Ethiopia’s financial industry is undergoing substantial transformation under the stewardship of Governor Mamo Mihretu, the 10th governor of the National Bank of Ethiopia (NBE). The series of reforms introduced over the past year signify a shift to address longstanding macroeconomic imbalances and position the country’s banking sector on par with international standards.
Recently, the central bank announced a shift from a quantity-targeting monetary policy to an interest-based market model, incorporating indirect policy instruments to meet price stability targets. The reforms include biweekly central bank auctions, policy interest rates initially set at 15pc, and standing overnight facilities to manage a liquid interbank market.
“This is a major shift,” Mamo noted.
Last month, the central bank issued five directives to regulate corporate governance and asset classification, marking a major move towards prudential oversight. The directives mandate banks to maintain comprehensive databases of related party transactions and updated credit profiles, pushing for transparency and risk management. Banks have three years to comply, with action plans required within 90 days.
Industry leaders like Neway Megersa, president of the two-year-old Siinqee Bank, and Dereje Zenebe, president of Zemen Bank, have largely welcomed the reforms, acknowledging the need for improved corporate governance and risk management. However, they call for flexibility in the implementation timeline, recognising the operational challenges banks face.
Neway tasked his legal and risk departments with assessing the operational implications of these changes. He reports that action plans are nearly finalized for most of the directives, emphasizing the positive outlook for the sector.
“They’re a healthy set of evolutions,” Neway told Fortune.
One compliance requirement is maintaining a database of all related party transactions and credit exposures, along with a constantly updated registry of credit profiles. Neway stresses the importance of investing in technology infrastructure.
“Any bank failing to invest heavily in improving its technology infrastructure will be swallowed by competition,” he said.
He believes that the new regulations on related party exposure and asset classification will ensure the long-term integrity of the banking sector.
“Some banks might have to sift through their loan portfolios carefully,” Neway said.
While he welcomed the enhanced supervision aimed at financial stability, he is particularly optimistic about the prospects of open market operations and an active interbank market. He expects the vibrant interbank market to improve overall liquidity and help newer banks establish a solid financial position. This anticipated liquidity boost is crucial for maintaining stability and fostering growth in the sector.
NBE’s latest draft for re-establishment strips key powers from the executive in issuing Franco Valuta permits, clears areas prone to conflicts of interest, and positions the central bank as the primary force dictating monetary policy. Dereje sees these developments as promising for industry stakeholders, emphasising the importance of the central bank’s independence from the government.
“The status quo needed to change,” Dereje told Fortune. “It’s evident what that has done for us.”
Ethiopia’s 31 banks, which have issued nearly two trillion Birr in loans and advances as of June 2023, maintain a Non-Performing Loans ratio of around 3.6pc, below the regulatory five percent threshold. Dereje said the latest directives are important in reducing risks within the financial industry, empowering depositors, and mitigating systemic risk from bad credit.
“Banks now belong to depositors more than they do to shareholders,” he said.
Dereje expects the NBE to show some flexibility regarding the haste with which banks must comply with all conditions, as some may need to conduct a deep dive into their loan portfolios. He also foresees liquidity improvements across the banking industry from the endorsement of vibrant interbank market operations and overnight lending facilities.
Seven months ago, the NBE revealed a three-year strategic plan outlining five objectives to restore fiscal and monetary stability. The three-year strategic plan and the new proclamation to re-establish the NBE’s autonomous position represent a clear intent to strengthen the central bank’s role in ensuring fiscal and monetary stability altering its 62-year trajectory. The reforms are part of a broader effort to modernise the banking sector, which has remained relatively isolated since the last batch of foreign banks, including the Addis Abeba Bank (40pc owned by the British Grindlays), shut down operations in 1975. The potential re-entry of foreign banks is expected to bring much-needed capital and expertise, stimulating competition and innovation in the banking sector.
However, some financial industry stakeholders feel left out by the rapid changes. Dawit Keno, president of Hijra Bank, a full-fledged interest-free institution that received the central bank’s nod three years ago, feels that its industry segment has not been adequately addressed in the new regulations. While he appreciates the stringent controls on assets and corporate governance, Dawit hoped for more detailed provisions for interest-free banking in the draft proclamation. He suggested an inclusive approach to the banking reforms.
“A dual banking system should be considered,” Dawit told Fortune.
Dawit advocates for establishing a department within the NBE to supervise interest-free banks, referring to standards set by the Accounting & Auditing Organisation for Islamic Financial Institutions from Bahrain. He also observes gaps in the oversight of interest-free windows at conventional banks, which he believes have created unhealthy competition due to uneven disclosure requirements and questionable accounting practices.
Despite these concerns, Dawit remains hopeful about the central bank’s introduction of open market operations and monetary policy interest rates, which he believes are vital for removing liquidity bottlenecks in bank-to-bank transfers. The NBE is still exploring modalities for interest-free banks’ participation in these operations.
“We hope something will be revealed soon,” Dawit said. “In the meantime, we will benefit from the trickle-down gains.”
Full-fledged interest-free banking establishments were not approved until 2019, despite regulators initially approving interest-free banking as part of the conventional system 13 years ago. According to Abdulmenan Mohammed (PhD), a London-based financial analyst, given revelations of intense credit concentration in the inaugural financial stability report three months ago, NBE’s tightening of the regulatory landscape was unsurprising. He suspects much of this concentrated credit comes from state-owned enterprises with government guarantees.
“The stringent controls are necessary, albeit difficult to implement,” Abdulmenan told Fortune. “There is rarely a shortage of laws.”
Abdulmenan expects the NBE to enhance its on-site supervisory capacities to address the loopholes in the current report-based regulatory framework. He also recognises the need to address the sluggish adoption of interest-free principles within the NBE’s governance board and administrative apparatus, calling for alternative modalities for interest-free options. Abdulmenan believes the recent policy orientations will facilitate the entry of foreign banks once the draft banking law is ratified by Parliament early next year.
As part of its efforts to promote transparency, the central bank released its inaugural financial stability report in April, highlighting several risk factors for a healthy financial industry.
Fikadu Digafie, vice governor and chief economist at the central bank, emphasises their evolving role in the economy will be tethered to ensuring price and monetary stability. He said the five directives were introduced to meet international banking standards and lower risks, aligning with the NBE’s primary goal of price stability.
“Contemporary standards for the banking sector are crucial,” Fikadu told Fortune.
Fikadu also noted the existence of a credit information directorate within the NBE to help map out credit exposure risks for banks. He expects the central bank’s ability to manage liquidity based on economic conditions will increase its power in controlling inflation.
“The interest rate will reflect whether a tight or loose monetary policy stance is being adopted,” he said.
He said they are investigating modalities for interest-free banking institutions’ participation in open market operations as part of its new monetary policy framework which would ensure that all segments of the banking industry benefit from the new policies.
A key issue is credit concentration, with the top 10 borrowers holding nearly 23.5pc of the total 1.9 trillion Br in loans and advances. The NBE’s financial stability report revealed that if the largest depositors from each bank were to withdraw all their funds simultaneously, 18 commercial banks would fall below the minimum regulatory liquidity requirements.
Industry veteran Eshetu Fanatye notes that business as usual is no longer feasible for the banking industry. He emphasises the need for substantial upgrades to commercial banks’ information and technology infrastructure to meet the stringent conditions of the asset classification directive.
“Manual credit review processes can’t cope with the new standards,” Eshetu told Fortune.
Eshetu said massive technological investments are needed to enable banks to maintain the necessary level of follow-up and analysis based on International Financial Reporting Standards (IFRS). This technological leap is essential for aligning with global standards.
“These are the international standards, after all,” Eshetu said.
Tracing the central bank’s actions since the issuance of its three-year strategic plan, marked by directives and the establishment of open market operations, Eshetu compares Governor Mihretu to a perfectly ticking clock, achieving strategic objectives one step at a time. He believes the governor needs public, multilateral finance institutions, and government support in this ambitious undertaking.
Governor Mamo Mihretu’s tenure at the NBE is marked by bold and comprehensive reforms reshaping the financial landscape. While the directives and strategic plans present a clear vision for stability and growth, experts believe the successful implementation of these policies will require coordinated efforts from all stakeholders, substantial investment in infrastructure, and a willingness to adapt to new regulatory environments.