2012 Cambridge Business & Economics Conference
ISBN : 9780974211428
2012 Cambridge Business & Economics Conference (CBEC)
June 27-28, 2012
University of Cambridge, UK
THE EGYPTIAN BANKING SYSTEM
POST JANUARY 25TH REVOLUTION
Dr. Sahar Nasr
World Bank, American University in Cairo, and British University in Egypt
Phone Number: +2-010-544-7706
June 27-28, 2012
Cambridge, UK
2012 Cambridge Business & Economics Conference
ISBN : 9780974211428
The Egyptian Banking System Post January 25th Revolution
Dr. Sahar Nasr, World Bank, American University in Cairo,
and British University in Egypt
ABSTRACT
A stable and solvent banking system requires a supportive macroeconomic environment, internal
corporate governance, external governance provided by prudential regulation and supervision,
and external discipline provided by market forces.
The banking sector in Egypt could be
affected by the overall macroeconomic framework during periods of political and economical
transition, following the January 25th revolution. Current assessment of the system reveals its
resilience to the shocks due to the reforms undertaken to strengthen the system. However, there
are concerns regarding the sustainability and irreversibility of the banking reform program.
Preventing such problems, addressing gaps, and maintaining a sound banking system, is
therefore an essential economic policy target.
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I.
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OVERVIEW
Following the January 2011 revolution, Egypt has embarked on a political and
economical transition. Two interim governments were appointed to help Egypt go through this
transition period. Uncertainty still exists concerning the political and economical future of the
country, not just about the hiatus period, and the outcome of elections, but about the future
orientation of Egypt.
The period has also witnessed deterioration in the macroeconomic
framework, and economic growth has slowed substantially following the events post revolution.
The uncertainty surrounding policies of the new administration have a major effect not only on
the banking sector, but more important on the future of Egyptian economic and financial sector
development.
The stability and performance of the banking system depends upon the macroeconomic
environment within which it operates. This requires an appropriate infrastructure and a stable
macroeconomic environment.
Sound macroeconomic policies that encourage sustainable
economic growth with low inflation have a strong positive influence on the soundness of the
banking system. By contrast, policies that result in significant macroeconomic imbalances
frequently have serious adverse implications for banks. Even sound banks can be pushed into
crises with a sufficiently large macroeconomic shock. These macroeconomic shocks often lead
to systemic unsoundness since all banks will be exposed to the same conditions.1
Economic conditions and policies are key determinants of the soundness of the banking
system. Banks, according to Lindgren et al. (1996) are “derivative institutions” in that their
health reflects the health of their customers, which in turn reflect the health of the economy as a
1
Nasr, Sahar (2006).
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whole. Recent empirical analysis has shown that certain macroeconomic developments have
often preceded banking crises, suggesting that the broad macroeconomic environment must be
taken into consideration when assessing the banking system.
Overall, the financial sector in Egypt has weathered the global financial crisis and
immediate impacts of the revolution. The ambitious reform program undertaken since 2004 has
lead to the strengthening of the financial sector and its regulatory and supervisory framework,
and the operational and financial restructuring of state-owned banks that dominate the sector,
accompanied by improving the institutional framework, which enabled it to be more resilient to
shocks. Moreover the continued confidence in the system has contributed to reducing the
likelihood of bank runs or any herding effects. Overall, the Egyptian authorities responded well
to the events post revolution through provision of financial services as needed. Nevertheless,
possible deterioration is expected in the coming period if the economic and political uncertainty
and the security situation continue.
The banking system showed resiliency to two large, unexpected shocks—the global
financial crisis and more recently the revolution, in terms of both solvency and liquidity. The
resiliency of the financial system reflected the strengthening of the banking sector, including the
state-owned commercial banks, under the previous reforms and strengthened regulation and
supervision by the Central Bank of Egypt (CBE). Before the global crisis, at end-June 2008,
bank capital to risk weighted assets was 14.7 percent and provisions were equal to 92 percent of
the 14.8 percent non-performing loans (NPLs). By the end of March 2010 all these figures are
reported to have improved.
The CBE responded well to the impact of the Egyptian revolution on the banking system
through undertaking measures that generally addressed specific, crisis-related issues and were
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time-bound. The provision of cash as needed when the banks reopened gave confidence to the
people and helped prevent a deposit run. Moreover, the CBE guaranteed all deposits in the
banking system and also issued circulars that generally addressed specific, crisis-related issues.
Under the circulars, withdrawals of foreign exchange or transfers abroad are still limited for
individuals and non-import or non-foreign investment related transactions. Bank deposits grew
about 18 percent between June 2008 and June 2010 although growth of credit to the private
sector was limited.
Egypt’s commercial banks seem well capitalized, even after conducting severe stress
testing. The capitalization of banks was high at the end of December 2010—16.1 percent of risk
weighted assets compared to 10 percent required, and 6.2 percent of assets, according to CBE
figures. Additionally, a severe stress test performed by CBE—the loan portfolio was downgraded by two notches; bank profits cut by 25 percent, and the value of collaterals by 50
percent—still indicated that the capital ratio would still exceed 11 percent. The capital injections
in the 1990s helped the banks sustain the shocks.
However, banks’ profits are likely to be lower in 2011 than in 2010. Personnel costs are
likely to rise as a result of the higher labor costs that followed the government’s announcement
of a 15 percent increase in wages, salaries and benefits for its employees and the settlement of
strikes in individual banks, in some cases at even higher increases. Revenues are likely to be
negatively affected by the lower demand for investment and lower GDP growth. All this will
contribute to a decline in the banks’ profitability in the coming period.
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II.
ISBN : 9780974211428
MACROECONOMIC FRAMEWORK – OPERATING ENVIRONMENT FOR BANKS
Macroeconomic shocks such as a sudden decline in growth often contribute to bank
unsoundness. Several cases of banking distress have been preceded by recessions and a decline
in economic activity. The sharp contraction in economic activity has been identified in the
empirical literature as one of the main early-warning signals of banking crises. Low and
declining growth rates can adversely affect the borrowers’ capacity to payback the loans and
hence increase credit risk. It also leads to invalidation of some of the crucial assumptions on
which loans and investment decisions were initially made.
Following the January 2011 revolution, Egypt has embarked on a political and economic
transition. The revolution has led to the former president leaving office, a change in the cabinet,
and dissolutions of the parliament, and the main political party.
The revolution was also
followed by social unrest, lengthy demonstrations, and strikes, including strikes by the staff in
the financial sector, especially state-owned banks. Some sectors, such as mining, tourism and
construction, which on aggregate account for a large percentage of the Gross Domestic Product
(GDP), were immediately hit by the crisis. During this period, economic growth fell sharply.
Interim governments were appointed to help Egypt go through this transition period. In
February 2011, a caretaker government took over and a new Prime Minister was appointed. In
response to the disappointment of the public on the performance of this government, a new
emerging government was appointed in December 2011. The caretaker government has mainly
focused on paving the way for a transition to a new democratic order for Egypt. Parliamentary
elections started in September 2011 with the presidential election set to follow a few months
later, and be finalized by June 2012. Certain members of the previous government were arrested
and the caretaker government is investigating families and major businesses associated with the
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previous government for corruption and other crimes. All this had implication on investments
and the overall economy.
The newly elected officials and the administration they install are likely to come from
new parties and mostly people not associated with the previous regime. The preliminary results
reveal a strong Islamist turnout, namely the Muslim Brotherhood and the Salafies. Although the
political and economic strategy of the government to be elected is unclear at this point, it will
emphasize a more even distribution of income and wealth and a focus on governance,
transparency and accountability. There could also be a trend towards a more Islamic and
“Shari’a” compliant financial products. It is expected that the new government will opt for
policies that will satisfy the populists’ demands in the short-run but that might not be sustainable
in the long-run.
Economic growth has slowed substantially following the events of the revolution. Given
the fluid situation, as well as the substantial pressure for the underfunded caretaker government
to improve the economic situation of various groups, it is not surprising that the Egyptian
economic activity has been slow to recover, investment is dropping and macroeconomic
conditions have deteriorated. The to-be-elected government, on assuming office, will need to
define its direction quickly and take macroeconomic actions consistent with its resources and
funding from abroad, to avoid inflation that will mostly hurt the poor, encourage investment and
retain the many highly skilled Egyptians needed to start more rapid, equitable growth.
In December 2010, before the revolution, the Egyptian economy was recovering from the
effect of the global crisis. GDP was growing at a 5.5 percent, unemployment had fallen to 8.9
percent, international reserves reached US$ 36 billion, and the CBE had US$7 billion additional
deposits in commercial banks. The public deficit was forecasted by the government of Egypt to
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be 7.9 percent of GDP. The government preliminary forecast is one percent GDP growth for this
fiscal year, without any major policy changes or additional political shocks, growth is expected
to be between three and four percent next fiscal year.
Post the 25th of January Revolution various macroeconomic indicators reveal some
deterioration. Growth is likely to be low in 2011 while GDP in the first half of the year was
negatively affected by the social disruptions that occurred.
While Suez Canal revenues,
remittances, and oil and gas revenues are steady, tax receipts and earnings from tourism are way
down from 2010 levels. Tourist arrivals and hotel occupancy fell substantially in what is
normally the “high” season. Tourism was one of the key sectors that were very badly hit owing
to widespread fears of violent unrest. Construction and demand for investment goods are likely
to be lower as a result of uncertainty regarding the policy stance of the new Parliament and
President. The industrial sector has been affected negatively by the economic situation and the
political instability as well as the workers demonstrations. Debt service payments alone are
estimated at US$3 billion a year, and Egypt has been borrowing heavily from domestic banks,
thus putting their liquidity at risk. Egypt’s credit rating has been downgrading, and in October
2011, its net foreign reserves dropped to US$22.07 billion from $36 in December 2010.
The projected drop in GDP growth, the decline in investments, and the returning migrant
workers from Libya will only push the unemployment rate upwards. Given that tourism and
construction are the most heavily affected sectors and both are labor intensive, it would not be a
surprise to see the unemployment rate increase by two to three percent. The limited space to do
any fiscal stimulus plan makes it imperative for private investment and consumption to retake
their roles as engines for growth; furthermore the central bank had to intervene to help support
the Egyptian Pound.
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The revolution has had some implications on the financial sector as well. Egyptian
sovereign ratings and banks’ ratings (which generally must be below the sovereign rating), have
been downgraded by three rating agencies. By January 27, 2011, political protests led Fitch to
cut Egypt’s BB+ country ceiling to negative. And as banks closed between January 27 and
February 6, Moody’s cut its ratings on January 31 on five Egyptian banks. These banks are:
National Bank of Egypt, Banque Misr, Banque du Caire, Commercial International Bank, and
Bank of Alexandria; and then shortly after, it downgraded its debt rating by one notch from Ba1
to Ba2, and also changed its country outlook from stable to negative. Similarly, Standard and
Poor’s (S&P) downgraded Egypt’s long-term foreign and local currency ratings to BB and BB+,
respectively, both with a negative outlook.
These downgrades reflect the political uncertainty that could negatively impact foreign
direct investments (FDI) inflows and disrupt economic activity. Both Moody’s and S&P warned
that further downgrades may follow if there is significant instability. In addition, the Egyptian
Stock Exchange was deeply affected, as it was shut between January 27 and March 23, after it
dropped 16 percent in the two days following the protests. Sharp losses have occurred as
investors pulled their money from the market amid ongoing investigations of former regime
officials, and some of the country's top businessmen whose companies are listed on the stock
market. By the end of May 2011, central bank’s deposits in commercial banks had evaporated,
due mostly to liquidation of foreigner's holding of Treasury Bills.
Overall the macroeconomic environment has been deteriorating since January 2011. The
uncertainty surrounding policies of the new administration have had a major effect on the future
of Egyptian economic and financial sector development. This includes the implications of the
current political situation as it evolves, and the consequences of the ongoing changes on the
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banking reform policies, as well as the implications of the macroeconomic environment on the
performance and soundness of the financial system. The situation is expected to continue in that
way if the authorities do not take the necessary actions in a timely manner. Obviously, the
macroeconomic environment has direct implications on the soundness of the banking sector, and
additionally, the transition period raises questions on what reforms the new government would
pursue.
III.
IMPACT
OF THE
POLITICAL
AND
ECONOMIC DEVELOPMENTS
ON THE
BANKING
SECTORS
The Egyptian financial sector has weathered the global financial crisis and the period of
political tensions following the revolution. The financial sector reforms that were undertaken
over the past years through strengthening the financial systems has helped it withstand the
global financial crisis of 2008-2009, as well as, the impacts of the revolution that began in
January 2011—two real-life stress tests that were probably larger than any that might have been
foreseen in macroeconomic stability analyses. In the global crisis years, although the GDP
growth rate declined, it nonetheless averaged nearly five percent per year.
The turmoil, protests and deteriorating security situation in the first few weeks during and
after the revolution, led to a temporary closure of banks and the stock exchange, limiting
financial services during that period. The Egyptian revolution that began in January 2011
brought large, unexpected stress to the banking system and the economy overall. The problems
were dealt with effectively, on an ad hoc basis, by the regulators. The CBE decided to close all
banks from January 27th to February 6th. During this period, payments were difficult to make
and a shortage of cash developed.
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The banks and the stock market were successfully reopened, and economic activity
started to rebound slowly. The CBE ensured sufficient cash was available, and announced their
commitment to guarantee deposits.
The February 6th re-opening of the banks took place
gradually throughout their branch systems but the public’s demands for cash were met
effectively and deposits have recovered, rather than falling. By the end of March 2011 nongovernment bank deposits had recovered to 99.3 percent of their December 2010 level.
Although deposits in Egyptian pounds have fallen slightly, deposits in foreign currency have
risen rapidly and accounted for 22.1 percent of total deposits in March 2011, compared to 19.3
percent in December 2010. On aggregate bank deposits have rebounded rather than fallen since
the banks were reopened in February, suggesting continued confidence in the banks.
The CBE's data on financial soundness indicators in March 2011 suggest continued
strength in the banking sector, although it is still too early to judge the full impact of the
Egyptian revolution on the system one could identify potential areas of weaknesses. The March
data show the improvements since the inception of the reform program in terms of asset quality,
profitability and liquidity. The reported average core capital ratio reached 13.6 percent at the
end of March 2011, which constitute a strong buffer in the sector in the case of an economic
slowdown, for example in tourism which was reflected in the earlier CBE stress test.2
The latest figures do not yet show signs of deterioration regarding NPLs; however the net
interest margin has increased by 64.2 percent since 2006 and has boosted operating profits, while
the cleaning-up of NPLs means less profit, must be devoted to provisioning.
Liquidity
remains strong and the high loan-to-deposit ratio provides room to face a run on deposits,
although in fact deposits have returned to their December 2010 level by the end of March 2011,
In particular, commercial banks’ capital had increased to high levels before the global crisis, reaching 14.7 percent of riskweighted assets and 6.2 percent of total assets in fiscal year 2008/09 prior to the global crisis.
2
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rather than fall since the revolution. Of course, some of these indicators, particularly NPLs, are
lagging indicators of problems, thus the financial soundness indicators require close monitoring
on a monthly basis due to the current situation, just as the CBE has been doing.
Banks’ reported NPLs may increase sharply as a result of not only slower GDP growth
and low tourist arrivals, but also of the turmoil of the revolution. Investigation of the owners of
major borrowers, the potential for takeovers or changes in ownership of property, and the falls in
the values of property collateral that are occurring could obviously all lead to higher NPLs. The
potential problems for banks are mitigated to some degree by the large share of government debt
and liquid assets in the banks' portfolio. Nonetheless, the situation in Egypt and the potential rise
in NPLs remain uncertain at this time. Provisions also had risen substantially relative to existing
and new NPL’s, reaching 92.1 percent of the 14.8 percent in June 2008. During the global crisis
the percentage of NPLs actually declined in commercial banks, where provisions-to-NPLs
remained over 90 percent. Profitability also remained high—for example, return on assets
during the crisis remained roughly constant at 1 percent. The resiliency of Egyptian banks to the
global financial crisis also reflected their improved personnel and institutional capacity,
including risk management and loan procedures, as well as the stronger regulation and
supervision of the CBE.
Staff strikes and demonstrations occurred in the banking system, calling for a wage
increase; they were granted this increase which will in turn raise expense ratios. The re-opening
of the banks was accompanied by demands by staff for higher wages, salaries, and benefits, to at
least keep pace with the Cabinet announcement of a 15 percent increase in government wages
and pensions. These demands resulted in some strikes in state-owned banks that added to the
disruptions. As a result, the CBE held meeting with the banks’ staff representatives, and an
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agreement was reached to raise the banks’ staff salaries. As a result, banks’ personnel costs are
expected to rise between 15 and 30 percent, depending on the bank. Authorities should resist
pressure to boost wages even if economic life remains uncertain after the people-power protests
that ousted the former president.
Regarding the crisis management process, the CBE increased its regular monitoring of
the system and closely examined the solvency of the banking system. The CBE required banks
to also conduct stress tests and assess the quality of their assets. The most important of these tests
were those on credit portfolios; this was complemented by the CBE’s requirement for banks to
monitor their portfolio in a circular. The CBE also took several temporary preventive and
precautionary measures in response to the developments, issuing six circulars in response to the
developments during the period of January-February, 2011; appropriately they were generally
temporary and limited to time bound corrections of specific issues that had arisen. These were
mainly related to cash withdrawals by individuals and corporate; risk management related to
retail loans and the tourism related corporate loans; overseas cash transfers; and the grace period
for banks divesture of their ownership of non-financial corporation’s.
The commercial banks were resilient and solvent in terms of capital after the revolution,
including use of a severe stress test as of December 2011. In the stress test, the entire loan
portfolio was down-graded by one notch; which would cut bank profits by 25 percent and the
value of collaterals by 50 percent. In that hypothetical situation, the capital to risk-weighted
assets ratio was still around 11.5 percent, above the 10 percent requirement. This strong result
reflected the banks’ high capital ratios and coverage of provisioning before the crisis and the
previous payoff their NPLs from state-owned enterprises (SOEs), which were achieved under the
reforms, as well as the CBE’s strengthening of regulation and supervision. The result also
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reflected the high liquidity ratios and the high ratio of government debt to total deposits (about
40 percent).
IV.
PROGRESS AND IMPLICATION ON THE BANKING REFORM PROGRAM
The CBE has embarked on an ambitious reform program. The program included the
operation, institutional and financial restructuring of state-owned banks, both commercial and
specialized banks. The restructuring of the three state-owned specialized banks has been much
slower. The restructuring process began in 2004 and focused on three critical areas: (i) risk
management functions, including NPL management; (ii) human resource functions, and
alignment of organization and general management functions; and (iii) information technology
and management information systems. While this process will continue, the second generation
reforms will also include setting profitability, efficiency and corporate governance benchmarks
by the CBE to be revised quarterly, to assess the three banks’ management performance.
The financial restructuring program will also ensure full compliance of state-owned
commercial banks with prudential requirements. This will include the full settlement of SOEs
NPLs, through an agreement between the holding companies and National Bank of Egypt and
Banque Misr to settle remaining outstanding NPLs through a debt-asset (mainly land) swap. In
addition, the financial situation of these SOEs has been improving steadily, as a result of the
Ministry of Investment’s Asset Management Program.
Overall, the reform program led to significant reduction in public ownership and
management of banks and increased competition in banking by privatizing one of the four state-
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owned commercial banks;3 divesting state-owned banks’ shares in joint-venture banks;4 and
consolidating the system through mergers and acquisitions of small and weak banks, by
enforcing stricter prudential regulations.5 The remaining commercial state-owned banks
underwent a financial, institutional and operational restructuring. This included the settlement of
more than 60 percent of the SOEs’ NPLs in state-owned commercial banks, reaching settlements
of 90 percent of private sector NPLs, and recapitalization through retaining capital gains realized
on the sale of non-core assets and investments.
In parallel, there was an in-depth program of improvement in information technology,
risk management, governance, and staff skills that allowed these banks to operate on a
commercially viable basis in increasingly open and competitive markets, without running the
risk of incurring new NPLs. The result of these reforms was a substantial strengthening of the
balance sheets of these banks, validated by the resiliency of the system throughout the global
crisis and an improvement in returns on capital and assets.
Strengthening the Regulatory and Supervisory Architecture of the Banking Sector 6, and
continued implementation of the Basel II project, including preparing guidelines for achieving
the drafting of regulations in line with Basel II framework. Despite the recent events, the CBE is
maintaining the momentum of further strengthening its capabilities to perform an effective risk3
The first generation reforms included the privatization of Bank of Alexandria through sale of 80 percent of the equity to Bank
San Paolo (later merged with Intesa to form Intesa San Paolo). Although the privatization of Banque du Caire was not part of the
reform program, the government decided in early 2007 to privatize the bank. The government’s commitment was evident in
completing all the necessary steps for a strategic sale. Specifically, in July 2007, the government had announced that 70 percent
of the bank would be sold to a strategic investor, and in October 2007 the government selected JP Morgan as sales advisor. The
government received three bids in May 2008. However, the sale transaction was not completed, mainly due to the fact that the
price was much lower than that estimated by the evaluation committee headed by the Central Audit Agency (CAA), and the
global financial crisis paralyzed the bank privatization world-wide. The government maintained the sales adviser until the
environment is more conducive to the privatization of the bank.
4 More than 94 percent of the state-owned banks shares in joint venture banks were divested.
5 Consolidation of the banking sector was through higher minimum capital requirements and stricter prudential rules resulted in
the exit of small and weak banks through mergers, acquisitions, and closure of foreign bank branches, which reduced the overall
number of banks from 57 in 2004 to 39 in 2008.
1 Organization of the supervisory review process, on site assessment of Basel 2 compliance, monitoring of new incoming
supervisory reports, incorporation of Basel 2 in licensing criteria, identifying the systemic risk in Basel 2 environment, managing
the international relations, and optimizing the credit data collection for Basel 2 supervisory purposes.
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based supervision.
ISBN : 9780974211428
CBE has launched a new program that aims at designing a Basel II
framework customized to the Egyptian banking system through a long term strategy. The
program encompasses pillars one (capital adequacy) and two (supervisory review process),
taking into consideration the length of the program and the situation of the Egyptian banking
system. The plan towards Basel II is divided in three phases, where the first phase focused on
gaps identification and finalized CBE Basel II Strategy. The second phase has focused on
discussion papers, Qualitative Impact Study (QIS) for drafting regulations guidelines, and data
reporting scheme. The third phase is dedicated on drafting the newly proposed regulations, and
preparing the Basel II framework implementation.
The first phase was achieved successfully and the second phase had started in July 2009
and is dedicated to elaborate guidelines for drafting new regulations, run simulations, and
designs a new data reporting scheme by July 2011. Despite the profound changes that have
affected the country at the beginning of 2011, the project has remained on track on core issues
but phase two has been postponed to September 2011. The “discussion papers” on operational
risk, credit risk, market risk and own funds were issued and disseminated to all banks for
comments. CBE received good feedback from banks and has drafted a final version of the
“discussion papers” that would help elaborate new regulations. The CBE is drafting guidelines
on the key themes and then new regulations in line with the basic Basel II framework. Dialogue,
awareness and capacity building were key factors for the success in the achievements already
made. Pillar two, strategic risks namely, liquidity risk, concentration risk and interest rate risks,
also internal control will follow the same process as pillar one issues.
One of the main deliveries of phase II was expected to be a new data reporting system in
order to implement these new regulations. Due to the recent events, this sub component is not
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expected to be operational until the end of March 2012 and will require further technical
assistance. Before the revolution, the European Central Bank (ECB) experts who supported and
advised the CBE made some progress with the formalization of business requirements and set up
of the data model. Through December 2011, the CBE and ECB experts will focus on the design
of the portal, the setup of a communication policy, the analysis of operational workflow and
completion of work on new reports and surveys which are needed for Basel II implementation.
This component has been quite challenging and requires strong coordination between the IT
department of the CBE, the banking supervision department, the ECB experts and the Basel II
task force. A coordination regarding data feeding requirements should be established with
Egyptian banks, since many of them are in the process of choosing new IT and risk management
systems.
The third phase is expected to last six months and will focus on drafting the newly
proposed regulations and, provide support to enhance the implementation process for the new
regulations; however a new round of technical assistance should overlap the existing one to
ensure effective implementation of a risk based supervision. This would include knowledgesharing and capacity-building7 to CBE staff on how to monitor the compliance of the Egyptian
banking system with these new regulations and the new data reporting scheme. From the onset
this project has been quite challenging because of the number of stakeholders involved and the
changes in the supervisory process. But the rationale was not only the benefits of compliance
with Basel II but also further progress by the CBE towards a risk based supervision and the
match-up with the diversity of the Egyptian banking system. However, the enforcement of the
new supervisory framework, especially the implementation of the new data reporting system but
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also capacity building in the CBE and in the Egyptian banking system, needs further work. At
the earliest, the private commercial banks have to comply with the new regulatory system
starting from December 2012 and from June 2013 for the state-owned banks.
Strong macroprudential surveillance capacity is essential to achieve sustainable
improvement in access to finance. The CBE has made considerable efforts to improve its
assessment and surveillance of macroprudential risks. The Banking Supervision Department has
set up a Macroprudential Unit with the aim to assess and produce regular reports on main
developments in the Egyptian banking sector at the aggregate level. The unit has also started to
make use of several analytical tools to assess financial stability, by conducting regular stress
testing and standard financial soundness indicator analysis on the banking sector. The Banking
Supervision Department is now in the process of strengthening the Macroprudential Unit with
the aim to prepare and publish a full-fledged Financial Stability Report, the first report of its kind
in the Arab countries.
Improving governance, transparency and accountability, strengthening governance and
addressing conflict of interest issues, are key priorities for the authority’s reform program. The
amendments of the Central Bank, Banking System, and Money Law 88 of 2003 on October 8,
2011, aim at strengthening the governance of the Central Bank and its Board of Directors. The
amendments of the law was endorsed and issued by The Supreme Council for Armed Forces that
rules the country until a Parliament is elected, being mandated to only pass “emergency laws”.
The CBE is also strengthening the corporate governance of commercial banks, and will issue a
Corporate Governance Regulation for the banking sector on August 2011, setting sound
governance standards, whereby banks would need to comply by March 2012. Evaluation of a
bank’s corporate governance will be part of the CBE’s supervision.
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This was also accompanied with improvements in transparency and better disclosures are
taking place. On transparency and disclosure of data the central bank made significant progress
post revolution. The CBE began to disclose and make public on its website the consolidated
banking sector financial statements and related indicators (capital adequacy ratio, return-toassets, efficiency ratio, liquidity rations, etc.) on a quarterly basis starting July 1, 2011. The CBE
will also post a description of its supervisory review process. These disclosures are part of
greater transparency in the financial system, which will improve market discipline.
More advantage of the credit register could also be taken for macroprudential
surveillance. The CBE could build up credit risk indicators based on the probabilities of default
from the credit register. In fact, they could do it by industry, by size of firm (large, SMEs, etc.).
It is recommended that the CBE to use the credit register as a stress testing tool, that is, use the
credit register for enhancing macroprudential surveillance. Furthermore, they could also produce
financial soundness indicators, which could be developed into macrosurveillance instruments,
with the usual caveats and limitations.
Substantial progress has continued to be made in improving the financial sector
infrastructure to enhance access to finance. The Real Time Gross System (RTGS) became fully
operational with additional features in 2010. It has been working since that time with no
problems and was used during the Revolution effectively, in combination with the Automatic
Clearing House (ACH) to pay pensions to some retirees. Around 2.4 million payments cards
have been issued to government workers and pensioners through the government payment
system program. During the revolution, when banks offices were closed, payments were made
through RTGS/ACH/ATMs to some pensioners. The limited number of ATMs may become an
increasing issue as more and more government employees and pensioners use this system,
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because government employees and pensioners typically wish to withdraw cash when they are
paid. A full ACH connection between the Ministry of Finance and CBE will be established by
the end of July 2011. This connection will allow direct payments to government suppliers.
The authorities started to focus more on enhancing access to finance, especially for small
and medium enterprises (SMEs), which were disadvantaged. The banking system has been
mainly catering the large privileged cooperates. SME banker training scaled-up and program
further developed through course participant feedback. The Egyptian Banking Institute (EBI), of
which all banks in the system are members, has offered an SME Training program for some
time, this program includes classes for both bankers lending to SMEs and a guide to help SME
entrepreneurs deal with banks.
The actual courses have been developed over time using
participant feedback. The enrollments in the courses had temporarily slowed and the courses
were suspended during the revolution and the closure of the banks. The EBI is also setting up
visits to other developing countries, to examine how banks in these countries make SME loans
and develop their courses further. The EBI expects that the demand for its SME courses will
increase under the future Egyptian government, given its likely emphasis on greater inclusion
and access to finance.
In addition, the SME Census completed, and data presented in a form that is accessible to
the banking sector. The EBI census of SMEs has been completed in all 27 Egyptian
governorates. It uses a single definition, which is based on company registration data, and
excludes micro-enterprises employing less than 5 persons. The results of the census will be
available on the EBI web site. The uniform definition of SMEs will permit a much better
evaluation and comparison of banks’ lending to SMEs. At the moment, The National Bank of
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Egypt (NBE) is the largest bank lender to SMEs, using funds from the Social Fund for
Development (SFD)—the apex institution for micro and small enterprises.
Overall, the revolution has posed questions regarding the sustainability and irreversibility
of the financial sector reforms, and more importantly the banking sector that dominates the
system by far. It was yet to be seem, the direction of the future government. The economic
vision after the revolution is still to be defined. The elections and the emergence of the Islamist
groups bring forward more clearly the need for Sha’ria compliant laws and regulations, as well
as new financial products. The revolution has also highlighted the need for a more inclusive
system, a level playing field, and equal opportunities, raising concerns on who benefited from
these reforms.
V. AUTHORITIES PREPAREDNESS FOR POTENTIAL RISKS
Although the state-owned commercial banks have generally improved, the performance
of the banking sector has improved substantially under the reforms of the Egyptian Financial
Sector Reform Program launched in 2004. Operating costs are likely to increase considerably as
a result of the increases in wages, salaries and benefits since the revolution began. NPL rates
may increase because of slower growth and other factors, and finally, uncertainty naturally
remains about the policy orientation of the government that will be elected this year.
Despite the good performance of the banking system during the global financial crisis
and the problems arising from the developments during January–February 2011, various issues
could arise during the coming period, until the new Parliament and President are elected and the
directions of their policies become clear. These issues, may affect, the financial sector’s ability
to mobilize resources and lend them efficiently to support development.
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There are concerns of possible setbacks in reforms oriented towards private-sector led
growth. The sentiments over the past few months have been against privatization and sale of
public assets. Even the sale of Bank of Alexandria, which was sold in October 2006 at well
above its book value, was attacked by the media. This accompanied condemnation of some
members of the private sector that are alleged to have benefited from improper behavior and,
could lead to condemnation of market oriented economy and private-sector led growth. The
reforms that the Egyptian authorities have undertaken over the past years were based on solid
analytical and diagnostic work, which was complemented by technical support and advisory
services from development partners, based on international best practice. Assessment of these
policies should be based on their implications for the financial sector and not solely their
association with the previous regime.
Potential “Crowding Out” and Liquidity Problems. A macro-financial issue of concern is
the potential “crowding-out” of credit to the private sector by government borrowing. The
higher government deficit and the sell-off of its bonds noted above indicate the risk of public
sector borrowing crowding out bank lending to the private sector. If the government spends
beyond its revenues from taxes and fees, plus its international funding from grants and
borrowing, then it must borrow from the domestic economy, largely the banks, thereby crowding
out private borrowing. This issue had already begun to develop in 2009 and 2010 when banks’
increased purchases of government debt contributed to a sharp decline in the already falling ratio
of bank loans-to-deposit, from 55.9 percent at the end of 2008 to 51 percent at the end of 2009
and 48.5 percent at the end of 2010, according to the CBE figures. Furthermore, the limited
growth of credit to private sector in 2009 and 2010 was not due to crowding out, but mainly due
to the economic situation and slow down post the 2008 crisis, especially on the private sector
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investments side. In order for private activity to expand, the government must allow room for
bank loans to the private sector for working capital and investments.
There is potential deterioration in the quality of assets. An increase in NPLs in the
banking system is likely to follow the contraction in economic activities and the turmoil of the
revolution. A key sector that has been significantly affected is tourism, while construction,
mining, and manufacturing have also suffered. Growth is likely to be slow in 2011; GDP in the
first half of the year was negatively affected by the social disruptions that occurred. In what is
normally considered the “high” season, tourist arrivals and hotel occupancy fell significantly.
Construction and demand for investment goods are likely to be lower as a result of the
uncertainty concerning the policy stance of the new Parliament. The operational capacity of the
factories of the groups that came under investigation as a result of the revolution has not been
affected as they continue to be run under the management of technocrats. However, they have
been affected negatively by the economic situation and the political uncertainty. This could have
negative implications on performance of the loans of borrowers in these sectors. Concerns over
transfers of property or takeovers of assets could also lead to higher NPLs. The stress testing
conducted by the CBE in April 2011 shows that the capital cushion would be able to absorb such
an increase.
Another Reason for a possible deterioration of the asset quality is direct lending. Under
populist pressure and condemnation of the private sector, the government may be tempted to
allocate credit to sectors considered important or strategic. Although such a process may seem
obvious to some, experience world-wide has shown that ultimately, it could add to the volume of
NPLs; which further limits the availability of funds to non-preferred clients; and requires
government injections of funds into the banking system, problems that were similar to those of
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the Egyptian financial system some years ago. The CBE indicated clearly that they would not
allow the allocation of credit on non economic or commercial viable terms.
Possible loss in managerial talents and brain-drain could be an issue with the discussions
on minimum and maximum wage rates. Possible loss of high quality staff in state-owned banks
and the CBE could occur, with the significant cut in their wages and change in management.
Such staff are required to run the improved lending process and risk management that were part
of the reforms. With the operational and institutional restructuring of the state-owned banks, high
caliber staff were recruited and potentially competent staff were trained and well compensated
based on performance. Hence, staff quality has improved significantly to operate the much
improved processes for lending and for risk management in general, as well as the regulatory and
supervisory processes of the CBE.
These improvements have played an important role in reducing the system’s NPLs. A
risk exists that these qualified personnel might leave and take positions in international banks
outside Egypt if their real salaries in Egypt are reduced or working conditions deteriorate. The
departure of these personnel would, in turn, contribute to a return of NPLs and a further limit on
the banks’ capacity to lend. More generally the lack of certainty regarding future government
policy, combined with frequent requests to provide information arising from public complaints,
is distracting key officials in the government and SOEs and making some vulnerable to
approaches from other countries in the region that are experiencing severe shortages of qualified
people.
Deterioration in profitability could also be witnessed post-revolution. Banks’ profits are
likely to be lower with the rise in the expense ratio of banks due to the rise of staff salaries across
the board, which is not necessarily based on performance.
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The government has increased
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nominal salaries in the public sector and pensions by 15 percent, effective of April 2011. This
increase was followed by demands for similar or greater increases in the financial sector, while
total increases in banks’ personnel costs have ranged from 15 to 30 percent. These increases not
only reduce banks’ earnings and their ability to continue increasing capital but contribute to cost
pressures that may lead to further demands for nominal adjustments in the coming months.8
Personnel costs are likely to rise as a result of the higher labor costs that followed the
government’s announcement of a 15 percent increase in wages, salaries and benefits for its
employees and the settlement of strikes in individual banks, in some cases at even higher
increases. Revenues are likely to be negatively affected by the lower demand for investment and
lower GDP growth. In addition, the higher NPLs noted above will require more provisioning, all
this along with a possible decline in revenue could lead to a drop in banks’ profitability and
earnings ratios.
Substantial improvement in key profitability and efficiency indicators of the state-owned
commercial banks that dominate the system.
The three state-owned commercial banks—
National Bank of Egypt (NBE), Banque Misr, and Banque du Caire are the largest three banks in
Egypt, accounting for more than 50 percent of bank assets—have substantially improved their
profitability, efficiency, and capital over the last three years.9 The reported ratio of capital to
risk-weighted assets in all three banks now substantially exceeds the required 10 percent level.
Moreover, as of the year end 2010, provisions were equal to NPLs. The three banks, particularly
NBE, have also increased efforts to recover on NPLs. The reported reduced rate of NPLs, the
increased coverage of provisions, and the recovery on some NPLs, including those of the SOEs,
8
In the case of the social insurance, with important impact in the general budget, the government expects to absorb increases in
pensions with adjustments in ceilings on contributions (pensionable salary), but this in turn represents an increase in the cost of
labor that will also represent an inflationary pressure, in addition to reducing incentives for the life insurance and private pension
industry.
9 CBE Monthly Bulletin (November 2011).
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have all contributed to the need for less provisioning and thus higher profits. Moreover, Stateowned commercial banks’ financial statements fully reflect bank net asset values and economic
position in line with International Financial Reporting Standards (IFRS).
State-owned and
private commercial banks’ accounting is now in line with IFRS. The state-owned commercial
banks’ provisions were equal to their NPLs as of December 2010; their financial statements
reflect net asset values and their economic position.
VI.
CONCLUSION AND POLICY IMPLICATIONS
A key demand of the Egyptian people in the January revolution was to attain fair
opportunities, level playing field, and equal access to finance.
The financial system and
especially the banking sector needs to be more inclusive to contribute more to sustainable
economic development. Despite the progress made in the reforms undertaken since 2004, very
few segments of society had access to the banking sector services. Further reforms are required;
these could focus on continuing the operation and financial restructuring of the banks,
strengthening the regulatory and supervisory framework, institutional structure, and the legal and
institutional environment through governance and transparency.
The government should continue the reforms of the state-owned commercial banks, and
more focus should be given to the state-owned specialized banks. This includes; passing the law
putting Principle Bank for Development and Agricultural Credit (PBDAC) on an equal
governance footing to the state-owned commercial banks, and the continuous monitoring and
improving of its activities and those of the Egyptian Arab Land Bank (EALB). Authorities
should resist pressure to boost wages, including banks’ staff, even if economic life remains
uncertain. Wage increase should be performance based, while the intern government should
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indeed be addressing such crucial social priorities, such as wage increase, it should also take into
account their medium and long term implications on fiscal balances.
Close and regular
monitoring of data and an assessment of all developments would be critical during this transition
period Egypt is going through. The center of national debate should be the legitimacy of the
economic system is simply because without it, being able to allocate resources to the various
production and service sectors, the various provinces and the various generations of society.
The performance of the banking sector is affected by the macroeconomic environment in
which is operates. The restoration of political stability and effective reforms are essential if the
Egyptian economy is to return to solid growth that benefits the population as a whole. Stability
would help in promoting investments, job creation and sustainable economic growth.
The
banking sector in turn, can play an essential role in financing these investments and be an engine
for growth. It is critical that the system becomes more inclusive, so that the society as a whole
can reap the benefits.
Greater democracy and transparency will boost confidence in the
economy, resulting in increased growth and foreign investment. Small firms should be given
equal access to finance, and a level playing field as to benefit, as their expansion is hindered less
by a corrupt bureaucracy and their overall business costs drop.
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Annex 1
BANKING SECTOR FINANCIAL SOUNDNESS INDICATORS
(in percentage; end of fiscal year1)
Ratios
FYE
FYE
FYE
FYE
FYE
Position
2006
2007
2008
2009
2010
Mar 11
Bank regulatory capital to risk-weighted assets
14.7
14.8
14.7
15.1
16.3
16.3
Tier 1 capital to risk-weighted assets
10.3
10.9
11.5
12.0
12.7
13.6
Equity to assets
5.8
5.5
6.2
6.4
6.7
6.6
Nonperforming loans to total loans2
18.2
19.3
14.8
13.4
13.6
* 11.2
Provisions to nonperforming loans
76.2
74.6
92.1
100.4
92.5
93.7
Return on average assets
0.8
0.9
0.8
0.8
1.0
N/A
Return on average equity
14.3
15.6
14.1
13.0
14.3
N/A
Net interest margin
1.4
1.6
1.7
2.2
2.3
N/A
Liquidity (local currency)
38.8
26.6
34.5
43.4
44.7
52.8
Liquidity (foreign currency)
55.4
51.9
46.8
41.0
40.6
47.9
Loans to deposits (local currency)
57.7
51.6
52.0
46.5
44.0
45.1
Loans to deposits (foreign currency)
51.0
60.1
71.3
69.3
75.8
65.2
1
Fiscal year ends at June 30th for public sector banks, and December 31 for other banks.
2
The reduction in NPL ratio was due to the write-off of a portion of NPLs related to two state-owned banks
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