The development of the banking sector in Ethiopia has received a significant boost from the acceptance of foreign entrants to the market.

By Monica JohnsonInternational Banker

INWith a population of more than 120 million, Ethiopia is fast becoming one of the most important economies in sub-Saharan Africa. Its gross domestic product (GDP) grew at an annual rate of more than 10 percent per year between 2003 and 2010, and has remained above 6 percent per year since. However, this growth during this time has not been accompanied by much receptivity to foreign investment. However, with the introduction of legislation on June 14 that will allow foreign entrepreneurs to enter the banking sector, Ethiopia has taken a key step in its journey of rapid financial and economic development.

In fact, banking liberalization has been on the horizon for years, with the central bank taking initial steps in August 2019 when it granted a business license to Ethio Lease, a unit of New York-based African Asset Finance Company (AAFC). The license allowed the U.S. group to lease imported equipment to Ethiopian companies using local currency contracts to bypass currency and capacity constraints. “This is incredibly important. Ethiopia is trying to liberalize its economy, and opening up the financial services sector is an important part of that,” said Frans Van Schaik, AAFC’s CEO. Financial Times then.

By May 2023, the National Bank of Ethiopia (NBE) approved its first license for a non-Ethiopian to operate a mobile money service — the recipient was Kenyan telecom giant M-Pesa. NBE Financial Institutions Vice President Solomon Desta soon followed with a promise to issue three to five more foreign banking licenses over the next five years.

A minor setback to the liberalization process came in November 2023 when Ethio Lease announced it would exit the Ethiopian market due to the impact of currency controls. However, the damage done by this announcement was quickly muted when the NBE confirmed later that month that a new legal framework would be in place by July 2024 to open up the banking sector to foreign competition.

In June, bills to liberalize the financial sector were introduced before the Federal Parliamentary Assembly, including a draft Business Banking Proclamation that would allow foreign investment in domestic banks. Another important bill is the NBE Proclamation, which, among other things, establishes the necessary legal framework for the launch of a central bank digital currency (CBDC). “These regulations are a significant step towards laying a solid foundation for the growth and enhancement of the credibility, accountability, transparency and governance of the National Bank of Ethiopia,” the central bank noted in a statement.

Approved by the Ethiopian cabinet but still awaiting approval by the Assembly, the Business Banking Proclamation Bill states that “a foreign bank that is well established, has a good reputation and is financially sound may be permitted to establish a wholly or partly owned foreign subsidiary of a bank, or to open a branch of a foreign bank, or a representative office, or to acquire shares of a bank.” This allows for the acquisition of a maximum 30 percent stake by strategic foreign investors, while total stakes by non-citizens and foreign companies are limited to 40 percent, with such investments made only in foreign currencies.

The law also stipulates that at least one Ethiopian resident must be listed on the boards of all foreign banks operating in the country. Foreign banks are prohibited from opening deposit-taking and non-deposit-taking branches at the same time, and the Central Bank of Ethiopia has the final say on the minimum capital thresholds for such banks.

Nevertheless, if approved, the law would significantly strengthen Ethiopia’s ability to attract foreign investment to its shores—a particularly important undertaking given the country’s years of internal conflict that have contributed significantly to destabilization and scared off global investment funds. A significant decline in foreign reserves in recent years has also accelerated the move, and the inflow of funds is expected to significantly strengthen the central bank’s asset base and reverse Ethiopia’s growing risk of default.

With a rapidly growing economy and population, Ethiopia could present an exciting opportunity for global banks looking for a new market to expand into. In turn, the addition of foreign entities will increase the competitiveness and efficiency of the banking sector and ultimately improve the customer experience in an industry that includes 29 local banks, many of which are state-owned.

“Foreign banks will introduce new technologies and new services to both corporate and retail banking,” said Mirkarim Yakubov, an Addis Ababa-based asset manager who spoke to African business magazine. Yakubov predicted that the first foreign banks to enter the Ethiopian market will be regional African banks, including multinationals from Kenya and South Africa, with potentially significant interest from China. “Foreign banks will introduce new technologies and new services in both corporate and retail banking. This will force existing players to significantly improve what they offer to businesses and consumers.”

In terms of the timing of this likely legislative approval, 2024 appears to be the right time for Ethiopia to take this important next step in maturing its banking sector, as demonstrated by the NBE’s inaugural 2023 Financial Stability Report, released in April. The report, which aims to address key risks and promote a “sound financial system in Ethiopia,” found that Ethiopia’s financial sector is both stable and resilient to the impacts of COVID-19 and other emerging risks.

“Despite the increase in credit, liquidity and operational risks, and to a lesser extent market risks, banks remain sound and stable, thanks to strong capital and liquidity buffers, solid profitability and other factors,” the report said, adding that the NBE’s risk stress tests further evidence that such elements also contribute to banks’ resilience to shocks. “In the microfinance sector, the capital adequacy ratio, non-performing loan (NPL) ratio and liquidity ratio are within NBE parameters and have improved over the 2023 review period.”

The strength of the Ethiopian banking sector is further underscored by Fitch Solutions, which released a report on May 10 describing the sector as being in “good financial health,” largely due to a strong economic environment that will continue to support banks in the coming years. Indeed, official government estimates put Ethiopia’s annual GDP growth rate at 7.9 percent in fiscal year 2023-24, which began July 8, 2023. Meanwhile, the International Monetary Fund (IMF) projects GDP growth of 6.2 percent in calendar year 2024 and 6.5 percent in 2025.

“The sector’s non-performing loans (NPL) to total loans ratio stood at 3.6 percent in June 2023, below the regulatory limit of 5.0 percent and down year-on-year,” Fitch said. “Despite a slight decline in the capital adequacy ratio (CAR) from a pre-pandemic level of 19.9 percent to 14.7 percent in June 2023, it remains well above the regulatory requirement of 8.0 percent. Furthermore, while the banking sector’s total income rose by 20.4 percent year-on-year in June 2023, rising expenses, which rose by 26.0 percent, meant that net income before tax recorded a modest increase, reaching ETB 62.9 billion at the end of June 2023, ETB 1.1 billion higher than a year earlier.”

It should be emphasized, however, that the current situation in the Ethiopian banking sector is not all positive. Fitch has also identified several key risks that could spill over into the entire sector:

An increase in credit risk could materialize this year as a result of drought, internal conflicts and a weakening external sector, as well as the concentration of loans among the sector’s 10 largest borrowers, which account for as much as 23.5 percent of all loans (as of June 2023).
NBE’s stress tests revealed a clear vulnerability to liquidity risk if the banking sector were to experience a run on deposits from major customers. As such, NBE predicted “a modest increase in liquidity risk in the near to medium term, attributed to asset-liability mismatches, funding shortfalls, concentrated deposits and failure to meet weekly liquidity standards,” Fitch noted.
Rising operational risk, which Fitch attributed to an increase in insider threats, social engineering, and bank fraud and forgery. Fraud doubled in the year to June 2023, reaching ETB 1.0 billion.
High interest rates have raised the market risk facing the banking sector, and rising funding costs are likely to weigh on profitability. “This is particularly relevant in Ethiopia, where floating-rate deposit liabilities contrast with fixed-rate assets and government bonds,” Fitch said. “In addition, banks’ overall FX open position was short by 81.7 percent at end-June 2023, well above the central bank’s 15 percent limit.”
Although the conflict in Tigray has calmed down considerably this year, there are still economic and geopolitical risks that could pose a serious threat to the financial stability of the banking sector.

“On a positive note, the Ethiopian Securities Exchange (ESX) plans to begin trading in corporate shares, government-issued fixed income securities and money market products as early as September 2024, which will bring a range of benefits to the banking and financial services sector,” the rating agency added, marking another key development in the country’s financial system. “Announced in April 2024, the exchange aims to list 90 publicly listed companies in the first seven to 10 years and has already approved the listing of about 10 state-owned companies, with investors able to buy stakes ranging from 10 to 100 percent.”

Editorial information: five points six