How banking reform is boosting business lending in Egypt

The largest of its kind in North Africa, Egypt’s banking sector has also long been seen as one of the most stable in the region. Since 2010 the industry has overcome the challenges of political revolution, currency crises and an interest rate environment that has acted as a barrier to credit extension. While Egypt’s macroeconomic outlook at the beginning of 2020 suggested more favourable conditions for the nation’s lenders, the impact of the global Covid-19 pandemic has dampened the sector’s short-term growth prospects. Nevertheless, years of prudent financial regulation have supported the development of a strong and liquid banking system that is set to help Egypt during its recovery stage. With a new banking law reaching the implementation stage, Egyptian financial institutions are well positioned to resume their usual growth trajectory as the global situation improves.

History

Egypt has one of the oldest banking sectors in the region, with modern banking practices commencing with the establishment of the Bank of Egypt in 1858. Foreign institutions powered the first phase of banking development in the country, led by Anglo Egyptian Bank, Crédit Lyonnais and the Ottoman Bank, along with a number of Greek, French and Italian institutions. In 1898 the National Bank of Egypt (NBE) was established with the support of British investors and granted a mandate to issue Egyptian banknotes. However, the first purely Egyptian bank was Banque Misr, which was founded in 1920.

After three decades of rapid expansion, the 1950s nationalisation programme of then-President Gamal Abdel Nasser reduced the industry to four stateowned commercial banks and a small number of specialised financial institutions. The NBE was separated into a public sector commercial bank that maintained the original name, and the Central Bank of Egypt (CBE), which assumed its central bank duties.

This period of stasis lasted until the 1970s, when then-President Anwar Sadat began a process of economic liberalisation. A new piece of banking legislation, 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 agriculture sector. In the 1990s a series of directives issued by the CBE sought to further liberalise the lending environment, ushering in a period of private sector investment and credit expansion. However, the banking boom that followed was accompanied by a deterioration in asset quality. The level of non-performing loans (NPLs) soon compelled the regulator to carry out deep reform of the sector, the most visible result of which was a reduction in the number of banks operating in Egypt: from 61 institutions licensed by the CBE in 2004 to 38 as of June 2020.

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, Egypt’s state-owned banks continue to play a prominent role in the industry, with three of them – the NBE, Bank Misr and Banque du Caire – controlling around 40% of the sector’s assets. With total assets of over LE1.6trn ($98.6bn) at the close of FY 2018/19, NBE dominates the sector, claiming a market share of 29.3%. Banque Misr has the second-biggest asset base in the sector, valued at LE887.5bn ($54.7bn), while Banque du Caire’s total assets stood at LE179bn ($11bn). The state’s interest in the market includes another seven public-private joint-venture institutions. Over recent years the government has moved towards a partial withdrawal from the banking sector, earmarking a number of public institutions for privatisation (see Capital Markets chapter). Banque du Caire has been the principal banking sector candidate for the privatisation programme for some time, with other potential divestments including 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. However, in early 2020 Banque du Caire announced that it had postponed its planned offering of between 20% and 30% of its shares, citing market turbulence caused by the Covid-19 pandemic. The timing of further bank privatisations is largely dependent on the readiness of individual institutions for an initial public offering (IPO), and whether or not market conditions will result in a fair price.

Private Sector

Two private banks are among the country’s “big five”. The largest of these is Commercial International Bank (CIB), which as of March 2020 had total assets of LE381.6bn ($23.5bn), making it the third-largest commercial bank in the sector. CIB is widely considered to be the best managed private sector bank in Egypt, and constitutes 30% of the Egyptian Exchange’s main index the EGX30. With its position within the domestic market well established, the bank has recently begun to pursue international expansion opportunities. In April 2020 CIB finalised its purchase of 51% stake in Kenya’s Mayfair Bank – which was subsequently renamed Mayfair CIB Bank. The purchase forms part of CIB’s strategy to pursue opportunities on the African continent, which are expected to multiply as a result of the recently established African Continental Free Trade Agreement.

Qatar National Bank, which operates in Egypt as QNB Alahli, is the only other private sector bank in the big five. With total assets of around LE284.4bn ($17.5bn) as of March 2020, it is the fourth-largest banking institution in Egypt. The bank has been present in the country since 1978 but its large-scale commercial banking operations began in 2013, when QNB Alahli purchased 97% of National Société Générale Bank’s Egyptian operations.

Structural Changes

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 2007-08 financial crisis. Kuwait’s Al Ahli Bank received its long-awaited licence in August 2015, joining a cohort of Gulf Cooperation Council banks with Egyptian operations that includes Union National Bank, First Abu Dhabi Bank, Mashreq Bank, Abu Dhabi Islamic Bank and Emirates NBD.

UK-headquartered Barclay’s Bank left the market in 2017, selling its local operation to Morocco’s Attijariwafa Bank – thereby ending a relationship with the country that had lasted since 1864. In early 2020 First Abu Dhabi Bank was in negotiations with Bank Audi to acquire its Egypt operation. The Lebanon-headquartered lender operates 50 branches in the country, holding $4.4bn in local assets as of September 2019. Since the mid-2000s the CBE has declined to issue licences to potential entrants to the market, encouraging them instead to seek out acquisition targets among existing financial institutions. Nonetheless, in a sign that this stance may be set to change, the CBE announced in March 2020 that it had been approached by a major international financial institution seeking a licence to operate in the country. However, as of June 2020 no additional information had been disclosed regarding this development.

Islamic Banking

While Egypt was a pioneer of sharia-compliant banking – spearheading the development and growth of the industry in the 1960s – the failure of a number of Islamic investment companies in the 1980s damaged the reputation of the segment. Consequently, the current Islamic banking industry in Egypt is small by regional standards.

Three Islamic banks operate in the country and 12 conventional institutions offer sharia-compliant windows. According to the Egyptian Islamic Finance Association, the segment accounts for around 6% of banking sector assets. There are currently no specific regulations governing sharia-compliant banking in the domestic market, although over the past decade the possibility of establishing an independent sharia authority and a section on Islamic banking in the banking legislation has been raised.

Non-Banking

As well as competing with one another, Egypt’s banks face an increasingly challenging contest for market share from the nation’s non-banking financial institutions. These include financial leasing companies, real estate finance companies and a rapidly expanding number of microfinance organisations. “Leasing companies are a growing industry in Egypt because it is able to fill the gap between demand for financing from developers and the lack of project financing available through banks due to the cost or length of the process,” Yehia Ezz Eldin, managing director of the international financial leasing firm Incolease, told OBG. The companies have also been an important part of the response to the Covid-19 pandemic. “The financing industry as a whole is focused on mitigating the impact of the pandemic and helping businesses continue operations,” Tarek Kandil, chairman and managing director of Al Ahly Leasing, told OBG. “In the near future these measures increase competition between banks and leasing firms. Despite this, the leasing outlook is expected to remain stable in the medium and long term.”

In May 2017 the CBE launched a new microfinance initiative aimed at directing LE30bn ($1.8bn) in credit to approximately 10m beneficiaries by 2021, and eight banks offering subsidised funding to microfinance companies and NGOs are expected to be licensed by the regulator. The involvement of financial institutions at this level is often confined to providing liquidity to microfinance providers, but some have developed microfinance capacities of their own. Banque du Caire, for example, began to roll out its microfinance operation as early as 2002 and subsequently achieved an annual growth rate of between 20% to 30% in the years to 2018. In 2019 the bank’s microfinance portfolio stood at LE4.4bn ($271.2m), with a NPL rate of 0.77%. Banks lending to microfinance intermediaries are permitted to include the credit in their calculations for the CBE’s small and medium-sized enterprise (SME) lending quota. The segment continues to evolve, and in October 2019 the government positioned it for a new phase of sustainable expansion by establishing revised capital requirements for non-banking funding institutions. The new regulations stipulate that companies wishing to finance SMEs must have paid-up capital of LE20m ($1.2m), while those looking to finance micro-enterprises are mandated to hold LE5m ($308,000). How banks will respond to the expansion of microfinance activity in the domestic market is one of the more salient questions facing the finance industry. “The strengthening of the regulatory framework around microfinance is a positive development, which is enabling a greater share of small businesses to enter the registered economy,” Amr Abou El Azm, chairman of Tamweely Microfinance, told OBG.

Performance

Egypt’s banks have operated against an increasingly promising economic backdrop since the depreciation of the Egyptian currency in 2016. That policy decision loosened constrictions on foreign currency operations, while the macroeconomic reforms that the government introduced at the time have resulted in positive GDP growth and a more favourable investment environment. The high interest rates that the government has been compelled to pay to secure funding in the open market, meanwhile, mean that banks have found it increasingly profitable to channel excess liquidity into high-yielding Treasury investments. Although this trend has the potential to constrain lending to the private sector, it has supported robust net interest margins for most lenders. According to the CBE, Egypt’s banking sector recorded a total net profit of LE83.2bn ($5.1bn) in 2019, nearly LE61bn ($3.8bn) of this was amassed in the first nine months of the year, a considerable rise on the LE48.5bn ($3bn) reported during the same period of the previous year. Around LE41.7bn ($2.6bn) of the 2019 net profit was accounted for by the nation’s five leading banks, while the top-10 banks in the sector were responsible for nearly 71% of the total. However, while the sector entered 2020 well positioned for continued growth, the effects of the Covid-19 pandemic are likely to exert considerable downward pressure on bottom lines. Domestic business disruptions included a curfew established in March 2020, as well as the implementation of 14-day quarantine periods for foreign arrivals.

In March 2020 the CBE introduced a number of measures that were aimed at mitigating the effects of the outbreak on the economy, many of which have the potential to undermine bank profits during 2020. Among the most significant of these measures were a requirement that banks refrain from imposing fees for late payment on NPLs, and a six-months delay on credit repayments for both institutions and individual clients, including consumer and real estate loans. Local banks were also instructed to raise daily transaction limits on credit cards, as well as cancel fees and commissions applied to points of sale and ATMs.

Lending

The effects of the pandemic are expected to undermine the liquidity position of Middle Eastern banks. Lenders in the region rely to a large extent on customer deposits to finance lending and in some markets these are insufficient to support the credit portfolios of banks, according to ratings agency Standard & Poor’s. However, while loan-to-deposit (LTD) ratios average 100% in the region, Egypt’s LTD ratio is significantly lower, at 46.2% as of December 2019. This means that banks in Egypt should be able to retain sufficient liquidity to expand credit operations utilising existing funding sources.

However, market concerns regarding the sector’s lending patterns pre-date the challenges brought about by the pandemic. These are largely centred on the tendency among lenders to seek easy margins from government debt rather than extending credit to the private sector. In 2018 Egypt’s banks held LE2.4trn ($147.9bn) in government debt, while their aggregate lending to the private business sector stood at LE804.8bn ($49.6bn). Nevertheless, the country’s declining interest rates may go some way towards reversing this trend. The government has also rolled out a number of lending stimulus measures over recent years in a bid to increase the flow of credit to the private sector. For example, an SME lending scheme, launched in 2016, enabled qualifying companies to secure loans with a 5% interest rate and by 2019 had provided funding to around 86,000 small factory owners. A mortgage subsidisation scheme for middle-income customers ran from 2014 to January 2019, providing homeowners with long-term loans at an interest rate of between 5% and 7%.

In mid-2019 the CBE announced that it would provide LE50bn ($3.1bn) for a similar support mechanism, the precise details of which left to a committee made up of central bank officials and representatives of local banks and real estate developers. In late 2019 the government introduced a policy framework aimed at providing subsidised lending to the manufacturing sector. Under the new scheme, companies with annual revenue of less than LE1bn ($61.6m) are permitted to apply for loans at a reduced interest rate of 10%.

The government has made LE100bn ($6.2bn) available to support the programme, with funding channelled through state-owned banks. The principal rationale for the scheme’s deployment is to address the problem of defaults in the manufacturing sector. The initiative therefore includes a debt-relief element that is intended to cover the arrears of more than 5000 companies, totalling around LE31bn ($1.9bn). The lending element of the scheme, meanwhile, targets a group of factories that together defaulted on principal loans worth around LE6bn ($369.8m). It is intended that the defaulting firms pay down 50% of the principal loan, receiving an exemption from the interest due, then pay the remainder of the loan at a reduced rate calculated on a monthly basis according to the outstanding amount owed. The rollout of the initiative marks a positive development for the country’s banks, who are now able to secure repayments on loans that would have otherwise been classified as NPLs. It also has the potential to benefit Egypt at the macroeconomic level, with research from Cairo-headquartered investment bank Beltone Financial forecasting that the funding initiative will help to boost both capital spending and the country’s purchasing managers’ index by the end of 2020.

Financial Stability

The domestic banking sector has succeeded in expanding its aggregate credit portfolio without any deterioration in asset quality. As of December 2019 the sector’s Tier-1 to risk-weighted assets ratio stood at a healthy 15.9%, according to the CBE. Banks have reported a gradual improvement in asset quality since 2011, with the ratio of NPLs to total loans declining from 10.5% to 4.2% by December 2019. Liquidity in the sector remains abundant, with local-currency liquidity underwritten by a robust retail deposit base. Foreign currency liquidity, meanwhile, has been boosted by the CBE’s decision in November 2016 to allow a depreciation of the currency. In April 2019 international credit ratings agency Moody’s upgraded the long-term local-currency deposit ratings of four major Egyptian banks – CIB, Banque du Caire, the NBE and Banque Misr – from “B3” to “B2”, while the rating for AlexBank rose from “B2” to “B1”. The move followed the rating agency’s upgrade of Egypt’s sovereign debt rating to “B2”.

“Egypt is better placed to weather the economic downturn caused by Covid-19 than many of its counterparts in the region,” Tarek Fayed, chairman of Banque du Caire, told OBG. “Not only does the country have a robust and liquid banking sector, but the CBE’s decisive actions early on in the crisis will help ensure monetary and fiscal stability over the short term.”

Regulation

The CBE governs Egypt’s banking sector according to 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 in 2020. The Cabinet gave its approval to the new Banking and Central Bank Act in October 2019, after which it was sent to the Council of State for amendments. As of May 2020 the revised Act was ready to be sent to the House of Representatives for final approval. Key changes introduced by the legislation include a 10-fold raising of the minimum capital requirement for domestic banks, to LE5bn ($308.2m), and a three-fold hike for foreign banks to $150m. It also includes new ownership regulations, including a prohibition on any individual or related group holding more than 10% of a bank’s equity, a requirement that all banks start their financial year in January and publish quarterly financial data; and a directive to establish a financial stability committee to prepare for and avert financial crises. The law also includes new regulations covering e-payment and financial technology (fintech) activities, the establishment of the CBE as regulator of cryptocurrencies, and new data-protection and customer privacy requirements. In May 2020 the House of Representatives approved the proposed legislation. Implementation will take place after a final vote and the signature of President Abdel Fattah El Sisi.

In addition, the CBE introduced new regulations in December 2019 that require banks to undertake background checks on the ownership and creditworthiness of suppliers that customers are borrowing to repay. The new framework requires that banks implement a know-your-customer process, including obtaining copies of the commercial registration documents of the supplier before a loan is approved. “The efforts being made to formalise the economy, extend credit to SMEs and boost microfinance are important for economic development,” Mohamed Kafafi, CEO of the Egyptian Credit Bureau (iScore), told OBG. “The ability to accurately assess creditworthiness is an essential aspect of being able to implement these initiatives.”

Financial Inclusion

Another overriding concern for both the government and the CBE is the question of financial inclusion. According to the World Bank, the number of Egyptians with a bank account has risen steadily over the past decade, from 9.7% of the population aged 15 and over in 2011 to 14.1% in 2014 and 32.8% in 2017. While the trend is encouraging, Egypt’s banking penetration remains significantly below that of the 43.5% average of the MENA region and the global average of 68.5%. Historical challenges to financial inclusion include a concentration of banking infrastructure in urban areas and slow innovation by state-owned institutions. More recently, the government’s reform of state-owned banks in preparation for their privatisation, combined with the innovations emerging from the private sector institutions, has resulted in a more accessible banking sector.

In the non-banking segment the government is driving microfinance growth as a means to boost financial inclusion. Since 2019 this effort has intensified, with a move towards the establishing a nano-finance segment. In January 2020 the Financial Regulatory Authority revealed terms and conditions for the concept would include a maximum loan of $190 per individual, to be repaid over a three-month period.

A move towards digitalisation is helping the government reach its financial inclusion goals, as well as improving efficiency. Reducing the dependence of Egyptians on banknotes has been a government priority since 2016, and the CBE has played its part in this effort by introducing regulations for mobile payments and directing banks to boost the proportion of their customers actively using e-wallets. The first digital wallet in the Egyptian market was rolled out in 2013 by NBE in collaboration with MasterCard and Etisalat. A new regulatory framework for the technology was introduced in 2016, paving the way for exponential growth in digital transactions. Just over 21% of Egyptians aged 15 and over reported receiving digital payments in 2017, up from 4% in 2014.

The proportion of the bankable population accessing their bank accounts via the internet remains low, however, with just 4.1% doing so in 2017. “Although there is a correlation between digitalisation and financial inclusion, for the rural and less-educated population a lack of trust can be an obstacle to technology adoption,” Akram Tinawi, CEO and managing director of Arab Banking Corporation Egypt, told OBG. “The real solution will require education and awareness to change the mindset of the unbanked.” With at least 47% of the population using the internet and a smartphone penetration rate of around 28%, this segment has considerable potential for expansion.

Outlook

In early 2020 the outlook for the rest of the year was a broadly positive one. Indeed, Moody’s expected the profitability of banks to improve further, with a projected acceleration in credit growth of between 12% and 15% over 2020, declining interest rates, and government funding initiatives for the industrial, tourism and mortgage sectors. Other market observers predicted an increase in the corporate sector’s capital expenditure in 2020, driven by cuts to the policy rate, that would feed into lending opportunities for banks. Before the close of the first quarter, however, it became apparent that Covid-19 would have a deleterious effect on the domestic economy.

In May 2020 the Institute of International Finance revised its forecast for Egypt’s GDP growth for the year, from 5.4% to 2.7%, citing economic headwinds resulting from the pandemic. As a result, Egypt’s financial institutions are likely to focus on maintaining their asset quality over the year rather than boosting their lending portfolios. Social distancing, meanwhile, is likely to add momentum to the more widespread adoption of online banking and digital payments.