US embassy cable - 05CAIRO6171

UNCLAS SECTION 01 OF 03 CAIRO 006171 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR NEA/ELA, NEA/RA, AND EB/IDF 
USAID FOR ANE/MEA MCCLOUD 
USTR FOR SAUMS 
TREASURY FOR MILLS/NUGENT/PETERS 
COMMERCE FOR 4520/ITA/ANESA/TALAAT 
 
E.O.  12958: N/A 
TAGS: ECON, EFIN, ETRD, EINV, PGOV, EG, USTR, Banking Sector 
SUBJECT: EGYPT: BANKING SECTOR REFORM UPDATE 
 
Sensitive but Unclassified.  Please protect accordingly. 
 
Ref:  Cairo 5941 
 
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Summary 
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1.  (SBU) As part of its banking sector reform program, the 
GOE has pushed legislation through parliament designed to 
strengthen the sector.  As a result, banks now have more 
leeway in pursuing legal remedies and setting compensation 
for public bank staff.  Requirements on foreign exchange 
bureaus and international money transfer agencies have also 
been relaxed.  Changes were also made to stimulate a 
moribund mortgage market by allowing foreign institutions to 
operate in it, permitting the establishment of credit rating 
agencies, and allowing banks to foreclose on mortgaged real 
estate.  The Central Bank of Egypt (CBE), which is 
undergoing positive internal reform, also signaled its 
commitment to sectoral reform by forcing banks to meet new 
minimum capital requirements, which resulted in the merger 
of several banks.  The legislative changes and recent CBE 
actions indicate that Nazif government and the reform-minded 
CBE Governor are determined to address long-festering 
problems in the banking sector.  While the GOE still faces 
some significant hurdles in restructuring the banking 
sector, progress to date demonstrates that the political 
will exists to move forward with the reform agenda.  End 
summary. 
 
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Banking Law Amendments 
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2.  (U) In addition to progress on privatization of public 
and joint venture banks (reftel), the GOE has advanced its 
banking sector reform program by pushing through parliament 
several amendments and additions to Banking Law 88 of 2003. 
Law 162 of 2004, issued December 22, 2004, amended the 
banking law to allow for suspension of legal proceedings 
against defaulting clients if those clients settle their 
outstanding debts with their banks.  The law had previously 
required that legal proceedings brought against clients in 
default be completed, regardless of the disposition of the 
loans.  A number of high profile cases last year resulted in 
jail sentences for prominent businessmen, prompting a flight 
from Egypt by a number of other businessmen fearing similar 
fates. 
 
3.  (U) Law 93 of 2005, issued June 21, made a number of 
amendments to the banking law.  In what some CBE officials 
claim is the most significant of the amendments, Law 93 
liberalized compensation schemes for public banks employees. 
Public bank employees were previously governed by broad 
public sector compensation regulations, which tended to be 
overly rigid and uncompetitive in comparison to market-based 
compensation schemes.  Public banks may now determine their 
own compensation packages designed specifically to attract 
talented employees and improve overall employee performance. 
 
4.  (U) Another significant amendment was the lowering of 
minimum capital requirements for foreign exchange bureaus 
from LE 10 million to LE 5 million.  Banking Law 88 of 2003 
had raised the minimum capital requirement for exchange 
bureaus from LE 1 million to LE 10 million, setting July 15, 
2005 as the deadline for meeting the new requirement.  Many 
exchange bureaus were up in arms over the LE 10 million 
requirement, fearing they would not be able to raise the 
additional capital and would be forced to exit the market. 
Although the new lower minimum capital requirement may give 
exchange bureaus some breathing room, many may still fail to 
meet the new LE 5 million requirement, and will likely be 
forced to exit the local foreign exchange market. 
 
5.  (U) Law 93 also amended the banking law to allow the CBE 
Board of Directors to issue licenses to money transfer 
companies.  This amendment addresses longstanding obstacles 
faced by foreign money transfer companies, including Western 
Union.  In the past, money transfer agencies had been 
granted special administrative treatment to handle these 
obstacles, but the amendment provides a new legal basis 
under which transfer companies will operate. 
 
6.  (U) As part of an effort to stimulate a moribund 
mortgage market, Law 93 also included amendments authorizing 
international financial institutions to secure and guarantee 
finances and operate in the mortgage finance market.  Many 
banking sector analysts had noted the lack of a developed 
mortgage financing market as one of the major impediments to 
development of Egypt's real estate sector.  Despite 
increased demand and rising prices, the lack of access to 
efficient mortgage financing hindered growth in the real 
estate market. 
 
7.  (U) Law 93 also removed another obstacle to growth of 
the mortgage market by allowing for the establishment of 
independent credit reporting agencies.  Bank managers and 
credit analysts had long expressed frustration at the lack 
of credit agencies in the Egyptian market, noting that their 
absence made credit risk assessment especially difficult. 
Law 93 provides a legal basis to establish credit agencies, 
complementing efforts already underway by several banks and 
financial institutions, notably CIB, NBE, HSBC Egypt and 
Bank Misr, to set up such agencies.  Independent credit 
rating agencies will provide a base of information on 
financial sector clients that can be shared among banks, 
mortgage finance and financial leasing companies. 
 
8.  (U) Law 93 also added a new article to the banking law 
that allows banks to foreclose on real estate mortgaged to 
the bank under the Real Estate Finance Law.  This new 
article strengthens banks' ability to manage mortgage 
finance operations.  Banks were previously in a weak 
position to foreclose on real estate assets, which added to 
their reluctance to enter into the mortgage market.  With a 
strengthened hand, banks are now in a better position to 
expand mortgage operations, meeting the increased demand 
noted above. 
 
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Consolidation of the Banking Sector 
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9.  (U) Another aspect of the GOE banking sector reform 
program is consolidation of the sector and reduction of the 
number of banks operating in the Egyptian market.  Most 
banking sector analysts believe the market is over-banked 
and under-serviced.  In what is likely to be the biggest 
step toward consolidation, CBE recently refused requests 
from numerous banks to extend the grace period for meeting 
the new bank capitalization requirements, which ended July 
15.  The banking law required banks to raise their minimum 
capital to LE 500 million for Egyptian banks and $50 million 
for foreign banks' branches by July 15. 
 
10.  (SBU) As a result of CBE's enforcing the deadline, 14 
banks are now in the process of merging, 11 voluntarily and 
3 under pressure from CBE.  CBE is also forcing a number of 
banks to exit the market.  Last week alone, 3 banks - Iraqi 
Rafidin Bank, Lebanese Gamal Trust Bank, and Sudanese 
National Bank - were forced to close their operations in 
Egypt (Note:  Rafidian Bank will continue to process pay 
transfers from Iraq).  CBE Deputy Governor Amer noted to 
econoff that although consolidation of the banking sector 
was scheduled to take 2-3 years, it is likely to be 
completed by 2006.  Analysts provide varying assessments, 
but most believe that approximately 20-25 banks will 
continue to operate in the market after consolidation is 
completed. 
 
11.  (SBU) While most bankers agree that consolidation of 
the sector is a positive step, some are critical of CBE's 
preferred method of merging banks to meet the new capital 
requirement.  Essam Abdel Hammed, Chairman of Alexandria 
Commercial and Maritime Bank, told econoff on a recent visit 
to Alexandria that CBE is approaching mergers in the wrong 
way.  Some of the smaller banks in the sector have been 
merged into larger banks with good management, but CBE has 
also approved the mergers of small, weak banks with other 
small, poorly managed banks.  Abdel Hammed believed this 
would not ultimately strengthen the banking sector as a 
whole, as these new banks would remain weak and poorly 
managed, albeit with the required minimum capital.  Abdel 
Hammed predicted a second wave of consolidation a few years 
down the road, once all banks have met the new minimum 
capital requirements and the sector becomes more 
competitive. 
 
12.  (SBU) International investors are taking advantage of 
this period of consolidation to enter or expand their 
operations in Egypt.  Mona Nasrallah, Head of the Alexandria 
Branch of Calyon Bank, told econoff that Calyon, a French 
bank, was looking to purchase the GOE's shares in one of the 
joint venture banks currently up for sale.  The French 
Societe General Bank has already purchased a controlling 
share in National Societe General Bank in Egypt (reftel). 
The Greek Piraeus Bank also recently acquired 69.3% of the 
Egyptian Commercial Bank for a total of 19 million Euros. 
Roderick Richards, Managing Director of Egyptian American 
Bank (EAB), told econoff that many of the inquiries he has 
received about EAB's impending sale have come from foreign 
investors. 
 
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Reform at CBE 
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13.  (U) CBE senior management also continues to restructure 
CBE itself and improve the quality of its personnel.  One 
primary focus is establishment of an effective system for 
implementation of monetary policy.  The European Central 
Bank and the EU are assisting CBE in creating models and 
systems for formation and implementation of long-term 
monetary policy.  As noted in previous reporting, the chosen 
monetary policy framework is inflation targeting, ultimately 
aiming to maintain inflation within a certain range.  CBE 
intends to use short-term interest rates as the operational 
target for the policy.  Plans are underway at CBE to hire an 
IMF expert by September 2005 to manage implementation of the 
new inflation targeting policy. 
 
14.  (SBU) USAID is also providing assistance to CBE in the 
personnel restructuring.  Mohamed Ozalp, Vice President of 
Bank Misr, told econoff that the effect of El Okdah's reform 
of CBE personnel could be seen most clearly in the behavior 
of auditors sent to audit Bank Misr's books.  According to 
Ozalp, in the past CBE auditors primarily conducted audits 
to ensure that the public banks were cooperating with 
government finance and spending priorities, and not acting 
too independently.  There was also a significant amount of 
corruption.  Since El Okdah took office in December 2003, 
CBE audits of the public banks have been less frequent and 
more professionally conducted, aimed at ensuring that the 
banks were following banking regulations. 
 
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Comment 
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15.  (SBU) While the GOE still faces some significant 
hurdles in restructuring the banking sector, progress to 
date demonstrates that the political will exists to move 
forward with this aspect of the GOE's economic reform 
agenda.  The strong interest in Egypt's banking sector among 
potential investors, particularly international investment 
banks, is testimony to renewed confidence in Egypt's economy 
as a whole.  This strong international response to the Nazif 
administration's performance bodes well for re-appointment 
of the economic reformers in the Nazif Cabinet after Egypt's 
September 7 presidential election.  End comment. 
JONES