SHOULD ETHIOPIA ACCEPT FOREI GN BANKS?

By TEKLEHAYM ANOT DAGNE BELAY*

Limitations in investment are a widely practiced phenomenon around the world. Countries opt
to restrict some group of individuals from engaging in a particular type of investment for many
obvious reasons. Whatever the economic ideology states follow, the regulatory power of limiting
or putting in place restriction in some sectors of the economy is not the issue for debate, but the
scope of it, is much contested.1 The form of limitation, its scope and the manner of implementing
these policies or laws differ depending on the social, economic and political consideration
underlying the limitations. The most notable limitation relies on delimiting the sectors that one
can participate as an investor i.e. laws regulate sectors of investment reserved for the
government, for nationals or for joint participation.

The Ethiopian investment regime in general and investment in the banking sector specifically is
no different in this regard. Laws are in place which control investing in the banking industry.
One of the most notable restrictions found under our law is the requirement of nationality for
investment in banking i.e. that, only nationals can invest in banks. 2 The cogent behind such
restrictions, as also these apply to other sectors under restriction consists of the need to retain
basic and strategic industries, the desire to protect national security and the need to control the
commanding heights of the economy. 3

This paper tries to identify the reasons forwarded by the proponents and opponents of the
argument whether Ethiopia should allow foreign banks or not. First the advantages of accepting
foreign investment in banking will be dealt with the critiques associated. In the second part, the
argument against involvement of foreign banking will be forwarded. Lastly, the author will try to
give his own verdict on the debate.

The thesis of the paper is that, although allowing foreign banks to operate in Ethiopia has its own
pitfalls, the merit to be derived from their involvement surpasses the problems associated with
them and hence they should be welcomed.

 LLB from Haram aya University, currently an LLM st udent in Addis Abeba Universit y and an Assist ant Judge
at t he Federal High Court of Et hiopia, succession liquidator and arbit rator.
1
Get enet Tem echew , investm ent lim it ations in and by Banks in Et hiopia, Thesis, 2010 (Unpublished, Addis Abeba
Universit y School of Law Library), p 5
2
Banking Business Proclam ation, 2008, article 9, proclam at ion no 592, Neg Gaz., year 14 no 57
3
Get enet Tem echew , cit ed above at not e 1, foot not e 1
Ar guments for accepting for eign banks

The first consideration relates financial sector openness to economic growth thereby arguing a
liberalized financial sector is crucial to economic development.4 Matteo and Shanaka argue that
the key element of financial openness includes domestic market competition, foreign ownership,
limited capital control, which are not in place in Ethiopia. In another paper by Kozo Kiyota,
Barbara Peisch and Robert Stern, restriction of investment in banks by foreigners will increase
concentration of financial sector in the hands of the state and will ultimately result in lack or
shortage of availability of finance for investment.5

Access to a stable and massive amount of credit would be boosted by entry of foreign banks in
the market. Currently the lending capacity of our banks is minimal hence, one should look
elsewhere to obtain loan for his mega project. No argument exists as to the fact that finance is the
blood of business, which in turn, is the basis of the economy.

The second line of argument stress the fact that accepting foreign banks will increase efficiency
of domestic banks and there by inject the all lacking competition in the financial system.
Liberalizing the banking industry, in the view of those who argue towards it, would invariably
help the poor, disorganized, uncompetitive and isolated domestic banking industry in many ways
It is widely accepted that foreign banks operating in developing countries, like ours are far more
efficient than domestic banks. 6 Most of our banks are state owned and as such are not efficient
enough like foreign banks in any way.

The efficiency of foreign banks could easily be measured in terms of lower charge for their
service, lower overhead cost, newer technologies, innovations, lower interest rates and the like.
Such would ultimately increase the competition in the banking sector and benefit customers in
particular through branch expansion and delivery of quality service. The financial sector benefits
by accepting knowledge and experience of their foreign counterparts and the construction of new
infrastructures. The overall economy will gain through the capital infusion by foreign banks and
FDI that could be attracted through the financial openness.

4
M at t eo F. Ghilardi and Shanaka J. Peiris, Capit al Flow s, Financial Int erm ediat ion and M acroprudent ial policies,
IM F Working Paper, WP/ 14/ 157(2014)
5
Kozo Kiyot a, Barbara Peisch and Robert St ern, The Benefit of Financial Sect or Liberalization for Developing
count ries; A Case St udy of Et hiopia, International Policy Cent er, (2008), p 10
6
Robert Cull and M aria Soledad, (Finance and Private Sect or Developm ent Research Group, The World Bank),
Foreign Bank Part icipation and Crises in Developing Count ries: World Bank Policy Research Working Paper 4128,
February 2007,p.3
The other benefit of permitting foreign investment in banks is associated with stability. Foreign
banks which are, in the majority of cases in possession of huge amount of capital and skill
management, would better absorb and endure financial crises which are prevalent in developing
countries like Ethiopia. A possible explanation of the macro economic instability in the
developing world relates to weaker and imperfect international financial integration. 7 We could
be easily mistaken to conclude that Ethiopia is not concerned with economic sector instability.
The reason could be that, we have not been integral part of the international trade. In the near
future, where accession to the WTO is on the horizon, economic instability could be our concern
and hence, such risks could be mitigated by accepting foreign banks.

Other benefits that Ethiopia could reap by allowing foreign investment in the banking sector
includes acceleration of economies of scale, availability of foreign currency, easier money
transfers , facilitation of the import and export of goods and services and others.

Ar guments against accepting for eign banks

The other side of the argument is most of the time conservative by its nature in the sense that it
stresses the protection of national interests either in the financial or other sectors of the economy.
The first line of argument that prohibition is usually grounded argues that foreign banks would
create foreign control over the economy. Banking business is necessarily related to credit
management, which is the gear shift to the economy. Hence, involvement of foreign banks would
result in a situation where the economy would be controlled by foreigner not by government.
Accordingly, in a least developing country loss of control of the economy would be at stake in
accepting foreign banks.8

Secondly, banking business in Ethiopia is in its infant stage of development. Their stage of
development, coupled with the fact that they operate in a least developed country makes them
vulnerable. They are not in a position to compete and win the banking market owing to lack of
finance and technology. Therefore, they should be protected so as to make them competitive.
After all, justice requires treating unequals differently.

The third line of reasoning takes the view that foreign banks may not only have business
purposes in mind while engaging in the financial system. There may be situations where entry is
sought for frivolous or vexatious ends, or for other reasons completely divorced from the
business itself. This is particularly the case for countries that undertake the great majority of
investments in the country like China.

7
M assim iliano Pisani, Financial Openness and M acroeconom ic Inst abilit y in Em erging M arket Econom ies, Bank of
It aly Research Departm ent , 2005, p 1
8
Abraham Am anuel, Is Et hiopia Ready To Accept Foreign Banks,(2008), Addis Abeba Universit y Depart ment of
Account ing and Finance(unpublished), p 68
Some argue that small firms are the ones who will suffer from engagement of foreign banks in
the country. Such small firms capitalize on small amount of credits from banks to operate.
However, foreign banks will, in most of cases concentrate on lending to foreign borrower and
titanic domestic industries with substantial amount of credit. This would deteriorate the capacity
of small firms and industries to develop their business by arranging for a credit. Ultimately, such
would have an adverse effect on the economy, which aspires to build itself development of small
scale industries and firms.

Other reasons associated with prohibition of liberalization of the banking sector includes lack of
strong domestic regulation to control, tilt of credit away from sectors that are the basis for the
economy, lack of interest in domestic fund mobilizations.

What would ultimately make Ethiopia better off?

In an empirical research conducted by Dailami (2000), the Ethiopian banking sector is the most
restrictive and un-enabling system of all the 96 countries under the research. 9 This data has a
thing to deliver by itself about our reality and by the fact that investment in banking is, after all
FDI to which we aspire to welcome. Is it not self contradictory, on the one hand we beg for FDI
while at the same time we prohibit investment in banking sector which is an FDI in itself and the
basis for other FDI? The case speaks for itself.

On the other hand, the explanations forwarded by those who argue against accepting foreign
banks are ill reasoned and lack proportionality. The ones relating to protection of national
interest, infant banking sector, ill motives and the like could be controlled not by closing the door
for foreign investment but by devising regulatory mechanisms. The other one that narrate about
small scale industries could be attacked on the fact that, first it is improbable to think that foreign
banks would leave the majority of business customers’ i.e. small firms. Secondly, it should be
wrong to decide which banks better serve these sectors and it should be left to the market to
decide.

The benefits, on the other hand are so obvious and many, that no credible counter argument
could negate them. Consumers would be in a position to utilize advanced technologies in an
accessible manner and with low cost. Employment opportunities would come along in a direct
way through the bank sector and indirectly, through investments created with the credit made
available. The banking sector would flourish with improved technologies and infrastructure.
Such developed and stable financial system has a direct and notable effect in the development of
the economy.

9
Kozo Kiyot a, Barbara Peisch and Robert St ern, cit ed above at not e 5, p 9
Other policy considerations like foreign exchange and investment reform also make accepting
foreign banks inevitable. Besides, the eminent accession to the World Trade Organization
(WTO) makes liberalization the more important and feasible choice.

The author strongly believes in the need to protect some national interests that are very much
needed to facilitate or foster economic development like domestic fund mobilization and making
domestic banks competitors. Nonetheless, closing the door is not also a viable solution. The
arguments for accepting foreign banks seem to be found on state of affairs in the world and
reasonable grounds while the argument against relies on a more conservative and country
specific realities.

Ethiopia could, on the one hand open the door for foreign bank involvement in the financial
sector and reap all the good benefits while enact laws and implement them in a more stringent
fashion in order to curb or minimize the potential downfalls of accepting them. As the saying
goes “don’t close your eyes not to see a bad person. Because, you will miss a good one”. Hence
the more pragmatic and reasonable choice should be striking the balance between the two
extremes. Therefore, regulated foreign banking institutions have a lot to offer to our financial
system.