This document analyzes crony capitalism in Egypt by examining politically connected firms' access to bank credit from 2003-2011. It finds that: 1) Politically connected firms received the vast majority (82%) of bank loans despite being less profitable than non-connected firms. 2) Politically connected firms had higher debt-to-equity ratios and price-earnings ratios, indicating they were perceived as less risky by banks. 3) Access to credit by politically connected firms was not related to profitability and appeared driven more by political connections than economic fundamentals. This likely led to misallocation of credit in Egypt's economy over this period.

1. Private Banking and Crony
Capitalism in Egypt
Ishac Diwan and Marc Schiffbauer
December 2016, Marrakesh

2. What is wrong with “crony”
capitalism?
• Much talks about cronyism and corruption – but not much quantitative
evidence -> Egypt a great laboratory
• State-led development under Nasser, timid opening to the private sector
by Sadat – constitution of a business elite – marriage of state bourgeoisie
and old money
• After 2004, “take-over” of the formal economy by business insiders closely
connected to the ruling party
– Can help given predatory public sector – corruption as oil in the
wheels
– But can also discourage investments (sand in the wheels)
– Empirical work needed to understand effect on economy
• We ask:
– did connected firms get an inordinate share of total credit?
– If so, by which mechanisms?
– Was credit allocation aligned with firms’ performance?

3. The puzzle
• Politically connected firms (PCFs) around the
world tend to have access to large amount of
credit.
– But how do privileged firms attract so much credit?
• Egypt in the 2000s: the bulk of bank loans in
2000s went to PCFs – but:
– banking sector was liberalized
– State banks had shrunk to 35% of market
– PCFs did not control major banks ..

4. Questions
1. Was the banking system in Egypt truly
liberalized?
2. Did the PCFs really get a lion share of loans?
3. If so why? two possibilities
– PCFs were more profitable?
– Or were perceived to be less risky?

5. Financial system developments
• Nasser’s nationalization of banks (and industry) in early
1960s - four large public sector banks along sector lines,
plus smaller regional banks.
• Sadat’s Infitah in late 1970s allowed for several new joint
venture banks – public sector and foreign interests,
• SAP (1991): liberalization of interest rates, and regulatory
framework tightened (reserve requirements, capital
adequacy..)
• Early 2000s: bank credit up to 70% of GDP (about MIC
average), half to private sector. But public banks still
dominant, and NPLs high again, at 24% of banks’ assets.

6. Cont’
• Deeper reforms in 2003 - new banking law, privatization of
a main bank, and of shares in private and joint venture
banks, consolidation (from 62 to 39 banks), foreign
ownership (15 banks)
• 2008: private banks control 50+ % of deposits and 65% of
lending
• NPLs fell to 15%: tighter quality controls + recapitalizations
partly funded by government bailouts and benefiting CFs
• 2010: most concentrated lending portfolio in MENA
– Lending to private sector at 30% GDP (about LMIC level), but
only 5% of firms with a credit line – 5 times less than LMICs
– Top 20 firms have 50% of all banks portfolios

7. Identification of PC firms
• Question: how much credit obtained by politically connected firms?
• We used the Orbis corporate data-base – a panel of about 20,000
large firms from 2003-2011.
• We identified 32 politically connected businessmen
– served in boards of 4 think tanks founded by Gamal Mubarak.
– Many had significant political posts
– assets of most frozen after the Egyptian uprisings of 2011
• We identified 469 firms that are directly or indirectly controlled by
one of the PC businessmen (o/w 22 traded on EGX).
• PC firms are present in about ½ of the sectors
– Larger, more capital intensive
– High concentration in new sectors: tourism, real estate, construction,
wholesale & retail trade, mining, finance, business services, and some
manufacturing sectors.
– Vertical and pyramidal structures common

8. PCF borrowings
PC firms borrowed a lot – by 2010, 82% of total
loans going to the private sector (in Orbis)
Determinants of Debt to equity ratios (2003-11)
EGX data-set Orbis full data-set
PC firms 1.083*** .403*
(0.167) (1.89)
No. of obs 381 589
Sector dummies Yes Yes
Year dummies Yes Yes
R-squared 0.123 0.394

9. How? PCFs are not more profitable
Full set EGX set
Return on
Assets
Return on
Equity
Return on
Assets
Return on
Equity
PC firms .510 3.62** -1.614* 1.681
(0.81) (2.61) (0.838) (2.206)
No. of obs 667 3,590 1,049 1,041
Sector dummies Yes Yes Yes Yes
Year dummies Yes Yes Yes Yes
R-squared 0.194 0.049 0.160 0.088
Returns on equity can be larger than return on assets if firms
borrow a lot at low interest rates – their gains is the lenders loss

10. In fact - borrowing not related to
profitability
ln (Long Term Debt/Revenues)
PC firm .753** .504** .670**
ln(profits/assets) -.113**
ln(profits/rev) -.096**
ROE -.025**
No. of obs 377 589 567
Sector dummies Yes Yes Yes
Year dummies Yes Yes Yes
R-squared 0.556 0.437 0.452

11. How can PCFs have lower profitability
given the privileges they received?
• Privileges: better regulation, energy subsidies,
land, policy influence, bail-out
• A shifting patron-client relation
– A gift exchange .. and a bargaining game
• PCFs must repay political favors – political
finance, NGO support, job creation …
• Selected on the basis of loyalty rather than skills
– including to occupy “economic heights” and exclude
potential opposition from growth sectors
• CFs may have sent profits to less taxed profit
centers, including abroad

12. PCFs are perceived to be less risky
• PER – measures risk (+ growth opportunities)
• Determinants of Price Earnings Ratios (PERs)
PER
PCF 7.772**
(3.868)
FE Sectors, years
Obs 479
Adj Rsq 0.014
• PERs of PCFs went down after 2011

13. What’s the value of connections?
Stock market prices of CFs drop by 23.4% more than
NCFs in early 2011
0
200
400
600
800
1000
1200
1400
1600
1800
Connected
Non Connected
Chekir and Diwan, 2015, JGD

14. Conclusions
• First phase: in the 1990s CFs were directly supported
by state-owned banks and became dominant
• Second phase: PCFs were in a position to benefit more
than non-connected firms from financial liberalization.
– Their influence, and expectations of “bail-out”, outside the
financial sector, were sufficient to make them more
attractive to banks than non-privileged firms.
– A history of earlier bail-outs must have also mattered.
• => Credit misallocated, reducing the overall
productivity of the economy and costing jobs
• What happens to NPLs now? Are PCFs too large to fail?

15. land
Aquired land from
government
No. of PCFs
.015*
sector dummy
yes
No. of observations
3,015
Sector dummies
yes
R-squared
0.194
• WBES has data on land ownership
• We compare sectors: does the probability for a sector
to acquire more land related to the number of PCFs in
the sector?
• Thus, the likelihood of PCFs acquiring land is larger
than for non-PCFs