Central Bank Lifts Lending Cap, Imposes Buying of Bonds

Addis Fortune (Addis Ababa)

Mahlet Mesfin

4 April 2011

Out of the total amount of money disbursed by all the private banks in the country, which amounts to 3.2 billion Br, 2.7 billion Br has been disbursed by the six major banks. The rest, which is 15.6pc of the total, comes from the remaining six private banks.

Subsequent to announcing the lift of the three-year old lending cap, National Bank of Ethiopia (NBE) instructed all commercial banks to buy 27pc of their annual loan disbursement in bonds, during a meeting held at NBE’s headquarters on Friday, April 1, 2011.

As of Monday, April 4, 2011, the lending cap that had been imposed by the central bank on all commercial banks since the beginning of 2009, will no longer be in force.

The bonds, with a three per cent interest rate and a five-year maturity date, must be purchased by each commercial bank at the end of the fiscal year. The amount of loans disbursed will be calculated from July 2010.

The meeting, held between the presidents of the all the commercial banks and higher officials of NBE, was chaired by Teklewold Atnafu, governor of the central bank.

The money used to buy the bonds will be mobilised for national development projects, according to officials at the meeting. The effort is to increase the capacity of commercial banks to finance long-term projects rather than concentrating on short-term loans, the officials claimed.

However, since the banks are not ready to provide long-term loans, it has been decided that it should be done through NBE until they can carry the risk, according to officials.

“It will positively affect the commercial banks as it redirects them from short-term financing to long-term development financing and addresses the constraints of aggregate supply in the long run,” an economist told Fortune. “However, the banks are required to lock 27pc to fund long-term national projects while they are mobilising funds from short-term without a liquidity management system.”

The private banks are also at more of a disadvantage when compared to Commercial Bank of Ethiopia (CBE) where the government makes deposits at a zero per cent interest rate, the economist said. “It always has liquidity, while private banks pay interest a all their deposits. The major reason to mobilise the bonds is to finance the government as the implementation of the GTP will not be possible if the banks do not.

Some bank presidents, who spoke to Fortune, accepted this.

“It is clear that we should contribute to the national economy, but since we are established for making profit it will be at our own expense,” a bank president said on condition of anonymity.

This is confirmed by the economist.

“Since banks are asked to subsidise the government with a three per cent bond while their cost of funds is five per cent, two per cent will be at their expense,” he told Fortune.

The meeting lasted around five hours with most of the time spent by officials in explaining the issue. However, some of the bank presidents were unhappy and left the meeting feeling unclear on some of the issues.

“It is difficult to comment on a subject you don’t understand after a five-hour explanation,” a president of a newly established bank told Fortune on condition of anonymity. “It would be easier to comment after seeing and studying the directive. NBE promised to send it to us on Monday, but it is a threat for newcomers to the industry.”

The lending cap was aimed at reducing inflation and maintaining it at a single digit level. At the same time, the government had also increased the legal reserves of the banks from 10pc to 15pc.

The average headline inflation reached nearly 39pc in July 2009, and 5.7pc in July 2010.

However, the step exacerbated problems instead of rectifying them because it increased the excess liquidity in the banking sector and created an excess in demand for credit, critics said.

The government was asked to eliminate the cap by the IMF on November 24, 2010. However, the elimination of the cap depended on inflation coming down to single digits, the government had responded.

The inflation rate in February 2011 was 17.7pc, far from a single digit.

“It is a given that the inflation rate will increase within the next months as aggregate demand or spending will increase,” the economist told Fortune. “The trend of issuing bonds is customary in other countries. The United States (US) issued war bonds during WW II.”

The immediate effect of the new system is that it diminishes the lending capacity of the banks since they have to divert funds to buy bonds, according to an expert who has worked in the banking sector for the past 13 years. In the long-term, it will discourage borrowing if the lending interest rates increase, something that is likely to happen, the expert claimed.

The overall effect will be a reduction in the profitability of banks, he concluded.

The average lending interest rate stands at 11pc, and the limit for an increase is 14pc. The amount of loans disbursed by all the private banks totalled 3.2 billion Br, in 2010.

“We cannot say that the cap has been lifted as the new system will have a similar effect, since it reduces the lending ability of banks,” a bank executive who attended the meeting, told Fortune.

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