Banking Sector: Slow Turnaround Ahead

BMI View: The modest improvements in Egypt's economic and political situation will provide relief to the country's banking sector. The injection of USD16bn in Gulf aid over the past year has served to stabilise the economic outlook of the country and reduce risks of dollarization in the economy. However, significant risks of dollarization remain over the longer term.

We expect a slight improvement in Egypt's banking sector over the coming months as greater political stability and low base effects provide room for relatively substantial gains. We forecast deposit and loan growth to come in at 11.0% and 7.0% respectively, in 2014, and stay around these levels for the period to 2018. These figures are notably higher than trend growth.

In line our cautiously optimistic outlook on the domestic banking sector heading into 2014, sentiment towards the industry appears to be turning, with the EGX Bank Index (an index composed of 12 banking stocks) up 16.0% since the start of the year. Moreover, it is important to keep in mind that amidst the economic and political headwinds, some of the country's largest publically-listed lenders have remained profitable, with Commercial International Bank seeing an 18.8% y-o-y jump in Q2 net profit.

Growth Above Long-Term Trend
Egypt - Loan & Deposit Growth

BMI View: The modest improvements in Egypt's economic and political situation will provide relief to the country's banking sector. The injection of USD16bn in Gulf aid over the past year has served to stabilise the economic outlook of the country and reduce risks of dollarization in the economy. However, significant risks of dollarization remain over the longer term.

We expect a slight improvement in Egypt's banking sector over the coming months as greater political stability and low base effects provide room for relatively substantial gains. We forecast deposit and loan growth to come in at 11.0% and 7.0% respectively, in 2014, and stay around these levels for the period to 2018. These figures are notably higher than trend growth.

Growth Above Long-Term Trend
Egypt - Loan & Deposit Growth

In line our cautiously optimistic outlook on the domestic banking sector heading into 2014, sentiment towards the industry appears to be turning, with the EGX Bank Index (an index composed of 12 banking stocks) up 16.0% since the start of the year. Moreover, it is important to keep in mind that amidst the economic and political headwinds, some of the country's largest publically-listed lenders have remained profitable, with Commercial International Bank seeing an 18.8% y-o-y jump in Q2 net profit.

Recovery Gaining Steam
Egypt - Banking Sector Client Loans (Left) And Deposits (Right)

Dollarization Risks Could Return

Over the past few quarters, one of the main risks facing the Egyptian banking sector was of dollarization. We believe that risks of this has peaked as we forecast sideways trade in the Egyptian pound over most of 2014 (See: 'EGP - Depreciatory Pressures To Build' April 30). However, we highlight that around the turn of the year risks of depreciation are set to return as financial assistance from the Gulf begins to wane. Therefore, we could see an uptick in dollarization in Egypt's banking sector in 2015.

Crowding Out Risks

Egypt's loan-deposit ratio has been in a secular downtrend since early 2010 and currently stands at 0.42, illustrating a significant increase in banks' liquidity. However, this increase in liquidity has come about due to the absence of growth in loans as banks continue to purchase treasuries given the high yield on offer. This is clearly evident in the ongoing rise in the banking sector's bond portfolio as a share of total assets, which reached record highs of 39.1% in January 2014, one of the highest levels since the beginning of our time series dating back to 2005. As banks have shifted their asset allocations over to treasuries, their willingness to lend to the private sector amidst a still uncertain political and economic backdrop has decreased substantially. Thus, Egypt's banks are in a position where their main function is to help finance the government's budget deficit rather than lend to the private sector, despite the demand from small and medium-sized enterprises for credit. This has created significant pent up demand which should drive growth in the long term.

Agriculture Losing Ground
Egypt - Loans by Sector, % y-o-y

Long-Term Growth Potential Remains

Despite these significant short-term challenges, we maintain a bullish outlook on the sector over the long term. Total loans-to-GDP (which we use as a proxy for the sector's maturity) stood at only 31.2% in January, well below regional peers across the Middle East and North Africa. Furthermore, the share of mortgages-to-GDP is only 0.5%, whilst outstanding credit to households and small and medium size enterprises is also relatively minimal. Given the country's rapidly growing population, there will be a significant increase in demand for financial services over the coming years.

One area which we are less optimistic on is Islamic banking as political opposition remains the key impediment to growth in this sector. The current interim government show little interest in Islamic banking, in contrast to the ousted Muslim Brotherhood who wanted to make Egypt an Islamic finance hub. Since the start of 2013 draft legislation that would permit the issuance of sukuk has been held up on several occasions due to objections from the country's highest religious authority, al-Azhar. Regardless of the country's dire need to tap international Islamic debt markets to help cover the budget deficit, political wrangling continues to slow the passage of the legislation.

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Related sectors of this article: Economy, Banking/Finance, Economic Activity, Deposits, Loans, Assets
Geography: Egypt, Egypt
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