Institutional Independence

The Missing Gap at NBE

For more than a decade, inflation has been a serious problem owing to expansive monetary policy. In recent years, political instability, food supply shortages, and the persistent depreciation of the Ethiopian Birr has exacerbated the inflationary phenomenon, peaking in excess of 20Pct recently. This problem is severely hitting the urban poor and the unemployed. Despite monetary tightening using reserve money as the operational target to control broad money growth, the nation’s inflation is unyielding. It has been persistently high over the past couple of years, and it seems there is no hope in sight of bringing it down to an acceptable level. Another serious trouble with the financial sector is the concentration and increased credit exposure of state banks. Unbridled lending to state-owned enterprises has increased their credit risks. Implicit and explicit debt guarantees by the government has increased the moral hazard where many state-owned enterprises have failed to service their debts according to the terms of their loan agreements, leading to the formation of a new state enterprise to take over their debts.

The Ethiopian economy is stuck in such quagmire—a legacy of the Ethiopian developmental state model that undermined “checks and balances” that should have been in place in the economic sphere. The culprit of the two economic maladies—inflation and state banks’ high credit exposure—appear unrelated, but at the heart of these problems lies the lack of institutional independence of the central bank.

Normally, a central bank has an array of responsibilities including maintaining the stability of money, ensuring a stable financial system, developing the payment and settlement infrastructure, and ensuring its security and efficiency. Two areas that any central bank is vigilant about is maintaining the stability of money and ensuring a stable financial system. Both require institutional independence.

The National Bank of Ethiopia (NBE) is entrusted by law with setting monetary objectives and formulating monetary policy instruments to control inflation. In reality, however, the macro committee chaired by the Prime Minister, deals with monetary policy issues, thus leading to the marriage of the fiscal and monetary policy spheres. This has been complicated further by the use of unconventional financial sector policies, including a range of administered interest rates and directed credit schemes. There are seemingly some reforms being undertaken, such as treasury bills auctions.

The other striking issue is the supervisory independence of the central bank. Although the NBE has full authority to equally enforce banking rules on all banks, it has shown considerable forbearance on state banks in the face of credit risks they have been increasingly exposed to. This as the government has heavily leveraged them for the expansion in state investment through state-owned enterprises and other agencies.

According to “Ethiopian Financial Sector Development,” published by the World Bank at the end of 2019, NBE has not effectively enforced prudent standards on state banks. The report says:

The NBE performs the full cycle of on- and off-site inspections on CBE and DBE similar to other banks and issues them fines for violations, however fines are paid without any subsequent corrective measures taken. From July 2015 to date, CBE was fined 5 times, for a total number of 117 violations at ETB 10,000 each, totalling around ETB 1.2 million. During the same timeframe, DBE was fined on 4 occasions for a total number of 25 violations, also at ETB 10,000 per violation (total of ETB 250,000). A consequence of this lack of enforceability by NBE is, the CBE is now exposed to material sovereign risk, foreign exchange risk and liquidity risk; while DBE’s asset quality deteriorated so significantly requiring an almost full restructuring of the bank’s structure and operations.

The above finding is very telling of the laxness of state bank supervision. The supervisory handling of the state banks with kids gloves coupled with the situation where banks’ strategic decisions are made by politicians on grounds often contrary to prudent lending has exposed state banks to risks of greater proportions. What makes the risk very concerning is that state banks control more than 60Pct of the industry. And any trouble with them could wreak havoc not only on the banking industry, but also on the whole economy.

The lax supervision of state banks emanates from the way in which these banks and the central bank are governed. Both the supervisor and the supervisee are governed by politicians appointed by the government, thus undermining “checks and balances” that should be in place regarding banking regulation and supervision. The state banks are the policy arms of the government, so they are afforded special treatment. As the central bank is not independent from the government, it is expected to extend implicit and explicit special supervisory treatments. This practice has undermined accountability.

Coming out of this economic swamp and achieving both monetary and financial sector stability entails institutional independence. For this to happen, the central bank needs to be freed from the grip of the government, made accountable to parliament and the public, given a full mandate to supervise state banks, and hire professionals on a competitive basis. Independence of the central bank should come with accountability. By setting explicit objectives and a working framework, ensuring transparency in its functions, and requiring periodic reporting, accountability can be established. To establish monetary policy and supervisory independence, parliament, government, NBE, and financial sector actors need to discuss the issues as a matter of urgency.

9th Year • Nov 16 – Dec 15 2020 • No. 92