Unit 5
Banking and Finance
One of the basic factors of production in economics is capital. Capital is the amount of money the producer pays for
the other factors of production (labor, land and entrepreneur) used in the production process.
Banks are one of the financial institutions that are used to transfer finance from those who have in excess to
those that are in need of it. People with excess money will go to finance and put it in banks, this is called
saving. People who faced shortage of money will go to the bank and ask for loans. This activity of banks is one
example of financial intermediation. Introduction to Financial Intermediaries
Financial intermediary is an entity that acts as the middleman between two parties in a financial transaction,
for instance- Commercial Bank of Ethiopia.
financial intermediaries mediate between the providers (with excess money) and users (with shortage of
money) of financial capital. The transfer of funds from surplus spending unit to deficit spending unit through
financial intermediaries is called Financial Intermediation.
What are the benefits of financial intermediaries?
For depositors: Financial intermediaries give safety and interest earning. Safety refers to the fact that the
money of the depositors is free from any risk of loss. Banks also pay interest on the money saved at their
banks by the depositors.
For the borrowers: People borrow money from banks and other financial intermediaries are known as
investors. In the process of production, they may face shortage of finance and go to financial intermediaries
(e.g., Banks), to get money or finance for their investment. The financial intermediaries will charge them
annual interest on the money they borrow.
finance (money) in the economy is like the blood circulating in the body.
(demand = willingness + Ability; where ability is the money or finance).
Introduction to Financial Markets
Financial markets are markets that provide channels for allocation of savings to investment. They provide a
variety of assets to savers as well as various forms in which the investors can raise funds and thereby
decouple the acts of saving and investment. The savers and investors are constrained not by their individual
abilities, but by the economy’s ability, to invest and save respectively.
financial markets, contribute to economic development to the extent that the latter depends on the rates of
savings and investment.
The financial markets have two major components:
Money market
Capital market
A. Money market: according to (1), money market is the sector of the financial market that includes financial
instruments with a maturity date of one year or less at the time of issuance. Money market instruments include
Treasury bills, Commercial papers, Negotiable certificates of deposit,
Repurchase agreements, and Bankers’ acceptances.
Treasury Bills: are financial instruments issued by the governments with maturity dates of three weeks, one
month, three months or six month.
Commercial papers: are promissory notes— written promises to pay— issued by a large, creditworthy
corporation or a municipality having an original maturity that ranges from one (1) day to two hundred seventy
(270) days. Commercial paper may be either interest bearing or sold on a discounted basis.
Certificates of deposit (CDs): are written promises by a bank to pay a depositor. They are issued by large
commercial banks with original maturities between one month and one year.
On the maturity date, the issuer repays the principal, plus interest.
B. The Capital market: is the sector of the financial market where long-term financial instruments are issued
by corporations and governments.
They have an original maturity greater than a year and perpetual securities (those with no maturity). There are
two types of capital market securities: a. Equity and b. Debt Obligations
a. Equity: is a capital market financial instrument which includes common stock and preferred stock. Common
stock represents ownership of a perpetual corporation and common stock is a perpetual security .
Preferred stock also represents ownership interest in a perpetual corporation but can either have redemption
(maturity) date or be perpetual
b. Debt Obligation: is capital market financial instrument whereby the borrower promises to repay the maturity
value at a specified period of time beyond one year. They include;
Bank loans and Debt securities.
Bank Loans- One form of such a bank loan is a syndicated bank loan. This is a loan in which a group (or
syndicate) of banks provides funds to the borrower.
Debt securities: a debt security with a maturity at issuance of 10 years or less(Notes); and those with a
maturity greater than 10 years (Bonds
Introduction to Financial Institutions
What are institutions?
Institution are norms that organize social, political and economic relations. They are ‘the underlying rules of
the game’ in any society or organization. There are two forms of Institutions: Formal and Informal.
Formal institutions include the written constitution, laws, policies, rights and regulations enforced by official
authorities
Informal institutions, on the other hand, are the usually unwritten social norms, customs or traditions that
shape thought and behavior.
What are financial Institutions?
Financial institutions are institutions that serve as financial intermediaries.
There are three major types of financial institutions:
1.Depositary Institutions: Deposit-taking institutions that accept and manage deposits and make loans.
Example: banks and credit unions.
2.Contractual Institutions: Insurance companies and pension funds; and
3.Investment Institutes: Investment Banks, underwriters, brokerage firms
The Banking Financial Institution
A bank is a financial intermediary that gives money (loan) to a borrower. They also accept deposits (savings)
from depositors. The banking sector, being an intermediary in any economy and has a major role to play in
enhancing development and growth through their activities of:
(a) Mobilizing saving (b) Identifying good investment and (c) Exerting through sound corporate control
Accordingly, the banks’ roles in an economy include;
I.Acquiring information about firms and managers and thereby improving capital allocation and corporate
governance.
II.Managing cross-sectional, inter-temporal and liquidity risk and thereby enhancing investment efficiency and
economic growth.
As an institution, the efficiency of bank depends on following two key factors:
1) Degree of competition that exists among banks and,
2) The nature of the regulation to which banks are subject to.
It is believed that a competition among banks in the economy will result in:
I.Greater technical efficiency within deposit institutions, II.Lower interest rates for borrowers,
III.Higher interest rates for depositors and IV.A greater variety of services
5.3.2 The Non- Banking Financial institution
A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license or is
not supervised by a national or international banking regulatory agency.
NBFIs facilitate bank-related financial services- such as investment, insurance, risk pooling, contractual
savings, and market brokering.
History of Banking in Ethiopia
1905 - 1931
It was Emperor Menelik II (King of Ethiopia) that introduced modern banking in Ethiopia. There was an
agreement signed between the King and the British owned National Bank of Egypt. The first modern bank,
Bank of Abyssinia, was founded in 1906 as a result of this agreement. The Bank was totally managed by the
Egyptian National Bank, a foreign bank.
According to The Bank was given a 50- years concession and was engaged in issuing notes, collecting deposits
and granting loans, but its clients were mostly foreign businessmen and wealthy Ethiopians. the bank had
opened branches in the following towns of the country:
Harar town (1906) Dire Dawa town (1908)Gore Town (1912) Dessie and Djibouti (1920)
Bank of Abyssinia was liquidated in 1931. The Bank financed the Franco-Ethiopian Railway project which
reached Addis Ababa in 1917.
1931 to 1936
In 1931, Bank of Abyssinia was liquidated and legally replaced by Bank of Ethiopia shortly after Emperor
Haile Selassie came to power
The new bank, the Bank of Ethiopia, was totally under Government control and retained the
management, the staff, the premises and the clients of the previous bank, Bank of Abyssinia.
the bank of Ethiopia became the first independent bank of Ethiopia, which was totally under
Ethiopian government control.
It was, however, short lived and was liquidated during the Italian occupation in 1936. (3).
1936-1941
The following new banks were introduced by the Italians during their invasion of the country (Ethiopia) from
1936 – 1941:
Banca d’Italia, Banco di Roma, Banco di Napoli and Banca Nazionale del lavoro
These were actually branches of the main Italian banks in Italy.
1941 - 1943
There was another foreign bank introduced in 1941 (Barclays Bank) with the coming of the British troops and
they organized banking services in Addis Ababa, until its early withdrawal in 1943.
1943 - 1963
The State Bank of Ethiopia was established in 1943 as the central Bank of Ethiopia with a power of issuing
bank notes and coins as the agent of the Ministry of Finance.
the establishment of the State Bank of Ethiopia, marked the rebirth of the Ethiopian independent banking.
commercial banking activities (providing loans and taking deposits) and central bank activities (issuing bank
notes and coins). Until 1963, the State bank was the Central bank of the country.
The State Bank of Ethiopia had established 21 branches including a branch in Khartoum, Sudan & a transit
office on Djibouti until it ceased to exist by bank proclamation issued on December, 1963.
1963 – 1974
The National Bank of Ethiopia was established in 1963 by Proc. No. 206 of 1963 and began operation in
January 1964. This proclamation “The previous State Bank of Ethiopia” into two banks: National Bank of
Ethiopia and Commercial Bank of Ethiopia.
In 1963, the Ethiopian government split the State Bank of Ethiopia into the National Bank of Ethiopia, the
Central Bank, and the Commercial Bank of Ethiopia (CBE).
The government later merged Addis Bank into the Commercial Bank of Ethiopia in 1980 to make CBE the sole
commercial bank in the country
From 1974 to 1991
Following the declaration of socialism in 1974, the government extended its control over the whole economy
and nationalized all large corporations. Accordingly, the three private owned banks:
Addis Ababa Bank, Banco di Roma and Banco di Napoli Were combined (Merged) in 1976 and
formed the second largest Bank in Ethiopia called:
1. Addis Bank
In 1980, Addis Bank and Commercial Bank of Ethiopia S.C. were merged / combined to form the sole
Commercial bank in the country till the establishment of private commercial banks in 1994.
The Commercial Bank of Ethiopia commenced/started its operation with a capital of Birr 65 million, 128
branches and 3,633 employees, in the year 1980.
The Agricultural and Industrial Bank was formed in 1970 as a 100 percent state ownership, and which was
under the umbrella of the National Bank of Ethiopia. Then after, in 1979, the bank was renamed Agricultural
and Industrial Development Bank (AIDB).
The following was the three dominant banks in the country during 1974 -1991 period (according to the
Gregorian calendar). This period was also known as the Socialist period in Ethiopian history.
1.The National Bank of Ethiopia (NBE) 2.The Commercial Bank of Ethiopia (CBE)
3.Agricultural and Industrial Development Bank (AIDB)
From 1991 to _
In 1991 the country became a liberal economy system. The National Bank of Ethiopia (NBE) outlined its main
functions separated from the previous total government control. The Licensing and supervision of Banking
Business was formulated in 1994
(Monetary and Banking Proclamation No. 83/1994). The proclamation laid down the legal basis for investment
in the banking sector.
Commercial Bank of Ethiopia (CBE)
The Commercial Bank of Ethiopia is the biggest and the leading commercial bank in the country.
As a government commercial bank, the bank has the following Roles and Functions mandated to it by the
NBE:
A.Saving/deposit for the households/individuals and firms; B. Gives loans to households and firms;
C. Provides safe custody for valuables for households/individuals; D. Sell and purchase foreign currencies;
E. Issue letters of credit (LC), traveler’s cheques, etc
Development Bank of Ethiopia (DBE)
The (DBE) is one of the financial institutions engaged in providing short, medium and long term development
credits/loans. It has a “project” based lending tradition.
(DBE), it took this last name in 1994 financial reform is mandated with the f.f roles in the country:
1) Provides loans for the development of the agricultural and industrial sectors;
2) Supervises and controls the activities of projects financed by the bank .
Micro-finance Institutions
The f.f are the first Private Banks (performing commercial banking services) that were established after
the proclamation:
1. Awash International Bank was established in 1994 with 486 shareholders.
2. Dashen Bank was established in 1995 with 11 shareholders.
3. Bank of Abyssinia was established with 131 shareholders.
4. Wegagen Bank was established in 1997 with 16 founding members.
5. United Bank was established in 1998 with 335 shareholders.
6. Nib International Bank was established in 1999 with 717 shareholders.
7. Cooperative Bank of Oromia was established in 2004.
8. Lion International Bank was established in 2006 with 3739 shareholders.
9. Zemen Bank was established in 2008
10. Oromia International Bank was established in 2008.
In 2008/09, the number of banks operating in the country reached thirteen
Roles and Functions of Banks in Ethiopia
National Bank of Ethiopia (NBE)
National Bank of Ethiopia, on behalf of the government, controls and regulates the activities of the
financial sector, the commercial banks, insurance companies and microfinance institutions.
Commercial banks generate profit by depositing money, borrowing money from the national bank, and
lending money to the public.
The objective of controlling the financial sector is to bring price stability or control inflation.
The following are the various roles that it plays to control the financial sector and bring price stability in
the country:
1.It prints the currency and mints the coins;
2.Issues bonds, treasury bills, and promissory notes on behalf of the government;
3.Maintains low levels of inflation; 4.Authorizes and controls micro and other financial institutions;
5. Deposits government money and provides direct advances to the government;
6Lends money to commercial banks; 7.Regulates the money supply, interest rates and other charges,
8.Controls the creation of credit by commercial banks;
9.Formulates the monetary policy framework for the country; 10.Manages the international reserve of the
country; 11.Regulates the foreign exchange of the country; and
