December 04, 2018

IMF published its staff report under the 2018 Article IV Consultation with Federal Democratic Republic of Ethiopia. Directors noted that financial sector reforms would increase the effectiveness of monetary policy and support development goals. These reforms should include the development of a market for government securities, with market determined interest rates. Until this market develops, National Bank of Ethiopia (NBE) bills should be used solely to manage liquidity in the banking system and delinked from funding of the Development Bank of Ethiopia which needs to complete a comprehensive financial assessment. Gradual opening of the financial sector to foreign investors could improve services and transfer technology and know-how.

The staff report notes that commercial banks appear to be mostly well-capitalized and liquid, with nonperforming loans (NPLs) well below the statutory 5% ceiling. However, the state-owned Commercial Bank of Ethiopia (CBE) is exposed to state-owned enterprises, whose income may be adversely affected by the phasing out of implicit subsidies, restrictions to competition, and other distortions. To map early remedial actions, NBE has instructed CBE to undertake a comprehensive asset quality review. Moreover, asset quality in the state-owned Development Bank of Ethiopia, which is a non-deposit-taking institution and hence not part of the commercial banking system, continues to deteriorate. The Development Bank of Ethiopia's NPL ratio stood at 39% in 2017–18, posing substantial quasi-fiscal risks—as outstanding NBE credit to the DBE represents 2.4% of GDP. The authorities have undertaken a financial assessment of the Development Bank of Ethiopia and are considering remedial strategies.

NBE bills need to be reformed and delinked from Development Bank of Ethiopia funding. These five-year NBE bills must now be purchased by private commercial banks in an amount equivalent to 27% of gross credit extended, irrespective of the maturity of the loans—about 75% of these funds are then used to fund the Development Bank of Ethiopia. NBE bills now represent 30% to 40% of private commercial banks’ loans outstanding; although the interest rate on them was recently increased, it remains negative in real terms. The bills have been successful in reducing banks’ excess liquidity, but their design should be improved to better serve this purpose until a T-bills market develops—by reducing their maturity and possibly basing the purchase obligation on excess reserves. Further funding of the Development Bank of Ethiopia by NBE should be discontinued, at least until the ongoing comprehensive assessment of its financial situation is completed and resolution measures are implemented.


Related Link: Staff Report

Keywords: Middle East and Africa, Ethiopia, Banking, Securities, NPL, Article IV, IMF