The IMF says that countries in the Middle East and North Africa (MENA) have made progress in the last decade or so in deepening and strengthening their financial sectors, but governments will have to go much further if they want to ensure strong, market-led economic growth.

‘In many countries, financial sectors remain thin and tightly regulated, government ownership of intermediaries is predominant and, with a few exceptions, market forces play a limited role in the determination of financial variables,’ says a report issued on 11 November by the IMF’s Middle Eastern Department. It makes several suggestions for improvement:

Strengthening market forces in the financial sector. Regulators should enforce anti-trust rules and make it clear how new banks are licenced. Sectoral restrictions on bank activity should be lifted.

Governments should issue more tradeable debt, which will make money markets deeper and more liquid. This in turn helps the market, rather than the state, to set interest rates. It also allows the central bank to influence the market indirectly rather than by giving orders to the banks. ‘While instruments of indirect monetary control have been introduced in many MENA countries, their use has been undermined by efforts to direct credit towards preferred sectors,’ the report says.

Reducing state shareholdings in banks and other financial intermediaries. ‘In a number of MENA countries the state still exerts a strong hold over the financial sector through ownership of the main intermediaries.’ A private banking market will be more competitive and allocate capital more efficiently, the IMF says.

Making regulation tougher and banks sounder. Banking sectors in many MENA states are now better-capitalised and better-regulated than a decade ago. However, many banking sectors still have bad loan problems and some banks, often government ones, do not meet global requirements on capital adequacy.

The report says banks need to have more provision, recapitalise more often and in some cases, merge. Government banks should deal with their bad loans. Disclosure and accounting rules should be strengthened and harmonised across the region. In many parts of the region, there is also a need for a simple, transparent and adequately funded system of deposit insurance.

Deepening the financial sector. The region needs a broader range of financial instruments. The growth of stock markets could be helped by more dynamic privatisation, reform of pension funds and removing tax distortions. Liquidity is also reduced where investors are able to do bilateral share deals off the official stock exchange, and where banks use their own mutual funds to limit trading in stocks to their own clients.

Opening up corporate ownership. Too many companies are owned by families which do not want to lose control by going public. Better stock markets and tax incentives could encourage private companies to raise more equity publicly, the IMF says. Some states need to allow more foreign ownership, though others have already opened up their financial sectors considerably.