Exposure to domestic sovereign debt remains the key risk for Egyptian banks, concludes a new report from US ratings agency Standard & Poor’s (S&P).

Since the ousting of former president Hosni Mubarak in January 2011, bank exposure to Egypt’s sovereign debt has soared, and currently represents more than half the sector’s total exposure.

This high concentration of sovereign risk leaves the banks highly vulnerable if the government were to default on any debt, the S&P report states.  

The risks to financial institutions have been mitigated in the short term due to the high yields paid out on government debt that have helped banks continue to perform relatively well in recent years.

With President Abdul Fattah al-Sisi newly elected to power, there are hopes for a new era of political stability and economic growth in the country. This should drive growth in the private sector, and create lending opportunities for banks, encouraging them to diversify away from sovereign debt.

Currently lending levels to the private sector is low, due to only a small proportion of the retail and corporate bases having bank accounts or accessing loans.

The S&P report recognises that the government has taken some steps to reform the country’s banking sector, but refers to efforts as a “work in progress” that could be hindered by continued political uncertainty.  

The banking industry currently has 40 licensed banks, but S&P anticipates that the consolidation of the sector, which tentatively began in 2004, is likely to continue in the coming years. Smaller banks could merge or the large state-backed banks could be privatised.

There are signs the health of the banking sector is slightly improving. Non-performing loans (NPLs), as a percentage of system-wide loans, are expected to hover around 10 per cent by the end of this year. This is slightly higher than the 9.1 per cent recorded in 2013, but an improvement on the 13.3 per cent NPL ratio recorded in 2009.

Yet, although S&P lists Egypt’s economic risk as stable, it maintains a negative outlook on the banking industry’s risk. This viewpoint is unlikely to improve until the new government successfully drives economic growth and banks start to increase their exposure to a developing private sector.

Download the MEED app today from the Apple store and the Google Play store