COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

RESEARCH METHODS IN ACCOUNTING AND FINANCE

(Acfn 3112)

CHALLENGES IN DEVELOPING ETHIOPIA'S FINANCIAL SECTOR

(Lack of Capital Markets, Limited Financial Inclusion, and Regulatory Constraints)

SUBMITTED BY: NUHAMIN NADEW

ID NUMBER: UGR/0849/15

SUBMISSION DATE: DECEMBER 18, 2024

SUBMITTED TO: INST. SEFIAGER. A

 Acknowledgment

First and foremost, I want to praise Almighty God for His assistance during the
preparation of this research proposal. I wish to express my gratitude to Instructor Sefiager
A. for granting me the opportunity to explore the challenges in developing Ethiopia's
financial sector, particularly focusing on the lack of capital markets, limited financial
inclusion, and regulatory constraints.

This research aims to examine the structural challenges that impede economic growth and
development in Ethiopia's financial landscape. It seeks to identify sustainable solutions
that can help transform the financial sector into a more inclusive and efficient system,
ultimately supporting the country’s economic aspirations.

The successful completion of this proposal reflects my capability and determination. I

acknowledge the many individuals who offered wise counsel, valuable advice,
encouragement, patience, and constructive suggestions that contributed to this work.

Therefore, I extend my heartfelt thanks to all who assisted me in the preparation and
completion of this research proposal. Your support has been invaluable.
 Abstract
This research proposal investigates the challenges facing Ethiopia's financial sector,
focusing on the lack of capital markets, limited financial inclusion, and regulatory
constraints. Despite the potential for economic growth, the sector struggles with
significant hurdles that hinder its development. Currently, only 46% of adults have access
to formal financial services, with stark disparities between men and women—38.9% of
men versus 22.7% of women. The absence of robust capital markets creates a significant
financing gap, where a mere 0.5% of borrowers control nearly three-quarters of all loans,
leading to severe capital concentration and limited access for most businesses and
individuals.

Moreover, regulatory constraints and operational inefficiencies further complicate the

financial landscape, resulting in limited outreach and high leverage. The intertwined
issues of technological barriers, such as inadequate interoperability in digital payment
systems, exacerbate these challenges, forcing many e-commerce platforms to rely on cash
transactions. Additionally, the macroeconomic environment, characterized by high
inflation and a significant current account deficit, creates volatility that complicates
sustainable reform implementation.

Given Ethiopia's ambitious economic transformation goals, there is an urgent need for
comprehensive reform in the financial sector. This research aims to identify effective
solutions that address these structural challenges, facilitating a more inclusive and
efficient financial system. By examining existing policies and proposing sustainable
alternatives, this study seeks to contribute to the broader discourse on economic
development in Ethiopia, ultimately supporting the transformation of the financial sector
to better serve the needs of its population and foster economic growth.
 Table of Contents
Abstract......................................................................................................................................................3
CHAPTER ONE....................................................................................................................................5
1.1. Background................................................................................................................................5
1.2. Statement of the problem..........................................................................................................6
1.3. Relevant Study Questions..........................................................................................................8
1.4. Objectives of the study..............................................................................................................9
1.4.1. General objective...............................................................................................................9
1.4.2. Specific objectives..................................................................................................................9
1.5. Significance of the Study...........................................................................................................9
CHAPTER TWO.....................................................................................................................................10
2. RESEARCH METHODOLOGY...................................................................................................10
2.1. INTRODUCTION...................................................................................................................10
2.2. RESEARCH DESIGN.............................................................................................................10
3. Significance of the Study.................................................................................................................11
4. Feasibility of the study.....................................................................................................................12
4.1. Time Schedule..........................................................................................................................12
 CHAPTER ONE
1. INTRODUCTION

1.1. Background
Ethiopia's financial sector plays a crucial role in the country's economic development, yet it faces
significant challenges that impede its growth and effectiveness. As a developing nation,
Ethiopia's financial landscape is characterized by a lack of well-developed capital markets,
limited financial inclusion, and stringent regulatory constraints. These issues contribute to a
financing gap that restricts access to essential financial resources for businesses and individuals,
thereby stifling economic growth.

Historically, Ethiopia has relied heavily on development assistance, a situation that is

increasingly unsustainable. Studies indicate that Africa is the only developing region where
development assistance flows exceed private capital flows (Lemma and Otchere, 2008). This
trend underscores the urgent need for a more robust financial infrastructure that can support self-
sustaining economic growth. Financial markets are vital for the flourishing of industry, trade, and
commerce, and they play a pivotal role in facilitating economic expansion (Firew, 2009).

One of the most pressing issues within the Ethiopian financial sector is the absence of effective
capital markets. Despite having a considerable number of shareholders—over 60,000—there is
no functioning market for share trading, resulting in high illiquidity. This situation not only
discourages new investments but also frustrates existing shareholders, ultimately limiting private
sector participation in the economy (Mohammed, 2010).

In addition to these structural deficiencies, the Ethiopian financial sector grapples with
regulatory constraints and operational inefficiencies. Challenges such as limited outreach,
insufficient funding, high leverage, and low liquidity hinder the sector's potential for growth. The
interplay of these factors creates an environment that is not conducive to financial innovation or
comprehensive reform.

The macroeconomic context further complicates these challenges. High inflation rates nearing
30% and a significant current account deficit create a volatile operating environment for
financial institutions, complicating efforts to implement sustainable reforms. Recent attempts by
the National Bank of Ethiopia to address these issues through a new monetary policy framework,
including a policy interest rate set at 15%, reflect a recognition of the need for change, although
the effectiveness of these measures remains uncertain.

Recognizing these interconnected challenges is critical for Ethiopia's ambitious economic

transformation goals. The government's initiatives aimed at liberalizing the financial sector, such
as adopting a market-based foreign exchange regime and modernizing banking regulations,
signal a commitment to reform. However, the success of these initiatives depends on addressing
the underlying structural issues within the financial sector. This research aims to provide a
comprehensive analysis of these challenges and propose sustainable solutions that can help
create a more inclusive, efficient, and robust financial system in Ethiopia, ultimately supporting
the country's development aspirations.

1.2. Statement of the problem

According to studies, Africa is the only developing region where development assistance flows
exceed private capital flows (Lemma and Otchere, 2008). This was mainly attributed to the lack
of well-developed financial markets and the poor economic policies and institutions in African
countries, where Ethiopia is not an exception. Financial markets are vital part of an economy
making it possible for industry, trade and commerce to flourish without any obstacle in terms of
financial resources. The financial markets play a pivotal role in expediting the nation’s economic
growth (Firew, 2009). The financial markets also assist the role of the private sector in the
economy by providing the required financial resources, diversified investment options and
liquidity functions.

Currently there is adequate shareholding constituency in Ethiopia allowing the establishment of

share companies. There are more than 60,000 shareholders in Ethiopia where there is no market
for share trading and retrading implying that there is high share illiquidity. If this illiquidity
persists, the existing shareholders tend to frustrate and new shareholders will be discouraged to
get into share company business which in effect hinders the growth of investment and private
sector involvement in the Economy (Mohammed, 2010).
Ethiopia's financial sector faces severe structural challenges that impede economic growth and
development, creating an urgent need for comprehensive reform. At its core, the sector suffers
from three interconnected problems that demand immediate attention. First, the absence of robust
capital markets has created a significant financing gap, with a mere 0.5% of borrowers
controlling nearly three-quarters of all loans, highlighting severe capital concentration and
limited access to funding for most businesses and individuals (NBE, 2024). Second, financial
inclusion remains critically low, with only 46% of adults having access to formal financial
services – significantly below regional peers like Kenya (83%) and Rwanda (77%). This
exclusion is particularly pronounced among women, with data showing that while 38.9% of
Ethiopian men are financially included, only 22.7% of women have access to financial services
(World Bank, 2024).

The situation is further complicated by regulatory constraints and operational inefficiencies that
hinder sector growth. Key challenges include limited outreach, inefficient operations, insufficient
funding, high leverage, low liquidity, and poor resource mobilization. These issues have created
a pressing need for research to identify effective solutions for developing a more inclusive,
efficient, and robust financial sector that can support Ethiopia's economic transformation goals.
The controversy stems from the tension between maintaining financial stability through strict
regulation and the urgent need to modernize and liberalize the sector to promote growth and
inclusion. The challenges are compounded by significant technological barriers in the financial
sector. The lack of adequate interoperability and the complexity of digital payment systems have
forced many e-commerce platforms to rely on cash transactions, creating a substantial obstacle to
financial innovation and digital transformation.

The macroeconomic environment adds another layer of complexity to these challenges. Ethiopia
faces serious macroeconomic hurdles, including high inflation rates approaching 30 percent and
a significant current account deficit. These conditions have created a volatile operating
environment for financial institutions and have made it difficult to implement sustainable
reforms. The recent introduction of a new monetary policy framework, with the National Bank of
Ethiopia setting its initial policy interest rate at 15 percent in July 2024, represents an attempt to
address these challenges, but its effectiveness remains to be seen.
The urgency of addressing these challenges is heightened by Ethiopia's ambitious economic
transformation goals. While the government has initiated reforms aimed at liberalizing the
financial sector, including the adoption of a market-based foreign exchange regime and the
modernization of banking regulations, the success of these reforms depends on effectively
addressing the fundamental structural issues within the sector. This research seeks to examine
these challenges comprehensively and propose sustainable solutions that can help transform
Ethiopia's financial sector into a more inclusive, efficient, and robust system capable of
supporting the country's development aspirations.

1.3. Relevant Study Questions

As the problems mentioned above, the study specifically addressed the following basic research
questions.

 What are the primary structural challenges facing Ethiopia's financial sector?
 How does the lack of capital markets affect access to financing for businesses and
individuals?
 What barriers to financial inclusion exist, particularly for women in Ethiopia?
 How do regulatory constraints impact the efficiency of financial institutions?
 What role do technological limitations play in hindering financial innovation?
 How does the current macroeconomic environment influence the financial sector's
performance?
 What measures has the government taken to liberalize the financial sector, and how
effective are they?
 What sustainable solutions can address these challenges and support economic
transformation?
 1.4. Objectives of the study
1.4.1. General objective
The main objective of this research is to comprehensively analyze the challenges facing
Ethiopia's financial sector, including the lack of capital markets, limited financial inclusion, and
regulatory constraints. This study aims to identify effective solutions and strategies to enhance
the sector's efficiency, inclusivity, and robustness, ultimately supporting Ethiopia's economic
transformation goals and fostering sustainable development.

1.4.2. Specific objectives

The study was specifically addressing on these distinctive objectives: -

 Identify the structural challenges affecting Ethiopia's financial sector.

 Assess the impact of the absence of capital markets on financing access.
 Investigate barriers to financial inclusion, focusing on women and marginalized groups.
 Evaluate the effects of regulatory constraints on financial institutions' efficiency.
 Explore technological limitations hindering financial innovation.
 Examine the influence of the macroeconomic environment on financial sector
performance.
 Assess the effectiveness of government measures for financial sector liberalization.
 Propose sustainable solutions to enhance inclusivity and efficiency in the financial
sector.

1.5. Significance of the Study

This study is significant as it aims to provide a comprehensive understanding of the challenges
facing Ethiopia's financial sector, which is crucial for the country's economic development. By
identifying barriers to financial inclusion and assessing regulatory impacts, the research will
inform policymakers and stakeholders on effective strategies to enhance financial access and
efficiency. Furthermore, the proposed solutions could facilitate a more inclusive financial
environment, support sustainable economic growth, and contribute to the overall transformation
of Ethiopia's economy.
 CHAPTER TWO

2. RESEARCH METHODOLOGY
2.1. INTRODUCTION
The methodology of the research chapter presents a description of the research methodology that
would use in this study, presents in detail the procedure that were used to answer the research
questions by discussing the research design, the sampling design including, target population,
sampling frame, sample size and sampling methods used, the data collection methods and data
analysis methods. The ethical considerations are also included on the final discussions.

2.2. RESEARCH DESIGN

This research design outlines the methodology and approach to investigate the challenges facing
Ethiopia's financial sector, specifically focusing on the lack of capital markets, limited financial
inclusion, and regulatory constraints. The study will adopt a mixed-methods approach,
combining both quantitative and qualitative research methods to allow for a comprehensive
analysis of the financial sector's challenges.

The research will employ a descriptive research type to detail the current state of Ethiopia's
financial sector, alongside exploratory research to investigate the perceptions and experiences of
stakeholders. The primary population for this study will include financial institutions, regulatory
bodies, and individuals within Ethiopia's financial ecosystem. A sample size of approximately
200 participants will be selected, comprising 100 representatives from financial institutions, 50
regulatory officials, and 50 individuals, with a focus on marginalized groups, including women.

To ensure representation across various sectors and demographics, a stratified random sampling
technique will be utilized. Data collection methods will include quantitative approaches such as
surveys and analysis of secondary data to assess financial inclusion and access to capital
markets. Qualitative data will be gathered through semi-structured interviews and focus group
discussions to gain deeper insights into the challenges faced and potential solutions.

Data analysis will involve statistical methods for quantitative data, utilizing software like SPSS
or R, and thematic analysis for qualitative data from interviews and focus groups. Ethical
considerations will be paramount, with informed consent, confidentiality, and adherence to
established ethical guidelines being strictly maintained.

The study acknowledges potential limitations, such as biases in self-reported data and the
availability of up-to-date secondary data. The expected outcomes include the identification of
key challenges within Ethiopia's financial sector, an assessment of the current state of financial
inclusion, and actionable recommendations for policymakers and stakeholders to enhance the
sector's efficiency and inclusivity. By following this structured research design, the study aims to
effectively address the research problem and contribute valuable insights to the field.

3. Significance of the Study

This study holds significant importance for several reasons. Firstly, it provides valuable insights
that can guide policymakers in reforming Ethiopia's financial sector, which is essential for
fostering economic growth and stability. By addressing the barriers to financial inclusion, the
research aims to empower marginalized groups, particularly women, enhancing their access to
financial services and opportunities. Furthermore, the findings will contribute to Ethiopia's
broader economic transformation goals by identifying solutions that promote a more inclusive
and robust financial system.

Additionally, by highlighting the challenges within capital markets, the study seeks to create a
more favorable investment climate, encouraging both domestic and foreign investments. It will
also raise awareness among stakeholders, including financial institutions and regulatory bodies,
about the critical issues facing the sector and the need for collaborative efforts to address them.
Overall, this study aims to contribute to the development of a financial sector that supports
sustainable economic growth and development in Ethiopia.
 4. Feasibility of the study

4.1. Time Schedule

Table 4.1 Time schedule
Phase Duration Activities
1. Preliminary Research 2 weeks - Review existing literature on Ethiopia's
financial sector.
- Identify gaps in the current research.
2. Research Design Development 1 week - Finalize research design and
methodology.
- Develop survey instruments and
interview guides.
3. Data Collection 4 weeks - Distribute surveys to participants
- Conduct interviews and focus group
discussions.
- Collect secondary data from relevant
sources.
4. Data Analysis 3 weeks - Analyze quantitative data using statistical
software (e.g., SPSS, R).
- Conduct thematic analysis of qualitative
data.
5. Interpretation of Findings 2 weeks - Interpret analysis results.
- Relate findings to research questions and
objectives.
6. Report Writing 3 weeks - Draft the research report, including
methodology, findings, and
recommendations.
- Revise and finalize the report based on
feedback.
7. Submission and Presentation 1 week - Submit the final research report.
- Prepare for presentation to stakeholders
and academic audiences.
Total Duration 16 weeks
 Reference

1. Senbet, Lemma and Isaac Otchere, 2008, “Financial Sector Reforms in Africa:
Perspectives on Issues and Policies,” World Bank Volume - Annual Bank Conference on
Development Economics, eds. Francois Bourgignon and Boris Pleskovic: 81-119
2. https://www.worldbank.org/en/publication/wdr2024
3.