PROSPECTS AND CHALLENGES OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA
BY:
SIMENEH TEREFE
DEPARTMENT OF ECONOMICS
UNITY UNIVERSITY
DECEMBER , 2013
ADDIS
ABABA
Acknowledgements
First of all I
would like to thank my thesis advisor Dr. Yegzaw Anagaw, for the opportunity to
pursue this is project and for his guidance, patience and invaluable ideas that
enabled this research to be successfully completed.
I also would
like to those staffs at different private commercial banks, including branch
managers, department and division managers at their head offices and in
branches who allowed me to distribute the questionnaire among their staff and
also collected the questionnaires, and to the staff at NBE, especially in the
Research & Planning departments who cooperated to fill the questionnaire as
well as provided me with important documents and researches conducted in the
area by their staff , that helped me a
lot in doing this research.
I would like to
thank, my mother who gave me a moral and financial support to start this
program and to finish it. I also thank two managers in Abyssinia Bank and in
Birhan International Bank with whom I conducted a personal interview with them
and that they gave me a first hand information and insights that helped me a
lot to the research. Finally, I would also thank to all individuals and
institutions, for their support and comments which I didn’t mentioned by name
who cooperated me.
Table of Contents
Page
Acknowledgements……………….……………………..………………………………
List of Acronyms
………………..………………………………………………………
List of Tables…………………….………………………………………………………
List of Appendicles …………….……………………………………………………….
CHAPTER ONE: INTRODUCTIION…………………….………………………………………………..
1.1 Background
…………………….…………………………………………………
1.1 Statement of
the problem……………….…………………………………………
1.2 Objectives
of the Study……….…………………………………………………..
1.3 Significance of the study………………………………………………………….
1.4 Scope of the study…………………………………………………
1.5 Organization of the paper ……………………………………………………
…..
1.7 Organization of the Study………………………………………………………..
1.6 Methodology and Data Collection……………………………………………….
1.5. Limitations of the Study …………………..………………..…………………..
CHAPTER TWO: LITRATURE REVIEW
……………………………………..
2 Literature review …….……………………………………….…….………..……
2.1 The concept of Banking
…………………………………………….………..
2.2 A Brief History of
Banking in Ethiopia…………………….…………………
2.3 The Financial Sector in
Ethiopia……………………………………………….
2.4 The Structural Shift in the Ethiopian Economy…………………………………
2.5 Monetary Policy, the Role
of NBE……………………………………………. .
2.6
The Structure of the Banking System……………………………………………
2.6.1 Banking Sector Reforms in Ethiopia………………………………………..
2.7 The Prospects for
Private Commercial Banks…………………………………..
2.7.1
Technologies Used in the Banking Sector………………………………….
2.8 The Challenges of Private
Commercial Banks……………………………….....
2.8.1 Non –
Perfuming loans (NPLs)………………………………………….…
2.8.2 Inflation ………………………..……………………..…………..….…….
2.8.3 The Exposure of the Private Banks for
International Crisis…….…..………
2.8.4 Lack of Appropriate
Technology……………………….………………….
3 Banking Business Risks
………………………………………….….….……….......
3.1 Risk Management
…………………………………………………….……..
3.2 Foreign Exchange Risks
……………………………….…….….….…….…
3.3 Interest Risks …………………………………………………..…..…….….
3.4 Credit Risks
………………………………………………………….….…..
3.5 Operational Risks
…………………………………………………….……..
3.6 Market Liquidity Risks
……………………………………….……………..
4 Theoretical Literature Review
………………………………………………….…….
4.1 Performance Measurements in
Banks …………………….…...……….……
4.1 .1 Efficiency of Commercial
Banks ………………………….……………
4.2.2 Profitability of
Commercial Banks…………………………….…….…..
5 Empirical Review …………….……………………………..…………………………
CHAPTER THREE: RESEARCH DESIGN
METHODOLOGY………………………………………………………………………
3.1. Methodology of
Analysis……………………………………………. …..……..
3.2 Quantitative Research Approach
…………………………………………………
3.3 Instrument Design and Data Collection
Method…………………………………
3.4 Mixed Research Approach
……………………………………………….…..….
3.5 Survey Design
…………………………………………………………….……..
3.6 Sample
Design……………………………………………………………………
3.7 Data Analysis Method
………………………………..………………………….
3.8 Summary of Results
……………………………………………………….…….
CHAPTER FOUR: RESULTS AND
DISCUSIONS …………………………………...
4 Research Results and Discussions …………………………………………………..
4.1. Survey Results
…………………………………………………………………..
4.1.1 Respondents’ Profile
………………………………………………….……..
4.1.2 Customer Satisfaction
………………………………………………….….…
4.1.3 Challenges that affect the
Performance of the Private Banks…………….….
4.1.4 Lending Challenges
…………………………………………………….……
4.1.5 The Prospects of Private
Commercial Banks ………………………..…...….
4.1.6 Performance Measurements in
Private Banks …………………..……..…….
4.2 Econometric Analysis ……………………………………………………….…........
4.2.1 Econometric Model Analysis
……………………………………...…..……
4.2.1 Model Proposed
…………………………………………………..…..…….
CHAPTER FIVE: CONCLUSIONS AND
RECOMMENATIONS………………...........
5.1 Conclusions
….…….……………………………………………….……….……
5.2 Recommendations
…………………………………….…………….….…………
REFERENCES ……..…………………………………………………….….…….….….
APPENDICIES ……..…………………………………………………..…....……….….
APPENDICIES ……..…………………………………………………..…....……….….
LIST OF ACRONYMS /ABBREVATIONS
AIDB Agricultural and Industrial Development Bank
AML Anti- Money Laundering
ATM Automatic Tailor Machines
CBE Commercial Bank of Ethiopia
CBB Construction and Business Bank
CPI Consumer Price Index
CTF Combating Terrorist Financing
DBE Development Bank of Ethiopia
DEA Data Envelopment Analysis
DFA Distribution Free Approaches
DMUs Decision Making Units
ECB European Central Bank
E – Commerce Electronic Commerce
E - Banking Electronic Banking
EIC Ethiopian Insurance Corporation
EPRDF Ethiopian Peoples Revolutionary
Front
E - Payment Electronic Payment
ETB Ethiopian Birr
EVA Economic Value Added
FY Fiscal Year
FDH Free Disposal Hull
GDP Gross Domestic Product
GNP Gross National Product
HI Herfindahl Index
HSB Housing and Saving Bank
ICT Information Communication Technology
IMF International Monetary Fund
KYC Know Your Customers
LCs Letter of Credits
MFIs Micro Finance Institutions
MOFED Ministry of Finance and Economic
Development
NBE National Bank of Ethiopia
NGOs Non - Governmental Organizations
NI Net Banking Income
PSSA Pension and Social Security
Authority
ROA Return On Asset
ROE Return On Equity
ROI Return on Investment
SFA Stochastic Frontier Approach
SMS
Short Message
SSA Sub Sahara Africa
SSA Sub Saharan Africa
TFA Thick Frontier Approach
USAID United Sates Agency for International
Development
USD United States Dollar
US
United States
WB World Bank
WTO World Trade Organization
List of Tables
Page
Table 4.1: Sample size and returned
questionnaires …….…………..……………………
Table 4.2 Employment of Respondents
…………………….…….………………………
Table 4.3 Working Position of the
Respondents……………….….……………………..
Table 4.4 Banking Experience of
Respondents ………………….………………………
Table 4.5 Measurement of Customer’s
Satisfaction ……………………………………..
Table 4.6 Respondents’ Perception
of the Level of Customer’s Satisfaction ……………
Table 4.7 Respondents Perception of
Challenges that affect bank performance …..……
Table 4.8 Respondents Perception of
from where private banks face competition…..…
Table 4.9 Respondents Perception of
Technology availability in their bank …………..
Table 4.10 Factors that Reduce
Lending …………………………………………….…
4.11 Respondents Perception about
Centralized Credit Information System …………..
Table 4.12 Measurement of the Level
of Competition ……………………...................
Table 4.13 Respondents Perception
of private banks face in the future ………………..
Table 4.14 Respondents Perception
of the availability, sufficiency of information from government offices
………………………………………………………………………
Table 4.15 Percentage Distribution
of Bank Performance Measurements ………….…..
List of Figures
Page
Fig.1 The Inputs and Outputs of the Stages ……………………………………..…...
List of Appendices
Page
Appendix I. Questionnaire distributed to employees of
banks.................................
ABSTRACT
This
study intends to assess the challenges and the prospects of private commercial
banks operating in Ethiopia and the factors that affect their performance. It
also attempts to examine the possible factors that compel the banks to reduce
their level of performance. Quantitative method particularly survey design
approach was adopted for the study. The survey was conducted with individuals
working in both private banks and in NBE (assuming different positions) using
questionnaire. In addition, the study used structured review of documents
and/or records held by banks and by NBE.
The findings of the study show that deposit has
statistically significant relationship with banks’ performance measured in
terms of return on equity ROE and ROA. Loan and liquidity have also relationship
with bank’s performance measured in terms of both return on asset (ROA) and
ROE.
The study suggests that when banks face performance
reduction, they also should expand other ways of generating income lending
constraints, they have to use their funds like by purchasing treasury bills and
bonds. Moreover, banks must develop non-interest generating services. Excess
cash maintained by banks should be used by diversifying credit options and to
avoid inefficiencies.
Private commercial banks also should prepare for
the inevitable stiff competition that will arise from local and possibility
with the entrant of foreign banks. And since some of them are recently
established their level of capital is small, they also need to raise their
capital and strengthen their financial position.
CHAPTER ONE: INTRODUCTION
1. 1 Background
Banks play an important function in the economy of
any country. They are the main intermediaries between those with excess money
(depositors) and those individuals and businesses with viable projects but
requiring money for their investment (creditors). Banks have at least the
following functions: lending money, depositing others’ money, transferring
money locally or globally and working as paying agent.
Private
commercial banks are a recent phenomenon in the Ethiopian economy. They came
into existence after the downfall of the Dergue regime. Before the Dergue, in
the Imperial regime, private commercial banks used to operate in the economy.
But after Dergue came to power, private commercial banks were nationalized and
amalgamated with the state owned banks, then after that Ethiopian economy was
dominated by state owned banks. And in the time of the Dergue they were not
allowed, and not only banks but also there were no other private sector - it
was a socialist economy.
After the
downfall of the Dergue private commercial banks were allowed to operate and
they started to have market share, and now they have some growing market share
in the Ethiopian economy and are some of the major players in the Ethiopian
economy. Their number is also growing from time to time and currently new
commercial banks are also joining the market.
Though private
commercial banks are becoming major players in the Ethiopian economy there are
challenges and prospects they face. Some are related with the internal
organization of the banks themselves and others are external. Like any other
business organization banks, specifically private commercial banks require a
suitable business environment and global economic recessions have created a
challenge to the banking industry but recently this global recession has
started to subside and the world economy particularly the economy of Western
countries is gradually recovering .
Further more one
of the challenges to the sector was the credit ceiling; the credit ceiling
imposed by NBE on all commercial banks has also been lifted. And the Ethiopian
economy is also continued to register high growth rates. The other area that
needs to be mentioned is that the economy is also showing a remarkable shift in
its distribution of sectoral contribution .The share of the service sector to
the overall GDP is rising, and the contribution of the financial sector,
particularly those of private commercial banks is significant.
Because of the
high and persistent inflation the National Bank of Ethiopia (NBE) has put a
lending cap on commercial banks and this hindered them from giving more loans
and reduced their level of profitability for a while, but recently the cap has
been lifted and private commercial banks are able to lend, but only recently
this lending cap was lifted.
Since these
institutions are privately owned and their objective is profit and growth, the
repeated government intervention in their decision making process, is not a
goods news to the sector, especially government intervention in the decision
making process of banks is creating a challenge to private banks and the
efficiency of the sector as a whole.
Private commercial banks into the picture of the
Ethiopian economy after the historical proclamation of licensing and
Supervision of Banking Business Proclamation No.84/1994” of Ethiopia to
undertake commercial banking activities. This proclamation is the foundation of
private banking in Ethiopia after the revolution.
It is not
surprising that customers see reliability when it comes to choose a bank;
therefore they mainly choose government owned banks. For a long period of time
government owned banks control the banking sector and still now the larger
market share is under the hands of government owned banks. This is also one of
the reasons that many customers still choose government owned banks for
decades, but the sector is mainly controlled by the hands of government banks
is one off the challenge of the banking sector especially in terms of
efficiency .
The stake in the financial particularly in the
banking sector is high. A banking sector’s efficiency of a country can be
represented by the average efficiency of its individual banks and, that
efficiency in the banking sector is a key contributor to macroeconomic
stability of a country. It is also a precondition for economic growth and
important for the effectiveness of monetary policy. Therefore this sector is
one of the priorities of the government.
1.1.
Statement of the Problem
Even though, the Ethiopian financial institutions have a far reaching
history, the use of money and coins in Ethiopia has a long history, and the
introduction of modern banking is nearly a century old. Despite the long
history, which precedes the advent of modern banking throughout most of Africa,
the Ethiopian financial system has not progressed that much as one expects and
the problems that private commercial banks face in Ethiopia are many.
The Ethiopian economy has yet untapped large potential
for commercial banking and private Banks in Ethiopia are in their infant stage.
They are less in number and scope; however they are playing a decisive role in
the Ethiopian economy at the same time challenges exist in their operations.
Since Ethiopia is a country which has no capital or
stock markets more than 90 percent financial saving is done by banks. The
National Bank of Ethiopia also raised the saving interest rate from 4 percent
to 5 percent. (Biritu, 2011) and yet this is less than the rate of inflation ,
and these problems call for
extensive research that aims at assessing the impacts of low level of saving
rate which is lower than the rate of inflation on in banking sector .
But
when we see the level of their development, the development of the financial sector
was constrained by the government takeover of the existing private banks in
1975. In the period of a shift from a mixed to a state managed economy, the
development of the financial sector was stunted. Although the financial sector
of Ethiopia has grown in the 1990’s, compared to its state during the
preceding decades, it is still in its infancy. (Ayalew, 2009)
Some of the
problems are the high and persistent rate of inflation, and the weak technology
they use like unstable internet and network connections, lack of trained
manpower, the non – performing loans they carry, the dominance of the state
owned banks in the market, sometimes the government uses them to implement its
policies, and they are also to a certain extent vulnerable to international
economic and financial crisis so on.
1.2 .Objective of the Study
The general
objective of the study will be to assess the prospects awaiting the private
commercial banks in the coming years in Ethiopia and to identify the main
challenges these private banks face while he the specific objectives are:-
a)
To foresee the prospects for the private banks
especially with related to policy changes and related with financial
liberalization and other external changes
b)
To specify and analyze the challenges like the impact
of the high and persistent inflation in the country on these private commercial
banks and other challenges , to analyze
the impact of the large liquidity reserve held by the banks on the banks
themselves
c)
To predict the challenges and problems the banks are
facing as a whole
d)
To have an overview of the impact of the privately
owned commercial banks on the Ethiopian economy as a whole
e)
To have a bird’s eye view about the business
development and administration issues like information technology, branch
expansion and human resources development related to private commercial banks.
The basic
attention of this paper is to evaluate the prospects and to assess the
challenges that private banks face, to analyze the issues and to conclude from
the findings, and to provide possible policy recommendations.
1.3 Significance of the Study
The significance
of the study will be to point out some of the challenges the private commercial
banks in Ethiopia face and the untapped potential and opportunities waiting.
Some of the operational performances of private banks include deposit
mobilization, providing loans and advances and soliciting import and export
transactions in other words international banking and fund transfer.
The paper will
also take into consideration the positive and negative impacts of the growing
and rapidly diversifying Ethiopian economy to the business of private
commercial banks. There are opportunities and challenges ahead as the Ethiopian
economy grows and diversifies, and integrates to the global economy and as well
as more private commercial banks join the market the landscape of the market
changes.
Besides, the
study will be expected to serve
a)
As a service for further study in the sector
b)
The results will be inputs for the concerned bodies and
policy makers and future researchers
c)
To foresee the overall health and activity of the
private commercial banks
1.4 Scope of the Study
From the entire
financial sector operating in Ethiopia, the research covers particularly the
activities of privately owned commercial banks that are registered by NBE and
become operational before the year 2010 / 11. It discusses about the challenges
they face and the prospects that await them and their relevance to the
Ethiopian economy. The paper covers exclusively the activities of these private
commercial banks.
It also raises
issues of problems like it assesses the financial performance like, incomes,
expenses and profit and loss accounts or gross profits or the level of
profitability. It will cover the influence private commercial banks have on
economic transformation of the country.
1.5. Methodology and Data Collection
The methodology
used will be descriptive analysis, questioners will also be prepared and filled
by randomly selected individuals, and primary data will also be collected from
selected banks and their respective branch personnel and their branches and the
necessary data will be gathered by using questioners. Secondary data is
collected from the annual re reports of the banks themselves and from NBE, as
well as the print outs from the head offices of private banks and NBE.
Both descriptive
and Econometric model will also be used to analyze primary and secondary data
respectively. Important data will also be collected and used from different
secondary relevant sources like domestic as well as international institutions
and from their official publications. Using a simple regression analysis, by
using different variable specifically loans, deposits, net profits and ROE and
ROA the data will be analyzed to show their performances and challenges.
1.6 Limitations of the Study
The study has
limitations due to time and budget constraints. And it also covers few branches
of the banks under study and will not cover all the private commercial banks
throughout the country. And the study also won’t cover new banks on the way of
formation; it is known that there are some private commercial banks that are
under formation.
Moreover the
availability of adequate and reliable data from secondary sources is found to
be crucial constraints of the study. In addition to that there are some private
commercial banks that have started operation in the past one or two years. And most of the time banks don’t make profit
in their first or in the second years, therefore it is difficult to say about
this new start up banks, and to analyze about their performances.
1.7 Organization of the Study
The paper will
be organized in four main chapters, the first chapter will be introduction
which gives a general aim, coverage and scope and other basic issues of the
paper, the second chapter deals with literature review which includes related
theoretical literature reviews in this chapter previous theoretical studies
that are related with Ethiopian private banks will be reviewed.
The third
chapter will be data collection and methodology, questioners are also used, in
addition to that, econometric models will also be employed, and the secondary
as well as primary data will be analyzed and interpreted this chapter also
presents analysis and interpretation of the findings.
The final
chapter will be conclusions and policy recommendations and remarks will be
presented, this last chapter reveals conclusions and policy implications of the
study, the concluding remarks and their policy implications will be presented
briefly.
CHAPTER TWO
2 Literature Review
2.1 The concept of Banking
Banking is one of
the oldest professions in human history, it also flourished with civilizations.
Since humans started using money bank services were in use throughout history. Modern
banking established as we know it today was established in Italy and Greece in
the 15th century. Today, banks are one of the most important
institutions to for a modern economy to
work in any country.
From different
historical sources the first foundations of the banking service in the world were
put by goldsmiths and
silversmiths. They have a safe box to put & they were the most trusted they
used to receive gold, silver and various jewelries to put with them. Therefore
an individual or merchant puts his wealth under their custody, for their
service they charge a small amount of money and give the customer a receipt to
guarantee their acceptance. Then they started using, money paying instrument
what we now call this document as ‘check’. However as time goes by , the
goldsmiths and silversmiths observed that their customers wouldn’t take their
jewelry soon, and those clients ,whenever they face they shortage of money they
started lending to this people and started to get profit from their service.
They encouraged depositing and lending and rather than making the customers to
pay a charge for depositing, they started to pay them interest and introduced
the public to work with money. It is believed that, ancient Assyrians,
Babylonians, Athenians, Romans and Abyssinians also used the banking service.
(Gedey, 1990)
Some
authorities, relying upon a broad definition of banking that equates it with
any sort of intermediation activity, trace early banking as far back as ancient
Mesopotamia,
where temples, royal palaces, and some private houses served as storage
facilities for valuable commodities such as grain, the ownership of which could
be transferred by means of written receipts. There are records of loans by the
temples of Babylon as early as 2000 BC; temples were considered especially safe depositories because,
as they were sacred places watched over by gods, their contents were believed
to be protected from theft. Companies of traders in ancient times provided
banking services that were connected with the buying and selling of goods.
(Britannica, 2010)
A broader definition of
a bank is any financial institution that receives, collects, transfers, pays,
exchanges, lends, invests, or safeguards money for its customers. This broader
definition includes many other financial institutions that are not usually
thought of as banks but which nevertheless provide one or more of these broadly
defined banking services. These institutions include finance companies,
investment companies, investment banks, insurance companies, pension funds,
security brokers and dealers, mortgage companies, and real estate investment
trusts. (Encarta, 2009)
Banks play a very important role in the economic
development of every nation. They have control over a large part of the supply
of money circulation. Banks are the main stimulus of the economic progress of a
country. The financial sectors contribution to growth lies in the central role
it plays in mobilizing savings and allocating these resources efficiently to
the most productive uses and investments in the real sector. (Ayalew, 2009)
Commercial banks are so
named because they specialize in loans to commercial and industrial businesses.
Commercial banks are owned by private investors, called shareholders, and there
are also state owned banks owned by the government itself. By setting up a bank, it could locate new
banks around the country and therefore put branches in locations where banking
service was not previously available, bankers could also diversify their product
lines and offer services requested by their customers and provide that as
demanded by the customers and allowed by NBE.
2.2 A Brief History of
Banking in Ethiopia
The history of
the use of modern money in Ethiopia can be traced back more than 2000
Years (Pankhrust
1968 cited in Gedey 1990). It flourished in what is called the Axumite
Era which ran
from 1000 BC to around AD 975. It is
widely assumed that the pioneer bank in middle ages was the “Venus Bank” it was
established in 1157 , but this bank was not a kind of bank that as we know
today but mainly an office established to transfer public debt from one party
to the other. The modern bank as we know it today has started giving service in
15th century in Greece and Italy.
But leaving the
ancient period and starting from the modern era, like his other
modernization legacies, modern banking services in Ethiopia started at the time
of Emperor Menelik II. The then Emperor also credited for bringing the first
telecommunication, railway and postal services as well as a modern banking
services started during his time .
Modern
banking in Ethiopia was introduced in 1905. At the time, an agreement was
reached between the Ethiopian Emperor Minelik II and a representative of the
British owned National Bank of Egypt to open a bank which led to Bank of
Abyssinia inaugurated in Feb.16, 1906 by the Emperor himself. In the 30’s the
bank was bought by the Ethiopian government and the State Bank of Ethiopia and was
established by a proclamation issued in august 1942. This bank was later
disintegrated to two different banks forming the National Bank of Ethiopia and
the Commercial Bank of Ethiopia. (Lulseged, 2005)
Though
Emperor Menelik gave the Bank of Abyssinia mentioned above many attractive
concessions and when the Bank started operation Mr. D. Mack Glivrime was
appointed as the first governor of the Bank. At that time the uses and services
of a bank were not widely known by the public, and many of its customers were
foreigners and only few Ethiopians who knew the uses of a bank were customers.
The public rather than putting his money in a bank for a small a limited amount
of interest, it prefers to buy land by his money. Because the public didn’t
know about the services of a bank, the bank has to face many problems. The uses
of a check were not known at all, and only few foreigners use it. After the
Ethio – Djibouti rail way started operation the business of the bank started to
expand. The Ethio – Djibouti railway line was constructed in 1894 at the reign
of Emperor Menilik. (Gedey, 90).
This
bank also opened branch offices in Harar, Dire Dawa, Gore, Dembidolo, and in
addition to that it had representative office in Gambella and it also had
transit office in port of Djibouti. The bank was responsible for the accounts
of the government, to it also lends small amount of money for import and
export, and also handles different activities.
After
Emperor Hailesselassie came to the throne the operation of the bank was
criticized for being inappropriate and was attacked on the grounds that it
stands only for its own profit, so the Emperor replaced the bank with Ethiopian
Bank. And the shares of the bank were presented for the public for sale.
Guaranteed buyers of the share were found and the government paid larger share
of the money. And with that sale a new bank emerged as the Ethiopian Bank. The
new enterprise named as Ethiopian Bank and it was fully owned by Ethiopia and
it was also the first National Bank in Africa. Knowing it was a profitable
venture the shares were bought by the Emperor and the aristocracy. The
Ethiopian Bank started its operation with the authority of issuing paper money
and coins. The Bank has branch offices in Dire Dawa, Gore,Dessie, Debre Tabor,
Harrar and also it has representative office in Gablella , and it also has
transit office in Djibouti. This bank started its operation in a building it
inherited from the former Bank. (Gedey, 1990)
The
public started to be aware that the money put in a bank was managed properly, the
people starts to use the bank, the role of the Bank in the Ethiopian economy
started to grow. In addition that the main reason for the bank to get public
trust easily was, according to some experts , is that it was fully an Ethiopian
owned bank.
During
Italian occupation in the larger cities of Ethiopia Through times, more foreign
and domestic banks were established. To name a few Banco di Roma, Banco di
Napoli, Banca Nazionale del lavoro and Agricultural Bank were the prominent
ones. After the Italians were defeated was forced to leave the country the
Italian banks were closed , but the branch offices of Banco di Roma , Banco di
Napoli continued their operations in Asmara , Massawa and Addis Ababa until
1974.
The
first private Ethiopian bank was Addis Ababa Bank Share Company, was
established on Ethiopians initiative and started operation in 1964 with a
capital of 2 million in association with National and Grindlay Bank, London
which had 40 percent of the total share. The Ethiopian Government Bank
established after the Italian occupation ended in 1934 E.C. This bank has the
mandate from the ministry of Finance to issue paper money and coins. After some
time in 1937 E.C., rather that the authorization from the Ministry of Finance
it became the sole printer and distributer of the currency of the country.
However,
the banking business could not move further because of the institutionalization
of private investments by the Socialist regime that came into power leaving
only three government banks; the National Bank of Ethiopia, the Commercial Bank
of Ethiopia and agricultural and Industrial Development Bank.
As the case of Ethiopia shows, the creation of a
sound financial system together with an appropriate regulatory framework is not
a straightforward task. During the era of state socialism (1974 to 1991),
Ethiopia's financial institutions were charged with executing the national
economic plan; state enterprises received bank finance in accordance with the
plan's priorities. This system, based on the template of the Soviet Union, saw
little need to develop the tools and techniques of financial regulation and
supervision found in market-based financial systems. (Geda, 2001)
The government placed all banks and financial
institutions under the National Bank of Ethiopia's control and supervision. The
National Bank of Ethiopia regulated currency, controlled credit and monetary
policy, and administered foreign-currency transactions and the official
foreign-exchange reserves. A majority of the banking services were concentrated
in major urban areas, although there were efforts to establish more rural bank
branches throughout the country. However, the lending strategies of the banks
showed that the productive sectors were not given priority. In l988, for
example, about 55 percent of all commercial bank credit financed imports and
domestic trade and services. Agriculture and industry received only 6 and l3
percent of the commercial credit, respectively. (Newbusiness, 2011)
This
was reversed when the Socialist regime was overthrown in 1991 and the issuance
proclamation for the licensing and supervision of insurance business, which led
to the beginning of a new era. Immediately after the enactment of the
proclamation private insurance companies began to flourish, leading more than
ten private banks operating in Ethiopia. As the number of commercial
banks increases the competition is becoming stiffer, and banks are expanding their
branches in different regions. (Yimam, 2005)
And as it is widely known, currently private
commercial banks are operating at large in the Ethiopian economy. And not only
they are in operation but there are also some private banks under formation.
And the National Bank of Ethiopia even declared to raise the starting capital
from 75 million birr to 500 million birr.
Currently, Ethiopian private
commercial banks offer four major services in all of their branches. Namely,
Credit Facility, Saving Scheme, International Banking, and Fund Transfer.
Moreover, some of the banks are also providing the customers credit card
payment systems that can be used internationally. The
other service the banks render is deposit services including demand deposit,
savings deposit, youth savings deposit and time/fixed deposit.
The banks also render
international banking services providing services like; opening letters of
credit for importers, handling of incoming LCs for exporters, purchase of
outward bills purchasing and selling of foreign currency denominated notes,
receiving and transferring foreign currency payment by swift and handling
incoming and outgoing international letters of guarantee. (Yimam, 2005)
The banking system has developed well over the years
in terms of its geographical coverage, deposit mobilization and credit
expansion. With regard to technology, it is underdeveloped, yet some private
banks have started a few ATMs in Addis Ababa in recent years.
These private commercial banks provide a credit
facility for their customers in different forms depending on their need and the
nature of their business they are to invest on. Some of the credit lines
offered include; overdraft facilities, term loans, letter of credit facilities,
merchandise loans and personal loans , the banks also provide international
banking services providing services like; opening letters of credit for
importers, handling of incoming letter of credits (LCs) for exporters, purchase
of outward bills purchasing and selling of foreign currency denominated notes,
receiving and transferring foreign currency payment by swift and handling
incoming and outgoing international letters of guarantee.
Furthermore,
these banks are currently offering fund transfer, both domestic fund transfer
all over the country and international fund transfer, rendered in cooperation
with international money transfer companies like Western Union, Moneygram and
others. This shows these private commercial banks have a pivotal role in the
Ethiopian economy and their growing importance to the health and of the economy
as a whole.
2.3 The Financial Sector
in Ethiopia
Theoretically, it is assumed that financial
intermediation promotes growth by directing resources from saver to investment
projects. Based on empirical findings by different authors, financial
intermediation plays four major roles in economic growth. Firstly, financial
intermediation improves the selection of funds-seeking investors and then
scrutinizes the funds-receiving investor that improves the allocation of
recourses. Secondly, financial sector encourages the mobilization of savings.
Thirdly, by screening and monitoring costs through economies of scale,
financial intermediaries lower cost of transaction and finally, financial
intermediaries provide for risk management and liquidity. (Biritu, 2011)
In Ethiopia the
banking system dominates the financial intermediation; however other financial
institutions too like insurance companies and microfinance institutions
operating in the Ethiopian formal financial system. The number of banks
operating as of 2009 /10 reached 16, of which 13 are privately owned banks. The
total number of bank branches also reached 681, as a result, the ratio of bank
branch to total population improved to 117,474 in the review quarter from
118,343 during the preceding quarter. Out of the total bank branches 38.9
percent are located in Addis Ababa which reveals very high special
concentration given the large size of the country. Out of the total bank branch
networks, the share of the private banks increases to 59.9 percent. (NBE,
2009/10)
As of 2011 the financial system, comprises of one
central bank (National Bank of Ethiopia), 16 commercial banks (of which two are
owned by the government), one development bank (Development Bank of Ethiopia),
30 micro – finance institutions (MFIs), twelve insurance companies of which 11
are privately owned, two pension funds
Social Security Authority and Private Sector Social Welfare Agency and numerous
savings and 30 microcredit associations. The sector is closed for non-Ethiopian citizens.
Proclamation No.592/2008 does not allow foreigners to own and operate banks in
Ethiopia. Hence presently there are no foreign banks operating in the country.
Capital markets
are also in initial stages of development. The government issues a limited
amount of 28-day, 3-month, and 6-month Treasury bills. The non-banking sector
remains largely undeveloped, except for 12 insurance companies with about 190
branches across the country. (USAID, 2010)
When we see
deposit and loans, which are the main activities of banks when we see the share
of private banks from the total deposits increased from 35.5 percent a year ago
to 39.0 percent at the end of the review quarter, while private banks also
managed to collect about 4.6 billion or 57.5 percent of the total collection.
The bulk of the repayment (71.0 percent) was fro, he private sector followed by
cooperatives. (NBE, 2010)
Excess reserve
and excess liquidity are among the major problems facing the banking system in
Ethiopia today. In addition to this, that these problems are not actually
distributed among the banks. Commercial Bank of Ethiopia, takes respectively
90.7 and 79.4 percent of excess reserves and excess liquid assets seen in the
Ethiopian commercial banking sector at the close of June 2005.the persistence
of these excess reserves and excess liquidity problem is also implied in the
interest rate structure of the banks as both the lending and deposit rates are
almost constant and show a very limited or no change unless NBE revised the
minimum deposit rates for saving and time deposits. (Ayalew, 2006)
In Ethiopia the banking is also a highly regulated
industry for a number of reasons. Some of the reasons include protecting
depositors’ fund, ensuring safety and stability of the banking system,
protecting safety of banks that means to limit credit to a single borrower, and
limiting or encouraging a particular kind of lending because of expected impact
on the economy. (Semu, 2010)
The
government also interfere in the decision making process of private commercial
banks, for instance Ethiopian private banks, were forced to limit their
lending in order to control inflation for the past few years, but finally are
set free with a condition of allocating 27 percent of their lending to the
government with an interest rate of just 3 percent . The National Bank of
Ethiopia has issued a Directive ‘Establishment and operation of National Bank
of Ethiopia Bills Market Directive No.MFA / NBE BILLS / 001 / 2011 ‘ which
requires all banks in Ethiopia to purchase NBE Bills to the amount of 27% of
the disbursement towards loans and advances. The Bills have a maturity period
of 5 (five) years and bear interest at the rate of 3% per annum, payable on
annual basis.
The NBE has repeatedly issued
directive Absorbing
the burden by reducing profits and shareholder returns: If banks opt to absorb the burden of
the new directive by accepting a lower income, then the loss of a 2 percentage
points in net interest margin will roughly translate into a loss of Birr 220
million given the Birr 1,129 million in net interest income collected by
private banks last year (the drop in the net interest margin is near 20
percent, from 10.3 to 8.3 percent, so this proportional drop is applied to the
Birr 1,129 in net interest income). Using FY 2009/10 data, the Birr 220 million
loss in interest income would, all else equal, reduce profits by 15 percent
(from Birr 1.4 to 1.2 billion). With a capital base of Birr 5.3 billion, this
reduction in net profit is (Access Capital, 2011)
And yet, many private banks including those who used to criticize the lending cap,
are not happy about the condition attached with the new directive of the
National Bank of Ethiopia. They argue that the condition of allocating 27
percent of their lending to the government with an interest rate of just 3
percent will reduce the profit of the banks.
Although
inflation reached high levels in 2008/09, interest rates remained at 18 percent
or below (with the exception of MFIs, which were allowed to charge higher
rates). The central bank has attempted to control inflation by restricting the
volume of credit, rather than the cost of credit. These controls eased in
February 2010 when banks were allowed small increases in their individual loan
caps; however, the majority of restrictions to reduce inflation remain. (USAID,
2010)
In response to the new
directive, private banks may choose to fully recover the added burden of the
new directive by adjusting their lending rates upwards; in this case, borrowers
will be hurt most by the new directive as they face higher financing costs, at
another extreme, banks may absorb most or all of the cost of this directive
themselves by accepting reduced incomes (due to the low 3 percent interest
rate) and the consequences that follow from this in terms of lower profits and
shareholder returns.(Access Capital ,
2011)
Not only that, a financial system that simply
channels credit to the government or state owned enterprises may not be
evaluating managers, selecting investment projects, pooling risks and providing
financial services to the same degree as a financial system that allocates
credit to the private sector, that government credit from banks in countries
with a highly regulated financial system is regularly captive and that lending
banks have no or less control over its use. (Digafie, 2011),
use. As a consequence, momentous credit allocation of the banking sector can be
accurately characterized by their lending to the private sector. Therefore in measuring such banks in such
countries will not reflect the management’s capacity, the incentives for banks
to have a competitive management will ne be reduced.
However, state - owned banks including Commercial Bank of Ethiopia,
the country’s biggest lender, are exempt as
they routinely finance long-term projects the government announced. A policy
directive has been issued to ensure banks provide funds for long-term
infrastructure projects.
The financial sector is
a significant component (10 percent) of Ethiopian GDP. The sector is dominated
by Government owned Enterprises (GOE)-financed institutions. The government
dominates lending, controls interest rates, and owns the largest bank (the
Commercial Bank of Ethiopia), which accounts for two- thirds of outstanding
credit. The central bank (the National Bank of Ethiopia) has a monopoly on all
foreign exchange transactions and supervises all foreign exchange payments and
remittances. (USAID, 2010)
According to the new banking regulations, the minimum
paid up capital requirement to form a new private commercial bank is ETB 500
million while the reserve requirement and the minimum interest rate on saving of
time deposits are respectively 15 percent and 5 percent (Biritu; 2011, SBB / 48
/ 2010).
The National Bank of Ethiopia has also issued
Directive No. SBB / 49 / 2011, limiting Board remuneration and number of
employees who sit on board of private banks board. According to the Directive,
annual board compensation to a director shall not exceed birr 50,000 and the
monthly allowances paid to a director shall not exceed birr 2,000 as of
January, 2011. However, private banks complain that this will hinder competent
individuals form joining the banks board of directors.
Cash is still the most dominant medium of exchange.
The use of checks is mostly limited to government institutions, NGOs and some
private business. Commercial banks in Ethiopia provide the same services with
the same operational style that they used to offer before decades. The common
banking functions provided by public and private banks in Ethiopia are deposit
mobilization, credit allocation, money transfer and safe custody. Banks in Ethiopia
are unable to improve customer service, design flexible and customized
products, and differentiate themselves in a market where product features are
easily cloned. Ethiopian banking is unable to come from long way of being
sleepy to a high proactive and dynamic entity. (Worku, 2010)
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 in 2009/10. Since the
introduction of the interbank money market in September 1998, merely
twenty-three transactions worth Birr 259.2 million were transacted with
interest rates ranging between 7 to 11 percent per year. The maturity period of
these loans widely spanned from overnight to 5 years. (NBE, 2009/10)
NBE directs the financial sector in Ethiopia through
direct policies and, methods. Interest rate liberalization was accompanied by
other reforms including the floating of the exchange rate and trade
liberalization. In the financial sector there was a move toward the use of
indirect monetary policy instruments, including reserve ratios, variable
liquidity ratios and liberalized market based interest rates. The government
took measures to remove the policy and institutional constraints in the
operations of Treasury bill and Treasury bond markets, including the attraction
of auction, reforms in the lending mechanism and issue of a broader range of
treasury bills. The period following the interest rate liberalization saw an
upward review of cash ratio and liquidity ratio aimed at regulating the
liquidity in banking institutions.
Capital markets are in initial stages of development.
The government issues a limited amount of 28-day, 3-month, and 6-month Treasury
bills. The non-banking sector remains largely undeveloped, except for 12
insurance companies with about 190 branches across the country. (USAID, 2010)
Although the banking industry in Ethiopia has about
hundred years of experience, it can be said that, the sector is not yet developed
and is still in its infancy or a growing stage. In addition to that, despite a
rapid increase in the number of financial institutions since the 1992 financial
liberalization, the Ethiopian banking system is still underdeveloped compared
to the rest of the world.
Following significant capital injection by the
private banks mainly Wegagen Bank, Awash International Bank, Dashen Bank, Nib
International Bank and Berhan International Bank, the total capital of the
banking industry showed a 16.7 percent increase to Birr 12.9 billion by the end
of June 2010. As a result, the share of private banks in total capital of banks
rose to 40.2 percent from 36.5 percent last year. Despite the continuous
increase in the capital base, the Ethiopian banking industry is still very
small even by African standard suggesting the need for further efforts to
enhance financial intermediation in the country. (NBE, 2009/10)
In addition to that, the efforts to introduce
competitiveness, the banking sector seemed to look an oligopolistic structure
for many years, with only a few institutions particularly state owned banks
controlling the majority market share in the sector. The financial system is
also characterized by repression factors including negative real interest
rates, inefficiency in financial intermediation and non – existing or underdeveloped
financial markets.
2.4 The Structural Shift in the
Ethiopian Economy
Before analyzing
the financial sector particularly the private banking sector in Ethiopia it is
helpful to understand the structure and sectoral background of the Ethiopian
economy. Therefore, like any other business organization banks operate in an
economy therefore understanding the structure of the Ethiopian economy is
important. For a long period of time, it is repeatedly said that the structure
of the Ethiopian economy is based on agriculture.
Since
agriculture contributes approximately 47 percent of the Ethiopian GDP, and
since more than 60 percent of agricultural production remains within the
household, or is traded between households at the village level, without
reference to a commercial market, roughly 30 percent of the GDP is therefore
only quantifiable through agricultural production estimates. In the past,
estimates of production have varied considerably. It is the rate of change
rather than the absolute level that is of greatest significance to the
performance of the economy overall, and will indicate with a useful degree of
accuracy whether or not conditions may be improving or deteriorating. (USAID,
2010)
When we see the
Ethiopian economy, according to Access Capital research without much notice,
the services sector has—for the first time in the country’s history—overtaken
agriculture as the largest segment of the Ethiopian economy. This reverses a
centuries-long economic structure, wherein agriculture was the dominant sector,
followed in a distant second place by the services sector, and lastly a very
small industrial sector. The recent release of FY 2008/09 GDP statistics,
however, revealed that the service sector is now clearly at top, comprising
45.1 percent of GDP, followed by agriculture at 43.2 percent, and Industry at
just 13.0 percent. The customary shorthand description of the Ethiopian
economy—as being overwhelmingly agriculture-based—has thus just become
obsolete. (Access Capital, 2010)
In the year 2010/11 financial year also this
structural shift in the Ethiopian economy has continued. According to (NIB, 2011) quoting MOFED
Ethiopia registered a growth of 11% during the 2010/11 financial year. This
growth is driven by the industrial sector (14%), followed by the services (12%)
and agriculture sector (8.5%). The service sector constituted about 46.2% of
the GDP, where as the agricultural sectors share declined to 40.6%. This
remarkable growth in services was mainly attributed to rapid expansion in
financial intermediation, public services, hotels & restaurants, and real
estate business activities.
The financial deepening, the proxy of financial
development/deepening measures the degree of monetization in the economy. It
shows the real size of the financial sector of a growing economy in which money
provides payment and saving services. Between 1993 and 2010 the average broad
money to GDP ratio has also increased by 17 percent on average and stood at
25.6 percent at the close of June 2010. (Degafe, 2011) and the increase in
monetization of the economy clearly provides a large opportunity of private
commercial bank. Share of
This shows that as the Ethiopian economy is shifting
from the less income generating primary agricultural sector towards a modern
and more productive and profitable service and manufacturing sectors, the
opportunities that will provide itself to the banking sector particularly to
the private commercial banking is significant. Of this service sector
development the private banking sector has considerable share, Access Capital
estimates that Financial Intermediation , which the businesses of private banks
are part of , its growth in GDP share of
services for the year 2008 / 2009 of the total services sector growth of 7.1 ,is
about to be 0.9 .
2.5 Monetary Policy,
the Role of NBE
Before this period there was no separation between
the central bank and commercial banking activities, but in 1943 the foundation
of the State Bank of Ethiopia, with two separate departments exercising,
respectively, the functions of an issuing bank and those of a commercial bank.
A final reorganization in 1963 created the Central Bank in its present shape.
By virtue of the Proclamation No.207, of 7 July 1963, the State Bank of
Ethiopia was discontinued as of end of 1963 and its assets and liabilities were
taken over by two separate banks, the National Bank of Ethiopia and the
Commercial Bank of Ethiopia .In this functionality more specialized banking
system, the National Bank of Ethiopia has since then exercised the typical
functions of a Central Bank. NBE continued its supervision activities until the
1974 revolution.
After the Revolution, under state socialism
(1974-91), popularly referred to in Ethiopia as the ‘Derg regime’, financial
institutions were basically executing the economic plans outlined by the
central planning organ. In that period regulation and supervision were not
critical because the national plan regulated and directed the activities of
financial institutions. Moreover, financial institutions were directed to
finance some public projects that may not have passed proper financial
appraisal but were simply based on either ideological grounds or ‘merit wants’
arguments. (Geda, 2006), therefore during the time of the Dergue there were
only state owned banks and they were also mere instruments of policy
implementation of the socialist government.
Hence, the
socialist oriented banking prototype reduced the entire banking industry to
four banks, namely the National Bank of Ethiopia (NBE), the CBE, Agricultural
and Industrial Development Bank (AIDB), and Housing and Saving Bank. And all
this restructuring and reorganizing was performed under the legal force of
proclamation No. 99 of the 1976 which has supervised the 1963 proclamation.
(Biritu, 2008)
To guide any
economy to the intended direction the government has two policy alternatives at
hand. The first one is fiscal policy the other one is monetary policy. Fiscal
policy mainly deals with government expenditure and revenue. While monetary
policy is about setting interest rates , determining the money supply and
generally supervising the banks and other financial institutions operating in
the economy. In the Ethiopian economy, the National Bank of Ethiopia (NBE) is
at the top of the banking system, which serves as the central bank and monitors
all financial institutions including private and government owned commercial
banks, insurance companies and microcredit institutions.
Nonetheless, in a free market economy monetary policy
is one of the instruments of the government and specifically the central bank
to guide the economy in an appropriate direction. Monetary policy of central
banks in a simplified analysis amounts to the determination of the “optimal”
quantity of money or (in a dynamic sense) the optimal rate of growth of the
money stock. But there is more to monetary policy than the determination of the
optimal stock or growth rate of money. More generally, monetary policy refers
to a bundle of actions and regulatory stances taken by the central bank
including all of the following. (NBE, 2009)
It is
self-evident that monetary policy plays an important role in the performance of
an economy. However, the effectiveness of the policy in achieving the intended
goal largely depends on the institutional factors that constrain or facilitate
the implementation process of the policy. In what follows the monetary policy
framework of the National Bank of Ethiopia is that detailing the monetary
policy objectives, the targeting framework, the instruments of monetary policy
and legal & institutional framework of the monetary policy decision-making
structure as well as the exchange rate regime of the country. It employs many
policy instruments, to implement its policy objectives.
The ultimate objective of policy makers and
regulatory authorities is to minimize inefficiency in the banking sector, in
order to realize a number of benefits. First, more efficient banks will
intermediate more funds, offer a wider range and better quality of services to
clients at competitive prices. The second benefit is that banks become more
profitable and therefore investors would expect higher dividends. Third, as a
result of increased profitability, investor confidence is boosted, thereby
attracting more capital in addition to an increase in internally generated
retained reserves thus bolster capital accumulation. This increases the safety
and soundness of the banks, and hence the stability of the financial system
which means a reduction in the risk of bank failures and the pertinent costs. (Tefula, 2002)
The principal objective of the monetary policy of the
National Bank of Ethiopia is to maintain price & exchange rate stability
and support sustainable economic growth of the country. Price stability is a
proxy for macroeconomic stability which is vital in private sector economic
decision on investment, consumption, international trade and saving. Finally,
macroeconomic stability fosters employment and economic growth. Maintaining
exchange rate stability on the other hand is considered as the principal policy
objective of NBE so as to be competitive in the international trade and to use
exchange rate intervention as policy tools for monetary policy to affect both
foreign reserve position and domestic money supply (NBE, 2009).
It is crucial that financial institutions are soundly
and prudently managed. Regulators have a strong interest in ensuring that there
is effective corporate governance at the entire financial industry for they are
entrusted to safeguard the interests of present and future depositors and
policyholders, beneficiaries and insurance claimants. (Shifa, 2011)
As NBE put on its quarterly report , the monetary
policy has continued to be geared towards containing inflation and inflation
expectations .The harmonized and tight monetary and fiscal policy measures
taken since 2007/08 have brought about promising results as annual average
general CPI inflation tumbled down to 18.7 percent in September 2009 from 37.2
percent same period last year. It also registered a 48.6 percentage point
decline against the previous quarter. Meanwhile, annual change in CPI
decelerated to -4.1 percent from 59.6 percent a year ago due to the same
effect. (NBE, 2009)
For example, after a two-year period of very tight
bank-by-bank credit ceilings, the lending restrictions imposed on Ethiopia’s
private banks, the central bank’s Vice Governor announced that the long-standing credit ceilings imposed on
Ethiopia’s private banks were finally removed on April 1, 2011. This was done
with several strings attached, however, including instructions that private
banks henceforth offer 27 percent of their loans to the government and do so at
an interest rate of just 3 percent. The new directive: (i) applies to
gross new disbursements per month; (ii) covers all “loans and advances”; (iii)
designates “National Bank of Ethiopia Bills” having five-year maturities as the
sole eligible government financial instrument that private banks must purchase;
(iv) applies retroactively to all private bank loans given since July 1, 2010,
and; (v) excludes the Commercial Bank of Ethiopia and the Development Bank of
Ethiopia. (Access capital, 2011)
Currently the ,main direction of NBE is that it is
focusing on compliance-based supervision , but as the economy grows and more
banks join the sector the supervision should focus to risk-based banks
supervision . That is as many banks operate and banks become more exposed to
and engaged in high risk financial activities, NBE as the central bank and
financial regulating and supervision authority should have the capacity to
assess the risk level to which these a banks are operating .
One of the reasons presented by NBE for to not
allowing foreign banks is that, NBEs supervisory capacity is not sufficiently
developed, it may be difficult to regulate these technologically advanced
foreign banks and secondly private commercial banks are newly established and
need some time to strengthen their capacity before allowing foreign banks to
enter the domestic financial sector.
(Biritu, 2008)
In addition to that, as the Ethiopian economy
integrates to the rest of the world economy, and as Ethiopia becomes a member
of the WTO which inevitably invites foreign banks in the Ethiopian economy, the
supervision capacity on NBE should be enhanced.
2.6 The Structure of
the Banking System
The structure of the Ethiopia banking sector can be
explained into two categories. The first is before the reform that is a pre-
reform period and the second is after the reform in the finance sector. This
reform refers to the major reform that was introduced to allow private
commercial banks into the sector.
2.6.1 Banking Sector
Reforms in Ethiopia
The NBE has made
numerous reforms in the Ethiopian banking sector. When EPRDF came to power the
main reform it introduced was that, before that time private banks were not
allowed to operate in the Ethiopian economy. EPRDF changed that and allowed the
private commercial banks to operate on the economy. This can be taken as the
main reform in the banking sector, particularly private banks concerned. After
that there are number of minor reforms the NBE introduced.
The pre-reform
period refers to the period 1974 to 1991 (the Derg regime). During this period
all private banks were nationalized. The National Bank of Ethiopia was at the
apex of the banking structure and was engaged in all the functions of a central
bank. CBE, AIDB (DBE), HSB (CBB) were in operation during this period. In
addition to these banks, there were also two other financial institutions:
Ethiopian Insurance Corporation (EIC) and the Pension and Social Security
Authority (PSSA).The CBE, followed by the DBE, were and remain the most
important banks in the country both before and after reform. Owing to the
dominant position of these two banks, their major activities and performance is
discussed at length below. This helps to provide a picture of banking activity
in the country both before and after the 1992 reform. (Geda, 2005)
After the 1991
government change, the provision of Licensing and Supervision of Banking
Business Proclamation no.84 / 94 and the 1960 commercial code of Ethiopia, many
private commercial banks flourished in to the business.
After the 1992
reform, in Ethiopia there are 13 privately owned banks 3 government owned
banks, of the there state owned banks, Development Bank of Ethiopia is a bank
that gives long term loans particularly for industries where as the rest the
private and commercial bank including the Commercial Bank of Ethiopia and
Construction and Business Bank give retail commercial banking services. They
accept deposit, provide loans and do the money transfer services.
The degree to which banks collect cash and generate
deposits stand for the degree of financial intermediation. By excluding,
currency out side banks from broad money supply, using this measure of
financial development in Ethiopia, was just 3.8 percent in 1971 increased to
12.5 percent in 1993. After the economic reform of 1993, it rises by about 18.3
percent annual average and reached 24.0 percent in 2010, significant
developments occur. (Degafe, 2011)
Since their
introduction, the role of private commercial banks has become increasingly
important. And the demand deposits mobilized by the private banks increased,
the loans dispersed by them also increased, and there is a significant shift
from the dominantly state owned banks controlling the finance sector in many
areas and towards privately owned commercial banks.
Banks, insurance companies and microfinance
institutions are the major financial institutions operating in Ethiopia. The
number of banks reached 16 of which 13 were privately owned. According to NBE
(2010/11) the total number of branches has reached to 712, and from this 38.6
percent of branches of banks are found in Addis Ababa. Yet Ethiopia remains one of the most under
banked countries in the world given its population is more than 84 million.
Some 37 percent of the total bank branches were located in Addis Ababa. Of the
total bank branches, the share of private banks slightly grew to 58.4 percent
from 57.1 percent in the previous quarter of the 2009. (NBE, 2009)
Even if the ratio of private
credit to GDP rose after the reform , according to (Access Capital 2010) calculation
, as of June 2010, private banks held Birr 38.3 billion in deposits, of which a
minimum of Birr 5.7 billion—or 15 percent—was already held at the central bank
as a reserve requirement, Birr 21.4 was lent out to borrowers, thus leaving
Birr 11.3 billion in estimated excess reserves; since this estimated June 2010
excess reserves figure has likely risen by around 20 percent over the last nine
months, it should now be near Birr 14 billion compared to the Birr 11 billion
in newly mandated NBE Bill purchases). The significant magnitude of this
diversion of funds is also evident when seen in relation several key economic
measures: it will amount 2.4 percent of GDP, 12 percent of total government
spending, and 90 percent of the government budget deficit this year.4 In USD
terms, the magnitude of the diverted funds will be around $650 million, which
implies that the contribution of private banks will be as much as 65 percent of
all foreign grants received. That the new directive will be very successful in
raising a large sum of money for the government, and thus in contributing to
the five-year plan’s financing objectives, is thus not in doubt; what is
debatable, however, is whether the appropriation of such a significant sum of
funds by the government is actually superior to what might have otherwise been
an allocation of the same sum of funds by private banks themselves.
The total capital of the banking system reached Birr
11.3 billion at the close of the 2009/2010 quarter, showing a 2.1 percent
increase. The private banks together owned 36.4 percent of the total capital.
Commercial Bank of Ethiopia, the largest commercial bank of the country,
accounted for 44.6 percent of the total capital of the banking system.
When we see share
of Public banks branch it is 41.6% while private banks share 58.4% while the
total capital of public banks is 63.6% while private
banks capital is 34.4%. This shows that in terms of branch coverage
private banks are in a better position than publicly owned banks but when we
compare the their capital base state owned banks have a superior position the
private banks .
The quarterly 2009 NBE report also showed that, of
the banks collected a total Birr 6.2 billion in loans and advances, which was
10.4 percent lower than the same period last year. Accordingly, private banks
collected Birr 3.4 billion (54.5 percent of total loans settlement); while
public owned banks collected Birr 2.9 billion. About 77 percent or Birr 4.8
billion loan was collected from private sector followed by public enterprises
(12.1 percent) and cooperatives (9.6 percent).
This is the case it is also true that the market
share of state owned banks is higher in Ethiopia, bank concentration, defined as the asset share of the three
largest banks is 87.9 percent in Ethiopia, which is the highest in East Africa.
Indeed, the Ethiopian banking sector is dominated by one large state-owned
bank, the Commercial Bank of Ethiopia (CBE).
In 2004, there were three state-owned banks and six private banks. The
asset share of the CBE was 66.3 percent, while the share of all three
state-owned banks was nearly 80 percent. These results clearly indicate the
dominant state control of the Ethiopian banking sector. (Stern, 2008)
2.7 The Prospects for
Private Commercial Bank
Obviously, as the Ethiopian economy grows it creates
a lot of potential for private commercial banks. Their customer base expands
and Ethiopia is also a country with a large population and this is one of the
indicators that the untapped potential in the sector is immense. Not only that,
since foreign investors are not allowed in the sector, investment in the
banking sector is attractive to domestic investors than other sectors.
And that the bank’s share price is presumed to
rise and the high yields to continue and thrive, selling shares to easily raise
more equity capital from the market. However, there is no absolute price of
shares, as the value of a share is what people who invest their monies in
public shares are prepared to pay for it. (Access capital, 2010)
While different kinds of businesses are
floating shares to raise capital to undertake various economic activities in
sectors such as brewery, cement, agro-industry, trade, transportation, oil,
eco-energy, and health; bank shares seemed more attractive, they seem unable to
raise the required capital to start their businesses from the share market
within the specified share floating period. The growing economy is sparking
more investment in the banking business, expanding the industry in which more
and more private banks are floating shares to raise capital in the public
market.
Given the good health of the economy, and attractive
profits declared in the private banking industry, investors are attracted to
invest to this sector with the hope that their future value of their shares and
yield. As a result, so far, many banks have floated shares to raise the
required capital to start a banking business.
But, there is no stock market in
Ethiopia and that the
share market is not regulated and the companies which float shares to the
public are unlisted; some banks have chosen auctioning their shares. Of course
that method is a good approach to testing the market value of shares in
addition to raising capital. If there is a stock market in Ethiopia the banking
sector will benefit because, it will enable them to easily raise capital and
their market price will be easy to know.
As Ethiopia is
also become a member of the World Trade Organization (WTO) it will boost the
growth of the economy and the market potential will expand. Reforms in the
sector specifically, liberalization of the finance sector is one of the
prospects of the banking sector. There are two arguments put forwarded , some
consider the joining of international banks in the Ethiopian economy as a
challenge, while others take it as a good opportunity for the finance industry
and for the private commercial banks .
2.7.1 Technologies Used in the Banking Sector
Nowadays , banks
can use advanced technologies and internet, networks, payment cards, Automated
Teller Machine (ATMs) and so on. This is one is of the prospects that enables
banks to increase the efficiency and productivity.
The banking business has continued realizing the
advantages of the cutting-edge information and communication technology. It has
become essential to effectively implement the appropriate technology to have
faster decision support and effective data integration in the financial
intermediary process and also to look for other avenues to augment income.
Concerning the sectoral outlook, there are emerging
initiatives to invest in electronic multi-service channels and also a tendency
to optimally utilize the available resources in a consortium, which partly
supports the effective implementation of the envisaged national payment system.
Additionally, the ongoing efforts of emplacing the electronic laws focusing on
the retail banking business are expected to have a positive effect on the
growth of the payment card business. These are other opportunities for banks to
expand their activities and ultimately realize a second-generation reform in
the Ethiopian financial sector (Dashen, 2009/10)
In this regard, private commercial Banks are still at
the forefront in effectively implementing modern banking technology and
value-added service provision. Withstanding the prevailing long attachment of
branch-based service channel, which is perceived to lead the society to only
value human interaction, we are succeeding in effectively implementing both the
branch-based and impersonal banking service channels. Though we have gone
through various challenges in popularizing and penetrating the market through
electronic delivery channels, we are now at the level of encouraging recognition
and flexibility to adopt the new habits as alternate service channels. We are
able to reap better returns by way of increasing non-interest income from
diversified service offerings and total solutions to the customers. (Dashen,
2009/10)
As it is known that the retail banking business
requires heavy investments to increase the number of branches, expand the ATM
network and establish various delivery channels, for example Dashen has registered
58 Area Banks, excluding the available 5 Foreign Exchange Bureaus.
Anticipating a further reduction in the processing
time and upholding service efficiency, we are attempting to continue
introducing modern banking services and further leverage our technologies to
provide the highest level of customer services and convenience, while keeping
cost of access to the minimum. We resolutely pursue taking unique initiatives
to reach for all relevant modern financial services and to up-hold the delivery
of convenience banking on a 24/7 base.
Ethiopian banking system is one of the most
underdeveloped compared to the rest of the world. In Ethiopia cash is still the
most dominant medium of exchange and electronic-banking is not well known, let
alone used for transacting banking business. All banks in Ethiopia except
Dashen Bank are too late to move with technological advancement and they should
clearly chart out the time schedule for their integration and technological
advancement. But it is a forerunner in introducing e-banking in Ethiopia, has
installed ATMs at convenient locations for its own cardholders. Different
services are available services on Dashen Bank ATMs. Currently, the bank gives
debit service only for Visa cards and its clients can withdraw up to 3,000 birr
in cash and can buy goods and services of up to 5,000 birr per day. Expanding
its leadership, it has also begun accepting MasterCard in addition to Visa
credit cards it began serving over two years ago. Dashen won the membership
license from MasterCard in 2008. (Worku, 2010)
To realize high quality service delivery standards,
Dashen Bank has kept on playing a leading role in the adoption of appropriate
modern banking technologies. Accordingly, the Bank has launched its mobile
banking service dubbed ‘Modbirr’ during the current year. The service will
entitle customers to conduct banking transactions using their mobile phones
anytime, anywhere. (Dashen, 2009/10)
Electronic Banking has been widely used in developed
countries and is rapidly expanding in developing countries. In Ethiopia,
however, cash is still the most dominant medium of exchange, and electronic
payment systems are at an embryonic stage. In the face of rapid expansion of
electronic payment systems throughout the developed and the developing world,
Ethiopia’s financial sector cannot remain an exception in expanding the use of
the system. Thus this study is conducted with the following objectives.
Many banks have changed their
system from the previous computer systems which does not have a centralized
database to different kinds of soft wares which can enable them centralized database processing as well
as distributed one. They have a network among their branches in different parts
of the country so that any branch can access the database from those branches.
This means all the branch banks
will have their own database of users, which as well be propagated to the
central server of the bank. This helps the recovery of data easier than that of
the previous system. If the servers at the branches crash the data can be
reclaimed from the central database since the data from the branches is
synchronized with the central server. The changes have not only affected the
software part, but also the hardware that the previous system used to use. This
includes the change in computers and network facilities and high
speed computers with high memory and hard disk capacity have been introduced. (Yemam, 2005)
2.8 The Challenges of
Private Commercial Banks
Relatively
speaking private commercial banks are a new phenomenon in the Ethiopian
economy. They used to operate before the 1974 revolution but after that they
were nationalized and amalgamated with the government owned banks and they
start to operate after the demise of the Dergue regime demise. As they are new
to the economy, some of them are more new comers to the sector, so their
capital has not yet strengthened.
In addition to
that private banks were ordered by the NBE to buy government denominated bonds
and to buy Treasury bills which compromises their own decisions in the way they
think is profitable and add to their long term growth. Not only that the
unprecedented high level of on inflation at home and as well as internationally
is a new challenge the sector is facing, and traditionally the non – performing
loans are also a challenge. These challenges are raised and discussed below.
2.8.1 Non – Performing
loans (NPLs)
Lending is the provision of resources (granting loan)
by one party to another. The second party doesn’t reimburse the first party
immediately there by generating a debt, and instead arranges either to repay or
return those resources at a later date. Banks function as financial
intermediaries, collecting funds from savers in the form of deposit and then
supplying to borrowers as loans. Those functions benefit both the banks and the
borrowers (Semu, 2010).
Loans and advances are financial instruments,
originated from the banks themselves, by providing money to the debtors and it
is one of the most important activities of private commercial banks.
According to NBE , impaired losses are comprise
specific provisions against debts identified as bad and doubtful and general
provisions against losses which are likely to be present in any loans and
advances portfolio. And all private commercial banks follow the National Bank
of Ethiopia Supervision of Banking Business Directive Number SBB / 43 / 2008 in
determining the extent of provisions for impairment losses accordingly the
directive classifies loans and advances. And under this directive, non –
performing loans or advances past due 90 days or more, but less than 180 days
are classified as non – performing loans.
And also , in
addition to that ,according to NBEs directive number SBB / 48 / 2010 ‘non -performing loans’ means whose credit
quality has deteriorated such that full collection of principal and / or
interest in accordance with the contractual repayment terms of the loan or
advance is in question.
Non -performing loans can be defined as defaulted
loans, which banks are unable to profit from. Usually loans fall due if no
interest has been paid in 90 days, but this may vary between different
countries and actors. Defaulted loans force banks to take certain measures in
order to recover and securitize them in the best way. Loans become
nonperforming when it cannot be recovered within certain stipulated time that
is governed by some respective laws so non- performing loan is defined from
institutional point of view. (Ayalew, 2009)
The definition of non-performing loan varies across
economies. For Australia and New Zealand, they use the ratio of non-performing
assets to total assets in the banking sector. The definitions of non –
performing loans as defined by the NBE is that loans that are not repaid in
more than three months will be considered as non – performing loans.
It is widely accepted that the quantity or percentage
of non-performing loans (NPLs) is often associated with bank failures and
financial crises in both developing and developed countries. In fact, there is
abundant evidence that the financial/banking crises in East Asia and
Sub-Saharan African countries were preceded by high non-performing loans. The
current global financial crisis, which originated in the US, was also
attributed to the rapid default of sub-prime loans/mortgages. In view of this
reality it is therefore understandable why much emphasis is placed on
non-performing loans when examining financial vulnerabilities. (Khemraj, 2004)
Usually, in
Ethiopian state owned banks, since they give a lot of long term loans and to
some extent to they are prone to corruption and large size, they are more
exposed to non – performing loans than privately owned banks. However, Private
commercial banks are not immune from the exposure of non – performing loans,
especially in recent times the National Bank of Ethiopia also issued a
provision for private commercial banks to keep a certain amount of their profit
for non – performing loans provisions.
To show the seriousness of NPLS create to private
banks, using the classification of NPLs on directive no. 43 / 2007 which
requires NPLs to be classified into three bases (substandard, doubtful &
loss) based on their uncollected loans, out of which the total NPLs of private
banks to the lion share of the NPL is constituted by the loss loan category,
making the situation more challenging to private banks. During the year 2007,
the share of loss loan stood 46% of the total loan showing a decline from the
preceding years by large amounts, however for the next consecutive years, i.e.
2008 & 2009 its share has increased by larger amount and reached 56% &
60% respectively. High volume of loan loss NPL affects bank operation in terms
of losing income to be obtained from loan and the extra effort that the bank
will be forced to make to recover such
loans (Assefa , 2010) .
However, contrary to expectations, the evidences
reveal that large banks are not also necessarily more effective in screening
loan customers when compared to their smaller counterparts as there is no
significant relationship between the size of a banking institution and the
level of NPLs it reports.
Non-performing loans are also sensitive to
macroeconomic and bank specific factors. The existing literature provides
evidence that suggests a strong association between NPLs and several
macroeconomic factors. Several macroeconomic factors are important determinants
like the annual growth in GDP,
credit growth, real interest rates, the annual inflation rate, real effective
exchange rate, annual unemployment rate, broad money supply and GDP per capital
etc. (Khemraj, 2004)
To be specific there is significant empirical
evidence of a negative relationship between the growth in real GDP and NPLs;
the explanation provided by the literature for this relationship is that
strong positive growth in real GDP usually translates into more income which
improves the debt servicing capacity of borrower which in turn contributes to
lower non-performing loans. Conversely, when there is a slowdown in the economy
(low or negative GDP growth) the level of NPLs would increase. In addition to
that, several studies report that high real interest rate is positively related
to these NPLs.
The reason for this high interest rate is, other
researches say that using accounting decompositions, as well as panel
regressions, and credit risk and operating inefficiencies (which signal market power)
explain most of the variation in net interest margins across ten SSA countries.
Macroeconomic risk has only limited effects on net interest margins. Credit
risk is the main reason for higher interest rate. (Flamini,
2009) .This credit risk is the reason for the high interest rate and this leads
to high Non – Performing loans.
Apart from macroeconomic variables, there is abundant
empirical evidence that suggests that several bank specific factors (such as,
size of the institution, profit margins, efficiency, the terms of credit (size,
maturity and interest rate), risk profile of banks (measured by several proxies
including total capital to asset ratio and loans to asset ratio) are important
determinants of NPLs. (Khemraj , 2004)
Ethiopia also has a foreclosure law which gives
banking institutions wider rights than other institutions. Thus unlike other
creditors, creditor banks can be authorized by the debtor to sell the property
if he does not make the payment on time. In 2011, the National Bank of
Ethiopian has established a network of credit information systems for loans.
2.8.2 Inflation
From the Keynesian framework, changes in monetary
expansion induce changes in the nominal rate of interest through the portfolio
allocation behavior of asset holders. The analysis concludes an inverse
relationship between money and nominal interest rates, so that monetary
expansion leads to lower interest rates. Changes in the nominal rate of
interest are then translated to changes in real rates of interests, given that
the elasticity of the real rate of interest to money is positive. This implies
that nominal rates and expected inflows respond differently to change in
policy, with expectation adjusting slowly to the changing economic environment.
For monetarists the impact of a change in monetary policy on nominal rates of
interest is influenced by the rate at which expectations adjust to new economic
policy. With expansionary monetary policy the public expects a higher rate of
inflation and the nominal rate of interest rises as lenders anticipate that
demand will raise interest rates and borrowers will be willing to pay a higher
rate. (Ngugi, 1998)
Accordingly
expansionary monetary policy is the main source of inflation for the neo –
classical economists particularly monetarists, while for the Keynesians, the
cause of inflation has some differences.
According to
World Bank figures, per capita incomes nearly doubled between 2003 and 2008
(US$870 by 2008), as Ethiopia’s economy experienced double-digit growth rates
(11 to 12.5 percent) during this period. However, the inflation rate, measured
by the consumer price index, tripled between 2005/06 and 2008/09. Thus, growth
would have been more robust in the absence of double-digit inflation over the
past few years. Inflation levels have risen as a result of an economic
expansionary policy, coupled with a temporary shortfall in the availability of
food due to the combined effect of a poor 2008 Belg harvest and the global food
crisis. The CPI increased substantially in early 2008, peaked in June (prior to
the global food crisis), and declined substantially thereafter. (USAID, 2010)
Bank health is can also be measured by capital
adequacy and by the amount of non- performing loans (NPLs). Therefore, banks
which have capital adequacy problem and high rate of NPLs will be forced to decrease
lending.
Since recent
times inflation has become the main global and domestic economic challenge. Before
the 2008 Global Financial Crisis there was also inflation and as the economies
of Asian countries like China and India grew at a faster rate the demands
especially for raw materials rose, and it was mainly caused by international
demand hikes. But after the crisis many developed countries followed the policy
of financial easing and released their currencies into the global economy. And
increase in the money supply has created a massive global inflation and that is
felt here in Ethiopia.
But for the explanation for inflation is not as
simple as it looks, there are three factors that determine the price level in
Ethiopia: monetary factors, cost push factors and supply factors. The three
factors are not independent of one another. Rise in the price level due to
(say) rise in raw materials cost or exchange rate depreciation may have
budgetary implications. High budget deficits may, in turn, lead the government
into monetization of the deficits and hence growth of money supply. This, then,
may lead to another round of price hikes. Associated with such price rises is
the possibility of price‐price
and wage‐price spirals
as workers demand higher nominal wage rates to mitigate the rise in price. On
the other hand, contractionary monetary policies may lead to decreased investment
which may have consequences for the supply of real output. This, in turn,
brings about inflation pressure in the Economy. However, as the economy
experiences fast increase in income, if the supply of food falls short of the
fast growing demand, it may result in rising prices of food which may easily
and significantly transmit into general inflation. Recent developments in
Ethiopia seem to suggest that price movements are influenced not only by supply
factors, as the reported fast growth of agricultural products failed to lower food
prices of late, but also by demand factors (Geda, 2005).
To summarize, the most important determinants of the
food price inflation process in Ethiopia, in order of importance, are inflation
expectation, real money supply growth, foreign food price movements and real
income growth. In addition to supply and demand issues , money supply is also
the other reason for high inflation, however for as country like Ethiopia with
no developed financial markets the impact of increment in money supply will not
a have inflationary impact in a short period of time and it will take some time
to see the full impact.
In addition to this international price increases and
currency depreciations and devaluations will also aggravate inflation, first
they will increase domestic production costs, and second they will have a price
transferring effect to importers, traders and producers. This shows that
inflation has a deep root and it has far reaching spiral consequences. NBE also
considers the non-food prices as core inflation. The non-food inflation series
has been more stable over the period under review (1998 – 2009) than the food
and headline series. That means the severe fluctuation is more of the
characteristics of the food component of the index. It can also be understood
that along with other factors political stability and weather condition also
affect the prices significantly. (Biritu, 2011)
For Private commercial banks the high rate of
inflation has series implications. Since they give loans at a fixed rate of
interest as inflation rises their profit margin will be diminished. And as for
a long period of time the rate of inflation is higher than the deposit saving
interest rate, the depositors will be less motivated to deposit their money in
a bank.
Inflation is one of the macroeconomic risks; the
determinants of bank interest margins in Latin America using bank and country
level data. Spreads are large because of relatively high interest rates (which
in the study is a proxy for high macroeconomic risk, including from inflation),
less efficient banks, and higher reserve requirements. (Flamini, 2009) And its effect doesn’t limit
but also, it reduces the efficiencies of the banks and also forces the banks to
increase their reserve requirements.
From the traditional theory, nominal interest rates
adjust fully to the expected rate of inflation leaving real interest rates
unchanged. In his works, Irving Fisher held the same sentiments. He believed
that there is a positive relationship between expected future price increases
and nominal interest rate. An increase in price increases the nominal value of
trade, resulting in an increase in demand for money and leading to an increase
in nominal interest rate. lrving Fisher's theory is controversial, however,
particularly when it is interpreted as suggesting a constant real interest
rate. (Ngugi, 1998)
When we see it its negative impacts on the business
on private commercial, banks there is evidence of a positive relationship
between the inflation rate and non-performing loans. Inflationary pressures contribute to the high
level of impaired loans in a number of Sub- Saharan African countries with
flexible exchange rate regimes.
Inflation is responsible for the rapid erosion of commercial banks’
equity and consequently higher credit risk in the banking sectors of these
African countries. (Khemraj, 2004) therefore inflation increases credit risk
and depletes commercial banks capital.
The NBEs new
directive indicates that funds collected from “NBE Bills” shall be used for
priority sector government projects. As such, the bills will not be performing a sterilization
function of withdrawing funds from the banking system to control the growth in
money supply. Rather, the collected funds are simply being re-allocated from
what would have been spending by the private sector to what will now be
spending by the government, with the central bank serving as an intermediary.
Given this, it is clear that—even after this new directive—the central bank
remains without any effective sterilization instruments of its own that could
be used on a short-term basis to withdraw funds from the banking system as
needed for monetary control purposes. (Access capital, 2011)
This left the central bank not to have a market
mechanism to control monetary policy, like to increase or decrease the money
supply. This can be one of the reasons
that the NBE can’t control the rate of inflation effectively. Since recent
times NBE rather than using market based indirect regulatory instruments, like
increasing or decreasing the rate of interest, towards a direct monetary
policy.
USAID , 2010
warns that the combination of international factors, coupled with a high
underlying rate of inflation (greater than 15 percent) and the existing
restrictions in credit, have created conditions in which stagflation is
possible. The restrictions in the availability of credit may reduce farmers'
confidence in the market, which would limit productivity of the largest sector
contributing to GDP. In this case, stagflation is probable. Whether or not the economy
heads toward stagflation will depend upon the extent to which the ongoing
government spending program is able to create real opportunities for increased
domestic production. Over the last three years, government capital expenditure
has risen from ETB1.839 billion to ETB3.060 billion. Although this nominal
increase of 50 percent is closer to 30 percent in real terms, it is
nevertheless significant.
It appears that money has played a significant role
in the increased inflation following the significant rise in its growth since
2005; however, the monetary factor alone does not seem to explain it. Other
non-monetary factors have also contributed. (Biritu, 2011)
These price
increases have a major impact on economies of developing countries, like
Ethiopian and the banking sector in particular. Central Banks have a major role
in fighting inflation because they have the policy tools at their disposal to
bring a desired change. In this regard, National Bank of Ethiopia (NBE) is
expected to interfere to contain inflation and its negative effect.
The decision to
restrict growth in domestic credit to 17 percent of GDP could contain
inflation. However, it remains to be seen whether a good balance between
controlling inflation and maintaining growth will be achieved, if government
expenditure results in real increases in performance in agriculture and other
sectors, the Ethiopian economy may avoid its potential crisis. Credit control
measures may or may not be maintained and/or they may or may not be at a
suitable level to achieve the desired "soft lending." (USAID, 2010)
The concept of underlying inflation is a critical
issue for central banks in conducting the monetary policy. Short-term price
fluctuations may misrepresent the actual inflationary trend. Some temporary
events that cannot be addressed through monetary policy may cause problems in
the consumer price index. Such a situation creates substantial difficulties for
implementation of monetary policy. No matter what the target is, defining and
measuring the core inflation determines the direction of the policy. (Biritu,
2011)
2.8.3 The Exposure of the Private
Banks for International Crisis
These days the
international financial and economic situations are not reliable as used to be.
Especially after the 2008 financial crisis and the following European countries
immersed in debts, has created a situation were the global financial and
economic system became more and more unreliable. Some banks are financial institutions they
are directly or indirectly linked to the international financial environment.
Banking sector crisis don’t just come spontaneously,
it gives indications, and real GDP growth is considered as the direct measure
of the strength of the economy. Weak economic growth which indicates the coming
of recession often precedes financial crises. High inflation rate is often
related to macroeconomic instability and will adversely affect the banking
sector and the economy. These variables are commonly used in banking distress
studies. (Jin, 2009)
Given that NBE
intended to promote stability in the system by solving the problem of
under-capitalization, by raising the starting capital, a common deficiency of
private banking institutions and enables them to withstand these kinds of
international turmoils.
In
the Ethiopian case, the impact would not be significant on the financial sector
since it is not completely integrated with the global financial system. In
Ethiopia’s financial sector, mortgage borrowing is not a particularly
significant activity of the national economy, is not directly affected by any
“Sub-Prime Mortgage” crisis. However, it would be naïve to say that Ethiopia’s
economy will not be affected by the credit crunch or global recession or debt,
not least because a big chunk of the money spent in Ethiopia comes from those
countries that are now in despair. The money flowing into the country; be it
through investment, international aid, remittance, exports etc, are all subject
to this global phenomenon. (Paul, 2010)
Even though the
Ethiopian banking sector is not highly linked to the international finance, its
impacts are indirect than being direct and has smaller impact. As the 2008
world financial crisis changed itself into being an economic crisis, this has a
direct impact than the financial crisis itself. As there is no data for
individual banks loss, the general picture on the economic activity is visible
to some extent. Hence, no doubt
that global recession will have a knock-on effect on Ethiopia’s economy. For
donor countries to honor their pledges would be unrealistic when they are faced
with domestic economic instabilities.
Although the global financial crisis has not directly
impacted the Ethiopian financial sector, it has impacted the Ethiopian economy
in at least three ways. Remittances which have exceeded US$1.3 billion in past
years have substantially declined to less than US$800 million per year. Foreign
direct investment has also declined (currently less than 3 percent of all investment
applications result in actual investment), and donor pledges have also been
reduced , all of these factors increase pressure on the Ethiopian Birr and
reduce the effective value of domestic incomes so that the cost of importing
food continues to rise. (USAID, 2010)
2.8.4 Lack
of Appropriate Technology
Even though the current advanced technology available
is a good prospect for the development and growth of commercial banks, in the
current realities lack of appropriate and advances technology is one of the
challenges that private commercial banks are facing.
The customers of Ethiopian commercial banks have
missed to enjoy with the technological advancement in banking sector which has
been entertained elsewhere in Africa and the rest of the world. The modern
e-banking methods like ATMs, Debit cards,
Credit cards, Tele banking, Internet banking, Mobile
banking and others are new to the
Ethiopian banking sector. E-banking which refers to
the use of modern technology that
allows customers to access banking services
electronically whether it is to withdraw cash, transfer funds, to pay bills, or
to obtain commercial information and advices are not known in Ethiopia.(Worku ,
2010)
The main challenges for private commercial banks in
this area is that applications and seize the opportunities presented by ICT
applications in general. Key challenges for E-Banking applications are low
level of internet penetration and poorly developed telecommunication
infrastructure, lack of infrastructure for telecommunications, Internet and
online payments impede smooth development and improvements in e-commerce in
Ethiopia. Most rural areas of the country, where the majority of small and
medium businesses are concentrated, have no Internet facilities and thus are
unable to engage in e-commerce activities lack of suitable legal and regulatory.
High cost of internet, to access relative to per
capita income is a critical factor. Compared to the developed countries, there
are higher costs of entry into the e-commerce market in Ethiopia. These include
high start-up investment costs, high costs of computers and telecommunication
and licensing requirements
Absence of financial networks that links different
banks (Banks are not yet automated): Most of the banking-transactions currently
taking place using credit and debit cards supplied by Visa and MasterCard and
other card service providers. For conducting e-banking, the use of credit or
debit cards is important, thus requiring the need for specialized systems which
are not currently available. Frequent power interruptions, lack of reliable
power supply are some of the key challenge for smoothly running e-banking in
Ethiopia. Undeniably, there is also resistance to changes in technology among
customers and staff.
Develop a comprehensive regulatory and legal
framework for e-commerce and payment, raise public awareness on the use of ICT,
e-commerce, and e- payment, provide incentives for financial institutions to
invest rigorously on ICT and use of E -Commerce, and E-Payment, encourage the
current efforts to develop and expand ICT infrastructure.
However, private banks in Ethiopia are trying their
best to acquire sand to use, modern technologies. For example they use broad band local money
transfer, telephone banking, internet banking and SMS banking.
3 Banking Business Risks
3.1 Risk Management
Risk management
is one of the components of commercial banking operation. In their day to day
activities, commercial banks are exposed to various types of banking risks. And
the most important types of risks to which the banks are exposed are credit
risk, liquidity risk, foreign exchange risk, interest rate risk and operational
risk.
More recently, a number of studies have emphasized
the relation between macroeconomic variables and bank risk. There is pro-cyclicality
in operational, credit, and market risk exposures. Such cyclical effects mainly
result from systematic risk emanating from common macroeconomic influences or
from interdependencies across firms as financial markets and institutions
consolidate internationally. They may ultimately exacerbate business cycle
fluctuations due to adverse effects on bank lending capacity. Using equity
returns data over the period 1973–2003, by examining the catastrophic risk of
financial institutions. Results suggest evidence of pro-cyclicality in both
catastrophic and operational risk measurements, implying that macroeconomic,
systematic, and environmental factors play a considerable role in determining
the risk and returns of financial institutions. (Flamini, 2009)
When the institution takes risks that it cannot
measure or control, regulators must hold the board of directors accountable and
require that corrective measures be taken in a timely manner. Supervisors
should be attentive to any warning signs of deterioration in the management of
the institution’s activities. They should consider issuing guidance to
financial institutions on sound corporate governance and the proactive
practices that need to be in place. They should also take account of corporate
governance issues in issuing guidance on other topics. (Shifa, 2011)
In a number of countries, financial institutions’
boards have found it beneficial to establish certain specialized committees
including: a Risk management committee - providing oversight of the senior
management’s activities in managing credit, market, liquidity, operational,
legal and other risks. (Shifa, 2011)
The new dimension of risk management and compliance
require reporting of the bank’s culture, processes, coordinated activities, and
the structures that are directed towards realizing potential opportunities
and/or managing adverse effects. The respective banks’ board defines tolerance
limits for each risk level and key risk areas; usually they also update their ‘risk
register’ by virtue of a monitoring and reporting program of risk management.
Some of the
private commercial banks like United Banks have established a comprehensive
Risk Management System in line with internationally accepted risk management
principles and best practices with the necessary adoption to suit their core
business activities.
The recent emphasis on effective corporate governance
has underscored the importance of robust risk management oversight at the board
level and the need for the board to set appropriate corporate policies and
strategies to prevent excessive risk taking. (Shifa, 2011)
At last, a bank should
sustain no such ‘risks of impairment’ and be able to maintain their ‘integrity
up to the interest of all stakeholders’ ensuring that all applicable laws,
rules and regulations are being complied with. Besides, in accordance to the
directive issued by the NBE; the private commercial banks should honor all
compliance duties with respect to customer due diligence, “Know Your Customers”
and “Anti-Money Laundering/Counter Terrorist Financing”. Banks not only protect
themselves from risk but they should also respect the rules and shouldn’t cause
a risk to others. There are also operational challenges, and risks. But these
risks are common to all commercial banks. And they are considered as a challenge.
3.2 Foreign Exchange Risks
Foreign exchange
risk results in changes in the exchange rates between a banks domestic currency
and other currencies. Foreign exchange risks are controlled by maintaining
major currencies whose exchange rate against the reporting currency has always
been appreciating. Banks settle foreign exchange transactions of customers at
the exchange rate prevailing on the date of the transactions. Hence, customers
bear the cost of the increase in the exchange rates.
In numerous
private commercial banks there is a so called Assets and liability Management
Committee, and it is this committee that is responsible to implement the system
designed to affectively manage and control foreign exchange risk.
3.3 Interest Risks
Interest rate
risk is a risk resulting from changes in interest rate. It is probability that
the rising / falling interest rates will adversely affect the banks interest
margin or the value of its net worth. The bank often revises its lending rate
across segments of the credit portfolio based on the change s in the cost of
fund, reserve requirement and the perceived risk in each credit portfolio
segment to keep the overall profitability.
Traditional theories define interest rate as the
price of savings determined by demand and supply of loanable funds. It is the
rate at which savings are equal to investment assuming the existence of a
capital market. The loanable fund theory argues that interest rate is
determined by non-monetary factors. It assigns no role to quantity of money or
level of income on savings, nor to institutional factors such as commercial
banks and the government. (Ngugi, 1998)
In a study of United States banks for the period
1989–93, net interest margins reflect primarily credit and macroeconomic risk
premia. In addition, there is evidence that net interest margins are positively
related to core capital, non-interest bearing reserves, and management quality,
but negatively related to liquidity risk. Macroeconomic volatility and
regulations have a significant impact on bank interest rate margins. Their
results also suggest an important trade-off between ensuring bank solvency, as
defined by high capital to asset ratios, and lowering the cost of financial
services to consumers, as measured by low interest rate margins. (Flamini, 2009)
The liquidity theory, on the other hand, looks at the
interest rate as the token paid for abstinence and inconveniences experienced
for having to part with an asset whose liquidity is very high. It is a price
that equilibrates the desire to hold wealth in the form of cash with the
available quantity of cash, and not a reward of savings. Interest rate is a
function of income. Its primary role is to help mobilize financial resources
and ensure the efficient utilization of resources in the promotion of economic
growth and development. (Ngugi, 1998)
In the Ethiopian
private commercial banks ,Asset liability Management Committees are responsible for managing rate – sensitive
assets and liabilities and the effects of rate, volume and mix changes so as to
preserve and optimize the interest return.
3.4 Credit Risks
It is a risk in
relation to a financial institution is the risk arises if a customer, bank or
other counter party will not meet its obligation (or to be permitted to meet
them) in accordance with the agreed terms , and as the banks counter –
parties are highly rated and its credit
risk will be very low . (NBE, 2009/10)
Credit risk is
the financial exposure resulting from a banks dependence on another party to
perform an obligation as agreed on a lending business. Commercial banks have
credit risk management system on the bases of maximizing return on its assets
while keeping its credit exposure with in acceptable limits, they also
regularly review the credit portfolio quality, provisioning requirements, and
customer exposure.
There are also
credit risk management committees that are responsible to implement the credit
risk management policy of the banks. Usually bank loan portfolios are
diversified in various sectors and this reduces their exposure to certain
economic sectors. In addition to this
the credit information system that NBE established also enables banks from over
financing or double financing of the same project.
To prevent this risk the credit information system
plays a very important role not to over finance, or not to double finance a
given project, and to cross check the credibility of the borrower.
3.5 Operational Risk
Operational risk is the risk of direct or indirect loss
resulting from inadequate or failed internal processes, people, and systems or
from external events or unforeseen catastrophes. Banks manage their operational
risk through putting in place sound policies, procedures and manuals, strong
oversight and supervision and internal control.
Many of the private commercial banks have Operational
Risk Management Committee which serves as facilitator and coordinator to ensure
that operating risk management is brought up to a common standard of awareness
and professionalism to match the best in other areas of banking risks .
Banks are also obliged to observe ,Anti- Money
laundering / AML / Combating Terrorist Financing / CTF regulations; anti money
laundering regulation require banks to know their customers and implement
process for combating money laundering as well as putting in place measures
aimed at understanding regulations as it affects the banking industry and the
implication for non compliance . Private commercial banks in Ethiopia have Anti
Money Laundering / Combating Terrorists Financing Manual, incorporating
guidelines for know your customers (KYC) and the risk management and compliance
departments or divisions are in charge of undertaking the compliance issues
related with AML/ CTF.
3.6 Market and Liquidity Risks
Liquidity risk
arises in the general funding activities of the banks and the management of
positions. It includes the risk of being unable to fund assets at appropriate
maturation and rates and the risk of being unable to liquidate an asset at a
reasonable price and in appropriate time frame. Normally banks have a
reasonable price funding base. Funds are raised mainly from the customer’s
deposits.
The banking
sector’s exposure to interest rate risk is limited. Most of the interest rate
risk is (both domestic and foreign) has been shifted to bank clients and
appears to materialize through the credit risk channel in the event of adverse
developments. This is because the loan contracts (including fixed interest rate
loans) often allow for pertinent interest adjustments by carrying safeguard
clauses. (ECB, 2010)
Because of this
market risk remains limited and has decreased over time and given that most
bank loans are issued with de facto variable interest rates, interest rate risk
is limited in the banks balance sheet. That is exposure of to interest rate
fluctuations is largely passed on to the borrower, this represents an
additional source of indirect credit risk. Liquidity risks increase, whenever
the ratio of liquid assets to total assets declines.
In many private
banks , Asset and liability management committees are responsible in managing
funding mismatch and attaining desirable level of liquidity in the manner
described in the risk management policy of the financial statement analysis of
the contractual maturities of assets and liabilities.
4 Theoretical Literature Review
4.1 Performance Measurements in Banks
There are different ways to
measure commercial Banks performance. There are many applications of Data
Envelopment Analysis (DEA) in measuring the performance of the bank industry.
That the recent DEA studies have examined almost all of the banking sectors
around the world. DEA has been used widely to measure profit efficiency,
technical efficiency, allocative efficiency, scale efficiency, effectiveness
and productivity of banks. There is a considerable amount of discussions
regarding the selection of input and output variables for banks. Emphasis that
details on inputs and outputs of each model can be determined based on the
specific questions at hand, and the availability of data enables the researcher
to implement a researcher by using a multi – stage DEA analysis of many banks
in different countries.
DEA is a linear programming method initially
developed to measure the comparative performance of homogeneous organizations.
Another recently developed financial measurement is EVA which determines if a
business is earning more than its true cost of capital. EVA considers the cost
of equity capital employed, whereas other traditional measurements do not (Popa
et al. 2009).
Several techniques have been suggested in literatures
to measure banking efficiency, based either on econometric techniques
stochastic frontier approach (SFA), distribution-free approach (DFA), thick
frontier approach (TFA) or linear programming tools (data envelopment analysis
(DEA), free disposal hull (FDH). A few studies have then been performed to test
the robustness of the results generated by these approaches, that even if the
approaches provide quantitatively different results because of different
assumptions, they can generate similar rankings of efficiency scores and
consequently give consistent results in terms of ordering, and the correlations
will be measured between the efficiency scores. (Weill)
DEA is also a nonparametric
method in operations research; it is used for the estimation of efficient
frontiers and to measure the efficiency of decision making units (DMUs) such as
banks. DEA technique calculates a relative score for each DMU (which is bank in
this study) based on frontiers in the sample. The parametric approach includes
stochastic frontier analysis, the free disposal hull, thick frontier and the
Distribution Free Approaches (DFA), while the non-parametric approach is Data
Envelopment Analysis (DEA) (Sathye,
2009)
Bank performance is explained in terms of its capacity to generate sustainable profi
tability. Profitability is a bank’s first line of defense against
unexpected losses, as it strengthens its capital position and improves future
profitability through the investment of retained earnings. An institution that
persistently makes a loss will ultimately deplete its capital base, which in
turn puts equity and debt holders at risk. Moreover, since the ultimate purpose
of any profit-seeking organization is to preserve and create wealth for its
owners, the bank’s return on equity (ROE) needs to be greater than its cost of
equity in order to create shareholder value. (ECB, 2010)
Therefore, identifying the effect
of the performance and risk in earning profit is vital; especially, in the long
term. Derived from the importance of risk and return view a DEA model is
defined as a measure the performance and risk in which the selection of inputs
and outputs has been carried out based on ROA and financial leverage concept. It
also determines the position of each bank in the two dimensions of performance
and risk. (Motlagh, 2011)
Traditionally banks used profitability measures like
return on equity (ROE), return on asset (ROA) and return on investment (ROI) ,
net banking income , efficiency ratios , benchmarking , cost per each completed
loan, cost per thousand of dollar ,total number of loans per employees are some
of the to measure their performance. Particularly, measures like ROA and ROE
are financial performance measures and traditional. Also banks used operational
measurement such as monetary output per staff number and operating expenses per
unit of output (Chung, 2006).
The traditional performance measures are similar to
those applied in other industries, with return on assets (ROA), return on
equity (ROE) or cost-to-income ratio , return on Investment (ROI), net banking
income, efficiency ratios, benchmarking,
cost per each completed loan, cost per thousand dollar of loans, total number
of loans per employees are being the most widely used. In addition, given the
importance of the intermediation function for banks, net interest margin is also
typically monitored. The return on assets (ROA) is the net income for the year
divided by total assets, usually the average value over the year.
Although net income gives an idea of how well a bank
is doing, it suffers from one major drawback: It does not adjust for the bank’s
size, thus making it hard to compare how well one bank is doing relative to
another. A basic measure of bank profitability that corrects for the size of
the bank is the return on assets (ROA), which divides the net income of the
bank by the amount of its assets. ROA is
a useful measure of how well a bank manager is doing on the job because it
indicates how well a bank’s assets are being used to generate profits.
(Measuring bank performance, chapter12)
Alternative approaches to measuring banks’
performance may require a deeper analysis
of the way in which banks run their business and make
use of their stress-testing results, or even further enhancement of their
high-level discussions with supervisors on consistency between performance and
business strategy. This may eventually call for more transparency from banks on
their profitability structure, and some adjustment in the governance process, as
suggested in the proposals for enhancing (ECB, 2010)
However, the analysis
points to an initial limitation of ROE, namely that it is not risk-sensitive. A
decomposition of ROE shows that a risk component represented by leverage can
boost ROE in a substantial manner. Other risk elements, on the other hand, are
missing in the ROE figure (e.g. the proportion of risky assets and the solvency
situation). ROE is therefore not a stand-alone performance measure, and
decomposition or further information is necessary to identify the origin of
developments and possible distortions over time. The recent crisis has shown
how ROE failed to discriminate the best performing banks from the others in
terms of sustainability of their results. ROE is a short-term indicator and
must be interpreted as a snapshot of the current health of institutions. It
does not take into account either institution’s long-term strategy or the
long-term damages caused by the crisis. Its weaknesses are even more obvious in
times of stress, when there is a climate of uncertainty surrounding the
medium-term profi tability of institutions. (ECB, 2010)
Bank health is can also be measured by capital
adequacy and by the amount of non- performing loans (NPLs).In challenging times, extraordinary elements in
challenging times, extraordinary elements may become very significant, but fail
to appear in reported ROE measures. As a matter of fact, ROE does not reflect
the sustainable performance of a bank, if the change comes from a one-shot
element that cannot be reproduced in the future. ROE from continuing operations
proves to be more relevant for comparing institutions and assessing operating
performance accurately.
ROE measures more generally fail to take into account
measures with a long-term impact (e.g. restructurings and consolidation), there
by posing an additional challenge to performance analysis. After the 2008 US
financial crisis and the European countries also sank deep into debt, the stake
in the sector is high that failure in the banking sector will transmit to the
rest of the economy and, not only for the banks health but also for the
activity of the economies as a whole, proper performance measurement and
supervision are critical.
The European Central Bank (2010) says that over the
crisis, ROE may have provided misleading information in differentiating good
performers from bad ones. In that context,
analysis was performed on a sample of 12 large
European and US banks to point out the dynamic of ROE (evolution and drivers)
over the different phases of the crisis. This indicates a high homogeneity of ROE
levels. Indeed, the dispersion (as measured by the interquartile range)
remained low and more or less constant. This trend changed in the second half
of 2007, when ROE registered a sharp downturn. The increase in dispersion of ROE
was mainly driven by the worst performing banks. This means that ROE failed to
show the coming crisis and only after the crisis occurred it reflected the
disparities among the performances of the banks.
Quantitative performance measurements
are incomprehensive as they lack qualitative elements such monetary policy,
regulation and supervision, financial sector openness, institutional
environment, financial sector and non-bank financial sectors, the management
style and risk taking behavior of the bank itself. The researcher argued that
these qualitative components are equally important in constructing
comprehensive index of financial sector development in addition to quantitative
indicators/ratios and hence any financial sector indicators lacking these
qualitative elements could not be complete enough to capture the true level of
the sector (Creane, 2004)
And the European Central Bank (2011) recommends that
Alternative approaches to measuring banks’ performance may require a deeper
analysis of the way in which banks run their business and make use of their
stress-testing results, or even further enhancement of their high-level
discussions with supervisors on consistency between performance and business
strategy. This may eventually call for more transparency from banks on their
profitability structure, and some adjustment in the governance process. Among
other things, these measures comprise a reassessment of the risk function with
respect to its independence and the available tools and an adequate level of
risk awareness at the top-tier management level. As a result, there may be some
opportunity here for regulators to address these issues with bank managers .A
comprehensive performance analysis framework needs to go beyond that kind of
indicator – though not excluding it – and provide for a more “informed”
assessment, using banks’ business-based data and qualitative information.
4.1.1
Efficiency of Commercial banks
The efficiency of the banking system has been one of
the major issues in the new monetary and financial environment. The efficiency
and competitiveness of financial institutions cannot easily be measured, since
their products and services are of an intangible nature. Many researchers have
attempted to measure the productivity and efficiency of the banking industry
using outputs, costs, efficiency and performance. (Kosmidu, 2008)
The term “efficiency” is one of the key concepts for financial
institutions. It refers to the bank’s ability to generate revenue from a given
amount of assets and to make profit from a given source of income. It has been extensively studied due to its
importance. Mainly, the studies making typical comparisons of bank performance
can be divided into two categories: (1) those which use simple aggregate bank
ratios relating cost to revenues or assets, and (2) frontier technique which
measures a bank’s efficiency by its distance to the efficient frontier.
This approach, also known as Data Envelopment
Analysis (DEA), is a mathematical programming technique that measures the
efficiency of a decision-making unit (DMU) relative to other similar DMUs with
the simple restriction that all DMUs lie on or below the efficiency frontier.
It was first introduced by Charnes, Cooper and Rhodes in 1978. Since then its
utilization and development have grown rapidly including many banking-related
applications. (Denizer, 2005)
One of the advantages of DEA is
the ability of this nonparametric method to work with small samples and because
of limited number of banks so ,DEA has become more prevalent technique to
measure the performance of banks . Even though, there are some studies which
focused on measuring performance in banks, none of them have measured
performance and risk together as two key factors of profitability. (Motlagh,
2011) One of the strengths of DEA is its ability to provide information about
sources of inefficiency in both the input and output sides.
Fig.1 The Inputs and Outputs of the Stages
World Review of Business Research Vol. 1. No. 3.
July 2011. Pp. 1-12 Motlagh
A banking sector’s efficiency can be represented by
the average efficiency of its individual banks. An efficient and
well-functioning financial sector is essential for the development of any
economy, and the achievement of high and sustainable growth. It is well known
that efficiency in the banking sector is a key contributor to macroeconomic
stability. It is also a precondition for economic growth and important for the
effectiveness of monetary policy. Through the 1980s and until late 1990s many
African countries restructure their banking sector to achieve greater
efficiency.
Countries with the efforts to enhance the efficiency of
intermediation were also undermined by the presence of large, weak
government-owned banks, which accounted for most of the banking system’s
nonperforming loans (NPLs). (Podpiera, 2005) Several studies have also found that the performances of
private banks are typically better than state-owned banks. The large asset
share of state-owned banks may be a factor that inhibits growth, and
state-owned banks underperform relative to private banks. (Stern, 2008)
When we compare private and state owned banks,
although there has been much debate over the theoretical advantages and
disadvantages of state ownership, empirical evidence mostly supports the idea
that privately owned firms perform better than similar state-owned firms.
Empirical studies that have looked at private and state-owned banks have
reached similar conclusions. Credit growth, portfolio quality, profitability,
and productivity are higher in systems dominated by private banks. (Fuchs, 2007)
It is also hypothesized that branch expansion and
asset size have a negative impact on the cost efficiency of the banks while age
and capital size a positive impact. As the asset size and number of branches
expands, attention of the management may divert from cost minimization and
other routine administrative activities. As the age of the bank increases it
accumulates management expertise and would increase efficiency. Banks with
higher level of capital have the legal right to let single borrower use a
higher amount of money and then they reduce their transaction costs. In addition,
higher capital connotes more funds are available to lend to borrowers without
borrowing from other sources that require incurrence of additional costs.
(Ayalew, 2006)
However other researchers argue that, there is
ambiguous evidence across literature concerning the relation between efficiency
and size. In their analysis focusing on large banks, by observing differences
between large and small banks that vary depending on the country. No
relationship was found between efficiency and size when regressing cost
efficiency score on size. (Weill,
2006)
A greater degree of competition, as proxied by the
concentration ratio in the banking sector, is associated with greater deposit
penetration. This is in line with earlier studies that argue that competition
in the banking sector would increase efficiency, and in turn, would lead to a
larger variety of products and services offered to a larger depositor base. The analysis of the
correlation between the interest rate spread (lending rate minus deposit rate)
and deposit account penetration lends support to this argument. Countries with
lower interest rate spreads also show a higher number of deposit accounts per
1,000 adults. (WB, 2005)
This policy has also impact not only the
profitability of the banks but also on the economy as a whole, so as to obtain
the more direct measure of financial intermediation; credit extended to the
private sector is also used as an indicator of financial intermediation. It is
assumed to contribute more to increase investment and productivity to a much
larger extent than credit channeled to the public sector. On the other hand,
loans to the private sector are given more stringently and that the improved
quality of investment emanating from financial intermediaries evaluation of projects
viability is more significant for private sector credit. This series has also
shown an up ward trend over the sample period, but most after economic reform
of 1993 in Ethiopia. The Ratio of Private Credit to GDP raised from 6 percent in 1993
to 17.5 percent in 2010. (Degafe, 2011)
The funds that are diverted are significant , had
private banks themselves allocated the resource their efficiency and , the
expectation that the central bank would increasingly use market-based methods
to regulate economic activity—such as the use of interest rates that is now the
standard in most developed and emerging economies—does not appear to be under
consideration . In Ethiopia, the central bank uses of direct monetary policy
instruments rather than market based methods to regulate the finance sector.
Therefore the policy of the central bank has its own positive or negative
effect on efficiency.
In terms of accounting ratios as well as estimated
bank efficiency, findings suggest that foreign banks tend to outperform better
than domestic banks for the profit efficiency and that foreign bank entry
appears to have an impact on improving performance of domestic banks. In
particular, among foreign banks, SSA (Sub- Saharan Africa) foreign banks appear
to be more profit efficient than Non-SSA foreign ones. Moreover, the results of
estimated average profit efficiency in all banks are consistent with those
findings by representing on average 67 percent in banks in the sample. On the
other hand, the trend for cost efficiency differs in results indicating that
Non-SSA foreign banks tend to be more efficient than SSA foreign banks.
Furthermore, findings are consistent with the hypothesis that explaining that
the higher leverage or a lower equity capital ratio is associated with higher
profit efficiency, (Keyota, 2009)
The above argument has similarity with banking sector
liberalization for efficiency of the financial sector, while closed financial
sector to outside banks competition is prone to inefficiencies.
However (Podpiera,
2005) argues that inefficiencies wouldn’t just wither away
with liberalization , overall, the study on three East African countries
illustrates that solely opening the banking sector to foreigners and
privatizing state-owned banks does not solve the problems in banking
efficiency, enhance the provision of banking services, or transform the banking
sector into an engine of economic growth. A number of structural issues need to
be addressed first or simultaneously, in particular, resolving the problems of
weak banks by taking remedial actions or closing them and removing impediments
to bank lending, including through an improvement of the legal framework for
property rights, insolvency, and creditor rights, acceleration of court decisions
and enabling information sharing among financial institutions on creditworthiness
of borrowers.
Not only liberalization but also
privatization of banks can also be considered. The comparisons between
private and state-owned firms suggest that privatization should improve bank
performance. But critics of privatization have noted that privatized firms do
not always act like firms that have always been privately owned, the empirical
evidence on the effect of privatization on bank performance in developing
countries is in fact mixed. But evidences do not suggest that outcomes are
random. Performance improvements are greater when the government fully
relinquishes control, and preferably fully divests its entire shareholding; when banks are privatized to
strategic investors, as opposed to being sold through a share issue
privatization that can result in dispersed ownership; and when bidding is open
to all bidders, including foreign owned banks (Fuchs, 2007). In addition to this privatization
also requires transparency and if appropriately done it can bring the envisaged
results.
Capital has also a direct impact on
efficiency of banks Ayalew, (2006) in his cost efficiency analysis of private
banks found out that, banks with higher capital tend to be more efficient than
those banks with smaller capital. Most studies also found that well –
capitalized banks are more efficient than those with low capital. This is
consistent with the moral hazard theory that suggests managers of institutions
closer to bankruptcy might be inclined to pursue their own interests. But the
causation could run the other way – less efficient institutions have lower profits,
leading to lower capital ratios. And he concludes that banks with higher level
of capital have the legal right to lend a higher amount of money to a single
borrower and can reduce their transaction costs. In addition, higher capital
implies more fund is available to lend borrowers without borrowing from other
sources that require incurrence of additional costs.
The banking systems in East Africa,
however, remain inefficient and perform only a limited intermediation role,
despite recent reform efforts and even with the presence of international
banks. This is due to the existence of various impediments to banking sector
lending, competition, and development in general. In the Kenyan case, for
instance, the presence of foreign banks is not sufficient to improve efficiency
in the banking system as a whole, since many weak domestic banks are allowed to
operate. The international banks are thus effectively insulated from more
vigorous competition, because of their size, reputation for deposit safety, and
international links. (Podpiera,
2005)
4.1.2 Profitability of Banks
The main drivers of banks’ profitability remain
earnings, efficiency, risk-taking and leverage. Various stakeholders (e.g.
depositors, debt or equity holders and managers) emphasize different aspects of
profit ability. These views need to be taken into account by market
participants (i.e. analysts, rating agencies, consultants and supervisors) when
looking at ways of measuring bank performance that meet their needs. For this,
each different group of market participants has its own preferred set of
indicators. (ECB, 2010)
Other research results also suggest that
macroeconomic and regulatory conditions have a pronounced impact on margins and
profitability. Lower market concentration ratios lead to lower margins and
profits, while the effect of foreign ownership varies between industrialized
and developing countries. In particular, foreign banks have higher margins and
profits compared to domestic banks in developing countries, while the opposite
holds in developed countries.
(Flamini, 2009)
Other researchers
also observed this fact, that sub – Saharan banks get a higher profit than
their other counterparts, ccommercial banks seem to
be very profitable in Sub-Saharan Africa (SSA). Average returns on assets were
about 2 percent in the last 10 years, significantly quite higher than bank
returns in many other regions all around the world. This scenario holds true
whether returns on assets are assessed by country, by individual banks or by
country income group. The net interest margins and an alternative measure of
profitability give the same picture. (Ambreen K, 2009)
Should high bank returns be seen as a negative
feature for financial intermediation in SSA countries? This could be the case
if high returns imply high interest rates on loans. Moreover, if high returns
are the consequence of market power, this would imply some degree of
inefficiency in the provision of financial services. In this regard, high
returns could be a negative outcome that should prompt policymakers to
introduce measures to lower risk, remove bank entry barriers if they exist, as
well as other obstacles to competition, and reexamine regulatory costs. But
bank profits are also an important source for equity. If bank profits are
reinvested, this should lead to safer banks, and, consequently high profits
could promote financial stability.
(Flamini, 2009)
The overhead costs are by far the most
important component of the interest rate spreads,
accounting for about 6–8¾ percentage points
of the spread. The high overhead costs are related to the low productivity and
overstaffing of East African banks. Compared to banks in other sub-Saharan
African countries and other emerging market countries, East African banks seem
to be overstaffed and their employees less productive. East African banks have
more than three times as many employees for a given amount of assets, loans and
deposits than other banks in emerging market countries, and the average East
African bank employee earns only half of the net interest revenue as the
average employee in emerging market countries. In Kenya, state-owned banks are
significantly overstaffed and less productive compared to private domestic
banks, which are in turn overstaffed and less productive than foreign-owned
banks. (Podpiera, 2005)
particularly the large state owned banks are their administrative and overhead
costs are higher.
5 Empirical Review
Research on the determinants of bank profitability
has focused on both the returns on bank assets and equity, and net interest
rate margins. It has traditionally explored the impact on bank performance of
bank-specific factors, such as risk, market power, and regulatory costs. More
recently, research has focused on the impact of macroeconomic factors on bank
performance. (Flamini, 2009)
Competition in the banking sector (Ayalew, 2006) made
a research by applying the Herfindahl Index to the banking industry and he
found out that, first applying this Index the problem arises from in selecting
the indicator of the market .taking only the balance sheet may result in biased
outcome. But by adding other variables,
By using this formula
HI =10,000∑S2
Where S is, the market share of the ith bank
Ayalew, (2006) found out that CBE as a major banker
to government mobilizes almost all deposits of both the central and regional
governments. It is known that that more than 99 percent of the government
deposits are put in current account (demand deposits). Hence, it wouldn’t
surprise if CBEs share in demand deposits is higher than its share in savings
and time deposits. He also calculated that taking additional considerations,
the HI index showed that quasi – monopoly power of CBE.
The, market
structure, may not affect the profitability of commercial banks and it id is
not the only cause for lower profitability , according to (Flamini, 2009) , even if the market
structure is not perfectly competitive, and research done on Greek banks find
some profit persistence, a result that signals that the market structure is not
perfectly competitive. The results also show that the profitability of Greek
banks is shaped by bank-specific factors and macroeconomic control variables,
which are not under the direct control of bank management. Industry structure
does not seem to significantly affect profitability.
Other studies done on the interaction of market
structure, profitability and risk, and argues that banks with monopoly power
systematically reduce the risk they take at the expense of greater
profitability. Given the importance of bank credit as a factor of production
for almost all firms, this effect may plausibly affect market concentration in other
sectors of the economy by making the expansion of smaller firms more difficult.
(Flamini, 2009), in other words the
profitability of larger banks will not be affected; rather the implication of
controlling the financial sector solely is to other sectors of the economy.
Studies done on Sub - Saharan banks, the results indicate
that individual bank characteristics explain variation in bank profitability.
High profitability was found to be associated with well-capitalized banks, with
efficient expenses management, bank size, credit risks and diversified earning
ability of the banks. In addition, per capita GDP growth rate and inflation
have a significant and positive impact on bank profitability, while inflation
showed mixed effects. The financial industry structure indicators, banks'
assets to GDP is statistically significant and negatively related to bank profitability
(ROA ), while the concentration positively affect bank profitability in terms of
ROA and negatively related to ROE. Also, bank profits show a tendency to
persist over time given the positive coefficient for ROA. (Buyinza, 2010)
Ayalew (2006) used ratio analysis with the help of
DEA model and the ratios were capital ratio, liquidity ratio and loan loss
provision to total assets when studied the financial performance of private
banks in Ethiopia. His study revealed that banks were becoming leveraged, the
growth of deposits from depositors increased, efficiency was also increased
from year to year. Generally, he concluded that the growth rate was positively
related to efficiency scores.
Some researchers wonder that why are banks so
profitable in Africa? Standard asset pricing models imply that arbitrage should
ensure that riskier assets are remunerated with higher returns. Bank
profitability should then reflect bank- specific risk, as well as risks
associated with the macroeconomic environment (non-diversifiable, systemic
risk). Progress has been achieved by many SSA countries in banking, supervisory
and regulatory reforms, as well as in the implementation of structural reforms
to reduce financial risks and promote financial development. However, banks in
most SSA countries still operate in risky financial environments, which include
weak legal institutions. Hence, risk appears a good explanation for high
returns. Weak economic performance also expose banks to risk as low economic
growth promotes the deterioration of credit quality, and increases the
probability of loan defaults. (Flamini,
2009)
CHAPTER THREE
3 Research Design and Methodology
3.1 Methodology of Analysis
The preceding chapter presented the review of the
existing evidence on factors affecting the financial performance of banks and
identified the knowledge gap. This chapter discusses the research design and
the methodology employed. Subsection 3.2 discusses the research approaches
while subsection while 3.3 discusses the instruments and data collection
methods while 3.4 mixed research approach presents the method adopted in the
study. 3.5 discusses survey design and 3.6 sample design while 3.7 explains the
data analysis method and 3.8 will present the results of the study. Finally,
conclusions and the link between research questions and findings will be
presents, and the different data sources are presented.
3.2 Quantitative research approach
This approach is used to answer question about
relationships among the important variables with the purpose of explaining,
predicting and controlling phenomenon. Quantitative studies represent the
mainstream approach to research and structured guidelines exist. Variables and methods
of measurement tend to be defined before the study begins and remain the same
throughout. In this approach the researcher identifies one or few variables
that they intend to study and collect data related to those variables.
Quantitative research approach has two strategies of
inquiry. The first is survey design which provides a quantitative or numeric
description of trends, attitude or opinion of a population by studying a sample
of that population. From the sample the researcher generalizes about the
population and predicts the trends being observed.
The analysis is made based on deductive reasoning,
beginning with certain theory or hypotheses and drawing logical conclusions
from it. Formal, impersonal and scientific type of reporting is common.
The target population would be all private commercial
banks registered by NBE and under operation during 2010/2011 fiscal year.
Sample size is determined by time and budget of the researcher. Because of time
and budget constraint, the sample was restricted to head offices, and bank
branches residing in Addis Ababa and to NBE itself. According to NBE (2010/11) the
total number of branches has reached to 712, and from this 38.6 percent of
branches of banks are found in Addis Ababa. The sample size for
self-administered questionnaires was 85 employees of banks and delivered
physically to all targeted categories. Financial information of all banks collected
from their annual reports which are collected from head offices of the
respective banks and from the NBE itself.
The sample selection based on the following process –
first NBE supervision directorate, Monetary Policy & Planning department, and
the private banks head offices and different departments and their branches in
Addis Ababa were targeted. Bank branches were then selected according to their
random distribution of their branches found in the city of Addis Ababa. However
all banks are not cooperative to respond for the questionnaire. Some banks used
the excuse that they are too busy and complained that the number of students
that come to them to do research is high.
Then, from banks that are willing, the employees from
each branch who are involved in diverse operational banks activities like operation
and planned and research activities such as experts, analysts & clerks , customer
relation officers & managers, branch managers, deputy managers, department
& division managers and loan officers were selected and covered by the
survey.
3.3 Instrument design and data collection method
Both primary and secondary data used in the study to
perform statistical analysis and reach to some conclusions. The researcher
collected data using survey questionnaire method (see appendix 1 & 2). The
questionnaires were distributed physically in person to the survey participants
and follow-up calls were made to provide feedback, clarification and remainder.
Unity University student Affairs Office wrote a
letter of cooperation to all concerned parties to gain acceptance and
positively assist the researcher. Then covering letter which described the
purpose of the research, prepared and attached with the questionnaire. The
questionnaire was classified into three parts.
The first part of the questions designed to collect
participants’ profile and the second parts 5 questions deal about customer
handling and the second part has about 6 questions and they deal about the future
prospects private commercial banks are facing, and the third part deals about
the challenges private commercial banks are facing and the final part of the
questionnaire raises policy issues and asked respondents about their perception
on policy related issues.
Financial information of all banks (secondary data)
that help to analyze performance of banks was needed. In addition, to make
financial performance analysis the researcher needed financial information from
each bank. The data collection form was structured in review format at the end.
This data was collected from the annual financial audit report of the banks
through their annual reports and to those data that are not found on the annual
reports, print outs from their research departments were collected. The
financial data collected/ obtained from each bank and NBE.
3.4 Mixed Research Approach
The mixed methods research approach is used when the
researcher combines elements of both quantitative and qualitative approaches.
Quantitative and qualitative research design (Mixed) is appropriate for
answering different kinds of questions through the questionnaire and interview.
During mixed research approach both quantitative and qualitative data are
collected to help answering a single research question.
The researcher also interviewed two of the staffs of
private banks in person, the first person is a Credit Division Manager at
Abyssinia bank and the other is a branch manager in Birhan International bank.
3.5 Survey design
Survey research involves acquiring information about
one or more group of people perhaps about their characteristics, opinions,
attitudes, or previous experiences-by asking them questions and tabulating
their answers. The ultimate goal is to learn about a large population by
surveying a sample of that population.
The purpose of survey research is to generalize from
the sample to the population so that inferences can be made about some
characteristic, attitude or behavior of the population. The researcher selected
survey design because of budget and time constraint i.e. economy of the design.
The data collection included self administered questionnaires and structured
record reviews (documentary analysis) to collect financial information
3.6 Sample Design
The target population is all banks registered by NBE
and under operation during 2010/11 fiscal year. Sample size is determined by
time and budget of the researcher. Because of time and budget constraint, the
sample was restricted to head offices, and bank branches residing in Addis
Ababa and the National Bank of Ethiopia (NBE). According to NBE (2010/11) 38.6
percent of bank branches and all head offices of banks which operate in
Ethiopia found in Addis Ababa and the share of the private banks grew to 60
percent from the 58.1 percent a year ago.
The questionnaire was distributed to all targeted categories of the
employees of six banks operating in Addis Ababa, and the sample size for
self-administered questionnaires was 85 employees, from the total 85
questionnaires 60 were filled by the respondents and returned.
The appropriateness of any sample design feature can
be evaluated only in the context of the overall survey objectives. The
important point for the researcher is to be aware of the potential costs and
benefits of the options and weigh them in terms of the main purpose of the
study.
Bank branches were then purposively selected according
to the number of branches found in Addis Ababa (the bank which had more
branches got more chances to be surveyed), and branches with better business
activity were targeted. Then, employees from each branch who are involved in bank
operations such as experts, customer relation managers, branch managers, deputy
managers , division managers , research & Planning and loan officers were
selected and covered by the survey.
Then the first part of the questionnaire was designed
in relation with customer handling credit related issues and about performance
measurements to show the impacts that have highest influence on bank
performance related issues and it has about 23 questions .The second part deals
with the future prospects of the private banking sector and it has about 7
questions.
The third part of questionnaire has two main
questions which were related to the main challenges of the banking sector and
the factors that limit lending or reducing bank lending the respondents were
also to rank from 1 – 6 according to which they give priority, and issues about
the technological problems if the respondents also agree on them .The last part
of the questionnaire has three questions and the questions are related with
policy issues.
In addition, to make financial performance analysis
the researcher needed financial information from each bank. The data collection
form was structured review format. Financial information of all banks
(secondary data) that help to analyze performance of banks needed. This data
was annual financial audit report. The financial data collected/ obtained from
each bank through the annual report and the print outs given and from NBE
Research Department and their websites.
3.7 Data Analysis Method
There are different types of inferential statistical
techniques or procedures used in quantitative research approach and their usage
varies based on purpose and appropriateness for each research situation. Both
descriptive and econometric analysis methods will be employed in the analysis
of the results.
For econometric analysis, this study has variables
such as ROA, ROE, liquidity, and deposit. These variables are ratio scale and
expected to fall in normal distributions. Therefore, parametric statistics is
more appropriate. From parametric statistical techniques a simple multiple
regressions are again suitable to this research. Because this research is to
examine how effectively one or more independent variables such as liquidity, loan
and deposit allow the researcher to predict the value of another dependent
variable such as ROA and ROE.
3.8 Summary of results
The survey results will be presented in descriptive
statistics and econometric analysis. With regard to descriptive statistics the
observation is presented in its frequency and relative frequency.
The study conducted survey of banks’ employees (using
self administered questionnaires) and structured survey of documents. Seventy five
percent of the respondents were employees of private commercial banks, while the
remaining were employees of the National Bank of Ethiopia (NBE). out of the
total 85 questionnaires distributes 60 questionnaires were returned and the
response rate is 70.5%, 28% of the respondents were planning and research
officers , while 18% of the respondents were loan officers and credit analysts
while 14% of the respondents are branch and division managers and 10 % of them
are bank clerks. Most respondents had below ten years of experience in banking operations
and lending.
All factors that affect performance have relevance in
the Ethiopian banking industry. The very important factors that affect performance
perceived by respondents were liquidity, monetary and fiscal policies, economic
condition and bank health. According to the respondents perception reducing lending
is one of the factor that limits banks performance. Banks would ration loan to
borrowers that they think have the capacity to repay, and this would decrease the
loans and advances they provide, it also decrease profits and increases losses.
This is particularly true when NBE imposes on private commercial banks a
lending cap as well, and from the total loans they give, 27% of it should be
used to buy government bonds and bills.
In respect of performance measures of banking
industry twenty seven percent of respondents indicated that ROA was the most
applicable measurement of bank performance. Twenty two percent of respondents
said that Return on Equity
(ROE) is suitable to measure performance, while performance measurements
based on return on Investment (ROI) or Net Banking Income (NI) scored 17%, Performance
measures in relation to percentage growth in revenue got 13% while modern
performance measures such as DEA scored six percent.
So, we look at ROA as
well as ROE. They are different, but together they provide a clear
picture of management's effectiveness. If ROA is sound and debt levels are
reasonable, a strong ROE is a solid signal that managers are doing a good job
of generating returns from shareholders' investments. ROE is certainly a “hint”
that management is giving shareholders more for their money. A high ROE can also
give investors a false impression about the bank's fortunes. On the other hand,
if ROA is low it shows that, the bank is carrying a lot of debt.
Using econometric analysis, from the financial data
of banks, relationship of independent variable such as liquidity, deposit and
new loan disbursement and dependent variable like ROA and ROE tested. Return on
Asset (ROA) is expressed as the ratio of profit before tax (the net income) to the average total assets, in
other words ROE for the year is defined as net income is
divided by total assets, usually the average value over the year.
Return On
Assets = Net income / Average Total Assets
While ROE is an
internal performance measure of shareholder value, and it is by far the most popular
measure of performance, since: (i) it proposes a direct assessment of the financial
return of a shareholder’s investment; (ii) it is easily available for analysts,
only relying upon public information; and (iii) it allows for comparison
between different companies or different sectors (ECB, 2010)
Return On
Equity = Net Income / Average Total stockholders Equity
CHAPTER FOUR
4 Research Results and Discussions
The previous chapters presented the orientation of
the study, theoretical foundations, literature review and the research methods
adopted in the study. As discussed in the preceding chapters this study aimed
at examining the operational challenges that private commercial banks are
facing and assessing their performance in Ethiopia and the prospects that
awaits them.
This chapter tries to present the results of the
survey in discrete statistics and uses econometric analysis. The chapter is
organized into three sections. The first section 4.1 discusses survey results
and the second section 4.2 presents documentary analysis. The last section 4.3
summarizes the results.
4.1 Survey results
The questionnaire was distributed to NBE, banking
supervision directorate and nine private and state owned banks headquarters and
branches. With respect to branches, bank branches of the banks covered in the
study were included.
The questionnaire was physically distributed to 85
employees (whose positions related to bank lending) of selected six bank head
offices, branches in Ethiopia registered before 20010/11 to National Bank of
Ethiopia. Out of 85 questionnaires 60 were completed and collected. As the
result the response rate was 70.5 percent. Research survey organization differs
considerably in the extent to which, it devotes time and money to improve
response rate. Thus, there is no agreed-upon standard for a minimum acceptable
response rate.
Table 4. 1 Sample size and returned
questionnaires
Sample Size
|
85
|
Completed and Returned Questionnaires
|
60
|
Response
Rate
|
70.5%
|
Source:
Field Survey and own computation, 2011
4.2
Respondents’ profile
In respect to employment, 75 percent of survey
respondents were employed in private banks. The rest 25 percent were employed
in government institution specifically in the National Bank of Ethiopia (NBE).
Table 4.2 Employment of
respondents
Employment
|
Frequency
|
Relative
Frequency (%)
|
Private
commercial banks
|
45
|
75%
|
National Bank of Ethiopia
|
15
|
25%
|
Total
|
60
|
100%
|
Source: Field Survey and own
computation, 2011
When we see the positions of the respondents in
banking sector the large group or 28 percent of respondents were planning and
research officers. The second largest numbers about 18 percent of respondents
were credit analysts and loan officers while 14 percent of the respondents are
branch and Division Managers. About 10 percent of the respondents were bank
clerks (Table 4.3)
Table 4.3 Working position of
the Respondents
Current
Position in the Bank
|
Frequency
|
Frequency
(%)
|
Branch & Division Manager
|
8
|
14%
|
Planning & Research Officers
|
17
|
28%
|
Loan
Officer & Credit Analyst
|
11
|
18%
|
Bank Clerk
|
6
|
10%
|
Branch Controller / Supervisor
|
5
|
9%
|
Customer Relations Officer
|
4
|
6%
|
International Banking Officer
|
3
|
5%
|
Teller
|
2
|
4%
|
Branch Accountant / Auditor
|
4
|
6%
|
Total
|
60
|
100%
|
Source: Field Survey and
Analyst’s computation
In respect to experience, 45 percent of survey
respondents indicated that they had 1-5 years of banking experience. The second
larger number of respondents, 25 percent, had banking experience from 6-10
years. About 18 percent of respondents indicated that they had experience
between 11 to 15 years and 12 percent said that they had greater than 15 years
of banking experience (Table 4.4).
Table 4.4 Banking experience of the respondents
Banking
experience
|
Frequency
|
Relative
frequency (%)
|
1-5 years
|
27
|
45%
|
6-10 years
|
15
|
25%
|
11-15 years
|
11
|
18%
|
>15 years
|
7
|
12%
|
Total 60 100%
Source: Field Survey and own
computation
4.3
Customers’ Satisfaction
Since the survival
of private commercial banks depend on their customers, it is important for them
to know the level of customer’s satisfaction. They were asked how they measure
customer’s satisfaction. Majority of them 33 percent said that customer’s feedback or appreciation enables them to know
customer’s satisfaction .Twenty percent of the respondents said that they know
customer’s satisfaction by observing the number of customer’s coming to their
banks, while 18 percent of the customer’s said they know their customer’s
satisfaction through the number of customer complaints, while twelve percent of
the respondents said that they know that whether customers satisfaction by
observing their market share in the sector. (Table 4.5)
Table 4.5 Measurements of
Customer’s Satisfaction
|
||
Measurements
|
Frequency
|
Relative Frequency (%)
|
Higher
number of customers
|
12
|
20%
|
low
number of complaints
|
11
|
18%
|
higher
market Share
|
7
|
12%
|
Customers
Feedback / appreciation
|
20
|
33%
|
Independent
Survey
|
6
|
10%
|
Average
time of an account stays
|
4
|
7%
|
Total
|
60
|
100%
|
Source: Field Survey and own computation
They said that
they depend on the traditional customer satisfaction measurement that is
customer feedback and appreciation. And many of their branches have suggestion
boxes in their branch offices where customers come, and the marketing and business
development departments collect the suggestions given to them from the boxes
and read them. However few of them said they depend on independent survey to
know the customers satisfaction. Only six percent of the respondents say that
they conduct independent survey and use them as the main source of knowing how
their customers feel.
They were also
asked what they think the level of customer’s satisfaction and most of them
about thirty five percent believe that the level of customer’s satisfaction is
good. While twenty eight percent of them believe that it is very good, and
fourteen percent of them, said customers satisfaction is satisfactory. Ten
percent of them said that they have no idea about customer’s satisfaction; most
of them are people at the head office, who are in not operational or branch
activities. And employees in the head offices and planning departments who
don’t have direct contacts responded that they don’t know customer’s
satisfaction. (Table 4.6)
Table 4.6 Respondents
perception of level of Customer’s Satisfaction
|
||
Level of Customers’
satisfaction
|
Frequency
|
Relative Frequency (%)
|
Excellent
|
5
|
8%
|
Very
Good
|
17
|
28%
|
Good
|
21
|
35%
|
Satisfactory
|
8
|
14%
|
Poor
|
3
|
5%
|
I
don't Know
|
6
|
10%
|
Total
|
23
|
100%
|
Source: Field Survey and own
computation
4.4
Challenges that Affect the Performance of Private Banks
There are deferent challenges that affect the performance of the
private banking sector facing. Therefore, as per the perception of the
respondents’ factors that affect bank performance in the Ethiopian banking
sector considered as very important were the following: respondents were
asked about what are the major challenges they think. Diverse answers were
received from the respondents, especially those at the head offices and
employees at the management level were able to put the challenges in a precise
manner.
Most of the respondents said that lack of technology and inability to
use and apply modern technology is the main challenge they are about 25 percent
of the respondents, while competition from other banks and the joining of more
and more banks joining the banking market is the second challenging problem of
the sector, they are about twenty percent. Some respondents even went to
explain that the predatory practices of other competent banks are a challenge.
Since recent times
the government imposes different policies to the banking sector and it is not
surprising that seventeen percent of the respondents especially those in charge
of management said that policy issues and uncertainties are the challenge that
adversely affect the performance of private commercial banks, while thirteen
percent of the respondents said that the high rate of inflation is the
challenge to the sector. Equal number of respondents said the capital
requirement and liquidity position and non – performing loans or bank health
pose equal challenge specifically about eight percent.
Table 4.7
Respondent’s perception of challenges that affect performance
The Challenges
|
Frequency
|
Relative Frequency
( %)
|
Competition from other banks / more banks joining the market
|
12
|
20%
|
Lack of technology / inability to apply modern
technologies
|
15
|
25%
|
Lack of trained manpower in the sector
|
4
|
7%
|
High rate of inflation
|
8
|
13%
|
Policy
issues / uncertainties
|
10
|
17%
|
Liquidity Position
/ Capital requirement
|
5
|
8%
|
Weak
Management
|
1
|
2%
|
Non –
Performing loan / bank health
|
5
|
8%
|
Total
|
60
|
100%
|
Source:
Field Survey and own computation
From the results above, all the factors that affect private
commercial banks performance relevance in Ethiopian private commercial banks. On
average, none of the factors had been considered not important, slightly important
or neutral. Even though ,all the factors are important and the main three
challenges namely competition, lack of technology and uncertain government
policies are the main challenges to the sector, nonetheless it doesn’t mean
that other factors are not much important to the sector . Relatively speaking,
even if some of the challenges got few respondents, still all the factors are
important and have their own effect on the performance.
As mentioned above the respondents were asked, if competition
from other banks private and state owned commercial banks is the main challenge
for private commercial banks. If we take
competition as a challenge, since the sector is dominated by state owned banks
the larger market share is still controlled by state owned banks , and most of
the competition comes from the state owned banks , and it is not surprising
that the respondents take competition from state owned banks a challenge.
However, most of them answered that great threat
comes from government owned banks rather than privately owned banks. It is not
surprising that, since the government is supporting its own banks and opening
new branches in the different parts of the country and the policy restrictions
imposed on private banks.
About forty eight percent of the respondents said
that it is state owned banks that pose great competition challenge and equally
twenty six percent of the respondents said that it is privately owned, and the
same twenty six percent said that it is both the privately and state owned
banks that cause great competition.
Table 4.8 Respondents
perception that private banks face competition
|
||
Competition they Face
|
Frequency
|
Relative Frequency (%)
|
Government
|
28
|
48%
|
Privately owned
|
16
|
26%
|
Both
|
16
|
26%
|
Total
|
60
|
100%
|
Source:
Field Survey and own computation
As can be seen
from the above response lack of technology is one of the main challenge and is
repeatedly mentioned by the respondents , and they were also asked if they
think that they have the most up to date technology and most of them forty
eight percent of them responded that they don’t have the latest technology,
while forty one percent of them said that they have the most up-to-date
technology, the remaining eleven percent of the, said that they don’t know
these respondents are people at the head offices and who are not directly
related with operational activities of branches.
4.9 Respondents Perception
of Technology Availability in Their Bank
|
||
Technology Availability
|
Frequency
|
Relative frequency (%)
|
Yes
|
24
|
41%
|
No
|
29
|
48%
|
I
don’t Know
|
7
|
11%
|
Total
|
60
|
100%
|
Source: Field Survey and own
computation
Lack of technology
is one of the challenges. But for this challenge there are various reasons
mentioned by the respondents. Some say the poor and slow internet
infrastructure of the country caused not to apply the technology to its fullest
potential, and others also mentioned that, since the high cost of the
technology, the reluctance of the major shareholders, and other respondents
also said that in some regions even if the banks built the infrastructure that
enables them to use the technology, due to the lack of internet connection in
those areas it made difficult to employ the technology.
4.5
Lending Challenges
Almost all respondents
said that their bank prepares a credit portfolio. And they also said that there
is concentration of credits given to the domestic sectors like trade and to
import and export sectors. And according to them the main challenge for the
banks to give as much as credit to its borrowers is that the liquidity position
of the banks that is the deposit loan ratio wouldn’t allow them to give loans,
since they can’t go beyond a certain level.
The second
challenge is that the government imposes different monetary as well as fiscal
policies to be strictly followed by the banks this includes ‘credit cap’,
mandatory purchasing of government bonds with a low interest rate , recently
the government has forced banks to buy government bonds and of the total loans
they provide they should buy 27% of the loan with 3% interest rate , thirdly
capital of the banks is also not large enough to give as much as loans and it
limits lending and eighteen percent of respondents pointed out this problem ,this
is compatible with the idea that most of the private commercial banks capital
is not high.
Economic condition
or activity is also mentioned by the respondents as a factor that limits
lending, branches in low economic activity areas give small amount of loans and
they simply collect deposits, thirteen percent of them said it is a limiting
factor as long as credit is concerned.
4.10 Factors that reduce lending
|
||
Factors that Affect Lending
|
Frequency
|
Relative Frequency (%)
|
Capital
Position of the Bank
|
11
|
18%
|
Economic
Condition / Activity
|
8
|
13%
|
Liquidity
of Position of the Bank
|
22
|
38%
|
Management
|
4
|
6%
|
Monetary
and Fiscal Policies
|
15
|
25%
|
Total
|
60
|
100%
|
Source: Field Survey and own
computation
They were also
asked about the level of cooperation from the NBE current practice of
centralized credit information
system , and if it has helped them and most of them have said that it is
helpful.
4.11
Respondents perception of centralized credit Information
Exchange System of NBE helped them
|
|||
Observation
|
Frequency
|
Relative Frequency
|
|
Yes
|
41
|
69%
|
|
No
|
17
|
28%
|
|
I
don’t Know
|
2
|
3%
|
|
Total
|
60
|
100%
|
|
Source: Field
Survey and own computation
4.6 The
Prospects of Private Commercial Banks
Regarding the
prospects of private commercial banks, from competition point of view the
respondents were asked what they expect for the private commercial banks, they
were also asked about how they feel the level of competition in the sector and
most of them think that the level of competition is medium.
Particularly the
supervisors and the researchers of NBE think that the level of competition in
the sector is medium and even some of them said it is weak. However most of
them, about fifty three percent of them responded that the level of competition
is medium, while thirty two percent of them responded that there is high level
of competition in the sector and fifteen percent of them said that the level of
competition is low. (Table 4.12)
Table 4.12 Respondents’ Perception
of the level of competition in the sector
Source: Field Survey and own
computation
When respondents
were asked about the prospects if more private commercial banks
join the market
whether it can bring challenges or opportunities and most of them thirty
eight percent of
them believe that it will bring opportunities and some forwarded an argument
that for example,
if foreign banks are allowed to operate they can bring technologies and
inject additional capital and modernize
the sector and twenty eight percent of them believe
that it will bring challenges by mentioning
the argument that competition will be stiff and
particularly if foreign banks join the
domestic banking sector they will drive out local banks
because they have a large amount of
capital advanced technologies and in addition to that the
supervision capacity of NBE is also
doesn’t match their advanced and complicated transactions
and thirty four percent of them
believe that it will bring both challenges as well as opportunities.
(Table 4.13)
4.13 Respondents Perception
of as the economy grows and more
private banks
join the market whether it brings
opportunities or challenges
Source : Field Survey outcome
and own computation
|
||||||||||||||||||||||||||||||||||
As the cooperation from the
different offices is important , they were asked about this and
said that most of
them believe that the level of cooperation is good about fifty five percent of
them , and
seventeen percent of them said it is very good ,while twenty percent of them
said it
is poor. (Table : 4.14)
|
||||||||||||||||||||||||||||||||||
Table : 4.14 The availability,
timelessness, and sufficiency of data or information
from government office
Information Availability
|
Frequency
|
Relative Frequency (%)
|
|
Excellent
|
5
|
8%
|
|
Very
Good
|
10
|
17%
|
|
Good
|
33
|
55%
|
|
Poor
|
12
|
20%
|
|
Total
|
60
|
100%
|
Source: Field
survey and own computation
4.7 Performance Measurement in the
Banking Industry
In
respect to performance measurement in the banking industry, about twenty seven percent
of respondents indicated that Return On Asset (ROA) was the most applicable
performance measurement in the Ethiopian banking industry. Return on equity
(ROE) got twenty two percent of the respondents while and net banking income
(NI) and Return on Investment which scored seventeen percent as a measurement
of performance. Percentage growth of revenue is the fourth repeatedly used
performance measurement. Usually in their annul reports banks mention the
growth is their revenue and profit as an indication of good performance.
Modern
performance measurement like , Data envelopment analysis (DEA) got six percent
of the respondents and especially the staff in NBE and few in the headquarters
of the private banks as well said DEA is a better measurement of performance.
Five percent of the respondents said that Asset turn over / quality is also a good measurement of
performance while Capital Risk Weighted Asset Ratio was the least performance
measurement in the banking sector. (Table 4.15)
Table
4.15. Percentage distribution: Bank performance measurement
Performance
Measurements
|
Frequency
|
Relative Frequency (%)
|
Return
On Assets (ROA)
|
13
|
27%
|
Return
on Equity (ROE)
|
16
|
22%
|
Return
on Investment (ROI) or Net Banking Income(NI)
|
10
|
17%
|
Data
Envelopment Analysis (DEA)
|
4
|
6%
|
Asset
turn over / quality
|
3
|
5%
|
Percentage
Growth in Revenue / profit
|
8
|
13%
|
Share
price
|
3
|
5%
|
Deposit
Loan Ratio / liquidity
|
2
|
3%
|
Capital
Risk Weighted Asset Ratio
|
1
|
2%
|
Total
|
60
|
100%
|
Source: Field Survey and own computation
4.3 Econometric Analysis
4.3.1 Model
Proposed
This study has variables such as ROA, ROE, liquidity,
and deposit and loan. These variables are ratio scale and expected to fall in
normal distributions. Therefore, parametric statistics is more appropriate.
From parametric statistical techniques multiple regressions is again suitable
to this research. Because this research problem was to examine how effectively
one or more independent variables such as liquidity, loan and deposit allow the
researcher to predict the value of another dependent variable such as ROA and
ROE.
From the survey and the questionnaire presented to
the private commercial banks themselves and including the research and
supervision departments of NBE, most of the respondents said that banking
performance measurement in Ethiopia is measured using Return On Equity (ROE),
Return On Asset (ROA) and using these variables as dependent variables a simple
multiple regression model is proposed to evaluate the relationship between the
above mentioned dependent and the independent variables.
The
regression analysis used the following equation:
ROA = α1 +
β1 (DP) + β2 (LD) + β3 (LQ)
ROE = α2+ β1 (DP) +β2 (LD) + β3
(LQ)
Where:
ROA –
Return on Asset
ROE –
Return on Equity
DP – Deposit
LD
– Loan Disbursement
LQ – Liquidity
α1
– Constant of ROA
α2
– Constant of ROE
β1, β2, β3, -
Slopes or Coefficients
4.2.2 Econometric
Model Analysis
As mentioned in chapter four financial data of the
private commercial banks which were established before 2010/11 fiscal year
tried to be collected. From the banks Dashen bank is chosen, since it has
established itself for a longer period of time and with a good capital
position, and data was collected data from the bank itself and from the data
available from NBE. And its financial data collected and used for statistical
analysis (see appendix 3).
Profitability ratios measure the extent to which
resources are been utilized to enhance shareholder value. Two most widely used
profitability ratios are return on assets (ROA) and return on equity (ROE).
While in this study deposit, paid up capital, loan
disbursement and liquidity are considered as independent variables. Return on
Asset (ROA) and Return on Equity (ROE) categorized as dependent variables. All
the variables are continuous and their level of measurement is ratio scale. The
study used Microsoft Excel for analyzing documentary and questionnaire survey
results. And STATA was also used for documentary analysis.
Table
4.16 Regression of deposit, loan and liquidity against ROE of Dashen Bank.
ROE
|
Coefficient
|
Std. deviation
|
t-stat
|
P-value
|
95% conf. interval
|
|||
Deposit (β1)
|
0.0001859
|
0.0001305
|
1.42
|
0.390
|
- 0.0014722 - 0.001844
|
|||
Loan (β2)
|
-0.0003167
|
0.0002483
|
-1.28
|
0.423
|
-0.0034781 - 0.002539
|
|||
Liquidity (β3)
|
-0.9934447
|
0.5550075
|
-1.79
|
0.324
|
-8.0454 -
6.058594
|
|||
constant α2
|
2.064407
|
1.038532
|
1.99
|
0.297
|
-11.1318 -
15.2602
|
|||
Source:
Analyst computation
The coefficient of deposit against ROE was positive.
This revealed that there is a direct relationship between net deposit and ROE.
However, the influence of deposit on ROE was very low i.e. 0.0001859. On the
contrary, the coefficient of loan and liquidity against ROE were also negative.
This denotes that there were an inverse relationship between loan, liquidity
and ROE. And as the level of liquidity increases, it will have an inverse
relationship with ROE, in other words the rise of liquidity will have an
adverse effect on ROE.
Therefore, if
the other two variables held constant, a one unit increase in new loan would
result in on average 0.9934447 units liquidity drop in ROE. And for each
liquidity unit increase 0.0003167 units drop in loan in ROE. This means for
each additional loan and liquidity, with other factor (deposit) held constant,
there will be a decrease in ROE.
Table 4.16 Regression of ROA against
deposit loan and liquidity of Dashen Bank
ROA
|
Coefficient
|
Std. deviation
|
t-stat
|
P-value
|
95% conf. interval
|
|||
Deposit (β1)
|
-.0000153
|
7.95e-06
|
-1.93
|
0.305
|
-.0001163
.0000857
|
|||
Loan (β2)
|
.000028
|
.0000151
|
1.85
|
0.316
|
-.0001642 .0002202
|
|||
Liquidity (β3)
|
.0599181
|
.0338016
|
1.77
|
0.327
|
-.3695713 .4894076
|
|||
constant α1
|
-.0688429
|
.0632625
|
-1.09
|
0.473
|
-.8726693 .7349835
|
|||
Source: Field Survey and own
computation
In the above table we can see that the coefficient of
deposit against ROA was negative. This indicates that there was an inverse
relationship between deposit and ROA. The higher the deposit, the lower ROA. In
this case, if the other two variables i.e. loan and liquidity held constant, a
one unit increase in deposit would result on average 0.000028
units of loan, 0 .0599181 units of liquidity drop in ROA respectively.
For each additional deposit, given that other factors are held constant, there
will be a decrease in ROA.
When we compare with ROA, the results show that the
coefficient of deposit against ROA was negative. This denotes that there was an
inverse relationship between net deposit and ROA. The higher the net deposit,
the lower ROA. In this case, if the other two variables i.e. loan disbursed and
liquidity are held constant, a unit increase in deposit would result on a drop
in ROA. For each additional deposit, with other factor constant, there was a
decrease in ROA.
By including capital, Semu (2010) also found the same
result. His result too shows that deposit had inverse relationship with ROA.
This means increase in deposit would result decrease in ROA. He further agues
that the reason for this may be that Ethiopian banks had high liquidity. They
don’t increase lending according to their customers’ increase or decrease of
deposits. He also analysed the three independent variables i.e. capital, new
loan and liquidity against ROE, the results are also the same and the
relationship is negative and he argues that the reason for this is the
inefficiency in the Ethiopian banking sector.
CHAPTER FIVE
5 Conclusion and Policy Recommendations
5.1 Conclusion
The broad objective of this research was to identify
factors that affect bank performance and assess the impacts of reducing
performance and to identify the challenges of the private banking sector and to
foresee the future prospects of the sector.
To achieve this broad objective, the study used
quantitative research approach. More specifically, the study used survey of
employees of banks and structured survey of documents held by banks. The
results showed that, based on the respondents’ perception it is evident that
most likely factors that are challenges to the sector are lack of technology,
the high liquidity ratio; government monetary and fiscal polices; bank health
(NPLs) and the high rate of inflation affect private banks performance and pose
a challenge.
With regard to bank performance measurement, it is
evident that banks measure their performance in a traditional way such as ROA,
ROE and revenue and profit growth is also used as measurement of bank
performance. Even if few respondents mentioned that DEA is a good measure, it
is evident that it also has additional dimensions. Also utilization of lending
activities measurement is limited with loans to total asset ratio and NPL.
Although this is exaggerated in government owned
banks like CBE, In the Ethiopian banking industry, there was excess liquidity.
Most banks had more than one times deposit to loan ratio. This shows they
underutilized their resource or there was idle money.
There is not much difference between big and long
years of service and newly established banks in terms of lending and
performance. This show there might be inefficiencies in big and long
established banks. The main reason for this is that lending activity of private
banks is restricted by government policy.
Since recent times more and more banks are joining the
banking sector and competition in the sector will become stiff, further more
banks are also ordered by NBE to raise their capital to 500 million birr and
except few of them who joined the business before a long period of time, most
of the recently established private banks’ capital is below that level, raising
their capital is a challenge to them.
Certainly the banking industry in Ethiopia is underdeveloped
and therefore there is an all
immediate need to embark on capacity building
arrangements and modernize the banking system by employing the state of the art
technology being used any where in the world. With a growing number of
import-export businesses, and increased international trades and international
relations, the current banking system is short of providing efficient and
dependable services and therefore all banks operating in Ethiopia should
recognize the need for introducing electronic banking system to satisfy their
customers and meet the requirements of rapidly expanding domestic and
international trades, and increasing international banking services.
5.2 Policy Recommendations
Currently the ,main direction of NBE is that it
focuses on compliance-based supervision , but as the economy grows and more
banks join the sector the supervision should focus to risk-based bank
supervision . That is as many banks operate and banks become more exposed to
and engaged in high risk financial activities and as the Ethiopian economy
integrates to the rest of the world economy the supervision capacity on NBE
should be enhanced. NBE as the central bank and a financial authority should
have the capacity to assess the risk level all banks that are operating.
Private banks
should know the fact that as the country is preparing to be a member of the WTO
they are obliged to prepare themselves to the inevitable competition that will
come from foreign banks . At this point the Ethiopian government will have no
excuses not to open the sector; therefore preparation by the private commercial
banks is necessary to encounter the competition.
Banks also should raise their capital so hat that
their lending capacity would increase. The minimum level of capital to form
private banks is raised from 75 million to 500 millions. This gives a better
protection for the depositor as well and most of the private banks are expected
to raise their capital.
Banks in Ethiopia give loans mostly based on the
availability of collaterals i.e. the ability of the borrower to provide
adequate collaterals. This is a problem by itself; because many capable
borrowers will lose the opportunity to realize their aims due to lack of
collaterals. This implies that, there should be appropriate legal protection to
banks with regard to other forms of securities. Laws on negotiable instrument,
investment securities and financial guarantee bonds should be developed to give
a chance to banks the opportunity to revitalize their delinquent portfolio in
existing environment.
When banks
face lending constraints, they have to use their funds like by purchasing
treasury bills and bonds. Moreover, banks must develop non-interest generating
services. Excess cash maintained by banks should be used by diversifying credit
options and to avoid inefficiencies.
As can be seen from the inefficiency of the large
state owned bank CBE , reducing government ownership and control , and giving
more wider space for the private commercial banks is important for enhancing
the performance of the financial sector , in particular the private commercial
banks .
The Ethiopian banking industry lacks some of the most
advanced technologies in the worlds , restructuring of the financial
institutions intended to promote competition, , balance the type of
institutions (commercial banks, merchant, development and household savings
banks), and upgrade services with ATMs and promissory notes. Using modern
technologies is important.
Low level of internet penetration and poorly
developed telecommunication infrastructure, lack of suitable legal and
regulatory framework for e-commerce and e-payment, high rates of illiteracy,
high cost of Internet, absence of financial networks that links different
banks, lack of reliable power supply, and Cyber security issues are the most
important challenges for development of e-banking in Ethiopia.
Develop a comprehensive regulatory and legal
framework for e-commerce and payment, raise public awareness on the use of ICT,
e-commerce, and e-Payment, provide incentives for financial institutions to
invest rigorously on ICT and use of ecommerce, and e-Payment, encourage the
current efforts to develop and expand ICT infrastructure
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APPENDEX 1
Questionnaire Presented to the Staff of
Private Commercial Banks
The purpose of this questionnaire is to
collect some information about the prospects and challenges of the private
commercial banks in Ethiopia, for conducting a research concerning this topic
for academic purpose.
Thank you for your cooperation and help in
advance.
Name of the Bank
……………………………….…………………..……………
Current Position in the Bank
………………………….…………………………
Education qualification
…………………………………….……………………
Overall Experience in Banking
Industry ……………………………………….
I.
Customer Handling
1
) How do
you rate your costumer satisfaction?
Excellent…… very good……..Good ………
satisfactory ……….. Poor………
2) Is there a mechanism, in which customers express their
satisfaction?
Yes …….. No ………
If yes, what tools or techniques do
they use to measure their satisfaction?
A……………………………………………………………………..…….
B…………………………………………………………………..………
C……………………………………………………………………………
3) Does your Bank have a written Credit Policy?
Yes…………. No ………………..
If your answer is yes, do you think
the manual is up to date and helpful to you in credit processing?
Yes………….No……………
If the answerer no, how does your
bank manage to process the loan request?
A ……..………………………………….……………………..……
………
B…………………………………….…………………………..…………….
C……………………………………………………………………..………..
If the answer is no, what do you
think is the main problem related to credit policy?
………………………………………………………………………………..
4) How frequent does your bank update or revise the credit policy
or manual?
1-2 years between 2 - 3 years , 3 –
4 years , 4-5 years , above 5 years
5) How long will it take on average to process any credit request
after full document is presented?
Less than 2 weeks ……………………………………..
Greater than 32 weeks but less than
one month………
Greater than one month ……………………………….
6) How do you rate the amount of the interest rate your bank
charges?
A high ………………..
B medium …………….
C low …………………
7) How do you rate the availability, timelessness, and sufficiency
of data or information from government office?
Excellent ….. Very Good ………..
Good……….. Poor …………..
8) How do you rate the level of cooperation among banks in sharing
credit information regarding customers?
Excellent ….. Very Good….... Good
………Poor…………..
9) Do you think that NBE’s current practice of centralized credit
information system has helped the private commercial banks in obtaining
accurate and up-to-date information?
Yes …. No ……
If no what is the main problem?
A ………………………………………………………………………..……
B ………………………………………………………………….………….
C ……………………………………………………………………………..
10) Does your bank have a proper system of credit monitoring and
follow up?
Yes…………. No……………………
If yes, do you pay regular visit?
Yes …….. No …………..
11) Does your bank practice a sectoral portfolio allocation in
maintaining credit risk?
Yes……………No………………….
12) Does your bank give large amounts of loans to a single
creditor?
Yes…. No……..
If yes, what are the advantages?
A……………….…………. B ………………………………
C………………………….. D ……………………………..
13) Do you finance big projects?
Yes………….No…………..
If your answer to the above
question is no, Why?
A……………………………………. B …………………………………..
C……………………………………….D…………………………………
If yes, how often does your bank
revise the portfolio allocation to accommodate any change in the business,
economic, political environment?
Less than 1 year, more than 2
years, between 1 and 2 years
14) Does your bank have huge concentration or excessive exposure to
certain kinds of specific sectors?
Yes … No ……
If yes which sectors? , and why?
………………………………………………………………………………..
15) Are non – performing loans are the main problem of your bank?
Yes …………….. No …………….
If yes why is it a major problem to
your bank and what are the remedies?
……..……………………………………………………………..
A ……………………………………………………………………………
B……………………………………………………………………………..
C……………………………………………………………………………..
D……………………………………………………………………………..
16) Do you think that the non – performing loans that the bank has
significant negative impact on the future profitability of the bank?
………………………………………………………….…………..……….
What measures do you take to
control the non – performing loans?
………………………………………………………………………….…….
17) Does your bank issue reminder to those customers who default to
repay back their loan?
Yes…….. No …….
18) What remedial action your bank takes to recover an unpaid loan
(rank according to priority given by your bank)
Compromise with negotiation
………………….…………….…….…….
Inject additional loan
………………………………..……………………
Rescheduling
……………………..………………………………………
Foreclosure
…………………………………………………………….…..
19) What are the main problems in recovering and foreclosure of
assets that are pledged as collateral to loans?
………………...................................................................................................
20) How much time does it
take for a customer to open a new deposit in your bank?
Less than 10 minutes …………………………,
Between 10 and 20 minutes ………… ……….
Between 30 to 30 minutes …………………….
More than 30 minutes ………………………..
21) How much time does it take for a customer to take his money out
or to put his money in the bank takes him?
Less than 10 minutes ……….
Between 10 and 20 minutes …….
More than 20 but less than 30
minutes ……….
More than 30 minutes …………..
II. The Future prospects of Private
Commercial Banks
1) How do you see the competition with other private and government
owned banks?
Stiff ……… Moderate ………Mild
………..Weak
2) Is government owned or privately owned banks pose great
competition to your bank?
Government ………….. Privately owned
banks ……….
3) In terms of technology do you think you have the most up to date
technology?
Yes ………. No ……..
If no, why your bank has not
employed modern technologies?
………………………………………………………………………………
4) As the economy grows and more private commercial banks join the
market, do you think it will bring opportunities or challenges to your banks
activities?
Opportunities …………. Challenges
………………..
If it is an opportunity what kind
of opportunities do you expect it will bring?
……………………………………………………………………………….
If it is a challenge what are the
challenges you think it will bring to your bank?
A ……………………………………………………………………………..
B …………………………………………………..…………………………
C ……………………………………………………………………………
III.
The Challenges of Private Commercial
Banks
1) What do you think are the main challenged to your bank?
Competition from other banks
………………………..……………….…….
More banks joining in the market
……………………………………………
Lack of technology
…………………………………………………………
Lack of trained manpower
……………………………………………………
High rate of inflation
…………………………………………………………
IV Policy Issues
1) Do you think that Ethiopia becomes a member of the World Trade
Organization (WTO)?
Yes ……No ………
If yes what benefits will you
expect for private banks in line with the membership of our country to WTO?
A …………….………………………………………………………………
B…………………………………………………………………………….
C …………………………………………………………………………….
D……………….…………………………………………………………….
By being a member of the WTO, what
challenges you also expect for private banks?
A …………………………………………………………………………….
B……………………………………………………………………………..
C…………………………………………………………………………….
D……………………………………………………………………………..
2) What are the general problems facing private financial
institutions?
A…………………………………………………………………………….
B……………………………………………………………………………..
C……………………………………………………………………………..
D……………………………………………………………………………..
E……………………………………………………………………………...
3) Which ones do you think are critical problems?
Competition
……………………………………………………….…………
Policy issues / uncertainties
………………………………………..………..
Inability to apply modern
technologies …………………………………….
Lack of manpower in commercial
sector …………………………………….
Decline the number of clients ………………………………………………..
4) What measures do you think are available to take in order to
minimize these problems and create conductive environment in the sector?
(Describe the measures for each problems listed under question 25)
A………………………………………………………………………………
B………………………………..…………………………………………….
C………………………………………………………………………………
D………………………………..……………………………………………
E …………………………………………………………………………….
APPENDEX 2
Questionnaire Presented to NBE staff
The purpose of this questionnaire is to
collect some information about the prospects and challenges of the private
commercial banks, for conducting a research concerning this topic for academic
purpose only.
Thank you for your cooperation and help in
advance.
Current Position in the NBE
…………………………………………….
Educational qualification
……………………………………………….
1) How do you rate the level of competition in private commercial
banks?
A) High ………. B) Medium ………… C)
Low……………………
|
2) Which of the performance
measurement are suitable to measure private banks’ performance?
A) Return on Asset (ROA) …………………………………….………….
B) Return on Equity (ROE)…………………….………………………….
B) Return on Investment (ROI) or Net banking Income
(NI)…………….
C) Data Envelopment Analysis (DEA)…………………..….…………….
D) Profit per employee ……………………………………………….......
E) Asset Turn over …………………………………………………..........
F) Percentage growth in Revenue………………………………………….
G) Share Price ………………………………………………………………
H) If other, please specify …………………………………………….........
3) What do you think are the main
challenged to private commercial banks?
A) Competition
from other banks …………………..…………………………….…….
B) More banks
joining in the market / competition ……………………………………
C) Lack of
technology …………………………………………………………….……
D) Lack of
trained manpower …………………………………….……….………….
E) High rate of
inflation ……………………………………………….………………
F) Non
performing loans ………………………………………..………..……………
G) Capital position (size of
capital)………………………………………………….
H) Government policies / Monetary and Fiscal Policies……………
…………….
APPENDEX 3
Dependent & Independent
Variables Used for the Regression of Dashen Bank
|
|||||
Year
|
2006
|
2007
|
2008
|
2009
|
2010
|
ROE
|
0.487046632
|
0.438532
|
0.3419973
|
0.356435644
|
0.40160285
|
ROA
|
0.040695117
|
0.042708
|
0.0425342
|
0.036165622
|
0.037076014
|
Net Income Before Tax (Gross
Profit)
|
185
|
258
|
333
|
352
|
458
|
Deposit
|
4916
|
6225
|
7914
|
10114
|
11825
|
Total Loans Disbursed
|
3900
|
4400
|
4500
|
4900
|
6100
|
Equity
|
386
|
545
|
731
|
909
|
1,123
|
Liquidity (Deposit / loan)
|
1.260512821
|
1.414773
|
1.7586667
|
2.064081633
|
1.93852459
|
Paid up Capital
|
612
|
731
|
819
|
967
|
974
|
Net Profit (Net Income After
Tax)
|
188
|
239
|
250
|
324
|
451
|
