implementation completion and results report (ibrd … · 2016-07-16 · document of . the world...

Document of The World Bank

Report No. ICR1837

IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-78940)

ON A LOAN

IN THE AMOUNT OF US$500 MILLION EQUIVALENT

TO THE

ARAB REPUBLIC OF EGYPT

FOR A

THIRD FINANCIAL SECTOR DEVELOPMENT POLICY LOAN

June 28, 2012

Finance and Private Sector Development Egypt, Yemen and Djibouti Country Department Middle East and North Africa Region

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

ARAB REPUBLIC OF EGYPT—GOVERNMENT FISCAL YEAR July 1st – June 30th

CURRENCY EQUIVALENTS (Exchange Rate Effective as of April 30, 2012)

Currency Unit Egyptian Pound US$1.00 LE 6.04

WEIGHTS AND MEASURES

METRIC SYSTEM

ABBREVIATIONS AND ACRONYMS

ACH Automatic Clearing House AfDB African Development Bank CAS Country Assistance Strategy CBE Central Bank of Egypt CFAA Country Financial Accountability Assessment CFR Corporate Financial Reporting CGAP Consultative Group to Assist the Poor CIB CIS CMA

Commercial International Bank Collective Investment Scheme Capital Market Authority

DB DPL

Defined Benefit Development Policy Loan

EALB ECB

Egyptian Arab Land Bank European Central Bank

EFSA EISA

Egyptian Financial Supervisory Authority Egyptian Insurance Supervisory Authority

EMRC Egyptian Mortgage Refinance Company ESE Egyptian Stock Exchange EU European Union FDIC FIRST

Federal Deposit Insurance Corporation Financial Sector Reform and Strengthening

FSAP Financial Sector Assessment Program FDI Foreign Direct Investment GAFI GDP

General Authority for Free Zones and Investment Gross Domestic Product

IAIS IBRD

International Association of Insurance Supervisors International Bank for Reconstruction and Development

ICA ICR IDB

Investment Climate Assessment Implementation Completion and Results Report Industrial Development Bank of Egypt

IEG IFC

Independent Evaluation Group International Finance Corporation

IFRS International Financial Reporting Standards

IHC IMF

Insurance Holding Company International Monetary Fund

IOSCO IPO ISA

International Organization of Securities Commissions Initial Public Offering International Standards on Auditing

ISDS LE

Integrated Safeguard Data Sheet Egyptian Pound

MFA Mortgage Finance Authority MFI MIC MOF MSE MTPL

Microfinance Institution Misr Insurance Company Ministry of Finance Micro and Small Enterprise Motor Third Party Liability

NBFI NBFC NCB NIC NPL

Non-bank Financial Institutions Non-bank Finance Companies National Central Banks National Insurance Company Non-performing loans

PBDAC PFM PPP

Principal Bank for Development and Agricultural Credit Public Financial Management Public-Private Partnerships

QIS REIF ROSC

Quantitative Impact Study Real Estate Investment Fund Report on the Observance of Standards and Codes

RTGS SME SOE SOI TSA

Real Time Gross Settlements Small and Medium Enterprise State-owned Enterprise State-owned Insurer Treasury Single Account

y-o-y year on year

Vice President: Country Director:

Sector Director: Sector Manager:

Task Team Leader:

Inger Andersen A. David Craig Loic Chiquier Simon C. Bell Sahar Nasr

ARAB REPUBLIC OF EGYPT Third Financial Sector Development Policy Loan

Table of Contents

DATA SHEET

A. Basic Information .................................................................................................................... i B. Key Dates ................................................................................................................................ i C. Ratings Summary .................................................................................................................... i D. Sector and Theme Codes ........................................................................................................ ii E. Bank Staff ............................................................................................................................... ii F. Results Framework Analysis .................................................................................................. ii G. Ratings of Project Performance in ISRs .................................................................................. v H. Restructuring ........................................................................................................................... v

1. Program Context, Development Ojectives and Design ........................................................ 1 2. Key Factors Affecting Implementation and Outcomes ........................................................ 8 3. Assessment of Outcomes .................................................................................................... 15 4. Assessment of Risk to Development Outcome .................................................................. 18 5. Assessment of Bank and Borrower Performance ............................................................... 19 6. Lessons Learned ................................................................................................................. 22 7. Comments on Issues Raised by the Borrower/Implementing Agencies/Partners .............. 22

Annex 1: Bank Lending and Implementation Support/Supervision Processes .......................... 24 Annex 2: Summary of Borrower's ICR ...................................................................................... 25 Annex 3: Comments of Cofinanciers and Other Partners/Stakeholders .................................... 30 Annex 4: Operational Policy Matrix .......................................................................................... 32 Annex 5. List of Supporting Documents.................................................................................... 39 Annex 6: Monitoring Indicators ................................................................................................. 40 Annex 7: Money and Banking ................................................................................................... 43 Annex 8: Achievement of Program Development Objectives ................................................... 45 Annex 9: Direct Impacts of the Revolution on the Financial Sector ......................................... 56 Annex 10: Adequacy of Government’s Commitment ............................................................... 58 Annex 11: Soundness of Background Analysis ......................................................................... 59 Annex 12: Assessment of the Operation’s Design ..................................................................... 61 Annex 13: Banking Soundness Indicators ................................................................................. 63 Annex 14: Lessons Learnt.......................................................................................................... 64 Annex 15: Map .......................................................................................................................... 66

i

DATA SHEET A. Basic Information

Country: Egypt Program Name: Third Financial Sector Development Policy Loan

Program ID P120470 L/C/TF Number(s): IBRD-78940

ICR Date: May 24, 2012 ICR Type: Core ICR

Lending Instrument: DPL Borrower: ARAB REPUBLIC OF EGYPT

Original Total Commitment:

USD 500 million Disbursed Amount: USD 500 million

Implementing Agencies: Central Bank of Egypt and the Ministry of Investment

Cofinanciers and Other External Partners: USAID, EU, IMF, and AfDB B. Key Dates

Process Date Process Original Date Revised / Actual Date(s)

Concept Review: 03/08/2010 Effectiveness: 06/23/2010 06/23/2010

Appraisal: 04/01/2010 Restructuring(s): NA NA

Approval: 05/25/2010 Mid-term Review: NA NA

Closing: 12/31/2011 12/31/2011 C. Ratings Summary C.1 Performance Rating by ICR

Outcomes: Satisfactory

Risk to Development Outcome: Substantial

Bank Performance: Satisfactory

Borrower Performance: Satisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR)

Bank Ratings Borrower Ratings Quality at Entry: Satisfactory Government: Satisfactory Quality of Supervision: Highly Satisfactory Implementing Agency/Agencies: Satisfactory Overall Bank Performance: Satisfactory Overall Borrower Performance: Satisfactory

C.3 Quality at Entry and Implementation Performance Indicators

Implementation Performance Indicators QAG Assessments (if any) Rating:

Potential Problem Program at any time (Yes/No):

No NA NA

Problem Program at any time (Yes/No): No NA: NA

DO rating before Closing/Inactive status: Satisfactory NA

ii

D. Sector and Theme Codes Original Actual

Sector Code (as % of total Bank financing)

Banking 37 37

Telecommunications 9 9

General finance sector 27 27

Private pensions and insurance 27 27

Theme Code (Primary/Secondary)

Other financial and private sector development Secondary Secondary

Public expenditure, financial management and procurement Secondary Secondary

Regulation and competition policy Primary Primary

Standards and financial reporting Secondary Secondary

State enterprise/bank restructuring and privatization Primary Primary E. Bank Staff

Positions At ICR At Approval

Vice President: Inger Andersen Shamshad Akhtar

Country Director: A. David Craig A. David Craig

Sector Director: Loic Chiquier Ritva S. Reinikka

Sector Manager: Simon C. Bell Simon C. Bell

Program Team Leader: Sahar Nasr Sahar Nasr

ICR Team Leader: Sahar Nasr NA

F. Results Framework Analysis (a) PDO Indicator(s): The main objective of the operation was to assist the Egyptian authorities in further developing the enabling environment for financial intermediation and financial access, and increase private participation in the provision of financial services, through a strengthened bank and non-bank financial system. This operation supported the government’s second generation Financial Sector Reform Program (2009–2012), aimed at building a financial system that is more inclusive, competitive and effective in financial intermediation. This, in turn, would contribute to the sustained growth of the Egyptian economy and combat the adverse consequences of the global economic crisis.

Baseline Value Original Target Values

(from approval documents)

Formally Revised Target Values

Actual Values Achieved

at Completion or Target Years

PDO [GEO] Indicator 1:

The main objective of the operation is to assist the Egyptian authorities in further developing the enabling environment for financial intermediation and financial access, and increase private participation in the provision of financial services.

iii

Value (Qualitative)

A financial system that is neither operating efficiently nor contributing to improved financial intermediation

A sound, and competitive financial system with an efficient banking system, capital market, and insurance industry contributing to the provision of modern and effective financial services

NA A competitive and sound financial system capable of withstanding the impact of the global financial crisis, the January 2011 Revolution, and the lengthy transition to a new government, while playing a moderate role in financial intermediation

Date achieved 06/30/2008 06/30/2010 NA 12/31/2011 Comments (incl. % achievement)

The January 2011 revolution, the lengthy transition to a new government and the associated risks made financial sector stability and the system’s resilience a priority, which the reform program supported.

(b) Intermediate Outcome Indicator(s) - from Project Appraisal Document Baseline Values from Project Outcome Indicators/Date of Value (from approval documents)

Baseline Value

Original Target Values

(from approval documents)

Formally Revised Target

Values

Actual Values Achieved at Completion or Target

Years

IO Indicator 1: Financial and Operational Restructuring of Commercial and Specialized State-owned Banks Value (Quantitative or Qualitative)

Performance indicators of commercial and specialized state-owned banks, such as NPLs-to-total loans, provisions-to-NPLs, capital adequacy ratio, coverage ratio.

Improvement in the performance indicators

NA State-owned commercial banks in full regulatory compliance and solid performance indicators in terms of low, provision coverage of NPLs, higher than legal capital ratios Progress on operational and institutional restructuring of the state-owned specialized banks. Some specialized banks, such as PBDAC have had difficulties in achieving legal changes because parliament’s dissolution.

Date achieved 06/30/2008 06/30/2010 12/31/2011 Comments (incl. % achievement)

Significant progress was made with the restructuring of the remaining three state-owned commercial banks and their strength contributed to resiliency to the impact of the Revolution. However, some delays occurred with the state-owned specialized banks, including laws regarding them that had been approved by the Cabinet but not considered because of parliament’s dissolution and post-January increases in staff costs that were decreed. .

IO Indicator 2: Strengthening the Regulatory and Supervisory Architecture of the Banking Sector Value (Quantitative or Qualitative)

Initiate the implementation of the Basel II accords at CBE, as well as the need to

Continued implementation of the Basel II project, including preparing guidelines for

NA All of Egyptian banks have adopted the Basel II framework CBE has improved transparency of risk

iv

strengthen CBE’s macroprudential supervision

achieving the drafting of regulations in line with the Basel II framework, as well as preparing for conducting annual stress-testing and a Financial Stability Report.

recognition in the financial system by broader communication with the financial community, preparing the Financial Stability Report, and conducting regular stress-testing.


CBE is maintaining the momentum of further strengthening its capabilities to perform an advanced effective risk-based supervision within the Basel II framework, utilizing several tools to assess financial stability and conducting stress testing. This helped CBE to closely monitor the system after the January revolution and to prevent a bank run.

IO Indicator 3: Reforming the Non-bank Financial Sector Value (Quantitative or Qualitative)

Performance indicators of the insurance sector and the capital market, such as gross non-life premium to GDP, the number of mutual funds, new bond issues.

Improvement in the performance indicators

NA Having a stable insurance sector and a well-developed capital market.


Progress was made in the insurance sector, and capital market, however, delays were in the legal reforms (microfinance and pensions).

IO Indicator 4: Strengthening the Regulatory and Supervisory Framework of the Non-Bank Financial Sector

Value (Quantitative or Qualitative)

A need to strengthen the regulatory and supervisory framework of the non-bank financial sector, and improving performance indicators for NBFIs

Issuance and enactment of Law 10 of 2009, regulating non-bank financial institutions consolidating the regulatory bodies of non-bank financial sector via the establishment of EFSA, as well as improved performance indicators for NBFIs

NA The Egyptian Financial Supervisory Authority (EFSA) operates as non-bank financial regulator, capable of maintaining safety and stability of non-bank financial markets, while at the same time helping improve access to finance and facilitate service to investors.

Date achieved 06/30/2008 06/30/2010 12/31/2011

v

Comments (incl. % achievement)

EFSA merger has been completed in January 2011, however, challenges remain regarding the move to a full risk based supervisory approach, which was disrupted by the departure of the first Chairman of EFSA, who has not been replaced, and by other implications from the revolution and risks associated with it. Parliament’s non-passage of the Cabinet-approved new NBFI law, because of its dissolution, has limited set up of new microfinance institutions.

IO Indicator 5: Improving the Financial Infrastructure Value (quantitative or Qualitative)

Promoting financial inclusion and a strengthened financial infrastructure

Operational Real Time Gross Settlements (RTGS) and Automatic Clearing House (ACH) Individuals receiving Government payments through financial institutions Mobil Phone Banking developed

RTGS and ACH operational; RTGS allows for low cost, efficient, and secure payments, as well as mobile payments. Payments are made to 2.9 million government employees and retirees through bank cards. Licenses have been issued for mobile phone payments.


One of the key achievements of the reform program is the strengthening of the financial infrastructure, namely the modernization of the payments system, payments to government employees and retirees, and licensing of mobile phone payments.

G. Ratings of Project Performance in ISRs

No. Date ISR Archived

DO IP Actual Disbursements

1 March 13, 2011 Satisfactory Satisfactory US$498.75 million 2 Dec 11, 2011 Satisfactory Satisfactory US$498.75 million

H. Restructuring

Not applicable

1

1. Program Context, Development Ojectives and Design

1.1. Context at Appraisal Political Context 1. The political context at appraisal was completely changed following the January 2011 revolution and Egypt started a long transition to a new political regime. The Egyptian revolution that started on January 25, 2011 led to the stepping down of the former President, the appointment of an interim caretaker government, and the dissolution of Parliament on February 11, 2011. The Supreme Council of Armed Forces (SCAF) assumed executive and legislative powers until the Parliamentary and Presidential elections are concluded, and a new constitution is in place. Writers of the new constitution have just been selected. The presidential elections took place on May 23 and 24, 2012, with a runoff on June 17-18. The results were announced on June 24, 2012, where Mohamed Morsi won (the Muslim Brotherhood Candidate). Parliamentary elections were held, and the first session of the newly elected Parliament was on January 23, 2012. Accordingly, the country had no Parliament for almost a year, which has negatively affected legal reforms and the passage of laws—some of which were already approved by the Cabinet. The prolonged political transition and change in prime ministers as well as Cabinet over the 18 months transition period contributed to the delay and ambiguity about policies and directions. The change in Cabinet also entailed a change in the heads of most authorities and government entities. However, the Central Bank of Egypt (CBE), the main counterpart for this operation, remained in place with the same Governor. Nevertheless, the political context of the country at the time of appraisal was very different from the current one. 2. Uncertainty exists about the political and economic future, not just about the hiatus period and the elections, but the future orientation of Egypt, which was not present at appraisal. The newly elected Parliamentarians come from new political parties; the majority of Parliamentarians are from Islamist Parties. A new President has been elected and a new constitution will be drawn up. Although the political and economic strategy of the government to be elected is unclear at this point, it almost certainly will emphasize equity, fairness, and a focus on governance, transparency and accountability. There is also a possibility that the new government will opt for policies that will satisfy the populists’ demands in the short-run but that might not be sustainable in the long-run. This was amplified by the social unrest, lengthy demonstrations, and strikes, including staff in the financial institutions, which followed the revolution. 3. Economic growth has slowed substantially following the revolution. Given the uncertain situation, as well as the substantial pressure for the underfunded caretaker government to improve the economic situation of various groups, it is not surprising that the Egyptian economic activity has been slow to recover, investment has dropped and macroeconomic conditions have deteriorated (as detailed in the section on macroeconomic framework below). The to-be-elected government, on assuming office, will need to define its direction quickly and take macroeconomic actions consistent with its resources and funding from abroad, to create employment opportunities, to avoid inflation that will hurt the poor most, and to encourage investment and private sector development, with the ultimate objective of achieving inclusive growth. 4. The revolution, and its associated risks, interrupted the financial sector reform program immediately after the loan had closed. The January 2011 revolution led to the closure of banks from January 27 till February 6, 2011, as well as the shutting down of the Egyptian Stock Exchange (ESE) until March 23, 2011. CBE had to respond to critical matters such as capital outflows, international reserves, the exchange rate, the inflation rate, and the overall macroeconomic policies. Moreover, as a regulatory and supervisory body, CBE had to closely monitor the quality of banks’ assets and non-performing loans (NPLs), and undertake rigorous stress testing for banks. Meanwhile, the banking system was subject to an increasing crowding-out effect by the government from sell-offs of its debt

2

and the growing budget deficit. Demand for private credit also fell with the deterioration in the investment climate and the overall macroeconomic environment and growth slow-down. On the non-bank side, regulations for disclosure and corporate governance were augmented by the Egyptian Financial Supervisory Authority (EFSA) post-revolution, and authorities introduced temporary trading measures aimed at reducing panic upon resumption of trading (after the re-opening of the stock market) and helping restore stability in domestic capital markets. Macroeconomic Framework 5. In December 2010 the Egyptian economy was recovering from the mild effects of the global financial crisis, but the January revolution sent the economy into a tailspin and still faces uncertainty. Egypt’s economic growth was on a recovery path, growing at 5.1 percent in FY10 and 5.6 percent in the first half of FY11 yet, the revolution led to a complete halt in economic activity during several weeks; widespread labor action demanding higher wages and management changes increased downward pressure on growth. Output contracted by 4.4 percent (y-o-y) in the quarter of the revolution, and registered 1.8 percent in FY11. In FY12, growth has oscillated around 0.3 percent (y-o-y) in the first semester, but it is expected to climb to around 2 percent for the entire fiscal year. Basically, the macroeconomic environment at the time of appraisal was different from that at the current time of ICR. 6. In general, Egypt coped well with the initial economic and market effects of the political crisis. This was largely due to the financial management of CBE, which stabilized the currency, kept liquidity at adequate levels, and oversaw commercial banks to ensure their normal functioning after two weeks of closure due to security concerns. However, as time evolved, traditional challenges such as a high fiscal deficit, moderately high inflation, and high vulnerability of the population to poverty, called for renewed action, in the context of new complicating factors such as a falling demand for Egyptian pound denominated assets which has implied loss of international reserves. Given the prolongued political transition, and policy inflexibility on both the fiscal and monetary sides, uncertainty prevailed and capital outflow persisted. International reserves have been declining from February 2011 until March 2012; however it started to increase marginally starting April 2012 to reach $ 15.2 billion. 7. Egypt’s revolution raised political uncertainty and significantly dampened economic growth prospects in the short run. Egypt’s uncertain political outlook makes it difficult to forecast how the transition will unfold. The final outcome will depend on the political agreement necessary to attain balance between the Executive, the Parliament, and the Judiciary, as well as on the economic policy responses required to stabilize the economy in the short run. The main factors affecting the outlook for FY12 are: (i) the extent of recovery of tourism (20 percent of Egypt’s foreign exchange revenues); (ii) business disruptions, especially at industrial areas near major cities; (iii) a slowdown in domestic demand, which has been the main growth driver in Egypt; and (iv) reduced investment following loss of confidence. Construction, manufacturing, and financial institutions are most likely to continue to suffer losses resulting from labor actions. 8. High unemployment, especially among the youth, continues to be a major concern. Unemployment had declined to 8.9 percent in Q1-FY11, down from a peak of 9.4 percent during the trough of the slowdown produced by the global financial crisis. By December 2011, unemployment had increased to 12.4 percent as the private sector accommodated the political shock. Unemployment is highest for younger age groups, reaching 21 percent for the 15-24 age group. Youth unemployment is similar to other middle income countries such as Colombia, Turkey, and Indonesia which oscillate around 25 percent, and lower than many European countries such as Italy, Greece, and Hungary that hover around 26 percent, and certainly lower than Spain at 38 percent. However, most of those countries have unemployment insurance, social safety nets that operate in extreme situation, and mechanisms through which citizens manifest their grievances. In Egypt, the high level of public debt and fiscal deficit limit the room for maneuvering.

3

9. Inflation has dropped to a single-digit level. Consumer Price Index (CPI) inflation oscillated between 7 and 9 percent during the last 7 months (August 2011–April 2012), and stood at 8.7 percent in April 2012. The fall in inflation is driven by lower food price increases. In the period 2008-2010 inflation rate remained in a double-digit or four consecutive years inflation rate. Food price inflation, the main driver of inflation, fluctuated between 18 and 22 percent over the same period. Core inflation1 was fluctuating between 6.8 and 9 percent and stood at 8.6 percent in March 2012. The Producer Price Index inflation has a declining trend: from 11.8 percent in September 2011 it dropped to 7.4 percent in January 2012. 10. The external balance severely weakened due mostly to the capital account. International reserves reached US$ 15.2 billion by end April 2012, equivalent to 2.6 months of projected imports of goods and services, while they stood at US$ 26.4 billion by June 2011. BoP information to December showed a current account deficit of US$ 1.8 billion and a capital outflow of US$ 4.5 billion. The September current account deficit was high by historical standards, it was associated with an atypical oil trade balance results. During H1 FY12, the current account balance deficit soared to US$ 4 billion (1.6 percent of GDP) up from US$1.3 billion (0.8 percent of GDP) in H1 FY11. The trade deficit is explained by a 24 percent y-o-y increase in petroleum imports that reached US$ 5.3 billion, up from US$ 4 billion in H1 FY11, an extraordinarily high figure reminiscent of the pre-global crisis levels of 2008. Exports slightly increased to reach US$ 13.5 billion in H1 FY12, increasing by 7 percent compared to H1 FY11 driven mainly by oil exports. Other exports declined by 5 percent y-o-y, to reach US$6.8 billion, down from US$ 7.2 billion in H1 FY11. 11. The fiscal deficit is expected to be higher than the budgeted figure for FY12. The FY11fiscal deficit closed slightly higher than expected, at 9.8 percent of GDP. The FY12 deficit is expected to be 9.2 percent of GDP, exceeding the 8.6 percent of GDP target originally budgeted. This increase is due to increased public spending, especially on wages and social benefits, and a revenue shortfall due to a fall in economic activity and trade. The overall fiscal deficit increased in H1-FY12. The fiscal deficit of the budget sector (narrow definition) increased from 4.4 percent of GDP in H1-FY11 to 4.7 percent of GDP in H1-FY12, (Table 1). Up to December 2011, the observed fiscal deficit was LE 73 billion, equivalent to 9.4 percent of the semester’s GDP, higher than last year’s LE 60 billion, or 8.9 percent of GDP, during the same period.

Table 1: Summary of Fiscal Operations (in percentage of GDP)

FY07 FY08 FY09 FY10 FY11

H1FY11 H1FY12 Revenues-RHS 24.2 24.7 27.2 22.2 19.3

7.3 7.4

Taxes 15.3 15.3 15.7 14.1 14.0

5.5 5.1 Grants 0.5 0.2 0.8 0.4 0.2

0.2 0.4

Other Revenues 8.3 9.2 10.7 7.7 5.2

1.6 2.0 Expenditures 29.8 31.5 33.8 30.3 29.3

11.7 12.1

Compensation of employees 7.0 7.0 7.3 7.1 7.0

3.1 3.4 Purchases of Goods And Services 2.3 2.1 2.4 2.3 1.9

0.7 0.5

Interests 6.4 5.6 5.1 6.0 6.2

2.6 2.8 Subsidies, Grants, and Social Benefits 7.8 10.3 12.2 8.5 9.0

3.0 3.6

Other Expenditures 2.8 2.7 2.6 2.4 2.3

1.2 1.0 Investments 3.4 3.8 4.2 4.0 2.9

1.2 0.7

Net Acquisition of Financial Assets 1.7 0.0 0.3 0.0 -0.2

-0.1 0.0

Cash Deficit / (Surplus) -5.6 -6.8 -6.6 -8.1 -10.0

-4.5 -4.7 Overall fiscal balance -7.3 -6.8 -6.9 -8.1 -9.8

-4.4 -4.7

Primary deficit -0.9 -1.2 -1.8 -2.1 -3.6

-1.8 -1.9 Source: Ministry of Finance (May 2012).

1 Excluding fruits and vegetables and some regulated items.

4

12. Public spending increased by 17.7 percent in H1-FY12, due mostly to higher wages, subsidies, and interest payments. This increase in public spending (Figure 2) was mainly due to higher compensation of employees (up by 27.3 percent in H1-FY12), higher subsidies and social benefits (up by 37.0 percent), and higher interest payments (up by 23.3 percent), especially those related to the domestic debt (increasing by 24.1 percent). By contrast, investment decreased by 29.4 percent in H1-FY12. 13. To reduce pressure on the State budget, electricity subsidies were eliminated for energy-intensive sectors. The cabinet approved a discontinuation of electricity subsidies for energy-intensive sectors, such as those producing petrochemicals, aluminum, ceramic and steel. The change was to be retroactive to January. Energy intensive sectors consume about 80 percent of total fuel oil consumption and 15 percent of total natural gas usage. Both fuel oil and natural gas account for approximately 25 percent of total energy subsidies. 14. Revenues increased thanks to grants and other income, while tax revenue fell as a share of GDP. Given the slowdown in economic activity and trade, taxes on income, profits, and capital gains and those on goods and services increased at lower growth rates. In addition, taxes on international trade decreased by 8 percent during the semester ending in December. On the other hand, grants (especially from foreign governments) and property income increased significantly, bringing total revenues up by 16.9 percent in H1-FY12. 15. Domestic public debt has continued its upward trend with increasing interest rates. The net domestic debt of the general government increased from 47.6 percent of GDP in June 2010, to 54.6 percent in March 2012. Interest rates on one-year T-bills reached 15.9 percent in March 2012. Furthermore, the CBE sold US$ 1.53 billion and US$ 1 billion worth of one year, dollar-denominated treasury bills with a weighted average yield of 3.87 percent and 3.88 percent in November 2011 and December 2011 respectively. By contrast, gross external debt decreased by 2 percent (y-o-y) at end of September 2011, reaching 12.9 percent of GDP. Financial Sector Background and Reforms Supported by the Bank 16. The government of Egypt pursued a major Financial Sector Reform agenda (2004-2008) that was consistent with the recommendations of the joint IMF-World Bank 2002 Financial Sector Assessment Program (FSAP). The program included restructuring and privatizing of state-owned banks, 1F

2 reforming the insurance sector (including restructuring the state-owned insurers), developing a new system of mortgage finance for a more sustainable housing market, and strengthening financial regulatory capacity and financial supervision apparatus. The first generation of these reforms, which was also characterized by in-depth diagnoses, balance sheet strengthening, development of detailed strategies for the banking and non-banking sectors, and improved corporate governance (including privatizing one bank), was supported by the First and Second Financial Sector Development Policy Loans (DPL I and DPL II). 17. Prior to this reform program, the financial sector in Egypt faced major challenges. Issues identified in the 2002 FSAP and subsequent pre-appraisal diagnoses for the DPLs included the fact that the banking system, which was dominated by public ownership, was burdened by high NPLs that were not adequately provisioned. The non-bank financial sector was characterized by underdeveloped bond, insurance, and mortgage markets, and thin trading in equities. Moreover, two of the state-owned insurers were financially distressed and approximately 25 percent of private pension plans were

2 For further details on money and banking in Egypt, please refer to Annex 8.

5

significantly underfunded. In addition, the whole system was characterized by weak corporate governance, an inadequate regulatory and supervisory framework, and poor financial infrastructure. 18. The first generation reforms, which the Bank supported, reaped positive results. For the first time in recent history, the banking sector is now majority-owned by the private sector and open to competition—through the privatization of the fourth largest state-owned bank, Bank of Alexandria, and divestiture of 94 percent of state-owned banks’ shares in joint venture banks. The banking sector was consolidated, and the number of banks was reduced from 57 to 39 banks by raising and enforcing minimum capital requirements. Other achievements included the financial, operational, and institutional restructuring of the remaining state-owned banks, including in the settlement of 60 percent of NPLs of the state-owned enterprises, and the operational restructuring of the state-owned commercial banks in three critical areas (human resource development, risk management, and information technology), as well as the adoption of a detailed program for capacity building in banking regulation and supervision.

19. On the non-banking front,3 the reform program entailed the comprehensive restructuring of the insurance sector (including reducing public ownership and overhauling the legal and regulatory framework), establishing a new mortgage finance system and a liquidity facility4, beginning reforms of private pensions, and deepening and strengthening the efficiency of capital markets and institutions. In addition, the program included developing a strategy for micro-lending through non-bank financial institutions (NBFIs) to enhance access to finance and achieve a more inclusive financial system. 20. The success of the First and Second DPLs and the Government’s desire to sustain and enhance the first generation reforms and support forward-looking second generation reform program in the context of a still-risky global environment led to the Government’s request for a Third Financial Sector DPL.. The main challenges for the government of Egypt included low financial intermediation, low levels of credit to the private sector, relatively high intermediation costs, and limited innovation. In addition, further work was required on strengthening supervision, preparing the state-owned insurers for a more competitive environment, and supporting improvements in financial sector infrastructure.

21. DPLIII’s main objective was to support the government’s second generation Financial Sector Reform Program (2009–2012), aimed at building up a financial system that was more inclusive, competitive and effective in financial intermediation. This was expected to lead to a financial sector capable of contributing to Egypt’s growth performance and providing access to a broader segment of Egypt’s population, and combat the adverse consequences of the global economic crisis. Reforms envisioned further strengthening of the banking system, including continued operational and financial restructuring of both the state-owned commercial and specialized banks; settling the remaining NPLs of state-owned enterprises (SOEs); providing adequate provisioning for any outstanding NPLs; as well as scaling up banker-training focused on serving small and medium enterprises (SMEs). A Bank Financial Intermediary Loan of US$300 million for Enhancing Access for Micro and Small Enterprises was approved in March 2010.

3Other achievements in the non-banking sector included: (i) establishment of the Institute of Directors to develop and train middle and upper level managers in adopting and implementing corporate governance procedures and rules; (ii) establishment of the Insurance Protection Fund to cover investors against non-commercial risk; (iii) strengthening of the government debt market, through increases in the share of tradable debt, publication of quarterly borrowing plans for t-bills and bonds, introduction of a new system of primary dealers in treasury bonds, and lengthening of the average debt maturity; and (iv) amendment of various laws and executive regulations, related to creditors’ rights, payments system, and stamp duties to improve the institutional infrastructure of the financial sector. 4 The World Bank supported the development of the mortgage finance market through two different operations, the Mortgage Finance Project and the Affordable Mortgage Finance Program DPL.

6

-

100,000

200,000

300,000

400,000

500,000

600,000

Figure 1: Credit to the Government by Banks 22. Although the reforms led to a sound and stable system (as evident in the capital adequacy ratio that increased from 14.7 in 2008 to 15.6 in December 2011 (Annex 13), improvement in financial intermediation to the private sector was not maintained, due to the developments associated with the January 25th revolution,5 which led to increased crowding-out of the private sector by the government’s budget deficit and sell-off of government bonds by non-financial sector holders. In addition, private borrowers were not interested in borrowing due to the overall uncertain

economic environment and the security situation. Credit of the banking sector to the government has continued to accelerate (Figure 1); it grew by 41.4 percent in December 2011 and 45.3 percent in January 2012. Credit in the private sector grew by 6.1 percent in December 2011 and 5.4 percent in January 2012. The government’s share in total credit increased to 53 percent in January 2012, up from 45.2 percent in January 2011. The private sector’s share shrank to 43 percent in January 2012, from 50.7 percent in January 2011, when it was starting to pick up right before the revolution. Rationale for Bank Involvement in DPL III 23. The World Bank involvement in DPL III was fully consistent with the Country Assistance Strategy (CAS) of May 20, 2005, covering the period 2006–2009, and the CAS Progress Report for the period of 2006–2011. DPL III addressed two key strategic objectives of CAS, namely to enhance the capacity of the financial system and facilitate private sector development. DPL III was fully consistent with the strategy articulated in the CAS and further confirmed in 2008 in the CAS Progress Report (one of the main thrusts of this strategy was to help “further implement reforms in the financial sector, including to broaden access to finance”). Moreover, the CAS Progress Report lending program was indicative, with an explicit mention that it would be implemented with flexibility. The CAS Progress Report (paragraph 36) mentioned criteria that would be used to select operations going to the Board, namely: (i) priorities expressed by the government—DPL III was a priority to the Egyptian government at the highest political level; and (ii) financial exposure consideration. While the DPL III was not explicitly mentioned in the CAS and the CAS Progress Report, it fitted within both the overall engagement strategy and the IBRD envelope. Since 2000, the Bank has worked closely with the government on financial sector development issues, which has been of great benefit to Egypt to develop the policy, legislative and institutional foundations for a sound and stable financial system. The Bank has been supporting the Government of Egypt in the implementation of the financial sector reform program, through an integral package of analytical work, technical assistance, advisory services, and lending (IBRD).

24. The DPL III operation was in response to a government request in 2010 for support to its Second Financial Reform Program (2009-2010) and therefore crucial for supporting the continuation and deepening of the financial sector reforms, especially after the global financial crisis that began in 2008. It was also important for increasing the irreversibility of the reforms—a key factor that helped to maintain the dialogue with the authorities when the revolution started, which was not predicted at appraisal time. There is ample evidence showing a strong and causal relationship between financial sector development and both economic growth and poverty reduction. Having an efficient financial

5 Refer to Annex 11 for more details on the direct impacts of the revolution on the financial sector.

7

system that can deliver essential services makes material contributions to a country’s economic development. Greater financial development increases growth, reduces economic volatility, creates job opportunities and improves income distribution, as has been well established by a substantial quantity of empirical literature.6 25. The Bank was uniquely placed for this operation given its ability to assemble a cohesive team of individuals with the required technical skills and relevant experience in other countries. The Bank also has the capacity to credibly interface with the government and industry counterparts while taking a completely objective approach. The Bank also was able to leverage this operation through provision of significant technical assistance and knowledge transfer, for example, the FIRST projects and assistance in pension reform . This operation was also in response to the government’s request for the Bank to help play a coordinating role in channeling the financial and technical support of other donors and development partners to the financial sector within a common framework. 26. It is worth noting that although each of the three financial sector DPLs built upon the results made by its predecessor, each DPL was a stand-alone operation and not part of programmatic series. Three separate operations were considered more underpinning to irreversible policy measures, as disbursement would occur upon the realizations of up front, specific actions under each phase. This would in turn ensure more stringent government commitment to the comprehensive implementation of the reform program. 1.2. Original Program Development Objectives (PDO), Policy Areas, and Key Indicators 27. The main objective of the operation was to assist Egyptian authorities in further developing the enabling environment for financial intermediation and financial access, and to increase private participation in the provision of financial services, through a strengthened bank and non-bank financial system. This operation supported the government’s second generation Financial Sector Reform Program (2009–2012), which was aimed at building a financial system that is more inclusive, competitive and effective in financial intermediation. This, in turn, would contribute to the sustained growth of the Egyptian economy and combat the adverse consequences of the global economic crisis. 28. To this effect, the World Bank operation sought to achieve: (i) financial and operational restructuring of commercial and specialized state-owned banks; (ii) strengthening the regulatory and supervisory architecture of the banking sector; (iii) reforming the non-bank financial sector, including finalizing the legal and operational restructuring of the state-owned insurers, adding to access opportunities and developing the retail investment market; (iv) strengthening the regulatory and supervisory framework of the non-bank financial sector, largely through the vehicle of the new integrated non-bank supervisor; and (v) improving the financial infrastructure. 29. These outcomes were to be measured by key indicators in five areas (pillars), as follows: 30. Pillar I: Financial and operational restructuring of commercial and specialized state-owned banks: (i) decline in NPLs-to-total loans; (ii) increase in provisions-to-NPLs; (iii) decline in SOEs’ NPLs; (iv) capital adequacy of the banking system ratio; (v) PBDAC improvement in coverage ratio; (vi) increase in number of PBDAC products. 31. Pillar II: Strengthening the regulatory and supervisory architecture of the banking sector: (i) 100 percent of Egyptian banks adopting Basel II; (ii) periodic stress testing of the aggregate balance sheet of the banking sector and individual banks; (iii) publication of a Financial Stability Report (at least once a year).

6 World Bank Report. Financial Development and Economic Growth: Views and Agenda (Levine, 1996).

8

32. Pillar III: Reforming the non-bank financial sector: (i) gross non life premium to GDP; (ii) gross adjusted life premium to GDP; (iii) increase in number of mutual funds; (iv) investment funds’ assets under management; (v) increase in new bond issues. 33. Pillar IV: Strengthening the regulatory and supervisory framework of the non-bank financial sector: (i) issuance and enactment of Law 10 of 2009; (ii) increased percentage of female microfinance clients; (iii) expansion of outstanding microfinance portfolio; (iv) increase in leasing assets as a percent of GDP; (v) microfinance, leasing, and factoring companies licensed under new NBFI Law; (vi) issuance and enactment of the Private Pension Funds Law. 34. Pillar V: Improving the financial infrastructure. (i) expansion of individuals receiving government payments through financial institutions (government payroll); (ii) expansion of mobile phone payments transactions; (iii) expansion of mobile phone payment products. 1.3. Revised PDO and Key Indicators 35. The PDO and the key indicators have remained the same during the life of the operation. 1.4. Original Policy Areas Supported by the Program 36. The five original program areas were the same as the five mutually enforcing pillars described above, which built on major improvements in soundness, stability, access, and risk management. The first area/pillar contained measures to enhance the efficiency of state-owned commercial and specialized banks in financial intermediation and widen access to financial services through extensive branch networks. The second pillar included actions that aimed at strengthening the resiliency of the financial system through improving the regulatory and supervisory architecture of the banking sector. The third focused on reforming the insurance and pension sectors, and improving the efficiency of the capital market to expand the reach of the non-bank financial sector to remote and underdeveloped areas. The fourth included measures that aimed at strengthening the regulatory and supervisory framework for the non-bank financial sector and enable further expansion of access to finance through non-bank financial institutions. The fifth comprised measures to improve the financial infrastructure and the legal framework, with the objective of enhancing the financial stability and safety of the payments system, and extending access to payments to low income and rural households. 1.5. Revised Policy Areas 37. The policy areas were not revised during the life of the operation. 1.6. Other significant changes 38. There were no changes made to the operation from the design stage to the completion of the operation. 2. Key Factors Affecting Implementation and Outcomes 2.1. Program Performance

Number of tranches One

Tranche Amount Expected Release Date

Actual Release Date

Release

1 500,000,000 June 24, 2010 June 24, 2010 Regular

39. A single tranche operation of US$ 500 million was approved by the Board on May 25, 2010,

9

and the Loan Agreement was signed on May 26, 2010. All prior policy actions had been met before Board approval. The operation was ratified by the Parliament on June 15, 2010 and became effective on June 23, 2010. Funds were released fully on June 24, 2010.

Tranche 1

Conditions from Legal Agreement/ Program Document Status

A. The Borrower has taken appropriate action to empower state-owned enterprises to settle non-performing loans due by the said state-owned enterprises to state-owned commercial banks

Met

B. The Borrower has ensured that Principal Bank for Development and Agriculture Credit is regulated by the Borrower’s Law No 88 of 2003 Met

C. The Borrower has taken measures required for implementation of the provisions of Law No 118 of 2008 governing transactions pertaining to life and non-life insurance portfolios

Met

D. The Borrower has adopted revamped and streamlined procedures to facilitate access to relevant financial products and to capital markets by underserved segments of the population

Met

E. The Borrower has established the Egyptian Financial Supervisory Authority Met F. The Borrower has established an adequate regulatory framework to foster appropriate

delivery of microfinance, leasing and factoring services Met

G. The Borrower has enacted adequate legislation governing the operations of private pension funds Met

H. The Borrower has adopted an adequate regulatory framework governing the conduct of mobile phone payments Met

I. The Borrower has concluded appropriate arrangements to foster adequate implementation of the Basel II protocols Met

J. The Borrower has established an adequate framework to sustain the production and regular dissemination of its financial stability report Met

K. The Borrower has established an automatic clearing house Met

2.2. Major Factors Affecting Implementation

Adequacy of Government’s Commitment7

The Egyptian authorities’ commitment to the reform program was key to the success of this operation. The extensive consultations with the stakeholders helped in building consensus and ownership of reforms by the market players. At the same time, strong partnership has been established between the Bank and the Egyptian authorities over the past years through an integrated financial sector work program, reflected in an effective policy dialogue, analytical work, technical assistance, and key operations, focusing on financial sector development. The operation’s team had a strong and professional policy dialogue with the Egyptian main counterpart, namely the Central Bank of Egypt, as well as EFSA that was in charge of NBFIs. The Bank team has also worked closely with the Ministry of Investment, the Ministry of Finance, the Stock Exchange, and the Misr Insurance Holding Company. Commitment to the reform program was maintained even after the revolution

Soundness of Background Analysis8

40. The design and implementation of the second generation Financial Sector Reform Program

7 Further details in Annex 12. 8 Further details in Annex 13.

10

and this DPL were significantly enhanced by the analytical work carried out.9 Several Bank studies provided strong analytical underpinning to the design of this operation and have helped identify areas that required further reforms. These studies included the 2002 FSAP; the 2007 FSAP Update; the 2005, 2006 and 2009 Investment Climate Assessments; the 2007 Finance for All: Policies and Pitfalls in Expanding Access; the 2008 Access to Finance and Economic Growth in Egypt; the 2009 Egypt Macro Policy Note; the 2010 Determinants of Savings in Egypt Report; in addition to the updates of the 2004 Accounting and Auditing Report on the Observance of Standards and Codes (ROSC); and the 2003 Country Financial Accountability Assessment (CFAA), which assessed the fiduciary risk based approach on the implementation of the Public Financial Management Action Plan. In addition the growing technical capacity of the Bank’s Egyptian counterparts has supported the analytical effort. Assessment of the Operation’s Design10 41. The design of the operation was well-thought-out. The operation was a one-tranche operation to support the government in implementing the second generation Financial Sector Reform Program. The design was influenced by the findings and recommendations of the 2006 IEG review, which noted that outcomes of loans classified under the Financial Sector Board were significantly better than outcomes of financial sector components of multi-sector loans.11 42. The operation reflected lessons learnt and benefited from the experience of earlier World Bank loans in Egypt. Excellent coordination among donors ensured synergy and effective support to the program. The reforms already implemented have contributed to the resiliency of the financial system throughout the global financial crisis, as well as the immediate impacts of the revolution. 43. DPL III was a single tranche, program loan, rather than part of a programmatic series of development policy loans for a number of reasons, most importantly that the Second Generation of Reforms and the supported actions had not existed, been identified, or considered possible at the time of the original Financial Sector Reform Program (2004-2008). First, the Second Generation of Financial Reforms (2009-2012) supported by DPL III naturally included a continuation of strengthening of commercial banks and the regulation and supervision of commercial banks and non-banks such as insurance and pensions. For commercial banks and the financial system, this included macro-prudential supervision, which had not yet been developed in 2004 and Basel II, which was only issued by the Basel Committee in June 2004 and has been steadily modified since then. Second, the Second Generation of Financial Reform also moved to strengthening and reform of the state-owned specialized banks, which had not been included in the Government’s 2004-2008 Financial Sector Reform Program because of their small market share (less than 5 percent for the three banks). Third DPL III included a number of legal changes not foreseen under the initial Financial Sector Reform Program, notably a law converting the specialized Principal Bank for Development and Agricultural Credit into a commercial bank with improved governance, a Non-bank Financial Intermediary Law that would put micro-finance institutions on a sounder basis, a Private Pensions Law, and granting licenses for mobile phone payments. Fourth, DPL III was two years after DPL II and could not commit a new Government, which in practice is proving to be very different than the last Government. Fifth, the request for DPL III from the Government also included support for combating the adverse effects of the Global Financial Crisis on the financial system, which was unseen in 2004 but which were still an issue in 2010.

9 In the form of ESW, earlier loan appraisals and related due diligence investigations carried out by international firms (including BNP Paribas and Milliman working with local advisors). 10 Further details in Annex 14. 11 For more details on outcomes of loans classified under the FSB versus those in multisector loans with a financial sector component see IEG (2006), World Bank, p. 84.

11

Relevance of Risks Identified 44. Risks identified at appraisal were relevant, and mitigating factors were embedded in the design, but obviously the risks of the January 25 Revolution and its implications were not. At appraisal, there were two types of risks: (i) country risks, including political risk, stakeholders’ opposition, and fiscal sustainability risk; and (ii) operational risks, including the governance risks associated with restructuring and recapitalizing state-owned banks, and the risk of non-sustainability and reversibility of the reform program. The major risk at the time of appraisal was associated with the uncertainty in the political sphere—Parliamentary elections, in May and November of 2010, as well as Presidential elections that were to take place in September 2011. Although there were uncertainties regarding cabinet change, it was considered comforting that the CBE, the operation’s main counterpart, was a separate and independent entity and its Governor (whose term was scheduled to end in 2011, after the closing date of the operation) has been a strong advocate for and engineer of the current reform program. 45. The risk of having a revolution in Egypt was of course not envisioned at appraisal, nor by any analyst, but the operation did flag some political and governance risks at appraisal.12 As mentioned earlier, although there were several changes in Cabinets, Prime Ministers, and ministers, as well as heads of authorities, the central bank’s management has not changed. In fact the Governor of CBE was renewed for another four year term on November 2011. Fortunately, the operation’s main counterpart CBE remained unchanged after the revolution, although the whole political system in the country was revamped with the stepping-down of the former President, the dissolution of Parliament, and the appointment of an interim government. 46. Nevertheless, the success and sustainability of the financial sector policy reform hinges on a stable and predictable macroeconomic environment, which may be more difficult to sustain in light of the revolution and a new political regime. The risks associated with the January revolution were totally unexpected—and imply much greater risks for the sustainability of the results of operation than considered at appraisal. Post Revolution Risks and Potential Challenges for the Financial Sector 47. Despite the surprisingly good performance of the banking system during the global financial crisis and the problems arising from the developments in January–February 2011, various issues could arise during the coming period, until a new President is elected, a new constitution is in place, and the directions of policies become much clearer. These issues, discussed below, may affect both the financial sector reform program and, more generally, the financial sector’s ability to mobilize resources and intermediate them efficiently to support development. 48. Increased risks can be divided into risks to the financial reforms, including those supported by DPL III, and more general risks arising from macroeconomic deterioration. Regarding the risks to financial reforms, there are concerns of possible setbacks in reforms oriented towards private-sector led growth. The sentiments over the past year have been against privatization and sale of public assets. Even the sale of Bank of Alexandria, which was sold in October 2006 at well above its book value, was attacked by the media. This accompanied condemnation of some members of the private sector that are alleged to have benefited from improper behavior and, could lead to condemnation of a market oriented economy and private-sector led growth. The reforms that the Egyptian authorities have undertaken over the past years were based on solid analytical work that has been conducted jointly by

12 Refer to Annex 10 for more details on post-revolution risks and potential challenges for the financial sector.

12

Table 2: State-owned Insurer General and Administrative Expense Rates ( as a percentage of gross premium revenues)

2006/7 2010/11 Life activities (%) 10.2 13.5 Non life activities (%) 7.9 10.8

Source: Misr Insurance Holding Company (May 2012).

the IMF-World Bank, the 2002 FSAP and 2007 FSAP Follow-up, which was complemented by technical support and advisory services from development partners, including the USAID, EU and AfDB; based on international best practice. Hopefully, the new regime’s assessment of these policies will be based on their implications on the financial sector and Egypt’s growth and poverty reduction, and not their association with the previous regime. 49. Under populist pressure and condemnation of the private sector, a new government may be tempted to allocate credit to sectors considered more important or strategic. Although such a process may seem obvious to some, experience world-wide has shown that ultimately, it would add to the volume of NPLs; further limits the availability of funds to non-preferred clients; and require government injections of funds into the banking system, problems that were similar to those of the Egyptian financial system some years ago—prior to the financial sector reform program supported by the series of DPLs. The CBE has indicated clearly that they would not allow the allocation of credit on non economic or commercial viable terms. During the reform, CBE established the necessary grounds/fundamentals in terms of risk management, internal control environment and credit underwriting to ensure non-occurrence of extending loans to customers based on preference or subjective criteria. 50. More specifically, risks to the financial system reform and DPL III relate to the lack of passage of a number of laws. The dissolution of the Parliament delayed the issuance of several key laws. The newly elected Parliament faces an overload and may face major political challenges in any new directions it decides to make, in particular, legislation to improve the functioning of the financial system and making finance more accessible, particularly if it relates to greater private presence. This potential problem could affect the results of DPLIII in the areas of non-bank financial institutions (NBFI), licensing, the regulation of private pension funds, pre-paid healthcare companies, amendments to the Mortgage Finance Law and Financial Leasing Law, and the legal changes in the Principal Bank for Development and Agricultural Credit Law, which were approved by the Cabinet but delayed initially by a legislative backlog at the end of 2011 and subsequently by the post January 25 events, the dissolution of Parliament, and then the political overload in the new Parliament. 51. NBFI reforms also were slowed due to various reasons associated with the revolution, as well as the failure to replace the Minister of Investment. The Ministry of Investment and EFSA, sub-units initially were established to ensure the effective implementation of the various reforms related to the non-bank financial sector. However, this has not been slowed due to the revolution and several other factors. The move to a full risk based supervisory approach at EFSA has been disrupted by the voluntary departure of the first Chairman of EFSA, who could not be replaced due to the freeze on upper level appointments. Also, the Minister of Investment, the counterpart in the 2007 FSAP, resigned and was not replaced, even before the resignation of the previous government in February 2012, which affected the ministry and the non-bank financial sector. 52. The state-owned insurers currently have at least double the staffing levels they need to operate effectively and many staff are effectively non productive. Recent and imminent supplementary salary increases arising from decisions taken 5 years ago are increasing costs rapidly, and while expense rates are still sustainable and competitive thanks to the scale of the state insurers (Table A10.1) and branch rationalization, this trend cannot continue without affecting the long term viability of the two insurers; particularly if investment returns are under pressure. Defined benefits private pension funds will also see funding levels reduced materially if a combination of rapid salary increases and reduced returns continues for even a few years.

13

53. Possible loss of high quality staff in state-owned banks and CBE could occur, with the significant cut in their wages and change in management. Such staff is needed to run the improved lending processes and enhanced risk management techniques that were part of the reforms. With the operational and institutional restructuring of the state-owned banks, high caliber staff was recruited and potentially competent staff was trained and well compensated based on performance. Hence, staff quality improved significantly to operate the much improved processes for lending and for risk management in general, as well as the regulatory and supervisory processes of the CBE. These improvements have played an important role in reducing the system’s NPLs. A risk exists that these qualified personnel might leave and take positions in international banks outside Egypt if their real salaries in Egypt are reduced or working conditions deteriorate. The departure of these personnel would, in turn, contribute to a return of NPLs and a further limit on the banks’ capacity to lend. More generally the lack of certainty regarding future government policy, combined with frequent requests to provide information arising from public complaints, is distracting key officials in the government and SOEs and making some vulnerable to approaches from other countries in the region that are experiencing severe shortages of qualified people. 54. A major macro-financial risk issue is the potential for inflation, damaging to the poor and the financial sector, and “crowding-out” of credit to the private sector by government deficits borrowing. The higher government deficit and the sell-off of its bonds indicate the risk of pressures on the central bank to finance and monetize the deficit creating inflation, and for public sector borrowing to crowd out bank lending to the private sector. If the government spends beyond its revenues from taxes and fees, plus its international funding from grants and borrowing, then it must borrow from the domestic economy, largely the banks, thereby crowding out private borrowing. In order for private activity to expand, whether in micro-, small-, medium- or large-enterprises, the government must allow room for bank loans to the private sector. 55. An increase in NPLs in the banking system is likely following the contraction in economic activities and the aftermath of the revolutionary turmoil, particularly if low growth continues. A key sector that has been significantly affected is tourism but construction, mining, and manufacturing have also suffered. Tourist arrivals and hotel occupancy fell substantially in what is normally the “high” season. Construction and demand for investment goods are likely to be lower as a result of uncertainty regarding the policy stance of the new Parliament and the new President.. The operational capacity of the factories of the groups that came under investigation as a result of the revolution has so-far not been affected as they continue running under the management of technocrats. However, they have been affected negatively by the economic situation and the political uncertainty. This could have negative implications on performance of the loans of borrowers in these sectors. Concerns over transfers of property or takeovers of assets could also lead to higher NPLs. The stress testing conducted by the CBE in April 2011 showed that the bank’s capital cushion would be able to absorb such an increase. The CBE is closely monitoring and supervising all banks to ensure that any financial weaknesses are addressed in a timely manner. Nonetheless, risk remains associated with macroeconomic developments, particularly if growth remains low for a prolonged period or government policy and changes in the political environment lead to generalized defaults by borrowers. 56. A significant macroeconomic risk to insurers and pension funds in the medium-term is that rates of investment return drop, and in the case that Misr Life state employee salary costs increase rapidly at the same time, adding significantly to the need to strengthen retirement fund group life reserves for certain categories of state employee. The contribution of investment income to insurers’ results has already reduced (the return on investment for the state-owned insurers dropped from 13.8 percent in 2006/7 to 8.5 percent in 2010/11 despite improved debtor ratios), although steps are being taken to counter this by, for example, moving terms deposits into government paper and reducing equity exposures. The maximum salary issue is not currently a problem for the management of state-owned insurers because reasonably high minimum salaries apply. However any moves to

14

further reduce salary caps could see a significant loss of critical skills and experience. EFSA is likely to see some losses as some senior officer’s salaries have been savagely cut. Banks’ profits are likely to be lower with the rise in the expense ratio of banks due to the rise of staff salaries across-the-board. The government increased nominal salaries in the public sector and pensions by 15 percent, effective April 2011. This increase was followed by demands for similar or greater increases in the financial sector. Total increases in banks’ personnel costs have ranged from 15 to 30 percent. These increases not only reduce banks’ earnings and their ability to continue increasing capital but contribute to cost pressures that may lead to further demands for nominal adjustments in the coming months. Personnel costs are likely to rise as a result of the higher labor costs that followed the government’s announcement of a 15 percent increase in wages, salaries and benefits for its employees and the settlement of strikes in individual banks, in some cases at even higher increases. Revenues are likely to be negatively affected by the lower demand for investment and lower GDP growth. In addition, the higher NPLs noted above will require more provisioning. All this along with a possible decline in revenue could lead to a drop in banks’ profitability and earnings ratios. 2.3. Monitoring and Evaluation (M&E) Design, Implementation and Utilization 57. M&E design. A set of qualitative and quantitative intermediate outcome indicators were defined to monitor progress towards the achievement of the Program Development Objectives (PDO). The M&E framework was established during the design of the operation for the clear purpose of monitoring progress against the agreed upon benchmarks as outlined in DPL III Operational Policy Matrix (see Annex 4). These indicators were selected in agreement with government counterparts, taking into account the availability of data, their relevance and feasibility. 58. Qualitative operational expected policy outcomes were selected to monitor progress in the execution of the Financial Sector Reform Program and the operation. Quantitative indicators were selected in areas where data was available, such as: (i) performance indicators of commercial and specialized state-owned banks, such as NPLs-to-total loans, provisions-to-NPLs, capital adequacy ratio, coverage ratio; (ii) 100 percent of Egyptian banks have adopted the Basel II framework; (iii) improved transparency of risk recognition in the financial system through broader communication with the financial community by the publication of a Financial Stability Report, and conducting regular stress-testing; (iv) performance indicators of the insurance sector and the capital market, such as gross non-life premium to GDP, the number of mutual funds, new bond issues; (v) issuance and enactment of Law 10 of 2009, as well as improved performance indicators for NBFIs; (vi) individuals receiving government payments through financial institutions; (vii) mobile phone payments transactions and mobile phone payment products launched. 59. M&E implementation. Data availability was adequate to follow up on the policy dialogue initiated during preparation of the operation. The program was jointly implemented by CBE and the Ministry of Investment. CBE was the Executing Agency for the aspects of the program dealing with the banking sector. Within the CBE, a Bank Restructuring Unit (BRU) was set up as the focal point for implementation of banking reforms. The BRU, headed by the Deputy Governor, a former international banker, is staffed with highly qualified and experienced professionals, many of whom were specially recruited for the purpose of implementing the banking reform program. At the Ministry of Investment, EFSA was responsible for implementing measures related to the non-bank financial sector. 60. Monitoring of the implementation of the operation was done regularly from the field, due to the fact that the TTL of the operation is field-based. The supervision from the field provided therefore an important channel through which the World Bank team was able to continue to support and advise the government on the next steps. Also, missions were equipped with high- level international experts. These missions provided sound technical advice to the authorities. In addition, the team was

15

responsive to clients' needs and changes in the market after the revolution, and shared their expertise with authorities to mitigate all unexpected risks. Post-revolution, an emergency supervision mission took place to guide authorities on means to mitigate unexpected risks associated with the revolution, and might emerge with the political and economic developments. 61. M&E utilization. Armed with the information collected from the first ever independent financial due diligence of the state-owned banks exercise, the Bank in coordination with the BRU was able to follow up on the implementation of the plans to restructure the state-owned banks and enhance their governance structure. Specific indicators were designed and monitored through meetings with the state-owned banks’ management to monitor progress in cleaning up the balance sheets, upgrading their IT systems to prepare them for the new competitive and risk management environment. The Bank’s supervision mission’s discussions with the BRU and the state-owned banks also helped the Bank’s staff monitor progress in implementing these restructuring plans and to pave the way for more reforms in the future. The most important element of M&E utilization was post-revolution. This is when there was an urgent need to closely and adequately monitor the performance of the financial sector during the political and economic crisis. The monitoring indicators developed with the World Bank support helped significantly the authorities in mitigating the risks. For example, the World Bank team moved promptly with a mission of experts to help the central bank in conducting stress testing, and in developing the model to include more projections and different scenarios to enable CBE to address any problems at an early stage. 2.4. Expected Next Phase/Follow-up Operation (if any) 62. In response to the Arab Spring, the Bank has articulated a Framework for Engagement in the MENA Region that proposes to do things differently and to provide support that could not be provided before. Given the political and economic uncertainties facing Egypt in the near term, the Bank presented an Interim Strategy Note (ISN) as an indicative program of support over an 18-month period, June 2012 through December 2013. The main focus of the three pillars of this ISN are economic management, jobs, and inclusion. The ISN does not envision a financial sector operation in the transition period. 63. A follow-up operation with a special focus on improving the efficiency and outreach of the NBFI sector, and enhancing the capacity building of its presently poorly structured regulator is expected. This would include a comprehensive agenda for the development of non-bank financial institutions and securities markets, with the objective of building a more diverse and balanced financial system, capable of providing a broader range of financial services to a wide range of clients while managing risks effectively. DPL III has paved the way and built a platform for such an operation to occur, when there is greater clarity regarding the political landscape after Presidential elections planned for May through June 2012. 3. Assessment of Outcomes 3.1. Relevance of Objectives, Design and Implementation 64. The main objective of the operation, as mentioned earlier was to assist Egyptian authorities in further developing the enabling environment for financial intermediation and financial access, and increase private participation in the provision of financial services, through a strengthened bank and non-bank financial system by supporting the Government’s second generation Financial Sector Reform Program of 2009–2012 (DPL III PAD, p.31). The second generation Financial Sector Financial Reforms aimed at building up a financial system that would be stronger and more effective in financial intermediation, competitive, and inclusive, This system would contribute to Egypt’s growth performance and improve access to credit and financial services, for a broader segment of Egypt’s population, and combat the adverse consequences of the global financial deleveraging and resultant economic crisis, as requested by the government. By providing support to the second

16

generation of the reform program, this operation contributed to the sustainability and continuity of financial reforms and, therefore, to the fulfillment of their final objectives. 65. The design of DPL III was highly aligned with the country’s priorities and CAS. The operation was also designed in a truly participatory way through frequent meetings with all key stakeholders and technical counterparts in the government, state-owned financial enterprises, private sector, academia, and regulatory bodies, which ensured ownership and commitment; in addition to other market players; and stakeholders. 66. The objectives continued to be relevant at ICR preparation as follows:

DPL III is consistent with the strategic objectives of the 2008 Country Assistance Strategy Progress Report and is aligned with the Bank Group’s 2007 Strategy for the Financial Sector, which emphasizes the use of Bank policy-based lending in support of market reform and the strengthening and expansion of access. The Egyptian authorities’ have shown a commitment, both before and after the revolution, to financial sector reforms, as they are demonstrably linked to growth and poverty reduction, as well as addressing governance and transparency issues. They are fundamental to reforms in other sectors as well, including private sector development, infrastructure, housing and social policies, being inherently integrated with national pension and health social insurance reform. Strengthened regulation and supervision and financial infrastructure act as a steady promoter of financial growth, economic growth, and poverty reduction and reduces the frequency and cost of financial crises—as evident in the Egyptian financial sector’s weathering of the global financial crisis and the Euro-zone crisis, and overcoming the immediate impacts of the revolution. The mitigation of the effects of financial crises is essential for preventing major economic crises, social unrest, and poverty reduction. Further reforms in the financial sector, especially post-revolution, could be pursued under future operations. Building a sound, competitive, and inclusive financial system is a long-term endeavor that requires years of reforms and implementation to fulfill the objectives fully.

67. Thus, the relevance of objectives, design and implementation is considered satisfactory, based on: (i) the consistency of the program with government and Bank priorities; (ii) quality of the design, with a clear focus on the resolution of the problem of NPLs, the financial and operational restructuring of state-owned commercial and specialized banks, the strengthening the non-bank financial sector while improving its efficiency and competitiveness, improving the overall financial infrastructure, and strengthening of the legal, regulatory and supervisory capacity of the banking sector and the non-bank financial sector; and (iii) adequate implementation, that resulted in increased sustainability of supported reforms, as evident in the resiliency of the financial sector in weathering the economic crisis and the immediate impacts of the revolution. Egypt’s commercial banks seemed well capitalized after the revolution, as evidenced by the CBE’s severe stress testing. The capitalization of banks was high at the end of December 2011—15.6 percent of risk weighted assets compared to 10 percent required, which acted as a cushion in times of crises. A severe stress test performed in 2011 by CBE where the loan portfolio was down-graded by two notches; bank profits cut by 25 percent, and the value of collaterals by 50 percent, indicated that the Tier one capital ratio would still exceed 11 percent. 3.2. Achievement of Program Development Objectives Achievement of Development Program Objectives is considered satisfactory 68. Significant progress has been made in the implementation of the second generation reforms supported by the operation. Key achievements are listed in Annex 8. However, the revolution and it

17

effects were unforeseen, and there were a number of other unexpected developments after Board approval of DPL III in May 25, 2010. These developments had implications for both the banking and non-bank sectors, as well as for the regulatory and supervisory framework and financial infrastructure development. They include delays on the non-bank financial institutions front, due to the fact that the Minister of Investment has not been replaced since his resignation in September 2010 and the unexpected voluntary departure of the first Chairman of EFSA. Parliamentary passage of certain laws and amendments that had been approved by the Cabinet (the NBFI law, legal changes that reformed the Principal Bank for Development and Agricultural Credit, regulation of private pensions, and amendments to the Mortgage Finance Law and the Financial Leasing Law) was delayed by the overload of Parliament in the second half of 2010 and the dissolution of Parliament after the revolution, and are expected to be further delayed by the overloaded agenda of any new Parliament. 3.3. Justification of Overall Outcome Rating Rating: Satisfactory 69. The overall outcome rating for DPL III is “satisfactory” based on meeting its key development objectives, in making all the achievements listed in Section 3.2, and more broadly avoiding a systemic financial crisis — although a force majeure event, the revolution, took place. 3.4. Overarching Themes, Other Outcomes and Impacts Poverty Impacts and Social Development 70. Though DPL III did not have explicit social development outcomes as objectives, clearly the shift from a public to a more market-oriented financial system with strong regulation and supervision is expected to have a direct and positive impact on growth, employment, and crisis prevention, while also increasing access of various social groups, including the poor, to financial services. Recent evidence has shown that a developed financial system can help reduce poverty and income inequality. Through its effect on growth, a mature financial system can also help reduce poverty, through the strong, causal relationship between the depth and reach of financial systems and economic growth. 71. Restoring the soundness of the state-owned insurance companies and increased innovation and competition in the sector is enabling the industry to provide better quality products at a more reasonable price. The measures aimed at addressing the soundness of private pension funds and strengthening of the supervisory framework for NBFIs will ensure that the interest of retirees are protected in the future and that their savings are well managed. 72. Also, the policy measures outlined in this operation would improve the opportunities for SMEs and for low income individuals to gain access to financial services, including female-headed enterprises and for women. Mobile phones will provide a low-cost point of access for financial services, which will benefit women due to the low barriers to entry in terms of cost, distance to travel, and paperwork. In addition to better access to finance, women will also be brought into the financial system through the government’s drive to offer pensions and public sector salaries through bank accounts. Institutional Change/Strengthening 73. DPL III had, and will continue to have, a substantial institutional development impact in the financial sector even though it was a single-tranche operation. The policies supported by the program are rapidly transforming the Egyptian financial sector. Substantial capacity building provided to CBE, is modernizing this institution while introducing state of the art risk management tools and IT systems and will lead to the emergence of a robust bank supervisory and regulatory capacity in the country. 74. The state-owned banks have undergone major reforms, which have significantly improved

18

their performance.. The comprehensive financial and operational restructuring of the state-owned banks is modernizing these banks and enhancing their operating environment thereby contributing to enhancing their capacity to increase intermediation and improve savings mobilization. Substantial staff training sector wide, in and outside Egypt, will have a long lasting impact and will develop a pool of financial skills hitherto not abundant in Egypt, thereby contributing to the sustainability of the reforms. 75. Further institutional strengthening is required for EFSA, where reforms effectively stalled after the revolution, although insurance and pension supervision are now operating on a much more professional basis than at the beginning of the reform program. Further support will be required if EFSA is to develop the capacity to produce useful risk ratings for the institutions over which has oversight responsibility. Other Unintended Outcomes and Impacts

Not applicable

3.5. Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops Not applicable

4. Assessment of Risk to Development Outcome Rating: Substantial

76. Despite the strong performance of the CBE and the resiliency of the financial system that had been supported by DPL III and the earlier DPLs, which have so far avoided a bank run and systemic financial crisis; the unforeseen events of the Egyptian Revolution, which began in January 2011 and the current Euro-zone crisis, have substantially worsened the risk to development outcomes, compared to the assessment risks at loan appraisal. Financial rating agencies also have down-graded Egypt’s ratings since the revolution. The events that led to these risks were unseen by all observers. These resulting unforeseen risks were not taken into account during the appraisal of the operation (unlike other risks that were foreseen during project preparation, and appraisal, and their mitigation measures were considered and means of mitigation were identified). However, the Bank team has adjusted to the new circumstances and will prompt support the authorities in mitigating the new risks. 77. The revolution that began in Egypt in January 25, 2011, the subsequent developments associated with it, as well as the current uncertainty has led to opportunities as well as a number of challenges. As discussed earlier in some detail, these developments had a major bearing on the future prospects for the economy, and the financial sector, and accordingly represent potential risks to the operation’s sustainability. Clearly the change of regime and the uncertainty surrounding the interim administration and the new government and constitution make it difficult to chart out progress and the risks to it. As noted earlier, it is useful to separate the risks into macroeconomic risks that could affect the financial sector, and risks that are specifically related to the financial sector. These two types of risks are discussed below generally; a more extensive discussion, with more specific examples, is contained in Section 1. 78. Risks of a Deteriorating macroeconomic environment. The macroeconomic environment is critical for the stability of the financial sector. Hence, the faltering growth following the global crisis and the further slowdown post-revolution will have implications on the operation. So far, the authorities have managed to mitigate some of these risks. Nonetheless, the slowdown is likely to lead to a rise in NPLs, and deterioration in the asset quality of banks, especially in the most affected sectors such as tourism and construction. It is also likely to reduce demand for loans by the private sector. In addition, the worsening deficit of the government raises a) risks of inflation, from monetization of the

19

deficit by government borrowing from the central bank and any depreciation of the exchange rate when international reserve sales are no longer to able to support it, which will hurt the poor and the financial sector, and b) risks of crowding-out bank lending to micro-, small-, medium- and large private enterprises because the government sells more bonds to the banks, a risk that has already occurred as discussed in Section 1. This development has already had a major negative impact on achievement of DPL’s goal of greater intermediation of deposits to private borrowers by the banks. 79. Risk from the Erosion of international reserves and ratings downgrades. Substantial and continuous erosion of Egypt's international reserves had taken place in 2011, however they have begun to increase in April 2012. It accelerated in October and November 2011, along with ongoing political turbulence which is delaying economic recovery and has contributed to worsened debt dynamics. CBE has announced that net foreign reserves had fallen to reach US$15.5 billion as of May 2012 (compared to US$ 36 billion in December 2010). Foreigners’ have largely liquidated their holdings of T-bills, which in turn has led to compensating government sales of its debt to the banks, furthermore capital outflows from T-bills have already bottomed which therefore alleviates further pressures on International reserves from the capital account Egyptian sovereign ratings and banks’ ratings (which generally must be worse than the sovereign rating), have been downgraded by three rating agencies. 80. Direct risks to the financial sector. The lengthy transition to the new political regime, as well as the new Parliament and the new president and the new constitution (drafters have recently been chosen by the Parliament) already have and can have future major effects on the financial sector. As noted numerous important laws for financial reform associated with DPLIII were not passed by Parliament by because of its dissolution and its substantial overburdening with formulation of the new regime. These laws or similar laws may not be passed. More generally, although Parliament seems to appreciate the strong resiliency of the financial system to the changes in Egypt and the slow-down in Europe, it may adopt a new approach to finance, for example, with less emphasis on the private sector, controls on interest rates and increased government allocation of credit. The revolution has brought tremendous political uncertainty for investors, and a new government will need a clear, market-friendly strategy based on inclusive consultation to restore clarity and confidence, while enhancing opportunity for new investors. 5. Assessment of Bank and Borrower Performance 5.1. Bank Performance Bank Performance in Ensuring Quality at Entry

Rating: Satisfactory

81. Bank performance is rated as satisfactory, for the following reasons: (i) the project team paid particular attention to ensuring high quality at entry for this operation. The loan identification and design were consistent with the CAS Progress Report, and the recommendations put forward by the 2002 FSAP, and the more recent 2007 FSAP Update (which was conducted after DPL II); (ii) the Bank was instrumental in taking full advantage of a window of opportunity presented by the reform-oriented Governor of CBE that led to this major progress on financial sector reform outcomes and strengthening of the financial system; (iii) sound preparatory work, strong policy dialogue, good working relationships with government counterparts, high level of consultation with market participants, and Bank expertise led to the design of this operation; and (iv) the close coordination with the USAID, IMF, EU, AfDB and other development partners, which ensured synergy that helped the authorities build the necessary capacity to implement the project.

20

Quality of Supervision

Rating: Highly Satisfactory 82. Bank supervisory performance is rated as highly satisfactory. The supervision has gone beyond the regular oversight of the project implementation, and provided advisory services and guidance to the government on how to deal with the unforeseen risks associated with the unexpected revolution of 2011. Monitoring of the implementation of the operation was performed regularly from the field, in addition to conducting missions comprising high level international experts. These missions provided sound and timely technical advice to the authorities. The supervision provided therefore a crucial channel through which the World Bank team was able to continue to support and advise the government on the next steps. Post-revolution, an emergency supervision mission was conducted in May 2011—right after missions were allowed to resume work in Egypt. The policy dialogue continued with official counterparts throughout supervision and afterward, despite change in regime and government.

Justification of Rating for Overall Bank Performance

Rating: Satisfactory 83. The rating of satisfactory is based on the following considerations: (i) the project was very well designed, its PDO was in line with the Country’s and the Bank’s priorities, the intermediate indicators were relevant and, helped focus the supervision; (ii) the Bank was aware of the challenges involved in addressing the restructuring of major financial institutions so it adopted a flexible results based framework and a risk mitigating strategy, in consultation with the authorities, who remained committed to the implementation of the reforms despite the attendant high political risks; (iii) from identification to closing, the team was extensively involved in a policy dialogue with the authorities and independent counterparts (even after the revolution and change in political regime), collaborating to ensure that strengthening the enabling environment for financial intermediation, resource mobilization and risk management, and increasing the private sector role and participation in the provision of financial services would be achieved; and (iv) the project team and the country office developed a high level of cooperation that played a key role in the success of the operation.

5.2. Borrower Performance

Government Performance

Rating: Satisfactory 84. From the design to implementation stage, the government was in the “driver seat” of seeking advice from the Bank where needed to implement its strategic reform agenda. The authorities remained focused on the success of the financial development objective as they recognized its important contribution to economic growth and improving Egyptians’ living standards. In this context, the Government took the initiative to seek support from other donors according to their respective comparative advantage, and was keen on ensuring good coordination between the various partners. The Bank was requested to play a lead role succeeded in getting the best out of each donor’s support and avoided waste that comes from unclear donors mandate and overlap. The donors coordinating committee, chaired by the Bank, also helped the Government address key financial sector issues on a timely and priority basis. 85. The authorities’ commitment to the reform program remained post-revolution. The CBE proceeded with reforms in the banking sector in a timely manner. In some areas, such as banking supervision and the adoption of a more advanced stress testing model, measures were advanced earlier than planned, because of their urgency. The issuance of the Code of Corporate Governance was speed up in response to the market demand for transparency and good governance. Requesting disclosure of salaries of the top 20 staff in all banks was in response to the demonstrations of the banks’ staff. All of foregoing reforms show that the CBE did react to the changing environment and the new priorities.

21

The Central Bank, Banking System, and Money Law 88 of 2003, strengthening the governance of the central bank itself, was one of the few laws issued by SCAF, as the Governor managed to make a good case of the importance and the urgency of having a financial system that is operational with good governance and in a transparent manner.

Implementing Agency or Agencies Performance

Rating: Satisfactory 86. The CBE and Ministry of Investment/EFSA were the two agencies responsible for the design and overall implementation of the operation. The BRU and the Banking Supervision Department at CBE were in charge of the implementation of the reforms, including at its head the Governor of CBE and his two deputies, were instrumental to the success of this operation. They were systematic in the way they went about designing the blueprint for the reforms, and seeking advice from the Bank and other donors, at critical junctures to keep the implementation moving and get support and advice when they encountered major challenges. In addition, most of the improvements in financial sector infrastructure were carried out by the CBE. 87. The CBE was highly successful in not only keeping reforms moving, but in using results and techniques related to the DPLIII to avoid bank runs and a systemic financial crisis after January 2011. Specifically, banks had become stronger in terms of higher capital, lower NPLs, and greater provisioning before January 2011. The CBE used stress tests and macro-prudential supervision to assess the risks to the system from the crisis. The CBE appropriately closed banks in January when public security was threatened, then, when it reopened the banks, appropriately provided liquidity as needed and issued circulars controlling the amount of daily cash withdrawals and the amount of foreign currency transfers. 88. EFSA, under the Ministry of Investment, was in charge of coordinating the reforms of NBFI. The actual reforms were undertaken by the Insurance Holding Company with its competent chairman, who managed to reforms the state-owned insurance companies after many years of status quo. The reporting and coordination of actions between the concerned agencies was efficient and timely throughout the life of the project, preparation, appraisal and implementation. Their availability and knowledge of all the program benchmarks allowed for a timely presentation of this operation to the Board. However, non-bank reforms did not occur at the same pace as bank reforms. Major laws were not passed by the Parliament in the non-bank financial sector. As noted, these laws were not passed because of the Parliament’s over commitment, and then its dissolution. In addition, the Minister of Investment resigned in September 2010 the chairman of EFSA departed, without replacements.

Justification of Rating for Overall Borrower Performance

Rating: Satisfactory The rating of satisfactory is justified by the following:

The government of Egypt demonstrated clear ownership of the operation. The respective responsibilities of the different stakeholders were clearly defined reducing to a minimum the potential for overlap or misunderstandings.

The reform program reflected a clear and complete vision of the needs of the financial sector. It was complete, comprehensive, articulated around the most important issues and sequenced according to priorities.

The government of Egypt, and the CBE specifically, were very instrumental in keeping the momentum of the financial reform agenda and the operation moving forward —even after the revolution, and were highly successful in avoiding a bank run and a systemic banking crisis. . This was no small task given the comprehensiveness of the reform and the scope of the operation, especially given such a difficult political environment. This was mainly due to the fact that

22

extensive consultations with the stakeholders took place before the launch of the program, which built consensus.

Having a champion, such as CBE that is empowered and more important that is technically competent to successfully build consensus around the program, and defend it in difficult times of political and social unrest, demonstrations, strikes, and when past reforms were questionable was key. In the NBFI area, progress was slowed by departures and resignations, without naming of replacements, and by inability to push legal changes to passage before parliamentary dissolution.

However, although the CBE’s performance highly satisfactory, as evident in the successful completion of the reform program, and its effective responsiveness and ability to mitigate the risks associated with the global financial crisis, as well as the recent revolution, a highly satisfactory rating could not be justified for EFSA, the other counterpart, that has not performed as well as a result of its need of a great deal of capacity building. But despite numerous challenges faced, EFSA is keen on a continued cooperation with the World Bank with regard to developing further the financial sector in Egypt.

6. Lessons Learned13

Strong analytic underpinning and building on other operations. The 2002 FSAP, and its 2007 Update, helped create a credible blueprint for the design of this operation. Consultations with stakeholders. Reforms have been undertaken after a process of close and continuous consultation with all stakeholders. 89. Effective cooperation with development practices. The Bank team worked in partnership with USAID, EU, IMF, and AfDB. The respective responsibilities of the different donors and development partners were clearly defined. Strong and sustained partnership. The close working relationship with the Egyptian authorities and implementing entities demonstrated that significant reforms were implemented, backed by a strong leadership and political commitment. 90. The design of the policy matrix is key to the sustainability of the reforms. A well-defined policy matrix owned by the government and endorsed by the Bank and partners is an essential implementation roadmap for the authorities to move the agenda forward

Having a champion in the government that is competent enough to coordinate efforts with other implementing entities. Having a government entity or authority that is empowered and competent enough to successfully build consensus around the program, and defend it in difficult times of political and social unrest is critical. The single tranche DPL III proved to be a suitable instrument for the Borrower and the Bank. It responded effectively to the needs of the authorities by providing them timely support based on clearly established prior actions. 91. Lessons Learnt from this operation can be disseminated at knowledge management events. The experiences in the preparation and implementation of the operation could be shared with other regions through various means, including the Finance and Private Sector Development (FPD) network monthly newsletter, as well as through hosting a brown bag lunches (BBL).

7. Comments on Issues Raised by the Borrower/Implementing Agencies/Partners

92. The Egyptian authorities were appreciative of the support provided by the World Bank. The authorities rated the World Bank's performance during the operation as overall highly satisfactory as

13 Refer to Annex 16 for further details.

23

indicated in Annex 2. The operation witnessed close coordination and communication with the implementing entity and the relevant officials, and they acknowledged that the day-to-day support and close supervision of the operation from the field has helped in ensuring successful implementation. The government also clearly stated that they greatly valued the technical assistance and advisory services packaged with the loan. 93. Moreover, various donors, development partners, and international institutions have been providing support for the implementation of the government’s overall financial sector reform program through the provision of technical assistance, and analytical work on reforming and restructuring the financial sector. This required effective coordination, which the Bank led in chairing the Financial Sector Donors Subgroup. This cooperation led to mutual design and agreement of conditionality issues that all donors agreed were essential for financial sector reform. In addition, donors were able to do a much better job of leveraging resources, both loan and technical assistance, when coordination is effective. The most effective and successful coordination was with USAID, IMF, AfDB, and the EU. More details are included in Annex 3.

24

Annex 1: Bank Lending and Implementation Support/Supervision Processes

a) Task Team Members Names Title Unit Responsibility/Specialty

Lending and Supervision Sahar Nasr Lead Financial Economist MNSFP TTL

Santiago Herrera Lead Country Economist MNSPR Macroeconomic framework

Patrick Conroy Program Director and Senior Adviser FCMDR NBFIs

Rodney Lester Insurance Sector Expert MNSFP Insurance sector

William Mako Lead Private Sector Development Specialist MNSFP Capital market

Xavier Reille Manager IFC Access to finance

Didier Debals Banking Sector Expert MNSFP Banking supervision

James Hanson Banking Sector Expert MNSED Banking restructuring

Mohammed Khaled Senior Operations Officer IFC Access to finance

Gustavo Demarco Senior Economist MNSSP Pension reforms

Murat Arslaner Financial Sector Specialist FFSAB Banking supervision

Laila Abdelkader Financial Sector Specialist MNSFP Financial Sector

Jesus Saurina Banking Sector Expert MNSFP Stress-testing

Steve W. Wan Yan Lun Operations Analyst MNSED Operations

Amira Zaky Program Assistant MNC03 Operations

Marwan Ezz El Arab Program Assistant MNCO3 Operations

(b) Staff Time and Cost

Stage Staff Time and Cost (Bank Budget Only)

No. of staff weeks USD Thousands (including travel and consultant costs)

Lending FY10 18.15 213,600 FY11 1.53 10,700

Total: 19.68 224,300

Supervision/ICR FY11 9.95 100,300 FY12 6.88 24,500

Total: 16.83 124,800

25

Annex 2: Summary of Borrower's ICR

A. Introduction The Egyptian financial system, dominated by the banking sector, has resisted very well both the global economic crisis and the more recent Arab Spring turmoil and the January 25th revolution, maybe even when compared to other countries in the region. Comprehensive financial sector reforms over the past seven years with World Bank support, led to a substantial strengthening of the balance sheets of the banks, as indicated by a risk-weighted capital-asset ratio that rose from 14.7 percent in 2006 to 16.3 percent in 2010 and a loan to deposit ratio has declined to about 51.8% in FYE 2010—typical of countries that have gone through extensive financial restructuring. These ratios show that Egyptian banks enjoy comfortable liquidity levels. The financial sector reform program aimed at creating a sound and diversified financial sector, capable of contributing to Egypt’s growth performance and providing access to financial services to a much broader segment of the Egyptian population. The main components of this program included the empowerment of the private sector in the provision of financial services, the development of effective bank and non-bank institutions providing a wide range of financial services, and the strengthening of financial infrastructure and the regulatory and supervisory framework. This entailed strengthening the institutional framework and the overall environment for financial intermediation, resource mobilization and risk management. The World Bank's Financial Sector Policy Loan (III) was affected to evidence the continuing support to Egypt. B. Assessment of the operation's objectives, design, implementation, and operational experience: The main objective of the operation was to continue supporting Egyptian authorities in further developing the enabling environment for financial intermediation and financial access, and increase private participation in the provision of financial services, through a strengthened bank and non-bank financial system. This operation aimed at building a financial system that is more inclusive, competitive and effective in financial intermediation.

Arab Republic of Egypt

26

The operation's design and implementation was agreed to be as a single disbursement of the full amount of the loan in the amount of US$ 500 million. This came into effect in view of a series of prior actions that have been concluded. C. Assessment of the outcome of the operation against the agreed objectives:

The loan objectives were satisfactorily met. The reforms implemented have yielded some of the most impressive results Egypt has seen in the financial sector. These have included:

Progress in implementing the financial restructuring of the state-owned commercial banks, including the full settlement of NPLs of state-owned enterprises (SOEs) held by state-owned commercial banks—in addition to improvements in the institutional and operational restructuring fronts.

Strengthening the regulatory and supervisory architecture of the banking sector, evident in initiating the implementation of Basel II accords.

Strengthening CBE’s macroprudential supervision by conducting annual stress testing for the banking sector, and by preparing quarterly consolidated banking sector reports that will serve as the basis for the CBE’s Financial Stability Report.

Reforming the non-bank financial sector, and improving the legal and regulatory framework—enactment of insurance law, strengthening the regulatory framework governing collective investment vehicles, and the establishment of EFSA.

Improving the financial infrastructure, through strengthening the payments system infrastructure and promoting financial inclusion through establishing a real-time gross settlement system and automatic clearing house and extending their scope, as well as issuing new regulations on mobile phone payments.

Due to early reforms conducted, prudential regulations, and strong supervision, the Egyptian banking sector remained immune to the effects of the collapse of global financial markets, as well as the immediate impacts of the Arab Spring and the January revolution. The following summarizes the landmark developments accomplished during the early reform phases:

Divesture of state-owned banks’ shares in joint venture banks eliminating conflict of interest, and indirect state ownership and intervention. This succeeded in attracting foreign and regional strategic investments and inviting banking know-how by means of drawing regional and international strategic investors.

State control of the banking sector was reduced as indicated by the direct and indirect share of state-owned banks of banking system deposits which declined from over 70 percent in 2004 to 45.5 percent in December 2009. This was due to the privatization of Bank of Alexandria, and the divestiture of the state-owned banks shares in the joint venture banks.

The privatization of Bank of Alexandria was acknowledged as one of the most successful privatization transaction in the MENA region in recent years.

Dealing with weak banks by means of consolidations with larger banking institutions, which was instrumental in securing depositors’ funds, protecting the financial system and ensuring its safety amidst the financial crisis.

Consolidations were encouraged to create robust entities with strong management, efficient processes and proper financial coverage, whereby (i) the number of banks has declined from 57 banks in December 2004 to a current number of 39 banks; (ii) doubling the Banking Sector’s Net worth from LE 35 billion in 2004 to LE 70 billion in 2008 and (iii) increasing the number of operative branches from 1795 in 2004 to 2424 in September 2009.

27

Implementation of a complete operational and financial reform for state-owned commercial banks, whereby (i) recapitalization measures of state-owned commercial banks were taken based on results of an independent audit, due diligence and IFRS conversions from EAS and (ii) operational and structural reform was implemented for National Bank of Egypt and Banque Misr covering 3 backbone areas, namely HR, Risk Management, IT & MIS.

Setting a national policy for dealing with NPL’s to improve economic performance and enhance growth.

Upgrading the Banking Supervision Unit in line with international standards by implementing a risk based approach.

Completing operational restructuring of the newly merged insurance company (Misr Insurance Company). All legal requirements have been fulfilled, and branches merged.

Strengthening the legal regulatory and supervisory framework in insurance and pensions.

Improving the ability of capital markets to provide financing and capital market/corporate governance discipline through (i) the adoption of International Standards of Auditing (ISA); (ii) enactment of amendment to the Executive Regulations of the Capital Market Law (CML), enhancing capital adequacy requirements and risk management requirements for financial intermediaries; (iii) enactment of amendments to CML simplifying four listing schedules at the EGX; (iv) establishment of a new SME stock exchange (NILEX) and initial listing of several SMEs on NILEX; (v) better disclosure, legal and pricing clarifications, and reduced capital burdens for the sponsors of investment funds; and (vi) bettering supervision and market surveillance.

Issuance of Specialized Economic Courts Law.

The housing finance market witnessed significant progress on various fronts relating to property registration fees, efficiency of procedures for land registration, property valuation, and access to long-term credit and cost of funding. Twelve mortgage finance companies and Egyptian Mortgage Refinance Company are now operating in the market with around LE 4.5 billion extended as mortgage finance loans as of December 2011.

D. Evaluation of the borrower's own performance during the preparation and implementation of the operation, with special emphasis on lessons learned that may be helpful in the future: The operation witnessed a series of reform measures that focused on developing a sound financial sector. The majority of the concluded reforms were thoroughly discussed with the World Bank on various occasions. Moreover, they mostly converge with the IMF-World Bank FSAP 2002, and 2007 FSAP Update recommendations. There has been significant progress by the Egyptian authorities towards achieving the expected intermediate outcomes of the Financial Sector Reform Program (2009–2012), with regard to the five main pillars; namely: (i) financial and operational restructuring of commercial and specialized state-owned banks; (ii) strengthening the regulatory and supervisory architecture of the banking sector; (iii) reforming the non-bank financial sector; (iv) strengthening the regulatory and supervisory framework of the non-bank financial sector; and (v) improving the financial infrastructure. On the banking sector and non-bank sector, as well as on the regulatory and supervisory framework and the financial institutional environment, there have been various developments after Board approval in May 25, 2010. There has been some delays mainly on the non-bank financial institutions front, regarding measures that required passage of laws, due to the dissolution and reelection of Parliament members, post-revolution.

28

The strategic pillars of the financial sector reform program has led to:

Substantial improvement in key profitability and efficiency indicators of the state-owned commercial banks. The three state-owned commercial banks—National Bank of Egypt (NBE), Banque Misr, and Banque du Caire are the largest three banks in Egypt, accounting for about 48 percent of bank assets—have substantially improved their profitability, efficiency, and capital over the last three years. The reported ratio of capital to risk-weighted assets in all three banks now substantially exceeds the required 10 percent level. Moreover, as of the end-2010, provisions were equal to NPLs. The three banks, particularly NBE, have also increased efforts to recover on NPLs. The reported reduced rate of NPLs, the increased coverage of provisions, and the recovery on some NPLs, including those of the SOEs, have all contributed to the need for less provisioning and thus higher profits.

Adopting and enhancing corporate governance best practices and regulations within the banking system. The CBE Board of Directors Circular of July 5, 2011, announced the corporate governance regulations and code that the banks should comply with and abides by. Strengthening the governance and enhancing the transparency of the banking sector are key priorities of the CBE’s agenda. CBE has also amended the Central Bank, Banking System, and Money Law 88 of 2003 in October 8, 2011, introducing changes regarding improving CBE’s own governance, reconstituting its own board of directors to remove conflicts of interests, and tightening supervisory capacity and processes.

State-owned commercial banks’ financial statements fully reflect bank net asset values and economic position in line with International Financial Reporting Standards (IFRS).

Implementation of a program of institutional and operational restructuring for the state-owned specialized banks. The CBE has been involved in programs of restructuring with the state-owned specialized banks, but the restructurings and recapitalizations have been slowed recently by developments related to the revolution.

CBE has continued the implementation of the Basel II project, including preparing guidelines for achieving the drafting of regulations in line with Basel II framework. Despite the recent events, CBE is maintaining the momentum of further strengthening its capabilities to perform an effective risk-based supervision.

Preparing and presenting to the CBE Board a full-fledged Financial Stability Report based on the CBE’s assessment of overall risks in the financial system facilitate the early detection of changes and vulnerabilities in the financial system.

Stress testing became an integral part of the CBE’s systemic surveillance of the banking sector.

Adopting an initiative promoting the development and growth of banking activities/services catering for various sectors especially the SME sector.

Expanding the activities of the financial institutions in remote areas to provide credit and other financial services for SMEs.

Strengthening the regulatory and supervisory Framework in the Non-Banking Financial Sector via the establishment of the Egyptian Financial Supervisory Authority (EFSA) consolidating the regulatory bodies of non-bank financial services, markets, institutions, and developing the regulatory framework for the NBFS to ensure the stability of the financial sector, by moving from a rule-based to a risk-based regulatory framework.

Developing the financial culture and raising public awareness of investment and financial services, and associated risks and returns associated with their investments.

On the non-bank front, EFSA has undertaken several reforms during the past year post revolution despite all the numerous challenges faced. Actions were as follows:

29

The first organizational chart of EFSA has been approved in 2011, where EFSA was able to fully integrate its departments based on functions.

The supervision department has undergone restructuring.

The salary scheme of all EFSA employees has been restructured to guarantee a leveled and fair compensation to all employees.

EFSA has succeeded in unifying the regulations and disclosures throughout the nonbanking financial sector.

EFSA has contributed substantially to reducing any systemic risk after the revolution and reopening of the Egyptian Stock Market.

E. Evaluation of the performance of the Bank, any co-financiers, or of other partners during the preparation and implementation of the operation, including the effectiveness of their relationships, with special emphasis on lessons learned: The World Bank's performance during the operation was overall highly satisfactory. The operation witnessed close coordination and communication with the relevant Bank officials, and special acknowledgment should be given to the efforts of the field team, especially the Task Team Leader during the preparation and supervision. The team showed a remarkable deal of diligence and technical support for the responsible authorities throughout the operation. The presence of the TTL on the ground during supervision provided effective communication and ensured all required and expected intermediate outcomes where duly met, especially post-revolution. The two emergency supervision missions held were of great support to the Egyptian authorities. The World Bank also conducted close coordination efforts with other donors who are actively involved in the financial sector reform including the IMF, EU, USAID and AfDB. F. Description of the proposed arrangements for future operation of the project: Despite recent events associated with the transitional period after the January revolution, there is a commitment from the side of the Egyptian authorities to continue its support to ensure the soundness of the financial sector, and maintain the confidence in the system, as well as taking the necessary precautionary measures to prevent any crises—evident in circulars issued by the central bank post-revolution, measures taken by the NBFI regulator EFSA, close monitoring of the banks’ performance, and severe stress tests conducted. In that context, the Egyptian government is keen on further cooperation with the World Bank, specifically on enhancing the financial sector soundness and outreach to the underserved segments of the society. The support of the World Bank has contributed to that success.

30

Annex 3: Comments of Cofinanciers and Other Partners/Stakeholders

1 Donors, and development partners, that are actively involved in the financial sector work, including, USAID, IMF, EU, and AfDB have commended the World Bank’s financial sector work, and especially the series of financial sectors DPLs. Various donors and international institutions have been providing support for the implementation of the government’s Financial Sector Reform Program through the provision of technical assistance, and analytical work on reforming and restructuring the financial sector. This required effective coordination, which the Bank took leadership in. A Financial Sector Donors Subgroup, chaired by the World Bank was formed in mid 2005, to coordinate efforts related to both technical and financial support provided to the government and to ensure that borrowed funds are used in the most effective manner. This cooperation led to mutual design and agreement of conditionality issues that all donors agreed were essential for financial sector reform. In addition, donors were able to do a much better job of leveraging resources, both loan and technical assistance, when coordination is effective. 2 There is good collaboration between the World Bank and the IMF in Egypt in the financial sector, through the joint FSAP program and coordination of technical assistance as indicated in the IMP Relations Note in Annex 15, of the Program Document. Donors have benefited from the analytical work that was undertaken by the Bank, especially the 2002 joint IMF-World Bank FSAP, and its follow-up in 2007. Most of the recommendations put forward by the FSAP were used in drafting the Memorandum of Understanding (MOU) between the government of Egypt and USAID. All major elements required for financial sector reform as identified by the FSAP were used in drafted the conditionality that appears in the MOU. Moreover, technical assistance to support the financial sector reforms was jointly discussed, designed and deployed, with USAID and EU, with an understanding that the different donors would support various activities, but attempting to promote complimentarily. 3 Among the bilateral donors, USAID has provided technical assistance in many areas, including debt and financial management, a legal framework for secured lending (movable assets), credit bureau regulation and data management, and the payments system (the latter in coordination with the EU and the Bank). USAID has a broad capacity-building and technical assistance project with the EFSA, and provides technical assistance focusing on transforming supervision from compliance based to risk-based. In addition, work with the Ministry of Finance on pension reform is ongoing. USAID is also funding a project supporting the development of the mortgage market through advisory services for strengthening the supervisory authority, securitization, and property registration. 4 From the USAID perspective, the strong relationship with the Bank was unique in that it was mutually reinforcing. USAID acknowledges such close cooperation that helped them in designing assistance strategies to effectively respond to the needs of Egypt. They appreciated the sharing of information and the close contact to advance in addressing major constraints. This close working relationship helped to ensure that activities of respective organizations did not conflict with each other. Both parties had a common objective to support the government of Egypt’s efforts to implement financial sector reforms. It is much easier for USAID to provide long-term technical assistance rather than long-term finance, whereas the World Bank is well positioned to address financing issues, a key component to help the authorities implement their financial sector reforms. Supporting common objectives helped the government in advancing with its reform agenda. This was really a three-win situation for the World Bank, USAID and most importantly for the government of Egypt.

31

5 The EU has also been actively involved in the financial sector over the past few years, supporting analytical work on reforming and restructuring the financial sector. The ECB has been providing technical support in the area of banking supervision. Several US regulators including the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the Office of the Comptroller of the Currency (OCC) have been providing training in this field as well. The first phase of the ECB’s large assistance and training program for banking supervision has been completed, and a second protocol was signed to assist in Basel II implementation. 6 AfDB provided parallel financing to the Financial Sector Reform Program, of an equivalent amount of US$ 500 million in the first phase of the program. The AfDB appreciates the Bank’s efforts in processing such a large operation. Their project document was largely based on the Bank’s analytical work and the preparation work that was done. The World Bank and AfDB have conducted joint appraisal mission, in which the Bank took a leading role in the policy dialogue, and in the identification of triggers on banking and insurance sector. This partnership between the two institutions continued in all financial sector work. 7 Overall, donors and development partners have commended the Bank’s efforts in moving forward with the implementation of the Financial Sector Reform Program, and in ensuring synergy in the policy measures supported by the various donors, and effective use of resources.

32

Annex 4: Operational Policy Matrix

Egypt—Third Financial Sector Development Policy Loan

PRIOR POLICY ACTIONS FOR BOARD APPROVAL ON MAY 2010

PHASE II OF GOVERNMENT’S PROGRAM*

EXPECTED INTERMEDIATE PROGRAM OUTCOMES

BY DECEMBER 2011 CLOSING DATE**

LONG-RUN INDICATIVE POLICY MEASURES AND MONITORING INDICATORS

I. Financial and Operational Restructuring of Commercial and Specialized State-owned Banks Continue the operational and institutional restructuring of the three state-owned commercial banks—National Bank of Egypt, Banque Misr, and Banque du Caire, including Central Bank of Egypt (CBE) setting profitability, efficiency and corporate governance benchmarks to be reviewed quarterly, to assess performance

Substantial improvement in key profitability and efficiency indicators of the state-owned commercial banks Adopt and enhance corporate governance best practices and regulations within banks

Profitability and efficiency indicators of state-owned commercial banks are at par with leading private banks Instill in the banking sector an enhanced corporate governance culture

Substantial further progress in implementing the financial restructuring of the state-owned commercial banks, including: Full Settlement of non-performing loans (NPLs) of

state-owned enterprises (SOEs) held by state-owned commercial banks

Ratios of provisions to NPLs (coverage ratios) of the state-owned commercial banks reach 80 percent

State-owned commercial banks’ financial statements fully reflect bank net asset values and economic position in line with International Financial Reporting Standards (IFRS)

State-owned commercial banks in full regulatory compliance and competing with private banks on a level playing field Monitoring indicators: Decline in NPLs-to-total loans

(Baseline, FY 08: 14.8 percent) Increase in provisions-to-NPLs

(Baseline FY08: 92.1 percent) Decline in SOEs’ NPLs

(Baseline, FY08: LE10 billion) Capital adequacy of banking system ratio

(Baseline FY08:14.7 percent) Adopt a framework for operational and institutional restructuring of the state-owned specialized banks— Egyptian Arab Land Bank (EALB), Principal Bank for Development and Agricultural Credit (PBDAC), and Industrial Development Bank—based on the findings of a complete independent audit

Implementation of a program of institutional and operational restructuring for the state-owned specialized banks

Satisfactory completion of operational and institutional restructuring of the state-owned specialized banks State-owned specialized banks operating as viable commercial banks

33

Submit the Egyptian Agriculture Bank Law (replacing Law 117 of 1972) to the Cabinet of Ministers whereby PBDAC would be regulated by Law 88 of 2003, and issue Ministerial Decree separating non-banking activities from the commercial banking

Issuance and adoption of the Egyptian Agriculture Bank Law, and Ministerial Decree

PBDAC operating as a commercial bank and providing access to a broad set of financial services, including to microenterprises Monitoring indicators: Improvement in Coverage Ratio (provisions-to-total NPLs) ratio (Baseline: FY08: 51.8 percent ) Increase in number of financial products offered (Baseline: FY08:10)

* Only bolded prior actions are required by the government for disbursement. ** The indicative policy measures for the proposed DPL III are indicated in the second phase of the Financial Sector Reform Program (2009–2012), as stated in the Government’s Development Policy Letter, and outlined in the Operational Policy Matrix.

34


PHASE II OF GOVERNMENT’S PROGRAM


BY DECEMBER 2011 CLOSING DATE


II. Strengthening the Regulatory and Supervisory Architecture of the Banking Sector

Initiate the implementation of Basel II accords CBE: Sign a protocol with the European Central Bank (ECB)

and seven European national central banks to assist in the implementation of Basel II accords

Setup and initiate capacity building for a specialized team in banking supervision, fully dedicated to Basel II implementation

Issue Egypt's Strategy Note on Basel II

Continued implementation of the Basel II project, including preparing guidelines for achieving the drafting of regulations in line with Basel II framework

Egypt has built a credible, risk-based supervisory and regulatory framework in line with the best international practices Monitoring indicator: 100 percent of Egyptian banks have adopted the Basel

II framework (Baseline FY08: 0 percent)

Strengthen the CBE’s macroprudential supervision by conducting annual stress testing of the banking sector, and by preparing quarterly consolidated banking sector reports that will serve as the basis for the CBE’s Financial Stability Rep ort

Stress testing becomes an integral part of the CBE’s systemic surveillance of the banking sector Preparing and presenting to the CBE Board a full-fledged Financial Stability Report based on the CBE’s assessment of overall risks in the financial system facilitate the early detection of changes and vulnerabilities in the financial system Strong macroprudential surveillance capacity is essential to achieve sustainable improvement in access to finance

Improving the transparency of risk recognition in the financial system and facilitating broad communication with the financial community by the publication of a Financial Stability Report. Regular stress testing makes prospective capital needs more measurable Monitoring indicators: Periodic stress testing of the aggregate balance sheet of

the banking sector and individual banks Publication of a Financial Stability Report at least once

a year

35

PRIOR POLICY ACTIONS

FOR BOARD APPROVAL ON MAY 2010 PHASE II OF GOVERNMENT’S PROGRAM




III. Reforming the Non-bank Financial Sector

Enact Insurance Law 118 of 2008 (Article 27), separating the life from the non-life insurance portfolios

Completed legal and portfolio transfer actions to establish separate life and non life state-owned insurers

Two major profitable and competitive insurers are supporting the development of a stable insurance sector and increased access to underserved sections of the population Monitoring indicators: Gross non life premium to GDP

(Baseline FY09: 0.5 percent)

Gross adjusted life premium to GDP (Baseline FY09: 0.3 percent)

Establish joint CBE-EFSA committee to establish rules for operation of banc-assurance and submit draft rules to Governor and Chairman of EFSA

Proper disclosure of product features and names of insurer and bank staff selling banc-assurance are trained and certified

Banc-assurance accounts for at least 50 percent of individual life insurance sales

Strengthen the regulatory framework governing collective investment vehicles: Issue EFSA Decision No. 88 of 2009 requiring the

appointment of independent Fund Administration Companies, to avoid conflicts of interest and protect investors by performing critical functions, per IOSCO best practice

EFSA Board to submit to Minister of Investment amendments to the CML Executive Regulations streamlining procedures and reducing administrative barriers for establishment of various types of funds

Performance of critical functions (e.g., NAV calculation, investment transactions and certificate-holder record-keeping, and calculation of management fees/bonus) by Fund Administration Company that is separate from fund manager provides additional protection for public investors in investment funds New chapter in CML Executive Regulations on the establishment, operation, and regulation of collective investment schemes in line with IOSCO best practices

Improve the pricing of investment certificates and increase overall transparency and disclosure of investment funds Increase the capacity of investment funds to meet investors’ needs Address SME access to finance needs by facilitating the establishment of specialized (e.g., small cap) funds Expand institutional investor base, and thereby promote improvements in price discovery Monitoring indicators: Increase in the number of mutual funds

(Baseline, Dec 09:57) Increase in investment funds’ assets under management

(Baseline, Dec 09: LE Billion 49.5) Increase in new bond issues

(Baseline, Dec 09: 22 issues)

36

Issue Ministerial Decree 1 of 2010 allowing public juristic entities to issue local bonds and facilitating corporate bond issues. Decree requires submission of EFSA of audited projections of main financial ratios—instead of pro forma financial statements—for entire tenor of bond

Facilitating corporate bond issuances, including by quasi-sovereign public authorities

Improved access to finance for corporations and public authorities, by activating fixed income market for medium- and long-term finance Greater diversification for domestic fixed-income investors

37

PRIOR POLICY ACTIONS

FOR BOARD APPROVAL ON MAY 2010 PHASE II OF GOVERNMENT’S PROGRAM




IV. Strengthening the Regulatory and Supervisory Framework of the Non-Bank Financial Sector

Issue Law 10 of 2009, regulating non-banking financial markets, institutions, and instruments, consolidating the regulatory bodies of non-bank financial sector via the establishment of EFSA

Completion of the merger of all EFSA departments by functions including core and non-core functions Establishment of an Arbitration and Dispute Resolution Center

EFSA operates as a well regarded non-bank financial regulator in line with international best practices capable of maintaining safety and stability of non-bank financial markets, while at the same time helping improve access to finance and facilitate service to investors Monitoring indicators: Issuance and enactment of Law 10 of 2009

Amend the listing and delisting rules for the stock exchange issued by EFSA Board of Directors Directive in accordance with corporate governance rules, with emphasis on setting tighter rules on insider and related party trading

Market observance of trading practices and governance has improved

Increasing the confidence in the Egyptian market

Cabinet of Ministers approved Non-Bank Financial Institutions Licensing and Regulatory Law, setting the regulatory framework for all non-bank financial institutions including microfinance, financial leasing, and factoring, as well as standards in transparency and corporate governance

Issuance of the Non-Bank Financial Institutions Licensing and Regulatory Law

Licenses issued to non-bank financial institutions, for microfinance, leasing and factoring

Provisions issued by EFSA for microfinance and factoring institutions; as well as amendment to financial leasing law

Financial services available to a significantly larger proportion of potential users, through well supervised institutions Monitoring indicators: Percentage of female micro finance clients (Baseline,

FY08: 50 percent) Outstanding Microfinance Portfolio

(Baseline:LE 2.21 billion) Leasing assets as percent of GDP

(Baseline: 0.43) Microfinance, leasing, and factoring companies

licensed under new NBFI Law (Baseline 08: 0)

Submit Private Pension Funds Law, regulating private pensions to the Cabinet of Ministers

Issuance of the law regulating private pension funds Transparent private pension fund industry through regular reporting; enhanced efficiency through compliance to a regulatory framework Monitoring indicators: Issuance and enactment of Private Pension Funds Law

38


PHASE II OF GOVERNMENT’S PROGRAM**




V. Improving the Financial Infrastructure

Strengthen the payments system infrastructure and promote financial inclusion through establishing a real-time gross settlement system and automatic clearing house and extending their scope

Full operationalization of the RTGS Launch of direct credit and direct services in ACH National Inter Bank Switch for retail payments operational Regulations submitted to Board for licensing Payment Services, and for Payment Systems oversight

Payments infrastructure that allows for low cost, efficient and secure payments Monitoring indicators: Individuals receiving Government payments through

financial institutions (Baseline FY 08: 170,000 card s through Government Payroll project)

CBE issues new regulations on mobile phone payments Licenses issued for mobile phone payment products or providers

Enhanced financial access through branchless banking, including to rural areas and low income users Monitoring indicators: Mobile phone payments transactions

(Baseline: 0) Mobile phone payment products launched

(Baseline: 0)

CBE to implement its SME strategy to encourage the extension of banking services and finance to SMEs including: Institute a SME training program at the Egyptian Banking

Institute (EBI) Launch a nationwide SME census to build a comprehensive

database, with CAPMAS

SME Banker Training scaled-up and program further developed through course participant feedback Census completed, and data presented in a form that is accessible to the banking sector

Banks expand access to financial services for SMEs Enterprise data used to monitor and support progress in improving financial inclusion

39

Annex 5. List of Supporting Documents Program Document (April 26, 2010) Loan Agreement (May 26, 2010) Letter of Development Policy (February 28, 2010) Letter of Effectiveness (June 23, 2010) World Bank Missions Aide Memoires

- Preparation Mission (January 31-February 11, 2010) - Appraisal Mission (March 28-April 8, 2010) - Supervision Mission (May 18-31, 2011) - ICR Mission (May 13-17, 2012)

40

Annex 6: Monitoring Indicators

INDICATOR

2008 (BASELINE)

2009 DECEMBER

2010 DECEMBER

2011 DECEMBER

I. Financial and Operational Restructuring of Commercial and Specialized State-owned Banks

Decline in NPLs-to-total loans (percent) 14.8 13.4 11.0 10.9 Increase in provisions-to-NPLs (percent) 92.1 100.4 92.6 94.6 Decline in SOEs’ NPLs (LE billion) 10 Zero Zero Zero Capital adequacy of banking system ratio (percent) 14.7 15.1 16.1 15.6 PBDAC improvement in coverage ratio (percent) 51.8 60 62 60 Increase in number of PBDAC products 10 11 11 13

II. Strengthening the Regulatory and Supervisory Architecture of the Banking Sector

100 percent of Egyptian banks have adopted Basel II Zero The banks are working on adopting the Basel 2 framework.

The private commercials banks have to comply with the new regulatory regime starting from December 2012 and from June 2013 for the state-owned banks

The private commercials banks have to comply with the new regulatory regime starting from December 2012 and from June 2013 for the state-owned banks

Periodic stress testing of the aggregate balance sheet of the banking sector and individual banks

Periodic stress testing has been activated on individual and aggregate balance sheets and on the peer group level once a year.

Periodic stress testing has been activated on individual and aggregate balance sheets and on the peer group level once a year.

CBE carried out the periodic stress test of the aggregate balance sheet in January–February 2011 as part of its monitoring of the impact of the events post-revolution. .

Stress testing has become an integral part of the CBE’s systemic surveillance of the banking sector. Currently, CBE is involved in an intensive technical assistance project with the Bank to strengthen its stress testing framework through the integration of the Financial Projection Model (FPM) into its supervision.

41

INDICATOR

2008 (BASELINE)

2009 DECEMBER

2010 DECEMBER

2011 DECEMBER

Publication of a Financial Stability Report (at least once a year)

Draft Financial Stability Report prepared by CBE

Expected to be published before end 2012. Draft is being revised to incorporate the impacts of the January-February 2011 closures of banks and the slowdown in the economy.

CBE prepared the first Financial Stability Report at the end of 2011. However, there is a delay in the publication of the report because of political and economic uncertainty. It is expected that the report will be approved by the CBE Board and published by the end of 2012.

42

*due to dissolution of the Parliament, as discussed earlier.

INDICATOR

2008 (BASELINE)

2009 2010 2011

III. Reforming the Non-bank Financial Sector

Gross non life premium to GDP (percent) 0.47 0.45 0.43 0.42 Gross adjusted life premium to GDP (percent) 0.39 0.37 0.36 0.32 Increase in number of mutual funds 49 19 11 9

Investment funds’ assets under management (LE billion) 49.5 50.5 61.7 58.4

Increase in new bond issues 22 5 9 1

IV. Strengthening the Regulatory and Supervisory Framework of the Non-Bank Financial Sector

Issuance and enactment of Law 10 of 2009 Signed by President February 2009 Law effective Law

effective Percentage of female micro finance clients (percent) 50 52 52 65

Outstanding microfinance portfolio (LE billion) 2.21 2.35 3.10 3.10

Leasing assets as percent of GDP 0.45 0.36 0.74 0.66

Microfinance, Leasing, and factoring companies licensee under new NBFI Law

Zero Law submitted to Cabinet Law submitted to Parliament but not passed

Law not forwarded or returned*

Issuance and enactment of Private Pension Funds Law

EFSA prepared draft law Law submitted to Cabinet Law not forwarded or returned

Law not forwarded or returned*

V. Improving the Financial Infrastructure

Individuals receiving government payments through financial institutions (government payroll) 0.60 million 0.85 million 2.4 million 2.9 million

Mobile phone payments transactions Zero CBE drafted regulations CBE issued regulations and licensed two banks.

CBE issued regulations and licensed two banks.

Mobile phone payment products

Zero

Issue license to two banks Licensed money transfer from customer to customer C2C and from Customer to Merchant C2B.

Licensed money transfer from customer to customer C2C and from Customer to Merchant C2B.

43

Figure A7.1: Credit to Government from CBE (LE billion)

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

Jan

-10

Mar

-10

May

-10

Jul-

10

Sep

-10

No

v-1

0

Jan

-11

Mar

-11

May

-11

Jul-

11

Sep

-11

No

v-1

1

Jan

-12

Source: CBE (2012).

Figure A8.2: Net Domestic Assets and Net Foreign Assets

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jan

-10

Ma

r-1

0

Ma

y-1

0

Jul-

10

Se

p-1

0

No

v-1

0

Jan

-11

Ma

r-1

1

Ma

y-1

1

Jul-

11

Se

p-1

1

No

v-1

1

Jan

-12

Annex 7: Money and Banking

1. Monetary and financial variables reflect the extreme external and fiscal situations that have exacerbated uncertainty. On the monetary side, base money growth (y-o-y) collapsed to 2.4 percent in February reversing the effect of the step-increase that occurred immediately following the January revolution. However, the composition of the base is strikingly different: a year ago the net foreign assets were 75 percent with domestic assets making up the remaining 25 percent; now the roles have reversed with foreign assets making up 33 percent of base money and domestic credit, the remaining 67 percent, reflecting the loss of reserves and the expansion of domestic credit, growing at 57 percent, explains this trend (Figure A8.1). Deposits in local currency of the banking sector increased by a meager 2.5 percent (y-o-y) in January, while deposits in foreign currencies increased by 15 percent (y-o-y). 2. Net foreign assets have declined sharply, while net domestic assets have increased. While net foreign assets of the CBE have decreased continuously since January, net domestic assets have surged. The expansion in domestic assets is due primarily to growth in the domestic credit (Figure A8.2).

3. M1 growth is decelerating due mainly to falling demand deposits in local currency. M2 growth has slightly decreased to reach 7.6 percent in January 2012, down from 11.8 percent in January 2011. M1 growth rates dropped from 16.4 percent in January 2011 to 12.8 percent in January 2012. The decline was driven by the drop in demand deposits in local currencies by – 5 percent. Quasi-money slowed to a 6 percent growth in January 2012, compared to 10 percent in January 2011, due to a declining pace of the creation of time and saving deposits denominated in local currency. The latter slowed to a 12.9 percent growth rate in January 2011 and dropped further to 3.6 percent in

January 2012, while dollar-denominated deposits grew at four times the rate (around 14 percent).

4. CBE increased interest rates on deposits by 1 percentage point in November 2011, but lowered bank reserve requirements in March 2012. CBE increased overnight deposit

44

rates to 9.25 percent, lending rates to 10.25 percent, and the cost of providing liquidity via “7-day repo” to 9.75 percent, with a discount rate of 9.5. This suggested that CBE would act strongly to avoid currency depreciation and to discourage Egyptians from converting local currency into foreign currency. However, on March 20th, the CBE reduced the required reserve ratio (RRR) on domestic currency deposits by 200 basis points from 14 percent to 12 percent, which will result in an increase of liquidity in local currency, thereby exerting pressure on the limited amount of foreign exchange reserves. The CBE issued two press releases following the reduction in RRR explicitly mentioning that the measure aimed at providing permanent liquidity and easing credit conditions in the market. The net domestic assets of the CBE grew over 100 percent (y-o-y) in February, but net foreign assets fell by 55 percent in the same period.

45

Annex 8: Achievement of Program Development Objectives

Pillar I: Financial and Operational Restructuring of Commercial and Specialized State-owned Banks 1. Key profitability and efficiency indicators of the state-owned commercial banks continued to improve despite the global crisis, due to financial and operational restructuring since the onset of the financial sector reform program that was continued under DPLIII. The three state-owned commercial banks—National Bank of Egypt (NBE), Banque Misr, and Banque du Caire, which account for about 44 percent of bank assets in FY 2011—have substantially improved their profitability, efficiency, and capital over the last three years.14 The reported ratio of capital-to-risk-weighted assets in all three banks now substantially exceeds the required 10 percent level. Moreover, as of the end-2011, provisions-to-NPLs exceed largely 80 percent. NBE has increased efforts to recover on the private sector NPLs15, and Banque Misr, which has inherited Banque du Caire’s NPLs, is working on their collection. Moreover, all the three commercial state-owned banks are now managed in line with good lending practices with a large amount of their existing NPLs reflecting the legacy of the past. Banque du Caire’s operational restructuring has not gone as far16, but all three have improved significantly. 2. Indicative of the reforms, NBE was able to tap the Eurobond market to get US$ 600 million on a five years bullet basis at 5.25 percent just before the revolution, to enhance its dollar liquidity. In addition, in the perspective of implementing Basel II regulation in 2013, Banque Misr plans to convert its US$ 1 billion subordinated loan into equity to shore up its capital base and Banque du Caire is ready to develop its activities following the strategy designed by its new Chairman. 3. In the aftermath of the revolution, state-owned commercial banks are facing various challenges. First, due to the uncertainty times, lack of bankable opportunities and the growing deficit and financial needs of the government, the state-owned banks are buying large amounts of sovereign debt, which now exceeds more than forty percent of their deposits. At the same time, the demand for loans is declining, reflecting the anemic economic situation. Second, in 2011, the government granted in 2011 a salary increase (15 percent to 30 percent), which put some pressure on banks’ profitability. Third, the Parliament tried to put a cap on the maximum wage in the public sector and then a maximum deviation (35 times) from the minimum wage. If not well managed, such rules could lead to a departure of top executives in the state-owned banks, as well as the state-owned, non-bank sector. 4. CBE has strengthened the corporate governance in the banking system by issuing Corporate Governance Regulations on July 5, 2011. All banks, including commercial and specialized state-owned banks, are instructed to comply with the new regulations. The principles require banks to establish better relations between their management, Board of Directors, and shareholders, as well as, other stakeholders with a clear definition of powers and duties of each of them. Banks also will need to have non-executive and independent members on their Board. Moreover, banks are required to put in place appropriate committees on compensation, audit, and risk management. They are also expected to develop policies to address conflict of interest and related party transactions. According to CBE, most

14 According to their annual reports and CBE data. 15 Its NPLs-to-total loans ratio is at 7.2 percent at the end of March 2012. 16 It was originally planned to merge Banque du Caire with Banque Misr then. Then it was decided to transfer ownership of BDC to BM and then privatizing BDC. The privatization transaction was cancelled and BDC is still owned by Banque Misr but it operates its activities independently from Banque Misr.

46

of the banks will comply with the corporate governance regulations, including state-owned banks. CBE also amended the Central Bank, Banking System, and Money Law 88 of 2003 in October 8, 2011, introducing changes that improved the central bank’s own governance, reconstituted its own board of directors to remove conflicts of interests, and tightened supervisory capacity and processes. 5. Commercial state-owned banks are competing with private banks on a level playing field. They are subject to the same legal and regulatory framework (Law 88 of 2003), and to the same supervisory guidelines and corporate governance code. State-owned commercial banks have also improved their accounting by adopting International Financial Reporting Standards (IFRS), which are already used by private banks. The state-owned commercial banks’ financial statements now reflect net asset values and their economic position. The quarterly balance sheets and income statements of the state-owned commercial banks are audited by two independent auditors, and published by the banks. Furthermore, as part of the reform program, the de facto state guarantees for state-owned enterprise loans held by state-owned commercial banks were abolished, which contributed significantly to putting state-owned banks on equal footing with their private peers. 6. CBE has also been involved in programs of restructuring and strengthening the state-owned specialized banks (that collectively represent less than a 5 percent share of total assets and deposits in commercial and specialized banks), but the restructurings and recapitalizations slowed down in PBDAC because of the legal delays and the political and economic uncertainty after the revolution. It is expected that a full-fledged operational, financial and institutional restructuring might resume in this bank, once the uncertainty clears-up. 7. The restructuring program with the Egyptian Arab Land Bank (EALB) was furthest along. EALB has to deal with the piling-up of non-interest earning assets in the form of non-performing loans (LE 4.6 billion) and recollected fixed assets (LE 2.4 billion) because of its unsound banking operations before 2002. According to the bank, the write off of NPLs could be around LE 1.3 billion at a minimum. There is also a risk that another portion of the portfolio may be classified as non-performing loans in the future, particularly in the aftermath of the revolution. The bank’s lending portfolio is concentrated in tourism and real estate sectors, which got the biggest hit from the economic slow-down. The government appointed a new CEO in September 2011 who has focused the bank’s efforts to wind up non-performing loans and fixed assets, while continuing to develop new business. Currently, the bank can comply with the capital adequacy regulation thanks to CBE and Government support. The bank generates losses, amounting to LE 400 million per year because of the deterioration in its interest generating capacity and increased operating expenses. Even with the new management`s capabilities, the bank’s bounce-back depends on how the real estate and tourism sector revive. . 8. The Principal Bank for Development and Agricultural Credit (PBDAC) had started to undertake a substantial program of financial and institutional restructuring, including increasing its mobilization of deposits to fund its lending, modernizing its branches and branch structure, connecting its branches by internet, and improving its risk management. It is the largest of the state-owned specialized banks, plays a major role in financing the agricultural sector and including its village branches, accounts for about one-third of bank branches in the country. The bank has also started new lending products after the revolution, such as microfinance and Islamic banking to cater the public’s demand for these products, especially underprivileged groups and those in the rural areas. As a result, PBDAC represents a major element in access to banking services in rural Egypt and its continued improvement would improve access to credit and financial services. The government began the process of changing the bank’s legal status to a state-owned

47

commercial bank, but the law was postponed with the revolution and dissolution of the Parliament. The Government appointed a new chairman in September 2011, who has focused so far on putting all the non banking activities into a commercial company. The bank plans to transfer almost 20 percent of its staff to that company over the next year. Despite these successes, the bank’s management faces important issues. The bank still has a bad lending portfolio, weak internal systems, and redundancy, which can be a drag in the bank’s ability to improve its efficiency and profitability. Salaries were rose substantially as a result of the Government’s decree. And, in prepartation to PBDAC’s shift to a commercial bank, it is holding non-interest earning reserves in the CBE. The bank experienced losses (around LE 600 million) last fiscal year. The bank has fallen short of CBE’s minimum capital adequacy requirements, which requires government’s extending support. Because of its weakening cash income generating capacity, the bank’s liquidity ratio is close to CBE’s minimum requirement. 9. The very small, state-owned specialized Industrial Development Bank (IDB) has been gradually undertaking a program of financial, operational, and institutional restructuring. The merger of the small, Workers Bank into IDB has delayed the restructuring of the bank. The sharp rise in salaries of the staff of state-owned banks will substantially increase IDB’s operating costs and the economic situation will make it even more difficult to liquidate collateral on NPLs, and probably increase NPLs on existing loans. However, it is worth noting that IDB is a very small bank with 19 branches, and a market share of 0.3 percent of total assets, and 0.1 percent of total deposits.

10. Monitoring indicators. Overall, the banking system proved its soundness and resiliency by weathering of the global crisis and the immediate implications of the January revolution. This reflects the strengthening of the banks, especially as a result of the successful financial and operational restructuring of the commercial state-owned banks. The improvement is evident in the: (i) decline in NPLs-to-total loans, from 14.8 percent in 2008 to 10.9 percent in 2011; (ii) increase in provisions-to-NPLs from 92.1 percent in 2008 to 94.6 percent in 2011; (iii) decline in SOEs NPLs to reach zero in 2011, as opposed to LE 10 billion in 2008; and (iv) increase in the capital adequacy ratio of the banking system to reach 15.6 percent, compared to 14.7 percent in 2008 (see Table 2). Although restructuring of the specialized state-owned banks was at a slower pace, 17 PBDAC managed to improve its coverage ratio from 51.8 percent in 2008, to 60 percent in 2011; in addition to introducing 13 products in 2011, as opposed to 10 in 2008. Pillar II: Strengthening the Regulatory and Supervisory Architecture of the Banking Sector 11. Despite the recent events, CBE is maintaining the momentum of further strengthening its capabilities to perform effective macro-prudential supervision, implement Basel II and strengthen risk-based supervision and other elements of supervision. These developments helped CBE monitor the banking system after January 2012, and contributed to its ability to intervene to avoid a bank run during the year. 12. CBE has made considerable progress in improving its assessment and surveillance of macro prudential risks. The Banking Supervision Department has set up a Macroprudential Unit with the aim to assess and produce regular reports on main developments in the Egyptian banking sector at the aggregate level. The Banking Supervision Department strengthened the Macroprudential Unit with the aim to prepare and publish a full-fledged Financial Stability

17 As discussed earlier, this is mainly due to the dissolution of the Parliament following the revolution, which delayed issuance of laws and legal reforms; as well as the outbreak of the foot and mouth disease, which adversely affected the operations of PBDAC.

48

Report, the first report of its kind in the MENA region. Indeed, the Macroprudential Unit prepared the first Financial Stability Report at the end of 2011. However, there is a delay in the publication of the report because of political and economic uncertainty. Financial Stability Report was presented to CBE board of directors who decided that report publishing will be subject to improvement of economic and political situation.

13. Stress testing has become an integral part of the CBE’s systemic surveillance of the banking sector. The Macro Prudential Unit has been conducting stress testing and standard financial soundness indicator analysis on the banking sector since 2009, which is also being supported by the World Bank through a FIRST Initiative. The focus in stress testing is on credit risk which accounts for around 85 percent of overall risks in the banking system. As part of stress scenarios, CBE downgrades exposures in each rating by one or two notches. The CBE also applies a haircut (50 percent) on all collaterals with the exception of cash and bank guarantees. 14. Currently, CBE is involved in an intensive technical assistance project with the Bank to strengthen its stress testing framework through the integration of the Financial Projection Model (FPM) into its supervision.18 The FPM will allow CBE to conduct stress tests on individual and system wide basis against credit, interest rate, liquidity, and foreign exchange risks. The FPM takes into account second round effects, balance sheet interconnectedness in the banking system, as well as systemic risks, such as funding liquidity and market liquidity risks. 15. Another area of improvement is in the implementation of Basel II in Egypt. An EU technical assistance program on banking supervision was launched early January 2009 and aimed at supporting the CBE in designing a Basel II framework customized to the Egyptian banking system through a long term strategy. The program, which closed at the end of March 2012, successfully achieved all its objectives. The EU representative in charge of the project rated it highly satisfactory as deliverables went beyond expectations and due to the full ownership of the project by the CBE staff. 16. The major deliverable was a set of regulations on Basel II implementation, drawing on discussions papers, quantitative impact studies and benefiting from an enhanced dialogue with the banking community. Regulations regarding Pillar I (own funds, credit risk, operational risk, and market risk) are ready to be adopted by the CBE Board by July 2012. In parallel, a regulation on internal control should be adopted along the same timeline to help streamline the implementation process of Basel II. Pillar II regulations (concentration risk, liquidity risk and interest rate risk) are expected to be enforced at the end of 2013 or later to give room to banks to absorb Pillar I. As scheduled, the private commercial banks will have to comply with the new regulatory regime starting from December 2012 and the state-owned banks by June 2013. (Fiscal years differ for the private and the state-owned commercial banks.)

18 The project was initiated in January 2012 after a training program on the standardized FPM in July 2011. Upon CBE’s request for the FPM to be customized to its prudential regulations and reports, a FIRST funded project was developed in January 2012. As part of the project, a mission visited CBE between May 6-12, 2012 to determine the main parameters of the customization of the FPM. Since the FPM Expert was able to determine the parameters earlier than planned, the customization with regards to the lending section was completed during the mission. Currently, CBE`s technical team is conducting a plot test on the -partially- customized Model. The customization of the FPM in relation to lending was done in a way that the CBE would be able to implement stress testing based on two alternative methodologies. The first methodology is identical to CBE’s current stress testing methodology with some improvements to take into account second round effects. The second methodology employs probabilities of default (PDs) and losses given default (LGDs) to estimate loan losses, which is in line with international best practices and Basel II rules on the calculation of capital adequacy against credit risk. Since the CBE plans to move to Basel II in capital adequacy calculation, it might find useful to implement stress testing based on PDs and LGDs in the future.

49

17. Another delivery aims at assisting CBE in its reform of the supervision reporting framework. CBE and the European Central Bank (ECB) experts have focused on the design of the portal, the setup of a communication policy, the analysis of operational workflow and completion of work on new reports and surveys. By October 2012, CBE should be ready to open discussions with banks to fine-tune the operational design of this new data feeding system. If all goes well, the raw date reporting system could be built, tested and run in by April 2015. However, CBE needs financing (around US$ 5 million) to acquire hardware and software. Once this new system is implemented, CBE would make a step further in risk-based supervision and improve dramatically the accuracy of data communicated by banks. 18. From the onset, this project has been quite challenging because of the number of stakeholders involved and the changes in the supervisory process. However, the rationale was in line with the progress made by the CBE towards a risk based supervision and the diversity of the Egyptian banking system. Dialogue, awareness and capacity building were key factors of success in the major achievements of this operation. For example, knowledge sharing and capacity building have been provided to all the CBE staff on how to monitor the compliance of the Egyptian banking system with these new regulations and the new data reporting scheme, in order to build ownership beyond the Basel II core team. Since 2005, Egypt has built a credible, risk based supervisory and regulatory framework in line with the best international practices conducing to a stronger and more resilient banking sector. 19. Monitoring indicators. Despite the revolution and risks associated with it, CBE maintained the momentum of strengthening its capabilities to perform an advanced risk-based supervision, evident in: (i) conducting regular severe macro-prudential stress testing, which has become an integral part of CBE’s systemic surveillance of the banking system; (ii) preparing the first Financial Stability Report, which was presented to CBE board of directors who decided that report publishing will be subject to improvement of economic and political situation; and (iii) applying Basel II framework, where all private commercial banks will have to comply with the new regulatory regime starting December 2012, and from June 2013 for the state-owned commercial banks. All these developments helped in monitoring the system after the revolution and, together with the CBE’s appropriate provision of liquidity and restrictions on size of deposit withdrawals and purchases of foreign exchange, prevented a major run on the banks in 2011. Pillar III: Reforming the Non-bank Financial Sector 20. In the insurance sector, the legal and organizational restructuring of the state-owned insurers was completed in July 2010. Misr Life is now the only state-owned insurer selling life products and Misr Insurance only sells non-life products. The establishment of pure life and non life operations has brought Egypt into line with global good prudential practices (2003 IAIS ICP 6, criterion G).19 Competent management is now in place in both the state-owned direct insurers and Misr Insurance Holding Company (the group holding company), and assets are being professionally managed by the insurers and other group companies. Transparency is excellent and, while some staff issues arising from the restructuring remain, management is rapidly developing mechanisms to improve communications. As mentioned in the risk discussion, reducing investment returns combined with rapidly increasing staff costs represent a medium-term threat. The insurers do have a 4 to 5 year strategy to deal with staffing levels and costs through attrition (facilitated by a relatively high average age) but

19 MENA is the only region where a significant number of composite insurers are still allowed to operate, however strict separation is now being introduced (UAE, Algeria) in some nearby jurisdictions. A partial list of G20 countries requiring separation of life and non-life activities includes the relevant EU countries. the US, Canada, Australia, Indonesia, Mexico and South Africa.

50

supplementary salary increases will need to be brought under control and new staff appointments limited to essential needs. 21. The balance sheets of both of the two state-owned insurers are now largely repaired, after approximately LE 2.5 billion of reserve strengthening over the restructuring period. The main technical challenges continues to be maintaining the stability of the Motor Third Party Liability (MTPL) non-life portfolio in Misr Insurance and containing the cost of certain legacy group life retirement arrangements that were incorrectly priced and poorly designed in Misr Life (formerly National Insurance). Although Misr Insurance has significantly strengthened its own technical reserves it discovered that it had inherited an enormous technical reserve shortfall when it took over National Insurance’s ‘Act’ insurance claims portfolio in 2009: in addition claims provisions for business written before claims were capped (under Law 72 of 2007) continue to prove to be inadequate as the claims are run off. This reflects National’s former dominant role in the MTPL business and the dependence of a section of the legal profession on representing accident victims and their need to maximize returns from the old claims portfolio during its run off period. On the other hand the business written since the claims cap was instituted and premiums were increased is providing an adequate overall return to underwriters, although some categories of vehicle continue to be highly unprofitable. These more recent years’ ratios will likely deteriorate but are significantly better then the accounted claims ratios which include old years’ run off deterioration. Table A8.1: MTPL Claims Ratios20 by Accounting Year since 2007

Accounting Year 2007 2008 2009 2010 2011 State-owned Insurers %

846.8 635.2 261.1 452.3 377.9

Private insurers % 267.1 131.2 28.5 59.2 66.7 Source: Misr Insurance Holding Company (May 2012). 22. Accounting loss ratios tend to understate growth of claims ratios in growing portfolios and the private sector experience will almost certainly deteriorate with time, but not to the levels being experienced by Misr Insurance. An alternative approach which helps to identify the impact of the old system business is to examine Misr Insurance’s post-2007 experience by underwriting year (Table A9.2).

Table A8.2: State-owned Insurer Claims Ratios by Underwriting Year

FY business written 2008/9 2009/10 2010/11 2011/12 Claims ratio developed to date % 65 178 92 83

Source: Misr Insurance Holding Company (May 2012). Private sector insurers now account for more than half of the MTPL market, representing a significant positive deliverable under the reform program. Anecdotal evidence indicated that several smaller insurers may now be viable as a result. However, under the current regime, private insurers are able to select the best risks while Misr Insurance continues to have to also accept inadequately rated and hence loss-making commercial vehicle business (including taxis). This, as noted by comparing tables 4 and 5, has led to worse underwriting results for Misr Insurance on post-2007 business than for the industry as a whole. In the past Misr could have been cross subsidized from appropriately priced government sourced business but in a competitive market and given current fiscal pressures this is less possible or desirable. Possible solutions to this issue are discussed in the Financial Development and Growth in

20 Claims ratio is claims cost over corresponding earned premium.

51

Egypt World Bank report currently under preparation. Figure A8.1: Private Sector Re-entry to the MTPL Market--following 2007 reforms

Source: Misr Insurance Holding Company (May 2012). 23. Regardless of the approach taken, there is a need to establish a central statistical database and analytical capacity so as to be able to produce indicative premiums and analyze which drivers are responsible for the poor experience. This ideally would be undertaken by the Egyptian Insurance Federation. 24. Other positive metrics include the facts that Misr Life in FY2010 and FY 2011 grew faster than its sector for the first time in many years, partly reflecting managerial actions to improve agency productivity. Both the life and non life sectors have had an unexpected dividend from the revolution, in that the corporate and tourist industry sectors (mainly for Strike, Riot and Civil Commotion (SRCC) Insurance) and individuals (life and medical) have become more conscious of risk. Reinsurers are imposing limits on the sum insured under SRCC policies and corporate are having to pay considerably more for full coverage (in the past this was added ‘free’ cover under most commercial insurance contracts). 25. Overall nominal insurance density (premium per capita) doubled over the 5 years to June 30, 2011, while insurance penetration (premiums as a percentage of GDP) dropped marginally (see outcomes matrix), but still bettered the baseline for life. This drop reflected a combination of factors including relatively high inflation, the global financial crisis, increased competition, the removal of the banc-assurance channel as an avenue for distribution expansion (see below) and more recently the impact of the February 2011 revolution on economic activity and employment. It is expected that the 2011/ 12 figures will show an increase in penetration. 26. Bancassurance now accounts for more than 40 percent of life sales world-wide and offers one of the best avenues for increasing access to family (life and disability) insurance in Egypt, particularly for Takaful products, while improving bank operating margins. Industry estimates are that it could rapidly increase insurance penetration in Egypt by one-third. However CBE (correctly) placed a ban on any new banc-assurance agreements in 2007 when examples of poor market conduct were brought to its attention: sales of conventional insurance under existing agreements between insurers and banks are continuing under an earlier set of EFSA approvals. A working committee of the Insurance Federation has agreed on a set of rules for banc-assurance activities and this was presented to the CBE in July 2011, with a follow up communication in November. CBE has stated that the industry will need to await the introduction of Basel II risk capital requirements in 2013 before there will be any possibility of lifting the ban. In the interim one recently licensed family Takaful insurer that

52

predicated its strategy on the banc-assurance business model has had to withdraw and two others are under pressure from their shareholders to also consider this option. The unfortunate (although unintended) result is that regional Takaful insurers are leaving the Egyptian market while European-based insurers continue to grow. 27. Solvency II will not solve the issue of banks taking responsibility for their market conduct where insurance sales are involved and one suggestion made was that banks should have a majority holding in any insurer with which they have an agency. This is not acceptable to the insurance sector and is not possible under the current insurance law. The World Bank is discussing alternative approaches with the CBE after having received clearance at a meeting held at the Insurance federation offices organized by the Chairman of the Federation. 28. On capital markets, EFSA Decision No. 88 of 2009 requires investment funds to appoint independent Fund Administration Companies to avoid conflicts of interest and protect investors by performing critical functions, per IOSCO best practice, in order to protect investment fund certificate-holders from adverse actions by fund managers. These critical functions include calculations of net asset value (NAV), maintenance of fund records on investment transactions and certificate holders, and calculation of management fees and bonuses for fund managers.21As of mid-2009, Egypt’s investment fund regulations fell short of IOSCO best practices in several regards, including potential for conflicts of interest (e.g., possible related-party investment, lack of code of conduct); lack of separate directors for bank-sponsored investment funds; and limited standards on permissible advertising by investment funds. Prior to the revolution, the EFSA Board had submitted to the Minister of Investment draft amendments on investment funds for the CML Executive Regulations. 29. The Ministry of Investment Decree No.1 of 2010 introduced a number of measures (such as permitting bond issues by public authorities, authorization of additional rating agencies, audited projections of main financial ratios in lieu of pro forma financial statements) to encourage development of Egypt’s corporate bond market. This did allow a quasi-sovereign agency, the New Urban Communities Authority (NUCA), to undertake three bond issuances (including 5-years) totaling LE 7.5 billion during the first half of 2010.22 30. The private pension fund sector has seen little progress, partly reflecting uncertainties as to the likely impact of the Law 135 of 2010 which proposes a radical restructuring of the social insurance regime in Egypt, and public pensions in particular. This Law has been frozen by the interim government and its future and its impact are now very uncertain. Discussions with Ministry of Finance indicate that its main author is willing to consider amendments (mainly through caps) that would leave scope for the private contractual savings sector while still improving fiscal space. 31. Monitoring indicators. On insurance, gross non life premium-to-GDP reached 0.42 percent in 2011; and gross adjusted life premium-to-GDP reached 0.32 percent in 2011. On

21 Market participants indicate that six Fund Administration Companies are operating and performing these critical functions. This may have encouraged greater public confidence in investment funds. According to EFSA, 79 investment funds were operating by December 2010 compared to 68 in December 2009 and only 49 in December 2008. 22 Other corporate bond issuances, however, were down. During 2010, 5 corporations undertook 12 bond issuances totaling LE 5.2 billion. Thus, the combined 15 bond issuances in 2010 are down from the 22 corporate bond issuances in 2009. Unsettled market conditions presumably had some negative effect. Market participants note, however, that Egypt has yet to develop a real secondary market in government securities. The resulting lack of a reliable yield curve may significantly dampen investor appetite for corporate bonds and discourage development of a corporate bond market. The Ministry of Finance has made major improvements in its primary issuance practices and development of benchmark issues. Additional measures are needed to encourage secondary trading in government securities trading. Such measures might include less liberal rules on government securities holdings by banks and enforcement of more stringent mark-to-market rules.

53

capital markets, the number of mutual funds was 9 in 2011; the investment funds’ assets under management reached LE 58.4 billion; and there was one new bond issue in 2011. Pillar IV: Strengthening the Regulatory and Supervisory Framework of the Non-Bank Financial Sector 32. The EFSA merger was completed and in January 2011 the then- Chairman was able to issue a comprehensive report covering background, establishment, internal restructuring plans and achievements to date.23 However the move to a fully integrated approach was interrupted by the departure of the first Chairman of EFSA, and subsequent limits placed by the interim administration on new senior appointments that prevented appointment of a replacement Chairman. The result is that EFSA is stuck in a half-way house with separate ‘islands’ based on sector rather than the functionally based structure originally envisaged (and still shown on its web still in contradiction to the list of offices shown on the same web site). In practice, this situation is not working well and this is widely understood in the financial sector. 33. Market observance of trading practices in equity markets and governance has improved. Efforts continue to protect equity investors from the potential for corporate governance irregularities, especially from insider and related-party share trading. In May 2011, the EFSA Board decided to require expanded disclosure by EGX-listed companies on major shareholders (i.e. 5 percent or more), free float, treasury stock transactions, and changes in the board of directors. EGX indicated in May 2011 that it is now attempting to link disclosures on such insiders to its ongoing market surveillance. 34. A comprehensive licensing law for all non-bank financial institutions was submitted to the Cabinet of Ministers in March 2010. The law allowed for the creation of the first commercial micro finance institutions (MFIs) in Egypt and would allow NGOs that are actively involved in microfinance to convert into a full-fledged MFIs reporting to EFSA, establish an MFI arm for their respective NGOs or continue functioning as an NGO reporting to the Ministry of Social Solidarity. The 2010 Parliament went into recess before the law was submitted and with the dissolution of both houses of Parliament during the revolution and the probable cabinet reshuffle after the Presidential elections, it remains unclear when or whether this law will pass. This not only causes problems for existing institutions, but hinders the growth of MFIs and their regulation. 35. After the new public pension law was enacted in 2010, a private pension fund law was drafted and submitted to Cabinet. However it has not been forwarded to Parliament and is considered a low priority by the interim government. Thus it is unlikely that the new private pension law will be enacted in the coming months and it will probably have to wait for some time until after new President is elected. While the new pension law is not expected to promote rapid growth in private pension provision, it will improve credibility by strengthening the role of the supervisor (EFSA) and significantly improve the poor management and investment standards that characterize the activity. In the interim EFSA’s pension unit has continued to monitor the funding levels of private pension plans and as noted these have not been markedly affected by recent developments, although there was a slight drop in overall funding level between 2011 and 2012 (from 89 percent to 84 percent). 36. Monitoring indicators. Progress in the strengthening of the regulatory and

23 Highlights include: (i) EFSA has decision making, budgeting and organizational autonomy; (ii) a cadre of new younger graduates not tied to past structures and approaches has been recruited after an exhaustive selection process and trained (including time with the Monetary Authority of Singapore). New cadres of such individuals will be recruited on an annual basis; and (iii) an Institute for Non-banking Financial Services has been established to enable local personnel to attain international qualifications (e.g. through sitting the CII insurance exams in Cairo).

54

supervisory framework of NBFI was reflected in the issuance of the Non-Bank Financial Sector Law 10 of 2009, which was enacted, and became effective; the establishment of EFSA, the single regulator for NBFIs; the merger of EFSA in January 2011. However, challenges remain regarding the move to a full risk based supervisory approach, which was disrupted by the departure of the first Chairman of EFSA, besides implications resulting from the revolution. Although legal reforms were lagging, such as the delayed in the issuance of microfinance law due to the dissolution of the Parliament, following the revolution, the Egyptian authorities gave priority to enhancing access to finance to the marginalized regions, and groups. This was reflected in the increase in the percentage of female microfinance clients from 50 percent in 2008 to 65 percent in 2011. There was also an increase in the outstanding microfinance portfolio reaching LE 3.1 billion in 2011, compared to LE 2.21 billion in 2008. On leasing, assets as a percent of GDP have reached 0.66 percent in 2011, compared to 0.45 percent in 2008. Pillar V: Improving the Financial Infrastructure 37. The RTGS became fully operational with additional features in 2010. The ACH became fully operational in June 2010. About 2.9 million payments cards have been issued to government workers and pensioners through the government payments system program and are being used. During the revolution, when banks offices were closed, payments were made through RTGS/ACH to some pensioners through ATMs. The limited number of ATMs may become an issue as more and more government employees and pensioners use this system, because government employees and pensioners typically wish to withdraw cash when they are paid. A full ACH connection between the Ministry of Finance and CBE will be established by end of 2012. This connection will allow direct payments to government suppliers. Also, the National Inter Bank Switch for retail payments is now fully operational in all banks—a key development in the financial institutional infrastructure. Relevant regulations applicable to licensing payments system and payments system oversight are currently being drafted through a process of consultations. 38. Licenses for mobile payments provision have been issued to two banks, the Housing Development Bank and BNP Paribas and their partner-mobile phone companies. The operation of systems under these licenses was delayed by the revolution, but they are expected to begin operation soon. The Central Bank, Banking System, and Money Law 88 of 2003 limits deposit taking to banks licensed and supervised by the CBE. This limit means that mobile payments systems and products involving deposit-taking are legally required to go through banks; mobile providers cannot offer deposit services independently of banks, as has been done in some countries, for example, Kenya. The purpose of the law is to ensure strong supervision of deposit-takers and to avoid bank collapses that would put pressure on other banks through contagion and could lead to government ad hoc coverage of deposits to protect depositors by banking laws, including the right to redeem their deposits. 39. The Egyptian Banking Institute (EBI), of which all banks in the system are members, has offered an SME Training program for some time. The program includes classes for both bankers lending to SMEs and a guide to help SME entrepreneurs interact with banks. The actual courses have been developed over time using participant feedback. The enrollments in the courses had temporarily slowed and the courses were suspended during the revolution and the closure of the banks. The courses then restarted. The EBI is also setting up visits to other developing countries, to examine how banks in these countries make SME loans and develop their courses further. The EBI expects that the demand for its SME courses will increase under the future Egyptian government. 40. The completion of SME Census, and the database was presented in a form that is accessible to the banking sector. The EBI census of SMEs has been completed in all of the 27

55

Egyptian governorates. It uses a single definition, is based on company registration data, and excludes micro-enterprises employing less than 5 persons. The results of the census are available on the EBI web site as the CBE is keen on better disclose of data and information. The uniform definition of SMEs will permit a much better evaluation and comparison of banks’ lending to SMEs. At the moment, the NBE which has established an SME Department is currently the largest bank lending to SMEs. 41. Monitoring indicators. One of the key achievements of the reform program was the strengthening of the financial infrastructure, evident in: (i) operational status of RTGS and ACH with capacity to encompass low value payments, (ii) the increase of individuals receiving government workers and retirees payments through financial institutions reaching 2.9 million in 2011, compared to 0.6 million in 2008; (iii) CBE issued regulations on mobile phone payments, and issued licenses to two banks and their mobile phone partners ; and (iv) licensed money transfer from customer to customer and from customer to merchant.

56

Annex 9: Direct Impacts of the Revolution on the Financial Sector

1. The Egyptian revolution that began in late January 2011 brought large, unexpected stress to the banking system and the economy overall. The turmoil, protests and deteriorating security situation in the first few weeks during and after the revolution, led to a temporary closure of banks for five working days only and the stock exchange, limiting financial services during that period. The problems were dealt with effectively, on an ad hoc basis, by the CBE and EFSA. The CBE took the decision to close all banks from January 27 to February 6. During this period, payments were difficult to make and a shortage of cash developed. The eight-week closure of the ESE, until March 23, 2011, raised concerns about reliable access to a ready exit for equity holdings. The authorities delayed reopening of the stock exchange several times in light of the extended and widespread nature of unrest, and introduced temporary trading measures aimed at reducing panic upon resumption of trading and helping restore stability in domestic capital markets.24 2. It is worth noting that CBE has responded well to the impact of the Egyptian revolution on the banking system through: a) provision of cash as needed when the banks reopened; and b) the issuance of circulars that generally addressed specific, crisis-related issues that limited withdrawals and foreign transfers and were time-bound. The provision of cash as needed when the banks reopened gave confidence to the people and helped prevent a deposit run. Under the circulars, withdrawals of foreign exchange or transfers abroad were controlled for individuals and limited non-import or non-foreign-investment related transactions. The reopening of the banking system’s branches was gradual, but by end-March 2011 deposits had recovered to 99.3 percent of their December 2010 level, suggesting there had been no loss of confidence in the banks, although deposits in foreign currency had risen to 22 percent compared to 19 percent at the end of 2010. 3. CBE required banks to also conduct stress tests and assess the quality of their assets. The most important of these tests were those on credit portfolios. This was complemented by the CBE’s requirement for banks to monitor their portfolio in a circular. The CBE took several temporary preventive and precautionary measures in response to the developments, as it issued six circulars in response to the developments; appropriately they were generally temporary and limited to time-bound corrections of specific issues that had arisen. These were mainly related to cash withdrawals by individuals (for foreign and local currency); however local currency restrictions were removed two months later; risk management related to retail loans and the tourism-related corporate loans, overseas cash transfers, and the grace period for banks divesture of their ownership of non-financial corporations. The CBE estimated that the commercial banks were resilient and solvent in terms of capital after the revolution, using severe stress tests. 4. Also, regulations for disclosure and corporate governance were augmented by EFSA post-revolution. In order to strengthen compliance of listed companies with internationally recognized corporate governance standards and enhance transparency of equity markets, EFSA reinforced the revised code on corporate governance. EFSA has added important disclosure provisions to its listing requirements through two recent decrees. EFSA also intends to add the "comply or explain" provision to its listing requirements. This means that any company listing shares on the EGX would have to either fully comply with the new code

24 For instance, the EGX suspended intra-day trading, shortened trading hours by an hour to three (a measure recently reversed), and amended price limits on listed equities.; trading would be suspended for half an hour if the broad EGX100 index declined by 5 percent and for longer if it dropped by 10 percent.

57

of corporate governance or explain for each provision why and how it deviates from the code. This reform is expected to strengthen corporate governance and transparency of listed companies. 5. Near-term capital market performance will be driven by political and economic developments. Confidence in Egypt’s political stability, fiscal performance, and credit prospects could reverse the recent rise in Treasury bill rates and make banks somewhat more ready to consider business lending as an alternative to buying and holding government debt. Development of a corporate bond market will remain constrained by Egypt’s lack of a reliable yield curve, which reflects a lack of secondary trading in government securities. Looking at equities, Egypt’s regulatory regime for equities already compares favorably with other MENA jurisdictions and the authorities seem committed to implementation of recent rules (e.g., on disclosure, on related-party transactions) and a strengthening of investment fund regulations. Moreover, EFSA’s equity market regulators have already started to shift from compliance-based to risk-based supervision. That said, both domestic and foreign portfolio investors will want to see greater prospects for political certainty and economic growth before supporting higher equity valuations. Without higher equity valuations, corporations will remain reluctant to move forward with initial or secondary public offerings of shares. 6. The insurance and private pension sectors are by their nature not subject to liquidity shocks. Solvency is more of an issue but balance sheet repair combined with the more professional management of assets that has followed the SOI restructuring and the very conservative investment policies followed by most private sector insurers and pension funds has minimized any immediate balance sheet damage to the institutional investors. In addition, the Deputy Chairman of EFSA currently responsible for the insurance and pension sectors has taken a strong line in restricting insurers from taking excessive investment risks. The evolving European crisis is not seen as being particularly relevant to the institutional investors for similar reasons. The global financial crisis, the revolution and the ongoing European financial crisis have had more implications for capital markets, given the presence of foreign investors and the resultant extreme impact on the Egyptian stock market, followed by the lengthy closing of the Egyptian market. 7. With the dissolution of the Parliament, the revolution has also delayed implementation of the Non-Bank Finance Intermediation Law that would provide a sounder basis for micro-finance institutions, the pension reform, and the treatment of the voluntary pension law. The reform in the pension law enacted by the Parliament in May 2010 has important implications for the financial sector, through the introduction of a new, funded-component of the public pension schemes. The previous administration had decided to postpone the discussion of the law regulating the market of voluntary private pensions until the public pension reform was passed, but during the second half of 2010 a number of important projects were pending Parliamentary treatment. The priorities of the newly elected Parliament have mainly been limited to matters relating to the drafting of the Constitution and its amendments, the National Budget, and the dissolution of the interim government and its program.

58

Annex 10: Adequacy of Government’s Commitment

1. The Egyptian authorities’ commitment to the reform program was key to the success of this operation. The extensive consultations with the stakeholders helped in building consensus and ownership of reforms by the market players. At the same time, strong partnership has been established between the Bank and the Egyptian authorities over the past years through an integrated financial sector work program, reflected in an effective policy dialogue, analytical work, technical assistance, and key operations, focusing on financial sector development. The operation’s team had a strong and professional policy dialogue with the Egyptian main counterpart, namely the Central Bank of Egypt, as well as EFSA that was in charge of NBFIs. The Bank team has also worked closely with the Ministry of Investment, the Ministry of Finance, the Stock Exchange, and the Misr Insurance Holding Company. Commitment to the reform program was maintained even after the revolution. The successful implementation of this operation benefitted from the leadership of the reformist Governor of CBE before and after the revolution, which ensured sustainability and continuity. The authorities’ continuous commitment to developing the financial system in Egypt, and this operation, helped significantly in addressing the changing environment post-revolution. These reforms have contributed to building the capacity of CBE, which enabled them to undertake crisis management measures. Naturally, some reform areas took priority over others in the transition period and in response to people’s demands. Enhancing access to finance became an even more urgent priority, as evident in the recent measures undertaken.

2. Moreover, stress testing and adequate monitoring of the banks’ portfolios and NPLs, especially in sectors that were hit by the crisis, were crucial. The close monitoring to the developments in the stock market and the combating of speculative behaviors, as well as pension reforms and their implications on the lower income segments of the workforce, were also of priority after the revolution. Reforms that moved at a slower pace were the legal ones which required Parliament ratification. Nevertheless, even on this, government commitment was maintained as evident in the issuance of some laws by SCAF, such as the amendments to the Central Bank, Banking System, and Money Law 88 of 2003, addressing governance issues. Overall, the government commitment was adequate, and the reform measures were implemented smoothly even after the revolution and with the disruptions that followed it. 3. On stakeholders’ collaboration, the authorities have also sought financial and technical support from the International Monetary Fund (IMF), USAID, the European Union (EU), and the African Development Bank (AfDB), to carry out this program. Development partners’ support on the financial sector is continuing. At the request of the government, the Bank was playing a coordination role among donors in the financial sector through a Financial Sector Donors Group that it chaired in the field.

59

Annex 11: Soundness of Background Analysis

1. The design and implementation of the second generation Financial Sector Reform Program and this DPL were significantly enhanced by the analytical work carried out.25 Several Bank studies provided strong analytical underpinning to the design of this operation and have helped identify areas that required further reforms. These studies included the 2002 FSAP; the 2007 FSAP Update; the 2005, 2006 and 2009 Investment Climate Assessments; the 2007 Finance for All: Policies and Pitfalls in Expanding Access; the 2008 Access to Finance and Economic Growth in Egypt; the 2009 Egypt Macro Policy Note; the 2010 Determinants of Savings in Egypt Report; in addition to the updates of the 2004 Accounting and Auditing Report on the Observance of Standards and Codes (ROSC); and the 2003 Country Financial Accountability Assessment (CFAA), which assessed the fiduciary risk based approach on the implementation of the Public Financial Management Action Plan. In addition the growing technical capacity of the Bank’s Egyptian counterparts has supported the analytical effort. 2. While the Bank studies and reports have documented the substantial progress made by the financial sector reform program since it was launched in 2004, they also identified areas where there are gaps and where more work is needed. Analytical work showed that the first generation reforms improved the soundness and performance of the financial system; however access to finance was still a problem. Improving financial intermediation was a priority area for the next series of reforms to be undertaken by the government. The analytical underpinnings highlighted the considerable empirical evidence that has shown the relationship between access to finance and economic growth and development, job creation, improving income distribution and reducing overall economic volatility. This has encouraged the authorities to adopt access to finance as the main theme of their second generation reform program. 3. The operation has also benefitted from five FIRST-financed technical assistance projects that have enhanced staff knowledge of the critical issues and challenges in the financial sector. These FIRST projects have included: (i) Strengthening Banking Supervision, building the capacity of the banking supervision department at CBE focusing on connected lending, large exposures and market risk assessment; (ii) Automation of CBE’s Credit Information System, with the objective of strengthening the existing credit information department at the central bank and improving data collection and analysis for credit information; (iii) Modernizing the Payments System, which aimed at strengthening the payments system at the central bank done in collaboration with the EU; (iv) Establishing the Private Credit Bureau, which entailed legal and regulatory amendments to allow for the establishment of private credit bureaus that would cater both to banks, and non-bank financial institutions; and (v) Reserving for and pricing mandatory Third Party Liability (Motor Act) insurance, focusing on developing domestic non life actuarial skills. 4. The Bank has also provided technical assistance in several aspects of pension reform, including: sustainability analysis of the current pension schemes and reform options; fiscal impact of the proposed pension reform; minimum pensions and minimum return guarantees; costs of survivorship and disability pensions; and draft regulatory framework for public (mandatory) and private (voluntary) pensions. 5. It is worth noting here, that the various technical assistance provided to the operation proved essential and key to the effectiveness of the operations because they provided the

25 In the form of ESW, earlier loan appraisals and related due diligence investigations carried out by international firms (including BNP Paribas and Milliman working with local advisors).

60

necessary background, training and assistance needed to both implement and compliment the various reforms required by the operation. Although the operation has closed, the Bank team intend to continue to provide technical assistance to the financial sector in Egypt under the umbrella of the Middle East and North African (MENA) Regional Micro, Small and Medium (MSME) Technical Assistance Facility. One of the three pillars of this facility deals exclusively with the capacity building of financial institutions to help them better serve MSME clients and enhance overall financial intermediation. 6. On governance and transparency, the Bank worked closely with the CBE on taking the required legal and regulatory measures. As a result, the Governance Code was issued in July 2011. This was followed by an amendment of the Central Bank, Banking System, and Money Law 88 of 2003 in October 2011. Furthermore, capacity building and training workshops were held with all banks to support them in complying with the new regulations. Technical assistance and advisory services were also provided to the central bank to strengthen its capacity in monitoring compliance with the corporate governance regulations. Banks are still in the preparatory phase to comply with the regulations. In that context, the central bank has started working on extensive training and awareness programs on corporate governance in March 2012, in collaboration with the Bank. A Train of Trainers program for corporate governance training for banks took place in the same month. CBE is determined to raise the standards of corporate governance of all banks. The CBE continues to play an important role in enforcing corporate governance regulations, and enjoys a positive reputation throughout the banking sector as a strict but fair regulator. 7. On the lending front, DPL III was closely linked to five key financial sector operations in Egypt. The World Bank has gained further experience in development policy lending in the Egyptian financial sector (through DPLs I and II) that was commended and used by the authorities to guide the design and implementation of the second generation program. DPLs I and II (each US$ 500 million) supported the government in implementing the first generation of its Financial Sector Reform Program (2004–2008) discussed above, where the focus was on attaining a sound and efficient financial sector. DPL III aimed to have a greater emphasis on improving financial intermediation and access. It was also linked and complemented the work done under the Mortgage Finance Project (equivalent to US$ 37.5 million) that aimed to establish a mortgage finance liquidity facility, strengthen the regulatory framework for mortgage lending, and modernize property rights registration; as well as the Affordable Mortgage Finance Program DPL (US$ 300 million), which focused on reforming the current system of inefficient and poorly targeted supply-side subsidies for housing for the broad low and middle income sector and replacing them with a transparent and economically efficient demand-side subsidy system. The financial sector operations were cohesive and complementary. 8. While DPL III focused on supporting the legal, regulatory, and institutional reforms to improve financial intermediation, the Enhancing Access to Finance for Micro and Small Enterprises Project (US$ 300 million) provided a line of credit to micro and small enterprises. This complementary project aimed at contributing to a sustainable improvement in inclusion, with a focus on regional disparities and gender and access to finance for micro and small enterprises on a commercial basis. This would ultimately lead to job creation, poverty reduction, and economic growth as well as reduce the impact of the global crisis on those enterprises, as improvements in institutions, financial infrastructure, and the legal, regulatory, and supervisory frameworks, that would sustain the increased levels of lending to underserved groups, and access to finance more broadly.

61

Annex 12: Assessment of the Operation’s Design 1. The design of the operation was well-thought-out. The operation was a one-tranche operation to support the government in implementing the second generation Financial Sector Reform Program. The design was influenced by the findings and recommendations of the 2006 IEG review, which noted that outcomes of loans classified under the Financial Sector Board were significantly better than outcomes of financial sector components of multi-sector loans.26 2. The operation reflected lessons learnt and benefited from the experience of earlier World Bank loans in Egypt, especially: a) the 1991 Structural Adjustment Loan, which did not receive satisfactory ratings and fell short of expectations; and b) The Technical Assistance Project for Privatization, Enterprise, and Banking Sector Reform, approved in 1992 and cancelled in 1996 that also received poor ratings, with less than US$0.5 million disbursed out of US$ 9 million and meager progress on the component to design and implement a comprehensive banking sector reform. In contrast, DPLs I and II (that paved the way for DPL III) were successful because of the government’s strong commitment to reform and effective consultations with stakeholders. Moreover, excellent coordination among donors ensured synergy and effective support to the program. The reforms already implemented have contributed to the resiliency of the financial system throughout the global financial crisis, as well as the immediate impacts of the revolution.

3. The authorities made extensive consultations with the stakeholders, which ensured ownership, and consensus on the design of the program. CBE was transparent with the public on the size of bank losses, and its implications on the performance of the system, and its ability to cater clients. Consultations with the stakeholders, the market players, banks, NBFIs, regulatory bodies, the government, and the private sector, as well as the outcomes of those discussions contributed to the design of the program. This has been evident when the revolution erupted; while many actions undertaken under the previous regime were criticized, the financial sector reform was not subject to any accusations or attacks. 4. Despite the complexity of the reform program and the number of organizations involved domestically, as well as outside donors, the policy areas were well identified and narrowly focused; and reforms were organized according to their degrees of priority. The distribution of responsibilities was clear, and a detailed timeline was set. The previous Egyptian government repeatedly indicated its appreciation of the Bank’s integrated delivery of assistance, and requested the DPL III operation as a means to improve program design and to enhance discipline in reform implementation. 5. DPL III was a single tranche, program loan, rather than part of a programmatic series of development policy loans for a number of reasons, most importantly that the Second Generation of Reforms and the supported actions had not existed, been identified, or considered possible at the time of the original Financial Sector Reform Program (2004-2008). First, the Second Generation of Financial Reforms (2009-2012) supported by DPL III naturally included a continuation of strengthening of commercial banks and the regulation and supervision of commercial banks and non-banks such as insurance and pensions. For commercial banks and the financial system, this included macro-prudential supervision, which had not yet been developed in 2004 and Basel II, which was only issued by the Basel Committee in June 2004 and has been steadily modified since then. Second, the Second Generation of Financial Reform also moved to strengthening and reform of the state-owned

26 For more details on outcomes of loans classified under the FSB versus those in multisector loans with a financial sector component see IEG (2006), World Bank, p. 84.

62

specialized banks, which had not been included in the Government’s 2004-2008 Financial Sector Reform Program because of their sensitivity. Third DPL III included a number of legal changes not foreseen under the initial Financial Sector Reform Program, notably a law converting the specialized Principal Bank for Development and Agricultural Credit into a commercial bank with improved governance, a Non-bank Financial Intermediary Law that would put micro-finance institutions on a sounder basis, a Private Pensions Law, and granting licenses for mobile phone payments. Fourth, DPL III was two years after DPL II and could not commit a new Government, which in practice is proving to be very different than the last Government. Fifth, the request for DPL III from the Government also included support for combating the adverse effects of the Global Financial Crisis on the financial system, which was unseen in 2004 but which were still an issue in 2010.

63

Annex 13: Banking Soundness Indicators

Source: CBE Database (May 2012).

Indicators (%) FY08 FY09 FY10 2011 March June Sept Dec

First: Capital Adequacy Capital Base to Risk Weighted Assets 14.7 15.1 16.3 16.3 16.0 16.4 15.6

Tier 1 Capital to Risk-Weighted Assets 11.5 12.0 12.7 13.6 13.3 13.7 13.0

Net Worth to Assets 6.2 6.4 6.7 6.6 6.4 6.5 6.2 Second: Asset Quality Nonperforming Loans to Total Loans 14.8 13.4 13.6 11.2 11.0 11.0 10.9

Loan Provisions to Nonperforming Loans 92.1 100.4 92.5 93.7 93.6 93.7 94.6

Loans to Private Sector to Loans to Customers 83.9 81.0 80.5 80.6 81.0 81.1 81.1

Third: Earnings Return on Average Assets 0.8 0.8 1.0 1.0 1.0 1.0 1.0

Return on Average Equity 14.1 13.0 14.3 14.3 14.3 14.3 14.3

Net Interest Margin 1.7 2.2 2.3 2.3 2.3 2.3 2.3 Fourth: Liquidity Liquidity Ratio Local Currency 34.5 43.4 44.7 52.7 55.3 55.8 55.4 Foreign Currencies 46.8 41.0 40.6 47.9 51.1 50.4 51.1 Securities+ to Assets 12.2 13.8 18.0 18.2 17.8 18.1 18.2 Deposits to Assets 78.4 82.4 81.0 74.2 75.8 75.6 75.4 Loans to Deposits Total 57.7 52.7 51.8 50.0 49.5 49.2 50.0 Local Currency 52.0 46.5 44.0 45.0 45.0 44.7 46.0 Foreign Currencies 71.3 69.3 75.8 65.0 63.5 63.6 63.0

64

Annex 14: Lessons Learnt

1. Strong analytic underpinning and building on other operations. The 2002 FSAP, and its 2007 Update, helped create a credible blueprint for the design of this operation, which in turn rendered easier the coordination of donors’ assistance around the realization of this blueprint. Given the multifaceted nature of the financial reform effort, the contribution of many donors was needed. Also, this operation benefitted from a number of analytical underpinnings, as well as numerous lending operations, as detailed in Section 2.2 earlier. 2. Consultations with stakeholders. Reforms have been undertaken after a process of close and continuous consultation with all stakeholders. This participative process with wider involvement not only encouraged a more informed evaluation of the underlying content of policies but also enhanced the credibility of policies and generated expectations that the reform process will be sustained. 3. Effective cooperation with development practices. The Bank team worked in partnership with USAID, EU, IMF, and AfDB. The respective responsibilities of the different donors and development partners were clearly defined. This approach was better than constant “hand holding” and double guessing of the authorities’ intent. The success of the operation required the right balance between flexibility in the implementation and pro-activity in providing technical assistance and guidance where needed. In this respect, the approach of a sub-donors committee followed under this DPL III can be considered best practice and one that may benefit other operations outside Egypt. See Annex 3 for more details on donors’ collaboration. 4. Strong and sustained partnership. The close working relationship with the Egyptian authorities and implementing entities demonstrated that significant reforms were implemented, backed by a strong leadership and political commitment. This was supplemented by supportive policy advice and coordinated sector interventions. This best practice partnership framework is among the key success factors of this operation. Indeed, the respective responsibilities were clearly defined, including giving the authorities the flexibility needed to implement the reforms. Since the Egyptian government had a clear vision of what was needed to be accomplished, cooperation and coordination of support was determined to be the best approach. It was critical to work with a team of professionals and build a strong policy dialogue to go the extra mile and provide technical inputs, in some cases beyond the operation. This has been evident in CBE’s ownership of the operation, which helped in keeping the operation on track despite the revolution. 5. The design of the policy matrix is key to the sustainability of the reforms. A well-defined policy matrix owned by the government and endorsed by the Bank and partners is an essential implementation roadmap for the authorities to move the agenda forward. A matrix that is built on solid analytical work that is endorsed by development partners is critical. However, most important is having a government’s program, which they have full ownership of and are committed to implement, and there is no sense of imposition.

6. Having a champion in the government that is competent enough to coordinate efforts with other implementing entities. Having a government entity or authority that is empowered and competent enough to successfully build consensus around the program, and defend it in difficult times of political and social unrest is critical. Moreover, experience has shown that having a limited number of implementing entities is often more effective and efficient and ensures smooth flow of work through the life of the operations—preparation, appraisal, negotiation and implementation. 7. The single tranche DPL III proved to be a suitable instrument for the Borrower

65

and the Bank. It responded effectively to the needs of the authorities by providing them timely support based on clearly established prior actions. It provides quicker feedback and momentum to the reforms that enables follow up and making early adjustments if necessary. It allows continuity in the dialogue with the authorities. Single tranche operations define benchmarks based on information available at the time of implementation and not on certain future developments which might not materialize. As noted above in more detail above (paragraph 69) the single tranche loan, rather than a programmatic loan, was appropriate, because the single tranche DPL III (March 2010) supported a Second Financial Sector Reform Program (2009-12) which entailed new reforms, some of which were unknown or underdeveloped at the time of DPL I, e.g. Basel II, mobile banking, and some of which were requested by the government to support the existing reforms in the context of unforeseen economic developments, such as the Global Financial Crisis that began in 2008. 8. Lessons Learnt from this operation can be disseminated at knowledge management events. The experiences in the preparation and implementation of the operation could be shared with other regions through various means, including the Finance and Private Sector Development (FPD) network monthly newsletter, as well as through hosting a brown bag lunches (BBL).

Comments on Issues Raised by the Borrower/Implementing Agencies/Partners

9. The Egyptian authorities were appreciative of the support provided by the World Bank. The authorities rated the World Bank's performance during the operation as overall highly satisfactory as indicated in Annex 2. The operation witnessed close coordination and communication with the implementing entity and the relevant officials, and they acknowledged that the day-to-day support and close supervision of the operation from the field has helped in ensuring successful implementation. The government also clearly stated that they greatly valued the technical assistance and advisory services packaged with the loan. 10. Moreover, various donors, development partners, and international institutions have been providing support for the implementation of the government’s overall financial sector reform program through the provision of technical assistance, and analytical work on reforming and restructuring the financial sector. This required effective coordination, which the Bank led in chairing the Financial Sector Donors Subgroup. This cooperation led to mutual design and agreement of conditionality issues that all donors agreed were essential for financial sector reform. In addition, donors were able to do a much better job of leveraging resources, both loan and technical assistance, when coordination is effective. The most effective and successful coordination was with USAID, IMF, AfDB, and the EU. More details are included in Annex 3.

W e s t e r n

D e s e r t

L i b y a n P l a t e a u

Li

by

an

D

es

er

t

QattaraDepression

Ea

st e

rn

De

se

rt

A L WA D IA L J A D I D

MARSA MATRUH

ASWAN

QENA

SOHAG

ASSIUT

SOUTHERNSINAI

NORTHERNSINAI

SUEZ

EL FAYOUM

BENI SUEF

AL MINYA

AL BAHR

AL AHMAR

Luxor

Kom Ombo

Halaib

Siwa

Qara

Mut.

Ras Gharib

Taba

Abu Zenima

Qena

Suez

Aswan

Sohag

Assiut

Benha

Tanta

Damietta

El Tur

Zagizig

Al Minya

Ismailia

Damanhur

El-Kharga

Beni Suef

El Fayoum

El Mansura

Shibin el Kom

Kafr elSheikh

CAIRO

LakeNasser

Nile

River

G I Z A

Giza

1

89

1011

1213

2

3

4

5

6 7

HelwanHELWAN

Luxor

Kom Ombo

Halaib

Marsa 'Alam

Salum

Siwa

Qara

Mut.

Quseir.

Bir Seiyala

Ras Gharib

Taba

Abu Zenima

Giza

Marsa Matruh

Qena

Suez

Helwan

Aswan

Sohag

Assiut

Benha

Tanta

Damietta

El Tur

Zagizig

Al Minya

Ismailia

Damanhur

El'Arish

El-Kharga

Beni Suef

El Fayoum

Port SaidEl Mansura

Alexandria

Al Ghurdaqah

Shibin el Kom

Kafr elSheikh

CAIRO

A L WA D IA L J A D I D

MARSA MATRUH

ASWAN

QENA

SOUTHERNSINAI

NORTHERNSINAI

SUEZ

HELWAN

G I Z A

AL BAHR

AL AHMARASSIUT

EL FAYOUM

BENI SUEF

AL MINYA

SOHAG

1

89

1011

1213

2

3

4

5

6 7

S U D A N

SAUDIARABIA

JORDANISRAEL

LIBYA

WEST BANKAND GAZA

Aswan Dam

Nile

River

LakeNasser

Gulf of Suez

Gul

f of

A

qaba

Red

Sea

M e d i t e r r a n e a n S e a To Tel Aviv

To Port SudanTo

BerberTo

Dongola

To Jalu

To Darnah

W e s t e r n

D e s e r t

L i b y a n P l a t e a u

Li

by

an

D

es

er

t

QattaraDepression

Ea

st e

rn

De

se

rt

25°E 30°E

30°N

25°N

20°N

30°N

25°N

20°N

35°E

25°E 30°E 35°E

ARAB REPUBLICOF EGYPT

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 50 100 150

0 50 100 150 Miles

200 Kilometers

IBRD 33400R

MAY 2010

ARAB REPUBLIC OF EGYPTSELECTED CITIES AND TOWNS

GOVERNORATE CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

GOVERNORATE BOUNDARIES

INTERNATIONAL BOUNDARIES

GOVERNORATES IN NILE DELTA:

1234567

KAFR EL SHEIKHDAMIETTAPORT SAIDALEXANDRIABEHEIRAGHARBIYADAGAHLIYA

MENOUFIYASHARGIYAHQALIUBIYAISMAILIACAIROGIZA

89

10111213