“The Reduction of Lending Rates is Inevitable as the Supply of Credit Surpasses Demand.”

Following the demonetization of the Birr early Septemeber this year; and the strict regulation of the financial sector, a huge sum of money circulating outside the formal banking industry is fast declining as citizens rush to open new bank accounts and change old notes with new ones.

This has increased banks liquidity by six-fold. How are the banks going to deal with this increased liquidity? Will it lead to reduced lending interest? Will it improve access to finance to cash-starving companies in the agriculture and manufacturing sectors?

EBR had an audience with Muluneh Aboyeh, vice president of risk and compliance management at the Commercial Bank of Ethiopia (CBE) to discuss about the possible impacts of excess liquidity in CBE and the banking industry at large and how they are working to utilize it.

What are the impacts of COVID-19 on the banking industry?
As COVID-19 interrupted mobility significantly, the transport, tourism, and hotel sectors are adversely affected. Import and export sectors are also affected. This had a significant impact on the economy, reducing the forecasted annual growth rate from 9Pct to 6.1Pct.

Banks also lost revenue streams and foreign currency that could have been generated from sectors affected by the pandemic. In addition, banks are forced to allocate additional resources to retain employees. For instance, the Commercial Bank of Ethiopia (CBE) has been allocating additional funds to cover employees’ salary and operational costs during COVID-19, without generating extra revenue.

However, the impact of COVID-19 was not as severe in Ethiopia, mainly because banks extended debt repayment periods and cut lending interest rates for affected sectors. In terms of deposits, ETB170 billion in additional deposits entered the industry during the first quarter of the current fiscal year while ETB32 billion in new loans were disbursed.

COVID-19 has even brought some opportunities to the banking sector. Especially, the use of digital financial services and digital banking outlets has increased during COVID-19. Close to 50Pct of CBE’s transactions since last year went through digital means. Mobile banking, POS, e-wallet, and ATM transactions have all increased. This has also significantly reduced banks’ operating cost.

Is the demonetization responsible for the excess liquidity observed in the banking sector currently?
There was a big liquidity problem until last December. But the liquidity crunch started easing even before the demonetization. This was because government injected ETB15 billion last year. Secondly, the mandatory 27Pct National Bank of Ethiopia’s (NBE) bill purchase, repealed last year, coupled with the maximum cash holding and cash withdrawal limits introduced by NBE last year have also eased the liquidity crunch, to a certain degree. These instruments served to bring money back to banks. The liquidity problem was solved through policy driven solutions, apart from the demonetization.

Although you said the liquidity level of the banking sector improved before the demonetization, the amount of credit disbursed declined during the fourth quarter of 2019/20.
Between June and September, economic activities are usually slow. So, banks do not disburse credit during this period. Credit disbursement usually starts taking off after October when the economy starts to pick up and harvesting season starts.

What is the level of liquidity before and after the demonetization?
Unlike past trends, deposits mobilized by banks has increased exponentially during the first quarter of this year. Banks’ deposits increased by more than 600Pct during this period, compared to last year’s first quarter. This indicates excess liquidity is coming to banks.

But the level of credit disbursement doesn’t correspond with the excess liquidity. This means the interest rate that must be paid on savings deposits is piling up but banks are not generating income from interest related activities. Will this affect banks’ income?
There is no question about that. Our major source of revenue is intermediation. Banks collect savings from the public, then lend it to businesses, and retain the margin. Over 70Pct of the banks’ revenue comes in the form of interest income. So, when the amount of credit disbursed declines, interest income also decreases. On the other hand, banks still pay interest rates on savings and time deposits. As a result, their interest expense rises. So, banks must think creatively, to find out how to utilize this huge surplus liquidity.

Experts argue that the current lending interest rate is high and banks should reduce the rate, as the mandatory NBE bill purchase has been repealed. Do you see room for cutting lending interest rates?
Many banks already revisited their lending rates after NBE repealed the mandatory bill purchase. Since banks are becoming more liquid, they are cutting interest rates to attract credit takers and penetrate the market. The reduction of lending interest rates further is inevitable as long as the supply of credit surpasses demand. In fact, there are such moves among some banks. Obviously, the margin between saving and lending interest rate is wide.

On average, 70Pct of banks’ revenue comes in the form of interest income. Are there reasons that restrict banks from diversifying their sources of revenue?
Ethiopian banks do not charge anything for the services they provide. Except from importers and borrowers, other clients get banking services for free. Before core banking was introduced, banks used to charge for local transfer service. But now it is free of charge.

Ethiopian banks have lost the majority of their sources of revenue apart from interest income. In other countries, income from transactions constitute the lion’s share of revenues for banks. If somebody transfers or withdraws from a local branch, he will be charged. In Ethiopia, withdrawals, transfers, deposits, and passbook replacement services are provided free.

Paradoxically, withdrawing money from an ATM is charged, while withdrawing money from a branch is not charged. As a result, banks are forced to rely heavily on interest income.

CBE used to generate large amounts of foreign currency from remittances. Has it been affected by COVID-19?
The flow of remittances declined at a national level due to COVID-19. Yet, the informal hawala market is still attractive. The diaspora’s income is also affected due to high layoffs.

Rather, export earnings grew during COVID-19. We continued exporting agricultural products, because Ethiopia did not shut down completely. Ethiopia’s coffee is availed at larger volumes in the international market. Although flower exports from Ethiopia were affected during the early months of the pandemic, it recovered immediately and grew by more than 20Pct.

How do you evaluate the impacts of conflict and instability on the performance of the banking industry?
The instability slashed investors’ confidence and reduced the flow of foreign direct investment. As a result, the demand for credit declined. This has adverse effects for the banking industry.

The less-incentivized service sector outperformed the much-sought growth of the manufacturing and agriculture sectors. Many agree that the service sector is bloated because banks prefer to fiancé businesses which have short term and immediate returns. Why do banks shy away from financing long term projects?
You are right; banks prefer to finance projects in the service sector because their loans can be collected shortly. Financing businesses in the service sector has an immediate and high return rates. Besides, the provision of loans to the service sector does not require sophisticated expertise.

On the other hand, financing manufacturing and agricultural projects take a long time. The default rate is high. Moreover, it requires banks to establish teams of expertise to study and follow up the progress of the financed projects. Import, on the other hand, isn’t as complicated as manufacturing. It does not require sophisticated skills and long project appraisal steps.

Unless the central bank enforces mandatory laws, private banks will prefer to channel more resources to fast returning businesses in the service sector. The government needs to regulate the sector efficiently if more financing has to go to manufacturing and agriculture.

In addition to tax cuts and duty-free privileges, the two critical productive sectors — manufacturing and agriculture — need increased financing with low interest rates. This needs policy direction. The government has the responsibility og rectifying such economic woes. So far, it is only CBE and DBE, which have been financing long-term projects on a massive scale. The government can force private banks to do the same.

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