Moody’s: Egypt’s higher SME lending quota supports economy but endangers banks’ asset quality

The Central Bank of Egypt (CBE) instructed on January 11th Egyptian banks to raise their lending to small and midsize enterprises (SMEs) to 20 percent of their loan books over the next four years, up from 5 percent -10 percent currently, according to Moody’s Investors Services’ estimates. Along with other government-led growth-enhancing reforms, the CBE’s regulation will likely shore up the country’s fragile economic recovery, a credit positive for Egypt (B3 stable), Moody’s said in a Monday statement.

However, although the CBE has provided tools to partly mitigate the associated funding and credit risks, the rapid growth in SME loans necessary to reach the 20 percent target will likely weaken loan performance, a credit negative for Egyptian banks. SME lending will support job creation and help lower the country’s high unemployment, which was 12.8 percent as of September 2015. SMEs employing fewer than 10 workers compose 97 percent of Egypt’s businesses, according to state-run statistics body CAPMAS, and a World Bank Enterprise Survey showed that a lack of access to credit is one of Egyptian business leaders’ chief complaints.

The central bank measure will support the country’s economic recovery by reviving investment. Although real GDP growth rose to 4.5 percent in second-quarter 2015 from 2.6 percent in the first quarter, and growth for the fiscal year that ended June 2015 was 4.2 percent, second-quarter 2015 growth was primarily supported by a 15.7 percent fall in imports. Exports fell 4.1 percent in second-quarter 2015, while investment declined 3.0 percent (see exhibit), and we expect both to remain depressed. Meanwhile, the tourism sector is suffering from fresh security concerns.

In addition to the minimum lending requirements, the CBE has capped the interest rate that banks can charge for loans to certain SME categories at 5 percent. However, since the regulator will now allow banks to fund these loans out of their required liquidity reserves, which currently earn nothing, the profitability benefit will be higher for banks particularly once we include the fee income banks will earn from this business. As part of the initiative, the CBE introduced a nationwide definition for SMEs6 and will expand the training it offers to bank employees and individuals in order to raise financial literacy.