The National Bank of Ethiopia (NBE) has announced that it will suspend the two mandatory bond instruments that banks were required to buy, even though it anticipated that Treasury bonds (T-bonds) alone would bring in 50 billion birr during the current fiscal year.

Regarding the introduction of the economic reform program on July 29th, the administration has pledged to implement several changes throughout the economy, including the banking sector.

Following a deal negotiated with international partners, such as the International Monetary Fund (IMF), the central bank has committed to suspending T-bonds by the end of this year and Development Bank of Ethiopia (DBE) bonds by the end of 2025, respectively.

Experts, including bankers, have applauded the action, stating that it will help the finance sector have enough liquidity.

The goal of the agreement between Ethiopian authorities and the IMF is to build the market for longer-dated government securities by gradually eliminating the requirement for commercial banks to acquire 5-year T-bonds at sub-market interest rates by the end of June 2025.

According to the agreement, the government will gradually phase out the requirement for commercial banks to acquire 5-year T-bonds by the end of June 2025.

In addition, NBE states that banks will be expected to purchase 50 billion birr of 5-year T-bonds at a 9 percent interest rate in the 2024/25 fiscal year.

Authorities have stated that the government intends to develop the market for longer-dated government securities exclusively through market-based mechanisms.

Additionally, the agreement stipulates that the requirement for financial institutions to buy DBE bonds will be eliminated prior to the Fund program’s fifth review.

The fifth review, known as the performance criteria period, will take place in April 2025.

Future domestic funding requirements will be met by market-oriented tools, according to government plans.

“The government’s net domestic financing is projected to shift predominantly to T-bills with market-determined interest rates, while SOEs are assumed to issue medium- to long-term bonds,” the document shared by the authorities and foreign partners states.

As required by the ‘Investment on DBE Bonds Directive No. SBB/81/2021,’ which went into effect on September 1, 2021, a commercial bank must invest at least one percent of all outstanding loans and advances each year in DBE bonds.

This investment requirement will continue until the total amount of bonds held by the commercial bank equals 10% of all outstanding loans and advances. Interest on DBE bonds is paid yearly, and the bond has a three-year maturity period beginning on the issue date.

The bond will pay a rate that is at least two percentage points greater than the minimum interest rate provided on a savings account at the time of issuance.

With the exception of DBE, a state-owned policy bank, all banks are required under the T-bonds directive (MFAD/TRBO/001/2022) that will become effective on November 1, 2022, to spend twenty percent of their fresh loan and advance disbursement on T-bonds.

Monthly T-bonds with a five-year maturity length and an interest rate two percentage points greater than the current minimum savings deposit rate of seven percent will be distributed to each bank.

The stock value of T-bonds, a domestic debt instrument that is 22 months old, was 80.3 billion birr as of March 31, 2024.

Bankers and financial industry specialists, such as former bank president Eshetu Fantaye, believe that the suspension of bonds is essential for banks to increase their liquidity.

The financial sector guru claims that “banks are currently struggling with a shortage of liquidity” and that “even today they are in a shortage of hands to buy foreign currency from the market.” Eshetu told Capital, “Of course, the bond suspension will have a significant contribution for them.”

Traders assert that the high commission demands from banks on the foreign exchange market may hinder the flow of hard currency to the black market, where smaller percentages are charged for the sale of foreign exchange. One solution to lower the commission charge rate that goes to correspondent banks is to use the guarantee of international partners.

Since the FX market opened last week, banks have been setting their own rates, which are increasing daily in order to reduce the purchasing rate with the parallel market. This has been commended by the governor of the National Bank of Ethiopia (NBE), Mamo Esmelealem Mihretu.

A day after the first foreign exchange auction in over 20 years, he remarked, “We are happy to see significant progress towards exchange rate stability over the past week, as well as a significant narrowing of the gap between bank exchange rates and parallel market rates.”

Traders and market specialists, including employees of certain banks’ forex bureaus, have noticed that the rate at which banks are selling foreign currency is sharply rising compared to the rate at which they have set to purchase it.

According to them, banks are now charging a fee of around 10% on foreign exchange sales, which they claim is excessively costly when compared to the parallel market.

“Black market players would leverage the advantage to continue their parallel business, which goes against the government strategy of shrinking the illegal exchange market with the new reform,” they expressed their concern, stating that “banks have to reduce some commission fees.”

According to industry experts, the commission fees for the parallel market are far less than what the banks are currently requesting.

“The commission fee that banks are demanding for currency is unseen anywhere else in the world,” a prominent businessman who wishes to remain anonymous told Capital.

Furthermore, experts have stated that in order to achieve the desired benefits of increasing the availability of hard currency through the legal system, the NBE must reduce the fee it charges for FX transactions immediately.

Since May 2022, NBE has been taking 2.5% of FX sales as a fee.

Former top banker Eshetu Fantaye, who currently consults with several local and foreign organizations and firms, mentioned that the forex transaction fee may be a government subsidy derived from traders to fund its operations.

The NBE fee distorts the market by suggesting that there are two rates. When the black market offers a cheaper rate for international transactions, particularly those originating from regions with lax rules, the transactions will gravitate towards the lower-rate provider.

Therefore, NBE should waive its fee in order to establish a single rate. According to a financial sector expert, the NBE charge may provide an opportunity for the parallel market to continue, as 2.5 percent is a high cost for large cash amounts against document trades, letter of credit, and remittance.

The expert stated, “Since it does not play a role in the transaction, the 2.5 percent NBE charge that banks are required to levy on exchange transactions should be discontinued. Instead, a service fee should be applied to the foreign currency that the central bank sells to banks.”

Eshetu recalled, “The International Monetary Fund (IMF) and the Ethiopian authorities have discussed that the government promised to remove this charge after the program ends.”

According to the terms of the agreement with the authorities for the economic reform program, which will be completed in four years, the IMF stated that the authorities will take action to eliminate the multiple currency practice (MCP) and exchange restrictions during the program period. They will also review the commission that the NBE charges after the full IMF Article VIII assessment.

With regards to the banking commission, Eshetu stated that currently, banks participate in the spot market without offering any risk mitigation services to their clients. He added, “So, the cost of providing foreign currency is very minimal, implying that the bank’s fee is unnecessary.”

“Banks are aware of their expenses; for example, they are currently more likely to invest their liquidity, which they will supply as a high-interest, ninety-day short-term loan that they will lock in by purchasing foreign exchange. Since the commission charge is determined by the market interest rate if the loan is supplied, it will be determined by the ninety-day cost of impact,” the expert said.

He advised banks to do assessments in order to determine the cost of letters of credit (LCs).

He emphasized that banks must offer a service that shields clients from fluctuations in foreign exchange rates over the course of ninety days.

For example, if a product is now worth 100 birr, but after banks settle the LC, it can reach 120 birr, with a 20 birr differential that would be passed on to customers.

“Banks should implement risk-mitigating instruments to prevent it from happening.”  He said that banks should focus on their hedging strategies, participate in the forward market, and take additional precautions to safeguard their clients.

“However, when it comes to spot buying and selling rates, the assumption of the cost of funds varies from bank to bank. For example, in certain banks, time deposits and savings account balances make up the majority of the current account balance sheet, which will increase the cost,” he continued.

The cost of hard currency is also significantly influenced by the banks’ relationships with correspondent banks, according to Eshetu.

“The correspondent banks charge certain boutique banks extremely expensive fees since these new and tiny banks might not have many transactions,” he says “In addition, foreign exchange translation fees are another expense incurred by international partners.”

When it comes to LC and cross-border payments, the charges imposed on large and small banks differ.

Eshetu, however, emphasized that the nation has been going through a difficult time lately because of problems with foreign exchange and debt restructuring, which have an impact on the nation’s sovereign rating, which is inferred by financial institutions.

“This is one of the causes of the ten percent in LC charges and cross-border payment fees.” He said, “The majority of the charges are not secured by local banks; rather, they go to foreign partners.”

He predicted that after the debt is restructured and fresh funding begins to enter the nation, the issue would be resolved gradually. He recommends using the Multilateral Investment Guarantee Agency (MIGA) guarantee of the World Bank as an urgent fix to reduce the LC costs generally.

Similar to this, as foreign correspondent banks get the majority of the LC costs, negotiating an expedient solution through the International Finance Corporation’s (IFC) guarantee is vital. According to the most recent announcement, the World Bank has stated that it is committed to helping Ethiopia achieve its goal of becoming a middle-income nation.

“Over the next three fiscal years, IDA expects to provide approximately USD 6 billion in new commitments and support economic reforms through fast-disbursing budget support,” the statement stated.

According to the statement, MIGA aims to increase its involvement, particularly through the World Bank Group Guarantee Platform, while IFC plans to contribute around USD 2.1 billion.

Subject to the Board’s approval of new operations and availability of IDA resources, this implies a total financial package of over USD 16.6 billion in undisbursed and future commitments available over the next three years.