A road sign around Zewditu leans into the main road as if desperately reaching to remind passers of road safety. The Addis Abeba Transport Bureau has recently started to issue tickets to transgressing pedestrians in a last-ditch effort to reign in traffic accidents. The recent nine-month performance review by the capital’s transport bureau revealed that around 286 people have died, with the majority being working-age young men. Massive digitization of the road infrastructure has been underway for the past four years, with a smart traffic management centre around Megenagna and self-regulating traffic lights in condensed areas, which has not yet materialized.
Author: Tizita S.
High-Level Event Aims to Address Humanitarian Crisis
Development partners and government officials are expected to discuss improved humanitarian responses at a crucial event in Geneva, Switzerland this week. Co-hosted by the Ethiopian government and the UN Office for the Coordination of Humanitarian Affairs (OCHA), the primary goal is to secure pledges from both development partners and the government, according to officials.
Millions face hardship due to conflicts, economic downturns, climate shocks, and disease outbreaks, according to a UN statement. Last year’s aid diversion incident eroded donor confidence, calling the need for stronger accountability. Development partners will pledge to increase resources and advocate for sustainable development strategies. Collaboration with humanitarian organisations will be crucial for boosting the impact of aid on vulnerable populations.
Partners will urge the government to prioritise emergency funding, implement pro-poor policies, and strengthen accountability measures to prevent future aid diversions. Calls are expected to be made to streamline bureaucracy, ensuring tax exemptions for humanitarian goods, simplified visa/work permit processes, and the safe, voluntary movement of internally displaced persons (IDPs).
Foundation Announces Up to $2.5m Grants for Agribusinesses
Small and medium enterprises (SMEs) in the agricultural sector are poised for financial support as the Mastercard Foundation Fund pledges to award grants over the next three years. The Agribusiness Challenge Fund will award grants ranging from half a million dollars to 2.5 million dollars to qualifying businesses in Ethiopia and 19 other countries.
According to Smita Sanghrajika, an engagement partner at the Foundation, agribusinesses have lacked the financial resources needed to scale up and improve their business practices.
The program aims to empower agribusinesses by providing financial resources, mentorship from established businesses, and technical assistance. Organisers hope to create jobs, increase agricultural productivity, and accelerate the commercialisation of agricultural products.
Daniel Hailu, executive director of Pan-African Programs at the Foundation, emphasised that the project aims to act as a catalyst for growth and propel participating businesses to reach their full potential.
The application window is open for 12 weeks, closing on November 22, 2024. Unsuccessful applicants will have a chance to re-apply with improved proposals.
Document Authentication Service Gets Fee Revamp
The Council of Ministers approved a new regulation for the Federal Document Authentication & Registration Service last week which introduces a two-tier fee structure for citizens and foreigners, with an overall increase.
Beginning at 100 Br for citizens seeking document authentication for an assigning agency of single documents, the ceiling goes up to 500 Br while foreigners pay double these rates.
Implementation of the new fees began this week. These changes come alongside a digitisation effort, serving about 7,000 people daily. According to officials, the goal is to improve service efficiency and reduce wait times. In the past nine months, the Service has identified over 1,000 fraudulent documents submitted for authentication. The 85-year-old institution recently partnered with Oberthur Solutions, a French company, to improve its digital archiving process. It has also offered the option to pay through Telebirr, a mobile banking service, for the past two years.
Ministry Consults on New National WASH Program
Officials at the Ministry of Water & Energy are launching a new 10-year National Drinking Water, Sanitation & Hygiene (WASH) Program, funded by a 500 million dollar World Bank loan. It aims to improve access to clean water and sanitation services across 118 weredas.
A consultation forum aimed to gather input on the program’s design and implementation was held last week. Kebede Gerba (PhD), advisor to the Minister, outlined key changes such as a shift from an input-based approach focusing on construction to a results-based payment system. He said the funding will be tied to achieving specific service delivery goals while ensuring service providers deliver at the best of their capacity.
Asfaw Dingamo, state minister, stressed the importance of policies and strategies to ensure fair and sustainable service delivery. He said the government’s role in coordinating WASH sector activities since the establishment has room for improvement with most residents lacking access to the essential services.
EU Renews National, Continental Commitment
European Union delegation pledges continued humanitarian aid, strong trade ties, and support for major infrastructure projects in Ethiopia, during a press conference held at its headquarters on Cape Verde Road. The announcement comes in light of Hope Day celebrations held on May 9th, which marks a significant step towards the formation of the Union 71 years ago.
Outgoing EU Ambassador to Ethiopia, Roland Kobia, put forth a historical context of the Union’s formation in post-World War II Europe, emphasising peace as the cornerstone of development. He asserted the Union’s willingness to assist in resolving conflicts in several parts of Ethiopia and plans to reinstate budgetary support, conditional on reforms to the macroeconomic policy framework.
EU is the largest contributor to the African Union (AU), providing approximately 40pc of the annual budget exceeding 600 million dollars. Niño Pérez, EU Ambassador to the AU, reiterated the commitment to Africa’s continued development by strengthening economic and political ties.
Digital Transformation Council Holds Inaugural Meeting
The newly formed National Digital Transformation Council, led by Deputy Prime Minister Temesgen Tiruneh, held its inaugural meeting last week. This follows Prime Minister Abiy Ahmed’s (PhD) announcement establishing the council to oversee the implementation of “Digital Ethiopia 2025,” the nation’s digital transformation strategy.
It brought together officials like Belete Molla, minister of Innovation & Technology; Firehiwot Tamiru, CEO of Ethio telecom; and Tigist Hamid, head of Information Network Security Administration (INSA). The council discussed the overall progress of Ethiopia’s digital transformation efforts focusing on monitoring the execution of national digital policies and strategies, along with evaluating the effectiveness of development measures.
According to Tigist, the council is making headway in coordinating and implementing the long-term vision for digital transformation. Firehiwot said plans need to be refined to achieve the strategy goals. Ethio telecom, with its expanding reach (4G in 340 cities and a launched 5G network), and over 70 million subscribers, is playing a crucial role.
Ethiopia’s digital transformation strategy, launched in 2020, shows promise with skyrocketed internet access, exceeding 36 million users by 2023. It represents 35pc of the population with a mobile penetration rate exceeding 40 million accounts.
However, as highlighted by the World Economic Forum, challenges remain. Bridging the digital skills gap, expanding infrastructure, and promoting digital literacy are crucial hurdles to overcome for a truly inclusive digital transformation.
Electric Utility Advances to Off-Grid Power, Electric Vehicles
Ethiopian Electric Utility (EEU) aims to establish off-grid electricity services in remote regions and develop battery charging stations for electric vehicles in partnership with Huawei Technology S.C. Shiferaw Telila, CEO of the Utility signed the agreement with Michael Liu, head of Huawei’s Ethiopian office.
Ethiopia recently became the first African country to ban the use of internal combustion vehicles for personal use. EEU kicked off a 339 million dollar World Bank-backed project in November of last year that would see the electrification of up to 200 rural towns using 30 off-grid power generation stations in one of the largest off-grid projects.
While off-grid electricity presents significant potential to enhance energy access and reach throughout the country, legislative hurdles have presented a formidable challenge for investors throughout the years, according to Shiferaw.
Ethiopia has abundant renewable energy resources and has the potential to generate over 60,000MW of electric power from hydroelectric, wind, solar, and geothermal sources despite only half of the population receiving electricity.
Prime Minister Abiy Ahmed’s (PhD) green economy strategy also entails a shift towards renewable sources. With only 60 electric car charging stations in the capital and a shortage of spare parts for EVs nationwide, experts recommend massive investments in the development of the necessary infrastructure to accommodate the ambitious strategy.
STRANGLED BANKS, INFLATION CURE’S COST
A severe financial stranglehold has been imposed on the banking industry, undermining businesses due to a loan cap policy imposed by the central bank to control inflation. While reducing inflation to 28pc by the end of 2023, the monetary tightening has cast a long shadow over the fledgling third-generation (3G) banks that have sprung up in recent years. These finance institutions are now being stifled under the weight of a one-size-fits-all regulatory cap, severely limiting their lending abilities.
The credit scene shows a banking sector that has expanded its loan portfolios — up 24.3pc to 1.8 trillion Br — with significant lending to manufacturing, domestic trade, services, and consumer banking. However, the distribution of credit across sectors has been overshadowed by the overarching constraints imposed on total loan growth, which remains capped at an annual 14pc irrespective of a bank’s size or market reach. The uniform cap penalised newer banks that have faced severe restrictions on their operational scale and investment in growth, as evidenced by a shortfall in branch expansion and constrained staff recruitment. Executives blame the policy’s lack of flexibility to account for financial institutions’ diversity and varying capacities to contribute to the economy.
The repercussions extend beyond the banks themselves to the broader economy, affecting investor confidence and the capital market, where share prices have been observed to falter. The directive requiring banks to increase their paid-up capital, while well-intentioned, further strains these financial entities, compelling some to consider mergers or face potential failure. There is a growing call among financial experts and bank executives for a more nuanced approach to loan growth regulation that considers the unique circumstances of newer banks and their strategic importance to economic diversification and growth. As the central bank continues its study on the impacts of the loan cap, the hope is for adjustments that will allow these financial institutions to thrive.
Policy Espresso Demands a Strong Brew to Transform Negative Dynamic
In the hushed corridors of the legislative house on Lorenzo Te’azaz Road (Arat Kilo), a chilly reception awaited Gebremesqel Chala, the minister of Trade & Regional Integration (MoTRI). Trusted by the administration to lead crucial negotiations with the World Trade Organisation (WTO) and several other bilateral trade partners, he faced the unenviable task of delivering grim news. Export revenues had fallen short by 164 million dollars to 2.16 billion dollars in the first eight months of the fiscal year, compared to the same period last year.
The shortfall is particularly troubling for a country where foreign currency reserves barely cover a month’s imports, averaging 1.5 billion dollars a month in 2023. The fuel bill, more than three billion dollars, takes the biggest share, registering a 37.6pc growth from the previous year. This expenditure consumed all the revenues generated from exports during the same year.
Undoubtedly, economic reforms are urgently needed to overhaul such a massive imbalance in external trade, causing a distorted foreign exchange regime.
The decline in exports is only a symptom of deeper structural maladies. A weak export strategy is compounded by bureaucratic inefficiencies, substandard product quality, and a supply chain compromised by insecurity from the ongoing violent confrontations. The export sector remains perilously dependent on the international coffee market, where price fluctuations directly impact national revenues. A 26pc spike in coffee prices two years ago boosted export earnings to 4.1 billion dollars. Yet a 35pc price drop erased an 11.9 million dollar gain to the 900 million dollars in earnings made the following year. Psychologists may describe such an over-reliance on coffee, comprising a quarter of the total export value, as a “maladaptive attachment,” evidencing a failure to diversify export products and to compete on quality and price on the global stage.
Major coffee buyers—Germany, Japan, Belgium, the United States, and Saudi Arabia—have halved their orders. Together, they account for more than 60pc of Ethiopia’s coffee exports. Germany cut its imports by a staggering 36,000tns last year, while Japan reduced its demand by 17,400tns, citing inflated prices, declining quality, and logistical delays as their main concerns. Such vulnerability was apparent when other traditional foreign exchange earners like khat and gold also faltered.
Khat, which had contributed 392 million dollars to export revenue two years ago, saw a 36pc decline following a surge in contraband, driven by heavy taxation and tariffs by regional authorities. In response, the Ministry doubled down its ill-advised policy. Gebremesqel centralised the regulation, requiring exporters to secure permits from the capital, a move that did little to stem the tide. Meanwhile, Kenya, a newcomer to khat export, is already threatening Ethiopia’s market share in Somalia.
The mining sector, too, is underperforming. Earnings from gold mining in regional states like Gambela, Oromia, and Benishangul Gumuz reached only half of the annual target, at about 210 million dollars. Increased contraband activities further plague the sector. The Council of Ministers is poised to approve a new export strategy, hoping to revive this crucial sector. However, the strategy may fall short without recognising that the root causes of the export woes are as much about a lack of overriding strategy as they are about the political crises that sap productivity.
Generously funded by multilaterals like the World Bank, the consulting industry may crunch all the data and create enticing PowerPoint presentations. However, there is a simple truth. Ethiopia is not producing enough to meet its basic needs, lest it realise its economic potential. Yet, this seems lost on contemporary policymakers who face the pressing need to boost productivity. Agriculture and services, which dominate the GDP, suffer from infrastructural deficiencies and low technological integration, undermining their efficiency and contribution to growth.
The agriculture sector, primarily reliant on subsistence farming, suffers from a lack of mechanisation, which keeps yields low and operations inefficient. No less, the services sector, despite its diversity, is crippled by inadequate digital infrastructure, limiting its market reach and overall performance.
Tenacious macroeconomic imbalances due to large budget deficits, high external debts, insufficient foreign direct investment (FDI), rampant inflation, and meagre export revenues mar the broader economic landscape. These are not isolated issues but interconnected, forming a web constraining economic growth and development. For instance, the heavy burden of external debt absorbs a significant portion of the federal budget for debt servicing, restricting public investment in vital sectors like agriculture and infrastructure. The lack of FDI, deterred by an ongoing armed conflict, and the low export revenues further limit the economy’s ability to integrate into the global market, thus impeding improvements in productivity.
Substantial public investment in infrastructure is essential to break out of this negative dynamic. Reliable transportation, efficient energy sources, and robust digital infrastructure can drastically transform the agricultural and service sectors by reducing costs, improving access to markets, and facilitating the adoption of modern technologies.
Technological advancements are essential. Introducing technologies like precision farming, drones, and improved irrigation systems could revolutionise productivity in agriculture. Digital platforms could expand market reach and enhance delivery for the services sector. Education and training must also be prioritised to equip the workforce with the necessary skills for these new technologies. But all these demand enormous resources at the state’s disposal. If handled unwisely, such high public spending could exacerbate the budget deficit, which would displease the guys from the International Monetary Fund (IMF).
Policy reforms currently negotiated with the IMF could help create a more conducive environment for productivity enhancements. These reforms should simplify regulatory frameworks, strengthen property rights, and reduce trade barriers to attract more FDI, a crucial driver of technology transfer and capital investment.
However, global economic structures also play a role. International cooperation and support from development partners are vital for managing external debt and facilitating access to global markets. Yet, the ongoing conflicts in regions like Amhara and Oromia deter these partners from engaging fully. Despite these daunting challenges, the highly anticipated IMF credit facility, while helpful, should not be viewed as a panacea but rather as part of a broader strategy to stabilise the economy and stimulate a shift.
Policymakers must undertake comprehensive and coordinated efforts to address the cycle of low productivity and economic stagnation, filled by political polarisation that should be settled through negotiations. Having a political force in charge of the state with a popular mandate perceived with legitimacy to rule can help enhance supply chain management for key commodities, create better export incentives, and improve agricultural produce in quality and volume. Beyond the over-reliance on commodities like coffee, a more diversified export strategy could provide the positive dynamic for stability and growth.
Only through comprehensive and concerted efforts will they break the cycle of low productivity and economic stagnation, setting the stage for a future of sustainable development and improved living standards for citizens. Be wary; the clock is ticking.
Loan Cap Impairs 3G Banks Squeezing Expansion
Established in 2019, East Africa Plastic Centre operates at a 30pc capacity due to a lack of working capital. Its managers’ application for a loan of 100 million Br submitted five months ago remains unapproved by all the banks they approached.
Dereje Weldeamanuel, the general manager, attributed the dry spell to a loan cap.
“We’re in survival mode,” he said.
Partly, his company is a victim of a little-heeded shift in monetary policymaking. A consequential reorientation of the central bank’s goal, which focuses on inflation targeting and price stability, has Governor Mamo Mehiretu imposed a loan cap policy on commercial banks. It may have moderate success in taming inflation, reducing the year-on-year (YoY) headline inflation by 2.2 percentage points to 28pc by the end of 2023.
However, the broader economic fallout tells a depressing story that a one-size-fits-all approach may be too blunt an instrument for the evolving financial sector. The loan cap that puts new entrant banks in troubled waters has created a domino effect. Businesses are struggling, share prices are falling, and investors’ confidence is waning.
A new wave of third-generation (3G) commercial banks that emerged over the past three years, aspiring to reshape the financial scene, are particularly impacted. Yet, these institutions are constrained by stringent regulatory measures meant to curb inflation but inadvertently stall their growth.
Banks’ total loans and advances grew by 24.3pc reaching a total of 1.8 trillion Br by June 2023, attributed primarily to the sectors of manufacturing, domestic trade and services, and consumer banking. The credit distribution to various economic sectors is notably diverse, with significant loans extended to manufacturing (23.2pc), domestic trade and services (20.7pc), and exports (15.7pc). There has been a shift towards increased private sector lending, with private sector credits constituting a majority (55.9pc) of the total banking sector credit by 2023.
Total deposits increased by 24.6pc, amounting to 2.1 trillion Br during the same time, a growth supported by upsurges in savings and time deposits. The share of total deposits as a percentage of GDP was 24.8pc by June 2023, indicating a substantial liquidity pool within the banking sector.
The authorities appear to be determined to redirect this pool to where they want. A mandatory purchase of annual bonds from state-owned banks and a uniform 14pc annual loan growth cap, which remains unchanged despite measures announced by the National Bank of Ethiopia (NBE) in August to bring inflation under 20pc.
Executives from about 10 of these banks — from Geda to Goh Betoch and Tsehay, Ahadu as well as from Amhara to ZamZam, Sidama and Shabelle — have raised concerns. In an appeal to regulators, they argue that the cap unfairly lumps them with long-established banks, ignoring the nascent stage of their development. The cap is particularly painful as several of them – Tsehay, Geda, Amhara, Ahadu, and Goh Betoch- reported losses in the last financial year.
These young banks are wrestling with the dual challenge of restricted loan growth and the high costs of setting up branches and staffing. The environment delays their path to profitability. They are increasingly focusing on short-term loans and alternative revenue streams like service charges and guarantees to stay afloat. However, their senior executives worry that such a strategy compromises the quality of customer service, a bedrock of their long-term business models, due to the heavy initial investments in infrastructure and staffing.
The loan cap also prevents companies from attracting new shareholders and meeting the minimum capital requirements of five billion Birr set by the central bank, which will expire in 2026.
Hijra Bank, a Sharia-compliant finance institution, illustrates a unique but similarly unsteady position. It mobilised 4.84 billion Br in savings last year, an impressive 263.9pc increase from its inaugural year, and reported a net profit of 27.8 million Br for 2022/23. Despite these gains, the uniform loan cap applies as stringently to them as to commercial banks, leading to scaled-back expansion plans. The Bank’s ambition of reaching 100 branches this year was short by 89pc, running only 82.
“The disparity between loans and deposits created a management challenge,” said Dawit Keno, president of Hijra Bank, noting that the cap restricts their ability to invest surplus deposits in Sharia-approved financial instruments like Murabaha and Mudarabah. It is not alone.
Sidama Bank, which transitioned from a rural microfinance origin, faces similar constraints. The institution started as the Sidama Rural Women’s Credit & Saving in 1994 before becoming a full-fledged microfinance institution four years later.
With a paid-up capital of 575 million Br and a subscribed capital of 1.45 billion Br, it has explored alternative revenue streams such as foreign exchange generation and guarantee bonds. Yet, according to Tadesse Hatiya, president of Sidama Bank, these methods are “not as satisfactory” compared to traditional interest income. A competitive disadvantage against more established banks, the loan cap indirectly affects Sidama’s profitability and potentially hinders the future share it wants to float to the public.
“We’ve limited branch expansion and staff hiring,” he said.
Sidama Bank posted a profit of 63.9 million Br last year, with loans and advances totalling 613.3 million Br. Nevertheless, Tadesse blamed lower interest income due to the cap that directly impacted their bottom line.
Another interest-free finance institution transformed from a microfinance operation in the Somali Regional State, Shabelle Bank, also faced these harsh realities. It reported a profit of 19.84 million Br last year but has seen a marked rise in profit taxes and operational costs. It has also increased expenses in profit taxes from 446,330 Br to 13.35 million Br during the year, while wage expenses surged by 50pc to 187.42 million Br. Yet, reaching the loan cap limited its growth opportunities.
Amid these constraints, some banks have opted to focus intensely on loan collection, as conventional avenues for deploying their capital are blocked. According to Khadir Ahmed, founding president of Shabelle Bank, balancing growth and regulatory compliance remains ungraspable.
“We’re exploring alternative revenue streams in the meantime,” said Khadir, one of the executives who signed the petition to the central bank, urging the regulators to reconsider their policies.
Regulators, however, maintain their position on the loan cap. According to Fikadu Degafe, vice governor, a study is underway to determine the potential impact of an exemption for new banks.
“The impact could be relative,” said Fikadu.
Khadir is, however, eyeing short-term financing and potentially introducing fees for previously free services like transfers and withdrawals. However, Khadir acknowledges that “repayment for the short-term financing burdens the customers.”
For Bedir Abdo, vice president of Rammis Bank, which began operations in June last year with substantial capital, Rammis has reached a bound, limited to mobilise deposits or disburse large loans fearing the impact in the coming years. It has scaled back its branch expansion plans like its peers, reducing the number from 40 to 15.
“The regulation is concerning,” he told Fortune.
Loan cap policies are not without historical precedent, though. Similar measures were adopted in the 1970s by countries including Japan, France, Italy, and Denmark to combat inflation. While the specific applications varied, the results were often mixed, with major repercussions including reduced competition in the banking industry, increased lending rates, and credit rationing. The broader implications of this policy are becoming evident as third-generation banks face these stringent regulations.
The pioneering interest-free finance institution, ZamZam Bank offers international banking services and derives a major portion of its revenue (40pc) from service-based income. Despite a strong initial capital base and a second-year recovery, Kadir Bedewi, its vice president, questioned the cap’s effectiveness in abating inflation, particularly when considering the potential outflow of funds from established banks with large existing loan portfolios. Like others, ZamZam is tightening its belts in response to the cap.
“We’ve slowed down branch expansion to lower overhead costs,” said Kadir.
It is an obvious cautious approach to capital expenditure. Kadir believes a system that better distributes the permissible loan volume could allow smaller banks to grow while still achieving inflation control objectives.
Some banks incurred losses for the first two years due to massive expansion. Ahadu Bank posted a 193.68 million Br loss for the year ended 2023, marked by high staff and operating expenses that soared due to the massive expansion. Tsehay Bank faced a similar fate with a 162.8 million Br loss.
Others had a bit of backstory. Tsedey Bank entered the commercial banking industry in September 2022, evolving from the Amhara Credit & Savings Institution. Upon transitioning, it bagged 30 billion Br in loans. However, its executives are among those who have opted out of joining the lobby group that dispatched the petition, although its executives say they were among the first to appeal to the central bank for a loan cap reconsideration three days after the directive was issued.
According to Mekonnen Yelewumwosen, president of Tsedey, micro and small loans are critical for stimulating production.
“We’ve shifted focus to micro and small loans,” he said, “particularly for farmers seeking financing to boost productivity.”
While third-generation banks struggle to stay afloat, industry observers saw the ripple effects extend to the share market.
Bereket Girma, operating in the Ethiopian Share Market, noted a troubling trend of declining share values and a reluctance to invest, a sentiment echoed by other industry observers. He observed shareholders voting to beef up paid-up capital, but hesitant to increase their shareholdings.
“It likely stems from anxieties about the overall economic climate,” he said.
A 2021 directive requiring banks to increase their paid-up capital – existing banks to five billion Birr in five years and new entrants to seven billion Birr in seven years – raises concerns alongside the loan cap policy. As most new banks incur operational costs in the first years, they might find meeting the minimum capital requirement an uphill task, according to Eshetu Fantaye, a veteran banker. He fears their long-term sustainability under current regulations.
“Possibility of mergers or failure looms in the coming years,” he said.
Nonetheless, the potential for consolidation through mergers or acquisitions with established banks raises concerns in the banking context. Eshetu argued that such a scenario would not work in the heterogeneous segments the third-generation banks are designed to cater to, affecting their market segment and customers.
“With some of them, it’s like mixing oil and water,” he told Fortune.
Eshetu criticised the aggressive branch expansion observed in some of the new entrants, which has resulted in high overhead costs and delayed their break-even point.
“Cost minimisation should be a key initial strategy,” he said.
Financial analysts like Abdulmenan Mohammed (PhD) argue that the loan cup policy disproportionately affects new banks, which are not yet on equal footing with established institutions in terms of key performance metrics like loans, deposits, and capital.
“Who would invest in a bank that’s haemorrhaging money?” Abdulmenan asked rhetorically.
He sees that these banks could alternatively invest their surplus liquidity in treasury bills, though this offers lower returns. He also warned of a domino effect; a struggling banking sector could lead to declining tax income from a weakened financial sector, economic stagnation impacting job opportunities, triggering business closures and a broader economic downturn.
“They should focus on digital than branch-based banking until the grip is loosened,” he told Fortune.
The central bank has yet to address these concerns fully, leaving the third-generation banks in a precarious position. Experts continue to advocate for a more nuanced approach to loan growth regulation, hoping for regulations that reflect their newfound tools to fight inflation. Established businesses like the East Africa Plastic Centre continue to feel the squeeze, operating at reduced capacity due to the unavailability of working capital influenced by the banking industry’s constraints.
UNDER STRESS!
In an unprecedented move, the central bank has published its inaugural stress test report, uncovering potential fault lines within the financial sector that could pose systemic risks to the country’s financial health. The “Financial Stability Report”, a deep dive into the economic and financial ecosystem, coincides with a period marked by global economic uncertainty and domestic upheavals, including persistent droughts and regional conflicts.
The report discovered that the banking industry, which holds an overwhelming 96.1pc of the country’s total financial assets as of June 2023, generally maintains robust health if traditional metrics like capital adequacy and liquidity ratios are deployed. However, the stress tests reveal vulnerabilities that could jeopardise stability. While overall profitability stays stable, a high concentration of credit among a select few borrowers in the manufacturing and trade sectors — a factor that poses a considerable risk — remains a worrying trend.
The financial stability report disclosed a high degree of credit concentration, with the top 10 borrowers in the banking industry holding nearly 23.5pc of the total 1.9 trillion Br in loans and advances. This translates to 21.7pc of GDP. Another startling revelation was that a mere 0.5pc of borrowers with a credit exposure of above 10 million Br held nearly three-quarters of the banking sector’s loans. Total deposits reached a healthy 2.2 trillion Br, with a high loan-to-deposit ratio. The ratio of loans and bonds to deposits has dipped slightly to 90.3pc, but it remains significantly high, suggesting a major portion of depositors’ money is tied up in loans.
With some banks’ sensitivity to a sudden shift in depositor behaviour, the repercussions of one or more borrowers failing could ripple across the financial sector, warns the report.
However, experts said the concentration of credit is not a new phenomenon, but its potential to inflict systemic damage has become increasingly apparent, prompting calls for tighter regulatory oversight.
The liquidity of banks, another critical aspect of the report, uncovered a precarious situation wherein if the 10 largest depositors of each bank were to withdraw all their funds simultaneously, 18 out of the 29 commercial banks would fall below the minimum regulatory liquidity requirements. The hypothetical yet plausible scenario casts light on the delicate balance banks maintain between accessible liquid assets and the demands of deposit withdrawals.
Several banks struggled to meet weekly liquidity requirements and real-time gross settlement system (RTGS) payments and exhibited mismatches in their liabilities and assets. The report found a decline in the ratio of liquid assets to deposits, uncovering banks may struggle to meet short-term obligations if faced with a surge in withdrawals. The overall ratio decreased by three percentage points to 24.2pc, while the ratio of loans to deposits rose by almost a single percentage point to 60.6pc.
Adding to these concerns, operational risks have escalated. The cost of fraud and forgeries in the banking sector has nearly doubled in the past year, reaching one billion Birr across 20 banks. These frauds involve fake financial instruments, embezzlement, ATM card thefts, and social engineering scams like phishing calls and texts as well as unauthorised bank guarantees. Recent unauthorised withdrawals at the state-owned Commercial Bank of Ethiopia (CBE) and robberies at three private commercial banks have further exposed the vulnerabilities in the financial sector.
Abdulmenan observed the banking industry’s exposure to systematic risk due to CBE’s dominant place although it meets the liquidity ratio of 15pc and the eight percent capital adequacy ratio under the central bank’s stress scenarios.
“CBE overwhelms the industry,” he said.
The total assets of the financial sector had grown to around 3.1 trillion Br, more than a third of the country’s GDP. The 31 banks account for around 96pc of the asset base, and the CBE contributes almost half. Microfinance institutions had a two percent share, while insurance companies accounted for a mere 1.6pc.
Abdulmenan concurred with the report’s finding that CBE’s high exposure was due to the large loan transfer to the Liability & Asset Management Corporation (LANC), which soaked up nearly half a billion Birr of loans during its formation three years ago. CBE was also the only bank to enter the ‘large’ category according to the central bank’s classification, with 27.5pc of the banking sector’s total capital despite most of its paid-up capital being government-issued promissory bonds, which have yet to be paid.
According to the report, CBE’s capital position requires targeted policy and regulatory attention in the event of unfavourable circumstances. Abdulmenan also pointed out that the lack of disaggregated data on credit concentration between CBE and private banks is inconvenient to interpret due to the different credit exposures between the two.
Awash, Abyssinia, Dashen, Hibret banks and the Cooperative Bank of Oromia have entered the medium-size category, with combined capital amounting to 28pc of the sector’s three trillion Birr assets.
Beyond domestic issues, Ethiopia faces external economic pressures, considerably from the geopolitical tensions fueled by the Russian-Ukrainian war and developed economies’ tightening of monetary policies. These conditions have repercussions for Ethiopia, particularly affecting its agricultural exports, which are vulnerable to foreign exchange rate fluctuations.
Despite the pressures, the domestic economy displays resilience, says the report. The International Monetary Fund (IMF) forecasts a GDP growth of 6.1pc in 2023, increasing slightly to 6.2pc in 2024. A rebound in tourism and liberalisation efforts supports this growth, while inflation is expected to drop to 20.7pc, and the budget deficit to narrow to 2.5pc of GDP by 2024, reflecting improvements in domestic revenue collection and fiscal consolidation.
The stress report the National Bank of Ethiopia (NBE) released stated the need for regulatory improvements to safeguard against potential financial instabilities, including improving governance standards, enhancing credit risk management, and developing financial infrastructure to keep pace with rapid changes in digital financial services. Digital transformations in financial services can enhance financial inclusion but also require robust cybersecurity measures and regulatory frameworks to manage risks associated with digital transactions and services.
The report also highlights the importance of sector-specific support, particularly for agriculture and export-oriented industries. Tailored financial products and risk management strategies could help address risks associated with these sectors and promote sustainable growth, said Abdulmenan Mohammed (PhD), a London-based financial analyst. He commended the central bank for publishing the report.
He told Fortune that publishing a financial stability report fulfils one of the primary responsibilities of a central bank.
“It’s a laudable step,” he said.
However, he wished to see details on the assumptions used in the risk stress tests. He said the elevated attention to the banking industry is “reasonable.”
“In general, the industry is safe and sound,” Abdlumenan told Fortune.
According to Abdulmenan, the risk stress tests should have been conducted on the policy changes that could occur if Ethiopia reached an agreement with the International Monetary Fund (IMF).
Another financial expert and banking veteran with a high reputation in the industry, Eshetu Fanataye, praised the report’s transparency and said it set the stage for policy reform.
However, he viewed the report as ultimately serving as a reassurance of the status quo rather than a trigger for rigorous economic scrutiny.
“For the report to be genuinely impactful, it must address the critical issues more directly, ensuring that the financial sector not only appears stable but is genuinely robust,” he told Fortune.
Eshetu disected the report, particularly in its methods of evaluating bank capital and liquidity. He argued that the evaluation of bank capital remains outdated, still based on standards set 25 years ago, lagging behind the current Basle III framework, which stated a minimum of 10.5pc of risk-weighted assets, potentially rising to 25pc depending on the bank’s leverage ratio. He also saw the liquidity assessment used as archaic.
According to Eshetu, modern standards prefer the Liquidity Coverage Ratio (LCR) and High-Quality Liquid Assets (HQLA) parameters, which are more stringent than the 15pc liquidity ratio banks currently use, which includes “assets of dubious quality.”
“Banks are overextended is a claim contradicted by actual liquidity shortages noted in local and foreign currency transactions,” said Eshetu, “indicating a disconnect between reported figures and ground realities.”
He also questioned the report’s accuracy, noting discrepancies between reported data and practical observations. He suspected the handling of NPLs, with banks reportedly ever-greening loans and restructuring debt to obscure the true health of their portfolios.
“External reviews of banks’ credit risks are essential to avoid such misrepresentations,” he said.
According to Eshetu, the report also understated the credit risk within the banking industry, a critical oversight given the looming threats from regulatory policies such as mandatory bond purchases and caps on lending. These policies, intended to stabilise the financial system, may instead constrain banks’ ability to support their primary customers. While the report acknowledges external risks to financial stability, Eshetu believes it overlooked the internal risks stemming from aggressive lending practices, particularly in real estate and commercial mortgages.
Says Eshetu: “As the market for these assets contracts, banks face escalating credit risks that could destabilise the industry.”
Liquidity risk, although classified as moderate in the report, appears more severe in practice. Central bank policies, coupled with banks’ tendencies to chase higher returns, have strained liquidity to the point of affecting customer transactions, from real-time gross settlement systems to direct withdrawals. Fluctuating prices in foreign exchange and local currency markets pose yet another considerable risk, threatening the stability of small and large banking institutions.
“The volatility shows the need for a more robust regulatory framework to adapt to changing economic conditions and ensure long-term stability,” said Eshetu.
The report reveals credit and liquidity risk stress under baseline (economy grows at 6.2pc): moderate non-performing loans (NPL) increase to 10pc due to drought, heightened conflict, or an increased forex crunch. The stress tests in the report simulate various scenarios, including severe conditions where NPLs could rise to 30pc. It warns that close to 12 banks could fall below the statutory minimum capital adequacy ratio of eight percent.
As of June 2023, the ratio of NPLs to gross loans in the commercial banking industry was 3.6pc, well below the maximum of five percent set by the central bank.
However, the report revealed that the state-owned CBE and most microfinance institutions transformed into commercial banks would not need additional capital even under these severe conditions.
According to the report, not all banks have the same requirement for capital injection.
Melkamu Solomon, acting president of Nib Bank, believes robust credit risk management systems are essential to prevent credit overconcentration.
“Specific risk appetite fuels credit risk,” Melkamu told Fortune.
He also noted the importance of operational efficiency as digitisation advances, pointing out that some banks face significant liquidity risks, with a few depositors accounting for a large portion of their liquid reserves.
Total net income in the banking industry remained steady at around 62 billion Br year-on-year. Return on equity and return on assets reflected “sufficient” profitability at 25.7pc and two percent, respectively. However, a slight decrease in profits was observed due to increased provisioning for potential loan defaults and rising expenses associated with the sector’s growing workforce of 187,450 employees.
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