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Foreign banks eye Ethiopia as government reforms gather pace

Foreign banks are becoming increasingly vocal about the prospect of entering Ethiopia, a country historically hostile to outside influence, as state reforms and a growing privatization push suggest the government could ease its grip on the financial sector.

The Ethiopian People's Revolutionary Democratic Front, in power since 1991, has long believed in government control of the economy, overseeing state monopolies in key industries such as telecom and aviation. But in June, the government said it would allow foreign investors to buy minority stakes in Ethio Telecom, Ethiopian Airlines and Ethiopian Power, increasing speculation that the banking sector could also be liberalized.

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The infrastructure in Ethiopia's capital, Addis Ababa, has advanced as the country's economy has grown.

Source: AP Images

That month, the chief executive of Kenya's largest bank, KCB Group PLC, told Bloomberg that Ethiopia was "ready for take-off," describing the country as a "very exciting market." The Kenyan lender, which has a representative office in Ethiopia, also said in July that it has ambitions to form a partnership with an Ethiopian bank or start a subsidiary in the country. Then in August, British lender Standard Chartered PLC's chief executive also said his bank wants operations in Ethiopia.

Restrictions on foreign banks

For now, foreign banks are constrained by Ethiopian legislation that restricts foreign investment in certain sectors, including banking, insurance and microcredit.

"Foreign banks will be allowed to operate in Ethiopia. It is more an issue of 'when' than 'whether or not,'" said Henok Assefa, managing partner of Precise Consult, a consultancy in Addis Ababa, the Ethiopian capital. "However, there's no timeline put together by the government. It will likely take some years."

Assefa said that judging by the privatization plans in other industries, the government would most likely first allow a joint venture with a foreign minority shareholding.

To allow foreign participation in the banking sector, "the procedure is straightforward," said Abdulmenan Mohammed, an independent financial analyst. "The parliament enacts a proclamation."

Ethiopia's recent reforms come as the country's economic growth continues to surge. Its GDP was around 1.7 trillion birr in 2017, and it registered a growth rate of 10.3% in that year, according to data compiled by S&P Global Market Intelligence.

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But economic improvements have failed to quell popular disquiet against the ruling party in a country where more than half of the population lack access to safe water, according to water.org, a U.S. nongovernmental organization. Prime Minister Abiy Ahmed took power in April after his predecessor quit following prolonged unrest. In October, he instigated a major government reshuffle in which half the 30-member cabinet were replaced, including the finance minister, in a move seen as accelerating the economic reform agenda.

Regulations constrain local lenders

State-owned Commercial Bank of Ethiopia dominates the banking sector, accounting for 47.7% of loans and advances, central bank data for 2016-2017 shows. Ethiopia's 16 private banks are required to buy bills worth the equivalent of 27% of their loan book from the National Bank of Ethiopia.

The proceeds are then transferred to the state-owned Development Bank of Ethiopia as it is mandated to then use this money to lend to riskier, strategically important sectors such as manufacturing and agriculture, which other banks are wary of doing business with. This plan has largely failed, while banks receive only 5% interest on their DBE bills and are required to pay a minimum of 7% interest on savings accounts, sapping their liquidity.

"Based on the data, over the past seven to eight years, probably only one-third of the amount collected from the banks under this edict has actually been invested in the economy; the rest has been used to fund the government deficit," said Mohammed. "People in the industry tell me they believe the government might relax the 27% requirement."

Banks are also lobbying to no longer have to surrender 30% of their hard-currency earnings each month, but these efforts are likely to fail, Mohammed said. "There's a serious shortage of foreign currencies even for priority imports."

Despite these strains, the banking sector is profitable, well capitalized, and liquid, the IMF wrote in a 2018 report that estimates sectorwide nonperforming loans at around 2.6%.

"There's huge demand for loans and other bank services. Competition isn't fierce. If foreign banks were allowed to enter, they would make good money — it's a very attractive industry," said Mohammed, who estimates the sector's posttax profits rose 180% from 2011-17.

Market ready for 'disruption'

Of the country's private banks, Awash International Bank Share Co. had a 7.0% share of loans and advances in 2016 to 2017, as per central bank data, while Dashen Bank SC at 5.6% and Bank of Abyssinia Share Co. at 4.4% were the next biggest private lenders.

Private banks' loans largely constitute short-term loans to importers, who typically must provide 100% collateral, and lenders rarely provide long-term loans to support more productive businesses. These shortcomings could spur the government to allow better-resourced foreign banks to enter the market, especially as DBE's NPL ratio is around 40%, according to the bank.

"Ethiopia isn't a rich country, but it has a large population that's mostly unbanked. If even half the current growth trajectory continues, it represents a big opportunity for foreign banks," said Andualem Mengistu, an Addis Ababa-based Research Fellow at the Ethiopian Development Research Institute, who spoke to S&P Global Market Intelligence in a personal capacity.

"If you enter the market, it's open for disruption. Local banks haven't faced real competition. A bank that's well capitalized and has a lot of expertise may be able to disrupt the market significantly. SNL Image

"If you asked me six months ago, I would have said there was no chance the government would allow foreign banks for at least five to 10 years. Now, the government's attitude seems to be changing. It has more appetite for privatization, attracting [foreign direct investment], so maybe the banking sector will be next."

According to S&P Global Market Intelligence data, Dashen Bank is the largest private lender, with assets of 45.43 billion birr as of June 2018, while Awash Bank's total assets were 41.97 billion birr as of June 2017, the most recently available data for the bank.

Mengistu predicted banking sector consolidation was probable in the long term.

"The industry is ripe for M&A, but I don't see much appetite for voluntary consolidation," he said. "There are no immediate government plans to reform the [Commercial Bank of Ethiopia], although the IMF and World Bank are putting on pressure to reform the banking sector, so it will happen eventually."

As of Dec. 12, US$1 was equivalent to 28.17 Ethiopian birr.

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