Is the banking sector finally about to turn over a new leaf? Wael Gamal looks into two recent reports "The Egyptian banking sector, having witnessed several difficult years, appears on the brink of a new era, with private commercial banks leading the way." This is the main conclusion of the annual banking report of Prime Securities published this month. The title of a similar report by EFG Hermes, also published this month, reaches a similar verdict: "Growth finally comes to Egyptian banks." The Egyptian banking sector has been struggling since 1999. Confidence was affected by a stalling domestic economy, as well as a weakening global economy amidst the fallout from the attacks of 11 September, combined with the adverse affect of regional instability on tourism and foreign currency inflows. With the full-blown devaluation of the pound in January 2003, losing about a third of its value, a host of problems in the local banking sector were exposed -- regulatory shortcomings, management weaknesses and deterioration in earnings and asset quality, which in turn led to banks becoming increasingly undercapitalised, with a rising level of dollar-denominated deposits in the system. But the monetary policy of the new government including rising interest rates and the high foreign exchange (Forex) revenues of tourism and the Suez Canal -- with the launch of the Forex interbank market on 29 December 2004 -- have all led to "a reversal in the associated trend, with the local currency picking up over six per cent against the greenback over the past few months," mentions the Prime report. Other positive signs include asset growth acceleration in the fourth quarter of 2004, "signaling a pick-up in demand for credit," as described by the EFG report. This was accompanied by "an improvement in asset quality, which prevailed across our coverage universe in 2004. Continued provisioning efforts at Commercial International Bank (CIB) and Misr International Bank (MIBank) exceeded the rise in their respective stocks of non- performing loans. The National Societe General Bank (NSGB) and the Egyptian American Bank (EAB) experienced a decline in the stock of non- performing loans (NPL), pushing the NPL coverage ratio way above the 100 per cent level to 124 per cent and 130 per cent as of the end of 2004, respectively," the EFG report added. Until June 2004, loan growth in the banking system was sluggish. However, "it began to accelerate in second half of 2004 with the third and fourth quarters delivering the bulk of the growth for the year," the report stated. Both reports consider the new government of Ahmed Nazif and its reform policies a vital factor in the prospects for a better future for the sector. The Prime report describes the situation by saying that "after relative stagnation with regard to financial sector reform, the ball has been set in motion following a number of action backed announcements by the new government, concerning both privatisation and consolidation within the sector. With an ultimate, medium term, target of privatising all four public banks, not a new assertion in itself, the Government is to sell its stakes in joint venture banks as a financing mechanism to prerequisite restructuring," It said. With the government moving its hand away from the sector, both reports see the beginnings of a bullish upturn. Firstly, interest rates are forecast to drop, improving the investment atmosphere. "Policymakers have started to imply that lowering the interest rate is needed to achieve the required growth rate in investment. We believe that Egyptian pound short-term interest rates are likely to stabilise or decline marginally in 2005," the EFG report said. The report justifies its forecast by four factors -- "First, strong liquidity growth. Second: The budget deficit is forecast to decline, thus lowering the forecast for government borrowing. Third: Current yields on treasury bonds suggest an inverted yield curve for EGP interest rates. And fourth: With the appreciation of the EGP, interest rates will no longer be used as a defensive mechanism for stability in the Forex market especially that the Central Bank of Egypt has recently shifted its emphasis from exchange rate targetting to inflation targetting, which suggests approaching a single-digit inflation rate in the short-term rather in the long-term." The Prime report is also enthusiastic about the sector performance in 2005. The report expects an improved regulatory framework and the overhaul of the CBE supervisory department to result in more stringent control and improved organisation of the entire sector. The report also anticipates the positive impact of tax reform on profitability. "Banking sector prove net gainers of the new proposed drop in service sector taxation rate from 42 per cent to 20 per cent. Expansion opportunities are there too based on 'Mortgage Law'; Dubbed as a potential sector gold mine expected to catalyse overall lending growth up into double digits from three per cent in 2004 and huge untapped retail banking market; Continuous roll out of new products and customer awareness on banking services," the Prime report says. Over the longer term, the streamlining of over 65 banks currently operating in Egypt to a target of 22, will make for a stronger, well-capitalised financial sector, "affording associated players a larger portion of the overall growing pie," it adds. Nevertheless, many factors suggest that the predictions of the two reports could be too optimistic. Firstly, the two reports are based on analysing only private banks. Although the private joint- venture banks have made considerable headway in the market in recent years, the sector is still dominated by public banks with the big four holding more than half the market. Factoring in the performance of the four banks considering profitability and the NPL situation changes the situation radically. The EFG report admits that "with the exception of EAB, our covered banks experienced significantly higher growth than the banking system average." Secondly, the improvement in the loan credit ratios are a result of heavy government investment in natural gas liquefaction, fertiliser and cement production and electricity generation, which were the drivers for the growth in syndicated and project finance loans in 2004. This means it is not a sign of a real reverse in investment atmosphere, especially from the private sector. Thirdly, the developments of the exchange rate are mainly based on external factors, which make it vulnerable to external shocks that could hurt the sector badly. Also, there is the fact that mortgage finance, which is the main catalyst for strong sustainable growth in retail loans, is still insignificant, with two real estate banks expected to merge into one this year claiming the largest market share. According to the EFG report, "legal aspects are currently hindering a pick-up in mortgage lending despite the fact that the mortgage law was passed almost four years ago. Thus, we believe that mortgage lending will not take off in 2005." Finally, recent statements and counter statements made by both the minister of investment, Mahmoud Mohieldin, and the governor of the Central Bank, Farouk El-Okda, reveal that the pace of privatisation, a main reason for the optimistic reports, is by no means a matter of consensus. Egypt's top banker urged Mohieldin to reaffirm the government's adherence to its present strategy based on selling government stakes in joint banks in addition to partially privatising the Bank of Alexandria. Mohieldin expressed reservations on the credibility of these statements, reiterating the government plan for the banking sector reform. "The government plans to sell off the Bank of Alexandria by the end of this year, in addition to offering stakes in joint venture banks for private investors," Mohieldin said. This disagreement, the first of its kind since the coming to office of the new government, could affect the sector forecasts of the two reports.
