A short primer on the Ethiopian banking system

By Doug Muir

Ethiopia’s banking system is weird. It’s like a throwback to an earlier Africa, the Africa of the 1970s or 1980s. Three reasons.

First, the system is dominated by two big state owned banks. One of them — the Commercial Bank of Ethiopia — accounts for almost 50% of all lending, by itself. Throw in the other one (the Development Bank of Ethiopia) and the majority of lending in the country is being done by state-owned banks. That was pretty common in Africa thirty years ago, when almost everyone had a big state-owned bank or two that dominated the sector. But in 2012, state-owned banks are an endangered species. About half of all African countries don’t even have them anymore. In those that do, the state-owned bank is usually small and specialized, focused on some neglected sector like agriculture.

There are a couple of reasons for this. One is that, historically, African state-owned banks generally didn’t work very well. Another is that the big multinational lenders — the World Bank and the IFC — dislike state-owned banks, and have encouraged African countries to break them up and privatize them, or at least shrink and marginalize them. (For the record, I think this was mostly a positive thing — but like a lot of World Bank/IFC policies, it’s been applied in a rather ideological and ham-handed way. A lot of bad, corrupt, ineffective old state banks needed to go, but a lot of babies got thrown out with that particular bathwater.)

Ethiopia, though. Ethiopia is run by a bunch of former revolutionaries who are very nationalistic and not inclined to trust or listen to the World Bank and its ilk. So they’re keeping their big state-owned banks. But at the same time, they’ve allowed — no, encouraged — the growth of a vibrant private banking sector. There are about fifteen private banks in Ethiopia today, and they account for about 40% of lending and about 60% of deposits. They’re a vital part of the economy already, and they’re growing by leaps and bounds. So the banking sector is a true public-private hybrid. In this, Ethiopia looks a bit like a less-developed version of Brazil, where public banks are common and the BNDES development bank plays a major economic role … but keep reading.

The second odd thing about the sector is that it’s closed and protected: no foreign banks are allowed. Ethiopia has no Barclays, no Bank of Africa, no Citi or HSBC. That’s also weird and unusual, because in 2012 most African and Latin American countries have opened up their banking sectors to foreign competition. Among other things, you can’t join the World Trade Organization unless you agree to do this — and everyone wants to join the WTO. Out of 54 African countries, all but seven or eight are already WTO members. (The ones that aren’t in the WTO are either oil-rich — Libya, Sudan, Equatorial Guinea — or recluse states like Eritrea, or tiny places like the Comoros. Oh, and Somalia, which doesn’t have a functioning government.) So pretty much everywhere in Africa, from Botswana to Senegal, you’ll encounter a bunch of international banks. But not in Ethiopia.

The third weird thing: the Ethiopian Central Bank? The guys who regulate the banks, control the money supply, set interest rates and all that? The Central Bank is not independent. Doesn’t even pretend to be. It’s an arm of the executive branch. It’s there to do all the normal central bank stuff, but it’s also there to carry out government policy. (In this, Ethiopia is also quite different from Brazil. The Banco Central do Brasil has little statutory independence, but plenty of de facto autonomy.)

Here’s an astonishing example. Couple of years back, the Ethiopian government wanted to build a hydroelectric dam. Huge, huge thing. Going to light up half the country. Also going to displace tens of thousands of villagers and do untold ecological damage, including possibly wiping out Lake Turkana, but do you want electricity or not? — So they want to build a dam, but for various reasons nobody wants to lend them money to build it. (Ethiopia’s credit is not good: Dagong rates the government at CCC, and Moody’s and Standard & Poor’s don’t even bother.) Where to get the money, then?

Well, the government of Ethiopia simply followed the Willie Sutton principle. The Central Bank told the private banks that they needed to start buying dam bonds. Lots of them. In fact, the Central Bank announced that for every dollar lent by a private bank, they would have to buy twenty-seven cents worth of bonds. Since commercial loan rates in Ethiopia are around 12% to 15%, and dam bonds pay just 3%, the banks were not very happy about this. But they had no choice: if they didn’t comply, the Central Bank would shut them down. So they’ve been buying dam bonds — millions and millions of dollars of them. And now the government has money to build its dam.

So, a mixed public-private banking system that’s protected from international competition, run by a non-independent central bank with a history of brutal intervention. How’s that working out?

Surprisingly well. But this may need another post.

Source: The Power & the Money