Banks across Egypt, Morocco, and Jordan face an uncertain 2023, marked by global economic instability and the accelerated tightening of monetary policy in the largest developed economies. S&P Global Ratings believes those factors could take a toll on the countries' banking sectors, though the recent decline in energy prices and the resilience of tourism may soften the financial and operational impact.

Banks are likely to feel the effects of those competing influences at different times due to their nations' specific risk exposures. We maintain our forecast that the regions' banks will remain profitable, supported by the positive impact of higher interest rates on revenues, yet we also see significant risk to that outlook.

Local banking systems remain vulnerable to the global macroeconomic environment due to its impact on funding costs, tourism flows, commodity prices, and inflation (particularly food inflation). These factors remain an issue despite increased support, demand, and remittance flows from Gulf Cooperation Council (GCC) countries, particularly for Egypt and Jordan. We expect the cost of risk to remain elevated, while asset quality will slowly deteriorate across the three banking sectors covered in this report due to muted economic growth, higher inflation, and the winding-down of pandemic-related support.

We consider the greatest risks to our forecast to be:

• Deterioration in sovereign creditworthiness;
• An escalation of the Russia-Ukraine conflict, leading to a second round of global inflation due to a spike in energy and food prices;
• Higher levels of asset quality deterioration due to a larger-than-expected impact from higher interest rates and slower economic growth.

Our Banking Industry Country Risk Assessments (BICRA) are seven for Morocco, eight for Jordan and nine for Egypt (see chart 1). Our economic and industry risk trends for the sector under consideration are stable.

Chart 1

Economic Volatility Remains A Challenge

High commodity and food prices and the resultant monetary policy tightening have hurt the region's economies, though the reopening of China and recent decline in commodity prices could provide some support via improved global demand.

North Africa and Jordan are exposed to cyclical sectors such as tourism, real estate, sea transportation, and to a lesser extent commodity exports. We expect high borrowing costs and still high, albeit easing, inflation rates will weigh on economic growth in 2023.

At a country level, Morocco should benefit from flattering base effects in the agriculture sector (see chart 2), after drought in 2022 weighed significantly on agricultural output. The Moroccan economy's still significant reliance on agriculture makes it sensitive to weather patterns.

Fertilizers, especially phosphates, should continue to support Morocco and Jordan's exports, following a surge in external demand in 2022.

Egypt's growth should continue to slightly outpace peers, with the construction and energy sectors as key drivers. On the downside, exchange rate devaluation is likely to dampen household spending for much of 2023, which explains the lower growth forecast compared to 2021 and 2022.

Chart 2

After peaking in 2022, we expect regional inflation will gradually decline and stabilize in 2024, albeit still above the pre-pandemic level of 2019 (see chart 3). Inflationary pressure is strongest in Egypt, where exchange-rate devaluation has magnified already rising prices. Central banks across the region raised rates in 2022, ending years of rate declines and following actions taken by the European Central Bank and the U.S. Federal Reserve. Egypt's main interest rate has increased 800 basis points (bps) since the beginning of 2022, Jordan's rate is up 450 bps, while Morocco is up 100 bps. We expect those higher rates will help manage inflation expectations and limit capital flight. At the same time governments in the region have generally increased subsidies and direct social payments in an effort to protect citizens from the impact of price rises in 2022 and to limit societal pressures.

Chart 3

Long-term positive economic performance remains dependent on the implementation of structural reforms. Jordan and Morocco have launched reforms aimed at improving growth and competitiveness, which we expect will support economic and political stability. Egypt is largely dependent on multilateral and bilateral financial support to meet this year's significant external financing needs. Egypt's government is making efforts to improve the operating environment for private business and reduce the state's role in the most productive sectors. We expect 2023 will be characterized by a more stable exchange rate (or at least an end to the sharp devaluation of recent months), a decline in inflation, and the maintenance of social stability.

Rising Interests Will Have A Mixed Effect On Profitability

Despite the uncertainty clouding the region's economic outlook, we are generally optimistic regarding the prospects for improved profitability among banks in 2023, and expect returns will rise to near their pre-pandemic levels everywhere except Egypt (see chart 4).

Chart 4

Those gains will be mainly be due to banks benefitting from rising interest rates, which tend to boost revenues and net interest margins (see chart 5) because the repricing of lending and securities portfolios at higher rates typically outpaces increases in the cost of funding.

Chart 5

Continued growth in lending should also contribute to increased revenue. This will primarily be driven by demand for credit from corporates, which require funds to meet working capital needs that are likely to remain high due to sustained inflationary pressure and local currency devaluation, particularly in Egypt. We expect that inflation-adjusted lending growth will remain insufficient, across most of the banking system, to meet countries' economic development needs as high interests' rate and uncertainty depress demand for investments.

Chart 6

We expect that increases in the cost of risk will deliver the biggest blow to operating income, though rising operating expenses will also weigh due to inflationary pressures and the still limited benefits of past digitalization efforts.

A combination of the economic slowdown, increased interest expenses due to higher rates, reduced disposable income eroded by higher prices, and declining ability to pass on increased production costs will lead to a gradual increase in new nonperforming loans (NPLs) in 2023 and credit losses (see chart 7). That increase will likely come from all sectors of the economy, though small and midsize enterprises (SMEs) and construction are most vulnerable. We expect the impact of that increase to remain broadly manageable, though it will vary depending on each countries' economic performance and provisions accumulated in recent years. We see risk to our asset quality expectations, particularly if inflation remains higher for longer and economic growth is weaker than anticipated. This is particularly the case for Egypt.

Chart 7

We don't expect banks' dividend policies will change significantly in the coming quarters. The resulting earnings distribution will significantly reduce the potential benefits of stronger organic capital generation, meaning it will likely result in a stabilization of banks' capital position rather than further improvement.

A Difficult Year For Egyptian Banks

Egyptian banks' huge exposure to sovereign debt is a key risk given Egypt's large and rising external imbalances.  Banks are the main source of financing for the government, while government debt is a key source of profitability for the banks, particularly amid higher interest rates. This is because of the large surplus of private sector savings compared to lending activity, which results in banks accumulating substantial liquidity that is reinvested in sovereign bonds (see chart 8). We expect banks to remain the main buyers of Egyptian government debt and believe purchases could increase in 2023 due to the state's greater funding needs and to compensate for foreign capital outflows.

Chart 8

We expect the stock of NPLs to increase, despite resilient GDP growth of about 4% in 2023.   Increased lending to SMEs, amid rising inflation and a higher cost of funding, will be the primary driver of an increase in NPLs. The Central Bank of Egypt (CBE) required bank loan books to have a 25% exposure to SMEs, and at least 10% to small enterprises, as part of initiatives to increase financial inclusion. Significant recourse to government guarantee schemes, however, limit potential losses from this segment. We also expect some foreign currency (FX) loans, which are about 20% of banks' total loan portfolios, to become non-performing due to the sharp decline in the value of the Egyptian pound, which fell 48% over the past year. The impact appears manageable under our baseline scenario, because (as per CBE guidelines) most of the FX loans are to exporters or the tourism sector, which benefit from a natural FX hedge.

Lending will continue to grow.  That will be sustained by growth in economic activity (which should outpace that of regional peers), a sharp rise in prices that will push up demand for working capital financing, and to a lesser extent the pound depreciation's impact on FX lending. In addition, we expect the CBE will continue to support initiatives to improve financial inclusion, which will drive additional credit demand.

The benefits to net interest income from rising interest rates will be partially eroded by increases in the cost of funding.  That expectation was reinforced in January 2023, when state-owned banks, which make up 50% of Egypt's banking system, launched one-year certificates of deposits (CDs) with a 25% interest rate, mostly to compensate customers for the increased cost of living and to prevent deposit dollarization amid strong currency depreciation. Some private banks responded by issuing new CDs at elevated interest rates. We estimate these CDs account for about 5% of total deposits, based on volume issued so far, and don't rule out similar initiatives in the future, particularly if inflationary pressures persist. Egyptian banks rely on a large pool of household deposits (almost two-thirds of total customer deposits). That, coupled with structurally-low penetration of banking services, results in a loan-to-deposit ratio consistently below 50%, but also exposes banks to a negative impact from prolonged higher interest rates in the event that their assets do not reprice as swiftly as their deposits.

The Egyptian banking sector's vulnerability to external funding has modestly increased.   Egypt was a net foreign creditor until mid-2022, when it started recording a small net liability position (see chart 9). We do not see this as a structural change, as it was likely driven by higher current account needs and increased recourse to multilateral funding, which represent the largest share of banks' foreign liabilities. We estimate that foreign bank funding accounts for about 2%-3% of systemwide liabilities. Under our base case, we expect the net external liability position to gradually decrease, trending toward zero by 2025.

Chart 9

Jordanian Banks Should Prove Resilient In 2023

GDP per capita should grow moderately in 2023 after several years of contraction and despite the global economic slowdown.  Jordan's economic expansion is supported by strong external demand for its fertilizer products and healthy tourist inflows, particularly from nearby GCC countries. Structural reforms and broader efforts to attract investment are likely to support medium-term growth. We expect lending to grow, despite the rise in interest rates. This will be primarily driven by corporate demand for credit to fund working capital needs, while the Central Bank of Jordan's program to support strategic sectors of the economy will be gradually phased out.

Increased lending will support loan portfolio repricing at higher interest rates, which would be positive for banks profitability. On the other hand, competition among banks for deposits will likely add to pressures on their cost of funding, which could have a negative impact on the margins of smaller banks.

Jordanian banks' NPL ratios are likely to increase moderately with rising inflation and increased costs eroding disposable income.   Despite that forecast, we expect Jordan's banking sector will experience manageable asset quality deterioration, and will once again prove its resilience. That deterioration will mostly stem from banks' exposure to volatile sectors like construction (25% of loans), trade (16%), and tourism (3%), all of which are highly sensitive to economic fluctuations. About 10% of credit is allocated to SMEs, which we view as more exposed to a downturn. Jordanian banks' creditworthiness and their ability to absorb potential losses is supported by their strong capitalization, compared to regional peers, and should benefit from higher interest rate's positive effect on profitability.

The major risks to our projections are weaker than anticipated economic performance and more aggressive monetary policy tightening. The latter could be used to safeguard the Central Bank of Jordan's foreign exchange reserves and could weigh on new lending as well as borrowers' ability to repay loans.

Significant sovereign exposure is a risk for Jordan's banks.  Exposure to sovereign debt accounted for about 22% of total assets at the end of 2022, and rises to 24.3% when taking into account government guaranteed credit facilities extended to government-related entities like Jordan's National Electric Power Company (NEPCO). We consider that sovereign exposure to be more manageable than that of Egypt's banks, though it still represents is a significant constraint for Jordanian banks.

External liabilities are high but are mostly in the form of non-resident deposits that reduce refinancing risk.  That is particularly positive given that external funding at Jordanian banks increased in 2022, as it did amongst regional peers. Remittances should continue to support deposits in 2023, underpinned by a strong economic outlook for GCC countries (compared to other regions) due to still high, although declining, oil prices. We assume an average Brent oil price of $85 per barrel for the rest of 2023.

That said, we do not expect deposit growth to materially increase in the near term, when inflationary pressure and tighter financing conditions will weigh on residents' savings capacity. We also note that about a quarter of bank deposits are denominated in U.S. dollars. We believe the peg between the Jordanian dinar and the dollar is unlikely to break, not least because of Jordan's substantial foreign exchange reserves and external support. Yet, if that peg did break, it could expose Jordanian banks to significant foreign currency risk.

Moroccan Banks' Asset Deterioration Should Prove Limited

We expect Moroccan banks' revenue will benefit from positive, albeit moderate, lending growth.  This will be primarily driven by corporate credit demand to fund working capital requirements, which are likely to remain high amid inflationary pressure. That should prove sufficient to offset a likely reduction in credit demand from borrowers who benefited from access to government support programs during the pandemic.

Morocco's interest rate increases have been less than in other regions and will have a limited impact on bank earnings.  Profitability should, however, continue to benefit from Moroccan banks' large share of non-interest-bearing deposits (67.2% of deposits as of December 2021), which reduce the pace of rate increases on funding compared to other markets in the region. Revenue increases will remain anemic though, leaving less room to absorb asset quality deterioration, particularly if a more negative economic scenario materializes.

Asset quality deterioration should prove moderate in Morocco.  Economic growth expectations and a stronger agricultural sector should combine to limit NPL inflows, which we expect to predominantly come from SMEs and real estate exposures (despite some improvement in first nine months of 2022). Morocco's NPL ratio is significantly higher than its peers due to the country's weaker post-pandemic economic rebound and a still large amount of legacy NPLs (see chart 10). Improving economic activity should help banks to work through older problematic loans.

Chart 10

Moroccan banks' funding base continues to benefit from increasing deposits.   That increase has helped the sector to gradually reduce its loans to deposits ratio, though it remains higher than that of its peers. We expect the ratio to remain stable, at about 100% in 2023 (see chart 11). A high proportion of non-interest bearing deposits along with deposits from expatriates in the EU (mostly in the form of workers remittances and other transfers) will continue to support the country's funding structure. Expatriates accounted for about 17.6% of total deposits as of December 2021, and their contribution remained robust during the pandemic, and should continue to be a stable source of funding in 2023.

Chart 11

Table 1

Related Research

• Egypt 'B/B' Ratings Affirmed; Outlook Stable, Jan. 26, 2023
• Banking Industry Country Risk Assessment: Morocco, Dec. 12, 2022
• Inflation, Geopolitics Are Twin Threats To Our Base Case, Dec. 8, 2022
• Global Bank Country-By-Country 2023 Outlook: Greater Divergence Ahead, Nov. 17, 2022
• Banking Industry Country Risk Assessment: Egypt, Sept 01, 2022
• Banking Industry Country Risk Assessment: Jordan, July 19, 2022