Financial Markets and

Instruments In Ethiopia
A Project Work
Submitted to Mohammed Seid
(Asst. Prof.)

For partial fulfillment of the course

Financial Market and Institution

2021

Group Members
Kidist Solomon SGS/0533/2013A
Eden Adane SGS/0531/2013A
Gelaye Nemera SGS/0532/2013A
Firew Gedefa SGS/0233/2013A
Tewodros Mitiku SGS/0240/2013A
MBA PROGRAM

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 SCHOOL OF GRADUATE
STUDIES SAINT MARY’S
UNIVERSITY

Table of Contents
Summary...................................................................................................................................................2
1. Introduction 2
1.1. Overview of Financial sector in Ethiopia
2
1.2. Objective 2
1.3. Scope 2
1.4. Methodology 2
2. Background 2
3. Result and discussion 2
5. References 2

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 Summary
The paper has discussed the history, current
state, structure, policy, and regulation of the
financial market of the country and shown that

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there are needs for further reform considering
both the international experience and
recommendations and the domestic situation.
It indicated the measures that need to be taken
in respect of the existing banking, insurance
and microfinance markets and institutions in
the country. It has made the discussions in
respect of the future securities market and
private pensions and indicated the needs and
measures that need to be taken to create these
markets and institutions in the country and
design their structures and regulations.

Ethiopian banking dates back to 1905, when

the Bank of Abyssinia was established as a
joint venture between the Ethiopian
government and the National Bank of Egypt.
The command system, which reigned from
1974 to 1991, put a stop to the competitive

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banking environment that had emerged in the
1960s and 1970s.

1. Introduction
1.1. Overview of Financial sector
in Ethiopia
In Ethiopia, there are official, semiformal, and
informal financial institutions. Financial
institutions such as banks, insurance firms, and
microfinance organizations make up the
formal financial system, which is a regulated
sector. Savings and credit cooperatives are
semi-formal financial institutions that are not
regulated or supervised by the Ethiopian
National Bank (NBE). Unregistered traditional
institutions such as Iqub (Rotating Savings and
Credit Associations), Idir (Death Benefit
Associations), and money lenders make up the
country's informal financial sector. The

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following headings go over the details of each
category's components.

The Formal Sector; - Banks, insurance firms,

and microfinance institutions are the main
formal financial institutions in Ethiopia.

I. The Formal Sector

Ethiopian banking began in 1905, with the

founding of the Bank of Abyssinia, which was
jointly held by the Ethiopian government and
the National Bank of Egypt, which was then
under British authority. However, after the
Italian departed in the 1940s, a well-structured
banking system began to emerge. In 1942, the
government founded the State Bank of
Ethiopia, and many foreign bank branches and
a private bank competed with the government-
owned commercial bank until 1976, when they

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were nationalized and combined into a single
government-owned mono-bank.

The command system that ruled from 1974 to

1991 put an end to the competitive banking
scenario that had begun to flourish in the 1960s
and 1974s. The financial market was
deregulated with the change of administration
in 1991 and the ensuing actions made to
liberalize and realign the economy toward a
system of economy based on commercial
concerns. A proclamation number 84/94 was
made to impact financial sector deregulation
and liberalization, and a number of private
banks and insurance businesses were founded
as a result. Directives published in succeeding
years increase the liberalization, primarily by
gradually liberalizing interest rates and foreign
exchange rates.

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Determination and the operation of the money
market there are currently 18 banks
functioning in Ethiopia, 16 of which are private
and two of which are state-owned, notably
Commercial Bank of Ethiopia (CBE) and
Development Bank of Ethiopia (DBE) (DBE).
Ethiopia remains one of the world's least
banked countries, with only one bank branch
serving more than 82,000 people.

II. Semi-Formal Banks

Microfinance is described as the provision of a

wide range of client-responsive financial
services to low-income persons by a number of
organizations. Local and international NGOs
started microcredit programs in Ethiopia's
rural and urban areas (Wolday, 2004).
According to Pischke (1996), Ethiopia had 30
NGOs providing microcredit services, all of
which were focused in metropolitan areas.

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Despite their contributions to the testing of
novel methodology and products, the NGOs
struggled to reconcile their humanitarian goals
with the commercial goals of the microcredit
program.

Integration of credit schemes initiated by local

NGOs such as the Relief Society of Tigray
(REST) and the Organization for Rehabilitation
and Development in Amara (ORDA) into the
formal financial system in Ethiopia contributed
to the formulation of a regulatory and
supervision framework for efficient delivery of
services to the urban and rural poor, as well as
the issuance of a new proclamation for
licensing and supervision of micro financing
institutions in 1996 (Proclamation No.

According to Getaneh (2005a), the government

has been revising the legal framework for
microfinance operations in order to further

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promote economic activity and create
possibilities for the majority of the poor to
overcome poverty by providing more and
suitable financial services.

The regulation that set a ceiling on the interest

rate that micro financial institutions could
charge their credit clients is no longer in effect,
and a new liberal system (Directive No.
MFI/92/98) has taken its place, allowing MFIs
to set their own interest rates as long as they
can compete in the market, presenting a new
opportunity in the effort to ensure both
operational and financial sustainability for
MFIs. Despite the fact that most MFIs in
developing nations aspire to help the poor, it
has become increasingly clear that they seldom
do so. The "upper poor" are reached by most
MFIs in far bigger numbers than the "very
poor."

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The extent to which microfinance programs
can reach the lowest of the poor is still a point
of contention (SEEP network, 2006). According
to Wolday (2004), the Ethiopian microfinance
industry has been growing in terms of its
outreach as well as its asset and capital base,
demonstrating the universal need for financial
services among the population, particularly in
rural areas, and the ability of professional
operators to provide some of these services as a
financially viable occupation under various
circumstances. Additional conditions like as
the delivery of merchandise, the supply of
labor, or the exchange of promises such as gold
and jewelry may be included in financial
transactions.

Despite the diversity of operators and

transactions, the informal professional
operators have a number of key characteristics

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that allow them to be classified as a single
category. Most of the rural financial services
supplied in Ethiopia are provided by the
informal sector. Worku (2000) highlights the
many informal professional financial services
that operate in Ethiopia in his research on
microfinance development.

III. Informal Finance

The term "informal" refers to service provision

that is not controlled by legislation in any way,
shape, or form, but instead relies on self-
regulatory systems. Moneylenders and
pawnbrokers may be compelled to register, in
which case they function under formal
legislation to some extent. Informal operators
can be found all around the world:

Ethiopia has a wide range of informal groups

(Worku, 2000). These include private sector

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rotating savings and credit organizations like
lddir and lqqub, which are founded and
operated by the people themselves on the basis
of reciprocal financial ties. The most prominent
informal organizations in Ethiopia include
lddir, Mahebers, Eqqqub, Debo, elders' group,
women's association, money lenders, friends
and relatives, pawnbrokers, money keepers,
and tradesmen.

1.2. Objective
The goal of this study is to accomplish two
equally significant goals. First and foremost, it
aspires to contribute to understanding about
the country's financial industry, policy, and
regulation. Second, it tries to identify the
country's need for, areas of, and types of
additional action in order to further enhance its
financial market, policy, and regulation. As a
result, this study is valuable for both the quest

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of information and the identification of
Ethiopia's form measures.

1.3. Scope
This article focuses on the growth, policy, and
regulation of Ethiopia's current formal
banking, insurance, and microfinance sectors,
as well as the country's future securities and
pension markets and institutions. Although the
necessity of formalizing and regulating these
institutions is acknowledged in the primary
study, it does not include a look at the ways to
formalize, develop, and regulate the country's
informal savings, currency exchange,
insurance, and social security programs.

It will also discussed in view of the need for

transforming the Ethiopian financial market
from a market where short term bank finance
dominates; securities are issued and traded
only informally; financial instruments and

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services are not disseminated, diversified and
modernized adequately; and negligible
insurance and pension coverage exists into a
market where the issuance and trading of
securities is formally institutionalized and
regulated; the generation of long-term finance
is facilitated; the coverage, type and modernity
of the banking, insurance and microfinance
services are enhanced; debt and equity finances
compete; and private pensions operate as
institutional savers and investors. Much of the
study, however, focuses on the policy and
regulatory thinking necessary for the markets.

1.4. Methodology
Unlike the plethora of research on financial
market regulation systems outside of Ethiopia,
there is little published about the Ethiopian
system. Only a few papers are published in
journals, conferences, magazines, and

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newsletters that focus on components of the
country's existing financial market and suggest
improvements without considering the
market's policy, regulation, and evolution as a
whole. This study takes use of the void and
follows the steps below:

 Review of the studies available in

Ethiopia
 Analysis of the existing policies and
laws of the financial market in the
country
 Data from official reports and
unpublished records of the country's
financial institutions, regulators, and
related institutions, including banks,
insurers, and microfinance
institutions, the National Bank of
Ethiopia (NBE), the Ministry of
Trade and Industry, the Trade

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 Practice Commission, the Ethiopian
Investment Agency, the Privatization
and Public Enterprises Supervisory
Agency, the Social Security Agency,
and the Ministry of Finance and
Economic Development.
 Field investigation of the country's
financial market practices (through
visits and discussions with
appropriate personnel).
 Employing previous work
experience as a former employee in
the country's financial market.
 A review of the literature and
consultation of legislation and
regulatory practices in countries
other than Ethiopia.

The study also relies on quantitative data to

back up its findings. However, it is mostly

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qualitative in nature, focused on legal policy
and regulatory issues. In light of the increased
internationalization and convergence of
financial market regulations around the world,
the persistence of differences in country-
specific regulatory solutions, and the use of
international experience for reflection and
benchmarking, it also draws the major lessons
from systems and practices across countries
and the Financial Market Development, Policy,
and Regulation international
recommendations.

The assessment of Ethiopia's regulation against

the BCBS and IAIS's internationally
acknowledged standards is also done to reflect
on the country's existing regime's stage of
development. The country's use of the IOSCO
and IOPS principles, on the other hand, is
simply expected. As a result, the strategy used

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is to draw lessons from both international
regulatory experience and recommendations as
well as the country's own context in order to
contribute to the country's continued growth of
its financial market structure, policy, and
regulation..

2. Background
Following the shift in government and
economic policy in 1991, Ethiopia undertook
financial sector reform. Through monetary,
banking, and insurance supervisory
regulations introduced in 1994 and updated in
2008, it has re-established the National Bank of
Ethiopia (NBE) as the country's central bank
and financial market regulator, as well as
opened the banking and insurance sectors to
domestic private investment. As of 1998, it has
operationalized interbank money and foreign
exchange markets. A law enacted in July 1996

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and amended in 2009 established a regulatory
regime for microfinance, required the formal
establishment of microfinance institutions
within the financial system, and required the
NBE to promote the development of traditional
savings institutions as well as microfinance
institutions, as well as encourage participation
of banks and other financial institutions in the
provision of microfinance. Banks, insurers, and
microfinance organizations are currently under
to supervision legislation that are similar in
design and complementary to one another. It
also permits the conversion of microfinance
institutions into formal banks, as well as the
direct involvement of formal banks and
insurers in microfinance provision. Under this
regime, it has licensed twelve private banks,
eleven private insurers, thirty microfinance
organizations, and over 1,000 insurance
auxiliaries. Three banks and one insurance are

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owned by the government. However, the
country has yet to reach a satisfactory level of
banking, insurance, and microfinance services.
Other than the Development Bank of Ethiopia,
banks focus on short- and medium-term trade
finance, while insurers focus on short-term
general insurance, with long-term insurance
accounting for less than 6% of total insurance
business in Ethiopia. Despite their broad
license to promote the development of micro
and small-scale operations, microfinance
organizations also focus on short-term deposit
taking and lending to a narrow segment of the
population.

All of this, combined with the country's lack of

a formal securities market and private
pensions, has resulted in a dearth of stable
domestic long-term funding. The country's
payment system has primarily remained

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focused on cash transactions. All of these are
areas where the country needs to improve. The
country's banking, insurance, and microfinance
oversight rules do not specify or prioritize their
specific goals. In fact, the NBE does not
consistently link its directives and regulatory
measures to specified objectives. There is no
comprehensive financial regulatory framework
in place in the country that specifies and
prioritizes the specific objectives of banking,
insurance, and microfinance laws. The powers
and objectives of the NBE as central bank, the
NBE's monetary policy framework, the
country's general economic policy, and the
pieces of principles included in the country's
competition and other laws are, therefore, only
inferred in practice from the powers and
objectives of the NBE as central bank, the
NBE's monetary policy framework, the
country's general economic policy, and the

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pieces of principles included in the country's
competition and other laws. The government
must clearly define and prioritize the specific
purposes of its regulations in its supervisory
laws, and the NBE must continuously link its
directives and regulatory measures to the
specific objectives so that regulations are not
overlooked or abused during enforcement.
This will also allow financial institutions,
customers, and other stakeholders to
understand the reasons for and goals of
financial regulation, recognize the value and
legitimacy of the tools utilized, and participate
to regulation enforcement.

As a transition economy moving toward a free

market, the country must consider the
experiences of both developed and transition
and emerging market countries, and set goals

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similar to those of the latter. The regulations
must be linked to the following goals:

 Developing the markets

 Disseminating, diversifying, and
modernizing the financial service
 promoting competition, efficiency, and
innovativeness in the financial system
 maintaining financial market health,
stability, and security
 preventing systemic failure; protecting
consumers, the public and the economy
from abuse and financial failure
 increasing information disclosure and
prudential decision making
 meeting monetary policy objectives; and
 Achieving economic and social policy
objectives contributory to its
development and transition to free
market.

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 3. Result and discussion
The banking and insurance regulations in
developed market countries have been used to:
enforce monetary policy objectives; promote
domestic and international competition;
improve efficiency; maintain financial stability
and security; protect consumers; encourage
information flow and prudential decision
making; and achieve general economic and
social policy goals. However, their utilization
of the regulations to achieve the previous set of
goals has decreased over time. They only use
financial regulation to impose this set of goals
when they are defined outside the realm of
monetary and financial policy and can be
coordinated with it.

Following a shift in government and economic

policy in 1991, Ethiopia implemented financial
sector reform. Through monetary, banking,

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and insurance supervisory regulations
introduced in 1994 and updated in 2008, it has
re-established the National Bank of Ethiopia
(NBE) as central bank and financial market
regulator, as well as opened the banking and
insurance sectors to domestic private
investment. Since 1998, it has operated
interbank money and foreign exchange
markets.

A law enacted in July 1996 and amended in

2009 established a regulatory regime for
microfinance, required the formal
establishment of microfinance institutions
within the financial system, and required the
NBE to promote the development of traditional
savings institutions alongside microfinance
institutions, as well as encourage participation
of banks and other financial institutions in the
provision of microfinance.

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Banks, insurers, and microfinance
organizations are currently under to
supervision legislation that are similar in
design and complementary to one another. It
also permits the conversion of microfinance
institutions into formal banks, as well as the
direct involvement of formal banks and
insurers in microfinance provision.

However, the country has yet to reach a

satisfactory level of banking, insurance, and
microfinance services. All of the services are in
the early stages of development, and a large
portion of the Ethiopian population still lacks
access to them. Fixed capital, service types,
governance, and competitiveness are all
lacking among banks, insurers, and
microfinance institutions. Their services have
not been diversified, upgraded, mechanized, or
networked. Other than the Development Bank

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of Ethiopia, banks focus on short- and
medium-term trade finance, while insurers
focus on short-term general insurance, with
long-term insurance accounting for less than
6% of total insurance business in Ethiopia.
Despite their broad license to promote the
development of micro and small-scale
operations, microfinance organizations also
focus on short-term deposit taking and lending
to a narrow segment of the population. All of
this, combined with the country's lack of a
formal securities market and private pensions,
has resulted in a dearth of stable domestic
long-term funding. The country's payment
system has primarily remained focused on
cash transactions. All of these are areas where
the country needs to improve.

4. Summary & Conclusion

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To summarize, financial reform generates
difficult technical challenges that are better
addressed by experts. When Ethiopia began its
reform process, it established state banks and
promoted private banks and insurance firms.
Interbank foreign exchange and currency
markets have been developed, and interest rates
are tightly managed. Simultaneously,
supervisory capacity is enhanced. Financial
change was slow and steady, but determined.
The government is well aware of the structural
and institutional hurdles that must be overcome
in order to build a market-based financial
system. This has caused some problems with
the IMF, but by enhancing the African
experience, they demonstrate that there are
different approaches to transition the economy
in Asia and Europe, some of which are effective
and others which are not. Other Africans have
shown promise.

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Focusing on macroeconomic stability is
something that countries may learn from
Ethiopia. Building institutions in the financial
sector and establishing a sound financial system
are critical for reform and rebuilding, as well as
raising the standard of living for Ethiopians.
The development and control of a country's
financial system is determined by policy and
coordination between market and government
organizations. A country's reform targets must
be clear; the objectives and instruments of
regulation must be clearly defined, prioritized,
and linked; the reforms must be holistic rather
than piecemeal; the reforms must be clearly
sequenced by considering both the domestic
and international context; and the country must
be committed to the pursuit and
implementation of its reforms.
Even if a country's economy is small, having
diversified financial markets, institutions,

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instruments, and services (in particular, having
a financial market that allows the interaction of
both debt and equity finances and encourages
the development of institutional savers such as
pensions) is important. A country's tax code
must also be nondiscriminatory and
development-friendly in order to improve the
development, diversification, and regulation of
its financial markets, institutions, and services.

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