Rift Valley University

Department of accounting and finance

YEAR III, EXTENSION-SECTION 6

Group assignment on

Financial Management II
GROUP MEMBERS:

o DAWIT CHUFAMO 0332/18

o DAWIT HAILU 0333/18
o EMBET ABEBE 0338/18
o ALEMITU ALEHEGN 0319/18
o SAMSON ASMARE 0361/18
o DIBORA KEDIR 0335/18
o HANA TAMIRU 0348/18
o TIGIST TESFAYE 0594/18

Instructor name: Melaku D.

Submission Date: Februery 26, 2021G.C.

References:

 National bank of Ethiopia( webpage and articles)

 Capital markets, student handout by dr. Gashaw T.
 Course hero.come
 Core.ac.uk
 Commercemate.com
 Investopedia.com
 Wikipedia
 Researchgate.net, Article by Letenah Ejigu Wale, Bahir Dar University
 Researchgate.net, Aticle by Muhammad Tanko
 Econstore.com
1. Financial system is a system that facilitates the movement of funds among people in
an economy. It is simply a means through which funds are exchanged between
investors, lenders, and borrowers. In Ethiopia, The financial sector 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). 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.
Currently, the Ethiopian financial system consists financial institutions such as 3
public banks including the National Bank of Ethiopia with aim to regulate
the finance industry in the country, 17 commercial Banks ; 15 insurance companies;
a public and private employed workers pension scheme; 33
Micro Finance Institutions.

For a country, the financial system plays a vital role for development. But, the role
the financial system plays in Ethiopia is not as significant as the developed nations.
However, the financial system has many efficient roles in our country’s economic
and social scenarios. For instance:-
a) Transfer Funds: Financial system helps in transferring of financial resources
from one person to another person. This system includes financial markets,
financial intermediaries, financial assets and services which facilitates fund
movements in an economy.
b) Mobilizes Saving: It helps in allocating ideal lying resources with peoples
into productive means. Financial system is the one which obtains funds from
savers and provide it to those who are in need of it for various development
purposes
c) Risk Allocation: Diversification of risk in an economy is important feature of
financial system. Financial system allocates people’s funds in various sources
due to which risk is diversified. 
 d) Facilitates Investment: Financial system encourages investment by peoples
into different investment avenues. It provides various income-generating
investment options to peoples for investing their savings.
e) Enhances Liquidity: Financial system helps in maintaining optimum liquidity
in an economy. It facilities free movement of funds from households (savers)
to corporates (investors) which ensures sufficient availability of funds. 
f) Facilitates Payment Mechanism: Financial system provides payment
mechanisms for the smooth flow of funds among peoples in an economy.
Buyers and sellers of goods or services are able to perform transactions with
each other due to the presence of a financial system.
g) Reduces Risk: It aims at reducing the risk by diversifying it among a large
number of individuals. Financial system distributes funds among a large
number of peoples due to which risk is shared by many peoples.
h) Improves Standard Of Living: It raises the standard of living of peoples by
promoting regional and rural development of the country. The financial
system promotes the development of a weaker section of society through
cooperative societies and rural development banks.
i) Facilitates Economic Development: Financial system influences the pace of
economic growth or development of an economy. It aims at optimum
utilization of all financial resources by investing all idle lying resources into
useful means which leads to the creation of wealth.
j) Job opportunities, social welfare, social works, aid and grants, and the like

2. Now days, the global economy highly affects every economic activity in developing
economies like Ethiopia. Among the activities highly affected by the world economy
is the financial sector. Therefore, we can draw many relationships between the
financial sectors in Ethiopia with that of the world economy. For instance, any
economical shocks that happened abroad affect the Ethiopian financial sector by the
decreasing flow of the remittance. As we know, remittance in Ethiopia generates
more foreign currency than the country’s’ export trade. The other is, the expansion
in the world economy brings foreign direct investment. The investment brings
foreign currency to the financial sector. Also, the amount of bank and insurance
transaction these companies brings is enormous. Also, for their exporting and
importing activities, this company’s use the financial institutions highly.
 On the other hand, the global economy is highly dependent on the global financial
system. As we can easily understand, now days, the global financial system is
highly interrelated with the growth in technology and new process. Due to this fact,
Ethiopian financial sector is highly benefited by copying and receiving these
technology and new processes.
3. 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. currently, there were 17 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.
4. Financial system aims at the efficient allocation of financial resources by
channelizing funds between net savers and net spenders. The financial system has an
efficient role in minimizing the risk through diversification of funds among a large
number of people. 
  Provides Payment System: The financial system provides a payment
mechanism for the smooth flow of funds among peoples in an economy.
Buyers and sellers of goods or services are able to perform transactions with
each other due to the presence of a financial system.
 Links Savers and Investors: The financial system serves as a means of
bridging the gap between savings and investment. It acquires money from
those with whom it is lying idle and transfers it to those who need it for
investing in productive ventures.
 Minimizes Risk: It aims at reducing the risk by diversifying it among a large
number of individuals. The financial system distributes funds among a large
number of peoples due to which risk is shared by many peoples.
 Helps in Capital Formation: The financial system has an efficient role in
capital formation of the country. It enables big corporates and industries to
acquire the required funds for performing or expanding their operations
thereby leading to capital formation in the nation.
 Raises Standard of living: It raises the standard of living of peoples by
promoting regional and rural development of the country. The financial
system promotes the development of weaker sections of society through
cooperative societies and rural development banks.
 Enhance liquidity: Maintaining optimum liquidity in an economy is another
important role played by the financial system. It facilities free movement of
funds from households (savers) to corporates (investors) which ensures
sufficient availability of funds in the economy.
 Promotes Economic Development: The financial system influence the pace
of economic growth or development of an economy. It aims at optimum
utilization of all financial resources by investing all idle lying resources into
useful means which leads to the creation of wealth.

5. A financial intermediary is an institution or individual that serves as a middleman

among diverse parties in order to facilitate financial transactions. Common types
include commercial banks, investment banks, stockbrokers, pooled investment
funds, and stock exchanges. Financial intermediaries reallocate otherwise uninvest
capital to productive enterprises through a variety of debt, equity, or hybrid stake
holding structures. However, in Ethiopia, the financial intermediaries are limited
mostly to accepting deposit, granting loans and selling insurance policy functions.
Through the process of financial intermediation, certain assets or liabilities are
transformed into different assets or liabilities. As such, financial intermediaries
channel funds from people who have surplus capital (savers) to those who require
liquid funds to carry out a desired activity (investors). A financial intermediary is
typically an institution that facilitates the channelling of funds between lenders and
borrowers indirectly. That is, savers (lenders) give funds to an intermediary
institution (such as a bank), and that institution gives those funds to spenders
(borrowers). This may be in the form of loans or mortgages. Alternatively, they may
lend the money directly via the financial markets, and eliminate the financial
intermediary, which is known as financial disintermediation.

According to the dominant economic view of monetary operations,[9] the following

institutions are or can act as financial intermediaries:

 Banks
 Mutual savings banks
 Savings banks
 Building societies
 Credit unions
 Financial advisers or brokers
 Insurance companies
 Collective investment schemes
 Pension funds
 cooperative societies
 Stock exchanges

According to the alternative view of monetary and banking operations, banks are not
intermediaries but "fundamentally money creation" institutions, while the other
institutions in the category of supposed "intermediaries" are simply investment funds

While this is the case for most of the rest of the world, in our country the financial
intermediaries are limited to only four types. These are:-

Banks, Credit Unions, Insurance Companies, Pension Funds

When it comes to financial intermediaries, there is a long list of those who qualify.
Often times, people may not even realize that they are interacting with a middleman
who is just overseeing the transaction in question. Nevertheless, without these
entities, the investment markets would be crippled and unable to operate.

I. Banks

Undoubtedly, banks are the most popular financial intermediaries in the world. They
come in multiple specialties that include saving, investing, lending, and many other
sub-categories to fit specific criteria. The most ancient way in which these
institutions act as middlemen is by connecting lenders and borrowers. For instance,
when someone raises a mortgage from a bank, they will be given the money that
another person deposited into that bank for saving. Similarly, large companies also
use banks to help find investors. Not to mention their role as the entities that people
use to receive pay checks via direct deposits.

II. Credit Unions

Similar to the aforementioned, credit unions also bring together people who need
money and those who have it. For instance, they are known to offer credit terms to
people by using the money that other individuals deposited into savings accounts.
So, when somebody needs a loan from a credit union, they will receive it because
there are funds at credit union’s disposal that someone else contributed. The main
difference between these entities and typical banks, however, is their role with
consumer credit. Besides lending, they also oversee many credit-related inquiries.

III. Insurance Companies

Although there are several different types of insurance organizations, almost all of
them operate in the exact same way. First, they find a large number of customers
who need to obtain coverage. Whether it is a car, home, or health policy does not
matter. Once those customers purchase their insurance coverage, all of the funds are
added to a large pool of money. Later on, whenever somebody needs to make a
claim and use the insurance company to request a pay-out, the insurance provider
will access that pool of money. This means that there is no net inflow of cash to the
market, per se.

IV. Pension Funds

 In Ethiopia, this category of financial intermediary does not stand as a separate
institution. But there is a lawful governmental institution that is formed for
collecting especially private organizations employees’ pension contribution funds.

Anyhow, Full-time employees often meet another popular financial intermediary

known as a pension fund. It is what millions of workers use to save for their
retirement by investing. The way it works is based on a risk factor, matching
contribution, and long-term investing. For instance, when somebody signs up for a
pension fund, they choose how much of their salary will be put away. Often, their
employer matches that contribution to a certain extent. Then, all of that money is
used to purchase assets that will grow and have a good yield. Once the employee
retires, they get all the contributions alongside any interest and realized gains.

On the other hand, in Ethiopia, Stock and equity are sold without the existence of
stock market. This activity is highly covered by commercial banks. That means,
their financial intermediation goes beyond the traditional banks’ functions.

Therefore, we can’t include stock markets to this category in the case of Ethiopia.

6. For this discussion, we solely used the article by Letenah Ejigu Wale of the Bahir
Dar University. Primarily, Financial Markets channel savings to those individuals
and institutions that need more funds for spending than that are provided by their
current incomes. The financial system consists of many players like financial
institutions, financial markets, regulators, market participants and others having
stake on it. Money and Capital Markets operating within the financial system make
possible the exchange of current income for future income and the transformation of
savings into investment which result in increased production, employment, income,
and living standards.

It is an accepted view that there is a close relationship between capital markets and
economic growth. Stock markets provide services that boost economic growth and
contribute to the achievement of these goals.

A capital market with greater breadth and depth will be able to attract domestic
savings. Small investors would be wooed to pool their savings and invest in capital
market instruments as they provide greater returns particularly in the long run. The
domestic savings mobilized in turn will be channelized into investment, paving the
way for greater and quicker capital formation. Higher capital formation in industrial
sector will enhance the capacity to produce capital and consumption goods. This will
gradually reduce the import burden of the country. Import substitution has multiple
effects on the economy, such as enhancement of employment potential, enthusing
agricultural and domestic production, reducing balance of payments deficit,
improving the productivity of agricultural and industrial sector and their contribution
to the GDP of the country, and the like. Higher GDP in turn will improve the
individual disposable income, enhance the standards of living, and increase the
saving potential. The increased saving potential will be met with higher
opportunities to invest in capital market instruments, and that is how the Capital-
Market-Induced-Growth-Cycle” will operate.

Opportunities

The current realities of the Ethiopian economy have many favourable conditions
(opportunities) that can pave the way for security market development. This includes
Ethiopian-specific advantages, favourable macro-economic and social conditions,
increased interest of foreign investors, financial sector development, enhanced
saving and investment potential, increased private sector participation, and high
enthusiasm among stakeholders.

When we say Ethiopia has some unique country-specific advantages that ease the
development of secondary markets we mean the country’s history of independence
that can have the potential to protect it from contagion effect of global turmoil;
considerable unexploited resources such as fertile land, gold, platinum, tantalum,
soda ash, potash and natural gas; and over 100 million people (second most populous
in Africa) thus providing one of the largest potential markets in Africa.

Also, the country is registering double digit GDP growth rates in the recent years,
inflation although was high is now showing declining trend, unemployment rates are
declining due to huge government projects and private sector development, foreign
exchange reserves are increasing due to increasing export earnings and high
remittance inflow. Besides the economic growth the human development is
increasing consistently. Owing to government’s commitment, access to education
and its quality are showing a discernable progress.
The current high enthusiasm among foreign investors in Ethiopia is a great
opportunity to open up the security markets. With the opening of such markets the
number of companies issuing shares and get listed in stock exchange will increase.
This in turn will make the market vibrant, active and liquid and will further attract
more foreign investors.

The Ethiopian government drafted a Plan that strives to change the country’s
economic structure in more fundamental way from agrarian based to modern
industrial based economy. Implementation requires huge financial resources. As one
of the ways of augmenting internal resources, saving mobilization is given much
emphasis in the plan. This triggers the development of security markets that are
known to mobilize small household savings.

The banking sector is growing phenomenally. Both public and private banks open
new branches in a phased manner. New market players like microfinance institutions
catering to the urban poor and rural areas are also increasing the access to finance.
Banking sector development is instrumental to security market development and this
is considered as excellent opportunity to develop such markets.

As a result of continued economic growth over the past years, the people’s capacity
to save is increasing and this can be considered as good opportunity to attract many
investors to security markets. The financial institutions like the pension fund,
insurance companies, and credit unions, are with large sums of money and if they are
allowed to invest in secondary market, such investment would boost the demand for
securities.

The level of private sector development is increasing continuously owing to

improved business environment conditions. As a result, many companies are issuing
shares to the public and this can be seen as nice opportunity to begin organized
security markets.

Stakeholders such as the business community, the government, the academia, and
society at large are enthusiastic about the possibility of developing security markets
in this country. Many conferences, workshop and symposia were and are organized
on such issues. Such high enthusiasm indicates that the time is appropriate for
developing secondary markets.

Challenges
Though it is highly laudable, the launch of security market is not without challenges.
Some of the major challenges can be listed as below.

Quality and quantity of financial services: Banking system in Ethiopia is still in

infant stage due to limited products range, poor outreach and weak inter-bank
markets. The major financial products of the banking systems are saving and loan
products. There are no many varieties even with such basic products. The use of
check as a payment system is restricted only for current accounts.

Paucity in communication network: Ethio-Telecom is the sole authority providing

telecommunication services in the country. No other private players are currently
operating in this field. For fast and smooth service, banks need highly developed
communication network. Private Banks in particular feel that one of the impediments
for the expansion of their branch network is the inadequate communication network
across the country.

Policy measures Impetus: The policy related challenges includes lack of tax
incentives for security market participants such as investors, firms and
intermediaries which otherwise can be used to promote such markets, lack of
awareness and willingness among the policy makers to push for such markets,
prohibition of foreigners to participate in the financial sector of the country and low
level of market orientation in the economy.

Gaps in accounting, auditing and legal infrastructure: Accounting and auditing

standards in Ethiopia are not of a high and international acceptable quality. Share
companies are not required to include audited financial statements. As there is no
public offering and listing, there are no requirements regarding publicly available
annual reports and their preparation and presentation in accordance with a
comprehensive body of accounting standards. Even without reporting requirement,
there is general unwillingness among Ethiopian businessmen to provide financial
information of any nature to the needy. As a result, the data compiled for private
businesses do not reflect the true picture in most situations. Such data shortages and
inaccuracies significantly affect researches made in accounting and finance areas and
lead to errors policy making. Unlike other countries, information is not made
available on the websites too, except for public and government undertakings. Often
in many cases, the information provided is too out-dated to be useful for any
meaningful conclusion. Laws and institutions governing corporations, securities and
investors are insufficient according to international best practices and standards. The
1960 Commercial Code of Ethiopia is not up to date and has many grey areas. The
registration of patents and trademarks are non-existent. The judiciary is poorly
staffed and inexperienced in commercial cases.

Low level of saving and financial literacy: There is low saving rate in the country
due to poor saving culture and weak saving capacity (a result of low per capita
income). As the financial literacy of those participating in security markets seems to
be poor, there is a strong and immediate demand to support financial literacy as soon
as possible.

Limited forms of business organizations: Most business organization forms in the

country are sole-proprietorship or private limited companies rather than share
companies. This is partly attributed to the owners need to maintain tight control over
the firm and the perception by many companies that the risks associated with
additional disclosure are not adequately compensated by additional returns. Since
banks do not require public disclosure like the stock market does, many firms would
prefer to remain privately-held and source their capital from banks. These firms
cannot be expected to use the services of stock market. The government should
encourage privately owned companies to go public through tax and other
motivational measures.

INFRASTRUCTURE REQUIREMENTS FOR ESTABLISHING SECONDARY

MARKETS IN ETHIOPIA: To address the issue of developing organized secondary
markets in Ethiopia, the following are identified as the requirements:

The development of secondary markets requires institutional building and

infrastructure development, Apex Authority, and Comprehensive and sound Banking
System, State-of-art Communication Network, and Sound Legal System to protect
the Interests of Investors and other Stakeholders.

Another major pre-requisite for secondary markets development is macro-economic

stability. This can be ensured by means of: (i) easing out inflation rates to acceptable
levels, (ii) ensuring economic growth through appropriate monetary and fiscal
policies, and (iii) stabilizing exchange rates.
 The tax system must be suitably adapted to induce market participants to save and
invest. Earners must be encouraged to save sizeable portion of their income for
which exemptions from tax levy may be granted. In order to attract small saving,
innovative products should be floated after appropriate research. Campaigns should
be undertaken at the national level.

The accounting, auditing and finance profession in Ethiopia must be strengthened.

Akin to University Qualifications at the National Level, clear guidelines for the
minimum eligibility for practice should be established. Code of Professional Practice
must be developed in order to ensure ethical behaviour among the professionals.
Strict adherence to the Code should be insisted upon.

Higher Educational Institutions must be encouraged to develop programs that

address the needs of corporate. They must also be directed to design and deliver
training programs to cater the needs of the surrounding business community. Efforts
must be taken to enhance the financial awareness among investing public. Active
research in development of young and upcoming financial sector should be
encouraged. Encouragement must be given to those Universities who try to
collaborate with foreign Universities in know-how enhancement.

To conclude, establishing Secondary markets in a country is not a task that can be

achieved over-night. It requires careful planning and long-term orientation. By
drawing information from primary and secondary sources, this study points out the
various issues to be considered for the development of secondary markets. Further
the study weighs the benefits and costs of these markets to the economy as a whole
and to market participants, and assesses Ethiopian-specific opportunities and
challenges. It lays out institutions and infrastructures needed for security market
development. Considering (i) current growth in the number of share companies, (ii)
need for infusing higher capital to various economic sectors, and (iii) increased
capacity to save due to higher economic growth, the researchers conclude that the
policymakers must seriously consider the launching of secondary markets in
Ethiopia.

7. According to a definition by investopdia, Privatization occurs when a government-

owned business, operation, or property becomes owned by a private, non-
government party. Note that privatization also describes the transition of a company
from being publicly traded to becoming privately held. This is referred to as
corporate privatization.

The main advantage of privatization is to generate financial resources for the

government to generate resources disinvestment of public sector enterprises,
Optimum Utilisation of Resources, Fostering Competition, Reduce Fiscal Burden,
Individual Motivation and the like.

If we look closely on the aforementioned advantages of privatization, we can easily

conclude their positive impacts on the establishment and operations of capital
markets. For instance, as more organization are owned by or transferred to the
private sector, it paves the way for its establishment. When more corporations are
there in the economy, they urged the markets establishment. Also, to establish the
market, the variety and amount of owners of a corporation is vital.

On the other hand, to efficiently operate the market, privatization must be

accelerated. This is due to the fact that privatization reduces monopoly of the few
state owned actors, it mobilizes additional resources, it improves the level of
competition among the actors and pulls down the price to the market level, and it
adds motivation and inventions.

Briefly, even if the market is on its way of formation in our country, privatization
can play a great role in its establishment and operation.