SENIOR BANK EXECUTIVES and leading businessmen were purged in a series of arrests in Egypt earlier this year. Some have faced trial and even imprisonment with hard labour after allegations of financial wrongdoing. It’s a startling approach to reforming the country’s financial sector.
Falling growth rates, ever more non-performing loans and a series of high-profile scandals have taken their toll on Egyptian banking. But for years little progress was made towards addressing these issues. Now the Egyptian government has begun to take decisive action. And though this is shocking, bankers are feeling optimistic.
The government began its reform efforts with a serious assault on corruption at the start of the year and most recently with its muddled attempt to allow the Egyptian pound to float freely [see Draconian measures follow dirty float, this issue]. Following a mysterious IMF report that was never made public, over 30 top bankers, businessmen, government officials and lawmakers were arrested for alleged involvement in illegal financial transactions.
Among those taken into custody and facing investigation are the heads of two of the country’s leading banks: Muhammad Abu Al-Fath, the former managing director of Banque du Caire, and the former head of Misr Exterior Bank, Abdullah Tayel.
The most sensational trial involved Hussam Abul Fotouh, a prominent businessman whose interests included the Egyptian businesses of BMW and Daewoo. A raid on his Cairo home for evidence of financial wrongdoing yielded not only evidence of loan fraud and embezzlement but also illegal weapons and secretly taped sex videos involving famous Egyptian belly dancer, Dina.
The chief executives of Egypt’s big four state banks – National Bank of Egypt, Banque Misr, Banque du Caire, and Bank of Alexandria – have all been forced out.
The government has replaced them with a new cadre of Egyptian bankers such as Mahmoud Abdel Latif, the new chairman of Bank of Alexandria. Its members are younger and better qualified than their ousted predecessors, and tend to have extensive experience working for large international banks including Citigroup, JPMorgan, and Bank of New York.
Privatization is a key yardstick that foreign investors and international donors use to measure the progress of reforms in Egypt. After notable sales in the 1990s in cement and electricity generation, the privatization programme seems to have stalled over the past couple of years as the economy weakened in Egypt and worldwide.
Bank privatization is now the highest priority for investors, lenders and multilaterals watching Egypt. Poor infrastructure, bad management and high non-performing loan ratios mean that the banks are not yet in a fit state for privatization. “Who would want to buy these banks?” asks the head of one of the largest foreign joint-venture banks in Cairo. “Certainly no foreign institution, and selling to the public would be meaningless because there isn’t the money to buy them.” The overhaul of the big four’s management is, however, seen as a first step and is being billed as the privatization of management, if not ownership.
The new management teams have their work cut out. Official estimates for the non-performing loan ratios of the big four are about 15% but private estimates put them nearer 25%. A slowing economy, poor risk management, directed lending, corruption, and recalcitrant borrowers are all to blame for the level of bad loans at the big four, which some of the better-run joint-venture and foreign banks have managed to avoid.
The new management teams, encouraged by the government, have started to tackle these problem more aggressively, reclassifying borrowers more conservatively, setting aside greater provisions, and increasing write-offs. Hisham Haikal, managing director of Nile Rating, a Fitch affiliate, says the banks have made a significant effort to clean up and restructure portfolios. “They’re not trying to hide any more,” he says, “they are trying to deal with it.”
The government is also said to be discussing ways to help clean up NPLs including the establishment of a special purpose entity to purchase and restructure the bad loans.
Capital injections prescribed The other key pillar of the government’s bank reform programme is changes to capital requirements. The Central Bank of Egypt had set the end of March as the deadline for banks to increase their capital adequacy ratios by 2006 to 10%, a step on the way towards fulfilling the Basle II requirement of 12%. Capital ratios vary significantly between the private joint venture banks and the big four. At the joint venture banks capital ratios stand between 10% and 17%; at the big four, ratios have tended to be only just over the 8% minimum.
In order to meet the new requirement, the big four and the other state-owned specialist banks will receive a cash injection of E£4 billion ($700 million) from the central bank. The biggest recipients will be National Bank of Egypt (E£1.2 billion), Banque du Caire (E£850 million), and Banque Misr (E£800 million).
The government is also drafting a law that will increase the minimum capital requirement for banks to E£500 million from E£100 million. This is designed to encourage much-needed consolidation.
There are just over 60 banks in Egypt but the big four and the other specialized government banks together control an estimated 70% to 80% of assets and deposits. If the law is passed without significant change, which looks likely, the majority of banks will either have to raise capital or contemplate serious M&A activity. Given political uncertainty surrounding the US-led coalition’s invasion of Iraq, and the poor state of equity markets in Egypt and worldwide, it is the latter option that looks most likely.
Consolidation will not be easy for any bank. Weak banks looking for a merger partner or a potential bidder will have a hard time making themselves attractive. The efficient and profitable joint-venture banks such as National Société Générale Bank (NSGB), a joint venture between Société Générale and National Bank of Egypt, and Cairo Barclays, a venture involving Barclays and Banque du Caire, will find the capital increase easier to achieve. But they will struggle to figure out what to do with this capital and how to earn a return on it.
Colin McCormack, managing director of Cairo Barclays, says: “We are concerned at what we will do with increased capital at this time. Rush to lend more? There may not be enough suitable opportunities. Buy more treasury bills? I’d rather not. We could look for an acquisition but the timing may not be right. It’s hard to justify just sitting on excess capital.”
Foreign enthusiasts Despite this, foreign banks with interests in Egypt are enthusiastic about business potential. They have all been increasing investments over the past few years. HSBC, Société Générale, and Barclays have increased their stakes in their Egyptian joint ventures and, since the law was changed in 1996 to allow majority foreign ownership, have taken majority control. HSBC bought an additional 50% stake in its joint venture, Egyptian British Bank, and changed its name to HSBC two years ago. Société Générale immediately increased its share in NSGB to 51% to give it management control and then bought a further 3% at the end of 2001. And Barclays, which increased its participation in Cairo Barclays by 11% to 60% three years ago, is considering buying up the rest.
Over the past year the foreign joint venture banks have also invested heavily in retail networks, increasing the number of branches and ATMs and attempting to win market share with premium services. Foreign banks see a lot of opportunity. Despite the fact that the $86 billion economy of 70 million people is served by over 60 banks and is over-banked by some measures, coverage is patchy. Only 15% of people aged over 18 use banks, and access to banking facilities is limited outside large urban centres such as Cairo and Alexandria.
Bankers point to favourable demographics. There are 14 million people in greater Cairo, and 35% of the city’s population is under 18. The workforce is well educated and whether a global bank sees Egypt as part of its Middle East, North Africa, EMEA, EEMEA, MENA, or Africa strategy, the country is one of the most important markets. It is the third largest in the Middle East after Israel and Saudi Arabia, the third largest in Africa after South Africa and Nigeria, and is positioned conveniently between the two areas.
The Egyptian government has also taken measures to encourage the domestic bond market. It recently introduced a market maker system for treasuries, aimed at improving liquidity, and it is thought it might seek to extend the system to corporate bonds as well.
Egypt has many of the important basic ingredients for a successful bond market. It has an adequate pool of quality corporates, tax incentives for bond issuance and investing, a sufficient investor base, a supportive capital markets authority, and rating agencies. Challenges still remain: pricing is difficult because there is no real base rate and the discount rate hardly moves.
According to the Egyptian Stock Exchange there are 28 corporate issuers with E£5.6 billion outstanding and an additional E£14.5 billion in treasuries. The volume of bond trading surged 32.2% year on year to E£ 14.3 billion, as local brokerages turned to the bond market to make their bread and butter amidst a poor year for equities in Egypt as in most other countries.
The market received a psychological boost in November 2002, with the launch of the E£1 billion issue by Egyptian Cement Company, part of the Orascom group, one of Egypt’s largest conglomerates. The deal, lead managed by Citigroup, and with the participation of Commercial International Bank and Banque Misr, was the country’s largest ever. Since then, several corporates have approached banks to discuss bond issuance but uncertainty surrounding the economic and political fallout of the invasion of Iraq has dampened enthusiasm.
Despite the government’s back-tracking on other reforms, measures taken to reform banks are concrete and should have lasting effects. Bankers in Cairo say they are more confident than ever of the government’s commitment to reform.
