Access to Finance and Economic Growth in Egypt Access to Finance and Economic Growth in Egypt Middle East and North African Region A Study Led By SAHAR NASR A Study Led By S AH AR NA SR T his publication provides a comprehensive and informative analysis of a key policy issue facing Egypt and other developing countries-how to enhance appropriate access to finance in support of sustained high economic growth and improved income distribution. The detailed and elegant evaluations of the key segments of the financial sector are supplemented by a holistic discussion that draws out the main interactions, including the linkages to institutional reforms. The timely publication will be interest to a large number of policy makers, academics, development practitioners and financial market participants.” Dr. Mohamed A. El-Erian, President and CEO of the Harvard Management Company, member of the faculty of the Harvard Business School, and Deputy Treasurer of Harvard University B roadening the reach of the financial sector is the key to invigorating both economy and society. If more small businesses can get access to the credit and other financial services they need to turn initiative into employment and profitability, and if low income households can gain the economic security offered by an account at an intermediary, economic growth and social welfare will both be enhanced. This report takes a close look at the Egyptian financial system to see how outreach and access can be improved. It is firmly based on recently collected statistics and it provides a comprehensive analysis with recommendations. Recent government initiatives have already begun to transform the Egyptian financial system. Access to Finance and Growth in Egypt points the way to future success in lifting the system to the next level.” Dr. Patrick Honohan, Senior Advisor, World Bank; and Professor of International Financial Economics and Development, Trinity College Dublin F inancial exclusion is likely to act as a “brake” on development as it retards economic growth and increases poverty and inequality. However, the access dimension of financial development has often been overlooked, mostly because of serious data gaps on who has access to which financial services. Hence, empirical evidence that links broader access to financial services to outcomes has been very limited, providing at best tentative guidance for public policy initiatives in this area. However, without inclusive financial systems, poor individuals and small enterprises need to rely on their personal wealth or internal resources to invest in their education, become entrepreneurs or take advantage of promising growth opportunities. Financial market imperfections—such s information and transactions costs—are likely to be especially binding on the talented poor and the micro and small enterprises, who lack collateral and credit histories.” Asli Demirguc-Kunt, Senior Research Manager, Finance and Private Sector Development, Development Research Group (DECRG), World Bank F or Egypt, access to finance can radically transform peoples’ lives, promote entrepreneurship, help bridge the urban-rural income divide, alleviate poverty and improve individuals’ lifetime economic and social prospects by integrating them into the market economy. In short, improved access to finance can be an engine of growth and structural transformation, if supported by other policies that reduce barriers to competition, lower the cost of doing business and create incentives for moving out of the ‘informal sector’. For Egypt, where fewer than seven percent of households have a bank account, investments and policies that create and improve access to finance and its infrastructure, can break down economic and social barriers to economic growth and development. This well-researched report is an excellent guide and provides a practical tool-kit for economic and financial policy makers, banks and financial institutions seeking to improve Egypt’s financial infrastructure and access to finance.” Dr. Nasser Saidi, Chief Economist Dubai International Financial Centre (DIFC) “ “ “ “ 41305 Introduction i Access to Finance and Economic Growth in Egypt Access to Finance and Economic Growth in Egyptii Introduction iii Access to Finance and Economic Growth in Egypt Middle East and North African Region A Study Led By SAHAR NASR Access to Finance and Economic Growth in Egyptiv Introduction v Abbreviations and Acronyms viii Foreword ix Preface xi Acknowledgments xiii Executive Summary xvii I. Introduction 1 II. Sources for Financial Services: The Banking Sector 23 A. Access to Bank Financial Services 23 B. Factors behind Weaknesses in Supply of Banking Services 28 C. Access to Microfinancial Services 45 III. Sources for Financial Services: Non-bank Financial Services 55 A. Capital Markets 55 B. Insurance and Contractual Savings 61 C. Mortgage Finance 68 D. Financial Leasing 73 E. Factoring 76 IV. Institutional Environment 81 A. Legal Framework 81 B. Information Infrastructure–Credit Registry, Credit Bureau and Other Sources 86 C. Financial Reporting Environment 89 D. Financial Infrastructure 91 V.Expanding Access to Finance 95 A. Enhancing the Role of the Banking Sector in Financial Intermediation 95 B. Expanding the Postal System and Microfinance Institutions 101 C. Promoting Capital Markets in the Access Agenda 105 D. Contractual Savings Industry Potentials for Growth 107 E. Developing the Mortgage Finance Market 113 F. Increasing the Financial Leasing Industry’s Contributions to Access 115 G. Developing the Factoring Industry 116 H. Improving the Institutional Environment 117 Annexes 130 Annex 1: Indicators For Assessing The Soundness And Performance 130 Of The Banking System Annex 2: Indicators For Assessing The Capital Market 135 Annex 3: Indicators For Assessing The Insurance And Contractual Savings Sector 136 Bibliography 137 Contents Access to Finance and Economic Growth in Egyptvi Tables Table 1.1: Main Macroeconomic Indicators in Egypt (2001-2006) 7 Table 1.2: Business Environment in Egypt 9 Table 1.3: Various Sources of Finance in Egypt, MENA, and the World 15 Table 1.4: Household Use of Financial Services by Education Level in Egypt 17 Table 1.5: Use of Finance by Employment Status of Head of Household in Egypt 18 Table 2.1: Frequency Distribution of Private Sector Credit in Egypt 25 Table 2.2: Share of Savings Accounts by Size of Deposits in Banks in Egypt 27 Table 2.3: Local Currency Deposit Interest Rates in Egypt 27 Table 2.4: Number of Credit and Debit Cards Issued in Egypt during 2005 28 Table 2.5: Branching and ATM Presence, Cross-Country Comparisons 30 Table 2.6: Earnings per Employee of Banks in Egypt 37 Table 2.7: Expense Ratio of Banks in Egypt 37 Table 2.8: Main Reasons for not Lending to SMEs in Egypt 40 Table 2.9: Lending Rates for Local Currency of Banks Operating in Egypt 41 Table 3.1: Compound Annual Growth Rate by Sub-Sector in Egypt 62 Table 3.2: Statutory Investment Limits—Life Insurers in Egypt 63 Table 3.3: Assets and Investments in Egypt 63 Table 3.4: Insurance Investment Allocation in Egypt 65 Table 3.5: Private Pension Investment Allocation in Egypt 66 Table 3.6: Investment Approach of the Contractual Savings Industry 66 Table 4.1: History of Public Credit Registry Database in Egypt 86 Table 4.2: Negative Databases of CBE Credit Registry 87 Figures Figure 1.1: Current versus Desirable Situation of Financial System 2 Figure 1.2: M2-to-GDP in Selected Countries across the World 8 Figure 1.3: Private Sector Credit-to-GDP in Selected Emerging Economies 9 Figure 1.4: Investment Climate Constraints in Egypt as Perceived by Businesses 15 Figure 1.5: Percentage of Firms Currently with a Loan from a Financial Institution in Egypt 16 Figure 1.6: Enterprises’ Access to Finance in Egypt and Selected MENA Countries 16 Figure 1.7: Households’ Share in Access to Financial Services by Educational Attainment in Egypt 18 Figure 2.1: Loans-to-Deposits Ratio in Egypt 24 Figure 2.2: Loan-to-Deposit Ratio in Egypt 24 Figure 2.3: Treasury Bills-to-Total Assets in Egypt 24 Figure 2.4: Government Sector Loans-to-Total Loans in Egypt 25 Figure 2.5: State-Owned Enterprises Loans-to-Total Loans in Egypt 25 Figure 2.6: Credit Extended to Private Sector in Egypt 26 Figure 2.7: State-Owned Banks’ Share of the Banking System Total Assets in Egypt 29 Figure 2.8: Urban and Rural Branch Density by Bank Type in Egypt 31 Figure 2.9: Equity-to-Assets Ratio of Banks in Egypt 33 Figure 2.10: Distribution of Staff in the Egyptian Banking System 38 Figure 2.11: Return on Assets of Egyptian Banks 39 Figure 2.12: Return on Equity of Egyptian Banks 39 Figure 2.13: Collateral Requirements as a Percent of Loan Values 41 Figure 2.14: Marginal Effects of Branching and Education on Access to Financial Services in Egypt 45 Contents Introduction vii Figure 3.1: Equity Finance and Corporate Bonds as Sources of Investment Funding in Selected Emerging Economies 56 Figure 3.2: Assessment of Enforcement in Egypt’s Capital Markets 60 Figure 3.3: State-Owned Insurers’ Share of Insurance Assets in Egypt 63 Figure 3.4: Funds under Management: Egypt and OECD 65 Figure 3.5: Developments in Mortgage Loans in Egypt 71 Figure 3.6: Volume and Number of Leasing Contracts in Egypt 74 Figure 4.1: Legal Rights of Creditors in Egypt and Other Countries 82 Figure 4.2: Cost to Create Collateral in Egypt and Other Countries 83 Figure 4.3: Bankruptcy Costs and Time in Egypt, MENA Region and OECD 84 Figure 4.4: Dominance of Collateral-Based Lending in Egypt 85 Figure 5.1: Funds Build Up Under Five Percent Mandatory Pillar Option 111 Boxes Box 1.1: Access to Finance as an Obstacle to Growth 5 Box 1.2: Rationales for the Privatization of Banks 12 Box 1.3: Egyptian Women’s Access to Finance 19 Box 2.1: Egypt Post Offices 32 Box 2.2: Status of Islamic Finance in Egypt 34 Box 2.3: Bank Performance Analysis by Size and Ownership 35 Box 2.4: Weaknesses in Corporate Governance in Egyptian State-Owned Banks 42 Box 2.5: The Relative Importance of Demand and Supply Factors in Explaining Access 43 Box 2.6: State-Owned Banks Actively Involved in Microfinance in Egypt 46 Box 2.7: NGOs are Key Players in Microfinance in Egypt 47 Box 3.1: Major Insurance and Pensions Investors in Egypt 67 Box 3.2: The Government of Egypt’s Housing Finance Program for the Poor 69 Box 3.3: The Egyptian Mortgage Refinance Company 70 Box 4.1: Current Status of the Private Credit Bureau in Egypt 88 Box 4.2: The Importance of Good Financial Reporting for Firm Financing 89 Box 5.1: Lessons on Bank Restructuring from Other Countries 96 Box 5.2: Subsidized Lending Schemes in Egypt 100 Box 5.3: Lessons from Successful Postal Financial Systems: Case Studies from Brazil and China 102 Box 5.4: International Evidence on Institutional Policies to Enhance Access 104 Contents Access to Finance and Economic Growth in Egyptviii ABBREVIATIONS AND ACRONYMS ABS Asset-Backed Securities AIM Alternative Investment Market ALM Asset and Liability Management AML/CTF Anti Money Laundering and Combating Terrorism Financing ATM Automatic Teller Machines AUM Assets Under Management BRU Bank Restructuring Unit CAGR Compound Annual Growth Rate CAPMAS Central Agency for Public Mobilization and Statistics CASE Cairo and Alexandria Stock Exchanges CBE Central Bank of Egypt CCMAU Crown Company Monitoring Advisory Unit CFD Corporate Finance Division CGAP Consultative Group to Assist the Poorest CGC Credit Guarantee Company CIB Commercial International Bank CIBOR Cairo Interbank Offer Rate CIS Cooperative Insurance Society for Small Enterprises CMA Capital Market Authority DB Defined Benefits DC Defined Contribution EAB Egyptian American Bank EAS Egyptian Accounting Standards EEGC Egyptian Export Guarantee Company EFG Egyptian Financial Group EISA Egyptian Insurance Supervisory Authority EMRC Egyptian Mortgage Refinance Company ESDF Egyptian Swiss Development Fund FCI Factors Chain International FIRST Financial Sector Strengthening Initiative FSAP Financial Sector Assessment Program FSS Financial Self-Sufficiency GAFI General Authority for Free Zones and Investment GATS General Agreement on Trade in Services GCC Gulf Cooperation Council GDP Gross Domestic Product GDR Global Depository Receipt GEM Gender Entrepreneurship Markets GSF Guarantee and Subsidy Fund HH Household IAS International Accounting Standards ICA Investment Climate Assessment ICS Investment Climate Survey ICT Information and Communications Technologies IFG International Factoring Group IFRS International Financial Reporting Standards IFI Islamic Financial Institutions IFS Islamic Financial Services IIC Islamic Investment Companies IPOs Initial Public Offerings KOSDAQ Korea Securities Dealers Automated Quotation LE Egyptian Pound M2 Broad Money MCSD Misr Clearing, Settlement and Central Depository Company MENA Middle East and North Africa MFA Mortgage Finance Authority MFIs Microfinance Institutions MIB Misr International Bank MIX Microfinance Information Exchange MTPL Mandatory Insurance NBFI Non-bank Financial institutions NBD National Bank for Development NBE National Bank of Egypt NGO Non-governmental organization NIB National Investment Bank NPL Non-performing loans NPS National Payments System NSGB National Societe Generale Bank OECD Organization for Economic Co-operation and Development OTC Over the counter PBDAC Principal Bank for Development and Agricultural Credit PML Primary mortgage lending PSB Postal Savings Bureau R&D Research and development RELC (Non-bank) real estate lending companies Repo Repurchase operations ROA Return on assets ROE Return on equity ROSC-AA Report on Observance of Standards and Codes Accounting and Auditing RTGS Real-time gross settlement SEDO Small Enterprise Development Organization SFD Social Fund for Development SIF Social Insurance Fund SME Small and Medium Enterprise SOE State-Owned Enterprises SRC Social Research Center SRO Self-regulatory organization TSX Toronto Stock Exchange US$ U.S. Dollars WBES World Business Environment Survey WFE World Federation of Exchanges Introduction ixContents This report was initiated at the request of the Egyptian Government to get a better understanding of why, as found by the Investment Climate Assessment, only 17.4 percent of Egyptian firms operate in the formal credit market. The report draws on surveys of firms, banks and households to determine why so few firms—and households—use formal financial markets for their investment and saving needs, and why banks and other financial institutions are reluctant to extend credit, even in conditions of high liquidity. The key findings are that: (i) significant public ownership of real and financial assets in Egypt has discouraged competition and the development of deep and well-regulated financial systems, including non-bank sources of financial services; (ii) a large fiscal deficit has encouraged financial institutions, particularly publicly owned ones, to invest predominantly in risk and tax free government securities; banks, and publicly owned ones in particular, have little incentive to lend to other than state-owned enterprises and large private firms; and (iii) smaller private and foreign banks are more active in expanding access to financial services by households and small and medium enterprises (SMEs) due to their capacity to better assess risk and capture opportunities. Improving access to financial services will require continuing the shift in the role of the government in the sector—away from asset ownership and towards creating an enabling environment for private (including foreign) financial service providers to innovate in providing services to firms and households. Here, as the report indicates, the government has a critical role to play in ensuring a stable macroeconomic environment, lower deficit and public borrowing, good supervisory oversight, and adequate institutional infrastructure. A number of the issues raised in this report are already being addressed by the government under the financial sector reform program initiated in November 2004. The objective of this report is help the government with the design of the second generation of financial reforms aimed at increasing the role of the private sector in financial services provision, particularly to SMEs and households, while strengthening risk management in financial institutions. Foreword Michael U. Klein Vice President and Chief Economist Financial & Private Sector Development International Finance Corporation The World Bank Group Zoubida Allaoua Sector Manager Finance and Private Sector Development Social and Economic Development Group Middle East and North Africa Region The World Bank Emmanuel Mbi Director Egypt, Yemen and Djibouti Country Department The World Bank [...]... President and CEO of Harvard Management Company; and Nasser Saidi, Director of Hawkamah Institute for Corporate Governance Comments and contributions from several World Bank colleagues on an earlier draft have also been provided by Noritaka Akamatsu, Roberto Rocha and Ahmed Galal The study also benefited from comments received from Gaiv Tata, S Ramachandran, and Omer Karasapan Valuable support was received... working papers, and no supervisory body to monitor auditors’ working practices of auditors and enforce disciplinary actions violators A company cannot appoint an audit firm, but rather appoints an individual partner of a firm; as a result audit firms cannot be held liable Various legal and institutional reforms undertaken so far to enhance accounting and auditing practices represent important interim arrangements... Insurance Holding Company; Osama Saleh, Chairman of Mortgage Finance Authority (MFA); Ashraf El Kadi, Deputy Chairman of MFA; and Ziad Bahaa El Din, Chairman of General Authority for Investment and Free Zones (GAFI); as well as Abdel Hamid Ibrahim, Senior Advisor; Mona Zobaa, Advisor; and Ahmed Rostom, Economist in the Ministry of Investment Strong support was provided all along for the missions and various... potential especially in terms of primary markets The corporate bond market is nascent and largely dominated by commercial banks, while access to international capital markets is limited to large enterprises and financial firms xxiv Executive Summary Insurance and Contractual Savings Egypt’s insurance and contractual savings sector is small compared to the size of its economy Institutional savings— life insurance... capital markets in Egypt remains below potential, especially in terms of primary markets Egyptian firms’ access to long-term capital has been hampered mainly by an inadequate legal framework, especially regarding new securities issuance; lack of active domestic financial investors; and a weak regulatory and supervisory framework While the secondary capital markets are active, new capital market issuance–both... Association; Institute of Banking and Finance; Misr Clearing, Settlement and Depository Company (MCSD); Egyptian Postal Authority; and Egyptian Society of Accountants and Auditors Feedback was also provided by the private-sector community in a roundtable organized by the American Chamber of Commerce in Egypt coordinated by Hisham Fahmy, Executive Director Partners who are actively involved in the financial... counterparts, including, Tarek Amer, Deputy Governor; Tarek Kandil, Sub-Governor; Lobna Hilal, Assistant Sub-Governor; Mona Bassiouni, Assistant Sub-Governor; and Gamal Nigm, Assistant Sub-Governor Valuable comments were received from Maged Shawki, Chairman of Cairo and Alexandria Stock Exchange (CASE); Hany Sarie El Din, Chairman of Capital Market Authority (CMA); Mahmoud Abdullah, Chairman of Egyptian Insurance... and to meet government borrowing requirements Investment in the real sector has been relatively insignificant The insurance sector suffers from a lack of investment skills, including lack of asset and liability management modeling capacity and limited ability to assess credit and market risks This is exacerbated by a legal and social environment that discourages risk taking and, in the state-owned insurers,... leasing is comparatively little used, and the annual volume of leases is quite small Financial leasing is comparatively little used in Egypt, and the annual volume of leases is quite small relative to other forms of financial intermediation and economic activity There is a small stock of outstanding leases, and the number of leasing contracts and leasing companies is modest Most leasing companies are... mechanisms and the regulatory framework for accounting and auditing The quality of financial reporting is another factor hampering access to finance xxx The modest quality of corporate financial reporting leads to increased risks to lenders and investors, and in turn higher costs of borrowers Moreover there are deficiencies in the accounting and auditing regulatory framework and its enforcement Executive Summary . Access to Finance and Economic Growth in Egypt Access to Finance and Economic Growth in Egypt Middle East and North African Region A Study Led By SAHAR. (DIFC) “ “ “ “ 41305 Introduction i Access to Finance and Economic Growth in Egypt Access to Finance and Economic Growth in Egyptii Introduction iii Access to Finance and Economic