Banks Reel as Birr Floats into Uncharted Waters

Banks Reel as Birr Floats into Uncharted Waters

Aug 10 , 2024. By Geremew Milkias ( Geremew Milkias (geremew.milkias@addisfortune.net) is a researcher and Deputy Editor-in-Chief whose interest is in digital innovation and sustainability. )

For decades, the financial sector has pondered the rocky ideas of market liberalisation and floating exchange rates. The recent upheaval triggered by the unpegging of the Birr has laid this struggle bare. When the government opted to restructure its debts and revalue the Birr — an essential step dictated by international lenders — the banking industry found itself in turmoil, revealing how unprepared it has been for such a seismic shift.

The disarray during that first week of floating the Birr was telling, demonstrating the disparity between the official exchange rate and the parallel market. The varying forex rates from commercial banks leading up to the National Bank of Ethiopia's (NBE) special auction revealed an inconsistent demand for foreign currencies. Questions arose about the prudence of private banks choosing not to buy from the state-owned Commercial Bank of Ethiopia (CBE) in the interbank market, a decision that resulted in opportunity loss for those banks.

Interestingly, the following week brought an unexpected calm, denoting a positive response from most private banks, with only a few stragglers. CBE, a frontrunner in setting the exchange rate, managed to weather the storm by keeping its rate stable, only to increase its spread to about 10pc from the previous five percent by week’s end. The special foreign exchange auction must have played a crucial role in stabilising the market.

As we advance into the digital age, the robustness of the banking infrastructure's cybersecurity is being put to the test. A recent glitch at CBE has brought to attention the urgent need to enhance security, especially as the economy becomes increasingly digital. The potential havoc a cyberattack could unleash — especially in the foreign exchange markets — is a threat the authorities should take seriously.

The floating exchange rate amplifies systemic risks within the banking industry and the larger economy. The shift has intensified the fiscal burdens on customers, who, despite having settled their letters of credit (LC), should now contend with inflated bills due to Birr losing its ground. The anticipated arrival of foreign banks would add another layer of uncertainty. Caught off guard, domestic banks are struggling to adapt to this new market reality.

These new entrants, supposedly equipped with substantial capital, technology and competitive advantages, would pose a formidable challenge to local banks, many of which have seen their total assets and paid-up capital nearly halved due to the exchange rate volatility. Yet, amidst these uncertainties, the Central Bank has begun to assert its regulatory influence on the market. However, the demand for regular updates on global forex standards and swift transaction reporting indicates a pressing need for even closer monitoring of market movements.

The evolution of foreign exchange markets has opened the floodgates to new risks for businesses and financial institutions. The economic risks posed by currency fluctuations, particularly given the country’s political climate and systemic vulnerabilities, are real threats. Interestingly, the recent deposit pledges of 2.5 billion dollars from multilateral financial institutions could have positively impacted liquidity and slightly boosted the Birr.

However, these positive trends exist alongside concerns about how the financial sector will respond to the influx of foreign banks and investors, as well as the looming threat of speculative attacks on the currency. The need for preparedness and adaptability has never been more crucial.

PUBLISHED ON Aug 10,2024 [ VOL 25 , NO 1267]

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