F S A P UDAN - World Bank · banking institutions in Sudan which comprised 23 domestic banks and 3 foreign banks. The operations of these banks are based on Islamic principles. 2

This volume is a product of the staff of the International Bank for Reconstruction and

Development / The World Bank. The World Bank does not guarantee the accuracy of the

data included in this work. The findings, interpretations, and conclusions expressed in this

paper do not necessarily reflect the views of the Executive Directors of the World Bank or

the governments they represent.

The material in this publication is copyrighted.

FINANCIAL SECTOR ASSESSMENT PROGRAM

SUDAN

TECHNICAL NOTES MAY 2005

INTERNATIONAL MONETARY FUND MONETARY AND FINANCIAL SYSTEMS DEPARTMENT

THE WORLD BANK FINANCIAL SECTOR VICE PRESIDENCY

AFRICA REGION VICE PRESIDENCY

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Contents

Glossary .....................................................................................................................................4

I. Prudential Regulation and Supervision ..................................................................................6

II. Stress Testing ......................................................................................................................10

A. Introduction .............................................................................................................10

B. Identification of Risk Factors ..................................................................................11

C. Stress Test Scenarios and Results ...........................................................................14

D. Future Capital Needs ...............................................................................................20

E. Conclusions .............................................................................................................24

III. Efficiency of Sudanese Banks ...........................................................................................26

A. Introduction .............................................................................................................26

B. Estimation of Efficiency ..........................................................................................26

C. Estimation Results ...................................................................................................27

D. Effects of Bank Characteristics on Efficiency ........................................................30

E. Profitability Versus Efficiency ................................................................................31

IV. The Insurance Sector in Sudan ..........................................................................................34

A. Market Development...............................................................................................34

B. The Regulatory Framework ....................................................................................40

V. Assessment of the Sudanese Payments System .................................................................46

A. Introduction .............................................................................................................46

B. Information and Methodology Used for Assessment ..............................................46

C. Institutional and Market Structure—Overview .......................................................46

D. Payment Systems Infrastructure..............................................................................47

E. Reforms Under Way ................................................................................................52

F. Recommended Actions ............................................................................................57

VI. Legal Framework ...............................................................................................................64

A. Introduction .............................................................................................................64

B. Financial Sector Legislation ....................................................................................65

C. Commercial Law Framework..................................................................................68

D. Corporate Governance ............................................................................................69

E. Accounting and Auditing ........................................................................................70

F. Company Registration .............................................................................................70

G. Bankruptcy and Creditor Rights .............................................................................71

H. The Court System....................................................................................................72

I. The Peace Accord .....................................................................................................74

J. Recommendations ....................................................................................................75

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Tables

1. Financial Soundness Indicators for the Banking Sector, 1999–2003 ..................................15

2. Stress Test Scenarios............................................................................................................17

3. Growth Stress Test Scenarios ..............................................................................................23

4. Sensitivity of Relative Efficiency Ranking ..........................................................................29

5. Regression Results ...............................................................................................................31

6. Indicators of Bank Efficiency and Profitability ...................................................................32

7. Comparison of Insurance Markets in Africa ........................................................................34

8. Insurance Sector Growth......................................................................................................35

9. Market Shares of the Largest Insurance Companies, 2003 ..................................................36

10. Insurance Company Investments .......................................................................................40

11. Premium Income and Claims .............................................................................................40

12. Detailed Assessment of Observance of CPSS Core Principles for SIPS and ....................54

Figure

1. Distribution of Efficiency in the Benchmark Case ..............................................................28

Box

1. Sharia-Compliant Insurance .................................................................................................38

Appendices

I. Stochastic Production Frontier Approach: An Example ......................................................33

II. IAIS Principles ....................................................................................................................43

III. Statistical Information on the Payment System .................................................................61

IV. Extract from the Comprehensive Peace Agreement ..........................................................76

V. Issues in the Introduction of a Dual Banking System .........................................................78

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GLOSSARY

Acronyms

AAOIFI Accounting and Auditing Organization for Islamic Institutions

AML/CFT Anti-Money Laundering/Combating the Financing of Terrorism

BOS Bank Of Sudan

CAR Capital Adequacy Ratio

CDD Customer Due Diligence

CPA Comprehensive Peace Agreement

DIF Deposit Insurance Fund

FATF Financial Action Task Force

FIU Financial Intelligence Unit

FSAP Financial Sector Assessment Program

FSSA Financial Sector Stability Assessment

GIC Government Investment Certificate

GMC Government Musharaka Certificate

ISA Insurance Supervisory Authority

KSE Khartoum Stock Exchange

MFE Ministry of Finance and National Economy

MFI Micro-Finance Institution

MLCA Money Laundering (Combating) Act

NPL Non-Performing Loans/Investments

NPO Non-Profit Organization

ROA Return On Assets

ROE Return On Equity

ROSC Report on Observance of Standards and Codes

RTGS Real Time Gross Settlement System

SD Sudanese dinar

SME Small and Medium-sized Enterprises

STR Suspicion Transaction Report

TPL Third Party Liability

Islamic Financial Terms

Al-Wadiah Safekeeping arrangement of funds with no interest payment

Government Investment

Certificate (GIC)

Securities based on securitized leasing and project financing

Government Musharaka

Certificate (GMC)

Securities based on units in a mutual fund of publicly-owned

companies

Ijara Leasing contract

Istisna’a Financing of work in progress, whereby financer receives goods

when manufactured

Mudaraba Instrument, in which one party contributes capital, the other

labor/expertise

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Murabaha Instrument, in which financer purchases good with agreement

on resale at a price based on initial cost plus a mark-up

Musharaka Instrument, in which parties contribute equity and share profits

and losses

Riba Interest

Salam Instrument, in which buyer pays price before receiving goods

Takaful Islamic insurance; operates similar to a mutual benefit company

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I. PRUDENTIAL REGULATION AND SUPERVISION1

Introduction

1. The banking sector is the backbone of the Sudan’s financial system and will continue

to play an important role as financial intermediary and primary source of financing for the

domestic economy. As of December 31, 2003, there were 26 commercial and specialized

banking institutions in Sudan which comprised 23 domestic banks and 3 foreign banks. The

operations of these banks are based on Islamic principles.2

General assessment

2. The banking system in Sudan is regulated and supervised by the Bank of Sudan

(BOS) as provided under section 6 (c) of the Bank of Sudan Law 2002 which states that one

of the objectives of BOS is to “regulate, control and supervise banking activity and act to

develop and enhance the effectiveness of banking activity, so as to achieve balanced

economic and social development.” Prudential regulation and supervisory by the BOS have

improved significantly in recent years. The BOS has made progress toward enhancing

banking supervision system and has achieved a degree of compliance with the Basel Core

Principles. Much effort has also been made to restructure the banking sector that includes

plans to merge the banking institutions. Compliance is enforced through appropriate off-site

supervisory activities and regular on-site inspections. Supervision and regulations have been

adapted to incorporate Islamic principles but the needed modifications have not been severe.

However, the BOS should continually ensure that prudent banking practices are followed and

never compromised.

3. The law governing Sudan banking sector is generally adequate. As the sole authority

responsible for the Sudan banking system, the BOS has exclusive powers to license,

supervise and inspect all institutions. The BOS’s broad powers and discretion include issuing

of prudential regulation and addressing compliance with laws and regulations. The Banking

Supervision Department is the department responsible for the issuance of prudential

regulations as well as off-site monitoring, while the Banking Inspection Department is

responsible for conducting regular inspections on banking institution. The BOS staff is

protected from being sued for performing their duties as long as they follow the BOS’s

procedures.

4. Starting in 2000, the BOS has increased the minimum absolute capital requirement in

stages to the equivalent of US$12 million with the aim of encouraging consolidation and the

realization of economies of scale. To meet this requirement, capital has been injected into

four state-owned banks. The capital of private and mixed public/private banks has been

1 Prepared by Mohamed Khairudin Abd Aziz (Bank Negara Malaysia).

2 Additional information on the structure of the financial system is contained in the FSAP Aide-Mémoire and

the Financial Sector Stability Assessment.

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increased through a combination of retained earnings, asset re-evaluations and realization,

and rights issues (the latter being more frequent in the case of banks with foreign

participation). Two banks have been merged to reach the minimum paid up capital

requirement. The BOS intends to announce a further increase in minimum capital to the

equivalent of US$25 million by December 2005.3

5. The BOS requires banks to comply with the 8 percent risk-weighted capital adequacy

requirement. While most of the banking institutions have complied with the requirement, the

8 percent minimum risk-weighted capital adequacy requirement however, may not be

adequate given the inherent vulnerabilities of a developing economy dependent on the

production of primary commodities. The BOS’ plan to increase the minimum capital

adequacy ratio a 12 percent —which would be in line with levels in other countries of the

region—is therefore appropriate. From a prudential perspective, this may be more important

than the announced process of increasing the required absolute minimum capital.

6. The definition of regulatory capital allows banks to include relatively illiquid fixed

assets. This reduces the effectiveness of capital as a buffer against shocks, and adds

uncertainty to the valuation of capital, especially given the recent rapid upward revisions in

real estate prices. Therefore, the BOS may need to consider limiting the inclusion of fixed

assets in regulatory capital. Introducing such limitation could be partially offset by a

reduction in the minimum capital requirement.

7. The BOS sets criteria for establishment of a new bank. Evaluation on proposal to set-

up a new bank is made among others, by reviewing ownership structure, assessing the

operating plan, and evaluating proposed directors and management. For prudential purposes,

a large shareholder is defined as one holding at least 7 percent of shares. This cut-off point

seems somewhat high and should be reconsidered; a shareholder with 5 percent of shares

could have a strong influence if other shares are widely held.

8. Banks are required to obtain approval from BOS when providing financing to

directors and shareholders of the bank. It is recommended that financing to directors and

shareholders’ related companies should also be subject to BOS approval. While the banking

law contains restrictions on lending to individual director and shareholder of the bank, there

is a need to introduce a restriction on aggregate financing of such connected parties.

Currently, only financing to members of the bank’s board of directors is subjected to the limit

which at anytime should not exceed the total of the whole capital and the bank’s reserves or

10 percent of the financing portfolio whichever is greater. It is recommended that financing

exposures to directors or large shareholders should be aggregated with that to their related

companies and be subject to a limit set by the BOS.

9. Corporate governance is one of the areas that needs improvement. To improve

corporate governance and enhance board effectiveness, the BOS should consider expanding

3 All new banks are required to have a paid-up capital equivalent to US$25 million.

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the number of qualified non-shareholders to sit on the board of banking institutions as

independent directors. In addition, BOS should consider discontinuing its practice of

appointing BOS staff to sit on bank boards. This is to avoid actual or apparent conflicts of

interest. Moreover, the appointed senior government officials may not be able to devote

sufficient attention to their duties as board members.

10. Classification of non-performing loans and required provisioning rates for NPLs are

differentiated between murabaha financing and non-murabaha financing.4 Murabaha

financing is considered non-performing if the installment is one month overdue; non-

murabaha financing is considered nonperforming if three months overdue.5 Details of the

classification of financing and provisioning rates are as illustrated in the following table:

Classification Murabaha Financing Non-murabaha Financing Provisioning Rate

Ordinary No overdue installment No overdue installment 2 percent

Substandard Installment overdue from 1

to 3 months

Installment overdue from

3 to 6 months

20 percent

Doubtful Installment overdue from 3

to 6 months

Installments overdue

from 6 to 12 months

50 percent

Bad Installment overdue for

more than 6 months

Installment overdue for

more than 12 months

100 percent

11. While not obviously inappropriate, the BOS should gather the necessary data to study

default rates and estimate expected loss in case of default under different circumstances. On

this basis, the provisioning rates may need to be revised. In addition, the BOS may also need

to review its asset valuation methods regarding fluctuations in the prices of underlying

contracted commodities that expose banks to risk.

12. Regular and formal contacts between the BOS and management of banks have been

part of the BOS’s coordinated on- and off-site supervisory activities. As part of the BOS’s

efforts to strengthen its supervision function, a meeting with the board of directors and senior

management of banks is held on a monthly basis. The performance of banks and policy

direction will be communicated to the banks at the meeting.

13. While consolidated supervision has yet to be developed in the BOS, on-site

inspections are conducted to ensure that banking institutions are sound and that the banks

comply with rules and regulations issued by BOS. The Banking Inspection Department has

4 The Aide-Mémoire and the Financial Sector Stability Assessment contain explanations of these terms in

Islamic finance. 5 Required provisioning is also adjusted depending on the availability of collateral.

- 9 -

adopted the CAMEL (Capital adequacy, Asset quality, Management competence, Earnings

potential, and Liquidity position) framework in assessing the overall performance of the

bank. Under this framework, each component is assessed based on quantitative and

qualitative factors. A rating ranging from 1 to 5 is assigned to each component (1-strong, 2-

satisfactory, 3-fair, 4-marginal and 5-unsatisfactory). Each institution is then assigned a

composite rating (1 to 5) after taking into consideration the rating of each component. In

performing its function, BOS has the legal right of full access to all bank records and

information. BOS also can request information as and when it needed, apart from regular

reports that banks have to submit to BOS.

14. There is a need to strengthen supervisory capacity that includes providing adequate

resources to perform on-site inspections and upgrade the technical skills of inspectors. The

scarcity of inspectors in the Banking Inspection Department has resulted in the inability of

the department to perform inspections on all banking institutions. As of November 30, 2004,

the department had only conducted inspections on 13 banks (out of 26). The IT inspection

was not conducted due to the unavailability of IT inspectors to perform this kind of

inspection. This problem was further compounded by the BOS’s practice of transferring staff

(after about five years in the department) to other departments, which to a certain extent has

affected the effectiveness of on-site supervision.

15. There is also an urgent need to improve coordination between on-site and off-site

supervision, and between supervision and the rest of the BOS, for example on data

management, reporting to BOS senior management, and the analysis of cross-section

variations and time trends.

16. The Sudan banking law provides the BOS with a wide range of corrective measures

to ensure the safety and soundness of banking institutions. Such measures include, depending

on circumstances: imposition of a directive, removal of the director and senior management,

cancellation of the license, and liquidation of the bank. Penalties are also provided in the

regulation to deal with infringement of legislation and regulation.

17. Cross-border cooperation is an area that needs to be enhanced. BOS should develop

cooperation with the home country supervisory authorities; moreover with foreign entry

becomes more pervasive. The existing law does not provide BOS with the express power to

share confidential information with the home country supervisory authorities, which is

needed for effective cooperation. Nevertheless, local branches of foreign banks are still

subject to the same prudential, inspection and reporting requirement as domestic banks.

Conclusion

18. While prudential regulations and supervisory skills by the BOS have improved over

the years, there are areas of concern that need the central bank’s attention to further

strengthen the banking system. For example, corporate governance should be enhanced in the

banking system. Regulations on financing to connected parties should be tightened. The

capital adequacy ratio should be reviewed. The supervisory capacity should be strengthened.

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The coordination among the BOS departments should be improved. Finally, cross-border

cooperation should be enhanced. This becomes more important with the following events

that will take place—that is, a proposed bank merger, the introduction of a conventional

banking system in the South, and the entry of additional foreign banks into Sudan.

II. STRESS TESTING6

A. Introduction

19. The Sudanese financial sector is small relative to GDP, but is rapidly growing.

Deposits in the banking sector currently represent a little over 10 percent of GDP, and credit

to the private sector has been rapidly expanding, driven by a strong economy. At present, the

banking system is small enough that a crisis would not have much immediate impact on the

overall economy. However in this environment there are still two reasons to be concerned

about the stability of the nascent banking sector.

20. First, as the banking sector grows it will eventually become systemically important.

In the past three years alone, broad money and total net domestic credit to the economy have

both more than doubled. If Sudan’s political and security problems can be resolved, there is

the potential for an even more rapid growth of credit. It is likely that in the near future

Sudan’s banking sector will become systemically important, so that a financial crisis could

possibly have a severe impact on the economy.

21. Second, if Sudan is to move forward, it will need a well-developed financial sector.

The deepening of the financial sector will depend on the gradual establishment of confidence

in financial institutions, a slow process that can take time and can be significantly delayed by

events that reveal weaknesses. While a crisis today might not have a strong immediate

impact in terms of GDP, it could have a tremendous cost over time by delaying for an

indeterminate period the development of the supporting financial structure without which the

present fast pace of growth cannot be sustained.

22. To assist in the authorities’ preparations to avert or to manage potential strains, the

staff conducted stress tests. These tests examined the effects of a set of quantified financial

and macroeconomic shocks that were identified and agreed on with the authorities as having

a reasonable chance of occurring. To some extent these shocks were calibrated to test the

limits of the system. The analysis focused on calculations of banks’ soundness indicators—

particularly capital adequacy ratios—after the hypothetical shocks occurred. A second

analysis looked at the possible effects on banks’ soundness indicators of a continuation of the

recent rapid expansion of the banking system and other structural changes, and assesses the

extent to which banks will have to adapt to keep up with changing circumstances.

6 Contributor: Joseph Crowley.

- 11 -

23. The analysis was hampered by data limitations. Data even for main aggregates such

as loans, deposits, or bank profits were provided only with a delay of months, left out some

banks (not always the same set), including some large banks, and were sometimes difficult to

reconcile with each other or with published data. Moreover, there are questions about the

measurement of capital. The results of this analysis should therefore be considered as

indicative only. The Bank of Sudan (BOS), the central bank, recognizes the need for

improving their data management capacity and is interested in taking urgent steps to address

the problem, including taking advantage of technical assistance.

B. Identification of Risk Factors

24. After reviewing country documents on Sudan, drawing on the experience of past

FSAP teams, and holding discussions with the Sudanese authorities and members of the

Sudanese private sector, the mission considered several sources of potential stress to the

Sudanese economy. Five short-term risk factors were considered.7 Actual events that affect

the banking sector would possibly result in a combination of these stress factors occurring.

Analyses of future capital needs and the implications of rapid growth of the banking sector

were also undertaken and are discussed in a subsequent section. The five risk factors

considered were:

Risk factor 1: nonperforming loans (NPLs)

25. The mission found widespread agreement that the greatest risk to the banking system

at present would be from an increase in NPLs. Several factors in the Sudanese economy

make the system particularly vulnerable to such a rise: (a) financial investments by banks

have grown rapidly in recent years, buoyed by a strong economy; the quality of these

investments is uncertain as many of them have not had time to become nonperforming even

if they are fundamentally unsound; (b) many investments have been growing over time, so it

is possible that new financing could have been used to repay old financing; (c) weak

accounting practices, questions about the effectiveness of management, and limitations on

the effectiveness of banking supervision add to the uncertainty about investment quality; (d)

the Sudanese economy is in a precarious position; it is poorly diversified—dependent on a

small number of primary commodities, including petroleum, which currently enjoys record

price levels that may not be sustained; and (e) political uncertainty could have an economic

impact.

26. The ratio of NPLs has declined rapidly, but this has occurred at a time of dramatic

expansion of bank financing of the private sector (a threefold increase between end-2000 and

end 2003). The absolute quantity of NPLs actually increased during this period. The

Sudanese authorities note, however, that the threshold for identifying a loan as

nonperforming is unusually strict (one month of delinquency versus an international norm of

7 Over the medium term, an additional risk factor is that banks may become capital constrained if they do not

achieve high enough profitability (see below).

- 12 -

three months) and therefore they argue that there are unlikely to be large quantities of loans

that have already gone bad but have not yet been classified as nonperforming.

27. NPLs could also increase throughout the economy as a result of an economic shock.

An economic shock could be limited to certain sectors. Financing of the agricultural sector,

for example, could be affected by inclement weather, or financing of the construction sector

could become defective if the economic boom leads to overdevelopment. As the economy

becomes more open, certain sectors could also fall victim to foreign competition.

Alternatively, NPLs could increase in the absence of a shock, simply because the strong

economy and the rapid growth of financing result in careless investment evaluation.

28. Regardless of the behavior of NPLs, banks could suffer a regulatory shock if

provisioning requirements are increased. Higher provisions would immediately have a direct

negative effect on banks’ capital (though there would be a compensating decrease in non-

provisioned losses in the future). At end-2003 barely one-third of NPLs in Sudan were

provisioned for, so this risk is significant.

Risk factor 2: exchange rate risk

29. Sudan’s exchange rate regime is classified as a managed float, but the exchange rate

remained remarkably stable at around SD270 to the dollar for an extended period before

recently appreciating to SD250 to the dollar. Furthermore, levels of external reserves are

returning to normal levels and are expected to increase further. In this environment, many

financial institutions have become complacent about the volatility of the exchange rate and

have not devoted significant resources to hedging their positions.

30. The limited data that were available on foreign currency positions suggested that most

banks do not have large net open positions, but that a few banks (some large) had large long

positions, that in some cases exceeded their stock of investment financing. Banks that do not

bear a direct exchange rate risk can nevertheless be indirectly exposed through enterprises

receiving financing, particularly if there are enterprises which must repay loans in foreign

currency but do not have matching revenue in foreign currency. Exchange rate risk scenarios

would therefore have a direct component and an indirect component through NPLs.

Risk factor 3: rate of return risk

31. The Sudanese financial system is run entirely according to Islamic principles, which

forbid the charging of interest. Therefore, there is no explicit interest rate in Sudan.

Nevertheless, all investments have a rate of return. In principle, investment account holders

share the risks that their bank takes with their money, and the rate of return to account

holders is theoretically closely related to the rate of return the bank earns on the investments

made with those funds, but in practice this is true only to some extent. In many cases in

Sudan, a rate of return is explicitly included in contracts, including but not limited to sight

deposits, which pay an explicit return of zero. This practice is much more prevalent with

deposit contracts than with lending contracts. In the case of investment accounts that earn a

variable rate of return, they are very unlikely ever to lose their principal, and even the rate of

- 13 -

return will probably not be fully adjusted to reflect economic realities, particularly adverse

ones, since banks feel pressure to realize a rate of return close to what was expected at the

time the investment was made.8

32. Thus many deposits in Sudan have a rate of return that is fixed or does not fully

reflect economic shocks. The same cannot be said of the investments that banks make. An

economic downturn would possibly reduce bank investment incomes without reducing their

investment expenses. And to the extent that there could also be some lack of responsiveness

in the rate of return on banks’ investments any benefit to the bank is likely to be lost to a

corresponding increase in NPLs.

33. Rate of return shock scenarios would ideally include a full breakdown of deposits by

type, though no such data were available. Even if a complete breakdown were available,

assumptions would need to be made about the capacity of banks to require different types of

depositors to accept losses related to their investments. In the history of Sudanese banking,

no depositor has ever received less than 100 percent of his original investment. It is difficult

to say whether an unprecedented crisis in the banking system could result in an exception to

this pattern.

Foreign competition

34. The BOS anticipates an increase in the number of foreign banks operating in Sudan.

It is this increase that is the motivation behind the bank restructuring program, which aims to

consolidate the local banking sector into a small number of large banks. Competition is likely

to increase the rate-of-return risk by squeezing spreads in the banking sector. The

proliferation of conventional banks in the south could also provide a new source of

competition.

35. More efficient foreign banks might offer sight deposit accounts without associated

fees and might even pay returns on these accounts. Depositors with high-fee, non-interest

bearing sight deposit accounts in local banks could switch those accounts to foreign banks,

depriving local banks of a vital source of profit.

Risk factor 4: deposit volatility

36. A loss of confidence in the banking system could result in deposit flight. To the

extent that capital controls are not airtight deposits could leave the country, resulting in a

significant liquidity drain. This could force the government to provide liquidity to banks (to

maintain their viability) and to absorb it elsewhere (to head off inflationary pressures),

including through a corresponding primary surplus adjustment.

8 Banks are permitted to make use of special reserves to smooth returns on investment accounts.

- 14 -

37. Furthermore, if a large share of the reduction in deposits were sight deposits, the

profitability of banks would suffer, since these deposits earn fee income but pay no return.

Investment accounts, which earn returns, often have penalties associated with early

withdrawal, and would therefore be less likely to be withdrawn than sight deposits.

38. To the extent that capital controls are effective, deposits could be converted into cash,

which would entail the same risk, though to a lesser degree. Even if there is no system-wide

capital flight, news of weaknesses in certain banks could cause deposits to move from those

banks to stronger ones, jeopardizing the weak banks.

Risk factor 5: capital valuation risk

39. Investments of banks must be backed by physical assets under Islamic law. Since the

valuation of these assets can change, bank capital is always subject to being reduced by a

capital revaluation. This can occur in the absence of any real shock, but it would be more

likely to occur in an economic slowdown, when other factors are likely to have a negative

impact on capital adequacy, such as an increase in NPLs.

C. Stress Test Scenarios and Results

Initial condition of the banking system and effects of full provisioning

40. At end 2003, the reported capitalization of the Sudanese banking system suggested

that the system was generally sound (Table 1). The reported ratio for the banking sector as a

whole was about 20 percent, and for the majority of publicly owned banks it was 17 percent.

Three banks with 9 percent of the assets of the banking system (two of which were majority

publicly owned with 7 percent of the assets of the banking system) did not meet the required

8 percent capital adequacy ratio (CAR) quantity and one majority publicly owned bank with

nearly 4 percent of the assets of the banking system was insolvent (i.e., had negative net

worth).9

9 It is often difficult to establish definitively the solvency of a bank. Experience in many countries suggest that

with low but non-negative measured solvency are very vulnerable. Therefore, the stress tests report also the

numbers of banks whose CAR fall below 8 percent and 4 percent.

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Table 1. Financial Soundness Indicators for the Banking Sector, 1999–2003

(in percent, unless otherwise indicated; end of period)

1999 2000 2001 2002 2003

Capital Adequacy

Regulatory capital to risk-weighted assets 33.2 13.9 19.3 13.0 20.1

Regulatory Tier I capital to risk-weighted assets ... ... ... ... ...

Capital (net worth) to assets 65.1 21.3 19.3 16.8 35.0

Free capital to assets 1/ ... ... ... ... 1.1

Asset composition and quality

Loans to nongovernment to total assets 10.7 15.7 21.6 26.7 30.8

Gross NPLs to gross loans ... ... ... ... 13.4

NPLs net of provisions to gross loans ... ... ... ... 10.5

NPLs net of provisions to capital ... ... ... ... 29.8

Loan provisions to NPLs ... ... ... ... 21.2

Foreign currency loans to total loans 2/ ... ... ... 16.0 27.9

Deposits and investment accounts to total assets 44.0 55.9 71.1 55.1 54.8

Foreign currency deposits to total deposits 42.2 37.3 37.2 46.2 42.4

Off-balance sheet commitments to assets ... ... 19.8 17.4 48.7

Earnings and Profitability

ROA (before tax) ... ... 0.5 1.1 1.5

ROA (after tax) ... ... 0.1 0.7 0.9

ROE (before tax) ... ... 6.7 13.6 11.2

ROE (after tax) ... ... 4.3 8.8 7.3

Liquidity

BOS deposits to total assets ... ... 13.5 11.4 12.7

Required reserves to total assets 0.7 7.3 9.1 6.1 5.6

Required reserves to total reserves 29.7 70.7 77.8 46.7 48.4

Cash in vault to total assets ... ... ... ... 2.3

Liquid assets to total assets 11.6 16.7 14.1 11.8 12.4

Liquid assets to total short-term liabilities 68.1 70.2 53.1 46.7 47.8

Customer deposits to total (non-interbank) loans 195.5 188.9 197.8 152.4 145.2

Sources: Bank of Sudan, and staff estimates

1/ Free capital equals regulatory capital minus fixed assets.

2/ Does not include specialized banks.

- 16 -

41. Several caveats should apply to the reported capitalization levels, however. First,

limited data management capacity raises uncertainties about the actual levels of

capitalization. Because these uncertainties include limited checking of data submitted by

banks, they are likely to be biased toward overstatement of the CARs. Second, most banks do

not fully comply with their provisioning requirements. Adjusting capital levels to take

account of incomplete provisioning reduces the overall CAR by nearly 4 percentage points,

causes two additional (small) banks to drop below the required 8 percent capital adequacy,

and renders two additional banks insolvent (Table 2). Third, bank capital includes fixed

capital, a practice that does not conform to international standards and that the BOS intends

to review.10

42. Data on fixed capital were available only late in the mission and their reliability could

not be checked, so it was not possible to do a thorough test of the impact of a change in

classification. However, a preliminary estimate suggested that full provisioning combined

with adjusting for fixed assets in CAR calculations causes the overall CAR to drop below 3

percent with nearly half of the assets of the banking system to be in insolvent banks.

43. Making an adjustment for fixed capital would result in a further significant

deterioration: based on preliminary estimates, deducting all fixed assets would reduce the

average capital adequacy ratio to 2.6 percent, 14 banks with three quarters of the assets of the

banking system would fall below 8 percent capital adequacy, and 8 banks with nearly half of

the assets of the banking system would have a negative capital adequacy ratio.

Stress testing results

44. One large majority publicly owned bank with over a fifth of the assets of the banking

system dominates the results in this section. This bank meets the required 8 percent CAR

even when it is required to fully provision. It has some vulnerabilities, however, and

therefore results indicating what proportion of the assets of the banking system are in

undercapitalized banks or insolvent banks after a shock are heavily influenced by the results

of this bank. Notably, this bank becomes insolvent if its capital is adjusted according to the

preliminary data on fixed assets that the mission was provided with.

45. Mainly—though not exclusively—because of this one large bank, the majority-

public-sector-owned banks were found to be on average significantly more vulnerable than

other banks. They have lower initial levels of capitalization and are at greater risk of being

undercapitalized or insolvent in response to a shock.

10

Banks have held fixed assets as a hedge against inflation, which practice helped them survive past episodes of

high inflation.

- 17 -

Table 2. Stress Test Scenarios

(data as of December 2003)

Number of banks Percent of assets

CAR 1/ CAR CAR CAR CAR

< 8% < 0% < 8% < 0%

Actual situation at end-2003

All banks 20.4 3 1 9.2 3.8

Majority public 17.0 2 1 7.4 3.8

Full provisioning

All banks 16.6 5 3 14.9 10.8


Full provisioning and adjust for fixed capital

All banks 2.6 14 8 77.1 46.8

Majority public -1.1 5 3 43.8 29.0

15 Percent of all loans deteriorate by 1 loan provisioning category 2/

All banks 17.9 5 1 33.1 3.8


15 Percent of all loans deteriorate by 2 loan provisioning categories

All banks 14.4 7 2 37.8 25.3


30 Percent of all loans to the agricultural sector deteriorate by 1 loan provisioning category

All banks 19.6 3 1 9.2 3.8


30 Percent of all loans to the agricultural sector deteriorate by 2 loan provisioning categories

All banks 18.6 3 2 9.2 7.4


Capital revaluation results in a 20 percent loss

All banks 16.3 5 1 12.4 3.8


10 percent appreciation of the exchange rate 3/

All banks 17.5 4 2 32.0 5.6


Source: BOS, and staff estimates.

1/ Ratio of capital to risk-weighted assets, in percent.

2/ 15 percent of all performing loans move to the 20 percent provisioning category, 15 percent of all loans

already in the 20 percent category move to the 50 percent category, and 15 percent of all loans in the 50

percent category move to the 100 percent category.

3/ Estimated using net open foreign exchange positions from November 30, 2004.

- 18 -

46. Nonperforming loan tests: The Sudanese banking system was found to be

moderately vulnerable to increases in NPLs. The threat is greater from the possibility that a

moderate quantity of loans could eventually be completely written off than from the

possibility that a large quantity of loans could require moderate levels of provisioning.

47. Several tests were performed to measure this vulnerability, including ones that

examined different rates of deterioration of loans. Since breakdowns of loan data into three

of the five loan classification categories were available stress tests could examine the effects

of a certain percentage of loans deteriorating by one or more categories of nonperformance.

48. For example, one test examined what would be the effect of 15 percent of all

performing loans moving into the first category of nonperformance, 15 percent of all loans

already in the first category moving into the second category, and 15 percent of all loans in

the second category moving into the third (total loss) category. The results of this test were

comparable to those of requiring full provisioning. The overall CAR fell only to 18 percent

and only two additional banks would fall below the required 8 percent CAR, though because

one of these banks is large one third of the assets of the banking system would be in

undercapitalized banks.

49. The banking system was fairly resilient to even a large quantity of loans deteriorating

by one category. In the event that 30 percent of all loans deteriorate by one category, the

overall CAR falls to 15 percent; nearly 40 percent of the assets of the banking system are in

undercapitalized banks; and no additional banks become insolvent. Even in the extreme

scenario where 100 percent of all loans deteriorate by one category, the overall CAR remains

positive at nearly 4 percent; 60 percent of the assets of the banking system remain in solvent

banks; and nearly 40 percent of the assets of the banking system remain in banks that meet

the required 8 percent CAR.

50. Under scenarios where loans deteriorate by two categories, however, there are more

significant consequences. If 15 percent of all loans deteriorate by two categories there is a

significant drop in the overall CAR to 14 percent, and because a large bank becomes

insolvent, one-quarter of the assets of the banking system remain in banks that are insolvent.

If 30 percent of all loans deteriorate by two categories, the overall CAR decreases to 8

percent; nearly half of all assets continue in undercapitalized banks; and 30 percent of assets

are in insolvent banks. A 51 percent shift of all loans by one category represents the breaking

point where the system becomes insolvent on average.

51. Sectoral tests indicated that the banking system is not particularly vulnerable to a

deterioration in one sector of the economy. The mission focused on the agriculture sector

because it is particularly volatile and loan data were available. A 30 percent deterioration in

all agricultural loans reduced the overall CAR of the banking system by less than 1 percent

and did not cause any banks to become insolvent or undercapitalized. Even if 100 percent of

all agricultural loans deteriorate by one category, the overall CAR falls only to 18 percent,

but some specialized banks would be in difficulties. Many banks are reluctant to make loans

to the agricultural sector because of the risks involved, so agricultural loans are concentrated

- 19 -

in a small number of banks and this particular test may not be as revealing as the subsequent

one on dollar loans.

52. Dollar loans would be vulnerable to a deterioration in the exchange rate since some

borrowers who owe dollars earn revenues mostly or entirely in local currency, however,

because banks generally have long net open positions in dollars they would benefit from the

devaluation. A deterioration of 30 percent of all dollar-denominated loans by one

performance category as a result of a 10 percent depreciation would result in an increase in

the average CAR to 22 percent and the assets of the banking system are in banks that do not

meet the minimum 8.0 percent CAR would increase slightly to 9.7 percent as one private

bank falls below the required 8 percent ratio while the foreign bank that was initially below it

comes into compliance. A worse deterioration of two performance categories maintains the

overall CAR at 22 percent, and one additional private bank becomes insolvent or

undercapitalized, and even In the extreme case where 100 percent of dollar-denominated

loans deteriorate by two categories, the overall CAR falls only to 13 percent; three-quarters

of the assets of the banking system remain in solvent banks; and over 60 percent of the assets

of the banking system remain in banks that are fully capitalized.

53. Exchange rate risk: There appears to be limited risk at present from movements in

the exchange rate. Because of banks’ long position in dollars they are somewhat exposed to

an appreciation of the currency. A 10 percent increase in the currency means that the overall

CAR will fall to 18 percent; a third of the assets of the banking system are in banks that are

undercapitalized banks, and 6 percent of the assets are in insolvent banks. Under an extreme

case of a 30 percent appreciation, the overall CAR falls to 12 percent; nearly half of the

assets of the system remain in undercapitalized banks; and a third of the assets of the system

continue in insolvent banks. Such a scenario would be problematic, but is unlikely to unfold

since the authorities would likely take steps to resist an appreciation before banks suffered

serious consequences.11

54. Rate of return risk: In 2003, five banks with 9 percent of the assets of the banking

system earned negative profits.12

Two types of test were performed on rate of return shocks.

First, a decline in average rates of return was considered. For simplicity and to accommodate

data limitations, all rates of return were assumed to decline by an equal proportion. For

example, in one test the fixed proportion was 25 percent, meaning that an 8 percent rate fell

to 6 percent, a 12 percent rate fell to 9 percent, a 20 percent rate fell to 15 percent, and so on.

Under this scenario, eight banks with 20 percent of system assets make negative profits.

11

End-November 2004 data for net open foreign exchange positions were used instead of end- 2003 data, which

were not available. All other data in these tests were from end-2003. An exchange rate of SD250 to the U.S.

dollar was used to convert the net open foreign exchange positions into Sudanese dinars. 12

It is also notable that 19 banks with 60 percent of the assets of the banking system earned less than a 13.7

percent return on equity, which is the average return on investment deposits. Thus, the majority of bank

shareholders could improve their return if they sold their shares and deposited the proceeds with their

competitors. This suggests that there are nonfinancial benefits to owning a bank, which should be investigated

and understood.

- 20 -

Under a more drastic scenario where all rates of return were reduced by half, 14 banks with

nearly half of system assets would make negative profits.

55. The second test looks at a decline in the fee income on which banks rely heavily. A

25 percent decrease in fee income causes 9 banks with 23 percent of system assets to make

negative profits. A 50 percent decline in fee income causes 15 banks with 71 percent of

system assets to make negative profits.

56. Deposit volatility: Tests of vulnerability to deposit volatility are discussed in the next

section on future capital needs.

57. Capital valuation risk: Capital revaluation is not a significant risk in itself, but if it

precedes other shocks it could have a more serious impact. These tests were straightforward.

If capital revaluation results in a 20 percent loss of all capital the overall CAR falls by 20

percent to 16 percent and two additional banks fall below the required minimum CAR so that

12 percent of the assets of the banking system are in undercapitalized banks. Capital

revaluation can result in the loss of over 60 percent of all capital before half of system assets

are in undercapitalized banks.

D. Future Capital Needs

58. Perhaps the greatest potential risks to the Sudanese banking system, and especially

incumbent institutions, were found to be related to the outlook for the expansion of the

banking sector. Between end-2000 and end-2003, net domestic credit in the Sudanese

economy approximately tripled, and deposits of the banking system increased by about two

and a half times between end-2000 and end-January 2004. The likelihood that this growth

will continue (or even accelerate in the context of improved domestic security and

international relationships) presents opportunities, but also risks. As bank balance sheets and

especially financing of the non-government sector grow, the banks will need more capital,

which they can obtain by retaining earnings or by attracting new capital. Both approaches

require that banks earn a sufficient return on capital, or else growth will eventually be

hindered by lack of capital. Hence, adequate profitability is required at a time when banks

will be exposed to increasing international competition. Capital injections or limits on growth

(such as prohibiting undercapitalized banks from accepting new deposits) are likely to be

needed under all but the best of circumstances.

59. The composition of the growth of the banking system will be crucially important

since banks offer a variety of services, some of which are more profitable than others. Zero-

return checking accounts that generate fees are particularly profitable for banks, which would

like to expand this business. However, longer-term investment accounts are needed if banks

are to provide longer-term project financing while maintaining a reasonable degree of

matching of asset and liability maturities. Over the past several years there has not been a

clear trend in demand deposit accounts as a share of total accounts. Data that were provided

to the mission indicated surprisingly erratic behavior of this ratio. However the trend is likely

- 21 -

to shift toward accounts that earn a return when foreign competition increases in the context

of the bank restructuring program.

60. The composition of assets does not have as much impact, but enterprise financing

appears to have been historically been more profitable than other types of investments that

banks make, so strong growth in such financing—which has occurred during the past several

years and could accelerate in the near future—would be to banks’ advantage. However, such

financing receives a 100 percent risk weighting, and therefore growth in financing requires

additional capital. The behavior of rates of return on financing will also have an impact.

61. Assumptions: Assets are broken down into “lending to the economy” and “other

assets.” Liabilities are broken down into “Demand plus savings deposits,” “time deposits,”

and “other liabilities.” Profits are equal to income minus expenses and then taxes are

subtracted from any profit using the individual 2003 tax rate for each bank. Income includes

“investment income,” “fees,” and “other income”; expenses include “investors’ return” on

time deposits, “provisioning,” “personnel costs,” and “other expenses.” The following

assumptions were made:

“Demand plus savings deposits” earn a rate of return of zero.

“Investment income” grows at the same rate as the volume of “lending to the

economy.”

“Fees” grow at the same rate as the volume of “demand plus savings deposits.”

“Other income” grows at the same rate as the volume of “other assets.”

“Investors’ return” on “time deposits” grows at the same rate as the volume of “time

deposits.”

“Provisioning” grows at the same rate as the volume of “lending to the economy.”

“Personnel costs” grow at the same rate as the volume of “demand plus savings

deposits,” but are not allowed to decrease. (Note, however, that this is a conservative

assumption since personnel costs have decreased in recent years.)

“Other expenses” grow at the same rate as the volume of total deposits.

Risk-weighted assets were assumed to grow by 85 percent of the increase in “lending

to the economy” plus 20 percent of the increase in “other assets.”

62. Tests: A three-year horizon was considered, and it was generally observed that trends

became more pronounced in the third year, suggesting that they would continue to accelerate

if left unaddressed (Table 3). There are favorable scenarios and unfavorable scenarios.

Favorable scenarios are ones that have relatively high rates of growth of “demand plus

savings deposits.” Higher growth rates of “credit to the economy” are also helpful, though

- 22 -

not nearly as significant. Under the most favorable scenarios, conditions for Sudanese banks

improve somewhat. Under the most unfavorable scenarios, all capital is eliminated, profits

become negative, and significant corrective actions would need to be taken within the next

couple of years or even the next several months.

63. Favorable scenarios: If “demand plus savings deposits” and “credit to the economy”

both grow by 30 percent, while investment deposits grow by only 15 percent and “other

liabilities” grow by 20 percent per year, the share of “demand plus savings deposits” in total

deposits grows from about two-thirds to about three-quarters and credit to the economy

expands in line with recent years. After three years, there is a slight increase in the capital

adequacy ratio and a doubling of the return on assets (from [0.8] to [1.6]), leaving most

banks well-capitalized and with a source of income to strengthen their capital stocks, though

two additional small banks become insolvent.

64. Even under this favorable scenario, however, the banking system is vulnerable to a

decline in rates of return. If rates of return decline uniformly by a quarter (as discussed

above), the overall CAR falls to 13 percent after three years and the return on assets halves

instead of doubling. If rates of return decline uniformly by half, the overall CAR falls to 5

percent after three years, profits become negative, two-thirds of system assets are in

undercapitalized banks, and a quarter of system assets remain in insolvent banks.

65. Unfavorable scenarios: Minor adjustments to rates of growth turn favorable

scenarios into unfavorable or even crisis scenarios. If “demand plus savings deposits” and

“credit to the economy” both grow by 20 percent instead of 30 percent, while investment

deposits grow by 50 percent and “other liabilities” grow by 20 percent, there is a decline in

the share of demand and savings deposits to about half and a somewhat more moderate

expansion of credit to the economy. However, the outcome is drastically different than in the

previous scenario. After three years the average capital adequacy ratio falls to 5 percent,

average profits become strongly negative, 13 banks with 60 percent of all assets would be

undercapitalized, and eight banks with over 40 percent of assets would be insolvent.

- 23 -

Table 3. Sudan: Growth Stress Test Scenarios

(data as of December 2003)

Number of banks Percent of assets

CAR 1/ Return on CAR CAR CAR CAR

assets < 8% < 0% < 8% < 0%

Actual situation at end-2003

All banks 20.4 0.8 3 1 9.2 3.8

Majority public 17.0 0.8 2 1 7.4 3.8

Scenario 1--Favorable growth rates:

Situation after 3 years

All banks 20.9 1.6 4 3 10.7 7.4

Majority public 16.8 1.7 2 1 6.7 3.5

Scenario 2--Unfavorable growth rates:


All banks 5.1 -2.7 13 8 60.5 41.1

Majority public 0.3 -3.1 4 4 34.6 34.6

Scenario 3--Liquidity crisis


All banks 14.7 -1.9 9 4 33.4 16.2

Majority public 12.7 -1.3 3 2 15.9 11.2

Scenario 4--Unfavorable growth rates and all rates of return and fees decrease by 1/4


All banks 0.4 -3.2 15 12 74.1 58.5

Majority public -3.0 -3.5 5 4 44.1 34.8

Growth rates of balance sheet components

Favorable growth rates

Credit to the economy 30.0 Deposits 25.0

Demand and savings deposits 30.0

Investment accounts 15.4

Other liabilities 20.0

Unfavorable growth rates

Credit to the economy 20.0 Deposits 30.0

Demand and savings deposits 20.0

Investment accounts 49.3


Liquidity crisis

Credit to the economy 0.0 Deposits -17.0

Demand and savings deposits -25.0

Investment accounts -1.6


Other assumptions:

Investment income grows at the same rate as credit to the economy.

Fees and other income grow at the same rate as demand plus savings deposits.

Returns paid by banks to investors grow at the same rate as investment deposits.

Provisioning grows at the same rate as credit to the economy.

Personnel and other costs grow at the same rate as total deposits.


1/ Ratio of capital to risk-weighted assets, in percent.

- 24 -

66. In this unfavorable scenario a concurrent decline in rates of return would result in a

need to take action to avoid a crisis. If there is also a decline in rates of return by a quarter,

and there is no intervention, all capital of the banking system is wiped out after three years,

profits become strongly negative, and 60 percent of system assets are in insolvent banks.

67. Even growth scenario: Even growth of all types of banking business would be a

relatively favorable scenario (in the absence of a decline in rates of return). After three years

of uniform 30 percent growth, the overall CAR ratio would decline only to 17 percent, and

return on assets (ROA) would remain at 0.8 percent. However, if there is a decline in rates of

return of a quarter, after three years the overall CAR ratio would drop to 10 percent and

profits would become negative.

68. Liquidity crisis: If there is a loss of confidence in the banking system or the

economy in general there could be a sudden loss of deposits from the banking system, and

capital controls may or may not be adequate to keep funds from leaving the country. Yet, the

banking system is not especially vulnerable to such a liquidity crisis. In the envisioned

scenario—an extreme case where demand and savings deposits contract by a quarter each

year for three years, credit to the economy ceases, and banks respond with a combination of

selling assets and recourse to borrowing—the average capital adequacy ratio falls only to

about 15 percent, though profits become negative; eight banks with a third of banking system

assets would be undercapitalized, and four banks with a sixth of all assets would be

insolvent. And even this decline is heavily dependent upon the assumption that personnel

costs would not decline in spite of the decrease in the volume of deposits and associated

transactions. Bank assets are highly liquid, so liquidity would not appear to be a serious

concern.

69. These scenarios focused on the significance of the composition of growth of the

financial sector. The indication above that rapid credit growth also has risks related to credit

quality should be reiterated. Such risks are not as easily quantifiable because the timing of

the emergence of NPLs resulting from over-aggressive lending is uncertain and would

depend on overall growth and the general state of the economy. But a rapid expansion of the

banking sector would call for more cautious policies regarding bank capitalization.

E. Conclusions

70. This analysis is based on capital adequacy figures that may be overly generous, yet

under plausible scenarios, this large stock of capital can become largely or completely

exhausted, and adjustments for full provisioning and subtraction of fixed assets could

potentially erase a large share of the capital stock before these scenarios even unfold. The

developing environment of high growth and increasing competition will require banks to

become more efficient, as the most significant threats to stability impact banks through their

profitability. In a well-developed competitive financial system, banks will not be able to rely

on large stocks of unremunerated fee-generating deposits, but will have to actively seek out

productive investments and other competitive advantages.

- 25 -

71. Some caveats to the warnings should be offered. The unfavorable scenarios are

unlikely to unfold as indicated in the stress tests because the BOS and commercial banks

would take actions in response to the adverse developments. In particular, banks could

respond to an unfavorable composition of growth rates by refusing to take investment

deposits or lowering the returns that are offered. Much of the capital needs of the expanding

banking sector and the demand for remunerative deposits could be satisfied by new foreign

banks, and this is to a large extent envisioned in the bank reform program now underway. An

expanded foreign presence in the Sudanese banking system may offer a desirable increase in

diversity. However, it would be unfortunate if domestic banks were unable to compete and

thrive alongside their foreign counterparts. While a foreign bank presence in Sudan may have

benefits, complete domination of the banking sector by foreign banks may be harmful.

72. To address the immediate risks from NPLs, exchange rate movements, and capital

revaluation, the BOS should strengthen the supervision of banks. Capital adequacy,

provisioning, and net open position requirements should be carefully monitored and

enforced.

73. To prepare for the expected expansion of the banking sector, bank owners should be

alerted to the possibility that significant capital injections may be required and warned of the

impending risks and the need to improve efficiency. Early warning systems—including

improved data and information collection and internal communication at the BOS—should

be implemented as soon as possible,13

and emergency and lender-of-last-resort policies

should be clearly defined in advance of any crisis. The bank restructuring program will

provide an excellent opportunity to address bank efficiency, and the large minimum stocks of

capital will provide banks with a cushion to enable them to adapt to the envisioned foreign

competition. Foreign competition has been associated with improved efficiency and lower

spreads in banking systems in other countries, and foreign bank entry should be welcomed as

a means to invigorate the Sudanese banking system, make it more resilient, and enable it to

more reliably accommodate the increase in economic growth that is anticipated over the

coming years.

74. The mission presented only one multiple-shock scenario for the static stress tests

(NPLs and exchange rate), however such multiple-shock scenarios are common. An increase

in nonperforming loans is likely to be associated with (if not caused by) a depreciation, a

change in rates of return, or a decline in capital valuation. To assess multiple scenarios the

decline in the average level of capitalization can be determined by adding the declines from

separate scenarios. However it should be noted that the number of banks that are insolvent or

undercapitalized will not necessarily increase in a linear fashion.

13

This will require a strengthening of data management capacity of the BOS, as envisioned.

- 26 -

III. EFFICIENCY OF SUDANESE BANKS14

A. Introduction

75. This note estimates the efficiency of the Sudanese banking system, particularly the

distribution of efficiency across banks, and explores what could explain the cross-bank

divergence in efficiency. It also examines how the efficiency of Sudanese banks has been

related to their profitability over the recent years.

76. From the analyses, we found that Sudanese banks differ considerably in their

efficiency, measured by total factor productivity (TFP). In addition, cross-bank differences in

TFP seemed to be closely associated with those in wage per employee and investment rate

spreads. We also found that, over the past three years, the Sudanese banks’ profitability has

risen without substantial increases in their efficiency.

77. The empirical results are interpreted as tentative rather than conclusive, given the

serious limitations in both coverage and quality of the available data. The number of

observations is small, and some variables (notably fixed capital) may be measured

imprecisely.15

B. Estimation of Efficiency

Methodology and data

78. To estimate the TFP of Sudanese banks, we use a standard Cobb-Douglas production

functions. Assume that the production technology of each bank is represented by:

(1) yi = Ai liβ ki

α,

where yi is output, Ai is total factor productivity, li is labor, ki is capital, β is the labor income

share, and α is the capital income share of the i-th bank, respectively.16

Then a bank’s total

factor productivity, which represents its efficiency, is: ii

i i

yA

l k .

79. To estimate TFP at the individual bank level, we use financial statement data of 21

Sudanese banks for the period 2001-2003, provided by the Banking Supervision Department

of the BOS. The data do not provide information that exactly matches the concept of output

and physical capital.17

As a proxy for output of individual bank, we use yi, the sum of profits,

14

Contributor: Se-Jik Kim 15

There is a large academic literature on measuring bank efficiency and productivity, where various techniques

are employed. One controversial issue is the measurement of bank inputs and outputs. 16

Use of a more flexible functional form is precluded by the limited number of observations in the sample. 17

The definition of bank inputs and outputs is the subject of some controversy in the literature on the estimation

of bank productivity and efficiency. The definitions used here were largely dictated by the limited availability

of data.

- 27 -

labor costs and capital costs, which approximates “value-added,” a standard concept of

output in economics. To measure total capital costs, we use fixed assets multiplied by a unit

cost of capital. For physical capital, ki, fixed assets is used as a proxy. Regarding labor input

of each firm, li, the number of employees is used.

80. The financial statement data on Sudanese banks does not provide information on the

capital and labor income share parameters, and the unit cost of capital. For the parameters for

which information is not readily available, we make some reasonable assumptions, which

serve as a benchmark.18

Then we carry out the estimation of TFP on the benchmark case, and

check the sensitivity of the results to alternative assumptions on the parameters to reassure

that the benchmark assumption is not critical to deriving the results.

81. For any given set of parameters, total factor productivity of each bank can be

calculated using the above equation for TFP and the annual data for yi, li, and ki, for each of

the three years, 2001, 2001, and 2003. To reduce potential measurement errors generated by

year-specific idiosyncratic shocks, we use a three-year-average productivity for each bank,

that is,

2003

2001,

3

1

ssit AA , where Ai s represents the TFP of the i-th bank in year s. The three-

year average productivity (Ai) may represent the underlying long-run productivity of each

bank as long as there is strong persistence in productivity of each individual bank over time.

We also use annual TFPs (Ai, s) to examine changes in efficiency over the past three years.

82. We can then derive a distribution of estimated TFP across banks. The bank (or a

group of the banks) with the highest TFP can be considered to have reached the “best

practice” or efficiency frontier. A bank’s distance from the best technology (in terms of

estimated TFP) can be interpreted as representing the degree of its inefficiency.

C. Estimation Results

Benchmark case

83. As a benchmark case, we assume that the sum of capital and labor income shares is

one (as in the standard Cobb-Douglas case), and that the capital income share of any bank is

0.7, with the labor income share being 0.3 (α = 0.7 and β = 0.3). The assumption might

capture the fact that the marginal product of capital tends to be higher than that of labor in

developing countries. We also assume that the unit cost of capital is 10 percent, which is

close to the average of the effective investment (lending) rate and deposit rate of the banking

system in 2003.

84. In the benchmark case, the TFP calculation shows that there is a large dispersion in

productivity across 21 Sudanese banks. By ranking the banks according to their estimated

TFPs, the distribution of Ai can be derived. The estimated productivity distribution across the

18

An alternative approach based on the estimation of a production frontier was also tried; results are reported in

the appendix.

- 28 -

banks shows wide diversion (Figure 1). The average productivity is 1.9, and the standard

deviation is 2.3.

85. We may consider that the average TFP of the five most efficient banks could form a

feasible efficiency frontier that other banks could reach. Then the TFP of other banks

compared to the efficient frontier can be interpreted as representing the degree of their

inefficiency. The estimated TFP of the five most efficient banks, which constitute 13.4

percent of total assets of the banking sector, surpasses by more than 20 times that of the five

least efficient banks, which hold 12.4 percent of total assets.19

This suggests the existence of

many inefficient banks.

Figure 1. Distribution of Efficiency in the Benchmark Case

Sensitivity analysis

86. Alternative assumptions on the key parameters can be made to examine the extent to

which the choice of the parameters affects the results obtained in the benchmark case

(including the relative ranking of TFPs across banks).

19

The relative asset shares of the second most efficient group of banks (ranking between 6 and 10) and the

second least efficient group (ranking between 11 and 16) are 46.4 percent and 23.6 percent, respectively.

0

1

2

3

4

5

6

7

8

9

10

-2 -1.5 -1 -8.63476E-14

1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8 8.5 9 9.5 10 10.5 More

TFP

Frequency

- 29 -

87. The sensitivity analysis suggests that the main results are robust against alternative

assumptions on income share parameters. Table 1 shows that the relative efficiency rankings

among the banks remain very stable even when we assume that α = 0.5, β = 0.5, or that

α = 0.3, β = 0.7. Despite the different assumptions on capital income share parameters, the

ranks of the five most efficient banks, and those of the five least efficient banks do not

change. The estimated TFP of the five most efficient banks amounts to about sixteen times

and twelve times that of the five least efficient banks in the case of α = 0.5 and α = 0.7,

respectively.

88. The results are also insensitive to the assumptions on the unit cost of capital. The last

column of Table 1 illustrates the relative efficiency rankings in the case where the unit cost

of capital is assumed to be 5 percent, close to the effective deposit rate of the banking sector

(instead of 10 percent in the benchmark case). A comparison between the first and the fourth

column suggests that the relative rakings in efficiency is little affected by the assumption of

lower cost of capital except a minor change in ranking between Banks 11, 12 and 13. In this

case, the ratio of TFP of the five most efficient banks to that of the least five efficient is even

larger than that of the benchmark case.

Table 4. Sensitivity of Relative Efficiency Ranking

α = 0.7

β = 0.3

α = 0.5

β = 0.5

α = 0.3

β = 0.7

α = 0.7

β = 0.3

r = 0.10 r = 0.10 r = 0.10 r = 0.05

Bank 1 Bank 1 Bank 1 Bank 1






















- 30 -

89. Thus, the main result of this note—that Sudanese banks differ considerably in their

efficiency—is robust with respect to changes in key parameters and proxies. The high

efficiency of banks following international best practices might suggest that there is

considerable scope for efficiency gains for less efficient banks. Note that the extent of cross-

bank difference in efficiency is crucial to determining the benefit of banking sector reform.

The greater the productivity difference across banks, the larger the benefit of banking sector

restructuring.

D. Effects of Bank Characteristics on Efficiency

90. This section explores what could potentially explain wide cross-bank divergences in

efficiency. To this end, we run regressions of the TFP calculated in the benchmark case on

various variables that might characterize banks.

91. Regressions of the three-year average TFPs on three-year averages of explanatory

variables generate the results reported in the first three columns of Table 2. The explanatory

variables we consider include total assets (as a proxy for the size of a bank); wage per

employee (as a proxy for the quality of workers); investment rate spreads (as a proxy for the

bank’s ability to effectively manage financial resources); the ratio of time deposits to total

deposits, the equity-liabilities ratio, and the ratio of fee income to total assets (as an indicator

of business strategy).

92. From the regression analysis, we find that banks with higher wages per employee

tend to have higher total factor productivity. The coefficient is positive and statistically

significant in all of the regressions. Provided that higher quality workers get paid more, the

result would suggest that the improvement in the quality of workers is critical to raising

efficiency. Furthermore, a bank that cuts its labor costs without due consideration on

maintaining the quality of its employees might undermine its efficiency (although the

reduction might raise its profitability over the short term). It should be noted, however, that

the correlation between the two variables does not necessarily imply that higher wages per

employee cause higher TFP; the correlation is also consistent with a contrasting hypothesis

of efficiency wage, whereby higher wages induce higher workers’ efforts.

93. In addition, the investment rate spread, calculated as the effective investment rate

(total income from credits/total credits) subtracted by the effective deposit rate (total

expenses paid to deposit holders/total deposits), appears strongly associated with TFP. The

coefficient tends to remain positive and significant as long as the number of explanatory

variables is limited. Again, the correlation between TFP and investment rate spread does not

imply a causal relationship between the two variables.

94. Finally, other bank characteristics such as total assets, the ratio of time deposits to

total deposits, equity-liabilities ratio and fee income-asset ratio appear not to be closely

associated with TFP. Their coefficients are consistently insignificant in various regressions or

their significance substantially varies across regressions.

- 31 -

95. We also ran regressions using annual data instead of three-year averages (the last two

columns of Table 2). In this case, we control bank fixed effects by grouping the banks into

high TFP, middle TFP, and low TFP banks, or, as an alternative, foreign, state-owned and

other domestic banks (based on BOS classification). The results in this case are similar to

those in the above case of using three-year averages: the coefficients for wage per employee

and the interest rate spread are positive and significant. Furthermore, we find that dummies

for high TFP banks and foreign banks are positive and significant. But the dummy for state-

owned banks is not significant, suggesting that there is no significant difference in efficiency

between state-owned and other domestic banks after controlling for other factors.

Table 5. Regression Results

(1) (2) (3) (4) (5)

constant -2.1 -1.3 -2.3 -1.5 -1.1

(-2.0) (-0.9) (-1.0) (-1.9) (-2.0)

wage per employee 2.1 1.9 2.0 1.3 1.1

(4.0) (3.1) (3.0) (4.5) (5.3)

total assets -0.000003 -0.000006 -0.000008 -0.000005 -0.000002

(-0.2) (-0.4) (-0.5) (-0.7) (-0.3)

investment rate spreads 7.7 8.2 8.1 5.4 3.8

(2.3) (2.4) (2.3) (3.1) (3.2)

time deposits/

total deposits 3.1 -3.1 -2.4 -1.8 -0.6

(-2.5) (-1.5) (-1.0) (-1.6) (-0.7)

equity/liabilities -1.9 -1.3 -0.3 -0.8

(-0.9) (-0.5) (-0.5) (-1.5)

fee income/total assets 16.6 12.0 12.7

(0.5) (1.0) (1.6)

dummy for high TFP group 1.7 ...

(3.0)

dummy for middle TFP

group

0.0 ...

(0.0)

dummy for foreign banks 4.8

(8.9)

dummy for state-owned

banks

0.3

(0.7)

Adjusted R2

0.55 0.54 0.52 0.62 0.81


Figures in parentheses are t-values.

E. Profitability Versus Efficiency

96. This section explores how changes in bank efficiency have been related to

developments in bank profitability. Table 3 summarizes the developments in profitability and

efficiency of the banking sector over the past three years.

- 32 -

97. The profitability of the banking system, measured by return on assets (ROA), has

trended upward over the past three years. In 2003, the before-tax return on assets amounted

to 1.6 percent, a significant improvement from 0.5 percent in 2001.

98. The rise in profitability (by 1.1 percentage points) reflects rises in net interest

revenues and above all large reductions in labor costs. Sudanese banks have raised net

interest revenues as a share of total assets by 0.6 percentage point. More important, they have

cut their personnel expenses from 4.4 percent of total assets in 2001 to 2.5 percent in 2003

(by 1.9 percentage points). This cut in wage expenses may reflect bank efforts to contain the

increases in both the number of employees (including even a substantial downsizing in 2002)

and wage rates.

99. Meanwhile, the average TFPs of the banks calculated for each year declined in 2003.

So the substantial improvement in profitability has not been accompanied by persistent

increases in efficiency. This suggests that recent growth in profitability is largely attributable

to improved trading conditions and might mask potential weaknesses in bank efficiency. The

decoupling of movements in profitability and efficiency may partly be explained by

reductions in wage per employee. Given that wage per employee is closely correlated with

efficiency in the Sudanese banking sector, the decline in wage per worker to SD 1.38 million

in 2002 might have induced the decline in TFP. Meanwhile, declines in wage expenses as a

fraction of total assets may have induced increased in return on assets. This suggests that

restraints on wage increase might help improve profitability but undermine efficiency.

Table 6. Indicators of Bank Efficiency and Profitability

2001 2002 2003

(Percent of total assets)

Return (before tax) 0.5 1.1 1.5

Net interest revenues 2.5 2.4 3.1

Fee income 4.0 3.5 3.6

Wage expenses 4.4 3.1 2.5

Other operating costs 2.0 1.6 1.9

Other net revenue 0.4 -0.1 -0.8

(In millions of Sudanese dinar)

Wage per employee 1.43 1.57 1.38

(In thousands of persons)

Number of employees 12.6 11.4 13.3

Average TFP 1.93 1.99 1.75

Source: BOS Banking Supervision Department, and staff estimates

- 33 -

Stochastic Production Frontier Approach: An Example

100. In this appendix, an alternative approach to estimate total factor productivity is

presented, namely, the stochastic frontier approach based on a logarithmic expression of the

Cobb-Douglas production function:

(2) ln yi = ln Ai + β ln li + α ln ki.

101. Using data from individual bank financial statements, the labor and capital income

share parameters (which are assumed to be common to all the banks) can be estimated, as

well as each bank’s individual TFP.

102. An advantage of this approach is that labor and capital income share parameters can

be estimated (rather than assumed as in the deterministic used above). However, this method

has the shortcoming that data on the banks that suffered negative TFPs must be excluded ,

because variables are in logarithmic form,. Hence, the regression equations cannot capture

information on an important group of banks, that is, the least efficient banks with negative

TFPs. Because the banks that had experienced negative value-added in at least one year are

excluded, the number of banks in the sample is reduced from 21 to 18.

103. If we use the three-year average TFP, the number of observations in the sample falls

to only 18. To mitigate small sample problems, we may use annual TFPs of each bank for

2001, 2002 and 2003, rather than the three year averages, which raises the number of

observations up to 54. To limit potential bank-fixed effects in the panel data, we use dummy

variables based on the grouping of the banks into high, medium, and low TFP banks.

104. The result from a regression with group-of-bank fixed effect is as follows:

(3) ln yi,t = 1.4 + 0.23 ln li,t + 0.57 ln ki,t + 1.0 DH + 0.1 DM

(3.4) (2.0) (5.4) (5.6) (0.8)

Adjusted R2

= 0.81, Observation = 54,

where DH represent a dummy variable that takes 1 for high TFP banks, DM is a dummy

variable for middle TFP banks, and the figures in the parentheses are the t-values of the

estimated coefficients. Based on the regression, we can calculate log Ai,t (and hence Ai,t

) for

each bank for each of the three years. Then we derive TFP of each bank by taking the three

year average of the calculated annual TFPs.

105. We find that Sudanese banks differ considerably in their TFPs even when we adopt a

stochastic frontier approach. The most efficient bank in this case (which is the most efficient

in the benchmark case), has a three-year average TFP 10 times that of the least efficient

among those with positive TFP. Note that the results obtained under this approach should be

also cautiously interpreted, given limitations on the availability and quality of data.

- 34 -

IV. THE INSURANCE SECTOR IN SUDAN20

A. Market Development

Size and growth

106. The insurance sector in Sudan is still small. With total premium income of

SD 23.6 billion (US$89 million) in 2003, the overall ratio of premiums to GDP (the

penetration ratio) was about 0.5 percent. Factors contributing to this low level include the

low per capita income and lack of a middle class, past economic and political instability, lack

of a general understanding and awareness among the public of cultural issues, limited

investment opportunities for insurance companies, weaknesses in the legal and regulatory

framework for the sector, and weaknesses in supporting infrastructure, such as accountancy

practices and the availability of actuarial expertise. The penetration ratio is low relative to

many other countries in Africa (Table 4), although not much below that seen in some

countries with higher per-capital income.

Table 7. Comparison of Insurance Markets in Africa

(in 2003)

Premium Volume

(in US$ millions)

Insurance Penetration

(Premiums as a percent of GDP)

Morocco 1,288 2.8

Egypt 566 0.7

Zimbabwe 482 4.2

Tunisia 456 1.8

Nigeria 422 0.8

Kenya 411 3.0

Algeria 399 0.6

Mauritius 241 4.6

Sudan 89 0.5

Source: Swiss Reinsurance Company, and staff estimates.

107. Nonetheless, the insurance sector is growing rapidly (Table 5). Over the last four

years, non-life insurance premiums have been growing faster than life premiums, perhaps

because the life business is only just now being established.

20

Contributor: Serap Oguz Gonulal.

- 35 -

Table 8. Insurance Sector Growth

Premium Income 1/

(In SD millions)

Growth

(percent)

1999 2003

Life (takaful) 1,763 2,485 41

Non-life 7,644 20,689 171

Sources: Sudanese authorities; and staff estimates.

1/ Excludes re-insurance.

Structure

108. No new firms have entered the market since 1990, and two insurance companies have

had their licenses withdrawn in recent years. At end-2003, 14 insurance companies and one

reinsurance company were licensed and operating. There are three composite companies,

including the largest, Sheikan, and 11 non-life companies.

109. The state is heavily involved in the insurance and reinsurance sector. The largest

company, Sheikan Insurance and Reinsurance Co. Ltd., is fully state-owned. Established in

1991 to serve as the government’s insurance agent, it is now the only company allowed to

provide the government with insurance (the government currently accounts for some 40

percent of insurance market premiums). Some of the government business is spread around

the market by way of coinsurance and reinsurance, but the restriction strengthens the control

of the government over the sector. One consequence of giving a government-owned business

a monopoly on government business is that the government is indirectly exposed to all

insured risks, although it benefits from Sheikan’s expertise in such areas as loss adjustment

and the management of reserves; in addition, the government can receive dividends from

Sheikan.

110. Sheikan dominates the market (Table 6). It received the majority of the sector’s gross

premium income in 2004, and is almost the sole supplier of life insurance, with 95 percent of

gross premium income in 2003.21

It has a special social mandate to provide service to lower

income groups, and in some ways acts to promote the sector as a whole rather than

maximizing its short-term advantage (e.g., by ceding co-insurance to smaller companies and

providing training).

21

The term “takaful” is often used in Sudan to refer to life insurance in particular, although the term can be used

to denote Islamic insurance more generally.

- 36 -

Table 9. Market Shares of the Largest Insurance Companies, 2003

Insurance Company Total Direct Premiums

(in SD millions)

Market Share

(percent)

Sheikan Ins & Re. 11,221 55

Islamic Insurance Co. 1,661 8

The United Ins. Co 1,374 7

Wataina Ins. 1,261 6

Sudanese Ins & Re. 874 4

Five largest companies 16,391 80

Total insurance market 20,689 100


111. Other insurance companies are mainly owned by commercial enterprises and by

individuals, and five insurance companies are partially owned by banks. A number of small

insurers are little more than captive companies dealing mainly, although not exclusively, with

their own shareholders; this structure allows the policy-holding shareholders to obtain a

sizeable share of any profits made. The Sharia (Islamic law) requires that profits generally be

distributed to policyholders (see below).

112. Foreign involvement in the insurance sector is minimal. No major international

groups have shareholdings or formal links with Sudanese companies. However, several

companies have links with companies in various Middle Eastern countries, particularly Saudi

Arabia.

113. Insurers attract business on a direct basis as well as via agency networks. The main

distribution channel for personal business is each company’s branch network. Sheikan has

the largest distribution network, with 22 branches throughout the Sudan.

114. A large number of principal agents operate, at three levels: principal agents, branch

agents, and producers. Principal agents have the highest levels of authority and are often

permitted to issue policies. All agents must be registered and licensed. In 2003, there were

777 agents, accounting for 80 percent of the market. Bank assurance is practiced widely in

Sudan. Virtually all Sudanese banks have agency relationships with insurers, and distribution

of insurance products via banks accounts for a significant volume of overall market premium.

At present there are no locally licensed insurance brokers operating in Sudan.

Business lines

115. Besides government business, the main products offered by insurance companies are

coverage for motor, worker compensation, and property risks. Insurance companies have

been innovative in introducing new products in recent years in such areas as health, crop

agriculture, and life products.

- 37 -

Motor insurance

116. Motor (or auto) insurance is the major line of business for insurance companies (as is

the case in many developing markets). Motor third party liability insurance is compulsory

both with respect to property damage and bodily injury. The level of compliance is difficult

to ascertain.

117. A mandatory tariff applies to third party motor rates. The setting of the rates is

coordinated by the Association of Sudanese Insurance and Reinsurance Companies and

approved by the Insurance Supervisory Agency (ISA), the regulatory agency (see below).

However, there is no claims database on the frequency and severity of claims to help insurers

and supervisors appropriately to price various products, including compulsory motor

insurance. On occasion, the industry has obtained large increases in rates. There is no

guarantee fund to compensate victims of accidents caused by uninsured vehicles or by

drivers.

Agriculture insurance

118. The authorities are considering the establishment of a National Fund for Alleviating

the Impact of Agricultural Hazards and for Agricultural Insurance Support that could

contribute to the further development of agricultural insurance. Given the importance of

agriculture to the Sudanese economy and the fiscal burden from the current provision of

agricultural subsidies offered by the government in response to insurable events, there would

seem to be broad scope for development of new products. 22

The government could choose to

replace various subsidies for the sector with an Agriculture Insurance Scheme built on a new

policy framework. In the process, part of the risk currently borne by the government could be

transferred to private insurance companies as a percent of the premium, and/or by providing

that partion of the reinsurance cost that exceeds the allowed limits. The advantage of such a

policy is that it helps develop the insurance sector while allowing the government to budget

more accurately its support to the agriculture sector. A cost benefit benefit analysis of could

be undertaken as part of provided technical assistance.

119. Limited crop insurance was recently introduced by Sheikan, and is currently only

available for irrigated cotton.23

Risks covered include pests, for example the boll weevil, but

excludes rats, locusts and birds. Cotton diseases are covered, as are weather conditions

22

In 1999, agriculture (mostly subsistence agriculture) accounted for about 43 percent of GDP and 80 percent

of employment. About 17 percent of the 80 million hectares of arable land is currently under cultivation, and

livestock—consisting of cattle, sheep, goats and camels—is estimated at about 100 million head. Agricultural

products such as cotton and live animals are major export earners. However from 2001, the ISA has been

compiling separate statistics for livestock insurance, according to which livestock insurance premiums

amounted to just SD 245 million, or 1 percent of total gross premiums at end-2003. 23

In 1995, Sheikan assigned a British consultancy to prepare a detailed feasibility study of the project, and the

consultancy proposed a Gezira pilot project for cotton and sorghum, given their importance as export and staple

crops respectively. The plan was delayed until 2001 when the reinsurance company was invited to update the

feasibility study and prepare a work plan for a pilot project in cotton, which is now covered by Sheikan.

- 38 -

(excessive rainfall or heat). The scheme involves close monitoring of farmers involved and

the provision of technical advice, and is operated in cooperation with the Agricultural Bank.

Initial indications are that the scheme is successful—false claims have decreased and

productivity has increased—but government subsidies are still required. Because of high

costs and the need to accumulate technical knowledge, livestock and crop insurance are

generally beyond the capacity of the smaller insurance firms.

Life insurance

120. Life insurance accounted for just over 10 percent of premium income in 2003. The

life or takaful contract market is particularly carefully monitored and supervised by the

Sharia Supervisory Boards because compliance with Sharia is more complex for life products

(Box 1). Nonetheless, companies are investigating how to develop a wider range of Sharia-

compliant life products, including annuity-type products.

Box 1. Sharia-Compliant Insurance

The insurance sector, like the remainder of the Sudanese economy, is governed by a legal

framework that mandates that all activities be compliant with Islamic law (Sharia). This

requirement imposes some special conditions on insurance and particularly on non-term life

insurance, where longer-term contracts with a savings element are involved. The main

relevant considerations are the prohibitions on gambling and on the conduct of financial

transactions unconnected with underlying “real” activity.

Sharia requires insurance to be a “donation contract,” whereby policyholders donate the

premiums to a common pool of resources, and payouts are considered a form of charity.

Since policyholders are donors, no gambling is deemed to have occurred. Any surplus may

be set aside as reserves or distributed to policyholders in proportion to the contributions paid.

Owing to the charitable, voluntary nature of the business, company profits on underwriting

and policyholders’ receipt of payouts are tax free, whereas profits on investment income are

taxable.

Insurers must maintain separate accounts for each policyholder to track all contributions.

Administrative charges and costs of claims are allocated in proportion to contributions. Any

surplus (after making provisions for pay-outs, operating costs, depreciation, bad debts and

establishment of reserves) is allocated to policyholders in proportion to contributions paid, or

set aside as reserves and investments on behalf of the policyholders. Shareholders—as

opposed to policyholders—may not profit from the insurance business, for example, by

receiving dividends, but may receive a fee for management services. In addition, it has been

argued that shareholders can share in profits on the invested reserves, as distinct from the

underwriting business itself. Investments must be in Sharia-compliant instruments. A Sharia

supervisory board must be appointed by every insurance company to ensure compliance with

Islamic law. This Sharia board has wide powers to vet business activities and conduct

inspections.

- 39 -

Reinsurance

121. There is only one local licensed reinsurance company in Sudan, the National

Reinsurance Company (National Re.), which was established in 1974. The government owns

52 percent of National Re., with the remaining shares held largely by institutional investors

including banks and insurance companies. National Re. benefits from a compulsory

reinsurance treaty of 50 percent of all locally insured business, including life (takaful), and

facultative insurance (placed through treaty programs).24

This arrangement means that half of

all insured risk covered by one insurer will be passed on to another insurer (National Re. in

this case) in return for a premium.

122. Insurers have to place 10 percent and 5 percent of their international treaty business

through PTA-ZEP Re. and Africa Re. respectively in addition to the 50 percent of their treaty

business that must go through National Re.25

However, this requirement is not always

observed. Support is also available from a number of international reinsurers and reinsurance

brokers. External reinsurance companies used are in the main Arig Re., Arab Union Re., Best

Re. (Tunisia), Egyptian Re., and Munich Re., which, at least in the past, was the lead insurer

on many engineering and Contractors/Construction All Risk treaties. Generali, once very

important in the local market, is no longer renewing its treaties. The main writer of domestic

market reinsurance is Sheikan.

Performance

123. At end-2003, most reserves were invested in bank deposits (Table 7). This tendency,

in part, reflects regulatory requirements, but is also the product of a lack of alternative

investment vehicles and the short-term nature of most underwriting business.

24

Facultative reinsurance is an optional, case-by-case method used when the insurance company receives an

application for insurance that exceeds its retention limit. The insurance company is under no obligation to cede

insurance, and the reinsurance company is under no obligation to accept the insurance. 25

The commitment to PTA-ZEP Re. reflects Sudan’s membership in the Common Market for Eastern and

Southern Africa. The commitment to AFR Re. reflects Sudan’s membership in the African Union.

- 40 -

Table 10. Insurance Company Investments

(2003)

Type of Investment (In SD thousands) (Percent of total)

Deposits 5,489,711 71.0

Shares 958,355 12.4

Government certificates 660,772 8.5

Land and real estate 578,857 7.5

Loans 5,674 0.1

Other Investment 36,158 0.5

Total 7,729,527 100.0


124. In Sudan, lack of competition, significant levels of reinsurance, and unpaid and non-

requested claims by policyholders have resulted in low claims ratios (Tables 8). Hence,

companies can make adequate profits on underwriting provided that they contain operating

costs.

Table 11. Premium Income and Claims

Year

Net premium Income

(In SD millions)

Net Claims

(In SD millions)

Net Loss Ratio

(percent)

1999 4,231 2,053 48.5

2000 6,238 3,289 52.7

2001 8,127 4,687 57.6

2002 9,926 5,095 51.3

2003 13,075 6,431 49.1


B. The Regulatory Framework

125. The authorities have been making efforts to upgrade the legal, regulatory, and

supervisory framework governing the insurance sector. However, they are aware that more

needs to be done if the sector is to develop on a sound basis. At present, few of the

International Association of Insurance Supervisors (IAIS) Principles would be observed; for

information, a summary of the IAIS Principles is included as an appendix.

Legal framework

126. The insurance sector is governed by the Insurance Supervision Act, 2001, which

replaced the Insurance Supervision Act, 1992. The current act may be amended in the near

- 41 -

future. There is no separate Insurance Contracts Law to regulate legal relations among

insured parties, policyholders and insurance companies. The Road Traffic Act, no.5 of 1962,

which includes the requirement to obtain third-party liability insurance, was amended in

1993 to take Sharia into account.

127. The present legislative framework is weak in several ways. It does not include

important internationally-accepted principles; it lacks regulations concerning

implementation; and, in general, does not give sufficient powers to the supervisory authority

to fully discharge its responsibilities. However, the Insurance Supervisory Agency (ISA) is

authorized to conduct checks and inspections whenever it deems necessary.

128. Investment, capital, solvency and liability determination rules are not clearly set forth

in the law, and this should be addressed in the new legislation currently under preparation.

Technical provisions should ensure that the companies are in a position at all times (or at

least in the vast majority of circumstances) to meet their commitments toward the insured.

The Insurance Supervisory Agency

129. The ISA, located in the Ministry of Finance and National Economy (MFE), is the

regulatory and supervisory agency responsible for supervision of the insurance sector and

licensing insurance companies. It approves policy conditions and premium schedules,

monitors insurers’ compliance with the law, and ensures that companies comply with

minimum capital and solvency requirements.

130. The ISA was established by government decree on June 12, 1991.26

The director of

the ISA is chosen by the Board and approved by the Minister of Finance and National

Economy. The Director should be well experienced in non-life insurance matters. The

director is supported by two deputies, who monitor takaful and non-life insurance sector.

There is also a part-time legal adviser employed, in addition to a mathematician.

131. There are four main departments in the ISA: licensing, financial, technical, and

research. ISA has a staff of 44, of which 20 are professional staff and the rest administrative.

There is substantial scope for strengthening the supervisory and institutional capacity of the

ISA.

132. For financial supervision—including capital resources (solvency), the formation of

technical provisions, and the existence and composition of assets (investments) necessary to

meet the insured liabilities—the ISA relies on its desk analysis of financial information

submitted by companies, and limited on-site supervision. Such off-site surveillance is

insufficient and may fail to obtain critical information, including quarterly reports, annual

reports, balance sheets, financial profit and loss accounts, or periodic statements of their

technical reserves and solvency margins.

26

It was previously called the Insurance Supervision and Control Public Cooperation (ISC).

- 42 -

Regulation

133. The minimum capital requirement for insurance companies of SD 300 million (about

US$1.2 million), which, however, is not achieved by all companies. The ISA requires a 30

percent solvency margin for both life and non-life business. Companies are required to

present to the ISA a certificate of solvency, an action plan to move into compliance, or

acceptance of the plan suggested by the ISA. The ISA also requires a minimum level of legal

reserves that can be easily liquidated (in the form of short-term bank deposits or easily-

liquidated government bonds).

134. Companies are required to establish unearned premium reserves, outstanding

reserves, and “incurred but not reported” reserves, though the insurance law does not specify

exactly how these should be calculated. Companies have little experience of claims

reserving, and it is not clear how reserves are calculated in practice. It seems likely that many

companies have neither the expertise nor the will to capitalize these liabilities in their

outstanding reserves. Sudan also suffers from inadequate technical provisions resulting from

the lack of historical data for calculation and weak actuarial system. There are no specific

regulations with respect to insurance company risk retention levels. The ISA has in theory

introduced a requirement that companies restrict their involvement in motor accounts to 60

percent of the gross premium, but it is unclear whether all companies are compliant.

135. Insurance companies may reinsure without additional capital. There are no special

criteria for the licensing of reinsurance companies. Any insurance company has the right to

perform reinsurance operations on the basis of the licenses held. According to present

insurance legislation in Sudan, reinsurance should only be ceded abroad after it has been

offered to, and declined by the local market.

- 43 - APPENDIX II

IAIS Principles

Organization of insurance regulations and supervision (IAIS Principle 1)

a) Regulatory Authority - The new IAIS Methodology approved in October, 2003, has

significantly expanded the Core Principles dealing with the structure and operations

of insurance supervisors.

b) Supervisory Authority - As a rule, insurance supervision is carried out by a special

institution. The insurance supervisory authority should be independent of political

influences and the supervised insurance companies. Supervisors should have legally

defined objectives, tasks, rights, and protections. Personally, supervisors should be

professionally independent and impartial, and they should have wide knowledge and

experience.

c) Financing - In the majority of countries, the regulatory and supervisory body is

financed by the insurance industry.

d) Workforce -The number of persons employed in insurance supervision depends on

the size of the country and the number of insurance companies operating there.

Licensing (IAIS Principle 2). Companies wishing to underwrite insurance in the domestic

insurance market should be licensed. If a company fails to comply with conditions imposed

with the license, then it is appropriate to cancel the license before the company issues any

more policies. The law should at least set out the minimum requirements for licensing and

the procedure for application.

Minimum licensing requirements:

Legal Form—should be either a joint stock company or mutual company.

Business Plan—must include at least pro forma financial statements and a capital plan

and projected solvency margins.

Managerial Requirements—must include fitness and propriety requirements of

company officers.

Shareholder Information—must include mention of the reputation of strategic

shareholders.

Financial Requirements—must include adequate capital and all other significant

financial information.

Changes in Control (IAIS Principle 3). The law should set up some rules to review changes

in the control of companies that are licensed in the jurisdiction. The insurance supervisor

should establish clear requirements to be met when a change in control is envisaged. These

may be similar to the requirements for granting a license.

Corporate Governance (IAIS Principle 4). It is desirable that standards be established in the

jurisdiction to deal with corporate governance. Preferably, the insurance supervisor should

- 44 - APPENDIX II

have responsibility for setting the requirements for corporate governance. The present law

does not deal effectively with expectations in respect of corporate governance.

Assets (IAIS Principle 6). Standards should be established with respect to the assets of

companies licensed to operate in the jurisdiction. Where insurance supervisors have the

authority to establish the standards, these should apply at least to an amount of assets equal to

the total of the technical provisions. Maximum exposure rules for assets covering technical

provisions include the following:

no more than 10 percent of gross technical provisions can be in one property

investment (including a number of pieces of land or buildings close enough to each

other to be considered as one investment);

no more than 5 percent of gross technical provisions can be, in aggregate, in the

securities of, or as loans to, any one firm, company, or undertaking. This can be

raised to 10 percent for public sector issuers, provided total exposure to such entities

does not exceed 40 percent of technical provisions;

no more than 5 percent of gross technical provisions can be in unsecured loans;

no more than 3 percent of gross technical provisions should be in cash in hand; and

no more than 10 percent of gross technical provisions can be in shares and debt

securities which are not dealt in on a regulated market.

Liabilities (IAIS Principle 7). The law should establish standards with respect to the

liabilities of companies licensed to operate in the country. Liability requirements should only

be established after exhaustive consultation with the actuarial profession and industry

practitioners.

Capital Adequacy and Solvency (IAIS Principle 8). The requirements regarding the capital

to be maintained by companies, which are licensed or seek a license in the jurisdiction,

should be clearly defined, and should address the minimum levels of capital or the levels of

deposits that should be maintained. Capital adequacy requirements should reflect the size,

complexity, and business risks of the company in the jurisdiction.

Solvency Margin (IAIS Principle 9). Solvency requirements should take account of current

developments in international criteria. The solvency margin sets out the amount of capital

funds an insurer must have at its disposal during current operations. The present European

Union (EU) requirement is for a capital base of the same amount as either the premium index

or the loss/claim index, whichever is higher, defined as follows:

Premium Index: 0.18 or 0.16 x (gross premiums) x (retention rate)

Loss or Claims Index: 0.26 or 0.23 x (gross claims) x (retention rate)

Retention rate: Net claims/gross claims (but no less than 0.5)

- 45 - APPENDIX II

Reinsurance (IAIS Principle 10). Insurance companies use reinsurance as a means of risk

containment. The supervisor must be able to review reinsurance. Reinsurance policy should

be subject to supervision

Market conduct (IAIS Principle 11). Supervisors should ensure that insurers and

intermediaries exercise the necessary knowledge, skills and integrity in dealings with their

customers. The Law should include significant scope for the supervision of intermediaries.

Intermediary supervision is becoming a fundamental issue in insurance markets, and is the

main concern of the EU and IAIS. The law should address the requirement that the

Regulatory and Supervisory Body should have legal powers to publish guidance on pure

premiums, to facilitate data sharing by insurers and to specify general prudential

requirements in setting premiums.

- 46 -

V. ASSESSMENT OF THE SUDANESE PAYMENTS SYSTEM27

A. Introduction

136. This assessment reviews the payment clearing and settlement procedures in Sudan. It

follows the Financial Sector Assessment Program (FSAP) for Sudan, conducted jointly by

the IMF and the World Bank.

137. The Commercial Banks Technology Directorate (ComBTD) as well as the Central

Banking Technology Directorate (CenBTD) within the Banking Technology Department

(BTD) in the Bank of Sudan (BOS) were very generous in making themselves available for

discussions, in addition to their coordination with other departments and parties outside the

BOS.

B. Information and Methodology Used for Assessment

138. Information was obtained during two missions in October and December 2004 by

carrying out extensive discussions with the BTD, the “Khartoum Branch” of the BOS

(operating the local Check Clearing House—CCH—for checks in local currency), the

Foreign Relations Department of the BOS (operating the CCH for checks denominated in

foreign currency), the Research and Statistics Departments of the BOS, a selection of

commercial banks, the Sudanese Financial Services Company (SFSC), the Electronic

Banking Services Company (EBS), and the Khartoum Stock Exchange (KSE).

139. While the BOS staff made an effort to provide information, the lack of certain

statistical and other information made it difficult to assess some details of the payment

systems. Access to regulations and laws governing the payment systems was very limited.

The response to the questionnaire was brief, and no self-assessment was provided. Hence, the

assessment could often only examine the practice as presented by the BOS staff.

140. This note does not contain a full, detailed assessment of the payment system

following the Committee on Payment and Settlement Systems (CPSS) Core Principles for

Systemically Important Payment Systems and Central Bank Responsibilities in applying

the Core Principles (CPs). Rather, it uses the CPSS as a framework to describe and

analyze the strengths and weaknesses of the current system, and to identify measures that

could make the system more secure and efficient. The CPSS tabular format (Table 1) is

used to present the analysis.

C. Institutional and Market Structure—Overview

141. There are 26 commercial banks with 547 branches covering all districts of Sudan

(Dec. 2003). The relative size of the Sudanese financial sector is small: assets of banks

27

Contributors: Bassam Farmawi (Central Bank of Jordan) and Jens Clausen.

- 47 -

constituted only 17.1 percent of GDP at end-December 2003—low compared to levels

observed in other countries.28

The financial sector in Sudan is almost entirely composed of

banks; assets of other financial institutions (mainly insurance companies and exchange

bureaus) constitute less than 1 percent of GDP. The outstanding stock of domestic

government certificates (known as GMCs and GICs) is equivalent to about 2.5 percent of

GDP. The SFSC supports the market for government certificates. There is a small but active

stock exchange, the KSE, where mainly equity and government securities are traded.

142. The payment system is dominated by the use of cash; currency outside banks

constituted 32.7 percent of M2 (currency in circulation plus deposit liabilities of the banking

system) in December 2003. Checks come in the second place; in the fourth quarter of 2003,

about 11,000 checks per day were processed at the Khartoum CCH. Although there is an

upward trend in the use of checks in terms of value and volume (see Figure A1), each

Sudanese individual issues on average about 0.125 checks per year. The total value of checks

cleared in 2003 relative to nominal GDP equaled 16.25 percent.29

The average value for an

individual check in 2003Q4 was SD 256,000, equivalent to about US$1,000. The use of

electronic credit transfers is rarely observed (except within a single bank); and statistics for

the volume and value of credit transfers were not available. Hence, the check clearing system

operated by the BOS is the only formal, systemically important payment system (SIPS).

143. The BOS has overall responsibility for the payment system. Within the BOS, the

BTD takes the lead on the development of the system; while the ComBTD within the BTD is

responsible for connecting the BOS with the commercial banks, the CenBTD within the BTD

is responsible for implementing an electronic system to connect the 11 branches of the BOS

with its head office. The CCHs are operated by local branches, and the Foreign Relations

Department handles foreign currency-denominated payments.

144. The BOS Law and the Banking Law provide the BOS with broad powers and

responsibilities over the payment system. Implementing regulations reportedly exist, but they

are not readily available. Legislation in such areas as electronic transactions is in preparation.

D. Payment Systems Infrastructure

Check clearing

145. The domestic currency check clearing system operates through CCHs at each of the

BOS’s eleven branches. Every bank operating in a particular region has an account at the

local BOS branch in order to participate in the local CCH and for cash-in-vault handling.

Under the current system, these accounts are not automatically consolidated. A general

28

In contrast, banking sector assets in Egypt constitute 125 percent of GDP, in Jordan 220 percent, and in the

Islamic Republic of Iran 55 percent. 29

Source: BOS 2003 annual report and Central Bank of Jordan 2003 annual report. The corresponding figure

for Jordan is 202.23 percent for the same year.

- 48 -

annual membership fee of SD 100,000 (approximately US$400) is to be paid for joining a

CCH.

146. The Khartoum branch of the BOS is by far the most important center to clear and

settle credit transfers. The incoming average daily number of checks processed at the

Khartoum CCH was about 11,000 in the last quarter of 2003 (the latest confirmed number

available), for an average total value of SD 2,825 million, or about 70 percent of the check

transactions in the whole country. After netting, the Khartoum branch processes per day

about 250 transactions between participants. It hosts about 540 accounts (in local currency),

which belong to three categories of customers (banks: 27; ministries, government entities,

and state-owned institutions: 513); all commercial banks are members of the Khartoum

Branch CCH. Five divisions execute the paper-based credit transfers on the local so-called

ORACLE software applications.

147. The clearing sessions in Khartoum start at 9.00 a.m. and normally end at 11.00 a.m.

The closure time is not fixed; the session normally continues until the processing of the

incoming checks is completed. The clearing cycle allows three business days to ensure

clearance during the full cycle, including the possibility of the return of a check. Checks

drawn on banks located outside the Khartoum area take between two to three weeks to be

cleared and settled because of the time to transport the check.

148. Clearing is processed manually and checks are physically exchanged at the CCH.

Once checks are sorted by payee and payer bank, the net payments are calculated. A “double

user entry method” is followed to check for the accuracy of entered data, but there is no

system to allow verification of transactions by the management of the respective division in

the CCH. When there are no complications, the net payments are then effected through BOS

transfers. However, finality of payment is not observed, because as any transaction could be

reversed upon instructions from the originally transferring party.

149. Operating hours at the BOS are from 8.30 a.m. to 2.30 p.m. The transfers have to be

received between 9.00 a.m. and 12.30 p.m. All received transfer orders are normally

processed the same day. In exceptional cases, transfers could be postponed to the next

business day. Any transfer received later will be treated individually depending on the overall

circumstances such as the importance and value of the transfer and depending on whether the

application is still running.

150. In principle, sufficient funds in the commercial banks’ accounts at the BOS are

necessary before any credit transfer is processed. It is not clear whether the software

application itself would permit overdrawing of accounts or whether the user has to check for

sufficiency of funds before any transfer is entered into the system.

151. An automatic overnight overdraft is provided in the BOS Khartoum branch for those

members who experience a shortage of liquidity as a result of the clearing session in the

- 49 -

CCH, to cover their positions and to ensure settlement of the net result.30

Thus, the BOS

bears the credit risk if the commercial banks fail to settle. Penalty fees exist (in tranches) on

the overdrawn account if the balances are not restored within the closure of the next business

day. If the overdrawn balance is not restored within three days, the member is suspended

from the CCH.31

The incident will also be reported to the inspection department of the BOS

by its representative in the CCH. The bank in need of liquidity can then transfer the needed

amount from its branches’ balances outside the Khartoum area (balances of commercial

banks at other BOS branches are not accounted for by the BOS Khartoum branch). Besides

this possibility, the bank would usually turn to the BOS by selling foreign exchange or

government securities. Approaching the interbank money market or using the capital market

operation is rarely considered by banks as a source for liquidity, in part, reportedly, because

banks fear revealing a liquidity shortfall to their competitors. There are no failure-to-settle

procedures in place, that is,. the system is not “capable of ensuring the timely completion of

daily settlements in the event of an inability to settle by the participant with the largest single

settlement obligation” (Core Principle V).

152. The BOS’s Foreign Relations Department operates a separate CCH for checks in

foreign currency (U.S. dollars, euros, and Saudi Arabian riyals). Almost the same regulations

apply for both the local currency CCH and the foreign currency CCH.

153. At the moment, banking operations between the BOS and the commercial banks are

mostly paper-based. At the end of each business day, the BOS produces hard copies of

statements of accounts and credit/debit notifications to be delivered physically to the

commercial banks.32

The only operations between the BOS and commercial banks conducted

electronically are found in the trading room in the Foreign Relations Department of the BOS,

which receives electronic messages through the Society for Worldwide Interbank Financial

Telecommunications (SWIFT) from some commercial banks.

154. The check clearing system is thus relatively slow, and gives rise to significant risks. It

also raises the costs of intermediation, mainly because banks have to keep large excess

reserves in each of their many accounts with BOS branches (Table A2): banks lack the

information and means to manage their liquidity, and therefore need a large stock of liquidity

as a buffer. As a result, they have less incentive to mobilize savings or need to obtain a

higher return on investments.

30

In 2005 the BOS is expected to tighten conditions on the provision of central bank liquidity and raise the

associated charges. 31

It was difficult to establish how frequently this penalty has been applied. However, one incident related to the

NIMA bank in 1999, a bank that was liquidated later. Another incident occurred when a major bank

experienced a suspension in 2001. 32

The BOS is able to use the “Data Cloud” or the SWIFT network (see below) to relay instructions and/or

information to commercial banks.

- 50 -

Electronic payments and communications

155. All 26 banks, except Habib Bank, are connected to the electronic SWIFT messaging

system. The EBS manages the gateway by installing the SWIFT alliance software at their

premises and providing workstations at commercial banks premises.33

Banks benefit from

this electronic means to connect to the whole banking community and to their cross-border

correspondents. The EBS provides an on-site primary server and, concerning business

continuity, a hot off-site back-up server. It has been reported that the average daily outgoing

and incoming messages are between 1,000 and 1,500. These are divided into 80 percent for

payments and 20 percent for trade finance and money market operations. Due to the U.S.

embargo, the EBS could not work as a service provider connected directly to SWIFT

network. The EBS solved this situation by connecting through another country. Special

attention should be paid to the utilization of this network because it provides the basis for

inter-bank communication. The SWIFT messaging system is used by most of the countries

operating modern Real Time Gross Settlement (RTGS) systems.

156. The physical infrastructure for conducting electronic inter-bank and inter-branch

operations has been recently installed in the form of a fiber-optic frame relay, called “Data

Cloud”. There are round 300 access points, inside and outside Khartoum. So far, they are

only used by commercial banks to conduct inter-branch operations in the form of transferring

balances from branches to its head office and vice versa. The BOS uses the network, which

connects 8 of its 11 branches, at the moment only to communicate with them via email, but

not for daily banking operations. So far, the BOS does not utilize the network to

electronically communicate with the commercial banks.

Government certificates

157. The SFSC is the primary dealer for selling government securities (GMCs, GICs). This

company was established in 1998 and is owned by the BOS (99 percent) and the MFE

(1 percent). Its customers are commercial banks, financial institutions and funds,

corporations, and the broad public (individuals) who participate in the primary offerings of

GMCs and GICs and in the secondary market. In the primary market, the clearing and

settlement of the cash-leg is usually done as follows: cash payments by individuals as well as

checks and credit transfers are directed to the account of the SFSC at the BOS. The delivery

of securities, the securities-leg, is conducted in a registered form in the SFSC registry within

one month from the date of issuance. This period is used by the SFSC to ensure that the

respective amount has been received in its account. This procedure could be considered as a

credit risk management technique: if a buyer does not fulfill its financial obligations partially

or totally, then the unpaid securities are usually sold to the BOS and the buyer is allotted with

the portion he has paid for. The SFSC estimates that between 4,000 and 5,000 new records

33

The “Electronic Banking Services Company (EBS)” was founded in 2000 to outsource and to delegate the

objective of modernizing the banking infrastructure. The BOS holds 49 percent of its capital, Sudatel (a

government owned telecommunications company) 30 percent, and the largest 21 banks hold equally 21 percent.

- 51 -

are created whenever a new issue is undertaken because the certificates are issued in small

denominations (SD 50,000 for GMCs and SD 10,000 for GICs).

158. The SFSC manages an electronic registration system. The back-up server is fed

updated data on a daily basis. It is worth pointing out that the back-up server is located in the

same room as the regular server. Original documentation in hard copy and electronic copy

are kept in a fireproof safe in the same building. The physical proximity of these systems

reduces their value in ensuring operational continuity. Furthermore, the various lags and

other aspects of the system create operational risk. In the secondary market, the government

securities are traded at the Khartoum Stock Exchange (KSE). While over-the-counter trading

between commercial banks is forbidden, the BOS can trade over-the-counter with

commercial banks.

Stock exchange transactions

159. Government securities and shareholding equities are traded on the KSE, which was

established in 1992 by an Act of the National Assembly. In 2003, the daily average value of

trading reached SD 100 millions for 39.9 million shares in 13 contracts. There are 16

brokerage firms and 47 listed companies. Stock market turnover (number of shares traded

relative to outstanding stock) increased in 2003 by 26.2 percent compared to the previous

year, and the traded value amounted to SD 24.4 billion, or slightly over ½ percent of GDP.

160. Trading hours are between 10.00 a.m. to 11.00 a.m. from Saturday through

Wednesday. The trading hall manager has the discretionary authority to lengthen the trading

session by up to about 10 minutes. In case he does so, he has to justify his action in written

form. Small investors can pay in cash (banknotes) to the broker, who will then settle by

check. Until about 1.00 p.m., checks are exchanged manually on a gross bilateral basis

between members. That means that a check is exchanged for every deal. Cash-settlement will

take at least three working days because the checks have to be cleared in the CCH.34

Therefore, brokers are exposed to credit risk until checks are settled. This credit risk is

managed by the KSE by allowing the general manager to suspend the broker who provided a

check with insufficient funds from trading sessions (also a report to the KSE’s board is

issued). The paying broker still has to settle his outstanding obligations. No Delivery-versus-

Payment (DvP) arrangements are available for normal transactions. Members, who have

accounts at the BOS where they can deposit these checks on the same day of trading, can

make express settlement for checks. The BOS will then settle the check by debiting the

drawer’s account and crediting the beneficiary’s account directly.

161. Extraordinarily high value transactions can be treated separately by the KSE by

arranging for the issuance of the certificate of ownership on the same day of the contract, and

settlement of the cash-leg. The system does not allow credit transfers between brokers unless

34

The practice whereby brokers settle their obligations by exchanging checks on the basis of individual

contracts increases the importance of the outcome of the CCH.

- 52 -

both brokers agree on arrangements where a proof from the transferring and beneficiary’s

bank can be presented.

162. No central registry for equities and government securities exists. The registry for

equity shareholders is located at the headquarters of the issuing companies, while the SFSC

keeps the electronic registry for government securities. The registry for equity is in registered

form where a certificate is actually issued, but kept on the company’s premises or in a bearer

form where the certificate is physically handed over to the owner. A potential seller has to

prove ownership; in the case of the bearer form, he/she has to hand over the ownership

certificates, in the registered form the broker will ask for a proof from the issuing company.

Upon completion of a trade, a copy of the contract should be sent to the company to change

the title to the new owner. The KSE receives the new certificates and distributes them to the

respective broker where they are handed over to the respective investor. If within six days

from the date of trading the new certificates are not received, the broker should report the

incident to the KSE in order to follow up with the issuing company. The same procedure is

followed with the SFSC regarding government certificates.

Exchange bureaus

163. Exchange bureaus conduct cross-border transfers as one of their main activities.

Regulations are issued by the BOS to govern their activities.35

A customer can deliver cash to

a money exchanger outside Sudan in any currency and ask that the same value of money will

be delivered to him personally or to someone else in Khartoum in any currency.36

37

This

implies a credit risk carried by the customer versus the creditworthiness and credibility of the

money exchanger. Although the regulations issued by the BOS state that foreign exchange

bureaus must keep a certain amount as “insurance” in the form of collateral with the BOS (5

percent of the paid capital for companies established in Sudan), it is not clear that this

collateral can cover any risk carried by the customers. Moreover, this risk could potentially

have systemic implications. There may also be some informal remittance systems in

operation, although reportedly banks and exchange bureaus compete effectively with

informal systems. It proved not to be possible to estimate the size of the formal or the

informal section of this market since no data was available

E. Reforms Under Way

164. Modernizing the payment systems is high on the agenda of the BOS. There have

already been significant efforts to install the necessary infrastructure, mainly by installing

electronic communications networks. The BOS is leading a complex project to modernize

most areas of the payment system, including its local applications. The department in the

BOS responsible for establishing the future payment system is the BTD.

35

See the Detailed Assessment of Compliance with the AML/CFT Recommendations on the extent to which

regulations address AML/CFT issues. 36

Banks conduct similar business. 37

Effectively, the bureaus facilitate informal remittance services.

- 53 -

165. The commercial banks have recently introduced other payment methods with the

cooperation of the EBS, but so far with limited success. Seven banks have issued 514 prepaid

cards (Shamekh) for use at 130 points of sale in the Khartoum area (see Tables A3 and A4).

There is a limit of SD 3 million (US$12,000) that can be transferred onto the card. Besides

targeting private customers, the prepaid cards are intended for government officials. There

are problems with new regulations and laws dealing with this kind of electronic payment.

Legislation is in preparation, but has not been passed yet. One basic goal of these prepaid

cards is to get customers acquainted with “plastic money.” There is only a volume-based fee

for merchants. From anecdotal evidence it, could be established that some merchants, despite

the existing reading machines for the prepaid cards, prefer cash payments. There is no credit

risk because of the nature of the prepaid cards. Nevertheless, operational risk might exist

while processing the transactions.

166. In addition, five ATM machines have been installed, which only allow for local and

regional use. Most of these ATMs are located at the head offices of the issuing commercial

banks. A wide area network can be used to install ATM machines in other places, especially

in commercial centers. Most projects employing electronic means of payment are financially

supported by the BOS to create an incentive for commercial banks to adopt new

technologies. Reasons for not relying more on electronic payment tools could be the limited

resources of the banking sector, limited awareness, and limited demand from the side of

customers.

167. Credit cards are not available at the moment. Banks do not issue credit cards and

commercial centers do not accept credit cards issued from foreign countries (except Diner’s

Club). If the U.S. embargo is lifted, the authorities plan to apply for licenses and to install an

authorization center.

168. There are three projects under way in the ComBTD:

the “Electronic Check Clearing Project” started in August 2004. Its objective is to

connect 150 branches in the Khartoum area to clear and settle checks in T+0 via an

image-based system (and at a later stage connect branches outside Khartoum). It is

supposed to be launched in the second or third quarter of 2006;

the “National Switch Project (ATM)” started in September 2004. Its main objective is

to install ATMs (for cash withdrawals and later for balance inquiries and transfers)

and to connect various banks’ ATM applications so that each participating bank can

service the customers of other banks as well as its own. The “National Switch” is also

necessary to connect commercial banks electronically with the BOS. It is supposed to

go life in 2005Q2. A contract with the company “S2M” from Morocco has been

signed. At the moment, the BOS finances this project, the pricing is unclear; and

the “Electronic Fund Transfers (EFT)”/“Online Settlements of Payments (RTGS)”

project constitutes a future undertaking, which has not started yet. Its objective will

- 54 -

be to transmit, process, and settle interbank payments on a real-time gross settlement

basis. It is planned to start the implementation at the beginning of 2006.

169. The CenBTD has two on-going projects:

the “core banking” project’s objective is to allow the BOS to manage its basic

banking activities and operations through real-time processing of financial and

accounting transactions and also to centralize customer accounts at the head office (a

contract with the company “SYSTEMACCESS” from Singapore has been signed). It

is planned to go live at the end of 2005; and

for the “banking returns” project, which is to help the BOS monitor and supervise the

banking sector’s performance, a contract has not yet been signed.

Table 12. Detailed Assessment of Observance of CPSS Core Principles for SIPS and

Central Bank Responsibilities in Applying the CPs

CP I - The system should have a well-founded legal basis under all relevant jurisdictions.

Description

The BOS Law and the Banking Law give the BOS responsibility and discretionary powers

for payment system oversight.

BOS staff were unable to provide the FSAP team with other laws and regulations that

might be considered a basis for a sound legal framework for a payment system.

Comments

Laws governing, for example, final settlement, netting, contracts, electronic payments and

insolvency are necessary to provide a well-founded legal basis for the payment system.

These laws and regulations must define rights and responsibilities of relevant parties,

including the system operator. Rights and obligations need to be established, especially for

operations related to risk management. However, in practice the BOS proved to run,

unchallenged, a manual system, assumingly based on “instructions” issued by the BOS to

the banks. During the mission’s visit, the BOS staff was unable to provide such documents

either in English or in Arabic.

CP II - The system’s rules and procedures should enable participants to have a clear understanding of the

system’s impact on each of the financial risks they incur through participation in it.

Description Financial risk management is implicitly addressed by the BOS in practice. There is no

clear understanding on the participants’ side for the systemic effect of liquidity and credit

risk. This could be a result of the BOS practice to provide a “safety net” for banks when

they are in need of liquidity. No rules or regulations clearly define the rights and

obligations of all the parties involved.

Comments The BOS should consider revising and/or drafting a new governance and regulatory

structure to operate and manage the whole system on the basis of comprehensive and

sound rules and procedures. Participants, the system operator, and other involved parties

should clearly understand the financial risks inherent in the system and where they are

assumed. The rules and procedures of the system will determine who has to bear the

risks. These rules should clearly define the rights and obligations of all the parties

involved and all such parties should be provided with up-to-date explanatory material.

In particular, the relationship between the system’s rules and the other components of the

legal environment should be clearly understood and explained. In addition, key rules

relating to financial risks should be publicly disclosed. Training might be a good source

for proper awareness.

- 55 -

CP III - The system should have clearly defined procedures for the management of credit risks and

liquidity risks, which specify the respective responsibilities of the system operator and the participants and

which provide appropriate incentives to manage and contain those risks.

Description Credit and liquidity risks are not well recognized at the BOS (as the operator of a manual

payment system). Paper-based transfer orders are easily queued and reordered depending

on the availability of funds. The subsidiary system (CCH) in Khartoum is not supported

by any financial risk management procedures. The BOS carries the credit risk by

providing free of charge overnight liquidity to the member with an insufficient balance to

meet its net debit position.

Comments Redesigning the procedures for the existing manual system or designing the future

electronic (RTGS) system should take into consideration the effective management of

financial risks. An efficient information system through real time monitoring will be a

good basis for credit and credit risk management. Gridlock resolution, a pool of collateral

securities, and a loss-sharing agreement should be taken into consideration.

CP IV - The system should provide prompt final settlement on the day of value, preferably during the day

and at a minimum at the end of the day.

Description BOS staff stated that any payment could be unwound if “convincing” justification is

provided from the concerned ordering party (orders are processed on gross basis).

Therefore, payments are not irrevocable and not final.

Comments The design for a future modern electronic system should ensure the promptness of final

settlement on the day of value which entails the following: (i) clarity in the system rules

and procedures that a payment accepted by the system for settlement cannot be removed

from the settlement process; (ii) a clearly defined and legally effective moment of final

settlement; (iii) assurance that the interval between the system’s acceptance of a payment

and the payment’s final settlement at least never lasts overnight and preferably is much

shorter; and (iv) assurance that operating hours and the settlement processes are strictly

enforced.

CP V - A system in which multilateral netting takes place should, at a minimum, be capable of ensuring

the timely completion of daily settlements in the event of an inability to settle by the participant with the

largest single settlement obligation.

Description Multilateral netting is done only in the CCHs. There is no significant delay between the

acceptance of payments for settlement and the final settlement of the payment. A pre-net

settlement file is submitted to the local BOS general ledger for settlement right after the

conclusion of the check clearing session.

Comments Uncollateralized, free-of-charge liquidity is automatically provided by the BOS if one or

more of the CCH members do not have the ability to cover their short net position.

Therefore, the BOS is exposed to credit risk. Liquidity risk can be managed normally by

other solutions to support the system, such as committed credit lines, a pool of collateral

deposits or securities. Alternatively, the promotion of a credit transfer system design (an

RTGS system) would give a better chance to control credit and liquidity risk and avoid

complications associated with multilateral netting systems.

CP VI – Assets used for settlement should preferably be a claim on the central bank; where other assets

are used, they should carry little or no credit risk and little or no liquidity risk.

Description Settlement is done using member banks’ accounts across the BOS books in Sudanese

dinars. This applies for the manual exchange of credit transfers. In addition to Sudanese

dinars, a separate CCH is operated by the BOS in foreign currencies including U.S.

dollars, Saudi Arabian riyals and euros.

Comments The BOS applies the same rules for both CCHs. Liquidity and credit risk are valued in

the same manner. The foreign currencies are ultimately claims on other central banks.

The credit worthiness of the issuers of those settlement assets is not questionable.

However, for international transactions in foreign currency, which are settled with the

- 56 -

correspondent network, there is a settlement bank risk. Also, transferability into other

assets could be a valid question considering the current political situation of Sudan.

CP VII – The system should ensure a high degree of security and operational reliability and should have

contingency arrangements for timely completion of daily processing.

Description The central system at the BOS is still paper-based and manually operated. A security

policy and service level agreement between operator and members does not exist.

Comments Issues in this context should be taken into account in the design of the intended “On-Line

Settlements” system. The design of the procedures should cover security and operational

reliability from end-to-end, or from the end user at the input level to the final settlement

of the money transfer. Well-trained staff is a must for successful implementation at

member and operator level. Sound technical design for hardware, software, and network

including back-up sites cannot be avoided to ensure business security and continuity.

CP VIII – The system should provide a means of making payments, which is practical for its users and

efficient for the economy.

Description It is clear that the current paper-based system is inefficient and slow.

Comments Using the local applications at the BOS is a good start, but it does not mean that the

system is efficient. Payment order creation, submission, processing with all the risk

management procedures included, should be reviewed. The system does not necessarily

have to be sophisticated and costly to be considered efficient. Using electronic

infrastructure which is already at hand, combined with a sound design of business rules,

can create a practical and efficient system. Efforts should be directed to replace cash

payments with less costly alternatives. This does not mean the promotion of the use of

checks.

CP IX – The system should have objective and publicly disclosed criteria for participation, which permit

fair and open access.

Description Under the current manual system, access is permitted for all banks and financial

institutions.

Comments Criteria should be in place for the future implementation of the intended “On Line

settlement” system. Concern should be given for the system’s safety.

CP X – The system’s governance arrangements should be effective, accountable and transparent.

Description Governance of the BOS in general is effected through several means (see main report).

Regulations on the operation of the payment system and its governance are not readily

available.

Comments Preparations for the future payment system should take into account the core principles.

Central Bank Responsibilities in applying the CPSIPS

Responsibility A – The central bank should define clearly its payment system objectives and should

disclose publicly its role and major policies with respect to systemically important payment systems.

Description The BOS plays a leading role through the Commercial Banks Technology Directorate

(CBTD). Nevertheless, the objectives, the role of the BOS and major policies are not

clearly defined or disclosed. Projects within the framework are not prioritized. The

business model is not clearly understood by the banking community. There is a relatively

low public awareness.

Comments CBTD and EBS are supposed to lead the payment system modernization project in

Sudan. Market needs should be defined more clearly. Market conditions should be taken

into account. The introduction of the prepaid cards (“Shamekh” ) has not prove to be a

successful project. To identify the market needs is an essential element to ensure the

proper acceptance by the community. A very limited number of prepaid cards issued and

a low volume of transactions covering very limited value of transfers compared to the

reasonable number of POS points (as a start) can be regarded as evidence.

- 57 -

Responsibility B – The central bank should ensure that the systems it operates comply with the core

principles.

Description The BOS operates the paper-based credit payment system and the CCH.

Comments Legislative framework and details of the projects currently under way should be revised

to ensure compliance with the CPs.

Responsibility C – The central bank should oversee observance with the core principles by systems it does

not operate and it should have the ability to carry out this oversight.

Description The network for prepaid cards is operated by the Electronic Banks Services (while the

EBS is 49 percent owned by the BOS).

Comments Legislative framework and details of the underway projects should ensure compliance

with the CPs.

Responsibility D – The central bank, in promoting payment system safety and efficiency through the core

principles, should cooperate with other central banks and with any other relevant domestic or foreign

authorities.

Description The BOS cooperates with the SFSC, the EBS and the KSE in designing and

implementing the payment system’s interaction with the securities settlement system.

Comments Activities of payment system oversight, supervision of financial institutions and the

surveillance of financial markets can be carried out within the central bank or within

separate authorities. The flow of funds between components of the system imply a

systemic risk. For Sudan, disruption in one sub-system (including future projects such as

ECCH and ATM switch) may cause disruption in others.

F. Recommended Actions

170. Feasible enhancements to the payment system could yield a significant improvement

to the soundness and efficiency of the financial system. Some possible measures could

include the following:

To start with, highest priority should be given to the development of a strategic plan

on how to modernize the payment system. This plan should help make the

government, banking industry, and the public aware of the need for development;

create the institutional framework for development, cooperation, and oversight (see

next bullet point); and link ongoing with future initiatives.

To help refine the BTD’s modernization projects, a “Payments Council” could be

established, including top-level officials from the BOS as well as management

representatives from commercial banks, to decide on the strategic and broad policy

framework. A “Technical Committee,” in which the EBS, commercial banks, and

other financial institutions are represented, should be established, which should have

the authority to decide on the technical details of the payment system issues at the

nationwide level, given the approval of the Payments Council. More generally,

greater effort is required to regulate securities markets, and coordinate regulation and

supervision across financial markets (see elsewhere in the FSAP documents).

More trained staff should be allocated to Working Groups to help design the business

model and its implementation. Legal issues should not be ignored within a specialized

team. The building of a common database, which collects statistics relevant to the

- 58 -

payment system, should become a priority. The centralized data would ensure an

analytic framework for reaching decisions in this area.

The BOS should be more transparent in the regulatory form of all segments of the

payment systems. The BOS should ensure that the current and future payment

systems have a well-founded legal framework and governance basis (including an

electronic transactions law) and clearly defined procedures for the management of

financial risks. The same rules should apply to, and be known by all participants in

the system. Special attention should be given to issues related to finality and

irrevocability of payments.

The electronic worldwide used messaging system, SWIFT, should be utilized more

extensively. All Sudanese commercial banks except one are SWIFT members and the

infrastructure to use it is in place, but the system does not seem to be utilized for daily

transactions (except a few transactions between some commercial banks and the

Foreign Relations Department at the BOS). One of the reasons for this could be the

lack of training at the users’ level, concerning the technical side as well as the

language side (English is predominantly used in employing the SWIFT system). The

BOS may direct banks to use SWIFT because of its low cost, safety, efficiency, and

high standards. In addition, it will enable the Sudanese banking community to interact

more strongly with the international community.

The existing CCH should improve its measures that ensure business continuity. It is

recommended to establish a hot back-up server at the Khartoum branch. The existing

CCHs in other regions could serve as remote back-up sites for each other. To avoid

incorrect data entries and to ensure an efficient procedure, software should allow the

verification of transactions by the management of the respective division before being

sent to the accounting system. In this case, there would be sufficient oversight, but no

need for a secondary user entry, unlike in the current “double user entry” method.

It is not normal for a central bank to provide liquidity in a failure-to-settle incident

within a netting system.38

In this case, an arrangement among the netting system

members should be established to protect against liquidity and credit risk. This

arrangement should comply with CP V and ensure the timely settlement of the netting

result. The BOS provides an (automatic) overnight draft in case of a short member.

The penalty in the form of a suspension of commercial banks from the CCH is

problematic and may add additional complications. Instead, collateralized credit lines

based on government securities may be provided. A pool consisting of cash or

securities could form the collateral behind a “loss-sharing agreement”, which is a

typical solution for a failure-to-settle incident.

38

See BIS (Bank for International Settlement) publication “Core Principles for Systemically Important Payment

Systems,” Section 7.5.5, Jan. 2001, “Central banks do not normally provide specific committed facilities in this

context although they could be a potential source of support.”

- 59 -

The balances of commercial banks at BOS branches may add extra liquidity to the

useable funds to settle the net result of the CCH. Therefore, those balances should be

consolidated in the BOS books for operational purposes. Such consolidation will

require the availability of a robust network (the existing “Data Cloud” system seems

usable) and appropriate application software. Furthermore, a modernized system

should provide banks with better access to information, in particular information on

balances with the BOS at the end of the day and even during the day; in some

systems, each bank has access to real-time information on payment order queues

affecting its position.

Instead of putting too much effort into the modernization of the debit system, namely

checks, resources should be allocated to modernize the credit transfer system.

Reasons for that are the overall weak use of checks in Sudan and the systemic risk

inherent in netting systems (like the multilateral net check clearing), in addition to the

legal, administrative, and operational risks and complications associated with this

process. It is questionable whether Sudan needs a technically advanced complicated

electronic clearing system based on imaging, considering the low value and volume

of checks exchanged in Sudan, and considering that many of the advanced financial

systems still depend on an “Automated CCH” and on the use of electronic

“Truncation.” It is advisable to give priority to a core RTGS payment system along

with the electronic retail payment tools, such as debit cards, credit cards, prepaid

cards, and internet banking, which normally replace the use of checks.39

The BOS has decided to finance the projects under way. A cost recovery plan should

be detailed. A membership fee, an annual fee, and a transaction fee can be considered

as the basis for the pricing policy to recover the capital and running costs. Initial

financing by the BOS will create an incentive for introducing and adopting new

technology. Simple cost effective solutions are needed more than unnecessarily

complicated ones.

A high commission to oversee the securities market is needed to play a connecting

role between the trading and settlement procedures. Brokers exchange checks at the

end of each trading date. However, the rules for a settlement value date are not clear

for the final investor. Change of title is allowed within six working days.

Synchronization for the settlement date for both legs is needed. A late change of title

is a hindrance for investors who want to sell securities bought on the same day or

shortly thereafter, because the certificate of ownership should be presented together

with the selling order and payment. The existence of a central depository for

securities would ensure that standardized procedures are followed and enhance

investor confidence.

39

See the BIS publication “Core Principles for Systemically Important Payment Systems,” Section 9.1.22,

January 2001.

- 60 -

Greater security could easily be achieved by storing the SFSC backup data outside the

SFSC building, for example, at the BOS. The observed operational risk could be

reduced if more efficient procedures are followed to ensure timely registration on the

day of issuance and settlement.

To increase efficiency in settlement at the KSE, net bilateral positions could be

calculated, which will reduce the number of checks exchanged after each session. The

most efficient way to settle is by sending the net settlement file electronically to an

on-line, Real-Time Gross Settlement (RTGS) System, taking into consideration

compliance with CP V.

A central registry for securities (concerning stocks and Government securities) should

be established as it would simplify matters and minimize financial and operational

risks. T+0 settlement and DvP arrangements should be part of any preferred solution.

Concerning the North-South Peace agreement, the integration of the south in the

ongoing and future payment system projects would prevent unnecessary additional

investment spending and ensure the inevitable, free movement of capital.

- 61 - APPENDIX III

STATISTICAL INFORMATION ON THE PAYMENT SYSTEM

Table A1. Settlement Media Used by Nonbanks

(SD billion)

(end-December) (October)

2000 2001 2002 2003 2004

Currency outside banks 142.1 153.8 193.6 240.2 276.2

Narrow money supply M1 234.6 271.4 352.3 458.5 542.4

Broad money aggregate M2 346.7 432.2 563.7 734.1 909.7

Source: The BOS – Research and Statistics Department.

Table A2. Settlement Media Used by Credit/Deposit-taking Institutions

(SD billion)

(end-December) (October)

2000 2001 2002 2003 2004

Required reserves at the central bank:

In domestic currency 15.4 16.3 23.4 28.4 37.2

In foreign currency 9.7 10.2 11.6 13.8 18.0

Excess reserves at the central bank

In domestic currency 18.0 16.8 12.9 23.2 32.8

In foreign currency 3.7 5.0 6.0 8.2 9.8

Institutions’ borrowing from the central bank 17.1 18.8 5.7 17.3 18.2

Transferable deposits at other institutions 0.0 0.0 0.0 0.0 0.0

Source: The BOS – Research and Statistics Department.

- 62 -

Table A3. Prepaid Card (Shamekh)

(2004)

Bank Name Issuing

Branches

Issued Cards Number of

POS Units

Saudi Sudanese Bank 8 145 39

Islamic Cooperative Development Bank 8 113 53

Animal Resources Bank 3 133 14

Farmers’ Commercial Bank 4 70 9

Al Baraka Bank 4 10 10

Omdurman National Bank 1 126 5

Workers’ National Bank 1 18 ...

SUM 29 514 130

Source: Electronic Banking Services Company (EBS)

Note:

“...” means that no data is available.

Table A4. Shamekh Transactions

Month 2003 2004

No. of Trans. Value

(in Sudanese

dinars)

No. of Trans. Value

(In Sudanese

dinars)

January ... ... 79 293,410

February ... ... 80 291,624

March 133 411,924 77 290,068

April 159 1,010,083 87 346,003

May 251 1,133,180 80 468,319

June 247 1,251,339 108 485,374

July 191 2,702,785 89 320,569

August 152 2,114,622 57 249,923

September 122 574,110 62 206,301

October 156 916,068 60 270,551

November 123 1,174,356 50 233,233

December 110 456,158 ... ...


Note:

“...” means that no data is available.

- 63 -

Table A5. Cash Dispensers (ATMs)

(2004)

Bank Name Issuing

Branches

Issued

Cards

No. of

ATMs

Average No. of

Withdrawals per Month

Omdurman Nat. Bank 1 340 1 700

Islamic Coop. Dev. Bank 2 65 2 100

Byblos Bank 1 ... 2 30

Total 5 405 5 830


Note:

“...” means no information is available

Figure A1. Value and Volume of Checks

Use of Checks -

Quarterly Average Volume (right scale) and Quarterly Average Value (left scale)

50,000

70,000

90,000

110,000

130,000

150,000

170,000

190,000

210,000

2000

Q1

2000

Q2

2000

Q3

2000

Q4

2001

Q1

2001

Q2

2001

Q3

2001

Q4

2002

Q1

2002

Q2

2002

Q3

2002

Q4

2003

Q1

2003

Q2

2003

Q3

2003

Q4

qu

art

erl

y a

ve

rag

e v

alu

e i

n m

illio

ns

of

SD

D

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

qu

art

erl

y a

ve

rag

e v

olu

me

(n

o.

of

ch

ec

ks

)

quarterly average value

quarterly average volume490,932

Source: BOS.

- 64 -

VI. LEGAL FRAMEWORK

A. Introduction

171. Among the key components of a country’s financial sector are the laws, regulations

and other legal instruments on which the sector is based, the institutions by which such laws

are implemented and the manner in which the laws are enforced. In most parts of the world

the laws are generally satisfactory–the main problems lie with their implementation and

enforcement. Sudan has weaknesses in both areas. The country has a plethora of laws and

regulations on its statute books, but most are outdated and the country has not been able to

keep up with the many developments that have taken place over the last two decades

particularly in relation to the legislation governing the business environment.

172. The Sudanese legal system is based on a combination of English common law and

Islamic law. Before, and for a period after independence in 1956, the country’s legal system

was entirely based on U.K. law. Following the imposition of military rule in 1971, efforts

were made to convert this system into one based on Islamic principles. This was not

successful and in 1974, the conversion approach was abandoned. In 1983, President Nimeiry

attempted once again to introduce Islam as the basis of the country’s legal system. This was

primarily achieved by the enactment in 1984 of the Civil Transactions Act. This law

incorporated a very wide range of provisions dealing with agency, sale of goods, companies,

land and torts, and was intended to constitute the civil law of the country. It drew upon civil

law concepts from the Egyptian, Jordanian and French legal systems and is similar to

comparable laws adopted in other parts of the Arab world. The Civil Transactions Act was

supplemented by the Sources of Judgments Act of 1984 which required the judges to

interpret laws in accordance with Sharia principles. At that time, a number of laws that were

based on U.K. practices and principles were repealed, although not the Companies Act of

1925 or the Bankruptcy Act of 1929.

173. The current situation is that in some areas the common law prevails while in other

respects the courts are bound to apply Sharia law. The situation is further complicated by the

fact that some of the country’s judges are trained only in Sharia principles and have no

familiarity with common law concepts. Similarly, some of the older judges continue to

adhere to the common law when deciding cases. The result is a degree of confusion and a

lack of predictability within the legal system which is unsatisfactory. Confidence in the legal

system is not high and its complexity represents a hindrance to its implementation and, more

generally to economic development. The uncertainty surrounding the country’s legal regime

is likely to be compounded having regard to the changes that will soon need to be made to

implement the recently signed Comprehensive Peace Agreement between the North and the

South. A large number of laws will need to be substantially revised and updated to

accommodate the values and traditions of the South and to bring the country’s overall legal

system into line with international best practices.

174. The focus of this chapter is on four key elements of the legal regime governing the

financial sector in Sudan. The chapter begins with a brief review and assessment of the core

- 65 -

financial sector legislation. The commercial framework including corporate governance,

company registration, and accounting are then reviewed. The third section deals with issues

of insolvency, creditor rights, and the taking and enforcing of security. The fourth section

offers a brief assessment of the judicial system as it impacts on the operation of the financial

sector. Finally, the chapter incorporates a brief discussion of the implications of the

Comprehensive Peace Agreement on the financial sector and some of the legal issues that

will need to be addressed in order to implement the new Agreement. The chapter concludes

with a series of recommendations for specific reform. It should be noted that the legislative

underpinnings of other sectors including securities, insurance and pensions, and anti-money

laundering/combating the financing of terrorism are dealt with comprehensively in other

sections of this report.

B. Financial Sector Legislation

175. The key laws underpinning the financial sector in Sudan comprise:

(a) The Bank of Sudan Act, 2002 (BOS Act); and

(b) The Law on the Regulation of Banking Activity, 2003 (Banking Act).

Other key laws that impact on the financial sector include:

(c) The Money Laundering (Combating) Act, 2003;

(d) The Property Mortgaged to Banks (Sale) Act, 1990 as amended in 2003; and

(e) The Code of Administrative and Financial Penalties for Banking Violations,

1992.

The BOS Act

176. The BOS Act is well drafted and relatively modern in its scope and content. It

provides that the BOS should be an independent legal entity governed by a Board of

Directors comprised of 9 individuals including the Governor, the First Deputy Governor, a

representative of the Ministry of Finance, the Chairman of the Sharia High Supervisory

Board and 5 qualified individuals appointed by the President in consultation with the

Minister of Finance. The Governor is appointed for a term of five years and may be

reappointed. He may not be dismissed except for prescribed causes. The independent

members are appointed for three-year terms which are renewable and again may not be

removed except as prescribed by law.

177. The objectives of the BOS are to implement the following:

(a) Issue, regulate, monitor, and supervise currency of various types;

(b) Issue and manage monetary and financing policies in consultation with the

Minister of Finance, so as to achieve the national objectives of the national

economy;

- 66 -

(c) Regulate, control and supervise banking activity and act to develop and

enhance the effectiveness of banking activity so as to achieve balanced

economic and social development;

(d) Act to achieve economic stability and the stability of the Sudanese dinar

exchange rate;

(e) Serve as the government’s bank and its advisor and agent regarding monetary

and financial affairs; and

(f) Adhere to Islamic Sharia law provisions in the performance of its duties,

achievements of its objectives, discharge of its authorities and supervision of

the banking system.

178. The Governor and the Board have wide powers to achieve the objectives of the BOS.

The Governor may require banks to obtain BOS approval for financing requests that exceed

certain prescribed amounts, may establish a ceiling on the investment financing by banks and

a ceiling on the total value of investment financing. The Governor also has wide powers to

request the banks to provide information. The BOS serves as the Government’s bank and it is

empowered to make temporary financing available within customarily prescribed limits.

BOS supervisors have very broad powers although no specific protection is available against

prosecution. The mission was advised that immunity from suit is contained in the Penal

Code.

179. Anecdotal evidence suggests that the BOS exercises a high degree of influence and

control over all banking sector activities. There are no obvious deficiencies in the BOS Act

and no current proposals to amend the law except such as will be necessary to accommodate

the need to introduce conventional banking in the southern part of the country. The BOS Act

is substantially in line with international best practices for central banking legislation.

The Banking Act

180. The Banking Act is also well drafted and relatively modern. It provides for the

granting and revoking of licenses of banks. Ministerial approval is required in the case of the

licensing of a foreign bank although that is rather academic as to date no such bank has

sought approval to establish a presence in Sudan. The BOS is responsible for supervising and

controlling all banks and financial institutions and any other person that engages in all or

other banking activities. The Act provides for the normal provisions regarding capital,

reserve provisions, ratios, retention of liquid assets and broad restrictions on financing.

Fitness and propriety criteria are adequately addressed as are the related lending provisions

although these do not appear to apply to family members. A restriction on the aggregate

financing of connected parties should also be introduced. The Banking Act would also

benefit from a strengthening of the provisions dealing with coordination between on-site and

off-site supervision and between the supervision staff and other parts of the BOS. Banks are

required to comply with relatively modern accounting and audit requirements.

181. The BOS has broad powers to inspect banks, to approve the appointment of senior

managerial staff, to remove such staff in appropriate cases and to supervise all aspects of

- 67 -

banking operations. In appropriate cases, the BOS may, in consultation with the Minister of

Finance, cancel a bank license and/or submit a request to a court to approve the liquidation of

a bank. While the BOS has broad operational independence, the requirement to consult with

the Minister of Finance and the power of the Sharia High Supervisory Board to intervene in

certain circumstances, in theory if not in practice, limits this independence. The provisions

governing the merger and liquidation of banks are contained in the Companies Act of 1925.

The BOS must be appointed liquidator in any proceeding to liquidate a bank and has the

power to attach the assets of that bank and to require the management of a bank to refund

assets improperly disposed of. The BOS also has wide powers to impose penalties. These are

also governed by the Code of Administrative and Financial Penalties for Banking Violations

of 1992.

182. There are currently two banks in liquidation, in both cases as a result of BOS

intervention. In one case, the general manager and his deputy were suspended and ultimately

replaced. The BOS’s decision on this matter was unsuccessfully appealed in the court, which

ruled that the BOS’ actions were consistent with its powers and responsibilities under

relevant laws. There are a small number of cases outstanding against the BOS brought by

foreign parties relating to the repayment of certain deposits that were confiscated 10 to 15

years ago. Liability in each of these cases is admitted, but the government does not have the

resources at the moment to repay damages. The BOS is in the process of trying to settle these

cases.

183. The Banking Act creates the Sharia High Supervisory Board, giving it the primary

function of overseeing the implementation and application of Sharia laws and principles by

the BOS and by the banking sector. The Sharia Board comprises experts in Sharia law,

economics, and banking. It meets weekly and issues fatwas (formal Islamic legal opinions),

in addition to advising on standardizing the principles and provisions of Islamic law

underpinning banking and financial activity. It also monitors the BOS policies and

performance, as well as the activity of banks and financial institutions to ensure compliance

with the provisions and values of Sharia. All commercial banks are required to create a

Sharia Supervisory Board. Appeals from such Boards are heard by the BOS High

Supervisory Board. Fatwas issued by the Sharia Board in any dispute concerning banking

activity are binding on the BOS and on banks and other financial institutions unless they are

appealed to the judiciary. So far, there has not been any such appeal.

184. Islamic financial institutions are characterized by two features:

a) A prohibition against the payment and receipt of a fixed or predetermined rate of

interest. Islamic transactions consist of profit and loss sharing (PLS) arrangements.

Where the rate of return on financial assets held in financial institutions is not known

and not fixed prior to the undertaking of the transaction, the actual rate of return can

be determined only ex post on the basis of actual profits accrued from real sector

activities that are made possible through the productive use of financial assets.

- 68 -

b) A requirement to operate through Islamic modes of financing which affects both the

asset and liability side of bank balance sheets. These modes can be divided into two

groups: those that are based on the PLS principle and those which are not. PLS-based

lending principles include Mudaraba (trustee financed), Musharaka (equity

participation), and direct investment. The main non PLS financing modes include

Bai-Salam (purchase with deferred delivery), Ijara (leasing and leased purchase) and

Murabaha (mark up).

185. The BOS has issued regulations relating to Mudaraba, Musharaka, and Bai-Salam

modes of financing and these are strictly regulated. Mudaraba is a profit partnership between

investors and workers and is executed between holders of investment accounts and the bank.

It entails dividing profits according to the agreement and provides that the investor will

assume the loss. Mudaraba is generally considered the main pillar of the Islamic banking

operations. In the case of Mudaraba, i Short- and long-term Mudaraba liabilities are

measured according to their nominal value when they are entered into. If the bank realizes

that the cost of the asset that is available for sale may not be recouped, the asset must be

accounted for according to the cash value that is expected to be realized. The BOS may from

time-to-time stipulate to banks and nonbanking entities the rate and division of profits

relating to various transactions and modes, the percentage of a partner in a Mudaraba

transaction and any other provision that serves the public interest in this regard.

186. The Sharia Board is also empowered to “purge the charters, bylaws, guide books and

activity of the BOS, the banks and financial institutions of usurious transactions and the

visible and invisible force of such transactions and anything conducive to the unlawful

spending of the people’s funds on that which is worthless.” In practice this means that non-

Sharia compliant contracts, etc. are judged to be void; no compensation is payable because

the transaciton is treated as if it never existed. The Sharia Board has wide powers to examine

and express an opinion on issues presented to it, undertake research, resolve Islamic law

disputes, summon employees and request documents. However, it may not examine matters

before the judiciary or in which a competent court has issued a judgment.

187. The Banking Act is relatively modern and given the context and the level of

sophistication of banking activity in Sudan is appropriate for the current state of the country’s

banking sector development. Amendments to the Act will be required to give effect to the

provisions of the Power Sharing Agreement and these are in the process of being prepared.

C. Commercial Law Framework

188. Sudan’s commercial law is primarily governed by the Companies Act of 1925.

Although this law has served the commercial community reasonably well many of its

provisions are archaic, outdated and in need of reform. The Act provides the standard

framework for the incorporation and internal management of companies but basic corporate

governance concepts are almost entirely missing from the law, the liquidation provisions are

outdated and there is no reference to mergers or restructuring. Moreover, the Act is

- 69 -

increasingly perceived by legal practitioners to be a major obstacle to economic development

and foreign investment, as it does not cater for modern contractual structures.

189. The authorities have long recognized these deficiencies. Initial efforts to review and

update the Companies Act were made in 1982 but these did not proceed. One cause of delay

was conflicts among partial reason for the delay in the reform process has been a series of

disputes involving Islamic scholars on the perceived conflict between some aspects of

traditional company law and the principles of Sharia. More recently, a Commission has

prepared a new draft of the Act which is currently being considered by the authorities. There

is doubt among some Islamic scholars as to the legality of an entity which purports to have

perpetual succession. There are also reservations over the use of preference shares, and there

is a particular concern with the concept of limited liability. Widespread abuses have occurred

with promoters forming companies with limited liability, securing bank finance and then

seeking to liquidate the companies and avoid the obligation to repay. The authorities are

under pressure to abolish the concept of limited liability.

190. While the mission was not given the opportunity to review the current draft of the

Companies Bill, it is understood that it is more in the nature of a piece-meal amendment than

a substantial re-write of the law. A new law is needed to reflect current international best

practices in relation to director’s duties, shareholder rights, audits and auditor

responsibilities, and other standard corporate governance safeguards. The liquidation

provisions should be separated from the Act and enshrined in a new and updated insolvency

law. The provisions that deal with company objects, capital, accounts and types and attributes

of shares also need updating. The review process should involve wide stakeholder

participation and be followed up with an extensive education and training program. Any such

revision will also need to be harmonized with the commercial sector legislation that currently

exists in the South of Sudan.

D. Corporate Governance

191. Robust corporate governance in legal entities is an essential underpinning of risk

management. The corporate governance provisions applicable to Sudanese banks and

financial institutions are generally satisfactory but their implementation needs to be improved

as indicated in the section on Prudential Supervision in these Technical Notes. The

appointment of senior bank management officials is subject to confirmation by the BOS and

managers are subject to specific responsibilities and obligations under the Banking Act.

Commercial banking activity is also subject to strict audit controls in accordance with

procedures laid down by the BOS that conform with international auditing standards.

192. Outside of the banking sector, however, awareness of the importance of corporate

governance is extremely limited and a great deal of education and training will be required to

bring the Sudanese practice into line with international best practices. While the basic rights

of shareholders and functions of company directors are understood, there is no concept of

shareholder protection or minority rights and accounting and auditing standards are not well

- 70 -

understood or applied. Most corporate entities are small and privately owned so corporate

governance is perceived as having limited relevance or application.

E. Accounting and Auditing

193. Corporate accounting in Sudan is governed by the Accounting and Financial

Procedures Act, 1977. This Act provides for accounting procedures and standards to be

followed in the preparation of accounts, their review and certification by external auditors

and for disclosure of information. In addition, since 1988 all Sudanese banks are required to

apply the Islamic accounting standards prescribed by the Accounting and Auditing

Organization for Islamic Institutions (AAOIFI). Section 5 of the Banking Act imposes

obligations on banks to prepare balance sheets and related provisions. Banks produce three

general types of financial statements. The first relates to financial statements prepared for

internal purposes, the second are those prepared for the BOS and the third are those that are

used for public disclosure purposes. The AAOIFI standards are broadly consistent with

international accounting standards although, of course, appropriate modifications are

required in view of the prohibition on interest. Financial disclosure standards for banks are

sound and auditing standards and practices are prescribed under regulations issued by the

BOS.

194. Sudan enacted the Society of Accountants Act in 1988 to create an independent

profession for accountants. The mission was informed that shortly thereafter the authorities

expressed reservations about the existence of an independent accounting profession and steps

have recently been taken to bring auditors under government control To this end, the Law on

Organization of Accounting Act was passed as a provisional decree in 2003 and purports to

repeal the 1988 law. It appears to provide that the accounting profession will be operated

somewhat akin to a government department with the members of the management council

being appointed by government. The constitutionality of this law is presently under review.

F. Company Registration

195. The registration requirements are contained in the Companies Act. As at the end of

November, 2004, over 23,600 companies were registered of which the vast majority were

private. In addition, there were 5,334 branches of foreign companies. The registry has a staff

of approximately 150 people operating out of seven branches in Sudan. Anecdotal evidence

suggests that company registration is relatively straight-forward and efficient. Companies can

typically be formed within three days once approval of the proposed name has been obtained.

Where foreign companies are registered, delays can occur while security concerns are

addressed. The Act imposes the normal registration requirements for proposed companies

and the level of compliance with registration obligations appears to be reasonably good. The

registry is in the process of being computerized. It is open to the public and filing and

inspection fees are modest. Where enforcement becomes necessary, action is taken through

the Commercial Court and this process seems to operate efficiently. Problem areas relate to

the need for additional training and improved infrastructure. The system also suffers from a

- 71 -

wide spread practice of individuals forming companies, borrowing funds then liquidating the

companies and disappearing without repaying their loans.

G. Bankruptcy and Creditor Rights

196. The bankruptcy of individuals is governed by the Bankruptcy Act of 1929.

Bankruptcy has a certain social stigma in Sudan and bankruptcy proceedings are relatively

uncommon. However, there recently have been some bankruptcy cases against high-profile

individuals and these have apparently had a very salutary effect on the repayment of debts by

these individuals in their desire to avoid the shame attached to being a bankrupt.

197. Insolvency of corporate entities including arrangements and voluntary and court-

ordered winding up actions are governed by the Companies Act. Liquidation proceedings

have been rather more common than bankruptcy. The procedures are well defined in the law

but are rather outdated. Anecdotal evidence suggests that the liquidation process is well

understood by the judges and the parties involved and works satisfactorily albeit slowly.

There is no provision for workouts, mergers or restructurings and, again, in many technical

respects, the legal framework needs to be updated to accord with modern insolvency law and

practice. While insolvency reform is not an immediate priority, it should form part of an

overall strategy to modernize the business environment legislation.

198. Problems in enforcing the repayment of outstanding bank credit led the government

to enact the Property Mortgaged to Banks (Sale) Act in 1990. This Act was subsequently

amended and substantially revised in 2002. It provides that a bank creditor may enforce the

repayment of debt without recourse to a court of law. The Act provides for a relatively

simple process whereby a creditor gives notice of the debt and, in the event it is not repaid,

can proceed immediately to the sale of the collateral, usually real estate, by means of a public

auction. The Act also applies to the recovery of pledged movable property and contains

provision for the resolution of any disputes that may arise in the course of these proceedings.

In the event that the debtor disputes the claim then the matter will be dealt with through the

courts. It appears, however, that this is a seldom occurrence. Usually, the debtor comes to an

accommodation with the creditor by persuading a third party to take over the debt. Anecdotal

evidence suggests that this law has been effective. A key element of the bank collateral

regime is the practice of requiring the debtor to sign individual checks to secure the

repayment obligation. In the event that these checks are presented and there are inadequate

funds to support the check, a criminal offence is deemed to occur and the debtor can be

imprisoned until such time as the debt is repaid. Again, anecdotal evidence suggests that the

threat of prison has a salutary effect on the repayment of bank debt.

199. Bank credit is almost always secured in Sudan, with the level of collateral cover

typically one and a half times the value of the loan. Land is the primary form of collateral.

Creditors can rely on a range of fixed assets to secure loan transactions but, surprisingly,

there is no concept of a pledge over movable property such as vehicles, consumer items, and

equipment. Experience in other countries suggests that access to finance for such types of

property is an important factor in facilitating small- and medium-sized enterprises (SME)

- 72 -

development. It is recommended that a study be commissioned to explore options for

introducing a register and regime for movable property.40

Evaluation of assets is carried out

by the creditor and the lending formalities are relatively straightforward provided the

transactions fall within one of the approved forms of Islamic financing.

200. The land registration system is also well established and regarded as efficient and

reliable. The registration requirements are set forth in the Land Settlement and Registration

Act of 1925. All urban land is registered and freely transferable on the basis of 99-year

leases. Conveyances are typically registered in a matter of days and cases of mistake, fraud

or misfiling are rare. Registration is not compulsory and as filing fees are relatively high (2.5

percent of the value of the property if registered within six months), it is not uncommon for

parties to fail to register transfers of land. This practice undermines the integrity of the

system and exposes the parties to considerable risks. It is recommended that registration of

all land transfers be made compulsory.

201. The Land Registry is part of the Judiciary and the Registrar General has the status of

a high court judge. The registry is open to the public in the sense of being open to parties

who have a specific interest in accessing the register and is in the process of being

computerized. The system is based on U.K. legislation. Auctions for the sale of land appear

to operate smoothly although are not very common. Banks are permitted to purchase at

auction but are required to dispose of the properties as soon thereafter as possible. The main

problem with the auction procedure is that it is often difficult to find a buyer. There is a

certain social reluctance to acquire the assets of a defaulting debtor.

H. The Court System

202. In most parts of the world, the court system represents a weak link in the contract

enforcement process. The courts are frequently described as slow and expensive and the

judges viewed as incompetent and, at times, corrupt. . The Sudanese court system certainly

has its weaknesses but in the context of the financial sector these criticisms have relatively

little application. Because of the Property Mortgaged to Banks (Sale) Act, banks have

relatively little need to rely on the courts to recover debt. Where transactions are disputed as

being in conflict with the principles of Sharia, the High Sharia Board of the BOS resolves

such issues. There has never been a case of an appeal from the High Sharia Board to a court

of law. The courts are involved in liquidation proceedings but no particular criticism was

voiced of their performance in this area.

203. The judicial structure consists of a Supreme Court made up of approximately 100

judges operating in panels of three judges. They have the power to co-opt experts as needed,

and the experts are regarded as well qualified. At the Court of Appeal, there are

approximately 158 judges. The next level is the Public Courts of which there are some 190.

40

This could be extended, for example, to secured interest in nontangible assets such as accounts receivable and

intellectual property.

- 73 -

These are courts of general jurisdiction. At the District Court level, there are about 400

judges, and in the towns the rural courts are presided over by local lay people, often tribal

chiefs who are familiar with customary law. There are approximately 1100 courts in this

category with some 900 lay citizens serving as judges. Members of the town or rural courts

are selected from citizens of good standing such as tribal chiefs and community leaders.

These courts deal exclusively with customary law and are conciliatory in nature.

204. The Judiciary also includes a Constitutional Court which has authority to adjudicate

on constitutional issues, the bill of rights and disputes between states. In addition, the court

has jurisdiction over any issue, civil or criminal, which involves the violation of a right, and

therefore the court has begun to assume major powers and is increasingly perceived as a

court of more general jurisdiction. This is a major problem as the Supreme Court has no

jurisdiction to consider appeals from the Constitutional Court. It seems to be the view of the

members of the Constitutional Court that they have jurisdiction to hear almost any case since

all cases can be formulated in such a way as to appear to involve a violation of a right.

205. A new Commercial Court was established in January 2002 by a Decree of the Chief

Justice pursuant to the Judiciary Law of 1986. Its formal title is the Khartoum Commercial

and Intellectual Property Court. The court deals with all commercial cases and the judges

appear to be well trained and well regarded. They have their own special jurisdiction and all

five judges have been serving since the commencement of the court’s operations. There is a

commercial division within the Court of Appeal and within the Supreme Court. Anecdotal

evidence suggests that the Commercial Court is well regarded and cases are disposed of

reasonably efficiently. The court keeps good statistics and is about to issue its first published

series of judgments. All judges use computer facilities, and the court is making an effort to

become a paperless court. There is no evidence of corruption or political interference in the

operation of this court.

206. The Judiciary is essentially run by the Chief Justice and his three deputies. All 26

states within Sudan have their own separate judicial organ. The Supreme Council of the

Judiciary is responsible for planning, promotion, appointments, discipline and general

supervision and inspection responsibilities. The court budget is not significant and under

funding of the judiciary is an ongoing problem.

207. Anecdotal evidence suggests that Sudanese judges are respected, perceived as

independent, and relatively free from political influence and corruption, although some

recent appointments were seen as overtly partisan. Judges are well paid by Sudanese

standards and receive generous allowances. Competition for positions on the judiciary is

keen. Infrastructure facilities are not good and computerization is only just being introduced.

There is an urgent need to strengthen the IT capacity of the courts, together with improved

transport, library and research facilities and training. Case management procedures are at a

very basic level and delays in the hearing and processing of cases are becoming significant.

208. Judges are not necessarily trained in both English common law principles and

principles of the Sharia law. Their different training backgrounds lead occasionally to

- 74 -

inconsistent judgments on similar issues. There is also a perception that standards within the

judiciary have fallen in recent years. Following the introduction of Islamic law in 1983, many

of the country’s leading lawyers and judges left to take up judicial positions in other parts of

the Middle East. Some training programs have been held but there is a need to develop a

much more comprehensive and systematic training program for the judges.

209. Some judges speak English and are well informed about common law principles but

others do not speak English. Judges used to be qualified by the National University of Law

but now there are some 15 institutes which provide training for potential judges. The quality

of instruction is said to vary considerably and most of the institutes have a purely Islamic

focus.

210. Arbitration is becoming increasingly common. The arbitration provisions are

contained in the Code of Civil Procedure but a draft Law on Arbitration is currently under

consideration. Efforts are also being made to establish a Center for Arbitration independent

of the government structure and to join the New York, Paris and Cairo Conventions.41

I. The Peace Accord

211. On December 31, 2004, representatives of the parties involved signed a

Comprehensive Peace Agreement. This Agreement has broad implications for all aspects of

Sudan’s political, legal, economic, social and cultural life. Article 14 of this Agreement,

which is attached as an Appendix to this chapter, provides for the monetary policy, banking,

currency and borrowing regimes that will apply under the new united political framework.

The major implications for the financial sector are as follows:

Introduction of a dual financial system involving Islamic institutions in the North and

conventional institutions in the South,

Amendments to the BOS management structure and the creation of a major branch of

the BOS in the South,

The maintenance of a unified monetary policy,

The issue of a new currency,

The maintenance of a free flow of goods, services, capital and labor across regions,

and

An even distribution of net oil revenues between the Governments of the North and

the South.

These terms will apply for at least six and a half years.

41

The New York convention is the Convention for the Recognition and Enforcement of Foreign Arbitration

Awards (1958). The Paris convention is the Convention for the Protection of Industrial Property (1883). The

Cairo convention (1997) addresses the Greater Arab Free Trade Area (inaugurated in 2001).

- 75 -

212. The provisions outlined in Appendix I are statements of general intent. Much detailed

negotiation will be required to resolve the many issues that will need to be addressed in order

to give effect to the dual financial system. Appendix II provides a breakdown of some of the

more important financial sector issues that are likely to arise. It should be noted that the

South also has a central bank law and a banking law drafted with the help of foreign

consultants. Draft legislation dealing with companies and other essential elements of a

normal business environment are also currently under consideration by the authorities in the

South. These will need to be harmonized with their Northern counterparts.

J. Recommendations

213. The immediate task confronting the BOS is to begin the process of introducing a dual

system of banking. This will involve significant amendments to the BOS Act and to the

Banking Act. The wider objective for the country is to review the entire legal system with a

view to determining which laws, regulations and institutions will need to be amended to give

effect to the Comprehensive Peace Agreement. This will necessarily be a long and detailed

process. In the meantime, progress can and should be made in terms of modernizing the

existing legal framework to improve efficiency in the financial sector. Specific areas of

reform include the following:

Updating the Companies Act of 1925,

Amending the Banking Act to include restrictions on aggregate financing to

connected parties, including family members in the definition of connected parties,

and strengthening the coordination between on-site and off-site supervisory staff and

between such staff and other parts of the BOS,

Introducing a new Law on Insolvency,

Requiring the registration of all transfers of interests in land,

Commissioning a study to review the merits of introducing a regime for movable

property,

Initiating a training program for the members of the judiciary with a particular focus

on modern banking and corporate sector issues.

- 76 - APPENDIX IV

EXTRACT FROM THE COMPREHENSIVE PEACE AGREEMENT

14.0. MONETARY POLICY, BANKING, CURRENCY AND BORROWING

A. MONETARY POLICY, BANKING AND CURRENCY

14.1. The Parties agree, consistent with the Machakos Protocol of 20th

July 2002, to have a

dual banking system in Sudan during the Interim Period. An Islamic banking system

shall operate in Northern Sudan and conventional banking system shall operate in

Southern Sudan.

14.2. The Parties agree that conventional banking facilities are urgently needed in Southern

Sudan. The Parties therefore shall agree to establish, during the Pre-Interim period,

the Bank of Southern Sudan (BOSS) as a branch of the Bank of Sudan (BOS)

consistent with paragraph 14.1 above.

14.3. The Parties agree to restructure, during the Pre-Interim Period, the BOS so as to

reflect the duality of the banking system in Sudan. The BOS shall therefore use and

develop two sets of banking instruments, one Islamic and the other Conventional, to

regulate and supervise the implementation of a single monetary policy through: (i) an

Islamic financing window in Northern Sudan under a deputy governor of BOS using

Islamic financing instruments to implement the national monetary policy in Northern

Sudan; (ii) the Bank of Southern Sudan (BOSS), headed by a deputy governor of

BOS, to manage the conventional window using conventional financing instruments

in implementing the same national monetary policy in Southern Sudan.

14.4. The BOS shall be responsible for the conduct of monetary policy. All banking

instructions shall be subject to the rules and regulations set by the BOS.

14.5. The primary responsibility and mandate of the BOS shall be ensuring price stability,

maintaining stable exchange rate, sound banking system and issuance of currency.

The monetary policy shall be carried out accordingly relying primarily on market-

based instruments instead of administrative allocation of credit.

14.6. The BOS shall be fully independent in its pursuit of monetary policy.

14.7. The Governor of the BOS and his/her two deputies shall be appointed by the

Presidency. The Governor of the BOS shall appoint in consultation with his/her two

deputies other senior officers within the Central Bank.

14.8. The Parties agree to establish, during the Pre-Interim Period, an independent Board of

Directors (BOD). Decisions of BOD on matters that may affect adversely the interest

of either Party to this Agreement shall be by consensus. The BOD shall be

responsible to the Presidency on the accountability of the BOS and shall consist of

nine (9) members as follows:

- 77 - APPENDIX IV

-

a) Governor of the BOS (Chairperson) and his/her two deputies and;

b) Six highly qualified Sudanese to be appointed by the Presidency taking into

account the agreed formula in the Power Sharing Protocol for the institutions of the

National Government.

14.9. The BOS shall adopt a program to issue a new currency as soon as is practical during

the Interim Period. The design of the new currency shall reflect the cultural diversity

of Sudan. Until a new currency has been issued with the approval of the Parties on the

recommendations of the BOS, the circulating currencies in Southern Sudan shall be

recognized.

14.10. The BOS shall be responsible for chartering and supervising financial institutions in

Southern Sudan.

14.11. All financial institutions shall be subject to internationally recognized regulatory and

prudential standards for Islamic and conventional finance, as set by the BOS.

14.12. All financial institutions shall be bound to implement monetary policies set by the

BOS.

B. BORROWING

14.13. The Government of Southern Sudan and the states/regions may borrow money based

on their respective credit worthiness. Neither the National Government nor the BOS

shall be required or expected to guarantee borrowing by sub-national governments.

14.14. The GOSS and all sub-national governments shall report financial and fiscal data to

the relevant National Government bodies for statistical purposes.

14.15. The Government of Southern Sudan and the states/regions may borrow money from

foreign sources based on their respective credit worthiness.

14.16. Foreign borrowing by all sub-national government shall be done in a manner that

does not undermine national macroeconomic policies and shall be consistent with the

objective of maintaining external financial viability. All sub-national governments’

foreign borrowing transactions shall conform to the BOS specifications.

- 78 - APPENDIX V

ISSUES IN THE INTRODUCTION OF A DUAL BANKING SYSTEM

1) Currency exchange

a) Production and distribution of new currency

b) Treasury/vault arrangements

c) Conditions for conversion

d) Conditions under which the BOS or banks will buy foreign banknotes. Note that,

unless conversion at a market exchange rate is offered, an arbitrage opportunity will

be created

e) Conditions under which the BOS or banks will exchange old Sudanese pound

banknotes

2) Legal

a) Legislation

i) Laws amended not to stipulate that all financial institutions be Sharia-compliant

ii) Laws (including BOS Law) permit transactions between Islamic and non-Islamic

financial institutions

b) Court system

i) Mechanism to resolve dispute between financial institutions and nonfinancial

agents across regions

ii) Mechanisms to resolve disputes among financial institutions across regions,

possibly through a BOS arbitrage service or contracting in other jurisdictions

iii) Enforcement of contracts across regions

3) BOS organization

a) Supervisory Board and Executive Board reorganized

i) to include regional representation

ii) possibly to include cross-regional economic interests

b) Internal organization allows

i) devolved elements. An important branch is to be established in the south and

possibly other regions

ii) coordination mechanisms

iii) effective data management, including exchange of information and analysis

c) Accountability mechanisms

d) Responsibility for BOS capitalization, and allocation of dividends/seigniorage

e) Human and physical capacity building, especially in new branches

f) Development and implementation of technical assistance program

4) Monetary policy

a) Determination of common policy

b) Nominal anchor with monetary instability

c) Exchange rate regime and exchange arrangements. Rules and implementation

d) Management of international reserves

e) Analysis of regional and sectoral economic developments

f) Devolved implementation

- 79 - APPENDIX V

g) Monetary instruments

i) Standing facilities

ii) Open market operations

iii) Reserve requirements

h) BOS and government support for credit programs for such sectors as agriculture

5) Regulation and supervision

a) Effects of free movement of goods, capital and people

b) Adapting current regulations while ensuring a level playing field

c) Off-site supervision responsibilities

d) On-site supervision responsibilities

e) Reporting, analysis and information aggregation across regions and between on-site

and off-site supervision, especially for financial groups

f) Licensing criteria and decision making

g) Scope for banks to operate different “windows”

h) Tax treatment

i) Accounting rules and their implementation

6) Government finances (see also under BOS)

a) BOS role as government agent

b) Government accounts and transaction services for central and regional governments

c) BOS role in issuing and registering securities

d) Access to certificates market

e) Financing of regional governments from BOS and commercial banks

7) Non-bank financial institutions. Similar to banking issues

a) Insurance

b) Stock exchange

c) Other

8) Payments system

a) Role of BOS branches

b) Developing system in the south

9) Corporate sector

a) Corporate accounting

b) Corporate accountability, disclosure

c) Credit register

d) Property register

Documents

F S A P UDAN - World Bank · banking institutions in Sudan which comprised 23 domestic banks and 3 foreign banks. The operations of these banks are based on Islamic principles. 2