The impacts of the developmental state model on competition, efficiency and performance : the case of the Ethiopian banking industry

Abstract

Inspired by the East Asian growth experience of the second half of the 20th century, the government of Ethiopia implemented a developmental state model in the middle of the 2000s. The model embedded a state-directed financial system to support industrialization. This financial system defined by directed credit schemes, interest rates control, the NBE advance to the government and sale of treasury bills to a captive market, financial restrictions, and state ownership of banks. These policy instruments may have impacts on the banking sector in Ethiopia. A large number of empirical studies on banking have been conducted in the context of financial sector liberalization. The opportunity for studying banking in the presence of a state-directed financial system is few. This thesis makes novel contribution by filling this gap. Hence, the aim of this thesis is to investigate the impacts of the Ethiopian developmental state model on the competition, efficiency, and performance of banks. The thesis focuses on annual panel data for 2001-2019, separated into two periods, 2001- 2005 and 2006-2019. The reason for the two-period analysis is that the developmental state emerged as the economic model of the Ethiopian Government in 2005. Including the period before 2006 in this research gives a comparative perspective on the situation of the banking industry in the absence of highly interventionist economic policies. The thesis adopts a positivist paradigm and quantitative methods as it deals with the measurement of quantitative variables, relationships between them and testing theoretical predictions via directional hypotheses. The Panzar Rosse method is used to measure competition, Data Envelopment Analysis to estimate efficiency and financial ratios are used to measure the performance of the Ethiopian banks. Regression methods are applied to establish the direction and strength of association between the developmental state model as implemented in Ethiopia and the competition, efficiency, and performance of the country’s banks. In doing so, bank-specific, market structure and macroeconomic factors are identified and controlled for their impacts. The study discovers robust results. Directed credit schemes, interest rates control, and lack of financial freedom reduce the competition and efficiency of banks. The NBE advance to the government and sale of treasury bills to a captive market enhance the competition of banks while negatively affecting banking efficiency. In similar vein, interest rates control and lack of financial freedom lower banking performance. Unexpectedly, directed credit schemes improve banking performance. The impact of bank ownership is mixed. Although the state banks are less competitive, they are more efficient than their private counterparts. When it comes to performance, the two state banks have a highly divergent result. The CBE is highest performer, the DBE is the lowest performer, and the private banks are in the middle. When the relationship between competition, efficiency, and performance of the Ethiopian banks is examined, a result that supports the “efficiency hypothesis” emerges. The efficient banks produce more output for given input prices, have a larger market share and achieve a higher performance. This thesis contributes to academic study and professional practice as it increases our understanding of the impacts of developmental state model policies as implemented in Ethiopia on the competition, efficiency, and performance of the country’s banks. It provides inputs for reforming the part of the financial sector which is not covered by the Ethiopian government current economic reform package. Furthermore, it offers insights to the banks pertaining the factors that affect the industry.