In one of the local Sunday newspapers, I read an interview with Teklewold Atnafu, governor of the National Bank of Ethiopia (NBE). The interview covered a wide range of issues: from the financial sector to export performance, from wider economy to some regulatory issues. What captured my attention was his claims regarding banking industry returns.
The governor claimed that the returns of private banks are 40pc, which is the highest in the world. It is not uncommon to hear similar claims by economists, academics and commentators when they talk about Ethiopian private banking. This claim has been employed to defend many stifling banking regulations.
The purpose of this article is to get facts right, as such a claim is a complete myth.
As a measure of performance, earnings per share (EPS) are shown in the annual reports of banks. In reality, all the EPS don’t get paid to shareholders for regulatory and internal policy reasons. In the context of Ethiopian banking, 25pc of profit after tax of banks should be set aside as a legal reserve. So, dividend per share (DPS) is one of the proper measures of return as it is what ultimately goes into the pockets of shareholders. Moreover, shareholders enjoy growth in share prices. In countries, where there are active security markets, determining the gain arising out of growth in share prices is a simple exercise. When it comes to Ethiopia, the matter is very tricky as shares are not actively tradable. So, proxy measure must be used: equity per share.
In the heydays of private banking when there were only six players and less competition the Commercial Bank of Ethiopia (CBE) was not as aggressive as it is now; they were times of negligible inflation, and the NBE followed light-handed regulation. The shareholders of private banks had enjoyed extraordinary returns. It was not uncommon for shareholders of Dashen to take DPS as high as 75pc home. There have also been some exceptional years when few banks have reported unusual returns.
Even currently, Dashen is exceptionally high performing bank although its DPS is decreasing year by year. Its seven-year average dividend per share is 52pc. The next best performing bank, Awash International Bank, has been able to achieve only two third of it. The shareholders of the two big banks, who have been splashed with huge returns over a number of years, hold only 23pc of the private banks paid up capital. Their share of banking shareholding has been in constant decline since 2010. Over the past seven years, it has dropped to 23pc from 29pc.
Dashen’s case is an exception and we have to be very careful not to let such exceptions obscure the real picture of the industry and lead us to the wrong conclusions.
The private banking sector is revealing dramatic changes. The time of low returns is dawning. The arrival of new comers since around 2004, the aggressive expansion of Commercial Bank of Ethiopia driven by the “developmental state” paradigm of the ruling party and increased regulatory requirements, have brought unprecedented competition to the sector. As a result, intense competition, escalating running costs and high capitalization have become the defining characteristics of the private banking sector. The effects of such phenomena on returns of banks have been in full swing since recently.
In fact, the total income and profits of banks have grown year by year. So have operating costs. To remain competitive and to comply with regulatory demands private banks have also increased their paid up capital massively. The dynamics of these factors have undermined what goes to the pockets of shareholders.
Despite returns widely vary across banks, the industry average DPS for the past five years is 21pc (2016), 24pc (2015), 26pc (2014), 29pc (2013) and 31pc (2011). Ten new entrants to the industry have earned lower than the above averages. As the data reveals, the average DPS has gone down by a third in just five years. The median DPS for 2016 is 21.3pc. The previous four years amounts have been pretty similar. This indicates that half of the banks have forked out DPS of less than 21.3pc. If we go by this trend, further decline is inevitable.
When inflation is factored in the calculation, the real returns of banks will be much lower than the above figures. If we use dividend yield as a measure, returns go further down. There is also 10pc dividend tax, which I have left out of the calculation.
The decline in returns of shareholders has driven the payback period of investments in shares up. A portfolio of shares of private banks will take up to 7.5 years to recoup the initial investment despite the variations from bank to bank, if an investor purchases shares at occasional auctions. The payback period has gone up to 7.5 years from 4.6 years in just five years. If the decline of DPS continues at this pace, the payback period will hit ten years in a short space of time.
The decline in returns is mainly attributable to escalating operating costs due to intense competition. The amount banks spend to earn one birr has increased to 69 cents from 50 cents, at annual growth rate of 6pc, chiefly due to increased salaries, benefits and general administration expenses.
Despite a huge chunk of profit after tax being held as legal reserve every year, the impact on growth of equities per share is negligible due to massive capitalization driven by regulation and internal policy. A portfolio of banking shares commanded a premium of 38pc in 2011. In five years, the premium has only increased to 41pc, resulting in an annual growth rate of 0.5pc.
Banks own mainly financial assets, which are easily consumed by inflation. In a time of hyperinflation, the impact on shareholders equities is huge. The sky-rocketing inflation of the past decade has eroded the value of equity per share of banks. The real value of shares of banks worth a fraction of their original investment amount.
Massive branch expansion to comply with NBE demands will surely increase running costs in years to come. When this is coupled with increased capitalization, the returns that shareholders of banks earn will surely dwindle. And at some point in the near future, the golden days of Ethiopian banking exceptional returns fade away.
Regulators should not only have a true picture of the past but also visualize what the future holds. In light of this, they should frame their arguments and take policy action rather than actions based on selected exceptional cases.
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