Sometimes all it takes for the regulators at the National Bank of Ethiopia (NBE) to communicate a definitive action is a single email. The regulatory body’s decision to impose a six-month lending ban was communicated to commercial bank managers through email, but the action paralyzed the financial industry and degraded its performance.
Given the frequency of such communications in the previous two years, banks were not surprised when the central bank this week announced a new regulation requiring the purchase of Treasury bonds with a five-year maturity. Banks are compelled to invest 20 percent of their loan in government bond, which have an interest rate of just nine percent—much lower than their average lending rate, which stood at 14.5 percent by the end of the previous year.
“I was not at all surprised. How do you expect that such a policy would be communicated, given that the same institution did not seek our input before liberalizing the banking industry, a move that would have an impact on generations to come?” said a senior manager at one of the private banks.
Bankers have adopted the new rule with a grain of salt as they were already urging government authorities to change the mandatory rule that requires financial institutions to invest one percent of their annual balance of outstanding loans to purchase a bond from the Development Bank of Ethiopia (DBE). As the rule went into effect at the end of the previous fiscal year, banks had already paid 10 billion birr.
Banks will be required to invest nearly 90 billion birr in total to satisfy the two mandatory rules of the regulatory body, with the addition of the new rule that compels them to buy another bond with 20 percent of their loan and the 18 billion birr investment they are expected to make this year to buy the DBE bond.
This would raise the overall proportion of loans they are obliged to invest to 28 percent when combined with the reserve requirement of seven percent determined by their annual loan disbursement.
The new directive issued for the establishment and operation of the government bond requires banks to purchase the bond from their monthly loans and advances, with the ratio subject to change by the central bank as required.
Every year, the federal government is required to pay interest on the bond, which should be two percentage points greater than the minimum saving rate. This rate is now at seven percent, but it is anticipated that it will be changed very soon due to the inflationary pressure that is repelling savers from making deposits in banks.
“Though it comes at a time when banks are operating under tight liquidity and dealing with the ever-rising cost of mobilizing deposits, the new rule is better than the popular ‘NBE bill’ which used to compel banks to invest 27 percent of their loans to buy a government bond with just a five percent interest rate. This time around, at least, we will get a better yield from the investment,” the president of one of the private banks said.
The 27 percent mandatory rule, which was lifted less than a year after Prime Minister Abiy Ahmed (PhD) assumed office, made banks operate in a restricted liquidity environment for more than a decade, despite studies that suggest it had a positive impact.
Tesfaye Boru (PhD), president of Debub Global Bank, conducted a study that found that the bill had given private banks the option of investing their excess funds in interest-bearing government securities rather than the customary practice of holding their liquid assets in zero-earning accounts at the NBE.
“The pre- and post-policy period comparison revealed a relatively better profitability record for private banks during times of policy restrictions,” the study added.
The Parliament approved a budget of 787 billion birr for the current fiscal year. Government revenue from tax and non-tax sources will cover 61 percent of that total. A deficit of about 308 billion birr makes up the remaining 39 percent.
The deficit was intended to be covered by external donors and the sale of Treasury bills at a competitive rate, although that did not produce the anticipated results.
In fact, the government’s preferred means of financing the deficit was an advance from the central bank, which is tantamount to printing money. Although policymakers managed to reduce direct advances from NBE to 31 billion birr in 2019–20, it increased to 83.5 billion birr in the following year as the government faces a budget shortfall.
“We understand that the government has no choice but to bring the mandatory rule. Yet this should be supported by incentives,” said a senior banker at one of the private banks.