The Effect of Monetary Policy on the Profitability of Banks in Ethiopia

Abstract

The study investigates the link between monetary policy and bank profitability in Ethiopia, using the generalized method of moments (GMM) estimator. Money supply, exchange rate, domestic credit, and reserve requirement are used as proxies for monetary policy. In contrast, bank size, capital adequacy ratio, non-performing loan ratio, cost-to-income ratio, loan-to-asset ratio, inflation, gross domestic product, and security situation are included as control variables in the model. The sample comprises 10 banks from Ethiopia over the period 2009–2022. The estimation results show that monetary policy, as measured by a variable such as domestic credit, has a positive impact and is a significant predictor of commercial bank profitability in Ethiopia. The results also show that reserve requirement has a negative impact on bank profitability. Furthermore, the study shows weak evidence to suggest that the money supply rate has a positive influence on the profitability of banks. In addition to monetary policy variables, some other factors have a significant effect on the profitability of banks in Ethiopia. The cost-to-income ratio has a negative impact on bank profitability and the security situation has a statistically insignificant impact. The regression results show that the impact of most variables varies when different profitability measures are used. To ensure a strong banking sector, the National Bank of Ethiopia should implement macroprudential tools alongside monetary policy to manage credit growth and risks. There is also a need for the National Bank of Ethiopia to monitor the micro-dynamics of individual bank behavior and continuously assess and enhance the monetary policy transmission mechanism.

JEL: E52, G21, C23, E44, G28