US embassy cable - 05SANAA56

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