The National Bank of Ethiopia (NBE; Amharic: የኢትዮጵያ ብሔራዊ ባንክ) serves as the central bank of Ethiopia, with its headquarters located in the capital city of Addis Ababa. This article delves into the history, evolution, and legal independence of the NBE, examining its role in Ethiopia's economy and the challenges it faces in maintaining autonomy.
Historical Overview of Banking in Ethiopia
The history of banking in Ethiopia began on 15 February 1906, with the inauguration of the first Bank of Abyssinia by Emperor Menelik II. It was a private bank with shares sold in Addis Ababa, New York, Paris, London, and Vienna.
The bank opened numerous branches including ones in Harar (1906), Dire Dawa (1908), Gore (1912), and Dese (1920). One of the first projects the bank financed was the Franco-Ethiopian Railway which reached Addis Ababa in 1917.
In 1931, Emperor Haile Selassie introduced reforms into the banking system. The Bank of Abyssinia was liquidated, with the newly established Bank of Ethiopia, a fully government-owned bank, taking over management, staff and premises of the ceased bank. The Bank of Ethiopia provided central and commercial banking services to the country.
On 15 April 1943, the State Bank of Ethiopia became the central bank and was active until 1963. The National Bank of Ethiopia was established in 1963 by Proclamation 206 of 1963 and began operation in January 1964. The establishment of the new organization was aided by U.S Department of State emissary, Earle O. Prior to this proclamation, the bank carried out dual activities i.e. commercial banking and central banking.
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The proclamation raised the bank's capital to 10 million Ethiopian Dollars and granted broad administrative autonomy and juridical personality. However, monetary and banking proclamation No. 99 of 1976 came into force in September 1976 to shape the bank's role according to the socialist economic principle that the country adopted.
Hence the bank was allowed to participate actively in national planning, specifically financial planning, in cooperation with the concerned state organs. The bank's supervisory area was also increased to include other financial institutions such as insurance institutions, credit cooperatives and investment-oriented banks. The proclamation revised the bank's relationship with Government.
This proclamation was in force till the new proclamation issued in 1994 to reorganize the bank according to the market-based economic policy so that it could foster monetary stability, a sound financial system and such other credit and exchange conditions as are conductive to the balanced growth of the economy of the country. Lastly, the proclamation has also raised the paid-up capital of the bank from Birr 30.0 million to Birr 50.0 million.
On 14 October 2022, NBE issued foreign currency restriction to control local forex. 38 imported goods were prohibited such as liquors, automobiles, furniture, foods among others unless they register to national banks to approve accessing the foreign currency.
The Role of Central Banks in Economic Stability
The Role of the National Bank of Ethiopia
NBE aims to foster monetary stability and a sound financial system, maintaining credit and exchange conditions conducive to the balanced growth of the economy. NBE may engage with banks and other financial institutions in the discount, rediscount, purchase, or sale of duly signed and endorsed bills of exchange, promissory notes, acceptances, and other credit instruments with maturity periods not exceeding 180 days from the date of their discount, rediscount, or acquisition by the bank.
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The bank may buy, sell, and hold foreign currency notes and coins and such documents and instruments, including telegraphic transfers, as they are customarily employed in international payments or transfers of funds. In 2015, NBE allowed commercial banks to provide mobile banking service and agent banking.
Ethiopia is recognized as the first African country to establish an independently owned central bank. This article evaluates the legal independence of the National Bank of Ethiopia (NBE), tracing its evolution from inception to the present day.
Various studies provide robust evidence that an independent central bank is crucial for maintaining price stability without adversely affecting economic growth. The primary objective of this article is to analyze the extent to which the NBE maintains legal autonomy and effectively executes its monetary policy mandate amidst governmental influences.
Findings indicate that while the NBE has made significant strides in enhancing its legal independence, such as emphasizing price stability as its primary objective and allowing the board to set remuneration, substantial challenges remain. Persistent governmental control over appointments and financial resource allocation continues to undermine its operational effectiveness.
Central Bank Independence: A Cornerstone of Economic Stability
Central bank independence (CBI) is widely recognized as a cornerstone of effective monetary policy and economic stability. Autonomy from governmental influence allows central banks to prioritize long-term economic health over short-term political considerations, a necessity in today’s dynamic and often volatile economic environment . A robust and independent central bank serves as a safeguard against inflationary pressures and ensures the integrity of the financial system, thereby fostering an environment conducive to economic development .
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In assessing the legal independence of the NBE, this article will provide a thorough analysis of the legislative framework that governs the bank. This assessment will track the evolution of relevant legislation from the bank’s inception in 1963 to the current “National Bank of Ethiopia Draft Proclamation,” which aims to update and strengthen the legal independence of the institution.
The review will highlight both the progress made and the challenges faced throughout this legislative journey, elucidating how legal instruments have shaped the NBE’s authority and autonomy. In extending previous research on the independence of the NBE, this study employs a comprehensive set of recently developed indices to evaluate central bank independence, an improvement over earlier methods that did not capture the bank’s autonomy holistically .
Recent frameworks, such as those developed by Tobias Adrian, Ashraf Khan, and Lev Menand (2024), provide innovative metrics that capture the multifaceted nature of CBI. These metrics assess various dimensions of independence, including monetary policy autonomy, budgetary autonomy, financial autonomy, and the ability of central banks to act free from political pressure.
Applying these metrics to the NBE allows for a comprehensive evaluation of its independence and capability to effectively fulfill its monetary policy objectives amidst Ethiopia’s unique socio-economic challenges.
The Evolution of Central Banking
The concept of central banking, a cornerstone of modern financial systems, dates back to the 17th century with the establishment of pioneering institutions such as the Swedish Riksbank in 1668 and the Bank of England in 1694 . However, it was during the 20th century that central banks significantly proliferated, enhancing their roles and influence within the global economy . Established mainly to issue currency, these institutions gradually expanded their roles by the early twentieth century, becoming non-profit maximizing, non-competitive entities that operated above commercial interests .
Unlike contemporary central banks, which primarily focus on achieving price stability, these early institutions engaged in both commercial and central banking functions. As their roles expanded, they assumed critical responsibilities, including the centralization of reserves for commercial banks and the management of both domestic and foreign currency reserves on behalf of governments . This evolution has solidified their status as essential components of the financial system and as pivotal players in maintaining economic stability.
Theoretical Foundations of Central Bank Independence
The concept of central bank independence (CBI) is primarily based on the idea that monetary policy should be shielded from political interference, especially the pressures exerted by governments during election periods. The core argument for central bank independence (CBI) arises from the recognition that politicians frequently pursue short-term economic policies aimed at gaining electoral favor, such as reducing unemployment or stimulating economic activity to demonstrate progress as elections approach, which can conflict with long-term economic objectives like controlling inflation and maintaining price stability .
This focus on short-term objectives can conflict with the long-term economic goals of controlling inflation and maintaining price stability. Such misalignment between the priorities of the central bank and those of the executive branch frequently leads to inflationary cycles and economic instability, underscoring the importance of ensuring central bank independence . The theoretical support for CBI became more pronounced in the 20th century, particularly after the inflationary crises of the 1970s and 1980s, which underscored the negative impact of politically-driven monetary policies .
Scholarly analysis has explored the divergence in objectives between central banks and government executives, highlighting the potential for adverse economic outcomes. For Instance, William Nordhaus’s “Political Business Cycles” theory posits that incumbent governments exploit inflationary policies to reduce unemployment in the lead-up to elections, aiming to boost their chances of reelection . However, this approach is often unsustainable, eventually resulting in higher inflation and economic fluctuations .
Nordhaus’s work highlighted how political motivations make it difficult for governments to simultaneously achieve low inflation and stable economic growth over the long term. The concept of political business cycles is often associated with the “time inconsistency problem” in macroeconomic policy, a notion first formally introduced by Finn Kydland and Edward Prescott, and later expanded by Robert Barro and David Gordon .
In contrast, Douglas Hibbs’s “partisan theory” adds another dimension to the relationship between macroeconomic policy and the executive by suggesting that political ideologies significantly shape a government’s economic preference . Left-wing parties, for instance, may prioritize policies that aim to reduce unemployment, even at the expense of higher inflation, while right-wing parties generally focus on controlling inflation, even if it means tolerating higher unemployment .
Hibbs’s theory underscores the political motivations behind macroeconomic outcomes and further supports the case for an independent central bank that can focus solely on price stability, irrespective of the political party in power. Another major theoretical justification for CBI is the
Measuring Central Bank Independence: Methodologies and Metrics
Central bank independence is a complex and multifaceted concept, and its definition varies depending on the perspective and criteria used by different scholars. Broadly, central bank independence refers to the capacity of a nation’s central bank to formulate and implement monetary policy based on its own objectives and preferred instruments, while managing the financial system without undue political interference, particularly from the government .
The term encompasses a range of meanings, including the methods used to select and insulate the governing board from political influence, the determination of the central bank’s objectives, and whether it can be used to finance government budget deficits . Scholars, including Mark Swinburne, further refine this definition by distinguishing between two forms of independence .
The first form insulates central banks from political pressures through established rules, such as the gold standard, which restrict the bank’s operational flexibility. The second form, more relevant to modern central banking, grants central banks greater discretion in shaping and implementing monetary policy while remaining free from political influence. Thus, central bank independence can vary in its scope, from rule-based constraints to broader discretionary powers, reflecting different levels of autonomy across institutions.
Measuring central bank independence presents challenges due to the influence of various factors and the absence of a universal criterion for ranking the level of independence among central banks. This complexity arises because scholars assess central bank independence through various dimensions, including political, legal, operational, and financial independence. These differing aspects can lead to varying interpretations and indices, with the specific variables within each dimension also subject to change.
Among the scholars who have proposed diverse methodologies to assess the independence of central banks are Cukierman, Webb, and Neyapti, along with Bade and Parkin, and Grilli, Masciandaro, and Tabellini . Bade and Parkin (BP) developed the first central bank independence () index, using a sample of 12 countries to assess financial and policy characteristics of central bank charters based on government influence . They ranked central banks on a scale from 1 to 4, with a lower government influence corresponding to a higher rank.
Financial characteristics include the extent of government control over the central bank’s budget, board members’ salaries, and profit allocation. Policy characteristics range from government control over policy and board appointments to full central bank authority with some independent appointments. Another central bank index was developed by Vittorio Grilli, Donato Masciandaro, and Guido Tabellini (), who expanded on Bade and Parkin’s work by including 18 countries and a total of fifteen elements, comprising eight political metrics and seven economic metrics .
Their eight political metrics evaluated factors such as the appointment process for governors, government involvement in decision-making, and the statutory relationship between the central bank and the government, while their seven economic metrics assessed monetary financing and instruments. Each of the fifteen metrics was scored on a binary basis, with specific criteria earning additional points, resulting in varying scores that indicated different levels of independence among central banks .
Banking Systems in Ethiopia
The GOE allowed the establishment of private banks and insurance companies in 1994 but does not yet permit foreign ownership in this sector, except for foreign nationals of Ethiopian origin. The Ethiopian banking sector is currently comprised of a central bank (The National Bank of Ethiopia, or NBE), one state owned development bank, a government owned commercial bank, over 30 banks, including newly established banks Amhara Bank, Zamzam Bank and Hijra Bank.
In March 2021, NBE released a new directive further uplifting the minimum paid up capital requirement to start a banking business to 5 billion Ethiopian birr ($90 million). Foreign banks are not permitted to provide financial services in Ethiopia, but GOE statements indicate that the sector may open in the medium term as the government pursues broad economic reforms.
Currently, Ethiopia has allowed a small number of foreign banks to open liaison offices in Addis Ababa to facilitate credit to companies from their countries of origins. Chinese, German, Kenyan, Turkish, and South African banks have opened liaison offices in Ethiopia. The state-owned Commercial Bank of Ethiopia (CBE) dominates the market in terms of assets, deposits, bank branches, and total banking workforce.
CBE holds more than 60% of total bank deposits, bank loans, and foreign exchange. The other government-owned bank is the Development Bank of Ethiopia (DBE), which directs credits to investors operating in priority sectors. The DBE has been plagued for years by a portfolio with a high percentage of non-performing loans (NPLs), inefficient capital allocation, and corruption.
Foreign Exchange Controls
Foreign exchange reserves maintained by the government of Ethiopia remain in short supply, a longstanding challenge for those seeking to source from abroad. The decrease in foreign exchange reserves has been exacerbated by international debt obligations contracted to fund previously built infrastructure projects.
All payments abroad require permits and all transactions in foreign exchange must be carried out through authorized dealers supervised by the NBE. Imports must be funded through accounts held in Ethiopia. The NBE has delegated most of the foreign exchange transaction functions to the commercial banks but maintains authority to approve large foreign exchange allocations.
NBE also requires commercial banks to surrender 50% of their foreign exchange (recently lowered from 70%) earnings obtained from export transactions with the exporter having a right to use remaining 40% leaving only 10% of the export earnings to be used by the commercial banks. Importers and exporters can obtain import/export permits through the commercial banks.
Private sector actors widely complain about the shortage of foreign exchange and point out the adverse implications on their businesses. As a result of the critical shortage of foreign currency, NBE regulations require commercial banks to allocate foreign currency to importers based on priorities, and debt obligations.
State owned enterprises and government sponsored infrastructure projects usually are given priority over the private sector when competing for access to foreign exchange. During the period of November 2019 through spring 2020 the NBE increased the rate of the devaluation of the birr.
Local sourcing of inputs and partnering with export-oriented partners are strategies employed by the private sector to address the foreign exchange shortage. As part of a potential International Monetary Fund (IMF) bailout, the GOE will have to harmonize the official and black-market rates to a significant degree.
Openness to Foreign Investment
The Ethiopian Government states that the private sector is an engine of growth and that private capital should play an important role in the economy. The government has eliminated most of the discriminatory tax, credit and foreign trade treatment of the private sector, simplified administrative procedures, and established a clear and consistent set of rules regulating business activities.
Despite the promotion of the private sector, state-owned enterprises and ruling party-owned entities dominate the major sectors of the economy. Though bureaucratic hurdles continue to affect implementation of projects, the Ethiopian Investment Agency (EIA), the main contact point for foreign investors, has improved its services and provides an expedited "one-stop shop" service that significantly cuts the time and cost of acquiring investment and business licenses.
A foreign investor intending to buy an existing private enterprise or buy shares in an existing enterprise needs to obtain prior approval from the EIA. A National Foreign Investment Promotion Advisory Council operates with the goal of conducting foreign investment promotion on textiles and garments, leather and leather products, fruits and vegetables, and agro-processing areas.
Methods of Payment
There are various methods of receiving payment for products sold in Ethiopia, the selection of which is usually determined by the degree of trust in the buyer’s ability to pay. exporters selling to Ethiopia for the first time are advised to transact business only on the basis of an irrevocable letter of credit, confirmed by a recognized international bank.
Any other form of payment carries a considerable level of risk. Using a letter of credit may result in delayed collection of receivables due to a shortage of foreign exchange. banks to accept Ethiopian letters of credit. For more information about the methods of payment or other trade finance options, please read the Trade Finance Guide.
| Indicator | Value/Description |
|---|---|
| GDP Growth (Government Claim) | 10.1% (2008/09) |
| GDP Growth (IMF & World Bank Estimate) | 6.5% (2008/09) |
| Average GDP Growth (Past 5 Years, Government Claim) | 11.5% |
| Foreign Exchange Reserves (December 2008) | USD $700 million |
| Foreign Exchange Reserves (Current) | USD $1.8 billion |
| Total Imports (2008/09) | USD $7.7 billion |
| Total Exports (2008/09) | USD $1.4 billion |
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