Editorial

Reforming banks' credit decision – a must for business growth

In Ethiopia the banking system's loan to deposit ratio is low. In other words banks do not provide enough loans. A large proportion of the banks' revenues today depend on service fees. To overcome this challenge, banks have to start rebuilding their loan portfolios. It would be fair to say that the Ethiopian banking industry has evolved over time. The average banker too should acquire an edge in appraising credit risks that he or she did not possess when economic reforms were ushered in some 15 years back.

Those who castigated bankers for inadequate services did underestimate the difficulties involved in working out the precise contours of the economy as it emerged from the era of tightly regulated supply of goods and services to one of freer internal and external competition. The problem, however, is that as the banks acquired greater confidence in taking on internal and external competition, some of the structural rigidities in the financial system got even stronger.

A bulk of the bad loan problem still remains hidden under the label of `on going' projects whose repayments terms are jigged and re-jigged. How far these projects can carry the baggage of accumulated debt and interest burden and still be viable in the face of local and international competition still remains to be seen.

There is also great confusion when it comes to asset valuation in Ethiopia . Anyone familiar with business valuation knows that valuation is both art and science. The perception is that government banks are abusive and unfair, while private banks are fairer when it comes to valuing personal assets. It is refreshing that many business men and women choose the private banks over the public ones when it comes to obtaining loans. Since public sector banks account for a substantial portion of flow of commercial credit in the economy, the dissatisfaction augurs a sorry state of the financial sector.

n practice, both private and public banks rely on collateral value as the primary basis for a credit decision. Still, one would assume that public banks would only engage in lending activities designed to ensure the protection of consumers. Unfortunately, that is not the case. Customers complain regularly against public banks involvement in, abusive and unfair lending practices. They complain that the evaluation of collateral are generally performed haphazardly by individuals who have not demonstrated the knowledge and experience necessary to value the type of collateral that is subject of the evaluation.   At a recent workshop organized by the Addis Ababa Chamber of Commerce many business operators said that financial transactions involving personal property collateral were not supported by adequate and accurate collateral evaluations. Participants alleged that loan officers have less incentive to conduct an involved credit analysis using repayment capacity because collateral value at the time the credit is issued at a very low level. But shouldn't banks rely more on cash-flow analysis of borrowers to support credit provided? Isn't cash-flow that services the debt, not the value of underlying collateral?   Indeed, the creditworthiness of any company should be based on its viability as an ongoing business, not on the market value of its physical assets. That's why we urge that loan repayment ability be the basis of credit extensions. True, appraisal plays an important role in the loan approval process; however, undue reliance should not be placed upon the collateral value in place of an adequate assessment of the borrower's repayment ability.