Exaggerated Optimism, Concerns toward New Liberalization Reform

Recently, the three-decade-old policy stance on foreign banks’ entry was abandoned – a watershed event since the 1990s financial sector liberalization. A proclamation that would allow foreign banks to join the Ethiopian banking industry is in the pipeline. The proclamation allows four entry modalities: acquiring shares in the domestic banks, setting up a subsidiary, opening a branch office, and opening a representative office.

The decision caught many people, even the industry players, by surprise. While the government is optimistic about the benefits (particularly foreign currency inflows) accruing from the entrance of foreign banks, subsequent discussions have shown that many have fears and concerns. It appears that the concerns have alarmed the government to add more restrictive rules.

I believe that both optimism and fears are exaggerated, although some concerns have validity.  Both the optimism and the fears arise from the belief that foreign banks would flood the banking industry as the industry is lucrative. This belief should be qualified.

Many people, even seasoned ones, are misled by headlines in the media that the Ethiopian banking industry is highly profitable. From this premise, they think that foreign banks would flood the industry. This is so naïve. Firstly, the industry is not as lucrative as many believe. To achieve the industry’s average nominal earnings per share (EPS) of about 30 Pct, it takes a decade, if not longer. Given the current inflationary situation, the real industry’s average EPS is negative. Over the past several years, for most banks, the real EPS has been negative.

The other important issue disregarded by many is the country’s political and economic situation, which may put off foreign banks. Over the past several years, the country has been ravaged by devastating civil war and political instability. To make things worse, the economy has been hit by violent inflation, severe foreign exchange shortages, and the fast depreciation of the Birr. In such a situation of political and economic uncertainty, foreign banks could be reluctant to join the banking industry due to significant risks, both political and economic.

Throwing my doubts regarding the coming of foreign banks at this time to the wind, let me focus on the technical issues on which valid concerns have been raised. While the entry modalities are made clearer, several controversial issues have emerged. This has made me suspect that the government adopted the policy half-heartedly.

Confusingly, the entry rules are liberal and at the same time restrictive. While foreign ownership of shares in domestic banks is liberal, the licensing and branching rules are the opposite.

Contradicting the rules applying to shareholders of domestic banks, foreign banks are allowed to acquire up to 30 Pct of the shares of the existing banks and form their own subsidiaries. Allowing foreign banks to own a significant stake in the domestic banks is a valid concern to domestic banks as this preferential rule would make foreign banks influential shareholders in the banks in which they have a significant share. Given the dispersed nature of the minority shareholders, the entry rule would give a foreign bank a significant say in the affairs of the domestic bank, compromising the interests of the minority shareholders unless they are well protected. Furthermore, their significant stake would enable them to institute rationalization measures that could shake up the existing management.

Our banking experience supports this. The emergence of influential shareholders in banking, and their tendency in influencing decision-making caused the classic principal agency problem, the result was restrictions in shareholding in banks, active monitoring of influential shareholders, and reforming the composition of the Board of Directors. The restrictions were included in the banking proclamation and related directives. Article 11(1) of Proclamation No. 592/2008 says “No person, other than the Federal Government of Ethiopia, may hold more than five percent of a bank’s total shares either on his own or jointly with his spouse or with a person who is below the age of 18 related to him by consanguinity to the first degree”. Furthermore, the same proclamation states “an influential shareholder of any bank may not acquire shares in other banks’’.

Apart from the above restrictions, an influential shareholder (who owns between two and five Pct of a bank’s share) is subject to serious monitoring by the National Bank of Ethiopia (NBE). Additionally, to increase the participation of minority shareholders on the board, they are given a certain proportion of seats.

Despite the rules regarding the modalities of entry such as share ownership being lax, a range of restrictions is being deliberated to be imposed including the number of licenses to be issued, branch numbers, and the nationalities of the top executives. The restrictions are problematic for new foreign banks. Particularly, the branching restrictions are severe to the point of deterring foreign banks from entering the Ethiopian market.

It appears that such confusion arose as a result of poor deliberation on foreign banks’ entry. This can be rectified by keeping the diversified nature of the share ownership in domestic banks, encouraging foreign banks to set up their own subsidiary, and lifting the branching restrictions and the nationalities of the executives. If foreign banks are allowed to have significant stakes in domestic banks as currently suggested, there should be strong corporate governance, minority shareholders protection, managerial autonomy, and employees right protection.

11th Year • Nov 2022 • No. 112