9 December 2012

Ethiopia: Flimsy Capitalisation


If there exists one particular industry that remains to be the focus of both investors and regulators over the past decade, it is banking. It has been the case since the trade of financial intermediation brings high return on capital, often unthinkable in other industries. The very power of money also gives the industry a disposable leverage to define different aspects of life, from social status to political influence, in our fairly poor nation.

The rather dismal rating that our fair nation receives in global rankings of financial intermediation seem to also have brought the impetus for the rush to establish banks, a trend that came to the halt with the regulation that raised the paid-up capital of start-ups to 500 million Br. Having shares of a bank is still considered as an investment that needs less attendance to generate returns. And so far, the industry seems to fulfil the wishes of all the money mongers.

Risks are rampant, however. A rather politicised regulator stands at the top. Once a darling of bankers, the central bank seems to have lost its affection to bankers after so many of them disappointed it by engaging in improper activities.

As a result, its recent focus had been on legislating its intents without advising the very players of the sector. This, partly, has contributed to the rising rate of perceived risks in the industry.

Risks also arise from strategic and operational fronts. Whereas strategic issues such as poorly defined visions misguide investment, operational risks including high staff turnover challenge the competitiveness of industry players.

Yet, the recent debate of the industry is on capitalisation. It so happens as the season sees banks disclosing their books of accounts of the last fiscal year.

Risk sensitive banks, such as United, Nib and Wegagen have settled for lower Earnings per Share (EPS) and less capitalisation, while other such as Dashen andAbyssiniaprovide shareholders with higher EPS.

An in-depth analysis of the decisions, however, would show that the acts of the former group of banks are unjustified. It, instead, improperly discounts shareholder investment and hangs the risk flag at a disproportionately higher level.

Even a layman's analysis of the books of accounts of Ethiopian private banks could show many unattended edges wherein a large amount of return could be tapped. Poor deposit mobilisation, undiversified non-interest bearing investments, heavily consolidated foreign exchange dealings and passive loan portfolios are only some of the edges that most of the private banks perform badly. And there is no denying that a large chunk of the blame for such a weak investment structure goes to the executive management of the banks, including presidents.

I would see no reason for a reduction in shareholder earning for the sake of capitalisation while there is a lot to be done in terms of generating better return on capital in many fronts. And I would see no thoughtful vision in settling for capitalisation whereas opportunities of generating better return are being lost for poor investment decisions.

Settling for capitalisation also embraces an unrealistic aggregation of risks. After all, a thorough analysis of the risk spectrum in the banking sector would show that the dimensions of sources vary. Capitalisation could not be a panacea.

The best possible risk management strategy that a private bank inEthiopiacould think of is diversified and flexible investment portfolio. It is by having a thoughtfully designed investment structure that a bank could effectively deal with (avoid, diversify or absorb) risks.

The variation in regulatory measures taken by the central bank over the last five years could easily show the variation in the risk bundle. Measures such as credit cap, forced investment on government bonds and limitations imposed on foreign exchange frontiers have little to do with capitalisation. No capitalised bank could have the resistance to such evolving regulatory risks unless its investment is thoughtfully structured.

Therein lays the futility of the argument being made by executives of banks such as United, Wegagen and Nib. I would say that their debates hold little water, if not tailored to shift attention away from poor investment management.

How come bankers that fail to create new lending instruments, hesitate to adopt ICT, entertain large branch inefficiency and remain passive towards rising expenses advocate for capitalisation as a way out, though?

It is indeed unrealistic. If anything, the euphoria towards capitalisation is a wrong strategy designed to fix an all the more wrong analysis of banking risks. It is also an unfair treatment of shareholder investments.

Reality, on the other hand, dictates for diversified and flexible investment structure.

Getachew T. Alemu is the Op-Ed Editor for Fortune.

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