Banks operating in the Egyptian market tend to invest part of their liquidity in foreign exchange abroad, which is common practice worldwide. Yet, what is important the employment of that liquidity, the apparatuses to invest in, and the related risks accompanying these investments.
The Central Bank of Egypt (CBE) has set several controls to protect banks from the risks of such investments, as part of its supervisory role, which aims to preserve banks’ funds, as they are originally depositors’ money.
Tarek Metwally, a banking expert responsible for the financial markets in one of the banks with over 30 years’ experience, describes investment in global financial markets as diverse and multi-purpose, but is also disposed to several risks.
There exists investment in conventional savings options such as deposits, treasury bills and bonds, commercial papers and government debt, and these types of investments are is less risky, pointed out the banking expert.
Furthermore, he said there are also investments in diversified investment funds as well as hedge funds which brave higher risks, along with investments in junk bonds, derivatives, and speculations, which are very high-risk investments.
“In light of this wide diversity of products and associated risks, each bank sets its investment policy in line with its strategic plans, objectives, and the risk level it can accept. This policy is presented to the board of directors for approval, and then submitted to the CBE for approval. Subsequently, it becomes the primary reference for all banks’ overseas investments,” declared Metwally.
The banking expert further clarified that there are many controls set by the CBE in the department of foreign investments, which aim to hedge and diversify investments, without focusing either on specific apparatuses nor on countries, likewise from investments in risky assets and junk bonds.
These controls include setting the country’s limits for banks’ investments, based on the state’s credit rating, achieve maturity balance, as well as regulate currency balances, according to Metwally,.
Furthermore, the CBE has banned banks from speculating in various types of precious metals, as well as investing in risky assets, indicated the banking expert.
Metwally pointed out that to achieve the objective of these controls, which is protecting banks and their funds, the CBE stipulated its approval before banks can implement strategic investment policies.
The CBE also decreed that an investment manager must be present in each bank in order to approve their activity, after ascertaining their experience, and obtaining sufficient qualifications in their field of specialization which qualifies them to carry out this role.
It is advisable for banks not to invest in instruments whose legal and technical risks are unknown.
The CBE has a few mechanisms to evaluate the forecasted risks that may affect the market, which leads to the issuance of instructions as a precautionary measure to maintain the status of banks, especially in anticipation of sudden changes in the market, which could have implications for the status of banks, stressed Metwally.
The CBE’s board of directors on 4 January, 2011 issued a decision limiting banks’ utilised liquidity in countries and financial institutions overseas.
Among these controls, each bank had to set a ceiling on the total investments in one country— a country limit—so that the maximum liquidity employment of banks in any financial institution abroad would remain below 10% of total investments overseas, or 40% of the capital base, or whichever is less.
According to the CBE, the financial institutions include branches of foreign banks operating in Egypt, however not the branches of Egyptian banks abroad nor foreign banks entirely owned by Egyptian banks.
Moreover, the CBE added that the maximum rate of banks or foreign banks’ branches in Egypt in a financial group must remain under 50% of the bank’s capital base. Foreign banks’ branches can invest in its main unit, branches, and subsidiaries around the world up to 100% of the local unit’s capital base.
Over and above, The CBE has required banks to submit a monthly statement of their investments in financial institutions, including banks and financial groups. It also compelled banks to submit a statement of investments in foreign countries on a quarterly basis.
However, the CBE excludes specific high-risk investments from banning banks from investing in them, such as high-risk investments guaranteed by a government in a currency different from theirs as long as said country’s credit rating is above A, or letters of guarantee supplied by banks operating abroad, which are leveraged by local letters of guarantees, as long as that bank’s rating is above A, and direct employment resulting from discounting bill exports for a period not less than one year.
Also, according to the CBE, each bank must independently determine the employment ceiling of each country, based on its strategy, detailed policy and the number of risks that the bank wishes to absorb in each country.
This is determined according to an analysis that includes several criteria, including the state’s assessment according to international rating institutions, the size of the country’s economy, the bank’s capital base, the bank’s total investments, as well as the bank’s total assets. The CBE clearly pronounced that it only accepts credit ratings provided by Standard & Poor’s, Moody’s, or Fitch.
Additionally, the CBE stressed the need to update and review the country’s ratings periodically, as it will not consider ratings that are over one and a half years old. The CBE emphasised that in case the rating drops by an amount which surpasses the concentration limit, the bank must then provide the control and supervision sector a specific corrective and adjustment plan.
The CBE’s controls also included prohibiting banks from speculating in precious metals, opening accounts in the Egyptian pound for banks operating abroad, and the market of foreign exchange transactions and the Egyptian pound using derivatives.
Among these controls, it is not permissible for banks to deal or speculate in precious metals in any form, whether for their own accounts or for their clients’ accounts. Banks operating in Egypt in the foreign exchange market are limited to necessary operations for banks to manage their daily activities. These banks shall not directly engage in any speculative operations in said market area, whether for their own accounts or for their customers’.
The regulations also included an emphasis on prohibiting banks from operating in the foreign exchange market to obtain any trade margin in different currencies and precious metals for their customers, adding that non-compliance with this interdiction places the bank in violation to all penalties permissible by law to the CBE’s board.
The CBE insisted on the need to strictly abide by the prohibition of speculative operations on the Egyptian pound, using derivatives of all kinds, including swap, either for the customer’s account, or for the bank’s account, except for operations required by the customer’s ordinary activity.
According to banking expert Zakaria Salah, investment in global financial markets requires a balance between return and risk and the availability of liquidity from foreign exchange.
Salah added that due to the volatility witnessed by these markets in the price of assets traded in shares, bonds, and currencies, it requires that risk managers deal efficiently and hedge against risks, through limiting these operations.
Due to the supervisory role of the CBE, it puts a limit for employment in enterprises and financial groups at 10% of total overseas investments or 40% of the capital base, whichever is lower, mentioned Salah.
According to the banking expert, it limits the direction of local banks to invest in international markets, especially since the last period witnessed a shortage of foreign exchange resources, and the high rates of return witnessed by the financial markets in Egypt which limited investments abroad.
The current period requires that banks contributes towards providing financing for projects and economic activities domestically in order to increase growth rates to desired levels. Therefore, banks tend to endorse treasury bills and provide funds, while benefitting from the appropriate return prices and concurrently affording a safe investment environment for global markets, concluded Salah.