Egypt held its third Financial Sector Reform and Challenges Conference last week, exposing industry figures to new ideas about banking
The road not taken
Other countries' experiences suggest different solutions to the problem of non-performing loans in Egypt, Wael Gamal writes
Asset quality deterioration has been a major weakness of the Egyptian banking sector at large in recent years. Despite poor disclosure and less conservative recognition criteria make it difficult to gauge the full extent of the problem; it is thought that non-performing loans are as high as 30 per cent of total loans in the system, according to independent estimations while government numbers are no more than 15 per cent. Officials have argued that the sluggish loan growth rate is one of the primary factors hampering economic performance.
Due to interest in solving this problem, the session on non-performing loans on the first day of the conference was jam-packed. Experts from Pakistan and Japan presented their countries' experiences in dealing with non-performing loans, surprising the audience by how they endorsed policies very much different than the Egyptian approach.
The new government of Ahmed Nazif has moved ahead with stalled plans announcing a banking reform plan in September 2004 to overhaul the banking sector, which had been suffering from the economic slowdown since 2000 following the rapid and often reckless credit extension of the late 1990s. Taking into consideration the fact that state-owned banks, which dominate the sector, account for about 70 per cent of outstanding NPLs, the authorities suggest also that proceeds from bank privatisations and the issuance of new treasury bills will be used to repay outstanding exposures from NPLs.
In late December the People's Assembly passed a number of amendments to existing legislation allowing for all charges and existing sentences against debt-defaulting businessmen to be dropped if they agree to a programme of debt rescheduling -- including write-offs -- that is acceptable to their creditors. The measure applies only to businessmen currently in prison and to debt defaulters who have fled the country. A joint committee has been formed by the Central Bank of Egypt and the Federation of Egyptian Industries to arbitrate between businesses and creditors.
The committee was reported in late January to already have 5,000 default cases on its books, 250 of which involve sums of more than LE50 million ($8.6 million).
Indeed, a number of high-profile businessmen have successfully negotiated debt reschedulings in recent months. Ahmed Bahgat, whose huge Bahgat Group is a major producer of electronic equipment and dominates the television market and whose interests also include telecoms, real estate, leisure and construction, rescheduled LE2.4 billion of debts in November. Creditors agreed to take equity in Bahgat Group and invest sufficient funds to revive its fortunes. The agreement envisages Bahgat repaying his debts within seven years, and in return a court case against him was dropped.
The successful experience of Pakistan did exactly the opposite through a strict legal approach. The country, which had more than $10 billion of NPLs in the 1990s and a NPLs to loan ratio of 25.9 per cent in 1999, managed to reduce this burden to $3.3 billion and 11.6 per cent in 2005, while overall loans jumped from $12.9 billion to 26.1 for the same period. The secret to Islamabad's success was reforming the legal system. Naemeddin Khan, a member of the Corporate and Industrial Restructuring Corporation in the Pakistani Ministry of Finance pointed out that the roots of the problem in his country were very similar to those in Egypt. Added to lethargic court procedures, there was also "inadequate project vetting, defective documentation, weak security and political pressure", he said.
The committee on which Khan serves played the central role in Pakistan's reversal of fortune by making for fast settlements. "In 90 days' time the case is closed. Either it is settled or transferred to court. The legal system does the dirty job for us," Khan said. When asked if the committee can be a fair judge, he replied by saying that the committee is more powerful than the central bank and immune to political pressure, even from the president, and is formed of ex-bankers. "When a business goes down you can always know what happened. We check every account and in 90 days' time we reach a judgement," he said.
The Japanese experience raises different questions, as its economic size and integration into the international economy are incomparable to that of the Egyptian economy. The NPLs were a symptom of a radically different cause, namely the bursting of the bubble economy. The Japanese also succeeded in decreasing the NPLs ratio from 8.4 per cent in 2002 to less than 4.7 per cent in March 2005. Tadashi Iwashita, CFO and senior executive director of international cooperation for Japan Bank says that it was a painful process. "It meant the disposal of nearly $400 billion. We did not recognise how serious it was till 1998 when major failures led to a different attitude. We had to inject $600 billion into the system."
Iwashita's conclusions were also very different from the main lines of the banking reform programme. To deal with the globalisation inevitably present in the financial sector, "you need to have a solid safety net to guarantee that the banking system will not fail. Solid protection of deposits is no contradiction to the market system." He continued to say that the state must play a role in ensuring that competent leadership is in place. "Sometimes we needed to nationalise banks to protect it. We also have severe restrictions for venture capital." The Egyptian economy, being smaller and more vulnerable, could require even tighter restrictions on venture capital than in Japan.