Central Bank Airs Liquidity Fears, Fraud Concerns In Stability Report

NPL ratio could rise to 30pct in worst-case scenario

The central bank’s latest Financial Stability Report forecasts increased liquidity risks for commercial banks in the short and medium terms. Trouble with meeting weekly liquidity and real-time gross settlement (RTGS) payment requirements, as well as asset and liability mismatches and funding gaps for short-term maturity brackets, persist, according to the National Bank of Ethiopia (NBE).

The root cause of the problems, according to the report, is the concentration of deposits and credit in the hands of a few clients.

At the end of June 2024, less than 0.4 percent of depositors accounted for 58.5 percent of all bank deposits, according to the NBE. However, most of these deposits belonged to state-owned enterprises (SOEs), and cash accounted for only a small share of banks’ liquid assets.

“As a result, some banks were facing real-time transaction-level liquidity shortages. A high concentration of deposits and the difference in maturities between deposits and loans may create a liquidity risk in the banking sector despite the existing above-the-minimum liquidity ratio,” reads the report.

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The top 10 borrowers held 14.7 percent of the industry’s total loans and advances at the end of June 2024. It is significantly lower than the 23.5 percent figure from a year earlier.

However, excluding SOEs and regional administration borrowing, concentration ratios are much lower, with the top 10 private borrowers making up 3.5 percent of bank loans and advances, according to the NBE.

Large borrowers, defined as those with credit exposure of above 10 million birr, constituted only 0.5 percent of the total, but they held almost three quarters (74.8 percent) of all loans. This statistic has grown compared to the year before, and a significant number of loans are held by borrowers from urban areas, reads the report.

The report calls for tighter regulatory standards on deposit concentration risks, to make sure the banking industry maintains a robust liquidity position and resilience to short-term liquidity shocks. Regulators are optimistic that shocks are unlikely as SOEs, the largest depositors, are not prone to sudden withdrawals.

“There is significant operational risk in the Ethiopian commercial banking industry, and it is expected to rise further in the short to medium term. Incidents of social engineering, insider threats and third-party risks are on the rise,” states the report.

It reveals the ratio of loans to deposits has remained stable, dropping by 0.4 percentage points to 60.2 percent while the ratio of loans and bonds to deposits increased by 0.5 percentage points to 87.9 percent.

“These ratios are still very high, though, and suggest that nearly all deposits are held up by borrowers, leaving limited room for large and unexpected deposit withdrawals. Nevertheless, the high ratios result in relatively low liquid assets, which could lead to a liquidity problem under unfavorable circumstances,” reads the report.

It posits that the decrease in the liquidity ratio may have been caused by increased lending, particularly to the building and construction, import, and households’ sectors. Regulators say it is essential to keep the loan-to-deposit ratio below 85 percent to prevent a liquidity crisis.

The report reveals a 0.3 percentage point increase in the ratio of non-performing loans (NPLs) to gross loans, which has risen to 3.9 percent. Although the figure is below the NBE’s five percent ceiling for NPLs, the report indicates that a few banks have surpassed the threshold.

Regulators say they are working with these banks to address the underlying challenges.

The NBE’s best-case scenario involves NPLs remaining stable at 3.9 percent, but notes that is dependent on economic growth, improved international and domestic conditions, and the absence of drought and conflict.

At worst, the ratio will climb up as high as 30 percent, according to the report.

A credit stress test carried out by regulators found that while all banks have sufficient capital to withstand a moderate shock, at least four of them would fail in the worst-case scenario. The failures would require an additional 6.5 billion birr in capital to avert, according to the report.

“This is a marked improvement compared to the situation a year earlier, when 12 banks would have fallen below the regulatory minimum CAR [capital adequacy ratio],” it reads. “There is no systemic credit risk for the banking sector as a whole, even under the severe scenario.”

Still, the report notes the banking industry has grown more susceptible to liquidity risks from sudden withdrawals by a few big depositors.

Regulators say the slew of revised NBE directives of the past few months, and others still to come, will gradually reduce liquidity risks by chipping away at credit concentration.

“Measures to enhance accurate mapping of large borrowers and compliance with the corresponding quantitative limits stipulated in the Large Exposures Directive will reduce banks’ exposure to large depositors,” reads the report.

The NBE also forecasts the industry’s credit risk to increase in 2024/25 due to armed conflict, shifts in global monetary policy, capital flow, and the impact of wars in Ukraine and the Middle East.

“Since loans, advances, and bonds constitute the lion’s share of bank assets, credit risk remains one of the most important and inherent risks that banks need to effectively manage. Therefore, it is imperative to follow prudent, principle-based lending and financing practices that are in line with a bank’s risk strategy and appetite,” reads the report.

Regulators say they will be keeping a close eye on banks’ NPL ratios and compliance with asset classification and provisioning rules. The NBE wants to see an end to the practice of using collateral as a factor in determining whether a loan is non-performing or not.

“[Banks] must also take into consideration forward-looking and qualitative factors, including ‘unlikely pay’ conditions while determining non-performing status,” reads the report.

It mentions growing operational risks in the commercial banking industry, which are only expected to rise further in the short to medium term. These include social engineering, insider threats, third-party risks, and fraud.

The report reveals that fraud and forgeries cost banks 1.3 billion birr in 2023/24, up from one billion birr the year prior. Virtually all commercial banks fell victim to the use of counterfeit currency and checks, embezzlement, the issuance of unauthorized bank guarantees, withdrawals using stolen ATM cards, and false calls or texts, according to the NBE.

The report warns that the risk of fraud and embezzlement could grow as banks continue to introduce new technology-based products and services as well as enter into agreements with third parties.

“Policies for banks and effective strategies for measuring and mitigating operational risks need to be put in place. In addition, this would pose an elevated cyber risk to the banking system more than ever before,” reads the report.