Steady returns: More sophisticated products are on offer from well-capitalised banks

Having emerged from the global financial crisis in good health, Jordan’s banking sector provided much-needed economic stability through 2011. As the government looked to finance a weak fiscal position, local banks had ample liquidity to provide credit and to maintain levels of lending to the private sector. The sector currently faces challenges in the form of increasing non-performing loans (NPLs), as well as criticism for not providing enough credit to small businesses. Still, banks largely remain profitable and low in exposure to risk.

PERFORMANCE: Of the 17 banks that had declared 2011 results by March 2012 all reported positive net profits, and total profit across these banks increased by nearly 5% on 2010. However, these profits were not evenly distributed. Arab Bank’s (AB) net income after taxes amounted to $305.9m at the end of 2011 as compared to $270.8m at the end of 2010, recording a growth of 13%. The profits of the Housing Bank for Trade and Finance (HBTF) increased from JD79m ($111m) to JD88m ($123.7m), but the majority of smaller banks recorded more stable profits. Cairo Amman Bank, which has 91 branches across Jordan and Palestine, saw its net income rise 2% from first-quarter 2011 to JD8.4m ($11.8m) in the first three months of 2012.

Figures for total assets for 2011 were not available at the time of writing, but at the end of 2010 total sector assets amounted to JD32.5bn ($45.7bn) corresponding to 167.5% of GDP. The Central Bank of Jordan (CBJ) reported a growth rate of 4.6% in total assets for the first six months of 2011, therefore, we can estimate assets stood at around JD34bn ($47.8bn) half way through the year.

DEPOSITS: Retail deposits are the largest contributor to funding Jordan’s banks. Total deposits at licensed banks stood at JD24.4bn ($34.3bn) at the end of 2011, having risen by JD1.9bn ($2.7bn), or 8.3%, on 2010. This compares with deposits of JD10bn ($14.1bn) at the end of 2003. Such a large increase usually indicates healthy macroeconomic stability and strong growth. However, for deposits to rise at a much higher rate than economic growth indicates other fundamentals at work. The primary drivers are the relatively high rates of interest offered by banks to depositors and the absence of other attractive investment opportunities.

Private sector residents drove deposits to JD19.9bn ($28bn) an increase of JD1.6bn ($2.2bn) or 8.5% on 2010, according to the CBJ. Deposits by non-residents grew by JD253m ($355.5m) to JD2.7bn ($3.8bn) and those from non-banking financial institutions rose by JD74m ($104m) to JD277m ($389.2m). Deposits of public sector institutions, on the other hand, decreased by JD16.5m ($23.2m), or 1.1%, on 2010 to JD1.5bn ($2.1bn). Private residents now account for 81.7% of all deposits and the public sector 6.3% of all deposits held in Jordan.

HIGH INTEREST RATES: One indicator of a lack of appetite to invest in the private sector is the Amman Stock Exchange. Whereas daily trading values prior to the global financial crisis hit $70.6m in 2007, this fell to just $16.3m in 2011 and dipped further in the first few months of 2012. Banks are currently able to offer depositors generous interest rates as overall interest rates are high, driven by inflation and the government’s need to borrow substantial amounts from local markets to service a tight fiscal position. With inflation at 4.3% (including government subsidies and much higher without), the government’s efforts to service its debt by selling millions of Jordanian dinars is largely responsible for pushing interest rates higher.

The rates offered on the sale of treasury bonds in 2011 were highly attractive to local banks. In August, the CBJ issued a three-year bond bearing a coupon of 7.3%, nearly 3 percentage points higher than offered in January of that year. While such high rates are good news for banks and bond-holders, this can be bad news for private sector growth as capital that could have been invested is sucked out of the system and loans to the private sector are more expensive to service.

Still, Adli Kandah, the director-general of the Association of Banks in Jordan, told OBG that the private sector had not been crowded out by this situation. “The liquidity from the banking sector to purchase government bonds has come from switching money out of international financial institutions and into loans to the public sector. Therefore, lending to the private sector has remained about the same, but lending to the public sector has increased from other sources.” In fact, Kandah said absolute lending to the private sector has increased over the long term. “Five years ago the proportion of total assets lent to the private sector was 10-12%, now it is 19%,” he told OBG.

DEBT RATIO: Public debt as a percentage of GDP increased from 61.1% in 2010 to 65% in 2011, according to figures from the Ministry of Finance. In total the government will have raised approximately JD5.4bn ($7.6bn) to cover the current account deficit. While some of this went to pay for food subsidies, household fuel allowances and an increase in pensions, a large proportion went to finance borrowing of JD670m ($941.5m) for the National Electric Power Company (NEPCO) to buy oil in the absence of regular gas imported from Egypt. The oil, most of which comes from Saudi Arabia, is considerably more expensive than gas, which explains why public debt to GDP was expanded. According to the Ministry of Finance, the aim is to reduce public debt to 64.5% in 2012, 63.5% in 2013 and 62% in 2014.

STRUCTURE: As of April 2012 there were 26 banks operating in Jordan, of which 13 were commercial, four Islamic and nine foreign. The sector is led by AB and HBTF. Reflecting the dominance of a few top banks in the market, AB alone held JD8.2bn ($11.5bn) of assets, equivalent to 24.3% of the sector, followed by HBTF with JD4.9bn ($6.9bn). The third-largest bank, the Jordan Islamic Bank, held JD2.9bn ($4.1bn) of assets. The majority of smaller banks are family-owned and although analysts point to the need for consolidation it is difficult to see this being likely in the short term as small banks are making decent profits within their current ownership structures.

Additionally, consolidations would result in 25-30% job losses from combining workforces, which would be unpopular at a time when families are looking for stable income and the government is looking to reduce unemployment. Most banks were able to comply with the CBJ’s increase of capital requirements from JD50m ($70.9m) to JD100m ($141.8m) for local banks, which took effect from the end of 2011. The move, which increased requirements to half that of foreign banks, did not encourage consolidation. Still, in the coming years the implications of stricter Basel III requirements may stimulate such discussions.

RISK ASSESSMENT: Macro level risk is commonly assessed according to the country’s capital adequacy ratios and the leverage ratio. By both measures, Jordan’s banks are well prepared for any additional stress on the banking sector. To mitigate this risk, the CBJ has set an individual bank capital adequacy ratio of 12%, well above the 8% required under Basel II guidelines. Although the ratio in Jordan’s banks declined from 20.3% to 18.2% from 2010 to 2011, largely as a result of increased lending to the public sector, it is well above international standards and has historically operated in the range of 18-21%. The CBJ is discussing the implications of adopting Basel III guidelines, although the 12.5% suggested capital adequacy ratio this entails should not be a problem for the sector. According to Basem Khalil Al Salem, the chairman of Capital Bank, “Jordanian banks have high capital adequacy ratios, which means they are well positioned to meet the new Basel III liquidity requirements.”

NON-PERFORMING LOANS: Asset quality and credit risk are more problematic for the sector, although levels are still safe by international standards. The rate of NPLs to total loans doubled from 4.2% in 2008 to 8.5% for the first six-months of 2011, according to figures released by the CBJ in January 2012. NPLs are expected to be closer to 10% by the end of 2012.

While local banks were not exposed to the toxic assets that came to light in 2008, they are starting to see higher rates of default, mostly from lending connected to real estate. CBJ figures also show banks have moved to reduce risk by boosting coverage ratios, which increased from 52.4% in 2010 to 56.3% in 2011. High levels of capital also ensure banks are equipped to deal with NPLs. Haethum Buttikhi, the assistant general manager of Jordan Kuwait Bank, told OBG, “Jordanian banks are highly liquid and were not exposed in any significant manner to the toxic assets that precipitated the financial crisis, however, there remains room for improvement when it comes to balancing risk management with lending practices that support growth in the real economy.” Buttikhi further noted that many financial institutions operate with “overly conservative” loan-to-deposit ratios of 50% to 55%.

CREDIT FACILITIES: Fuelled by increased deposits, the licensed banking sector expanded credit facilities in 2011. According to the CBJ’s January 2012 bulletin, the overall balance of credit facilities extended by licensed banks was worth JD15.9bn ($22.3bn) by end-2011, an increase of 9.7% during the year. Loans to the industrial sector saw the biggest growth, at 19.1%, while the construction sector saw a 9.3% rise in lending. Meanwhile, lending to individuals rose by 10.1% on 2010 levels. Add to this the JD7bn ($9.8bn) of credit offered by government facilities and the private sector has access to a theoretical JD22bn ($30.9bn). According to the Association of Banks in Jordan, the weighted average of loans to the private sector as a proportion of total bank assets amounts to 34%, the same as in 2008.

SME LENDING: Despite the apparent availability of credit, a long-standing criticism of the sector is that it regularly struggles to provide adequate levels of finance to small and medium-sized enterprises (SMEs) (see analysis). In the current climate, NPLs are reducing banks’ appetite for lending, and high interest rates are forcing up the cost of capital beyond what the private sector can realistically pay back. In addition, banks often ask for guarantees worth up to 100% of the loan value, considerably beyond what most SMEs can provide.

In response, several initiatives have been established to boost financing to the private sector. In October 2011, for example, the US government launched a loan guarantee fund for SMEs worth $300m through the US-run Overseas Private Investment Corporation (OPIC). The facility guarantees up to 75% of loans taken with banks outside Amman and up to 60% of loans taken in the capital. Several local banks have signed up to the scheme, which covers loans ranging from $50,000 to $2m. “Given that 99% of Jordanian businesses are SMEs, the OPIC scheme, along with other SME lending initiatives that have been sponsored by the CBJ, are key to achieving sustainable growth in the local economy,” Basem Khalil Al Salem, the chairman of Capital Bank, a boutique bank focused on corporate clients that recently launched an independent SME department, told OBG.

While the initiative will provide additional cover for lenders and satisfy high guarantee requirements, there is no control over the interest rates they offer and it is uncertain whether they will be lower than current market rates. The CBJ’s January bulletin estimated the weighted average rate for loans and advances stood at 8.7% at the end of December 2011, 34 basis points higher than at the end of 2010.

Further support is being called for by the private sector. Hatem Halawani, the president of the Jordan Chamber of Industry, made several statements in the local press to this end during 2011. “The biggest problem facing the industrial sector is the lack of financing channels that offer long-term lending, particularly to SMEs,” he said. Other industry players talking to OBG pointed to the sale of the Industrial Development Bank and its conversion to the Jordan Dubai Islamic Bank as hindering industrial development, commenting that a specialist bank that understands the sector and can provide long-term loans is needed. Facilities over seven years with rates of around 4% – half the interest rate currently available – were cited as crucial to growth.

RATING DOWNGRADE: Several banks had their credit rating downgraded by international rating agencies, mostly due to their high exposure to sovereign debt and a downgrading of the kingdom’s own sovereign credit rating. In late 2011, Standard & Poor’s lowered Jordan’s long-term local currency sovereign credit rating from BB+ to BB, expressing concern about the country’s economic and political situation. The short-term local currency rating was maintained at B, but with a negative outlook. The recovery rating was valued at four out of a possible five. Due to a high-level of exposure to sovereign debt, credit ratings were subsequently revised for some Jordanian banks.

Standard & Poor’s downgraded AB from BB+ to BB mainly due to currency instability and despite positive end of year results in 2011. HBTF was downgraded by Fitch in February 2012 from three to four, reflecting tough local operating conditions and exposure to the unrest in Syria through its subsidiary there, which represents 13.5% of HBTF’s total assets. The rating also reflects the difficult fiscal situation faced by the government, which now has less room to support banks in case of a crisis. The downgrade comes despite increased revenue and profitability for the year.

Ratings agency Fitch also downgraded the Bank of Jordan and Cairo Amman Bank from three to four. Once again, these downgrades reflected Jordan’s weakened credit position caused by higher domestic borrowing and greater fiscal debt. However, Standard & Poor’s did say that the “challenges are partially mitigated by Jordan’s close relations with donor countries supporting comparatively modest external borrowing needs”.

SOPHISTICATION: One positive outcome of the pressure on the government to raise debt is the need to better manage exposure and lower risk. This means the government is increasingly open to using sophisticated products, particularly risk-management packages.

With two large local banks and nine international banks, a greater diversity of products is now being offered as demand becomes more acute and consumers more exposed to the benefits of additional packages. For its part, the banking sector knows it can also make more revenue from selling a package of services rather than simply providing credit.

Talking to OBG, the CEO of Standard Chartered Bank, Ahmed Abu Eideh, stated that, “Although many people consider the Jordanian banking sector to be ‘plain vanilla’; in other words, traditional lenders offering simple products and services, the sector is increasingly offering clients a wider range of sophisticated products to help them better manage their risk.”

FOREIGN CURRENCY RESERVES: The CBJ’s foreign currency reserves declined further in 2011 following falling remittances and tourist revenue, a widening trade gap and lower foreign investment. At the end of December 2011 reserves had declined by 14.1% from the end of 2010 to stand at $10.5bn. At this level, Jordan’s reserves would cover over six months of imports, well above international standards which recommend reserves equal to three months of imports.

Travel receipts and payments decreased by 16.4% to JD2bn ($2.8bn) during 2011 and remittances declined by 5.2% to JD2.5bn ($3.5bn), according to the CBJ. The trade balance widened by the end of November 2011 to JD6.7bn ($9.4bn), an increase of 20.2% on 2010 according to the Department of Statistics. Foreign direct investment inflows fell over the first three quarters of 2011 to JD802m ($1.1bn) from JD975m ($1.4bn) in 2010. To reduce the level at which investors were transferring Jordanian dinars into dollars, the CBJ increased the interest rate difference between the two currencies by 25 basis points to 4.5%.

INCREASED LIQUIDITY: Domestic liquidity, or M2, stood at JD24.1bn ($33.9bn) at the end of 2011, an increase of 8.1% over the year according to the CBJ bulletin from January 2012. Such a large rise in liquidity is a result of several factors. The bulletin shows deposits increased by JD1.6bn ($2.2bn) to JD21.1bn ($29.6bn) between 2010 and 2011, a lower rate of growth than 2009 to 2010, when they rose by 12.3%. Currency in circulation also increased by 6.2% to JD3bn ($4.2bn). Net domestic assets were up by 20.7%, adding a sizeable JD2.6bn ($3.7bn). This was split between JD1.1bn ($1.5bn) held by the CBJ and JD1.5bn ($2.1bn) held by licensed banks. Offsetting this was the decline in foreign assets, which fell by 7.2% over 2011.

ISLAMIC BANKING: The kingdom’s Islamic financial services (IFS) sector includes four banks and three insurance companies, with several traditional banks also looking to offer an ever-increasing range of Islamic banking products (see analysis). The Islamic banks are Jordan Islamic Bank, Islamic International Arab Bank, Jordan Dubai Islamic Bank and Al Rajhi Bank, which is the newest entrant, having started operations in March 2011. While the domestic IFS sector is growing, it faces three major challenges. First, there are differences in interpretation among the country’s Islamic financial companies, creating a need to clarify Islamic banking principles from within the sector.

Second, the CBJ does not have the power to decide if a bank is officially Islamic, so regulation will need to be strengthened. Third, Islamic lenders are presently more expensive than conventional players. This is partly because conventional banks are better established, but also because they have more flexibility.

OUTLOOK: Jordan’s banking sector is well placed to underpin economic recovery and return the country to healthy levels of growth. The sector is well-capitalised and is introducing increasingly sophisticated products to both retail and commercial customers. As ever, stability will be the watch word and while the attraction of government bonds for private sector lending will remain steady, recent schemes should help to boost access to credit for small businesses and industry. Consolidation is unlikely in the short term, and with a large number of players in the market, competition for customers should drive further sector innovation.