Very Final 2 PDF

A CONFERENCE CO-ORGANIZED BY HARAMAYA UNIVERSITY AND
PUBLIC FINANCIAL ENTERPRISES AGENCY
How to cite the proceeding

Mengistu K., Mengistu U., Nigussie D., Endrias G., Mohammadamin H., Temesgen K., & Yemisrach
G.(eds.), 2013. Proceedings of the National Conference on ‘Loan and Saving: the Role in Ethiopian Socio-
economic Development’, 15-16 February 2013, Haramaya, Ethiopia.
PROCEEDINGS OF THE NATIONAL CONFERENCE ON ‘LOAN AND
SAVING: THE ROLE IN ETHIOPIAN SOCIO-ECONOMIC
DEVELOPMENT’ HELD 15-16 FEBRUARY 2013
CO-ORGANIZED BY HARAMAYA UNIVERSITY AND PUBLIC

FINANCIAL ENTERPRISES AGENCY
Edited and compiled by:
Mengistu Ketema (PhD)

Mengistu Urge (PhD)
Nigussie Dechassa (PhD)
Endrias Geta (PhD)
Mohammadamin Hussein
Temesgen Keno
Yemisrach Getachew
December 2013
Haramaya University, Ethiopia
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iv
Contents
PRELIMINARIES………...……………………………………………………………………... 1
Preamble………………..…………………………………………………………………………. 1
Nigussie Dechassa (PhD), Vice-President for Research Affairs, Haramaya University

Welcoming Address……………………………………………………………………………….... 3
H.E. Mr. Murad Abduhadi, President of the Harari National Regional State
Opening Speech………………………………………………………………………………...…... 7
H.E. Dr. Sintayehu Woldemichael, Director of Ethiopian Public Financial Enterprises Agency
Keynote Address…………..…………………………................................................................................ 11
PAPERS PRESENTED IN THE CONFERENCE IN THEMES......................................... 13
Theme 1: Institutions in Loan and Saving................................................................................. 13
Kifle Tesfamariam and Hailemichael Tesfay

Relative Efficiency of Rural Saving and Credit Cooperatives: An Application of Data Envelopment
Analysis.................................................................................................................................................................. 13
Tamiru Belete
The Effect of Asset Liability Management on Profitability of Ethiopian Commercial Banks ............... 24
Endalew Wale, Endrias Geta and Jema Haji

Determinants of Microfinance Service Utilization in Dire Dawa Administration, Ethiopia .................. 34
Yonas Mekonnen, Arega Seyoum and Anteneh Gorfu

Health Check-up of Commercial Banks in Ethiopia………......................................................................... 45
Theme 2: Governance and Policy Dimensions in Loan and Saving ......................................... 51
Aregawi Tesfay and Kifle Tesfamariam

Deficiencies in Legal, Regulatory and Supervisory Frameworks of Saving and Credit Cooperatives in
Ethiopia……………………………………..……….................................................................................. 51
Theme 3: Saving, Loan, and Development ............................................................................... 65
Aron Hailesellasie, Nigus Abera and Getnet Baye

Assessment of Saving Culture among Households in Ethiopia ................................................................... 65
Gebeyehu Raba
The Role of Saving and Loan in the Economic Growth of Ethiopia ......................................................... 73
Sefiager Alem
Poverty Reduction Impact of Microfinance Institutions and Determinants of Client Success: A Case
Study on Two Rural Kebeles of Fogera Woreda............................................................................................. 92
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Ramesh Rengasamy
Financial Access to Everyone: A Review.......................................................................................................... 116
Mebratu Leake
The Linchpin Nature of Saving, Investment and Growth: A Review of Literature and Drawing a
Lesson for Ethiopia.............................................................................................................................................. 127
Tezeta Ketema and Deribe Assefa

Savings Mobilization through Saving and Credit Cooperatives in Ethiopia: Performance, Trend,
Challenges and the Way Forward...................................................................................................................... 145
Theme 4: Innovative Saving and Loan Schemes, Products, and Services................................. 160
Beza Muche
Assessment of the Opportunities and Challenges for the Adoption of e-Banking Services in Selected
Ethiopian Commercial Banks............................................................................................................................. 160
Theme 5: Loan and Saving in Agriculture and Pastoralism....................................................... 180
Melkamu Belina and Mengistu Ketema

Impact of Microcredit on Farm Productivity: The Case of Deder and Goro Gutu Districts, East
Hararghe Zone, Ethiopia.................................................................................................................................. 180
Ayalew Mekonnen and Lemma Zemedu

Determinants of Loan Repayment Performance of Smallholder Farmers: The Case of Soro Woreda,
Hadiya Administrative Zone, Southern Nations, Nationalities and Peoples’ Regional State, Ethiopia. 187
Temesgen Keno
Determinants of Microfinance Loan Repayment Performance of Smallholder Pastoral/Agro-pastoral
Farmers in Ethiopia: The Case of Dire Microfinance Clients in Shinile District of the Somali National
Regional State……................................................................................................................. 202
Theme 6: Information Asymmetry and Credit Risk Management............................................ 213
Zafu Hailesilase & Abadi Teklehaimanot

Determinants of Loan Repayment Performance of Beekeeping Cooperatives in Kilte-Awlaelo
District, Tigray Region, Northern Ethiopia…………………………………………………………. 213
Wolde Bulto
Information Asymmetry and Credit Risk Management Practice in Ethiopian Banking Business......... 222
DISCUSSIONS, VIEWS, AND REFLECTIONS.................................................................... 239
Fekadu Beyene (PhD), Vice-President for Administration and Student Affairs

Closing Remark................................................................................................................................................... 245
List of Participants 247
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Proceedings of a Conference on ‘Loan and Saving: The Role in Ethiopian Socio-economic Development’
PRELIMINARIES
Preamble
Saving is a pillar of economic growth when its provision as a loan passes through appropriate channels.
Saving mobilization and credit provision by financial institutions are considered as a proxy for economic
growth. The contribution of these institutions to economic growth symbolizes them as leading players
in the sector. In addition, different national and regional regulatory organs and the public at large have
their own contributions to this sector.
Saving rate in Ethiopia is low even by the Sub-Saharan African standard. A number of issues can be
raised as to what accounts for the low rate of saving in the country. In fact, it can be argued that if there
is willingness and motivation for effective saving, people can save whatever amount they have as dew
drops provided that filling the pitcher is the aspiration. However, in low income nations like Ethiopia,
where production is meant basically for subsistence with a uniformly inflationary period, saving is very
difficult. Even if people save, the savers may lose due to decline in the purchasing power of the saved
money surmounting the earning interest rate.
Problems related to loan and saving in Ethiopia should be mitigated for the purpose of attaining
economic development through engaging all stakeholders. This is particularly vital at this juncture when
Ethiopia has envisaged achieving its five-year Growth and Transformation Plan (GTP). Cognizant of
this fact, Haramaya University, in collaboration with Public Financial Enterprise Agency, has organized
a conference to provide a platform for stakeholders, including policy makers, practitioners and scholars
in the academia for discussing on issues revolving around loan and saving in the country. The conference
generated useful ideas and directions to enhance efforts towards upgrading the scale of deposit
mobilization and loan provision, creating societal awareness on the need for saving and loan provision
as well as pinpointing policy implications for the government of Ethiopia.
Seventeen scientific papers addressing the nature and behavior of saving and loan in particular and the
role of financial sector development in pursuance of economic sector development in general, were
presented and discussed. Specifically, the topics included the role of institutions in loan and saving,
issues of governance, policy and regulations. The topics also dealt with the nexus of loan-saving-
development, emerging innovations in saving and loan, the role of loan and saving in the main sectors
of the Ethiopian economy, and problems of information asymmetry and credit risk management.
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The scientific papers presented under the aforementioned themes are included in this Book of Proceedings.
On the whole, in the two-day conference, there was a significant accomplishment that also pinpointed
policy directions and future actions to be taken to enhance loan and saving and stimulate economic
growth in Ethiopia.
This book of proceedings is prepared to communicate the knowledge generated and experiences shared in
the conference. We hope that the proceedings will inspire readers’ thoughts and actions towards further
progress in the area of loan and saving in the country.
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Welcoming Address
Dr. Nigussie Dechassa, Vice-President for Research Affairs, Haramaya University
Your Excellency, Dr. Sintayehu Woldemichael, Director of Public Financial Enterprises Agency,
Your Excellency Ato Murad Abdulhadi, President of the Harari Regional state,
Distinguished Guests,
Staff members of the University,
Ladies and gentlemen,
First of all, on behalf of Haramaya University and myself, I would like to extend a warm welcome to all
of you to this national conference on loan and saving, which is the first of its kind in the history of our
University. I am indeed honoured and privileged to make this welcoming address.
The conference has been organized by the joint efforts of Haramaya University and the Public Financial
Enterprises Agency. I would like to pay my tribute to all distinguished representatives who have come
from various organizations to contribute to the fruition of this conference. Having all of you here has
proved to us that this conference is indeed the common interest of all of us who desire to have a
thorough understanding about the trend, nature, and behaviour of domestic resource mobilization and
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loan provision in Ethiopia. The event also reveals how much we all appreciate understanding the
mechanisms through which the financial sector contributes to the enhancement of the economy of our
country.
Ladies and Gentlemen,
Our University and the Public Financial Enterprises Agency are indeed gratified by the opportunity of
hosting this conference on the subject of loan and saving, which is a milestone for increasing saving
mobilization and its appropriate allocation for enhanced growth of the country’s economy.
Such a conference could have been conducted at no better time than now when the country has
envisaged achieving remarkable economic growth through robust strategies like the Growth and
Transformation Plan (GTP) and multipurpose mega projects like the construction of the Great
Renaissance Dam. Implementation and execution of these development endeavours require huge
amounts of monetary outlay, the lion’s share of which has to be generated domestically. The issues of
domestic resource mobilization and loan provision have been well addressed in the GTP plan with the
understanding that a well functioning financial system is a major input for the successful execution of
the development plans and achievement of the targeted goals. In other words, if the financial system
distorts the allocation of funds in the presence of financial repression, economic growth cannot be
realized and sustained and financial depth will remain deficient.
Thus, it is important to create a common understanding in the nation and make further efforts to
strengthen the saving capacity and proper allocation of loans. This is also primarily required because in
any society, promoting saving and creating public awareness on financial responsibility enhances self-
economic wellbeing of savers in particular and the economic growth of the nation in general.
In this regard, the lessons from fast growing economies such as India and China demonstrates how
enhancement of the national saving habit and development of the financial sector to effectively mobilize,
pool, and channel domestic savings into productive capital is crucial to accelerate economic growth.
This workshop is hoped to generate useful ideas that will inform policy makers to put appropriate
actions in place. It will also stimulate academics, practitioners, and professionals to make further
investigations and practise innovative financial services and technologies, which may further address the
current challenges and improve prospects of the Ethiopian financial sector and its role in the country’s
economic growth.
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In this conference, various scientific papers in different areas of saving and loan will be presented;
reflections and discussions will be made, leading to fruitful and concrete outcomes.
I feel that the two-day conference will be a significant accomplishment that will set action packed agenda,
providing something for everyone, which will include thought-provoking keynote speeches, challenging
discussions, reflections, presentations, as well as informal networking outside the conference room.
What is more, eventually, an informative and educative proceeding will be prepared for public use.
I would also like to take this opportunity to thank the Commercial Bank of Ethiopia for making a
substantial generous financial contribution to the cost of holding this conference.
I would also like to thank the conference organizing committee members, who were drawn from both
Haramaya University and the Ethiopian Public Financial Enterprises agency for their dedicated efforts
in organizing and realizing this conference.
I would also like to thank the various offices of both institutions for the wonderful support they have
given to the organizing committee.
With this note, I wish you a very good conference packed with stimulating discussions and reflections
on loan and saving that can feed into our efforts of achieving our goal of becoming one of the middle
income nations in the World by the year 2025.
Thank you very much.
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Opening Speech
H.E. Mr. Murad Abdulhadi, President of the Harari National Regional State
Your Excellency, Dr. Sintayehu W/Michael, Director for Public Financial Enterprises Agency,
Distinguished Guests,
First of all, I would like to express my deep feeling that I am personally honored to make this official
opening remark for the conference on ‘Loan and Saving: The role in Ethiopia Socio-economic Development’, on
behalf of His Excellency, Mr. Abdulaziz Mohammad, Vice-President of the Oromia National Regional
State and the chairman of the Haramaya University Administrative Board, who has been unable to
attend this conference due to other urgent official assignments.
I would like to thank the organizers of the conference, Haramaya University and Ethiopian Public
Financial Enterprises Agency, for fully engaging themselves in executing this important event which
forms a platform for researchers, professionals, practitioners and policymakers to discuss on the role of
saving mobilizations and loan provision in Ethiopian financial sector development and its role in
Ethiopian socio-economic development.
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The Government of Ethiopia has made a tremendous stride to harmonize the effort of different
stakeholders in Ethiopian financial sector so as to enhance its role in the country’s envisaged
development plans. As a matter of this fact, the promotion of collaborative efforts between the
Ethiopian Public Financial Enterprises Agency and public universities is worth-mentioning. In this
regard, preceding conferences have been held at the University of Gonder in December 2011 and at
Hawassa University in June 2012 and now the third conference is being held at Haramaya University.
Hopefully, a series of similar conferences will be held in the future in a very organized and improved
manner.
As we all repeatedly reflected on many occasions, we are working on many ambitious but achievable
plans including the Growth and Transformation Plan (GTP) for 2011-2016 and the construction of the
Great Renaissance Dam which are hoped to be a mantra for our vision, to be one of the middle income
nations by the year 2025. Until today, with full commitment of the Government and the people, we
have seen a bright light which could lead us to the overall success of these plans. Our economy has
grown at 11.4% of real GDP during the years 2011 and beyond that in 2012 which were greater than
the lower case 11% targeted in GTP. Accelerated economic growth has remained a continued
momentum over the last eight years in Ethiopia.
At this juncture, it is important to note that the financial sector which is expected to play a vital role in
the economic development as well as in the implementation of our development targets is in a road of
success. Over the last two years, our financial sector development indicators such as reserve money have
grown at about 40% which is by far greater than the targeted growth rate in GTP.
Thus, these and other achievements in our financial sector and the role that these play in our economic
development and realization of the GTP plan are sound. In implementing GTP, the government of
Ethiopia has planned to develop an accessible, inclusive, efficient and competitive financial system. This
also helps the country to increase its domestic saving so as to sustain the fast and sustainable growth
required to provide resources for expanding improving public services. The government is also working
to create healthy competition among the different sub-sectors through supporting the private sector,
micro-and-small scale enterprises (which are the incubations of growth) and financial institutions in
order to improve the coverage and quality of financial services.
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However, as the main importance of this conference, the role of domestic saving and loan provision
should be improved further to enhance our achievements. This is because while about 1 trillion Birr is
expected to be domestically rose from our nation over the GTP period, our current saving rate is about
9.5% of our GDP which is lower than the Sub-Saharan African case. This, thus, requires our focus to
scale effective mobilization of savings and provision of credits through our financial institutions. It also
requires enhancing our consensus and harmonizing our efforts towards upgrading the technologies
(invention and innovation) for deposit mobilization and loan provisions, creating societal awareness
about the need for saving and loan provision, as well as pinpointing policy directions for the government
of Ethiopia to take effective actions to improve our saving and loan culture and concerns.
As we all know, it is true in any kind of economic and political system that financial sector development
serves as the engine of growth and a real growth emanates internally through domestic mobilization and
conversion of resources. Cognizant of this fact, we should consider our financial sector as a factor
fueling our economic growth and socio-economic development. Our today’s conference, is, therefore,
aimed at broadening our thoughts so as to put in place the proper functioning of the financial sector for
financial self-sufficiency and domestic mobilization of resources as well as for creation of equity and
equitability in the allocation of financial resources in our economy through provision of productive
loans for the needy. In this fashion, let the financial sector play its basic role in the economy; serve the
interest of government, private bodies and other stakeholders working in the sector.
I am pretty sure that this kind of national conference is what we need to achieve all the above targets of
our country. I hope this conference will go through evaluating the development of our financial sector
and the role it plays in our economic development, addressing the nature and behavior of saving and
loan in our financial institutions, their governance, policy and regulatory issues, the nexus of loan-saving-
development and the important policy issues to be considered for effective financial sector
development. Then, we will be focusing on overcoming our weaknesses and replicate our best practices
to get most in terms of economic growth out of the sector. The increased investment in higher learning
and research systems will provide the academics, researchers, and professionals who are researching,
innovating and inventing a new way of doing things with added values, thereby increasing the efficiency
and effectiveness of the economy, political system, and the social environment. I also hope that after
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this conference, the collaboration between Universities and the financial sector will be much more
enhanced.
I wish you all a stimulating and rewarding time.
Thank you very much for your attention!
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Keynote Address
H.E. Dr. Sintayehu Woldemichael, Director of Public Financial Enterprises Agency
H.E. Dr. Sintayehu Woldemichael has made keynote address focusing on issues related to loan and
saving. Among the major points he briefly addressed are the following:
 His Excellency, Dr. Sintayehu Woldemichael, has reminded the participants about economic growth
that Ethiopia has registered over the past nine years. He said that the current growth and
transformation plan would require boosting and sustaining economic growth in the years to come.
He noted that this would require adequate focus on domestic savings.
 He also indicated the need to focus on human and physical capital development, among others. He
stressed that capital accumulation and saving need to be taken as development agenda in the country,
which could be achieved through domestic savings.
 His Excellency also briefly summarized the views of Keynes, Friedman, Modigliani, and other
economists on theories of saving and consumption. He also mentioned that some of the
assumptions of these different views may not work in the context of developing countries. The
possible reasons he mentioned included the level of income which is at subsistent level in these
countries, the prevailing strong relationship of family members to support each other, borrowing
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constraints where current consumption is directly related to current income, and the problems of
macroeconomic stability.
 H.E. Dr. Sintayehu Woldemichael also emphasized on the trends of saving in Ethiopia and the
reasons thereof. He indicated that the current saving level in the country was at a better position.
He also mentioned that the major reason of saving is for the saver to smoothen consumption though
it could be also for economic development of the country.
 His Excellency has also indicated reasons for having low savings which deserve special focus in
terms of further research investigations. These included, among others, poor access to financial
institutions, less knowledge on finance (financial illiteracy), limited products from financial sectors
(saving and loan), and macroeconomic stability. He stressed that it would be necessary to assess
these four structural problems, and that concerted efforts should be made by various stakeholders
towards this endeavor.
 Finally, he also indicated what should be done to solve the indicated structural problems. These
included enhancing financial accessibility, improving financial literacy, introducing new financial
products, and focusing on bringing macroeconomic stability.
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PAPERS PRESENTED ON THE WORKSHOP IN THEMES
Theme 1: Institutions in Loan and Saving
Relative Efficiency of Rural Saving and Credit Cooperatives: An Application of Data

Envelopment Analysis
Kifle Tesfamariam1 and Hailemichael Tesfay2

1
Assistant Professor, Department of Cooperative Studies, Mekelle University,
Email: kifletesfamariam@gmail.com
2
Assistant Professor, Department of Finance and Investment, Mekelle University
Email: hailemichaelt2002@yahoo.com
Abstract: Saving and credit cooperatives have been playing a distinct and important role in providing various financial
services in rural areas of Ethiopia. However, the performance of rural financial cooperatives in mobilization of saving and
provision of credit has been inadequate. Therefore, greater degrees of efficiency among rural saving and credit cooperatives
would result in greater access to finance, higher profitability and increased financial services to rural people. This study was
conducted to examine the technical efficiency of rural saving and credit cooperatives operating in Tigrai region of Ethiopia.
Data were collected from 329 saving and credit cooperatives during the year 2012 and analyzed using Data Envelopment
Analysis (DEA). The result showed that the extent of technical efficiency varies across geographical location and capital
size of the cooperatives. Only 5.5% of the rural saving and credit cooperatives were found to be working at technically
efficient level, while the rest are found to be inefficient. The average efficiency was 21.3% which indicates that there is
substantial amount of inefficiency among rural saving and credit cooperatives in the study area. Technical efficiency was
high for larger saving and credit cooperatives and low for smaller cooperatives. In terms of geographical location, the highest
efficiency was observed among the cooperatives located in western and central zones of the region which accounted for 20 and
27.8%, respectively. The most interesting aspect of this study was that most of the efficient rural saving and credit
cooperatives are the ones that received reward from the regional government for their best performance.
Keywords: Data Envelopment Analysis, saving and credit cooperatives, technical efficiency
1. Introduction
The financial service sector in Ethiopia is composed of formal, semi-formal and informal sectors. The
formal sector comprises diverse range of financial institutions such as commercial banks, insurance
companies and microfinance institutions that are regulated and licensed by the National Bank of
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Ethiopia (NBE). However, the semi-formal and informal sector mainly comprises of financial
institutions like saving and credit cooperatives, and iqqub and iddir, respectively. These institutions play
a central role within the financial sector in providing liquidity for payment services and facilitating
financial transactions of various entities.
In addition, the emergence of member based financial institutions such as saving and credit cooperatives
(SACCOs) has also been recognized for the provision of banking services in Ethiopia. SACCOs, which
were only 495 in 1992, reached 10,270 in the year 2012, and currently constitute the first most common
type of cooperatives in the country in terms of both number and membership with an extensive
networking. As per the proclamation No. 147/1998, SACCOs were expected to play active role in
bringing about broad-based development and poverty alleviation as they were permitted to take deposit
from and grant loan to members. However, this proclamation failed to recognize SACCOs as formal
financial institutions even though they were allowed to accept deposits and grant loans. As a matter of
this fact, SACCOs are not subjected to the regulation and supervision by NBE that other formal
financial intermediaries are subjected to.
Empirical evidences that elucidate these facts were scanty in Ethiopia. The few existing comprehensive
economic analysis of the semi-formal sector like SACCOs which brought light to the nature and relative
economic importance of this sector in Ethiopia were that of Dejene (1993), Mauri (1987) and Girma
(1987). The economic analysis made so far has focused on the formal financial sector like banks.
However, little empirical evidence has been generated to measure the efficiency of SACCOs. In this
regard, whether SACCOs in Ethiopia operate efficiently in providing financial services as well as factors
that affect efficient operation like capital size and location were not studied yet. Hence, the main
objective of this study was to examine the overall efficiency of rural SACCOs in Tigrai region of
Ethiopia.
SACCOs in Tigrai Region: The provision of efficient financial products and services plays a key role in
developing a robust financial sector and enhancing outreach which in turn leads to greater economies
of scale, thereby improving profitability and ensuring sustainability. In this context, the SACCOs in
Ethiopia need structural changes for diversification of their activities to enhance self-sufficiency and
provide access for rural people. For the SACCOs to perform, grow and achieve sustainability while at
the same time proving to be the instruments of development and poverty alleviation, it is relevant and
appropriate to study their relative efficiency.
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The primary beneficiaries of financial services offered by SACCOs are agricultural cooperatives. These
SACCOs do not exclusively target the rural or define their mission as serving the poor. Their long term
strategic direction is to ensure source of finance to agricultural cooperatives, innovate financial products
and services, satisfy key financial needs and diversify members income and wealth base.
In Tigrai region, SACCO members usually rely on their own capital (shares) to foster their economic
development through accessing financial services, saving and credit products. Since 2002, several rural
SACCOs have been established in the region in collaboration with development organizations. Their
appeal to rural people is spreading rapidly as evidenced by the demand indicated in rapid growth rates
in membership and growing average sizes of loans and deposits.
As of June 2012, the number of rural SACCOs in Tigrai region has reached 793 with active total
membership of 120,607 of which the percentage of women members were 38.8 %. These SACCOs
pulled a total saving amount of 2.36 Million USD with 64,764.8 USD in share capital. These share capital
and savings were invested in a 4.03 Million USD loan portfolio that finances microenterprises and
agricultural activities of cooperatives. However, the SACCOs provide less than 1% of the country’s total
financing, and struggle with low-capacity management and governance (Kifle, 2012).
2. Research Methodology
Data sources: as of June 2012, there were 793 rural SACCOs operating throughout the Tigrai region.
However, due to lack of complete data, this study considered only 329 SACCOs operating in all 36
districts of the region. Secondary data were also collected from different sources including financial
statements of the SACCOs. In addition, data were obtained from the annual financial statements and
annual reports of the Federal Cooperative Agency (FCA) and the Tigrai Regional Cooperative
Promotion Agency during the year 2012.
Data Analysis: The two principal method of studying comparative efficiency are parametric and non-
parametric methods. Stochastic Frontier Analysis (SFA) is a parametric method which determines
comparative efficiency levels by hypothesizing a functional form. Data Envelopment Analysis (DEA),
on the other hand, is a non-parametric method which employs mathematical linear programming model
(Coelli et al., 1998). The popularity of DEA rests on its capability to consider multiple inputs and outputs
for calculating relative efficiency. DEA comes up with a single scalar value as a measure of efficiency
and does not require any specification of functional forms as required under parametric models.
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Efficiency of any firm can be defined in terms of either output maximization for a set of inputs
or input minimization for a given output. In DEA, relative efficiencies of a set of decision-making units
(DMUs) are calculated. Each DMU is assigned the highest possible efficiency score by optimally
weighing the inputs and outputs. DEA constructs an efficient frontier composed of those firms that
consume as little input as possible while producing as much output as possible. Firms that comprise the
frontier are efficient while those below the efficient frontier are inefficient. For every inefficient DMU,
DEA identifies a set of corresponding benchmark efficient units (Coelli et al., 1998). Generally, DEA
evaluates the efficiency of a given firm, in a given industry, compared to the best performing firm in
that industry by considering many inputs and outputs. Thus, it is a tool of relative measure.
Various empirical studies on efficiency of banks and financial institutions had employed DEA method
in different contexts. Some of the research work that measured efficiency in the banking sector includes
comparisons made between cooperative rural banks in Sri Lanka (Jayamaha and Mula, 2011), Portuguese
banks (Portela and Thanassoulis, 2007), Taiwanese Commercial banks (Kao and Liu, 2004), Cyprus
Commercial banks (Soteriou and Zenios, 1999), American banks (Brockett et al., 1997), large Canadian
banks (Schaffnit et al., 1997), and Mexican banks (Taylor et al., 1997).
Inputs and outputs: A considerable debate underlying the assessment of the efficiency of service sectors in
general and the banking sector in particular were about what constitute input and output of the banking
industry (Sathye, 2003; Casu, 2002). Two different approaches appear in the literature regarding the
measurement of inputs and outputs of the bank. These approaches are the ‘intermediation approach’
and ‘production approach’ (Humphrey, 1985). The intermediation approach views financial
institutions mainly as mediators of funds between savers and investors (Banker et al.,1984). Outputs
are measured in monetary values and total costs include all operating and interest expenses (Sealey and
Lindley, 1977). In contrast, the production approach view banks as using purchased inputs to produce
deposits and various categories of bank assets. Both loans and deposits are, therefore, treated as outputs
and measured in terms of the number of accounts. This approach considers only operating costs and
excludes the interest expenses paid on deposits since deposits are viewed as outputs. Although the
intermediation approach is most commonly used in the empirical studies, neither approach is completely
satisfactory, largely because the deposits have both inputs and output characteristics which are not easily
disaggregated empirically.
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Berger and Humphrey (1997) suggested that the intermediation approach is best suited for analyzing
bank level efficiency whereas the production approach is well suited for measuring branch level
efficiency. This is because at the bank level, management will aim to reduce total costs and not just non-
interest expenses while at the branch level a large number of customer service processing take place and
bank funding and investment decisions are mostly not under the control of branches. Also, in practice,
the availability of data required by the production approach is usually exceptional rather than in
common. Therefore, following Berger and Humphrey (1997), we have selected intermediation approach
as opposed to the production approach for selecting input and output variables in the present study.
The efficiency scores are estimated for individual SACCOs and mean efficiency scores are calculated
for the sample as a whole. In terms of size and geographical location, estimated efficiencies are also
examined with mean estimated scores over the study year. Moreover, correlation coefficients for
input and output variables are estimated. Saving and total expenses have been identified as inputs and
loans and total income have been identified as outputs. The following table presents the input-output
specifications based on prior studies.
Table1: Input-output specifications of the intermediation approach
Variables Definition Input/ Output

Total Amount paid as interest on deposits, wages and other Input
expenses benefits to employees, and expenses incurred on others.
Savings Deposit mobilized from the members and includes share Input
capital, voluntary, and compulsory savings.
Loans Amount of loan dispersed to the members. Output
Total income Income received on income generating activities and Output
investments as interest.
Table 2 presents the status of SACCO in Ethiopia in terms of number, membership, and savings and
loan dispersed in 2012. The table reveals that despite the importance of commercial banks, organizations
based on cooperative model remained the dominant financial product/service provider. Moreover,
SACCOs compete with other institutions in saving markets as well as lending markets.
Table 2: Status of SACCOs in terms of number, membership, savings and loan dispersed
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Type of SACCO Number of SACCO Membership Size Saving Loan dispersed

Urban 3573 381212 994,960,169 73,185,994
Rural 6134 529063 211,358,991 179,509,934
Total 10270 910275 1,206,319,160 252,695,928
Source: FCA, 2012
3. Results and Discussion
Table 3 presents the results of the descriptive statistics on inputs and outputs. The correlation
coefficients show that all variables have positive and significant relationship with each other. With regard
to the estimated coefficients all output variables (loans and income) are positively and significantly
correlated with deposits and expense. In particular, the association between loan and saving is very high
(0.87). The strong statistical correlation justifies that the selected variables in the DEA models are
appropriate. Overall, the correlation results indicate that change in one variable can be expected to
impact the overall efficiency of the SACCOs. The reminder of this section discusses the efficiency of
SACCOs based on estimated DEA scores.
Table 3: Descriptive statistics of inputs and outputs in DEA model

Input/output Savings Loans Income
Loans 0.870 (0.000)
Income 0.284 (0.000) 0.353 (0.000)
Expense 0.224 (0.000) 0.312 (0.000) 0.442 (0.000)
Correlation is significant at the 0.01 level
Efficiency Score: the summary of estimated efficiency results of the study is presented in Table 4. Using
the variable returns to scale (VRS), the average technical relative efficiency was found to be 0.213, which
means that overall technical inefficiency of SACCOs is around 79% in 2012. Of the 329 SACCOs, 18
SACCOs are identified as “relatively efficient” with technical efficiency score equal to one. The
remaining 311 SACCOs were found to be “relatively inefficient” with efficiency score less than
one in the same year. The inefficient SACCOs can improve their efficiency by decreasing resource
inputs and increasing outputs. In other words, it implies that the SACCOs will be maximizing the
output at given inputs or minimizing the inputs at given out put level depending on the amount of
resource utilized. Most of the SACCOs were inefficient with a very low overall efficiency score of 0.213.
18
This indicates that there is huge possibility for the SACCOs to increase their efficiency by improving
utilization of their inputs and outputs. It should be clear that there are only 18 SACCOs which were
efficient in relative terms.
19
Table 4: Summary of efficiency scores

Descriptive Statistics
Description No of DMUs evaluated Efficient Inefficient Mean Max Min SD
VRS 329 18 311 0.213 1.000 0.008 0.256
SE 329 7 322 0.770 1.000 0.053 0.256
VRS= variable returns to scale; SE = Scale efficiency
Efficiency analysis by size: Table 5 presents the percentage of the sample for the small, medium and large
categories based on capital size in a three tier classification. Based on researchers’ discretion, DMUs
with capital below Birr 100,000, from Birr 100,000 to 200,000 and over Birr 200,000 were categorized
as small, medium and large, respectively. Out of the total sample, the proportion of small, medium and
large SACCOs were 63%, 18% and 19%, respectively.
Table 5: Size metric of the sample
Size Large Medium Small Scale

19% 18% 63% Large = More than 200 thousand Birr, Medium=100
Capital
thousand to 200 thousand Birr, Small=below 100 thousand
Birr
In addition, the efficiency scores were analyzed for each size category using the DEA. Accordingly, the
TE efficiency score were 17%, 16% and 41% for small, medium and large SACCOs, respectively, in
2012 (Figure 1).
TE
0.60
0.40
TE
0.20
0.00
Large Medium Small
TE 0.41 0.16 0.17
Figure1: TE and size
20
Efficiency analysis by location: efficiency scores were examined to see whether geographical disparity affects
the efficiency of the SACCOs. According, Table 6 showed that SOCCOs located in eastern and south
east zones were the relatively efficient and this constitute the lowest proportion. In fact, though South
East zone had none of its SACCOs with a relative efficiency score of one, its overall mean efficiency
score was greater than that of Eastern zone. In relative terms, the other three zones had better number
of efficient SACCOs. It looks like the location factor has effect on efficiency but this requires further
investigation by employing different approaches.
Table 6: Mean efficiency by location
S/No Zone Mean TE No of efficient No of inefficient %age of Efficient

SACCOs SACCOs SACCOs
1 South 0.276 4 65 6.15%
2 South East 0.221 0 35 0%
3 Eastern 0.137 2 69 2.9%
4 Central 0.201 7 104 6.73%
5 Western 0.259 5 38 13.16%
4. Conclusion
The primary objective of this study was to assess overall efficiency of SACCOs in Tigrai region by
employing 329 rural SACCOs in 2012. It was found that the majorities of SACCOs were less efficient
and did not use their inputs efficiently. However, it was found that there were significant differences in
the efficiency of SACCOs by geographical size and locations. The findings of this study are relevant
in making policy decisions in the financial sector to help SACCOs operate in different markets
especially in today’s changing macroeconomic environment in Ethiopia.
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Honolulu 2-4 June, 1987.
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Aredo, D., 1993. The Informal and Semi- Formal Financial Sectors In Ethiopia: A Study Of The
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directions for future research. European Journal of Operational Research 2:175-212.
Brockett, P. L. & A., C., 1997. Data transformations in DEA cone ratio envelopment approaches
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Casu, B. & Molyneux, P., 2001. Efficiency in European banking’, in Goddard, J.A., Molyneux, P. and
Wilson, J. O. S. (ed.) (2001),European banking: efficiency, technology and growth’, John Wiley
& Sons Ltd., Chichester, England. .
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Delis, M. D. & Papanikolaou, N. I., 2009. Determinants of bank efficiency: evidence from a semi-
parametric methodology. Managerial Finance 35:260-275.
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Eisenbeis, R. A. (ed.), Handbook for Banking Strategy, John Wiley and Sons, New York, pp. 745-
83.
Jackson, P. M. & Fethi, M. D., 2000. Evaluating the technical efficiency of Turkish commercial banks:
An Application of DEA and Tobit Analysis. In: International DEA Symposium, University of
Queensland, Brisbane, Australia,2-4 July, 2000.
Jayamaha, A. & Mula, J. M., 2011. Best Financial Practices Analysis and Efficiency of Small Financial
Institutions: Evidence from Cooperative Rural Banks in Sri Lanka. Journal of Emerging Trends
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commercial banks. Journal of Banking and Finance 28:2353-2368.
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Indian banks. . International Journal of Bank Marketing, 20, 122-139.
Portela, M. C., Silva, A. & Thanassoulis, E., 2007. Comparative efficiency analysis of Portuguese bank
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23
The Effect of Asset Liability Management on Profitability of Ethiopian Commercial Banks
Tamiru Belete
Lecturer, University of Gonder, Email: tamsolan2003@gmail.com
Abstract: This study examined the effect of Asset Liability Management (ALM) on the profitability of Ethiopian
commercial banks. The Social Cost Accounting (SCA) framework was used to conceptualize profitability measured as
Return on Asset (ROA). Data were collected from eight commercial banks over the period from 2005 to 2010 and
analyzed using pooled ordinary least square regression model. The result showed that all assets, except fixed assets, affect
profitability positively. From liabilities, saving and fixed deposits, other liabilities and credit balances had significant and
negative effect on commercial banks’ profitability. Among the macroeconomic variables, real growth rate in GDP had
negative and significant effect on commercial banks’ profitability. Based on the result, the study recommend that commercial
banks should focus on increasing public awareness to mobilize more saving and fixed deposits to enhance their profitability.
Keywords: Asset Liability Management, macroeconomic variables, ordinary least square regression model, profitability
1. Introduction
Commercial banks are financial intermediaries that raise funds primarily by issuing checkable demand,
saving, and time (fixed) deposits. The underdeveloped nature of the Ethiopian financial system makes
the commercial banks to be authorized to provide universal banking service in the financial market. For
instance, commercial banks undertake almost all of the transactions and activities of money and capital
market. This conglomeration entails lack of diversification which exposes banks to credit, interest rate
and liquidity risks. Credits risks are only associated with the asset of a bank while both interest rate and
liquidity risks are associated with liabilities which influence investment decisions.
Asset liability management (ALM) involves the management of the uses of funds (assets) including
investments, loans and advances as well as the sources of funds (liabilities) including various savings
collected by banks and equities retained in a way that banks undertake productive financial services in
an economy and maximize their own earnings. In this regard, ALM is considered as a dynamic process
of the planning, organizing, coordinating and controlling system of the various natures of the assets and
liabilities of banks in order to achieve a specified net interest income.
24
Mishikin (2004) indicated that ALM is the practice of managing the various potential risks of commercial
banks that arise due to mismatches and disproportions between the assets and liabilities of the bank.
Such risks were indicated as the risks arising from the movement of interest rates, foreign exchange rates
or liquidity problems. Even though such risks are highly prevalent among Ethiopian commercial banks,
studies focusing on identification, measurement and control of these risks through tracing the effect of
ALM on profitability were negligible. Hence, this study was undertaken to investigate cumulative effect
of ALM and macroeconomic variables on profitability of commercial banks in Ethiopia using the social
cost accounting (SCA) framework. The specific objectives of the study were i) examining the effect of
assets management on profitability ii) examining the effect of liability management on profitability iii)
identifying the specific items of asset that significantly contributes to the profit and iv) identifying the
specific items of liability that significantly cost the profit of commercial banks.
Empirical studies on ALM and profitability in commercial banks: Various studies (Shubiri, 2010; Sayeed and
Hoque, 2008; Asiri, 2007; Kosmidou et at., 2004) pointed out that ALM is a major factor having a
significant effect on the profitability of commercial banks and require major policy concerns among
nations with highly controlled financial systems. Calcagnini and Hester (1997), Vasiliou (1996), Kwast
and Rose (1982), Hester and Pierce (1975), Hester and Zoellner (1966), Hester (1964) also addressed
issues of profitability of commercial banks in developing countries and in Ethiopia. However, such
studies are few and there is a need for further investigation. Besides, macroeconomic factors such as
real growth rate in GDP and general rate of inflation were evidenced to be highly associated with ALM
thereby affecting the ability of commercial banks to generate profit (Sayeed and Haque, 2008; Staikouras
and Wood, 2001). Ramlall (2009) widely described that rapid economic growth increases profitability in
large number of countries and movements in general activity are likely to generate direct impacts on
profitability of banks. Staikouras and Wood (2001) explained that the effect of inflation can substantially
undermine the stability of the financial system and the ability of the regulator to control the solvency of
financial intermediaries, and as a result inferred that an important indirect influence on commercial
banks can lie in the impact of inflation that influences customers behavior and change in demand for
different kinds of financial services.
Data: This study used data from eight purposively selected commercial banks in Ethiopia which
constitute 94.70%, 94.44% and 92.62% of the total assets, deposits and loans, respectively, for the whole
25
commercial banks in the country. The period from 2005 to 2010 was considered and the data were taken
from the NBE.
Model Specification: The SCA model was used to examine the effect of ALM and selective macroeconomic
variables on operating net income of banks explained as the revenues (interest income, service fees and
commissions) and the costs/expenses (interest expenses on deposits and other liabilities and
administrative expenses). The SCA model explains the variation in operating income of bank b in time
t as:
𝜋𝑏𝑡 =∝0 + ∑ ∝1𝑖 𝐴𝑖𝑏𝑡 + ∑ ∝2𝑗 𝐿𝑗𝑏𝑡 + 𝜖𝑏𝑡 …….. (1)
where:
πbt = Operating profit of a commercial bank
Ai = the ith asset of a bank; i = 1, 2, 3… n
Lj = the jth liability of a bank; j = 1, 2, 3… m
b = banks; b = 1, 2, 3… z
t = the time period; t = 1, 2, 3… T
α1i = the marginal rate of return on assets
α2i = the marginal cost of liabilities
α0 = Constant term
εbt = Stochastic term
As the banks included in this study have varying sizes, scale related inefficiencies in estimating the
coefficients associated with heteroscedasticity of residuals (Kosmidou et al., 2004) were minimized by
dividing the values of all the variables for average total asset values as:
𝜋𝑏𝑡 ∝ 𝐴 𝐿 𝑗𝑏𝑡
= 𝐴𝑇𝐴𝑜 𝑖𝑏𝑡
+ ∑ ∝1𝑖 𝐴𝑇𝐴 + ∑ ∝2𝑗 𝐴𝑇𝐴 + 𝜇𝑏𝑡 ……… (2)
𝐴𝑇𝐴𝑏𝑡 𝑏𝑡 𝑏𝑡 𝑏𝑡
𝜖𝑏𝑡
Whereas ATAbt represents average total assets for bank b at time t and but is the ratio 𝐴𝑇𝐴𝑏𝑡
However, the specification of the SCA model indicated above should take into account the effect of
macroeconomic variables on profitability and a modified SCA model employed in this study is as given
below.
26
αo Aibt Ljbt
ROAbt = + ∑ α1i + ∑ α2j + α3 GDPt + α4 INFt + μbt (3)
ATAbt ATAbt ATAbt
Where ROAbt represents the return on assets for bank b at time t, GDPt is the rate of gross domestic
product at time t, INFt is the general rate of inflation at time t, α3 and α4 represents coefficients of real
growth rate in GDP and general rate of inflation, respectively.
Dependent variable: Since income tax is the rate levied by government, it is fixed and the use of net income
after tax as a dependent variable cannot provide unbiased estimate of the influence of ALM and
macroeconomic variables on profitability. As a result, the current study used the return on assets (ROA)
defined as the ratio of operating net income to average total assets as a dependent variable.
Table 1: Explanatory Variables
Variables Description
Assets variables
A1 Deposits in other banks
A2 Other Investments and debit balances (treasury bills, bonds, sundry
debtor, trust funds, and letter of credit)
A3 Loan and Advances
A4 Fixed Assets
Liabilities variables
L1 Demand Deposits
L2 Saving and Fixed Deposits
L3 Other Liabilities and credit balances (other banks deposits, margin held on
letter of credit, provision for taxation, state dividend payables and long
term loans).
Macroeconomic variables
GDP Real Growth rate in GDP
INF General rate of Inflation
Explanatory variables: This study used two categories of independent variables i.e. balance sheet related
asset liability variables and selected macroeconomic variables. The labeling and description of these
variables is given in Table 1.
27
Data Analysis: Both descriptive statistics and econometric approaches were used in this study.
Descriptive statistics including mean, standard deviation, minimum and maximum values of the
explanatory variables were measured. In addition, this study employed a linear regression analysis
explained above to measure the effect of ALM and macroeconomic variables on profitability of
commercial banks. To test the suitability of this method, Hausman and Breusch-Pagen Lagrangian
Multiplier (LM) tests were used to discriminate between the fixed and random effects. Based on the
tests results, the Pooled Ordinary Least square (OLS) model was fitted into the data set to get efficient
and consistent estimates. In addition, Pearson correlation matrix and Variance Inflation factor (VIF)
tests were made to deal with the problem of multicollinearity, cluster regression was run to test the
existence of autocorrelation, Breusch-Pagen Godfrey test for normality was employed to test
heteroscedasticity. Additionally, the normality test was made by using Anderson-darling (Skewness-
kurtosis) and Shapiro-Francia and Chapiro-Wilk tests.
This part of the study provides the empirical evidences on the effect of ALM on commercial banks
profitability in the Ethiopian banking sector over the period of 2005-2010.
4.1. Results of descriptive statistics
Table 2 below presents the descriptive statistics of both dependent and independent variables included
in the study. Accordingly, the ROA of the sample banks was found to be 4.45% with standard deviation
of 0.92%. For assets, the mean value of the deposits made in other banks to ATA ratio (A1) was 12.19%
with standard deviation of 6.85%. The ratio of total investments and other debit balances to ATA (A 2)
was observed to have a mean value of 12.34% with standard deviation of 8.11%. The loans and advances
to ATA ratio (A3) was 61.78% indicating that half of the assets of the commercial banks were in the
form of loans and advances. The standard deviation of 17.20% reveals a greater variability than all other
asset variables used in the study. The mean ratio of fixed assets to ATA (A4) was 1.65% with standard
deviation of 0.74%. This might imply that funds used in acquisition of fixed assets has minimum portion
than other asset items.
On the other hand, for liabilities, the ratio of current deposits to ATA (L1) was found to have a mean
value of 26.04% with standard deviation of 10.66% whereas the mean value of saving and fixed deposits
to ATA ratio (L2) was 59.31% with standard deviation of 13.45%. The mean and standard deviation
28
differences between these two variables can be due to the fact that commercial banks usually accept
deposits with short term maturities from a large number of individuals and grant loans with long term
maturities to a small number of borrowers. The ratio between other liabilities and credit balances and
ATA variable (L3) has the mean value of 15.11% with the standard deviation of 8.15%.
Similarly, with regard to the macroeconomic variables incorporated in this study, the real growth rate in
GDP and the general rate of inflation had mean values of 11.23% and 16.16% with the standard
deviation values of 0.89% and 11.69%, respectively. The minima-maxima comparisons showed that the
mean values of the real growth rate in GDP were with a lower variability while that of the general rate
of inflation was with a higher variability and greater standard deviation.
Table 2: Descriptive statistics of the variables
Variable Mean Std. Dev. Min Max
ROA .0445406 .0092582 .0179993 .0601415

A1 .121973 .0685992 .0212681 .3319977
A2 .1234916 .0811342 .0073624 .5886136
A3 .6178181 .1720636 .2461131 .8723988
A4 .0165206 .0074317 .0060778 .0375375
L1 .2604076 .1066681 .0892808 0.495429
L2 .5931932 .1345706 .3295338 .7966882
L3 .151184 .0815949 .029029 .4638283
GDP .1123333 .0089759 .099 .126
INF .1616667 .1169785 .028 .364
4.2. Results of the econometric model
Before running the econometric model, all the necessary tests with regard to specific and econometric
assumptions were made to validate the models and minimize biases in the data set.
Effects of assets management on profitability: the pooled regression results indicated in Table 3 revealed that
all assets (except fixed assets) had a positive effect on the profitability of commercial banks implying
that effective management of these assets can enhance profitability. From the asset items, loans and
29
advances to ATA ratio was observed to have significant contribution to ROA as a measure of
profitability. The parameter α0/ATA was observed to be positive and significant in affecting profitability.
This also revealed that the existence of diseconomies of scale, thus, there is no significant profitability
difference among larger and smaller banks included in the study.
Effects of Liability Management on Profitability: As shown in Table 3, the pooled OLS regression analysis
result showed that all liabilities have negative effect on commercial banks’ profitability. The data further
indicated that the ratios of saving and fixed deposits to ATA as well as the ratio of other liabilities and
credit balances to ATA were significantly costing the profitability of commercial banks in the Ethiopian
financial market at 10% level. This can be due to the fact that saving and fixed deposits are the only
large size source of funds while other liabilities and credit balances are costly source of funds.
Effects of Macroeconomic Variables on profitability: As indicated in Table 3, both real growth rate in GDP and
general rate of inflation were significantly and negatively affected the profitability of the sample
commercial banks. Real growth rate in GDP was observed to significantly affecting profitability at 0.01
which might be due to the fact that the level of GDP influences the supply and demand for loans and
deposits, the cumulative sum of which may result in negatively affecting the profitability of banks. The
negative and insignificant relationship between profitability and general rate of inflation exist either
because bank managements may not be able to well anticipate the future rate of inflation or it may be
happened unexpectedly. This is important because bank management’s ability to predict inflation
accurately can positively affect the profitability of the bank as the bank can adjust interest rates in the
desired direction in order to increase profit, while failure to accurately predict inflation could raise costs
due to imperfect adjustment of interest rates and thus adversely affect bank’s profit.
30
Table 3: Pooled OLS regression result
ROA Coef. Std. Err. T P>t [95% Conf. Interval]

A1 .0333322 .0224744 1.48 0.146 -.0121649 .0788293
A2 .0095676 .0145893 0.66 0.516 -.0199669 .039102
A3 .0494292 .0117355 4.21 0.000* .0256718 .0731865
A4 -.003068 .1827806 -0.02 0.987 -.3730881 .366952
L1 -.0165925 .0226817 -0.73 0.469 -.0625092 .0293242
L2 -.0430796 .0193108 -2.23 0.032** -.0821723 -.0039869
L3 -.0420708 .0218657 -1.92 0.062*** -.0863356 .002194
GDP -.6291626 .1699912 -3.70 0.001* -.9732918 -.2850334
INF -.0004752 .011432 -0.04 0.967 -.0236182 .0226677
_cons .1157945 .0232292 4.98 0.000* .0687693 .1628196
Number of Observations = 48
F(9, 38) = 4.63
Prob > F = 0.00004
R-Squared = 0.5231
Adj. R-Squared = 0.4102
*,**,*** = Significant at 0.01, 0.05, and 0.1, respectively
5. Conclusion and Recommendations
5.1. Conclusion
The basic purpose of this study was to empirically examine the effect of ALM and macrocosmic
variables on profitability of commercial banks in Ethiopia. The findings evidenced that the profitability
of commercial banks in Ethiopia was positively affected by assets management and negatively affected
by liability management. Specifically, loans and advances positively affected the profitability of
commercial banks. All other asset variables were found to have no significant effect on commercial
banks profitability implying that the asset base of commercial banks in Ethiopia is too narrow. The
parameter α0/ATA is positive and significant indicating diseconomies of scale. Thus, there is no
significant profitability difference between large and small banks during the study period. Liability items
like saving and fixed deposits as well as other liabilities and credit balances were significantly costing the
profitability of commercial banks. As a result, the performance of commercial banks is related to their
ability to attract individual depositors.
31
The real growth rate in GDP has significant because its effect will depend on the economic conditions
available in the economy. Favorable economic condition will affect positively the demand and supply
of commercial banking services and profitability.
In general, assets management, mainly loans and advances, contributes positively to the profitability of
commercial banks, except fixed assets. While liability management, particularly saving and fixed deposits
and other liabilities credit balances, negatively costs the profitability of commercial banks. Therefore, in
the Ethiopian commercial banking market, assets management positively and liability management
negatively affects profitability.
4.2. Recommendations
Since saving and fixed deposits are the main source of funds for commercial banks, there should be
clear and precise strategies to aggressively attract individual depositors. For this, public awareness on
investments should be increased to increase the liability base of commercial banks. Commercial banks
should be able to look into long term effects of inflation on the overall bank performance and need to
expect adverse effects of such uncertainties on commercial banks’ profitability.
To improve profitability as much as possible, commercial banks have to formulate aggressive policies
for attracting saving and fixed deposits, even if the NBE require banks to retain a certain portion of the
deposits with the bank as liquidity requirement. The supervisory and related services of policy makers
should be geared towards optimum utilization of resources, prudent risk management, sound
competitive environment, and excellence in service. Policy makers should enforce the government to
have hard rules on loan default makers. This would enable commercial banks to diversify their loans
and advances and they could realize the required profit out of it.
Possibly, if the money and capital markets are created and expanded, the asset and liability bases of
commercial banks will increase and their asset portfolio might have more significant and positive effect
on profitability. Therefore, the government should try to have solid rule and procedures on it and every
concerned body should strive for its realization.
32
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33
Determinants of Microfinance Service Utilization in Dire Dawa Administration, Ethiopia
Endalew Wale1, Endrias Geta2 and Jema Haji2

1
Meserete Kristos Church Relief and Development Association, Email: endalwtg@yahoo.com
2
School of Agricultural Economics and Agribusiness Management, Haramaya University
Abstract: In Ethiopia, poverty is pervasive and it is argued that one of its causes is deprived access to credit and other
microfinance services to be used for the purpose of working capital as well as investment. Thus, micro credit service is among
the areas of priority in the fight against poverty and ensuring sustainable development. The objectives of this study were to
identify the determinants of microfinance credit service utilization and the prevailing challenges and opportunities faced by
the MFI in the provision of the service in Dire Dawa Administration. It was based on the data obtained from 160
respondents, selected using multi-stage sampling technique as well as focus group discussions and key informant interviews.
A binary logit model and descriptive statistics were used for the analysis of the data gathered. The result indicated that
utilization of microfinance credit service was significantly influenced by factors such as area of residence, possession of fixed
asset, sex of the respondent, educational level attained and distance of the respondents’ residence from microfinance service
giving center. Moreover, problems related to institutional capacity building, client mobility, and lack of facility for screening
defaulters, harsh intervention environment, prevalence of HIV/AIDS, lack of incentive and limited awareness among the
community were found to be the major challenges of credit service provision. However, supportive policy environment and
improvements of the saving culture were the available opportunities for the betterment of microfinance service provision in
the area. Therefore, developing gender sensitive strategies that promote the service provision among the female members of
the community as well as developing an incentive package targeting female members of the community, establishment of
satellite offices in the peripheral parts of the administration, focus to institutional capacity building, implementing a working
and effective follow-up system, and designing human resource development plan need to be implemented by the concerned
authorities to improve the performance of microfinance service provision and utilization.
Keywords: Credit service, logistic regression model, microfinance institutions
1. Introduction
In our world, it is common to observe a few rich and a lot of poor people who cannot fulfill the
minimum requirements of basic needs for their survival. Despite the score of modernization and
advancement that have been registered in the world, the percentage of people living below poverty line
is still huge (Todaro, 2000). Such condition is pervasive especially in least developed countries like
Ethiopia. Like most developing countries, Ethiopia is one of the low income countries in the world.
34
The Ethiopian economy is mainly dependent on agriculture and vulnerable to several internal and
external shocks such as frequent draughts, high population growth, low investment, and volatile
primary product prices. These and other factors have resulted in declining level of the economy with
deteriorating living conditions.
Since unemployment is the major problem in the Ethiopian economy, a lot of people were to join the
informal sector. This sector is said to have a significant role in the creation of jobs and income
generation for a large proportion of the population in Ethiopia. According to a paper compiled by the
Ministry of Finance and Economic Development, the number of people earning their livelihood from
the informal sector activities and small scale manufacturing industries is eight times larger than those
engaged in the medium and large scale industrial establishments (MoFED, 2002). But, one of the
major challenges in the informal sector was acquiring financial resources. To overcome this problem,
microfinance services were indicated as suitable solutions that meet the need of borrowers who need
capital in small amount.
In Ethiopia, delivery of financial services to the poor is a very recent development which was started
with proclamation number 40/1996 in which the legal framework that allow the establishment and
operation of microfinance institutions was framed. Microfinance credit service has become one of the
most prominent instruments in the development programs and strategies of the country. Dire Dawa
Microfinance Institution (DMFI) is one of those MFIs that were established and operating in the
country. This institution is currently engaged in providing financial access to a large number of low
income group and unemployed people in and around the residents of the Dire Dawa administration
who were not able to have access to the financial services including micro credit service provided by
formal banks due to perceived risk and lack of collateral (DMFI, 2010).
Despite the efforts made by DMFI to increase outreach in financial services, there is still a huge amount
of unmet demand for such services. MFDR (2009) indicates that although consecutive reforms and
efforts were made by the organization to sustain the service, utilization of the service among the
community is affected by a number of factors. Hence, it is crucial to identify the determinants of
microfinance credit service utilization and explore related challenges and opportunities. The objective
of this study was, therefore, to identify the determinants of microfinance credit service utilization in
Dire Dawa Administration and assessing the prevailing challenges and opportunities faced by the MFI
in the provision of the service.
35
Types and sources of data: Both primary and secondary data were collected. Primary data were collected
from a random sample of 160 households having exposure to DMFI while secondary data were collected
from documents of DMFI, CSA abstracts and Regional Bureau of Agriculture and Bureau of Finance
and Economic Development.
Sampling design and procedure: A multi-stage stratified sampling technique was employed to select sample
respondents. In Dire Dawa administration, 9 urban kebeles and 5 rural kebeles were identified. Hence,
the target groups were stratified based on the geographical location. Taking time, budget and accessibility
into consideration, a total of four kebeles, two from rural and two from urban were randomly selected.
Accordingly, kebele 01 and kebele 06 from the urban PAs and Biyo Awale and Wahele kebeles from the
rural PAs were selected. Table 1 summarizes the samples taken.
Methods of data analysis: The data were analyzed using econometric model and qualitative approach. An
econometric model known as binary logit regression model was used to identify the relative influence
of explanatory variables on the dependent variable. A qualitative approach was used to summarize the
constraints and opportunities identified during focus group discussion and key informant interview.
Table 1: Sample kebeles and sample size
Kebeles Total HHs Sample service Non-user Sampled Total

user HHs HHs non-user sample
HHs HHs
Kebele 01 1400 18 1382 14 32
Kebele 06 4950 40 4910 50 90
Wahele 950 7 943 10 17
Biyo Awale 1050 10 1040 11 21
Total 8350 75 8275 85 160
3.1. Determinants of microfinance credit utilization
The binary logit model results indicated in Table 2 revealed that utilization of microfinance credit service
was determined by the interaction of different demographic, socio-cultural, economic, and institutional
36
factors. To test the measure of goodness of fit in logistic regression analysis, the chi-square was
computed and showed that the model was significant at 1%. Hence, the null hypothesis stating the
coefficients of independent variables to be equal to zero was rejected. The result indicated that 83.6%
of the non-user and 86.6% of the users were correctly predicted at the cut value of 0.5. The model
correctly predicted 85% of the sample cases.
Table 2: Maximum likelihood estimates of the logit model
Estimated S.E Wald Sig. Odds Ratio

Coefficient B Statistics Level. Exp (B)
SEXOFRES -2.607 0.638 16.695 0.000 0.074
AGEOFRES 0.008 0.026 0.088 0.766 1.008
LENDNGPRO 0.099 0.500 0.039 0.843 1.104
FIXDASSET 2.036 1.225 2.763 0.096 0.131
MARGE -0.235 0.351 0.448 0.503 0.791
KNOW 0.875 0.815 1.155 0.283 0.417
MEDAUSER 0.504 0.570 0.782 0.377 0.604
AOROFRES 2.099 0.612 11.751 0.001 8.156
PDSEPI 0.332 0.563 0.349 0.555 0.717
MOC 0.760 0.597 1.624 0.203 0.467
LONPAYMNT 0.458 0.500 0.838 0.360 0.633
DSTFINC -0.744 0.227 10.751 0.000 0.475
EVRRISK 1.051 0.522 4.052 0.244 2.861
EDULEVL 0.109 0.089 1.524 0.017 0.896
Constant 2.819 2.353 1.435 0.231 16.764
Pearson -  value
2
77.571*** df = 16
-2Log Likelihood 116.253
***, ** and * refer to significance at 1%, 5%, and 10% probability level, respectively.
Education level of the respondent (EDULEVL): This variable was significant at 5 percent and positively
related with microfinance credit utilization. This implies that all other things being kept constant, the
odds ratio in favor of utilizing microfinance credit service would increases by a factor of 0.896 for a unit
increase in education. The possible explanation for this is that education helps the individual to utilize
37
microfinance credit service, because the capacity created would help the individual to analyze and
interpret and make use of it than less educated individuals.
Sex of the respondent (SEX): The variable was significant at less than 1 percent significance level and
negatively related with microfinance credit service utilization in the study area. This indicates that all
other things being kept constant, utilizing microfinance credit service would decrease by a factor of
0.074 for female respondent. The possible explanation may be that male respondents have high
involvement in the outdoor activity and better access to information accompanied by high decision
power in comparison to that of female respondent.
Area of residence of respondents (AOROFRES): Area of residence of the respondents positively and
significantly influences the probability of utilization of micro credit service at 1% in the study area. As
indicated in Table 2, the odds ratio in favor of utilizing microfinance credit service increases by a factor
of 8.156 for respondent residing in the urban area, citrus paribus. The possible explanation for this is
that urban residents may have better access to the microfinance institution service and information
related to microfinance credit institutions than that of the rural counterparts.
Distance of the microfinance institution from the respondent house (DSTFINC): The result showed that the distance
of the respondent from the microfinance institution was significantly and negatively related to the
utilization of microfinance credit service. This revealed that respondents in short distance from the
microfinance institution were more likely to use microfinance credit service. Moreover, the odds ratio
in favor of utilizing microfinance credit service decreases by a factor of 0.475 for those respondents
residing at a far distance from the site of the microfinance institution. The possible explanation for this
is that as the respondent is close (near) to the institution, he/she may have more knowledge about the
service than the one in far place.
Respondent possession of fixed asset (FIXDASSET): The variable was significant at 10 percent and positively
related to microfinance credit service utilization. This implies that, citrus paribus, the odds ratio in favor
of utilization of microfinance credit service increases by a factor of 0.131 for respondents having a
resource considered as a fixed asset. The possible reason for this is that the possession of fixed asset
would help the individual to easily meet the collateral requirement for the service.
3.2. Constraints of microfinance service provision
38
The responses obtained from the sample respondents both in the rural and urban area were triangulated
with the experts and authorities affiliated to microfinance service provision. The following constraints
were forwarded and underlined by the participants of the focus group discussion and individual
interview as the main challenges hindering microfinance service provision in the administration.
Problems related with institutional capacity building: The result of interview and focus group discussion
indicated that institutional capacity building was not given attention due to lack of sufficient funds as
referred from the budget of DMFI.
Client mobility: In the group discussion with the microfinance officials, client mobility is one of the
major challenges affecting the service provision of the institution. As a result, the organization is being
forced to prefer dealing with clients of fixed seat as security for their investment. It was mentioned that
large number of clients were reported to change their residence after taking credit from the institution.
They either change residence within a city or relocate to other places in search of better job opportunities.
It was underlined that client mobility causes lending institutions to incur huge operational costs as costs
for follow-ups and tracing are high.
Lack of capacity for screening defaulters: The institution has tried to decentralize the service across offices in
all the kebeles especially in the urban part of Dire Dawa. With this expansion of the service across all
the kebeles, the number of microfinance service users has significantly increased. Despite the increase
in the number of beneficiaries of the service, the institution does not have a well-functioning system to
screen the defaulters. In the discussion with the officials, it was clearly stated that with the increasing
number of defaulters, a well-developed mechanism and capacity to screen defaulters has become
imperative. The institutions have been already funding the same defaulters thereby affecting its loan
books. It is, therefore, apparent that lack of such capacity is a constraint to the development of the
microfinance service in the area.
Challenges in macroeconomic environment: In the discussion with the officials of Dire Dawa Microfinance
Institution, it was found that working in the microfinance sector by itself is a challenge due to many
factors including the nationwide high inflation rate. The macroeconomic environment is very
challenging and it requires the institutions to innovatively take the market conditions into account and
quickly responds to the emerging changes.
39
Lack of incentives: The participants of group discussion both from the community and the institution clearly
disclosed the limited capacity of Dire Dawa Microfinance Institution in comparison to the huge demand
of the service by residents in the urban and rural areas. The importance of participation of other
stakeholders in the microfinance service provision was also considered to be crucial for which there has
been no established attractive incentive structure. Since this sector has given high priority in the
development agenda because of its potential to create jobs and increase household incomes, there should
be clearly defined incentives for participants in the sector.
Low level of awareness about the service: It was found out during the group discussion that the DMFI has no
experience of promoting the service and there was no deliberately organized and strategically planned
awareness creation mechanism that targets the promotion of the service. The same result was also
obtained in the discussion with the community in which the majority of the participants did not know
even the objective of the institution.
Staff turnover: During the focus group discussion with the officials and experts as well as the beneficiaries
of the microfinance institutions, workers turnover was mentioned as the main challenge faced by the
institutions. Significant turnover was underlined to affect the service delivered by the organizations. In
discussion with the staff, the key reasons were identified to be low salary rate and absence of incentive
package. During the discussion it was mentioned that at least one staff member has resigned both from
main and branch offices during the previous budget year.
Lack of coordination among partners: In discussion with the experts and officials of DMFI, the participants
mentioned that different NGOs have been using microfinance service as a means of extending revolving
fund to their targeted beneficiaries. Despite increasing number of NGOs working on microfinance
services, there is no coordination among the organizations. This created lending duplication in addition
to challenges created to control defaulters.
3.3. Opportunities available for effective microfinance service provision
Favorable policy environment: The focus group discussion has revealed that the existing government policy
offers an opportunity for the promotion of microfinance services as it is very supportive and allows the
institutions to expand their service.
Improvement in saving culture: Different efforts are being exerted by government of Ethiopia to cultivate
saving culture and thereby increase the saving rate. As part of enhancing saving culture, both
40
promotional and institutional measures are being implemented. For example, the saving for housing is
one form of the institutional saving promotion strategy being applied by the government. In the
discussion with the community and the officials of DMFI, it was stated that the saving culture is
improving and this is believed to be a good opportunity for the development of microfinance service in
the area.
Changing attitude towards the service: In discussion with the beneficiaries and experts of DMFI, it was
mentioned that the service is becoming effective in creating jobs and addressing the need of marginalized
groups that can be used as social collateral. The experts of DMFI stated that the number of people
benefiting from the service is increasing through time. This appears to be above the capacity of the staff
members who serve the customers and as a result customers wait for long time to be served.
4. Conclusion and recommendations
This study was carried out with the objectives of identifying the determinants of microfinance service
utilization as well as the associated challenges and opportunities by taking DMFI as a case. In the
study, it was observed that education was positively and significantly related to utilization of
microfinance credit service. Therefore, it is recommended that the microfinance institution has to find
ways by which the uneducated members of the community can better benefit from the service. In
addition, the institution has to strengthen its effort of promoting the service among the uneducated
and marginalized parts of the community.
The other important factor identified to significantly influence microfinance credit service utilization
was sex of the respondents. It was observed that microfinance credit service utilization is higher
among the male respondents. Hence, the concerned authorities have to develop the strategies that
promote the service provision among the female members of the community. Furthermore, the
microfinance institution has to develop an incentive package targeting female members of the
community. Promotional activities focusing on female beneficiaries must ensure their active
participation.
The area of residence was identified to significantly and positively influence microfinance credit
utilization by the respondents. Therefore, the microfinance institution in the administration is strongly
advised to design a strategy by which the rural community can better benefit from the service. In
addition, DMFI should open satellite offices in rural kebeles of the administration so that the
41
communities in the administration could benefit from the service. Also, distance from microfinance
institution was negatively related to microfinance service utilization. This also indicates the need to open
satellite offices at adjacent areas of beneficiaries to ease access to the service. It was found that lack of
due attention towards institutional capacity building is the major constraints in microfinance service
provision due to lack of sufficient funds. This indicates that microfinance institutions need to have a
clear vision of targeting institutional capacity building with sufficient budget allocation. The
organization is also advised to put in place a regular capacity assessment plan so that the identified
gap could be addressed in a regular manner.
Client mobility was one of the major challenges affecting the service provision. This requires the
DMFI to design and implement effective monitoring system so that the institution can take timely
action. Moreover, staff turnover was one of the challenges faced by DMFI. Hence, the DMFI should
put in place performance based salary structure as well as incentive package to retain qualified staff.
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44
Health Check-up of Commercial Banks in Ethiopia
Yonas Mekonnen, Arega Seyoum and Anteneh Gorfu

Lecturers, College of Business and Economics, Jimma University
E-mail: Mekonneny@gmail.com
Abstract: One of the problems of Ethiopian commercial banks is their tendency to rely on mere ratio analysis in evaluating
their financial performance. No attempt has been made to apply Capital adequacy, Asset quality, Management efficiency,
Earning ability and Liquidity position (CAMEL) framework to check their performance. This study evaluated the
performance of selected commercial banks in Ethiopia using a framework of CAMEL. Data were collected from sample
audited annual reports of private and public banks for the years 2000-2010 which were selected using judgmental sampling
technique. Descriptive and inferential statistics as well as multiple regression models were used to analyze the data. The
result showed that the independent variables in CAMEL framework have highly explained the performance variables i.e.,
return on assets and return on equity. The private banks were in a better position than the public banks in terms of asset
quality, management quality, and earning ability, while public banks were better in capital adequacy. However, liquidity
position was high for both private and public commercial banks.
Keywords: Bank performance, CAMEL framework, health of commercial banks
1. Introduction
Banks are the key financial institutions that provide financial services thereby highly contributing to the
economy of a given country. The returns on asset are the indicators of the healthiness of these
institutions. According to Flamini (2009), the banks in most sub-Saharan African countries have shown
an increase to their return as compared to other banks in other developing countries. Banks in Ethiopia
has also shown a great improvement in their return on asset (NBE, 2010). There were 15 banks in
operation and 30 microfinance institutions, among which 12 were private banks and the rest 3 were state
owned banks. In 2008, the Ethiopian banking industry covered 91.5% of the total asset share of the
financial institution (EEA, 2011). Performance of banks in Ethiopia as stated by many researchers is in
a good position compared to other African countries.
According to Access Capital (2010), Ethiopian banks were showing growth in terms of their profitability
and dividend shares. Mostly the private banks in Ethiopia get their main revenue from collecting deposit,
providing loans and foreign exchange. By the end of June 2010, the bank sector had capital and reserves
of 5,064 billion Birr while having a loan portfolio of 21,385 billion Birr with 23.7% capital adequacy
ratio (CAR) (Addis fortune, 2010).
45
There are different measurements of bank performance used by different countries. The international
framework set by the bank for international settlement in Basel accord is used as a base in most countries
to evaluate the financial performance of their banks. This framework sets the extent that banks should
acquire capital i.e., at least 8% of the risk-weighted asset. The directives of the National Bank of Ethiopia
(NBE) have adjusted its standard to the Basel standard stated above.
This paper attempted to assess the overall performance of Ethiopian banks in a comprehensive manner
based on international and national standards with the objective to test whether or not the banks in
Ethiopia meet the directives set with respect to financial performance. Specifically, the study attempted
to check the financial health of banks and identified the strength and weakness of the banks. The study
used the CAMEL framework and directive set by national bank of Ethiopia to evaluate the stand point
of the commercial banks in Ethiopia.
2. CAMEL Framework Based Bank Health Check-up
Saidov (2011) stated that the role of the commercial banks is considered as a backbone to the survival
of the economy of a country as their function intermediates between depositors (savers), borrowers,
investors, and other stakeholders in the financial sector. Most commercial banks in different countries
use different methods to evaluate their performance. In addition to the customary ratio analysis, banks
use methods like CAMEL framework, GIRRAFE, EAGELS and PEARLS. Uyen (2011) pointed out
that CAMEL can figure out the performance of banks in all aspects, provide a useful tool to examine
the safety and soundness of banks, and mitigate the potential risks which may potentially lead to bank
failures. Kouser (2012) also indicated that CAMEL framework is used for evaluating performance,
ranking and assessing banks based on capital adequacy, asset quality, management ability, earning ability
and liquidity position.
CAMEL rating has become a concise and indispensable tool for examiners and regulators of banks. This
rating ensures a bank’s health conditions by reviewing its different aspects based on various information
sources such as financial statements, funding sources, macroeconomic data, budget and cash flow
(Dang, 2011). Nevertheless, Hirtle and Lopez (1999) emphasized that CAMEL rating is highly
confidential, and only exposed to the bank’s senior management for projecting the business strategies,
and to appropriate supervisory staff. CAMEL framework has five components: capital adequacy, asset
quality, management quality, earning ability and liquidity position as elucidated below.
Capital adequacy: Capital adequacy or regulatory capital is determined to understand how well banks can
have enough capital in order to sustain operational losses and show whether the banks are not engaged
46
in investment activities that increase risk to default. The capital structure of banks is usually highly
regulated because capital plays a crucial role in reducing the number of bank failures and losses to
depositors. When a bank fails, the highly leveraged firms are likely to take excessive risk in order to
maximize shareholder value at the expense of finance providers (Olweny and Shipo, 2011). Capital
adequacy for this study has been analyzed using two categories such as capital adequacy and leverage
ratios.
Asset quality: Asset quality is one of the major factors that affect the health of banks. The quality of assets
held by an individual bank has an impact on the performance of the bank. Exposure of credit risk, trends
of non-performing loan and borrower’s profitability determine the heath of the asset quality of a bank
(Baral, 2005). In addition to assessing trends in classified assets, delinquent loans and credit
concentrations, the asset quality component rating takes into account management’s ability to
underwrite and administer credits in a prudent and sound manner (Ilhomovic, 2009). To evaluate asset
quality, the current study used two financial ratios i.e., loan loss provision to total loan and loan loss
provision to total asset.
Management quality: Measuring of management quality is subjective by its nature. As such sound
management is a key to bank performance but is difficult to measure. It is primarily a qualitative factor
applicable to individual institutions. Several indicators, however, can jointly serve as an indicator of
management soundness. Expenses ratio, earning per employee, cost per loan, average loan size and cost
per unit of money lent can be used as a proxy of the management quality (Baral, 2005). For this study,
two rations i.e., operating expense and interest expense ratios were used to measure management quality.
Earning ability: Earning ability indicates the ability of the banks in generating revenue by using assets,
shareholders equity and the proportion of gross income. To assess the earnings performance of a bank,
it will be helpful to look at a variety of ratios and measures including return on assets (ROA), return on
equity (ROE) and profit margin (PM).
Liquidity position: Liquidity is defined as the capacity of financial institutions to finance the increases in
their assets and pay their liabilities as these mature. Siegel (2007) defined liquidity as the ability of a firm
to meet its short-term obligation. Banks can concretely manage their liquidity risk in many ways such as
where it is exactly performed in the organization, how liquidity is measured and monitored, what
measures banks can take to prevent or tackle a liquidity shortage.
47
Quantitative data has been used to evaluate the performance of the banks using the last ten year data
starting from year 2001 to 2010. The reason to focus on secondary data was that CAMEL framework
mainly demands data from audited annual and published reports. Out of 15 banks which are in full
operation, 8 were purposively selected based on three criteria i.e., capital size of the banks, year of
establishment and rank of banks in 2010 African banks rating. Both descriptive and inferential statistics
were used to analyze the data. In addition, multiple regression analysis was used to analyze the
relationship between the independent variables and the dependent variables of health indicators (ROA
and ROE).
Model specification: The multiple regression model was specified as:
ROA = βo+ β1CAR1it + β2LLPLit + β3IER3it + β4PM4it + β5LDRit + ε
ROE = βo+ β1CAR1it + β2AQ12it + β3IER3it + β4PM4it + β5LP15it + ε
Where ROA refers to return on assets, ROE is return on equity, βo is the constant variable, CAR 1it
stands for capital adequacy ratio of banks at time t, LLPLit refers to loan loss provision to total loan at
time t, IER3it is interest expense ratio to loan of banks at time t, PM4it is profit margin of banks at time
t, LDRit is liquidity position based on loan to total deposit ratio of banks at time t, and ε indicates the
error term. Similarly, β1, β2… β5, represent the coefficients that infer the change to the dependent
variable.
Capital Adequacy: The capital adequacy ratio result showed that all Ethiopian banks fulfill the standard
set by the Basel accord and national bank of Ethiopia as well as the sub Saharan African capital adequacy
ratio benchmark. The minimum and the maximum average in the last ten years is 25% and 33%,
respectively. This result is quite greater than the standard of minimum 5%. However, private banks
average was below the industry average in contrast to the public banks. Based on the result computed
from audited annual financial statement of the banks, all banks included in the study were highly
leveraged banks.
Asset Quality: Asset quality was measured in relation to the level and severity of non-performing assets,
recoveries and level of provisioning. Based on loan loss provision ratio, the result for Ethiopian banks
showed a good position. Banks that give higher loan had higher loan loss provision ratio. The higher
ratio indicates that the banks were participating in a more risky loan provision service. The default rate
of private banks was lower than that of public banks. Loan loss provision to total asset was used to see
48
whether Ethiopian banks loan loss provision is kept in their account in proportion to their asset, so that
they can have the ability to cover if default occurs. The higher ratio indicates the banks’ ability to control
any losses occurred on its asset. Nevertheless, higher ratios indicate that the bank is participating in a
riskier business. If the bank kept a higher provision, it means the bank is expecting loan provided to
customer has a high probability of not being returned. The result indicated that all Ethiopian banks loan
provision to total asset is small compared to their asset size. Based on NBE status, the private banks
were strong and the public banks are said to be satisfactory in their asset quality.
Management Quality: The lower the ratio the better is the performance of the manager in using the
resource in generating revenue. The minimum expense spent by Ethiopian banks was 29% indicating
an expense of 29 cents from 1 Birr earning generated by operating the business. Almost 87.5% of the
Ethiopian bank managers were effective and efficient in spending in operation to generate revenue.
Lower ratio shows how well the manager is effective in achieving its goal. Interest expense ratio shows
how well banks manage the loan and this helps the bank to pay an interest expense. Higher ratio indicates
that the financial health of the banks is worsening. This in other term indicates that the manager of the
bank is not efficient in controlling its asset. The industry average of Ethiopian commercial banks in the
last ten year showed that banks should spend 3% of the total loan provided as interest expense from
the loan they are providing. In general, Ethiopian commercial banks are said to be effective and efficient.
Earning Ability: This shows how well manager make control to the asset of the bank and equity in order
to get a better earning. Earning quality of Ethiopian banks in this study was calculated and analyzed by
using three measurements including ROA, ROE and profit margin. The higher the ROA ratio, the better
is the health of the financial institutions. The industry average of Ethiopian banks for the last ten years
was 2.5, which was greater than the African standard (2.0). Hence, Ethiopian banks can be considered
to be healthy banks implying that Ethiopian banks are very strong in generating revenue using their asset
efficiently during the period. Regarding ROE, Ethiopian banks were strong enough in generating profit
using their shareholder equity properly. On the other hand, the profit margin of Ethiopian banks were
said to be in a good level. In general, the above analyses indicated that the earning ability of the Ethiopian
commercial banks was at a good position.
Liquidity Position: The liquidity position of Ethiopian banks has been evaluated using two methods, liquid
asset to deposit ratio and loan to deposit ratio. The result indicated that the Ethiopian banks included
in this study were liquid. This is a good indication for the bank to attract more customers because
customer will be free of fear to deposit in bank. The other is loan to deposit ratio which indicates
49
institution's ability to cover withdrawals made by its customers. The higher the ratio of loan to deposit
ratio, the weaker is the financial health of the banks. Ethiopian banks asset have the ability to cover the
liability of the banks. So they are said to be strong and liquid banks.
Results of Regression Model: From the variables included in this study, capital adequacy, interest expense to
loan and net income to gross income were significant in influencing the healthiness of banks as measured
by ROA and ROE proxies. Loan loss provision to loan, interest expense to total loan as well as loan to
deposit ratio affected ROA negatively where as capital adequacy ratio and loan to deposit ratio affected
it positively. The study showed that 49.1% and 74.7% of the variations in ROA and ROE, respectively,
were explained by independent variables.
This study showed that the commercial banks in Ethiopia had high non-utilized money which indicated
mobilization of resources was difficult and showing low profit generation of the public banks. The
managers of banks can alleviate the problem by setting different strategies like lending tied money to
different investors by participating in non-interest business and in a business that helps in generating
stable income. They should give due consideration to their capital adequacy as it plays a crucial role in
reducing the number of bank failures and losses to depositors when a bank fails.
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Ganeriwal, L. and Modi, U., 2010. Camel Framework as a Tool of Performance Evaluation for
Banking Institution. Som-Latit Institute of Management Studies, India, Ahmadabad.
Hirtle, B. J. and Lopez, J. A., 1999. “Supervisory Information and the Frequency of Bank
Examination”. FRBNC Economic Review, p. 4.
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Kosmidou, K., 2008. Measurement of bank performance in Greece. South-Eastern Europe Journal of
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the Italian banking supervisory system. Published in Banca Impresasocieta, AnnoXXVI, N.2, agosto.
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Commercial Banks in Kenya. Economics and Finance Review 1(5): 01 – 30.
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Addis Ababa, Ethiopia.
51
Theme 2: Governance and Policy Dimensions in Loan and Saving
Deficiencies in Legal, Regulatory and Supervisory Frameworks of Saving and Credit

Cooperatives in Ethiopia
Aregawi Tesfay and Kifle Tesfamariam

Mekelle University
Email: aronet2@yahoo.com, kifletesfamariam@gmail.com
Abstract: Deficiencies in legislative and regulatory frameworks risk the growth and soundness of any financial institutions
in any country. These need to be under the control of national level organizations like central banks, which are highly
specialized in various aspects of finance. However, only a single cooperative legislation rule governs all saving and credit
cooperatives (SACCOs) in Ethiopia. This legislation lacks the needed and specialized legislatives as well as regulatory
and supervisory frameworks which are vital to meet the financial needs of cooperative members. Consequently, the
cooperatives find themselves limited in growth, in mobilizing savings and in making loans to the lower-income groups whom
they generally serve. Further, they are unable to participate fully in national financial markets, where their services could
contribute to greater economic efficiency and expanded development opportunities for current and potential members. This
paper examined the deficiencies in legal framework and policy for SACCOs in Ethiopia. More specifically, the study was
focused on comparison of the available legal frameworks with the international standards with a view to find out the gaps
for the successful functioning of the SACCOs. The benchmark for this purpose was the standards of the World Council
of Credit Union (WCCU) and the experiences of various financial cooperatives from different developed and developing
countries.
Keywords: Legal framework, SACCOs, WCCU
1. Introduction
The history of Savings and Credit Cooperatives (SACCOs) establishment in Ethiopia dates back to 1957
with employees of the Ethiopian Roads Authority as the pioneers. Cognizant of the role of cooperatives,
successive governments, took measures to promote cooperatives (including SACCOs), in both urban
and rural areas, for their respective ends. But, their motives for doing so and hence the approach and
principles and norms followed as well as the extent of intervention differed depending on the ideological
orientations of the respective governments. The promotion, regulation and supervision of SACCOs
were based on the Proclamation No.241/58. The basis of this proclamation is associated with the then
five year development plans to serve as a tool in the transformation of the smallholding agriculture.
52
After the overthrow of the monarchial rule, a socialistic system of centralized command economy has
been constituted in which the promotion, regulation and supervision of cooperatives has been changed
radically. A new cooperative proclamation was promulgated as No.138/70. According to this
proclamation, different types of cooperatives were promoted, regulated and supervised under different
ministries. Consequently, SACCOs were licensed and regulated by National Bank of Ethiopia (NBE).
However, no effort was made by NBE to come up with specialized directives or legal environment to
license, regulate and supervise SACCOs. Hence, the NBE used the general cooperative
law/proclamation to perform its assigned duties and responsibilities pertaining to the operation of
SACCOs. NBE was also constrained by its absence of branches or other delegates throughout the
country to promote and provide technical assistance to SACCOs.
The whole approach of cooperative promotion has been changed with the adoption of the new
economic policy (i.e., market economy). In particular, the incumbent government issued a new legal
framework (Proclamation No. 147/1998 and 402/2004) which incorporated internationally accepted
principles, values and ethics of cooperatives. Unlike the previous regime, all cooperatives types were
promoted, regulated and supervised under the umbrella of a single authority. On the other hand,
Proclamation No. 147/1998, failed to recognize that SACCOs are financial institutions despite the fact
that they accept deposits and grant loans. They are not subjected to promotion, regulation and
supervision that other formal financial intermediaries are subjected to. Thus, SACCOs were taken from
NBE and made under the supervision of one unified authority.
Despite the ups and downs experienced, SACCOs are now expanding (in terms of number as well as
membership) in both rural and urban areas. Many have formed unions (which have reached about 64)
and some even have formed cooperative banks. Performance analyses of the sector indicate that at
present there are 10,270 SACCOs active in the country with the total membership of 910275 and a
saving amount of 1.2 Billion Birr. However, the sector provides less than one percent of the country’s
total financing, and many struggle with low-capacity management and governance (Kifle, 2012).
Therefore, for the SACCOs to perform, grow and achieve sustainability while at the same time prove
to be the instruments of development and poverty alleviation endeavor; it is important to examine the
current regulatory and supervisory document, weaknesses and challenges of saving and credit
cooperatives by reviewing pertinent literatures on SACCOs operation in the country and from
international experiences.
53
2. Rationale for regulatory framework
Prudential financial regulation refers to the set of general principle or legal rules that aim to contribute
to the stable and efficient performance of financial institutions and markets. These rules represent
constraints placed on the actions of financial intermediaries to ensure the safety and soundness of the
system (Chaves and Gonzalez, 1994). Thus, financial regulation should serve macroeconomic goals by
ensuring the solvency and financial soundness of all financial institution. In addition, regulation should
provide the client protection against excessive risks that may arise from failure, fraud, or opportunistic
behavior on the part of the financial service institution. Finally, regulation should also promote efficient
performance of financial intermediaries and competitive markets (Wright, 2000). Despite, the level of
development of SACCOs, having regulation and supervision appears indispensable for their operational
efficiency and effectiveness as it reduces risks that are likely to occur and function prudentially.
The theoretical review on the framework shows that having well organized regulatory and supervision
assists the management effectiveness and efficiency of financial institutions. In connection to this, the
regulation & Supervision can be undertaken by several different parties which includes: i) The general
assembly ii) The board of directors or the management committee iii) The control committee or internal
audit iv) External auditors are knowledgeable and competent v) External supervision by a special agency,
central bank/its agents. In this context, Chaves and Gonzalez (1994) laid out points to be considered in
the regulation and supervision framework design that include: the financial condition and structure of
local microfinance institutions; their roles within the financial services industry; and the capacity of the
regulating entities to administer external regulation and supervision effectively.
Specifically the regulation framework addresses the main risks: financial and governance. It addresses
financial risks associated with quality and equity to liabilities; provisioning of non-performing assets;
whether deposits will be accepted from members only or includes non-members, rules that prevent the
concentration of shares, deposits or loans in the hands of few members. Regulation can address the
governance risks in setting out the minimum qualification for board members, the fiduciary
responsibilities of the boards, and audit requirements.
Moreover, to support its practicality and ensure the relevance of the regulatory environment, it should
maintain the element of simplicity. The simplicity of regulatory requirement for small financial
cooperatives emanates from assisting them to provide services to their members.
54
In order to ensure that financial cooperatives are adhering to the regulatory standards, there should be
close supervision by various level external bodies. Though, different countries might follow one or more
than one of the supervision approaches, generally there are four types of supervision systems. These
are: (i) direct supervision; (ii) auxiliary supervision; (iii) delegate supervision; and (iv) self-regulation.
Furthermore, in order to provide the required regulatory and supervisory functions by federations or
unions, a provision should be made on the proclamation and equip them with professionals to undertake
the intended activities.
3. Review of the current regulatory and supervisory Framework of SACCOs in Ethiopia
As the Federal Cooperative Agency (FCA) is the sole organization to regulate and supervise SACCOs,
they are not considered as formal financial institutions. However, international experience has shown
that the legal framework for financial cooperatives plays a double role such as empowering, enabling
their development and encouraging growth and sustainability, and ensures that financial sector rules are
appropriately applied, particularly to protect owners and depositors against poor financial management.
Although, the financial cooperatives in Ethiopia are governed by the general cooperative
proclamation/law, provisions are not made with regard to liquidity, solvency and risk management. In
order to address this problem, a new organizational manual has been prepared by adopting World
Council of Credit Union (WOCCU’s) monitoring and evaluation system.
However, a problem has been encountered in its implementation due to various reasons. Most
regulatory and supervisory activities were geared towards agricultural cooperatives, while other types of
cooperatives receive little attention. Accounting and auditing framework and bylaws were mainly derived
from this and made to comply with the anthem of the above rules and regulations. Hence, there is no
clear demarcation between the financial and non-financial cooperatives. Here below are the major issues
in regulatory and supervisory framework of SACCOs which are currently practiced and their critical
limitation in Ethiopia.
Membership base: the membership in a primary society is restricted to persons living or working within a
given area (article 6(2)) may have merit in the sense that the spirit of cooperation and sharing of
information is likely to be stronger. However, critical review of framework on this issues show that: (a)
size of the respective organizations put limit on the size of the primary SACCOs members number-
hence SACCOs in small organizations remains too small to achieve economies of scale; (b) membership
ceases upon termination of employment or retirement or labor trimming. The trouble is that this is likely
55
to create a short-term horizon among members and management of SACCOs in their investment
decisions. For example, they are unlikely to be interested in long-term projects/investment by the
SACCO, thus constrain themselves by limiting their engagement to short term opportunities. This later
problem cannot be resolved by forming SACCO union since their union membership also ceases the
moment they leave the primary SACCO.
Trust: It is essential to generate mutual trust among members of the society as a mechanism for saving
mobilization for SACCOs in Ethiopia. Lack of effective and efficient regulation and supervision of
deposit taking entities therefore not only puts doubt on the integrity of the cooperative system but also
fails to generate greater trust within the community. It might have a devastating effect in the rural areas
if it continues like this, where there is no close follow up and supervision by the Woreda office and
having incapable management committee.
Operation areas: Both the federal (No. 147/1998, and the amended No. 402/2004) and regional (201/2008
of Tigrai, 134/2006 of Amhara and 111/2006 of SNNP) cooperative proclamations, and guideline did
not define operational areas for SACCO unions. What is stated both in the federal and regional states’
cooperative proclamations and in the guideline is that any two and more primary SACCOs can establish
SACCO unions.
The SACCO unions in urban areas established on the basis of work areas and community based
organization. The Addis Ababa SACCO union is established by employed workers’ saving and credit
cooperatives while Women self employment SACCO union is established by individual self employed
members organized at community level. However, in the case of rural SACCO unions, they are
established on the bases of geographical proximity which covers one Woreda in the minimum and up
to eight Woredas as a maximum. Hence, this created inconsistency in area of operation in urban and
rural areas that limits primary cooperatives potential to grow.
Performance standards for SACCOs: SACCOs in Ethiopia are characterized by poor performance and
operational structures, weak internal control system and inappropriate financial technologies. Even
SACCOs who have adequate capital have not diversified their services and operate the mercy of their
member interest. Besides, the regulating agency focuses on the constitution of reserves and dividends
not on the financial regulation, the regulatory and supervisory framework clearly do not include
performance standards. However, cognizant of this fact recently the federal cooperative agency (FCA)
has tried to adopt standards commonly cited on the world council of credit union (WOCCUs) PEARLS
56
system. As indicators the standard include P= Protection, E= Effective financial indicator, A=Asset
quality, R= Rate of return and cost, L= Liquidity and S= Signs of growth and has 44 ratios that are
grouped to measure.
However, there is no clear distinction as how these SACCOs are classified according to their level of
development. Moreover, lack of adequate trained manpower in the area (finance) has constrained also
to regulate and supervise SACCOs according to these performance standards. There is no specificity as
to which type of SACCOs (their capital size, tier, etc) should be applied these rations categorically. The
intention of FCA is to classify SACCOs in to various levels and determine the type and number of ratios
to be applied accordingly. If we see some of the big SACCOs in Addis Ababa in terms of the amount
of saving mobilized and the assets they own they have surpassed the minimum requirement to establish
a commercial bank according to the banking law of the country. Their resources have been tied up and
deposited in the commercial bank of Ethiopia. Therefore, classification of SACCOs according to their
level of development appears indispensable. Categorization to different levels, viz., (i) sustainability
stage; (ii) development stage; and expansion stage allowing distinct measurement parameters to
differentiate them accordingly has not been done. Consequently all SACCOs are treated similarly
irrespective of their level of development or asset size and others.
Member economic participation and the question of reserves and solidarity funds: The general cooperatives
proclamation (section 33, No 147 of 1998) has determined that 30% of their met profit should be
deducted and maintained as statutory reserve. The amount allocated for the reserve fund shall not exceed
30% of the capital of the cooperatives and it shall be deposited in saving account either for a reserve
fund, or for the expansion of work. But this is not envisaged in reality/ this amount is not divisible. No
SACCO has materialized this rule and no follow up and pressure is made from the regulating agency as
such.
Audit of Saving and Credit Cooperatives: It is clearly stated in the proclamation that the appropriate authority
shall audit or causes to be audited by the person assigned by the agency, the account of any cooperatives
at least once in a year. But the agency faced a critical shortage of auditors to do the task. The recent
report of the agency (2010) has revealed that only 30% of the existing cooperatives have received
auditing services. Here, we can see how the problem is serious and it hinders to investigate whether
cooperatives are operating efficiently and provide the required services to members according to given
standards. On the other hand, it is clearly stated in the proclamation that the inspecting personnel can
57
be assigned by the agency. However, until 2006 there was no guideline on how inspection should be
carried out. Even the new inspection manual is a generalist one without any distinction on the type of
cooperatives.
Provisions for actions to be taken for loss of property of fund of the society: It is indicated on the proclamation that
the auditor or inspector shall make a report to the managing committee of the agency. For any
misconduct on the proclamation, it is indicated on the document that as to how measures can be taken
but the authority failed to exercise due to limited capacity. Furthermore, the audit findings are not
properly handled and made ready to take appropriate measures.
Uniform treatment/view of SACCOs: The SACCOs in the country differ considerably in terms of their
stages of development and experience, size, degree of sophistication of their members as well as their
potential and opportunities they face. Yet, they are subjected to uniform regulation which the advanced
ones find unduly restrictive and inadequate. It might be necessary to introduce tiered regulation with
differentiated rules that allow the large SACCOs to graduate to ‘open’ SACCOs which engage in various
functions including accepting deposits from and lending to non-members, issuing securities, providing
payments services, investing in equity etc. This however, requires commensurately rigorous prudential
regulation and supervision that ensure their safety and soundness. Provisions related to licensing
requirements, governance standards, safe guards (capital adequacy, reserves, liquidity, loans loss
provisioning), disclosure and reporting requirements, inspection, limits on risk exposure etc. become
crucial. Manner of distribution pertinent to financial cooperatives, power of the regulator and the
manner it is to be institutionalized etc are only some examples that are not entertained by the general
law.
Differences in interpretation of the cooperative legislation at various levels: In some cases, the demarcation of
authorities between federal and the regional states are not clearly understood at all levels. A typical
example would be the formation of cooperative federation. According to the FCA strategic plan, the
country follows four tier vertical structures: primary, union, federation and league. In practice some
regions like SNNP and Tigrai regions have established federation at regional level, but are not backed
by the respective regional level cooperatives law. If cooperatives continue to integrate vertically, the
federations established or would be established at regional levels are expected to form another layer
before joining the league or the league will be established including the regional level federations. We
58
believe that such misunderstanding emanated from misinterpretation of the grand federal cooperative
law and such confusions need to be clearly defined.
Absence of linkage between Urban and Rural SACCOs: SACCOs have a peculiar feature as they are basically
financial institutions and hence cannot be lumped together with other types of cooperatives. As such
they need an appropriate legislation as well as institution that guide their development and nurtures and
promotes them. The urban and the rural SACCOs in different regional state (Oromia, Amhara, Tigrai
and SNNP) of the country are being promoted under different authorities. The urban SACCOs are
being promoted and regulated by the Municipality in the SNNP and Tigrai, while the same is under the
mandate of the Trade and Industry in Oromia and Amhara national regional states. The rural SACCOs
are however regulated and promoted by the regional agriculture and rural development bureaus. The
separation of urban and rural SACCOs in terms of the authority to promote, support and regulate
debilitate the financial cooperative movement of the country.
NGOs model: NGOs have played significant role in the formation of grass root SACCOs in Ethiopia.
NGOs like Self Help, VOCA Ethiopia have played important role in initiating and organizing some of
the rural SACCOs that are operating in the country today in the pursuit of their community development
objectives. For example, as of 2012 in Tigrai regional state, there are 793 rural SACCOs registered with
the Regional Cooperative Promotion (RCP). Out of these, 738 were formed by the RCP under the
RUFIP program and 55 by VOCA Ethiopia. The driving motive behind the promotion of SACCOs by
NGOs is poverty reduction.
However, NGOs did very little to give the necessary orientation on universally accepted cooperative
principles and values and mode of business operation to SACCOs. This has not helped the primary
cooperative to develop vision and frame the way forward to ensure both institutional and financial
sustainability. In this regard, the regulatory framework could not clearly state the mandate and the play
ground rule of NGOs.
4. Cooperative regulatory and supervisory frameworks in practice
Countries across the world have different levels of cooperative legislation. According to an ILO review
(Frazzio, 1994) the legislations can be grouped as follows.
General cooperative laws that regulates all types of cooperatives in a country: this is the most common form of
cooperative legislation found in Brazil, Côted’Ivoire, Germany, Hungary, India, Jordan, Kenya, Mexico,
59
Spain, and Thailand. Such laws become operational only if they are supplemented by sector-specific
regulations that must be adopted by the government. On the other hand, countries like Japan, Romania,
and Uruguay, adopted separate laws for special types of cooperatives. Some others countries adopted
specific codified law like civil code (e.g. Switzerland), the commercial code (e.g. Belgium, partly Czech
Republic and Guinea) or the Rural Code (e.g. France), or as a part of company law (e.g. New Zealand).
A few countries (China, Denmark, Norway, some states in USA) have not passed any special legislation
on cooperatives, but this is exceptional. At the other extreme, there are countries such as Guyana, Italy,
Mexico, Namibia, Spain, and Thailand that have included specific provisions on cooperatives in to
national constitution.
ILO document recommended the following concerning the types of laws relevant to regulatory and
supervisory frameworks. The various options outlined above have their own advantages and
inconveniences, but the general view that has emerged over the years is that there is a need for a specific
cooperative law which will permit the incorporation and registration of cooperatives and give confidence
to those with whom they have commercial or financial dealings. Moreover, it is generally felt that the
more satisfactory type of legislation covers cooperatives of all types, urban and rural, primary and
secondary, and places them under the jurisdiction of a single ministry or governmental authority. This
kind of arrangement, which of course does not prevent cooperatives from establishing working relations
with other technical ministries, avoids the fragmentation of the cooperative movement itself, which may
take place where cooperatives are registered under different acts and placed under the supervision of
different public authorities with perhaps, heterogeneous policies.
Furthermore, the document underlined its remakes on new legislation to be passed or revised in the
context of the developing countries. In the case of Ethiopia, cooperatives are being promoted based
on the existing general cooperative legislation No. 147/1998 and the amended proclamation
No.402/2004. The proclamation reflects the basic cooperative principles and values. This law is by far
better than cooperative laws passed in the past. Besides, as federal country the federal states have their
own cooperative laws formulated which reflect the grand cooperative law of the country. However, the
promotion of financial cooperatives requires specific law to be in place as the existing general
cooperative law is not responsive to all the needs of financial cooperatives.
Similarly, the law does not provide for formation of cooperative banks, and insurances, which are vital
to the development of SACCOs. Therefore, it is important to revisit the existing cooperative law.
60
Similarly, the law does not provide for formation of co-operative in to banks, and insurances, which
are vital to the development of SACCOs’. Thus, this is also an area of concern that should be
revisited in the regulatory and supervisory framework of Ethiopian cooperatives law. Specific review on
Bolivia and Ghana financial cooperatives show that, it is possible to adopt some of the provisions for
Ethiopian SACCOs regulatory and supervisory framework. For instance, the Bolivian approach of
regulation and supervision of saving and credit cooperatives has two cooperative laws, viz: (a) general
cooperative law; and (b) saving and credit cooperative law. Furthermore, Bolivia has a multi-regulatory
authority to regulate and supervise financial cooperatives. Unlike our general cooperative laws, Bolivia
has separated laws. i.e., the general cooperative law and SACCO law. SACCOs are categorized in to
“open” and “closed” type of cooperatives, where the open SACCOs are highly regulated and liable to
conform to financial rules strictly. There is no excuse or exemption to SACCOs specifically to tolerate
or bypass some of the prudential norms for being a cooperative financial institution.
The central points in this regard are adhering strictly to regulatory and supervisory framework
irrespective of the type of financial institutions; definite/demarcated rules to conduct appropriate
regulations by designated institution/agency, etc.; categorization of SACCOs, where the regulatory and
supervisory function of the multiple regulating authorities will make it simple and easy. Ghana has a
separate credit union law besides the general cooperative law. The law is prepared by Ghana cooperative
credit union association (CUA) LTD. Some of the main points or provisions of the law are that the
ministry of cooperatives is designated as a regulating body of credit unions of Ghana. In addition, unless
authorized by the bank of Ghana to do so, no credit union shall accept demand deposits, and provide
computerized banking services including the operation of Automated Teller Machines (ATM),
telephone banking, internet banking, inter-credit union networking and smart cards.
Besides, CUA shall have the authority to develop and amend from time to time, financial standards as
required for governing the operation of credit unions. The financial standards developed by CUA shall
not be binding and effective until the financial standards have been approved by the bank of Ghana and
the supervision board, and notice of financial standards has been sent to the credit unions. Besides a
credit union shall, in its operations comply with all financial standards. A credit union shall ensure that
it maintains accurate and reliable accounting systems which include a record of all amounts received
from, and payments made by members together with interest calculated there on if any, and shall prepare
a monthly income statement and balance sheet that complies with generally accepted accounting
61
principles and any guidelines or standards issued by CUA or any other body authorized by the
supervision board.
The registrar appoints a liquidator with the advice of the bank and other liquidation of a credit union
when, the registrar on examination has determined that the credit union no longer is in operation, or is
insolvent and when the registrar has received a recommendation from the supervisory board that the
credit union be liquidated or the registrar has received a request in the form of resolution approved at
least by three-fourth of the members at a general meeting.
In this case Ghana has adopted a multiple authority regulation approach. Even though the ministry of
cooperatives is designated as a regulating organization, the role of bank of Ghana in the overall
supervision appears to be indispensable. Beside the CUA has a vital role in setting financial standards
and provide financial services and part of the supervisory body. This has been revealed in the
composition of the supervisory board, which comprises the bank of Ghana, ministry of cooperatives
and CUA. There is no categorization of credit unions as open or closed type. Hence, they provide service
to members and are not allowed to do business with non-members or the general public. The allocation
of a clear cut duties and responsibilities among the multiple regulating and supervising institutions to
prevent redundancy and duplication of activities is what matters in determining the approaches to be
adhered. Unlike other central banks in some countries, financial standards, accounting systems, and
audit requirements are to be set by CUA, while approval is received from the bank before its execution.
Therefore, in multiple regulatory and supervisory approaches, an integration and
interrelationship/interdependency of all stakeholders is required to conduct these functions properly.
5. Conclusion
From the review made so far, it is possible to conclude the following critical intervention points on
Ethiopian regulatory and supervisory framework taking in to consideration the World Bank report.
Clarity on the powers and duties of financial cooperatives, and on regulatory and supervisory
responsibilities is important. Legal frameworks should evolve with the growth of the financial
cooperative sector. Regulatory requirements should reflect both the degree of complexity and degree of
risk, and accompanied by a supervisory arrangement that works in a cost effective manner. A specialized
regulatory framework with a hierarchical supervisory regime that takes into consideration the capacity
of cooperatives and their future growth potential are appeared to be imperative. A good legal, regulatory,
62
and supervisory framework is a prerequisite for sustainable growth and development of financial
cooperatives, and hence for sustainable rural outreach.
References
Chaves, A., Gonzalez-Vega, C., 1994. Principles of regulation and prudential supervision and their
relevance for microenterprises finance organization. In O. Maria & R. Elisabeth (Eds), the new
world of microenterprises finance for the poor. Hartford, CT and London: Kumarian Press.
Federal Negarit Gazeta, 1998. Cooperative Societies (amendment) Proclamation No. 402/2004, Addis
Ababa, Ethiopia.
Federal Negarit Gazeta, 1998. Cooperative Societies Proclamation No. 147/1998, Addis Ababa,
Ethiopia.
Frazzio, 1994. Promoting Cooperative: a guide to ILO recommendation No.193.
Graham, A.N. Wright, 2000. Principles and practice: myths of regulation and supervision.
Gilberto M. Lianto, 2000. Protecting deposits in saving and credit cooperatives, Philippine institute for
development studies.
Ghana cooperative credit unions association (CUA) LTD, 2005, credit union legislation.
Hennie Van Greuning, Joselito Gallardo, and Bikki Randhawa, 1998. A framework for regulating
microfinance institutions, financial sector development department, the World Bank.
International Labor Organization (ILO), 2002. The Promotion of Cooperative Recommendation

(No.193), international Labor Office, Geneva.
Providing financial services in rural areas, 2007, report No.40043, GLB, The international bank for
reconstruction and development, the World Bank, NW, Washington, DC.
Saving and Credit Cooperatives credit administration guideline, 2007. Federal Cooperative Agency.
Saving and Credit Cooperatives model bylaws (primary, union, federation), 2007. Federal Cooperative
Agency.
Tesfamariam, K., 2011. Management of Savings and Credit Cooperatives from the Perspective of
Outreach and Sustainability: Evidence from Southern Tigrai of Ethiopia. Research Journal of
Finance and Accounting 2:10-23. Available online http://www.iiste.org.
63
64
Theme 3: Saving, Loan and Development
Assessment of Saving Culture among Households in Ethiopia
Aron Hailesellasie, Nigus Abera and Getnet Baye

Lecturers, College of Business and Economics, Mekelle University
Email: aronsellasie@gmail.com, nassizeab@yahoo.com, gbg1976@yahoo.com
Abstract: Empirical studies conducted over time have indicated that domestic saving and investment are highly correlated.
It is recognized that saving is an important factor in economic development as it enables the conversion of resources into
capital. Adequate savings are important for capital formation and have a direct impact on economic growth, and as such
are vital for achieving macroeconomic stability. Despite this fact, saving rate of Ethiopia to GDP is 9.5% i.e., the poorest
saving rate in the world as compared to China, Bangladesh and South Africa which have a better saving rate in the world.
Hence, Ethiopia is characterized by poor saving culture which results in very small domestic savings available for investment.
Knowing this fact, the country has envisaged in its five year Growth and Transformation Plan (GTP) (2010/11 -
2014/15) to increase saving rate from 9.5% to 20% of the GDP. This study was carried out to investigate the root causes
of poor saving habit in selected cities of Ethiopia. Data were collected from 544 households’ selected using non-proportional
quota sampling technique covering three major cities namely Addis Ababa, Hawassa, and Mekelle. The study employed
descriptive statistics and chi-square tests to analyse the data. The result indicated that the main causes of poor saving were
inappropriate saving products, lack of incentive to save, low income level, high level of debt, low interest rate and high
inflation rate. Based on the findings, the study suggests that government and development actors should work to create
awareness on saving among the society, stabilize inflation, implement forced saving, modernize and make saving institutions
accessible. In addition, mechanisms of enhancing income generation and reviewing the saving interest rate regulation should
be devised.
Keywords: Income, inflation, interest rate, saving culture, saving product
1. Introduction
The business dictionary (www.businessdictionary.com) defines savings as the portion of disposable

income not spent on the consumption of consumer goods, but accumulated or invested–directly in
capital equipment, by paying off a home mortgage or indirectly through the purchase of securities. The
other form of saving is through putting money aside in a bank or financial services provider, investing
in a pension plan or in other forms of income–generating investments. Elbadawi and Mwega (2000)
stated that empirical studies conducted over time have indicated that domestic saving and investment
65
are highly correlated. It is recognized that saving is an important factor in economic development as it
enables the conversion of resources into capital. Strong saving performance is crucial for
macroeconomic balance and for the maintenance of financial and price stability. Saving is beneficial for
the economy as a whole and thus for the citizens of the country. Sekgobela (2004) stated that adequate
savings are important for capital formation and have a direct impact on economic growth, and for
achieving macroeconomic stability.
There is lack of adequate domestic savings in most developing countries and as a result more reliance is
placed on foreign savings in the form of capital inflows. The issue of low levels of domestic savings is a
major problem in developing countries due to high levels of unemployment, low wages, and engagement
of a large proportion of the population in the informal sector as well as poor performance of the
economy (Reddy et al., n.d.). Prinsloo (2000) pointed out that the low level of domestic saving limits a
country’s rate of investment, restrains the rate of economic growth and makes the country more
vulnerable to international capital shifts.
The continent of Africa has been identified as having an unsatisfactory growth in saving rates, which
slows down capital accumulation. Africa’s low saving rate influences the ability of banks to lend to small
enterprises due to the limited availability of capital. Sub-Saharan countries are also facing low saving rate
problem which is below 17%, so Ethiopia is not unique. Currently, only about six million households
save money in financial institutions in Ethiopia with average of 875 Birr per year. Saving rate from GDP
of Ethiopia is 9.5%, i.e., the lowest saving rate as compared to that of China, Bangladesh and South
Africa which have better saving rates.
Hence, Ethiopia is characterized by poor saving culture which resulted in very small domestic savings
available for investment. In the coming ten years, the industry sector is expected to lead the economy
instead of the current agriculture-lead economy. In order to realize this, the industry sector needs to be
promoted. For the sector to be promoted, it requires among other things adequate capital that is readily
available for investment in the form of domestic savings. Recognizing this fact, the country has planned
to promote saving habit among citizens so as to mobilize adequate saving. In the five years Growth and
Transformation Plan (GTP) of the country (2003 -2007), it is envisaged to increase saving rate from
9.5% to 20% of the GDP. To achieve the GTP target, there is, therefore, a need to investigate the root
causes of low saving and cultivate saving culture of households thereby ensure success in the economic
growth. The overall objective of the study, therefore, was to investigate the root causes of poor
66
household saving culture so that appropriate actions can be taken to promote saving culture among
households. More specifically, the study has attempted to assess household saving rate from the total
income, investigated the saving habit of households, identified factors that affect household saving and
explore alternative to promote saving.
2. Research methodology
The Study Design: This study was conducted in order to investigate the root causes of poor household
saving culture in Ethiopia. It applied the descriptive type of research. As widely accepted, the descriptive
method of research is a fact-finding study that involves adequate and accurate interpretation of findings.
The study opted to use descriptive type of research considering the desire to acquire firsthand data from
the respondents so as to formulate rational conclusion and recommendations.
Sampling Technique: The study was based on the data collected from 544 households who earn income
either from worker compensation or self employment. It was carried out in two major regional cities
(Mekelle and Hawassa) and Addis Ababa. Non-proportional quota sampling technique was used to
allocate sample respondents and convenient sampling method was applied to select the sample
respondents.
Methods of Data Collection and Analysis: To collect the data required, the study used both primary and
secondary sources of data. The primary data were derived from the answers given by the respondents
using a self-administered questionnaire. Both close- and open-ended questions were included to allow
for in-depth investigation of household saving culture. The secondary data were derived from published
and unpublished documents and literature related to the research problem such as journals articles,
magazines, books and periodicals. The data were analysed by employing descriptive statistics and Chi-
square test.
About 64% of the respondents saved a portion of their income whereas 35.9% of them did not save.
This shows that the majority of the households in Ethiopia save their money. However, only 36.8% of
the respondents saved their money in saving accounts, while the remaining preferred purchasing physical
assets. However, they have very low habit of saving regularly. The study indicated that only 7% out of
the total sample included in this study had regular saving and the remaining majority saved irregularly,
in physical assets or never at all.
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Two categories of factors were identified to be responsible for low saving habit of households in
Ethiopia, i.e., internal factors (characteristics of households) and external factors. The internal factors
of saving habit that emanate from characteristics of households were identified using chi- square test.
The Pearson chi-square value for household age is greater than the table value that is 1.402 > 0.711,
which showed age to be significant factor of the saving behavior of households. This implies that as
households’ age increases, their saving will decrease. This could be due to the fact that young aged
households work more than the old aged households and hence earn more income that allows for more
saving. There are various studies showing that age of households affects saving behaviors. For instance
a study by Bovenberg and Evant (1990) showed that the higher the old aged population in the nation,
the lower is the saving rate in the economy. Similarly a study by Foley and Pule (2005) concluded that
the young and elder population saves more than the middle aged population. Another study by Attasion
(1997) showed that individual’s age is expected to be negatively correlated with saving.
The Pearson chi-square value for household gender is greater than the table value that is 1.429 >
0.00393. This shows that gender is a determinant factor of the saving behavior of households. The
behavior and terms of saving of individuals’ differs from one sex to another. The study revealed that
female headed households tend to save better than male headed ones. The possible reasons for the
observed less inclination to save by male households could be that male households are highly vulnerable
to unexpected expenses because of the already developed life style by the community. They are expected
to cover the principal household consumption and outside the family affairs in any social interaction.
Besides, the personality of male headed households is open to extravagancy that is males maximize
consumption simply because of their financial capacity. However, females are reserved from such
extravagancy and they are financially well planned than males. Since saving is primarily a function of
income the situation leads into low level of saving.
The Pearson chi-square value for household education level is greater than table value that is 5.679 >
0.1145. This shows that the level of education is a significant determinant of the saving behavior of
households. The study revealed that as level of education of the households’ increases, their behavior
to save improves. With regard to frequency of saving, majority of households with low level of education
practiced inconsistent and less frequent saving while households who were able to access and complete
secondary and tertiary education practiced regular saving.
68
The Pearson chi-square value for household work status is greater than table value that is 5.478 > 0.103,
indicating that work status is a significant factor for the saving behavior of households. The study
revealed that self-employed households save more than employed and retired households. Because of
continuous flow and more uncertain nature of their income, self-employed households have a keen
interest for saving. Conversely, wage employees were relatively certain about the flow of their income
and whatever the amount of salary they earn, they are less eager for saving.
The Pearson chi-square value of household housing status is greater than the table value that is 5.806 >
0.00393. This shows housing status is a significant factor for the saving behavior of households. The
study revealed that households who did not have their own house saved more than those having their
own house. This may be due to the fact that having a house in the future is what motivates people in
the study area to save more.
The Pearson chi-square value of household income level is greater than the table value that is 14.522 >
0.1145 showing that income level is a significant factor for the saving behavior of households. The study
revealed that as the income level of the households’ increases, the saving rate also increases.
The Pearson chi-square value of household marital status is greater than the table value that is 7.003 >
0.352. This shows that marital status is a significant factor of the saving behavior of households. The
study revealed that the saving behavior of widowed and married households is better than unmarried
ones. Majority of unmarried individuals would spend unplanned expenditure mainly in favor of their
own interest. Moreover, unmarried household financial planning scope is narrow and designed in self-
oriented way. Because of these reasons their saving behavior is weak. But married households are
morally and socially responsible for collective interest especially in financial sphere. Married household
heads’ financial plan is also somewhat broader in scope than unmarried ones. Because of this reason the
married household saving behavior is better than unmarried ones but less than widowed households.
The Pearson chi-square value for household’s number of dependents is greater than the table value that
is 3.572 > 1.635. This shows number of dependents is a significant factor determining the saving
behavior of households. The study revealed that when the number of dependents increases, the saving
behavior of households increases.
The saving habit of households is also affected by economic and social factors. In this study respondents
were asked to rank factors that affect saving behavior from different socio-economic factors such as
69
attitude of the society towards saving, lack of appropriate saving product, lack of incentives to save, low
interest rate, low income of the society and inflation rate. Among these, the majority of respondents
ranked inflation as first factor that discourage saving. Next to that low attitude of saving habit of the
society, low interest rate and low income of the society were ranked from second to fourth, respectively.
The saving culture of the society in the study area was found to be poor. The causes for the poor saving
practice in this study include demographic, economic and social factors. The critical economic factors
that affect saving culture include low interest rate of saving, lack of incentives to savers and high inflation
rates prevailing in the country. The single most determinant of poor saving habit is attitude of the
societies towards consumption than saving. The demographic factors that affect saving habit include
age, gender, education level, work status, housing status, income level, marital status, and number of
dependants.
Government has to take the major role in installing the saving culture through financial literacy. In
addition, stabilization of inflation, implementing forced saving, modernization of and accessibility to
saving institutions, stabilization of the income level of the society, and reviewing the saving interest rate
are some of the major issues that should be emphasized by the government.
Reference
Marianne, A. Hilgert, Jeanne, M. Hogarth, & Sondra, G. Beverly, Household Financial Management:
The Connection between Knowledge and Behavior, US Federal Reserve Bulletin July, 2003
Thomas, G. and Raymond, F., 2003. Personal Finance. Boston: Houghton Mifflin.
Absa Group Limited, 2007. Household saving behavior & its promotion in South Africa, Economic perspective,
Absa Group publications.
Al-Awad, M. & Elhiraika, A. B., 2003. Cultural effects and savings: Evidence from Immigrants to the
United Arab Emirates. The Journal of Development Studies 39 (5):139-151.
Ardington, C., Lam, D., Leibbrandt, M. & Levinsohn, J., 2004. Saving, Insurance & Debt over the post-
apartheid period: A review of recent research. South Africa Journal of Economics. Special Conference
issue.
Aron, J. & Muellbauer, J., 2000. Personal & corporate saving in South Africa, The World Bank.
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Baumann, T., 2003. Community microfinance network newsletter.
Business in Africa, 2007. Saving to be theme of SA budget speech. Business in Africa online.
http://www.businessinafrica.net/news/southernafrica/631740.htm (accessed 18/09/2010)
Zikmund W., 1997. Business Research Methods, 5th edition, USA, Dryden Press.
Business Dictionary.com (http://www.businessdictionary.com/definition/savings.html) (Accessed

19/09/2010)
Butelmann, A. & Gallego, F., 2001. Household saving in Chile (1988 and 1997): Testing the life cycle
hypothesis. Cuad.econ 38(113) Santiago abr.
Devaney, S. A., Anong, S. T. & Whirl, S. E., 2007. Household savings motives. Journal of Consumer Affairs
41(1):174+
Elbadawi, I. A. & Mwega, F. M., 2000. Can Africa’s saving collapse be reversed? The World Bank Economic
Review 14(3): 415-43.
Hazelhurst, E., 2007. Household debt scales a new peak. Business report.
http://www.busrep.co.za/index.php?fArticle=4033548 (Accessed September 2010)
Hussein, K.A. & Thirlwall, A. P., 1999. Explaining differences in the domestic savings ratio across
countries: A panel data study. The journal of Development Studies 36(1):31-52.
Junlu, M. A. & Gan, T., 2006. Risks, Financing Constraints, and High Savings Ratio in the Rural
Economy of China: A Model Incorporating Precautinoary Savings and Liquidity Constraints.
Maimbo, S. M. & Mavrotas, G., 2003. Financial sector reforms and saving mobilisation in Zambia.
Discussion paper No. 2003/13. World Institute for Development Economics Research
(WIDER).
Mavrotas, G. & Kelly, R., 1999. Financial sector development and savings mobilisation: An assessment.
O’Grady, K., 2005. Government must reverse dissaving – Economist. Business Day.
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Prinsloo, J.W., 2000. The saving behaviour of the South African Economy. South African Reserve Bank.
Occasional paper No.14.
http://www.reservebank.co.za/internet/Publication.nsf/LADV/8372AC8394E3B8042256B
6C003B92CA/$File/occ14fin.pdf (Accessed 01/10/2010)
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Reddy, M. Naidu, V. & Vosikata, S (n.d.). Determinants of Household Savings Behaviour in an

Emerging Economy: Market vs. Non Market Factors.
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72
The Role of Saving and Loan in Economic Growth of Ethiopia
Gebeyehu Raba
Planning and Research Office, Nib International Bank S.C.
Email: gebeyehur2010@yahoo.com
Abstract: The objective of this study was to assess factors influencing domestic saving and evaluate the impact of saving
and loan on Ethiopia’s economic growth. Both descriptive and multiple regression analysis were applied on annual data
sets covering the period from 1975 to 2011. The long-run co-integration method and the short-run Error Correlation
Models were employed. The empirical results revealed that value of GDP per capita, financial deepening, investment, and
accessibility of bank branches have positive influence while inflation rate and private consumption have negative influence
on saving mobilization in Ethiopia. Other variables including gross domestic saving, domestic credit to state owned
enterprises, domestic credit to private sector, and interest rate spreads have showed positive impact on Ethiopia’s economic
growth both in short-run and long-run. The findings of the study suggested that workable policy action should be put in
place to improve the level of per capita income and degree of financial depth so as to accelerate economic growth.
Keywords: Economic growth, financial sector, loan, saving
1. Introduction
It is widely accepted that financial sector development is an essential element for economic growth.
Mobilizing domestic resources and its efficient uses helps a country to attain sustainable development
and get rid of dependence on external resource for investment. In the realization of this notion, the
issue of proper utilization and fair distribution of internal resources for development requires special
attention in developing countries like Ethiopia. In connection to this, the Federal Democratic Republic
of Ethiopia (FDRE) has issued remarkable financial sector liberalization policy in 1992.
Following the free-market economic policy, a number of privately owned financial institutions have
been established and they are contributing a lot to the economy through their intermediary role of
channeling financial resources to investment. Moreover, existence and strength of the private sector in
an economy could smoothly facilitate the distribution of resource. Though workable and potential
economic policies were issued by FDRE, the status and share of some macroeconomic variables such
as domestic savings and domestic credits have showed low progress.
Ethiopia is one of the less developed countries whose economic performance is partly dependent on
external resources. Domestic resource mobilization in Ethiopia needs an extra effort and coordination
73
with appropriate policy and right regulation to attain the desired development. Most of the financial
institutions functioning in Ethiopia use deposits as an input for loan disbursement and allied activities.
Therefore, mobilizing significant amount of savings and channeling it to productive investment through
domestic credit is one of the major functions of them. This study deals with the roles and importance
of financial sectors’ loan and savings to the Ethiopian economy. More specifically, this study analyzed
the key determinants of savings mobilization, examined the growth pattern of gross domestic savings
and domestic credit, assessed the impact of savings and loan in promoting the socio-economic
development, evaluated the savings and loan products functioning in Ethiopian financial sector,
analyzed the legal framework governing financial activities in pre and post reform periods and identified
prospects for better resource mobilization and credit access in the countries financial sector.
2. Savings, Loan and development in Ethiopia
Development of financial institutions contribute a lot to economic development in different ways

particularly in developing countries including Ethiopia where level of monetization is very low. Strong
and well structured financial sector facilitates economic growth by providing variety of services based
on needs of the different economic sectors. Domestic saving mobilization by commercial banks and
credit allocation functions stem from their role as the financial intermediaries in the domestic economy.
The link between domestic savings, commercial bank credits and economic growth is not a new
discovery. Its debate has a pedigree and is marked with conflicting conclusions. The difference in
conclusion is due not only to differences in theoretical perspectives, but also to the way in which the
link between them is taken into account by researchers (Orji, 2012).
There are some empirical studies that deal with impact of bank savings and bank credits. Some authors
have found a significant positive relationship between savings and per capita income (Orji, 2012, and
Mahmoud, 2008). Moreover, the study made by Tochukwu (N.d) revealed that a unit change in income
growth will bring about a 0.3% change in private saving in Nigeria. Mahmoud (2008) found that degree
of financial depth has significant positive impact on domestic savings and negative relationship between
budget deficit and domestic savings in Egypt. Orji (2012) revealed significant positive relationship
between per capita income and financial deepening on domestic savings. On the other hand, bank
savings, bank credits and interest rate spreads significantly determine economic growth.
74
Data Source and method of data collection: secondary data source was used for this particular study from
published and unpublished documents, articles, proclamations, books and annual reports. In addition,
the study used time series data from 1975 to 2011 to empirically analyze the role of savings and loan in
Ethiopian economic growth. Data were also collected through observation techniques.
Method of analysis: Descriptive statistics and econometric model were employed to analyze the collected
data. The descriptive statistics was used to summarize the qualitative and quantitative aspect of the study.
The study applied co-integration method and Error Correlation Model to show the influence of policy
and non-policy variables on savings and loan as well as economic growth in Ethiopia.
Based on the nature and aim of the study, co-integration and ECM models were adopted. Model adopted
by Orji (2012) is modified to arrive at model of domestic savings in Ethiopia.
Model I
DSA=F (PCY, FLD, RIR, SIR, ADR, PRCN, I, FB) ……………………………………… (1)
Where:
Domestic Savings (DSA): (is the total savings mobilized by financial institutions in Ethiopia)
Per Capita Income (PCY): (This is real GDP per capita income of people). Various economic theory and
empirical evidences confirms that an increase in people income influences positively their savings
capacity.
Financial Deepening (FLD): Financial deepening is the degree of financial depth or development
represented by broad money (M 2) as a ratio to GDP. Financial deepening enhances the degree of
monetization of the economy. Strong financial intermediation facilitates financial deepening. That is
financial performance of different sectors of the economy are highly dependent on level of
monetization. Based on this premises financial deepening have positive impact on savings.
Investment (I): Investment and savings are more interrelated macroeconomic variables that feed each
other. In most cases savings support investment as an input. On the other side investment creates job
opportunity for people, adopts new technology, and improves standards of livings at national level. The
expected sign here is positive.
75
Real Interest Rate (RIR): is the difference between nominal interest rate on savings deposit and annual
inflation rate. Its impact on savings depends on the annual inflation rate of a country. In Ethiopia where
double digit annual inflation rate is experienced recently, it impacts savings negatively.
Private Consumption (PRCN): gross private consumption, people uses their disposable income for
consumption and savings. Even at the condition of absence of income people consume by borrowing
or selling their assets to survive what is called autonomous consumption. That means consumption is
compulsory needs of human life. High consumption implies less saving in the households and economy
and vice versa. Here consumption has negative impact on savings.
Age Dependency Ratio (ADR): Demographic factors such as population age structure and dependency ratio
influences savings behavior of the economy. Of the three stages in human life childhood, middle age or
youth stage and old age, people consume more than they produce during childhood and old age. Age
dependency ratio here is the ratio of the sum of people younger than 15 and those older than 64 to the
working age population. Life cycle hypothesis assumes that when there are too many dependent people
in the country, consumption tends to increase and savings decline. Therefore, the expected sign here is
negative.
Saving Interest Rate (SIR): can be defined as an incentive or benefit made to savers on the money saved
for various purposes. When saving interest rate is relatively high, people encouraged to save their money
instead of hoarding or holding with physical assets. It has positive relationship with savings.
Fiscal Balance (FB): is the overall surplus or deficit as percentage of GDP. This variable helps to evaluate
the Recardian equivalence on Ethiopia’s budget deficit. With regard to the government budget deficit
impact on savings, there are two opposing views whether it decreases or no effect on national savings.
Owing to the long standing deficit trend in the country, the expected sigh is negative.
To make empirically verifiable, equation (1) has to be transformed into econometric equation;
DSA = βo + β1PCY + β2 FLD + β3 RIR + β4SIR + β5 ADR + β6PRCN + β7 I + β8FB +

μ … … … … …. (2)
Where;
𝛽𝑖 = Parameter to be estimated
𝜇 = Error term which incorporates other determinants that are not included in this model
76
Equation (2) can be re-write as follows;
∆ DSA = βo + β1(∆ PCY) + β2 (∆ FLD) + β3 (∆ RIR) + β4(∆ SIR) + β5 (∆ ADR) +

β6(∆ PRCN) + β7(∆ I) + β8(∆ FB) + μ … … … … … … … … … … … … … … … … … … …. (3)
Whereas ∆ =Difference operator
The model used to analyze the impact of gross domestic savings and domestic credit on economic
growth can be specified as follows;
GDP =F (DSA+DCSE+DCP+IRS+EXR) -------------------------------------------------------- (4)
Where:
GDP: Gross Domestic Product (proxy for economic growth in Ethiopia) at current market
prices
DSA: Domestic Savings
DCSE: Domestic Credit to State Enterprises
DCP: Domestic Credits to Private sector (domestic credit disbursement by financial
Institution to privately owned sector in Ethiopia)
IRS: Interest Rate Spreads (the difference between maximum lending rate and floor
Saving interest rate)
EXR: Exchange rate (Birr per unit foreign currency)
𝐺𝐷𝑃 = 𝛽𝑜 + 𝛽1𝐷𝑆𝐴 + 𝛽2𝐷𝐶𝑆𝐸 + 𝛽3𝐷𝐶𝑃 + 𝛽4𝐼𝑅𝑆 + 𝛽5𝐸𝑋𝑅) + 𝜇 − − − −(5)
∆GDP = 𝛽𝑜 + 𝛽1 (∆DSA) +𝛽2(∆DCSE) +𝛽3(∆DCP) +𝛽4(∆IRS) +𝛽5(∆EXR) ---- (6)
4.1. Review of gross domestic savings in Ethiopia (1975 to 2011)
Ethiopia has experienced low domestic savings rate in the two successive regimes (the Derg & the
FDRE) for 36 years. From 1974/75 to 2010/11, average saving rate as a percentage of GDP was 7.1%.
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During the Derg regime (1973/74 to 1990/91) the average percentage share falls down to 6.7% from
that of 11.3% from 1960/61 to 1973/74 (EEA, 2011). This high decline was mainly due to the political
instability, successive war and conflict in the regime. While during the FDRE regime, the gross domestic
saving rate in the first decade (1992 to 2002) showed insignificant change and registered only 7.7% of
the GDP. During the period 2003 to 2011, saving rate declined to 6.5%. Though the country has
following the free-market economic policy for the last two decades and private sectors involvement
have flourished, gross domestic saving rate did not show progress than that of former regimes. The
major reasons for this are fluctuation of saving interest rate with declining trend, double digit inflation
rate, low per capita income, underdevelopment of formal financial sector, high dependency burden, and
limited financial services and absence of stock market, which are factors that discourage saving by
citizens.
4.2. Deposit mobilization behavior
During the Derg regime, deposit mobilization was undertaken by public banks. At the end of the regime
in 1991/92 all deposits (100%) was mobilized by Commercial Bank of Ethiopia (CBE) and the other
two public banks were involved in making loan mainly to state enterprises. Following the fall of the
regime, the issuance of free-market economic policy, and new banking business proclamation No 84/94,
private banks were established and started banking business since 1994. In 2010/11, due to the
competition between the fourteen private banks and three public banks’, the deposit mobilization share
of CBE fallen to 62.3%. The market share of the two public banks, Development Bank of Ethiopia and
Construction and Business Bank was only 2.2% and 35.5%, respectively while the rest was mobilized by
the fourteen private banks. Out of the total deposit by all banks in 2010/11, 50.4% was demand deposit
followed by 45.9% saving deposit and 3.7% time deposit. This result indicated that on average Ethiopian
banks pay interest expenses to only half of their deposit balance in the reporting period.
78
100
80
60
40
20
0
1992/93 1995/96 2000/01 2005/06 2010/11
Commercial Bank of Ethiopia Development Bank of Ethiopia

Construction and Business Bank Private Commercial Banks
Figure 1: Composition of total deposits with Banks.
Microfinance Institutions (MFIs), though their number reached 31 in 2010/11, the total deposits
mobilized by this institution were found to be only 2.7% of bank deposits. That is due to the MIFs’
capacity of intervention in rural areas for resources mobilization. Because of this, their rural credit
disbursement potential was also very low in reducing rural poverty.
4.3. Loan disbursement and collections
In this sub-section the study tried to compare loan disbursement and collection in three successive
regimes (Imperial, the Derg and the FDRE regimes) in Ethiopia. During the imperial regime, domestic
credit had different features with informal, semi-formal and formal sectors. According to Dejene (1993)
‘credit during the pre-revolution in Ethiopia was characterized by concentration of bank operations in
few urban centers (e.g. Addis Ababa alone accounted for 64% of the bank branches), high collateral and
minimum loan requirements which favored big businessmen and the virtual neglect of the agricultural
sector. By 1974 agriculture had received no more than 10% of the total bank credit in spite of the fact
that the sector had accounted for more than 50% of the GDP. The interest rate varied from 4.5% to
9.5% per year depending up on the type of project and borrowers.
In the imperial regime landlords were potential sources of rural credit as loan by informal sector. Like
modern formal financial sectors they had considered different factors. Prior to 1974, money lenders
were often rich land owners. Following the nationalization of land, landlords have disappeared as a
social class, and their roles as money lenders are being replaced by rich traders. The financial operations
of money lenders are simple, cost-effective and flexible compared to those of banking system. Interest
rates, which are never stated in the agreement made with the borrower are influenced by the extent of
79
personal relations, degree of risk involved, availability of funds in the community, length of the maturity
period and extent of competition from the formal financial market (Mauri, 1987, p.15 cited in
Dejene,1993)
In the Derg regime (1973/74 to 1990/91) the remarkable economic reform where all privately owned
financial institutions were nationalized to provide financial services mainly to public projects, state farms
and cooperatives, but gave little attention to private sectors. When the ruling party came to power in
1975 before nationalization policy was implemented, the share of domestic credit disbursement to public
projects was only 34 %. In 1980 it was increased by more than two folds and reached 74.4 % as a result
of the 1975 nationalization policy and 1978 Cooperative Societies Proclamation No.138/78. After a
decade the figure declined to 60.2% in 1990/91. From 1980/81 to 1990/91 the average domestic credit
disbursement to public project and cooperatives were constituted 72.1% of the total loan disbursement.
When disbursement by institutions is reviewed, in 1980/81 CBE made the highest (79.7%) followed by
DBE (18.6%). By the end of 1990/91, the share of CBE fallen to 62.5% and the other two banks’ share
was raised to 28.7% by DBE and 8.8% by that of CBB out of the total disbursement. With regard to
disbursement by sector, in 1980/81 the highest was to agriculture (29.5%) followed by import (18.4%),
and housing and construction (12.7%). After a decade, 81.1 % of the total loan disbursement was made
to three sectors; agriculture (49.9%) which is half of the total disbursement, housing and construction
(17.1%) and industry (14.1%).
The issuance of economic reform and liberalization policy by FDRE put incredible change in the
country’s financial sector. One of this is the licensing and supervision of banking proclamation No.
84/94 and monetary and banking proclamation No. 83/94 resulted in re-organization and
transformation of privately owned financial institutions in the country. The policy moderately removed
the sector discrimination on domestic resources distribution especially in domestic credit allocation with
establishment of private banks and some internal policy adjustment of state owned banks. It is
noteworthy that at the first year of the FDRE, the share of private sector raised to 52.2% in 1992/93
from low level of 39.8% in 1990/91. Furthermore, in 2005/06 it reached 81.7%. However, the ratio was
declined to 67.8% in 2010/11. The argument behind the fall is the long standing credit ceiling which
was removed in 2011 and 27% of the NBE purchase on each loan and advance. From the total loan
disbursement during FDRE regime, on average, 76% has made to private sectors.
80
90 CBE
80 DBE
70 CBB
60
Private Banks
50
40
30
20
10
0
1980/81 1990/91 2000/01 2010/11
Figure 2: Total Loans disbursements by banks (%age).
Disbursement by sector as of 2010/11: the highest loan was disbursed to international trade (25.1%),
followed by industry (24.8%), agriculture (19.5%), domestic trade (16%) and export. Though agriculture
contributes the lion share to GDP and employment in the country, loan disbursed to this sector has
been significantly declining from 49.9% of the total disbursement in 1990/91 to 19.5%, but loan
disbursed to the industry sector was relatively satisfactory.
Loan collection feature of agriculture, industry and, housing and construction during the Derg regime
was relatively low (66.9%, 80.6% and 91.7%, respectively) as compared to that of domestic trade,
international trade, and import and export sector. In the post reform at the end of the review period,
loan collection from the public sector was low compared with collection from private sector (85%).
When institutions are compared, loan collection status of both the public and private banks showed
increased performance in 2010/11 making about 91% and 92% for the public and private banks,
respectively. The aggregate progress observed in loan collection by the banking sector is the result of
proper policy and regulation by NBE and necessary analysis of pre-disbursement and close loan follow–
up scheme of each bank.
81
Public Enterprises Co-operatives Private sectors
90
80
70
60
50
40
30
20
10
0
1980/81 1990/91 2000/01 2010/11
Figure 3: Credit disbursements by clients (%age).
4.4. Outstanding loan and advances
When outstanding loan and advances of Ethiopian banks is reviewed, it was found that on average,
outstanding loan of private sector has escalated to 70.2% at 2010/11 from 24.4% in 1990/91. The
market share of CBE was 46.3% followed by DBE (16.2%), CBB (2.3%) and the fourteen private banks
shared 35.2% of the total outstanding loan and advance (Figure 4). When the outstanding loan status by
sectoral distribution is reviewed, industry takes the highest (27.9%) followed by international trade
(24.4%), and agriculture stood at third stage with percentage share of 14.3% (Figure 5).
82
CBE DBE CBB Private Banks
80
60
40
20
0
1980/81 1985/86 1990/91 1996/97 2000/01 2005/06 2010/11
Figure 4: Composition of outstanding loans by Banks (%age)
Agriculture
2010/11 Industry
4.2
Domestic trade &
0.1 0.4 0 services
1.9 4.8 International Trade
12.2
14.3
Hotel & Tourism
14.6
Transportation &
9.8 27.9 Communication
Housing & Construction
24.4 9.8 Mines,power & Water

resources
Others
Personal
Interbank lending
Figure 5: Composition of outstanding loans by Sector (%age)
In addition to the banking sector, all micro finances have disbursed Birr 7 billion to their members. The
total small credit made by them constitutes only 9.5% of the outstanding loan and advances of banks
and 1.4% of GDP in 2010/11. The share and magnitude of private credit has been increasing at
increasing rate except for the recent few years. The outstanding loan made by all banks was 14.5% of
GDP. However, the share is remaining stagnant for the past three decades which was 14.2% of GDP
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in 1980/81. Because of this low percentage of loan to GDP with different successive government, the
accessibility to credit facilities remains constraint to the majority of business people and investors.
Savings and investment trends (1980/81 to 2010/11) as percentage of GDP: Several economic theories confirm
that savings and investments are very interrelated macroeconomic variables. Figure 6 below depicted
that during the last three decades the average gross domestic saving rate from 1980/81 to 2010/11 was
7.2% of GDP. On the other hand, the average gross fixed investment in the same period is 18.2% of
the GDP showing wide resources gap of 11%. This witnessed the heavy dependence on foreign sources
for investments. The average gross investment during the last two decades in Ethiopia was 20.5% of
the GDP while the average gross domestic savings was 7.1% of the GDP at 2010/11 widening the gap
to 13.4%.
Domestic Savings Investment
30.0
25.0
20.0
15.0
10.0
5.0
0.0
1983/84
1999/00
1980/81
1981/82
1982/83
1984/85
1985/86
1986/87
1987/88
1988/89
1989/90
1990/91
1991/92
1992/93
1993/94
1994/95
1995/96
1996/97
1997/98
1998/99
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
Figure 6: Domestic saving and Investment
Sources: NBE
Table 3 shows the OLS estimation of domestic saving as explained by different factors. The result
showed that per capita income has positively and significantly (at 1% level) affected gross domestic
savings in Ethiopia. Therefore, a unit increase in per capita income resulted in 20 units increase in the
gross domestic savings in the country’s economy. Hence, an increase in real GDP per capita income has
positive and significant impact in mobilizing domestic savings in the short run and national economy in
the long run. Financial deepening which represents broad money supply to GDP (M2/GDP) as an
indicator of financial development or degree of monetization in the economy, is found to positively and
84
significantly (at 1%) influence gross domestic savings. The result indicated that financial sector
development in Ethiopia has significant and positive impact on savings at national level.
Real interest rate in Ethiopia affected domestic savings negatively and found to be statistically significant
at 5% level. As a result a one percent increase in real interest rate leads to 161 percent decline in size of
savings in Ethiopian economy. On the other hand, the saving interest rate positively and significantly
affected savings mobilization at 1% level. Hence, raising savings interest rate increases size of savings in
long run (Table 3).
Age dependency ratio was found to be negatively related to domestic saving which is significant at 10%.
This significant influence of age dependency ratio on gross domestic savings might owe to the high
population with low income. Besides, gross private consumption has showed negative but insignificant
impact on savings in Ethiopia (Table 3).
According to this regression result, fiscal balance has showed insignificant positive relationship with
savings in Ethiopia. That is government budget deficit has no impact on gross domestic savings. This
result met the theory of Recardian equivalence which says when government budget deficit increases or
public savings decline, people tend to save expecting future burden. Thus private saving is perfect
substitute of public savings (Table 3).
Table 3: OLS result of Domestic Saving
Variable coefficient Standard Error t-prob

PCY 20.18751 3.33413 0.000
FLD 524660.26 17130.37 0.005
RIR -161.8218 72.26038 0.033
SIR 893.9582 379.0402 0.026
ADR -7722.245 4279.09 0.080
PRCN -29297.28 17990.17 0.115
I -148.6301 284.5271 0.606
FB 253.3368 362.4995 0.490
ECM-1 -080588 .353888 0.822
R2 =85
85
4.5. Error Correlation Mechanism (ECM)
Table 4 shows the empirical result of the error correlation mechanism of the immediate past (ECM t-1).
In the long run the error term adjust itself to equilibrium position at the speed of 8%. This low speed
adjustment on savings mobilization is mainly due to the low degree of monetization in the economy,
low saving trends, and other economic factors. From the Dickey Fuller test for unit root, residual is
stationary at 1% level. The variables are co-integrated.
Table 4: Residual test
Variable T-ADF lag t-prob

Residual -3.682*** 1 0.002
NB: indicates significance at 1%
The estimated OLS model results are depicted in Table 5. The gross domestic savings is found to be
positively related to economic growth represented by gross domestic product which is statistically
significant. A 1% increase in gross domestic savings leads to 5.3% in GDP in long run. The result
confirmed the prior argument that states increase in savings promotes investment which in turn
contributes to growth. Moreover, domestic credit to state owned enterprise was found to have positive
and statistically significant influence on economic growth in Ethiopia. That is economic growth in
Ethiopia is promoted by huge government expenditure financed by banks. This result is similar with
prior expectation that government expenditure increases outputs which facilitate economic growth. In
this case 1% increase in bank loan to state enterprise leads to 7% increase to Ethiopian economic
growth.
The regression result showed that domestic credits to private sectors have statistically significant and
positive impact on economic growth. This confirms the prior expectation that bank loans to private
sector enhance investment in income generating activities which accelerate economic growth. Further,
the result for interest rate spreads in Ethiopia showed no significant impact on economic growth which
might be due to instability of saving interest rate (since 1992 saving interest rate has revised six times)
which fluctuates the spreads over times. Exchange rate (EXR) was also found to have no significant
impact on economic growth that implies Birr earned per unit Dollar have no impact on overall economic
growth. In the long run the error term adjust itself to equilibrium position at the speed of 71.6%.
Table 5: Modeling GDP by OLS
86
Variable coefficient Standard Error t-prob

DSA 5.28 1.54 0.002
DCSE 7.18 1.80 0.000
DCP 4.56 1.06 0.000
IRS -2412.39 2810.15 0.398
EXR -3664.42 2325.63 0.126
ECM_1 -0.72 0.21 0.002
R 2 =0.984
5. Conclusion and recommendations
This study investigated determinants of domestic savings and impacts of savings and loan on economic
growth in Ethiopia for the period of 1975 to 2011. The coefficients of determination (R 2) of the models
were high which indicated that the explanatory variable were able to show the variation in the
dependents variables. The empirical results shows growth in income, degree of financial depth, and
saving interest rate have significant positive impact on savings mobilization whereas age dependency
ratio and real interest rate have significant negative impact on savings in Ethiopia. Furthermore,
domestic savings, credit for enterprises and credit to private sector were found to have positive and
significant influence on economic growth in Ethiopia.
Based on the findings of this study, recommendations could be forwarded. The performance of saving
and savings mobilization in Ethiopia with difference in successive regimes was assessed to arrive at
efficient and workable savings mobilization strategies. Accordingly, the domestic savings performance
observed so far is very low. This trend implies that, deposits mobilization becomes one of the
confronting activities of deposit taking financial institutions in Ethiopia to redress the increasing
demand for loan. They should design various deposit mobilization strategies considering the existing
situation in the country. In compliance with National Bank of Ethiopia directives, the following
statements could be commendable strategies for Ethiopian financial institutions:
 Provide adequate training to staff in order to raise their participation and awareness on
importance of deposit mobilization to the institution as well as to the national economy.
 Gain customer trust by building strong relationship with potential customers to build strong
deposit base that ensure safety, sustainability and profitability of the institution.
87
 Benchmark other financial institution’s services and facilities to provide customer preference
oriented services based on customer needs analysis.
 Increase customer access to funds by implementing modern banking technology and use best
system such as ATM, POS and online banking services.
 Apply aggressive promotion through electronic media and printed materials to attract new
deposit and maintaining close connection with depositors.
 Expand outreach by identifying different target markets such as potential farmers, associations,
co-operatives, unions, NGOs, investors, pastoralists, wholesalers, retailers and others.
 Develop personalized banking relationship with potential depositors by appointing customer
relationship manager; new product development based on customer needs and areas of interest.
 Offer variable saving interest rate, limited types of account, and time and amount of the deposit
 Introduce public awareness program particularly on fund usage in order to adapt them with
banking habit and inculcate saving culture in the community and open sub-branches in rural
areas where seasonality matter, like during grain collection and coffee harvest farmers have
potential to save their money.
The macroeconomic policy in Ethiopia should develop the productive base of the economy to increase
the real income growth of the people and minimize unemployment. This can be achieved since the
country’s GDP growth is from agriculture, but due attention should be given to the sector than what
has been done so far by introducing or expanding modern commercial farming with proper fertilizer
and improved seeds in order to increase agricultural productivity which in turn increases households
income. In urban areas, government policy should gear its effort in creating jobs and income generating
activities.
Financial sector development should be improved because degree of financial depth or degree of
monetization significantly encourages savings. Where sound financial sector is available and appropriate
domestic savings is mobilized, domestic credit could be available to the existing high demand which will
accelerate economic growth.
In FDRE regime saving interest rate is revised six times and most of them were at declining trend.
Saving interest rate analysis result showed strong relationship with domestic savings. Increase in saving
interest rate encourages depositors. Therefore, government policy should give necessary attention to
increase the floor saving rate. On the other hand, there is a need to improve the level of real interest
88
rate as it significantly and negatively influence savings. The recent double digit inflation increases cost
of living and uncertainty which limits ability to save. Necessary actions should be taken in order to
reduce current inflation rate to single digit.
Demographic factors showed that age dependency ratio has significant negative impact on savings. This
is due to the fact that Ethiopia is a populous country and low income per capita which increases
dependency burden on households. Government policy should make more effort in family planning
and management to all people in order to adjust things in line with the existing situation in the country.
The focus of development policy should pay more attention to domestic credit allocation as it is
statistically significant in positively influencing economic growth. Both credit to state enterprise and
private sectors have showed significant impact in the analysis. The capacity of financial sector should be
improved in credit disbursement. As revealed by the result of the descriptive analysis, private banks are
in trouble of liquidity risks. That is loan to deposit ratio of private commercial banks were only 52%.
Nearly half of their deposit of funds was not directly invested on loan and advances rather 20% is held
in reserve and liquidity account and 27% in NBE Bill purchase at very low interest rate. Here it is better
if the percentage of NBE Bill purchase or reserve and liquidity rate is revised again in order to stretch
the private commercial banks’ hands in the magnitude of credit disbursement. Besides, government
should introduce financial literacy education program like budgeting and planning mainly focusing on
savings through school curriculum and mass media.
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Wolday Amha, 2008. A decade of Microfinance Institutions (MFIs) Development in Ethiopia:

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Poverty Reduction Impact of Microfinance Institutions and Determinants of Client Success:

A Case Study on Two Rural Kebeles of Fogera Woreda
Sefiager Alem
Lecturer, Department of Accounting and Finance, Addis Ababa University
Email: sefiager@gmail.com
Abstract: Currently, there is a strong belief among development economists that microfinance interventions can have
significant poverty reduction impacts through improving income generation, smoothing consumption and reducing
vulnerability to shocks of their beneficiaries. Cognizant of this fact, much research has been conducted on the impacts of
microfinance institutions (MFIs) on poverty reduction. In this study, attempts were made to assess the poverty reduction
impact of Amhara Saving and Credit Institute (ACSI). Data were collected from a randomly selected sample of households
from two rural kebeles of the Fogera district in two rounds of 2004/05 and 2008/09. The data were analyzed using the
difference-in-difference model fitted to a quasi-experimental research design. Results indicated that borrowers in the study
area were poorer than the non-borrowers which reflect the fact that ACSI targeted the poor households in its intervention.
In addition, the results revealed that borrowers have experienced a significant increase in their income and wealth. The level
of poverty reduction among the borrowers was higher than that among non-borrowers. The study, thus, concludes that
microfinance interventions of ACSI had a positive impact in reducing the incidence, depth and severity of poverty.
Keywords: Difference-in-difference, impact evaluation, microfinance
1. Introduction
Ethiopia is one of the poorest countries in the world. According to the 2008 statistical update of the
UN, Ethiopia, with an HDI index of 0.389 ranked 169 out of 177 countries. The national incidence of
poverty is 38.7 percent being 39.3 percent in rural areas and 35.1 percent in urban areas. The annual
average per capita consumption in the country as of 2004/05 in terms of 1995/96 prices was Birr 1,256.
The annual per capita consumption of the rural population by 2004/05 in terms of 1995/96 prices was
Birr 1,147 whereas the per capita consumption of the urban population for the same period was Birr
1,909 (MoFED, 2005).
In an effort to tackle such a very high incidence of poverty, various strategies have been devised by the
government of Ethiopia. In November 2000 the interim Poverty Reduction Strategy Paper (PRSP) was
developed. Among the major items included in the PRSP was assessment of the nature and causes of
poverty in the country and analysis of the broad impacts of a reform program on poverty. Based on
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such an assessment the first phase of the PRSP, Sustainable Development and Poverty Reduction
Program (SDPRP) was adopted in 2002 (MoFED, 2002 cited in Kassahun, 2007). Improvement of rural
financial services through expansion of microfinance services was among the measures emphasized in
the SDPRP (Kassahun, 2007). Credit to the rural population was meant to increase their utilization of
modern agricultural inputs and diversification of livelihoods. The expected results were to increase
income and hence reduce poverty in rural areas. Consequently, the government of Ethiopia allowed the
establishment and operation of microfinance institutions by proclamation number 40/1996. Since then,
28 microfinance institutions have been licensed and are operating all over the country.
Even if a lot of debate is going on and critics are questioning microfinance’s effectiveness as anti-poverty
tool, there is an overwhelming evidence that microfinance does improve the living standard of the poor
(Khandker, 1998). In Ethiopia, studies have documented the potentials of microfinance as an anti-
poverty tool. Yet a lot has to be done in identifying the modalities under which the service should be
provided under different socioeconomic settings. This study assessed the poverty reduction impact of
ACSI and the underlying factors that determine the success of the ACSI clients in their efforts to step
out of poverty.
2. Measuring poverty impacts of microfinance
There are contending views on the potential of microfinance services on poverty reduction. One view
holds that microfinance and microcredit programs are not effective ways of reducing poverty
(Khandker, 1998). Amongst the proponents of this view Bouman and Hospes (1994) argue that activities
financed through microcredit programs have limited growth potential and no sustained impact on the
poor. Rather they make the poor dependent on the program itself. In a similar line of argument, Buckley
(1997) argues that the shift from less poor clients i.e. from microenterprises to small businesses, at least
in Africa, has not been answered. Others from the Ohio school (Adams and Pishke, 1992) noted that
such programs are usually highly subsidized by donors and the government, therefore even if they
manage to reach the poor they are not cost effective means of alleviating poverty. In general, those that
argue against microfinance programs, claim that microcredit and microfinance programs are social
liabilities consuming scarce resources without significantly affecting long-term outcomes.
On the other side, proponents of the microfinance programs argue that institutional credit is important
means of ending poverty (Yunus, 1983 cited in Khandker, 1998). In addition, they claim that they can
overcome problems of credit imperfections (Khandker, 1998). According to this view, credit smoothes
93
consumption and eases constraints in production raising the income and productivity of the poor.
Khandker (1998) mentioned that microfinance institutions should exist because traditional banks and
financial institutions fail to meet the needs of women and the poor hence alternative institutions should
be developed to meet these groups` demand for financial services.
Measuring Poverty: Any poverty analysis cannot be effective without proper understanding and
measurement of poverty. However, there is no single satisfactory measure of poverty that could be
universally applied. Ravallion (1996) put this fact as poverty measures are contentious and prone to
disputes. Yet various efforts were made to quantify poverty.
Sen (1976) summarized the issues in the measurement of poverty into two, identifying the poor among
the total population and constructing an index of poverty using the available information about the
poor. The former involves the choice of a criterion of poverty i.e. the selection of a poverty line and
ascertaining those who satisfy that criterion, i.e. fall below the poverty line and those who do not. While
the later deals with the issue of setting indices that properly indicate the incidence, depth and severity
of poverty. Thus, setting a proper poverty line is an essential step in poverty analysis as this helps to
determine the comparisons of interpersonal welfare and structure of the resulting poverty profile
(Ravallion, 1996).
Conceptually, the term poverty remains grey and affected by a number of social subjectivities as a result
of which there is no single method of setting the poverty line. The common approaches used to set a
poverty line are the absolute poverty line, relative poverty line and subjective poverty line. World Bank
(2005) defines absolute poverty line as fixed in terms of the standard of living it commands over the
domain of poverty comparisons. This poverty line remains fixed over time with adjustments only for
inflation and revisions in the threshold of real poverty.
One important issue in defining absolute poverty lines is the selection of a welfare indicator. In this
regard, two approaches are commonly used in setting poverty lines i.e., the welfaristic and the non-
welfaristic approach. The welfaristic approach or the utilitarian is based on attainment of a certain
welfare or utility level. Sen (1976) argues that this approach presumes a comparable interpersonal utility
functions and preferences among individuals though this might not be the case. The non-welfaristic
approach, on the other hand, defines poverty lines based on the basic needs or calorie requirements of
individuals.
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The other crude measure of poverty is the head count index (Ravallion, 1996) that measures the
proportion of people from the total population whose income falls below the poverty line. This measure
determines the percentage of people living below the poverty line and indicates the incidence of poverty
in a given population. Sen (1976) has criticized this poverty measure as that which does not provide
adequate information about the distribution of income among the poor and hence fails to measure the
level of inequality among the poor. It is insensitive to the extent (depth) of poverty.
Poverty gap ratio is also a measure of the percentage of the mean short fall of the poor from the poverty
level. It measures the extent of the income shortfall from each poor people. Unlike the head count
index, the poverty gap index is insensitive about the number of people below the poverty line. This
approach fails to measure the severity or intensity of poverty because it assigns equal weights to all the
poor below the poverty line. This is a good measure of the depth of poverty in that it indicates the
average resource required to pull the poor out of the poverty line. In association, the squared poverty
gap index is the measure of severity of poverty. This is a poverty index measured by squaring the poverty
gap index. Squaring the poverty gap index assigns larger weights for incomes farther away from the
poverty line and as a result it takes inequality or distribution of income among the poor into account
(World Bank, 2005). This is the only measure among the three that indicates the severity (intensity) of
poverty in a population. The Foster, Greer and Thornbeck (1984) termed as FGT model considers all
the above indices as a family of measures. The FGT model is specified as:
n
Squared Poverty Gap Index (Pα) = 1/N Σ(Gi/z)α
i =1
Where Z is the poverty line; n is the number of people earning income below the poverty line Gi is the
poverty gap; N is the total population living in the community; and α is an FGT parameter which can
have values of 0, 1, and 2. When α is 0 the model calculates the head count index, when α is 1, it measures
poverty gap index and when α is 2 it measures squared poverty gap.
MoFED (2005) criticizes the welfarist approach as it does not provide a well-defined poverty line and
justifies the non-walfarist approach as a more objective, suited and widely used measures in Ethiopia.
The poverty line is, thus, defined as a threshold of per capita income or consumption level below which
an individual is labeled as ‘poor’(MoFED, 2005). Two common welfare indicators applied are income
and consumption. Though both have their own merits and demerits, consumption is a better indicator
of welfare in developing countries than income.
95
Sampling technique: A two-staged sampling procedure was employed to select the sample households
included in the study. First, sixteen sub-areas in Fogera woreda where ACSI provides service were
categorized into distant and near kebeles based on their distance from Woreta town, the major market
place in the area. Then, one kebele from each category was randomly selected. Quhar kebele was selected
from the near kebeles and Kidist Hana kebele was selected from distant kebeles. Then every third client
was drawn using systematic sampling from the 2006 loan records of ACSI. To incorporate the long term
impact of the credit, clients who have taken three loans were considered. Hence, clients who have started
taking loans in 2006 were considered.
Thereafter, a numerically comparable number of non-clients from each of the kebeles were randomly
selected from the records maintained by the development agents. In this study clients refer to the
respondents who were the borrowers from ACSI and non-clients refer to respondents who have never
borrowed from ACSI.
Table 1: Sample size
Clients Non-Clients
Quhar Kidist Hanna Quhar Kidist Hanna
Total population 104 108 984 HannaHana
1020
Sampled Households 27 29 26 27
Percent 26% 27% 2.7 2.7
Data sources and methods of data acquisition: The study has used both primary and secondary data sources.
Primary data were collected through structured questionnaire. Respondents were asked about various
household economic indicators such as income, wealth, and expenditure at two points in time, i.e. in
2005 and 2006 based on the recall of the respondents. Village level data such as access to infrastructure
were also collected through key informant interview in the Woreda Agriculture Bureau and employees
of ACSI and focus group discussion was conducted with both household and key informant groups. In
addition, secondary data were collected from statistical reports of the CSA, Bureau of Rural
Development and Bureau of Finance and Development in Amhara National Regional State.
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Methods of Analysis: In impact assessment studies controlling for factors that could generate bias remains
a basic task. Khandker (1999) noted that bias in assessing program impacts arises from differences in
the capacity of individuals, households and village. This is technically termed as heterogeneity and
required to be controlled in assessing the impact of intervention program such as credit. Quasi-
experimental research design with a difference-in-difference (DID) method was highly recommended
in impact assessments and this method was employed in the current study too.
DID procedure employs analysis of data from two separate periods, one before the program
intervention and the other at the time of measuring the impact. Similarly, the analysis makes two
comparisons i.e. comparisons across time and comparisons across groups (treatment and control
groups). This method is called a difference-in-difference technique. This analysis is reasonable because
there are no exogenous limitation for being a member of ACSI i.e. membership is self-selected. In
addition, ACSI’s program placement is not biased by accessibility of roads and infrastructure.
Based on Khandker et al. (2006) the current study used the semi-logarithmic reduced form of income
equation conditional on credit as indicated below.
lnYij = αHij + βVj + γCi + µj + ηi + εyij
where Yij is the per capita expenditure of the i-th household living in j-th village, H is set of observed
non-credit household characteristics, C is an indicator of credit at the household level, V represents
village level characteristics, µ is unobserved village-specific heterogeneity, η represents unobserved
household characteristics, and ε is a vector of idiosyncratic errors distributed across households.
In order to solve the effect of unobserved heterogeneity bias on the outcome of interest, a panel data
regression with household level and village level fixed effects is determined. If this is to be valid there
must be a variation in the credit status over time in the sample households. The simple way to proceed
is if the data allow a clean division between periods where the household becomes a member (t=1) and
when it is not (t=0). This allows a straight forward before and after comparison of welfare between
clients and non-clients. Therefore, including the time factor in the above model results in the following
model specification:
lnYijt = αHijt + βVjt + γCit + µj + ηi + εyijt
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Taking the difference over the four-year period of the study, one would obtain the following difference
equation, where the sources of endogeneity (i.e. the unobserved village and household characteristics,
and assuming these characteristics do not change over time) are dropped out. In this case, the simple
OLS can be applied to the following differenced equation (difference in time equation) to estimate
unbiased effect of the credit (γ):
∆lnYijt = α∆Hijt + β∆Vjt + γ∆Cit + εyijt
Where ∆lnYijt is the difference in income or consumption across time, ∆Hijt the difference in the
observed household characteristics across time, ∆Vjt is the difference in village-level characteristics over
time, ∆Cjt is the difference in the credit status, and εyijt overtime.
Then, to see the effect of credit on welfare the above difference in time equation can be formulated to
a difference-in-difference equation for the clients and non-clients, for the treatment and control group,
for the two periods as:
[∆lnYijB - ∆lnYijN] = α[∆HijB - ∆HijN] + β[∆VjB - ∆VjN] + γ
In theory, if the data are from a randomized experiment, the expected values of the bracketed terms on
the right-hand side of the above expression will collapse to zero, leaving only the credit impact
coefficient, γ, which is the estimate of the credit impact. However, if the data are not from an
experiment, taking the expectation does not similarly collapse the right-hand-side bracketed
expressions, the estimate of γ, will be biased upward or downward depending on how the expression
on the right-hand-side turn out after the differences are performed. Khandker et al. (2006) suggested
differentiating of the above equation with respect to C, where C is a dummy C=1 for clients and C=0
for non-clients. The estimated γ from the above equation then is:
(1/yijt)∂ ∆lnYij/∂∆Cit = γ
This equation estimates the elasticity coefficient of taking credit on welfare as measured by per capita
expenditure. The other part of the paper analyses the relative importance of household and village level
characteristics on the welfare (increase in per capita expenditure) of clients. To this end, a multivariate
regression analysis is employed. Here, household income differential conditional to program
participation is regressed over household and village level variables. The model is specified here below:
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∆Yij = Xijβy + Vjγy + Cijδ + αµj + θηij + εijy
Where ∆Yij is the difference in the income and/or per capita expenditure of a household, Xij is a vector
of household characteristics, Vγc is vector of village level characteristics, Cij is level of participation by
the borrower, β, γ and δ are unknown parameters, αµj and θηij are unobserved village and household
specific variables, respectively with parameters α and θ, and εijC is the error term uncorrelated with the
regressors. The parameters for the unobserved household and village level effects are assumed to be
zero and uncorrelated with the same parameters that determine demand for participation.
Dependent Variable
Change in per capita expenditure: This measures the change in the per capita expenditure of households
from 2005 to 2009. The per capita expenditure of households is calculated using the cost of basic needs
approach that is the total food and non-food expenditures of a household divided by the adult equivalent
units in the household. The rationale for using expenditure instead of income is due to the fact that
income usually lacks objectivity and reliability is difficult to remember when generated from self-
employment and many households have a tendency to under or over report their income (World Bank,
2005).
The classification of households as poor and non-poor has been made using the poverty lines set by
1995/96 HICE study (MoFED, 2006). The poverty lines set in this study are Birr 806.27, 1,075.03, and
1,343.78 per capita expenditures for extreme poverty, poverty, and moderate poverty, respectively. This,
hence, requires converting the per capita expenditures determined based on 2005 and 2009 prices to
1995/96 prices. In converting the expenditures, the food and non-food indices of the Amhara Region
State are used.
99
Independent variables
Table 2: List of explanatory variables in the model
Variable Measurement
Age Ratio scale that takes age of the household age

Mean Age of the household The average age of all the household members
Household size Ratio scale measured in household equivalent units
Education Education level of the household head
Level of participation with The total cumulative loan taken from ACSI (This is used for the second
ACSI regression only)
Income Expenditure of the household in 1997 E.C. in terms of 1995/96 prices.
Land holding size Ratio scales that measures land ownership in hectares
Oxen ownership The number of oxen owned by the household.

Livestock Ownership Ratio scale measured in tropical livestock units
Engagement in non-farm Dummy variable 1 if the household engages in non-farm activities and 0
activities otherwise.
Infrastructure Ordinal scale 2 if the village has access to paved road, 1 if the household has dry
weather road, 0 if no access to road
Irrigation Dummy variable 1 if the village has access to irrigation and 0 otherwise
Distance from Woreta Dummy variable 1 for Quhar (near) and 0 for Kidist Hana (distant)
Age and mean age of the household: Table 3 below presents the age profile of the household heads and the
mean household age of the respondents. Age of the household head captures the effect of life-cycle
such as, experience, asset accumulation, family formation and other inter-generational differences
among the respondents. As the caretakers of their family, household heads in rural household have a
significant input on household decisions. As an individuals’ maturity improves with age and the
optimality of the above household decisions also improves. The mean age of the household heads of
the total respondents is 43.71 years. The mean ages of the two sample groups are 44.75 and 43.38 years
for clients and non-clients, respectively. Even if the clients are slightly older, the age difference between
the two groups is not statistically significant (t value=0.300; P value=0.585).
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The mean ages of the household members of the respondents is also summarized in Table 1. Mean
household age indicates the dependency ratio in a household. Households with very low mean age or
very high mean age have child and old age dependency ratio within the household. The mean household
age of the two sample groups are 25.38 and 21.89 for clients and non-clients, respectively. There is no
significant difference in the mean household ages between the two sample groups (t value=0.10; p
value=0.920).
Table 3: Demographic Characteristics of the respondents
Clients Non-Clients Total

Household age 44.75 43.38 43.71
Mean age of the household 21.89 22.03 21.96
Household size 5.61 5.40 5.55
Household Size: Household size has two opposing implications. On one hand, larger household size
implies more consumption hence can affect a household’s welfare negatively. On the other hand, rural
households depend primarily on family labor, consequently households with larger members tend to
have higher productivity, particularly in peak times such as weeding. Families with limited family labor
are forced to hire labor. The salary, usually in kind, takes part of the household’s yield. Besides, there is
a possibility of lower productivity due to motivation problems (Stiglitz, 1993). As opposed to this,
families with larger family size can earn additional income by sending a family member to work in
families with scarce labor. Another important demographic variable that can affect a households’
welfare is household size.
During the focus group discussion the participants have mentioned that boys as young as 13 or 14 can
earn up to 7 madiga (1 madiga is about 30 kgs) of crop by working as a cattle keeper in recently married
or very old couples, who has very limited labor available. Yared (1999) argued that boys and girls as
young as 10 years old can have significant effect on the overall productivity of a household as they can
help in some chores (such as keeping cattle or babysitting), which relieves adults to focus on important
tasks during peak periods such as weeding. The focus group participants’ rated having more children
(larger households) positively. The sample respondents in the study have a mean household size of 5.55.
The non-clients have mean household size of 5.40 and clients have a mean household size of 5.61. The
difference between the two groups is not statistically significant.
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Education: From the total respondents 58 (44.4%) of the household heads are illiterate and the remaining
64 household heads are literate. Out of the 64 household heads 67.2% (43 household heads) can only
read and write, 21.9% (14 household heads) have attended primary education, and the remaining 10.9%
(7 household heads) have reached to the mid school (5-8th grade). None of the respondents has education
beyond 8th grade.
The inter group comparison indicates that clients have the higher percentage of illiterates with 55.4 %
(31 households) illiterates. The comparable figure for the non-clients is 43.4% (23 households). Fifteen
(26.8%) and 22 (41.5%) of the household heads can only read and write among the clients and the non-
clients, respectively. Ten of the clients have formal education of which 7 (12.5%) are at the elementary
level (1-4th grade) and the remaining three (5.4%) have reached the junior level (5-8th grade). From the
non-clients eight household heads have attended formal education, of which 6 (11.3%) are 1-4th grade
and the remaining 2 household heads (3.8%) have reached the junior levels (5-8th grade). In general,
there is no significant difference between the education level of the clients and the non-clients, but in
terms of the ability to read and write the non-clients are significantly better than the clients. (χ2 =5.037
p < 0.05).
Table 4: Education status of the sample respondents
Relationship Those who can at Education level of the house hold head T
with ACSI least read and write No Read and Write 1 - 4th grade 5 - 8th o
Clients 25 (44.6) education

31(55.4) only
15(26.8) 7(12.5) 3(5.4) ta
5
Non- 30(56.6) 23(43.4) 22(41.5) 6(11.3) 2(3.8) l65
Total
clients 64(52.5) 58(47.5) 43(35.2) 14(11.5) 7(5.7) 13
2
Land holdings: The mean land holding of the respondents is 1.18 hectares (standard deviation=0.6673) in
2
2004/05 and 1.13 hectares in 2008/9 (Standard deviation= 0.572). As can be seen from Table 5 the
mean land holding of the respondents declined over the four year period from 2005 to 2009 by 4.2
percent (t value=1.856 p, value= 0.066).
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Table 5: Land holdings (in hectares) of the respondents
2004/05 2008/09 Total

Clients Non-Clients Clients Non-clients 2004/05 2008/09
Mean land size 0.96 1.45 0.94 1.35 1.18 1.13
Standard deviation 0.495 0.782 0.462 0.640 0.667 0.572
t value 3.608 3.833
P-value 0.001 0.001
The reasons for the decline are inheritance given to children when they get married (58.8%), taken by
government for common resources such as forests and grazing land (23.5%), land sales (1.6%) and given
to a family member other than children (0.8%). This implies the significant role inheritance plays in the
landholdings of the households in the study area and the long term effects of household size in land
holding of the households. Besides, there is a convergence in the land holding of respondents. The non-
clients have larger land holding size than the clients in both periods. In both periods the average land
holding of the non-clients is significantly higher than the clients. The percentage decline over the period
is 2.13% and 7.14% for the clients and the non-clients, respectively.
Livestock ownership: Ox is the major source of draught power in Ethiopia. It is a major source of family
labor. As a result the number of oxen a household owns significantly determines the household’s
productivity and wealth status. A complete farmer is one who at least has a pair of oxen. The participants
during the focus group discussion have emphatically expressed the importance of having a pair of oxen.
The importance of oxen can be seen at different level of oxen ownership. A household with no ox at
all cannot plough its land unless it rented oxen from other farmers who own more than two oxen. As
has been pointed out by the focus group participants the decision taken by most farmers with no ox is
either to rent their land or give their land for share cropping (siso as locally called). Farmers with only
one ox however need not rent their land rather most of them either rent an ox or share their ox with a
household with one ox. This is locally called mekenajo. Both of these have significant implication on the
yield and productivity of the households. Renting out and share cropping take significant portion of the
produce from the household, and sharing oxen (those in mekenajo) results in significant reduction of
productivity as they lose significant part of the peak ploughing time since they have to share the time
with other farmers.
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On the other side, farmers with more than two oxen can earn extra income by renting out their oxen.
In addition, these households do not face any risks of missing the peak ploughing period. However,
households with more than two oxen in the study area are limited due to the large costs associated with
feeding an ox and only 8.2% (10 households) in 2004/05 and 21.3% (26 households) in 2008/09. To
further strengthen this point, participants during the focus group discussion claimed that many farmers
do not have the incentive to own oxen for the purpose of renting. Participants during the focus group
discussion have pointed out that the cost of keeping an ox is demotivating for the farmers especially
when the small amount of grazing land is taken in to account. Besides, the participants have also
mentioned social ties as another disincentive for renting out oxen as social ties reduce the net benefit
from renting.
Table 6. Oxen and livestock ownership of the respondents
2004/05 2008/09 Overall
Number of Clients Non-Clients Clients Non-Clients 2004/05 2008/09

Oxen
0 20(35.7) 2(3.8) 1(1.8) 1(1.9) 22(18.0) 3(2.5)
1 11(19.6) 15(28.3) 20(35.7) 3(5.7) 35(28.7) 25(20.5)
2 21(37.5) 32(60.4) 31(55.4) 30(56.6) 55(45.1) 68(55.7)
3 4(7.1) 3(5.7) 4(7.1) 14(26.4) 9(7.4) 20(16.4)
4 0 1(1.9) 0 5(9.4) 1(0.8) 6(4.9)
Mean 1.16 1.74 1.68 2.36 1.44 2.01
t value 4.415 7.609 7.884
P value 0.001 0.0001 0.001
Livestock in TLU
Mean 2.22 3.46 3.33 4.97 2.83 4.15
Standard dev. 1.81 2.00 1.65 2.71 2.01 2.41
tDeviation
value 3.392 3.831 8.564
P value 0.001 0.001 0.0001
The average number of oxen owned by the total sample respondents has increased from 1.44 per
household in 2004/05 to 2.01 in 2008/09. This implies a significant increase in ox ownership over the
period (t-value = -7.884, p <0.001). The major reason for this increase is the increase in oxen ownership
by the clients. For instance clients with no oxen have declined from 20 (35.7) in 2004/05 to just one in
2008/09.
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Group wise the non-clients have the largest mean ownership of ox in both periods with 1.74 oxen per
household and 2.36 oxen per household in 2004/05 and 2008/09, respectively. This is a significant
increase in wealth as measured by number of oxen owned from 2004/05 to 2008/09 (t-value= -7.609,
p value < 0.001). Similarly, there is a significant increase in ox ownership of clients from 1.16 oxen per
household in 2004/05 to 1.68 oxen per household 2008/09 (t-value -4.4149 p-value < 0.001)
The data presented in Table 6 above indicates a mean livestock ownership of 2.83 in 2004/05 and 4.15
in 2008/09. This is a significant increase over the four year period. (t value -8.564, p-value<0.001). This
indicates a significant increase in the wealth status of all the respondents. Another indicator of this
significant increase in the livestock ownership of the respondents is the significant decline in the
respondents that own two or less TLU from 40 (32.1%) to 18 (14.8%) (χ2= 10.94 p value <0.001) and
the increases in the frequency of ownership of higher TLU categories.
Comparison of the two groups indicates that non-clients are richer than the clients in both periods. They
have mean livestock of 3.46 TLU and 4.97 TLU in 2004/05 and 2008/09, respectively. The comparable
figure for the clients is 2.22 TLU in 2004/05 and 2.96 TLU in 2008/09, respectively. A t-test also
indicates that the difference in livestock ownership between the clients and non-clients in both periods
is statistically significant (t value = -3.392 p-value =0.001 for 2004/05; t-value -3.831 p value <0.001 for
2008/09). Individually, both groups have exhibited significant increases in livestock ownership during
the period covered by the study (tested at 99% confidence level).
Engagement in Rural Non-farm Activities: Engaging in non-farm activities has dual effects on households’
productivity and welfare. It is a means of diversifying income sources and earning of higher levels of
income by investing in high risk high return activities. Besides, income generated from non-farm
activities can be plowed back to agriculture with an effect of increasing agricultural productivity. Over
the study period, participation in rural non-farm activities of the total respondents has increased from
22.9% to 32.8% (χ2=37.705 p-value < 0.001) mainly due increased involvement by the clients as the
non-clients engagement did not change significantly. Besides, participation of the clients in the rural
non-farm activities has increased significantly. The major source of this increase comes from livestock
trading (trading goats and sheep). It increased from just 4 households (3.2%) to 12 households (9.8%),
which is an increase of 200%. The higher involvement of the clients in non-farm activities coupled with
the fact that most of the activities are low return and labor intensive indicates the clients are more
concerned about the security of their income. This emanates either from the better awareness of the
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clients which in turn led to their becoming a borrower or from their higher need for security because
they are poorer than the non clients.
Comparison between the two sample kebeles reveals that the involvement in the rural non-farm
activities is more prevalent among Kidist Hanna respondents. This is because Kidist Hanna is farther
than Quhar from Woreta and there is no formal road connecting Kiddist Hana to Woreta town. These
make going and trading in Woreta costly. Hence, it increases the incentive to engage in non-farm
activities especially in trading activities.
Table 7: Respondents participation in rural non-farm activities
Clients Non-clients Total

2004/05 2008/09 2004/0 2008/0 2004/ 2008/09
HHs engaged in RNFA 19(33.9) 28(50.0) 6(11.3)
5 9(17.0))
9 28(22.
05 40(32.8
Non-farm Activities 9)
Petty trading 4(7.1) 4(7.1) 2(3.6) 3(5.7) 6(4.9) 8(6.6)
Trading 1(1.8) 3(5.4) 1(1.8) 1(1.8) 2(1.6) 4(3.3)
Employment 4(7.1) 3(5.4) 1(1.8) 2(3.6) 7(5.7) 7(5.7)
Selling food & drinks 3(5.4) 7(12.5) 1(1.8) 1(1.8) 4(3.3) 8(6.6)
Selling fire wood 3(5.4) 6(10.7) 1(1.8) 1(1.80 4(3.3) 7(5.7)
Livestock trading 0 9(16.1) 2(3.6) 3(5.7) 4(3.3) 12(9.8)
Selling construction 6(10.7) 5(8.9) 0 3(5.7) 9(7.4) 5(4.1)
Carpentry
wood 1(1.8) 0 1(1.8) 1(1.8) 2(1.6) 2(1.6)
Others 4(7.1) 4(7.1) 3(5.7) 4(7.5) 7(5.7) 8(6.6)
Expenditure: The expenditure amount of both the clients and non-clients has exhibited a significant
increase over the study period. The 2004/05 expenditure by the non-clients is significantly higher than
the clients for the same period.
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Table 8: Mean expenditure of the sample respondents
Clients Non-clients Total

2004/05 2008/09 2004/05 2008/09 2004/05 2008/09
Mean 1,103.07 1,257.51 1,393.07 1,588.02 1239.63 1,413.5
t-value 3.886 3.336 11.752
P-value 0.001 0.001 0.001
Improvements suggested: Respondents were asked to give their suggestions regarding the improvements of
ACSI services. Clients were asked to list the problems they have noticed from the ACSI services, while
the non-clients were asked to list the constraints that pushed them away from ACSI. The three most
important improvements suggested by the respondents are individual lending (36%), increasing the loan
amount (33%) and improving the loan design (timing of releasing funds, repayment pattern, and the
loan term).
For the clients the three most frequently suggested improvements are improving loan design (23
respondents), increasing the loan amount (12 respondents) and individual lending (11 respondents).
During the focus group discussion, the group discussants also mentioned that the loan design especially
the timing where repayments are expected did not suit their situations. They mentioned that they are
expected to make repayments in August which forces them to sell their oxen. They stated that they
would have preferred if repayments are made after they have collected their crops (in February and
March). The loan amount they claim is also another limitation that ACSI has to improve. They stressed
that the loan size ACSI is borrowing does not keep in track with the increase in the price of inputs
(especially oxen). The focus group participants have also mentioned that the joint liability and frequent
meetings requirements of group lending are the other features they want ACSI to change.
For non-clients the three most frequent improvements they need ACSI to implement are individual
lending (22%), increasing the loan amount (19%) and reducing the frequency of meetings and equal
access (11%). During the non-client focus group discussion the participants have utterly mentioned that
the most important factor which pushed them away from becoming ACSI clients is being accountable
for the defaults of others. Besides, they have mentioned the frequent meetings and the related productive
time loss while attending ACSI meetings did not justify the amount of loans provided. This reason may
have come from their better economic position, since most of them already own ox they need loans
much larger than what ACSI is already giving. Eleven respondents mentioned that they are not treated
107
equally in the loan approval process. During the focus group discussion too some have stated that
assessments are being made by local political officers rather than professionals working in ACSI.
Poverty Reduction Impact and Determinant Factors: This section primarily presents the poverty analysis of the
respondents in 2005 and 2009, and tries to present the factors that determine success in the poverty
reduction through credit. To this end, the expenditure effect of credit is determined using the difference-
in- difference of method. Then, the effect of various household and village level variables on the success
of clients is determined using a multivariate regression method.
Incidence, Depth and Severity of Poverty: The incidence of poverty among the sampled respondents in 2005
is lower than the national average of 2005, which was 38.7% (MoFED, 2005). However, the incidence
of poverty amongst the clients of ACSI (50.8%) is significantly higher than the country average for the
same period. This is an indication that the clients are poorer than the other two sampling groups.
Table 9: The head count, poverty gap and squared poverty indices of the respondents
2004/05 2008/09
All Sample Clients All Sample Clients
Headcount Index(poverty line) 0.324 0.508 0.138 0.314
Headcount Index (moderate) 0.603 0.772 0.371 0.577
Poverty gap index 0.053 0.095 0.026 0.059
Poverty gap index (Moderate) 0.13 0.231 0.054 0.115
Poverty severity index 0.014 0.026 0.005 0.012
Poverty Severity Index (Moderate) 0.043 0.080 0.016 0.036
The head count indices for the non-clients by 2005 were 13.20% (seven households). As far as extreme
poverty is concerned only 8 households (6.8%) of the sampled households lie below the extreme poverty
line, all of whom are clients. The poverty gap index for the total respondents by 2004/05 is 0.053. This
is lower than the country’s index of 0.083 for 2004/05. However, the index for the clients in the same
period is significantly higher than the country’s average, still indicating ACSI’s targeting of the poorer
sections of the society. As far as the targeting by ACSI is concerned, it is successful in excluding the
relatively rich groups of the society. The major barriers to entry for the richer households seem to be
group lending and frequent meeting requirements by ACSI as indicated in the focus group discussion.
These are too costly for richer households to afford.
108
The severity index of 0.014 for the total sample is also much lower than the country’s average of 0.027.
In this case the clients’ index is slightly lower than the country’s average indicating very low income
inequality. During the period covered in the study, 2004/05 to 2008/09, significant improvements have
been made in terms of reducing poverty in the area. For sure ACSI has played a role in that. Comparing
the 1997 E.C. indices with the 2001 E.C. indices can reveal these improvements. All the three measures
of poverty incidence, depth and severity of poverty have improved significantly among the clients of
ACSI. The incidence of poverty has reduced from 50.8% to 31.4% amongst the clients. This is a
significant decline (χ2= 4.44 p value < 0.05). Besides the depth and severity of poverty as measured by
poverty gap index and poverty severity index has shown significant improvements over the period.
However, care should be taken not to jump to a conclusion that the above changes on the clients have
been commenced by credit and credit alone. This is because various macro, meso and/or micro level
phenomena, apart from or coupled with credit, may have brought the changes. One indicator of the
significant impact these other variables have made is the significant increase in the expenditures and
incomes of the non-clients. Therefore, to see the impact credit has on household expenditure, the
contribution of credit on the households’ expenditure should be isolated. To that end, a fixed effect
estimate of the effect of credit controlling for the household and village level characteristics other than
involvement in the credit program has been conducted.
After controlling for wealth (land holdings in 2005, total livestock and number of ox owned in 2005),
the mean age of the household, age of the household head, household size, engagement in rural non-
farm activities, literacy and type of road to which the household has access, the difference in per capita
expenditures over the four year period indicates a favorable result for the clients. The clients’ per capita
expenditure differential is higher than the non-clients by 2.00% (t-value=2.402 and p-value= 0.062).
The result is significant at 90% confidence level. This implies borrowing from ACSI has on average an
extra 2.00 increase in expenditures from 2005 to 2009. That is, there is a 2.00% income (expenditure)
effect for being a client of ACSI. Applying this estimated impact of credit, 2.00%, on the 1997 E.C.
expenditure of the clients’ indicates the poverty reduction effected by ACSI. Table 10 below indicates
the poverty impact of borrowing calculated based on the 2.00% estimated income effect.
Table 10: Poverty impact of ACSI
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Actual before Estimated based on 2.00% Poverty

joining ACSI incremental impact of borrowing impact of
credit
Head count index 0.508 0.433 0.075
Poverty gap index 0.095 0.087 0.008
Poverty squared 0.026 0.024 0.002
Moderate poverty head 0.772 0.684 0.088
count gap (moderate)
Poverty 0.231 0.190 0.041
Poverty squared 0.080 0.066 0.014
(moderate)
P value = 0.046 for the poverty change P value = 0.125 moderate poverty
Out of the 18.4% poverty reduction in the area (Table 10), microfinance credit (ACSI) operation
contributed 7.5%. In terms of the moderate poverty head count index, ACSIs operation contributed
8.8% reduction out of the total. It has also contributed 0.8% and 0.2% of the decrease in depth and
severity of poverty in the study area.
In terms of other measures ACSI resulted in a significant improvement in the ownership of oxen.
However, when the number of oxen owned is considered the non-clients has made more improvements.
Keeping the 2004/05. oxen ownership constant, the non-clients’ ownership in 2008/09. is higher than
the clients by 0.379 oxen. This is significant at 90% confidence level (t- value = 2.758; p value=0.007).
The relatively lower effect on the number of oxen owned coupled with the significant increase in the
ownership (just having an ox) could be because the clients repay their loan by reselling the oxen they
buy with the loan. The net result is the number of the oxen they own will not increase. This in turn
implies that ACSI is required to reassess its loan design, which is also suggested by the clients.
Determinants of success: So far the analysis has focused on assessing the poverty impact of credit using its
effect on household per capita expenditure. To this end various household and village level
characteristics have been controlled. The forth coming section analyses the effect these variables have
on the expenditure difference on the clients. To see the extent to which the explanatory variables affect
expenditure and income of the clients, a multiple regression analysis has been conducted. The
independent variables selected are age of the household head, mean household age and household size
from the demographic factors, and land size, size of livestock by 2004/05 and number of oxen owned
from the wealth measures and participation level in the credit program. Besides, collection of market
information and access to paved road are used.
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Demographic factors; age of the household head, mean age of the household, and household size
significantly determine the per capita expenditure increases of the clients. An R square value of 0.252
indicates that these three variables determine 25.2% of the variation in per capita expenditure. The
model has an F value of 5.738 and a p value of 0.002 indicating the relationship of these explanatory
variables with the per capita income and that the difference is not a result of chance. Individually, the
coefficient for household mean age and age of the household heads is significant at the 90% confidence
level, and household size coefficient is significant at 95% confidence level.
The result indicates that household mean age and age of the household head have positive impacts on
the per capita difference for households; 0.280 and 0.017 standardized beta coefficients, respectively.
The result implies that a one year age in the mean household age and age of the household head increases
per capita expenditures of a client household by 1.7% and 2.8%, respectively. The effect of household
age is minimal but it is positive towards older members.
On the other hand, household size has negative effect on per capita expenditure difference in the client
households. The output can be interpreted as, an increase of family size by one person decreases
household per capita expenditure by 34.9%. This is in direct contrast to what the participants during the
focus group discussion have claimed. Most of the participants have claimed that having more children
improves their welfare by increasing their productivity. However, as this analysis indicate the presence
of disguised unemployment for long periods of the year and the expansion of school enrolments in the
area, made the marginal productivity of dependents lower than their marginal consumption. The high
positive coefficient for mean household age strengthens this point.
Both wealth and level of participation have a positive impact on the expenditure differences across the
study period. The coefficients of land and level of participation in the credit program on per capita
expenditure differences are coefficients of 0.100 and 0.141 for per capita expenditure difference. These
individual coefficients are statistically significant. The effect of land is larger than level of participation
on income but lower effect on per capita expenditure.
Regarding the demographic variables, mean age of the household has the highest positive impact on the
households’ per capita expenditure and household size in general has a negative effect on per capita
expenditure. Age of the household head has only a slightly positive effect on the per capita expenditure
differences of the clients.
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In another scenario, wealth as measured by land holdings of the household in 2004/05has the strongest
effect on the overall income of a client and level of participation in the credit program as measured by
cumulative loans, which has significant effects on the difference in the per capita expenditure of the
clients.
From the other variables, literacy has no effect on the per capita expenditure increases of the clients.
Besides, participation in rural non-farm activities has negative impact on per capita expenditure and
income. This could be due to the very low income and labor intensive nature of the non-farm activities
the clients are currently engaged in. At the village level variables, access to paved road has significant
effect on the expenditure of the clients.
5. Conclusion
As measured by expenditure, land size, oxen, and livestock, the clients of ACSI are poorer than their
non-client counterparts. This indicates that ACSI’s success in targeting the poorer households. The
study revealed that credit given by ACSI has brought positive impacts on the clients’ livelihood. It
increased income and ownership of oxen. ACSI’s impact in terms of reducing poverty as measured by
its 2% effect on per capita expenditure is 7.5% in poverty incidence, 0.8% in the depth of poverty, and
0.2% in the severity of poverty. In terms of asset accumulation ACSI has resulted in a significant
decrease in the percentage of clients with no oxen even though its impact on the number of oxen owned
is limited. The limited result is due to the fact that clients have to sell their ox to repay the loan.
In terms of livelihood diversification participation, ACSI resulted in increased participation on non-farm

and off-farm rural activities. But it was also found out that clients participation on non-farm activities
have low returns with a negative impact on total income of the household. Therefore, ACSI has to
provide business development service to its clients so that they are able to identify and engage in more
profitable activities.
Regarding the service ACSI is currently delivering, respondents have dissatisfaction about the
methodology, flexibility and design of loans. According to the respondents, the four most important
areas ACSI has to improve in order of importance are individual lending instead of group lending,
increase in the amount of loan, improvement in the loan design, such as its term, repayment pattern and
period, and reduction in the frequency of meetings. This implies that borrowers of ACSI are sensitive
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about the loan design, flexibility of methodologies and transaction costs, which is in accordance with
the evidence in literature of rural finance (Stiglitz 1991; Robinson 2001).
Finally, the factors that significantly contribute to clients’ success in graduating out of poverty are the
level of participation (cumulative loans taken), land holding size, ownership of oxen, level of dependency
in the household, age of the household head, and access to paved roads. On the other hand, participation
in rural non-farm and off-farm activities and household size negatively affect expenditure increases of
the clients during the period covered in the study.
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Financial Access to Everyone: A Review
Ramesh Rengasamy
Assistant Professor, College of Agriculture and Environmental Sciences, Bahir Dar University. email:
ramesh.gri@gmail.com
Abstract: Expanding financial access to everyone is an interesting development idea, particularly in the context of
effectively reaching the world's poorest families in a more effective way. Pinning faith on this concept, there has been a surge
of interest in promoting microfinance in the recent past. Ethiopia is reported to have one bank branch per hundred thousand
people. In the absence of bank branches, often, it is Micro Finance Institutions (MFIs) or local savings and loan groups
that serve as a source of finance for all. The potential of micro finance in generating self-employment as well as lifting women
and poor families out of poverty is macro in scale, which perhaps, remains the main reason it has found centre-stage in
development discourse and practice. This paper is a review of outstanding studies on the performance of MFIs in Africa in
general, and Ethiopia in particular. The focus is on what works, and what remains a pitfall in effectively expanding
financial access to everyone in rural Ethiopia. Microfinance is characterized by provision of loans to a group of poor
individuals without collateral for the purpose of income generation and economic empowerment. It is evident from the review
that since its advent, there have been many conflicting views about micro-lending’s ability to empower those without access
to credit. Scholars have argued that aid and hand-outs to African countries ought to be abandoned altogether in favor of
partnerships like microfinance. Others still maintain that microfinance is a misnomer asserting that microfinance is not
used for entrepreneurship but instead for ‘consumption smoothing’. The third set of researchers go further, declaring that
extending credit to marginalized groups or communities in nation is futile and even counterproductive because ‘no one was
ever liberated by being placed in debt’. This way, the debate goes on. Critically reviewing these literatures, this study concludes
that from the size of poverty spread in rural, semi-urban and urban areas in Ethiopia, the task of providing microfinance
service to families living below the minimum standard is dominant. The avenues for semi-urban poor for improving their
lives are large compared to their rural counterparts. Hence, microfinance has a greater qualitative role to play in case of
rural poor. It is also found that at least 43 countries around the world have adopted some version of the micro-credit model,
and that if this sector is growing too quickly we should be careful to monitor it and consider various regulations and
measures to prevent or correct instances of voracious lending. An ideal loan would be one that immediately goes towards
funding a new venture or increasing the capacity of an existing project. Another interesting revelation as revealed in this
review was ensuring competition. It is an essential part of broadening access as competition encourages incumbent institutions
to seek out profitable ways of providing services to previously excluded segments of the population. This also helps to increase
the pace of adopting new lending technologies that improve access to microfinance services.
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Keywords: Broadening access, financial inclusion, microfinance
1. Introduction
Expanding financial access to everyone is an interesting development idea, particularly in the context of
reaching the world's poorest families in a more effective way. In plain language, microfinance describes
loans given to a group of poor individuals without collateral, for the purpose of income generation.
Pinning faith on this concept, there has been a surge of interest in microfinance in the past decade. The
world’s largest aid agencies have worked in many of the least developed and developing countries to
assist the poor committing people, money, and countless hours with a view to building more inclusive
financial systems—systems that work for the poor. The potential of micro-finance in generating self-
employment, and to lift women and poor families out of poverty are macro in scale, which obviously,
are the reasons it has found centre-stage in development discourse (and practice) today.
The efforts of the funders and their network of micro finance institutions (MFIs) are unprecedented.
Their efforts have today helped achieve almost a near-universal consensus around the fundamentals of
an inclusive financial system: from regulation and supervision at the policy level, to financial reporting
and disclosure at the institutional level, to fairly priced products at the client level. All have contributed
to the professionalization of microfinance, once considered a marginal, even charitable, activity by
financiers. Interestingly, in the process, it has helped push microfinance beyond the conference rooms
of aid agencies, to the boardrooms of commercial bankers and policymakers. Best practices are
becoming standards to emulate. Credit to small groups who were too impoverished to be considered
credit-worthy has generated different micro-lending models, including profit-based ones today.
The picture so far is breathtaking. Where small, heavily subsidized microcredit schemes used to be the
norm, hundreds of profitable microfinance providers of all institutional shapes and forms are now
offering a wide range of financial services—money transfers, deposit services, and insurance—to ever-
larger numbers of poor people in their communities in many Africa countries today. In a sure sign that
microfinance is going mainstream, domestic and international commercial banks are now entering the
fray, motivated by the excellent performance of poor clients and the promise of new information and
delivery technologies to reduce cost and risk. Certainly, micro finance is one of the admirable
innovations as a development strategy.
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This paper is a review or a synthesis of outstanding studies on the performance of MFIs in Africa in
general, and Ethiopia in particular. The purpose of the paper is to take stock of the nature of discourse
and debate current to ‘providing financial access to the poorer communities in Africa’. The focus is on
what works, and what are the pitfalls in expanding financial access to everyone in Ethiopian Villages.
Pro-poor policies and strong institutions to deliver services are essential for human development to take
place. It holds good - be it provision of safe drinking water or providing financial access to the
enterprising poor to start small business. Recent development theory sees the lack of access to finance
as a critical mechanism for generating persistent income inequality, as well as slower growth. Without
inclusive financial systems, poor individuals and small enterprises need to rely on their own limited
savings and earnings to invest in their education, become entrepreneurs, or take advantage of promising
growth opportunities. Accessibility can be seen as physical accessibility (proximity) and financial
accessibility (affordability).
2. Where have we reached, and where are we heading?
Microcredit Summit Campaign Report 2011 reports that MFIs extend loans to more than 200 million
clients by the end of 2010. Through various socio-economic ties of the borrowers and their families,
microfinance has impacted upon the lives of around 1 billion people in emerging markets and
developing countries. That tells about the reach of MFIs world-wide (Larry, 2011).
Connecting groups of poor households to lending institutions, or micro loans through institutional
(non-exploitative) arrangements foster the strengthening of local economies by enhancing the financial
flow within households and villages. It makes way for consuming life-improving facilities and
technologies, while incurring minimal risk to the lending party. The spreading of and innovation within
the microfinance sector demonstrates a successful initiative that is both socially conscious and
economically beneficial (Campbell, 2010).
The reach of micro finance as a development strategy – operating at the micro level, and creating an
impact at the macro level is well-documented. Whatever be the obscurity of the nature of village one
lives in, financial access is a dire need to be able to move beyond subsistence, putting to use one’s
entrepreneurship acumen. The Global Financial Inclusion Indicators Index- 2012 (Findex) reports that
worldwide approximately 2.5 billion of the people – world’s poor - do not have a formal account at a
financial institution. The reason is not only because of poverty, but also due to costs, travel distance and
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paper work involved etc. Access to affordable financial services is linked to overcoming poverty,
reducing income disparities, and increasing economic growth.
The financial systems of many African countries still remain under-developed (as compared to other
developing economies) even though most of these countries have undergone extensive financial sector
reforms in the last two decades. Indicators of the use of financial products and services by adults and
enterprises in the region show that many challenges remain toward building a more financially inclusive
financial sector in Africa. For instance, recent evidence from Global Findex database shows that less
than a quarter of adults in Africa have an account with a formal financial institution and many adults in
Africa use informal methods to save and borrow. Similarly, many small and medium size enterprises
(SMEs) in Africa cite access to finance as a major obstacle.
Access to Banking & Bank Account penetration: A publication of the World Bank (2012) reports that overall,
24% of adults in the African region have an account. Within Africa, there is a large variation in account
ownership: 24% of adults in Sub-Saharan Africa are reported to have an account at a formal financial
institution, though this ranges from 51% in Southern Africa to 11% in Central Africa. In Eastern Africa,
account penetration reported is 23% (Demirguc-Kunt and Klapper, 2012). In Sub-Saharan Africa the
most frequently cited reason for not having a formal account is lack of enough money to use one. This
is the response given by more than 80% of adults without a formal account (Asli Demirgüç-Kunt Leora
Klapper, 2012), and the second reason attributed is physical access and documentation related barriers.
Ethiopia is reported to have less than 1 bank branch per 100,000 people (World Bank, 2008). Perhaps
not surprisingly, there are 229 deposit accounts for every 1,000 people in Bangladesh (WB, 2008). In
many of the African countries, in the absence of bank branches, often, it is Micro Finance Institutions
(MFIs) or local savings and loan groups that serve as source of finance for all. We must note here that
the history of formal establishment of Micro Finance Institution in Ethiopia is limited to about fifteen
years. The first group of a few MFIs was established in early 1997 following the issuance of
Proclamation No. 40/1996 in July 19961. But like in most African countries, there are barriers related
to physical distance, technological inaccessibility, documentation requirements etc.
1
In the recent proclamation no.626/2009 of Ethiopia, microfinance is defined as a business and hence banks
licensed by NBE are allowed to engage in microfinance without a separate microfinance business license.
The New proclamation also allows MFIs to apply any lending methodology at their own discretion.
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Many firms, particularly small ones, often complain about lack of access to finance (World Bank, 2012).
Recent research using detailed firm-level data and survey information provides direct evidence
suggesting that such complaints are valid in that limited access stunts firms’ growth. This finding is
supported by studies based on census data and individual case studies using detailed loan information.
For example, an Investment Climate Survey conducted (in the year 2008) by the World Bank reads that
more than 60% of the firms in Sub-Saharan Africa report that both access to finance and cost of finance as the
major constraint to firm growth (World Bank, 2008; World Bank, 2012). The Global Competitiveness
Report (2011-2012) confirms this statement reporting that among the most problematic factors for
doing business in Ethiopia, the one that stands on the top is access to finance. Thus, access is one
prominent reason for the least percentage of population using the financial services of a commercial
bank or an MFI.
If one goes through the evidences on micro finance penetration across countries in Africa, one finds
that Ethiopia is at the bottom most of the rung. That means to say that the percentage of people using
MFI services in Ethiopia is (14%) very minimal (World Bank, 2008 p.135 & p.191) and when we probe
further, the reasons that stand out prominent are: Physical or geographical inaccessibility, and inability
of the poor to produce the documents demanded.
Physical/Geographical Access: Bringing financial services to ‘rural clients’ is a major challenge on the
financial inclusion agenda. Geographic distance to the nearest branch, or the density of branches relative
to the population, can provide a first crude indication of geographic access or lack of physical barriers
to access. Often the main barrier to financial inclusion in rural areas is the great distances that rural
residents must travel to reach a bank branch. Poor infrastructure and telecommunications, and heavy
branch regulation, also restrict the geographical expansion of bank branches (CGAP, 2009). Indeed
financial inclusion is positively and significantly correlated with access points measured as commercial
bank branches per 100,000 people. Sub-Saharan Africa economies are at the low end of the spectrum
with low number of commercial bank branches per 100,000 adults and low account penetration.
Box – 1: Regulatory Framework – Ethiopia
The regulatory framework that governs the financial system in Ethiopia among others consists of
National Bank of Ethiopia establishment proclamation no. 591/2008, licensing and supervision of
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Banking Business Proclamation No. 592/2008, licensing and supervision of Insurance business
Proclamation and licensing and supervision of Microfinance Business Proclamation No. 626/2009.
National Bank of Ethiopia establishment proclamation no. 591/2008 has provided authority for NBE
to set prudential standards for banking and other financial institutions. The proclamations are enacted
by the parliament and secondary legislations or directives that govern the operation of financial
institutions are issued by the central bank.
Source: Yigrem Kassa, 2010. Regulation & Supervision of Microfinance Business in Ethiopia:
Achievements, Challenges & Prospects, National Bank of Ethiopia.p.34
Expanding Access through Technology: One of the ideas for expanding financial / banking access is by putting
to use technology. The idea that physical access barriers can be overcome by technology is an excellent
idea, but this can become a reality when a country can make available the relevant technology, and makes
it accessible to the poor. Thus, in terms of tiding over the ‘access-related problem’ by introducing
technological solutions such as the mobile phone banking or the use of Automated Teller Machines
(ATM), the ATM access reported in Ethiopia is 0.28%, which is used by 0.41% of those who use the
financial services of one or the other of the institutions for loan and savings.
Among the Sub-Saharan African countries, only in Kenya about 68% of those with bank accounts use
mobile banking, followed by Sudan (52%) and Algeria (44%) (Demirguc-Kunt, 2012). Ethiopia is
reported to be one of the lowest in the world in mobile phone use (26%), and we have a figure to report
about those using mobile banking.
Box – 2: Prodem’s ATMs and biometric technology respond to poor customers
In 2002, Prodem’s private financial fund (FFP) in Bolivia began installing Smart Automatic Teller
Machines (SATMs), which incorporate fingerprint readers to verify clients’ identities rather than relying
on Personal Identification Number (PIN) technology. The ATMs also use voice instructions in three
languages and an easy-to use graphic interface to allow illiterate clients to use them. The ATMs are used
in conjunction with smart cards that contain the relevant client information, so transactions are
immediately recorded on the card. The ATM updates data centrally only twice a day, which saves
Prodem an estimated $800,000 per year in Internet charges. Today, Prodem has 52 ATMs, along with
40 POS devices at gas stations and supermarkets, where clients can use their smart cards to access funds
24 hours a day, seven days a week. Customers have found these user-friendly ATMs and POSs attractive,
with nearly 50,000 smart card savings accounts by 2003 (out of a total of nearly 62,000 savers). The
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machines encouraged clients to save more often, whenever they have cash available, increasing deposits
in regular savings accounts from $102,000 in 2000 to $19 million as of June 2005.
Sources: Whelan, “Automated Teller Machines,” Hernandez and Mugica, What Works: Multilingual Smart
ATMs for Microfinance, Cited in Brigit Helms, 2006. Access for All, Building Inclusive Financial Systems, CG to
Assist the Poor.
Documentation Requirements as a Barrier: Limited geographic or physical access to a bank is only one type
of barrier that potential customers face. Insufficient documentation is a commonly cited reason for
younger adults in Sub-Saharan Africa and distance from a bank is an important barrier for adults living
in rural areas. By limiting eligibility, documentation requirements can be another important barrier to
access. For example, banks in Albania, Mozambique, Spain, and Sweden demand on average only one
document to open a bank account, whereas banks in Bangladesh, Cameroon, Chile, Nepal, Uganda,
Ethiopia and Zambia require at least four documents, including an identity card or passport,
recommendation letter, wage slip, and proof of domicile. Given the high degree of informality in many
developing countries, only a small proportion of the population can produce these documents. More
than sixty percent of the population in countries like Cameroon and Ethiopia work in the informal
sector and is thus unable to produce a wage slips. People in rural areas in Sub-Saharan Africa—61% of
the overall population—are often unable to provide a formal proof of domicile, which becomes a barrier
or limits banking services to poor clients from villages.
The Habit of Thrift and Savings: The data on saving behavior of adults shows that about 50% of the people
in western Africa have the habit of saving, followed by about 38% in Eastern Africa. They save either
at a formal financial institution, or using other local informal methods. Local informal methods seem to
dominate in both the regions referred to (Demirguc-Kunt and Klapper, 2012). While many savers blend
formal and informal methods, many use only community savings clubs. Formal savings practices are not
very common in Ethiopia, and savings practices are reported to be common in Nigeria, South Africa
and Kenya. In Sub-Saharan Africa, 34% of those who save report having used only a community based
savings club. Large scale saving surveys generally do not gather data on the alternative methods, such as
the poor might save through asset accumulation (such as gold or livestock) and saving ― ‘under the
mattress’ (Asli Demirgüç-Kunt et al., 2012).
Box – 3: The Ethiopian Financial system
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The Ethiopian Financial system, generally speaking falls into three categories. These include: formal,
semi-formal and informal financial system. The formal financial system is a regulated sector, which is
well organized and provides financial services mainly to urban areas. This formal financial system in
Ethiopia is mainly compared with financial institutions such as banks, insurance companies and
microfinance institutions. At the end of 2008/2009, there are 12 Commercial Banks (two government
owned), 1 government owned development bank, 12 insurance companies (one of which is government
owned,) and 30 microfinance institutions (owned by regional governments, NGOs, individuals,
associations etc.) The saving and credit cooperative are considered as semi-formal financial institutions,
which are not regulated and supervised by NBE. The informal financial system includes Equib, Eddir
and others, which are not regulated.
Source: Yigrem Kassa, 2010. Regulation & Supervision of Microfinance Business in Ethiopia:
Achievements, Challenges & Prospects, National Bank of Ethiopia.p.28
Borrowal Accounts with Small Firms as an Indicator: Bank finance is typically the major source of external
finance for firms of all sizes. Improvements in the functioning of the formal financial sector can reduce
financing constraints for small firms and others who have difficulty in self-financing or in finding private
or informal sources of funding. Research indicates that access to finance promotes more start-ups: it is
smaller firms that are often the most dynamic and innovative. Countries that strangle this potential with
financial barriers not only lose the growth potential of these enterprises but also risk missing
opportunities to diversify into new areas of hitherto unrevealed comparative advantage. Financial
inclusion also enables incumbent firms to reach a larger equilibrium size by enabling them to exploit
growth and investment opportunities.
A useful measure of access to financial services is to look at number of borrowal accounts in the rural
financial system vis-a-vis the population. Thus outreach can be measured in terms of number of
borrowal accounts vis-a-vis the rural poor in terms of households. The same holds good firms as well.
World Bank Enterprise Survey (year) of Africa reports that on average, percent of enterprises in African
countries with a bank account (across all firm size groups) is comparable to or greater than the percent
of enterprises with a bank account in all other developing economies. For instance, 83% of small and
94% of medium sized enterprises in Africa are reported to have bank account. However, only 22% of
enterprises have a loan or a line of credit from a formal financial institution, due to procedural and
documentation related formalities.
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Furthermore, greater financial inclusion allows firms the choice of more efficient asset portfolios as well
as more efficient organizational forms, such as incorporation. If stronger financial systems can promote
entry of new firms, enterprise growth, innovation, and risk reduction, then it is almost inescapable that
stronger financial systems will improve aggregate economic performance.
3. Key messages and conclusion
Micro credit is considered an excellent development idea, in the sense, by providing loans rather than
grants, the micro-credit provider can become sustainable by recycling resources over and over again.
Hence, micro-credit serves to deliver the ‘holy trinity’ of outreach, impact and sustainability (Julius H.
Kotir et al., 2009). The review concludes that from the size of poverty spread in rural, semi-urban and
urban areas in Ethiopia, the task of taking microfinance to the below poverty-line families is enormous.
Access to credit enables poor people to invest in a wide range of assets, better nutrition, improved
health, access to schooling, a better roof on their homes and expansion of their small businesses (World
Bank, 2002; Littlefield et al., 2005; Ashcroft, 2008). Access to financial services can be essentially viewed
as a fundamental driver of increased household income and resilience. Therefore access or outreach
encompasses the ability of Microfinance Institutions (MFIs) to reach the poor and remote people.
Micro finance programmes with features like innovative loan products, coupled with low incidence of
default and modest interest rates have made it very attractive, encouraging entrepreneurship among
individuals and groups. It has, indeed, demonstrated a development initiative both socially and
economically beneficial.
Despite the recent financial sector growth in Africa over the past decades, many individuals and firms
are still excluded from access to financial services in African countries. Analysis of the usage and access
of financial services by adults and enterprises shows that African countries lag behind other developing
economies in both aspects, and that cost, distance, and documentation requirements are important
obstacles. Despite the fact that the costs of technology are reducing, successful use of technology in
microfinance is still the exception rather than the rule. Several challenges remain that inhibit the
widespread adoption of technology to extend financial services delivery across vast distances and to
millions of people quickly. They include: literacy level of the clients, as well as the capacity of staff,
infrastructure such as internet connectivity, and even electricity.
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Removing physical, bureaucratic, and financial barriers to expand financial inclusion is challenging since
this also requires addressing the underlying structural causes. Nevertheless, measures to improve
contestability of financial systems and underlying information and regulatory environment are also likely
to speed up the introduction and adoptions of new products, processes, and technology that may help
further lessen these barriers, especially in Africa. The most evident example is the recent success of
mobile money in Sub-Saharan Africa which shows that innovations can bring about dramatic changes
in how people engage in financial transactions by lowering entry barriers, reducing costs, and expanding
access.
References
Asli Demirgüç-Kunt Leora Klapper, 2012. Financial Inclusion in Africa: An Overview. The World Bank,
Development Research Group Finance and Private Sector Development Team, June 2012.
WPS6088.
Birgit Helms, 2006. Access for all: Building Inclusive Financial Systems, Capturing 10 years of CGAP
Experience, The World Bank, Washington DC.
CGD, 2009. Policy Principles for Expanding Financial Access, Report of the CGD Task Force on Access to
Financial Services, Center for Global Development, Washington DC.
CGAP (Consultative Group to Assist the Poor), 2009. Financial Access 2009: Measuring Access to Financial
Services around the World. Washington, DC: CGAP/World Bank.
Demirguc-Kunt, Asli and Leora Klapper, 2012. Measuring Financial Inclusion: The Global Findex Database,
World Bank Policy Research Working Paper 6025.
Enterprise Survey, 2011. Enterprise Survey-Ethiopia. Available at www.enterprisesurveys.org, accessed on

28th February 2013.
Getaneh Gobezie, 2005. Regulating Microfinance in Ethiopia: Making it more Effective, No.3 Essays on
Regulation and Supervision, ACSI.
Gregor Campbell, 2010: Micro financing the Developing World: how small loans empower local economies and catalyse
neoliberalism's endgame, Third World Quarterly, 31:7, 1081-1090.
Julius H. Kotir and Franklin Obeng-Odoom, 2009. Microfinance and Rural Household Development:
A Ghanaian Perspective. Journal of Developing Societies 2009 25: 85.
126
Reed, Larry, 2011. State of the Microcredit Summit Campaign Report 2011. Microcredit Summit Campaign.
Washington D.C.
The Global Competitiveness Report 2011-2012, Key Indicators 2010. Country/Economy Profile: Ethiopia.
World Bank, 2008. Finance for All: Policies and pitfall in Expanding Access.A World Bank Policy Research
Report – 2008, The World Bank, Washington DC.
World Bank, 2012. Financial Inclusion in Africa: An Overview, Development Research Group, Policy
Research Working Paper 6088, The World Bank, Washington DC.
Yigrem Kassa, 2010. Regulation & Supervision of Microfinance Business in Ethiopia: Achievements, Challenges
& Prospects, National Bank of Ethiopia.
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The Linchpin Nature of Saving, Investment and Growth: A Review of Literature and Drawing
Lessons for Ethiopia
Mebratu Leake
Lecturer, College of Business and Economics, Haramaya University
E-mail: mebratuleake@yahoo.com
Abstract: Theoretical and empirical literatures have provided compelling evidence on the causal, direct and positive
interrelationship between saving, investment and economic growth. One popular empirical research finding but a debatable
issue is that causality relationship can run in both directions: there exists a positive causality relationship from saving to
economic growth and from economic growth to saving. Despite the reciprocal relationship, however, one inevitable reality is
saving plays a fundamental role on national capital formation, and is a seminal factor in the investment and economic
development pattern. With the help of financial vehicles and institutions, resources are mobilized from surplus and
unproductive economic units (mainly from households in developing countries like Ethiopia) in the form of savings to deficit
and demanding units (private investors and government) for productive usage, thus stimulating economic activities. Several
studies conducted in developing countries have revealed that the existence of stubborn and underdeveloped economies owing
to weak domestic resource mobilization practices (low saving culture), lack of structured and organized mechanisms and
low income generating ability of households. Thus, in low income countries, private large scale investments are difficult.
Hence, a systematic fill up of a pitcher with dew drops (savings) that becomes full after some periods (capital accumulation)
to finance large scale industries and national mega projects should be promoted. In light with this, this study reviews
theoretical and empirical literatures revealing the tangible relationship between saving, investment and growth (in the saving
to economic growth direction) justifying the reasons why countries (specifically African countries) look into domestic resource
mobilization (saving) and why saving remains low in Africa. Finally, a lesson is drawn from which Ethiopia can learn
and enhance its saving status to fill the financial gap and envisage investment and economic growth.
Keywords: Economic growth, investment, saving
1. Introduction
The cause-effect relationship between domestic saving, investment and economic growth has received
considerable attention among researchers, academia and policy makers. The role of domestic saving and
investment in promoting economic growth has been perplexing researchers and is still remained
unsettled agenda (Jangili, 2012; Gutiérrez and Solimano, 2007). Proponents of domestic saving argue
for promoting domestic saving (capital accumulation) to create productive capacity (investment) where
investment is an essential vehicle to enhance productivity and likely to generate knowledge spillover and
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new technologies. Domestic saving is an important variable as capital importation (foreign savings) can
be volatile and lead to sudden circuit breaking, and may force to costly macroeconomic adjustments and
eventually growth crises.
From the standard growth theory, however, a country can grow faster by investing on its physical and
human factors of production with a cross border (global) capital markets and investment financed from
international capital flows (foreign saving). Hence, saving is not an essential element of growth process.
Many commentators of the saving, investment and growth correlation argue the effect of growth on
saving, not saving on growth. Thus, the causality and direction of the trend depends on X (growth)
causes Y (saving), and hence, change of growth happens first for saving to occur (Aghion et al., 2009).
The essence of this economic philosophy is bringing economic growth by attracting foreign investments
to create employment opportunities and low income households begin to generate income and hence
save the extra consumption for investment and asset accumulation to sustain development.
Literature debates on the importance of saving in promoting investment and economic growth. In
countries with low income society, saving is either immaterial or abandoned as a strategy to promote
investment and economic growth. Many studies conducted in developing countries, however, advice
the countries to work on enhancing domestic resource mobilization and integrate with other
development strategies to finance domestic investment and create job opportunities to stimulate and
sustain growth. In light of this, reviewing theories of economic growth and empirical findings is helpful
to design policies that can foster investment and economic performance.
The purpose of this paper is to scantly review essential theoretical and empirical literatures regarding
the causal relationship of saving, investment and growth. Understanding the causation is fundamental,
not just for simple knowledge consumption, but for policy design. If saving is merely a passive variable
to investment or growth, then policies for growth should focus on promoting investment on human,
plant and equipments of accelerating innovation/creativity, entrepreneurship and technological
advancements. Otherwise, if savings are seminal factors in driving growth, policies should be designed
in light of incentivizing households, the private sector, and government to save. Accordingly, the
direction of the relationship is first reviewed followed by related controversies of financing investment
and economic growth (domestic saving or foreign saving). The main reasons why African countries
should look for domestic resource mobilization than attracting international cash inflows (foreign direct
investment and remittances) are discussed. Saving in Africa, especially in the Sub-Sahara, is at its low
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standard. Thus, studies conducted on the reasons why it remains low are reviewed and explained. Lastly,
lessons for policy implications are drawn from where Ethiopia can learn to enhance its saving culture
and finance its economic growth in general and large scale national projects in particular.
Based on these argument, this study was aimed at reviewing the casual relationship between saving,
investment, and economic growth, investigating the reasons why African countries should look for
domestic saving for economic development, identifying the reasons why saving is at its lower status in
Africa, and drawing a lesson as well as forwarding policy recommendation from the review.
2. Saving, investment and growth: The causality pattern puzzle
The Monterrey Consensus that emerged from the International Conference on Financing for
Development in March 2002 called for mobilizing and increasing the effective use of domestic financial
resources in pursuit of internationally agreed development goals, including those contained in the
Millennium Declaration (UN, 2002). This consensus seems to support the role of saving (saving to
growth direction) in capital accumulation and the channel for productive use (investment) and facilitate
growth. A scant review of literature on the relationship of domestic saving and economic growth also
depicts a positive relationship that higher rates of domestic saving induce growth. Despite the above
notions, both theoretical and applied research have been disputed on the direction of the causality
relationship of domestic saving, investment and economic performance (growth): the effect of domestic
saving on investment and growth (saving to growth direction) Vs the effect of growth on saving (growth
to saving direction). Different theoretical models provide quite different interpretation and empirical
findings reach in varied results. The schools of thought and study findings can be categorized into three.
One school of thought claims that domestic savings drive higher growth rate. This view was stipulated
by the early growth models of Harrod (1939), Domar (1946), and the new growth models of Romer
(1987). Harrod-Domar growth model (a pre-neoclassical model) meant the direct relationship between
current investment and the rate of economic growth that investment induces growth. The traditional
growth model of Solow (1956), in which higher savings lead to higher per capital income in a steady-
state, and thus, higher growth rates on the transition path is consistent with this view. The central idea
of Lewis’s (1955) traditional theory was that an increase in saving would accelerate economic growth
(Jangili, 2011). Pre-neoclassical and neoclassical growth models, with their underlying assumptions and
greatly focusing on the supply side, emphasized on the role of domestic saving in promoting economic
growth. What is more, the growth model implied for an economy to have positive and sufficient
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marginal saving rates in order to embark on a sustained path of economic growth. If this condition is
not met, credit aid would fail to generate growth while foreign debt would continue to accumulate,
driving the economy into a debt trap (UNECE, 2000).
Classical economists in the 18th and 19th centuries, like Adam Smith (who is commonly considered as
the founder of modern economics) and David Ricardo (known follower of Adam Smith), addressed the
question which compel, saving or growth. Both economists regarded savings in an economy as
important vehicles for capital formation, and important factor for growth since it leads to higher labor
productivity and, thus, to more output per worker. According to Smith and Ricardo view, supply creates
its own demand based on the assumptions of efficient working market. Neoclassical economic models
are also primarily based on the assumption that investment is financed from household savings
(Flassbeck, 2008). Neoclassical approach emphasizes on the need for households saving and
alternatively for developing countries to attract more foreign saving to finance fixed investments and
promote economic development. Accordingly, capital accumulation and economic performance will be
maximized by policies designed to promote domestic saving integrated with capital importation.
Feldstein and Bcchetta (1991) concluded that an increase in domestic saving has a substantial effect on
investment and hence on economic growth indicating that saving drives growth. This signifies crafting
policies to promote saving, and hence growth (Attanasio et al., 1998).
The saving to growth direction view, as some economists call it “Mill-Marshall-Solow view” or “Harrod-
Domar-Solow” growth model (see Chakravarty, 1993; and Solimano, 1997) viewed the causality that all
savings is automatically invested and translated into output growth under wage–price flexibility and full
employment. As a result, in the Mill-Marshall-Solow approach savings leads economic growth (Solimano
and Gutiérrez, 2006). Empirical evidences from various countries (see for example Lucas, 1988; Levine
and Renelt, 1992) by Alguacil, Cuadros, and Orts (2004) and Singh (2009) are consistent with the
endogenous growth theory and the hypothesis that higher saving rates promote economic growth.
Jappelli and Pagano (1994) also claimed that saving contributes to higher investment and higher GDP
growth in the short-run. Roux (2009) stated that saving plays an important role in economic growth
with a different role at different levels, in contrast to international capital flows dependent on political
view, global economic stability, and absorbing capacity of hosting countries. According to Roux (2009),
households (household saving), companies (companies saving) and government (government saving)
should have sufficient savings to finance future planned expenses and capital projects essential to
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envisage economic growth, otherwise remain dependent on others, damper efficiency and growth
potential or suffer in financing gap to finance fixed national investments on infrastructure.
The other school of thought argues the reverse order that it is the level of economic growth that drives
saving, not saving that induces growth. The growth-saving direction approach backed by Keynes model
(1936), and thus Keynesian model, assumes that if a country makes an extensive investment in human
and material capital or scientific research and development, technological aspects and make its market
international (the essence of open economy, not a closed one), economic growth increases. It is the
hypothesis that innovation, enhanced exports, and foreign direct investment facilitate economic growth
and economic growth creates employment opportunities, able to generate income, saves and channels
for productive capacities. This approach commonly referred to as “Marx–Schumpeter-Keynes” view,
claims that investment with an open economy flowing from anywhere in the world (Keynes, Marx), and
innovation (Schumpeter, Marx) are the two ascertaining variables that drive out growth. This implies
domestic saving is not significant to accumulate large sum of resource to finance investment that bring
reckonable growth. In this case, growth leads to saving. Carroll and Weil (1994) also hypothesized that
it is economic growth that contributes to saving, not saving to growth. In his study, Mühleisen (1997)
also found significant causality from growth to saving but rejected causality from saving to growth for
all forms of saving. Sinha and Sinha (2008), and Agarwal (2001) also examined the relationships among
growth rates of the GDP, household saving, public saving and corporate saving for the period studied
(1950 to 2001) in different panel of countries and found that economic growth precedes and Granger
causes higher saving in various forms and never in the reversed direction. Modigliani (1970), in his
hypothesis and study of cross-countries, confirmed the positive relationship between saving and growth,
but in the direction that growth drives saving.
Christopher et al. (1994) who examined the association between saving rate and economic growth using
a sample of 64 economies found conclusive evidence in support of the condition that economic growth
precedes domestic savings rates and economic growth auto-regressively predicts future saving rates,
contrary to the Solow growth framework. Again, focusing on the savings rate-economic growth nexus
in Latin America, Gavin et al. (1997), further reached to a conclusion that sustained economic growth
precedes higher savings. In an estimation focusing on a similar causal relationship in the case of Nigeria,
for example, Abu (2010) asserted economic growth Granger cause savings growth in the Nigerian
economy, further supporting the evolving view that economic growth precedes or causes growth in
domestic savings.
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A third reciprocal view that there is a possibility of saving leading to growth and growth causing saving
(the bi-directional causal relationship) is also evidenced. For example, Bassam (2010) found a bi-
directional causal relationship between the variables in the case of Morocco. Sajid and Sarfraz (2008)
who studied the same between domestic savings and output growth in Pakistan further supported the
existence of significant bi-directional long run causal relationship. Likewise, Rumen (2005) reviewed
empirical findings and found that there exists a positive causality both from savings to economic growth
and from economic growth to savings. The reciprocal (bi-directional) relation between saving and
economic growth is well documented, but remains debatable. Generally, either domestic saving and
capital accumulation follows or leads economic growth, there is a positive and strong relationship
between domestic saving, investment and growth and sustaining high rates of growth requires
substantial levels of domestic saving and capital accumulation.
3. Financing investment and growth: The paradox of domestic vs foreign savings
Empirical evidences don’t reach in an undisputable consensus about how the advanced economies reach
to their today’s state of development or the emerging nations (both in Asia and Latin America) are
usually financing their huge fixed investment inducing economic growth. China’s stride economic
performance is massively mentioned in academic and study disputes. China has the highest saving rate
from many perspectives including historical experience, international standards and the predictions of
economic models. The aggregate marginal propensity to save in China is well above 50%, more than
half of its GDP (Ma and Yi, 2010). It is the net saver in all the sectors: household, firms and government.
If the reality goes with the notion that saving is the core driver for economic growth and development,
then the main reason for China’s high growth is because of its high domestic saving. However, Harbaugh
(2004), Modigliani and Cao (2004), and Kraay (2000) indicate that it is after the 1970s following Deng
Xiaoping’s (the silent capitalist) economic reforms of opening the economy that higher economic
growth was registered. This rise of economic growth with the support of demographic restructuring
(the one child policy) brought about higher employment opportunities, higher income and investment.
According to Harbaugh (2004), China was a poor country with a very low saving status before 1970,
questioning the so claimed saving “culture” of Chinese people. The growth pattern of China that higher
growth rate leads to higher income and saving was earlier evidenced by high growth economies of Japan,
South Korea and Taiwan and higher saving rates in Asia were happened only after economic growth
took off (Kraay, 2000), so culture as a dominant factor for higher saving rates in China has no room.
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Others such as Kujis (2005), and Tyers and Lu (2008) assert that Chinese excess saving, after economic
reforms and mainly in the 2000s, is meant happened due to government interventions, distortions and
subsidies to its monopolized state-owned and private firms to promote growth and export. This shifts
China from a net debtor position of 10% of GDP to a net creditor position of 37% within one decade
(Ma and Zhou, 2009).
In contrary to the above argument, Fatás and Mihov (2009) argue for the misinterpretation of the
commentators that China’s growth is due to capital flow from abroad. Rather Chinese bulk of
investment on buildings, equipments and factories is financed from domestic savings and its growth
primarily depends on domestic resources, unlike to the United States that its economic performance is
based on investment on human capital, innovation, exports and liberalization and empowerment of
financial institutions. Lugauer and Mark (2011) backed the economic growth model that China’s growth
is derived from its domestic savings. They further explained that China followed a gradualism economic
reform initially focusing on domestic reforms through downsizing the control of state-owned sector
and promote the private sector to engage in massive business activities. Thus, China’s growth was
primarily funded by internally generated saving which household saving was the most important
component. By this virtue, The evidence from Modigliani and Cao (2004) that rejects the idea on prima
facie grounds from the observation that the household saving rate in the pre-reform era was very low,
averaging 3.9% from 1959 to 1977 and hence the saving culture/habit of the Chinese household is low
has no acceptance. They also defended that the low saving rate was during the central planning Mao era
when people participated in an extensive social safety net provided by the state so there may have been
few reasons to save.
Currently, the high saving rate of China is important in balancing the global economy by financing the
struggling economies of the United States and European countries. Besides, for the fear that China’s
population is ageing, the higher saving rate is considered as a solution that pension funds are invested
in higher return investment vehicles to finance the living costs of the unproductive age. Despite
innovation, human capital, and institutional liberalization and empowerment derived the western
advanced economies, lower saving culture of citizens and old innovations do not prevent them from
economic shocks and their citizens have been suffering from the financial economic crises (Tufano and
Schneider, 2005). Thus, to further re-balance the global economy, the Americans must save more while
the Chinese consume surplus saving.
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From the above discussions and economic model disputes, the evidence on the association of GDP
growth, domestic savings and foreign savings is mixed: there are episodes of high growth with relatively
low levels of foreign saving rates, but high domestic savings (in East Asia) and episodes of low growth
episodes and high foreign savings, but low domestic savings (low income countries in Africa and Latin
America that receive sizeable levels of foreign aid) (Gutiérrez and Solimano, 2007). Sub-Saharan
countries experiencing huge resource gap can learn much from China’s technology adaptive and historic
economic performance. According to Culpeper and Bhushan (2008), resources for development can be
mobilized from both domestic and external sources, but for developing countries, the bulk of resource
for development should be sourced from within since external sources are uncertain.
4. Why saving remains low in Africa? The chronic challenge in Africa’s development
Even though, there are fast growing countries, today, Sub-Saharan Africa (SSA) is the poorest and least-
developed region in the world with about three-fourths of the countries in it are classified in the low
income category. Furthermore, among developing regions in the world, the subcontinent is the most
dependent on official development assistance (ODA) (WB, 2007). The primary reason for this is political
and economic instability, which weakens several sectors that can play an important role in strategic
development (UNCTAD, 2009). WB (2007) also revealed that the SSA economy is underdeveloped
because Agriculture, the mainstay of the region’s livelihood, is highly dependent on traditional practices
and erratic rainfall. Moreover, the overall share of exports from SSA, including South-Africa and
Nigeria, is yet less than 2 percent of the global trade and the continent has the lowest income level in
the world, thereby, enhancement of domestic saving is difficult.
Due to higher dependencies on external aid and borrowings, domestic resource mobilization (DRM)
has been a relatively neglected factor in strategic development, especially in sub-Saharan Africa and
contributes very less in the region’s economic growth (Culpeper and Bhushan, 2008). WB (2007)
indicated that one of the main problems in Africa’s development is that sufficient domestic saving is
not mobilized (17.6% of GDP) as compared to East Asia and Pacific countries (49.2% of GDP) and
Latin American countries (24% of GDP). According to World Bank report (2011) for Africa’s
development, domestic saving has declined from 25.3% (as percentage of GDP) in 1980 to 16% (as
percentage of GDP) in the period 2000-09. This decline depicts that African countries discard domestic
resource mobilization as a strategy for development and increasing their dependency on external
financial sources. It is, therefore, not surprising that in Asia, most of the countries that were on a similar
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economic footing as Sub-Saharan countries in the early 1960s, have boosted their economic
performance and made significant strides, while Sub-Saharan Africa has deteriorated (Aryeetey, 2009).
East Africa is among the fastest growing regions, but it is one of the poorest and unstable regions in the
world. East African countries have the smallest share of exports, lower degree of financial deepening
(thin financial products), lower levels of domestic savings, higher reliance on donor aid and borrowing,
and limited physical infrastructure and human capital (IMF, 2012). While domestic savings are important
to finance investments and narrow the financial gap (saving and investment gap), saving remains weaker
(as percentage of GDP) in most East African countries with Ethiopia having 5.7%, Burundi (-12.3%),
Eritrea (-29.2% o), Kenya (8.7%), and Uganda (9.5%) as compared to Angola (31.9%), Gabon (53.2%),
Algeria (49.1%), and Cameroon (18.8%) in 2009 (WB, 2011).
Conclusively, volatile macroeconomic policies, structural constraints, political unrest, weak integration
with international market, low income society, underdeveloped financial sector, limited financial access,
lower financial education, abandoning of domestic resource mobilization (dependency on foreign aid)
as development strategy, narrow tax base and inefficient tax administration, etc are cited, in several
studies, as responsible factors for lower domestic saving (household, private and government) deterring
the development of sub-Saharan Africa.
5. Why Africans seek for domestic resource mobilization to support their development?
Despite the debate about the causality of saving and growth, saving remains the principal factor in
sustaining economic development. The study conducted by Abaidoo (2012) from 1977 to 2010 in
African countries found a uni-directional causal relationship running from foreign aid and borrowing,
foreign direct investment (FDI) and gross regional savings to regional GDP growth. FDI responds to
the commercial profit opportunities of, and retained earnings flow to, foreign investors, while foreign
aid and debt relief are often motivated by political objectives of the donors and creditors and may not
coincide with domestic development objectives. This makes difficult and inevitably impossible to
achieve domestic development objectives principally through external financing sources (Culpeper and
Bhushan, 2008). In poor countries, catching up of technology for growth requires huge investment and
the cooperation of a foreign investor who is familiar with the frontier technology and a domestic
entrepreneur familiar with local conditions. However, the foreign investor doesn’t make investment
unless the country has advanced infrastructure and promising market opportunities. Thus, the country’s
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domestic saving matters for development and expansion of infrastructure, creation of market
opportunities and encouragement of innovation, and therefore growth.
In the study by Aghion et al. (2009), a cross-country regression shows that lagged savings is positively
associated with productivity growth in poor countries. The use of domestic resource mobilization
(DRM) for development purposes in developing countries has also become, in recent years, significant
as the access to foreign funds become difficult due to global financial crisis and economic debacles
(Aryeetey, 2010). In this connection, Abaidoo (2012) suggested that policies geared towards promoting
sustainable regional economic growth should be oriented to mobilize regional savings to support local
investments as foreign direct investments may not be sustainable due to global economic and financial
conditions. Experiences of past recent histories also shows us savings decline in Sub-Saharan Africa and
rise in South Asia since 1980s, showing South Asia registered better economic performance. This reality
leads to the conclusion that countries due to more saving and investment grow faster than countries
highly dependent on foreign aid and borrowing.
As UNCTAD (2009) testified, African countries greatly focused on external source of development
finance. Flows of external aids to Africa have increased since the late 1990s, but doubts increase on the
quality, efficacy, predictability and the ability of donors to meet set targets. Similarly, doubts have been
expressed about the quality of FDI flowing into Africa, its impact on development in terms of job
creation, diffusion of technology and clarity of its agenda. The economic crisis broken out in 2007
highlights the problems associated with overreliance on external financial resources as donors, lenders
and investors struggle to curve the economic and financial crisis at home. Remittances from western
countries hosting large diasporas and exports to those economical smacked countries began to decline.
Thus, UNCTAD (2009) rectified that domestic resource mobilization and efficient investment in areas
that promote the structural transformation and sustainable development of African countries are of
utmost importance.
In general, as the World Bank and UNCTAD put it, African countries to sustain and improve their
current rate of growth should increase their investment rates. To finance the increment in investment
and close the resource gap, the Sub-Saharan countries should look for domestic resource mobilization
mainly domestic saving in all economic units like household, corporate and government for various
concrete reasons including i) by enhancing domestic resources and its role in development, African
countries reduce their dependence on external capital inflows such as official development assistance
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(ODA), foreign borrowing and foreign direct investment ii) by reducing the dependence on these
inflows and their associated conditionality, domestic resources allow them to have more policy space
(more flexibility and diversified policies tailored to specific country situation); and hence, they own and
control their development process. This enable them to pursue truly nationally-owned development
process iii) Domestically generated public resources are important in creating strong bondage between
government and citizens, enhance civic consciousness that citizens are keen and alert to know how these
resources are utilized iv) Domestic resources are relatively stable while external capital inflows are more
likely to be volatile (FDI, foreign borrowings, and aids/donations are highly volatile, not easily
predictable, attached with required rate of return of investors, political dogma of countries and global
financial conditions) and v) Even in an open economy, international capital (capital importation)
mobility is limited (failing to fill saving-investment gap), making the link between domestic savings and
domestic investment strong.
6. Lessons and policy recommendations for Ethiopia
The World Bank’s African development indicators (2011) averaged the Ethiopian real growth rate at
8.5% in 2009. Ncube, Lufumpa and Ndikumana (2010) (cited in Taddesse, 2011) averaged real GDP
growth to 11.2 % per annum during the 2003/04 and 2008/09 period. Based on the latter or former
growth rates, Ethiopia is placed among the top performing economies not only in Africa but in the
world. Moreover, the average investment as a percentage of GDP increased from 12.9% in 1990 to
25.4% in 2004/05 and latter declined to 22.6% in 2008/09, but increased to 25.5% in 2010/11 (WB,
2011; MoFED, 2012). The average investment is above the SSA average which is about 18%. However,
there is a saving-investment gap (resource gap). In 2008/09 and 2011, for example, domestic investment
was in excess of domestic saving by 16.9% (22.6-5.7) and 16.7% (25.5-8.8), respectively, the gap financed
through external sources. This reveals the country’s high dependency on foreign aid/debt and exposed
to risk of external shocks.
The other challenge for Ethiopia is the huge resource requirement to realize the objectives of the
Growth and Transformation Plan (GTP) and construction of Abay Renaissance Dam. When officially
announced in November 2010, stakeholders like the World Bank and IMF said GTP is very ambitious
plan demanding huge resource for which the country can’t afford. Thus, to fulfill the huge resource
need, the country should engage on massive domestic resource mobilization (domestic saving) by
fostering the saving culture of citizens, private firms and ensure public revenue-expenditure equilibrium.
138
Furthermore, the Ethiopian government should strongly commit itself to integrate domestic saving,
investments on human and physical capital, innovativeness and entrepreneurship and foreign savings as
co-variables of development strategy. Improving domestic resource mobilization capacity of different
actors/stakeholders is also fundamental. To improve the low domestic saving rate, the following
measurements, among many, are worthwhile.
Ensure macroeconomic stability: Macroeconomic stability in a broader sense extends from preserving price
stability and fiscal balance to avoiding swings in economic activity, employment, external accounts and
the real exchange rate (Culpeper and Bhushan, 2008). Macroeconomic stability strongly influences the
long-term growth performance of an economy. Designing policies (both monetary and fiscal) to control
and maintain inflation at acceptable level is paramount to promote saving capacity of citizens. Setting
policies that promote the ability to work, save and invest is another pillar to foster domestic saving.
Hence, public expenditures should be allocated to foster entrepreneurship, encourage small-scale
industries and create diversified employment opportunities.
Strengthen the financial sector and Enhance ease of access to saving vehicles: The financial sector plays a vital
intermediary role in channeling resources from the unproductive use (resource suppliers) to its
productive use (resource demanders). The system of financial intermediation can affect economic
performance and growth directly through the role it plays in resource allocation. Financial sector
development is at the heart of resource mobilization, industrialization, boosting investment and
accelerating economic growth. In particular, the financial system can affect saving and investment
decisions (and hence capital accumulation and technological innovation) by reducing information and
transaction costs, creating mechanisms of risk sharing, facilitating trade and payments among economic
agents and providing various supporting services. Therefore, Ethiopia should strengthen, modernize,
and integrate its financial sector and bestow a ground for effective, thick (broad-based) and accessible
financial system. Coverage of the financial sector and alternative saving products must be improved.
Easy of access to convenient and safe saving vehicles has considerable effect on increasing domestic
savings.
Financial Education: In developing and transition economies where the saving habit of low income
households is low, perpetual financial educations and modest interest rates at acceptable level of inflation
help to attract higher rates of saving to promote capital accumulation and channel it for productive
usages. As defined by OECD (2005), financial education is the process by which financial
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consumers/investors improve their understanding of financial products and concepts, and through
information, instruction and/or objective advice, develop the skills and confidence to become more
aware of financial risks and opportunities, to make informed choices and decisions, and to take other
effective actions to improve their financial management. In doing so, the sector should be
professionalized by producing specialists and experts capable, competent and committed to analyze and
interpret saving, saving mechanisms and benefits.
Increase the diversity of Financial Assets: At times real interest rates are negative, saving is not encouraging
since interest rates on deposits do not compensate the high inflation rate. For example, in Ethiopia, the
national bank has set the minimum interest rate on deposits at 5%, but inflation rate was fluctuating
between 20% and 30% and even was beyond 30% in 2009 and 19.6% in 2012 (CSA, 2012). Due to this
handicap, general observations indicate that households prefer to put their money either under their
mattress or invest it in potential and less risky investment opportunities. This has become, in recent
years, an advantage for initiators of incorporated companies to pool resources from small saver
households to establish incorporated companies. The introduction of new and diversified financial
assets where households can get alternatives to put their petty money is fundamental. Introduction of
bonds (like the saving bonds introduced currently) can also be an efficient way for the government to
raise long-term financing for infrastructure projects. However, floating medium to long term financial
assets demand the government to promulgate legislation and develop efficient and liquid capital (bond
and equity) markets.
Support and enhance the role of Microfinance Institutions: The Ethiopian financial system constitutes mainly
banks (17), insurances companies (14) and microfinance institutions (30) (NBE, 2011). However,
Ethiopia is still one of the most under banked countries in the world with 970 bank branches serving
about 84,975,606 (WB, 2012) populations (one branch serving over 87,000 people). Bank branches are
also unfairly distributed and concentrated in major cities and towns of the country. 38% of bank
branches are concentrated in Addis Ababa, the capital city, with residents only 2% of the country’s
population. Similarly, there are only 221 branches of 14 insurance companies that one insurance branch
serves over 380,000 people in major cities. This reveals access to finance and saving instruments of the
rural part of the country is limited. Since majority of Ethiopian population lives in rural areas, the
expansion of MFIs, enhancing their outreach services, and introduction of financial vehicles convenient
to the situation of and tailored to rural savers is imperative to promote rural saving and integrate them
140
in the nation’s development process. MFIs play significant role in accessing and enhancing the awareness
of rural dwellers and mobilizing resources from rural households.
Improve tax revenues collection (public revenue mobilization and government saving): Effective and efficient tax
administration (assessment, estimation, and collection) process is instrumental in the generation of
sufficient public revenue to finance public expenditure. The existence of convenient, fair, equitable,
diversified and economical tax administration helps to ensure voluntarily compliance of taxpayers, hence
reduces tax administrative costs and maximize government revenue. Sufficient collection of taxes
accompanied with putting public resources to the maximum advantage of the society leads to the virtue
of government saving. In 2010/11, total tax revenue as percent of GDP has reached 11.5% from the
level of 11.3% in 2009/10, but lower than the SSA average (16.3%).
Expanding the coverage of Contractual savings (Pension and Insurance coverage): Expanding the coverage of
contractual savings like pension and insurance is crucial in domestic resource mobilization. For example,
liability insurance (an insurance type that many countries make it compulsory is employer’s liability
insurance that requires every employer to insure against liability for bodily injury/disease of employees
arising from their employment), education insurance coverage, etc. Since the performance of invested
pension funds is also an important factor in improving domestic saving, pension funds should also be
invested in safe and modest returns.
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Savings Mobilization through Saving and Credit Cooperatives in Ethiopia: Performance,

Trend, Challenges and the Way Forward
Tezeta Ketema1 and Deribe Assefa2

Manager, Joshua Multi-Purpose Cooperative Society Ltd, E-mail: ktezma@yahoo.com
2
Lecturer, Ethiopian Civil Service University, E-mail: deribeassefa@yahoo.com
Abstract: Saving policies would depend on the structure of saving in a given country. From the point of view of various
characteristics of saving behaviour, economies can be divided into three sectors, namely, government, corporate and non-
corporate. Savings mobilized from non-corporate sectors including saving and credit cooperatives (SACCOs) are crucial for
economic growth in many developing countries like Ethiopia. The major asset of SACCOs is the money that their members
deposit as savings for various purposes including safeguarding, interest earning and future investment. While savers can
earn commensurate amount of interest on their deposit, those customers having long-term credit worthiness can borrow from
the SACCOs. The objectives of this study were to map out the development trends, identify growth determinant and
compare the performances of SACCOs in Ethiopia with Sub-Saharan African standards. Primary data were collected
from randomly selected management members of SACCOs at both primary and union levels. And secondary data were
collected from various documents of the selected SACCOs. Bench mark data were also collected from the database of World
Credit Council (WCC). Descriptive statistics and correlation analysis were used for the study. Results revealed that
membership and financial performance of the SACCOs had shown improvement over time. On the other hand, the study
showed that lack of awareness, poor saving culture, weak organizational arrangement and governance, policy and regulatory
environment, weak institutional capacity, low capital base, lack of differentiated products, inappropriate loan security
requirements, and threats from other financial institutions were among the factors affecting the outreach and sustainability
of SACCOs.
Keywords: Loans, SACCOs, savings
1. Introduction
Saving is one of the important variables for economic development that has emerged as the central
issue in developing countries at least for two reasons. First, foreign aid inflow to the developing
economies has declined during recent years. Second, saving positively affects the growth and
development. The greater is the saving rate, the higher is the growth rate a country can attain. For
economic development, growth is a must which cannot be achieved without investment or capital
accumulation and saving through investment plays a vital role in this process (Pollet, 2009).
146
Poor performance in economic growth for countries like Ethiopia is frequently attributed partly to low
savings. On the other hand, the formal financial institutions in developing economies leave the poorest
population tightly constrained in their access to financial services. It is also widely recognized that
economic progress relies largely on access to financial services such as savings, insurance, and credit.
Where formal financial institutions fail to serve the large majority of the poor population, there is
evidence to support the proposition that credit unions can fill some of the gap (Hussain et al., 2002).
An interesting alternative to formal banking that has emerged within the semi-formal sector is the saving
and credit cooperatives (SACCOs) which have a wide outreach in most parts of the world. They are
member-driven and democratically organized. SACCOs have developed and become a tool for
mobilizing and increasing savings culture mainly for developing nations. Although the reliability of
figures is poor, cooperatives appear to operate on a significant scale in developing countries: studies
have shown that over seven percent of the African population is affiliated to primary cooperatives, and
this number is increasing (Delvetere et al., 2008; Pollet, 2009).
The work of Develtere et al. (2008) revealed that cooperatives in Africa are about to enter a phase of
“renaissance”, but need a favorable legal and institutional environment, greater visibility, a stronger
voice, further diversification, improved governance, better management, solid horizontal networks and
strong vertical structures, in order to make this a reality. In Ethiopia, savings and credit cooperatives
(SACCOs) as financial intermediaries, are channeling savings into loans, provide saving opportunities
for the poor, especially in the rural areas. But further improvements are necessary to make their services
more efficient and sustainable. Thus, understanding the degree to which different obstacles limit the
development of quality pro-poor saving facilities in developing counties like Ethiopia is crucial in
designing appropriate policy and programmatic interventions. The main objective of this study,
therefore, was to analyze the performance trend of savings and credit cooperatives in terms of their
number, membership sizes, savings mobilization; and identifying the critical challenges and gaps that
affect the growth and success of SACCOs in Ethiopia.
2. SACCOs in Ethiopia
The sources of finance are classified as formal, semi-formal and informal sources. Formal sources are
providers of finance who are subject to banking laws of the country of operation and are engaged in
loan extension to customers and diversified financial intermediaries. SACCOs are semi-formal financial
institutions in the sense that they are registered entities and subject to all general rules, but are not subject
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to the same prudential standards applicable to formal financial institutions. Unlike the commercial banks
and MFIs, savings and credit cooperatives are not subjected to the rigorous supervision and regulatory
rule of the National Bank of Ethiopia (Wolday, 2002).
The first savings and credit co-operative in Ethiopia was established in 1964 by employees of Ethiopian
Airlines. During the same period, credit co-operatives were established by employees of the Ethiopian
Road Authority and the Telecommunication Agency. Currently, SACCOs in Ethiopia operate within
the framework of the proclamation No. 147/98 and the proclamation No. 402/2004 (amendment
version of the latter).
The objective of this category of institution is mainly to provide savings facilities and granting short-
term loans to members in various firms. The sources of funds of the cooperative include shares, special
savings, entrance fees and dues. Entrance fees and weekly dues are used for the administration of these
societies. Shares held by members represent the main source of the loanable funds. The special savings
may be shared at a particular time or distributed in rotation, while loans are given to members on
personal recognition and, or, guarantors could be demanded if the members total financial holding in
the society is inadequate. Many of these societies give loans for businesses that yield quick return. It is
administratively easy and cheaper for banks to deal with large group. This is because transaction costs
are proportionately higher for all small borrowers, although it tends to vary little with size of loans.
Similarly, farmers within a cooperative union are able to put forward viable projects that would be
acceptable to the banks.
SACCOs are promoted not only for money, but also for its contribution to the promotion of total
human development. SACCOs develop people's minds by providing motivation, creating initiative,
promoting self-development and self-reliance and providing leadership. They also develop material well-
being by raising the living standards of members, making possible regular savings and wise use of money,
providing loans at low interest rate and by making possible economic emancipation of members (Wolff,
et al., 2011). Another core benefit of cooperatives is the fact that cooperatives allow individuals to
increase their bargaining power, through aggregation of their purchasing/selling power. However, in
order for this to be effective, the cooperative itself must have skills in bargaining, negotiation and
communication, in order to effectively represent its members (Rutherford, 2000).
SACCOs have been significantly contributing to employment, to the national economy, poverty
eradication among SACCO’s members, creation of wealth and new financial services to the customers.
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For a number of years, savings and credit cooperatives societies have been at the heart of the
development of communities by striving to make available financial resources based on the community’s
own resources (i.e. Member savings) and the safe recycling of this money (member loans) into the
community’s activities thereby making a significant contribution to the development of the environment
and the well-being of the population in general.
SACOOs are widely seen to have potential to impact on development and poverty reduction. The UN
has also acknowledged important direct and indirect impacts on socio-economic development in terms
of promoting and supporting entrepreneurial development, creating productive employment, raising
incomes and helping to reduce poverty while enhancing social inclusion, social protection and
community-building (UN, 2009).
Savings and Credit Cooperatives (SACCOs) are increasingly popular and may soon be the most common
form of cooperative within the African cooperative movement (Wolff et al., 2011). They are seen to
expand poor people‘s access to financial services (loans and savings), support enterprise start-up and
expansion, and reduce vulnerability by allowing the poor to accrue savings, build assets and smooth out
consumption.
3. Methodology of the Study
In this study, mixed research methods were employed to utilize both quantitative and qualitative data
on the issues. The quantitative data were obtained through secondary data collection checklists related
with performance trends of SACCOs in terms of saving, membership and penetration ratio and these
data were mainly obtained from Federal Cooperative Agency and WOCCU website.
The qualitative data were mainly collected through interview and focus group discussions conducted
with representatives from Self-help Savings and credit union, Addis SACCOs union, Federal
Cooperative Agency and six primary cooperatives (Ethiopian Airlines, Ethiopian Electric and Power
Cooperation, Ethiopian Road Authority, Ethiopian Civil Service University, Addis Ababa University,
and Joshua Saving cooperative).
The required data were also obtained from management members of some selected SACCOs at primary
and union levels and their documentations. In addition, thorough literature review work has been done
in order to develop conceptual framework for the study and to get best practices of SACCOs at
international level. Policy and legislation on cooperatives in Ethiopia were also reviewed as to evaluate
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the enabling environment at the country level. Both qualitative and quantitative data were analyzed
using descriptive analysis techniques of content analysis, tabulation and graphical presentation tools with
the help of Excel and SPSS.
4. Results and discussion
4.1. The legislative and policy context
In cognizance of the importance of cooperatives for economic development in Ethiopia, the

Government has increased its involvement in cooperative development through policy formulation,
including a five year cooperative development plan and proclamations on cooperatives.
The Federal Democratic Republic of Ethiopia enacted legal framework for establishment and
management of cooperative societies (proclamation No. 147/98). The preamble of the proclamation
states that cooperative societies are formed by individuals on voluntary basis and who have similar needs
for creating savings and mutual assistance among themselves by pooling their resources, knowledge and
property. It provides enabling legal environment for cooperative societies to actively participate in the
free market economic system. The proclamation also recognizes saving and credit cooperatives. It clearly
sets out general provisions for registration of cooperatives, legal form of registered cooperatives, rights
and duties of members, governance and management of cooperatives, special privileges of primary
cooperatives, assets and funds of primary cooperatives, audit and inspection, dissolution of cooperatives
and other miscellaneous provisions. This Proclamation conforms to the universal cooperative principles
and the ILO Promotion of cooperative Recommendation (No. 193/ 2002).
In 2002, the Cooperatives’ Commission Establishment Proclamation No. 274/2002 that created the
institutional framework for promoting and supporting the cooperative movement in Ethiopia.
Proclamation No. 147/98 was further revised in 2004 with the issuance of the Cooperative Society
Proclamation (No. 402/2004). Regional states of the Federal Democratic Republic of Ethiopia have
also enacted their own proclamations for the promotion of cooperatives. Particularly, three of the nine
regions of Ethiopia, namely the Southern Nations Nationalities and People’s Region (SNNPR), Tigray
and Amhara have enacted their own cooperative proclamations.
4.2. Performance trend of SACCOs in Ethiopia
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Figure 1 depicted the development trend of SACCOs in terms of their number. The number of SACCOs
has been growing fast since 2005. The decade between 1995 and 2012 has witnessed more than twenty-
fold increase in the number of saving and credit cooperatives in the country with a corresponding
increase in contributions and savings. For instance, by 2005, there were 2,146 SACCOs in the country
comprising 155,120 members with savings amounting to 504.3 million Birr. By 2012, there were 10,502
SACCOs in the country comprising 885,777 members with savings amounting to 1.3 Billion Birr.
Moreover, the number of SACCOs in 2011 increased by 280 percent from 2005. The annual rate of
increment in number of SACCOs between 2011 and 2012 was 28%.
12000
10000
No. of SACCOs
8000
6000
4000
2000
0
1965 1975 1985 1995 2005 2011 2012
No. of SACCOs 35 44 218 522 2,146 8,144 10,502
Selected years
(Source: AEMFI, 2007 and Federal Cooperative Agency data base, 2012)
Figure 1: Trend in Growth of number of SACCOs in Ethiopia
Taking the number of SACCOs in Ethiopia in the year 2012, their distribution is uneven across the
regions. The majority of SACCOs are found in Oromia (34.8%), SNNPR (24%), Amhara (15.4%), Addis
Ababa (13.8%), and Tigray (7.5%). However, the numbers of SACCOs in other regions are almost
negligible ranging from 1.7% in Dire Dawa to 0.1% in Gambella (Figure 2). This shows that the required
attention has not been given by majority of the regions in the country.
151
1.7 0.8 0.8 0.7 0.4 0.1

Oromiya
7.5 Debub
Amhara
34.8
13.8 A/A
Tigray
Dire-Dawa
Somalia
15.4
Afar
B/Gumz
24 Harari
Gambella
Figure 2: Distribution of SACCOs by region for the year 2012.
One of the unique features of SACCOs as compared with other financial institutions like banks and
micro-finance institutions (MFIs) is their local nature and accessibility to rural communities. Figure 3
indicated that more than 64% of the total SACCOs in the country are found in rural areas.
12000
10000
8000
6000
No. of SACCOs Rural
4000
2000 No. of SACCOs Urban
0 No. of SACCOs Total
2009 2010 2011 2012
No. of SACCOs Rural 3561 5370 6729 6729
No. of SACCOs Urban 2852 2850 1415 3773
No. of SACCOs Total 6413 8220 8144 10502
(Source: Federal Cooperative Agency data base, 2012)

Figure 3: Number of SACCOs by urban and rural areas, 2009-2012.
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In addition the SACCOs movement in Ethiopia is also characterized by the formation of cooperative
unions. By the year 2012, there were 69 unions of SACCOs in Ethiopia as revealed in Table 1. But, the
proportion of primary SACCOs which are the members of unions is represented only by 20.6% from
the total primary SACCOs in the same year. This clearly indicates that the movement of SACCOs in
Ethiopia at the secondary level is very low. This was also confirmed by majority of interviewed
individuals on the issue.
Table 1: Unions of SACCOs in Ethiopia for the year 2012
Categories of SACCOs Number

Unions 69
Primary SACCOs in unions 2164 (20.6%)
Total primary SACCOs 10, 502
(Source: Federal Cooperative Agency data base, 2012)
In terms of the size of members, the growth of SACCOS in Ethiopia is also increasing from year to year
at fast rate as indicated in Figure 4. For example, SACCOs memberships in 2011 (840,878) increased by
more than fivefold in the size of members in 2005 (155,120). The annual rate of number of SACCOs
membership between 2011 and 2012 was 5.3%.
1,000,000
900,000
800,000
700,000
No. of members
600,000
500,000
400,000
300,000
200,000
100,000
0
1965 1975 1985 1995 2005 2011 2012
No. of Members 8,332 10,136 38,166 116,619 155,120 840,878 885,777
Selected Years
Figure 4: Trend in Growth of SACCOs' members in Ethiopia
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Regarding the role of SACCOs in benefiting both female and male members (the gender issue), it is
promising as shown by figure 5.
1000000
900000
800000
700000
600000
500000
400000 Membership female
300000 Membership male
200000 Membership total
100000
0
2009 2010 2011 2012
Membership female 227948 277209 319319 410528
Membership male 280869 341213 521559 475249
Membership total 508817 618422 840878 885777
Source: Federal Cooperative Agency data base, 2012)

Figure 5: Gender disaggregated members of SACCOs, 2009-2012.
SACCOs are one common mechanism of mobilizing saving. Figure 6 below revealed the capacity and
contribution of SACCOs in terms of saving mobilization in Ethiopia since 1985 which improved
dramatically. By the year 2012, the total saving of SACCOs in Ethiopia reached more than ETB 1.3
Billion.
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Saving mobilization ,Birr (in Million)

1400.0000
1200.0000
1000.0000
800.0000
600.0000
400.0000
200.0000
0.0000
1965 1975 1985 1995 2005 2011 2012
Saving mobilization 1.9997 2.6490 12.9709 111.1731 504.3341 792.2054 1321.5633
Figure 6: Saving mobilization by SACCOs.
With respect to product diversification and innovation strategies of SACCOs, though the saving
mobilization and culture has been improved, SACCOs have had no product diversification, and
innovation strategies and mechanisms yet. As obtained from focus group discussion, the most common
and possibly the sole saving product offered by SACCOs is saving deposit/accounts. This situation may
not attract and satisfy the interests of the clients. There must be a shift from such single saving product
to the use of a mix of saving products as indicated by the works of Wright et al. (2000) and WOCCU
(2001).
Though the performance trend of SACCOs in Ethiopia has shown increasing trends in terms of their
numbers, membership sizes and amount of contribution and saving, many experts on the areas
underscored that the performance in terms of penetration rate, average membership and saving ratio is
still very low as compared with Sub-Saharan African countries such as Kenya, Rwanda, Uganda, etc.
The information obtained from WOCCU database also revealed this fact. As shown in Table 2, the
penetration rate of cooperatives in Ethiopia is found to be 2% which is below the average penetration
rate of cooperatives in Africa (7.7%). Hence, this figure implies that much work is needed in order to
utilize SACCOs as an opportunity to mobilize savings and address the saving-investment gaps in the
country.
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Table 2: Penetration rate of some Africa countries, 2011.
Country Penetration rate (%)

Ethiopia 0.6
Benin 32.6
Burkina Faso 18.2
Cameroon 3.5
Gambia 4.40
Ghana 2.10
Africa level2 7.7
(Source: WOCCU, 2012)
On the basis of the interview, focus group discussions and documentary analysis, SACCOs experience
a wide range of problems partly owing to the fact that they target low income earners and have to
establish a balance between serving them adequately and also meeting their operation costs. The major
problems experienced by SACCOs are as follows in order of most recurrent problem.
Lack of SACCOs apex in the country: Ethiopia does not have cooperative apexes at all. However, the
government is currently fulfilling the representative role and it is uncertain when and whether an
independent confederation will emerge.
No comprehensive loan policy and procedures: Most SACCOs either have no loan policy and procedures or
what exists is not very clear and comprehensive. There are cases where loan-aging analysis is hardly
practiced, there are no provision for loan write offs and losses. No guidelines exist as to what to do in
cases where a member defaults in loan repayment. Where they exist they are inadequate to serve the
purpose as to why it is intended.
No special government incentives: There are no special incentives provided by government for SACCOs in
Ethiopia. If any, it is usually to support the establishment of SACCOs. For instance, the government of
Uganda has subsidized the founding of new SACCOs all over the country. Newly established SACCOs
can apply for a start-up grant from the government owned apex-institution Microfinance Support
Centre (MSC). MSC also gives out interest free loans to the SACCOs or other subsidized loans. In
2
Average penetration rate of cooperatives in Africa for 2008 as studied by Pollet (2009)
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addition to grants and loans, SACCOs can also receive operational support from the government. The
government pays salaries and rent for the first two years after the start-up. These support schemes are
important elements of the government’s “One SACCO per sub-county” initiative, which is a part of the
wider program “Prosperity for All” (Wolff et al., 2011).
No institutional capacity to introduce other products & services: Most SACCOs lack capacity to expand their
product range because of lack of capital and lack of necessary management systems. They lack capacity
for market research and product development to introduce other services that cover time deposit or
term deposit, current account and special saving deposits.
Lack of sufficient funds for provision of services: Some SACCOs suffer from lack of sufficient funds to provide
services especially loans to its members. Whereas waiting period for loans in some institutions could be
14-30 days, members have to wait for between 6-12 months to have access to the loans. Even seemingly
organized SACCOs with comprehensive loan policies suffer from lack of enough capital for service
provision.
No internal control systems put in place: For some SACCOs, there are no savings & internal control
procedures in place. They lack from internal audit committee, no written audit policy and procedures.
This is risky as it may encourage fraud within organization. Reconciliation of cashbook balances and
actual cash in the safe is sometimes not done frequently. There is poor documentation of loans and
other financial record.
Lacks of vision/strategy follow up: Some SACCOs lack a clear cut direction of where they are going, what
they want to achieve or progress they are making towards their targets. They have no grass root structure
to support effective delivery of services and supervision. They also lack in culture of using regular
program reports to review direction. Very little or no market survey is carried out to have a feel of client
needs. There are cases where disbursement targets have fallen behind growth targets. Systematic process
towards product development or improvement is also lacking.
Weak participation in protecting the constituency’s rights/social protection services & voice: Due to lack of effective
representation systems, cooperatives are not involved in government policy as much as they could be.
Cooperatives do not yet provided additional systems of social protection (other than traditional in-group
mutual support), nor do they bring about a voice on behalf of their constituency. Likewise, cooperatives
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are mostly not yet equipped to serve as a vehicle for life quality campaigns such as gender equality,
environmental awareness or HIV/AIDS prevention.
5. Conclusions and the way forward
This study analyzed the performance trend of savings and credit cooperatives in terms of their number,
membership sizes, savings mobilization, and identified the major challenges of SACCOs in Ethiopia.
Accordingly, the growth of SACCOs in Ethiopia as semi-informal financial institutions is improving
from time to time in terms of number of SACCOs, membership base and savings amount. Moreover,
female participation in SACCOs has grown over time. Among the challenges that SACCOs face lack of
SACCOs apex in the country, no comprehensive loan policy and procedures, no special government
incentives, no institutional capacity to introduce other products & lack of sufficient funds for provision
of services, no internal control systems put in place, lack of vision/strategy follow up and weak
participation in protecting the constituency’s rights/social protection services & voice are the major
once. Hence, based on the findings of this particular study, the following recommendations are
forwarded.
SACCOs as semi-informal financial institution should be given proper recognition and adequate
consideration in the nation’s financial system. To this effect, government should redesign the existing
regulatory policies to formalize and standardize the operations of the major SACCOs. However, such
regulations should not be framed in a way that will totally cripple or paralyze institutions’ activities, but
effectively enhance their performance for maximum contribution to development.
Serious efforts should be made by both the government and relevant institutions concerned to establish
confederations and federation of SACCOs as apex structure which would contribute towards the
international principles of cooperatives. In addition, it will represent the sector at national, continental
and global levels. Cooperative federation/confederation should be established at the country level and
should pursue the overarching goal of mobilizing the cooperative self-help mechanism in order to
improve the governance, efficiency and performance of cooperatives, so that they may strengthen their
capacity to create jobs, access markets, generate income, reduce poverty, provide social protection and
give people a voice in society. The apex level of SACCOs would be of paramount importance because
it facilitates and supports in networking both within country and through regional and North-South
links.
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SACCO’s should engage with policy makers in identifying workable programs that address cross cutting
issues in the society, thus empowering the community and making SACCOs relevant to the community.
The national umbrella bodies in conjunction with the continental body can make this possible by
working closely with various arms of government responsible for policy formulation.
SACCOs need to focus on all the three basic functions of saving mobilization: removal of the “savings
constraint” on growth, the optimization of the saving pattern of the economy, and the transmission of
savings to efficient investment.
SACCOs internal operations such as collection of money, loan management and searching for
investment opportunities should meet international financial standards and cooperative principles. For
instance, many SACCOs in Ethiopia do not issue shares, as a result their liabilities are by much greater
than their capital.
SACCOs need to scale up their activities and expand market access. Thus, they have to diversify their
offer in order to address special client segments (children, elderly, clubs and associations) or special
purposes (pilgrimage, education, housing, retirement, marriage, emergencies, etc.) rather than providing
the current very limited saving product. Other services and products that cover time deposit or term
deposit, current account and special saving deposits should be introduced by them.
The Government and SACCOs organizing authority/FCA/ should emphasize on promoting the
benefits of SACCOs and providing incentives for the transformation of SACCOs movement to union
and federation levels, providing the relevant legal framework for SACCOs engagement in Bank and
insurance services in order to enhance their loan provision capacity, and creating awareness for the
importance of saving & saving culture (through SACCOs) especially for the low performing regions/city
administration (Dire Dawa, Harari and the four emerging regions).
References
Association of Ethiopian Microfinance Institutions/AEMFI/ (2007) Development in saving and Credit

Cooperatives in Ethiopia: Evolution, Performances, Challenges and Interventions, Occasional paper No.
19, Addis Ababa.
Develtere, P., Pollet, I. and Wanyama, F., 2008. Cooperating out of Poverty: The renaissance of the
African cooperative movement, International Labor Office and World Bank Institute, Geneva.
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Hitiris, T. and Wiseman, J, 1982. Mobilization of savings for development: a restatement, University of
York, England
Hussain N. M., Kameir, M. E. and Mohammed, N., 2002. Resource Mobilization, Financial
Liberalization, and Investment: The Case of Some African Countries Document(s).
International Development Research Centre (IDRC).
Kifle Tesfamariam, 2012. Determinants of saving Behavior of cooperative members survey evidence
from Tigrai region. Ethiopia, Journal of Research in Economics and International Finance (JREIF) Vol.
1(5) pp. 150-158.
Pollet, I., 2009. Cooperatives in Africa: the age of reconstruction: synthesis of a survey in nine African
countries, Coop-Africa working paper No.7, Dar es Salaam: International Labor Office /ILO/.
Rutherford, S., 2000. The Poor and Their Money. Oxford University Press
UN, 2009. Cooperatives in Social Development, Report of the Secretary-General, United Nations, New
York http://www.un.org/esa/socdev/social/cooperatives/coop_docs.html
Wolday Amha, 2002. The Role of Finance and Business Development Services in Micro and Small Enterprise, Addis
Ababa, Ethiopia.
Wolff, et al., 2011. Assessing the sustainability of Savings and Credit Cooperatives in Uganda”, German
Development Institute, Bonn.
World Council and Credit Units, Inc. /WOCCU/ (2001), Credit Unions: Vehicles for providing
sustainable microfinance, http://www.saccol.org.za/printdocs/saccos.htm
World Council of Credit Unions, 2012. Statistical report, World Council of Credit Unions, Canada
Wright, G., 1999. A Critical Review of Savings Services in Africa and Elsewhere, Micro Save Africa,
Uganda.
Wright, G., Peck, R. and Matin, I., 2000. Saving Culture, Competition and Choice: Introducing Savings
Services into a Micro Credit Institution, Micro Save Africa.
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Theme 4: Innovative Saving and Loan Schemes, Products and Services
Assessment of the Opportunities and Challenges for the Adoption of e-Banking Services in
Selected Ethiopian Commercial Banks
Beza Muche
Lecturer, Department of Banking and Finance, Debre Markos University
E-mail:bezamt@gmail.com
Abstract: Despite the growth of e-banking adoption worldwide, Ethiopian banks continue to conduct most of their
banking transactions using traditional methods. The general objective of this study was to assess the extent, benefits, driving
forces, opportunities and challenges of adopting e-banking system in Ethiopia. Primary and secondary data were collected
from the selected commercial banks and analyzed using descriptive statistics. The findings revealed that balance inquiry,
cash withdrawal, fund transfers and statement printing were among the major e-banking practices for the banks studied.
The study also revealed that uses of automated teller-machine (ATM), debit card, credit card, salary card, visa card, master
card, internet and mobile banking were initiated among the banks studied. Cost reduction, coverage of wider geographical
area and customer satisfactions were indicated as the benefits of adopting e-banking system for the banks. On the other
hand, the existence of high competition in the banking industry, the need to improve organizational performance, transaction
cost reduction, wide geographical coverage and building organizational reputation were among the main driving forces that
initiate banks to adopt e-banking services. Risk aversion behavior of banks, lack of suitable legal and regulatory
framework, absence of financial networks that links different banks, low level of service quality and high internet cost,
poorly developed telecommunication infrastructure and security concerns were among the major challenges for the adoption
of e-banking services in the country. However, improvement in using the e-banking system among customers was the major
opportunity for the adoption of the system in the banking industry. Based on the findings, it is recommended that all the
stakeholders should give quick emphasis to strengthen the banking industry by introducing the system to make Ethiopian
banks competitive both in the domestic and international markets.
Keywords: Commercial banks, e-banking
1. Introduction
Financial services industry has recently been in historic transformation in terms of e-developments such
as e-finance, e-money, electronic banking (e-banking), e-brokering, e-insurance, e-exchanges, and even
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e-supervision. The driving forces behind the rapid transformation of banks are influential changes in
the economic environment: innovations in information technology, innovations in financial products,
the dynamic nature of customers demand, liberalization and consolidation of financial markets,
deregulation of financial intermediation etc. The financial services market is continuing to change
rapidly, which brings the question whether traditional banks, as they are now structured, will actually
continue to exist in the context of changing economic environment (Olga, 2003). The evolution of e-
banking started by the use of Automatic Teller Machines (ATMs) in Finland (Mishra, and Kiranmai,
2009) in order to provide efficient and effective service to their customers.
Electronic banking has been widely used in developed countries and is rapidly expanding in developing
countries. However, the slow diffusion of e-commerce to African countries has been attributed to a
number of issues some of which may be unique to the African Continent (Darley, 2001). Electronic
banking (e-banking) is nothing but e-business in banking industry. It may also be referred as internet
banking. The internet is transforming the banking and financial industry in terms of the nature of core
products /services and the way these are packaged, proposed, delivered and consumed (Sathye, 1999).
In this era of globalization, with increased competition around the globe in all sectors, a strong banking
industry is important in every country and can have a significant effect in supporting economic
development through efficient financial services. As a result, many banks in the world are modifying
their strategies to reach customers worldwide more easily and cheaply. Therefore, banks are developing
the technologies that will help them deliver banking products and services by the most cost-effective
channels and one of such channel is adoption of e-banking or internet banking. E-banking is a way to
keep existing customers and attract new ones to the bank. In Ethiopia, the role of the banking industry
needs to change to keep up with the globalization movement, both at the procedural level and at the
informational level. This change will include moving from traditional distribution channel banking to
electronic distribution channel banking. E-Banking transactions have opened up new window of
opportunity to the existing banks and financial institutions. It permits business process re-engineering,
serving borderless market, to achieve zero latency leading to improvements in customer service levels
and better risk management because of real-time settlement. Since its evolution, it is having
unprecedented growth. The growth rate is higher in developed countries, and comparatively lower in
least developed countries (Chang, 2003 and Gallup, 2008).
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Despite the growth of IT worldwide, electronic payment systems are at an infant stage. Certainly, the
banking industry in Ethiopia is underdeveloped. Ethiopian commercial banks customers missed to enjoy
the technological advancement in banking sector, which has been entertained elsewhere in African and
the rest of the world. It is difficult to withdraw money without presenting the passbook and money
transfer is allowed only in between branches of the same bank. However, there is a strong need from
the public and the economy for strengthening linkages among banks in order to allow healthy flow of
financial resources among financial institutions and optimize the contributions of the entire financial
system to the development processes as a whole (Gardachew, 2008). Every bank customer is highly
dissatisfied by the disappointing status of financial development in Ethiopia. Hence, this study is aimed
at exploring the practice, benefit and extent of current e-banking service, and assessing the challenges
and opportunities of the adoption of e-banking service in Ethiopia.
2. E-banking in Ethiopia
E-banking is the modern delivery channel for banking services. According to Mohammed (2008),
electronic Banking is transforming the financial services industry through various innovations. It
provides the ability to create more effective systems of controls in individual institutions and in the
market themselves. Compared to the paper based operation, Electronic Banking Systems, in its most
proficient form, offer instant verification of transfer and reduces the flow of costly paper in the record
keeping process. In addition, electronic banking could reduce operating costs for banks.
E-Banking channels include internet banking, electronic payment methods (ATM, E-cards), mobile
banking, tele banking, home banking, Point of Sale Terminal and Society for Worldwide Inter-Bank,
and Financial Telecommunication (SWIFT). According to Booz et al. (1999), “Internet banking” refers
to systems that enable bank customers to access accounts and general information on bank products
and services through a personal computer (PC) or other intelligent device. Based on the levels of access
granted, internet-banking products are divided into 3 types. They are Information Only System,
Electronic Information Transfer System, and Fully Electronic Transactional System. While mobile
banking (also known as M-banking or SMS banking) is a term used for performing balance checks,
account transactions, payments etc. via a mobile device such as a mobile phone.
Tele banking refers to the services provided through phone that requires the customers to dial a
particular telephone number to have access to an account, which provides several options of services.
On the other hand, home banking frees customers from visiting branches and most transactions will be
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automated to enable them to check their account activities, transfer funds and to open L/C sitting in
their desk with the help of a personal computer and a telephone. An advanced payment system enables
customers to use an ATM card to pay for goods and services and it requires electronically debiting the
cardholders account and crediting the account of the merchant (Rahman, 2006).
SWIFT is a bank owned by a co-operative based in Belgium servicing the financial community
worldwide and non-profit making. It is a highly secured messaging network which enables banks to send
and receive fund transfer, L/C related, and other free formal messages to and from any banks active in
the network. Especially it will be of great help for clients dealing with imports and exports etc
(Mohammed, 2008).
An exploratory research conducted by Mahdi (2004) in Iran indicate that the adoption status of e-
banking is the transition of pre-development to development phase and the main drivers for adopting
e-banking are downsizing, gaining competitive advantage, increasing market share and improving bank’s
image. The analysis further reveals that inefficient ICT infrastructure, political challenges and traditional
organizational culture are barriers for adoption of e-banking.
In addition to the above factors, the case study conducted in China by Sherah, Fei, and Yi Ruo (2005)
suggests that government support is strong driver for e-banking adoption. The government support is
manifested in two ways. Firstly, the Government is establishing an electronic commerce (EC)-friendly
environment in the country. The government in recent years to revamp the national ICT and logistic
infrastructures has committed heavy investments. New EC laws and regulations have also been passed
and adjusted to provide legal protections for EC activities in general. Secondly, the government also
directly offers financial incentives to promote e-banking adoption.
3. Research methodology
Description of the Study Area: The study was conducted in Adiss Ababa where head office of each bank
and the national bank of the country are located. Addis Ababa is the capital city of Ethiopia and the
diplomatic capital of Africa with a population of greater than 3 million. In addition, employees have
better understanding about e-banking as compared to other locations in the country.
Research Design: An exploratory research design was employed for this study as it is the most suitable
approach in view of the nature of the problem being investigated. According to Zikmund (2000),
exploratory research is conducted to clarify and research a better understanding of the nature of the
164
problem. Consequently, it is appropriate to use when there is little prior knowledge of the problem being
researched. Saunders & Thornhill (2003) argue that exploratory research is advantageous because it is
flexible and adaptable to change.
Sampling: Both private and public commercial banks were included as a target population. Purposive or
convenience sampling technique was used to select the target population and all commercial banks that
are currently providing service and have age of five and above in the banking business were included in
the study. Accordingly, commercial bank of Ethiopia, Dashen bank, United bank and Zemen bank were
included among those providing the service and six commercial banks such as Wegagen bank, Abyssinia
bank, Nib international bank, Awash international bank, and cooperative bank of Oromia were included
among those banks which are not providing the service.
Data Source and Method of Collection: The study was conducted by collecting data both from primary and
secondary sources. Primary data were collected from the respondents using structured questionnaire
and interview with the higher official of the National bank of Ethiopia and IT managers of respondent
banks. Secondary data was collected from the websites of the respective commercial banks.
Method of Data Analysis: In order to meet the stated research objectives, descriptive type of analyses
(tables and percentages) were employed to analyze the collected data.
As shown in Table 1, almost all banks except Zemen bank have an age of more than five years. The
study used IT managers of the respective bank as respondent, all of whom have an experience of more
than five years. With regard to sex, all respondents are male and the educational status of the respondents
is BSc (66.7%) and MSc (33.3%). This implies that data were collected from employees who have good
educational status.
Table 1: Demographic characteristics of respondents
Bank Year of Job position Exper gender Educational

establishment ience status
Commercial Bank of 1980 IT manager 10 M Degree
Ethiopia(CBE)
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Awash international 1994 IT manager 10 M Masters

Bank(AIB)
Dashen bank(DB) 1995 IT manager 10 M Degree
Wegagen Bank(WB) 1997 IT manager 12 M Degree
Nib international 1999 IT manager 4 M Masters
Bank(NIB)
United Bank(UB) 1998 IT manager 12 M Degree
Cooperative Bank of 2004 IT manager 3.5 M Degree
Oromia(CBO)
Zemen Bank(ZB) 2008 IT manager 14 M Masters
Source: Own survey
Descriptive result of banks adoption of e-banking indicated that only four banks among those currently
operating in the country are providing banking products to their customer through electronic channels
but the remaining banks are not using electronic channels as a means of service delivery. However, they
are planning to adopt the system and among these some banks are currently on the way of installing the
system. For example, Wegagen Bank has signed an agreement with Technology Associates, a Kenyan
based IT firm, for the development of the solutions for the payment system and installation of a network
of ATMs on December 30, 2008.
In addition, the table also indicated that e-banking service is in an infant stage in the country since most
banks did not yet adopted the system and even those banks that are currently providing the services
have commenced the system after 2006 and did not fully adopted the technology because of different
challenges.
Table 2: Banks adoption of e-banking
Banks providing e- Year of commencement Banks not providing e-banking service but
banking service of e-banking planned to adopt
CBE 2001 AIB
DB 2006 WB
UB 2009 NIB
ZB 2009 CBO
Source: Own survey
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Among the total branches of the CBE, only 35 (16.7%) branches are currently providing ATM service
to their customers. All the branches of Dashen bank are providing ATM services but only selected banks
are delivering electronic point of sale service. With regard to United bank, 38 (92.7%) branches are
currently providing e-banking services to their customers but only three of them (7.3%) are not. In
addition, Zemen bank is currently providing the service with its single branch located in Addis Ababa.
The difference in the adoption of e-banking service among the branches is due to the difference in the
availability of ICT infrastructure among the branches in different locations and lack of customer
awareness on the service especially with those branches located in the rural areas (Table 3).
Table 3: Number of branches providing e-banking services
Bank Total branch Number of branches providing the service

CBE 209 35
DB 54 54 (ATM), selected for POS
UB 41 38
ZB 1 1
Commercial bank of Ethiopia is providing only ATM services for the customer. Undeniably, the largest
state-owned bank, CBE, is the pioneer in introducing ATM service for local users in 2001 with its fleet
of eight ATMs located in Addis Ababa. Moreover, CBE has had Visa membership since November 14,
2005. However, due to lack of appropriate infrastructure, it failed to reap the fruit of its membership.
Despite, being the pioneer in introducing ATM based payment system and acquired Visa membership,
CBE lagged behind Dashen Bank, which worked aggressively to maintain its lead in electronic payment
systems. Dashen bank, a forerunner in introducing e-banking in Ethiopia, has installed ATMs at
convenient locations for its own cardholders. At the end of June 2009, Dashen bank has installed more
than 40 ATMs in its area branches, shopping malls, restaurants and hotels. Expanding its leadership,
Dashen Bank has begun accepting MasterCard in addition to Visa credit cards. Dashen won the
membership license from MasterCard in 2008. In addition, Dashen Bank also introduced salary cards
to companies and started issuing debit cards to access one’s account.
The younger single-branched Zemen Bank launched multi-channel banking (MCB) services in Ethiopia,
which includes ATMs, Internet Banking, Banking through Call Centre and SMS banking. These services
introduced by Zemen Bank makes it the first in its kind in Ethiopia to introduce fully IT supported and
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24/7 customers services. Currently, it is the only bank in the country offering ATM, SMS and internet
banking services all at the same time. Zemen’s new services would enable customers of the bank to get
the services listed in Table 4.
United is the first bank to introduce the MCB for the first time in Ethiopia in August 2008. This service
enables customers to get banking services without a need to physically visit branches of the Bank.
Customers can get a 24/7 service anywhere as long as they have an internet access. A customer who
subscribe to the internet banking service of the bank can enjoy the services listed in Table 4. As United
strides forward to develop new products, it introduced SMS Banking service in September 2008. Like
Telephone Banking, Internet Banking and BLMT services, United is a pioneer to introduce SMS
banking. Like the internet banking service, customers can get a 24/7 service using SMS banking.
Broadband local money transfer (BLMT) is one of the peculiar services of United Bank S.C. The
introduction of this electronic money transfer service, which uses a broadband connection, is quiet a
departure from a transfer service given by using telephone lines.
In general, as shown in Table 4 the most dominant e-banking channel among those banks, which are
currently providing the service, is ATM card, which is the first generation of electronic banking channel.
Therefore, it is possible to conclude that even banks that are providing the service did not sufficiently
adopted the latest e-banking channel such as internet and mobile banking.
Table 4: Extent and Practices of e-banking in Ethiopia
Bank e-banking channels Services /transactions available

CBE ATM, credit card and debit card Balance inquiry, cash withdrawal, and statement printing
DB ATM, master card, visa card, Balance inquiry, cash withdrawal, statement printing, fund
salary card, debit card, mobile or transfer, PIN change, purchase of goods or services,
SMS banking and electronic point accessing his/her accounts 24*7
of sale (POS)
UB Internet banking, phone banking, Balance inquiry, fund transfer, mini-statement or view
mobile /SMS banking and BLMT account statement, information about the exchange rate of
major currencies, purchase of goods or services, request a
new cheque book, make a stop payment order, accessing
his/her accounts 24 hours a day, 7 days a week, and 365 days
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a year, cheque-status enquiry, view account transaction, view

loan status
ZB Internet banking, phone banking, New account set up, credit application, Balance inquiry, fund
mobile /SMS banking, SWIFT, transfer, mini statement, information about the exchange
ATM-credit card and debit card rate of major currencies, purchase of goods or services,
request a new cheque book, make a stop payment order,
accessing his/her accounts 24 hours a day, 7 days a week,
and 365 days a year, bill presentment and payment, password
change and management features, cheque-status enquiry,
and credit-card payments
Source: Own survey
Regarding operational issues, all banks check their links and interactive programs periodically for its
accuracy and functionality since this helps banks to take corrective measures timely. In addition, to
prevent the web site information from being altered, security measures like firewall and secure socket
layer (SSL) is being taken by all banks except that of the commercial bank of Ethiopia. Though it is not
satisfactory, banks put in place using passbook and checkbook when there is an interruption in the
service of e-banking for customers. Pertaining to providing electronic banking training to employees,
all banks trained their staff. However, it is not sufficient and confined to the ICT personnel’s of each
bank.
Addressing banking activities beyond the traditional trade area is one among the different driving forces
of delivering banking products to the customer through electronic channels. In this regard, all banks
have policies and procedures in place to address this activity. Moreover, with respect to target market
or trade area, all banks have target market area for ATM services.
Table 5: Operational issues related to e-banking service
S.No. Operational Issues CBE DB UB ZB
169
1 Are links and interactive program’s check for accuracy yes yes yes Yes
and functionality?
2 Are security measures in place to prevent the website No Yes yes Yes
information from being altered?
4 Does the bank have procedures in place for when there yes yes yes Yes
is an interruption in service of e-banking for customers?
5 Is electronic banking training provided to employees? yes yes yes Yes
6 Are any policies and procedures in place to address yes yes yes Yes
activities beyond the traditional trade area?
7 Do the banks have a target market or trade area for e- yes yes yes Yes
banking.
Source: Own Survey
As reported in Table 6, all banks (100%) believe that providing banking products to the customer by
using electronic channels have the benefit of building good image, load reduction that enables bank
employees to focus on strategic issues instead of focusing on traditional activities and improvement of
organizational performance.
Table 6: Benefits realized by banks from the adoption of e-banking service
Bank Benefits
CBE Enhanced image, improvement of organizational efficiency, and load reduction.
DB Attracting high value customers, enhanced image, cost reduction, improvement of
organizational efficiency, high foreign currency earning, and low risk of cash management,
load reduction.
UB Attracting high value customers, enhanced image, cost reduction, Improvement of
organizational efficiency.
ZB Attracting high value customers, enhanced image, larger customer coverage, cost
reduction, improvement of organizational efficiency, better monitoring of their customer
base, and load reduction.
Source: Own Survey
170
Even though there are some sort of differences regarding the driving forces that initiate for the adoption
of e-banking service in each bank, the existence of high competition in the banking sector, rapidly
changing customers’ needs and preferences, desire to improve organizational performance, desire to
improve the relationship with customers, desire to reduce transaction cost, desire to build organizational
reputation, and desire to satisfy customers are the major common driving forces that initiate banks for
the adoption of e-banking as a means of service delivery to their customers (Table 7).
Table 7: Driving forces that initiate banks to adopt e-banking services
Bank Driving forces

CBE Rapidly changing customers’ needs and preferences, desire to improve organizational
performance, desire to improve the relationship with customers, desire to reduce
transaction cost, desire to cover wide geographical area, desire to build organizational
reputation and desire to satisfy customers.
DB Existence of high competition in the banking industry, desire to improve organizational
reputation, desire to satisfy customers, to keep the international banking standard, and
rapidly changing customers’ needs and preferences.
UB Desire to improve organizational performance, desire to improve the relationship with
customers, desire to reduce transaction cost, desire to cover wide geographical area,
desire to build organizational reputation, desire to satisfy customers.
ZB Existence of high competition in the banking industry, desire to improve organizational
reputation, desire to satisfy customers and rapidly changing customers’ needs and
preferences.
CBO Existence of high competition in the banking industry, desire to improve organizational
reputation, desire to satisfy customers, to withstand the prospective competition with
the foreign banks provided that if they are tolerated to operate in Ethiopia and rapidly
changing customers’ needs and preferences.
171
NB Existence of high competition in the banking industry, desire to improve organizational

reputation, desire to satisfy customers and Rapidly changing customers’ needs and
preferences.
WB Existence of high competition in the banking industry, desire to improve organizational
reputation, desire to satisfy customers and rapidly changing customers’ needs and
preferences
AIB Existence of high competition in the banking industry, desire to improve organizational
performance, desire to improve the relationship with customers, desire to build
organizational reputation, desire to satisfy customers and rapidly changing customers’
needs and preferences
Source: Own Survey
Table 8: Challenges for the adoption of e-banking service in Ethiopia
Bank Major challenges

AIB Chances of risk, lack of suitable legal and regulatory framework, lack of government
initiation or lack of government prioritization, absence of financial networks that links
different banks, low level of internet penetration and poorly developed telecommunication
infrastructure, high cost of internet, security issues.
WB High installation cost, chances of risk , lack of suitable legal and regulatory framework, high
rate of customer illiteracy, non-readiness of banks to adopt the system, lack of government
initiation or lack of government prioritization, absence of financial networks that links
different banks, low level of internet penetration and poorly developed telecommunication
infrastructure, high cost of internet and security issues.
NIB High installation cost, chances of risk, lack of suitable legal and regulatory framework,
non-readiness of banks to adopt the system, lack of government initiation or lack of
government prioritization, absence of financial networks that links different banks, low
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level of internet penetration and poorly developed telecommunication infrastructure, high

cost of internet and security issues.
CBO Chances of risk, lack of suitable legal and regulatory framework, high rate of customer
illiteracy, non-readiness of banks to adopt the system, lack of government initiation or lack
of government prioritization, absence of financial networks that links different banks, low
level of internet penetration and poorly developed telecommunication infrastructure, low
level of initiation on the side of the shareholders to adopt the system, high cost of internet
and security issues.
CBE Chances of risk, lack of trained and efficient staff in e-banking context, lack of suitable
legal and regulatory framework, absence of financial networks that links different banks,
low level of internet penetration and poorly developed telecommunication infrastructure,
high cost of internet and security issues.
DB Chances of risk, lack of trained and efficient staff in e-banking context, lack of suitable
legal and regulatory framework, absence of financial networks that links different banks,
low level of internet penetration and poorly developed telecommunication infrastructure,
high cost of internet and security issues.
UB Security issues, lack of public awareness on the use of e-banking service.
ZB Security issues, lack of public awareness on the use of e-banking service.
Source: Own Survey
The major challenges identified in this particular study in the industry are: chances of risk (such as
operation, security and reputation risk as stated by both banks ), lack of suitable legal and regulatory
framework that govern and regulate e-banking transaction in the country, absence of financial networks
that links different banks, lack of government initiation or lack of government prioritization, high cost
of internet, low level of internet penetration and poorly developed telecommunication infrastructure are
the major common challenges for the adoption of e-banking service in the country’s banking industry.
The study identified the existing opportunities in the country for the adoption of e-banking. These are
improvement in the banking habit of the society, sustainable economic growth in the country, increment
of tourist inflow to Ethiopia, commitment of the government to facilitate the expansion of ICT
infrastructure, and willingness among banks to cooperate in building infrastructure. Moreover,
cooperation among banks for instance three private commercial banks (Awash International Bank S.C.,
Nib International Bank S.C, and United Bank S.C.) to launch an Automated Teller Machine (ATM) and
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Point of Sale terminal (POS) network is encouraging strategy to improve electronic payment system in
Ethiopia. In addition, the commitment of the government to strengthen the banking industry is a good
opportunity for the adoption of e-banking service in the country.
Table 9: Existing opportunities for the adoption of e-banking services
Bank Opportunities
CBE Late adopter opportunities, commitment of the government to facilitate the expansion of
ICT infrastructure, improvement in the banking habit of the society, sustainable economic
growth in the country, increment of tourist inflow to Ethiopia and willingness among banks
to cooperate in building infrastructure.
DB Late adopter opportunities, commitment of the government to strengthen the banking
industry, commitment of the government to facilitate the expansion of ICT infrastructure,
improvement in the banking habit of the society, sustainable economic growth in the
country, increment of tourist inflow to Ethiopia and willingness among banks to cooperate
in building infrastructure.
UB Late adopter opportunities, commitment of the government to facilitate the expansion of
ZB Late adopter opportunities, commitment of the government to strengthen the banking
WB Late adopter opportunities, commitment of the government to facilitate the expansion of
NIB Commitment of the government to facilitate the expansion of ICT infrastructure.
174
AIB Late adopter opportunities, commitment of the government to strengthen the banking
CBO Late adopter opportunities, commitment of the government to strengthen the banking
Source: Own Survey
5. Conclusion and Recommendation
The Ethiopian banking system is at an infant stage in terms of providing e-banking compared to the
rest of the world. Cash is still the most dominant medium of exchange. ATM, Credit Card and debit
card services, internet banking, mobile banking and other electronic payment systems are at infant stage.
In general, the most dominant e-banking channel among those banks, which are currently providing the
service, is ATM card, which is the first generation of electronic banking channel. In view of the extent
of e-banking adoption, majorities of the banks have not adopted this technology and are using traditional
services to reach and serve their clients. In general, banks in Ethiopia are trailing behind in acquiring the
required quality of banking services to effectively compete in the global market.
Adoption of e-banking service have the benefit of attracting high value customers, enhanced image,
larger customer coverage, cost reduction, improvement of organizational efficiency, and load reduction
etc from the view point of the bank. Moreover, important perceived benefits of using e-banking among
those banks that are not currently providing the service but are planning to adopt the system were
relative advantage, organizational performance, customer relationship and perceived ease of use.
Chances of risk, lack of trained and efficient staff in e-banking context, lack of suitable legal and
regulatory framework, absence of financial networks that links different banks, low level of internet
penetration and poorly developed telecommunication infrastructure, high cost of internet, lack of
customer awareness and security issues are the main challenges for adoption of e-banking in Ethiopia.
175
On the other hand, commitment of the government to facilitate the expansion of ICT infrastructure,
improvement in the banking habit of the society, sustainable economic growth in the country, increment
of tourist inflow to Ethiopia and willingness among banks to cooperate in building infrastructure are
among the major opportunities for the adoption of e-banking in the country. Based on the findings of
this study, the following recommendations are forwarded in order to promote and develop viable e-
banking service in Ethiopia.
Although the Government of Ethiopia is making efforts to expand basic communication technology to
the country, more efforts should be made to expand modern telecommunication network to the country.
Therefore, government should implement the national ICT policy as quickly as possible so that the ICT
infrastructure at ETC should be available.
With regard to capacity building, the National Bank of Ethiopia should prepare various capacity building
activities for banks regarding e-banking operation and provide incentives for banks to invest rigorously
on ICT and use of e-banking. In addition, each bank should strengthen its ICT department through
providing training to IT personnel and procuring required hardware and software. The government of
Ethiopia should consider the liberalization of the banking industry to foreign bank entry to enhance the
introduction of modern technology in the banking sector. Banks that are currently providing the service
should promote the system in order to raise public awareness on the use of e-banking service.
Furthermore, as mobile banking is the latest electronic banking channel, it is important for each bank
to formulate relevant acts, policies, and adopt operative guidelines.
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179
THEME 5: Loan and Saving in Agriculture and Pastoralism
Impact of Microcredit on Farm Productivity: The Case of Deder and Goro Gutu Districts,
East Hararghe Zone, Ethiopia
Melkamu Belinaa and Mengistu Ketemaa

a
School of Agricultural Economics and Agribusiness, Haramaya University
E-mail: melkizan@fastmail.fm and mengistuket@gmail.com
Abstract: This study evaluated the impact of micro-credit on farm productivity in Deder and Goro Gutu districts of East
Hararghe zone. For the analysis, a total of 180 (micro-credit beneficiary and non-beneficiary) households were randomly
drawn and cross-sectional data were collected from these households using a structured questionnaire. The collected data
were analyzed using descriptive statistics and econometric tools. Propensity score matching (PSM) method was employed to
analyze the impact of micro-credit on farm productivity of households in the districts. The PSM method was checked for
covariate balancing, t-ratio, and joint significance level tests. Additionally, sensitivity analysis was done to check the
existence of hidden bias due to unobserved confounders using Rosenbaum bounds approach. The results obtained from
PSM technique showed that education of the household head, improved seed usage and amount of fertilizer usage were
found to have positive relationship whereas religion, livestock holding, and off/non-farm income were found to have negative
relationships with participation in micro-credit and farm productivity. In addition, the PSM result showed that
participation in micro-credit had a positive and significant impact on farm productivity as measured by value of crop
production per hectare. Participation in micro-credit was found to have increased the value of crop production per hectare
by 2,067.52 Birr for beneficiary households as compared with non-beneficiary farm households. Therefore, the study
recommends promotion of education, improving use of and access to seed and fertilizer inputs, and provision of the option
of non-interest bearing loans based on Islamic principles by microfinance institutions in the study districts.
Keywords: Farm productivity, impact evaluation, micro-credit, PSM
1. Introduction
Agriculture is the backbone of Ethiopian economy, the main source of foreign exchange and
employment (Shimelles and Zahidul, 2009). Hence, the ability of the nation to address food and
nutritional insecurity, poverty, and to stimulate and sustain national economic growth and development
180
is highly dependent on the performance of the sector. Yet, achieving higher and sustained agricultural
productivity growth remains one of the greatest challenges facing the nation (Spielman et al., 2010).
Agricultural growth depends on increased use of improved agricultural inputs, technological change and
technical efficiency. Technical efficiency with which new technology is adopted and used more rationally
is affected by the flow of information, better infrastructure, and availability of funds and managerial
capabilities (Muhammad et al., 2003). Rural credit in the form of loans, cash or commodity improves
farm productivity (Jaffar et al., 2006).
Currently, the government of Ethiopia is promoting micro-credit service. Following these, 31

microfinance institutions (MFI) are operating in the country. Oromia Credit and Saving Share Company
(OCSSCO) is among these MFIs and the only MFI in the study districts. To the best of the researchers’
knowledge, no work has been done on the impact of micro-credit on farm productivity in the country
as well as the study districts. Hence, the study was aimed at assessing the impact of micro-credit on farm
productivity in the study districts using value of crop production per hectare as an impact indicator.
2. Materials and Methods
Study Area: Deder and Goro Gutu districts are found in East Hararghe Zone of Oromia National
Regional State (ONRS). Deder district is located in the northwestern part of East Hararghe zone. The
district has an area of 877.6 square kilometer. Goro Gutu district is found in the north western part of
East Hararghe zone and covers an area of 531.2 square kilometer (ONRS, 2011).
Sample Size and Method of Sampling: A two stage sampling technique was adopted to collect the required
primary data. First six kebeles where selected out of 114 kebeles based on the distribution of micro-
credit in the kebeles. Then, households were stratified as micro-credit beneficiary and non-beneficiary
in the selected kebeles. Finally, 90 households from beneficiary and 90 households from non-beneficiary,
totally 180 households were used in this study.
Method of Data Analysis: The study employed both descriptive statistics and econometric method to
analyze the collected data. To assess the impact of micro-credit on farm productivity, propensity score
matching (PSM) method was employed. PSM is chosen among other methods because it does not
require baseline data and considered as second-best alternative to experimental design in minimizing
selection biases (Baker, 2000). For comparative computational simplicity logit model was used to
estimate propensity scores (Rosenbaum and Robin, 1983) and matching is then performed using
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propensity scores of each observable characteristics. These characteristics include covariate variables
that influence the participation decisions and the outcome of interest. The mathematical formulation of
the logit model is as follows:
𝑒 𝑍𝑖
Pi = 1 + 𝑒 𝑍𝑖 ,
Where: Pi is the probability of participation in micro-credit for the ith household and it
ranges from 0 to 1,
Zi: is a function of N-explanatory variables which is also expressed as:
Zi = β0 + Σβixi + Ui
Where, i = 1, 2, 3… n
β0 = intercept,
βi = regression coefficients to be estimated or logit parameter,
Ui = a disturbance term, and Xi = explanatory variables.
Table 1: Variable definitions and measurement
Variable Types and definition Measurement

Participation Dummy, micro credit beneficiary 1 if yes, 0 otherwise
Value of crop
production per hectare
SEXH Dummy, sex of household head 1 if female, 0 otherwise
AGE Continuous, age of household head years completed
FSHH Continuous, family size family member’s number
DEPRATIO Continuous, dependency ratio ratio of family members
EDLHH Dummy, education of household head 1 if literate, 0 otherwise
RELG Dummy, religion 1 if Muslim, 0 Christian
FARMSIZE Continuous, farm size Hectare
LH Continuous, tropical livestock holding TLU
IMPSEED Dummy, improved seed usage 1 if usage, 0 otherwise
ACCIRRI Dummy, access to irrigation 1 if access, 0 otherwise
AMTFERTI Continuous, amount of fertilizer used kg
FRQYEXT Continuous, frequency of extension number of days /month
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OFFINCOM Continuous, off/non farm income birr
Description of Sample Households’ Characteristics
Non-beneficiary households have relatively larger land and livestock holdings as compared to the
beneficiary households. Beneficiary households, on the other hand, used more fertilizer and have
relatively frequent extension contacts as compared to the non-beneficiary households.
Table 2: Descriptive and inferential statistics for continuous variables
Beneficiary Non-beneficiary Total

(N = 90) (N = 90) (N = 180)
Variable Mean SD Mean SD Mean SD t-test
Age 35.5 9.1 37.2 7.6 36.3 8.4 1.4
Family Size 5.8 1.9 5.9 2.2 5.8 2.1 0.2
Dep. Ratio 1.4 1 1.3 0.8 1.4 0.9 -1.4
Farm Size 0.27 0.1 0.34 0.2 0.31 0.2 2.7***
LH 2 1.8 2.7 2 2.4 1.9 2.6***
Fertilizer 11.2 10.1 5.6 9.9 8.4 10.4 -3.8***
Extension 2.6 0.9 2.4 0.9 2.5 0.9 -1.8*
*** and * means significant at 1% and 10% probability levels, respectively.
The proportion of female beneficiaries is larger than that of female non-beneficiaries. Furthermore,
literate members are larger in beneficiary households as compared to that in non-beneficiary households.
The differences in terms of other variables are as indicated in Tables 2 and 3.
Table 3: Descriptive and inferential statistics for discrete variables
Beneficiary Non-beneficiary Total

Variable Category (N = 90) (N = 90) (N = 180) χ2-value
N % N % N %
Sex Male 72 47.1 81 52.9 153 85.0 3.53*
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Female 18 66.7 9 33.3 27 15.0

Education Literate 66 58.9 46 41.1 112 62.2 9.45***
Illiterate 24 35.3 44 64.7 68 37.8
Religion Muslim 53 54.1 45 45.9 98 54.4 1.43
Christian 37 45.1 45 54.9 82 45.6
Improved Yes 45 63.4 26 36.6 71 39.4 8.39***
seed No 45 41.4 64 58.7 109 60.6
Access to Yes 38 52.8 34 47.2 72 40.0 0.37
irrigation No 52 48.1 56 51.9 108 60.0
*** and * means significant at 1% and 10% probability levels, respectively.
Impact estimation
Before impact estimation, logit model is fitted to estimate the probability of participation of sample
respondents in the intervention. The estimated model coefficients in Table 4 show that participation in
micro-credit was significantly influenced by independent variables such as education, religion, livestock
holding, improved seed usage, amount of fertilizer usage and off/non farm income.
Table 4: Estimates of the Logit model
Variables Coef. S.E z p> |z|

Sex 0.202 0.541 0.37 0.710
Age -0.036 0.023 -1.62 0.105
Family size 0.007 0.103 0.07 0.944
Dependency ratio 0.276 0.240 1.15 0.251
Education 0.819 0.388 2.11** 0.035
Religion -0.892 0.395 -2.26** 0.024
Farm size -1.481 1.221 -1.21 0.225
Livestock holding -0.222 0.112 -1.99** 0.047
Improved seed 0.690 0.399 1.73* 0.084
Fertilizer usage 0.044 0.019 2.38** 0.017
Access to irrigation -0.206 0.381 -0.54 0.588
Extension contact 0.300 0.188 1.6 0.111
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Off/Non-farm income 0.000 0.000 -2.29** 0.022

Constant 1.753 1.177 1.49 0.136
Number of obs = 180 Prob > chi2 = 0.0000 PseudoR2=0.20

LR chi2(13) = 50.70 Log likelihood =-99.42
Source: Own estimation result; ** and * means significant at 5% and 10% probability levels, respectively.
Propensity score matching result showed that micro-credit have statistically significant impact on farm
productivity as demonstrated by value of crop production per hectare increments (Table 5). The value
of crop production per hectare has increased by Birr 2,067.52 for the beneficiary households and
statistically significant at less than 1% probability level. The sensitivity analysis also indicated that the
impact estimates (ATT) are not affected by the unobserved covariates.
Table 5: Average treatment effect on the treated (ATT)
Variable Treated Control Difference SE t-value

Value of crop production per
hectare (Birr) 10,685.89 8,618.37 2,067.52 472.16 4.40***
Source: Own estimation result; ***Significant at 1% probability level.
Being micro-credit beneficiary as well as farm productivity was affected by six explanatory variables.
These variables were education, religion, livestock holding, improved seed usage, fertilizer usage, and
off/non-farm income. Furthermore, the study found that, on average, micro-credit has an impact on
farm productivity measured in terms of value of crop production per hectare by Birr 2,067.52, which is
statistically significant at 1% probability levels. This implies that micro-credit is playing a great role in
enhancing farm productivity in the study districts. Therefore, it is necessary to give due emphasis for
the microcredit institutions. In the study, religion is found significant in micro-credit participation.
Therefore, OCSSCO which is the only MFI in the districts need to adopt non-interest bearing loan
based on Islamic principles. Besides, attention should be given in promoting and encouraging the
farmers to use improved seed and fertilizer in the study districts.
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35: 185–194.
186
Determinants of Loan Repayment Performance of Smallholder Farmers: The Case of Soro

Woreda, Hadiya Administrative Zone, Southern Nations, Nationalities and Peoples’ Regional
State, Ethiopia
Ayalew Mekonnen1 and Lemma Zemedu2

1
MSc Student, School of Agricultural Economics and Agribusiness Management, Haramaya University
Email: ayalew2@yahoo.com
2
Assisstant Professor, School of Agricultural Economics and Agribusiness Management, Haramaya
University Email: zemedul@yahoo.com
Abstract: Improved agricultural technologies, knowledge and inputs such as fertilizer, improved seeds and pesticides that
help to boost production and productivity are needed by smallholder farmers to transform their farm structure and capacity.
But access to these is limited due to various reasons among which financial problems are the dominant. The Government
of Ethiopia has put various efforts to solve rural financial problems by extending rural financial institutions. However,
due to social, economic and institutional factors, a number of farmers turned out to be defaulters. As a result, the lending
institutions faced problems of self-sustainability. The main objective of this study was to analyze the determinants of loan
repayment performance of smallholder farmers in the study area. Primary data were collected from 125 randomly selected
borrowers using a structured questionnaire. Two-limit Tobit regression model was used to identify factors influencing loan
repayment performance and intensity of loan recovery among smallholder farmers. Results indicated that out of the total of
13 explanatory variables tested, 5 of them including total number of livestock, experience in extension services, source of
loan, expense in social ceremony and amount of cash borrowed were found to be statistically significant in affecting loan
repayment performance. Hence, to undertake effective actions with the aim of improving loan repayment performance in the
study area, careful consideration of these factors is very important for policy makers and lenders in their attempt to minimize
default risk.
Keywords: Defaulters, loan repayment, smallholder farmers, two-limit Tobit
1. Introduction
In Ethiopia, agricultural sector has been unable to produce sufficient quantities to feed the rapidly
growing population. The reasons for low productivity of the agricultural sector and the growing gap
between the demand and the supply of agricultural products are many in number and different in
character. These include poor and backward technology, limited use of modern inputs, lack of
transportation and storage facilities, inadequate extension and credit facilities and natural calamities such
as drought and ecological degradation (EEA, 2007). Similar to other parts of the country, agriculture is
187
the mainstay of Southern Nations, Nationalities and Peoples Regional State from which about 90% of
the population earns their livelihood accounting for 70% of the regional GDP. It is dominated by a
small-scale farming which accounts for about 98% of the total agricultural production in the regional
state. Wheat, maize, teff, barely and sorghum are the principal crops that are grown under rain fed.
Development and adoption of new agricultural technologies and the use of credit facilities is vital for
rapid growth in agricultural productivity. However, with the introduction of new production
technologies, the financial needs of farmers increased by many-fold. Steady agricultural development
depends up on the continuous increase in farm investment. Large investment cannot be made by the
farmers out of their own funds because of their low level of incomes. Thus, here comes the importance
and significance of the availability of rural credits to bridge the gap between owned and required capital
(Gebrehiwot, 2007).
The delivery of efficient and effective credit services to the poor requires favorable micro-economic
policies and the establishment and enforcement of legal and regulatory frameworks of a country. An
effective financial system provides the foundation for successful poverty alleviation program (Wolday,
2000). This is because low repayment performance discourages the lender to promote and extend credit
to large and fragmented farm households. Therefore, a thorough investigation of the various aspects of
loan defaults, source of credit and condition of loan provision are of great importance both for policy
makers and lending institutions.
Failure by farmers to repay their loans in time or to repay them at all is a serious problem facing both
agricultural credit institutions and smallholder farmers. According to Hunte (1996), loan default is a
tragedy because failing to implement appropriate lending strategies and credible credit policies often
result in demise of credit institutions.
In Hadiya Zone, Soro Woreda, the regional government and a non-governmental organization extend
credit facilities to farming households to narrow the gap between the required and the owned capital to
use improved agricultural technologies that would increase production and productivity. However, there
is a serious loan repayment problem in the area, where about 40% loan given in 2009/10 was not been
repaid on time (SWAO, 2011).
Although there are such severe problems, factors that affect loan repayment performance of
smallholders from formal sources have not been studied in the area. Therefore, this study was initiated
188
with the main objective of analyzing the determinants of formal source of loan repayment performance
of smallholder farmers in Soro Woreda, Hadiya Administrative Zone.
2. Methodology
Description of the study area: Soro is one of the 10 Woredas in Hadiya zone, Southern Nations Nationalities
Peoples Regional state, located about 262 km from Addis Ababa. It is the largest Woreda in the zone
with an area of 58,000 ha and cultivable land of 38,000 ha. Currently, the Woreda is divided into 47
kebeles. The elevation of the Woreda ranges between 1500-2300 m.a.s.l. The Woreda encompasses three
agro-elological zones, namely dega, woina dega and kola covering 15.5%, 53% and 31.5% of the Woreda,
respectively.
Sample size and Method of Sampling: A two-stage sampling method was used to select the sample
respondents. In the first stage, from 47 Kebeles found in the Woreda 6 kebeles were selected using stratified
sampling technique. The three agro ecological zones (Dega, Woinadega and Kola) were represented
with two, three and one kebeles, respectively, in the strata. In the second stage the list of farmers who
have obtained loans from formal credit sources were recorded from each kebeles and a total of 125 farm
households were selected randomly based on probability proportional to sample size as indicated in
Table l.
Table 1: Proportional allocation of sample size
Name of Kebele Strata No. of borrowers Number of sampled

borrowers
Sundusa Woinadega 634 25
Arrara Dega 473 20
Segeda Dega 446 20
Harcheuyaya Woinadega 715 28
Bonadebero Woinadega 378 14
1st Hangota Kola 451 18
Total 3097 125
189
Methods of Data Collection: Information pertaining to respondents, socio-economic characteristics,

institutional situations, and other related issues were obtained directly through the structured
questionnaire interview, which was conducted at household level. Secondary data were obtained from
government offices and other relevant organizations.
Methods of Data Analysis: Descriptive statistics such as mean, standard deviation and frequency
distribution were used to compare and contrast different categories of sample units (in this case farm
households) with respect to the desired characters so as to draw some important conclusions. Moreover,
chi-square and t-test were applied to test for statistical significances. In addition, a Tobit regression
model was used to identify the determinants of loan repayment performance. The use of Tobit model
to study censored and limited dependent variables has become increasingly common in applied social
science research (Smith and Brame, 2003). Tobit is an extension of the probit model and it is one
approach of dealing with the problem of censored data (Johnston and Dinardo, 1997).
In this study, the value of the dependent variable is repayment ratio that has been computed as the ratio
of amount of loan repaid to the total amount borrowed from formal sources of credit. Thus, the value
of the dependent variable ranges between 0 and 1 and a two-limit Tobit model has been chosen as a
more appropriate econometric model. The two-limit Tobit was originally presented by Rossett and
Nelson (1975) and discussed in detail by Maddala (1992) and Long (1997). The model derives from an
underlying classical normal linear regression and can be represented as:
y *   ' xi   i ,   0,  2 
Denoting Yi as the observed dependent (censored) variable
L if Y *  L

Yi  Y *  X   i if L  Y *  U

U if Y *  U
Where, yi=the observed dependent variable, in our case repayment ratio (ratio of amount repaid to the
amount borrowed), yi*=the latent variable (unobserved for values smaller than 0 and greater than 1). X i
=is a vector of independent variables (factors affecting loan repayment and intensity of loan recovery).
190
 i =Vector of unknown parameters.  i =Residuals that are independently and normally distributed with
mean zero and a common variance  2 , and i = 1, 2, ….n (n is the number of observations).
The log likelihood function for the general two-limit Tobit model can be given as follow:
1  yi  x  2 
log l   wj    log 2  2 
2 jc    
 y Lj  x    y Rj  x 
 w j log  


 w j log 1   


j L   j R   
  y 2 j  x   y  x 
 w j log  
  
    1 j



j l   
Where C’s are point observations, L’s are left censored observations, R’s are right-censored
observations, and I’s are intervals,  is the standard cumulative normal distribution, and the wj is the
normalized weight of the jth observation.
The Tobit coefficients do not directly give the marginal effects of the associated independent variables
on the dependent variable. But their signs show the direction of change in probability of being non-
defaulter and marginal intensity of loan recovery as the respective explanatory variable change
(Amemiya, 1984; Goodwin, 1992; Maddala, 1985). The Tobit model has an advantage in that its
coefficients can be further disaggregated to determine the effect of a change in the ith variable on changes
in the probability of being non-defaulter (Mc Donaled and Moffit, 1980) as follows:
1. The change in the probability of repaying the loan as an independent variable Xi changes is:
   
    i (4)
Xi 
2. The change in intensity of loan recovery with respect to a change in an explanatory variable among
non-complete defaulters is:
191

E Yi / U  Yi*  L, X 


 i 1 
 L  L    U   U     L     U   

2
(5)

X i    U    L     U     L  

3. The marginal effect of an explanatory variable on the expected value of the dependent Variable is:
E Y / X i 
 i   U     L  (6)
X
1 X i
Where, Xi=explanatory variables,     the cumulative normal distribution,   = the Z score

for the area under normal curve, i  a vector of Tobit maximum likelihood estimates,   the standard
L Xi  U  Xi 
error of the term,  L  , U  where, L and U are the threshold values (L=0 and
 
U=1),  and  are probability density and cumulative density functions of the standard normal
distribution, respectively.
Descriptive Statistics Results: The descriptive statistical analysis results given in Table 2 describe the
socioeconomic and institutional characteristics of sample households. Out of the total interviewed
households, 52.8% were non-defaulters and the remaining 47.2% were defaulters. Among the defaulters,
25% were complete defaulters while 75% repaid 35 to 98% of the total loan of which they borrowed.
The average age of household heads was 50.45 years with the minimum and maximum ages of 26 and
85 years, respectively. The average age of non-defaulter household heads was 56.43 years, while that of
defaulters was 43.97 years with significant mean difference at 1%. On the other hand, the average family
size of the sample households was 7.77. The largest family size was 13 and the smallest was 2. The
average family size of non-defaulters was 8.09, while that of defaulters was 7.42 with no significant
difference between means of the two groups.
The result also revealed that 47.2% of the sample household heads were illiterate whereas 52.8% of the
household heads were literate (Table 2). Of the total sample respondents, 43.1% of the non-defaulters
and 51.7% of defaulters were illiterate, respectively. There was no significant difference between
defaulters and non-defaulters in terms of their literacy level. The sample was composed of both male
and female headed households. Of the total sample household heads, 97.6% were male household heads
192
and 2.4% were female household heads. About 1.7% of the defaulters and 3.1% of the non-defaulters
were female-headed households, respectively. The average distance traveled by the respondents to the
market was about 6.39 km. On average non-defaulters traveled about 3.89 km while the defaulters
traveled on average about 9.08 km. This difference between the distances covered by non-defaulters
and defaulters was statistically significant at 1% level of probability (Table 2).
Land is the basic asset of farmers. The average size of cultivated land owned by the sample households
was nearly 1.54 ha. Non-defaulters cultivated on average larger area of land (1.61 ha) than defaulters
(1.47 ha). There was no significant difference between defaulters and non-defaulters in terms of
cultivated land ownership. Nearly 4% of the sample households cultivated farm plots by renting in from
relatives, neighbors and others. On the other hand, nearly 1.6% of the sample households indicated that
they rented out their cultivated land. However, there was no significant difference between defaulters
and non-defaulters with regards to land rented-in or rented-out.
Table 2: Sampled household characteristics for continuous variables in the study area
Characteristics Non-defaulters Defaulters (N=60) Total sample

(N=65) t value (N=125)
Mean St.dev Mean St.dev Mean St.dev
Age (year) 56.43 9.93 43.97 11.33 6.549*** 50.45 12.30
Family size (Number) 8.09 2.303 7.42 2.227 1.66 7.77 2.283
Total livestock (TLU) 7.055 2.022 3.591 1.931 9.777*** 5.39 2.63
Total cultivable land (Ha) 1.61 1.01 1.473 0.792 0.823 1.54 0.91
Shared cultivable land(Ha) 0.457 0.63 0.523 0.62 0.585 0.48 0.62
Rented out land (Ha) 0.007 0.062 0.013 0.100 0.358 0.010 0.083
Rented in land (Ha) 0.011 0.068 0.050 0.204 1.42 0.03 0.151
Expense for ceremony 404.78 974.70 518.55 1379.49 0.538 459.11 1182.84
Amount of loan in cash 906.31 544.37 962.18 606.95 0.542 933.12 573.60
Extension contact/month 2.17 0.77 1.033 0.901 7.629*** 1.624 1.01
Yr. of extension experience 14.28 1.56 6.933 4.066 13.55*** 10.76 4.77
Input market distance 3.89 2.13 9.08 4.24 8.718*** 6.39 4.20
*** represents level of significance at 1 % level
193
Crop and livestock production activities were the common agricultural practices in the study area. From
the survey data, it was found that all the respondents owned and keep livestock for various economic
and social reasons including generation of draught power, earning cash income, food and animal dung
(organic fertilizer and fuel). Using Stork et al. (1991) standard conversion factor and the Tropical
Livestock Unit (TLU), on average a household have 5.39 TLU with standard deviation of 2.63 (Table
2). Non-defaulters owned a larger number of average livestock (7.05 TLU) compared to the defaulters
(3.59 TLU) with a significant mean difference at 1%. The implication is that non-defaulters have more
access to financial capital by selling their livestock to recover their loan (Table 2). Similarly, the average
expenditure on social festivals was higher for the defaulter group than the non-defaulter although the
difference was not found to be statistically significant (Table 2).
Experience in agricultural extension package varied among the sample borrowers from minimum value
of 2 year experience to a maximum of 15 years experience. Non- defaulters participated on average for
higher number of years (14.28) as compared to the defaulters who participated on average for 6.93 years
(Table 2). The mean difference between the two groups was significant at 1% level. That is, farmers’
experience in agricultural extension services has significant role in loan repayment performance.
The results of the survey also indicated that 84% of the respondents had extension contacts while 16%
did not have any contact with extension agents. The frequency of monthly extension contacts were 2.17
for non defaulters and 1.03 for defaulters. The difference between the two groups was significant at 1%
level.
The average amount of money borrowed by sample households was 933.12. The survey result also
revealed that on average Birr 906.31 and Birr 962.18 was borrowed by non-defaulters and defaulters,
respectively, with no significant mean difference among the groups (Table 2). With regard to sources of
credit, out of the total respondents 34.4% borrowed from Omo- microfinance and 65.6% borrowed
from cooperatives. The performance of credit repayment varied with respect to sources of loan. Larger
proportion of defaulter households (61.7%) borrowed from cooperatives as compared to Omo-
microfinance (38.3%).
On the other hand, off-farm activities were additional income sources for the farmers of the area. About
52% of the sample household heads reported that at least one of their family members was engaged in
off-farm activities which helped them to earn additional income. The survey results also indicated that
larger proportion of non-defaulter households (55.4%) sent their members to off-farm activities as
194
compared to the defaulter households (46.4%). About 16% of the sample households have responded
that they have good traditions of putting money aside for future use. However, there was no significant
difference in saving behavior between the defaulters and non-defaulters.
The sample households usually borrowed money for a wide range of purposes. About 69% and 60%
non-defaulters and defaulters, respectively, used the money they borrowed for purchase of agricultural
variable inputs. However, the difference between the two groups with respect to this variable was not
significant. The sample farmers were asked about their perception of the benefit of loan. Out of the
total respondents, 84.6% of the non-defaulters and 78.3% of defaulters replied that they have benefited
from the loan service. The difference in perception of loan benefits was not significant between the two
categories.
Determinants of probability of being defaulter and degree of loan recovery: Results of the two limit Tobit model that
indicate probability of being non-defaulter and intensity of loan recovery among the sample farm
households is indicated in Table 3 and Table 4, respectively. A total of 13 explanatory variables were
considered in the model out of which 5 variables significantly influenced the probability of being non-
defaulter and intensity of loan recovery among the farm households.
Table 3: Two-Limit Tobit Model Maximum Likelihood Estimates and the effects of explanatory
variables on probability of being non-defaulter
Effect of change in
Variable Coefficient St. Error t-ratio independent variable on
probability of being non-
  
defaulter
xi
Age 0.00039 0.00748 -0.05 -0.00004
Educl 0.05293 0.05411 0.98 0.00586
Famlyz 0.03609 0.02984 1.21 0.00400
Cult land total -0.03551 0.09283 -0.38 -0.00393
TLU 0.10921 0.04399 2.48** 0.01210
Extcon -0.03405 0.08299 -0.41 0.00377
Expext 0.07417 0.02803 2.65*** 0.00821
195
Souce-loan 0.37734 0.28867 1.31* 0.04180

Amt-cash 0.00012 0.00013 0.90 0.00001
Purp-loan 0.37518 0.28787 1.30 0.05289
Dist–input-m 0.01084 0.02339 0.46 0.00120
Offarm-income 0.04553 0.13004 0.35 0.00506
Expens-Cero. -0.00006 0.00005 -1.13* -6.80e-06
Constant -1.52795 0.81534 -1.87
Number of observations=125
Threshold values for the model: Lower=0, Upper=1
Log likelihood function=-76.33
Uncensored observations=45
Left-censored observations=15
Right-censored observations=65,
***, ** and * represent level of significance at 1 %, 5% and 10 %, respectively.
Total livestock owned (TLU) is positively and significantly related to the probability of being non-
defaulter at 5% level of significance. Each additional increase in TLU increases the probability of being
non-defaulter by 1.2%. For each additional unit of TLU, the rate of loan repayment increases by 0.0241
among the whole borrowers and by 0.1092 among non-complete defaulters. The implication is that
livestock are sources of cash in rural Ethiopia and serve as security against crop failure. Farmers who
owned more livestock are able to repay their loans even when their crops fail due to natural disaster.
Moreover, due to oxen ownership, the result suggests that farmers who have larger number of livestock
have sufficient number of oxen to plough their field timely and as a result obtain high yield and income
to repay their loans.
Years of experience in agricultural extension services was positively and significantly related to the
dependent variable loan repayment performance at 5% level. Each additional year of agricultural
extension package experience increases the probability of being non-defaulter by 0.82%, and on average,
one year additional participation experience in the extension package increases rate of loan repayment
by 0.0164 among the whole respondents and by 0.0741 among non-complete defaulters, citrus paribus.
This implies that experienced farmers in extension programs have developed their credit utilization and
management skills that helped them to pay loans timely. In addition, as a result of their participation in
196
extension for a number of years, these farmers are the beneficiaries of the use of improved agricultural
technologies that would increase their income generation capacity and loan repayment performance.
Source of loan was an institutional factor which was positively related to the loan repayment
performance at 10% level. The formation of borrowers group, monitoring and the use of group
responsibility are the main principles guiding financial transactions of Soro Woreda micro-finance.
Better repayment achievement was due to group lending programs, careful screening of borrowers,
monitoring and enforcement of repayment. Therefore, group lending might be the case for better
repayment performance of borrowers of Soro Woreda microfinance. The probability of being non-
defaulter of borrowers of microfinance institutions was 4.17%, which enhanced the loan repayment rate
by 0.0835 for the whole sample and by 0.2298 among non-complete defaulters.
Expense on social ceremony was negatively related to the loan repayment performance at 10% level.
The model output also revealed that less expenditure on social ceremonies enables borrowers to repay
their loan on time, thus, increases the probability of being non-defaulter.
Table 4: Marginal effects of independent variables on rate of repayment
Effect of change in independent variable on dependent variable

Variables for observations at for observations at For non-complete for all observation
the lower limit the upper limit defaulters (N=45) (N=125)
(N=15) (N=65) E Y / U  Y  L, X  E Yi 
   E Y  U    

xi xi
L  E Y 
xi  xi 
Age -0.0002712 0.0008185 -0.0003878 -0.0000858

Educl 0.0158471 0.0454964 0.0529258 0.0117152
Famlyz 0.0142315 0.0284267 0.0360857 0.0079876
Cult land total -0.0241514 -0.0244351 -0.0355075 -0.00787596
TLU 0.0325962 0.0830212 0.1092092 0.0241736
Extcon -0.0281375 -0.0183372 -0.0340491 -0.0075368
Expext 0.0371455 0.0589319 0.074172 0.016418
Souce-loan 0.2298666 0.2867927 0.3773424 0.083525
197
Amt-cash 0.0000837 0.0000559 0.0001198 0.0000265

Purp-loan 0.1695236 0.2863279 0.3751796 0.0848909
Dist–input-m 0.0004726 0.011293 0.0108355 0.0023984
Offar-income 0.0160563 0.0359825 0.0455336 0.0100811
Expens- -0.0000454 0.0000324 -0.0000614 -0.0000136
The descriptive results showed that 48% of the sample households defaulted on the loans they obtained.
Of these, 25% were complete defaulters and the remaining 75% repaid 35 to 98% of the loan they
received.
There were significant differences between defaulters and non-defaulters with respect to age, total
amount of livestock owned (TLU), extension contact days in a month, experience in agricultural
extension, and distance from market for inputs. On the other hand, from a total of 13 explanatory
variables used in the two-limit Tobit regression model, amount of livestock owned (TLU), experience
in agricultural extension, source of loan, expenditure in social ceremony, and amount of cash borrowed
had statistically significant influence on the loan repayment performance of the sample households.
Results of the two-limit Tobit model showed that farmers who had larger number of livestock were
relatively non-defaulters than those who had less number of livestock. Therefore, it is indispensable that
more consideration be given to the livestock sector to improve livestock holding of the households.
Experience in agricultural extension services was also positively related to loan repayment performance.
This could be because of the fact that those farmers who have participated in the extension package had
developed the skills of using new agricultural technologies that would enhance their income and hence
repayment capacity. Moreover, farmers who were regular participants in the extension package were
aware of the credit for the next production season and were likely to make conscious decision to repay
loan timely.
Farmers who had taken loan from Soro Woreda microfinance branch office were relatively non-
defaulters than those who borrowed from multi-purpose cooperatives. Formation of borrowers’ group,
use of group responsibility and equal monitoring are the principles guiding financial transaction in Soro
Woreda microfinance. Loan given to group borrowers has high repayment performance than that given
198
to individuals. Loans given to groups reduce the information asymmetry between the lender and the
borrower. Because of this, adverse selection and moral hazard are reduced in such ways. Then, the joint
liability mechanism in group lending brings group pressure on members to repay loans timely and would
increase the repayment rate. Due to this, loan given in the area should target group lending as it would
increase the likelihood of loan repayment by group members.
The other important point is that expenditure on social ceremony was one of the defining features of
smallholder farmers in the study area. The result of the study showed that individuals who spend less
on social ceremony had better repayment performance than those who spend more. Therefore, the
government should create awareness and encourage smallholder farmers to save their money rather than
spending too much on social ceremonies.
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Daniel Belay, 2006. Performance of primary agricultural cooperatives and determinants of members
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Determinants of Microfinance Loan Repayment Performance of Smallholder Pastoral/Agro-

pastoral Farmers in Ethiopia: The Case of Dire Microfinance Clients in Shinile District of the
Somali National Regional State
Temesgen Keno
Assistant Professor, College of Business and Economics, Haramaya University,
Email: temesgenkenobelissa@yahoo.com
Abstract: Over the last two decades or so, provision of adequate microfinance service to the poor rural farm households
has been hotly persuaded as a promising pro-poor financing strategy in Ethiopia. However, because of the poor loan
repayment performance of the smallholders, significant outreach of microfinance credit delivery has become a problem-plagued
undertaking in the country. Particularly, among pastoral/agro-pastoral households, loan default and low intensity of loan
recovery is evidenced to have acute effect on financial self-sufficiency and operational sustainability of lending institutions
that in turn put outreach decisions to trade-off with survival and impact. Identification of determinants that largely influence
timely repayment of loans disbursed to borrowers, thus, enables effective credit targeting to enhance both outreach service to
large class of customers and sustainable operation of the credit institutions. Hence, this study was aimed at identifying the
demographic, socio-economic and institutional factors that limit loan repayment capacity of smallholder agro-pastoral
farmers in eastern Ethiopia. Using a structured questionnaire, primary data were collected from a random sample of 162
households in Shinile district who often use Dire Microfinance as a formal source of credit. Two-limit Tobit censored
regression model was employed to analyze the determinants of loan repayment performance and intensity of loan recovery.
Using this model, the dependent variable loan repayment performance was framed as the rate of the amount of loan repaid
by individual farm households out of the total amount of loan disbursed to them. Sixteen explanatory variables were tested,
out of which eleven were statistically significant in determining the loan repayment performance of the sample farm
households. Gender of the borrower household head, off/on-farm income, size of land holding, number of heads of livestock
owned, loan usage experience, loan size, loan due date, customer loyalty, credit policy and peer monitoring were observed to
be positive while family size, expenditure on social festivals, availability of alternative credit sources, household shocks and
drought-induced risk perception about future crop/livestock collapse were negative in affecting loan repayment performance
of the households. The findings of the study imply that household socio-economic factors and credit policy instruments from
demand and supply side, respectively, should be coupled with predictions on external shock factors in crafting polices aimed
at minimizing loan default risk in microfinance service in the study area.
Keywords: Loan repayment, microfinance, pastoral economy, Somali, two-limit Tobit
1. Introduction
202
A well functioning financial system is crucial for stimulating economic growth. However, fitting a
feasible financial scheme in a particular socio-economic set-up is very challenging. For instance, the
Ethiopian economy is predominantly based on agriculture which accounts for nearly 85% of labor force
employment, 48.6% of GDP and 90% of foreign exchange earnings (MoFED, 2006; Moges et al., 2007).
But, formal financial services like banks exclude the smallholders engaged in this sector as non-credit
worthy, due to nature and seasonality related risks prevailing in the agricultural sector. As a result,
farmers face acute shortage of access to financial capital to acquire agricultural inputs and adopt modern
technologies, and this makes them to yield a very low rate of return on their investment. The Ethiopian
financial sector is, thus, ill-suited to support the dominant economic sector, thus, the contribution of
the financial sector to the overall economy is minimal. In attempts to overcome this problem, the
government of Ethiopia has taken practical and timely steps to provide policies and legal framework
services that promote rural financial intermediation. In this regard, 31 microfinance institutions (MFIs)
were promoted and various rural saving and credit cooperatives were established to provide credit,
saving and insurance services to the poor farm households. The promotion of MFIs in Ethiopia and
other parts of the world was based on successful social experiments and evidences in Asia and the
Caribbean like the Grameen Bank in Bangladesh and Bank Raykat in Indonesia (Hossain, 1998).
Modern microfinance as an effective rural finance system has gone through many subsequent paradigm
shifts including agricultural credit era (1950–1985) to donor microfinance era (1980–2000),
commercialization of microfinance services (2000–to present) and value chain finance (2005– to
present). This indicates the gradual move of pro-poor finance towards the creation of inclusive financial
systems that operate in accordance with the dynamics in the global financial market. Today, the
microfinance revolution is proved to be a successful pro-poor finance and anti-poverty tool with
significant impacts in increasing household income, smoothing consumption, generating employment
and reducing risks through easing liquidity constraints in production (Barbara and Dunford, 1998).
Thus, microfinance contributes to the overall economic growth, poverty reduction and the creation of
a more equitable society.
In developing countries where agriculture remains the mainstay of their economy, the rise in price of
inputs leads to substantial dependency of farmers on financial institutions for credit (Akram et al., 2008).
But the lending terms, regulations and pre-conditions of banks do not allow smallholders, land less poor
and women farmers to borrow. Banks require collateral assets and sound business plans. Moreover,
formal banks are concentrated in urban areas where infrastructures are well established (Wolday, 2006).
These imply that the rural credit market is improperly functioning. Among others, imperfect repayment
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and asymmetric information are the functioning limitation. The problems that arise can often be
characterized by a borrower’s inability to commit to fulfilling a debt contract. Debtors cannot credibly
reveal their borrower’s type truthfully (adverse selection), promise to exert effort so that their production
enterprise does not fail (ex-ante moral hazard), report their production output honestly (ex-post moral
hazard), or promise to repay the loan even when output was sufficient (opportunistic default). To serve
this purpose, MFIs have three basic goals, often called the ‘triangle of microfinance’: Outreach,
sustainability, and Impact. In this regard, the microfinance industry faces a number of challenges
providing adequate capital to the needy given that the majority is in acute shortage of capital, in directing
the loan to be invested for productive purposes and generate additional income to be repaid to the
lending institutions to have sustainable and viable production processes. Default rates are very high
(about 30%) which discourages the lenders to promote and extend credit to large and fragmented
households. These problems are reported to be very immense among pastoral/agro-pastoral
households. For instance, in Dire Microfinance, loan default and low intensity of loan recovery is
evidenced to have acute effect on financial self-sufficiency and operational sustainability. Thus, outreach
decisions are indicated to make a trade-off with survival and impact in loan provision. The underlying
factors for such low repayment rate are not thoroughly investigated. This study was, thus, aimed at
identifying the demographic, socio-economic and institutional factors that limit loan repayment capacity
of smallholder agro-pastoral farmers being served by the MFI. Identification these factors was expected
to generate useful information that help for effective credit targeting, enhanced outreach service to large
class of customers, and sustainable operation of the institution to bring the desired poverty reduction
impacts.
2. Methodology
Data: Data for this study were collected from both primary and secondary sources. Primary data were
collected through a formal household questionnaire survey, key informant interviews and focus group
discussions. A multi-stage random sampling technique was employed to select the final observations.
Firstly, Shinile zone was purposively chosen among the nine zones of the Somali region due to its
geographical bordering with different regional states of Ethiopia where financial services were better
developed. Secondly, the Shinile district which is at the center of the Shinile zone was selected as it holds
the common socio-economic characteristics of all the districts in the zone. Thirdly, kebeles (local
administrative units) were categorized as pastoral, agro-pastoral and sedentary farming areas in
discussion with the district bureau of agriculture. Finally, proportionate random samples of 162
204
households were chosen from the three categories. A structured questionnaire was designed to elicit
information on a wide variety of topics including household socio-economic and demographic
characteristics that determine their demand for microfinance, saving and credit experience, household
enterprises as well as the sources and uses of financial resources. In administering the questionnaire,
enumerators who have experience in socioeconomic surveys were employed and were also introduced
to the purpose of the study. The survey questionnaire was pre-tested and actual field survey was done
from October 2010 to March 2011. Then, updated secondary data were collected from financial
institutions, regulatory agencies and government development finance structures. Proclamations and
directives of the National Bank of Ethiopia, Five Year Development Plans, policies, strategies and
programs of government were considered. As microfinance service development was evidenced to be
largely determined by socio-cultural factors like religion in the study area, the collected data was critically
analyzed using qualitative approaches and descriptive statistics.
Empirical Model: In this study, the dependent variable loan repayment performance (𝑌1 ) was framed as
the rate of the amount of loan repaid by individual farm households out of the total amount of loan
disbursed to them. This is a repayment ratio that has been computed as the ratio of amount of loan
repaid to the total amount borrowed from formal sources of credit. Thus, the value of the dependent
variable ranges between 0 and 1 and a two-limit Tobit model has been chosen as a more appropriate
econometric model (Rossett and Nelson, 1975; Maddala, 1997; Long, 1997). Censored regression
models refer to a model in which we observe the dependent variable only if it lies above or below some
cut off level. The Tobit model is one of the censored regression models that arise when the dependent
variable is limited (or censored) from above and/or below. It is a nonlinear model and is estimated using
maximum likelihood estimation techniques. It was used to analyze factors that influence loan recovery
rate of borrowers of the two lending institutions. This method estimates the likelihood of default and
the extent (i.e., intensity) of default. The Tobit approach has been applied in previous studies of loan
repayment performance (Oke et al., 2007; Godquin, 2004).
The model derives from an underlying classical normal linear regression and can be represented as:
𝑌𝑖∗ = 𝛽 ′ 𝑋𝑖 + 𝜀𝑖
whereas 𝑌𝑖∗ is a latent variable (unobserved for values smaller than 0 and greater than 1) representing
loan recovery rate, 𝑋𝑖 is a vector of independent variables, representing factors affecting loan recovery
205
rate, 𝛽 is a vector of unknown parameters and 𝜀𝑖 is a stochastic (disturbance) term assumed to be

independently and normally distributed with zero mean and constant variance  2 . Denoting the
proportion of the loan recovered as observed dependent variable by𝑌𝑖 , then, the two limit model can be
specified as:
0, 𝑖𝑓 𝑌𝑖∗ ≤ 0
𝑌𝑖 = {𝑌𝑖∗ 𝑖𝑓 0 ≤ 𝑌𝑖∗ ≤ 1
1 𝑖𝑓 𝑌𝑖∗ ≥ 1
Understanding the marginal effects of changes in explanatory variables on the loan repayment
performance requires considering the fact that each marginal effect includes both the influence of the
explanatory variable on the probability of default as well as on the intensity of default. More explicitly,
the total (marginal) effect takes into consideration that a change in an explanatory variable will affect
simultaneously the number of defaulters and the extent of default by borrowers. The most common
method for marginal analysis in this case is the McDonald-Moffit decomposition method for a two-
limit Tobit which is indicated as follows.
Based on the assumption that the stochastic error term 𝜀𝑖 is independently and normally distributed
with zero mean, the expected value of the latent variable for the two-limit Tobit can be given as
𝐸(𝑌𝑖∗ /𝑥) = 𝛽𝑥 and 𝜕𝐸(𝑌𝑖∗ /𝑥)/ 𝜕𝑥𝑘 = 𝛽𝑘
However, the conditional expected value of the truncated outcome is:

𝜑(𝑧𝐿 ) − 𝜑(𝑧𝑈 )
𝐸(𝑌𝑖 /𝑥; 0 ≤ 𝑌𝑖∗ ≤ 1) = 𝛽𝑥 + 𝜎
𝛷(𝑧𝑈 ) − 𝛷(𝑧𝐿 )
whereas 𝐿 and 𝑈 denote the lower and upper limit, respectively; 𝑍𝐿 = (𝐿 − 𝛽𝑥)/𝜎 and 𝑍𝑈 = (𝑈 −
𝛽𝑥)/𝜎. And, 𝛷(. ) and 𝜑(𝑍) are the cumulative distribution and density function for the standard
normal distribution. Similarly, the expected value of the dependent variable (observed outcome) can be
given as:
𝐸(𝑦/𝑥) = [𝐿. Pr(𝑦 = 𝐿/𝑥𝑖 )] + 𝐸(𝑦/𝑥, 𝐿 ≤ 𝑌𝑖∗ ≤ 𝑈/𝑥. 𝑃𝑟. (𝐿 ≤ 𝑌𝑖∗ ≤ 𝑈/𝑥𝑖 ) + 𝑈. Pr(𝑦 = 𝑈/𝑥𝑖 ),
and by Substituting the expressions, Pr(𝑦 = 𝐿/𝑥𝑖 ) 𝑏𝑦 𝛷(𝑧𝐿 ) and Pr(𝑦 = 𝑈/𝑥𝑖 ) 𝑏𝑦 1 − 𝛷(𝑧𝑈 ) =
𝛷(−𝑧𝑈 ), then,
206
𝑌∗ 𝛷(𝑧𝑈 )−𝛷(𝑧𝐿 ) 𝜕(𝐸(𝑌𝑖∗ /𝑥,𝐿≤𝑌𝑖∗ ≤𝑈))

𝜕𝐸 ( 𝑖 )/ 𝜕𝑥𝑘 = 𝐸(𝑦/𝑥), 𝐿 ≤ 𝑌𝑖∗ ≤ 𝑈). [𝜕 ] [𝛷(𝑧𝑈 ) − 𝛷(𝑧𝐿 )]. [ ]+
𝑥 𝜕𝑥𝑘 𝜕𝑥𝑘
𝜕𝛷(−𝑧𝑈 )
𝜕𝑥𝑘
The last equation is the extension of the McDonald-Moffit decomposition for the case of a two-limit
Tobit. It decomposes the total marginal effect of a change in an independent variable 𝑥𝑘 on the expected
value of the extent of loan recovered (i.e., the percent of the loan recovered) into three components as
i) the change in the probability of non-default weighted by the conditional expected value of the percent
of the loan recovered that had been borrowed by the farmers ii) the change in the percent loan recovered
for farmers that are already borrowing weighted by the probability of non-default and iii) The change in
the probability of recovering on 100% of the loan on due time. These three components explicitly
indicated as follows.
1. The change in the probability of repaying the loan as an independent variable Xi changes is:
𝛛𝚽(𝛅) 𝛃𝐢
= 𝛗(𝛅)
𝛛𝐗 𝐢 𝛔
2. The change in intensity of loan recovery with respect to a change in an explanatory variable among
non-complete defaulters is:
2
𝜕𝐸(𝑌𝑖 /𝑈 > 𝑌𝑖∗ > 1) 𝛿𝐿 𝜑(𝛿𝐿 ) − 𝛿𝑈 𝜑(𝛿𝑈 ) 𝜑(𝛿𝐿 ) − 𝛿𝑈 (𝛿𝑈 )
= 𝛽𝑖 [1 + −( ) ]
𝜕𝑋𝑖 𝛷(𝛿𝑈 ) − 𝛷(𝛿𝐿 ) 𝛷(𝛿𝑈 ) − 𝛷(𝛿𝐿 )
3. The marginal effect of an explanatory variable on the expected value of the dependent variable is:
𝜕𝐸(𝑌𝑖 /𝑋𝑖 )
= 𝛽𝑖 [𝛷(𝛿𝑈 ) − 𝛷(𝛿𝐿 )]
𝜕𝑋𝑖
whereas 𝑋𝑖 = represents a vector of explanatory variables, 𝛷(𝛿) = the cumulative normal

𝛽𝑖 𝑋𝑖
distribution, 𝛿 = = represents the Z-score values for the area under the normal curve, 𝛽𝑖 = is
𝜎
the vector of Tobit maximum likelihood estimates, 𝜎 = is the standard error of the error term, 𝛿𝐿 =
𝐿−𝛽𝑖 𝑋𝑖 𝑈−𝛽𝑖 𝑋𝑖
, 𝛿𝑈 = , 𝐿 and 𝑈 are the threshold values (𝐿 = 0 and 𝑈 = 1), 𝜑 and 𝛷 are probability
𝜎 𝜎
density and cumulative density functions of the standard normal distribution, respectively.
207
Variables and hypotheses: In this study, the dependent variable loan repayment performance (𝑌𝑖 ) was
defined as the rate of the amount of loan repaid by individual farm households out of the total amount
of loan disbursed. A number of explanatory variables that are believed to have significant influences on
the dependent variable were identified and summarized in Table 1.
Characteristics of sample households: The descriptive statistics showing the characteristics of the sample
households is given in Table 2.
208
As the table reveals, an average sample household was headed by a 38-year-old person who attended
about 2.12 years of formal education, having a household size of about seven persons, three of whom
were in the productive age while the rest were school or pre-school dependents. In terms of resource
endowment, the average household owned about 3.72 TLU of livestock and operated 0.13 hectares of
irrigated land. The average household generates annual non-farm income of about 2273.06 Birr but the
household’s annual expenditure on social festivals was significant as compared with its income
amounting to 2541.73 Birr. As an indicator of degree of access to infrastructures, the household was far
away from the nearby town market center at an average distance of 11.04 kilometers. The average
household faces shocks of covariate nature almost very frequently because of the recurrence of climate
change induced drought. The average household has been served for the last 3.5 years and borrowed
about 1047.59 ETB from Dire MFI.
Determinants of loan repayment performance: The Two-limit Tobit result of the maximum likelihood
estimation for determinants of loan repayment performance is indicated in Table 3. Gender of the
borrower household head was found to be negatively significant in affecting loan repayment
performance indicating that male-headed households have no better loan repayment performance as
compared with their female counter parts. The marginal effect also indicates being a male headed
borrower reduces the probability of loan repayment by a factor of 0.0762 and this is in line with various
209
findings in microfinance that gender differentials were proved to have varying effects of success.
Similarly, the size of the family of the borrower households was also observed to have a negative and
significant impact on loan repayment performance.
The marginal effects show that each additional person to a family decreases the rate of repayment by a
factor of 0.048. On the other hand, non-farm income was observed to have a positive and significant
impact on the dependent variable and the marginal values indicate that each additional Birr generated
from non-farm activities increase the loan repayment rate by a factor of 0.0619. Access to irrigated land
has positive impact on loan repayment performance and this might be the effect of the income generated
from crop selling or the effect of using own produce for consumption and using the microfinance loan
for the meant purpose including loan repayment.
Similarly, livestock holding positively and significantly related to loan repayment rate. An increase in
livestock holding by one TLU increases the rate of repayment by 0.068 for the total sample borrowers.
210
The model result also indicated that household’s drought-induced risk perception affects the loan
repayment performance implying that uncertainty about the effect of changing climate affects
households’ decision to discharge their loan on time. Access to alternative credit sources was observed
to have negative and significant effect on loan repayment performance. Similarly, the size of loan
borrowed is negatively related with the LRR. As loan size increases by a unit, LRR reduces by a factor
of 0.011. Loan due date was also negatively affect loan repayment rate. As the loan repayment schedule
increases by one month, the LRR reduces by 0.055. Peer monitoring is positively affected LRR
performance. Membership duration was positive and significant and this is the indication of customer
loyalty.
4. Conclusion and Policy Implications
This study has indentified demographic, socio-economic and institutional factors determining the
probability and intensity of loan repayment performance among pastoral/agro-pastoral households that
usually borrow from Dire Microfinance Institute in Ethiopia. Accordingly, gender differentials, family
size, generation of non-farm income with the availability of irrigated land and increased livestock were
indentified to have significant potential to improve loan repayment performance of microfinance
beneficiaries. Hence, lending institutions can be targeted to female headed households who can be
engaged in diversified income generating activities. Those having reduced family size, access to irrigation
and increased livestock number should be given due attention in loan provision decisions. From the
perspectives of the MFIs, it should be noted that customers that have no alternative borrowing sources
and those that develop long term loyalty through membership durations should be given priority for
effective loan recovery. Package of loans should be designed in small amounts for those who can form
a cohesive group for peer monitoring and social collateral in the events of default. On top of this,
predictions on external shock factors like climate change-induced risks of probable crop or livestock
loss should be coupled with the above socio-economic and institutional factors in crafting polices aimed
at minimizing loan default risk of microfinance services in pastoral/agro-pastoral areas of the country.
References
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Behavior of Farmers in Rural Punjab, Pakistan. European Journal of Scientific Research.
211
Amare Berhanu, 2005. Determinants of formal source of credit loan repayment performance of small
holder farmers. M.Sc. Thesis presented to Haramaya University, Ethiopia.
Barbara, MkNelly and Christopher Dunford, 1998. Impact of Credit with Education on Mothers and
Their Young Children’s Nutrition in Ghana. Freedom from Hunger Research Paper No. 4. Davis,
Calif.
Godquin, M., 2004. Microfinance Repayment Performance in Bangladesh: How to Improve the
Allocation of Loans by MFIs. World Development, 32(11):1909–1926.
Hossain, M., 1998. Credit for the Alleviation of Rural Poverty: The Grameen Bank in Bangladesh. IFPRI
Research Report No. 55. Washington, D.C.
Long, S., 1997. Regression Models for Catogorical and Limited Dependent Variables. Thousand Oaks, CA: Sage
publications.
Maddala, G.S., 1997. Limited Dependent and Qualitative Variables in Econometrics, Cambridge University
press, Cambridge.
MoFED - Ministry of Finance and Economic Development of Ethiopia, 2006. A Plan for Accelerated
and Sustained Development to End Poverty (2005/06-2009/10). Strategy Document, Volume II.
Addis Ababa.
Moges, T., G. Ayele, and Z. Paulos, 2007. The Bang for the Birr: Public Expenditures and Rural Welfare
in Ethiopia. IFPRI Discussion Paper No. 702. Washington, DC.
Oke, J. T. O., R. Adeyemo and M.U. Agbonlahor, 2007. An Empirical Analysis of Microcredit
Repayment in Southwestern Nigeria. Humanity and Social Sciences Journal, 2 (1): 63-74.
Rosett, N.R and Nelson, F.D., 1975. Estimation of the Two- limits Probit Regression Model.
Econometrica, 43: 141-146.
Wolday A., 2006. Microfinance for Pastoralist Areas in Ethiopia: Policies, Strategies, Instruments and
the Way Forward. AEMFI, Occasional Paper No.23. Addis Ababa.
212
Theme 6: Information Asymmetry and Credit Risk Management
Determinants of Loan Repayment Performance of Beekeeping Cooperatives in Kilte-Awlaelo

District, Tigray Region, Northern Ethiopia
Zafu Hailesilase1 and Abadi Teklehaimanot2

1
MA Student, College of Business & Economics, Mekelle University, Ethiopia
2
Assistant Professor, College of Business & Economics, Mekelle University, Ethiopia
Email: abatekle@gmail.com
Abstract: Credit provision is one of the principal components of rural development, which helps to attain rapid and
sustainable growth of agriculture. Agricultural lending involves giving credit (in cash and kind) to small-scale farmers.
There is no doubt about the crucial roles of credit in economic development. In spite of the importance of loan in agricultural
production, its achievement and repayment are burdened with a number of problems especially in the smallholder farmers
organized as cooperatives. Currently, there are different organizations involved in providing credit to beekeeping cooperatives
of the Kilte-Awlaelo District. These organizations are trying to organize and promote beekeeping cooperatives to improve
their traditional beekeeping practices by providing credit which is expected to be repaid on time. Organizing beekeeping
farmers as cooperatives in the study area is for the purpose of improving living standards and market access of their members.
However, the cooperatives were unable to payback their credit as per the contractual agreement due to various reasons for
which the underlying factors were poorly understood. Therefore, this study was aimed at analyzing and examining the
determinants of loan repayment performance of beekeeping cooperatives. Multistage sampling and simple random sampling
methods were employed to select sample beekeeping cooperatives and sample cooperative members, respectively to collect the
data using a structured questionnaire. Besides, key informant interview and focus group discussions were held. A total of
170 respondents were included in the study. The analysis was made using descriptive statistics and logistic model. The
result revealed that age, family size, annual income, livestock ownership, access to additional source of credit, loan size and
supervisory visit were found statistically significant to enhance loan repayment. However, being male headed member of the
cooperatives and number of dependent family members significantly increased the probability of loan default. Therefore,
based on the results, it is recommended that credit institutions or lending agencies should consider the above demographic
and socio-economic characteristics that significantly influence loan repayment before granting loans and advances to
beekeeping cooperatives to reduce the incidence of loan defaults. Besides, effective supervision, training, lending appropriate
amount of loan and promoting woman participation in beekeeping cooperative should be given due attention in order to
minimize loan default.
Keywords: Credit institution, farm business, loan repayment, logistic regression model, microfinance
213
1. Introduction
Ethiopia is one of the lowest income countries in the world. Its economy, which is mainly dependent
on agriculture, where this sector provides 85% of the employment, 50% of the GDP and about 90% of
export revenue. In spite of the fact that agricultural has huge potential, the growth in agricultural
production has not been able to keep pace with ever increasing demand due to variety of factors.
Lack of access to credit was one of the shocks the economy has been experiencing. Generally the
accessibility of a good financial service is considered as one of the engines of economic development.
In the recent years, however, some NGOs have been providing credit to poor households in some parts
of the country, side by side with activities like delivering relief and development services. The loans
given by these NGOs are very small, in short term period, with in short period repayment system and
with no need of collateral. Therefore, these NGOs are facing the challenges of beneficiaries to repay
back the credit according to the contract. So they find themselves unable to continue providing credit
service.
Credit provision is one of the principal components of rural development, which helps to attain rapid
and sustainable growth of agriculture. There is no doubt about the crucial roles of credit in economic
development. In spite of the importance of loan in agricultural production, its achievement and
repayment are burdened with a number of problems especially in the smallholder farmers organized as
cooperatives. Most of the defaults arose from poor management procedures and unwillingness to repay
loans. Currently, there are eighteen beekeeping cooperatives having legal recognition with about 552
members organized by Kilte-Awlalo District Agricultural and Rural Development Office. The main
objectives of these cooperatives are to improve the living standard and markets access of the members
and repay their credit on time. However, the cooperatives are unable to pay back their credit according
to the contract due to many factors. Therefore, this study was aimed at analyzing and examining the
determinants of loan repayment on beekeeping cooperatives of Kilte–Awlaelo District as there was no
adequate study previously conducted.
2. Methodology
Description of the study area: The particular study site, Kilte Awlaelo District is located in Eastern Zone of
Tigray, at about 50 kms to the North of Mekelle (Regional capital) along the Mekelle-Adigrat main road.
Kilte Awlaelo District has 18 rural administrative localities called 'tabias'. The total area of the District
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is 100,556 hectare. The altitude ranges between1900-2300 m.a.s.l. The mean annual rainfall falls between
400mm-600mm and the temperature ranges from 160C-270C. There are eighteen honey producing
Tabias (Villages) in the District, with eighteen beekeeping cooperatives with total of 552 membership.
Currently, honey is the most important cash generating commodity in the District with an annual output
of 234.61 metric tons (MTs) of both traditional and modern beehives. Out of the total production 95%
is supplied to the markets of Wukro, Atsbi Womberta, Hawzen and Mekelle. The total population of
the District is estimated to be 117,862 out of which 60,330 (51.2%) were female. The total households
are 24,253; out of which 3,647(15%) are women headed households. The age distribution of the
population in the District was 44.3% under 15 years, 52.2% between 15-64 years and 3.5% were 65 and
above.
Selection of the Study Area: The study area was Kilte Awlaelo District which is purposively selected by
considering its potential for beekeeping. The woreda has higher number of beekeeping cooperatives,
and beekeeping is also being practiced as a means of income generation and improving household food
security.
Data source and collection: The study included both primary and secondary data. The primary data was
collected using, questionnaire survey, focus Group Discussion, and key informant interview. While the
secondary data was collected from, different organizations, researches and other related literatures.
Sampling method and sample size: Multi-stage sampling technique was adopted in selecting the respondents.
The first stage involved purposive selection of six Tabias in the District where there is preponderance
of beekeeping cooperatives that obtained loans for agricultural purposes. The second stage involved a
simple random selection of one beekeeping cooperatives from each of the six selected Tabias. The third
step involved adopting simple random sampling technique to select respondents from each cooperative.
From the total 269 members of the selected cooperatives 44% that is 120 members were selected as
respondents. Three members of management of each cooperative were taken as key informants. And
Five to Eight members from each cooperative were included in focus group discussion.
Data Analysis: Descriptive statistics method was used to describe and analyze the characteristics of the
population under study such as mean, percentage, standard deviation, tabulation, and frequency
distribution. Economertic model, specifically Logit model, was applied to estimate the effect of
hypothesized variables on loan repayment. The cumulative logistic probability model is specified as :
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 The logit model could be written in terms of the odds and log of odds.
 The odds ratio implies the ratio of the probability (Pi) that an individual would choose an
alternative to the probability (1-Pi) that he/she would not choose it.
Therefore,
 Taking the natural logarithm of equation (3)
 If the disturbance term (ui) is taken into account, the logit model becomes
From the total sample size about 24% (n=29) are female while the remaining 75.83% (n=91) are male
members. This indicates that proportion of male member of cooperative are higher than female
members. Looking at the educational status of the sample respondents, illiterate accounts 25.83%
(n=31) , basic education accounts 6.67% (n=8), primary accounts 58.33% (n=70), high school accounts
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6.67% (n=8) and diploma accounts 2.5% (n=3). Looking at the occupation of the cooperative members,
87.5% (n=105) are farmers, 7.5% (n=9) are involved in trading and the rest 5% (n=6) are civil servants.
Loan repayment with respect to sex of the cooperative members: The sex of the cooperative members is one of the
most important factors that determine loan repayment. From the total respondents twenty nine female
members 65.5% (n=19) have repaid their loan. On the contrary, out of the total ninety nine male
members 62.7% (n=57) have repaid their loan. This indicates that there is a positive relationship
between female membership and better loan repayment status.
Loan repayment with respect to Age of the cooperative members: Age of the cooperative members is one of the
factors which is expected to affect loan repayment. The age between 56-70 years and above 71 years has
repaid 100%. This indicates that as the age of the respondents increases the repayment capacity also
increases.
Loan repayment by Educational status of cooperative members: Education is also one of the key variables that
influence the behavior and attitude of borrowers in loan repayment. It was assumed that the higher the
educational status, the better would be the knowledge and awareness level on efficient utilization of
loan. However, coming to the actual ground of the cooperative members the repayment rate decreases
as level of education increases. Looking at their repayment rate 70.9% of the illitarate has repaid their
loan, but only 33.33% of those who had college diploma has repaid their loan. In line with this it was
explained in the focus group discussion that, as the educational status of members increased the
probability of loan diversion increase. Thus, probability of loan repayment will decrease.
Loan repayment by total family size and number of dependents: The other important factor that features
remarkable difference on loan repayment is family size and number of dependents in the household of
cooperative members. The result in the above table shows that with increasing family size the probability
of loan repayment increased. The result in the above table shows that with increasing family size the
probability of loan repayment increased. As explained in the focus group discussion, it was raised that
those households with larger family size able to generate higher income from off farm and nonfarm
activities and will possibly repay their loan as compared to the households with smaller family size. This
is also true that with increasing number of dependents in the household the repayment status is also
better off.
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Annual Income of cooperative members and loan repayment: It is important to point out here is that the total
income from the different sources (off farm, non-farm and farm income) is considered as a determinant
of loan repayment. The result indicates that, probability of repayment increase as the annual income of
the cooperative increases.
Land holding and Access to irrigation with respect to loan repayment: The size, location and quality of land is
considered as a major factor that determines the annual farm income of households’; hence loan
repayment. The result indicates, size of land owned by a farm household has a positive relationship with
the household’s loan repayment performance. This implies that landless households and households
with small size of land are more or less unable to repay their loan. The same is true for access to
irrigation.
Livestock holding with respect to loan repayment: Livestock represents the most important livelihood resource.
Thus determines loan repayment status of cooperative members. The indication here is the cooperative
members who do not own livestock were less able to pay their loan as compared with those members
who own livestock.
Access to additional credit sources with respect to loan repayment: Access to additional credit sources is
determinant factor for loan repayment. If the members have other sources of loan, they may use these
sources to be able to settle their loan obligation in case they are forced to repay. The result provides
evidence that, access to additional credit services have significant influence on loan repayment capacity
of the cooperative members.
Participation of cooperative members in local social institutions: Participation and access to local institutions
(Ekub, Edir, farmers association, spiritual/religious associations (Tsebel), and other associations) are
significant determinants of loan repayment . The result shows, those households who are members of
a given association seem to have a better repayment capacity.
Loan repayment with respect to supervision by loan organization: Sufficient number of supervision by loan officer
on loan utilization is an important factor contributing to a better loan repayment. The result shows that
supervision by loan organization is positively related to loan repayment performance as the percentage
defaulter not supervised is more than twice of defaulter who are supervised.
Loan repayment and composition by training given before loan: Training increases the awareness of the borrowers
and would increase the exposure to information, opportunities, and working environment. And it is
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expected to have positive impact on loan repayment. The result indicates 64.1% of those who have got
training have repaid their loan while only 33.33% of those who have not taken training were able to
repay their loan. This shows the existence of positive relationship between training before loan and loan
repayment.
Loan repayment composition by loan size and Interest rate: If the amount of loan released is enough for the
intended purpose, it will have a positive impact on the capacity of repayment. On the contrary, if the
amount of loan exceeds, it will be more of burden than be of assistance; there by loan repayment will
decline. The result indicates there is only small difference in repayment as the loan of the cooperative
increases. The same is true for interest rate.
Determinants of loan repayment: A logistic regression model was used to determine factors affecting loan
repayment capacity of beekeeping cooperatives of Kilte-Awlaelo District. The logit result revealed
acceptable log likelihood of 38.26. The maximum likelihood estimate of the logistic regression model
result shows that repayment was influenced by 9 variables out of fifteen variables used to fit the logistic
model estimation. Sex, age, family size, number of dependents, livestock ownership, annual income,
loan size, access to additional source of credit and supervision by lending organization are found to
affect the probability of loan repayment.
Hence, sex of a cooperative member, number of dependents affect loan repayment negatively and
significantly while age, family size, annual income, loan size, availability of other source of credit and
supervision by lending organization affect loan repayment positively and significantly. Meaning those
beekeepers who are female headed, older age, have larger family size, fewer numbers of dependents,
higher annual income, higher loan size, availability of other source of credit and those having supervision
by lending organization has high chance of repaying loan (Table 1).
Table 1 Logistic regression model estimation
Variables Coefficients S. E. P-Value

Sex -2.93 1.63 0.073*
Age 0.31 0.12 0.009***
Education 0.91
Education (1) 1.76 4.55 0.69
Education (2) -0.42 4.85 0.93
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Education (3) 0.92 4.48 0.84

Education (4) 1.17 5.08 0.82
Family size 1.02 0.48 0.03**
No. of Dependents -0.84 0.47 0.07*
Livestock ownership (1) 5.30 2.81 0.06*
Annual income 7.15 2.03 0.000***
Access to irrigation -0.37 1.15 0.74
Land Holding -1.65 1.07 0.12
Loan Size 0.00 0.00 0.03**
Interest rate -0.15 0.13 0.23
Additional source of credit 2.66 1.44 0.06*
Participation of cooperative members in 0.00 0.00 0.46
local social institutions
Training given before loan 3.23 5.20 0.53
Supervision by lending org. 4.34 2.15 0.04**
Constant -13.81 7.72 0.07*
-2 Log likelihood 38.23
R-Square 0.862
Chi-square 119.46
Source: ***, ** and* means significant at 1%, 5% and 10% probability levels, respectively.
Conclusion
This study determined factors affecting loan repayment performance of beekeeping cooperatives in
Kilte-Awlaelo District, Eastern Zone of Tigrai Region, Northern Ethiopia. Accordingly, efforts have
been made to assess the demographic characteristics, socio-economic characteristics of cooperative
members and institutional factors which affect loan repayment of the cooperative members. Moreover,
the results indicated that age, family size, livestock ownership, annual income, loan size, access to
additional source of credit and supervision by lending organization are found to affect loan repayment
positively and significantly. While sex of cooperative members’ and number of dependents are found to
affect loan repayment negatively and significantly. Thus it can be concluded that, age, family size,
livestock ownership, annual income, loan size, access to additional source of credit and supervision by
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lending organization are factors that significantly enhance loan repayment . Besides, sex of cooperative
members’ and number of dependents are factors that significantly undermine loan repayment.
Based on the findings of this study number of recommendations are given on how to promote loan
repayment on beekeeping cooperative with particular reference to the study areas. Credit institutions or
lending agencies should also look out for the demographic, socioeconomic characteristics that
significantly influence loan repayment before granting loans and advances to beekeeping cooperatives
to reduce the incidence of loan defaults. In the study area, female are observed to be less likely to
participate in beekeeping cooperatives as compared to male members. Therefore, efforts should be
made to enhance women’s involvement in beekeeping cooperative activities, which in a way strengthens
and bring about better loan repayment status. Age, family size, annual income, loan size, availability of
other source of credit and supervision by lending organization were identified among the major factor
that enhance cooperatives from becoming profitable and repaying their loan. Thus, efforts should be to
consider and take in to account of this factors while providing loans for better repayment performance.
Finally, further research is needed to establish whether or not there are regional differences in the loan
repayment status of the sample cooperative members.
References
Abadi Teklehaimanot. 2011. Determinants of Agricultural Marketing Cooperative Socities in India. Pusa
Agri Sciences Vol 34, 113-120, 2011.
Zafu Haile-Slasse . 2012. Determinants of Loan repayment on Beekeeping Cooperatives of Kilte-

Awlalo District, Eastern Zone of Tigray Region, North Ethiopia, MA Thesis, Mekelle
University, Ethiopia
221
Information Asymmetry and Credit Risk Management Practices in the Ethiopian Banking
Business
Wolde Bulto
Director, Department of Credit Management, Oromia International Bank,
Email: woldebi@yahoo.co.uk
Abstract: The objective of this study was to identify problems pertinent to exercising prudent lending in banking business
in Ethiopia. Special emphasis was given to assessing the degree of information asymmetry and credit risk together with
mechanisms that Ethiopian commercial banks use to mitigate the risks. A combination of qualitative and quantitative
approach was deployed to address the problem. The finding of the research entails that commercial banks operating in the
country were suffering from the prevalence of high degree of information asymmetry both before and after disbursement of
loans, as a result of which they were forced to mostly depend on tangible collateral for the loan they provide to borrowers. In
this process, borrowers with viable business propositions but with no tangible collateral are not mostly getting loans. Thus,
in order to encourage commercial banks to lend loans based on business viability and cash-flow of the business and enhance
investment in the country, there should primarily be comprehensive national database of all citizens of the country from
which banks could obtain relevant information and data of the borrowers at a reasonable cost and time to minimize the
existing information asymmetry. Commercial banks shall also work hard to capacitate their concerned employees in charge
of handling due-diligence assessments and analyses.
Keywords: credit risk, information asymmetry, prudent lending
1. Introduction
Lending in Ethiopia has been both a controversial and a difficult matter. On the one hand, firms
complain about lack of credit and the excessively high standards set by banks. On the other hand, banks
have been suffering from losses3 on bad loans. Lending inherently requires that the lender trust the
borrower to repay the loan at a later date. For the lender to be able to trust the borrower, the lender
must have means of screening out incompetent and untrustworthy borrowers. However, one chooses
to put it, the bank’s problem is to distinguish between good and bad firms (or projects), and good and
bad character. By good and bad firms (or projects)-mean expected return and risk. Moreover, good and
bad character refers to the borrower’s honesty.
3
In the past, there were times when non-performing loans to total loans and advances of some banks reached 50%.
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The review shows that Ethiopian banks have trouble distinguishing the good from bad in both firms
and character. This is partly due to intrinsic problems in Ethiopia, and partly due to their own methods.
In this perspective the review indicates that solutions adopted by banks often seemed inefficient from
the perspective of a profit-maximizing bank. Probably, this reflects both incomplete learning by banks
about the most effective way to make loans, and internal incentive problems that banks have not solved.
The objective in conducting the research is to identify problems pertinent to exercising prudent lending
in Ethiopian banking business.
Therefore, the main purpose of this paper is reviewing pertinent documents on conceptual and empirical
discussion of the lending problem, how they try to determine who is creditworthy and who is not, and
the problems they face, how banks use the mechanisms of reputation, collateral and punishment to
influence who will approach them for loans, and to encourage repayment and to limit their losses when
loans go bad, etc.
2. Discussion
Banking Business in Ethiopia4: The history of banking in Ethiopia dates back to the turn of the century,
when in 1905, the Bank of Abyssinia was established in Finfinne under the regime of Menelik II. This
event marked the introduction of banking in the country. National Bank of Egypt was entrusted for the
project and the new institution was chartered in Cairo and its shares were subscribed in a number of
countries besides Ethiopia. The Bank of Abyssinia was given a 50-years concession and was engaged in
issuing notes, collecting deposits and granting loans, but its clients were mostly foreign businessmen
and wealthy Ethiopians. A few years later, disappointed by the behavior of this bank, mainly devoted to
profit-making rather than promoting economic development, the Emperor is asserted to support the
establishment of a wholly Ethiopian bank, the Société Nationale d’Ethiopie pour le Dévéloppement de
l’Agriculture et du Commerce. Haile Sellassie, after acceding to the throne in 1930, could not accept that
the country’s issuing bank was foreign-owned and in agreement with National Bank of Egypt, decided
liquidation of the Bank of Abyssinia.
A new bank, the Bank of Ethiopia, under Government control, was established in 1931 and retained
management, staff, premises and clients of the old bank. Italian occupation in 1936 brought the
liquidation of the Bank. This bank was later disintegrated into two different banks forming the National
Most of the facts presented under this title can be accessed at http://www.nbe.gov.et/History/history.htm
4
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Bank of Ethiopia and the Commercial Bank of Ethiopia. Through time, more foreign and domestic
banks were established. To name a few: Banco di Roma, Banco di Napoli, Banca Nazionale del lavoro
and Agricultural Bank were the prominent ones.
The first private Ethiopian bank was Addis Ababa Bank Share Company, which was established by
Ethiopians initiative and started operation in 1964 with a capital of 2 million in association with National
and Grindlay Bank, London which had 40% of the total share. However, the banking business could
not move further because of the institutionalization of private investments by the Socialist regime that
came into power leaving only three government banks; the National Bank of Ethiopia, the Commercial
Bank of Ethiopia and Agricultural and Industrial Development Bank. This was reversed when the
Socialist regime was overthrown in 1991 and the issuance of proclamation for licensing and supervision
of banking and insurance business, which led to the beginning of a new era. Subsequent to enactment
of the proclamation, private banks and insurance companies began to flourish.
Brief Review of Related Literature: Banks very often suffered from what we would consider today lack of
prudent lending practices. The banks appeared to have had concentrated loan portfolios, with a large
share of loans being made to business associates of the bank officers and directors5. The banks often
provided long-term finance (debt and equity) to intrinsically risky industrial ventures such as railroads,
mines or textile mills. Apparently, the lack of adequate capital markets created a vacuum that the
banks stepped in to fill.
However, in providing long-term capital, the banks performed a function that they were ill-equipped to
perform. In making “insider” loans, the information about the borrower’s character available to the
banker may have been more accurate than information about “outside” lenders. This was, after all,
before the development of financial accounting standards or independent accounting firms. However,
insider loans may have been subject to a bias with respect to judgments about the quality of the
investment project. Normally arms-length bankers ask skeptical questions that optimistic firms do not,
forcing firms to be more cautious. However, apparently on insider loans, the lenders frequently put the
cautious external perspective into abeyance.
Two particular examples (the US and Japan) may help elucidate the strengths and weaknesses of insider
lending. Lamoreaux (1991 & 1994) has argued that insider arrangements were common in the early
5
This is mainly holds true for private banks
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United States, specifically in New England. Between 1820 and 1850, merchants in New England
established banks with the goal of providing loans to themselves. The banks then also provided loans
to business associates of the owners. The system worked fairly well. The insiders watched each other to
assure competence and honesty, as they were collectively responsible for the success of the bank.
In the absence of accounting systems, personal knowledge of each other gained from years of contact
in schools, social activities and business was probably the best source of information. Also, the
merchants were descendants of New England puritans and were extremely concerned about their
personal reputations for honesty. In describing banking in Japan, Tamaki (1995), and the authors in
Aoki and Patrick (1995) and Aoki and Kim (1995), describe institutions substantially different from
either the Anglo-Saxon or German forms of banking. In Walter’s (1992) terminology, the Japanese
financial system is an ultra-insider system and stands in contrast to the Anglo-American outsider system
and the Franco-German insider system.
In the pre-World War II Japanese zaibatsu system, family-owned holding companies owned both a bank
and industrial companies. The bank then lent primarily to group companies. During the post-World
War II Japanese kigyo shudan system consists of mutually exclusive groups of firms that own shares in
each other and in a bank, with the bank also owning shares in the firms. Because the bank lends to firms
in which it owns shares and that own its shares, loans to related parties are de facto standard. These
zaibatsu and kigyo shudan lending arrangements has been successful overall in terms of creating incentives
to repay, but have been less effective in ensuring that lenders receive arms-length information about the
merits of loans and investments.
Also, government has acted to enforce rules and often to rescue failing banks. We can sum up this
historical record as showing two things. First, in developing and developed economies, banking crises
are common and banks often make serious mistakes in lending6. Second, insider or “connected”
borrowers are common and represent a substitute for objective financial or accounting information. In
fact, evidences show that many countries in the world have credit bureaus although the form of the
bureaus’ establishment and the quality and comprehensiveness of the data supplied by these bureaus to
financial institutions vary from country to country.
6
The cause of almost all financial crises in the past was traced back to credit risk.
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Coming back to Ethiopian specific, as far as the knowledge and assessment of the researcher goes, there
is no related literature except Directives of National Bank of Ethiopia issued in 2003 and subsequent
amendment in 2012 to force banks operating in the country to share information of borrowers
maintained at their end via National Bank of Ethiopia. Therefore, lenders mostly depend on information
gathered from borrowers with very little additional data to decide on credit propositions.
The Lenders’ and Borrowers’ Problems, and the Equilibrium: The researcher reviewed by dividing the lending
process into two stages: the decision to lend and the response if problems occur. In the first stage, the
basic problem is information. The bank wishes to screen-out bad borrowers (borrowers likely to default),
and for this it needs information. However, whenever a borrower presents himself, there is an
asymmetry: the borrower knows more about himself, his firm and his project than the bank knows.
Although the bank can demand that the borrower disclose information as a condition for making the
loan, the borrower has an incentive to conceal any potentially deleterious information. Still, at this stage
the bank has the money and the borrower is a supplicant.
Once the bank has made loans, the situation changes. Now the borrower has the money and the bank
must depend on the borrower’s willingness and ability to repay the loan. If the borrower is unwilling or
unable to repay, the bank will suffer a loss. The bank’s problem is two-fold. First, it must create
incentives to discourage borrowers who are able to repay from defaulting. Second, the bank must
minimize its losses in cases where the borrower is willing to pay but unable to do so. Spot contracts can
solve many contracting problems between firms though at the cost of some loss in efficiency (Koford
and Miller 1996).
However, bank lending exists precisely to reduce these inefficiencies. The production of goods takes
time, in the absence of intermediaries or capital markets, entrepreneurs would have to save the entire
initial investment themselves before commencing production. Bank loans, the savings of others, bridge
the time gap between production and sale. The following simple Gibrat model (Sutton, 1997) of the
growth of the firm and the lending decision may help provide a starting point for understanding the
banker’s problem with respect to selecting good firms to which to lend. The model has its limitations
and we will return to these later in the discussion. For now, let us assume the following model of the
growth of the firm’s assets:
lnA t+1 = µ+ lnAt + et
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Where, lnAt is the natural logarithm of the assets at time t, µ is the expected growth of the assets, and et
is the firm’s overall luck. Luck depends on many factors and is equally likely to be good or bad. We,
therefore, assume that it has a Gaussian distribution with mean (0) and variance (s2).
The growth of the firm’s assets depends on its expected profitability and its luck. The firm’s assets grow
with its undertaking projects that it correctly expects to be profitable on average and with good luck.
The firm’s assets decline with losses which are attributable to bad luck. The firm can increase its assets
by borrowing. This gives rise to a third parameter of interest to the banker that we call Dt-- the amount
by which the firm’s assets exceed its liabilities.
The probability of default depends on µ, s2 and Dt. We may put this more formally. Insolvency occurs
at the point at which liabilities exceed assets (Dt < 0). Then the firm’s expected first passage time to the
point of insolvency increases with µ and Dt, and decreases with s2. The more profitable the firm, and
the less risky and levered the firm, the lower the probability that the firm will go bankrupt during any
given period. The banker wants to find firms that have a high µ (expected profitability), low s2 (low risk),
and high Dt (low leverage). The banker also does not want the firm to take any actions that would reduce
µ or Dt or increase s2 after he has made the loan. This is the moral hazard problem in lending. To reduce
the moral hazard problem, the bankers will demand loan covenants that enjoin the borrower from
actions that worsen the banker’s claim. One forbidden action is taking on debt that is senior to the bank
loan in the event of bankruptcy. Another forbidden action is a material change in the business of the
firm. Actions that reduce the probability of default are, of course, welcome. The banker has to estimate
the three parameters to determine the probability of a loss. Estimating Dt is relatively straightforward.
The banker needs balance sheet data that shows all the outstanding claims against the firm. Obviously
the banker will prefer situations where an auditor has certified that the firm has correctly prepared the
accounting data. It is in estimating µ and s2 that problems of information asymmetry are most severe.
The borrower generally will know more about his business, industry and prospects than the lender does.
The lender, if his scale is large enough, can mitigate the problem somewhat by letting loan officers
specialize in certain industries but the problem of knowing the borrower and his firm remains area of
problem.
The banker takes into account µ, s2 and Dt, together with an assessment of the risks of information
asymmetry; moral hazard and adverse selection to calculate the likelihood that the loan will get into
trouble. The lender then wishes to charge an interest rate that is high enough or the earnings on good
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loans to offset the losses on bad ones. The gains on all the loans that do not get into trouble pay for the
losses on the few that do. The lender does not have a free hand to set interest rates. The bank not only
competes with other lenders but also it needs to understand that the more it charges, the lower µ will
be. Some potential loans are so risky that attempting to price to take the risk into account becomes a
self-fulfilling prophecy. In that case the banker will refuse to lend, even if the borrower expresses a
willingness to accept the rate.
The willingness to accept the rate is itself an adverse signal about the borrower. The result is that the
lender rations the borrower out of the market. The problem of distinguishing good firms from bad
continues after the bank has made the loan. If the banker could monitor the firm continuously and
accurately the banker could close the firm the minute Dt = 0. When Dt = 0, the firm’s assets exactly
cover its debts. When the borrower has difficulty in paying, the bank has to determine if the situation is
one of illiquidity, i.e., cash-flow, or insolvency, i.e., Dt < 0. The key insight for the banker is to realize
that as long as Dt > 0, the borrower has equity in the firm and does not want to surrender the firm to
the lender.
Also, the lender can demand collateral. The transaction costs to establish collateral reduce the return to
the bank and to the firm. However, collateral gives the bank first claim to the pledged assets in the event
of default. Even if the firm is insolvent, if the collateral is adequate the bank recovers its loan in full. On
default, the bank seizes and liquidates the collateral. The bank uses the proceeds to pay of its loan and
returns any surplus to the other creditors. So far, we have assumed that the only estimation problem
that the banker faces is one of inaccuracy in its assessment of the borrower’s firm.
The discussion of the historical evidence suggests that in the case of insider loans, lenders and borrowers
do not make independent assessments. Instead they may make a joint estimate in which they
overestimate2µ and underestimates s2. Apparently in some circumstances, a community of opinion or
information cascade may be formed (Bikhchandani et al., 1992 and Orléans 1995). In the banking
context, particularly in the case of lending to related parties, the result is that the bank’s officers suspend
their normal good judgment.
Many of the governance mechanisms that banks and regulators apply such as ex ante lending limits on
loans to related parties, to particular firms, or particular sectors, are a form of tying oneself to the mast
or putting wax in one’s ears. Dörner (1996) points out that one problem with safety rules is that breaking
safety rules is frequently reinforced, i.e., it pays off. Safety rules impose a constraint and generally at a
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level well before crisis stage. Ignoring the rules gives the actor an increased freedom of action and
generally an improved immediate result, with no immediate adverse consequences. In the banking
context, ignoring the safety rules leads to higher profitability for long periods before disaster strikes.
That is why it is important that regulators who have little stake in µ but a great concern with s2, enforce
the bank’s own safety rules.
Moreover, there is the issue of the maturity of the loans. Although it is not a part of the model, I have
treated loans as being discrete, long-term contracts. Actually, a major role of banks is to fund working
capital requirements. Usually the bank funds working capital with a line of credit or overdraft line,
repayable on demand. The “on demand” feature merely allows the banker to call in the loan at the first
sign of insolvency rather than having to wait for default. From the firm’s point of view, working capital
is essential to the operation of the business and so the need is long-term. Only the amount required
fluctuates, and that around some long-run, growing level as the firm grows.
Before we leave the model and turn to the problem of ensuring that the borrower pays the loan, it is
important to note that the two stages of whether or not to lend and how to ensure repayment are not
independent. The bank’s own policies will affect which borrowers will approach it for loans. If the bank
does a good job of creating incentives, it will discourage potential bad borrowers from even applying
and will encourage possibly borderline borrowers to bond themselves to be good. In the discussion
below we emphasize the issues of creating incentives that will induce the borrower to repay; we neglect
the issue of the borrower’s ability to repay. We believe that this is the correct way to consider the
incentive issue. Ability to repay ex ante is rarely a matter of certainty: the reason that borrowing is an
interesting issue is that there is risk that bank and borrower evaluate. Ability to repay ex post is also
commonly not a matter of certainty: with sufficient time and inducement to effort, borrowers will repay
many apparently bad loans.
However, there are two key reasons that ability to repay is not an incentive issue. One reason is that as
a first order approximation we can take ability to pay as being outside the control of borrower or lender.
The second reason is that if the borrower intends to defraud the lender, ability to pay is irrelevant. The
third reason is that honest borrowers expect to be able to repay. If the firm fails, the borrower loses his
investment in the firm but if the firm does well, the borrower keeps all the profit net of the loan
repayment.
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Banks have several ways to ensure that borrowers repay their loans. The three mechanisms discussed
briefly below and again in part 5 are reputation, collateral, and punishment for fraud. All can and may
involve court action. For both the lender and borrower the value or cost of civil action depends upon
the probability of collection and the costs of legal action. In brief, default incurs reputation costs to the
borrower of which the most important is the effect on the borrower’s ability to borrow in the future.
This includes not only the ability to borrow from the bank in question, but also from other banks, from
suppliers in the form of trade credit, and even from the firm’s own workers in the form of the time
between paychecks. Furthermore, a firm known to be in trouble will have difficulty securing the long-
term contracts on which it may depend. An important social variable (a constant for the bank and firm)
therefore, is how public is the knowledge of default likely to be and how harmful will that knowledge
be to the firm’s owners. If a loan goes bad, the lender’s first line of defense in Ethiopia is to publicize
and sell the collateral. Publicizing and foreclosing collateral results in explicit and implicit costs. The
explicit costs are the (minimal) legal costs.
The implicit costs are the possibility that legal action against collateral may turn a situation of illiquidity
into one of insolvency; publicizing and foreclosing of collateral may make it impossible for the firm to
operate and so force it into bankruptcy. The bank must compare these costs with the expected loss from
waiting in the hope that the borrower will eventually be able to repay. The final recourse for a bank
upon discovering of fraud is court prosecution. The effectiveness of recourse to courts in this case
depends on whether the legal system treats this as a civil or criminal matter and whether the court system
assigns it a priority or not. On the other hand, if the least cost combination is ineffective, then the bank
must rely more heavily on another combination at an overall higher cost. If one mechanism becomes
less effective, the bank may turn down potentially problematic loans until the expected probability of
repayment reaches an acceptable level.
Alternatively, the bank may make other adjustments to increase the probability of repayment. This of
course increases costs and so reduces the amount of lending. Most importantly, if practices and
institutions reduce information asymmetry, this allows the lender to adjust other margins as well. Then
the price of loans will fall and the total amount of lending in the economy will rise. In the present
analysis, there are two over-riding problems. The first is the banks’ ability to distinguish good and bad
loans due to lack of adequate experience. The second is limitations on the social and legal costs of failure
to repay. For both problems the banks’ solution involves increased reliance upon collateral with all its
costs for the banks, firms and society.
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Separating the Wheat from the Chaff: Banks usually try to avoid making bad loans. Loans go bad for one of
two broad reasons; the firm runs into difficulty or the borrower has engaged in fraud. Petersen and
Rajan (1995) put the issue another way. They suggest that the three character defects of greatest concern
to bankers are competence, laziness and dishonesty. Incompetence and laziness result in waste and
missed opportunity. The incompetent or lazy harm the banker by reducing the firm’s expected
profitability and hence the firm’s ability to service the loan. The dishonest steal, either directly from the
banker, or indirectly by stealing from the firm and hence imperiling the loan. The discussion in this
section is separated into two parts. The first part represents the banker’s task of avoiding firms that are
likely to run into trouble whether because of incompetence or laziness, or simply great risk. The second
part represents the banker’s task of avoiding crooks.
Good Firms and Bad Firms: The firm may run into difficulty because of µ, s2 or D. That is, the firm may
pick poor projects in which to invest, it may be unlucky, or it may be indebted to the hilt. It is the
banker’s job to avoid lending to firms that have or are picking bad projects. Luck is ex post; by definition
there is nothing that the banker can do to determine whether a firm will be lucky or unlucky, beyond
remembering the adage, “Fortune favors the prepared.” Bankers can however estimate variance and
select against companies that are taking too much risk for the expected return. Bankers can also
determine the firm’s leverage and refuse to lend to firms that have too much debt outstanding. In
developed countries banks use the device of asking for several years (3-5) of audited financial statements
as the first screen to separate into good from bad firms7.
As Diamond (1984) points out in his seminal article, the passage of time helps to separate good firms
from bad firms that have simply been lucky. If a firm has operated successfully for several years this is
a sign that management has been picking good projects and is competent. The longer the firm has been
operating successfully, the less likely it is that the firm’s past success has been due to luck. Audited
statements are a sign of well constructed accounting systems and some openness to disclosure.
Most small to moderate-sized Ethiopian firms are unable to provide several years of good financial
records and they generally do not have well-audited financial records. First, the firms are almost all
young. Second it is very expensive to use accounting firm. Most firms use less reputable local
accountants. Bankers allege that these local accountants are willing to be generous to a firm if it
7
Zeller, Manfred. 2010 PP 23-29
231
“suggests” that good numbers would be appropriate. Still, it is also practical experience of bankers in
the country that borrowers don’t want to be asked to present audited financial statements.
A second screen that bankers in some developed economies use is the reports of commercial credit
reporting firms. In Ethiopia, as in other less developing economies, the information available on firms
from other sources is poor. This makes it hard for banks to learn whether firms are paying their trade
debts on time or not. The lack of trade credit information deprives the banker of a useful early warning
signal. The signal arises from the fact that firms in difficulties are more likely to delay their payments to
their trade creditors than they are to delay their payments to their bankers.
A third screen is to visit the premises of the borrower. By visiting the premises, an experienced banker
can get some sense of whether the firm is busy, well-organized, and appears successful without being
spendthrift. The banker can also find out whether or not the firm exists. Bankers visit firms as a matter
of course, both before making a loan and during the life of the loan. They might make several visits
before approving a loan. However, not all borrowers welcome the visits. Some borrowers regarded visits
as unwarranted intrusions on the borrower’s privacy. It is also possible that individuals and firms in
Ethiopia, as in many other countries, see themselves as existing in a non-cooperative, predatory
environment. Cooperation, in such an environment, leads not to reciprocal cooperation but to
exploitation.
As part of their credit evaluation, many banks require prospective borrowers to provide a business plan
and the credit officers evaluate the plan. However, many of their clients had no idea how to write a
business plan and the officers themselves ended up teaching the borrower. Also, some firms resorted
to consultants who would provide a generic and hence meaningless business plan. Still, the requirement
of a business plan acted as another screen against fraudulent borrowers and poorly managed firms.
There is a second problem that bankers reported regarding business plans. The bankers claimed that
business plans did not deal seriously with the possibility of bad events, particularly of bad
macroeconomic events. It appeared that the problem was inexperienced business people. The business
people had never weathered hard times and did not naturally think about how to respond to adversity.
The result was that the business plans were not very useful.
While the plans could show realistic cash flows under good conditions, if conditions worsened
significantly the businesses were unprepared with a contingency plan and so were immediately in trouble.
The borrowers’ reluctance to present pessimistic scenarios may also have been another example of the
232
operation of information asymmetry. The borrower may know more than the bank about possible risks
and be reluctant to reveal them to the less knowledgeable loan officer. The borrowers may fear that
revealing the risks they face will increase the probability that the bank will refuse to lend to them. Bankers
consider the information problems associated with lending working capital to be large. Firms are
typically unwilling to describe their business in realistic detail.
Good Character and Bad Character: An assessment of the borrower’s character is critical in the loan
decision. Default would embarrass the borrowers too much. Generally though banks made substantial
efforts to learn whether the borrower was of a “type” that would want to pay off the loan. Although
they wanted to determine the borrower’s true type, doing so was difficult. The devices that help a banker
screen out incompetent borrowers obviously also help in screening out the dishonest. A history of
successful operation, credit reports, company visits, and business plans all provide useful information
on honesty as well as competence.
Visiting companies and requiring business plans of borrowers however were possible and the bankers
we spoke to do use them. Visiting the premises of firms obviously helps but was not fool-proof in
ensuring that the bank would not suffer losses on loans to “credit millionaires”. Some entrepreneurs set
up paper firms just to capture credits. After the bank made the loan, the credit millionaires simply
ignored demands for repayment while living well. Some borrowers simply disappeared.
Minimizing the Impact of Information Asymmetry: Encouraging loan repayment involves three incentive
mechanisms: reputation, collateral and legal punishment. First, does a defaulting borrower suffer a
reputation cost that reduces the gains from default? Second, does a defaulting borrower forfeit collateral
that is sufficiently valuable and marketable to pay off the value of the loan? Third, does a fraudulent
borrower suffer legal punishment sufficient to deter fraud? Again, the sign that the mechanisms work
well is that the problem of an unwillingness to pay crops up rarely.
Recourse to legal action may be part of any one of our three incentive mechanisms. First, the firm can
go to court to win a judgment that harms the borrower’s reputation. Second, the firm may go to court
to establish title to collateral, or in the event there is no specific collateral, to take its place in the queue
of claimants. A judgment is also necessary to enlist the court’s assistance in seizing assets. Third, the
firm may go to court to punish fraud with a view of discouraging others from attempting fraud in the
future. Large banks have lawyers on their staffs so they argue that their marginal cost is only court fees.
If they win the judgment then their fees become part of their claim. Instituting a civil claim is thus the
233
natural response to default and insufficient collateral. Bankers and firms in Ethiopia often do resort to
the courts, though all assert that courts are slow and inefficient (Koford and Miller, 1995).
Reputation: Borrowers with poor reputations would have difficulty in getting new loans or would get
new loans only with more onerous conditions and restrictions. A poor reputation may encompass a
history of slow payment or even just a general lack of cooperation and openness. For reputation to work
as a general incentive, the borrower has to know that his lender’s experience with him will become
public knowledge. Other banks and firms must be able to find out easily whether someone is a good
payer or not. In this respect, there is no comprehensive database maintained for such and other related
purposes.
Ethiopian banks pointed out that the bank secrecy law prevented them from informing the public about
problem borrowers. In principle, the law allowed them to inform other bankers of certain facts about
borrowers, through a system that the National Bank of Ethiopia established: Credit Reference Bureau
System. Firms had great trouble in showing that they deserved a good reputation, and bad firms could
easily claim to be good. Often, people express the issue to us in cultural terms: information is very
valuable, and so should not be passed around. Holding unique information gives power.
The lack of good objective information about businesses in Ethiopia (balance sheets, past cash flows,
value of capital, and history of paying debts) suggests that informal information through close personal
relations should be more important. The implication is that one could readily find out about people; still
gossip was more effective in towns rather than cities. A mechanism that one observes in situations where
business information is difficult to obtain is that businesses typically operate through close-knit “groups”
where trust will be better. When objective data is not available, knowledge of individual personalities is
a partial substitute. Moreover, when one works with a small, intimate group of other business-people,
violating an agreement should bring a collapse of business relations.
Collateral: Requiring collateral can also reduce information asymmetry risks. Collateral reduces adverse
selection by requiring a specific value of collateral. After all, look what happened when mortgage lenders
were offering nothing-down loans—the credit crises of 2008 and 2009. Collateral also lowers moral
hazard risk because the borrowers stand to lose their collateral if they do not make the required
payments. Requiring a certain amount of net worth also reduces adverse selection because only those
individuals or businesses with sufficient assets over liabilities will be considered for a loan. Moral hazard
is reduced because the borrower can be sued if they fail to make timely payments on their loans. Bankers
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often describe the lending system as being based on the guarantee that even in default the lender would
remain whole. In practice, this was neither a very efficient nor effective system.
Legal Action: The simplest form of private enforcement if the borrower just fails to repay, is a call or
visit by the lender to “discuss” the matter with the borrower. The discussion will certainly be unpleasant,
especially if the borrower has not warned the lender that difficulties were starting to develop. Lenders
may call the borrower regularly to “remind” the borrower of the obligation. After all possible amicable
resolutions of the loan collection have been made, banks resort the case to legal action. Therefore, taking
timely, proper and appropriate legal action against such defaulter definitely minimizes default by other
borrowers.
3. Conclusion
Overall assessment reveals that prevalence of information asymmetry between the borrower and the
bank, which is reflected in adverse selection during sanctioning and moral hazard after disbursement of
the loan has forced commercial banks to excessively rely on collaterals to manage associated risks. Banks
could deploy different types of screening mechanisms of good firms and character from the bad ones
to minimize the possible adverse impact of information asymmetry. Moreover, the customized Gibrat
model also implied the possibility of using the amount by which the firm’s assets exceed its liabilities,
expected profitability and luck of the firm to help banks to screen the wheat from the chaff. However,
it is the implication of the review to capacitate personnel engaged in credit operations and working
towards maintaining comprehensive citizens’ database to enhance investment in the country and
minimize the information asymmetry.
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DISCUSSIONS, VIEWS AND REFLECTIONS
Saving
The saving rate in Ethiopia is considered to be very low even by the sub-Saharan African standards.
Discussions were made at length on the underlying factors for poor performance of this macroeconomic
variable and mechanisms of improving the Ethiopian saving rate.
It was indicated that improving saving conditions should take into account the nature of consumption
in a community. However, the concept of consumption was obscured during the conference since it is
difficult to put effective saving in place without accounting for consumption. Therefore, the discussants
emphasized the need to include the concept of consumption into themes in a conference to be organized
on the same topic in the future. It was noted that saving could be mobilized by reducing the inflation
rate, the tax rate, and by increasing real income.
The negative effect of inflation on saving was emphasized. It was argued that inflation severely affects
household capital accumulation, which further depletes the saving margin. Thus, it was noted that all
stakeholders such as higher learning institutions, financial institutions, government, and public financial
agencies should come up with innovative and effective mechanisms of saving mobilizations.
It was also opined that absence of diversified saving products such as saving for real estate development
in Ethiopia adversely affected the intrinsic saving motive of individuals. Absence of long term loan
provision as one of the reasons for low saving among citizens and lack of access of citizens to different
saving packages was underlined to be the major factors having important bearings on the low level of
saving in the country.
The issue of aggregate saving in Ethiopia including household savings, business savings, and
government savings was addressed and noted that it is within a single digit rate. In this regard,
participants noted to critically see the effect of inflation on the overall saving. Accordingly, the effect of
inflation on aggregate saving was suggested to be not as such significant. It was reiterated that low
savings could be attributed to many factors and it was argued that the effect of inflation was negligible.
On the whole, undertaking a thorough investigation into the macro and micro level factors as well as
multidisciplinary perspectives involving sociological, anthropological and religious issues was indicated
to provide the answer to the questions why the saving rate in Ethiopia is low and how the saving culture
could be promoted. Moreover, further research on the effect of inflation on saving mobilization and
239
behavior was suggested to test the hypothesis that inflation negatively affected savings mobilization.
Furthermore, it was suggested that the feasibility of institutional or forced savings in Ethiopia should be
thoroughly studied. It was also mentioned that financial institutions are expected to play key roles in
setting research agenda and supporting research endeavors in the area of loan and saving mobilization.
The participants recommended that research should be conducted to come up with policy
recommendations that promote saving in the country in case there are any policy gaps that discourage
it.
Financial sector development and infrastructure
Participants of the conference argued that the underdevelopment of the financial sector in Ethiopia
including lack of efficient banking services, low access to financial services, poor infrastructural
development, lack of liberalization of financial sector and entry barriers, and lack of diversified saving
schemes and opportunities are the major problems constraining saving mobilization in the country. It
was noted that most of the banks in the county are inefficient in service delivery, particularly public
banks. Specifically, the services are limited in scope and delivery is slow. There was a general notion that
the government would have to influence these financial institutions to become efficient operators. In
addition, it was stressed that there is limited access to financial services due to limited availability of
financial sector infrastructure. For example, it was noted that there are limited banking services in rural
Ethiopia. Moreover, it was opined that lack of capital or secondary markets and absence of foreign
banks in the country is also another factor limiting access to financial services. This was attributed to
the low level of liberalization of the financial sector. Participants noted that the poor availability of ICT
and other supportive infrastructure is also a factor that contributed to the limited services extended to
savers. It was also commented that the limited availability of alternative investment opportunities that
would promote saving also contributes to the poor availability of saving products and schemes in the
country.
In regard to the ways of creating a well functioning financial system in Ethiopia, notable arguments were
made by participants. Some participants suggested opting for full liberalization of the Ethiopian financial
sector, initiation of the financial markets, and dollarization of deposits would be the best ways forward
for attaining a well functioning financial system. They supported their views with the notion that
liberalization would enhance financial sector efficiencies. However, these arguments were refuted by
some other participants with the view that liberalization of the financial sector has its own negative
240
implications on the economic and political sovereignty of the country. Participants supporting this
position further explained that allowing foreign investors into the financial sector of the country would
have detrimental effects: i) Since most of the commercial banks in Ethiopia are inefficient and have
limited capital base, inviting foreign banks into the system would threaten the survival of the local private
and government banks; ii) The limited capacity of the National Bank of Ethiopia (NBE) to supervise
experienced foreign banks may also pose other challenges; and iii) Overseas banks virtually have the
desire to skim the market and they do not have the interest in moving closer to the rural communities,
where the country has limited financial infrastructure.
The opening up of stock exchange markets was also discussed by the participants and it was argued that
the project would not be feasible at least within the coming couple of years given the context of Ethiopia.
Participants from the private sector and invited practitioners also emphasized the low level of
empowerment of savers in using their money and argued for the need to empower them. It was
remarked that allocating resources of savers need to be made with the knowledge and involvement of
the savers. The savers would have to be partners in the decision making process without ignoring the
challenges posed in its implementation. Participants also indicated that there would have to be
institutionalized system of incentivizing top savers.
Participants stated that the financial sector strategy of Ethiopia, if implemented properly, would have
the potential to solve problems related to financial services and accessibility in the country. It was stated
that, presently, only 25% of the banks exist in the rural part of the country, limiting most financial
services to urban areas. However, participants argued that, in the future, there would be a possibility to
capitalize on the introduction of electronic banking, mobile banking, agent banking, and Islamic Banking
to widen the scope in both rural and urban areas.
Innovations in the financial sector development
Networking and collaboration among stakeholders including the financial sector, the private sector,
public sector, research organizations, and higher learning institutions was given emphasis during the
discussion. This aspect was stated as one of the leverage point for innovations in the financial sector of
the country. Particularly, the roles of public-private and civil society partnerships (PPCP) were
emphasized. On the other hand, the importance of PPCP and the role of NGO in Ethiopia and Africa
were questioned.
241
Participants suggested that networking would have to be done through the National Bank of Ethiopia
(NBE). This would require a new approach and “out of the box thinking” with the already existing
facilities and infrastructure. It was also argued that the roles of key players and actors would have to be
identified. One important benefit of networking is information exchange. A striking question was
raised by one of the participants as to which data would be accessible in the National Bank of Ethiopia.
Participants from the bank argued that only aggregate data rather than detailed data would be provided
for researchers. In this regard, the problem of information asymmetry was emphasized. It was noted
that there is no audited and standardized borrowers’ information system that describes the history of
the borrowers before extending the next loan services. It was pointed out that this should call for the
establishment of a national database system that would provide standardized information for financial
service providers in the country.
Research and development
A key question arose as to how far both the financial sector and higher learning institutions are prepared
to open-up their doors for research and development. In this regard, participants argued that financial
institutions would not be prepared to support/fund research projects. In line with this, participants
critically evaluated the roles of research and development in the financial sector. Given the three
mandates of Universities, namely, teaching, research, and community services, a number of issues were
required to be addressed. These included:
1. The status of financial institutions in supporting research. It was questioned whether or not
financial institutions have appropriate policies for supporting research projects.
2. It was also inquired how the financial institutions would collaborate with Haramaya and other
public Universities in developing the capacity of the sector.
Regarding the collaboration between Universities and the financial sector the following points were
forwarded by the participants:
 Establishing joint research themes and teams;
 Formulating and offering different courses that would build the capacity of the financial sector, for
example, supervision courses in the areas of Insurance, SACCOs, MFI and Banks, etc;
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 Inviting practitioners and experts to share practical insights, expertise, and lectures to students in
the higher learning institutions;
 Seeking funds from financial sectors for training, consultancy, and research;
 Establishing a joint team with members drawn from Haramaya University and the financial sector
under the coordination of the College of Business and Economics of the University that would
play the role of setting up partnerships.
With respect to the linkage between Universities and financial institutions, it was urged that universities
take the lead in strengthening the collaboration. It was also recommended that Universities ponder over
the quality of their graduates and the relevance of their curricula in view of harmonizing the imparted
skills and knowledge with the existing realities of the financial sector in the country. It was emphasized
that subjects taught at Universities should generate relevant knowledge and skills that would support
the economy. Similarly, research done at Universities should be demand driven and problem solving.
Some conference participants opined that the lagging of Universities behind practitioners in terms of
generated knowledge and imparted skills would have a detrimental effect on their future. Therefore, it
was suggested that Universities should develop their capacities commensurate with the needs of the
financial sector. It was also stressed that collaboration between senior and junior researchers, as
evidenced in the conference should be promoted. As a whole, the conference was lauded as a fruitful
scientific forum that brought forth a number of issues for discussions and actions. Therefore,
participants suggested that such a conference should be continued at regular intervals so as to deal with
existing and emerging issues of the country’s financial sector for enhancing socio-economic
development.
243
244
Closing Remark
Dr. Fekadu Beyene, Vice-President for Administration and Student Affairs
Dear invited guest, participants, colleagues, ladies and gentlemen,
I feel honored to make a concluding remark upon the successful completion of the national conference
on loan and saving.
Over the last two days, we deliberated on a wide range of issues related to loan and saving. Several
scientific papers were presented and discussed; some covering macro and others micro perspectives.
These deliberations have motivated participants to raise a number of critical issues related to loan and
saving, culture of saving and how saving and investment are useful for a developing nations like ours.
Addressing these issues would in fact enable us to overcome social and economic challenges and move
smoothly and become more confident than ever before to realize the millennium development goals. I
believe that the papers presented enabled all of us to capture the essential strategies that state and non-
state actors need to put in place to improve efficiency of the financial sector and institutions operating
in the sector. An important challenge associated with loan and saving is embedded in the culture in
which institutions operate, bureaucratic barriers they introduce to overcome risks, and at large lack of
adequate insurance mechanisms to encourage investment, particularly in the agricultural sector. The
underdevelopment of the culture of saving and the fact that low income households undermine the
contributions of smaller savings to their economy has reduced the amount of loan available for investors
in the financial institutions. This indicates that strategies for mobilization of savings need to be
introduced by each financial institution, both in the private and public sectors.
245
Ladies and gentlemen, we are really gratified to host such a timely conference where researchers from
Universities, other organizations and practitioners from the different financial institutions have come
together to discuss on the practical problems of the financial sector and search for solutions jointly to
improve the competitiveness of our economy. Ethiopia has for more than a decade shown a remarkable
progress in the economy partly because of the effective policies supporting the performance of the
financial sector. In the event that unstable exchange rate and inflation have challenged growth of our
GDP, the stabilization strategies introduced by the government in controlling monetary flow and the
illegal foreign exchange markets have brought successes to our economy. I believe that further
institutional reforms and organizational changes that took place in the financial sector in the delivery of
public services have played a vital role in boosting GDP growth. From these developments, we could
expect that further research efforts and deliberations, such as what we have exercised in this conference,
are instrumental in exploring better ways of dealing with the problems. There is no doubt that
development strategies that do not take full account of how to mobilize saving and improve availability
of loans for business entrepreneurs are doomed to fail. I hope, my colleagues will agree with me that
Haramaya University would take the responsibility to strengthen academic and research endeavors in
collaboration with professionals working in the different financial institutions. I am sure that the
National Bank of Ethiopia, Commercial Bank of Ethiopia, Development Bank of Ethiopia,
Construction and Business Bank, Ethiopian Insurance Company and other financial institutions will
benefit from our efforts provided that they commit themselves to contribute to our research endeavors.
As you noticed during our two-day deliberations, we did have a number of young scholars who have
the inspiration to take up the challenges in the research and development processes.
With this brief remark, I declare that the workshop is closed.
Thank you for your attention!
246
List of Participants
1. Dr. Nigussie Dechassa 39. Mr. Mohamedamin Hussein

2. Dr. Mengistu Urge 40. Mr. Abdurahman Aliyi
3. Dr. Mengistu Ketema 41. Mr. Mulugeta Damie
4. Mrs.Yemisrach Getachew 42. Dr. Bobe Bedadi
5. Mr. Abebe Ambachew 43. Mrs. Mulu Birhanu
6. Mr. Mulugeta Yitayih 44. Dr. Girma Goro
7. Mr.Zelalem Bayissa 45. Dr. Abi Tadesse
8. Dr. Endrias Geta 46. Dr. Getnet Demissie
9. Mr. Mengistu W/hana 47. Mr. Sileshi Yilma
10. Mr. Kassahun Mamo 48. H.E. Dr. Sintayehu Woldemichael
11. Mr. Muzeyin Hussein 49. Mr. Sewagegn Chane
12. Mr. Kifle Tesfamariam 50. Mr. Gebre Erkalo
13. Mr. Aron Hailesellasie 51. Mr. Ermias Mebratu
52. Mr Solomon Desta
14. Mr. Ayalew Mekonnen 53. Mr. Solomon Tadesse
15. Mr. Beza Muche 54. Mr. Betrework Asefa
16. Mr. Endalew Wale 55. Mr. Asmamaw Yeshanew
17. Mr. Gebeyehu Raba 56. Mr. Frew Kassa
57. Mr. Kifle Alula
18. Mr. Hailemichael Tesfay
58. H.E. Mr. Murad Abdulhadi
19. Mr. Mebratu Leake 59. Mr. Abdurahiman Abdella
20. Mr. Melkamu Belina 60. Mr. Haimero Limenih
21. Dr. Ramesh Rengasamy 61. Mr. Ambaye Merga
22. Mr. Sefiager Alem 62. Mr. Admasu Akale
63. Mrs. Kidist Mamo
23. Mr. Tamiru Belete 64. Mr. Hailu Tadesse
24. Mr. Temesgen Keno 65. Mr. Afework Abebe
25. Mr. Deribe Assefa 66. Mr. Alemshet Teshome
26. Mr. Wolde Bulto 67. Mr. Wasihun Mohammed
68. Mr. Sisay Diriba
27. Mr. Yonas Mekonnen
69. Mr. Amare Mebre
28. Dr. Abadi Teklehaimanot 70. Dr. Kesari Polsheti
29. Dr. Fekadu Beyene 71. Mr. Amdemichael Abera
30. Dr. Workneh Kassa 72. Mr. Ermias Bogale
31. Dr. Belaineh Legesse 73. Mr. Yonas Niguse
74. Mr. Dakito Alemu
32. Dr. Lema Zemedu 75. Mr. Melsew Gessesse
33. Dr. Endrias Geta 76. Mr. Takele Teshome
34. Dr. Jemal Yosuf 77. Mr. Ketema Bekele
35. Mr. Jebessa Teshome 78. Miss Kiros Gitet
79. Mr. Tesfaye Guta
36. Mrs. Mesay Tiku 80. Mr. Freyihun Fikru
37. Mr. Meles Sitotaw 81. Mr. Mohammed Aman
38. Mr. Jemal Mohammed
247

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A CONFERENCE CO-ORGANIZED BY HARAMAYA UNIVERSITY AND

PUBLIC FINANCIAL ENTERPRISES AGENCY

How to cite the proceeding

CO-ORGANIZED BY HARAMAYA UNIVERSITY AND PUBLIC

Edited and compiled by:

Mengistu Ketema (PhD)

Haramaya University, Ethiopia

Nigussie Dechassa (PhD), Vice-President for Research Affairs, Haramaya University

PAPERS PRESENTED IN THE CONFERENCE IN THEMES......................................... 13

Theme 1: Institutions in Loan and Saving................................................................................. 13

Kifle Tesfamariam and Hailemichael Tesfay

Endalew Wale, Endrias Geta and Jema Haji

Yonas Mekonnen, Arega Seyoum and Anteneh Gorfu

Theme 2: Governance and Policy Dimensions in Loan and Saving ......................................... 51

Aregawi Tesfay and Kifle Tesfamariam

Theme 3: Saving, Loan, and Development ............................................................................... 65

Aron Hailesellasie, Nigus Abera and Getnet Baye

Tezeta Ketema and Deribe Assefa

Theme 5: Loan and Saving in Agriculture and Pastoralism....................................................... 180

Melkamu Belina and Mengistu Ketema

Ayalew Mekonnen and Lemma Zemedu

Theme 6: Information Asymmetry and Credit Risk Management............................................ 213

Zafu Hailesilase & Abadi Teklehaimanot

DISCUSSIONS, VIEWS, AND REFLECTIONS.................................................................... 239

Fekadu Beyene (PhD), Vice-President for Administration and Student Affairs

List of Participants 247

Dr. Nigussie Dechassa, Vice-President for Research Affairs, Haramaya University

Staff members of the University,

Ladies and gentlemen,

Ladies and Gentlemen,

Thank you very much.

Ladies and Gentlemen,

Ladies and Gentlemen,

Ladies and Gentlemen,

Ladies and Gentlemen,

I wish you all a stimulating and rewarding time.

Thank you very much for your attention!

H.E. Dr. Sintayehu Woldemichael, Director of Public Financial Enterprises Agency

PAPERS PRESENTED ON THE WORKSHOP IN THEMES

Theme 1: Institutions in Loan and Saving

Relative Efficiency of Rural Saving and Credit Cooperatives: An Application of Data

Kifle Tesfamariam1 and Hailemichael Tesfay2

Table1: Input-output specifications of the intermediation approach

Variables Definition Input/ Output

Type of SACCO Number of SACCO Membership Size Saving Loan dispersed

Source: FCA, 2012

3. Results and Discussion

Table 3: Descriptive statistics of inputs and outputs in DEA model

Table 4: Summary of efficiency scores

VRS= variable returns to scale; SE = Scale efficiency

Table 5: Size metric of the sample

Size Large Medium Small Scale

Figure1: TE and size

Table 6: Mean efficiency by location

S/No Zone Mean TE No of efficient No of inefficient %age of Efficient

The Effect of Asset Liability Management on Profitability of Ethiopian Commercial Banks

Lecturer, University of Gonder, Email: tamsolan2003@gmail.com

𝜋𝑏𝑡 =∝0 + ∑ ∝1𝑖 𝐴𝑖𝑏𝑡 + ∑ ∝2𝑗 𝐿𝑗𝑏𝑡 + 𝜖𝑏𝑡 …….. (1)

Table 1: Explanatory Variables

4. Results and Discussion