Friday, September 4, 2020

Institutional Aspects of Reforming the Financial Sector: The Case of Regulating Banking in Post-Reform Ethiopia

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Alemayehu Geda

Introduction

Following the 1974 popular revolution all privately owned financial institutions including three commercial banks, thirteen insurance companies and two non-bank financial intermediaries were nationalised on 1 January 1975. The nationalised banks were reorganised and one commercial bank (the Commercial Bank of Ethiopia), a National Bank (recreated in 1976), two specialised banks (the Agricultural and Industrial Bank – recently renamed as the Development Bank of Ethiopia and Housing and Savings Bank – recently renamed as the Construction and Business Bank) as well as one insurance company – Ethiopian Insurance company were formed.

After the change in government in 1991, and the new direction in economic policy (especially after 1992), these financial institutions are being reorganised to work in a market oriented policy framework. Besides, new privately owned financial institutions are also being allowed to work along with the publicly owned ones. The discussion about these financial institutions, in particular their regulation and supervision, being a major institutional issue, is the subject of the rest of this paper.

The intermediary role of financial institutions takes different forms in different economic systems. In Ethiopia, under ‘State Socialism’ (1974 to 1991), financial institutions were basically executing the economic plans outlined by the central planning organ. In such set-up regulation and supervision were not critical since the national plan was believed to regulate and direct the activities of the financial institutions. Moreover, financial institutions were directed to finance some public projects that may not pass proper financial/economic appraisal, the arguments simply based on either ideological grounds or on ‘merit wants’. Such a system was running in Ethiopia until 1991, a year that witnessed the overthrow of the ‘Socialist State’.

In terms of economic policy, 1991 witnessed a marked departure from the previous ‘Socialist System’. The basic difference lies on openly adopting a market-oriented economic policy, which was actually initiated, even if not implemented, by the previous (Derge) regime.

In terms of the financial sector, this new change in policy required an enormous change in its activity. Not only it is going to serve the private sector, which hitherto had been demonised, but also new private financial institutions were emerging. Equally, the role of the Ethiopia’s central bank (named National Bank of Ethiopia, NBE henceforth) needed to be reformulated again. Thus, financial sector reconstruction was the top item in the government’s agenda.

In undertaking this task the Ethiopian government adopted a strategy of; (a) gradualism: in undertaking different economic financial liberalisation measures (the issues of sequencing and timing), and (b) strengthening domestic competitive and operational capacity before full liberalisation: restricting the sector to domestic investors only, strengthening the regulatory and supervisory capacity of the NBE, providing autonomy to banks etc. This latter issue, i.e. institutional building, was taken as fundamental component of financial sector liberalisation. In line with this strategy various proclamations and regulations were passed since 1992.

In this study an attempt to understand these transitions will be made. In particular what is required of both the new financial institutions and the regulatory organ, the NBE, will be examined. In doing so the study will attempt to capture whether proper regulatory and supervisory capacity - institutional building - is in place when the role of the financial sector is in such a state of flux. Further, the Ethiopian strategy is very slow in the eyes of the IMF. Thus, this paper will also explore the implications of this strategy on the relationship between Ethiopia and international institutions such as the IMF.

The rest of the paper is organised as follows. In section 2 brief theoretical points about liberalisation and regulation of financial sectors will be made. Section 3 will be devoted to the analysis of the regulatory mechanisms in the financial sector. In sections 4 and 5 some economic liberalisation measures and Ethiopia’s relation with the IMF are, only briefly, discussed. Section 6 concludes the paper.

 

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