The future of banking in Ethiopia

Telecoms will lead the Charge, Can Banks Keep Up?

Although commercial banks in Ethiopia introduced a digital payment system some time ago, it has made considerable strides over the past few years as telecom operators with far more customer base than banks were allowed to provide the services. The expansion of the digital payment system has been challenging banks at the trial level, as it involves payment services and small credits. Commercial banks have come to a common understanding that they have already lost the retail aspect of their operations to telecoms.

Previously, the absence of a conducive environment, including regulatory restrictions, limited telecom infrastructure, low digital connectivity rates among the general population, high costs of network access, and absence of competition in the telecom sector, has undermined the development of digital payment services.

As part of Ethiopia’s financial reform package, the NBE issued two directives a few years ago to deal with payment operators and issuers of payment instruments. The former directive allowed nonfinancial institutions to run a digital payment system, such as running a national switch, a switch ATMs, etc. The latter directive enabled nonfinancial institutions to issue payment instruments, including cash deposits and payments, domestic payments, local transfers, loading and transferring to card or bank account, inward remittances, etc. Partnering with a financial institution, a nonfinancial institution payment instrument issuer can also provide micro-saving and micro-credit services.

The reform of payment instrument issuers was a watershed moment. Ethio-Telecom entered this line of business with Telebirr with the entire drive. Since its launch on 11 May 2021, over 40 million users have opened accounts on Telebirr. This large customer base has made it one of the largest financial operators in the country. Small private payment instrument issuers (fintech companies) have also joined the business, while M-pesa, issued by Safaricom, joined the sector later and took digital payment to the next level. M-Pesa’s late entry was due to regulatory restrictions, which allowed Telebirr to be ahead of the competition as it expanded its reach well in advance.

Regulatory reforms, improved telecom connectivity, falling costs, and owning more smartphones have improved the ecosystem for expanding digital financial services. Notably, the entrance of telecom operators in digital financial services has transformed digital financial services because of the massive customer base they have built for over a century.  Due to their sheer size, technological capability, simplicity of services, and outreach, they quickly emerged as major players in the digital payment ecosystem. What is remarkable is that nonfinancial institution digital payment issuers have immensely contributed to financial inclusion. Based brick-and-mortar banks have faced a formidable challenge in this branch due to its high investment, operational cost, and sluggish pace.

Nonfinancial institution digital payment issuers have become formidable competitors in certain lines of financial services. They even perform better compared to commercial banks in certain aspects. However, this should differ from the conclusion that they are direct competitors to financial institutions, particularly banks, as the digital payment system still relies on the banking system. The banking system is the custodian of the fund of payment instrument issuers. While banks create credits based on a fractional reserve system, digital payment instrument issuers serve as a payment platform for the means of payment made by the banking system. Notably, the amount of funds payment instrument issuers can handle is regulatorily caped. For instance, they don’t process payments above a certain threshold.

The digital payment system has implications for the financial system. It increases the movement of funds within the banking system and the velocity of money in the economy. The first issue has implications for bank liquidity management, and the latter might have monetary policy implications.

Despite the strides, demand, supply, and regulatory factors constrain the digital payment system. Supply-side factors such as the structure of the telecom and banking industries have significant constraining elements, as the telecom sector is dominated by Ethio Telecom and the banking industry by the Commercial Bank of Ethiopia (CBE).

Although Safaricom recently joined the telecom sector, Ethio Telecom is still the leading actor in the industry because of its century-old built capabilities. This has made the industry less competitive. Similarly, the structure of the banking industry has its fair share in constraining the growth of the digital payment system. The state-owned CBE, with a market share of more than 50 per cent, is the most significant factor in the banking industry. The CBE’s considerable market power coupled with the range of unique privileges (such as a collection of utility payments and as a main, if not a sole, payment channel for state-owned enterprises and the government) has created an unlevelled landscape for competition. As a country still working to exit from a Marxian model of government operations, such tendency of putting regulatory restrictions intentionally or further by extended interpretation of the same policy on private enterprises and uncalled-for favours to state-owned enterprises is still evident. The effect of such imbalances has created unlevelled domestic competition. Correcting it is very necessary before even opening the economy to foreign competition.

Equally important is the role of interoperability. In Ethiopia, limited interoperability across different platforms hampers competition, fosters duplication of services, increases costs, and makes service delivery less efficient.

Demand side factors such as relatively lower mobile and internet subscribers (though the figure shows massive expansions in recent years) hampers the growth of digital payment systems. Using four main variables, availability, affordability, relevance, and readiness to access, the annual Inclusive Internet Index, published by the Economist Impact, covers 100 countries, ranking Ethiopia between 91 and 95 over 2022-2017. These figures are much lower than Kenya’s (58-63 during the same period). Similarly, low mobile phone penetration and higher tariffs in Ethiopia are other significant demand-side constraints that still make the overall situation less favourable for digital banking. While the fact remains so, the progress and scale at which change is happening in the sector is massive and highly promising that the country could catch up with its African peers very soon.

Enhancing the digital payment system requires fostering competition, significant infrastructure investment, interoperability across platforms, increased access points and lower tariffs, better regulation, a digital national ID system, personal data protection laws, better cybersecurity, etc.

The Ethiopian financial landscape is undergoing a seismic shift. With their massive customer base, telecom operators are emerging as dominant players in the digital payment arena, challenging banks’ traditional role. While this might seem like a zero-sum game, the future of banking in Ethiopia hinges on collaboration between these seemingly disparate players.

Banks possess a crucial advantage: they are the custodians of financial resources. Telecom operators, on the other hand, excel at providing user-friendly payment platforms. By embracing this complementary nature, both entities can thrive. Banks can offload the costly burden of retail services, like essential payments and micro-loans, to telecom operators. This frees them to focus on core competencies like wealth management, investment banking, and more oversized loan products.

The telecom-led digital payment boom also allows banks to shed the outdated model of branch expansion. These physical locations are expensive to maintain and call for alternative solutions to be more efficient for basic transactions. By partnering with telecom operators, banks can leverage their extensive mobile networks for broader customer reach at a fraction of the cost. This allows banks to redeploy resources towards innovation and improving customer experience within their core service areas.

This collaborative approach, however, hinges on a robust regulatory framework. The Ethiopian government must ensure a level playing field by addressing the dominance of state-owned institutions in the banking and telecom sectors. Fostering competition among private players will enhance service quality and drive down consumer costs.

The future of Ethiopian banking is not about banks versus telecom operators but rather about banks with telecom operators. By embracing collaboration, both entities can unlock the true potential of digital financial services, propelling Ethiopia towards a more inclusive and efficient financial system. This, in turn, will empower citizens and businesses, ultimately fueling the nation’s economic growth.

12th Year • June 2024 • No. 130