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|b The current paper aimed to analyse the performance of the Egyptian banking sector over the period 1991-2014, using financial soundness indicators which include capital adequacy. asset quality, profitability and liquidity. In early 1990s. Egypt adopted the Economic Reform and Structural Adjustment Programme. The reform of the financial system during 1990s included the liberalization of the financial variables, improving the regulatory framework, and the inclusion of the banking sector in the privatization programme. Moreover, a comprehensive reforin plan. meluding two phases. was introduced in 2004. It meluded consolidating the banking system and increasing private participation within banking assets, restructuring of public banks, and enhancing the competitiveness and efficiency of the Egyptian banking sector. The efficiency of the banking system is influenced by the institutional environment including. inter alia. information infrastructure (i.e. credit information) and financial infrastructure (e.g. payment system). Starting from 2008, substantial global and country-specific shocks has adversely affected the Egyptian economy. Following the political turmoil in early 2011 Egyptian sovereign ratings and banks' ratings have been reduced by three rating agencies (i.e. Moody's, Fitch, and Standard and Poor's). In early 1990s. public banks were undercapitalized Whereas private banks were initially better capitalized. The equity-to-asset ratio of private banks had an upward trend in the 1990s, but it declined for both public and private banks during the first half of 2000s. However, banking system capital adequacy ratio improved during the period 2007-2014, implying that Egypt's banks are well capitalized, even after country-specific shocks emerged in 2011. Proxies for asset quality of the banking system include credit allocation, foreign currency-denominated lending, and non-performing loans (NPLS). There was a sizable shift in banking towards private-sector lending since 1994. However, almost all banks shift their interest to the retail business services in recent years because they are associated with lower risk lending compared to corporate lending. The distribution of loans by economic activity showed that the manufacturing sector was a major recipient of loans whereas the agriculture sector received the smallest proportion of total loans. The private-business credit as a share of GDP has been declining since 2002 due to excessive public borrowing to finance the budget deficit crowded out the private sector in the credit market. Moreover, banks shifted their portfolio away from risky private loans and opted for lazy behavior characterized by a contractionary credit tilted more and more toward government debt-instruments. The distribution of bank financing is uneven since large proportions of loans were directed to large, politically- connected and well-established enterprises. Banks do not prefer costly lending to small and medium enterprises which requires intensive monitoring and overhead cost. The proportion of foreign currency-denominated lending to total lending was quite stable during the period 1991-2000. However, the adoption of a more flexible exchange rate regime, in January 2003, has increased defaults on foreign currency loans. Following the stability of the Egyptian pound against US dollar during the second half of 2000s. this proportion increased due to minimizing risks embodied in foreign-currency borrowings given that most of these borrowings were within maturities of less than one year. The period of global financial crisis 2007-2009 and political instability emerged in early 2011 witnessed a decline in the percentage of foreign-currency dominated loans. Despite recent depreciation of the domestic currency. stress tests regularly performed by the CBE suggested that plausible losses could be absorbed by banks' profits and capital buffers, and exchange rate exposure was insignificant. NPLs to total loans decreased from 30% in 1992 to 8.5% in 2014. Under Law 88 of 2003, public banks are requested to follow rigorous lending policies, and since then, public banks have stopped lending to defaulting state-owned enterprises. Starting from 2004, banks have focused more on loans rescheduling and seizing real property collateral in lieu of loan payments banks. Other reason for the decreasing NPLs to total loans of the banking system include restructuring the banking industry and applying Basel committee norms. Profitability of private banks are much higher compared to public banks. Profitability of the banking system improved during the period 2004 - 2014 due to reforms implemented by the CBE since September 2004 which resulted in lowering NPLs. The Egyptian banking system was characterized by high liquidity during the first half of the 1990s. however, it slightly declined during the second half of 1990s. Over the period 2000-2014, a considerable amount of idle financial liquidity continued to remain dormant within the banking system which was reflected in a decreasing loans-to-deposits ratio. The NPLs problem. emerged in early 2000s. had a Significant impact on the sluggish pace of credit to the private sector. Banks became more risk-averse preferring investment in more liquid assets (i.e. investing in government debt- instruments). The banking sector's adjustment to capital outflow in early 2011 resulted in a cut in the net credit position With the CBE by a similar magnitude.
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