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."