US credit ratings agency Standard & Poor’s (S&P) announcement on 14 May that it was cutting the rating of Egypt’s biggest banks, even though the sector was publishing record profit increases, came as little surprise.

The long-term counterparty credit rating on National Bank of Egypt, Banque Misr and Commercial International Bank (CIB) was reduced to CCC+ from B-, in line with Egypt’s foreign and long-term domestic rating. It followed a similar move by another US ratings agency, Moody’s Investors Service, earlier this year. The reason is simple: Egypt’s banks have been buying up vast amounts of high-interest government paper.

A few days before the S&P downgrade, Egypt’s central bank had expressed its own concern with local banks’ appetite for government debt. In a privately forwarded circular, it told banks not to invest more than 2 per cent of their Tier 1 capital in local money market and fixed income funds, down from 5 per cent previously. State-owned Banque Misr, the country’s second-largest in terms of assets, has more than £E20bn in the local market, according to central bank figures. In late May, interest rates on state treasury bills varied from 13 per cent for a one-month paper up to 14.7 per cent for 12 months.

Budget deficit

Another concern is that Egyptian pound deposits are being inflated by the government’s decision to pay many of its joint-venture partners in the oil and gas industry in local currency, rather than in dollars, as stipulated in their contracts. They flatter the figures, but are storing up trouble for the future.

The huge growth in the lucrative lending to the government has meant record first-quarter profits this year for CIB and others. CIB reported a 30 per cent year-on-year rise in first-quarter net profit to £E658m, while National Societe Generale Bank (NSGB) posted a 32 per cent rise in profit to £E463m.

The news is in stark contrast to lending to the private sector. Sluggish loan growth has been characterised by hesitation on both sides, amid general uncertainty over the future of the Egyptian economy. Total assets at NSGB, for example, rose by only 3 per cent in the first quarter, year-on-year.

“The budget deficit is a serious concern to potential investors in Egypt,” says Andrew Long, deputy chairman and chief executive officer of HSBC Bank Egypt. “People offshore are showing interest in investing in Egypt, but need clarity on the budget and the currency issues before they decide to start reinvesting in the Egyptian market.” Egypt’s budget deficit stood at 10.6 per cent of gross domestic product for the 10 months to the end of April.

We have the money to lend, and are lending more than we have ever done, but demand for borrowing remains low

Andrew Long, HSBC Bank Egypt

At the same time, however, the acquisition of two leading local banks by Gulf financial institutions suggests a medium- to long-term confidence in the sector. Dubai-based Emirates NDB paid $500m for BNP Paribas Egypt, while Qatar National Bank (QNB) paid $2.5bn for NSGB. The sums included payment to both controlling French banks and local investors. 

And the talk is of expansion. “We intend to grow NSGB’s branch network to about 300, from 160 currently, within five years,” says Mohamad Moabi, assistant general manager, QNB. “The increase will be concentrated mostly in Greater Cairo and Alexandria.” He declined to say how much new investment this would represent.

While some competitors have seen the change of ownership as potentially weakening NSGB and BNP Paribas Egypt, QNB’s Moabi is adamant this is not the case. “Yes, [former owner France’s Societe Generale] has a larger network [than QNB] but NSGB was not a top priority. NSGB is much more important to us than it was to them. This is our biggest investment to date.” QNB also has a significant and growing presence in Europe and Asia.

Moabi adds that QNB is in a good position to support Egypt’s regional trade, thanks to subsidiaries in countries such as Libya, Tunisia and Iraq, as well as a branch network in Sudan. There will also be more emphasis on retail.

“The business mix at present is 60:40, corporate to retail. In the future, there will be a greater focus on retail, including upscale retail,” he says. “We will be competing with the state banks on retail by offering a better customer service, delivery of sophisticated retail products, an advanced IT system.”

Potential growth

Egypt certainly lags behind neighbouring countries when it comes to credit and debit cards and point-of-sale (PoS) machines.

According to Hossam Abou Moussa, Cairo-based director at the UK’s Actis, an emerging markets private equity firm, among Jordan’s 6 million inhabitants there are 4 million cards and 20,000 PoS machines. Egypt’s 85 million people own just 17 million cards and there are only 40,000-45,000 PoS machines. This compares with 1.2 million in Turkey whose population is slightly less than Egypt’s.

Actis is both CIB’s largest shareholder and the main investor in Emerging Markets Payments Holdings, which provides card issuing, processing and ATM switching to 140 regional and African banks.

One source of potential growth for the Egyptian banking sector is home loans. “The entire Egyptian mortgage market is $600m, about the same size as a large town in the northwest of England,” says Long. “The main hurdle is the lack of a viable land registration system. With 80 per cent of land currently unregistered, title transfer is problematic. In Saudi Arabia, by contrast, registration takes 30 minutes.”

He adds that interest rates will also have to come down to encourage prospective home owners to borrow. Bankers estimate an active mortgage market could push the loan-to-deposit ratio up to about 70 per cent, from less than 50 per cent currently.

Abou Moussa agrees that land registration, longer duration products, and clarity about repossession are needed before the mortgage market can expand. In the car-leasing market, he says, repossession is also still an issue.

Low demand

The shortage of foreign currency is also hindering business, particularly trade finance.

“The value of the Egyptian interbank Forex trade was $1.5bn to $2bn a week in December 2012; now the Central Bank of Egypt’s (CBE’s) auction mechanism is just $120m,” says Long. “Exporters are becoming more conservative in selling dollars back to banks. There are some difficulties in getting the dollars to finance imports, [but] the priority is given to strategic goods.”

In terms of general business activity, the picture is currently stagnant, he says. “We have the money to lend, and are lending more than we have ever done, but demand for borrowing remains very low. In terms of losses on lending, delinquency rates haven’t risen.”

Non-performing loans account for 2.7 per cent of assets at NSGC and 3.97 per cent at CIB, according to first-quarter figures. Nevertheless, Long says “Egypt is still one of the 20 priority markets for the HSBC Group and one of the top three markets for the Mena [Middle East and North Africa] region. We are confident in the medium term.”

There is much praise for the CBE, which in the past few years has had to steer the sector through an international banking crisis and a revolution. “The Egyptian banking sector is well-regulated. The banking sector weathered the post-2008 and 2011 periods extremely well and showed great resilience,” says Abou Moussa.

Long agrees. “HSBC Bank Egypt has ongoing communications with the CBE, both verbal and written,” he says. “Meetings between the CBE and the banks have increased in frequency and we are happy with the level of communication.”

The relationship between CBE governor Hisham Ramez, who took up the position in January, and the government is, however, showing signs of strain. The Tier 1 capital ruling certainly had the effect of reducing Cairo’s access to local funding. In late May, he spoke openly that he had not been consulted on the new loan provision tax passed by parliament.

“I learnt about the law on loan loss provisions from newspapers,” he told a TV station on 27 May, and complained about the lack of coordination between the CBE and the Finance Ministry. He also muttered darkly about political interference and declared that “the bank is independent and I will resign if a decision or something else will be imposed on me”.

Amendments to the law, proposed by a Freedom and Justice Party (FJP) MP, cancelled the tax deductibility granted to 80 per cent of loan losses. Three days later, in another piece of straight-talking, Ramez announced he was unaware of the government’s plans to issue $12bn-worth of bonds, including a portion of sukuk (Islamic bonds), by the beginning of 2014. The previous day, it had been reported that HSBC Group and QNB had been appointed joint lead arrangers and dealers for the programme.

Islamic finance

The previous week, Maridive & Oil Services, a local marine services firm, obtained a $150m syndicated loan using an Ijara (Islamic leasing) structure, the first of its kind in Egypt. President Mohamed Mursi twice signalled his ideological commitment to Islamic finance in May.

First, he approved a law permitting the state to issue sukuk, despite criticism from religious critics that parliament and the president were not competent to rule on the legislation.

Second, his new finance minister, Fayyad Abdel Moneim, appointed in the May cabinet reshuffle, is like his predecessor a specialist in Islamic finance. He was previously a professor at Cairo’s Al-Azhar University, but has no prior experience in government. It is also understood the Muslim Brotherhood has been filling the Finance Ministry with its own advisers.

The new tax law and the breakdown in communication with the central bank may be yet another example of the FJP-dominated government’s ineptitude, say critics, or it may be something more significant. Whatever the case it seems Islamic finance is set to play a greater role in Egypt’s banking system in the future.