Beyond the “merger”

The “merger” between two state-owned banks, the Construction and Business Bank (CBB) and the Commercial Bank of Ethiopia (CBE) has dominated headlines over the week. For one, the “merger” is one of a kind in the financial sector while on the other hand it also saw the bowing out of a seasoned mortgage banker from the scene. What looks to more interesting is what this “merger” implies for the overall financial sector in Ethiopia and an impending push towards mergers; writes Dawit Taye and Asrat Seyoum.     

Last week, the Public Financial Institutions Supervisory Agency (PFISA) has finally announced its decision to pull the plug on the weaker of the two state-owned commercial banks that it directly oversees. The decision was long overdue if the performance of the bank is something to go by. But, rather surprisingly, the director of the agency was careful not to allude to performance deficiency as the main cause for the decision. Nevertheless, the effort could not have been more misplaced since everything including the annual performance report of the Construction and Business Bank (CBB) points to one direction—years of sluggish progress and performance.

According to Sintayehu Woldemichael (PhD), director general of the Agency, the move has nothing to do with the weak performance of the bank. In fact, he went ahead and argued that in the past six years the CBB has shown quite the transformation in the area of branch expansion and investment in technology. Especially, he made reference to the big leap in terms of branch expansion that the bank has made. “In six years time, CBB’s branch network has grown from just 30 to more 100; this is a very encouraging achievement by any standards,” Sintayehu said.

Indeed, Sintayehu was right in indicating a huge investment in the banking software technology. Better yet, the Core Banking Solution that connects the 122 branches of the bank, which was procured for a little over 300 million birr, became live just last month at a lavish ceremony held at Capital Hotel and Spa. Furthermore, the massive branching out activities at CBB was also rolling until the last minute the agency announced the decision to “merge” it with the giant Commercial Bank of Ethiopia (CBE).

Although Sintayehu argued that the activities of the bank attest to the successful route that it was following, performance figures that was released by the bank itself casts down on such assertions. For one, the audited performance reports of the bank attest to the highly volatile profit levels of the bank in the past six years.

For instance, the bank posted a net profit of 91.5 million birr for the fiscal year 2009/10, some six years ago. However, the profit for 2010/11 can be seen to slip by 6 percent to reach 85.9 million birr. Then, net profit revived at 115.8 million birr for fiscal year 2011/12, a 34.8 percent improvement over its previous year. For a while, it looked like CBB will continue to sustain its improvement in terms of profit when it posted the highest net profit levels in the past six years. Indeed, 2012/13 appeared to be a good year for the bank registering a net profit of 200.4 million birr, a whopping 73.05 percent increase over the previous year.

That is not all. Just when hopes started to revive, CBB’s net profit plummeted again in 2013/14 to 97.7 million showing a drastic decline of 51.3 percent. Things are not as rosy as they are claimed to be especially when the last fiscal year’s performance is considered. Six-month performance report for the last fiscal year also showed some 21.3 million birr net profit which by the bank’s own admission is 40.3 percent lower than previous year's half year performance.

However, contrary to popular conception that the CBB is made to join forces with CBE because it will not be unable to meet the National Bank of Ethiopia’s directive of the minimum paid-up capital requirement is not true either. According to NBE’s report, CBB has surpassed the minimum paid-up threshold back in 2013/14 posting 642.1 million birr ahead of the 2015 deadline. According to the same account, CBB is the eighth bank in terms capitalization just ahead of Lion International Bank, which posted 514 million birr in 2013/14.

Performance and numbers aside, the debate surrounding the “merger” begins from the very nature of the “merger” itself. For one, there are some who argue that the move could not even be called a merger to begin with. According to a macroeconomist who spoke to The Reporter on conditions of anonymity, the move is not a merger since mergers could not be initiated and justified by a direct order from the government. “Although both are government-owned banks, the merger between them should be convincing for both institutions and have a sound economic reason,” he argues.

Constentinos Berhe, a lecturer at Addis Ababa University post-graduate program, on the other hand argues that there is no need to rationalize a merger between two government-owned banks.

Furthermore, there are also others who point out that in case of a merger the two companies have to come together to form a new company which usually takes a name signifying the traits of the two parent companies. It could not be called an acquisition either since an acquisition entails one of companies acquiring a controlling stake in another in a financial transaction. “It is clear; CBE has swallowed CBB and it was initiated by the decision of the officials,” the macroeconomist asserts.

As far as mergers and acquisitions are concerned, there appear to be some gaps in terms of the legal guideline. According to a legal expert, both the Commercial Code of Ethiopia and the Trade Competition and Customer Protection Proclamation address the issue of merger and acquisition albeit very broadly. The latter gave the power to legislate a detailed directive to regulate the merger and acquisition activities in Ethiopia, which is still at its drafting stages.

According to the legal expert, the Public Enterprises Proclamation is also another legal document that should be referred to when trying to understand the recent merger. As far as he is concerned, there is not that much of an issue when it comes to the legality of the merger. But, questions if financial institutions need their own independent guidelines especially when it comes to sensitive activities like mergers and acquisitions. “Banks affect the economic well-being of a nation far more than any other sector; and as such there is a need for an independent merger guideline,” he argues.

According to Sintayehu, the measure would help create one strong banking institution and avoid redundancy. He said the move would help create one strong bank with a large capital base and fit for competition should the sector opens its doors to global banks. Zemedeneh Nigatu, managing partner of Ernst and Young Ethiopia, believes in the merger fully.

The truth, however, lays elsewhere, says the macroeconomist. According to him, CBB became weaker across time only because of the action of the government itself. “This is a bank which was neglected by the government for many years,” he continues to argue. He said the CBB currently has little by way of objectives and unique business plan. “One indication here is the decision of the government to assign the recent housing/mortgage scheme launched in 2012/13.

This project rightly belonged to CBB, an originally mortgage bank with over 40 year of experience in the business. At one time, the announcement of the bank to be privatized has put a dent on the customer base of the bank, said the macroeconomist arguing government’s own action are responsible for the gradual weakening of CBB.

Nevertheless, for Zemedeneh, what is happening with CBB is not the most important thing; rather the overall trend is what is critical. “Not only state-owned banks, but I believe that the whole banking sector is due for a massive consolidation through merger,” Zemedeneh told The Reporter. And, the basic justification is the need to buckle up for what could be a tough competitive environment to come ahead. The impending accession to the World Trade Organization (WTO) and the possibility of gradual opening up of the financial sector necessitates recapitalization and consolidation of the sector, according to Zemendeneh.

A banking consolidation experience that is worth exploring for Ethiopia, according to experts, is that of Nigeria’s. Following the banking sector distress in Nigeria that took place in from 2001-03 has provided the push factor for consolidation in Nigeria. In fact, after the wave of mergers that happened between 2004 and 2005, 89 banks in Nigeria were reduced to only 25. The move was actually induced by the Nigeria's central bank's decision to raise paid-up capital requirement from two to 25 billion dollars for banks.

This – in the opinion of many – has helped the Nigerian financial sector become stronger. “But, has it made it competitive?” is an issue which is divisive. Some still claim that the Nigerian banking sector is still not better off after the wave of mergers. Similarly, the experts look to be supportive of consolidation in the Ethiopian banking sector. However, they fear that extreme sector concentration could result in the loss of competitive nature of the financial market. Eyesuswork Zafu, veteran insurer, is one of them. He actually questions if it is the time to push for consolidation in a young and very limited banking sector like that of Ethiopia’s, which is composed of only l9 actors at the moment.

In a broader sense, the macroeconomist also argues whether beefing up CBE further is the right move or not. For him, it is questionable to fatten a bank which was formed to play the role of a commercial bank, which caters for working capital needs of firms. “Across the years, CBE has turned into a development bank with the balance of its loan portfolio slowly titling towards long-term financing,” he said. On top of that, CBE is also the housing bank, the bank for the public and so many other tasks, he says. This, according to him, is a dangerous trend since at some point it will be challenged to be efficient. There are also those who argue that CBB should have been given another specialized role like being an industrial bank, agriculture bank or focus on its traditional jurisdiction – mortgage banking. “We need more specialized banks like an EXIM bank and definitely all of these roles cannot be played by CBE; for there will come a time that it could realize that it has taken a bite off more than it can chew,” the macroeconomist says.

Ed.'s Note: Birhanu Fikade of The Reporter has contributed to this story.