Fitch Ratings-Dubai, London-19 May 2022: Egyptian banks’ net foreign assets should continue to recover following the devaluation of the Egyptian pound due to a boost to foreign investor confidence from a more flexible exchange-rate regime and a new IMF programme, Fitch Ratings says. The Central Bank of Egypt (CBE) devalued the pound by 17% and raised its main interest rate by 100bp on 21 March to tackle inflation. Higher interest rates will support the banks’ profitability but, along with high inflation, could put pressure on asset quality.
The banks’ net foreign liabilities widened to EGP185 billion (USD12 billion) at end-February 2022 compared with net foreign assets of EGP26 billion at end-June 2021. This was driven, we believe, by public sector banks using foreign assets to buy foreign-currency (FC) securities issued by the sovereign to finance its current account deficit and upcoming maturities. In March, the CBE’s placements with domestic banks decreased by USD7.4 billion as it used them to cover large outflows.
Link to Infogram: Egyptian Banks' Net Foreign Assets and FC Liabilities Coverage
The sector’s net foreign liabilities narrowed to EGP128 billion at end-March 2022, supported by a 58% increase in foreign assets, according to preliminary data. We expect non-resident portfolio holdings to increase to USD20 billion at end-FY21/22 and USD25 billion at end-FY22/23 from USD17.5 billion in mid-March. Meanwhile we expect Egypt’s current account deficit to decline to 3.5% of GDP in FY22/23 from 4.6% in FY21/22. These factors should improve the sector’s FC liabilities coverage, which fell to 17% at end-January 2022 (end-June 2021: 31%). That said, most of the sector’s external debt is long-term, which limits refinancing risks, and foreign assets comfortably cover short-term external debt (more than 5x at end-September 2021).
We expect the CBE to raise interest rates by 200bp-300bp on 19 May. Higher rates will weigh on the banks’ net interest margins (NIMs) following the issuance of 18% certificates of deposit by National Bank of Egypt and Banque Misr, which will lead to higher sector funding costs as other banks compete for deposit funding. However, private sector banks’ NIMs should improve in 2023 as assets reprice faster than liabilities. During the last monetary tightening cycle, private sector banks’ NIMs increased by 120bp on average over FY17-FY20, while public sector banks’ NIMs contracted by 30bp.
The currency devaluation should not affect the banks’ capital ratios significantly. We estimate that a 17% depreciation against the US dollar reduces Tier 1 ratios by 120bp, on average, across a sample of five banks, due to the inflation of FC risk-weighted assets (RWAs). The direct effect on capital should be marginal owing to low open currency positions. Higher interest rates could cause mark-to-market losses on ‘fair value through other comprehensive income’ securities but these losses will not crystalise if the securities are held to maturity.
We do not expect banks to need fresh capital given their comfortable capital buffers. The sector’s common equity Tier 1 ratio and total capital ratio were 12.9% and 22.5%, respectively, at end-2021, and public sector banks’ ratios should be supported by asset sales to Abu Dhabi Developmental Holding Company.
Link to Infogram: Egyptian Banks' Net Interest Margins
Asset quality is the key risk in 2022-2023, with trade, industry and retail being the segments most vulnerable to inflation and supply-chain disruption. Banks have increased their exposure to micro, small and medium-sized enterprises in line with CBE instructions, which increases their vulnerability to credit deterioration. We expect loan restructurings and credit losses to increase, and the sector’s non-performing loans ratio by end-2023 to approach the 2018-2019 level of around 4.1% (end-2021: 3.5%) as credit growth weakens and interest rates rise. However, provisions have strengthened in recent years, which will mitigate the impact. Total reserve coverage was 92.2% at end-2021.
Link to Infogram: Egyptian Banks' Capital Ratios and Non-Performing Loans Ratios
Media Relations: Louisa Williams, London, Tel: +44 20 3530 2452, Email: louisa.williams@thefitchgroup.com
Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@thefitchgroup.comThe above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
