Basel II Strategy June 2009

Banking Sector an​d Supervisory Framework in Egypt – Reform and Present Situation.

Central Bank of Egypt is responsible for different roles that contribute directly to the enhancement of the Egyptian economy, mainly; insuring a strong, safe and sound Banking System through its regulatory and supervisory role, managing the monetary policy of the Egyptian economic system, the country foreign exchange reserves, and the issuance of banknote.

Central Bank of Egypt completed a time lined Banking Reform Program that started in 2004 and ended in December 2008. Its purpose was strengthening the banking sector and increasing its robustness to face global and regional competition effectively and help achieve economic growth. The Plan entailed four main pillars: privatization and consolidation of the banking sector, addressing the issue of non performing loans (NPLs), financial and managerial restructuring of State Owned Banks, and upgrading Central Bank of Egypt Banking Supervision.

Banking supervision has shifted from a compliance based to a risk focused approach. It has also improved its MIS system to insure the quality and timeliness of required data. The banking sector privatization program was successfully fulfilled by selling 80% of Bank of Alexandria to the Italian Banking Group Intesa Sanpaolo in 2006, after undergoing a restructuring plan.

In line, the number of banks in Egypt has decreased from 57 banks in 2004 to 39 well capitalized banks in 2008. Central Bank of Egypt also created a specialized unit to set a national policy for dealing with NPLs through various innovative initiatives, which lead to a substantial reduction in their outstandings.

A detailed restructuring plan for state owned banks was finalized creating strong and efficient entities that are able to sustain future domestic growth.

The reform program was the cornerstone to minimize the impact of the present international financial crisis on the Egyptian banking sector as Central Bank of Egypt did not have to inject any additional liquidity. Other pillars of the reform program included the finalized payment system programme (RTGS) and ongoing reforms of monetary policy, foreign exchange and reserve management. The program set the tone for the new wave of reform.

In January 2009 Central Bank of Egypt initiated the second wave of its reform programme scheduled to end by 2011. It will continue the restructuring phases of the remaining specialized public sector banks, facilitate SME development, continue upgrading banking supervision technical abilities and apply Basel II in the Egyptian banking sector.

The Egyptian Banking sector is currently composed of 39 banks that are categorized by Central Bank of Egypt into four peer groups according to their shareholding and activities. Public sector commercial banks (three banks) represent 38.2% of total loans as of 30/6/2009. Specialized banks (five banks)2 represent 11% of total loans. The third group is composed of 24 private sector banks with 45.6% of total loans. Finally, seven foreign branches have loans market share of 5.2%.

The existing supervisory framework consists of a capital adequacy ratio as well as other fundamental prudential regulations. These regulations address essential relevant areas of risks such as credit and liquidity risks.

Basel II Supervisory Framework

Basel II is the agreement signed by an international group of bank supervisors in June 2004, on convergence of capital measurement and capital standards. It has since been regularly revised and constitutes a target for most of the bank supervisors all around the world. Its main purpose is to ensure the convergence of supervisory actions on similar standards, avoiding regulatory arbitrage. The overall target of Basel II is a better management of risks inside banks.

Basel II is based on three pillars, namely, regulatory minimum capital requirements (pillar I), supervisory review process (pillar II) and, lastly, market discipline (pillar III).

The minimum capital requirements are focused on apprehending credit, market and operational risks embedded in the activities of banks and defining a subsequent minimum level of coverage by capital. The first pillar sets different approaches to measurement of capital requirements related to the sophistication of a bank’s activities. In pillar II, supervisors are also required to review the individual situation of each bank, taking intoconsideration risks that are not assessed by the minimum capital requirements, for example liquidity risk.

Pillar III sets guidelines for enhancing the market discipline that applies to banks, for instance setting principles about the disclosure of information by banking institutions.

The implementation of Basel II is the logical continuation to the reform of the banking system that Central Bank of Egypt has undertaken since 2004. It has been chosen to be part of the Egyptian regulatory framework for three main reasons: Basel II aims at enhancing the management of all kinds of risk, therefore strengthening financial stability; it leads to a more efficient management of capital, ensuring that capital will be mobilized where real risks are located; eventually, Basel II in line with best international practices, will help upgrade the competitiveness of the Eg yptian Banking system.

Central Bank of Egypt Basel II Methodology and Approach

Central Bank of Egypt will follow two core principles for the implementation of Basel II: Simplicity and Communication. Simplicity is required to remain consistent with varied levels of sophistication in banks’ information and control systems and to ensure smooth transition with existing regulations; standardized approaches are the logical consequence of this. Communication is a core factor of success for a new regulatory framewo rk; the scope of Basel II is very comprehensive, it has to be understood by all stakeholders.

Specific structures shall be set up to open dialogue with the banks. Working Groups will be comprised of a significant sample of Egyptian banks and other stakeholders. This structure will ensure a mutual understanding on the contents of the Basel II framework, as well as closely monitoring its impact on the banking system. The Working Groups will have a broad mandate to examine and advise on all implementation issues.

Basel II stems from a common intention to harmonize supervision standards; therefore, international cooperation has been sought in this field. The European Central Bank, together with seven other National Central Banks will assist Central Bank of Egypt on a three year implementation program. For that purpose, a contract has been signed with the European Union in December 2008. When needed, the help of other foreign institutions might also be utilized. On bilateral basis, dialogue will be opened with foreign supervisory authorities in order to foster future cooperation such as home host relations.

Implementation

A dedicated task force has been set up inside Central Bank of Egypt to manage all aspects leading to the implementation of the coming regulatoryframework.The full time dedicated team consists of a mix of different skills and experiences to increase its ability to address all issues. A project Committee regularly meets to supervise the progress. The Board of Central Bank of Egypt has been made aware of this organization.

A strong dedication from the Working Groups is expected all along this period,in order to ensure the best level of quality to this important reform implemented in a relatively tight schedule

Central Bank of Egypt’s implementation strategy will focus on standardized approach and its related issues for credit and market risks and basicindicators for operational risk.

 

 

Identified Issues

The Basel II agreement leaves place for “national discretions”, i.e. options in the assessment of capital adequacy that are left to the decisionof national supervisors. Central Bank of Egypt will take stock of other countries’ experience in this field, and consider the particular situation of the Egyptian economic system to make these discretionary choices consistent with national priorities.

Diversity of Banking System

Egyptian banks are not homogeneous as concerns their activities and size.Some of them are focused on retail operations, while others limit their development to corporate banking. Their geographical and business coverage,consistent with their own strategy,is consequently very diverse.Acknowledging advanced risk management frameworks in regulations supports a better management of risks; however, it may jeopardize the level playing field.

The Central Bank of Egypt will ensure there is no undue competitive advantage. Hence standardized approaches will be the first step, but the regulations will also pave the way for the development of more sophisticated methods in the future. The banks’ management information systems are also widely positioned. The human resources they can benefit from is far from equal in terms of qualification and experience. Hence one of the issues facing Basel II Working Groups will be to open equal opportunities to all banking institutions, whatever their strategy or their structure.

Avoiding Pro Cyclicality

Financial stability requires that prudential rules do not reinforce adverse effect on credit caused by economic downturns. Any economic crisis is made deeper by the credit crunch that inadequate prudential regulations might trigger. Works recently performed either in Basel or in other supervisors’ international congregations in light of the current economic and financial crisis shall be taken into account to enhance the accuracy of Egypt’s own implementation of the Basel II framework. Hence, Basel II new regulations will have to address this necessity. It should be noted that a ssessment of credit rating is to be done through the business cycle and not in a singular point in time.

Regular Assessments

Post Basel II implementation, banks shall be asked to perform a regular assessment of their capital adequacy, following a comprehensive review of risks. Frequency of these reviews shall be a matter of discussion inside the Working Groups, bearing in mind that this process is a permanent feature of the Basel II framework. Central Bank of Egypt in its capacity as the banking supervisor regularly assesses the capital need of each bank, following a defined methodology. This supervisory review process shall not only take into consideration well identified credit, market and operational risks, but all other risks that could entail negative impact on the financial soundness of the considered banking institution.

Basel II opens a valuable opportunity for banks to more efficiently manage their capital. For the economy as a whole,it contributes to lowering the risks of banks’ failures thanks to a better apprehension of risks. The Central Bank of Egypt will take advantage of the existing unprecedente d level of international reflections to apply a regulatory and supervisory framework fitting to the present Egyptian context.