Financial institution in Ethiopia

Abstract

This article presents comprehensive review of annual reports and articles on development of financial Institution in Ethiopia and for open discussion.

Keywords: development, financial institution, Ethiopia

1. Introduction This article provides an overview of development of financial institution in Ethiopia, including Background and Structure of the Financial institution in Ethiopia, Rural Financial systems in Ethiopia, Financial Developments in Ethiopia, Major Financial Product Services, Supplies-Demand Gaps in the Financial institution, The Legal and Policy Environment and The Role of the Government in the Financial institution.

The chapter is organized as follows: Section 2 focuses on Background and Structure of the Financial Sector in Ethiopia, section 3 focuses on Rural Financial systems in Ethiopia and provides a review of the formal rural financial system as well as informal rural financial systems in Ethiopia. Section 4 discusses Financial Developments in Ethiopia; Section 5 discusses Major Financial Product Services in Ethiopia; the gap between credit supply and credit demand in rural Ethiopia is discussed in Section 6; Section 7 discusses the Legal and Policy Environment in financial sector; and Section 8 discusses the Role of the Government in the Financial Sector.

2. BACKGROUND AND STRUCTURE OF THE FINANCIAL INSTITUTION IN ETHIOPIA

Banking in Ethiopia started in 1905, with the establishment of the Bank of Abyssinia that was owned by the Ethiopian government in partnership with the National Bank of Egypt then under British rule. But a well structure banking system started to evolve starting the 1940s-after the Italian departure. A government owned bank-the State Bank of Ethiopia-was established in 1942, and a number of foreign bank branches and a private bank were operating in competition with the government owned commercial bank until they were nationalized and merged into one government owned mono-bank in 1976. The competitive banking situation that started to flourish during the 1960s and 1974s was nipped in the bud by the command system that reign over the 1974-1991 periods.

    Following the change of government in 1991, and the subsequent measures taken to liberalize and reorient the economy towards a system of economy based on commercial considerations, the financial market was deregulated. A proclamation number 84/94 was issued out to effect the deregulation and liberalization of the financial sector, and a number of private banks and insurance companies were established following the proclamation. Directives issued in subsequent years further deepen the liberalization mainly including the gradual liberalizations of the interest rate, foreign exchange determination, money market operation, etc. In the year 2013/14, there were 16 private banks operating along with three public banks, namely the Commercial Bank of Ethiopia, the Construction and Business Bank, and the Development Bank of Ethiopia. Other financial institutions operating in the economy includes 17 insurance companies, one pension fund and about 31 Micro Finance Institutions with a business focus mainly in the rural areas but in reality concentrated in urban area. The Development Bank of Ethiopia (DBE) is a specialized bank in project financing and is not a deposit taking institution (NBE, 2013/14).

    Generally, public banks dominate the financial industry in Ethiopia. The Commercial Bank of Ethiopia (CBE), the largest bank in the industry, accounts 38.8% of the branch networks, over 53.3% of the outstanding loans and mobilizes about 66.4% of the deposits of the commercial banks (NBE, 2014). However, the progress observed by the private banks in the last ten years appears commendable. In terms of the fresh loans annually disbursed, the share of the private bank is at par with the public commercial banks. In addition, private banks also managed to capture more than half of the private sector commercial banks’ loan customers (CBE, 2013/14).

3. RURAL FINANCIAL SYSTEMS IN ETHIOPIA

 Rural finance in Ethiopia, as in other developing countries, has dualistic features. There exist both formal and informal credit institutions in the country.

3.1 Formal financial institutions in Ethiopia:

 The formal sources are financial institutions that are set up legally and engaged in the provision of credit and mobilization of savings. These institutions are regulated and controlled by the National Bank of Ethiopia (NBE). In the Ethiopian context formal financial sector includes National Bank of Ethiopia (NBE), commercial banks (owned by private and public), Development Bank of Ethiopia (DBE), credit and savings cooperative, insurance companies (both public and private) and microfinance institutions (owned by regional governments, NGOs, associations and individuals)(NBE, 2013/14). According to the proclamation number 84/94, foreign entry in to the financial sector is not allowed until domestic banks attain a certain degree of desired competitiveness and the National Bank’s supervisory and regulatory capacity is adequately strengthened.

Microfinance institutions in Ethiopia: Microfinance can be defined as provision of a broad range of client-responsive financial services to poor people through a wide variety of institutions. Microcredit activities in rural and urban Ethiopia were initiated by local and international NGOs (Wolday, 2004). According to Pischke (1996), there were 30 NGOs in Ethiopia who were delivering microcredit services but concentrated in urban areas. Although the NGOs had contributed to testing innovative methodologies and products, they had the problem of combining the humanitarian objectives of the NGOs with the financial objectives of the microcredit program. In Ethiopia integration of the credit schemes initiated by local NGOs like the Relief Society of Tigray (REST) and Organization for Rehabilitation and Development in Amhara (ORDA) into the formal financial system contributed to the formulation of a regulatory and supervision framework for efficient delivery of services to the urban and rural poor and the issuance of a new proclamation for Licensing and Supervision of Micro-Financing Institutions in 1996 (Proclamation No.40/1996)

3.2. Informal credit institutions in Ethiopia: The inability of the formal financial sector to provide adequate financial services to small farmers and the poor in general continued even after the reform (Assefa 2004). A study by the National Bank of Ethiopia (1996) concluded that “CBE and DBE have only catered for insignificant demand for credit of small farmers. The bulk of financial services provided to small and micro-enterprises in rural and urban areas, therefore, mostly originated from the informal sector such as Eqqub, moneylenders and friends” (NBE, 1996). On the other hand, as Dejene (2003) stated the non-formal sources in Ethiopia include relatives and friends, moneylenders, neighbors, Iddir, Eqqub and Mahaber are the major sources of loans include friends and relatives (66 percent), moneylenders (14 percent), and Iddir (7 percent). In other words the bulk of the rural credit comes from informal sources. Every year, the informal sector mobilizes resources equivalent to about 10 percent of deposits mobilized by all banks in Ethiopia. Rural Iddirs mobilized through informal loans alone an amount 3.5 times the total capital of all micro finance institutions in Ethiopia. The socio-economic base line survey in the Amhara region review that the most widely used financial institutions in rural areas were informal, which provided very small loan size, for short period and especially for daily consumption. The survey result of Dejene (2004) indicates that from the total respondents about 65 per cent of the households were accessing credits from informal institutions. Ethiopian cooperative agency (2014) also identifies the percentage share of the number of borrowers by institution as ACSI caters to 22%, co-operatives 9 %, NGOs 3%, Arata Abedari 20% relatives/friends 44% and others 2%. It is argued that informal sources, however, do not generate enough and affordable finance for business to stimulate economic development. In particular, the individual moneylender (the Arata Abedari) is extremely expensive, and is only resorted to in the absence of any alternative. In this case borrowers are required to provide guarantors and the interest rate is excessively high. Until recently the annual interest rates that the money lenders charged was estimated to range from 60% to 120% (Getaneh, 2005a).

3.2.1 Types and Roles of informal Finance in Ethiopia

The term informal refers to the provision of service which is not generally or partly regulated by law but which relies on self-regulating mechanisms. Moneylenders and pawnbrokers may be required to register, and in that case, they operate to some extent under formal legislatures. Informal operators are a worldwide phenomenon: this demonstrates the universal need of the population, particularly the rural, of finical services and the ability of the professional operators to provide some of these services under different circumstances as a financially viable occupation. The variety of financial transactions reflects the variety of circumstances, and additional conditions such as the delivery of products the provision of labor or the exchange of pledges such as gold and jewelers may be part of the transaction. Despite the variety of operators and transactions, the informal professional operators have various main features in common which justify their classification in one group. The informal sector accounts for most of the rural financial services provided to the rural areas in Ethiopia .In his study of micro- finance development in Ethiopia, Worku (2000) describes the different informal professional financial services operated in Ethiopia.

4. FINANCIAL DEVELOPMENTS IN ETHIOPIA

Financial development in Ethiopia is generally low. The degree of monetization is obviously low in a country where the economy itself is dominated by a subsistent oriented agriculture. Broad money as a proportion of the GDP, which is broadly taken as a measure of the extent of financial development, is in the range of 24% to 28%. While this statistic is comparable to many low-income African countries (Table 4.1), it nonetheless suggests that financial deepening in Ethiopia is far lower than those upper and high-income countries. Other indicator such as claims to the non- government as a proportion of the GDP, which stands at about 22%, also points to the same conclusion. Bank credit to the non-government and deposit of the banking sector as a proportion of GDP normally rises as the economy grows.

                           Table 4.1: Indicators of Financial Deepening in Ethiopia

Table 4.2 below provides some comparative financial deepening statistics for some low-income African countries, and mid to high-income African and Asian countries. Broadly speaking, both credit and deposit to GDP ratio for Ethiopia are fairly comparable to many low-income African countries. However, compared to middle and high-income countries, both ratios are significantly low, suggesting the undeveloped nature of the financial sector in Ethiopia.   

        Another indicator of banking development is the number of banks and bank branches in relation to totalpopulation of the country. As of 2013/14 fiscal year, there are only nineteen commercial banks for the 96.9 million population of the country, suggesting the per capita commercial bank is very low about 5.7 million populations per one commercial bank. This rather crude measure also indicates that access of the population to financial services is limited. This is also confirmed by financial access survey conducted by IMF as indicated in tables 4.3a&b and 4.4

Table 4.2: Comparative Financial Indicators for Some African countries

Source: IMF financial access survey (2014)

IMF financial access survey (2014)

Source: IMF financial access survey (2014)

Countries like Kenya; with over 43 commercial banks for a population slightly above 44.8 million has a far better per capita. Nigeria has 23 commercial banks for a population of 177 million, which suggests about 7.72 million per bank. Ghana has about 27 banks including commercial banks, merchant banks, and development banks for a population of about 26.7 million. Uganda, Zambia and Tanzania have also a better bank per capita

5. MAJOR FINANCIAL PRODUCT SERVICES

 Broadly speaking, the banking industry in Ethiopia provides products mainly deposit facilities, loans and advances, local transfers, foreign letter of credit facilities, etc. These are traditional commercial banking businesses.

Credit business is of course the key income generating activities for many of the banks operating in the country. Over 60% of the income of banks is generally derived from credit businesses, although fee based income are also growing to a sizeable level (Annual Reports of the commercial banks, various issues). Short-term loans, mainly trade and working capital finance dominates the commercial banking businesses, but some of the public banks  are  also  involved  in  medium  to  long-term  loans.  Sectorally,  many  of  the  commercial  banks  focus  on domestic and international trade. Over the last fifteen years, the Commercial Bank of Ethiopia has extended large amount of loans to farmers to finance fertilizer and improved seed purchase, largely on the basis of guarantees from regional governments, which in effect take the responsibility of collecting the loans and repaying the bank (SDPRP 2002). However, extending loans to the sparsely settled and with limited viable collateral farmers has not been done on their own by any of the commercial banks, and their business, by and large, remained urban based. Even in the urban economy, good business entities and project ideas may be under-financed unless they are well backed up by collaterals. The information base on which credit decision is based is too weak to be relied on to manage  risks,  and  good  projects  with  viable  collateral  would  most  likely  be  excluded  from  the  formal  bank financing.