In preparation for Ethiopia’s forthcoming capital market, the National Bank of Ethiopia (NBE) is revising its current regulations to make it possible for commercial banks to take on investment banking functions. Because of their existing legal standing, retail banks are unable to perform the functions of an investment bank, necessitating the change.
The Capital Market Proclamation defines an investment bank as a “non-deposit-taking financial institution” that helps other businesses, governments, and organizations raise money. To achieve this goal, investment banks engage in activities such as underwriting, acting as an intermediary between a securities issuer and the investing public, assisting in mergers and other corporate reorganizations, and acting as a broker or financial advisor for institutional clients.
Existing commercial banks, on the other hand, cannot function as investment banks since they mobilize deposits. Officials from the Ethiopian Capital Market Authority (ECMA) and the Ethiopian Stock Exchange (ESX) urged that the central bank revise the banking business legislation.
“Currently, there are retail banks in Ethiopia. They are regulated by the NBE. The NBE’s main objective is to protect depositors’ money. On the other hand, capital market service providers like investment banks will engage in risky businesses. So the main objective is to avoid investment banks taking depositors’ money. That is why the role of an investment bank is clearly separated from retail banking,” said Sirak Solomon, capital market legal advisor at the Authority.
Sirak says that since the proclamation clearly states deposit-taking banks cannot be investment banks, “we are urging the central bank to amend the law to enable existing commercial banks to become investment banks and at the same time do their usual works including mobilization of deposits. This means banks will be regulated both by the NBE and the Capital Market Authority.”
The stock exchange is slated to go online by the first half of 2024. About sixteen service providers in the capital market ecosystem, including investment banks, will be licensed.
Officials at the Authority and the ESX project office management believe investment banking cannot be done without the local banks.
Investment banks basically evaluate the market values of securities such as shares. An investment banker is expected to have market expertise, set up companies, or merge companies. It also underwrites IPOs, buys them, and presents them on the capital market, or directly links IPOs with potential investors.
“There are no investment banks in Ethiopia. New investment banks can be established, but repurposing existing banks is preferred because of their experience in the industry,” Brook Taye (PhD), director general of the ECMA, said. He stated that they are waiting for the government’s decision.
In other countries’ practices, holding companies are formed with retail and investment banks as subsidiaries.
“The new Ethiopian commercial code allowed the formation of holding companies for the first time, but no holding company has been formed so far because the commercial code takes time to be fully implemented,” Sirak says.
He believes this will make it difficult for the NBE to order existing banks to be reestablished as holding companies. The existing retail banks can form investment banks as subsidiaries, which will not affect depositors’ money, according to Sirak.
The first proposal is to convert existing retail banks into holding companies. The holding companies will have subsidiaries that do retail banking, investment banking, and custodial service at the same time. If one of the subsidiaries fails, it does not affect the other subsidiaries under the holding company. The restructuring is recommended mainly to avoid any effect on depositors’ money if the investment banking business goes bankrupt.
The other option is allowing the existing retail banks to form a subsidiary arm that does investment banking activities separately. Both options have the same outcome.
“We have reached consensus with the NBE, and it is working on it,” Sirak said. “We cannot recommend to the NBE how they should regulate the banking sector. We are optimistic that a solution can be found, but the NBE will have the last say in this matter.”
He believes that a holding company will not be realized soon since the concept is very new for Ethiopia. “But what we have underlined for the NBE is that investment banking cannot be done without the existing financial institutions in Ethiopia. Nobody has more experience with the business environment in Ethiopia than the existing banks, insurance companies, and Micro Finance Institutions (MFI). They are very important for the capital market,” added Sirak.
NBE agreed to this recommendation and is already working on the amendments, according to the officials.
“Existing commercial banks will be able to play the role of investment banks. We are amending the banking business proclamation currently,” said Frezer Ayalew, banking supervision director at the NBE. Once the amendment is completed, banks will be permitted to serve as investment banks simultaneously.”