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CHAPTER TWO

FINANCIAL SECTOR DEVELOPMENT IN ETHIOPIA

2.1 Introduction

This chapter provides an overview of the economy and financial sector development of

the country. The chapter begins with an overview of the countrys economic status and

describes the major social and macroeconomic performance for the study period 2004-

2009; then GDP composition and its trends followed by the poverty profile of the country

and its trends. The next section provides details of the financial sector evolution and

development. The third section focuses on the MFIs sector with reference to legal and

regulatory framework, establishments, ownership structure. Finally, the last section

concludes.

2.2 Overview of Ethiopian Economy

Ethiopia is the second most populated country in Africa with an estimated population of

more than 83 million people. Ethiopia is one of the least developing countries which

ranks 157 out of 169 countries on the United Nations Development Programs 2009

Human Development Index. According to a recent survey nearly 30% of the countrys

population live below the poverty line MoFED (2011). The Ethiopian economy is based

on agriculture, which in 2009accounted for about 42 percent of the gross domestic

product (GDP), about 80 percent of total employment, and nearly 80 percent of foreign

currency earnings (MoFED, 2009). Ethiopia's major exports include coffee, oil seeds,

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gold, chat, flowers, pulses, and live animals. Coffee is the leading export, constituting

30.6% of total exports by value in the year 2009 (MOFED, 2009).

Generally, the overall economic growth of the country has been highly associated with

the performance of the agriculture sector. Recently the industry and service sectors have

been increasing their share of the GDP. The industrial sector, which mainly comprises

small and medium enterprises accounted for about 13 percent of GDP in 2009. In the

same year, the services sector accounted for about 44 percent of GDP (see Table 2.2).

2.3 Social and Economic Performance

In recent years, the country has been experiencing strong economic growth. More

importantly, it has registered an average annual real GDP growth rate of 11 percent

during the study period. During the period the agriculture sector, the mainstay of

Ethiopias economy, has grown by an average rate of 9.2 %. The industry and service

sector registered an average growth rate of 9.92% and 14.17% respectively (see, Table

2.1). In addition, the countrys performance on human development in recent years has

also been strong (see Table 2.1 and Table 2.4). In the last few years, the country has

made significant strides in reducing rural poverty, improving life expectancy, and rising

education levels. However, these gains have been accompanied by high urban income

inequality and surging inflation. Despite the years of rapid growth, Ethiopia is among the

worlds poorest countries with a gross national income per capita of US$230. Table 1

provides economic and social indicators of the country for the study period i.e., 2004-

2009.

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Table 2.1: Ethiopias main social and economic indicators

Indicator 2004 2005 2006 2007 2008 2009

Population (million) 72.53 74.26 75.99 77.72 79.45 81.19

Population growth (annual) 2.43 2.37 2.30 2.24 2.20 2.17

Life expectancy at birth, total (years) 54 55 56 57 57 58

Mortality rate, under 5 (per 1,000) 112 107 101 96 90 86

Primary completion rate , total (% of relevant group) 37.41 43.24 47.40 48.33 52.07 55.16

GDP (Current, US$ billions) 10.05 12.31 15.16 19.55 26.64 31.96

GNI per capita, PPP (current international $) 560 630 710 800 880 950

GDP growth (annual %) 13.57 11.82 10.83 11.46 10.79 8.80

Inflation, GDP deflator (annual %) 3.91 9.88 11.55 17.22 30.31 24.15

Source: World Development Indicators database 2009

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The government of Ethiopia has outlined its growth targets for the next five years in its

Growth and Transformation Plan (GTP 2011-2015). According to this strategy document,

the country aims to maintain the average annual economic growth at 11% and hence,

meet all millennium development goals by 2015.This government plan also has ambitions

to double the countrys GDP in 2015 from the level of 2010.

2.3.1 GDP by Sector

Although the economy remains heavily reliant on agriculture, the service sector has

driven recent growth, accounting for nearly half of the GDP by the end of year 2009.

More importantly, during the period, the share of the services sector in GDP has been

rising, while that of agriculture has been declining steadily (see Table 2.2).

Table 2.2: Decomposition of GDP Trend, 2004-2009

2004 2005 2006 2007 2008 2009

Agriculture, value added (% of 47.4 47.1 46.1 44.6 43.2 42.0

GDP)

Industry, value added (% of 13.6 13.4 13.2 13.0 13.0 13.0

GDP)

Services, value added (% of 39.7 40.4 41.7 43.5 45.1 46.1

GDP)

Source: MoFED, 2009

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The agriculture sectors share of GDP declined gradually from 47.4 percent in 2004 to 42

percent in 2009 and has now been surpassed by the service with its share increasing from

39.7% in 2004 to 46.1% in 2009. However, the share of industry showed no significant

change during the period (see Figure 2.1). Although the share of agriculture in GDP

tended to decline over time, it still remains the largest employer, the main source of

foreign exchange, and supplier of raw materials and market to domestic industries.

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Figure 2:1 Sectoral distribution of GDP in 2004 and 2009

2004 2009

Services Services
39.7% Agriculture
Agriculture 46.1% 42%
47.4%

Industry
Industry
13%
13.6%

Source: MoFED, 2009

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Table 2.3 shows the GDP growth rate by sector for the period 2004-2009. The double

digit growth has been sustained throughout the study period that led to a simple average

real GDP growth rate of 11.3%. The economy registered a 10.4% real growth in the year

2009. According to MoFED (2009), this is one of the highest growths compared to the

performance of Sub-Saharan economies which averaged 5% growth. The growth

registered in Ethiopia is not only the fastest, but is also broad-based in the sense that

agriculture, industry and services sectors registered commensurate growth rates of 9.2%,

9.92% and 14.9%, respectively (see Table 2.3).

Table2.3: Growth rate by sector 2004-2009

GDP growth rate 2004 2005 2006 2007 2008 2009 Average
Agriculture 13.50 10.90 9.40 7.50 6.40 7.60 9.22
Industry 9.40 10.20 9.50 10.10 9.70 10.60 9.92
Services 12.80 13.3 15.30 16.60 14.00 13.00 14.17
All Sector 12.6 11.5 11.8 11,2 10 10.4 11.26
Source: MoFED data

Figure 2.2: Growth rate by sector, 2004-2009

18.00
16.00
14.00
12.00 Agriculture
10.00
Industry
8.00
Services
6.00
All Sector
4.00
2.00
0.00
2004 2005 2006 2007 2008 2009

Source: Computed from MoFED data

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2.4 Poverty profile in Ethiopia

Poverty reduction has been the overriding development agenda of the government of

Ethiopia. Accordingly, the government has been implementing a series of poverty-

focused development strategies, beginning with the Sustainable Development and

Poverty Reduction Program (SDPRP) which was executed during the years 2002/03-

2004/05. This was followed by the five-year plan: the Plan for Accelerated and Sustained

Development to End Poverty (PASDEP) which covered the period between 2005/06 and

2009/10 and now the Growth and Transformation plan (GTP) covers 2010/11-2014/15.

Indeed, the rapid growth over the periods (SDPRP and PASDEP) has helped reduce the

incidence of income poverty (MOFED, 2011). According to the recent Household

Income, Consumption and Expenditure Survey (HICES) by MoFED(2011), the

proportion of people living below the poverty line (measured by headcount index)

declined from 38.7% in 2004 to 29.6 % in 2010. Further, the report shows that the

poverty incidence in rural areas dropped from 39.3% in 2004 to 30.4% in 2010, while in

the urban area's poverty declined from 35.1% to 25.7%. According to the report between

2004 and 2010, income (consumption) inequality measured by Gini Coefficient has

shown a slight decline from 0.3 in 2004 to 0.298 in 2010. Inequality as measured by the

coefficient has declined in urban areas from 0.44 to 0.37, while rural inequality increased

from 0.26 to 0.27 though inequality is still higher in urban than in rural areas.

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Table 2.3: Trends of the country poverty

Poverty indices over time


1995/96 1999/00 2004/05 2010/11
Head count Index 0.445 0.442 0.387 0.296
Poverty gap index 0.129 0.119 0.083 0.078
Poverty severity index 0.051 0.045 0.027 0.031
Source: MoFED, 2011

2.5 Overview of Financial sector in Ethiopia

The financial sector in Ethiopia consists of formal, semiformal and informal institutions.

The formal financial system is a regulated sector which comprises of financial institutions

such as banks, insurance companies and microfinance institutions. The saving and credit

cooperative are considered as semi-formal financial institutions, which are not regulated

and supervised by National Bank of Ethiopia (NBE). The informal financial sector in the

country consists of unregistered traditional institutions such as Iqub (Rotating Savings

and Credit Associations) Idir (Death Benefit Association) and money lenders. The

components of each category are discussed in detail in the following headings.

2.5.1 The Formal Sector

The major formal financial institutions operating in Ethiopia are banks, insurance

companies and microfinance institutions.

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(i) Formal Banks

Banking in Ethiopia started in 1905, with the establishment of the Bank of Abyssinia that

was owned by the Ethiopian government in partnership with the National Bank of Egypt

then under British rule. But a well structured banking system started to evolve starting in

the 1940s-after the Italian departure. A government owned bank-the State Bank of

Ethiopia-was established in 1942, and a number of foreign bank branches and a private

bank were operating in competition with the government owned commercial bank until

they were nationalized and merged into one government owned mono-bank in 1976. The

competitive banking situation that started to flourish during the 1960s and 1974s was

nipped in the bud by the command system that reign over the 1974-1991 periods.

Following the change of government in 1991, and the subsequent measures taken to

liberalize and reorient the economy towards a system of economy based on commercial

considerations, the financial market was deregulated. A proclamation number 84/94 was

issued out to effect the deregulation and liberalization of the financial sector, and a

number of private banks and insurance companies were established following the

proclamation. Directives issued in subsequent years further deepen the liberalization

mainly including the gradual liberalizations of the interest rate, foreign exchange

determination, and money market operation.

Currently, there are 17 banks operating in the country, of which 13 are private banks

while the remaining three are state owned banks, namely Commercial Bank of Ethiopia

(CBE), Development Bank of Ethiopia (DBE) and Construction and Business Bank

(CBB). The total number of bank branches in the sector reached 970, with a larger

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concentration of them(more than 40%) located in the capital city, Addis Abeba (NBE,

2009). Ethiopia is still one of the most under banked countries in the world with one bank

branch serving over 82,000 people.

Although one can observe a strong growth and revival of the private sector since

liberalization in the 1990s; yet, the state-owned banks seem to dominate the industry. As

of the year 2009, the state owned banks account for 67% of total deposits and 55% of

outstanding loans and advances and 55 percent of the capital. More specifically, the

stateowned Commercial Bank of Ethiopia (CBE) - the largest bank in Ethiopia alone

controls about 43% of the branch networks, nearly 40% of the capital , about 46% of the

outstanding loans and advances, and about 58 % of the deposits of the commercial banks.

Table 2.4 provides the share of capital and branch network of Ethiopian Banks as of the

year 2009.

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Table 2.4: Capital and branch share of the formal Banks in Ethiopia as
of 2009(Capital in million ETB1)

Capital Branches
Amount Share Number Share
Public Bank
Commercial Bank of Ethiopia 6,262.0 39.3 417 43.0
Construction & Business Bank 277.0 12.7 34 3.5
Development Bank of Ethiopia 2179.0 13.7 32 3.3
Total Public Banks 8718.0 54.7 483 49.8
Private Banks
Awash International Bank 1104.0 6.9 70 7.2
Dashen Bank 1152.0 7.2 65 6.7
Abyssinia Bank 532 3.3 57 5.9
Wegagen Bank 1093 6.9 53 5.5
United Bank 748 4.7 50 5.2
Nib International Bank 983 6.2 51 5.3
Cooperative Bank of Oromiya 207 1.3 43 4.4
Lion International Bank 318 2.0 30 3.1
Oromia International Bank 265 1.7 36 3.7
Zemen Bank 193 1.2 3 0.3
Buna International Bank 220 1.4 11 1.1.
Berhan International Bank 138 0.9 10 1.0
Abay Bank 161 1.0 8 0.8
Addis International Bank 117 0.7 - -
Total Private Banks 7231 43.6 487 50.2
All Banks 15949 100 970 100
Source: National Bank of Ethiopia, 2009

1
1 USD is equivalent to 16.66 Ethiopian birr

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Despite some improvement in the sector in the last couples of years, Ethiopian banking

remains in its low status. For instance, the estimates of Banks recent Financial Sector

Diagnost show that less than 10% of households have access to formal credit (African

Development Bank, 2011). In general, the sector is characterized by small banking,

limited range of services, absence of capital markets and the sector largely remains closed

to foreign investors.

(ii) The Insurance Company

Likewise to banking, Ethiopias insurance industry is undeveloped. Its emergence is

traced back to the establishment of the Bank of Abyssinia in 1905. The Bank had been

acting as an agent for foreign insurance companies to underwrite fire and marine policies.

Before liberalization the command economy including political instability had been the

stumbling block for the growth of the financial sector in Ethiopia. The 1990s ushered in

economic liberalization that led to the revival of private sector participation in the

financial sector. This has led to the formation of a number of private insurance

companies. According to the National Bank of Ethiopia (2010) there were 14 insurance

companies with a total of 221 branches operating in the country. In terms of ownership,

all insurance companies except the Ethiopian Insurance Corporation (EIC), are privately

owned. Private insurance companies accounted for 69.5 percent of the total capital, while

the remaining share was taken up by the single public owned enterprise, the Ethiopian

Insurance Corporation. Of the total insurance branches, 50.7 percent are concentrated in

Addis Ababa. Private insurance companies owned 81.4 percent of the total branches.

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According to Gebreyes (2011) the insurance market is undeveloped, uncompetitive and

there exist paucity of information on the kind of life insurance that is currently present.

The current practice of bulk of insurance coverage and business in Ethiopia is targeting

the corporate market and focuses mainly on general insurance with a very limited

coverage in life insurance.

The insurance sector is dependent on the banking sector for much of its new business.

Most Ethiopian insurance companies have sister banks and it's common for these banks

to refer their clients to their sister insurance companies, but this is largely restricted to

credit life insurance products. Moreover, insurance companies tend to derive a large

portion of their total income from investments in banks (Smith and Chamberlain, 2009).

(iii)Microfinance Institutions

The emergence of Microfinance institution is a recent phenomenon in Ethiopia compared

to other developing countries. The first microfinance service in Ethiopia was introduced

as an experiment in 1994, when the Relief Society of Tigray (REST) attempted to

rehabilitate drought and war affected people through the rural credit scheme. It was

inspired by other countries experiences and adapted to the conditions of the Tigray

region (northern part of Ethiopia). In the second half of the 1990s, as a result of its

success, the microfinance service was gradually replicated in other regions (Berhanu and

Thomas, 2000).

Similar to microfinance approaches in many other parts of the world, MFIs in Ethiopia

focus on group-based lending and promote compulsory and voluntary savings. They use

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joint liability, social pressure, and compulsory savings as alternatives to conventional

forms of collateral (SIDA, 2003). These institutions provide financial service, mainly

credit and saving and, in some cases, loan insurance. The objectives of MFIs are quite

similar across organizations. Almost all MFIs in the country have poverty alleviation as

an objective. They focus on reducing poverty and vulnerability of poor households by

increasing agricultural productivity and incomes, diversifying off farm sources of

income, and building household assets. They seek to achieve these objectives by

expanding access to financial services through large and sustainable microfinance

institutions.

The Ethiopian microfinance industry has undergone tremendous growth and development

in a very short period of time (Micro Ned, 2007, Amaha 2009), As of 2009, the 29 MFIs

licensed by the National Bank of Ethiopia succeeded in reaching more than 2.3 million

clients and delivered about 7 billion Birr in loans. They also mobilized about 3.8 billion

Birr of savings. In the same year, the sector has a total asset Birr 10.2 billion and total

capital of Birr 2.9 billion. Despite the notable achievements, the operating MFIs reach

less than 20% of the total microfinance demand in the country (AEMFI, 2010). Turning

to market concentration, the three largest MFIs, namely Amhara, Oromia and Dedebit

Credit and Savings institutions accounted for 67.1 percent of the total capital, 81.4

percent of the savings, 74.0 percent of the credit and 76.2 percent of the total assets of

MFIs.

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2.5.2 Semiformal Saving and Credit Cooperatives

In Ethiopia there are three types of saving and credit cooperatives, namely Institution

based SACCOs; Community based SACCOS; and SACCOs sponsored by NGOs.

Savings and credit cooperatives are type of organizations providing financial services to

the poor in rural areas of Ethiopia. These include multi-purpose and credit and saving

cooperatives.

Unlike other formal financial institutions (banks and micro finance institutions), saving

and credit cooperatives are owned, controlled and capitalized by their members. This

implies that the savings and credit cooperatives are not subjected to supervision and

regulation of the National Bank of Ethiopia. The ministry of cooperatives is responsible

for the coordination of their activities. One of the principles of SACCOs is that lending is

limited to only members of the cooperatives and the amount of loan depends on the level

of individual saving deposits. One of the weaknesses reflected in the co-operative sector

is poor administrative and financial management. On the other hand the government

through the relevant ministry is not adequately equipped to monitor and control the

cooperative movement.

Savings and credit cooperatives in Ethiopia are not permitted to take deposits from non-

members. Many rural saving and credit cooperatives provide loan services for

agricultural inputs, animal fattening and in some cases for off farm activities. Loan

disbursement policies are prudent, only those with sufficient savings and collateral can

lend. The majority of loans are provided for a period of one year or less. Usually interest

on loans is higher than charged by commercial banks but often lower than that of MFIs

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and definitely lower than the money lenders rate. At the end of 2006, almost 5 500

SACCOs served more than 380 000 members with savings and credit services. According

to the Cooperative Agency (CA), SACCOs mobilized 994 million Birr (US$111 million)

from member contributions. The average deposit size of a single SACCO member is 2

626 Birr (US$293).

2.5.3 Informal Finance

In both rural and urban areas in Ethiopia, it is common that neighboring family

households organize themselves and develop their own institutions, popularly known as

Community-Based Organizations (CBOs). The nature of the CBOs highly varies from

social, religious and financial concerns, but are all aimed to address the needs of the

people. In most communities, membership in traditional community associations such as

iddirs, iqqubs and mehabers are very common. More importantly, these traditional

institutions also play a crucial role in savings and beneficiary mobilization in the informal

financial sector.

According to Micro Ned (2007), the outreach of the informal financial sector is high;

more than two thirds of the population have access to an informal finance provider,

whether it is from money lenders, friends/relatives, or from one of the three popular

systems (iddirs, iquips and mehabers) of informal finance. The price of informal credit

fluctuates greatly from 10.5% per month on average from money lenders and traders to

0% from relatives and friends (ibid).

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According to Micro Ned (2011), the informal finance has been popular due to three main

reasons. First, it has more often than not been the only form of service delivery available.

Second, loan processing is quick and not too many questions are being asked about the

application of the borrowed sum. Third, in the case of Iddir and Iqqub, loans are provided

in the context of social intermediation and self-organization. The capacity of these

traditional systems, however, is limited (Ibid). The three most common informal finance

or traditional institutions are discussed in detail in the following subheadings.

Iddirs

An Iddir is the most common informal institution in Ethiopia, common in both rural and

urban areas. It is an association made up by a group of persons united by ties of family

and friendship, by living in the same district, by jobs, or by belonging to the same ethnic

group and as an object of providing mutual aid and financial assistance in certain

circumstances. It is primarily a burial society whereby savings are made to cover the cost

of funerals, but also weddings. Whenever a death occurs among its members, the

organization raises an amount of money to handle the burial and other related

ceremonies. It further aims to address different community concerns and provides various

services to its members. Membership is regularly by residence, whereby members pay a

small monthly fee (Pankhurst and Mariam, 2000).

In practice Iddir is a sort of insurance programme run by a community or a group to meet

emergencies. Iddir, unlike the insurance system is very popular among people because it

is culturally appropriate, flexible, easily accessible and cost-effective. It is basically a non

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profit making institution based upon solidarity, friendship, and mutual assistance among

members.

In general, individuals tend to join iddirs when starting to have a family. Membership of

iddirs is also increasingly widespread particularly among the poorest members of society,

who are in most need of their support. Only new migrants without a fixed address and

those who cannot afford the fees (the most impoverished of society) lack membership,

and are consequently without the only form of social insurance that currently exists in

Ethiopia (Ibid). Most of the associations are however not officially registered due to the

high cost of registration. As a consequence, most iddirs remain unable to open bank

accounts, obtain credit, or become partners with the government or NGOs in

development activities (ibid).

Concerning its organizational structure, nearly all iddirs have a secretary and a treasurer

as well as a chairman and judge. Due to its impartial membership structure, it is often

said to be Ethiopias most democratic and egalitarian social organization where

membership is open to anyone regardless of religion, socioeconomic status, gender and

ethnic affiliation (Johansson, 2010)

During the current rule of the Ethiopia Peoples Revolutionary Democratic Front

(EPRDF), the potential of iddirs as a vehicle for development has been further

acknowledged by both the government as well as by nongovernmental institutions

(NGOs). From the governments point of view, the general recognition of civil societys

role in development has led to that iddirs have been accepted as possible partners for

successful and sustainable development (Pankhurst et al., 2009).

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Iqqubs

Iqqubs have played a significant role especially for the informal sector in Ethiopia. An

iqqub is a traditional saving and credit association (Rotating Saving and Credit

Association), of which its purpose is basically to pool the savings of their members in

accordance with the rules established by the group. Members usually deposit

contributions on a weekly or monthly basis, and lots are drawn by turns so that the one

who wins the chance gets the total sum. This process continues on a regular basis until

the last member receives his/her share or what she/he has been saving through the months

and the whole process starts again.

Mehabers

Another common CBO is the Mehaber, which is a religious, informal institution that

aims to raise funds for medical and burial expenses. It is widespread among the Orthodox

Christians of Ethiopia, as it typically draws its members from the church. Members

usually meet on a monthly basis for food and drink, and commonly support each other in

times of difficulty (Pitamber, 2003).

2.6 MFIs Legal and Regulatory Framework

Prudential regulation is very critical in ensuring the sustainability and viability of MFIs.

In other words, microfinance cannot be sustainable without an appropriate legal and

regulatory framework. In recognition of these concerns, the government of Ethiopia took

the initiatives to establish the regulatory framework in order to facilitate the development

of microfinance institutions. Consequently, proclamation No 40/1996 was issued to

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establish the legal framework for microfinance institutions and define the regulatory role

of the National Bank of Ethiopia (NBE). The requirements for establishing microfinance

institutions (MFI) include: 1) MFIs should be owned by Ethiopians or Ethiopian

companies 2) They should elect board of directors and other officers and 3) Deposit

minimum required capital and 4) They should obtain a license from the NBE. The

following section discusses the main regulations which are relevant to the study and the

discussions are based in Amaha (2008).

2.6.1 Minimum Capital Required of New MFI Entrants

Directive No. MFI/01/96 states that MFI applying for a license shall have a minimum

paid up capital of 200,000 Birr (25,000 USD). However, the minimum capital required

by the NBE is low (Amaha, 2008). This is a deliberate action of the government to

improve entry and growth in the microfinance industry. On top the minimum capital

requirement, an MFI is applying for a license should submit memorandum and articles of

association, work plan indicating major financial services to be offered, overview of

economic conditions of the area, cash flow, income statement and balance sheet

projections for the first year of the operations, curriculum vitae of the board of directors

and the Chief Executive Officer (Directive No. MFI/01/1996 of NBE). Table 2.5 gives

the year of establishment for the sample MFIs.

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Table 2.5: List of the selected MFIs along with the year of establishment

No Name of institution Abbreviation Year Established


1 Amhara Credit and Saving Institution S.C ACSI 1995
2 Africa Village Financial Services S.C ADCSI 1998
3 Addis Credit and Saving Institution S.C. AVFS 2000
4 Agar Micro finance Share Co Agar 2004
5 Benishangul Gumuz Micro finance S.C Benshangul 2001
6 Bussaa Gonof Microfinance S.C Bussa Gonofa 1999
7 Dedebit Credit and Saving Institution S.C DECSI 1994
8 Eshet Micro finance Instituion S.C Eshet 2000
9 Gasha Micro finance Institution S.C Gasha 1998
10 Meklit Micro finance Instituion S.C Meket 2000
11 Metemamen Micro finance Metemamen 2002
12 Omo Micro finance Institution S.C Ocssco 1997
13 Oromia Credit and Saving Institution S.C Omo 1997
14 Poverty Eradication & Community Empowerment PEACE 2000
15 Shasemene Eddir Yelimat Shashimene 2001
16 Sidama Micro finance Instituti S.C. Sidama 1994
17 Specialized Financial and Promotional Inst. SFPI 1997
18 Wasasa Micro finance Institution Wasasa 2000
19 Wisdom Micro finance Instituions S.C Wisdom 1998
Source: National Bank of Ethiopian (NBE)

As stated earlier, the development of the microfinance industry in Ethiopia can be traced

back to the early 1970s, when NGO's in Ethiopia were delivering relief and development

services such as emergency food, education, water and medicine to the under privileged.

The NGO's were directly funding micro credit services as part and parcel of their relief

programs. The enactment of the MFI legislation in 1994 has led to the transformation of

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the traditional NGO microcredit programs into full fledged autonomous Microfinance

institutions including SFPI, Bussa Gonofa, PEACE, ESHET, Wasasa etc. In this case the

principal shareholders of the concerned MFIs are their mother NGOs. On the other hand,

most regional governments stimulated the establishment of new MFIs or co-invested in

existing ones that were previously aligned to NGOs such as ACSI, DECSI, OMO and

OCSCO (Micro Ned, 2009)

2.6.2 Ownership Structure of MFIs

Ownership of financial institutions in Ethiopia is set aside for Ethiopian nationals only.

Proclamation No.84/1994 clearly states that financial institutions including MFIs should

be owned by Ethiopian nationals. In other words, foreigners are not allowed to participate

in the MFIs; however, they can support the MFIs by providing fund as part of their

objective of alleviating poverty and support development activities in the country.

Amaha (2000) and SIDA (2003) claim that restriction of ownership in MFIs to Ethiopian

nationals has led to the existence of nominal shareholders who nominally hold shares

effectively provided by foreigners, and who do not have real stake in the MFIs.

The ownership structure of the microfinance institutions (MFIs) is characterized by a

mixture of regional government, local NGOs, associations and individuals (see Table

2.6). The majority of MFIs are in reality owned either by NGOs or Regional

Governments. Individual owners except in very few cases have merely posed as owners

at the request of either an NGO or Regional Governments and the ownership

arrangements basically reflecting the promoters /investors behind them. As shown in

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table 2.6 below ACSI, ADCSI, Benshangul, DECSI, Omo and OCSI are predominantly

owned by regional government. When we look the percentage share of respective

regional governments, ADCSI and Omo are largely owned by their respective regional

governments with ownership share 96.7 percent and 80 percent respectively while ACSI,

DECSI, and OCCSI have similar ownership with the same share of regional governments

(25 percent) and for Benshangul 40 percent. On the other hand, AVFS, Agar,

Metemamen, Shashemene, and Wisdom are truly individual owned MFIs in which

owners expect profit from their share contribution. Bussaa, Eshet, PEACE and Wasasa

are also institutions where individual ownership is high.

According to Bienen et al. (2009) in many of the investor- owned MFIs (regional or

NGOs), those classified as individual shareholders are not the real owners with personal

stake in the MFIs in the sense that they actually paid for the shares, hence have

something to lose. Instead, the funds for the shares were actually contributed by the

institutions/NGOs promoting the MFIs and the individuals are merely acting as nominal

shareholders representing these institutions so as to satisfy the legal requirements of

establishing them as share companies with at least five shareholders.

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Table 2.6: Ownership Structure of Microfinance Institutions in Ethiopia

Name of institution Regional Associatio Individuals Total


Governm n & NGOs share
ent share share
Amhara Credit and Saving Institution S.C 25 75 - 100
Africa Village Financial Services S.C - - 100 100
Addis Credit and Saving Institution S.C. 96.7 3.3 - 100
Agar Micro finance Share Co - 0.2 99.8 100
Benishangul Gumuz Micro finance S.C 40 60 - 100
Bussaa Gonof Microfinance S.C - 19.6 80.4 100
Dedebit Credit and Saving Institution S.C 25 75 - 100
Eshet Micro finance Instituion S.C - 20 80 100
Gasha Micro finance Institution S.C - 61.9 38.1 100
Meklit Micro finance Instituion S.C - 91 9 100
Metemamen Micro finance - - 100 100
Omo Micro finance Institution S.C 80 19.5 0.5 100
Oromia Credit and Saving Institution S.C 25 70 5 100
PEACE Micro finance Institution S.C - 16 84 100
Shasemene Eddir Yelimat - - 100 100
Sidama Micro finance Institution S.C. - 70 30 100
Specialized Financial & Promotional Inst. - 80 20 100
Wasasa Micro finance Institution - 20 80 100
Wisdom Micro finance Instituion S.C - - 100 100
Source: National Bank of Ethiopia

2.6.3 Interest Rates

According to Amaha (2008) the interest rates of MFIs have been revised four times by

the NBE. Initially, the NBE issued Directive No. MFI/09/96 that sets the lending and

saving interest rates of MFIs. According to this directive, the lending interest rate of

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MFIs should not be higher than 2% above the maximum lending interest rate charged on

loans extended by formal banks. Thus, the maximum lending interest rate was set at

12.5% per annum. The interest rate on savings and time deposits shall not be less than 1%

higher than the minimum interest rate paid on such deposits extended by formal banks. In

May 1998, the NBE increased the maximum ceiling of the lending interest rate of MFIs

to 15.5 percent per annum (Directive No. MFI/10/98). However, both directives did not

state whether the lending interest rate was flat rate or declining rate. In June 1998, the

NBE removed the ceiling of the lending interest rate of MFIs. It has clearly stated that the

board of directors of each MFI can set its own lending interest rate (Directive No.

MFI/11/98 and Directive No.MFI/13/2002). Initially, the minimum interest rate on

savings and time deposits was 7% per annum. Directive No. MFI/12/98 was issued to

reduce the minimum interest rate on savings and time deposits from 7% to 6% per

annum. However, in 2002 (Directive No. 13/2002) the NBE reduced the lower ceiling of

saving interest rate for formal banks and MFIs to 3%. The minimum saving interest rate

for the MFIs was increased to 4% in 2007 (Directive No. 19/2007 of NBE).

2.6.4 Reporting

Reporting is one of the tools to supervise MFIs in Ethiopia. MFIs are required to provide

quarterly reports on income statements, balance sheet, loan, saving and status of impaired

loans and loan provision to the NBE. Moreover, MFIs with deposits of 1 million Birr (re-

registered) are required to submit quarterly liquidity and capital adequacy reports within

one month after the close of each quarter (Directive No. MFI/07/96). In practice few

MFIs do so for a variety of reasons: sheer size and volume of activities covering entire

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regional states, limited functionality and capacity of management information systems

(Micro Ned, 2007)

2.7 Conclusion

The country background shows that the country has been experiencing strong economic

growth during the study period. In sector wise, the service sector has driven recent

growth and yet the economy remains heavily reliant on agriculture. Indeed, the rapid

growth over the years has helped in reducing the incidence of poverty in the country. The

countrys financial sector also seems to be flourishing only recently. Despite the

improvement in the last couples of years, Ethiopian banking remains in its low status. For

banking, the state-owned banks seem to dominate the industry. Surprisingly, the

Commercial Bank of Ethiopia (CBE) - the largest bank in Ethiopia CBE) alone controls

for nearly half of the branch networks, capital, outstanding loans and advances, and

more than half of the deposit of the countrys banks. In general, the sector is

characterized by small banking, limited range of services, absence of capital markets and

the sector largely remains closed to foreign investors. Likewise to banking, Ethiopias

insurance industry is undeveloped and uncompetitive and seems dependent on the

banking sector for much of its new business. Though the emergence of microfinance is a

recent phenomenon in Ethiopia, surprisingly the industry has undergone tremendous

growth and development in a very short period of time. However, the demand for

microfinance is far from being met by the existing MFIs. Consequently, the informal

sources of finance have been remaining as the main sources for many of the countrys

poor.

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