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Published On  Oct 16,  2011
   
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Having a vibrant financial sector that provides an array of modern services in a fast-growing economy such as Ethiopia’s calls for banks to have a strong capital and liquidity standing, argues Alemseged Assefa, former vice governor of the National Bank of Ethiopia. Therefore, the new capital requirement threshold issued by the central bank is imperative, he observes.

Recapitalizing Banks: A Penny Saved, A Penny Earned 

 

Over the past sixteen years, a number of private banks have joined the banking industry posting a double-digit profit growth and high returns following the emergence of the country from mono and state-owned banks to markets opening up in line with the thrust of the government’s economic policy.  Year after year, more and more private banks are joining the banking industry, in which investors are attracted by bumper profits and high dividend payouts. Thus, buying bank shares has become an attractive investment.

As a result, there are about sixteen private banks currently in the business and more than a dozen of banks are in the offing to join the industry.  With the renewed capital requirement, nevertheless, the banks are poised to look into how to raise the required capital and stay in business with healthy and strong balance sheets.

The initial capital requirement of 50 million Br at the beginning of 1990s, equivalent to about 5.6 million dollars at that time, and the subsequent raised capital requirement of 75 million Br, may have been appropriate to the then economic and business environment.

With the country’s stellar record of stable macroeconomic management, continued solid growth and an increased capital requirement to operate a business, however, small banks with little capital may not meet the growing demand for financial services. So they would not be able to underpin modern products required by investors, entrepreneurs, companies, individuals, households, and consumers.

The National Bank of Ethiopia (NBE) has raised the capital threshold that banks must have by June 2016 to 500 Br million, having realized the need for banks to build up their capital.  It amounts to a capital requirement of 30 million dollars with the current exchange rate.

Given the current capital level of most private banks, the requirement may look a bit large in today’s value of Birr.  But if we consider the value and exchange rate of Birr in five years, it will not be large enough for banks to maintain lending for small and medium enterprises, companies to build new factories and expand their operation, consumers to buy new car, real estate developers to develop land, individuals to build houses or households to buy modern appliances.

Although the banks’ current profitability is strong with double-digit growth, they must have adequate capital and liquidity reserve to fall back on if their profitability falls due to an unfavorable economic and business environment.  The banks cannot adequately maintain their prime business of increased lending with small capital and liquidity reserves if the economic situation becomes unfavorable for them. 

No doubt that the long-term prosperity of the nation cannot be ascertained if banks cannot lend enough money to investors as required by the growing economy of the country.  Therefore, the need to press banks to build their capital and liquidity position, and boast their capital adequacy ratio, is necessary for the health of the financial system and the economy. 

To remain afloat in the business and protect themselves against risks or losses from their operation, banks must always improve their liquidity positions and raise their core tier-one capital ratio; which is a key measure of strength. They need to ensure that the ratio does not fall below the crucial threshold set by the Basel standard.  This is what we see is happening in the emerging market economies of South East Asia and Latin America. Some countries even have a banking sector with an average capital ratio of above 10pc, which is well beyond the Basel III standard.

The growth of internet banking, mobile banking, credit cards and an array of investment products for depositors and borrowers demands that banks be ready for intensified competition in the banking business.  The stiff competition they will have to face in the long run, when the banking industry to becomes open to foreign competition, should also not be overlooked.

Thus, there should be no disagreement with the move to press the banks to build their capital over a five-year period to the new level.  The moot question is how the banks will raise enough cash to meet the requirement.

The first option would obviously be to go public and issue shares to raise money from the market. This, of course, would not be an easy task as many of the established banks that have been in the business for several years and those in the offing would be in a rush to issue considerable shares in order to raise sufficient cash from the public market.  Cashing in by going public would require conducting research and developing a marketing strategy to attract investors with significant cash or wealth, and the lower and middle income class of society to buy the floated shares.

Noting the current bumper profit of banks and the impressive yield of bank shares, in which their profitability and high investment return is the envy of other share companies in the economy, this group of investors may go out and buy the bank shares right away and earn a decent return on their real financial assets holdings.

Recapitalization could also be undertaken by cutting dividend payouts of shareholders until the capital requirement is raised to the required level. A third possible way would be to mull over the possibility of mergers.  This is more applicable to banks that are finding it difficult to gain access to public resources within the required time frame.

In effect, Ethiopian banks need to grow bigger by building their capital and liquidity position as the economic resilience and long-term prosperity of the nation highly depends on a healthy financial system. It also depends on the evenhanded balance sheets of the banks. 

All the unfolding circumstances in the international financial system dictate this; although, not so evenly in developed and emerging market economies.  The new capital requirement has, therefore, begun to write a new chapter for the future of the banking industry and the nature of the financial sector in Ethiopia.

Banks need to wake up to the call by the central bank and develop a well-planned strategy to meet the capital requirement over the fixed time horizon.  If so, it might be possible to see strong banks and a vibrant financial sector that provides an array of modern services in an economy that is enjoying a growth rate beyond most of the emerging markets for over seven consecutive years.

By Alemseged Assefa,
Former vice governor of the National Bank of Ethiopia

 
 
 
   
   
   
 
 
 

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