ODA BULTUM UNIVERSITY DEPARTMENT OF MANAGEMENT

POST GRADUATE MBA PROGRAM YEAR II – SEMESTER III (WEEK

END AWASH 7 KILO)

DETERMINANT OF BANKING SECTOR DEVELOPMENT IN

ETHIOPIA: WITH THE REFERENCE OF PRIVATE COMMERCIAL
BANKS
INDIVIDUAL ASSIGNMENT ON BUSINESS RESEARCH

Prepared By: ABDUREHAMAN NASIR ZEYNE

ID No: WM0069/14

SUBMITTED TO: MILKIYAS AYELE (PhD)

OCTOBER, 2023
 Table of Contents
Acronyms and Abbreviation ............................................................................................................................... i
CHAPTER ONE: Introduction ......................................................................................................................... 1
1.1. Background of the study ....................................................................................................................... 1
1.2. Research Problem ................................................................................................................................. 2
1.3. Research Objective ............................................................................................................................... 3

1.3.1. General Objective ...................................................................................................................... 3

1.3.2. Specific Objectives ..................................................................................................................... 3
1.4. Research Question/Hypothesis.............................................................................................................. 4
1.5. Scope of the Study/ Delimitation of the study........................................................................................ 4
1.6. Significance of the study....................................................................................................................... 4
1.7. Definition of terms/ Operational Terms ................................................................................................ 5
CHAPTER TWO: Review of Related Literature Review ................................................................................... 6
2.1. Theoretical Literature Review..................................................................................................................... 6
2.2. Role of Banking in the Economy ................................................................................................................ 6
2.3. Conceptual framework of the study............................................................................................................. 7
2.4. Identified Gaps in the Literature ................................................................................................................. 8
CHAPTER THREE: Methodology of the Study................................................................................................. 9
3.1. Research design ......................................................................................................................................... 9
3.2. Research approach ..................................................................................................................................... 9
3.3. Population and Sample Design ................................................................................................................... 9
3.4. Data collection Procedure ........................................................................................................................... 9
3.5. Method of data analysis and presentation .................................................................................................. 10
3.6. Ethical Consideration ............................................................................................................................... 10
3.7. Validity and Reliability test ...................................................................................................................... 10
CHAPTER FOUR: Budget and Time Schedule……………….……………………………………….…………13

4.1. Research Time Schedule…………………………………………………………………….………………13

4.2. Research Budget Schedule…………………………………………………………….…………………….13

REFERENCE ............................................................................................................................................... 114

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Acronyms and Abbreviation

AB: Awash Bank

AIDB: Agricultural and Industrial Development Bank

BIB: Birhan International Bank

BOA: Bank of Abyssinia

CBO: Cooperative Bank of Oromia

CLRM: Classical Liner Regression Model

DB: Dashen Bank

EVIEWS15: Econometric Views Software Version 15

REMI: Remittance inflow

RIR: Real interest rate

GDP: Gross Domestic Product

INF: Inflation Rate

LB: Lion Bank

M2: Money Supply

NBE: National Bank of Ethiopia, the Central Bank of the Country

NIB: Nib International Bank

OIB: Oromia International Bank

OLS: Ordinary Least Square

SSA: Sub-Saharan Africa

TO: Trade openness

UN: United Bank

VIF: Variance inflation factor

WB: Wegagen Bank

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 CHAPTER ONE
1.INTRODUCTION

1.1. Background of the study

The banking sector is a subset of the financial sector and its role in the growth process of an economy
cannot be overemphasized. It plays a dominant role in the financial intermediation process of most
developing and developed countries, thus connoting that the financial sector of most countries is bank-
based. The banking sector is a pivotal segment in many countries, hence the need for continuous
implementation of adequate policy measures and reforms in order to ensure that the banking sector
development its function efficiently. Olufemi A.and Michael A. (2015).

According to Levine, (2005), the banking sector performs five functions, which can facilitate
economic growth. These functions are providing ex ante information about possible investments and
allocate capital, monitoring investments and exert corporate governance after providing credit,
facilitating trading, risk diversification, and risk management, mobilizing and pooling deposits, and
facilitating the exchange of goods and services. Therefore, banking sector development refers to the
increase in the ability of the banking sector to perform these functions efficiently.

Banking sector development differs across countries inter alia due to, economic institutions, legal
systems, legal tradition/organs, openness to trade and capital, economic growth, stability, geographical
endowments, income level, political institutions/democracy, cultural and human capital. Identifying
what makes the banking sector develop is essential because better developed banking sectors have
greater ability to alleviate poverty, reduce household and firm financing constraints, increase
competition among firms, and promote economic growth compared to less developed banking sectors.

According to Zerayehu et al, (2013) a sound financial system is indispensable for a healthy and vibrant
economy. The financial system in Ethiopia, which is characterized as highly profitable, concentrated,
and moderately competitive is dominated by banking Industry and it is amongst the major under
banked economy in the world. The development of a vibrant and active private banking system that
complements with the existing public sector work is considered important to Ethiopia’s economic
progress according to the professional advice of group of experts working in well-known financial
organization like WB, AFDB, and IMF. Keatinge, (2014).

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1.2. Research Problem
According to Olufemi A and Michael A., (2015) study using a composite index of banking sector
development, the estimation results show that population density and simultaneous openness to trade
and capital promote banking sector development while financial liberalization hinders banking sector
development. The same study reveals that institutional quality, population density, and trade openness
increases the depth of the banking sector. Also, it demonstrates that law, inflation, and religion
promote the efficiency of the banking sector while latitude, trade openness, income level, and ethnic
diversity reduce banking sector efficiency. In addition, it shows that law and simultaneous openness
to trade and capital enhances the stability of the banking sector while land area, financial liberalization,
economic growth, and inflation adversely affect banking sector stability. Olufemi A and Michael A
conduct the research to address first; it identified the factors responsible for cross-country differences
in banking sector development in sub-Saharan African countries using a more robust composite index
which accounts for three dimensions of banking sector development banking sector depth, efficiency,
and stability. Second, it showed that banking sector development is sensitive to alternative measures.

As Hussein Jarso., (2016), the structure of Ethiopian financial system, and size, accessibility,
efficiency and concentration of the banking sector in particular. These dimensions of Ethiopian
banking sector measured using ratio of private sector credit to GDP, demographic and geographic
distribution of banks’ branches, interest rate spread, concentration ratio and Herfindahl-Hirschman
index. As the result of the analysis show Ethiopian banking sector was shallow, less inclusive and
highly concentrated.

According to Abreha Gezae., (2015), tried to see the macro factors that affect the development of the
Ethiopian banking sector. Because, the banking sector is rudimentary due to the problems such as
heavy dependence of investors in borrowed fund, excessive government borrowing, absence of
secondary markets, less attractive deposit rate, limited outreach of banking services, underdeveloped
saving culture, poor cross-selling activity of inflow of foreign remittance, deficit in the trade balance
of the country. Hence, he founds that Trade Openness, Real Interest rate, population growth, and
Government consumption expenditure have far-reaching statistically significant impact on the
development of the banking sector by influencing the volume of credit provided by banks to the private
sector. Remittance to GDP ratio, Real Interest Rate and GDP growth rate significantly influences the
broad money supply (M2). There is also significant concentration of asset of the sector in three big

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banks and the Level of liquid asset to total deposit is lower than the East African countries though
NPL is the least.

In light of the above facts and research gaps, the researcher tried to see the bank sector development
in Ethiopia specifically in selected private commercial banks using private sector credit as a measure
of bank sector development within the variables GDP, Trade Openness, Real Interest rate, Remittance
inflow, inflation. To this end, this study tried to provide real information about the determinant factors
affecting the selecting private commercial banking sector development and feasible recommendation
for the impact of identified variables.

1.2. Research Objective

1.2.1. General Objective
The general objective of the study is to examine the determinants of banking sector development in
Ethiopia with the reference of private commercial banks.

1.2.2. Specific Objectives

 To assess the impact of real GDP growth rate on the selected private commercial banks
development in Ethiopia.
 To assess the impact of real Interest rate on the selected private commercial banks development
in Ethiopia.
 To assess the impact of Remittance inflow has on the selected private commercial banks
development in Ethiopia.
 To assess the impact of inflation rate has on the selected private commercial banks
development in Ethiopia.
 To assess the impact of Trade Openness on the selected private commercial banks
development in Ethiopia.

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1.3. Research Question/Hypothesis
H1: Real GDP growth rate has positive and significant impact on the selected private commercial
banks development in Ethiopia.

H2: Real Interest rate has positive and significant impact on the selected private commercial banks
development in Ethiopia.

H3: Remittance inflow has positive and significant impact on the selected private commercial banks
development in Ethiopia.

H4: Inflation rate has negative and significant impact on the selected private commercial banks
development in Ethiopia.

H5: Trade Openness has positive and significant impact on the selected private commercial banks
development in Ethiopia.

1.4. Scope of the Study/ Delimitation of the study

The scope of the research will mainly limit to the selected private commercial banks. By using panel
data analysis of eleven years (2010 to 2020) from annual reports of audited financial statement for
each private commercial banks and national banks of Ethiopia (NBE). Nine commercial Banks
operating in Ethiopia have been selected using non-Probability purposive sampling using two criteria
such as Banks having more than eleven-year experience and their proportion of capital as compared
to all commercial banks Capital. Based on these criteria the Following commercial banks selected as
a sample for analysis Awash bank, Bank of Abyssinia, Dashen bank, Cooperative bank of Oromia,
United bank, Nib bank, Wegagen Bank, Oromia international Bank and Lion Bank. The study used
one dependent and five independent variables i.e., the dependent variables are private sector credit
(PSC), the five independent variables are real GDP growth rate (RGDPGR), Real interest rate (RIR),
Remittance inflow (REMI), Inflation rate (INR) and Trade Openness (TO).

1.5. Significance of the study

This study will have vital role played by the private commercial banking sector in the economic
development process. And also, its role to provide the necessary fund for investments by the public
and the private sectors, which require studying the main determinants that affect the development of

4
the entire banking sector by employing highly applicable standard measures and indicators of banking
sector development.

1.6. Definition of terms/ Operational Terms

 Private sector credit: private sector by banks refers to financial resources provided to the
private sector by other depository corporations (deposit taking corporations except central
banks), such as through loans, purchases of non-equity securities, and trade credits and other
accounts receivable, that establish a claim for repayment.
 Real GDP: is the sum of gross value added by all resident producers in the economy plus any
product taxes and minus any subsidies not included in the value of the products. It is calculated
without making deductions for depreciation of fabricated assets or for depletion and
degradation of natural resources.
 Real Interest Rate: is the lending interest rate adjusted for inflation as measured by the GDP
deflator.
 Remittance inflow: Personal remittances comprise personal transfers and compensation of
employees. Personal transfers consist of all current transfers in cash or in kind made or
received by resident households to or from nonresident households. Personal transfers thus
include all current transfers between resident and nonresident individuals.
 Inflation rate: The general price level of goods and services changes in an economy at the
rate. It was measured by annual growth of the GDP deflator.
 Trade openness: This shows the degree to which a country is open to external trade and it is
calculated as the ratio of the imports plus exports to GDP.

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 CHAPTER TWO
2. REVIEW OF RELATED LITERATURE REVIEW

2.1. Theoretical Literature Review

Having explored why banks exist, it is also imperative to look at the basics of banking business and
the respective theory of the banking business firm. Theory of the banking firm is different from the
theory of the firm that is widely applicable to any business with the exception of banks. Theory of the
banking business underlined that banks make profit by selling liabilities with one set of characteristics
(a particular combination of liquidity, risk, size, and return) and using the proceeds to buy assets with
a different set of characteristics through the process of asset transformation (S. Mishkin& Eakins,
2012).

According to Abreha Gezae, (2015), Banks are different from any other commercial businesses
because of the peculiar features they possess. The monetary mechanism enables them to attract
deposits for onward investment. By taking part in the payments mechanism and by emphasizing the
medium of exchange function of money, they are able to encourage the store of value functions. They
have also advantage that is very different from other business firms. The debt equity ratio for
conventional commercial firms will be in the order of 0.5 to 0.6. Banks, however, have debt liabilities
sometimes nine times greater than their equity. Because, guardians of the payment system, the central
banks, think that commercial banks are special. This, therefore, accentuates that theory of the banking
firm is distinct from the economic theory of the firm.

2.2. Role of Banking in the Economy

The conduct of monetary policy has effects on the banking system itself in its role of the provision of
finance and, hence, the money supply. Thus, the relationship between monetary policy is a two-way;
the banks affecting the conduct of monetary policy and the conduct of monetary policy affecting the
banks. Mathew & Thompson, (2005).

Financial development creates enabling conditions for growth through either a supply leading
(financial development spurs growth) or a demand following (growth generates demand for financial
products) channel. Direction of causality is more difficult to determine. At the cross-country level,
evidence indicates that various measures of financial development (including assets of the financial
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intermediaries, liquid liabilities of financial institutions, domestic credit to private sector, stock and
bond market capitalization) are robustly and positively related to economic growth (King and Levine,
1993; Levine and Zervos, (1998).

By allocating capital to the highest value use while limiting the risks and costs involved, the banking
sector can exert a positive influence on the overall economy, and is thus of broad macroeconomic
importance (Roland, 2011). Since the general importance of a banking sector for an economy is widely
accepted, the questions arise under which coordination mechanism state or market it best performs its
functions, and, if necessary, how to manage the transition to this coordination mechanism Kaminsky
and Schmukler, (2002).

2.3. Conceptual framework of the study

According to, (Riggan, 2016), Conceptual framework will be used in research to outline possible
courses of action or to present a preferred app

roach to an idea. In addition (Ravitch & Riggan, 2012). Conceptual framework is an analytical tool
with several variations and context. It will be used to make conceptual distinctions and organize ideas.
Based on the result of literature reviews and theoretical assumptions of the following conceptual
framework will be developed for this study.

Independent Variable Dependent Variable

(Real Growth Domestic product)RGDP

(Real Interest Rate)RIR

(Remittance inflow)REMI PSC (Private

Sector
(Real interest rate)RIR
Credit)
(Trade openness)TO

Source: Self-extracted

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2.4. Identified Gaps in the Literature
There is no any empirical literature regarding the determinant of banking sector development in
Ethiopia with the reference of private commercial banks. Moreover, the private commercial banking
sector development in Ethiopia is not much studied. Therefore, the paper will believe to fill the gap
by contributing to the literature.

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 CHAPTER THREE
3. METHODOLOGY OF THE STUDY

3.1. Research design

The main objective of this study is to investigate the determinants of banking sector development in
Ethiopia with the reference of private commercial banks. In doing so, the study will adopt explanatory
approach by panel data research to realize the stated objectives.

3.2. Research approach

In this study, the researcher will use the quantitative research approach based on quantitative nature
of the data. This approach will use to identify and measure the determinants of banking sector
development. Specifically, multiple regression analysis will be adopted to measure the effect of
determinants on banking sector development. To comply with the objective of this research, the study
is exclusively based on quantitative data, which will be constructed an econometric model to identify
and measure the determinants of financial performance and their level of significance.

3.3. Population and Sample Design

According to NBE annual report (2020), currently sixteen private commercial banks are working in
Ethiopia. Out of these nine banks; Awash Bank, Dashen Bank, Bank of Abyssinia, cooperative bank
of Oromia, United Bank, Nib Bank, Wegagen Bank, Oromia international bank and Lion bank will be
taken as a sample using non probability purposive sampling by taking into consideration two criteria’s,
the first is the researcher believes that 11 years of data is sufficient for the research accordingly banks
that have established after 2010 GC will be excluded from the sample. Second is according to NBE
these nine banks jointly contributed above 70% share of total capital of private commercial banks.

3.4. Data collection Procedure

Only secondary data will be used for the study. Applying appropriate data gathering instruments help
researchers to combine the strengths and amend some of the inadequacies of any source of data to
minimize risk of irrelevant conclusion. Data will be collected from annual published audited financial
statements report of each sample banks and National Bank annual report.

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3.5. Method of data analysis and presentation
Stata 14 financial software package will be used in analyzing the data and testing the assumptions
hypothesized. The formal tests for Multiple Ordinary Least Square regression will also be performed
in order to enable to make valid and reliable inference from the model. Accordingly, the study model
will be focused on panel data technique that comprises both cross-sectional elements and time-series
elements; the cross-sectional element will reflect by the different selected private commercial banks
and the time-series element will be revealed by the period of study (2010-2020). Therefore, the
collected panel data will be analyzed to determine the relationships between the independent variables
and dependent variable. Correlation will be used to determine the degree of relationships between the
variables.

Regression analysis will be used to determine the contribution or predictability of the independent
variable to the dependent variables. The data will be tested using test of normality, white test of
Heteroscedasticity, test of autocorrelation, Mulitcollinerity and Test of model specification to achieve
the objective of the study.

3.6. Ethical Consideration

In the course of this study, all requirements of the selected organization and the research procedures
of the Odda Bultum University will be properly adhered. All the scientific evidence and supporting
documents will be consulted and acknowledged. All the participants in this study are appropriately
will be informed about the purpose of the research and their consents will be secured before the
beginning of the data gathering process. The researcher also will inform the subject that their response
will only for the purpose of the study. In addition, the researcher will assure the respondents that their
identity and that of their organizations. Confidential issues kept confidential.

3.7. Validity and Reliability test

Diagnostic tests will be used to check for the validity of the parameters. The researcher is to test for
normality, multi-collinearity, heteroscedasticity and autocorrelation and also is going to perform
maximum likelihood tests.

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 CHAPTER FOUR

4. BUDGET AND TIME SCHEDULE FOR THE RESEARCH

4.1. Research Time Schedule

2023

No. Activities Aug- Sept- Oct

sept Oct
1 Developing a concept
2 research proposal
3 Develop questions
for data collection
4 Data collection
5 Data analysis
6 Write up for first
draft
7 Write up for final
draft
8 Submission of
dissertation

Table 1. Charts showing research time schedule

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 4.2. Research Budget Schedule

No Budget category (Items) Unit Quantity Unit Total

Price Price(birr)
(birr)
1 Secondary data access fee Lump sum 1000
2 Stationaries (Photo copy, binding, print and Lump sum 4000
scanning etc.)
3 Transportation cost Lump sum 600
4 Communication fee (mobile card & internet) Lump sum 400

Total 6000
Miscellaneous Lump sum 500
Grand Total 6500
Table 2. Research budget Schedule

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