Finance and Private Sector Chief Economist Series. Financial Sector Reform in Egypt: Achievements and Challenges

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1 Finance and Private Sector Chief Economist Series Financial Sector Reform in Egypt: Achievements and Challenges Mahmoud Mohieldin Washington D.C. November 8,

2 The Financial Sector Prior to Reforms Banking Sector Banks account for 95 percent of financial sector assets The system was overbanked and under-branched. Dominance of public ownership: seven state-owned and 23 joint venture banks with substantial public ownership Unsound and inefficient banking sector: large NPLs, low profitability, low capital adequacy, week governance structure, low and unproductive credit Weak regulatory and supervisory framework Negligible competition and limited innovation Non-Bank Sector Small and underdeveloped Insurance sector s premium accounted for less than 0.7% of GDP Absence of appropriate regulation Small private pension sector (assets less than 3% of GDP) Thin capital market A non-existent leasing markets and absence of mortgage finance Deficient legal and information infrastructure 2

3 First Generation Financial Sector Reform Program ( ) Objectives Foster the emergence of a sound, efficient, and diversified financial system, private sector-led, that could contribute to Egypt s growth performance Main Components of the Program Implementing Agencies Reforming the Banking Sector Restructuring the Insurance Sector Deepening the Capital Market Introducing Mortgage Finance (law was already issued in 2001) Strengthening the Regulatory and Supervisory Authorities Improving the Institutional Infrastructure (credit bureau, payments system, single non-bank financial regulator) Ministry of Investment and Central Bank of Egypt (coordination for effective implementation) 3

4 Second Generation Financial Sector Reform Program ( ) Objectives Build a financial system that is more inclusive, competitive and effective in financial intermediation, with sound banking and non-banking financial institutions Main Components of the Program Enhance the Intermediary Role of State-owned Banks through Operational and Financial Restructuring Strengthen the Regulatory and Supervisory Architecture of the Banking Sector Reform the Non-bank Financial Sector Strengthen the Regulatory and Supervisory Framework of the Nonbank Financial Sector Improving the Financial Infrastructure Implementing Agencies Ministry of Investment and Central Bank of Egypt 4

5 Major Developments in the Banking Sector Privatization of the fourth largest state-owned bank Weak banks were weeded out of the system through M&As and recapitalization Consolidation of the banking sector (57 to 39 banks) Divestiture of 94% of state-owned bank shares in joint venture banks Full settlement of all State Owned Enterprises NPLs and 90% of private sector NPLs. Sufficient provisions in place Branch density rose by 60 percent (from 2006 till 2010) Financial, institutional and operational restructuring of stateowned banks Recapitalization of State Owned Banks Applying a risk-based supervisory framework (in line with the best international practices) 5

6 Private Sector Led Banking System Private Ownership increased through privatization of a public bank and divesture of public shares in JV s and relatively high growth of private banks Share in Total Assets For the first time in recent history, the banking sector is majority-owned by the private sector

7 Restructuring of State-owned Enterprises......went hand in hand with restructuring of state-owned banks (LE billion) NPLs of State-owned Enterprises Without reform * (LE billion) 6000 Net Profits of SOEs (LE billion) SOEs Networth (LE billion) Investments in SOEs Source: CBE and Ministry of Investment (2010)

8 Improved Profitability Rise in Return-to-Assets and Return-to-Equity Ratios Return on Assets Return on Equity Provisions-to-NPLs Source: CBE (2010)

9 Enhanced Efficiency Measures Cost-to-Income Ratio Net Income-to-Personal Expenses Source: CBE (2010). 9

10 Compliance with Capital Adequacy Requirement Rise in the capital adequacy ratio Source: CBE (2010). 10

11 Enhancing Physical Access to Finance Increase in number of branches and ATMs Number of Branches per 100,000 Adult Population Number of ATMs per 100,000 Adult Population Source: CBE (2010). Branch density rose by 60% Number of ATMs rose by 26% 11

12 Efficiency of Intermediation Overnight Interbank Rates Interest Rate 13.5% 11.5% 12.5% 13% % Percent % 10.5% 10.75% % %10% % 10.75% 10.5% % 10.5 % 10 8% 10% 10% % % 8.75% 9 % 8.25% 9 8.5% %8.25 % 30% 25% 20% 15% 10% 5% 0% Credit Growth to Private Business and Household Sector Deposit Rate Lending Rate 30% 25% Total Deposits Growth Rate 80% 75% 70% Loans and Discount Balances / Deposits with Banks 20% 15% 65% 60% 55% 10% 50% 5% 45% 0% %

13 Reforming Non Bank Financial Services ( ) Deepening the Capital Market Objectives Main Components of the Program Ensuring an effectively regulated efficiently operating market, possessing adequate tools and liquidity to ease firm s access to finance Developing an effective framework for regulating the capital market (strict rules for liquidity/solvency of brokerage firms, ensuring transparency and integrity and minimizing manipulation and advantages of private information) Introducing new instruments to the market to enhance financial intermediation (regulating activities of Margin Trading and Short Selling, Market Makers, Management Service, Money Market Funds, Real Estate Funds, Exchange Traded Funds and reviewing the regulation of Mutual Funds,) Launching the Nile Stock Exchange (NILEX) for SMEs in 2007 to facilitate SMEs access to finance. Implementing Agencies Ministry of Investment/ Capital Market Authority (EFSA) The Egyptian Exchange 13

14 A more Efficient Capital Market 200% 150% 100% 50% 0% -50% -100% Annual Return 146% 122% 51% 57% 35% 33% 36% 10% 5% -9%-7% -56% -49% May-10 EGX30 EGX70 EGX100 EGX 30 Index Market Capitalization EGP Billion Jun-05 Jun-06 Jun-07 Jun-08 Jan-09 May-10 Market Capitalization As Percent of GDP Corporate Bonds Issuances Issue size No. of issuances 130% % 100% 70% 40% 10% (LE million)

15 Reforming Non Bank Financial Services ( ) Restructuring the Insurance Sector Objectives Ensuring an effectively regulated efficiently operating market, possessing adequate tools and liquidity to ease firm s access to finance Main Components of the Program Restructuring of state-owned insurance companies Establishing a specialized company for state owned insurers real estate asset management Shifting from rule based to risk based supervision Introduction of insurance brokerage to enhance market penetration and access to insurance services. Introducing legislative amendments to raise the minimum issued capital of insurance companies in early Implementing Agencies Ministry of Investment/ EISA (EFSA) 15

16 A Growing Insurance Sector 1.3% 1.2% 1.1% 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% (LE billion) 50 Premium / GDP Investments of Insurance Companies (LE billion) (LE billion) 30 Net Profit of Insurance Sector Foreign Private sector Public Enterprise sector Egypt Private sector Investments of Private Pension Funds

17 Simplifying income recognition rules. Reducing property registration fees to a maximum of EGP Establishing the Egyptian Mortgage Refinance Company. Reforming Non Bank Financial Services ( ) Introducing Mortgage Finance Number of Mortgage Finance Companies Number of Appraisers Introducing various insurance coverage for mortgage finance beneficiaries. Standardizing contracts of mortgage finance to facilitate securitization. Developing a mortgage subsidy scheme to finance low and middle income housing Number of Brokers Number of Agents Number of Mortgage refinance Companies Mortgage Finance Availed by Banks and Mortgage Finance Companies Banks MFC's 2004/ / / / / /2010 Implementing Agencies Ministry of Investment/ MFA (EFSA) 17

18 Enhancing soundness and stability of the financial system and the role of the World Bank Diagnostic Work FSAP 2002 FSAP Update 2007 Technical Assistance FIRST Initiatives TA Capacity Building TA Advisory work 2008 Lending DPL I US$500 million 2006 Mortgage Finance Project US$37.5 million 2006 DPL II US$500 million 2008 DPL III US$500 million

19 Enhancing soundness and stability of the financial system and the role of the World Bank Diagnostic & Analytical Work Development Policy Loan (DPL) 2009 Investment Loan 2009 Access to Finance Affordable Mortgage Finance DPL ($300 million) Enhancing Access to Finance for Micro and Small Enterprises ($300 million) 19

20 Towards a more inclusive financial sector in Egypt According to the ICA (2009): Only 17.4 percent of firms have access to finance from the formal financial sector. Only 7 percent of new investments are financed externally through the banking sector. According to the Household Survey on Income and Expenditure (2005): Few Egyptians use any kind of formal financial services. Though savings instruments are more common than credit, less than 1 percent of households surveyed had a formal loan. 20

21 Towards a more inclusive financial sector in Egypt First ICA (04/05): Manufacturing Sector: 1000 firms Second ICA (06/07): Manufacturing Sector (998 firms) with Panel and Services (496 firms) Third ICA (08/09): Manufacturing Sector (1156) with Panel, Services (544) with Panel, Informal Sector (501), and Expanded Upper Egypt Coverage 21

22 Towards a more inclusive financial sector in Egypt Evolution of top constraints among panel of manufacturing firms 2008 Leading constraints to Egyptian Manufacturing Firms (by size) Macroeconomic Uncertainty (Ex: inflation, exch. rate) Illegal Competition from the informal sector/smuggling and dumping Macroeconomic Uncertainty (Ex: inflation, exch. rate) Illegal Competition from the informal sector/smuggling and dumping Regulatory Policy Uncertainty Regulatory Policy Uncertainty Skills and Education of Available Workers Skills and Education of Available Workers Corruption Corruption Tax Rates Cost of Financing (Ex: interest rates) Tax Rates Cost of Financing (Ex: interest rates) Price of land Access to Financing (Ex: Collateral) Large Medium Small Price of land Tax Administration Access to Financing (Ex: Collateral) Labor Regulations (Like Social Insurance) Access to Land Tax Administration Customs and Trade Regulations Labor Regulations (Like Social Insurance) Illegal Competition from the formal sector Transportation % identifying constraint as "major" or "very severe" % identifying constraint as "major" or "very severe" 22

23 Towards a more inclusive financial sector in Egypt Tax Rates Macroeconomic Instability Regulatory Policy Uncertainty Tax Administration Illegal/Informal Competition Corruption 2006 Macroeconomic Instability Illegal/Informal Competition Corruption Regulatory Policy Uncertainty Tax Rates Cost of Financing 2008 Macroeconomic Instability Informal sector competition Regulatory policy uncertainty Worker Skills Corruption Tax Rates Access to finance is not a top constraint, but has stayed among the top Cost of Financing Tax Administration Cost of Financing Access to Finance as a Major or Severe Constraint (% of Manufacturing Firms surveyed since 2004). Cost of Finance as a Major or Severe Constraint (% of Manufacturing Firms Surveyed since 2004) 40% 35% 30% 25% 20% 15% 10% 5% 0% 33.33% 35.21% 28.09% 2004 Survey 2006 Survey 2008 Survey 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 43.20% 37.09% 37.97% 2004 Survey 2006 Survey 2008 Survey 23

24 Towards a more inclusive financial sector in Egypt The percentage of firms that have loans declined from 17.4 % in 2004 to % in 2008 one of the lowest rates in MENA. Panel data shows decline from 17.8 % of manufacturers in 2004 to 10.5 % in 2006, remained the same (10.6%). in

25 % of respondents % from each source Towards a more inclusive financial sector in Egypt Share of Enterprises with Bank Finance, by Size and Sector Share with overdraft facilities OR line of credit excluding loans Share with a LOAN 100% 90% 80% Sources of Working Capital, Egyptian Manufacturing Firms, Other (specify) 10. Informal sources (e.g. money lender) % 9. Family, friends Egypt (Manufacturing) Manufacturing: Small Manufacturing: Medium Manufacturing: Large Egypt (Services) Services: Small Services: Medium Services: Large 60% 50% 40% 30% 20% 10% 0% Small Medium Large 8. Equity, sale of stock 7. Credit cards 6. Trade credit (supplier or customer credit) 5. Special development financing/ or public financing (Government agencies) / or other public services 3. International commercial banks 2. Domestic commercial banks (loan, overdraft) Internal funds or retained earnings

26 Egypt (Manufacturing) Small Medium Large Towards a more inclusive financial sector in Egypt Share with overdraft facilities OR line of credit excluding loans % of overdraft or line of credit currently unused Share with a LOAN For the most recent loan: Share that require collateral: Average value of collateral required (as % of the loan): Average interest rate on loan: Average duration of the loan: (mns) For small firms, loans will more likely require collateral and, on average, be of shorter term. 26

27 Towards a more inclusive financial sector in Egypt Egypt (Services) Small Medium Large The reason for not having a loan is because: I did not apply for a loan The last application for a loan was turned down The approval of the application for a loan is still pending What was the main reason for not applying for a loan? Do not need loans Application procedures for bank loans are too burdensome Collateral requirements of bank loans are too high Interest rates are too high Corruption in the allocation of bank credit Did not think that it would be approved It could create complications with tax administration Did not want to deal in interest rates Others

28 Towards a more inclusive financial sector in Egypt Macroeconomic Uncertainty (Ex: inflation, exch. rate) Illegal Competition from the informal sector/smuggling and dumping Regulatory Policy Uncertainty Skills and Education of Available Workers Corruption Tax Rates Cost of Financing (Ex: interest rates) Price of land Upper Egypt: How different? Constraints by Location Access to Financing (Ex: Collateral) Tax Administration Labor Regulations (Like Social Insurance) Access to Land Customs and Trade Regulations Illegal Competition from the formal sector Transportation Urban Lower Upper Electricity Business Licensing and Operating Permits Water Telecommunications Legal System/ Conflict Resolution Theft,disorder and crimes % identifying constraint as "major" or "very severe" 28

29 Financial Policy Challenges 1. Financial inclusion: Supply side reforms and Demand side reforms 2. Taxation of financial intermediation 3. Appropriate regulatory structure 4. Informal finance 5. Does ownership really matter? Structure of the financial sector Regulations and quality of supervision Financial culture Competition Consumer protection Corporate governance Entry rules Exit rules 29

30 Financial Policy Challenges 6. Deposit Insurance: Explicit Vs Implicit Is there a mix or something else? 7. Islamic Finance: regulation, compliance, and dealing with Conventional Finance 8. Specialized Finance: agriculture, industry, real estate, infrastructure, SMEs 9. Gender based Finance: more than windows? 10. IT, Innovation and the advantage of starting late?! 11. Life after FSAPs, Basel III compliance and quality of implementation of reforms and their sustainability (the role of World Bank DPLs, ILs, RBLs and TAs) 12. Post Crisis issues: financial development, inclusive growth and the G20 30