Circular No. 206 Study on Assessing the Interest of Banks Operating in Palestine in Entering the Specialized Lending Sector

Palestine Monetary Authority
PALESTINE MONETARY AUTHORITY

Circular No. (206/2022)
To all banks operating in Palestine
Date: Monday, September 12, 2022

Subject: Study on Assessing the Interest of Banks Operating in Palestine in Entering the Specialized Lending Sector

Following the study conducted in collaboration with the World Bank on assessing the interest of banks operating in Palestine in entering the specialized lending sector, the study revealed several conclusions and recommendations centered on the following:

First: Conclusions:
Status of the Micro Lending Sector:

1. The number of beneficiaries of microfinance services reached 64,500 in 2021, with a portfolio size of approximately 274.9 million dollars in 2021.
2. There is a significant gap in microfinance, with approximately 70% of borrowers and the existing portfolio concentrated in the West Bank.
3. An unserved population segment exists within the microfinance sector, ranging between 330,000 to 430,000 potential borrowers in the market. The potential market gap is estimated between 630-900 million dollars, indicating that the microfinance sector has an available opportunity to benefit from the progress made since the Palestine Monetary Authority assumed supervision and oversight of this sector.
4. There is a significant gap in women's access to and use of financing, as well as substantial gaps in access to and use of financial services and products between the West Bank and the Gaza Strip.
5. The level of demand for lending is high, yet demand directed toward banks is low, as a wide segment of potential borrowers refrains from approaching banks due to entrenched perceptions of application rejection (due to circumstances related to that segment "demand side", or reasons linked to the bank's lack of willingness and enthusiasm for this type of lending "supply side" under prevailing conditions and parameters.
6. The specialized lending sector (small and micro) is progressing at a relatively steady upward pace, and there is a positive trend among banks toward entering the small lending market.

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Palestine Monetary Authority
PALESTINE MONETARY AUTHORITY

7. Numerous incentives drive banks to enter the micro lending market: high profitability rates, large demand volume, short repayment periods, loan guarantees and endorsements from specialized international institutions (lower risk) for lending.
8. There are no theoretical obstacles to banks entering the microfinance sector; legislation related to banking and lending institutions (Law Amendment No. (9) of 2010 concerning Banks and the Licensing and Supervision System for Specialized Lending Institutions, and the PMA's instructions regarding Credit) imposes no restrictions concerning bank operations in the specialized lending field.
9. The legal framework and instructions issued by the Palestine Monetary Authority support and encourage increased bank involvement and participation in small specialized lending (e.g., the Sustainability Fund).

Challenges Facing the Microfinance Sector:

1. Lack of a clear development concept from a microfinance perspective.
2. Absence of an integrated microfinance system in Palestine.
3. Lack of loan guarantee funds dedicated to providing guarantees for small and micro loans.
4. Competition among microfinance institutions, as they serve the same target demographics.
5. The legal system does not facilitate the implementation of justice requirements, as it is difficult to establish rights and return them to their owners from debtors generally and banks specifically, due to the high value of banking transactions and consequently higher credit risks and increased default probabilities.

Developing the Micro Lending Sector:

1. Banks can enter the microfinance field through two models: a "service company" model owned 100% or partially by the bank, and an "independent microfinance company" model, which will encompass various company categories such that the supervision and oversight system depends on the types of services and products they provide.
2. The optimal formula for engaging in the lending market involves establishing a specialized lending company, in which the bank participates according to its willingness and capabilities. Its board of directors is formed according to bank contributions, and the company is managed by a professional and neutral executive management evaluated by the board. Thus, the proposed company can contribute to developing the small lending market, meet a significant portion of the high demand for small lending services, and simultaneously enable banks to achieve relatively high profit levels. This formula represents an entry point to solving

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Palestine Monetary Authority
PALESTINE MONETARY AUTHORITY

the dilemma facing the small lending sector, characterized by high demand for loans (with attractive profit levels) accompanied by a relative weakness in the supply side.
3. Theoretically, the entry of new players (supply side) into the small lending market should lead to a reduction in loan interest rates in this market. However, in reality, demand volume is very high, as borrower demand for small lending will continue unaffected under prevailing interest rates, and the desire of banks and lending institutions to expand their activities should not conflict with their goal of maximizing profits (given the availability of demand).

Second: Recommendations:

1. Develop the current contractual formula between banks and lending institutions, institutionalizing and framing the relationship by concluding agreements between them under the supervision of the Palestine Monetary Authority that define the duties and rights of each party to ensure the required balance.
2. Establish a specialized lending company, in which banks participate and whose board of directors is formed according to bank contributions, managed by a professional and neutral executive management evaluated by the board. Considerations and notes from Islamic banks regarding the company's field of work, foundations, and operational methods can be taken into account.
3. Implement modifications to bank organizational structures by establishing specialized departments or divisions in the field of small lending, and allocating qualified and specialized human resources capable of operating under a different credit approach, as prevailing structures are unsuitable for entering the small lending sector and dealing with its specifics.
4. Change the bank's credit approach toward differentiating and classifying customers according to new criteria based on real-world differences according to the circumstances and requirements of each group.

Supervisory Group
Palestine Monetary Authority

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Ramallah and Al-Bireh Governorate - Palestine P.O. Box 452 | Tel: +970 2 2415251 | Fax: +970 2 2415310 | info@pma.ps Gaza - Palestine P.O. Box 4026 | Tel: +970 8 2825713 | Fax: +970 8 2844487

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