Liberalizing Financial Sector in Ethiopia: Constraints, Consequences and Policy Issues

Abstract

This paper was instigated to examine the constraints, consequences, and policy issues of the intended financial sector liberalization process in Ethiopia. Primary data from financial sector operators and secondary data from National Bank of Ethiopia, IMF and the WB were employed to achieve the objectives of the study. Descriptive and econometric approaches were used to analyse the data and the results revealed that Ethiopian financial sector performance is not satisfactory. The liberalization process can be effective if implemented sequentially within a stable macroeconomy; in both the long run and the short run. The policy will also improve economic growth directly and indirectly by improving efficiency. However, it may reduce economic growth indirectly by increasing bank fragility. In nut shell, the intended financial sector's liberalization is expected to bring both benefits and costs to individual firms and the country as a whole. The benefits may include speeding up foreign direct investment, reducing the population to financial sector ratio; lowering lending interest rates; economies of scale; improving consumer and mortgage credit; and ensuring a more stable source of credit. While the negative consequences of liberalization may include a loss of macroeconomic stability and biased credit provision, causing small businesses to face credit shortages, less mobilizing of domestic capital, capital flow volatility. Therefore, the government should design strong prudential regulations, and strengthen institutional capacity to implement sequential financial sector reform.