Wednesday, June 19, 2024
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Strengthening Ethiopia’s financial sector: The case for mergers in banking

In the business world, a merger refers to the joining of two companies into one entity. Advocates of mergers argue that they provide numerous benefits to the financial sector, including the weeding out of young banks, thereby strengthening the overall industry. However, some believe that the concept may be too cumbersome for Ethiopia’s nascent private banking industry, which they argue needs more time to mature.

Ever since the government expressed its intention to open the financial market to foreign providers, the inability of domestic banks to withstand the ensuing competition from their foreign counterparts has been a hotly discussed topic. Central bank regulators have frequently highlighted the need for mergers among existing providers. While a merger is not the sole survival mechanism for Ethiopian banks post foreign bank entry, it is the fastest route to growth and expansion.

To strengthen the financial sector, the National Bank of Ethiopia (NBE) has been developing a legal framework since April 2021 that will raise the minimum paid-up capital of all private banks to 5 billion birr (about USD 90 million) by the end of June 2026. This figure represents a ten-fold increase from the previous requirement.

According to the latest available figures from the NBE’s Financial Stability report, the Ethiopian banking sector comprises more than 30 banks, including one large public bank, five medium-sized banks, and 24 small banks, with a collective capital of 212.4 billion birr as of June 2023. However, one public bank dominates the market, with its total assets and deposits constituting almost half (49.5 percent and 48.7 percent, respectively) of the entire banking sector. Additionally, more than half of the country’s banks have yet to meet the new capital requirement.

Despite the fascinating consolidated results of the industry, there are also banks facing challenges in key performance indicators. Deposit contraction, soaring non-performing loans, and significant liquidity problems triggered by the pandemic have affected the industry. The two-year war and enduring policy developments, mainly from the regulator, have further impacted the sector, disregarding internal organizational factors and key partnerships.

Unofficial data indicates that three of the five medium-sized banks and 15 of the 20 small-sized banks have experienced deposit contraction compared to the previous year. This has compelled them to fight for liquidity, even at a high cost, while their paid-up and total capital has increased by 10 percent and six percent, respectively.

Although mergers are common in developed nations’ financial sectors, with the aim of reaping the benefits of economies of scale and minimizing competition, their presence in Ethiopia is not significant.

The history of mergers in Ethiopia’s financial sector is fairly recent. In 1980, the Ethiopian government merged Addis Bank and the Commercial Bank of Ethiopia to form what is now the Commercial Bank of Ethiopia (CBE). Prior to that, Addis Bank was created from the merger of Addis Ababa Bank, Banco di Roma, and Banco di Napoli, two Italian banks that operated during the imperial regime, all of which were nationalized by the Derg regime in 1975.

Before the 1980 amalgamation, only a few financial institutions had merged. For instance, the Ethiopian Investment and Savings merged with the Ethiopian Government Savings and Mortgage Company to form the then Housing and Savings Bank, which later became the Construction and Business Bank (CBB) in 1975.

More recently, in December 2015, the Government Financial Enterprises Agency announced the merger of two state-owned banks: CBB and CBE. According to the Agency, the move was intended to create one giant bank that would be competitive in Africa and worldwide. However, industry insiders claim that the merger was a way to help CBB, which was not performing well in Ethiopia’s competitive banking industry.

The experiences of Kenya and Nigeria in the past three decades offer valuable lessons as well. Kenya, with a population of around 54 million and an annual GDP of USD 113.4 billion, has witnessed 34 mergers and 15 acquisitions since 1989. These decisions were motivated by the need for increased capital, network and market share expansion. The merger and acquisition deals have benefited the economy to the tune of around USD 900 million.

Nigeria, with a population of 206 million and an annual GDP of over USD 472.6 billion , has seen 89 banks merge since 2004 as part of its banking reform efforts to restore public and global confidence. These mergers have contributed significantly to the growth of Nigeria’s real GDP.

However, mergers and acquisitions are easier said than done in Ethiopia’s financial sector regulatory environment and market practice, where several barriers hinder the process. Some of the challenges include a lack of experience, regulatory issues, and possible management resistance. Moreover, some of these institutions hold more than just business significance, as their formation involved ethnic representations. These banks carry deep appeal among their respective ethnic or religious communities. Thus, while mergers should be rational market decisions, a merger of two institutions with ethnic symbolism may appear to be a merger of two ethnic communities.

Therefore, it is crucial for the NBE to take the initiative and support banks by providing guidelines, training, and coordination for knowledge and experience sharing. While mergers and acquisitions may be a matter of survival for Ethiopia’s banks, pulling them off successfully is not a walk in the park.

Ethiopia’s banking industry cannot remain isolated from global challenges. It must build a shock-absorbing level of capital base, gear up for foreign and disruptive competition, and understand the changing global banking paradigm. Now is the time to initiate discussions between bank CEOs and influential shareholders to create synergy and build top-tier banks in the region through mergers.

(AmehaHailemairam holds a Master of Arts in Economics from Indira Ghandi University, with experience in the banking sector and as a financial analyst.)

Contributed by Ameha Hailemariam

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