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Banking risk score on Egypt maintained at group '8'

Standard & Poor's Ratings Services maintained its Banking Industry Country Risk Assessment (BICRA) on the Arab Republic of Egypt at Group 8.
21.03.12 | Interesting article at Business Intelligence Middle East

On March 20, 2012, Standard & Poor's Ratings Services maintained its Banking Industry Country Risk Assessment (BICRA) on the Arab Republic of Egypt (B/Negative/B) at group '8'.

It also lowered its economic risk score, a component of the BICRA, to '9' from '8'. The industry risk score, a second BICRA component, remains unchanged at '7'.

Rationale

The unchanged BICRA and the lowered assessment of "credit risk in the economy" reflect our view of increased sovereign risk for Egypt's banking sector. Since the popular uprising in January 2011, we have lowered our long- and short-term foreign currency sovereign ratings on Egypt to 'B/B' from 'BB+/B'. Our opinion of the higher sovereign risk we see is mainly included in our reassessment of "credit risk in the economy" as "extremely high risk" compared with our previous assessment as "very high risk," as our criteria define these terms. We have consequently revised our economic risk score on Egypt to '9' from '8'.

Our criteria define the BICRA framework as one "designed to evaluate and compare global banking systems." A BICRA analysis for a country covers rated and unrated financial institutions that take deposits, extend credit, or engage in both activities.

A BICRA is scored on a scale from 1 to 10, ranging from the lowest-risk banking systems (group '1') to the highest-risk (group '10'). Other countries in BICRA group '8' include Argentina, Kazakhstan, Lebanon, Nigeria, Tunisia, and Uruguay.

The economic risk score of '9' is based on our maintained assessments of economic resilience as "very high risk," of economic imbalances as "high risk," and our lowered assessment of credit risk in the economy to "extremely high risk" from "very high risk," as our criteria define these terms.

Uncertainties surrounding Egypt's political transition phase, and security issues, may hamper the country's economic growth and put additional pressure on public finances. Egypt is sensitive to a sharp economic downturn because of the low level of wealth in the country--GDP per capita is below $3,000--and its large and fast-growing population.

Public finances have also weakened substantially during the past 12 months. Long-term economic prospects remain good as long as existing infrastructure and key service industries, such as tourism, are preserved.

The deterioration in the economy will weigh on the banking sector by increasing credit costs and lowering revenue generating capacity. On top of this, the real estate sector is in a correction phase. Although the banks' direct exposure to this sector and the stock market is limited, a major downturn could harm them, especially the large public sector banks.

Credit risk is the main source of risk for Egyptian banks, in our view. Our successive lowering of Egypt's sovereign ratings over the past 14 months has reflected the rising sovereign credit risk that the Egyptian banking sector faces.

Sovereign risk has increased significantly and systemwide direct and indirect exposure to domestic sovereign risk has also increased, amounting to about half of system assets. Most banks carry large credit exposure to sovereign debt compared with their equity bases. We believe that most Egyptian banks are unlikely to withstand a scenario where the sovereign defaulted on its debt obligations.

Private sector debt is low compared with GDP, partly because only a small portion of the retail and corporate bases have bank or loan accounts. Lending to private sector companies remained flat year-on-year in absolute terms, standing at about Egyptian pound (EG£) 290 billion as of Dec. 31, 2011, and we expect this figure to increase only slightly during 2012.

We consider lending and underwriting standards to be "relaxed," as our criteria define the term. On the lending side, banks deal with the most sophisticated customers, but for this reason the customer base is narrow, creating concentration risk. Banks are also exposed, directly and indirectly, to the performance of cyclical or vulnerable sectors like tourism, real estate, and construction.

In addition, the legal system and payment culture do not support banking activities. Lending practices and enterprise risk management vary widely among banks. Recently reformed public sector banks still need to show a track record of appropriate credit risk management through a full economic cycle.

Our industry risk score of '7' is based on our opinion that Egypt has "very high risk" in its "institutional framework," "high risk" in its "competitive dynamics," and "intermediate risk" in "systemwide funding," as our criteria define these terms.

Despite recent improvements and a clear commitment from the authorities to reform the banking sector, this is still a work in progress. We also consider it highly likely that political uncertainties and the economic slowdown may delay the full implementation of the initial reform program, from the privatization of some state-owned banks to improved transparency.

During the political transition, we do not exclude the possibility that regulations might be relaxed, and we could even see some cases of regulatory forbearance.

Risk appetite is restrained, in our view. The Central Bank of Egypt has been instrumental in prohibiting complex transactions or products. However, we consider that banks operate in a moderately unstable competitive environment. We view the Egyptian banking industry as fragmented--it has 39 licensed banks.

The three largest state-owned banks represent 40% of the sector. These modernizing institutions are adopting more aggressive commercial practices, which could increase competition. In addition, the consolidation of the banking sector is not yet complete, in our view.

We view systemwide funding as a relative strength for the system. Stable core customer deposits are abundant and could increase if banks were able to attract customers that are used to dealing in cash. That said, the level of intermediation is low and excess funds are mainly invested in local sovereign debt. Banks do not have easy access to international capital markets and the domestic debt capital market is underdeveloped.

We classify the Egyptian government as "supportive" toward domestic banking. The government's track record of support for distressed financial institutions is positive. We believe the government is willing to provide extraordinary support to the banking system in times of exceptional stress, but that its financial ability to do so is limited.