Are the “Salad Days” for Private Banks Ending?
Teklewold Atnafu, the longest serving governor of The National Bank of Ethiopia (NBE), in his speech on financial liberalization in the country, at the eighth general assembly of the Ethiopian Economic Association (EEA) on July 15, 2000 asked the assembly, “Have we created, through financial sector liberalization, a diversified and deep financial system?” and answers himself “Obviously, there is still a long way to go in this respect. We still don’t have active money and capital markets. The types of financial instruments remain limited. The sector is not well diversified in terms of financial institutions. Competition in the sector is far from being fierce.” Fast forward 13 years and almost nothing is changed, except may be for the competition part, and his institution’s Neanderthal nature and the stifling directives it formulated through the years are partly to blame. And now the sector is facing yet another obstacle.Since the liberalization of the economy in 1991, the banking industry has become the poster child for the success of the private sector in the economy. Most private banks were able to register profit starting their second year of operation. Earnings per share of 30 and 40Pct are still common in the sector. Capital and branch network growth has been exponential, especially in the last couple of years. This all was possible on the back of an economy that is among the most unbanked on the planet and protection from foreign competition. But all these seem going to become the thing of the past. Because of a combination of many reasons, but mainly due to restrictive directives of the central bank and lack of dynamism in the industry, the sector is facing its biggest challenge to date.
Ethiopia still has a small banking system, with a single digit banked society ratio, but increasing level of intermediation. The number of private banks has increased significantly, reaching 16 currently. Credit to the private sector has increased steadily. But financial institutions in the country are constrained by high transaction costs, low population density and lack of mechanisms by which risks and viability can be adequately assessed, and new ventures selected, monitored and repayment enforced, according to a 2011 report on the Ethiopian economy by EEA. Despite its small size the banking sector continued to be relatively healthy. Non Performing Loans (NPL) in private banks is less than five percent compared to a Sub-Saharan Africa (SSA) average of seven.
The financial performance of banks is also relatively strong with average returns on equity reaching 31Pct in 2009 compared to 27Pct for SSA. This is likely reflective of the protected and low levels of competition in the sector, according to the report by EEA. Yet operating revenue per employee, which shows management efficiency, is USD 30,000, lower than the SSA average.
In most periods between 1999 and 2004, driven by weak lending skills and highly conservative use of funds, excess reserve was the main character of the sector. Then again after four years of huge public spending, that triggered the boom in the economy, in 2008, the sector started to recover its depleted reserve, in part due to various inflation targeting directives by the NBE. The growing foreign currency market with growing international trade and remittance was also another segment of the industry that proves the mouth watering profitability of the sector. But things are turning down ward and fast, heralding the private banking sector entering yet another phase of existence.
Business not as Usual
According to industry insiders, things start to change dramatically in the sector, since the start of the Growth and Transformation plan (GTP) period, in 2010. The sector has seen liquidity and foreign exchange shortage on and off since then. This can be the reflection of the scramble for financial resource between the private sector and huge public investments. “Deposit mobilization has become a tough task and Commercial Bank of Ethiopia (CBE)’s aggressiveness has made things even harder for the private banks,” says Andualem Hailu, manager of planning and research division at Awash International Bank. A couple of years ago private banks used to avoid time deposits, now they are willing to pay up to 10 Pct, showing the scale of liquidity shortage in the sector. Even when the banks managed to collect deposits 27Pct of it will go to NBE every time they disburse loans.
The NBE issued a law in April 2011, which requires private banks to purchase NBE bills equivalent to 27pct of new loans extended. Redirected to Development Bank of Ethiopia (DBE), this fund is expected to be availed to the manufacturing and agricultural sector. These bills have interest earnings of three percent and maturity periods of five years. All private banks and another state-owned bank, the Construction and Business Bank (CBB) are expected to buy the bills, exempting only the public owned CBE and DBE. In addition to this there are directives that force 40pct banks’ loan portfolios to be short term, where as there is another one that limits the ratio of pre-shipment loans to be not more than 10Pct. All these directives are making things hard for private banks to operate. (NBE was not willing to respond to issues regarding this, despite EBR’s repeated visit to its bank supervision directorate).
Some observers relate the present liquidity shortage in the sector with the recent requirement by Ethiopian Revenue and Customs Authority for businesses to present their bank statements for tax verification purpose. This is assumed to have led business people to withdraw their cash from banks and transact through cash, operating outside the banking system, except for some critical transactions.
It is now close to two years since the economy starts facing acute foreign exchange shortage. To cope with the limited supply, banks have started buying foreign currencies with official selling prices because of competition. This has increased cost of foreign exchange mobilization. Big returns from foreign exchange operations are no more, according to Gashawtena Amdetsion, vice president for strategic support and modernization at Nib International Bank. NBE’s directive that designate all exports to china, which is a growing export destination especially for the country’s oil seeds, to be handled by CBE in addition to last year’s disappointing export performance of the economy, has made it even harder for private banks to secure foreign exchange.
Backed by favorable governmental directives and clearer institutional objectives CBE has expanded its operations exponentially and is handling its business with fierce aggressiveness. As the dominant institution in the sector this development has multi faceted impacts on private banks. This is more visible in deposit mobilization. With its expanding branch network, as it opens new branches almost every other day, it has now close to 800 branches throughout the country. This represents close to half of the industry’s number of branches and has enabled it to collect massive savings. This is in addition to being the exclusive account holder of governmental institution and the huge civil service apparatus. “CBE is regaining its lost market share,” says Gashawtena. “In the mean time increasing rent and human resource expenses has made it costly for private banks to open and operate new branches hindering collection of deposits and addressing new markets.”
Financial service coverage of formal banks in Ethiopia is far below international and sub-Saharan African standards. Bank branches are mainly concentrated in urban areas. More than 52Pct of all bank branches in Ethiopia are located in the eight major towns where only 6.6Pct of the population live in; Addis Ababa alone accounts for 37.6Pct of all bank branches, according to a research conducted in 2010 by Wolday Amaha (PhD), then president of the Ethiopian Economic Association, also a member of the Board of Directors of CBE. The new private banks have followed this trend.
Most of the people in the private banks are former employees of CBE and this has its own impact in making the private banks to be the followers of CBE. Starting with similar product and services and management structure the private banks are identical to CBE. Except competing in the existing market they are not able to create their own market, in the process contributing almost nothing for the dynamism of the sector. “Almost all private banks in the economy have the same business model as CBE and they were able to survive because profit making in the sector was as easy as cherry picking, mostly due to huge unsatisfied demand,” explains Eyob Tesfaye (PhD), a macro economist and former director general of Public Financial Institutions Supervision Agency.
There is high level of complacency in the sector because there is high profit in the sector; therefore banks don’t want to take risk. Car loans, housing loans and other consumer related loans are absent in most of the banks unless there is adequate collateral that covers the risk (see table). “It is a risk and reward scenario; the sector doesn’t have enough capacity to introduce different new products simultaneously.” Gashawtena elaborates. Andualem agrees with this idea. “Existing customers were not asking for new products and the sector was profitable so there was not enough incentive to be as much innovative. But now new products may come especially in regard to deposit mobilization.”
The sector was also not able to make big strides in adopting and using technologies. Lack of infrastructure, tight regulation in combination with capacity deficiency form NBE and absence of research and development in banks with limited human resource capacity building are blamed for the dismal result in the area. This has created additional challenge for a sector that is marred by regionalism.
Since the birth of the sector regionalization, different banks established by people from different ethnicity targeting mainly to serve their respective region or ethnic population, is one of the unique feature of the sector. This situation has reached its peak with the entrants of new banks with seemingly political backing from the respective regional governments. Gashawtena has doubts on the applicability of regionalization of banks in the country. “Regionalization may be visible during establishment and organization. But it fades in an institution through years of operation. In the long run it can be a challenge for those banks. Limiting yourself to a certain corner doesn’t have a business rationalization. Ethiopian customers have started to choose better service than follow regional approach.”
Regionalization will also have negative impact on corporate governance and since human resource management in these banks is not merit based, it will certainly create inefficiency in the labor market. Ethnic targeting banking approach is not sustainable, it is a wrong strategy and economic forces in the market are expected to change it in the future, according to Eyob.
Since the sector was liberalized in the early 90’s things had similar patterns with temporary up and downs. But now it seems like things are changing for good, and a new statuesque seems to be taking shape.
Even though some indicators in the private banking sector like profit is still growing and paid up capital in the sector has reached ETB 8,148,000,000 in September 2013 from 6,731,100,000 a year earlier, there are worrying signals when it comes to liquidity. Deposits have started decreasing reaching 76,272,000,000 in September 2013 from 76,715,100,000 just three months earlier. Percentage of NBE bill to total loan has reached 44.3Pct in September 2013 from 38.3Pct a year earlier. According to industry insiders defaults are also increasing, since borrowers avoid paying back the loans they took because they are afraid they may not get another loan due to shortage of liquidity in private banks, so instead they are trying to extend the period of their prior loans even by paying penalties.
If things continue like this, the situation may turn to the worst in the near future. “After one or two years there will be some banks with serious insolvency, if things in the sector couldn’t show drastic change,” predicts the macro economists. This situation may force banks, especially the youngest ones to consider merger. Otherwise huge capitalization and aggressive deposit mobilization will be the main feature of the sector for the foreseeable future. This trend has already started and the growing supply of shares for sale is having its impact on premiums paid. New shares that used to be sold with 40pct premium are now becoming the thing of the past. One business person with intimate knowledge of the sector told EBR that he has sold his share in one of the private banks to invest in the property market which has become more profitable and less risky.
Banks should shift from the traditional supply-driven products to demand- driven and innovative products, by using a product development process that is client-centered. “We are aggressively trying to mobilize deposit. Branch additions are becoming costly yet we have to work hard to address the unbanked society and are working to increase capitalization. If we work to address the unbanked society, getting out of the traditional banking mind set in to different technological services like mobile and agent banking we can pass the storm,” says Gashawtena. The same works for the whole sector, Andualem adds to this the need for banks to be strategically managed. “The problem of liquidity is becoming a real challenge. Banks should be well managed and must made research based decisions. The sector will continue to grow. But banks must be innovative because business doing in the sector has changed, so they must be more vigilant while deciding where to allocate their finance.”
There is also a need to articulate a national financial strategy, looking both to the near-term and the future. Choice of the strategy and sequencing of its elements should be based on prior detailed analysis of the financial landscape that prevails in the country, and proper forecasting of the macro-economic growth both in the short-run and long term, according to the report by EEA.
The present dearth of formal financial institutions and underdeveloped infrastructure in Ethiopia makes the use of debt and credit transfer payment instruments difficult. In the absence of checks and electronic payments in rural Ethiopia, cash is the most used payment instrument. Although the situation is expected to expand with time, adopting the new system could still be difficult given the high level of illiteracy and unreliable electric and telecom services in rural areas. So, these issues must be addressed to deliver innovative financial services to the rural population.
Private bankers in the country are hopeful that NBE in consultation with the bankers association will do something to sort out the liquidity problem in the sector and ease the burden in the sector. The macro economist agrees, “Some of the directives must be revised.” (Officials from the Bankers association were not willing to respond to this issue despite EBR’s repeated effort).
The new foreign exchange directive to be issued soon by NBE is expected to ease some of the restrictions in the area. This will be taken as a litmus test for what direction the government will take regarding the sector. EBR
2nd Year • January 2014 • No 11