Chapter Five:

Overview of the Ethiopian Financial System

5.1 Historical Development of the Ethiopian Financial System

Modern banking in Ethiopia began in 1905 with the Bank of Abyssinia, a private company
controlled by the Bank of Egypt. In 1931 it was liquidated and replaced by the Bank of Ethiopia
which was the bank of issue until the Italian invasion of 1936. During the Italian occupation,
Bank of Italy banknotes formed the legal tender. Under the subsequent British occupation,
Ethiopia was briefly a part of the East Africa Currency Board.

In 1943, the State Bank of Ethiopia was established, with 2 departments performing the separate
functions of an issuing bank and a commercial bank. In 1963, these functions were formally
separated and the National Bank of Ethiopia (the central and issuing bank) and the Commercial
Bank of Ethiopia were formed. In the period to 1974, several other financial institutions emerged
including the state‐owned:
 The Agricultural and Industrial Development Bank (established largely to finance stateowned
enterprises)
 The Savings and Mortgage Corporation of Ethiopia
 The Imperial Savings and Home Ownership Public Association (which provided savings and
loan services) Major private commercial institutions, many of which were foreign owned,
included
 The Addis Ababa Bank
 The Banco di Napoli
 The Banco di Roma
In addition, there were several insurance companies. The shift to Marxist government in 1975
brought several changes to the banking system, and saw the nationalization of private banks and
insurance companies. The major 3 commercial banks were merged under the Addis Ababa Bank,
and the National Bank of Ethiopia was given oversight over all financial institutions. The
Ethiopian Insurance Corporation incorporated all the nationalized insurance companies and the
new Housing and Savings Bank provided loans for new home construction and home
improvements.

5.2Natures of the existing financial institutions in Ethiopia

Central bank and its role in the economy:

The functions of the National Bank of Ethiopia are as follows: The first and most important
function of a central bank is to accept responsibility for advising the government on the making
of the country’s financial policy, and thus to see that it is carri

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ed out. The government must decide how much money there shall be in the country at a given
time, and the central bank must take steps to increase or decrease the supply accordingly
 prints and issues the legal tender currency, and regulates the country's money supply

 regulates the applicable interest rate and other cost of money charges

 Formulating implements and follows‐up the country's exchange rate policy, and manages and
administers the international reserves of the country

 Licenses, supervises and regulates the operations of banks, insurance companies and other
financial institutions

 Sets limits on gold and foreign exchange assets, which banks, and other financial institutions
authorized to deal in foreign exchange an hold in deposits

 Sets limits on the net foreign exchange positions and terms, and the amount of external
indebtedness of banks and other financial institutions
 Provides short and long term refinancing facilities to banks and other financial institutions

 Accepts deposit of any kind from foreign sources

 Promotes and encourages the dissemination of banking and insurance services throughout the
country

 prepares periodic economic studies, together with forecasts of the balance of payments,
money supply, prices and other relevant statistical indicators of the Ethiopian economy useful for
analysis and for the formulation and determination by the Bank of monetary, saving and
exchange policies

 Acts as banker, fiscal agent and financial advisor to the Government

 represents the country in international monetary institutions and acts consistently with
international monetary and banking agreements to which Ethiopia is a party
 Exercises and performs such other powers and activities as central banks customarily Perform
The Central Bank has a monopoly on all foreign exchange transactions and supervises all foreign
exchange payments and remittances. The currency, the Birr, is not convertible. The government
carefully monitors and controls its movement and as a result, it trades in a very narrow range.
The Birr is widely considered to be overvalued particularly in light of Ethiopia’s high inflation
rate.

Financial market in Ethiopia

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Government Bond Market

The Treasury Bill market is the only active primary market in the country. Tenders are offered
periodically by the Central Bank. The government offers 28‐day, 91 day and 182‐day bills. A

Stock Market
No stock exchange exists
Other Types of Finance/Financial Market
Micro finance
The formal microfinance industry began in Ethiopia in 1994/1995 with the government’s the
Licensing and Supervision of Microfinance Institution Proclamation designed to encourage
Microfinance Institutions (MFIs) to extend credit to both the rural and urban poor of the country.
By 2005, there were 23 MFIs with almost 1 million clients. Since the government prohibits any
foreign national from providing banking services in Ethiopia, MFIs in the country must be
established as share companies with capital wholly owned by Ethiopian Nationals or by
organizations wholly owned and registered under the laws with a head office in Ethiopia. This
has led to lack of transparency in the sector since much of the initial capital comes from foreign
donors who must enlist “nominal” shareholders to act as fronts. (MFIs are licensed under the
central bank). Gobezie (2005) notes, These shareholders are precluded from selling or
transferring their shares and "voluntarily forsake" their claim on dividends, if any, declared by
the MFI. Such shareholders do not have a real stake in the organization and would be unlikely to
lend it support at a time of financial crisis.

Interest rates charged on loans are not fixed, but a minimum interest rate of 3% to depositors is
required by law, which sometimes discourages mobilization in hard‐to‐reach areas (where
administrative costs added to the cost of capital make investment too expensive). Such high
transactions costs mean that most MFIs operate in urban or semi‐urban areas, leaving the rural
poor underserved. On the other hand, MFIs are exempt from Income and Sales Tax on their
profits. Other than the formally‐licensed MFIs, there are NGOs informally involved in the
delivery of microfinance.

Development bank of ethiopia

Economic Sectors Financed by the Bank
The Bank provides loans for financing the establishment and expansion of agricultural, agro-
industrial, transport, and communication, mining and energy, education, health, hotel, tourism
and other sectors of the economy.
Equity (capital) Contribution

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For purpose of Comittement to the success of the project to be financed, the applicant shall be
required to make a contribution towards the project cost. The level of borrower’s contribution
shall not in any event be less than 30% of total project cost.
Loans to Second hand Machines]: the Bank does not normally finance the purchase of
second hand items.
Loan terms and Conditions
(a) Interest Rate
Annual interest rate on loans = 9.75%
Service charge = 0.75%
(b) Loan term
 Minimum loan term = 12 months
 Maximum loan term = 15 years
(c) Loan Size
 Minimum loan size = up to Birr 3 million
 Maximum loan size = ≥ Birr 3 million and the loan by the Bank shall at no time exceed
15% of its total capital with out prior approval of the National Bank of Ethiopia.
(d) Collateral Requirement
DBE requires that its loan be secured by a first-degree mortgage on fixed asset. This could be
building, machinery and equipment or vehicle depending on the specific nature of the project.
In case pf projects located in rural areas (out side of municipality), the Bank requires 100%
collateral outside of the project. However, for projects located in urban areas, 125% of the loan
including fixed assets of the project is required.
(e) Insurance
All fixed assets of a project as well as collateral are required to be covered by appropriate
insurance policy with DBE as a co-beneficiary until the loan is fully settled.
(f) Repayment Schedule
Loan repayment period is determined taking into account the profitability and debt servicing
capacity of the borrowing concern as well as the economic life of major investment items.
(g) Maintenance of Financial Records
The borrower is required to keep sound and acceptable financial records.
(h) Grace period
The Bank shall give its clients maximum grace period that involves the period up to the
commencement of operation and the grace period shall not exceed three years.
(i) Some of the Documents required from a borrower to establish a new Project
 Work permit from relevant organ of the Government (depending on the nature of the
project);
 Title deed certificate of the plot of land required for the project, construction permit and bill
of quantity approved by an appropriate Government authority for projects located in urban areas.
 Investment certificate for projects with estimated capital of over Birr 250,000.

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 Pro forma invoice for machines, equipment, furniture, vehicles and other fixed assets as well
as consumables to be purchased for the project.
 Certificate of the commercial register.
 Details of project implementation program (schedule) indicating major implantation
activities with corresponding period of accomplishment.
Note: Depending on the type of the project, applicants may be required to present documents
other
than the ones mentioned above.
Loans to Legal Entities
Business organizations are required to submit the following additional documents:
 Copy of Memorandum of Association and Articles of Association;
 Copy of News paper in which its formation has been publicized;
 Legal personality certificate;
Steps involved in Loan Processing
1.Borrowers first contact the Clients’ Guidance and Advisory Desk (CGAD) of the
loaning organs;
2.For detail discussion on loan application, the project idea, background, equity
contribution, etc, the borrower is forwarded to the Loaning Department;
3.The Department may either accept or reject the application at prima facie
consideration based on policy or technical grounds;
4.Appraisal work is carried out by the loaning division, checked by the General Manager,
commented by the loan committee and forwarded to the Board of Management for approval.

Business Plan Presentation

Standardized business plan should be presented by borrowers to get loans from the DBE.
Financing Micro and Small Enterprise Sector Operators
The DBE has a plan to finance Micro and Small Enterprise operators through group loans,
without physical collateral, but group liability.
Plan to avail loan fund to Micro Finance Institutions (MFIs)
DBE is working on the possibility of financing MFIs, on a concessionary lending rate, in
collaboration with the International Fund for Agricultural Development (IFAD).
(c) Savings Products
No. Type of Saving Annual
Deposit
Rate
1. Time deposit 3-4.5%
2. Savings deposit 3%
3. Demand deposit -
4. Managed Fund 2-3%
(d) Other Services

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 Technical and Management Advisory Services.
Service Out-let
The services of the Bank are accessible through its branch offices and through cooperatives on-
lending channels.
Frequency of revising loan policies
The Bank operates in pursuant to the overall economic policy and development strategy of the
Federal Government.

The Basic Functions of Commercial Banks

This is the main function of commercial banks to collect savings of individuals and firms. They
offer different types of deposits for the facility of the customers.

i. Current Account or Demand Deposits:

Any amount can be withdrawn from this account any time without any notice. No interest is
allowed on this type of account.
ii. Saving Account:
This type of deposit account which is usually held by the middle class group. The
saving account carries lower rate of interest.
iii. Fixed Deposit:
Amount cannot be withdrawn before the fixed future date in this type of deposit. High interest is
allowed in fixed deposit which is different according to period.

2. Advancing Loans:
This is the important function of the commercial bank. Credit is given to the people in different
ways.
(a.): Making Loans:
There are three types of loans given to borrowers.
i. Short Term Loans:
These loans are advanced for the period of six months to one year. High Interest rate
Is charged on this type of accounts.
ii. Medium Term Loans:
Loans from one to five years are called medium term loans.
iii: Long Term Loans:
Loans which are advanced for the period, more than ten years are long term loans.
(b.): Bank Overdraft:
Banks allows their trustful customers to draw more than the deposit they have in the
Bank. Bank charges interest on overdraft.
(c.): Cash Credit:
Bank also gives credit against immovable property and interest is charged by the
bank.

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(d.): Discounting of Bills:
This is income source of bank to discount bills of exchange. They charge nominal
Interest and discount only reputed and clear bills of exchange.

Comercial bank of ethiopia

Year of Establishment
1943
Current Operational Area (s)
Commercial Bank of Ethiopia (CBB) operates almost all over the country. some of the areas are:
 Tigray
 Amhara
 Oromiyaa
 Southern Nations and Nationalities Peoples’ Regional State (SNNPR)
 Afar
 Addis Ababa
Future Expansion Plan
The CBB wants to increase its outreach through out the country.
Total Number of Branches Opened so far
CBB has 172 branches operating allover Ethiopia.
1. Short-term Loan
Maximum Loan Term: This is a loan to be settled within one year
Purpose of Loan: for working capital requirement of people engaged in any type of business
sector
RE-payment schedule: Based on the nature of their businesses, borrowers can amortize the
loan on monthly, quarterly, bi-annually or at the end of the year.
Type of collateral: Building, vehicle, machine and equipment,
2. Single merchandise Loan
Maximum Loan Term: 90 days
Repayment Schedule: the loan should be paid back fully in three installments within the 90 days.
Purpose of Loan: for locally produced and imported merchandizes
Type of collateral: Calculated percentage of the merchandize
Loan Criteria:
 written application for the loan;
 renewed trade/business licensee;
 for imported merchandizes, declaration of the custom’s office for the amount of the
merchandize to be held as collateral;

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 the merchandize presented for collateral should be durable (not easily perishable) and
easy to count and stock;
 the merchandize should be kept within a warehouse that meets the standard of the CBB.
If it is borrower’s warehouse, he/she should produce evidence of ownership and if rented, rental
agreement concluded with the owner should be presented to the Bank;
 the borrower shall purchase insurance coverage for the full value of the merchandize in
his/her name as well as the Bank;
 the borrower pays any expense that the Bank may incur in keeping the merchandise from
damage.
3. Revolving Merchandise Loan
Maximum Loan Term: usually not more than 6 months
Repayment Schedule: the loan should be paid back within the six month-period and ask two-
month ahead for another renewal before the six-month period is finished.
Purpose of Loan: for locally produced and imported merchandizes
Type of collateral: Calculated percentage of the merchandize
Loan Criteria:
All criteria stated under (2) with the following additions
 Merchandise held as collateral must be taken out of the warehouse on a ‘first-in-first out’
order;
 Merchandise held as collateral must fully taken out of the warehouse within 90 days.
4. Project Finance
This type of loan is provided for investment on new projects as well as upgrading of existing
projects.
Loan Term:
 for medium-term loan , 2 to 5 years;
 for long-term loan, 5 to 7 years.
Repayment Schedule: it depends on the nature of the project. It is possible to amortize the loan
monthly, quarterly, bi-annually and yearly basis. The Bank gives grace period based on the
nature of the project.
Purpose of Loan: This loan is provided for projects related to industry, hotel and tourism,
transport, agriculture as well as to meet their working capital requirements. Loan is also provided
for investments required to upgrade privatized enterprises.
Loan Criteria:
(i) For new projects
 Project feasibility study;
 Lease agreement and license (only for
 construction of buildings);
 Work permit from concerned government offices;
 Land ownership certificate (for building);
 Memorandum and articles of association (for organizations);

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 Pro forma (list of prices) collected within a period of not more than two months;
 Project equity contribution;
 Bill of quantity and specification (for building);
 Curriculum vitae of project administrators.
(ii). For expansion/upgrading of existing projects:
 Project study;
 Financial statements (audited by external auditors);
 List of fixed assets with their book value and current market price;
 list of fixed assets to be purchased with their current market value;
 Projected financial statements.
5. Agricultural Loan
Agricultural Loan is provided to individuals, enterprises and associations on a short and medium-
term basis.
Loan Term:
 Short-term loan is for a period of one year;
 Medium-term loan is for a period of 2 to 5 years.
Repayment Schedule: Based on the nature of the business, it is possible to repay loans on
monthly, quarterly, semi-annually and yearly based.
Purpose of Loan: The loan is to be used as working and investment capital in the agriculture
sector.
Grace Period: Grace period is provided based on the nature of the
agricultural activity loan is requested for.
Loan Criteria:
 Certificate of land holding/ownership;
 Investment license;
 Project study;
 Equity contribution.
6. Other Types of Loans
 Letter of Credit
 Advance on export bills
 Overdraft loan
 Foreign bank Guarantee
Time needed to process get loans,
annual interest rate, service charge and other fees
No Type of Loan Time needed Annual Servic Remark
. to get loan Interest e
Rate (%) charge
(%)
1. Short-term loan 2 – 5 days 7.5% -

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 2. One-time 2 – 5 days “ -
merchandize
loan
3. Revolving 2 – 5 days “ -
merchandise
loan
4. Project Finance 1 – 3 months “ - 40% of the investment
should be covered by the
project and collateral can be
building.
5. Agricultural 2 – 5 days “ -
loan
6. Letter of credit 2 – 5 days “ 2.5%
7. Advance on 2 – 5 days “ - National Bank (NBE)
export bills guarantee is required for
80% of the amount. For the
20%, no collateral is needed.
8. Overdraft 2 – 5 days “ -
9. Foreign bank 2 – 5 days “ -
Guarantee
10. Local bank 2 – 5 days 0.5%
guarantee
General Conditions for all loan types
Collateral:
 Building: residential houses, buildings of associations/organizations and warehouses,
building under construction, privatized building and houses, etc.
 Vehicles of different types;
 Bank guarantee: local bank guarantee, Foreign bank guarantee
 Unconditional Insurance guarantee;
 Money in bank account: savings account, current account, time deposit.
 Merchandise pledge;
 Treasury bills;
 Government bond.
Who is eligible?
Any person or enterprise engaged in the following sectors is eligible for the services:
 domestic trade;
 foreign trade;
 factories;
 services;
 transport;

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 mining;
 construction;
 agriculture;
 hotel and tourism;
General criteria for all loans
 Written document on purpose and amount of loan;
 Renewed trade/business license as well as other relevant licenses;
 Memorandum and Articles of Association (for legally registered enterprises);
 Financial statements: Balance sheet, income statement and cash flow statement;
 Annual business plan;
 Management profile;
 Certificate of ownership for properties pledged as collateral;
 Insurance for the collateral;
 Opening of saving account at the branch where the loan is allowed;
Some of the economic activities financed so far
 Agriculture;
 Manufacturing and industry;
 Domestic trade;
 Hotel and tourism;
 Foreign trade (import and export);
 Construction and
 Services.
Basic Contents of Business plan to be presented for all loan types
 Name and address of the borrower;
 Purchase plan;
 Production plan;
 Projected income statement;
 Projected balance sheet
 Projected cash flow statement.
Contents of Application Form
 Name and address of the borrower and the business;
 Year of establishment of the business;
 Type of business;
 Type of credit request;
 Collateral offered;
 Owners (major shareholders)
 Others.
Financing Micro and Small Enterprise Sector Operators

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 The CBE is studying the possibility of financing Micro and Small Enterprise operators.
Plan to avail loan fund to Micro Finance Institutions (MFIs)
CBE has a plan to finance MFIs.
(c) Savings Products
No. Type of Saving Annual Remark
Deposit Rate
1. Time deposit 3%
2. Savings deposit 3% Individual savors can open savings account with
Birr 5.
It is Birr 50 for organizations and two or three
signatories are required to run the account.
3. Demand deposit 3% Birr 1000 is required for organizations to open
demand deposit account.
(d) Other Services
 Money transfer;
 Foreign currency exchange

Micro finance institutions

Microfinance is the provision of financial services to low-income clients or solidarity lending

groups including consumers and the self-employed, who traditionally lack access to banking and
related services.

More broadly, it is a movement whose object is "a world in which as many poor and near-poor
households as possible have permanent access to an appropriate range of high quality financial
services, including not just credit but also savings, insurance, and fund transfers."[1] Those who
promote microfinance generally believe that such access will help poor people out of poverty.

Microfinance is a broad category of services, which includes microcredit. Microcredit is

provision of credit services to poor clients. Although microcredit is one of the aspects of
microfinance, conflation of the two terms is endemic in public discourse. Critics often attack
microcredit while referring to it indiscriminately as either 'microcredit' or 'microfinance'. Due to
the broad range of microfinance services, it is difficult to assess impact, and very few studies
have tried to assess its full impact.[2]

Traditionally, banks have not provided financial services, such as loans, to clients with little or
no cash income. Banks incur substantial costs to manage a client account, regardless of how
small the sums of money involved. For example, although the total gross revenue from
delivering one hundred loans worth $1,000 each will not differ greatly from the revenue that
results from delivering one loan of $100,000, it takes nearly a hundred times as much work and

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cost to manage a hundred loans as it does to manage one. The fixed cost of processing loans of
any size is considerable as assessment of potential borrowers, their repayment prospects and
security; administration of outstanding loans, collecting from delinquent borrowers, etc., has to
be done in all cases. There is a break-even point in providing loans or deposits below which
banks lose money on each transaction they make. Poor people usually fall below that breakeven
point. A similar equation resists efforts to deliver other financial services to poor people.

In addition, most poor people have few assets that can be secured by a bank as collateral. As
documented extensively by Hernando de Soto and others, even if they happen to own land in the
developing world, they may not have effective title to it.[3] This means that the bank will have
little recourse against defaulting borrowers.

Seen from a broader perspective, the development of a healthy national financial system has long
been viewed as a catalyst for the broader goal of national economic development (see for
example Alexander Gerschenkron, Paul Rosenstein-Rodan, Joseph Schumpeter, Anne Krueger).
However, the efforts of national planners and experts to develop financial services for most
people have often failed in developing countries, for reasons summarized well by Adams,
Graham & Von Pischke in their classic analysis 'Undermining Rural Development with Cheap
Credit'.[4]

Because of these difficulties, when poor people borrow they often rely on relatives or a local
moneylender, whose interest rates can be very high. An analysis of 28 studies of informal
moneylending rates in 14 countries in Asia, Latin America and Africa concluded that 76% of
moneylender rates exceed 10% per month, including 22% that exceeded 100% per month.
Moneylenders usually charge higher rates to poorer borrowers than to less poor ones. [5] While
moneylenders are often demonized and accused of usury, their services are convenient and fast,
and they can be very flexible when borrowers run into problems. Hopes of quickly putting them
out of business have proven unrealistic, even in places where microfinance institutions are
active.

Over the past centuries practical visionaries, from the Franciscan monks who founded the
community-oriented pawnshops of the 15th century, to the founders of the European credit union
movement in the 19th century (such as Friedrich Wilhelm Raiffeisen) and the founders of the
microcredit movement in the 1970s (such as Muhammad Yunus) have tested practices and built
institutions designed to bring the kinds of opportunities and risk-management tools that financial
services can provide to the doorsteps of poor people. While the success of the Grameen Bank
(which now serves over 7 million poor Bangladeshi women) has inspired the world, it has proved
difficult to replicate this success. In nations with lower population densities, meeting the
operating costs of a retail branch by serving nearby customers has proven considerably more
challenging. Hans Dieter Seibel, board member of the European Microfinance Platform, is in
favour of the group model. This particular model (used by many Microfinance institutions)

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makes financial sense, he says, because it reduces transaction costs. Microfinance programmes
also need to be based on local funds. Local Roots

Although much progress has been made, the problem has not been solved yet, and the
overwhelming majority of people who earn less than $1 a day, especially in the rural areas,
continue to have no practical access to formal sector finance. Microfinance has been growing
rapidly with $25 billion currently at work in microfinance loansIt is estimated that the industry
needs $250 billion to get capital to all the poor people who need it. The industry has been
growing rapidly, and concerns have arisen that the rate of capital flowing into microfinance is a
potential risk unless managed well.

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