Will Egypt’s Dream Of Microfinance Being The Gateway For Financial Conclusion Turn Into A Nightmare.
The new administration in Egypt strongly believes in the importance of micro, small and medium enterprises (“MSMEs”) to the Egyptian economy. Since President Sisi assumed office in July 2014, his key goal has been reviving the economy via all possible means. He is doing everything to support strategic sectors that will help Egypt achieve high real GDP growth rates that must be at least double the population growth rates; otherwise, social unrest cannot be avoided.
It is no surprise then that one of the key priorities of the Sisi Government was facilitating access of finance to MSMEs given the fact that the parallel or the so-called underground economy constitute an estimated range of 30% to 50% of the Egyptian economy.
Moreover, the only way to bring those informal businesses into the system and have them pay taxes is to make it easier for them to borrow from the financial sector. Accordingly, it was not long enough until the new microfinance law issued in November 2014, i.e., just a few months after the election of President Sisi. Moreover, the Central Bank of Egypt (“CBE”) also issued a circular mandating all banks operating in the country to have a minimum of 20% of their loan books to MSMEs by the end of 2019.
That new circular and the new microfinance law have changed the scene entirely in the Egyptian financial sector. Banks who were mainly not doing much but investing in sovereign paper and lending to the blue chips (40 to 50 large corporates that almost all banks were chasing) all of a sudden found themselves requested for once to do real banking – lending to MSMEs that hire 90% of the Egyptian labour force.
At the time, most banks (especially privately-held ones) operating in the country did not have an infrastructure to lend to MSMEs, whether in terms of branches, policies, knowledge or staffing. Also, despite that many of those banks now have 10 to 20% of their loan portfolios in MSMEs still they lack the adequate infrastructure for lending to this sector. Some of those banks have also found it easier to just extend quite generous credit lines to microfinance institutions (“MFIs”), whether NGOs or for-profit companies, as they are seen by banks as better equipped to do this kind of lending but also a faster (and less costly) way to grow in this segment.
Likewise, the long-awaited microfinance law finally allowed for-profit companies to provide on-balance sheet lending as well as NGOs to be shareholders in microfinance companies. According to the law, microloans are exempted from all types of taxes, including fees and stamp duty. The Law still does not allow microfinance institutions (whether NGOs or companies) to take deposits and the maximum loan amount to any single borrower from one institution shall not exceed. That amount can, however, be increased 5% per year according to a decree issued by the Prime Minister dependent on the economic conditions.
Consequent to the above, the Egyptian microfinance sector has been growing at very high rates since 2015. For instance just in the 12 months ending Q3 2018, the Egyptian microfinance sector increased to EGP 10.6bn (equivalent to USD 0.6bn) up strongly by circa 73% y-o-y (Q3 2017: EGP 6.12bn equivalent to USD 0.34bn), with no of borrowers growing at a much lesser pace of 27% y-o-y reaching 2.68mn as of Q3 2018 (Q3 3017: 2.11mn). This points to a high probability of cross-lending, i.e., lending to the same borrowers, especially given the absence of debt burden threshold set by the regulator – Egyptian Financial Regulatory Authority (“EFRA”).
Many Egyptian microfinance professionals have expressed their concerns about the potentially high level of cross-lending in the sector, especially in some geographical regions in Greater Cairo and upper Egypt. Those professionals talk about hundreds of thousands of microfinance borrowers receiving top-up loans from their existing lenders and new loans from other microfinance institutions especially the new for-profit entrants. In other words, many people whose income has not increased much (or real income eroded because of the persistently high inflation over the last few years) have been taking loans from multiple MFIs.
Worryingly enough, there is no restriction or monitoring by the non-bank financial sector regulator, the Egyptian Financial Regulatory Authority (“EFRA”), on the number of MFIs that can give simultaneous loans to the same borrower, let alone the fact that those borrowers can also borrow from other non-MFI lenders, e.g., loan sharks, group borrowing (Gamaya in Arabic).
Indeed, there is a credit bureau (i-Score) where the credit history of those borrowers is available to lenders, but several MF professionals have confirmed that the MFIs, especially the new entrants, largely disregard the borrower’s existing loans from their credit analysis. As per those professionals, this phenomenon is becoming increasingly common especially with the entrance of several new players that want to grow fast to reach break-even. There are reports that many of those micro-borrowers are using one loan to repay part of the others, leading to increasing over-indebtedness in some geographical regions especially those where MFIs are abundantly present.
The impact of the potential default of one or more MFIs cannot be underestimated given the primary source of funding for the microfinance lenders is the Egyptian banking sector. The accelerated growth of the Egyptian microfinance sector over the last few years might result in many banks losing their monies even though credit lines to MFIs constitute a small fraction of the banks’ portfolios. Nonetheless, the collapse of one or more MFIs will indeed destabilize the whole Egyptian financial sector particularly given the increasing focus on MSME lending.
So what shall Egypt do?
Similar to the CBE, The EFRA must enforce regulations on aggregate lending from MFIs to a single borrower, ideally a max debt burden ratio of 35% (calculated as total borrowings from all lenders, whether banks or MFIs, divided by total disposable income). Besides, the EFRA shall request MFIs to have an independent risk management function, provide monthly portfolio and asset quality data, refuse to grant approvals on MFI branches in full areas, and impose punitive actions on non-compliant MFIs. There must be better coordination between the CBE and the EFRA to ensure healthy and sustainable growth of the microfinance sector.
Mohamed E. Morsy currently oversees the investment activities of Finance in Motion (FiM) in Egypt, Iraq, and Yemen. FiM is a German asset management firm, based in Frankfurt, with 15 offices around Europe and the MENA region. FiM is the fund advisor for EFSE, the largest fund for MSMEs (micro, small and medium enterprises) in the world, with assets under management exceeding euro 1.3bn. Mohamed is mainly responsible for the operations of the SANAD fund for MSMEs as well as the Green for Growth Fund in those three countries. He is also heading FiM’s Egypt office.
Mr. Morsy has extensive experience in the areas of investment banking, credit risk management, and corporate lending, both locally and regionally. Before joining FiM in 2012, Mohamed was an investment banking manager at Prime Capital (2011-2012) and a corporate lending manager at Egypt’s second largest private bank – Arab African International Bank (2005-2010).
Mohamed holds a Masters in Investment Banking and Islamic finance from Henley Business School (UK) and an MBA from the University of New Brunswick (Canada). M. Morsy is also a Chartered Islamic Finance professional and is currently working towards his Chartered Financial Analyst (“CFA”) Designation. Mohamed has received extensive training in the area of corporate credit, intensive bank analysis, leasing, corporate valuation and restructuring from AAIB, Fitch Ratings, ABN Amro, Arab Academy, and the University of New Brunswick.
Mohamed is a visiting fellow in the MBA program at the Maastricht school of business (Cairo Campus) and has delivered numerous academic and executive courses in credit risk management, bank management, corporate finance, Islamic finance, financial planning, business administration, human resources, and economics, both inside and outside Egypt.