Revisiting Policy Banking in Ethiopia

Although development banks have existed since the imperial era, there has not been a time where they played as significant a role as in the past fifteen years. The developmental state paradigm, which was adopted since the mid-2000s, has given renewed impetus for development banking.

The economic policy that envisages fast-track industrialization has developed successive industrial policies. Credit policy has been the lynchpin of the industrial policies. As a result, both state-owned banks, the Commercial Bank of Ethiopia (CBE) and the Development Bank of Ethiopia (DBE) have emerged as major policy instruments.

CBE, as a depositary institution, was established with the objective of providing commercial loans, but it has been involved in massive long-term lending, exposing the bank to huge credit risks and maturity mismatch.

DBE has been hit by soaring non-performing loans (NPL) for the past few years. Even though there are signs of a reduction in NPL levels and improvements in the profits of DBE in the past half-year, the size of its NPL is still huge, hovering around 34Pct, more than twice the level recommended for developmental financial institutions. More than 90Pct come from manufacturing and agricultural loans.  The loans of few top borrowers not only turned to NPLs but also accounted for the majority of NPLs.

Moreover, the CAMEL Rating Report, a regulatory framework that evaluates five major operational and financial aspects of banks, issued by the National Bank of Ethiopia (NBE) for the year ended 31 December 2018 underlined that DBE was not only in serious trouble but also in a worsened condition from the preceding year. The quality of its assets tapered, the size of its capital waned, and its losses worsened. If not for the huge liquid resources that were collected from private banks channelled by NBE for industrial and agricultural loans, DBE would have been on the brink of collapse. DBE’s problem was compounded by the lack of adequate oversight by the bank’s board and management and its failure to finalize and submit to risk management programs.

Agricultural borrowers are also riddled with many problems. Apart from constituting the bank’s NPL, the whereabouts of a large number of borrowers is not known. Lease financing, which was started without adequate study, is facing serious hurdles. Recovering more than ETB4 billion advanced to acquire various machineries is getting difficult, and is posing further serious threat to the sustainability of the scheme. Due to the lack of market and non-repayment of lease financing, several of the offices, which have opened for this purpose, are closing.

Several factors could cause a loan to non-perform. Leniency in lending, breach of lending procedures, and unpleasant political and economic situations are major causes. The large number of NPLs of a policy bank makes us question the industrial and agricultural credit policy of the government.

The Ethiopian state-defined economic development model attempted to create a pro-development financial system where credits were allocated according to the state’s priority. This credit policy was conceived to tackle market failures in credit allocation but proved itself to be the pinnacle of government failures. The pitfall of the policy was that it was too ambitious and lacked good governance structure with adequate controlling mechanisms.

Politicians, rather than economic rationale, hugely influence the decision making of the policy banks. Political intervention, overwhelming focus on development, and corruption within DBE has compromised prudential lending and undermined the performance of the bank.

Currently, economic reforms inclusive of the financial sector are underway. Yet the role of state-owned banks within the new economic paradigm has not been made clear. Moreover, the source of funding for DBE has been curtailed as the reform has lifted the requirement of private banks investing 27Pct of their gross loan disbursements for DBE’s operations.

The government should take serious lessons from the failures of policy banking and undertake appropriate reforms within the context of the prevailing economic system. This includes the redefinition of the bank’s roles, their governance structures, and sources of funding.

The major role of Ethiopian policy banks is supporting development. Pro-developmental financial systems should be realistic and not wasteful. When policy banks have clear mandates, they would be better able to play their developmental role. The mandate should identify the market policy in which banks step into, their source of funding  and governance structure, as well as have a policy for capacity building.

The intervention of policy banks should be limited to areas neglected by the private sector and also have positive externalities. Serving this market should not compromise their financial sustainability, and extra care should also be taken to make sure that the intervention is not distortionary. Securing the right type of as well as sustainable funding, particularly for DBE, is very crucial as its funding source has been curtailed.

The biggest challenge for policy banks is political intervention. The setting of clear objectives and an appropriate timeframe for performance evaluation, clear demarcation of rights and responsibilities of various stakeholders, less political intervention, and robust governance structures can alleviate this problem.

Capable policy banks can result in development. For this, building capacity in the sphere of project evaluation and monitoring, credit risk assessment, and technical skills is essential.

9th Year • Mar.16 – Apr.15 2020 • No. 84