Ambo University

College of Business and Economics

Department of Economics
Financial Economics and Development Finance
(Econ 5061)
Instructor Name: Tadele Melaku Chala (PhD)
StudentName: Lechisa Bekele Jebessa
ID. Number: PGR/56486/14
Term Paper

1
 EVOLUTION OF MICROFINANCE IN ETHIOPIA

Table of contain Page

Chapter one --------------------------------------------------------------------------------------------------1

Introduction---------------------------------------------------------------------------------------------------1

Background----------------------------------------------------------------------------------------------------1

Country context ---------------------------------------------------------------------------------------------1

Demography and Economy-------------------------------------------------------------------------------1

Chapter Two--------------------------------------------------------------------------------------------------3

Financial Market --------------------------------------------------------------------------------------------3

Poverty and financial exclusion--------------------------------------------------------------------------2

Chapter Three------------------------------------------------------------------------------------------------6

Microfinance Market---------------------------------------------------------------------------------------6

Evolution of Microfinance --------------------------------------------------------------------------------6

Provision of microfinance---------------------------------------------------------------------------------7

Interconnection system------------------------------------------------------------------------------------9

Regulation----------------------------------------------------------------------------------------------------9

Chapter Four------------------------------------------------------------------------------------------------10

Conclusion---------------------------------------------------------------------------------------------------10

Recommendation -----------------------------------------------------------------------------------------11

Reference--------------------------------------------------------------------------------------------------- 11

2
 ABSTRACT:

The main objective of this study is to analyze the evolution of microfinance market
in Ethiopia; the Study will start with an overview of the demographical and
economic environment of the country, exploring the financial market and financial
exclusion and its relation to poverty. The study will investigate the evolution of
microfinance as an emerging sector, exploring the provision of microfinance and the
interconnection system, investigating the regulatory context, and the role of the
Ethiopian government in this process. The study uses data and statistics from data
repositories of national institutions such as National Bank of Ethiopia and other
empirical evidences.

Chapter One

1.1 Introduction

Microfinance emerged at the end of the last century as a financial instrument to

serve low-income households who are unable to access the formal financial services
provided usually through commercial banks. Microfinance seeks to provide financial
services for that segment of the population in the developing world that does not
have ready access to formal financial services. However, Microfinance initially
emerged in a form of microcredits programs provided to the poorest people to help
them establish their small businesses and play out their way to get out of poverty
(Abay Yimer, 2011.) Microfinance in Ethiopia formally started in 1995. In Particular,
the licensing and supervision of Institution proclamation of the government
encouraged the Spread of microfinance Institutions in both rural and Urban areas as
it authorized them among other things, to legally Accept deposits from the general
3
public (hence diversify sources of funds), to draw and accept drafts, and to manage
funds for the Micro financing business. Microfinance is referring to the provision of
financial services such (credit, insurance, payments) affordably, targeting mainly the
poor.

1.2 Background

Country context

Demography and Economy

Ethiopia is a landlocked country in the Horn of Africa. With a population of about

109 million people as of 2018 Ethiopia belongs to one of African’s most populated
countries. The population is expected to increase highly. It has a surface of 1.1
million km² and huge potential resources to produce agricultural output far beyond
the need of its people.

The economy of Ethiopia is a mixed and transition with a large public sector. The
government of Ethiopia is in the process of privatizing many of the state
owned businesses and moving toward a market economy. In 2020, ministers set out
a national transformation strategy called Digital Ethiopia 2025. Its aim is to prepare
the country for the development of an economy based on digital technology. In
2021, the Ministry of Education began implementing a scheme based on block chain
technology to track the performance of five million pupils and teachers, and provide
digital credentials. However, the banking, telecommunication and
transportation sectors of the economy are dominated by government -
owned companies. (Wikipedia)

Ethiopia has one of the fastest-growing economies in the world and is Africa's
second most populous country. Ethiopia’s growing economies has an average
growth of 9.9% a year from 2007/08 to 2017/18, compared to a regional average of
5.4%. Ethiopia’s real Microfinance Provision in Ethiopia 3 of 9 gross domestic

4
product (GDP) growth decelerated to 7.7% in 2017/18 as well. Industrial sectors in
particular construction and services accounted for most of this growth (World Bank,
2019).

Many properties owned by the government during the previous regime have now
been privatized and are in the process of privatization. However, certain sectors
such as telecommunication (partially), financial and insurance services, air and land
transportation services, and retail, are considered as strategic sectors and are
expected to remain under state control for the foreseeable future. Almost 50% of
Ethiopia's population is under the age of 18. Even though education enrolment at
primary and tertiary level has increased significantly, job creation has not caught up
with the increased output from educational institutes. The country must create
hundreds of thousands of jobs every year just to keep up with population growth.
(Wikipedia)

Chapter Two

2.1 Financial Market

Financial markets are associated often stock markets; sometimes they are
differentiated with the view that on financial markets we trade only securities and
on the stock market we can trade other values, such as real estate, property and
currency. The stock market is also known as the stock exchange. A stock exchange is
a market for different kinds of securities, including stocks, bonds and shares, as well
as payment documents. As for the randomness, the situation is such that the prices
in the financial market, more specifically, in the stock exchange, are affected by
many external factors that cannot be predicted in advance and cannot be controlled
completely. This is mainly a consequence of economic circumstances, for example,
of the state of the world economy and of the local economy, the production levels in
some sectors, and the balance between supply and demand. For example, the
weather and climate factors can affect a certain type of agricultural product. The

5
activities of large exchange speculators can also have large consequences. Since
stock prices at any given time are random, over time they accordingly become
random processes. (Yuliya Mishura, 2016 )

Ethiopian’s financial sector origin’s date back to the beginnings of the last century
when the first commercial bank established in 1905. However, the financial market
in Ethiopia has gone through different stages of growing and relapsing in the last
100 years. Ethiopia opened its financial market to the international banks and
insurance companies until 1936 when the country got colonized by Italy and
changed this policy to allow only the Italian banks to operate. After independence in
1943, the State Bank of Ethiopia (SBE) has been established and dominated all the
commercial and banking activities in the following two decades. However, in 1991,
which considered the 2nd financial sector reform, the new government achieved
significant progress in the financial sector, the National Bank of Ethiopia (NBE)
established as a central bank and financial market regulator, the government
developed the monetary and insurance supervision laws, and opening the financial
market to the domestic private investments. However, with this significant legal and
regulatory achievements, “The country has not, however, achieved a desirable level
of banking, insurance, and microfinance services” (Abay Yimer, 2011) and the
financial market still dominated in some way by state-owned banks (ABDULKAWI
MOHARRAM, 2020). According to National bank of Ethiopia 2021 report a number
of banks reached 19, of which 17 were private banks and 2 banks state owned. Total
capital of the banking system reached Birr 117.2 billion, of which state owned banks
accounted for 50.9 percent and private banks 49.1 percent. The share of Commercial
Bank of Ethiopia (CBE) in total capital of the banking system was 44.3 percent.
Similarly, the number of insurance companies stood at 18, of which 17 were private
insurers while 1 insurer state owned whose branch network increased to 616 from
574 a year ago. Of the total branches, about 54.5 percent were situated in Addis
Ababa. Meanwhile, total capital of these insurance companies reached Birr 10.3

6
billion compared to Birr 8.5 billion a year ago. Private insurance companies
accounted for 71.7 percent of the total capital of the insurance sector. During the
report period, there were 39 micro-finance institutions (MFIs) which have
mobilized close to Birr 47 billion in saving deposit, depicting a 13.9 percent annual
increase.

2.2 Poverty and Financial Exclusion

The recent definition of poverty by the World Bank extended the conceptual
dimension beyond the conventionally held ideas of permanent
income/consumption and social income (basic needs) to a more comprehensive
notion of lack of income/assets, sense of voiceless-ness and vulnerability to external
shocks. Ethiopia is one of the poorest countries in the world. While the economy is
growing rapidly, poverty is still widespread, especially in rural areas where the
majority of the population lives. Inequality is a major obstacle to an inclusive
development. Productivity in agriculture, which accounts for the majority of
employment, has great potential for improvement. Unemployment for women is
significantly higher than for men. The business climate also needs improvement.
(SIDA, 2020)

Thus the anti-poverty strategies not only need to create income earning
opportunities, but also must ensure empowerment of the poor in the sphere of
state/social institutions, and security against variety of shocks. Micro-finance is
believed to be one important entry point to addressing many of them. But services
are limited in some urban areas, neglecting the majority of the poor. In Ethiopia, for
example, the Development Bank of Ethiopia and the Commercial Bank of Ethiopia,
respectively having 5 and 33 branches, provide virtually no access to the rural
population since they all are located in urban and semi-urban towns. Also, private
banks, though growing in number, do not engage themselves in this activity.
According to an earlier study, in rural Ethiopia as a whole, less than 1% of the

7
population has access to this source. Consequently, accessing credit for small scale
and informal operators continues to pose a major constraint to growth of the sector.
The alternative is the "informal" financial sector, mainly the individual
moneylenders. In this case, borrowers are required to provide guarantors and the
interest rate is extremely high, varying from 50% to 120% per annum. Recent IFAD
study estimated that the Arata interest can go as high as 400% in some instances.
And this exploitative interest rate of the informal sector diminishes potential return
to factors of production, and is a constraint to diversify economic activities of the
rural sector. The Federal Government of Ethiopia has taken several economic
reform measures to address poverty in its every aspect. Thus, while trying to fulfill
the basic needs of the population, it also embarks upon economic reform measures
conducive for free market competition and employment creation which includes the
promotion of policies that will encourage savings, private investment, increasing
income earning opportunities and promotion of small-scale industries in the
informal sector among others. The five-year development program document
emphasizes, among others, credit as a means to increase smallholder production.
Financial markets are considered by the Government as a good entry point in
achieving food security objectives as this will allow rural households in both food
secure and insecure areas to explore their "comparative advantages" in the market
place and to create possibilities for exchange between factor markets Thus, in
addition to promoting provision of credit through government channels, the
program encourages microfinance institutions to provide their services of credit
provision and savings mobilization. 5 However, even if policies aimed at changing
the regulatory environment were expected to pave the way for increased flows of
resources to the rural and informal sectors, micro financial services are very
inadequate still. (M.Venkata Ramanaiah, A Review of Ethiopian Micro Finance
Institutions and their Role in Poverty Reduction).

Chapter Three

8
 3. Microfinance Market

a. Evolution of Microfinance

The establishment of microfinance is related with the growth of non-governmental

organizations that provide small credit service to the poor society. It has
traditionally referred to microcredit or small working capital loans delivered to the
working poor by community-based financial institutions known as microfinance
institutions. (Ira W. Lieberman). Microfinance seeks to provide financial services for
that segment of the population in the developing world that does not have ready
access to formal financial services. Around 1990s, rules and regulations began to
appear that make microcredit providers to have formal management and make
report to the concerned party. In 1996 (proclamation 40/96) the Ethiopian
government issued its first microfinance legislation with the objective of providing
microcredit service to poor. Ethiopian microfinance has made remarkable progress
over the past decade, reaching almost two million clients in a country of 77 million
people. Nevertheless, financial services for the low-income population, poor farmers
and MSMEs are still characterized by limited outreach, high transaction costs for
clients, a generally weak institutional base, weak governance and a nominal
ownership structure as well as dependence on government.

What Is Commercial Microfinance and How Has it evolved?

By commercial microfinance, we mean MFIs that meet the following criteria:

 They are structured as shareholder-owned institutions.

 They seek to and in time do operate profitably, offering their investors an
acceptable return on investment.
 They raise their funds in commercial markets in a variety of ways.
 They operate as regulated nonbank financial institutions or commercial
banks.

9
  They are increasingly expanding their product offerings to such products as
savings, insurance, money transfers, housing improvement loans, and small
business loans.
 Successful MFIs have been able to scale up and serve increasing numbers of
the working poor, while also operating profitably. (Ira W. Lieberman)

b. Provision of Microfinance

As of September 2020 there were 39 micro-finance institutions (MFIs) which have

mobilized close to Birr 47 billion in saving deposit, depicting a 13.9 percent annual
increase. Similarly, their outstanding credit rose by 4.9 percent to Birr 64.6 billion.
Their total asset also exhibited a 12.6 percent growth and reached Birr 93.4 billion
and their capital increased to Birr 19.7 billion showing a 16.7 percent annual
expansion. The top five largest Microfinance institutions that provide services
namely; Amhara, Dedebit, Oromia, Omo & Addis Credit and Savings Institutions
accounted for 81.4 percent of the total capital, 89.9 percent of total deposit, 85.3
percent of total credit and 85.9 percent of total assets of MFIs (NBE).

Microfinance Institutions Performance as of September 30, 20

(In thousands of Birr)

Particulars 2019/20 2020/21 % change

QI QIV QI
A B C C/A C/B
Total Capital 16,873,907.9 19,440,089.7 19,695,910.5 16.7 1,3
Saving 41,168,473.0 44,714,061.1 46,911,371.6 13.9 4.9
Credit 61,593,529.5 64,901,669.5 64,630,555.5 4.9 -0.4
Total Assets 82,988,456.7 92,200,086.4 93,405,604.6 12.6 1.3
Source: NBE First Quarter 2020/21 report

10
The performance of microfinance in Ethiopia is growing though time. When we
analysis the above data its total capital is increasing from Quarter to quarter.
Increase from 16,873,907.9 to 19,440,089.7 and 19,440,089.7 to 19,695,910.5.

It’s saving increase from Quarter to quarter from 41,168,473.0 to 44,714,061.1 and
44,714,061.1 to 46,911,371.6.

Its Credit also increases from time to time from 61,593,529.5 to 64,901,669.5 and
64,901,669.5 to 64,630,555.5.

In general the performance of microfinance institutions is growing from time to

time in Ethiopia. As their capital increases from time to time the microfinance
institutions operate new branches to approach to their clients and mobilize
additional savings and credit.

c. Interconnection system

Association of Ethiopian Microfinance Institutions (AEMFI) was registered and

licensed as an association by the Ministry of Justice on June 28, 1999. ( Hayder Al-
Bagdadi). AEMFI established with the goal of being the interconnect body of the
microfinance sector in Ethiopia. AEMFI is a non-profit and non-governmental
association formed to serve the microfinance sector and strengthening the
microfinance business environment. In Addition, AEMFI has a social goal that is
working with other public and private financial institutions to strengthen the
microfinance environment and provide micro-finance services to the economically
and socially disadvantaged Ethiopians.

However, AEMFI has 36 MIFs members by the end of 2019. AEMFI supports the
microfinance sector through carrying out several activities such promotion of
professional standards through training, experience sharing, research, performance

11
monitoring, influence national policy, and regulatory environment. AEMFI also
supports MFI through enabling the industry environment, facilitate networking and
collaboration, information sharing, fundraising, and identifying sources of loan, and
funds from domestic and foreign sources (AEMFI, n.d.)

d. Regulation

Throughout the late 1990s and to the present, MFIs have commercialized and have
also become regulated by national banking supervisors. They may fall under general
banking regulations or special regulations governing the microfinance sector (Ira W.
Lieberman).

Ethiopia has conducted financial sector reform following the change in government
and economic policy in 1991. It has re-established the National Bank of Ethiopia
(NBE) as central bank and financial market regulator and opened the banking and
insurance sectors for domestic private investment through monetary, banking and
insurance supervision laws.

introduced a regulatory regime for microfinance, required the formal establishment

of the microfinance institutions within the financial system, and required the NBE to
promote development of the traditional savings institutions of the society along
with the microfinance institutions and to encourage participation of the banks and
other financial institutions in the provision of microfinance by a law enacted in July
1996 and amended in 2009(Abay Yimer).

Chapter four

Conclusion

Ethiopian microfinance has made remarkable progress over the past decade;
reaching almost two million clients in a country of 77 million people and it have
mobilized close to Birr 47 billion in saving deposit, depicting a 13.9 percent annual
increase.

12
Today microfinance institution reach 39 in Ethiopia among these top five MFI that
provide services namely; Amhara, Dedebit, Oromia, Omo & Addis Credit and Savings
Institutions.

Association of Ethiopian Microfinance Institution (AEMFI) has a social goal that is

working with other public and private financial institutions to strengthen the
microfinance environment and provide micro-finance services to the economically
and socially disadvantaged Ethiopians. Microfinance institutions are
commercialized and they are also become regulated by national banking
supervisors.

Recommendation

Microfinance evolution in Ethiopia formalized in 1996 by proclamation of 40/1996.

And now day microfinance reached 39 and has around two billion clients. And has
around 93.4 billion capita.

Ethiopian Government has to keep and sustain this growth in the microfinance sector
and give it more attention in its regular Growth and Transformation Plan

Ethiopian central and regional governments should promote the competition in

microfinance market and support mid-size and small-size of MFIs.

MFIs in Ethiopia have a long way of work and commitment. Thus, they have to expand
their capacities by opening new branches and scale up their coverage in rural areas.

Ethiopian MFIs should strengthen and support agriculture-based projects, and adapting
their interventions in a way that would help in targeting the most vulnerable groups
specifically women in the rural areas.

13
References

Abay Yimer, 2011

Wikipedia

Yuliya Mishura, 2016

World Bank, 2019

ABDULKAWI MOHARRAM, 2020

SIDA, 2020

M.Venkata Ramanaiah, A Review of Ethiopian Micro Finance Institutions and their Role in Poverty
Reduction).

Ira W. Lieberman

NBE First Quarter 2020/21 report

Hayder Al-Bagdadi

AEMFI, n.d

14