Ethiopia’s abolition of the minimum deposit rate is overdue. For years, the country maintained an interest rate floor that had ceased to serve any useful purpose and had become an active impediment to rational economic policy. The reform corrects a fundamental distortion. Its success now depends on whether policymakers have the discipline to follow through.
But this reform does not stand alone. It is one piece of the most ambitious economic transformation Ethiopia has attempted since the early 1990s. Since Prime Minister Abiy Ahmed’s administration took office, the country has embarked on a comprehensive restructuring of its economic model: liberalizing telecommunications, restructuring state enterprises, opening the financial sector to competition, introducing exchange rate flexibility, and engaging with the IMF. These changes are interconnected. They rise or fall together. And they demand a level of policy coherence and institutional capacity that Ethiopia has not previously demonstrated at scale.
The stakes are high. Get this right, and Ethiopia can build a more dynamic, market-oriented economy capable of sustaining growth and absorbing a young, rapidly urbanizing population. Get it wrong, and the country risks policy incoherence, financial instability, and public disillusionment with reform itself.
The Old Model Has Failed
The case against the old system is straightforward.
Between 2022 and 2024, inflation ran above 20 percent—at times approaching 30 percent—while the deposit rate floor remained frozen. Savers lost purchasing power year after year. The floor did not protect them; it deceived them. It created the illusion of stability while inflation quietly eroded their savings. Worse, it prevented interest rates from performing their most basic function: signaling the true cost of capital and the real return to saving.
This was not a stable equilibrium maintained by wise policy. It was a controlled distortion sustained by administrative fiat, and it could not last.
But the deposit rate floor was merely symptomatic of a broader model: state-directed credit allocation, fixed exchange rates, closed capital accounts, limited private sector participation in strategic sectors, and fiscal dominance over monetary policy. That model delivered growth in the 2000s and early 2010s, when global conditions were favorable, commodity prices were rising, and China was willing to finance infrastructure at scale.
It broke down when those conditions reversed.
By the time the Abiy administration arrived, the contradictions were obvious. Foreign exchange shortages had become chronic. The parallel market premium had widened to absurd levels. State enterprises were bleeding resources. Inflation was accelerating. The banking system, sheltered from competition and directed to finance government priorities, had little incentive to innovate or manage risk properly. Growth was slowing, and the political consensus supporting the old model was fracturing.
The administration’s response has been to dismantle key elements of that system and replace them with market-based mechanisms. The question is whether the new framework can be implemented coherently and sustained politically.
The Banking Sector Transformation
The banking sector transformation has been particularly comprehensive, and it deserves special attention because the deposit rate reform cannot be understood in isolation from these changes.
The National Bank of Ethiopia has undertaken a systematic overhaul of the regulatory framework that goes far beyond simply removing the deposit rate floor.
Minimum capital requirements have been raised substantially. Banks must now hold significantly more capital than before—a shift designed to strengthen resilience but one that forces smaller banks to raise equity, merge, or exit. This is not a technical adjustment. It is a deliberate strategy to consolidate the sector and eliminate weak institutions. The higher thresholds will reshape the competitive landscape, favoring larger banks with access to capital markets and wealthy shareholders while squeezing smaller institutions that have neither.
Basel III capital and liquidity standards are being phased in, bringing Ethiopia’s banking regulation closer to international norms. This requires banks to hold higher-quality capital, maintain liquidity buffers, and manage risk more systematically. The standards are sensible, but implementation is demanding. Banks accustomed to light supervision and informal risk management now face stringent reporting requirements and regulatory scrutiny.
Some will struggle to comply.
The transition from relationship-based banking to rule-based supervision is cultural as much as technical, and it will not happen smoothly. These standards also impose real costs: banks must hold expensive capital, maintain liquidity buffers that reduce profitability, and invest in systems and staff to comply—resources many banks do not have.
Lending rate caps have been removed in stages. The administration has gradually freed banks to price credit based on risk rather than administrative decree. This complements the deposit rate reform and creates a coherent interest rate framework. But it also means that riskier borrowers—especially small and medium enterprises without collateral or credit history—will face higher borrowing costs or reduced access to credit. The removal of lending rate caps is economically rational, but it has distributional consequences that cannot be ignored.
New banking licenses have been issued to private banks, expanding the sector and increasing competition. This dilutes the dominance of the state-owned Commercial Bank of Ethiopia and creates space for more innovative, customer-focused institutions. But it also fragments the market and raises questions about supervision capacity. Can the NBE effectively oversee a larger, more diverse banking sector?
The historical record suggests caution. Banking systems often become less stable, not more, during periods of rapid license expansion.
Foreign banks are now permitted to enter the market, initially through minority stakes in domestic banks and eventually through full operations. This is perhaps the most consequential change. For decades, Ethiopia’s banking sector was closed to foreign competition. That insulation protected domestic banks but also left them technologically backward, operationally inefficient, and inexperienced in managing risk.
Foreign entry will bring capital, expertise, and competitive pressure. Domestic banks will either modernize or lose ground.
But the entry of foreign banks also raises questions about financial sovereignty, profit repatriation, and whether domestic banks can compete on equal terms with better-capitalized international institutions.
The NBE has also adjusted reserve requirements dynamically to manage liquidity and established credit information sharing systems to improve lending decisions. Non-performing loan management has been tightened, forcing banks to classify, provision for, and write off bad loans more rigorously—exposing weaknesses that were previously hidden and compelling banks to improve credit assessment.
Taken together, these changes represent a fundamental reordering of how Ethiopia’s banking sector operates. The old model—protected from competition, lightly supervised, directed to serve government priorities—is being replaced by a system that emphasizes market discipline, risk-based regulation, and private sector competition.
This is a necessary transformation. But it is also a risky one, because it demands institutional capacity that may not yet exist and imposes adjustment costs that will be felt unevenly across the sector.
The Coherence Problem
The challenge is that these reforms interact in complex and sometimes contradictory ways.
Currency depreciation raises inflation, which makes disinflation harder. Financial sector opening increases competition, which squeezes margins and could weaken banks just as Basel III requires them to hold more capital. Higher capital requirements force banks to raise equity or shrink, which could reduce credit supply just as the economy needs financing. Lending rate liberalization allows banks to price risk, but it also raises borrowing costs for marginal borrowers. State enterprise restructuring reduces fiscal support, which could trigger layoffs and political backlash. Telecommunications liberalization generates revenue, but only once—and does not address the structural fiscal imbalances that drive inflation.
The banking sector faces a particularly acute version of this coherence problem.
Consider the position of a mid-sized private bank. It must raise capital to meet new Basel III requirements, but equity is expensive and investors are cautious about Ethiopian banks. It faces new competition from foreign banks with deeper pockets and better technology, but it cannot cut costs quickly because it needs staff and branches to serve customers. It must compete for deposits now that rates are liberalized, but raising deposit rates squeezes net interest margins. It must improve credit assessment and provision for non-performing loans, but this reduces reported profitability and makes raising capital harder. It must invest in digital banking and risk management systems, but these require upfront spending that further pressures margins. And it operates in an environment of high inflation, weak credit demand, and tight liquidity, which makes all of these challenges harder.
This bank is being asked to do everything at once: strengthen capital, improve risk management, compete more aggressively, invest in technology, and maintain profitability.
Some banks will manage this transition. Others will not.
There is also a risk of regulatory overload—banks cannot absorb unlimited change simultaneously. The NBE must be strategic about timing and realistic about its supervisory capacity. It cannot effectively oversee thirty banks with the same rigor it applied to fifteen. It may need to consolidate the sector more aggressively, forcing mergers among weak institutions rather than allowing them to limp along. This is politically difficult but necessary.
For the reform package to succeed, these tensions must be managed through disciplined macroeconomic policy.
Sustained disinflation is essential, achieved through tight monetary policy, controlled liquidity, and credible use of the policy interest rate. The NBE cannot afford to ease prematurely or accommodate fiscal needs. History is clear on this point: disinflation fails when central banks are expected to finance government deficits, directly or indirectly. The NBE cannot allow that dynamic to take hold. If fiscal pressures force accommodation, credibility will collapse and inflation will resurge.
Monetary policy must remain independent without compromise.
Fiscal consolidation must accompany monetary tightening, reducing the deficit and limiting government borrowing from the banking system. Monetary policy cannot stabilize prices if fiscal policy remains loose. The two must move in the same direction.
Effective financial supervision is equally critical. The NBE must ensure that banks remain sound as they adjust to new competitive pressures and regulatory standards. This requires skilled examiners, clear enforcement, and willingness to take tough action against weak institutions. Supervision cannot be light-touch or relationship-based. It must be intrusive, data-driven, and willing to impose costs on banks that fail to comply. Weak banks must be identified and resolved early, before they become systemic problems.
Capital account liberalization must proceed gradually, managed carefully to avoid destabilizing outflows while allowing greater integration with global markets. Ethiopia cannot open its capital account fully while inflation remains high and the exchange rate is adjusting. But it also cannot maintain tight controls indefinitely without discouraging investment and perpetuating distortions.
Institutional development is the foundation on which all of this rests. Markets do not function without the rule of law, contract enforcement, and regulatory capacity. Ethiopia must strengthen these institutions even as it implements reforms. This is difficult because institutional development takes time, and reforms create immediate pressures.
But there is no alternative. Without strong institutions, market-based reforms will produce instability rather than efficiency.
None of this is automatic. Each element requires political will, technical expertise, and sustained commitment. And each faces resistance from vested interests that benefited from the old system.
Who Bears the Cost? The Distributional Impact of Reform
Abstract policy discussions obscure a hard reality: these reforms will create clear winners and losers, and the transition will be painful for many Ethiopians.
The distributional consequences deserve direct examination because they will determine whether the reforms are politically sustainable.
Consider savers first.
In the short run, the removal of the deposit rate floor does not necessarily mean savers lose. Some banks—particularly smaller, liquidity-constrained institutions—may compete aggressively for deposits and offer higher rates than the old floor required. This creates an opportunity for savers who are willing and able to move their funds.
But most savers will not benefit.
They lack the financial literacy to compare rates, the mobility to switch banks easily, or the deposit sizes that make banks compete for their business. For these savers—which means most households—the practical effect is that their returns remain low while inflation, even if declining, continues to erode purchasing power.
A pensioner living on fixed income, a civil servant with modest savings, or a rural household keeping funds at a local branch will see no immediate improvement and may see their real wealth decline further before it stabilizes.
The long-run picture is better, but conditional. If disinflation succeeds and nominal deposit rates adjust upward as competition intensifies, savers could eventually earn positive real returns for the first time in years. But this outcome depends entirely on macroeconomic discipline. If inflation remains elevated, or if banks collude tacitly to keep deposit rates low, savers will continue to lose.
The reform removes a bad policy, but it does not guarantee good outcomes.
Borrowers face a clearer but harsher adjustment.
In the short run, credit becomes more expensive and less accessible for many. Small and medium enterprises without collateral, established credit histories, or relationships with well-capitalized banks will find borrowing costs rising sharply. This is by design—lending rate liberalization allows banks to price risk properly, which means charging more for risky loans. But the result is that marginal borrowers who previously accessed credit at subsidized rates will now be shut out or face prohibitive costs.
A small manufacturing firm seeking working capital, a trader needing inventory financing, or a startup without assets to pledge will struggle. Some will contract operations. Others will fail.
This is the price of moving from administratively allocated credit to market-based lending.
Large firms, by contrast, benefit relatively quickly. Established businesses with strong balance sheets, exporters earning foreign exchange, and firms with relationships with multiple banks will find that credit becomes cheaper as banks compete for high-quality borrowers. These firms were never the ones who needed subsidized lending. They were already creditworthy. The reform simply makes credit allocation more efficient, directing resources to productive uses rather than politically favored ones.
But this efficiency comes at the cost of excluding smaller, riskier borrowers.
Over time, if credit information systems improve, collateral registries function properly, and banks develop better risk assessment tools, lending should expand to a broader set of borrowers at more reasonable rates. But this is a long-term process, and in the interim, many small businesses will be credit-constrained.
Households experience the reforms unevenly depending on their position in the economy.
Urban wage earners and middle-class households face short-run pressure from inflation and squeezed real incomes, but may eventually benefit from improved financial services and lower inflation. However, the transition period is painful: real incomes decline, borrowing becomes more expensive, and financial planning becomes harder in a volatile environment.
Rural households face different pressures. Most hold little in bank deposits and are less exposed to interest rate changes. But they feel exchange rate depreciation directly through higher prices for imported goods—fuel, fertilizer, consumer products. They also face tighter credit conditions if they rely on microfinance or rural bank branches that are squeezed by higher funding costs.
For subsistence farmers or smallholders, the reforms are largely negative in the short run: higher input costs, reduced access to credit, and limited benefit from improved financial services that are concentrated in urban areas.
Pensioners and those on fixed incomes face the harshest adjustment. They have no ability to increase earnings to keep pace with inflation. If their pensions are not indexed or adjusted, they simply become poorer. The removal of the deposit rate floor does nothing to help them—they likely hold their savings in low-yielding accounts that barely budge even as inflation eats away value.
These households are being asked to bear the cost of stabilization without receiving the benefits of reform.
Firms, like households, experience divergent outcomes.
Exporters are clear winners. Exchange rate depreciation makes their products more competitive, they earn foreign exchange that appreciates in birr terms, and they benefit from improved trade finance as banks become more sophisticated. A flower grower, a coffee exporter, or a leather goods manufacturer should see margins improve significantly, especially if they can manage input costs. These firms drive employment and growth, and the reforms are designed partly to advantage them.
Import-competing firms and those dependent on imported inputs face the opposite pressure. Currency depreciation raises costs, banks charge more for working capital, and demand weakens as consumers face squeezed incomes. A textile manufacturer relying on imported fabric, a pharmaceutical distributor, or a construction firm using imported materials will see margins collapse unless they can pass costs forward. Many cannot, particularly in competitive markets.
Some will shut down.
This is part of the intended reallocation—away from import-dependent activities and toward tradable sectors—but it creates unemployment and dislocation in the short run.
Firms in non-tradable sectors—retail, hospitality, local services—face the weakest position. They do not benefit from exchange rate adjustment, they face higher borrowing costs, and their customers have less purchasing power. A restaurant, a small retailer, or a local transportation company will struggle through the transition unless demand holds up. These businesses employ significant numbers, particularly in urban areas, and their distress translates into job losses and income declines for workers.
The labor market effects are substantial.
Firms under pressure cut employment first. The tightening of credit and the increase in input costs will lead to layoffs, reduced hours, and slower hiring. Youth unemployment, already high, could worsen. Formal sector jobs may be protected somewhat by labor regulations, but informal sector workers—who make up the majority—have no such protection.
A day laborer, a street vendor, or a domestic worker will find fewer opportunities and lower earnings as the economy adjusts. The promised gains from reform—a more dynamic, competitive economy—are years away. The job losses are immediate.
Women, disproportionately represented in microenterprises and informal work, will bear significant costs, and female-headed households face particular vulnerability. Geographically, Addis Ababa and major urban centers will see improvements faster, while rural areas lag—the Commercial Bank of Ethiopia, which dominates rural banking, faces little competitive pressure to improve service or raise deposit rates.
All of this creates a political problem.
The reforms ask ordinary Ethiopians—savers, small borrowers, wage earners, informal sector workers—to bear significant costs now in exchange for benefits that are uncertain and distant. The winners from reform—large firms, exporters, wealthier urban households with financial assets—are a minority. The losers are more numerous and more politically visible.
If inflation does not come down quickly, if credit remains tight for too long, or if employment losses mount, public support for reform will erode. The administration must deliver tangible improvements within a politically relevant timeframe, or the reform agenda will stall.
This is why macroeconomic discipline is not merely a technical requirement—it is a political necessity.
Bringing inflation down quickly makes the pain tolerable. Allowing inflation to persist, or worse, to accelerate again, would turn the reforms into a political disaster. Savers would continue losing wealth, real wages would decline further, and the promise of eventual stability would lose credibility.
The deposit rate reform, and the broader transformation it represents, can only succeed if the costs are temporary and the benefits arrive soon enough to maintain public patience.
Managing the Transition
The administration’s ability to manage the political and economic pressures of transition will determine whether these reforms succeed.
Clear communication means explaining honestly what the reforms entail, who will bear costs, and when benefits should materialize. The temptation is always to oversell reform—to promise quick wins and minimize pain. But this strategy backfires when reality proves harsher than promised. Better to be candid about the adjustment ahead and build credibility through honest messaging than to lose trust when outcomes disappoint.
Consistent policy execution means holding firm when pressure mounts. These pressures must be resisted. Reforms that reverse at the first sign of difficulty are not reforms at all—they are policy experiments that teach markets to expect capitulation.
The mobilization of reform constituencies is equally essential. Exporters who benefit from exchange rate adjustment, technology firms that gain from telecommunications liberalization, young entrepreneurs who can access finance from competitive banks, consumers who benefit from lower prices and better services—these groups must be organized politically to counterbalance those who lose from reform. Without such mobilization, the losers will dominate the political conversation and reforms will stall.
The question is whether the administration can build and sustain a coalition strong enough to overcome resistance from entrenched interests.
International support provides resources and technical assistance, but it cannot substitute for domestic political will. The IMF can provide financing and policy advice. Development partners can offer budget support and capacity building. But they cannot force Ethiopian policymakers to maintain discipline when inflation rises, credit tightens, or political pressures mount. External actors can create incentives for reform, but they cannot implement reforms or sustain them politically.
That responsibility rests with Ethiopian policymakers, and it cannot be delegated.
The Path Forward
Over time—if capital markets deepen, saving instruments diversify, and financial literacy improves—competition will strengthen. Depositors will have real choices. Interest rates will reflect economic fundamentals rather than administrative decree. Foreign banks will bring capital and expertise. Weak domestic banks will either strengthen or exit. The exchange rate will allocate foreign exchange where it is most productive. And inflation will stabilize at levels consistent with sustained growth.
But these benefits are not automatic. They depend on continued reform and institutional development. And they depend on the administration’s willingness to prioritize coherence over expediency.
The removal of the deposit rate floor is a necessary correction, not a triumph. It eliminates a distortion that had become unsustainable. What matters now is whether Ethiopia’s policymakers can sustain the discipline required to make the reform work—and whether they can integrate it into a broader transformation that reshapes the country’s economic model.
That means keeping inflation down, maintaining central bank independence, building robust financial supervision, consolidating the fiscal position, and developing the institutions that support market-based finance. It means enforcing the new banking regulations even when compliance is difficult. It means accepting that some banks will fail and managing those failures professionally. It means resisting the temptation to reverse course when reforms become politically uncomfortable. And it means recognizing that the success of any single reform depends on the success of the broader package.
Handled seriously, this reform can anchor a more resilient financial system and contribute to a more dynamic economy. Handled carelessly—or implemented in isolation from the broader reform agenda—it will be remembered as a missed opportunity.
The choice is clear. The responsibility is shared. And the time to deliver is now.
Tesfaye T. Lemma (PhD) is a tenured Full Professor of Accounting at Towson University and Associate Editor of Business Strategy and the Environment. His research focuses on sustainability, climate-related governance, and sustainable finance in emerging economies. He taught accounting at Addis Ababa University (1999-2008), serving as Associate Dean/Acting Dean of the Faculty of Business and Economics. He subsequently taught at major South African universities, spearheaded SAICA accreditation for a historically disadvantaged university, and served on SAICA’s Accreditation Teams. He is a past president of the American Accounting Association Mid-Atlantic Region.
