The banking industry is witnessing its biggest change at a pace not observed for the past two decades. With different reforms undertaken by the Prime Minister Abiy Ahmed-led administration, for the first time in a decade, new entrants are on the verge of joining the banking industry. So far, 11 full-fledged Islamic, investment, mortgage, and conventional banks are under establishment. Majority of them are joining with higher paid up capital, a move criticized for being unwise as it’s likely to affect shareholders’ return. EBR’s Samson Berhane spoke with industry insiders, experts, and officials to find out the likely impact of the new players in the banking industry.
Residing in London, United Kingdom for 14 years, Mekbib Gebrekidan, an accountant by profession, had long been thinking about investing in the financial sector in Ethiopia, where he was born and raised. This had not been possible for him because of the ban that restricts Ethiopian-born foreign nationals from investing in the financial industry. But it changed soon after Prime Minister Abiy Ahmed (PhD) took power and the decades-old law was amended.
Such a move enabled people like Mekbib to realize the dream of establishing a bank in their birthplace. Acting quickly, he, along with other founding members, started the process of establishing an investment bank. Their aim of establishing an investment bank involves the creation of capital for other companies, governments, and big projects, either in the form of debt or equity. Currently, they are preparing to sell shares to the public.
“This is a big potential market where big returns will be made with just one transaction,” says Mekbib. “Other founding members and I have expansive experience in the area, so entry to the market will be much easier.”
The change in the financial sector does not only bring positive change for the diaspora community. Due to the wave of changes witnessed after Prime Minister Abiy took power, more than five Islamic, two conventional, two mortgage, and two diaspora banks are under establishment, adding to the five microfinance institutions that got the green light to transform into conventional banks. Even better, the administration of Abiy promised to establish a stock exchange market by 2020, which is expected to bring more opportunities for the financial industry and the country as a whole.
Where to where?
As soon as the ruling Ethiopian People’s Revolutionary Democratic Front (EPRDF) took power, the government introduced a mixed economic system, resulting in the liberalization of the banking industry. The entry of the private sector in to the financial sector has created better opportunities to access financial services. Between 1994 and 1999, several financial institutions were established, with Awash being the first private bank to be operational as a share company. Dashen, Abyssinia, United, Wegagen, and Nib banks followed suit. These private banks are known as the first generation of banks. No additional banks were established until 2008. Then in the following five years, 10 second generation banks emerged and joined the banking industry, the final entrant being Enat Bank. Currently, 16 private and two state owned banks operate in the financial industry.
Relying on large-scale branch expansions, these 16 private banks broadened their geographic reach over the past decade, boosting access to finance in Ethiopia. Over the past two decades, branch to population ratio improved because the number of branches opened by commercial banks rose by 30 times to over 6,000 now. This means one branch serves 18,308.6 people, on average.
Despite the growth of the banking industry, many are still being challenged by lack of access to finance. A look at the credit allocation of commercial banks reveals that a large chunk of the credit still goes to the public sector. Although commercial banks have increased their total credit to the public and private sector by about 12-fold over the past decade, from ETB67 billion to 740 billion, roughly two thirds of this has gone to the public sector. The majority of the private sector, on the other hand, remains unfinanced.
Although private banks have followed an aggressive branch expansion strategy, the majority of their branches are concentrated in the capital city and other urban centers, where a great deal of business activities is executed.
Yet, Mulugeta Asmare, former President of Bank of Abyssinia, believes the urban market is still not satisfied. “Even in urban areas, one branch serves on average more than 2,300 people. This indicates that there is still room for new players.”
Girum Kassa, an economist with decades of experience, also asserts that the financial industry in Ethiopia can accommodate new players, even if the focus is still in urban areas. The market is barely touched with an ever growing potential. “One can understand by just looking at the trends of banks’ branches per adult, number of borrowers, account ownership, and penetration of digital banking,” he says.
Of course, although the continuous expansions in branch network has intensified competition, the country remains one of the under-banked economies even at sub-Sahara African standards. While the number of bank accounts opened by users in Ethiopia skyrocketed by more than 20-fold over the past two decades, currently reaching as high as 20 million, account ownership amongst adults remains low compared to neighboring countries. For instance, 43Pct of adults have an account in the sub-Sahara African region while 82Pct of Kenyan adults and 50Pct of adults in Rwanda hold accounts.
Different actions have been taken to improve financial inclusion in Ethiopia, including the approval of a new directive instructing commercial banks to expand their branch numbers by 25Pct annually, a measure that even pushed Zemen Bank, which was the first private bank with a distinctive business model of relying on a single branch, to change its business model. The government also launched a financial inclusion strategy two years ago, targeted at expanding the banked population by three-fold by the end of this fiscal year to 66Pct, though this seems unachievable thus far. Not only that, the strategy aims to make financial institutions accessible to 80Pct of the population within a five-kilometer radius. But, the chance of its success is very low at the current pace.
While more than three-fourths of branches of commercial banks are concentrated in urban areas, largely in Addis Ababa, rural areas remain largely unbanked. To be exact, about 37.3Pct of the total bank branches is located in Addis Ababa. “Even though a lot has been achieved in regards to expansion of branches, the major focus of commercial banks has been the urban market, with corporates and big companies being the target of commercial banks,” says Asfaw Alemu, President of Dashen Bank. “But this trend is likely to improve with the expansion of the existing banks and entrance of new banks. This will help reach the rural areas, thereby raise financial inclusion”
With the past seven years being a time in which no new entrant joined the banking industry, the rising number banks under formation are pledging that they will contribute greatly once they become operational. This includes Amhara Bank, which has collected almost one billion Birr capital within just two months after it started selling shares. “Our aim is to capitalize on the gaps existing in the banking industry. There is a huge market untapped by existing banks, majority of which are small in size with too few types of products and services,“ argues Melaku Fenta, head of the Organizing Committee of Amhara Bank, during a launching ceremony held at Sheraton Hotel to announce the offering of shares to the public. Mesenbet Shenkute, founding member of the Bank also affirmed this. “We want to form a bank that serves the unreached community. That is why we sold shares at a Woreda level,” she said, during the same event.
Although time will tell whether the upcoming banks will keep their promises, running a banking business is not that simple. For instance, operating a small branch can cost between ETB150,000 to around half a million Birr every month. Keeping this in mind, even small banks with 50 branches can spend between ETB100 million and 300 million to cover such expenses.
Board Chairperson of United Bank, Zafu Eyessuswork, a veteran in Ethiopia’s financial industry with more than three decades of experience, believes spending such amount of money to expand branches at the age of digitization is nothing but a waste of resources. “It is possible to provide financial services at the fingertips of everyone, but the usual practice is opening more branches. This is not the right move and benefits neither employees nor banks,” Zafu says. “Unfortunately and seemingly, new entrants are attempting to employ the same business model, which is outdated in the age of digitalization.”
Branches are a critical place where bank employees and customers interact. This model of human-based interaction is widely used in Ethiopia. When ATMs were invented, a second service delivery model appeared. And, now technological advancements have allowed banks to create more innovative and efficient service delivery models. “Instead of following this path, there is a tendency to stick with branch-based banking, largely because of the insensible requirement put in place by the National Bank of Ethiopia,” Zafu says. “If the new banks want to be competitive, they must embrace digital technologies as an opportunity to reduce cost, boost revenues, and provide fast and efficient service to their customers.”
Abdulmenan Mohammed, a financial expert with 16 years of experience, also argues that Ethiopian banking system has been characterized by inward looking, restrictive, less competitive, low technology utilization, and inefficient tendencies. “Despite the emergence of electronic banking, the banking sector is predominantly paper based. Ethiopia needs a competitive banking sector, he says. “Competition enables efficient production of services, increases access, improves quality, and fosters innovation.”
President of Oromia International Bank, Abie Sano, also believes it won’t be easy to be competitive and become profitable in the financial industry if the new banks follow business as usual approaches. “I fear that they will use the same approach and thus be challenged to stay afloat. If they, however, come up with new models, products, and services, it is the existing banks that should fear and would likely be impacted in terms of market share.”
Being amongst the new comers, Mekbib agrees. “Aside from the existing operating environment and products, new entrants in the market will obliviously encourage the design of new products.”
According to Mekbib, there is a big market for new saving products like interest on overnight deposits, loans based on future projects (based on profitability potential rather than collateral), re-mortgage (based on market value), investment bank, and consumer loans at affordable rates for buying cars, furniture, etcetera. “The hope is that the new administration will slowly open up the market and change some of the bottlenecks so that all the above products will be sold by the new banks.”
Verity or illusion?
Profitability of the existing banks is one of the major factors that prompt many to join the financial industry. Indeed, lucrative profits are stated in prospectus of almost every bank that is under formation which is offering shares to the public. This is not surprising. The banking industry has enjoyed high growth, high profits, and high returns—almost without interruption—for over a decade. In this time, gross profit of commercial banks has more than quintupled, reaching close to ETB21 billion at the end of the past fiscal year. Further, this period has been characterized by an annual growth of deposit by 28Pct, 31Pct for loans, and 22Pct for profits, while interest income remains the main source of revenue for the banks.
However, contrary to widely accepted perceptions that banks gain ‘excessive’ returns, their average return on equity is actually not much different from banking returns seen in most other emerging markets. The sector’s profit stands at one percent of GDP, unchanged from its share a decade ago. “The profit narrative has made banks bigger than their real size. It is the economic gaps and lack of real competition amongst banks, in terms new products and services, that have made the existing commercial banks profitable. Almost all of us employ the same strategies,” stresses Dereje Zebene, President of Zemen Bank. “Most banks are also formed in an ethnicized and politicized manner or based on affiliation, largely to serve a group whom they belong to,” he adds
If such trends continue, the delight and cheer of making profits every year might soon be history with the oncoming of stiff competition due to the likely proliferation of many small banks. Even though time will tell if commercial banks would face a drop in earnings, trends indicate that shareholders’ return have been dwindling for the past half a decade. Although banks have been a source of steady profits and dividends for more than 115,000 shareholders for a long period of time, such a trend has lately been seemingly fading away.
Although the banking industry, on average, delivered shareholder returns, in Birr terms, of at least 25Pct annually, earning per share (EPS) trends show a decline from a peak of 38.5Pct in 2009/10 to 31Pct last year. Over the past decade, the highest earnings per ETB1,000 share among all commercial banks plummeted from above ETB1,000 to 543. “Shareholders’ return will continue declining. The age of registering huge earnings per share is over. In the years to come, the possibility of paying earnings per share of more than 30Pct will be unlikely,” anticipates Mulugeta.
The joining of new banks with huge capital is also likely to impact shareholders’ return, according to industry insiders. “Even when returns to investment hovered around zero percent globally, Ethiopian banks have been continuously declaring 20Pct to 40Pct for over 20 years. That shows the level of abnormality existing in the banking industry,” says Ayele Gelan (PhD), an economist. “Within the banking sector, opportunities will tighten up. More banks means that dividends will be shared among them, given the limited market size.” Under formation banks, be it conventional or Islamic, are currently trying to accumulate paid-up capital of between two billion Birr (USD75 million) and four Billion Birr (USD150 million).
But this does not seem feasible and is not a step in right direction for Abdulmenan. For him, for instance, raising capital as high as four billion Birr, an attempt underway by members of the diaspora residing in the US, is nothing but a daydream. “Why would a new bank need such a massive capital at start?” he questions. “If we see past experiences, a bank with a capital of ETB4.13 billion needs to have assets of ETB13 billion, and this requires between seven and 10 years-time to produce an earnings per share of seven percent.”
Abdulmenan suggests banks start with a minimum paid up capital of ETB500 million and target to increase it by 10Pct within five years. If not, it is likely the average shareholders’ return of the industry would fall with the entrance of the new banks, according to him. Mekbib also contends that shareholders’ return is likely to decline based on what has been registered in recent years. “The EPS over the last 10 years has been declining and the payback period is no more 3 years. It takes a good 10 years to recover the initial investment through dividend,” he says.
The veteran financial sector insider, Zafu, on the other hand, argues that the new banks must join the banking industry with huge capital, even higher than Awash, currently the biggest in the industry. “Majority of commercial banks in Ethiopia have very small capital compared to countries that have similar features with ours. So, the industry cannot afford to have many small banks. It is better if we have few big banks instead of having too many small ones,” Zafu says. “I recommend the regulatory body to raise the minimum paid up capital requirement to five billion Birr, which is necessary to ready the industry for any possibility, including foreign competition. To do so, mergers and acquisitions can be a step in right direction.”
But Zemedeneh Nigatu, an investment consultant and Managing Director of Fairfax Africa Fund, recommends that banks should raise their capital voluntarily, and not by regulatory measures. “The capital held by the existing banks indicates that they are not in a position to support an economy with a size of 100 million people. To avert this, consolidation is very important,” he says. “It is enough to have five highly capitalized banks, instead of having too many banks.”
Industry insiders and experts also fear that the joining of new banks is likely to push commercial banks into adjusting their lending rates, which has averaged 17Pct over the past five years. “It is likely that banks will start competing more to bring the lending rate down,” Ayele says.
Girum agrees. “Competition will force the banks to relax the lending rate. But the possibility of more new products is also another aspect.”
More is yet to come
Ever since Prime Minister Abiy took power, various measures targeting at reforming the economy have been undertaken. The banking industry is not immune to this change. Governed by Yinager Dessie (PhD), the central bank introduced new proclamations, regulations, and directives over the past 12 months. In April 2019, aiming to raise foreign currency mobilization, the ceiling put on foreign currency accounts was lifted and the diaspora was allowed to deposit and withdraw forex without limitation. Lately, parliament legislated a law that allows shareholders to form full-fledged Islamic (interest free) banks. Yinager also recently announced that his bank is preparing a bill to establish a new authority that will only supervise banks.
An additional major amendment is the opening up of the financial sector to the diaspora. Legislated by the Parliament, the new proclamation entails that they are allowed to invest in bank shares in foreign currency, but they don’t have the right to collect their dividends on the same arrangement. Rather they are entitled to take their dividend in local currency only. “This is frustrating and will make new potential diaspora investors shy away from spending their hard-earned foreign currency in the industry,” says an organizing committee of one of the diaspora banks that is under formation.
Such a worry is also shared by Mekbib, a founding member of another diaspora bank. “I am still concerned that central bank wants to control the foreign currency which is not encouraging.”
Another key revision made by the central bank is the authorization of microfinance institutions to engage in the provision of credit to productive sectors and big investors, previously only allowed for conventional banks. The new proclamation also allowed microfinance institutions to transform into conventional banks, so long as they meet the minimum requirement needed to open a bank. But there is fear that if the microfinance institutions managed to do so, a gap will be created as their role is primarily reducing poverty.
Girum sees this from two angles. “As mature microfinance institutions are transitioning into fully fledged banking services, new ones will emerge to take the baton and serve the lower class. And mature microfinance institutions can still dedicate a portion of their work to serve the poor,” he says.
For Ayele, it is a gross misconception to hinge microfinance institutions to poverty reduction and overlook their potential contribution to economic growth. “If they are solidified into banks and dispatched to rural areas, then they will lend to farmers and towards farm infrastructure, including digging of water wells, producing twice or thrice yearly, and proper fencing of farming plots,” he recommends.
8th Year • Nov.16 – Dec.15 2019 • No. 80