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Balancing inflation control and support for new banks entrants in Ethiopia

In recent years, Ethiopians have confronted an array of formidable hurdles, encompassing political instability, social unrest, and economic hardships, all of which have dealt a heavy blow to countless lives. The COVID-19 pandemic, coupled with geopolitical tensions, has wreaked havoc on the global economy, causing widespread disruption in production, supply chains, and logistics. Countries heavily reliant on imports for their fundamental necessities have suffered particularly grave consequences as a result of this global phenomenon. To compound matters, internal challenges within Ethiopia have further exacerbated the economic predicament.

The confluence of these global disruptions and internal predicaments has precipitated a steep surge in prices, impacting a broad spectrum of goods ranging from everyday consumables to real estate. Ordinary individuals and those with fixed incomes bear the brunt of this inflationary onslaught. Resolving this longstanding issue demands unwavering dedication, genuine analysis, and a collaborative endeavor involving diverse stakeholders.

In a bid to alleviate the impact of inflation, the National Bank of Ethiopia (NBE) under new management has recently implemented a series of policy measures. These measures primarily concentrate on enhancing supply chain activities, exercising fiscal policies to control government spending, and regulating monetary affairs. The overarching objective of these policy actions is to achieve single-digit inflation within a few years.

One of the key strategies employed to rein in inflation is the control of the money supply. The new measures acknowledge that both credit extended to the government and the private sector have contributed to inflationary pressures. It is evident that the substantial volume of money circulating in the economy plays a significant role in driving inflation.

In 2021 alone, commercial banks disbursed approximately 329.5 billion birr in fresh loans, marking a notable 21.5 percent increase compared to the previous year.

Ethiopia currently boasts a total of 30 commercial banks in operation, among which is the Development Bank of Ethiopia (DBE). These established banks have successfully mobilized significant resources commensurate with their size and have already disbursed funds up to their authorized maximum limit. This positions them to withstand policy changes more effectively.

Nevertheless, it is expected that new entrants will experience a more pronounced impact from these recent measures for several reasons.

First and foremost, new banks entering the market typically face a challenge in mobilizing substantial resources, which can lead to lower returns.

When credit growth restrictions are imposed in conjunction with these existing difficulties, it places these banks under significant financial strain. As a consequence, their earnings are likely to be affected, necessitating a reassessment of their strategies. This, in turn, will compel banks to reconsider their expansion plans, ultimately impacting their ability to mobilize resources effectively.

Secondly, the banking sector is characterized by fierce competition, which has driven new entrants to aggressively expand their networks in a bid to attract larger deposits and broaden their customer base. These recent market participants have embarked on an unparalleled level of network expansion compared to their predecessors.

An illustrative example is Amhara Bank, which, astonishingly, has managed to open a remarkable 272 branches within a mere year and a half of commencing operations as of August 31, 2023. However, given the expenses involved in running such an extensive network of branches and considering the newly imposed credit limits, it becomes evident that these policy measures will exert a detrimental effect on their profitability. The operational costs associated with maintaining these branches are likely to surpass the revenue generated from loans and other sources, ultimately leading to financial losses.

Thirdly, as part of the government’s initiative to attract foreign investment in the finance sector, it has revealed its intention to grant up to five banking licenses to foreign investors. In light of this development, banks have been directed to bolster their financial positions accordingly.

However, these new banks find themselves in a less advantageous position when it comes to mobilizing the necessary resources to increase their paid-up capital and establish themselves as strong competitors. Given the limited time available for foreign investors to enter the industry and the heightened importance of financial strength, the implementation of these new measures will disproportionately weaken these banks in comparison to their well-established counterparts.

While it is crucial to acknowledge the attention devoted to addressing inflation, it is equally important to assess the impact of these policy measures on new entrants. These measures are likely to affect new banks differently than those with more market experience and greater financial strength. Treating them on equal footing with established banks poses risks. Therefore, it is imperative for the NBE to develop a mechanism that safeguards the interests of new entrants while effectively addressing concerns related to inflation.

Contributed by Abreham Terecha

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