Hopes for increased competition in Ethiopia’s banking system

In May the National Bank of Ethiopia announced new plans to open up the East African country’s banking sector to foreign competition. The Commercial Bank of Ethiopia, which is state-owned, currently dominates the country’s banking industry. In 2019, Cepheus Growth Capital Partners, an investment management firm based in Addis Ababa, calculated that the bank accounts for 62% of assets and deposits in Ethiopia. The country is home to 29 banks in total, all of which are locally owned.

However, Ethiopia’s central bank, the National Bank, which also serves as the banking regulator, has committed itself to increasing competition in the sector. A vice governor of the National Bank, Solomon Desta, said that the organisation intends to issue between three and five licences to foreign banks within the next five years. Desta said that foreign investors would have several options as to how they enter the Ethiopian market, such as forming joint ventures with Ethiopian companies or establishing local subsidiaries.

The move comes as the Ethiopian government, led by Prime Minister Abiy Ahmed, continues its mission to liberalise critical markets in the country – in a bid to attract greater amounts of foreign investment and drive higher levels of economic growth. In May the National Bank granted a mobile money service licence to Safaricom, a Kenyan multinational company listed on the Nairobi Securities Exchange (NSE). This was the first licence awarded to a foreign company to offer mobile money services and means that the state-owned service Telebirr now faces serious competition.

Wider liberalisation

The Ethiopian government has also explored other ways to liberalise the national economy. Ahmed has already committed himself to privatising telecommunications, while Ethiopia’s new sovereign wealth fund, Ethiopia Investment Holdings, has announced that it is working to establish an Ethiopian Securities Exchange (ESX) within two years. Instigating greater levels of competition within Ethiopian banking is an important part of the wider mission to prompt lasting economic change in the country.

Mirkarim Yakubov, chief financial officer at 54 Capital, an asset management firm based in Addis Ababa, tells African Business that “the move is quite a significant one.”

“Compared to the rest of Africa, Ethiopia is one of only a few [countries] that does not have an open financial sector, that is not open to foreign investors and foreign banks,” he says. “I think it’s a very significant step towards opening up and liberalising and also stirring up competition within the financial sector. The local banks have remained unchallenged until now.”

Perhaps partly because of this lack of competition, Ethiopian banks have performed relatively poorly according to many metrics. Despite Ethiopia being one of the fastest growing economies in Africa, the World Bank noted in 2018 that only a third of Ethiopians have a bank account – a considerably lower level than in neighbouring Kenya and Rwanda, and below the regional average.

Furthermore, Ethiopian banks have often proved reluctant to deploy capital in the form of loans. Only 10% of Ethiopians are reported to borrow from financial institutions. Yakubov believes that “some of the established banks are quite nervous that, when the foreign banks come, they will offer formidable competition, because of the technology and financial strength that they possess.”

Incumbent strength

However, he also notes that, when foreign banks do arrive, they will still face several hurdles in establishing a foothold in the local market.

“The new foreign banks that are coming into the country will face uphill competition in competing against local established banks, especially the Commercial [Bank of Ethiopia], which dominates the sector,” Yakubov tells African Business.

“Foreign banks will need to manage big challenges in the Ethiopian market. For example, they will need to be able to manage the fact that there is still a gap between the official exchange rate and the grey market rate in dollar-birr foreign exchange markets,” he adds. “Local banks will need to adapt to the newcomers, but they have a home advantage.”

For foreign banks that decide to take advantage of Ethiopia’s moves to liberalise the banking sector, there could be lucrative opportunities available. Ethiopia is Africa’s second most populous nation after Nigeria and has an enormous unbanked population. Economic growth rates have slowed, both because of the coronavirus pandemic and the civil war in the Tigray region – but are on their way to rebounding towards double digits. Yakubov sees a particularly good opportunity for large pan-African financial institutions in Kenya and South Africa to expand into Ethiopia and “capture the market”.

There is also the hope that the entry of foreign banks into Ethiopia could lower barriers to trade and investment more widely. A more sophisticated and competitive banking system could lower the perceived risk of investing in Ethiopia in the eyes of foreign investors.

A foreign reserves crisis

This would in turn help resolve Ethiopia’s severe foreign reserves crisis. Ethiopia has a widening current account deficit and dwindling reserves, leading the central bank to impose stringent restrictions on the use of foreign currencies in local transactions. The country’s lack of US dollars is also making it more difficult for the government to service its dollar-denominated debt, particularly given that higher interest rates globally and a weakening Ethiopian birr have made it more expensive to do so, raising fears of a default. Foreign investors and their much-needed US dollars would help assuage these concerns and put the Ethiopian economy on a stronger and more sustainable footing.

While it is likely that foreign banks would first seek to service Ethiopia’s corporate market, before offering retail banking services, their entry into Ethiopia could also benefit Ethiopians directly. Greater competition should lead to higher-quality services and greater availability of capital for lending. It should drive up the numbers of citizens able to access formal banking services. Foreign banks might even come to play a pivotal role in the country’s housing crisis by improving the affordability and availability of mortgages.

Speaking last year, Abiy Ahmed said that “we will bring foreign banks because we need additional wealth and hard currency.” As he sets his country up for another phase of financial liberalisation, he will be hoping that both these things will be on their way.