FINANCIAL SYSTEM IN EYHIOPIA; STRENGTH AND

WEAKNESS
Objectives;
 To define the term financial system.
 To introduce the weakness and strength financial of system in
Ethiopia
 To list and explain the weakness and strength of financial system
of Ethiopia.

Introduction
A financial system is said to be developed if it produces and processes information on
investment opportunities and challenges, allocates capital based on those information;
monitoring individuals and firm’s investments and puts forth corporate governance;
managing risks; mobilizing and pooling savings; and easing the exchange of goods and
services. When financial systems perform these functions poorly, it hampers economic
growth, restrains economic opportunities, and destabilizes economies. According to the
government failure hypothesis which is similar to the private interest view of regulation; the
governments regulate banks in order to make government expenditures financing easy,
direct credit to politically desirable ends, and to maximize the benefit and the decision
power of politicians and bureaucrats on the economy. Whereas the market failure
hypothesis states that markets fail due to: anticompetitive behavior, market misconduct,
information asymmetries, and systemic instability. The first two components of the market
failure (anticompetitive behavior and market misconduct) lead to inefficiencies of the
financial market that requires being resolved through market regulation; however
information asymmetries and systemic instability demand prudential regulation. This
market failures hypothesis is also in line with public interest view of regulation, where
according to this view; governments initiated to regulate financial institutions in order to
facilitate the efficient functioning of banks, insurance companies, and financial markets by
reducing or eliminating market failures, for the good of the general public by allocating
resources in a socially efficient manner.

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 Trends and financial performance in Ethiopia. Before 1992 the Ethiopian economy was
characterized as a command economy whereas after 1992 when the new EPRDF
government comes to power a free market economy was declared as a result several private
firms have flourished. Regarding the financial sector even though it has been opened for
domestic investors it remains closed for the entry of foreign national investors, for this
reason it remains less developed than many developing countries including its neighbors for
example; Kenya, Sudan and Uganda. Similarly the Ethiopian banking sector as it was in the
past regime continued cut off from the influence of globalization and global financial crises.

1. Since foreign banks, have more capital and more experience, they can hinder the
development of domestic financial sectors because they are too young, small in numbers
and inexperienced to compete. Which is the infant industry argument for protection? This
argument is also supported by domestic private financial investors.

2. As Ethiopian economy is agricultural and majority of its citizens (85%) are living in
the rural areas and its credit policy favored the agricultural sector, small scale
industries and rural dwellers.

However when foreign banks enter the country, their credit policy can be skewed towards
large scale industries due to their reputation and sufficient collateral and also foreign banks
will focus lending to urban dwellers and industries using foreign funds, therefore their
contribution towards the development of rural areas will be less.

3. Experience from developing countries shows that foreign banks are more interested in
lending their foreign capital than in mobilizing domestic savings.

4. Because foreign banks are engaged in worldwide capital markets which may create
foreign exchange shortages.

This can have adverse effect on the balance of payments and capital account of the give the
limited capability of the National Bank of Ethiopia in regulating and supervising the
financial markets.

Even though the short-term capital inflow is controlled, other modes of supply are more
open. For example Cross-border financial services are permitted for selected services;
Ethiopian insurance companies buy reinsurance services from foreign reinsurers and Cross-
border banking services exist but are limited to: (a) borrowing abroad by the government
and some state-owned enterprises (e.g., Ethiopian Airlines, Ethiopian Telecommunication

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 and Ethiopian Electric Power Authority) and (b) foreign borrowing by exporters without a
government guarantee of foreign exchange availability.

Definition of financial system.

Financial system is a system that facilitates the movements of funds among people in an
economy. It is simply mean that through which funds are exchanged between investors,
lenders, and borrowers. A financial system is a composed of varies elements like Financial
institution, Financial intermediaries and other.

Strength of financial system

Credit Creation: The existence of a financial institution is a kind of security that ensures that
less money is left unused in an economy. This means that financial institutions are
intermediaries between the savers and the borrowers. This process creates money out of money
and boosts growth in an economy.

Provide Funds: Financial institution is a good source of medium and long-term finance. They
provide both owned and borrowed capital to the organization.

Economic Development: Financial institution promotes economic development in an

economy by way of funding all the development plans of government and private
organizations.

Infrastructural Development: The establishment of financial institutions builds a strong

banking base in an economy. Besides this, it offers all the financial services needed for the
development and promotion of other infrastructures, like industries, roads, hospitals,
educational institutions, etc.

Promotes Regional Balances: Financial institution takes up their social responsibility to

establish their units in backward areas to uplift these areas by educating and providing basic
monetary services to people. The financial institution aims to bring backward regions on equal
footing with developed regions.

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Employment Generation: Financial institution provides all necessary funding to build and
develop industries and infrastructure in a country. This creates new employment opportunities
for the available manpower.

Provides Payment System: The financial system provides a payment mechanism for the
smooth flow of funds among peoples in an economy. Buyers and sellers of goods or services
are able to perform transactions with each other due to the presence of a financial system.

Links Savers and Investors: The financial system serves as a means of bridging the gap
between savings and investment. It acquires money from those with whom it is lying idle and
transfers it to those who need it for investing in productive ventures.

Minimizes Risk: It aims at reducing the risk by diversifying it among a large number of
individuals. The financial system distributes funds among a large number of peoples due to
which risk is shared by many peoples.

Helps in Capital Formation: The financial system has an efficient role in capital formation of
the country. It enables big corporates and industries to acquire the required funds for
performing or expanding their operations thereby leading to capital formation in the nation.

Raises Standard of living: It raises the standard of living of peoples by promoting regional
and rural development of the country. The financial system promotes the development of
weaker sections of society through cooperative societies and rural development banks.

Enhance liquidity: Maintaining optimum liquidity in an economy is another important role

played by the financial system. It facilities free movement of funds from households (savers) to
corporates (investors) which ensures sufficient availability of funds in the economy.

Promotes Economic Development: The financial system influence the pace of economic
growth or development of an economy. It aims at optimum utilization of all financial resources
by investing all idle lying resources into useful means which leads to the creation of wealth.

Weakness of Financial System in Ethiopia

Under Ground economy (Black Market); nowadays black market has been changing
illegally different countries currency. This leads to decrease the money values of our
country’s currency compared to other countries’ currency

Commercial Bank usually works for interest rather than for community

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Complex Process: The process of granting loans by Financial Institutions is rigid and involves
lots of paperwork. This makes the process time-consuming and expensive.

Restriction on the Borrower: The financial institutions have a right to have their nominee on
the Board of Directors of the borrowing company, which restricts the power of the company.
Besides this, they may directly interfere with the dividend distribution decision of the
borrowing company.

System of Collateral Securities: Financial institutions are governed under strict rules of the
Government, which requires them to grant loans only against some security. Due to this,
sometimes deserving organizations fail to get financial assistance due to a lack of security.

Lack of Co-ordination among financial institutions: The financial system faces a lack of
coordination among various financial institutions. The presence of a large number of financial
institutions and government roles in controlling authorities of these institutions leads to a lack
of coordination.

Monopolistic Market Structure: Many institutions in the Ethiopian financial system occupy a
monopolistic position in the market. LIC and UTI are two institutions that have grabbed a large
part of the life insurance business and the mutual fund industry. These large structures could
lead to mismanagement or inefficiency of funds.

High Rate of Interest: There is a possibility of the high-interest rate charged by several
financial institutions in the financial system of our country. Various institutions due to their
monopolistic structure in the market may charge high or unfair interest rates.

Inactive Capital Market: Our country’s financial system faces the problem of the inactive
capital market. All corporates in India are mostly able to acquire funds through development
banks and do not need to go to the capital market.

Imprudent Financial Practice: The financial system of India has developed imprudent
financial practices due to the dominance of development banks. Development banks provide
funds to corporates in the form of term loans which makes the capital structure of borrowed
concerns uneven. These banks even permit the use of unwarranted debts which is against the
sound capital structure.

Conclusion
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 Financial system is simply meant that through which funds are exchanged between
investors, lenders, and borrowers. A financial system is a composed of varies elements like
Financial institution, Financial intermediaries and other. Financial system of Ethiopia
has both strength and weakness. We elaborate its strength. But government, society,
monetary policy and other financial institutions must improve the weakness of financial
institution of Ethiopia.

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