The Ethiopian Bankers Association (EBA) has voiced strong objections to a draft regulation on Value Added Tax (VAT) under review by the Ministry of Finance. Its leaders argued that the proposal could impose undue burdens on the banking industry and create confusion over what financial services should remain exempt.

The Association's leadership sought clarification in a letter to the Finance Minister, Ahmed Shide. Its Secretary General, Demissew Kassa, stated the need for clear guidelines to ensure banks comply with the new VAT requirements without disrupting their operations. He noted that the banking industry's feedback came after extensive discussions with policymakers, during which the Ministry requested the Association provide detailed comments.

"We need clarity and answers," Demissew told Fortune, echoing the industry's concerns.

The draft regulation, a part of the federal government's broader effort to widen the tax base, has sparked concern within the banking community, particularly over categorising certain financial services as taxable, a departure from longstanding tax exemption rules. Under the proposed regulation, financial services provided by licensed banks or financial institutions remain generally exempt from VAT. However, the exact scope of these exemptions is unclear for industry operators, notably lacking a precise definition of what constitutes a "financial service."

Bankers warn that this ambiguity could lead to inconsistent tax applications and confusion among financial institutions, potentially disrupting services. The Association, chaired by Abie Sano, president of the state-owned Commercial Bank of Ethiopia (CBE), urged that this definition be broadened to include emerging market players, such as capital market service providers, who are expected to enter the financial landscape soon.

The draft regulation follows a proclamation passed by Parliament several months ago, which laid the groundwork for exempting certain financial services, including savings, loans, pension administration, and related services. However, it marks other financial activities as taxable, which has ignited debate. Transactions involving the foreclosure of a debtor's property are not exempt, a decision that has stirred controversy within the financial sector.

The Association leaders, representing 26 of the 30 banks, argue that foreclosure sales proceeds should be exempt. Bank executives claim that the process of recovering debt through property foreclosure is a financial service that should not be subject to VAT. They contend that these activities are standard practice for financial institutions dealing with defaulting debtors and that taxing them would complicate an already challenging process.

Worku Lemma, a senior banker, described the taxation of foreclosed properties as impractical, seeing them as sales methods for banks to recover sick loans. He warned that imposing VAT on these sales would inflate prices, deter potential buyers, and likely increase unsold properties.

"It doesn't make sense," said Worku, expressing scepticism about the rationale behind the proposal.

The banking industry is currently assessing the potential impact of the new tax, though some executives admit that the full implications remain uncertain. Wegagen Bank, among others, is analysing the possible consequences of the VAT law, though its senior executives acknowledge that it is still too early to determine its impact on the industry.

"It's too early to know the implications," an executive told Fortune.

His voice echoes the uncertainty prevailing in the banking industry.

A recent financial stability report from the National Bank of Ethiopia (NBE) unveiled several challenges the industry faced, adding context to the ongoing VAT debate. Non-performing loans (NPLs) in the commercial banking segment have risen to 3.9pc, driven by factors such as drought, conflicts, and a severe shortage of foreign currency. The report also revealed a high concentration of credit, with the top 10 borrowers accounting for nearly 23.5pc of the total 1.9 trillion Br in loans and advances, equivalent to 21.7pc of GDP. Only 0.5pc of borrowers with credit exposure exceeding 10 million Br hold nearly three-quarters of loans. Total deposits have reached 2.2 trillion Br, with a high loan-to-deposit ratio, though the ratio of loans and bonds to deposits has slightly dipped to 90.3pc.

The Association's letter to the Finance Ministry argued that the combined impact of VAT on financial services could undermine affordability and accessibility, potentially undermining efforts to include low-income individuals and small businesses in the formal financial system.