EGYPT'S banks, freed six years ago from the command economy, are learning to find their way in a new era of open markets, stiff competition and discerning customers. Four state-owned heavyweights dominate the industry but the most dynamic institutions are to be found in the private sector, tempting Egypt's business class and foreign multinationals with the offer of fast, efficient service and a wide range of products.

Yet the biggest question is still about the future of the four state- owned banks, which most analysts consider to be inefficient but deeply entrenched in the Egyptian economy. There is talk that the government is now ready to think about their privatisation, a move which could have dramatic results for the rest of the industry.

The liberalisation of Egyptian banking began in 1991, almost exactly three decades after Egypt's revolutionary government nationalised most of the industry and took charge of the allocation of credit. Since 1991, controls on credit and interest rates have been removed, curbs on fees and commissions have been lifted and foreign banks have been allowed to do business in local currency. The reforms have triggered rapid growth in the banking sector, which is expanding at a faster rate than the economy as a whole.

Egypt's gross domestic product grew by about 125 per cent in nominal terms between 1991 and 1996 to its current £E 257,000 million ($75,800 million). During the same period, the value of loans and advances by commercial banks grew by about 145 per cent to £E 110,938 million ($32,727 million), way ahead of domestic inflation. With the economy expected to grow at 5 or 6 per cent a year for the next few years, the banking industry should find no shortage of business. 'We've seen financial assets in the banking sector growing by 18-20 per cent in the last three years, so there is room for competition,' says Ahmed al-Bardai, the chief executive of Arab- African International Bank and former head of Citibank in Cairo.

Interest rates are also falling as the central bank tries to prevent the Egyptian pound rising too strongly in the wake of foreign capital inflows, which should also increase domestic demand for credit. Interest rates on local-currency loans are between 11-13 per cent and bankers expect them to fall below 10 per cent in the longer term.

The rapid progress of Egypt's privatisation programme in the last few years has galvanised the stock market and provided the banks with new areas of business to explore, including underwriting, brokerage, corporate advice and fund management. Several banks are following the route taken by the leading private sector bank, Commercial International Bank (CIB), in setting up investment companies.

Foreign banks are also getting in on the act: HSBC Holdings and Morgan Stanley have both announced investment joint-ventures with Egyptian firms: ING Barings and several other banks are expected to follow suit. At the moment, the central bank is not giving out new commercial banking licences.

Despite the growth of the economy, some consolidation is likely among the smaller of Egypt's 80-plus commercial banks. 'The best way for the small entities is to merge, and I think this will happen in the near future,' says Essam el-Ahmady, chairman of the state-owned Banque Misr. For the bigger private sector banks, upmarket retail banking is one area where their relative sophistication may put them ahead of the state-owned giants. Economic liberalisation is likely to swell the ranks of the affluent minority, and many of these people live in Cairo where the private-sector banks are strong.

'I think niche banking will develop, because you can't have so many banks being all things to all people,' says Mohammed Ozalp, the chief general manager of Misr International Bank (MIBank), an affiliate of Banque Misr. Following in CIB's footsteps, MIBank has just gone to the international markets with a global depositary receipt (GDR) issue which is expected to raise $180 million-$200 million, as part of Banque Misr's plans to reduce its stake (see page 35).

The international markets seem to approve of what the top private-sector banks are doing: CIB got a finely-priced 40 basis points over the London interbank offered rate (Libor) on its $200 million Euroloan last year, following Egypt's investment-grade rating from Standard & Poor's. Moody's Investors Service has also been in town, rating the four state-owned banks - National Bank of Egypt (NBE), Banque Misr, Banque du Caire and Bank of Alexandria - and three of the top banks in the private sector: CIB, Egyptian-American Bank (EAB) and MIBank.

The Moody's judgement on the three private banks, though constrained by its sub-investment grade sovereign rating for Egypt, was generally positive: though much smaller than the state-owned banks, they are well- managed and have done more to diversify their income. The verdict on the state-owned banks was less flattering. '[They] remain disadvantaged compared to some private sector market leaders, in terms of overall competitiveness, strategic focus, staff calibre, operating infrastructure, efficiency and financial agility,' according to Moody's. The agency rated NBE's financial strength at D and the other three at E - the lowest grade it has assigned to any bank in the Middle East.

Nevertheless, the big four will continue to occupy a commanding position because they control 70 per cent of all banking assets and 75 per cent of customer deposits, as well as owning most of the bank branches in Egypt and counting many large public sector companies among their clients. They are big enough to take on large, long-term industrial financings and, unlike many private sector banks, they are well-represented outside Cairo and Alexandria.

The big four are in the process of shedding their majority shareholdings in a number of joint-venture banks set up with foreign partners after Egypt's first burst of economic liberalisation in the 1970s. CIB and MIBank were both in this category. Societe Generale of France has just upped its stake to 51 per cent in another joint venture with NBE, while Barclays of the UK and Banque Nationale de Paris are still negotiating over the future of their respective joint ventures with Banque du Caire. The state- owned banks are supposed to have sold down all their holdings in joint ventures to below 20 per cent by this summer, though this seems unlikely to happen in time.

Once they have ceded control of their joint ventures, the next step could be the privatisation of the big four themselves. Rumours are rife, though no official timetable has been announced. Bankers expect the government to sell off other state-owned industries first, then test the water by floating 10 or 15 per cent of one of the banks on the local market. There is talk that the smallest of the big four - Bank of Alexandria - could be the first to go.

If privatisation succeeds, things could get tough for smaller banks. 'If these [state-owned] banks are privatised and the quality of service improves to match that of the private-sector banks, then there's going to be gruelling competition which will put downward pressure on wholesale margins,' says Mohamed Metwally, head of Middle East corporate finance at Salomon Brothers in London. Salomons is one of several banks working on the MIBank GDR.

Privatisation should help the performance of the big four, if only because it would allow them to match the high salaries offered by private sector banks. Demand is growing from the industry for senior executives with international experience and, lower down the management ladder, for the best graduates from elite colleges like the American University in Cairo (AUC). The many new brokerage and investment companies springing up on the back of the stock market boom are also looking for staff, and employers are starting to poach from each other. 'There's no problem finding people, but it is a problem finding good people,' says MIBank's Ozalp.

Privatisation will also force a solution to the big four's most serious problem: a mass of non-performing loans, mostly made to public sector companies and dating back to before 1991. There are no published figures for the exact size of the problem, which drove the average level of provisions last year to nearly 20 per cent of the banks' total loan portfolios. These old loans also weigh down the banks' return on assets. 'The returns that they're making on new loans look a lot better than their current returns based on the whole

portfolio,' says Metwally.

The big four themselves say they have tightened their credit criteria. 'We are more cautious in granting facilities to the public sector than before,' says El-Ahmady of Banque Misr. However, some private-sector bankers still suspect that there may be more bad loans on the big four's books than they have provisioned for. The size and seriousness of the bad debt issue may not be revealed until the banks are sold.

Optimists counter that even if a pre-privatisation audit reveals some nasty surprises tucked away in the accounts, these should be offset by big undervalued assets, which include some prime real estate, holdings in joint-venture banks and investments in industrial companies. 'There's no magic about it,' says one optimistic Egyptian investment banker. 'The government will have to pay off the bad debts before privatisation, just as in other developing countries. It's as simple as that.'