Commercial banks in Ethiopia are currently finding themselves with more liquidity than they can work with. While this is a good moment for those who have been desperately looking for credit, it has pushed commercial banks to sit on resources that come with a high cost. As a result, many banks are being forced to find alternatives to invest their extra liquidity, including introducing mortgage schemes with various real estate companies. EBR’s Samson Berhane spoke to bankers, experts and businesses to shed light on the matter.
Almost six months ago, getting a loan from a bank was not an easy prospect for Adel Hussein, a businessman who owns and manages a plastic material manufacturing company in Burayu. In recent times, waiting for the approval of his proposal would take three to four months, whereas cash disbursement might take another two or three weeks, depending on the liquidity of the bank.
It was discouraging, and a source of disappointment for him and his partners. He even gave up on commercial banks. His despair, however, was short-lived. Just a month after the beginning of the current fiscal year, he started to get calls from commercial banks, saying he could get a loan. “The waiting time to get approved for a loan has diminished drastically. Officers from various banks have contacted me, wanting me to apply for a loan,” he told EBR. “Gone are the days when we would wait weeks or months to access credit.”
Surprisingly, a shortage of credit was one of the key features of the banking sector half a year ago. Now, however, it seems like the days of waiting three to four months for credit approval are long gone. In fact, commercial banks operating in Ethiopia are poised to lower lending interest rates, because their hand is being forced by surplus liquidity and low credit demand.
Commercial banks, be they large or small, seem to be on the same page now about the need to lower rates and improve services in order to boost demand for credit. The International Monetary Fund (IMF), in a report published at the end of last month, echoed similar sentiments. “Commercial banks appear to be mostly well-capitalized and liquid, with non-performing loans (NPLs) well below the statutory five percent ceiling,” the Fund said.
While this is a time to cheer for those who are seeking loans, it is a source of concern for lenders. “Investment activities are seemingly at a standstill,” said Abie Sano, president of Oromia International Bank (OIB). “Many are now putting their money in banks because it is less risky than investing.”
How liquid are banks?
By almost all parameters, no bank has been as successful as OIB, whose profit skyrocketed three-fold to ETB938 million. What makes its performance even more astonishing is that such growth was reported despite the high liquidity of the Bank. In particular, the Bank mobilized deposits totaling almost ETB20 billion during the last fiscal year, showing a 46.7Pct increase from 2016/17, while its loans grew by 40Pct to ETB11.6 billion.
Hence, its loan-to-deposit ratio fell marginally from 60Pct in 2016/17 to 58Pct last fiscal year, which is lower than the industry average of 65Pct for the last five years. While this clearly shows that loans are not growing at the same pace as deposits, it perhaps portrays that OIB has not properly used its liquid resources in the past financial year.
Not many differences were observed in its liquidity level since then. “The accumulated financial resource we had in the past fiscal year, as well as the drop in credit demand, resulted in excess liquidity,” Abie explains. “In addition, the credit cap levied in the past fiscal year resulted in many idle financial resources.”
Following the decision of the government in October 2017 to bring down the overvalued Birr by 15Pct to promote exports and discourage imports with a target of raising foreign currency flow, the National Bank of Ethiopia (NBE) levied a cap on credit availed by commercial banks, in order to control the adverse impact of the exchange rate adjustment. The cap limited the outstanding credit growth of banks to 16Pct of deposits mobilized.
At first, exporters and manufacturers were removed from the list of sectors to which the cap applied. “But when the cap was levied, the Bank’s outstanding credit was already beyond the limit. As a result, we were forced to sit on our resources. The high liquidity in the banking sector observed in recent months is the result of such factors” argues Abie.
True to the trend observed for the past two decades, the Commercial Bank of Ethiopia (CBE), Awash International Bank (AIB) and Dashen Bank were the most liquid banks as of the end of September 2018, with deposits of ETB308 billion, ETB45 billion and ETB37.6 billion, respectively. On average, the three banks’ liquid resources showed drastic growth in just three months. “This growth rate, which occurred in three months, is rare in the banking industry,” said a senior banking expert with two decades of experience.
Studies indicate that a bank’s liquidity is a crucial point, which demonstrates its capacity to fulfill its financial needs. According to the NBE, “liquid assets” include cash, deposits with the central bank and other local and foreign banks, as well as other assets readily convertible into cash expressed and payable in birr or foreign currency accepted by NBE.
Although scholars use different methods to measure the level of liquidity in a given company, loan to deposit ratio is a popular one. A higher loan to deposit ratio indicates that a given bank is relatively disbursing more of its deposits in the form of interest bearing loans. So the bank generates more income. But higher ratios also signal a bank’s high explosiveness level in case of unforeseen events. On the contrary, a very low ratio means the bank is at low risk but is highly liquid. This means it is not utilizing its assets to better generate income.
The latter seems to be the reality amongst commercial banks in Ethiopia. Over the past five months, the loan to deposit ratio of commercial banks operating in Ethiopia reached around 60Pct from 65Pct at the end of the last fiscal year, according to data obtained from sources at the Ethiopian Bankers’ Association.
Many have witnessed this. “The first quarter of this year exhibited a huge increase in deposits, while loans availed by the banks showed slight growth. Demand for credit has dwindled,” explains the senior partner.
For him, political instability in the country is a major factor for the reduction in demand for credit. “Rational investors always assess the political environment of a particular area before investing. Bearing this in mind, it is unsurprising to see investors dragging their feet regarding taking loans from commercial banks while the political situation is not stable.”
This is an argument affirmed by well-known economists who have conducted studies on the investment and credit structure of banks in several countries. Zahid Hussain, the lead economist at the World Bank, is one of the experts who stress that economic growth and political instability are deeply interconnected. As a result, uncertainty associated with an unstable political environment may reduce investment and the pace of economic development, according to Hussain.
Abdulmenan Mohammed Hamza, a financial expert with over 20 years of experience, has a similar opinion. “The liquidity of banks has increased due to the reduction in demand for loans and advances,” he argues. “The main culprit is the slowdown of economic activities while banks are mobilizing huge deposits.”
The situation is no different from that explained by Zahid and Abdulmenan. According to the IMF, the growth rate of the real gross domestic product (GDP) of Ethiopia dwindled to 7.7Pct in the past year, a decrease from 8.5Pct a year ago. While the positive growth, according to the Fund, was driven by favorable harvests and rapid growth in air transport as well as manufacturing exports, political uncertainty, along with foreign exchange shortages, and adverse terms-of-trade trends, hindered economic activity.
Not only that, but the excess liquidity is also a result of an approach used by speculators to hold cash so as to make the best use of any investment opportunity that arises later on. The senior banker explains, speculative motives arise when investing all of one’s money doesn’t seem good all the time. “When political uncertainties exist, maintaining a fair amount of liquidity in one’s portfolio is one of the top priorities for an investor. Saving is now more preferable for businesses than investing.”
Kibru Fondja, president of Nib Bank, has similar concerns. “Excessive liquidity is a reflection of macroeconomic instability. The role of the state in the economy seems to be reducing, although it is still the main actor.”
Abie from OIB concurs. “The decline in investment activities by the state, coupled with the slowdown of activities in the construction sector, which used to be one of our biggest borrowers, is another reason for the decline in credit demand.”
Indeed, recent reports indicate that capital spending has declined drastically in annual terms, as the government tries to encourage private enterprise and reduce the role of the state in the economy. While this translates into a narrower fiscal deficit, it has affected the business environment because of the suspension of many projects and contracts by the government. “A reduction in government expenditures resulted in a slowdown in economic activities, as the government is the biggest spender. As a result, demand for loans and advances declines. Then the liquidity of banks increases,” Kibru adds.
The determinants of excess liquidity can be grouped into two categories: internal and external factors. Internal factors come from specific banking performance, including NPLs, profitability, deposit, loans, interest rates on loans, and size of the bank. The external factors, on the other hand, include aspects such as GDP growth rate. This does not mean there are no exceptional cases. The management of Dashen Bank, for instance, believe that their excess liquidity comes from their distinct policy and strategy. “Because of the introduction of new products and an extensive growth in footprint, we have achieved unprecedented growth in resource mobilization, which has in turn boosted our liquidity position,” stress Mulugeta Alebachew, marketing and corporate communications director of Dashen Bank.
In contrast, studies indicate that excessive liquidity is the result of poorly developed interbank markets and other impediments to financial markets, such as an underdeveloped securities market and lack of competition. Such factors, according to a study dubbed ‘The Determinants of Excess Liquidity in the Banking Sector´ published in 2017, push banks to make liquidity cushions to safeguard themselves against risks.
Excess liquidity has multifaceted impacts. Studies conducted by various organizations, including the IMF, reveal the effects of excess liquidity as being as unpleasant as those of a liquidity shortage. Of course, as the experience of commercial banks across the world shows, the importance of liquidity must not be neglected, because it compensates for expected and unexpected events besides providing funds for growth. Yet, in excess, its effects can be the opposite, according to Abie, who says, “It will eventually affect performance, if it persists.”
What’s more, if banks are excessively liquid, they might consume their financial resources to finance both healthy and unhealthy firms, according to a study called ‘The Limits to Credit Growth’ conducted by Sander van der Hoog, a Dutch computational economist. The unhealthy firms are financially unsound and require large sums of liquidity to satisfy their financial commitments, and the banks, if they have excess deposits on their hands, would be more willing to fund financially fragile and risky firms. This will eventually increase banks’ NPL, according to the study.
However, Atlaw Alemu, an economist and associate professor at Addis Ababa University, argues differently. “There is no reason for the commercial banks to waste their resources by lending to unhealthy firms. I believe they should invest it by identifying areas which they could become involved in. Not only that, they should also introduce new products targeting those who have less access to finance.”
Many banks have already started following such a path, with Bunna Bank being the latest. The Bank recently started availing finance to clients who wish to buy a brand new taxi, by covering 50Pct of the cost. Dashen also follows a similar approach, having launched a scheme, which covers half of the cost for those who want to buy a car. Many banks are also introducing mortgage schemes in partnership with various real estate companies.
Not only that, Dashen is also keen to avail finance to the middle class and micro, small, and medium enterprises, according to Mulugeta.“We intend to impact the lives of the vast majority of the society. By doing so we will expand our customer base and guarantee sustainable growth,” he says.
If excess liquidity remains for long, banks might be pushed to lower lending rates (which are currently between 15 and 21Pct) to push credit demand, according to bankers EBR spoke to. “Failing to do so would force companies to turn their backs on banks which were unwilling to lower rates,” argues a senior banker at Awash.
But for Abie, what matters is the state’s role. “Unless the government resumes what it started until the private sector is ready to replace it, the macroeconomic stability of the country will be undermined,” Abie warns.
7th Year • Dec.16 – Jan.15 2019 • No. 69