The two-decade-old financial system of Ethiopia appears to have been surmounted by a deep anxiety and strain these days. As the full repercussions of the much-talked-about 27 percent bond directive began to be felt in the industry, private commercial banks look as if they are waiting eagerly for the regulatory body to take a curative measure any time.
According to bankers, the situation that they have experienced during the past few weeks is matched by none undergone before. And, the key to the whole ordeal is, indeed, in the hands of the banking sector regulatory body - the National Bank of Ethiopia (NBE). As it stands at the moment, NBE’s actions appear to be on a 24-hour watch from the side of private banks. To their dismal, the core of attention in the financial industry - the 27 percent bond directive - is still fully in force.
If truth be told, the bank-dominated financial system has been in constant commotion in the past couple of years. From the end of 2008, regulation after regulations squeezed the relatively young banking sector. If not for the steep reserve requirements that the banks have to hold at NBE, it will be the credit cap or other corporate governance directives taking over the agenda. Upon the issuance of the directives that instituted the reserve requirement (15percent of the deposit) and liquidity reserves requirements (25 percent of their liability), sector players objected to the new rule on account of slicing away their loanable funds. As the directive stayed in the industry, the banks appear to grow accustomed to the rule and function within the directive. According to the research conducted by Access Capital, the reserve requirement withheld some 7.5 billion birr of banks’ deposit which was acquired at 5 percent interest per annum. Yet, it was just a matter of time before the industry went to the headlines again. The two reserve requirements already in place, the central bank followed up with a much constricting credit limiting edict that put quantitative restriction on the amount of loan that is advanced by the banks. The credit cap stayed long enough for ample debate and discussions to take place on the issue. The rationale behind the cap was the much needed contraction in the monetary variables which were taught to be behind the galloping inflation. After much altercation, finally the lending cap too was decided to be removed and the banks hoped for a much rosy future.
But, the expectation of the banks was far from what actually happened. Worse, NBE replaced the cap with the current bond purchase requirement that amounted to further squeezing whatever liquidity available at the banks’ disposal. In recent weeks, matters appear to be escalating as the banks begin to turn down either already processed or new proposals for credit. A bank professional who spoke to The Reporter in anonymity thinks that the bond directive is not going to be in place for long as they (the banks) are already approaching the point of virtual standstill. “It is like who can hold their breath under water the longest,” he says. Even the bigger banks are struggling to cope with the situation in just nine months after the directive went live, he explains.
If the estimates of Moshe Semu, president of Ethiopian Democratic Party (EDP) and banking professionals, were correct, assuming no growth on deposits, the directive has the power to wipe out the entire current deposit from the banking system in the country in a matter of four and five years. Moshe also argues that in real terms, the 27 percent of the deposit is, in fact, 33 percent in practice.
The macroeconomic handbook that Access Capital researches released last week also dwelt on the matter in a greater detail. Although Access Capital seemed more concerned about the relative shares of private credit and public credit from the overall loans, severe illiquidity of the banks and the credit starved private sector were also cited as alarming issues.
The central bank as well seems to be feeling the tension of the industry these days. Just last week, the bank pushed through an amendment on the two reserve requirement directives and lowered the percentage requirements of the two accounts allowing for more lending rooms. According to the amendment directives, the 15 percent was lowered to 10, while the 25 percent was slashed to 20 percent. Moshe says that the move does not amount to a significant improvement in the liquidity position of the banks, as long as the 27 percent of deposit continues to flow to government projects. “The private sector would continue to ache for credit as long as the directive is not amended,” he strongly argues.
Access’s projection on its part sees even a darker prospect for the private sector borrowers in the coming year. According to the handbook, in the coming years the growth of money supply in the economy would significantly go down to 20 percent as opposed to the 36 percent of last year. It is to be remembered that the government and other international organizations have pointed figures on the excessive money growth during the last fiscal year for the double digit inflation rate. Traditionally, money growth has been around 19 percent per annum and if the projection of Access Capital holds true, monetary growth would not be a significant source of inflation in Ethiopia. And the pledge made by government not to take direct advance from the central bank is the one and the main reason behind the access’s projection of lower money growth. While, on the other hand, projected decline in amount of foreign asset held by banks, yet again as a result of a projected pickup in imports that stayed low last year, is another factor inducing lower monetary growth and hence by expansion credit flows to the private sector. Of course, the 27 percent bond directive will continue to play its part in keeping the credit market (mainly for private sector) dry, noted the research.
In fact, the relative shares of private and public borrowings have shown significant shift during the last year. According to the above study, classically private sector borrowings have been more than twofold of their public counterparts. However, the data for 2010/11 shows that public borrowing have been closing in on its private counterpart. The share of the private sector credit, which stood at 46 billion birr at the moment, was in the neighborhood of 12 percent of GDP for the past couple of year; but it slipped to 9 percent of GDP during the last budget year showing a significant decline.
Nevertheless, from the point of view of the overall economy, the implication of the liquidity crunch of the private banks is not powerful enough to weigh down on GDP growth, at least in the short run, asserted the study. Here again, Access’s finding showed that only 95,000 borrowers are the main players in the country’s credit market. “For a country of 84 million people, the figure is a very striking one,” says the research. And, this shows that the credit-starved private sector might not bring about significant change in growth, except the fact that it would have been better in face of good credit facilities.
Nevertheless, there are many that disagree with the above assessment. For one, the professionals in the embattled sector itself say that the consequence would kill the private sector business and investment, as we know it. “Not to mention the banking sector itself that employees many people,” argues bankers.
Nevertheless, Access’s approach to the problem (the bond issue) appears to be more subtle and compromising for the most part. In fact, the research made five suggestions to keep the directive less painful, while still achieving its goal. “(i) usefully exempt loans to priority sectors, namely manufacturing and exports; (ii) apply the 27 percent calculation on the stock of loans at the end of a given period rather than on new lending flows; (iii) broaden the range of eligible instruments (such as including DBE bonds, Abay Dam Bonds, and other similar higher-yielding public sector instruments); (iv) allow banks to temporarily liquidate their stock of NBE Bills when warranted for short-term liquidity needs; and (v) adjust the interest rate to the same average levels that state banks receive when they lend to priority sectors so there is a level playing field between the two sets of banks.”
Regardless of the snags, however, Access review of the sector (banking) reveals that the sector was able to realize a pretty impressive performance in budget year. For example, on average private banks were able to secure some 30 percent return on their assets. However, Access also noted that the performance, though impressive, is not to be labeled as excessive, since the rate of inflation itself is above the 30 percent return on Assets.
In sum, as the bond directive is still alive and kicking, the banks are still left to deal with task of balancing their affairs and keep their heads above the water.
