Issue No. 611
Economy
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November 2002 Issue No. 611 Economy |
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Banks battle with Basel
The new Basel agreement is scheduled to come into force within three years, but local and international experts say Egypt is far from ready to adopt it. Sherine Abdel-Razek investigates
On the face of it, the Basel Two accord is very much the same as its predecessor, 1998's Basel One. Both are international agreements aimed at regulating the global banking system. However, the new accord, to be implemented in 2006, focuses on risk management and demands higher capital requirements, a supervisory review process and market discipline.
The need for better risk management and the lack of market discipline in the Egyptian banking sector have made headlines in recent weeks. Indeed, the media has blamed banks for their failure to protect against the rising risk of loan defaults. According to Central Bank of Egypt (CBE) figures, the banking sector's non performing loan ratio reached 14 per cent.
Robert Monro-Davies, chairman of Fitch Ratings, recently attended the Risk Management and Global Finance Seminar, organised by the International Institute of Finance, and held in Cairo. He spoke to Al-Ahram Weekly about Egypt's credit culture and the difficulty it creates for the banking system.
"The smooth implementation of the Basel accord requires a sound credit culture. This is extremely basic, but in Egypt, as in other state-controlled systems, the credit culture is not very advanced. Different management disciplines are the reason. In a private sector bank, if you have a lot of bad loans you go broke, but with state-controlled banks you are usually bailed out," Monro-Davies explained.
He attributed the absence of a sound credit culture in Egypt to the influence of politics on the banking system's management. "Loan extension is a political decision", he pointed out.
Local bankers agree with this assessment of the banking sector. One leading Egyptian banker, speaking at a private workshop last week, said the reason for mounting loan problems was a directive issued by senior state officials which instructed bank managers to extend loans without exercising due diligence.
Such practices cannot survive the criteria established by Basel Two. Monro-Davies pointed out that credit provisions in Basel Two must be predicated upon sound data, disclosure, a well organised accounting system, and good risk assessment.
Aware of the shortcomings in the Egyptian banking sector's risk assessment measures, CBE Governor Mahmoud Abul-Oyoun identified the Basel Two "Know Your Customer" (KYC) criteria as one of the main challenges facing the banking sector. Abul-Oyoun said "KYC safeguards go beyond simple account opening and record-keeping, [the safeguards] require banks to formulate a customer acceptance policy and a tiered customer identification programme that incorporates extensive due diligence for high-risk account(s)."
However, in Basel Two, good customer risk assessment becomes a top priority after reducing risk in the banking operations themselves. The banking protection given by Basel Two is based on increasing the capital adequacy ratio. This means that the bank has adequate capital to cover different risks without jeopardising the interests of depositors and customers. The ratio should be increased from the current eight per cent to ten per cent. The Central Bank of Egypt has asked banks to meet the new requirements by the end of this year. Less than five banks have achieved this goal so far.
The CBE recently ruled out the possibility of mergers between banks as a way of increasing the capital adequacy ratio. But bankers fear it is unlikely that banks will be able to implement the necessary risk management systems or raise the required capital without mergers. Ahmed El- Bardai, chairman of Banque du Caire, one of Egypt's four state-owned banks, said that Egyptian banks will have to merge if they are to comply with Basel Two. El-Bardai argued that consolidation will have its own risks as fewer numbers and larger sizes of banks will make the regulator's job more difficult.
A closer look at the financial sector in Egypt reveals that it is under a lot of pressure. In July, Capital Intelligence, the international emerging markets rating agency, said that, following a period of rapid credit growth in the years preceding the economic slowdown, the banking sector is coming under pressure as non-performing loans continue to rise in the banking system.
A statement issued by the agency said that earning difficulties are being exacerbated by the need to create additional loan-default provisions, thus placing additional strains on bank profitability. It also pointed out that as bank foreign currency ratings are linked to a country's sovereign rating, all Egyptian banks are viewed negatively and their credit ratings are placed on review.
These problems hinder the sector's ability to comply with the requirements of Basel Two.
By agreeing to fulfil the capital adequacy requirement, Egyptian banks are selecting the lowest level of credit assessment stipulated by the Basel Two agreement.
Monro-Davies said that Egyptian banks will definitely choose a standardised approach which increases their capital base. The alternative approach, for levels two and three, would be to undergo a more thorough assessment of their risk profile.
"It [the standardised approach] is the simplest, but it needs capital to compensate for the increased detail in which risk is measured and to provide a cushion against risk profile," points out Monro- Davies.
Banks surviving the second and third levels of risk assessment will have lower risk ratings and will be more attractive investment opportunities.
Therefore, risk assessment will be the main scale of measurement for determining strengths and weaknesses of banks worldwide; a fact that raises the fears of local bankers.
"All banks will be judged by the same yardstick, but we don't live in a standard environment. This yardstick is designed for banks working in developed markets and different economic parameters," El-Bardai said.
"We risk falling behind global banks on the competitiveness scale. This will be mirrored by the increase in our cost of funding, be it from equity or debt, making it hard for us to reach a level playing field," he added.
Another looming repercussion of implementing Basel Two is the loss of much needed foreign investments in the banking sector. "Global banks might pull out of emerging markets with the introduction of the Basel Accord, as doing business in less developed countries will require more capital to cover the presumed higher risk. This might drive them out of the mainstream economy of emerging markets," El-Bardai said.
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