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AfricaApril 1 2019

Buoyant Egyptian banks target SMEs and unbanked in growth push

Having successfully weathered the turbulence following the 2011 uprising, Egypt's banks now enjoy good capital adequacy levels and low loan default rates. Many are eyeing the small business sector and an underbanked populace as the next areas of growth, as Kit Gillet reports.
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Central Bank of Egypt

Egypt’s banking sector has shown remarkable resilience in recent years, despite the global financial crisis and the years of political turmoil that followed the country’s 2011 uprising.

Now, with Egypt’s economic growth set to pick up speed, banks are hoping to benefit from a more favourable operating environment, as well as the government’s drive to extend financial inclusion to the country’s vast unbanked population and increase lending to small and medium-sized enterprises (SMEs), considered key for Egypt’s long-term growth.

Source of stability

Banks have long played an outsized role in the Egyptian economy, and the banking sector has proven to be an important source of stability as the country has weathered recent social, economic and political crises.

“We went through three or four years of extreme turbulence and we came out of it unscathed. Most of the banks in Europe and the US, indeed across the world, go through theoretic stress tests; we’ve gone through the most stringent of stress tests,” says Mohamed Ozalp, managing director and chief executive of Blom Bank Egypt.

Between 2011 and 2017, Egypt’s five largest banks increased their balance sheets by more than 40%, from the equivalent of $113bn to $160bn. National Bank of Egypt, the country’s largest lender, saw its balance sheet grow an impressive 47% over that period.

Meanwhile, according to the Central Bank of Egypt, total deposits in the country’s banking system increased from E£3330bn ($191.4bn) in December 2017 to E£3820bn in December 2018, with government deposits rising to E£614bn. Local currency deposits accounted for 77.3% of the total.

Stable rating

In February 2019, rating agency Moody’s maintained its ‘positive’ outlook for the Egyptian banking sector, based on the belief that the country’s banks would continue to have good access to stable, deposit-based funding and hold large volumes of liquid assets, especially in local currency. “We expect balance sheet growth of about 15% in 2019 and for banks to maintain ample local currency funding, high liquidity and strong and stable profitability,” Constantinos Kypreos, senior vice-president at Moody’s, said at the time.

Moody’s added that it expects non-performing loan (NPL) levels to remain broadly stable, having dropped to 4.4% of the total loan book as of September 2018, compared with 19.3% in 2007 – though it added that loans remain vulnerable to economic challenges due to the large volume of untested new loans and ongoing security risks in the country.

Meanwhile, the capital adequacy ratio of the Egyptian banking sector currently stands at 16%, with its Tier 1 capital adequacy ratio increasing to 12.6% at the end of June 2018, well above the regulatory minimum.

“Capital adequacy ratios are very strong across the board, and we have historically low NPL ratios, despite the difficult macroeconomic conditions of the past eight years or so,” says Elena Sanchez-Cabezudo, head of financials and equity research at EFG Hermes, a financial services group headquartered in Cairo. “Egyptian banks are in a very healthy financial position, and in a very good position to start growing their loan books once demand, specifically from corporates, picks up, whether that’s towards the end of this year or from 2020.”

An unbanked opportunity

Financial inclusion is a key area of focus for both the Egyptian government and the country’s lenders, with banking sector penetration sitting at as little as 30% in a population close to 100 million.

“The importance of financial inclusion to a sustainable Egyptian economy cannot be overstated. It is clearly the government’s highest priority,” says Hisham Ezz Al-Arab, chairman of Commercial International Bank, Egypt’s largest private lender. Mr Al-Arab adds that the bank’s strategy to reach the young, unbanked population is through the integration of current technology. “This is why we have invested heavily in digital platforms, versus traditional channels, which has led to the launch of many significant products such as the smart wallet, internet banking and the CIB mobile banking app.”

Commercial International Bank, which saw a full-year 2018 consolidated net income of E£9.6bn, up 27% year on year, with a return on average equity of 33.1% and a return on average assets of 3.06%, launched Egypt’s first digital smart wallet in January 2016.

Many in the financial sector see the opportunities that technology offers in reaching unbanked customers in Egypt, in addition to improving services for existing clients. In a recent study, Beirut-based organisation Union of Arab Banks said it expects fintech to revolutionise traditional financial services in countries such as Egypt, helping to reshape the financial landscape. Meanwhile, the Egyptian central bank is said to be working on establishing the foundations and rules for the launch and operation of digital banks in the country.

“In a country the size of Egypt, with a population of 100 million, the number of bank accounts is very low,” says Mohamed Aly, managing director and chief executive of Abu Dhabi Islamic Bank Egypt (ADIB-Egypt). “Technology will allow us to have a much better reach into the overall economy, plus it is going to make it easy for everyone to open an account,” he says, adding that his bank is set to spend E£700m on technology in 2019 alone.

Even so, digital banking is considered to be at an early stage of development in Egypt, though most Egyptian banks now offer mobile wallets, electronic payments and are investing heavily in their digital and IT platforms.

Targeting SMEs

The Egyptian government has also prioritised lending to SMEs as a way to stimulate long-term economic growth. In early 2016, the Central Bank of Egypt mandated that banks were required to allocate 20% of their loan portfolios to SMEs by 2020, and to establish dedicated SME units. Between 2016 and the end of 2018, Egyptian banks increased their credit to the SME sector by E£136bn, according to the central bank. EFG Hermes adds that microfinance has been growing at more than 100% annually over the past three to four years.

“Previously banks have been relying on top-tier corporates and government lending providing the majority of our portfolios, and hence profitability,” says Sherif Elwy, chief executive of Arab African International Bank (AAIB). “The central bank has been directing the market into giving more focus on middle markets and small companies [and] changing risk appetite.” 

In May 2018, AAIB launched Egypt’s newest microfinance lending institution, Sandah, which has a working capital of E£155m and is focused on the commercial, agricultural, industrial and service sectors. It did this alongside the Sanad Fund for MSMEs, which is part of Germany’s KfW Development Bank.

Mr Elwy believes that entrepreneur funding is also growing in importance, given that 60% of Egypt’s population is under 30. “Our main objective is to support innovative entrepreneurs and empower them to become an integral actor in the emerging ecosystem to drive Egypt’s economic development,” he says.

Ms Sanchez-Cabezudo at EFG Hermes believes it may be difficult for some banks to hit the 20% target for SME lending, especially if there is a pick-up in large corporate lending. However, things seem to be moving in the right direction. “All the banks now have an SME unit, and they’ve been looking at this segment more seriously. In the past they were relying mainly on larger corporate lending,” she says.

However, challenges persist. “The issue in Egypt, as is the case in many other emerging markets, is that there are a lot of SMEs, but many of these are part of the informal economy,” adds Ms Sanchez-Cabezudo. “They don’t file tax returns, they don’t have audited financial statements, in some cases they might have land but they might not have property deeds. There has to be some incentive given to SMEs to move from the informal economy to the formal economy, so that they can become bankable and banks can more efficiently price their risk profile.” 

Regulatory changes

Egypt’s central bank has proved to be a proactive regulator, pushing through laws that have helped the sector to grow, and which have brought stability to the economy as a whole over the past two decades.

“The Central Bank of Egypt had the foresight 15 years ago to implement a series of regulations, including conservative liquidity requirements, deposit reserves and capital adequacy requirements, all of which served to strengthen the sector,” says Commercial International Bank’s Mr Al-Arab. “These moves produced banks that were perhaps the strongest, most efficient and most liquid among emerging markets.” He adds that the main issue for the sector in recent years has been high interest rates, but these have been coming down, most recently in February, which could help to reactivate borrowing.

Meanwhile, the central bank has continued to shepherd through measures to strengthen the financial sector, and add more assurances to international and domestic investors, as well as lenders. In January 2018, the country passed its first ever bankruptcy law, which simplifies post-bankruptcy procedures, and in March 2018 the Financial Regulatory Authority launched a moveable collateral registry. This is expected to help banks reduce their credit risk, especially when it comes to loans to SMEs, which often have their wealth tied up in assets such as machinery, inventory and crops.

“All these new laws are made with the intent of promoting new investment, of encouraging new and foreign direct investment, and making business procedures easier. I think anything that revolves around that is positive,” says Blom Bank’s Mr Ozalp.

Strong potential

Those operating in the Egyptian banking sector see strong potential for growth, with the country’s gross domestic product (GDP) expected to rise by 5.5% in 2019 and 5.8% in 2020, and the financial inclusion drive bringing more individuals and businesses into the formal economy. “The beauty of Egypt is that GDP is growing fast, and the banking market is growing faster,” says Michel Accad, group CEO of Al Ahli Bank of Kuwait, which has 40 branches across the country and saw its net profits increase 62% in 2018, to reach E£537m.

“If you think of all the Gulf Co-operation Council countries, their growth is less rapid because they are more mature; if you want to grow there you need to take market share from someone else,” he adds. “In Egypt you don’t need to, because you have such a big unbanked population that is coming into the market.” 

Mr Accad believes a similar purchase to the one Al Ahli Bank made in 2015, when it bought its Egyptian operations from Piraeus Bank for $150m, would cost upwards of $400m in 2019. “Today we have a return of about 20% a year. In the first year we broke even and that was preceded by years of losses,” he adds.

At the same time, Egyptian lenders are considered to have one of the lowest loan-to-deposit ratios among emerging economies, meaning there is plenty of money to invest. 

“The banks are liquid. The average loan-to-deposit ratio is relatively low, but you can look at it as an advantage as you go forward because it means that as the economy grows the banks have the ability and the muscle to finance new projects and the new requirements that normally come with an expanding economy,” says Blom Bank’s Mr Ozalp.

Retail lending could be one source of growth. A February 2018 report by management consultant McKinsey & Company said Egypt, along with Angola, Nigeria, South Africa and Morocco, accounts for 68% of Africa’s total banking revenue pool, with the countries combined likely to generate about 60% of Africa’s total expected retail revenue growth over the next five years.

“Retail lending has a lot of potential,” says Ms Sanchez-Cabezudo. “Because of the demographic dynamics, where a huge percentage of the Egyptian population is young, and given how underbanked it is, in the medium term retail lending [personal loans and car loans] is definitely going to be a key driver of growth.”

Alternative opportunities

Outside traditional banking, some also see opportunities in areas such as Islamic finance, given Egypt’s large Muslim population. According to ADIB-Egypt’s Mr Aly, Islamic banking currently represents about 6% to 7% of the banking sector, with three fully fledged Islamic banks and a number of windows for Islamic banking. “There are currently efforts to present sharia-compliant liquidity instruments by the government. This could be a very important step in supporting Islamic banking to grow substantially in Egypt,” he says.

One remaining area of concern is the high level of exposure to sovereign debt among Egyptian lenders. According to Moody’s, 32% of Egyptian banking sector assets are invested in government securities. In February 2019, Egypt issued $4bn-worth of dollar-denominated bonds, with maturities of five, 10 and 30 years, in a sale that was five times oversubscribed.

“This is a feature of some emerging markets,” says Ms Sanchez-Cabezudo. “In the context of Egypt, the exposure has increased because banks have been key in financing the government, as happened during the period from 2011 to 2016, [when] there was very low demand from foreign investors for Egyptian government securities,” she says, adding that the situation would only be of concern if the government is at risk of default, or needs to restructure its debt, “and we don’t think that this is a risk in Egypt”.

For those operating in Egypt’s banking sector, after years of cautious optimism, the future looks bright. 

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