Loan Classification, Average Recovery Rate and Provisioning Practices of Ethiopian Banks- Cross Country Comparison

Abstract

The current classification and provisioning practice of Ethiopian banks has been framed by the National Bank of Ethiopia’s directives. For loans with fixed repayment terms, the NBE’s directive and the current practice of the banks are based on an objective indicator of collectibility i.e. the period that payments of interest and principal are past due. However, country’s’ experience lead us to conclude that the decision to classify loans should be largely judgmental based on assessment of the borrower’s capacity to repay and on the degree of doubt about the collectibility of the principal or interest of a loan. Thus, payment in arrears is only one of a number of factors to be considered in classifying problem loans. In such respect, the NBE has also tried to integrate many factors into its classification system by providing the discretion to its onsite examiners. Most of the standards were related to financial factors, collateral factors, business risk factors and ownership and management factors. Therefore Banks need to revitalize their loan classification system by developing an internal workable guideline which provides coverage to the aforesaid standards. The guideline shall be framed in a way to incorporate criteria required by the regulator (objective standards) and subjective /judgmental criteria adopted from the international bank experiences and the National Bank of Ethiopia’s (NBE’s) on site practices.  In addition, enhancements of internal system via ensuring independence of the classification and provision tasks, the MIS and the involvement of independent evaluators like internal auditors requires considerations from the Banks.

Keywords: Loan Classification, Average Recovery Rate, Provisioning, Ethiopia, Banks