Benefitting from the nation’s increasing economic stability over the past year, Egypt’s banks have enjoyed both ratings upgrades and continued profitability. Thanks to an ambitious government development strategy and new investment legislation, the project finance pipeline is returning to form after a period of muted activity. Elsewhere on the aggregate loan book, competition is heating up to serve a largely untapped retail segment and the nation’s challenging, but potentially rewarding, small and medium-sized enterprise (SME) segment.
The economic and political upheavals faced by the banking sector since the revolution of 2011 were not the first that it has had to contend with in its modern history. The introduction of socialism under President Gamal Abdel Nasser in the 1950s 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. Two decades later, the “open door” policy of Nasser’s successor, Anwar Sadat, turned the nation’s economic gaze outwards once again. The banking law promulgated during this period (Law 120/1975) opened the industry up to the private sector once more, and defined a triform mode of operation for the banks, which consisted of commercial and retail banks; corporate and investment banks; and specialised banks focused on certain sectors, such as agriculture.
The private sector move into the banking industry that took place during the 1970s gained momentum in the 1990s, when a series of central bank decisions resulted in a more favourable lending environment. 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. Banks operating in the modern sector also have more options open to them as they set about expanding their business: the differing banking models established by the 1975 law have been removed by a process of reform, and banking licences today cover the whole spectrum of activities, including commercial and investment banking. Instead, banks are usually classified by ownership: public sector, private and joint venture, or foreign. A rapid rise in the number of non-performing loans held by Egyptian banks impelled the Central Bank of Egypt (CBE) to embark upon a process of sector reform – the most visible result of which has been the reduction of the number of banks operating in Egypt from the 61 of 2004 to the 40 banks licensed by the CBE as of 2015.
The Modern Sector
Today’s banking sector is one of the largest and most diverse in the region. According to the most recent data published by the CBE, the 40 licensed banks operated a total of 3690 branches between them as of March 2014 – an increase of 39 branches on the previous year.
While much of this infrastructure is concentrated in the large urban conurbations of Cairo and Alexandria, recent years have seen banks attempt to increase market share through greater geographic coverage in areas such as the heavily populated Delta region, and the new satellite towns and cities springing up around the traditional population centres.
Despite the steadily increasing number of branches, however, the Egyptian market remains relatively under-penetrated. According to the World Bank, Egypt’s banking density stood at 4.9 in 2013 (defined by commercial bank branches per 100,000 adults). This places the country alongside other emerging economies such as Algeria, which exhibited a banking density of 5.1 in 2013, and Iraq (5.5). There is, therefore, considerable room for expansion. By way of comparison, Saudi Arabia has a banking density of 9.0, according to the World Bank, while the UAE and Qatar are on 12.4 and 13.2, respectively.
The legacy of the 1950s nationalisations is apparent in the significant role still played by publicly owned institutions. Of the “big five” commercial banks in the market, three are public sector institutions, the largest of which is the National Bank of Egypt (NBE), which, with assets in excess of LE470bn ($64.1bn) as of 2015, occupies a dominant market position. Coming second in terms of balance sheet size is Banque Misr, another state-owned institution, which posted total assets of LE274.4bn ($37.4bn) at the close of the 2013/14 financial year. A third public sector player, Banque du Caire, rounds out the big five, as the fifth-largest in the country with total assets of LE70.5bn ($9.6bn). Another seven public-private joint venture banks further extend the government interest in the market.
Over the past two decades the nation’s private sector banks have moved beyond their initial focus on trade-related financial services to the private business sector, and expanded significantly into retail services and the loanable fund market. As a result, two of the 26 licensed banks in the private segment have made it into the big five. The largest of these is Commercial International Bank (CIB), which at the close of 2014 had total assets of LE143.6bn ($19.6bn), making it the third-largest commercial bank in the country. Qatar National Bank (QNB), which operates in Egypt as QNB Alahli, is the fourth-largest player in Egypt, with total assets of LE102.2bn ($13.9bn) at the close of 2014.
The prominent position of a subsidiary of QNB in the Egyptian market is representative of a wider move by Gulf banks into the sector. In December 2012 BNP Paribas announced the sale of its entire 95.2% stake in BNP Paribas Egypt to Dubai-based Emirates NBD, and the subsequent purchase of the remaining stock by the institution made it the sole proprietor of the bank and its network of 69 branches. Meanwhile, QNB bought an additional 19.95% stake in National Société Générale Bank in March 2013, acquiring a controlling stake of 97.12% in the Egyptian subsidiary of France’s Société Générale. The Qatari institution took possession of the second-largest publicly listed bank in the market with a branch network of 160 units.
In late 2014 Kuwait’s Al Ahli Bank became the latest Gulf institution to choose the Egyptian sector as means of escape from a crowded home market. According to the proposed deal, the Kuwaiti bank will pay $150m in cash for a 98.5% stake in Piraeus Bank’s Egyptian unit, which has 39 branches in the country and total assets of nearly LE10bn ($1.4bn). As of July 2015, the Central Bank of Kuwait had given its permission for the deal to go ahead, while the regulators in Egypt and Greece had yet to grant their final approval.
Operating alongside these newcomers are a number of well-established foreign players, such as HSBC (which had total assets in Egypt of LE58.6bn [$8bn] at the close of 2014) and Barclays (which has operated in the country since 1864). In addition to the locally licensed banks and subsidiaries of foreign institutions, the market contains more than 20 representative offices of foreign banks – including 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.
The CBE is charged with regulating the activity of the banking sector, as well dealing with the daily settlements and clearings of all licensed banks, which it carries out according to the Banking Sector and Money Law No. 88 of 2003 and its numerous amendments. Since 2004 it has steered a process of banking sector reform, which it implemented in two broad phases. The first stage involved sector stability. The CBE set about increasing minimum capital requirements, setting higher capital adequacy ratios, introducing measures to improve asset quality and establish a more conservative provisioning regime.
The second phase of reform involved three major objectives: following up on the restructuring of the state banks which had implemented new processes as a result of the CBE’s earlier reform phase; preparing some smaller, specialised state-owned banks for a similar restructuring process; and applying the banking standards formulated by the Basel Committee on Bank Supervision to the entire banking sector.
Although a final circular on the Basel requirements was published in 2012, the changing nature of the Basel precepts means that it is an ongoing process. The full implementation of regulations arising from the Basel Committee has also been delayed by the need to address several sector issues that arose from the political turbulence of 2011, which saw the temporary closure of banks and new currency controls.
Egyptian banks are, however, already reporting to the CBE both in the traditional format in terms of capital adequacy and according to the new regulations formulated by the CBE to comply with Basel reporting criteria. Egypt’s return to economic stability has allowed the regulator to return its attention to a longer-term objective of boosting financial inclusion.
In late 2014 the CBE introduced new regulations concerning the opening of “mini-branches” by banks, which establishes a range of capital requirements depending on branch location. According to the new system, banks are required to hold LE5m ($682,000) for every branch operated in Cairo and LE2m ($273,000) for those established in other governorates except Upper Egypt, where a more favourable LE1m ($136,000) requirement is imposed. The move brought results in 2015, with Arab Investment Bank announcing that it would open 12 new mini-branches along with five regular units, and Ahli United Bank Egypt making a similar commitment across a number of governorates. “In allowing banks to open mini-branches with less capital than conventional ones, the government has greatly expanded the area and amount of people that will have access to quality banking services,” Nevine Loutfy, managing director and CEO of Abu Dhabi Islamic Bank Egypt, told OBG. “This is particularly important in underserved rural areas like Upper Egypt, where current facilities are not enough to handle the large amount of remittances destined for the region each year.”
In 2013 the Cabinet passed a new maximum wage law, to be applied to all employees in the administrative body of the state, local government servants, and employees in the various economic, national and general authorities. As a result, the wage ceiling for these groups, which include those working in the public sector banks, is now set at LE42,000 ($5700) per month, a level which makes it difficult for institutions such as NBE, Banque Misr and Banque du Caire to retain the talent that played a crucial role in the successive phases of sector reform since 2004.
The CBE’s history of careful stewardship has enabled the sector to survive both the global economic downturn which began in 2008 and the revolution of 2011 without a significant erosion of financial soundness indicators. As of March 2015 aggregate capital adequacy for the sector stood at a healthy 13.5%, comfortably above the 10% regulatory requirement. Banks have also reported a gradual improvement in asset quality since 2011, with the ratio of non-performing loans to total loans falling from that year’s 10.5% to 8.3% in March 2015 and declining again to 7.6% at the end of June 2015, according to the CBE. Moreover, the Egyptian banking sector’s loans-to-deposits (LTD) ratio declined from 50.2% in 2011 to 41.4% in June 2015. The sector’s liquidity ratio in local currency has increased over the same period, reaching 63.1% in June 2015.
Despite this, Moody’s Investors Service downgraded the local currency deposit ratings for five Egyptian banks in early 2013. This was a result of their exposure to the sovereign, the downgrading of which made a similar downward reassessment of some Egyptian lenders an inevitability.
With the macroeconomic economic situation improving in 2015, Moody’s upgraded its outlook on the sector to stable in mid-July. Explaining its decision, the ratings agency stated that it expects the Egyptian banking system to “benefit from improved operating conditions, resulting in rising consumer confidence and business investments, which in turn will support loan growth and asset quality”.
From its solid base, the sector has succeeded in showing a consistently strong performance in the face of political and economic turbulence, although some players are cautious about increasing sector risk. “The Egyptian Financial Supervisory Authority currently requires that a leasing company’s assets not exceed its capital base by more than 8:1,” Yehia Ezz El Din, executive president and managing director of international leasing firm Incolease, told OBG. “While there is talk of changing this to 9:1, or even 10:1, we think that this would create unnecessary risk in an otherwise healthy industry.” According to CBE data, the aggregate financial position of the sector stood at LE2.03trn ($276.7bn) at the start of 2015, up from around LE1.68trn ($229bn) at the beginning of 2014. Over this period the sector showed its ability to consistently attract deposits, which grew from around LE1.31trn ($178.6bn) in December 2013 to reach LE1.59trn ($216.7bn) in January 2015. This rise of roughly 21% was not, however, matched by a similar expansion of lending activity: over the same period loans to customers rose from LE550bn ($75bn) to LE646bn ($88bn), an increase of around 17%. A rate of credit expansion trailing that of deposit growth and a modest LTD ratio of 41% suggest that the banking sector is not lending to its potential.
Hatem Sadek, chairman and managing director of Bank Audi, told OBG, “While lending has declined over the past few years, it is beginning to pick up. Sectors such as pharmaceuticals, fertilisers, electricity and renewable energy, real estate development, construction and waste management have particularly seen strong growth.”
All the big five players expanded their total assets according to their most recent financial results, while four of them posted increases in net profit. In the first half of 2015, market leader NBE showed a 25% growth in net profit year-on-year to reach LE2.3bn ($313.5m), while the leading private sector bank, CIB, saw its net profit rise from LE2.62bn ($357.1m) in 2013 to LE3.65bn ($497.5m) in 2014 – up around 39%.
The relatively modest levels of sector lending in comparison to deposit growth over the past year mean that the question of lending opportunities remains at the top of the agenda.
Egypt’s banks have faced a challenge in building their loan books, as demand for credit from the corporate sector has remained muted. While this might ordinarily have encouraged financial institutions to expand beyond their usual lending horizons, they have instead been able to secure steady yields from the number of Treasury bills (T-bills) and government bonds which Egypt – frozen out of the international markets – has issued to buyers over the past years.
The size of the domestic debt programme has helped the government to meet its fiscal commitments and provided the banking sector with easy yields, but it has also led to a radical alteration of the nation’s aggregate domestic credit profile. In June 2010, according to CBE data, net claims by Egypt’s banks on the government stood at LE326.1bn ($44.4bn), while claims on the private business sector and households totalled LE419.1bn ($57.1bn). However, by April 2015, claims on the government had expanded by as much as 278% to reach LE1.2trn ($163.6bn), even though the combined claims of private business and households had increased by only 44% to reach LE604.9bn ($82.4bn).
This rapid expansion of public sector credit on the balance sheets of Egypt’s banks has, in the view of some, crowded out private sector lending activity. While banks might counter that reduced demand is as much to blame for the relatively limited growth of private sector credit expansion, the preponderance of T-bills in the system has other deleterious effects, particularly with regards to profit stability. When Egypt secured significant tranches of aid from the Gulf in the second half of 2013, the yield on T-bills dropped from around 14% to 11%, negatively affecting the profit margins of some lenders. The CBE’s decision to raise interest rates in 2014 brought yields back to the 12.5% level, but a subsequent cut in rates saw them fall again to around 11.5% by April 2015. “Of course we benefit from T-bills, but they also place a risk on banks. Interest moves have become paramount as a result,” Mohamed Naguib Ibrahim, chairman of SAIB Bank, told OBG.
The solution to this interest rate vulnerability is more balanced loan portfolios, and the last year saw some encouraging developments in this regard. The election of President Abdel Fattah El Sisi in 2014 was followed by a number of large development projects, such as an expansion of the Suez Canal, which suggest that the big-ticket financing and project finance pipeline interrupted by Egypt’s political strife will resume under the new administration.
Moreover, during the Egypt Economic Development Conference (EEDC) held in Sharm El Sheikh in March 2015, $72.5bn was generated in investments, facilities and loans, according to the prime minister’s closing statement, including $36.2bn in signed investment contracts, $18.6bn in vendor-financed infrastructure contracts (mostly in the energy sector), $5.2bn worth of loans from international banks, and $12.5bn in investments/aid packages from Saudi Arabia, Kuwait, the UAE and Oman.
Yet more investment arising from the EEDC is promised in the short term as a result of a number of memoranda of understanding. Combined with a new investment law which has removed many of the obstacles to private sector involvement in the economy, the improving economic backdrop makes the expansion of corporate lending one of the most promising routes to yield for the coming year (see analysis).
At the other end of the lending spectrum, the search for new sources of revenue since the global economic crisis of 2008 has increased banks’ interest in lending to SMEs. “There is considerable room to expand lending to micro activities and small enterprises” Mounir El Zahid, chairman and CEO of Banque du Caire, told OBG. “To do so, however, the right processes must be implemented with respect to the requirement of financial safeguards and the performance of due diligence, among other factors.” The CBE has encouraged this trend through regulatory means: 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.
The arrival of new mini-branches in hitherto under-banked areas of the country, thanks to the CBE’s 2014 regulation, is also seen as an important facet of the government’s wider efforts to support SME growth.
Moreover, private sector lenders are starting to appreciate the gains on offer in the segment, with some of the largest operators exceeding the efforts of their public sector counterparts. CIB, for instance, serves SMEs through its business banking unit, while QNB Alahi offers advisory services in finance, trade finance and investment as well as medium-term credit facilities. Faisal Islamic Bank has also stated in 2013 that increasing its SME portfolio is a key objective, Crédit Agricole has operated a dedicated SME division since 2006 and National Bank of Kuwait caters to the needs of SME clients through its corporate division (see analysis).
As they go about extending their reach in the SME segment, Egypt’s banks are being greatly assisted by the increasing capacity of the nation’s only credit bureau, I-Score, which began operations in 2012 and, as of June 2015, had logged the credit details of around 9.23m consumers and 131,100 SMEs. To date, the company has rated small businesses using the same framework it applies to its monitoring of individuals, but the launch of a subsidiary dedicated to SMEs promises to significantly enhance its coverage of the segment. Recently branded as Tasnif, the new SME-focused bureau is being developed with Standard & Poor’s as technical partner, and 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.
All this represents a solid advance in risk assessment, and will in theory enable banks to more easily make risk-based lending decisions to companies beyond their usual credit horizons. While the expansion of I-Score’s activities in the SME sector does not constitute a panacea for its considerable challenges, it promises to play a major role in bridging the funding gap faced by many expanding businesses. Hassan Abdalla, vice-chairman and managing director of Arab African International Bank, told OBG, “Banks need to better educate their staff on how to adequately assess credit risk relating to SMEs, which is different from large corporate credit risk, so as to more effectively allocate their resources. Concepts such as the use of credit history and the necessity of accurate payroll records can be more fully developed.”
SMEs will also need to do more. According to Mohamed Ahmed Kafafi, executive chairman of I-Score, record-keeping is one area in particular need of improvement. “SMEs and microenterprises, which comprise more than 90% of the country’s businesses, need to be encouraged to keep comprehensive financial records of their business activities. This will provide them with a marketable position toward the banking sector to access the capital needed to grow, which is something that would benefit the Egyptian economy as a whole,” Kafafi told OBG.
Mortgage lending is another potential area for expansion. Banks share this segment with several dedicated mortgage finance firms, the first of which opened in 2004. In 2006 the government created the Egyptian Mortgage Refinance Company to provide funds for refinancing by primary mortgage lenders, including commercial banks. However, home loan activity has remained low – Egypt’s housing loan penetration was at 2.2% in 2011, according to the World Bank’s “Housing Finance Across Countries” report, published in January 2014 – due to the relatively conservative lending criteria of Egyptian banks, the level of informality in the housing sector, and the high interest rates that make monthly instalments unfeasible for low- and middle-income earners.
In 2014 the CBE announced it would allocate LE10bn ($1.4bn) for banks to re-lend in the form of housing loans with terms of 20 years and interest rates of 7-8%, while in 2015 President El Sisi issued an amendment to the Mortgage Law, allowing firms with foreign capital to offer mortgages in the Egyptian market. “The mortgage programme has done an effective job of bringing more people into the formal banking system and should be seen as part of a broader effort by the government to promote more financial inclusion,” Hisham Ezz Al Arab, chairman and managing director of CIB, told OBG.
The banking sector has much potential. Only 14% of the adult population owns or shares an account at a formal financial institution, according to a 2014 survey by the World Bank and Gallup. “Around 10% of the bankable population has a bank account. Banks need to encourage more people to actively use their services by building more branches, developing more specialised products and expanding payment systems like mobile banking,” Mohamed El Dib, chairman and managing director of QNB Al Alahli, told OBG. There is, however, some disagreement in the industry regarding the bankable population, with some players claiming that the statistics count too many people. “The total addressable population, consisting of adults over the age of 25 from urban and rural households, is closer to 20m. With about 12m bank accounts currently, there is still 40% of the addressable population that can be brought into the system as and when their per capita income would entail as such,” El Zahid told OBG.
The World Bank survey also revealed a largely informal credit market: less than 2% of all adults possess a credit card, while 22% borrow money from family and friends. Accordingly, segments like microfinance hold significant promise. Amro Abouesh, executive chairman of Tanmeyah Microenterprise Services, told OBG, “Microfinance is an area of immense opportunities. At an average ticket size of LE8000 ($1090), microfinance loans are particularly attractive for small-shop owners, such as grocery stores and kiosks.”
A low median income plays a part in modest banking penetration. Yet the Egyptian economy contains significant investable liquidity, as was shown in September 2014 when LE64bn ($8.7bn) was raised in Suez Canal development certificates in a week, mostly through individuals. How banks approach this largely untapped market is a very compelling question.