New microfinance legislation offers opportunities to enter the small business lending arena

The success with which Egypt’s banks have increased their deposit base against the backdrop of political unrest and economic uncertainty is good news for the sector. According to a recent report by Lebanon’s Bank Audi, total deposits rose by 20.6% in 2013 to reach $189.2bn, an expansion more than double the size of that seen in the previous year.

Where the nation’s banks have been less successful, however, is translating this increased liquidity into private sector lending. While the call for more credit to be extended to businesses is common in any emerging market, the majority of new credit extension over recent years in Egypt has been directed to the government, which has relied on the domestic market to fund its budgetary commitments. With attractive yields on government securities, banks have purchased large volumes of sovereign debt, as is often the case elsewhere in Africa where local banks frequently serve as large consumers of government paper. This has a knock-on effect on credit to the private sector, where returns are less assured or lower.

The extent to which this has constrained non-government lending is subject to debate, however, given that low demand, macroeconomic uncertainty and credit opacity also play significant roles. To put the growth in lending in context, total credit facilities to the private sector increased by 5.6% in 2013, while the amount of credit extended to the government grew by 18.3% over the year, according to Bank Audi. The Central Bank of Egypt’s (CBE) data show that as of May 2014 aggregate exposure to government securities had reached LE990.4bn ($140.64bn), compared to total private sector lending of LE343.3bn ($48.75bn).

Supply & Demand

While elevated levels of public sector lending have been useful to both banks and the government, an increase in private sector lending is vital to the longer-term health of the economy. While much of the debate concerning lending patterns has focused on the question of supply, and framed in terms of banks choosing where to direct their capital, less attention has been directed at the question of demand. While the high yields of government securities are attractive, there has been noticeably low demand for lending since 2011 due to weaknesses in the real economy and persistent uncertainty.

High Yields

The ready availability of high-yield government securities has impeded the market’s ability to adequately test demand levels, and is likely to do so for some time: the presidential elections and the adoption of a new constitution in 2014 saw a reduction in Treasury-bill (T-bill) yields, which raised hopes that banks would be encouraged to seek new lending opportunities, but the 1% rise in 91-day and 273-day T-bills in July 2014, which resulted in the highest rates seen since September 2013, came as a reminder of the country’s economic vulnerability. It is likely, therefore, that the CBE will continue to encourage banks to diversify their loan books, while the government is compelled to prolong this eventuality by relying on domestic lenders to underwrite its fiscal programme.

Concrete Steps

Despite this conundrum, some decisive steps towards credit diversification have already been taken both by the regulator and the banks themselves. Following the global economic crisis of 2008, Egypt’s banks, which had traditionally grown their loan books on big-ticket facilities to corporates, began to seek out the potential of the small and medium-sized enterprise (SME) sector.

Egyptian lenders began to create specialised products, train personnel in the distinct issues of SME lending and, in some cases, work with industry bodies and non-governmental organisations (NGOs) to offer credit to SMEs in return for their formalisation. While the National Bank of Egypt leads the way in providing dedicated SME services, other lenders are starting to follow suit. For example, Commercial International Bank opened its business banking division on a pilot basis in 2011 and officially launched it in 2012. The division manages the bank’s interaction with the SME sector and has introduced a number of financial products and service offerings specifically created for the nation’s smaller businesses. Meanwhile, Société Arabe Internationale de Banque is working with the Egyptian Agribusiness Association and other industry associations to seek out lending prospects. In turn, the industry associations assist their members to formalise.

The CBE has also flexed its regulatory muscle in a bid to boost SME lending. In 2012 it allowed lenders to write off an amount equivalent in size to their SME credit facilities from the 14% required reserve ratio, whilst also reducing it from 14% to 12% – in effect freeing up liquidity to be directed at the SME sector.

New Legislation

A law passed in May 2014 establishing the Egyptian Financial Supervisory Authority adds yet more intriguing questions in relation to competition at this end of the market. The new authority will supervise the microfinance industry and allows companies other than banks and NGOs to undertake microlending activity for the first time.

Under the current proposal, borrowers will be able to obtain credit facilities of up to LE100,000 ($14,200), a relatively high upper limit compared to other microfinance bills. To put that figure in context, the average household income in the country between 2010 and 2011, the most recent period for which the Central Agency for Public Mobilisation and Statistics ( CAPMAS) has published data, was just LE25,353 ($3600). A nationwide census of SMEs carried out by CAPMAS on behalf of the CBE and the Egyptian Banking Institute over the same timeframe, meanwhile, showed that some 83.6% of SMEs in Cairo held capital of less than LE250,000 ($35,500).

Access to such financing should allow SMEs to build capacity to take on larger projects. “A way to support SME growth is improving procurement laws to require mandatory subcontracting to local SMEs,” Giel-Jan M van der Tol, CEO of Emirates NBD, told OBG.

Egypt’s new microfinance legislation has thus allowed companies from outside the traditional banking and NGO sectors to enter into the increasingly vibrant SME lending arena – albeit at the smaller end of it. Whether lenders will be happy to cede this territory to non-banking institutions and concentrate on the mid- and large-cap companies in the future remains to be seen.

Looking Ahead

Future lending growth is likely to be at the extremities of the credit portfolio. In terms of big-ticket lending, recently announced development plans, which include a possible expansion of the Suez Canal and a new development corridor that will radically alter the economic geography of the country, while still sparse in detail as of yet, do point to a new era of corporate lending. At the opposite end of the spectrum, though, the salient question is how effectively Egypt’s banks can tap into the country’s expanding SMEs. “On the lending side, major opportunities are arising primarily in construction and infrastructure, but also in the food, energy, pharmaceuticals and industry segments. On the deposits side, the potential for increasing banks’ reach to individual customers is still largely untapped,” Mohamed Ozalp, the CEO and managing director of Blom Bank Egypt, told OBG.