First step to recovery is admitting sickness, if conventional wisdom serves as any guide. There would be hardly a solution until problems are uncovered, studied and understood. 

Unfortunately, this concept seems to elude those at the helm of the Development Bank of Ethiopia (DBE), a state owned investment bank originally created to finance agricultural and industrial projects, public and private alike. Its internal deficiencies are seemingly brushed under the table and operations continue as if all is well. Ironically, its top executives tried to justify what goes wrong under their watch, claiming that DBE has not been created to “make profit and transact money”. What else is a commercial enterprise supposed to do is a question only they can answer.

However, as with all illnesses, DBE’s malaise can only be ignored for so long until it grows into a point of no return.

As revealed in an inspection report by the National Bank of Ethiopia (NBE), the regulatory agency of all financial institutions, the timeframe to find small fixes to minor problems has passed. DBE’s woes now appear to require drastic measures of a brand almost unthinkable to an organisation that has to date behaved less like the responsible public body it should than an ailing patient stubbornly avoiding the inevitable tough medicine a prudent doctor would recommend.

Despite a strong dissent from DBE’s management, everything from procedural shortcomings to asset deterioration have characterised the bank that at times has even brushed aside regulations set by NBE, according to the inspection report.

 These startling findings come at a time when the banking industry has been in bonanza, in large part led by a fledgling but rapidly expanding financial sector. At a time when new banks are pressing all the buttons to enter an industry reaping some of the highest dividends in the world, a bank struggling to stay afloat is not only disturbing to the public whose funds it is the custodian of, but also signals deep problems in the system it operates in.

In a country where the government’s modus operandi is to propagate successes while often leaving the problems unattended, it is time the sickness of the 99-year-old DBE is addressed in a serious manner. This Administration’s handling of a distressed public institution should be seen as a test case to examine its commitments to a disciplined growth, even when it could mean rethinking an overly centralised state and exposing mistakes.

DBE’S GROWING PAINS

The state-owned giant controlling 46 branches and with 1.6 billion Br in paid up capital is deep trouble, according to the disputed inspection report by the ‘central bank. Should the government be interested to grant DBE a good fix? A complete examination of its deep-rooted problems requires both an extended study and space beyond the scope of a single editorial. But a cursory glance at the main components of its woes should be of interest for a public that should have legitimate concerns with the destination of limited public funds, originating internally through taxes and externally from grants.

One of three state-owned banks, DBE is charged with advancing medium and long-term loans to businesses operating in priority sectors set forth by the government, loosely encompassed in the overall Agriculture Development Led Industrialisation (ADLI), a guiding economic policy recently given philosophical backing by the World Bank, and a series of centrally developed plans. Though it can be a challenging task to follow dictates from a body with interests far beyond the mere financial considerations of private institutions, there are convincing reasons this hierarchy should be a recipe for success.

There are certainly privileges afforded by working hand-in-hand with the body that controls vast assets, including a federal budget of 43.2 billion Br this year. Whose influences are normally put towards aiding the very sectors the bank is charged with promoting. Loans destined for business is currently one of the government’s favourites.

 In this third phase of PASDEP they include export oriented and value-added sectors such as leather, horticulture and small manufacturers. Complimentary public investments for the necessary surrounding infrastructures and economic incentive packages,   gives them every reason to enjoy success.

Even though DBE managers dispute the accuracy of the inspection report and sometimes their problem appears to be that it was leaked to the media and made public, many facets of its operation and structure are grounds for deep concern.

At its very foundation is an asset base deemed “critically deficient” by the central bank. It has the power to conduct spontaneous inspections of banks should its officials deemed it appropriate. This important designation shows the serious lack of sources of liquidity and room to manoeuvre should loans turn-up unpromising.

The route to the lowest asset rating NBE gives is troubling but not surprising considering the mismanagement of DBE, for too long now. Holding acquired assets past advised periods of time, result in trouble, deterioration, depreciation and machines that should have been put to productive uses. However, a poor 62 percent recovery rate from disposal of assets requires the Bank to re-shuffle its already lacklustre books to hold more provisions against holdings now with less value. Apparently, DBE officials rather see what is put aside (715 million Br) as provision for non-performing loans (NPLs) as part of their annual profit, contrary to what international audit standard requires.

Proper management of assets has not occurred, though, as no investment policy and procedures that guide the proper utilisation of excess funds exist.

Instead, DBE has held an average of 275 million Br in non-interest earning demand deposits in the past couple of years, operated with irregularities such as failing to revise insurance coverage since November 2003 and allowed Respective Property Administration Department staffs to take inventory without independent witnesses from internal audit.

But DBE’s most troubling aspect is its high volumes of “sick” loans that result from excessive numbers treated on exceptional bases that have “become the norm of the Bank”, according to the inspection report. Failure to properly classify and re-classify loans and evaluate borrowers both in the pre and post-disbursement stages means that provisions for NPLs has been deficient to the scope of 657 million Br. When the payment schedules for these ill-advised extensions of credit kick-in, massive defaults will most likely follow, despite the generous and positive outlook DBE officials may have.

PROBLEMS UNSURPRISING WITHOUT OVERSIGHT

DBE’s miserable outlook is to be expected considering its dismal management that has not conformed to a number of directives by the central bank. Its seven-member board appointed by the government, and chaired by Melaku Fanta, minister of Revenue, has not been approved by the NBE. Considering the trials experienced by private banks complying with rules governing board membership, severely stressed in a market drastically lacking human resources, it is in question whether DBE would even have renewed its license to operate if it were strictly regulated.

The lack of an independent board review committee, proper loan classification system and expensing of long-outstanding items, all not in line with NBE directives, give sufficient explanation for the Bank’s current standing. But what is inexplicable is how the Bank has been allowed to continue in this vein.

Judging from the report of the agency responsible to inspect public books, the Audit Services Corporation, NBE has not been living up to its duties. While it has been relatively firm in giving private banks a handful in terms of regulating their operations, and even issuing a rare but fairly ineffective measure aimed at cooling the roaring inflation, NBE has been missing the mark in guarding the public funds.

Exposing the line of responsibility leading up to DBE’s dilemma should not stop at its regulator, NBE. The private sector would never let balance sheets deteriorate to the level of DBE’s. Driven by profit motivated management and checked by private investors and shareholders keen to capture the highest returns, the source of credit being extended without prudent considerations would dry up quickly, forcing the bank to liquidate assets, thus far unwisely held by DBE.

Management born of and guided by a system that is apt to obscure deficiencies and pursue questionable policies originating in the minds of bureaucrats is bound to fail.

The function DBE performs in an underdeveloped economy is important. It channels credit to potential sectors that a fledgling financial sector is prone to missing funds. However, the rapidly expanding economy and growing capacity of banks is reason to consider policies developed in a different time with an economy vastly less advanced.

Examples of other poor countries to utilise a combination of public and private micro-finance institutions to reach young sectors, should be studied to potentially take the place of DBE. Moreover, the new entrants and larger private banks may now be able to responsibly take the reigns of an inefficient public sector actor.

The state no doubt has good intentions in mind with its proliferation of DBE and other state owned enterprises. The problem, however, is in the complacency and inefficient perpetuation characteristic of the public sector lacking dynamism. While the private sector is quick to adapt to new circumstances, governments are notoriously slow to react.

DBE’s troubles should be taken as a wake-up call for the government to change its philosophy and pursue free market options. It cannot control the economy to the current extent forever. Otherwise, DBE may become just one example of sick companies needing treatment.