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Arab Banking Systems: Towards a Common Model?

19.06.2011Estelle Brack

Despite their differences and heterogeneity, Arab countries have much in common: Arabic as official language and dominant culture, as well as political, economic and legal influence from neighboring Western European countries and the United States. Another common feature is their banking systems which, although deep, are still vulnerable and play an insignificant role in financing the local economy. The political changes underway in some Arab countries could provide a justification for in-depth reform.

The region’s countries embarked on banking and financial sector modernization almost at the same time, firstly, following the opening up of trade for natural resource-exporting countries or at the time of their independence. This was followed, in the 80s and 90s, by macroeconomic and structural reform programs implemented within the framework of the Washington Consensus. Their gradual integration and adherence to international rules (such as those of the Basel Committee) also contributed to the modernization and development of banking sectors in Arab countries, to the extent where, today, we are talking of a convergence towards global systems. The extension of banking services, governance, risk management, development of retail banking and the financing of SME are today the primary concerns, and solutions are derived not only from the West, but also from within the region. The regional and international expansion of Arab banks, especially towards the African continent, illustrates this, with Moroccan and Lebanese banks serving as examples.

In many countries, the public sector still plays a dominant role within the banking sector, be it in terms of banking institutions or businesses that are beneficiaries of bank financing. And, even in countries where most institutions are privately-owned, competition remains low. As a result, even when stable, the financial system performs poorly, with high rates of bad debts compared to countries with similar income levels, with a large proportion of the population having limited or no access to banking services.

Furthermore, the demand for and supply of finance for small and medium-sized enterprises are not in equilibrium, and this is due, in part, to a lack of trust between the banker who does not have reliable information on the company’s health and the SMEs that are not always able to present a coherent business plan and are not always inclined to seek external financing. These are some of the priority areas that are common to countries within the region. Major initiatives have been taken to bring bankers closer to SMEs, which represents over 90% of local production.

The subprime crisis has led Gulf States to redefine the global distribution of their investments in favor of the Mediterranean region whose recent gains are higher than potential losses, with real risk estimated at only 2%. Since 2007, the Maghreb region is once more benefiting from a surge in investments from Gulf States. A testimony to this is a listing of investment projects in Maghreb countries by financial and banking institutions of Gulf States.

Arab banking systems are today still heterogeneous, but they have more in common than with other regions of the world. Bank financing is very much geared towards affluent businesses and segments of the population, concentrating the majority of their assets in countries where a significant proportion of the population lives below the poverty line. Islamic financing represents a small proportion of the financial assets; rather developed in Gulf countries, it accounts for 34%, at the most, in Saudi Arabia, and it is still marginal throughout the Mediterranean region. Given its size, it serves as a “proximity solution”, alongside microcredit which, for its part, serves very small businesses on more expensive terms and with fewer guarantees for the client, compared to the banking sector. There should therefore be a “mesocredit” solution there are many initiatives to find a solution to this dilemma; extending banking services to capture savings, refocusing credit decisions on the cash flow potential of the project to be financed in the first place and, if guarantees are needed, building a public guarantee system.

However, we should certainly not copy models tested in the West and apply them to distinctly different development goals and economic fabrics, half of which fall within the informal sector. We need to innovate, indeed re-invent, certain aspects of banking.

Handicapped by restrictive offers and a lack of confidence, the full potential of banking in the Arab region is yet to be attained in order to properly allocate considerable resources for projects that are likely to ensure the pursuit of economic and social development.

Considering that it follows a relatively homogeneous trend gives development policies a regional dimension potential, including across the entire African continent.

Systèmes bancaires des pays arabes

Estelle Brack, Assistant delegate in charge of international affairs & Senior economist for the French Banking Federation / Professor at Université Paris 2 - Panthéon Assas in the LLM in Arab Business Law.

Why do African banks lend so little?

06.06.2011Andrianova Svetlana

A recent research project at the University of Leicester funded by the Economic and Social Research Council in the UK sheds new light on the reasons why banks in Africa are excessively liquid.

Our work shows how the failure of credit markets in Africa to function efficiently might combine with institutional failures to inhibit bank lending. Credit markets can malfunction when there is a shortage of information about borrowers, either information about their propensity deliberately to default on a loan (moral hazard) or information about the true return of the investment they intend to undertake and their likely ability to repay (adverse selection). Both of these problems will discourage banks from lending to domestic customers. Rule of law can mitigate these problems. If loan contracts are easier to enforce, then borrowers are less likely to default deliberately, or to choose to engage in investments they know to be highly risky. A legal system that is even-handed, consistent and free from corruption will make it easier for banks to enforce loan contracts.

Our study shows that a certain minimum standard of contract enforcement will ensure that the market does not malfunction, however substantial the underlying moral hazard and adverse selection problems are. Below this minimum standard, the expected liquidation value of defaulted loans is so low as to discourage banks from lending.  The degree to which this happens depends on both the extent of institutional failure and the proportion of borrowers who are bad default risks, either because they are opportunistic or because they have bad projects or bad luck.
We also provide empirical evidence on the magnitude of these effects by analyzing data on default rates and asset structure for individual banks in different African countries. Specifically, we show that there is a threshold standard of regulatory quality that will effectively protect banks from any level of moral hazard or adverse selection. This minimum standard is roughly that of the average country around the world (in the World Bank’s World Governance Indicators) – that is, a country which has quite a high standard for Africa. In countries which fall below this standard – that is, most countries in Africa – an increasing rate of loan defaults is associated with increasing liquidity. In the worst cases, with almost no effective regulation and a high propensity to default, banks will channel most of their deposits into foreign assets.

Our evidence confirms that many banks suffer from a shortage of information about the creditworthiness of many of their customers. As a result, local savings are not channelled into local investment, and the money leaves the local economy.

A companion study of banks operating in the WAEMU over 2000-2005 by Demetriades and Fielding (2011) – a summary of which can be found in Table 1 - reveals that banks which are older, or owned partly by foreign banks, are less sensitive to a high rate of default in the country, and more likely to shift assets abroad or take on government debt when the default rate rises. Younger banks without any foreign or government ownership are more sensitive. One possible ex planation for this difference is that younger local banks have relatively little information about their customers, or have relatively few long-standing relationships that dissuade customers from defaulting when it is convenient to do so. Similar problems arise in banks which do a relatively large amount of business away from the main financial centre in the country. Banks committed to lending to provincial customers are more sensitive to changes in national default rates. This might be because information about customers is more expensive to acquire in the provinces, or because regulatory quality tends to be weaker there. Interestingly, there is no strong association between the sensitivity to loan default and the overall profitability of a bank. Banks which lend less to local households and businesses, and acquire foreign or government assets instead, are not significantly less profitable. The alternatives are typically much more liquid, but their average rate of return is apparently not that much lower than conventional lending. This may be part of the problem.

Table 1. Average effect of a one percentage point increase in the national default rate on a bank's loans-to-assets ratio (in percentage points).

completely domestically owned

completely foreign owned


20 provincial branches

no provincial branches

20 provincial branches

no provincial branches

1 year

-7.5 pct. pts.

-4.7 pct. pts.

-6.4 pct. pts.

-3.6 pct. pts.

10 years

-6.5 pct. pts.

-3.7 pct. pts.

-5.4 pct. pts.

-2.6 pct. pts.

20 years

-5.5 pct. pts.

-2.7 pct. pts.

-4.4 pct. pts.

-1.6 pct. pts.

30 years

-4.4 pct. pts.

-1.6 pct. pts.

-3.3 pct. pts.


40 years

-3.4 pct. pts.


-2.3 pct. pts.


Many new banks have been created in the last twenty years, but this has not led to significantly more competition in the loans market, because the younger banks lack the market information to make much money out of lending locally.

Aside from encouraging improvements in institutional quality, one way to widen access to bank loans might be through creating or increasing the number of credit information bureaux.

By Svetlana Andrianova, Reader (Associate Professor) in Economics, University of Leicester, United Kingdom,
with Badi H. Baltagi, Distinguished Professor of Economics, Center for Policy Research, Syracuse University, USA, and Professor of Economics, University of Leicester, United Kingdom
Panicos Demetriades, Professor of Financial Economics, University of Leicester, United Kingdom
David Fielding, Professor of Economics, University of Otago, New Zealand

Andrianova, S., B. Baltagi, P.O. Demetriades and D. Fielding. 2011. “Why Do African Banks Lend So Little?”, University of Leicester Working Paper No. 11/19.
Demetriades, P.O. and D. Fielding. 2011. “Information, Institutions and Banking Sector Development in West Africa, Economic Inquiry, Early View  


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