A modern approach: Regulatory reforms and digitalisation to boost penetration rates

Djibouti’s economic growth, based to a large degree on capital investment in infrastructure development and logistics, has been underscoring the expansion of its banking system. Since liberalisation of the sector in 2006 a number of new financial institutions have set up shop in the country, hoping to take advantage of its growing role as a regional transport and financial hub. With a population of approximately 900,000 inhabitants as of mid-2018, Djibouti’s domestic financial services market remains small. However, the low level of banking penetration can also be seen as an opportunity for growth, both in terms of new customer acquisition and product sophistication.

Efforts by banking institutions to expand their offerings have been underpinned by an increasingly robust regulatory environment. This has translated into new rules regarding credit allocation as well as the use of assets as collateral. A new electronic payment infrastructure is also set to facilitate the relationship between the Central Bank of Djibouti (Banque Centrale de Djibouti, BCD) and various sector operators. Over the medium term, these efforts are expected to achieve two very important objectives: increasing the penetration of banking services and modernising the sector.

Although a handful of key reforms are under way, sector progress will nonetheless have to contend with some obstacles. In its 2016 Article IV consultation, published in April 2017, the IMF stated that the country’s financial sector is “characterised by a high level of non-performing loans (NPLs), high credit concentration and low profitability, and it remains vulnerable to adverse shocks”. However, recent statistics show that financial services have made some progress. Between 2007 and 2017 the banking penetration rate increased from 10% to 25% of the population, the BCD told OBG, while total banking assets expanded from DJF217.9bn ($1.2bn) to DJF436.8bn ($2.5bn) over the same period. The sector is also expected to be galvanised by the expansion of online banking offerings and new regulations to support mobile banking.

OPEN CONDITIONS: Financial stability and the overall attractiveness of Djibouti’s banking system rests on the country’s fully exchangeable currency, free movement of capital and fixed exchange regime. These conditions make it an exceptional market in a region with several less regulated, mature markets and currency controls. Additionally, the fact that the government has been channelling investment into infrastructure development, to take advantage of Djibouti’s natural position for commerce, has made it an increasingly attractive market for newcomers. The economy’s overall openness is one of the government’s strongest arguments as it attempts to transform the country into a regional financial hub.

However, this external openness serves in stark contrast with the sector’s ability to help domestic businesses and serve as an effective tool to leverage economic growth. “The transformation rate in the banking system is still very low, at around 30%,” Fouad Mohamed Houssein, finance manager at Tanzania-based Exim Bank, told OBG. “So only about one-third of total deposits returns to the economy in the form of loans.”

Thus, transforming existing banking resources into economic activity will be key to realising the sector’s full potential. In 2017 the financial services sector accounted for 13% of GDP, according to the 2017 annual report by the BCD. The majority of assets come from the banking system, which was made up of 12 banks as of end-2017. In addition, the financial services market also included three microcredit institutions and two insurers.

CREDIT ALLOCATION: Despite its growing importance in the economy, the banking sector has experienced difficulties allocating credit, which has kept its contribution to the country’s development well below its potential. BCD data shows that in December 2017 total deposits stood at DJF358.1bn ($2bn), up 25.8% from DJF284.6bn ($1.6bn) in 2016. Over the same period, total credit allocation expanded by 9.9%, from DJF93.1bn ($523.8m) to DJF102.3bn ($575.5m). “The allocation of credit represents 29% of GDP, which is very weak,” Abdirahman Robleh, head of statistics at the BCD, told OBG. “Because of this, the question is how to encourage banks to allocate more credit, especially to small and medium-sized enterprises (SMEs).”

As of December 2017 the majority of the sector’s loan portfolio, at over DJF88bn ($495.1m), was allocated to private firms, a 15.8% increase on 2016 figures. The biggest comparative increase in financing was for state-owned enterprises, which saw their credit portfolio rise by 36.8% to DJF17.3bn ($97.3m). By comparison, credit allocated to individual Djiboutians rose by just 4%.

Although the total credit allocation relative to the volume of deposits remains low, overall credit conditions have been improving in recent years. For instance, average interest rates for personal loans decreased from 12% to 9.2% in 2017, while average interest rates on housing credit saw a relatively modest reduction from 8.6% to 8.3%.

DJIBOUTIAN FRANC: The national currency was valued at a fixed exchange rate of DJF177.72:$1 well before the country’s independence in 1977, with the BCD maintaining the rate by covering money in circulation through its foreign exchange reserves.

The fixed exchange regime has been instrumental for the country’s overall attractiveness for investment, and the IMF has noted that this arrangement has positively influenced the economy. Furthermore, the fund reported that as of 2016 the reserves-to-base money ratio stood at 109%, while foreign reserves equated to 3.4 months of imports.

KEY REGULATIONS: Although banking penetration rates remain low, much of the sector’s expansion has resulted from the use of regulatory levers that have influenced market participation. Besides the country’s strategic position and relatively open regulations, banks have been drawn by the 2005 scrapping of legislation that demanded banks operating in the Djiboutian market to be at least 30% owned by reputable international players. This expanded the number of banks operating in the system considerably, transforming a duopoly into a highly competitive, albeit still concentrated, market.

Another key piece of regulation that helped propel the sector forward was the 2009 government circular that made it compulsory for monthly salaries of over DJF40,000 ($225) to be paid directly into bank accounts. This led to an increase in the number of bank accounts in a country long accustomed to dealing mainly with cash. In 2009 the number of accounts was 31,982, but by 2012 it had expanded to 54,512, and surpassed 162,000 accounts by the end of 2017. Regulation also began to focus more acutely on the system’s overall solvability. To reinforce solidity, the authorities raised minimum capital requirements in 2011 from $1.7m to $5.6m, with the BCD allowing a three-year adaptation period for banks to add to their capital. Despite the more stringent requirements, however, the move did not lead to any consolidation of the sector.

MARKET PLAYERS: Though Djibouti has seen a large number of competitors enter the market over the years, for a long time there were only two banks present. The oldest player in the country, Indosuez-Mer Rouge bank, began operating in 1908 and was later acquired by Bank of Africa (BOA) and rebranded as BOA-Mer Rouge. The second institution was Banque pour le Commerce et l’Industrie Mer Rouge, which began operating in 1957.

New competition arrived in 2006, when Yemeni-owned Saba Islamic Bank entered the market in June, to be followed by Malaysia-based International Commercial Bank (ICB), which opened up its Djibouti offices a few months later. Switzerland-based Banque de Dépôt et de Crédit Djibouti and locally owned Salaam Africa Bank, the second Islamic institution to begin operations, joined the market in 2008. The following year a second Yemeni bank, the Cooperative and Agricultural Credit International Bank, and a third Islamic institution, Dahabshiil Bank – now known as East Africa Bank – got their banking licences. Exim Bank was the sole new addition to the market in 2010, the same year BOA bought Indosuez-Mer Rouge, pointing to the growing potential for Djibouti to become a regional banking centre.

The following years saw additional arrivals, which added to the sector’s diversification. Commercial Bank of Djibouti began operations in 2015, focusing on corporate and investment banking activities, in contrast to the retail-oriented nature of some of the sector’s main competitors. Aiming to capitalise on the two countries’ growing trade connection, state-owned Commercial Bank of Ethiopia got its licence in 2016 and began operations in Djibouti in mid-2017. The bank previously operated in Djibouti as the State Bank of Ethiopia, but its activities were interrupted for more than a decade due to an increasing amount of NPLs.

Another licence was allocated in 2016, this time to Chinese-owned Silk Road International Bank, which opened its Djibouti operation in 2017. The expansion was the bank’s first brick-and-mortar location on the African continent, and the bank will likely aim to capitalise on the rising volume of Chinese investment across East Africa in general (see Transport & Logistics chapter).

Despite the growth in the number of major players, the sector’s physical network remains limited, albeit adapted to a country with a small population that is mostly concentrated in the capital. There were a total of 36 branches and 80 ATMs spread across the country for all the banks combined, the BCD told OBG in May 2018. However, economic development might see the number of contact points increase, although accurately gauging demand in some of the smaller urban centres might prove to be challenging. Nevertheless, the expansion of economic activity beyond the country’s capital is expected to positively impact banks. “With the opening of a new port in Tadjourah and the development of industrial activities in Ali Sabieh, it is undeniable that decentralisation is taking place, encouraging banks to open new branches outside the capital,” Abdulraqeb Salem, general manager at Saba Islamic Bank, told OBG. “This should help increase the banking penetration rate within the country.”

NEXT STEP: Banking penetration growth without the creation of additional banking branches is also being achieved through the use of mobile bank payments, regulated since a sector law was implemented in 2016. In order to continue modernising the sector, additional regulatory measures have continued to be rolled out since then. Efforts to reduce the rate of NPLs, improve credit allocation for SMEs, and allow for the sector’s move towards digitalisation are expected to be key in improving local banking operations and attracting more customers. To provide digital financial services, however, the country must first target digitalisation on a broader scale. “Djibouti shall invest locally in the digitalisation of its economy,” Jacky Kayiteshonga, director-general of Exim Bank, told OBG. “This will allow the banking sector to adjust and modernise its services within the country.”

One key programme involves the modernisation of credit verification mechanisms to reduce vulnerability to NPLs. For several years the sector has relied on a central de risque (centralised risk database), which lists all loans over $15,000. Though this did little to reduce credit risk for banks, regulatory changes in 2016 and 2018 strengthened credit reporting practices and requirements.

Additionally, the new legislation makes it easier for banks to retrieve assets used as collateral in instances of financial non-compliance. “This is a considerable advantage for financial institutions,” the BCD’s Robleh told OBG. “It gives them more confidence to allocate credit,” he added.

The new credit registry system, which was scheduled to become operational in October 2018, aims to digitally centralise information and make it available for all sector players. To this end, the central bank has requested banks change the way in which they collect client data, including updating of existing customer information. Although the regulatory change is relatively simple for smaller institutions, it requires more time and effort from bigger institutions, which is delaying the overall implementation of the new digitalised credit bureau.

COLLATERAL REGISTRY: Other aspects of the credit information system have been advancing more swiftly. One key way in which the government is trying to encourage banks to raise loan volumes is through the introduction of a collateral asset registry. A guarantee system covering property assets was already in place, but sector authorities have extended the guarantee system to include other assets held by companies or individuals, which will now be listed by the central bank. The goal is to ease credit access for individuals and SMEs by allowing commercial banks to access information on specific assets, such as vehicles, equipment and other elements that can be used as collateral.

“Companies had trouble accessing financing because banks require high collateral, such as land or a house,” Robleh told OBG. “However, in many cases these companies are small and do not have such assets. Therefore, we needed to allow banks to use other assets, such as cars and equipment.” The system became operational in April 2018. As of mid-May that year a total of 958 assets had been registered as collateral for loans, of which 899 pertained to credit allocated to individuals, and 59 were related to loans to companies, according to the BCD.

Furthermore, the new collateral registry system is expected to prevent individuals or businesses from using the same asset as collateral for multiple loans. For the cases in which a single asset has sufficient value to cover more than one loan from different banking institutions, the first bank will have primacy if any litigation arises among different creditors.

DIGITAL PAYMENT SYSTEM: Another critical development for the sector is the impending launch of a new digital payment system, which is being implemented with support from the World Bank. Instead of requiring banking operators to physically process cheque payments at the central bank, for instance, the new system aims to connect all sector operators to the BCD through a secure digital link, which will eliminate the need to process payments manually and reduce time constraints.

The project began in early 2018 and is expected to be finalised by 2020 after the link between each institution’s headquarters and the central bank is established. The new system brings obvious advantages to banks as well as customers. “Currently, it can take up to two days for the money to be made available after you cash a cheque,” Mohamed Robert Carton, head of the research department at the BCD, told OBG. “For SMEs working with big amounts of money in their daily operations, this is a big change. It makes the process more secure and allows companies to save time. Additionally, it will make it easier for us to get the statistics on payments.”

Similarly, Ahmed Hameed Al Deib, director-general of the Cooperative and Agricultural Credit Bank, sees Djibouti’s digital transformation as key to providing greater transparency and thus achieving a larger banked population. “Solutions such as e-wallets and digital banks will help formalise the market and enable more transparency on transactions,” Al Deib told OBG. “It is fundamental for Djibouti to develop its digital infrastructure in order to increase its banking penetration rate.”

ISLAMIC BANKING: Digitalisation is expected to be a game changer for the sector; however, other developments have also promoted the adoption of banking services across the country. Since the banking sector began to broaden its appeal to a larger number of competitors, Islamic financial institutions have also been entering the market. As of mid-2018 three out of the sector’s 12 operators were Islamic banks, which accounted for roughly 16% of all credit, according to the BCD. New product offerings from Islamic banks have attracted nearly 20% of banking customers, according to the BCD’s 2017 annual report. One reason for Islamic banking’s large appeal to customers, besides its varied sharia-compliant offerings, could be its early adoption of digital technology. “The Islamic banks are even more technologically advanced than the conventional banks,” Robleh told OBG. “They have been quite quick to integrate digital banking services into their operations in Djibouti.”

In response to market demand for Islamic products and services, since 2011 the BCD has allowed commercial banks to establish Islamic banking windows in parallel to their regular operations. In these cases, Islamic financial windows at commercial banks need to have their activities completely separate from the institution’s regular banking services. Over the short term the banking sector will likely see further increases in the adoption of financial services as the number of Islamic products and banks expand.

OUTLOOK: The financial system and banking market have made significant strides in recent years, with many improvements connected to the country’s efforts to become both a regional transport and a financial hub. Since 2008 regulatory steps have helped increase banking penetration rates; however, the credit-to-deposit ratio remains small. Several recent reforms, such as the establishment of a collateral guarantee system and ongoing improvements to a new credit bureau, are likely to encourage lending over the coming years. Nevertheless, industry players are mindful that changing the existing cash culture will take more than regulatory steps alone.

Efforts to this end, therefore, will likely require the help of commercial banks and the sophistication of their product offerings. The fact that new banks joined the market in 2016 and 2017 underlines the sector’s high level of attractiveness in a region with traditionally closed financial markets.

The rising potential for digital banking and mobile transactions should help the sector become more competitive, although the expansion of the digital payment system will also require further advancement in telecommunications. Overall, however, the financial services sector is expected to continue growing at a steady pace over the medium term.