VZCZCXYZ0000
RR RUEHWEB

DE RUEHEG #5001/01 2261103
ZNR UUUUU ZZH
R 141103Z AUG 06
FM AMEMBASSY CAIRO
TO RUEHC/SECSTATE WASHDC 0537
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC 0176

UNCLAS CAIRO 005001 
 
SIPDIS 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR NEA/ELA, NEA/RA, EB/IDF AND EB/OMA 
USAID FOR ANE/MEA MCCLOUD AND DUNN 
USTR FOR SAUMS 
TREASURY FOR NUGENT AND HIRSON 
COMMERCE FOR 4520/ITA/ANESA/TALAAT 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN ETRD EINV EG
SUBJECT: EGYPT:  FINANCIAL SECTOR MOU UPDATE, PART I 
 
 
Sensitive but Unclassified.  Not for Internet distribution. 
 
REF:  A. Cairo 1838 
  ¶B. Cairo 3746 
 
------------------------ 
Summary and Introduction 
------------------------ 
 
¶1.  (SBU) Since the last update on the status of the Financial 
Sector MOU (Ref A), the GOE has met all of the benchmarks for 
disbursement of USD 25 million in DSP-II funds tied to Policy Item 1 
- Central Bank Management.  The GOE has indicated that it expects to 
complete, by September 2006, all of the benchmarks for disbursement 
of USD 25 million tied to Policy Item 2 - Government Securities 
Market, and USD 100 million tied to the first part (public bank 
audits and joint venture bank divestment) of Policy Item 3 - 
Financial Sector Reform.  Once all of these benchmarks have been 
met, the GOE intends to request one large disbursement of funds. 
 
¶2.  (SBU) The GOE and the USAID Mission are close to finalizing a 
Monitoring Program for the MOU that will specify the documentation 
needed to certify that benchmarks have been met and funds can be 
disbursed.  Agreement on the Monitoring Program, however, awaits the 
outcome of discussion between the USG and GOE regarding use of the 
term "full financial due diligence" versus "audit" for the financial 
assessments of the public banks required by benchmark 3.1.  The 
Ambassador has conveyed to the Minister of Finance the U.S. position 
that the 2006 report may be called "full financial due diligence," 
but subsequent annual reports required by the MOU must be called 
"audits."  Post will report septel when GOE agreement has been 
confirmed.  End summary and introduction. 
 
--------------------------------------- 
Policy Item 1 - Central Bank Management 
--------------------------------------- 
 
¶3.  (U) USD 25 million in DSP funds are tied to completion of the 
following three benchmarks for Policy Item 1: 
 
Benchmark 1.1 - The Central Bank of Egypt (CBE) will establish and 
appropriately staff units for: 
 
- Monetary Policy: 
 
Completed - CBE established a Monetary Policy Unit in October 2005. 
The unit provides support for the Monetary Policy Committee (MPC), 
which was established in June 2005 and is composed of members from 
various GOE ministries and CBE.  The MPC is responsible for setting 
overall monetary policy, including key interest rates. 
 
- Foreign Exchange Management and a Foreign Exchange Dealers 
System: 
 
Completed - An inter-bank market for foreign exchange was set up in 
September 2004 and the convention governing inter-bank foreign 
exchange trading was formally adopted in December 2004.  CBE also 
established a Foreign Exchange Unit in December 2004 (an extension 
of the previously-existing Foreign Exchange Dealings Chamber).  A 
foreign currency clearing mechanism was created in October 2005. 
 
- Non-performing Loan (NPL) Management Unit responsible for setting 
a national policy of dealing with NPLs, setting up and NPL data 
base, monitoring recovery efforts and introducing an 
arbitration/conciliation mechanism for NPLs: 
 
Completed - CBE set up an NPL Management Unit in October 2005.  The 
unit supported efforts by the CBE, Ministry of Finance (MOF) and 
Ministry of Investment (MOI) to develop a national NPL policy, which 
was first announced in January 2006.  Further details of the policy 
were announced earlier this month (see para 8).  The unit has also 
set up an Arbitration Committee to conduct settlement negotiations 
and a monitoring program to track implementation of negotiated 
resolutions. 
 
Benchmark 1.2 - CBE will hire the required competent advisors. 
 
Completed - CBE has completely restructured bank management and 
hired numerous private sector bankers to work in the new units 
established at the bank.  USAID has funded the hiring of some of 
these advisors. 
 
Benchmark 1.3 - CBE will introduce an optional early retirement 
policy and compensation scheme for the CBE. 
 
Completed - CBE announced its optional early retirement policy and 
compensation scheme in two stages, the first in May 2006, for 
employees aged 51 to 55, and the second in June 2006 for employees 
aged 46 to 50.  According to CBE Deputy Governor Tarek Amer, over 
1000 employees (approximately 20 percent of CBE's workforce) have 
taken the early retirement option and left CBE's personnel rolls. 
 
-------------------------------------------- 
Policy Item 2 - Government Securities Market 
-------------------------------------------- 
 
¶4.  (U) The U.S will disburse USD 25 million in DSP funds upon 
completion of the following three benchmarks for Policy Item 2: 
 
Benchmark 2.1 - Implement a Primary Dealers System with dealers 
underwriting new government debt issuance through auctions and 
trading of government securities on the open market. 
 
Completed - The Primary Dealers System was launched in July 2004. 
It allows 13 financial institutions registered with the MOF, 
including banks and bond dealers, to underwrite primary issues of 
government securities and activate trading in the secondary market 
through sale, purchase and repurchase agreements of government 
securities.  Information on the Decree and Executive Regulations 
establishing the Primary Dealers System can be found at: 
www.mof.gov.eg/debt. 
 
Benchmark 2.2 - Initiate trading of government bonds off the stock 
exchange in an open market where buyers and sellers may directly 
trade. 
 
Completed - The Primary Dealers System was restricted, in the first 
quarter of FY 2004/05 (July - September 2004), to Treasury Bills in 
order to ensure efficient functioning of the system.  In October 
2004 it was extended to bonds.  A secondary market for government 
securities, working through the Primary Dealers System, has 
developed and trading is taking place off the stock exchange, i.e., 
over the counter, but the Capital Market Law requires that all over 
the counter transactions be reported to the Capital Market 
Authority. 
 
Benchmark 2.3 - Establish the legal status of and launch operation 
of Repurchase Agreements for government securities consistent with 
international best practices. 
 
Pending - A Repurchase Agreement template was drafted by the 
Ministry of Finance and circulated to banks for comment via the CBE. 
 Amendments to the Capital Market Law to allow short selling are 
still pending but are expected to be issued by September. 
 
--------------------------------------------- -------- 
Policy Item 3:  Financial Sector Reform/Privatization 
--------------------------------------------- -------- 
 
¶5.  (U) The U.S. will disburse USD 100 million in DSP funds for 
completion of the following two benchmarks for Policy Item 3: 
 
Benchmark 3.1 - Auditing of the four largest state-owned banks by an 
internationally recognized impartial institution in accordance with 
standards set by the International Accounting Standards Board 
(IASB). 
 
Pending - The audit of Bank of Alexandria (BOA) was completed in 
late 2005, and according to CBE Deputy Governor Tarek Amer, auditing 
of National Bank of Egypt, Banque Misr and Banque du Caire has been 
completed by BDO-Seidman International, KPMG International and 
Deloitte, Touche and Tohmatsu, respectively, but the reports have 
not yet been released publicly. 
 
Benchmark 3.2 - Divestment of GOE shares in the four largest joint 
venture banks. 
 
Completed - The GOE divested all of its shares in the four largest 
JV banks, i.e., Misr-International Bank; Egyptian-American Bank; 
National Societe Generale Bank and Commercial International Bank. 
 
¶6.  (U) The U.S. will disburse USD 150 million in DSP funds upon 
completion of the following benchmark for Policy Item 3: 
 
Benchmark 3.4 - Privatization of the candidate bank (BOA). 
 
Pending - As reported in Ref B, on August 2, CBE and MOI announced a 
short list of six candidates who will be allowed to carry out their 
own due diligence on the bank.  Final financial and technical offers 
from the short listed bidders are due at the end of September.  The 
GOE audit and due diligence on BOA was completed in late 2005.  In 
accordance with the national NPL policy, the bank's NPL portfolio 
(LE 6.9 billion) was settled in February 2006, using proceeds from 
the Telecom Egypt IPO in December 2005.  As noted in Ref B, GOE 
contacts have given various estimates, ranging from September to 
December 2006, for completion of the sale. 
 
¶7.  (U) The U.S. will disburse USD 200 million in DSP funds, on an 
annual pro rata basis, upon completion of the following benchmark 
for Policy Item 3: 
 
Benchmark 3.5 - The private sector banks' share of new loans made in 
the banking system during the previous calendar year will be equal 
to at least 62.5 percent.  Intermediate progress toward this goal 
will be measured from the baseline determined by the initial audit 
referenced in benchmark 3.1 and calculated each year by annual 
audits of banks according to IASB standards.  Pro-rata disbursements 
against this benchmark may be made for annual increases in the 
private sector banks' share. 
 
Pending - Progress on this benchmark can only be measured when the 
2006 full financial due diligence reports on the public banks are 
issued. 
 
¶8.  (U) The U.S. will disburse USD 250 million in DSP funds, on an 
annual pro rata basis, upon completion of the following benchmarks 
for Policy Item 3: 
 
Benchmark 3.6 - The share of NPLs as a proportion of all loans in 
the banking system will be reduced by 50 percent from the baseline 
determined by the audit of the four largest state-owned banks and 
the annual audit of private sector banks. 
 
Pending - Progress on this benchmark can only be measured when the 
2006 full financial due diligence reports on the public banks are 
issued.  However, according to IMF, NPLs declined from approximately 
26 percent of total loans in April/May 2005 to 25 percent by 
December 2005.  Beginning in June 2005, provisioning also increased 
as a percentage of NPLs from around 53 percent in June 2005 to 55 
percent in December 2005.  Earlier this month, CBE Governor El Okdah 
held a press conference to announce details of the national NPL 
policy.  El Okdah claimed that 46 percent of total NPLs in the 
banking sector had already been resolved.  After settlement of BOA's 
NPLs in February 2006, the remaining NPLs held by public banks 
totaled approximately LE 26.1 billion.  These NPLs would be settled 
with proceeds from the GOE's privatization program, including sale 
of BOA, and revenues from issuance of a third cellular phone 
license.  El Okdah also noted that about one half of private sector 
NPLs held by public banks had been resolved by individual bank 
settlement units, supported by CBE's Arbitration Committee. 
 
Benchmark 3.7 - The cash recovery on NPLs will equal at least 20 
percent of the book value of NPLs to be disposed of under the 
previous benchmark. 
 
Pending - Progress on this benchmark can only be measured when the 
full financial due diligence is completed on the remaining public 
sector banks.  However, according to CBE, of the 46 percent of total 
NPLs that have been settled, 27 percent were collected, including 
cash recoveries of 24 percent of the overall debts resolved. 
 
¶9.  (U) Post will report on GOE progress on Policy Items 4-6 
septel. 
RICCIARDONE