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    Money TalksUndiversified Credit Portfolio: Tickling Bomb in Banking Industry

    Undiversified Credit Portfolio: Tickling Bomb in Banking Industry

    Date:

    No business is as lucrative as the financial sector in Ethiopia. Of all share companies, it is only banks that pay dividends without an interruption of a single year. It is these establishments that declare a profit in the very first year of starting operations. While many share companies in other sectors struggle to stay afloat, every reporting period is a profitable year for investors in the financial sector.

    It is uneasy to come across a business that pays a dividend of 50 percent for every penny invested, unless it is a bank in Ethiopia. It is no surprise, considering the huge appetite for credit and foreign currencies, the two major source of income for banks. What is perplexing, however, is when these institutions report a profit upsurge or spike in bad loans, a rare incident in the banking industry. A case in point is the latest performance of Lion Bank.

    Established 15 years ago with a paid-up capital of 108.2 million birr, Lion Bank has been among the financial institutions that were able to climb the ladder of success, in major parameters, including profitability, deposit mobilization, foreign currency generation and return on equity, in a very short period of time.

    In the last five years, Lion’s deposit grew by an average of 45 percent, while the Bank’s income also saw almost similar upsurges during the same period. Similar change has also been witnessed in the profitability of the bank. Its profit overshot from 3.7 million birr when it fully started operation in 2009 to 780 million birr, with a five-year average growth of 35 percent.

    For the banks management, who were expecting another successful year, things changed direction as of late. The Bank’s profit dwindled by 366 million birr to 414 million birr and its earnings per share fell. This is an outcome of falling business activities, portrayed by a fall in deposits and a soaring uncollected credit.

    Lion’s savings deposit, for the first time since its establishment, saw a 900 million birr decline, to almost 20 billion birr, a situation rarely reported in the financial sector. The war in the north disconnected the bank from many of its customers based in Tigray, leading to a surge in Non-Performing Loans to 16 percent by the end of the last fiscal year.

    “The outbreak of the conflict in the northern part of the country rendered almost all branches in the region remain dysfunctional, while many branches have been looted and damaged, causing immense financial damage. Many of our borrowers also have their businesses affected, hence remain unable to repay, with consequences on bad debts and losses,” said Gebrehiwot Ageba (PhD) Chairperson, Board of Directors of Lion, while explaining why the Bank has underperformed in the last fiscal year in his message to shareholders.

    It is not only Lion that has gone through similar experience. Wegagen Bank, another financial institution with a larger customer base in North Ethiopia, particularly in Tigray Region, has also felt the pinch of the war than any other commercial banks. Its net operating income plummeted from 2.9 billion birr to 2.6 billion birr, leading to a drastic fall in its gross profit from a little over one billion birr to 193 million birr. Earnings per share fell by five folds to 6.7 percent, a performance that has left its shareholders disappointed.

    Industry insiders believe the sudden fall is linked with customer diversification, which is important in sustaining profitability in the financial sector. “Though they are not the only ones with a similar business strategy, the underperformance of the two banks is an outcome of a failure to diversify customers,” said a senior executive working in one of the private banks in Ethiopia.

    Building a diversified portfolio is one of the principles of investment. Experts agree on its importance to build a successful business empire that is not exposed to any kinds of shocks. It is critical to reduce the overall investment risk, a critical aspect of business often overlooked in the banking industry. Though almost all banks have a diversified credit portfolio in terms of sector, the same trend may not hold true as one goes through the background of their borrowers and deposits.

    The establishment of banks based on affiliation has been reflected in their operational activities. Shareholders have an influence over key financial decisions of banks as they are major sources of deposits. In fact, when promoters of banks that are under-formation persuade businesses invest in their establishment, they usually return the favor by facilitating credit once they start operations.

    Though executives of banks try to offset this by diversifying their deposits and customer base, little has changed due to their ownership structure. Even some banks reported a sluggish performance in terms profit and return on equity as shareholders are hit with a bolt from the blue.

    “Few have an access to credit and this signals there is a risk in accumulation of credit,” said Abraham Terecha, a banking expert with over eight years of experience, who believes the banking industry will not remain solid unless a solution is given to diversifying customers, despite the impact of ownership structure in doing so.

    Abraham believes commercial banks must learn from their counterparts in the insurance industry, which he believes operate by analyzing every business based on its risk on their financial performance. “Affiliation exists in every business, but it should be in line with risk management strategies of any firms, including commercial banks,” said Abraham.

    It appears the Board of Lion Bank understood the rush to diversify customers, as the impact of not doing so has been reflected in its daily operations.

    “On the Board’s advice, ad-hoc committees from the management have been established to revitalize business initiatives in the areas of customer satisfaction, expansion and diversification of customer base. Accordingly, detailed action plans have also been approved and cascaded to the level of various organs at Head office and branches,” remarked Gebrehiwot.

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