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    BusinessCost of protection: Banking sector

    Cost of protection: Banking sector

    Date:

    Reports of difficulty to import essential commodities like food and medicine have taken the nation by surprise, during the past few week. Local banks have more or less stopped writing letter of credit contracts as their foreign currency account suffered a serious blow in recent years. Scores of FDI companies and other multinationals working in and with Ethiopia are also expressing concern with regards to delayed payments and profit remittances caused by the foreign exchange problem. Hence, the culmination of all these events is leading some commentators to urge the government to reconsider another alternative: opening up the banking sector for foreign financial institutions, writes Asrat Seyoum.

    Cost of protection: Banking sector

     

    Ethiopia has never been short of perplexities and conflicting narratives. This is particularly true for its economic development. These days, Ethiopia’s growth narrative is becoming as interesting as ever. From a distance, with IMF’s 8.5 percent annual growth projection, which puts the nation above Ghana as the fastest growing economy in African, Ethiopia appears to be on its best form yet. Especially in the context of recent challenges like political instability and the worst drought in the past 50 years, the growth figures that the country is pulling off is puzzling.

    On the other hand, a recent face-to-face meeting between the business community in Addis Ababa and the new Prime Minister Abiy Ahmed (PhD) draws a completely different picture. Abiy touched up on various economic issues at the gathering but none of them grabbed the attention of the public like the foreign exchange problem. The new PM, with unprecedented level of frankness, admitted to the debilitating foreign exchange shortage the nation is facing and went to the extent of besieging members of the business community to stop syphoning wealth overseas thereby drenching the nation’s meager foreign currency reserve. In fact, Abiy went even further and requested the immediate return of capital which he said (jokingly) has flown to place like “China and Dubai”.

    Accentuated by the PM’s remarks, Ethiopia is currently facing one of its worst foreign currency crises in years. With dangerously low nationalreserve (covering only 1.2 months of imports), reports of difficulty to import essential commodities like food and medicine have taken the nation by surprise in the past few weeks. Local banks have more or less stopped writing letter of credit contracts as their foreign currency account suffered a serious blow in recent years. Scores of FDI companies and other multinationals working in and with Ethiopia are also expressing concern with regards to delayed payments and profit remittancescausedby the foreign exchange problem.

    Hence, the culmination of all these events is leading some commentators to urge the government to reconsider another alternative: opening up the banking sector for foreign financial institutions.

    Financial liberation or opening up of the banking sector hasalways been some sort of a taboo among policymakers in Ethiopia. Perhaps it still is. However, at the cusp of a major economic upheaval, pundits argue that it is time for Ethiopia to revisit this longstanding closed-door policy.

    Nevertheless, for the past 20 years, the Ethiopian banking sector has been closed off for foreign financial institutions, while domestic liberalization of the sector has given rise to some 16 private banks with combined asset value of 314 billion Birr (USD 9.3 billion at current exchange rate).Today, Ethiopia stands among few countries in the world including North Korea to completely block foreign banks from operating in the country.

    Formulated by the late Prime Minister, Meles Zenawi, the policy of shielding local banking sector from competition is premised on one big rationale: the infant industry consideration.

    It is a rather simple proposition;it is about affording infant local industries and their players the protection they require from developed foreign competitors until they generate the capacity to withstand international competition. Hence, banks in Ethiopia largely operated in a shielded environment for more than two decades. Nevertheless, after all this time, commentators have serious concerns regarding the capacity of protected banking sectors in Ethiopia.

    “To be honest, in the past 20 years, the banking sector has come very far from where it started,” says Gemechu Waktola (PhD), an assistant professor at the College of Business and Economics, Addis Ababa University (AAU), and CEO of Icapital, a local consulting firm. In his view, the protection provided to local banking sector paid off in a sense that Ethiopia today has relatively stronger privately owned banks as opposed to state-owned and highly inefficient banks in the previous regime.

    As far as operational profit and loans and advances are concerned, the “infant” banking sector in Ethiopia has been doing extremely well. In fact, in the first nine-month of the current fiscal year, the 16 private banks in Ethiopia have recorded a combined profit of 8.4 billion Birr (USD 248 million).Accordingly, most of these banks have been enjoying a supernormal rate of Earning Per Share (EPS) with some of the big ones recording as high as 92 percent EPS and the majority posting EPS above 30 percent over the years. The combined deposit and loan portfolio of these banks has reached 249 Billion Birr and 172.5 Billion Birr, in the same period, respectively.

    “Yes, we have grown in size over the years,” says Atikilt Admasu, Director at Debub Global Bank, however, he is not sure if that growth actually implies improvement in bank’s competitiveness and efficiency. He also told The Reporter that the banking sector has made limited investment in technology and networking (core banking software); and yet he admits the sector has not made much headways in terms of banking services and products.

    “Our financial products are very outdated and there are some products which are not in use in the rest of the world anymore,” Atikilti says. As far as Gemechu is concerned, there is no need for deep scientific investigation to understand that Ethiopia banks are not at the level where even African banks are, at this time. 

    “They are not competitive in terms of innovation and offering diversified banking services,” Gemechu argues. This is especially true with regards to integrating the financial services technologies (Fin Tech) to their day- to-day operations, he goes on saying. “And some of our banks are lucky if they can exploit or make use of 50 percent of the banking technologies they acquire before it becomes outdated”.

    This shortfall gets more apparent when one considers the human capital of most of Ethiopia’s local banks. “In comparison to African banks like Standard and Zenith, the human resource of Ethiopian banks leaves much to be desired,” he added.

    As far as Atikilt is concerned, the regulatory capacity in Ethiopian closed-off banking sector may even be worse off than it was twenty years ago, although people like Gemechu argue that the role of National Bank of Ethiopia (NBE) in keeping the sector relatively stable and improving corporate governance is something that deserves recognition.

    So, the question still remains; “has protecting local banks paid off in Ethiopia?”

    In fact, for Gemechu, it is even backfiring at this moment. “I think the protected learning environment has overstayed its welcome in the sector; it is clearly extended for too long and is now backfiring,” Gemechu told The Reporter. And he argues this has one critical impact in the sector. Because it has stayed for long, the protection regime and its resultant supernormal profit have created a culture of amassing huge profits(by Ethiopian standards).According to him, EPS has now becomethe number one priority to shareholders across the banking sector rather than investments on competitiveness enhancing technologies.

    By all measures,bank shareholders in Ethiopia are now used tosupper normal profits. Even bank leadership bodies have been conditioned to please their shareholders than responding to competitive market condition and have no long term strategic goals. It is all about the short term bottom line, he says.

    Atikiltalso shares Gemechu’s observation about shareholders’ pressure on managers to keep focus on short termbalance sheet. But, he also says, “there is learning curve for shareholders”.

    “These days, shareholders understand that this EPS bonaza is not sustainable; for instance, those enjoying high earnings have come to learn that it could not be sustained for more two or three years,” he says.

    According to experts, the operation of the local banks in Ethiopia has defied most of consideration in the “infant”industry argument and as such the same argument can’t be made in favor of protection these days.

    In retrospect, as much as protection was important for emergingindustries it is also something that should have been managed well, according to Gemechu.

     “I don’t believe NBE’s regulatory approach has been strategic,” he argues. “To begin with, it should have set a specific deadline for the protection to elapse; and also lay down what is expected of the banks by the end of this time period.”

    Not only that, Gemechu is also convinced that the central bank should have planned the opening up of the sector at the end of specific time period where the protection would end. Regardless, he believes that the country should start somewhere, sometime. And he argues this is as good a time as any.

    As a matter of fact, for economists like Costentinos Berhe (PhD), lecturer at Addis Ababa University graduate school, Ethiopia is running out of options to fix its economic malaise in connection to foreign exchange and shortage of finance.

    “Debt stress is becoming an issue now. The nation is expected to service some one billion dollar this year; and until it services its debt it can’t take extra loan. So,the source of finance is increasingly shrinking,” he argues.

    According to Costentinos, debt servicing requires considerable amount of foreign currency; so he argues the country needs foreign exchange badly.

     “The manufacturing sector could not perform because it does not have adequate raw material and spare parts,” he explains. In his view,the private sector has reached a level where it could not access loan both in terms of foreign exchange and local currency since banks are not in the position to satisfy these demands.

    Based on all of these, Costentinos asserts that foreign banks offer another viable option for both of our financing and foreign exchange problems.

    “When foreign banks come they come with strong business plan to lend to the most viable projects in the private sector. In one hand, the private (foreign direct investment) sector will no longer have to compete for scare credit with government projects. On the other, FDI companies which are benefiting from the credit of both their home banks and our own Development Bank of Ethiopia (DBE) are enjoying liquidity that Ethiopian businesses are not; so the entry of foreign banks will level the playing field,” he asserts.  

     

    Notwithstanding the challenges of foreign exchange, people like Zemedeneh Nigatu, Global Chairman of Fairfax Africa Fund, cautions that foreign banks should be taken as the “silver bullet” to the currency problem. Atikilt, on his part, is of the view that the foreign currency problem, being a structural issue, should not be a determinant in opening up the financial sector.

    Furthermore, Costentinos makes a strong case for opening up the sector by arguing that foreign banks would eventually promotecompetition and efficiency in the banking sector.

    All the same, apart from the infant industry argument, Ethiopian policymakers are also suspicious of foreign banks for their potential of disrupting the financial sector and causing instability. Well, there is a wide body of literature, addressing the correlation of opening up the financial sector and the eventuality of banking crisis in the developing world: Latin America and Asian.

    For Gemechu most of these fears by Ethiopian policymakers is nothing but unreasonable jitters about something they now little about.

    “There are a number of models which can be used by the regulators to open up this sector,” he argues. In fact, a number of studies in this area assert that various countries use various forms of restrictions when they open up their banking sector.

    The availability of many safe liberalization options is in fact something that all the three commentators agree on.  True to form, countrieswhich have opened up their financial sector fairly recently,employed entry restriction, restrictions in ownership composition and strong operational restrictions.

    As far as the entry mode is concerned, the entrant bank could be compelled by host country to come either via branches, subsidiaries or in joint venture with local banks, depending on the policy target that could be reducing its risk to financial instability. On the other hand, foreign banks could also be restricted to have direct ownership control beyond a certain level in the financial industry.

    Perhaps, a more commonly used restriction is the operational restriction, which refers to the nature of the financial intermediation or number of branches in the host country.

    “Letting in foreign financial institutions does not necessarily mean giving thema pass to have free operation,” Costentinos argues.

    There are all kinds of operational and ownership restrictions that can be exploited to protect the local banks, he continues to explain. “For instances, in places like Dubai foreign banks entry have been managed in way that benefits the local economy. Most of them are not allowed to accept deposits and to expand branches across the nation that gives competitive edge to local banks since they are the ones colleting deposit and making all the profitable lending. They also can borrow foreign currency from these banks making the linkage and complementarity work for the economy.”

    Zemedeneh has different perspective when it comes to opening up the sector. As far as he is concerned, Ethiopian banks would not stand a chance once the sector is liberalized and hence he insists that it has to go through a serious consolidation process.

    “Ethiopian banking sector has to consolidate and reduce their number to four or five if they are to survive in the global market place,” he stated.   

    However, the weaknesses of developing countries’ regulatory organs to deal with these “supposedly sophisticated” financial institutions is also another grieve concern to Ethiopia. Both Costentinos and Atikilt are adamant about reinventing the regulatory organ in Ethiopia before opening up the sector. Meanwhile, Ethiopian policymakers are unsure if the overall state structure even had the potential to put together such a strong regulatory organ;if it is at all possible in Ethiopia in the near future.

    Both commentators take issue with this. Costentinos argues Ethiopia has not tapped into its human resources so far and it is time to do that now. Meanwhile, others also argues that regulatory strength is something that comes with exposure and experience and that it will be difficult to gain if there is fear to even try.  

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