Ever since Ethiopia liberalized the financial sector in the 1990s, the country witnessed different waves of banking formation. The first wave was 1994 to 2000. Six private banks were formed during this time. Following the enactment of the Monetary and Banking Proclamation of 1994 that allowed domestic private investments in the banking sector.
The second wave was 2004 to 2012. During the early 2000s, the ruling party pursued highly interventionist economic policies with the aim of transforming the economy from one that’s agriculture-focused to industry-focused. The growth of the economy picked up and a new wave of banking formation began. Between 2004 and 2012 ten more private banks were established. The Commercial Bank of Ethiopia (CBE) emerged as the main financer of mega government projects with the Development Bank of Ethiopia (DBE) positioned as policy bank to fund private agricultural and industrial ventures.
Concerned by the number of banks in the pipeline during the second wave, the National Bank of Ethiopia (NBE) increased the minimum paid-up capital for setting up a bank to ETB500 million, resulting in the dissolution of several banks that failed to fulfill this requirement.
Currently, the third wave of banking formation is underway. At this moment, Ethiopia has 18 banks; two state-owned and 16 private banks. Due to the rule changes regarding interest free banking and Diaspora communities’ engagement in the financial sector, about a total of 10 Islamic and conventional banks are being formed. Five micro-finance institutions are to be upgraded into banks with a mortgage bank also in the pipeline. Soon, the number of banks operating in the country will be more than 30 if the new banks are able to comply with the NBE rules.
The Ethiopian banking sector is expanding. Its expansion and performance is highly related to the macroeconomic situation of the country. Expansion of the banks’ assets is driven by; economic growth, high inflation, and monetization of the economy. Over the past decade, the assets of private banks soared and so did their profit. Whereas the average earnings per share of private banks constantly dropped until they stabilized two years ago. Their number of branches increased and population to branch ratio reached below 20,000.
On the other hand, the Ethiopian banking system is characterised by inward looking, restrictive, less competitive, low technological utilization and inefficient. Despite electronic banking emerging, the banking sector is predominantly paper based.
Ethiopia needs a competitive banking sector. Competition enables efficient production of services, increases access, improves quality and fosters innovation. In the face of the comprehensive economic reforms (including the financial sector) that the government of Ethiopia is undertaking, having a competitive and efficient banking industry is essential
An increased number of banks intensifies the competition in the industry. However, if we go by the past track record of the industry; product innovation, technological utilization, and increasing access have been slow. And, the private banks focus more on serving major urban centres. For example, 41Pct of the private bank branches are found in the capital.
Previous experience shows that the battleground for most new comers into the industry will be in these urban centres that are relatively well served. Addition of a dozen more banks in the same line of business will certainly make the competition in the industry so fierce. The NBE should take proactive measure to make sure the financial sector remains stable.
Stability of the financial sector is as important as competition and efficiency. For any regulator, it is a balancing act. But, it’s better to pay the price in terms of lost efficiency while maintaining the financial sector’s stability as the cost of instability is unaffordable.
The key to any regulation is predictability and proactivity. The NBE needs to proactively monitor the developments in the financial sector as the large number of banks take formation. It should not only review what the industry has gone through but also have the foresight to visualize how the industry will look in the medium term. In light of this, it should set the rules.
When taking any precautionary measures, the NBE needs to consider the industry’s capacity to accommodate a dozen new banks and their implications to the competition and the stability of the sector. Moreover, the plan the new banks submit should be rigorously scrutinized for its viability in such a competitive industry. The NBE should also take into account the protection of the bank’s potential shareholders if the promoters fail to fulfil the new rules that may lead to the dissolution of the bank.
8th Year • Aug.16 – Sep.15 2019 • No. 77