What Will Weed Out Ethiopia’s Young Banks, Capital Regulation Or Liquidity Crisis?
In the business world, a merger refers to joining two companies into one entity. The concept has made headlines recently because the government is preparing to open the sector to foreign competition. This is the second time in recent years that the issue has taken Centre stage in Ethiopia’s financial news after the two state-owned banks – the Commercial Bank of Ethiopia (CBE) and the Construction and Business Bank (CBB)– ‘merged’ in December 2015. Advocates of mergers say they provide several benefits to the financial sector, the 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 needs more time to mature. EBR updates an article published from the 4th Year • January 16 2016 – February 15 2016 • No. 35. We spoke with banking leaders and experts to get a better grasp of the concept and its potential role in Ethiopia’s fledging banking sector.
Although mergers are common in developed nations’ financial sectors to reap the benefits of economies of scale and minimise competition, they have yet to occur significantly in Ethiopia.
The history of mergers in Ethiopia’s financial sector is relatively recent. In 1980, the Ethiopian government merged Addis Bank with the Commercial Bank of Ethiopia (CBE). Before 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. These banks 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 two decades ago, another merger occurred in the insurance sector. It happened after the then-United Insurance Company (recently rebranded as Hibret Insurance) merged with Lion Insurance Company in 2002.
Nine years ago, in December 2015, the news of the two state-owned banks, CBB and CBE, made headlines. 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 could have performed better in Ethiopia’s competitive banking industry.
After nine years, so much has happened in the financial sector. Since 2018, a dozen new banks have joined the industry. Three are full-fledged interest-free banks, and one is a specialised mortgage bank. In this situation, the issue of mergers and acquisitions has further resurfaced on the horizon.
When two firms join to form one new institution, mergers can create a more dominant position in the sector, achieve economies of scale, and garner a larger market share. Banking mergers can ensure efficiency, profitability, and synergy. They also play a crucial role in forming and growing shareholder value, offering a promising outlook for the future of Ethiopia’s banking sector.
To strengthen the financial sector, the National Bank of Ethiopia (NBE) developed the legal framework in 2021 that will increase the minimum paid-up capital of all private banks to ETB5 billion by June 2026. However, as of June 2024, only a few banks have achieved this figure, and many still need help to reach the threshold.
One of these late-entrant banks, Ahadu, officially started its operations on July 16, 2022. As of June 30, 2024, the Bank had a paid-up capital of one billion birr, 25% of the required capital. While the possibility for Ahadu to sell four billion birr in the next 18 months remains a puzzle, the idea of merger and acquisition in Ethiopia’s financial landscape, as tabled in its November 2024 general assembly meeting, offers hope for the future. Whether it continues as Ahadu or is acquired by a bigger fish or merges with other smaller banks to form a bigger one and achieve the capital requirement, shareholders decided to keep investing in the Bank and further strengthening efforts to sell more shares.
Wogagen Bank, a first-generation bank tremendously affected by the Tigray war, also did the same by tabling an agenda to the shareholders about the possible scenario of merger and acquisition among private banks in Ethiopia. Wegagen is a larger bank with a paid-up capital of 5.1 billion in the 2023/24 fiscal year, modestly surpassing the regulatory requirement set by NBE.
Although Weggen has already achieved the capital requirement, it’s been seeking experience in mergers and acquisitions, even by sending its senior executives abroad to study the experiences of others. A few other banks among the first-generation banks also tabled a proposal to their management and board about selling a quarter of their equity to a foreign bank. Some approached their aspired banking partner, hoping to sell the equity when the wheel started going.
Indeed, in the face of substantial capital requirements and a tightening operational environment, the future of Ethiopian banks remains uncertain. However, the resilience and determination of a few private banks that have capitalised significantly in the past to stay agile in the competition, be it from local banks or foreign entrants, is truly inspiring. Despite the challenges, these banks are forging ahead with new business strategies and products that set them apart.
The rush to establish the fourth-generation banks in the wake of the political transition in 2018, which brought Prime Minister Abiy Ahmed to the helm, saw the formation of numerous new banks, some of which were full-fledged interest banks such as Zam Zam, Hijra and Rammis. The nation’s banks grew from 18 to 32 as some microfinance institutions such as Sineeqe, Tsedey, Siket, Omo, and Shebele also transitioned to full-fledged banks. Other conventional banks joined the market, including Goh Betoch, Amhara, Tsehay, Geda, and Ahadu.
These banks, established at a paid-up capital of ETB 500 million, which at the time of establishment was not even USD15 million, soon found themselves in a precarious situation because expansion and technology acquisition became too expensive. In contrast, the first-generation banks such as Awash, Abyssinia and Dashen aggressively expanded on all fronts, making it difficult for the newer banks to get their footing grounded on solid bases. Their struggle is visible, and as the economy undergoes tectonic policy shifts to stabilise and adjust to macroeconomic imbalances, the burden on financial institutions has become colossal. The banking sector received a series of unfavourable policy reforms, from credit cap to stringent Treasury bill purchases requiring the banks to advance 20% of the value of the loans they disburse. This policy has worsened their liquidity to a point where some banks cannot allow depositors to withdraw even fifty thousand birrs in cash.
As of June 2024, some banks have already reached a loan-to-deposit ratio of 94%. This means 94% of the deposits mobilised have already been disbursed. Together with the 20% Treasury bill commitment for every loan, they have finished the deposit they mobilised and went to loaning their capital. This shows the extent of the severe liquidity they have rightly faced.
Most new banks, first-generation banks, or those in between already live in this ugly reality. That’s why, even if the Central Bank lifts the 14% credit cap, most banks will remain unable to provide loans, or approved loans will not be sufficiently disbursed because they have already surpassed their lending capacity, while further deposit mobilisation seems thin in the air.
Many factors contribute to this situation. Beyond the country’s slow business and economic activities, which make deposit mobilisation extremely challenging, the banks’ undercapitalised nature exacerbates the problem. This calls for immediate consolidation as the most viable option before their inescapable collapse. Consolidation alone may not suffice, as prudent leadership is also required to navigate the complex and ever-changing operating environment. At the moment, most banks still need to develop this capacity.
Government officials say increasing the minimum paid-up capital 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,” a senior executive at the Central Bank said in a meeting with the bank executives. “Fewer strong banks in capital, human resource and [technology] are better.” The official said.
Prime Minister Abiy Ahmed has also raised the issue of consolidation in the Ethiopian financial sector several times and recommended bank mergers as necessary.
“Five or six strong banks will do well,” Abiy underscored.
The PM hinted at protecting the banks if they can integrate to form ‘what could be called ‘banks’ extricated from ethnocentrism, favouritism, and exclusivity. Abiy scolded the banks for practising nepotism and, at times, engaging in parallel market dealings in their recent history.
“What we have now are not banks but kiosks,” the commander-in-chief noted.
Abiy emphasised the need to shift from localised small financial institutions offering ‘ownership to relatives’ toward strong banks locked in on grander economic targets.
He alluded to the recent increase in mobile subscribers and internet users following the opening of the telecom sector to illustrate the benefits of competition.
The PM recalled economic opening up being the first agenda item at his inaugural chairmanship of the now-dissolved Ethiopian People’s Revolutionary Democratic Front (EPRDF) party meeting.
Abiy called on the banks to prepare for competition, share their expertise and innovate as the sector opens to foreign capital.
However, the wild speculations are rooted in much more than the Prime Minister’s words. The draft banking law clearly states “Statutory mergers” as an option for the NBE to move to create “strong, viable banks.”
Zemedeneh Negatu, known for his commentaries on the Ethiopian economy, often highlighting issues such as privatisation and economic reforms, has been vocal about the need for bank consolidation in Ethiopia.
“Ethiopia’s banks must consolidate to create five very large ones that are highly efficient and competitive,” he wrote in his X-account, formerly Twitter. Zemedeneh attributes the need for consolidation to the banks’ existing low capitalisation and the need to modernise their services by investing in technologies.
For Zemedeneh, Ethiopian banks must grow fast and prepare for cross-border services wherever a sizable diaspora population lives. This would ease money transfer and remittance inflow to Ethiopia, he concludes.
Indeed, the experience of several African countries demonstrates that escalating the paid-up capital limit is a mechanism to whittle down the number of banks to a few strong ones. This, in turn, will enable the remaining banks to have well-trained employees and substantial capital to help them compete in the market and meet the country’s needs.
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 cannot 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 2005 banking consolidation.
The consolidation process ultimately reduced the number of banks in Nigeria, stabilising at 21 by the end of 2013. The consolidation led to the emergence of more substantial, more resilient financial institutions. Nigeria hasn’t seen new banks since then.
Indeed, one of the solutions for struggling banks to cope with increases in the minimum paid-up capital is by merging with another distressed bank or being acquired by larger ones to benefit from consolidating assets and resources.
At the moment, smaller private banks face many challenges beyond the need for paid capital. These challenges threaten their survival, from the liquidity shortage to the mounting cost of operations and the threat of more liberalised and open competition.
The fast digitisation of Ethiopia’s economy, which has achieved a great stride over the past couple of years, has also created massive competition from telecom operators, who have a technological advantage over banks. The proliferation of fintechs, which massively scaled up without requiring huge capital and investment costs like the banks, have also outperformed some emerging banks, which largely depended on the most expensive and outdated brick-and-mortar banking model.
The younger banks are indeed facing numerous challenges. These challenges, rooted in internal and external factors, have far-reaching economic implications.
One of the most pressing issues confronting smaller banks is the dominance of the state-owned and state-affiliated banks. With their deep pockets and government backing, these behemoths often enjoy preferential treatment, limiting the opportunities available to smaller institutions. This unequal playing field can hinder smaller banks’ ability to compete for quality clients, secure affordable funding, and expand their operations.
Moreover, smaller banks need to grapple with operational inefficiencies and a need for technological advancement. Outdated systems and processes lead to higher costs, slower service delivery, and a diminished customer experience. In an increasingly digital age, these limitations put smaller banks at a significant disadvantage.
The regulatory environment also presents challenges for smaller banks. While regulations are necessary to ensure financial stability, excessive bureaucracy and stringent compliance requirements burden smaller institutions. The costs associated with meeting these requirements erode profitability and stifle growth.
Furthermore, the economic climate in Ethiopia poses risks to smaller banks. Economic downturns, currency fluctuations, and political instability all impact the financial performance of these institutions. In particular, credit risk, the risk of borrowers defaulting on their loans, can be exacerbated during periods of economic uncertainty. EBR
13th Year • December 2024 • No. 136