World Bank Approves 700$ Million Credit to Clean Up Ethiopia’s Financial Sector

On Thursday, the World Bank announced the approval of a $700 million credit line for Ethiopia under the Financial Sector Strengthening Project. Nearly 80% of the funds will be directed towards cleaning up and restructuring the state-owned Commercial Bank of Ethiopia (CBE)'s balance sheet.

Ethiopia's policy bank the Development Bank of Ethiopia (DBE) and its central bank are also poised to access around 107 million and 23 million dollars each as part of the financial support. The Project will provide the funds on a performance basis, including significantly improving regulatory and supervisory capacity in the financial sector. Key among the performance conditions was the issuance of a 900-billion-birr bond by the government, predominantly to settle years of accumulated non-performing loans by CBE to State-Owned Enterprises.

The Project, which is set to close in four years, is intimately tied to the series of economic reforms Ethiopia has been championing over the past few years. Ethiopia agreed to the Project as part of the conditions for the 3.4 billion Extended Credit Facility (ECF) approved by the International Monetary Fund in August.

Under the leadership of the Mamo Mihretu, governor of the National Bank of Ethiopia (NBE), the central bank has been transitioning to market-based principles. Open market operations, interbank lending facilities, and an interest-based monetary policy have been introduced to untangle the dysfunctional relationship between the central bank and the federal government.

A decade of double-digit economic growth in Ethiopia was largely predicated on heavy lending for state-led infrastructure projects. Consecutive years of a ballooning budget deficit pushed the government to rely more and more on direct borrowing from the central bank. CBE, which managed nearly half of the banking industry’s assets played a significant role in fueling the precarious economic growth through its lending to SOEs.

Since August of last year, a price stability approach adopted by the Central bank has attempted to reverse this trend by slashing direct lending to the government by 2/3rds and capping annual credit growth from commercial banks to 14%.

Furthermore, on Monday, Ethiopia’s parliament ratified two bills reestablishing the central bank in a more autonomous position and opening the financial sector to foreign investors. While inflation rates dropped to below 20% at the end of the fiscal year, Ethiopians continue to grapple with the depreciating value of their currency following the birr’s float in late July. 

Alongside a boom in FX reserves, cash shortages have become prevalent while decades of peculiar lending practices continue to threaten the stability of existing commercial banks. 

The latest stability report by NBE indicates that the banking industry has become even more sensitive to liquidity risks over the past year as 20 banks, an increase of two from 2023, would fall below the regulatory threshold if 10 of their biggest depositors withdrew their money. Furthermore, a withdrawal of 360 billion birr would push these banks' liquidity ratio down to 9.4% which is significantly below the regulatory minimum of 15.