Unit 6

Financial Markets and Institutions in Ethiopia

Introduction

The financial system is a foundation for the entire economic activities. All other economic
activities, one way or another, depend on the financial system. The financial system plays a
considerable role in economic the development of the nation. Financial markets and institutions
forces businesses and Governments to set economic and social goals based on which plans are
designed and resources are allocated.
Besides, the financial system regulations help in insuring efficient use of scarce economic
resources. That is a well formulated policy is used as a point of reference when controlling the
efficiency with which resources are used. Hence, much care is given to the formation and
regulation of the financial system with which financial institutions are established and the
financial markets are formulated.
5.1 The Role of National Bank of Ethiopia
5.1.1 Beginning of Banking in Ethiopia
The history of banking in Ethiopia dates back to the turn of 20th century when the Bank of
Abyssinia was established in 1905 with objective of promoting banking habit. The Bank of
Ethiopia was established later in 1931 retaining the offices and personnel of the old bank.
During the period of Italian occupation, the banking business was held Italian banks. Between
1943 and 1963 all aspects of banking activities central, commercial, savings and mortgage, was
dominated by the State Bank of Ethiopia.
A ground-breaking phase in the history of Ethiopian banking was started with the introduction
of monetary and banking proclamation of 1963. With the coming into effect of this
proclamation, the State Bank of Ethiopia was split into two separate bodies: The National Bank
of Ethiopia and the Commercial Bank of Ethiopia. The former assumed central banking
functions while the latter took up commercial banking business of the old bank
The Banking sector was changed into a mono-banking system during the rule of the command
economic system in the country. The Housing and Savings Bank was established in 1975 by
proclamation No.60/1975 decreeing the transfer of all assets and liabilities of the former
Savings and Mortgage Corporation of Ethiopia S.C. and the Imperial Savings and Home
Ownership Public Association (ISHOPA). The bank was established with the objective of
providing loans for residential and commercial construction industries.
As part of the recently launched economic reform, different financial liberalization measures
and restructuring of financial institutions have been undertaken. All the measures have the aim
of promoting a competitive environment and efficient banking services to the public. The
Commercial Bank of Ethiopia was re-established in 1994 by proclamation No. 202 taking over
the rights and obligations of the Commercial Bank of Ethiopia which was established under
proclamation No. 184/1980. The Construction and Business Bank has also been established
under proclamation No. 203/1994 by taking over the rights and obligations of the Housing and
Savings Bank which was established under proclamation No. 60/1975.

The bank's objectives include providing loans for construction, repair, modification and
acquisition of dwelling houses and buildings, for construction sector activities and for the
development of hotels and tourism, accepting savings, demand and time deposits, administering
funds entrusted to it by the government or other institutions and carrying out all other activities
as are customarily done by banks.

The Development Bank of Ethiopia has also been established by Regulation No. 200/1994. The
bank took over the rights and obligations of the Agricultural and Industrial Development Bank
which was established under proclamation No. 158/1979. The bank's objectives include
mobilizing funds from sources within and outside the country and providing medium and long
term investment credits, holding savings, demand and time deposits, acting as a trustee and
other activities usually performed by development banks.

The first, Monetary and Banking Proclamation No. 83/1994, defines the powers and
responsibilities of the National Bank of Ethiopia which is the Central Bank of the country. The
second, a proclamation to provide for the Licensing and Supervision of Banking Business No.
84/1994, which sets out the conditions under which commercial banks can be licensed and the
supervisory requirements they should observe in the course of their operation.

With the coming into effect of the Licensing and Supervising Banking Business Proclamation
different private banks have also emerged and joined the market since 1994. For instance,
Awash International Bank, Dashen Bank, Bank Of Abyssinia, Wegagen Bank, United Bank,
Nib International Bank, Cooperative Bank of Oromia, Lion International Bank, Zemen Bank,
Oromia International Bank, Buna International Bank and Berhan International Bank are among
the private banks established in the country. By now different banks are emerging from time to
time basing the favorable conditions and welcoming policies facilitated in the country.

The Origin of NBE at a glance

February 15, 1906 marked the beginning of banking in Ethiopia when the first Bank of
Abyssinia was inaugurated by Emperor Menelik II. It was a private bank whose shares were
sold in Addis Ababa, New York, Paris, London, and Vienna. One of the first projects financed
by the bank was the Franco-Ethiopian Railway which reached Addis Ababa in 1917. In 1931,
Emperor Haile Selassie introduced reforms into the banking system and the Bank of Abyssinia
became the Bank of Ethiopia, a fully government-owned bank providing central and
commercial banking services.
The Italian invasion in 1935 brought the demise of one of the earliest initiatives in African
banking. During the Italian occupation, Italian banks were active in Ethiopia. On April 15,
1943, the State Bank of Ethiopia became the central bank and was active until 1963.

Prior to this proclamation, the Bank carried out dual activities, i.e. commercial banking and
central banking. The proclamation raised the Bank's capital to 10 million Ethiopian birr and
granted broad administrative autonomy and juridical personality. Following the proclamation,
the National Bank of Ethiopia was entrusted with the following responsibilities:
 to regulate the supply, availability and cost of money and credit;
 to manage and administer the country's international reserves;
 to license and supervise banks and hold commercial banks reserves and lend money to
them;
 to supervise loans of commercial banks and regulate interest rates;
 to issue paper money and coins;
 to act as an agent of the government; and
 to fix and control the foreign exchange rates.

However, monetary and banking proclamation No. 99 of 1976 came into force on September
1976 to shape the Bank's role according to the socialist economic principle that the country
adopted. Hence the Bank was allowed to participate actively in national planning, specifically
financial planning, in cooperation with the concerned state organs. The Bank's supervisory area
was also increased to include other financial institutions such as insurance institutions, credit
cooperatives and investment-oriented banks. Moreover the proclamation introduced the new
'Ethiopian birr' in place of the former one that ceased to be legal tender.

The proclamation revised the Bank's relationship with government. It initially raised the legal
limits of outstanding government domestic borrowing to 25% of the actual ordinary revenue of
the government during the preceding three budget years against the proclamation 206/1963,
which set it to be 15%. This proclamation was in force till the new proclamation issued in 1994
to reorganize the Bank according to the market-based economic policy so that it could foster
monetary stability, a sound financial system and such other credit and exchange conditions are
conductive to the balanced growth of the economy of the country.

Powers and Duties of the National Bank

What are the authorities and responsibilities of National Bank of Ethiopia?
 For the fulfillment of its purposes, currently, the National Bank has the powers and duties
to:
1. coin, print or cause to be coined, printed and circulated the legal tender currency;
 2. dispose or cause to be disposed coins and notes issued legally;
3. issue its own debt and payment instruments;
4. regulate and determine the supply and availability of money and credit as well as the
applicable interest rates and other charges;
5. formulate and implement exchange rate policy;
6. manage and administer the international reserves of Ethiopia;
7. license and supervise banks, insurers and other financial institutions;
8. create favorable conditions for the expansion of banking, insurance and other financial
services;
9. set limits on gold and silver bullion and foreign exchange assets which banks and
authorized dealers can hold;
10. set limits on the net foreign exchange position and on the terms and the amount of
external indebtedness of banks and other financial institutions;
11. make short term and long term refinancing facilities available to banks and other
financial institutions as might be necessary;
12. accept deposits of any kind from foreign sources;
13. collect data from any person and prepare periodic economic studies, on the balance of
payments, money supply, price forecasts and other relevant statistical indicators for
analysis and for the formulation and determination of monetary, saving and exchange
policies as are useful to Ethiopian economy;
14. act as banker, fiscal agent and financial advisor to the government;
15. take such steps to establish, modernize, conduct, monitor, regulate and supervise
payment, clearing and settlement systems;
16. act in compliance with international monetary and banking agreements of Ethiopia and
represent Ethiopia in the international monetary fund and other international financial
organizations formed by central banks;
17. coin special commemorative coins;
18. establish and manage deposit insurance fund;
19. Exercise such other powers and functions to execute its purposes as central banks
customarily perform.

The role of National Bank of Ethiopia

One of the most important financial institutions in any modern economy is the National Bank.
Basically, a National Bank is an agency of government-which is not concerned with maximizing
its profit, has an important public policy functions in monitoring the operations of the financial
system and controlling the growth of its money supply. National bank ordinarily does not deal
directly with public; rather it is “bankers’ bank,” communicating with commercial banks and
securities dealers in carrying out their essential policy making functions.
Accordingly, the main responsibility of the National Bank of Ethiopia is to maintain price
stability including exchange rate stability, ensuring fair competitiveness and soundness of the
financial system and enhancing the economic progress of the country in pursuit of its mission.
Since early 1990s, which marks a period of transition from a command economy to a market-
based economy, the NBE has been at the forefront in formulating and implementing policies
that enhance macroeconomic and financial stability. The coordination of fiscal and monetary
policies, over the past years, has resulted in the achievement of remarkable economic progress
with price stability.
The NBE directed its efforts to enact a series of regulations that would allow the establishment
of financial institutions and strengthen the regulatory and supervisory capacity of the Bank. The
main functions of the National Bank of Ethiopia are:
1. Control of the money
Money is anything that serves as a medium of exchange in the purchase of goods and services.
Money has another important function, however serving as a store of value, for money is a
financial asset that may be used to store purchasing power until it is needed by the owner. If
money is defined exclusively as a medium of exchange, then the sum of all currency and coin
held by the public plus the value of all publicly held checking accounts and other deposits
against which drafts may be made would constitute the money supply.

The National Bank has the power to regulate money supply and value. It is the source of
currency and coin (pocket money) used by the public, but also the principal government agency
is responsible for stabilizing the value of currency and protecting its integrity in the
international financial markets.

First, changes in money supply are closely linked to changes in economic activity. To this end,
if the National Banks carefully controls the rate of growth of money, it can influence the growth
rate of the economy as whole.

Second, in the absence of effective controls, money in the form of paper notes or bank deposits
could expand virtually without a limit. The marginal cost creating additional units of money is
close to zero. Therefore, the banking system, the government, or both are capable of increasing
the money well beyond the economy’s capacity to produce and services. Because this action
would bring on severe inflation, disrupt the payment mechanism, and eventually bring business
activity to a halt, it is not surprising that modern governments have come to rely so heavily on
National Bank as guardian of the quantity and value of their currencies.

2. Stabilizing financial markets (Regulation and supervision)

The financial system transmits savings to those who require funds for investment so that the
economy can grow. If the system of money and capital markets is to work efficiently, however
the public must have confidence in the financial institutions and be willing to commit savings to
them. If the financial markets are uncontrollable (unregulated and unsupervised), with
extremely volatile fluctuations in interest rates and security prices, or if financial institutions are
prone to frequent collapse, public confidence in the financial system might well be lost.

The flow of capital funds will dry up, resulting in a drastic slowing in the rate of economic and
a rise in unemployment. All National Banks play a vital role in fostering the mature
development of financial markets and ensuring a stable flow of funds through those markets.
Pursuing on this objective, the National Banks from time to time, provide funds to major
securities dealers when they have difficulty financing their portfolios so that buyers and sellers
may easily acquire or sell securities.

The National Banks may change the rates it charges banks on direct loans or engage in
securities trading in attempt to moderate changes occurring in the money and capital markets.
3. Lender of the last resort
Another essential function of National Banks is to serve as a lender of last resort. This means
providing liquid funds to those financial institutions squeezed by severe liquidity pressures,
especially when alternative sources of funds have dried up. The reason the National Banks is
able and willing to make loans at such time is that it has the power to create reserves.

4. Providing information to the public

Another critical function, which the National Banks has performed particularly in recent years,
is the provision of information to the public. The National Banks has research staffs that follow
current economic and financial developments and recommend changes in policy. The National
Banks makes available on a daily, weekly, and monthly basis an impressive volume of
statistical releases, special reports, and studies concerning the financial markets, the nation’s
money supply, long term and short term interest rates, etc.
5. Maintaining and improving the payments mechanism
Finally national banks have a role to play in maintaining and improving a nation’s payments
mechanism. This involves clearing checks, providing an adequate supply of currency and coin,
wiring funds, selling government securities and preserving confidence in the value of the
fundamental monetary unit. A smoothly functioning and efficient payments mechanism is vital
for carrying on business and commerce. If checks cannot get the currency and coin, it needs to
carry out transactions, business activity will be severely curtailed .The result might well be
large scale unemployment and a decline in both capital investment and the rate of economic
growth.
5.2 Commercial Banking and Insurance
Commercial Banking in Ethiopia
A Commercial bank is an institution which accepts deposits, makes business loans, and offers
related services. Commercial banks allow a variety of deposit accounts, such as checking,
savings, and time deposit.
These institutions are run to make a profit and owned by a group of individuals. While
commercial banks offer services to individuals, they are primarily concerned with receiving
deposits and lending to businesses.
Banking activity, as a part of the economy of any country, plays a vital role for the development
of the economy particularly in the investment sector. Even if, modern banking has began in
Ethiopia in 1905 (as expressed above/in the previous sub section), when the bank of Abyssinia
was first established in Addis Ababa under a 50-Year franchise agreement with the then British
owned National Bank of Egypt.
However, the environment was not smooth for more than half of a century for banking business
until the economic reform was made in 1991. Following the economic reform, the number of
banks in Ethiopia is increasing from time to time. This is a radical change in Ethiopian banking
businesses.

Many of the banks in Ethiopia are reporting profit since their establishments. We are also
observing a continuous expansion of branches in different corner of the capital city and regions.
It gives the impression that the sector is promising.
Basic Characteristics of commercial banks

 The distinguishing characteristics of commercial banks in the financial system include the
following:
(1) Specialize in the provision of credit for projects, which involve high evaluation and
monitoring costs (i.e. information intensive), hence cannot easily be funded by issuing
securities in the open market. The information intensity of bank investment makes it difficult
for outsiders to ascertain the value of bank assets.
 Commercial banks perform two intermediary functions:
a) They determine which projects in the pool are ex ante viable and worthy of investment;
and
b) They monitor the projects in which they invest in order to determine their true ex post
returns.
 A single institution performs both these functions because,
(i) There exist informational economies of scope in ex ante and ex post project
evaluation;
(ii) The bank's evaluation and auditing/monitoring technology requires a fixed set-up
cost, which discourages individuals from independently evaluating projects.
 (2) Finance their lending business by issuing liabilities, which, for the most part, are non-
contingent claims, and are typically more liquid than their assets.
(3) Commercial banks capital (although small relative to their assets) plays a vital role as a
"buffer"; that is, the existence of capital allows banks to meet their fixed interest obligations
despite variations in deposits or asset returns.
(4) Commercial banks may fail not only due to insolvency but also because of the lack of
liquidity (less so with other financial institutions (OFIs)) - Banks' current accounts provide a
medium of exchange and a means of payment for their customers as they operate main
payments transmission service which gives them market strength in command over funds
and in access to information; and leaves them liable to special risks (with wider social
consequences). They hold a portfolio of assets which, except for cash reserves (cash in vault)
must have a longer maturity than their sight-deposit liabilities greater risk of liquidity than
other financial institutions –the form of their liabilities, which are longer-dated, gives other
financial institutions time to prepare defenses (i.e. enough time to realize marketable assets),
hence their liquidity will not be imperiled easily.
(5) Commercial banks failure has secondary response (a subsequent round of forced asset
realization and/or borrowing under pressure) – Given that banks hold a sizeable portion of
their customers’ money balances which they require for current transactions uses, bank
failure/closure not only entails loss of wealth but also forces bank’s customers to realize
other assets in order to restore their liquidity so as to carry on their day-to-day expenditures.
 Thus, the difference between the social and private costs of failure is more marked for
banks than other financial institutions.

The role of commercial banks in the economy

The role of commercial banks is unique among all the other financial institutions. Commercial
banks are the vehicle through which credit and monetary policies are transmitted to the
economy. In addition, commercial banks deal in a wide variety of assets and accommodate
different types of borrowers.
The major activities/role of commercial banks are illustrated below.

i. Deposit mobilization
The source of fund to banks is from deposits that customers made in their saving, current,
demand deposit, and time deposits.
ii. Granting Credit/Loans
The uses of funds that are mobilized are to provide or grant loans to investors in return to
payment of interest and the principal amount granted periodically. Therefore banks use the
funds mobilized for providing loans. The activities of granting loans can be dealt using two
aspects i.e. outstanding credits/loans available and disbursement of fresh/new loans.
iii. Collection of loans
Loans of course are not granted for, thus revealing payments/collections periodically to the
terms and agreements are critical to the survival and existence of the banks. Performing a
healthy loan must prevail for the good image of the banks as well as for a better economic
development of the country as a whole. Non-performing loans are unhealthy loans, which are
the result of uncollectible disbursed loans.
iv. Interest rate development

Following the liberalization of interest rate by the NBE in January 2, 1995 every banks are
mandated to set their own lending and deposit rates given the minimum deposit rate set by the
NBE. To this effect, every bank are practicing interest rate development using loan and saving
pricing techniques by setting the prime-lending rate taking into considerations the costs
associated to granting loans.
v. Banks deposit at NBE
Following the reserve requirements, commercial banks deposit money at the NBE.
vi. Treasury bills market
Commercial banks do participate in the treasury bills market to invest their idle money for short
period of time.
vii. Foreign exchange transaction
Commercial banks usually participate in retail foreign exchange markets. They purchase and
sale foreign currencies from exporters and importers and facilitate the import and export market
transactions by providing letter of credit facility to customers.
Current regulations of Ethiopian Government concerning commercial banks
Banks control the payment system and Government monetary policy is implemented through
the banking system. The huge mobilized funds from within and outside the country can be
utilized in the economic development through the banking system. Because of this and other
special roles that these institutions play in the financial system, they are highly regulated in
Ethiopia-as it is true in other countries. The general reasoning behind regulating banks is almost
the same as what we will discuss for insurance.
 Below are some of the basic regulations applicable to banks in Ethiopia:
 Licensing banks
- License for doing banking business is issued by the National Bank of Ethiopia,
- Foreign national shall not undertake banking business in Ethiopia.
 Maintenance of Required Capital and Reserve requirement

As per the revised directive of SBB No. 24/99 the minimum paid-up capital to obtain a banking
business license is birr 75,000,000. Every existing bank shall at all times maintain minimum
unimpaired capital of seventy five million birr to commensurate with the volume of their
business to withstand adverse effects, which shall be fully paid in cash and deposited in bank in
the name and to the account of the bank. According to proclamation 84/1994, and directive
27/99, at the end of each fiscal year, every bank shall maintain a legal reserve of not less than
25% (twenty five percent) of its net profit.
One of the important monetary policy instruments and prudential regulation tools is reserve
requirement. In this regard, banks carrying on business in Ethiopia shall maintain with the NBE
a reserve account 5% (though now it is increased to 15%) of all birr and foreign currency
deposit liabilities held in the form of current, saving and time deposits.

 Disclosure requirement (Audit, Information, Inspection and Examination)

Accordingly to Proclamation 84/1994, every bank shall appoint an independent auditor to report
to the shareholders of the bank upon the annual balance sheet and profit and loss statement,
whether they exhibit a true and fair statement of the Bank's affair and the copy of the report
shall be sent to the NBE not later than 90 days after the end of financial year. Each bank shall
send to NBE the duly signed Balance Sheet every month within 20 days from the end of each
month, balance sheet and profit and loss statement every six month and every year within one
month from the closing of each financial year. In addition the NBE may periodically or at any
time, without prior notice make or cause an on-site inspection to be made of any bank whether
the inspected or examined bank has failed to comply with applicable laws or regulations or with
the terms and conditions of the license to carry on banking business in Ethiopia.

 Limitation of the activities of Banks

The activities of banks are regulated by the government. Without the prior written approval of
the NBE, no person may acquire either directly or indirectly in a bank a voting right exceeding
20% (twenty percent) of the total capital. No bank shall enter into any arrangement or
agreement for the sale or disposal by amalgamation or effect restructuring, dispose of the whole
or any part of its property whether in or out of Ethiopia and other activities not given by the
provision of proclamation no 83/1994. The overall open foreign currency position of each bank
at the close of business day shall not exceed 15% (fifteen percent) of its total capital.

The aggregate sum of loans extended or permitted to be outstanding directly or indirectly to one
related party and related parties at any one time shall not exceed 15% (fifteen percent) and
35%(thirty five percent) respectively of the total capital of the bank. The aggregate loan or
extension of credit by a bank to any one borrower, either a natural person or business
organization at no time shall exceed 25% (twenty five percent) of the total capital of the bank.

 Penalties for Non-Performance

Because the fundamentals of these proclamations are to safeguard the whole economy and
achieve sustained economic growth through fostering monetary stability and sound financial
system, not to comply with it and/or with the directives would result in a consequence. As it is
clearly indicated in proclamation No. 86/1994, penalties could range from fine in Birr and
imprisonment up to cancellation of licenses.
Insurance Sectors in Ethiopia
The term insurance can have different definitions. However, the main purpose of insurance is
helping individuals in case of financial problems resulting from misfortune by pooling such
risks from many people. The commercial code of Ethiopia defines insurance from the legal
point of view as "contract whereby a person called the insurer undertakes against payment of
one or more premiums to pay to a person, called the beneficiary, a sum of money where a
specified risk materializes."
From the very definitions of the insurance, there are two parties: the insured and the insurer.
The insured transfers his risk to the insurer and to this effect, he will have to pay the price
which in insurance terminology is called premiums; whereas the insurer will make financial
compensation to the instead and the insurer assumes or retains risk and provides protection
against financial loss according to the insured in variety of situations as specified in their
binding contract; accordingly, insurances security against financial hardship.
It is believed that insurance service was started in ancient China and Greek. The code
Hammurabi, a collection of Babylonian laws of the 1700's B.C, included a form of credit
insurance. Ancient Greek and Roman organizations provide money for burial of their members,
old -age pension and disability insurance. During the middle ages, associations formed by
aircraft workers offered the same type of insurance as well theft insurance to their members.
Then after, it was expanded to England, France and other European countries through traders
and gradually to the rest of the world.
In Ethiopia insurance practice was started through religious organizations. The organizations
around the Orthodox Church used to practice and participate in Senbetes, Mahber, Edir and
Ekub. These were insurance- like practices and exist along side the real insurance practices.
These organizations had contributed a lot to the development of insurance practice in Ethiopia.
Contemporary type of insurance practice developed in Ethiopia during the Imperial time.
During this time, particularly in 1905 insurance practice began in Ethiopian when Bank of
Abyssinia, a branch of the Bank of Egypt, sold the first Fire and Marine insurance polices as an
agent to a foreign insurance company. In 1922, a company named institu to per Lavoro
Nazionale per Employer's Liability insurance through its local agent. In 1923 an Austrian
National Insurance named Weinzinger issued policies as agent of "LABALIOIS" Fire Insurance
Company in 1929 paid the first fire loss of a commercial building in Ethiopia.

However, during the Italian occupation of 1932, all insurance activities were taken over by the
Italian insurance companies. In 1941 immediately after the war of the occupation period,
foreign insurance companies like phoenix, Caledonia, Royal, and south British of London sold
different policies through their respective local agents. In 1947, South British Company of
Great Britain issued the first motor policy and until 1950, 99% of the policyholders were
foreigners.
Though foreign initiated, the company has opened a new chapter in history of the Ethiopian
insurance industry. The only legal provisions available at the time were the1960 commercial
and Maritime Codes. In 1970, the insurance proclamation no. 281/1970 came into effect and as
a result of this proclamation 16 insurance companies were licensed, namely:
1. Imperial Insurance Company;
2. African Solidarity insurance Company;
3. Lion insurance Company;
4. Blue Nile Insurance Company;
5. International Insurance Company;
6. Union Insurance Company;
7. General Insurance Company;
8. National Insurance Company;
9. Afro-Continental Insurance Company;
10. Pan Africa Insurance Company;
11. Rasai Ethiopian Insurance Company;
12. Ethiopian Life Insurance Company;
13. Ethio- American Life Insurance Company;
14. Queen of Sheba;
15. Ras Insurance Company; and
16. Star Insurance Company.

During the Derg regime, the activities of the insurance companies were threatened. It was a
socialist orientation period where the restructuring of the financial system was in process. In
1975 all the 13 insurance companies and agencies working with them were nationalized as per
proclamation no. 68/1975 issued in February6 1975. At first, the three nationalized companies
were allowed to continue as a separate entity for one year. Thereafter, all of them were
amalgamated into one body and the Ethiopian Insurance Corporation was established at a
capital of 1 million. The Corporation was then organized into 5 main branches and one life
branch and gained monopoly power. Rate fixing, preparation of policies, and manuals and
procedures works were performed. Reinsurance arrangements improved and competition
confined to be among branches only.
Accordingly, the Banking and insurance proclamation no. 86/1994 were issued to this effect
declaring that the minimum capital requirement for general insurance to be Birr 3 million and
for life insurance Birr 4 million. Gradually many private insurance companies were established.
The following are the private insurance companies established in Ethiopia after the introduction
of free market economy but up to the end of the year 2002 E.C.:
1. National Insurance Company of Ethiopia (NICE);
2. Awash Insurance S.C (AIC);
3. Africa Insurance S.C (AIC);
4. Nile Insurances S.C (NIC);
5. Nyala Insurances S.C (NISCO);
6. United Insurance S.C. (UNITED);
7. Global Insurance S.C. (GIC);
8. Lion Insurance S.C. (Late merged with United);
9. Nib Insurance S.C. (NIB);
10. Universal Insurance .S.C. (Later Liquidated); and
11. Nice Insurance Company of Ethiopia S.C.
Basic Characteristics of Insurance
Insurance activity is a unique doings by itself, and has its own distinctiveness that makes it
different and its own principles which guide its activities. The basic characteristics of Insurance
comprise:

i. Pooling of losses-
is the spreading of losses incurred by the few over the entire group, so that in the process
average loss is substituted for actual loss. In addition, pooling involves the group of a large
number of exposure units so that the law of large number can operate. Ideally, there should
be a large number of similar but not necessarily identical, exposure units that are subject to
the same perils. Thus pooling implies:
1. the sharing of losses by the entire group
2. prediction of future losses with some accuracy based on the law of large number
ii. Payment of fortuitous losses –
A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance.
iii. Risk transfer-
it means that a pure risk is transferred from the insured to the insurer, who typically is in a
stronger financial position to pay the loss than the insured.
iv. Indemnification- it means that the insured is restored to his or her approximate financial
position prior to the occurrences of the loss.
 Legal Principles of insurance contracts
Insurance contracts are complex legal documents that reflect both general rules of law as well as
insurance law. The various legal principles of Insurance consist of:

1. Principle of indemnity
This principle states that the insured should not profit from a covered loss but should be
restored to approximately the same financial position that existed prior to the loss.
Not all insurance contracts are contracts of indemnity e.g. life insurance. Indemnity is important
as it deals in part with moral hazard. Most property insurance contracts are contracts of
indemnity. If a covered loss occurs, the insured should not collect more than the actual amount
of the loss. Indemnity does not imply that the insured will be indemnified to the full value of
his loss e.g. a person whose factory is destroyed by fire cannot recover for loss of profits or
against any liability that may arise from the fire unless he has appropriate policies in place
specifically designed to deal with these losses.
2. Principle of insurable interest
It states that the insured must be in a position to lose financially if a loss occurs. For example,
you have an insurable interest in you car because you may lose financially if the car is damaged
or stolen. Similarly, you have an insurable interest in your personal property. Insurable interest
is required for all types of insurance and its absence renders the contract void and hence
unenforceable.

3. Principles of subrogation
Literally means “to stand in place of”. It is the right of one person to stand at law in the place of
another and to avail him of all rights and remedies of that other person. The principle of
subrogation strongly supports the principle of indemnity. Subrogation means substitution of the
insurer in place of the insured for the purpose of claiming indemnity from a third person for a
loss covered by insurance. The insurer is therefore entitled to recover from a negligent third
party any loss payments made to the insured.

4. Principle of utmost good faith

An insurance contract is based on the principle of utmost good faith. That is, a higher degree of
honesty is imposed on both parties to an insurance contract than is imposed on parties to other
contracts. This principle has its historical roots in ocean marine insurance. An ocean marine
underwriter had to place great faith in statements made by the applicant for insurance
concerning the cargo to be shipped. The property to be insured may not have been visually
inspected, and the contract may have been formed in a location far removed from the cargo and
ship.
The role of insurance in the economy

Insurers are not simple pass-through mechanisms for diversifying risk under which the
unfortunate few who suffer losses are indemnified from the funds collected. It has so many
benefits. The Mechanisms by which insurance contribute to economic growth, include:
(i) Promote financial stability
By indemnifying those who suffer unexpected loss or harm, insurance helps stabilize the
financial situation of individuals, families and organizations. The assurance that their resources
can be protected encourages individuals and firms to create wealth. Without insurance,
individuals and families could become financially destitute and forced to seek assistance from
relatives, friends, or government; organizations may suffer financial loss (thereby reducing
their contribution to the economy- employees lose jobs, suppliers lose business, customers
forgo the opportunity to buy from the firm, government loses revenue).

(ii) Substitute for and complement Government security programs

Private insurance relieves pressure on social welfare systems by reducing welfare payments,
thereby reserving Government resources for essential social security and other purposes, and
allowing individuals to tailor their security programs to their own preferences.
(iii) Facilitate trade and commerce
Insurance coverage may be a condition for engaging in trade activities with high risk of failure-
e. g. funding by venture capitalists requires adequate coverage of tangible assets and the
entrepreneurs' lives (because entrepreneurs are more likely to create and expand their business
ventures if they can secure adequate protection).
[
(iv) Mobilize savings
Insurers enhance financial system efficiency by:
a) Reducing transaction costs associated with bringing savers and borrowers together insurers
collect small premiums from individuals and invest them as loans to business and other
ventures (thereby avoid time consuming and costly direct lending and investing by
individual policyholders); insurers can acquire information necessary to make sound
investments more efficiently than individuals, the benefits of which are passed to
policyholders;
b) Creating liquidity (reduce the illiquidity inherent in direct lending) - although insurers invest
long-term (i.e. borrowers need not repay immediately) policyholders still have immediate
access to loss payments. If individuals were to undertake equivalent direct lending, the
proportion of their wealth in long-term illiquid assets would be high.
c) Facilitate economies of scale for investment- projects may be large relative to available
finance but may also involve economies of scale, promote specialization, and stimulate
technological innovation. Insurers (contractual savings institutions-life insurers and private
pension funds-in particular, which take longer-term view, unlike banks which collect short-
term deposits) can meet the financing need by amassing large sums from small premium
payers (thereby enlarge the set of feasible investment projects and encourage economic
efficiency) their long-term liabilities and stable cash flows are ideal sources of long-term
finance.
(v) Enable risk to be managed more efficiently
 Intermediaries price risks and provide for risk transformation, pooling, and reduction.
a) Risk pricing- risk is priced at two levels:
Insurers evaluate the loss potential of businesses, persons, and property for which they
might provide insurance (the greater the expected loss, the higher the price). In the
process, they cause the insured’s to quantify the consequences of their risk-causing and
risk-reduction activities, thus deal with risk more rationally.
Insurers evaluate creditworthiness of their borrowers and those businesses in which they invest.
These may better inform business owners, potential investors, customers, creditors,
employees, and other stakeholders about the firm's overall risk characteristics, (thus make
better informed decisions).
b) Risk transformation- Insurance permits businesses and individuals to transform their
own needs better. Property, liability, loss of income, and other risk exposures can be
transferred to an insurer for a price. In the process, the insured's risk profile changes. Life
insurers also tailor contracts to the needs of different clients (thereby) helping individuals
and business transform the characteristics of their savings to their desired profiles of
liquidity, security, and other risk.
c) Risk pooling -occurs at two levels:
In aggregating individual risk exposures, insurers can make reasonably accurate
estimates of the pool's overall loss-the larger the number of insureds, the more stable
and predictable is the insured's experience, leading to a reduction in volatility, hence
permitting insurers to charge small premiums and maintain more stable premiums.
Insurers benefit from pooling through their investments-in providing funds to a broad
range of enterprises, individuals, and others, they diversify their investment portfolios
(The default of a few borrowers is likely to be offset by the many sound investments).
(vi) Encourage Loss Mitigation measures
Insurers have incentive to help insured to prevent and to reduce losses. Insurers' detailed
knowledge about loss-causing events, activities, and processes affords them a comparative
advantage in loss assessment and control.
Insurers support loss control programs (e.g., fire prevention; occupational health and safety
activities; industrial loss prevention; reduction in automobile property damage, theft, and injury;
etc.), which reduce losses to businesses and individuals and complements good risk
management (thereby benefiting society as a whole).
(vii) Foster Efficient Capital Allocation
Because of the substantial information they gather to conduct evaluation of firms, projects, and
mangers (in deciding whether and at what price to issue insurance, in their role as lenders and
investors) and their better capacity to process it, insurers have an advantage and are better at
allocating financial capital efficiently. That is they will choose to insure and to provide funds to
the soundest and most efficient firms, projects, and mangers.
They encourage mangers and entrepreneurs to act in the best interests of their stakeholders
(customers, stockholders, creditors, etc.), thereby signal the market's approval of promising,
well-managed firms and foster a more efficient allocation of scarce capital and risk bearing
capacity.
Current regulations of Ethiopian Government concerning Insurance Sectors
The first regulations governing insurance were enacted to protect insurers against fraudulent
action on the part of the insured. It is only because of the appearance of compulsory insurance
and the increasing level of complexity of insurance contracts, that legislators concern
themselves with protecting the interests of the insurance consumers.
The contractual relationship between the insured and the insurer reveals a potential imbalance.
In other words, the insured pays his consideration (premium payment) at the very beginning of
the contract. But before the insurer is called to perform his part, time may change the security
profile of the insurer. In view of the economic importance of insurance, this has led
Government Authorities to enact regulations that should guarantee the long term viability of
insurers.
Regulating the insurance industry does not seem a question of choice for Ethiopia-rather a must
to do. Some individuals who are participating in this industry believe that Ethiopian insurance
companies are working at the capital of other country’s insurance capital which requires legal
protection. Besides, because the attitude, awareness of the public and information flow about
insurance activities are at a lower level there is no any better than developing the
trust/confidence of the people on insurance companies through regulating their activities.
1 Regulation related to licensing
Historically, fixed capital requirements have been specified in most countries insurance statues
to ensure that applicants seeking licenses to conduct insurance business have sufficient capital
to support their operational activities. In accordance with Article 4 of proclamation 86/1994 the
minimum paid up capital requirement for non life and life insurance business in Ethiopia is Birr
3,000,000 and Birr 4,000,000 respectively. For composite insurers (undertaking both life and
non-life) the requirement is Birr 7,000,000. In accordance with Article 6, application for the
grant of a license shall be accompanied by Memorandum and Articles of Association, insurance
policy forms and such other particulars as may be prescribed by directive to be issued by the
National Bank.
2. Regulation related to reserves and solvency
Some reserves are specified and compulsory by law: i.e., statutory deposit and various technical
provisions. According to Article 4 of proclamation 86/1994:
i. Every insurer shall, in respect of each main class of insurance business carry on in Ethiopia
deposit and keep deposited with the bank an amount equal to fifteen percent (15%) of his paid
up capital in cash or Government securities.
ii. The deposit specified in sub-article (1) above shall be held to the credit of the insurer
provided that the aforesaid deposit or any part there of shall not be withdrawn except with the
written permission of the National Bank: nor shall such deposit be used as a pledge or security
against any loan or overdraft.
The law also requires 10% of annual net profit to be deposited into a legal reserve account.
Insurers can also make additional reserves as prudent underwriting practice dictated them. All
these legally and practically required reserves are aimed at ensuring the financial strength of an
insurer in discharging its financial commitments

According to the definition of Article 20 of proclamation No.86/1994, an insurer carrying on

general insurance business shall be deemed insolvent if the value of the insurer’s assets does not
exceed the amount of his liabilities by whichever is the greater of the amount of the statutory
deposit (i.e. 15% of the paid up capital), or 15% of the net premium written by the insurer in his
last preceding financial year.
3. Disclosure Regulation
As per Article 18 of the proclamation, the balance sheet, profit and loss account and revenue
account of every insurer shall be audited annually by an auditor. A copy of every report of the
auditor shall be sent to the bank not later than ninety (90) days after the end of its financial year.
In addition, according to Directive No SIB/17/98, each insurer shall submit to the supervision
department of the National Bank of Ethiopia separate quarterly reports for general and long-
term insurance business within twenty days after the end of each quarter.
4. Prohibitions or restrictions
Usually, large funds remain under the custody of insurers and invested to produce additional
returns. Under competitive pressure, this additional income may enable the insurer to charge
lower rates than would be usual, and make the insurers, products attractive here by improving
its overall profitability. The management of these funds is thus very important both to insurers
and insured and may also play a significant role in the national economy.
Appropriate regulations to channel these funds so as to target developmental areas of the
economy may contribute to the overall economic development of the country.
 Hence the National Bank of Ethiopia (NBE) Issued Directive No. SIB25/2004 which Limits
on investment of insurance funds as follows:

i. General Insurance Funds

The General Insurance funds of an insurance company can be invested in Treasury Bills and
bank deposits not less than 65% of admitted assets; provided, however, that aggregate bank
deposits (checking, savings and time deposits ) held with any one bank shall not exceed 25% of
total admitted assets; in investment in company shares not exceeding 15% of total admitted
assets; in real estate not exceeding 10% of total admitted assets; and 10% of admitted assets in
investments of the insurance company’s choice.
ii. Long –term Insurance Funds
The Long-term Insurance funds of an insurance company can be invested in Treasury
Bills/Bonds and bank deposits not less than in aggregate of 50% of total admitted assets;
provided, however, that aggregated deposits (checking, savings and time deposits) held with
any one bank shall not exceed 25% of total admitted assets; investments in company shares not
exceeding 15% of total admitted assets; investments in real estate not exceeding 25% of total
admitted assets; and 10% of total admitted assets in investments of the insurance company’s
choice.
In addition, Article 29 sub article 1 of the proclamation sets restriction on loans, advances, etc,
by an insurer.
That is Unless provided otherwise by regulations and directives issued hereunder, no insurer
shall grant any loan, advance, financial guarantee or other credit facility either on
hypothecation of property or on personal security or otherwise, except loans on life polices
issued by him within their surrender value, to any shareholder of the insurer or to any
director manager, actuary, auditor or officer working for the insurer or to any insurance
auxiliary or to any other person connected with the said persons.

5. Other regulations

 Re-Insurance:
In Ethiopia, reinsurance contracts are subject to supervision by NBE. The bank may give advice
and information about re-insurers but the task of monitoring (screening) the security of re-
insurers falls principally upon ceding companies, since it is up to them to choose their re-
insurers.
 Amalgamation:
Article 40 requires that no insurer shall amalgamate with or takeover the insurance business of
another insurer except with the prior approval of the NBE.

 Certification of Soundness of Terms of Insurance Business: According to Article 36:

The National Bank shall ensure that the terms of insurance policies safeguard the
rights of policy-holders, under the laws of Ethiopia.
At any time, the NBE may take any modifications to insure that premium rates,
advantages, terms and conditions offered are workable and sound.
Micro financing business is an activity of extending credits in cash or in kind to peasant farmers
or small entrepreneurs the size of loan which shall be fixed by the National Bank of Ethiopia.
This section primarily focuses on the regulation of micro finance industry in Ethiopia.

Regulation is prudential when it is aimed specifically at protecting the financial system as a

whole as well as protecting the safety of small deposits in individual institutions. When a
deposit-taking institution become insolvent, it cannot repay its depositors, and if it is a large
institution, its failure could undermine public confidence enough so that the banking system or
the entire microfinance industry suffers a run on deposit. Prudential regulation and supervision
of financial intermediaries involves definition of detailed standards for financial structure,
accounting policies and other important dimensions of an institutions business. Enforcing these
standards and otherwise monitoring institutional soundness require much more intensive
reporting, as well as on-site inspection that goes beyond the scope of normal financial statement
audits.

Since the microfinance institutions (MFls) in Ethiopia are all depository microfinance
institutions (collect deposits from both the public and members}, the government through its
National Bank of Ethiopia (Central Bank) needs to oversee the financial soundness of the MFls.
The prudential regulation in Ethiopia aims at ensuring that the licensed MFls remain solvent or
stop collecting deposits if they become insolvent. In order to implement prudential regulation,
the Government of Ethiopia issued microfinance law in 1996 (proclamation 40/96). The
National Bank of Ethiopia (NBE) that was given by law the power of regulating the
microfinance institutions issued 17 directives to guide and regulate the microfinance
institutions. The NBE also established a microfinance division under the supervision
department to undertake off-site and on-site supervision of MFls.
Basic Characteristics of Micro Finance
The most distinguishing characteristics of MFIs from the conventional banks include:
1. Procedures are designed to be helpful to the client and therefore are user friendly. They are
simple to understand, locally provided and easily and quickly accessible;
2. The traditional lender's requirement for physical collateral (such as land, house and
productive assets) is usually replaced by system of collective guarantee groups whose
members are mutually responsible for ensuring individual loans are repaid. Loans are
dependent not only on individual's repayment performance, but also on that of every other
group members;
3. Loan amounts especially at the first loan cycle are too small, much smaller than the
traditional banks would find it viable to provide and service;
4. Borrowers are usually required to be savers;
5. Together with their long term sustainability they have the objective of ending poverty; and
6. MFI's operating costs as well as administrative cost per loan are higher than the
conventional banks.
The role of micro finance institutions
International donors, NGOs, and the Government in Ethiopia have supported the expansion of
credit services to rural poor in the 1970s, 1980s and 1990s. The delivery of rural credit in
Ethiopia through formal banks owned by the Government such as Agricultural and Industrial
Development Bank (AIDB), currently the Development Bank of Ethiopia (DBE) and
Commercial Bank of Ethiopia (CBE) focused on input loans delivered through the service
cooperatives.
Until 1994, AIDB was the only supplier of agricultural input loan to small farmers. AIDB
terminated the provision of agricultural input loan to rural households (through cooperatives)
and started specializing in long and medium term credit. The performance of AIDE in the
delivery of agriculture loan (particularly for inputs) was a failure. The arrears of AIDB had been
progressively increasing which incurred significant amount of losses. This has destroyed the
credit culture in the country where farmers/borrowers have developed wrong attitude and
expectation of debt rescheduling or write-off. The heavy arrears increased the transaction costs
of AIDB (costs of loan administration, supervision and follow-ups).

On the other hand, Micro finance is making small loans available to the poor through schemes
specially designed to meet the Poor’s particular needs and circumstances. A microfinance
institution is a company licensed which engage in micro financing business in rural and urban
areas with the following goals.
The development objectives generally include one or more of the following:
1. To reduce poverty;
2. To help existing businesses grow or diversify their activities and to encourage the
development of new businesses;
3. To create employment and income opportunities through the creation and expansion of
micro enterprise; and
4. To increase the productivity and income of vulnerable group, especially women and
the poor.
Accordingly, to fulfill the development objectives of the country, micro finance institutions are
giving different services for the society. Credit provision & saving mobilization are the core
financial products /services provided by MFIs. But there are other services provided by MFI.
 Micro financial Institutions provide the following types of services:
1. Credit provision
 Small size credit (loans) to:
- Rural and urban poor households
- Petty traders
- Handcraft producers
- Unemployed youth and women ...etc.
2. Saving mobilization
- One of the objectives of MFIs is to encourage the saving habit of the poor society.
3. Other services
 - Now days, in addition to credit provision and saving mobilization, some MFIS
provide other financial services like local money transfer, insurance and pension
fund administration and short-term training to clients.
Regulations of Ethiopian Government concerning Micro-finance Institutions
The theoretical foundation for regulation in general is the new institutional economics that is
centered on the asymmetry of information between relevant market actors. Regulation of MFIs
refers to government regulation that should serve three basic goals:
i. Macroeconomic in nature, ensures the solvency and financial soundness of all
intermediaries in order to protect the stability of the country's payments system.
ii. Provide consumer protection against undue risks of losses that may arise from failure,
fraud, or opportunist behavior of the suppliers of financial services.
iii. Promote the efficient performance of institutions and markets and the proper working of
competitive market forces.
In Ethiopia, there is an increasing recognition of the importance of the microfinance
industry as a component of the overall financial system serving huge portion of the
population. There is a growing acceptance of the effectiveness of microfinance in poverty
alleviation. With the increase in the number of MFIs and MFIs taking voluntary deposits
from the poor, the issue of prudential regulation and supervision of the microfinance
industry is unquestionable. The main motives of prudential regulation of the microfinance
industry in Ethiopia include:
Promoting the microfinance industry to alleviate rural poverty by increasing outreach
and protecting small borrowers;
Protecting the safety of the depositors;
Prohibiting the NGOs and other institutions, which mix charity and delivery of financial
services, from delivering financial services;
Introducing strong financial discipline in the delivery of financial services to the poor;
and
Promoting the emergence of sustainable MFIs.

Actually, MFIs providing financial services to the poor with numerous repeated loans
attempting to provide their services physically to clients, quick repayment, using group lending
methodology, highly decentralized system and with high operating cost per loan or deposit
amount and management orientation towards poverty reduction (not always profit) do have
specific risk profiles different from those of conventional banks. The high-risk profiles of MFIs
will then increase the importance of prudential regulation and strict supervision in the industry.
The NBE has been given the legal power to supervise MFIs, grant and revoke license and
maintain confidence in the deposit safety by setting appropriate requirements and ensuring that
institutions are sound, with enough capital and earnings to cover operational costs and risks and
enough liquidity requirement to meet client withdrawal demands. Moreover, the microfinance
law of 1996 clearly states that the NBE should provide technical assistance to the MFIs.
The delivery of efficient and effective microfinance services to the poor require conducive
macroeconomic policies and the establishment and enforcement of legal and regulatory
frameworks when savings from the public are mobilized in the country and good governance.
There are different government policies, laws and directives in Ethiopia, which affect directly or
indirectly the development of MFIs. These mainly include: Proclamation No. 83/1994,
Proclamation No. 84/1994, Proclamation No. 40/1996 and the 17 directives issued by the
National Bank of Ethiopia which are consistent with the Proclamation No. 40/1996
(Microfinance Law).
Proclamation No. 83/1994, Monetary and Banking Proclamation has clearly indicated that the
NBE has the legal authority to license, supervise and regulate banks, insurance companies and
other financial institutions. The other financial institutions in the proclamation include MFIs,
postal savings, credit cooperatives and other similar institutions engaged in any type of banking
business.

Proclamation No.84/1994, Licensing and Supervision of Banking Business provides that only
incorporated institutions may conduct banking business, and only if they are licensed by the
NBE to do so. The proclamation allowed, for the first time, the establishment of private
financial institutions, thus breaking the state monopoly in the banking sector. To date, six
private banks and eight private insurance companies have been established. The proclamation
precludes a foreign national from undertaking banking business in Ethiopia, and no person is
permitted to own more than 20% of a banking company's shares.
This law also applies to the MFIs. Obviously, this prohibits foreign banks from bringing
expertise in banking practices, management and improved technology, more efficient services;
increase the inflow of capital and competition. The argument to protecting given the limited
experience, capacity and expansion of newly established private banks, foreign banks would
destroy the ability of the young private banks owned by Ethiopian nationals.
Moreover, the supervision department of the NBE should be given definite time to build its
capacity in supervising foreign banks. However, this limits competition, efficiency and transfer
of technology to MFIs. There should be a specific timetable showing when foreign banks will
be allowed to operate in the financial sector, including MFIs. Since proclamation No. 83/1994
and proclamation No. 84/1994 did not address specifically the delivery of sustainable financial
services to the poor, a separate law for microfinance institutions was found necessary.

Thus, Proclamation 40/1996 was issued to ensure savers' confidence, integrity and orderly
functioning of the financial system of MFIs in Ethiopia. It must be noted that producing and
implementing the regulatory framework is not a panacea for the major constraints in the
delivery of financial services to the poor. The regulatory framework is one of the important
elements and even precondition to create well-managed and sustainable financial institutions in
Ethiopia. However there are evidences in some countries where sustainable MFIs such as ASA
in Bangladesh and MFIs in Bolivia have developed successfully in the absence of a regulatory
framework.
The prudential regulatory framework criteria and supervision methods of MFIs are based on the
core principles for effective supervision established by Basel Committee on banking
supervision. The key core principles include:

1. A sound legal framework, including satisfactory licensing systems;

2. Prudential standards covering capital adequacy, liquidity ratio, income recognition, asset
classification and provisioning;
3. Prudential operating policies and procedures for credit and investment
management including single individual, company or group exposure limits;
4. Risk management strategies;
5. Efficiency and performance standards;
6. Sound governance structures;
7. Internal controls that are adequate for the nature and scale of their businesses;
8. Management information systems;
9. Disclosure norms including publication of annual accounts, and
10. Effective banking supervisory systems.
Although the prudential regulatory framework for MFIs was guided by the above core
principles, limited adjustments have been made to fit to the special characteristics of MFIs in
Ethiopia. The regulatory framework of MFIs is expected to strike an appropriate balance
between flexibility to encourage innovation and outreach expansion.
Proclamation No. 40/1996 " A proclamation to provide for the licensing and supervision of the
business of microfinance institutions" is the major law, which is used to regulate and supervise
MFIs. In the proclamation, microfinance business is defined as “an activity of extending credit,
in cash or in kind, to peasant farmers or urban small entrepreneurs". The NBE is empowered to
license, supervise and regulate the delivery of financial services to the rural and urban poor
through microfinance institutions. The main features of the Proclamation 40/1996 and the 17
directives of the NBE, which are serving as the regulatory framework for MFIs in Ethiopia, are
summarized as follows:

 Features of MFIs
i. Minimum Capital Required of New MFI Entrants
Directive No MFI/01/96 states that MFI applying for a license shall have a minimum paid up
capital of 200,000 Birr. However, the minimum capital required by the NBE is low. This is a
deliberate action of the government to improve entry and growth in the microfinance industry.
ii. Ownership of MFIs
Proclamation No.84/1994 clearly states that financial institutions including MFIs should be
owned by Ethiopian nationals. MFIs in Ethiopia should be established as share companies as
defined under Article 304 of the Commercial Code, the capital thereof owned fully by Ethiopian
Nationals and/or organizations wholly owned and registered under the laws of and having its
head office in Ethiopia. The Commercial Code of Ethiopia indicates that a share company is a
company whose capital is fixed in advance and divided into shares and whose liabilities are met
only by the assets of the company.

 The members shall be liable only to the extent of their share holding.

Only members of a company may manage the company. A company shall have not less than
three or more than twelve directors who shall form a board of directors. The microfinance law
and directives of the NBE has the intention of creating business like shareholders and board of
directors who control, guide and monitor the activities of the MFIs as a private share company.
 The shareholders in the Ethiopian MFIs are individuals, regional government and local
NGOs.

Although Proclamation (40/96) clearly indicates that the shareholders are investors who buy
shares from their own resources, in reality the shareholders in MFIs are nominal shareholders
who are not investing their own money in the institutions (without real stake). As a result, the
nominal shareholders of MFIs may not have sufficient interest to seriously oversee the activities
of the MFIs in detail. Moreover, many of the MFIs, through their Memorandum of Association,
have made it clear that shareholders will not receive any dividend from the profits of MFIs; we
believe that, the ownership structure of MFIs should create true stakeholders.

iii. Board Structure and the Requirement to be appointed as Executive Director

Directive No.MFI/03/96 of the NBE has clearly indicated the criteria for selection of officers
and directors of MFIs. The directive states that the chief executive director of an MFI should
have first degree in the field of social science or equivalent in relevant field, minimum of three
years experience in a senior post in a financial institution and the director should not be less
than 30 years of age. Board members of MFIs should be high school complete with preferably
adequate managerial experience and with a minimum age of 25 years.

However, the experience in the industry indicates that board members did not have the right
mix of professionals to lead an MFI and support management. Moreover, given the current
objective condition in Ethiopia, it will be difficult to acquire highly qualified executive director
as per the directives.

iv. Re-registration of Micro Finance Institutions

As per the Proclamation No. 40/1996, the MFIs in Ethiopia should re-register when the savings
mobilized by these MFIs equal Birr 1000,000.

v. Operational Modality
Proclamation 40/1996 indicates that loans are delivered to clients based on group guarantee
with no property collateral. However MFIs are allowed to use other individual lending
methodology. Directive No MFI/17/2002, MFIs can lend to individuals on the basis of physical
and other collateral on limited scale.

Although Directive No. MFI/05/1996 states that loans extended to any one borrower by a
licensed MFI shall not at any time exceed 5,000 Birr Directive No. MFI/17/2002 removed
partly the 5,000 Birr single borrower limit for MFIs that mobilized 1,000,000 Birr of savings.
However, the total amount that these MFIs tend (loans exceeding 5,000 Birr) should not exceed
more than 20 percent of their total disbursement.
Moreover, Directive No. 17 limited the maximum loan extending to any client in an MFI to not
exceed 0.5 percent (half a percent) of the total capital of an MFI. Directive No.MFI/05/1996
states that the single loan period of an MFI shall not exceed 12 months. Directive
No.MFI/17/2002 (which supersede Directive No.MFI/05/1996) increased the repayment period
of loans not exceeding 5,000 Birr to 24 months. Moreover, the repayment period for loans
exceeding 5,000 Birr extended by re-registered MFIs should not exceed five years.

vi. Financial Products of Microfinance Institutions

Proclamation No 40/1996 allows that MFIs could be involved in the delivery of credit accept
savings as well as demand and time deposits and engage in other activities customarily
undertaken by MFIs. As per the proclamation, deposit is any regular or irregular savings that
may be withdrawn partially or totally at anytime by the account holder. All MFIs in Ethiopia
provide limited financial products focusing only on loan and saving products to clients.
Moreover, some MFIs have already started money transfer, insurance services and paying
pension fund to pensioners in various districts and sub-districts

vii. Interest Rates

The interest rates of MFIs were revised four times by the NBE Initially; the NBE issued
Directive No, MFI/09/96 that sets the lending and saving interest rates of MFIs. According to
this directive, the lending interest rate of MFIs should not be higher than 2% above the
maximum lending interest rate charged on loans extended by formal banks. Thus, the maximum
lending interest rate was set at 12.5% per annum. The interest rate on savings and time deposits
shall not be less than 1% higher than the minimum interest rate paid on such deposits extended
by formal banks. In May 1998, the NBE increased the maximum ceiling of the lending interest
rate of MFIs to 15.5 percent per annum (Directive No.MFI/10/98).
However, both directives did not state whether the lending interest rate was flat rate or declining
rate. In June 1998 the NBE removed the ceiling of the lending interest rate of MFIs It has
clearly stated that the board of directors of each MFI can set its own lending interest rate
(Directive No.MFI/11/98 and Directive No.MFI/13/2002). The minimum interest rate on
savings and time deposits was 7% per annum. Directive No.MFI/12/98 was issued to reduce the
minimum interest rate on savings and time deposits from 7% to 6% per annum. However, in
2002 (Directive No 13/2002), the NBE reduced the lower ceiling of saving interest rate of
formal banks.
vii. Reporting
Reporting is one of the tools to supervise MFIs in Ethiopia. MFIs are required to provide
quarterly reports to the NBE (Directive No.MFI/07/96).
However, the relatively bigger MFIs have not reported regularly because of their large
geographical coverage (e.g. covering the entire woredas in Tigray and Amhara)
concentration on rural poor and the weak Management Information System (MIS) As a result,
complete and timely reporting was difficult for these MFIs, building a networked MIS and
using appropriate software in all MFIs will improve reporting problems of MFIs.
The regular on-site supervision is expected to verify the reports submitted by the MFIs
However, given the limited capacity of the Supervision Department of the NBE, has only made
limited on-site supervisions for MFIs by sending inspection team to perform on-site
supervisions. Normally, the inspection team finally prepared summary reports of its findings,
which should be discussed with the board and management of MFis. A lot remains to be done in
improving the reporting system and the capacity of the NBE to conduct regular on-site
supervision.

viii. External Audit

The proclamation (No.40/1996) states that an independent auditor acceptable to the NBE prior
to the payment of dividends to shareholders shall audit accounts of MFIs annually. The
directive of the NBE requires MFIs to submit an external audit report to the NBE within six
months from the end of its financial year. Many of the MFIs have started auditing their accounts
by external auditors.
Currently 90% of the MFIs have provided external audit reports to the NBE However, the
external audits were not undertaken annually by few of the MFIs. The NBE insists on annual
external audit that could serve as one of the tools of improving management and add significant
value to MFIs with complicated financial structures.
ix. Opening a Branch
The directive of the NBE (Directive No.MFI/07/1996) indicates that MFIs can open branches
without prior approval of the NBE. They are only required to inform the NBE in writing about
the opening of the new branch. However, MFIs can only close a branch after obtaining approval
from the NBE. The application for closure of a branch office should be submitted to the NBE at
least three months prior to the intended closure of the branch office.
x. Taxable Status
There is no clear Government directive on tax exemption for the MFIs Proclamation 40/1996
states that the Ministry of Finance is empowered to determine the period, manner and
conditions of exemption of microfinance institutions on income tax. In fact, there has not been
any clear distinction by the Ministry of Finance on this issue and none of the MFIs in Ethiopia
have paid or accounted any type of taxes. Since many of the MFIs are not seriously concerned
with the profit tax.
The argument from the side of MFIs is that, since MFIs are engaged in poverty reduction,
requiring them to pay taxes cannot be deemed reasonable. However, recently, some of the
MFIs have been requested to taxes on interest income on savings and profit tax. The .issue was
brought to the Board of Ethiopian Association of Microfinance Institutions (AEMF) for
discussion.
The board members decided that AEMFI should discuss this issue with the Ministry of Finance
and the NBE on behalf of the industry. As a result, the Ministry of Finance has exempted MFIs
from paying profit tax for a unlimited period of time.
xi. Minimum Provisioning Requirements
According to Directive No.MFI/17/2C02, MFIs are required to classify non-performing loans,
based on number of past due days, into the following three categories:
1. Sub-standard: 91-180 past -due days, 25 % of the outstanding balance as provision;
2. Doubtful: 180-365 past due days 50% of the outstanding balance as provision; and
3. Loss: Over 365 past due days. 100% of the outstanding balance as provision.
The directive also states that MFIs should deduct any deposit held with the institutions as
security against the loans from the outstanding balance of non-performing loans before making
the provisions. However, the provision directive is only applicable to MFIs, which are re-
registered, i.e., MFIs whose total deposits equal or exceed Birr one million.

xii. Capital Adequacy Ratio

Technically, capital adequacy is a measure of an institution's capacity to absorb loan losses and
still have adequate fund to maintain regular financial services. The rule of the thumb is that
capital should be commensurate with the volume and risk involved in business and adequate to
absorb losses related to defaults in loan portfolio and other operational losses. Directive
No.MFI/16/2002 states that MFIs should maintain at all times a minimum capital ratio of 12
percent (ratio of risk-weighted assets to total capital) MFIs are also required to submit quarterly
report on capital position within three weeks after the close of each quarter. However, this
directive is only applicable to MFIs, which are reregistered, i.e., MFIs whose total deposits
equal or exceed birr one million. The capital adequacy ratio requirement for commercial banks
is 8% (much lower than MFIs). Even for the re-registered MFIs at various stages, capital
adequacy ratios should have been based on size, experience and financial sustainability.
xiii. Minimum Liquidity Requirement
Until May 2002 there were no reserve and liquidity for MFIs. However, as per Directive of
NBE No, MFI/15/2002, MFIs are required to maintain, at ail times, at least 20 percent of their
total savings in their liquidity assets (ratio of liquidity assets). This directive is only applicable
to MFIs which are re-registered. Commercial banks are required to maintain with the NBE 15%
their deposit liabilities in the form of liquid assets such as cash, bank deposits, treasury bills,
and other short-term assets that can readily be liquidated or discounted.

Pension Trust Funds

A fund established by an employer to facilitate and organize the investment of employees'

retirement funds contributed by the employer and employees. The pension fund is a common
asset pool meant to generate stable growth over the long term, and provide pensions for
employees when they reach the end of their working years and commence retirement.
Pension funds are commonly run by some sort of financial intermediary for the company and its
employees, although some larger corporations operate their pension funds in-house. Pension
funds control relatively large amounts of capital and represent the largest institutional investors
in many nations.
Basic characteristics of Pension Trust Fund
A pension trust fund is a fund that is made up of money which is contributed by the employer
and the employee for pension benefits. Every organization maintains a pension trust fund for its
employees and protects liabilities of misappropriation and mishandling of pension funds.
A pension plan is a fund that is established by private employers, governments, or unions for
the payment of retirement benefits. Pension plans have grown rapidly largely because of
favorable tax treatment. Qualified pension funds are exempt from federal income taxes, as are
employer contributions. The two types of pension funds are defined contribution plans and
defined benefit plans. In the former plan the sponsor is responsible only for making specified
contributions into the plan on behalf of qualifying employees but does not guarantee any
specific amount at retirement. A defined benefit plan sponsor agrees to make specified
payments to qualifying employees at retirement.
Since the funds flowing in are not demand deposits, you cannot write a check against your
balance in a pension fund. Like life insurance companies, these institutions can accurately
predict payouts and hence can hold long-term assets. They hold portfolios consisting mostly of
stocks and bonds. The returns on these assets are paid out to participating individuals when
reach retirement age.
Sponsors of pension plans can agree with various types of pension obligations to the
beneficiaries of the plan. There are plans where retirement benefits depend on the participant's
income for a specified number of years before retirement and the total number of years the
participant worked. This will affect the amount of the cash outlay. The timing of the cash outlay
depends on when the employee elects to retire, and whether the employee remains with the
sponsoring plan until retirement/ Moreover, both the amount and the timing will depend on how
the employee elects to have payments made over only the employee's life or those of the
employee and spouse.

Pension plans are usually considered "patient capital" because of their long time horizon. The
types of investments undertaken by a pension fund depend on its objectives and constraints
which are provided for its "investment policy statement". Legislation demands a "prudent
approach" of diversifying risk across a number of securities or asset types. Taking prudence into
account, pension funds strive to achieve the highest practical return which lowers the cost of
their pension "obligation" considerably. The responsibilities of an appointed trustee include:
 administering the funds;
 investing the money;
 collecting the earnings and interest; and
 distributing the benefits.
The major limiting factor to putting a company’s entire pension fund in very high return and
"risky" assets is the financial condition of the pension fund. A pension fund that doesn't have
enough investment to cover its pension obligations is said to be "under-funded" or have a
"shortfall" in invested assets and companies are required to make this up through higher
contributions. A pension fund that has more investments than necessary to cover its pension
obligation is called "over-funded" or said to have a pension "surplus". Companies with a
pension surplus can reduce or suspend their contributions altogether. The financial condition of
a pension plan depends on a number of factors, including:
The demographic characteristics of the plan members very much dictate the time
horizon for investment. If the plan sponsor is a new company with relatively young
employees, the eventual pensions are very far in the future. This means if the value of
the plan investments fluctuates considerably, there will not be a need for funds to be
withdrawn at a low point when the investments' value is down considerably. A "young
plan" can have a high weighting in riskier or more illiquid assets such as stocks, real
estate and non-traditional investments. This is in contrast to a "mature plan" which has
much older participants and actually is paying pensions to many retirees. The
investments of these plans usually are much more towards fixed income securities such
 as bonds and mortgages which fluctuate much less in price and provide a stable income
source to pay pensions regularly.
The financial state of the company itself is important. If a company is in a difficult
financial situation, it will be more difficult to make large contributions to the pension
fund to make up potential shortfalls from investment performance. This usually results
in a more capital risk averse approach and higher fixed income weighting.
The historical investment performance of the fund's investments results in the amount
of assets available at any point. A plan with poor historical investment performance will
have generated a much lower rate of return and therefore will have less funds on hand
to provide for pension obligations. Perversely, a "conservative" investment approach
with a low equity weighting will result in low returns which might lower the future risk
tolerance of a plan. All funds paid to a company pension scheme have to be deposited
into a pension trust scheme by legislation.
This is to avoid a situation where the owners of the business can misappropriate the funds.
Alternatively, the funds can count as an asset for the business which may therefore be at risk in
case the business fails. It is also critical that the pension trust is protected. This way, the
employees can receive full benefits of their own and their employer's payments on retirement.
The right balance needs to be achieved in terms of legislation and law to determine:
 how a pension trust should be run; and
 who are the trustees with responsibilities to the members.
 The company pension trust is a three way integration product, with:
 the company representing one component;
 the employee representing the second component; and
 the trustees representing the third one.

 All need to interact responsibly with each other for the pension trust to work smoothly.

The biggest drawback of a pension trust fund and company pensions in general, is that many
such plans guarantee to pay a certain level of pension, often based on the employee's salary
upon retirement. This is in contrast to most private plans, where the pension depends on how
well investments perform. This creates the risk that a pension trust fund may not have enough
money to pay the guaranteed pensions if investments do not go as well as planned. In some
cases, the set-up of a pension trust fund relies on the money invested by current employees to
provide the pensions of people who have retired. This can be problematic if demographic
changes, such as the “baby boomers” reaching retirement age, create an imbalance between
employees and retirees.

The role of Pension Trust Fund in the economy

A pension plan is a fund that is established for the payment of retirement benefits. The entities
that establish pension plans called the plan sponsors - are private business entities acting for
their employees; state and local entities on behalf of their employees; unions on behalf of their
members; and individuals for themselves. Pension funds are financed by contributions by the
employer and/or the employee; in some fund plans employer contributions are matched in some
measure by employees.
A Pension fund is a pool of assets forming an independent legal entity that are bought with the
contributions to a pension plan for the exclusive purpose of financing pension plan benefits.
Pension funds are savings plan through which fund participants accumulate savings during their
working days so that they withdraw the fund during their retirement years.

Pension plans exist to provide post-retirement income to employees. A pension plan is really a
number of promises to pay people income after retirement. In a traditional "defined benefit"
pension plan, the pensions are defined according to a formula specified in the plan documents.
This usually takes the form of a percentage of the "best years" of salary.
Regarding pension trusts, the trustees are responsible for managing the funds. They also make
sure that the investments are:
 Sound;
 Yield appropriate returns;
 Take care of the well-being of existing employees and of employees who are retired; and
 Trustees also ensure risk free investment return of their employees.
At the time of retirement, or death in service, the trustees are responsible for deciding where
and to whom the money is to be paid. If an employee prefers a pension transfer, the trust must
also be involved in:
 acquiring a transfer value
 helping to facilitate the transfer

Pension funds also have served traditionally to discourage employees from quitting, as usually
the employee lost at least the accumulation resulting from the employer contribution, i.e.,
pension benefits have not been portable. The key factor explaining pension fund growth is that
the employer's contributions and up to a specified amount of the employee's contributions, as
well as the earnings of the fund's assets, are tax-exempt. In essence a pension is a form of
employer remuneration for which the employee is not taxed until funds are withdrawn.
At any point in time, an actuary can calculate how much money must be set aside to cover the
future cost of pensions, given an investment return until eventual retirement. Actuaries also
calculate how much a company must contribute to its pension plan to cover its obligations.
Accountants also get into the act, providing a valuation of a company's "vested benefit
obligation" which pension obligations are given an immediate termination of the pension plan.
 Types of pension plan
There are two main types of pension plan in most countries:
i. A private pension plan involves an individual, usually an employee, saving in a private
plan operated by a financial company. The only involvement an employer has with the
plan is to deduct money from the employee's wages and send it to the plan and, in some
cases, to contribute extra money to the plan as a form of employment benefit.
ii. The second type of plan is the company pension plan, where the entire process of savings,
investment, and pension provision is controlled by the employer. Usually this is done
through a pension trust fund.
The employer acts as a trustee and holds money on behalf of the settler that is the
employee. Although the trustee has legal control of the money, the rules of the trust fund
force them to act in the interests of the settler and follow agreed procedures.
Pension funds are not in the spread business in that they do not raise funds themselves in the
market. They seek to cover the cost of pension obligations at a minimum cost that is borne by
the sponsor of the pension plan. Many corporations and government agencies offer
pension plans to their employees; their employers, or both periodically contribute funds to the
plan. The funds contributed are invested in securities until they are with drawn (upon
retirement) by the employees.
Investments by pension funds provide financing for deficit units. Pension funds can invest in
many different types of financial securities and can own assets directly. The types of
investments undertaken by a pension fund depend on its "investment policy statement". The
nature of the investments allowed in the policy statement depends in a large part on the
financial situation of the plan. The major benefits are:
i. One major benefit of a pension trust fund is that it allows money from the pension savings of
multiple employees to be pooled together for investment. This can reduce administration
costs. It can also give more bargaining power to the fund's investors, meaning they may be
able to buy or sell investments at more favorable rates.
ii. The other main benefit of a pension trust fund is that it protects the savings. In theory, the
employer will not be able to use the money in the fund for its own purposes. In practice, this
has happened in some cases and many countries have brought in tighter regulations to prevent
abuse.

Now days, many developing countries have reformed their pension plans from a defined benefit
to a defined contribution plan. One of the reasons for this shift is that it is beneficial for the
development of domestic financial markets. In defined contribution plans, the accumulation of
assets by pension funds bolsters the domestic market, which in turn leads to more efficient
allocations of moneys to productive investments in the domestic economy. Theoretically, this
will lead to increases in productivity and growth.
Pension funds have a unique role to play in the development of national stock markets in
developing nations. They can trade frequently thereby increasing the liquidity of the domestic
stock markets, or introduce innovations and new financial instruments to reduce costs. Research
points out that the most important thing that pension funds can do is improve the corporate
governance of publicly traded firms. Because pension funds are so large, they can use their
influence to monitor insiders and improve shareholder legal protections.
Regulations of Ethiopian Government concerning Pension Trust Fund
In line with internationally used rules and regulations, every country has its own policies to
administer the pension funds. Accordingly Ethiopian Government has its own regulations as
follows:
 Old Age, Disability, and Survivors
Regulatory Framework
1. First and current law: 1963 (public employees), with 1974, 1975, 1996, 1999, 2003, 2004,
and 2006 amendments.
2. Type of program: Social insurance system.

3 Coverage: Public-sector employees only, including military and police personnel and
employees of government-owned enterprises.
4. Source of Funds:
 Insured person: 4% of basic salary.
 The insured's contributions also finance work injury benefits.
 Does not \apply to Self-employed person.
 Employer: 6% (civilian) or 16% (military) of payroll.
 The employer's contributions also finance work injury benefits.
 Government: None, except as an employer.
Qualifying Conditions
Old-age pension: Age 60 with at least 10 years of service and contributions.

Early pension: Age 55 with at least 25 years of contributions (civilian personnel); aged 45 to
55 (depending on rank) with at least 10 years of contributions (military personnel).

Old-age settlement: Age 60 and does not meet the qualifying conditions for the old-age pension.
Disability pension: The insured must be assessed as incapable of normal gainful employment
and have at least 10 years of service and contributions.
Disability settlement: The insured must be assessed as incapable of normal gainful
employment and have less than 10 years of service and contributions.
Survivor pension: The deceased met the contribution conditions for the old-age pension or was
a pensioner at the time of death. Eligible survivors are the widow(er), children younger than
age 18, and dependent parents.
Survivor settlement: Paid to eligible survivors if the deceased had less than 10 years of service
and contributions and was not eligible for a pension. Eligible survivors are the widow(er) and
children younger than age 18.
is the spreading of losses incurred by the few over the entire group, so that in
the process average loss is substituted for actual loss. is the spreading of
losses incurred by the few over the entire group, so that in the process
average loss is substituted for actual loss. is the spreading of losses incurred
by the few over the entire group, so that in the process average loss is
substituted for actual loss. is the spreading of losses incurred by the few over
the entire group, so that in the process average loss is substituted for actual
loss. is the spreading of losses incurred by the few over the entire group, so
that in the process average loss is substituted for actual loss. is the spreading
of losses incurred by the few over the entire group, so that in the process
average loss is substituted for actual loss. is the spreading of losses incurred
by the few over the entire group, so that in the process average loss is
substituted for actual loss. is the spreading of losses incurred by the few over
the entire group, so that in the process average loss is substituted for actual
loss.Old-Age Benefits
Old-age pension: The pension is equal to 30% of the insured's average monthly basic salary in
the last 3 years before retirement, plus 1.125% (civilian) or 1.5% (military) of the insured's
average monthly basic salary for each year of service exceeding 10 years. The minimum
monthly pension is 100 birr. The maximum monthly pension is equal to 70% of the insured's
average monthly basic salary.
Early pension: The pension is calculated in the same way as the old-age pension.
Benefit adjustment: Benefits may be adjusted by the Council of Ministers every 5 years.
Old-age settlement: A lump sum is paid equal to the insured's basic salary in the month before
retirement times the number of years of service.
Permanent Disability Benefits
Disability pension: The pension is equal to 30% of the insured's average monthly basic salary
in the last 3 years before the disability began, plus 1.125% (civilian) or 1.5% (military) of the
insured's average monthly basic salary for each year of service exceeding 10 years. The
maximum monthly pension is equal to 70% of the insured's average monthly basic salary.
Benefit adjustment: Benefits may be adjusted by the Council of Ministers every 5 years.
Disability settlement: A lump sum is paid equal to the insured's basic salary in the month
before the disability began times the number of years of service.
Survivor Benefits
Survivor pension: 50% of the deceased's monthly pension is paid to the widow(er). The
pension ceases on remarriage.
Orphan's pension: Each eligible orphan receives 20% of the deceased's pension; 30% for full
orphans.
Dependent parent's pension: Each eligible parent receives 15% of the deceased's pension; 20%
in the absence of other eligible survivors.
Survivor settlement: A lump sum is paid to each eligible survivor. The lump sum is calculated
using the percentage rates used to calculate the survivor pension or orphan's pension.
Benefit adjustment: Benefits may be adjusted by the Council of Ministers every 5 years.
Administrative Organization
Accountable to the prime minister and managed by a board and a director general, the Social
Security Agency administers the program.
 Sickness and Maternity
Regulatory Framework
No statutory benefits are provided. The public service amendment proclamation (2002) and the
labor proclamation (2003) require employers to provide paid sick leave for up to 3 months:
100% of earnings is paid for the first month; thereafter, 50% of earnings. The public service
amendment proclamation (2002) and the labor proclamation (2003) require employers to
provide paid maternity leave for up to 45 days after childbirth; thereafter, paid sick leave may
be paid in the event of complications arising from childbirth.
 Work Injury
Regulatory Framework
First and current law: 1963 (public employees), with 2003 amendment.
Type of program: Social insurance system. The labor proclamation (2003) allows for the
provision of private insurance for public-sector employees.
Coverage: Public-sector employees only, including military and police personnel and
employees of government-owned enterprises.
Source of Funds
Insured person: See source of funds under Old Age, Disability, and Survivors, above.
Self-employed person: Not applicable.
Employer: See source of funds under Old Age, Disability, and Survivors, above.
Government: See source of funds under Old Age, Disability, and Survivors, above.
Qualifying Conditions
Work injury benefits: There is no minimum qualifying period.
Temporary Disability Benefits
A lump sum is paid equal to 45% of the insured's monthly basic salary multiplied by 5 years
times the assessed degree of disability. Benefits may be adjusted by the Council of Ministers
every 5 years.
Permanent Disability Benefits
Permanent disability pension: The pension varies from 45% to 70% of the insured's monthly
basic salary, according to the assessed degree of disability. If the value of the disability pension
is less than or equal to the insured's entitlement under the old-age pension, then the old-age
pension is paid up to a maximum of 70% of the insured's monthly basic salary. Benefits may be
adjusted by the Council of Ministers every 5 years.
Survivor Benefits
Survivor pension: 50% of the deceased's pension is paid to the widow(er). The pension ceases
on remarriage.
Orphan's pension: Each eligible orphan receives 20% of the deceased's pension; 30% for full
orphans.
Dependent parent's pension: Each eligible parent receives 15% of the deceased's pension;
20% in the absence of other eligible survivors.
Benefit adjustment: Benefits may be adjusted by the Council of Ministers every 5 years.
Administrative Organization
Accountable to the prime minister and managed by a board and a director general, the Social
Security Agency administers the program.
 Disability Compensation System

Regulatory Framework

 Medical Benefits

Eligibility
Workers are eligible to medical benefits in cases where an employment injury is sustained by a
worker during or in connection with the performance of his work. Employment injury means an
employment accident or occupational disease.
Employment accident means any organic injury or functional disorder sustained by a worker as
a result of any cause extraneous to the injured worker or any effort he makes during or in
connection with the performance of his work and includes:
 Any injury sustained by a worker while carrying out the employer's orders, even away
from the workplace or outside his normal hours of work;
  Any injury sustained by a worker before or after his work or during any interruption of
work, if he is present in the workplace or the premises of the undertaking by reason of his
duties in connection with his work;
 Any injury sustained by a worker while he is proceeding to or from place of work in a
transport service vehicle provided by the undertaking which is available for the common
use of its workers or in a vehicle hired and expressly destined by the undertaking for the
same purpose;
 Any injury sustained by a worker as a result of an action of the employer or a third person
during the performance of his work.
Occupational disease means any pathological condition whether caused by physical, chemical
or biological agents which arise as a consequence of:
 The type of work performed by the worker; or
 The surroundings in which the worker is obliged to work during a certain period prior to the
date in which the disease became evident.
Benefits and funding
Where a worker sustains employment injury, the employer shall cover the following expenses:
1. General and specialized medical and surgical care;
2. Hospital and pharmaceutical care; and
3. Any necessary prosthetic or orthopedic appliances.
Duration of benefit
Medical benefits shall be withdrawn in accordance with the decision of the Medical Board.
xiv. Periodical Payments for Temporary Disablement
Regulatory Framework
Eligibility
A worker who has sustained employment injury is entitled to periodical payments while he is
temporarily disabled. Employment injury means an employment accident or occupational
disease.
Employment accident means any organic injury or functional disorder sustained by a worker as
a result of any cause extraneous to the injured worker or any effort he makes during or in
connection with the performance of his work and includes:
 any injury sustained by a worker while carrying out the employer's orders, even away from
the workplace or outside his normal hours of work;
 any injury sustained by a worker before or after his work or during any interruption of work,
if he is present in the workplace or the premises of the undertaking by reason of his duties in
connection with his work;
 any injury sustained by a worker while he is proceeding to or from place of work in a
transport service vehicle provided by the undertaking which is available for the common use
 of its workers or in a vehicle hired and expressly destined by the undertaking for the same
purpose;
 any injury sustained by a worker as a result of an action of the employer or a third person
during the performance of his work.
Temporary disablement means disablement that results from the reduction for a limited period
of time of the worker's capacity for work which prevents him from doing his work partially or
totally.
Benefits and their duration and funding
The periodical payments are paid at the rate of not less than 75 per cent (seventy-five per cent)
of the worker's pervious average yearly wages during the first six months following the date of
the injury and not less than 50 per cent (fifty per cent) of his previous average yearly wages for
the remaining six months.
The employer shall pay for one year the periodical payment. Periodical payments shall cease
whichever of the following takes place first:
when the worker is medically certified to be no longer disabled;
on the day the worker becomes entitled to disablement pension or gratuity; or
twelve months from the date the worker stopped work.
 Permanent Disablement Payments

Regulatory Framework
Eligibility
Disablement payments include disablement pension or gratuity or compensation where a
worker sustains permanent disablement as a result of employment injury. Employment injury
means an employment accident or occupational disease.
Employment accident means any organic injury or functional disorder sustained by a worker as
a result of any cause extraneous to the injured worker or any effort he makes during or in
connection with the performance of his work and includes:
any injury sustained by a worker while carrying out the employer's orders, even away from
the workplace or outside his normal hours of work;
any injury sustained by a worker before or after his work or during any interruption of work,
if he is present in the workplace or the premises of the undertaking by reason of his duties in
connection with his work;
any injury sustained by a worker while he is proceeding to or from place of work in a
transport service vehicle provided by the undertaking which is available for the common use
of its workers or in a vehicle hired and expressly destined by the undertaking for the same
purpose;
any injury sustained by a worker as a result of an action of the employer or a third person
during the performance of his work.
Occupational disease means any pathological condition whether caused by physical, chemical
or biological agents which arise as a consequence of:
the type of work performed by the worker; or
the surroundings in which the worker is obliged to work during a certain period prior to the
date in which the disease became evident.
Permanent disablement partial and total disablements:
"Permanent partial disablement" means incurable employment injury decreasing the injured
worker's working capacity.
"Permanent total disablement" means incurable employment injury which prevents the
injured worker from engaging in any kind of remunerated work.
Injuries which, although not resulting in incapacity for work, cause serious mutilation or
disfigurement of the injured person shall be considered permanant partial disablement, for the
purpose of compensation and other benefits.
Benefits and funding
Disablement benefits payable to workers of state enterprises are paid according to the insurance
scheme arranged by the undertaking or pension’s law. Where the undertaking does not have any
insurance arrangement, the pension law shall apply to workers covered under this Proclamation.
An employer shall pay a lump sum of disablement compensation to workers who are not
covered by the pension law.
The amount of the disablement compensation to be paid by the employer is:
a sum equal to five times his annual wages, where the injury sustained by the worker is
permanent total disablement;
a sum proportionate to the degree of disablement calculated on the basis of a sum equal to
five times his annual wages, where the injury sustained by the worker is below permanent
total disablement.
Where a worker who has sustained permanent disablement was at the date of the injury an
apprentice, his disablement compensation is calculated by reference to the wages which he
would probably have been receiving as a qualified workman after the end of his studies.
 Dependant's Benefits
Regulatory Framework
Eligibility
Where a worker or an apprentice dies as a result of an employment injury, the worker's widow
or widower, children of the deceased worker who are under 18 years of age and any parent who
was being supported by the deceased worker are entitled to the dependant's compensation.
Employment injury means an employment accident or occupational disease.
Employment accident means any organic injury or functional disorder sustained by a worker as
a result of any cause extraneous to the injured worker or any effort he makes during or in
connection with the performance of his work and includes:
 any injury sustained by a worker while carrying out the employer's orders, even away from
the workplace or outside his normal hours of work;
any injury sustained by a worker before or after his work or during any interruption of work,
if he is present in the workplace or the premises of the undertaking by reason of his duties in
connection with his work;
any injury sustained by a worker while he is proceeding to or from place of work in a
transport service vehicle provided by the undertaking which is available for the common use
of its workers or in a vehicle hired and expressly destined by the undertaking for the same
purpose;
any injury sustained by a worker as a result of an action of the employer or a third person
during the performance of his work.
Occupational disease means any pathological condition whether caused by physical, chemical
or biological agents which arise as a consequence of:
the type of work performed by the worker; or
the surroundings in which the worker is obliged to work during a certain period prior to the
date in which the disease became evi.
Benefits and funding
The amount of the dependant’s compensation for workers not covered by the Public Servants
Pension Law shall be a sum equal to five times the annual salary of the deceased and paid by
the employer in a lump sum. Payment for funeral expenses which shall be not less than two
months' wages of the worker is subject to the provisions of a collective agreement or work
rules.