A short primer on the Ethiopian banking system

 Because this is what I do.

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.

Comments

[Florad]

Thanks for this interesting article. However, I do not think the story is over yet.

It is true that Ethiopia is a laggard in many ways, even in comparison with its peers in Africa. Compared to Ethiopia, most African countries now have a very open and liberalized market. Some embarked on the challenge to liberalize and open up their economy as soon as they acquired independence in the 1960's and 1970's. Others submitted to the influence of the World Bank in its structural adjustment programs in the early 1990's. Although the results are mixed, in general this has led to a more diversified and dynamic economic field.

Ethiopia followed a very different path. There were many improvements in opening up in the early 1970's. Foreign and domestic investment was rising, and there was increasing commercialization. However, these changes occurred in a backdrop of a very archaic political environment in which the land-owning aristocracy played a dominant role. The majority of farmers did not own the land they farmed. Needless to say, the country needed change, and was swept by a revolution that overthrew the monarchy in 1974.
Unfortunately, the revolution culminated by the military's control of power. For 17 subsequent years, the self-proclaimed communist junta did nothing but wage wars against a proliferating group of liberation fronts. The neglected economy marched backwards during those years.

The current government came to power in 1991 and opened up the economy once more, but this started to yield results only by the turn of the 21st century. The economic has been remarkably expanding since then. The problem today, however, is the accelerating inflation, which is in double digits since 2008.

I think the lack of central bank independence is the thing to blame for this. As alluded to in the article, the government has the power to squeeze money out of the hands of private banks with little regard to the law. This same power, I believe, has been illegitimately used to print money to finance government deficit. In fact, the major reason the government forced banks to invest on its bonds could be to absorb the excessive liquidity that is its own making. I think the government is still struggling to contain the ravages of inflation which it initiated without fully understanding the dangers involved.

[Frex]

I think you miserably failed to understand about rationalities for independecy Central Bank. Do you have a clue how liberalization/deregualtion by Fed triggered the wave of financial/economic crises? brain washed by imaginary economic models/THEORY? contextualization?

[Bizy]

Thanks but no thanks man for meddling. Don`t forget what happened in 2008 in the great USA and whats happening right now in Europe. Deregulation is destroying the countries. So, I do not think its advisable to let the big international banks, which are reasons for the callapse of the world economy, to come to Ethiopia. No no no. Brazil`s great leader Da Silva has said no to the west and made concrete place for his country in the world economy; now every one wants to do business with Brazil. China said no to the western debt driven developement system and is the big driver of the world economy right now. Hadn`t Brazil and China said no to the western system, I am not sure what would have happened to the world economy in 2008. What I know is that China and Brasil were growing when the west was in recession and saved the world Economy. So, my friend before you judge one`s system as wierd (and by implication backward), ask yourself why and learn to apperciate whats different from what you have been indoctrinated-one fits it all aproach.

[Teddy]

The corruption is high in Ethiopia, the government printing money to pay for its loyalists mainly to spy the rest of more than 80 million Ethiopians.

The minority Ethiopian regime is a group of ethnic centered families. A guerrilla fighters group how took power some 23 years ago until today.

[meron]

Hello Great article. Can you give me permission to share it on sodere.com...an Ethiopian social media site?

[Doug M.]

I have no objection.

Doug M.

[Mark]

Not to nit pick, but the hydropower dam linked to the bond (Renaisaance Dam) has nothing to do with Lake Turkana etc. That's another hydro dam (Gibe 3 Dam)

[Doug M.]

That's not a nit pick at all. Good to know.

Doug M.

[Alan Thompson]

Doug,
Would you say overall that Ethiopian banks are safe entities in which to deposit funds? In your
opinion is there a threat of having deposits frozen or seized? Please email me as well.
Alan

[maryjane]

thank you for the information.