Two men are haggling with a shopkeeper over prices for consumer goods and for good reason. Last month's headline inflation was registered at a decade-high of 30.4pc.

The past year has been all but dull for the authorities at the central bank and executives of the banking industry. The first was busily churning out directives, the latter frantic about coping with a series of decrees.

The tumultuous ride might have begun with the demonetisation of the Birr in September last year, a measure the central bank took after more than two decades. This was followed by restrictions imposed on transactions and cash holding limits, the freezing of accounts opened in Tigray Regional State (twice), a ten-fold increase on the minimum capital requirement for banks, and significant alterations to forex retention accounts by members of the diaspora.

It all culminated with an informal order to commercial banks to freeze all collateralised loans last month. Or so it had seemed.

The era of decrees was not to be over. Last week saw three additional regulations from the National Bank of Ethiopia (NBE), including the demand on commercial banks to double their reserve ratio to 10pc, effective September 1, 2021. The last time the central bank felt the compulsion to tell banks to increase their reserve ratio was eight years ago. In both instances, the economy was under inflationary assault, eroding household incomes, particularly those of the salaried population.

Adjusting the reserve ratio is a regular policy tool central bank officials use whenever they feel the economy is under inflationary pressure. In 2004, the reserve requirement was at five percent, later doubled in 2007. The following year, the requirement reached an all-time high of 15pc and stayed that way for four years. In 2012, it returned to 10pc, and the following year, the ratio again dropped to five percent.

The banks have enjoyed a somewhat lax reserve ratio for the past eight years, driving deposits to 1.3 trillion Br, from 62 billion Br. It was a monumental increase, fuelled partly by the number of banks joining the industry. Competition among the banks, young and old, through the expansion of branches and adoption of technology, is attributed to such an impressive outcome.

However, the underlining factor was a significant increase in broad money supply, currency in circulation. It shot from 700 billion Br to over one trillion Birr during this period. It has been one of the primary drivers of inflation, although the gradual loss of the Birr against foreign currencies exacerbated the rising cost of living, as recently admitted by the central bank.

"Even though the government has employed multifaceted approaches to contain the inflationary pressure, it is getting worse, making it imperative to reduce the money supply," reads a statement the central bank issued last week.

Prices of food and non-food items are at their highest since 2013; the last time the national consumer price index showed over 25pc. The data for August 2021 reached 30.4pc, building up for months.

Nonetheless, the series of decisions by the central bank to slash exporters' forex retention to 50pc and doubling reserve ratio comes as a bit of a shock both for exporters and the banking industry.

The requirement will be challenging for most banks, who also have to deal with already-existing liquidity requirements, on top of a not-so-remarkable liquidity standing, says Dereje Zenebe, president of Zemen Bank, which enjoys an annual growth of 41pc. He refers to the regulation that obliges all banks to maintain liquid assets of no less than 15pc of their net current liabilities.

Zemen's legal reserve reached almost 640 million Br last year, a figure that is certain to increase with the new rules and its growing deposits, which saw a 24pc jump last year.

Officials at the central bank hope the exemption of import items, such as edible oil, from the freezing of collateralised loans will ease inflationary pressure.

Its President believes the grace period provided by the central bank in the rule is good – reserve requirements will grow monthly until reaching 10pc in November 2021. However, the changes will not be without consequence.

"It goes without saying that banks will be affected by this measure," said Dereje, an old hand in the industry with over two decades of experience.

Despite the phenomenal rise in deposit mobilisation over the decade, liquidity crunches remain worrisome for those in the banking industry. The state-owned Commercial Bank of Ethiopia (CBE) receives preferential treatment with federal and state agencies keeping accounts with it, helping it retain a higher market share. Its disbursement of foreign currency can cause other banks to tremble, leading them to lose billions of Birr in deposits in a matter of days. Importers often take cash from other banks to fulfil their letters of credit obligations when rare opportunities come from the CBE.

The risk appetite of commercial banks has also grown recently after the central bank lifted the mandatory bonds they had to buy with 27pc of their loans and advances, destabilising their liquidity position. Industry players fear that the requirement to adjust the reserve ratio, together with the rise in interest rates on borrowing from the central bank, which has grown by three percentage points to 16pc, would affect their competitiveness.

Some will be hard-pressed to meet the requirement for they have advanced their remaining deposits, according to Tadesse Gemeda, chief wholesale banking officer at the Awash International Bank, the oldest and largest private bank.

"There will be a scramble to mobilise deposits, leading to cutthroat competition," he said.

Experts seem to be more upbeat about the new measure, however.

Alemayehu Geda (Prof.), known to keep a close eye on inflation, advocates controlling the money supply manifested in credit expansion. But he cautions the trade-off between money supply and economic growth.

"A balance must be maintained," said Alemayehu.

According to the economics professor, a significant reduction in inflation can be better achieved by increasing food supply and keeping a hold on the unabated devaluation of the Birr.

Not long ago, the central bank introduced a monumental regulation freezing all collateralised loans, attempting to tame capital flight and the excessive increase of exchange rates in the parallel market. Following the freeze, the value of the dollar in the parallel market dropped by up to 30pc. Alemayehu supports this measure but urges it should remain in place until the war subsides.

Officials of the central bank have brought back last week the mandatory bond the state-owned Development Bank of Ethiopia (DBE) issues to other banks, and this time around, including insurance firms. Banks are told to spend one percent of their loans and advances to buy this bond, while insurers are expected to spend 15pc of their net incomes. DBE bonds could raise 12 billion Br from the banks, accounting for 27pc of its outstanding loans last year, while it can secure up to 200 million Br from private insurers, less than one percent of its loans during the same period.

The DBE bonds will have a maturity period of three years and offer an interest rate two percent higher than the prevailing interest rate on deposits.

Identifying means to inject financing to the DBE has been on the government agenda for some time now, as stated in the Homegrown Economic Reform policy.

"Alternative and sustainable financing models for the DBE will be identified and implemented," reads the policy document issued in 2019.

Last year, the DBE registered an unaudited net profit of 3.2 billion Br, more than a two-thirds jump from the previous year. It was also a conspicuous turnaround from a loss of 1.6 billion Br reported in the previous year, owing to the reduction in the size of non-performing loans by eight percentage points to 26pc.

The federal government is luring financial institutions to invest in DBE bonds claiming the policy bank has undergone a series of reforms.

"I don't expect any resource to be misused this time around," said Fikadu Digafe, vice governor and chief economist at the central bank.

Some remain sceptical of the claimed reforms.

"It's a policy measure I am fully behind," said Alemayehu. "But the bank needs to act in a transparent and accountable manner not to repeat its past mistakes."

Banks are forced to invest in DBE's bonds until aggregate bond holding equals 10pc of their total outstanding loans. The maturity period and interest rate are set similar to those of the investments required from insurance companies. Bankers do not seem to be too bothered about the burden.

"It's a noble idea," said Tadesse of Awash Bank. "The amount may not be much for the banks, but its effect when it goes to borrowers is tremendous."

Insurance firms, however, seem troubled by the new measure, viewing it as a sentence to death row.

The insurance industry is struggling with low growth in premium collection and increasing claims paid, not to mention the investment restriction imposed by the central bank.

"This is a death sentence for the industry," said an executive of a private insurance firm, livid that the central bank took the measure without consulting industry players. "Why should we fund a bank that is on its deathbed because of its own mismanagement?"

Insurance firms are already buying bonds for the Grand Ethiopian Renaissance Dam (GERD) out of a legal reserve taken from 10pc of their net income.

The impact may not be that significant as the bond matures in three years and entitles the financial sector to at least above the savings rate, according to Abdulmenan, Mohammed, a keen observer of the Ethiopian financial sector.

"This does not mean that the measure is fair," he said.

He compares what financial institutions could earn from the nine percent on average on treasury bills, risk-free and short-term investments.

The series of measures by the central bank shows the financial sector keeps getting the short end of the stick in the authorities' desperate efforts to control inflation. With the popular perception that the banking industry is highly profitable and would sustain strains, demanding measures continue to be levied.

The central bank has changed its rule in forex management, not even a year since it amended the directive last.

In March, the central bank had justified its decision to reduce forex retentions because export revenues were used solely by the exporters, leaving nothing for other importers. Account-holders from the diaspora and exporters were told to surrender 30pc of their earnings in foreign currency. Of the remaining 70pc, almost half goes to the account holders and the balance to the banks. Exporters contested the measure as it brought the forex they could use down to 31.5pc, which was a huge drop from the 100pc they had once enjoyed.

The market responded with backlash. Imports plummeted, forcing the central bank to rethink its decision last week.

Forex flow from foreign investment and diaspora accounts are exempted from surrendering 30pc. The burden seems to have shifted to exporters and non-governmental organisations with forex accounts. They are told to surrender 50pc of receipts in foreign currency to the central bank every month.

PUBLISHED ON Sep 04,2021 [ VOL 22 , NO 1114]

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