The Loan Is Denied

Despite Excess Liquidity, Banks are Disbursing Less Credit

Following the replacement of currency notes, the banking industry’s liquidity level grew six-fold compared to the previous year. Close to ETB45 billion of fresh savings entered the banking system, while 2.5 million new saving accounts were opened. Despite surplus liquidity, commercial banks are not disbursing credit as per their capacity. Some attribute this to the political violence and instability in Ethiopia in the past five years, which has diminished the appetite of credit seekers. Others claim banks are currently holding back from giving loans because economic and business activities are slowing down and default rates are increasing. EBR’s Ashenafi Endale explores.

Desalegn Tolera, is a Credit Analysis and Portfolio Management Officer at Awash Bank (AB). Over the past decade, he witnessed the joyful days of the banking industry where liquidity levels peaked and huge amounts of credit were disbursed. Desalegn also remembers the darkest moments where the vaults dried up and banks suffered from a liquidity crunch, which ultimately shrank the amount of credit they disbursed.

However, he has not come across such a contractionary situation as currently observed in the banking industry. Due to the replacement of currency notes, the liquidity level of the industry has improved six-fold since September 2020. Close to ETB45 billion in fresh savings and 2.5 million new saving accounts were welcomed by banks.

“During the demonetization period, a minimum of ETB500 million in savings came to AB, on a daily basis,” explains Desalegn. “This boosted the bank’s deposits immensely.”

Banks are now more liquid than ever, but the amount of credit they are disbursing is relatively small. “Almost all banks are currently refraining from giving loans, especially as of November,” says Desalegn. “Banks are currently disbursing loans to only a few sectors.”

Such a surprising turn of events is witnessed in all commercial banks operating in Ethiopia. Although industry players agree with the fact that the amount of credit disbursed by the banking industry is now relatively small compared with previous times, they are divided on the factors that led to this situation.

Some argue the demand for credit has been gradually declining after the country was submerged in political violence and instability for the past five years. “Due to the instability across the country, loan applications submitted to banks have declined,” argues Muluneh Aboyah, Vice President of credit management at the Commercial Bank of Ethiopia (CBE).

The decline of demand for credit gained momentum following the spread of COVID-19 in March 2020. During this time, commercial banks had very little loanable funds and they were under a severe liquidity crunch resultant to close to two-thirds of the total currency circulating in the country being outside the banking system. Similarly, savings fell to ETB21.1 billion during the third quarter of 2019/20, from ETB25 billion during the previous fiscal year’s corresponding period, according to the annual report of the National Bank of Ethiopia (NBE). These factors forced the central bank to inject capital into commercial banks to bailout them from the liquidity crisis .

A senior manager at Abay Bank contends the demand for loans declined because business people that required funds for operations and investment were anxious to invest due to COVID-19 and the violence in different parts of the country. Muluneh says even credit to cover operational costs drastically declined after COVID-19. “The demand for credit from the hotel and tourism sector shrank drastically,” explains the Vice President.

During the fourth quarter that ended June 2020, total disbursed loans by commercial banks declined to ETB63.7 billion, down from ETB99.1 billion in the third quarter. The amount is also 15Pct lower than the amount disbursed during the same quarter of the previous fiscal year, according to NBE.

But saving rates and liquidity levels of banks started to improve after the government decided to change currency notes on September 14, 2020. “Savings increased after the demonetization, especially for banks with a larger branch network,” Dereje Zebene, President of Zemen Bank, informs.

During the first quarter of 2020/21, savings increased by 600Pct compared with the same period of the previous fiscal year. Close to 2.5 million new saving accounts were opened between September 14 and November 20, 2020, according to Solomon Desta, Vice Governor of NBE, while ETB45 billion in fresh savings came into the banking system in two months’ time. This exponentially improved banks’ liquidity by six-fold during the first quarter of the current fiscal year, compared to the same quarter last year.

However, some banks could hardly find credit takers, even with their super-liquid stance. “Currently, banks have surplus liquidity but the demand for credit is almost nonexistent,” says Alazar Dessie, Financial Consultant and Bank Expert.

Desalegn has a different outlook. “Currently, banks are very selective to which sectors and firms they disburse loans to,” he argues. “Almost all banks are transitorily holding back from loaning, especially since November as economic and business activities are slowing down and default rates are increasing.”

Muluneh says for whatever reasons, banks now have surplus cash but the amount of credit they disburse is comparatively small. “This means that interest rates that must be paid on savings deposits are amassing but banks are not generating income from interest-related activities. This will have a profound effect on the performance of banks at the end of the year,” argues Muluneh.

Interest income is the dominant source of revenue for most commercial banks operating in the country. According to a study conducted by Cepheus Research and Analytics in May 2019, CBE, Abyssinia, Nib, Awash, and United are the top banks that relied heavily on income from interest between 2008/09 and 2017/18.

In 2019/20 fiscal year, over 70Pct of banks’ revenue came from interest related activities, according to data from NBE. For instance, out of CBE’s total income in the last fiscal year, the share of interest income was 78Pct. It was similarly 74.2Pct for Awash and 80.33Pct for Dashen. This shows that most commercial banks are highly dependent on the revenue generated from interest related activities. However, fees from foreign exchange dealings and commissions were a more relevant revenue source for other banks, namely Zemen, Debub Global, Enat, and Addis International, according to Cepheus’ research.

According to the latest annual report published by NBE, the average lending interest rate is 14.25Pct. Desalegn argues most banks are dependent on interest income, and as such, they tend to charge high lending interest rates. “There are banks that charge 18Pct but the maximum rate Awash charges is 15.7Pct. This is part of the reason why people and businesses shy away from taking credit. Lending interest rates are very high.”

To boost the demand for credit, Awash already reduced rates for some sectors. “Over the last three months, our bank reduced the lending interest rates for hotels and flower growers to 7Pct, equal to the interest rate paid by the bank on savings deposits,” explains Desalegn. “As a result, Awash lost more than half a billion Birr from interest income.”

CBE has reduced lending interest rates for some sectors while other banks are also considering following suit in order to disburse the loanable funds at hand, which are sitting idly and incurring cost.

Experts say there is room to cut lending interest rates even further. Following the base saving rate increment by NBE for saving and time deposits by two percentage points to 7Pct in first quarter of 2018/9 commercial banks ensued to revise their interest rate structure. Currently, the average interest rate on savings deposit is 8Pct. With average lending rates at 14.25Pct, banks on average enjoy a spread of around 6.25Pct. But maximum lending interest goes up to 21pct.

“This could have been permissible before NBE lifted, in November 2019, the mandatory purchase of NBE bills equivalent to 27Pct of gross loan disbursements,” argues Desalegn. “However, this is not the case now. So, the central bank must cut the base interest rate.”

“Banks are considering cutting lending interest rates but not because of the declining appetite for loans, but rather because close to 15 new banks are in the pipeline to enter the market,” argues a senior manager at Abay Bank. “When the number of banks increases, no doubt there will be high competition to tap onto customers. Cutting loan interest rates will be one of the tools to compete with for current banks.”

Gudeta Kebede (PhD), Lecturer of developmental economics at Jimma University, has a different take on the issue. “Even if banks slash loan interest charges, investors still won’t take out loans, unless peace and stability is realized in the country. Even if the conflict can be settled in six months’ time, investment and business activities need longer to revive.”

But if banks must reduce the interest rates they charge, they should first diversify their sources of revenue by boosting non-interest related activities, according to experts. Until now, the main non-interest source of revenue for banks has been via international money transfers. But on the other hand, the success of banks in providing financing to exporters and facilitating foreign direct investment flow is minimal.

Besides reducing loan charges, Yidnekachew Tegegn, Importer, stresses that banks have to improve in various areas. “There are many hurdles that discourage credit seekers from taking out loans. Although banks used to request high collateral fearing default, they recently raised their collateral requirements even higher,” says Yidnekachew, who claims he recently could not access credit, with the same asset he used as collateral before.

Indeed, the banking system in Ethiopia is highly collateralized. Banks require fixed assets 234Pct of the credit value as surety to provide loans, which is much higher than the 120.8Pct collateral rate in Kenya. In addition, the majority of the population is excluded from credit markets as they lack the array of productive assets such as houses, buildings, and cars, readily accepted as collateral by Ethiopian banks.

In order to rectify this situation, the Parliament passed a law that forces financial institutions to accept movable assets such as livestock, patents, land operating rights, land ownership rights, warehouse receipts, and intellectual property rights as collateral. Yet, only time will tell the effectiveness of such mechanisms. EBR

9th Year • Dec 16 2020 – Jan 15 2021 • No. 93