CHAPTER TWO FINANCIAL SECTOR DEVELOPMENT IN ETHIOPIA

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 country s 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 Program s 2009 Human Development Index. According to a recent survey nearly 30% of the country s 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, 15

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 Ethiopia s 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 country s 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 world s 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. 16

Table 2.1: Ethiopia s 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 17

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 country s 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 18

The agriculture sector s 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. 19

Figure 2:1 Sectoral distribution of GDP in 2004 and 2009 2004 2009 Services 39.7% Agriculture 47.4% Services 46.1% Agriculture 42% Industry 13.6% Industry 13% Source: MoFED, 2009 20

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 10.00 8.00 6.00 4.00 2.00 0.00 2004 2005 2006 2007 2008 2009 Agriculture Industry Services All Sector Source: Computed from MoFED data 21

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 povertyfocused 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. 22

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. 23

(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 24

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 state owned 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. 25

Table 2.4: Capital and branch share of the formal Banks in Ethiopia as of 2009(Capital in million ETB 1 ) 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 26

Despite some improvement in the sector in the last couples of years, Ethiopian banking remains in its low status. For instance, the estimates of Bank s 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, Ethiopia s 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 1990 s 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. 27

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 28

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. 29

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 nonmembers. 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 MFI s 30

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). 31

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 32

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 Ethiopia s 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 government s point of view, the general recognition of civil society s role in development has led to that iddirs have been accepted as possible partners for successful and sustainable development (Pankhurst et al., 2009). 33

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 34

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. 35

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 36

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 37

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. 38

Table 2.6: Ownership Structure of Microfinance Institutions in Ethiopia Name of institution Regional Associatio Individuals Total Governm ent share n & NGOs 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 39

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 (reregistered) 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 40

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 country s 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 country s 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, Ethiopia s 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 country s poor. 41