Mega banking: Future of Ethiopian banks

It seems that consolidation is the new way to go for banks. Although difficulty in managing “too big to fail” banks is highly apparent, still the industry prefers mergers and acquisitions to expand shareholder benefit. This global move is also inducing countries in Sub-Saharan Africa to consolidate their domestic banks and regulators of the Ethiopia banking industry appears to be on the same wave length with the latest move to combine the two state-owned banks being one example, writes Asrat Seyoum.

On September 15, 2008 the America investment bank Lehman Brothers filed for bankruptcy in a single largest bankruptcy filing in the history of the United States with the bank holding over USD 600 billion in assets. The bankruptcy triggered one of the worst financial meltdown in history resulting in the loss of trillions of dollars and over tens of millions of jobs around the world. Nevertheless, September 2008 was a far more complicated month since the fall of Lehman Brothers was preceded by the takeover of Merill Lynch which was on a verge of collapse by the Bank of America and the failure of the biggest insurance company in the world—American Insurance Group (AIG).

What made things more complicated was the fact that top rating agencies in the US maintained a positive opinion of these companies up until days before their collapse. The crisis, which was referred to as the subprime mortgage crisis, went down in history as one of the worst financial downturns since its impact was not simply limited to the financial services sector; rather the loss of jobs and savings affects all aspects of life in both the developing and developed world.

In its broader sense, the world has not yet fully recovered from the subprime crisis as it was shortly followed by another form of financial trouble— the European sovereign debt crisis of 2009. One thing that put the subprime crisis and the financial sector as whole under the radar is the resulting transference of the ills in the sector to taxpayers in the form of bailout packages. The then Federal Reserve Chairman Ben Bernanke went in front of legislators three days after the failure of Lehman Brothers requesting for USD 700 billion bailout package, the likes of which was unprecedented in the history of the world. Bernanke told US lawmakers that if the bailout was not approved, the meltdown would not be limited to the financial sector but of the whole economy.

The “too big to fail” financial institutions received the support ultimately. But, the incident left a cloud of doubt over the merit of concentration and consolidation in many industries; one such doubt was in the financial sector. Regardless, consolidation appears to be a preferred strategy of growth for financial institutions across the world.

Zemedeneh Nigatu, managing partner of Ernst &Young Ethiopia, looks to be convinced that the Ethiopian banking sector, composed of 18 banks, is ripe for consolidation. In a paper he recently presented on the occasion of the 20th year anniversary of Dashen Bank, one of the oldest private banks in Ethiopia, Zemedeneh told bankers that they should seriously consider consolidation and capitalization if they are to grow in par with countries economic levels.

A closer look at the issue reveals that it is not only Zemedeneh who holds this opinion. The regulatory body, the National Bank of Ethiopia (NBE), have also started to go public on the need to consolidate the sector. In fact, the telltale signs are already there. A few years back, the NBE set precedence by raising the paid-up capital of banks from 75 million birr to 500 million and gave the banks until June 2016 to comply. What was rather important was what the NBE proposed an exit strategy for banks if they were unable to meet the capital requirement— either horizontal or vertical merger.

According to bankers, the message that the central bank wants to get across is obvious; it is to encourage banks to take the initiative to consolidate before it reaches a point where it has to intervene. NBE’s push – as it was understood by bankers – is not unique to say the least. A number of central banks around the world have taken the initiative to implement bank consolidation programs. In fact, the bulk of the academic literature suggests that consolidation in many countries is driven either by market factors and firm level decisions or induced by the policy.

Consolidation by way of merger and acquisition is largely driven by market conditions in the advanced economies. Meanwhile, central bankers in Asia are also know to have taken a more hand-on approach by designing consolidation programs and steering banking towards merger and acquisition.

Especially following the Asian financial crisis in the late 1990s, a number of Asian economies including Malaysia, Thailand, Singapore, Indonesia, Philippines, South Korea and most recently Sri Lanka have successfully consolidated their financial sectors. In Africa, the likes of Nigeria have also pursued the policy-induced consolidation angle ending up in reducing number of banks from 89 to 25 in a span of a few years.

Elias Schulze, a venture capitalist and an investment analyst, who is currently the co-founder and managing director of Kana Television, argues that both approaches are widely used and both have their own merits depending on the conditions on the ground. Ideally, it is preferred for markets to drive mergers and acquisitions resulting in consolidation of the sector, Elias told The Reporter.

Nevertheless, he recognizes that emerging markets with no stock trading platform might not be motivated to drive mergers and acquisitions by themselves; and policymakers would be justified to induce such behavior given the long-term advantages consolidated financial institutions bring to the nation.

Nevertheless, from the policy angle, central banks are often forced to devise consolidation programs due to distress in the banking sector. In fact, there are very few central banks which opted for consolidation without experiencing distress or crisis in their banking sectors. Obviously, consolidation following crisis is mitigation against future damage.

Meanwhile, preemptive policy move to consolidate, like the decision the NBE looks to be pushing for, is based on a totally different logic. As far as the Ethiopian banking sector is concerned, big policy concern is the strength of the domestic banking sector and the possibility of the opening up of the sector for foreign banks. This looks to be high on the agenda of every banker in town. And the central bank's agitation as well is telling to say the least.

An official of a bank, who wants to remain anonymous, on his part, says that opening up of the sector for foreign investment is an eventual inevitability. Of the 70+ countries, who have managed to join the World Trade Organization (WTO) since 1995, he continues to argue, none of them have succeeded in acceding without opining up their financial sector for investment. “However, what is important is if increased capitalization and consolidation is key to give a competitive edge for the sector,” he asks.

Addisu Habba, president of Debub Global Bank and the Ethiopian Bankers’ Associations, has no doubt that the sector still has a long way to go to be competitive at the international scale; and says that capitalization and more consolidation are big factors to be competitive. Indeed, whether it is policy-induced or not, the single most driving factor for mergers and acquisitions consolidation by extension is tapping into scale economies and efficiency.

Wondwossen Teshome, president of Enat Bank, says that capital base is the most important factor for banks to grow and stay competitive in the market. Capital is required if banks are to hire expertise, acquire technology or to expanding their branching network; these are the factors that determine competitiveness, Wondwessen argues.

“One should be thrown off course by the rather stable Capital Adequacy Ratio (CAR) in the Ethiopian banking sector,” he says. According to data, the CAR (defined as the ratio of bank capital to risk-weighted assets) has stayed well above 20 percent over the past five years although the industry standard is just around eight percent. Wondwessen rather attributes the stable CAR to the small sized loans and deposits in the Ethiopian banking industry. “What is biggest loan figure for private banks in Ethiopia?” he asks “It is not more than 300 or 400 million birr and the level of capital required to cover such small loan portfolio is not that big,” he argues. Nevertheless, his worry is the size of loans and deposit that local industry is used to now is quite insignificant by global standards; so this does not mean that industry does not have capitalize more, he opines.

The anonymous banker, however, argues that when one speak of competitiveness. It is about the global banking industry. As far as, he is concerned, capitalization would not help local banks if they are to face fierce competition from international banks. For one, he argues, it is important to know that the profitability of the domestic banking sector stems from: it is huge interest spread (difference between deposit and lending interest) and extremely low pay for it manpower.

“The average interest margin across Africa is not more two percent while in Ethiopia banks enjoy a minimum of 10 percent spread on each loan; this is huge by all standards,” he continues to argue. Meanwhile, he also indicates the average bank branch manager remuneration in Kenya is close USD 10,000 while the maximum bank president earns in Ethiopia is not more than USD 3,000,” he illustrates.

Nevertheless, the competitive edge of the global banking sector emanates from market efficiency and banking product innovation, the anonymous banker argues, and these are the areas that local banking sector has shown very little progress in the past 20 years. “I doubt if capitalization or consolidation could help this sector, if exposed to the global competition,” he stresses.

Schulze as well is of the view that capitalization and consolidation although necessary condition for competitiveness is not a sufficient condition. He rather wants to emphasize capital base as a tool than an end by itself; it is the overall strengthening of the banking institution that would pay off eventually, he says.

On the other hand, should consolidation be the ultimate fate of the Ethiopia banking sector, the possible ways to achieve that it is also another point of interest. From the get go, bankers hold diverse views as to what type of market or policy consolidation would work for Ethiopia. “Although the central bank could take a more involved approach by selecting merger fits and so on, what would be sustainable is if the banks themselves take their time to find the right partners,” Addis opines. Nevertheless, Addis says that he is aware of the inherent difference is the ambition and long terms vision of banks in Ethiopia and the difficulty in finding the right fit. Both Wondwessen and the anonymous banker agree that the basis on which shareholders of the 16 banks in Ethiopia were organized is another big challenge should consolidation be the fate of the industry. They also don’t deny the implicit ethnic, religious and gender factors in organizing shareholder in Ethiopian banks; the possible challenge it poses to possible mergers and acquisitions. For Wondwessen, this reason alone could be major factor in discouraging mergers and acquisitions and possibly market driven consolidation. “Although I think time for consolidation is still too early, when it should happened, given the diverse nature of the banks, I think regulatory enforcement would be required to make that happen,” he concludes.

The anonymous banker on his part admits that the diverse industry would be challenged to join forces but it would be a short-term challenge. “Once mergers are formed the overarching shareholder, which is earning on the capital, would align them on one side and the challenges would dissipate,” he projects. Wondwessen also thinks that stock trading platforms would effectively dilute such sentiment in the industry and opens the door for consolidation.

All in all, the consolidation history of country shows that it is post-consolidation period that is worrisome. If banks could not make the merger and unions work consolidation measure no matter how diligently they were undertaken would be pointless, experts argue.