Ethiopia's financial industry is undergoing substantial transformation under the stewardship of Governor Mamo Mihretu, the 10th governor of the National Bank of Ethiopia (NBE). The series of reforms introduced over the past year signify a shift to address longstanding macroeconomic imbalances and position the country’s banking sector on par with international standards.

Recently, the central bank announced a shift from a quantity-targeting monetary policy to an interest-based market model, incorporating indirect policy instruments to meet price stability targets. The reforms include biweekly central bank auctions, policy interest rates initially set at 15pc, and standing overnight facilities to manage a liquid interbank market.

"This is a major shift," Mamo noted.

Last month, the central bank issued five directives to regulate corporate governance and asset classification, marking a major move towards prudential oversight. The directives mandate banks to maintain comprehensive databases of related party transactions and updated credit profiles, pushing for transparency and risk management. Banks have three years to comply, with action plans required within 90 days.

Industry leaders like Neway Megersa, president of the two-year-old Siinqee Bank, and Dereje Zenebe, president of Zemen Bank, have largely welcomed the reforms, acknowledging the need for improved corporate governance and risk management. However, they call for flexibility in the implementation timeline, recognising the operational challenges banks face.

Neway tasked his legal and risk departments with assessing the operational implications of these changes. He reports that action plans are nearly finalized for most of the directives, emphasizing the positive outlook for the sector.

"They're a healthy set of evolutions," Neway told Fortune.

One compliance requirement is maintaining a database of all related party transactions and credit exposures, along with a constantly updated registry of credit profiles. Neway stresses the importance of investing in technology infrastructure.

"Any bank failing to invest heavily in improving its technology infrastructure will be swallowed by competition," he said.

He believes that the new regulations on related party exposure and asset classification will ensure the long-term integrity of the banking sector.

"Some banks might have to sift through their loan portfolios carefully," Neway said.

While he welcomed the enhanced supervision aimed at financial stability, he is particularly optimistic about the prospects of open market operations and an active interbank market. He expects the vibrant interbank market to improve overall liquidity and help newer banks establish a solid financial position. This anticipated liquidity boost is crucial for maintaining stability and fostering growth in the sector.

NBE's latest draft for re-establishment strips key powers from the executive in issuing Franco Valuta permits, clears areas prone to conflicts of interest, and positions the central bank as the primary force dictating monetary policy. Dereje sees these developments as promising for industry stakeholders, emphasising the importance of the central bank's independence from the government.

"The status quo needed to change," Dereje told Fortune. "It's evident what that has done for us."

Ethiopia's 31 banks, which have issued nearly two trillion Birr in loans and advances as of June 2023, maintain a Non-Performing Loans ratio of around 3.6pc, below the regulatory five percent threshold. Dereje said the latest directives are important in reducing risks within the financial industry, empowering depositors, and mitigating systemic risk from bad credit.

"Banks now belong to depositors more than they do to shareholders," he said.

Dereje expects the NBE to show some flexibility regarding the haste with which banks must comply with all conditions, as some may need to conduct a deep dive into their loan portfolios. He also foresees liquidity improvements across the banking industry from the endorsement of vibrant interbank market operations and overnight lending facilities.

Seven months ago, the NBE revealed a three-year strategic plan outlining five objectives to restore fiscal and monetary stability. The three-year strategic plan and the new proclamation to re-establish the NBE’s autonomous position represent a clear intent to strengthen the central bank's role in ensuring fiscal and monetary stability altering its 62-year trajectory. The reforms are part of a broader effort to modernise the banking sector, which has remained relatively isolated since the last batch of foreign banks, including the Addis Abeba Bank (40pc owned by the British Grindlays), shut down operations in 1975. The potential re-entry of foreign banks is expected to bring much-needed capital and expertise, stimulating competition and innovation in the banking sector.

However, some financial industry stakeholders feel left out by the rapid changes. Dawit Keno, president of Hijra Bank, a full-fledged interest-free institution that received the central bank's nod three years ago, feels that its industry segment has not been adequately addressed in the new regulations. While he appreciates the stringent controls on assets and corporate governance, Dawit hoped for more detailed provisions for interest-free banking in the draft proclamation. He suggested an inclusive approach to the banking reforms.

"A dual banking system should be considered," Dawit told Fortune.