Chapter 5

Chapter-outline

Financial Market and Institutions in Ethiopia

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FINANCIAL MARKETS AND INSTITUTIONS IN ETHIOPIA

✓ The financial sector in Ethiopia consists of formal, semiformal

and informal institutions.
✓ The formal financial system is a regulated sector which
comprises of financial institutions such as banks, insurance
companies and microfinance institutions.
✓ The saving and credit cooperative are considered as semi-
formal financial institutions, which are not regulated and
supervised by National Bank of Ethiopia (NBE).

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Cont.

✓The informal financial sector in the country consists of

unregistered traditional institutions such as Iqub (Rotating
Savings and Credit Associations) Idir (Death Benefit
Association) and money lenders.

✓The components of each category are discussed in detail in

the following headings.

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 1. Formal sectors
✓ The major formal financial institutions operating in Ethiopia are
banks, insurance companies and microfinance institutions.

(i) Formal Banks

✓ 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 structured banking system started to evolve starting in

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. 4
Cont.
✓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.

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 Cont.
✓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, and
money market operation.

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 II. The Insurance Company
✓Likewise to banking, Ethiopia’s insurance industry is undeveloped.

✓Its emergence is traced back to the establishment of the Bank of

Abyssinia in 1905.

✓The Bank had been acting as an agent for foreign insurance companies to
underwrite fire and marine policies.

✓Before liberalization the command economy including political instability

had been the stumbling block for the growth of the financial sector in
Ethiopia.

✓The 1990’s helped in economic liberalization that led to the revival of

private sector participation in the financial sector. This has led to the
formation of a number of private insurance companies.
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✓ The insurance market is undeveloped, uncompetitive and there exist
scarcity of information on the kind of life insurance that is currently
present.
✓ The current practice of bulk of insurance coverage and business in
Ethiopia is targeting the corporate market and focuses mainly on
general insurance with a very limited coverage in life insurance.
✓ Most Ethiopian insurance companies have sister banks and it's
common for these banks to refer their clients to their sister insurance
companies, but this is largely restricted to credit life insurance
products.
✓ Insurance companies tend to derive a large portion of their total
income from investments in banks.
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 III. Microfinance Institutions

✓The first microfinance service in Ethiopia was introduced as an

experiment in 1994, when the Relief Society of Tigray (REST)
attempted to rehabilitate drought and war affected people through the
rural credit scheme.

✓It was inspired by other countries’ experiences and adapted to the

conditions of the Tigray region.

✓In the second half of the 1990s, as a result of its success, the
microfinance service was gradually replicated in other regions.

✓ These institutions provide financial service, mainly credit and

saving and, in some cases, loan insurance.

✓ The objectives of MFIs are quite similar across organizations.

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✓ Almost all MFIs in the country have poverty alleviation as an
objective.
✓ They focus on reducing poverty and vulnerability of poor
households by
increasing agricultural productivity and incomes,
diversifying off farm sources of income, and
building household assets.
✓ They seek to achieve these objectives by expanding access to
financial services through large & sustainable microfinance
institutions.
✓ The Ethiopian microfinance industry has undergone tremendous
growth and development in a very short period of time. 10
✓ Despite the notable achievements, the operating MFIs reach

less than 20% of the total microfinance demand in the country.

✓ Turning to market concentration, the three largest MFIs,

namely Oromia, Amhara, and Dedebit Credit and Savings

institutions accounted for 81.4 % of the total capital, 67.1 % of

the savings, 74.0 % of the credit and 76.2 % of the total assets

of MFIs.

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 Semiformal – Saving and Credit Cooperatives
❖ In Ethiopia there are three types of saving and credit cooperatives,
namely
Institution based SACCOs;
Community based SACCOS; and
SACCOs sponsored by NGOs.
✓ Savings and credit cooperatives are type of organizations
providing financial services to the poor in rural areas of
Ethiopia.
✓ These include multi-purpose and credit and saving cooperatives.
✓ Unlike other formal financial institutions (banks and micro
finance institutions), saving and credit cooperatives are owned,
controlled and capitalized by their members. 12
✓ The savings and credit cooperatives are not subjected to
supervision and regulation of the National Bank of Ethiopia.
✓ The ministry of cooperatives is responsible for the coordination of
their activities.
✓ One of the principles of SACCOs is that lending is limited to only
members of the cooperatives and the amount of loan depends on the
level of individual saving deposits.
✓ One of the weaknesses reflected in the co-operative sector is poor
administrative and financial management.
✓ On the other hand the government through the relevant ministry is
not adequately equipped to monitor and control the cooperative
movement. 13
✓ Savings and credit cooperatives in Ethiopia are not permitted
to take deposits from non members.
✓ Many rural saving and credit cooperatives provide loan
services for agricultural inputs, animal fattening and in
some cases for off farm activities.
✓ Loan distribution policies are careful, only those with
sufficient savings and collateral can borrow.
✓ The majority of loans are provided for a period of one year
or less.
✓ Usually interest on loans is higher than charged by
commercial banks; but often lower than that of MFI’s and
definitely lower than the money lenders rate. 14
 Informal Finance
✓ In both rural and urban areas in Ethiopia, it is common that
neighbouring family households organize themselves and develop
their own institutions, popularly known as Community-Based
Organizations (CBOs).
✓ The nature of the CBOs highly varies from social, religious and
financial concerns, but are all aimed to address the needs of the
people.
✓ In most communities, membership in traditional community
associations such as iddirs, iqqubs and mehabers are very common.
✓ More importantly, these traditional institutions also play a crucial
role in savings and beneficiary mobilization in the informal
financial sector. 15
 MFIs Legal and Regulatory Framework

✓ Wise regulation is very critical in ensuring the sustainability

and viability of MFIs.
✓ In other words, microfinance cannot be sustainable without an
appropriate legal and regulatory framework.
✓ In recognition of these concerns, the government of Ethiopia
took the initiatives to establish the regulatory framework in
order to facilitate the development of microfinance institutions.
✓ Consequently, proclamation No 40/1996 was issued to establish
the legal framework for microfinance institutions and define the
regulatory role of the National Bank of Ethiopia (NBE).
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• The requirements for establishing microfinance institutions
(MFI) include:
1. MFIs should be owned by Ethiopians or Ethiopian companies
2. They should elect board of directors and other officers and
3. Deposit minimum required capital and
4. They should obtain a license from the NBE.
❖ The following section discusses the main regulations which
are relevant to MFI.

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 1. Minimum Capital Required of New MFI Entrants
✓ Directive No. MFI/01/96 states that MFI applying for a license
shall have a minimum paid up capital of 200,000 Birr (25,000
USD).
✓ However, the minimum capital required by the NBE is low.
✓ This is a deliberate action of the government to improve entry
and growth in the microfinance industry.
✓ On top the minimum capital requirement, on MFI is applying for
a license should submit memorandum and articles of association,
work plan indicating major financial services to be offered,
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✓ overview of economic conditions of the area, cash flow, income
statement and balance sheet projections for the first year of the
operations, curriculum vitae of the board of directors and the
Chief Executive Officer (Directive No. MFI/01/1996 of NBE).
✓ The performing of the MFI legislation in 1994 has led to the
transformation of the traditional NGO microcredit programs into
full fledged autonomous Microfinance institutions including
SFPI, Bussa Gonofa, PEACE, ESHET, Wasasa etc.
✓ In this case the principal shareholders of the concerned MFIs are
their mother NGOs.

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 Interest Rates
✓ The NBE increased the maximum ceiling of the lending
interest rate of MFIs to 15.5 % per annum (Directive No.
MFI/10/98).
✓ However, both directives did not state whether the lending
interest rate was flat rate or declining rate.
✓ The NBE removed the ceiling of the lending interest rate of
MFIs.
✓ It has clearly stated that the board of directors of each MFI can
set its own lending interest rate (Directive No. MFI/11/98 and
Directive [Link]/13/2002).
✓ Initially, the minimum interest rate on savings and time
deposits was 7% per annum.

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✓ Directive No. MFI/12/98 was issued to reduce the minimum
interest rate on savings and time deposits from 7% to 6% per
annum.
✓ However, in 2002 (Directive No. 13/2002) the NBE reduced
the lower ceiling of saving interest rate for formal banks and
MFIs to 3%.
✓ The minimum saving interest rate for the MFIs was increased to
4% in 2007 (Directive No. 19/2007 of NBE)

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 The Role of Capital Flows
The structure, level and role of capital flows to the country

✓ Taking account of the basic macroeconomic identity, we can

locate the role of capital flows within the accumulation balance
of the economy.
✓ The starting point for the macroeconomic accounting of capital
flows is the identity that equates the saving-investment gap
with current account and capital account.
✓ Capital flows finances the current account deficit from the
capital account as follows:
Investment-saving gap = current account = capital account (1)

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Algebraically this can be expressed as:
GDI-GDS=M-X = Net capital flows (2)
✓ Capital inflows consist of public/private long and short-term loans,
private capital inflows largely FDI, and other flows.
✓ Based on this macroeconomic accounting framework, which ensures
equality across the saving investment account, the current account
and the resulting capital account, we now attempt to place the
evolution of capital inflows in the accumulation balance of Ethiopia.
✓ The accumulation balance for an economy as a whole sets out how
total investment is financed.
✓ By rearranging equation 2, it follows that:
GDI = GDS + foreign capital inflows (3)
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• End of the chapter

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