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TABLE OF CONTENTS
1.1 Statement of the problem
1.2 Background of the study
1.3 Objective of the study
1.4 Significance of the study
1.5 Delimitation of the study
1.6 Research Methodology and Methods of Analysis
REVIEW OF RELATED LITURATURE
2.1 Meaning and Conceptual Analysis of Deposit Insurance Scheme and Related Issues
2.2 The Types, Nature and Comparative Analysis of Deposit Insurance Systems
2.3 The Objectives, Advantages of and Challenges to EDIS
2.3 Structural Models of Deposit Insurance Agencies
3. Background, Performance Analysis of the Banking Sector and Design Considerations and Implementation Methodology to the EDIS
3.1 Background and Performance Analysis of the Banking Sector in Ethiopia
3.2 Fundamental Considerations of Design for the Ethiopian DIS
3.3 Self-Assessment Methodology (SAM) for the Implementation of the EDIS
The Legal and Institutional Framework of DIS in Ethiopia
4.1 The Institutional Framework of DIS in Ethiopia
4.2 The Legal Framework of Deposit Insurance Scheme in Ethiopia
5. Conclusion and recommendations
First of all, I am thankful to the almighty God for the happening of all the good things in my life.
Then, I am greatly indebted to Professor Tilahun Teshome, my advisor, for his continuous and helpful guidance throughout the writing of the thesis. His valuable comments, from the formulation of the title of the thesis to the accomplishment of the study, have been wonderful.
My thankfulness is also extended to the Addis Ababa University for providing me with the required financial support to the successful accomplishment of the research.
Finally yet importantly, I also express my heartfelt gratitude to all my family members and Classmates.
Abbildung in dieser Leseprobe nicht enthalten
This paper tries to provide the legal and institutional framework of deposit insurance scheme in Ethiopia. Utilizing the cross-sectional and time series variation in the existence of deposit insurance schemes all over the world from the experience of other countries, international organizations on deposit insurance such as the IMF, the FSF, the Basle committee, the IADI and the contextual realities of the banking sector in the country, the researcher finds that the establishment of explicit deposit insurance scheme in the banking sector significantly reduces, on one hand the risk taking of banks and the other the sustainability of the entire financial sector. Though Ethiopia has for long established an implicit system of depositors’ protection, the findings of this study supports the hypothesis that the banking sector should not for long stick only to the implicit mechanisms of depositors protection.
As a result the FDRE government should come up with the mechanisms of establishing the deposit insurance scheme in the country while at the same time devising strategies to phase out the long existing implicit protection scheme in the country. In this and other related contexts the paper has provided details on the establishment of the legal and institutional framework of deposit insurance scheme in Ethiopia.
Banks are the most important financial institutions for intermediating between savers and borrowers, assessing risks, executing monetary policy, and providing payment services. But, the configuration of their portfolios makes them especially vulnerable to illiquidity and insolvency. In particular, by law, bank deposits have to be repaid up on demand. In addition, banks are highly leveraged and often maintain liquid assets to meet withdrawals only in normal times. Moreover, there is a concern that the demise of one bank, if handled poorly, can spill over to other banks thereby causing a more general problem on the entire sector.
At the present time, banking instability has emerged as a major problem in both developed and developing countries. In response, governments in many of the countries have taken strong actions to restore their banking systems to health and strengthen their prudential regulation.
Nevertheless, the reasons why governments want to have a stable banking system may vary across territories; governments have developed varieties of institutional arrangements that tend to promote banking stability. In addition to establishing legal framework for banking, governments have established systems for supervising and examining banks. These systems are designed to assure bank compliance with laws and regulations and to prevent banks from engaging in unsound banking practices. Besides, governments have authorized their Central (National) bank to lend to individual banks experiencing liquidity pressures. By acting as the lender of the last resort, Central banks can shield illiquid banks from having to sell assets at depressed prices in a disorderly market. In doing so, Central banks can prevent bank liquidity problems from turning into insolvencies.
Currently, the evolution of such efforts to better-shield the banking sector, being supplemented by the technical assistances of the World Bank and IMF, resulted in the burst of interest in explicit deposit insurance schemes worldwide.
As a result, DIS is currently accepted as the latest version of all the remedies that has been for long employed to alleviate the problems of the financial sector.
In a similar fashion, while trying to protect it from crisis, the Ethiopian banking sector has passed through all the mentioned evolutions and these has been extended up to the establishment of an implicit depositor protection system. However, in the 21century, the existing experience has proved that an implicit depositor protection system per se is not enough to absolutely guarantee those objectives in the sector.
In line with this argument, in this paper, the researcher has dealt with the Legal and Institutional Framework of Explicit DIS in Ethiopia.
This paper will have five different chapters: Chapter one deals with the Research Proposal. Then, it will be the main task of Chapter Two to discuss, analyze, and review the existing literature related to DIS. Then, it will be the main purpose of chapter three to: analyze the ongoing performance of the Ethiopian banking sector, fundamental design considerations of the EDIS and suggest ways of implementation to the EDIS. After that, Chapter Four will deal with the major issue of the study which is “the Legal and Institutional Framework of DIS in Ethiopia.” Finally, Chapter Five will provide the necessary Conclusions and Recommendations per the outcome of the study.
1.1 Statement of the problem
Ethiopia is a country with an emerging financial sector. With the lapse of time, the sector is growing both in terms of volume and its role of contribution to the country’s entire GDP. For instance, we can understand such growth by comparing the following statistics taken from a data collected for five years before 2007, with the figure in 2010:
The Ethiopian banking sector consists of eleven banks that are operational, of which three are state-owned and eight private. Five banks are in the process of establishment [emphasis added, they are indeed established right now]. The total deposits held by Ethiopian banks more than doubled from ETB23.1 billion in 2001 to 53.9 billion by 2006/7 i.e. an annual average growth of 13.9%. Relative to the GDP, total deposits reached a peak of 46.6%, the deposits of private banks increased to 33.5 per year on average. In public banks the total amount of deposit increased in 9.4% and finally in absolute terms, public and private banks mobilized deposits of approximately ETB 10 billion. In these periods, for instance, the loans extended by the commercial bank of Ethiopia are three or four times greater than the capital of the bank itself. This exposes the fact that the difference is covered by public deposits which in turn covers about 10% of the funds of private banks.
As stated in the above datum, deposits cover an integral part of the investment of banks. Without such deposits the banking sector will be economically self-insufficient and prone to crisis. As a result, everything about banking business has numerous implications on the interest of depositors. Banks shall serve the best interest of such depositors by employing all the necessary policies, practices, rules and procedures which guarantee depositors protection. As part and parcel of these practices placed to guarantee depositors protection in the banking business, not few numbers of legal systems have incorporated laws on the establishment and implementation of “Deposit Insurance Fund or Scheme” and in most it is already mandatorily executed.
However, this being the international situation, in Ethiopia, until the present time, there is no practice or legal and institutional framework of explicit deposit insurance scheme, despite the rapid development of the banking. Although the existing law vests the power to issue regulations to this effect on the Council of Ministers, no such scheme or regulation has been put in place yet. It is also expressly ruled by the NBE establishment proclamation that for the fulfillment of its powers and duties the NBE may establish and manage the Deposit Insurance Fund. Nevertheless, currently the legal framework and the institutional structure of an explicit DIS is non-existent in Ethiopia.
The fact of the matter is, even if there is no explicit commitment to expressly legislate on DIS, the reading of pertinent laws and IMF countries report testifies that there was/is an indirect form of depositors’ protection in the Ethiopian legal system called an implicit depositor protection System.
Now let’s deal with some of the expressions of the practice of an IDPS that implicitly deal with depositor protection in the Ethiopian legal system.
The banking business proclamation states that the NBE shall appoint a ‘receiver’ to a bank: To take possession and control of a bank, if it determines that the bank has engaged in a pattern of unsafe and unsound practices which may likely constitute a significant danger to its depositors; or If there is a strong likelihood that the bank may be unable to fulfill its obligation or meet its depositors demand in the normal course of business; or If the bank follows policies which would endanger the general economic interest of the country or the public through in appropriate, illegal, or imprudent banking practices.
Moreover, the proclamation states that the immediate effect of appointing a receiver to a bank is the transfer of all rights and powers that any depositor has over the bank or its assets to such receiver. Regarding the duty of the receiver, it is also stated that, if a bank becomes unviable, the receiver is at duty: (1) to result in conserving the greatest amounts of the bank’s assets and in providing the best protection to the interest of depositors or other creditors; (2) to provide every depositor a statement of a bank’s records in favor of that person; (3) to publish, a notice of the date and place where the schedule of allowance shall be available for inspection, and the time limit by which any objections to it may be filed once in a week for three consecutive weeks in one or more newspapers of wide circulation in every locality where the bank has an office. This has its own implication on depositors’ protection.
Regarding the right of depositors during bank liquidation, the proclamation states that, depositors are entitled to file an objection against the ‘schedule of allowable claims’ issued by the receiver. And, depositors are hierarchically at priority to be paid on the fourth rank among interested payees, i.e., after the payment of the remuneration and other necessary and reasonable expenses of the receiver; the creditors who extended new credit to the bank after the appointment of the receiver or incurred by him, and the outstanding salaries and other benefits of non-managerial staff of the bank for the three month period preceding the effective date of the receivership.
The other expressions of an IDPS under this proclamation are the requirements of: (1) maintenance of the required minimum capital and reserve that are imposed on other banks by the NBE, (2) maintenance of legal reserve by annually transferring sums of not less than 25 percent of its net profit to its legal reserve account until such account equals its capital, (3) maintenance of adequate ‘liquidity and reserve balance’, (4) maintenance of provisioning, depreciation, loss coverage and amortization requirements, and (5) disclosure of information.
On the other hand, article 15 (1-d) of proclamation No. 591/2008 states that, the NBE may make loans or advances to banks and other financial institutions on the basis of obligations and conditions determined by its directive. This role of the NBE is known as the Lender of the last resort. One of such conditions to advance loans to banks may be in case the later encounter a financial panic and the interests of the depositors at large are at stake.
After having discussed these indirect ways of depositor protection in Ethiopia, it would be plausible to question as to, ‘why the FDRE government avoided an explicit legislation to establish an Explicit DIS and compromised the best interest of the depositor at large by merely sticking to other indirect and latent ways of depositor protection that lack proper legal enforcement?’
In response, when one considers the fundamental benefit of an explicit DIS (compared to the implicit one) to generally guarantee depositors protection, financial stability of banks, and its shielding role to the entire financial sector against crisis, s/he might easily understand how much those interests related to the important but still emerging, banking sector, are at stake.
Perhaps, after having considered all these concrete realities and merits of EDIS from the current status of the Ethiopian financial sector, the entire legal system, the prospect of accession to the WTO which is likely to entail stiff competition in the sector due to the commercial presence of foreign banks in Ethiopia or the importing of banking services from abroad (it is argued that liberalization and integration into the world trading system were the main directions of Ethiopia’s foreign trade policy, pursuant to which Ethiopia applied for WTO membership in 2003), the prospect of financial panics, the banking experience of other countries, the prevailing condition of the global economy (prone to financial unrest) and the guidelines of international financial organizations or task forces (like the FSF, the Basle Committee on Banking Supervision, the IADI, the IMF and World Bank); the researcher is convinced that the absence of legal framework and institutional structure of EDIS in the Ethiopian banking sector could be a great risk to the well-being of the depositing public in particular and the banking sector and the entire economy in general. As a result, the issue has been developed into a researchable problem and will be dealt by this piece of writing under a title, “The Legal and Institutional framework of Deposit Insurance scheme in Ethiopia.”
1.2 Background of the study
From a global perspective, DIS is a recent phenomenon: of the sample of 50 EDISs studied by the IMF, nine were adopted in the 1960s, seven in the 1970s, seventeen during the 1980s, and 31 during the 1990s and many after that. On a further survey conducted in 1999 on 72 country’s systems of depositors’ protection, it was found that 68 of the systems are explicitly defined in law and/or regulation. Ten of the 68 countries with an Explicit DIS are in Africa, 9 in Asia, 32 in Europe, 3 in the Middle East, and 14 in the Americas.
Moreover, as banking problems continued to escalate on all continents, revisions to EDISs have been quite common, especially since the European Union’s Directive in 1994. In the aftermath of recent banking crises in such countries as Argentina, Mexico, Japan, South Korea, Sweden, and Thailand, government regulators worldwide are considering far reaching reforms to their bank deposit insurance systems.
Comparatively speaking, DI has existed for a substantial period of time in the USA. The United States was the first country to introduce a national deposit insurance system in the 20th century. In the European Union, the second Banking Directive took effect On January 1, 1993, becoming the basic banking law of the European Union. Then, a directive mandating union-wide deposit insurance was adopted, as the Deposit Guarantee Directive took effect on July 1, 1995. In Democratic Republic of Korea, EDIS was established in Jan, 1997. In Japan EDIS was established in 1971. In Germany, a uniquely private EDIS was established in 1976. In the United Kingdome, EDIS was established in 1982. And in Canada, the deposit insurance system was created in the 1960s.
Besides, not few numbers of countries have also adopted EDIS as of 1999. These countries include Algeria, Bahamas, Belarus, Bosnia and Herzegovina, Guatemala, Honduras, Indonesia, Isle of Malta, Kazakhstan, Liechtenstein, Malaysia, and Thailand. Moreover, Norway (1961), France (1999), and Sweden (1996) established their own respective EDISs.
The most recent scenario dictates that, the following countries are generally sorted out to be the new adopters of EDIS: Albania (in 2002), Bolivia (in 2001), Cyprus (2000), Jordan (2000), Malta (2003), Nicaragua (2001), Paraguay (2003), Russia (2003), Serbia and Montenegro (2001), Slovenia (2001), Turkmenistan (2000), Vietnam (2000), Uruguay (2002), and Zimbabwe (2002).
On the other hand, regarding the incorporation of EDIS in developing countries; India (1962), Kenya (1985), Nigeria (1989), Paraguay (1971), Argentina (1979), Brazil (1989), Chile (1977), Colombia (1985), Cuba (1952), Philippines (1963), Spain (1977), Thailand (1985), Turkey (1960), Venezuela (1985), and Yugoslavia (1988), established their own respective EDISs.
Regarding the adoption of deposit insurance in sub-Saharan Africa, Kenya (1988),Tanzania (1994), Zimbabwe (2003), Nigeria (1988/1989), and Uganda (1994) has introduced EDIS in to their Banking sectors.
On the other hand, with respect to the adoption of Implicit Depositor system (IDPS) in sub-Saharan Africa as of 2003, 41 states have established it. These are; Angola, Central African Rep., Gabon Madagascar, Niger, South Africa, Benin, Chad, Gambia, Malawi, Republic of Congo, Sudan, Botswana, Comoro Is., Ghana, Mali, Rwanda, Swaziland, Burkina Faso, Cote d'Ivoire, Guinea, Mauritania, Senegal, Togo, Burundi, Equatorial Guinea, Guinea-Bissau, Mauritius, Seychelles, Zaire, Cameroon, Eritrea, Lesotho, Mozambique, Sierra Leone, Zambia, Cape Verde, Liberia, Namibia, Somalia, and Ethiopia.
With respect to the international organizational aspects of deposit insurance scheme, while there is no global deposit insurer (despite proposals for one), there are international organizations comprised of deposit insurers. Among these, the largest deposit insurer organization is the International Association of Deposit Insurers (IADI). Founded on October 2002 at the initiative of the Canadian Deposit Insurance Corporation (the CDIC), the AIDI is a non-profit organization that aimed at enhancing the effectiveness of deposit insurance by promoting guidance and international cooperation among deposit insurers and other interested parties.
Finally, in addition to the IADI, the recent efforts of the FSF, the Basle committee, and the IMF to universalize DIS are quite substantial.
1.3 Objective of the study
The general objective of this study is to propose the necessary legal and institutional framework to the establishment of explicit deposit insurance scheme in Ethiopia.
The Specific objectives of the study are:
1. To enumerate the possible advantages and disadvantages of explicit deposit insurance scheme to the Ethiopian banking sector in particular and the financial sector in general by reviewing the pertinent literature and experience of other countries;
2. To analyze what type of Deposit Insurance Schemes should be employed in Ethiopia;
3. To give a detailed account as to how the government should structure and design the scheme in a way it fits with the ongoing economic realities of the country in general and internal market stability and other elements of financial safety net, in particular;
4. To quantify other parallel regulatory measures that needs to be taken in due course of implementing the scheme. And finally,
5. To itemize all the possible strategies to ascertain international cooperation to the Ethiopian DIS.
1.4 Significance of the study
As a pioneer-work conducted on the issue of DIS, which is by itself a new area of business law in Ethiopia, it would provide a detailed legislative input to the concerned organs vested with the power to legislate on Deposit Insurance Scheme and its related institutional structures.
Moreover, the study would create awareness to all stakeholders, especially the depositors at large, the NBE, other banks in Ethiopia, the deposit insurance agency, Investors, the Government (especially the Council of Ministers and the Ministry of Finance and Economic Development), etc.
Finally, this study may serve as frame of reference or an input to the undertaking of further researches on the same or other related issues.
1.5 Delimitation of the study
This research is in effect delimited to study “The Legal and Institutional Framework of Deposit Insurance Scheme (i.e., Explicit DIS) in the Ethiopian banking sector.” Hence, it will not be the concern of this study to deal with issues other than deposit insurance scheme or deposit insurance scheme for non-bank institutions. Thus, the paper will exclusively deal with the issue having emphasized on the banking sector in Ethiopia.
According to article 2 (4) of the National Bank Establishment (as amended) proc. No. 591/2008, Banks are, “companies licensed by the National Bank to undertake banking business and banks owned by the Government.” Moreover, the definition of a ‘banking business’ should be taken as it is under article 2 (a-f) of the same proclamation.
1.6 Research Methodology and Methods of Analysis
This study will be carried out in accordance with specific guidance, methodologies, and methods of analysis on deposit insurance scheme development and implementation devised by the Financial Stability Forum, the International Association of Deposit Insurers guidance for the development of uniform effective deposit Insurance, the Core Principles of the Basle Committee, the IMF Standards and Technical Assistance on Deposit Insurance.
Per the guidelines of all the above organizations, the researcher will try, first to output a situational analysis, including the state of the Ethiopian economy, current monetary and fiscal policies of the country, state and structure of the entire banking system, public attitudes and expectations, strength of the prudential regulation and supervision, the existing legal framework, and soundness of the accounting and disclosure regimes in the financial sector.
In addition, the researcher will make use of the comparative law (jurisprudence) method to comparatively study the experience of practical, influential and efficient EDISs in other countries selected based on their relevance, which are all to be appropriately applied given the domestic financial realities of Ethiopia.
Finally, the researcher has also taken advantage of row data and reports of the NBE which are helpful to conduct a situational analysis on the condition, structure and efficiency of the entire banking business.
REVIEW OF RELATED LITURATURE
2.1 Meaning and Conceptual Analysis of Deposit Insurance Scheme and Related Issues
2.1.1 Meaning and Conceptual Analysis of DIS
Technically speaking, deposit insurance exists in a variety of forms, and the term may apply to different situations. However, having considered its conventional connotations, DIS may be defined differently from the following different perspectives:
From the perspective of the interest of depositors, DIS can be defined as, a guarantee that all or a limited amount of a bank deposit account and in some cases, interest accrued on the account will be repaid to the depositor in the event that a bank fails.” In a similar fashion, Diamond and Dybvig have tried to define DIS as a scheme for the protection of a bank’s co-creditors against losses resulting from bank failures. DIS also attributes the connotation that, it is the scheme which protects depositors from losing their deposits in case a financial institution fails (or a during disruptive bank failures occurs).
From the view point of the well-being of the financial sector, DIS in most countries is recognized as, a scheme that can avert panics among depositors in a financial crisis and prevent the panic from spreading to healthy financial institutions (the so-called contagious effect) and endangering them as well.
In line with this, it is perceived as, an imperative tool that helps to: establish an adequate financial safety net, reduce runs on banks, limit government fiscal and political exposure, and create a formal mechanism for transferring costs of bank failures to industry rather than taxpayers, and shore up the financial system in times of crisis. In a similar fashion, Asli Demirgüç Kunt opt to explain the concept in line with its positive externality to the wellbeing of the entire financial sector as, DIS is an increasingly used tool by governments in an effort to ensure the stability of the banking systems and protect bank depositors from incurring large losses due to bank failures.
Jang-Bong Choi, a Chinese scholar, has quoted and explained DIS from the stand point of the insured financial institutions as; deposit insurance is something like a complex (callable put) option. I.e., it is a means by which financial institutions purchase the right to surrender their remaining assets and character to the deposit protection agency in exchange for payments to protected depositors (the equivalent of a put option).”
Furthermore, from the approach of the duty of deposit taking institutions to cause accelerated repayment or compensation to their respective depositors, Deposit insurance refers to the obligation of a credit institution under law and terms of a contract to repay any credit balance left by the depositor in an account or resulting from normal banking transactions, as well as any debt contracted by the credit institution and evidenced by a certificate it has issued.
The definition accredited to DIS by Mr U. Ibrahim, who was the chairman of the Nigerian Deposit Insurance Corporation, conveys a meaning that, DIS is a financial guarantee to depositors, particularly the small ones in the event of a bank failure. As it exists, DIS in Nigeria can be explained as a tool which forms a second layer of protection for depositors which reinforces the efforts of the primary regulator or supervisor in ensuring safety and soundness of the financial institutions.
As Demirgüç-Kunt, Baybars K., and Laeven pointed out, DIS can also be illustrated relative to its immediate opposite- IDPS. They stressed that, as a matter of fact every country is deemed to have a de facto implicit deposit protection scheme (IDPS) in place. Since governments get pressed for relief at the breakout of a large systemic banking distress, it is assumed that if an explicit deposit insurance scheme (EDIS) does not exist, then the country has implicit depositor protection system.
In a continuing definition they further articulate DIS from the viewpoint of its nature, governance and administration, as due as a scheme that relays on formal regulation through central bank law, banking law, or the constitution and so on whereby, the relevant law explains the main ingredients of the deposit insurance scheme, such as, the beginning date, the coverage limit, how they are going to be funded, and how bank failures will be resolved. If such regulation is not present for deposit insurance, it is assumed that the DIS is implicit than explicit, relying on the observation that every country establishes a de facto insurance system for banks.
While trying to highlight the possibility of hazard and the need to precaution in due course of establishing a DIS, Mr. William S. (former chairman of the FDIC, USA) tried to provide analogical definition of DIS as,
A deposit Insurance System is like a nuclear power plant. If you build it without safety precautions, you know it is going to blow you off the face of earth and even if you do, you cannot be sure it won’t.
After discussing the slippery slope of bank failure and the inevitable need of DIS during a bank failure, Beat B. and Susanna W. described DIS as, a crucial system to prevent a run on an illiquid but not yet insolvent financial institution which protects the spread of a crisis in one individual institution to the other network partners via the interbank market. And it is also an apparatus which makes good the losses incurred by depositors caused by an illiquid or insolvent financial institution up to a certain amount, since it is assumed that the majority of smaller depositors of a bank were hardly able to monitor themselves the risk that they had taken by, for example, opening a deposit account.”
Besides, from the stance of its affiliation and complementariness with other elements of the financial safety net, DIS can be defined as, a scheme which is part and parcel of the entire comprehensive system of financial safety net (such as- lender of the last resort, regulation and supervision, bank insolvency or resolution law) for enhancing and ensuring the financial stability of a country irrespective of the national peculiarities of the financial intermediation systems.
Sebastian S., who was a principal economist and scholar of the OECD, strengthened this context of EDIS and explained that,
Though there is no generally accepted definition of the key elements of the financial safety net. In its narrow definition, the safety net is limited to a deposit insurance scheme being backed by the lender-of-last-resort function, while a more widely accepted one includes at least three elements, adding the prudential regulatory and supervisory framework to the previous components of a proper financial safety net.
Schich further discussed that, without an appropriate financial safety net (one which embodied DIS) even simple rumors of problems regarding solvency or liquidity of a financial institution have the potential to turn into a full-blown financial crisis. However, with an appropriate financial safety net in place, confidence tends to be greater and the inception of financial crises would be less likely than otherwise.
On the other hand, DIS can be further characterized as the actual system which complements supports and strengthens the protective functions of the other system elements, just as these complement and support the deposit insurance scheme in fulfilling its function, or, which secure clearly defined accounts of specific categories of depositor, thereby reducing the risk of a bank-run and, as a result, preventing a liquidity crisis in the financial system as a result of it.
From the view point of the deposit insurance agency, DIS can be defined as a scheme that contains the explicit guarantee of an institution (DIA), usually limited as far as the sum is concerned, in respect of a precisely defined category of depositors of specific financial institutions (mostly banks or other financial intermediaries with deposits from the public) in case of a shortfall in precisely defined deposit classes.
DIS can also be described in line with the instruments of capital market as an instrument of ‘direct protection’ scheme that guarantee in some ways against the failure of the intermediaries in the capital market: this scheme may operate not only for banks, but also for intermediaries in the capital markets, which protects customers of securities, broker-dealers, pension funds or insurance companies.
Relative to other alternative means of supervision and regulations, the IADI attributed DIS as, an imperative tool often preferred by policymakers (compared to other alternatives such as reliance on implicit protection) via which the policy maker clarifies the authorities’ obligations to depositors (or if it is a private system, its members), limits the scope for discretionary decisions, promotes public confidence, helps to contain the costs of resolving failed institutions and can provide countries with an orderly process for dealing with bank failures.
It is also mentioned that, while deposit insurance is a fairly straight forward concept, deposit insurance scheme in practice is found to be relatively complex. In most cases, it is viewed as supplement to other official measures which are designed to protect bank depositors from the risk of loss or to contain that risk. These include a system of bank licensing and supervision which operates primarily by controlling the amount of risk assumed by commercial banks relative to their resources of capital and management and “lender of last resort” facility. DISs can also be viewed as an alternative, not merely to the situation in which insurance does not exist, but more importantly, to the various ad hoc arrangements which many governments or central banks put in place in order to protect depositors from loss in the event of an actual bank closure.
Now let’s deal with the lexical definition of DIS and the related concepts. According to the Black’s law dictionary, DIS is defined as,
(a) Federally sponsored indemnification program to protect depositors against the loss of their money up to a specified maximum, if the banks or savings and Loan associations fail or default.
Additionally, the same dictionary has defined the notion of ‘deposits’ for whose protection DIS is devised as,
The act of giving money or other property to another who promises to preserve it or to use it and return it in kind; esp., the act of placing money in a bank for safety and convenience. 
Besides a ‘demand deposit’ (which made the duties of banks more serious) is defined in the same dictionary as a bank deposit that the depositor may withdraw at any time without a prior notice to the bank.
On the other hand, the same dictionary has defined an ordinary ‘insurance contract’ generally. It reads that,
An insurance contract is an agreement by which one party (the Insurer) commits to do something of value for another party (the Insured) up on the occurrence of some specified contingency; esp., an agreement by which one party assumes a risk faced by another party in return for a premium payment, or the amount on which someone or something is covered by such an agreement.
More contextually to the Ethiopian situation, however, the contract for the deposit of fund is indirectly defined by the commercial code of 1960. It is stated that,
The contract of deposit of funds renders the bank owner of the funds deposited, irrespective of the mode of deposit. The bank may dispose of these funds in respect of its professional activity, subject to their repayment under the conditions provided in the contract: provided that the bank shall not acquire the title to nor the right to dispose of coins or other individual monetary tokens in respect of which there is a provision that they shall be refunded in kind.
The other relevant provision of the commercial code that dictates depositors’ right to accelerated withdrawal or repayment or the banks’ duty to pay up on demand is article 898. The provision stipulates that:
(1) Unless otherwise agreed, a deposit of funds shall be at sight and the holder of the account may dispose at any time of the whole or part of the balance.
(2) The right of disposal as defined in sub-art. (1) May be made subject to notice or the expiry of a fixed period.
On the other hand, though it exclusively deals with the deposit of a chattel (which is still one accepted form of a deposit in banking activity per articles 919 and 912 of the commercial code and article 2 of the Banking Business Proclamation), article 2779 of the civil code of Ethiopia enumerates a relevant idea to deposit of funds by defining a ‘contract of bailment’ as,
A contract of bailment is a contract whereby one person, the bailee, undertakes to receive a chattel from another, the bailor, and to keep it on the latter’s behalf.
Moreover, similarly with the case of deposit of funds, articles 2781 and 2786 of the civil code guarantee the bailor’s right of ownership and restitution of the bailed chattel up on lapse of duration or up on demand.
In a more relevant context to DIS however, though it is more of a promise, the National Bank Establishment Proclamation [as amended] tried to define the concept of deposit insurance fund as,
Deposit insurance fund” means a fund to be established in accordance with regulation to be issued by the Council of Ministers.
To sum up, from the above definitions (scholarly, dictionary or legislative) of the three notions i.e., deposit (or the contract of deposit), insurance, and deposit insurance (or the scheme), in the Ethiopian context, the researcher wants to comprehend the definition that,
DIS is an institutional and legal scheme by which the deposit insurance agency commits to repay for the insured deposit taking banks or their respective depositors, which in turn are obliged to pay periodical premiums up on the occurrence of a bank failure.
2.1.2 Deposit Insurance vs. Insurances in General (Regular Insurances)
While trying to comparatively analyze DIS Vis-a-Vis regular insurance, Bartholomew stated that, although it is commonly used, the term deposit insurance is really a misnomer, because the depositor per se does not purchase insurance in the sense that a parent buys life insurance to provide for his or her family in the event of his death or a home-owner obtains protection against fire or burglary.
However, whereas deposit insurance exhibits some superficial similarities to life or health and property or casualty insurance (regular insurance), we can at least outline four major differences among them.
First, bank failures are not independent events that other forms of insurance typically cover. Rather, failures tend to occur in waves, partly in response to a severe recession or some other macroeconomic shock, partly because the legal or regulatory (supervisory) structure is inadequate, and partly because bank failures can be contagious when the failure of one bank brings down its counterparties.
Second, regular insurance aims to protect against ‘acts of God’ or against the acts of other men over which the insured party has no control. Thus, life insurance policies do not cover suicide. There is always a danger (moral hazard) that the insured may reduce his efforts to minimize the incidence of the insured risk. But there isn’t much depositors can do to minimize the risk of bank loses once they keep their money under the custody of the later. Hence the incidence of moral hazard is much greater for deposit insurance and extends beyond negligence on the part of insured depositors. In this context, Benston and Kaufman, pointed out that, bank failures are often self-inflicted wounds arising from mismanagement.
Moreover, the losses from such failures can be substantially reduced if the supervisor closes the bank before it becomes insolvent, whereas delayed resolution tends to exacerbate those losses. Thus, moral hazard can infect the actions not just of insured depositors, but of several other parties (including uninsured creditors, bank shareholders, managers, supervisors and politicians).
Third, while deposit insurance is aimed principally at protecting deposits and their owners, it also serves to ensure the continued existence of individual insured banks by providing them with continued funding even in times of stress. That protection for the bank occurs because, unlike the bilateral nature of a property and casualty insurance contract, deposit insurance directly involves three parties- the guarantor, the depositor, and the depository institution.
Moreover, Kyie reflected a similar idea that, the immediate benefits of the surety’s guarantee are divided between the bank’s depositors whose funds are protected and the institution that receives credit enhancement to lower its funding costs and some protection against runs that could threaten its continued existence. But other interested parties (such as supervisors and politicians) can also take advantage of the availability of insurance to pursue their own interests, oftentimes to the disadvantage of the DIS.
Fourth, unlike the case in regular insurance, to make the guarantee effective in avoiding the danger of financial panic and other negative externalities, the government typically stands behind the deposit insurer in times of widespread failures, either explicitly or implicitly via means of extending long or short term borrowing or the National bank may act as the LOLR, or the government may facilitate efficient means of rescue from liquidation via proper inspection of banks, accelerated merger and so on.
At last, let’s close this section with the following argument extended by scholars; deposit insurance should be described as a form of insurance or guarantee. From a legal perspective, however, deposit insurance cannot be so characterized since this scheme lacks the attributes of both insurance and guarantee contracts. They involve no contractual relationship between the ‘insurer’ and the ‘insured-depositor’, nor are any duty of disclosure owed by the insured to the insurer. Hence, it is concluded that deposit insurance should not be used in the strict legal sense, but generally to indicate some or other kind of arrangement either by the state or the banks themselves to insure or guarantee or protect the savings of depositors.
2.1.3 Co-insurance in Deposit Insurance
Co-insurance is an arrangement whereby depositors are insured for a pre-specified portion, less than 100 percent of their deposits.
Regular insurance companies sometimes require a deductible and then cover more catastrophic losses that exceed this amount. Deposit insurance tends to work the other way round. It typically covers small losses and requires depositors and creditors to shoulder the largest losses. The burden of large losses can be shared, however, under a system of co-insurance where the insurer covers only a proportion of the loss. For instance, the insurance fund may cover 100 percent of the first tranche of losses and then share the risk with insured depositors by paying, say, 90 percent of the next tranche, 75 percent of a third tranche, 50 percent of the fourth tranche and no more.
In many countries, the use of co-insurance is aimed at addressing moral hazard. Under this arrangement depositors will lose some of their deposits in the event of bank failure. This encourages depositors to apply market disciplines toward deposit-taking institutions through requiring interest rates weighted according to the risk to their deposits. By placing a limit on the maximum deposit coverage, financial institutions will face greater scrutiny from these large, presumably more sophisticated depositors. Additionally, from the bank’s point of view, there will be significant loses not met by the deposit insurance scheme which should temper their risk strategies. As a result, co-insurance can enhance indirectly the monitoring and regulating mechanisms of banking operations.
However, co-insurance may reduce, but not eliminate runs by large depositors. But a question arises whether depositors do in fact obtain any advantage by having co-insurance, if the rate of recovery from failed bank asset is high. It should give them speedier access to their funds. On the other hand, a disadvantage of co-insurance is that, like systems with limited coverage, it may encourage banking consolidation as depositors will prefer to place their funds in large diversified banks that they regard as “too big to fail”.
2.2 The Types, Nature and Comparative Analysis of Deposit Insurance Systems
2.2.1 Types of Deposit Insurance Schemes
Generally stipulated, there are two basic types of depositor protection systems. These are explicit DISs and implicit deposit protection systems. In order to compare these two systems, it is necessary to specify the major features of implicit and explicit systems. It is important to emphasize that in actual practice implicit and explicit systems do not take the same form in every country. Plus, not few believed that such comparisons may constitute a satisfactory basis for reaching conclusions regarding the pros. and cons. of the two systems. Of course, in evaluating the two systems in a given country policymakers should identify the specific features of the two systems in that country, and then use these features to compare the systems. In line with this, let’s discuss a little on their attribute features as follows;
2.2.2 Nature of Deposit Protection Systems
18.104.22.168 Nature of Implicit Deposit Protection Systems
An implicit deposit protection system (also called government protection of depositors) is totally discretionary. The government offers such protection, not because it is obliged to do so by law, but because it believes that such action will achieve certain public policy goals or because it may feel at least partly responsible for the losses that must be absorbed, or because it may consider it to be cheaper in the long run to do so. Moreover, in IDPSs, the determination of the amount and form of the protection is based on ad hoc decision making within the government. No pre-existing rules and procedures guide the decision making process, although prior actions in similar circumstances may influence the outcome. Any protection offered to depositors normally would be financed out of the government’s current budget or through the central bank.
In an IDPS, the government can extend protection in three basic ways. First, when an insolvent bank is closed, the government can make direct payments to depositors or arrange for the failed bank’s deposits to be assumed by another bank. Second, the government could arrange and financially support the merger of a troubled bank into another bank. This initiative would prevent the failure of the bank, thereby protecting all depositors. Finally, the government can prevent the failure by rehabilitating the bank. This rehabilitation could take the form of a direct equity capital injection into the bank. Alternatively, the government could acquire some or all of the failing bank’s nonperforming assets at book value. This transaction would be tantamount to an equity injection, and also would have the advantage of giving the bank a fresh start with a clean portfolio. With both types of rehabilitation, the government is likely to emerge as the dominant shareholder, thereby effectively nationalizing the bank.
In a similar fashion, if we look at the Banking Business proclamation No. 592/2008, we can infer these roles of the Government in an IDPS. It is stated that,
Any receiver of a bank may: (a) if the bank is viable, continue the operations of the bank until termination of the receivership and return it to the previous owners, or to previous owners and other partners, under terms and conditions to be determined by the National Bank; or (b) if the bank is not viable, terminate the operations of the bank through acquisition, merger or liquidation.
Besides, article 41 (1 (a-b)) of the same proclamation dictates that,
When the bank is not viable, the receiver shall, within a period of time specified by the National Bank, either: (a) arrange for the assumption of some or all of the bank’s assets and liabilities by one or more other banks; or (b) liquidate the assets of the bank as provided for in Articles 42 to 45 of this Proclamation.
22.214.171.124 Nature of Explicit Deposit Insurance Scheme
Explicit deposit insurance Scheme (EDIS) is created by the passage of a deposit insurance statute, which sets forth the rules and procedures for the operation of the system. In particular, the act would specify the types of financial institutions and deposits that would be eligible for insurance, whether membership in the system would be voluntary or compulsory, the maximum amount of deposits that would be insured, how the system would be funded, the devices the insurer could employ to resolve failing bank situations, and so forth. The amount of protection that the EDIS extends to depositors depends on the maximum insurance coverage specified in the statute and whether the insurer has authority to resolve failing bank situations in ways that extend de facto protection to uninsured depositors.
For purposes of this section, we will focus on three basic insurance coverage schemes that can be employed in EDISs. These three systems of coverage are deemed to quite well cover the range of deposit protection incorporated in EDISs that already exist.
a. The Limited Coverage Scheme
This coverage scheme is designed primarily to protect small depositors when banks fail. Under this scheme, deposit accounts are insured up to a certain maximum amount. When a bank fails, the insurer is authorized to pay off insured depositors up to the maximum amount, or arrange for the entire failed bank’s insured deposits to be transferred to another bank. With a limited coverage scheme, the insurer is not authorized to rehabilitate banks or arrange financially assisted mergers, because to do so would extend de facto protection to uninsured depositors by preventing failures.
b. The Full Coverage Scheme
This scheme of coverage is at the other end of the protection continuum (range). Under this scheme, all deposit accounts are fully insured. The insurer can employ a broad range of devices to resolve failing bank situations, including insured deposit payoffs or transfers, financially assisted mergers, and rehabilitations. It should be noted that 100 percent deposit insurance systems have been widely discussed in public policy circles and in the deposit insurance literature, but in practice have rarely been implemented.
c. The Discretionary Coverage Scheme
This coverage scheme lies between limited coverage and 100 percent insurance. In a discretionary coverage system, all deposit accounts are insured but up to a certain amount (as with a limited coverage scheme). However, unlike a limited coverage system, the insurer is authorized under certain circumstances to extend de facto coverage to uninsured depositors by using a purchase and assumption transaction to resolve a failure or by arranging a financially assisted merger or rehabilitation to prevent a failure.
2.2.3 Comparison of the Two Types of Depositor Protection Systems
The goals of IDPSs and EDISs are essentially the same- to promote banking stability, the development of the banking system and to contribute to social justice by protecting small depositors from losses when banks fail. At the same time, there are some important differences in the features of IDPSs and EDISs. The identification of these differences is crucial because they serve as the basis for evaluating the relative effects and desirability of these two alternative deposit protection systems. Now let’s outline the major differences based on the following parameters:
a. Existence of Rules and Procedures Governing Deposit Protection: EDISs are characterized by the existence of such rules and procedures governing deposit protection. But IDPSs have no such rules and procedures.
b. Obligation to Protect Depositors: in EDISs there is a legal obligation to protect depositors up to the specified insurance limit. Besides, the deposit insurer may also have discretion to protect uninsured depositors. But, in IDPSs there is no legal obligation or protection is at the full discretion of the government.
c. Amount of Protection Extended to Depositors: in EDISs the amount of protection extended to depositors can vary from limited protection to total protection. However, in IDPSs, it can vary from no protection to total protection.
d. Funding Mechanism in Normal Times: EDISs follow an e x ante mechanism of funding i.e., they mostly augment the funding of the DIS typically from banks through premium payments or government may provide initial capitalization in the form of loan. But IDPSs are not characterized by such funding to the protection system.
e. Funding in Event of Bank Failure: EDISs acquire the fund from the deposit insurance fund. Then, shortfalls if any may be covered by special assessments levied on banks or by loans or additional capital from government. But IDPSs use a funding from the government during a bank failure.
f. The Failure Resolution Process: the two systems are different regarding the administrative process involved in resolving failures. As a rule, the administrative process for handling failing banks and protecting depositors should be fast and smooth and produce outcomes that are relatively consistent over time. Based on these criteria, EDISs produce better results than IDPSs. Because, unlike IDPSs, EDISs operate on the basis of established rules and procedures spelled out in the deposit insurance statute and they are prefunded, thereby eliminating the need to determine the funding source for protecting depositors. In marked contrast, the process of handling failing banks and protecting depositors with an IDPS will not necessarily be fast and smooth, and outcomes are likely to be unpredictable and inconsistent over time due to excessive political pressure.
g. Capacity to Curb Moral Hazard: The problem of moral hazard arises from the distortion in incentives induced by deposit protection, whether implicit or explicit. The presence of protection affects the behavior of the economic agents involved (shareholders, depositors, bank managers, politicians, and the insurer etc.) particularly their willingness to assume greater risk. With an EDIS, some depositor are given full protection and all depositors have at least some protection. By contrast, with an IDPS, no depositors are guaranteed protection. In the case of an EDIS with a high coverage level, the system could involve considerably more moral hazard than an equally credible IDPS.
In conclusion, it is not possible to establish categorically how the conversion from an implicit protection scheme to an explicit scheme would affect the overall amount of moral hazard in the banking system. However, it seems likely that the conversion from IDPS to EDIS would result in less moral hazard on the banking sector for, if it is properly implemented, EDIS can avoid or mitigate moral hazard via cures like co-insurance or discriminatory pricing.
h. The Ability to Curb Bank Runs: a bank run is a rapid loss of deposits precipitated by fear on the part of the public that a bank may fail and depositors may suffer losses. The ability of deposit protection systems to stem bank runs depends on the extent that depositors feel protected from loss in the event of bank failure. As indicated above, an EDIS is likely to extend somewhat more assured deposit protection than an IDPS. Consequently, it follows that an EDIS is likely to be somewhat more effective than an IDPS in preventing bank runs. Moreover, the difference in the effectiveness of the two systems would tend to be greater the higher becomes the coverage of the explicit system.
i. Protection of Small Depositors: One of the traditional objectives of deposit protection systems is to protect small depositors. Both IDPSs and EDISs are potentially capable of protecting small depositors. However, EDISs appear to be better designed to accomplish this objective because the protection of small depositors is in the form of a legal obligation, and this legal obligation is backed up by a deposit insurance fund. By contrast, IDPSs involve no legal obligations to protect even small depositors.
j. Treatment of Banks: One of the important differences between an IDPS and an EDIS is the treatment of banks. An IDPS confers a subsidy on banks that increases their profits. By contrast, an EDIS either could confer a subsidy on banks or impose a tax. By extending some form of protection to depositors, an IDPS lowers the risk of deposits. This reduction in risk should result in portfolio adjustments by wealth holders that would lower the interest rate on deposits. This reduction in banks’ cost of funds should increase bank profits.
With an IDPS, the losses incurred from protecting depositors are absorbed entirely by the government (tax payers) or the central Bank. Consequently, since banks derive benefits from an IDPS, but shoulder none of the costs, an IDPS confers a subsidy on banks. On one hand, by protecting depositors, an EDIS lowers banks’ cost of funds. On the other hand, the costs of protecting depositors, while initially absorbed by the insurer, are ultimately passed on to banks in the form of premium payments.
k. Capacity to Absorb Losses during Bank Failures: One of the key features of a deposit protection system is the ability to absorb losses when banks fail. If a system lacks the resources to absorb losses, bank supervisors may be forced to allow insolvent banks to continue to operate. Experience has shown that the failure to close insolvent banks is apt to compound the problem of banking instability because insolvent banks have an incentive to take high risks in an attempt to return to solvency. With an IDPS, losses are absorbed either by the national government budget or the Central Bank. Both of these constitute potentially large funding sources, far exceeding the resources of even a well-financed EDIS. However, national government budgets typically have strong contending demands, and governments may be reluctant to use Central Bank resources because of the inflationary implications. Therefore, the actual capacity of an IDPS to absorb losses may be significantly less than its considerable potential.
With most EDISs, losses are absorbed by an insurance fund set up for that purpose. The ability of an EDIS to meet its obligations depends primarily on the fund’s initial capitalization, the amount of premiums paid into the fund by insured banks over time, the size of the payments made to resolve failing bank situations, and the ability of the fund to borrow or receive additional capital injections when its resources are exhausted. It is certainly possible for nations to establish financially sound EDISs that are capable of dealing effectively with sizable losses.
2.3 The Objectives, Advantages of and Challenges to EDIS
2.3.1 The Major Objectives of DIS
Experience has made it evident that different countries’ authorities have pursued numerous objectives when they adopted EDISs. While divergent circumstances in different countries may explain the several reasons behind such decision, most literatures on the issue suggest that some objectives are more justifiable and worth achieving than others. That does not imply that they are easier to accomplish, however.
Generally speaking, two public policy objectives are often cited in support of EDISs. On micro level, an EDIS is intended to protect small or less financially sophisticated depositors who may not be in a position to assess the risks of multiple competing depository institutions. As vividly narrated in a cross-country study published by the Financial Stability Forum (FSF), one of the largest and most active multilateral financial forums, Opaqueness of information on depository institutions makes it difficult, if not impossible, for less-sophisticated depositors to obtain and analyze the financial conditions of these institutions. In this context, several economists have emphasized the information asymmetries that place small depositors at a disadvantage over banks. 
This asymmetry of information arises from the fact that bank managers inherently know more about the value of their asset portfolios and the motives behind their investment and management decisions than depositors. An effective EDIS that guarantees depositors access to their insured deposits can thus protect depositors from the information asymmetry.
On a macro-level, an EDIS potentially aims to assist the maintenance of financial stability. Without an EDIS in place, there is likelihood that depositors might run-away by withdrawing their deposits from a bank in response to difficulties (either real or perceived) of that bank. Perhaps this context can be better explained by the following quote:
DIS has an enormous impact in increasing the stability of the banking system. Simply because it exists, the threat against which it insures is much less likely to occur. It is as if life insurance has somehow prolonged life. 
2.3.2 The Major Advantages of EDIS
The following are the major advantages of an EDIS:
a. Avoiding or Resolving a Crisis: The principal justification for deposit insurance is that it reduces the danger of bank runs and banking panics. Because banks typically have large amounts of demand debts in their balance sheets, they are susceptible to precipitous withdrawals based on adverse information, i.e. runs. Runs may be inefficient because they take the form of self-fulfilling prophesies in which depositors demand their funds immediately in order to get ahead of those who wait. Therefore, explicit deposit insurance reduces the danger of runs by guaranteeing repayment to depositors even if the bank fails.
b. Protecting Small Depositors’ Funds: Perhaps the most common advantage of deposit insurance is depositor protection. Given the opaqueness of bank assets, it is difficult for bank customers (especially widows and orphans- also mentioned as Families of moderate means - those most in need of this protection which do not usually have the requisite knowledge to distinguish institutions that are sound from those that are not, as opposed to investors) to monitor the condition of their bank and it may be an inefficient use of their resources to expect them to do so. Thus, governments frequently protect small transactions and savings deposits via EDIS.
While trying to emphasize on the advantages of EDIS to assure the protection of the American depositor at large it is stated that, for over sixty years, the FDIC has been the cornerstone on which the American consumer’s confidence in its banking and financial systems rests, a worldwide model. The insurance system arose to address a series of actual and threatened bank runs and ensuring bank failures across the nation, as well as the public’s distrust of the US banking system.
c. Reducing the Impact of Recession: Authorities recognize that losses incurred in the financial sector reduce wealth and expenditure. If widespread, they can cause a recession. However, it is wishful thinking to believe that EDIS will absolutely avoid the occurrence of recession, partly because bank failures typically occur after a recession has started. But it can attenuate the severity of recession by providing insured depositors with speedy access to their funds. In addition, the guarantees would need to be comprehensive to avoid wealth effects entirely. Nevertheless, even partial protection is deemed to mitigate recessionary effects.
d. Guarding the Payments System: It has been often argued that the availability of a deposit insurance contract is important to facilitate making payments. First, even in a cash-based economy, bank deposits are useful for replenishing cash balances on hand and for storing funds in excess of immediate needs. Second, demand deposits are essential if the payments system is to evolve beyond a system of settlement by cash. Checks, credit cards and electronic transfers are all settled by adjustments to the payer’s and payee’s current account balances. But in many countries transactions accounts by law can only be offered by banks. It is an open secret that the obligation to service and honor demand deposits contracts is an onerous one, so a LOLR and EDIS are valuable in protecting the integrity of the payments system.
e. Enhancing Competition Among Banks: In the absence of an explicit system of deposit protection, depositors are likely to prefer using large banks that are perceived to be less risky (the so-called ‘too big to fail’) because these banks: (1) have more diversified portfolios than small banks or (2) are mostly protected by an implicit government guarantee because they are too big to fail (TBTF) and this may distort competition. In this regard it is argued that, explicit insurance will help small banks to prosper and it will encourage the creation of banks which tend to be small. The authorities hope that additional competition in the banking industry will improve financial efficiency, lowers interest rates and spreads and foster investment and economic development.
f. Providing a Formal Mechanism for Resolving Failed Banks: Where a country lack laws that are designed explicitly to govern the demise of failed banks, it may use the establishment of a formal EDIS as an immediate opportunity to put the missing laws into place and to hasten the disposal of failed banks. Banks cannot operate under bankruptcy protection (the same holds true under the Ethiopian reality per article 49 of the Banking Business Proclamation no. 592/2008), so speed is necessary in handling failed banks.
g. Reducing the Government’s Obligations and getting Banks to Contribute: In countries that have no formal DIS or where the guarantee is implicit, the cost of any attempt to protect deposits falls on the government directly or indirectly through the central (National) bank. In this situation, instituting an explicit DIS can reduce the government’s obligation by limiting coverage and providing a formal mechanism that forces banks to meet at least the major part of the cost of deposit protection via payment of premiums.
h. Helping to Justify Bank Legislation, Regulation, and Supervision: It is evident from experience that, for a variety of reasons, legislators were often unwilling to enact necessary banking laws, and supervisors are hesitant to impose and enforce prudential regulations and to supervise banks’ condition. However, the prospect that governments have to cover the costs of an under-funded insurance scheme and face the consequent taxpayers’ anger may provide the impetus for legislators and supervisors to pay greater attention to serving the taxpayers’ interests by keeping the banking system sound.
i. Promoting Economic Growth, Investment and Regulatory Saving: Deposit protection can encourage saving and reduce the risk premium that depositors require on their funds, which enables banks to charge lower loan rates, and so stimulates investment. The greater competition that an EDIS facilitates also encourages banks to reduce the spread between their deposit and loan rates. Thus, EDISs can promote saving, intermediation and investment reduces both interest rate levels and spreads and fosters economic growth.
2.2.4 The Possible Challenges to Explicit Deposit Insurance Scheme
Technically illustrated the failure or otherwise of an EDIS grossly depends on factors related to its proper design and implementation. Accordingly, the possible pitfalls to be incurred from the establishment of an EDIS may contextually vary along territories. Though not uniformly experienced by states, the following major challenges may emanate from the improper adoption or implementation of an EDIS;
a. It Gives Rise to Incentives
In the life, health, property, and casualty branches of the insurance industry, the policy-holder knows his exposure better than the insurer. This can lead to adverse selection and heavy losses. The insurance company reacts by taking steps to limit its costs by choosing the risks and the risk takers that it will guarantee and charging risk-adjusted premiums to deter adverse selection. The information asymmetry can also promote moral hazard that the insurer discourages by giving the insured incentives to avoid taking risks.
Similarly, asymmetric information is also a problem in banking, where the guarantee gives rise to particularly strong problems of adverse selection and moral hazard. Since deposit insurance is similar to a put option that involves three parties, which are depositors, their bank and their guarantor, it can alter the behavior of bank owners, managers and depositors. It also provides opportunities for other interested parties (such as supervisors and politicians) to take advantage of its protection. In this regard, an EDIS may give rise to five differing types of incentives: (a) Incentives for depositors and other creditors, (b) Perverse incentives for bank owners, (c) Incentives for managers, (d) Perverse incentives for borrowers, and (e) Opportunism by regulators and supervisors.
On the other hand, the following are the main sources of these incentives in an EDIS:
1. Adverse Selection in Banking: Adverse selection is the tendency for higher-risk banks to opt for deposit insurance and lower-risk banks to opt-out of deposit insurance when membership in a deposit insurance system is voluntary in nature.
Adverse selection is a problem that confronts an EDIS that cannot differentiate and impose the premiums charged according to the true condition of the insured banks. Schemes in most countries employ a flat rate premium structure. In a scheme that is priced to cover average cost, a guarantee will be a bargain for the worst banks while it will not be worthwhile for the strongest institutions. A voluntary scheme is unstable because first, the best banks will drop out, which will require the level of premiums to be raised. Second, the second best tier of banks will withdraw, necessitating a sudden increase in premiums and perhaps the third and fourth, until only the worst banks remain and the deposit insurer will fail.
2. Deposit Insurance as a Put Option: While the intuitive idea is that deposit insurance protects depositors, recognizing that deposit insurance involves three parties suggest the ways in which bank owners and managers benefit from its operations. When a bank in an uninsured banking system gets into difficulties, its owners have to decide whether to continue to operate the bank in a weak condition and risk a run, insolvency and default, or recapitalize it, or voluntarily wind it up or terminate its operations by defaulting on its obligations.
In addition, deposit protection gives the owners a fifth alternative that can disrupt healthy internal governance- by obtaining a guarantee, the owners in a way, purchase the right to surrender the remaining assets and the charter of the bank to the insurance agency in exchange for payments to insured depositors, which is equivalent to purchasing a put option?
3. Moral Hazard: Moral hazard in DIS is the incentive for additional risk taking that is often present in insurance contracts and arises from the fact that parties to the contract are protected against loss. In its infancy, the word “hazard” referred to a game of dice that survives today in a simplified version. Early insurers identified two kinds of hazard- those that caused a loss, e.g., fires, and those that affected the likelihood or amount of a loss. Later, in an attempt to avoid underwriting poor risks, insurers used the phrase ‘moral hazard’ as shorthand to describe the undesirable traits in an insured that might increase the probability of a loss.
The moral hazard danger from deposit insurance arises when the many parties affected by the guarantee become less careful in their personal habits or business practices or deliberately exploit it. The parties directly affected by the surety bond include insured small depositors, the bank’s owners and its managers. But the effects may extend to other creditors, borrowers and other parties (such as regulators, supervisors and politicians), who may take advantage of the protection the guarantee offers to pursue their own interests at the expense of the insurance fund and the taxpayers that back it.
As a group of scholars explained, the creation of DIS comes at a cost, namely ‘moral hazard’. Depositors no longer have an incentive to monitor (or pay to monitor) banks since their deposits are guaranteed up to the coverage limit. Banks have an attendant incentive to increase risk. Hence the name of the game in designing a safety net has been to balance the need to prevent bank panics (and other social costs to bank failure such as credit crunches) with the moral hazard brought on by the very presence of the safety net . 
Finally the problems of moral hazard in the financial safety net can be addressed in two ways. These are: co-insurance and discriminatory pricing
b. Mispriced Deposit Insurance
Systematically under-priced insurance can have adverse macroeconomic implications. Banks obtain arbitrary profits by increasing their deposits (whose risk and interest rates are reduced by the guarantee) and expanding their loans beyond the socially optimal level. When the overexpansion can no longer be sustained, the subsequent recession and decline in asset prices will be sharper than would have occurred without the deposit guarantee. This problem is hard to limit by regulation and supervision, especially where promoting savings and stimulating the economy are objectives of deposit insurance.
c. The Cost of Deposit insurance
An EDIS that is poorly designed can be expensive. By insuring the worst banks, encouraging risky behavior, postponing the need for effective regulation, supervision and information dissemination, and delaying exit, an EDIS can cause the condition of the banking system to deteriorate and the cost of its ultimate restoration to escalate. In general, many healthy banks, depositors, other creditors, the government, central bank, suppliers, consumers, and taxpayers stand to lose from a banking system that is operating without regulatory or market discipline. Deposit protection that weakens internal governance, market discipline and official oversight can distort the financial system. Thus, it is important, for the insurer to manage its operations, by applying various ways to avoid this catastrophe and for the government to back up the fund when a systemic crisis places unanticipated demands on the fund.
2.3 Structural Models of Deposit Insurance Agencies
On the basis of the functions, powers and duties legally attributed to deposit insurance agencies or institutions, it is possible to distinguish four separate models of deposit insurance agencies, which differ with regard to their roles and powers and also regarding their fundamental design. The functions of the simpler model are always contained in those of the more complex model. Accordingly, the following are the major models or forms to deposit insurance institutions:
a. The ‘Pay Box’ Model: In this model the role of the deposit insurance institution is limited to paying out on the covered deposits in favor of the eligible deposits. In the case of a claim, the deposit insurance fund receives a corresponding instruction (from the bank supervisors, for example) and ensures an orderly settlement of all claims.
b. The ‘Cost Reducer’ Model: In addition to the settlement function, in this model the deposit insurance institution takes on the role of handling any occurrence of insolvency in an insured institution with the lowest possible costs and externalities for the financial intermediation system. In this case, the deposit insurance is granted powers in specific circumstances or events to intervene in the insured institution and to arrange preventive or corrective measures to protect the covered deposits.
c. The ‘Resolution Facilitator’ Model: This model of the powers of deposit insurance goes a step further. It allows the deposit insurance institution to use its capital not only to settle deposit shortfalls that have occurred, but also proactively to support a bank that has got into difficulties (but is not yet illiquid or even insolvent). In this model, the deposit insurance institution will, for example, help to sell an insured institution to a suitable partner, split up individual business areas, or prepare recapitalization in order to protect covered deposits.
d. The ‘Supervisor’ Model: This model has the broadest portfolio of powers. Here the deposit insurance institution itself becomes part of the supervisory system. It exercises direct supervisory functions and has a corresponding influence over the financial institutions associated with it.
3. Background, Performance Analysis of the Banking Sector and Design Considerations and Implementation Methodology to the EDIS
3.1 Background and Performance Analysis of the Banking Sector in Ethiopia
3.1.1 Historical Development of the Banking Sector
The history of the use of modern money in Ethiopia can be traced back more than 2000 years. It flourished in what is called the ‘Axumite’ era which ran from 1000 BC to around AD 975. Leaving that long history aside, modern banking in Ethiopia started in 1905 with the establishment of the Bank of Abyssinia which was based on a fifty year agreement with the Anglo-Egyptian National Bank. In 1908 a new development bank and two other foreign banks (Banque de l’Indochine and the Compagniedel’ Afrique Orientale) were established. These banks were criticized for being wholly foreign owned.
In 1931 the Ethiopian government purchased the Bank of Abyssinia, which was the dominant bank, and renamed it the Bank of Ethiopia- the first nationally owned bank on the African continent. During the five years of Italian occupation, banking activity expanded. The Italian banks were particularly active. After independence from Italy’s brief occupation, the Barclays Bank was established and remained in business from 1941 to 1943. Following this, in 1943 the Ethiopian Government established the State Bank of Ethiopia. The establishment of the bank was a painful process because Britain was against it.
The State bank of Ethiopia was operating as both a commercial and Central bank until 1963 when it was remodeled into today’s National bank of Ethiopia and the Commercial Bank of Ethiopia. After this period, many other banks were established; and just until the 1974 revolution these banks were in operation.
In the aftermath of the 1974 revolution, all privately owned financial institutions including three commercial banks, thirteen insurance companies, and two non-bank financial intermediaries were nationalized on 1st January 1975. The nationalized banks were reorganized and one commercial bank, the National bank, two specialized banks- the Agricultural and Industrial Bank, renamed recently as the Development Bank of Ethiopia and a Housing and Savings Bank, renamed recently as the Construction and Business Bank, and one insurance company (Ethiopian Insurance Company); were formed. Following the regime change in 1991 and the liberalization policy in 1992, these financial institutions were reorganized.
3.1.2 The Structure of the Banking System in the Post-Reform Period
Proclamation No. 84/1994, that allowed the private sector (but, this law required banks to be formed as share companies and the shareholders to be Ethiopian national) to engage in the banking and insurance businesses marked the beginning of a new era in Ethiopia’s financial sector. Following this Proclamation, the country witnessed a proliferation of private banking and insurance companies. For instance, within ten years of the enactment of the proclamation, i.e., in 2003/4, there were six new private banks with 115 branches. These new private banks accounted for about a quarter of the total banking capital in the country.
However, despite the proliferation of privately owned banks, their relative market share was relatively small. The dominant position in terms of deposit mobilization was held by the public sector in general and the CBE in particular. The public sector’s share did, however, fall from 96 percent in 1996/97 to 80 per cent in 2002/03, while the share of the private banks rose from 4 percent to 20 percent over the two periods. This private sector share was highest for time deposits followed by savings and demand deposits. A similar pattern was observed in terms of disbursement of loans, outstanding loans, and loan collection. In general, in terms of loan disbursement, the share of the public sector (the CBE being the dominant bank, accounted for more than 95 percent of public banking sector, followed by DBE) declined from 93 percent in 1996/97 to 44 percent in 2002/03. In terms of loan collection, the public banks’ share declined from 94 percent to 60 percent during the two periods, while the share of the private sector increased from 6 percent to 40 percent. Outstanding loans were highest in the public sector, being 96 percent in 1996/97 and declining a little to 82 percent in 2002/03 (the corresponding figure for the private banks increased from 4 to 18 percent).
In sum, it was after ten years of the enactment of the proclamation that the private banks grew to catch up with the public banks in almost all banking activities.
3.1.3 The Structure and Performance of the Banking System after 2004
At the end of 2004/05, the number of banks reached ten , with the establishment of the Cooperative Bank of Oromia. Of these ten banks, three were government owned and no foreign entry into the banking business was allowed or noticed. In the same period, the number of bank branches reached 389, of which 174 (or about 44.7 percent) belonged to the CBE. The ‘bank branch to population’ ratio for Ethiopia stood at 1:185,000, compared to 1: 227,797 in 2001/02. Likewise, total capital of the banking system reached Birr 3,486 million at the end of June 2005, of which Birr 1,979.0 million (56.8 percent) was held by the three government owned banks.
The total capital of the seven private banks stood at Birr 1,507 million (or 43.2 percent). CBE accounted for about 41 percent of the total capital of the banking system. However, it is worth to note that the share of private banks both in bank branches and capital tended to increase over the years as it went up from 37.2 percent and 33.2 percent in 2003/04 to 40.4 and 43.2 percent respectively in 2004/05.
Yet, in the same period, geographical distribution of bank branches was highly skewed to major towns and cities as well as few regions. Nearly 30 percent of bank branches were located in Addis Ababa- the commercial and business center of the economy. Similarly, 59.6 percent of branches were found in four of the regional states- Oromia, Amhara, Tigrai, and SNNPRS.
In the review month of Sep, 2009, the total number of banks reached 15. The total number of bank branches reached 663 from 656 in Mar, 2009.
With respect to the banking operations in 2009, the amount of new loans disbursed by the banking system reached Birr 2.8 billion, about 42 percent higher than that of same period of in 2008. Similarly, loan collection by the banking system increased by 24 percent to Birr 1.8 billion. As a result, outstanding loans of the banking system reached Birr 48.2 billion, up by 12.3 percent against the preceding year of the same period.
Regarding the ‘Reserve and Liquidity ratio’ of the banking system (in million Birr), Actual reserves increased from Birr 15,839.2 million in Oct, 2008 to 21,315.2 million in Oct, 2009. Excess reserves grew from Birr 5,803.1 million in Oct, 2008 to 8,927.9 million in Oct, 2009. And liquidity ratio (in percent) in the banking sector grew from 40.1 million in Oct, 2008 to 43.4 million in Oct, 2009.
In Oct, 2010, the number of banks operating in the sector stood at 15. However, there was an increase in the total quantity of bank branches to 673 from 617 in Mar, 2009. In the same period, the amount of new loans disbursed by the banking system arrived at Birr 2.9 billion, about 40.8 percent higher than 2009. Likewise, loan collection by the banking system increased by 10.4 percent to Birr 2.05 billion. As a result, outstanding loans of the banking system reached Birr 53.09 billion, 15.8 percent higher than the preceding year.
On the other hand, Actual reserves grow from Birr 17,846.8 million in Mar, 2009 to 22,711.23 million in Mar, 2010. Excess reserves grow from Birr 6553.0 million in Mar, 2009 to 9229.1 million in Mar, 2010. Liquidity ratio (in percent) grows from Birr 39.5 million in Mar, 2009 to 46.55 million in Mar, 2010.
Having carefully analyzed the above statistics on the Ethiopian banking sector since the emergence of modern banking, it would not be difficult to understand how much the sector is graduating to the next level overtime. This growth of the sector is of two folds. One is in terms of the volume of the sector and the other is in terms of its efficiency and influence on the entire economy of the country i.e., there is a meaningful increment regarding the financial capability of the banks in terms of Liquidity, Legal reserve, Amount of Saving, Loan extension and collection, and the contribution of the banking sector to the entire GDP of the country. Moreover, at the present time and in the future the statistics is deemed to increase in both aspects.
On the other hand, the prospect of Ethiopia’s accession to the WTO is also expected to result in an increase on the volume and efficiency of the banking sector- due to the likelihood of foreign banks’ commercial presence in Ethiopia which is new to the history of the country.
The obvious conclusion from these facts is, the more the sector is growing, the stiffer becomes the competition and the stricter gets its regulation thereof. Perhaps, the likelihood of an increase in bank failure in the future, or the need to stabilize the entire financial sector, or the vulnerability of the sector to a system crisis or the fact that the sector is always prone to contamination problems, can be the main justifications behind such a strict regulation.
The thing is such an increase in quality and volume of the banking sector, aggravated by the prospect of establishment of new and large number of banks (domestic or foreign) in the sector, if not dealt with the required mechanisms of strict and efficient regulation, would entail a banking crisis.
Hence, as plenty literature and the experience of other countries reveals, the proper adoption and implementation of an explicit DIS, inter alia is a key means of assuring a safety net, above all, to either remedy an already created financial-panic or prevent potential risk of a crisis in the sector.
3.2 Fundamental Considerations of Design for the Ethiopian DIS
Fundamentally, the organization of the Ethiopian deposit insurance scheme should depend on the legal, political, economic and cultural conditions of the country. Independently of these national characteristics, however, policymakers may derive from recent experiences of some countries principles of design which are identified universally valid for all modern systems.
Accordingly, the Government cannot afford to neglect these principles. Even in the strong institutional environments, weaknesses in deposit insurance design and distortive political pressures that support them can fuel financial fragility and lessen the discipline that banks receive from private counterparties. To control and offset these effects, design features have proved themselves useful. Hence, the design of the Ethiopian DIS shall carefully consider the following points:
3.2.1 Explicit Deposit Insurance Scheme should be a Priority in Ethiopia
Establishing a formal and legally binding DIS in Ethiopia (as a firm choice between explicit and implicit deposit insurance, the better view is that the program should be both explicit and clearly set forth in public or banking law) would allow the concerned Ethiopian authorities to design a structure that avoids the pitfalls of an implicit system of depositor protection, while maintaining the benefits of explicit DIS. This is because implicit systems in developing countries like Ethiopia are low on benefits and high on pitfalls. On the other hand, if explicit DIS is established in Ethiopia, it avoids these problems (refer to the discussion on chapter two) because the government will be forced to take some degree of responsibility or is likely to behave more responsibly in its supervision policies and in its financial planning due to the costs of the contingent liabilities. The government, moreover, is likely to resolve problems that do arise more expeditiously and on the basis of predetermined rules and procedures. Most significantly, adoption of explicit guarantee gives Ethiopian policymakers more flexibility to limit the explicit guarantees per the need of the situation. A limited guarantee allows the government to argue that, while it is required to pay out guaranteed deposits, it is not required to pay more. Therefore, the adoption of explicit DIS in Ethiopia should be a priority for it is the only practical way to ensure that the coverage is also limited in amount.
3.2.2 The Structure of the Ethiopian Banking System
As a rule, theory and operations in much of the general insurance industry rely on the law of large numbers. That is, if we want guarantees to work best, there should be reasonable number of insured entities or elements. This helps to share the costs of rare mishaps that are independently distributed. What is a sufficient number of banks for insurance purposes is not an issue that has been properly addressed in existing literature, but the normal distribution in statistics is approximated based on reasonable number of insured entities when other conditions hold true. Pursuant to this, the risk of the Ethiopian DIS should be diversified. The best way to do so would be to diversify such a risk at least geographically. As a state structured with the parliamentary system of government and federalism, doing so would not be a taxing job to policymakers. Otherwise, if the banking system merely appears to be large enough to meet only the quantity criterion, failures may not be independently or geographically distributed and the risks in banking systems would not be evenly distributed among all the banks, but would instead be mainly concentrated at a small number of large banks (capable to shoulder risks) for the remaining elements of the system will be larger number of small banks holding few assets and unable to shoulder risks.
Taking in to consideration the increase in volume and geographical or branch coverage of the Ethiopian banking sector, one could draw a conclusion that it fulfills the structure requirement to establish a DIS. For instance, if one considers the volume of the banking sector in Ethiopia (already established and in process of establishment), it can satisfy the required reasonable minimum number of insured institutions that have to be present to establish an EDIS.
Besides, since 1991-92, the FDRE government have employed various, strict and preparatory rules and regulations in order to guarantee the development (for the transition to free market) of the sector. The other factor that would make the banking sector eligible to EDIS is the fact that Ethiopia is divided in to 9 regional states and two federally administered cities and most of the banks have large number of branches in the states. This enables to geographically diversify the risk of the EDIS. As stated above, both the requirement of volume and geographical diversification requirements can be met by the Ethiopian banking sector with a minimum cost. Hence, if backed by other policy measures, Ethiopian policy makers can establish a DIS with a diversified risk.
3.2.3 The Condition of the Banking System in Relation to the Establishment of the DIS
The other basic factor policymakers should consider while introducing EDIS is the timing i.e., they should carefully consider the prevailing financial condition or situation of the banking sector. For instance, if large numbers of insolvent or weak banks are operating in the sector, the initiation under these circumstances invites depletion of the EDIS fund. Consequently, policy makers are advised to strictly examine, on one hand, the amount of capital and the conditions of the loan portfolios in the Ethiopian banking system as a whole before initiating EDIS and on the other, the adequacy of the capital available to each individual operating bank and the condition of its loan portfolio before allowing it to join the insuring scheme. Where capital inadequacies are widespread, it would be wise to recapitalize banks before starting EDIS.
Until the present time, Ethiopian banking sector has experienced no bank failure. In addition, the sector is strictly regulated by the National Bank of Ethiopia. This bank is vested with the power to conduct and put in place adequate systems of prudential regulation, accounting and loan valuation, capital and reserve requirements, auditing, reporting, and supervision. As a result, it is plausible to allege that, Ethiopia should not wait until banks become victims of a crisis (unlike the case of many countries), whilst it can set EDIS as a means of prevention than as a means of cure.
3.2.4 Should Ethiopia Establish a Publicly or a Privately Administered DIS?
This is the other important issue that Ethiopian policymakers should ascertain. Several questions relating to the administration of the system must be answered by the legislature- Will there be a separate, independent DI agency? Or will the scheme be a special department of the National bank or the supervisory agency? Will the insurer have the power to set prudential regulations and enforce them by supervising insured institutions? Answers to these questions should depend on the history, institutional tradition, size and resources of the country making the decision.
Existing EDISs take a variety of forms with regard to their sponsorship, administration and financing, and cover broad range from pure public systems to pure private systems. The amount of independence that these corporations have, particularly with regards to the Central Bank, varies from country to country. In fact, all countries that have recently reformed their EDISs have moved further to adopt either purely private or mixed systems.
The EDIS to be established in Ethiopia, with in the current status of the entire economy and the banking sector, should rely to a greater extent on government participation due to the following factors: (1) Unlike the banks in developed countries that have the financial strength to absorb the additional cost of deposit insurance assessments and to face potentially high contingent liabilities, these factors could constitute an excessive burden for banks in Ethiopia; (2) because the banking system in Ethiopia is still emerging, banking activity is very interconnected and hence mutual insurance would be unworkable at least temporarily; (3) bank ownership in Ethiopia is tilted more toward the government, and it is only reasonable for the government to be directly or indirectly involved in the insurance of banks; and (4) private management of EDISs would tend to drain the already very limited managerial resources of private banks in the country.
In general, however, the DIS in Ethiopia is more likely to achieve its objective, if it employs a public system of administration at present and the system may evolve to a quasi-public system (a system that is jointly managed by government and banking officials, but has some form of government financial backing) with the changing situation of the private sector eventually. But, pure private systems that rely solely on the banking industry for financial support should be avoided in Ethiopia, because they are apt to break down during a banking crisis.
Due to these factors, it will not be a taxing duty to determine whether the Ethiopian DIS should be under a government ownership. In developing countries like Ethiopia, where the financial sector is still emerging, unsophisticated and prone to crisis, where the process of leveling the playground for the sustainable development of the sector is still unfinished in terms of both enacting the pertinent laws, and establishment of legal and institutional frameworks; to exclusively leave the administration of the EDIS to the private sector would entail unbearable consequences to the wellbeing of the sector. This however should be without denying the meaningful participation of the private sector in the administration of the system and with strict emphasis to ensure the autonomy of the DIS agency from superfluous government or political interference.
Hence, it is important to make the ownership of the Ethiopian DIS fell under a government insurer but it has to be established as a separate and independent, legal entity.
3.2.5 Compulsory or Voluntary System of Deposit Insurance Scheme in Ethiopia
EDISs can be either compulsory or voluntary in nature. In most developing countries (and the majority of developed countries), banks are mandatorily required to join the system. Relatively speaking, the major arguments in favor of a voluntary system are essentially philosophical and political in nature. But the disadvantages of it are practical.
This researcher is of the opinion that the DIS in Ethiopia should be compulsory for the following rationales: (1) as a major disadvantage, a voluntary system if applied in Ethiopia could exacerbate banking instability. The reason is that a voluntary system is likely to produce a two-tiered banking system- one part protected and the other unprotected; (2) A voluntary system could produce problems because its membership may be unstable. For example, well regarded banks might choose to withdraw from the system if bank failures rose sharply and large special premium assessments were levied in order to replenish the insurance fund. These withdrawals from the system would tend to throw an evenly greater financial burden on those less regarded banks that feel that they could not survive outside the insurance system; (3) a voluntary system is unlikely to extend protection to all small depositors because at least some banks may stay out of the system. If so, depositor protection, which is one of the major objectives of EDIS, could not be realized; (4) in initially designing a voluntary EDIS and changing some of the features of such system over time, policy makers would always have to consider the effects of their decisions on membership and the resulting robustness of the DIS. This factor could act as a constraint and may force policy makers into trade-offs that could result in a less designed system. By contrast, if a compulsory system is introduced in Ethiopia, no such constraints will affect the decision making process.
On the other hand, if the DIS in Ethiopia mandatorily requires subscription of all banks in the country, public and private banks will be given parallel treatment in order to maintain competitive equality. Consequently, if private banks are compelled to join the DIS, public banks should also be required to join. If this is not done, both types of banks would end up with different forms of deposit protection (private banks through deposit insurance and public banks through likely government bailouts), but only private banks would have to pay for the protection (through insurance premiums). Moreover, government could favor public banks over private banks through other channels such as lenient supervision, favored tax treatment and lower reserve requirements.
As a final suggestion however, with the changing situation or development of the Ethiopian banking sector and especially the increasing contribution of the private banking sector to the entire GDP of the country, policymakers may push the system down the hierarchy, i.e., from compulsory to mixed and then to voluntary system of EDIS.
3.2.6 Amount of Deposit Insurance Coverage
The amount of insurance protection extended to individual depositors is another important feature of EDISs. Indeed, it probably has more to do with the basic character and the ultimate effects of the system than any other feature. Researches dictate that insurance protection can take either the form of de jure protection- the amount of protection that the insurer is legally obligated to extend to depositors in the event of a bank failure, or de facto protection- the protection that the insurer effectively extends to uninsured depositors by resolving a failure in a way that protects all depositors from losses.
The maximum amount of de jure protection to be offered to depositors varies widely from country to country. In several countries, there are certain caveats that are applied on the stated amount of insurance protection to expand or contract the actual coverage. In most other countries, the ceiling is modified from time to time to reflect changes in the price level, the financial status of the insurance fund and/or the country’s policy goals. Besides some countries have employed the concept of co-insurance, which insures only certain percent of the deposit balance. With this system, therefore, there is always some risk sharing between depositors and the insurer, thereby instilling a considerable degree of market discipline into the banking system.
For the purpose of analyzing the policy implications of different coverage schemes on the EDIS, refer to the three coverage arrangements reviewed earlier in the study (under section 126.96.36.199)- the limited coverage, the 100 percent coverage, and the discretionary coverage.
In this regard, policymakers should consider all the above ways of coverage as per the need of the situation. However, from the experience of other countries with similar economic situations in order to defend the interest of small depositors, implementation of a limited type of coverage is appropriate and advisable. This is because, on the one hand, economic strength makes it clear that 100 percent coverage could be unrealistic in the Ethiopian DIS and on the other, aggravated by information asymmetry against all the stakeholders discretionary coverage could be devastating for it invites for unnecessary flexibilities and case by case treatment to determine the amount of coverage.
Moreover, the strict bank supervision by the NBE (which can be measured by the thoroughness of the supervisory process and the willingness of supervisory authorities to take strong actions) and its role of the lender of the last resort may be used as a cure to the likelihood of the inequities of a limited coverage, i.e., such roles of the National bank can provide de facto protection to all deposits at least during a bank failure.
3.2.7 Setting and Adjusting the Level of Coverage
Experience shows that coverage limits inherently encompass a relatively high percentage of the number of accounts, but a smaller percentage of the total value of deposits in the system (countries typically cover 90 percent or more of the number of accounts but only perhaps 40 percent of total deposits system wide). Based on the practice of other countries (which fix the coverage amount in their own local currencies), subject to proper review and adjustment in the future, it is advisable to set the coverage limit of the EDIS to range from Birr 20,000 to 100,000 per depositor per institution. I therefore suggest that, this proposed limit should be adopted.
In addition, coverage can be adjusted upwards over time to reflect higher GDP and faster rates of inflation. If the coverage ratio was initially set very low because the DIS fund needed time to build its resources, the level can be raised as the fund matures. The adjustments can be made by indexing coverage or making preferably rare adjustments. There is both an advantage and a disadvantage to indexing coverage levels. The advantage is that it avoids setting unduly high limits initially and the disadvantage is that it will be hard for the public to keep abreast of changes in the coverage level.
It is also perceived from by country customs that, the coverage limit of the DIS should be applied to both the principal amount of an insurable deposit and the interest accrued on that deposit. Thus, if the principal payment is Birr 95,000 and the accrued interest is Birr 7,000, the depositor should be entitled to a payment of Birr 100,000 (the coverage limit) rather than Birr 102,000. The next question to decide is the period up to which accrued interest should run.
It is proposed that for the purpose of determining the amount covered under the DIS, the interest accruing and payable in relation to a deposit should normally be calculated up to the date of appointment of a provisional liquidator.
In this regard, a similar approach can be adopted in the Ethiopian scheme, except the manner of fixing the cut-off date of accruing interest, for it has been already employed in the banking sector. In the Ethiopian case, it is vested to the discretion of the receiver to: (1) reset the rates of interest payable on the bank’s liabilities; provided, however, that such rates may not be less than those prevailing on the relevant market; And/ or (2) set a cut-off date on which accruing interest on deposits and other liabilities terminates. As a result, the EDIS can maximize a lot out of the office of the receiver in this regard.
3.2.8 Types of Deposits Eligible to EDIS Coverage
In addition to determining the amount of insurance coverage to be extended to depositors, the concerned organ in the country must decide on what types of deposits should be included or excluded from coverage.
Ethiopian policymakers should start the journey of determining eligible deposits by first determining as to what is an “insurable deposit”. Hence, the following definition may be incorporated into the EDIS legislation: An “insurable deposit” is any sum of money denominated in any currency which meets the definition of “deposit” under the Banking Business proclamation or the Com. Code and maintained with a participating bank.
Besides, such definition should be consistent with the advice of the IMF that, the definition of deposits under the deposit insurance legislation of a jurisdiction should preferably be consistent with that adopted under its other banking laws and regulations. In this regard, though the term “deposit” is not expressly defined both under the com. Code and the banking business proclamation, but it can be inferred indirectly that it includes Funds deposited in a bank, irrespective of the mode of deposit (time or demand deposits, a deposit in foreign or local currency) and Securities deposited in a bank and so on. As a result, these should be eligible to coverage.
On the other hand, it is also advisable to expressly state those deposits excluded from coverage for one or another reason. With respect to this, experience dictates that countries exclude some or all of the following types of deposits: Foreign deposits of domestic banks; Domestic deposits of foreign banks; Inter-bank deposits; deposits denominated in foreign currencies; “deposits secured on the assets of the bank” and “bearer instruments”-are excluded based on the advice of the IMF and the FSF Working Group on Deposit Insurance which support the exclusion of certain instruments such as certificates of deposits so as to avoid abuse of the coverage limit on a per-depositor basis.
All the mentioned excluded deposit types above are basically excluded for the main reason that they, if are covered by the domestic insurer, will tend to protect the foreign element than the domestic interests of the insuring (host) state.
Particularly, if the Ethiopian DIS extends coverage to foreign deposits of domestic banks, domestic deposits of foreign banks, and inter-bank deposits, in the short run, the country can benefit nothing meaningful. This is due to the fact that the banking sector, at least currently, benefits nothing from protecting foreign deposits or vice versa- in turn, this is because the Ethiopian banking sector has been closed to foreign influence for a longer period of time and chance of securing an advantage based on reciprocity- coverage is almost zero. The researcher, however, has a positive approach towards deposits of insured banks dominated in foreign currency for: (1) securing such currencies could help a lot in terms of foreign exchange or balance of payment, or set-off with Ethiopian Birr and (2) Foreign currencies are recognized as one mode of payment or deposit in our country, as it can be inferred from the definition of foreign currency from article 2 (5) of proc. No. 591/2008.
However, having more prospect of further liberalization of the Ethiopian banking sector in the long run, the likelihood of commercial presence of foreign banks (importing of such services from abroad) or presence of Ethiopian banks abroad, and high chance of reciprocity, the EDIS may consider protecting some of those types of deposit which have to be currently excluded according to their possible order of importance- deposits in foreign currency, domestic deposits of a foreign bank, Inter-Bank deposits and foreign deposits of a domestic bank.
3.2.9 Requirements of Admission to the Deposit Insurance coverage
In a similar fashion with the ordinary entrance requirements of banking business in Ethiopia, in order to protect the deposit insurance fund, banks should be normally required to be in satisfactory financial condition before being allowed to join the EDIS. However, two issues concerning entry and exit from the scheme need to be addressed: (I) whether membership should be automatically granted to all licensed banks without the need for the EDIA to make a separate determination; and (II) whether the EDIA should have the power to terminate the membership of any participating bank.
Given the narrow mandate of the EDIA, it would be appropriate to link DIS membership directly to a bank’s license. Effectively, this would mean that DIS membership would be automatically granted to an institution which has been granted a banking license by the NBE, and its DIS membership would be automatically withdrawn if its banking license is revoked. It would thus not be necessary to confer a separate power on the EDIA to grant or terminate membership of the DIS. For this is a pre-established authority of the NBE.
In view of the above, it is advisable that provisions should be included in the EDIS legislation to provide that: (i) Membership of the DIS would be automatically granted to an institution which is licensed as a bank under the Banking Business Proclamation; (ii) Regarding the banks licensed before the establishment of the EDIS, the legislature should presume and determine the date on which DIS membership is granted; (iii) for banks licensed after the establishment of the DIS, the date on which DIS membership is granted would be the date on which the banking license is granted; and (iv) the DIS membership of a participating bank would be automatically revoked upon revocation of its banking license by the NBE.
Moreover, the issue of foreign banks membership can be in a way dealt by this approach, i.e., for they are expressly prohibited from participation in the sector in Ethiopia, the NBE would not issue a license for them, which indirectly imply that they are not eligible to protection under the EDIS.
In the case of newly chartered banks they should have adequate capital and reasonable prospects for operating profitably. In addition, the management (the Board) of the bank should be experienced and competent and have a history of integrity in business affairs.
It is possible that when EDIS is initially created, some banks may be solvent, but below the standards set for admission to the EDIS. Probably the best way to handle this situation in the Ethiopian case would be to grant these banks admission but subject to the condition that they meet normal admission standards within reasonable period of time or have their insurance revoked.
This procedure would give these banks a cooling-period to comply, for example by raising additional equity capital. The threat of losing their insurance would act as a strong incentive for these banks to improve their condition. Furthermore, under a compulsory system, the withdrawal of insurance would be tantamount to the withdrawal of a bank’s license to generally operate in banking business.
Moreover, the EDIS should not allow member banks to discretionarily leave the system (for the interests involved in here are public). Standard insurance firms can deny coverage initially or refuse to renew it for customers that do not meet the criteria that they impose, but a deposit insurer has less leeway in this regard. While it is feasible to decline to license a bank that does not meet the EDISs criteria, it is more difficult to deny protection once a bank is already in business because it would in effect amount to withdrawing the bank’s license. Consequently, restrictions on licensing become crucial to selecting the risks the insurer will take. Demanding conditions should be made before a bank is granted any license that is accompanied by a right to a deposit guarantee. While many countries grant licenses in perpetuity, others require periodic re-licensing to enhance control over the quality of banks already in operation.
To sum up, Ethiopian policymakers should design and declare a mandatory DIS and should carefully adjust the membership requirement of securing a license for banking operations from the NBE to be met by member banks. This inter alia enables to assure whether a bank can pay its periodic premium to the EDIA in the future. Moreover, the EDIA should be given the power to take strict measures against non-compliant banks for such defiance may generally affect the entire payment system in the sector. In addition, the fact that the NBE strictly looks after the compliance of such requirements could make life easy to the EDIA.
3.2.10 Eligible Banks to EDIS Coverage
This is the other vital issue that policy makers should deal with strict care. In some developing countries, only commercial banks are eligible to deposit insurance. Like the case of most developing countries, the DIS in Ethiopia should in addition include at least all banks involved in normal banking business- deposit accepting, such as loan rendering, savings banks, merchant banks, and development banks. In the Ethiopian financial sector, the primary purpose should be to protect the payments mechanism in particular and the banking sector in general. Hence, the deposit insurance system could be logically confined to banks in Ethiopia regardless of their purpose, i.e., the commercial bank and other banks that perform day to day banking activities.
Experience ascertains that membership of the EDIS should be confined to only those banks that secured a license for banking business from the NBE according to part two of proclamation No. 592/2008.
Furthermore, participation in the EDIS should be mandatory for all licensed banks. This is essential to ensure the viability of the scheme and to avoid the problem of adverse selection. There are two other reasons for including all domestic banks in the Ethiopian explicit DIS. First, if some banks in Ethiopia are not insured and they begin to experience runs, these runs may spill-over to insured institutions (due to the so called contamination or spill-over effect of a financial panic). The reason is that during panic, depositors may not carefully distinguish between insured and uninsured institutions. Second, differential access to deposit insurance in banks could confer disadvantages on various types of competing banks, thereby introducing distortions within the financial sector.
Hence, for the above rationales, the Ethiopian DIS should include in its ambit all the banks in Ethiopia as far as the latter are capable of complying with membership requirements. However, as time goes on, in line with the development of the sector to a meaningful status, the protection might be extended to all depository or savings institutions including non-banks or a separate fund could be established for the later.
3.2.11 Grounds for Termination Deposit Insurance Membership
Like the workings of the National bank of Ethiopia, in addition to controlling qualification and admission to the deposit insurance system, the Ethiopian deposit insurer should be authorized to terminate a member bank’s insurance for certain actions that may jeopardize the fund (after all the requirements are set to serve this purpose). More specifically, the Ethiopian insurer should be able to terminate insurance, if a bank engages in repeated unsafe and unsound banking practices after receiving directions from the insurer and the primary supervisor to cease such practices (the NBE). In addition, the EDIA should be authorized to terminate insurance, if a bank repeatedly violates banking laws and prudential regulations.
In most countries with deposit insurance system, the termination of insurance is likely to represent the demise for the bank involved. Consequently, it is important that the insurer’s authority to terminate insurance be used in a reasonable manner and in collaboration with the NBE. For instance, the insurer should not be authorized to terminate insurance merely because a bank has encountered serious problems due to adverse economic conditions in the bank’s area or to errors of judgment on the part of the bank’s management. Moreover, when the Ethiopian insurer terminates a bank’s insurance for appropriate reasons, depositors of that bank should be notified of the termination, and the insurance should remain in force for a reasonable period of time to give depositors an opportunity to transfer their deposits to another bank.
3.2.12 Financing of the Ethiopian DIS
There are two major questions that must be resolved relating to the financing of the deposit insurance scheme in Ethiopia. First, who should bear the costs of the DIS or who should absorb these losses? And second, how should the financing of deposit insurance be arranged or should an insurance fund be set up and, if so, how large should the fund be?
Getting a protection scheme up and running it requires initial funding. The lawmakers may essentially exercise their discretion to use either of the following four ways to obtain the initial resources for EDIS: (1) place a start-up levy solely on the insured or member banks; (2) share the levy jointly among the commercial banks, the National Bank and the Treasury; (3) hold the government alone responsible for meeting the initial financial needs; or (4) start the system without accumulated funds but grant authority for the scheme to borrow to meet its needs and repay the borrowing through an emergency ex post levy if a bank fails.
As a rule, like the case of most existing deposit insurance systems, the costs of protection of the Ethiopian DIS should be absorbed ultimately by insured banks in the form of required premium payments into the insurance fund. The primary rationale for allocating the costs of deposit insurance to the banks is that they are the direct beneficiaries of the scheme. Deposit insurance lowers the risk of deposits and results in a decrease in banks’ cost of funds. Technically speaking, banks should absorb the costs because banks produce the losses that must be covered.
However, in so doing, the government should device a solution for the following two problems of requiring banks ultimately to absorb all of the costs of deposit insurance. First, the deposit insurance system may experience very large losses during a banking crisis. If so, the costs passed on to the banks may seriously erode their capital and push some of them into insolvency. Second, the benefits accruing to banks from insurance may bear no close relationship to the costs. Then, if the costs exceed the benefits, the deposit insurance system, in effect, would be imposing a tax on the banks. In order to alleviate this two problems the FDRE government should, in one form or another, share some of the cost burdens with the banks.
In addition, the following factors regarding funding of the EDIS shall be determined seriously:
a. Should an Initial Fund be established?
A decision also has to be made on whether official funding will be permanent (ex-ante) funding or is to be repaid by the banks over time (ex post). Starting the EDIS with funds that the public perceives to be insufficient will not win depositors confidence and risks the fund becoming insolvent. Insolvent funds are prone to forbearance, costly forms of resolution, and crises. Like the case of the EDIS’s ownership, the inherent nature of the financial sector in developing countries like Ethiopia makes it mandatory to establish a permanent or ex ante initial deposit insurance funding.
As a rule, the sustainability and perpetuation of the fund depends on whether it is absolutely covered by the government in the form of loan or on the contribution of the insured banks. This is because the banking sector lacks all the means required to deal with the negative externalities of ex post funding. Even, from the perspective of the depositor at large, they feel comfortable if and only if the DIA has already possessed a permanent fund which can materialize accelerated payment during a crisis. Otherwise, if the ex post funding mechanism is employed, it may erode public confidence for some insured banks may fail to pay or subscribe the required premium whenever requested to do so during or post the materialization of a panic.
However, once the fund is established and begins to perform properly (being backed by the further development of the Ethiopian financial sector), the EDIS may transfer to the ex post funding mechanism.
b. Single or Multiple Funding to the Ethiopian DIS
The issue of establishing one or more funds to the EDIS established in Ethiopia should not only be a matter of capacity to raise the required fund. Rather, in due course of determining this point, the legislature should also deliberate on the issue of using one fund for all types of institutions to be included in the insurance program regardless of their respective nature of risk or vice versa. Experience has made it evident that few developed countries have implemented separate funds to insure different types of institutions. To the contrary, many countries choose to establish only a single fund for all insured institutions under their DIS.
Coherently, it would be appropriate for Ethiopia to establish a single fund for all institutions which are to be covered under the DIS. The main rationale behind is related to, the volume, efficiency, expertise staff, financial ability and risk diversification ability in the Ethiopian banking sector. When one considers these factors properly, at the present time it is not as such crucial to develop multiple DIS funds for it would rather entail problem of division of attention to the DIS fund. This is, however, without neglecting the fact that banks that possess different risk profiles should be inherently entertained under separate funds.
However, having considered facts like banks in developing countries have almost similar risk profiles and those mentioned factors, the EDIS should have a single fund but the policymakers should look for ways like: (i) charging differential insurance premiums based on an institution’s (a bank’s) overall risk profile or (ii) implementing differential capital requirements that bring the overall risk profile of different institutions into balance, which are important to alleviate the problem of possessing a single fund. However, followed by further improvement of the sector, policy makers may increase such single fund to a multiple fund which may entertain different Ethiopian banks in different insurance funds based on their risk profiles.
c. Size of the DIS Fund
It is difficult to determine the appropriate size of a deposit insurance fund because it is very hard to predict the number and the size of banks that will fail over a given period, or the extent that they will be insolvent. What Ethiopian policymakers can do is using their best judgment and allow for a wide margin of error.
While there are many ways to arrange the funding of a DIS, to properly quantify the appropriate size of its fund that can cover the losses which might be suffered by the EDIS, by country experience say aloud that the methodology used to derive the target fund size and premium should involve the following steps: (i) making assumptions about possible shortfall loss and funding costs of the DIS Fund, and the probability of default of participating banks; (ii) feeding these assumptions into a statistical model in order to calculate the target size of the DIS Fund and the level of annual premium required to build up the Fund to the target level within a reasonable period of time. The target level of the Fund would be designed to cover both expected and unexpected losses up to a given confidence interval. Upper and lower limits of the Fund would also be set to produce a target range; (iii) re-calculating the target level of the DIS Fund each year to take account of deposit growth, changes in the risk profile of participating banks and the funding costs of the DIS; (iv) once the target level of the DIS Fund had been reached, basing the annual premium on the expected loss of the DIS; (v) paying a rebate or levying a surcharge, when the balance of the DIS Fund rose above the upper limit or fell below the lower limit, as the case may be, of the target range; and (vi) differentiating the premium paid by individual participating banks, based on their supervisory (CAMEL) ratings given by the NBE.
In general, given the great uncertainty regarding future losses, it should be considered preferable to adopt a risk-based approach towards calculating the premium so that banks would be rewarded for having strong management and good asset quality. Moreover, the following set of variations cant lower the cost of the EDIS further- a lower target fund size, a lower upper fund limit, a longer fund build-up period, a cap on surcharge and government contribution to the DIS Fund.
d. System of Premium Calculation
Ethiopian policymakers may exercise their discretion to choose and adopt as between adopting a flat rate premium system or a premium system that is differentiated on the basis of individual bank risk profiles, also called risk adjusted system. Both systems of premium calculations have their own advantages and disadvantages.
As the name indicates, a flat rate system imposes an identical rate of premium on all insured banks horizontally, i.e., without taking in to consideration factors like the risk profile of a bank or the size of a bank and so on. The primary advantage of a flat rate premium system is the relative ease with which assessments can be calculated and administered. However, in a flat rate system, low risk banks effectively pay for part of the deposit insurance benefit received by high risk banks. Most newly established systems initially adopt a flat rate system given the difficulties associated with designing and implementing a risk adjusted differential premium system.
However, because flat rate premiums do not reflect the level of risk that a bank poses to the deposit insurance system, banks can increase the risk profile of their portfolios without incurring additional deposit insurance costs. As a result, flat rate premiums may be perceived as encouraging excessive risk taking by some banks, unless there is a mechanism to impose financial sanctions or penalties.
On the other hand, Risk adjusted differential premium systems can mitigate such criticisms and may encourage more prudent risk-management practices at member banks for this system imposes rates of premium based on the risk profile of individual banks. When the relevant information required in applying a risk adjusted differential premium system is available, relating premiums to the risk a bank poses to the deposit insurer is preferable.
The information-intensive nature of the intermediation process in the sector, however, makes risk measurement a complicated task. The particular difficulties related to risk adjusted differential premium systems include: finding appropriate and acceptable methods of differentiating bank risk; obtaining reliable and timely data; ensuring that rating criteria are transparent; and examining the potential destabilizing effects of imposing high premiums on already troubled banks. As well, risk adjusted differential premium systems require resources necessary to administer the system appropriately. An important but delicate issue that policymakers should consider is whether to allow the release of information related to the risk profile of each bank, or to restrict this information for confidentiality or other reasons.
Pursuant to the above arguments, it is better if Ethiopian policymakers initially adopt the flat rate system for the first few years of the DI fund. This is because of the fact that the risk profiles of banks in Ethiopia or elsewhere in developing countries almost have similar standings. In addition to this, the strict regulation being conducted by the NBE on the day to day activities of other banks’ in the country has played its role in improving the status of their risk profile. This is however without denying the fact that the policymakers could transfer to the risk adjusted system of premium calculation in the future in line with the fulfillment of the mentioned preconditions to effectively adopt a risk adjusted premium calculation.
e. A back-up or Supplementary Funding to the Ethiopian DIS
The deposit insurance system in Ethiopia should layout the sources of back up resources that will be provided and procedures for obtaining them. Whereas, an insurance scheme can reasonably be expected to pay its own way when failures are rare and independent events, it is likely to become insolvent in the face of a systematic disaster. Then it may need to borrow temporarily and should have government guarantee when it does so. It should repay the loan over time from additional bank contributions. In extreme circumstances, it may need a permanent subvention from the government (which is the only one that can provide it) that must be included in the budget. Regarding this, the researcher believes that being supported by the lender of the last resort principle of the NBE, policy makers can in a meaningful manner adjust all the way outs necessary for the backup of the DI fund.
3.2.13 Enhanced Information Obtaining Mechanism to the EDIS
If the information obtaining mechanism employed by the EDIS is well organized, it enables the agency to properly choose insurable risks. For instance, absent the required information about a customer, a private insurer will deny or cancel coverage. As noted above, it is difficult to cancel coverage in banking, nevertheless initial information is important for licensing purposes and data on a continuing basis is needed to enable a bank’s regulators, its insurer and its customers to restrain the risks they take.
On the other hand, it helps the deposit insurance agency to ensure that the public has access to reliable information, provided publicly or privately, on the conditions of individual banks and of the insurance system. Reliable and timely information facilitates market discipline, prevents bank insolvencies and forces the timely resolution of those that do occur, which is essential to a strong exit policy. Moreover, lacking data, depositors may run unnecessarily.
To be meaningful, the EDIS should follow an information system based on internationally accepted accounting standards, represent market values wherever feasible, and follow adequate rules for provisioning of loan losses. Most countries keep information about borrowers strictly confidential, but some have established credit bureaus that can warn banks about overextended borrowers. In this regard too, the strict requirements of the NBE on Disclosure and Reporting can be helpful.
3.2.14 Investment Policy of the Deposit Insurance Fund
In a similar fashion to the banking business which depends on the activity of collecting deposits from part of the society who are not using it at a time and lend or invest it to those who are in need of the same, Ethiopian policy makers should make a decision as to how to invest the deposit insurance fund’s resources in safe, liquid, and interest bearing instruments, which are usually, but not always, government securities. It is also necessary to decide on what types of assets should be held by the insurer for a deposit insurer typically only has a limited investment mandate. The EDIA can safely invest only in such funds because financial panics by nature do not occur frequently and it can take advantage of the time between the collection of premiums and payment during a crisis. However, this requirement should be set in law and in order not to erode public confidence be invested in a calculated manner.
For instance, the Ethiopian DIA should consider the following important considerations: (i) In order to preserve the principal of the fund, the fund should be invested in assets that have relatively little risk (including credit risk, interest rate risk and foreign exchange risk); (ii) The fund should be invested in assets that are relatively liquid. The reason behind is to assure that the insurer can sell the assets promptly in order to meet its obligation to protect depositors; (iii) The fund should avoid getting involved in the location of credit among competing interests in the private sector; (iv) The sale of the assets should not have large monetary implications, or should be appropriately sterilized by the National Bank. The types of assets that seem to meet these requirements best are short-term government securities and foreign exchanges (either in the form of short-term foreign bank accounts or short-term foreign government securities- in the Ethiopian case the former is more important). In addition, the National Bank should possess effective instruments of monetary control and work in coordination with the insurer, so that it would be possible to offset this increase in the money supply.
3.2.15 Adopting Incentive-Compatible Forms of Bank Failure Resolution
The other subject that should be dealt side by side with the implementation of EDIS is the adoption of incentive compatible forms of failure resolution in the Ethiopian banking sector. Accordingly, if the need arises, the functions of a deposit insurer may be extended to resolve failing bank situations. Hence, it is important for the Ethiopian government to specify in its deposit insurance law what failure resolution devices the insurer can use and how these devices should be employed. The method chosen to resolve a failed bank can alter the risk exposure of a failed bank’s stakeholders. For example, if a bank is put into receivership and liquidated, the rules limiting insurance coverage and imposing losses on owners, managers and uninsured depositors can readily be observed. However, if a failed bank is merged (voluntarily or forcibly), the rules may be bypassed, so that these parties lose less than in a liquidation and discipline is thereby reduced. As a result, the Ethiopian legislature should require and pave the way to the deposit insurer to use the least costly form of resolution to avoid protecting owners, managers and uninsured creditors. This duty of the legislature would be relatively simplified for the Ethiopian legal system strictly deals with cases of bank failures as different from the liquidation of share companies in general- so this in a way finds a means to appropriately and exclusively deal with bank failures.
To be more specific, the following four failure resolution devices might be used: insured deposit pay offs or transfers, purchase and assumption transactions, financially assisted mergers, and the provision of financial assistance to a failing bank to prevent its closure.
A supervisory system that discovers and remedies bank deficiencies at an early stage can prevent many bank failures and will promptly address those that do occur. Such policies will keep the banking system strong and competitive and will reduce demands on the fund. The same principle holds true under the pertinent provisions of the Banking Business Proclamation for the proclamation expressly follows different ways of dealing with the situation of banks that have chance of viability and ‘unviable’.
In creating the EDIS, the government should include provisions in the deposit insurance law relating to failure resolution devices. Moreover, these provisions should assure that the devices used by the insurer are consistent with the objectives and form of the DIS.
There are two ways that failure resolution provisions can be specified in the Ethiopian deposit insurance law. One way is simply to list the devices that the insurer can use. The other way is to include general language that requires the insurer to use only those devices that are consistent with the objectives and form of the system. In general, the latter approach may be the better alternative in the Ethiopian context because it would give the insurer the flexibility to employ new devices over time as business practices change and as innovations in handling failing bank situations are developed. In addition to specifying the types of failure resolution devices to be used, the deposit insurance law should specify the criteria that the insurer should consider in choosing among alternative authorized devices. In many DISs, the sole or dominant consideration is cost minimization. Some failure resolution devices tend to be more cost effective than others they tend to preserve the value of the failing bank’s assets.
At any cost, some failure resolution devices shield depositors and borrowers from the disruptions of a failure better than others. Others may concentrate on the adjustment of private sector interest or stabilization of the entire sector. Consequently, since the function of the banking system is to serve these ends, it would seem reasonable to allow the Ethiopian insurer to consider such conveniences into account in resolving failures.
3.2.16 Accelerated Reimbursement, Right to set-off, and Assignment of Rights
Determining who should be reimbursed and ensuring that deposit insurance limits are respected are the most crucial steps in the reimbursement process and are important to the effectiveness of a variety of resolution methods. This is most evident in a liquidation process where depositors’ claims need to be reimbursed up to their insured limits. In other resolution transactions, determining the insurance status of individual accounts is also necessary, if such resolutions are to meet a least-cost test or when acquirers of failed banks assume only insured deposits. A determination of the status of individual accounts is also necessary when applicable statutes mandate the priority of insured depositor claims. Systems and processes should be developed in order to undertake preparatory reviews of deposit liabilities held by troubled banks. This requires development of administrative practices and procedures and the ongoing review of the quality and security of bank deposit records.
The trigger for deposit insurance payout is an important consideration for any DIS because depositors need to know when and under what circumstances the DIS will start the compensation process. The key factors that should be taken into account in designing the appropriate trigger conditions are: (i) minimizing EDIS cost; (ii) providing a clear and transparent point of payment; and (iii) protecting the interests of depositors. Taking the above into account, it is often suggested that that the EDIA should make payment to the insured depositors of a participating bank where: (i) the NBE has made an order to wind up the participating bank; or (ii) A Receiver (as defined in the Banking Business Proclamation) has been appointed to manage the affairs of the participating bank under article 32 of the same proclamation.
In the Ethiopian case, the EDIA should trigger payment to insured depositors up on the fulfillment of the requirements under 40 and 41 of the banking Business Proclamation are met. This means, signs like the ascertainment of the fact that the bank will be unviable by the receiver up on the order of the NBE, the commencement of the procedures of winding up by the receiver. And so on.
Depositors need to know when and under what conditions the EDIA will start the reimbursement process, as well as the applicable coverage limits. If reimbursement does not occur immediately after closure of the bank, depositors should be told the time frame over which reimbursement will take place. The Ethiopian deposit insurer should as soon as possible know when a bank will be closed. Access to the necessary deposit data before a bank is closed lessens the risk of record manipulation, shortens the time for completing the reimbursement process, and helps to preserve public confidence. The Ethiopian deposit insurer must decide whether to maintain adequate resources internally or whether it will outsource the function by employing contractors to handle reimbursements as they arise.
Regarding, the decision whether to set-off a depositor’s liabilities to a failed participating bank in determining his deposit insurance entitlement is an important consideration which not only affects the payout to depositors but also the cost of the EDIS. There are two main options to considerer: (i) Partial netting: the DIS should only set-off contractually due and past due liabilities of a depositor against his deposits in determining the amount of his entitlement; and (ii) Full netting: a depositor’s liabilities would be completely set-off against his deposits before his entitlement is determined.
However, experience dictates that there is greater support for adopting a full netting approach in determining deposit insurance payouts, which is consistent with the current bank insolvency procedures. It would also reduce the risk that the EDIS would pay out more to depositors than it could recover in liquidation (owing to differences in its netting approach from that of the liquidator).
Per the dictation of the banking business proclamation, the EDIS should apply full netting in determining the payout to depositors, in accordance with the current insolvency law and practice. This means that the DIS would set-off a depositor’s liabilities to a failed participating bank (including particularly liabilities arising from any credit facilities) against his deposits with the bank in determining his entitlement under the DIS. It is expressly stipulated that, in case a bank is not viable and liquidation is must to occur, the receiver is vested with the power to allow set-off of the deposit liabilities to any depositor against outstanding loan payments owed by that depositor.
The other important point that needs express consideration by lawmakers is ascertaining the rights of subrogation of the EDIA in relation to all the rights and remedies of the paid insured depositor. Otherwise stipulated, the EDIA should pay to an insured depositor only after the depositor has assigned all his rights and remedies in relation to the deposit (up to the amount of the payment made) to the DIS. The thing is, it would be cumbersome, and could undermine the efficiency of payout, if the EDIA has to approach all eligible depositors and obtain an assignment in writing from each of them. It would rather be desirable to include an explicit provision in the EDIS legislation to provide for an automatic assignment of rights from the depositors to the DIS. In this regard, the relevant provisions of the civil code dealing with “assignment of claims” or “subrogation” would be indispensible. Perhaps, the following declaration could be considered in the DIS legislation:
Where the EDIA makes a payment in respect of any deposit with a participating bank, all the depositor’s rights and remedies with respect to the deposit existing immediately before that payment shall, to the extent of the amount of the payment made, be transferred to and vest in the EDIA for the benefit of the DIS Fund and the DIA may take such steps as it considers necessary to enforce those rights and remedies.
3.2.17 Composition of the Board of Directors of the EDIA
In current context of the banking business in Ethiopia, it is the express authority of the NBE to: appoint Board members, determine qualification of competency, decide on the minimum number of directors, rule on the duties, responsibilities and good corporate governance of the boards of directors, determine the maximum number of years a director may serve and the conditions for his re-election, to fix on maximum remuneration of director and the maximum number of employees who may be elected and serve as members in the board of directors. As a result, the researcher believes that it will not be inconvenient if board members of the EDIA are appointed by the NBE as far as the appointees are dominantly chosen from lay members, in comparison to the ex officio and executive members.
On the other hand, article 347 (2) of the com. Code also provides a clue to determine the minimum and maximum number of directors for it exclusively stipulate that, a company shall have not less than three nor more than twelve directors who shall form a board of director.
Regarding the composition, while it is important to have the NBE, the Ministry of Finance and Economic Development, be represented ex officio on the board of the EDIA, government members should not dominate the board by constituting the majority of its members or by holding the position of chairman. The chairman and the majority of the board should be worthy, experienced but independent members of the public (lay members) with no current ties to the banking industry that would ensure sufficient independence of the Board. Thus, bankers should not be on the board, although their valuable experience can be utilized through their presence on an advisory board.
3.2.18 Back-Up Powers for the Ethiopian DIA
The supervisory may surrender to the agency problem of protecting the interests of a bank or his/her own career (that might be destroyed by admitting supervisory failure when closing a bank). The EDIA, on the other hand, should have more pressing needs to close a failed bank in order to curtail the losses it imposes on the fund. A balance needs to be struck between preserving supervisory autonomy and avoiding the EDIA’s potential eagerness to close troubled banks and the danger of inappropriate forbearance by the supervisor. Some countries have resolved this particular governmental conflict of interests informally, while others have legislated formal back-up powers for their DIA to be present at the onsite inspection of troubled banks, and to publicly revoke the guarantee from a bank it deems to be back-up powers to a DIS that is run by a public body.
3.2.19 Public Awareness and the Ethiopian DIS
In order to assure the effectiveness of the Ethiopian deposit insurance system, it is essential that the public at large is informed about its benefits and limitations. Experience has shown that the characteristics of a deposit insurance system need to be publicized regularly so that its credibility can be maintained and strengthened. A well-designed public-awareness program, if implemented in Ethiopia can achieve several goals, including the dissemination of information that promotes and facilitates an understanding of the deposit insurance system and its main features. Also, a public-awareness program can build or help to restore confidence in the Ethiopian banking sector.
Additionally, such program can help to disseminate vital information when failures occur, such as guidance regarding how to file claims and receive reimbursements. When designing a public-awareness program, it is critical to identify the target audience. Bank employees, especially those in operation, as well as those on the front-line, are important conduits for providing information about deposit insurance. Meanwhile, due care should be taken to select strategies that meet the goals set in the public-awareness program. A public-awareness plan that addresses issues related to failures should be carefully developed in the EDIS before an actual failure occurs.
The practice of a well-designed public-awareness program in EDIS helps to counteract the potentially disruptive effects of bank failures and helps to maintain confidence in the stability of the financial system. In countries where public confidence in the banking system and awareness of an existing deposit insurance system is very low, special communication strategies need to be developed to ensure that the stated goals are achieved while public confidence is maintained.
3.3 Self-Assessment Methodology (SAM) for the Implementation of the EDIS
Existing literature and experience suggests that, Ethiopian policymakers should use an iterative “self-assessment methodology” as a tool to design, implement, modify and continually assess the deposit insurance system. The six-step methodology presented below may allow Ethiopian policymakers to begin from general principles and then modify, as appropriate, the specific design features to meet the needs of the Ethiopian banking sector:
a. Setting out the Public-Policy Objectives: The process begins with an articulation of the relevant public-policy objectives to be attained from the adoption of EDIS in Ethiopia. This analysis should take into account the conditions and factors that are present in Ethiopia. A public-policy paper should outline the mandate and the role that the Ethiopian deposit insurer is expected to achieve within the financial safety net and set out the key attributes and important elements of the system.
b. Situational Analysis of Conditions and Factors: The analysis should consider economic factors, current monetary and fiscal policies, the state and structure of the banking system, public attitudes and expectations, the state of the legal, prudential regulatory and supervisory environment and the accounting and disclosure regimes in the country. The analysis should expose the strengths, weaknesses, opportunities and threats of the system and identify the changes required in constructing the Ethiopian deposit insurance system.
c. Validation: A review and validation process of the proposed public-policy objectives, key attributes and important elements should be undertaken and adjustments made if necessary.
d. Strategic Action Plan: A strategic action plan should be developed after the validation phase has been completed. This plan should set out the goals and their priorities, time frames, critical paths, communication strategies, and consultative processes. It should define how the Ethiopian deposit insurance system will be made operational and how it will deal with transitional issues. When transitioning from a blanket guarantee, care must be taken to ensure that the banking system is not disrupted. Policymakers should have contingency plans to deal with any adverse developments. It is critical that the public understand the planned changes and the time frame for completion.
e. Implementation and Acceptance Phase: Implementation and other changes should be supported by mechanisms to track progress and identify required adjustments. The purpose of this phase is to make the system operational and deal with transitional issues. For example, appropriate corporate governance arrangements (the governing body, senior management, internal controls, and an accountability regime) will need to be put in place. Also, budgets, funding, and access to information, including information-exchange arrangements, will need to be addressed at the outset.
f. Ongoing Evaluations and Validation: Ongoing evaluation and validation is needed to ensure the effectiveness of the Ethiopian deposit insurance system, and to make changes when required. This continuous-improvement process should incorporate new developments in the financial system and the lessons learned at home and abroad. After its establishment, the Ethiopian Deposit insurance system should be reviewed in a timely fashion benchmarking it against core principles, guidelines and best practices.
The Legal and Institutional Framework of DIS in Ethiopia
4.1 The Institutional Framework of DIS in Ethiopia
4.1.1 Ethiopian Deposit Insurance Scheme Structure
As already mentioned, the scheme structure of deposit insurance in Ethiopia should not only be adjusted based on an institution created for the purpose but also with the efficient collaboration of all institutions entrusted with roles in securing the stability of the financial system. Like any system, the system of deposit insurance in Ethiopia should be understood first, through its internal elements or the relationships between these elements and second, in relation to other stakeholders of the entire safety net- Lender of the Last Resort, Regulation and Supervision, Bank insolvency or Resolution law.
Accordingly, the following typical system elements should be found in the general institutional framework of the Ethiopian DIS:
a. Insured Financial Institutions: this refers to the circle of Banks included in the scheme or members of the Ethiopian DIS or, put negatively, other than those institutions whose deposits are not explicitly insured.
b. Insured Depositors: this group denotes the legal classification of the depositors who are in possession of eligible deposits to DIS coverage. Or those depositors whose deposits are insured by a premium paid by the bank that has accepted their deposits.
c. Eligible Deposits: it refers to the legal classification and factual and/or quantitative demarcation of the various covered deposits accepted by insured banks or, put negatively, deposits to the exclusion of accepted deposits but not covered by the deposit insurance.
d. The Deposit Insurance Agency: This refers to the Deposit Insurance Agency which is established to manage the EDIS. Institution wise, this is the most important element of the DIS.
e. Supervisory Organs: this refers to the supervisory organs that are directly or indirectly connected with the deposit insurance. These organs may include, the Board of the EDIA, the Chairman, the Managers, and other CEOs.
f. The National Bank: it specifically refers to the National Bank of Ethiopia which has every interest to deal with financial issues including the EDIS. However, it should take on specific functions in connection with deposit insurance. For example, it should play role of guarantee, or back up functions to the EDIS.
g. Government: This exclusively refers to the FDRE Government. In any deposit insurance scheme the state has an important role, be it as the agency of the deposit insurance institution or as an additional explicit or implicit guarantor. Finally, legal and regulatory provisions should define the overall conditions within which the mentioned participants in the system operate and fulfill their functions. These stakeholders in the Ethiopian DIS may have different interests and aims. However, common to all stakeholders is the need for the highest possible level of stability in the financial intermediation system. Hence, financial system stability should become a public commodity that has a positive value for all stakeholders of the Ethiopian DIS.
4.1.2 Basic Prerequisites to the Ethiopian Deposit Insurance Scheme
In order to achieve its main objectives, the EDIS must fulfill the following set of basic requirements:
a. Financial Stability: The deposit insurance scheme to be established in Ethiopia can only fulfill its role if it has the necessary financial capacity available to do so. The fund’s capital base should thereby fulfill an important function in assessing the credibility of the insurance and thus the confidence in the security of the eligible deposits.
b. Fair Competition: Contributions made in support of the EDIS must be organized to offer fair competition. Individual or groups of insured institutions in Ethiopia must not be disadvantaged.
c. Originator Orientation: in the future, contribution payments to the EDIS by other insured institutions should be organized according to their risk profile i.e. according to the claim risk of the insured institution. Anyone who represents a bigger claim risk for the deposit insurance scheme shall pay a higher contribution to the fund. Premiums for the insured institutions that are not risk-based do not fulfill this requirement of fair competition.
d. Incentive Compatibility: The trade-off between the security connected with high coverage sums and the reduced market discipline (moral hazard) must be prevented by the designing of appropriate deposit insurance scheme.
e. Regulation of Powers: The Ethiopian deposit insurance scheme should be inherently vested with extensive power to ensure the payment of contributions, to stabilize endangered financial institutions and to ensure the rapid and complete payout of covered deposits.
f. Simplicity and Transparency: the EDIS should create credibility based on convincing communication of the aims and mechanisms of the deposit insurance scheme. Hence, Simplicity and transparency of the structures and processes are the keys to this.
g. Cost Efficiency: Directly connected with the above is the concept of cost efficiency. The administration of the fund’s assets, the management of the fund and the handling process must be organized in a cost-efficient way.
h. Independence: The Ethiopian deposit insurance scheme should be organized on the one hand, as an integral element of the national safety net, but on the other, being independent of the external influence by stakeholders.
i. Responsibility: Independence of the EDIS should go along with its accountability for capital, returns and costs to the HPR, the Government and the public.
j. Reasonableness: the EDIS should indispensably consider all the country-specific conditions. It has to ensure that its specific design features are compatible with mainly economic circumstances of the country ensuring that deposit insurance is not over priced so that premiums are bearable.
4.1.3 The Institutional Arrangement of the EDIS in the Ethiopian Financial Safety net
The Ethiopian Deposit insurance scheme should always be part of the comprehensive system for enhancing and ensuring the financial stability of the country. Irrespective of national peculiarities of the financial intermediation systems, such an extensive financial safety net in Ethiopia should consist of five elements that complement and strengthen each other:
a. Regulation and Supervision: The basis for securing the stability of the financial system in Ethiopia or elsewhere is an efficient regulation and supervision of financial intermediaries, which, on the one hand, should prevent the onset of a crisis and, on the other, should reduce the effects of the crisis if it does happen. Findings from the latest financial crisis show that the significance of bank specific liquidity regulations and the maximum level of deposit insurance coverage must be reconsidered.
b. Lender of Last Resort: A further finding is that every national financial intermediation system needs an explicit or implicit lender of last resort in case of a broader financial system crisis. This can be by the state, the National bank or both of them together. It is also worth noting that the NBE plays the role of Lender of the Last resort in case of depletion of liquidity by a bank.
c. Bank Insolvency or Resolution Law: As a part of the regulation specific to the financial industry, these legal provisions regulate the specific conditions for the handling of bank failures and insolvencies. Here it is important to take note of the fact that, the Ethiopian legal system has already put in place bank insolvency mechanisms. Moreover, having considered the indispensability and sensitive nature of the banking sector, the HPR has devised a separate proclamation and procedures of bank insolvency (under the Banking Business proclamation) as different from the ordinary procedure of liquidation of share companies that are treated under the commercial code of 1960.
d. Deposit Insurance Scheme: There should also be an actual deposit insurance scheme which secures clearly defined accounts of specific categories of depositors, thereby reducing the risk of a bank-run and preventing a liquidity crisis in the financial system as a result of it.
e. Institutionalized Decision Making or Cooperation and Resolution Processes: The viability of the Ethiopian safety net in case of a future crisis also depends on efficient communication and cooperation between all the above network elements. This requires the concerned organs to put in place appropriately standardized and clearly regulated processes that at best are also internationally harmonized. The Ethiopian deposit insurance scheme should complement, support and strengthen the protective functions of the other system elements, just as these complement and support the deposit insurance scheme in fulfilling its function.
Finally, the researcher wants to extend the following concluding remarks on the interrelationship of the Ethiopian DIS with other Safety net Participants;
1. The EDIS should play critical complementary function within the Ethiopian financial safety net. As such, the mandate of the deposit insurer should be aligned with institutional functions of other members in the safety net. The mandatory roles, responsibilities and authorities of different safety net participants have to be well coordinated and clearly defined in the relevant laws to prevent overlaps and to avoid delayed intervention.
2. The powers, authorities and mandates of other safety net members need also to be explicitly defined in the respective laws. Clearly stated division of responsibilities improves the corporate governance in the sector and enhances the decision making process and accordingly the system’s efficiency.
3. Although signing of memorandum of understanding is a flexible formal means of information sharing amongst safety net elements, it has a major shortcoming for the scope, frequency, timing and even continuance of information flows that depend on the readiness and willingness of the regulatory bodies to cooperate with the deposit insurer. Consequently, it is preferable to stipulate the right to receive critical information in the law with further specification in the memoranda.
4. Coordination mechanisms are particularly important in handling a systemic banking crisis. All financial safety net participants in Ethiopia should join the regulation exercise. The Deposit insurer should form an integral part of the solution which depends on its mandate and the nature of the problem.
5. The EDIS has to be part of a well-designed system of regulation and supervision that makes sure banks do not go overboard with risk. Ultimately, deposit insurance does not replace supervision, but calls for its intensification. Without effective supervisory system it cannot, on its own, prevent depositors from losing faith in the financial system as a result of banking failures.
4.1.4 The Ethiopian Deposit Insurance Agency or Authority
This section deals with the main characteristics of the Ethiopian Deposit Insurance Agency in terms of roles and responsibilities, public policy objectives and authorities.
The choice of an appropriate structure and organization for a DIA is heavily influenced by its mandate, roles and responsibilities. The majority of the existing practice and experience dictate the idea that the EDIA in Ethiopia should confine its role to that of a “pay-box” (refer to the discussion under Section 2.4. in chapter two) to reduce the cost of deposit insurance and to avoid duplication of functions with the regulator (the NBE). There is also enough support from experience and literature that the EDIS should be administered by a separate legal entity to offer greater accountability and transparency to the public. Care should be taken, however, to ensure that the proposed entity is as lean and cost-effective as possible.
188.8.131.52 Roles and Responsibilities of the EDIA
There should be three primary roles set for the Ethiopian DIA. First, it should collect the premiums, second, it should manage the accumulated funds and finally, it should reimburse depositors. However, the deposit insurers analyzed by the researcher indicate that the level of responsibilities and the extent of autonomy in carrying out the roles may vary based on the specific conditions of the contextual nature of the DIA. The Ethiopian DIA should have the following responsibilities:
a. Licensing and Controlling Membership: Taking into consideration the nonnegotiable power of the NBE to control licensing or entry of banks to the banking business in Ethiopia, the EDIA should not interfere in the general role of controlling and licensing of entry to banking activities. However, the Ethiopian DIA should be vested with the supportive power to license and control membership to the deposit insurance agency or system. This, however, does not preclude the fact that both the NBE and the DIA may perform the activity in harmony.
b. Calculating and Raising Premiums: The Ethiopian deposit insurance agency (EDIA) should have an ex ante funding mechanism. In the future, however, the agency may follow an ex post funding method, or follow a combination funding methods.
c. Fund Management: the EDIA should invest the accumulated funds in the fixed income government securities market, mainly in Treasury bills and government bonds.
d. Reimbursing Insured Depositors: There should be an established legal basis to base the reimbursement process and this process should be subjected to explicit standards in the EDIS legislation. In case a member institution fails, depositors in general need to file a claim to the deposit insurance agency.
e. Risk Management and Monitoring: the EDIA should play unlimited role in risk monitoring, should have the power to obtain information for offsite supervision directly from member institutions, or should perform examinations for the member institutions. Moreover, the EDIA should also adopt the flexibilities to conduct these activities in a combined effort with the NBE for the latter is expressly vested with the power to conduct such activities.
f. Role in Handling Bank Failures: Although EDIA may to some extent be involved in the failure resolution process and play some role in claims and recoveries, the experience of other countries show that the EDIA should not have the ability to act as a receiver. However, the researcher believes that, the Ethiopian DIA could work hand-in-hand with the NBE or the Receiver appointed by the NBE. In most countries, however, failed institutions go through the regular corporate bankruptcy process and the receiver of the failed institution is the responsible party for disposition of the failed institution.
g. Intervention in the Affairs of Member Institutions (Pre-failure) to Minimize Exposure to Loss: In the same manner, in the Ethiopian banking sector, the ability to intervene in pre-failure of a bank to manage its risk and to limit its financial exposure is vested to the Receiver (whose identity is not specified for the post is open for any one qualified). As a result, technically speaking, the EDIA should not participate in pre-bank failure procedures unless otherwise it is invited by the receiver or the NBE to that effect.
h. Role in the Decision to Close Failed Institutions Membership (termination and closure): In consistence with the role in licensing member institutions of the DIS and membership granting, the EDIA should have a supportive-role in closing or terminating the insured status of member institution to the Ethiopian DIS. However, in this regard, it is better if the EDIA substantially rely on the existing role of the NBE as a license issuer and terminator.
184.108.40.206 Public Policy Objectives of the Ethiopian DIA
As evident from the analyzed experience and practice of other countries, the principal objectives for EDIA should be to pay-off depositors of a failed financial institution and to promote confidence in the banking system. In addition to this, the EDIA may have additional objectives, such as promoting stability in the financial system, risk and cost minimization by preventing intervention and reducing adverse effects of bankruptcy of banks.
However, it should be noted that these objectives should be in line with the primary responsibility of the EDIA given its roles and authorities and reflecting a good deal of consistency between the public policy objectives and the mandatory responsibilities.
220.127.116.11 Institutional Arrangement of the EDIA in the Ethiopian Financial Sector
Existing DIS experience in developing countries makes it evident that there are significant differences in the way deposit insurance corporations are organized within the national government. In general, DISs may be structured to fall into two basic organizational models, one where the insurer is part of the Central Bank, and the other where the insurer is an independent agency with managerial ties to the Central Bank and other governmental units . There are both pros. and cons. with having the insurer lodged in the Central Bank. In Ethiopia, the National Bank is the supervisor of other banks. In such cases, having the EDIA in or under the NBE means that all functions relating to preserving banking stability i.e., supervision, deposit insurance and lender of last resort, would be in the same agency. Having considered the emerging nature of the Ethiopian economy, such an arrangement would promote consistent policy making. It also results in at least some synergies in the use of human resources. Here, the fundamental care should be to make sure the independence of the EDIA from various pressures of the NBE or the government via the National Bank. As stated above, this pressure or conflict of interest may be curtailed by careful application of the principal design requirements in due course of adopting DIS in Ethiopia.
As a general rule, however, there is probably no objective and best way to organize the Ethiopian deposit insurance corporation in the national government’s organizational structure. All countries have their unique characteristics, and what is the best organizational arrangement for one country may not be best for another. In the Ethiopian situation, what is important is the fact that the supervisory, insurance and lender of last resort functions be coordinated and operated harmoniously. This objective could be achieved in a variety of ways- putting all functions in a single agency i.e., the NBE, or having multiple agencies with some overlapping management, or having multiple agencies and establishing some form of interagency coordinating committee. When the insurance and supervision, functions are placed in separate agencies, there is a particular need to coordinate bank examinations. This is because these examinations can be costly.
Hence, per the need of the situation and with the growth of efficiency of the entire financial sector, Ethiopian policymakers may place the EDIS in either of the options mentioned above. At the present time however, the researcher suggests that the EDIA should be physically or operationally independent but subjected to the supervision (accountability) of the NBE. Moreover, this idea is also supported by article 5 (7) of the National Bank Establishment Proclamation. It is stated that, “for the fulfillment of its purposes, the National Bank shall have the powers and duties to license and supervise banks, insurers and other financial institutions.” Perhaps, the wording ‘insurers’ certify that the Ethiopian deposit insurer will not escape at least the supervisory hands of the NBE.
18.104.22.168 Relationship between the Ethiopian Deposit Insurance Agency and the NBE
Deposit insurance is only one component of the safety net for a banking system, which also includes prudential regulation and the lender of last resort (LOLR) function. In Ethiopia, the latter two functions are performed by the NBE and the former function should be assigned to the EDIA.
As part of the safety net system, the roles of the regulator, the LOLR and the DIS should be complementary to each other in achieving the common objective of promoting the stability of a banking system. To the extent that effective banking regulation and availability of LOLR support to banks reduce the incidence of bank failures, this would reduce potential calls on the DIS and minimize its costs. Likewise, to the extent that the existence of a DIS could prevent bank failure caused by rumor driven runs by small depositors, this would avoid the need for unnecessary regulatory intervention or provision of LOLR support. If a bank failure does occur, a DIS can reduce the resulting fall-out effects, by providing an orderly means of compensating small depositors.
Moreover, the fact that each safety-net player is held accountable for its own mandate creates checks and balances in the system. But at the same time it also means that the division of responsibilities between the various agencies needs to be made clear and that their work needs to be well coordinated. Where appropriate, the existing arrangements should be strengthened to avoid or minimize overlapping of responsibilities or tension among the various agencies.
Per the advices of international Working Groups on Deposit Insurance, an important way to promote smooth cooperation between the various safety-net players is to have a clear division of powers and responsibilities. It is important for the public at large to agree and fix, through the legislative process, what the respective roles and responsibilities should be for the EDIA and the NBE. Without an absolute denying of collaboration among them, the DIS and the NBE each should basically have a different role to play in achieving the common policy objective of promoting the stability of the banking system. These differences should be recognized by law. As I tried to propose, the functions of the EDIA should be confined to collection of premiums, making compensation payments to insured depositors, and recovering the amount paid out to insured depositors upon a bank’s liquidation. Accordingly, the EDIA’s powers should not be more than those that are needed to fulfill those responsibilities. These functions and powers should be clearly set out in the EDIS legislation so that the Agency and the NBE could efficiently and effectively carry out their respective functions in a bank crisis. As noted earlier, the EDIA may delegate some of its functions to the NBE or the MOFD. It would also be helpful to include an explicit provision in the pertinent Banking Business Regulations and Directives to make it clear that the NBE has the function of cooperating with, and assisting, the EDIA to the extent permitted. This would put it beyond doubt that the NBE may assist the EDIA in discharging its functions under the DIS legislation.
The other point of consideration is related with the potential for tension between the EDIS and the LOLR, e.g. in the event that a participating bank that has borrowed from the LOLR eventually fails, the LOLR could become a large secured creditor with priority over the DIS. Experience substantiates that a more rule-based LOLR policy would help to minimize such problems.
In fact, the NBE has already adopted a rule-based policy in relation to the provision of LOLR support. Generally, experience shows that the following pre-conditions for access to LOLR support should be considered by the NBE: (i) LOLR support should be provided only when the failure of a troubled institution would damage the stability of the exchange rate, monetary or financial system; (ii) only institutions with a sufficient margin of solvency can have access to LOLR support; (iii) there should be no prima facie evidence that the management is not fit and proper, or that the liquidity problem is due to fraud; (iv) the institution must be prepared to take appropriate remedial action to deal with its liquidity problems; and (v) there should be statutory limits on the maximum amount of LOLR support that can be provided to an individual institution.
The fact of the matter is, if the NBE is capable enough to establish sufficient checks and balances in the existing LOLR policy, it would help to minimize the possible tensions between the supervisors and the NBE.
The other potential tension between the EDIA and the NBE is related to the manner of taking Prompt corrective actions. For instance, it may arise in case the NBE’s action is not swift enough to prevent losses to the DIS. This raises the question as to how the corrective action should be taken. Such a system should define a series of trigger points based on a bank’s capital strength and mandate a set of enforcement actions for the supervisor to implement at each point. Such a system can be helpful to limit undue supervisory forbearance.
In practice, the system in Ethiopia already incorporated certain features of a system of prompt corrective action. Perhaps there will be no problem in this regard. The system in Ethiopia works as follows:
First, the NBE is vested with power to conduct, periodically or at any time, without prior notice, make, or cause to be made, an on-site inspection of any bank. Second, where an application, accompanied with supporting evidence, is made to the National Bank by one-fifth of the total number of depositors or by any number of depositors holding not less than one-third of the deposits of a bank, the National Bank shall examine, or cause to be examined, under conditions of secrecy, the affairs of the bank in order to determine whether it is in a sound condition and the provisions of this Proclamation and regulations and directives issued pursuant to this Proclamation have been complied with.
Thirdly, the inspection report before its final preparation shall be communicated to the inspected bank and, the inspected bank shall be given an opportunity to express its views on the report. Then it will be submitted to the NBE. Finally, where an inspection of a bank results in a finding that the bank has failed to comply with the relevant laws and directives or with the terms and conditions of license or has engaged in practices detrimental to the interests of depositors or has serious weaknesses in its corporate governance, the National Bank is vested with the power to call a meeting with the concerned bank, appoint the required officers to view the meeting, instruct in writing corrective measures to be taken by the bank, order the dismissal or suspension of one or more members of the management, prohibit the bank from opening new branch offices, restrict, suspend or prohibit payment of dividends by the bank, order the bank to suspend for specified time any or all of its banking businesses; or put the bank under receivership. Hence, as long as it is conducted swiftly, prompt corrective action can be conducted effectively as between the EDIA and the NBE.
For a simple “pay-box” system, the DIS should have less need for information compared with a DIS with a broader mandate. It should have access to information about the level of insured deposits and other relevant information for the purpose of premium assessment and collection. In the case of a failed participating bank, it should also have access to specific information such as the amount and size distribution of insured deposits at the bank for the purpose of effecting timely payout to depositors.
While it is important for the DIA to have the necessary powers to obtain relevant information for the discharge of its “pay-box” function effectively, it would also be useful for the Board to co-ordinate the collection of such information with the NBE. For example, the NBE could collect the relevant information on behalf of the EDIA. This would have the advantage of leveraging on the NBE’s existing systems for information collection from authorized institutions and help maintain a lean management structure for the EDIA.
In certain circumstances, the EDIA should also have direct access to supervisory information provided by the NBE for the purpose of premium assessment. It is therefore proposed that an additional gateway should be included in the EDIS legislation so that the NBE may disclose information to the EDIA if such disclosure will enable or assist the EDIA to discharge its functions.
4.2 The Legal Framework of Deposit Insurance Scheme in Ethiopia
4.2.1 General Points on Legal Framework
The choice of legal form, which in turn depends on the national legal circumstances, is a function of the chosen aim and of the degree of independence desired for the deposit insurance institution. Literature and practice agree that a deposit insurance institution should enjoy an independence that is as great as possible both from the banking industry that is insured and from other public elements of the financial safety net (NBE, Government, and MOFD).
To this end, it requires a legal form in which, although the management and governing body are selected by political committees, they can take decisions and act independently.
A further determining factor for the legal form (and the governance structure connected with it) is the choice of ownership for the deposit insurance fund. Essentially, the fund can be conceived of either as a public or private special asset.
4.2.2 Possible Contents of the Ethiopian DIS Legislation
Pursuant to the promise made under article 25 of the NBE establishment proclamation No. 591/2008, the EDIS or DIF legislation which is likely to be issued by the Council of Ministers should (in addition to other subsidiary matters) expressly rule on:
a. Establishment of the Deposit Insurance Scheme Fund: A fund, to be known as the Deposit Insurance Scheme Fund (“DIS Fund”). It shall be established and shall consist of:
- Premiums collected from member institutions;
- Amounts recovered from the estate of a failed member institution;
- Investment returns;
- Amounts borrowed for the DIS Fund as permitted under this legislation; and
- Any other amounts that are lawfully paid into the DIS Fund.
b. The Type of Deposit Insurance Scheme: That an Explicit Deposit Insurance Scheme will be established.
c. Scope of Application of the Legislation: That the EDIS legislation is applicable on both banks located in the jurisdiction of the federal government and the states.
d. Time of Commencement of the Scheme: That the DIS should commence (activation) to function in a convenient time and having regard to the prevailing condition of the banking system.
e. Administration and Ownership of the Scheme: That the EDIS is a publicly administered scheme but without denial of meaningful participation of the private sector in so doing.
f. Nature of Membership: That membership to the EDIS is mandatory for all banks in the country.
g. Coverage under the EDIS: the legislation should expressly state:
- The types of deposits which are eligible to protection or coverage. An “insurable deposit” should be defined as “any sum of money denominated in any currency which meets the definition of “deposit” under the pertinent laws of the country on Banking Business and maintained with a member institution;
- Those deposits that are excluded from deposit insurance coverage;
- Banks which are eligible to EDIS coverage;
- The amount of protection that the insurer is legally obligated to extend to depositors in the event of a bank failure should be specified;
- The mechanisms of setting and adjusting the level of coverage;
- Depositors’ entitlement to protection (Where DIS payout is triggered each depositor of the member institution shall be entitled to compensation by the EDIA of an aggregate amount held on insurable deposit and any interest accrued thereon, up to a specified maximum in Ethiopian Birr, regardless of the number of his deposits with that institution);
- For the purpose of calculating the payment of compensation by the EDIA in respect of any insurable deposit, the interest accruing and payable in relation to the deposit shall be calculated up to the date to be determined by the EDIS legislation; In respect of any insurable deposit denominated in foreign currencies, compensation shall be payable in Ethiopian Birr, using the foreign exchange rate which is the determined by the NBE.
h. Requirements of Admission to Membership: The objective and subjective requirements of admission, licensing and membership to the EDIS.
i. Requirement of Exit or Termination of Membership: The grounds for termination of membership to the EDIS, revocation of license, and related penalties or sanctions for non-compliance.
j. Financing or Funding of the EDIS:
- That the initial funding of the EDIS shall be raised by an ex ante funding mechanism and a promise that the issue is open to legislation in the future;
- That the legislation establishes only a single deposit insurance fund as different from multiple funding and the issue is open to future legislation by the concerned organ;
- An express determination and quantity of the actual size or at least a possible margin to the size of the DIF;
- The amount of premium to be imposed or the mechanism of premium calculation i.e., either a flat-rate or risk-adjusted or a mixed type of premium calculation;
- The possible sources of back-up or supplementary funding and resources to the EDIA;
- Administration and Management of the Fund;
- That Agency shall follow specified rules in making levies on and paying rebates to member institutions;
- For the avoidance of doubt, all premiums paid to the DIS Fund shall cease to be the property of the member institution which makes the payment and shall become the property of the agency;
- The EDIA shall ensure that the DIS Fund should, so far as practicable, be derived from the banking industry; The agency shall have the power to make rules specifying the manner and timing in which premiums shall be paid by member banks.
- Fund to the EDIS for the next financial year: The EDIA shall keep and maintain proper accounts and records of all transactions of the DIS Fund. After the end of each financial year, the EDIA shall cause to be prepared a statement of accounts of the DIS Fund, which shall include an income and expenditure account and balance sheet and shall be signed by the Chairman of the its Board.
- Financial year and estimates: The EDIA may, with the prior approval of the NBE, fix a period to be the financial year of the DIS Fund. In each financial year, before a date to be fixed by the NBE, the EDIA shall submit to the NBE, for its approval, estimates of the income and expenditure of the DIS.
- Fund investment: express stipulation as to the funds subjected to investment and all the requirement and areas of investment of the fund.
k. Information Obtaining Mechanism to the EDIS:
- The EDIA may require a member banks to submit (including periodically submit) such information as it may reasonably require for the exercise of its functions, and such information shall be submitted within such period and in such manner as the DIA may specify;
- The Agency may require a member institution to submit returns showing the amount of insured deposits of a bank and the breakdown of such deposits in such manner as the agency may require;
- The agency may specify the requirements of the information systems to be maintained by a member banks so as to facilitate compensation payment to eligible depositors, and require a member banks to submit a report prepared by an auditor or auditors appointed by the bank and approved by the Agency as to whether or not, in the opinion of the auditor or auditors, the bank has in place adequate systems of control for such purpose;
- Where DIS payout has been triggered the agency shall have access to the relevant books, transactions and systems of the relevant member banks for the purpose of effecting the compensation payment to eligible depositors;
- The agency may appoint an agent or authorize a third party (which may include the MA) to access the relevant books, transactions and systems of the relevant member banks.
l. Rules on Procedures for Claims: The Agency shall, after consultation with the NBE, make rules relating to the following practical matters regarding claims made under the DIS- the procedures whereby claims are to be made; the manner in which the DIA may call for claims; the circumstances and manner in which the Agency may determine, deal with and pay a claim; and The information or documents to be supplied to the Agency for the purpose of assessing a claim.
m. Mechanisms of Taking Corrective Action
n. Trigger Criteria for Deposit Insurance Payout: The agency shall make payment to the insured depositors of a member institution where:
- An NBE order has been made to wind up the member institution; or
- A Receiver (as defined in the Banking Business Proclamation) has been appointed to manage the affairs of the member bank under article 33 of the proclamation;
- The NBE believes that the institution is likely to become unable to meet its obligations, or that it is insolvent or about to suspend payment to depositors; or
- The NBE believes that payment to depositors by the EDIA is necessary to promote the general stability and effective working of the banking system;
- The accelerated mechanisms of compensation or reimbursement to bank depositors during a bank failure, maximum amount of protection, order of importance.
o. Management of the EDIS:
- Qualification of persons (the board, chairman, managers, CEOs) entrusted to manage the DIS, qualification of employment, powers and duties, and accountabilities;
- The EDIA shall, with the prior approval of the NBE, appoint an auditor (which may be the Director of Audit), who shall have access to all the books of account and other records kept by the Agency. The auditor shall audit the statement of accounts prepared and report thereon to the EDIA.
- The power to transfer certain activities of the EDIA to third parties. And so on
p. Mechanisms Public Awareness of the Scheme
q. Priority Claim, Set-off and Assignment of Rights:
- For the purpose of calculating the amount of compensation to any claimant, the EDIA shall take into account the amount of his overall net claim against the member institution;
- Where the EDIA makes a payment in respect of any deposit with a member institution, all the depositor’s rights and remedies with respect to the deposit existing immediately before that payment shall, to the extent of the amount of the payment made, be transferred to and vest in the Agency for the benefit of the DIS Fund and the agency may take such steps as it considers necessary to enforce those rights and remedies;
- The rights and remedies of a depositor in respect of a deposit transferred to the Agency shall include the rights and remedies of the depositor in respect of so much of that deposit as the depositor would, on the winding up of the institution, be entitled to priority under article 45 (d) of the Banking Business Proclamation;
- Early reimbursement from the Receiver: The receiver of a failed member bank may, subject to the approval of the court, make payments to the EDIA out of the estate of the bank.
r. The Relationship between the EDIS and Other Elements of the Financial Safety net: i.e., regulation and supervision, LOLR, and bank insolvency or resolution law.
s. The Establishment of the Ethiopian Deposit Insurance Agency:
- The Relationship between the EDIA and the NBE or the MOFD (working, structural or accountability);
- Public objectives of the EDIA or EDIS; Roles and duties of the EDIA;
- The institutional placement of the EDIA in the Ethiopian financial sector.
t. Mechanisms of international cooperation of the EDIS or the EDIA: with equivalent schemes in other countries and other international or regional organizations working on or providing technical assistance on DIS. This endeavor may also be made via the NBE per article 19 (4) of proclamation No. 591/2008.
5. Conclusion and recommendations
While banks are important organizations to the Ethiopian economy, they are vulnerable to illiquidity and insolvency. For these reasons, until now, the FDRE Government has chosen to implement financial safety nets to deal with these contingencies which are extended from stringent regulation and supervision via series of banking laws and systems to guarantee the same, up to the general implementation of lender of the last resort and implicit deposit Protection system.
However, unlike the case of the situation in the Ethiopian banking sector, a system of explicit but limited depositor protection that guards the holders of small deposits when their bank fails has in recent years become crucial part of this safety net in a growing number of countries globally.
In Ethiopia, nevertheless the sector has been experiencing an increase both in its dimension of volume and efficiency on the one hand and the entire economy is gradually joining the influence of the global economy on the other, there has been no tangible effort by the government to implement an explicit DIS. The only exception in this regard is the promise made under the National Bank Establishment Proclamation (as amended) to issue a regulation and establish a deposit insurance fund. It is also the view of the researcher that the existence of the promise by itself can serve as a hint for policymakers that it is time to establish a DIS in the country.
The main point I have dealt in this paper is if implemented in Ethiopia, a well-designed DIS can strengthen depositors’ protection, incentives for good governance for banks via strong internal governance from owners and managers, firm discipline from the markets, and effective oversight from bank regulation and supervision.
Consequently, an important lesson to the Government to learn from country experiences in due course of establishing an explicit DIS or transition from implicit to explicit DIS is that good design and suitable timing are essential.
To be more specific, one of the rationale behind choosing the issue as a research problem under this study is the fact that it is indeed the right time for the Ethiopian banking sector to seek explicit deposit protection for experience dictates that the right time is when a country implements DIS before a time of crisis or in normal times and when all the elements in the system possess a sound banking practice- both are deemed to be the case in Ethiopia at the present time.
In conclusion, the researcher believes that the major problem with DIS, particularly in developing countries like Ethiopia, is that it tends to be given weak financial structures. Especially, this is a serious problem in countries with emerging sector, because they tend to have unstable banking systems that are likely to produce large losses. Given this situation, I certainly believe that side by side with the implementation of the EDIS, the FDRE Government should further continue to: (i) have at least a fairly stable banking system; (ii) have an effective prudential regulation and bank supervision system; and (iii) exhibit a willingness to adequately fund the DIS and give it the necessary Government back up support that may be required to get the system through a period of stress.
These would not be as such taxing to the government because since 1991-1992, the Government has been endeavoring to: get the banking system under prudent control; stabilizing the macroeconomic environment in which banks and business firms have to operate; strengthen the nation’s banking laws and bank supervisory and examination systems, and even these efforts are getting more facilitated due to the externalities (commitments) of Ethiopia’s accession to the WTO.
After the undertaking of critical and thorough analysis over the subject matter of this study, the researcher, per the outcome of the study, wants to suggest the following policy recommendations in addition to those recommendations forwarded under chapter three of this paper (refer to points mentioned under section 3.2):
a. Enforcing Prudential Regulation: The vigorous enforcement of enhanced prudential standards including the adoption of: stricter, fit and proper tests for owners, directors and managers of Banks, stricter corporate governance rules, timely and more complete disclosure requirements, as well as the adoption of consolidated and risk-based supervision and audits, and a progressive increase in solvency requirements (including minimum capital requirements) are important disciplining measures that are critical for the future stability of the Ethiopian banking system.
b. Reforming the Bank Resolution System: on top of the ongoing regulation of the banking sector, additional reforms are required for the Ethiopian banking sector to have effective disciplining tools for a quick and orderly exit of nonviable banks. For instance, the EDIA should not be allowed to assume losses directly or through the purchase of bad loans in the event of bank rescue operations or the EDIS should not provide open bank assistance to banks that might fail (i.e., banks that have a solvency problem but are not eligible to access the liquidity window of the NBE). This is important because experience has shown that bank liquidations are often more costly than the cost of using other support mechanisms.
c. Consolidating the Banking Sector: Given the probability of weakness of banks in the Ethiopian banking system, Ethiopian authorities should promote mergers, acquisitions, and orderly market exits in the banking sector. In addition to increasing difficulties to meet capital adequacy requirements, private banks should not be put at a severe disadvantage compared to state-owned banks. However, they may be able to broaden their capital base and reap synergies through mergers, and possibly even achieve new capital injections in the process. Such partnerships and mergers should ideally also involve the participation of reputable foreign banks, in the future.
d. Reforming the Contracting Environment: additional reforms are needed to reduce prevailing legal uncertainties in the safe and sound operation of Ethiopian financial intermediaries, including revising of loan requirements, strengthening the bankruptcy regime, and improving the fairness and effectiveness of courts (creation of commercially specialized courts). Similarly, it will be important to differentiate and enforce an adequate time structure of liabilities. For instance, a system of penalties for early withdrawal is important to reduce the liquidity risks faced by banks today.
e. Reforming Corporate Governance and the Corporate Sector: The issue of corporate governance in Ethiopian banks and corporations is of paramount importance. Without clarity of ownership, responsibilities, and accountabilities, basic requirements for the safe operation of banks, like effective internal control systems, could not be credible. Given the occurrence of financial-industrial groups, further progress in the Ethiopian banking system must also be accompanied by changes in the corporate sector towards better definition of inter-company structures, with well-defined holding company structures, better corporate and bank governance, and increased transparency. In this regard, the pertinent provisions of the commercial code should be revised. In the meantime, the risks to be taken by the EDIS could be largely unknown and quite likely to be higher than those that it would assume in an environment of more transparent legal and organizational arrangements.
f. Reforming and Eventually Privatizing State-Owned Banks: Finally, there is the major issue of the public banking system in Ethiopia. There is no doubt that the market share and privileged position of these banks distort financial sector development, at least in urban markets where they are competing with a significant number of private banks. Yet, at the same time, a big-bang privatization of this sector may lead to a substantial level of financial disintermediation in the short to medium term, and it is politically unfeasible under the current circumstances. A gradual approach is required however. In the short term, the focus should be on minimizing duplications and inefficiencies in the operation of these banks, limiting their growth in areas with a strong influx of private banks, transparency on the explicit and implicit subsidies provided to them, and introducing a hard-budget constraint for their fiscal impact. The limited guarantee to be provided under the Ethiopian explicit deposit insurance system will have, at best, only a marginal impact on this situation.
g. A strategy must be designed for phasing out the implicit guarantee currently provided by the Ethiopian Government. Ethiopia could be by no means unique in this situation. Otherwise, the elimination of the existing implicit guarantee could lead to more turbulence on the banking market with substantial operational implications for the EDIA.
h. Other reforms: At the more micro level, Ethiopian policy makers also need to address the design of the deposit insurance system itself. For instance, in case there necessitate a need to review the approach to be selected for setting the insurance premium. For instance, currently, the premium by law must be uniform for all banks, irrespective of their level of risk, which implies a subsidy of the stronger to the weakest banks, with a “welfare loss” from an economic perspective. From the Ethiopian perspective, a much preferable option would include, ex ante and confidential, rebates on banks’ deposit insurance fees paid to the EDIF, reflecting lower effective payments for better managed and financially stronger institutions. In this way, incentives of banks, insurers and supervisors would be aligned to avoid the negative signaling effect (which might precipitate deposit runs) of differential, ex post, deposit insurance fees for different types of banks.
Finally, Ethiopian authorities are well advised to complement the explicit DIS with an ambitious financial education and communication initiative to the public at large.
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 ‘WTO Accession: Assessing the benefit and costs for Ethiopia, Ethiopian Business law series, Vol. 2. A.A.U., (2007), PP. 7-8. However, this figure has changed a lot in 2009/10, according to a data retrieved from the, National Bank of Ethiopia Annual Report, Mar, 2009-Mar,2010, Monetary and Financial Developments Department. The number of banks operating in the country increased to 15 and in terms of branch expansion, the total number of bank branches reached 673:http://www.nbe.gov.et/Financial/Banks.htm
 Articles 5 (18), 25, The National Bank of Ethiopia Establishment (as amended) Proc. No. 591/2008, Federal Negarit Gazeta 14th year, No. 50
 Asli D. Kunt, Baybars K., and Luc Laeven, Deposit Insurance around the World: A Comprehensive Database, World Bank Policy Research Working Paper No. 3628, (June 2005), P. 22, Table 2-Pannel A
 Ibid, Table 2-Pannel B
 Article 33- 1 (d, g, and m), A Proclamation to Provide for Banking Business No. 592/2008, Fed. Negarit Gazeta 14th year, No. 57
 Id., Art. 37 (3)
 Id., Art. 41 (2)
 Id., Art. 42 (3)
 Id., Art. 43 (2)
 Id., Art. 44 (1)
 Id., Art. 45 (1-d)
 Id., Arts. 18-21, and 28; Read also article 2 of Directive No. SBB/4/95 on Legal Reserve a Directive No. SBB/21/96 on Manner of Reporting of Financial Information
 Mamo E. Mihretu, Preparation for WTO Accession: the Case of Ethiopia, (2005), [Preparing for WTO Accessions: Insights from Developing Countries, Country studies], P. 156. It is stated that Many Ethiopian service sectors- including key producer services like financial services, Transport, and telecommunications are either government monopolies or reserved for Ethiopian nationals. However, in services negotiations, Working Party members are likely to request commitments from Ethiopia to liberalize imports of many such services. In this regard, the experience of recent accessions suggests that significant concessions by Ethiopia on services imports may be necessary to conclude accession negotiations. Nepal, Cambodia, Vanuatu made substantial offers, inter alia, in the area of financial services.
 Gillian G. Garcia and Carl-Johan Lindgren, Deposit Insurance and Crisis Management, Monetary and exchange department of the IMF, (1997), P. 8 and chart 1; See also Gillian G.H. Garcia, Commonalities, Mistakes and Lessons: Deposit Insurance analysis and lessons from recent Bank Failures World-Wide, (June 1997), PP. 12-13; Gillian G. Garcia, Deposit Insurance: A Survey of Actual and Best Practices, International Monetary Fund working paper no. WP/99/54, (1999), Table 3 PP. 30-33
 Towards Effective Risk-Adjusted Bank Deposit Insurance: A Transitional Strategy, Columbia Journal of Transitional Law, (2003-2004), P. 830. Available at: http://www.au.law.edu.com
 Geoffrey P. Miller, ‘Deposit Insurance for Economies in Transition’, Year Book of International Financial and Economic Law, (1997), P. 116
 Golembe C. H., ‘The deposit insurance Legislation 1933: An Examination of Its Antecedents and Its Purposes’, Political Science Quarterly, (1975), PP. 181-200; A. B. Butts, ‘Federal Bank Deposit Insurance,’ Mississippi Law Journal, (1934-35), PP.478-481; John F. Rhodes and Robert M. Zehring, ‘Some Legal Effects of the Act Creating FDIC on Missouri Banking Institutions’, Kansas City Law Review, (1938-39), P. 50; Depository Institutions Deregulation and Monetary Control Act of 1980, pub. L. No. 96-221, section 308 (a) (1), 94 stat. 147 12 U.S.C. sect. 1813 (1982); David W. Lobdell, ‘Maximizing Federal Deposit Insurance Corporation’s Insurance of Deposits’, Loyola Consumer Law Reporter, Vol. 3, No. 2, (1991), P. 58.
 Geo. Wash. Journal of International Law & Economics, Vol. 28, (1994-95), P. 172; Read Art. 14 (1), 1994 O.J. (L 135) 5, 11, the EU Directive on Deposit Guarantee Directive No. 94/19, (May 30, 1994); ‘The European Union’s Deposit Guarantee Directive: A critical Analysis’, Boston College International and Comparative Law Review, and Vol. xx., No. 2, (1997), P. 340; Read also, Art. 4 (4) of the EU Deposit guarantee Directive no. 1994.
 ‘Korea Introduces Bank Deposit Insurance Scheme’, International Financial Law Review, (1997), P. 46; Dong Won Ko, ‘Bank Deposit Insurance System In Korea’, Korean Journal of International & Comparative Law, Vol. 25, (1997), P. 93; Read also Art. 1, 2(1) of the Korea Non-Bank Deposit Insurance Corporation Act of 1982, Law No. 3633; Id., P. 95.
 Curtis J. Milhaupt, ‘Japan’s Experience with Deposit Insurance and Filing Banks: Implications for Financial Regulatory Design’, Washington Law Review, Vol. 77, P. 339, (1999), P. 402; Ryuzo Sato, Risk Adjusted Deposit Insurance for Japanese Banks, (1990), PP. 10-11; Maximilliam J. Hall, Banking Regulation and Supervision: A comparative study of the UK, USA, and Japan, (1992), P. 162
 Thorsten Beck, ‘Deposit Insurance as Private Club: Is Germany a Model?’ Policy Research Working Paper No. 2559, World Bank Financial Sector Strategy and Development, (2001), PP.1-10;
 Francis W. Neaten, The Banking Act 1979’, International Business Lawyer, (1980), PP.199-202
 Supra note 3, P. 118
 CRBF Regulation No. 99-06 (July 9, 1999) (Fr.), amended by CRBF Regulation No. 2000-07 (Sept., 6 2000), Available at: http://www.garantiedesdepots.fr/spip/reglements_99_06.php.
 Burkhard Drees, ‘the Nordic Banking Crises: Pitfalls in Financial Liberalization’, IMF Occasional Paper No. 161, (1998)
 Supra note 3, P. 2
 Samuel H. Talley and Ignacio Mas, ‘Deposit Insurance In Developing Countries’, World Bank policy research and external affairs working paper WPS 548, Appendix- A, PP. 1-33: The Deposit Insurance Corporation Act No. 67, (1961), as amended up to August 1970
 Text of the Banking (Amendment) Act no. 17, (1985), and the Banking (Deposit Protection Fund) Regulations, (1986)
 Nigerian Deposit Insurance Corporation Decree No.22, (1988); Conclusions and Recommendations of the FDIC Assessment Mission to the NDIC, Federal Deposit Insurance Corporation, (July 1988)
 Supra note 30
 Talley, Samuel, Appraisal of Prudential Regulation Relating to Brazil: FSAL I, The World Bank, (December 1988)
 Text of Law 117 of 1985, Decree 32 of 1986, and Decree 59 of 1986; Consultant’s report on Colombia for The Cross Country Comparison of Financial Systems in Latin America, (1988)
 Lasi, Juan, El Seguro sobre log Degositos Bancarios vs. Posibilidades de su aslicAcion en Venezuela, Banco Central de Venezuela, (1961), as quoted by Samuel Talley
 Silverberg, Stanley, Philippine Deposit Insurance Corporation, World Bank, (January, 1989); McCarthy, Ian, Deposit Insurance: Theory and Practice, IMF Central Banking Service, (January, 1980)
 Larrain, Mauricio, and Fernando Montes, The Spanish Deposit Guarantee Fund, unpublished manuscript, the World Bank, (February 1986)
 Distressed Financial Institutions in Thailand: Structural Weaknesses, Support Operations and Economic Consequences, (1989), World Bank Report No. 7445-TH
 Erol, Cengiz and Eugene Sauls, The History of Deposit Insurance in Turkey, Middle East Business and Banking, PP. 20-22, (1984); Hakan Kayaaslan, The Sky is not the Limit anymore’ Ankara Bar Review, (2008), P. 59
 Gutierrez Joaquin, Prudential Regulation and Banking Supervision: The Venezuelan Institutional Framework, (August 1989); Latin America’s Financial Systems in the 1980s: a Cross-Country Comparison, LATTF, (June 1989)
 Ognjanovic Vuk, The Banking and Credit System in Yugoslavia, Belgrade, (1986); Draft of the Law on the National Bank of Yugoslavia and of the Bank Law, (October 1988)
 Supra note 3
 Supra note 4
 George Soros, The Crisis of Global Capitalism, (1998), PP.182-83; Kenneth Rogoff, ‘International Institutions for Reducing Global Financial Instability, International Finance Reade, (2003), PP. 70-159
 See the website of the IADI, available at: http://www.iadi.org.
 Supra note 16, P. 833
 Diamond D. and Phillip Dybvig, Bank Runs, Liquidity and Deposit Insurance, Journal of Political Economy, Vol. 91 (1983), PP. 401-19. Available at http://heinonline.org
 Okan V. Şafakli, ‘A Research on Designing an Effective Deposit Insurance Scheme for TRNC with Particular Emphasis on Public Awareness,’ International Research Journal of Finance and Economics ISSN 1450-2887 Issue 7 (2007). P. 2
 Jang-Bong Choi, Structuring a Deposit Insurance system from the Asian Perspective, PP. 4-9
 Deposit Insurance Establishment (Financed by the People’s Republic of China Regional Cooperation and Poverty Reduction Fund): Technical Assistance Report Project Number: 43074 Regional- Policy and Advisory Technical Assistance (R-PATA) Asian Development Bank, (2009), P. 3
 Supra note 3, at P. 2
 Supra note 53
 Ibrahim U., Deposit Insurance and Consumer Protection, Being a Paper Delivered by the Acting CEO of Nigeria Deposit Insurance Corporation, at the world’s Consumer rights day Held on 15TH March, 2010, PP. 1-2; Ogunleye G. A., ‘Deposit Insurance Scheme in Nigeria: Problems and Prospects,’ International Association of Deposit Insurers (IADI), BASEL, SWITZERLAND, (May, 2002), P. 2
 Supra note 3; read also Kane, Edward J., Changing Incentives Facing Financial-Services Regulators, Journal of Financial Services Research, Vol. 3 (1989), PP. 265-274
 Id. P. 5.
 Clifford F. Thies and Daniel A. Gerlowski, ‘Deposit Insurance: A History of Failure’, Cato Journal, Vol. 8, No.3 Cato Institute, (Winter 1989), P. 677.
 Beat Bernet and Susanna Walter, Design, Structure and Implementation of Modern Deposit Insurance Scheme, SUERF- The European Money and Finance Forum Vienna, (2009), P. 11
 Id., PP. 12-15
 Sebastian Schich, Financial Crisis, Deposit Insurance and Related Financial Safety Net Aspects, Financial Market Trends ISSN 1995-2864, OECD, (2008), P .4
 Id. P. 14
 Carmine di Noia, ‘Structuring Deposit Insurance in Europe: Some Considerations and a Regulatory Game,’ Wharton Financial Institutions Center Working Paper Serious, (May 1995). P. 4
 Core Principles for Effective Deposit Insurance Systems, International Association of Deposit Insurers, (29 February 2008); Read also Core Principles for Effective Deposit Insurance Systems, Basel Committee on Banking Supervision, International Association of Deposit Insurers Consultative Document Issued for comment, (May 2009), P.7
 Ronald MacDonald, Deposit Insurance Handbooks in Central Banking, No. 9, Issued by the Centre for Central Banking Studies, Bank of England, London EC2R 8AH, (August 1996), PP.6-10
 Bryan A. Garner, Black’s Law Dictionary, Seventh Edition, West Group, St. Paul, MINN, (1999)
 Article 896, the Commercial Code of the Ethiopia 1960, Proclamation No. 166, 1960, Federal Negarit Gazeta
 Supra note 2, Art. 2 (4)
 Bartholomew, Philip F., and V. A. Vanderhoff, Foreign Deposit Insurance Systems: A Comparison, Consumer Law Quarterly Report, Vol. 45 (Summer 1991), PP. 243-48
 Gillian Garcia, Deposit Insurance: Obtaining the Benefits and Avoiding the Pitfalls, IMF Working Paper Series WP/96/83, (1996), PP. 2-5
 Gillian Garcia, Deposit Insurance: Actual and Best Practices, IMF Working Paper Series, WP/99/54, PP. 6-7
 Benston, George J., and George G. Kaufman, Regulating Bank Safety and Soundness - In Rose Marie Kushmeider (eds.), Restructuring Banking and Financial Services in America, Washington D.C., American Enterprise Institute for Public Policy Research, (1988), PP. 63-99
 Supra note 80
 Kyei, Alexander, Deposit Protection Arrangements: A Comparative Study, IMF Working Paper No. WP/95/134, (December 1995), as quoted in Gillian Garcia (1996)
 Fr Malan and Rudolph Willemse, Banks, Village banks, and Deposit Insurance, TSAR 1996.4, [ISSN 0257-7747], PP. 618-620; and a similar idea is stated in, McGuinness and Abrams, ‘Deposit Protection: Lessons from recent experiences’, Canadian Business Law Journal 184, (1986-7), PP. 187-188.
 Guidance for Developing Effective Deposit Insurance Systems, The Financial Stability Forum , (Sep, 2001), PP. 57-61
 Supra note 81, at P. 44
 Geoffrey P. Miller, Deposit insurance for Economies in Transition, Year book of International Financial and Economic Law, (1997), PP. 109-113
 Supra note 3, PP. 3-6
 Supra note 63, PP. 19-21
 Supra note 81, PP. 30-31
 Supra note 5, Art. 14 (1 (a-b))
 Supra note 71, PP. 9-14; Similar ideas are reflected in, Ian S. McCarthy, Deposit Insurance: Theory and Practice, International Monetary Fund, Staff Papers, (1980), PP. 578-600
 Charles W. Colomiris, Deposit Insurance: Lessons from the Record Economic Perspective, Federal Reserve Bank of Chicago, (May/June 1989), PP. 10-30
 Supra note 3, at P. 5
 Aslı Demirguc-Kunt, Edward Kane, and Luc Laeven, Deposit Insurance around the World Issues of Design and Implementation, (The MIT Press Cambridge, Massachusetts, London, England, 2008), PP. 3-27: In a purchase and assumption transaction, the insurer arranges for another bank to assume all of a failing bank’s deposits and acquire some or all of the failing bank’s assets in return for a cash payment by the insurer. Such a transaction also could be used with 100 percent coverage or in an implicit system.
 Thorsten Beck and Luc Laeven, Deposit Insurance and Bank Failure Resolution: Cross-Country Evidence, World Bank Policy Research Working Paper No. 3043, May 2003, PP. 4-8
 Supra note 65, P. 19
 Id., PP. 10-11
 Mr. John Raymond LaBrosse, International Guidance on Deposit Insurance A Consultative Process, the FSF Working Group on Deposit Insurance, (June 2000), PP. 11-12
 Supra note 87
 Hakan Kayaaslan, ‘The Sky is not the Limit anymore’, Ankara Bar Review, (2008), P.57-60; Curtis J. Milhaupt, Japan’s Experience with Deposit Insurance and Failing Banks, 77 Wash. U. L.Q. 399, 408-24 (1999) (detailing Japan’s move from an implicit to an explicit DIS); Demirguc-Kunt A., and Detragiache E., Does Deposit Insurance Increase Banking System Stability? WPS No. 2247;
 Supra note 89, PP. 12-13; Read also, William Seidman (ex-chairman, Federal Deposit Insurance Corporation), The facts about the FDIC, Wall Street Journal, June 5, 1991, P. 668
 Supra note 99, PP. 15-16
 Supra note 87; See, e.g., in Richard Cothren, Asymmetric Information and Optimal Bank Reserves, 19 J. Money, Credit, and Banking, (1988)
 Joseph E. Stiglitz and Carl E. Walsh, Economics 541 (3d ed. 2002); read also Stiglitz, Joseph,, The Role of the State in Financial Markets , Institute for Public Policy Reform, Working Paper No. IPR56, (October 1992),
 Geoffrey p. Miller, ‘Deposit insurance for Economies in Transition,’ (1997), Year book of International Financial and Economic Law, PP. 106-109
 Supra note 65, PP. 9-12; Read also, Geoffrey P. Miller (at note 117, PP.118-119) - ‘The Argument from Necessity’- Another argument in favor of deposit insurance for transitional economies is based on a doctrine of necessity. This argument suggests that in the case of a severe banking crisis, governments have no choice but to bailout depositors.
 Emily Kwong, Nicole C. Yu-Fong, Carol T. Hing-Yee, and Sharon C., Analysis of the Deposit Protection Scheme in Hong Kong, (2009), P. 5
 Supra note 99, PP. 5-10
 Supra note 21, PP. 7-12
 Supra note 89, PP. 17-20
 Kane, Edward J., Changing Incentives Facing Financial-Services Regulators, Journal of Financial Services Research, Vol. 3 (1989), PP. 265-274
 Jonathan R. Macey, Banking Law and Regulation, No. 258, 3rd ed., (2001), P.843
 Supra note 3, at PP. 20-35
 Furlong, Frederick T., Changes in Bank Risk-Taking, Federal Reserve Bank of San Francisco, Economic Review, (Spring 1988), PP. 54-56
 Philip F. Bartholomew and Michael G. Bradley, Determinant of Thrift Institution Resolution Costs, Journal of Finance, 45 (July 1990), PP.731-754
 Shoven, John B., Scott B. Smart and Joel Waldfogel, Real Interest Rates and the Savings and Loan Crisis: The Moral Hazard Premium, Journal of Economic Perspectives, Vol. 6, No. 1. (1992), PP. 155-67
 Wheelock, David C., and Subal C. Kumbhakar, Which Banks Choose Deposit Insurance? Evidence of Adverse Selection and Moral Hazard in a Voluntary Insurance System, Journal of Money, Credit and Banking, Vol. 27, No. 1 (February 1995), PP. 186-201; Read also, Carnell, Richard Scott, A Partial Antidote to Perverse Incentives: The FDIC Improvement Act of 1991, Annual Review of Banking Law, 1993
 Supra note 81, PP. 17-20
 Harris Weinstein, ‘Moral hazard Deposit Insurance and Bank Regulation’, Cornel Law Review 1100, Vol.77: 1099, (1991-1992), P. 1102-1109; Marcus, A and Israel Shaked, The Valuation of FDIC Deposit Insurance Using Option Pricing Estimates, Journal of Money, Credit and Banking, (November 1984), PP. 446-60; Pennachi George, Alternative Forms of Deposit Insurance: Pricing and Incentive Issues, Journal of Banking and Finance, Vol. 11 (1987), PP. 291-312
 Supra note 88, 41-42
 Eric D. Beal, Posner and Moral Hazard, Connecticut Insurance Law Journal, Vol. 7: 1, (2000-01), P.84
 Supra note 64, P. 12
 Supra note 16, P. 840; Jonathan R. Macey, and Elizabeth H. Garret, ‘Market Discipline by Depositors: A summary of the Theoretical and Empirical Arguments in, (1989) 5, Yale Journal of Regulation, P. 215; Read also supra note 119, PP. 109-113
 Supra note 117, PP. 29-30
 Supra note 99, PP. 28-30
 Supra note 30:The systems which are classified as pay-box systems are: Brazil (Fundo Garantidor de Creditos (FGC)), Cyprus (Central Bank of Cyprus (CBC)), Czech Republic (Fond Poijsteni Vkladu / Deposit Insurance Fund Czech Republic (FPV)), Finland (Deposit Guarantee Fund (DGF)), France (Fonds de Garantie des Depots (FGD)), Hungary (National Deposit Insurance Fund of Hungary (NDIFH)), Lithuania (Deposit and Investment Insurance (DIFL)), Slovenia (Bank of Slovenia (BSI)), Spain (Fondo de Garantia de Depositos en Cajas deAhorro /Guarantee Funds for Deposits held by Credit Institutions (FOGADE)), Sweden (Deposit Guarantee Board/ Swedish Deposit Guarantee Broad (IGN)), Tanzania (Deposit Insurance Board of Tanzania (DIBT)), and the UK Financial Services Compensation Scheme (FSCS).
 Alemayehu Geda, the Structure and Performance of Ethiopia’s Financial Sector in the Pre- and Post-Reform Period with a Special Focus on Banking, Research Paper No. 2006/112, United Nations University, (2006), PP. 6-12
 Kozo Kiyota, Barbara Peitsch, Robert M Stern, the Case for Financial Sector Liberalization in Ethiopia, Research Seminar in International Economics, Discussion Paper No. 565, (University of Michigan, 2007), PP. 3-34
 National Bank of Ethiopia Annual Report 2002/3 - These banks were- Awash International Bank (1994, 26 branches, 132 million Birr), Dahen Bank S.C. (1995, 28 branches, 122 million Birr), Bank of Abyssinia (1996, 14 branches, 141 million Birr), Wegagen Bank (1997, 23 branches, 83 million Birr), United Bank S.C. (1998, 13 branches, 91 million Birr), and Nib International Bank (1999, 11 branches, 11 million Birr). In comparison however, the CEB (capital-1277 million Birr), the CDB (75 million Birr), and the CBB had a capital of 643 million Birr.
 Supra note 150, PP. 24-33
 National Bank of Ethiopia Report on the Annual Macroeconomic Indicators for 2004/05, Monetary and Financial Developments department; Read also article 9 of the Banking Business Proclamation No. 592/2008
 National Bank of Ethiopia Report on the Annual Macroeconomic Indicators for Sep, 2009- March 2009, Monetary and Financial Developments Department: the Public Banks are- the National Bank of Ethiopia (1963,1976), the Commercial Bank of Ethiopia (1963, 209 branches), Development Bank of Ethiopia (1970, 32 branches), Construction and Business Bank (1975, 32 branches), and the Private Banks were- Awash International Bank (1994, 60 branches), Dashen Bank (1995, 55 branches), Wegagen Bank (1997, 50 branches), Abyssinia Bank (1996, 47 Branches), United Bank (1998, 41 Branches), Nib international bank (1999, 45 branches), Cooperative bank of Oromia (2004, 38 branches), Lion International Bank (2006, 20 branches), Zemen Bank (2008, 1 Branch), Oromia International Bank (2008, 25 branches), Buna International Bank (2009, 1 branch), Berihan International Bank (2009); Read also supra note 1.
 National Bank of Ethiopia Annual Report, March 2009- March 2010, Monetary and Financial Developments Department
 Refer to the view mentioned on the related determinants of the Ethiopian economic structure in, Jill Mitchell, Rosalinda Digal, and Mayank Agarwal, Ethiopia Trade and Transformation Summary and Recommendations: Diagnostic Trade Integration Study, International and Ethiopian team of trade and sector specialists, (July 2004), Vol. 1. PP. 10-100
 Supra note 1, PP. 1-34
 Supra note 14 , PP. 3-4
 Supra note 3, Annex-Table 2- Panel B: Ethiopia has for long established an implicit DPS, nevertheless its financial sector has been under developed until recently and there was no meaningful change brought to the sector as a result; Read also supra note 90, PP. 8-9
 Supra note 99, PP. 20-21: The arguments against implicit DPSs are usually strong enough to give the government no practical choice but to pay out deposits, at least in the context of wide spread banking disruption. Thus, avoiding a prior commitment may not actually buy the government much flexibility.’ Moreover, if an implicit DI guarantee is established in Ethiopia it would carry with it the danger that the Ethiopian government will not commit itself to properly supervise banks in order to prevent losses in the first place. Since, the contingent liability if not carried on the books, can fall through the cracks of responsibility.
 Supra note 80, PP. 5-10
 Supra note 3, PP. 30-31
 Arts. 45-47, the FDRE Constitution, Proclamation No. 1/1995, Federal Negarit Gazeta
 Supra note 159
 Supra note 3, PP. 31-32
 Supra note 5, arts. 5-11; Supra note 2, arts., 18-25. Read also NBE’s Directives No. SBB/3/95, No. SBB /4/ 95, No. SBB /9/ 95, No. SBB/12/1996; No. SBB /19/ 96, No. SBB /21/96; No. SBB /24/99, No. SBB/29/2002
 Supra note 89, PP. 124-126: At one end of the side are unconditional government guarantee systems that are entirely managed and funded by the national government. At the center are government-sponsored deposit insurance corporations that are managed by representatives drawn from both the government and the banks. These jointly administered insurers are at least partially funded by the banks. At the other side are systems that merely involve voluntary private agreements among banks to insure each other’s’ deposits. The government plays no role in sponsoring and administering such systems and provides no financing. However, there seems to be a tendency for more recently established DISs to rely less on government financing and management than earlier schemes.
 Garcia (at note 80 above) mentioned that in this regard the DISs of Spain, Argentina, Chile, and Turkey are typical. The reason for this movement to the private system, especially regarding funding, may be that governments have become increasingly unwilling to accept the full burden of potentially unlimited losses.
 Supra note 80, P. 8; read also supra note 22; supra note 99, P. 30. In general, voluntary systems tend to be either private systems (as in France, Germany, and Switzerland) or systems where the funding has been switched from sole reliance on the government to funding by insured banks (as in Argentina).
 S upra note 98, P. 32
 Supra note 86, P. 12
 Supra note 5, Art. 39 (2 (e, f))
 Supra note 80, P.11; read also supra note 14, PP. 10-11- Annex-Table A.1.2; Read also supra note 87, P. 23
 Read arts. 896 - 898, 912 of the com. Code and art. 2 (5) of proc. No. 591/2008
 Supra note 30, PP. 42-46: Foreign Deposits of Domestic Banks: The major reason for not covering the foreign deposits of domestic banks is that these deposits are as susceptible to a run as deposits held in domestic offices and they are not basically part of the domestic banking system, the domestic money supply or domestic savings.
 Ibid: Domestic Deposits of Foreign Banks: The major reason for not insuring the domestic deposits of foreign banks is that they are not part of the domestic banking and monetary system. These are foreign banks’ in a developing country by a branch.
 Ibid: Interbank Deposits: The rationale for excluding interbank deposits from coverage is that banks are likely to be particularly well informed regarding the financial condition and operations of other banks. Consequently, these banks constitute the best potential source of market discipline, and by excluding interbank deposits from coverage, this market discipline is retained.
 Ibid: Deposits Denominated in a Foreign Currency: the main rationale to exclude these deposits in developing countries is that the insurer might not be able to acquire needed foreign exchange in order to pay off holders of foreign currency deposits.
 It is stated that, “foreign currency” means any currency other than Ethiopian legal tender which is legal tender in any country outside Ethiopia as to which the National Bank has declared to be acceptable for payment in Ethiopia. Given the substantial need for foreign currency in Ethiopia, it would be necessary to include such deposits in the coverage of the EDIS. However, two decisions have to be made. The first is, whether foreign currency deposits should be re- paid in the relevant foreign currency or in Ethiopian Birr. As noted by the FSF Working Group, a scheme that offers to repay depositors in foreign currencies must have access to sufficient foreign assets or other sources of foreign currency funding (which is not the case in Ethiopia) to make this commitment credible. On the other hand, if the payout is made in local currency, transparent rules should be set out in advance with respect to the choice of the exchange rate used to calculate the amount to be compensated. Given that the funding of the DIS and the dividend payment from the liquidator of a failed bank would be in Ethiopian Birr, it is proposed that the DIS should make all payments in Ethiopian Birr, irrespective of the currencies in which the deposits are denominated. This would place some foreign exchange risk on the depositors but they should be no worse off than they would be if they were paid out in liquidation.
 It is common for new banks to incur losses during their first several years of operation until they have attained sufficient size to operate profitably. These early losses do not constitute a major problem if a bank is well capitalized initially and the bank makes steady progress towards profitability. In this context, read arts. 18 and the following of Proc. No.592/2008
 Supra note 5, art. 14 and the following
 This requirement is also in line with the BASLE Capital Accord which came in to effect in March 1989 requiring all G-10 Banks to maintain capital equal to eight percent of “Risk Adjusted Assets” by the end of 1992. The goal of the Accord was to tailor regulatory capital adequacy requirements to the risk inherent in a bank’s portfolio; to eliminate the “off-balance Sheet” escape hatch which banks were using to avoid previous capital requirements; and to create incentives to hold more low-risk assets.
 Supra note 87, PP. 45-47.
 Supra note 2, Arts. 3-6, and Part Five; and supra note 5, art. 31
 Supra note 5, arts. 3-9 on Requirements of obtaining a license, Pre conditions of licensing, Issuance of License, commencement of banking operations, Renewal of license, Publication of licensed banks, and Prohibitions from licensing.
 Moreover, per the dictations of the FSF (2001) at supra note 87, domestically incorporated or chartered banks are the principal members of most deposit insurance systems. On the other hand, non-bank institutions are excluded for the rationale that such institutions may not be as relevant as banks to a country’s financial stability, or that they may be subject to different regulatory and supervisory standards, and they may have different authorities overseeing their affairs. In such circumstances, policymakers may establish separate protection schemes to cover non-bank financial institutions.
 In this context, Read article 32 of proc. No. 592/20008.
 However, the EDIA should consider revocation of license of a bank by the NBE as priema-face evidence to terminate insurance.
 S upra note 14, PP. 13-15; Read also supra note 3, PP. 9-11
 Supra note 87, PP. 47-48
 Refer to chapter seven of proclamation No. 592/2008.
 Supra note 99, PP. 36-39: ‘funded schemes’ appear to be more rule-based and offer less uncertainty than ex post funding. Ex post systems are often privately run by their member institutions; do not have clearly specified responsibilities regarding sharing the costs of compensating depositors; lack back-stop funding from the government; offer co-insurance; are limited in their roles and responsibilities; and because they are privately run, have difficulty in obtaining information from the supervisor and the central bank. Given that best practices recommend avoiding ambiguity and sharing information, it is perhaps not surprising that most recently created DISs have opted to build a fund.
 S upra note 30, PP. 33-34: Most deposit insurance systems have used the ‘fund approach,’ and this appears to be the best alternative. One advantage of creating a fund is that it tends to promote depositor confidence because there is something tangible for insured depositors to look forward to protection.
 Ibid: For instance, in Germany and the United States different funds are used to insure different types of institutions. In the case of Germany, separate funds exist for commercial and mortgage banks on the one hand, and savings banks and regional institutions on the other. In the United States, three different funds are employed for, respectively, commercial banks, savings institutions and credit unions.
 Supra note 99, PP. 35-40
 The lawmakers should decide that the Government should provide a back up to the DIS. A well-run DIS that is met by unexpected demands on its resources is in need of additional funds in order to carry out its responsibilities. Moreover, the fund staff should argue in favor of such government backing. However, it should be noted that providing the needed resources is not only the responsibility of the Ministry of Finance and Economic Development, but also the National Bank of Ethiopia. Since the Ministry may not be able to marshal quickly the resources needed, the EDIA may need to borrow from markets, or the National bank. The Government should guarantee any loan from the National bank or from the markets, and member banks should be required to repay the EDIS’s loan over time.
 To do its job efficiently and cost effectively, the DIA will need adequate notice of the approaching closure. Thus, the DIA must be kept informed of the status of individual institutions and the remedial actions that are taken against troubled banks. In addition, the NBE may provide lender-of- last-resort liquidity that allows an insolvent bank to remain liquid and continue operating. Such action can thwart the desires of the supervisor to revoke the license and the DIA to minimize its cost of resolution. To avoid these pitfalls, there must be close cooperation and exchanges of information, under appropriate conditions of confidentiality, among the MOFD, NBE, and EDIA.
 To be aware of the contextual Ethiopian requirements read the pertinent provisions of Directive No. SBB/21/96 on Manner of Reporting Financial Information
 Supra note 80, PP. 54; for similar knowledge on the issue read article 28 or Part seven of proc. No. 592/2008, and the pertinent provisions of Directive No. SBB/12/1996 on Limitation on Investment of Banks
 Supra note 65, PP. 59-64
 Supra note 87, PP. 31-33: In an ‘insured deposit payoff’ the failing bank is closed and the insurer reimburses all depositors for the full amount of their deposits up to the coverage limit. Uninsured depositors and other general creditors receive no payments and become claimants in the receivership; read also article 40 (1 (a, b)) of proc.no.592/2008.
 With a ‘purchase and assumption transaction,’ the insurer arranges for all of the deposits of a closed bank to be transferred to another bank, along with some or all of the failed bank’s assets.
 In arranging a ‘Financially Assisted Merger,’ the insurer and the acquiring bank would have to negotiate the terms of the deal, including the amount and form of the payment that the insurer would have to make to encourage the acquiring bank to take over an insolvent institution.
 Providing ‘financial assistance to the bank’ in order to prevent its failure is most likely to be used when all depositors must be protected to preserve public confidence, and a purchase and assumption transaction or financially assisted merger either is not feasible or is not authorized under the deposit insurance law.
 Supra note 5, Art. 41; Kaufman, George G., and Lender of Last Resort: A Contemporary Perspective, Journal of Financial Services Research, Vol. 5 (1991), PP. 95-110
 An example will illustrate this point. Suppose that Ethiopia has established a limited coverage DIS, which is expressly designed to protect small depositors, but by so doing, exposed large depositors to potential losses in order to maintain market discipline. In this event, the deposit insurance law should prevent the insurer from using failure resolution devices, such as purchase and assumption transactions, mergers and financial assistance that extend de facto protection to uninsured depositors.
 Supra note 64, PP. 32-40
 For instance, under article 42 (3) of proc. No. 592/2008, it is provided, under a title preliminary procedures for liquidation of banks, that in the case of liquidation of any bank, the receiver shall, in advance provide to every person a statement of claim shown on the bank’s records in favor of that person, together with a notice that any objection to the bank’s records in that respect may be filed with the receiver within a specified reasonable period of time. Moreover, the requirement of publication of the schedule of allowance of claims is also stipulated on article 43 (2)
 Supra note 5, art. 41 (4 (b))
 Article 1962 of the civil code rules that, “a creditor [insured depositor] may assign his rights to a third party [the EDIA] without the consent of the debtor [the insured bank], unless such assignment is forbidden by law or the contract or is barred by the very nature of the transaction”. Besides, article 1968 states that, “(1) A creditor [the insured depositor] who is paid by a third party [the EDIA] may subrogate him [the EDIA] to his rights and (2) Subrogation shall be express and effected at the time of payment [should be automatic]”. Finally, article 1973 rules the effects of subrogation or assignment as, “(1) the subrogated creditor [the EDIA] or the assignee of a right may exercise the liens, securities and other accessory rights attached to it”.
 Supra note 5, Arts. 14-17
 Supra note 5, arts.14 and the following
 Supra note 87, P. 28
 Supra note 87, P.14: this methodology is designed by the working group on deposit insurance of the Financial Stability Forum in 2001. The forum has expressly invited new DIS adopters to take advantage of this special methodology in due course of implementing DIS
 Supra note 5, arts. 5 (11), and 15 (1-d)
 Supra note 5, arts. 32 and the following on ‘Revocation of License’, ‘Receivership and Liquidation of banks’
 Refer to the EU Directive No. 94/19/EC and the appropriate list of exclusions in its Annex- I.
 Supra note 2, Art. 3 declare that it is prohibited to transact banking business in Ethiopia without obtaining a banking business license from the National Bank. And sub 2 states that, No person shall use the word ‘bank’ or its derivatives as part of the name of any financial institution unless it has obtained a license from the National Bank.
 Supra note 5, arts. 18 and the following with special attention to article 29
 Arts. 39 (2), 40 (1-a), proc. No.592/2008
 For instance, Talley, (at note 30) stated that, In India, the insurance corporation is fully owned by the Central Bank, and the corporation’s board comprises representatives from the central Bank and the national government. In Colombia, the insurer will be attached to the Central Bank during its first few years in operation. Thereafter, it will become an independent agency, but will be overseen by the Super intendance of Banks and will have representatives from the Central Bank and the national government on its board. The Nigerian Deposit Insurance Corporation is meant to be an independent agency, but is jointly owned by the Central Bank of Nigeria and the Ministry of Finance, and has representatives of both of these agencies on its board. The Philippines Deposit Insurance Corporation is an independent agency, but has representatives of the Central Bank and the national government on its board.
 Supra note 2, Art. 5 (7), dictates that, “For the fulfillment of its purposes, the National Bank shall have the powers and duties to license and supervise banks, insurers and other financial institutions”
 However, there are probably two arguments against placing the insurance function in the Central Bank. First, liquidation activities are not an appropriate central banking function (Central Banks have generally proven to be ineffective at recovery and liquidation). Second, if a Central bank served as both the insurer and the supervisor of banks, there are occasions when the Central Bank might become involved in at least the appearance of a conflict of interest.
 Moreover, readers should be aware of the fact that, the power to establish and manage the DIS fund is also vested in the NBE (art. 5 (18), 591/2008). Perhaps, in the Ethiopian case full independence of the EDIS is hard to figure out.
 Moreover, in most developing countries, bank examiners, especially experienced ones, are in short supply. Consequently, it is important to minimize any duplication by the insurer and the supervisor in the examination area. Probably the best way to achieve this result is to give the supervisor sole responsibility for conducting regular examinations.
 Reading of article 5 (11) of proc. No. 591/2008 is important in this regard. It states that, “For the fulfillment of its purposes, the National Bank shall have the powers and duties to make short term and long term refinancing facilities available to banks and other financial institutions as might be necessary”. Besides, it is mentioned on article 4 that that, “the purpose of the NBE is The purpose of the National Bank is to maintain stable rate of price and exchange, to foster a healthy financial system and to undertake such other related activities as are conducive to rapid economic development of Ethiopia. Plus, article 15 (d) states that, “the NBE may make loans or advances to banks and other financial institutions on the basis of obligations and conditions determined by its directive.”
 Supra note 5, art. 29
 Id., Art. 30
 Id., art. 32 (1-8)
 The reading of article 28 of proc. No. 592/2008 ascertains the fact that it is in the NBE’s existing authority to collect information about other banks in the country. It is stated that, “Every bank shall, within a time period to be determined by the National Bank, send to the National Bank duly signed financial statements and other reports as prescribed by it.” And “The National Bank may collect any information from banks, as it may deem appropriate Provided, however, that such information may not be disclosed to any person unless the disclosure: is required to ensure the financial soundness of banks; or is made to recipients who are legally authorized to obtain such information.” Perhaps, the EDIA may be legally authorized in this regard.
 The researcher is trying to suggest the possible contents of the EDIS legislation according to the research conducted. Hence, the lawmakers may exercise their liberty to consider them or not.
 This may be done per the requirements of an ‘audit report’ stipulated on article 27 (1-2) of proc. No. 592/2008. It reads that, “The National Bank shall determine by directive the time limit for issuance of audit reports after the end of a bank’s financial year”
 In this context, Article 28 could be helpful, it rules that “Every bank shall, within a time period to be determined by the National Bank, send to the National Bank duly signed financial statements and other reports as prescribed by it.”
 The article dictates that, “In any liquidation of the assets of a bank, secured claims, if any, shall be paid in accordance with their terms. Other claims shall have priority against the general assets of the bank in the following order: and accordingly ‘deposit-claims are to be paid at the fourth rank’”
- Quote paper
- Samuel Maireg Biresaw (Author), 2011, The Legal and Institutional Framework of Deposit Insurance Scheme in Ethiopia. Design Considerations, Legal and Institutional Framework, Munich, GRIN Verlag, https://www.grin.com/document/388224