Book IV Title III of the Commercial Code of Ethiopia which deals with banking transactions fails to provide a definition of a bank and banking transactions though the latter may be gathered from the various sections governing the various types of transactions undertaken by banks. Therefore, we have to refer to other laws to define and determine what banks and banking transactions are under the Ethiopian legal system.

According to Art 2 (12) of the Monetary and Banking Proclamation No 83/1994, banking business means any operation involving receiving money on deposit, lending money, receiving commercial instruments on deposit, accepting, negotiating/ transferring, discounting commercial instruments and other evidences of debt, and buying and selling of gold and silver notes and  foreign exchange. Similarly, Art 2 (2) of the Licensing and Supervision of Banking Business Proclamation No 84/1994 defines banking business as:

Any business involving acceptance of money on deposit, using such funds or deposits, in whole or in part, for loans or investments on the account of and at the risk of the person undertaking the business, purchasing, selling and deposit of negotiable instruments (shares, bonds and other securities/ and checks, bills and notes, and buying and selling of gold and silver bullions and foreign exchange).

On the other hand, the term bank is defined, under Art 2(1) and (4) of the same proclamation, as a share company whose capital is wholly owned by Ethiopian nationals and/or business organizations wholly owned by Ethiopian nationals and which is registered under Ethiopian laws and which has its head office in Ethiopia and licensed to undertake banking business by the national bank of Ethiopia.

In addition to this, Art 4(2) of the same proclamation clearly prohibits foreign nationals and business organizations from undertaking banking business in Ethiopia. The definition of a bank and this provision exclusively reserve the banking sector to Ethiopian nationals or business organizations wholly owned by Ethiopian nationals mainly on the ground of protection of domestic banks which are at an early stage of development, at least until they develop their financial and manpower capabilities, to be able to compete with foreign banks which have enormous financial strength, experience, technology and knowhow.

Role of Micro Finance Institutions

According to the preamble of Proclamation No. 40/1996, the monetary and banking laws in force do not provide for micro financing institutions catering for the credit needs of peasant farmers and others engaged in small scale production and service activities. So it has become necessary to legislate on the licensing and supervision of the business of micro financing institutions.

So the development of microfinance in Ethiopia should be viewed as (a) an identification of considerable levels of unrealized demand and potential market growth for financial services and (b) a shift by the NGO sector and government from relief assistance to sustainable development which intersects at the point of institutionalization of microfinance provision (Fiona, 1999).

Although the development of microfinance institutions in Ethiopia started very recently, the industry has shown a remarkable growth in terms of outreach particularly in number of clients. Since the issuance of Proclamation 40/1996, which provides the establishment of microfinance institutions, sixteen microfinance institutions (MFIs) have been legally registered by the National Bank of Ethiopia (NBE) and started delivering services, and two more applications by new MFIs are currently being processed.

According to the Micro start Project document of UNDP (1999), the economically active poor in Ethiopia who can potentially access financial services are about 6 million. Out of this, about 8.3% of the active poor have gained access to the licensed microfinance institutions. Despite the obvious disadvantages of the microfinance industry in Ethiopia such as poor communication and infrastructure, weak legal systems, banking sector and technical capacity when compared with other Sub-Saharan countries, the sector has been growing at a significant rate.

The Regulatory Framework for the Microfinance Industry and Micro and Small Enterprises

The delivery of efficient and effective microfinance services to the poor required conducive macroeconomic policies and the establishment and enforcement of legal and regulatory frameworks of a country. An effective financial system provides the foundation for a successful poverty alleviation program. However, regulations in the microfinance industry do not only mean government regulations; it also involves self-regulations and code of conducts introduced by networks or associations.

Regulatory frameworks governing the microfinance industry should ensure that the MFI has a sound portfolio performance; low delinquency or default rate; high diversification to reduce the risk of specializing in the delivery of one loan product; ensure the safety of deposits through equity capital; ensure lower levels of liquidity risk; provide regular and high quality financial information and reduce the risk arising from dependence on subsidy and influence of donor.

There are numerous policies, laws and directives which affect the development of microfinance industry and micro and small enterprise development in Ethiopia. An attempt is made here to review only the most relevant and recent policies affecting the industry. The Monetary and Banking Proclamation No. 83/1994 empowered the National Bank of Ethiopia (NBE) to license, supervise and regulate financial institutions such as banks, insurance companies, microfinance institutions and savings and credit cooperatives. The Licensing and Supervision of Banking Business Proclamation No. 84/1994 allowed for the first time the establishment of private financial institutions, thus breaking the state monopoly. To date, six private banks and eight private insurance companies have been established.

Since micro-credit delivery and savings mobilization in Ethiopia were performed by NGOs, government departments, cooperatives and others in a fragmented and inconsistent way, the government took the initiative to establish the regulatory framework in order to facilitate sound development of the

Microfinance industry Proclamation No. 40/1996, which aims to provide for the licensing and supervision of the business of micro financing clearly indicates the requirements for licensing microfinance institutions by empowering the National Bank of Ethiopia to license and supervise them. According to article 4 of the Proclamation, any institution that needs to engage in microfinance activity should fulfill the following:

1. obtain license from the National Bank of Ethiopia;
2. formed as a company governed by the commercial code of 1960 (a share company owned fully by Ethiopian nationals and having its head office in Ethiopia);
3. deposit the minimum capital required, i.e., 200,000 Birr in a bank;
4. the directors and other officers meet requirements set by the bank.

Furthermore, as to the purpose and duty of macro finance institutions, article 3 of the same proclamation provides:

1. the purpose of micro financing institutions is granting credit, in cash or in kind, the maximum amount of which shall be determined by the bank.
2. subject to conditions set under this Proclamation, a micro finance institution may carry out some or all of the following activities:
   1. accepting savings as well as demand and time deposits;
   2. drawing and accepting drafts payable within Ethiopia;
   3. borrowing money for its business purpose against the security of its assets or otherwise;
   4. purchasing such income generating financial instruments as treasury bills;
   5. acquiring, maintaining and transferring of any moveable and immovable property including premises for carrying out its business;
   6. providing counseling services to its clients;
   7. encouraging income generating projects for urban and rural micro-operators;
   8. rendering managerial, marketing, technical and administrative advice to borrowers and assisting them to obtain services in those fields;
   9. managing funds for micro financing business; and
   10. engaging in other activities customarily undertaken by micro financing institutions.

To realize the above purposes and duties, the National Bank of Ethiopia has also issued 12 directives, which have been consistent with Proclamation No. 40/1996. These included setting a loan ceiling of 5,000 Birr and loan duration of one year. The interest rate has been waived and MFIs are now free to set their own interest rates ceiling. There is also a requirement for re-registration once an MFI mobilizes deposits greater than one million Birr.

The regulatory framework has affected the welfare-oriented NGOs in Ethiopia which focus on welfare programs by providing free or subsidized micro-credit services. They tend to provide credit services at very low interest rate (below market interest rate) focusing on the poorest of the poor (based on humanitarian reasons) rather than on sound credit management principles. As a result, many of the NGOs, providing micro-credit services in Ethiopia, are in a transition from highly subsidized credit programs to a finance based system. Although the initial reactions of the NGOs in Ethiopia to the implementation of the regulatory framework (Proclamation No. 40/96) were negative, they have now realized that the regulatory framework has institutionalized and unified microfinance services in the country.

The required minimum paid-up capital payment for MFI in Ethiopia (about 25,000 US Dollars) is low and affordable. The recent full liberalization of lending interest rates is also a positive development towards implementing an operationally sustainable strategy for MFIs. This assists to adequately price small-scale and risky loans and microfinance operations.

The government has recognized the importance of micro-enterprise development to the overall economic growth of the country and poverty alleviation. It has established the Micro and Small Enterprise Development Agency to co-ordinate and support the sector. According to Proclamation No. 33/1998, the Agency shall be involved in designing policies and strategies for the development and expansion of the micro and small enterprise; study the demand for training and conduct training; establish skill up-grading, technical and demonstration centers in different regions of the country; and disseminate information to the entrepreneurs. However, these enterprises require adequate flow of institutional credit to finance both short-term operating expenses and long-term investment needs.

In addition to addressing poverty and food security issues, micro-enterprises teach the poor new skills and help them generate greater savings for investment and promote inter-sectoral linkages.

The main constraints of micro and small enterprises include lack of finance, business information, business premises, skills and managerial expertise, access to appropriate technology, lack of adequate infrastructure and in some instances discriminatory regulatory practices. In the Ethiopian context, and in terms of partially solving the problem of financial resources, the agency has to integrate its activities with the microfinance industry.

The Federal Government of Ethiopia has produced the Micro and Small Enterprises Development Strategy to address the above problems and create an enabling environment for the growth of these enterprises. It has identified criteria and prioritized the target beneficiaries of the support program. The support program will consider those micro and small enterprises using local raw materials and/or labor intensive technologies, having greater inter-and intra-sectoral linkages; potentially competitive and have objective of exporting their products; and those engaged in facilitating and promoting tourism. The support program focuses on creating an enabling legal framework; streamlining existing regulatory conditions; facilitating access to finance; training in entrepreneurship, technical and management skills; facilitating access to market, raw materials and fostering partnership; and facilitating the availability and access to adequate infrastructure.

Proclamation No. 83/1995 provides for the establishment of primary and secondary agricultural cooperatives on voluntary basis and democratic principles. One of the objectives of the new Proclamation 147/1998. (Co-operatives Societies Proclamation) is to develop and promote saving and credit services for members to participate actively in the free market economic system.

Implementing, Monitoring and Evaluating the Regulatory Framework of the Microfinance Industry

The process of policy formulation, implementation, monitoring and evaluation is, by and large, the same whether it refers to the policy formulated at macro or micro levels. It applies equally to policies formulated by the government, a particular private firm or by an NGO. Just as in a project, the formulation, implementation and monitoring process of financial policy, or any development policy, should follow a defined path. The process starts with the identification of financial policy constraints which impede the achievement of the stated objectives. This is then followed by the analysis of the constraints, formulation of alternative financial policy options or remedial measures, appraisal and approval, implementation and finally monitoring and evaluation of the effects and impacts of the financial policies of the regulatory framework of the microfinance industry. We can call this the financial policy cycle instead of the project cycle.

The search for appropriate change in the regulatory framework and identifying the problems starts when the stated government objectives and targets fail or are failing. The need for financial policy reform or change could also start when concerned government departments (such as the National Bank of Ethiopia) or stakeholders realize that existing regulatory frameworks are having unanticipated negative consequences. The identification of a financial policy reform for the microfinance industry and designing appropriate policy options could start when one of the following situations or a combination of these occur.

1. When the Ethiopian government itself, the National Bank of Ethiopia or the Prime Minister's Office believes that the envisaged financial policy objectives and targets are not met or realized.
2. When the government, with an external pressure e.g., from the IMF or World Bank, considers that current financial policies are not sustainable in the long term.
3. When existing regulatory frameworks result in negative consequences that were not envisaged or the effect has been underestimated at the time of their conception.
4. When the government realizes that there are better financial policy options to bring about an accelerated development in the microfinance industry.
5. When stakeholders such as the practitioners in the microfinance industry demand a change in the current policies or regulatory framework.

Thus, the possible identification of a change in the regulatory framework of the microfinance industry could originate from (a) government line departments; (b) multilateral and bilateral donors; (c) organized and unorganized stakeholders such as the practitioners in the microfinance industry; and (d) research institutes acting as think tanks for policy analysis, financial policy monitoring and evaluation.

In Ethiopia, there is no government department which follows up the overall development of the microfinance industry.  Currently, there are no research institutes involved in microfinance development and policy research which recommend a change in the regulatory framework. There are attempts, however, by the Prime Minister's Office and the Ethiopian Economic Association to establish an Economic Policy Research Institute. In the Ethiopian context, multilateral and bilateral organizations do not have the mandate and responsibility of identifying and changing government policies through direct or indirect pressure. The last option to the microfinance industry is to use the network which is established with the objective of creating a forum to discuss policy issues and problems of the industry and share experiences. The Association of Ethiopian Microfinance Institutions (AEMFI) has created a forum to discuss and review the performance of the regulatory framework and monitor its impact.

The entry point for policy analysis in the financial sector in general and microfinance industry in particular is the review of the existing policies with the view to understanding shortfalls and to assess the extent of overhauling or complete changes required. The analysis involves both quantitative and qualitative approaches.

The progress made in the implementation of the various activities related to policy reforms in light of the reform targets and schedule of achievements should be monitored regularly. Once the implementation of the financial policy is launched, the National Bank of Ethiopia, or stakeholder organizations such as AEMFI should review the progress of the implementation.

The impact monitoring aspect involves measuring the qualitative and quantitative changes brought about as a result of the implementation of the regulatory framework of the microfinance industry. This should be compared against the objectives and targets set for the industry. The National Bank of Ethiopia with full participation of the stakeholders should undertake such impact evaluation or policy monitoring regularly. This involves highlighting the progress so far registered, problems encountered, measures taken, recommendations made for remedial measures, resources required etc.

Moreover, as indicated earlier, regulation in the microfinance industry refers to a set of enforceable laws and rules. These rules could be enforced by government departments or associations of practitioners such as AEMFI which, in the later case of the latter, is self-regulation. In the Ethiopian case, there is already an established government regulatory and supervisory department under the National Bank of Ethiopia. What is suggested is to combine implementation of self-regulation by networks and government regulations, as the two approaches to regulate the microfinance industry are not mutually exclusive. Here self-regulation mainly involves drafting the code of conduct for the industry and developing performance indicators or self-rating system.