I  am a strong supporter of financial sector regulations and supervisions in Ethiopia. I believe that the central bank has done a good job over the past few years of disciplining an otherwise difficult business. I only wish that the National Bank of Ethiopia could have a strong law passed and then continue to be powerful enough to enforce it, as depositors and minority shareholders are at the mercy of boards of major shareholders and their appointees.

It is in light of this view that I appreciated reading the commentary on banking by  Dani Rodrik, a professor at Harvard University, which was published last week headlined: “Guns, Drugs and Financial Markets”, [Volume 8 Number 415, April 13, 2008]. His analysis of “finance skeptics” is relevant to Ethiopia, I would argue, for sufficient reasons.

The private banking phenomenon is a relatively new development in Ethiopia; this is why managements, boards, auditors, shareholders and depositors have limited knowledge and experience of modern banking. I suspect that depositors and even shareholders have not much capacity to monitor banking activities. 

Senior management of banks is appointed by boards of directors. The boards, however, are deliberately hand-picked by a few major shareholders with controlling stakes, so both the senior bank management and the directors are consequently controlled by a few shareholders who hold the larger piece of the banking pie and therefore treat the banks as their own finance estate despite the fact that about 90pc of the banks’ assets belong to the public.

Directors of boards were known to issue over 100pc of deposits as loans and advances some years back in spite of the clearly specified liquidity and reserve requirement of a minimum of 20pc of deposits set by the National Bank of Ethiopia (NBE). That was also a period when paid-up capital was uniformly low.

The practice of taking loans and advances for share trading or spending them on ventures totally unrelated to the loan agreement has been wide-spread in all private banks.  This is an indication of the audacity of boards and managements, as well as of the poor quality of external auditing in enforcing banking regulations in Ethiopia today.

Unlike Europe, United States, Asia, Australia and some countries in Africa, Ethiopia does not have deposit insurance. Depositors are at the mercy of major shareholders and their appointees, the boards of directors. Nevertheless, there are those who argue that deposit insurance has problems which cause bank managers to take more risks than necessary and make shareholders reluctant to closely monitor these banks thinking that their investments are duly protected. I believe that this argument does not hold water in the Ethiopian case. 

Ethiopian banks have legally-limited activities. Neither the depositors nor the controlling shareholders know exactly what is going on in these banks; only about one per cent of the group may have limited knowledge of what is going on because shareholders hardly have access to information, while the others may not necessarily be interested in enhancing the sound development and profitability of private banks as their primary goal is to use banks to advance their other businesses. There is no way that effective supervision can be made by shareholders in Ethiopia. 

All stakeholders and the national economy can benefit from a deposit insurance scheme which could protect banks, depositors, employees and shareholders from wayward major shareholders and boards of directors, therefore reducing the risks that banks face.

This is most important considering that Ethiopia’s financial industry has no rating firms. Even external auditors are practically useless since they rarely measure up to the powers and duties entrusted to them by the Commercial Code. As it is, there is no financial institution that uses risk models; bank monitoring through such practices is virtually non-existent in Ethiopia.

That leaves the responsibility for serious regulation and supervision of the banking world on the shoulders of the National Bank of Ethiopia (NBE). I commend its officials for having this year come up with a loan management directive in a bid to avert such crises. I strongly believe that this directive, coupled with another set of directive issued in 2006, has taken great strides towards ensuring selection criteria for individuals chosen for the board of directors.

Unfortunately, this directive falls short of providing clear guidance on mechanisms for implementation. As a result, incompetent and weak directors have continued to be recruited by a few major shareholders who have consistently failed to learn lessons from their past failures.

 What I see in the latest directive is a determination by the regulators at the NBE to protect depositors, shareholders and the economy from incompetent bank management. If anything, it will force these banks to manage loans and advances with more transparency and accountability. For instance, the directive requires quarterly reports on loan classification and provisioning to be filed to the NBE, thus encouraging more investment in the financial sector from Ethiopian nationals, both locally and abroad.

The reference to sampling in Article 5.5 can be made more clear by requiring the use of “scientific sampling” to ensure the accuracy and usefulness of the estimates in a sample-based report for Examiner Review (Article 10 of the directives), although it could be argued that such details is not NBE’s business. I strongly believe, however, that boards of directors have proven to have little capacity to manage such issues effectively on their own.

As a supporter of regulation and supervision, the current draft banking law will, hopefully, be strong enough to foster the growth of a healthier and more competitive financial sector and prepare Ethiopian banks for survival and continued development within the global village, even when Ethiopia becomes a member of the World Trade Organization (WTO) in a few years.

It will facilitate a still stronger central bank to continue to implement more effective regulation and supervision. The bill also provides controlling power to a larger group of unrelated shareholders after gradually lowering the maximum percentage of shares that can be owned by individual or related parties from 20pc to about five per cent now. It is worth noting that 20 or more major shareholders are unlikely to agree on a control cartel.

The bill will therefore furnish an environment in the financial sector that enables the appointment of independent, competent and professional boards of directors that are elected by all shareholders based on well-considered, search-based nominations conducted by professional search committees appointed at previous annual meetings by shareholders. I also believe that this approach will not deny the rights of major shareholders who can always use their strong voting power to influence the final elections of board of directors.

Undoubtedly, the bill is a good instrument to bring about reasonable uniformity in the financial sector on compensations, fees and benefits paid to board of directors, a regulating body which should be free from the influence of major shareholders; while it will also guarantee adequate protection to depositors. In the end, all these safety valves and protective measures will minimize the likelihood of bank runs.