A-Perfect-Storm

A Perfect Storm

Ethiopia’s Banking Sector Navigates Uncharted Waters

Ethiopia’s banking sector is currently grappling with a severe liquidity crunch, causing significant distress to individuals and businesses. The effects are palpable, with delayed transfers, restricted cash withdrawals, and challenges in securing loans becoming the norm.

Why are banks struggling with liquidity? How have the government’s recent economic reforms impacted the banking sector? What are the real-world implications for businesses and consumers? And what steps are being taken to address the crisis? These are the pressing questions that need answers.

This in-depth analysis by EBR’s Munir Shemsu explores these questions, examining the root causes of the liquidity crisis, the challenges banks face, and the potential consequences for the broader economy. The liquidity crisis in the banking sector is not just a problem for individual banks or their customers. It has the potential to significantly disrupt the entire economy, affecting businesses, consumers, and investors alike.

Aymen Mohammed, 32, was fuming angrily on a Wednesday afternoon last month. The businessman had wired around 200,000 birr for a Real Time Gross Settlement (RTGS) between two local banks that had taken nearly two weeks.

“I kept calling and they keep telling me the transfer is imminent,” he told EBR.

Learning from an all-too-similar experience just a month ago, Aymen had given up on successfully pressuring the processing Bank with physical visits to branches.

While the bank transfer ultimately settled, it echoed a similar frustration increasingly felt by customers in recent months. Cash withdrawals for individuals are limited to 50,000 birr daily. At the same time, companies can withdraw up to 70,000 birrs, and payments for a higher amount can only be settled through the interbank substructure and seemingly at the convenience of the banks.

Even small-scale transactions face significant delays within the Ethiopian banking system, particularly among the newer banks. The situation has worsened for new clients, with banks becoming increasingly unable to provide loans to hopeful clients. What makes things worse is the disbursement of approved loans, even for exporters who traditionally enjoyed preferential treatment, has become very challenging.

A COO of a prominent manufacturing and export company has firsthand experience with these challenges. Despite securing a 300 million ETB approval of a reshipment export loan from a major private bank, including an additional 100 million ETB term loan financing and a 50 million overdraft facility, the company has only received 10% of the approved amount of preshipment loan while the remaining remained undisbursed. Despite persistent efforts and frequent visits to the bank’s credit department, this delay has forced the company to take drastic measures.

To alleviate the financial strain and unlock stalled projects, the company has requested the bank to release some of the collateral used to secure the approved but undisbursed loan. The plan is to sell these assets and use the proceeds to fund critical operations and investments.

This case underscores Ethiopia’s urgent need for a more efficient and supportive banking system. As businesses struggle to access necessary financing, the overall economic climate risks being negatively impacted. The time for change is now.

Experts attribute the worsening liquidity crisis to a combination of factors, including poor governance practices within the banking sector. While the Commercial Bank of Ethiopia claims to be unaffected, most other banks struggle to maintain adequate liquidity. This situation has raised concerns about the overall stability of the financial system and its potential impact on the broader economy. The liquidity issue that has rattled the Banks in recent years has worsened in the current financial year. Complaints of delayed transfers, protracted time spans for loan deposits, and widespread cash shortages have seeped into the economy.

A year before Prime Minister Abiy Ahmed (PhD) triumphantly announced Ethiopia’s transition into a market-based exchange regime policy in July, the central bank laid out a tightened monetary policy. The National Bank of Ethiopia (NBE) capped annual credit growth from banks at 14%, increased the emergency lending rate by 2% and cut direct borrowing to the government by two-thirds. Governor Mamo Mihretu’s ambitious move to cut inflation to single digits got favourable feedback as a possible target, and the figures dropped to around 19% by the end of the financial year.

However, the continued enforcement of mandatory treasury bill purchases equaling 20% of the bank’s disbursements, the rapid rise of mobile money services funnelling cash from the banks, and a slowdown in overall business left the Banks parched of liquidity.

Even though Ethiopia’s banking industry has struggled with year-on-year liquidity crunches for consecutive years, a peculiar trend has dawned in recent months. Commercial banks that have long exercised a shoestring FX reserve disbursement appear to be experiencing a ‘Birr’ crunch. The banking industry’s liquid assets to deposits ratio has continued its steady decline, dipping by 1.8% to 22.4% in the current year after falling by 3% in 2023.

Following Ethiopia’s adoption of a four-year economic reform programme prescribed by the International Monetary Fund (IMF) in late July, the macroeconomic substructure has changed dramatically. The close to 3.4-billion-dollar Extended Credit Facility entailed under the programme is predicated on successfully meeting several structural benchmarks upon periodic review by the Fund. A staff-level assessment of progress in meeting the structural benchmarks published in November reveals that Ethiopia still needs to meet more than one target over three months of implementation. NBE did not implement the emergency liquidity framework as expected by the end of the September review. Economic actors navigating a seismic structural overhaul grapple with accumulated hang-ups over the years.

Members of the private sector across varying sizes are feeling the impact.

A business lobby representing around 185 European investors in Ethiopia recently voiced their concerns to the central bank governor. Investors from the European Chamber in Ethiopia, including some of the country’s biggest taxpayers, relayed a new currency crunch to the Governor. While noting a marked improvement in FX liquidity, the investors relayed experiencing a local currency crunch after the reforms.

Mamo indicated that price and financial stability will remain the central bank’s enduring targets as it implements tight monetary policy until an inflationary target is met. He suggested that FX reserves had nearly doubled from 3.1 billion dollars to 5.9 billion dollars post-reforms.

“We expect inflation to be on a gradually declining trend throughout 2025,” the Governor noted. According to the IMF, Ethiopia’s projected consumer price inflation rate in 2024 is 23.9%. The Central Bank has achieved its target to reduce inflation to below 20% by June 2024 and is now working to bring it down to below 10% by June 2025.

While the IMF’s forecast entails a slight uptake in inflation, it largely cosigns pronouncements of “well-coordinated” implementation of the reforms. This “well-coordinated” implementation refers to the government’s efforts to manage the transition to a market-based exchange regime policy and tightening monetary policy. However, the effectiveness of these measures in addressing the liquidity crisis remains a point of contention.

However, the inflationary targets, with stringent cash controls and an increased crackdown on a largely informal economy, fueling a drop in aggregate demand.

London-based financial analyst Abdulmenan Mohammed (PhD) paints a nuanced picture of tradeoffs between economic activity and inflationary targets. He pointed out that the decision to cap credit growth last year led to a decrease in inflation alongside a dip in fresh loan disbursements.

“A cash shortage is to be expected,” Abdulmenan told EBR.” Most of the business activity was predicated on fresh credit.”

The keen financial observer has witnessed a significant dip in the fresh loans disbursed across all banks, which functioned as the primary fuel for demand even when the country was at war. Noticing some smaller banks growing their fresh credit by as little as six percent Abdulmenan considers the slowdown in inflation to be much lower than it should be. He attributes the price inelasticity in most developing economies to the fact that prices have not fallen on par with the dip in credit.

“I expect the central bank to remove the credit cap most likely in June of next year,” Abulmenan says.

He says the amount of money in the economy would have been enough to sustain consumer demand if prices responded with a simultaneous drop.

Despite a nearly 10-point drop in inflation rates to 19.9% by the end of June 2024, Ethiopia and Rwanda are two countries across East Africa with double-digit inflation rates. The IMF forecasts a rise to 25% at the end of June 2025 as the impact of the July macroeconomic overhaul takes effect. Despite the significant increase in NBE’s FX reserves, several other economic indicators still need to be clarified.

Abdulmenan points out how formidable FX reserves help minimize the impact of events like a drop in exports or any other unforeseen event while noting that it is not the sole measure of economic health.

“FX reserves are not a comprehensive indicator just on their own,” he says.

However, as banks have begun averaging around half a billion dollars in average monthly FX purchases and above 700 million dollars in sales, reserves appear to reign atop the policy agenda. Interestingly, the share of loans given to exporters dropped by 1.6% at the end of June 2024. In these peculiar times, bank liquidity has been placed as a concern set to be addressed by overnight lending and deposit facilities alongside prudential directives.

A senior banker in one of Ethiopia’s most prominent financial institutions says the liquidity issues date back a few years. He recalled how the central bank reinstituted a previous stipulation that commercial banks buy treasury bonds equaling 20% of their loan disbursements two years ago. He also pointed to the introduction of mandatory bond purchases from the state-owned Development Bank of Ethiopia as a relatively recent liquidity drain.

Liquidity pressures are almost inevitable when short-term deposits are invested in long-term investment securities, stemming from an asset-liability mismatch.

The banker underscores that even with the amount decreasing from the 27% imposed until 2019; industry experts say its pressure on the banks was more acutely felt due to structural changes across the sector.

“A few banks are no longer the center of financial services,” he told EBR.

According to an industry insider, the increasing number of commercial banks (31), the accelerated expansion of digital financial services like Telebirr and M-Pesa, and an overall slowdown in economic activity have all conspired to drain individual banks’ liquidity gradually.

The central bank’s soft nudge to phase out cash use as part of a shift into a cash-lite economy adds a new layer of complexity.

The Ethiopian government’s long-term economic target is a cash-lite economy. One of NBE’s three-year targets is for citizens to pay for everything from traffic tickets to taxes and common commerce through digital payment services.

The banker expects the government’s transition towards a cash-lite economy to inevitably entail stricter control over cash movement, tight prudential liquidity regulations by NBE, and stringent restrictions on cash transactions.

“Several factors are at play that strains the local currency liquidity,” the banker says. “But, it is not just about cash.”

According to the banker, every bank needs to contend with its lending history, types of deposits, and overall operational management as it navigates liquidity pinches.

“Some are just better equipped to deal with macroeconomic shifts,” he says.

The banker expects developing an active interbank market to partly address the concerns during pinching shortages.

While Ethiopia’s shift to a market-based exchange reform in July brought about significant revaluation of the banking industry assets, resource mobilization by the sector had been going through a marked decline all year round. By the end of the second quarter of 2023/24, resources mobilized by the banking industry had plummeted by 84 billion Birr from the same period a year back, illustrating the industry’s precarious position. The 13% increase in loan collection was offset by a 47.9% slowdown in net deposits and a 46.5 dip in borrowing, according to the NBE’s report.

The 36% drop-off in new disbursements was unsurprising, as the 14% credit cap growth implemented during the year tied up the industry. Total loans by the banking industry were almost exactly in line with NBE’s target in 2024, with a growth of 14.5% to reach

Liquidity in the banking industry is as intimately tied to external market conditions as it is to internal factors within the institutions. The quality of bank assets, demand-liability status on the balance sheet, capital base, and quality of deposits all contribute to this complex indicator.

NBE’s second financial stability report, released in late November, provides peculiar insights into current trends shaping Ethiopia’s financial sector. Within three weeks of its launch, the money market electronic platform administered by the Ethiopian Securities Exchange (ESX) facilitated nearly 20 billion Birr transactions. Banks are beginning to recognize the opportunities entailed by the Platform as they reel from liquidity shortages.

However, last month’s report also reveals that Banks have yet to restructure in a manner that would shield them from several stress scenarios. Even the Commercial Bank of Ethiopia, the only bank that qualifies as significant by NBE’s standards, would fall below the regulatory capital adequacy ratio if just ten of its biggest depositors withdrew their money. The rest of the players are faring no better.

A high concentration of deposits and a marked difference in maturities between deposits and loans prevail across the industry. At the end of June 2024, 58.5% of the total banking sector deposits was held by only 0.4% of depositors. State-owned enterprises are among the largest depositors, rendering the concentration of private-sector deposits considerably small. Additionally, banks’ liquid assets only incorporate a small share of high-quality liquid assets (cash), which sets them up for difficulties settling real-time transactions.

The banking industry has become even more sensitive to liquidity risks over the past year. Twenty banks, an increase of two from 2023, would fall below the regulatory threshold if 10 of their biggest depositors withdrew their money. Furthermore, a withdrawal of 360 billion Birr would push these banks’ liquidity ratio down to 9.4%, significantly below the regulatory minimum of 15.

Surprisingly, the NBE forecasts that the liquidity risk across the banking sector will increase in the short and medium term. Sources within the central bank expect compliance with the directives about related party exposures and enhanced regulatory supervision to alleviate some pressure from the industry,

Nevertheless, banks’ profitability could also take a hit in the near term, with most of the mandatory treasury bonds they purchased pegged at fixed interest rates despite rising domestic rates. This is a worrying development as the ratio of loans and bonds to deposits rests at around 87% despite accounting for 66% of the banking industry’s assets.

While Ethiopia’s IMF program entails the removal of mandatory bond purchases by the end of next year, improvements in bank liquidity are more likely in the long term. As the financial fabric of the nation shifts towards more market-based leanings, the government might have to brush off its habit of forcing financial actors to finance its budget deficit. Increased vigilance from the banks in adherence to recent exposure standards will prove pivotal. Experiences of countries like Ghana, which underwent a severe banking crisis six years back, indicate that financial health stems from internal controls in a relatively market-based economy. Poor corporate governance was the main reason for the collapse of seven banks in the West African country. As some businesses deal with negative equity following the fall of the Birr, banks face foreign competitors, and a capital market opens up, liquidity in all its forms will likely prove highly consequential for Ethiopia’s new economic horizons. EBR


13th Year • December 2024 • No. 136

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