The Federal Democratic Republic of Ethiopia: Selected Issues and Statistical Appendix

This Selected Issues paper assesses the implications of a significant increase in the flow of external financing and grants on real GDP growth in Ethiopia. The paper presents an analysis of the sources of growth during 1991/92–2003/04, as well as an assessment of potential GDP growth. The paper also seeks to assess the historical relationship between foreign aid and the performance of the external sector in Ethiopia to establish whether foreign aid inflows have had an adverse effect on the tradable goods sector in the past.


This Selected Issues paper assesses the implications of a significant increase in the flow of external financing and grants on real GDP growth in Ethiopia. The paper presents an analysis of the sources of growth during 1991/92–2003/04, as well as an assessment of potential GDP growth. The paper also seeks to assess the historical relationship between foreign aid and the performance of the external sector in Ethiopia to establish whether foreign aid inflows have had an adverse effect on the tradable goods sector in the past.

V. Financial Sector Development in Ethiopia22

77. This chapter provides an overview of financial sector reforms in Ethiopia and the agenda for the future. Section A provides an overview of the financial sector, section B describes ongoing financial sector reforms, section C compares the financial market structure and reform experience with other countries in the region, and section D considers the reform agenda for the future.

A. Overview of the Financial Sector

78. The financial sector in Ethiopia is dominated by the banking system (Table V.1). The financial sector comprises (i) the National Bank of Ethiopia (NBE), (ii) eight deposit-taking commercial banks, (iii) one development bank, (iv) 22 micro-finance institutions (MFIs), (v) an estimated 600 small savings and credit associations (SCAs), (vi) nine insurance companies, and (vii) two pension funds. The total assets of the financial sector at end-2002/03 (excluding SCAs) are estimated at Br 38.7 billion (68 percent of GDP), of which the banking system holds 94 percent.

Table V.1.

Ethiopia: Financial Sector

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Source: Authorities.

Number of institutions with 75 percent of total assets in the subsector. For total, the share of the largest three banks (CBE, DBE, and Dashen Bank) represents 78 percent of the financial sector assets.

The Development Bank of Ethiopia (DBE); the DBE has not taken deposits from the public, although it is allowed.

Banking business by foreign banks are not allowed in Ethiopia. No securities companies exist.

Including only microfinance institutions (MFIs). There are estimated 600 small savings and credit associations under supervision of regional governments, but no data are available.

Exist only for public employees. Assets and deposits are proxied by the account outstanding of the social security authorities, as no balance sheet data are available.


79. The banking sector is dominated by the state-owned Commercial Bank of Ethiopia (CBE). Of the nine banks, (i) two are state-owned commercial banks–the CBE and the Construction and Business Bank (CBB); (ii) six are domestically owned private commercial banks established since 1994; and (iii) one is the state-owned Development Bank of Ethiopia (DBE). No foreign-owned bank is allowed to operate in Ethiopia. The CBE is the most dominant bank, holding 76 percent of assets, 54 percent of loans, and 75 percent of deposits of the banking system at end-2002/03. The largest private bank, Dashen Bank, holds 4 percent of assets of the banking system. Although still highly limited, competition in the banking sector has been increasing as the dominance of the CBE, in particular with respect to its loan share, has gradually declined.23

80. The banking sector remains underdeveloped and highly liquid (Table V.2). Broad money as a share of GDP is relatively high at 53 percent at end-2002/03. However, net claims on the government account for 59 percent of broad money, and currency for about 28 percent, indicating that financial deepening has largely been driven by an extension of credit to the government. Credit to nongovernment (i.e. private sector and public enterprises) has remained at about 20 percent of GDP since the early 1990s, consistent with the steady share of private investment and the industrial sector in GDP. Reflecting weak credit expansion to the private sector, excess reserves of the banks have remained high.

Table V.2.

Ethiopia: Monetary Survey

(In millions of birr, unless otherwise indicated)

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Source: Ethiopian authorities.

81. Banks focus on short-term financing. At end-June 2003, short-term trade financing accounted for 25 percent of loans outstanding and 53 percent of loans disbursed during 2002/03. Agriculture and industry account for 8 percent and 17 percent of loans outstanding, respectively, while housing and construction represents 11 percent. The private sector is the dominant borrower, accounting for 86 percent of loans outstanding. The DBE, which specializes in development finance, supplements long-term financing needs.

82. The level of nonperforming loans (NPLs) in the banking system is high, due to a number of structural weaknesses (Table V.3). A large portion of NPLs are held by public banks and have been nonperforming for a long period of time; some dating from the Derg regime (1974-1991). While the process of foreclosing on collateral by banks was streamlined in 1998,24 write-offs of old NPLs have been hampered by a lack of authority within bank management and onerous requirements.25 Loan classification and provisioning requirements have been strengthened in recent years, which, coupled with the effects of the border conflict and declining coffee prices, caused the NPLs to rise, in particular in 2002. The vulnerability of the economy to exogenous shocks, particularly droughts, also poses a high risk of deteriorating asset quality for the banking system.

Table V.3.

Ethiopia: Financial Soundness Indicators 1/

(In percent, unless otherwise indicated)

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Source: Ethiopian authorities.

Excluding the DBE.

83. Excess liquidity in the banking system reflects both supply and demand factors. From the supply side, factors include restrained lending activity by banks26 under strengthened prudential regulations, steady deposit inflows owing to a lack of investment options other than bank deposits, and a constant inflow of remittances and donor assistance from abroad. On the demand side, excess liquidity has been driven by weak credit demand from the private sector, due to the uncertain business environment, declining coffee prices, cumbersome investment requirements, and the lack of infrastructure and readily available land.27 In addition, insufficient liquidity management by the NBE and liquidity risks associated with an outdated payments system28 contributed to the excess liquidity.

84. The high level of liquidity imposes costs on the banking system and could hinder effective monetary management. Banks receive no interest income from excess reserves, while paying interest on deposit liabilities other than demand deposits. Monetary policy tools of the NBE include (i) reserve and liquidity requirements; (ii) discount and repo facilities; (iii) open market operations (a treasury bill primary market); (iv) administrative placement of government bonds; (v) intervention in the foreign exchange market; and (v) adjustment of the minimum saving rate. The NBE has so far resorted to open market operations and a limited issuance of bonds but succeeded to reduce excess reserves only marginally and temporarily. However, excess liquidity has not so far been considered to be a major problem in macroeconomic management as fluctuations in overall inflation have been driven mainly by food price developments, core inflation has remained low, and credit expansion to the private sector has been weak. Nonetheless, looking ahead, the development of effective mechanisms to control liquidity will be important to ensuring excess liquidity does not endanger macroeconomic stability.

85. Saving and lending rates are characterized by nominal rigidity and have followed the minimum saving rate (Table V.4). In March 2002, the NBE lowered the minimum saving rate from six to three percent in response to deflation in 2000/01-2001/02. Time deposit rates and minimum lending rates have been lowered by commercial banks by the same magnitude, although maximum lending rates remained unchanged. 91-day treasury bill rates have been consistently lower than the minimum saving rate, reflecting the excess liquidity of banks. Nominal saving and lending rates have remained almost unchanged irrespective of overall price developments, although real interest rates based on nonfood inflation have been relatively stable and positive.

Table V.4.

Ethiopia: Interest Rate Developments, 1997/98-2002/03

(In percent per annum; end of period, unless otherwise indicated)

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Source: National Bank of Ethiopia (NBE).

Minimum rate set by the NBE.

Maturity of 1-2 years.

91-day bill; at auction.


Microfinance institutions (MFIs)

86. The micro-finance sector has grown appreciably, although large credit demands remain unmet. Since 1996, 22 licensed MFIs have been established. Five are partially owned by regional governments, while the others are owned by local nongovernment organizations (NGOs) and individuals. The number of active clients reached roughly 2.2 million in January 2001, and the largest two—Amhara Credit & Savings Institutions S.C. and Dedebit Credit & Savings Institutions S.C.—rank among the largest in Africa. On average, 57 percent of the clients are women, and 75 percent are in rural areas (only four MFIs focus on urban areas). Loans outstanding amounted to Br 508 million (0.9 percent of GDP or 3.3 percent of total loans in the banking system) at end-June 2003, and the accumulated saving reached Br 303 million (0.5 percent of GDP or 1.1 percent of total deposits in the banking system). The average loan size is small at around Br 870. The loan recovery rate is reportedly high, averaging around 95 percent, reflecting an effective group guarantee scheme. The lending rate ranges from 12 to 24 percent, while the saving rate ranges from 6 to 8 percent. Despite expansion since 1996, it is estimated that credit demand by the rural poor amounted to Br 2.6 billion in 1999, compared with Br 285 million in loans outstanding by MFIs, and an estimated rural credit outstanding by commercial banks of about Br 490 million, leaving unmet demand around Br 1.8 billion (3.4 percent of GDP).29


87. The securities markets are at the initial stage of development. There is a treasury bill primary market with maturities of 28 days, 91 days, and 182 days. Government securities outstanding are equivalent to 38.3 percent of GDP at end-2002/03 (with the T-bills amounting to 15.4 percent and bonds to 22.9 percent) (Table V.5). The 91-day T-bill market is the largest, amounting to 57 percent of total T-bills outstanding. Domestic fiscal financing needs are met through the issuance of T-bills and direct advances from the NBE (currently bearing 4 percent interest), and only a limited volume of government bonds has been issued.30 The NBE has been trying to absorb some of the excess liquidity in the banking system through auctioning T-bills in excess of government needs,31 although the impact on the level of excess liquidity has been marginal.

Table V.5.

Ethiopia: Government Domestic Debt, 1992/93-2002/03

(In millions of birr, unless otherwise indicated)

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Source: Ethiopian authorities.
Insurance and pension sector

88. The insurance and pension sector is underdeveloped. The insurance sector consists of one large state-owned company, with a market share of 50 percent, and eight small privately owned companies, which have been established since 1994. Nonlife insurance is the main business, and life insurance is fairly limited. There is no compulsory insurance for vehicles or health coverage for workers. In the pension sector, two pension funds exist under the Social Security Authority, serving permanent government employees and military personnel, including those of public enterprises and regional and local governments.

B. Financial Sector Reforms

Commercial Bank of Ethiopia

89. The authorities have commenced implementing a financial restructuring plan for the CBE in line with the recommendations by a joint IMF/World Bank technical assistance mission. The restructuring plan includes: (i) a time-bound plan for reducing NPLs; (ii) a business plan to keep the risk-weighted capital adequacy ratio over 10 percent (projected to increase to 12.5 percent by end-June 2007) with no capital injection envisaged from the government; (iii) strengthening of credit risk and portfolio management, with the assistance of consultants from the Bank of Scotland, through improved credit guidelines, organizational restructuring, and staff training; and (iv) the establishment of a mechanism to follow up the implementation of the restructuring plan.

National Bank of Ethiopia

90. The NBE is not sufficiently autonomous. The Board of the NBE is dominantly occupied by incumbent ministers of the economy and the economic advisor to the Prime Minister. The tenure of the Board members and the conditions of their removal from the Board are not specified so that they could be removed at any time at the government’s will for unspecified reasons. The Governor of the NBE is only accountable to the Council of Ministers and not to the parliament or the public. In addition, the objectives of the NBE are not clear and prioritized32.

91. The banking supervision of the NBE lacks a strong legal basis and sufficient staffing. The banking supervision proclamation does not have a sufficiently strong clause for dealing promptly with insolvent and failing banks.33 The Supervision Department has only 30 staff positions and has been suffering from a loss of experienced staff, due mainly to insufficient remuneration. On-site inspections, to be conducted once a year, have not been conducted as frequently as required, with the number of inspections having reached just 30 in total since 1996.

92. The authorities commenced implementing, in December 2003, a restructuring plan for the NBE based on a study by KPMG, which will continue into 2004-05. Actions include (i) enacting the revised NBE and banking supervision proclamations, following a discussion by the Council of Ministers; and (ii) implementing the reorganization of the NBE, following the completion of an ongoing study on pay scale and job grading.

Other banking reforms

93. Restructuring of other state-owned banks is ongoing. The privatization of the CBB has been on the government reform agenda since 2001, but it has been delayed on a number of occasions as a result of repeated failures to complete unqualified audited accounts. Regarding the DBE, a financial restructuring was implemented during 2003 through a recapitalization and a limited write-off of old NPLs. However, its financial condition remains weak, and NPLs amounted to 51 percent of total loans at end-June 2003.

C. Regional Comparison

94. This section compares Ethiopia’s financial sector development and reform with that of a number of countries in east Africa. Countries selected for comparison with Ethiopia are Kenya, Uganda, and Tanzania, and the comparison focuses on the structure of financial sector, financial market development, financial soundness, prudential regulations, and reform experience.

Structure of financial sector

95. The banking sector in Ethiopia is relatively concentrated (Table V.6). The state-owned CBE is in a near-monopoly position, while the asset share of the largest bank in neighboring countries is much lower. There are no foreign banks in Ethiopia, while the presence of foreign banks in neighboring countries is quite high. The share of the largest three banks are relatively high in all countries, but more equally distributed shares suggest that competitive forces are stronger in neighboring countries.

Table V.6.

Ethiopia: Structure of Banking System in the Region 1/

(In percent, unless otherwise indicated)

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Sources: Authorities of Ethiopia, Kenya, Uganda, and Tanzania; IMF, International Financial Statistics.

Based on the latest available actual data: end-2002/03 for Ethiopia, 2002 for Kenya, Uganda and Tanzania

Including specialized banks, e.g. the Development Bank of Ethiopia (DBE).

Commercial Bank of Ethiopia (CBE), Construction and Business Bank (CBB), and Development Bank of Ethiopia (DBE) for Ethiopia; Kenya Commercial Bank (KCB), National Bank of Kenya (NBK), Co-operative Bank, Consolidated Bank, and Industrial Development Bank (IDB) for Kenya; Uganda Commercial Bank Limited (UCBL) for Uganda (10 percent retained by the government following the privatization will be floated by 2004); National Microfinance Bank (NMB), and Cooperative and Rural Development Bank (CRDB) for Tanzania.

Financial market development

96. Ethiopia’s financial market is relatively deep, and interest spreads are the narrowest in the region (Table V.7). While currency as a share of broad money is similar to that of the other countries, broad money and bank assets in percent of GDP are highest in Ethiopia. Although a large portion of bank assets is occupied by credit to the government in Ethiopia, credit to nongovernment is relatively high, compared with neighboring countries, despite the fact that private investment is not particularly high within the region. A salient feature of Ethiopia in the region is that nominal and real lending rates are lowest, and that interest spreads between saving and lending rates are narrowest. The narrow interest spread despite a lack of competition in Ethiopia suggests less profit orientation compared with other countries.

Table V.7.

Ethiopia: Financial Market Development 1/

(In percent, unless otherwise indicated)

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Sources: Authorities of Ethiopia, Kenya, Uganda, and Tanzania; IMF, International Financial Statistics.

Based on the latest available actual data: end-2002/03 for Ethiopia, Kenya, Uganda, and Tanzania.

Financial soundness indicators

97. NPLs in Ethiopia are higher than in neighboring countries, and capital is low (Table V.8). Ethiopia and Kenya have a much higher NPL-to-loan ratio than Uganda and Tanzania, where financial restructuring has progressed. Capital adequacy is lower in Ethiopia, whereas neighboring countries have higher capital, owing to the progress in financial restructuring, higher interest spreads, and the presence of well-capitalized foreign banks. Nonetheless, the profitability of Ethiopia’s banks is comparable in the region. The loan-to-deposit ratio is highest in Ethiopia, indicating that financial intermediation is relatively well functioning. While interest margins are low in Ethiopia, noninterest expenses to income are limited, partly reflecting low remuneration at state-owned banks.

Table V.8.

Ethiopia: Financial Soundness Indicators in the Region

(In percent, unless otherwise indicated)

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Sources: Authorities of Ethiopia, Kenya, Uganda, and Tanzania; IMF, International Financial Statistics.

Only commercial banks.

Prudential regulations

98. Prudential regulations in Ethiopia are comparable in the region (Table V.9). Following a strengthening of prudential regulations, in particular during the recent years, key prudential norms are in line with regional and international practices. The treatment of collateral is conservative in Tanzania in that no collateral values can be deducted from loans outstanding for provisioning purpose.

Table V.9.

Ethiopia: Prudential Regulations in the Region

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Sources: Authorities of Ethiopia, Kenya, Uganda, and Tanzania; IMF, International Financial Statistics.

Financial sector reforms

The pace of reform has been slower than in neighboring countries (Table V.10). Uganda and Tanzania implemented a comprehensive financial restructuring of the large state-owned banks, which contributed to an improved health of the overall financial sector. These banks were subsequently privatized. In Tanzania, the largest commercial bank was split into a large business-oriented bank and a microfinance bank that is still state-owned. These developments, as well as foreign bank entry that was allowed in 1991, contributed to a more competitive banking sector. Ethiopia just started a comprehensive financial restructuring of the CBE, but the market competition is still limited as the near monopoly status of the CBE has not been addressed yet.

Table V.10.

Ethiopia: Financial Sector Reforms in the Region

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Sources: Authorities of Ethiopia, Kenya, Uganda, and Tanzania; IMF, International Financial Statistics.

D. Future Reforms

99. The authorities’ financial sector reform and development strategy needs updating and further articulation. The authorities developed a financial sector strategy in March 1998 with two objectives: (i) to link the financial sector to the long-term agricultural-development-led industrialization; and (ii) to bring about the development of a sound financial system that can sustain financial liberalization. The strategy focuses on (i) mobilizing savings; (ii) modernizing commercial banking; (iii) creating a securities market; (iv) strengthening prudential banking; (v) developing nonbank financial institutions; and (vi) conducting policy-based lending. While the strategy covers a wide range of issues, it lacks an action plan with a clear timeframe as well as well prioritized and sequenced concrete measures to be taken. The gradual reforms adopted over the last decade, following a long period of state control suggest a cautious attitude by the government toward any radical and fast-paced reforms and difficulties in building a consensus in the country. Nonetheless, as discussed in the ex-post assessment for Ethiopia, a more robust and speedy reform effort would likely strengthen growth potential.

Banking sector

100. Persevering with the ongoing financial restructuring of the CBE is the highest priority. The financial sector should be ready for further reforms as the financial restructuring of the CBE progresses. At the same time, the privatization of the CBB needs to be expedited, and a further restructuring plan of the DBE developed and implemented.

101. The near-monopoly status of the CBE should be addressed. While its share in the sector has been gradually declining, its dominance severely weakens the competition in the sector. Allowing foreign bank entry is a solution not only to realize a more dynamic financial sector, but to bring a wider variety of financial services to the public and improving the soundness to the sector.

102. Structural impediments for credit expansion to the private sector need to be removed. These include vulnerability of the economy to exogenous shocks, insecurity, remaining investment requirements, lack of infrastructure, readily available land, and borrowers’ information. A recent industry survey indicated that a lack of access to credit is the biggest obstacle in doing business. While the recently strengthened prudential regulations restrained bank lending, efforts to ease structural bottlenecks for credit expansion to the private sector need to be enhanced. Coupled with an improvement in the payments and settlement system, this would help reduce excess liquidity in the banking system.

103. The interest rate policy may need to be revisited. Adjusting the reserve requirement reduces excess reserves without alleviating the burden on banks, and open market operation or administrative placement of bonds can only temporarily reduce excess reserves. The current minimum saving rate has been consistently higher than the market-determined yield of treasury bills, indicating that the saving rate to be offered by commercial banks would be lower should the minimum saving rate be abolished. Such a policy could lead to lower lending rates and raise credit demand from the private sector, both alleviating the excess liquidity in the banking system.


104. The regulatory framework of the MFIs sector needs to be improved. The maximum loan size is set by the NBE at Br 5,000, compared with Br 20,000 of the reported minimum loan size offered by commercial banks, leaving a gap in credit size to medium-sized borrowers. The maximum loan maturity ceiling is set at one year, limiting the use of finance to working capital and precluding investment-related finances. While a large portion of resources originates from donors and international NGOs, foreign-owned MFIs are not allowed–this weakens the governance of MFIs by breaking the link between financiers and owners. Only a group guarantee (composed of five members) is allowed, and no physical collateral is accepted, limiting tailored credit services. Although MFIs comply with few prudential norms under the MFIs’ proclamation, the NBE has not taken action. The NBE has conducted only seven on-site inspections of MFIs to date.

105. The MFI proclamation needs to be amended,34 in particular (a) allowing foreign bank entry for the future; (b) allowing MFIs to accept collateral in addition to the group guarantee; (c) limiting the NBE’s inspection only to MFIs with savings in excess of Br 1 million (tiered approach) in view of the NBE’s capacity constraints; (d) recognizing that the NBE “may”, and not “shall”, fix the maximum loan size; (e) introducing sanctions for noncompliance; and (f) establishing a legal basis for dealing swiftly with insolvent MFIs without a court process required under the Commercial Code.

106. Developing a secondary market for T-bills and extending the maturity is a priority. Banks have indicated that, under the volatile economic environment of Ethiopia, investing in a long-term bond with a fixed rate was difficult, and that they would prefer a variable and short-term bond. This suggests a need for a secondary T-bill market. Extending the maturity of T-bills to the level of bonds, and denominating these in small amounts or values, e.g. around the level of the average T-bills auction, would attract institutional investors.

107. Insurance and pensions need to be promoted further. In view of the weak social security system in the private sector, life insurance could play a supporting role as a social safety net.


108. Financial sector supervision and the independence of the supervision need to be enhanced. There is a need to strengthen the supervision at the NBE as evidenced by a long-standing insufficiency and erosion of staff and infrequent on-site inspections. Supervision by the NBE, in particular on state-owned banks, has been limited and rarely gone beyond monitoring. Supervision of MFIs and insurance companies is virtually nonexistent.

Judiciary system

109. A faster litigation process would help the banking system. As a result of slow court processes, there are apparently a large number of cases under litigation, in particular for the uncollaterized portions of loans or uncollaterized loans, related to the bankruptcy of borrowers. While banks can write off loans even if they are still in the court process, the backlog of court cases diverts attention and resources of bank and management away from the core business. Establishing a special tribunal for bankruptcy resolution is worth considering.

Table 1.

Ethiopia: Gross Domestic Product by Economic Activity at Factor Cost, 1998/99-2002/03 1/

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Source: Ministry of Finance and Economic Development.

Beginning in 1997/98, data pertain to the period July 8-July 7; prior to that, data pertain to the period July 1-June 30.

Table 2.

Ethiopia: Expenditure on Gross Domestic Product at Current Market Prices, 1998/99-2002/03 1/2/

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Sources: Ministry of Finance and Economic Development; and Fund staff estimates.

Beginning in 1997/98, data pertain to the period July 8-July 7; prior to that, data pertain to the period July 1-June 30.

GDP at current market prices match authorities’ figures; expenditure data depart from these to ensure consistency with Fund staff estimates of the current account.