Thriving in a free market.

The Egyptian banking and financial sector is adapting with enthusiasm to the new era of open markets and competition. For an informed Egyptian assessment on progress and prospectss for financial liberalisation, The Middle East turned to Adel el Labban, general manager of the Commercial International Bank.

WHAT DO you think are the most important implications of new legislation augmenting the Central Bank's control over the financial sector, especially regarding provisions permitting the Central Bank to order liquidations and mergers?

The strengthening of the Central Bank's role is necessary in the current period of rapid and widespread economic changes because these will have a major impact on Egyptian banks. They are presently having to make the transition from the regulated banking environment which prevailed before January 1991 to a free and competitive market. The need for legislative action has been made apparent, for example, by the problems of BCC Misr [the Egyptian subsidiary of the collapsed BCCI] and the under-capitalisation of several Egyptian banks relativek to ratios set by the Bank for International Settlements (BIS).

Under the new banking law adopted by the People's Assembly in June, foreign currency branch banks are permitted to trade in local currency. Will this encourage competition or simply lead to overbanking?

Foreign banks are now required to incorporate as Egyptian shareholding companies with a minimum paid-in capital and will be subject to the same sets of regulations and controls imposed by the Central Bank on existing onshore banks. Given the present overbanking and fragmentation in the Egyptian banking sector, the addition of new banks will result in increased competition as they try to acquire a share of the market at the expense of existing institutions. But I hope that their appearance on the scene will accelerate the introduction on new capital markets, foreign exchange and electronic banking products.

The four major public sector banks have recently received major capital injections and are being steered towards meeting BIS criteria for doubtful loans. Is this a prelude to a gradual divestiture of state shareholdings in these banks?

To date the government's privatisation policy has not been applied to its holdings in the financial sector such as its stake in public sector banks and insurance companies. Given the existing and historical importance of the public sector banks, particularly the National Bank of Egypt and Banque Misr, partial privatisation could be feasible because of investor confidence. An alternative approach to privatisation might involve the sale of public sector bank holdings in Law 43 joints venture banks to private investors.

How has the downfall of BCCI affected confidence in the banking sector in Egypt and what hope is there of recouping some of the losses incurred at BCC Misr?

Rapid Central Bank intervention and the appointment of a new and experienced management team has minimised the impact of BCC Misr's collapse. Containing the BCC Misr debacle is a major achievement, especially in light of the damage caused by the earlier collapse of several Islamic financial houses. To date, depositors have received small cash repayments. The key determinant of revival will be BCC Misr's ability to obtain its pro rata share of the recovered portion of its deposits placed with the BCCI network.

How do you evaluate the success of the Treasury bill auction system in soaking up excess liquidity?

The Treasury market has been extremely successful since its inception in early 1991. It has grown both in size (up to E 7 bn [pounds]) and in maturity (extending from the original three-month issues to exclude six and 12-month instruments). The scope of participation has also grown as individuals now purchase a significant portion of the weekly issues.

The freeing of interest rates and the tight money policy adopted by the government have reportedly led to the repatriation of funds lodged abroad and increased savings in local as opposed to foreign currenciess. How do you assess the extent to the shift in these two areas?

The reverse arbitrage between the Egyptian pound and foreign currencies (primarily, the US dollars) has been very marked over the past year. A spread of 13-14% between Egyptian pound and US dollar deposit rates, coupled with an extended period of stability in the exchange rate, have led depositors to convert foreigh currency deposits into Egyptian pound deposits to benefit from the higher interest income. This represents a complete about-turn from the previous trend of converting Egyptian pound funds into foreign currency deposits to benefit from the devaluation in exchange rate.

In the absence of precise statistics, it is difficult to judge the impact of these factors on the repatriation of funds. A more stable exchange rate environment and a unified free exchange market with abundant foreign currency resources have undoubtedly eliminated a key obstacle to investment in Egypt and should encourage a greater inflow of funds from abroad..

Although the Egyptian pound was floated well ahead of schedule, it has remained remarkably stable. What effect will this have on Egypt's trading competitiveness?

The floating of the Egyptian pound was an indispensable element for economic reform geared towards establishing a competitive market-oriented economy. Exchange rate stability is a result of short-term supply and demand factors in the market. It will also have an impact over the short term on price competitiveness of our foreign trade. But this will effect only about half of our exports made up of non-oil related goods, since Egyptian crude is sold at prevailing [dollar-denominated] spot prices.

There are several other importantk influences on Egypt's export performance, such as weak global economic growth, quality inconsistency and the need to develop overseas marketing. All of these are more significant than the exchange rate level in fulfilling Egypt's export potential. But exchange rate considerations will always be felt particularly in the services sector, especially tourism where Egypt competes with other Mediterranean countries including Turkey, Cyprus, Tunisia and Morocco for the medium and low budget tourist market.

Finally, in what direction do you expect to see further steps towards banking and financial liberalisation taking over the next few years?

Egyptian banks have over a hundred years of operating experience and should play the leading role in implementing the economic reform programme. I think that market forces can be expected to drive banks in three general directions: a gradual merger and acquisition process to establish larger units with a more effective critical minimum size; progressive capital injections into the banking sector in general to meet BIS requirements and support future growth; and a more forceful presence in regional and international markets.

To help the banking sector realise its potential, I would recommend six key policy measures. First, the elimination of all remaining forms of control over determining banking fees and commissions. Second, provision of additional tax incentives for banks (and other companies) to increase capital, particularly if this can be done through a public share issue. Third, encouragement for the development of other financial services such as insurance and leasing. Fourth, setting up a clearing house interbank payments system (Chips) in Egypt. Fifth, extension of the Treasury bills market to longer maturities which will form the basis of a fixed rate issue market for Egyptian pound issues. And finally, the elimination of restrictions on foreignk exchange trading, to be followed at a later stage by removal of restraints on securities and commodities brokerage and trading transactions.