Five Billion or Merge!

Over the last two years the number of entrant banks has proliferated, almost equaling the amount of working banks. Nonetheless, a new directive issued by the caretaker National Bank of Ethiopia has shut the door on the further entrance of new banks, whilst also raising the bar on smaller banks and the close to 20 already in the pipeline.
Banks are now expected to raise their minimum paid-up capital to ETB5 billion within five years from the existing ETB500 million mandated in 2011. Although central bank authorities stress the intention is to discourage unbalanced proliferation and nurture few competitive banks, industry leaders and experts claim that this move is the interest of the leading banks. Up to six existing private banks are forecasted to consider merging, while a substantial number of under-formation banks will either abort their efforts or join hands. EBR’s Ashenafi Endale investigates the implications of the new move. 

A wave of regulatory reforms has been introduced in Ethiopia since Prime Minister Abiy Ahmed (PhD) assumed power three years ago. Aiming to create a conducive environment for the private sector, expected to be the economy’s primary engine, the administration has amended and enacted numerous laws.

The financial sector, in particular the banking industry, has also received its fair share of reforms ranging from allowing Ethiopian-born diaspora members to be shareholders in financial institutions to the sanctioning of Islamic banks.

But none compare with the decision of the National Bank of Ethiopia (NBE) to raise the minimum paid-up capital threshold for a banking business license to ETB5 billion on April 12, 2021—a tenfold increase.

Banks in operation are given a five-year transitory period to meet the new base, whilst under-formation banks are afforded seven years. “The new paid-up requirement will improve financial resilience and ensure the soundness of the banking industry,” stresses Frezer Ayalew, Director of Bank Supervision at NBE. “Banks have a sufficient transition period before the deadline.”

The bigger, the safer
The Commercial Bank of Ethiopia (CBE), with its 60Pct market share, is immune to the new capital threshold as its paid-up capital is ETB51.8 billion. The same applies to the other state bank, the Development Bank of Ethiopia (DBE), which raised its paid-up capital to ETB28.5 billion in 2020.

Besides CBE and DBE, the notion of “the bigger, the safer” also applies to a few current and under-formation private banks. Awash, the first private bank in Ethiopia established in 1997, is among few financial institutions with a paid-up capital above ETB5 billion even before the directive’s introduction. By the end of 2019/2020, Awash’s paid up capital reached ETB5.87 billion. Compared with the previous financial year, the bank’s share capital grew by 33.4Pct or ETB1.46 billion.
During this year’s annual meeting, shareholders even agreed to double the bank’s paid-up capital to ETB12 billion in the next three years.

Awash is not exceptional in this regard. Surprisingly, Amhara Bank, now under-formation, managed to garner above ETB6 billion in paid-up capital, surpassing the new threshold form the outset. The pioneering Amhara Credit and Saving Institution, which has now transformed itself into Tseday Bank, is also safe after registering ETB8 billion. However, some of the remaining 15 operating private banks and the more than 20 under formation will be tested by the new capital requirement.

Based on the year of establishment, private banks can be categorized into three groups. Pioneer banks which were formed between 1996 and 2001 are usually referred to as first-generation banks. This includes Awash, Dashen, Wegagen, Abyssina, Hibret, and Nib.

Second-generation banks, born between 2002 and 2008, includes the Cooperative Bank of Oromia (CBO), Lion, Zemen, and Oromia International Bank (OIB). Bunna, Berhan, Abay, Addis International Bank (AIB), Debub Global Bank (DBG), and Enat, established between 2009 and 2013 are known as third-generation banks.

Among first-generation banks below the new capital threshold, Dashen leads with ETB3.5 billion, while Wegagen has the least paid-up capital of ETB2.9 billion. To reach ETB5 billion by 2026, Dashen needs to increase its paid-up capital by at least ETB300 million annually while Wegagen needs to raise ETB420 million per year until 2026.

The extent to which banks could fulfil the new requirement depends on their size, earning power, and capital-raising capacity. Drawing from their previous performance, it is safe to conclude that reaching or perhaps surpassing the threshold seems easy for most first-generation banks. Even the youngest bank in this category, Nib, has managed to boost its share capital by ETB786.2 million in 2019/20 alone. Its current paid-up capital is ETB3.4 billion.

The way forward for second-generation banks also appears smooth. In fact, some including OIB and CBO stand better than first-generation banks with a paid-up capital of ETB3.7 billion and ETB3 billion, respectively.

These second-generation banks have been annually increasing their paid-up capital by an average of ETB300 million. To fulfill the requirement, they have to double their efforts.
Even the management of Zemen, the least capitalized bank in this category, is optimistic. “The new threshold is within our reach,” says Dereje Zebene, President of Zemen. “In fact, our shareholders have already decided to raise the bank’s capital to ETB5 billion last year.”

The fate of some third-generation banks, however, looks uncertain. For instance, the paid-up capital of AIB and DGB is below ETB1 billion as of June 2020. Further, they have only been increasing their paid-up capital by ETB200 million annually in recent years. At this rate they will be unable to fulfill the requirement.

“Some third-generation banks might face an existential threat because of the difficulty of raising more than ETB700 million annually,” argues Eshetu Fantaye, Founding Member of Goh Bank and former president of Bunna. “Especially for late comers, it will be hard to raise this amount of capital even if they sell additional shares and recapitalize dividends.”

The directive states that any licensed bank unable to secure the ETB5 billion by June 30, 2026, will be dissolved and put under receivership, or the “NBE may take any measure it considers fit.”

However, Wendifraw Tadese, Chief Strategic Officer at Abay Bank, claims the new threshold is easily achievable. “Most banks are already halfway to ETB5 billion.”
The case of banks currently under formation is more complex. These banks currently selling shares can get licensed by the central bank only if they can collect ETB500 million within the next six months. Even if that is managed, they face a further and perhaps tougher task of reaching the ETB5 billion threshold in the ensuing seven years. Currently, there are 20 banks in the pipeline, of which four have fulfilled ETB500 million and have requested the NBE for an operational license.

Drawing from the past experience when a number of under-formation banks went defunct when the central bank raised the paid-up capital threshold from ETB75 to 500 million in 2011, stakeholders stress that the new requirement will be devastating for banks selling initial shares.

Dawit Keno, President of Hijra Bank licensed last year but delayed due to COVID-19, says it is even difficult for under-formation banks which have already garnered ETB500 million. “Hijra Bank mobilized ETB600 million from its 9,000 shareholders but we are expected to increase our paid-up capital by an annual ETB1 billion from now on, which is difficult. We can raise our capital by selling shares to our existing shareholders but this will not be enough.”

The other option available for such banks is to sell shares to the public, according to Dawit. “But to do this, we first we have to prove the bank is profitable. However, it takes at least two years for a new bank to become profitable. Therefore, the transition period for banks under-formation should be extended to at least eight years.”

The end result
The central bank stresses the move is necessitated by the need to improve financial resilience and ensure the soundness of the banking industry. However, it didn’t link how the push for capital build-up improves the stability of the banking industry.

“As always, the directive lacks objective function,” says Tekie Alemu (PhD), Lecturer at Addis Ababa University. “We don’t know whether the intention of the central bank is to stabilize the industry or reduce competition.”

The experience of many developed and developing countries shows that capital build-up improves the banking industry’s stability by creating well-capitalized banks which can withstand financial instability. In fact, regulatory capital beef-up became globally common after the financial crisis began in 2007.

But experts stress there is another reason for enacting the new requirement. “The new threshold seems to reduce the influx of banks joining the industry,” argues Dawit. “More than 20 new banks are looking to enter the industry. This was way beyond the central bank’s expectations. Thus, the entry barrier was raised.”

If what Dawit is saying is true, the aim is the reduction of competition in the banking sector by locking out new entrants. Since there already is stiff competition among existing banks, the new requirement looks to prevent the likeliness of extreme competition that can lead to financial fragility.

“By raising the capital requirement, the central bank can ensure that there isn’t excessive competition amongst banks,” argues Abdulmenan Mohammed, Financial Expert and Accounts Manager at the London-based Portobello Group. “Thus far, any bank that could raise ETB500 million was allowed to become a bank, without any pressure to specialization. Now, only very few can meet the requirement and get licensed.”

“If discouraging new entrants was the intention, NBE could have just raised the minimum paid-up capital for banks under-formation. There is no reason to put in danger especially third-generation banks that have been struggling to even to meet the ETB500 million threshold,” Wendifraw stresses.

Proponents of the new level justify their argument in stating that ETB5 billion is still small in dollar terms—around USD125 million at current rates. Some experts even propose the central bank adopt a dollar-based capital requirement to make Ethiopian banks equal with their African peers.

On the other hand, opponents of the directive mention legitimate reasons for the unlikely outcome of the directive. The fact that most existing and oncoming banks are formed along ethnic lines is a self-made trap disabling them from selling shares to the wider market outside their circles. They also stress instability in several parts of the country makes raising more funds very difficult.

The need to raise more capital is vital for Dereje. “COVID-19 exposed how much our banks are unable to absorb shocks, because of their limited capital,” he stresses. “There are many corporate customers with more capital and shock-absorbing capacity than most existing banks.”

For Abdulmenan, the fundamental problem in Ethiopia’s banking is the dominance of CBE. “CBE controls over 60Pct of the market. Close to 40 banks have to compete for the remaining bit, if the new banks in the pipeline are to go operational.”

However, Tekie argues what matters is economic efficiency. “If a few banks can provide every banking service, then they are enough for Ethiopia.” EBR

9th Year • Apr 16 – May 15 2021 • No. 97