By Zaid Jerab
For many decades, Palestine has been an area of extreme instability. Tensions, political events, and the never-ending conflict have confronted the Palestinian economy with a formidable and unique set of fiscal and economic challenges. Given these difficult circumstances, Palestine’s small economy has never failed to defy the expectations, bounce back, and teach the world lessons in survival economics. But whereas political and economic conditions never seemed very promising or bright, and growth and employment figures never were too impressive, these conditions have come to be considered the norm. One might surmise that Palestinians and Palestinian institutions have supernatural adaptation skills and learned how to live, grow, and work under an unremitting crisis mode. It takes the combination of resilience, will, hope, agility, and stubbornness to achieve that.
The Palestinian banking sector is just one of many great examples of this survivorship and resilience DNA that is embedded in Palestine’s economy. Throughout history and since the first bank started its operations in Palestine in 1960, the banking sector led by strong efforts and support of the Palestine Monetary Authority (PMA) has achieved remarkable milestones and has proved itself as secure, reliable, and a great positive contributor to the Palestinian economy. Witnessing and going through a long stream of consecutive political and economic fiscal crises, the banking sector has shown the ability to weather and overcome financial shocks of strong magnitude, which reflects in strong growth figures in all indicators.
|Indicators of growth between the end of 2011 and the end of 2021|
|Indicator type||Growth range in US$||Annual compound growth rate|
|Deposits||6.97B to 16.52B||9%|
|Credit facilities||3.49B to 10.35B||11.5%|
|Total assets||9.34B to 21.67B||8.8%|
|Paid-in capital of banks||875M to 1.28B||3.9%|
|Total shareholders’ equity||1.185B to US$2.18B||6.3%|
In addition to these strong balance sheet activity growth figures, the banking sector has also proven its prudence, soundness, and safeness by a number of factors. It is highly liquid, with liquidity coverage ratios well above all minimum international requirements; it is well capitalized to withstand unexpected events or episodes of financial stress in the economy (the banking sector has a 16.7 percent capital adequacy ratio, well higher than the PMA minimum requirement of 13 percent and the Basel 3 International Minimum Requirement of 10.5 percent); the quality of its credit portfolio is great, as reflected by a low nonperforming loans (NPL) ratio of 4.2 percent and good provisioning, and the existence of good credit bureau systems that have been implemented by the PMA; it is compliant with all international banking supervision regulations and well monitored under a strong regulatory oversight, exercised by the PMA; the sector exercises strong anti-money laundering (AML) and anti-terrorist financing (ATF) policies and procedures in compliance with international best practices; it continues to create value for its shareholders in terms of a good return-versus-risk tradeoff and good profitability ratios with calculated and acceptable levels of risk; and it is extremely competitive (13 banks currently operate in Palestine), which has reflected positively on the product offerings and the level of services and financial solutions provided to consumers and businesses.
Despite all the success and positive figures, business is never as usual in Palestine. Every journey has its challenges, but the challenges and obstacles that the Palestinian banking sector faces are unique and extremely disruptive. To start with, the Palestinian economy and Palestinian banks operate without the existence of a fully pledged central bank and without a local currency. The PMA does a great job in exercising regulatory oversight and overseeing the development and implementation of modern efficient payment systems. However, its ability to apply monetary policies that could achieve economic stability, price stability, or stimulate economic growth is very limited. Having to work with four currencies (USD, JOD, ILS, and Euro) in the absence of a local currency further complicates things. For example, one of the biggest challenges facing the PMA and the banking sector is their lack of control over the levels of physical cash held by banks. In short, the Palestinian banks in recent years held very high levels of physical Israeli shekel (ILS) cash, well above the normally required levels. While this could look good in terms of having very high cash reserve ratios, having excess cash on hand limits the banks’ ability to lend those funds and encumbers banks with additional and unnecessary liquidity and cash handling costs that are eventually passed on to consumers and businesses.
This problem exists because Palestine is mostly a cash-based society, and not having a fully pledged central bank that accepts cash notes means that Palestinian banks need to ship excess cash to the Israeli central bank, which puts limitations in terms of quotas on the amount of physical cash that the central bank of Israel accepts. Several initiatives and attempts have been made by the PMA to solve this issue with the Israeli side, but the problem has been going on for long and remains. In addition to the political efforts, the PMA has also worked on a national strategy to develop and implement digital payment systems to decrease the reliance on physical cash transactions. The percentage of cash transactions is decreasing, but we still have a long way to go.
Another major issue that affects the Palestinian economy and Palestinian banks is the financial situation and the fiscal challenges that the Palestinian Authority (PA) and the Ministry of Finance (MOF) are facing, caused mainly by the continuous disruptions in PA cash inflows, received by Israel in the form of tax and customs collections due to political reasons. Those cash flows represent around 70 percent of the PA and MOF total income. The Palestinian banks are big lenders to the public sector, both directly – through direct loans to the MOF (around US$2.13 billion as of June 2022) – and indirectly – through indirect loans to public sector employees (US$1.8 billion as of June 2022) and to private sector businesses that work with the public sector. Although direct lending to the MOF represents only 20 percent of the total credit facilities granted by the banking sector, the public sector remains a big part of Palestine’s economy, and the continuous disruptions in PA cash flows cause instability and a slowdown in all economic activity as well as instability in the financial condition of many consumers and businesses.
The PMA and the Palestinian banking sector have become experienced in this type of challenge and can manage it rather well, especially because the fiscal conditions are caused by political reasons and usually short-lived. However, this remains one of the biggest challenges that the banking sector and the Palestine economy face. It is worth noting that the PA is currently leading multiple financial restructuring initiatives to improve its financial situation. The PA’s level of debt to GDP (both direct and indirect) remains within acceptable levels. However, financial restructuring of the wages it pays, allocating more of the PA’s budget to capital expenditures, and finding a long-term solution to the disruptions of cash flows are necessary endeavors to get out of the bottleneck.
In addition, the banking sector faces many other challenges that include operating in multiple jurisdictions with different rules and different business environments (West Bank, Gaza, and some parts of East Jerusalem). Given that little support is given by the government to certain sectors, a strong legal system is necessary to enable banks to take on more risks and play a more active role in lending to small enterprises. The banking sector cannot rely on a strong technological infrastructure in Palestine that could better facilitate and complement banks’ digital transformation initiatives. It finds difficulties in establishing new correspondent banking relationships with big international banks to facilitate international trade and open new prospects. And finally, it must cope with restrictive PMA instructions related to fees and commissions that do not incentivize banks to create innovative products and services and limits their ability to follow global trends of changing the business model. Globally, banking is moving towards increasing transactional revenue as part of the total income and strives to decrease the reliance on interest income in order to achieve de-risking targets and offer loans to consumers and businesses at lower interest rates, which would help stimulate economic activity and achieve wider macro-level economic goals.
Despite all these challenges and obstacles, the Palestinian banking sector must continue to build on its history and achievements, find ways to overcome the current challenges, and continue to develop and grow. The global landscape of banking is changing; banking sectors around the globe are witnessing a significant transformation in their business models. Perhaps the most significant change is in the use of advanced technologies to serve clients digitally and enhance operational efficiencies. Competition between the largest global banks is no longer over size or market share; the race is about which bank is more digitally advanced, more operationally efficient, and fits better in the technological ecosystem. Now, the focus in banking is on open data and open banking and on providing customers with technology-enabled add-on services and products that are related to payments and nonpayment transactions. Banks cannot operate in silos anymore; they are now more like platforms and facilitators that engage as part of a big ecosystem that includes banks, financial technology firms (fintechs), and many other small and large players.
Although the Palestinian banking sector is investing heavily into digital transformation initiatives and technologies, there remains much to do to catch up with the global trend of developed and emerging economies. Unfortunately, banks cannot achieve this on their own. Joint efforts are needed from various players in the private and public sectors to allow for a swift change in the technological landscape; they must bring about a significant transformation to enable banks to serve customers better and make a positive impact on the Palestinian economy. All related parties should focus on where the world is going and set a national technological ecosystem strategy that focuses on digital transformation and digital payments and leads multiple collaboration efforts and initiatives to implement it. The task at hand is similar to building a puzzle or a Lego set: it is not complete and does not work until all the pieces fit together.
On another note, banks in Palestine have long been accused of developing lending programs that focus more on consumer spending instead of productive lending. As of the second quarter of 2022, total pure consumption credit facilities amounted to US$1.5 billion, which represents around 14 percent of total credit facilities granted in the banking sector. So, it’s not true that banks focus more on lending pure consumer spending. However, the right claim might be that banks do not take enough risk in lending to the small and medium enterprises (SMEs) that make up more than 90 percent of the Palestinian economy. Instead, they focus more on lending to corporate large enterprises and the public sector. As of the second quarter of 2022, the total credit facilities granted to SMEs amounted to US$1.45 billion, which represents around 13.6 percent of the total credit facilities granted. As we read the numbers, it becomes clear that this important segment is underserved by banks. One of the main reasons is that banks feel that this segment possesses a high level of risk. The financial literacy among SMEs is very low, most of those businesses are small cash businesses that are not financially included and therefore do not have any financial data or any official bank cash flows or tax records to prove their credit worthiness. In addition, this segment usually does not possess any collateral and is not well supported by any government programs.
To be fair, we must acknowledge that there are many international loan guarantee funds that operate in Palestine and provide banks with guarantees to enable them to lend to this segment of the economy. These initiatives are appreciated and work well, but they are just not enough to solve the problem. What is needed are joint efforts of the government and the public sector, along with the PMA and the banking sector, to educate and increase the financial literacy of this segment, provide technical assistance for this segment to expand their businesses, and find direct and indirect support and guarantee programs to improve the creditworthiness of this segment. Serving this segment not only supports the economy, it is also a great opportunity for banks to increase their customer base and portfolios and diversify their risk.
Going back in history, it is clear that the Palestinian banking sector has faced numerous political and economic challenges and shocks and will continue to do so. By weathering all these events while continuing to grow and develop, the Palestinian banking sector has proven its soundness, safeness, and resilience, and, most importantly, it has shown that it has always contributed greatly to the Palestinian economy and will continue to do so. The successful journey should continue, and for this to happen, the future focus should be on the technological revolution in banking and on the financial inclusion of all segments, enabling them to make a more significant positive impact on the Palestinian economy. To do so, we must encourage innovation and out-of-the-box thinking. Innovation not only solves problems but also creates new markets and a blue ocean of new products and services that match consumer expectations.