Critical Evaluation of the Arab Financial Markets - Essay Example

?Critical evaluation of financial markets Table of Contents Introduction 3 Reforms in Libyan Financial Sector 4 Area of reforms 5 Need for financial reform in Libya 7 Benefits of financial regulation in Libya 8 Drawbacks of financial regulation in Libya 9 Reasons for financial reforms in Libya 10 Reform instruments 11 Success of the reform measures 14 Conclusion and Recommendations 15 Reference 17 Introduction Over the last decade and a half several Arab countries have initiated economic diversification such as the establishment of stock markets and their eventual privatisation and liberalisation. This has been done with the view of providing the indigenous economies with improved financial depth. By way of this the government aims at providing the necessary financial resources to the nascent domestic firms for the purpose of diversification and expansion, to render absorptive capacity with the aim of privatising or deregulating the state-controlled infrastructure or telecommunications or to bring about an improvement in the corporate governance policies of the developing private sector. As stated by Bolbol & Omran (2003) in their paper on stock market emergence in Arab countries, a change in the technology and output mix of the indigenous industries will require the stock markets to allocate the resources to the industries more efficiently. This is because stock market activities provide an effective way to check the performance of the new firms in the event of any opinion divergence in the manner it is managed. At present in the Arab countries there are stock exchanges in Egypt, Algeria, Jordan, Morocco, Lebanon, Tunisia, Sudan, Dubai, Bahrain Abu Dhabi, Oman, Qatar, Kuwait and Saudi Arabia. Among these countries it is said that the Arab stock markets are dominated by five countries in terms of active and large markets- Jordan, Egypt, Saudi Arabia, Morocco and Tunisia. On 3 June 2006 a resolution was passed in Libya which paved the way for the creation of the Libyan stock market, set up as “Syarika Musahima” with capital strength of LD20 million split into 2 million shares of 10LD per share. The headquarters as per Article 2 of the resolution was decided to be Tripoli with main branch to be set up in Benghazi. Levine & Zervos (1996) used a dataset of 47 nations for the period 1976 to 1993 to highlight that the stock market liquidity is an important predictor of real per capita gross GDP growth, physical growth in capital and growth rate in productivity. This highlights the importance of the establishment of Libyan Stock Market for the authorities in Libya1 The banking system in the country comprises four major banks which are either fully owned or in majority ownership of the Libyan Central Bank. This list of banks includes Wahda bank, Jamahiriya Bank, Umma Bank, Sahara Bank and National Commercial Bank. These banks comprise nearly 90 percent of the assets related to the Libyan banking sector. All these banks have capital strength of minimum 100 million Libyan Dinars with the two of these banks on the verge of privatisation. The finance availability in the local market is frugal. The Libyan banks provide limited number of financial products, loans are granted based on personal rapport and the managers of the public banks do not seem to have any incentives in portfolio expansion. Scarcity of financing is a major deterrent in local development impeding the completion of the projects and the initiation of new projects. Presently the banking system in the country is undergoing a modernisation program to improve the existing products or services, handling of non-performing assets, promotion of the use of payments in modes other than cash and establishment of new accounting standards2 Reforms in Libyan Financial Sector The Libyan government is jointly working with reputed international organisations to facilitate improved transparency in the financial sector, chalking out plans to bring in international credit rating agencies in the country to evaluate the domestic financial instruments and the recently established stock market besides working towards the improvement of the banking supervisory practices. The government of the country has plans to issue Certificates of Deposits (CD’s) to banks and direct the same to the public. A process has also been initiated for the training of the banking officials in assessment of loan risk with the aim of broadening the lending to medium and small sized businesses3 Area of reforms The Central Bank of Libya (CBL) has joined hands with international advisors to develop a vision for the modernisation of the domestic banking sector. This process of modernisation started in the year 2005. A vast part of the programme deals with the integrating the domestic banking sector with its international counterpart. To bring about an improvement in the performance of the commercial banks under the public domain various organisational restructuring programmes are taking place along with training programmes. The proposed organisational structure is expected to exhibit higher levels of decentralisation as compared to an authoritative format, the lending practices are expected to be more standardised and to tackle the managers’ disincentive in portfolio expansion there is a need for the development of sales mentality among the bank employees. The Article 9 relating to the formation and authorities of a financial information unit have been re-defined linking the Libyan economy directly with the international practices and foreign judiciary. This includes- The Central Bank of Libya shall create a unit referred as the “Financial Information Unit” to tackle issues relating to money laundering. A report will be sent on any type of suspicious transaction to this Unit from various establishments be it commercial, financial or economic by any entity. This Unit will then exchange the information with its overseas counterparts, in line with the agreed upon international agreements or in line with reciprocity principle. All the banks functioning in the country shall form a ‘subsidiary unit’ referred as “the Subsidiary Unit for Information on Combating Money Laundering” that will be accountable for the monitoring of banking transactions or activities or parties involved in such deals, when there is a suspicion of money laundering involving unknown sources of funds. The subsidiary unit will have to report the related data or information to the Financial Information Unit of CBL. A decree shall be issued by the Governor with respect to regulation of Financial Information Unit and the various subsidiary units of the banks demarcating their responsibilities, duties and procedures of work4 The pace of change in the economy has been extremely slow and laden with difficulties. In the year 2003 in order to induce foreign investments, the Libyan Central Bank unified the system of dual exchange rate according to which the individuals used the “commercial rate” for foreign currency transactions while the transactions of the state companies were executed at the an “official rate”. A privatisation program has also been initiated in the country which is expected to transform the domestic economy. Under the privatisation plan 360 companies were earmarked for privatisation. However the impact of this privatisation program was not very impressive as mainly the small firms were privatised. In 2005 the government passed a banking law that permitted the foreign banks to set up offices or branches in Libya, seeking a minimum capital provision of US$50 million. In a span of three months of the introduction of the banking law there was an announcement for the restructuring and privatisation of five state banks with the promise of foreign participation in two of these state banks. These promises were eventually realised in the year 2007 with the acquisition of 19 percent ownership by BNP Paribas in Sahara Bank with an embedded option of buying up to a stake of 51 percent by the year 2012. There has been a steady improvement in banking supervision. The establishment of a Credit Bureau in a country that lacked a credit culture is a major step in encouraging lending practices in the market. The steps initiated in the banking sector have been positive but the process of restructuring is slow and clearly shows that there is a long way ahead5 (Pargeter, 2010, p.7-8). There has been a considerable progress in integrating the various complexities associated with the system of payments. In the year 2008 CBL joined the “Real Time Gross Settlement System” thereby developing the Automated Clearing House (ACH) and Automated Check Processing (ACP). A “deposit insurance fund” has also been created by commercial banks with the aim of deposit protection of up to LD100000. The interest rates on deposits as well as lending are determined by the market forces. The banking sector in the country has achieved extraordinary growth from the period of 2007 as reflected from the volume of deposits which has nearly doubled over the period. This has been achieved by the improvement in loan portfolio and higher provisioning6. The Capital Market Law is touted as a significant achievement of the Libyan Stock Market (LSM). This law regulates the capital market in matters relating to trading, listing, registration, membership and depository. By virtue of this achievement the market will achieve a more flexible and secure trading pattern7. Need for financial reform in Libya The banking sector of Libya is partially liberalised as is relevant from the restriction they impose over the entry of foreign financial institutions within their national premises. Furthermore, the domestic banking sector is highly centralised in the sense that there are five major state-owned commercial banks which account for more than 76% of financial assets in the nation. The nation is also endowed with 4 privately owned commercial banks which capture 3.7% of total bank assets which automatically suggest the limited market power that the latter group enjoys. That apart, there are 48 regional banks and 5 state-owned specialized banks whose activities are limited to some special tasks. Libya also owns a non-bank financial sector although quite insignificant in size and comprising of a single investment bank and two non-bank financial institutions8. However, the nation still lacks a properly formed equity market and insurance sector. Hence, it could be clearly established that the economy needs a financial reform in the true sense of the term. Benefits of financial regulation in Libya Globalisation has opened up domestic boundaries to the entire world. Such a gigantic move facilitated financial openness that improved the financial status of the concerned nations. However, the government of Libya had been against opening up. In fact, the economy had been strictly against privatisation prior to 2006 which stole its residents of ample competition. Competition on the other hand is beneficial for the consumers of an economy as it helps reduce opportunity costs of banking. Libyan banking sector is essentially a public sector body which has no such profit motive as such which is why these institutions have no objective in introducing services other than the commonest ones of accepting deposits and advancing loans. Privatisation could have initiated such privileges in the economy as well that could help in the expansion of the nation. In addition, privatisation invites foreign firms within the nation which helps to boost the amount of competition in the economy. The financial sector also has limited scopes for investment opportunities in the economy with only a single investment bank existing within the nation. This readily helps in admission of the fact that the nation indeed employs little means to explore its investment potentials. There is also a need for the development of a proper stock exchange in the nation in order to facilitate equity trade which actually assists potential investors in accumulating capital for expansion plans. As the economy also maintains a large degree of restriction about the entry of foreign companies or the proportion of financing which they might be permitted to make, there is little hope for domestic investors. Hence, on the whole it could be said that the benefits arising out of a financial sector reform in Libya will be in terms of allowance of higher competition within the economy, greater social welfare through reduced costs of services as well as improved quality of the same, better investment opportunities and finally an economic expansion. Furthermore, an improvement in the condition of stock markets in the nation is favourable for the distribution of wealth in the economy. The economy is characterised by a teeming population of around 6 million which is growing as well, so that the amount of expansion necessary to sustain such a huge mass is not possible only by means of government undertakings and projects. The economy must also be endowed with investment projects which yield hefty returns over time so as to finance future investment projects. In fact, lack of investment initiatives owing to absence of financiers is one of the reasons why the economic growth rate of the nation had been recorded as one of the lowest even in the underprivileged Maghreb region. The nationals are not free to seek help from abroad without obtaining prior permission from the domestic administration. In addition, the national commercial banks have a limited network of branches which deprives many of them of the privilege of depositing their money with the banks and earn regular interests in return. Hence, the nation cannot even create credit on its own. Creation of credit is regarded as a primary factor for economic development. However, in the absence of such facilities, the national government has to spare some part of its revenues earned from other sources such as tax and trade, to finance investments. But those sums could have been utilised in other areas as well so as to multiply the rate of economic growth. Hence, the nation incurs a huge amount of opportunity cost which makes it necessary to allow financial openness. Furthermore, the banks do not enjoy a high degree of trust from its people given a limited amount of transparency about their business dealings. The nationals cannot be ensured at any point of time about the financial efficiency of the concerned bank so that the people can never rest assured about the safety of their money with the latter. The fear among them is especially great owing to the fact that a lion’s share of the population is poor and live in dire poverty. Drawbacks of financial regulation in Libya Financial regulation might not be as beneficial for a nation in every single case. For instance, in a centralised economy, investment implies those involving the national government. The bank being a public sector is often involved in projects which are least likely to yield profits and in most cases indulge in activities meant for social welfare. The privatised banks on the other hand, are less likely to invest in such ventures which are often not associated with any financial return in future. Another possibility is that of a collusion arising between banks in an economy. Collusive activities often lead to an increase in producer surplus while causing a simultaneous fall in consumer surplus. The situation in case of a pure oligopoly could be tense though not as much as it is in the case when cartels exist between underlying firms which turns the market structure into that of a monopoly. In the presence of cartels, the underlying firms are found to frame similar policies to serve their consumers so that it is only a matter of external factors such as distance to be travelled and brand names, which are left to be considered. However, such situations are less likely to occur in case of public sector units which are least guided by profit motives. A third but remote possibility is that of increased liabilities from abroad in case that financial openness is allowed. In 2005, the claims of credit as a percentage of GDP had been the lowest in case of Libya among the five nations underlying the Maghreb region owing to the fact that the former did not open up their boundaries to the world as did its peers. Such low liabilities help to reduce the dependence of a particular nation on others. Reasons for financial reforms in Libya The Libyan banks face major obstructions in the form of- increased difficulties in loan risk accessibility due to non-availability of standardised data relating to borrowers; lack of managerial incentives in expanding the loan portfolio of the banks. All this calls for a string of reforms in the financial markets. In the absence an established banking system there are chances of financial instability. The banks have a tendency to be highly susceptible to instabilities in the market due to reasons like the balance sheet of the banks show short term deposits on the liabilities side and long dated illiquid assets. The reforms in the Libyan banking system is encouraged by reasons like- The fundamental changes affecting the global financial services industry such as introduction of new rules relating to deregulation and regulation; innovation of systems & services etc. Necessity of changes in the worldwide regulatory framework such as the regulations s relating to prevent money laundering practices. The participation of the Libyan banks in the global arena through Libyan Aran Foreign Bank & Libyan Arab Foreign Investment Company Ltd. Provide new opportunities due to the changes in the banking laws in 2005 and the need to attract higher capital investment through the route of foreign investments. Due to the impact of global credit crisis on major financial sectors there is a requirement of altering the banking environment in Libya by emulating major Western countries like UK. The growing interest of the overseas entities in the financial markets in the country has transformed the domestic financial services industry. This is reflected from- The emergence of the foreign branches like JP Morgan which applied for a license in 2008. The foreign banks are permitted to acquire shares in the local banks. The overseas banks are permitted to participate in the privatisation program of the banks under state ownership9. Reform instruments Having enlisted the areas of the financial sector which needs to be reformed in order to ensure a proper financial reform in the nation, the next step will be to list the financial instruments to achieve them. One of the most important of all areas to be reformed is that about an improvisation of the investment climate in the economy which had been found to be quite discouraging in the nation. Lack of financial openness could be assessed as one of the reasons behind the lack of a favourable investment climate in the nation which also had taken a toll on the economic growth of the nation. Some of the reform measures being undertaken have been depicted as follows. One of the prime necessities to ensure that the nation attains financial reform is to privatise the banking sector of the nation. The national government has initiated such steps however, so as to assure that the financial weakness of the nation could be countered. To be precise, the privatisation move was initiated post 2007 when a number of foreign banks were shortlisted to acquire over the major commercial banks of the nation. Such a move had been essential to improve the financial and investment state of the nation and build a proper business environment. BNP Paribus of France acquired 19% stakes of the Libyan National Bank in July, 2007 followed by the acquisition of Wahda Bank by the Arab Bank of Jordan amounting to another 19% of stakes, by the end of the same year. However both BNP Paribus and Arab Bank of Jordan were provided with options to acquire 51% of the stakes within a span of three to five years. The Central Bank of the nation also had been merged with Umma Bank and Jamahiriya Bank in 2008 even though each one of the latter still have branches opened up in their names at different regions. Such a move had been adopted to ensure that the national financial sector is equipped by a huge monetary reserve necessary to strengthen the financial status of the economy. Privatisation could not only provide a ready solution to the dwindling financial reserves of nation but also motivate the managers towards framing strategies to improve the condition of their organisations and build a loyal base of consumers. Employees of public sector units, are least driven by profit motives which is the case with the commercial banks of Libya. They tend to grant loans to people who are personally connected to them rather than those who are in actual need for the same or want to borrow to finance a profitable project. Out of 16 commercial banks in the nation, 6 are partnered by foreign banks. In addition, the national government also has showed some degree of lenience in allowing foreign financial houses within the nation through allowing the Unicredit S. A. owned by Italy to open up a subsidiary in the nation where it has the right to possess 49% of the stakes while the remaining 51% are to be owned by Libyan investors. A second instrument that the national government has mustered to modernise the financial state of the nation is to invoke some amount of transparency within the system. The Libyan banking sector is characterised by low degree of transparency and poor state of accountability leading to high volumes of non-performing loans. These very factors had repelled people from trusting their domestic financial institutions and have attracted equal degree of revulsion from investors who seek out the financial efficiency of a firm prior to making an investment move. Thus, the Banking Law of 2005 was passed that allowed the entry of foreign banks within the nation. Such a move was anticipated to improve the financial aspects of the banking sector owing to a greater degree of surveillance and infiltration of modern techniques within the system10. The Libyan banking sector also has forgone the traditional system of payments and introduced the RTGS (Real Time Gross Settlement) Payment System in 2006. Introduction of this system has helped in reducing the time needed to transfer funds between banks and hence, reduce the amount of risk involved in making payments at credit which is especially high when a large sum of money is involved. Initiation of the system had brought in a revolution within the financial sector of the nation and has helped make rapid improvements in the same11. Law No. 11 of 2010, resolved by the Libyan Government has accredited the Stock Market Authority of Libya as the apex institution to regulate the operations of Libyan Stock Market which is a privately owned company comprising of 12 listed entities. However, the national government in its drive to improve the business environment of the nation has resolved to include more companies within the list. One of the most enthusiastic roles being played by the national government in this regard had been an influx of banks and non-bank financial institutions to start off the LSM. Furthermore, the stock market also introduced an electronic mechanism of trading so as to encourage investment activities. The inclusion of trusted financial institutions like the national insurance company is anticipated to attract many other firms to get enlisted within the LSM. This is the basis on which the national authorities have decided to privatise another 375 public companies within the coming few years. In order to make up for the absence of useful skills to run the stock exchange the Libyan Stock Exchange entered into a pact with the London Stock Exchange where the latter is entrusted with training Libyan workers to sharpen their skills in this aspect12. In addition, the nation had relaxed its financial sector regimes through framing measures meant to encourage the entry of foreign direct investment in the nation. However, it could not have been a success had these reform measures not been complemented by the relaxation of subsidies from United Nations to the country, in 2003. In addition the national government also encourages higher amount of FDI in the nation through relaxation of excise duties and levies from foreign investors, according to the provisions made in Law No. 9 adopted in 2010. This point is especially important given the fact that globalisation is one of the important factors to promote financial stabilisation in an economy. The more relaxed that the nation is about the entry of foreign investments within domestic premises, better will be the economic prospects and hence, more robust will be the chances of ensuring financial stability. However, in case that these instruments are not implemented properly, the nation is exposed to dangers of a feeble financial system. These dangers or risks arise due to the lost opportunities of an economic expansion. In a world where every other nation is adopting strategies to strive up the ladder of economic development, it is terribly important that others move in order to match the pace. Lack of economic development could lead to deterioration in the exchange rate position of a nation which could hamper its development from the perspective of international trade. Similarly, lack of ample investment opportunities owing to a retarded financial position of the nation could lead to a variety of economic problems such as poor rates of unemployment, low GDP, stagnancy and finally a recessionary state of the nation. Success of the reform measures Following the reform measures adopted by the Government of Libya for commercialisation and openness, the banking sector of the nation had been successful in enhancing its profitability over the years. One of the most important causes behind a rise in profitability of the banks is a rise in the base of corporate clients in the nation. Between 2007 and 2008, the number of corporate clients of the banking sector had increased from 2601 to 5032. This is relevant from the rise in its assets by almost US$ 50 billion between 2005 and the first quarter of 2008. Moves to ascertain transparency in the financial sector of the nation also paid off well as could be noted from the increase in the volumes of loans being advanced and deposits being accepted by the commercial banks. This had obviously been due to a rise in the incentive with people to involve them in banking activities. Another reason for a rise in banking activities among people is the increase in the number of ATMs within the nation which helps people to have access to their money even at places where the particular bank does not have a branch. Aman Bank is one of the pioneers in this field with more than 60 ATMS across the nation. Conclusion and Recommendations The Libyan financial structure hence had highly been kept under cover for a prolonged period of time which had actually deprived it of many potential opportunities to expand the rate of economic growth. It had been endowed with a stunted financial system with poor potentials for investments and lack of ample funds to finance the same. Further, the financial companies were least interested about forwarding credit to people on the basis of the nature of projects. Instead, these loans had been more on the basis of personal contacts being maintained with their customers. Commercial banks in the nation also lacked diverse financial instruments and suffered from large volumes of loan defaults. Lack of transparency had been one of the reasons why these banks did not enjoy consumer loyalty and trust. However, the national government of Libya considered it to be a ripe time for opening up their financial barriers and moving towards a path of liberalisation. The very first move which they adopted had been to invite foreign investors within their nation and assist in accomplishing domestic investible projects for which the domestic reserves were falling short. In order to win the confidence of the nationals, the government decided to privatise the financial sector through inviting foreign financial institutions to prop the former up through owning stakes in the latter. This move to privatise and furthermore, to invite institutions settled in more advanced economies had been one of the wisest of decisions being adopted by the Libyan government since it made room for the inflow of better technology within the system and monitor the financial proceedings as well. In addition, the domestic managers and employees were trained likewise so as to meet the increasing demands of consumers. The Libyan stock market too had been improved considerably through the introduction of financial organisations in the list of enlisted companies and further room for improvement has been made through the initiation of the electronic trading mechanism. However, there is still a long way to go so that the economy is ranked at par with the advanced or at least the emerging economies of the world. Some such advanced features which needs to be added are, online banking facilities and more number of ATMs within the economy. Unless these aspects are met, the nation cannot attain economic expansion in the true sense of the term13. Reference Almasri, M, ‘Libya reforming banking and financial system’ (2010). Available at: . accessed on April 19, 2011. Embassy Tripoli, ‘LIBYA'S CENTRAL BANK CONTINUES FINANCIAL SECTOR MODERNIZATION EFFORTS’ (2008). Available at: accessed on April 19, 2011. Ian, S. A Study of Customer's Attitudes to Cross Selling by Banks with Particularly Reference to the Practice in Libya: Marketing, (GRIN Verlag, Germany 2010). Millard, S. & Halden, A. G. (ed), The Future of Payment Systems (1st edn Routledge, New York 2008) 195. Nagi, A, ‘The Capital Market Law. Country Overview and The Recent Developments of the Libyan Stock Market’ (2010). Available at: . accessed on April 19, 2011. Otman, A.W. Karlberg, E. The Libyan economy: economic diversification and international repositionin,. (Springer, 2007). Oxford Business Group. The Report: Libya 2008, (Oxford University Press, Oxford 2008). Pargeter, A, ‘MODERNIZING THE ECONOMY. RE FORM IN LIBYA: CHIMERA OR REA LITY?’ (2010). Available at: . accessed on April 19, 2011. Tahari, A. et. al. ‘Financial Sector Reforms and Prospects for Financial Integration in Maghreb Countries’ [2007] 2 IMF Working Paper. WP/07/125. accessed April 20, 2011. 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