Long Overdue Finance Sector Opening Not Silver Bullet

Sep 17 , 2022.

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The debate shortly after the Council of Ministers nodded a bill to open the financial sector to foreign capital was emblematic of how the economic discourse has deteriorated. Some thought this entails Ethiopia is for sale. Others lamented that an International Monetary Fund (IMF) and World Bank conspiracy is in the offing. A social media thread claimed the initiative is useless absent land reforms.

Joking aside, liberalising the financial sector is long overdue.

The latest bill that makes its way to the legislative house would complement the capital markets proclamation Parliament ratified, which broadens the types of financial products that can be introduced, the services provided and the market players that would engage. Even if the law makes it possible for the first foreign bank to set foot in Ethiopia perhaps years from now, the bill provides certainty and guides the government's priorities.

It can also be seen as a natural progression.

History bears witness to this. Two foreign banks were operating before the military-Marxist regime took the industry several decades back through sweeping nationalisations and a ban on private ownership. Only four financial firms were in business when the industry was opened to domestic private capital in the mid-1990s. They were all owned by the state: the Commercial Bank of Ethiopia (CBE), the Ethiopian Insurance Corporation (EIC), the Construction & Business Bank (CBB) and the Development Bank of Ethiopia (DBE). Eventually, the CBB was swallowed by the CBB, while the DBE underwent several transformations.

Private banks and insurance firms had to start anew.

In its current form, the financial industry has expanded at rates and scales never seen before in the country's economic history. Together with the new banks in or near operation, there are 30 banks, including specialised ones such as Goh Betoch and ZamZam. No less than 18 insurance firms and 37 microfinance institutions. That is not counting three transitioning to commercial banks.

Collectively, banks have raised 200 billion Br in capital. They have accumulated 2.4 trillion Br in assets and mobilised 1.7 trillion Br in deposits. It is a remarkable feat for an industry as young as a quarter of a century. The financial sector is a crucial economic engine, mobilising national savings, providing credits, and facilitating transactions. The banks, in particular, have emerged as principal sources of debt financing for the government, making it possible to cover hundreds of billions of Birr in budget deficits. They hire tens of thousands and provide opportunities for career advancement to the country's educated few.

This was all a value unlocked because of the decision to open the financial sector to the private sector nearly three decades ago. Undoubtedly, it forced the CBE to compete (although favouritism towards the state bank remains evident). It should only be understood if it feels that it is now time to take the next step. It is better late than never that the bill reaches the floors of the legislative house.

Many people, especially the political class and the academic elite, remain distrustful of the decision to liberalise the financial sector to foreign capital. There were voices that brought up their concerns with previous administrations. The most notable issues raised were the central bank's lack of regulatory capacity and the need to shield the domestic financial sector from undue competition. However, both arguments were not strong enough to pass a serious examination.

Ethiopia is not the first country to allow foreign investment in the finance sector; it is not even its first time doing so. Several African countries at similar levels of economic size have liberalised their financial sector long ago. Kenya or Nigeria may sound relatively advanced, but there is Uganda, Zimbabwe and the youngest state around the bloc, South Sudan.

Can the government not raise its regulatory capacity to the levels of these countries? The National Bank of Ethiopia (NBE) would have to up its game to regulate and support a more dynamic market, but it should do this any ways.

Neither is a persuasive argument to shield domestic banks and insurance firms from robust competition from overseas companies entering the market. Perhaps such a policy would fly in the 1990s, and maybe even in the early 2000s when the first generation of private banks was setting up. A nearly three-decade head start can only be taken as more than enough.

If it is not, then what will be satisfactory? A decade more? Another three decades?

The well-being of a few businesses should not have been allowed to come before the public's welfare. The success of profit and deposit growth the banks have enjoyed has not trickled down to the main economy as much as expected. Only one percent of their customers have access to credit. The millions of depositors are saddled with double-digit negative interest rates, thereby subsidising the few borrowers. For much of the population, the financial sector is not an alternative when money is needed for education, health issues and start-ups. The source for these is still with family and friends. These should not be the financial institutions the government bends backwards to protect.

While restricting foreign capital was not wise, the enthusiasm the potential opening prompted should also be measured. There needs to be realism about the professed benefits to the economy.

The assumption that multinational banks would rush to seize the moment in the aftermath of the opening can be misleading, if not disappointing. The experience of the telecom sector liberalisation should be instructive. However, regional banks active in eastern, western and southern African markets may be the first to test the water.

Despite the attention the bill has received, it is neither godsend nor a revolutionary act. Foreign capital is only as good as the doing business environment of the host country. It is not a silver bullet but a compliment. A few factors need careful consideration to make it successful and ensure that the economy benefits through financialisation.

Start with the type of foreign investment that will be allowed. The talk on the streets was that it would be through a joint venture structure where nationals should own a controlling stake in financial institutions. Public appearances by central bank officials suggest that incorporating a new bank and buyouts, along with joint ventures, are under consideration.

The authorities should remember how the indecisiveness on mobile money poured cold water over the enthusiasm for the telecom sector. Uncertainty and continued protectionism are red flags to prospective international investors who will question the long-term commitment behind the liberalisation. It can turn off anyone with interest. The financial sector should be opened fully, and foreign investors should be allowed to participate and structure their business like any other domestic bank or insurance firm.

There is an elephant in the room. Like any other investors, foreign banks will face the trauma of repatriating money out of the country. They are not aid agencies. At some point, whatever the time frame of the investors, they will need to repatriate profits. This can be difficult without liberalising the capital account, which will address Ethiopia's foreign currency debacle. Suggesting land reform could be a bold move that will require tinkering with constitutional reforms. Opening up the capital account is the prerogative of the administration of the day. But it will serve as a game changer for the economy.

Short of this, opening the financial sector for foreign capital may fail to live up to its promises and potential.

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PUBLISHED ON Sep 17,2022 [ VOL 23 , NO 1168]

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