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Middle EastNovember 3 2008

Unfinished reforms test Egypt’s advance

The Central Bank of Egypt’s reform programme has made significant improvements to the sector but a turbulent economic environment is creating challenges. Writer Nadine Marroushi.
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Five years after the Central Bank of Egypt (CBE) launched its programme of reform, the restructuring of Egypt’s banks is still a work in progress. While many changes have been successfully implemented, the failure of recent large deals has dampened optimism within the sector.

The 2003 banking law introduced stricter rules to improve asset quality, increase minimum capital requirements and force consolidation. Its achievements include reducing the number of banks from 62 to 40, and encouraging the role of the private sector by reducing the market share of state banks from 80% to 45%. But the CBE’s work is far from over.

The postponement in June of the sale of 67% of Banque du Caire (BdC) shows just how difficult it is to balance efforts to continue domestic reform while dealing with both global and home-grown economic challenges. BdC is one of the last state-owned banks to be offered in a series of privatisations. Its sale was setback because the government and bidders could not come to an agreement on price. Although the National Bank of Greece bid $2bn, this was still below the price set by the evaluating committee. Many analysts, including finance minister Youssef Boutros Ghali, thought the set price was too high – Mr Ghali called it “overly ambitious”. He said in September that “technically, the offers were attractive, and for any banker they would have been extremely attractive”.

Other commentators have agreed that the government was being unrealistic about what it should expect, particularly in the climate of globally tight banking liquidity. The industry has reacted with disappointment at the refusal of the offered price. While the asset quality of BdC is believed to be relatively clean, it needs modernisation and more restructuring in terms of information technology and risk management systems. It has a good branch network, but it is overstaffed and has a limited loans portfolio. Credit ratings agency Standard & Poor’s (S&P’s) Egyptian banking analyst Emmanuel Volland says: “For any bidder, it will be a significant challenge to turn BdC into a modern and profitable bank.”

The most recent state-owned bank to be privatised was Bank of Alexandria (BoA). In 2006, Italian banking group Intesa ­Sanpaolo bought an 80% stake for $1.6bn. The remaining 20% was split, of which 5% went to employees and 15% was set aside for an initial public offering (IPO). BoA’s vice-chairman Fatma Lotfy told The Banker in May that the IPO would be held by the third quarter of 2008 after the sale of BdC, but it remains unclear whether this date is still on schedule with BdC’s sale cancellation.

Another deal to have fallen through was the merger between one of Egypt’s largest private banks, Commercial International Bank (CIB), and the Arab African International Bank (AAIB) – jointly owned by the CBE and sovereign wealth fund, the Kuwait Investment Authority. It was announced in May that the talks had failed to reach an agreement, seven months after the bidders agreed to conduct exclusive due diligence studies. CIB’s director for strategic planning, Ashraf Shash, says: “It looked very unlikely that we could reach an agreement with AAIB shareholders on mutually acceptable terms.”

Risky environment

The future of Egypt’s banking sector is closely correlated with the strength of the economy. “During the past three or four years we have seen improvements in economic growth, but at the same time inflation has been rising rapidly. This is putting pressure on borrowers to repay their debt,” says S&P’s Mr Volland. Inflation rose to a 16-year high of 24% in August, which economists expect to drag gross domestic product growth to less than 7% in the 2008/09 fiscal year, from 7.2% in the previous year.

S&P regards the Egyptian banking sector as relatively risky. It gives it a marking of eight out of 10 (10 being the riskiest). This is on a par with other north African banks in Morocco and Tunisia, but is still higher than S&P’s risk rating for banks in the Gulf.

The risks include weaknesses in the asset quality of some banks. S&P estimates that non-performing loans (NPLs) range between 20% and 25% for the sector. Although this figure has improved in comparison with the 2006 estimate that NPLs were between 25% and 30%, it is still high even by emerging markets standards. NPLs remain from an economic crisis in the late 1990s when public banks over-extended large loans.

Bank profitability and the capitalisation of the sector are also said to be weak, and there remain big differences between the performance of public and private sector banks, with the latter outperforming the former. The remaining public sector banks are BdC, Banque Misr and National Bank of Egypt.

The evident difficulties that remain should not discredit the major improvements and achievements in the sector since the 2003 restructuring plan began, which has included privatisations, mergers and the consequent consolidation of the sector. BoA is perceived as a success story, and the sector has attracted an influx of foreign investment, with banks from the Gulf showing particular interest. Two major public sector banks were sold to Gulf investors, including National Bank for Development, which is now owned by Abu Dhabi Islamic Bank, and Al-Watany Bank (AWB), now owned by Kuwait’s leading bank, the National Bank of Kuwait (NBK). Most of the bidders for BdC were also from the Gulf.

Subprime exposure

Egyptian banks are believed to have no exposure to the US subprime mortgage market, which is more than can be said for banks in the Gulf. The United Arab Emirates and Kuwait governments have created emergency lending facilities to help ease credit liquidity, although mainly for foreign banks operating in the local market, and banks in Saudi Arabia have experienced some losses believed to be subprime related.

A risk, which is more sovereign than sector specific but still relevant, is the question of who will succeed president Hosni Mubarak after next year’s presidential election. Although the most popular rumour is that his son, Gamal Mubarak, is in line to succeed, this is not guaranteed. It is unclear what role the opposition Muslim Brotherhood will decide to play in the event of a ­succession. There are also rival candidates from the military – from where all of Egypt’s past presidents have emerged – with ambitions of rising to the executive. Despite this, an increasing number of analysts think that while there will be some temporary tensions, the elections will pass smoothly with Gamal Mubarak, a former investment banker and secretary-general of the ruling National Democratic Party’s policy committee, elected as the next president.

Ambitious players

A review of recent successful entrants into the market reveals the potential upsides that exist despite the Egyptian banking sector’s problems and risks. NBK’s purchase of AWB was a logical step for a Kuwaiti bank aiming to expand its geographical presence in a country where more than 400 Kuwaiti companies and organisations, most of them already NBK clients, are present in investment and business-related activities. The most well-known Kuwaiti investor in Egypt is the Al-Kharafi Group, which has a presence in a number of sectors including insurance, food and energy.

Conversely, there are also more than 400,000 Egyptian expatriates living in Kuwait. NBK’s chief executive officer has said that AWB aims to double its network of 26 branches nationwide within the next two years and introduce more advanced banking products into the market. Demand remains high for basic products such as savings, loans (especially car loans) and mortgages.

Blom Bank, one of two Lebanese banks present in Egypt (the other being Bank Audi), has recently received approval from the Egyptian Capital Market Authority for a rights issue to raise its capital to £E750m ($37.7m) from £E500m. The capital will be used to fund the bank’s continued operations and its expansion. Blom Bank Egypt was formed after its purchase of a 99% stake in Misr Romania Bank for $97.8m in 2005.

While Egypt has a number of ambitious players operating in its market, it is worth noting that these banks only serve 10% of the 75 million residents. This is a figure that has remained unchanged for a few years. The remainder of the population is too poor to bank. This creates the need for private sector banks – to offer financing solutions for low-income individuals. A number of banks are working towards increasing their penetration of the small and medium-sized enterprise market but microfinance solutions remain marginal. Although not the most profitable segment of the population, it could potentially be by far the largest.

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