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PolicyMarch 10 2009

Egypt faces the acid test

Extensive reform means Egypt’s banks are better placed to face global economic turmoil than ever before, but the fragile, export-driven economy will be hit hard and the bank sector is not immune to the consequences. Writer Charlie Corbett in Cairo.
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Egyptian bankers have good reason to feel smug. As some of the world’s biggest and most prestigious banks struggle for survival, begging handouts from over-stretched state governments, Egypt’s banking sector can boast an impressive bill of health.

In the past, Egyptian bankers scraped by in an environment of lumbering state-owned institutions, with portfolios poisoned by non-performing assets, while the blue-blooded banks of the West showed them what an efficient, well-regulated privatised regime could achieve. Recent events have turned the world on its head. Five years after the Egyptian government began a dramatic financial reform process, the local bank sector is thriving. Privatisation and consolidation has slashed the number of banks from 61 in 2004 to 36 in 2008, while a clean-up of non-performing loans has given banks the resilience needed to weather the economic storm lashing global financial markets.

“It is hard to tell what emerging markets need to aspire to anymore in terms of best practice,” says one financial markets professional based in Cairo. “I was about to say ‘international best practice’ – but that whole house of cards fell down.”

Such schadenfreude, however, should be tempered by reality. The overwhelming reason that Egypt’s banks are now is such a strong position compared with banks in more developed countries is because of the unsophisticated nature of the system. Egypt’s bank sector was not mature enough to be exposed to the kind of toxic structured assets that brought down the West’s banks, and an almost non-existent mortgage market meant they were protected from a collapse in house prices. International exposure is limited and retail assets, such as home loans and credit cards, still make up just 9% to 10% of total assets in Egypt’s bank sector.

Credit growth low

Despite the reform process, credit growth among the banks has remained stunted. In the past, this would have reflected badly on the sector, but this conservatism has left the banks in a strong position. With an average loan-to-deposit ratio of just 54%, Egypt’s banks are sitting on a potential goldmine of liquidity.

It is an exciting proposition for some. Hassan Abdalla, managing director of Arab African International Bank (AAIB), sees huge opportunities in using the excess liquidity to fund growth in the retail market. “Trouble with mortgages abroad does not imply that all mortgages are a sin. With prices of real estate becoming reasonable, mortgages can become an area of growth,” he says.

This is not the only area of potential growth. Mr Abdalla also believes that the small to medium-sized corporate sector is ripe for development. “This [sector] has always been underbanked. In these conditions, we do need to be prudent, but because of the vast availability of projects you can pick and choose according to criteria that fit your own risk appetite,” he says.

Domestic potential

The real potential in Egypt’s bank sector lies at home. The country is hugely under-banked and branch networks outside major urban areas are almost non-existent. AAIB plans to build a further 10 branches in 2009 and most other banks plan a similar strategy. It is not only the domestic banks that are looking to seize on this opportunity. Banks from across the Gulf Co-operation Council (GCC) region are committing funds to capturing the Egyptian retail pound. Lebanese banks Blom Bank and Bank Audi recently opened offices in Cairo, and National Bank of Kuwait (NBK) bought Al Watany Bank (AWB) of Egypt in late 2007. AWB managing director Yasser Hassan believes that, after a slow start, retail lending will grow and grow. “A good economy has increased the ambitions of people, which has encouraged them to borrow to increase their standard of living,” he says. “The retail market is still largely untapped. NBK is quite strong in the retail area and can draw on the expertise it has developed in other markets and build on that in Egypt.”

AWB plans to expand its network from 29 branches to 40 by the end of the year.

Aggressive strategies to capture business from Egypt’s nascent middle classes, however, should be tempered with caution. The country has no effective credit bureaux and few Egyptians even have bank accounts, let alone a credit history. In the words of one Cairo-based banker: “Retail lending is still a case of hold your breath and jump.”

Despite the relative strength of the Egyptian bank sector, few are naïve enough to believe the country is completely shielded from the global economic turmoil. According to Henri Guillemin, managing director of Crédit Agricole in Egypt, retail banking faces its acid test in 2009. “It is still very, very young. The economic situation in the past was good, but now with the slowdown the cycle is going downward. This is the first time our retail portfolio has faced something like this and we don’t have the track record.”

The external factor

Egypt’s economy will be hit hard by external factors in 2009. The country is almost completely reliant on exports to fund its budget, with domestic markets accounting for a tiny proportion of government revenues. The nation’s stock exchange has already felt the fallout. The benchmark CASE 30 index plummeted 59% in 2008 as foreign investors fled emerging markets to lick their wounds at home.

Finance minister Youssef Boutros-Ghali said last month that Egypt was facing a “serious contraction” in economic growth because of the global financial crisis. In a speech to the American University in Cairo he said that all interaction with the outside world was coming practically to a standstill. This has had a drastic negative impact on the country’s four main sources of revenue: tourism, Suez Canal receipts, worker remittances and oil. As a result, the country’s net foreign reserves fell $680m in January to $33.4bn, according to the Central Bank of Egypt.

Gross domestic product (GDP) growth forecasts have been slashed from last year’s 7% down to about 5% for 2009. Mr Abdalla believes even this figure is optimistic. “The real economy will show signs of weakness in different areas, which in turn will make previous GDP growth targets hard to achieve. GDP growth could be as low as 3% or 4% this year,” he says.

Reforms hit

The global economic crisis has already affected the government’s reform process. After several years of successful bank privatisations, the government hit a stumbling block in 2008. Buoyed by the 2006 sale of the Bank of Alexandria to Italy’s Gruppo Sanpaolo IMI, the government set an unrealistically high price on state owned Banque du Caire. A potential deal with the National Bank of Greece fell through when it would not pay the $2bn-plus price tag.

“The government was too greedy. The offer by Bank of Greece was a good one but the government worked off the wrong benchmark,” says one Egyptian banker. Another deal hit by the global downturn was the proposed merger between two of Egypt’s biggest banks, Commercial International Bank and AAIB. Talks broke down in May last year after the two parties could not reach mutually agreeable terms.

The government’s response to the economic downturn has so far been measured. It has introduced a fiscal stimulus of about 0.5% of GDP, which will be spent on infrastructure projects and public-private partnerships. This response has met with little criticism internally. Despite the failure of the Banque du Caire deal, most observers in the market agree that the government is managing the financial sector well, even if some feel more reform is necessary.

“[The government] understands the banking industry very well. We can speak to them, they know what we do and they are on the same wavelength,” says Mr Guillemin. “What we are missing is more coherent regulation. We tend to have several layers of regulation. We need to streamline the regulation so we know exactly what we are allowed to do and what we’re not allowed to do. But this is on the way; the government is fully aware of this.”

AWB’s Mr Yasser agrees. “The most important next step is the application of Basel II, which would require shareholders to follow certain disclosure requirements, international standards, better risk management and putting up more capital into the local banks,” he says.

The government plans to continue its reform process unabated. In November it announced the planned mass privatisation of 152 publicly owned companies, in which shares will be transferred to 41 million Egyptians. Its aim is to repel criticism that the last round of privatisation benefited only foreign buyers who purchased undervalued assets.

The scale of the government’s reformist zeal has impressed many onlookers, both internationally and at home, but there is still much to do. The global economic downturn has so far had a limited impact on Egypt’s banks and could benefit them through their ability to capitalise on such low loan-to-deposit ratios. However, most are aware that Egypt’s export-driven economy will suffer from the contraction in global trade, in turn hitting domestic banks.

New ideas needed

“We need to have new ideas and views,” says Mr Guillemin. “We need to give assurance to [foreign] direct investors that they will be treated as they are in other emerging economies, with good standards and regulation so they can invest for the long term.”

As it stands, the biggest threat facing Egypt’s banks is asset quality. In the last downturn in the late 1990s, NPL ratios rocketed. “The economy is going to slow down and if our borrowers get affected, this risk will be increased,” says Mr Yasser. Egypt’s economy, however, is in a much stronger position than it was in the late 1990s. Then a bloated, state-dominated bank sector with loose credit risk policies and an overvalued currency left the economy open to economic malaise. Today, a sleeker, privatised system with a history of conservative banking practice is well placed to weather the global economic crisis, even if Western banks are not.

Loan growth at the largest private sector banks % growth year-on-year unless otherwise stated

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