Palestinian Banking Sector

Palestinian Monetary Authority (PMA) was established as an independent entity in 1994 with its responsibilities stated in accordance to the protocol on economic relations. According to the protocol, the Shekel (New Israeli Shekel-NIS) would be one of the circulating currencies and that required reserves on shekel should be in-line with those in Israel. However, there has been no Palestinian currency for over fifty years and three foreign currencies circulate freely: the Israeli Shekel, the Jordanian Dinar, and the U. S. dollar.

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Generally, the largest share of currency denomination in both deposits and lending is in U. S. dollar. This was reflected through the period 1999-2003 where private sector US$ deposits at commercial banks averaged 61. 5% of the total deposits followed by Jordan Dinar at 22% and finally NIS at 14. 6%. The historical development of the banking sector in Palestine was marked by weakness and deformity in its structure and activities due to the political circumstances that Palestine went through. However, the sector went through many developments since the establishment of PMA in 1994.

There were eight banks operating in Palestine in 1994, two of which were national and the rest were foreign. Going forward there was a rapid expansion in the number of banks and branches operating in West Bank and Gaza since late 1990’s. Currently the banking system is comprised of 10 domestic national banks and 12 resident branches of foreign banks. Within foreign banks, 11 banks are Arab (9 Jordanian and 2 Egyptian) and one foreign namely HSBC Middle East. Generally, banking operations are denominated in the three circulated currencies, NIS, JD and US$.

However, the year 2000, which marked the start of the second Intifada, witnessed an exceptional temporary trend of increased NIS deposits compared to other currencies. This was backed by panicking agents whom perceived deposits in NIS as the easiest to access cash transactions. Despite the major stress on the Palestinian financial system during the Intifada, the banking system has survived the severe recession. The sector continued to function although at lower levels but managed to avoid a major collapse. Banks continued to provide basic banking services to the population.

It is estimated that during the period 2000-2004 total assets of the Palestinian banking sector grew at a CAGR of 2. 71%. Customer deposits grew at a CAGR of 3. 07% for the same period. On the lending side, banks adopted a cautious policy due to the risky political and security environment. This was a direct result of the quality of bank’s loan portfolios that suffered with increasing level of non-performing loans and some collateral being destroyed as a result of military operations. It is estimated that during the Intifada non-performing loans increased from 8% in 1999 to around 30% in 2002.

Snapshot of the Banking Sector In 2005, PMA’s latest data on banking sector reported that banking assets continued the rising trend and increased to US$5. 49bn in October 2005, from US$5. 11bn at the end of 2004. Foreign assets continued to form the bulk of banking assets, amounting to 44. 2% or US$2. 43bn. Credit facilities for residents formed 33. 24% of the total assets, reaching US$1. 82bn at a relatively high growth of 31. 86%. The asset growth was funded from the liability side through public sector and government (PNA) deposits, which witnessed YTD growth rates of 3.09% and 29. 89% at the end of October 2005 respectively.

Public sector deposits and PNA deposits constituted 2. 03% and 8. 78% of total liabilities at the end of October 2005. More importantly, deposits of residents represented 63. 59% of total liabilities. It grew by 2. 96% to reach a new landmark of US$3. 49bn at the end of October 2005. PMA’s responsibilities mainly include licensing, regulating, and supervising the operating banking system ensuring that the capital adequacy ratios are respected this is in addition to protecting depositors.

This role in effect is limited to the Palestinian banks without being able to offer these banks a Lender Of Last Resort (LOLR) facility which neither the Jordanians nor the Israelis have been willing to offer. Thus, although PMA has some of the powers and functions of a central bank, it does not issue its own currency. Consequently, the control of inflation is therefore beyond its remit and the only existing monetary instruments are required reserves and quantitative guidelines on lending and foreign assets offering limited scope for influencing monetary policy.

Moreover, PMA has had no recent experience with any form of exchange rate management. Looking forward if there were to be a Palestinian state, the PMA should become the central bank, charged with monetary and exchange rate policies. However, it is likely that the economy would remain dollarized even if a new national currency is introduced. This is mainly because the credibility of the new currency would require initially flexibility to exchange the three existing legal tenders for the new currency at a fixed rate.

However, on the positive side inflation is still expected to stay at acceptable levels as there has been no recent history of high inflation to counter against. In January 25th 2006, Hammas, won the Palestinian Elections, which had no negative effect on the Total Deposits that reached 4,202. 50 with a 0. 3% increase. The same goes for the Total Assets which increased by 2. 4%, this increase was a bit lower than the 10% increase in 2005, nevertheless it was still an increase. During the year of 2007, Total Deposits and Total Assets reached 5,117. 7 and 6,983. 3 respectively with a 21. 8% increase in both.