Fitch: challenges remain for Egypt's banks despite reform

In a special report published today, Fitch says that the Central Bank of Egypt's regulatory and supervisory capabilities have been strengthened, with a marked improvement in the quality of bank supervision.

Privatisation and consolidation in the system is ongoing, driven by both by increased capital requirements and by larger private-sector banks' expansion drive.

The government's privatisation programme culminated with the successful sale in 2006 of state-owned Bank of Alexandria.

Although the privatisation of another of the main state-owned banks, Banque du Caire, was cancelled due to a lower-than-expected response, Fitch does not expect any change in the government's commitment to the eventual privatisation of the bank.

Despite the sector's privatisation and consolidation, it remains dominated by the three main state-owned banks, National Bank of Egypt, Banque Misr and Banque du Caire.

The three banks together account for around 45% of banking assets.

However, Fitch notes pressure is growing from competitive private-sector banks, many of which are intent on increasing their franchise.

The report goes on to note that while significant improvement has been made to banks' balance sheets, it remains difficult to determine the exact level of system-wide non-performing loans (NPLs).

The Central Bank of Egypt has recently been pressuring banks to increase their often inadequate provisioning levels, even at the expense of profits, giving rise to a higher level of non-performing loan coverage.

'Poor asset quality has historically been one of the main problems in the Egyptian banking sector, and poor disclosure and lax recognition criteria made it difficult to gauge the full extent of the non-performing loan problem,' says Mark Young, Managing Director in Fitch's Banks team.

Profitability is improving, with the aggregate net profit/assets ratio slowly inching upwards to 0.8% at end-2007 from 0.5% at end-2004; although there is a wide and increasing disparity between banks' performance, with many of the more dynamic private sector banks achieving a ratio well over 2% and, in some cases, close to 3%.

The improving domestic economy has supported increased lending volumes, including in the retail sector, which has compensated for increasing margin pressure.

Loan growth accelerated to 11% during 2007, its fastest growth rate in years; in Q108 it grew by an even stronger annual rate of 15%.

Significantly, lending to households is growing as a proportion of total loans, reaching 18% in March 2008, with many banks shifting to the more profitable, but riskier, retail sector and expanding their branch network, often massively.

Retail lending is still underdeveloped in Egypt; strong retail credit growth could weaken asset quality as loans season.

Fitch also notes that many banks' capitalisation is less than adequate.

If unreserved NPLs were deducted from banks' capital, ratios would look significantly weaker.

State-owned banks tend to have particularly weak capital ratios.