Holding steady: Despite systemic risks and ongoing political uncertainty, the sector is well placed to weather current challenges

Although summer 2013 has seen increased political risk and uncertainty in the country’s broader macroeconomic environment, the positive financial results of Egypt’s banking sector over 2012 and into 2013 attest to its overall resilience. A process of regulatory reform, which began in 2004, underpins this solid performance, and continues to this day as the sector readies itself for the implementation of Basel standards.

However, while the fundamentals of the banking sector have made it an enticing proposition, particularly to Gulf banks, the challenging economic environment has resulted in systemic risks, particularly in relation to banks’ exposure to sovereign debt. Negotiating these challenges is central to the success of the sector.

REFORM & EXPANSION: Rapid growth in the number of non-performing loans (NPLs) held by Egyptian banks compelled the Central Bank of Egypt (CBE) to pursue sector reform, which has resulted in the number of banks operating in Egypt falling from 61 in 2004 to 40 CBE-licensed banks as of 2013. As per CBE data for 2012, these institutions operated 3610 branches among them, resulting in a banking density of 22.7 (thousands of population per banking unit). While most infrastructure is concentrated in Cairo and Alexandria, recent years have seen banks attempt to increase market share through greater geographic coverage, such as the heavily populated Delta region and the new satellite towns and cities springing up around the traditional population centres. The civil unrest in some parts of Egypt, however, have had an adverse effect on branch expansion. “Selecting a location depends on multiple factors. One of them is stability. The situation has been fluid for most of the past year. For example, when we planned for new branch openings, the decision was difficult geostrategically due to civil unrest,” Sheriff Elbehery, director of strategy and business development for Barclay’s Egypt, told OBG. “Our expansion plans now include opening branches in Cairo, Alexandria and the Delta.”

PUBLIC SECTOR: Public sector banks continue to play an important role. A privatisation programme of government-owned institutions came to an end in 2009, when an attempt to sell Banque du Caire was called off due to the inability of the government to secure what it deemed a fair value for the institution. An unfavourable economic environment in 2011 resulted in the scheduled second attempt’s cancellation and a decision by the Ministry of Finance to concentrate on improving the performance of the remaining public sector lenders to create what it describes as “national champions”.

Of the six public sector banks, three of them ( National Bank of Egypt (NBE), Banque Misr and Banque du Caire) control around 40% of the sector’s assets. The government-owned operators are also the most visible in the market: according to CBE data, of the 3502 bank branches in 2010, some 2080 of them were operated by one of the five public sector banks. Meanwhile, seven public-private joint venture banks further extend the government interest in the market.

The private segment of the market comprises 27 licensed banks, the largest of which is Commercial International Bank (CIB), with total assets of LE89.6bn ($12.8bn) at the close of 2012. Its principal rivals in the private segment are National Société Générale Bank (NSGB), with assets of LE63.8bn ($9.1bn) at the close of June 2012, and a number of large multinationals with headquarters outside Egypt, such as HSBC and Barclays.

In addition to the locally licensed banks and subsidiaries of foreign players, the market has 24 representative offices of foreign banks. Included are global financial brands such as JP Morgan Chase, Credit Suisse, Standard Chartered, Royal Bank of Scotland and State Bank of India, although their activities in the country are limited by the Regulation for Companies Law to market research and advisory services.

REGULATION: The CBE is charged with supervising the banking sector, as well as regulating the monetary system (see Economy chapter), and deals with the daily settlements and clearings of all licensed banks. It carries out these activities according to the Banking Sector and Money Law No. 88 of 2003 and its amendments. Recently it has demonstrated its ability to react to Egypt’s rapidly changing economic and political landscape. During the civil unrest of 2011 it acted decisively to curb damage to the banking sector by closing the banks for more than a week and moving LE5bn ($711.5m) into the system before depositors were granted access to their capital. Further precautions included the imposition of a daily withdrawal limit of LE50,000 ($7115), a five-day execution period for outbound transfers and enhanced monitoring of foreign exchange transactions. It has also moved to increase liquidity in the system by reducing the local currency reserve requirement in March 2012 from 14% to 12%, followed by a further reduction to 10% in May.

While this development eased credit conditions in the market, the principal beneficiary was the Ministry of Finance, which has been meeting budgetary shortfalls with sales of treasury bills to the domestic banking sector at yields that in some cases have exceeded 16% (see analysis). In the financial year 2011/12, the CBE gave further liquidity support to banks through open market measures in the form of its weekly repo operations. As a result, the average value of repo operations rose from LE8.2m ($1.2m) in June 2011 to around LE15.3m ($2.2m) in March 2012.

REFORM: While the CBE’s regulatory focus since early 2011 has been to safeguard the banking system from the effects of Egypt’s process of political transition, it also carries a longer timetable for sector reform. Since 2004 the CBE’s Banking Reform Unit has overseen a series of structural changes aimed at creating a stable and sustainable banking sector that is better capable of serving the needs of the wider economy.

To this end, it began by increasing minimum capital requirements, setting higher capital adequacy ratios, introducing measures aimed at improving asset quality and establishing a more conservative provisioning regime. Between July 2009 and June 2011 the CBE oversaw a second phase of reform, which it described as the pivotal component of its programme. The focus of the second phase was the application of Basel II standards across the banking sector. During this time, the bank consulted with interested parties through discussion papers and open forums, and studied the methodologies employed by other nations in implementing the Basel II financial standards.

With the draft regulations in place, a third phase of the reform programme followed in July 2011, lasting until December that year, at which time the CBE tuned the proposed framework related to Basel II implementation. The CBE also undertook a study of the qualitative impact of the new regime via a number of sample banks and made plans for a new data warehousing framework to support the proposed supervisory regime.

The fourth phase, the exact timing of which is dependent on the stabilisation of both the economy and the political arena, will see a parallel run of the new regulations based on the Basel II framework and the existing regulations, alongside the implementation of the data warehousing framework.

While the challenges raised by Egypt’s turbulent political transition have prolonged the CBE’s move to Basel II compliance, they have granted Egypt’s banks time to ready themselves for the changes. “It will be easy for the sector to comply with it now. We’ve been through all of the discussion papers on capital adequacy, liquidity risk, market risk, and so on, and with the exception of perhaps three or four banks we are able to comply with Basel II,” said Mohamed Albaz, portfolio manager of the credit risk group at NBE.

BANKING PERFORMANCE: Despite the difficult economic circumstances of 2012, Egyptian banks have to date displayed a high degree of stability. A traditionally conservative loan-to-deposit ratio has aided them in this regard – in December 2012 it stood at 47.7% – as has the fact that most of Egypt’s banks do not rely on external funding or interbank lending from international banks. The CBE’s efforts to maintain consumer confidence in the system and safeguard against transfers of capital out of the country have also been central to the robust performance of Egypt’s banks over the past year. All of Egypt’s largest five lenders by total assets (NBE, Banque Misr, CIB, NSGB and Banque du Caire) posted net profits for the financial year 2012 (see analysis), while the wider sector followed a positive trend on the major indicators.

According to CBE data, the aggregate financial position of the licensed banks rose by 10.1% between December 2011 and December 2012 to reach LE1.44trn ($204.9bn). By March 2013 this figure had grown a further 6.3% to reach LE1.53trn ($217.7bn). On the liabilities side, the largest single contributor to the increase seen of over the 2012 calendar year was provided by a growth in deposits, which expanded 10.85% to reach LE1.08trn ($153.7bn). Provisioning showed a 6.34% increase over the year to reach LE56.3bn ($8.01bn), while bonds and long-term obligations showed a rise 16.52% rise to reach LE30.8bn ($4.4bn). Obligations to domestic and international banks, however, fell by 22% and 4.9%, respectively. On the assets side, growth in the sector was largely derived from banks’ investments in securities and treasury bills (T-bills), which rose from LE503.3bn ($71.6bn) in December 2011 to LE612.7bn ($87.2bn) in December 2012 – a rise of around 21.7%. Lending and discounts to customers, meanwhile, grew by a more modest 5.54% over the same period, from LE489.7bn ($69.7bn) to LE516.8bn ($73.5bn).

LENDING: The asset growth of Egypt’s banks over 2012 reveals an interesting phenomenon: the relatively minor role played by lending activity and the more significant contribution of T-bills. Reduced demand for big-ticket corporate deals in the wake of the political crisis has played a part in this trend, but in the eyes of many the actions of a government effectively frozen out of the international debt markets are the underlying cause.

Certainly, the Ministry of Finance’s resorting to largescale T-bill issuances in order to finance the budget has allowed Egypt’s banks to obtain high yields at low risk, and served to dis-incentivise riskier corporate and consumer lending. This in turn has had a significant effect on their credit profiles: by the close of 2012, exposure to government debt represented the single largest credit concentration in the sector, at LE536bn ($76.3bn), exceeding balances with domestic banks, which were two-thirds smaller than in 2008, at LE102bn ($14.5bn), and even accounting for a greater share of overall exposure than lending activity, which stood at LE512bn ($72.9bn, see analysis). However, concern regarding lending growth in Egypt’s banking sector predates both the global economic downturn and the more recent domestic upheaval. “The year 2012 was a period of stagnation for the economy. The banking sector expanded during this period but we have seen a substantial reduction in new lending,” Bruno Gamba, chairman and managing director at Bank of Alexandria, told OBG.

CREDIT REGULATION: While reducing the local currency reserve requirement from 14% to 10% has gone some way toward boosting liquidity in the system, the regulatory environment is a conservative one, favourable to stability but not to an expansion of credit. To some extent, this is the legacy of a period of high NPLs in the 1980s and 1990s, which left both banks and regulator cautious. There is also the question of the bankable population. “Egypt’s population is around 90m. Of this, half is too young to be bankable, so that leaves you with around 45m. Of these, 40% are below the poverty line, so you are left with 20m bankable individuals, before we apply lending criteria,” said Barclay’s Elbehery. A lack of credit information regarding this segment of the population has traditionally been viewed as another barrier to lending growth, although this challenge is being addressed by Egypt’s only credit bureau, I-Score. After commencing operations with a soft launch in 2007, as of 2012 the company has logged the credit data of around 100,000 companies and 10m consumers (and 20m consumer facilities). With sufficient historical data in its system to provide a viable service, I-Score has more recently shifted its focus to providing value-added services beyond the basic credit report, such as credit scoring, portfolio review, MIS reports (monitoring and analysing credit portfolios by products such as credit cards) and account monitoring, by which members are alerted when their customers default in any other members’ database. The development of I-Score’s capacity to analyse the market has made it a useful tool for banks seeking to broaden their lending portfolios. According to the company, more products are expected, including a fraud detection solution that will analyse the records of individuals and small and medium-sized enterprises (SMEs), a collateral registry, the development of a negative list and credit scoring via SMS.

SME LENDING: To date, I-Score has rated SMEs using the same framework it applies to its coverage of individuals, but this is expected to change in late 2013 or early 2014 with the launch of a subsidiary dedicated to SMEs. I-Score is expected to retain a 75% stake in the new company, which will produce holistic ratings for Egypt’s SMEs that will incorporate their credit history, financial statements, management expertise, supplier and customer bases, competitors, and the laws and procedures governing their activities.

This development is likely to be welcomed by lenders whose interest in the SME sector has been rekindled by a combination of a cooling global economy and a slowdown in large-scale projects in Egypt. The development of Egypt’s SMEs has been a government strategic priority for some years, most markedly since the 2002 introduction of a more favourable tax regime. During the boom years prior to 2008, however, banks had little incentive to extend credit to what they considered to be a high-risk segment. Moreover, a recent study carried out by NBE showed that of the nation’s estimated 2m SMEs, 90% operate in an informal capacity, which greatly limits the banking sector’s ability to address them. Efforts by some banks to boost their small business portfolios, however, reveal a greater appetite for SME lending as traditional revenue sources have come under pressure. “SMEs have everyone’s attention now because of their effects on the economy – we need to have youth jobs, revenue for families, increase our production – in all elements they are involved,” Soha Soliman, head of SMEs at NBE, told OBG.

Egyptian banks have therefore started to create specialised SME products, train personnel in the distinct issues of SME lending and, in some cases, work with industry bodies and non-governmental organisations to offer credit to small businesses in return for their formalisation. As the nation’s largest bank, NBE has played a central role in this process, and as a result of its efforts its SME loan portfolio has expanded from around LE4bn ($569.2m) in 2010 to LE10.4bn ($1.48bn) at the close of 2012. In 2012 it took its strategy a step further, announcing that it would offer small-ticket loans to the informal SME segment as part of a strategy to deepen its SME portfolio and encourage SMEs to formalise to get access to larger credit facilities.

The results of NBE’s experiment with informal businesses in Egypt are as yet unclear, but by addressing this massive and unbanked segment of the economy the lender is at the head of one of the most significant banking sector developments in years (see analysis).

MORTGAGES: The mortgage concept is a new one in the Egypt and represents an area of potential credit expansion should some structural challenges be addressed. The legal framework for mortgage lending was born in 2001 with the promulgation of the Real Estate Finance Law No. 148. The government took a proactive role in the development of the mortgage segment with its creation of the Egyptian Mortgage Refinance Company (EMRC), which is mandated to provide funds refinancing to primary mortgage lenders.

Currently, it draws its equity from its shareholders and founding investors, which includes the World Bank, but the company is also mandated to obtain capital via bond issuance in the domestic market when economic conditions allow. The first mortgage finance company (MFC) opened its doors for business in 2004, and by 2011 more than 10 MFC licences had been granted, while around 20 banks have developed mortgage instruments based on the regulatory framework.

However, mortgage uptake in Egypt remains relatively modest: in mid-2013, aggregate mortgage lending stood at around LE4.5bn ($640.4m), or around 0.3% of GDP. Although this figure represents a significant rise on the LE3.8bn ($540.7m) recorded in 2011, comparable markets have achieved considerably higher mortgage penetration rates in recent years. “In Jordan it is around 11%, and in Morocco it is about 7%. However, we have managed to grow it slightly, and the encouraging signs are that the growth has been in the lowincome segment and that overall default rates are around 3%, which is quite low by international standards,” Iman Ismail, CEO of EMRC, told OBG.

Hassan Abdalla, the CEO of the Arab African International Bank, told OBG, “The tourism and real estate sectors are unfulfilled sectors of the economy that are currently underutilised.” General economic challenges such as a low average wage (LE25,352 [$3607] per annum between 2010 and 2011, according to the Central Agency for Public Mobilisation and Statistics) have hindered the growth of mortgage lending. Another significant barrier to mortgage growth is a lack of formalisation in the housing sector, with less than 30% of household units registered. Government bureaucracy acts as a disincentive to formalisation, and a real estate tax law proposed before recent political unrest that would have gone some way to formalising the sector is unlikely to be implemented. Egypt’s MFCs also face competition from developers who use financing deals as part of their marketing strategy, which many in the industry believe operate with an unfair advantage.

“We are competing with developers offering loans. They are unregulated and have no declared interest rates. There is a huge risk here for the buyer if the developer does not finish its project, as they take cheques which are payable on demand regardless of progress. From a consumer protection perspective, we need to make them come clean,” said Ismail.

In late 2012 the regulator of Egypt’s non-bank financial markets, the Egyptian Financial Services Authority (EFSA), proposed changes to the existing mortgage law aimed at increasing the volume of home loans. Included in the EFSA’s strategy are new instruments such as re-mortgaging, refinancing of mortgages, equity finance and alternative methods of finance such as the sharia-compliant murabaha model. The latter would allow MFCs to sidestep the issue of home registration because in Islamic finance the property is owned by the lender until it has been paid off by the purchaser.

ISLAMIC FINANCE: While it is unlikely that any changes to Egypt’s mortgage law will come before parliamentary elections and the resolution of Egypt’s political turbulence, the EFSA’s reference to sharia-compliant processes for housing finance points to a wider interest in Islamic banking and finance. Egypt’s early embrace of the concept came to an end in the 1980s as a result of a number of scandals and insolvencies which tainted the image of sharia-compliant financing firms, and activity in the Gulf and South-east Asia has happened at a far more rapid pace in the years since.

At present, the market features only three fully fledged Islamic banks – ADIB (formerly the National Development Bank of Egypt), Al Baraka Bank of Egypt and Faisal Islamic Bank – although a further 11 offer sharia-compliant services through Islamic windows. Their estimated combined assets represented 5% of the sector total at the end of 2011, compared to a GCC average of 20%. In June 2012 Egypt’s government proposed a number of amendments to the banking law aimed at increasing the role played by Islamic banks in the sector, establishing a goal of 35% market share within five years.

MEETING TARGETS: A number of specific proposals that might be implemented in order to achieve this target have been outlined, including: the addition of a new Islamic banking section to the current banking law; the development of new sharia-compliant instruments by Islamic banks; the creation of an Islamic money market, which is considered crucial for liquidity management by Islamic banks; the promotion of takaful, or Islamic insurance, by requiring it for deposits at Islamic banks; regulations regarding Islamic windows and the separation of Islamic accounts from conventional ones; and regulations concerning the composition of the sharia boards that will supervise the activities of Islamic lenders. In May 2013 the Islamic finance segment received a fillip in the form of a new sukuk law, which has established the legal framework of the issuance of sharia-compliant bonds. The law provides for the issuance of sukuks within Egypt, as well as international issuance through special purpose vehicles – although assets must be located within Egypt’s borders.

OPPORTUNITY & RISK: Despite the challenges it has faced in the form of the global economic crisis and the more recent domestic unrest, Egypt’s banking sector has significant potential. According to the World Bank’s Global Financial Inclusion Database, in 2011 only around 10% of the adult population possessed or shared a banking account at a formal financial institution, and only 1% had saved money in a formal account over the previous year. A modest 4%, meanwhile, had obtained a new loan from a formal financial institution over the same period, while of the entire adult population only 1% owned a credit card and 2% had obtained a mortgage. The most popular form of borrowing, according to the World Bank, was from family and friends, with 25% of the adult population engaged this way.

These market characteristics, as well as its sheer size, have attracted interest from foreign players. The retrenchment of some European banks facing capital challenges in their home markets allowed Gulf banks to enter the market in 2012 and 2013. In March 2013 Qatar National Bank completed its purchase of the second-largest private sector player in the country, NSGB, for LE17.1bn ($2.4bn), and by the end of the first half of 2013, Dubai-based Emirate’s NBD had bought BNP Paribas’s Egyptian assets for $500m and was waiting for regulatory approval to buy out the remaining minority shareholders. This market shake-up is the largest seen in Egypt in years, and the capital and expertise brought to the sector by these new players is expected to hasten its development (see analysis).

However, while the potential in the market is clear, the political and economic shocks in recent years have resulted in a number of heightened risks. Since 2011 all three major credit rating agencies have downgraded a number of Egypt’s domestic banks, largely as a result of what they perceive to be their over-exposure to sovereign debt, which stood at an aggregate LE536bn ($76.3bn) in November 2012 (see analysis). Moreover, should political uncertainty continue into the medium term, increased provisioning requirements and muted business volumes threaten the profitability that lenders have so far been able to maintain.

OUTLOOK: The exposure of Egypt’s banks to sovereign debt during a time of difficult political transition has resulted in the major rating agencies placing the banking sector on negative outlook in terms of operating environment, asset quality and capital, profitability and systemic support. However, the sector’s funding and liquidity profiles garner a stable outlook from most agencies, thanks to the high proportion of customer deposits in relation to local and foreign funding. In the longer term, the macroeconomic fundamentals that have attracted Gulf banks to the market are expected to remain in place – a diverse economy, a large and young population, an anticipated 3.3% growth rate in 2014 (according to the International Monetary Fund), and an underleveraged market, with a loans-to-deposits ratio of 47% in March 2013. A history of conservative regulation has enabled the banking sector to ride out the economic crisis and most in the industry expect it to successfully weather its current political challenges.