The National Bank of Ethiopia has taken major steps to overhaul the country's banking regulations in a major move said to strengthen financial stability and align with international standards. Â
NBE has revised five key directives governing areas such as risk management, governance and financial reporting in line with global best practices as outlined by bodies such as the Basel Committee on Banking Supervision.
The changes come at a time when Ethiopia is seeking to open up and modernize its banking sector in support of ambitious economic growth targets and to address risks accumulating in the industry, which pose threats to banks.
As the NBE's inaugural Financial Stability Report from April 2024 shed light, an alarming degree of loan concentration existed among a powerful few in Ethiopia's banking industry. The report found that a mere 10 borrowers collectively accounted for nearly a quarter (23.5 percent) of all bank loans.
Safeguarding financial stability is a core function of NBE: a sound and stable financial system helps channel resources to their most productive uses, the central bank said while announcing the new directives approved by its board under chairperson Girma Birru.Â
"It is critical for public savings to be mobilized, protected, and deployed safely for the purposes of economy-wide lending, investment, and growth," NBE added.
At the core of the revisions are efforts to reduce vulnerabilities in the financial system and to improve risk oversight.
The large exposure limit directive now caps a bank's total lending to any single counterparty or group of connected parties at 25 percent of capital. This tighter borrowing limit is aimed at curbing excessive risk concentration that could destabilize individual banks or the sector in the event of a default.
Similarly, related party exposure is now restricted to a single maximum of 15 percent of capital for any one related borrower such as a director, with an overall limit of 35 percent across all related parties. Prior to the changes, banks faced no explicit numeric cap on related lending, creating opportunities for abuse. Through introduction of quantitative restrictions, regulators hope to minimize conflicts of interest and limit the potential for connected borrowers to extract funds on preferential terms. Â
When it comes to managing loan quality, the new asset classification and provisioning directive significantly raises the bar. All non-performing loans must now be placed on non-accrual status irrespective of collateral, aligning with global standards. Loans are also more quickly classified as non-performing if borrowers miss payments. Banks will have to set aside larger reserves against possible losses upfront rather than delaying through restructures.
The directive also limits banks to a maximum of three short-term loan restructures and four for long-term credit before declaring default, down from five and six previously.
This tighter rule is aimed at preventing evergreening practices that mask underlying credit risks. Aiming to clean up borrowers' records sooner, the new regime forces banks to take corrective action and make timely provisions against problem accounts rather than delay inevitable write-offs.Â
On the governance front, requirements for persons with influence such as directors and managers have been significantly enhanced. Key positions now demand higher qualifications and relevant experience.
Serving as a board member across multiple banks has been restricted to address conflicts of interest. At the same time, corporate boards will now need to include at least two independent directors and two women to boost oversight and diversity.
While a select elite few hold the financial sector in their grip, the April 2024 report also revealed 99.8 percent of loans go to urban dwellers, leaving many in rural areas unserved.
Key financial metrics indicate the industry faces significant risks in terms of loan diversification.
Borrowers with exposures over 10 million Birr, a tiny 0.5 percent of clients, are virtual kings - controlling a staggering 73.7 percent of all loans from the banking system.