Ethiopian Banking Sector: Risks, Structural Characteristics, and Regulatory Overview

Key Risks

The Ethiopian banking sector is not without its challenges. Several key risks pose a threat to the stability of the industry.

Credit Risk

• The credit risk in the industry is moderate but expected to increase in 2024 due to factors such as:
  • Droughts and internal conflicts that may affect borrowers’ repayment capabilities.
  • A weakening external sector, which can reduce export earnings and decrease the ability of businesses to repay loans.
  • Concentration of credit risk, where a small group of borrowers account for a significant portion of outstanding loans.

Liquidity Risk

• The banking sector faces liquidity risk due to:
  • Potential mass withdrawals by major depositors, which can lead to funding shortfalls if not managed properly.
  • Concentrated deposits, where a few large depositors hold a significant proportion of total deposits.
  • Lapses in meeting weekly liquidity norms, which can indicate inadequate cash management practices.

Operational Risks

• Operational risks are on the rise due to:
  • Insider threats, such as employees intentionally causing harm to the bank or its customers.
  • Social engineering tactics used by cyber attackers to gain unauthorized access to sensitive information.
  • Bank fraud and forgeries, which can result in significant financial losses.

Structural Characteristics

The Ethiopian banking sector exhibits several structural characteristics that impact its stability and growth.

Asset Quality

• The ratio of non-performing loans (NPLs) to total loans has improved but remains below the regulatory maximum.
• This suggests that banks are actively managing their loan portfolios and working to reduce NPLs.

Funding Structure

• The loan-to-deposit ratio is expected to remain low due to increasing financial sector penetration, which leads to deposit growth outpacing loan growth.
• This indicates a stable funding structure for the banking sector.

Capital Adequacy

• Capital adequacy ratios remain robust, with a capital adequacy ratio above the minimum requirement of 8.0%.
• This suggests that banks have sufficient capital to absorb potential losses and maintain stability.

Sovereign Support Capacity

• The government’s persistent fiscal deficits will weigh on its sovereign support capacity.
• However, it is likely to support state-owned banks in case of a financial crisis, which can mitigate some risks.

Ownership Structure

• Public and private banks have relatively equal ownership shares.
• Public banks hold significant deposits and new loans, while private banks are expected to increase their share of loans and deposits as the government lifts restrictions on foreign investment.

Regulatory Body Assessment

The National Bank of Ethiopia (NBE) regulates the commercial banking sector, providing licenses and supervision. The regulatory environment has improved since removing a requirement for private sector banks to invest 27% of their portfolio in government bonds in 2015.