Regulators Turn Up the Heat on Banks to Brace Capital Ratio Shake-Up

May 4 , 2025. By AKSAH ITALO ( FORTUNE STAFF WRITER )

Commercial banks face stringent new capital adequacy rules, with regulators saying they are designed to compel them to meet international standards and strengthen their ability to withstand financial shocks.

Officials of the National Bank of Ethiopia (NBE) distributed the draft directive to commercial bank executives last week. The regulations, modeled after the Basel II and III frameworks, represent a major shift from the simpler capital adequacy requirements in place since 1988 under Basel I.

Under the previous rule, banks mainly relied on basic leverage ratios, restricting their on-balance-sheet assets to a simple multiple of available capital. They were required to maintain capital equivalent to at least eight percent of risk-weighted assets, with marginal differentiation between various types of financial risk.

The new directive expands this framework, requiring banks to hold greater and higher-quality capital. It introduces a comprehensive risk-based approach that requires banks to calculate capital requirements not only for credit risk but also for market and operational risks. This marks a shift away from relying primarily on simple asset ratios.

Under the new rules, banks should maintain a Common Equity Tier 1 (CET1) capital ratio of 7.5pc of risk-weighted assets, a Tier I capital adequacy ratio of 9.5pc, and total capital adequacy of at least 11.5pc.

The updated standards introduce additional capital buffers to absorb potential losses during periods of heightened financial instability. Banks should calculate credit-weighted assets using a hybrid approach that combines Basel II and III standards. The directive specifies new methodologies and expands risk categories from two provisions to seven, covering cash, exposures to state-owned enterprises, development banks, corporate and commercial real estate, among others.

The use of credit derivatives is expressly prohibited.

According to Martha H. Mariam, an advisor to the Vice Governor of NBE, the purpose is clear.

"We want to see banks align with international best practices and ensure financial sector stability," she told Fortune. "We'll be holding discussions with the banks about their compliance concerns in the coming weeks."

However, the exact financial gaps under Basel I requirements remain unassessed by Central Bank regulators. International experiences show the importance of fully implementing Basel standards. Following the 2008 financial crisis, which was triggered by subprime mortgage losses in the United States, Basel III emerged as a global response to enhance capital adequacy and systemic risk management. Partial implementation or selective adoption of Basel standards, according to the IMF, can lead to distorted incentives and compromised financial stability.

Current vulnerabilities within Ethiopia’s banking industry underline the necessity of rigorous compliance. A recent NBE financial stability report painted a scenario that if the top 10 depositors simultaneously withdrew their funds, 20 of Ethiopia's 29 commercial banks would drop below minimum liquidity requirements. This number increased from 17 banks the previous year, alarmingly growing liquidity risks.

Credit concentration remains high, with the top 10 borrowers holding 14.7pc of total loans, excluding state enterprises where the concentration drops to 3.5pc. Operational risks, especially digital fraud, insider information, and third-party risks, have surged dramatically. Reported bank fraud losses reached 1.3 billion Br by mid-2024, up by 300 million Br from the previous year. Fraud cases include counterfeit cash, unauthorised bank guarantees, ATM card theft, and fraudulent communications, affecting 28 banks.

Banking executives say they are "carefully evaluating" the implications of the new regulations.

Leaders of the Ethiopian Bankers Association plan meetings with commercial bank executives to discuss compliance strategies. According to Demsew Kassa, secretary general of the Association, the primary goal is achieving a common understanding and ensuring banks have sufficient training and resources to comply effectively. Banks should fully meet by June 2026 to a threshold capital base of five billion Birr, complying with the recently amended Banking Business Proclamation.

Though many banks currently exceed the Central Bank’s minimum paid-up capital requirement, regulators urge further improvements in risk-asset evaluation.

Sidama Bank, among others, is preparing for compliance by establishing dedicated teams. Its President, Tadesse Haitya, acknowledged the importance of the directive in strengthening financial foundations.

"It will definitely have an effect," he said, noting that the directive will clarify the "real" financial health of institutions.

Sidama Bank, which began operations with a paid-up capital of 574 million Br, doubled its capital last year, though it plans to reach for five billion Birr by 2030. Currently, its equity comprises 42pc of total assets, providing a strong buffer. Still, further increases are necessary to meet new regulatory demands.

Zemen Bank's President, Dereje Zebene, echoed this sentiment, describing the standards as critical given the banking industry's evolution.

Zemen Bank's capital grew by 49.1pc to 7.45 billion Br in 2023/24, achieving a capital adequacy ratio of 25.9pc, well above the mandated threshold. The Bank plans to raise its capital further, aiming for 15 billion Birr to maintain robust financial resilience.

"It's not just about opening up the sector to foreign markets," Dereje said. "It's about knowing where we stand."

According to him, the urgency of addressing diverse risks, including deposits, credit, and digital products. Dereje stated the danger posed by credit exposure, which could lead to insolvency without adequate safeguards.

"We'll be eying all the risks," he said.

Zekre Mekere, corporate financial advisor at HST Consulting, believes in the directive’s broader importance in protecting the public interest and forcing banks to undergo rigorous self-assessment.

"Banks might need to expand their capital base more than the National Bank requires," he told Fortune.

He anticipated the new standards would trigger balance sheet restructuring and asset liquidity improvements, possibly leading weaker banks toward mergers and acquisitions.

"The new requirement will filter out the weak," said Zekre.

The multi-year compliance timeline, however, has generated some apprehension among banking executives. They say, adequate training and clarity on implementation remain critical for effective compliance. The industry-wide effort is anticipated to fundamentally reshape the banking industry, increasing transparency and resilience against future financial stresses.

In the interim, banks are taking practical steps toward meeting these new, stringent standards. Sidama Bank’s Tadesse highlighted particular concerns about market risks associated with foreclosure processes and operational risks such as fraud.

"The comprehensive nature of these regulations reflects a meticulous approach to integrating and managing various banking risks," he told Fortune.

As banks transition toward these demanding international standards, industry leaders remain cautiously optimistic that these measures will enhance financial stability, protect depositor funds, and strengthen the overall economy.

"The requirement might be challenging to some banks," Zemen Bank’s Dereje stated, "but we needed the new standards."

PUBLISHED ON May 04,2025 [ VOL 26 , NO 1305]

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