2012:Tough but bearable year for bankers

Despite tough measures imposed on the lending capacity of banks by the National Bank of Ethiopia (NBE), private banks have been able to remain profitable in the last Ethiopian fiscal year. Fourteen private banks jointly amassed more than 3.5 billion birr in gross profit. Dashen Bank alone announced 896.5 million birr gross profit in the 2011/12 budget year, while the newly established Addis International Bank (AdIB) registered the least profit. Dashen Bank’s gross profit is nearly double of the previous year profit which was 451 million birr.
Capital’s Pawlos Belete examines the performance of private banks visa-a-vis the Commercial Bank of Ethiopia, the Ethiopian financial giant. He also looks at the impact of the financial sector’s regulating arm of Ethiopian government; the National Bank of Ethiopia’s 27 percent bill and banking modern infrastructure.

The National Bank of Ethiopia imposed tough measures on the lending capacity of private banks a year ago. Nonetheless, the banks remained profitable in the last Ethiopian Fiscal Year. The fourteen private banks currently operating in the country amassed more than 3.5 billion birr in gross profit. The gain of the 14 private banks is less than half of what the Commercial Bank of Ethiopia (CBE) earned over the same period. CBE’s gross profit totaled almost double of what it had cashed in as gross profit in the 2010/11 budget year; 4.2 billion birr and more than double of the cumulative gain of the 14 commercial private banks operating in the country.
The directive was introduced in April, 2011, ending a two-year long credit cap policy in the industry. The collective profits of the 14 commercial banks stands at 3.544 billion birr representing only 45 percent of CBE’s gross profit.  Dashen Bank raked in a staggering 896.5 million birr gross profit in the last budget year; leading more than a dozen private banks. Dashen’s landmark gain is up from the 451 million birr net profit it announced the previous budget year.
The financial sector’s regulating arm, the National Bank of Ethiopia (NBE), introduced a bill that compels private banks to buy government bonds for a total of 27 percent of the loan disbursement capacity of each bank, bearing only three percent interest as opposed to the five percent interest they give on deposits they mobilised a year ago. The introduction of the directive ultimately drew out more than 11.5 billon birr from the financial sector of the country according to reports. Awash Bank is the biggest buyer of treasury bills so far according to reports. It bought close to 2.3 billion birr worth bonds while Zemen bank has purchased half a billion birr.
The directive has a tangible impact on the banking sector including maturity mismatch and less profitability according to the International Monetary Fund (IMF) staff report released last October.
“The requirement on private banks to purchase NBE bills equivalent to 27 percent of any new loans appears to have a sizable negative impact on private banks’ intermediation activities,” says IMF in its staff report.

“The requirement also has the potential of creating maturity mismatches as private banks collect savings at two to three-year maturity, even shorter in some cases, but have to freeze these resources for five years at rates lower than the cost of funds. There is also a risk that the profitability of private banks reduces on account of less intermediation because of the directive. As a result, private banks could raise noninterest income charges such as fees and commissions to recoup these losses, further impacting negatively on the private sector,” adds the report.
Except for CBE, many commercial banks have increased transfer commissions following the introduction of the directive.
Financial soundness indicators do not point to immediate concerns, but vulnerabilities appear to be building in the sector argues IMF.
The banking sector overall is well capitalized and the capital adequacy ratio (CAR) for the sector has consistently been around 18 percent from June 2008- June 2011. That is well above the regulatory demand of minimum eight percent. However in less than a year, the ratio sharply declined from 18.1 percent (June 2011) to 13.6 percent (March 2012), possibly reflecting an increase in risk-weighted assets driven by the high domestic credit growth to finance public enterprises, argues the staff report.
Similarly, the ratio of liquid assets to total assets, which has consistently been above 30 percent over June 2008 – June 2011, has declined to 19 percent in March 2012 according to the report.
The sharp decline in the CAR and the liquidity ratio could reflect warning signs that vulnerabilities might be building in the sector, adds the report.
A given country’s financial sector policies mirror the country’s development strategy according to economics pundits.
The dominant market share of CBE, its growing exposure to large public enterprises and the impact of the 27 percent requirement on private banks, suggest a need for a closer scrutiny of the banking system according to the staff report.
The IMF staff report pinpoints substantial information gaps on the health of the financial sector.
However, Ethiopian authorities do not share the concern of IMF.
Authorities disagree with IMF staff assessment on the impact of the 27 percent bill requirement on the basis of private banks overall performance. In addition, Ethiopian authorities indicated that the NBE is vigilant in taking actions to mitigate any risks that might emerge.
The actions taken by the Ethiopian authority include training of staff on risk based supervision, based on World Bank financial sector capacity building recommendations, quarterly stress testing of banks, close supervision of CBE given its systemic importance and exposure to large public enterprises, and benchmarking of the CBE operations to those of international banks.
The IMF argues that the 27 percent bill requirement has the potential of crowding out private sector financing. To highlight this possibility, an illustrative numerical scenario is considered where the initial fund available to a bank for its intermediation activities is 1.27 million birr. Out of this fund, the bank is assumed to disburse the fund on year one. It loans the amount of 1 million birr at the current lending rate of 9 percent and purchases NBE bills of 0.27 million birr as required. After one year when this loan is paid back, the total fund available to the bank (birr 1,098,100) would be the loan repaid plus the interest it generated, plus the interest accrued on the NBE bills. Out of this fund, the bank can extend the maximum of birr 864,676 and is required to purchase additional NBE bills of birr 233, 463, with the stock of NBE bills rising to birr 503,454. Renewing such an operation every other year over five years would reduce the fund available for lending by the bank to birr 590,677 in the fifth year while the stock of NBE bills rises sharply to 1,045,748 birr suggesting a significant crowding out of private bank lending to the private sector.
The scenario is also an indication that the role of private banks to allocate financial resources is being taken over by the government, raising the issue of the efficiency of such an allocation. If private banks were to try to circumvent this heavy penalty, by issuing one long term (5 years) loan and to comply with the 27 percent only once, it would put the financing of the Development Bank of Ethiopia (DBE)—which relies on the proceeds of the 27 percent NBE bills—at risk.
The requirement also has the potential of creating maturity mismatches. Private Banks collect savings mostly at two to three-year maturity periods. Fulfilling the 27 percent requirement means that they have to freeze these resources for 5 years, creating a clear maturity mismatch.
It seems that private banks are now feeling the impact of the bill. Most of the banks have performed well below their target in the past six months of the budget year according to Capital sources in the financial sector. 
Another bill introduced by NBE is automating banking services. Part of the order calls for a National Payment System to facilitate automated settlements and inter-bank money transfers. Seventeen Ethiopian banks formed a consortium called Ethio-Switch Solutions which is expected to finalize its preparations by the next Ethiopian fiscal year 2013/14.
As a result of the automation bill, in July 2012 AIB together with two other banks; Nib International Bank and United Bank launched a company called Premier Switch Solution S.C. (PSS). It aimed at providing shared Automated Teller Machine (ATM), Point of Sales (POS), Mobile Banking and e-Commerce services to be available on a 24/7 basis.
PSS started its operations by installing 60 ATMs and 300 POS systems in major business districts in Addis Abeba. It plans to install 40 ATMs and 300 more POS every year for the coming five years.  The three banks are the first to have realized an integrated card payment system. The system is expected to increase the competitive edge of the banks. They have more than 1.2 million account holders between them.