Banks Warn as Crackdown on Loans Triggers Fears of Toxic Debt Surge

Apr 19 , 2025. By AKSAH ITALO ( FORTUNE STAFF WRITER )

Key Takeaways

• The National Bank of Ethiopia has introduced a new loan classification system, imposing stringent grading requirements on banks.
• Banks feel the directive's timeline is unrealistic, given challenges such as weak borrower cash flows and a stagnant property market.
• The directive could increase reported NPL ratios, impacting bank profitability and altering investor perceptions.
• The new rules add operational burdens that may lead to increased costs for banks, many of which are already working with thinning provision buffers.

Commercial banks are scrambling to meet a tougher loan classification regime rolled out by the National Bank of Ethiopia (NBE) in mid-June, warning that the rules could turn thousands of shaky credits into toxic assets and sap an industry already bruised by a slow economy.

The regulator issued five directives, but the most contentious one forces lenders to grade every exposure, on or off balance sheet, as "Pass," "Special Mention," "Unlikely to Pay," "Doubtful," or "Loss." It caps combined exposures to related parties at 25pc of capital and orders banks to build databases on connected borrowers. Officials say the overhaul, modelled on international standards, will curb credit concentration and improve nonperforming loan (NPL) reporting.

Executives counter that the schedule is unrealistic. The Ethiopian Bankers Association, chaired by Abie Sano, also president of the state-owned Commercial Bank of Ethiopia (CBE), has appealed to the Central Bank to postpone or relax the directive, citing weak borrower cash flows, a stagnant property market and trouble collecting group loans.

“Banks need more time and less rigid requirements, given the current conditions,” said Demsew Kassa, the Association’s secretary general. “Compliance will take time.”

The rule reduces the number of times a troubled loan can be restructured and extends the period it must remain in NPL status — six months for monthly or quarterly payers, up to a year for semiannual or annual payers — before it can be considered performing again.

Analysts say that change alone could swell reported NPL ratios because a loan remains tagged as bad even when money is being repaid. The industry’s NPL-to-gross loans ratio already ticked up 0.3 percentage points to 3.9pc last year, while provisioning coverage slipped to 104.1pc from 132.5pc. The directive also imposes a two percent provision on off-balance-sheet exposures, a heavier hit than some “Pass” assets, and prevents banks from offsetting the charge with margins they hold as collatoral.

Lenders say the measure ignores collateral values and creates uneven treatment.

“We will be incurring costs with no corresponding income,” said Tadesse Hatiya, president of Sidama Bank.

His Bank carries two billion Birr in loans to nearly 30,000 borrowers and an NPL ratio of 2.6pc, below the five percent prudent industrial exposure.

Veteran bankers on one hand fear premature loss recognition will backfire.

“Loans are a bank’s most valuable asset,” said Dereje Zebene, president of Zemen Bank. “When those go bad, profitability declines, and financial risks rise. They are bound to create toxic assets.”

Zemen’s revenue rose 35.3pc last year, driven by a 33.9pc jump in interest income to 5.35 billion Br and a 49.5pc surge in fees to 1.98 billion Br. However, Zemen's senior executives worry that a wave of reclassified loans could erode gains.

Aggregate figures reveal the concentration risk that the directive targets. Of 1.5 trillion Br in loans and advances, the 10 biggest borrowers account for 14.7pc. Strip out state-owned enterprises and the share drops to 3.5pc, yet regulators remain uneasy after past failures rattled the system.

Some relief has arrived. Companies in the war-damaged Tigray Regional State won a one-year extension on 86 billion Br in repayments, a gesture meant to aid recovery from a two-year civil war that had upended the local economy. Bankers say similar forbearance is needed elsewhere until the economy steadies.

The economy has slowed under high inflation, chronic foreign currency shortages and uncertainty over external debt talks. Property prices have flattened, making collateral sales more complicated. Import-dependent borrowers face foreign exchange bottlenecks that crimp their cash flow.

Worku Lemma, a former banker who researches credit trends, warns that shorter restructuring windows could push viable firms over the edge.

“Banks will have a hard time managing their assets,” he said.

Regulators insisted they have listened. A circular issued after the backlash eases some provisioning and rescheduling rules, though details remain sparse.

“Banks must thoroughly assess their total exposure before requesting exceptions,” said Martha H. Mariam, advisor to the Central Bank’s Vice Governor.

Any further concessions, she added, will be granted “case by case” and only with strong evidence.

Leaders of the Bankers' Association continue pressing for wholesale amendments. They want more restructuring iterations, allowances for sector and regional disparities and a rethink of the two percent off-balance provision. Lenders also seek clarity on whether earlier circulars that permitted flexible restructuring count toward the new caps. They argue the exclusion of held margins contradicts the treatment of similar on-balance guarantees.

For newer entrants such as Sidama Bank, the stakes could not be more higher. Rapid expansion and lending to small businesses with thin capital buffers leave young institutions vulnerable.

“The requirements are too rigid given operational realities,” Tadesse told Fortune.

Older players echo the concern. According to Dereje, Zemen’s loan book has ballooned along with the industry’s, but many borrowers struggle to service debts accumulated during the different economic conditions. Reduced room for restructuring, he argued, “does not adequately reflect the prevailing economic conditions.”

The directive requires banks to keep loans tagged as non-performing even after payments resume, until the seasoning period ends. Executives say the rule will distort asset-quality ratios and may restrict new credit. Dereje warned: “When NPLs increase, bank profitability suffers.”

Financial statements show the strain. Some banks already exceed the five percent NPL ceiling, raising the risk of capital gaps if provisions climb. Asset yields remain robust, as many lenders charge rates above 16pc while deposits pay about seven percent. But, that cushion could shrink if the regulator tightens monetary policy.

International investors are also watching. Ethiopia plans to open its financial sector to foreign capital under an International Monetary Fund-backed reform, but potential entrants cite credit opacity as a barrier. A smooth rollout could polish the sector’s image; a disorderly one could scare money away. For now, the standoff endures. The directive became effective on publication, and although the Central Bank has signalled flexibility, the clock is ticking.

Banks should start reporting under the new framework in the subsequent quarterly filings. Worku sees a silver lining.

“Banks need time, but they shouldn’t sit idle,” he said. “They must work toward compliance. Strengthening monitoring systems and revising loan portfolio strategies will safeguard their operations.”

Whether a compromise emerges or not, the episode brought a precarious situation of tightening oversight to shield the system without choking credit to an economy hungry for growth. For commercial banks, keeping that balance could shape their fortunes for years. Under the revamped table, a loan drops from Pass to Special Mention once interest or principal is 30 days overdue, and it falls into Unlikely to Pay at 90 days, even if no formal default has been recorded. Doubtful and Loss sweep up anything 180 days past due.

Bank technology chiefs say mapping every exposure to the new labels will require costly software upgrades and retraining. Data rules add another burden. Each bank should build a register linking borrowers, directors and beneficial owners and reconcile it with state registries. Many small firms lack paperwork, so lenders are sending staff into the field to confirm connections.

Provision buffers are already thinning. Coverage slipped because bad loans grew faster than reserves. If the two percent off-balance charge remains, analysts figure lenders need to set aside about 20 billion Br within a year, a quarter of last year’s combined profits.

Regulators remain firm.

“Their concerns will receive due attention,” said Martha. “But, the system can no longer afford lax provisioning or opaque related party lending.”

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PUBLISHED ON Apr 19,2025 [ VOL 26 , NO 1303]

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