In the Presence of Cut-throat Competition in Conventional Banking, the Next Best Arena is Digital

The Ethiopian banking industry has seen several episodes of banking formation. These episodes are often associated with policy changes. Liberalization in the early 1990s laid the foundation for private investment in banking. In the ensuing years, several banks were established. Fast forward, over the past few years, many new banks have joined the industry, lured by the returns of the industry and in response to economic reforms. Currently, more than 20 banks are in operation, two state-owned and the rest private banks.

Despite the growing number of private banks joining the industry, the state-owned Commercial Bank of Ethiopia (CBE) is the most formidable player. Its market share (based on assets) accounts for about 60%. The larger private banks also have an entrenched position in the industry due to their age. This market structure will force the new private banks to scramble for a narrow market share. This has implications for competition, financial stability, and financial inclusion.

It is widely accepted that an increased number of banks enhances competition, and as a result, the competition increases access to financial services, narrows the interest margin (the difference between lending and saving rates), improves customer services, and encourages innovation.

The reality may not be as realized due to the structure of the Ethiopian banking industry.

The Ethiopian banking industry is segmented. CBE mainly provides services to a captive market – its main objective is granting credits to the public sector and mobilizing a significant chunk of cheap savings from the same segment. Whereas the private banks serve the private sector. Due to this segmented nature of the industry, the CBE tends to have monopolistic pricing conduct. When the pricing behavior of the CBE is combined with service homogeneity and replicability of the industry affects the pricing behavior of the rest of the banks in a way that is not beneficial to customers, such as application of wider rate margin, and lower savings rates, etc.

Although the banks have different pricing conducts, serious competition is seen with deposit mobilization and foreign currency generation. Alongside a range of promotional tools, banks use branch expansion to reach out to their depositors. This “brick-and-mortar” service expansion is costly. If the newcomers pursue the same approach as the existing banks, the degree of competition will be highly intense. The competition will mainly affect those banks at the lower rung of the industry. It is an issue that should concern the regulators as increased competition may undermine financial stability.

Undoubtedly, an increased number of banks fosters financial inclusion- an area where Ethiopia lags far behind neighbors Kenya and many countries in Sub-Saharan Africa. The limitation of conventional banking for financial inclusion is that services are inaccessible to the majority of the people engaged in the informal economy and the rural population, although these segments of the society represent the majority in Ethiopia.  

Financial inclusion can be improved when the services of financial institutions are complemented by other forms of digital finance platforms. For instance, with the creation of M-Pessa, the poster child of Kenya’s digital revolution, in 2007, the digital finance landscape was transformed unprecedentedly. The once-mobile phone payment system has been transformed into a dynamic digital ecosystem that provides financial services to those left out of the conventional financial system. The Digital transformation enabled people to have easier access to payments, transfer, savings, investments, and insurance services.

In Ethiopia, the past decade has seen a move to automation and digitalization of the finance system. The story begins with the formulation of “Vision and Strategic Framework for the Modernization of the National Payment System in Ethiopia” in May 2009. This was followed by Proclamation No. 718/2011 which aimed “to provide rules on establishment, governance, operation, regulation and oversight of the national payment system so as to ensure its safety, security and efficiency”. This proclamation, combined with subsequent directives and circulars, set the stage for digital transformation.

The groundwork has been done over the past decade. Modernizing the payment system commenced in the early 2010s. In 2011 the National Bank of Ethiopia launched Ethiopian Automated Transfer System (EATS) to integrate inter-bank transactions. Subsequently, and the NBE and banks installed CORE banking systems, comprising Automated Teller Machines (ATM), Point-of-Sale Terminals (POS), cards, internet and mobile banking. On mobile money front, telebirr was launched in the middle of 2021 and the first licensed private payment instrument issuer has also been formed recently.  

Despite the legal and regulatory framework being in place, and some observable progress taking place, the use of digital platforms is still in its infancy. Improving this situation requires the cooperation of the public (such as the NBE and the telecom regulator) and the private sector, both banks and the telecom sector. Hopefully, a focused implementation of the National Digital Payment Strategy (NDPS 2021-2024) will enhance this cooperation.