Kickstarting Growth

Could the Central Bank’s new directives be the, uhm, encouragement that Egypt’s banks need?

In an increasing trend, the Central Bank of Egypt (CBE) has been leaning on the local banking sector to support fiscal and monetary policy goals as well as a growing number of more general government initiatives. Of course, the big public-sector banks have long been a tool of the government, but now it appears the entire sector is being marshalled to back public policy.

Egypt’s banking sector has been one of the most heavily regulated by global standards, particularly since the domestic banking crisis in the early 2000s. While this cosseting has had some benefits (such as preventing local banks from making unwise investments in real estate or CDOs), it can also be said, with some justification, that the stifling regulatory framework has instilled a sense of complacency in the sector.

Egyptian banks are not exactly jostling to provide the most innovative services or the lowest pricing — it wouldn’t be unfair to say the sector has settled into a comfortable oligarchy, especially since Western banks have either sold their local operations or ratcheted down their business appetite post-2011.

Local banks have been building up world-class profit margins, more than double global averages, lending to the debt-hungry government and public sector. But in doing so, banks are failing to fulfil their core role of helping Egyptian businesses to grow. Why waste time on the private sector — particularly those who don’t measure their revenues in the hundreds of millions — when ‘risk-free’ T-bills and bonds pay out so much? To be fair, Egypt does face the strange situation of the government paying more to borrow than most large private corporations. It’s hard to blame banks for going after the easy money.

So what’s new? Well, a new CBE governor for a start. Recent moves by the Central Bank have a different flavour about them, suggestive of real change for the first time in years. Toward the end of 2015, the large public-sector banks abruptly raised their term deposit rates 2.5 percentage points (roughly 25% higher). Simultaneously, these same banks worked to ensure that rates on government paper did not rise to match the increase, effectively squeezing profit margins to help support the Egyptian pound while holding down government debt payments. Some of the smaller private-sector banks followed suit, but the main players held back, unwilling to compromise their margins but losing billions in deposits as a consequence.

The CBE took the market by surprise again shortly into the new year with a raft of new banking sector initiatives:

• Credit concentration: Banks have three years to reduce their maximum single-client exposure below 15% (down from 20%) of their capital base. Including affiliated companies, this exposure is capped at 20% (down from 25%) of their capital. More importantly, local banks have one year to reduce their exposure to their 50 largest clients to below 50% of their total loan portfolio or face capital penalties. Foreign banks have leeway to exceed this threshold by 50% of their capital base.
• Consumer debt burden: Instalments for new loans may not exceed 35% of monthly income (40% in the case of mortgages). Although current practices allow payments of 50-60% of income and beyond, there will be some leniency in the calculation of incomes, which can include year-end bonuses and other earnings, so the final impact is unlikely to be significant for most retail loans. This ruling will, however, halt the issuance by banks of ‘no income loans’, such as those given at car dealers. As it stands, this will be a boon to non-bank lenders.
• Money market funds: banks may not sell such funds if their total balance exceeds 2.5% of the bank’s total local currency deposits (down from 5%). The net effect will be to complete the decimation of local money market funds, which face the prospect of gradual attrition over the coming years.
• SME lending: Within four years, banks must raise SME lending to at least 20% of their total loan portfolio (SMEs are defined as having revenues between EGP 1 to EGP 100mn). Within a month, banks must submit details of their SME strategies to the CBE. Loan rates for businesses with revenues between EGP 1 to EGP 20mn are to be capped at 5%.

Taken together, these directives point to a strong push for SME funding and away from business as usual. Much like Brazil’s perennial status as ‘the country of tomorrow,’ Egypt’s SMEs have failed to meet the potential trumpeted for them every year in countless government and banking sector proclamations. To date, however, the talk has been just that, with minimal concrete action taken. Funding has remained very difficult to raise for smaller companies without the founder mortgaging their entire asset base (encompassing personal assets up to and including articles of intimate clothing).

This is despite the ready availability of SME funding from multi-lateral and development agencies. Even more sadly, the purported “riskiness” of the sector is an unfair myth, with many SME and even microfinance units reporting sterling repayment rates on those loans that did make it out the door.

Yet banks have remained unwilling or unable to target the sector properly. In fact, up until late 2015, only a small handful of banks had even bothered to create formal SME units. It was clear that nothing would change the status quo despite the protestations of bank management that they were making best efforts. Obstacles inevitably materialised when it came time to commit actual funding, whether it was a lack of the ‘right’ paperwork or potential risk. One is reminded of the never-ending Israeli government quest for a “partner for peace.”

A large part of the problem is that at most domestic banks SME lending is lumped under corporate lending, with its disproportionately exhaustive credit process, or under retail lending, where the SME founder is essentially taking out a personal loan. In either case, the unique nature of SMEs is not taken into account which results in a real lack of funding. It has just been easier for banks to keep lending to the same select circle of major conglomerates and government entities, even if they ended up having to support them when their loans went bad every so often.

At the end of the day, no one got fired for following the herd. Small borrowers were effectively shut out.

So will these latest moves be a trigger for real action? Will Egypt’s small entrepreneurs finally be allowed to bloom?

The new loan concentration restrictions are likely to come down hardest on smaller banks, although they may also act to limit public sector lending to public sector businesses. As always, there are loopholes and ways around the restrictions, such as the formation of project-based entities to mitigate credit concentration. Already exempt from these limits are loans backed by the Finance Ministry, which covers many of the larger infrastructure projects. However, the new directives should still serve to broaden the ranks of participants in many large syndications beyond the usual four-to-six banks. Beneficially, there will be added pressure to diversify client bases and to raise capital or merge, particularly for smaller banks.

The structure of the 5% interest rate cap on SME loans is one of the more interesting features of the new CBE directives. To provide some incentive for banks to fund at this level, which is below most of their costs of funds, the CBE has allowed them to tap qualifying loans from their non-interest bearing regulatory reserves. Banks thus have the opportunity to activate non-earning assets to boost their margins. It should be noted that this rate cap applies only to loans made to companies with revenues between EGP 1 mn and EGP 20 mn. Banks are free to structure their own products for SMEs falling outside this range (up to EGP 100 mn in revenues), which can help them meet their SME loan targets.

As well as driving economic growth and generating employment, the CBE’s initiative will help formalise many small businesses (in order to meet minimum registration requirements for borrowing companies). This will aid the enforcement of industry and employment regulations, as well as facilitating tax collection, both significant side-benefits for the government given the size of Egypt’s grey economy.

The CBE has committed itself to enabling EGP 200 bn in new loans to 350,000 SMEs over the next four years, directly supporting an initiative announced by President Abdel Fattah El Sisi on Youth Day earlier in January. Even half this figure would be an achievement, given past performance. Egypt’s banks have a golden opportunity to wean themselves off the government’s largesse and develop real and sustainable new sources of business. It’s now up to them to grab the baton.

Already, a number of the smaller banks have made noises about forming new standalone SME financing departments. Banque Misr has stated that it hopes to see its SME portfolio grow to 5% of total loans this year (up from 3%). Even the Federation of Egyptian Banks is considering forming an SME-support fund. Perhaps finally a young Egyptian entrepreneur can go into a bank with a solid business plan and a dream and walk out with funding. Is that too much to ask?

The author is a senior professional in the financial services sector.