Bad Loan Piles-up

Even under normal banking operations, not all loans can be collected fully because loans are not free of risks. This affects the financial performance of any bank because it leads to an increase in non-performing loans (NPLs). This is exactly what is happening in Ethiopia at the moment. Due to macroeconomic and bank specific factors, borrowers are increasingly finding it difficult to pay back loans. Industry insiders say the average NPL figure has now reached eight percent. The National Bank of Ethiopia (NBE) has set five percent as the upper limit any bank’s NPLs may go. EBR’s Ashenafi Endale examines the causes.

When EBR met Yared Nigussie, a 38-year-old businessperson engaged in construction works on June 18, 2019, he was discussing with his lawyer, Taye Fente at his office in Addis Ababa. The discussion was about the ETB30 million he took from the Commercial Bank of Ethiopia (CBE), the repayment period of which has already passed its due date.

“There is almost no new construction project in the country. On the other hand, we could not finalize the ones already in our hands on time because of financial limitations.” Yared told EBR. “We could not even pay salary for our employees since the construction industry have slowed down.”

Just like Yared, many business people who took loans from banks are finding it difficult to repay the money they borrowed. Although in Yared’s case, CBE can recover the money it loaned by selling the asset it hold as a collateral without going to court, the Ministry of Revenue’s claim over the collateral complicated the issue. Other commercial banks are not immune to the problem. As a result of such increasing developments in the country, the Non-Performing Loans (NPL) of commercial banks in the country is mounting.

For instance, the unaudited report of CBE shows that the bank’s NPL increased from 2.5Pct in 2016/17 to 3.4Pct in 2018/19. However, this does not reflect the actual picture since the NPL figure does not include the huge amount of loans advanced especially to public institutions.
Until the second quarter of 2018/19, CBE extended loans in the form of corporate bonds worth of ETB304.4 billion, according to a report published by the National Bank of Ethiopia. Out of this, ETB256 billion (84Pct) is borrowed by Ethiopian Electric Power and Ethiopian Railway Corporation while the remaining goes to regional governments. Despite their maturity, the major portion of the loans remains unpaid by government enterprises.

“CBE has currently the second highest NPL only next to the Development Bank of Ethiopia,” says an official at the NBE, who spoke to EBR on the conditions of anonymity. “Even though private banks are performing relatively better in this regard, their NPL is also showing increment.”

Even though officials at the NBE prefers to keep the average NPLs allowed in the banking industry confidential, insiders who spoke to EBR stress that the figure has reached a staggering eight percent, which is higher than the five percent upper limit set by the financial regulatory body. However, Solomon Desta, director of banking supervision at the central bank, rejects the claim. “It is just a rumour,” he told EBR. “The NPL ratio is still below the recommended rate,” he said.

Most of the senior managers of private banks beg to differ. “The NPL ratio has increased especially since last year, due to internal and external factors,” stress Fikru Woldetinsae, marketing and communications manager at Wegagen Bank. “Even though there is no accurate data, it is fair to conclude NPL is increasing.” Andualem Alem, marketing and communications manager at Dashen Bank agrees. “The NPL ratio is increasing due to various reasons.

Although the definition varies across countries, NPLs (or bad loans) generally refers to loans that are not paid (principal and/or interest) within a certain period after overdue time. In Ethiopia, the NBE classifies loan portfolios in to five categories to calculate and determine the NPL status of a given bank. The calculation is made in order of deteriorating level. The categories are pass, special mention, substandard, doubtful and loss. Any loan or advance, which is fully recovered, both the principal and interest, by cash or cash-substitutes, is classified under the ‘Pass’ category, whereas loans with pre-established repayment programs which passed 30 days due date but still within the 90 days fall under ‘Special Mention’ category.

On the other hand, loans with pre-established repayment programs that passed the 90 days due date but are still within the 180 days are classified as ‘Substandard’. Loans whose repayment stalled for more than 180 days but are still bellow the 360 days are grouped in to ‘‘Doubtful’’ category; while those loans unpaid after 360 days from the due date, are classified as ‘Loss’. According to this arrangement, loans categorized under substandard, doubtful and loss are classified as NPL.

In Ethiopia, the NPL ratio has been fluctuating. It reached 6.8Pct in 2007/08. Consequently, the NBE introduced various measurements to lower the ratio. As a result, the figure declined to 1.4Pct in 2011/12 although it rose to 2.4Pct in 2015/16. With 14.52Pct NPL rate, the state giant, CBE, had one of the highest NPL in 2007/08. This declined to 6.34Pct in 2014/15. The NPL of Dashen Bank also declined from 5.95Pct in 2007/08 to 1.4Pct in 2014/15 while Awash Bank managed to reduce the figure from 7.36Pct to 2.3Pct in the same period.

Nevertheless, industry players and experts stress that the NPL at each bank as well as the industry’s average is ascending since last year. “Although the NBE managed to decrease bad loans in the past, the figure is growing back to its previous position,” explains Alemayehu Geda (PhD), professor of macroeconomics and international economics at Addis Ababa University.

Studies conducted in the subject categorize factors responsible for the rise of NPL in to two: macroeconomic and bank specific. Macroeconomic (external) factors include the economic, political and legal environment that affect the loan quality of banks.

Alemayehu stresses that the economic slowdown coupled with the political instability are among the reasons for the increasing NPL. “These issues, which have an enormous impact on the overall macro economy, are likely to affect the borrowers’ capacity to repay their loans on time.”

Of course, the experiences of many countries around the world reveal that political instability and economic slowdown have tremendous impact on the level of bad loans. For instance, due to high levels of corruption and periodic rounds of unrest, linked to poor governance and diminishing support for local authorities, Ukraine was under risk of instability in 2018. As a result, the average NPL in the country currently stands at 54Pct. On the other hand, the average NPL in Greece, a country still under economic slowdown after losing 25Pct of its GDP between 2009 and 2017, reached 47Pct in 2019.

At this moment, there are traces of both political instability and economic slowdown in Ethiopia. The country has been undergoing political unrest since 2016. Especially since last year, Ethiopian’s economy has been experiencing headwinds, which have prompted economic slowdown. For that reason, real GDP growth slowed to 7.7Pct in 2017/18 from 10.3Pct average growth rate registered between 2006/07 to 2016/17, according to the International Monetary Fund.

Due to these reasons, many businesses are closing their doors. For instance, 14,096 businesses returned their licensees at a federal level over the past three years, according to the information obtained from the Ministry of Trade and Industry. In addition, Out of the 1.4 million business licenses issued at the federal level except in the states of Gambela, Somali, Afar, Benisahngul Gumuz and Harari between 2010 and 2018, only 1.1 million renewed their licenses while 328,265 businesses, representing a quarter of the total, failed to renew.

High lending interest rate and double-digit inflation are two major macroeconomic factors that contribute to a growing NPL. The average lending interest rate in Ethiopia increased from 12.75Pct in 2015/16 to 15Pct currently while inflation already climbed to 16.5Pct, the highest since April 2018. However, experts and industry practitioners indicate that these factors have a negligible impact on the level of NPL in the country.

Although macroeconomic factors have their own impact on NPL, many studies indicate that bank specific factors such as internal structure, terms of credit and risk profile that are serious factors because they determine the riskiness or robustness of loans. “For instance, banks tend to give loans to exporters just because they want to generate as much hard currency as possible,” says Fikru. “This is despite the weak performance of the export sector and high risk profile of the borrowers.”

On top of this, a number of exporters divert pre-shipment loans, into other businesses, according to Andualem. “The transport and construction sectors are also exposed to such misbehaviours. This is why banks need to diversify their loan portfolio, to reliable and potential sectors.”

Yet, for Munir Hussein, chairperson of the founding committee of Zad Bank (an Islamic bank under formation) and manager of Zurif Real estate, the external factors are more influential. “NPL might increase due to internal factors, but does not put banks under risk, since banks in Ethiopia are the most collateralized banks globally,” he argues. “Rather, the decline of government involvement in the economy and the business slowdown that followed are casting a shadow on the banking business.”

To deal with bank specific factors, Munir suggests the adoption of KYC (know your client) approach, which is the best way to keep NPLs in check. “Once loan is disbursed to a client, knowing for what purpose they will use it is very difficult. So, tackling poor credit risk assessment as well as weak loan monitoring and follow-up is important to keep NPL below the recommended limit.”

8th Year • July.16 – Aug.15 2019 • No. 76