Speakers at the two-day seminar in Damascus included, from left: Fahim Moudad, Jassem Al-Munai, Mohammad Bashar Kabbara, Mohammad Al-Imadi, Nahla Alnamli.

A long overdue modernization of Syrian banking procedures and financial sector reform has begun to pave the way for the return of private banks to the country. The necessary exercise in reform is not expected to be easy and critics note that economic reform cannot be separated from political openness.

Nevertheless, recent legislation is set to transform what has been a decades-old state monopoly in virtually all areas of financial services. Law No. 28, signed on April 16, 2001, marked a turning point in allowing private banks to operate in Syria, provided that a 51% stake is Syrian-held. Law No. 29, passed in the same year, guarantees banking secrecy, and the more recent law No. 23 of 2002 has established a Credit and Monetary Council.

A two-day seminar held in Damascus this May highlighted some of the issues the newly-developing sector will face, with neighboring Arab banking delegations furnishing their share of know-how.

According to Fahim Moudad, Lebanon's second deputy governor at the Central Bank, "the deregulation in financial services is considered a basic condition that goes with the development of the financial sector, and in our opinion, that requires the availability of a number of fundamentals. The most important are the deregulation of interest rates, privatization of public sector companies, allowing new entrants into the financial sector and doing what is possible to maintain a stable macro-economic infrastructure in order to reap the benefits of financial deregulation."

                            Reform Timeline
The Banking System

Nationalized in 1963 after the ruling Ba'ath party came to power, Syria's rudimentary banking sector has consisted of a Central Bank working alongside other specialized sector banks concentrating on industry, housing, agriculture, savings, insurance and general business. But the Central Bank's monetary policy has been largely limited due to government-imposed price controls, a multiple exchange rate system and exchange controls.

Credit and Monetary Council

In order to strengthen the bank's role in time to meet the introduction of private banks, Law No. 23 was introduced to establish a Credit and Monetary Council, entrusted to undertake comprehensive monetary reforms. Those measures include stabilizing the Syrian pound's exchange rate and maintaining its free convertibility into other currencies (see table 3).

The Council, to be headed by the governor of the Central Bank and his deputies, will be composed of a number of experts in money and credit and representatives of the Minister of Economy and Trade.

Commercial Bank of Syria

As the country's only retail banking network during the last 40 years, the Commercial Bank of Syria is also the only institution allowed to deal in foreign exchange within the country. However, excessive regulation and a lending policy largely limited to the public sector, by both the Commercial Bank and other institutions, has crowded out private sector access to credit. Favorable rates are given to the public sector, leaving the private sector to borrow at a higher, fixed rate. Interest rates are also fixed by the government, irrespective of the rate of inflation, which often results in negative interest rates in real terms.

Modernization                                                                            Law no. 28
                                                                           Establishing Private & Joint Sector Banks

Law No. 28 is set to overhaul the archaic state-controlled banking system by legalizing private and joint sector bank operations in Syria, and allowing foreign ownership stakes in them. While foreign ownership by institutions is limited to 49%, each individual owner may not possess more than a 5% share (See Table 2). The law also stipulates that the Syrian government own a 25% share in any venture, According to one bank official, this alliance structure complicates ownership scenarios and reduces the interest of banks in seeking entry into the Syrian market.

Ensuring Banking Secrecy

Law No. 29 follows in the footsteps of Lebanon's banking regulations, protecting the confidentiality of clients through numbered deposit accounts. Penalties for violating this law extend from three months up to one year in prison, according to Article 8 of the law. While aiming to attract greater foreign investment with this piece of legislation, Syria also hopes to compete with Lebanese banks to win over Syrian depositors who have turned to Lebanon for their financial services. See Table 4 for some of the key provisions of this law.

Previous Reform Efforts

The Syrian government has periodically attempted to reform and liberalize the economy, most notably since Bashar Al-Assad took over from his father in July 2000. In an effort to kickstart the country's stagnant economy, foreign tax-exempt banks were allowed to operate in the free economic zones that had been set up in 1972 in Damascus, Aleppo, Adra, Lattakia and Tartus. License applications soon followed from a number of Lebanese banks interested in entering the virgin market; among those who set up operations were Societe Generale Libano-Europeenne de Banque (SGLB), Banque Europeenne pour le Moyen-Orient (BEMO), Banque du Liban et D'Outre Mer (BLOM) and Bank of Beirut and the Arab Countries (BBAC).

The government's decision at the time was seen as a means to bypass the country's strict controls and set up a parallel banking system for international investors, while preparing for their eventual access to the local market. But the operating conditions proved to be highly restrictive, obstructed by administrative constraints, government bureaucracy and a limited clientele. Activity in the zones is now minimal, say bank officials.

What is Needed                                                                      Law no. 23
                                                                          Forming the Credit & Monetary Council

According to the World Bank, key issues in the economic area include "the elimination of distortions such as the multiple exchange rate system, subsidies and price controls, streamlining of the bureaucracy and public administration in order to introduce efficiency, overhauling Syria's regulatory and legal framework to transform the economy into a market-oriented system, and the modernization of the existing economic infrastructure to generate an environment suitable for private sector growth and job creation."

Introduction of legislation such as Law Nos. 28 and 29 therefore comes as a welcome sign that Syria is seriously committed to liberalizing and reforming its financial sector. Banks applying for licenses expect to receive approval by the end of the year and hope to begin operations by early 2002. Besides the introduction of private banks, the government has also authorized the establishment of a stock exchange and said it will unify the exchange rate to reflect the Syrian pound's free market rate.

Challenges

Critics note that new legislation is encouraging, but that implementation is another matter which remains to be seen. A handful of knotty issues that need to be unravelled include a contradictory legislative process, labor market restrictions and the need for a secure and stable business environment.

Contradictory regulations at the implementation stage may pose some complications, according to a representative of one Lebanese bank studying entry into the Syrian market. For example, Article 4 of Law No. 28 and its Implementation Order No. 2060 differ on the final licensing decision maker. Law No. 28 states that applications for bank licenses should be submitted to the Central Bank of Syria for study and subsequently referred to the Minister of Economy and Trade to give his opinion and then to the Prime Minister, who will issue the licensing decision. However, Article 6 of Order No. 2060 leaves the final decision with the Council of Ministers, rather than the Prime Minister. Such contradictions abound in the bogged-down legislative process.

The inflexibility of Syria's labor laws in terms of recruitment and dismissal of employees is another hurdle banks have to face. The cumbersome hiring process requires banks to submit names of all potential candidates to the Ministry of Labor for approval before any hiring decision can be made. There is also concern among bankers about the reliability of Syria's legal framework in the event of complications. "There must be a secure, operational legal structure in place that banks can rely on in order to attract serious foreign investment in Syria," said one bank official.
                                                                                                  Law no. 29
                                                                                     Ensuring Banking Secrecy

Still, Lebanese banks have been studying the risks of entering the Syrian market at this early stage and many feel the prospects are worth the risk. The untapped potential of the country's retail market at a time when Lebanon's banking sector is suffering stagnation and reduced profits is seen as a vehicle for growth. According to one banker, entering the Syrian market is a long-term, strategic decision based on reaping the benefits of early entry, even if that means suffering losses in the initial period of operations.

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