An-Najah National University Faculty of Graduate Studies The Impact of Banking Financial Services Innovations on the Development of the Financial Sector in Palestine By Ahmad Taleb Ismael Supervisor Prof. Dr. Jehad Yasin This Thesis is Submitted in Partial Fulfillment of the Requirements for the Degree of Master of Economic Policy Management, Faculty of Graduate Studies, An-Najah National University, Nablus, Palestine 2018 iii Acknowledgement I would like to extend my special thanks and sincere respect, gratitude appreciation are expressed to my supervisor Prof. Jehad Yasin for his support and invaluable supervision, great efforts in guidance and encouragement throughout the research work. Sincere appreciation and thanks are also extended to the committee members, Dr. Sameh Atout and Dr. Khaled Zubdeh for their time and effort in reviewing this work. I am forever indebted to my family for their encouragement and support throughout my entire life. Special thanks are expressed to my dearest friends for their help and encouragements. Finally, I like to thank the staff members of the Economic Policy Management Program at An-Najah National University for their support. Thank You All, v Table of Content Subject Page Defense Committee Members ii Acknowledgment iii Declaration iv List of Contents v List of Figures vii List of tables viii Abstract ix Chapter One: Introduction 1 1.1 General Introduction 1.2 Motivation to Conduct the Research 4 1.3 Important of Banking Sector in Palestine 4 1.4 Problem Statement 6 1.5 Research Questions 7 1.6 The Aim of the Study 7 1.7 Research Hypothesis 8 1.8 Organization of the study 9 Chapter Two: Banking System in Palestine 10 2.1 The Palestinian Economy 11 2.2 Brief History of Banking System in Palestine 16 2.3 Palestinian Monetary Authority 18 2.4 The Development of Deposits 19 2.5 The Development of Credit Facilities Depending on the Type of Currency 19 2.6 The Development of Credit Facilities Depending on the Type of Sector 20 2.7 The Development of Credit Facilities Depending on the Economic Activity 21 2.8 Financial Innovation 22 2.8.1 The importance of financial innovation 23 2.8.2 Financial Innovation Function 24 2.8.3 Innovation Diffusion Theory 24 2.9 Related Definitions 25 Chapter Three: Literature Review 27 3.1 Introduction 28 3.2 Previous Study 28 3.3 Commitments on Previous Studies 40 vi Subject Page Chapter Four: Data And Methodology 42 4.1 Data and Variables 43 4.2 Definition of the Dependent and Independent Variables 46 4.3 Model Specification 49 4.4 Hypothesis 50 4.5 Summary Statistics 51 Chapter Five: Results & Findings 53 5.1 Estimated Result for Model 1 54 5.2 Estimated Result for Model 2 63 5.3 Results Regarding Challenges Facing Banking Development in Palestine 70 Chapter Six: Summary & Recommendation's 73 6.1 Summary 73 6.2 Recommendations 74 References 82 Appendixes 86 Appendix1: Feedback and Analysis by Banks Officials on Obtained Empirical Results 87 Appendix 2: Descriptive Analysis 98 Appendix 3: Comparative Performance of Banks 102 Appendix 4: Survey Instrument 114 ب الملخص vii List of Figures Page Subject Number 19 The Development of Deposits Between 1996 – 2015 Figure (1) 20 The Development of Credit Facilities Depending on the Type of Currency Between 1996 - 2015 Figure (2) 21 The Development of Credit Facilities Depending on the Type of Sector Between 2008 - 2015 Figure (3) 22 The Development of Credit Facilities Depending on the Economic Activity Between 2008 - 2015 Figure (4) 80 New Channel in Smart Bank Figure (5) 80 Explanation on New Channel in Bank Smart Figure (6) 81 The role of the branch will change significantly to match evolving customer requirements Figure (7) viii List of Tables Page Subject Table No. 4 Important of Banking Sector in Palestin Table (1) 51 Descriptive analysis of dependent & independent Factors Influencing the Financial Innovation in Palestine. Table (2) 54 Regression analysis for the relationship between innovation variables (X1-X6) and development of bank sector Y1 variable Table (3) 56 Regression result using innovation index against and development of bank sector Y1 variable Table (4) 63 Regression analysis for the relationship between innovation variables (X1-X6) and financial performance of bank sector Y2 variable Table (5) 66 Regression result using innovation index against Y2 variable. Table (6) ix The Impact of Banking Financial Services Innovations on the Development of the Financial Sector in Palestine By Ahmad Taleb Ismael Supervisor Prof. Dr. Jehad Yasin Abstract This research aims at investigating the impact of financial banking innovation factors on banking development in Palestine. A Regression analysis was used to estimate the impact of specific factors related to the development of the financial sector in Palestine. The research utilized both qualitative and quantitative research methodology. Qualitative data were collected via interviews with banks officials. In addition, the quantitative data were gathered from a purposive sample of seventy (N=70) from five departments in all banks in Palestine via a survey that was developed for this purpose. Results indicate that production innovation has a positive impact on the development banking sector but it has no impact on profitability in short term. The result also indicates that marketing innovation has no impact on the development banking sector and on financial performance for all banks in Palestine. Regarding the process of innovation variable has a positive impact on the development of the banking sector and on the financial performance for all banks in Palestine. x The result indicates that administrative procedure innovation has a positive impact on the development and the performance of banking sector in Palestine. Finally, the result indicates that the variable risk management has no impact on development banking sector but it does have a negative impact on the financial performance for banks in Palestine. Based on the research findings, the study recommend that individual banks conduct a separate study to examine the needs of individual customers and to identify appropriate products for each period of time to all customers in order to achieve financial inclusion. It also recommended that banks in Palestine adopt a comprehensive marketing strategy to market their various products based on quality elements, which can promote bank name and enhance trust with customers in order to attract more customers. It is also recommended that banks works to reduce customers' visits to branches by increasing awareness of electronic banking services, smart cards, and transforming the system of operations from decentralization to centralization to reduce the complexity of the implementation of banking movements (transfers, checks, loans) and investment in the latest technologies to modernize their various sections to enhance financial and banking performance and increase competitiveness. xi It is also recommended that banks simplify operation procedures and updating them in line with the technological development and eliminating procedures that does not add any value to the banking business It is recommended that banks develop their risk departments in banks, especially the risks of operations and training staff to be able to deal with risk management systems and programs, which helps in governance and good governance. Finally, banks needs to work on the adoption of electronic banking strategies, including smart bank and electronic bank. It is only with the development and modernization of the legal environment banks will be able to use the technological development and electronic banking operations to protect them from piracy. This will allow banks to meet other challenges in dealing with the government, that might impact the implementation of banking operations all these will lead to higher performance and improve financial efficiency, which will increases the volume of economic activity. 1 Chapter One Introduction 1.1 General Introduction 1.2 Motivation to Conduct the Research 1.3 Important of Banking Sector in Palestine 1.4 Problem Statement 1.5 Research Questions 1.6 The Aim of the Study 1.7 Research Hypothesis 1.8 Organization of the study 2 Chapter One Introduction 1.1 General Introduction: The financial sector in Palestine is considered new. It was established when the West Bank and Gaza Strip were under the Israeli military government before1993. This restriction prevented the Palestinian banks and the financial intermediate companies from developing and working efficiently. The Israeli banks were operating in the West Bank and Gaza Strip and the policy of the Israeli banks was not to extend agricultural and industrial credit to Palestinian businesses. This was done intentionally to make the Palestinian economy dependent on the Israeli economy. After signing the Oslo Accord in 1994, the Monetary Authority was established and it started carrying out its duties. By year 2000, it managed to establish22 banks in Palestine. Following that, the Palestinian Monetary Authority increased the minimum capital from 25 million Dollars to 50 million Dollars, forcing banks to be more integrated institutions (Ashour, 2007,15). In 2015 the Monetary Authority decided to increase the paid capital from 50 million Dollar to 75 million Dollars. The purpose of the Palestinian Monetary Authority policy is to reduce the number of banks and have huge and strong capital. As a result, the capability of the Palestinian financial sector became stronger. After the establishment the Monetary Authority, the Palestine stock entity was created in 1995 as a 3 private joint-stock company. Following that many microfinance institutions emerged and started to offer loans for individuals with less income. Historical experiences emphasize that any company that fails to recognize globalization and technological advancement will lose its competition position and will not be able to develop its business model. Business institutions have to deal with all market changes that include offering high quality products and services at a cheap price. As a result, financial innovation provided businesses an opportunity to improve their competitive position in this changing market. The financial institutions are working hard to be innovative through various resources including the import of modern technology. However, the speed of technology revolution is extremely fast, which did not allow them to shape a real policy to innovate and spend more on research and development. Moreover, the financial sector has limited cooperation or support from other institutions in the area of research and development. If this is done, the profits from the financial sector in Palestine will increase over time. Thus, we need to support the financial sector and make it complementary to other sectors in the economy. It is known that financial sectors considered one of the most important economic sectors in both developed and developing countries. The role they play is effective and crucial in achieving the financial goals for the country. 4 1.2 Motivation to Conduct the Research: The banking sector in Palestine is considered done of the most growing and largest sectors operating in Palestine. It has been reported that customer deposits has exceeded nine billion dollars and that the value of direct credit facilities has exceeded five billion dollars (economic monitor, 2016, 20). Nonetheless, the banking sector in Palestine needs more innovations to become more efficient and more effective in order to achieve steady growth. This research is considered the first research in Palestine with a focus on the factors influencing financial service innovation on development of financial sector in Palestine. Hence, the lack of research on this area and study his created sufficient motives to conduct this research. 1.3 Important of Banking Sector in Palestine Table (1): Main indicators of banking sector in Palestine, 2010-2015 2015 2014 2013 2012 2011 2010 Indicator/year 5,824.7 4,895.1 4,480.1 4,199.3 3,550.7 2,885.9 Total credit facilities 9,654.6 8,934.5 8,303.7 7,484.1 6,972.7 6,802.4 Total deposits 1,088.4 921.7 885.6 783.0 415.2 144.3 Total consumer loans 6.78 6.41 7.51 6.97 6.79 6.33 Average interest rates on dollar Value in USD million The value of total deposits in bank sector during 2015 recorded an increase of 8.1% compared to 2014 and reached to USD 9,654.6 million. 5 The value of deposits to resident individuals was USD 6,475.7 million, accounted to 67.1% of the total value of deposits in 2015, while deposits to the Palestinian Central Government reached to USD 487.6 million, and represented 5.1% of the total value of deposits. The value of total credit facilities, were provided by banking sector, stood at USD 5,824.7 million, showing an increase of 19.0% compared to 2014. The credit facilities provided to the public sector amounted to USD 1,456.0 million, represented 25.0% of the total value of the credit facilities provided by banking sector in 2015 compared to USD 1,239.8 million in 2014, showing thus a rise by 17.4%. While the value of the facilities provided to finance consumption loans was USD 1,088.4 million, this only represent 18.7% of the total value of credit facilities, while the value of the facilities offered to finance cars and vehicles was estimated at USD 200.7 million, and this represent 3.4% of the total value of the credit facilities. The average interest rate on loans to the USD price recorded an increase of 5.8% during the year 2015 to reach 6.78%, while the average interest rate on USD deposits of up to 0.94%. The banking sector provides basic support and development for the Palestinian economy, which is reflected in the figures and bank statements in the previous table, and work to increase its performance and diversify its services will achieve positive growth rates. 6 1.4 Problem Statement: Some of the international assessment institutions as World Intellectual Property Organization" WIPO" uses an indicator called the innovation factor to measure the ability of countries to grow and develop. Stock market which is part of the financial market is very crucial in any country’s economy development. Hence, strengthening the stock market will contribute to the economic growth and help reduce poverty. The financial sectors in Palestine offer various services that vary from each other. These services have an impact on the customer who receives these services. One of the most important elements is the bank ability to attract a lot of clients and offer them good services. In addition, to the financial sector and the stock market which offers intangible services to customers, innovation and improvement in bank services are likely to have positive impact on the number of client banks serve and on the quality of services. Failure to do that on the part of a certain bank may lead to bankruptcy or being controlled by other institutions. Based on the above, problem of this research is represented in Answering the following questions: 1. What effect has innovation in financial services on developing the Palestinian financial sector? 2. What effect has innovation in financial services on financial performance? 7 1.5 Research Questions: This research seeks to answer questions related to the performance of banking system in Palestine and how financial innovation has impacted its performance and growth of the banking operation. 1- Identifying the factors which have led to financial innovation in Palestine. 2- Measuring the marginal impact of these factors on the performance of the banking system in Palestine. 1.6 The Aim of the study: 1- Highlighting the methods and techniques of the innovation in developing the financial sector in Palestine. 2- Identifying the role of innovation on developing the financial sector. 3- Spreading the culture of innovation in our financial institutions. This will increase level of competitiveness and development in order to enhance the ability of the financial sector to face any financial crisis in the future. 4- Measuring the financial strength by creating new innovations in financial services. 8 1.7 Research hypotheses: Our hypothesis are: H1: There is a positive and significant relationship between the two dependent variables, development of financial sector and financial performance, and production innovation as the first independent variable. H2: There is a positive and significant relationship between the two dependent variables, development of financial sector and financial performance, and marketing innovation as the second independent variable. H3: There is a positive and significant relationship between the two dependent variables, development of financial sector and financial performance, and process innovation as the third independent variable. H4: There is a positive and significant relationship between the two dependent variables, development of financial sector and financial performance, and innovation in administrative procedures as the fourth independent variable. H5: There is a positive and significant relationship between the two dependent variables, development of financial sector and financial performance, and innovation in risk management as the fifth independent variable . H6: There is a negative and significant relationship between the two dependent variables, development of financial sector and financial 9 performance, and challenges facing innovation in all banks as the sixth independent variable. 1.8 Content of the study: This study is organized to include six chapters. Chapter one is the introduction. Chapter two provides a review of the banking system in Palestine. The review of the literature is discussed in chapter three. The methodology is presented in chapter four which includes the data & the model specification. Chapter five includes the results and the findings. Finally, chapter six includes a summary & conclusion. 10 Chapter Two Banking System in Palestine 2.1 The Palestinian Economy 2.2 Brief History of Banking System in Palestine 2.3 Palestinian Monetary Authority 2.4 The Development of Deposits 2.5 The Development of Credit Facilities Depending on the Type of Currency 2.6 The Development of Credit Facilities Depending on the Type of Sector 2.7 The Development of Credit Facilities Depending on the Economic Activity 2.8 Financial Innovation 2.8.1 Innovation Diffusion Theory 2.8.2 Related Definitions 11 Chapter Two Banking System in Palestine 2.1 The Palestinian Economy: The most important production sectors in Palestine are agriculture, industry, tourism, and services. The agricultural sector is small and has many problems such as marketing problems and the is limited in the market. Despite this, the agricultural economy is a promising economy, but there is a need to support the infrastructure of the agriculture sector to play its role. The Palestinian agriculture sector suffered from the occupation and its various measures to obstruct the movement of trade, industry, capital and labor. The losses accumulated during the period 2000-2004 and they amounted to about 6.4 billion dollar, which is equivalent to 140% of annual GDP before the aggression in 28/9/2000 “(Malhees, 2006). As for the industrial sector, it is growing but it is suffering from many problem and its share in GDP dropped from 32% to 17% in 2016. It seems there is a lack of trust between the public and private sector to promote and expand the industrial sector. Otherwise, the industrial sector should lead growth in the economy. 12 The Israeli Occupation authorities seek to keep the Palestinian market a non-productive and consumer market for its products, so as not to compete, both in the local market and in the Israeli market. (Makhoul, 2006) The Palestinian Authority is working continuously to provide financial support and infrastructure for the construction of industrial cities that will employ tens of thousands of workers. However, the occupation is hindering the work on a continuous basis. (Shaath, 2016) One sector that is worth mentioning is the investments in the tourism sector which is feasible and has achieved a material return for those who provide high quality service, and the tourism sector share of 15% in GDP. The Palestinian economy grew rapidly in 2016 with a growth rate averaging 4.1 percent in comparison with 3.4 percent in 2015. This was attributed to an accelerated growth rate in Gaza Strip mainly, and a slower rate in the West Bank. The economy in Gaza witnessed a 7.7 percent growth, its highest in five years, compared to 6.1 percent last year, mainly due to an increase in investments .This growth is a natural result of the return of economic activity and the reconstruction process after the cessation of all activities and the great destruction inflicted upon the Strip by the Israeli war of summer 2014. In the West Bank, the growth rate almost reached 3.0 percent compared to 2.6 percent in 2016, despite the ongoing unrest caused by the exacerbating public anger against Israeli occupation, especially in the first months of the year. However, in general, 13 the situation did not leave a significant impact on the economic performance, as it grew calmer in the last months of the year (Palestinian Central Bureau of Statistics, 2016). Moreover, this year was characterized by a relative calm and normal activity, and witnessed a regular transfer of clearance and salaries of public sector employees. This accelerated growth contributed to an increase in the per capita income of almost 0.5 percent in the West Bank which reached USD 2,278.9 and 4.2 percent in the Gaza Strip which reached USD 1,037.7, which constituted only 45.5 percent of the per capita income in the West Bank. On the one hand, consumer prices in Palestine shrank for the first time by 0.2 percent in comparison with a 1.4 percent inflation rate in 2015 attributed to a decline in global oil and food prices. It goes without saying that inflation levels are rarely similar in the West bank and Gaza Strip as the political and economic factors differ. But in 2016, price trends in the two regions seemed more consistent as the decline in global prices affected both West Bank and Gaza Strip. As a result, inflation in both regions declined and a deflation was recorded. Inflation fell from 1.3 percent to -0.1 percent in the West Bank and from 1.8 percent to -0.8 percent in Gaza Strip. On the other hand, high unemployment rates continued to represent one of the main challenges to the Palestinian economy, especially in Gaza Strip. Despite an accelerated growth rate in 2016, unemployment rates in Palestine have increased, albeit slightly, reaching 26.9 percent of the total labor force compared to 25.9 percent in 2015. The unemployment rate rose from 17.3 percent in 2015 to 18.2 percent in 2016 in the West Bank and from 41.1 percent in 2015 to 14 41.7 percent in 2016 in Gaza Strip. Moreover, in 2016 the average daily nominal wage of the Palestinian worker rose by 5.2 percent compared to 2015, reaching NIS 109.3. Improving nominal wages was accompanied by a fall in prices in 2016, which led to an increase in real wages in Palestine by 5.4 percent. This increase in real wages was clearly different in each of the three areas: improving by 4.3 percent in the West Bank, they only slightly improved by 0.2 percent in Gaza Strip, and by 9.7 percent for Palestinian workers in Israel and the settlements. The year 2016 witnessed a relative improvement in public revenue collection and a decline in grants and foreign aid. But overall revenues and grants increased by 15.2 percent compared to 2015, reaching about NIS 16,816.5 million. Furthermore, actual public spending rose by 5.5 percent and reached NIS 14,760.1 million. As a result, these developments led to a significant decrease in the current deficit to about NIS 412.3 million, in comparison with a deficit of NIS 2,075.7 million in 2015. Despite the decrease in the current deficit, government arrears rose by 7.6 percent, reaching a cumulative value of NIS 11,843.1 million at end of 2016. The government’s public debt (denominated in US dollars) fell by 2.1 percent at end of 2016 in comparison with 2015, reaching USD 2,483.8 million, or the equivalent of 18.5 percent of the nominal GDP. On the external sector, the current account recorded a deficit of USD 1,348.0 million in 2016, a 34.8 percent improvement compared to 2015, representing about 10.1 percent of the GDP compared to 16.3 percent in 2015. The main reason behind the decline in the current account deficit was a 57.9 percent increase in current 15 transfers compared to 2015. Moreover, the slight decrease in the balance of trade deficit contributed to the improvement of the current account. The financial and capital account (including reserve assets) recorded a surplus of USD 1,113.9 million in 2016, a decrease iv v of 54.6 percent compared to 2015, representing 8.3 percent of the GDP compared to 19.3 percent in 2015. The reason behind this decline is a 15.5 percent drop in capital transfers compared to 2015. On another front, the Palestinian banking system recorded many achievements in 2016, despite the ongoing difficult situation in Palestine in view of the occupation’s policies and procedures and the restrictions and hurdles it imposed on the Palestinian economy in general, and the banking system in particular. The PMA continued to develop regulatory systems and issue a number of regulations to banking institutions. It further consolidated its Arab, regional and international relations to gain a stronger foothold on the international banking scene in light of its remarkable achievements in terms of its credit information systems, financial inclusion, research activities, and relevant economic, banking, and financial reports. In consequence, the Palestinian banking system financial indicators rose with increases in banking sector’s liquidity, assets, customer deposits, and credit facilities. Whose quality also improved as indicated by a decline in the default rate. On net, the system’s capacity to meet expected and unexpected risks strengthened. In the same context, available financial statements of 2016 indicate a rapid growth in the total assets (liabilities) of the banking system to 12.7 percent (to USD 14,196.4 million), compared to 6.6 percent in 2015. This rise reflected the 16 increase in the main components of both assets and liabilities of the banks’ consolidated balance sheet (Palestinian Monetary Authority, 2016). Also, the portfolio of direct credit facilities increased by almost 18.0 percent, to USD 6,871.9 million. This is a sign that the role of financial intermediation between surplus and deficit units strengthened further and more financing opportunities were provided, which contributed to increased economic development. Customer deposits reached USD 10,604.7 million, an increase of 9.8 percent, and the banking sector’s equities rose by 14.9 percent, to USD 1,682.4 million. On the other hand, the PMA continued to develop its systems and regulations and increase its capital to enhance its capability to overcome the challenges it encounters in the exercise of its functions, powers and responsibilities. By the end of 2016, the PMA’s equities increased by 5.8 percent, reaching USD 109.6 million as a result of an 8.2 percent increase in paid-up capital, reflecting the transfer of profits it’s generated to its capital(Palestinian Monetary Authority,2016). 2.2 Brief History of Banking System in Palestine: Before 1948, the banking system in Palestine was characterized by the existence of the British Mandate on the Palestinian land in which many local, Arabic, and foreign banks were working. The most important features of that period are the existence of the Palestinian currency which was issued by the Palestinian government in the British Mandate era, and the presence of the Palestinian Monetary Council which was supervising 17 the operations of the banks not only in Palestine but also in Transjordan. (Ashour, 1995). After 1948, the West Bank was combined administratively to Jordan while Gaza was administratively put under the Egyptian Arabic Republic. As a result, the Jordanian currency and rules and regulations prevailed in in the West Bank and the Egyptian currency and rules and regulation were prevailed in Gaza. The banks in the West Bank were in fact branches of Jordanian banks, which gave the Jordanian banks a lot of benefits and controlling power. The number of the working banks in the West Bank reached to 8 and had 32 branches: The Arab bank, Cairo Amman Bank, Arab land bank, Ottoman Bank, Jordan Ahli Bank, the bank of Jordan, Intra (Almashriq) and HSBC. While in Gaza, there were branches for the banks outside except for the Bank of Palestine. The number of banks total 5 in that period and had 7 branches: the Arab bank, the bank of Palestine, Bank of Alexandria, CAC Bank, and Bank of Nation. (Ashour, 1995) Between the 1967 and 1993 and on the seventh of June 1967, the Israeli authorities required all the working banks in the West Bank and Gaza to be closed. On 8th of June 1967, the Israeli authorities allowed the Israeli banks to start banking business in the West Bank and Gaza through 6 banks that had 39 branches and gave each one the characteristic of monopoly. 18 2.3 Palestinian Monetary Authority: One of the most important developments in the history of the Palestinian banks in Palestine is founding the Palestinian Monetary Authority (PMA, 1996) with the following goals: 1. Maintaining and managing the Palestinian National Authority’s foreign currency and gold. 2. Stating the Monetary Policies in the context of macroeconomics. 3. Organizing the amount and cost of credit according to the requirements of the Palestinian economy. 4. Preserving an efficient developed banking system. 5. Giving licenses to the new banks and approvals for the existing banks to open new branches. The above goals do not include issuing currency or coins and hence the Palestine Monetary Authority does not have control over the money supply. It also does not have control over any of the monetary policy tools that are concerned with the markets. As a result, the Israeli Shekel become the most deliberated currency beside the Jordanian Dinar which prevents the Monetary Authority from controlling the market and makeit difficult for the Monetary Authority to face many economic problems to deal with such as inflation among other problems. 19 2.4 The Development of Deposits: The development of total deposits between 1996-2015 is shown in figure (1). It is clear that deposit has been on the rise since then. The greatest increase happened between 2007 and 2015 because the economic and security situation became more stable during that period. During the time of the Prime Minister Dr. Salam Fayyad, many efforts were made to increase the external support to the infra structure projects and other projects damaged by the Israeli Occupation more exerted. Figure (1): The Development of Banks Deposits Between 1996 – 2015. Source Of Data: Palestine Monetary Authority. Diagram from Researcher Work. 2.5 The Development of Credit Facilities Depending on the Type of Currency: The development of credit for the three currencies ILS,USD and JD between 1996 and 2015 is shown in figure (2). It is clear that credit 0.0 1000.0 2000.0 3000.0 4000.0 5000.0 6000.0 7000.0 8000.0 9000.0 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 Year Deposit 20 denominated in dollar was the largest because the dollar was a strong and fairly stable currency. The absence of a local currency has forced most large companies to borrow from commercial banks in dollars. Figure (2): The Development of Credit Facilities Depending on the Type of Currency Between 1996 - 2015. Source Of Data: Palestine Monetary Authority. Diagram from Researcher Work 2.6 The Development of Credit Facilities Depending on the Type of Sector: The development of credit facilities for both the public sector and private sector between 1996-2015 is shown in figure (3). It is clear that the credit facilities for the private sector were the largest. This is an indication of expansion activities in the private sector during that period. 0.0 500.0 1000.0 1500.0 2000.0 2500.0 3000.0 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 20 16 Loans in JOD Loans in NIS Loans in USD 21 Figure (3): The Development of Credit Facilities Depending on the Type of Sector Between 2008 – 2015. Source of Data: Palestine Monetary Authority. Diagram from Researcher Work 2.7 The Development of Credit Facilities Depending on the Economic Activity: The development of credit facilities depending on the nine economic activities is shown in figure (4). These activities are: loans for real estate, loans for land development, loans for industry, loans for agriculture, loans for tourism, loans for services, loans for consumption, loans for cars, loans for visa credit. It is clear that the largest credit facilities were for the service sector up to 2010. However, after 2010, loans for real estate took the lead over loans to the services sector. This is an indication of the economic expansion in the real estate in private sector more than any other sector. 0.0 1000.0 2000.0 3000.0 4000.0 5000.0 6000.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 Loans for Public Sector Loans for Private Sector 22 Figure (4): The Development of Credit Facilities Depending on the Economic Activity Between 2008-2015. Source of Data: Palestine Monetary Authority 2.8 Financial Innovation: Its concept is generally the process of finding and disseminating new financial instruments, institutions and markets. And (Tufano, 2011) believes that financial innovation is the process of creating and disseminating financial instruments as well as technologies and institutions, processes and new economic models, including new applications of ideas already exist, but in a new context Financial innovation is the way in which the financial product is developed, the product is commercially available, and the product is marketed. The group of processes used by man with the available mental and intellectual capabilities and the surrounding environmental influences in 0.0 200.0 400.0 600.0 800.0 1000.0 1200.0 1400.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 Loans for Real Estate Loans for Lands Development Loans for Industry Loans for Agriculture Loans for Tourism Loans for Services 23 reaching an idea or method or theory so as to benefit the community or organization in which it works. 2.8.1 The importance of financial innovation: Many financial scientists consider that financial innovation is the engine of economic growth (Mertom, 1992). This view is very logical. Financial innovations are as close as they are to the concept of general purpose technologies General Purpose Technologies is a term used to refer to those innovations that result in a wide range of financial innovations, such as the most common of electricity or the Internet, each of which has led to the emergence of countless other innovations. 2.8.2 Financial Innovation Function: The basic function that most financial scientists believe that financial innovations must investigate is to work on the perfection of the market. Financial innovations, for example, help to provide secure online payment mechanisms and find new ways to price risks Financial innovations reduce market friction, such as the high costs of certain transactions. There is also a very important function of introducing new ways for individuals to benefit from the advantage of 24 cooperation and complementary needs such as the desire to lend and manage risk. 2.8.3 Innovation Diffusion Theory: According to Rogers (1983, 1995), there are five categories that influence the spread of innovations. These five categories are: 1- Relative Advantage: New innovations should introduce benefits to all people. 2- Compatibility: The consistency of innovation with norms, habits and social systems are from the compatibility of innovations. 3- Complexity influences the spread of any new technology. Technology should be easy to use as much as possible. 4- Trial ability: People always need to try new innovations before make their decisions. 5- Absorbability: The output and results from innovations should be clear, obvious, and can be noticed from all people without ambiguity. All these categories should complement each other to achieve high diffusion for new innovations. 25 2.9 Related Definitions: E-Banking Services Types: 1- PC Banking. 2- Internet Banking. 3- Telephone Banking. 4- Mobile Banking Smart Cards: Smart cards are plastic cards contains microchips which enable data to be saved on them, Smart cards are used for several activates such as purchase through the Internet, purchase products and services from markets, withdraw or deposits cash money, etc. There are several types of smart cards like visa, visa electron, master card, union cards, etc. (IT bankers,2011). Mobile Banking: Mobile banking is considered to be the latest E-banking services technology by which customers access their accounts and perform their financial transactions using Mobile Devices. Customers can communicate with banks servers through Short message service (SMS), Internet connections (WAP), or high speed 3d generation mobile connection which is also Internet based (Bank Negra Malaysia, 2011) 26 Governance: Establishment of policies, and continuous monitoring of their proper implementation, by the members of the governing body of an organization. It includes the mechanisms required to balance the powers of the members (with the associated accountability), and their primary duty of enhancing the prosperity and viability of the organization. 27 Chapter Three Literature Review 3.1 Introduction 3.2 Previous Study 3.3 Commitments on Previous Studies 28 Chapter Three Literature Review 3.1 Introduction This chapter summarizes related articles on the subject of financial innovation. It also highlights some of the most important factor or determinants of financial innovation. 3.2 Previous Study There are many studies done in the past and they dealt with the impact of innovation on banks performance . For example, a study by Al-Tamimi(2006) investigated the impact of marketing innovation on the quality of banking services. Important factors such as individual, procedural and technological levels of marketing innovation were considered when examining the quality of banking service. Different dimensions such as sympathy, responsiveness, reliability, tangible aspects were found in the case of Jordanian Banks. The study concluded that there is a moral effect of marketing innovation on the banking service quality in the Jordanian banks as seen by clients. 29 It is also found that there is a moral effect of marketing innovation , on individuals and procedures levels, on the tangible aspects,reliability, responsiveness and safety. The study recommended the need for proper selection for individuals who assume the responsibility of banking services. In addition, it recommended the bank management to keep up with technology and modern banking systems to affect the banking services quality dimensions. Adolfo Rodríguez (2007) assessed the contribution of financial innovations to the production of implicit services of financial intermediation in Costa Rica, The results of the study showed that the banks considered rely heavily on traditional products for the provision of their intermediation services. This reflected the conservative character of State-owned banks in Costa Rica, and might indicate the weight of innovation output across the whole financial system. However, given that in the Costa Rican private financial intermediaries traditionally have been more innovative, it would be only natural to extend the scope of the study to include data on product innovations from a more heterogeneous group of intermediaries. The success of such endeavour, as in this study, depends critically on the disposition of the intermediaries to provide information. Although it is still low, the importance of innovations on total intermediation output grew steadily during the period considered. Several intermediaries have reported that new products were planned to be introduced during 2008, like loans specific for payment of tuition costs and 30 several deposits with specific purpose. Hence, it is likely that such upward trend continues because the drive for innovation in the Costa Rican financial system persists. A study by Philipp Hartmann, Florian Heider, Elias Papaioannou and Marco Lo Duca(2007), The extended period of limited growth experienced until recently in many European countries raised the issue as to which policies could be most effective in improving their economic performance. This paper argued that further financial sector reforms may be a valuable complement to ongoing efforts to reform labor and product markets. There is a long-standing view in the economic literature that well-functioning financial systems allow economies to exploit the benefits of innovation in terms of productivity and growth. Moreover, measured productivity differentials between Europe and the United States seem to originate particularly in the financial sector and from sectors that are particularly dependent on external financing. Building on and summarizing the existing literature, this paper first introduced a number of concepts that are important for financial sector analyses and policies. Second, it presented a selection of indicators describing the efficiency and development of the European financial system from the perspective of a variety of dimensions. Third, an attempt was made to estimate the extent to which greater financial efficiency might improve the allocation of productive capital in Europe. While in the recent past the research and policy debate in Europe has focused on fostering financial integration, the present paper puts the 31 main emphasis on financial development or modernization in the context of the finance and growth literature. The results suggested that there are a number of ways in which the financial market framework conditions in Europe can be improved to increase the contribution of the financial system to innovation, productivity and growth. The most robust conclusions can be drawn for certain aspects of corporate governance, the efficiency of legal systems in resolving conflicts in financial transactions and some structural features of European bank sectors. For example, econometric estimations indicate that improving these conditions is likely to increase the size of capital markets – a summary measure of overall financial development – and thereby enhance the speed with which the financial system helps to reallocate capital from declining sectors to sectors with good growth potentials. The study by F. Arnaboldi, B. Rossignoli (2008), examined the determinants of financial innovation in 81 listed commercial banks in Europe and in the United States from 2005 to 2008. The researcher used annual reports to identify six broad innovation categories, from the launch of a new product, to the implementation of a new organizational structure. The study investigated the impact of bank- and country-specific features on innovation. When banks hold higher market share in less concentrated and more efficient banking systems, innovation is stronger. In addition, banks with less volatile returns and a lower quality of loan portfolio exhibit a significantly higher level of innovation. The impact of the market share on 32 innovation is higher for banks incorporated in the US, while lower quality of loan portfolio increases the incentive for European banks to innovate. When the financial crisis hits less risky banks take the lead on innovation. A study byShelagh Heffernan (2008), Financial Innovation in the UK. This study employs a recent national survey of over 1100 British financial firms to ascertain the determinants of financial innovation and their sales success using Logit and generalized Tobit models. The researcher found the likelihood of financial innovation rises with the size of financial firms, employee education, greater expenditure on research and development, the availability of finance, and the extent to which firms cooperate with each other. R&D and cooperation, and appropriability are the main variables driving the success of financial innovation, measured by the percentage share of innovations sold. Firms in London/the south have a significantly greater tendency to innovate, though Scotland also does well. Stock broking, fund management and related activities are more innovative than firms in the financial intermediation and pension/insurance sectors. A study by Lars Norden, Consuelo Silva Buston and Wolf Wagnery(2009), Financial innovation and bank behavior: Evidence from credit markets. This paper investigated whether, and through which channel, the active use of credit derivatives changes bank behavior in the credit market, and how this channel was affected by the crisis of 2007-2009. Our principal finding is that banks with larger gross positions in credit derivatives charge 33 significantly lower corporate loan spreads, while banks ignet positions are not related to loan pricing. They argue that this is consistent with banks passing on risk management benefits to corporate borrowers but not with alternative channels through which credit derivative use may affect loan pricing. They also found that the magnitude of the risk management remained unchanged during the crisis period of 2007-2009. In addition, banks with larger gross positions in credit derivatives cut their lending by less than other banks during the crisis and have consistently lower loan charge-loans. In sum, this study suggested that significant risk management benefits from financial innovations that persist under adverse conditions that is, when they matter most. A study by Roberto Piazza (2010) pointed out the empirical evidence which suggests that financial innovation increases diversification opportunities and reduces investment costs, but does not reduce the relative cost of information. The constructed an analytically tractable theoretical model that examines how financial innovation affects incentives to collect costly information about the riskiness of production technologies. The researcher found that financial innovation tends to be associated with lower collection of private information and thus, via a spillover effect, with lower quality of public information. This result has important implications for the business cycle, since aggregate productivity becomes more subject to systemic shocks, even when its overall volatility decreases. Recent empirical evidence shows that the US agents have indeed shifted over time 34 from active to passive investment strategies. Higher diversification and lower investment costs improve welfare, even though the lower quality of information has a negative effect on passive investors. In an extended model where risk is time varying risk, financial innovation increases the probability of liquidity crises. In fact, financial innovation lowers information collection during periods in which excess risk is mainly idiosyncratic and thus increases the frequency at which uninformed agents mistakenly invest in excess risk technologies. Liquidity crises arise when the excess risk becomes systemic: information collection rises and triggers a wave 21 of liquidation. If liquidation crises impose aggregate costs to the economy then financial innovation can decrease welfare. The paper showed that financial innovation and endogenous information collection can be intertwined in important ways. More research on this issue is certainly needed. A study by Arnoud W.A. Boot and Matej Marinč (2011), A fundamental feature of more recent financial innovations focused on augmenting marketability. They point out the potential dark side of marketability. Marketability has possibly led to an excessive proliferation of transaction-oriented banking (trading and financial market activities). The 2007-2009 financial crisises appeared to have countered this trend, and possibly reemphasized the importance of relationship banking. In order to focus on these issues in a rigorous way, the study evaluated the conflicts of interest between intermediated relationship banking activities and financial 35 market (underwriting, securitization, etc.) activities. The study pointed at institutional and regulatory changes that might be needed to improve the stability of the financial sector. One could say that the institutional structure (including regulation) has not kept up with the enhanced marketability and "changeability" of the industry. Another study by Obeid (2012) which examined the Role of Electronic Banking Services in Enhancing the Competitive Advantage in Banking Sector in Jenin Governorate. The study found that increasing banks competition and the banks’ recognition of the importance of having good quality services has forced banksto meet theircompetitive goals. The study also identify the role of e- banking services in enhancing the competitive advantage in the banking sector in Jenin Governorate. The researcher used descriptive and analytical approach as a methodology. To achieve this goal, the study used a sample which consisted of clients of all banks working in Jenin (which are 10 banks). The study sample consisted of 100 clients from all these banks. The researcher used a questionnaire after verifying it. The study found that the arithmetic mean for the banking electronic services as a variable was 3.27. The study also found that there are no statistical differences between the banking electronic services among all banks. This means that the qualities of the banking electronic services were the same among all banks. 36 Abdul Wahab (2012) studied the role of innovation in support of competitive advantage for economic foundation in Algeria. The researcher used descriptive and quantitative analysis as his methodology distributed 130 questionnaires on the staff of a company called Mobinil and after collecting the data, SPSS was used to examine the importance of management innovation. The study found a strong positive relationship between the administrative innovation and competitive advantage at R = 0.526. The study found that there is a direct positive correlation between technical innovation and competitive advantage, and at the same time found a direct weak correlation between additional innovation and competitive advantage. Another study by Thorsten Beck, Tao Chen, Chen Lin and Frank M. Song(2012), pointed out that the financial turmoil from 2007 onwards, spurred renewed debates on the “bright” and “dark” sides of financial innovation. Using bank, industry and country level data for 32, mostly high-income, countries between 1996 and 2006. This study was the first to explicitly assess the relationship between financial innovation in the banking sector and (i) real sector growth, (ii) real sector volatility, and (iii) bank fragility. The researcher found mixed results for both bright and dark sides of financial innovation. On the one hand, The study found that a higher level of financial innovation is associated with a stronger relationship between a country’s growth opportunities and capital and GDP 37 per capita growth and with higher growth rates in industries that rely more on external financing and depend more on innovation. On the other hand, it has been found that financial innovation is associated with higher growth volatility among industries more dependent on external financing and on innovation and with higher idiosyncratic bank fragility, higher bank profit volatility and higher bank losses during the recent crisis. A study done by W. Scott Frame Lawrence J. White (2013), and delt with Technological Change, Financial Innovation, and Diffusion in Banking. The paper found that the commercial banking business has changed dramatically over the past 30 years, due in large part to technological change. The paper first describes the role of the financial system in economies and how technological changed and financial innovation can affect social welfare. The paper also surveyed the literature relating to several specific financial innovations – broadly categorized as new products or services, new production processes, or new organizational forms – and evaluate them in the context of the broader economics literature on innovation. While much effort has been devoted to understanding the characteristics of users and adopters of financial innovations and the attendant welfare implications, still little known about how and why financial innovations are initially developed. Another Study by Al-Taher and Faris(2014) examined the Role of Marketing Innovation in Obtaining a Competitive Advantage for Islamic BanksProducts. 38 The study reported marketing innovation is the foundation for development in any institution, as it directs the institution into the future. This means that it helps earn more customers by marketing mix, especially in product. The product crucially reflects the capabilities of the institution in competing others and achieving the competitive advantage. This study aimed at highlighting the role of marketing innovation in solving different problems for institutions, particularly the banking institutions which are suffering from a financial crisis they has never witnessed before. The innovation of new financial products in Islamic Banks is considered a serious start to resolve the global financial crisis and to achieve compatibility with Sharia’a’s. Fernandez (2014) investigated the relationship between finance and growth by analyzing the relationships between financial intermediation and economic growth within the regions of one country, rather than different countries. The analysis was undertaken for the Spanish regions. The focus on regions is relevant since regional information is more homogenous, the legal and institutional factors are similar, and the relevant financial market is more accurately defined. This study also incorporates the effect of a set of banking innovations. The results showed that product and service delivery innovations contribute positively to regional GDP, investment and gross saving growth. William R. Kerr (2014), We reviewed the recent literature on the financing of innovation, inclusive of large companies and new start-ups. 39 This research strand has been very active over the past five years, generating important new findings, questioning some long-held beliefs, and creating its own puzzles. The review outlines the growing body of work that documents a role for debt financing related to innovation. The researcher highlights the new literature on learning and experimentation across multi-stage innovation projects and how this impacts optimal financing design. He further highlighted the strong interaction between financing choices for innovation and changing external conditions, especially reduced experimentation costs. A study by Mark Yeandle (2017), Trends and Innovations in Financial Services, Innovations in financial services are one of the key areas occupying senior executives in financial services firms worldwide. Things are changing and existing business processes are being disrupted at such a pace that it is often difficult to make sense of the developments in the industry. In order to see through some of the confusion, this report provides an overview of the perceptions of international finance professionals and their views regarding recent trends and innovations in financial services and by FinTech. The report was commissioned by the Toronto Financial Services Alliance (TFSA) and produced by the Z/Yen Group Limited. The research was conducted via two online questionnaires as well as desk research and informal interviews with experts in the industry. The studied ten current trends in financial services including Brexit, increased concern over data protection, increased regulatory 40 pressures, increased transparency in asset and wealth management, increased volatility in oil & gas finance and the global slowdown in economic growth. The research examined a number of specific areas of FinTech including cyber-security, mutual distributed ledgers (MDLs, aka blockchains) and new payment and transaction systems. The researcher also assessed how different financial centers may fare with the innovations taking place. The centers selected in the study to gave a good coverage of the different geographical regions. 3.3 Comments on previous studies: It is important to note that there are no previous studies in the Palestinian banking sector on the impact of innovation in financial services on the development of the financial sector, which constitutes a scientific addition The Tamimi study in 2006 revealed to the Jordanian banks that marketing innovation in its various dimensions positively affects the quality of service provided to customers. This is in line with our study, as the marketing innovation affects the quality of the service provided thus affects the development of the financial sector. Therefore, the effect of marketing innovation on the development of the financial sector is not a direct effect. That is, there is no direct impact in marketing innovation on financial performance. 41 According to the study by Obaid in 2012 in the province of Jenin, there are no significant statistical differences between electronic banking services among all banks, which is not consistent with our study as he found that electronic banking services contribute to the development of the financial sector significantly, which contributes to the competitiveness between banks in Palestine The Fernandes study of 2014 showed that innovation in the provision of services and products contributes significantly to the growth and development of GDP. This is in line with our study that innovation in banking services contributes to the development of the financial sector in Palestine. All previous studies studied marketing innovation and financial innovation but did not include all elements of innovation in the financial institution from innovation at the level of (services, marketing, operations, procedures, risk management, innovation challenges) but this was found in this study. 42 Chapter Four Data and Methodology 4.1 Data and Variables 4.2 Definition of the Dependent and Independent Variables 4.3 Model Specification 4.4 Hypotheses 4.5 Summary Statistics 43 Chapter Four Data and Methodology This study will utilize both descriptive statistics as well as regression analysis to study the impact of banking financial services innovation on the development of the financial sector in Palestine.The use of the descriptive statistics is very useful because this tool provides simple summaries about the sample of the study and its various variables measures. In addition, the use of regression analysis, which is a statistical methodology, helps estimate the strength and the direction of the relationship between the variables. 4.1 Data and Variables The descriptive statistics will provide insight regarding the collected data. The major types of descriptive statistics are measures of central tendency, , measures and variability, and measures of relationships or correlation among the variables. In addition, regression analysis will be used to investigate the impact of one variables upon another. In this way the impact of the independent variable on the dependent variable will be estimated and measure their influence on the dependent variable. The data collected through a survey which include a total of eighty nine (89) questions which will be distributed to bankers to help us understand the financial development in Palestine . The survey questions 44 will be allocated among the employees and it will have the following categories or factors: A- General information about financial institutions in Palestine which includes fourteen (14) banks. B- Determining the quality of innovation in all banks in Palestine. C- Innovative performance standards and a culture of innovation in all fourteen (14) banks. D- Cooperative efforts to introduce innovative activities in banks operation. E- Challenges facing innovation in all banks in Palestine. The above factors will help us develop our model, variables and hypothesis. The size of the sample has been decided to be 70 questionnaire. This has been determined based on the number of banks which are 14bank in Palestine. This mean that each bank will have five (5) employees responding to the survey, This mean the sample size is seventy (70). Five main departments were selected in each bank, which had a significant impact on the development of the financial performance of the bank. The questionnaire was distributed to each department manager. 45 The survey instrument collected from the people or the respondents shows many indicators that can measure innovation. The first indicator in this study that is some of the banks introduced new innovative services in the Palestinian market before their competitors. This indicates that there is diversity in the banking services in all operating banks. The second indicator shows that different methods in the renovations services introduced in the last two year were higher than previous services provided in previous years. The third indicator reflect the fact that banking institutions in Palestine have strengthened their modern management methods in line with the development of the global banking system. The fourth indicator shows that the ratio of new services to total services was high. This indicates that banking sector commitment to modernize its banking operation. The fifth indicator shows that their strategic plan support the innovation elements of the organization. The sixth indicator shows that laws and regulations within banking institutions were supportive of the process of innovation and creativity. The seventh indicator show the banking institutions utilized a customer participation in suggesting and in discussing the latest innovations employed at the bank and to get their feedback. The eight indicators show that most financial institutions have provided incentives to employees to foster an innovative spirit in the working place. The Ninth indicator shows that the number of property rights in innovation activities has officially registered and has increased in quantity. The tenth indicator show the renewal of administrative procedures occurs in all bank departments to create positive changes and simplifying 46 working procedure. The Eleventh indicator show that new adoptions of innovations have reduced operation costs in the financial institutions. This cost saving is more effective than their traditional cost-cutting programs such as employee layoffs or reduced salaries. 4.2 Definition of the Dependant and Independent Variables : We have two dependent variables labeled as Y1&Y2 defined as follows: (A) Dependent Variables: We have two dependent variables and these are: First Dependent Variable is (Y1): This measures the criteria of financial sector development. It includes financial market size, number of branches, credit for investment, increase in bank assets, customer deposits, number of accounts, services quality, bank service and meeting banking standard in services. Second Dependent Variable is (Y2): This measures the criteria of financial performance which covers the following: bank income, share of innovation expenditure in the bank budget, return on assets, liquidity, return on equity, and increase in bank stock prices. 47 (B) Independent Variables: The independent variables in this study are six and they are conducted from the survey instrument. First Independent Variable is (X1): This measures the criterion of innovation in services on the level of production which covers the following: Various banking packages tailored to the needs of individuals and companies with credit, investment and service facilities. Retail products include credit cards, Visa Electron, personal loans, auto loans and all types of deposits such as current accounts, savings accounts, time deposit accounts and notice accounts. Second Independent Variable is (X2): This measure the criterion of innovation in services on the level of marketing which covers the following: A systematic, continuous and integrated planning to examine the changing financial needs of banking institutions to meet the needs of beneficiaries through effective programs. Third Independent Variable is (X3): This measures criteria of Innovation in services on the level of process which covers the following: This variable reflects the financial activities that contributed to the delivery of new services to the customers. Among there are the use of new 48 technology, increase the customer base, provide free services to customer, introduction of ATM machines at several location and providing insurance services. Fourth Independent Variable is (X4): Innovation in administrative procedures: This variable reflects the financial activities that contributed to the renewal administrative procedures, simplifies procedures transaction: develop an organizational unit, modifying the organizational structure, continuous monitoring and follow up by management. Fifth Independent Variable is (X5): Innovation in Risk Management: This variable reflects the financial activities that contributed to developing new ways to measure potential customers, new system of collateral, develop risk management system, develop internal rating system, and establish a special unit specialized in information security. Sixth Independent Variable is (X6): Innovation challenges: This measures the criteria of innovation challenges which cover the following: lack of allocation of financial resources, lack of competencies, 49 lack of information, lack of laws, weak customer culture, lack of a technological base for state. 4.3 Model Specification: Based on the above instrument, two models are specified and will be estimated: Yi1 = f( X1, X2, X3, X4, X5, X6,ei) ………………………..(1) Yi2 = f( X1, X2, X3, X4, X5, X6,ei) ………………………..(2) The above two functions represent the relationship between the two dependent variables and the six (6) independent variables . In linear form, the above two functions can be expressed as : Yi1 = A0 + A1X1 + A2X2 + A3X3 + A4X4 + A5X5 + A6X6 + ei…..(3) Yi2= B0 + B1X1 + B2X2 + B3X3 + B4X4 + B5X5 + B6X6 + ei…….(4) The coefficients of A1,A2 to A6measure the marginal impact of the six independent variables on the financial sector development ( Y1) . It is expected to have a positive and significant relationship between the dependent variables (Y1) and each of the independent variables (Xi) except independent variable six(6) which is assumed to have a negative relationship with the dependent variable Y1. The coefficient of B1,B2 to B6 measures the marginal impact of each of the six independent variables on the financial performance ( Y2)which 50 represent financial performance . It is expected to have a positive and significant relationship between the dependent variable (Y2) and each of independent variables (Xi) except independent variable six(6) which is assumed to have a negative relationship with the dependent variable Y2. 4.4 Hypotheses: H1: There is a positive and significant relationship between the two dependent variables, development of financial sector(Y1) and financial performance (Y2), and production innovation (X1) as the first independent variable. H2: There is a positive and significant relationship between the two dependent variables, development of financial sector (Y1) and financial performance (Y2), and marketing innovation (X2) as the second independent variable. H3: There is a positive and significant relationship between the two dependent variables, development of financial sector(Y1) and financial performance(Y2), andprocess innovation(X3) as the third independent variable. H4: There is a positive and significant relationship between the two dependent variables, development of financial sector (Y1) and financial performance (Y2), and innovation in administrative procedures (X4) as the fourth independent variable. 51 H5: There is a positive and significant relationship between the two dependent variables, development of financial sector (Y1) and financial performance (Y2), and innovation in risk management (X5) as the fifth independent variable . H6: There is a negative and significant relationship between the two dependent variables, development of financial sector (Y1) and financial performance (Y2), and challenges facing innovation in all banks (X6) as the sixth independent variable 4.5 Summary of Statistics: The table reports the qualitative results of descriptive statistics that uses applied to the data set. Table (2): Descriptive Analysis of Dependent and Independent Factors Influencing the Financial Innovation in Palestine: S.E Standard Deviation Median Mean .08238 0.689 2.1 2.24 Y1 .08295 0.694 2.5 2.56 Y2 .06359 0.532 2.0 2.04 X1 .06417 0.536 2.0 2.05 X2 .07149 0.598 2.0 2.05 X3 .07572 0.633 2.0 2.09 X4 .07449 0.623 2.0 2.05 X5 .05988 0.500 2.3 2.43 X6 The average mean for Y1 which is the development of the financial sector was 2.24 with a standard deviation of 0.689, whereas the average mean for Y2 which is the financial performance was 2.56 with a standard deviation of 0.694. It is clear that both the mean and standard deviation of Y2 are greater than that of Y1. 52 The table that shows that X2,X3 and X5 has the same mean of 2.05,but with a different standard deviation of 0.536 for X2 and 0.598 for X3 and 0.623 for X5. The lowest mean was obtained for X1 with 2.04 and with standard deviation of 0.532 whereas the highest mean was obtained for X4 with a mean of 2.09 and with standard deviation of 0.633. This means that the quality of the data is high and that the dispersion of values from the arithmetic mean was low. 53 Chapter Five Results & Finding 5.1 Estimated Results for Model 1 5.2 Estimated Results for Model 2 5.3 Results Regarding Challenges Facing Banking Development in Palestine 54 Chapter Five Results & Finding 5.1 Estimation Result for Model 1: The two model specified in equation (3) and (4) were estimated using regression analysis. The result for model (3) is presented in table (3) whereas the result for model (4) is presented in table (5). Table (3): Regression Analysis for the Relationship Between Innovation Variables (X1-X6) and Development of Bank Sector Y1Variable Independent Variables Estimated Coefficient Standard Error T Value Significance Level Intercept .06 .399 .156 .877 X1: Production Innovation .349 .190 1.843 .070*** X2: Marketing Innovation -.247 .216 -1.144 .257 X3: Process Innovation .441 .196 2.254 .028** X4: Innovation in administrative Procedures .387 .201 1.919 .060*** X5: Innovation in Risk Management -.103 .157 -.654 .516 X6: Challenging Facing Innovation .195 .131 1.491 .141 R square =.709 F-statistics=10.6 Sig =.000 (*) Significant at the 1% level (**) Significant at the 5% level Table (3) Provides the finding for model (1) by presenting estimated coefficient of each independent variable as well as the standard error, the t- value, and the level of significance. The dependent variable is Y1 which is the development of bank sector. 55 It is clear from the result that X1 (production innovation) and X4 (innovation in administrative procedure) are both significant at the 10% level and the two coefficients have the expected positive sign. Whereas the variable X3 (process innovation), as shown in the table, is significant at the 5% level and also has the expected positive sign. In general, for X1 a possible explanation for having a positive sign and being significant is that new product banking which was introduced by most banks as a result of innovation such as increase in lending activities and this has benefited the community as well as the banking sector. Although the coefficient of X2 is not significant, it has the unexpected negative sign. This means banks follow a limited marketing campaign that has no impact to expand their activities. It seems that many of these banks use their well-known name to attract new customers instead of employing an active marketing plan. The coefficient for X3 is significant at the 5% level and has the expected positive sign. This is an indication that adding a new technology to the banks activities will enhance the banking system operation. For example, the Palestinian Monetary Authority has introduced a credit technology system (Query System) in 2009 which has resulted an increased in credit activities. In addition, banks have improved their facilities and eliminated many of the procedures that does not add value to their operations. The coefficient for X4 is positive and significant at the 10% level. This positive relationship reflects the fact that banks have adopted different internal written procedures that enhance its administrative capacity. Regarding the coefficient for X5its has a negative sign and it is not significant. This mean 56 a risk increase will delay the development of the banking sector. Finally, X6 the coefficient is positive but not significant. The positive sign reflected the fact that banks were trying very hard to overcome obstacles they face in their operation. The obtained R2 is about 71% which means the independent variable explained 71% of the total variation in the first dependent variable Y1 (Development of the Banking Sector). The F – test or F computed has a value of 10.6 which is larger than the value of the F table and this shows that the model is well specified and the dependent variables (X1-X6) are important variables in estimating the total variation in dependent variable Y1. To confirm the result an index was formed from the six independent variables to represent what is called in this study an innovation index (Inndx). Another regression equation was estimated using the first dependent variable Y1 (development of banking sector) against this new formed index. The result obtained presented in table 3. The table also shows an R-square of 0.66 percent and the F-value was 52.8 also significant at the 1% level. This mean the result obtained by using innovation index is acceptable and this confirm that the previous model is well defined. Table (4): Regression Result Using Innovation Index against Y1 variable Independent Variable Estimated Coefficient Standard error T-value Significance level Intercept .072 .306 .235 .815 Slope (B2) for innovation index 1.025* .141 7.267 .000* R-square = .43 F test = 52.8 (*) Significant at the 1% level. 57 The estimated equation using the innovation index is: Y1=0.072 + 1.025 Xi(=Indx) Where Y1: Development Banking Sector Indx : Innovation Index This means a one percent increase in innovation index will lead to a 1.025 percent increase in the development of the banking sector. The obtained R square is about 66%, which means the independent variable explained 66% of the total variation in the first dependent variable Y1 ( Development of the Banking Sector ). The F – test or F computed has a value of 52.8 which is larger than the value of the F table and this shows that the model is well specified and the dependent variables (Indx) are important variables in estimating the total variation in dependent variable Y1. Recommendations on the results of the impact of innovation on the development of the financial sector: * Based on the first finding that there is a positive impact of innovation in the development of financial services (credit facilities) on the development of the financial sector. 58 Therefore, the innovation in banking services (credit facilities) increased the number of customers and accounts, which increased the size of the deposit and increased the bank's investment in credit facilities and reflected positively on the banking assets, which led to the expansion of the bank's business and increase its market share and the number of branches. Therefore, the recommendations for this result: 1. Continuing to conduct studies on selected samples of customers and existing customers to determine their needs, trends and classification, because the cost of retaining an existing customer is less than the cost of attracting new customers. 2. Continuation of studies on selected samples of clients who are supposed or not dealing with the bank to know their needs in order to attract them to the bank. 3. Diversify the services and credit facilities that are suitable for all segments and categories in proportion to the financial ability of the customers (i.e. applying the financial coverage in the bank, which contributes to diversification of the investment portfolio). 4. Grant special privileges for each offer by category or segment. * Based on the finding that there is no impact of innovation in marketing on the development of the financial sector. 59 1. The high competition between the banks make all the banks are conducting intensive marketing campaigns so the customer's choice of the banking product based on the quality of the product and conditions and not based on marketing. 2. Marketing is a link between the services development department and the final customer. Therefore, the decision of the final customer to choose the bank or the banking product is based on the terms, quality, judgments, credibility and privileges granted to the customer. 3. The impact of innovation in marketing is on the quality of banking service and then reflected on the development of the financial sector and increases its share so we conclude that there is no direct impact of marketing innovation on the development of the financial sector. Therefore, the recommendations for these results: 1. Continue to innovate in marketing methods and the most important electronic based on the target group of the banking product. 2. The marketing medium to present the guidelines of the banking product must be effective and short to attract its attention. 3. Change the promotion when the product defaults. 4. Promise the bank name in the promotion continuously. 60 * With regard to the third conclusion about the strong positive impact of innovation in operations on the development of the financial sector. Where many banks have switched the system of banking operations and is responsible for the implementation of facilities and the conduct of remittances and checks work from decentralization in the branches to the central in the general administration instead of dispersing banking operations and their overlap in the branches. The process have been converted into a unified system which facilitates and expedite the work of facilities and checks and remittances. This has impacted positively the volume of banking transactions and has increased the development of the financial sector and increase its business. Recommendations for these results: 1. Great efforts must be made to increase electronic banking services, such as applying for a loan or electronic money transfers, and minimizing paper transactions, thus increasing the speed of transactions. 2. Investment in technology and information technology in order to increase banking operations such as ATMs, which accept the implementation of all banking operations. 3. The electronic checks and clearing system must be developed. 61 4. The client's visit to the branches should be reduced to the use of electronic services instead. * With regard to the fourth result, which says there is a positive effect between innovation in the procedures and the development of financial sector. There are techniques and methodologies in the design of work procedures such as: 1. Use of certain technology. 2. Improve the use of certain technology. 3. Rebuilding operations in accordance with quality principles 4. Operations management. 5. Disposal of waste in the institution as the disposal of the procedure is not required and do not need it and adds no value These different techniques contribute to the simplification and acceleration of the work procedures, which is positively reflected on the development of the financial sector. Recommendations for these results: 1. Eliminate complex procedures that do not add any value to banking. 62 2. The use of new technology that contributes to raising the efficiency of work. 3. Simplifying the procedures and updating them periodically in line with the technological development. * Regarding the fifth result, which says that there is no relationship between innovation in risk management and the development of the financial sector. The risk department objective is to issue recommendations to the General Administration and the Services Department to increase or reduce the volume of lending from a market share of a particular product. This does not have a direct impact on the development of the Bank's business and its impact is indirect by issuing recommendations Recommendation for these results: 1. Issuing recommendations should not relate to the bank's growth in a high-risk investment portfolio, but its objective should be to reduce risks in order to provide us with high quality credit facilities. 2. The market should be studied and its risks examined internally and externally before making recommendations which reduces the rate of stumbling. 3. Coordination between the relevant departments of the Bank before making recommendations. 63 * Regarding the sixth result, which says that there is no relationship between the challenges of innovation and the development of the financial sector. This means that the Palestinian financial sector is financially robust and large and able to overcome challenges and crises. There are no recommendations for these results. 5.2:Estamated Result for Model 2: Table (5): Regression Analysis for the Relationship Between Innovation Variables (X1-X6) and Financial Performance of Bank Sector Y2Variable : Independent Variables Estimated Coefficient Standard Error T Value Significance Level Intercept -.180 .396 -.454 .652 X1: Production Innovation .177 .188 .938 .352 X2: Marketing Innovation -.057 .215 -.265 .792 X3: Process Innovation .417 .194 2.142 .036** X4: Innovation in administrative Procedures .494 .200 2.465 .016* X5: Innovation in Risk Management -.415 .156 -.659 .010** X6: Challenging Facing Innovation .598 .130 4.605 .000* R square .718 F statistics 11.186 Sig .000 (*) Significant at the 1% level (**) Significant at the 5% level Table (5) Provides the finding for model (2) by presenting estimated coefficient of each independent variable as well as the standard error , the t – value , and the level of significant. 64 It is clear from table 4 that the coefficient for the independent variable X3 and X4 are significant at 5% level and has the expected positive sign. Whereas X4 & X6 coefficients all, are significant at the 1% level. It is also observed that X6 coefficient has the expected positive sign, whereas X5 has a coefficient with a negative sign. This means a risk increase then financial performance will decrease. The remaining coefficients for X1 & X2 are not significant. In general, for X1 a possible explanation for having a positive sign and being not significant is that new product banking was introduced by most banks as a result of innovation such as increase in lending activities and this has benefited the community as well as the banking sector do not reflect on profitability on the short term but on the long term. Although the coefficient of X2 is not significant, it has the unexpected negative sign. This means banks have problems with their limited marketing campaigns as they have no impact on their activities. It seems many of these banks use their well-known name to attract new customer instead of an active marketing plan. The coefficient for X3 is significant at the 5% level and has the expected positive sign. This indicates that adding new technologies to the banks activities will enhance the banking system operation. For example, the Palestinian Monetary Authority has introduced credit technology system (Query System) in 2009 which has resulted in an increase in credit. 65 In addition, banks have improved their facilities and eliminated many of the procedures that do not add value to their name. The coefficient for X4 is positive and significant at the 10% level. This positive relationship reflects the fact that banks have adopted different written procedures that enhance their administrative capacity. Regarding the coefficient for X5 it has a negative sign and it is significant. This mean banks are in the process of building, developing and strengthening risk management, resulting in additional cost to the Bank, building risk management systems and changing organizational structures, which negatively affects profitability on the short term. Finally, coefficient X6 is positive and significant. The positive sign reflected the fact banks more products, services and customers, the greater the challenges will be, especially in the large banks, where challenges arise that did not exist therefore increasing services means increasing profits and increasing challenges. The obtained R2 is about 71%, which means the selected independent variables explain 71% of the total variations in the second dependent variable Y2 (Financial Performance of the Banking Sector). The F – test has a value of 11.1,which shows that the model is well specified and the independent variables (X1-X6) are important variables in estimating the total variation in the dependent variable Y2. 66 To confirm the result, an index was formed from the six independent variables to represent what is called in this study an innovation index (Inndx). Another regression equation was estimated using the second dependent variable Y2 (Financial Performance) against this new formed index. The result obtained presented in table 5. The table also shows an F- square of 0.57 percent and the F-value was 34.2 also significant at the 1% level. This means the result was very acceptable and the model is well defined. Table (6): Regression Result Using Innovation Index against Y2 variable Independent Variable Estimated Coefficient Standard error T-value Significance level Intercept .642 .335 1.917 .059 Slope(B2)for innovation index .904* .154 5.852 .000* R square= .57 F test= 34 (*) Significant at the 1% level. The estimated equation using the innovation index is: Y2=0.642 + 0.904Xi(=Indx) Where: Y2: Financial Performance of Banking Sector Indx: Innovation Index This means a one percent increase in innovation index will lead to a 0.904 percent increase in the financial performance of the banking sector. 67 The obtained R square is about 57%, which means the independent variable explained 57% of the total variation in the second dependent variable Y2 (Financial Performance of the Banking Sector). The F – test or F computed has a value of 34 which is larger than the value of the F table and this shows that the model is well specified and the dependent variables (Indx) are important variables in estimating the total variation in dependent variable Y2. Recommendations on the impact of innovation in financial services on financial performance: 1) With regard to the first result there is no impact of innovation in banking on profitability. On the economic side, the profit is achieved at the end of the financial cycle ie in the long run so this study was short term for this result came out there is no relationship. Recommendation for these results: There is no specific recommendation for this result. 2) With regard to the second result, there is no relationship between innovation in marketing and profitability. Marketing is a link between the organization and the client, so the final decision of the customer depends on the quality of the product and its terms and conditions and characteristics. 68 3) Regarding the third finding of the strong relationship between innovation in operations and profitability, the faster the transactions the greater the volume of activity and the higher the profit. 4) With respect to the fourth result, which says that there is a strong relationship between innovation in procedures and profitability. Whenever the procedures are simple and not complicated and were updated periodically and eliminate the procedures that do not add value to the banking process whenever reflected positively on profitability and increase banking operations. * Regarding the fifth result, which says that there is a relationship between innovation in risk management and profitability, this relationship was negative. 1. The greater the awareness of the risks of a particular product, the less the process of expansion in lending and therefore less profitability. 2. High-risk risk management systems and employees are not qualified to manage therefore an additional cost to the financial institution. 3. Basel has set the capital adequacy ratio at 8%, but the Monetary Authority has raised this ratio to 12%, thus wasting the investment opportunity on the banks, thus reducing profitability due to high risks. 4. Provision for risk management is deducted from net profit. 69 5. Non-profit regulatory bodies have a negative impact in the short term but have a long-term positive effect. Recommendations for these results: 1. Commitment to risk management and non-expansion of uncertainty, which constitutes long-term credit facilities. 2. Training and qualifying employees in risk management and expanding the work of this important department. 3. Recommendations that come out should reduce future default rates. Therefore, all scenarios that may damage the lending expansion process and allocate financial ratios for hedging should be assumed. 4. Evaluate the investment portfolio periodically * Regarding the sixth result, which says that there is a positive relationship between the challenges facing innovation and profitability. 1. The greater the products and customers the greater the profits and thus increase the challenges at large banks, that is, it increased the functions and burden on the institution. 2. The greater the challenges of innovation, such as the lack of laws that protect innovations, piracy has increased by other institutions, thus increasing their profits with no costs. 70 Recommendations for these results: 1. The legal environment and the legal system should be developed in a manner consistent with electronic banking operations such as the payment system, in order for the banking system to maintain its protection. 2. Laws should be in place to protect piracy and innovation. 3. The system of classification of returned checks must be changed to reduce the number of checks. 4. Increasing cooperation between universities and financial institutions in order to produce studies that benefit the financial sector. 5. Increase awareness among customers about workshops on banking awareness. 6. Increase funding and investment in technology and innovation. 7. Work on developing the technological base of the state. 5.3: Results Regarding Challenges Facing Banking Development in Palestine (Related to questionnaires): 1- Lack of administrative competencies to deal with the issue of innovations. This has led many institutions to introduce programs for the training of staff, which is costly the institution additional financial resources. 71 2- Some financial institutions do not provide sufficient funding for these innovations. 3- There is a blurry of information about the market and the future as there is uncertainty about what will happen. 4- Lack of sufficient information on new staff technology. 5- Non-enforcement of laws that protect innovations in the state.. 6- Lack of a state technology base. 7- Lack of inter-institutional partnerships to collaborate on the creation of new innovations. 8- Regulatory legislation is not commensurate with innovations. 9- Weak customer culture regarding new innovations. 10- Lack of cooperation between universities and the banking sector in the field of research and development. 72 Chapter 6 Summary and Recommendations 6.1 Summary 6.2 Recommendations 73 Chapter 6 Summary and Recommendations 6.1 Summary This research aims at investigating the factors influencing of financial banking innovation on banking development in Palestine. A regression analysis was used to estimate the impact of specific factors related to the development of the financial sector in Palestine. The research utilized both qualitative and quantitative research methodology. Qualitative data were collected via interviews with banks officials. In addition, the quantitative data were gathered from a purposive sample of seventy (N=70) for five departments in all banks via a survey that was developed for this purpose. Results indicate that a positive impact of production innovation on development banking sector and no impact on profitability in short term. The result also indicate that there is no impact of marketing innovation on development banking sector and financial performance for banks in Palestine. In addition, the result indicate that there is a positive and high impact for the process innovation on the development of the banking sector and the financial performance for banks in Palestine. 74 Another result indicates that a positive impact of administrative procedure innovation on development and performance banking sector in Palestine. The final result which indicate that there is no impact to risk management on development banking sector but a negative impact on financial performance for banks in Palestine. 6.2 Recommendations Based on the above mentioned results and findings, the following recommendations would be listed: 1- It is recommended that individual banks conduct a separate study to examine that needs of individual customers and to identify appropriate products for each period to all customers to achieve financial inclusion. 2- It also recommended that banks in Palestine adopt a comprehensive marketing strategy to market their various products based on quality elements, build a bank name and enhance trust with customers, thus attracting more customers. 3- It is recommended that works to reduce customers' visits to branches by increasing awareness of electronic banking services, smart cards, and transforming the system of operations from decentralization to centralization to reduce the complexity of the implementation of 75 banking movements (transfers, checks, loans) and investment in the latest technologies to modernize their various sections to enhance financial and banking performance and increase competitiveness. 4- It is recommended to simplify