Survival of the Fittest

Will Capital Regulation Weed out Ethiopia’s Young Banks?

In the business world, a merger refers to the joining of two companies into one entity. The concept has made headlines recently because the two state-owned banks – the Commercial Bank of Ethiopia and the Construction and Business Bank – ‘merged’ in December 2015. Advocates of mergers say they provide a number of benefits to the financial sector, not least of which is weeding out young banks, thereby strengthening the overall sector. Others, however, think that the concept may be too cumbersome for Ethiopia’s nascent private banking industry, which they say needs more time to mature. EBR’s Fasika Tadesse spoke with banking leaders and experts to get a better grasp of the concept and its potential role in Ethiopia’s fledging but promising private banking sector.

Although mergers are common in developed nations’ financial sectors – with the aim of reaping the benefits of economies of scale and minimising competition – it has no significant presence in Ethiopia.
The history of mergers in Ethiopia’s financial sector is fairly recent. In 1980, the Ethiopian government merged Addis Bank and the Commercial Bank of Ethiopia to form what is now the Commercial Bank of Ethiopia (CBE). Prior to that, Addis Bank was created from the merger of Addis Ababa Bank, Banco di Roma and Banco di Napoli, two Italian banks that operated during the imperial regime, which were all nationalised by the Dergue regime in 1975.
Before the 1980 amalgamation, few financial institutions merged. For instance, the Ethiopian Investment and Savings merged with the Ethiopian Government Savings and Mortgage Company to form the then Housing and Savings Bank, which later became the Construction and Business Bank (CBB) in 1975.
More than a decade ago, another merger took place – this time in the insurance sector, which occurred after the merging of United Insurance Company (UNIC) with Lion Insurance Company in 2002.
More recently, in December 2015, the Government Financial Enterprises Agency announced the merger of the two state-owned banks: CBB and CBE. According to the Agency, the move was intended to create one giant bank that would be competitive in Africa and worldwide. However, industry insiders claim that the merger was a way to help CBB, which wasn’t performing so well in Ethiopia’s competitive banking industry.
Mergers occur when two firms join together to form one institution; the resulting entity usually enjoys a more dominant position in the sector, achieves economies of scale, and garners a larger market share. In the banking sector, mergers have the capacity to ensure efficiency, profitability and synergy. It also helps to form and grow shareholder value.
In an effort to strengthen the financial sector, the National Bank of Ethiopia (NBE) is developing a legal framework that will increase the minimum paid-up capital of all private banks to ETB2 billion by the end of the second phase of the Growth and Transformation Plan (GTP II) in June 2020. That figure represents a threefold increase from the current minimum requirement of ETB500 million in paid-up capital.
To alert the banks and allow them time to prepare, the central bank notified them of its intention well before the new regulation will be enforced. “We recognised the current ETB500 million paid-up capital limit is not enough for banks, as they are disbursing a huge amount of loans, which should be backed by strong capital. Therefore, we decided to increase it,” said Teklewolde Atnafu, Governor of the NBE, during a two-day meeting with executives of financial institutions in November 2015.
Many private banks already have a paid-up capital of in excess of the required amount – and some are even close to the ETB2 billion mark.
However, a few banks had a paid-up capital below the ETB500 million minimum one year before the deadline, which is in June 2016. These banks are Addis International Bank (AdIB), Enat Bank, and Debub Global Bank (DGB). As of June 30, 2015, these banks had a paid-up capital of ETB366 million, ETB384 million and ETB198 million, respectively.
Government officials say increasing the paid-up capital minimum of banks will ultimately strengthen Ethiopia’s financial sector. “Since the country’s economy is growing very fast, the capital of the banks needs to grow massively, and having 50 or 60 banks means nothing if they are not strong,” said Teklewolde. “I prefer to have not 19 [weak banks] but rather 5-6 banks that are very strong in capital and human resource.”
According to Teklewolde, the experience of some African countries demonstrates that escalating the paid-up capital limit is a mechanism to whittle down the number of banks to a few strong institutions. This, in turn, will enable the remaining banks to have well-trained employees and strong capital that will help them be competitive with foreign banks.
Figures from the Central Bank of Nigeria show that after successive minimum paid-up capital requirement increments, the number of distressed and weak banks declined dramatically.
The total number of banks in Nigeria was 115 in 1995, while the number of distressed banks – which refers to banks that are unable to meet their financial obligations to their customers – stood at 60 that same year. By 1997, after an increase in the minimum paid-up capital requirement, the number of distressed banks decreased to 47. At the end of 2002, that was reduced to 13 and dropped again to 10 shortly after the 2004 banking consolidation.
One way struggling banks cope with increases in the minimum paid-up capital is by merging with larger ones in order to benefit from the consolidation of assets and resources.
But AdIB, one of the private banks in Ethiopia with a paid-up capital of less than ETB500 million, is not considering mergers in order to reach the new limit that the government set. According to Hailu Alemu, the Bank’s president, the company is looking towards an alternative to meeting the demands of the new regulation: “We are working to raise our capital by floating shares to the general public.”
AdIB became operational on May 30, 2011, with a paid-up capital of ETB106.3 million. By the next year, the Bank managed to increase its paid-up capital to ETB 194.5 million and ETB261.6 million during the 2013/14 fiscal year. As of June 30, 2015, the Bank’s paid-up capital reached ETB366 million, representing a nearly 40Pct increase from the preceding year.
According to Hailu, as of December 2015 AdIB attained a paid-up capital of ETB410 million and it will be easy for them to reach the stated amount within the next five years. The Bank acquired an after-tax profit of ETB58.6 million during the 2014/15 fiscal year.
Still, not every bank executive is reluctant to consider mergers: Tadesse Kassa, Board Chairman of Abay Bank, seems open to the idea should it prove to be the best option. “We do not have a closed policy towards mergers and we do not say we will not merge with any banks, but it depends on the situation, such as the legal framework and enabling environment [that may come] in the future,” he told EBR.
Indeed, the experience of Nigeria demonstrates that mergers can bring about benefits when it becomes one component of a total reform framework that ensures efficiency in the banking sector. According to a 2012 study entitled “Bank Recapitalisation in Nigeria: Resuscitating Liquidity or Forestalling Distress?” the relationship between increases in the minimum paid-up capital requirement and strength of banks is insignificant.
Rather, the study recommends that capital regulation should be one component of a total reform framework to ensure effectiveness. These include stricter enforcement of quality corporate governance principles, zero tolerance on misreporting and infractions, strengthening risk management systems in the banks and risk-based supervision.
Yet local experts stress that Ethiopia has a long way to go before mergers become commonplace. “We can say the practice of merger is non-existent in Ethiopia,” argues Tsegabrihan Woldegiorgis, a lecturer of economics at Addis Ababa University. “We cannot even call the recent amalgamation of CBB and CBE a merger, because for a merger to occur the two parties should have different owners and the same negotiating capacity.”
Still, Tsegabrihan says that mergers have a lot of advantages, including economies of scale, the increased ability to compete on an international level, increasing accessibility, having greater investment for research and development, and greater efficiency. “All these advantages come when a given institution’s capital increases through the process of a merger,” he explains.
Realising these potential benefits, Tadesse of Abay Bank says that while his institution would consider a merger, it is not their first option: “Our main strategy is to raise our paid-up capital, but in the process when things happen we will consider it accordingly.”
Abay Bank became operational in November 2009 and was established with a paid-up capital of ETB125.8 million and it increased its capital to ETB157.8 million the following year. It also managed to increase its paid-up capital to ETB239 million, ETB376 million and ETB550.8 million in the 2012/13, 2013/14 and 2014/15 fiscal years, respectively. Last fiscal year, Abay earned an after-tax profit of ETB125.5 million.
On the other hand, some bank executives believe now is not the time to think about mergers. “It is too early to consider a merger, as we believe we can raise our capital since we have financially strong shareholders. We believe we can transfer our profits to the capital,” says Adissu Habba, President of DGB and President of the Ethiopian Bankers Association.
Adissu’s bank became operational in 2012, with a paid-up capital of ETB127.5 million. During the 2013/14 fiscal year, the paid-up capital of DGB reached ETB177 million and ETB198 million as of June 30, 2015. It also obtained an after-tax profit of ETB17.2 million during the 2014/15 fiscal year.
“After we got the green light from shareholders during the 2013/14 fiscal year’s general assembly meeting, we already floated shares worth ETB1 billion and we are campaigning to sell the shares with the main target of reaching ETB400 million by the end of June 2016 and ETB1 billion by 2017,” says Adissu. As of December 31, 2015 the paid-up capital of DGB reached ETB240 million.
“But If we cannot achieve [our goal] to raise our capital, we can consider a merger as plan B in the future,” Adissu adds.
Unlike Addisu, Wondwossen Teshome, President of Enat Bank, says a merger is not an option. “The promoters of the Bank are women who are very determined and circumvent the concept of merging with other banks,” he says.
Enat is the country’s newest bank, which began operations as the 16th private bank on March 5, 2013, with ETB120 million in paid-up capital. According to its 2014/15 annual report, it managed to expand its paid-up capital to ETB383.8 million from ETB261.6 million in the 2013/14 fiscal year. Although it’s a latecomer, the Bank managed to earn an after-tax profit of ETB53.1 million during the 2014/15 fiscal year, which was its second full fiscal year in business.
Still, Wondwossen believes that reaching ETB2 billion in paid-up capital within five years will be difficult for Enat Bank. “Our share capital structure is very small; we have more than 11,500 shareholders and over 90Pct of them have shares less than ETB100,000. So we planned to approach shareholders that have good financial capacity and are planning to do it skilfully, by giving the assignment to the Board of Directors,” he explains.
Addisu of DGB, however, thinks that mergers in Ethiopia may prove fruitful if done correctly. “Mergers need preparation and we will see the experience of the recent merger by the CBB and CBE. So it will remain to be seen and it could be a chance for the private banks to draw lessons from it,” he explains.
But Wondwossen, who is motivated by pragmatic concerns, says the way banks have been established; their backgrounds; and the individual and collective attitudes of their management, board of directors and shareholders may hinder these banks from subscribing to the idea of mergers, which is more palatable now than at any other time since the partial liberalisation of the sector in 1994: “As we know, the Ethiopian banking sector is owned by shareholders from the same ethnicity, religion and gender groups. We can find two banks from the same area but it will be very difficult to merge them, as they established two different banks because they had differences at some point.” EBR