Palestinian banks weather crisis but govt debt is threat

Wed Jan 23, 2013 9:00am EST

* Proto-central bank presides over conservative lending

* One of few technocratic, non-political institutions

* Central bank working with IMF

* But exposure to government debt may be Achilles heel

* Occupation, unrest undermine government revenues

By Noah Browning

RAMALLAH, West Bank, Jan 23 (Reuters) - A central bank in the making, the Palestine Monetary Authority (PMA) is a rare bright spot as the economy of the Palestinian territories struggles with Israeli sanctions.

Enforcing on Palestinian banks a regimen of conservative lending that has kept bad loans minimal and guaranteed liquidity, the PMA's technocratic prowess is the pinnacle of a Palestinian drive to build institutions fit for a future state.

But its efficiency is meeting a hard reality: the banks are exposed to around $2.5 billion in debts incurred by the government, its workforce and its private sector partners - over a fifth of banks' total assets.

"Our room is all in order, spick and span, on what could turn out to be the Titanic," joked PMA chairman Jihad Al Wazir.

"Banks have reached the upper limit of what they can prudentially lend (to the government) without increasing risks to the system," Al Wazir told Reuters. Al Wazir is the son of Khalil Al Wazir, a top Palestinian leader assassinated by the Israelis in Tunis in 1988.

Economic prospects for Palestinians in the West Bank are limited by Israeli restrictions on trade, and the Palestinian government is deeply dependent on foreign aid and bank credit to pay its bills.

Help from abroad plunged by two-thirds from four years ago to just $600 million in 2012, as the global economic downturn and Arab revolts taxed the attention of wealthy Gulf state donors and U.S. funding dwindled.

Public debt to the Bank of Palestine, Al Quds Bank and other banks supervised by the PMA more than doubled in the same period. The government's budget deficit has reached $1.3 billion, over 12 percent of gross domestic product.

The government's ability to pay its $300 million in monthly expenditures was further hampered by Israel's docking of $100 million in customs duties it collects on the Palestinians' behalf each month as punishment after Palestine secured de facto United Nations recognition of statehood in November.

Despite the economic difficulties, regular stress tests of banks, supervised by the PMA, have found that only a doomsday scenario of a massive run on deposits combined with a near- shutdown of the private sector could upend the system.

The banking system's Tier 1 capital, its main benchmark of health, stood at a remarkably robust 24 percent of assets last year, according to the International Monetary Fund. Struggling European banks' Tier 1 ratios generally hover between 7 and 10 percent, and at around 8 percent for Israeli banks.

Non-performing loans at Palestinian banks stand at less than 3 percent of total loans, and debt-to-deposit ratios remain far healthier than in neighbouring Jordan and Israel.

Since they do not deal in complex financial commodities such as derivatives and are largely isolated from global financial markets, Palestinian banks weathered the 2008 global financial crisis largely unscathed.

The banks also owe their vitality to a robust PMA credit bureau which sniffs out and discourages dubious debts.

"The credit registry, in which all loans and defaults on loans and credit worthiness of customers are examined, is considered one of the best in the region and an example for other countries," said Udo Kock, resident representative of the IMF, which provides technical assistance to the PMA.

PAIN AND NO PAYCHECK

The banking sector's stability contrasts with the pain experienced by government employees, who have staged work stoppages and protests outside government offices with increasing frequency in recent weeks because of the state's inability to pay salaries on time.

Luay Ghashash, 45, a worker in the Palestine Liberation Organisation, a diplomatic organ, said he and his wife, a public school teacher, hadn't received a full paycheck in almost three months, making mortgage and car loans ever more onerous.

Rattling off the rising prices of food and basic commodities, Ghashash said the government's financial problems were undermining his family's ability to live a decent life.

"My little daughter had a school field trip the other day, but we couldn't afford it. She came to me and said 'It's OK, I'll just tell my teacher that I overslept,'" he sighed.

Bank lending for personal consumption in the Palestinian territories has risen fivefold in the last two years to $417 million, according to the PMA.

But manufacturing, construction and agriculture have now slowed, depriving the government of yet more indirect revenue, while the seeming permanence of the Palestinian economic malaise has discouraged foreign investors, analysts say.

"The Palestinian economy is squeezed into 40 percent of land, with less than 20 percent of water," said Samir Abdullah, head of the Palestine Economic Policy Research Institute and a PMA board member.

"Jerusalem is excluded, the wall takes 10 percent of the land - all this makes it more difficult for normal movement and access," Abdullah said, referring to a security barrier built by Israel on West Bank lands.

ABOVE THE POLITICAL FRAY

In the wake of the Arab uprisings elsewhere in the region, social unrest has become a more important concern in the government's fiscal policy, and this has also limited its ability to balance its books.

Protests thwarted a government plan for across-the-board income tax rises and a public sector early retirement scheme in 2011, while austerity measures last September were eased after violent street protests rocked West Bank cities.

Even collecting electricity and water bills risks blowback.

When the government issued an amnesty for old utility bills to poor refugee families in the northern city of Nablus last month, on condition that customers just pay in future, their neighbours took to the streets calling for debt forgiveness too.

The government acquiesced.

"Residents want the economic burden on them eased and don't like government initiatives that seem ad hoc or selective," said economic analyst Nasser Abdul Kareem.

Part of the PMA's discipline and success is based on its independence from the rough-and-tumble of Palestinian politics.

The PMA was the only national institution to survive the bitter split in 2007 between the Islamist Hamas party in Gaza and the secular Fatah, which rules in the West Bank.

Neither faction appeared willing to undermine the banking system or compromise supporters' deposits by dragging the PMA too close to its political orbit.

In the previous year, the PMA cut much of its staff and hired experts and degree-holders based on merit - a luxury that swollen and inefficient ministries can ill afford, given current social tensions.

"The banking system is the livelihood of the Palestinian people," Al Wazir said. "We have to survive."

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