GOE MAKES SIGNIFICANT PROGRESS ON FINANCIAL SECTOR

UNCLAS SECTION 01 OF 05 CAIRO 001838 SIPDIS SENSITIVE STATE FOR NEA/ELA, NEA/RA, EB/IDF AND EB/OMA USAID FOR ANE/MEA MCCLOUD USTR FOR SAUMS TREASURY FOR NUGENT/ADKINS COMMERCE FOR 4520/ITA/ANESA/TALAAT E.O. 12958: N/A TAGS: ECON EFIN ETRD EINV EG SUBJECT: GOE MAKES SIGNIFICANT PROGRESS ON FINANCIAL SECTOR REFORM -------------- Summary and Introduction -------------- ¶1. (SBU) The GOE made substantial progress in financial sector reform in 2005 and is nearing completion of many of the benchmarks in the DSP-II Financial Sector MOU, signed in March 2005. Post and the USAID Mission estimate the GOE will have met all of the benchmarks for the first three policy items in the MOU by September 2006. Though the targets for meeting these benchmarks, as set out in the MOU, have all passed, post and USAID agree that the targets were not realistic at the time the MOU was signed. The dates were set when negotiation on the MOU began in 2002 and were not adjusted when negotiations finally concluded in December ¶2004. ¶2. (SBU) Following is an assessment of GOE progress on benchmarks in the MOU. As noted above, the GOE is likely to meet the benchmarks for the first three policy items by September 2006, but will need more time to complete the benchmarks for policy items 4 and 6. Policy item 5 has been completed, but disbursement of DSP funds tied to policy item 5 is contingent on completion of the benchmarks for policy item 4 as well. The informal assessment below is based on information gathered from GOE and private sector contacts, official GOE statements and websites and independent media reports. The USAID Mission and GOE are close to finalizing the specific documentation that will be needed to certify that benchmarks have been met. USAID will maintain this documentation at post and will seek Washington approval of disbursement of DSP funds as the benchmarks are met. End summary and introduction. -------------- Policy Item 1 - Central Bank Management -------------- ¶3. (U) $25 million in DSP funds are tied to completion of the following three benchmarks for Policy Item 1: ¶A. The Central Bank of Egypt (CBE) will establish and appropriately staff units for: - Monetary Policy Status: CBE established a Monetary Policy Committee (MPC) composed of members from various GOE ministries and CBE in June 2005. The MPC has held regular monthly meetings since its establishment, setting the goals or Egypt's monetary policy and administering changes to interest rates accordingly. - Foreign Exchange Management and a Foreign Exchange Dealers System Status: An interbank market for foreign exchange was set up in September 2004 and the convention governing interbank foreign exchange trading was formally adopted in December ¶2004. A Foreign Exchange Unit was also established. - NPL Management Unit responsible for setting a national policy of dealing with NPLs, setting up and NPL data base, monitoring recovery efforts and introducing an arbitration/conciliation mechanism for NPLs Status: CBE set up as monitoring unit to develop a long- term solution to the NPL problem. In September 2004 it also established an Arbitration Committee to help resolve private sector NPL problems and other disputes between banks and borrowers. ¶B. CBE will hire the required competent advisors. Status: CBE has hired numerous private sector bankers to work in the new units established at CBE. USAID has funded the hiring of some of these advisors. ¶C. CBE will introduce an optional early retirement policy and compensation scheme for the CBE. Status: CBE is still drafting an optional early retirement policy and compensation scheme, but anticipates introducing the policy by September 2006. -------------- Policy Item 2 - Government Securities Market -------------- ¶4. (U) The U.S will disburse $25 million in DSP funds upon completion of the following three benchmarks for Policy Item 2: ¶A. Implement a Primary Dealers System with dealers underwriting new government debt issuance through auctions and trading of government securities on the open market. Status: The Primary Dealers System was launched on July 4, ¶2004. It allows 13 financial institutions registered with the Ministry of Finance, including banks and bond dealers, to underwrite primary issues of government securities and activate trading in the secondary market through sale, purchase and repurchase agreements of government securities. The system is expected to establish a proper yield curve reflecting actual supply and demand for government debt and encourage a more efficient bond market. Further information on the Decree and Executive Regulations organizing the Primary Dealers System can be found at: www.mof.gov.eg/debt ¶B. Initiate trading of government bonds off the stock exchange in an open market where buyers and sellers may directly trade. Status: The Primary Dealers System was restricted, in the first quarter of fiscal year 2004/2005 (July - September 2004),to Treasury Bills in order to ensure efficient functioning of the system. In October 2004 it was extended to bonds. A secondary market for government securities, working through the Primary Dealers System, has developed, but trading is still taking place on the stock exchange. ¶C. Establish the legal status of and launch operation of Repurchase Agreements for government securities consistent with international best practices. Status: The legal status of Repurchase Agreements for government securities has been drafted, but has not yet been issued. However, CBE is applying various open market tools to affect short-term interest rates and liquidity, including outright sales, repurchase and reverse repurchase auctions for Treasury bills and deposits. -------------- -------------- Policy Item 3: Financial Sector Reform/Privatization -------------- -------------- ¶5. (U) The U.S. will disburse $100 million in DSP funds for completion of the following two benchmarks for Policy Item 3: ¶A. Auditing of the four largest state-owned banks by an internationally recognized impartial institution in accordance with standards set by the International Accounting Standards Board (this audit will serve as the baseline measurement for completion of several other benchmarks in under this policy item). Status: The audit of the Bank of Alexandria has been completed. Auditing of the other three state-owned banks will be completed in the next two months and will form the basis for calculation of other benchmarks under this policy item. ¶B. Divestment of GOE shares in the four largest joint venture banks. Status: The GOE has divested all of its shares in the four largest JV banks, i.e., Misr-International Bank; Egyptian- American Bank; National Societe Generale Bank and Commercial International Bank. ¶6. (U) The U.S. will disburse $150 million in DSP funds upon completion of the following benchmark for Policy Item 3: ¶A. Privatization of the candidate bank (Bank of Alexandria). Status: The audit and due diligence on the Bank of Alexandria have been completed and sale of GOE shares, to an anchor investor and through an IPO, have been announced, as have the terms of the sale. CBE believes the sale will be completed by September 2006. Citibank is acting as advisor for the sales strategy. ¶7. (U) The U.S. will disburse $200 million in DSP funds, on an annual pro rata basis, upon completion of the following benchmark for Policy Item 3: ¶A. The private sector banks' share of new loans made in the banking system during the previous calendar year will be equal to at least 62.5%. Status: Progress on this benchmark can only be made upon completion of the audits of the four largest state-owned banks. ¶8. (U) The U.S. will disburse $250 million in DSP funds, on an annual pro rata basis, upon completion of the following benchmarks for Policy Item 3: ¶A. The share of NPLs as a proportion of all loans in the banking system will be reduced by 50% from the baseline determined by the audit of the four largest state-owned banks and the annual audit of private sector banks. Status: According to the IMF, NPLs rose to over 25% of total loans in September 2004, compared to 20% in June 2003, and provisioning continued to fall. Given the dearth of new credit, the recent behavior of these indicators mostly reflects improved classification of old loans and stricter enforcement of prudential regulations. In early January 2006, the government announced a new scheme for the repayment of public enterprise loans to banks, on the order of LE 32 billion, including LE 25 billion in irregular loans. As a first step in the new plan, a cash settlement has been concluded for public sector debts of LE 6.9 billion to the Bank of Alexandria. ¶B. The cash recovery on NPLs will equal at least 20% of the book value of NPLs to be disposed of under the previous benchmark. Status: Progress on this benchmark cannot be made until progress is made on the previous benchmark. -------------- -------------- Policy Item 4: Strengthening the Financial Sector and Policy Item 5: Corporate Governance -------------- -------------- ¶9. (U) The U.S. will disburse $50 million upon completion of the following 6 benchmarks for Policy Items 4&5: ¶A. Issuance of regulations that would: - Establish standards for real estate appraisal; Status: The standards and the system for conducting the real estate appraisals are currently being prepared in cooperation with the Mortgage Finance Authority and the MOI through the national project for urban real estate registration being implemented by the Ministry of State Administration Development (MSAD). - Establish a real estate appraisal and certification program; Status: Appraisers are currently required to sit for a course with the Mortgage Finance Authority in order to be certified. - Establish a national land title registration system, including procedures and appropriate information systems; Status: The national land title registration system is still being developed and there are nine pilot projects ongoing in three governorates (three in Cairo, three in Giza and three in Qalyubeya). The GOE is currently working on a deed (personal) registration system. - Reduce property transfer and/or registration fees to less than 1% of the transaction price; Status: Registration fees have been reduced from 6% to 3% of the property amount. The Ministry of Justice (MOJ) and MSAD are preparing a draft law to amend the current law, which would fulfill the benchmark. The draft law is to be submitted to Parliament in March 2006. ¶B. Pass legislation to: - Define rules for joint property ownership; Status: A draft regulation was submitted to MOJ in February 2006 on divided co-ownership of moveable property. - Establish land ownership (title) certification for the purpose of securing land holding for residential or commercial property; Status: The draft law being prepared by the MOJ and MSAD, should, according to MSAD, establish land ownership (title) certification. Land ownership certification is still problematic. In Egypt, even if land is initially registered, ownership transfer is not registered. This is mainly due to cumbersome registration procedures and lack of awareness by the public. ¶C. Pass legislation and issue implementing regulations to enact modern bankruptcy procedures, including foreclosure and eviction and procedures that would facilitate joint lender/debtor resolution of outstanding debts. Status: Regulation on bankruptcy procedures exists in the mortgage law. Agents entitled to certify foreclosure, eviction, and other procedures are receiving preparation at the Mortgage Finance Authority, although foreclosure and evictions procedures remain extremely difficult to enforce. ¶D. Pass legislation, if required, and implementing regulations that would permit establishment of private credit bureaus. Status: On August 30, 2005 CBE issued rules and procedures for the licensing of credit bureaus, and also issued approval to establish the first private credit bureau, the Egyptian Credit Bureau (ESTAILAM). ESTAILAM will have responsibility for credit investigations and credibility ratings for bank loans, real estate transactions, financial leasing and commodity procurement. The minimum required capital for credit bureaus is LE 5 million. On January 16, 2006, the CBE Board of Directors approved implementing regulations for the operation of credit bureaus; rules governing the exchange of data and information and the system CBE will employ to monitor credit bureaus. ¶E. Facilitate securitization through completion of legislative changes. Status: Securitization regulations were introduced into the Capital Market Law in June 2004. However, to date no securitization has been carried out. According to industry sources, there are no strong financial notes meriting securitization. ¶F. Publish a corporate governance best practice code to generate awareness and encourage companies to comply with the code. Status: Guidelines for private sector corporate governance have been issued by the Ministry of Investment, in the form of a Ministerial Decree No. 332/2005 in October 2005. The guidelines were prepared in accordance with OECD corporate governance principles, and are not binding. The guidelines apply primarily to share-holding and limited-liability companies, established under Law 159 for 1981 (the Companies Law) and Law 95 for 1992 (the Capital Market Law),in addition to brokerages. Guidelines for public enterprise sector are under preparation and will be legally binding when issued. The Ministry of Investment anticipates issuing these guidelines in April 2006. -------------- Policy Item 6: Insurance Sector -------------- ¶10. (U) The U.S. will disburse $25 million in DSP funds upon completion of the following benchmark of Policy Item 6: Privatization of the candidate public insurance company. Status: Ministry of Investment announced in mid-September, that Egypt has commissioned an international consortium to restructure its major state-owned insurance companies, opening the way for their privatization. The ministry selected BNP-Paribas, Egypt's Commercial International Bank, and the New York-based insurance consultancy firm Milliman to do the job and signed a contract in February 2006.