24 February 2013

Ethiopia: Temporary Banking Fixes, No Long-Term Solutions

Although the central bank lowered the reserve requirement to five percent, senior managers of the private banks worry that the 3.3 billion Br windfall made available by the National Bank of Ethiopia (NBE) might not provide a sustainable solution.

At a time when many private banks have become more cautious over lending, the National Bank of Ethiopia (NBE), last week, lowered reserve requirements to five percent; freeing close to 3.3 billion Br in liquidity, whilst fixing the portfolio share of short-term loans at least 40pc of total disbursement.

Based on the two directives signed by Teklewold Atnafu, governor of the central bank, the required amount that each bank must hold in reserve from customer transactions has been realigned to five percent from 10pc. This is the second decrease to have been made over the last two years.

The new directive, which repealed the previous one, will be effective from March 01, 2013 onwards.

In a separate directive issued in the same week, the central bank also instructed all private banks to maintain loan portfolios that are comprised of at least 40pc short-term loans.

Private banks have been given a grace period until January 01, 2015, in which to enforce the new requirement, according to the directive.

The move follows a decision by the central bank to fight the galloping inflation, in September 2011, compelling all private banks to buy NBE Bills, amounting to 27pc of the loans they make. A move that industry observers believe led to a near freeze of investment and a massive slowdown in businesses.

Although it was a decision that many in the banking industry expected, most senior managers of private banks hope it will marginally improve the current liquidity crunch.

Berhanu Getaneh, president of United Bank and the Ethiopian Bankers' Association (EBA), believes the change will create a favourable business environment by availing more money for private banks to lend.

"Even if the amount is little, it has a big impact in the banking operation," said Berhanu.

It is not what we expected, said a president of a private bank who wants to remain anonymous. "Even if it is not a sustainable solution, it will give us some time to adjust ourselves".

The banking sector has been in a liquidity crunch ever since the introduction of the lending cap, imposed by the central bank on all commercial banks at the beginning of 2009.

Although the announcement by the NBE that a three-year old lending cap had been lifted, provided some relief to private banks, the central bank replaced it by ordering private banks to buy 27pc of their annual loan disbursements in NBE Bills.

This is in addition to a series of reserves that the central bank obliged banks to hold, including 15pc of primary (legal) assets and five percent of secondary assets.

As many in the industry warned in the beginning, these measures, coupled with additional reserve requirements, is drying up the deposits mobilised by private banks, thus sending them into a liquidity crunch, said a macro economist who has been following the issue closely.

The data obtained from the NBE supports the macro economists' argument.

Up until December 2012, the 14 private banks operating in the country mobilised 66.2 billion Br, whilst disbursing 40.7 billion Br in loans to the public. In the same period, banks purchased 15.3 billion Br worth of NBE Bills, which is 15.5pc of the total assets held and 23pc of the deposits mobilised by the banks.

By any standard, this is a huge amount of money and it could dry the liquidity of the banks, argued the macro economist.

The six biggest private banks; Awash, Dashen, Abyssinia, Wegagen, United and Nib, purchased 12.2 billion Br worth of Bills. Awash International Bank (AIB) and Dashen Bank rank first and second, spending 2.8 billion Br and 2.5 billion Br, respectively.

The recent move by the central bank might give the private banks a little room to breathe. The 3.3 billion Br, which came as a windfall to the banks through the reduction of the reserve requirement, will not have long lasting effects, said the macro economist.

Based on the 66.2 billion Br in deposits that the banks held at the end of December 2012, Dashen Bank, which mobilised 14.7 billion Br, will benefit the most from the directive; accessing 734.6 million Br as a result.

AIB and United Bank are next in line, with 512.9 million Br and 383.9 million Br, respectively, released from the decrease in the reserve requirement.

The directive will also benefit small banks, although on a smaller scale, according to Worku Lemma, president of Debub Global Bank.

The situation may also worsen if the decline in deposit growth continues, said the president of the private bank.

Despite the 23pc growth in the number of private bank branches - up to 676 in 2011/12 from 550 in 2010/11 - growth of deposits in private banks declined to 18.7pc in the 2011/12 fiscal year, from 29.9pc.

Industry observers and experts fear the central bank might run out of policy options with which to correct future problems.

The central bank applied the same measurement in February 2012, which only lasted for one year, according to a private consultant closely associated with many of the private banks.

This is a short term solution, according to the private consultant, and former employee of the state-run Commercial Bank of Ethiopia (CBE).

In January 2012, the central bank lowered the reserve requirement on deposits by five percentage points down to 10pc, and liquidity requirements to 20pc from 25pc. The central bank should focus on long term solutions, which tackle the major causes of the liquidity problem, the consultant advised.

The problem has been exasperated by the basis of calculation for the investment and loan terms provided by banks, according to Abdulmena Mohammed, who has worked as an external auditor for eight years in Ethiopia and is an accounts manager for Portobello Group Ltd, a London based holding company with subsidiaries in property investment and development.

The basis of calculation of investment in NBE Bills is flawed, as it is on gross loan disbursement, rather than the source of funds, according to Abdulmena.

This was the same complaint put forward by the EBA to the NBE, in a 24-page preliminary assessment of the NBE Bill, with alternative proposals, a year ago.

The basis of the calculation to determine the amount of Bills to be purchased should be changed to the net deposits of a bank, instead of using the disbursement, the EBA suggested.

However, instead of implementing what will be the ultimate solution to the problem, the central bank continues to insist on using the reserve requirement as a policy tool, said the macro economist.

There is a limit in using this tool, agrees Abdulmena.

"Since the reserve requirement has reached five percent, further reduction means approaching close to zero reserve requirement, which ultimately violates international standards," he added.

On September 2012, central bank governors and senior regulators agreed to new rules designed to prevent a repeat of the recent global financial crisis. At a meeting in the Swiss city of Basel, they agreed to increase the reserve requirement of banks from two percent to seven percent.

Although the new agreement seems appropriate for western banks, which currently do not have the same ability to absorb losses, developing countries should also follow the same trend to absorb liquidity crises, recommends the macro economist.

However, industry observers fear that the little space created for private banks, may be overshadowed by the requirement to ensure that loan portfolios are made up of 40pc short-term loans that will mature within one year.

The impact of this loan restructuring depends on the composition of the loan books of individual banks, according to Abdulmena.

The majority of bank loan requests are for at least an 18-month repayment period, unless they are overdraft applications, says Abdulmena. Therefore, pushing a considerable number of loans into a one-year maturity period, so as to comply with the directive, would further drain the liquid resources of banks, he added.

This assessment was also confirmed by the majority of bank presidents that Fortune talked to.

Before the introduction of the NBE Bills, private banks tended to give out short-term loans that were due in less than a year, said the president of the private bank.

"After 2011, however, most of them retreated from disbursing short-term loans," he added.

We cannot say whether restructuring the loan portfolio has a positive or negative impact at this time, said Berhanu.

However, experts advise the NBE to suspend the 27pc requirement and to figure out a sustainable solution. Bankers, on the other hand, are of the opinion that the central bank should think about the proposals presented by the EBA.

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