In recent months, Ethiopian banks have been releasing their annual reports to investors and the public, outlining performance from the previous year. While the banking sector remains largely profitable and stable for investors, signs of potential trouble have emerged. A number of banks reported sliding profit margins, and some new entrants disclosed losses, raising concerns about the potential challenges that lie ahead for the industry.
To gain insights into this emerging trend, The Reporter Magazine has turned to Eshetu Fantaye, a retired senior bank executive with a wealth of experience in the sector. Eshetu, who previously served as president of Ahadu Bank and played a pivotal role in founding Goh Bank S.C – the country’s sole mortgage bank – understands the intricacies of the industry’s ups and downs all too well.
With a background in banking and finance from the esteemed University of Rome Tor Vergata, Eshetu is regarded as a top-tier expert in the field. He has also held key positions such as vice president of Awash International Bank S.C and president of Buna Bank S.C.
Taking the initiative to address these concerns comprehensively, Eshetu sat down with The Reporter’s, Nardos Yoseph, to discuss the future prospects of Ethiopia’s banking sector, both for local and international investors.
The Reporter Magazine will publish the full interview in subsequent issues. Excerpts:
While the Ethiopian banking industry has long been touted as a safe haven for investors, recent annual reports have revealed a different story. Several banks, including those where you have held leadership positions and have been a shareholder and founder, have reported losses. With your deep familiarity with these banks, what do you make of this development? Does this emerging trend suggest that the glory days of banks are coming to an end?
Let me first set the background to loss in De novo or new banks as it can help. De novo banks or new banks can experience financial losses for a host of reasons including; strategic miscalculation and Strategic mismanagement, Overextension and excessive risk-taking, Misallocation of resources, Ineffective cost management, Initial investment and startup costs, Low initial deposit base, Operating expenses, as well as Loan defaults and credit risk among others. The performance of de novo banks can also be significantly affected by economic conditions and regulation. For example, a downturn in the economy or unexpected regulatory changes can lead to higher loan defaults and decreased demand for loans, impacting the bank’s profitability. The other possible factor worth mentioning is competitive pressure. De novo banks often face intense competition from established banks and other financial institutions. This can result in pressure to offer higher deposit rates, lower lending rates, and invest in marketing efforts, all of which can impact the bank’s bottom line.
It’s important to note that not all de novo banks experience or need to experience financial losses, and many successfully navigate these challenges to become profitable institutions, in the immediate year. Strong management, effective risk management practices, a clear business strategy, and the ability to adapt to market conditions are critical factors that can contribute to the success of de novo banks.
It is also important to note that all or most first- generation banks in Ethiopia (that is banks opened before 2008 or under the Regulated Capital limit of 10 million Birr) did not return profit in the initial year or most of them were not able to return profit up to the third year of their life. So, loss making is not, I need to emphasize this, is not the specific ailment of the new banks emerging. The reason for the loss making of the seven or so banks established prior to 2008 and under the Birr 10 million regulated capital was straight forward. The capital these banks started business with was too small to generate enough revenue on its own. And at the same time, they were unable to fast-achieve the necessary leverage, by way of deposits, that will allow them to cover their operating cost and more. As soon as these banks were able to leverage their capital three to four times, they were able to break-even and then report profit. That is in the nature of banking business. That was how the banks of the early year made losses, before later reporting profit.
But the reference in your question that banks in the past were profitable for certain was not without its background and its reason is not casual as well. Banks established after 2008 and established under the 75 million Birr Regulated Capital regime, were able to easily break-even or report profit, some of them significant profit, because their capital itself was sizable and they were able to achieve the required leverage early and easily. As a result, they fast reported profit and sustainably.
But again the question still remains, why do the new banks that started with adequate and large capital and have fast achieved adequate leverage, as their reported deposits mobilization figure attests, return loss!? The answer to this question is also straight forward. The loss reported by some of the Banks can only be either of the nine or ten reasons given above, especially the ones adumbrated under 1-7. From the limited reading I have about the incidence, a not-so well thought out strategic choice or a misaligned strategy that back-fired, can be mentioned as the main reason of the loss. Essentially, you can call the loss a choice of business design or ascribe it to the banks’ governance system choice predicated in calculated risk. Either way whether the risk calculation may work right or may have misfired, would not take too long to prove, by the shareholders and their representatives.
In both cases, however, given the 5 billion Birr capital the banks are required to reach in 2027, according to my assessment, the loss is a very serious and heavy baggage for the banks which reported it. Given the flux in the banking regulation regime and its unpredictability, I call the risk taking as brazen as a Russian duel. Shareholders may feel bad about their bank making loss and will think twice before making any additional capital contribution. Furthermore, it means that the capital of these banks is not only eroded by the amount of the loss, but it takes the banks backwards in fulfilling the regulated capital threshold. Unless they do something out-of-the-ordinary, therefore, these banks may be fat prey for acquisition, if any change of regulation in relation to the regulated capital threshold is re-issued, which is not unlikely. These banks have to work hard not only to come out of the Red, but their governance system must think hard and fast how it can catapult itself to the regulated capital or the required limit and save itself from acquisition and an unnecessary merger, anytime in the future.
The failure or sluggishness of banks in meeting the central bank’s minimum paid capital requirement raises pertinent questions about the underlying causes and potential remedies. What does this situation signify? What factors have contributed to it, and what measures can be taken to address these challenges?
We must see what is happening in our economy recently. The Ethiopian economy, for the last 7 years or so, is bedeviled by snowballing inflation and progressive devaluation of our currency. This kind of environment is bad for investment on financial instruments of any kind. Because of the galloping inflation which is eroding shareholders purchasing power they may be or are using their dividend payment to augmenting the loss of their purchasing power rather than using it for capitalization.
Many are investing their money in other assets which is bringing, presumably in the short run, a higher return than bank shares. This does not augur well for investment in bank shares or any other kind of investment on instruments. The excessive devaluation and its impact is pushing many, many people to investments in areas that protects them from devaluation, which is mostly an import business or similar activity that relates to hoarding wealth in devaluation-protective assets. This also does not bode well to bank investment.
I tend to classify banks in our country into three categories; first generation, second generation and third generation banks. Many of the third-generation banks may find the capital hike difficult to meet, unless they merge. Some second-generation banks may not find it easy to propose themselves as candidates for merger cases. And given the little knowledge available in Bank Assets Valuation and Managing Merger and Acquisition, the transition to the hiked capital regime that NBE has stipulated may not be an easy affair.
Even more so, now that inflation and devaluation is making investment by individuals, especially by the lower and upper middle-class investors, a privilege. As a result, most of the third-generation banks will have difficulty meeting the Regulatory Capital Cap in time. Not only that, but they may be in a bind to make constructive engagement with other similar banks for acquisition or merger, as most of them are border-line cases. The question relating to which bank acquires which other bank or which bank can initiate merger with which bank is a tough debate to settle, given the nature of the banks formation. Probably, regulatory fiat and/or suasion may be required to facilitate the merges of some banks.
My own assessment and recommendation, given the devaluation and the increasing and huge investment requirement of important projects in the different sectors of our economy, is that banks must increase their capital significantly and fast.
Given the inflation and aggressively crawling depreciation obtaining in the economy, the immediate solution that I can see to address the more and more growing ticket-size of capital required by operators in the real sector of the economy, is the merger of banks which can be achieved through the suasion of the National Bank of Ethiopia, and the opening up of the Sector to a well-thought-out and crafted Foreign Capital infusion. I also believe that the thoughtful sequencing of these two solutions is very, very important, in the interest of the country at large and the shareholders interest which were invested, for far-too-long in the banking system. I strongly believe that the merger should come first before the Foreign Capital infusion is permitted into the banking system.
Given the current events unfolding within the banking industry, what can we foresee for the future of Ethiopia’s banking sector?
Ethiopia is a very big country, in terms of population, and a richly endowed country in-terms of all kinds of resources. The entrepreneurship required in the banking system to effectively marry these two resources for improving the well-being of the nation and people living in it is immense. The financial system, especially the banking system is at its rudimentary level. It has to go a long way to go to recreate itself to meet the demands of the country and the people living in it. In terms of the role of intermediation, access and advancement of inclusion, the sky-is-the-limit for the sector. The banking system has as its future an unlimited potential.
The regulator should re-invent the system by working to re-architect it in view of the development of the country and its people. We have scratched little in that direction. We need to develop, at least, a coherent Banking Sector or Financial Sector Road Map that will match the very good Ten-Year Perspective Plan we have developed. Efforts to-date address the challenges and issues of the sector in silos and scatter-shot fashion. We need to go beyond that and work for a holistic design, architecting and building of a development focused financial system.