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Nonbanking financial institutions (NBFIs) are a vital part of the financial landscape in developed economies. Institutions such as insurance companies, private pension funds, mutual funds, leasing institutions and factoring companies all play a role in availing financing to the real sector as they compete with and complement traditional banks. This competition increases bank efficiency and expands the range of financial services available notably to small and medium enterprises (SMEs) and households.  

Currently, NBFIs are poorly developed in the Arab world. The formal banking sector, with assets over 130% of GDP on average in the Arab world, dominates the world of finance. This is in sharp contrast to insurance companies and mutual funds, with average assets of 5% of GDP, and dwarfs the average 1% of GDP assets held by the remaining NBFIs.  

In developing fully fledged diversified financial systems, Arab countries will need a significant and robust NBFI’s presence. Governments are going to have to develop or enhance an enabling environment through policies, legislation and regulation, implement an efficient tax regime and foster technical capacity building. A few examples below point to just how challenging the promotion of NBFIs can be.

The region’s insurance sector is characterized by a low level of penetration and a small ratio of assets to GDP relative to expected levels, given the region’s per capita income and demographic characterisitcs. Insurance is currently dominated by the motor, transportation and construction sectors with life insurance remaining neglected. The slow development of the sector can be attributed to the lack of mandatory insurance in key lines, the dominance of state companies in some countries, regulatory and supervisory weaknesses and inadequate tax rules as well as a lack of technical skills. Morocco has made strong strides in creating a strong regulatory system and mandatory insurance lines, followed by progress made in Egypt, Jordan and Tunisia. However, other countries such as Libya, Syria and Algeria must yet recover from previous nationalization.

Further, Arab pension fund markets are highly disjointed.  Private pension funds are rare and target employees in the financial sector as social welfare program already offer generous benefits to the population as a whole. These private funds have yet to accumulate large financial resources. Public pension funds, however, have been able to amass assets up to 20% of GDP in countries such as Bahrain, Egypt, Jordan, Kuwait, Morocco and Saudi Arabia in response to the impending needs of the youth demographic bubble. However, governance of both private and public pension funds remains opaque and lacking transparency with regulatory induced conservative investment policies. Only a few countries such as Jordan and Morocco have introduced reforms to the governance and transparency of their funds (Rocha, Arvai and Farazi 2011).

Similarly, mutual funds development tends to be negligible across Arab countries, constrained by regulatory and market deficiencies including cross-border investment restrictions and lack of adequate supply of suitable instruments, especially private fixed-income instruments. Only Bahrain and Morocco have seen mutual fund assets accumulate to 25% of GDP while total assets managed by mutual funds in Egypt, Kuwait, Saudi Arabia and Tunisia remain at a low 5% to 7% of GDP.

Finally, the leasing and factoring markets in Arab counties remain hampered by a lack of a clear legal framework defining party obligations, the absence of leased asset registries and ineffective repossession mechanisms. Leasing is growing in Bahrain, Kuwait, Tunisia and the UAE, which now collectively constitute 60% of the Arab leasing market. The fact that operating leasing is Sharia-compliant has led to rapid increases in the sector in Egypt, Morocco and Jordan as well.

As the Arab world integrates into the global financial community, addressing the legal, regulatory and incentive challenges to NBFI development will be critical.

References

• Rocha, R., Z. Arvai, and S. Farazi. 2011. “Financial Access and Stability: A Road Map for the Middle East and North Africa.” World Bank, Washington, DC

Wafik Grais is an International Senior Adviser specializing in Islamic finance, financial regulation, investment financing, private equity management, and corporate governance with expertise in SMEs and green growth financing. He was co-founder and chairman of Viveris Mashrek, a Cairo-based, financial advisory services company specialized in private equity investments in SMEs, licensed by Egypt's Financial Supervisory Authority. He spent 28 years in international finance notably with the World Bank in Washington DC where he held several senior positions both in operations and at corporate levels. He holds a Ph.D. in Economics.