Are Banks Really Lazy? Evidence from Middle East and North Africa

Contributor Notes

Authors’ E-Mail Addresses: sgray@imf.org; pkaram@imf.org; rturk@imf.org.

We investigate whether low loan-to-deposit (LTD) ratios and high levels of reserve balances at the central bank (or holdings of government securities) are a reflection of policy-driven factors compared to commonly cited reasons of reluctance to lend or sometimes weak investment demand in uncertain environments. We examine changes to central bank (CB) balance sheet structures as well as commercial banks’ flow of funds over the period 2007–2012. First, Middle East and North Africa (MENA) CBs play an active role in view of their size that is very large with respect to their economies compared to CBs in advanced economies. Second, under exchange rate targeting, most MENA CB balance sheets are asset-driven, holding foreign exchange (FX) reserves to support the exchange rate policy and resulting in lower loan-to-deposit (LTD) ratios in the case of unsterilized increases in FX. Third, CB policy decisions seem to be accompanied by an increase in commercial bank reserve money balances, with ensuing reduction in the LTD. Finally, if governments meet their financing needs from the banking system—whether from commercial banks or by monetary financing—commercial bank balance sheets will tend to expand, resulting in lower LTD ratios. Our analysis suggests that government and CB actions may also drive the demand for and supply of credit, which are traditionally attributed to the behavior of banks and non-financial corporates and households only. The findings offer a different interpretation of changes in CB and banks’ balance sheets, with direct implications for LTD, calling to exercise caution in recommending policy action which aim at propping up LTD to ‘appropriate’ levels in an effort to reinvigorate credit following a downturn.

Abstract

We investigate whether low loan-to-deposit (LTD) ratios and high levels of reserve balances at the central bank (or holdings of government securities) are a reflection of policy-driven factors compared to commonly cited reasons of reluctance to lend or sometimes weak investment demand in uncertain environments. We examine changes to central bank (CB) balance sheet structures as well as commercial banks’ flow of funds over the period 2007–2012. First, Middle East and North Africa (MENA) CBs play an active role in view of their size that is very large with respect to their economies compared to CBs in advanced economies. Second, under exchange rate targeting, most MENA CB balance sheets are asset-driven, holding foreign exchange (FX) reserves to support the exchange rate policy and resulting in lower loan-to-deposit (LTD) ratios in the case of unsterilized increases in FX. Third, CB policy decisions seem to be accompanied by an increase in commercial bank reserve money balances, with ensuing reduction in the LTD. Finally, if governments meet their financing needs from the banking system—whether from commercial banks or by monetary financing—commercial bank balance sheets will tend to expand, resulting in lower LTD ratios. Our analysis suggests that government and CB actions may also drive the demand for and supply of credit, which are traditionally attributed to the behavior of banks and non-financial corporates and households only. The findings offer a different interpretation of changes in CB and banks’ balance sheets, with direct implications for LTD, calling to exercise caution in recommending policy action which aim at propping up LTD to ‘appropriate’ levels in an effort to reinvigorate credit following a downturn.

I. Introduction1

Bank credit is crucial for financing investments and achieving higher levels of economic growth and employment (Levine, 1997; Levine and others, 2000). In predominantly bank-based financial systems, external sources of financing are limited to securing funding from deposit-taking financial intermediaries, as capital markets lack depth and breadth. Generally, lower financing is attributed to banks’ reluctance to lend, and in standard credit models, the ability to invest is determined by binding credit constraints (Bernanke and Gertler, 1989; Kiyotaki and Moore, 1997). Furthermore, rising risk may reduce firms’ willingness to borrow and engage in new investments (Aghion and others, 2010). In brief, financing conditions may reflect the particular lending behavior of banks on the supply side (risk averse, conservative, or even ‘lazy’) or mirror weak investment demand by borrowers.

In this paper, we postulate that overall credit conditions in the economy may be a reflection of policy-driven factors compared to commonly cited reasons of reluctance to lend or weak investment demand in uncertain environments. In their conduct of fiscal and monetary policy, governments and CBs may add to the perception (or reality) that banks are lazy because policy actions result in changes to the portfolio composition of commercial banks. An expansion in banks’ holdings of government securities and greater reserve balances at the CB mechanically translate into a lower LTD ratio, a metric that is often used to assess the lending practices of commercial banks. Does this mean that banks are being lazy, investing deposits in risk-free assets rather than engaging in credit extension in support of economic growth resumption in a downward cycle? Or are there other interpretations to observed low LTD ratios?

In the wake of the global financial crisis (GFC), weak growth in credit remains a significant concern. Credit revival has varied widely across different regions of the world (IMF World Economic Outlook, October 2013). Slow economic recovery was particularly pronounced in the Euro area, notwithstanding different policies that have targeted credit creation through either enhancing credit supply or supporting credit demand (IMF Global Financial Stability Report, 2013); such sluggish recovery in the Euro area has impacted Middle East and North Africa (MENA) countries (Maghreb countries, in particular) in light of strong tourism, goods trade, and remittance linkages.

In the MENA region, a number of countries undergoing major transformations prompted by the ‘Arab Spring’ events continue to face major socio-economic challenges. The latter differ in nature, when the larger MENA group of countries is examined. As such, and in enabling a more adept analysis, countries are grouped accordingly in two main groups, namely (i) oil-importing (OM) (Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia); and (ii) oil-exporting (OX) economies. The latter group is further distinguished as OX-Gulf Cooperation Council countries (OX-GCC) (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates) and OX-Non-GCC countries (Algeria, Iraq, Libya, and Yemen). Despite closer growth rates between OX and OM countries expected in 2013–2014, the underlying economic performance of the two groups varies greatly, reflecting different economic, monetary, and financial developments, and risks (IMF Regional Economic Outlook—Middle East and Central Asia (IMF REO- MCD), May 2013). In OM countries, mounting pressures from sluggish economic activity in trading partners, declining exports, capital outflows, anemic FDI, and tempered tourist arrivals have exerted a drag on foreign reserves. Furthermore, fiscal policy space has been significantly reduced, with rises in deficits and debt, resulting from weakened revenues (a consequence of weak economic activity) and high subsidies and wage bills (which were raised in efforts to address social demands and lessen the impact of high international prices for food and energy). In OX countries, increasing vulnerability to prolonged oil revenue shocks may weaken fiscal and external positions: this reflects current increases in hard-to-reverse expenditures (such as wages and subsidies), and declining current account surpluses, notwithstanding a near-term positive outlook owing to continued robust non-oil GDP growth.

In regaining macro stability and achieving sustainable and inclusive growth over the medium-term, fostering private sector-led growth is key.2 Building private sector confidence is however challenging as it requires, among other things, access to vital credit in support of economic activity, in a region where funding sources are predominantly channeled through the banking system and equity and bond markets remain underdeveloped.3 So how can enabling credit be secured to meet this objective, unclogging channels of credit for cyclical (downturn) or other structural and institutional reasons impeding the flow of credit? To answer this question, past analyses of weak credit growth in MENA have been attributed to both demand (weak economic activity and uncertainty about investment prospects) and supply (cutback in domestic and external funding and increased strains on banks’ balance sheets) factors (IMF REO-MCD, 2010).4 A fitting study by Barajas and others (2010) decomposes credit growth rates across MENA into changes to balance sheet accounts relative to the initial level of credit to the private sector and identifies cautious bank funding as the reason behind credit stagnation, suggesting that credit recovery hinges on improved banks’ balance sheet conditions and a stabilizing macroeconomic environment. The study further attributes low LTD ratios across a number of MENA countries between 2008 and 2010 to bank funding difficulties, unwillingness to extend credit following macroeconomic and regulatory uncertainty, and lackluster loan demand under weak macroeconomic conditions. While there are reasons to believe that both demand and supply factors play in role in restraining credit, absence of lending surveys and borrower-bank matched data make it difficult to disentangle demand and supply factors to help guide policymaking.5

In this paper, we explore credit developments in MENA, focusing on level rather than percent changes in loans, and provide a thorough analysis of the LTD ratio as a metric to gauge credit conditions. A key stylized fact (see section 3) indicates that ratios are relatively low in comparison with other regions of the world. While LTD ratios can mirror changing funding sources or different loan risk exposure by banks (Demirgüc-Kunt and Huizinga, 2010), the prototype analysis is further extended to incorporate the likely effect of banks’ holdings of government securities or FX reserve management policy, where ratios tend to be lower under larger holdings of government securities or higher level of excess reserves. In the MENA case and to varying degrees, we will show that low LTD ratios can be justifiably attributed to official policies which notably result in high borrowing by some governments and CB build-up of FX reserves.

To investigate whether low LTD ratios are indeed a manifestation of say government and monetary financing in a group of MENA countries, we examine the balance sheet structures of MENA CBs and commercial banks and hypothesize that policy actions may either allow for more credit to the private sector or alternatively displace it. The relevant question is whether increased commercial banks’ balances with the CB complement or substitute for private sector lending? Changes in reserve balances must reflect policy decisions by the authorities, and to this extent, complementarity rather than substitution appears more likely, a priori. As for policy recommendations, we advise to exercise caution in adopting policies that are motivated by observed low LTD ratios in the banking sector without undergoing a nuanced analysis of the sources of trends in LTD attributed to a myriad of behavior and policies in various government and non-government sectors.

The paper is structured as follows. Section 2 presents an overview of MENA’s main macroeconomic, monetary, and financial sector developments including credit and banking conditions. Section 3 discusses CB asset-and liability-driven balance sheet structures and changes therein between 2007 and 2012. Section 4 discusses the effect of policy decisions on LTD ratios, focusing on both government and CB actions, while Section 5 investigates changes to the balance sheet structures of commercial banks in MENA which can shed light on LTD behavior. Section 6 concludes.

II. MENA Overview

A. Macro, Monetary, and Financial Sector Developments6

Table 1 shows real growth rates for MENA, OM, and OX countries. Between 2007 and 2012, MENA’s economic performance was increasingly characterized by a two-speed growth, with OX growing at twice the pace of OM in 2012: OX countries grew at healthy rates while OM faced subdued economic prospects. In GCC countries, growth was robust, supported by expansionary fiscal policies and accommodative monetary conditions (reflecting the peg to the US dollar, and thus to an accommodative monetary policy). In the context of booming oil prices and growing social demands, stepped-up government spending (including hard-to-reverse wages and salaries) has meant that fiscal breakeven oil prices have risen faster than the actual oil prices and are expected to continue to rise, increasing vulnerability to negative and protracted oil-price shocks.7 Gradually saving more and reducing spending rigidities will strengthen fiscal resilience to oil-revenue shocks. In OM, the slowdown witnessed in 2011 has persisted in 2012 with a moderate recovery expected in 2013, subject to heightened downside risks. For Arab Countries in Transition (ACTs), ongoing political transitions have weighed on growth.8 With policy buffers (fiscal and external) largely eroded, the need for action on both macroeconomic stabilization and growth-oriented reforms is becoming increasingly urgent.

Overall, Table 1 points to declining real growth rates in GDP between 2007 and 2012, and slow economic growth may explain, at least partially, weak credit conditions. Previous analyses of credit boom-bust cycles in MENA indicate that, on average, it takes three years for private sector credit growth to recover to normal rates following a credit bust (IMF, REO-MCD, 2010).

Table 1.

MENA Real Growth Rates

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Source: Figures for 2007–2011 are authors’ calculations using data from the International Financial Statistics and figures for 2012-2014 are from IMF REO-MCD (November 2013).

In 2013, differences in a two-speed region are expected to narrow and modest growth is expected across the region—albeit, underlying performance varies greatly.9 OX healthy growth rates are projected to moderate and OM (many of whom are ACTs) subdued growth is expected to improve only somewhat in 2013, while still well below potential. Resolute policy action, across the region, will be needed going forward. In many OM, greater fiscal consolidation and exchange rate flexibility will be necessary to preserve macroeconomic stability, instill confidence, improve competitiveness, and mobilize external financing. For OX, further strengthening of fiscal and external positions will be important to reduce their vulnerability to a potential material oil price decline.

One other important macro variable reviewed is inflation given its association with policies weighing in on LTD determination. In OX-Non GCC countries, inflation drivers have been diverse, including conflict (Libya) and expansionary policies (Algeria). In Yemen, CB financing of fiscal imbalances has often contributed to monetary growth and inflation. Iraq experienced rapid government-driven monetary growth in 2011, but the level of credit extension to the economy is still low and measured inflation there remains the lowest among the OX-Non GCC. Moderating food and import prices and a benign global inflationary environment are expected to help ease inflation in these countries. In OX-GCC countries, inflation is starting to rise but remains moderate (from 2.4 percent in 2012 to 3.2 percent in 2013). Monetary aggregates have generally expanded at a slower pace than reserve accumulation (large balance of payments surpluses generated by commodity-price booms). Figure 1 depicts the growth rate in private sector nominal credit across OX-GCC and OX-Non GCC countries. Broad money growth and private sector credit growth have increased and are even accelerating, probably a result of the accommodative monetary conditions that are largely the result of low interest rates in the U.S., pegged exchange rates, and the absence of alternative monetary instruments.

Figure 1.
Figure 1.

Private Sector Credit Growth

Citation: IMF Working Papers 2014, 086; 10.5089/9781484386460.001.A001

Source: IMF REO-MCD, November 2013

As for OM, inflation is expected to rise in Egypt, Jordan, Morocco, and Tunisia, reflecting recent and planned subsidy cuts and, in some cases, pressure from monetization of fiscal deficits and supply shortages. In other countries, tempered domestic demand and declines in certain food prices are likely to subdue inflation in the near-term future.

B. Credit and Banking Conditions

A brief analysis of the select variables above aims at providing a needed understanding of the surrounding macroeconomic conditions during the focus period of the paper and a segue to the discussion that follows. As such, this section presents stylized facts about credit and banking conditions in MENA relative to other regions of the world. Table 2 provides insights about these conditions to help us identify ingredients for analysis of the LTD behavior, with definition of variables relegated to Appendix I. What clearly stand out are the following observations: First, the role of governments in credit markets is largely visible in MENA countries. On average the ratio of bank-intermediated credit to government and state-owned enterprises to GDP is close to 18 percent compared to averages ranging between 4 and 14 percent in other regions. Second, comparing ratios of deposits and credit to GDP, most OX-GCC countries provide credit at a faster pace than their ability to raise deposits. This pattern is akin to high-and upper middle-income countries, suggesting greater reliance on non-deposit or wholesale (including cross-border) sources of funds. As for other non-GCC countries, most exhibit bank credit to deposits ratios below 100 percent (with the exception of Mauritania and Tunisia), with the MENA region overall ranking second from the bottom of the list (average credit to deposits ratio of close to 77 percent).10

Table 2.

Stylized Facts on Credit and Banking Conditions, MENA vs. Other Regions, 2007–2011*

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Source: Global Financial Development Database, World Bank, April 2013, except for Bank credit to bank deposits for Saudi Arabia (from the IFS).

The last available year in the WB Global Financial Database is 2011.

Third, on average the share of liquid assets to deposits and short term funding is highest in the MENA region (close to 42 percent) exceeding a world ratio of 32 percent. However, this average masks the lowest average registered in the OX-GCC group (at only 25 percent). This may reflect reserve balances (high quality liquid assets) at the CB, which for the banking system as a whole are a product of CB policy actions. While pointing to a better liquidity position for MENA, these figures may also suggest missed investment opportunities for banks in the region.

Fourth, loan portfolio quality in OM economies is on average worse than the world average (8.2vs. 3.6 percent for the ratio of nonperforming loans (NPLs) to gross loans); provisioning is generally in line with world figures; but the lending-deposit spread is lower than the world average (5.2 vs. 6.3 percent). High NPLs and low spreads in OM may be indicative of ‘under-pricing’ of loans, suggesting that credit risk management practices could be lagging in OM economies compared to others. In OX-GCC economies, the lending-deposit spread is narrower (3.9 percent) compared to OM (5.2 percent) and OX-Non GCC (5.1 percent) countries, and it corresponds to the average figure for high-income countries. If lending in OX-GCC economies is supported by direct debiting of government salaries, the relatively low risk involved may justify a lower interest spread compared to other regions. Low credit spreads over deposits for OX-GCC countries also result in narrower interest rate margins on average (2.9 percent) compared to OX-Non GCC economies, albeit higher than the average for high-income countries (2.2 percent).

III. MENA Central Banks—Salient Features

A. Asset-and Liability-driven Central Bank Balance Sheets

We first draw an analogous distinction between asset- and liability-driven balance sheets in the case of financial intermediaries, exemplified by banks. Where the latter have a strong (retail) deposit base and determine their loan portfolio (and particularly interbank lending) in accordance with their deposit funding capacity, then own balance sheets are known to be liability-driven. They are asset-driven when banks market loans and fund the loans by borrowing in wholesale markets. Similar balance sheet distinction applies in the CB case, with implication on liquidity provision in the banking sector.

In what follows, the main assets and liabilities of CBs are highlighted: on the asset side, foreign assets, credit to government (in the form of overdraft, or holding of government securities), and credit to banks via open market operations (OMO) or in some cases Lender of Last Resort (LOLR) funding; on the liability side, currency in circulation, government deposits, commercial bank deposits (reserve money balances), and in some cases term deposits or CB bills.

Under a CB liability-driven balance sheet, currency in circulation and reserve money balances are large, determining the overall balance sheet size and the CB has more freedom to select its assets. As such, when demand for currency is strong (over 50 percent of liabilities) buttressed by CB credibility, a liability-driven balance sheet allows the CB to choose how to provide liquidity to the banking system; banks need to buy the banknotes from the CB via OMO credit, outright purchase of government bonds, or building up FX reserves.

On the other hand, an asset-driven CB balance sheet prevails under the following circumstances: the CB is subject to fiscal dominance (its credit to government is dictated by government borrowing needs, not by its choice); the CB in supporting a particular exchange rate policy maintains a sizeable amount of FX in its official reserves; the CB engages in targeted/subsidized lending to sectors of the economy, or in Lender of Last Resort (LOLR). In these cases, CB assets may exceed the economy’s demand for reserve money (currency in circulation and banks’ reserve balances), resulting in ex-ante surplus of reserve money.

Two examples of an asset-driven balance sheet structure follow. First, the advent of Quantitative Easing (QE) by Advanced Economies (AE) CBs, targeting long-term interest rates, has led to balance sheets becoming asset-driven. When zero lower bound (ZLB) nominal short-term interest rates constrain CB conventional monetary policy, the purchase of long-term assets is then geared to affect longer-term yields and interest-sensitive investment. Second, from an exchange rate policy perspective, a CB balance sheet is asset-driven in the case of CB FX purchase to lean against exchange rate appreciation; such CB asset purchases then drive the balance sheet total.

Recent country examples of CB asset-driven balance sheets include: GCC CBs purchasing FX to maintain an adopted exchange rate peg; the U.S. Federal Reserve (US-Fed) using QE; the Swiss National Bank (SNB) buying FX to lean against exchange rate appreciation; and other CBs conducting LOLR operations (e.g., Central Bank of Chile)—see IMF Policy Paper, October 2013.

To recap, the interest in identifying whether CB balances sheets are asset- or liability-driven stems from its implication on banking sector liquidity provision. Under a liability-driven case, reserve money is supplied strictly to meet demand and the CB tends to be in a strong position to determine the terms (i.e., the price) on which it meets demand. By contrast, if its balance sheet is asset-driven, there will typically be an excess supply of liquidity in the market and the CB role as a monopoly supplier of liquidity weakens.

B. Central Bank Balance Sheet Structures

Table 3 depicts CB balance sheet structures at two points in time (before the GFC in 2007, and five years later in 2012) in AE countries (Panel A); and in MENA countries (Panel B), divided in OM (Panel C), OX-GCC (Panel D), and OX-Non GCC (Panel E) countries. It also reports the size of CB balance sheet assets relative to GDP. With the advent of the GFC, a number of AE CBs engaged in asset purchases, considerably expanding their balance sheets between 2007 and 2012. The US-Fed, the SNB, and the Bank of England (BoE) doubled or even tripled in size relative to GDP, and assets of the Bank of Japan (BoJ) and the European Central Bank (ECB) rose by 40 and over 80 percent as a proportion to GDP, respectively. As for MENA CBs, not all of them experienced an increase in the share of assets to GDP between 2007 and 2012; on average, their size with respect to the economy are generally in line with (or larger than) most AE CBs (with the exception of SNB as of late). However, zooming in on individual CBs, Algeria, Lebanon, Libya, and Saudi Arabia (where FX assets drive the balance sheet) are much larger relative to GDP in comparison with AE CBs.

Table 3.

(A–E) Structure of Central Bank Balance Sheets—2007 and 2012

(in percent of total and of GDP)

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Note: SNB stands for Swiss National Bank.Source: Authors’ calculations using data from the International Financial Statistics.

At the beginning of the GFC, demand for reserve money rose sharply and CBs responded by lending to commercial banks, as part of normal liquidity management in response to a change in demand. In a number of AE countries (Panel A), while demand subsided with improving macro conditions, some CBs continued balance sheet expansion under an unsteady economic recovery. In AE, QE resulted in larger balances of government (or government-guaranteed) securities, where in the case of the US-Fed, adding “other securities” (which includes mostly government-guaranteed agency securities) to “government securities” points to very large government balances on the CB asset side. In the euro zone, the ECB expanded credit provision to banks as market fragmentation meant they could no longer fund themselves from the market. In Switzerland, the CB has leaned against currency appreciation and increased its FX reserve balances. Across all AE CBs, commercial bank balances held with the central bank increased substantially between 2007 and 2012, suggesting that commercial banks are currently holding significantly more excess reserves than they used to.

Similar to AE-CB more recent balance sheet structure, most MENA CB balance sheets are also asset-driven, mainly the result of largely accumulated FX reserves rather than long-term assets (a more rampant case in AEs). This is evident in Panel B, with large FX reserves dominating CB assets, albeit registering marginally a small decline between 2007 and 2012 in OX economies (Yemen and UAE are an exception having exhibited substantive declines). On the liability side, deposits from governments and capital balances are markedly higher in MENA than in AE. In OX countries, oil revenues can afford governments to hold higher cash balances with some balances being FX-denominated. In OM economies, FX assets prevail but to a lesser extent when compared to OX.11 Across MENA countries (and at the SNB), the counterpart of dominant FX-denominated assets in MENA takes the form of liquidity-draining operations (such as term deposits from commercial banks, or issuance of CB bills) or, in some cases, simply excess free reserve balances (Gray, 2011).12 Similar to AE CBs, commercial bank deposits have increased across most economies, except for some countries in transition (Egypt, Tunisia, and Yemen) and other countries for reasons related to spillovers from the GFC (Morocco, Qatar, and UAE).

Furthermore, in a select group of OM countries, CBs have demonstrated striking changes between 2007 and 2012, moving from a situation of structural excess liquidity towards balance or even a structural shortage (at a time where many AE countries have moved in the opposite direction). In Egypt, Morocco and Tunisia, notable modifications to CB balance sheets since early 2011 (earlier in the case of Morocco) included a reduction in the proportion of FX assets (as some reserves have been used to stabilize the exchange rate in difficult circumstances) that is offset by a change in net lending to banks.13 This has typically involved a drawdown of excess reserves initially, but with excess reserves dwindling, the CB increased its lending to banks. Indeed, the sale of official FX reserves (for e.g., in the face of capital outflows) drained surplus reserve money balances from the commercial banks (because commercial banks have to pay for the FX), in some cases leaving the banking system with an ex-ante shortage of reserve money and thus a need to borrow from the CB. In such conditions, the CB became a regular supplier of liquidity to the market, operating a liability-driven balance sheet. As long as this lending is conducted as an OMO (rather than as LOLR finance), the CB’s monetary policy interest rates tend to become more effective; at least in this context, such rebalancing of the CB’s balance sheet could be seen as a positive development.14

More recently, it has become clear that the benefits of a move to a liability-driven balance sheet may be fragile, generally speaking. To the extent that MENA CBs (and other emerging market economies (EMEs) CBs such as Brazil, India, South Africa and Turkey) experienced FX inflows as a consequence of QE in AE countries, an unwinding of QE would expect to lead to a reversal of flows. To draw on an earlier episode (May and July 2013), even a hint of near-term tapering of QE in the U.S. led to capital outflows from a number of EMEs, as international investors sought to get ahead of the game—buying U.S. dollar in anticipation of a dollar appreciation, and moving into relatively short-term (up to three-year maturity) U.S. government securities (but not into longer-term bonds, as the prices of longer-term securities are expected to fall over time as and when QE unwinding results in higher yields). Such previous hints that the US-Fed was set to reduce, or taper, its purchase program had caused turbulence in EMEs. More recently, the December announcement of the Fed’s gradually ending its bond-buying program during 2014 was met with relative calm in EMEs, suggesting that half a year of ‘talk’ from the Fed had prepared the ground well. This said some analysts are warning that the road ahead may be bumpy in a beginning of the end of easy money period.

IV. Policy Decisions and Loan-To-Deposit Ratios

In this section, we review how government and CB actions may affect the balance sheet structure of the latter and of the banking sector. In the process, we investigate whether observed low limited LTD ratios can be ascribed to government and monetary financing, separately from credit demand and supply conditions—independently of firms’ demand for credit behavior and/or and banks’ reluctance to lend under an uncertain environment or for possibly being ‘lazy’.

A. Government Actions and Loan-to-Deposit Ratios

When the government runs a budget deficit, and to the extent that the banking sector intermediates between the public sector and the private sector savings that finance it, government borrowing by definition results in an increase in commercial bank holdings of government securities. Banks will generally hold government bonds in their asset portfolios if yields are rising and when state-owned banks control a larger share of the market. If government borrowing intermediated by the banking sector grows faster than bank lending to the economy, then credit to the economy, as a percentage of total lending, falls and the LTD drops; this does not necessarily imply that the level of credit to the private sector has dropped.15

To shed further light on this, Table 4 shows the evolution of the share of gross claims on government to domestic claims in MENA countries averaged yearly and covering the period 2007Q1–2012Q4.16 In countries like Egypt, Jordan, Sudan, and Yemen, a clearly emerging upward trend in this share, can be attributed to deteriorating fiscal balances and a pullback of capital inflows by investors; as a result, the government increased its borrowing from the domestic economy with much of the increased government spending was financed by domestic sources (IMF REO-MCD, 2012). Indeed, Figure 2 shows that government financing in Egypt and Jordan has spiked, with greater reliance on domestic financing as external financing turned negative. In Bahrain and Qatar, the share of government credit has risen significantly over 2007–2012, albeit for different reasons having possibly to do with an increase in government-sponsored projects in the economy.

Table 4.

Evolution of the Share of Gross Claims on Government to Domestic Claims, (2007Q1–2012Q4)

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Source: Authors’ calculations using data from the International Financial Statistics.
Figure 2.
Figure 2.

Financing of Government Deficit—2010–2011, Selected Countries

(percent of GDP)

Citation: IMF Working Papers 2014, 086; 10.5089/9781484386460.001.A001

Source: IMF REO-MCD, April 2012.

On the implication of excessive reliance on domestic financing and its likely impact of private sector credit, in addition to its statistical impact on LTD ratios, such reliance in a low-growth environment could crowd out credit to the private sector, put pressure on domestic interest rates (as in Egypt already), worsen fiscal positions, and further slow the recovery…” (IMF REO-MCD, 2012). While such a ‘crowding out’ is apparent, it is important to understand how it is manifested. To the extent that credit to the sovereign carries zero risk weighting for capital adequacy purposes, lending to the government does not ‘use up’ commercial bank capital resources.17 Similarly, if government assets are included in the definition of high quality liquid assets (HQLA), there should be no constraints in terms of liquid asset holdings: if government securities are all counted as liquid assets, their purchase will increase a commercial bank’s ratio of liquid assets to total assets. As banks intermediate government borrowing from the economy, higher deposits held by banks will imply a higher reserve requirement; but it is relatively uncommon that reserve requirements are binding in situations where there is excess reserve money in the market. This leaves two ways through which crowding out may impact the economy: First, via an interest rate channel where additional government borrowing is likely to push up term interest rates, making it more expensive for other borrowers to obtain credit, and thereby ‘crowding them out’ of the market; second, if government assets are funded by sight deposits (or short-term wholesale market borrowing), there may be a maturity mismatch which limits the banks’ appetite for additional long-term assets. Banking supervisors normally set maturity mismatch limits, restricting commercial banks’ ability to engage in liquidity transformation; and even if they did not do so, prudent treasury management at commercial banks would still limit this activity. Recent evidence on the crowding out effect indicates that large fiscal deficits in OM (8.4 percent of GDP on average in 2012) “… raised public debt, and in some cases, were financed by domestic banks, which strained their capacity to lend to the private sector…” (IMF REO-MCD, May 2013).

On the implication of excessive reliance on domestic financing and its likely impact of private sector credit, in addition to its statistical impact on LTD ratios, such reliance in a low-growth environment could crowd out credit to the private sector, put pressure on domestic interest rates (as in Egypt already), worsen fiscal positions, and further slow the recovery…” (IMF REO-MCD, 2012). While such a ‘crowding out’ is apparent, it is important to understand how it is manifested. To the extent that credit to the sovereign carries zero risk weighting for capital adequacy purposes, lending to the government does not ‘use up’ commercial bank capital resources.18 Similarly, if government assets are included in the definition of high quality liquid assets (HQLA), there should be no constraints in terms of liquid asset holdings: if government securities are all counted as liquid assets, their purchase will increase a commercial bank’s ratio of liquid assets to total assets. As banks intermediate government borrowing from the economy, higher deposits held by banks will imply a higher reserve requirement; but it is relatively uncommon that reserve requirements are binding in situations where there is excess reserve money in the market. This leaves two ways through which crowding out may impact the economy: First, via an interest rate channel where additional government borrowing is likely to push up term interest rates, making it more expensive for other borrowers to obtain credit, and thereby ‘crowding them out’ of the market; second, if government assets are funded by sight deposits (or short-term wholesale market borrowing), there may be a maturity mismatch which limits the banks’ appetite for additional long-term assets. Banking supervisors normally set maturity mismatch limits, restricting commercial banks’ ability to engage in liquidity transformation; and even if they did not do so, prudent treasury management at commercial banks would still limit this activity. Recent evidence on the crowding out effect indicates that large fiscal deficits in OM (8.4 percent of GDP on average in 2012) “… raised public debt, and in some cases, were financed by domestic banks, which strained their capacity to lend to the private sector …” (IMF REO-MCD, May 2013).

B. Central Bank Actions and Loan-to-Deposit Ratios

In addition to government financing, CB actions may also drive LTD ratios to lower levels through either a policy of monetary financing, QE, and FX reserves management. Appendix II provides illustrative numerical examples of the effect of government and CB actions on the balance sheets of both CB and commercial banks.

First, when the CB lends to the government (i.e., engages in monetary financing), customer deposits at commercial banks increase as the government spends the money (with LTD ratios falling mechanically), and both CB and commercial bank balance sheets increase correspondingly (see Table 13 in Appendix II). It is assumed that some of the government expenditure stimulates additional demand for currency in circulation and that some demand feeds through to imports, so that the CB sells part of its FX reserves to stabilize the exchange rate (and/or allow banks to maintain their net open FX position as customers buy FX from the banks). In this case, bank deposits fall when customers buy the FX. Some MENA countries have experienced such a combination of monetary financing of government coupled with a drawdown in FX reserves; the overall impact will depend on the relative scale of the monetary financing and drawdown of FX reserves.

Second, QE directly affects commercial bank reserve balances at the CB. If policy rates drop to as low as half a percent or below, most CBs judge that the ZLB has effectively been reached, inciting a motive to start purchasing long-term assets. As bank reserves balances rise, the ratio of credit to the economy to deposits (the LTD ratio) falls, for reasons that are quite distant from other more obvious reasons such as banks’ reluctance to lend.

However, on the issue of ZLB and QE in EMEs, no country has reached the ZLB in its policy rates, though some have come very close.19 As long as nominal policy rates can be adjusted downwards, there is no clear justification for QE policies.20 This said, regardless of whether CBs in EMEs (including MENA’s) has pursued QE policy, the risks of spillovers from QE policies in AEs mount in an integrated world. Investors in AEs, having sold medium- to long-term government securities to the CB, may not maintain all of the funds in sight deposits at a commercial bank earning a very low or even zero return and assuming some credit risk. In their hunt for higher yields, they are likely to move into assets with a positive return, including investing in good quality assets in EMEs. As a result, EME CBs then need to manage the consequent FX inflow, normally purchasing some of it at least. Other things equal, this may depress short-term interest rates and statistically depress LTD ratios of commercial banks if CB’s purchase of FX is not fully sterilized.

In the case of MENA, spillover effects from QE undertaken elsewhere around the world have not been felt, as the region experienced, on average, net portfolio outflows contrary to other EME receiving large inflows.21 In OM, prevailing low economic confidence led to net portfolio outflows22 and increases in average yields; in OX, however, net portfolio outflows were a result of investment patterns of sovereign wealth funds.23

Third, and perhaps as important as QE is for some AE, the exchange rate is a significant factor in policy considerations for most MENA countries that have opted for a pegged exchange rate regime in some form or other. Many CBs in the region support the exchange rate policy by holdings of FX reserves and their operations are geared towards managing the impact of a structural excess of reserve balances (notwithstanding a short-lived liquidity shortage in some OM countries). The CB may intervene as a buyer of FX to lean against exchange rate appreciation, mopping up the extra FX, and building its FX reserves, thereby increasing market liquidity. Alternatively, the CB may intervene as a seller of FX to lean against exchange rate depreciation.

Similar to the impact of QE, a decision not to fully sterilize net increases in FX reserves will directly affect commercial bank reserve balances at the CB. When capital inflows increase (or the demand for local currency rises), the supply of foreign currency increases and commercial banks FX reserves also expand. To lean against currency appreciation, the CB buys FX, which increases commercial banks reserves balances. In this case, the LTD ratio falls because of the balance sheet expansion of commercial banks, as there is no change to the absolute level of customer loans.

The fact that asset purchases add to commercial banks’ reserve balances, increasing the volume of surplus reserves, suggests that bond purchases would not be appropriate for MENA CBs that operate a managed exchange rate policy. Instead, regular purchases of FX when there are current or capital account inflows have some parallels with QE for exchange rate targeters, in that they result in an expansion of commercial bank reserve balances which, other things equal, depress market interest rates. However, the goal is not to depress the whole of the yield curve as with QE, but rather to support an exchange rate policy.24 Except for Egypt, Mauritania, Somalia, and Yemen, MENA countries use the exchange rate as the nominal anchor for their monetary policy framework (IMF, Annual Report on Exchange Rate Arrangements and Exchange Restrictions, 2011). To better understand the CBs’ ability to support the exchange rate policy, Table 5 shows the evolution of net foreign assets (NFAs) in proportion to total CB assets averaged each year over 2007Q1–2012Q4.

Table 5.

Evolution of Central Bank Net Foreign Assets to Total Assets in MENA, 2007Q1–2012Q4

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Source: Authors’ calculations using data from the International Financial Statistics.

Table 5 indicates that CB holdings of NFAs differ significantly among OX and OM countries. OX CBs hold a higher ratio of FX assets to total compared to OM, with regional averages of 89 and 87 percent of CB assets, respectively, for OX-non-GCC and OX-GCC countries compared to 42 percent for OM countries. Higher oil receipts in OX countries have sustained a high level of foreign reserves at CBs. Among these countries, however, the UAE and Yemen have experienced a pronounced drop in NFA (more than 38 and 55 percent decrease, respectively) over 2007-2012.25 The run down on FX reserves is also evident in Egypt, Morocco, and Tunisia (a decrease of 20, 30, and 29 percent, respectively, in their share of assets) between 2007 and 2012. The decline in NFA in OX can be attributed to recent oil price increases, loss of foreign direct investment in Arab Spring countries, and low tourist receipts. Morocco’s large decrease in NFA has resulted in part from a bad harvest in 2012 but—more importantly—reflects trend deterioration in the current account over a number of years. In contrast to the run down on foreign reserves in some cases, NFA in Iraq and Lebanon have increased cumulatively by more than 50 percent during that period, and Mauritania registered a surge in NFA that turned positive in 2012 buoyed by a rise in mineral and fishing export proceeds.

To touch on regulatory policies’ likely impact on banks’ preferences, a zero capital adequacy weighting typically applied to credit to government in domestic currency, coupled with a relatively high return on credit to government, may give banks added incentive to intermediate between savers and the government. This will expand their balance sheets and by doing so—mechanically—reduce the LTD ratio. However, this does not necessarily reduce the level of lending to the private sector, just its share under such expanded balance sheet.26

In this section, providing a more nuanced look at a falling LTD ratio due perhaps to Government and CB policy actions, would lead a casual reader to withhold judgment in hastily accusing commercial banks of laziness. This section also recognizes that some banks may well be quite cautious in their approach to credit extension under circumstances that banking supervisors may welcome under cases of drifting asset prices away from their underlying fundamentals. Moreover, a high level of government indebtedness and concerns about the future consequences of (overly lax) monetary policy stance may be an important causal factor in the reluctance by banks to lend and by corporates to borrow—that could be justifiable.

V. Balance Sheet Structures of MENA Commercial Banks

IMF quarterly data over 2007–2012 is used to analyze the balance sheet structures of commercial banks in MENA.

Focusing on the levels and patterns of LTD ratios across MENA countries, Table 6 reveals some striking differences.27 Generally, these ratios fall between 60 and 90 percent, compared to a world average of close to 85 percent (as seen in Table 2). We ascribe to a common understanding that values below 60 or above 90 percent are labeled as ‘markedly low’ or ‘excessively high’.28

Table 6.

Evolution of Loan-to-Deposit Ratios in MENA, (2007Q1–2012Q4)

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Source: Authors’ calculations using data from the International Financial Statistics.

Looking at individual countries, LTD ratios for Egypt, Lebanon, and Syria fall below 50 percent, similarly to low exhibited ratios in OX-Non GCC economies—this can be explained by a combination of relatively weak loan demand and high government borrowing requirements (financed domestically) coupled in some instances with unsterilized FX reserves growth at the CB (commercial banks may keep large reserves at the CB, especially under existing capital controls). At the other end of the spectrum, Mauritania, Tunisia, and most GCC banks exhibit very high LTD ratios, implying greater reliance on wholesale (and cross-border) funding which is deemed to be a less stable source of financing. Recent analysis indeed suggests greater lending by global banks to GCC countries compared to pre-Lehman peaks (except for Kuwait) as well as increase in funding through bond markets (IMF REO-MCD, 2012). It might also be the case that greater state ownership of (GCC) banks may have engendered a depositor perception that these financial institutions are less likely to fail as they enjoy (or are believed to enjoy) implicit government guarantees. In the case of Mauritania and Tunisia, high LTD may reflect bad loans where the ratio of NPLs to total loans was close to 39 and 15 percent, respectively, in 2011 (IMF REO-MCD, November 2013).

Focusing next on the evolution of LTD ratios averaged each year over 2007Q1–2012Q4 and in search of emerging trends, great variation is noted across MENA countries. While Egypt, Jordan, Libya, Mauritania, Qatar, Saudi Arabia, Sudan, and Yemen exhibited a declining trend in the LTD ratio, Algeria, Bahrain, Morocco, Oman, Tunisia, and the UAE registered an increase.

Table 7 shows the evolution of the real growth rate in credit and deposits at year end between 2008 and 2012. It indicates that real growth rates in credit and deposits have accelerated persistently in the last few years in Kuwait, Oman, and Saudi Arabia, with Iraq and Qatar exhibiting the highest growth rates in the region. On the other hand, most OM countries (Jordan, Lebanon, Morocco, Syria, and Tunisia) exhibited a clear downward trend in real deposit growth rates since 2009. In Lebanon, Morocco, and Tunisia, real credit growth has also generally decelerated since 2010 (earlier for some periods). Moving to OX-Non GCC countries, no clear growth rate pattern is evident; they however exhibit real credit and deposit growth rates that are higher, on average, compared to OM and OX-GCC economies over the past five years. As for negative real growth rates in credit and deposits experienced in Egypt, Sudan, and Yemen in a number of all years during 2007–2012, they are associated with high inflation rates at the time.

Table 7.

Evolution of Real Deposits and Credit Growth MENA, (2008–2012)

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Source: Authors’ calculations using data from the International Financial Statistics.

Next, we examine level changes in deposit funding and credit as well as changes in other main items in the commercial banks’ balance sheets. Table 8 presents a concise summary of the flow of funds for MENA banks’ balance sheets over 2007–2012. The cumulative increase in deposits over 2007Q1–2012Q4 is presented in the first row, followed by the change in credit and the difference between them. Showing line items for deposits and credit separately from other balances at commercial banks allows us to shed light on private sector activity independently of other banking decisions such as the intermediation of government financing or the accumulation of reserves at the CB.

Table 8.

Flow of Funds of Banks’ Balance Sheets

(in local currency units, except for U.S. Dollar total and percent of GDP)

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Note: The difference between changes in deposits and credit to the private sector shows the amount of private sector funds that can be invested in government claims or that can add to balances at the CB. A positive sign on the residual, Remaining Sources/Uses of Funds, implies that new deposit sources of funds exceed increases in private credit, new government claims, and additions to CB balances, implying idle/excess sources of funds. A negative sign implies that new deposit sources of funds are not enough to cover increases in private credit, new government claims, and additional CB balances, implying a financing gap/shortage of funds. Local currency (LC) figures for Egypt, Jordan, Mauritania, Morocco, Sudan, Syria, Tunisia, Libya Yemen, Bahrain, Kuwait Oman Qatar, and United Arab Emirates are in million. LC figures for Algeria, Iraq, Lebanon, and Saudi Arabia are in billion.

GDP for Libya is for 2009; GDP for Kuwait is for 2011.

Source: Authors’ calculations using data from the International Financial Statistics.