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Egyptian banks bounce back as sovereign saved from crisis
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EGYPTIAN BANKS BOUNCE BACK AS SOVEREIGN SAVED FROM CRISIS


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AS THE ECONOMIC OUTLOOK OF EGYPT IMPROVES, THE COUNTRY’S BANKING SECTOR IS
EXPECTED TO REAP THE BENEFITS.

After yet another bout of economic turmoil, something like calm is returning to
Egypt’s financial sector. There will be, of course, a period of adjustment. A
noxious combination of poor policy and external shocks left the country facing
record inflation, a growing debt crisis and a crippling shortage of foreign
currency. The measures to prevent collapse have been understandably severe.

This time last year, the central bank’s overnight deposit rate was 18.25% – it
is now 27.25%. The Egyptian pound’s official exchange rate to the US dollar was
then just over E£30 - it is now almost E£50. But such is the price of economic
salvation. A long-expected currency devaluation on March 6th opened the doors to
an expanded IMF programme that will provide another $8 billion. Less than two
weeks earlier, Egyptian prime minister Mostafa Madbouly announced a $35 billion
deal with the UAE, $29 billion of which is for the development of Ras al-Hikma
on the Mediterranean coast.

Rich Gulf states like the UAE that are prepared to keep providing financial
support are just as keen as the IMF to see Egypt make good on promises of
structural reform. Like the IMF, they are also increasingly willing to make
investments contingent on proof of progress. Egypt’s officials are keen to
signal their commitment to long-term reform, knowing the country’s future
depends on it.

In an Atlantic Council interview in late April, central bank deputy governor
Rami Aboulnaga was clear that going forward it will be the market that
determines the Egyptian pound’s value. “Whether it's fair or not will only be
set by the market and the market dynamics,” he said.

Similarly, the government’s promise of reforms to kick-start private sector
growth are not, Aboulnaga emphasised, a set of one-off policy measures. “This is
a change in paradigm and I think this is here to last,” he said.

A stressful symbiosis

The health of a country’s banking sector is always tied at least in part to that
of the sovereign and the public sector. But among their emerging market peers,
Egyptian banks stand out for their high exposure.

Back in 2018, S&P Global Ratings estimated sovereign exposure accounted for
around 55% of total banking assets. By the end of 2023, that figure had reached
60%. Fitch estimated that total exposure to the sovereign and broader public
sector was almost 75% of total banking assets at the end of 2022 – or around 11
times banks’ equity.

“This is one of the cases where we have an extremely strong correlation between
sovereign risk and banking risk because exposure to the sovereign is extremely
high,” says Regina Argenio, a senior analyst in S&P Global Ratings’ financial
services team.

The immediate benefit to the banks of the UAE and IMF agreements, therefore, is
that the ship of state to which they are tied looks far less likely to sink.
FDI, a liberalised exchange rate and ambitious budgetary consolidation targets,
lay the foundation for growth and debt stability, according to S&P Ratings,
which promptly changed its outlook on the sovereign to positive.

A second boon for the banks is that unifying the official and black market
exchange rates has helped clear a massive and unmet demand for dollars.
Quantifying the scale of this demand is not straightforward. Some analysts
suggest excess liquidity in the Egyptian pound is a solid proxy for dollar
shortages. Firms that would typically change pounds into dollars to pay for
imports struggle to source dollars, and have nowhere else to put them but the
banking sector.

> If you'd asked me a few months ago, I would have said the dollar shortage
> would take six months to resolve. We cleared our entire outstanding demand for
> dollars in six days.

Todd Wilcox, CEO of HSBC Egypt.

In the weeks before the currency devaluation, central bank auctions for one week
fixed-rate pound-denominated deposits were almost nine times oversubscribed. But
when the long-awaited revaluation arrived the shortage disappeared with
unexpected speed. The central bank injected dollars through the state-owned
banks, and hot money investors sold dollars to the banks in the wake of the
exchange rate cut.

“If you'd asked me a few months ago, I would have said the dollar shortage would
take six months to resolve,” says Todd Wilcox, CEO of HSBC Egypt. “We cleared
our entire outstanding demand for dollars in six days.”

Wilcox says around 60% of the outstanding FX requests were met. Much of the
remaining demand simply disappeared as the exchange rate corrected. “When the
Egyptian pound hit 48 to the US dollar, investors started to take interest in
the domestic currency again,” he says.

The Ras al-Hikma announcement changed everything, say bankers. The deal injected
a huge amount of confidence back into the market, which has started to bring
retail investors and their dollars back to the banking sector.

Although the short-term demand for dollars has been sated, there is a longer
term issue. Banks had to use their FX liquidity to support the government and
central bank as foreign investors left. Foreign assets have declined, while
foreign liabilities have increased. The result is that Egyptian banks’ negative
net foreign asset position reached a record -$16.2bn in December 2023, according
to BMI research.

This is going to take a while to redress, but the devaluation is a solid first
step. Analysts expect it will make Egyptian companies in receipt of foreign
currency earnings more likely to place those with the banking sector. Tourism
remains a major earner for Egypt. Despite the war in Gaza and growing
geopolitical volatility, foreign visitor numbers have held up well. Suez canal
receipts – another vital source of FX – have fallen in wake of attacks on
shipping by Yemeni militants. But they are still well above the pandemic lows.

“Most of those monies should eventually be channelled into the banking sector,
which in turn will help reduce the sector’s net external liability position,”
says Argenio.

The return of remittances would be another shot in the arm for the economy and
the banking sector. Money from Egyptians working abroad is a key source of
foreign currency, and one that plunged as the gap between the official and bank
market exchange rates widened in 2023. Remittances in 2023 are likely to have
fallen 15% to $24.2 billion, according to World Bank projections.

“That’s what we're watching for now although we’re still at the early stages of
adjustment,” says Wilcox. “Remittances accounted for a huge amount of foreign
currency and I think it will come back, but it might take longer.”


Egyptian prime minister, Mostafa Madbouly (centre) oversees the signing of the
UAE/Egypt investment deal (Photo by Xinhua/Shutterstock)


Devaluation rattles ratios

The massive shifts in currency and interest rates is also rippling through to
risk weighted assets (RWA) and capital ratios. Despite the negative net foreign
asset position, a decent chunk of banking sector assets are still in FX. S&P
Global estimates that about 19% of assets were in foreign currency as of October
2023.

The devaluation of the pound – which fell almost 40% when the government
announced a market determined exchange rate in early March – has increased the
value of those RWA in local currency terms. Following the announcement, S&P
estimated that a market determined exchange rate could consume 300bp-400bp of
banks' total capital ratios, depending on their balance-sheet structure.

But for the banks that S&P covers adjustment should be manageable, says Argenio.
In fact, across the sector high regulatory capital ratios mean lenders should
have sufficient buffers to absorb the hit. This is not luck.

Egyptians banks are – almost across the board – well run, well capitalised and
protected against risk. Egyptian lenders cannot lend more than 50% of the
acquisition for a leveraged buyout. They cannot trade in derivatives. They
cannot take speculative positions on FX.

> This new interest rate environment might be hard for some borrowers to manage,
> particularly the SMEs who might struggle to refinance at this new level

Regina Argenio, senior analyst, S&P Global Ratings’ financial services team.


For borrowers, the devaluation has increased the amount of money that they will
have to repay to the banks. This will be particularly hard for borrowers without
a natural hedge. But it is unlikely to be ruinous for many firms. When it comes
to corporate lending, banks mainly lend to exporters who earn revenue in foreign
currency. The rest of the FX lending is to the sovereign.

A bigger issue for borrowers - and by extension banks’ asset quality - is the
hike in interest rates. The IMF package comes alongside a 600bp hike in interest
rates, on top of the 200bp hike earlier in the year and the hikes in 2023. The
central bank’s overnight deposit rate has risen from 9.25% to 27.25% in less
than two years. This is almost certainly going to cause problems for borrowers –
the question is to what extent this feeds through into loan quality,

“This new interest rate environment might be hard for some borrowers to manage,
particularly the SMEs who might struggle to refinance at this new level,” says
Argenio. “Economic growth has been sluggish over the past year, so they might
not have much in the way of cash reserves.” The hope is that this kind of
struggle will be relatively short lived as FDI and reform improves medium-term
economic growth and stability.

But so far there has been little sign of anything problematic in loan
portfolios. Wilcox says he views retail banking as the canary in the coal mine.
“If you start seeing the credit card default edge up, that's when there’s an
issue,” he says. “There’s been no change whatsoever in our credit card
portfolio, it’s one of the cleanest I’ve seen. The banking sector here is very,
very resilient.”

Ending the cycle

Profits bear that statement out. Total banking sector net profit more than
doubled in 2023 to E£283.4 billion ($5.9 billion at current exchange rates). All
of the main Egyptian banks have approved dividend payments for the 2023
financial year. If in some cases the dividends are perhaps a little smaller than
in previous years, this is mostly banks being prudent in using healthy earnings
to strengthen their capital base. No-one expects sticky inflation, asset
repricing and higher deposit rates to really dent profitability.

“Banks have managed partly because of very good systems and good quality people
running the banks,” says Angus Blair, the CEO of the Cairo-based Signet
Institute. “Institutions become much better over time when faced with crises
because they can anticipate and know what to do based on experience.”

The question then turns inevitably to the future, and whether this time really
is different. Or whether the next few years will bring only temporary respite
before banks are forced to yet again face economic turmoil. The Egyptian
authorities have promised a market-determined exchange rate, fiscal restraint,
budget consolidation and – perhaps most importantly – an economic environment
that allows the private sector to grow.

> Banks have managed partly because of very good systems and good quality people
> running the banks. Institutions become much better over time when faced with
> crises because they can anticipate and know what to do based on experience.

Angus Blair, the CEO of the Cairo-based Signet Institute.

Mahmoud Bahaa, head of global markets & treasury at Emirates NBD Egypt, says the
major shift in international investors’ confidence and the government's
commitment to create a more liberal and competitive market is a huge opportunity
for Egypt. “It’s a path for the country to restore its position among the most
competitive emerging market investment opportunities.”

Egyptian banks and businesses are dearly hoping the government follows this
path. Stripping away needless bureaucracy would be a great start. A seemingly
endless list of approvals for business activities has hampered the economy for
years.

Analysts often point to the dominance of state and army-owned firms as a key
factor behind the lack of competitive Egyptian exporters. But Tarek Abdel
Rahman, managing partner, Compass Capital says that in fact there are parts of
the private sector that could be far more competitive if freed from all the red
tape.

“Chemicals is a big export business, as is agriculture and garments,” he says.
“A lot of firms across the economy are looking to invest abroad or export
because of the crisis.”

Ultimately, says Rahamn, what will improve the banking sector is a more vibrant
private sector and increased living conditions for the majority of Egyptians.
“Unless we have a significant change in economic policy, we have a honeymoon
period of three, four or five years and then we end up in the same situation.”


TOPICS

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