Egypt's financial inclusion strategy focuses on small business loans and digitalisation

Even when faced with complex regional politics, currency fluctuations and the impact of global crises such as the Covid-19 pandemic, Egypt’s banking sector remained resilient amid wider economic pressures in recent years. Part of this is attributed to the sector’s size – with Egypt having the largest banking system in North Africa – and stability. The industry has played an important role in economic development in one of the most dynamic markets in the region, where a large segment of the population remains unbanked: as of April 2022 around two-thirds of Egypt’s population of 103.5m people remained outside the banking sector.

The sector’s performance has been supported by the fact that while it experienced temporary disruptions during the early months of the pandemic, by 2022 it was clear that the country had avoided some of the worst economic consequences of the health crisis seen elsewhere. “Egypt’s banking sector performed well during the stress test presented by the pandemic, and played a significant role – with backing from the Central Bank of Egypt (CBE) – in supporting economic stability and business continuity,” Hussein Refaie, chairman and managing director of Suez Canal Bank, told OBG. “Adaptability has been a key factor in business success given recent volatility. In that way, digitalisation has become a priority because of the efficiencies and flexibility allowed by digital tools.”

Despite this, new challenges arose with Russia’s invasion of Ukraine in February 2022. Turbulence in capital markets led to a significant squeeze on foreign exchange liquidity, with the CBE issuing restrictions on non-strategic imports in the first quarter of the year. Lower levels of foreign investment led to additional pressure on the balance of payments. Meanwhile, inflation – which surpassed 10% year-on-year in March and April 2022 – had also become an increasing worry for Egyptian households and businesses alike. However, Egypt entered into negotiations with the IMF in March 2022 for a third support mechanism after previous packages in 2016 and 2020. If an eventual agreement is reached, it is expected to add a level of reassurance to foreign investors who began to shift away from Egyptian bonds towards more traditionally secure investment options after the US Federal Reserve raised interest rates in March 2022 for the first time since 2018.

Years of careful financial regulation have helped to create a robust banking system. The sector has continued to boast low levels of non-performing loans (NPLs), high capital adequacy ratios and sufficient provisioning. As lenders work to implement a recently ratified banking law, they are continuing to compete in a market characterised by opportunity.

History

Egypt is home to one of the oldest banking sectors in the Middle East. Modern banking activity started in 1858 with the founding of the Bank of Egypt. Foreign banks such as Anglo Egyptian Bank, Crédit Lyonnais and Ottoman Bank played a key role the early years of the sector’s development, and a number of lending institutions from Greece, France and Italy were also active players in the market. In 1898 the National Bank of Egypt (NBE) was established and given the mandate to issue Egyptian banknotes. However, it was created with the support of British investors and, as such, it would not be until the 1920 launch of Banque Misr that the sector would have its first purely Egyptian bank.

Although lending activity saw decades of growth, the nationalisation drive implemented by President Gamal Abdel Nasser in the 1950s reduced the sector to four government-owned commercial lenders, and a small number of specialised institutions. This period also saw the separation of the NBE and the CBE, with the former transformed into a public commercial entity and the latter assuming a regulatory role.

Reforms

The period of liberalisation brought about by President Nasser’s successor, Anwar Sadat, started a wave of economic openness in the 1970s. A key piece of legislation, Law No. 120 of 1975, divided the sector into three categories: commercial banks, which accept deposits and offer financing and other services; business and investment banks, which operate through medium- and long-term financing of new companies and fixed-asset investments, while also offering commercial services; and specialised banks, which focus on specific sectors of the economy.

Starting in the 1990s the CBE moved to liberalise the lending environment further. Although this goal initially buoyed banking activity, it also led to an increase in NPLs. In time, regulatory authorities began to implement reforms to help stem the deterioration of banking assets and loan portfolios, leading to a decrease in the number of banks operating in the Egyptian market. As of May 2022 there were 38 registered banks in Egypt, down from 57 lenders in 2004.

Performance

According to the CBE’s most recent annual report, for FY 2019/20, the banking sector’s aggregate financial position reached LE6.4trn ($406.7bn) at the close of the fiscal year, up 16.2% from FY 2018/19. The pandemic led to a drop in net foreign assets, which fell by LE178bn ($11.3bn) to LE122.1bn ($7.8bn). The majority of the decline, or LE107.8bn ($6.8bn), was held by the CBE, while the remaining LE70.2bn ($4.5bn) was held by banks.

The pandemic also had a measurable effect on profitability. In March 2021 the CBE reported that the sector’s net profit was roughly LE30bn ($1.9bn), down from LE36.9bn ($2.3bn) in March 2020. As much as LE26.3bn ($1.7bn), or nearly 88% of total profit, was accrued by the top-10 banks operating in the sector.

Even as the pandemic weighed on profit, asset quality improved. The ratio of NPLs to total loans fell from 4.9% in FY 2017/18 to 4% in FY 2020/21 and 3.5% at the close of 2021. Meanwhile, deposits accounted for 73.1% of total liabilities in FY 2019/20, while investment in securities and bills represented 40.9% of assets. Lending stood at LE2.2trn ($139.8bn) at the close of FY 2019/20, comprising 34.3% of total banking assets and 46.9% of total deposits.

Deposits grew by 17.4% to LE4.7trn ($298.6bn), with 69.4% of deposits coming from households, followed by the government (15.6%), private businesses (12.5%), public businesses (2.1%) and the external sector (0.4%). Local currency deposits accounted for 83.5% of the total. Deposits continued to increase, reaching LE5.7trn ($362.2bn) in FY 2020/2021, a 22.3% increase relative to the previous year, according to the Central Agency for Public Mobilisation and Statistics. This trend continued until the close of 2021, when deposits totalled LE6.5trn ($413bn).

Structure

The sector is overseen by the CBE, based on the Banking Sector and Money Law No. 88 of 2003 and subsequent amendments. While there are a number of private players in the market, the two main government banks, the NBE and Banque Misr, account for more than 60% of the sector’s total assets. Several smaller lenders have market shares of less than 1%. Because of this, the sector could see a wave of consolidation. Industry players expect that consolidation would bolster the overall health of the market and improve financial stability.

The two large government banks are among the CBE’s vehicles to transmit monetary policy, allowing initiatives to be implemented with a high degree of responsiveness. However, the smaller size of private banks makes it difficult to compete with public entities at times. For example, at the height of the pandemic the CBE raised interest rates, and both the NBE and Banque Misr increased their return on deposits, a move that was difficult for most private banks to follow. More recently, in March 2022 the two government banks sold the equivalent of LE303bn ($19.3bn) in special certificates of deposit, with a maturity of one year and an 18% yield. The goal was to both combat inflation and increase liquidity in the market after the authorities devalued the pound by 16% against the US dollar in March 2022.

There are three Islamic banks active in the market, and 11 banks offer Islamic finance windows. According to a report published in 2022 by the Egyptian Islamic Finance Association, the segment was valued at LE429bn ($27.3bn) in 2021, an increase of LE63.6bn ($4bn) from the previous year. The report also found that there were over 60 Islamic banking products available on the market, as well as 248 Islamic bank branches serving 3.2m customers.

Support & Reform

The onset of the pandemic led the CBE to issue several regulations on March 2020 to soften the impact on the banking sector and the wider economy. The regulator moved to reduce the interest burden on loans and introduced several initiatives, including subsidised lending to the sectors most affected by the crisis, such as tourism, construction, agriculture and industry. Individuals and institutions received a six-month waver on loan payments. Fees and commissions on cash withdrawals were suspended for a period of six months, as were the fees charged to merchants for electronic payments. Banks were barred from imposing fees for late payments of NPLs, and had to increase daily transaction limits on credit cards for customers. In January 2021 the CBE ordered the withholding of shareholders’ dividends in order to boost the capital base.

A series of legislative reforms were also implemented during this period, key among them Law No. 194 of 2020, which updated the sector’s regulatory framework and aimed to strengthen governance, capital adequacy and management. Approved by Parliament in May 2020 and ratified into law in September of that year, the law contains a number of important changes, including an increase in the minimum capital requirement for domestic banks, from LE500m ($31.8m) to LE5bn ($317.7m). Among the other changes were new ownership rules that limited individuals from owning more than 10% of a banking institution’s equity and measures to enhance the independence of the CBE. Banks will be required to begin their financial year in January and publish their financial information on quarterly basis. The package also covers the activities of financial technology (fintech) operators, allows the CBE to regulate cryptocurrency, and contains new data and privacy obligations for financial firms. The regulatory framework will apply not only to banks, but also to money transfer and foreign exchange companies, payment operators and providers, and credit ratings firms.

The sector has also seen the entrance of non-bank players providing microfinance, factoring, leasing and payment services. In 2018 the Parliament passed a law regulating leasing and factoring activities in a bid to help smaller firms improve their cash flow.

“Leasing and factoring can be beneficial alternatives to traditional borrowing in a high-interest-rate environment and can help improve cash flow,” Yehia Ezz El Din, managing director of Incolease, told OBG. “The growth of leasing and factoring in the past several years is part of a broader trend to increase financial inclusion and financing options.”

Included in the 2018 law’s provisions was a rule that financial leasing or factoring activities could only be carried out by a joint-stock company with at least LE10m ($635,000) in capital. It must also receive a licence from the Financial Regulatory Authority.

“The regulatory framework for leasing and factoring has been improving in recent years, with the regulator taking a hands-on approach that has been sensitive to feedback from the private sector,” Tarek Kandil, chairman and managing director of Al Ahly Leasing and Factoring Company, told OBG. “At the same time, the creation of a leasing federation has opened a forum for feedback from the industry.”

Lending

Although the effects of the pandemic and Russia’s invasion of Ukraine were expected to negatively influence the liquidity of banks in the region, Egyptian lenders have been able to maintain stable underlying resources. Deposits in local and foreign currency have continued to grow, and provide an ample liquidity cushion for banks. “The interest rate environment also changed fundamentally in May and June 2022, helping banks to continue to make healthy risk-adjusted returns as they direct their deposits to both sovereigns and loans,” Amr Shawki, head of liabilities and investments at Commercial International Bank (CIB), told OBG. “In the prevailing interest rate environment, loans to individuals have more or less the same risk-adjusted returns when compared to the risk-free rate offered by sovereign debt investments.”

Small Scale

The CBE has worked in recent years to boost lending to the private sector, and to small and medium-sized enterprises (SMEs) in particular. From 2016 onwards, a lending mechanism for SMEs enabled firms to access financing with a 5% interest rate. Rates on working capital loans for medium-sized companies were capped at 12%. Perhaps more importantly, the CBE began to set minimum exposure requirements for SME lending for Egyptian banks. For this added exposure, banks were allowed to reduce reserves held at the CBE. “Due to the significant size of the country’s informal economy, financial inclusion has been a priority for both the government and the CBE as they seek to implement economic reforms, improve the local business environment and expand the tax revenue base,” Mohamed Kafafi, CEO of the Egyptian Credit Bureau, told OBG. “The current initiative of extending lines of credit to micro- and small businesses and incorporating them into the formal sector will be an important pillar supporting Egypt’s economic recovery going forwards.”

In February 2021 the CBE’s Board of Directors announced its intent to increase the sector’s exposure to SMEs, requiring banks to channel 25% of their lending portfolio to the segment. The move is expected to direct an additional LE117bn ($7.4bn) to these enterprises by the end of 2022. The CBE also introduced incentives to support banks, including preferential interest rates, clearer onboarding policies and credit guarantees. “The CBE’s initiative to increase lending to SMEs is an important catalyst for directing banks’ focus towards creating opportunities for SMEs, which are key drivers of economic growth,” Ahmed Ismail Hassan, country manager of Arab Bank Egypt, told OBG. “Technology is helping banks reach out to SMEs and reduce lending risk by increasing clarity as SMEs transition away from cash.”

The need to lend to a larger number of potentially riskier customers is encouraging procedural changes within banking structures. “Some banks are trying to move away from the conventional credit assessment processes to a new system, based on data and behavioural models,” Abanob Magdy, vice-president of equity research at Beltone Financial, told OBG. “This is the only new thing banks can do right now. But there is a lot of effort to attract quality SMEs, and that is pressuring the overall market because the number of smaller companies readily equipped to qualify for credit is somewhat limited.”

Entrances & Exits

As the sector continues to reform and strengthen, it has seen a host of exits and new entries over the last decade that showcase its competitiveness and interest from foreign investors. The instability associated with the 2011 political revolution caused a number of international banking institutions to leave the market, with others taking their place. French bank BNP Paribas signed a deal in late 2012 to sell its business in Egypt to Emirates NBD for $500m. That same year another French lender, Société Générale, sold its Egyptian operation, National Société Générale Bank, to Qatar National Bank for a reported $2bn. Greek lender Piraeus Bank sold its Egyptian presence to Al Ahli Bank of Kuwait in 2015 for $150m, the same year that Citibank Egypt sold its retail arm to CIB. British lender Barclays announced in 2016 it was looking to leave Egypt, and in 2017 sold its retail and corporate banking businesses that spanned 56 branches in 18 cities to Morocco-based Attijariwafa Bank.

Even under the current challenging macroeconomic conditions, the largely untapped potential of Egypt’s banking sector has continued to attract investment. In September 2020 Italian group Intesa Sanpaolo, the majority owner of ALEXBANK, re-acquired a 9.4% stake in the Egyptian bank from the International Finance Corporation that it sold in 2008 for $162m, increasing its holding in the Egyptian lender to 80%.

Other international players are looking to enter the market. In February 2022 UK-based Standard Chartered obtained the regulatory approval to open a branch in Egypt. According to CBE regulations, the bank’s new venture was expected to commit at least $150m in minimum capital. The bank has announced plans to open a branch in Cairo in September 2022 and one in Alexandria in 2023.

Looking to the future, the structure of the Egyptian banking sector may also be influenced by the government’s announced willingness to divest, at least partly, from its shareholder positions in several banks. The plan might include selling part of the CBE’s 99.9% stake in United Bank of Egypt, for which the authorities are hoping to find an investor willing to take a controlling stake. Another potential candidate for a partial sale is Arab African International Bank, of which the Egyptian government holds 49.4%.

The government has also made moves to privatise Banque du Caire, but a deal to sell the bank was called off in 2008. More recently, in 2020 the bank’s leadership announced plans to offer 45% of its shares on the Egyptian Exchange, part of the government privatisation programme, which included a roadshow in the US to attract foreign investors. The plans were suspended due to the pandemic, but at least a partial privatisation of the bank will likely remain a priority.

Fintech

The restrictions imposed in response to the pandemic have accelerated the development of the fintech industry (see ICT & Innovation chapter). Not only did they encourage traditional banks and insurers to expand their digital service offerings, but they also forced hesitant customers to acclimate to the use of remote banking channels. Change was also spurred by the ratification of the new banking law in September 2020, which opened the door to the establishment of digital banks in Egypt. The authorities are looking to the fintech space to accelerate financial inclusion within the unbanked segments of the population. “We have seen higher level of activity from mobile operators and e-payment companies in recent years,” Magdy told OBG. “Egypt also decreased the daily maximum withdrawal and deposit limit to LE50,000 ($3180). These measures and others have increased the dependence on digital channels.”

In March 2022 public banks Banque Misr, Banque du Caire and the NBE joined forces to establish an $85m fund to invest in financial innovation. Banque Misr will anchor the initiative, with the other two institutions acting as strategic investors. The fund aims to attract both local and international investors, and the CBE hopes it will be an important step towards transforming Egypt into a regional leader in fintech.

The same month the fund announced it had made preliminary investments in four companies, including Mozare3, which allocates financing and technical support to small farmers. The fund aligns with wider goals to create a cashless economy. “The pandemic proved that it is necessary to invest in and further develop digital payments, as well as accelerate their adoption,” Tarek Fayed, chairman of Banque du Caire, told OBG. “Moving towards a cashless economy is an essential element of financial inclusion, and a cashless system will increase banking penetration as familiarity with such payment methods increases.”

Despite the growing importance of innovative banking services, expanding banking penetration across Egypt will require a suitable physical network. In 2020 the CBE launched an initiative to set up an additional 6500 ATMs across the country’s smaller towns and rural areas by December 2021, among wider aims to increase the number of ATMs in line with the global average. The programme brought the total number of ATMs in Egypt to around 20,100.

Outlook

The 2022-23 period is likely to continue to bring volatility to global financial markets. The 0.75-percentage-point interest rate hike by the US Federal Reserve in June 2022 – the biggest increase since 1994 – is expected to impact Egypt’s investment climate as investors turn to more traditionally secure investments, and potentially lead to further currency depreciation. In this context, banks will have to balance the added risks with ongoing modernisation efforts to diversify and improve their services. With such a significant percentage of assets concentrated among top players, and some smaller lenders pressured by the unfavourable economic climate and more stringent minimum capital requirements, it is likely that the banking sector will see some degree of consolidation over the medium term. Such a trend has been seen in the Gulf, where several conventional and Islamic banks have consolidated in recent years.