Macroprudential Policy and Financial Stability in the Arab Region
  • 1 0000000404811396 Monetary Fund
  • | 2 0000000404811396 Monetary Fund

Contributor Notes

Several characteristics of the structure of the Arab economies, their economic policy framework, and their banking systems make macroprudential policy a particular relevant tool. For most oil exporters, heavy reliance on the extractive sector for generating fiscal revenues and export earnings translates into increased vulnerabilities to oil price shocks. In the case of oil importers, relatively small external and fiscal buffers make them highly vulnerable to shocks. This paper discusses the experience of Arab countries in implementing macroprudential policies and contains recommendations to strengthen their macroprudential framework.


Several characteristics of the structure of the Arab economies, their economic policy framework, and their banking systems make macroprudential policy a particular relevant tool. For most oil exporters, heavy reliance on the extractive sector for generating fiscal revenues and export earnings translates into increased vulnerabilities to oil price shocks. In the case of oil importers, relatively small external and fiscal buffers make them highly vulnerable to shocks. This paper discusses the experience of Arab countries in implementing macroprudential policies and contains recommendations to strengthen their macroprudential framework.


The global financial crisis not only triggered major changes to financial regulation, but it also led to the recognition that financial stability is important to ensure macroeconomic stability. The crisis highlighted the need for a better understanding of macrofinancial linkages and underscored the importance of macroprudential policies, in addition to microprudential regulation and supervision and strong fiscal and monetary policy frameworks. Macroprudential policies aim to increase the overall resilience of the financial system, contain the buildup of systemic risk over time, and address vulnerabilities stemming from structural relationships between financial intermediaries.2

Several characteristics of the structure of the Arab economies, their economic policy framework, and their banking systems make macroprudential policy a particularly relevant tool. The importance of macroprudential policy to limit systemic risk in the financial system is underlined by the high dependence of the Arab countries on hydrocarbon revenues in fostering economic growth, which makes them especially vulnerable to swings in global energy prices. Volatility in the hydrocarbon sector spills over to the rest of the economy, amplified in many cases by the financial sector. The lack of ex ante crisis management and resolution regimes would make a banking crisis even more difficult to handle ex post.

For most oil exporters, heavy reliance on the extractive sector for generating fiscal revenues and exports earnings also translates into increased vulnerability to oil price shocks. In addition, their pegged exchange rate regimes and the consequent limited independence of monetary policy places an additional premium on macroprudential policies. In the case of oil importers, relatively small external and fiscal buffers make them highly vulnerable to shocks. Macroprudential policy can help increase buffers to protect the financial system from potential systemic risks. However, macroprudential policies cannot serve as a substitute for sound fiscal policy and essential structural reforms—including financial sector reforms— to attain macroeconomic stability.

Arab countries have made important strides toward strengthening the stability of their financial systems. Since the global financial crisis, they have sharpened prudential regulation by tightening capital and liquidity requirements and are in the process of implementing Basel III standards on capital, liquidity, and leverage. A number of central banks have established a separate financial stability office/unit and set up an early warning system, in addition to conducting periodic stress testing of banks. Many countries in the Arab region, particularly the GCC, were ahead of others around the world in implementing some measures now widely accepted as macroprudential tools. These measures include the loan-to-deposit ratio, regulations on personal lending such as debt service to income ratio and limits on loan tenor, and limits on concentration, including on real estate exposure.

There is scope for the Arab countries to better understand, identify and mitigate spillovers through the financial sector, and in particular to build up appropriate buffers and limit excessive leveraging and credit booms in good times. Maintaining financial stability requires flexible and adaptive macroprudential policies. A macroprudential policy framework should ideally encompass: (i) a system of early warning indicators that signal increased vulnerabilities to financial stability; (ii) a set of policy tools that can help contain risks ex ante and address the increased vulnerabilities at an early stage, as well as help build buffers to absorb shocks ex post;and (iii) an institutional framework that ensures the effective identification of systemic risks and implementation of macroprudential policies.

The existing institutional arrangement in many Arab countries requires adjustments to support an effective macroprudential policy function. Key improvements would involve: (i) assigning a macroprudential policy mandate and a delineation of its powers; (ii) establishing a financial stability coordination committee comprised of all financial system regulators, including the capital markets authority, the insurance supervisor, and the Ministry of Finance; (iii) ensuring appropriate accountability mechanisms; and (iv) elevating to a legal requirement the exchange of information.

Strengthening the effectiveness of macroprudential tools requires improving the availability of data. The recent global financial crisis in the advanced economies revealed major gaps in the information available to the authorities to monitor systemic risks. In Arab countries, there is room for enhancing data infrastructure and availability to allow for a more complete assessment of systemic risks and a more comprehensive basis for selecting and operating macroprudential tools.

I. Why is Macroprudential Policy Important in the Arab Region?

The Arab economies are heavily dependent on oil, which makes them especially vulnerable to swings in global oil prices. Volatility in the hydrocarbon sector has a direct impact on the rest of the economy, especially the financial sector. For most oil exporters, in particular, there is a direct line between their heavy dependency on oil and less diversified economies. Countries deeply dependent on the extractive sector for fiscal revenues and export earnings are also much more exposed to shocks. In addition, the financial sector operates as a shock amplifier as banks tend to have high US dollar and energy sector exposure.

Most of the Arab oil-importing countries also suffer from high macroeconomic volatility connected to sharp movements in oil prices. Small external and fiscal buffers and in some cases weak policy frameworks, make oil importers highly vulnerable to shocks. Foreign exchange reserves are low, and current account deficits remain substantial in many countries. High or rising public debt levels are of concern, driven by persistently large fiscal deficits. Even as countries are realizing the need for fiscal consolidation and strengthening their fiscal frameworks, fiscal deficits are still high in most countries.

The pre- and post-global crisis period demonstrates the vulnerability of the region to credit and asset price cycles. In the pre-crisis period, domestic liquidity in the region grew by 24 percent in 2007 compared to 13.3 percent in 2003, while private sector credit growth of banks recorded a substantial increase over this period—especially by 2007—to 29 percent. When these factors reversed, they caused considerable stress to the financial system. The growth of domestic liquidity in the region declined by 11 percentage points in 2009, and private credit facilities slumped by more than 20 percentage points in the same year to 4.3 percent (Box.1).3

Monetary policy independence is constrained in most Arab oil-exporting countries due to fixed exchange rate arrangements, despite the presence of capital controls in some countries. Monetary operations are further constrained by relatively limited capabilities in liquidity management as central banks’ liquidity management relies primarily on reserve requirements and issuance of Certificates of Deposit (CDs) and T-Bills. In addition, monetary operations are constrained by the absence of liquidity forecasting, the shallow nature of money markets and financial markets, all of which limit the capacity to conduct open market operations. Credit growth is characterized by a buildup of large exposures in oil-related and real estate sectors (see Box 1).

Despite more flexible exchange rate regimes in some cases and thus greater independence in monetary policy, some Arab oil-importing countries are also exposed to global economic shocks, which exacerbate existing vulnerabilities. The transmission occurs either through their increased level of sensitivity to external demand, which contributes about one-third of their gross domestic product, or through oil prices which heavily affect their fiscal and external balances in a context of small policy buffers. Furthermore, bank liquidity strains may severely affect the provision of credit while excessive concentration on some risky exposures like the real estate sector may contribute to the building-up of systemic risks. Twin deficits have amplified during oil prices surges as in 2009–11, and moved in the opposite direction when oil price decreases (Figure 1).

Fiscal policy has been used as a first line of defense to offset shocks in both in oil-exporters and importers, but with mixed results. Fiscal policy proved to be procyclical in many Arab countries due to heavy reliance on hydrocarbon revenues in oil-exporting countries and lack of automatic stabilizers in oil-importing countries. However, during the global financial crisis, many countries resorted to countercyclical fiscal policy to offset the effects of oil shocks on aggregate demand with substantial negative impact on fiscal and external balances. Fiscal policy is not always flexible enough to prevent credit booms and the buildup of systemic risk in the financial sector due to implementation time lags and rigidities in expenditure as a result of the significant share of wage and subsidies bill in total public spending.

The global financial crisis showed that prudent monetary policy and strong microprudential policy cannot by themselves ensure financial stability. Serious financial imbalances were accumulating before the crisis due to excessive credit and exposure to risky assets, even in a more stable macroeconomic environment characterized by low levels of inflation and solid growth rates. Therefore, it became clear that the policies adopted prior to the crisis were neither sufficient for containing systemic risks nor in ensuring the resilience of the financial sector. Micro prudential policies, on the other hand, should focus on ensuring the soundness of financial institutions at the individual level. However, the lack of ex ante crisis management, and resolution regimes which do not provide a clear division of responsibilities and burden sharing complicates even more a potential crisis scenario.

In sum, macroprudential policy has a key role to play to limit systemic risk. Given the vulnerability of the region to credit and asset price cycles, the limited monetary policy independence under the fixed exchange regimes in many oil exporters, and the absence of fiscal buffers in oil importers, macroprudential policy also has an important role to play to limit systemic risk in the financial system. However, macroprudential policy cannot be a substitute for structural reforms—including financial sector reforms—needed to reduce medium and long term vulnerabilities and imbalances.

This study assesses the current regulatory and institutional macroprudential frameworks, identifies the macroprudential tool kit used in Arab countries, and traces the progress achieved towards the implementation of Basel III standards.4 Information in this study is based on survey conducted by the IMF and AMF with the regulatory and supervisory departments of central banks. 5 The rest of the paper is structured in the following manner. Section II discusses the institutional framework for macroprudential policy. Section III discusses the role of macroprudential policy in achieving financial stability. A detailed discussion on the experience of Arab countries in implementing macroprudential policies can be found in Section IV. Finally, Section V contains recommendations to strengthen the macroprudential framework in Arab countries.

Potential Vulnerabilities in Credit, Equity, and Real Estate Markets in Arab Countries1/

The majority of the Arab world’s bank domestic credit is concentrated in the private sector (except for Qatar, Algeria, Yemen, and Lebanon which have a high percentage in the public sector). Private sector credit distribution also varies within the GCC and Arab oil importing countries. Bahrain, Egypt, Morocco, and Tunisia have a high percentage of their private credit for trade, industry, and finance sectors. However, banks in the GCC countries and Mauritania have a large share of the credit portfolio in personal consumption loans. For many GCC banks’ credit is also concentrated in the real estate sector. Furthermore, many GCC countries face borrower concentration risk in their credit portfolio. For instance, the five largest borrowers account for about seven percent of the Omani banks’ total credit portfolio (35 percent of capital), while the top 10 largest borrowers represented about 109 percent of Tier 1 capital in Qatar at end-2012. The 10–20 largest borrowers in three Kuwait banks represented more than 18 percent of their gross loans, advances.2,3 Their gross exposures are concentrated on claims on corporates, sovereigns, and public entities. Specifically their credit exposures are in sectors that are ultimately dependent on oil. Many GCC banks are found not to lend much outside of the Middle East. By international standards, banks in GCC countries have sizable capital buffers considering the concentration risks they currently face in their credit portfolios.


Distribution of Domestic Credit in some Arab Countries, 2014 /1

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

1/ 2013 for Jordan, Tunisia and Yemen. September 2014 for Algeria and Libya.

Equity market values to GDP ratios are generally below 100 percent in the Arab region. GCC countries, for instance, have a market cap to GDP ratio of above 50 percent with Qatar exceeding 80 percent in 2014. Oil-importing Arab countries further vary with the size of their equity markets; some like Jordan and Morocco exceeded 50 percent of market cap to GDP, while the ratios of Lebanon and Egypt are well below 50 percent.


Size of Equity Market in Arab Countries, 2014

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

Although the availability of information on the real estate sector in the Arab world is scarce, few available indicators (such as credit to real estate and construction to total credit) point to a relatively significant size of the real estate sector in oil-importing countries. All available information for Arab countries’ banks point to exposures in the threshold of 20 percent of their total credit to real estate and construction sectors. Some GCC countries have constructed housing price indices that clearly indicate a surge in their real estate prices (e.g., Qatar). The real estate price trends seem more subdued in Arab oil importing counties. By looking at other available indicators—such as the trading volume of real estate stocks for Jordan and its real estate price index—steady growth is evident.


Real Estate and Construction Credit to Total Credit, 2014 /1

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

1/ 2013 for Jordan, Tunisia and Kuwait. June 2013 for Mauritania.
Prepared by: Hania Qassis, IMF1/ Arab Countries Central Banks’, Annual and Financial stability reports and IMF’s article IV reports for each respective country.2/ Based on IMF paper for the Annual Meeting of Ministers of Finance and Central Bank Governors; “Assessing Concentration Risk”; October 25, 2014.3/ Information on concentration of Banks in non GCC countries was not available.
Figure 1.
Figure 1.

Oil Dependency and Variability of Main Macro Variables

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

Source: IMF staff calculations
Figure 2.
Figure 2.

Oil Prices, Monetary Developments and Exchange Regimes

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

Source: IMF calculations, Bloomberg
Figure 3.
Figure 3.

Arab Banking Sector Developments, Effects of the Global Financial Crisis, Measures taken to Mitigate the Effects of the Crisis and Main Characteristics

Citation: IMF Working Papers 2016, 098; 10.5089/9781484361641.001.A001

II. Institutional Framework for Macroprudential Policy6

A. Mandate

A strong institutional framework is crucial for ensuring that the authorities can use macroprudential tools effectively.7 The framework needs to ensure a so-called ability and willingness to act while fostering adequate coordination across different sectors and policies. In particular, the macroprudential authority should be guarded from political and industry pressures to delay action, while providing an adequate system of checks and balances to avoid using macroprudential policy beyond its call of duty (see Box 2). The necessary coordination mechanisms should be in place to facilitate information sharing and policy cooperation, while preserving the autonomy of separate policy functions.

In practice, different models can be identified in Arab countries depending on who has the mandate for macroprudential policies (Table 1):8 (i) there is no explicit financial stability mandate legally assigned to any institution (Kuwait, and Libya); (ii) different agencies ensure different aspects of financial stability but there is no coordination between them (the UAE); (iii) the financial stability mandate is shared by multiple agencies including the central bank, which chairs the coordination body (Morocco); (iv) the central bank, or a committee of the central bank, is the sole owner of the mandate (Saudi Arabia, Bahrain, Oman, Jordan, Iraq, Qatar, Lebanon, Tunisia, and Egypt). The central bank, in a majority of countries, plays an important role.

There is no one-size fits all model but most Arab countries would benefit from strenghtening their institutional setting. In particular, for most countries, greater clarity on the mandate, instruments and functions of the institutions involved together with a transparent accountability framework would reinforce the capactiy and willingness of those institutions to act.

As part of the implementation of the financial stability objective, some countries have established a separate financial stability office within the central bank. Central banks in all Group 1 countries (GCC) have set up separate financial stability offices and publish financial stability reports. In Group 2, Lebanon has recently established a financial stability unit within the central bank and a department within the banking control commission to monitor the systemic risk in the banking sector, and a financial stability committee chaired by the vice governor of the central bank, together with members of the banking control commission, the financial stability unit, and representatives from other departments in the central bank.

Considerations for Institutional Framework

An explicit mandate assigning clear roles and responsibilities to the relevant agencies with powers to decide—while remaining accountable—should be clearly defined in the law. A rules-based approach helps to overcome the inaction bias or avoid extra limitations in the use of the tools, but some discretion may be needed to enable the authorities to respond to changing conditions in financial sectors as sources of systemic risks evolve. Guided discretion should be accompanied by clear communication based on the systemic monitoring of various key indicators combined with expert judgment. Clear communication and transparency creates public awareness of risks and an understanding of the need for action. An adequate accountability arrangement involves two elements: an internal system of checks and balances, complemented by the scrutiny of external third parties (e.g. parliament, public opinion). Transparency should also involve the publication of an overall strategy, motivation for policy decisions, and the periodic assessment of effectiveness and costs.

There is no one-size fits all.1 No institutional model is without weaknesses and each has different strengths. Different institutional arrangements are shaped by country-specific circumstances, such as historical events, legal traditions, resource availability, and the size and complexity of the financial markets. A variety of frameworks exists depending on the degree of integration between the main building blocks and the structure of coordination across policies. Nier et al. (2011) identify five key distinguishing dimensions for different arrangements: (i) the degree of institutional integration between central bank and financial regulatory and supervisory functions; (ii) the ownership of the macroprudential mandate; (iii) the role of the government in macroprudential policy; (iv) the degree to which there is organizational separation of decision making and control over instruments; and (v) whether or not there is a coordination committee that while not itself charged with the macroprudential mandate, helps coordinate several bodies. The need for coordination is especially important since macroprudential policies interact with other policies.

While there are advantages and disadvantages to any model, some general lessons can be translated into basic guidance.

  • The macroprudential mandate should be assigned by law to an authority with clear objectives and accountability.

  • The central bank should play an important role in macroprudential policy. However, its independence and credibility should not be undermined.

  • Complex and fragmented regulatory and supervisory structures are unlikely to lead to the effective mitigation of risks to the system as a whole. Formal coordination mechanisms across institutions and policies are needed.

  • Participation by the Ministry of Finance is useful, but if the ministry plays a dominant role, that may pose important risks.

  • Systemic risk prevention and crisis management are different policy functions that should be supported by separate arrangements.

Source: This box is based on information in Nier, Erland, W and others (2011).1 See Arvai, Zsofia Prasad Ananthakrishnan and Katayama Kentaro (2014) for more details.
Table 1.

Who Runs Macroprudential Policy?

article image
Source: Authors’ calculations from survey of 12 countries

B. Coordination

The need for coordination arises because macroprudential policy, inevitably, interacts with other policies. Coordination is especially important when formal authority over tools for specific systemic risks rests with bodies other than macroprudential authorities, such as in the case of Morocco. Nonetheless, coordination should respect the autonomy of the different bodies in achieving their primary responsibilities. Coordination helps exploit complementarities with micro prudential, fiscal, monetary, and structural policies.

The current regulatory structure for most Arab countries depends on informal mechanism for coordination and information sharing. Some countries, including Kuwait, Oman, Qatar, Saudi Arabia and the UAE have established authorities to regulate capital market institutions and investments. Although the central bank is the de facto single integrated regulator of the financial market, capital markets are regulated and supervised by the capital market authority. In the UAE, there are multiple regulators.9 Qatar has established a formal structure for coordination among the regulatory bodies through the financial stability and risk control committee. The recently established Higher Committee on Financial Stability in Oman is headed by the Executive President of the central bank and includes other regulatory bodies—plus the Ministry of Finance—as members. Morocco has amended laws governing the supervisors for insurance, pensions, and capital markets in order to strengthen their respective independence. These new institutions will become fully operational with the appointment of their respective management bodies.

III. Macroprudential Policy Tools: A Practical Approach

A successful macroprudential policy framework should closely monitor systemic risks in time varying and cross-sectional (structural) dimensions. Supervisory authorities should monitor and evaluate financial imbalances and procyclical financial activities over time. They must also give due attention to the cross-sectional (across the firms) systemic risks that emerge from the interconnectedness of the financial institutions, common exposure, and high risk concentration.10

There are many classifications for macroprudential instruments according to their dimensions, purpose of use, and the financial variables they are targeting. Macroprudential policy measures could be classified into five major groups according to the source of systemic risk.11 Credit booms can be addressed by measures that influence all credit exposures of the banking system. These measures include, for instance, countercyclical capital buffers (CCBs), dynamic loan loss provision requirement, and leverage ratio. These measures are also called broad based macroprudential tools as they affect all the credit exposure of the banking system.12 On the other hand, household sector vulnerabilities can be contained through a range of sectoral tools that target specific credit categories such as sectoral capital requirements (risk weights), loan-to-value (LTV), and debt-service-to-income (DSTI) ratios. Financial vulnerabilities arising from increasing corporate leverage can be addressed using sectoral capital requirements (risk weights) and exposure caps, in addition to other measures such as LTV limits. Systemic liquidity and currency risks can be contained through liquidity buffer requirements, stable funding requirements, liquidity charges, reserve requirements, constraints on open FX position, and constraints on FX funding. Structural risks can be addressed through capital and liquidity surcharges for systemically important institutions, measures to control interlinkages in funding and derivatives, and exposure limits. (Table 2).

Table 2.

Macroprudential Policy Toolkit

article image
Source: International Monetary Fund (2013), “Global Macroprudential Policy Instruments Survey”

Macroprudential measures had been widely used in emerging market economies long before the crisis. The macroprudential tool most frequently used by regulatory authorities is loan to value ratio for both advanced and emerging economies.13 More specifically, advanced economies tend to use LTV, DSTI ratios, while emerging economies prefer LTV, limits on foreign currency lending, and limits on credit growth.14 Generally, housing measures have been the key focus of MaPP interventions in many different jurisdictions.

Regulatory authorities should continuously trace all relevant information to identify the proper macroprudential policy stance. Regulators are encouraged to make use of all available and relevant indicators to identify when to tighten, or ease, their macroprudential stance (Table 3). Therefore, if policy makers discover market participants to be excessively risk-averse, they can intervene to restore confidence in the market, and vice versa. The regulatory authority’s discretion is also important for determining whether systemic risks are the result of an accumulation of financial imbalances, or merely the result of reasons completely unrelated to the financial sector. For instance, higher levels of private credit to GDP could be linked either to financial development or as a result of some economic plans aimed at fostering economic growth. Also, housing price asset bubbles could be associated in some countries to a shortage in the supply of housing units, rather than excessive real estate loans.

Table 3.

Indicators Used to Identify When to Tighten and Ease Macroprudential Measures

article image

IV. How Arab Countries Have Implemented Macroprudential Policy

This section reviews the macroprudential tools Arab countries have been using. The discussion is structured using the three-group classification specified earlier. The Annexes provide an overview of the major macroprudential instruments, the institutional structure, and progress in the implementation of Basel III standards used in individual countries that responded to the survey.

GCC central banks have been using several macroprudential instruments over many years to mitigate against exposures to real estate and personal loans, and group concentration risks. GCC countries implemented a number of macroprudential tools before the global financial crisis, particularly in order to contain retail lending. However, these measures often came late in the credit boom.

  • Capital, provisioning, and liquidity requirements for banks. Most of the GCC countries have established a fixed ratio for general provisions, but none have dynamic or countercyclical measures, except Saudi Arabia, where banks are required to maintain a provisioning ratio of 100 percent of nonperforming loans (NPLs), a requirement raised to as high as 200 percent at the peak of the economic cycle. In Kuwait, Oman, Qatar, and the UAE, the general provisioning ratio was adjusted upward after the crisis. In addition, in Kuwait precautionary provisions are applied since 2008. Other requirements for banks—such as those forbank deposit reserves and liquidity levels—have been commonly used in the region.

  • Basel III regulations. Basel III capital regulations have been implemented in all the GCC countries except in the UAE. The framework for domestic systemically important baks (DSIBs) has been implemented in Bahrain, Kuwait, Oman, Saudi, and Qatar. The framework is expected to be finalized in the near-term in the UAE. With regard to liquidity regulations, the liquidity coverage ratio has been introduced in all the GCC countries except the UAE, the same with regard to leverage ratio.

  • Ceilings on personal loans. Personal lending regulation assumes macroprudential significance because of its high share in total lending and the moral hazard related to the debt-bailout expectations of nationals.15 DSTI ratios are commonly used in the region, except in Oman and Kuwait. In Kuwait the applicable DSTI is 40 percent. Most countries have imposed a cap on monthly repayments as a share of the monthly salary of the borrower. This limit ranges from between 33 percent (Saudi Arabia) and 50 percent (Bahrain, Qatar, and the UAE). While the UAE has set a ceiling on the total amount of personal loans, Oman has no such ceiling. Qatar has imposed a differential ceiling on individual loans to nationals and expatriates. The use of LTV ratios on mortgages is still uncommon, although the UAE has implemented a ceiling on LTV ratios. Only Qatar and Saudi Arabia have taken explicit measures, while business practices in other countries have resulted in the ratio being around 80 percent.

  • Loan-to-deposit ratios: GCC countries have been ahead of many other countries in imposing LTD ratios. Ceilings on credits for banks, such as LTD ratios, are common in the region, with the range of ratios varying from 60 percent in Bahrain to more than 100 percent in Qatar. The only exception is the UAE, where there is a related regulation prohibiting loans that exceed stable resources as percent of bank’s capital. These ratios helped contain liquidity risk and the reliance on wholesale funding. However, constant LTD ratios failed to sufficiently slow credit growth in the run-up to the crisis: the deposit base was expanding due to high liquidity in the system (the average annual real growth in credit to the private sector in the GCC ranged from between 17 percent for Oman to 35 percent for Qatar during 2003–08). A gradual tightening of LTDs might have contributed more effectively to limiting credit growth, though it would not have prevented the kind of exuberant foreign borrowing observed in the UAE prior to 2008.

  • Limits on real estate exposures. Such limits were in place in GCC banking systems even before the global crisis, but the definition of real estate in the regulations did not adequately cover real estate–related lending and financing activities. As a result, banks’ actual exposure to the real estate sector turned out to be higher than suggested by the regulatory caps. LTVs for real estate lending were generally not part of the macroprudential toolkit prior to the crisis. Although mortgage lending is still only a small share of residential real estate financing—which remains largely cash-based—LTVs for real estate developers, where relevant, might have helped to stem the real estate boom. In the aftermath of the crisis, LTVs are increasingly recognized in the GCC as potentially useful instruments for containing banks’ exposure to the real estate sector. All countries have some form of LTVs, except Bahrain.

The oil-importers group (Egypt, Jordan, Lebanon, West Bank and Gaza, Morocco, Tunisia and Sudan) is characterized by high levels of banking concentration. Banks in this group are more vulnerable to business cycle shocks due to the credit concentration in some sectors that are highly sensitive to the economic cycle.16 Liquidity problems, credit concentration and large sectoral exposures constitute the main risks that banks face within this group.17 Most of these countries use different macroprudential instruments to manage these risks.

  • Broad-based macroprudential tools. All the countries in this group have some form of general provisioning requirements aimed at helping banks to establish a “safety cushion” to strengthen resilience against risks. In Lebanon, banks are required to maintain a minimum general provision of 1.5 percent of the retail loan portfolio, gradually phased over 4 years beginning 2014. In addition, banks are required also to hold a general reserve of 1.5 percent of corporate and SME loans over a four-year period and 3.5 percent of retail loans (excluding housing) over 7 years starting 2014. In West Bank and Gaza, banks have to maintain a general provision of 1.5 percent of direct performing loans and 0.5 percent of the off-balance sheet facilities. Sudan applies a general provision of 1 percent of credit facilities. It is worth noting that, despite high levels of banks’ vulnerability to business cycle risks, none of these countries use time-varying loan loss provisioning requirements.

  • Liquidity tools. A legal reserve requirement is a commonly used tool to mitigate liquidity risks. In addition, liquidity ratios are imposed on banks, ranging from between 60 and 70 percent of the total short-term banking obligations. Moreover, limits on forex currency positions and mismatches have been enforced within this group. In Egypt, long and short positions in any single currency cannot exceed 1 percent and 10 percent, respectively, of the capital base, and 2 percent and 20 percent, respectively, for all currencies. In Jordan, they cannot exceed 15 percent for position in total currencies and 5 percent in individual currency, while in Lebanon there are limits of 1 percent of Tier 1 capital for net trading position and 40 percent of Tier 1 capital for global forex position. Banks in Morocco are required to maintain their forex position under 20 percent of capital for all currencies and 10 percent per currency, while in Tunisia there are two limits on FX position: one in relation to net capital equity and another related to total loss on a position. In West Bank and Gaza, open position of each currency should not exceed 5 percent of the bank’s capital base and the aggregate total of short and long positions should not exceed 20 percent of the bank’s capital base for all currencies. In Sudan, foreign exchange position should not exceed 20 percent of capital.

  • Basel III regulations. Basel III capital requirements have been enforced in Lebanon and Morocco since 2014 for progressive implementation, respectively, by end-2015 and end-2018, while frameworks required to enforce these regulations are expected to be finalized in the near-term in Jordan and Tunisia. Jordan, Lebanon, and Morocco are working on a framework for introducing countercyclical capital buffers. Frameworks for DSIBs have not been finalized by any of the countries in this group of countries.18 With regard to liquidity regulations, the implementation of liquidity coverage ratio (LCR) is being phased in in Morocco and Tunisia, while others have not implemented this standard. As for leverage ratio, the framework has not been finalized in any of these countries. However, in Lebanon, the central bank is monitoring this variable on a semi-annual basis and expects to set a minimum leverage ratio for banks in 2015. The Central Bank of Egypt is completing Pillar 2 of Basel II regulations, and is on track to implement Basel III regulations according to the internationally agreed timeline.

  • Ceilings on personal loans. Personal loans constitute a high proportion of banking assets portfolio in some countries in this group. For instance, credit to households constituted about 40 percent of total credit in Jordan at end-2013 Limits on DSTI ratios have been enforced in Lebanon (at 35 percent, and 45 percent if debt includes housing loans), Tunisia (40 percent), and West Bank and Gaza (50 percent). Jordan, Lebanon, Tunisia, and Sudan have introduced LTV ratio ranging from between 70 and 80 percent for housing, car and mortgage loans. In West Bank and Gaza, the LTV ratio depends on borrower’s credit rating scores, ranging from 30 percent for the lowest graded borrowers to 85 percent for the highest graded borrowers.

  • Limits on exposures. Single-borrower and country limits on bank exposures are extensively used by countries in this group. In Lebanon, measures have been enforced to limit exposure to single borrower, not exceeding 20 percent of Tier 1 capital. Other exposure limits include country-limits not exceeding 50 percent of Tier 1 capital, and a minimum BBB rating, and limits on non-resident bond issuances not exceeding 10 percent of Tier 1 capital. In Egypt, the single exposure limit is 20 percent of the capital base and 25 percent for group exposure. In Tunisia, the total amount of incurred risks should not exceed three times the net core funds of the lending institution. West Bank and Gaza enforces between 10 percent and 25 percent of bank’s capital base subject to a prior approval from the PMA. Limits on real estate and foreign currency exposures are uncommon in these countries. In Jordan, there is a maximum limit for real estate exposure of 20 percent of the total deposits in local currency and a 30 percent limit for foreign currency loans, which should only be used for exporting purposes. Sudan imposes a 25 percent ceiling on direct finance and 25 percent on indirect finance. Related parties have an added condition that their total finance must not exceed 10 percent of their portfolio or 100 percent of their capital, whichever is lower. Limits on interbank exposures exist in Lebanon.19 None of the countries in this group use sector-specific capital buffers. However, in Jordan, residential mortgage loans should have a preferential risk weight of 35 percent in which the LTV does not exceed 80 percent, otherwise the risk weight should be set at 100 percent. Also, concentration risk is the main component in implementing the Internal Capital Adequacy Assessment Process (ICAAP) and many banks in the preparation of the ICAAP document assign capital for specific sectors.

  • Loan-to-deposit ratios. The Central Bank of Egypt has imposed a guiding limit of 75 percent. Tunisia imposes a limit on domestic currency loans, while in Sudan, domestic lending must not exceed the available domestic resources and foreign lending must not exceed the available foreign resources.

The banking sector in the third group of Arab countries (Iraq and Libya) are characterized by the dominance of public banks, high levels of liquid assets, low levels of financial deepening (credit to GDP) and high levels of non-performing loans.20 The focus of macroprudential measures in these two countries has been to enhance capital adequacy ratios and to limit the risks of large exposure.

  • Broad-based macroprudential tools. Both countries rely on caps on credit growth to contain banks’ total exposure. Since 2007, the Iraqi central bank has implemented a plan to increase the capital base of the banking sector, mandating commercial banks to increase their capital base to a minimum of US$215 million. However this plan contributed only in increasing capital adequacy for private banks—which now account for around 80 percent of the total capital base—while public banks’ capital base still needs to be strengthened.

  • Liquidity tools. Given the excess liquidity in both countries, central banks have imposed legal reserve requirements ranging from between 15 and 20 percent of total deposits.21 Liquidity buffers are imposed in both countries, ranging from between 25 and 30 percent of the total short-term obligations.

  • Basel III regulations. There is no schedule for the implementation of Basel III regulatory requirements in either Iraq or Libya.

  • Ceilings on personal loans. There are no ceilings on personal loans in Libya, while in Iraq, the DSTI ratio for those holding positions of leadership in banks must not exceed 50 percent of their annual incomes. Iraq also has in place an LTV ratio of 40 percent to limit exposure to real estate loans.

  • Limits on exposure. In Libya, individual large exposures should not exceed 20 percent of the bank capital base, and government entities are not allowed, by law, to borrow from commercial banks. In Iraq, loans provided to “natural and moral persons”—including public institutions—should not exceed 10 percent of bank capital and its total reserves.22 Sectoral exposure is capped at four times the level of capital and reserves, and interbank lending is limited to 10 percent of capital and sound reserves.

  • Loan-to-deposit ratios. Total credit must not exceed 70 percent of deposits in both countries.

V. Towards A More Effective Macroprudential Policy Framework in the Arab Region

Despite the absence of formalized legal and institutional frameworks for financial stability, Arab countries have a history of using several macroprudential instruments. Certain macroprudential tools were already part of the regulatory toolkit before the global financial crisis, the extent varying between country-groups. Macroprudential policy will have to play an important role in this region to mitigate systemic risk in the financial sector. The special characteristics of the Arab economies, reliance on volatile oil revenues, limited monetary policy independence in light of the pegged exchange rates in some countries, the lack of sophistication in operating instruments of monetary policy in others, and the risk of procyclical fiscal policy pose challenges to the central bank for maintaining financial stability.

There is scope for strengthening the macroprudential policy framework, refining the toolkit, and developing the enabling market infrastructure for effective implementation of macroprudential policy.

  • ➢ Strengthening the institutional framework. Based on the emerging international experience, having a clear mandate for financial stability and strengthening interagency coordination would better facilitate the use of macroprudential policy instruments to address systemic risks. The mandate will strengthen the ability and willingness to act in the presence of evolving systemic risks. A necessary element of such a framework would also include an appropriate accountability mechanism to assess the efficacy of the implementation. In the Arab region, central banks seem well placed to take a leading role in ensuring financial stability, given their longstanding experience in monitoring and managing financial risks.

  • ➢ Strengthening macroprudential instruments. Arab countries should focus on expanding the range of macroprudential instruments and refining the existing instruments as needed. Multiple macroprudential tools should be available in order to maximize their effectiveness, while reducing leakages. In particular, countries should focus on implementing Basel III regulations, CCBs, instruments targeting real estate risk, liquidity tools, and instruments for dealing with DSIBs.

  • ➢ Strengthening the regulatory capacity to monitor and assess systemic risks. Arab countries need to strengthen their capacities for monitoring time-varying, and cross-sectoral, risks. Effective early warning systems and regular assessments of systemic risks are integral parts of macroprudential policies. Macro stress testing would help the regulators to align the macroprudential toolkit with the changing nature of financial risks. Better monitoring of systemic risks and addressing financial vulnerabilities could be achieved through several steps, including:

    • ✓ Developing a financial stability risk map. The regulatory authorities should work on identifying systemic risks through, for example, “financial stability risk map.” This map includes all the risk elements crucial for financial stability. These risks are mainly related to macroeconomic performance, credit growth, financial activities, and interconnectedness. In addition to market risk, the map would also identify liquidity risk, contagion risk, real estate exposure risk and other risks related to linkages between different components of the financial sector, structural indicators and financial infrastructure.

    • ✓ Adopting of an Early Warning System (EWS). The macroprudential technical staff should adopt an EWS, built on the analytical work, forecasting outputs and macro stress testing results to identify the potential financial risks.

    • ✓ Establishing ex ante crisis management and resolution regimes with clear division of responsibilites and burden sharing mechanisms.

    • ✓ Choosing tools. The authorities should focus on choosing macroprudential instruments that are effective in preventing the buildup of systemic risks.

    • ✓ Communicating with the market. After choosing the adequate stance of macroprudential policy, regulators should communicate their decisions to the market at an appropriate time to ensure better understanding of the reasons behind tightening or easing the macroprudential stance.

    • ✓ Continuous monitoring and updating of the risk map. Regulatory authorities should work on monitoring the implementation of the macroprudential tools to align the policy mix, according to the dynamic nature of financial activities.

  • ➢ Ensure effective policy coordination. Arab countries’ regulatory authorities should ensure effective coordination between macroprudential and macroeconomic policies on the one hand, and macro and microprudential policies, on the other. In this respect, there are positive complementarities across policies but also negative spillovers that need to be taken into account when quantifying the expected impact.

  • ➢ The urgent need to address the challenges related to Basel III implementation. While a number of Arab countries are ahead in implementing Basel III requirements, others are in the early stages of applying these standards. Further efforts are needed to enable Arab countries to implement Basel III regulations. The Arab regulatory authorities should work on addressing the challenges they are likely face to cope with the Basel III framework, especially with regard to liquidity standards.

  • ➢ Sharing of cross-sectional country-experiences. This provision would bridge the gap in macroprudential policy implementation across the region. There is no one-country fits all solution, but regional experiences can provide good lessons of do’s and don’ts.

  • ➢ Other financial reforms. Such reforms, including developing domestic debt markets and strengthening bank resolution frameworks, are needed to enhance the resilience of the Arab banking sector and ensure financial stability. Macroprudential policies cannot substitute for needed medium and long term structural reforms; in fact, macroprudential policies are more effective in the context of well-working financial structures. Strengthening corporate governance, financial disclosure, credit reporting systems, and insolvency regimes would mitigate systemic risk and increase the resilience of Arab banking sectors.

Appendix I The Financial Sector in the Arab Countries

The financial sector in most Arab countries is mainly dominated by banking activities. The banking sector constitutes about 54.2 percent of the total size of the Arab financial sector, with the equity and bond markets contributing to about 33 percent and 12.8 percent, respectively. Arab banking sector assets exceeded US$ 3 trillion by the end of 2013.1

The Arab banking sector has witnessed remarkable progress during the past three decades. Reforms have aimed at liberalizing interest rate structures in varying degrees, removing credit controls, strengthening the regulatory and legal framework and the restructuring of banks. In addition, banking reforms included the privatization of some public banks and opening the sector for foreign banks, for increasing competition and access to finance. Credit bureaus and deposit insurance schemes have been established in some countries. These reforms have reflected positively on banking sector activities and led to an increase in banking assets, deposits, and profitability. Since 2000, reforms mainly focused on enhancing banking supervision, increasing the level of compliance with international banking regulatory requirements, ensuring the soundness of banking sectors and moving towards the adoption of international standards in transparency and corporate governance.

Despite the reforms, the banking sectors in many Arab countries still face major challenges that limit their potential growth. Public banks still dominate the banking sector activities in some Arab countries, exceeding 70 percent of the share in certain countries. Although this dominance enabled Arab countries to intervene to limit the consequences of the financial crisis, it hinders competition and leads to an increasing level of credit facilities to public sector, hence, crowding out private lending in some Arab countries (Figure. 3). Enhancing sound competition is a key factor for improving intermediation and supporting financial stability. Using the structural approach to assess bank competition by examining measures of market structure such as concentration ratios (the share of assets held by the top 3-5 institutions) or indices (e.g., the Herfindhal index), reveals high levels of concentration in some Arab banking sectors. Also, some studies concluded that banking sectors in the region are best characterized as markets operating under “monopolistic competition” using a non-structural approach. According to these studies, competition throughout the region has declined—or has not changed significantly—from the second half of the 1990s to 2008.2 On the contrary, it is noteworthy that some other Arab banking sectors remain highly competitive. This is clearly reflected in the high levels of competition between local and foreign banks and the low levels of interest rate margins. Another challenge facing the Arab banking sectors is the high level of credit concentration. Credit facilities in some Arab jurisdictions are more concentrated in some risky assets, such as personal and real estate loans, where the share of these loans exceeded 40 per cent of the total banking assets in a number of Arab countries.

Impact of the Global Financial Crisis on the Arab Banking System and Response

High global oil prices and the subsequent increase in oil revenues during the period (2003–08) led to a surge in domestic liquidity in Arab oil exporting countries, especially in the GCC. The liquidity spread to other oil-importing countries through the channels of capital inflows and workers’ remittances, which contributed to a notable increase in banking credit to the private sector. The major part of this credit boom financed consumption, real estate, and stocks-guaranteed loans, and triggered bubbles in asset prices. As a result, the Arab banking sector was more vulnerable to the risk associated with the correction in asset prices, particularly in light of the consequences of the global financial crisis.

The global crisis impacted negatively on economic activity and led to the burst of asset bubbles, causing a sharp decline in domestic liquidity and private loans (Figure 3).1 Non-performing loans (NPLs) increased significantly in countries most affected by the crisis. The banking sectors in the Arab oil-importing countries were affected by such developments in a different way. High oil prices led to a widening of external and fiscal deficits (due to energy subsidies) which caused drains on foreign reserves and volatility in the management of treasury accounts, which, in turn, generated major banking liquidity deficits. Banking credit was also affected because of supply (tight liquidity, higher risks) and demand (lower expectations). Nonetheless, the total effect was relatively limited due to lower levels of openness with international financial markets, and as a result of regulatory measures already adopted before the crisis limiting exposure to high-risk assets.

The response of Arab policy makers and banking regulatory authorities to the crisis was decisive. Policy makers and banking regulatory authorities adopted a diversified set of measures to mitigate the impact of such a crisis on their domestic economies in general and the banking sectors’ activities, in particular. In GCC countries, these measures included imposing limits on loan-to-deposit ratios, ceilings on some private loans, increasing non-performing loans provisions, buying the assets of some banks, supporting capital bases through injecting liquidity among other measures (Figure. 3). Though some of these interventions were costly (for instance, the cost of these policies constituted 8 percent of GDP in some GCC countries), they helped restore confidence in the banking sectors and minimized the negative effects of the crisis. On the other hand, oil-importing countries tended to ease monetary policy and avail access to central banks’ credit facilities, among other measures, to weather the impact of the crisis (Figure. 3).2

The subsequent global banking regulatory reforms motivated the Arab regulatory authorities to move forward on increasing banking sector resilience against potential internal or external shocks. During the past four years, Arab banking regulatory authorities have focused on strengthening financial stability through increasing capital adequacy, enhancing liquidity, limiting exposure to risky assets and implementing risk-based supervision. Moreover, some Arab central banks have recently developed a framework and methodology to identify DSIBs and deal with the risk associated with them, according to BIS methodology.

1 See Ali, H. (2013).2Arab Monetary Fund, (2010).

Appendix II: Macroprudential Policy Framework in Arab Countries

Macroprudential Toolkit: First Group

article image
article image
article image
article image

Macroprudential Toolkit: Second Group

article image
article image
article image
article image

Macroprudential Toolkit: Third Group

article image

Macroprudential Framework: First Group

article image
article image

Macroprudential Framework: Second Group

article image
article image

Macroprudential Framework: Third Group

article image

Basel III Implementation Schedule: First Group

article image

Basel III Implementation Schedule: Second Group

article image

Basel III Implementation Schedule: Third Group

article image

Financial Stability: First Group

article image
article image
article image

Financial Stability: Second Group

article image
article image
article image

Financial Stability: Third Group

article image

Financial Stability Indicators: First Group

article image
article image

Financial Stability Indicators: Second Group

article image