Download 3.1 Profile of Dashen Bank SC - Ethiopian Economic Association

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 Contents
CHAPTER 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
Introduction
1.1
Background of the Study
Etymologically, 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 17thcentury 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).
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,
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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
Agricultural and Industrial Development Bank.(Ibid)
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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 Problem
Banks 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 lack
incorporation of standard measurements of banks performances and hence the roles played to the
economy.
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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 study
The 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 Study
Considering 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 Study
This 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 Source
The 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 Study
This 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 Literature
This 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 research. In this section, it will
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be tried to critically review the studies that are done on the role and performance of commercial
banks in the economy.
2.1 Theoretical Review
2.1.1 Evolution and Definition of Banking
Although 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, 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).
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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 system
The 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 country, the numbers of
corporations are decreasing and the numbers of branch offices are on the contrary increasing (R.I.
Robinson, 1966).
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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 Countries
Recently 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).
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
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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 Economy
Banks 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
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.
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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.
2.1.5 Performance Measurements
2.1.5.1 Theories on measuring bank performance
Performance, 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
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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 performance
The following some are among financial indicators that are used to evaluate performance of a bank.
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.
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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 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
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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 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).
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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 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
14
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 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).
15
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 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
16
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 Review
Commercial 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 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
17
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
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
18
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
(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.
19
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.C
3.1 Profile of Dashen Bank S.C
3.1.1 Establishment of Dashen Bank SC
The 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 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
20
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 Bank
The 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
3.2 The Legal and Policy Environment
Before 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.
21
3.3.1 The Legal framework
The 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 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 21 st
day of August 1995.
C) Maintenance of Adequate Liquidity
22
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.
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
23
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.
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 Aspect
Another 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.
24
3.3.2.1 Interest Rate Policy
Interest 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 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
25
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 Policy
Before 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.
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.
26
. 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.
 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.
27
 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.
 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.
28
 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.
29
CHAPTER FOUR
Data Presentation and Analysis
In 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 Evaluation
4.1.1 Branch Expansion
It 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 mobilization
The 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
32
financed. Although capital formation can be accomplished with the help of external 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
Demand
deposit
Saving
deposit
Time/fixed Total
deposit
deposit
%growth
in
total 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
33
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
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 delivery
Deposit 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)
34
Year
Outstanding loan balance
% increase
2004
1627
_
2005
2161
32.88
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 Profitability
The 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)
35
Year
Net profit after
tax
Net
2004
Paid
asset
up Return
on asset
capital and
reserves
Return on
equity
%increase
on profit
56
133
172
2.40
37.21
-
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 Economy
As 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
36
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 Formation
The 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
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
deposits
Total loan
dispersed
% growth % growth
in total
in loans
deposits
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
37
2013
15851
8663
8.98
12.7
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.
4.2.2 Provision of Sectorial Loans and Advances
The 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 birr
Year
agriculture
sector
manufacturing %Growth %Growth in
in loan to loan to the
agriculture 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
38
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.
4.2.3 Employment Opportunity Creation and Human Capital Development
One 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
39
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
(human capital formation)
4.2.4. Investment by the bank
Dashen 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 Recommendations
5.1 Conclusions
Financial 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.
5.2 Recommendations
Based on the finding of the study and policy reviewed, some possible recommendations are
forwarded as follows.
41
 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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