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建立人际资源圈Financial Sector Development Concerns Economics Essay---Essay论文范文
2016-07-21 来源: 51Due教员组 类别: Essay范文
51Due论文代写平台essay代写范文：Financial Sector Development Concerns Economics Essay这篇Essay范文讲述了金融部门的发展问题，它是刺激经济增长减少贫困的关键因素，金融系统，为生产商品服务，这反过来促进一个国家的人民的生活水平和提供必要的财政投入。本文分析了埃塞俄比亚金融发展，金融做出的改革等等，然后得出金融部门的重要性。
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Financial sector development in developing countries and emerging markets is part of the private sector development strategy to stimulate economic growth and reduce poverty. It is the set of institutions, instruments, markets and also includes the legal and regulatory framework that permits transactions to be made through the extension of credit. The development of the sector takes place when financial instruments, markets, and intermediaries work together to reduce the costs of information, enforcement and transactions.
Fundamentally, financial sector development concerns overcoming costs incurred in the financial system. This process of reducing costs of acquiring information, enforcing contracts, and executing transactions results in the emergence of financial contracts, intermediaries, and markets. The economic development of a country depends upon the existence of a well organized financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living of the people of a country.
A good measurement of financial development is vital in evaluating the advancement of financial sector development and understanding the corresponding impact on all over economic performance of a country. However, in practice, it is difficult to measure financial development given the complication and extent it encompasses. There is no general consensus in the literature about the factors that should be taken into account in explaining financial development, nor what indicators of that development are most reliable. Different scholars and institution used different means and indicators of financial development (IMF (2012), Gelbar (1999), and Noureen Adnan)
The financial system of Ethiopia is underdeveloped with the domination of banking sector. According to NBE (2011), the number of banks operating in the country reached 17 with 970 branches. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned, 14 Insurances with 221 branches and 31 microfinance institutions. Kiyota and others observed that the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia. Besides, there is no stock exchange market and foreign banks in the country.
The paper is organized as follows: Section two states objective and methodology of the paper. In section three a brief review of related literature based on scholars arguments and debates on the subject matter will be discussed in details. In section four overview of financial sector development in Ethiopia perspective. This will be followed by the conclusion and recommendation.
2. Objective and Methodology of the paper
Objective of the paper is to explain the discussion pertain to financial sector development by different literature and analysis the situation of financial sector development in Ethiopia.
Secondary source of data from journals, working papers, reports, websites and research papers are used in order to discuss and explain financial sector development in Ethiopia. The method of analysis is deductive and descriptive type of analysis.
3. Literature review
3.1. Conceptual definitions
Financial development can be defined as the factors, policies, and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services (Financial development report 2012).
3.2. The financial sector development report 2012
According to 2012 financial development Report Measurement of financial development are captured across the seven pillars of the Index:
Institutional environment: The institutional environment encompasses the macro prudential oversight of financial systems, as well as the laws and regulations that allow the development of deep and efficient financial intermediaries, markets, and services. It includes financial sector liberalization, corporate governance, legal and regulatory issue and contract enforcement.
business environment: considers the availability of human and physical capital, and other aspects of the business environment, including taxation policy and the costs of doing business for financial intermediaries.
Financial stability: captures the risk of currency crises, systemic banking crises, and sovereign debt crises. The severe negative impact of financial instability on economic growth emerged sharply in the recent financial crisis, as well as in past financial crises. Such instability can lead to significant losses to investors, resulting in systemic banking and corporate crises, currency crises, and sovereign debt crises.
Banking financial services: measures size, efficiency, and financial information disclosure. Bank-based financial systems emerge to improve acquisition of financial information and to lower transaction costs, as well as to allocate credit more efficiently, which is particularly important in developing economies.
Non-banking financial services: includes broker-dealers, traditional asset managers, alternative asset managers, and insurance companies. They can be both an important complement and a potential substitute to banks. Their complementary role lies in their efforts to fill any vacuum created by commercial banks. Their competition with banks allows both parties to operate more efficiently in meeting market needs. Activities of non-bank financial intermediaries include their participation in securities markets as well as the mobilization and allocation of financial resources of a longer-term nature.
Financial markets: encompasses foreign exchange and derivatives markets, and equity and bond market development. The four major types of financial markets include bond markets (for both government and corporate bonds), stock markets where equities are traded, foreign exchange markets, and derivatives markets.
Financial access: evaluates commercial and retail access. Empirically, greater access to financial services is associated with the usual proxies for financial development and the resulting economic growth.
Based on the above
seven pillars, the report ranks 62 countries from all over the world. Hong Kong SAR, United state and United Kingdom ranks the top 3 respectively whereas Tanzania, Nigeria and Venezuela rank the bottom 3 respectively.
Regionally, 14 Asian and pacific countries ranked on the top 62. Hong Kong SAR maintains the first according to the financial development index. Besides Singapore, Australia and japans ranks 4th, 5th and 7th respectively. This region is relatively done a remarkable work on financial sector development.
On the other hand, 25 Europe and North America countries ranked on the top 62. United state and United Kingdom ranked 2nd and 3rd respectively. Out of 25 countries 14 of them are on the top 20. Only few countries, Hungary, Greece, Romania and Ukraine are on the bottom of 62.
When considering Middle East and North Africa, 9 countries are on top 62. Kuwait, Israel and Bahrain ranked 21st, 24th and 25th respectively. Like Middle East and North Africa, Latin American countries are doing little on development of their financial sector. Only 8 counties are ranked on the top 62. Among this Chile, Brazil and panama ranked 29th, 32nd and 36th respectively. The rest of them are ranked above 40th.
Finally, when we come to sub Saharan Africa the problem becomes worst. According to 2012 finical development report only 5 countries get a rank. South Africa is a leading country from Africa and ranked 28th from the world followed by Kenya (54th), Ghana (56th), Tanzania (60th) and Nigeria (61st).
Even if Ethiopia is not mention in this report, the World Economic Forum’s Global Competitiveness Report 2011/2012, ranked Ethiopia 125 out of 142 countries with respect to financial-market development.
3.3. Importance of Financial Sector Development for Growth
Economists hold the view that the development of the financial sector is a crucial element for spurring economic growth. Through their role of allocation capital, monitoring managers, mobilizing savings and promoting technological changes among others, financial intermediaries play a significant role in economic growth.
According to the 2012 financial development report explanation, financial intermediation and financial markets contribute to economic growth and aggregate economic welfare. On the one hand, greater financial development leads to greater mobilization of savings and diverting to productive investment projects. This leads to the accumulation of capital which enhances economic growth. On the other hand, by allocating capital to the right investment projects and promoting sound corporate governance, financial development increases the rate of technological innovation and productivity growth, further enhancing economic growth and welfare.
King and Levine (1993) justifies that higher level of financial development are positively related with faster rates of economic growth, physical capital accumulation, and economic efficiency improvements. Besides higher level of financial developments are strongly associated with future rate of capital accumulation and future improvements in the efficiency with which economies employ capital.
Agbetsiafa (2004) examines relationship between financial development and economic development using data of sub-Saharan countries and he concludes that countries with better function of financial systems today will grow faster over the next decades. Since the financial system mobilizes savings, allocates these savings, reduces risk, generates liquidity, and facilitates trade by extending credit and guaranteeing payments.
3.4. Importance of Financial Sector Development for Poverty Reduction
Financial development affects poverty in two ways. On the one hand, financial development reduce poverty indirectly by stimulating growth and directly by facilitating transactions and allowing the poor to benefit from financial services that increase their income and enhance their ability to undertake profitable investments and other activities, and they concludes that financial development is more stronger with the direct effect than the effect through economic growth .On the other hand, to the extent that instability arises at various stages of the financial development process, it demonstrably undermines poverty reduction because the poor are generally more vulnerable than the rich to unstable and malfunctioning financial institutions and indirectly through negative macroeconomic impacts . In general, financial instability hurts the poor and partially offsets the benefit of financial development (Jeanneney and Kpodar 2008) .
Similarly, Ghufran and et al find out that financial sector development have strong impact on poverty reduction. The banking sector, stock market and bond market have the positive impact on poverty reduction. Besides the study shows that the positive relation between concentration and overhead cost with poverty. As concentration decreases the number of rival in banking sector because different banks merge with one another and also decreases the choices with the customers, and the increase of overhead cost is also harmful for financial sector development if it is not fairly managed.
The empirical analysis of Inove and Hamori also conclude that financial deepening has significant positive effect on poverty ratio in India. They measure financial deepening by the credit amounts or deposit amounts of the schedule commercial bank, this indicates that the development of banking sector has been beneficial for the poor India.
4. Financial sector development in Ethiopia
4.1. An overview of the structure of Ethiopia's financial sector
The Imperial era (prior to 1974)
In 1905, the foreign-owned Bank of Abyssinia was established and the Ethiopian banking sector started to develop. The bank was purchased by the government in 1931 and renamed Bank of Ethiopia, the first nationally owned bank on the African continent. After a period of Italian and British bank ownership in the 40’s and 50’s, the Monetary and Banking Proclamation No 206 of 1963 stipulated that a banking license was granted only to partnerships with Ethiopian ownership of at least 51% of the capital (Bekezela Ncube, 2008).
In the meantime, the State Bank of Ethiopia was established as the Central Bank of Ethiopia. As an agent of the Ministry of Finance and as the principal commercial bank in the country, the Central Bank also engaged in all banking activities. The banking law of 1963 then determined the separation of commercial and central banking and created two separate entities, the National Bank of Ethiopia (NBE) as the Central Bank and the Commercial Bank of Ethiopia (CBE) (ibid).
The Derg era (1974 - 1990)
Derg period all banks were nationalized. The National Bank of Ethiopia (NBE) was at the apex of the banking structure and was engaged in all the functions of a central bank. The financial sector the socialist government left behind constituted only of four banks, each enjoying a monopoly in its respective market, namely the NBE, the CBE, the Construction and Business Bank and the Agricultural and Industrial Development Bank. In addition to these banks, there were also two other financial institutions: Ethiopian Insurance Corporation (EIC) and the Pension and Social Security Authority (PSSA). On the average the CBE alone comprises more than 90% of total deposit and 71% of the total loans (Alemyahu Geda 2003).
Financial Reform period (post 1991)
The Monetary and Banking Proclamation of 1994 established the NBE as a judicial entity separate from the government and outlined its main functions. Monetary and Banking proclamation No 83/1994 and the Licensing and Supervision of Banking Business No 84/1994 that allows the private sector (owners have to be Ethiopian nationals) to engage in the banking and insurance businesses marks the beginning of a new era in Ethiopia’s financial sector. Following this proclamation the country witnessed a proliferation of private banking and insurance companies.
The financial system of Ethiopia is underdeveloped with the domination of banking sector. According to NBE (2011), the number of banks operating in the country reached 17 with 970 branches. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned, 14 insurances with 221 branches and 31 microfinance institutions.
4.2. Monetary policy
Monetary policy refers to a bundle of actions and regulatory stances taken by the central bank to regulation money supply and interest rates in order to control inflation stabilize currency and further bringing general economic stabilization of a country.
A higher participation of financial intermediation sector as a source funds for production will significantly a broad scope of action taken for monetary policy. All other things equal, average share of credit extended to the private sectors should be associated with more efficient policy (Felix Rioja &et al, 2006). Thus the appropriate approach of monetary policy is crucial not only to the financial system but also to the whole economy.
According to NBE (2010/11), the ratio of M2/GDP, an indicator of financial deepening, went up merely by 6.7% to 29.1% in 2010/11, partly indicating the tight monetary policy measures taken to mitigate the inflationary pressures. Money multiplier defined as narrow money to reserve money and broad money to reserve money remained the same at 1.1% and 2.1%, respectively.
4.2.1. Monetary Policy Instruments
The introduction of a wide range of monetary instruments by central banks engenders competition, efficiency and transparency and broadens financial intermediation in the banking system. It also promotes liquidity management of commercial banks and gradually leads to the development of well functioning money and financial markets which could serve as catalysts for economic growth and development. So far, the use of such instruments has been extremely limited in Ethiopia due to the underdevelopment of the money market and the virtual non-existence of a financial marketOpen Market Operation (OMO)
OMO has generally been used by countries as one of the main instruments for the development of money markets. Trading in these instruments liquefies the financial system in particular and the national economy in general and increases financial intermediation among market participants. To develop market-based monetary instruments in underdeveloped financial market the first step would be primary issues of treasury bills and central bank bills. In light of this, the NBE will use open market operations (sale and purchase of government securities) as one of its monetary policy instruments (Gazena Erchafo, 2001).
In Ethiopia, bi-monthly treasury bills auction market is introduced in 1994/95 with the intention of financing government budget deficit from non-bank sources, to create a base for the establishment and development of secondary market and to boost the NBE’s controlling power on money stock as well as interest rate. However, as a result of low interest rate in the treasury bills market which is lower than the deposit rate, the market failed to attract private bidders. Besides, except providing fund for government, the treasury bills market is not serving most of its objectives because of NBE has allowed inter-bank money market, more than half of the treasury bills are purchased by commercial banks (ibid).
Reserve requirement
Reserve requirement in Ethiopia is computed by netting out uncleared checks paid and uncleared effect foreign from the total deposits. The requirement is currently 5 percent of the net deposit and failing to comply with this requirement will be penalized. The NBE uses this instrument to control the liquidity of banks by varying the rate according with the targeted level. The higher Reserve Requirement contracts the liquidity as well as credit expansion power of commercial banks and the opposite will increase liquidity and credit expansion power of banks (Gazena Erchafo, 2001).
4.3. Banking and Non-banking financial sector
The major financial institutions operating in Ethiopia are banks, insurance companies and micro-finance institutions. Currently, there are 17 banks, 14 insurance companies and 31 micro-finance institutions operating in the country. As result the bank to people ratio reached to 82,474 in 2011.
The private banks had 487 branches and paid-up capital of 7.231 billion Birr, compared to 483 branches and a paid-up capital of 8.718 billion Birr of the three public banks. The total capital of the banking system reached Birr 15.949 billion in 2010/2011, of which private banks together possesses 45.3%. Commercial Bank of Ethiopia, the biggest state owned bank, accounted for 39.3% of the total capital of the banking system, implying high but slowly declining concentration in market share (NBE 2010/11 annual report).
4.4. Developments in Financial Markets
Treasury Bills Market
Treasury bills market is the only regular market where securities are transacted on a fortnightly basis. Three types of T-bills with a maturity period 28 days, 91 days and 182 days are supplied to the market. There is no secondary market for the security. Government bonds are occasionally issued to finance government expenditures and to absorb excess liquidity in the banking system.
The dominance of commercial banks in the T-bills market continued to diminish owing to enhanced participation of non-bank institutions. At the end of 2010/2011, the total outstanding T-bills stood at Birr 10.8 billion, of which 91.7 percent was hold by non-bank institutions.
NBE Bill Market
On April 4, 2011 NBE introduced NBE Bill market to mobilize resource from the banking system to finance priority sectors identified as the driving forces of the economy. Following the introduction of the NBE Bill market, the total NBE bill purchased by the banking sector reached
Birr 6.3 billion.
Bonds Market
In recent years, following the strong growth in economic activities and real income, the issuance of corporate bonds has tended to increase. Outstanding Corporate bond holdings of CBE issued by regional states, EEPCO and DBE.
Inter-bank Money Market
The interbank money market was not active in Ethiopia due to the existence of excess reserves in the banking system. Accordingly, no inter-bank money market transaction was conducted since April 2008. Ever since the introduction of the interbank money market in September 1998, merely twenty three transactions worth Birr 259.2 million were conducted with interest rates ranging between 7 to 11 percent per year. The maturity period of these loans widely spanned from overnight to 5 years.
5. Financial Openness
The importance and impact of financial sector openness on financial sector development is debating issues. According to N.Birdsall (2006), Openness is not necessarily good for the poor. Reducing protection has not brought growth to today’s poorest countries, including Africa, and open capital markets have not been particularly good for the poorest households within many developing countries. He argues that within high-debt emerging market economies the financial crises, whether induced by domestic policy problems or global contagion, costly for the poor.
On the contrary Siong Hook Law and et al (2008) suggested that financial openness is an essential determinant of financial sector development especially for developing countries and emerging economies. Their analysis, suggests that the simultaneous opening of both trade and capital accounts holds the key to successful financial development. They conclude that opening up their capital accounts provide an effective stimulus to financial development in developing countries.
Kiyota (2007) strengthen the idea that liberalizing restrictions on foreign bank entry accelerated the efficiency of the domestic banking sector, and also contributed to long-run economic growth. He also found that higher government ownership of banks leads to not only slower subsequent financial sector development but also lower productivity growth.
HongHanh (2010) on the other hand argued that financial openness does contribute to financial sector development, but only when a threshold level of general development of legal systems and institutions has been attained. Otherwise, simply making country’s financial sector open to foreigners may not lead to the development of the sector.
In case of Ethiopia, due to the nature of financial sector, in which there are no foreign banks, a non-competitive market structures the state-owned banks have the dominant role and strong capital controls. Although series of financial sector reforms has been introduced since 1994 and private banks were allowed to be re-established, the three large state-owned banks continue to dominate the market in terms of capital, deposits and asset (Ghirmai T Kefela, 2008).
The Ethiopian economy would benefit from financial sector liberalization, especially from the entry of foreign banks and the associated privatization of state-owned banks. Kiyota and others observed that the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia. That is, high bank concentration indicates a lack of competition in Ethiopia’s banking sector. Foreign banks are not permitted to enter the market in any form, and the Ethiopian Government maintains strong control over international capital movements. This highly closed nature of the Ethiopian financial negates the positive effects that would otherwise come from greater financial intermediation. This makes Ethiopia unique from its East African neighbors (namely Kenya, Tanzania, and Uganda) and many other developing countries. That is why Ethiopia’s financial sectors remain closed and they are less developed than its neighbors (Kiyota, 2007).
Although Ethiopian government and policy makers understand the potential importance of financial liberalization, they strongly refused to open the financial sector for foreign investors. They believed that liberalization may result in loss of control over the economy. Since the NBE is not in its potential to control the well organized, equipped and financially strong foreign banks, permitting foreign investors to invest in the financial sector may leads to economic crises. In addition, they believed that the Ethiopia financial sector is too young to compete with foreign banks i.e. the domestic sector will be out of game and the foreign completely control the financial system of the country. In this case the former prime minister of Ethiopia, Meles Zenawi, clearly stated in his writing entitled, African Development: Dead Ends and New Beginnings, those financial reforms takes place before result in high incidence of non-performing loans and excess liquidity in many African countries. This excess liquidity reflected the failure of banks to effectively mobilize savings and promote lending. He completely argued that in this stage of economic and financial sector development, complete liberalization doesn’t work for Africa including Ethiopia.
6. Measurement of financial development
6.1. Is financial sector development measurable?
A good measurement of financial development is vital in evaluating the advancement of financial sector development and understanding the corresponding impact on all over economic performance of a country. However in practice, it is difficult to measure financial development given the complication and extent it encompasses. There is no general consensus in the literature about the factors that should be taken into account in explaining financial development, nor what indicators of that development are most reliable. Practical works so far are usually based on standard quantitative indicators accessible for a longer time period for a broad range of countries.
IMF (2004), explain that using conventional measures of financial deepening, such as the level of real interest rates and the ratio of broad money to GDP, may give misleading signals about the success of financial reform and its implication for real activity.
According to Noureen Adnan, financial development can be measured by a number of factors including the depth, size, access, and soundness of financial system. It can also be measured by examining the performance and activities of the financial markets, banks, bond markets and financial institutions.
Gelbard and et al (1999), conclude that bank credit to the private sector is the most appropriate indicator of financial development in their study of financial sector development in sub-Saharan African countries.
But the widely accepted measures of financial development were developed by World Bank includes ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, ratio of deposits to GDP and Private Sector Credit to GDP.
6.2. Comparative analysis of Ethiopian financial sector development
The major financial institutions working in Ethiopia are banks, insurance companies and micro-finance institutions. According to NBE (2011), the number of banks operating in the country reached 17. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned. As the recent data of NBE indicates, the share of private banks branch network went down to 49 percent at the end of 2010/11 from 60 percent of the previous year due to the aggressive branch expansion by CBE. This clearly shows that Ethiopia’s financial sector is dominated by state-owned banks, mainly the Commercial Bank of Ethiopia (CBE). Currently public banks account for 67% of total deposits and 55% of loans and advances. Due to the expansion of new bank branches, the bank to people ratio reached to 82,474 (NBE, 2011).
Since private banks don’t operate in the rural side of the country due to high transaction costs, taking commercial bank to people ratio is good indicator for financial sector accessibility. This visibly indicates that access of the population to financial services is limited. This actual bank coverage stands at about 120,755 people per commercial bank branch, making Ethiopia one of the most under-banked countries in sub-Saharan Africa (ibid).
According to kiyota (2007), credit issued to the private sector in Ethiopia in 2004 was 19.1 percent of GDP (the 2nd highest in East Africa and the 5th in SSA), and liquid liabilities were 44.6 percent of GDP (the largest in East Africa and the fourth in SSA).This may lead to a wrong conclusion that the financial sector of Ethiopia is very developed compared to other SSA countries. However, on closer inspection, with respect to private credit to GDP, he argued that Ethiopia’s GDP is relatively low, so this does not necessarily mean then that intermediation is stronger in Ethiopia on this dimension.
Note also that Ethiopia’s gross domestic saving rate is the lowest in East Africa. This implies that much of the population does not have ready access to banking services, and it may also be the case that the infrastructure for banking in rural areas is especially poor. It should also be noted that liquid liabilities (i.e., M3) can be increased by worker remittances rather than domestic saving. Hence, the credit issued and liquidity indicators noted may not reflect depth in Ethiopia’s financial system (ibid).
As of June 2011, the private credit to GDP ratio for Ethiopia was
around 9% compared with the average of 30% for sub- Saharan Africa .This indicates because of aggressive branch expansion of stated owned banks, especially CBE, the credit share of the private sector has been declined in recent years compared with the year 2004. According to the World Economic Forum’s Global Competitiveness Report 2011/12, Ethiopia ranked 125 out of 142 countries with respect to financial-market development. But after liberalization, the general trend that private banks are easily spread up quickly with the public ones is a hopeful phenomenon which shows the improvement of financial sector development in Ethiopia. After liberalization, the available evidences clearly show that the share of the private banks both in deposit mobilization and lending could increase significantly (Alemayehu, 2003).
7. Conclusion and recommendation
Conclusion
The financial system of Ethiopia is underdeveloped with the domination of banking sector. Due to the nature of financial sector, the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia.
The private credit to GDP ratio which is one of financial development indicator was around 9% compared with the average of 30% for sub- Saharan Africa. Gross domestic saving rate is only 3.6 percent, the lowest in East Africa. This implies that much of the population does not have ready access to banking services, and it may also be the case that the infrastructure for banking in rural areas is especially poor.
Treasury bills market is the only regular market where securities are transacted on a fortnightly basis which indicates that the lowest level of financial market development of the country. According to the World Economic Forum’s Global Competitiveness Report 2011/12, Ethiopia ranked 125 out of 142 countries with respect to financial-market development.
After liberalization, the general trend that private banks are easily spread up quickly with the public ones is a hopeful phenomenon which shows the improvement of financial sector development in Ethiopia. After liberalization, the available evidences clearly show that the share of the private banks both in deposit mobilization and lending could increase significantly. It is also worth noting that the share of credit extended to the private sector has jumped from in the recent past the public sector’s share declining. This is a clear demonstration of the impact of the liberalization scheme pursued by the government.
Ethiopian government and policy makers strongly refused to open the financial sector for foreign investors. They believed that liberalization may result in loss of control over the economy and may not be economically beneficial. Since the NBE is not in its potential to control the well organized, equipped and financially strong foreign banks, permitting foreign investors to invest in the financial sector may leads to economic crises. In addition, they believed that the Ethiopia financial sector is too young to compete with foreign banks i.e. the domestic sector will be out of game and the foreign one completely control the financial system of the country.
Recommendation
The government of Ethiopia continues to prohibit the entry of foreign-owned intermediaries, to minimize the perceived macroeconomic risks arising from a more open financial sector. It prefers to seek the transfer of foreign financial technology and expertise through advisory assistance. However, entry of foreign financial institutions is the important way to improve the depth and breadth of the financial sector, gradual liberalization and openness is necessary for the development of the sector.
A problem that used to exist in the Ethiopian financial sector was the narrow interest rate spread between lending and borrowing rates. The private banks frequently complained of the low interest rate margins that used to exist, arguing that low interest rate margins risk reducing the provision of credits to projects that are risky from the perspective of the banks. Thus, widening the margin of the lending and borrowing rate will enable to finance risky projects and in doing so accelerating the economic growth of the country.
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Financial sector development in developing countries and emerging markets is part of the private sector development strategy to stimulate economic growth and reduce poverty. It is the set of institutions, instruments, markets and also includes the legal and regulatory framework that permits transactions to be made through the extension of credit. The development of the sector takes place when financial instruments, markets, and intermediaries work together to reduce the costs of information, enforcement and transactions.
Fundamentally, financial sector development concerns overcoming costs incurred in the financial system. This process of reducing costs of acquiring information, enforcing contracts, and executing transactions results in the emergence of financial contracts, intermediaries, and markets. The economic development of a country depends upon the existence of a well organized financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living of the people of a country.
A good measurement of financial development is vital in evaluating the advancement of financial sector development and understanding the corresponding impact on all over economic performance of a country. However, in practice, it is difficult to measure financial development given the complication and extent it encompasses. There is no general consensus in the literature about the factors that should be taken into account in explaining financial development, nor what indicators of that development are most reliable. Different scholars and institution used different means and indicators of financial development (IMF (2012), Gelbar (1999), and Noureen Adnan)
The financial system of Ethiopia is underdeveloped with the domination of banking sector. According to NBE (2011), the number of banks operating in the country reached 17 with 970 branches. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned, 14 Insurances with 221 branches and 31 microfinance institutions. Kiyota and others observed that the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia. Besides, there is no stock exchange market and foreign banks in the country.
The paper is organized as follows: Section two states objective and methodology of the paper. In section three a brief review of related literature based on scholars arguments and debates on the subject matter will be discussed in details. In section four overview of financial sector development in Ethiopia perspective. This will be followed by the conclusion and recommendation.
2. Objective and Methodology of the paper
Objective of the paper is to explain the discussion pertain to financial sector development by different literature and analysis the situation of financial sector development in Ethiopia.
Secondary source of data from journals, working papers, reports, websites and research papers are used in order to discuss and explain financial sector development in Ethiopia. The method of analysis is deductive and descriptive type of analysis.
3. Literature review
3.1. Conceptual definitions
Financial development can be defined as the factors, policies, and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services (Financial development report 2012).
3.2. The financial sector development report 2012
According to 2012 financial development Report Measurement of financial development are captured across the seven pillars of the Index:
Institutional environment: The institutional environment encompasses the macro prudential oversight of financial systems, as well as the laws and regulations that allow the development of deep and efficient financial intermediaries, markets, and services. It includes financial sector liberalization, corporate governance, legal and regulatory issue and contract enforcement.
business environment: considers the availability of human and physical capital, and other aspects of the business environment, including taxation policy and the costs of doing business for financial intermediaries.
Financial stability: captures the risk of currency crises, systemic banking crises, and sovereign debt crises. The severe negative impact of financial instability on economic growth emerged sharply in the recent financial crisis, as well as in past financial crises. Such instability can lead to significant losses to investors, resulting in systemic banking and corporate crises, currency crises, and sovereign debt crises.
Banking financial services: measures size, efficiency, and financial information disclosure. Bank-based financial systems emerge to improve acquisition of financial information and to lower transaction costs, as well as to allocate credit more efficiently, which is particularly important in developing economies.
Non-banking financial services: includes broker-dealers, traditional asset managers, alternative asset managers, and insurance companies. They can be both an important complement and a potential substitute to banks. Their complementary role lies in their efforts to fill any vacuum created by commercial banks. Their competition with banks allows both parties to operate more efficiently in meeting market needs. Activities of non-bank financial intermediaries include their participation in securities markets as well as the mobilization and allocation of financial resources of a longer-term nature.
Financial markets: encompasses foreign exchange and derivatives markets, and equity and bond market development. The four major types of financial markets include bond markets (for both government and corporate bonds), stock markets where equities are traded, foreign exchange markets, and derivatives markets.
Financial access: evaluates commercial and retail access. Empirically, greater access to financial services is associated with the usual proxies for financial development and the resulting economic growth.
Based on the above
seven pillars, the report ranks 62 countries from all over the world. Hong Kong SAR, United state and United Kingdom ranks the top 3 respectively whereas Tanzania, Nigeria and Venezuela rank the bottom 3 respectively.
Regionally, 14 Asian and pacific countries ranked on the top 62. Hong Kong SAR maintains the first according to the financial development index. Besides Singapore, Australia and japans ranks 4th, 5th and 7th respectively. This region is relatively done a remarkable work on financial sector development.
On the other hand, 25 Europe and North America countries ranked on the top 62. United state and United Kingdom ranked 2nd and 3rd respectively. Out of 25 countries 14 of them are on the top 20. Only few countries, Hungary, Greece, Romania and Ukraine are on the bottom of 62.
When considering Middle East and North Africa, 9 countries are on top 62. Kuwait, Israel and Bahrain ranked 21st, 24th and 25th respectively. Like Middle East and North Africa, Latin American countries are doing little on development of their financial sector. Only 8 counties are ranked on the top 62. Among this Chile, Brazil and panama ranked 29th, 32nd and 36th respectively. The rest of them are ranked above 40th.
Finally, when we come to sub Saharan Africa the problem becomes worst. According to 2012 finical development report only 5 countries get a rank. South Africa is a leading country from Africa and ranked 28th from the world followed by Kenya (54th), Ghana (56th), Tanzania (60th) and Nigeria (61st).
Even if Ethiopia is not mention in this report, the World Economic Forum’s Global Competitiveness Report 2011/2012, ranked Ethiopia 125 out of 142 countries with respect to financial-market development.
3.3. Importance of Financial Sector Development for Growth
Economists hold the view that the development of the financial sector is a crucial element for spurring economic growth. Through their role of allocation capital, monitoring managers, mobilizing savings and promoting technological changes among others, financial intermediaries play a significant role in economic growth.
According to the 2012 financial development report explanation, financial intermediation and financial markets contribute to economic growth and aggregate economic welfare. On the one hand, greater financial development leads to greater mobilization of savings and diverting to productive investment projects. This leads to the accumulation of capital which enhances economic growth. On the other hand, by allocating capital to the right investment projects and promoting sound corporate governance, financial development increases the rate of technological innovation and productivity growth, further enhancing economic growth and welfare.
King and Levine (1993) justifies that higher level of financial development are positively related with faster rates of economic growth, physical capital accumulation, and economic efficiency improvements. Besides higher level of financial developments are strongly associated with future rate of capital accumulation and future improvements in the efficiency with which economies employ capital.
Agbetsiafa (2004) examines relationship between financial development and economic development using data of sub-Saharan countries and he concludes that countries with better function of financial systems today will grow faster over the next decades. Since the financial system mobilizes savings, allocates these savings, reduces risk, generates liquidity, and facilitates trade by extending credit and guaranteeing payments.
3.4. Importance of Financial Sector Development for Poverty Reduction
Financial development affects poverty in two ways. On the one hand, financial development reduce poverty indirectly by stimulating growth and directly by facilitating transactions and allowing the poor to benefit from financial services that increase their income and enhance their ability to undertake profitable investments and other activities, and they concludes that financial development is more stronger with the direct effect than the effect through economic growth .On the other hand, to the extent that instability arises at various stages of the financial development process, it demonstrably undermines poverty reduction because the poor are generally more vulnerable than the rich to unstable and malfunctioning financial institutions and indirectly through negative macroeconomic impacts . In general, financial instability hurts the poor and partially offsets the benefit of financial development (Jeanneney and Kpodar 2008) .
Similarly, Ghufran and et al find out that financial sector development have strong impact on poverty reduction. The banking sector, stock market and bond market have the positive impact on poverty reduction. Besides the study shows that the positive relation between concentration and overhead cost with poverty. As concentration decreases the number of rival in banking sector because different banks merge with one another and also decreases the choices with the customers, and the increase of overhead cost is also harmful for financial sector development if it is not fairly managed.
The empirical analysis of Inove and Hamori also conclude that financial deepening has significant positive effect on poverty ratio in India. They measure financial deepening by the credit amounts or deposit amounts of the schedule commercial bank, this indicates that the development of banking sector has been beneficial for the poor India.
4. Financial sector development in Ethiopia
4.1. An overview of the structure of Ethiopia's financial sector
The Imperial era (prior to 1974)
In 1905, the foreign-owned Bank of Abyssinia was established and the Ethiopian banking sector started to develop. The bank was purchased by the government in 1931 and renamed Bank of Ethiopia, the first nationally owned bank on the African continent. After a period of Italian and British bank ownership in the 40’s and 50’s, the Monetary and Banking Proclamation No 206 of 1963 stipulated that a banking license was granted only to partnerships with Ethiopian ownership of at least 51% of the capital (Bekezela Ncube, 2008).
In the meantime, the State Bank of Ethiopia was established as the Central Bank of Ethiopia. As an agent of the Ministry of Finance and as the principal commercial bank in the country, the Central Bank also engaged in all banking activities. The banking law of 1963 then determined the separation of commercial and central banking and created two separate entities, the National Bank of Ethiopia (NBE) as the Central Bank and the Commercial Bank of Ethiopia (CBE) (ibid).
The Derg era (1974 - 1990)
Derg period all banks were nationalized. The National Bank of Ethiopia (NBE) was at the apex of the banking structure and was engaged in all the functions of a central bank. The financial sector the socialist government left behind constituted only of four banks, each enjoying a monopoly in its respective market, namely the NBE, the CBE, the Construction and Business Bank and the Agricultural and Industrial Development Bank. In addition to these banks, there were also two other financial institutions: Ethiopian Insurance Corporation (EIC) and the Pension and Social Security Authority (PSSA). On the average the CBE alone comprises more than 90% of total deposit and 71% of the total loans (Alemyahu Geda 2003).
Financial Reform period (post 1991)
The Monetary and Banking Proclamation of 1994 established the NBE as a judicial entity separate from the government and outlined its main functions. Monetary and Banking proclamation No 83/1994 and the Licensing and Supervision of Banking Business No 84/1994 that allows the private sector (owners have to be Ethiopian nationals) to engage in the banking and insurance businesses marks the beginning of a new era in Ethiopia’s financial sector. Following this proclamation the country witnessed a proliferation of private banking and insurance companies.
The financial system of Ethiopia is underdeveloped with the domination of banking sector. According to NBE (2011), the number of banks operating in the country reached 17 with 970 branches. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned, 14 insurances with 221 branches and 31 microfinance institutions.
4.2. Monetary policy
Monetary policy refers to a bundle of actions and regulatory stances taken by the central bank to regulation money supply and interest rates in order to control inflation stabilize currency and further bringing general economic stabilization of a country.
A higher participation of financial intermediation sector as a source funds for production will significantly a broad scope of action taken for monetary policy. All other things equal, average share of credit extended to the private sectors should be associated with more efficient policy (Felix Rioja &et al, 2006). Thus the appropriate approach of monetary policy is crucial not only to the financial system but also to the whole economy.
According to NBE (2010/11), the ratio of M2/GDP, an indicator of financial deepening, went up merely by 6.7% to 29.1% in 2010/11, partly indicating the tight monetary policy measures taken to mitigate the inflationary pressures. Money multiplier defined as narrow money to reserve money and broad money to reserve money remained the same at 1.1% and 2.1%, respectively.
4.2.1. Monetary Policy Instruments
The introduction of a wide range of monetary instruments by central banks engenders competition, efficiency and transparency and broadens financial intermediation in the banking system. It also promotes liquidity management of commercial banks and gradually leads to the development of well functioning money and financial markets which could serve as catalysts for economic growth and development. So far, the use of such instruments has been extremely limited in Ethiopia due to the underdevelopment of the money market and the virtual non-existence of a financial marketOpen Market Operation (OMO)
OMO has generally been used by countries as one of the main instruments for the development of money markets. Trading in these instruments liquefies the financial system in particular and the national economy in general and increases financial intermediation among market participants. To develop market-based monetary instruments in underdeveloped financial market the first step would be primary issues of treasury bills and central bank bills. In light of this, the NBE will use open market operations (sale and purchase of government securities) as one of its monetary policy instruments (Gazena Erchafo, 2001).
In Ethiopia, bi-monthly treasury bills auction market is introduced in 1994/95 with the intention of financing government budget deficit from non-bank sources, to create a base for the establishment and development of secondary market and to boost the NBE’s controlling power on money stock as well as interest rate. However, as a result of low interest rate in the treasury bills market which is lower than the deposit rate, the market failed to attract private bidders. Besides, except providing fund for government, the treasury bills market is not serving most of its objectives because of NBE has allowed inter-bank money market, more than half of the treasury bills are purchased by commercial banks (ibid).
Reserve requirement
Reserve requirement in Ethiopia is computed by netting out uncleared checks paid and uncleared effect foreign from the total deposits. The requirement is currently 5 percent of the net deposit and failing to comply with this requirement will be penalized. The NBE uses this instrument to control the liquidity of banks by varying the rate according with the targeted level. The higher Reserve Requirement contracts the liquidity as well as credit expansion power of commercial banks and the opposite will increase liquidity and credit expansion power of banks (Gazena Erchafo, 2001).
4.3. Banking and Non-banking financial sector
The major financial institutions operating in Ethiopia are banks, insurance companies and micro-finance institutions. Currently, there are 17 banks, 14 insurance companies and 31 micro-finance institutions operating in the country. As result the bank to people ratio reached to 82,474 in 2011.
The private banks had 487 branches and paid-up capital of 7.231 billion Birr, compared to 483 branches and a paid-up capital of 8.718 billion Birr of the three public banks. The total capital of the banking system reached Birr 15.949 billion in 2010/2011, of which private banks together possesses 45.3%. Commercial Bank of Ethiopia, the biggest state owned bank, accounted for 39.3% of the total capital of the banking system, implying high but slowly declining concentration in market share (NBE 2010/11 annual report).
4.4. Developments in Financial Markets
Treasury Bills Market
Treasury bills market is the only regular market where securities are transacted on a fortnightly basis. Three types of T-bills with a maturity period 28 days, 91 days and 182 days are supplied to the market. There is no secondary market for the security. Government bonds are occasionally issued to finance government expenditures and to absorb excess liquidity in the banking system.
The dominance of commercial banks in the T-bills market continued to diminish owing to enhanced participation of non-bank institutions. At the end of 2010/2011, the total outstanding T-bills stood at Birr 10.8 billion, of which 91.7 percent was hold by non-bank institutions.
NBE Bill Market
On April 4, 2011 NBE introduced NBE Bill market to mobilize resource from the banking system to finance priority sectors identified as the driving forces of the economy. Following the introduction of the NBE Bill market, the total NBE bill purchased by the banking sector reached
Birr 6.3 billion.
Bonds Market
In recent years, following the strong growth in economic activities and real income, the issuance of corporate bonds has tended to increase. Outstanding Corporate bond holdings of CBE issued by regional states, EEPCO and DBE.
Inter-bank Money Market
The interbank money market was not active in Ethiopia due to the existence of excess reserves in the banking system. Accordingly, no inter-bank money market transaction was conducted since April 2008. Ever since the introduction of the interbank money market in September 1998, merely twenty three transactions worth Birr 259.2 million were conducted with interest rates ranging between 7 to 11 percent per year. The maturity period of these loans widely spanned from overnight to 5 years.
5. Financial Openness
The importance and impact of financial sector openness on financial sector development is debating issues. According to N.Birdsall (2006), Openness is not necessarily good for the poor. Reducing protection has not brought growth to today’s poorest countries, including Africa, and open capital markets have not been particularly good for the poorest households within many developing countries. He argues that within high-debt emerging market economies the financial crises, whether induced by domestic policy problems or global contagion, costly for the poor.
On the contrary Siong Hook Law and et al (2008) suggested that financial openness is an essential determinant of financial sector development especially for developing countries and emerging economies. Their analysis, suggests that the simultaneous opening of both trade and capital accounts holds the key to successful financial development. They conclude that opening up their capital accounts provide an effective stimulus to financial development in developing countries.
Kiyota (2007) strengthen the idea that liberalizing restrictions on foreign bank entry accelerated the efficiency of the domestic banking sector, and also contributed to long-run economic growth. He also found that higher government ownership of banks leads to not only slower subsequent financial sector development but also lower productivity growth.
HongHanh (2010) on the other hand argued that financial openness does contribute to financial sector development, but only when a threshold level of general development of legal systems and institutions has been attained. Otherwise, simply making country’s financial sector open to foreigners may not lead to the development of the sector.
In case of Ethiopia, due to the nature of financial sector, in which there are no foreign banks, a non-competitive market structures the state-owned banks have the dominant role and strong capital controls. Although series of financial sector reforms has been introduced since 1994 and private banks were allowed to be re-established, the three large state-owned banks continue to dominate the market in terms of capital, deposits and asset (Ghirmai T Kefela, 2008).
The Ethiopian economy would benefit from financial sector liberalization, especially from the entry of foreign banks and the associated privatization of state-owned banks. Kiyota and others observed that the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia. That is, high bank concentration indicates a lack of competition in Ethiopia’s banking sector. Foreign banks are not permitted to enter the market in any form, and the Ethiopian Government maintains strong control over international capital movements. This highly closed nature of the Ethiopian financial negates the positive effects that would otherwise come from greater financial intermediation. This makes Ethiopia unique from its East African neighbors (namely Kenya, Tanzania, and Uganda) and many other developing countries. That is why Ethiopia’s financial sectors remain closed and they are less developed than its neighbors (Kiyota, 2007).
Although Ethiopian government and policy makers understand the potential importance of financial liberalization, they strongly refused to open the financial sector for foreign investors. They believed that liberalization may result in loss of control over the economy. Since the NBE is not in its potential to control the well organized, equipped and financially strong foreign banks, permitting foreign investors to invest in the financial sector may leads to economic crises. In addition, they believed that the Ethiopia financial sector is too young to compete with foreign banks i.e. the domestic sector will be out of game and the foreign completely control the financial system of the country. In this case the former prime minister of Ethiopia, Meles Zenawi, clearly stated in his writing entitled, African Development: Dead Ends and New Beginnings, those financial reforms takes place before result in high incidence of non-performing loans and excess liquidity in many African countries. This excess liquidity reflected the failure of banks to effectively mobilize savings and promote lending. He completely argued that in this stage of economic and financial sector development, complete liberalization doesn’t work for Africa including Ethiopia.
6. Measurement of financial development
6.1. Is financial sector development measurable?
A good measurement of financial development is vital in evaluating the advancement of financial sector development and understanding the corresponding impact on all over economic performance of a country. However in practice, it is difficult to measure financial development given the complication and extent it encompasses. There is no general consensus in the literature about the factors that should be taken into account in explaining financial development, nor what indicators of that development are most reliable. Practical works so far are usually based on standard quantitative indicators accessible for a longer time period for a broad range of countries.
IMF (2004), explain that using conventional measures of financial deepening, such as the level of real interest rates and the ratio of broad money to GDP, may give misleading signals about the success of financial reform and its implication for real activity.
According to Noureen Adnan, financial development can be measured by a number of factors including the depth, size, access, and soundness of financial system. It can also be measured by examining the performance and activities of the financial markets, banks, bond markets and financial institutions.
Gelbard and et al (1999), conclude that bank credit to the private sector is the most appropriate indicator of financial development in their study of financial sector development in sub-Saharan African countries.
But the widely accepted measures of financial development were developed by World Bank includes ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, ratio of deposits to GDP and Private Sector Credit to GDP.
6.2. Comparative analysis of Ethiopian financial sector development
The major financial institutions working in Ethiopia are banks, insurance companies and micro-finance institutions. According to NBE (2011), the number of banks operating in the country reached 17. In terms of ownership, fourteen were private commercial banks and the remaining three state-owned. As the recent data of NBE indicates, the share of private banks branch network went down to 49 percent at the end of 2010/11 from 60 percent of the previous year due to the aggressive branch expansion by CBE. This clearly shows that Ethiopia’s financial sector is dominated by state-owned banks, mainly the Commercial Bank of Ethiopia (CBE). Currently public banks account for 67% of total deposits and 55% of loans and advances. Due to the expansion of new bank branches, the bank to people ratio reached to 82,474 (NBE, 2011).
Since private banks don’t operate in the rural side of the country due to high transaction costs, taking commercial bank to people ratio is good indicator for financial sector accessibility. This visibly indicates that access of the population to financial services is limited. This actual bank coverage stands at about 120,755 people per commercial bank branch, making Ethiopia one of the most under-banked countries in sub-Saharan Africa (ibid).
According to kiyota (2007), credit issued to the private sector in Ethiopia in 2004 was 19.1 percent of GDP (the 2nd highest in East Africa and the 5th in SSA), and liquid liabilities were 44.6 percent of GDP (the largest in East Africa and the fourth in SSA).This may lead to a wrong conclusion that the financial sector of Ethiopia is very developed compared to other SSA countries. However, on closer inspection, with respect to private credit to GDP, he argued that Ethiopia’s GDP is relatively low, so this does not necessarily mean then that intermediation is stronger in Ethiopia on this dimension.
Note also that Ethiopia’s gross domestic saving rate is the lowest in East Africa. This implies that much of the population does not have ready access to banking services, and it may also be the case that the infrastructure for banking in rural areas is especially poor. It should also be noted that liquid liabilities (i.e., M3) can be increased by worker remittances rather than domestic saving. Hence, the credit issued and liquidity indicators noted may not reflect depth in Ethiopia’s financial system (ibid).
As of June 2011, the private credit to GDP ratio for Ethiopia was
around 9% compared with the average of 30% for sub- Saharan Africa .This indicates because of aggressive branch expansion of stated owned banks, especially CBE, the credit share of the private sector has been declined in recent years compared with the year 2004. According to the World Economic Forum’s Global Competitiveness Report 2011/12, Ethiopia ranked 125 out of 142 countries with respect to financial-market development. But after liberalization, the general trend that private banks are easily spread up quickly with the public ones is a hopeful phenomenon which shows the improvement of financial sector development in Ethiopia. After liberalization, the available evidences clearly show that the share of the private banks both in deposit mobilization and lending could increase significantly (Alemayehu, 2003).
7. Conclusion and recommendation
Conclusion
The financial system of Ethiopia is underdeveloped with the domination of banking sector. Due to the nature of financial sector, the key elements of financial openness which includes domestic market competition, foreign ownership, and limited capital controls are lacking in Ethiopia.
The private credit to GDP ratio which is one of financial development indicator was around 9% compared with the average of 30% for sub- Saharan Africa. Gross domestic saving rate is only 3.6 percent, the lowest in East Africa. This implies that much of the population does not have ready access to banking services, and it may also be the case that the infrastructure for banking in rural areas is especially poor.
Treasury bills market is the only regular market where securities are transacted on a fortnightly basis which indicates that the lowest level of financial market development of the country. According to the World Economic Forum’s Global Competitiveness Report 2011/12, Ethiopia ranked 125 out of 142 countries with respect to financial-market development.
After liberalization, the general trend that private banks are easily spread up quickly with the public ones is a hopeful phenomenon which shows the improvement of financial sector development in Ethiopia. After liberalization, the available evidences clearly show that the share of the private banks both in deposit mobilization and lending could increase significantly. It is also worth noting that the share of credit extended to the private sector has jumped from in the recent past the public sector’s share declining. This is a clear demonstration of the impact of the liberalization scheme pursued by the government.
Ethiopian government and policy makers strongly refused to open the financial sector for foreign investors. They believed that liberalization may result in loss of control over the economy and may not be economically beneficial. Since the NBE is not in its potential to control the well organized, equipped and financially strong foreign banks, permitting foreign investors to invest in the financial sector may leads to economic crises. In addition, they believed that the Ethiopia financial sector is too young to compete with foreign banks i.e. the domestic sector will be out of game and the foreign one completely control the financial system of the country.
Recommendation
The government of Ethiopia continues to prohibit the entry of foreign-owned intermediaries, to minimize the perceived macroeconomic risks arising from a more open financial sector. It prefers to seek the transfer of foreign financial technology and expertise through advisory assistance. However, entry of foreign financial institutions is the important way to improve the depth and breadth of the financial sector, gradual liberalization and openness is necessary for the development of the sector.
A problem that used to exist in the Ethiopian financial sector was the narrow interest rate spread between lending and borrowing rates. The private banks frequently complained of the low interest rate margins that used to exist, arguing that low interest rate margins risk reducing the provision of credits to projects that are risky from the perspective of the banks. Thus, widening the margin of the lending and borrowing rate will enable to finance risky projects and in doing so accelerating the economic growth of the country.
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