4 November 2017

Ethiopia: Credit Cap Puts Businesses, Banks in Limbo


Businessman Elias Tessema, whose name was changed upon request, has over a hundred employees in his plastic manufacturing plant located at the Kolfe Qeraniyo district, supplying various types of plastics to his mounting number of customers.

He would love to hire more labourers to keep up with demand and expand his horizon, but cannot get a bank loan.

A victim of the credit cap put by the central bank on all commercial banks, Elias, in his late 20s, had to recently turn away an order that could have created 100 new jobs and would have helped his firm stretch its 50 million Br investment.

"Our loan request has been pending at the desk of the Bank for over two months," said Elias, who has requested a 20 million Br loan from Debub Global Bank.

Then, unexpectedly, the devaluation became effective, and his plans turned to ash.

"We are a labour intensive company," he said. "Unless we get finance from banks, we won't be able to employ anybody."

The problem is not that commercial banks lack deposits to lend.

After deciding to bring down the overvalued Birr by 15pc to encourage exports and reduce imports, thereby reversing the problem of accessing forex, the central bank implemented laws on the banking industry. The regulations aim at controlling the adverse effects of the devaluation.

Amongst the laws that attracted the attention of many in the past three weeks was the 16pc outstanding credit growth limit put on commercial banks. The credit cap was applied to all businesses except those engaged in the exports of goods in a bid to control the devaluation-caused inflationary pressure using money supply.

During the third quarter of the past fiscal year, broad money supply, the amount of money circulated in the economy, reached 534.3 billion Br- showing a 30pc growth similar to the same quarter in 2015/16.

The loan limit, which is applied to control the adverse effects of the recent devaluation in Ethiopia's banking system, has led to a credit crunch that was inflicted on mid-scale industries such as Elias' that depend upon banks for their day-to-day working capital and long-term borrowing needs.

"Loan is like fuel for our business. We cannot afford to be deprived of finance," said Elias.

For private banks, the limit is stringent to undertake as they have been witnessing an average credit growth of more than 30pc a year.

"The adverse effect of the cap on banks is multidimensional," said the senior executive of Bunna International Bank. "With the two percent adjustment in saving interest rate, it will cost us much unless we find a way to compensate the effect."

The central bank usually uses reserve and liquidity requirement of banks to control the monetary policy and sometimes to channel funds to the priority sector of the economy. Amongst the notable actions of the Bank, the revision of the reserve requirement aimed at controlling the inflationary pressure was one of the major monetary reforms.

This was implemented in conjunction with a credit cap intended to cool the overheated economy of the country down during the last devaluation made seven years ago.

Several strings were attached to the cap including the requirement for commercial banks to put a little over one-fourth of their loan in government treasury bonds maturing in five years and at an interest rate of three percent.

"It is not difficult to witness the effects of these requirements on the bank's performance," said a senior executive of Bunna.

Despite the challenges, the banking industry managed to witness a credit growth rate of 27.5pc over the past five years, even higher in the case of private banks.

The amount of loans disbursed by all commercial banks as of June 2017 stands at 560.8 million Br- 24pc higher than the preceding fiscal year, according to the National Bank of Ethiopia (NBE). Of the total loans, over 40pc was doled out by 16 private banks while the two public banks shared the rest.

Around 29pc of the loans were availed to the industry sector followed by domestic trade, housing and construction, agriculture and international trade.

This trend does not seem to continue in the months ahead. Almost all the banks were forced to suspend loans to all sectors except to exporters after passing the credit cap levied by the regulatory body.

"I believe the export sector cannot absorb any more loans right now," said a senior executive working at Debub Global Bank.

Bunna's executive agrees with the statement above.

"It is obvious that exporters are not using previously disbursed resources efficiently," he said. "Adequate amount of loans were disbursed to the export sector. If an additional loan is given to them, it will result in a surge of a nonperforming loan ratio."

Following the action of the central bank, projects nearing completion were forced to be ceased including the one owned by a real estate investor, who requested a 25 million Br loan from one of the private banks to construct a commercial building near Ayat.

"My loan proposal got rejected even after completing more than half of the construction," the investor remarked.

Henock Assefa, a managing partner of Precise Consult and an investment consultant by profession, believes that the cap is very crucial to protect the economy from devaluation-caused inflationary pressure.

"It is the right remedy to contain inflation, albeit it will temporarily affect the business environment," he said.

However, despite the target of the central bank to contain the inflationary pressure using monetary policies, the cost of living, measured by consumer price index, has already hiked to 12.2pc in the past month.

Furthermore, the limit, which was followed by an instruction where all banks are required to transfer their forex earnings to central banks and allow exporters to retain 30pc of the forex they generate, is worrying for the veteran financial industry insider who has over four decades of experience.

"The regulatory body should have consulted us before taking such measures," said Zafu Eyesuswork, board chairman of United Bank. "No doubt, profitability will be affected by the limit."

Other industry insiders are also concerned that it will diminish the appetite of banks for deposit mobilisation.

"The only option we are left with is reducing our administrative expenses on branch expansion and deposit mobilisation to offset the profit decline caused by the limit," said an executive working at Bunna. "Additionally, the desire of investors to join the banking industry will be low at such times, making it difficult to attain the capital requirement set to be achieved in the next three years."

As the credit cap is set at a time when private banks are required to expand branches, increase their capital and pay higher interest rates on savings, their profitability will decline, and the money that goes into the pockets of shareholders will dwindle, according to Abdulmenan Mohammed, a financial expert.

"The credit cap on commercial banks will succeed if NBE keeps an eye on its unbridled lending to the government," he said.

Alemayehu Geda (Prof.), a three-decade experienced macro-economist, shares Abdulmenan's idea.

"The cap is useless lest the government cuts its expenditure and puts a credit cap on itself," he said. "It should not borrow from the central bank and print money."


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