In June last year, Egypt's financial markets were digesting the shock news of the failed privatisation of the state-owned Banque du Caire. If it had been successful, the deal would have been the second largest ever sale of the country's public assets.

The successful $1.6bn sale of an 80 per cent stake in Bank of Alexandria to Italy's Intesa Sanpaolo in 2006 had raised hopes for the Banque du Caire privatisation, and in 2007, central bank governor Farouk el-Okdah had valued Banque du Caire at $2.6bn.

But on 24 June 2008, when the bids were publicly opened, even the highest price of $2.025bn from National Bank of Greece fell far short of what the government wanted.

Faced with such low offers, the Egyptian authorities opted to abandon the sale and wait for more favourable circumstances.

All the main bidders and would-be bidders, both Arab and European, had good, strategic reasons for wishing to expand in Egypt, which represents a strong opportunity, not least because of its population of 81 million. Yet none came up with an offer that was anywhere near the government's valuation of the bank.

The failure of the Banque du Caire auction was a sobering reminder for Cairo of the distance that the Egyptian financial sector has to travel before it can convince international markets that it will realise its potential for growth.

Expansion opportunity

"We see the industry as a two-tier system," says Constantinos Kypreos, Egypt banking analyst at credit ratings agency Moody's Investors Service. "The public sector and recently privatised banks are still benefiting from the overhaul of balance sheets in the banking sector reform programme. The leading private banks start out from a stronger position."

The failed sale dealt a blow to the credibility of the Egyptian banking sector, but the way it has since reacted to the global financial crisis, which hit the region months later, is restoring investors' confidence. "The Egyptian banks did not have an exposure to the structured investment products that were at the root of the international financial crisis because Egypt's regulations prohibit local banks from engaging in this activity," says Mohamed Damak, credit analyst in the Middle East team at ratings agency Standard & Poor's.

While the Egyptian banking sector is clearly underdeveloped, an ongoing reform process, which began in 2005, of what was once a state-dominated sector, requiring banks to apply strict risk-management measures and international financial reporting standards, has helped the banks cope with the effects of the international crisis.

"The market in general is holding up pretty well because the central bank has been alert over the past few years in actively implementing banking sector reform measures," says Atef Ibrahim, managing director, Banque du Caire.

The reforms have triggered consolidation in the sector. All banks were required to have capital of at least£E500m ($89m) by the end of 2005, and banks that could not meet the new capital targets were forced into closure or merger, reducing the overall number of local commercial banks from more than 40 to 33. Those that survived were mostly well capitalised, well managed and more transparent than their rivals.

The new regulations have paid off. In 2007-08, the bank's total reserves jumped by 28.6 per cent,£E3.5bn, to£E16.13bn.

Improved service

Banks have also been steadily improving their services, extending branch coverage and their use of electronic technology. For example, Banque Misr has now linked all its branches with a single electronic system, and introduced a service that allows universities to collect fees from students through their electronic payment cards.

Meanwhile, the overall density of service coverage has improved from an average of one banking unit for every 24,500 people in 2004 to one for every 22,500 people in December 2008.

It is too early to fully assess the impact of the global crisis on Egyptian banks, even those that have already published results up to the end of 2008. But some indicators are available.

The volume of lending to the private sector dipped slightly at the end of last year and again in February, but to no greater extent than the fluctuations seen in previous years.

A report published in November last year, Egypt Banking Sector Analysis, by Indian research firm RNCOS is bullish. "The Egyptian banking industry is expected to remain unaffected from the global financial meltdown," it says in the report, conceding that its findings might come as a surprise to its readers.

RNCOS argues that strong demand for corporate credit will sustain annual business lending growth in Egypt at 9.5 per cent through to 2011. This prediction is partly based on a forecast that deposits, particularly by retail customers, will continue to rise by as much as 14 per cent a year.

For some Egyptian banks, this optimism is being borne out by their results. National Societe Generale Bank (NSGB), a subsidiary of French banking group Societe Generale, reports a 74 per cent rise in net profits for 2008 to£E492m, followed by profits of£E160m for the first quarter of this year, a rise of 51 per cent compared with the first quarter of 2008.

This striking jump in profits is partly explained by the impact of its merger with Misr International Bank, which was finalised in November 2006. First-quarter profits for 2009 show growth is continuing. Its net banking income for January to March 2009 is up by 24 per cent and client deposits are up by 7 per cent.

Commercial International Bank (CIB), another dynamic private sector institution, also reports a sharp rise in net operating income in 2008, to£E3.4bn from£E2.4bn the previous year. In dollar terms, the rise is less spectacular, at just $15m, but the final result, a surplus of $600m, is still impressive.

CIB's figures hint at some impact from the global financial crisis, with the bank increasing its provisions against specific credit losses to£E346m from£E139m.

Strong regulation

Hisham Ezz al-Arab, chairman of CIB, is complimentary about the central bank's regulatory approach. He argues that its reforms have left Egypt "nearly immune" to the toxic debt emanating from the US, while the relatively low loan-to-deposit ratios of Egypt's banks - at 58 per cent - provide a cushion against the global liquidity pressures, meaning they have spare funds available to maintain lending.

Even state-owned giants such as National Bank of Egypt have been at least partly cushioned from the global financial turmoil by the improved positions they have built up over recent years.

At National Bank, results for the year to 30 June 2008 show a spectacular leap in net operating revenue, which climbed to more than£E11bn from just£E4.9bn the previous year. But provisions also soared, from almost£E2.8bn to more than£E7bn, leaving the bank with a distinctly unspectacular rise of just£E12m in net post-tax profit, to£E385m.

The challenge for the state-owned Banque du Caire, if it is to attract high bids for any future sell-off, is to follow the lead set by banks such as CIB and NSGB and improve profitability. In the wake of the failed auction, Mohammed Barakat, then chairman of Banque du Caire, said the idea of a sale had not been dropped altogether, although the timetable was no longer clear.

But as the global credit crunch deepened late last year, it became clear that Egypt would face a long wait before credible foreign bank investors rediscovered their appetite for investing in the complex and challenging emerging banking markets. So the authorities resigned themselves to the need for a radical change of strategy. In June 2008, Cairo announced that Banque du Caire would remain in public hands, but a new management team was installed with the task of continuing the overhaul and development of the institution that was already under way.

Last month, the central bank governor confirmed that there was no prospect of any renewed attempt to sell the bank in the near future. Atef Ibrahim, part of the new independent management team, says the start of the bank's financial year in July will mean the arrival of consultants who will work with the bank on the development of a new strategy.

He also says the decision not to privatise or merge the institution has bolstered morale among staff, who have taken the government's decision to give the bank a chance to revive under its present ownership as a gesture of confidence.

Moreover, Ibrahim points out that it is starting from a solid base, because of the work that has already been carried out in preparation for a possible merger with Banque Misr, a plan that was announced in September 2005 but was abandoned in September 2006.

"By the time Banque du Caire was offered for sale in June last year, the balance sheet was completely cleared up," says Ibrahim. "Banque du Caire is now a cash-rich institution with a lot of opportunities."

To finance the write-off of non-performing loans, the bank has sold assets. This leaves it in a strong liquidity position, well placed to expand lending at a time when competitors squeezed by the credit crunch find it hard to do so. And it is looking to develop new products such as a money market fund, says Ibrahim.

The bank also has a track record in micro-credit, which is important in a country where much of the population and many people in the business community are on low incomes.

"Banque du Caire has been into micro-finance historically," says Ibrahim. "The portfolio is still there, and operating profitably."

Al-Arab says that as the worst of the global crisis passes, banks with strong finances will be able to take advantage of the opportunities that emerge. In common with the chairmen of all Egypt's leading banks, he is looking forward to an improvement in profits this year.