Central bank Governor Mamo Mihretu has introduced a series of new rules for the banking industry as he looks to counteract growing credit concentration, guard against banks’ exposure to risky loans, and protect banks from overstating profits by accruing uncollected interest on loans or advances.
The National Bank of Ethiopia (NBE) approved no less than five directives on June 12, 2024, focused on reducing loan exposure, introducing more stringent collateral evaluation mechanisms, reworking asset classification and provisioning, and streamlining corporate governance and mechanism.
The new rules come after an NBE Financial Stability Report published a few months ago revealed that 10 borrowers account for a quarter of all loans from commercial banks.
The ‘Licensing Supervision of Banking Business Large Exposures to Counterparty or Group of Connected Counterparties’ directive caps bank exposure at 25 percent, limiting aggregate exposure and credit concentration. It instructs that the aggregate sum of all exposures directly or indirectly held by a bank to a counterparty or a group of connected counterparties shall never exceed 25 percent of the bank’s capital.
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It lists a variety of business and trade relationships as falling under the ‘connected counterparties’ classification, including relationships between tenants and the owners of residential or commercial properties.
The directive obliges banks to submit monthly reports detailing exposures of counterparties that exceed 10 percent of the bank’s capital.
The ‘Licensing and Supervision of Banking Business Asset Classification and Provisioning’ directive requires banks to undertake stringent collateral valuations and keep sufficient provisions.
It mandates the thorough review of collateral evaluations submitted to banks by external evaluators to cross check the validity of the collateral before approving loans. Banks are required to submit quarterly reports to the NBE detailing loans and advances that have been restructured and those that have been restored from non-accrual to accrual status.
Banks are now required to keep a 100 percent minimum prudential provision for loans categorized as ‘losses’, while the figure is 50 percent for ‘doubtful’ loans, and 20 percent for the ‘substandard’ category. The directive requires banks to report exposures and bad loans in accordance with International Financial Reporting Standards (IFRS).
It instructs that if a single borrower has one loan or advance that accounts for 20 percent or more of his or her total loans with the same bank and meets the criteria for a non-performing loan (NPL), then all of the other loans and advances to the borrower will automatically be classified as NPLs as well.
Banks which are not in full compliance with the requirements set out in the directive have a maximum of two years to fully comply.
The ‘Licensing and Supervision of Banking Business Exposure to Related Party’ directive sets rules about conflict of interest in the loan approval process. It obliges banks to refer any transactions with a ‘related party’ (this includes bank subsidiaries, executives, board members, shareholders, and senior management) exceeding 15 million birr to the board for approval. Board members with conflict of interest are not permitted to get involved in the approval process.
The ‘Corporate Governance’ directive looks to protect banks from influential stakeholders and executives. It mandates the election of at least two women to the board of any bank and sets out guidelines for diversity in board composition, including in academic qualification and industry experience.
The directive limits loans to related parties like bank executives to 15 percent of the portfolio, while aggregate loans that go out to related parties are capped at 35 percent. It mandates that all NPLs must be placed on ‘nonaccrual’ status regardless of collateral status.
The directive also sets out terms for programs that would allow bank staff and other stakeholders to report complaints and suspicious activity under whistleblower policies.
The barrage of new rules is surprising to Abdulmenan Mohammed (PhD), a financial analyst based in London. He sees the NBE’s decision to ratify the directives at this time as stemming from recent reports that indicated that credit is increasingly concentrated in the hands of a few influential borrowers who enjoy special relations with Ethiopia’s commercial banks.
“NBE rushed to introduce five directives at once. I believe NBE regulators are unnerved by the concerning findings revealed by the Financial Stability report a few months back. It revealed loans are concentrated in the hands of very few borrowers who take huge loans. This is risky for banks and concerning for the central bank,” said the expert.
Abdulmenan argues the scenario could have been averted entirely if the NBE had been diligently carrying out its regulatory duties.
“But why is the central bank concerned now? The central bank has known this from the beginning. There is no institution in Ethiopia more resourceful in terms of updated information. The NBE prepares quarterly reports, and regularly meets with bank presidents. Why did it not react to the findings before? Regulators have been sitting on the information for so long, but are rushing now. It is also well known who the big borrowers are. Most of them are state-owned enterprises,” said Abdulmenan.
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