Introduction

With a rapidly growing population of 120 million people, Ethiopia is the fifth-largest economy in Africa by GDP, making it an attractive destination for foreign investment in the banking sector. On December 17, 2024, the Ethiopian Parliament approved the new Banking Business law, which allows foreign banks and foreigners to rejoin the Ethiopian market after an absence of half a century. This proclamation provides various avenues for foreigners to enter the Ethiopia market, marking a significant step in opening one of the last remaining sectors in the country to foreign investment. This move signals a shift from a protectionist to a more liberal policy approach by the government.

Overview of Ethiopia’s Investment Climate

In 2020, Ethiopia introduced a new investment law to expand opportunities for foreign investment. Previously, only specifically identified sectors were open to foreigners. The new law restricted only a few sectors to domestic investors, while all other sectors are available for foreign investment. In 2024, the Ethiopian Investment Board issued a directive further permitting foreign investment in industries that were previously restricted to domestic investment, including export, import, wholesale, and retail trade,. 

Additionally, the Ethiopian government has liberalized sectors that were previously monopolized by the state, such as telecommunications and logistics. This initiative has expanded foreign investment opportunities across multiple industries. Investors now have the option to acquire shares, enter joint ventures, or invest through the Ethiopian Investment Holdings (EIH), which functions as the strategic investment arm of the Ethiopian government.

These reforms indicate Ethiopia's move towards economic liberalization by attracting foreign direct investment, including the recent significant shift in opening the financial sector to foreign investment.

The New Banking Business Proclamation

The recent 2024 proclamation aims to enhance the banking industry's competitiveness and efficiency by allowing foreign investment. 

The proclamation allows foreign banks to enter the Ethiopian market by establishing subsidiaries, opening branches or representative offices, or acquiring shares in domestic banks. It also permits foreign nationals to buy shares in Ethiopian banks.

A foreign bank or strategic investor can acquire up to 40% of shares in a domestic bank, while foreign individuals can hold up to 7%, and entities can hold up to 10%. The total foreign investment is capped at 49%.

Foreign banks entering Ethiopia must invest as foreign direct investment (FDI) using foreign currency, with the capital fully paid in cash up front. Additionally, Ethiopian organizations partially owned by foreign nationals must invest through FDI based on their foreign ownership percentage, also in foreign currency.

Potential Benefits and Challenges

Enabling foreign investment in Ethiopia's financial sector is projected to bring numerous benefits and challenges. One potential advantage is the increased competition and efficiency. The entry of foreign banks is expected to encourage competition, leading local banks to improve their efficiency, service delivery, and technological advancements. Additionally, the introduction of diverse financial products by foreign banks, such as derivatives, trade finance, and specialized credit facilities, can diversify the local financial market. 

Another benefit is the transfer of knowledge and skills. The involvement of foreign banks introduces professionals and practices to the Ethiopian financial sector. This exposure to international banking standards, risk management frameworks, and digital technologies can enhance the financial ecosystem. Additionally, foreign banks can support the inflow of FDI by connecting with global financial markets, integrating Ethiopia's economy into the international financial system.

However, the entry of foreign banks also poses several challenges. One significant concern is the risk of market domination. Foreign banks, with their substantial resources, advanced systems, and international networks, could potentially overshadow local banks, leading to market imbalances and reduced competition in the long term. This dominance may stifle domestic financial institutions, hindering their growth and development.

Economic risks are another challenge, as increased foreign bank participation exposes Ethiopia’s economy to external risks such as exchange rate volatility and potential capital flight. The resource disparity between foreign and local banks is also a concern. Foreign banks' access to sophisticated technologies and funding could widen the gap, restricting domestic banks' ability to compete effectively and exacerbating financial service inequalities.

Lastly, the integration of foreign banks necessitates robust regulatory frameworks and institutional capacity to monitor and mitigate associated risks. Addressing these regulatory challenges is crucial to ensure the stability and sustainability of Ethiopia's financial sector.

The enactment of the banking business represents a significant milestone in Ethiopia's investment landscape, opening the financial sector to foreign investment after half century of protectionist policy. By allowing foreign banks to enter its financial sector, Ethiopia aims to enhance competitiveness, diversify financial services, and integrate its economy into the global financial system.