Commercial banks are the most important savings mobilization and financial resource allocation institutions. Consequently, these roles make them an important phenomenon in economic growth and development especially in countries where capital markets lag behind and financing needs of the economy generally flows from the banking system.
It is interesting to note that the role of banks in saving mobilization and allocation of financial resources to various investment opportunities in the country dating back to the period of the establishment of the first bank, bank of Abyssinia in 1906. This bank introduced for the first time in Ethiopian financial systems history banking services and instruments such as deposits accounts and export financing (Getahun, 2008).
In pre 1974 Ethiopia, the financial system operated in a free market economic environment. However, in 1980s, the financial system was restructured and reorganized to serve centrally planned economic system which was created following the change of government in 1974. During this period, the Government nationalized all financial institutions in the country and created three specialized banks (excluding the central bank) and one insurance company. Private ownership of financial institutions was prohibited.
Among the specialized banks, the then Agricultural and Industrial Development Bank (the current Development Bank) was responsible for financing agricultural and industrial projects with medium and long gestation period, while the then Housing and Savings Bank (the current Construction and Business Bank) used to lend for construction of residential and commercial buildings. The third bank, Commercial Bank of Ethiopia, was the only bank engaged in trade and other short term financing activities.
In 1990s, as a result of the shift from socialist to market economic system, Ethiopia reformed its financial services industry. The reform measures included comprehensive restructuring of government owned financial institutions and opening the sector for local private equity participation. The three governments owned banks inherited from socialist regime were made autonomies in terms of managing their business and recapitalized. While there was no change in the role of Commercial Bank of Ethiopia (as short term financer), Development Bank of Ethiopia (as provider of medium and long term development finance), Construction and Business Bank has been allowed to engage in short-term financing activities.
Opening of the financial services industry for local private equity participation resulted in establishment of 13 profit oriented/motivated privately owned commercial banks that lend on short term basis until June 2011. The share of private commercial banks in key areas of banking operations i.e. collecting deposits and providing loans showed very strong progress over time. For instance, the share of private banks in total deposits and outstanding lending which remained below 10 percent each until 1999/00 reached 39 percent each by June 2009/10. Following this the lending strategies of the banks showed that the productive sectors were not given priority. Over the period 1980/81-1994/95, for example, the share of agriculture, industry, distributive services and other services was 31.3, 25.8, 18.7 and 24.2 percent respectively. Over the period 1995/96-2001/02 about 65.6 percent of all commercial bank credit financed distributive and other services. Agriculture and industry received only 8.1 and 28.3 percent of the commercial credit, respectively.
This remained against the development policies of the country and government strive to support development programs. The role of government in supporting development has not been uniform in the global economy. For instance, in Indonesia, government intervention in the financial market has been through state-owned banks, which operated using credit ceilings and selective credit allocation to specific...