Accessing Reserves Tricky for Banks

In the midst of the liquidity crises that engulfed Ethiopia’s private banking industry, the National Bank of Ethiopia (NBE) has been trying to respond to the crisis in the country’s banking system. In addition to the many challenges the banks are facing, they are attempting to stay competitive in the shadow of the eventual appearance of international banking industry players on the local market.

Earlier this year, a decision was made by the Commercial Bank of Ethiopia (CBE) that became one of many factors that created a “run on a bank” scenario. Local banks were forced to cash a huge number of letters of credit rendered by CBE. However, it was a decision by the NBE, the stewards of the commercial banking industry, which pushed them to near collapse. This was while CBE decided to lend four billion Birr to clients.

Part of the cause of the problem was the NBE’s decision to charge a 17pc interest rate on money needed to mitigate the effects of the liquidity crisis. Some say this decision was made to penalize banks for their failures while citing inflation. Each bank was charged different interest rates. While that might have been a profitable decision, it could prove unproductive to the new banking industry of the country by creating added pressure.

Ethiopia’s banking industry is continually subjected to regulations which have limited its growth. Although there are infrastructures built to safeguard the banking system; it seems they have failed to protect the industry. The banks were saved, not because of an infrastructure created by the government, but by their willingness to pay huge sums of interest on their own reserve funds.

Since private banks were allowed to operate in the country two decades ago, 16 banks and 17 insurances have opened more than 3,800 branches. Most have experienced record profits in the face of a slew of challenges, engineered by the intervention of the state.

Banks have many responsibilities to the state, even while being over regulated. This includes mandatory investment of 27pc of their gross loan into government bonds while the calculation system that does not take into account the types of investment. Almost all the loans to the state come with very low interest rates, in order to benefit the country’s long-term projects.

When loans are given to the private sector, they come with an old government directive that forces them to purchase five-year bonds. These have very limited interest, as an endorsement of the government’s long term agenda. So far, the central bank has earned billions of Birr, which otherwise would have been spent by the Bank to supply these resources to the private sector and earn a healthy income.

The liquidity level of the industry has declined due to an investment in NBE’s five-year bonds as liquid assets. Total assets ratios have dropped to 20pc from 27pc. This has affected all banks and has cost them dearly. Loans and investments in NBE bonds are a large part of what constitutes as the National Bank’s assets. As the country invests in its second edition of the Growth & Transformation Plan, there will be more need for the banks to invest in five-year bonds. This will surely take away from much needed resources of the private sector and will limit the growth and capability of private banks’ ability to stay profitable.

The banks are required to enter into binding short term loans, instead of more profitable long term loans. This is an order to make their resources available to the government in case they need them.

Another factor that caused the liquidity crises is a serious shortage of foreign currencies, since the country continues to import many of its strategic commodities and capital goods from abroad. Also the enormous debt to GDP ratio of 55pc is troublesome. And it still has not floated its currency, to compensate for the pressure on the local economy, as advised by the World Bank and the IMF.

The Ethiopian banking industry is vulnerable and is expected to face a lot of challenges, more so because of its burden of government responsibilities. The latest data indicates the probable fate of the country’s banking industry. If five percent of all the private banks’ total assets go sour, all of the private banks would incur massive losses.

Based on the tightening of credit conditions, its ability to serve the population is being affected. As its capacity decreases, it will be forced to increase credit on consumers which further limits entrepreneurship. The central bank and the government are influencing the direction of the private banking system, when it should be the economy that is its architect. Undue regulations, taxes and the panic mood among the middle class have not created a stable economy. The banking system and its experience with liquidity crises, is the result of these actions.

It is time to reflect on the experiences of the banks and find a solution, instead of creating limiting environments in which they cannot succeed. The government’s ambitious plan to rely on the private sector to meet its goal could cripple the private sector in the process.

Ethiopia’s banking industry has generated a total income of 14.96 billion Birr last year, an increase of 28pc. Its forced commitment to the central bank’s bonds, worth billions, has limited its ability to invest more in the private sector. In 2015/16, reserve money expanded 16.3pc in response to inflation expectation pressure, arising from El Nino related drought. This growth was attributed to 34.3pc rise in deposits of banks at NBE and 9.8 percent increase in currency in circulation. They play a profound role in the transformation of the country and the government should reform the mechanism to build them, not limit them.

Published on Dec 20,2016 [ Vol 17 ,No 868]



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