Banking Sector Reform: Significant Medium-Term Gains

BMI View: Tunisian authorities are embarking in a reform of the fragile domestic banking system under the aegis of the International Monetary Fund. Although the pace of reforms will be slow, their implementation will improve stability in the sector over the medium term, which will contribute to diminishing systemic financial risks for the North African country.

The International monetary Fund (IMF) approved on June 13 a 24-month US$1.74bn Stand-By Arrangement which was agreed with Tunisia in April ( see 'IMF Agreement: Taking Stock', April 24). Among the key priorities set by the fund is to improve stability of the banking system, which is exposed to significant systemic risks. For one, the Central Bank of Tunisia's (CBT) liquidity support to banks is elevated, having increase by 53.0% y-o-y in 2012. Policies have been put in place to tackle this issue, which resulted in a 36.0% y-o-y reduction in direct financing from the CBT over the October 2012 - April 2013 period, while deposit growth has recently accelerated, reducing the need for central bank refinancing. That said, structural dependency of the sector on the central bank remains a key concern, given that the central bank has limited capacity to provide emergency aid in the event of a major crisis.

A Tentative Recovery
Tunisia - Banking Sector Deposits (TNDmn)

Deteriorating loan quality and profitability are exacerbating existing bank vulnerabilities. Estimates indicate that end-2012 nonperforming loans (NPLs) came in at 17-18% of total loans, from approximately 16.0% in 2011 and 13.0% in 2010. The increase in NPL's was largely due to the failure of large businesses associated with the family of former Tunisia's ruler Zine El Abidine Ben Ali and its associates. Finally, 37.0% of all Tunisia's banking assets remain in the hands of the three state-owned banks - Société Tunisienne de Banque, Banque Nationale Agricole and Banque de l'Habitat, while the commercial banking system is fragmented and poorly regulated. Importantly, while bad loans amount to approximately 9% of total loans in the commercial banking segment, they amount for approximately 30% of public banks' loans.

Growth Slowing
Tunisia - Banking Sector Loans (TNDmn)

The IMF's published on June 17 a staff report relating to the recently approved Stand-By Arrangement, which contains the main provisions the fund intends to put in place to improve stability of Tunisia's banking system. Among these we highlight:

Reducing banks' structural reliance on central bank refinancing. The IMF plans to reform the current liquidity forecasting framework and to enhance coordinating mechanisms with fiscal policy, by establishing a coordination committee with the mandate to monitor the liquidity situation. The fund also plans to establish a new collateral management framework in order to minimize risks to the CBT's balance sheet, and encourage banks to manage their liquidity in a more forward looking way by putting in place a haircut system for loans accepted as collateral in CBT's refinancing operations. As the range of eligible collateral is reduced, a lender of last-resort facility will be established, in order to keep illiquid but solvent banks from defaulting.

Tackling the fragilities of public banks. Options set out by the IMF to reform public sector banks include recapitalization, merger, or the reduction of the participation of the state. The fund aims to exempt public banks from obligations imposed on them by the law on public enterprises, in order to give them greater freedom in the area of governance and ensure that state banks are subject to the same management rules as private banks. Indeed, Tunisian authorities said on June 17 that the government is preparing to "mobilise all necessary resources" to recapitalise public banks in the next two years, a process which Tunis estimates will cost approximately US$1.1bn. a recent audit of the three financial entities is set to be completed by December 2013.

Strengthening the banking supervision and regulatory framework. The International Monetary Fund will conduct an analysis on the situation of banks' performance and solvency, in a view to identify banks that should be subject to inspection. The fund plans to apply sanctions on banks that are in breach of regulatory standards and strive to move towards international prudential standards, particularly with regard to norms on collateral guarantees. In addition, the IMF plans to strengthen banking supervision capacity by increasing dedicated human and financial resources. Finally, it aims to develop a crisis management mechanism and a special bank resolution regime. Such mechanism will involve defining the respective roles and responsibilities of the CBT and the Ministry of Finance in the event of a financial crisis, as well as create a special bank resolution regime.

Growth Accelerating After 2013
Tunisia - Components Of GDP, TNDbn, Real GDP Growth, % y-o-y

Reform Bearing Its Fruits Over The Medium Term

With the coalition government holding only a slight majority in the constituent assembly and parliamentary and presidential elections are set to take place in Q413, the implementation of reform to the banking sector will be gradual at best this year. That said, we believe that, barring a sudden increase in political instability, sudden policy reversals such as those which took place in Egypt and Jordan in 2012 as a consequence of the government's reluctance to push ahead with reforms (see 'IMF Agreement: Taking Stock', December 14 2012) are unlikely at this stage. Moreover, while reforms to the public banking system met significant resistance before the revolution, given that Ben Ali and his relatives used the country's banking system to build up their personal wealth, the fall of the regime is likely to make reform much easier. Finally, the IMF will provide a fundamental policy anchor to Tunis, which will facilitate the implementation of reforms. As a result, reform of the sector in the North African country will proceed more swiftly compared to other countries in the Middle East and North Africa region which are attempting to reform their domestic banking system, such as Iraq ( see 'Banking Sector: Piecemeal Reforms Set To Dissuade Investors', May 9) and Libya ( see 'Banking Sector Reforms Unlikely', March 28).

The beneficial effects of the proposed reform to the banking sector will not be felt in the economy over the short term. As a result, the lack of a growth-enhancing financial system, limiting access to credit for start-ups, entrepreneurs, and small and medium-sized enterprises, is set to continue hindering the expansion of the commercial private sector over the coming quarters, which will hamper Tunisia's tentative economic recovery. Moreover, as the central bank's liquidity support to the banking system remains elevated, risks that its stock of foreign reserves could be further depleted remain significant, which will contribute to keeping risks to the country's external position elevated. That said, we are confident that banking sector's stability will improve significantly over the medium to long term, significantly reducing systemic financial risk for the North African country.

This article is tagged to:
Sector: Country Risk
Geography: Tunisia

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