Governor Mamo Tests Transparency. Will It Pass a Test of Time?

Apr 20 , 2024.

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In a departure from its traditionally opaque practices, the National Bank of Ethiopia (NBE), under the stewardship of Governor Mamo Mehiretu, has unveiled a new report mapping the financial sector's stability—a move signalling a broader commitment to transparency in financial governance. On the surface, the report, dubbed the stress test, details the financial sector's robustness and vulnerabilities. But more importantly, its release marks a cultural shift towards openness that could set a precedent for other federal institutions to do the same.

Like many developing economies, Ethiopia is exposed to the choppy waters of global economic fluctuations, exacerbated by domestic turmoil such as recurrent droughts and regional conflicts. During such times of uncertainty, the clarity and comprehensiveness of the Central Bank's report can serve as a crucial navigational aid. By laying bare the country's financial health, the Governor appears to have decided to inform the market and fortify investor confidence as well as public trust when both are sorely needed.

The report concluded that the banking industry, commanding 96.3pc of the financial sector's total assets, remains fundamentally sound. It boasts a Capital Adequacy Ratio (CAR) of 14.7pc, although down by 1.6 percentage points from the previous year, it was still well above the eight percent regulatory threshold. Such figures suggest that, while capital buffers are tightening, the banks continue to maintain a resilient position against potential financial shocks.

However, the report uncovered a decline in the liquidity ratio, from 27pc to 24.2pc, and a slight uptick in the ratio of loans to deposits to 60.6pc. These shifts may hint at growing reliance on deposit funding, which, under stress conditions, could exacerbate liquidity risks. Nevertheless, the report takes a tone of cautious optimism, backed by data and a clear outline of regulatory strategies targeting enduring financial stability.

Encouragingly, the Central Bank does not shy away from acknowledging the potential clouds on the horizon. Its stress test report is candid and discusses at length the economic repercussions of international conflicts and geopolitical confrontations, such as Russia's war in Ukraine, alongside internal pressures from inflation and shortages in foreign currency. Such candour is crucial because it allows domestic economic actors and international investors to make well-informed decisions, potentially promoting a more permissive economic environment.

Governor Mamo’s decision to steer the central bank towards greater transparency can be seen as strategic and indicative of a broader shift in governance philosophy. Historically, the lack of direct and effective communications from the central bank has often led to market speculations and economic uncertainty, eroding public trust and deterring investment. By reversing this trend, the Governor is adhering to his regulatory responsibilities and reinforcing a transparent governance ethos, recognising that informed public engagement is fundamental to accountability.

Continuing with the ethos of transparent governance, the report's in-depth analysis also opens up conversations about the need for broader economic reforms in Ethiopia. The report goes further, detailing the stress testing undertaken to assess the banking industry's resilience against adverse economic shocks. The exercise shows that it is poised to withstand potential crises despite global and domestic turmoils, owing to solid capital and liquidity buffers.

However, it also calls for attention to areas of concern, particularly the high concentration of credit among the top 10 borrowers, who account for 23.5pc of total loans. This could mean that, on average, each of these borrowers tapped 42.3 billion Br last year, a lopsided share compared to the 4.4 million borrowers registered in the system, the vast majority of which were serviced by microfinance institutions. It is clear from the data that while the banking sector is stable, its stability hinges on a relatively narrow base. The concentration of loans and deposits among a select few is a financial risk and a barrier to broader economic participation. Its foundations could be brittle if primary borrowers default.

The banking industry is also characterised by a notable aversion to risk, primarily focusing on collateral-based lending. While prudent, this conservative approach has stymied the sector’s evolution, particularly in adopting digital banking technologies and expanding credit to underserved markets.

The state-owned Commercial Bank of Ethiopia (CBE) demonstrates this trend, with nearly half of the banking industry's assets. Its substantial holdings in government bonds and involvement in a liability corporation created to absorb non-performing loans (NPL) ascertain its systemic importance but also expose vulnerabilities. The report’s characterisation of the CBE as a stable financial institution yet fundamentally entangled with the government’s fiscal health paints a nuanced picture of what stability means in the Ethiopian context.

However, the top 10 depositors hold a disproportionate share of the industry's deposits. Although a remote possibility, this could lead to instability if these major depositors were to withdraw their funds simultaneously. The stress test report should serve as a timely warning that a more diversified and inclusive banking system that extends services beyond the elite few to a broader population segment is needed.

As the administration of Prime Minister Abiy Ahmed (PhD) continues with its signature zeal of liberalisation, particularly in the financial sector, and the country prepares to welcome foreign capital, the transparency demonstrated in the Central Bank’s report could serve as a valuable practical guide. It demonstrated the necessity of evolving past outdated practices to embrace a more robust regulatory role and diversified banking models consistent with global standards.

The banking industry could benefit from implementing higher capital adequacy ratio (CAR) requirements for systemically important banks and introducing measures like countercyclical capital buffers (CCyB), a regulatory tool critical to ensure a stable and resilient banking environment. Capital buffers can help dampen the amplitude of financial cycles, reduce systemic risks, and support sustainable economic growth by counterbalancing the inherent cyclicality of credit markets. It has been prudent for the Central Bank to push all commercial banks to meet a threshold capital of five billion Br before June 20026, a prudent policy that promotes a stable industry that can withstand economic shocks and support the broader economy in times of stress.

Another wise policy of the Central Bank is its determination to promote financial inclusion by encouraging the transition of microfinance institutions into formal banking. A number of these institutions—such as Shebelle, Sidama, Gadda, and Tsehay—have already graduated to become full-fledged commercial banks. However, their entry into the market has intensified the competition in the industry on several fronts, most noticeably the hardship in mobilising deposits during economic turbulence. Many of them are seen wresting against all odds to remain liquid.

Governor Mamo can adopt liquidity standards such as the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR), which could help banks manage cash flows even under stressful conditions. Transitioning to a more risk-based supervisory approach would also enable the Central Bank to tailor its oversight to banks' specific risk profiles and business models, enhancing the financial sector's health. Encouraging fintech solutions that expand access to financial services is also crucial.

Governor Mamo's initiative to bring these issues to light can be seen more than his desire to adhere to modern financial practices. It could also be about his urging for a systemic overhaul of how banking and financial services should be approached. It may signal a move towards a system that not only supports large entities and public projects but also nurtures smaller enterprises and offers services to the underbanked and unbanked segments of the population.

The regular conduct of such comprehensive stress tests and their public disclosure should be encouraged. They can elevate investor confidence and enhance public trust in the financial system.

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PUBLISHED ON Apr 20,2024 [ VOL 25 , NO 1251]

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