Monday, January 23, 2023

Handling astutely challenges of banking sector liberalization

The liberalization of the tightly controlled Ethiopian banking sector seems to be a step closer. In the past fortnight Prime Minister Abiy Ahmed (PhD) said on two occasions that the banking industry would be opened up to foreign competition as soon as the policy allowing it is adopted. Though he did not specify the exact time the policy would go into effect, he indicated that foreign banks should be able to set foot in Ethiopia once the necessary preconditions were met. Citing the fact that shielding domestic banks from foreign competition had benefited them until now, the premiere argued that the time had come to liberalize the sector and urged them to prepare themselves for the inevitable. Relaxing the restriction on foreign banks constitutes a reform of one of the last major sectors of the economy the administration of PM Abiy had pledged to liberalize when he took office in April 2018.

Although the first bank in Ethiopia opened its doors over a century ago, the industry was closed to the private sector for the majority of this period. After the military regime nationalized private banks in 1974, the government permitted the establishment of private banks in 1994, but limited the ownership of shares to Ethiopian nationals. The rule was relaxed in 2021, enabling foreigners of Ethiopian origin to become shareholders of such banks. Currently, the country’s banking sector is comprised of the central bank—the National Bank of Ethiopia (NBE) — a government-owned commercial bank, one state-owned development bank and twenty-one private banks with more than a dozen seeking approval to set up shop. The government-owned Commercial Bank of Ethiopia (CBE) dominates the market in terms of assets, deposits, bank branches, and total banking workforce. It holds more than 60 percent of total bank deposits, bank loans and foreign exchange.

Advocates of the move to open up the banking sector, namely international financial institutions, argue that the closure has constricted the Ethiopian economy from growing to its full potential. They are of the belief that a lack of foreign investment is preventing faster growth, highlighting the chronic shortage of foreign capital the country has been experiencing for decades. They further point out that foreign banks will not only help ease the exchange market pressure, but also introduce superior technology, know-how and products, thereby fostering greater competition, efficient allocation of capital,  acceleration of economies of scale, and facilitation of the import and export of goods and services. The liberalization would also align the banking system of Ethiopia with the global financial architecture, they also contend.

While most experts do not oppose outright the lifting of the prohibition on foreign banks from operating in Ethiopia and concede that its effects are beneficial in the long run, they caution against opening up the sector too much too soon. The bases for their warning are the pains the presence of foreign banks potentially inflicts including dealing a debilitating blow to domestic banks to the extent of bankrupting them as well as increasing the likelihood of systemic crises by providing an additional avenue for capital flight and “cutting and running” during a crisis. These risks could damage the economy in general and the banking sector in particular if the necessary preparations are not made in advance.

The decision to allow the entry of foreign banks into Ethiopia is in principle correct. It can have multi-faceted dividends if it’s prudently managed. Moreover, it is practically fait accompli given Ethiopia will sooner or later join the World Trade Organization with all its attendant privileges and obligations and has ratified the African Continental Free Trade Area Agreement (ACFTA), which has already come into force. Nevertheless, it’s imperative to undertake various measures aimed at cushioning the blow the entry of overseas banks is bound to cause. First, it’s vitally important to put supervisory and regulatory mechanisms in place to closely monitor their operations. This calls for, inter alia, the enhancement of the capacity of the regulatory bank. Second, the government needs to consider capping the limit of the shares foreign banks are allowed to hold initially and gradually lift the ceiling after assessing the benefits they bring about. Third, domestic banks must ready themselves for the stiff competition they will face to withstand by devising and executing a coping strategy, including initiating negotiations for possible merger to form a handful of string commercial and investment banks with a view to achieve capital consolidation and competitive edge. NBE can play an instrumental role in this regard by setting a high capitalization requirement. If the stakeholders in the banking sector undertake these and similar other preparatory steps ahead of time the benefits of licensing foreign banks will far outweigh the costs.

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