Banks’ High Cost of Making Money

Reports are in, shareholders have assembled and pocketed their dividends. It is now opportune time to look at the whole industry’s performance throughout last year. SOLIANA ALEMAYEHU, FORTUNE STAFF WRITER checks up on performance and efficiency of the industry that seems to exhibit all the clichés: first-come-first-served, the struggling middle class, and last but not least, last but not least.

Last fiscal year, shareholders of newer banks went home happier than shareholders who have been receiving dividends for longer.

The money earned by each private bank, measured in earnings per share, and the amount of that reaching the shareholders’ pockets – dividends, – decreased by 27pc over the past five years. Large banks are on the decline, while medium sized ones are in even worse shape. In contrast, smaller banks have been able to report a three-fold increase.

Among the private banks, two can be relatively categorized as big. Various industry data indicate a correlation between age and size. Awash International Bank and Dashen Bank, established in 1994 and 1996 respectively, are therefore both the oldest and biggest banks. Bank of Abyssinia was established in the same year as Dashen. It was followed by Wegagen, United, and Nib International Banks, which were formed consecutively until 1999. These four make up the middle-sized category. The remaining 10 private banks can be classified as small.

While the monopoly in the industry belongs to the state-owned Commercial Bank of Ethiopia, the dominance within the privately-owned section of the industry is clear.

One determining factor is market share. Dashen and Awash together control a third of all the industry’s income. The four that make up the middle-sized firms control another third; but so do the 10 small banks. Competition has caused the market shares of the biggest banks to decrease, while the medium sized firms are doing the same at a much faster rate – resulting in a scenario where the income of the two big banks is almost the same as the income of the ten small ones combined.

In the analysis of an industry veteran, with decades of experience in the Ethiopian context, this is due to strong branch expansion.

“Although Awash started with modest means, it is both a pioneer, and very well networked in terms of branches outside of the capital,” he said, requesting to remain unnamed. “Dashen, on the other hand is a special bank. It has a faithful and large clientele, like the Midroc group, that help it grow.”

Both banks have the highest branch networks of the private banks in the country. Within the last fiscal year, Dashen opened 24 new branches, bringing its total to 162, while Awash opened 42, bringing its sum to 200.

Put simply, more branches mean more deposits mobilized, more deposits mean more money for loans, and more loans generate more income, the veteran banker explained.

A similar scenario is observed when looking at assets owned by the banks. The large category, again, has as much assets as all 10 in the small category combined. Each category controls a third of the 154 billon Br worth of assets owned by all banks in Ethiopia.

Age and size clearly affect income as well, since the six private banks formed before the new millennium, were also the top six earners in the fiscal year that ended in June 2015.

Such differences, make the playing field uneven.

“But the market is not saturated yet, there is still room to compete,” the industry source insisted.

He is of the view that by nationalizing their branch networks, offering competitive service charges, commissions, and shortening queues, the small banks could still compete. He suspects though, that later down the line the smaller ones may need to merge.

Dashen and Awash Bank also led the pack in profits. The 964 million Br and 861 million Br the two earned pre-tax put them far ahead. Their figures are 400 million Br more in untaxed profits than the Bank third in line, Wegagen.

On the flip side, the younger banks recorded the largest rates of growth. Abay and Lion both more than doubled their profits, and Enat, the youngest bank, increased profits by 93pc.

One key indicator of a bank’s profitability is return on assets, a measure of how much a bank earned in relation to its assets. All four that recorded returns on assets above four per cent are small banks.

Lion Bank has exploited its resources to make more profits per asset than any other private bank. Its Return on Assets (ROA), was the highest last year – 4.7pc. Addis, Zemen, and Bunna followed, managing four plus per cent in ROA each.

Debub Bank’s assets, which stand at a little over a billion Birr in worth, had the least returns on assets at 2.1pc.

Asset utilization ratio has also dropped throughout the industry. Last year’s average of 3.5pc was a decrease of over nine per cent.

Ethiopia’s banks are heavily dependent on assets. In the current year, if just five per cent of all assets were to become sore, Abdulmenan Mohammed Hamza, an accounts manager at the London-based Portobello Group Ltd., calculates that all banks would incur massive losses.

United, a bank heavily invested in assets, would be most affected. Twenty four per cent of its capital and reserves would be consumed to recover such a loss. Addis, on the other end of the spectrum, would suffer a loss of only two per cent.

Addis would also remain largely unaffected if 10pc of loans and advances became sore. Abdulmenan’s calculations indicate that it would be the only one that could break even when all the others incurred what he describes as huge losses. Abdulmenan also discerns that Oromia International Bank (OIB) would suffer the most in that scenario; it would lose almost a quarter of its capital.

However, Addis had disbursed the second lowest number of loans and had amassed the third lowest amount of capital in the industry.

With the exception of those scenarios, the banking industry is actually well-capitalized. The total capital and reserves of the industry have gone up by 22 pc to Birr 18.4 billion. The central bank directives have driven this by pushing for more capitalization. After the youngest bank, Enat, barely made it to the half a billion Birr mark set for the end of 2015, the banks are now required to work towards achieving two billion Birr by 2020.

Although capital adequacy has dropped by 14pc from the 2013/2014 fiscal year, it still stands at 25pc, three-fold more than the legal minimum of eight per cent.

Shareholders’ equity, the money the shareholders have invested in the bank proved to be the most profitable in Lion Bank as well.

Lion turned out to be the Bank that most efficiently generated earnings. Its shareholders were witness to return on equity that stood at 33.5pc. That figure is more than three times the efficiency displayed by the second youngest bank – Debub – in the same fiscal year. Lion managed to beat the much older, and bigger Dashen Bank, as well as its contemporary, OIB. This bank recorded rates right above and below the 30pc mark, securing the place of first and second runner-up in that category.

Across the board, banks have found that making money has become more costly. For each single Birr banks made last fiscal year, they spent 64 cents. The year before that they dished out only 60 cents. Debub Bank’s shortage in efficiency is also exhibited here, as it is currently the highest spender in the industry. It is the toddler in the industry, which is also least achieved in terms of resources, spent 79 cents to make a Birr.

Interest expense took the major share of their expenses, the Bank’s President Addisu Habba explained. Fixed time deposits, which, at the time made up 30pc of Debub’s total deposits took a toll. The Bank had also opened four new branches.

He added that since June 2015, they had substantially increased their foreign exchange (ForEx) gains, which boosted their income and loans disbursed.

But Debub is not alone on that expensive boat.

“As this is an industry-wide phenomenon, the management of the banks should seriously be concerned,” Abdulmenan opined.

Risk seems to be an ever-increasing factor. Provision for doubtful loans has shown a phenomenal increase. It has gone up by 65pc to 302 million Br. Half of the total is provided for by the Cooperative Bank of Oromia (CBO).

That bank had witnessed a storm in the fiscal year that ended June 15, the central bank found an evidence of fraudulent activities committed by the Bank and suspended a substantial number of its Board of Directors pending investigation. The central bank also had CBO revise its annual report to increase its provision for doubtful loans, which cut the Bank’s profit.

The industry, being relatively young and driven by competition, shows enormous increase in expenses. To remain competitive and grow, banks have spent much of their resources without a corresponding growth in income.

Branch networks reached 2,606 at end of June 2015, and increased by 430 from last year. The growth of profit after tax is almost half of the growth made by the increase in total income – all due to soaring expenses.

If increase in expenses keeps rising at its current rate, while income remains the same, Abdulmena, predicts that all the banks except Debub, will remain profitable – an absorbable loss but a loss nonetheless.

Unlike its founder’s other creation in the real estate industry, Zemen Bank has managed its expenses better than any other bank in the country. The seven year old bank’s Return on Revenue, ROR, stands at 55pc. Zemen started out with single branch concept, claiming a low cost-to-income ratio emanating from a lean operating model that is focused not on branch expansion but rather on the use of alternative service delivery channels such as ATMs, Internet Banking and others. It later dropped the concept, as by June of 2015, it had opened eight fully operational branches, and 14 sub-branches that handle only withdrawals and deposits. These branches make up less than two per cent of the branches in the country owned by private banks. But their associated expenses, staff and general administration, jumped that year by 36.4pc to 165 million Br.

Although Zemen managed to top other banks in this arena, looking back into its own books shows an alarming increase.

“The growth in operating costs at Zemen is outpacing the growth in income. Unless Zemen puts cost reduction measures in place, the profit from its operation will surely decline,” Abdulmenan commented at the time.

Dashen and Lion follow, each having returned more than 50pc of revenue.

Banks, by definition, are saving and lending institutions. Their revenue emanates from lending what others have entrusted them with. The difference between the interest they pay to their depositors, and take from their borrowers is their profit margin. But in Ethiopia, that definition does not seem to apply.

Only six banks have managed to source more than half their income from a bank’s definition of business. The middle-sized banks dominate this category, it seems, as all four managed to make it to the top. Bunna Bank and Oromia Cooperative are the only non-medium sized firms in the higher echelons of this category as 56pc and 51pc of their income came from the difference of interests. On the other end, figures as low as 33pc were recorded by Addis International Bank.

“Interest is a bank’s bread and butter,” Fortune’s source explained. “Nothing else is dependable, except investments.”

He went on to explain that gains in ForEx, for instance, cannot be predicted. As exports are not recording substantial growth, shortage of foreign currency will continue to persist.


Published on May 03,2016 [ Vol 17 ,No 835]



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