Banking Sector Report 2010: Mobile Technology

Below is the cover story of the Business Monthly Magazine published by American Chamber of Commerce in Egypt in July 2010. It is titled "Conservative Frameworks, New Opportunities" and it starts with "The government and banking sector consider how best to meet the challenges of a rapidly changing financial environment".
Let's go through the report that was prepared by Tamer Hafez:

Egypt’s banking sector was largely insulated from the worst of the 2008 financial crisis, and the Central Bank of Egypt (CBE) has been widely credited for preventing the use of complex instruments such as financial derivatives and currency margin trading.

Fast forward to 2010 and questions emerge as government and financial leaders look ahead. Should the country maintain its longstanding conservative regulatory environment? Or will investors’ appetite for emerging markets and the rise of sub-Saharan African nations as viable competitors dictate the retooling of the Egyptian banking system to encourage expansion?  

The unbanked

Most experts agree that for the banking sector to grow it must embrace progressive products and services to increase penetration and access new market segments. Only 10 percent of adults in Egypt use banks. Of the country’s 39 banks, 28 are privately run or joint ventures with a reputation for more liberal and aggressive strategies than their government-owned counterparts.
Despite the relatively large number of private sector banks,  there are less than 3,000 branches nationwide, says Amr Abbas, CEO of Standard Chartered Bank, Cairo Representative Office. “Most of the banks are working on building their retail banking platform, yet they are now approaching retail in a more conservative way than before,” says Abbas.

Part of the second phase of the current CBE reform plan is to facilitate access to credit for small and medium enterprises (SMEs), which represent more than 90 percent of private companies in Egypt. “Those companies provide 80 percent of the private sector value added,” says Abbas. Yet the appetite to lend to SMEs is quite low because of a lack of collateral and the perception that they have a high risk of default. For SME financing, the CBE exempts banks from the standard 14 percent loan reserve requirement.
Akram Tinawi, commercial banking director and board member at Barclays Bank Egypt, sees helping small and medium enterprises as crucial. “SMEs are the future for any bank,” says Tinawi. “They need partner banks that not only finance them but help them succeed because if they crash, we crash with them.”

The telecom industry is another key to banks’ near-term expansion of their client base. Perhaps the most promising service is mobile money transfer in which customers use their phones to open accounts with CBE-certified agents (mostly mobile operators) to gain access to a variety of financial transactions through encrypted text messaging (SMS).

Some sub-Saharan African nations are at the forefront of mobile money transfer services. Vodafone’s M-PESA service in Kenya, for example, has 9.5 million subscribers – 23 percent of the population – and 17,600 agents, and each year handles transfers equal to 11 percent of Kenya’s gross domestic product.
Vodafone Egypt plans to introduce a version of M-PESA this year, with MobiNil and Etisalat likely to follow suit. Hatem Dowidar, CEO of Vodafone Egypt, thinks the service will be successful in Egypt, in part because of lessons learned elsewhere. He says Vodafone is working to make the service 100 percent secure with fast transaction confirmations. “We have had a lot of experience in Kenya, Tanzania and Afghanistan. At least from the telecom side, our networks are more advanced and secure, so the service here will be much better than they have,” Dowidar says, noting that the technology is similar to the prepaid card service already so popular in Egypt.

The CBE has been working with the National Telecommunication Regulatory Authority (NTRA) for the past year to create a regulatory framework to integrate telecom providers into the banking sector. “The best model of cooperation would be that banks hold a major ‘operator’ account that includes mini-accounts, each identified by the mobile number of the subscriber, and reconciliation of accounts would be done as per bank standards,” says Dowidar. The service will be available to users of the same mobile operator and “when we are confident that the service is running smoothly it will be offered across all operators,” says Dowidar.

Mobile phone transfers will be more expensive than traditional bank transfers, so consumers could be expected to minimize their transactions thus making it more difficult for banks to make money. “In other countries, the operator takes a fixed fee from every transaction depending on how much money is transferred,” says Dowidar. That will be in addition to banking fees already in place. Dowidar doesn’t think that correctly pricing the service will be a problem.  “Banks will definitely benefit from the large economies of scale of newly banked individuals. The cooperation model will be very similar to that seen in Kenya and Tanzania,” he says. Jerome Jacquier, National Société Générale Bank (NSGB) deputy managing director, says correct pricing will be crucial.

Dowidar believes Egypt offers great potential with its 60 million mobile lines and foresees no serious problems between telecom and financial institutions. “I don’t think there will be any sort of conflict between what this technology offers and banks. By making the younger generation comfortable with using such technologies, the possibilities will be limitless,” he says. Jacquier agrees: “I think such services would complement current offerings from banks to their clients.”

Status of the sector Egypt’s banking sector was valued at about LE 1.2 trillion at the end of 2009. Deposits were LE 810 billion while loans were over half that at   LE 432 billion.

“The Egyptian banking sector has a very good supply of domestic currency deposits which it can use to capitalize on new opportunities,” says Tinawi. Hala Abou Hussein, group head for coverage and corporate banking at Crédit Agricole Egypt, agrees. “The problem is where to invest it,”she says. With gross domestic product standing at just under LE 1 trillion by the end of 2009, proper utilization of deposits would effectively double GDP size.
High interest rates for domestic currency deposits and low interest rates for foreign currency is causing currency supply imbalances. People want to have domestic currency deposits to take advantage of the high interest rates and take foreign currency loans because of their low interest rates.

Foreign currency deposits are in short supply for the longer tenure. This is worrying because it prevents banks from being able to finance large-scale projects that require foreign currency funding such as infrastructure, and oil and gas,” says Tinawi. During the second half of 2009, domestic currency deposits increased by LE 50 billion while foreign currency deposits decreased by LE 11.5 billion. Meanwhile, domestic currency loans decreased by LE 1 billion compared to an increase of foreign currency loans by LE 3.6 billion.

One issue limiting banks is that banks can’t lend more than 20-25 percent of bank capital to a single client (single obligor limit). “Such regulation is limiting banks from entering into single large-scale projects like public-private partnerships,” says Abou Hussein. The International Finance Corporation has its single obligor limit at 35 percent. Dubai restricts it to 7 percent. Bahrain requires regulatory approval if bank’s single obligor limit exceeds 15 percent.

New standards Alignment with international banking standards requires the implementation of Basel II and International Financial Reporting Standards (IFRS). “You need to look at the sector in two parts. There are the international banks, which have the right procedures in place and others with inherited structural deficiencies that are being solved now. But still there is a lot to do,” says Mohamed Ozalp, managing director of Blom Bank Egypt.

IFRS is a step toward Basel II, according to Nigel Lee, chief commercial officer at FinArch, a financial services provider specializing in banking. NSGB is implementing Egyptian Financial Supervisory Authority (EFSA) guidelines as it moves toward adoption of the IFRS standard next year, says Jacquier. NSGB has been working with the CBE for almost a year to study the likely effects of IFRS on the sector. “We don’t see any problems with the switch to the international standard because the domestic version is very close,” he says.

Basel II is a set of recommendations issued by the Basel Committee on Banking Supervision published in 2004 as a standardized basis for regulatory decisions. It deals with credit, market and operational risk. Abbas, of Standard Chartered, expects all Egyptian banks to be in compliance with Basel II by the end of 2012. “Domestic banks will have to increase their capital to meet the Basel II capital adequacy ratios and implement tighter controls across all areas,” he says. “This will increase their costs, reducing profits and pressuring their pricing strategy.” Eventually, this could lead to market stabilization in terms of price and competitiveness, according to Abbas.  Abou Hussein thinks “there will be risks, of course, but the excess liquidity will ensure that our appetite for loans will remain the same.”

Tinawi believes any problems will be related more to the attitudes of those implementing the standards. “The challenge is the paradigm shift needed in the mindset of the domestic banking sector in order to be aligned with international mindsets,” he says, noting that Barclays is working on Basel II requirements in preparation for the 2012 deadline.

NSGB already is Basel II complaint in credit and operational risks standards, in accordance with regulations controlling French banks operating outside France. Egypt is considered a “domestic market” because it is largely unaffected by international markets. “There will be slight implementation modifications to suit the environment here,” says Jacquier.

Implementation of Basel II, in particular, will greatly change the way banks manage their internal operations. “Current technology might look like it can get you there, but in reality it can’t,” says Lee, of FinArch, and a significant challenge will involve stored data. “Basel II will be useless without clean data. You need daily updates to track what every client is doing. There also could be a significant challenge when two banks merge because one might store data that the other doesn’t,” says Mounir Baccouche, FinArch vice president for business development in the Middle East and Africa.

Technological challenges Amr Soliman, managing partner of e.vision, an IT compliance consulting company, has been working to enhance Egyptian banks’ IT infrastructure since 1999. “The financial sector is being bombarded by multiple global regulations and guidelines, all aiming for more bank corporate governance,” he says. A big part of that involves IT governance, which he says is a “critical requirement for regulation execution.” 
Basel II defines IT governance in banks as “operation risk.”  “Confidentiality, integrity and availability of the systems and information is the cornerstone in achieving enhanced corporate governance,” says Soliman. “Regulations which are being introduced today are being received by environments which are not ready to apply policies and procedures.” Bank auditors, for example, often lack the technical skills necessary to assure compliance, he says.

According to Mohamed Fouda, assistant sub-governor and chief financial officer of the CBE, existing systems will be one of the biggest obstacles banks will face in the move toward IT governance. “We have reached a point where the cost of changing or upgrading a system has become so high that bank executives don’t want to change it,” says Fouda. Most executives are comfortable with their existing systems, he says, but changing practices and technical advances will compel banks to take a hard look at upgrading. “The time has come to focus more on data analysis than data collection. This will be a challenge because we will need the best tools to perform this analysis and to integrate these tools into the system,” says Fouda.

Part of the CBE stage two reform is introducing significant changes to core banking and financial systems, including a unified data warehouse to help provide accurate and timely information and data. The CBE is also working on a new domestic money monitoring system to track investment fund and interbank transactions. For system backups, the central bank is currently upgrading its Tanta facility to act as a safety net to existing central operations in Cairo.

Replacing legacy systems in banks is likely to be complicated, costly and risky, especially when it comes to migrating data that is used in daily operations. “You can’t do the changes step by step,” says David Bentivegna, managing consultant for the financial services industry for Hewlett Packard. “But such risks are temporary. In the medium and long term, the new system will be able to analyze and mitigate operational and market risks more effectively.”

IT governance is also related to implementing the correct set of policies and procedures. “One of the main challenges to achieving IT governance using a set of standard policies is the actual mapping of the procedures on the IT architecture and systems,” says Soliman.

Virtual assets Cloud computing is one of the waves of technology that will change the way business is done, according to Wael Fakhrany, head of Google in Egypt and North Africa. The concept involves outsourcing data storage and basic applications, such as word processing, to a third party that would be responsible for security and access regardless of a client’s location. “Cloud computing is the evolution of IT services from companies having their own IT department and managing all their data and services,” says Olaf Krahmer, Cisco Egypt president, and general manager.

Corporations can utilize clouds for internal functions, such as connecting branches, or external services, such as e-mail. Some organizations have sufficient IT staff to build and manage their own clouds, while others might not want to invest in creating the IT infrastructure and staff,” says Krahmer. While security issues would probably make banks less willing to utilize public clouds, they could create and manage their own cloud. “This cloud is then used by bank branches in a particular geographic location or globally through security protocols. This will increase redundancy and tolerance of the system because providing services will be independent of physical location,” he says. There can be significant differences among cloud-based services, and “IT staff need to be familiar with how such services are provided,” says Krahmer.

The first step for banks to move into a cloud environment would be to outsource basic productivity tools such as e-mail, calendar, spreadsheet, word processing and workflow management tools. “Verification and authorization standards are in place, and then these tools are accessed through the Internet,” says Fakhrany.

Cloud environments can be a real asset for banks when it comes data and security. “Voice recognition had always been a data problem, and you need a very large sample for it to work properly. But if your system is in a cloud, your voice will be digitized and sent securely to thousands of servers for processing. The result will be faster and more accurate authentication,” says Fakhrany. Data protection “is about economies of scale. Their core business is to manage data and tools so they can afford to hire the best experts and have the right technology,” says Krahmer.

Looking ahead What the banking sector might look like in five years is difficult to predict. Perhaps the only visible change will be the widespread use of mobile money transfer services.

Crédit Agricole and NSGB are aiming for large infrastructure projects and more appetite for risk. Barclay’s and Blom are heading into more basic practices with strictly calculated risks and a prudent strategy until the crisis repercussions end. “Whether you call it Basel II or something else, in the end, this crisis has proved that there is no substitute for basic banking practices. Be flexible, don’t increase risks, lend prudently, deal with individuals and adhere to proper corporate governance,” says Ozalp of Blom. “If you abide by these basic tenets, then virtually 100 percent of what the regulators want will happen.” 

Bank Lending and Deposits