Downturn After Boom: Slow Credit Growth in Middle East, North Africa

By Masood Ahmed

In the midst of an early and uncertain economic recovery from the global crisis, countries in the Middle East and North Africa (MENA) region have been experiencing a sharp slowdown in the growth of credit to the private sector, by about 30 percentage points on average relative to precrisis peak rates.

For many sectors, firms, and households that depend on bank financing, this slowdown may be forcing them to scale back their spending plans, or to resort to scarce or costly alternative avenues for financing. Slow credit growth may therefore be constraining the strength of the recovery in the short run, in addition to limiting prospects for longer-term growth. Policymakers are understandably concerned.

 How did we get here?

To understand the slowdown, one must first recognize that precrisis credit growth in MENA countries was very high, perhaps unsustainably so in some cases. Evidence indicates that several MENA countries (Jordan, Morocco, Qatar, the United Arab Emirates, and perhaps Iran) experienced a credit boom prior to the crisis, in the sense that credit not only surpassed its historical trend, but did so by a sufficiently large amount.

Worldwide studies of similar credit boom episodes have shown that, if large enough, of long enough duration, and accompanied by other signs of macroeconomic overheating, they tend to result in severe distress to their banking systems. Even in the absence of a full-blown credit boom, above-trend growth in credit—as observed in most MENA banking systems prior to the crisis—often exerts strains on bank balance sheets.

What caused the slowdown?

The most immediate cause for the credit slowdown in some countries has been precisely the emergence of these balance-sheet strains, built up during the credit expansion and exacerbated by the economic downturn. Bank profitability declined, nonperforming loans mounted, and capital losses ensued in many cases, all of which weakened the ability of banks to continue lending at the same pace.

A second cause was the loss of bank funding. Deposit growth, as well as banks’ ability to tap international markets for funding, declined notably in most countries, considerably limiting the funds available for lending. However, in many countries these funding constraints were offset to some degree by countercyclical policy, whereby central banks and governments injected liquidity, capital, or even deposits into the banks.

A third cause of the slowdown, also on the supply side, has been an observed reluctance of banks to lend, perhaps exhibiting greater risk aversion in the face of an uncertain macroeconomic and regulatory environment. In addition, it has also been argued that, as a result of home-grown financial difficulties stemming from the failure of two family-based  conglomerates in Saudi Arabia, investment companies in Kuwait, and the Dubai World crisis, the credit culture in MENA countries may be undergoing a transformation—away from name-lending and toward a more arm’s-length approach.

A fourth cause of the slowdown has been a noticeable decline in the demand for credit, also a product of the economic downturn as well as a greater degree of uncertainty. It is likely that borrowers are more risk averse, as their long-held assumptions on the viability of certain projects and sectors—witness the Dubai real estate market’s severe correction over the past two years as a prominent example—are being tested.

How can policy help?

A preliminary note of caution is warranted. Credit booms tend to result in a phase of protracted sluggishness in credit, often lasting several years. Therefore, one should not reasonably expect a rapid recovery in credit, regardless of policy responses.

That said, there are several areas in which policy can have an impact, promoting credit growth and thus shortening the slowdown phase. First, in banking systems where financial strains have been greatest, cleanup of balance sheets should proceed quickly—recognizing loan losses and injecting additional capital if needed—as a precondition for lending to resume.

Second, funding and capital support—effective in partially offsetting banks’ loss of funding—should continue, provided that other objectives, such as preventing a re-emergence of inflation, are not jeopardized.

Third, transparency and communication on monetary and regulatory policy should be enhanced to temper risk aversion that may be causing credit to lag. Also, to the extent that banks are migrating to a business model that relies less on personal connections, policy should promote greater corporate governance and disclosure.

Finally, in the longer run, efforts should be taken to reduce the economy’s dependence on bank financing by developing domestic bond markets, thereby providing viable alternatives to bank credit.

Have policymakers exhausted all avenues for reviving credit? Are there other policy objectives that might conflict with that of encouraging credit growth?

4 Responses

  1. I agree, retrospectively speaking, bank credit decline may not essentially be a bad thing. Due to downgrades by credit rating agencies and from higher rated clients, banks in general are suffering from a lack of capital that has resulted in a reduction in capital requirements for banks. However, the positive outcome for instance in the Dubai real estate downturn may be that there is a chance for banks to encourage responsible consumerism.
    Sundar Parthasarathy, head of consumer assets and consumer banking at Abu Dhabi Commercial Bank said that credit growth rates in the UAE, and even Qatar and Bahrain, exceeded the nominal GDP growth rates by an average 15% per annum. He added that in hindsight, these rates of growth were unsustainable over the long term. Local deposit bases were insufficient to fund the loan growth, and banks, despite having access to large pools of low-cost deposits — particularly those in the UAE — had to increase their reliance on wholesale funding.

    Despite the economic difficulties, some banks in the UAE managed to grow their business by following a strategy “to maximize expected future value, even at the expense of lower near term earnings”. Average real estate prices in Dubai are expected to fall another 15% this year, according to a May report from Bank of America-Merrill Lynch. Though Dubai’s real estate market remains in the doldrums, developers and banks need to get perspective from others who have become successful in previous bust cycles.

  2. The issue of the recent decline in bank credit in countries like Jordan may not necessarily be a bad thing. In other words, what if a large proportion of bank credit is provided to individuals who always obtained credit to finance their “imported” consumption? In addition, what if the national economy has a high degree of export concentartion and those “limited” number of firms which are involved in the exporting market do not rely on “local suppliers”? or rely on expatriate workers? One needs to examine the issue of financial development in detail and arrive at “better” measures than those currently available. Naturally, such an effort should take into consideration the “peculiarities” of economies like the Jordanian one.

  3. Banks in general are suffering from a lack of capital, much of it resulting from downgrades of higher rated clients and which now required them to hold more capital.

    In this respect what is missing above is the temporarily lowering of capital requirements for banks, for instance from 8 to 6 percent, when lending to those small business and entrepreneurs upon which so much of the vitality of the economy depends, and who by the way have so little to do with causing this or any crisis, and who by the way, on their road to the capital markets, are the natural clients of the banks.

  4. [...] Slow credit growth in Middle East, North Africa – iMFdirect [...]

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