Special to The Reporter
Recently, a Policy White Paper (PWP) on Banking Law reforms has been submitted to the Ministry of Justice of the Federal Democratic Republic of Ethiopia. The document contains nine sections and twenty-five pages, covering a range of issues pertaining to banking.
The aim of the PWP is to provide inputs to private law banking which are found in Part III and IV of the Commercial Code Proclamation No. 166/1960 and not included in the Commercial Code Proclamation No. 1243/2021. At the same time, an amendment is being deliberated to make the banking business proclamation (Proclamation 592/2008) agreeable to foreign bank entry.
Historically, Ethiopia maintained a distinction between public and private law banking. The earliest act, Proclamation No.206 of 1963 (Monetary and Banking Proclamation, 1963), detailed the public law of banking while entrusting the National Bank of Ethiopia (NBE) with the regulatory role. The Commercial Code, which was enacted a few years earlier, set out the rules regarding the transaction law of banking. Although the public law of banking has made several changes over the past six decades, this separation has been maintained to date.
The latest banking rules are found in Proclamation 592/2008 and Banking Proclamation Amendment No.1159/2019 (related NBE directives and circulars) and the Commercial Code of Ethiopia (1960). The purpose of the public banking law is to ensure a stable and sound financial system. The law is complemented by a large number of directives and circulars, dealing with a range of issues: bank entry and operation, capital adequacy; asset valuation and provisioning, activity restrictions; and corporate governance, among others.
What is perplexing is that the Ethiopian public banking rules give little attention to competition. This is manifested in the dominant position of the state banks, their preferential status, and some collusive behaviour of the private banks.
The dominant position of the state banks in Ethiopia has both historical and ideological roots. For instance, over the past two decades, the Commercial Bank of Ethiopia (CBE) has grown by leaps and bounds as a result of special privileges and regulatory forbearance based on the philosophical underpinning of the developmental state model.
The philosophical underpinning that supports the state intervention in the banking sector using a range of instruments (state ownership of banks is a direct form of intervention) is crumbling. There is no justification to provide the state banks with extra privileges so that they remain dominant in the banking industry and cause considerable market distortions. Apart from the distortions, the existence of such “too big to fail” or “too important to fail” banks poses a significant systematic risk to the industry. The risk arises from their enormous credit exposure to the state-owned enterprises (SOEs).
What is even more puzzling is that the dominance of the state banks in the banking industry and their preferential treatments are tolerated, although Ethiopia has enacted a series of proclamations to promote competition in trade and services and protect consumers since 2003.
In the era of foreign bank entry, the public law of banking needs to include provisions regarding banking competition. This involves setting out the rules that create a level playing field for competition for all banks. A couple of issues are very crucial with regard to the state banks.
First, the gradual withdrawal of the privileges afforded to them. Second, subjecting them to the same prudential regulations as private banks. Fostering competition in the banking industry does not mean letting unbridled competition reign. Global experience shows that although many countries have rules against collusive behaviour and abuse of dominant positions, banking competition policy has shifted between the promotion of competition and toleration of concentration.
Despite the apparent benefits of competition, regulators often tolerate concentration as the cost of financial instability arising from increased banking competition is substantial. When crafting its banking competition policy, Ethiopia needs to strike a balance between competition and stability.
What should go hand in hand with fostering banking competition is reforming the National Bank of Ethiopia (NBE). This entails reconstituting the NBE as an independent regulatory body. Regulatory independence enables the NBE to enforce regulatory standards across banks uniformly. This enhances the stability, soundness, and competitiveness of the Ethiopian banking industry.
Contributed by Abdulmenan Mohammed (PhD)