Digital and fintech initiatives keep Egypt's banks regionally competitive

Egypt has been a regional banking powerhouse for more than a century and is home to the biggest banking sector in North Africa, according to the Union of Arab Banks. The industry is also one of the region’s most stable, surviving both the economic turbulence that followed the Arab Spring and a more recent foreign currency crisis that saw government auctions of US dollars and the growth of a parallel market for foreign currency.

The resolution of the currency challenge through the flotation of the Egyptian pound in 2016 has helped strengthen bank profitability, and a positive economic outlook for 2019 underwrites the continuance of this trend. However, the sector also faces near-term challenges, including a looming deadline for a bold small and medium-sized enterprise (SME) lending target, the introduction of new accountancy standards and the probable implementation of a significantly revised banking law.

History

Egypt’s formal banking sector emerged in 1858 with the establishment of the Bank of Egypt. The Anglo Egyptian Bank entered the arena six years later, and in the following decade a number of other foreign institutions established a presence, serving a rapidly expanding economy and the most diverse population in the Middle East. These included Crédit Lyonnais in 1866, the Ottoman Bank in 1867 and other Greek, French and Italian institutions.

During this period gold coins remained the principal medium of exchange – a state of affairs that lasted until 1898, when the National Bank of Egypt (NBE) was established with British capital and granted a mandate to issue Egyptian banknotes. The first purely Egyptian Bank was Banque Misr, which was founded in 1920.

The 1930s and 1940s saw rapid sector growth, but the abolition of the monarchy and the introduction of Nasserite socialism in the 1950s reduced what had been a largely privately held banking industry to just four state-owned commercial banks and a small number of specialised financial institutions. The NBE, which expanded its operations to perform the main functions of a central bank, was divided into a public sector commercial bank that maintained the original name, and the Central Bank of Egypt (CBE), which assumed its central banking duties.

In the 1970s former President Anwar Sadat’s open-door policy reopened the banking sector to private ownership, and Law No. 120 of 1975 established three types of banks: commercial banks, which accepted deposits and offered financing and other customer services; business and investment banks, which focused on the medium- and long-term financing of new businesses and fixed asset investments, while also accepting deposits and offering commercial services such as trade finance; and specialised banks, which serviced a particular type of economic activity, such as lending to the agricultural sector.

In the 1990s a series of CBE directives sought to further liberalise the lending environment, ushering in a period of private sector investment and significant credit expansion. However, the banking boom that followed was accompanied by a deterioration in asset quality. An uncomfortable level of non-performing loans soon compelled the regulator to carry out a deep reform of the sector, the most visible result of which has been a reduction in the number of banks operating in Egypt: from 61 licensed by the CBE in 2004 to 38 banks as of January 2019.

Public Sector

The modern banking industry is home to a wide variety of institutions, generally classified as public sector, private and joint venture, or foreign. Despite years of market liberalisation, public sector banks continue to play a central role in the market. Of the big five commercial banks operating in Egypt, three are state-owned, together controlling around 40% of sector assets. By far the largest of these, with a market share of around 30%, is NBE, which at the outset of 2018 held total assets in excess of LE1.4trn ($78.7bn). Banque Misr, another state-owned institution, has the second biggest asset base in the sector, reporting LE787bn ($44.2bn) in June 2017. The third-largest state-owned bank, and the fifth biggest in the market, is Banque du Caire, with total assets of LE150bn ($8.4bn) as of mid-2017.

The government’s interest in the market is further extended by the presence of another seven public-private joint venture institutions. The role of the state in the banking sector is, however, expected to diminish over the short term due to an ongoing government divestment strategy. Banque du Caire is thought to be the first government-owned bank to be opened up to private sector investment, with the central bank reportedly planning to offer a 30% stake in the institution in 2019. Other divestment possibilities in the banking sector include the Arab African International Bank, of which the government intends to sell off a minority stake, and United Bank of Egypt, for which the authorities are seeking a strategic investor to take a controlling stake.

Private Sector 

Two private banks have made it into the big five. The largest of these is Commercial International Bank (CIB), which as of December 2018 had total assets of approximately LE342.4bn ($19.2bn), making it the third largest commercial bank in the country. Qatar National Bank, which operates in Egypt as QNB Alahli, is the fourth largest player, with total assets of LE257.3bn ($14.5bn) in December 2018. The bank has been present in the local market since 2013, when it bought 97% of National Société Générale Bank’s Egyptian operation.

The departure of a French institution and its replacement with a regional one is part of a broader trend that has seen global institutions retreat from emerging markets in the years since the 2007 economic crisis. In August 2015 Al Ahli Bank of Kuwait received permission from the CBE to establish a presence in the domestic market, and Egypt has been a popular destination for banks from the Gulf Cooperation Council that are seeking to expand beyond their relatively small populations.

The UAE alone is represented in Egypt by five major institutions: First Abu Dhabi Bank, Mashreq Bank, Union National Bank, Abu Dhabi Islamic Bank and Emirates NBD. Since President Abdel Fattah El Sisi entered office in 2014, instigating a process of economic reform, other regional lenders have expressed an interest in expanding their Egyptian operations, including Lebanon’s Bank Audi in 2017 and Blom Bank in 2018. The biggest ownership change of recent years came in 2017, when Barclay’s exited the market by selling its Egyptian operation to Morocco’s Attijariwafa Bank, thereby ending a relationship with the country that had existed since 1864.

The CBE has for some years frozen the issuance of licences to international banks seeking to enter the Egyptian market, encouraging them instead to obtain stakes in the institutions already present. However, in December 2018, the central bank governor revealed to local press that the regulator was mulling the resumption of licence issuances to foreign lenders. It was separately reported in the Egyptian press that two international banks and a European lender had shown interest in obtaining local operating licences.

Regulation

The CBE is charged with overseeing Egypt’s diverse banking sector. In doing so, it applies the Banking Sector and Money Law No. 88 of 2003, and its numerous amendments. The regulator has been working on a new banking law for some years, the promulgation of which is expected to provide a platform for sustainable industry growth for decades to come. During the development of the new law, however, stakeholders raised concerns about some of its proposals. A term limit for bank CEOs proved particularly controversial when details of a draft law emerged in 2017, as well as an innovation that would allow the CBE to send a representative to attend the board meetings of any bank, without an invitation. The banking sector’s industry body, the Federation of Egyptian Banks, expressed its opposition to these changes and formally requested that the article concerning term limits be removed.

Despite not being finalised by the outset of 2019, announcements made by the regulator in 2018 indicate a willingness to accommodate industry requests. In April 2018 a statement from the CBE suggested that the amended banking act would not establish term limits for bank managing directors. By the final quarter of 2018 the act’s revision appeared to be near completion, with the presidential office reporting to press that the CBE governor had presented the amended law to the president. The publication of the final draft is expected in the near term and should provide the industry with the clarification it requires to make any necessary adjustments.

The new minimum capital requirements established by the law are likely to be a key focus of attention. It is also probable that banks will face a stricter regime with regard to their customer relations: the proposed amendments are expected to establish the CBE as the primary consumer protection agency for the banking industry, with the ability to impose punitive measures on banks that contravene laws and standards. The new legislation is also likely to hand some powers of the Egyptian Competition Authority to the regulator, positioning it as the arbiter of monopoly disputes in the market.

Reporting Changes

Banks face another regulatory change in the form of International Financial Reporting Standard (IFRS) 9, which has been rolled out across global markets since January 1, 2018. Its implementation date in Egypt was set by the CBE as January 1, 2019 for banks which prepare their financial statements according to the calendar year, and July 1, 2019 for those which report according to the financial year. The effects of the new standard on the key ratios of banks are likely to be considerable.

The IFRS 9 framework radically alters the way banking institutions calculate their potential impairments, or bad loans, changing the process from a historical one – whereby banks reviewed previous performance to determine their provisions against impairments – to a forward-looking one, in which the losses from an impaired asset are projected over the next 12 months. If there is a significant increase in credit risk, the credit losses are projected over the instrument’s full lifetime. In essence, IFRS 9 makes it more difficult for banks to delay recognition of their impaired assets, and is in part a response to the regulatory weaknesses exposed during the global economic crisis of 2008.

The CBE is, therefore, keeping a close eye on banks’ key performance indicators throughout the implementation period. For example, lenders are required to report their capital adequacy ratios on a quarterly basis after taking into consideration the IFRS 9 standards. In May 2018 the CBE reported that 40% of domestic banks were not ready to apply the new standards to their financial reporting and that their processes would therefore “need adjustments”.

Financial Inclusion

Financial inclusion has been another key regulatory theme over the past year. Extending financial services to a greater part of the population has been on the government’s agenda since the revolution of 2011, and recent years have shown a significant improvement in basic financial inclusion indicators: the World Bank reported that in 2017 around 33% of Egyptian adults held a bank account, up from less than 20% in 2014.

“The financial sector has been resilient over the course of recent economic reforms, with banks maintaining healthy levels of liquidity,” Mohamed El Etreby, the chairman of Banque Misr, told OBG. “The focus now is on boosting accessibility and financial inclusion.” The government has recently embarked on a drive to develop non-bank financial services. As part of this effort, it intends to increase the number of recipients of microfinance from 2.5m currently to 4m, and the amount of microfinance loans issued from LE11.5bn ($646.3m) to LE15bn ($843m).

Banks have traditionally facilitated the operations of microfinance organisations, providing funding in tranches that are then parcelled off to individual clients. Recent microfinance legislation, however, allows banks to engage in microlending directly. Elsewhere in Africa banks have enthusiastically moved into the microfinance arena; therefore, one of the questions facing domestic banks is whether to persist with a facilitative approach, or claim the segment for themselves (see analysis).

In the meantime, the authorities are continuing with efforts to include more Egyptians in the formal financial system. “Banks need to be at the forefront of efforts to increase financial inclusion, because once someone has a bank account accessibility to other aspects of the formal economy increases dramatically for them,” Mohamed Aly, CEO and managing director of Abu Dhabi Islamic Bank Egypt, told OBG. However, a paucity of data on the daily interactions of Egyptians with banks and other financial institutions is a hindrance to this effort, so in 2018 the CBE established a new database to gather and analyse information regarding financial inclusion in the banking sector. The platform will be developed in phases, beginning with the collection of basic data on deposits and electronic banking services based on official documents associated with the regulator’s customer identification and money laundering rules.

Digital Drive

Recent digital developments in the sector are supporting the financial inclusion drive and benefitting banks by allowing them to lower costs, increase their customer base more efficiently, and penetrate Egypt’s large and dispersed population. While bricks-and-mortar networks remain the primary means by which banks interact with their customers, digital services are developing rapidly. “Digitalisation is improving accessibility to financial tools and increasing the amount of data available for assessing credit,” Mohamed Kafafi, CEO of the Egyptian Credit Bureau (iScore), told OBG. “This helps encourage banks to offer financing, particularly to SMEs, in line with the regulatory requirements.”

The CBE is helping drive the digital trend by introducing regulations for digital payment services as part of a longer-term strategy to move towards a cashless economy. For example, licensed banks have been able to provide mobile wallets to their customers since the CBE introduced regulations for the process in 2016, and the regulator has taken steps to increase the amount of bank account holders using this technology. In August 2018 a CBE directive instructed banks to ensure that at least 10% of their e-wallet customers are active users. Banks were also required to grow their active e-wallet users by 30% annually, or explain their strategy to increase the number to the regulator. The CBE has also revealed it is in the process of establishing a mechanism to allow mobile money transfers from overseas without requiring users to open a bank account in Egypt.

Fintech

The relationship globally between banks and financial technology (fintech) firms is a complex and rapidly evolving one. In some cases fintech firms are rivals to traditional lenders, while in others they act as partners. Egypt, as an emerging fintech hub, is a prominent part of this rapidly changing landscape. “The big challenge for banks is to adopt technology quickly enough to compete with financial services offered by tech companies, but in a way that is responsible and mindful of security and regulatory constraints,” Hussein Refaie, chairman and managing director of Suez Canal Bank, told OBG.

In March 2019 the CBE announced plans to establish an innovation support fund and the Innovative Financial Technology Applications Lab, a regulatory sandbox for fintech companies to trial new products and services. This will consolidate the country’s key position in the regional fintech universe. The UAE, Jordan, Lebanon and Egypt together account for 75% of all start-ups, according to the entrepreneurship facilitation platform, Wamda. Egypt’s large consumer market makes it an attractive proposition to fintech developers, and recent years have seen a steady stream of fintech accelerators established there.

Egypt’s first specialised fintech development programme was the 1864 Accelerator, launched in 2016 by the Cairo-based Flat6labs in partnership with Barclays Bank. It was quickly followed into the arena by AUC Venture Lab Fintech Accelerator, developed by the American University in Cairo and CIB.

The government has also begun to play an active role in Egypt’s fintech sector through its involvement with Fekretak Sherketak. The initiative aims to support Egyptian youth and entrepreneurs, and was launched in late 2017 as a partnership between the Ministry of Investment and International Cooperation, investment bank EFG Hermes and the UN Development Programme. In July 2017 Egypt was chosen as a pilot country for the Financial Inclusion Global Initiative, a programme to advance research into digital financial inclusion established by the World Bank Group, the International Telecommunication Union and the Committee on Payments and Market Infrastructures. The development of the Egyptian fintech universe, however, has been patchy. The government’s drive to boost non-cash transactions in Egypt means that mobile cash and smart wallet services are the most mature segment of the fintech scene. In other areas, such as blockchain-enabled financial services and crowdfunding, the regulator has yet to act. Perhaps more challenging for local banks is the lack of legal recognition of technologies such as biometric authentication, which means that customers are still required to visit branches in order to open a bank account.

Performance

Egypt’s banks have thrived in the macroeconomic conditions that have prevailed since the revolution of 2011. As the government has been compelled to pay more to secure funding in the open market, banks have found it increasingly profitable to channel excess liquidity into high-yielding Treasury bonds. Accordingly, government debt has become more prominent in the industry’s aggregate loan book: in 2010 around 30% of the sector’s assets were accounted for by government debt instruments, but by mid-2016 this figure had risen to approximately 45%, and by December 2017 net claims on government bonds stood at 64.9%. This dynamic has resulted in healthy net interest margins for most lenders, a trend further buoyed by the fact that the robust deposit growth in the post-revolution period included a sizeable component of low-cost demand deposits, especially for large private sector banks, where they accounted for about 50% of total deposits. “The banks’ ability to adjust to new market dynamics and to guide their clients through macroeconomic turbulence resulted from their strong technical expertise and seasoned management in dealing with such fundamental change. Continuous growth in deposits, up around 25% year-on-year (y-o-y) in 2018, is evidence of this successful management,” Sherif Elwy, chairman and managing director at Arab African International Bank, told OBG.

For the banks, this has led to a sustained period of profitability. According to the CBE, the domestic banking sector recorded an aggregate net profit of LE48.5bn ($2.7bn) in the first nine months of 2018. The big five institutions accounted for around 44% of this figure, while the top-10 banks in the country by asset size comprised 61% of the total. Within this positive trend, some of the larger private sector players performed especially well. The biggest of them, CIB, recorded profits of LE7bn ($393.4m) for the period, which represented a y-o-y expansion of 24%. QNB Alahli, meanwhile, saw its profits rise y-o-y from LE4.24bn ($238.3m) to LE5.38bn ($302.4m). “The banking sector has been very stable in Egypt and the profitability of 2018 is expected to continue in 2019,” Maged Fahmy, chairman and managing director of Industrial Development Bank, told OBG. “This stability has helped the economy to weather a number of difficult periods.”

Lending

The ability of banks to be able to secure easy margins via government securities is not, however, unproblematic. In the view of some market observers, the predominance of state debt on banks’ loan books is crowding out the private sector, resulting in lenders no longer performing their primary function of enabling economic growth by providing credit to individuals and businesses.

In September 2018 banks held LE2.35trn ($132.1bn) in government securities, compared to the LE804.8bn ($45.2bn) they held as assets in the form of loans to the private business sector. Bankers maintain, however, that the problem lies not in a lack of desire to extend credit to the private sector, but a lack of demand for credit due to the high interest rate environment that has prevailed over recent years. “There is a need to encourage banks to increase lending to businesses that are expanding and investing in growth, but this is difficult at the current interest rates,” Mohamed Abdel Kader, country officer of Citibank Egypt, told OBG.

While the high interest rate challenge remains, a more encouraging policy trend has emerged over the past year: over February and March 2018 the CBE reduced its deposit and lending rates twice, for an accumulated 2% cut. This brought the lending rate to 17.75% and deposit rate to 16.75%, where they stayed for the remainder of the year. Lending activity is likely to increase as a result of this development, as businesses find borrowing costs are decreasing. Banks’ profitability is also likely to be buoyed by the lower cost of deposits (see analysis). In 2018 there were some early signs of an improving credit scenario: CIB announced that it had expanded its loan book by 13% over the year’s first half. Bankers reported, however, that much of the credit growth over that period was being used by firms for working capital, rather than capital expenditure. Nevertheless, some areas of the economy, particularly those associated with the government’s large infrastructure pipeline, are generating significant capital expenditure lending opportunities. For many of these big-ticket facilities, local banks work together to serve the market. The most important arranger of syndicated loans in Egypt, according to Bloomberg’s global banking survey in the third quarter of 2018, is NBE. As well as being Africa’s biggest financier for the period, it was also the continent’s third-biggest book runner and arranger of syndicated loans, overseeing deals that totalled approximately LE61bn ($3.4bn). At the other end of the business lending spectrum, the government and CBE have taken steps to increase the amount of credit available to SMEs. In 2016 the CBE stipulated that banks must limit interest rates on loans to SMEs that have revenues of between LE1m ($56,200) and LE20m ($1.1m) to 5%, and increase the share of SME loans in their total loan portfolios to 20% by 2020. A number of lenders had already reported their compliance with the target by the outset of 2019, but with some banks struggling to meet the deadline, the regulator has taken steps in order to aid them. These measures include broadening the definition of SMEs to include more mid-sized firms and the acquisition by the central bank of a stake in the Credit Guarantee Company, which has allowed the regulator to effectively underwrite bank loans to some SMEs (see analysis).

Financial Stability

Egypt’s banks have succeeded in growing their loan books in a sometimes challenging economic environment without a significant deterioration in financial stability indicators. As of September 2018 the aggregate capital adequacy for the sector stood at a healthy 16%, according to the CBE. Banks have also reported a gradual improvement in asset quality since 2011, with the ratio of non-performing loans (NPLs) to total loans falling from that year’s 10.5% to 4.4% in September 2018. Liquidity in the sector remains abundant, with local currency liquidity underwritten by a robust retail deposit base. Foreign currency liquidity, which was squeezed throughout 2015 and 2016, has been notably eased by the currency devaluation.

In October 2018 Moody’s Investor Service upgraded its outlook for the Egyptian banking system from stable to positive, citing an improving economy, increasing demand for credit, strong internal capital generation and “strong links between the banks’ and the government of Egypt’s (B3 positive) improving credit profile”. The ratings agency expects loan quality to remain relatively high, anticipating no significant departure from the current NPL ratio.

Outlook

Egypt’s banking system is one of the most well defended in MENA. The debt repayment capacity of corporates is underwritten by their relatively low levels of overall indebtedness, while retail lending – a cause for concern in much of the region – is not a significant determinant of the system’s stability, as credit extension is confined to wealthier households.

The sector is therefore well positioned to take advantage of the economic growth anticipated in the short term: both the IMF and Moody’s expect Egypt’s real GDP growth to reach 5.5% in 2019, up from 4.2% in 2017. A nascent recovery in the tourism sector, rising levels of foreign investment and an increase in domestic consumption are all catalysts for further expansion of the domestic banking sector. Lending volumes are also likely to be buoyed by the cut in interest rates made in 2018, as borrowing costs for Egyptian companies are reduced. However, banks may also face some challenges over the medium term. While a government-driven infrastructure programme will continue to provide lending opportunities to the industry, the state is attempting to reduce its overall debt burden by more closely monitoring borrowing by public bodies.

In September 2018 the CBE obliged banks to obtain written approval from the Ministry of Finance before extending credit to public sector companies. A proposed tax change gained preliminary Cabinet approval in December 2018. This change may also nudge banks away from a widespread tendency to rely on government debt securities for easy margins.

The new measure would remove a provision that allows domestic banks to deduct taxes paid on Treasuries from their bottom-line income tax. With government paper becoming pricier, banks are likely to find the extension of credit to the private sector a more attractive option.

Meanwhile, digital financial services, although rapidly expanding, remain at a relatively nascent stage in the country: in 2017 over 81% of Egyptian bank account holders still paid their utility bills with cash, according to the World Bank. The opportunities for expansion in this area, therefore, are significant.