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New Foreclosure Rules Leave Bankers on Edge

The administration of Abiy Ahmed (Ph.D.), has been undertaking wide-ranging legal reforms as part of its pledged economic liberalization and modernization process. Legislation has been devised or amended to regulate exchange rates, interest rates, demonetization, transaction limits, a loan freeze, and capital thresholds, among others, over the past couple of years. Among the reforms was also a revision of the half-a-century-old Commercial Code that many saw as overdue. However, changes to foreclosure laws in the new Code have left banking executives uneasy, writes EBR’s Bamlak Fekadu.

Over the last four years, the National Bank of Ethiopia (NBE) has been embarking on various policy issues aiming to address bottlenecks and lingering problems in the financial sector,” Governor Yinager Dessie (Ph.D.), said in a meeting with bank presidents at the Hilton Hotel on August 8, 2022.

The Governor was referring to a slew of proclamations, directives, and other legal instruments issued and amended in the recent past as part of efforts to regulate exchange rates, interest rates, and demonetization under the administration of Prime Minister Abiy Ahmed (Ph.D.).

The last few years have seen the central bank introduce transaction limits, freeze loans, double banks’ capital thresholds, and issue a record number of banking licenses. The financial sector has also been beholden to the introduction of a new Commercial Code in March 2021, replacing the Commercial Code of the Empire of Ethiopia Proclamation No. 166/1960 that governed business operations since 1960.

Though the revised Code offers new opportunities, one clause seems to have left a bad taste in the mouths of banking executives.

Article 3 of the 1998 foreclosure regulation authorizes creditor banks with whom a property has been mortgaged or pledged and whose claim is not paid within the due date as stated in the contract, to sell the property through auction, giving a prior notice of at least 30 days to the mortgagor and a binding transfer of property ownership to the new buyer. Similarly, Article 4 of the same proclamation allows creditor banks to sell the property by auction after giving the debtor at least 30 days’ notice and transferring ownership to the new buyer, or if no interested buyer appears, the bank has the right to transfer ownership to itself, as stated even before the proclamation’s effective date that year. However, it was amended in proclamation 216/2000 by corrigenda both to articles 3 and 4 of 1998, replacing the phrase “if no buyer appears at the second auction, it may acquire the property at the floor price set for the first auction and have the ownership of the property transferred to it” with addition after the word “buyer.”

Likewise, a regulation ratified by the former president of Ethiopia, Negasso Gidada (PhD), on Article 9 stated any suit or decree on execution pending before a court prior to the coming into force of this proclamation may be terminated upon application by the creditor bank with which the property has been mortgaged or pledged, and the bank may sell and transfer the property to the buyer in accordance with this proclamation.

Bankers are expressing distress over changes in the new Commercial Code, arguing they will present challenges if and when issues with foreclosure arise. The revised Code grants debtors the right to appeal to courts to prevent their mortgaged properties from immediate foreclosure.

The Code stipulates that the supervisory judge may exclude other claims from the scope of general stays when the debtor is not in possession of encumbered assets, individual enforcement actions are less likely to jeopardize the restructuring of the business, or when one or more creditors would be unfairly prejudiced by a general stay of individual enforcement actions, according to sub-article 5.

Still, the changes have been alarming to banking executives.

Abie Sano serves as the president of the state-owned Commercial Bank of Ethiopia (CBE) and heads the Ethiopian Bankers Association. He argues that the new Commercial Code is vague when it comes to foreclosure although the proclamation was initially intended to smooth out credit schemes and processes.

“Properties are frozen by the court when banks proceed to foreclosure; this will be a challenge for the sector and the nation as a whole,” noted Abie. His bank reported ETB 1.2 trillion at the end of the last financial year, up from ETB 991.3 billion the year before.

The CBE managed ETB 27.5 billion in profits last year, surpassing its executives’ forecasts by over 16 Pct and its previous performance by 43.9 Pct. It operates with over 1,800 branches and boasts close to 36 million deposit accounts, five million of which are signed up under its interest-free banking services. The CBE has mobilized ETB 890 billion in deposits, up 21 Pct from June 2021.

Daniel Fikadu, an attorney specializing in business law, argues the new provisions exist to reorganize business institutions and enforce debt payment rather than deprive banks of their rights. The lawyer says the new rules help cover up shortcomings in previous foreclosure procedures.

“As a provision behind the Commercial Code, it aimed to protect banks from embarrassment when repossessing their resources,” Daniel explained to EBR. “But it didn’t do much to help the borrower to rehabilitate, make money, and become more profitable.”

Daniel observes the revised Code introduces better opportunities for making bad debts good, such as preventive restructuring, reorganization bankruptcy, and discharge, most of which, but not all, are new to Ethiopian law.

One of the major components of a bank’s assets is loans and advances. Failure to manage loans, which make up the lion’s share of a bank’s assets, would likely lead to the occurrence of high levels of non-performing loans. In this regard, the NBE set the threshold at five percent in 2011.

Ethiopian banks have used various methods to recover non-performing loans, such as settlement, which involves both the lender and the borrower in a negotiation to settle through cash collection.

The expert also emphasizes a rescheduling or renewal method, which is used whenever a bank believes that the NPLs can be regularized on favorable terms and conditions through negotiation (term loans) and renewals (overdrafts). This is not without limitations. National Bank Directive No. SBB/43/2008 states a bank shall not reschedule, restructure, or negotiate a short or medium-term loan to a borrower for more than three periods. Before rescheduling, restructuring, or renegotiating a short or medium-term loan, a bank shall collect in cash the full amount of interest thereon and the following principal amounts a minimum of 25 Pct outstanding principal balance in case of rescheduling, restructuring, or renegotiating for the second time: a minimum of 50 Pct of outstanding principal balance in case of rescheduling, restructuring, or renegotiating for the third time.

“These provisions offer a favorable scene for both the creditor to collect the debts and the debtor, avoiding damage to the economic well-being of the business ecosystem and the country,” Daniel argues.

Debtors, on the other hand, see many internal and external factors that might push them to default on their loans. Kiya Seyoum, who works in import and export, has seen the private sector caught between a rock and a hard place for years.

“Among them are the global supply chain disruption, the forex crunch followed by bank failure to process payments of letters of credit and LC permits, and country-wide instability,” Kiya said.

The central bank, on the other hand, has an entire economic ecosystem to protect. It emphasizes that it will never revise the 70 Pct hard currency surrender directive unless the global situation and inflow disbursement show improvement, yet the continually decreasing reserve of banks is paralyzing the private sector, and the inability of the commercial banks to settle LCs remains a headache affecting vendor relations.

“I think medicating the bankrupted customers would be better as boosting the private sector matches the ruling agenda,” says Kiya, “while the government has formed an organization to rehabilitate state-owned enterprises that have done major damage to the country’s economy.”

Amid the introduction of wide-ranging legal reforms as part of the economic liberalization and modernization process, the emergence of publicly held share companies and the rise in the number of shareholders’ demands for responsible corporate management were some of the factors that necessitated the revision of the Commercial Code.

Currently, the central bank is working with the Ethiopian Bankers Association to identify projects and loans caught up in the war in northern Ethiopia and considering taking bankers’ NPLs in Tigray off the balance sheets.

The Development Bank of Ethiopia’s (DBE) loss in the Tigray war of around ETB 10 billion in NPLs is the largest among the leading banks, followed by Wegagen Bank with ETB 2.9 billion and the CBE with around ETB 2 billion.

In order to help commercial banks manage their way out of bad loan records, Governor Yinager Dessie vowed that the foreclosure difficulties will be resolved with the involvement of appropriate administrative bodies..EBR

11th Year • Nov 2022 • No. 112

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