CHAPTER ONE - eeaecon.org Getahun final.… · Web viewBanking, in the modern sense of the word,...

ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

SCHOOL OF ECONOMICS

THE ROLE AND PERFORMANCE OF PRIVATE COMMERCIAL BANKS

IN THE ETHIOPIAN ECONOMY: THE CASE OF DASHEN BANK S.C

A SENIOR ESSAY SUBMITTED TO SCHOOL OF ECONOMICS IN

PARTIAL FULFILMENT OF THE REQUIREMENT FOR BACHELOR OF

ART (B.A) DEGREE IN ECONOMICS

BY: SHUMET GETAHUN

ID No: BER/1347/05

ADVISOR: DEREJE YOHANNES (ATO)

June 2015

Addis Ababa

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Acknowledgment

First, I would like to thank my advisor Ato Dereje Yohannes for his professional advices,

comments and guidance who contributed to this study a lot. Next my heart full gratitude is for

my family for their financial and psychological support throughout my life: Dr. Endihnew

Zeleke, Ato Tadilo Zeleke, Enyat Zeleke, my father Ato Getahun Andargie and my mother Wro

Neges Zeleke. Thirdly, I am also thank full for the information staff of Dashen Bank S.C and

National Bank of Ethiopia providing me the necessary data.

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Table of ContentsCHAPTER ONE...........................................................................................................................................1

Introduction...................................................................................................................................................1

1.1 Background of the Study .................................................................................................................1

1.2 Statement of the Problem....................................................................................................................3

1.3 Objectives of the study........................................................................................................................4

1.4 Significance of the Study....................................................................................................................4

1.5 Limitation and Scope of the Study......................................................................................................5

1.6 Methodology and Data Source............................................................................................................5

1.7 Organization of the Study ...................................................................................................................5

CHAPTER: TWO.........................................................................................................................................6

Review of the Related Literature ..................................................................................................................6

2.1 Theoretical Review.............................................................................................................................6

2.1.1 Evolution and Definition of Banking...........................................................................................6

2.1.2 Structure of the banking system...................................................................................................7

2.1.3 Banking in Developing Countries................................................................................................8

2.1.4 Role of Commercial Banks in a Developing Economy ...............................................................9

2.1.5 Performance Measurements.......................................................................................................11

2.1.5.1 Theories on measuring bank performance ..............................................................................11

2.1.5.2 Financial indicators as measures of bank performance...........................................................12

2.2 Empirical Literature Review.............................................................................................................17

CHAPTER THREE ....................................................................................................................................21

General Overview of Dashen Bank S.C......................................................................................................21

3.1 Profile of Dashen Bank S.C..............................................................................................................21

3.1.1 Establishment of Dashen Bank SC ............................................................................................21

3. 1.2The Motive behind Its Name, “Dashen Bank”...........................................................................21

3.1.3 The Business Purpose of the Bank.............................................................................................22

3.1.4 Mission of Dashen Bank............................................................................................................22

3.1.5 Vision of the Bank .....................................................................................................................22

3.2 The Legal and Policy Environment ..................................................................................................22

3.3.1 The Legal framework.................................................................................................................23

3.3.2 The Policy Aspect......................................................................................................................25

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3.3.2.1 Interest Rate Policy.................................................................................................................26

3.3.2.2. Foreign Exchange Policy .......................................................................................................27

3.4 Problems Faced by Dashen Bank SC................................................................................................28

3.2.1 Internal Problems.......................................................................................................................28

3.2.2 External problems ......................................................................................................................29

CHAPTER FOUR.......................................................................................................................................31

Data Presentation and Analysis ..................................................................................................................31

4.1 Performance Evaluation....................................................................................................................31

4.1.1 Branch Expansion ......................................................................................................................31

4.1.2 Deposit mobilization......................................................................................................................33

4.1.3 Credit delivery ...........................................................................................................................35

4.1.4 Profitability ................................................................................................................................36

4.2 Role of Dashen Bank S.C. to the Ethiopian Economy......................................................................37

4.2.1 Role of Dashen Bank in Capital Formation...............................................................................38

4.2.2 Provision of Sectorial Loans and Advances...............................................................................39

4.2.3 Employment Opportunity Creation and Human Capital Development .....................................40

4.2.4. Investment by the bank .............................................................................................................41

CHAPTER FIVE ........................................................................................................................................43

Conclusions and Recommendations ...........................................................................................................43

5.1 Conclusions.......................................................................................................................................43

5.2 Recommendations.............................................................................................................................44

Bibliography

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List of Tables

Table 1: Dashen Bank SC branch expansion figure

Table 2: Deposit mobilization by Dashen Bank SC

Table 3: Dashen Bank S.C. outstanding loan balance

Table 4: Dashen Bank share company profit figures

Table 5: Amount of deposit mobilized and credit disbursed and numbers of deposi tors and

loanees by Dashen Bank

Table 6: Loans provided by Dashen Bank to manufacturing and agriculture sectors

Table 7: Employment opportunity created by Dashen Bank

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Abstract

Financial intermediation is one of the significant economic activities that can facilitate the

smooth functioning of business activities and economic development of a country. Banks as

financial institutions or intermediaries are engaged in borrowing and lending fund from and to

economic agents.

This study is intended to analyze the role and performance of private commercial banks in the

Ethiopian economy taking Dashen Bank S.C. as a case study for the period covering 2004-2013.

It has employed descriptive data analysis method using tables, ratios and percentages. Dashen

Bank is operating under a highly regulated financial system and face internal and external

problems. The founding of the study shows that the bank plays a crucial role in capital formation,

human capital development and giving sectorial loans. Investment in long term bills and

expanding to the rural part of the country is also recommended to the bank to get higher market

share and hence have high contribution to the economy.

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CHAPTER ONE

Introduction1.1 Background of the StudyEtymologically, the word “bank” is derived from the Greek word “Bisque”, or the Italian word

“Banka” both meaning a bench mark referring to a bank at which money lenders and money

changers used to display their coins and transact business in the market place (Smith, 1991).

Because of multiple activities played by modern banks, it becomes difficult to give a precise

definition of the word “Bank”. The oxford dictionary defines a bank as “establishment for the

custody of money, which it plays out on a customer order”. This however is not satisfactory

definition as it ignores the most important function of a bank that is creating money or creating

credit.

As many reliable sources indicate, the history of banking begins with the first prototype banks of

merchants of the ancient world, which made grain loans to farmers and traders who carried

goods between cities. This began around 2000 BC in Assyria and Babylonia. Later in ancient

Greece and during the Roman Empire, lenders based in temples made loans and added two

important innovations: they accepted deposits and changed money. Archaeologically from this

period in ancient China and India also shows evidence of money lending activity (Goldthwaite

R.A, 1995).

Banking, in the modern sense of the word, can be traced to medieval and early Renaissance Italy,

to the rich cities in north such as Florence, Venice and Genoa. The Bardi and Peruzzi families

dominated banking in the 14th Florence, establishing branches in many other parts of Europe. The

development of banking spread from northern Italy throughout the Holy Roman Empire, and in

the 15th and 16th century to northern Europe. This was followed by a number of important

innovations that took place in Amsterdam during the Dutch Republic in the 17 thcentury and

London in the 18th century. During the 20th century, developments in telecommunications and

computing caused major changes to banks’ operations and let banks to dramatically increase in

size and geographic spread (Huggson N.F, 1926).

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The banking sector in Ethiopia is recent phenomena. It begins around the end of 19th century

during the reign of Emperor Menelik II. The emperor made agreement with Mr. Ma Gill ivory,

representative of the British owned National Bank of Egypt. Following this the first bank, Bank

of Abyssinia, was inaugurated in February 16, 1906 by the Emperor. The bank was totally

managed by the Egyptian National Bank. In 1931 Bank of Abyssinia was legally replaced by

new bank, Bank of Ethiopia after Emperor Haile Sellasie came to power (NBE, 2004).

During the Italian invasion, the Italians established branches of their own banks, namely Ban

cod’ Italia, Ban cod’ Napoli and ban cod’ Nazionale Del Livorno and started operation in the

main town of Ethiopia. However, they all ceased operation soon after liberalization except Ban

cod’ Roma and Ban cod’ Napoli which remained in Asmara.

After the Italian invasion, the National Bank of Ethiopia started its operation in January 1946

with more power and duties. Commercial Bank of Ethiopia took over the commercial banking

activates the former state Banking of Ethiopia. It starts operation in January 1964 with a capital

of Ethiopian 20 million birr. In the new commercial bank of Ethiopia, all employees were

Ethiopians (NBE, 2004).

In line with the new banking law which requires at least 51 percent Ethiopian reserve or capital

rather than foreign capital, the Addis Ababa Bank was the first bank, owned privately,

established by Ethiopian shareholders in collaboration with National and Gridley bank.

Following the declaration of socialism in 1974, the government extended its control over the

whole economy and nationalized all large corporations. Organizational setups were taken in

order to create stronger institutions by merging those that perform similar functions.

Accordingly, the three privately owned banks; Addis Ababa Bank, Banco’ de Roma and Napoli

merged in 1976 to form the second largest bank in Ethiopia called Addis Bank. Then Addis Bank

and Commercial Bank of Ethiopia S.C were merged by proclamation number 184 of August 2,

1980 to form the sole commercial bank in the country till the establishment of private

commercial banks in 1994. The financial sector that the socialist oriented government left behind

constituted only three specialized commercial banks and each enjoying monopoly in their

respective market namely; Construction and Business Bank, Commercial Bank of Ethiopia and

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Agricultural and Industrial Development Bank.(Ibid)

In line with its market economic policies, the government of Ethiopia allowed the establishment

of private banks and insurance companies in 1994, but prohibited foreign ownership of such

companies. Today, the Ethiopian banking sector comprises a central bank, three government

owned and sixteen private commercial banks. Namely; Abay Bank SC, Addis International

Bank, Awash International Bank, Cooperative Bank of Oromiya, Bank of Abyssinia, Berhan

International Bank, Bunna International Bank, Dashen Bank, Debub Global Bank, Enat Bank,

Lion International Bank, Nib International Bank, Oromiya International Bank, United Bank,

Wegagen Bank and Zemen Bank. (Ibid)

The main objectives of these private banks are to deliver competitive efficient and

customeroriented banking services and thus fostering sustainable growth and profitability.

1.2 Statement of the ProblemBanks constitute an important segment of the financial infrastructure of any country. The

economic history of many countries reveals that economic development and growth of financial

infrastructure go in hand in hand. There is interaction between the two. Without the growth in the

financial infrastructure, there can be no development and the latter in turn changes the shape and

size of the financial institutions. (M.Radha Swamy and S.V. Vasudevan, 1980)

Banks in low or developing income countries like Ethiopia play a significant role and contribute

a lot to the economic growth and development of countries. On the basis of this, nowadays,

especially after the EPRDF government declared liberal economic system, the number of banks

operating in the economy has been growing by very high rate from day to day. From this it can

be understood that the role and performances of these private commercial banks is increasing as

well. Since expansion of the financial infrastructure is highly interacted with economic growth.

It is generally acceptable that deep and careful evaluation of performance of banks operating in

the economy using appropriate methodology and performance indicators will increase the role

and contribution of banks in economic growth. There are many studies conducted on the roles

and performance of private banks to the growth of the economy. However, most of these studies

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lack incorporation of standard measurements of banks performances and hence the roles played

to the economy.

For example; Tewedros 2007 tries to see the performance of Dashen Bank and its role to the

Ethiopian economy by considering deposit mobilization and credit allocation by the bank. But

measuring performance of a bank by using deposit mobilization and credits provided ignores

other performance of the bank like profitability and branch expansion.

The study conducted by Lidya 2014 showed that performance of a bank is measured by its cost

effectiveness in different other perspectives. These perspectives include cost effectiveness in

customer servicing, cost effectiveness in applying technology to the bank and cost effectiveness

in general day to day activities of the bank. But cost effectiveness by itself could not measure

performance of a bank. Performance is beyond being cost effective.

This study this will try to fill the gap that performance of Dashen Bank in particular and banks in

general is not only measured by the above variables considered by the researchers but also by

considering profitability, credit allocation, resource mobilization and branch expansion of the

bank. Beyond these performances, the bank contribute to the economy by mobilizing capital;

creating employment opportunities and human capital development and giving sector specific

loans.

1.3 Objectives of the studyThe general objective of this study is to assess the role and evaluate performance of Dashen Bank

SC and to give highlights on the current status of this bank in the banking industry.

The specific objectives are:

To assess the performance of Dashen Bank SC in deposit mobilization,

credit allocation, profitability and branch expansion.

To analyze the role of private commercial Banks for the growth of the

Ethiopian economy through their deposits and investments.

To assess problems that face private banks in general and Dashen Bank in

particular.

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1.4 Significance of the StudyConsidering the role of private commercial banks in the financial sector and their contribution in

enhancing the development of other sectors, this evaluation of performance will help for policy

makers and to the top management of the banks to develop ways of improving their performance.

And also it may help as a reference for further studies.

1.5 Limitation and Scope of the StudyThis study covers the role and performance of Dashen Bank SC to the Ethiopian economy

covering the period from 2004 to 2013. Due to the lack of data many other performances of the

bank could not be assessed.

1.6 Methodology and Data SourceThe data source of this study is secondary data from banks, magazines, research papers, manuals,

annual reports of Dashen bank SC, annual report of National Bank of Ethiopia and internet.

The methodology is descriptive statistical data analysis using ratios and percentages. Tables are

also to be used for data presentation.

1.7 Organization of the StudyThis paper has five chapters: the first chapter is an introductory part which gives general

background about the research problem and this particular research. The second chapter deals

with review of related literature, both theoretical and empirical on the role and performance of

private commercial banks in the economy. General overview of Dashen Bank S.C. is highlighted

under chapter three. The forth chapter is about the role and performance of the bank on the

Ethiopian economy and the final chapter is conclusion and recommendation based on the results

of the study.

CHAPTER: TWO

Review of the Related LiteratureThis chapter is going to focus on the survey of surrounding literatures on the role and

performances of commercial banks to the growth of the economy. The first part explains

institutional definitions and terms and the role of banks to economic growth theoretically. The

second part of this chapter will give emphasis to the survey of empirical studies related to the

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research. In this section, it will be tried to critically review the studies that are done on the role

and performance of commercial banks in the economy.

2.1 Theoretical Review2.1.1 Evolution and Definition of BankingAlthough the exact origin of banking is hidden, there is evidence to show that the practices of

safe keeping and saving flourished in the temples of Babylon as early as 200 B.C. clay tablets

discovered in the ruins of Babylonia indicate that credit instruments in the form of promises and

orders to pay gold and silver coins were used in the ninth century B.C. as much as promissory

notes and bank cheques are used today (Tewedros, 2007).

Banking grew out of the custom of goldsmiths, who took in their customers’ gold and silver for

safekeeping. They then discovered that then could lend such coins out, keeping certain

proportion as a reserve, since all customers were not coming for payment at the same time. In

addition, they gave their depositors receipts, which these depositors could pass on to other

people. Eventually, to make such transfers more convenient, they issued these receipts in round

in number of sums. They then become private bank notes. That is a note repayment on demand

by the banks in gold or silver (Girum, 2005).

Many practices common to banking nowadays were flourished in the Roman Empire of the

zenith of its power. Bankers accepted deposits, purchased drafts drawn on traders in the foreign

and domestic cities, made commercial loans, bought and sold mortgages, on the basis of their

maturity dates and interest was paid on time account (Daniel, 2011).

The art of banking was reappeared during the period of the renaissance which was weak for

years, when trade and commerce began to flourish in Venice and Florence. A public bank

established in Venice 1587 became a pattern for public banks established in Amsterdam 1909

and Hamburg 1618and ultimately influenced the growth of banking in England (Robinson,

1966).

In England, the banks of Lombardy had taken the initiative to start modern banking along with

their trading activities in London. But commercial banking had begun in the country in 1640,

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when merchants started receiving deposits from the public for safe custody and issued receipts of

the acknowledgments, which were being used as bearer on demand notes later on (Smith, 1991).

Banks typically developed where there was trade: at river posts along the china cost, at watering

holes on the arid plains of Asia Minor, and in the Mediterranean ports of Italy, Greece and Spain.

In Italian markets, the banco (the Italian word from which the word bank originated from and it

means a bench where the money changer sat) was where merchants deposited their gold and

silver specie for safe keeping until they selected what they wanted to buy. Then they endorsed

certificates turning over their claims for coins to the sellers of the goods. The sellers could

redeem the certified when they needed coins. Thus, during those years, conducting business

would have been much more difficult without banking (Mc Carty, 1982).

Commercial banks are joint stock companies dealing in money and credit. A commercial bank

may be defined as financial institution that accepts check able deposits of money for lending.

The most distinctive function of commercial banks is that, it accepts deposits called demand

deposits from the public which are withdraw able by means of a check (Asrat, 2006).

2.1.2 Structure of the banking systemThe term banking structure, in our context, focuses on number and the different sizes of

commercial banks operating across nation.

The structure and system of banking differs from country to country. It depends on the economic

conditions, traditions and political conditions in the countries under consideration. With the

development of banking institutions various systems of banking come in to existence. The most

important and popular banking systems are unit branching and branch banking (M.R. Swamy and

S.V. Vasudevan, 1980:556).

According to R.I Robinson, in unit banking system one corporation maintains only one office or

place of business. A bank in a small town has its correspondent bank in the city and the bank in

the city has in turn a correspondent bank in the small town. Almost half of the commercial

banking offices in United States are independent and individual units, each representing a

separate business corporation. Although the United States is characterized as a unit banking

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country, the numbers of corporations are decreasing and the numbers of branch offices are on the

contrary increasing (R.I. Robinson, 1966).

Branch banking is a system in which one corporate organization carries on its banking operation

at more than one office. In branch banking system, each commercial bank has a large number of

branches scattered all over the country and outside the country even. Thus branch banking is

another name for delocalized banking which carries all business through number of offices. The

head office is generally located in a large city and the branch operated in different parts of the

country. The best example of branch banking is British banking, but now it has become popular

in all other countries of the world (Daniel, 2011).

A comparison between unit banking and branch banking is essentially a comparison between

small scale and large scale operation. A bank having branches has advantages over the unit bank.

It provides safety that result from wider diversification in the types of the bank’s assets. The

other claim favoring branch banking is more validity of the inter office relations with in which a

branch system make a transfer of funds quick and easily promote mobility of banking resource. It

is also contended that branch banking would destroy the monopoly power enjoyed by the unit

bank in a single community. Cheap operation and provision of complete banking services are

also advantages of branch banking (R.I. Robinson, 1966).

2.1.3 Banking in Developing CountriesRecently in developing countries, the central issue of economic development is the problem of

mobilizing or allocating resources for growth in such a way that growth becomes sustained. It is

obvious that the growth of production is mainly determined by the rate of capital formation.

Capital investment raises productivity and productivity in turn initiates development, which is

great concern of every country. Any rise of the investment rate requires proportion of aggregate

production of the national product to be saved. Subjected to the low level of income in

developing nations, it is difficult to raise the rate of net domestic savings in the shortrun. In the

long run, however, the intermediation process of financial institutions there is more reliance on

domestic savings which lies on the rate of financial institutions particularly banks in attracting

saving from the public channels in to productive involvements (Taye, 2010).

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The type of national economic system that characterizes developing countries plays a crucial role

in determining the nature of the banking system in those countries. In capitalist countries, a

system of private enterprises in banking prevails. In state-managed economies, however, banks

have been nationalized. In Egypt, Peru and Kenya, government and privately owned banks

coexist. In many countries, in which the banking system developed under colonialism, the banks

were owned by institutions in the parent country. In some countries, such as Zambia and

Cameroon, this heritage continued, although modified after decolonization. In other nations like

Nigeria and Saudi Arabia, the rise of nationalism led to ownership by majority of indigenous

population.

2.1.4 Role of Commercial Banks in a Developing EconomyBanks play a very useful and dynamic role in the economic life of every modern state. They are

important constituents of the money market; and their demand deposits serve as money in

modern community. Thus, they have control over a considerable part of the stock of money. In

fact, their lending and investing activities are sources of changes in the quantity of money

circulating in the economy which in turn influences the nature and character of production.

Banks are also the pivots of modern commerce (Asrat, 2006).

Banks in developing countries play an effective role in their economic development. It is obvious

that people in those countries are poor, unemployed and engaged in traditional subsistence

agriculture. There is shortage of capital and the means of transport are under developed.

Therefore, commercial banks help to overcome these obstacles and promote economic

development (Ibid).

The role of commercial banks to economic growth of the under developed countries may be

summarized as follows

1. Promoting capital formation: the commercial banks help in mobilizing savings

through a network of branch banking. Developing counties need higher rate of capital formation

to accelerate the trend of economic development. But the rate of capital formation depends on

the rate of saving. Besides the low incomes of people in developing countries, commercial banks

induce them to save by introducing various deposit schemes. By mobilizing savings, the banks

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channelize them into productive investments. Thus, commercial banks help in capital formation

of developing countries.

2. Financing industry: by providing short term, medium term and long term loans to

finance the industrial sector.

3. Encouraging innovation: innovation is one of the factors that are responsible for

economic development. The role of entrepreneurs in innovation is largely dependent on

the way in which bank credit is allocated and utilized in the process of economic growth.

Bank credit enables the entrepreneurs to innovate and invest, and thus uplift economic

activity and progress.

4. Monetization: banks are the manufacturers of money and they allow money to play its

role freely in the economy. Banks monetize debts and also they assist the backward

subsistence sector of the rural economy by extending their branches into the rural areas.

5. Financing trade: the commercial banks help in financing both internal and external

trade. Banks provide loans to retailers and wholesalers to stock goods in which they deal.

They also help in the movement of goods from one place to another.

6. Financing innovation: commercial banks help the agriculture sector in under

developed nations in a number of ways. They provide loans to traders in agricultural

commodities. They also provide credits to farms through their extended branches.

7. Influence economic activity: banks influence economic activity in a country by

influencing rate of interest. They can influence the rate of interest in the money supply through

their fund supply.

8. Help in money supply: monetary policy of a country should be conducive to

economic developments. But a well-developed banking system is an essential precondition to the

effective implementation of monetary policy.

Commercial banks also finance consumer activities and employment generating activities.

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2.1.5 Performance Measurements2.1.5.1 Theories on measuring bank performancePerformance, as defined by Lessier (1996), is a means of evaluating how effectively and

efficiently organizations use resources to achieve their objectives. The performance of

commercial banks is judged by many factors. For the sustainability of commercial banks,

profitability is a very significant factor and can be used to measure the performance of

commercial banks (Dagmawi, 2011).

Commercial bank performance can be measured using either macroeconomic or financial

indicators. Macroeconomic indicators include economic growth, balance of payment, inflation,

interest and exchange rates. Financial indicators on the other hand consists of profitability,

capital adequacy, risk vulnerability, asset growth reserve requirement, capital adequacy, market

share and branch expansion (IMF, 2005 cited in Edossa, 2009).

Pertaining macroeconomic indicators in recent studies have explored that macroeconomic data

such as those stated above can be used to evaluate a bank’s performance. This analysis is a key

building block of any policy framework on vulnerability analysis. In other words this analysis

focuses on the health and stability of financial systems.

Microeconomic analysis uses financial indicators to evaluate the performance of commercial

banks and focuses on individual financial institutions. However, there is no a general agreement

between scholars on the use of either macro or micro analysis to examine the performance of

banks. But many scholars consider financial indicators as the most obvious performance

indicators that can be used to evaluate the performance of commercial banks in aggregate as well

as individual level. They more or less agree that these indicators are simple to calculate, easy for

comparison, and the data they need are abundant or mostly are not confidential. These indicators

are available in the bank’s balance sheet and statements of profit or loss are related to the

soundness of the banking system (Dagmawi, 2011).

2.1.5.2 Financial indicators as measures of bank performanceThe following some are among financial indicators that are used to evaluate performance of a

bank.

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A) Profitability

According to Miller and Vanhoose (1993), the most widely accepted measure of bank

performance is their current profitability. Profit can be obtained by subtracting expense and tax

from gross income of the bank. For our case, Return on Equity (RoE), and Return on Asset

(RoA) can also be considered as profitability measures.

Return on Assetof a depository institution measures the net income or profit as a percentage of

total assets. This measure provides an indication of the profitability of bank’s assets and

therefore is especially useful in making comparisons of different types of asset categories

profitability.

Return on Equity measure of profitability is the ratio of total net income to the depository

institution equity capital; it provides a measure of how profitable are ownership share of the

depository institution is particularly useful when comparing profitability of depository

institutions.

Current profit alone, however, cannot permit one to judge the long term performance of a bank.

Because, by the nature of their business current profits could be a misleading indicator of banks;

if they have made loans that will perform poorly in the future (NBE, 2001 cited in Asrat, 2006).

Therefore, a variety of the measures of a bank are considered beyond profitability.

B) Asset Growth

For any individual or firm, including a banking firm, an asset is any item legally owned by that

person or business that has a market value. For instance, when a commercial bank makes a loan

to a business, that loan represents a legal obligation of the business to repay the loan principal

and interest to the lending bank within the specified period. Consequently, the loan is an asset of

the bank (Miller and Vanhoose, 1993).

Miller and Vanhoose categorized the key assets of commercial banks in to three, which are loans,

securities, and cash assets. Loans include commercial and industrial loans, real estate loans,

consumer loans, and very short term loans that banks make in the federal funds market or

through purchases of repurchase agreement. Securities include government securities and

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municipal and state bonds. Cash assets include vault cash, reserve deposits at Federal Reserve

banks, correspondent balances, and cash items in the process of collection.

Therefore, asset growth can be considered as another important measure of performance.

Measuring the growth or decline of banks’ assets over time provides a reasonable indicator of both their current and long term performance (ibid cited in Dagmawi, 2011).

C) Capital adequacy and reserve requirement

Another measure of performance is the amount, price and growth of their equity capital. If

investors regard the banking industry as healthy and potentially profitable in the future, they

should be willing to hold shares of ownership in the industry. If the industry is particularly

healthy, the growth of equity capital ownership in the industry should be very strong. In addition,

the prices of bank shares, bank stock prices, should be relatively high and stable (Miller and

Vanhoose, 1993).

A banks capital includes equity shares and other items that assist in protecting the insured deposit

accounts from losses in the event of failure. Capital requirement are legally imposed limitations

on the amounts of assets that banks may hold in relation to their capital. These requirements are

imposed in the form of minimally acceptable ratios of total capital to assets.

The main objective of imposing higher capital requirements on banks is to encourage bank

managers to operate in less risky ways. Since deposit insurance can encourage bank managers to

make riskier loans than they might otherwise, higher capital requirement will reduce this

incentive. The other objective is to increase the size of the cushion protecting depositors, more

directly the deposit insurance fund, from losses in the event of the bank failure. The third

objective of stiff capital requirement is to increase the public’s confidence in the banking system.

Higher capital requirement may attract depositors and regard the bank as less prone to failure. If

enough depositors share this perception, the chance of the bank running out of money or issuing

bankruptcy will be reduced (Dagmawi, 2011).

The concept of required reserve was started at the beginning of the 19th century when bank

panics reached their highest level. The panics occurred when people attempted to run their bank

deposits into currency at the same time. Since the supply of currency was fixed and smaller than

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the amount of bank deposit, these ensured bank failures and economic downturns. Immediately

after this situation, agitation and discussions followed and in 1918 the Federal Reserve System

was created in the United States of America (Ibid).

Required Reserve is the value of reserves that a depository institution must hold in the form of

vault cash or in a reserve account with the central bank. However, this does not mean that the

bank needs to hold a hundred percent reserve on its transactions balance liabilities. Rather, it is

required to hold only a fractional reserve; it lends out part and keeps the other part on reserve at

all times (Miller and Vanhoose, 1993).

The reason for the requirements of banks holding reserves is to build public confidence in

converting the deposits into cash. This reserve requirement, called reserve ratio, is usually

expressed as a ratio to the total deposits of the bank. This could be set down by regulation hence,

mandatory ratio or left to the banks own judgment hence prudential ratio (ibid).

D) Market share and branch expansion

Market share is the proportion or total sales of a product by a company in a given market. Market

share can be calculated in terms of units sold. Markets may be defined geographically by city,

region, country, continent or the world- or markets may be calculated according to some other

distinguishing characteristics, like age group, social class or ethnicity. However, the more

specific the market segment the more difficult it is to get accurate data. The products may be

defined narrowly or broadly (www.wikipedia.com).

Market share is an indicator of success of a company’s marketing policy. The company that has

the largest market share for a given geographical market is said to be the market leader in that

market. The importance that companies attach to market share varies according to the culture of

the economy or business. In countries like United States, Canada and most of Europe, companies

tend to focus on profit, even though market share is a key determinant of profit. It is popular for

Japanese companies to invest hugely in order to gain market share and to give higher emphasis to

long-term success rather than profits in the short run (Asrat, 2006).

Reasons that a firm may seek to increase its market share include economies of scale in which

higher volume can be instrumental in gaining a cost advantage, sales growth in a stagnant

14

industry (in a situation when the industry is not growing, the firm still can raise its sales volume

by increasing its market share), is a reputation that market leaders benefit from their power

which they can use to their advantage, and increased bargaining power where a large player has

an advantage in negotiations with suppliers and channel members (ibid).

On the other hand, an increase in market share may not always be desirable. For example, if the

firm is near production capacity, an increase in market share might necessitate investment in

additional capacity. If capacity is underutilized, it will result higher costs. Secondly, overall

profits may decline, if market share is gained by increasing promotional expenditures or by

decreasing prices. Additionally, antitrust issues may arise if the firm dominates the market

(Dagmawi, 2011).

Market share can be increased by changing the variables of the market mix such as product,

price, distribution and promotion. The product attribute can be changed to provide more value to

the customer, for example, by improving product quality. The price variables can be used if the

price elasticity of demand is elastic (that is greater than one). Then a decrease in price will

increase sales revenue. This tactic may not succeed if competitors are willing to meet any price

cuts. The distribution variable works by adding new distribution channels or increase the

intensity of distribution in each channel. The promotion variable is simply increasing in

advertising expenditure in a way to increase market share, unless competitors respond with

similar increase (ibid).

Therefore market share can be used to measure a bank’s performance. A banks market share can

be measured by the amount of capital they hold, loans they disbursed and deposits they received

from the public. In a nut shell, it is related with the level of competition that exists in the banking

industry among banks. The more a bank has larger amount of capital, deposits and loans as

compared to competitors, the more it controls the market. This concept is highly related with

branch expansion and the type of services rendered by banks (Tamiru, 2003).

A branch may be defined as a separate structure from the main office of the bank that accepts

deposits. It may do other things such as extending loans. But generally, the key function for the

legal distinction is offering deposit services. Laws governing the number and type of branches

15

may affect the amount of deposits a bank can obtain as well as type of local competition it faces

from other banks and financial intermediaries (Auebach, 1985).

Branch banking is essential to a banks survival. Branching is not just a costly endeavor by banks

to provide customer convenience, but increased branching lowers a banks average operation cost.

Typically, the banks that are not permitted to branch banking experience diseconomies of scale.

This means that these banks are forced to have an efficiently large banking office because they

cannot run branches which in turn lead to the conclusion that branch banking restriction leads to

inefficiency and decline in performance (Vaish, cited in Dagmawi, 2011).

E) Risk vulnerability

Uncertainty, with all its attendant excitement and frustration, is unavoidable. Life is filled with

uncertainty, ranging from tomorrow’s weather, to the success of marriage to war and peace.

Bank, too must confront the unknown (Miller and Vanhoose, 1993).

Banks, unlike other organizations are much vulnerable to various types of risks. These risks

emanate from structural and managerial inefficiency of each bank or the regulation under which

the concerned banks are administered. Among the risks, solvency and interest rate risks are vital

(Girum, 2005).

The credit risk is the uncertainty that arises from the collection of loans. The probability that

some bank’s asset value especially, its loans will decline and perhaps becomes worthless is

known as credit risk. The inability to meet depositor’s sudden withdrawals is the uncertainty

attached with liquidity risk. In this connection, banks are very much concerned about the danger

of not having sufficient cash and borrowing capacity to meet deposit withdrawals, net loan

demand and other cash needs (Dagmawi, 2011).

Movements in market interest rates can also have powerful effects on a bank’s margin revenue

over operating expense. The impact of changing interest rate on a bank’s margin of profit is

usually known as interest rate risk. If the bank takes on an excessive number of bad loans or if a

large portion of its portfolio declines in its market value, generating serious capital losses when

sold, then its capital account, which is designed to absorb such losses may be overwhelmed. This

16

brings the bank’s long run survival in danger and the uncertainty attached with this is known as

solvency risk (Ritter, 2000).

F) Managerial capacity

The bank managers attempt to maximize shareholders’ wealth. In effect, bank managers create

both risks and returns for the bank’s shareholders when they provide financial service. A bank

manager can select some asset liability portfolio that has a higher potential return but is more

risky, or the manager can select a different asset- liability portfolio that is less risky but earns a

lower rate of return. Therefore, the equality of the banks’ management in decision making is also

important factor in making a difference in the banking industry (Asrat, 2006).

2.2 Empirical Literature ReviewCommercial banks exist because of the various services they provide to sectors of the economy;

e.g., information services, liquidity services, transaction cost services, maturity intermediation

services, money supply transmission, credit allocation services, and payment services. Failure to

provide these services or a breakdown in their efficient provision can be costly to both the

ultimate sources (households) and users (firms) of savings, as well as the overall economy. The

effect of a disruption in the provision of the various services on firms, households and the overall

economy when something goes wrong in the commercial banking sector makes a case for the

need to monitor performance and market value. For example, deterioration in a commercial

banks performance and value to the point that the bank fails may destroy households’ savings

and at the same time restrict a firm’s access to credit (Marcia M. Cornett and Hassan Tehranian,

2004).

If money is essential for developing into a modern economy, a banking system is almost as

important. Nearly a thousand years ago, bankers began holding money for depositors, and

eventually creating new kinds of money to satisfy the growing needs of an expanding economy

(Mc Carty, 1982).

In every economy, commercial banks occupied a major concern of economists, researchers,

financial analysts and policy makers because of the important role they play. Many of the

17

previous studies show that a strong link exists between the commercial banks and overall

performance of the country.

King and Levine (1993) researched cross country data of 80 countries. They measured financial

sector development with considering their performance after controlling other sectors influencing

economic growth and found a strong positive relationship between each performance indicator of

commercial banks with economic growth. Levine and Zervos (1995 and 1998) researched in

addition to the banking sector also the stock markets by cross country analysis and they found

that stock market liquidity and bank development are highly correlated with economic growth.

However, the variables measuring the financial sector development and thus the research of

causality in these studies were strongly criticised by Rajan and Zingles (1998). They argued that

both the growth of financial sector and economic growth can be driven by a common variable

such as the saving rate, the amount of credit and size of stock market because of the fact that

financial markets anticipate future economic growth.

The quarterly bulletin of Bank of England, quarter one of 2014, by Michael McLealy; Amar

Radia and Ryland Thomas discussed how money is created in the modern economy. Most of the

money in circulation is created, not by the printing presses of the Bank of England, but by the

commercial banks themselves: banks create money whenever they lend to someone in the

economy or buy an asset from consumers. And in contrast to descriptions found in some

textbooks, the bank of England does not directly control the quantity of either base or broad

money. The Bank of England is nevertheless still able to influence the amount of money in the

economy. It does so in normal times by setting monetary policy-through the interest rate that it

pays on reserves held by the commercial banks with the Bank of England. More recently,

though, with bank rate constrained by the effective lower bound, the Bank of England’s asset

purchase program has sought to raise the quantity of broad money in circulation which in turn

affects prices and quantities of a range of assets in the economy, including money.

A study by Dr.Aurangweb (2012) investigated the contributions of banking sector in economic

growth of Pakistan using Augmented Dickey fuller and Philip Person unit root test for the period

covering 1981 to 2010 on 10 banks. Regression results of the study indicated that deposits,

investments, advances, profitability and interest earnings have significant positive impact on

18

economic growth of Pakistan. The study also recommended that the policy makers should make

policies to enhance the banking sector in the country because the banking sector is significantly

contributing in the economic growth of Pakistan.

Numerous studies have examined the performance and profitability of the Greece banking

system. Zo Poundis et al (1995) dealt with the illustration of an ordinal utility model up on a

sample of Greece commercial banks for the period 1989-2002, in order to evaluate their banking

performance over multiple attributes. A multi-criteria analysis approach was applied to measure

banking performance on the basis of financial ratio.

The empirical result of the study by Aliyu Momman and Alhaji Hashim reveals that commercial

banks in Nigeria exhibit a low level of activities and a weak capacity to funds to the Nigerian

economy. Another conclusion that can be drawn from the findings of this study is banks are

important in stimulating economic growth in Nigeria. Specifically, bank lending contributed

about 86.2 percent variation in the growth of Nigerian economy during the period under review

(A. Mamman and Y.A. Hashim, 2014).

Next to this the study is going to review some of the researches conducted in Ethiopia concerning

the performance of the banking industry.

Birhan (2007), using descriptive analysis, concluded that private commercial banks improved in

deposit mobilization and loan disbursement in the time period between 1999 and 2006.

Bechene (2007) analyzed the performance of private banks in Ethiopia taking bank of Abyssinia

as a case study in the time period between 1996 and 2003 and came to the conclusion that the

bank of Abyssinia faced a huge challenge in collection of the highly increasing outstanding loans

granted by the bank due to political risk, corruption, and unexpected decline in the price of

coffee and the absence of valuable collateral during for a closure. These problems resulted in

enhancing the volume of non-performing loans that forced the bank to hold highest provision for

doubtful loans according to the directive of the National Bank of Ethiopia.

Gebre Mariam (2007) using descriptive analysis analyzed the performance of Dashen Bank in

relation to deposit mobilization, loans and advances and branch expansion. He came to a

conclusion that there was a continuous improvement through the seven operation years

19

(1999/2000-2005/2006). The bank was the highest profitable private bank in the country. In

addition, Tesfaye (2006) came to the same conclusion, by analyzing the bank’s performance

from 1999 to 2004 fiscal year. Tesfaye also added that the bank concentration in the hands of

public owned banks, particularly by Commercial Bank of Ethiopia, did not affect the

performance of private commercial banks.

Tewabech (2008) tried to assess the role and performance of commercial banks in the Ethiopian

economy and concluded that even though the commercial banks are contributing a great role to

the economy of the country, they are not equally benefiting the sectors of the economy. The main

reason according to the study was that the private commercial banks are opening branches

mainly in the cities, they cannot benefit the agricultural society living in the rural part of the

country.

Hana (2010) using descriptive analysis concluded that even if Ethiopia is a country having infant

economy, and the financial system is not developed as compared to the other countries, financial

development has a positive relationship with economic growth. She also added that private

commercial banks do not grant loans to the agriculture sector because of fear of risk. These

banks engage widely on domestic and international rate which have lower risk and short time

return compared to the agriculture sector.

CHAPTER THREE

General Overview of Dashen Bank S.C3.1 Profile of Dashen Bank S.C

3.1.1 Establishment of Dashen Bank SCThe new economic policy introduced in November, 1991 caused the culmination of the

command economic heralding the establishment of a market oriented one. This policy change

created an opportunity and conducive environment for the emergency of private financial

institutions aimed at bringing a meaningful role in the economic development efforts of the

country.

Dashen Bank was established as per the intent of the new policy and the Ethiopian investment

code. It came into existence on September 20, 1995 according to the commercial code of

20

Ethiopia, 1960, and the licensing and supervision of Banking Business proclamation number

84/1994.

The founding members were 11 businessmen and professionals that agreed to combine their

financial resources and expertise to form this new private bank.

3.1.2The Motive behind Its Name, “Dashen Bank”

Obviously, “RasDashen” is the highest mountain in Ethiopia. Beyond its length, it is also the

habitat of rare wild animals; Walia Ibex, Chelada Baboon, and the Hammergeyer-the beautiful

bone breaker eagle. These unique features of the mountain coincided with the interests of the

founding members of the bank prompted them to adopt this great name and epitomize their

aspiration. Rightly, reaching the top of the banking business in dynamic and competitive

business environment symbolized the highest peak, while the efficient and unique services the

bank caters for the public through state- of-the-art computer technology and carefully selected

and trained man-power equated with the rare wild animals. Today, indeed, reliability, efficiency

and modernity is the hallmark and the Bank’s distinguished features which make them

synonymous with Dashen Bank as much as the rare animals are synonymous with RasDashen

Mountain.

3.1.3 The Business Purpose of the BankThe business purpose of the bank as enshrined in its basic documents is to render commercial

banking activities both at domestic and international levels.

3.1.4 Mission of Dashen Bank“Provide efficient and customer oriented domestic and international banking services,

overcoming the continuous challenges for excellence through the application of appropriate

technology”.

3.1.5 Vision of the Bank“In as much as mount Dashen excels all other mountains in Ethiopia, Dashen Bank will continue

to prove unparalleled in banking service”.

Source:www.dashenbanksc.com

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3.2 The Legal and Policy EnvironmentBefore analyzing the performance of Dashen Bank, it is important to review the legal framework

and the policy environment under which the bank is operating. A properly designed legal and

policy environment will provide a safe environment for the bank to perform well and in turn

determine its performance. Therefore, this section explains how government policies influence

the selected bank and its competence in the banking industry.

Banks are not expected to perform well if they are not properly regulated. The importance of

financial sector regulation is emphasized based on the assumption that markets are not best

dynamic regulators and the likelihood of market failures.

If there is inadequate bank regulation, banks may be inclined to lend to borrowers with

potentially high yielding investment projects (in search for higher return) that are more risky.

This in turn will increase the risk of default on bank loans and eventually may lead to financial

instability and bank failures. The desire of regulatory agencies to prevent bank failures had led

them to specify minimum requirement for the bank equity capital and restrict the amount of risky

asset that the bank can hold. In accordance to the above argument, the Ethiopian case will be

presented next.

3.3.1 The Legal frameworkThe National Bank in Ethiopia is the regulatory agency that provides licenses, supervise, and

regulate banks and other financial institutions. “Monetary and Banking Proclamation No.

83/1994”, defines the powers and responsibilities of the bank. In addition to defining NBEs

duties and responsibilities, the proclamation specifies the capital and reserve requirements, and

the needed financial statements. Proclamation No. 84/1994, on the other hand, outlines the

requirements and procedures for undertaking a banking business in Ethiopia.

In line with the above proclamations, the National Bank of Ethiopia set the following financial

obligations and limitations.

A) Maintenance of the Required Capital

In accordance with Directive No. SBB/24/99 of Article 13(1) and 36 of Proclamation No.

84/1994, the minimum paid up capital of any bank should be birr 75 million, which shall be fully

22

paid in cash or maintain minimum total capital levels not less than 8% of risk weighted assets. If

a bank fails to comply with the capital requirements specified above, the National Bank of

Ethiopia may prohibit such bank from engaging in any additional business until the deficiency on

capital is corrected; require such bank to merge with another bank; close such bank; or take away

other measures it considers fit. And these directives were enforced as of the first day of June,

1999.

B) Maintenance of Legal Reserve

Article 41 of the Monetary and Banking Proclamation No. 83 1994, and Article 13(4) of the

Licensing and Supervision of Banking Business Proclamation No. 84 1994, require every bank to

transfer annually 25% of its annual net profit to its Legal Reserve Account until such account

equals its capital.

When the legal reserve account equals the capital of the bank, the amount to be transferred to the

legal reserve account shall be 10%of the annual profit. These Directives were enforced as of 21st

day of August 1995.

C) Maintenance of Adequate Liquidity

Article 16 of Proclamation No. 84/1994 imposes a liquidity requirement on banks to maintain

liquid assets amounting to not less than 15% of their total current liabilities to avoid critical asset

or liability mismatches.

For the purpose of this article, liquid assets shall include: cash, deposits with the National Bank

and other local and foreign banks having acceptance by the National Bank, other assets readily

convertible into cash expressed and payable in Birr or foreign currency having acceptance by the

National Bank, and such other assets as the National Bank may from time to time declare to be

liquid assets.

D) Maintenance of adequate reserve balance

Article8; 2.1 of Directives No. SBB/45/2008 states that, any bank operating in Ethiopia shall at

all times maintain in its reserve account 15% of all birr, and foreign currency deposit liabilities

held in the form of demand (current ) deposits, saving deposits and time deposits.

23

Deficiencies in reserve balance are subject to a penalty and the penalty shall be assessed at a rate

twice the current average rate of interest on loans and advances charged by banks, computed on

the amount of the deficiency in reserve and multiplied by the number of days over which the

reserve account remained deficient. The National Bank may waive the penalty stated here in

above grounds it considers acceptable.

E) Elimination on Accommodation

Article 41 of the Monetary and Banking proclamation No. 83/1994 and article 71(1) of the

Licensing and Supervision of Banking Business Proclamation No. 84/1994 state that no bank

shall, directly or indirectly, except with the written approval of the bank, grant or permit

unsecured loans, advances or credit facilities of an aggregated amount in excess of birr 30,000

(thirty thousand Birr) to its directors, whether severally or jointly with any person. This

limitation was enforced as of September 1st 1995.

F) Limitation on Investment of Banks

These directives are issued by the National Bank of Ethiopia pursuant to the authority vested in it

by article 41 of the Monetary and Banking Proclamation No. 83/1994 and by article 36 of the

Licensing and Supervision of Banking Business Proclamation No. 84/1994.

1) No bank shall engage in insurance business but mat hold up to 20% in an insurance

company and up to a total of 10% of the bank’s equity capital in such business.

2) Banks are prohibited from engaging directly in non-banking businesses such as

agriculture, industry and commerce.

3) A bank may hold shares in a non-banking business only up to 20% of the company’s

share capital and total holdings in such business shall not exceed 10% of the bank’s net

worth.

4) A bank’s equity participation in another bank shall be subject to prior authorization by

National Bank of Ethiopia.

5) No bank shall commit more than 20% of its net worth in real estate acquisition and

development other than for own business premises without prior approval of the National

Bank of Ethiopia.

24

6) A bank may not invest more than 10% of its net worth in other securities.

7) The aggregate sum of all investments at any time (excluding investment in government

securities) may not exceed 50% of the bank’s net worth, without prior approval by the

National Bank of Ethiopia.

8) Dealing in securities shall be done by banks only through a limited liability subsidiary

company where in the holdings of the bank shall not exceed 10% of its equity capital.

These Directives were enforced as of April 8, 1996.

3.3.2 The Policy AspectAnother way of regulating the banking industry is by setting the interest rate and foreign

exchange policies. These policies affect a bank’s profit and competition strategy and can be

used as a regulating mechanism by the central bank. In accordance with this, the National

Bank of Ethiopia has the power to set the rate and implement foreign exchange policies.

3.3.2.1 Interest Rate PolicyInterest rate is among the most closely watched variables in the economy. Their movements

are reported almost daily by the news media, because they directly affect our everyday lives

and have important consequences for the health of the economy. They affect personal

decisions such as whether to consume or save, whether to buy a house, and whether to

purchase bonds or put funds into a savings account. Interest rates also affect the economic

decision ns of businesses and households, such as whether to use their funds to invest in new

equipment for factories or to save their money in a bank.

Banks derive most of their profit from interest differences that exist between deposit rates

and the lending rates. Banks can also attract potential savers by increasing deposit rates and

oppositely attract investors by lowering lending rates. These methods can be used as a

marketing strategy if interest rates are set by the banks themselves or are not regulated by the

central bank.

In relation to the above discussion, interest rates policy changes through the past ten or

eleven years are reviewed as follows. After the fall of the Dergue Regime, a series of reform

measures were taken in the banking industry. The reforms regarding interest rates began with

the raising of both deposits and lending rates in October 1992. The adjustments were aimed

25

at ensuring real interest rates structure and abolishing interest rate discrimination by

ownership and sector. Subsequently, in august, 1994, the preferential interest rate on lending

to selected economic activities were banned. Then in 1995, minimum deposit rate and

maximum lending rates were set for the banking sector as a ground for competition among

banks. Hence, the maximum lending rate and the minimum deposit rate were set in 1996 at

15% and 10% respectively, holding the 5% difference as a margin.

By September 1996, a dramatic downward change in both rates has been observed, so that

deposit rate has been set at 7% and lending rate at 10%. Then in January 1998, the system of

minimum deposit and maximum lending rate as a whole were left to the bank’s own

discretion.

Another interest rate structure change was recorded on March 4, 2002. The floor deposit rate

was reduced taking it to account the global economic slowdown and its likely consequence

on the Ethiopian economy. In response to this situation, the National Bank of Ethiopia

revised the minimum floor on savings and time deposits from 6% per annum to 3%. As a

result, the average deposit rate dropped from 6.51% in the previous years to 3.47% and

average lending rate was down from 12.75% to 10.25%. Finally, on July4, 2007 National

Bank revised the minimum saving rate and the time deposit rate to be 4% and 5%

respectively. The average lending rate has also been increased to 11.5% in that same year.

In a nutshell, these interest rate fluctuations affect profits and competition strategies of the

banks that are operating in the economy. So it is highly recommended that interest rates

should be properly regulated to ensure the proper functioning of a bank and the economy as a

whole.

3.3.2.2. Foreign Exchange PolicyBefore setting the proper foreign exchange policy, the government should select what it

thinks is the best exchange rate regime. The choice is determined by various factors, such as

the objectives pursued by the policy makers, the sources of shocks hitting the economy and

the structural characteristics of the economy. But once the choice s made, the authorities are

expected to adjust their macroeconomic policies to fit the chosen exchange rate policy.

26

Considering the underlying economic situation, managed floating exchange rate regime is

practiced in Ethiopia since 1992.

In the year 1993, Ethiopia adopted the auction exchange rate discrimination system. The

auction was held among bidders on a two weeks basis and has allowed a nondiscriminatory

distribution of foreign exchange and could be capable of decreasing the gap between the

official and parallel foreign exchange replacing the weekly wholesale foreign exchange rates.

But, as part of the efforts to liberalize foreign exchange market and with the view of

achieving a market determined exchange rate system, the daily interbank foreign exchange

market, October 25th 2001, replaced the weekly wholesale foreign exchange auction.

The development has brought three major changes in the foreign exchange market. First, the

National Bank of Ethiopia is no more a sole provider of foreign exchange. Secondly,

participant banks freely determine the exchange rate in the currency trading, based on

demand and supply conditions. Finally, the official exchange rate is determined on the daily

basis.

. 3.4 Problems Faced by Dashen Bank SC

Although Dashen Bank is expanding its branches, its profit is increasing from time to time, the

amount of capital disbursed and total capital is also growing since its establishment, it faces

variety of problems. These problems were presented in different ordinary and extra ordinary

general meetings of shareholders. These challenges will be discussed by dividing them in to

internal and external as follows. The internal problems occur within the bank and can be

addressed by the bank’s managerial staff. On the other hand, external problems occur in the

banking industry and specifically affect Dashen Bank directly or indirectly.

3.4.1 Internal Problems Problems related to structure of branch expansion

With respect to branch expansion, Dashen Bank concentrates more on opening branches in Addis

Ababa. At the end of 2013, the bank has 63 branches in Addis Ababa while there are 67 branches

in the rest of the country. Thus, Dashen Bank’s concentration in urban areas which creates low

opportunities for the rural society to use the bank’s services.

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Problems related to deposit mobilization

Despite the fact that Dashen Bank is one of the leaders in mobilizing deposits, its source of

loanable funds is dominated by saving deposits followed by demand deposits. The bank’s saving

deposit constituted 66.7%, while the demand deposits constitute 26.9% and time deposit

accounted for 6.4 % of total deposits in the year 2013. This implies that, time deposits are very

low, which could be loaned for a long period of time and generate higher income.

Problems related to extending loans and advances

In Ethiopia, private commercial banks in general and Dashen Bank in particular has got a

problem related to extending loans and advances. By far, the loans and advances of Dashen Bank

were growing through time even though it is below its potential. This problem can be attributed

to different factors. One of the factors is the absence of sound financial records of customers

(unavailability of the necessary data). The other is the restriction made on branch managers by

the bank to give certain volume of loans by their authority.

Problems related to capital base

Unlike government owned banks, private commercial banks including Dashen Bank, suffer from

low amount of capital. And a bank’s loans and advances are highly dependent on capital. This is

because loans are disbursed on some percentage of capita the bank sets. As a result, the bank is

restricted from giving loans even when it wants. And whatever justification the bank has, it

cannot land beyond the limit. Because of this, the bank loses potential customers. This again has

a negative impact on income and consequently on earnings per share of the bank.

3.4.2 External problems Regulations and directives issued by the National Bank of Ethiopia

As a financial institution, Dashen Bank is regulated by the National Bank of Ethiopia. The

regulations are strict and tight. One of the regulations that affect the bank is the limitation on

investment. This regulation prohibit the bank from directly investing in non- banking business

activities such as agriculture, industry, and commerce which are profitable and can help the bank

in securing higher capital amounts.

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Attitude of the customers towards credit

The other external problem of private banks particularly Dashen Bank is the society’s bad habit

of credit. Due to this, the bank’s loan portfolio quality becomes bad. The major reasons behind

this are the fact that borrowers default because of loan diversion and misuse. As a result, Dashen

Bank always requires reducing performing loans according to the commercial bank’s follow up

reports.

Lack of infrastructure and skilled labor

Dashen Bank is attempting to deliver efficient and competitive services to customers through a

computerized and integrated system. Despite these attempts, the system requires adequate

infrastructure suchas telephone, electric and internet services, which are not available readily. On

the other hand, the lack of skilled labor has been affecting the bank. Although there are many

fresh university and college graduates, they lack the knowledge and skill to perfectly work in a

bank. To solve this problem, the bank can train potential employees but the process will be costly

and exhausting.

Weak legal court system

Poorly functioning court systems hinder the bank from properly functioning and continuing its

services to public. In our country, contracts related to negotiable instruments like checks,

property rights and collateral are not properly enforced. And if they are properly enforced, which

rarely occur, consume a lot of time and money. In a nutshell, this kinds of situations negatively

affect the bank’s capability to properly secure its assets and as well as its profits.

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CHAPTER FOUR

Data Presentation and AnalysisIn this chapter, the performance of and roles of Dashen Bank to the Ethiopian economy will be

assessed. The first part of this chapter is going to focus on the tabular presentation of

performance indicators of the bank as discussed by far. And in the second part of this chapter, its

contribution to the economy is going to be shown.

4.1 Performance Evaluation4.1.1 Branch ExpansionIt is often argued that branch expansion by commercial banks is a great contribution for an

increase in the savings propensity of a nation. From experience, it is observed that the amount of

savings depends partly on how wide spread financial institutions are, that if “if they are pushed

right under the individuals nose” people will save more than if the nearest saving institution is

some distance away. Statistical evidences also seem to support the hypothesis that the greater the

numbers of financial intermediaries, the larger will the amount of national savings (Fanaye, 2001

as cited in Asrat, 2006).

Theoretically, there are two approaches involved in the theory of growth of financial institutions

(Patrick, 1996). The first approach is the demand following approach. In this approach, emphasis

is given to the demand side of financial institutions. As an economy grows, new and increased

demands for such institutions are created which will match with the supply response of the

growing financial system. Thus, the demand for services of financial institutions depends on the;

growth of real production and development of commercialization of the whole economic system.

According to this argument, the shortage of financial institutions in developing countries is

merely due to lack of demand for them.

The second approach is the supply- leading approach where the creation of financial institutions

and supply of their services is provided before the demand for them is created. This argument

serves the purpose of transferring resources from the traditional to the modern sector of the

economy and creating entrepreneur values. The supply leading approach is assumed to greatly

motivate entrepreneurs to open new horizons on possible business alternatives which serve a

30

significant purpose especially in developing countries where entrepreneurship is a major

constraint to development.

The branch banking by far was the most important commercial banking system. In this system, a

single bank operates in the country through a country wide network of branches. This system

banking has a strong influence ondeposit mobilization. In most cases, branch expansion and

deposit mobilization are positively correlated. So as banks expand in branches, the amount of

deposits mobilized will also increase. Thus, in countries like Ethiopia where the saving rate is

low, the opening of commercial bank’s branches in different areas will facilitate the saving habit

of people and create a relatively easy access to bank credit.

In 1994, after the financial liberalization was introduced in the sector, freedom was granted for

commercial banks to open branches in places where they think banking service is profitable. As

per directive number SBB/22/96 of National Bank of Ethiopia, to open a branch office, the

applicant bank should submit feasibility steady and a branch shall open the said branch and

commence operation within six months from the date of the grant of authorization.

Following this, Dashen Bank Share Company has opened different branches in different areas

and mainly on commercial criteria. This resulted in the current network of commercial banks in

general and Dashen Bank in particular in Addis Ababa and cities and towns of the country.

31

Table 1: Dashen Bank SC branch expansion figure (2004-2013)

Year Number of branches Total no. branches

of Increase in no.of branches

Addis Ababa Outside Addis

2004 16 15 31 -

2005 19 15 34 3

2006 22 17 39 5

2007 24 21 45 6

2008 26 25 51 6

2009 28 29 57 6

2010 32 31 63 6

2011 36 33 69 6

2012 47 45 92 23

2013 63 67 130 38

Source: Annual Report of Dashen Bank (2004-2013)

As can be seen from table 4.1.1, Dashen Bank S.C. has opened99 additional branches within ten

years of operation. The increase in number of branches is significant especially in 2012 and 2013

fiscal years. In early years of operation, the bank was concentrated in Addis Ababa and other

large cities and towns which influenced the bank’s ability to attract the rural people to use the

bank which in turn reduced the bank’s capacity to share the market of the banking industry.

Currently, however, the bank is expanding in the rural Ethiopia which is also expected to

increase in the coming years. Thus, the bank has started the way of taking advantage in deposit

mobilization and credit delivery than other private commercial banks recently.

4.1.2 Deposit mobilizationThe need for mobilization of domestic resources is for the purpose of financing development

programs which is highly recognized especially in developing economies. The economic

program of developing countries to some extent depends on foreign loans in which these

programs are financed. Although capital formation can be accomplished with the help of external

32

finance, the ability of any country to sustain its economic growth lies in its ultimate capacity to

mop up domestic resource.

In addition, the level of investment depends on the level of income and sacrifice the people is

able and willing to make. Tomorrow’s satisfaction depends on the amount of today’s sacrifice. In

order to make sacrifice the people must be aware of the objective of mobilizing saving and the

aim of channeling the investment and all facilities must be made available to them.

Deposit mobilization is one of the major functions of commercial banks. In Ethiopia, deposit

mobilization by both the governmentally owned and privately owned commercial banks has

shown a significant increase in the past years. This is mainly reflected in demand deposit, time

deposit and savings. The deposit mobilized by Dashen Bank SC is shown in the following table.

Table 2: Deposit mobilization by Dashen Bank SC (in million birr) from 2004 to 2013

Year Demanddeposit

Saving deposit

Time/fixed deposit

Total deposit

%growth intotal deposit

2004 623 1448 107 2178 -

2005 793 1897 143 2833 30.1

2006 1039 2343 310 3692 30.3

2007 1361 2843 657 4861 31.7

2008 1617 3842 693 6152 26.6

2009 2190 5034 702 7926 28.8

2010 2715 6730 699 10144 28.0

2011 3408 7797 636 11841 16.7

2012 4393 8889 784 14066 18.9

2013 4266 10577 1008 15851 12.7

Source: Dashen Bank SC annual report (2004-2013)

As can be seen from table 3.3.2.1, Dashen Bank’s deposit has shown a tremendous increase in all

the three types of deposits. It has registered a 30.1 percentage increase in the fiscal year 2005. A

33

30.3 percent in 2006 and soon. In a nutshell, on average, the bank has registered a 25 percent

increase in total deposit each year. The increase in number of customers and its branch network

are the major factors along with the economic factors for the upward movement of the deposit

balance.

4.1.3 Credit deliveryDeposit mobilization is not an end by itself: an efficient allocation of credit is also needed to

bring about development in all sectors of an economy. Of all functions of modern banking,

lending is by far the most important role. Statistical evidences also support that a substantial

proportion of total revenue of all banks in Ethiopia comes from interest income on loans and

advances. Loans and advances comprise very large proportion of a bank’s total assets. Thus,

financial strength of a bank is judged by the soundness of its advance.

Although bank lending is inherently risky, the risk can be minimized and controlled by

establishing highly professional organization and management of the lending function through

formulation of product policies and procedures which will enhance efficient customer service,

maintain consistency in credit extension, transparency and control in credit decision making. The

organizational structure of credit function of banks varies with its size and type of business. At

all times, it should ensure maximum efficiency in credit processing, clearly delineate

responsibility and accountability which allows effective credit supervision.

A loan is a liability for an individual or corporation receiving it. But it is an asset for the bank

that provides it because it brings income to the bank. Loans are the highest yielding assets that a

bank can add to its portfolio and they provide a significant portion of operating revenue.

All loan applications of customers are handled and processed by branches. The branch credit

committee approve loan request under their discretionary recommendations which are above

their limit to the appropriate head office credit committee.

Table 3:Dashen Bank S.C. outstanding loan balance 2004-2013 (in million birr)

Year Outstanding loan balance % increase

2004 1627 _

2005 2161 32.88

34

2006 3080 42.53

2007 3889 26.27

2008 4292 10.36

2009 4349 1.33

2010 4939 13.57

2011 6094 23.39

2012 7949 30.44

2013 8663 8.98

Source: Dashen Bank annual report 2004-2013

As depicted in the above table, the loan portfolio of Dashen Bank S.C. has shown a continuous

increase each year. It was in 2006 in which the bank registered the highest percentage increase,

which is around 42.53% when compared to the previous year. According to the bank’s report,

branch expansion; increase in deposit and bank’s paid up capital are the factors for such increase

in outstanding loans. The lowest loan balance is recorded in 2009 attributed to worldwide

economic recession. At the end of the fiscal year ended June 2013, the total loan dispersed of the

bank reached 8.6 billion birr.

4.1.4 ProfitabilityThe most widely accepted measure of the performance of financial institutions is their current

profitability. From variety of measurement of profitability, return on equity and return on asset

ratio are the most popular ones.

Table 4:Dashen Bank share company profit figures for the period 2004-2013 (in million birr)

Year Net profit after tax

Net

asset

Paid up

capital and reserves

Return on asset

Return on equity

%increase on profit

2004 56 133 172 2.40 37.21 -

35

2005 71 3420 243 2.33 34.22 26.8

2006 133 4546 386 3.34 42.29 82.3

2007 187 6041 545 3.53 40.19 40.6

2008 239 7829 731 3.45 37.50 27.8

2009 250 9733 909 2.85 30.49 4.6

2010 324 12353 1123 2.93 31.89 29.6

2011 451 14660 1396 3.34 35.77 39.2

2012 652 17520 1828 4.05 40.44 44.6

2013 607 19747 2046 3.26 31.33 (6.9)

Source: Dashen Bank annual report (2004-2013)

As shown in the above table, the profitability of Dashen Bank S.C is increasing each year except

in 2013, in which it has registered a 6.9% decrease in profit from the previous year. In the year

2006, the bank has registered the highest profit, which is 82% more than its previous year profit

and also; the return on asset and return on equity reached 3.26% and 31.33% respectively.

4.2 Role of Dashen Bank S.C. to the Ethiopian EconomyAs discussed above, Dashen Bank plays a major importance in disbursing loans and advances,

mobilizing capital, and enabling the rural people to save through reaching them by opening

branches from time to time. In addition to these, however, Dashen bank also helps the economy

by creating employment opportunities, giving loans to entrepreneurs and hence promoting

innovation, and in general it gives sector specific loans to different sectors of the economy.

4.2.1 Role of Dashen Bank in Capital FormationThe commercial banks help in mobilizing savings through network of branch banking. As we

know, our citizens have low incomes but the banks induce them to save by introducing a variety

of deposit schemes to suit the needs of individual depositors which is discussed in the first part of

this chapter by taking Dashen Bank as an example. Besides helping them to save, commercial

36

banks also mobilize idle savings; the banks allocate them to productive investments. Thus, the

help in the capital formation of the country in turn contributing to the economic development of

the country. To show this role of Dashen Bank, let us consider the total deposited capital and

loans dispersed by Dashen Bank using table.

Table 5: Amount of deposit mobilized and credit disbursed by Dashen Bank from 2004 to 2013 (In million birr).Year Total

depositsTotal loan dispersed

% growth in totaldeposits

% growthin loans

2004 2178 1627 - _

2005 2833 2161 30.1 32.88

2006 3692 3080 30.3 42.53

2007 4861 3889 31.7 26.27

2008 6152 4292 26.6 10.36

2009 7925 4349 28.8 1.33

2010 10145 4939 28.0 13.57

2011 11841 6094 16.7 23.39

2012 14066 7949 18.9 30.44

2013 15851 8663 12.7 8.98

Source: Dashen Bank annual report (2004-2013)

The table proves that, the total loans disbursed and a deposit mobilized by the bank is showing a

tremendous increase. This means, it is contributing to the capital formation (that is saving and

investment) of the country and generally helping in the economic growth of the country which

depends on investment and saving. At the end of June 2013, the total amount of deposits is

contributed by 1.03 million people and 7.23 million people get loan services of the bank (Annual

Report of Dashen Bank S.C. 2013). This means, the listed before number of people are saving

and investing which is good for the economy.

37

4.2.2 Provision of Sectorial Loans and AdvancesThe bank have been financing various economic activities and sectors since its establishment

ranging from agriculture to manufacturing projects found in different parts of the country, hence

playing a critical role in supporting the national development endeavors.

Table 6: loans provided by Dashen Bank to manufacturing and agriculture sectors (2004-2013) in million birrYear agriculture

sectormanufacturing %Growth

in loan to agriculture

%Growth in loan to the manufacturing

2004 68 384 - -

2005 107 522 57.4 36.0

2006 133 676 24.3 29.5

2007 147 803 10.5 18.8

2008 162 1013 10.2 26.2

2009 137 1027 (15.4) 1.0

2010 139 1137 1.5 10.7

2011 125 1418 (10.1) 24.7

2012 165 1704 32 20.2

2013 173 1867 5.0 9.6

Source: Dashen Bank Annual Report (2004-2013).As can be observed from the above table, loans to the agriculture sector were high in the earlier

operation of the bank where the role of the agriculture sector was very significant to the

economy. However, through time, the manufacturing sector is given much attention by the bank

and loans given to the sector is increasing.

According to annual report of the bank for the year ended June 30, 2013; 21.1% of the total loans

disbursed were for the manufacturing sector and the loan to agriculture sector is only 2.0% of

loans provided. This means, the bank is supporting the country in creating an industrial economy.

38

4.2.3 Employment Opportunity Creation and Human Capital DevelopmentOne of the major objectives of macroeconomic policies of most countries of the world is creating

full employment. Considering Ethiopian case, where getting jobs is highly difficult, Dashen

Bank employs degree holders who studied business disciplines and hence helping the economy

in creating employment opportunities.

By the end of June 2013, the staff strength of the bank including short and long term contract

employees reached 3690 which is greater than the number of staff in 2008 by 97.7% and 2.1%

higher than in 2012.

Table 7: Employment opportunity created by Dashen Bank (2004-2013)Year Total number of employees Percentage increase

2004 1051 _

2005 1224 16.5

2006 1379 12.7

2007 1623 17.7

2008 1866 15.0

2009 2249 20.5

2010 2541 13.0

2011 2826 11.2

2012 3042 7.6

2013 3690 21.3

Source: Dashen Bank S.C Annual Report (2004-2013)

Beyond running the day to day activities of the bank, the employees get different trainings and

capacity raising programs. Annual Report of Dashen Bank S.C of 2013 adds that, various in

house and external trainings were arranged that benefited 1713 staff in different capacities and

education assistance has given to staff that have been pursuing further education at various

levels. This means the bank is also playing significant role in human resource development

39

(human capital formation)

4.2.4. Investment by the bankDashen Bank, since after few years of establishment, has been investing in short term and long

term investments. Among short term investments, short term treasury bills take the lion share. In

addition to these short term investments, the bank also invests in long term investments like

constructing own buildings (for example Tana Department Store Building) jointly with Midroc

Ethiopia PLC. The bank agreed with Midroc in 5 October 2001 and from the total birr

57,004,488, 60% of the acquisition (birr 34,202,693) was contributed by the bank. Construction

of own buildings is a response to the intention of the bank to improve customers’ in branch

experience, smoothen operations, circumvent rising rental costs and diversify investment

portfolios of the bank. Beyond this, Dashen Bank has 5,584 shares at par value of Birr 1,000

each in Nyala Insurance Share Company. The long term investments of the bank do not end by

this; it also has long term bill of the Nations Bank of Ethiopia amounting birr 2,922,820,000 at

the end of the fiscal year ended 2013. Similarly, Dashen Bank invested birr 5,030,000 and birr

377,527 in Ethswitch S.C and Swift S.C respectively by 2013.

40

CHAPTER FIVE

Conclusions and Recommendations5.1 ConclusionsFinancial sector is one of the significant economic sectors that can facilitate the smooth

functioning of business activities and economic development of a country. Banks as financial

institutions or intermediaries are engaged in borrowing and lending fund from and to economic

agents.

It was in the period of Menlilk II that the banking system started. But it is only in 1994 that the

sector was liberalized. This liberalization policy embarked the establishment of different private

commercial banks including Dashen Bank S.C.

Based on the findings of this study it is concluded that, Dashen Bank is profitable. Because of a

very fast increase in number of shareholders, the bank’s assets and equity are increasing. As

indicted by the ROA measure, however, return on asset is very low. Owing to the influence of

public banks, Dashen Bank is controlling high percentages of market share in terms of capital,

deposit mobilized and loans disbursed. Besides these performances of the bank, it is also tried to

show the role of the bank in the economy like employment opportunity generation, capital

formation and sector specific lending.

The research proposes that, proper intervention of the government is needed since economic

situations are highly sensitive to changes in the financial sector. The Ethiopian government

through the National Bank of Ethiopia is practicing strong financial regulations on the banking

industry. These regulations have a considerable impact on the bank’s investment capabilities, and

interest rate policies of the government also affect ability to compete. The study also tried to

show some internal and external problems that the bank faces and hindering its performance.

Other interesting issues are left open for further research. The contribution of the bank in

financing innovation, monetizing the economy and others and also foreign factors that affect the

bank’s performance can be considered using different complicated measures and systems.

41

5.2 RecommendationsBased on the finding of the study and policy reviewed, some possible recommendations are

forwarded as follows.

Dashen Bank is better give more emphasis to the agriculture sector in its loan able funds

since significant portion of people of the country is dependent on the sector.

Accepting deposits and lending finds cannot be the only intermediation activities of the

bank. To get higher returns, Dashen Bank is advised to actively participate or invest in

treasury and government bills actively than before.

Redirecting efficient and market oriented service is important to secure market share and

retain existing customers while attracting new ones. High level of customer orientation in

addition to higher customer satisfaction causes higher amount of profit. This implies that,

plans and programs shall be designed in such a way that quality plays a significant role in

achieving customer satisfaction.

The integration of Dashen Bank with other banks improve total capital adequacy and

finance huge projects. These projects can yield higher profit and help the bank to increase

its total capital. Thus integration with other banks is helpful for Dashen Bank.

The government shall also improve the current status of basic infrastructures like

telephone, internet and electricity in rural parts of the country since these factors highly

influence the banks in opening area banks.

Greater attention is better given to the establishment of stock exchange market which

enables banks to sell their stocks in order to maximize their paid up capital and make

strong their management as well as builds the confidence of their customers.

Although strong government regulation is necessary for the proper functioning of the

banking industry, the central bank shall give some level of freedom to private banks at

least in setting interest rates. These rates can be used as a marketing strategy to attract

customers and also improve competition among banks.

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