Blanket Banking Regulation Serves No Purpose

There is hardly any industry which has benefited as much from the economic growth the Revolutionary Democrats are proudly talking about, as the financial industry. Enhanced economic monetization has unleashed the potential of what has for long been an asset-dominated economy. And this has translated into increased demand for financial services.

It all came into being with the change in government in 1991. What had been a thriving banking industry during the imperial era faced the fate of nationalization as the military dictatorship took over power following a popular revolution. The Dergue brought banking under state control and reduced it to a flagellate of the state.

It took a wholesome change in government for banking to get out of its shadows of subservience. As the light of economic liberalization shone on the land, with the coming into power of the Revolutionary Democrats, banking got a new momentum. Underpinning the momentum was the law that allowed Ethiopian private businesspeople to own commercial banks.

Still closed to foreign nationals, unfortunately, if not unwisely, including those who are with Ethiopian origin, the industry has close to 17 players. The state continues to control the commanding heights of finance mobilization, with its two commercial banks; one development banks, and one central bank which sets banking policy. The playground is far from even, with the state-owned banks enjoying both regulatory and functional privileges. Even then, the private players are increasingly becoming competitive and profitable.

Of course, the journey has not been smooth. It has been filled with multiple ups and downs. None, however, has been as challenging for private banks as the regulatory zeal coming from Teklewold Atnafu, the longest serving governor of the National Bank of Ethiopia (NBE).

What has been typical of the Governor’s way of doing business is that his actions are unpredictable, unprecedented, obligatory and blanket. Further, capital has been the singular line of action in his mind. As if to show that the trend is here to stay, the latest rollout from the Governor and his team has recommended that banks raise their paid-up capital to two billion Birr. The number entails a fourfold raise from the existing minimum capital threshold.

Of course, this is not the first such raise. Since 1996, there have been multiple occasions that saw obligatory increases in paid-up capital, from 25 million Br to 75 million Br, and then on to 100 million Br, before the last threshold of half a billion Birr. Yet, the latest suggestion, stemming from the forthcoming Second Growth & Transformation Plan (GTP II), is the single largest raise in history.

Certainly, there is a major difference between the past thresholds and the new one. The past came in the form of mandatory requirements, but the latest appears to be a suggestion, rather a nod. Nonetheless, the presumptions and intents of Teklewold and his team remain the same. Ironically, in their minds, capital is considered the major guarantee to default.

Risks to the millions of depositors who put their money into the nation’s nascent banking industry, according to the regulator’s perspective, can be avoided only with a strong capital base. Even more puzzling is the fact that the capital requirement comes in the form of an across the board directive with which each bank must abide.

The one-size-fits-all approach Teklewold follows appears to be a pattern. The realities being faced by the industry, not to mention the inherent differences between banks, seem to have no place in his eyes. He would rather would want to push every athlete to the fore, without considering their physical fitness, previous minimum, mental readiness and running style.

This principle and way of doing business is as wrong in banking as it is in track running. Success can only be achieved through a tailored approach. It is in aligning the metrics of success with realities on the ground, that winning athletes, analogous to champion banks, can be produced.

Banks in Ethiopia have operational differences. Partly, these differences arise from variability in their shareholder base, which drives variability in business focus, priority, structure, model and even spatial presence. Yet, the difference does not end there.

Ethiopian banks differ in life span, capital base, target customer, asset structure, loan portfolio, type of liability and linkage with real economy. Thus, a given regulatory action will have varying impacts on different banks.

The case will not be different with the latest paid-up capital push. Banks will be feeling the heat unevenly as the thickness of their skins varies. Yet, the central bank, which has proven itself to be out of touch and paternalistic, seems to stick to its traditional pattern of pushing blanket recommendations. It is unfortunate to have a regulatory body that is arrogant in its approach and nonprogressive in its character, as it is a drag to the nation’s aspiration to realize its middle income status in a decade.

It is not obvious that Teklewold’s interest is to create a competitive banking industry – one that not only meets the financing needs of the economy, but also corresponds to equivalent economies. A raise in paid-up capital no doubt contributes to this endeavour. Sufficiently capitalized banks would have the capacity to absorb shocks. This, of course, is not to discount the central bank’s role in serving as creditor of the last resort.

True, the level of capitalization of banks is a reflection of the economic activities and investment culture in the country. A massively asset-dominated economy with undeveloped investment culture, wherein public investment accounts for more than 80pc of the total investment in the economy, means fewer resources for banks to leverage.

Nonetheless, capitalization infers the magnitude of buffer that banks think they should keep to absorb the risks they shoulder. And this depends on their risks in exposure and management strategy as well as business functions.

By putting a single capital threshold to banks, therefore, the Governor is ill advised in ignoring their variabilities. Aside from putting an unnecessary burden on less capitalized banks, which are healthy enough to conduct their business (with industry level capital adequacy ratio staying at over eight per cent), this approach will force banks to get away from their planned strategic directions. It certainly is an unwise approach.

Further, the central bank ignores the fact that all risks banks shoulder cannot be resolved by having better capital buffers. This is especially true to systemic risks, which emanate from the none-institutional factors, such as risk valuation, economic structure and linkages. Systemic risks can be managed only through careful oversight of structures, functions, business relations and linkages.

Teklewold should know this better. He should also know that capital serves only part of the purpose. And even when it does, its capability and impact will differ between banks, hence, the need for a diversified and tailored approach.

The era of blanket capital requirements ought to end. What the time demands is a regulatory framework that is comprehensive, targeted and flexible. Again, as with track running, only a tailored approach can create champions.

Yet another occupation for the central bank is to get away from its long overdue reduction of risk set to institutional box. Systemic risks ought to also get enough attention. For this to happen though, the singular focus on paid-up capital needs to be ducked. What is needed is a comprehensive look into the industry and its linkage with the real economy.

Much as this is the task of central bank, it should also worry the guardians of the system. Hence, the political core ought to also push for such a change in perspective, approach and instruments. It is only, then, that they can be sure that their legacy of creating a banking industry out of the shadows of a military dictatorship can be well preserved.


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