End of Ethiopia’s Banking Sector Protectionism in Sight
Ethiopia is poised to enact a Banking Business Proclamation (Draft Proclamation), which will repeal and replace the existing Banking Business Proclamation No. 592/2008. The enactment of the Draft Proclamation will be significant in major respects, including the liberalization of what can be described as the last frontier market, Ethiopia’s banking sector.
This legal update discusses some of the changes anticipated to be introduced focusing on liberalization of the sector to foreign investment and bank mergers.
Foreign Investment in the Banking Sector
While the country’s financial sector has partly been liberalized recently to foreign investment (with the opening of digital payment services to foreign investors), the Draft Proclamation will mark a significant development in the liberalization of the country’s financial sector. In a significant departure from the existing laws, the Draft Proclamation contemplates that foreign investors may engage in the banking business through various forms: establishment of a subsidiary, opening a branch, or acquiring shares from domestic banks. As has been the case, foreign banks are also allowed to open a commercial representative office.
According to the Draft Proclamation, a subsidiary may be wholly or partially owned by a foreign bank. As such, a foreign bank intending to establish a subsidiary does not have to own all the shares but can allocate some of the shares to other persons if it wishes. The subsidiary of a foreign bank (possibly a wholly owned subsidiary) does not have to take a share company form. That said, the subsidiary of a foreign bank is required to have a board of directors, the details of which will be outlined in a future National Bank of Ethiopia (NBE) directive. A foreign bank is also allowed to set up a branch, that does not have separate legal personality from its principal.
Further, foreign entities and/or individuals are also permitted to acquire shares from domestic banks. Foreign banks and other strategic investors such as international development finance institution and private equity funds can own up to 40 percent shares in domestic banks. The draft law also proposes individual foreigners to own up to a 7 percent and foreign entities up to 10 percent shares in domestic banks (such limitation also applies to nationals). However, the aggregate foreign shareholding in a domestic bank cannot exceed 49 percent. That said, the NBE may exceptionally allow foreign banks to partially or fully acquire existing domestic banks if such a decision would promote financial stability and rescue a distressed bank.
The Draft Proclamation envisages fulfilment of certain additional conditions, including minimum capital, payment of license and license renewal fees. The Draft contemplates the details of these conditions to be determined by future directives to be issued by the NBE.
Bank Mergers
The Draft Proclamation has included regulatory framework for bank mergers with a view to fostering a more resilient and competitive banking sector. It specifies two types of bank mergers: Statutory and voluntary.
A statutory merger is an amalgamation of two or more banks by the decision/instruction of the NBE. Such merger is imposed by the NBE to rescue banks exhibiting significant financial, operational, or managerial weaknesses and/or to create a more viable and stronger bank. A voluntary merger, on the other hand, is amalgamation of banks by the decision of the respective banks. Such decision needs to be passed by the extraordinary meeting of shareholders. That said, a prior written approval from the NBE is required to carry out a voluntary merger. Further, as is the case with other transactions, regulatory pre-approvals including tax and merger clearances are required to implement bank mergers.
The Draft Proclamation contemplates that further details on conditions of merger will be provided in a future directive. It is also important to note that other relevant legislations including the Trade Protection and Consumer Protection Proclamation No. 813/2013 and the Commercial Code of Ethiopia Proclamation No. 1243/2021 need to be consulted.
The rationale for the legal framework for bank mergers set out in the Draft Proclamation needs to be analysed in light of the historical and current status of domestic banks. Many private banks have been established in Ethiopia over the last three decades. However, many of these banks face challenges in relation to fulfilling minimum capital requirement, technological and operational efficiency. Such challenges have resulted in an inefficient, weak and unstable financial system.
Some of these banks are even struggling to meet the current minimum capital requirement of 5 billion Ethiopian Birr (Approximately USD 40.81 million based on current exchange rate). This minimum capital requirement is anticipated to be raised by the NBE in the future, which is likely to mount pressure on some of the domestic banks.
The provisions governing bank mergers under the Draft Proclamation are thus apparently aimed at addressing some of these challenges and thereby creating a more robust and efficient banking sector.
Concluding Remarks
The anticipated regulatory changes coupled with other economic and technological challenges will add strain on domestic banks’ current operations. This suggests that business as usual will not continue for domestic banks and as such the traditional banking model in Ethiopia needs to transform to address such challenges.
In particular, the liberalization of the sector to foreign investment would be a challenge as well as an opportunity for domestic banks. Domestic banks should brace for a very competitive environment as foreign banks enter the Ethiopian market. It is high time for domestic banks to explore various options, including bank mergers, joint investment with foreign banks and enhancing their operational and technological efficiency, to remain competitive and solvent in the future.
Foreign banks should also examine whether share acquisition in domestic banks, establishing subsidiary or branch would be the best feasible option to engage in the banking sector in Ethiopia. In so doing, it is critical that they assess the legal and regulatory requirements (including tax and competition clearances).
In sum, the enactment of the Draft Proclamation into law and its implementation is likely to reshape the Ethiopian banking sector landscape.
