Competition and Efficiency in Ethiopia's Banking Sector

Abstract

This study investigates the efficiency and competitive dynamics of the Ethiopian banking sector from 2011 to 2022. Efficiency is assessed using Data Envelopment Analysis (DEA), a non-parametric linear programming approach, while market competition is analyzed through the Panzar-Rosse (PR) model, quantified by the H-statistic, the findings reveal fluctuating yet progressively improving technical and cost efficiency scores across the sector, with a notable divergence between private and state-owned banks following 2019. Specifically, the repeal of the National Bank of Ethiopia’s (NBE) 27% credit rule had a significant positive impact on the operational efficiency of private banks, enabling more flexible resource allocation and increased profitability. The estimated H-statistic of 0.497 indicates that the banking sector operates under monopolistic competition, where banks respond to input price changes while retaining some market power. This structure reflects the sector’s high concentration, dominated by a few large players, particularly the Commercial Bank of Ethiopia (CBE). Despite efficiency improvements and regulatory changes, the PR model results suggest that these factors have not yet produced measurable impacts on total revenue, implying that recent reforms have yet to translate into increased competition or market-wide performance gains. The study underscores the potential for enhanced competition and efficiency through banking sector liberalization. However, realizing these benefits requires robust regulatory frameworks, strategic adaptations by domestic banks, and innovative approaches to address structural inefficiencies. These interventions will be critical in fostering a stable and competitive banking landscape, particularly as Ethiopia prepares for foreign bank entry and deeper financial sector reforms.