Reforms prove successful, as the sector maintains robust performance

Despite a challenging economic backdrop, Egypt’s banks have succeeded in growing their assets and maintaining profitability over the past year. Their solid performance has been facilitated by a process of banking reform that began a decade ago, and the Central Bank of Egypt (CBE) continues to command the attention of the sector with its final implementation of the Basel III regulations.

With deposits rising comfortably, attention has turned to the question of lending growth. Banks have taken significant steps to diversify their loan books, but have yet to reap the rewards for their efforts. The uncertainty following the 2011 revolution has heightened the challenge in this regard, but Egypt’s banking sector has overcome similar upheavals in its storied history and is well positioned to do so again.

Sector Origins

The landscape of Egypt’s banking sector, characterised by a large number of state-owned institutions as well as an increasingly active private segment, owes much to the nation’s political development since its establishment as a republic in 1952. The era of Nasserite socialism that followed the abolition of the monarchy saw what had been a vibrant and largely privately held banking industry reduced to just four state-owned commercial banks and a small number of specialised financial institutions.

By the 1970s, however, the sector was opening up again thanks to the “open-door policy” of former President Gamal Abdel Nasser’s successor, Anwar Sadat, and the public sector institutions found themselves competing with a large number of banking joint ventures and branches of foreign banks. Private sector involvement in the market grew still further in the 1990s when a series of central bank decisions resulted in a more favourable lending environment.

Making Changes

However, while deregulation and liberalisation boosted competition and made Egypt’s banking sector one of the largest in the region, by the early years of the present century concern began to mount regarding the long-term sustainability of its expansion. Rapid growth in the number of non-performing loans held by Egyptian banks impelled the CBE to embark upon a process of sector reform (see analysis), the most visible result of which has been the reduction of the number of banks operating in Egypt from 61 in 2004 to 40 banks as of 2014.

The government has taken considerable steps to reduce the role of state-owned institutions in the sector, although with mixed results. A privatisation programme of government-owned institutions ended in 2009 after a number of successful divestments, when an attempt to sell Banque du Caire was called off due to a lack of fair-value offers. The outbreak of political unrest in 2011 resulted in the cancellation of a scheduled second attempt and a decision by the Ministry of Finance to retain the remaining public sector lenders and concentrate on improving their performance.

Today's Sector

On a retail basis, the 40 banks licensed by the CBE operated 3651 branches between them in 2013, an increase of 41 branches over the previous year, which resulted in a banking density of 22.9 (thousands of population per banking unit), according to CBE data. While much of this infrastructure is concentrated in the large conurbations of Cairo and Alexandria, recent years have seen banks attempt to increase their market share through greater geographic coverage, targeting areas such as the heavily populated Delta Region and the new satellite towns and cities springing up around the traditional population centres.

“While Cairo and Alexandria are still the focal points, the fact that a large portion of the population is concentrated in Upper Egypt should encourage public and private banks to expand there,” Hatem Sadek, chairman and managing director at Bank Audi, told OBG.

Players

Of the five public sector banks in Egypt, 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, 2080 of them were operated by one of the five public sector banks. A further seven public-private joint venture banks extend the government’s interest in the market.

The private segment comprises 26 licensed banks, the largest of which is Commercial International Bank (CIB), with total assets of $16bn at the close of 2013. Its principal rivals in the private segment are QNB ALAHLI with assets of $11.47bn, and Faisal Islamic Bank of Egypt, with assets of $6bn.

Foreign banks have had a long presence in the country. In addition to the locally licensed banks and subsidiaries of foreign players such as HSBC, the market contains 24 representative offices of foreign banks. Included in this number are global financial brands such as JPM organ 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.

Changing Hands

The sector’s rude health has meant it has continued to attract capital in recent years, even amidst the broader instability of the country’s macroeconomic environment. In December 2012 BNP Paribas announced the sale of its entire 95.2% stake in BNP Paribas Egypt to Emirates NBD, and the subsequent purchase of the remaining stock by the UAE-based institution made it the sole proprietor of the bank and its network of 69 branches. In March 2013 another Gulfbased bank stepped into the market when the regulator approved the offer presented by Qatar National Bank (QNB) to buy 97.12% of NSGB. As a result, the Qatari institution took possession of the second-largest publicly listed bank in the market with 160 branches. Now known as QNB Al Ahli, the bank’s first annual report reported assets of LE80.8bn ($11.47bn) in 2013.

Regulation

The task of overseeing this diverse sector falls to the CBE, which works according to the Banking Sector and Money Law No. 88 of 2003 and its amendments. Since 2004 the CBE has led a process of reform, implemented in two broad phases. The first stage, or regulatory restructuring, focused on creating a stable and sustainable banking sector better suited to serving the needs of the wider economy. To this end, the CBE set about increasing minimum capital requirements, setting higher capital adequacy ratios, introducing measures to improve asset quality and establishing a more conservative provisioning regime.

The second phase of reform involved three major objectives: following up on the restructuring of the state banks that had implemented new processes as a result of the CBE’s earlier reform phase; preparing a number of smaller, specialised state-owned banks for a similar restructuring process; and applying the banking standards formulated by the Basel Committee on Banking Supervision to the sector. Although this phase was declared complete in 2012, the changing nature of the Basel precepts means that it is ongoing.

The full implementation of regulations arising from the Basel process has been delayed by the need to address a number of sector issues that arose from the political turbulence of 2011. Since that time, the CBE’s attention has been on safeguarding the sector, its first step being to prevent a run on the banks by temporarily closing them and injecting LE5bn ($710m) into the system before depositors were granted access to their capital. Further precautions included the imposition of a daily withdrawal limit of LE50,000 ($7100), a five-day execution period for outbound transfers and enhanced monitoring of foreign exchange transactions. The central bank 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 2012.

With the prospect of a sustained period of stability now a reality following the 2014 presidential election, the CBE is likely to return to its efforts to harmonise the sector with the Basel requirements, as well as address the question of financial inclusion, which has emerged as an important issue in the wake of Egypt’s social unrest (see analysis).

Financial Soundness

The result of the CBE’s reform initiative is a banking sector capable of meeting recent political and economic challenges. As of March 2014 aggregate capital adequacy stood at a healthy 13.7%, comfortably above the 10% regulatory requirement. The banks have also reported a gradual improvement in asset quality over the last three years, with the ratio of non-performing loans to total loans falling from 10.5% in 2011 to 9.3% in March 2014. Moreover, the Egyptian banking sector’s loans-to-deposits ratio declined from 50.2% to 41.5% over the same period, while its core liquidity ratio, defined as the ratio of readily available liquid assets to customer deposits, was increased in that timeframe.

Despite these strong fundamentals, Moody’s investors service downgraded the local currency deposit ratings for five Egyptian banks in early 2013. Crucially, this was not due to concerns regarding the financial soundness of these institutions, but rather came as a result of their exposure to the sovereign, the downgrading of which made a similar downward reassessment of some Egyptian lenders an inevitability.

Performance

The robust performance of the banking sector during the recent political and economic turbulence is testament to the success of the CBE’s reform efforts. According to CBE data, aggregate assets for the sector grew to a dollar equivalent of $242.2bn in 2013, against $226.5bn in 2012. This gain was driven by banks’ success in attracting deposits, which rose by 20.6% in local currency terms over the year, more than twice the rate of growth achieved in 2012. Within this overall increase, private sector deposits in local currency showed the most significant gain, reflecting a welcome degree of confidence in both the wider banking system and the Egyptian pound.

Lending

However, as is the case in many emerging markets, Egypt’s banking sector has yet to transform this rise on the assets side of the balance sheet into lending activity. The last year of significant lending growth was 2008, when it posted a 12.7% expansion of credit facilities, according to a recent report by Bank Audi. Since then a cooling global economy and domestic unrest has dampened demand for credit and led to subdued lending growth levels, which reached a modest high of 2.8% in 2011 before sinking to 0.1% in 2012.

In 2013 the lending activity of the sector posted a 2.6% contraction in dollar terms, and a modest rise of 5.6% in local currency terms thanks to a depreciating Egyptian pound. Nevertheless, Egypt’s banks have maintained a high degree of profitability over the past year.

Boosting Borrowing

While the country’s banks have proven themselves to be both stable and profitable, there has been a broad push in the last few years to boost private sector credit, but a lack of demand, compounded by a reliance by the state to borrow from local banks, has constrained activity.

The need by the government to borrow locally has allowed Egypt’s banking sector to secure an easy yield by extending credit to the sovereign, given that demand from the private sector has been low in the past three years. In local currency terms, total credit extended to the government over 2013 grew by 18.3%, according to research from Bank Audi, compared to a 5.6% increase in lending to the private sector. This trend continued into 2014: the CBE’s 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).

“In the last three years banks have been preoccupied with investing in Treasury bills, leaving a significant space for the leasing industry to grow,” Yehia Ezz El Din Nour, managing director of Incolease, told OBG. Indeed, there are signs that private sector activity will pick up in the coming years. The large development projects recently announced by the government, such as an expansion of the capacity of the Suez Canal, suggest that big-ticket project financing will accelerate demand in the short to medium term. With a long list of capital investments planned for the transport, housing and utilities sectors, the state is increasingly looking to the private sector to develop these initiatives through public-private partnerships – a template with a decent track record in Egypt following the 2006 creation of a dedicated unit at the Ministry of Finance – which represents a major opportunity for local banks.

At the other end of the spectrum, the search for new sources of revenue since the global economic downturn of 2008 has increased interest in lending to small and medium-sized enterprises (SMEs). The CBE has encouraged this trend through regulation: in 2012 it allowed lenders to write off an amount equivalent in size to their SME credit facilities from the 14% required reserve ratio (RRR), whilst also reducing the RRR from 14% to 12% – in effect freeing up liquidity to be directed to the SME sector. Egyptian banks are therefore likely to deploy lending strategies that tap into corporate credit as Egypt’s political settlement takes hold and private business recovers, while also broadening their revenue base by expanding into the currently underbanked SME segment (see analysis).

Credit Bureau

Despite the obvious potential of Egypt’s SME and retail segments, banks have traditionally found that extending credit in these areas presented a challenge from a risk perspective. However, the ability of lenders to make sound, risk-based decisions when lending to individuals and small businesses has been greatly enhanced in recent years by the work of the nation’s first credit bureau. I-Score commenced operations in 2012, and as of May 2014 it logged the credit data of 118,277 businesses and 8.9m consumers.

“In Egypt credit bureaux are still working to ensure buy-in from financial institutions, however as their capacity to determine credit-worthiness improves, so too does lending activity in the banking sector,” Mohamed Kafafi, chairman and CEO of I-Score, told OBG. To date, I-Score has also rated SMEs using the same framework it applies to its coverage of individuals, but this is expected to change in the short term with the launch of a subsidiary dedicated solely to the SME sector. 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. By the summer of 2014 the new company, as yet unnamed in English, had been legally formalised and had held its first general assembly, while its technical partner, Standard & Poor’s, was in the process of appointing the project team.

Mortgages

As in many emerging markets, particularly in the Middle East and North Africa, mortgage lending in Egypt is still far below potential. The segment is well established, however, dating back to the turn of the century. The legal framework was created in 2001 with the promulgation of the Real Estate Finance Law and the first licensed mortgage finance company (MFC) opened its doors for business in 2004, but like all primary lenders offering housing finance, the early MFCs to enter the market lacked reliable access to sources of term finance at favourable rates. As a result, loans to homebuyers remained a negligible part of banking activity, with few MFCs and a small number of commercial banks offering home finance – usually as part of their retail operations and on a collateral basis.

The creation of the Egyptian Mortgage Refinance Company (EMRC) in June of 2006 was intended to address this issue through the creation of a liquidity facility, and came about as a result of a partnership between the Egyptian government, the World Bank and its private sector arm the International Finance Corporation. The company is mandated to provide funds for refinancing by primary mortgage lenders, including commercial banks, and to date it has drawn its equity from its shareholders and founding investors, which includes the World Bank. The EMRC is also mandated to obtain capital via bond issuance in the domestic market when economic conditions allow.

The EMRC has met with some success: according to the World Bank, the number of MFCs grew from two in 2006 to 12 by 2011, while the volume of market-based mortgage loans, including bank lending, rose from LE300m ($42.6m) to LE4.5bn ($639m) over the same period. However, mortgage take-up remains low: in mid-2013, according to the EMRC, aggregate mortgage lending stood at around LE4.5bn ($639m), or around 0.3% of GDP. Obstacles to growth in the mortgage market include low average wages (LE761, $108 per month, according to the Central Agency for Public Mobilisation and Statistics) a lack of formalisation in the housing sector (with less than 30% of household units registered), and state bureaucracy.

In response, the authorities have examined ways to boost Egypt’s nascent mortgage industry. In late 2012 the regulator of non-bank financial markets, the Egyptian Financial Services Authority (EFSA), proposed changes to the existing mortgage law by which it aimed to introduce instruments such as remortgaging, refinancing of mortgages, alternative methods of finance such as the sharia-compliant murabaha (cost-plus financing) model, and equity finance. While these measures have yet to be implemented, the CBE has addressed the challenge more adroitly by announcing in February 2014 that it would allocate LE10bn ($1.42bn) in funding for banks to re-lend in the form of housing loans with terms of 20 years and interest rates of 7-8%.

Building a customer base for these new mortgage services will also be a vital part of the segment’s success. “To increase mortgage financing, awareness of the service must be developed, as the average Egyptian buyer is not familiar with it,” Hassan Abdalla, the CEO of Arab African International Bank, told OBG.

One way to do this might be to rely on Islamic and sharia-compliant financial services. "Given its own regulatory framework, Islamic banking products and services could reach less developed areas of the country, as it is often there where religion plays a more important role in the lives of the citizens,” Mohamed Naguib Ibrahim, chairman of SAIB Bank, told OBG.

Technoogy

Another way in which banks are seeking to expand and diversify revenue streams is through the use of technology. The CBE has encouraged banks to develop their ATM networks, increase the number of point-of-sale (POS) terminals and issue more bankcards as part of a social inclusivity drive initiated in the wake of the 2011 revolution. Banks have responded enthusiastically: according to the CBE, the annual increase in the number ATMs and POS terminals rose by 14% and 15%, respectively, in the 2012/13 financial year. The number of bankcards, meanwhile, grew between 8% and 15% for the three years prior.

The first payment service provider (PSP), Fawry, entered the market in 2008 with 6000 POS terminals in major cities, and banks such as NBE, CIB, Bank du Caire, Banque Misr, Bank Alexandria and Credit Agricole use its services. Since then other PSPs, such as Masary and Bee, have entered the market.

Technological channels can also provide a useful route to Egypt’s large unbanked population – a recent report by professional services firm EY suggests that only 10% of Egyptian adults are account holders – and some PSPs have already held discussions with banks on the subject of partnering to provide e-wallets. The e-money model has been slow to gain a foothold in Egypt, due in large part to a regulatory overlap between the CBE and EFSA that stalled its introduction to the market. But with the major regulatory obstacles worked out, four mobile wallet products reached the market over 2013 and early 2014, with the NBE, the Housing and Development Bank and Emirates NBD involved with three of the projects. Given the size of Egypt’s market and its increasingly tech-savvy population, it is likely that more banks will enter the e-money arena.

Outlook

Egypt’s banking sector has shown its ability to thrive even in turbulent times by posting a growth in banking activity over the past year, while maintaining profitability. Over the next year it is likely that the question of regulatory compliance will continue to occupy banks’ management across the sector as the CBE presses on with the Basel III Accord.

While the sector has succeeded in maintaining deposit growth over the past year, promoting asset growth through lending is to a large degree tied to the nation’s fragile economic recovery. The IMF foresees 4.1% growth in GDP over the 2014/15 financial year, an improvement on the projected 2.3% of 2013/14, but one that is vulnerable to downside risks such as domestic unrest or political uncertainty. A warming economy, should it be sustained, will provide increased lending opportunities, which would support Egypt’s banks in tackling their most serious challenge: to reduce