Dubai: Egyptian banks’ net interest margins (NIMs) are likely to come under pressure in 2021-2022, according to rating agency Fitch Ratings. The degree of compression pressure is driven by the extent of potential interest rate cuts and changes in yields on government debt, as well as any shift in banks’ balance sheet structures. The sector average NIM was 4.1 per cent in 2020 and was resilient despite the Central Bank of Egypt (CBE) lowering interest rates by 400 kb to 8.75 per cent.
High-yield government debt
NIMs were backed by yields on 90-day treasury bills, which were held at about 13 percent high in 2020 to attract foreign portfolio investors after global volatility caused $ 17 billion in capital outflows in March-April 2020. “If the CBE were to reduce policy rates by 50 bp-150 bp and keep the returns on sovereign bonds, we would expect the sector average NIM to be resilient. This is because interest income is highly dependent on sovereign returns, which represent about 65 percent of the sector’s total interest income. Nevertheless, the impact will vary according to each bank’s asset pricing power, financing structure and the ability to downplay liabilities, ”said Zeinab Abdalla, director, financial institutions – banks. Conversely, if both interest rates and yields on sovereign bonds fall by 50bp-150bp, the pressure on NIMs will be greater. If revenue on treasury bills drops by up to 150 bp, Fitch expects NIM compression of up to 70 bp. Inflation-adjusted yields on Egyptian government debt are among the highest in emerging market economies. While there may be room for a reduction in yields if inflation remains stable in general, Fitch expects the CBE to strive to maintain positive real interest rates to maintain the inflow of the portfolio.
Exposure to government debt
Egyptian banks place their excess liquidity in sovereign securities, which represent about 40 percent of the sector’s assets, due to their high returns and the limited availability of good credit risk counterparties. “We expect high single-digit loan growth in 2021, backed by lower interest rates and various CBE measures to boost lending,” Abdalla said. Such measures include the CBE expanding its EGP100 billion, 5 per cent to 8 per cent subsidized lending program to more sectors, and asking banks to increase SME lending to 25 per cent of their loan portfolios (20% previously). We forecast low double-digit lending growth in 2022 as capital financing increases with the recovery in GDP growth (Fitch predicts 6% GDP growth in 2022, in line with pre-pandemic levels) and possibly higher inflows of foreign direct investment.
Shift in the balance sheet structure
The shift in banks’ balance sheets from government debt to higher loans could have consequences for NIMs. In a scenario where the share of sovereign bonds in total assets falls by 5 to 15 percentage points, and policy rates and returns remain the same, Fitch sees the sector NIM shrink to 90 bp. A shift in the balance sheet structures of banks combined with lower returns and policy rates (green line) would have a significantly greater impact, with NIM dropping to 170 bp. Fitch expects the liquidity distribution in treasury bills to remain high given the high liquidity of banks in local currency (the lending / deposit ratio in local currency was 45% at the end of 2020) and the capital benefit of the zero risk weight on government debt. Egyptian banks have higher profitability ratios than local counterparts, giving them more room to maintain adequate profitability margins and internal capital generation when interest rates are lowered. The sector average return on equity for Egypt was 23 percent in 2020 compared to 10 to 17 percent of GCC banks.