CHAPTER TWO

THE ETHIOPIAN BANKING SECTOR

2.1 Organization and Structure of Ethiopian Banking Industry
 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.

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 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.

2.2 The Origin of National Bank of Ethiopia

 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.
 The National Bank of Ethiopia was established in 1963 by proclamation 206 of 1963 and began
operation in January 1964. Prior to this proclamation, the Bank used to carry out dual activities, i.e.
commercial banking and central banking. The proclamation raised the Bank’s capital to Ethiopian
dollars 10.0 million and granted broad administrative autonomy and juridical personality.

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 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 National Bank of Ethiopia Establishment (as Amended) Proclamation No. 591/2008, the capital of
the National Bank shall be totally owned by the Government. The paid up capital of the National Bank
is Birr500,000,000 (five hundred million Birr) and may be increased as might be found necessary by
regulation to be issued by the Council of Ministers. 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.

 Regulate the supply and availability of money & credit and applicable interest and other
changes.

 Set limits on gold and foreign exchange assets which banks and other financial institutions
authorized to deal in foreign exchange an hold in deposits.

 Set limits on the net foreign exchange position and on the terms and amount of external
indebtedness of banks and other financial institutions.

 Make short and long-term refinancing facilities available to banks and other financial
institutions.

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2.3 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.
2.3.1 Basic Characteristics of commercial banks
Characteristics of CB
 acceptance of deposits (of money) from the public on various accounts ;
 main purpose of accepting deposits should be to lend the money to individuals, firms and the
government or invest it;
 the deposits are repayable on demand or otherwise as directed by the depositor ; and
 the deposits can be withdrawn by means of an instrument whether a cheque, draft, withdrawal form
or otherwise.

2.3.2 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.
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 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.
2.3.3 Current regulations of Ethiopian Government concerning commercial banks
The Proclamation of Banking Business Proclamation No. 592/2008, define “Bank” means a company
licensed by the National Bank to undertake banking business or a bank owned by the Government.
Banking business means any business that consists of the following activities: receiving funds from the
public through means that the National Bank has declared to be an authorized manner of receiving
funds; using the funds referred to, in whole or in part, for the account and at the risk of the person
undertaking banking business, for loans or investments in a manner acceptable by the National Bank; the
buying and selling of gold and silver bullion and foreign exchange. The transfer of funds to other local
and foreign persons on behalf of the banks themselves or their customers; the discounting and
negotiation of promissory notes, drafts, bills of exchange and other evidence of debt; any other activity

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 recognized as customary banking business, which a bank engaged in the activities described from above
paragraph of this sub-article may be authorized to undertake by the National Bank.
The financial year of a bank is from July 1st to June 30th of the following year. The influential
shareholder is a person who holds directly or indirectly two percent or more of the total subscribed
capital of a bank;
 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:
i. Licensing banks: license for doing banking business is issued by the National Bank of Ethiopia, and
foreign national shall not undertake banking business in Ethiopia.
ii. 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.
iii. 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
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 with applicable laws or regulations or with the terms and conditions of the license to carry on
banking business in Ethiopia.
iv. 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.
v. 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.
2.4 Micro Financing in Ethiopia
 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.

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 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.
2.4.1 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.

2.4.2 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

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 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:
i. To reduce poverty;
ii. To help existing businesses grow or diversify their activities and to encourage the development of
new businesses;
iii. To create employment and income opportunities through the creation and expansion of micro
enterprise; and
iv. 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.

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 2.4.3 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
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 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.

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 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.

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 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:

2.4.4 Features of MFIs

1. Minimum Capital Required of New MFI Entrants: Directive No MFI/01/96 states that MFI
applying for a license shall have a minimum paid up capital of 200,000 Birr. 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.
2. 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.
3. 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

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 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.
4. 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.
5. 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.
6. 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
7. 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

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 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.
8. 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.
9. 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.

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 10. 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.
11. 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.
12. 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:

i. Sub-standard: 91-180 past -due days, 25 % of the outstanding balance as provision;

ii. Doubtful: 180-365 past due days 50% of the outstanding balance as provision; and
iii. 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.
13. 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

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 (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.
14. 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.
2.5 Savings and loan associations

Savings and loan associations (S&Ls) are old institutions established to provide finance for acquisitions
of homes. They can be mutually owned or have corporate stock ownerships. NB: Mutually owned
means depositors are the owners. They have traditionally served individual savers, residential and
commercial mortgage borrowers, take the funds of many small savers and then lend this money to home
buyers and other types of borrowers. The collateral for the loan would be the home being financed.

These institutions were to aggregate depositors’ funds and use the money to make long term mortgage
loans. The institutions were not to take in demand deposits but instead were authorized to offer savings
accounts that paid slightly higher interest than offered by commercial banks (they issue NOW
(Negotiable Order of Withdrawal–pays interest) account to commercial customers. Which are
traditionally reserved for commercial banks).

In function, Savings and loan associations are similar to commercial banks, and in recent years the
distinction between commercial banks and savings and loan institutions has become blurred as the
financial services industry has become more homogeneous. In the past, savings institutions were legally
required to engage primarily in home mortgage finance, and even though they now may hold other types
of assets, their traditional emphasis continues to be a major difference between savings institutions and
commercial banks.

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