Managing the COVID-19 Crisis in the Banking Industry
Following the spread of COVID-19, the Ethiopian government has taken a large number of prevention and containment measures since mid-March 2020. The economic impacts of these measures are considerable. According to the International Monetary Fund (IMF), Ethiopia’s GDP growth will decline to 3.2Pct from a previously projected 6.2Pct.The impacts on air transport, hospitality, tourism, export, remittance, and foreign direct investment (FDI) are glaringly visible. The overall balance of payments is predicted to widen, resulting in an additional financing gap of USD 1.7 billion. The government is implementing several packages to contain the adverse health, economic and social impacts of the pandemic: a 300-million-birr scheme to support the healthcare system; tax exemptions and deferrals, priority access to forex for imports of items that will be used for prevention and containment of COVID-19 and a multi-sector emergency package of USD 1.6 billion are the major ones.
The banking industry, which has not recovered from the liquidity problem since November 2019, is facing the economic maladies from the outbreak. There has never been as tough a time as this year for Ethiopian banks as they have to deal with the brunt of a major economic problem which could have calamitous effects. In spite of the fact that a serious threat is posed to the financial sector, the way the NBE is dealing with the problems lacks coherence and foresight. Addressing the current problem requires extraordinary wisdom, foresight, attention to every development, communication and coordinated actions.
The banking industry is facing a systematic risk that does not spare a single bank. The major risk is the deterioration of loan quality, liquidity crunch and reduction of revenues from international banking operation. The worsening economic situation drives a large number of borrowers particularly in the sectors that are hit hard by the economic impacts of COVID-19 into financial trouble. Borrowers in a dire financial situation will not be able to service their loan repayments.
The building up of arrears affects the cash flows of banks, lowers the quality of loans and escalates the probability of default. Decreased loan quality forces banks to maintain higher provision for loans impairment, resulting in lower profits. The deteriorating economic situation will have lasting impact on borrowers. Apart from the economic havoc their businesses have to endure, their loan repayment history will be tainted. That, in turn, makes borrowing difficult in the future as their credit records are maintained with the NBE.
The National Bank of Ethiopia (NBE), as a lender of last resort, stepped in as a pre-emptive measure to keep the financial sector afloat. It advanced ETB15 billion to private banks for 15 months and ETB16 billion to the Commercial Bank of Ethiopia (CBE) for three years at eight percent interest rate per annum. Moreover, the NBE decided to use its discount window for expanding working capital credits to sectors largely affected by COVID-19, particularly hotels and tourism, at an interest rate of five percent per annum. DBE’s capital has also been beefed up to ETB28.5 billion from ETB7.5 billion.
Injecting liquidity has its own costs that go along with its benefits. Injecting liquidity into the banking system keeps banks afloat even though borrowers do not pay their debts according to the terms of the loans. However, the injection of more money to maintain the stability of the financial sector will expand reserve money, which will result in higher than expected inflation if additional liquidity is used for expanding loans and advances. It is essential to make sure that funds are used for maintaining the liquidity of the financial system, and plans should be in place to withdraw the money injected.
There is absurdity with regard to the money injected to the CBE. It was loaned at eight percent per annum, repayable in three years while private banks obtained the fund for 15 months at a competitive rate of 13Pct. This measure is not only unfair but also does not seem to address the short-term liquidity problem of the CBE. It seems implicitly supporting of the state bank solvency as the CBE has structural problems due to over exposure to few SOEs and high loan to deposits ratio.
As things began to unfold, the CBE demanded additional ETB17 billion from the Ministry of Finance as it has been drained by over exposure to few SOEs. This reveals that the economic impacts of Covid-19 seem harsher on CBE due to the mix of its loan portfolio, maturity mismatch (long-term loans financed by short term savings) and over lending. The trouble is that the shaky financial standing of the state bank has pernicious spill over effect on the entire banking system as it is very big. Tackling the problems of the CBE requires a serious financial restructuring rather than fire fighting. This can include increasing its capital, reducing its exposure to few enterprises, designing means to increase long-term deposits and expanding short-term loans.
The NBE suspended certain provisions related to assets classifications of banks, foreclosures, and credit records of borrowers to help both the banks and the borrowers. This means the rules for computation of non-performing loans (NPLs) and provision for assets impairment are not applicable for a while so that the financial performance and position would be presented in a better light. Such measures would only work provided that the borrowers survive the economic havoc caused by the pandemic.
Otherwise, the financial reports which do not take economic impacts of COVID-19 into account will window dress the problem. Window dressing cannot change the reality. It will rather postpone the day of reckoning as, at some point, borrowers will have to repay their debts and those that are severely hit by the economic catastrophe of COVID-19 will surely default. Hence, the banks will end up carrying massive bad loans that need a huge provision for losses. Even though the NBE rules pertaining to NPL and provisions for loan impairment are lifted, the banks should consider maintaining a realistic provision for prudential reason. This will serve them as a buffer against possible bad loans if borrowers struggle to repay their loans at some point.
Recent developments also show that the NBE has gone as far as setting a daily and monthly limit on the amount of money that can be withdrawn from banks based on a questionable claim of fighting unlawful transactions. The fact of the matter is protecting the banking system from money drain. This idea was suggested by private banks few months back when they were seriously hit by liquidity problem. The drawback of this action is that it slows down economic activities as the economy is predominantly cash based. The confusions and worries the measure causes is also very considerable. Lifting this requirement as early as possible is essential as the banking system functions based on trust and confidence.
The banking industry is cruising through a time of high economic uncertainty. A large number of borrowers are demanding interest waiver, rates reduction and repayment rescheduling. The industry can cope up with this tough time if it has enough liquidity and strong capital, and work with borrowers and the NBE. Interest rate reductions, penalties and fees waiver, and loan rescheduling are laudable moves. The banks need cutting loan disbursements, holding adequate capital, slowing down expansion, postponing dividend payments, and adequate communication with borrowers and depositors to survive the most difficult time in their history.
The COVID experience should give a lesson that the whole financial sector could face a serious risk. A new paradigm of financial sector regulation should be considered as several countries instituted macroprudential regulation in the aftermath of the last global financial crisis. We need a regulatory approach that incorporates both micro and macro regulations. The macroprudential regulations proactively identify risks and vulnerabilities and enable the financial sector to be resilient to systematic shocks, both endogenous and exogenous.
9th Year • Jun.16 – July.15 2020 • No. 87