Egypt: Improving Systemic Surveillance
Following the FSAP 2010 recommendations, the Central Bank of Egypt (CBE) approached FIRST for help with developing a tool for strengthening the risk assessment and management framework for individual banks and the whole financial system. FIRST funded TA worth $180,000 to provide the CBE with a customized Financial Projection Model (FPM), a tool that helps bank supervisors implement dynamic stress tests, identify and monitor problem banks, assess systemic vulnerability, and evaluate a bank's value for liquidation or resolution options, among other tasks. The TA was carried out between January 2012 and June 2013.
Challenge:
The January 2011 revolution in Egypt greatly affected the financial sector, not least through the closure of banks from January 27 until February 6, and of the Egyptian Stock Exchange until March 23. As a regulatory and supervisory body, the CBE had to closely monitor the quality of banks' assets and nonperforming loans, and undertake rigorous stress testing for banks. The banking system was vulnerable to a growing crowding-out effect by the government from sell-offs of debt and from the growing budget deficit. The deterioration in the investment climate and the overall macroeconomic environment negatively affected demand for private credit. The attendant risks made financial sector stability and the system's resilience a crucial priority for the government.
In the context of strengthening the stress testing framework, a World Bank team in July 2011 provided training to the CBE's supervisors on the FPM (see box). The need to customize the model to the country's accounting standards and prudential regulations led to a request for FIRST funding to help with the customization and with knowledge transfer for this tool.
Solution:
The FPM experts customized the model in a way that enabled the CBE to carry out stress testing based on international best practices and Basel II rules on capital adequacy, while having the flexibility to apply the country's prudential regulations in terms of capital, liquidity, and loan loss calculation. The experts developed a system-wide FPM containing all 12 banks' data, which also allows for individual bank assessments. Training on using the tool was provided for both CBE supervisors and the potential users at the Macro-Prudential and Off-site Surveillance Units. Hypothetical and real case studies were used to maximize the transfer of know-how. The experts also developed a technical note on the integration of the customized model into the CBE's supervision.
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Results:
The FPM was innovative and impactful. It led to an improvement of the CBE's early warning system through the identification of both idiosyncratic and systemic risks. It allows the CBE to take preemptive measures to mitigate the impact of risks before they threaten the viability of individual banks and the whole system. In addition, the project led to significant knowledge transfer to and capacity building for the CBE staff, to enable them to maintain the model in the future. The CBE's integration of the FPM into its ongoing supervisory surveillance and its continuous use will contribute to a sound and stable financial system.