CENTRAL BANK OF YEMEN USING "MORAL PERSUASION" FOR

UNCLAS SECTION 01 OF 02 SANAA 000056

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN KMPI YM ECON COM
SUBJECT: CENTRAL BANK OF YEMEN USING "MORAL PERSUASION" FOR
ENFORCEMENT


1. (SBU) Summary: During a MEPI-sponsored assessment of the
Yemen banking system, representatives of the Financial
Services Volunteer Corps engaged in lengthy discussions with
Central Bank of Yemen (CBY) Sub-Governor for Control Abdullah
Ulafi and Payment Systems Director Omar Bazara. Both
officials gave candid assessments of the weaknesses of the
Yemeni banking system: Prevalent insider lending, over-use of
short-term loans, limited CBY oversight authority and
capacity, and intervention of the Ministry of Finance in CBY
regulatory policy. End Summary.

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Commercial Banking: Short-term loans for "trade finance"
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2. (SBU) According to Ulafi, Yemen,s fourteen commercial
banks, four of which are Islamic, lend about one-third of
their capital to "trade-finance" projects with terms under
one year. Ulafi claimed commercial lending is on the rise
and that the liquidity of Yemen's banks is not a problem
since the commercial banks are heavily invested in Treasury
Bills. Ulafi said that deposits are increasing 25 percent a
year due to point-of-sale purchases. Most of the banking
sector, however, contends that lending remains stagnant
because of a lack of legal enforcement against defaulters and
the absence of a reliable credit rating system. (Note: only
three percent of Yemenis hold bank accounts. End Note).
Ulafi said that Islamic banks are the fastest growing sector
of the market.


3. (SBU) The banking law requires Yemeni banks to have a
minimum capital adequacy ratio of 8 percent, and the Central
Bank requires ten percent of bank liquidity to be held in
Yemeni Riyals (YR) and twenty percent in foreign currency.
Existing capital requirements are 6 billion Riyals, roughly 2
million USD.

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CBY Enforcement: "Moral Persuasion"
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4. (SBU) The Central Bank has seventeen bank examiners
located at the bank to do monthly on site inspections. Ulafi
affirmed that insider lending, with banks lending to their
own boards of directors and close associates, is the biggest
problem facing the banking system. Ulafi said the CBY uses
"moral persuasion" to reduce these practices, complaining
that the CBY,s oversight powers as defined in the banking
law, were watered down due to the influence of powerful
Yemeni banking families. (Comment: Most of Yemen,s banks
are essentially vaults for the major families and their
business associates to place their money, they are by and
large reluctant to lend to anyone unknown to them. End
comment).


5. (SBU) The CBY uses the Capital, Assets, Management,
Earnings and Liquidity (CAMEL) system to rank their banks
from 1 (best) to 5 (worst). Ulafi admitted that two banks
in Yemen ranked a five and one a 4. (Note: One FSVC volunteer
said that these three banks should be shut down. End note.)
Ulafi said 85 percent of banks in Yemen rank at one or two on
the scale. If a bank scores a five the CBY prohibits it from
distributing profits or opening new accounts or branches.
Ulafi characterized the two poorly performing banks as
suffering from non-performing loans, low capital and bad
management.


6. (SBU) The CBY does not have an arbitration office, and
maintains only a limited credit bureau. The CBY revoked one
bank's license for issuing bad loans after several depositors
were unable to withdraw their deposits. Because they
exceeded the bank's capital, the ROYG took over these loans.
Complicating the situation Yemen,s weak commercial courts
are unable to enforce claims on collateral. Without strong
commercial courts, Ulafi asserted, insider trading is
encouraged and banks are reluctant to expand business.

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T-Bills crowding out Loans?
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7. (SBU) Ulafi discussed IMF concern that the CBY is over
reliant on Treasury Bills and therefore crowding out other
investments. Ulafi contended that this is not a problem and
that T-Bills are a low risk option for banks. (Note: Ulafi
may be correct, but as liquidity is not an issue for most
banks they should have sufficient funds for both T-Bill and
other investments. End note). T-bills are sold at 3 month, 6
month and 1 year increments. This year the CBY sold 500
Million YR in T-Bills as opposed to last year,s sales of 700
million YR. Ulafi said that Yemen's monetary policy applies
indirect measures to maintain monetary stability and to
forecast liquidity in an effort to bring inflation down. The
Central Bank Law mandates that inflation control and exchange
rate stability are the two priorities of Yemen's monetary
policy. It accomplishes this by selling T-Bills to reduce
the money supply and by selling foreign currency. Due to
negligible borrowing in Yemen, the CBY cannot regulate
monetary policy by raising or lowering interest rates.


8. (SBU) Omar Bazara, Payments Systems Director for CBY,
noted that T-Bills are often used by commercial banks when
balance sheets show an end-of-the-day deficit. Rather than
disclose their financial status to competitors in order to
receive bridge loans (a normal practice in healthy banking
systems),banks sell back T-Bills to the CBY. Members of
FSVC pointed out that a strong central bank would discourage
this practice, which should not be one of its core functions.
The CBY purchases T-Bills at near market price, however, so
there is little incentive for the banks to change this
practice.

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Draft Banking Law to Strengthen Central Bank
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9. (SBU) Ulafi was optimistic the draft banking law (when
passed) would give the CBY new powers to remove incompetent
bank management, even at private banks. Ulafi said that the
World Bank had advised the CBY and Ministry of Finance to
create a new law focusing on non-performing loans and
low-capitalization and offered to assist in its drafting.
Ulafi said that while the CBY is independent according to the
1998 banking law, in practice the powerful Minister of
Finance regularly interferes with monetary policies.

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Comment
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9. (SBU) The CBY's authority is constrained by the
interference of the Ministry of Finance and by its role as a
commercial bank for government employees. FSVC volunteers
recommend that the Central Bank cease functioning as a
commercial bank and focus instead on oversight and management
of Yemen,s poorly performing banking sector. Unfortunately,
the CBY, under the thumb of the Minister of Finance, seems to
be moving in the opposite direction. The ROYG has moved the
direct deposit of public salaries from commercial banks back
to the CBY, where they are paid in cash. This perpetuates
Yemen's cash economy and maintains MOF's control over payroll
(which is often abused). The CBY is even considering
installing its own ATM machines. MOF is also looking to
expand its reach into the insurance and accounting sectors.
These actions increase MOF's involvement with the CBY and
serve to weaken its focus on performing core functions. End
Comment.
KHOURY