such size and diversity are a boon to consumers, many participants, including the central bank, consider the sector overcrowded. As of end-2011, the CBJ reckons there were 8100 citizens per bank branch, and has taken steps to encourage banks to merge. “The central bank has been pushing for consolidation for around 10 years, even doubling the capital requirements institutions must adhere to in order to operate,” Yousef Ensour, CEO of Bank Audi, told OBG. “This has not had the desired effect though, and we have not seen positive results." The most important of these measures came in 2010, when the regulator raised the minimum paid-up capital requirement for local banks to JD100m ($141.3m). However, banks elected to meet the new target independently rather than merge, and the expected phase of market rationalisation, as with other banking sectors in the region, remains as elusive as ever.

Local Giants

In the sector’s wide range of institutions, two local lenders dominate: Arab Bank and the Housing Bank for Trade and Finance, which together account for about 40% of the industry’s total assets. Arab Bank, founded in Jerusalem in 1930 as the first private bank in the Arab world, is now one of the largest financial institutions in the Middle East. Regional conflict brought its headquarters to Amman, and it now operates more than 600 branches in 30 countries on five continents. During its long history, the bank has acted as a prominent catalyst for regional growth. Within Jordan its significance is even greater: in 2013, according to AWRAQ Investments, it had the highest market capitalisation of all firms listed on the Amman Stock Exchange, accounting for 28% of the total. With assets of JD24bn ($33.9bn) as of the first half of 2013, it is by far the largest bank in the country, with a loan portfolio heavily weighted towards the large corporations that account for around 70% of its loan book.

The Housing Bank for Trade and Finance was established in 1973 as a public shareholding limited company to answer the growing need for housing finance in the country. With total assets of around JD7.1bn ($10bn) as of the first half of 2013, it is the second-largest bank in Jordan. Though it has broadened its activities to serve a range of segments, mortgage lending still makes up 24% of its loan book, while large corporations claim 36%.

The only other bank holding assets above JD3bn ($4.24bn) is also one of the nation’s three sharia-compliant financiers. Jordan Islamic Bank, with assets of JD3.1bn ($4.38bn) as of the first half of 2013, was set up as a public shareholding company in 1978, at a time when Islamic finance was first emerging across the region. It has benefitted greatly from the resurgence of interest in Islamic finance coming from other regional centres such as the UAE, and is now one of Jordan’s fastest growing banks. As with other Islamic financiers, retail lending remains its strongest suit, accounting for about 38% of its loan book, followed by loans to the state (33%) and loans to large companies (22%).

Performance

In recent years, the trajectory of Jordan’s banking sector has followed that of others in the region. During the boom years prior to 2008, it profited greatly from a rapid rise in demand for credit. Large development projects, syndicated lending, corporate and individual borrowers, margin accounts opened to fund stock market investments all represented easy routes to interest income. According to a recent report by the Jordan Investment Trust, between 2000 and 2008 credit facilities to the construction sector alone grew from JD744.9m ($1.05bn) to JD2.3bn ($3.24bn).

The onset of the global financial crisis, however, saw a major halt in credit expansion. As customers became concerned by the banking collapses in the US and Europe, the biggest challenge at this time was to prevent bank runs: between September and October of 2008, deposits worth JD298.5m ($421.7m) were withdrawn from the nation’s licensed lenders. Asset quality also emerged as a major concern. As doubts about debt repayments rose, higher levels of provisioning were required, which in turn affected banks’ profitability. These concerns – asset quality and provisioning levels – remain central to the sector’s performance today.

While activity in the sector remains more muted than pre-2008, Jordan’s banks have shown they can grow even in challenging times. According to the CBJ, total assets for Jordan’s lenders in 2013 rose 9% year-on-year to $60.5bn. In one of the most impressive indicators for the year, total deposits rose 11% on an annual basis to $39bn, a rate four times higher than in 2012. Most of this increase (88%) came from the private sector, driven largely by residents’ response to improving domestic economic growth. While lending also increased by 7%, its slower expansion compared to deposit growth yielded a loan-to-deposit ratio of 70%, meaning Jordan’s banks have ample room to increase credit facilities in the short term. Importantly, asset quality too showed strong improvement: non-performing loans (NPLs) decreased over the first six months of 2013 to reach 7.4%, the lowest level since 2009. Banks are also better provisioned against doubtful loans than previously, showing an NPL coverage ratio of 75% as of the first half of 2013, compared to 69.4% at the close of 2012.

This rise in provisioning has been achieved without too much harm to the bottom line. While profitability remains more modest than pre-2008, the sector’s interest margin to gross income ratio rose in the first half of 2013 to 76.9%. In the same period, annualised return on assets rose 1.2% and return on equity 10.3%. As for net income, Arab Bank Group led in fiscal year 2013, posting a profit of JD346.2m ($489m), followed by the Housing Bank for Trade and Finance with JD106.9m ($151m) and Jordan Kuwait Bank with JD47.4m ($67m).

Loan Books

Lending growth remains central to banks’ development plans, so the expansion of credit facilities in 2013 was welcome news. Thanks to Jordan’s relatively diverse economy, lending opportunities arose across a range of areas. The most fruitful sector as of December 2013 was construction, which accounted for 21.6% of the sector’s total credit facilities, followed by general trade (20.8%), industry (14%), and public services and utilities (11.5%), according to Bank Audi.

One area of credit is growing faster than some industry observers wish: government securities. In recent years banks have directed an increasing amount of their liquidity into these, a trend that continued in 2013. By the end of that year, claims on the public sector, including the central government and a range of public entities, rose by 15.9% compared to 2012, to almost a quarter of total assets. Such exposure to public entities has the effect of linking Jordan’s lenders to its sovereign credit rating, and hence pegs the soundness of their balance sheets to sovereign risk metrics. The country’s location and lack of natural resources mean it is exposed to external shocks such as regional unrest or spikes in energy prices, factors which most ratings agencies account for in their analyses. As a result, despite Jordanian banks’ capital adequacy – which was 17.9% at the end of June 2013, according to the CBJ – the level of government debt on their balance sheets means that any deterioration in the sovereign rating is likely to affect the ratings of individual lenders.

SME Lending

For this reason, Jordan’s banks are keen to diversify their loan books away from corporate and government lending. As intense competition steers lenders to new sources of revenue, one area of particular interest is lending to SMEs. “Industry lending portfolios are weighted heavily on the corporate side,” Haethum Buttikhi, assistant general manager of Jordan Kuwait Bank, told OBG. “This will gradually shift as SMEs build transparency and meet lending credentials.” In part due to its long history as a refuge from regional turbulence – conflict has driven waves of Palestinians, Iraqis and Syrians into the country – Jordan has become a crucible of entrepreneurship. The potential for future credit growth in the SME segment is therefore considerable: the Jordan Enterprise Development Corporation (JEDCO) estimates that 98% of businesses in the kingdom are SMEs, which the Ministry of Trade and Industry defines as those with fewer than 250 employees and capital investment below JD30,000 ($42,378).

Nevertheless, banks have been reluctant to lend. Many SMEs fall below the levels of transparency and accountancy required for risk-based lending assessments. As a result, these receive only about a tenth of all formal loans, according to a 2012 statement by the former minister for planning and international cooperation, Jafar Hassan. Resolving this issue is of great importance for a country trying to boost economic growth. “It is my belief that the long-term growth and prosperity of the Jordanian economy will come from the SME segment,” Ahmad Abu Eideh, CEO of Standard Chartered, told OBG. Similarly, Omar Malhas, CEO of Housing Bank, told OBG, “SMEs are the backbone of all developed economies, and if we are to reach developed status, it will be by this segment alone.” The government has therefore taken steps to boost lending to SMEs in cooperation with local banks.

The first of these is the Banking Window Programme, which aims to prepare SMEs to enter formal financing and maximise their chances of securing a loan. To allay banks’ concerns about lending risk, it employs a loan guarantee scheme funded by the Jordan Services Modernisation Programme (itself co-funded by the EU), which backs commercial banks’ loans up to JD100,000 ($141,260) for SMEs or JD15,000 ($21,189) for micro-enterprises. Since June 2012, its activities have been extended into Islamic banking via the kafala programme.

In a second move, the government has inked a $70m loan agreement with the International Bank for Reconstruction and Development, which the CBJ will then lend on to licensed banks at subsidised rates to finance SMEs and micro-projects. Third, it is working to overhaul the legal framework surrounding SME financing, concentrating on four complementary axes: credit information, secured lending, insolvency law and micro-finance law. Last, SME lending will soon receive a useful fillip in the form of a new credit bureau. Scheduled for a launch in late 2014, the new body promises to greatly enhance the sector’s ability to engage in transparent, risk-based lending to individuals and the nation’s increasingly important SME sector (see analysis).

Regulation

The CBJ is charged with ensuring that this growth progresses in a prudent manner. Established in 1964 as an independent body, it has exclusive power to issue or withdraw banking licences and full supervisory authority over banks. Traditionally, it has used the standards of the US National Credit Union Administration to assess capital adequacy, asset quality, management capability, earnings and liquidity ratings. More recently, it has turned to implementing the precepts of Basel II and Basel III: as of mid-2014 all of Jordan’s banks comply with the former and are preparing themselves for the introduction of the latter.

The regulator’s prudent approach in the past means the banking sector is well positioned for such changes. The CBJ’s minimum capital adequacy ratio of 12%, well above Basel’s 8%, is met by all of the banks it has licensed. Its latest focus for reform is corporate governance, for which it issued a new set of criteria in May 2014 to ensure that “board members possess experience and competency besides guaranteeing that there is no conflict of interest”. The proposed new rules are in line with the principles of the Basel Committee on Banking Supervision, the OECD and the Financial Stability Board’s efforts to address systemic weaknesses exposed by the global financial crisis (see analysis).

Outlook

Although regional turbulence and the rapid influx of refugees since 2010 remain downside risks, Jordan’s economy has proved resilient in recent years, and the banking sector is poised to gain from what the IMF expects to be a trend of steady growth. In its most recent assessment in May 2014, the fund said it expected Jordan’s GDP growth to be 3.5% for 2014, and 4.5% a year in the medium term, while bank lending is to rise by 8.6% in 2014 and 9.6% in 2015. Banks’ ability to attract deposits over the past two years underpins much of the sector’s growth prospects, and the CBJ’s recent moves on monetary policy have helped produce a positive outlook for future credit expansion: “By cutting several key discount rates, the central bank is signalling to the banks that it is safe to lend again,” Haytham Kamhiyah, general manager of Capital Bank, told OBG. “I believe that the banks will react positively, and help to stimulate growth.” For the long term, a big question facing the sector is how Jordanian banks will expand into the wider region (see analysis). This process has already begun and is one in which the country’s geographic position could well lend it a competitive edge.