Most policymakers in the Middle East and North Africa agree that stronger economic growth is a crucial component of any strategy to address the region’s persistently high levels of unemployment and raise its living standards. One question that arises is: What role can the financial sector play?
It is well known that a dynamic and vibrant financial sector will improve economic outcomes for a country, leading to faster and more equitable economic growth. The key to answering this question, therefore, is to look to the past and examine how the financial sector has contributed historically to growth in the region.
Unfortunately, the experience in the Middle East and North Africa has not been as successful as in other regions. Although the overall scale of activity by banks and stock markets in the region—known by economists as financial depth—has been similar to the global emerging and developing country average, there are two important differences:
- The region’s financial sectors vary greatly from country to country. For example, in 2008, the country with the deepest banking sector (Jordan) provided credit to the economy at a scale equivalent to 16 times that of the shallowest (Libya). Countries such as Saudi Arabia exhibit levels of stock market activity similar to those in developed countries, while others lack a stock market altogether (Yemen).
- Banking systems in many Middle East and North African countries should be providing greater amounts of credit, given their ability to attract deposits. Excluding the countries of the Gulf Cooperation Council, the average loan–deposit ratio in regional banking systems has been well below the global emerging and developing country average for the past 30 years.
More crucially, for a given level of depth, banks in the region have not delivered benefits to the same degree as elsewhere. Access to financial services has fallen short, according to surveys. Relative to other regions, fewer firms receive bank financing, a greater proportion cite access to credit as a major constraint to their business plans, and a smaller percentage of the population has access to checking accounts or ATMs. Bank loans tend to be concentrated among a small number of borrowers, excluding many potentially growth-enhancing firms.
So, it is not surprising that the impact of banking depth on growth in the Middle East and North Africa is at least a third lower than in other emerging and developing countries, according to a worldwide analysis. If Yemen’s banking system were to deepen to the emerging and developing country average, for example, annual per capita growth would increase by just 1½ percentage points. By contrast, a country—say, Armenia—with a similarly shallow banking system in another region would accelerate its growth rate by a full 2⅓ percentage points.
Thus, in addition to financial shallowness in some Middle Eastern countries, the region as a whole seems to suffer from a quality gap in bank intermediation with respect to the rest of the world.
How, then, can policymakers in the region enhance the financial system’s contribution to growth? In countries where shallowness in the banking sector or domestic stock and bond markets continues to be an issue, they could take steps to
- improve the conditions under which banks, households, investors, and firms participate in financial transactions;
- improve legal frameworks that protect creditor and shareholder rights;
- streamline insolvency regimes;
- develop primary and secondary markets for government securities; and
- remove excessive controls on credit and/or interest rates.
- Continued macroeconomic stability would also help, by increasing the public’s willingness to place funds in bank deposits or in domestic capital markets.
To address the quality gap, policymakers will have to boost competition in the banking sector. Actions to remove entry barriers and improve the credit information environment, in addition to promoting the development of local debt markets, would go a long way toward accomplishing this. Policymakers should also assess—and possibly scale back—the role of state banks in countries where their large presence may be stifling both financial depth and banking competition.
This post originally appeared at iMFdirect and is reproduced here with permission.