Agency and Bank Liberalization: The Case of Ethiopia

This paper addresses the issues of governance and ownership structure, and extends the agency theory of Jensen and Meckling (1976) to the Ethiopian banking sector. It analyzes the degree of the sector’s fragility, and raises the reform issues of the day. Based on grounded theories and following a qualitative methodology, the paper confirms that Ethiopia’s banking sector is dominated by a single state-owned bank (SOB), finds that the form of agency is complex, and argues that the draft banking law needs to aim at addressing the problems of ownership concentration and management on one hand, and capital structure on the other hand. The paper proposes that the Commercial Bank of Ethiopia (CBE) be privatized in a specific way; defensive mechanisms be set up for the banking sector to prevent Akerlof and Romer’s (1993) “looting” scenario; and “optimal” board size and significant influence criteria be applied in sorting out board structure and ownership concentration in all banks. Furthermore, the new regulation must aim at reforming the central bank itself. The reform must address the extent to which the National Bank of Ethiopia (NBE) can be protected from political intervention.