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The banking system in the Arab Republic of Egypt remains weak, reflecting its fragile financial profile – particularly for its public sector banks – and a challenging economic environment, Standard & Poor’s Ratings Services says in a report entitled Bank Industry Risk Analysis: Egypt.

“Weak industry fundamentals, combined with constraining business conditions and regional uncertainties will keep the banking system under pressure in the medium term,” says Standard & Poor’s credit analyst Anouar Hassoune, lead author of the report.

As a result, the banking system of Egypt (foreign currency, BB+/Stable/B; local currency, BBB-/Stable/A-3) is ill-equipped to weather unexpected shocks, despite an ambitious reform programme that the country is likely to implement gradually.

The system’s creditworthiness is supported by the strong retail-funding profile for state-owned banks and low cost of labour.

“If the economic environment deteriorates, Egyptian banks could find themselves with an unsustainable level of bad loans. We estimate that non-performing loans are close to 20-25% of total loans,” says Standard & Poor’s credit analyst Emmanuel Volland, co-author of the report.

Despite a recent pickup in economic growth and moves toward structural reform, overall risk factors for the banking system remain high. Meanwhile, competition is intensifying.

The four large public sector banks, which dominate the system, are underprovisioned. They face the challenge of improving their mediocre profitability, asset quality, and capitalisation.

“For these reasons, we believe the planned privatisation of state banks will most probably be painful and slow,” Hassoune says.

In the meantime, government ownership will continue to be a positive factor in the credit profile of these banks, as will the state’s efforts to upgrade managerial skills and tools – a positive step toward restructuring and subsequent privatisation.

The rest of the Egyptian banking system is likely to consolidate further, given that banks must adhere to minimum regulatory capital requirements of Egyptian pound 500mn (US$86.3mn) by June 30, 2005, under the Banking Law of 2003.

“In contrast to public sector banks, the risk profile at top-tier private banks is satisfactory,” Volland says.

Limited by their reach, private banks are mostly involved in corporate banking, trade finance, and retail-banking services for urban middle and upper-income individuals. Their competitive position is based on a wider product range, more efficient IT systems, and modern management tools, in part imported from foreign shareholders.