Five years after teetering on the brink of a tumble due to alarmingly high levels of non-performing loans (NPLs), the state-owned Development Bank of Ethiopia (DBE) has staged an impressive recovery, its senior executives told federal legislators last week. The Bank has built a robust capital base of 39.7 billion Br, second only to the Commercial Bank of Ethiopia (CBE), another state-owned company.

A state-owned policy bank, DBE received a crucial lifeline four years ago when the Council of Ministers approved a capital injection of 28.5 billion Br. Shortly, the National Bank of Ethiopia (NBE) mandated commercial banks to purchase bonds DBE issues amounting to one percent of their annual loans and advances.

According to Tewodros Mekonen (PhD), a senior macroeconomist at the International Growth Centre (IGC), policy banks are financed through capital markets, bond issuance, government budgetary support, or financial flows from development partners. Over the past three years, DBE has raised about 39.04 billion Br from mandatory bond sales.

"I've not heard of mandatory bond purchases elsewhere in the world," said Tewodros.

However, these policy changes were instrumental in reviving the Bank’s performance over the past three years.

DBE's annual report for 2023 shows revenues of 8.5 billion Br and net income of 1.2 billion Br. Its robust financial standing, with total assets of 95 billion Br and total equity of 20 billion Br, results in a net profit margin of 14.12pc. This margin indicates the bank's efficiency in converting its revenues into profit, suggesting a strong control over costs and expenses.

However, the asset turnover ratio results in a relatively low figure, revealing that DBE's assets are not being utilized as efficiently. This inefficiency could be typical for development banks like DBE, which often focus on long-term projects rather than immediate returns.

The equity multiplier, a measure of financial leverage, stands at 4.75, revealing how DBE employs a substantial level of debt to finance its assets. While high leverage can boost the return on equity (ROE), it also introduces higher risk, particularly if the bank encounters problems meeting its debt obligations. However, its return on assets (RoA) improved from negative one percent five years ago to 4.9pc, and its return on equity (RoE) from -34.5pc to 21.9pc last year.

Financial analysts observe that DBE's executives could focus on improving asset utilisation by optimising loan portfolios and enhancing asset efficiency. Maintaining or increasing the net profit margin through effective cost management could contribute to a higher RoE. Balancing financial leverage to avoid excessive risk is crucial, as is ensuring sustainable debt levels and prudent leverage practices. DBE’s debt portfolio has seen substantial improvement, with the NPL ratio dropping from a high of 57.6pc to about 7.8pc, nearly half of the central bank’s requirement.

Mohammed Abdo, chairperson of the Standing Committee, sounded curious about how DBE managed to reduce its non-performing loans so drastically without resorting to a mechanism like the Liability Asset Management Corporation (LAMC), which absorbed over half a billion Birr of debt owed by several state-owned enterprises to the CBE. Yohannes Ayalew (PhD), president of DBE, attributed the success to disciplined loan portfolio management, which includes no rescheduling of repayments, no capitalisation of interest, and quick responses to non-performing loans.

According to the Ministry of Finance’s nine-month report, transforming DBE’s loans into long-term bonds has impacted domestic loan repayment rates. The government’s strategy of extending short-term debt instruments into long-term bonds has seen outstanding government bonds rise from 36.5 million Br four years ago to nearly 627 million Br in 2022/23. DBE’s liability-to-asset ratio has also been improving, falling from 0.913 five years ago when it had assets of 85.1 billion Br to the current 0.778 mark despite more than doubling its assets to 179 billion Br.

The macroeconomist noted that policy banks worldwide engage in long-term investments deemed unsuitable for commercial banks. These institutions, which do not take deposits from the public, must rely on feasible long-term projects to support government development goals.

"A certain level of high NPL is expected," he told Fortune.

Tewodros referred to successful policy banks in some Asian countries while stressing the need for robust management and adequate information to manage portfolios with broad risk successfully in the long run. This sentiment is echoed in a World Bank study, which notes that effective corporate governance depends on the flow of accurate, timely, and relevant information within development banks and externally to the government, legislature, and the public.