After promising they would do so for a year, the National Bank of Ethiopia (NBE) has repealed the controversial bill imposed on private banks, requiring them to buy 27 percent of bonds for every loan they disburse.
The ‘MFA/ NBEBILLS/001/2011’ directive introduced in April 2011 forced banks to buy billions of birr worth of bonds from the central bank. The government took this action as a way of mobilizing resources for government targeted investment activities and these funds are administered by the Development Bank of Ethiopia, the state owned policy bank.
The directive mandated that all banks except the Commercial Bank of Ethiopia and Development Bank of Ethiopia, both which are state owned, buy 27 percent of NBE bills for every loan disbursement at a five percent interest rate with a five-year maturity period.
Banks have long complained the NBE bills shrink their liquidity and smash their capacity to provide loans for clients. They have also argued the 3 percent interest rate, which was attributed when the directive was issued and later increased to 5 percent in October 2017, was far below what banks pay as interest for the deposit. When the directive, ‘MFA/NBEBILLS/001/2011’, became effective, the minimum interest rate was 5 percent and then increased to 7 percent a year ago when the birr was devalued by 15 percent.
In the past during several discussions held with the government, including public private dialogue forums, the issue was one of the main topics brought up by the private sector. However, the government strongly defended and rejected the claim. International partners like the International Monetary Fund (IMF) also expressed their concern about the directive, saying that the directive affected the private sector’s access to finance.
Just a year ago, in his meeting with bankers a few months after he became Governor of NBE, Yinager Dessie had promised the directive would be lifted.
When, at the meeting held on November 5, 2018, bankers expressed their concern about the directive, the Governor disclosed that the Central Bank has created an exit strategy to lift the directive.
And, with its latest directive MFA/NBEBILLS/004/2019, the Central Bank has repealed MFA/NBEBILLS/003/2018 directive.
Jules Leichter, IMF’s Resident Representative to Ethiopia, told Capital that it seems to be a positive step and that the IMF definitely supports the move.
“The Home Grown Economic Reform Plan has already noted this. In the past report of the IMF, we have noted that this particular rule does hamper the ability of private banks to stimulate credit of the private sector,” the IMF head in Ethiopia explained.
“It consists of the government’s objective for the private sector to start picking more of the engine of growth,” Leichter said.
“This relief has high importance, because the banks have been on liquidity constraint that was pushing them for unnecessary competition, while their lending capacity will also be improved,” Eyob Tesfaye, macro economist working for the UN, told Capital.
Their lending capacity will boost the private sector and so it will be a good opportunity; as a slowdown was observed in the private sector but this decision will help them.
Eyob underlined that it might not be on larger level, but this will help the private sector to access the finances that will lead better economic activity.
“It is unexpected and bold move despite it being late coming. For the finance industry it is big news,” Dereje Zebene, President of Zemen Bank said.
“In the past, several opinions were given regarding the issue; some think it pressured the banks’ liquidity; it makes the resource scares and push them to increase the interest rate which indirectly pressured other sectors,” he told Capital.
Dereje explained even though the government said the bill would be lifted, we were expecting that the lifting process would take place in several phases, “this is why I said it is a bold decision. Now we are very grateful as this is not only for the banks but the pressure on borrowers will also be eased.”
With regards to issue of whether the government might come up with other instruments to control the loan, Leichter said “my understanding is they are trying to allow the banks to do more financial intermediation to take deposit and to convert it to loan to the private sector. “So, I don’t know of any plan to replace to something similar; but of course what happens is the government has to work to improve its monetary policy framework,” he added.
According to the IMF Resident Representative to Ethiopia, as the 27 percent rule was taking some liquidity from the banks, so now they need to think about ways of modernization of the monetary policy framework to be able to manage the liquidity.
“I think this is also something the government is looking into, as to trying to strengthen its monetary policy,” he added.
Inflation
Some experts argued lifting the NBE bill might exacerbate the current rampant inflation.
Eyob explained that one of the sources for inflation is through bank lending which is called money creation through fraction of reserve, and when banks pump credit it is going to be inflationary.
He recalled that one of the purposes of introducing the NBE bill was to curtail the inflation but it was not fruitful since the Central Bank pumped the money via another direction.
But, he argued, lifting the NBE bill might not significantly increase inflation even though it boosts banks’ capacity to provide more money to their customers.
“They are assuming due to harvest season, food prices will decline but I don’t think so,” he added.
The IMF Ethiopia head on his part says; “the inflation is obviously high; it is well above the government’s target and indeed its monetary policy, with or without this change, would need to think about lowering inflation.”
He said, this is an objective they would have, even without this reform. In the context of this reform which is the matter of looking at the whole monetary program and figuring out exactly what instrument they have and how they control the money supply at the right level to achieve lowering inflation. Because I think, for Ethiopia high inflation is something very costly. It is not much of an abstract economic concept. It actually hurts people; and so the government, I think, is committed to bring inflation down, and they have to look for tools and decide how they can achieve their monetary objectives.
On the other hand, experts argued that the NBE bill has contributed to the rise in inflation. One of the private banks’ president explained in anonymity that due to the interest rate of the bill which was lower than the market, the banks would compensate the difference by imposing more interest on their lending, which indirectly contributes for the inflation.
“Besides the low liquidity due to the bill at the banks level, it also contributes to the scarcity of the resources,” the president told Capital
Dereje of Zebene Bank also said, if the cost of fund is increased, obviously the inflation would rise because lenders also transfer their cost to others. But now, he said, the liquidity will grow, so the cost of funding will be also harmonized.
He argued inflation will not occur due to lifting of the bill. “The banks finances that were withdrawn by NBE were also supplied to the market in another direction. The NBE instrument was not implemented to keep the money idle from the market; if that was the target the credit cap would have been implemented,” he said.
One of the arguments of the government to impose the NBE bill was that the private banks were not interested to provide long term loans for strategic sectors and hence it has to do it via the DBE.
It argued “strategic sectors, such as manufacturing and agro processing require long term and large loans. However, private banks are not interested in providing long term loans and also have limited capacity in providing large loans.” It claimed that due to this, it issued the directive to mobilize resources and facilitate access to long term and large loans for strategic sectors.
However, Dereje argues that, “Initially we are commercial banks, and by nature we focus on short term loans. Besides, the government itself has issued a directive that forced banks to provide only 20 percent from their total loan disbursement for long term.
“So how could we bypass this directive?” he asks.
“In my view, the finance that the government collected from the banks and released on the market in unproductive ways has cost the country,” he added.
According to NBE directive MFA/NBEBILLS/003/2018, from the total loan disbursement banks should provide 40 percent for short term, 40 percent for medium and the balance 20 percent for long term loans.
Experts told Capital that under the Home Grown Economic Reform Plan, the government has targeted to facilitate different instruments to finance pro development policy projects. “The government wants to use various monetary instruments including reducing government borrowing to control the money supply and inflation,” these experts said.
According to the first quarter data of the 2019/20 financial year, the private banks bought close to 95 billion birr worth NBE Bill.
The data indicates that Dashen Bank has purchased a huge amount of bill under the NBE directive. Dashen purchased 12.6 billion birr worth of bill, followed by Awash Bank by 11.8 billion birr, and Cooperative Bank of Oromia and Bank of Abyssinia by 8.9 and 8 billion birr respectively in the first quarter.