Introduction

The financial system is the cornerstone of any economy, acting as a bridge that
facilitates the exchange of funds between savers, investors, and borrowers. It
encompasses a network of institutions, markets, financial instruments, and regulatory
frameworks that enable the smooth flow of capital. In the context of Ethiopia, the
financial system plays a pivotal role in supporting the country’s development by
mobilizing savings, providing credit to businesses and individuals, and driving
investments into productive sectors.

Ethiopia’s financial system has undergone significant evolution over the years,
transitioning from a predominantly state-controlled structure to a more inclusive and
market-oriented framework. The liberalization efforts of the 1990s introduced private
banks and microfinance institutions, creating new opportunities for competition and
innovation. Today, the financial landscape is characterized by a diverse mix of
formal, semi-formal, and informal institutions.
Despite these advancements, the financial system in Ethiopia faces persistent
challenges. Access to financial services remains limited, particularly in rural regions
where banking infrastructure is sparse. Financial markets are underdeveloped, with no
functioning capital market to support long-term financing needs. Regulatory
oversight, though comprehensive, struggles to keep pace with the rapid changes in
technology and market dynamics. Furthermore, macroeconomic instability, including
high inflation and currency shortages, continues to strain the system.

In recent years, promising developments have emerged. The establishment of the

Ethiopian Capital Markets Authority (ECMA) and plans to operationalize a capital
market signal a turning point in the country’s financial landscape. Digital financial
services, such as mobile banking and fintech innovations like Telebirr, are bridging
gaps in financial inclusion and offering new avenues for economic participation.
Additionally, government initiatives to combat money laundering and terrorism
financing have strengthened the integrity of the financial system, aligning it with
international standards.

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This paper aims to provide a comprehensive overview of Ethiopia's financial system,
exploring its structure, institutions, markets, financial assets, and regulatory
frameworks. It examines the interplay between the financial sector and the broader
economy, highlighting how financial reforms and innovations can foster sustainable
growth. By identifying the strengths, weaknesses, opportunities, and threats within the
system, the paper seeks to contribute to a deeper understanding of Ethiopia’s financial
landscape and provide actionable recommendations for its improvement.

As Ethiopia continues its journey toward economic modernization, building a resilient

and inclusive financial system is essential. Addressing structural deficiencies,
leveraging technological advancements, and strengthening regulatory frameworks will
be critical in unlocking the system’s full potential. This study serves as a roadmap for
understanding these dynamics and envisioning a future where Ethiopia’s financial
system effectively supports its ambitious development goals.

Abstract

This study examines Ethiopia's financial system, emphasizing its structure, key
institutions, financial markets, and regulatory frameworks. It explores the system's
evolution from a state-dominated model to a more market-oriented framework,
identifying the challenges and opportunities shaping its development. The dominance
of banking institutions, underdeveloped financial markets, limited access to financial
services in rural areas, and macroeconomic instability are highlighted as significant
barriers to progress.

The research underscores recent advancements, such as the establishment of the

Ethiopian Capital Markets Authority, the introduction of digital financial services, and
the strengthening of anti-money laundering and counter-terrorism financing measures.
These developments signal Ethiopia's commitment to fostering financial inclusion,
transparency, and economic growth.

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By analyzing the interplay between the financial sector and the broader economy, the
study provides insights into how targeted reforms, technological innovations, and
improved regulatory oversight can transform Ethiopia's financial system into a
resilient and inclusive platform. The findings emphasize the importance of addressing
structural deficiencies, expanding financial literacy, and stabilizing the
macroeconomic environment to achieve sustainable economic development.

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Acknowledgment

I would like to express my deepest gratitude to my instructor, Dr. Takele Fufa, for his
invaluable guidance, support, and encouragement throughout the preparation of this
study. His profound knowledge, insightful feedback, and constructive suggestions
have been instrumental in shaping the direction and quality of this work.

Dr. Takele's dedication to fostering a deeper understanding of financial systems and

his commitment to academic excellence have inspired me to approach this subject
with curiosity and rigor. I am profoundly grateful for his mentorship and the
opportunity to learn under his expert guidance and I am truly appreciative of the time
and effort he has invested in my academic journey.

I also want to express my gratitude to everyone who has supported me on this

journey ,my classmates who were willing to share ideas and references, the librarians
who helped me identify books, and also the college community as a whole.

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CHAPTER ONE

General Introduction About a Financial System in Ethiopia

Definition and Components of a Financial System

A financial system is a framework that allows the exchange of funds between lenders,
investors, and borrowers.
A financial system is a network of institutions, instruments, markets, and regulatory
frameworks that facilitate the flow of funds within an economy. It plays a crucial role
in mobilizing savings, channeling investments, and enabling efficient resource
allocation.

Key Components of a Financial System:

1. Financial Institutions: Banks, microfinance institutions, and insurance companies.

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2. Financial Markets: Money markets (short-term financial instruments) and capital
markets (long-term investment instruments).
3. Financial Instruments: Loans, bonds, equities, and derivatives.
4. Regulatory Framework: Policies and regulations enforced by central authorities like
the National Bank of Ethiopia (NBE).

Overview of Ethiopia’s Financial System

Ethiopia's financial system is underdeveloped compared to global standards, primarily

dominated by banking institutions. Other sectors, such as capital markets and
insurance, remain nascent. The system is pivotal in supporting the country’s real
economy, which is heavily reliant on agriculture, manufacturing, and services.

Historical Context: Ethiopia’s financial system was primarily state-controlled until

liberalization efforts in the 1990s, which allowed private banks and microfinance
institutions to emerge.
The financial system in Ethiopia consists of various components, including banks,
microfinance institutions, insurance companies, pension funds, capital markets, and
regulatory authorities. The National Bank of Ethiopia (NBE) serves as the country's
central bank and is responsible for regulating and supervising the financial sector,
formulating monetary policy, and ensuring stability in the financial system.
Commercial banks, as well as specialized banks such as development banks, play a
vital role in providing banking services, including deposit-taking, lending, and
financial intermediation. Microfinance institutions contribute to financial inclusion by
offering services to under served segments of the population, particularly in rural
areas. Ethiopia's insurance sector provides risk management solutions and protection
for individuals, businesses, and agricultural activities. Additionally, the country's
capital markets serve as platforms for raising long-term capital through the issuance
of equities and bonds, thereby promoting investment and expansion of businesses.

Current Landscape: The financial system includes 31 commercial banks (as of 2024),
insurance companies, microfinance institutions, and cooperatives. However, its reach
in rural areas is still limited.

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The Financial System and the Real Economy

The financial system in Ethiopia plays a crucial role in the country's economic
development by facilitating the flow of funds from savers to investors and providing
essential financial services to businesses and individuals. The interaction between the
financial system and the real economy in Ethiopia is multifaceted and impacts various
aspects of economic activity. The financial system and the real economy are deeply
interconnected. A well-functioning financial system provides the necessary capital,
credit, and liquidity to fund investments in the real economy. This facilitates the
expansion and modernization of industries, infrastructure development, agricultural
productivity, and the provision of essential services. In turn, a vibrant and growing
real economy generates income and profits, contributing to savings and investments
that flow back into the financial system, creating a cycle of economic activity.
 Access to Capital: The financial system provides access to capital for
businesses and entrepreneurs, enabling them to invest in productive activities,
expand operations, and create employment opportunities. This interaction is
vital for fostering economic growth and development.
 Credit Availability: The availability of credit through banks, microfinance
institutions, and other financial intermediaries influences investment
decisions, consumption patterns, and overall economic activity. A well-
functioning financial system ensures that credit is allocated efficiently to
support productive sectors of the economy.
 Risk Management: Financial institutions in Ethiopia play a critical role in
managing risks associated with lending, investment, and financial transactions.
Effective risk management practices contribute to the stability of the financial
system and support sustainable economic growth.
 Monetary Policy Transmission: The interaction between the financial system
and the real economy is evident in the transmission of monetary policy.
Central bank policies, such as interest rate adjustments and reserve
requirements, influence borrowing costs, inflation, and overall economic
conditions.

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  Financial Inclusion: The expansion of financial services to underserved
populations and rural areas contributes to inclusive economic growth.
Improved access to banking, insurance, and other financial products enhances
household savings, investment opportunities, and resilience to economic
shocks.
 Regulatory Framework: The regulatory environment governing the financial
system influences the behavior of financial institutions and their impact on the
real economy. Sound regulations promote stability, transparency, and
consumer protection while fostering confidence in the financial sector.

Chapter Two

Ethiopian Financial Institutions

Financial institutions form the backbone of any financial system by intermediating

funds between savers and borrowers. In Ethiopia, these institutions are classified into
three main categories: formal, semi-formal, and informal. Additionally, financial
institutions are further categorized into deposit-taking and non-deposit-taking entities
based on their operations. This chapter provides a detailed exploration of these
classifications and their contributions to Ethiopia's economy.

Formal, Semi-Formal, and Informal Financial Institutions

Formal financial institutions

Formal financial institutions are fully regulated entities operating under the
supervision of the National Bank of Ethiopia (NBE). They include commercial banks,
insurance companies, and microfinance institutions (MFIs).

Formal financial institutions in Ethiopia refer to legally established entities that

engage in the provision of credit and mobilization of savings and typically refer to

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regulated entities such as commercial banks, microfinance institutions, insurance
companies, and pension funds. These institutions are licensed and supervised by the
National Bank of Ethiopia (NBE) and other regulatory bodies. They play a crucial
role in mobilizing savings, providing credit facilities, managing risks through
insurance products, and facilitating long-term savings and investments through
pension funds.
These institutions are subject to regulation and control by the National Bank of
Ethiopia (NBE). The formal financial sector in Ethiopia encompasses the NBE,
commercial banks (both privately and publicly owned), Development Bank of
Ethiopia (DBE), credit and savings cooperatives, insurance companies (both public
and private), and microfinance institutions (owned by regional governments, NGOs,
associations, and individuals) (NBE, 2013/14). The entry of foreign entities into the
financial sector is prohibited until domestic banks achieve a certain level of desired
competitiveness and the supervisory and regulatory capacity of the National Bank is
adequately strengthened, as stipulated by proclamation number 84/94(yifredew
bizualem, 2021).
 Commercial banks: Is the cornerstone of the formal financial sector in
Ethiopia. They offer a wide array of financial services, including
deposit accounts, loans, business financing, and international
transactions. The Commercial Bank of Ethiopia and other private
commercial banks operate as key players in the country's financial
landscape, providing services to individuals and businesses.
 Micro-finance institution: in Ethiopia, while diversified in their
deposit-taking capabilities, typically offer small loans, micro-savings,
and other financial services to individuals and small businesses,
especially those in rural and underserved areas. They often prioritize
serving individuals who may have limited access to traditional banking
services.
 Insurance companies provide essential risk management services,
offering life and non-life insurance products to protect individuals and
businesses from financial uncertainties

Semi-formal financial institutions

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Semi-formal financial institutions occupy a unique space in Ethiopia’s financial
system. While they are not directly regulated by the NBE, they operate within
cooperative or regional laws. Savings and Credit Cooperatives (SACCOs) are the
most notable examples of this category. These member-driven organizations promote
savings and provide small loans to their members, typically targeting specific
communities or professional groups. SACCOs play a critical role in fostering
financial inclusion by reaching populations that formal institutions often overlook.

Informal Finance Institutions

In both rural and urban areas in Ethiopia, it is common that neighboring family
households organize themselves and develop their own institutions, popularly known
as Community-Based Organizations (CBOs). The nature of the CBOs highly varies
from social, religious and financial concerns, but are all aimed to address the needs of
the people.
The three most common informal finance or traditional institutions are discussed in
detail in the following subheadings.

1.Iddir
An Iddir is an informal association made up by a group of persons united by ties of
family and friendship, by living in the same district, by jobs, or by belonging to the
same ethnic group. Its main objective is providing mutual aid and financial assistance
in certain circumstances such as a burialrites whereby savings are made to cover the
cost of funerals.
In practice Iddir is a sort of insurance programme run by a community or a group to
meet emergencies. Iddir, unlike the insurance system, is very popular among people
because it isculturally appropriate, flexible, easily accessible and cost-effective.It is
basically a nonprofit making institution based upon solidarity, friendship, and mutual
assistance among members.

2. Iqqubs
An iqqub is a traditional saving and credit association (Rotating Saving and Credit
Association), of which its purpose is basically to pool the savings of their members in
accordance with the rules established by the group. Members usually deposit
contributions on a weekly or monthly basis, and lots are drawn by turns so that the

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one who wins the chance gets the total sum. This process continues on a regular basis
until the last member receives his/her share or what she/he has been saving through
the month sand the whole process starts again.

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

Deposit taking vs Non- deposit taking and their operations

In Ethiopia, the financial sector consists of both deposit-taking and non-deposit taking
financial institutions, each with distinct roles and operations. Both types of financial
institutions are regulated by the National Bank of Ethiopia (NBE), which sets
guidelines and supervises their operations to ensure stability and protect the interests
of customers and the overall financial system. In recent years, Ethiopia has seen
significant efforts to promote financial inclusion and expand access to financial
services for underserved populations. This has led to the growth of both deposit-
taking and non-deposit taking institutions, contributing to the development of a more
inclusive and robust financial sector in the country.
A. Deposit taking Financial institutions and their operations

Deposit-taking institutions, such as commercial banks and microfinance institutions,

are licensed to accept deposits from customers. These deposits form a significant
portion of their funding base, which they then use to provide loans and other financial
services. Commercial banks in Ethiopia play a crucial role in mobilizing savings,
providing credit facilities, facilitating domestic and international transactions, and
offering various financial products such as savings accounts, checking accounts, and
loans.
Deposit-taking financial institutions in Ethiopia refer to institutions that accept
deposits from individuals and entities and provide various financial services. The key

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deposit-taking financial institutions in Ethiopia include commercial banks,
development banks, and microfinance institutions.
1. Commercial Banks:

The Commercial Bank of Ethiopia (CBE): As the largest state-owned commercial

bank in Ethiopia, CBE holds a significant market share of financial assets and credit
to the economy. It plays a crucial role in deposit mobilization and lending activities
Private Banks: Ethiopia has several private commercial banks that operate alongside
CBE. These banks contribute to deposit-taking activities and provide a range of
financial services to individuals and businesses).
2. Development Banks:

Development Bank of Ethiopia (DBE): DBE is a government-owned development

bank that provides long-term financing for priority sectors such as agriculture,
industry, and infrastructure. It also offers deposit-taking services to its clients
3. Microfinance Institutions (MFIs):

MFIs in Ethiopia play a vital role in providing financial services to underserved

populations, particularly in rural areas. They accept deposits from individuals and
provide microcredit, savings, and other financial services tailored to the needs of low-
income individuals and small businesses.

Operations of Deposit-Taking Financial Institutions in Ethiopia:

Deposit Mobilization: These institutions accept deposits from individuals,

businesses, and other entities. Deposits can be in the form of savings accounts, current
accounts, fixed deposits, and other deposit products .
Lending and Credit: Deposit-taking financial institutions in Ethiopia provide loans
and credit facilities to individuals, businesses, and other borrowers. They assess
creditworthiness, disburse loans, and collect repayments .

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Financial Services: These institutions offer a range of financial services, including
foreign exchange services, money transfers, payment services, trade finance, and
other banking services
Regulatory Compliance: Deposit-taking financial institutions in Ethiopia are
regulated and supervised by the National Bank of Ethiopia (NBE). They must comply
with prudential regulations, capital adequacy requirements, and other regulatory
guidelines set by the NBE

B. Non-Depository Financial Institutions

None depository financial institutions generate funds from other sources other than
deposits. But also play a major role in financial intermediation. These institutions
include:

(i) Finance companies/Microfinances

Most finance companies obtain funds from issuing securities then lend the money to
individuals and small businesses. Although the functioning of finance companies
overlaps those of depository institutions, each type of institution concentrates on a
particular segment of the financial market. Many large finance companies are owned
by multinational corporations

(ii) Mutual funds/ Investment trusts

These types of companies sell shares to surplus units and use these funds to buy a
portfolio of securities. The Ethiopian capital market is almost none and such
companies are not very common. Some mutual funds concentrate their investment in
capital market securities, such as stocks or bonds. Others Known as money market
mutual funds concentrate in the money market securities. These are mutual
investment schemes. These pool the small savings of individual investors and enable a
bigger investment fund. Therefore, small investors can benefit from being part of a
larger investment trust. This enables small investors to benefit from smaller
commission rates available to big purchases.
Security Firms
Securities firms use their information sources to act as brokers, executing securities
transactions between two parties. Brokers earn their profits by charging a brokerage
fee by differentiating between bid and asking prices. Securities firms also underwrite

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new issues for government and private companies. Securities firms also act as dealers
in which case they i.e. they can make a market for a specific security by adjusting
their portfolio inventory. Securities firms also provide investment banking services
which include advisory services on mergers and other forms of corporate
restructuring. And also execute the change in the firm’s capital structure by placing
the securities issued by the firm.
(iv) Insurance companies
They provide insurance services to individuals and other firms that reduce the
financial burdens associated with death illness and damage to properties including
theft. Insurance companies charge premiums in exchange of the insurance that they
provide. The funds collected in form of premiums,is invested (mainly in stocks or
bonds issued by companies or bonds issued by the government) by the insurance
companies until the funds are required to pay for the risks insured when it happens.

(v) Pension funds

The working population, know very well that their energy to work is limited. To
guard themselves against the eventuality, employers and employees save for old age
where they contribute periodically. Such funds are available for a long time i.e. until
retirement. The pension funds manage the funds until they are required when the
employee retires. The money saved is normally invested in securities and bonds
issued by corporations and governments. This way they pension savings are used to
finance the deficit units thus acting as intermediaries.

Ethiopia’s financial institutions are diverse in their structure and operations, catering
to a wide array of financial needs. Formal institutions provide a regulated framework
for economic activities, while semi-formal and informal systems fill gaps in rural and
underserved areas. Deposit-taking institutions promote financial inclusion by
mobilizing savings and providing credit, whereas non-deposit-taking entities
contribute to risk management and investment opportunities. Together, these
institutions form a complex yet essential network that supports Ethiopia's economic
development.

Coverage of Financial Services in Ethiopia

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Ethiopia’s financial services sector has seen notable growth over the years, albeit with
persistent challenges in accessibility and inclusivity. The coverage of financial
services varies significantly between urban and rural areas, and between formal and
informal financial systems. Recent innovations, particularly in non-bank financial
services, have begun to address these gaps, introducing diverse financial products and
technologies that cater to a broader population.

Current Coverage of Financial Services

Despite improvements, financial service penetration in Ethiopia remains relatively

low. Access to banking services is concentrated in urban centers, leaving a large
portion of the rural population underserved. According to recent estimates:

1. Urban Coverage: Over 70% of urban households have access to at least one
financial service, primarily through commercial banks and microfinance institutions.

2. Rural Coverage: Financial inclusion in rural areas lags significantly, with less than
35% of the population having access to formal financial services. Rural communities
rely heavily on informal systems like Iqub and Idir.

3. Mobile and Agent Banking: These have begun to bridge the gap, particularly
through initiatives like Telebirr, which enable financial transactions without requiring
traditional bank accounts.

Factors affecting coverage include limited infrastructure, low financial literacy, and
the absence of physical bank branches in remote regions. However, efforts by the
government and private sector are steadily improving the reach of financial services.

Recent Financial Services by Non-Bank Institutions

In recent years, non-bank financial institutions have introduced innovative services to

address gaps in Ethiopia’s financial system. These include fintech-driven digital
payment systems, Islamic financing, and capital lease financing.

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1. Fintech and Digital Payment Systems
Fintech companies are revolutionizing Ethiopia’s financial landscape, especially in
payments and fund transfers.

Telebirr: Launched by EthioTelecom, Telebirr is a mobile money platform that allows

users to deposit, transfer, and withdraw funds using their mobile phones. With
millions of subscribers, Telebirr has significantly enhanced financial inclusion in both
urban and rural areas.

Digital Banking Apps: Banks such as Dashen and Awash have introduced mobile
apps, enabling customers to access banking services remotely.

Agent Banking: Agents act as intermediaries, providing financial services in remote

areas where physical bank branches are unavailable.

2. Islamic Financing
Islamic finance has gained traction in Ethiopia, catering to the needs of the Muslim
population, which constitutes a significant percentage of the country.
Interest-Free Banking: Offered by several banks, including Oromia International
Bank, Islamic banking operates under Sharia-compliant principles, prohibiting
interest-based transactions.
Sukuk Bonds: Although still in its infancy, the issuance of Islamic bonds (Sukuk) is
being explored to attract investments from Muslim-majority regions.

3. Capital Lease Financing

Capital lease financing provides businesses with the ability to acquire machinery and
equipment without upfront payments.
Growth in Leasing Companies: Institutions like Ethio Lease offer leasing solutions,
enabling businesses in agriculture, construction, and manufacturing to expand
operations without requiring significant capital investment.
Impact: This has been instrumental in boosting productivity, especially for small and
medium-sized enterprises (SMEs).

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The coverage of financial services in Ethiopia is improving, driven by the
introduction of innovative non-bank financial services. While traditional banks
continue to dominate the financial sector, fintech solutions, Islamic financing, and
leasing services are addressing the needs of previously underserved populations.

These advancements signal a positive shift toward greater financial inclusion and a
more dynamic financial ecosystem.

CHAPTER THREE

Ethiopian Financial Markets

Ethiopian financial markets are an essential component of the country's economic

system, serving as a mechanism for mobilizing and allocating financial resources.
However, these markets are still in the early stages of development, with a heavy
reliance on banking institutions for financing. This chapter explores the structure of
Ethiopian financial markets, delves into money and capital markets, examines foreign
markets, evaluates the role of government borrowing, and highlights recent
developments, including the establishment of the Ethiopian Capital Market.

Structure of the Ethiopian Financial Market

The financial market in Ethiopia is relatively underdeveloped and primarily bank-

centered. Unlike mature economies, Ethiopia lacks a well-functioning capital market,
which restricts the availability of long-term financing instruments such as stocks and
bonds.
Components/Types/ of Financial Market
Types of financial markets can be classified based on market level or security types.
Based on market levels, financial markets cab be classified as:
Primary market and Secondary market
1. Primary is a market for new issues or new financial claims. Simply put, primary
market is the market where the newly started company issued shares to the public for

17
the first time through IPO (initial public offering).The transactions in primary markets
exist between issuers and investors, while secondary market transactions exist among
investors.
2. Secondary market: It’s a market for secondary sale of securities. In other words,
securities which have already passed through the new issue market are traded in this
market. Generally, such securities are quoted in the stock exchange and it provides a
continuous and regular market. Secondary market is the market where the second
hand securities are sold. Liquidity is a crucial aspect of securities that are traded in
secondary markets.
Liquidity refers to the ease with which a security can be sold without a loss of value.
Securities with an active secondary market mean that there are many buyers and
sellers at a given point in time. Investors benefit from liquid securities because they
can sell their assets whenever they want; an illiquid security may force the seller to
get rid of their asset at a large discount.
Based on security types, financial markets are classified as Money market and
Capital market
3.2.1Money Market
Money market is a market for dealing with financial assets and securities which have
a maturity period of up to one year. In other words, it’s a market for purely short term
funds.
Some of money market includes the following.
Bills of exchange-are negotiable instruments incorporating an unconditional order in
writing,requiring the person to whom it is addressed to pay a certain sum in money to
or to the order of a specified person. Bills of exchange, therefore, involve an order to
pay money rather than a promise to pay money. The person issuing the order is the
drawer, the person ordered to pay is the drawee and the person who receives the
payment is the payee. 
A promissory note- is a document incorporating an unconditional promise in writing
made by one person to another signed by the maker to pay sum certain in money.
This, definition implies that promissory notes are promise to pay money and they are
only two parties i.e., the maker of the promise and the payee to whom payment is
effected.
Check-is the most widely used form of commercial instrument. It is bill of exchange
drawn on a bank and payable on demand. The check is an unconditional order in

18
writing, signed by the drawer, requiring the bank to pay, on demand, a sum certain in
money to or to the order of specified person or to bearer. 
A certificate of deposit- is a form of commercial instrument issued by a bank. It is an
instrument containing an acknowledgement (credit) by a bank that it has received a
sum of money on deposit and a promise to repay the sum of money. When a person
deposits money in a bank he will be given the document showing the deposit of
money which could be withdrawn by the depositor or the holder of the certificate. 
Commercial bills (commercial papers) -Commercial paper refers to unsecured
short-term promissory notes issued by financial and non financial corporations. It is
typically issued by large, credit-worthy corporations with unused lines of bank credit
and therefore carries low default risk.Unlike some other types of money-market
instruments, in which banks act as intermediaries between buyers and sellers,
commercial paper is issued directly by well-established companies,as well as by
financial institutions. Banks may act as agents in the transaction, but they assume no
principal position and are in no way obligated with respect to repayment of the
commercial paper.
Bankers' Acceptances-is an instruments produced by a nonfinancial corporation but
in the name of a bank. It is document indicating that such-and-such bank shall pay the
face amount of the instrument at some future time. The bank accepts this instrument,
in effect acting as aguarantor. To be sure the bank does so because it considers the
writer to be credit-worthy.Bankers' acceptances are generally used to finance foreign
trade, although they also arise when companies purchase goods on credit or need to
finance inventory. 
Treasury bills (T-bills) - are government bills are short-term notes issued by the
government.
Features/characteristics/ of Money Market
The following are the general features of a money market:
1. It is market purely for short-term funds or financial assets called near money.
2. It deals with financial assets having a maturity period up to one year only.
3. It deals with only those assets which can be converted into cash readily without loss
and with minimum transaction cost.
4. Generally, transactions take place through phone i.e., oral communication. Relevant

19
documents and written communications can be exchanged subsequently. There is no
formal place like stock exchange as in the case of a capital market.
5.Transactions have to be conducted without the help of brokers.
6. The components of a money market are the Central Bank, Commercial Banks,
Non-banking financial companies, discount houses and acceptance house.
Commercial banks generally play a dominant in this market.
Particular Objectives/Purposes/ of Money Market
The following are the important objectives of a money market:
a. To provide a parking place to employ short-term surplus funds.
b. To provide room for overcoming short-term deficits.
c. To enable the Central Bank to influence and regulate liquidity in the economy
through its intervention in this market.
d. To provide a reasonable access to users of Short-term funds to meet their
requirements quickly, adequately and at reasonable costs

3.2.2.Capital market:
A capital market is a market for financial assets which have a long or indefinite
maturity. Generally ,it deals with long term securities which have a maturity period of
above one year. Capital market in turn consists of:
Stock markets , which provide financing through the issuance of shares or common
stock, and enable the subsequent trading thereof.
Equity markets: A market where ownership of securities are issued and subscribed is
known as equity market.
Bond markets , which provide financing through the issuance of bonds, and enable
the subsequent trading.
Debt market: The market where funds are borrowed and lent is known as debt
market Arrangements are made in such a way that the borrowers agree to pay the
lender the original amount of the loan plus some specified amount of interest.

Challenges and opportunities

Despite recent advancements, Ethiopia's money and capital markets confront

obstacles such as restricted product offerings, insufficient liquidity, and the need for
more regulatory reforms to boost investor confidence.

20
However, there are chances for expansion, such as the possibility of broadening the
variety of financial products, growing involvement from local and foreign investors,
and strengthening market infrastructure to facilitate more efficient trading and
settlement procedures. the money market and capital market in Ethiopia are essential
components of the country's financial system, providing avenues for short-term
financing, long-term investment, and capital formation. As Ethiopia continues to
implement financial sector reforms and strengthen its regulatory framework, the
money market and capital market are expected to play an increasingly significant role
in supporting economic development and promoting investment opportunities.
Benefits of financial market in Ethiopia

 Promotes private sector development

Public investments vastly exceed private investments in developing economies
amongst which the Government of Ethiopia is one of the front liners in public
investment and the last in terms of private investment Financial markets provide for
access to and easy movement of financial resources which fundamentally influences
the prospects for private sector growth in developing country economies. Existence of
financial markets enhances the extent that existing firms can borrow and grow, the
ability of emerging firms to act entrepreneurially, their willingness to invest in assets,
and the ability to allocate their assets freely.

 Liquidityfunction
financial markets enable security holders to easily convert their investment in
securities into cash at the prevailing market price. Increased number of players,
number and amount of financial transactions, generates liquidity and promotes
active trading. Liquidity has a proven relationship with economic growth; studies
have found that countries with liquid markets experience faster rates of capital
accumulation and greater productivity gains.
 Helps mobilize local savings and makes resources available for local decision
making
The system of financial markets provides a conduit for more public’s savings.
Bonds, stocks, and other financial claims sold in the money and capital markets
provide a profitable, relatively low-risk outlet for the public’s savings. An

21
 increase in domestic investor interest originates from
the availability of profitable options for saving within the local economy.
 Enhances competition among financial institutions/banks and develops a
greater diversity of financialinstitutions
Studies show that the competition among financial institutions/banks is weak in
the Sub-Saharan Africa as it is reflected in the large gap between deposit rates for
savers(which tend to be very low) and interest rates for borrowers (which tend to
be very high). Establishing financial markets cultivates channels for firms to issue
various debt instruments and raise equity, while simultaneously providing more
long-term options for saving and asset management for investors that will benefit
enlarging economies by increasing market efficiency. Therefore, financial markets
are presumed to stimulate competition and speed up economic growth.
The nature of foreign markets in Ethiopia.
The foreign markets in Ethiopia present a mix of opportunities and challenges for
businesses looking to invest and trade in the country. Ethiopia, with its large
population, strategic location, and growing economy, offers a promising market for
foreign companies. However, navigating the regulatory environment, infrastructure
limitations, and socio-political dynamics requires a nuanced understanding of the
local context.
One of the key aspects of foreign markets in Ethiopia is the abundance of investment
opportunities. The country has been actively seeking foreign direct investment (FDI)
and has identified various sectors such as agriculture, manufacturing, infrastructure,
energy, and services as priority areas for investment. The government has
implemented policies to attract FDI, including offering incentives and establishing
industrial parks and special economic zones to facilitate business operations.
Additionally, Ethiopia's membership in regional trade blocs such as COMESA and
ACFTA provides access to a large market for Ethiopian goods and services, making it
an attractive destination for foreign businesses.
However, the regulatory environment in Ethiopia presents challenges for foreign
companies. Bureaucracy, regulatory complexity, and inconsistencies in policy
implementation can create hurdles for businesses. Issues related to land ownership,
foreign exchange controls, and import/export regulations may require careful
navigation. Furthermore, while Ethiopia's infrastructure is gradually improving, there
are still gaps in transportation networks and energy supply that can pose challenges

22
for foreign businesses in terms of logistics, connectivity, and access to reliable
utilities.

Despite these challenges, the market potential in Ethiopia is significant. With a

population of over 110 million people, Ethiopia represents a substantial consumer
market. The country's growing middle class and urbanization trends offer
opportunities for consumer-oriented industries. However, businesses must also
consider the impact of political and social factors on the market. Ethiopia's evolving
political landscape and cultural dynamics can influence the stability and predictability
of the business environment, as well as consumer behavior and market dynamics.
In general foreign markets in Ethiopia offer substantial potential for investors and
businesses, but they also require careful consideration of the local context, regulatory
environment, and market dynamics.
As the country continues to develop and open up to foreign investment, businesses
that approach the market with a strategic understanding of these factors can position
themselves for long-term success in Ethiopia
Government borrowing and the financial market
In Ethiopia, government borrowing consists of the issue of treasury bills and bonds to
finance budget shortfalls and economic initiatives. The National Bank of Ethiopia
(NBE) operates as the government's fiscal agent and holds auctions to sell these
assets. The Ethiopian financial market is governed by the NBE and the Ethiopian
Securities Exchange (ESE), which permits trading of government securities and
corporate bonds. Government borrowing is critical in Ethiopia for funding economic
initiatives and meeting budgetary obligations. To obtain revenue for budgetary
obligations and infrastructure development, the government sells securities such as
Treasury bills and bonds to institutional and individual investors both locally and, in
certain circumstances, abroad. The cash obtained through government borrowing is
critical in financing public investment projects, encouraging economic growth, and
assisting in the implementation of government policies and programs.
 Ethiopian government borrowing and the financial market are critical to the
country's budgetary operations and economic growth. Government borrowing
is a tool used by the Ethiopian government to raise cash for critical initiatives
such as infrastructure development, social programs, and public investment

23
 projects. In contrast, the financial market serves as a channel for this money to
be generated and handled.
 The interaction between government borrowing and the financial market is
symbiotic in nature. As the government issues securities and borrows cash
from the financial market, it feeds the financial market with government-
backed investment alternatives. In consequence, the market provides a
platform for the government to acquire cash while also providing a route for
investors to trade, boosting liquidity and depth within the financial system.
 This connection entails a cycle of involvement in which the government's
borrowing actions affect financial market dynamics, altering interest rates,
liquidity circumstances, and the general market environment. At the same
time, the financial market's reaction to government borrowing, which is
influenced by investor demand and market sentiment, is critical in influencing
the cost and availability of government funding. As a result, a harmonious
connection between government borrowing and the financial market is critical
for resource mobilization, effective public debt management, and economic
development in Ethiopia.

Ethiopian financial markets, while still developing, are critical for the country’s
economic progress. The dominance of money markets and the absence of a formal
capital market have constrained growth opportunities. However, recent efforts,
including the establishment of a capital market, signify a turning point. These
initiatives, coupled with reforms in foreign exchange and government borrowing, are
expected to create a more dynamic and inclusive financial ecosystem. As Ethiopia
navigates these changes, the focus must remain on building robust regulatory
frameworks, enhancing market infrastructure, and promoting financial literacy to
ensure long-term success.

Emergence of Ethiopian Financial Market

Capital Market
A capital market is a market for financial assets which have a long or indefinite
maturity. Generally, it deals with long term securities which have a maturity period of
above one year.
The establishment of the Ethiopian Capital Market has been a significant milestone in

24
the country's economic development. The idea to establish a capital market was first
introduced in the early 2000s as part of the government's plan to modernize the
financial sector and attract foreign investment. After years of careful planning and
preparation, the Ethiopian Capital Market Authority was established in 2008 to
oversee the market operations and regulate its activities.

One of the main objectives of the Ethiopian capital market is to provide a platform for
businesses to raise capital and access long-term financing. Prior to the establishment
of the capital market, most businesses in Ethiopia relied heavily on bank loans for
funding, limiting their growth potential. The capital market has opened up new
opportunities for businesses to raise funds through initial public offerings (IPOs) and
corporate bond issuances, enabling them to expand their operations and invest in new
projects.
The Ethiopian capital market has also played a crucial role in mobilizing domestic
savings and increasing financial inclusion. By providing individuals with the
opportunity to invest in stocks and bonds, the capital market has encouraged a culture
of savings and investment in the country. Additionally, the market has provided
access to financial instruments for small investors and individuals who were
previously excluded from the formal financial sector. This has not only increased the
participation of individuals in the economy but has also contributed to the overall
development of the financial sector in Ethiopia.
Some of the capital markets traded in Ethiopia are: Stock markets/shares, Bonds,
Debentures, Equity
Stock market refers to capital market in which stocks (shares) of corporations are
sold to investors. In simple terms, it is a market place where equity interests are
exchanged either at par value, premium value or for less than the par value – also
called discount stock. Thus stock market allows stockholders (shareholders) to
transfer to another investor when they want to sell their stocks.
Primary Stock Market: It should be noted that stocks could be sold and bought in
primary capital market. In primary markets, new business can start by obtaining funds
directly from households in which new stocks are sold to investors via the through
Initial Public Offering (IPO).In Ethiopian context, there are primary markets for
stocks/shares. Any share company is legally allowed to issue stocks to subscribers to
raise funds.

25
Secondary Stock/Share/ Market: in the secondary market, existing stocks are sold and
bought among investors or traders in the stock market through stock exchange.
Furthermore, secondary market could be either auction market or dealer market.
The difference between stock market and OTC is that the former exchange market
operates in a structured manner and physical facility with a trading floor to which all
stock transactions are supposed to be directed. However, OTC market traditionally
operates in unstructured manner without any physical facility in which any qualified
firm freely engages in the transactions of stocks.

CHAPTER FOUR
Financial Assets in Ethiopia

Financial assets play a vital role in the economic development of any country, serving
as instruments for savings, investment, and economic activity. In Ethiopia, the
financial assets market is relatively underdeveloped but growing steadily. This
chapter focuses on the types of financial assets currently traded in Ethiopia, the
methods used to value these assets, and the interest rate theories and structure in the
Ethiopian context.

Types of Financial Assets (Securities) Currently Traded in Ethiopia

In Ethiopia, the financial assets market is heavily dominated by banking institutions

and government securities. The types of financial assets traded include:

1. Treasury Bills
These are short-term government debt instruments issued to finance budget deficits.
They are auctioned by the National Bank of Ethiopia (NBE) weekly.
Primarily purchased by banks and other financial institutions due to their low-risk
nature.

26
2. Government Bonds

Ethiopian government bonds are fixed-income instruments that allow the government
to borrow cash from investors. These bonds provide consistent interest payments over
a certain time period, making them a generally safe investment option. Government
bond investors receive monthly interest payments as well as a return on their initial
investment when the bonds mature. Government bonds are important in the financial
market because they provide investors with a reliable source of income while also
allowing the government to acquire funds for various development programs

3. Corporate Bonds

Corporations issue corporate bonds to raise capital. These bonds provide investors
with monthly interest payments as well as principle repayment at maturity. Corporate
bond investors act as lenders to the issuing company, thereby contributing to its
capital structure. Corporate bond trading allows investors to diversify their fixed-
income holdings while also participating in the credit risk and long-term prospects of
different corporate entities.

4. Microfinance and Cooperative Savings Products

Financial products offered by microfinance institutions (MFIs) and cooperatives,

targeted toward rural and underserved communities.
These include loans and savings accounts rather than formal tradable securities.

5. Foreign Exchange Instruments

Foreign currency trading is tightly regulated by the National Bank of Ethiopia.

Exporters and importers participate in foreign exchange transactions under strict
guidelines.

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Valuation Approaches for Financial Assets

There are several approaches to valuing financial assets, and the appropriate method
depends on the specific asset being valued. Here are some common approaches:

1. Market value: This approach uses the current market price of the financial asset as
its value. Market value is often used for assets that are actively traded in a liquid
market, such as publicly traded stocks and bonds.
2. Net asset value (NAV): This approach is commonly used for mutual funds and
other pooled investment vehicles. NAV is calculated by subtracting the fund's
liabilities from the value of its assets and dividing it by the number of shares
outstanding.
3. Discounted cash flow (DCF): This approach values an asset based on the present
value of its expected future cash flows. DCF analysis is commonly used for valuing
fixed income securities such as bonds, as well as for valuing companies in a business
valuation context.
4. Comparable company analysis: This approach involves comparing the financial
asset to similar assets that have recently been sold or are currently trading in the
market. Valuations are derived by applying a multiple or ratio derived from the
comparable transactions to the financial asset being valued.
5. Option pricing models: These models are used to value financial assets with
option-like features, such as stock options or convertible bonds. Option pricing
models, such as the Black-Scholes model, take into account factors such as the
underlying asset's price, time to expiration, volatility, and interest rates.
6. Cost approach: This approach values financial assets based on the cost it would
take to replace or reproduce the asset. This method is often used for valuing tangible
assets or assets with significant tangible components, such as real estate or machinery.

Interest Rate Theories and Structure in the Ethiopian Context

The Classical Theory of Interest Rates in Ethiopia
The classical theory of interest rates is founded on the notion that the interest rate is
determined by the supply and demand for loanable funds. In the Ethiopian context,

28
the supply of loanable funds is determined by the savings of households and
businesses, while the demand for loanable funds is determined by the investment
plans of businesses and the government. The supply of loanable funds in Ethiopia is
relatively deficient due to various factors, including low levels of income. This
implies that households have limited residual income after covering basic needs,
leaving little room for saving.
Additionally, high levels of inflation in recent years have diminished the value of
savings, discouraging individuals from saving money. Moreover, the lack of access to
formal financial services, such as banks and credit unions, presents a significant
obstacle to saving money for many Ethiopians. On the other hand, the demand for
loanable funds in Ethiopia is relatively high due to several factors.
Notably, Ethiopia is currently experiencing a period of rapid economic growth,
leading to an increased demand for investment. Furthermore, the government of
Ethiopia plays a significant role in borrowing funds, which further intensifies the
demand for loanable funds.
As a consequence of the combination of a low supply of loanable funds and a high
demand, interest rates in Ethiopia have reached elevated levels. This circumstance has
impeded businesses from obtaining loans for investment purposes, ultimately
hampering economic growth. In response to this situation, the government of Ethiopia
has implemented various measures aimed at reducing interest rates. These measures
include augmenting the supply of loanable funds through issuing bonds and
borrowing from international organizations

The Liquidity Preference Theory of Interest Rates in Ethiopia

The Liquidity Preference Theory of Interest Rates in Ethiopia is based on the idea that
the determination of the interest rate depends on the balance between individuals'
inclination to hold money in liquid form and their desire to earn interest on their
funds. In the specific context of Ethiopia, there is a relatively high demand for money
due to several factors.
Firstly, inflation levels in the Ethiopian economy have been consistently high,
leading to a decrease in the value of money. As a result, individuals have chosen to
hold a larger portion of their wealth in liquid form to protect its value. Secondly, a
significant portion of the Ethiopian population lacks access to formal financial

29
services like banks and credit unions. This limited accessibility prevents them from
earning interest on their funds, further increasing the demand for money.
Additionally, the supply of money in Ethiopia is relatively constrained due to various
factors. Firstly, the level of economic activity in Ethiopia is relatively low, resulting in
a reduced circulation of money. Secondly, the Ethiopian government has implemented
policies that restrict the supply of money, such as imposing strict reserve requirements
on banks. The combination of high demand for money and limited supply has led to
high interest rates in Ethiopia. Consequently, businesses face significant challenges in
obtaining loans for investment purposes, which hinders economic growth.
To address this issue, the Ethiopian government has implemented several measures to
reduce interest rates. Firstly, they have increased the supply of money by issuing
bonds and obtaining loans from international organizations. Secondly, they have tried
to decrease the demand for money by reducing their own borrowing practices and
encouraging banks to provide more credit to businesses.

The Loanable Funds Theory of Interest Rates in Ethiopia

Theory, posits that the interplay between the supply and demand for loanable funds
determines the interest rate. In Ethiopia, the supply of loanable funds is relatively
limited due to various factors. These include a low savings rate attributed to factors
such as low income levels and high inflation rates. Additionally, high levels of
investment in the country, coupled with the Ethiopian government's significant role as
a borrower of funds, further diminish the supply of loanable funds. Conversely, the
demand for loanable funds in Ethiopia is considerably high, driven by factors such as
the rapid economic growth and government borrowing. This combination of limited
supply and high demand has resulted in elevated interest rates in Ethiopia, posing
challenges for businesses seeking loans for investment and leading to a deceleration in
economic growth. To address this issue, the Ethiopian government has implemented
measures aimed at reducing interest rates. These include increasing the supply of
loanable funds through issuing bonds and borrowing from international organizations,
as well as reducing the demand for loanable funds by curbing its own borrowing and
encouraging banks to extend more loans to businesses. While these measures have
contributed to a reduction in interest rates, they still remain relatively high compared
to international standards.
The Rational Expectations Theory of Interest Rates in Ethiopia

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The Rational Expectations Theory of Interest Rates in Ethiopia is grounded in the
notion that the interest rate is established by the anticipations of market participants
regarding forthcoming economic circumstances. In the context of Ethiopia, the
Rational Expectations Theory of Interest Rates posits that the interest rate is
determined by the expectations of market participants regarding future inflation,
economic growth, and government policy.

Market participants' expectations concerning future inflation are a pivotal determinant

in establishing the interest rate. Should market participants anticipate a surge in
inflation, they will require a higher interest rate to offset the projected diminution in
purchasing power. Conversely, if market participants expect a decline in inflation in
the future, they will be amenable to a lower interest rate. The expectations of market
participants regarding future economic growth also play a critical role in establishing
the interest rate.
If market participants anticipate an upswing in economic growth in the future, they
will demand a higher interest rate to compensate for the expected rise in demand for
loanable funds. Conversely, if market participants anticipate a decline in economic
growth in the future, they will be willing to accept a lower interest rate. Furthermore,
the expectations of market participants regarding future government policy are also a
pivotal determinant in establishing the interest rate. If market participants anticipate
that the government will implement policies that augment the supply of loanable
funds, such as increasing the money supply or reducing government borrowing, they
will demand a lower interest rate.
Conversely, if market participants anticipate that the government will implement
policies that reduce the supply of loanable funds, such as decreasing the money
supply or increasing government borrowing, they will demand a higher interest rate.
In Ethiopia, the Rational Expectations Theory of Interest Rates suggests that the
interest rate is determined by the expectations of market participants regarding future
inflation, economic growth, and government policy. These expectations are predicated
on a multitude of factors, including past economic data, current economic conditions,
and the government's economic policies

31
The Ethiopian financial assets market is nascent but evolving. While treasury bills and
government bonds dominate the market, the absence of a fully developed capital
market limits the availability of diverse financial instruments. Valuation approaches
are basic, reflecting the early stage of market development. Interest rates remain a
significant area of focus, as they impact financial inclusion and economic growth.
Addressing these challenges through regulatory reforms and infrastructure
development will be critical for creating a vibrant financial market in Ethiopia.

CHAPTER FIVE
Regulations of the Financial System in Ethiopia

The regulatory framework of Ethiopia’s financial system plays a crucial role in

maintaining financial stability, ensuring fair practices, and fostering economic
development. The chapter delves into the roles of regulatory bodies, the conduct of
monetary policy, financial regulations, and recent measures such as combating money
laundering and terrorism financing.

Ethiopian financial system regulations

Several main authorities manage the Ethiopian financial system's regulatory structure,
which is entrusted with preserving the financial ecosystem's stability, integrity, and
fairness. The National Bank of Ethiopia (NBE) is the principal conductor of monetary
policy, responsible for regulating the quantity of money and establishing interest
rates.
I. National bank of Ethiopia (NBE): The National Bank of Ethiopia is the
country's central bank and the major supervisor of its financial sector. It

32
 supervises and regulates the banking system, formulates monetary policy,
issues currency, and manages the country's foreign exchange reserves.
II. Insurance regulatory authority: This regulatory organization monitors the
insurance industry, ensuring that businesses follow rules, safeguarding
policyholders' interests, and encouraging the insurance industry's stability and
development.
III. Ethiopian Securities and Exchange Commission (ESEC ): The ESEC is in
charge of overseeing the securities market and guaranteeing fair and
transparent trading procedures. It regulates the issuing and trading of
securities, such as stocks and bonds, with the goal of protecting investor
interests.
IV. Ministry of finance (MOF): is responsible for developing fiscal policy,
administering government finances, and supervising public financial
management. It collaborates closely with the NBE in order to coordinate
monetary and fiscal policy.

2. Conduct of Monetary Policy

The NBE implements monetary policy to achieve price stability, support economic
growth, and control inflation. Key tools include:
Open Market Operations: Issuance of treasury bills to manage liquidity in the banking
system.
Reserve Requirements: Mandating banks to hold a portion of deposits as reserves.
Interest Rate Policy: Setting minimum deposit and lending rates to influence savings
and investment.
Foreign Exchange Management: Regulating currency exchange to stabilize the
Ethiopian Birr.

Financial Institutions Regulations

33
Financial institutions in Ethiopia are subject to strict regulations imposed by the
National Bank of Ethiopia (NBE). These regulations are designed to ensure the
stability and soundness of the Ethiopian financial system, protect the interests of
depositors and investors, and promote transparency and integrity in the operations of
financial institutions. One key regulation is the requirement for financial institutions
to maintain a minimum capital adequacy ratio, which ensures that they have enough
capital to absorb potential losses and maintain the confidence of depositors and
investors. Another regulation is the licensing requirement, which means that financial
institutions must obtain approval from the NBE before they can operate in the
Ethiopian financial system. This helps to ensure that only reputable and well-
capitalized institutions are allowed to participate in the system, reducing the risk of
fraud or failure. Overall, these regulations play a crucial role in safeguarding the
stability and reputation of the Ethiopian financial system.

In addition to capital requirements and licensing, there are also regulations governing
the conduct of financial institutions in Ethiopia. These regulations encompass areas
such as anti-money laundering and counter-terrorist financing measures, consumer
protection, and corporate governance. Financial institutions must comply with these
regulations to prevent illicit financial activities, protect consumers from unfair
practices, and ensure proper management and accountability within the institutions.
The NBE conducts regular inspections and audits to monitor compliance with these
regulations and takes appropriate enforcement actions against institutions that fail to
meet the required standards. By imposing these regulations, the Ethiopian financial
system aims to foster trust and confidence among its participants, promote financial
inclusion, and contribute to the overall economic development of the country

Financial markets regulations

 The primary regulatory body overseeing the financial markets in Ethiopia is
the National Bank of Ethiopia (NBE). It acts as the central bank and is
responsible for regulating and supervising the country's financial sector. The
NBE formulates and implements monetary policy, issues licenses and
directives for financial institutions, and oversees the stability and soundness of
the financial system.

34
 The Financial Markets Proclamation outlines the legal framework for the
regulation and supervision of financial markets in Ethiopia. It covers a wide
range of areas including the establishment, operation, and regulation of
financial institutions, securities markets, and financial market infrastructures.
The Proclamation also sets out the powers and responsibilities of regulatory
authorities such as the National Bank of Ethiopia and the Ethiopian Securities
Exchange.
 In addition to the overarching Proclamation, there are also specific directives
issued by regulatory authorities that provide detailed guidelines and rules for
various aspects of financial markets. These directives address specific areas
such as licensing and prudential requirements for financial institutions,
disclosure and reporting standards for listed companies, rules for trading and
settlement in securities markets, and investor protection measures.
 5.5.Financial assets regulations
 In the Ethiopian financial system, financial assets regulations serve as a
cornerstone for ensuring the integrity, safety, and reliability of investment
instruments and services. These regulations are designed to govern the
issuance, trading, and management of financial assets, including equities,
bonds, money market instruments, and other capital market products. The
Ethiopian Securities Exchange Commission (ESEC) plays a pivotal role in
overseeing the regulations and standards that guide the issuance and trading of
financial assets, promoting transparency, investor protection, and market
integrity. The regulatory framework addresses areas such as disclosure
requirements, investor education, market transparency, and the prevention of
fraudulent practices, all aimed at fostering a fair and efficient market
environment for the issuance and trading of financial assets.

 Additionally, the regulations governing financial assets in Ethiopia seek to

enhance corporate governance, financial reporting standards, and market
conduct, thereby bolstering investor confidence and fostering the development
of a dynamic and inclusive financial market. The regulatory framework
mandates compliance with ethical practices, risk management standards, and
investor communication requirements, creating a structured environment that
supports responsible investment practices and sustainable market growth.

35
Risk management provisions in Ethiopian financial Institutions.
Risk management provisions in the financial institutions of Ethiopia play a vital role
in ensuring the stability and sustainability of the banking sector. These provisions aid
banks in identifying, evaluating, and mitigating various risks, including credit risk,
liquidity risk, operational risk, market risk, foreign exchange risk, and interest rate
risk. The implementation of effective risk management practices is crucial for
preserving the financial well-being of banks and safeguarding the interests of
depositors and stakeholders.

1. Management of Credit Risk: Credit risk poses a significant challenge to financial

institutions, including banks, in Ethiopia. It pertains to the likelihood of borrowers
failing to fulfill their repayment obligations. To effectively manage credit risk,
Ethiopian banks employ several measures, including:
 Assessment of Credit Risk: Banks evaluate the creditworthiness of borrowers
by analyzing their financial position, repayment capacity, collateral, and other
pertinent factors.
 Diversification of Loan Portfolio: Banks diversify their loan portfolios to
mitigate concentration risk. Through lending to a diverse range of borrowers
and sectors, banks can reduce the impact of defaults on their overall portfolio.
 Monitoring of Credit Risk: Banks continuously monitor the creditworthiness
of borrowers and the performance of their loan portfolios. This enables the
early detection of potential defaults and facilitates timely intervention.
 Provisioning: Banks set aside provisions to cover potential losses arising from
non-performing loans (NPLs). Adequate provisioning ensures that banks
possess sufficient reserves to absorb credit losses and maintain their financial
stability.
e. Adoption of Risk-Based Pricing: Ethiopian banks may adopt risk-based pricing
strategies, wherein the interest rates charged to borrowers are determined based on
their credit risk profile. This approach aligns the cost of credit with the level of risk
associated with each borrower.

36
2. Management of Liquidity Risk: Liquidity risk entails the possibility of a bank
being unable to meet its short-term obligations. Ethiopian financial institutions
employ the following measures to manage liquidity risk:
 Assessment of Liquidity Risk: Banks assess their liquidity requirements and
establish suitable frameworks for managing liquidity risk. This includes
monitoring cash flows, maintaining adequate liquid assets, and conducting stress
tests to evaluate liquidity positions under different scenarios.
 Contingency Funding Plan: Banks develop contingency funding plans to
ensure access to sufficient funds during periods of liquidity stress. These plans
outline strategies for obtaining additional funding, such as borrowing from other
banks or utilizing central bank facilities.
 Monitoring of Liquidity Risk: Banks closely monitor their liquidity positions
and regularly review their sources of funding. This enables the identification of
potential liquidity shortfalls and facilitates proactive management of liquidity
risks.
3. Management of Operational Risk: Operational risk refers to the possibility of
losses arising from inadequate or failed internal processes, personnel, systems, or
external events. Ethiopian financial institutions address operational risk through the
following measures:
 Identification and Assessment of Risk: Banks identify and evaluate
operational risks by conducting risk assessments, internal audits, and
implementing robust control mechanisms.
 Implementation of Risk Mitigation Measures: Banks adopt measures to
mitigate operational risks, including the implementation of strong internal
controls, segregation of duties, regular staff training, and the adoption of
robust IT systems and cybersecurity measures

Legal & Juridical System, Institutional Framework, Proclamations, Regulations,

and Directives

1. Legal Framework
The Ethiopian legal system supports financial market operations through
proclamations and directives.

37
The Ethiopian Capital Markets Proclamation (2021) is a significant step toward
establishing a regulated securities market.

2. Institutional Framework
Collaborative efforts among the NBE, MoF, ECMA, and FIC form the backbone of
financial regulation.

3. Proclamations and Directives

Banking Business Proclamation regulates banking activities.
Insurance Business Proclamation governs the insurance sector.
Directives on anti-money laundering and know-your-customer (KYC) procedures
enhance financial integrity.

Recent developments like the fight against money laundering and the
financing of terrorism in Ethiopia
Ethiopia has made considerable strides in recent years in strengthening its efforts to
combat money laundering and the financing of terrorism. The country's commitment
to bolstering its anti-money laundering (AML) and countering the financing of
terrorism (CFT) measures is evident through the enactment of regulatory and legal
frameworks, enhancements in enforcement and supervisory capacities, and active
collaborations with international organizations and partners to combat illicit financial
activities.
One development includes the issuance of the "Anti-Money Laundering and Counter-
Terrorism Financing Directive" by the National Bank of Ethiopia (NBE), which
provides a comprehensive guideline for financial institutions to strengthen their
AML/CFT policies, procedures, and controls. This directive outlines requirements for
customer due diligence, transaction monitoring, reporting of suspicious activities, and
coordination with law enforcement agencies, thereby promoting compliance with
international AML/CFT standards.
Moreover, the establishment of the Financial Intelligence Center (FIC) of Ethiopia has
been a significant milestone in the country's efforts to combat money laundering and
terrorist financing. The FIC acts as the central authority responsible for receiving,
analyzing, and disseminating financial intelligence related to suspected illicit financial

38
activities, providing critical support to law enforcement, regulatory authorities, and
NBE, and enhancing the effectiveness of AML/CFT efforts in Ethiopia.
Ethiopia's engagement with international bodies, such as the Eastern and Southern
Africa Anti-Money Laundering Group (ESAAMLG) and the United Nations Office
on Drugs and Crime (UNODC), has also contributed to the country's recent
developments in AML/CFT. Through its cooperation with these organizations,
Ethiopia has benefited from technical assistance, capacity-building programs, and
peer reviews to strengthen its AML/CFT framework, foster international cooperation,
and align its practices with global AML/CFT standards.

The Ethiopian financial system is governed by a robust regulatory framework, with

the National Bank of Ethiopia playing a central role. Regulations for financial
institutions, markets, and assets aim to ensure stability, transparency, and growth.
Recent initiatives, such as combating money laundering and terrorism financing,
demonstrate Ethiopia’s commitment to aligning with international standards.
However, challenges such as limited market development and enforcement capacity
remain. Strengthening the regulatory environment will be critical for fostering a
resilient financial system.

39
 CHAPTER SIX
Major Findings, Reflections, Conclusions, and Recommendations

The Ethiopian financial system is evolving, transitioning from a predominantly state-

controlled setup to a more market-oriented structure. Based on the assessments in
earlier chapters, this section highlights the major findings, reflections, conclusions,
and recommendations regarding Ethiopia’s financial system and its critical
components.

Major Findings
1. Structure and Coverage of the Financial System
Ethiopia’s financial system is heavily dominated by banks, with limited
diversification into non-bank financial institutions and markets.
Financial services are concentrated in urban areas, leaving rural populations
underserved despite the presence of microfinance institutions.

2. Underdeveloped Financial Markets

The absence of a functioning capital market limits investment opportunities and
economic diversification.
The money market is operational but remains restricted to government securities like
treasury bills.

3. Regulations and Risk Management

The regulatory framework is comprehensive but faces challenges in enforcement and
adaptation to modern financial trends.
Provisions for risk management are in place, but institutions often lack the capacity to
implement them effectively.
4. Recent Developments
The establishment of the Ethiopian Capital Markets Authority and efforts to create a
capital market represent significant progress.

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Anti-money laundering and counter-terrorism financing measures are strengthening
financial integrity.

5. Interest Rates and Monetary Policy

Fixed interest rates hinder the efficient allocation of resources and fail to respond to
market dynamics.
Inflation and currency devaluation erode the real value of financial assets and savings.
Reflections
1. Strengths
The government’s commitment to reform, as evidenced by recent proclamations, is a
step in the right direction.
The financial system has shown resilience despite economic and political challenges.
Microfinance institutions and cooperatives contribute significantly to financial
inclusion.
2. Weaknesses
Overreliance on banks creates systemic risks and stifles innovation.
Limited financial literacy among the population hinders the adoption of advanced
financial services.
Regulatory bodies face resource constraints, affecting their ability to oversee the
growing financial sector.
3. Opportunities
The introduction of a capital market provides an avenue for raising long-term capital
and attracting foreign investment.
Digital financial services, including mobile banking and fintech, offer solutions to
increase access and efficiency.
4. Threats
Macroeconomic instability, including high inflation and currency shortages, poses
risks to financial stability.
Rising non-performing loans in the banking sector indicate underlying vulnerabilities.

Conclusion
Ethiopia's financial system is a critical component of the nation's economic
framework, influencing growth, stability, and development. The system has evolved

41
significantly, transitioning from a state-dominated model to one increasingly
characterized by market-oriented reforms. However, this transformation is still
incomplete, with numerous challenges and opportunities shaping its trajectory.

One of the defining features of Ethiopia's financial system is the dominance of

banking institutions, which account for most financial activities. While these
institutions have contributed to mobilizing savings, providing credit, and supporting
investment, their reach remains largely urban-centric. This has left rural and
underserved populations reliant on microfinance institutions and informal systems
such as Iddir and Iqqubs. Bridging this gap is essential to achieving financial
inclusion and ensuring that economic growth benefits all segments of society.

The underdevelopment of financial markets, particularly the absence of a fully

functioning capital market, has restricted the availability of long-term financing
options. As a result, businesses and the government have relied heavily on short-term
instruments such as treasury bills. The recent establishment of the Ethiopian Capital
Market Authority represents a significant step forward, promising to create avenues
for investment, enhance liquidity, and attract both domestic and foreign investors.
Nevertheless, the success of this initiative will depend on building robust market
infrastructure, fostering investor confidence, and implementing comprehensive
regulatory frameworks.

Regulatory reforms have been a focal point of Ethiopia’s financial sector. The
National Bank of Ethiopia (NBE) has played a central role in overseeing the banking
and financial system, ensuring compliance with monetary policy, and promoting
financial stability. Recent measures, such as combating money laundering and
terrorism financing, align Ethiopia with international standards and underscore the
country's commitment to fostering a transparent and secure financial environment.
However, resource constraints and enforcement challenges continue to hinder the full
implementation of these regulations.

The integration of digital financial services, including mobile banking and fintech
solutions like Telebirr, has the potential to revolutionize the financial landscape.
These innovations address key barriers to financial inclusion by offering accessible

42
and cost-effective services to rural and low-income populations. Additionally, the rise
of Islamic financing and capital leasing provides alternative solutions tailored to
diverse economic and cultural needs.

Macroeconomic challenges, including inflation, currency instability, and high interest

rates, pose significant risks to the financial system. These issues erode the real value
of savings, discourage investment, and constrain economic growth. Addressing these
challenges requires a coordinated approach that includes stabilizing the
macroeconomic environment, reforming monetary policy, and fostering sustainable
fiscal discipline.
In conclusion, Ethiopia’s financial system is undergoing a pivotal transformation. By
addressing its structural weaknesses and leveraging emerging opportunities, the
system can evolve into a resilient and inclusive platform that drives economic growth.
Continued government commitment, private sector engagement, and international
collaboration will be crucial in realizing this vision. Strengthening regulatory
capacity, enhancing financial literacy, and expanding the reach of financial services
are essential steps in building a financial ecosystem that supports Ethiopia’s long-term
development aspirations.

Recommendations
1. Strengthen Financial Market Infrastructure
Expedite the establishment of the Ethiopian Capital Market and promote the issuance
of diverse financial instruments.
Develop secondary markets to enhance liquidity and price discovery.
2. Expand Access to Financial Services
Encourage banks and microfinance institutions to extend their operations to rural
areas.
Invest in financial literacy programs to educate the public about savings, investments,
and risk management.
3. Enhance Regulatory Capacity
Provide adequate resources and training to regulatory bodies like the NBE and
ECMA.
Streamline regulations to balance oversight with the encouragement of innovation.
4. Modernize Monetary Policy

43
Transition to market-based interest rates to improve resource allocation.
Strengthen inflation targeting mechanisms to stabilize prices.
5. Leverage Technology
Promote digital financial services and fintech innovations to bridge the financial
inclusion gap.
Implement robust cyber security measures to protect digital platforms.
6. Improve Risk Management
Mandate regular stress testing for financial institutions to assess resilience under
adverse scenarios.
Encourage diversification in loan portfolios to reduce credit risk.
7. Address Macroeconomic Challenges
Implement policies to curb inflation and stabilize the Ethiopian Birr.
Seek multilateral support to manage external debt and maintain fiscal discipline.

Criticisms
1. Slow Pace of Reform
Delays in establishing the capital market and liberalizing financial policies impede
progress.
2. Neglect of Informal Financial Sector
Limited attention to informal financial activities undermines their potential
contribution to the economy.
By addressing these issues, Ethiopia can create a robust, inclusive, and efficient
financial system capable of supporting its economic aspirations.

References

 Ethiopian Capital Markets Authority. (2023). Capital Markets Development in

Ethiopia. Addis Ababa: ECMA.
 Financial Intelligence Center (FIC). (2023). Annual Report on Anti-Money
Laundering and Combating Terrorism Financing. Addis Ababa: FIC.
 International Monetary Fund (IMF). (2021). Ethiopia: Financial Sector
Assessment Program. Washington, DC: IMF Publications.
 National Bank of Ethiopia. (2022). Annual Report. Addis Ababa: NBE.

44
 Organization for Economic Co-operation and Development (OECD). (2021).
Strengthening Financial Markets in Developing Economies. Paris: OECD.
 Proclamation No. 1113/2019. National Bank of Ethiopia Establishment
Proclamation. Federal Negarit Gazette, Ethiopia
 Proclamation No. 1248/2021. Ethiopian Capital Markets Proclamation.
Federal Negarit Gazette, Ethiopia.
 Bezabih, M. (2015). The Role of Informal Financial Institutions in the
Ethiopian Financial Sector: The Case of Moneylenders in Addis Ababa.
Journal of Applied Finance & Banking, 5(6), 95-110.
 Abebe, A., & Zerfu, D. (2018). The Development of the Ethiopian Financial
Market: An Overview. Journal of African Business, 19(3), 291–306.
https://doi.org/10.1080/15228916.2018.1549621
 Berhane, G. (2019). Rural Financial Institutions in Ethiopia: A Case Study of
Rural Saving and Credit Cooperatives in Enderta Woreda, Ethiopia. European
Journal of Accounting, Auditing and Finance Research, 7(3), 33-47
 United Nations Conference on Trade and Development (UNCTAD). (2020).
Economic Development in Africa Report: Financial Systems in Africa.
Geneva: UNCTAD.
 World Bank. (2023). Financial Inclusion in Ethiopia: Challenges and
Opportunities. Washington, DC: World Bank Group.

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Appendix

Appendix A: Questionnaire
Title: Assessing the Financial System in Ethiopia
1. General Questions
What is your role in the financial sector?
How long have you been involved in the Ethiopian financial system?
What are the main challenges you encounter in your operations?
2. Financial Institutions
How do you classify the financial institutions in Ethiopia?
What is your view on the role of microfinance institutions in promoting financial
inclusion?
How effective are regulations in managing financial institutions' risks?
3. Financial Markets
What is the current state of money and capital markets in Ethiopia?
What are the key barriers to the development of the Ethiopian capital market?
How do foreign investors participate in the Ethiopian financial market?
4. Financial Assets and Instruments
Which financial assets are commonly traded in Ethiopia?
How are financial assets valued, and do you think the methods used are sufficient?
What is the current structure of interest rates in the Ethiopian context?
5. Regulatory Environment
What is your evaluation of the National Bank of Ethiopia's regulatory role?
How effective are anti-money laundering measures in Ethiopia?
What reforms would you recommend to improve financial system regulations?

Appendix B: Interview Questions

1. Can you describe the role of your institution in Ethiopia's financial system?
2. What are the major achievements of the financial sector in recent years?
3. What challenges do financial institutions face regarding regulatory compliance?

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4. How is the adoption of fintech solutions impacting the financial sector?
5. What steps do you think are necessary to develop a robust capital market in
Ethiopia?

Appendix C: Observation Checklist

Objective: To observe the operations and functionality of financial institutions in
Ethiopia.
1. Banking Institutions
Accessibility of branches in rural and urban areas.
Availability of digital banking services.
Customer service and financial literacy programs.
2.Microfinance Institutions
Outreach to underserved populations.
Loan disbursement and repayment mechanisms.
Training programs for clients.
3. Financial Markets
Existing infrastructure for trading securities.
Accessibility and transparency of money market operations.
Investor participation and confidence levels.
4. Regulatory Environment
Compliance with NBE directives.
Implementation of risk management practices.
Anti-money laundering and terrorism financing initiatives.

Appendix D: Additional Materials

Graphs and Charts: Illustrations showing the growth of financial institutions, trends in
government borrowing, and the development of fintech solutions in Ethiopia.
Proclamations and Policies: Copies of relevant proclamations, including the Capital
Markets Proclamation and Banking Business Proclamation.

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