Ethiopia's banking system dominates the country's financial sector. By channeling funds from surplus parties to parties with an investment idea, the banking sector contributes to the country's goal of growth and prosperity. The financial system which is the combination of both banks and non-bank is the lifeblood of any economy by mobilizing savings from surplus economic units to deficit economic units (Shuaib, 2018). Besides, it also ensures the efficient allocation of resources by channeling funds for different development projects. By doing so, they transfer funds from those with surplus funds to those that need them for productive activities which in turn stimulate investments and improve economic growth and development (Olokoyo et al., 2020).
The banking sector failures have many consequences on the economy so that the sector requires periodical investigation concerning their performances. Because of this reason, the Ethiopian government has been taking necessary measurements to keep the efficiency and profitability of the banking sector on track. The major objective of a business organization is to maximize both the profit and wealth of its owners. Since the banking sector is known by profit-seeking business organizations, to act as an intermediation role they have to be profitable. The pliability of the banking sector is even more important in transitional economies that are continuously restructuring their legal and macroeconomic environment to comply with the international policies introduced by the World Bank and International Monetary Fund (Hasanov et al., 2018).
Since April 25, 2018, the Ethiopian government is found to be in the political reform which includes economic reforms. As economic reform, the banking sector obtained necessary focus by Ethiopian government since bank plays a vital role in the growth and development of the nation. Therefore, the regulatory bodies carried out various banking reforms to improve the performance of the sector.
(FDRE, 2016 PP.110)
The Ethiopian banking sector is owned by both government and private sectors. Currently, there are sixteen privately owned, and two public-owned commercial banks operating in the country under the supervision of the National Bank of Ethiopia. Both structures of the banks ought to support the development goals that the country planned during GTP-II particularly by financing the manufacturing industry to support the country’s strategy to transform the economy from agriculturally dominated to industry lead economy. Besides, according to the GTP-II strategy, since the focus is given to support the private sector that invests in the export-oriented manufacturing sector, and in the tradable modern service sector, the financial services given to these activities need to be sufficient.
Different scholars conducted a study on the factors affecting the performance of banks in Ethiopia at different times. Abera (2013), conducted a study on the financial performance of the Ethiopian banking sector by selecting seven private commercial banks using a simple random sampling technique and using six years (2005-2010) financial data. The study found that between the study period the banks showed a persistent increase in the volume of deposits, granting of the loan, and possession of assets throughout the study periods. Furthermore, the profitability of the banks revealed remarkable improvement during the study periods. Lelissa (2014), studied the determinants of Ethiopian commercial banks performance between the study period of 1990-2012 taking Return on Assets (ROA) as a financial performance measurement tool, and found that bank size and macroeconomic variables do not affect the banks’ profitability while the inflation rate has a significant effect on profitability measured by ROA. The study conducted by Abara (2015) on financial performance analysis in the banking sector on selected commercial banks in Ethiopia for the years from 2007 to 2011 discloses that state-owned Commercial Bank of Ethiopia possessed the first rank in terms of assets management while private-owned bank Awash International Bank and United Bank stands first in terms of profitability and solvency respectively between the study periods.
Alemu and Negasa (2015) investigated the determinants of the financial performance of commercial banks in Ethiopia using panel data over the years of 2003 to 2013 with a quantitative data analysis approach. The findings of the study reveal that, except inflation, all bank-specific, industry-specific, and macroeconomic variables have a significant impact on the financial performance of banks measured by ROA, while variables considered as independent significantly affect the financial performance of banks measured by NIM. Shanko, Abera, and Mengesha (2019) examined factors affecting the profitability of the Ethiopian banking industry from 2010 to 2017. The studys’ result shows that while loan and advance, current deposit, other liabilities, and gross domestic product have a statistically significant and positive relationship with banks’ profitability, fixed deposit, and market concentration has a negative and statistically significant relationship with banks profitability measured by ROA. In contrast, the impact of deposit with other banks, the sum of investment, saving deposit, and inflation is found to be statistically insignificant.
Leykun (2016) conducted a study to examine factors affecting the net interest margin of commercial banks in Ethiopia from 2005 to 2014 by using pooled ordinary multiple regression models. The result of the study shows that capital adequacy, credit risk, operating costs, degree of competition, and deposit growth rate have a positive and significant effect on the financial performance of banks as measured by NIM. The study conducted by Abate and Mesfin (2016) to investigate the impact of bank-specific, industry-specific, and macroeconomic factors on the profitability of commercial banks in Ethiopia between the years of 2007 and 2016 using a random effect regression model shows that capital adequacy, leverage, liquidity, and ownership have a statistically significant and positive relationship with banks’ profitability. Furthermore, operational efficiency, GDP, inflation, and interest rates have a negative and statistically significant relationship with banks’ profitability.
The findings of the study conducted by Assfaw (2018) to investigate the bank-specific factors which can affect the financial performance of private commercial banks in Ethiopia over the periods of 2011 to 2017 by using panel data of six private banks reveal that there is a positive and significant relationship between capital adequacy, management efficiency, and size of banks and financial performance of private commercial banks in Ethiopia measured by ROA, ROE, and NIM, while liquidity management has a negative and significant effect on ROE. Moreover, Abdissa (2019) found that, except for credit risk and management expense, all bank-specific factors have positive and significant effects on bank profitability. Besides, all of the macroeconomic variables, including economic growth, interest rate spread, and exchange rate, have statistically significant and positive relationships with banks’ profitability.
LITERATURE GAP
As stated in the introduction, various scholars have conducted studies on the financial performance of Ethiopian banking sectors at various times. This study is unique because of the following reasons. First, as far as the researcher’s knowledge there are no significant studies conducted to compare private and state-owned commercial banks’ performance throughout Growth and Transformation Plan II (GTP-II). Second, the financial statements used in this study were prepared and audited according to International Financial Reporting Standard (IFRS). There were no sufficient studies that used financial statements prepared according to the standards of IFRS. Therefore, in this study, the author tried to examine and compare the financial performance of private and public-owned commercial banks in Ethiopia. Third, some of the variables used in this study were not applied in the previous studies to examine the financial performance of banking sectors. These variables are the efficiency ratio and national investment. Fourth, the direction of (Zenebe, 2017) about the future studies upon his conclusion of the first Growth and Transformation Plan I(GTP-I).
To sum up, to fill the above literature gap, this study tried to examine the financial performance of the banking sector measured by ROA, ROE, NIM, Efficiency Ratio, and other measurement tools: bank-specific which includes capital adequacy, assets management, management quality, earning management, and liquidity management. Besides, macroeconomic variables like inflation rate, GDP, national investment, and exchange rate were applied as the determinant of the financial performance of the banking sector.
Therefore, this study tried to investigate and compare the financial performance of private and state-owned commercial banks of Ethiopia throughout GTP-II (2016-2020). Consequently, the researchers were intended to conduct a study on the title “Banking sector Performance Evaluation in Ethiopia for the Period of GTP-II: Private vs Public Banks’’.
OBJECTIVES OF THE STUDY
The main objective of the study is to evaluate the banking sector’s performance for the period of GTP-II (2016-2020). Parallel with the main objective, the following specific objectives were devised to examine the performance of commercial banks in Ethiopia during the study period. These are:-
- To evaluate the financial performance of commercial banks in Ethiopia during the study period
- To compare the financial performance of state and privately owned commercial banks between the study periods.
- To examine factors that affect the financial performance of banks in Ethiopia during Growth and Transformation Plan II.
THE HYPOTHESIS OF THE STUDY
Ho: GDP growth rate has no significant effect on the financial performance of commercial banks
Ho: Inflation rate has no significant effect on the financial performance of commercial banks
Ho: Exchange rate has no significant effect on the financial performance of commercial banks.
Ho: National investment has no significant effect on the financial performance of commercial banks
Ho: Capital adequacy has no significant effect on the financial performance of commercial banks
Ho: Assets quality has no significant effect on the financial performance of commercial banks
Ho: Management efficiency has no significant effect on the financial performance of commercial banks
Ho: Earning quality has no significant effect on the financial performance of commercial banks
Ho: Liquidity position has no significant effect on the financial performance of commercial banks
SCOPE AND LIMITATION OF THE STUDY
The research was carried out in Ethiopia using financial data from 2016 to 2020. In Ethiopia, this period was known as the Growth and Transformation Plan II (GTP-II) period. Between the study periods, both bank-specific and macroeconomic factors were examined for their impact on the financial performance of Ethiopia's banking sector. Macroeconomic factors that include GDP, annual inflation rate, national investment, and exchange rate were taken as independent variables, while capital adequacy ratio, debt to equity ratio, total loans to total assets, total loans to total deposits, loan loss provision to total loans, net profit per employee, non-interest expense to total expenses, total loans per branch, total liquid assets to total deposits, total income to total assets, total interest income to total income, and cash to deposits were taken as bank specific independent variables. Return on Assets (ROA) and Efficiency Ratio (ER) were taken as dependent variables. Moreover, the main limitation of this study is the financial performance for the year after and before GTP-II was excluded from the study, and unpublished works were not included in the investigation.
REVIEW OF RELATED LITERATURE
Historical Development of Banking in Ethiopia
The history of banking in Ethiopia was back to the reign of emperor Minilik II. The banking business was started with the establishment of Abyssinia Bank in 1905 which was affiliated with the national bank of Egypt. The country established the State Bank of Ethiopia, which went operational on the 15th of April 1943 has a status of a central and principal commercial bank with powers to issue banknotes and coins as an agent of the then Ministry of Finance and to engage in all commercial banking activities(Abera, 2013). Since 1964 private commercial banks were started to established and nowadays the number of banks including private commercial banks is 19. The following table depicts the name of banks, year of establishment, and affiliation:
Table 1. Historical Development of Banks in Ethiopia
No.
|
Bank Name
|
Year of Establishment
|
Owners/Affiliation
|
1.
|
Abyssinia Bank
|
1905
|
Ethiopia/National Bank of Egypt
|
2.
|
Bank of Ethiopia
|
1931
|
Ethiopia/Dissolved after Italian Occupation in 1936
|
3.
|
Banca d’Italia,
Banco di Roma,
Banco di Napoli, and Banca Nazionale del Lavoro
|
Established during Italian occupation
|
Owned by foreigner
|
4.
|
Barclays Bank
|
1941
|
Foreign bank by British
|
5.
|
State Bank of Ethiopia
|
1943
|
Dissolved by the Ethiopian Government in 1963.
|
6.
|
National Bank of Ethiopia
|
1963
|
Ethiopia
|
7.
|
Commercial Bank of Ethiopia
|
1963
|
Ethiopia
|
8.
|
Addis Ababa Bank
|
1964
|
The first private bank dissolved by the Derg regime
|
(Source: National Bank of Ethiopia: https://nbebank.com/history-of-banking/)
Bank Performance And Its Determinants
Performance in the banking industry can be expressed in different ways. Profitability, efficiency, and soundness are some of the tools that can be applied to measure banks’ performance. Profitability can be measured using ROA, and ROE while the overall efficiency can be observed using CAMELS, data envelopment analysis, and other tools.
“Although banking institutions have become increasingly complex, the key drivers of their performance remain earnings, efficiency, risk-taking, and leverage. In detail: while it is clear that a bank must be able to generate “earnings”, it is also important to take account of the composition and volatility of those earnings. “Efficiency” refers to the bank’s ability to generate revenue from a given amount of assets and to make a profit from a given source of income. “Risk-taking” is reflected in the necessary adjustments to earnings for the undertaken risks to generate them (e.g. credit-risk cost over the cycle). “Leverage” might improve results in the upswing – in the way it functions as a multiplier – but, conversely, it can also make it more likely for a bank to fail, due to rare, unexpected losses.”
(ECB, 2010 PP. 8)
Theoretical Reviews of Bank Performance
Pure Expectations Theory
The theory points out that the rising term structure of rates means the market is expecting short-term rates to increase. This implies the two successive years rate is higher than the single-year rate so that the rate should rise. The market is expecting that short-term rates will remain low or hold constant in the future if the curve is flat (Cekrezi, 2015). Besides, it is believed that a declining rate structure indicates it will continue to decline. The states that, the expected return from holding long-term money or capital market investment until maturity is equal to the expected return from rolling over a series of short-term investments with a total maturity equivalent to that of the long-term investment (Korir and Oluoch, 2019).
The Portfolio Theory
One of the important theories concerning banking performance is portfolio theory which states that several factors such as the vector of rates of return on all assets held in the portfolio, a vector of risks associated with the ownership of each financial asset, and the size of the portfolio are the building block of asset diversification. This is to means that portfolio diversification and the desired portfolio composition of commercial banks are the results of decisions taken by the bank management (Cekrezi, 2015).
Liquidity Preference Theory
Liquidity preference theory is different from Pure Expectations Theory (Abdirizak et al., 2019). It essentially provides a top rate to the PET-calculated yield for long-time period debt to account for investor desire for short-time period bonds over long-time period ones (Dolphine, 2018). According to Abdirizak, Willy, and Mohamed (2019), this premium is called the term premium or the liquidity premium. It recognizes the dangers worried in conserving long-time debt, that's much more likely to be exposed to catastrophic activities and rate uncertainty than is short-time debt. The second top rate is likewise covered in LPT, for default risk, which is much more likely whilst maintaining a bond for an extended length of time, yet again because of uncertainty (Dolphine, 2018).
CONCEPTUAL FRAMEWORK
Figure1. Conceptual Framework