COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

____________________________________________________________________________

Financial Institutions and Markets (Acfn 3081)

A project on an assessment of Ethiopian Financial system (Financial Institutions, Financial

Markets, Financial Assets, and Financial system Regulations)

Submitted By: Nuhamin Nadew

Id.No: Ugr/0849/15

Submitted To: Takele Fufa (PhD)

Date of Submission: January 14, 2025

 Table of contents
Chapter one: General Introduction about a Financial System in Ethiopia..........................................................4
1.1. An Overview of the Financial System................................................................................................4
1.2. Overview of financial system in Ethiopia..........................................................................................4
1.3. An Overview of the Structure of the Ethiopian Economy.................................................................5
1.3.1. Definition of Real economy......................................................................................................5
1.3.2. The Transformation of Ethiopia's Economic Landscape......................................................5
Chapter Two: Financial Institutions....................................................................................................................6
2.1. Definition of financial institutions.....................................................................................................6
2.1.1. Overview of Financial Institutions...........................................................................................6
2.2. Formal, Semi-formal and Informal Financial Institutions and their operations...............................6
2.2.1. Formal Financial Institutions..................................................................................................6
2.2.2. Informal Finance Institutions..................................................................................................9
2.3. Classification of financial institutions in Ethiopia (depository and non-depository financial institution)
and its operations.............................................................................................................................................10
2.3.1. Depository Institutions...........................................................................................................10
2.3.2. Non-Depository Financial Institutions..................................................................................11
2.4. Coverage of financial services in Ethiopia................................................................................12
2.5. Financial Services by Non-Bank Institutions....................................................................................13
2.5.1. FinTech....................................................................................................................................13
2.5.3. Capital Lease Financing.........................................................................................................14
Chapter Three: Ethiopian Financial Markets....................................................................................................15
3.1. Introduction to financial markets....................................................................................................15
3.2. Structure of the Ethiopian financial market....................................................................................16
3.3. Money Markets vs. Capital Markets: An Overview.........................................................................17
3.4. The nature of foreign markets in Ethiopia.......................................................................................20
3.5. Government borrowing and financial markets...............................................................................21
3.5.1. The Context of Government Borrowing in Ethiopia............................................................21
3.5.2. The Role of Financial Markets...............................................................................................21
3.6. Recent developments like the establishment of Ethiopian Capital market...................................22
Chapter Four: Financial assets in Ethiopia........................................................................................................23
4.1. Types of financial assets in Ethiopia................................................................................................23
4.2. The approaches these financial assets are valued..........................................................................23
(Valuation approaches)...............................................................................................................................23
4.3. Interest rate theories and the structure of interest rates in Ethiopian context.............................24
4.3.1. THEORIES OF INTEREST..................................................................................................24
Chapter Five: Regulations of the financial system in Ethiopia..........................................................................25
5.1. Financial Institutions Regulation.....................................................................................................26
5.2. Financial markets regulations..........................................................................................................26
5.3. Financial Assets Regulations in Ethiopia..........................................................................................27
5.4. Risk management provisions in Ethiopian financial Institutions....................................................28
5.5. Legal & juridical system, Institutional framework, proclamations, Regulations and Directives....28
5.6. Recent developments like the fight against money laundering and the financing of terrorism in
Ethiopia........................................................................................................................................................29
Chapter Six: Major Findings, Reflections, Conclusions, and Recommendations - Assessment of the Ethiopian
Financial System...............................................................................................................................................29
References........................................................................................................................................................32
 Chapter one: General Introduction about a Financial System in Ethiopia
1.1. An Overview of the Financial System
The financial system is the set of markets and intermediaries used by households, firms, and
governments to implement their financial decisions. It includes the markets for stocks, bonds, and
other securities, as well as financial intermediaries such as banks and insurance companies. Funds
flow through the financial system from entities that have a surplus of funds to those that have a
deficit. Often these fund flows take place through a financial intermediary. A financial system makes
possible a more efficient transfer of funds by mitigating the information asymmetry problem
between those with funds to invest and those needing funds.

In addition to the lenders and the borrowers, the financial system has three components:

1) Financial markets, where transactions take place; 2) Financial intermediaries, who facilitate
the transactions; and 3) Regulators of financial activities, who try to ensure that everyone is
playing fair.

1.2. Overview of financial system in Ethiopia

The financial sector in Ethiopia consists of formal, semiformal and informal institutions. The
formal financial system is a regulated sector which comprises of financial institutions such as banks,
insurance companies and microfinance institutions. The saving and credit cooperative are considered
as semi-formal financial institutions, which are not regulated and supervised by National Bank of
Ethiopia (NBE). The informal financial sector in the country consists of unregistered traditional
institutions such as Iqub (Rotating Savings and Credit Associations) Idir (Death Benefit Association)
and money lenders.

Currently, the Ethiopian financial system consists financial institutions such as the National Bank of
Ethiopia with aim to regulate the finance industry in the country, 17 commercial Banks; 15 insurance
companies; a public and private employed workers pension scheme; 33 Micro Finance Institutions
evolution was marked by three different stages: financial repression, financial development, and
financialisation. Each stage is associated with a different impact of the financial sector in the real
economy or in society. Financial system plays a vital role for the economic development of the
country through creating and mobilizing of capital. Among them bank's play a major role and take
the highest percentage of the financial institutions.

Generally, the financial system in the country is underdeveloped. This

underdevelopment adversely affects the adequacy and the level of financial access. the recent study
of world bank concerning the accessibility of financial system depict that, only around 10 percent of
the populations in Ethiopia have an account in formal financial institutions (Nana,2008).

1.3. An Overview of the Structure of the Ethiopian Economy

1.3.1. Definition of Real economy
A broad definition of the ‘real’ economy involves the production, transportation, and selling
of goods and services — as opposed to the exchange of paper assets, which is the concern of the
‘paper’ economy of the world of finance. A narrower definition would focus on material goods
only; sectors like industry, commerce, agriculture, shipping, supermarkets, and construction.
Either way, the ‘real’ economy, directly or indirectly, is, and always will be, the foundation of the
economy as a whole. In Greece, the survival, and, here and there, good performance of the ‘real’
economy, despite the weak infrastructure of the country and atrocious state policies, is almost a
mystery until, that is, one realizes that, when all is said and done, people need the ‘real’ economy
in order to make a living.

1.3.2. The Transformation of Ethiopia's Economic Landscape

The Ethiopian economy has experienced changes in economic systems over time. Under
the Monarchy (up to 1974), the economy of Ethiopia was primarily agricultural. The economy
was based on a feudal system under which land ownership was highly inequitable. The major
portion of farmland was in the hands of wealthy landlords. There were very few industries, most
them owned by foreigners. During the Military Regime (1974 – 1991), the economy shifted to a
command economy where socialist principles and ideologies ruled. Substantial land reforms
were introduced in the agricultural, industrial and financial sectors. The government owned all
the large-scale manufacturing industries, banks and insurance companies. Since the assumption
of power by EPRDF (1991), its government has followed a market oriented economy. It has
supported a process of economic reforms based on privatization of state enterprises, promotion
of agricultural exports and deregulation of the economy. Currently, though the contribution of
the service sector and the industrial sector is improving, the Ethiopian economy is based on
agriculture.
 Chapter Two: Financial Institutions
2.1. Definition of financial institutions
Financial institutions deal with various financial activities associated with financial systems, such as
securities, loans, risk diversification, insurance, hedging, retirement planning, investment, portfolio
management, and many other types of related functions. With the help of their functions, financial
institutions transfer money or funds to various tiers of the economy and thus play a significant role in
acting upon the domestic and international economic scenario.

A financial institution (FI) is a company engaged in the business of dealing with financial and
monetary transactions such as deposits, loans, investments, and currency exchange. Financial
institutions include a broad range of business operations within the financial services sector,
including banks, insurance companies, brokerage firms, and investment dealers.

Virtually everyone living in a developed economy has an ongoing or at least periodic need for a
financial institution's services.

2.1.1. Overview of Financial Institutions

Financial institutions serve as intermediaries by channeling the savings of individuals,
businesses, and governments into loans or investments, and usually, people use the term financial
institution interchangeably with financial intermediaries. They are major players in the financial
marketplace, with large amounts of financial assets under their control. They often serve as the main
source of funds for businesses and individuals. Some financial institutions accept customers’ savings
deposits and lend this money to other customers or firms. Many firms rely heavily on loans from
institutions for their financial support. Financial institutions are required by the government to
operate within established regulatory guidelines. Financial institutions/intermediaries are institutions
engaged in the business of channeling money from savers to borrowers. i.e., channel funds between
borrowers and lenders. Intermediation improves social welfare by channeling resources to their most
effective use.

2.2. Formal, Semi-formal and Informal Financial Institutions and their operations
2.2.1. Formal Financial Institutions
The major formal financial institutions operating in Ethiopia are banks, insurance companies and
microfinance institutions.

I. Formal Banks
Banking in Ethiopia started in 1905, with the establishment of the Bank of Abyssinia that was owned
by the Ethiopian government in partnership with the National Bank of Egypt then under British rule.
But a well-structured banking system started to evolve starting in the 1940s-after the Italian
departure. A government owned bank-the State Bank of Ethiopia-was established in 1942, and a
number of foreign bank branches and a private bank were operating in competition with the
government owned commercial bank until they were nationalized and merged into one government
owned mono-bank in 1976.

A proclamation number 84/94 was issued out to effect the deregulation and liberalization of the
financial sector, and a number of private banks and insurance companies were established following
the proclamation.

Currently, there are 17 banks operating in the country, of which 13 are private banks while the
remaining three are state owned banks, namely Commercial Bank of Ethiopia (CBE), Development
Bank of Ethiopia (DBE) and Construction and Business Bank (CBB). The total number of bank
branches in the sector reached 970, with a larger concentration of them(more than 40%) located in
the capital city, Addis Abeba (NBE,2009). Ethiopia is still one of the most under banked countries in
the world with one bank branch serving over 82,000 people.

Despite some improvement in the sector in the last couples of years, Ethiopian banking remains in its
low status. For instance, the estimates of Bank‘s recent Financial Sector Diagnost show that less than
10% of households have access to formal credit (African Development Bank, 2011).

II. The Insurance Company

Likewise to banking, Ethiopia’s insurance industry is undeveloped. Its emergence is traced back to
the establishment of the Bank of Abyssinia in 1905. The Bank had been acting as an agent for
foreign insurance companies to underwrite fire and marine policies.

According to the National Bank of Ethiopia (2010) there were 14 insurance companies with a
total of 221 branches operating in the country. In terms of ownership, all insurance companies except
the Ethiopian Insurance Corporation (EIC), are privately owned. Private insurance companies
accounted for 69.5 percent of the total capital, while the remaining share was taken up by the single
public owned enterprise, the Ethiopian Insurance Corporation Of the total insurance branches, 50.7
percent are concentrated in Addis Ababa. Private insurance companies owned 81.4 percent of the
total branches.
 According to Gebreyes (2011) the insurance market is undeveloped, uncompetitive and there
exist paucity of information on the kind of life insurance that is currently present. The current
practice of bulk of insurance coverage and business in Ethiopia is targeting the corporate market and
focuses mainly on general insurance with a very limited coverage in life insurance. The insurance
sector is dependent on the banking sector for much of its new business. Most Ethiopian insurance
companies have sister banks and it is common for these banks to refer their clients to their sister
insurance companies, but this is largely restricted to credit life insurance products. Moreover,
insurance companies tend to derive a large portion of their total income from investments in banks
(Smith and Chamberlain, 2009).

III. Microfinance Institutions

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

developing countries. The first microfinance service in Ethiopia was introduced as an experiment in
1994, when the Relief Society of Tigray (REST) attempted to rehabilitate drought and war affected
people through the rural credit scheme. It was inspired by other countries’ experiences and adapted
to the conditions of the Tigray region (northern part of Ethiopia). In the second half of the 1990s, as
a result of its success, the microfinance service was gradually replicated in other regions (Berhanu
and Thomas, 2000).

Similar to microfinance approaches in many other parts of the world, MFIs in Ethiopia focus on
group-based lending and promote compulsory and voluntary savings. They use joint liability, social
pressure, and compulsory savings as alternatives to conventional forms of collateral (SIDA, 2003).

The Ethiopian microfinance industry has undergone tremendous growth and development in a very
short period of time (Micro Ned, 2007, Amaha 2009), As of 2009, the 29 MFIs licensed by the
National Bank of Ethiopia succeeded in reaching more than 2.3 million clients and delivered about 7
billion Birr in loans.

IV. Semiformal – Saving and Credit Cooperatives

In Ethiopia there are three types of saving and credit cooperatives, namely Institution based
SACCOs; Community based SACCOS; and SACCOs sponsored by NGOs. Savings and credit
cooperatives are type of organizations providing financial services to the poor in rural areas of
Ethiopia. These include multi-purpose and credit and saving cooperatives.

Unlike other formal financial institutions (banks and micro finance institutions), saving and credit
cooperatives are owned, controlled and capitalized by their members. This implies that the savings
and credit cooperatives are not subjected to supervision and regulation of the National Bank of
Ethiopia. Savings and credit cooperatives in Ethiopia are not permitted to take deposits from
nonmembers.

2.2.2. Informal Finance Institutions

In both rural and urban areas in Ethiopia, it is common that neighboring family households organize
themselves and develop their own institutions, popularly known as Community-Based Organizations
(CBOs). The nature of the CBOs highly varies from social, religious and financial concerns, but are
all aimed to address the needs of the people. In most communities, membership in traditional
community associations such as iddirs, iqqubs and mehabers are very common.

According to Micro Ned (2011), the informal finance has been popular due to three main reasons.
First, it has more often than not been the only form of service delivery available. Second, loan
processing is quick and not too many questions are being asked about the application of the
borrowed sum. Third, in the case of Iddir and Iqqub, loans are provided in the context of social
intermediation and self-organization. The capacity of these traditional systems, however, is limited
(Ibid). The three most common informal finance or traditional institutions are discussed in detail in
the following subheadings.

I. Iddirs

An Iddir is the most common informal institution in Ethiopia, common in both rural and urban areas.
It is an association made up by a group of persons united by ties of family and friendship, by living
in the same district, by jobs, or by belonging to the same ethnic group and as an object of providing
mutual aid and financial assistance in certain circumstances. It is primarily a burial society whereby
savings are made to cover the cost of funerals, but also weddings. It provides various services to its
members. Membership is regularly by residence, whereby members pay a small monthly fee
(Pankhurst and Mariam, 2000).

Concerning its organizational structure, nearly all iddirs have a secretary and a treasurer as
well as a chairman and judge. Due to its impartial membership structure, it is often said to be
Ethiopia’s most democratic and egalitarian social organization where membership is open to anyone
regardless of religion, socioeconomic status, gender and ethnic affiliation (Johansson, 2010).

During the current rule of the Ethiopia People’s Revolutionary Democratic Front (EPRDF), the
potential of iddirs as a vehicle for development has been further acknowledged by both the
government as well as by nongovernmental institutions (NGOs). From the government’s point of
view, the general recognition of civil society’s role in development has led to that iddirs have been
accepted as possible partners for successful and sustainable development (Pankhurst et al., 2009).

II. Iqqubs

Iqqubs have played a significant role especially for the informal sector in Ethiopia. An iqqub is a
traditional saving and credit association (Rotating Saving and Credit Association), of which its
purpose is basically to pool the savings of their members in accordance with the rules established by
the group. Members usually deposit contributions on a weekly or monthly basis, and lots are drawn
by turns so that the one who wins the chance gets the total sum. This process continues on a regular
basis until the last member receives his/her share or what she/he has been saving through the months
and the whole process starts again.

III. Mehabers

Another common CBO is the Mehaber, which is a religious, informal institution that aims to
raise funds for medical and burial expenses. It is widespread among the Orthodox Christians of
Ethiopia, as it typically draws its members from the church. Members usually meet on a monthly
basis for food and drink, and commonly support each other in times of difficulty (Pitamber, 2003).

2.3. Classification of financial institutions in Ethiopia (depository and non-

depository financial institution) and its operations
2.3.1. Depository Institutions
Depository institutions are financial intermediaries that accept deposits usually demand deposits and
savings deposits from customers and invests those funds in loans and securities. Deposits are
liabilities of these institutions. With the fund raised through deposits they make direct loans to
various entities. They include commercial banks (or simply banks), savings and loan associations
(S&Ls), savings banks, microfinance and credit unions.

A) Commercial banks

Commercial banks accumulate deposits from savers and use the proceeds to provide credit to firms,
individuals, and government agencies. . Thus they serve investors who wish to “invest” funds in the
form of deposits. Commercial banks use the deposited funds to provide commercial loans to firms
and personal loans to individuals and to purchase debt securities issued by firms or government
agencies.
 B) Savings Banks and Savings and Loan Associations

Saving Banks and Savings and Loan Associations are depository institutions that traditionally have
specialized in extending mortgage loans to individuals who wish to purchase homes. Just as there is
asymmetric information in business loan deals, a person who wants a mortgage loan may or may not
become a bad risk after receiving the loan. And so there are adverse selection and moral hazard
problems specific to mortgage lending.

C) Credit Union

The credit unions are the smallest of all depository institution. A credit union is a depository
institution that accepts deposits from and makes loans only to a closed group of individuals. To be a
member of a credit union and eligible for its services, a person usually must be employed by a
business with which the credit union is affiliated. Most credit unions specialize in making consumer
loans, although some have branched into mortgage loan business.

D) Microcredit Institutions

Microfinance institutions are found among the institutions which provide different financial service
for the poor who are out of the conventional banking system particularly in developing countries.
Microfinance Institutions (MFIs) provide financial services to poor clients who in most cases have
no access to formal financial institutions. During the last three decades, microfinance has captured
the interest of both academics and policy makers. This is, among other things, due to the success of
the industry (Assefa et al., 2013).

2.3.2. Non-Depository Financial Institutions

Non-depository or contractual intermediaries bundles the provision of some other contractual
services, with the investment of funds e.g., insurance companies, pension funds, mutual funds and
hedge funds.

A) Insurance company

Insurance companies specialize in trying to limit adverse selection and moral hazard problems
unique to efforts insure against possible future risks of loss. They issue policies, which are promises
to reimburse the holder for damages suffered in the event of a “bad” event, such as an auto accident.

B) Pension Funds

Pension funds are institutions that specialize in managing funds that individuals have put away to
serve as a nest egg when they retire from their jobs and careers. Part of what many workers get paid
is in the form of contributions that their employers make to such funds. The key specialty of pension
funds is creating financial instruments called pension annuities.

C) Mutual Funds

A Mutual fund is a mix of redeemable instruments, called “shares” in the fund. These shares are
claims on the returns on financial instruments held by the fund, which typically include equities,
bonds, government securities, and mortgage backed securities. Mutual funds usually are operated by
investment companies, which charge shareholders fees to manage the funds.

D) Hedge funds

A hedge fund is a limited partnership of private investors whose money is pooled and managed by
professional fund managers. These managers use a wide range of strategies, including leverage
(borrowed money) and the trading of nontraditional assets, to earn above-average investment returns.

E) Finance Companies

A finance company also specializes in making loans to individuals and businesses. Finance
companies, however, do not offer deposits. Instead, they use the funds invested by their owners or
raised through issuing other instruments to make loans to households and small businesses. Many
finance companies specialize in making loans to people and firms that depository institutions regard
as high risks.

F) Investment Banking firms

Investment Banking is financial institutions that underwrites and distributes new investment
securities and helps businesses obtain financing. Investment banking houses in the US such as
Goldman Sachs or Credit Suisse Group provides a number of services to both investors and
companies planning to raise capital. Such organizations: (a) help corporations design securities with
features that are currently attractive to investors, (b) buy these securities from the corporation, and
(c) resell them to savers

Although the securities are sold twice, this process is really one primary market transaction, with the
investment banker acting as a facilitator to help transfer capital from savers to businesses.
Each of these non-banking financial institutions serves a different purpose, but they all work towards
the ultimate goal of providing funding for businesses and individuals.

2.4. Coverage of financial services in Ethiopia

The Ethiopian financial sector is shallow (African Economic Outlook, 2012) and the coverage of
financial services in Ethiopia is low (ADB, 2011). Recent studies estimated that less than 10% of
households have access to formal credit (ibid). In addition, there is a lack of more sophisticated
financing mechanisms such as leasing, equity funds, etc. Starting from a very low base, the total
asset of the banking system has registered an encouraging growth over the last 10 years. It increased
from Birr 153 billion (USD 14.68 billion) in 2008/09 to Birr 400.9 billion (USD 21.9 billion) in
2012/13, an increase of 163%. Though from low base the growth is too fast and now the NBE has
put new regulations that slowdown the increase in the banking sector.

It should be noted that the banking system is the largest among the financial sector accounting for
over 80% of the total assets of the financial sector. Yet its size is quite limited compared to the
financing need of the economy.

According to Tsegabirhan (2010) the Ethiopian banking industry is underfinanced itself with a
total capital of Birr 10.5 billion, which is about USD $840 million. This constrains the size of credit
available to the Ethiopian economy. Given this limited capital base relative to the credit demand of
the economy, the Ethiopian banking sector at its current size cannot be expected to finance major
physical infrastructure like hydroelectric power generation projects.

2.5. Financial Services by Non-Bank Institutions

2.5.1. FinTech
The FinTech industry in Ethiopia has undergone some considerable changes in recent years due to
new regulatory changes introduced by the Ethiopian government. In March 2020, the National Bank
of Ethiopia issued a new Directive on issuers of payment services, allowing local non-banks,
including mobile network operators to offer mobile money services.

While Ethiopia’s FinTech ecosystem is still quite small-scale, the government’s supportive reforms
towards promoting a digital economy and favorable market conditions have led to growth in the
sector. There are five FinTech companies in Ethiopia to watch out for

1) Arifpay: Arifpay Financial Technologies S.C. is a financial institution licensed by the National
Bank of Ethiopia providing digital payment solutions, ArifPOS and ArifGateway. Arifpay is
 Ethiopia’s first Point of Sale (POS) Payment System Operator (PSO) with payment solutions for
smartphones, POS and QR payment terminals.

2) BelCash: BelCash International was officially founded in 2010 in the Netherlands. In 2011
BelCash decided to establish itself in Ethiopia, 2nd largest market African market, with 115
million people. Although the Ethiopian Bank sector is still at an early stage, BelCash has
successfully deployed its digital banking platform in 4 major banks and 2 microfinances
providing under the Brand “HelloCash”, its Open API BAnking Solutions to Financial
Institutions and monetize it via transactional fees.

3) Chapa: Chapa Financial Technologies S.C is an online payment gateway that empowers small
businesses and large merchants to accept local or international payments from their customers via our
APIs and Chapa’s platform. Chapa offers services in the following areas: Payment Gateway and Bill
Aggregator Solutions.
4) Kifiya : Established in 2010, Kifiya is a technology and services company developing scalable and
secured technology platforms. It is a digital finance and payment services provider that leverages
innovative technology to build and enable distribution channels that make financial and non-financial
services affordable and accessible.
5) Telebirr : Telebirr is a mobile money service developed and launched by Ethio telecom, the state-owned
telecommunication and Internet service provider in Ethiopia.

2.5.2. Islamic Finance

Sharia-compliant financial services are provided by different financial institutions. The common
Islamic financial institutions are Islamic Banking, Islamic Capital Markets, Takāful (Insurance) and
Islamic microfinance institutions. Islamic banking is a financial institution providing banking
services following the Islamic Shariah principle. Islamic banking is a deposit-taking institution
without paying interest on collected deposits (Shanmugan & Zahari, 2009).

Islamic financial system is accommodated in the Ethiopian financial system lately. Initially, offering
Islamic banking products and services by conventional banking through a separate window is
permitted and finally, establishing full-fledged Islamic finance institutions are permitted in late 2020.

This indicated that Islamic finance practices are ancient as Islam itself. As stated by Chachi
(2005), Muslims have established their interest-free financial system for resource mobilization and to
invest it for productive business and end-user needs from the early era of Prophet Muhammed
(PBUH). They were applying Islamic finance practice through “profit and loss sharing modes” of
Mudarabah (a form of partnership in which one individual gives capital and the other party effort)
and Musharakah (a form of partnership in which two or more individuals or institutions contribute
capital effort).

2.5.3. Capital Lease Financing

A capital lease, also referred to as a finance lease, is a contract that allows a lessee to use an asset
while transferring most of the ownership benefits and risks from the lessor to the lessee. To qualify
as a capital lease, the agreement must meet at least one of several criteria, such as the transfer of
ownership by the end of the lease, the option to purchase the asset at a bargain price, a lease term that
spans most of the asset's economic life, and lease payments that closely reflect the asset's fair value.
When at least one of these conditions is met, the lessee must account for the lease as if they own the
asset.

A capital lease requires the lessee to record the leased asset and associated liability on their balance
sheet if the lease meets specific criteria. Essentially, a capital lease is treated as a purchase of an
asset under generally accepted accounting principles (GAAP), while an operating lease is handled
as a true rental agreement. Capital leases impact a company's financial statements, affecting interest
expense, depreciation expense, assets, and liabilities.

Chapter Three: Ethiopian Financial Markets

III.1. Introduction to financial markets
The Reserve Bank of Australia (www.rba.gov.au/Glossary/text only.asp, cited in Amare, 2008),
defines financial markets as “a generic term for the markets in which financial instruments are
traded. Financial instruments have no intrinsic value of themselves”. They represent a claim against
the income or wealth of a business firm, household, or unit of government represented usually by a
certificate of receipt or other legal document and usually created by the buying of securities - both
debt and equity. The four main financial markets are the share or equity market, the fixed interest or
bond market, foreign exchange market, and the derivatives market.

People and organizations wanting to borrow money are brought together with those having surplus
funds in the financial markets. A financial market is therefore an arrangement where financial assets
such as stocks and bonds can be purchased and sold. Financial markets facilitate the flow of funds
and thereby allow financing and investing by households, firms, and government agencies (Madura,
2012).
 Financial market provide long term finance of two types: (i) loans with periodic payments of
interest with principal usually repaid at maturity, and (ii) equity shares for which there is no
commitment to repay funds but a right to share in the profits of the venture paid as dividends. Thus,
the providers of funds in the financial market deal essentially with the long term risk related to
payments of interest and principal on the debt or dividends on equity shares (Elias, 1995).

III.2. Structure of the Ethiopian financial market

The descriptions of several categorizations of financial markets illustrate essential features of these
markets.

i. Debt and Equity markets

A firm or an individual can obtain funds in a financial market in two ways. The most common
method is to issue a debt instrument, such as a bond or a mortgage, which is a contractual agreement
by the borrower to pay the holder of the instrument fixed Birr amounts at regular intervals (interest
and principal payments) until a specified date (the maturity date).

The second method of raising funds is by issuing equities, such as common stock, which are claims
to share in the net income (income after expenses and taxes) and the assets of a business. Stock
means that you own a portion of the firm and thus have the right to vote on issues important to the
firm and to elect its directors.

ii. Primary and Secondary Markets

A primary market is a financial market in which new issues of a security, such as a bond or a stock,
are sold to initial buyers by the corporation or government agency borrowing the funds. A secondary
market is a financial market in which securities that have been previously issued (and are thus
secondhand) can be resold.

iii. Exchanges and Over-the-Counter Markets

Secondary markets can be organized in two ways. One is to organize exchanges, where buyers and
sellers of securities (or their agents or brokers) meet in one central location to conduct trades. The
New York and American stock exchanges for stocks and the Chicago Board of Trade for
commodities (wheat, corn, silver, and other raw materials) are examples of organized exchanges.
The other method of organizing a secondary market is to have an over-the-counter (OTC) market, in
which dealers at different locations who have an inventory of securities stand ready to buy and sell
securities “over the counter” to anyone who comes to them and is willing to accept their prices.
Because over-the-counter dealers are in computer contact and know the prices set by one another, the
OTC market is very competitive and not very different from a market with an organized exchange.

iv. Money and Capital Markets

Another way of distinguishing between markets is on the basis of the maturity of the securities traded
in each market. The money market is a financial market in which only short-term debt instruments
(generally those with original maturity of less than one year) are traded.

The capital market is the market in which longer-term debt (generally those with original maturity of
one year or greater) and equity instruments are traded. Capital market securities, such as stocks and
long-term bonds, are often held by financial intermediaries such as insurance companies and pension
funds, which have little uncertainty about the amount of funds they will have available in the future.

III.3. Money Markets vs. Capital Markets: An Overview

Money and capital markets are fundamental to the economy, serving investors and businesses
alike. Money markets deal in short-term debt instruments, usually for one year or less. It's where
governments, banks, and large corporations go to manage their immediate cash needs. Capital
markets involve long-term securities, such as stocks and bonds that mature in more than one year.
This is where companies and governments raise funds for major projects and long-term growth.

A. MONEY MARKET INSTRUMENTS

Those markets are dealing with short-term securities that have a life of one year or less. Because of
their short terms to maturity, the debt instruments traded in the money market undergo the least price
fluctuations and so are the least risky investments.

Types and Examples of Money Markets

Money markets play a crucial role in the financial system, providing a place for institutions and
individuals to park cash safely for short periods. These markets deal in highly liquid, short-term
debt instruments, typically with maturities of one year or less. Let's explore the main types of
money market instruments and how they function.

 Treasury Bills

These short-term debt instruments of the government are issued in 3-, 6-, and 12-month maturities to
finance the federal government. Treasury bills are the most liquid of all the money market
instruments, because they are the most actively traded. They are also the safest of all money market
instruments, because there is almost no possibility of default, a situation in which the party issuing
the debt instrument (the federal government, in this case) is unable to make interest payments or pay
off the amount owed when the instrument matures. The federal government is always able to meet its
debt obligations, because it can raise taxes or issue currency (paper money or coins) to pay off its
debts. Treasury bills are held mainly by banks, although small amounts are held by households,
corporations, and other financial intermediaries.

 Negotiable Bank Certificates of Deposit

A certificate of deposit (CD) is a debt instrument, sold by a bank to depositors, that pays annual
interest of a given amount and at maturity, pays back the original purchase price. CDs are an
extremely important source of funds for commercial banks, from corporations, money market mutual
funds, charitable institutions, and government agencies.

 Commercial Paper

Commercial paper is a short-term debt instrument issued by large banks and well-known
corporations, selling to other financial intermediaries and corporations for their immediate borrowing
needs; in other words, they engage in direct finance.

 Bankers’ Acceptances

These money market instruments are created in the course of carrying out international trade and
have been in use for hundreds of years. A banker’s acceptance is a bank draft (a promise of payment
similar to a check) issued by a firm, payable at some future date, and guaranteed for a fee by the
bank that stamps it “accepted.” The firm issuing the instrument is required to deposit the required
funds into its account to cover the draft. If the firm fails to do so, the bank’s guarantee means that it
is obligated to make good on the draft. These “accepted” drafts are often resold in a secondary
market at a discount and are therefore similar in function to Treasury bills. Typically, they are held
by many of the same parties that hold Treasury bills.

 Repurchase Agreements

Repurchase agreements, or repos, are effectively short-term loans (usually with a maturity of less
than two weeks) in which Treasury bills serve as collateral, an asset that the lender receives if the
borrower does not pay back the loan.

 Federal (Fed) Funds

These are typically overnight loans between banks of their deposits at the Federal Reserve. The
federal funds designation is somewhat confusing, because these loans are not made by the federal
government or by the Federal Reserve, but rather by banks to other banks. One reason why a bank
might borrow in the federal funds market is that it might find it does not have enough deposits at the
Fed to meet the amount required by regulators. It can then borrow these deposits from another bank,
which transfers them to the borrowing bank using the Fed’s wire transfer system.

CAPITAL MARKET INSTRUMENTS

Capital market instruments are debt and equity instruments with maturities of greater than one year.
They have far wider price fluctuations than money market instruments and are considered to be fairly
risky investments. The principal capital market instruments are:

 Stocks

Stocks are equity claims on the net income and assets of a corporation. A share of a stock in a
corporation represents ownership. A stockholder owns a proportionate interest in the company
consistent with the percentage of outstanding stocks held. Stockholder is an owner in contrast with
the bondholder who is a creditor of the firm. Investor can get return from a stock in two ways: The
price of the stock raise over time and the corporation pays the stock dividend. Being owners they
have the right of residual claim and right to vote. There are two type of stock: Preferred Stock and
Common Stock.
  Mortgages

Mortgages are loans to households or firms to purchase housing, land, or other real structures, where
the structure or land itself serves as collateral for the loans. Savings and loan associations and mutual
savings banks have been the primary lenders in the residential mortgage market, although
commercial banks may enter this market. The majority of commercial and farm mortgages are made
by commercial banks and life insurance companies.

 Corporate Bonds

These are long-term bonds issued by corporations with very strong credit ratings. The typical
corporate bond sends the holder an interest payment and pays off the face value when the bond
matures. Some corporate bonds, called convertible bonds, have the additional feature of allowing the
holder to convert them into a specified number of shares of stock at any time up to the maturity date.

 Government Securities

These long-term debt instruments are issued by the Government Treasury to finance the deficits of
the federal government. Because they are the most widely traded bonds in the market, they are the
most liquid security traded in the capital market. They are held by the Federal Reserve, banks,
households, and foreigners.

 State and Local Government Bonds

State and local bonds, also called municipal bonds, are long-term debt instruments issued by state
and local governments to finance expenditures on schools, roads, and other large programs. An
important feature of these bonds is that their interest payments are exempt from federal income tax
and generally from state taxes in the issuing state. Commercial banks, with their high income tax
rate, holders consist of wealthy individuals in high income brackets, and insurance companies are the
biggest buyers of these securities.

 Consumer and Bank Commercial Loans

These are loans to consumers and businesses made principally by banks, but—in the case of
consumer loans—also by finance companies. There are often no secondary markets in these loans,
which makes them the least liquid of the capital market instruments

III.4. The nature of foreign markets in Ethiopia

After a decade of double digit economic growth, the Ethiopian economy is at an important point in
its transition to a middle-income economy. Rates of economic growth are now slowing and
authorities are seeking to shift the engine of economic activity to the private sector, while the public
sector consolidates. Ethiopia's foreign markets are characterized by a diverse range of products and
destinations. Key exports include coffee, gold, oilseeds, vegetables, flowers, and legumes, with
major markets being the United States, Saudi Arabia, Somalia, Germany, and the Netherlands.
Imports primarily consist of palm oil, wheat, fertilizers, and vehicles, sourced mainly from China,
India, the United States, Turkey, and Morocco.

The country's trade balance typically shows a structural deficit, influenced by its investment-led
economic model and occasional grain import needs. Foreign exchange shortages remain a persistent
challenge, although export earnings and diaspora remittances are expected to alleviate the situation to
some extent.

While Ethiopia has made significant strides in recent years to diversify its economy and attract
foreign investment, challenges such as infrastructure constraints, bureaucratic hurdles, and political
instability continue to hinder its full economic potential.

III.5. Government borrowing and financial markets

III.5.1.The Context of Government Borrowing in Ethiopia
Ethiopia, classified as a developing country, has experienced significant changes in its political and
economic landscape over the past few decades. The government's borrowing practices have evolved
as it seeks to finance ambitious infrastructure projects, stimulate economic growth, and meet the
basic needs of its population. The fiscal policies employed by the government have relied on
borrowing to fund critical projects, especially in areas such as transportation, energy, and agriculture.

While borrowing has enabled the Ethiopian government to mobilize resources for development, it
raises concerns regarding sustainability and the long-term implications for economic stability.
Ethiopia has faced inflationary pressures and has been grappling with rising public debt levels.
Government borrowing, when not managed prudently, can lead to an unsustainable debt burden,
potentially hampering economic growth and threatening macroeconomic stability.

III.5.2.The Role of Financial Markets

Financial markets play a pivotal role in the context of government borrowing by providing avenues
for raising funds. In Ethiopia, the financial sector has undergone several reforms aimed at increasing
efficiency, promoting financial inclusion, and fostering a stable economic environment. The
government issues treasury bills and bonds, which are key instruments for financing its expenditures.
Furthermore, banks and other financial institutions have become increasingly involved in purchasing
these government securities, thereby providing the government with vital liquidity.

However, the growth of Ethiopia’s financial markets has been a double-edged sword. On the one
hand, it facilitates access to capital; on the other hand, it highlights existing challenges that need to
be addressed. The Ethiopian financial market is still relatively underdeveloped compared to other
nations, characterized by limited financial instruments and depth. A shortage of risk assessment
tools, inadequate regulatory frameworks, and low investor confidence can hinder the effective
operation of financial markets.

III.6. Recent developments like the establishment of Ethiopian Capital

market

In recent years, Ethiopia has seen significant economic reforms aimed at liberalizing its financial
sector. Among the major developments is the emergence of a capital market, which promises to
reshape the country’s financial landscape and potentially redefine the role of commercial banks. This
article explores the implications of this shift, analyzing how the capital market is poised to influence
Ethiopia’s economy and the future trajectory of its banking sector.

A capital market is a vital component of any economy, facilitating the buying and selling of financial
instruments such as stocks, bonds, and other long-term investments. Unlike traditional banking,
which focuses on lending and deposits, capital markets provide avenues for businesses and
governments to raise funds directly from investors. This direct access to capital can fuel economic
growth by financing infrastructure projects, expanding businesses, and promoting innovation.
Ethiopia’s move towards establishing a capital market signifies a shift away from its predominantly
bank-centered financial system. The emergence of a capital market poses both challenges and
opportunities for Ethiopia’s commercial banks.
The successful establishment of a capital market hinges on a robust regulatory framework that
ensures transparency, fairness, and investor protection. Ethiopia’s capital market authorities must
develop stringent oversight mechanisms to prevent market manipulation, insider trading, and other
unethical practices. Effective regulation fosters trust among investors and promotes long-term market
stability, which is essential for sustainable economic growth.

In conclusion, the emergence of a capital market represents a transformative opportunity for

Ethiopia, signaling a shift towards a more diversified and resilient financial sector. Ethiopia can
unleash the full potential of its capital market and propel sustainable economic development for
years to come.

Chapter Four: Financial assets in Ethiopia

A financial asset is a legal contract that gives its owner a claim to payments, usually generated by a
real asset. Examples include currency (Birr, dollar, etc), stocks, bonds, bank deposit, bank loans,
options, futures, etc. Financial assets in other words refer to the different financial instruments on
which parties in the financial market traded with. For financial instruments, the typical future benefit
is a claim to future cash. The entity that has agreed to make future cash payment is called the issuer
of the financial assets whereas the owner of the financial asset is referred to as the investor.

4.1. Types of financial assets in Ethiopia

While the Ethiopian financial market is still developing, it offers a diverse range of financial assets
for investment and trading. Here's a more comprehensive list:

 Cash and cash equivalents

o Cash on hand, short term-deposits, etc
 Equity instruments of other entities
 Bonds
o ETB denominated
o Foreign currency denominated
 Loans: financial institutions, employees
 Related party loans
 Operating, e.g. trade receivables
 4.2. The approaches these financial assets are valued
(Valuation approaches)
In Ethiopia, the valuation of financial assets is critical for both investors and regulatory bodies to
determine fair market value, aid in investment decisions, and ensure compliance with national and
international standards.

The key approaches used for valuing financial assets include several methods, each suited for
different types of assets and circumstances here are some of the approaches:

1. Market Approach: This method evaluates financial assets based on comparable assets'
market prices. It is commonly used for publicly traded securities, where recent transaction
prices provide a clear indicator of value.
2. Income Approach: This approach estimates the worth of financial assets based on their
expected future cash flows, discounted back to their present value. It is particularly useful for
valuing investments that generate consistent income, like bonds and dividend-paying stocks.
3. Cost Approach: This method determines the value by calculating the cost associated with
acquiring or creating a financial asset. It is mainly used for valuing assets that may not have
active markets or established pricing, such as startups and newly formed enterprises.
4. Discounted Cash Flow (DCF) Method: This specific income approach focuses on
forecasting the future cash flows of an asset and then discounting them using a suitable
discount rate. It is a widely accepted method for valuing businesses and investment projects.
5. Asset-Based Approach: This method assesses the value of a business based on the total
value of its underlying assets, both tangible and intangible. It is often used during liquidation
scenarios or mergers and acquisitions.

Overall, the choice of valuation approach in Ethiopia depends on the specific financial asset
involved, its market environment, and the purpose of valuation, thereby ensuring that stakeholders
have accurate and reliable information for decision-making.

4.3. Interest rate theories and the structure of interest rates in Ethiopian
context
Interest rate is the price paid on money borrowed within a given period of time (Anyanwu, 1999).
Borrowing and lending in the financial market depend to a significant extent on the rate of interest.
In economics, interest is a payment for the services of capital. It represents a return on capital. In
other words, interest is the price of hiring capital. While the necessity of charging interest on credit
has been widely accepted, there seems to be plenty of disagreement over the level of interest rate
charged by financial providers because the factors that go into these calculations are not well known.
(Alidu, 2012).

4.3.1. THEORIES OF INTEREST

A) CLASSICAL THEORY

This theory is also regarded as savings and investment theory of rate of interest. According to this
theory the rate of interest is determined by the interaction of savings and investment. Interest is
regarded as a reward for savings in classical theory. The rate of interest is a real phenomenon
because it is determined by the real factors like savings, investment, and thriftiness and so on.

B) NEO-CLASSICAL OR LOANABLE FUND THEORY OF INTEREST RATE

According to this theory the rate of interest is the price paid for the use of loanable fund. The rate of
interest is determined by the equilibrium between demand and supply of loanable funds in the credit
market. Source of Demand for loanable fund: Loanable funds are demanded for three purposes: (a)
Investment (I) (b) Dissaving /Consumption(C) (c) Hoarding (H) Investment by business is the most
important source of demand for loanable funds.

C) KEYNES’S LIQUIDITY PREFERENCE THEORY OF INTEREST

According to this theory the rate of interest is determined by the demand for and supply of money.
Rate of interest is a monetary phenomenon. It is payment for the use of money. Keynes has defined
interest as reward for parting with the liquidity. The supply of money is institutionally given. It
depends on the currency issued by government and policy of the central bank.

Chapter Five: Regulations of the financial system in Ethiopia

Financial regulation is a form of regulation or supervision, which subjects financial markets and
institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of
the financial system. This may be handled by either a government or non-government organization
or a body established by a government for this purpose.

The financial regulation agencies are also called as financial regulators. Generally every country has
its own financial system and like thus has/have financial regulators. Financial regulation agencies or
bodies or regulators differ from country to country. In some countries, governments directly engage
in financial regulation activity whereas in other countries, governments may appoint one or more
such regulation bodies. Generally, financial regulators include: a) Ministry of Finance of the central
government b) Federal Reserve Bank or central bank of the country c) Securities Exchange
Commission d) Insurance Regulatory Authority e) Banking Regulation Authority etc.

The financial system in Ethiopia consists regulatory bodies of the financial system such as NBE
(National Bank of Ethiopia), Ministry of Trade-Ethiopia (MoT), Public Financial Enterprise Agency
(PFEA), Ethiopian Commodity Exchange Authority (ECEA), and Federal Cooperative Agency-
Ethiopia (FCA).

The National Bank of Ethiopia (NBE) as the central bank, the NBE is responsible for monetary
policy, banking supervision, foreign exchange management, and payment systems oversight. These
regulatory bodies work together to ensure the stability, integrity, and efficiency of Ethiopia's
financial system.

5.1. Financial Institutions Regulation

Over the years, the regulatory framework governing financial institutions in Ethiopia is aimed at
safeguarding the interests of depositors, maintaining financial stability, and promoting the soundness
of the banking system. Here is a list of some financial institution regulations in Ethiopia:

Licensing Requirement: All financial institutions in Ethiopia must obtain a license from the
National Bank of Ethiopia to operate legally.
Capital Adequacy: Financial institutions are required to maintain a minimum level of capital
to absorb potential losses and maintain financial stability.
Liquidity Requirement: To ensure that financial institutions can meet their short-term
obligations, they must maintain a minimum level of liquid assets.
Risk Management: Financial institutions in Ethiopia are required to have robust risk
management practices in place to identify, measure, and mitigate various types of risks.
Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF): Financial
institutions are required to implement measures to prevent money laundering and terrorist
financing activities.
In conclusion, financial institution regulations in Ethiopia play a crucial role in maintaining
stability, protecting consumers, and promoting transparency in the financial sector. By
adhering to these regulations, financial institutions can contribute to the overall economic
development of the country.
 5.2. Financial markets regulations
Ethiopia has made significant strides in developing its financial market landscape over the past few
decades. A series of regulations have been implemented to ensure stability, transparency, and
integrity in financial markets, which are essential for fostering economic growth and attracting
investment. This essay will outline key financial market regulations in Ethiopia, providing a brief
description of each.

1. Proclamation No. 550/2007 - Proclamation to Provide for the Establishment of the Ethiopian
Commodity Exchange: This proclamation established the Ethiopian Commodity Exchange
(ECE), aiming to enhance market efficiency for agricultural commodities.
2. Proclamation No.592/2008 - Proclamation on the Regulation of Banking Business: This
regulation governs the establishment and operation of banks in Ethiopia. It stipulates minimum
capital requirements, licensing procedures, and operational standards.
3. National Bank of Ethiopia Directives: The NBE issues various directives to implement the
banking proclamation effectively.
4. Proclamation No. 626/2009 - Proclamation on the Regulation of Microfinance Institutions: This
proclamation provides a framework for the establishment and regulation of microfinance
institutions (MFIs) in Ethiopia.
5. Proclamation No 1164/2019 - Micro-finance Business (Amendment) : The Micro-finance
Business (Amendment) Proclamation aims to create a more robust and effective micro-finance
sector that can contribute to economic development and poverty alleviation
6. Proclamation No. 1248/2021 - Proclamation on the Establishment of the Capital Market
Authority

Financial market regulations in Ethiopia play a critical role in fostering a stable and trustworthy
economic environment. By establishing clear and enforceable guidelines for banking, investment,
microfinance, insurance, and commodities.

5.3. Financial Assets Regulations in Ethiopia

Ethiopia's financial sector is governed by a series of regulations aimed at ensuring stability,
promoting transparency, and protecting investors. Key components include:

1. Banking Regulations:
 o National Bank of Ethiopia (NBE): Regulates commercial banks, ensuring compliance with
capital and liquidity requirements.
o Licensing: Banks must obtain a license from the NBE.
2. Microfinance Regulations:
o Governed by the Microfinance Business Proclamation, focusing on licensing, operational
standards, and consumer protection.
3. Insurance Regulations:
o The Insurance Business Proclamation regulates insurance companies, ensuring solvency and
consumer protection.
4. Capital Markets:
o Governs the establishment of the Ethiopian Securities Exchange and outlines trading of
securities.
5. Foreign Investment Regulations:
o The Investment Proclamation sets guidelines for foreign direct investment, including approval
processes.

These regulations aim to foster a stable financial environment and promote inclusive growth.

5.4. Risk management provisions in Ethiopian financial Institutions

Risk management is a critical component of the operational framework of financial institutions in
Ethiopia, particularly in light of the country’s evolving economic landscape. Ethiopian financial
institutions have implemented various risk management provisions to mitigate financial, operational,
and credit risks. Notably, the National Bank of Ethiopia (NBE) has established guidelines to enhance
risk governance and compliance among banks and microfinance institutions (NBE, 2020). These
provisions include risk assessment frameworks, capital adequacy requirements, and stress testing to
ensure resilience against economic shocks (World Bank, 2021). Additionally, the emphasis on
corporate governance and risk culture within institutions aims to foster a proactive approach to risk
identification and management (Abebe, 2020).

Despite these advancements, challenges remain, including limited risk management expertise and
inadequate technological infrastructure, which can impede effective risk mitigation (Ethiopian
Banking and Insurance, 2021). Thus, while significant efforts are underway, continuous
improvement and capacity building are essential for enhancing the resilience of Ethiopia's financial
system.
 5.5. Legal & juridical system, Institutional framework, proclamations,

Regulations and Directives

The legal and juridical system in Ethiopia is a complex framework that underpins the country's
financial governance. Rooted in the 1995 Constitution, Ethiopia's financial regulations are designed
to facilitate economic growth while ensuring compliance with both domestic and international law.
The primary institution overseeing finance is the National Bank of Ethiopia (NBE), which regulates
the financial system and implements monetary policies to maintain price stability and financial
integrity.

Ethiopia has established various proclamations and directives to guide financial transactions,
including the Proclamation on Banking Business and the Proclamation on Financial Institutions.
These legal instruments set forth the operational standards for banks and other financial entities,
ensuring transparency and accountability within the sector. Regulatory frameworks also include
guidelines on anti-money laundering and financing of terrorism, demonstrating Ethiopia's
commitment to adhering to global financial standards.

Additionally, the Ethiopian government frequently issues regulations and directives to adapt to
changing economic environments and challenges. These regulations serve as mechanisms for
supervision and enforcement, providing a legal backbone for the country's financial stability and
development (World Bank, 2021). Overall, Ethiopia’s financial legal framework reflects an evolving
commitment to enhancing economic performance while adhering to principles of good governance.

5.6. Recent developments like the fight against money laundering and the

financing of terrorism in Ethiopia

In recent years, Ethiopia has significantly intensified its efforts to combat money laundering and the
financing of terrorism (AML/CFT). The government has established a robust legal framework and
regulatory mechanisms to address these issues, in line with international standards set by the
Financial Action Task Force (FATF) (Ethiopian Financial Intelligence Centre, 2022).

Key developments include the establishment of the Ethiopian Financial Intelligence Centre, which
plays a vital role in monitoring financial transactions and reporting suspicious activities
(Woldemariam, 2023).

Additionally, Ethiopia has increased collaboration with regional and international partners to
improve information sharing and technical assistance. These initiatives reflect the country's
commitment to enhancing its financial integrity and safeguarding its economy from illicit financial
flows (Nour, 2023).

Chapter Six: Major Findings, Reflections, Conclusions, and Recommendations -

Assessment of the Ethiopian Financial System
In this chapter, we delve into the major findings resulting from an in-depth analysis of the Ethiopian
financial system. The exploration is grounded in extensive research and evaluation of structural,
functional, and regulatory aspects, revealing crucial insights that demand attention from
policymakers, stakeholders, and financial practitioners in Ethiopia.

Major Findings
The assessment of the Ethiopian financial system uncovers several key findings. Firstly, access to
financial services remains limited for a substantial segment of the population, especially in rural
areas. Despite recent efforts to expand banking services through mobile technology and microfinance
institutions, significant barriers persist, including geographical isolation and a lack of financial
literacy. Consequently, many citizens remain unbanked, which inhibits economic growth and poverty
alleviation.

Secondly, the dominance of state-owned banks over the financial sector has attracted scrutiny. While
these banks have been instrumental in providing stability and liquidity, their monopolistic behavior
has stifled competition and innovation. In contrast, private banks, while growing in number and
capabilities, face regulatory hurdles and disparities that hamper their competitiveness and ability to
serve diverse client needs.

Furthermore, the regulatory framework governing the Ethiopian financial system is often seen as
inadequate. A lack of clarity and consistency in regulatory practices has created uncertainty and
sometimes discouraged foreign investment. The financial system’s vulnerability to external shocks,
coupled with an underdeveloped capital market, poses additional risks to economic stability.

Reflections

Reflecting on these findings, it becomes clear that the Ethiopian financial system operates in a
complex environment influenced by historical, cultural, and economic factors. The challenges
identified signal a need for a multi-faceted approach to reforms, emphasizing not just regulatory
changes but also enhanced financial literacy programs and community-based initiatives to increase
accessibility.

Moreover, the reflections highlight the potential of fintech innovations within Ethiopia's financial
landscape, which could serve as a bridge to close the gap in financial inclusivity. The interplay
between traditional banking institutions and emerging digital platforms can foster a more resilient
financial ecosystem if nurtured through appropriate policies and support systems.

Conclusions

In conclusion, the assessment reveals that while the Ethiopian financial system has shown
progressive trends, significant improvements are necessary to achieve a more inclusive and dynamic
financial environment. The challenges of limited accessibility, regulatory constraints, and an
uncompetitive banking sector underline the need for comprehensive reforms that facilitate growth,
encourage competition, and ensure financial stability.

Recommendations

To address these challenges, the following recommendations are proposed:

1. Enhancing Financial Literacy: Programs aimed at improving financial literacy should be

initiated, particularly targeting rural populations. Such initiatives can empower individuals to
engage with financial institutions more confidently and encourage savings and investment.

2. Strengthening Regulatory Framework: The government must work towards establishing a more
transparent and consistent regulatory framework that promotes competition among financial
institutions. This includes revisiting policies that currently favor state-owned banks and creating
a level playing field for private banks and fintech companies.

3. Promoting Fintech Solutions: Encouraging the growth of fintech solutions can significantly
enhance access to financial services. This may involve reducing regulatory barriers for fintech
 startups and facilitating partnerships between traditional banks and technology-driven
enterprises.

4. Infrastructure Development: Investments in physical infrastructure, such as road and

telecommunications networks, are essential to reach underserved populations and improve
service delivery in the financial sector. By implementing these recommendations, Ethiopia can
pave the way for a more inclusive, competitive, and resilient financial system that effectively
meets the needs of its citizens and fosters sustainable economic growth. The findings from this
assessment serve as a critical foundation for shaping the future of Ethiopia's financial landscape.

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31) Sunita Pitamber,(2003). Factors Impeding the Poverty Reduction Capacity of Micro-Credit:
Some Field Observations from Malawi and Ethiopia, Working Paper 74 .
32) Tafesse, I., & Mahul, O. (2015). Ethiopia Financial Sector Diagnostic. World Bank Group.
33) The IMF and Islamic Finance. (2015, March)
https://www.imf.org/external/themes/islamicfinance/
34) Tsegabirhan W. (2010), Stretching-out to Reach the Potential to Mobilize Domestic Financial
Resources of Africa low Income Economies: Case study of Ethiopia, The North-South Institute
(NSI), Dec. 2010.
35) World Bank. (2021). Ethiopia: Financial Sector Review.
36) Woldemariam, N. (2023). Financial Regulations and Compliance in Ethiopia.
37) https://www2.lawrence.edu/fast/finklerm/mishkin_ch02.pdf
38) https://www.coursehero.com/file/225113920/ETHIOPIAN-Economy-1-5pdf/
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 Questionnaire

Addis Ababa University

Dear respondents

This questionnaire is designed by a student of Addis Ababa University a project on an assessment of

Ethiopian Financial system (Financial institutions, Financial Markets, Financial Assets and Financial
system Regulations).
The objective of the project assessing the Ethiopian financial system is to evaluate and analyze the
structure, functioning, and effectiveness of the Ethiopian financial system, including its institutions,
markets, assets, and regulatory framework, in order to identify strengths, weaknesses, opportunities,
and challenges that impact economic growth and financial stability.

This assessment aims to provide insights that can inform policymakers, stakeholders, and investors
about the current state of the financial system and potential areas for improvement.

I was indebted by your cooperation to respond this questionnaire

General Instructions:

 To maintain confidentiality, please do not write your name or sign anywhere in the questionnaire.
 Please complete each parts of survey with care, honesty and due attention
 Put a tick mark in the space provided.
 You may mark more than one choice if you find it appropriate.
 You may pass over a question if it is not applicable for you.

I would like to pass my heart felt gratitude for your precious time!!

Sincerely yours

Appendix I: Questionnaire

By the means of tick (√) kindly indicate an option that best describes you where appropriate. Also fill
in the blanks where necessary.

Section A: General Information

1. What is your gender?

Male Female

2. What is your age?

18-25 years 26-35 years 36-45 years

46-55 years Above 55 years

3. What is your level of education?

Certificate Diploma Undergraduate

Postgraduate Other ______________________________

4. How many years have you worked at Bank of Abyssinia?

Less than Less than a year 3 to 5 years

5 to 10 Years 10 to 15 years Above 15 years

5. What is your current position level at Bank of Abyssinia?

Lower Management staff

Middle Management

Top Management

Section B: Overview of the Financial System

1. How would you define a financial system in your own words?

2. What are the three main components of a financial system?
3. Describe the role of financial intermediaries in the Ethiopian financial system.

Section C: Financial Institutions

4. What are the different types of financial institutions present in Ethiopia?

5. Explain the differences between formal, semi-formal, and informal financial institutions.
6. Discuss the significance of microfinance institutions in Ethiopia’s financial landscape.

Section D: Financial Markets

7. What is the structure of the Ethiopian financial market?

8. Compare and contrast money markets and capital markets.
 9. How do recent developments, such as the establishment of the Ethiopian Capital Market,
impact the financial system?

Section E: Financial Assets

10. Identify and describe the types of financial assets prevalent in Ethiopia.
11. What valuation approaches are used for financial assets in Ethiopia?
12. Discuss interest rate theories and their relevance to the Ethiopian financial context.

Section F: Regulations

13. What are the key regulations governing financial institutions in Ethiopia?
14. How do these regulations impact financial market operations?
15. Describe recent developments in the fight against money laundering in Ethiopia.

Section G: Major Findings and Recommendations

16. Based on your understanding, what are the major findings regarding the Ethiopian financial
system?
17. What recommendations would you suggest to improve the financial system in Ethiopia?
18. How can financial inclusion be enhanced in the country?

Section H: Personal Insights

19. In your opinion, what are the greatest challenges facing the Ethiopian financial system today?
20. How do cultural factors influence financial behavior and practices in Ethiopia?
21. What role do you think technology (e.g., FinTech) will play in the future of the Ethiopian
financial system?