State lending dominates sector activity in Egypt

07 June 2015

The fragile recovery of the Egyptian economy has opened up new opportunities for local banks, but they will need to find a way to wean themselves off a rich diet of treasury bills

The recent performance of Egypt’s leading banks has been encouraging from an investor’s point of view, with returns on equity at the three largest listed banks averaging 28.5 per cent in 2014.

The sector’s prospects have also spurred interest in acquisitions, with a deal concluded in May 2015 for the sale of Piraeus Bank Egypt to Al-Ahli Bank of Kuwait, and six lenders vying to buy the retail operations of Citibank’s Egypt branch. However, banks depend on income from treasury bills (T-bills) for a large chunk of their profits, and as long as the government continues to need to borrow heavily from local banks to finance its budget deficit, the scope for more lending to projects and business will be constrained.

Foreign exchange

Another structural constraint on the banking sector is the shortage of foreign exchange in the system. Both problems could be alleviated if international banks were to resume their pre-2011 role in investing in Egyptian government debt. This would generate capital inflows that would improve the balance of payments position and it would relieve local banks of some of the burden of financing the deficit.

In numbers

23 per cent Lending to private businesses as a percentage of total credit today

36.5 per cent Lending to private businesses as a percentage of total credit in 2010

Source: Central Bank of Egypt

The forthcoming issue of eurobonds will be a potentially important first step, but foreign lenders remain wary of investing in Egyptian domestic bonds because of exchange rate risk and the 20 per cent withholding tax that applies to income derived from such securities. They also have concerns about the sheer size of the fiscal deficit.

The positive aspects of the banking sector were reflected in a note by Renaissance Capital, an investment bank focusing on emerging markets, which analysed the performance of the local Commercial International Bank (CIB) in the first quarter of 2015. The note highlighted the strong growth in the lender’s loan portfolio, which increased by 9 per cent during the quarter and by 25 per cent year-on-year, and it projected loan growth of about 30 per cent a year in 2016 and 2017.

Loans now make up just under one-third of total [Egypt bank] assets, compared with almost 40 per cent in 2010

However, CIB’s first-quarter performance is likely to have been affected by the devaluation of the Egyptian pound during that period, which would have boosted the local currency value of loans and deposits. Moreover, despite the strong growth in the bank’s loan portfolio, the loan-to-deposit ratio has continued to decline, reaching 39 per cent in March, compared with 41.7 per cent a year earlier.

Government borrowing

The effects of the relentless increase in government borrowing are clearly shown in the aggregate banking figures issued by the Central Bank of Egypt. The government now accounts for almost two-thirds of total domestic credit, compared with about one-third in 2010. Lending to private businesses has fallen to 23 per cent of total credit from 36.5 per cent in 2010, and lending to the household sector has dropped from 12 per cent to 9 per cent over the same period.

In 2010, T-bills made up about one-third of the total assets of Egyptian commercial banks, already a relatively high proportion, reflecting the rise in the fiscal deficit after the 2008 global financial crisis. Loans now make up just under one-third of total assets, compared with almost 40 per cent in 2010, and the loan-to-deposit ratio has fallen to 40 per cent from 52 per cent. This ratio is only about 30 per cent at the two largest banks, National Bank of Egypt and Banque Misr, both of which are state-owned.

The supply of foreign exchange in the banking system remains highly dependent on Gulf Arab largesse

There is little sign that the preponderance of public debt on commercial banks’ balance sheets is going to change anytime soon as the government is making heavy weather of reducing the fiscal deficit. The deficit was 12.8 per cent of GDP in 2013/14 (July-June fiscal year); if the $13.4bn of grants from Gulf Arab donors are excluded from those accounts, the shortfall was about 17 per cent of GDP. The deficit in the first nine months of the 2014/15 fiscal year stood at 9.4 per cent of GDP, and is likely to end up at a similar level to the previous year.

Bruising setback

The modest benefits of cuts in energy subsidies have been offset by large increases in spending on public sector wages and interest payments, and the improvement in economic growth has not translated into a significant increase in tax income.

The Ministry of Finance’s efforts to generate new tax streams from the financial services industry received a bruising setback in May, when it was forced to suspend plans to levy tax on share dividends and capital gains, after harsh criticism from prominent business people, as well as from the head of the Egyptian Exchange and officials in the Ministry of Investment. Two months previously, the finance ministry had been forced to scrap a 5 per cent wealth surcharge on corporate and personal income tax.

The pressure of Egypt’s parlous fiscal position on the banking sector has also been reflected in a significant increase in direct borrowing by the government from the central bank. Since 2010, the central bank’s net claims on the government have risen more than four-fold to £E472bn ($62bn) as of February 2015. The bulk of this increase has been accounted for by direct credit facilities, which have risen almost 10 times to £E280bn.

Besides the fiscal deficit, one of the main concerns for banks operating in Egypt is the shortage of foreign exchange. Since the end of 2012, the central bank has rationed the supply of hard currency to the banking sector through holding regular auctions. This fostered the re-emergence of an active parallel market.

The central bank clamped down in early 2015 by setting limits on cash deposits with banks, at $10,000 a day and $50,000 a month. This was directed at clients who would procure large amounts of dollars on the black market and deposit them for short periods with banks as security for opening letters of credit. At the same time, the central bank sanctioned a modest devaluation of the Egyptian pound, whose official rate had held steady for most of 2014 at £E7.14 to the dollar. The rate has stabilised since April at about £E7.6.

Central bank governor Hisham Ramez said the squeeze on the black market would result in increased flows of foreign exchange into the banking system, in particular from Egyptians working abroad, whose remittances comprise more than one-quarter of the country’s annual current account receipts ($19bn out of a total $65bn in 2014).

However, banks and clients are still complaining of a scarcity of foreign exchange, and black market trading is on the increase again. There have also been allegations that banks are charging fees of up to 2 per cent to clients on foreign exchange transactions, although Ramez in mid-May issued a statement denying this was the case.

Gulf funding

The supply of foreign exchange in the banking system remains highly dependent on Gulf Arab largesse. Grants from Gulf donors totalled $14.7bn in total in the past two years, according to central bank balance of payments data, which was slightly more than Egypt’s earnings from tourism during this period.

Saudi Arabia, the UAE and Kuwait have also bolstered the central bank’s foreign exchange reserves by placing long-term deposits. These included a total of $6bn in April 2015, which helped push foreign exchange reserves up to $16.8bn after they had slipped to $11.6bn, only just above their level on the eve of the removal of Mohamed Mursi from the presidency in July 2013.

One of the positive side-effects of the low level of bank lending (other than to the government) is that the balance sheets of Egyptian banks are not heavily encumbered with bad loans. The ratio of non-performing loans fell to 8.6 per cent of total loans at the end of 2014. The banks are also relatively well capitalised, with the Tier 1 capital to risk-weighted assets ratio standing at 11 per cent.

This suggests lenders have the potential to play a more active role in financing private sector projects and business expansions, however they will continue to be held back by the government’s demand for more credit.

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