Macro-financial linkages in Egypt: A panel analysis of economic shocks and loan portfolio quality

• We study macroeconomic shock transmission to banks and second-round feedback effects.
• We run dynamic panel regressions and a panel VAR for banks in Egypt over 1993–2010.
• Egypt had experienced capital inflows (reversals) and is destabilized with the Arab spring.
• Positive shocks to capital inflows and GDP improve loan portfolio quality at banks.
• Higher lending rates increase adverse selection problems, worsening loan quality.

This paper investigates macro-financial linkages in Egypt using two complementary methods, assessing the interaction between different macroeconomic aggregates and loan portfolio quality in a multivariate framework as well as through a panel vector autoregressive method that controls for bank-level characteristics. Using a panel of banks over 1993–2010, the authors find that a positive shock to capital inflows and growth in gross domestic product improves banks’ loan portfolio quality, and that the effect is fairly similar in magnitude using the multivariate and panel vector autoregressive frameworks. In contrast, higher lending rates may lead to adverse selection problems and hence to a drop in portfolio quality. The paper also reports that a larger market share of foreign banks in the industry improves loan quality.