Ethiopian Financial Sector Structure And The Liberalization Committee

Financial markets

Financial sector liberalization committee & Council of Ministers Draft Policy

In early 2022, the Ethiopian government set up a committee that would be responsible for replacing the current financial services code with a new one that allows more liberalization; specifically, one that allows for the entry of foreign banks. This was in response to banks from countries such as Kenya (Equity and KCB) expressing interest in being able to set up a full operation. This new financial services code was expected to be ready by December 2022.

In the last quarter of 2022, the council of Ministers (Cabinet of the Ethiopian government) issued a draft policy that allows for foreign ownership into its banking institutions. The draft allows for foreign lenders to acquire up to 30% equity stake and foreign individuals up to 5% equity stake. Additionally, these foreign banks will also be allowed to set p subsidies or open branches in the nation and get full banking license. Previously banks such as KCB had representative offices but were prohibited from providing certain banking functions such as extending credit and accepting deposits. However, KCB has increased its interest in Ethiopia and in April 2023, it has been reported that they are in talks with three potential lenders to acquire stakes in them.

Towards the beginning of this year the Prime Minister replaced the National Bank of Ethiopia governor with an appointee who was seen as more receptive towards the government plan of opening up the banking sector to foreign investors and also has experience with working with international partners such as IMF who are critical in providing financial and technical support to implement the HGER and 10-year plans.

Challenges faced in the past

Historically, the financial sector of Ethiopia has been led by state owned banks and this is the case till today. Additionally, these banks have had regulations that favored them compared to other privately-owned banks. For example, there was the 27 rule that was repealed in 2019.  This rule prompted promoted unfair competition in the banking sector as it was a rule that only applied to private banks. The rule stated that banks must purchase long term government bills at fixed interest rates using short term savings and deposits at variable rates. The amount of government bills purchased under this rule was by an amount equivalent to 27% of each new loan issued. This caused significant interest rate mismatch and liquidity risk as all the liquidity of the banks would be held up in long term securities.

The state of regulation of financial markets in Ethiopia

The regulator of the banking sector is the National Bank of Ethiopia (NBE). Some of the key mandates of the bank include:

  • Regulating interest rates and other costs of money
  • Providing short- and long-term refinancing facilities to banks and other financial institutions
  • Setting limits on the net foreign exchange positions and terms, and the amount of external indebtedness of banks and other financial institutions
  • Licensing, supervising and regulating the operations of banks, insurance companies and other financial institutions
  • Setting limits on gold and foreign exchange assets which banks and other financial institutions authorized to deal in foreign exchange and hold in deposits.

Being the regulator of the banking sector NBE plays a critical role in implementing the planned sectoral reforms under the HGER plan to achieve economic objectives under the 10-year plan. However, certain constraints limit the efficient operation of NBE as a regulator.

NBE has a monetary policy committee of which global best practices dictates that they be independent from the executive arm of the Government in order to set sound economic policies that are not a factor of political promises. However, in Ethiopia the macroeconomic committee within the Prime Minister’s office set the monetary policies. People appointed to lead the regulator are also political appointees and this compromises the independence of the regulator from the executive. Additionally, NBE has a compliance-based approach to supervision which is not effective given the fact that NBE is understaffed and has a high staff turnover. The supervision standard that they follow is based on Basel 1 and there are no minimum capital requirements for certain risks such as market and operational risk.

Another major challenge faced by NBE is their inability to regulated the biggest banks in Ethiopia that is the CBE and DBE that are both state owned institutions. This could be attributed to the fact that the board of both institutions tend to be political appointees and it is difficult for the state regulator to take any action against them or their institutions. It is almost as though CBE and DBE are able to operate and do as they please as enforcement on them is almost non-existent.

Risks in the financial sector in Ethiopia

There is lack of significant micro-prudential and operational oversight on CBE and DBE and this has exposed the banking sector to certain risks as they hold about two thirds of the assets in the banking sector. Firstly, there is significant concentration risk at CBE as it is used to extend loans to SOEs and purchase government bonds. Funding for CBE that goes towards government comes from NBE that grants liquidity to CBE using 5-year bonds. This practice exposes them to financial risks as some of their lending practices do not follow best market behavior.

On the other hand, Ethiopia lacks a non-banking sector that limits competition and innovation in the banking space. Minimum capital was increased in 2011 and 2015 that basically increased the barriers to entry. This together with the fact that the sector is still insulated from foreign competition to some extent.

Who are the major players?

According to the National Bank of Ethiopia the following institutions were licensed to operate in Ethiopia as at August 2022:

  • 29 commercial banks
  • 1 development bank
  • 40 microfinance institutions
  • 18 insurance companies
  • 1 re-insurance company
  • 6 capital goods finance/lease companies
  • 8 payment instrument issuers/system operators

The two state owned banks, Commercial Bank of Ethiopia (CBE) and the Development bank of Ethiopia (DBE) dominate the banking sector.

Author: David Kageenu