Following the ongoing reversal of the interest rate cycle, as the Central Bank of Egypt (CBE) has cut interest rates for two consecutive months with an aggregate of 200 basis points (bps) (100 bps each month), Beltone Research issued a report studying how the CBE’s decisions will affect banks.
According to the report, banks’ average duration (AD) figures—a method for measuring interest rate risk, which examines the sensitivity of the market value of the financial institution’s net worth to changes in interest rates—that are based on maturity or repricing dates, whichever is earlier, as per each bank’s financial statements, will not be in jeopardy following the rate cuts.
Moreover, the AD of the combined balances of a bank’s loans and investments can be roughly considered as the period for which each bank’s high net interest margins (NIMs) are mostly locked in, shielded against lower rates. Beltone Research estimates the asset-liability duration gap by netting out the AD of liabilities from that of assets.
The CBE’s Monetary Policy Committee (MPC) decided to cut interest rates by 100 bps (1%), according to a statement issued by the CBE in March—the second time in 2018.
The report indicates that Egyptian banks have been prepared for interest rate cuts since Q3 2017, as most banks’ management teams surveyed by Beltone responded that they expect interest rates to be cut by at least 400 bps throughout 2018.
Consequently, most banks have been adjusting their asset/liability duration gaps to alleviate anticipated NIM compression this year and onwards through lengthening asset durations to lock in higher interest rates for a longer period of time while focusing on gathering short-term deposits that should reprice faster in a lower interest rate environment.
Furthermore, the report indicated that banks with a positive duration gap between assets and liabilities should technically be able to lock in higher NIMs for a period of time.
On the other hand, banks that have heavier exposure to loans as a percentage of assets (such as QNBA) versus t-bills should be in better shape given that t-bill yields have already priced in around 400bps, while loans have only priced in a 200 bps cut thus far.
Moreover, Beltone believes that Islamic banks in particular have greater flexibility to reprice their liabilities lower, as they are based on the model of sharing profits and losses. The report states that such assessment is just a snapshot of where the banks stood in December 2017, while keeping all other things constant, without taking into consideration the anticipated asset/liability growth.
In regards to the durations analysis, Beltone researchers believe that Al Baraka Bank enjoys the best combination of longer asset durations and shorter liabilities durations, privileging the bank with a superior durations’ gap, while CIB follows suit as per those calculations.
“Overall, we anticipate an average 30-40 bps cut in NIMs across the board this year. We also stress that banks that will be able to grow their asset volumes while keeping their cost of funds under control by growing cheaper liabilities can partially absorb the anticipated impact of NIM compression. We believe that HDB fits in the aforementioned category,” the report concluded.