`

Capital Market Development and Financial Institution

Performance in Ethiopia

ADDIS ABABA UNIVERSITY

FACULTY OF BUSINESS AND ECONOMICS
DEPARTMENT OF BUSINESS ADMINISTRATION
POST GRADUATE PROGRAM

A Research submitted in Partial Fulfilment of the Requirements for the Award of

Master of Arts Degree in Business Administration

By: Mekdes Bulti

Advisor: Yitbarek Takele (Assoc. Prof.)

January, 2020
Addis Ababa, Ethiopia
 ADDIS ABABA UNIVERSITY
FACULTY OF BUSINESS AND ECONOMICS
DEPARTMENT OF BUSINESS ADMINISTRATION
POST GRADUATE PROGRAM

Capital Market Development and Financial Institution Performance

A Research submitted in Partial Fulfilment of the Requirements for the Award of

Master of Arts Degree in Business Administration

By: Mekdes Bulti

Advisor: Yitbarek Takele (Assoc. Prof.)

Approved by Board of Examiners

Yitbarek Takele (Assoc. Prof.) ____________ ______________

Advisor Signature Date

_____________________ _____________ ______________

Internal Examiner Signature Date

_____________________ _____________ ______________

External Examiner Signature Date

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DECLARATION
I Mekdes Bulti, declare that this Research Project entitled „Capital Market Development and
financial institution Performance‟ is my own original work. It contains no material which has
been accepted for the award of any other degree of the University or any other institution of
higher learning. All sources of materials used for the research paper have been duly
acknowledged.

…………………………………
Mekdes Bulti

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 ENDORSEMENT
This Research Project entitled „Capital Market Development and financial institution
performance‟ has been submitted to Addis Ababa University Faculty of Business and
Economics, Department of Business Administration, with my guidance and approval as a
University Advisor.

…………………………………
YitbarekTakele
(Assoc. Professor)

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 AKNOWLEDGEMENT

I would like to acknowledge my indebtedness and render my warmest thanks to my supervisor,

Yitbarek Takele (Assoc. Professor) for his time, patience, unlimited support and guidance
throughout this research.

I would also like to especially thank my family for putting up with my absence and the many
hours of work required to conduct this research. Thank you Amore, Hiyab, Naomi, Nona and
Eyu.

I would like to dedicate this thesis to my father and mother, mentors and life coaches Ato Bulti
Terfassa and Wro. Fetlework Shibeshi. I am forever in your debt for all my life
accomplishments.

My appreciation also goes to financial institutions executive management staff and experts who
gave their valuable time filling the questionnaires, answering the interviews and also giving me
their valuable suggestions and recommendations. I trust that the finding will be of benefit to you
and the financial institutions in Ethiopia. It will also provide insights for further financial system
development investigation into the intricacies of financial system components, to continually
improve development and guarantee stable and resilient financial system in Ethiopian.

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 ABSTARCT
Capital market in Ethiopia was established at the beginning of the Imperial era, although it was
disrupted by the military regime and has never since resumed. After a trifling effort to establish
the capital market since the early 1990s, the current government has shown a strong interest in
developing the capital market and looking forward to promoting economic growth. The study
endeavours to investigate how the introduction of capital market could potentially interact with
existing financial institutions that might unfold as competitive, complementary or co-
evolutionary. The paper utilized market capitalization and trade volume as proxy measures for
capital market performance. It also used liquidity, efficiency, profitability, capital adequacy and
asset quality to measure banks performance; and profitability, operation growth, solvency, asset
quality and management soundness to evaluate insurance companies’ performance. The study
employed a combination of multi-criteria decision making approaches to establish level of
importance of each indicator and capture influence relationship. AHP ranked liquidity, capital
adequacy, asset quality, profitability and efficiency based on their level of importance in
measuring banks’ performance. Projected the forthcoming capital market interplay with bank
performance using DEMATEL revealed, market capitalization, efficiency and asset quality
would affect-influence liquidity, trade volume and profitability of banks. Regarding insurance
companies’, profitability, operating growth, solvency, asset quality and management soundness
were ranked, respectively. Moreover, the affect-influence relationship between capital market
and insurance companies’ performance indicated, operating growth, solvency and management
soundness bi-directional relationship with profitability, asset quality, market capitalization and
trade volume. Therefore, this research concluded that banks would have a competitive
relationship during the advent of capital market; whereas insurance companies would have
complementary interplay.
Keywords: Capital market, Bank, Insurance, AHP, DMATEL.

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 TABLE OF CONTENTS
ENDORSEMENT ........................................................................................................................... II
AKNOWLEDGEMENT ............................................................................................................... III
ABSTARCT .................................................................................................................................. IV
List of Figures .............................................................................................................................VIII
CHAPTER ONE ............................................................................................................................. 1
1.1 Background of the study ....................................................................................................... 1
1.2 Statement of the problem ...................................................................................................... 3
1.3 Research questions ................................................................................................................ 4
1.4 Objectives of the study .......................................................................................................... 4
1.4.1 General objective ............................................................................................................ 4
1.4.2 Specific objectives .......................................................................................................... 5
1.5 Definition of key terms ......................................................................................................... 5
1.6 Delimitation of the study ....................................................................................................... 6
1.7 Limitation of the study .......................................................................................................... 7
1.8 Contribution of the study....................................................................................................... 7
1.9 Organization of the paper ...................................................................................................... 7
CHAPTER TWO ............................................................................................................................ 8
LITERATURE REVIEW ............................................................................................................... 8
2.1 Introduction ...................................................................................................................... 8
2.2 Theoretical review ................................................................................................................. 8
2.3 Capital market development and bank performance ........................................................... 10
2.3.1 Empirical review........................................................................................................... 12
2.4 Capital market development and insurance performance ................................................... 13
2.5 Empirical review on banks and insurance company performance indicators evaluation. .. 15
2.5.1 Bank performance evaluation ....................................................................................... 15
2.5.2 Insurance company performance evaluation ................................................................ 17
2.6 Conceptual framework ........................................................................................................ 23
CHAPTER THREE ...................................................................................................................... 24
METHODOLOGY OF THE STUDY .......................................................................................... 24
3.1 Introduction ......................................................................................................................... 24
3.2 Research Approach ............................................................................................................. 24
3.3 Research Design .................................................................................................................. 24

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 3.3.1 Definition of Study Variables bank performance indicators ........................................ 25
3.3.2 Definition of Study Variables stock market performance measures ............................ 27
3.3.3 Definition of Study Variables insurance performance measures ................................. 28
3.4. Target Population ............................................................................................................... 30
3.5 Data type and source ........................................................................................................... 31
3.6 Data Collection Method and Design ................................................................................... 32
3.7 Data Analysis ...................................................................................................................... 32
3.8 Instrument Validity &Reliability ........................................................................................ 36
3.8.1Instrument Validity ........................................................................................................ 36
3.8.2 Instrument Reliability ................................................................................................... 37
3.9 Ethical issues ....................................................................................................................... 37
CHAPTER FOUR ......................................................................................................................... 38
RESULTS AND DISCUSSION ................................................................................................... 38
4.1. Introduction ........................................................................................................................ 38
4.2 Performance indicators trend analysis................................................................................. 38
4.2.1 Bank performance indicators ........................................................................................ 38
4.2.2 Insurance performance indicators................................................................................. 41
4.3 Performance indicators ranking with empirical approaches to making decisions using AHP
Application ................................................................................................................................ 44
4.3.1 Hierarchy Structure of bank and insurance company performance indicators. ............ 44
4.3.2 Judgment Matrix for Pair-wise comparisons ................................................................ 47
4.3.3 Eigenvector and Eigen value ........................................................................................ 48
4.3.4 Calculating consistency ................................................................................................ 49
4.3.5 Consistency Verification .............................................................................................. 49
4.3.6 Calculating the relative importance of elements in single criterion ............................. 50
4.3.7 Vectors integrated for priority ranking ......................................................................... 53
4.4 Establishing interdependency matrix using DEMATEL .................................................... 53
4.4.1 Creating direct relation matrix ...................................................................................... 53
4.4.2 Normalizing the direct relation matrix ......................................................................... 54
4.4.3 Creating total relation matrix........................................................................................ 55
4.4.4 Calculating the influence degree, the affected degree, the centre degree and the cause
degree..................................................................................................................................... 56
4.4.5 Creating visual diagram ................................................................................................ 57
4.5 Discussions .......................................................................................................................... 61
4.5.1 Introduction .................................................................................................................. 61

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 4.5.2 Capital market and bank performance indicators ......................................................... 61
4.5.3 Bank performance indicators result interpretation ....................................................... 62
4.5.4 Capital market and insurance companies‟ performance indicators .............................. 66
4.5.5 Insurance performance indicators result interpretation ................................................ 67
CHAPTER FIVE .......................................................................................................................... 70
SUMMARY, CONCLUSION and POLICY IMPLICATIONS ................................................... 70
5.1 Summary ............................................................................................................................. 70
5.2 Conclusion........................................................................................................................... 71
5.3 Policy implications .............................................................................................................. 71
REFERENCES ............................................................................................................................. 73
Appendixes
Appendix I
Appendix II
Appendix III
Appendix IV

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 List of Figures

Figure 2.1: Conceptual framework 23

Figure 4.1: Liquidity trend of banking industry 38

Figure 4.2: Capital adequacy trend of banking industry 39
Figure 4.3: Asset quality trend of banking industry 40
Figure 4.4: Profitability trend of banking industry 40
Figure 4.5: Efficiency trend of banking industry 41
Figure 4.6: Profitability trend of insurance industry 42
Figure 4.7: Solvency trend of insurance industry 42
Figure 4.8: Asset quality trend of insurance industry 43
Figure 4.9: Operating growth trend of insurance industry 43
Figure 4.10: Bank performance indicator hierarchy structure 45
Figure 4.11: Insurance companies performance indicator hierarchy structure 46

Figure 4.12: Centre degree of bank performance indicators 57

Figure 4.13: Casual diagram of bank and market performance indicators 58

Figure 4.14: Centre degree of insurance performance indicators 58

Figure 4.15: Casual diagram of insurance and market performance indicators 59

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 List of Tables
Table 2.1: Summary of empirical literature 20
Table 3.1: List of performance criteria and sub criteria of banks 27
Table 3.2: List of performance criteria and sub criteria of stock market 28
Table 3.3: List of performance criteria and sub criteria of insurance companies 30
Table 3.4: Profile of Ethiopian banks 30
Table 3.5: Profile of Ethiopian insurance companies 31
Table 3.6: The Saaty (1980) Rating Scale 33
Table 4.1: Pairwise comparison matrix of bank performance indicators 47
Table 4.2: Pairwise comparison matrix of insurance companies performance indicator 47
Table 4.3: Respective eigenvector of banks performance indicators 48
Table 4.4: Respective eigenvector of insurance companies performance indicators 48
Table 4.5: Consistency index of bank performance indicator 49
Table 4.6: Consistency index of insurance performance indicator 49
Table 4.7: Corresponding average random consistency index R.I. (Saaty 1982) 50
Table 4.8: Three alternative judgment matrix based on liquidity 51
Table 4.9: Three alternative judgment matrix based on efficiency 51
Table 4.10: Three alternative judgment matrix based on profitability 51
Table 4.11: Three alternative judgment matrix based on capital adequacy 51
Table 4.12: Three alternative judgment matrix based on asset quality 52
Table 4.13: Three alternative judgment matrix based on profitability 52
Table 4.14: Three alternative judgment matrix based on operating growth 52
Table 4.15: Three alternative judgment matrix based on asset quality 52
Table 4.16: Listed labels of bank and capital market performance indicators 53
Table 4.17: Direct relation matrix for capital market and bank performance indicators 53
Table 4.18: Listed labels of insurance companies and capital market performance 54
indicators
Table 4.19: Direct relation matrix for capital market and insurance performance indicators 54
Table 4.20: Normalizing direct relation matrix N of capital market and banks 54
Table 4.21: Normalizing direct relation matrix N of capital market and insurance 55
companies
Table 4.22: Total relation matrix t for capital market and banks 55
Table 4.23: Total relation matrix t for capital market and insurance companies 55
Table 4.24: Influence degree, affected degree, centre degree and cause degree of bank and 56
market performance indicators
Table 4.25: Influence degree, affected degree, centre degree and cause degree of 56
insurance and market performance indicators
Table 4.26: Ranked performance indicators of bank 61

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Table 4.27: Influence degree, affected degree, centre degree and cause degree of bank and 62
market performance indicators
Table 4.28: Ranked performance indicators of insurance companies 66
Table 4.29: Influence, affected, centre and cause degree of market and insurance 66
performance indicators

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 List of Acronyms and Abbreviation
ADL Allowance for Doubtful Loans
AHP Analytical Hierarchy Process
DBE Development Bank of Ethiopia
DD Demanded Deposit
DEMATEL Decision-Making Trial and Evaluation Laboratory
EBT Earning Before Tax
FDI Foreign Direct Investment
GDP Gross Domestic Product
LA Liquid Asset
LLR Loan Loss Reserves
NBE National Bank of Ethiopia
No.Emp. Number of Employees
NPL Non-performing Loan
NYSE New York Stock Exchange
OL Outstanding Loans
OTC Over the Counter
ROA Return on Asset
ROE Return on Equity
RWA Risk weighted Asset
SE Security Exchange
TA Total Asset
Tad Total advance
TC Total Capital
TD Total Deposit
TE Total Equity
TR Total Revenue
WB World Bank

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CHAPTER ONE
INTRODUCTION
1.1 Background of the study
The financial system is complex in structure and function throughout the world. This system is
composed of financial institutions (banks, insurance companies, mutual funds) and financial
markets (stock and bond markets) which are regulated by the government (Mishkin, 2007).
The financial system plays a pivotal role in the economy by making it possible for households,
companies and governments to access capital (Rogers, 2018). The financial system channels
money from savers to productive investment opportunities in three ways: borrowing from a bank,
selling shares on a stock market and issuing bonds on a bond market. It is essential for every
economy to have these options called "three-legged" approach to guarantee risk sharing and
enhances any financial system's ability to cope with shocks. Most developing countries lack this
integration in their financial system which compromises stability (Friedman, 2000). Ethiopia is
one of the developing countries where its financial system only bases on financial institution
though minimal effort had been taken to establish financial market (Capital market) early on.
Capital market is a market for debt or equity securities and other financial instruments, where
government or private owned businesses can raise long-term funds. Capital market is categorized
into primary and secondary market. Primary market is a market where new bond or stock issues
are sold by the process of underwriting. Secondary market is where existing securities are bought
and sold among investors on a stock exchange (SE) or over-the-counter (OTC) (Ruecker, 2011).
The first genuine stock markets didn‟t arrive until the 1500s. However, there were plenty of early
examples of markets which were similar to stock markets. The world‟s first stock markets are
generally linked back to Belgium. Bruges, Flanders, Ghent, and Rotterdam in the Netherlands all
hosted their own “stock” market systems in the 1400s and 1500s. However, it‟s generally
accepted that Antwerp had the world‟s first stock market system. Antwerp was the commercial
centre of Belgium and it was home to the influential Van der Beurze family. As a result, early
stock markets were typically called Beurzen. Due to the lack of regulation and few ways to
distinguish legitimate companies from illegitimate ones, the stock market could not function
properly and was forced to shut down. The first stock exchange was later found in the city of
London, United Kingdom in1801 followed by New York Stock Exchange (NYSE) establishment

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in 1817 (Nyasha and Odhiambo,2013). In recent times, stock markets are a driving economic
force all around the world contributing to the growth of the global economy.
The development of capital market and its contribution to economic growth has been justified by
many scholars. Researchers such as Choong, Lam and Yusop, (2010); Francis, Hasan and Ofori
(2015); Bremus and Stelten, (2017) and Coskun, (2017) suggested the development of capital
market is crucial to mobilize resources to fund projects with capital needs and their risk sharing
behaviour with financial institution to provide financial system stability and contribute to
economic growth. Especially in a developing country like Ethiopia, capital market development
will boost the economy by promotion and development of the private sector, provision of relief
to liquidity constraints, improvement of competition among financing sectors, enhancement in
the volume of remittance, improvement of corporate governance, rewarding sound economic
policies and creation of tools to conduct monetary policy (Ruecker, 2011).
The history of the stock market in Ethiopia dates back to as early as the Imperial period. During
this time, Ethiopia inaugurated institutions of stock market, such as the “Addis Ababa Share
Dealing Group”. However, the stock market was put to an end due to the introduction of
command economy by the Derg regime in 1974 (Geda, 2017).
The Ethiopian financial system consists of 2 public banks, 16 private banks, 16 private insurance
companies, 1 public insurance company and 31 microfinance institutions. “The Ethiopian
economy has been under state control through a series of industrial development plans ever since
the Imperial government. Even though significant development steps were taken since 1991,
Ethiopia‟s financial sector is relatively small, closed and much less developed than those of its
neighbours. The government dominates lending, controls interest rates and owns the largest
bank” (Ruecker, 2011). Therefore, due to lack of political will and state controlled economy, the
launch of the capital market was delayed for some decades. This delay made the financial system
fully bank based. Thus, banks became key players in the financial system dealing with short-term
finance, temporary cash requirements and long term physical investment needs across all sectors
of the economy playing a pivotal role in the growth of the economy.
The current government seems to have taken a different path regarding establishment of capital
market. Accordingly, the National Bank of Ethiopia (NBE) is undertaking detailed assessments
on capital market in order to launch it in May, 2020. NBE is currently working on the
development of the policies and regulations to adopt a suitable financial platform. However, how

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capital markets emerge and evolve with existing financial institution in shaping the financial
structure of an economy still remains debatable in the body of the literature. According to studies
done in developing and developed economies around the world, during the introduction and
development of capital market complementary, competitive and co-evolutionary
interdependencies may exist towards existing financial institutions. Researchers such as Deidda
and Fattoouh, (2008); Boot and Thakor, (1997) and Mattan and Pannetti, (2012) suggest
competitive or substitute interdependency while Francis et.al, (2015); Osoro and Osano, (2014)
and Odhimbo, (2010) claim complementarity. And others such as Song and Thakor, (2010);
Ahokpossi, (2013) and Arize, Kalu and Nkwor, (2018) assert co-evolutionary interaction.
Therefore, this study attempts to investigate the possible interaction between capital market
development and the two major financial institutions in Ethiopia (banks and insurance
companies) because of their relative size and importance in the economy to set a potential road
map for the financial sector.
1.2 Statement of the problem
The finance-growth debate has evolved over the years, initiating a number of theories and
hypothesis including financial liberalization; finance-led growth; growth-led finance; market
feedback; bank-based and market-based.
The development of financial institutions and markets and their contribution towards economic
growth have been supported with empirical evidence by various scholars (Demirguc-Kunt and
Levine (2001); Choong, et. al., 2010; Francis et. al., 2015; Bremus and Stelten, 2017 and
Coskun, 2017). Especially for developing economies financial development and integration of
institutions and markets guarantees risk sharing which enhance financial system's ability to cope
with shocks by three financing mechanisms called “three-legged” approach (Friedman, 2000).
Although the integration of capital market and financial institutions foster economic growth,
there exists mixed interplay between the two components with respect to performance (Sayari
and Shamki, 2016). Further, these interdependencies vary due to level of economic development
(Nyasha and Odhiambo, 2017). Moreover, this interdependencies were studied on already
existing markets and there are methodological conflicts see (Deidda and Fattoouh, 2008;
Odhimbo, 2010; Mattan and Pannetti, 2012 and Mogbolu and Tizhe, 2017).
There is abundant extant literature that studied the interdependence between existing financial
markets and institution; there exist competing and contradictory claims among various scholars.

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Some claim competitive relationship (Dey, 2007; Deidda and Fattoouh, 2008; Boot and Thakor,
2010 and Mattan and Pannetti, 2012), while others claim complementary (Skipper, 1997; Catalan
et. al., 2000; Impavido, Musalem and Tressel, 2003; Bossone and Lee, 2004; Arena, 2008;
Odhimbo, 2010; Osoro and Osano, 2014; Francis et.al, 2015 and Al Shubiriand Jamil, 2017).
There are also others who claim co-evolutionary interdependency (Song and Thakor, 2010;
Ahokpossi, 2013 and Arize et.al, 2018). However, there is no research that investigated the
potential interplay between financial markets and institutions during the introduction phase
especially in a developing economy context.
Given that, Ethiopia is about to introduce capital market, exploring the potential interplay
between existing financial institutions and the to be introduced capital markets is believed to
have paramount importance which otherwise will have unintended and detrimental effect. Such
endeavour helps financial institutions to get ready and tap potential benefits and with stand
possible setbacks.
This study therefore, explores the projected interdependence between existing financial
institutions and forthcoming capital market by importing AHP and DEMATEL multi-criteria
decision making models from decision science discipline. Accordingly, over and above, what has
been stated before, the study also methodologically contributed by introducing multi-criteria
decision making models in to the main stream management research undertaking.
1.3 Research questions
In attempting to address the issues highlighted under the statement of the problem, the following
research questions were developed:
1. How do key performance indicators of financial institutions evolve over a period of time?
2. What is the relative importance of key financial institutions‟ performance indicators?
3. How do capital market development and financial institution performance affect-influence
each other?
1.4 Objectives of the study
1.4.1 General objective
The main objective of this study is to analyse the trend and pattern of the two main existing
financial institutions (banks and insurance companies) performance indicators over a period of
time and rank each indicators as per their level of importance. Further, the study extends to

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assess the potential interdependency of these financial institutions in Ethiopia with the
forthcoming capital market and its implication.
The thesis will also widen knowledge base for stakeholders of the financial institutions in
Ethiopia by providing information about the basic changes of integrated financial system.
Moreover, the study will propose coping mechanisms in case of projected challenges and
strategies for potential benefits, by assessing and identifying the main performance indicators of
financial institution that highly interact with capital market.
1.4.2 Specific objectives
The specific objectives of this study are;
1. To assess the trend and pattern of financial institution key performance indicators.
2. To rank each performance indicators (liquidity, efficiency, profitability, capital adequacy and
asset quality) for the banking industry and with respect to (profitability, operating growth, asset
quality, solvency and management soundness) for insurance companies according to their level
of importance.
3. To project the possible interplay between the forthcoming capital market and existing financial
institutions performance indicators.
1.5 Definition of key terms
Performance
Performance refers to the capability of an organization to grow, remain profitable and respond to
challenges and threats. It could also be used to mean how well the organization attains its set
goals and targets.
Multi-criteria
The multi-criteria decision making methods pursue the objective approach of taking a decision.
Various criteria are considered before the selection of the optimal alternative. There are two
types of MCDM method: Compensatory and Outranking. Analytical Hierarchy Process is an
example of compensatory method which selects the better alternatives from various available
options by the adaptation of a hierarchical structure comparing each of the alternatives with each
other with respect to the criteria and each of the criteria with the other criteria with respect of the
goal of the decision making ( Majumder and Saha, 2016).

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Analytical Hierarchy Process (AHP)
The Analytic Hierarchy Process (AHP) is a general theory of measurement. It is used to derive
ratio scales from both discrete and continuous paired comparisons. These comparisons may be
taken from actual measurements or from a fundamental scale which reflects the relative strength
of preferences and feelings. The AHP has a special concern with departure from consistency, its
measurement and on dependence within and between the groups of elements of its structure. It
has found its widest applications in multi-criteria decision making, planning, performance
evaluation, resource allocation and in conflict resolution. In its general form the AHP is a
nonlinear framework for carrying out both deductive and inductive thinking without use of the
syllogism by taking several factors into consideration simultaneously and allowing for
dependence and for feedback, and making numerical trade-offs to arrive at a synthesis or
conclusion. T. L. Saaty developed the AHP in 1971- 1975 while at the Wharton School
(University of Pennsylvania, Philadelphia, Pa).
Decision-Making Trial and Evaluation Laboratory (DMATEL)
Decision-Making Trial and Evaluation Laboratory (DEMATEL) methodology is proposed to
research and solve complex and closely linked problem groups because of its capability in
verifying interdependence between variables and try to improve them by offering a specific chart
to reflect interrelationships between variables. Decision-Making Trial and Evaluation Laboratory
(DEMATEL) technique was employed by (Fontela and Gabus, 1976) and it has managed to
solve many global complex problems in scientific, political and economic by considering
experts‟ attitudes (Gabus and Fontela, 1972; Gabus and Fontela, 1973). This method mainly
identifies interdependency relationships between variables (Chen, 2016).
1.6 Delimitation of the study
The scope of this study is restricted to the interaction of the financial institutions (banks and
insurance companies) and capital market only in Ethiopia. This study is focused on only firm
specific performance factors for each financial institution. The research does not consider any
policy or legal platform related concepts that could affect the relationship. Therefore, a more
extensive study on past-completed researches will bring additional detailed insights on the
subject matter.

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1.7 Limitation of the study
Experience of the stock market is limited in Ethiopia. During the development of this research
finding experts both on capital market development and financial institution performance was a
major challenge. Having more access to more experts with first-hand experience of capital
market would have enhanced the validity of the research outcome. This is mainly because there
is no first-hand experience of capital market in Ethiopia and the experts found for this study
developed their experiences in different economic context. For this reason when it comes to the
full picture once again the predictions of interaction with the existing financial institutions is not
going to be as accurate as countries with experience. Therefore, the study cannot fully cover all
expectations of this market interdependency with precision.
1.8 Contribution of the study
This thesis will contribute by creating awareness and proposing remedies from success
experience with the provision of alert to failure by trying to answer the above research questions.
It will also try to give insight on the possible interaction results that come from the two financial
systems to contribute to other countries with similar context.
1.9 Organization of the paper
The rest of the chapter is categorized as follows. Chapter Two presents literature review with
general descriptions by different researchers, empirical literature review, summary of literature
review and conceptual framework. Chapter Three depicts about research methodology followed
by Chapter Four consisting of research findings and discussions. Finally Chapter Five will
conclude with research conclusions, recommendations and areas for future study.

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`

CHAPTER TWO

LITERATURE REVIEW
2.1 Introduction

This section presents evolving financial system and economic growth theories and
interdependencies of financial system components in promoting growth. Further, this section
compiled the findings from different reviewed literatures on financial institution (bank and
insurance) performance measures and interdependencies they have with financial market (capital
market) performance indicators.
2.2 Theoretical review
Finance-Led Growth Hypothesis
The Finance-led Growth Hypothesis was proposed by Schumpeter, (1911) which elaborates the
interrelations between financial markets and efficiency in the capital markets. The theoretical
foundation of the relationship between finance and growth can be traced back to the early
discussions of Bagehot, (1873) who argue that the financial system plays a critical role in
facilitating the mobilization of capital and growth; subsequently extended by Schumpeter, (1911)
who contends that the services provided by financial institutions are essential drivers for
innovation and growth. Schumpeter notes that a well-developed financial system channel
financial resources to the most productive use; thereby suggesting that finance leads economic
growth. This has come to be known as the finance-led hypothesis.
The economic aspect in a country and the financial sector exists in a supply lending
relationships. Hence development in the financial sector will result in economic growth being
experienced in different sectors. This is because the availability of well-functioning financial
sector and financial intermediations will act to provide efficient allocation in resources which in
turn promotes growth.
The proposition of the theory is that in scenarios whereby there is evolved and developed
financial markets, there will be increased capital accumulation levels from the normal. Higher
capital accumulation levels are desirable as there increased capital resources for developing
various sectors of the economy. Therefore, based on this theory, improving the financial sector
policies and determinants of financial development is mechanism for promoting overall
economic growth (Ohwofasa and Aiyedogbon, 2013). Development of capital market is a vital

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part in growth of the financial sector as it substitutes the functions of banks in economic growth.
This is because they help price allocation, provision of liquidity, trading costs reduction and
transfer of risk.
Growth-led Finance Hypothesis
Growth-led Finance Hypothesis was formulated and developed by Robinson, (1952) in
challenging the Finance Led Growth Hypothesis of Schumpeter, (1911). According to this
theory, a country experiencing high growth in the economy will result in increased demand for
certain financial instruments and arrangements that respond effectively to these changes and
demand in the economy. Therefore, the economy will develop the necessary financial markets
and institutions to finance the opportunities arising from experienced economic development
(Robinson, 1952).
The theory suggests that where enterprise development leads, finance follows. In other words the
main cause of financial development is economic growth in response to the demand thus created.
Argument arising from this theory is that the factors that determine how economies grow are not
confined by the financial sector.
The Theory of Financial Liberalization
Theory of Financial Liberalization was proposed by Mc Kinnon, (1973) which explains
importance of liberalized financial markets in a country. The theory suggests that financial
liberalization policies would increase savings which consequently promote investment and
hasten economic growth. They argued that higher interest rates brought about by liberalization
leads to a more efficient allocation of resources, higher level of investment and economic
growth. A fully liberalized financial system domestically is mainly characterized by lack of
controls on borrowing interest rates, no subsidies to certain sectors and lack of credit controls.
Financial liberalization may result to adverse effects on market development in both short term
and positively in the long run. Through the liberation of the financial markets, the banks are able
to operate more freely and widely with minimal restrictions. The reason is that liberalizing the
system would result to financial crunches since current account opening leads to over borrowing.
The importance of the theory is that it links capital market deepening to come about as a result of
liberalization in the financial markets which in turn influences the banking sector. This is
characterized by increased financial intermediation by both savers and traders with monetization
of the economy (Kaminsky and Schmukler, 2003).

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Market Feedback Hypothesis
This theory which is also known as Bi Directional Hypothesis was introduced by Shaw, (1973).
The theory states that there exists a relationship that is two way between economic growth and
development in the financial sector. Hence the financial sector will develop as a result of
economic growth which will act as a feed back in stimulation of real economy growth (Akinlo
and Egbetunde, 2007). This theory backs the argument of both supply leading and demand
following hypotheses. In this hypothesis, the proposition is that having well developed financial
systems could promote high expansion in the economy through innovation in product and
services, and technological advancement (Levine, 1997). This in turn results in increased
demand for financial arrangements and services. Based on the theory, capital market
development and performance of the financial institutions are interrelated; hence expansion and
development of one sector would result in improvement in the other.
2.3 Capital market development and bank performance

The financial system is a composition of financial institution and financial markets. It is

complex, in function and in having internal mixed interdependency between its major system
components in different economies. Literature reveals three types of interactions between
financial institutions and market; competitive, complementary and co-evolving.
Competitive or substitute relationship suggests the development of one component at the expense
of another. In support of this interaction Dey, (2007) and Deidda and Fattouh, (2008) inferred
that the development of markets will come across with a huge competition for banks because of
the similarities of the rendered services such as credit allocation; improving information
asymmetry problems (Boot and Thakor, 1997); offering insurance against risks and providing
information on investment opportunities (Mattana and Pannetti, 2012). Further, based on studies
conducted in Africa, researchers such as Odhiambo (2010) and Nyasha and Odhiambo, (2017)
concluded that there exists competitive interplay between bank and market. Moreover, Boyd and
Smith, (1996); Song and Thakor, (2011) showed concerns on specifics suggesting that positive
efficiencies may not develop in the banking system in association with capital market
development if there is high government intervention in the financial system.
The other possible interplay between banks and capital market is complementarity. This
relationship suggests development of one financial component opens up more opportunity to
grow and prosper for another. Researchers such as Brogaard, Ngo and Xia, (2019) explained

Page 10
complementarity of banks and stock market through improved stock price informativeness,
which allows banks to learn more about the borrowing firm, reducing the adverse selection costs
associated with syndication. Similarly Francis et al, (2015) emphasised that after the launch of
stock market bank credit availability to the private sector increases significantly. Furthermore,
the relationship between efficiency of banks and capital market is also defined complementary
suggesting efficiency measures influence share price on stock market (Beccalli, Casu and
Girardone, 2006; Ioannidis et.al, 2008; Vardar, 2013; Rawlin et.al, 2015 and Sharma, 2018).
On the other hand, Nyasha and Odhiambo, (2017) identified mixed results by analysing the
interplay between banks and capital markets in different economic contexts. Based on their
research findings, two out of three countries reveal complementary interdependency.
When the complementary interdependency between bank and market carries on for an extended
period of time the relationship can be labelled as co-evolving. Song and Thakor, (2010) were the
first to lay a theoretical basis about co-evolving interplay by extending on competitive and
complementary interaction of banks and markets. They argued that banks are seen as competitors
in markets and vice-versa only when they are viewed on a stand-alone or dominance basis. This
means that when they are viewed from an interactive standpoint, they complement and co-evolve
rather than compete. To elaborate further the authors used two scenarios (securitization and bank
capital) that are significant for connectivity between banks and markets.
The process of securitization removes the frictions („certification‟ and „financing) that hamper
borrowers‟ denial of financing as a result of wrong judgment from either bank (certification
friction) or markets (financing friction). This encourages greater investor participation and
speeds up capital market evolution.
Meanwhile, in the case of a bank capital scenario, bank financing frictions are reduced through
markets, and capital requirements for riskier loans are boosted , thereby reducing the certification
friction and serving the previously un served customers. These feedback eff ect on the
interdependency between banks and markets are what the authors described as a vicious cycle
that confirms a co-evolution between these sectors. Supporting the previous finding, Ahokpossi,
(2013) stated that banks improve pressure from solvency and regulation on lending by accessing
additional capital to meet regulatory requirements or indicate their solvency. Lower cost of
equity capital is a potential driver of how costs of additional bank capital transmits into the
interest rate charged on loans to bank borrowers. Moreover, Arize et. al., (2018) concluded that,

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“a long-run link exists between bank models and market models, a complementary rather than a
competing association, which suggests a co-evolving development.”
2.3.1 Empirical review
In the body of literature there is also empirical evidence that suggest the three types of
interaction between bank and market. Deidda and Fattouh, (2008) empirically analysed the
interaction between bank and market finance in a model where bankers gather information
through monitoring and screening. They showed in the study that, if a market characterized by a
disclosure law is established such that entrepreneurs wishing to raise market finance can credibly
disclose their sources of financing, this might undermine bankers‟ incentive to screen, even when
screening is efficient. Correspondingly, they concluded other things being equal, the change from
a bank-based system to one in which market-finance and bank-finance coexist might have an
adverse effect on economic growth. Consistent with this result, suggesting bank and stock
market development have a positive effect on growth, but the growth impact of bank
development is lower the higher is the level of stock market development. Supporting these
findings, Mattana and Paretti, (2012) on a panel study conducted on 45 countries found evidence
that one unit increase in an index of securities market liberalization leads to a drop in the bank
liquidity ratio between 15 and 22%. Concluding market capitalization significantly affects bank
liquidity. Moreover, Mogbolu and Tizhe, (2017) also analysed whether capital market
development influences banking system efficiency, and whether level of liquidity of the
capital market is important for this relationship in SSA countries (Kenya, Nigeria and South
Africa) using panel data instrumental variables regression methods. Based on the findings
of the study, the researchers conclude that level of capital market activity contributes
negatively to banking efficiency and that these effect is determined by low capital market
liquidity.
Contrary to the above findings, Osoro and Osano, (2014) empirically tested the interaction of
banks and capital markets in the Kenyan financial system by deploying a Vector Error Correction
Model (VECM). They found a complementary and co-evolving relationship between the bank
and the capital market in the Kenyan financial structure, although it is a bank-based economy.
Similarly Odhimbo, (2010) empirically analysed the relationship between stock market and
banks in South Africa using ARDL-Bounds testing approach. The empirical results show that
there is a distinct positive relationship between banks and stock markets in South Africa. Further,

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AlShubiri and Jamil, (2017) on an empirical study conducted in Oman stated market
concentration measures have a significant impact on interest rate spread of banks among many
other things that increase efficiency of banks concluding complementarity between bank and
stock market
On a detailed approach Sayari and Shamki, (2016) conducted a study in Jordan regarding the
impact of two stock market developments using multiple regression models. The researchers
found mixed results on different profitability indicators of banks. The study concluded that;
market capitalization variable has negative and significant influence on ROA, but it has
significant positive influence on ROE; trading volume has strongly significant and positive
influence on both ROE and ROA, suggesting that trading volume is the determinant factor for
the bank‟s profitability; and finally, concluded that the ROE is a more superior measure of
profitability to ROA suggesting capital market complements the banking sector in Jordan.
Similarly, Nyasha and Odhiambo, (2017) found mixed results about capital market and financial
institution interdependency because of different economic context. The study investigated three
countries (USA, Brazil and Kenya) during the period from 1980 to 2012 which represent a
modest cross-section of the general financial structure prevalent in many developed and
developing countries. Unlike some of the previous studies, the study employs the newly
developed ARDL-Bounds-testing approach to carry out the test. The study also employed the
method of means-removed average to construct both bank-based and market-based financial
development indices. And in conclusion, while in the USA and Brazil, bank-based and market-
based financial systems complement each other in enhancing economic growth; in Kenya, the
two financial systems seem to be substitutes rather than complements.
Based on these literature reviews the following prepositions were developed.
P1: Capital market development has competitive interplay with banks‟ performance.
P2: Capital market development has complementary interplay with banks‟ performance.
P3: Capital market development and banks‟ performance are co-evolutionary.
2.4 Capital market development and insurance performance

The interplay between stock markets and insurance, appear to be complementary in the body of
the literature. Insurance activities, especially for life insurance companies, could promote stock
market development (and bond markets) by investing funds (savings) raised through life
insurance products into equities (Catalan, Impavido and Musalem, 2000 and Impavido, Musalem

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and Tressel, 2003). Skipper, (1997) believes that the development of insurance fosters a more
efficient capital allocation because the insurance companies gather significant information to
evaluate projects and firms and so better allocate their financial capital. On the other hand, the
development of stock markets will foster the growth of insurance companies because it provides
them a more liquid market in which to invest their premiums. This is especially important for life
insurance companies which seek to match their long-term liabilities with long-term assets
(Arena, 2008). Arena, (2008) is among the very few studies of the interaction effect of insurance
and stock markets in promoting economic growth. Moreover Catalan et. al., (2000) concluded
that causality is mainly from contractual savings to stock markets. Given the evidence, it seems
an interrelationship exists between insurance and the stock markets and appears complementary.
When it comes to the bond market the relationship between bond markets and insurance can be
viewed more of a complementary nature as well. According to Turner, (2002) insurance
companies, together with pension funds, are called institutional investors, and these are
considered the key players in the debt markets (bond markets). Given the long-term nature of
their liabilities, insurance companies play a large investor role in the bond markets (and equity
markets as discussed above) (Catalan et al., 2000 and Impavido et al., 2003). Insurance
companies also issue catastrophe bonds, which are attractive to investors for diversifying their
portfolios because they are uncorrelated with business activities (Arena, 2008). The bond
markets, likewise, offer insurance companies more investment opportunities and liquidity (less
liquidity risk). Insurance companies and bond markets are also related through risk transfer.
According to Cox and Pedersen, (2001) insurance companies transfer to bond markets not only
their market risk by hedging of embedded options in life insurance portfolios but also insurance
risks related to natural catastrophe (cat bonds). On the insurance side, bond markets may transfer
market risk to insurance companies when the latter write options and buy bonds with embedded
options. These two components are expected to have interrelationship and the relationship seems
to be complementary.
Based on these literature reviews the following prepositions were developed.
P1: Capital market development has competitive behaviour towards insurance performance.
P2: Capital market development has complementary behaviour towards insurance performance.

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`

2.5 Empirical review on banks and insurance company performance indicators evaluation.

Understanding the factors that influence the performance of financial intermediaries is critical
not only to the management of these institutions but also to other stakeholders and interest
groups such as the country‟s Central Bank, the government as a whole, the banker‟s association
as well as other financial authorities in the country (Ayele, 2012).A well-established financial
sector can absorb major financial crisis, changes in the economy and can provide a plat form for
strengthening the economic system of the country (Aburime, 2009). To insure sustainable and
resilient financial system, appropriate understanding and management of key performance
determinants is crucial.
2.5.1 Bank performance evaluation
The performance evaluation methods of banks differed among the researchers. Alshatti, (2016);
Erina and Lace, (2013); WuYueh-Cheng, Ting, Lu, Nourani and Kweh, (2016) and Ferrouhi,
(2017) investigated the critical determinants that affected the profitability using performance
indicator ratios ROA and ROE of the banks by using descriptive and multiple regression model.
But researcher like Karr, (2005) suggest ROA and ROE measures largely correlate with each
other and both of them provide particularly the same indication of performance associated with
the tendency and movement of financial performance or profitability.
Although these measures are widely used, they are criticized and have significant shortcomings
that are proposed by diff erent financial analysts and scientists. The main limitations of ROE are
as follows: 1) Can induce inaccurate and incorrect results because of a diff erent size of
companies and in terms of credit risk (Lindblom and Von Koch, 2002). 2) Face the problems
connected with the allocation of assets, equity and net income in case of branch level (Avkiran,
1997). 3) The cost of equity is not taken into account in its calculation, thus it can be seen that
bank performance is good when the value to its shareholders is diminishing. However, a major
weakness of ratio analysis is that there is a lack of agreement in the literature on the relative
importance of various types of indicators. If a particular study wishes to incorporate the related
financial indicators to measure technical efficiency in banks, it will lead to an issue of the weight
assignment to each indicator. In addition, financial ratio analysis, each single ratio must be
compared with some benchmark ratios one at a time while one assumes that other factors are
fixed and the benchmarks chosen are suitable for comparison. The financial ratio method can be
an appropriate method when firms use a single input or produce a single output.

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CAMEL and CAMELS are another ratio based models commonly used for the evaluation of
performance and ranking. Researchers such as KS, Thomas and Abraham, (2018) examined the
economic sustainability of the biggest public sector banks in India using CAMEL model during
the period 2013-14 to 2015-16.Thiagarajan, (2018) also analysed the performance of five major
commercial banks in Belize during the period of 2008-2015 using CAMEL approach. Moreover,
Zagherd, and Barghi, (2017) performed an empirical study on the performance evaluation of
Iranian banking industry through CAMELS framework.
Financial ratio analysis has been the ultimate tool for assessing the financial
performance of organizations. However, given the increasing complexities in business operations
in recent times, there is increasing shift to alternative methods that takes a multi-
dimensional approach and combine several indicators to assess the financial performance of an
organization (Aidoo and Mensah, 2017). AHP is one of the well-known and the most widely
exploited decision making methods in cases when the decision (the selection of given
alternatives and their ranking) is based on several attributes used as criteria. The application of
AHP in banking performance has been research interest after the late 1990's and most of the
significant applications of AHP are found after 2000. As Stankevičienė and Mencaitė, (2012) put
it, AHP has got wider acceptance because of the fact that it allows considering financial and non-
financial measures in the evaluation process, which is very important because the business of
financial institutions is very complex, and therefore it is not enough to take into account only
financial measures.
Researchers such as Bhandari, (2014) explored the determinants of performance exposed by the
financial ratios and determine the financial performance of banks in Nepal through AHP based
on their financial characteristics. Lu, Wang and Lee, (2013) in their study used (AHP) to
evaluate bank‟s operation risk rating in various stressed scenarios and to prioritize rating items.
Cehulic, Hunjak and Begicevic, (2011) have used financial ratios into four groups Balance Sheet
Ratios, Income Statement Ratios, Profitability Ratios and Market Ratios and several subgroups
to analysed banks in Croatia by Analytical Hierarchy Process. Stankevičienė and Mencaitė,
(2012) also used (AHP) model, and to evaluate the performance of banks in Lithuania. The
researchers used three main criteria to evaluate the performance of banks: customer‟s
perspective, financial ratios and qualitative evaluation. Overall, the performance of banks was
investigated using 22 criteria. And the research concluded smaller banks were falling behind the

Page 16
banks that were managing solid assets and controlling a significant part of the market asserting
bank size significantly affects performance. Bhattarai, (2016) also convey the imperativeness of
the ability of integrated or holistic decision analysis, putting subjective and objective information
on the single framework for decision analysis in financial institutions in Nepal.
Researchers also used DEMATEL frequently to evaluate the performance of different complex
systems and define influence relationships such as: creating a model for sustainable consumption
and production (Luthra, Govindan, Kannan, Mangla and Garg, 2017); evaluating CRM partners
(Büyüközkan, Güleryüz and Karpak, 2017); defining critical success factors (Zhou, Shi, Deng
and Deng, 2017) and evaluation of performance (Supeekit, Somboonwiwat and Kritchanchai,
2016).
Although these performance measuring techniques appear to be powerful and flexible, recent
studies started using a combination of MDCMs to reveal better results. The combination of
MCDM tools benefits researchers to fill gaps of one tool by another.
For instance AHP is a decision making technique that helps decision-makers to set priorities and
select the best alternative but it has its own drawbacks. AHP cannot deal with interconnections
among the decision factors at same levels, because the decision framework in the AHP assumes a
one-way hierarchical relationship between decision levels. In many issues that interactions
among the decision variables exist, AHP is not effective to use on its own (Isik, 2007).
Researchers such as Rezaei and Ketabi, (2016) identified the criteria and their coefficients used
for financial performance evaluation of private banks using fuzzy AHP method. After that, they
evaluated financial performance of Iran private banks and ranked them using TOPSIS method.
Guru and Mahalik, (2019) similarly used a combination of combination of AHP, TOPSIS, and
Grey Relational Analysis for efficiency calculation of different public sector banks in India.
AHP is used to determine the weight criteria and Grey Relational Analysis and TOPSIS are used
to rank the bank performances.
2.5.2 Insurance company performance evaluation
Previous studies dwelling on key insurance performance indicators that have been documented in
the academic literature. Almajali, Alamro and Al-soub, (2012) carried out a study to examine
and identify the factors affecting the financial performance of Jordanian insurance companies
during the period 2002 to 2007. ROA was used as the dependent variable while leverage,
liquidity, age, size and management competence index were independent variables. The results

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of regression analysis revealed that liquidity, leverage, size of the company and management
competence index have a significant and positive effect on the financial performance of
Jordanian insurance companies. Results also suggest that there is no significant relationship
between the age of the company and performance. Burca and Batrinca, (2014) investigated the
factors that affect the financial performance of 21 insurance companies operating in the
Romanian insurance market during the period 2008-2012. For this purpose, the explanatory
variables used were financial leverage in insurance, company size, number of years of operating
in the Romanian market, growth of gross written premiums, equity, total market share,
diversification, underwriting risk, investment ratio, reinsurance dependence, retained risk ratio,
solvency margin, and growth of GDP per capita. ROA was utilized as an indicator of company
performance. By applying panel data techniques, the authors showed that the major determinants
of financial performance in the Romanian insurance market are financial leverage in insurance,
company size, growth of gross written premiums, underwriting risk, risk retention ratio, and
solvency margin.
In a more recent study Shahnawaz, (2018) analysed performance of Indian insurance companies
using AHP score using five criterion (premium, benefits, productive diversity, customer service,
distribution network) concluding the most significant criterion being premium and benefits.
Similarly Valahzaghard and Ferdousnejhad, (2013) used analytical hierarchy process (AHP) and
factors analysis (FA) to rank insurance companies using four criterion (capital adequacy, quality
of earning, quality of cash flow and asset quality) and results indicated that capital adequacy and
quality of earning taking higher weight of importance and quality of cash flow and quality of
asset covering the rest. On a study conducted in Ethiopia Sambasivam and Ayele, (2013)
investigated performance of Insurance companies using firm specific factors (age of company,
size of company, volume of capital, leverage liquidity ratio, growth and tangibility of asset) on
profitability proxied by return on asset. Findings concluded that growth, leverage, volume of
capital size and liquidity to be important determinant factors of profitability. While growth, size
and volume of capital are positively related with profitability others have negative relationship.
Moreover, Mandić, Delibašić, Knežević, and Benković, (2017) analysed the efficiency of
insurance companies in Serbia using fuzzy analytical hierarchy process to give criteria weight of
importance to determinant factors (equity and reserves, business assets, provision and liabilities,
financial incomes and cost of insurance) and used TOPSIS method to rank companies

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accordingly. Findings indicated that financial parameters, criteria such as equity and reserves and
business assets have proven to be the most important vectors of weights of 0.345 and 0.274,
followed by the criteria financial income of 0.202, provisions and liabilities with 0.148 and costs
of insurance with 0.029.
Due to the uncertainty and complexity of the global market, as well as increase in the flow of
information are major obstacles for accurate performance measurement. In such circumstances,
the traditional performance measurement does not give satisfactory results. However, the fuzzy
approach has been successfully used to overcome this problem (Mandić, et.al, 2017).

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Table 2.1: Summary of Empirical Literature
Author(s) Focus of study Methodology and adopted Key findings
model

Capital market development and bank performance

Deidda and Fattouh, (2008) Analyse the interaction between bank and multiple regression model by Concluded bank and stock market development have a positive effect on growth
market finance. applying panel data techniques but the growth impact of bank development is lower the higher is the level of the
stock market. Inferring their interaction negatively influences growth.

Mattana and Paretti, (2012) Analysed 45 countries on a panel data to Neoclassical growth model Found evidence that one unit increase in an index of securities market
identify relationship of stock market liberalization leads to a drop in the bank liquidity ratio between 15 and 22%.
development and banking liquidity. Concluding market capitalization significantly affects bank liquidity.

Mogbolu and Tizhe, (2017) Analysed SSA countries And investigated the multiple regression model by Concluded that liquidity of stock market has a negative effect on bank efficiency
relationship between stock market and banks. applying panel data techniques using a specific lending –deposit spread linkage.

Nyasha and Odhimbo, To examine relationship between stock Autoregressive distributed lag Identified bank based financial system and stock market development does not
(2015) market development and bank based bounds testing approach. show a positive relationship towards each other‟s development.
financial system.
Odhimbo, (2010) To examine relationship between stock Autoregressive distributed lag Concluded they have a distinct positive relationship.
market development and bank based bounds testing approach.
financial system.
Osono and Osamo, (2014) To examine empirically the interaction of multiple regression model by They found a complementary and co-evolving relationship between the bank and
banks and capital markets in the Kenyan applying panel data techniques the capital market in the Kenyan financial structure, as though it is a bank-based
financial system. economy.

Shamki and Sayari, (2016) Analysed impact of stock market multiple regression model by Concluded market capitalization variable has negative and significant influence
developments on the profitability measures in applying panel data techniques on ROA, but it has significant positive influence on ROE; trading volume has
Jordanian banking sector. strongly significant and positive influence on both ROE and ROA, suggesting
that trading volume is the determinant factor for the bank‟s profitability. And
finally, concluded that the ROE is a more superior measure of profitability to
ROA.
Al Shubiri and Jamil, (2017) Focused on empirical study conducted in Ordinary least square In conclusion stated market concentration measures have a significant impact on

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 Oman investigating the relationship between interest rate spread of banks among many other things.
stock market and banks.
Capital market development and insurance performance

Banks and insurance companies’ performance indicators evaluation.

Almajali, Alamro and Al- Carried out a study to examine and identify the factors multiple regression The results of regression analysis revealed that liquidity, leverage, size of the
Soub, (2012) affecting the financial performance of Jordanian insurance model by applying company and management competence index have a significant and positive
companies during the period 2002 to 2007. ROA was used panel data techniques effect on the financial performance of Jordanian insurance companies. Results
as the dependent variable while leverage, liquidity, age, size also suggest that there is no significant relationship between the age of the
and management competence index were independent company and performance.
variables.
Alshatti, (2016) To investigating the critical determinants that affected the Descriptive and Capital adequacy, capital and leverage positively effect on the banks‟
profitability of the commercial banks in Jordan. econometrics analysis profitability and the variable of assets quality negatively effects on the banks‟
approach. profitability.
Bhandari and Nakarmi, Explored the determinants of performance exposed by the By using analytical Based on Pair wise Comparison of the Financial Criteria's and Sub Criteria. It
(2014) financial ratios and determine the financial performance of hierarchy process was seen that Liquidity in Banks (W= 0.311) Capital Adequacy (W=0.216) Asset
commercial banks in Nepal. AHP based on their Quality (W=0.185) Efficiency (W=0.149) and Profitability (W=0.139).
financial
characteristics.
Burca and Batrinca, (2014) Investigated the factors that affect the financial performance Multiple regression Authors showed that the major determinants of financial performance in the
of 21 insurance companies operating in the Romanian model Romanian insurance market are financial leverage in insurance, company size,
insurance market during the period, 2008-2012. growth of gross written premiums, underwriting risk, risk retention ratio, and
solvency margin.
Cehulic, et..al., (2011) Used financial ratios into four groups Balance Sheet Ratios, Analytical Hierarchy Ranking showed that in the case of comparing 15 largest banks in Croatia
Income Statement Ratios, Profitability Ratios and Market Process according to the total value of assets on 30th June 2009, the Volksbank d.d. is
Ratios and several subgroups to rank banks in Croatia. the best business bank from the standpoint of the central bank.

Erina and Lace, (2013) To determine the impact of the external and internal factors Descriptive method Profitability has had a positive effect on operational efficiency, portfolio
of bank performance on the profitability indicators of the and correlation and composition and management, while it has had a negative effect on the capital
Latvian commercial banks. regression analyses and credit risks, as measured according to ROA, while according to ROE,
positive influence is exerted on composition of the capital portfolio and negative
– on operational efficiency and credit risk. With regard to macroeconomic
indicators, the authors have revealed that GDP has a positive impact on
profitability as measured by ROA and ROE

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Ferrouhi, (2017) To define long-term determinants of Moroccan commercial Johansen Long-term performance of Moroccan commercial banks depends on deposits,
banks performance. cointegration test short-term, long-term and funding liquidity, the size of the bank and its square,
internal and external funding, deposits interest rates and foreign direct
investments.
Stankevičienė and Mencaitė, To check AHP adaptation to evaluate performance of banks Analytical Hierarchy Concluded the appropriateness of the methodology to evaluate bank
(2012) in Lithuania Process performance.

Mandić, et.al, (2017) Analysed the efficiency of insurance companies in Serbia to Using fuzzy Findings indicated that financial parameters, criteria such as equity and reserves
give criteria weight of importance to determinant factors analytical hierarchy and business assets have proven to be the most important vectors of weights of
(equity and reserves, business assets, provision and process (FAHP) and 0.345 and 0.274, followed by the criteria financial income of 0.202, provisions
liabilities, financial incomes and cost of insurance) used TOPSIS method and liabilities with 0.148 and costs of insurance with 0.029.
to rank companies
accordingly.
Sambasivam and Ayele Investigated performance of Ethiopian Insurance companies multiple regression Findings concluded that growth, leverage, volume of capital size and liquidity to
(2013) using firm specific factors (age of company, size f company, model be important determinant factors of profitability. While growth, size and volume
volume of capital, leverage liquidity ratio, growth and of capital are positively related with profitability others have negative
tangibility of asset) on profitability proxied by return on relationship.
asset..
Shahnawaz (2018) Analysed performance f of Indian insurance companies Analytical hierarchy Concluding the most significant criterion being premium and benefits.
using five criterion (premium, benefits, productive diversity, Process (AHP)
customer service, distribution network)
Stankevičienė and Mencaitė To investigate the performance of Lithuanian commercial Analytical Hierarchy The performance of banks can be influenced by their size.
(2012). banks. Process (AHP) model
Valahzaghard and Ranking performance of insurance companies using four Analytical hierarchy Results indicated that capital adequacy and quality of earning taking higher
Ferdousnejhad (2013) criterion (capital adequacy, quality of earning, quality of process (AHP) and weight of importance and quality of cash flow and quality of asset covering the
cash flow and asset quality) factors analysis (FA) rest
WuYueh-Cheng et al., Performance evaluation and earning management using a Regression and An efficiency analysis reveals that Singaporean banks obtained the highest
(2016)
sample of ASEAN commercial banks. frontier analysis overall and profitability efficiencies, while Bruneian banks had the lowest rates
of banking performance. In the stage of managerial efficiency, the most
inefficient banks are those of the Philippines, whereas the greatest level is related
to Malaysian banks. A frontier projection analysis

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`

2.6 Conceptual framework

This conceptual frame work demonstrates the research‟s attempt which tries to investigate the
possible interaction between performance indicators of each financial system towards the
upcoming capital market performance indicators. This study will identify the weight of
importance of each indicator to measure performance of financial institutions and will try to
reveal the potential influence of capital market performance indicators on each weighted
performance indicators.

Bank Performance Capital market Insurance

Performance Performance

Liquidity Profitability
Market Capitalization
Efficiency Operating growth

Profitability
Trade volume Asset quality
Capital adequacy
Solvency
Asset quality

Management
soundness

Figure 2.1. Conceptual frame work

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 CHAPTER THREE

METHODOLOGY OF THE STUDY

3.1 Introduction
This chapter is concerned with the overall plan, approach and design of the study, the purpose of
the study, data sources and types, methods and procedures of data collection.
3.2 Research Approach
This paper used sequential and quantitative dominated mixed approach to identify and rank
financial institution performance measures and study interdependence with capital market
development.
3.3 Research Design
The study used descriptive, evaluative and exploratory designs. The descriptive design was
employed to capture existing financial institution performance trends and patterns. This study
also utilized evaluative design to examine financial institution performance using AHP and
exploratory design to analyse financial institution performance interplay with capital market
development using DEMATEL.
In this study, Multi Criteria decision making methods were used. In the first step with review of
the literature and interviews with experts in the banking and insurance industry, key performance
indicators of banks and insurance companies in Ethiopia financial industry were extracted.
Model of analytic hierarchy process has been used to determine weight of each of the Criteria.
The correlation matrix of the criteria were designed and distributed among 12 experts in the
banking and 12 experts in the insurance industry, and with the consensus of expert opinions,
pairwise comparisons questionnaire based on the analytic network process filled and completed
by the experts. Then using analytic hierarchy process (AHP), the criteria weights were extracted.
It should be noted that to analyse data and calculate ranks, Microsoft excel has been used. Here,
the first phase of the study is completed.
The second step includes verifying inter relationship of variables using Decision-Making Trial
and Evaluation Laboratory (DEMATEL). This study used the DEMATEL technique to build a
pairwise influential network relation map (INRM) to detect the interrelationships among
evaluation dimensions and criteria. In addition, the DEMATEL technique can identify the level
of influence of each criterion over others. The values of these influence levels can be used as the
basis of determining weights of criteria to derive relative importance in the system.
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3.3.1 Definition of Study Variables bank performance indicators
Liquidity
Liquidity measures the bank‟s ability to meet its current obligation. Banks remain liquid by
deposit mobilization and earn profit by extending credit from the obtained resource. Therefore
banks should be liquid enough to meet depositor‟s payment demand when needed. The ratios
used to evaluate liquidity are,
a. Liquid asset to Total asset (LA/TA): it measures the overall liquidity position of the bank. The
higher the ratio the more liquid the banks position is.
b. Liquid assets to demand deposits (LA/DD): This ratio measures the ability of bank to meet the
demand from depositors in a particular year. To offer higher liquidity for them, bank has to
invest these funds in highly liquid form.
c. Liquid assets to total deposits (LA/TD): This ratio measures the liquidity available to the total
deposits of the bank.
Efficiency
The ratio in this segment involves subjective analysis to measure the efficiency and effectiveness
of banks. The ratios used to evaluate management efficiency are described as:
a. Total advances to total deposits (TAd./TD): This ratio measures the efficiency and ability of
the bank in converting the deposits available with the bank excluding other funds like equity
capital in to high earning advances.
b. Earnings before Tax (EBT) to Total Revenue (TR): It rates efficiency in reducing costs that
would be incurred to generate bank's revenue.
c. Total revenue per employee (TR/No.Em): it shows the productivity of human force of bank. It
is used as a tool to measure the efficiency of employees of a bank in generating business for the
bank. Higher the ratio, the better it is for the bank.
Profitability
Profitability explains banks‟ sustainability and growth. The main components of this ratio are,
a. Profit before tax to equity (ROE): measures the efficiency in utilizing the bank equity. The
higher return on equity the more efficient in equity utilization.
b. Profit before tax to asset (ROA): This ratio measures return from assets employed or the
efficiency in utilization of assets. The higher return on asset the more efficient in asset
utilization.

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c. Interest income to Total Revenue (II/TR): Shows the share of banks interest income earned
from advances out of the total revenue.
Capital adequacy
Capital Adequacy reflects the overall financial position of the bank. It also indicates whether the
bank has enough capital to absorb unforeseen losses having sufficiency of equity to absorb any
unexpected shocks that a bank may face. Capital Adequacy ratio acts as an indicator of bank
leverage. The main components of this ratio are,
a. Total debt to Total asset (TD/TA): This ratio indicates the degree of leverage of a bank. It
indicates how much of the bank business is financed through debt and how much through equity.
Higher ratio indicates less protection for the creditors and depositors in the banking system.
b. Total equity to Total asset (TE/TA): This ratio of shareholders equity to total asset.
c. Total capital to Risk-Weighted Assets (TC/RWA): it indicates the riskiness of asset employed
by the bank.
Asset quality
Asset quality is one dimension that can affect performance of a given bank. The dimension of
asset quality is an important factor that helps the bank in understanding the extent of risk of loss
due to a debtor‟s failure to make repayment of loan (Olweny and Shipho, 2011 and Baral, 2005).
Default occurs when a debtor unable to fulfil legal obligations according to the contract, or has
violated a loan condition of the debt contract, which might occur with all debt obligations
including bonds, mortgages, loans, and promissory notes. The main components of this ratio are,
a. Allowance for doubtful loans to total assets (ADL/TA): This ratio discloses the efficiency of
bank in assessing the credit risk and, to an extent, recovering the debts. It is the ratio of
allowance for doubtful loans and total assets.
b. Loan loss reserves to outstanding loans (LLR/OL): It is the most standard measure of assets
quality measuring the net non-performing assets as a percentage to net advances.
c. Non-Performing Loans to total loans outstanding(NPL/TLO): this measure the loss incurred
due to poor loan quality.

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Table 3.1 : List of performance criteria and sub criteria of banks
Goal criteria Sub criteria
C1 LIQUIDITY L1 Liquid asset / total asset

L2 Liquid asset / demanded deposits

L3 Liquid asset / total deposit
C2 EFFICIENCY E1 Total advances / total deposits
E2 Earnings before Tax / Total Revenue
Bank performance

E3 Total revenue/total number of employee

C3 P1 Profit before taxes / equity
PROFITABILITY P2 Profit before taxes / asset
P3 Interest income / Total Revenue
C4 CAPITAL C1 Total debt / total asset
ADEQUACY C2 Total equity/total asset
C3 Total capital / risk weighted asset
C5 ASSET A1Allowance for doubtful loans / total assets
QUALITY A2Loan loss reserves / outstanding loans
A3Non –performing loans/ outstanding loans

3.3.2 Definition of Study Variables stock market performance measures

Market Capitalization

Market Capitalization refers to the value of a company that is traded on the stock market,
calculated by multiplying the total number of shares by the present share price (Laeven, 2014).
This entails the aggregate value of a company‟s stock. It mainly indicates any movements which
are made by accessing the total value of stocks in a particular stock market and aggregating the
market value of the quoted stocks. The market capitalization is not constant as it moves with
movement in share prices. As the size of monetary system increases it generates more
opportunities for profitable operation thus boosting capital market development.

Market capitalization= Current market price per share* Total number of outstanding shares

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Trade volume /Liquidity

Liquidity is the degree to which an asset or security can be bought or sold in the market without
affecting the asset‟s market price. Liquidity is characterized by a high level of trading (buying
and selling) activity. Assets that can be easily bought or sold are known as liquid assets.
Liquidity is the ability to convert an asset to cash quickly also known as “marketability”.
Liquidity is often calculated using liquidity ratios. Liquidity is a main factor to consider for the
investor and issuer. Liquidity is also the benchmark for each capital market. Investors interested
in capital market will focus on the liquidity to engage in any kind of transaction around the globe
(Ruecker, 2011).

Trade volume= monthly birr volume / sum of absolute value of daily percentage change in stock
price.

Table 3.2: List of performance criteria and sub criteria of stock market

Goal criteria Sub criteria

C1 MARKET MC= Current market price per share* Total number of
Stock market
performance

CAPITALIZATION outstanding shares

C2 TRADEVOLUME TV= (monthly birr volume) / (sum of absolute value of daily
/LIQUIDITY/ percentage changes in stock price)

3.3.3 Definition of Study Variables insurance performance measures

Profitability
Profitability indicates the enterprise capital appreciation profitability, including net assets yield
rate, total return on assets, income margins, profit margins and return on investment.
Capital profit margin (net assets yield) = net profit / net assets average balance * 100%
Asset profit margin (total return on assets) = total profit / total assets * 100%
Income profit = operating profit / operating income * 100%
Expenditure margin = operating profit / operating expenses * 100%
Return on investment=net profit/total investment *100%

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Operating growth
Operating growth mainly includes the state-owned capital preservation and appreciation rate,
profit growth rate, economic profit margins.
Premium growth rate = (Gross Premium Written (Y1) - Gross Premium Written (Y0))/ Gross
Premium Written (YO) x 100%
Profit growth rate = (total profit for the year - total profit for the previous year) / total profit for
the previous year × 100%
Economic profit margin = (net profit - average balance of net assets × capital cost) / net assets
average balance × 100%
Asset quality
Asset quality is an important part of the enterprise asset management level and the use of
efficiency. Mainly including tangible asset, recognized asset rate and accounts receivable ratio.
Tangible asset rate= tangible asset/ total asset*100%
Approved asset rate = recognized assets / total assets × 100%
Accounts receivable ratio = (premium payable + interest receivable + other receivables) / total
assets × 100%
Solvency
Solvency refers to the ability of an enterprise to repay short-term and long-term debt. Its strength
is the main embodiment of the enterprise's economic strength and financial condition, and also
an important measure to measure whether the enterprise is stable or not. The main indicator is
solvency adequacy ratio.
Solvency adequacy ratio = (Net income + Depreciation and amortization) / total liability × 100%
Management soundness
Sound management is one of the most important factors behind financial institutions‟
performance. Indicators of quality of management, however, are primarily applicable to
individual institutions, and cannot be easily aggregated across the sector.
Premium per employee= Premium / No of employees
Asset per employee= Asset /No of employees

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Table 3.3: List of performance criteria and sub criteria of insurance companies
Goal criteria Sub criteria
C1 PROFITABILITY P1Net asset yield
P2 Total return on asset
P3 Income margins
Insurance company performance

P4 Profit margin
P5 Return on investment
C2 OPERATING GROWTH O1 premium growth rate
O2 profit growth rate
O3 economic profit margins
C3 ASSET QUALITY A1 tangible asset rate
A2 recognized asset rate
A3 accounts receivable ratio

C4 SOLVENCY S1 solvency adequacy ratio

C5 MANAGEMENT SOUNDNESS M1Premium per employee
M2 Asset per employee

3.4. Target Population

The target population of this study consists of experts in bank, insurance companies as well as
intellectuals who studied about capital market and regulatory bodies. The population size is
determined by purposive sampling technique. There are 17 banks in Ethiopia two of them are
state owned and the rest are private share companies‟ and17 insurance companies.
Table 3.4: Profile of Ethiopian banks

Item Name of Bank Year of Paid-up Deposit Total loans Total

No. est. capital balance and asset
(Billion) (Billion) advances (Billion)
(Billion)
1 Abay Bank S.C. 2010 0.71 4.83 3.07 6.18
2 Addis International Bank 2011 0.71 2.97 2.03 4.20
3 Awash Bank 1994 2.9 43.45 31.04 55.3
4 Bank of Abyssinia 1996 2.56 25.79 17.99 31.98
5 Berhan International Bank 2010 1.7 12.2 7.2 14.1
6 Bunna International Bank 2009 1.47 9.15 6.84 13.02

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7 Commercial Bank of Ethiopia 1963 40 451.8 100.68 565.5
8 Cooperative Bank of 2005 1.59 25.39 14.71 29.88
Oromias.c.
9 Dashen Bank 2003 2.2 35.98 23.05 40.32
10 DebubGelobal Bank 2012 0.57 2.15 1.55 3.12
11 Enat Bank 2013 0.97 5.09 3.31 6.48
12 Lion International Bank 2006 1.18 11.63 7.37 14.31
13 Nib International Bank 1999 2.5 25.1 17.5 31.1
14 Oromia International Bank 2008 0.8876 19.9 14.7 23.79
15 United Bank 1998 1.78 19.76 14.86 28.03
16 Wegagen Bank 1997 2.31 20.06 14.78 27.39
17 Zemen Bank 2009 1.12 10.21 4.99 12.43
Source: Each bank web page 2017/18

Table 3.5: Profile of Ethiopian insurance companies

Item Name of Insurance company Year Paid-up Capital Profit
No. of Est. (million) (million)

1 Abay Insurance Company 2010 141.18 56.5

2 Africa Insurance Company S.C. 1994 30 71
3 Awash Insurance Company S.C. 1994 300 128.7
4 Berhan Insurance S.C. 2010 9.7 10
5 Bunna Insurance S.C. 2013 78.8 7
6 Ethiopian Insurance Corporation 1976 1971 698.5
7 Ethio-Life and General Insurance S.C 2008 86 17.76
8 Global Insurance Company S.C. 1997 102.94 21.4
9 Lion Insurance Company S.C. 2007 66.4 14.8
10 Lucy Insurance S.C. 2012 104 26
11 National Insurance Company of Ethiopia S.C. 1995 302 117
12 NIB Insurance Company 2002 247.99 58.2
13 Nile Insurance Company S.C. 1995 188.1 100.7
14 Nyala Insurance Company S.C. 1995 259 122.2
15 Oromia Insurance Company S.C. 2009 155.2 81.5
16 The United Insurance S.C. 1994 372.95 60.29
17 Tsehay Insurance S.C. 2012 77 11.6
Source: Each bank web page 2017/18
3.5 Data type and source

Data for the study was collected using both primary and secondary sources. The primary data
were obtained through design of questionnaires and interviews directed to a bank top
management officers, insurance top management officers and researchers who studied about
capital market development in Ethiopia. The secondary data were sourced from the published

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and unpublished sources such as credible web pages, books and different peer reviewed
published journal articles. The secondary data is used to get an insight of the problem and
considered for content validation of findings obtained from primary data.
3.6 Data Collection Method and Design

Mixed data collection methods were adopted with sequential manner. Qualitative interview
followed by quantitative survey questionnaire. Survey research is a commonly used method of
collecting information about a population of interest. There are many different types of surveys,
several ways to administer them, and many methods of sampling. One of the key features of a
survey research is questionnaires: a predefined series of questions used to collect information
from individuals. After evaluating the above methods this study employed assisted self-
administered questionnaires to generate the required information for analysis, since each person
(respondent) were asked to respond to the same set of questions. This provides an efficient way
of collecting reliable data from a sample prior to quantitative analysis.
Furthermore, an interview which consisted 8set of questions was administered on 7respondents
from bank, insurance and experts with exposure of global capital market. The interviews were
conducted in order to guide refinement on the questionnaires and fill the gap in the responses
received from the questionnaires. A set of AHP and DEMATEL questionnaire were constructed
accordingly and analysed through Microsoft excel and Matlab.
3.7 Data Analysis

In this section, an integrated method, combined (Decision Making Trial and Evaluation
Laboratory) DEMATEL method and (Analytic Hierarchy Process) AHP method were developed.
The procedures that are used in the proposed method are described as follows.
The Analytic Hierarchy Process (AHP)
AHP method component is the mathematical model by which the priorities (weights) of elements
positioned on the same hierarchy structure level are calculated.
Stankevičienė and Mencaitė, (2012) suggested the adaptation of the AHP model for its help with
evaluating financial institutions and their performance by combining diff erent advantages of
multi-criteria decision making with a single balanced system. The model also can be considered
as the universal one because it can be applied and used by both professional analysts and the
clients of a bank as it requires information available in public sources. The AHP model also

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helps with revealing bank ranking and recognizing better performing banks and those that need
more attention either from supervisory institutions or management in order to improve the
current performance. This model also includes external judgment that could help with building a
more specific evaluation framework. AHP is used in Complex decision problem solving. The
other significance of AHP is: it breaks down a decision-making problem into several levels in
such a way that they form a hierarchy with unidirectional hierarchical relationships between
levels (De Felice and Petrillo, 2014). The AHP for decision making uses objective mathematics
to process the inescapably subjective and personal preferences of an individual or a group in
making a decision. With the AHP, one constructs hierarchies or feedback networks, then makes
judgments or performs measurements on pairs of elements with respect to a controlling element
to derive ratio scales that are then synthesized throughout the structure to select the best
alternative (De Felice, 2012). The top level of the hierarchy is the main goal of the decision
problem. The lower levels are the tangible and/or intangible criteria and sub-criteria that
contribute to the goal. The bottom level is formed by the alternatives to evaluate in terms of the
criteria. The modelling process can be divided into different phases for the ease of understanding
which are described as follows:
STEP 1: Pairwise comparison and relative weight estimation. Pairwise comparisons of the
elements in each level are conducted with respect to their relative importance towards their
control criterion. Saaty suggested a scale of 1-9 when comparing two components (see the table
below). For example, number 9 represents extreme importance over another element. And
number 8 represents it is between „„very strong important” and „„extreme importance” over
another element.
Table 3.6: The Saaty (1980) Rating scale
Intensity of Definition Explanation
importance aij
1 Equal Importance Two activities contribute equally to the
objective
3 Moderate importance Experience and judgment slightly favour one
activity over another
5 Strong importance Experience and judgment strongly favour one
activity over another

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7 Very strong or demonstrated An activity is favoured very strongly over
importance another; its dominance demonstrated in practice
9 Extreme importance The evidence favouring one activity over
another is of the highest possible order of
affirmation
2,4,6,8 For compromise between the Sometimes one needs to interpolate a
above values compromise judgment numerically because
there is no good word to describe it.

For a general AHP application we can consider that A1, A2,…,Am denote the set of elements,
while aij represents a quantified judgment on a pair of Ai, Aj. Through the 9-value scale for
pairwise comparisons, this yield an [m x m] matrix A as follows:
A1 A2 …. Am
A1 1 a12 …. a1m
A=aij= A2 1/a12 1 …. a2m
…. …. …. …. ….
Am 1/a1m 1/a2m …. 1
Where, aij> 0 (i, j = 1, 2,..,m),
aii = 1 (i = 1, 2,…,m), and
aij = 1/aji ( 1; 2;…,m).
A is a positive reciprocal matrix. The result of the comparison is the so-called dominance
coefficient aij that represents the relative importance of the component on row (i) over the
component on column (j), i.e., aij=wi/wj.
The pairwise comparisons can be represented in the form of a matrix. The score of 1 represents
equal importance of two components and 9 represents extreme importance of the component i
over the component j. In matrix A, the problem becomes one of assigning to the m elements A 1,
A2,…,Am a set of numerical weights w1, w2,…,wm that reflects the recorded judgments. If A is a
consistency matrix, the relations between weights wi, wj and judgments aij are simply given by
aij = wi/wj (for i,j = 1, 2.. m).
If matrix w is a non-zero vector, there is a λmax of Aw = λmaxw, which is the largest eigenvalue
of matrix A.

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If matrix A is perfectly consistent, then λmaxw = m. But given that aij denotes the subjective
judgment of decision-makers, who give comparison and appraisal, with the actual value (wi/wj)
having a certain degree of variation. Therefore, Ax = λmaxw cannot be set up. So the judgment
matrix of the traditional AHP always needs to be revised for its consistency.
STEP 2: Priority vector. After all pairwise comparison is completed, the priority weight vector
(w) is computed as the unique solution of Aw = λmaxw, where λmax is the largest eigenvalue of
matrix A.
STEP 3: Consistency index estimation. Saaty (1990) proposed utilizing consistency index (CI) to
verify the consistency of the comparison matrix. The consistency index (CI) and (CR) of the
derived weights could then be calculated by:
CI = (λmax−n)/ n−1
CR=CI/RI
In general, if CR is less than 0.10, satisfaction of judgments may be derived.
Decision Making Trial and Evaluation Laboratory (DEMATEL)
Decision Making Trial and Evaluation Laboratory (DEMATEL) method gives a contribution to
solving the complex problems. It was developed in 1976 by the Institute of Geneva Battelle
Memorial. The main advantage of DEMATEL method in comparison with others is that it is very
helpful to evaluate the way and the power of the relationship between the variables (Chen, 2016).
The steps of DEMATEL approach are demonstrated below
Step 1: Initial direct relation matrix is generated. This matrix is illustrated in Equation 1. The
matrix of the elements in each level are conducted based on the opinions of the experts. There is
a suggested scale of 0-4 when comparing two components (see the table below). For example,
number 4 represents very high influence on another element. And number 0 represents no
influence on another element.
Level of influence Definition

0 No influence
1 Low influence
2 Medium influence
3 High influence
4 very high influence

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 𝐴𝑘 = 0 ⋯𝑎1𝑛𝑘
⋮⋱⋮ …………………………….(1)
𝑎𝑛1𝑘⋯ 0

Step 2: Initial influence matrix is calculated. In this step, the relationship among the elements can
be identified.
Step 3: Direct relation matrix is normalized. In this process, Equation 2 is used. In this equation,
the term “bij” takes values between 0 and 1.
𝐵 = [𝑏𝑖𝑗] =𝐴/𝑚𝑎𝑥∑n𝑗=1𝑎𝑖𝑗……….……………….……..(2)
Step 4: Total relation matrix is developed which is shown in Equation 3. In this equation, “C”
represents total relation matrix and “I” gives information about identity matrix.
𝐶 = [𝑐𝑖𝑗] = (𝐼 −𝐵)−1…………………………………… (3)
Step 5: The prominence (D+E) and cause-effect (D-E) values are calculated. For this purpose,
Equation 4 and 5 are taken into the consideration.
𝐷 = [𝑑𝑖𝑗]1 = [∑𝑛 𝑗=1 𝑐𝑖𝑗𝑖j] 𝑛𝑥1………………………….(4)
𝐸 = [𝑒𝑖𝑗]1𝑥𝑛 = [∑𝑛 𝑗=1 𝑐𝑖𝑗𝑖j] 𝑛𝑥1………………………..(5)
Step 6: Inner dependence matrix is defined. In this process, entries, which are less than the
threshold value, are eliminated. The threshold value can be calculated by using Equation 6.
𝑎 =∑ 𝑛 𝑗=1∑ 𝑛 𝑖=1 𝑛 𝑐/𝑛2……………………………..(6)
3.8 Instrument Validity &Reliability
3.8.1Instrument Validity
Validity refers to the degree to which results obtained from the analysis of the data actually
represents the phenomena under study. Validity is a matter of degree and not a specific value. In
order to check instrument validity, a pilot study was conducted to refine the methodology and
test instrument such as a questionnaire before administering the final phase. Issues that were
raised by respondents during the interview (expert opinion) were used to correct and refine the
questionnaires. The preview of the questionnaire with experts also contributes to avoid any
redundancy or error. Moreover, proper detection and approval by the research advisor was
adopted to ensure validity of the instruments. Finally, the improved version of the questionnaires
were printed, duplicated and dispatched. Quantitative and qualitative analysis were made to
ensure the consistency of findings corresponding to each research question.

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3.8.2 Instrument Reliability

Reliability is the degree to which a questionnaire will produce the same result if administered
again. The test-retest concept was applied to test reliability.
3.9 Ethical issues

In conducting this study, the privacy of participants was kept, and it was disclosed to every
participant that the nature of participation is voluntary. The confidentiality of data and the
participants' anonymity was be maintained. In all cases, names will remain confidential thus
collective names like “respondents” or “study participants” will be used unless the participant are
willing to be named.
The researcher will take into account the issues of feasibility and efficiency in relation to gaining
access to data and the impact of these on the nature and content of the study questions and
objectives. In addition, all sources cited in this study were appropriately acknowledged.

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 CHAPTER FOUR

RESULTS AND DISCUSSION

4.1. Introduction
This chapter explains how the performance indicators of financial institutions were analysed and
discusses the results. The performance indicators trend analysis was depicted and discussed to
address research question one. Further, the performance indicators were ranked according to
their level of importance to address research question two. Moreover, interdependency between
performance indicators were established in order to address research question three.
Finlay, this chapter discusses the results of the analysis by triangulating the expert opinion
findings with the trend analysis of financial institution performance.

4.2 Performance indicators trend analysis

4.2.1 Bank performance indicators
The trend analysis of bank performance indicators below describes trend of the banking industry
as a whole. The data is collected from National Bank of Ethiopia (NBE) in order to reveal the
actual movement of performance indicators form 2010-2017 accommodating seven fiscal years
(FY).
Liquidity

Fig 4.1: Liquidity trend of banking industry.

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Liquidity trend of Ethiopian banking industry that is measured by liquid asset to total asset is
depicted above. As per NBE‟s data the liquidity ratio seems to take descending path for the past
seven years. This kind of trend in the banking industry exists due to stiff competition in the
financial system according to justifications given by scholars. The liquidity trend took a big drop
around 2012. On 2011/12 inflation re-emerged when it reached 26.7% from 17.5% the previous
year, the real GDP growth declined from 10.7% to 7% the previous year. Thus, the economic
development status of the country reflects its pressure on the banking industry. The lowest
liquidity position was recorded on 2016 which could be explained by the descending economic
growth to 8 present in FY2016 due to drought-related lower agricultural production.
Capital adequacy

Fig 4.2: Capital adequacy trend of banking industry.

Capital adequacy trend analysis of the Ethiopian banking industry that is measured by total
capital to risk weighted asset is shown on the above figure. As per NBE‟s data capital adequacy
ratio picks up on 2017 after a significant drop on 2012 and showing consistency for consecutive
years. Capital adequacy is also affected by the economic condition of the country during 2012
and 2016.

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Asset quality

Fig 4.3: Asset quality trend of banking industry.

Asset quality trend analysis of the Ethiopian banking industry that is measured by non-
performing loans to total loans outstanding is shown above. As per NBE‟s data the ratio picked
up after dramatic decrease on 2012. After the improvement of credit quality in 2012 the highest
asset quality ratio appeared on 2016.
Profitability

Fig 4.4: Profitability trend of banking industry.

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Profitability trend analysis of the banking industry that is measured by ROE is depicted on the
above table. As per NBE‟s data ROE appears to have a gentle rise until 2015 and face dramatic
drop on 2016. This could also be explained by the economic development change particularly on
that fiscal year.
Efficiency

Fig 4.5: Efficiency trend of banking industry.

Efficiency trend of the banking industry that is measured by total advances to total deposits is
shown above. As per NBE‟s data efficiency had a gentle rise until 2015 and remained stagnant
after wards. According to expert‟s this trend could possibly be explained by: the fact that
efficiency is considered the least important key performance indicators.
4.2.2 Insurance performance indicators
The trend analysis of insurance performance indicators below describes trend of the insurance
industry as a whole. The data is collected from National Bank of Ethiopia (NBE) in order to
reveal the actual movement of performance indicators form 2012-2017 accommodating five
fiscal years.

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Profitability

Fig 4.6: Profitability trend of insurance industry.

Profitability trend of Ethiopian insurance industry that is measured by ROI is depicted above. As

per NBE‟s data the ROI seems to take ascending path until 2014 until it faced a sharp decrease

reaching its lowest on 2016. 2016 FY is a year with a descending economic growth due to

drought-related lower agricultural production with the reflection of pressure on the financial

institutions. After wards the ROI picks up comfortably the following year.

Solvency

Fig 4.7: Solvency trend of insurance industry.

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Solvency trend of Ethiopian insurance industry that is measured by solvency ratio is depicted
above. As per NBE‟s data the solvency ratio took ascending path except on 2014 and 2016.

Fig 4.8: Asset quality trend of insurance industry.

Asset quality trend of Ethiopian insurance industry that is measured by tangible asset is depicted
above. As per NBE‟s data the tangible asset ratio faced a sharp fall on 2015 and remained for
consecutive years.

Fig 4.9: Operating growth trend of insurance industry.

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Operating growth trend of Ethiopian insurance industry that is measured by premium growth is
depicted above. As per NBE‟s data the premium growth rate had descending trend until 2014
which picked up the next year to go back down on 2016 with a big leap the following year.
4.3 Performance indicators ranking with empirical approaches to making decisions using
AHP Application
Accordingly the performance indicators were ranked using AHP. “Analytic Hierarchy Process is
a flexible model that will enable individuals or organizations to mould ideas and make their own
hypothesis; it also enables people to test solutions, or the results of sensitivity, so as to change
information” (Saaty, 1980).
In the thesis, the Judgment matrix calculation method was utilized to rank performance
indicators of banks and insurance companies and give criteria weight to each indicator.
4.3.1 Hierarchy Structure of bank and insurance company performance indicators.
“A hierarchy is a more or less faithful model of a real-life situation; it represents our analysis of
the most important elements in the situation and of their relationships” (Saaty,1980).
Three level hierarchy structure were established in this thesis, which is target layer, criterion
layer and sub criteria layer. Target layer is to rank performance indicators of these financial
institutions. Criterion layer consists of five criteria which were replaced by C1, C2, C3, C4 and
C5. Sub criterions are grouped under each criterion. In the analytic hierarchy model, straight
lines are used to indicate relationship between factors in the left layer to the right layer. If each of
the layers are associated with all elements consisted in the right layer, it indicates these two
layers have full level relationship. The hierarchy structure is the base for further analysis.
The specific evaluation indicators corresponding model is shown as below:

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`

Layer 1= Goal Layer 2= Criterion Layer 3= Sub-Criterion

L1- LA/TA
C1- Liquidity L2- LA/DD
L3- LA/TD

E1- Tad/TD
C2- Efficiency E2- EBT/TR
E3- TR/No.Emp
Bank performance

P1- ROE
C3- Profitability P2- ROA
P3- II/TR

Ca1- TD/TA
C4- Capital adequacy Ca2- TE/TA

Ca3- TC/RWA

A1- ADL/TA
C5- Asset quality
A2- LLR/OL
A3- NPL/OL

Fig 4.10: bank performance indicator hierarchy structure

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Layer 1= Goal Layer 2= Criterion Layer 3= Sub-Criterion

P1- Net asset yield

P2- ROA
C1- Profitability P3- Income margin
P4- profit margin
Insurance company performance

P5- ROI

O1- Premium Growth

C2- operating growth
O2- Profit growth rate
O3- Economic profit margin

A1- Tangible asset

C3- Asset quality A2- Recognized asset

A3- Accounts receivables

ratio
C4- Solvency S1- Solvency adequacy ratio

M1- Premium per employee

C5- Management
M2- Asset per employee
Soundness

Fig 4.11: Insurance companies performance indicator hierarchy structure

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4.3.2 Judgment Matrix for Pair-wise comparisons
After structuring the hierarchy, the step of collecting input data by pair-wise comparison comes
for establishing judgment matrix. Saaty, (1980) recommended a scale of 1 to 9 when comparing
two factors, with a score of 1 refers to there is no difference between two factors and 9 represents
one factor is extremely important than the other one. On the other hand, if a factor has weaker
impact, the range of scores will be from 1 to 1/9, where 1 represents indifference and 1/9
represents the factor is extremely unimportant than the other one.
It is very important to fill the judgment matrix. Twenty judgment matrix tables were filled by
experts. Twelve of the matrixes were for bank performance criteria ranking and eight were for
insurance companies performance indicators ranking. The pair wise comparison matrixes were
filled by experts in the banking and insurance industry with at least more than 15 years of
experience and in a position of top level management.
From the hierarchy, 6 pair-wise data was collected for each performance indicators of the
financial institutions, that is 1 pair-wise comparison for criteria in layer 2 and 5 pair-wise
comparison layer 3 of sub criteria. For instance the filled pair-wise comparison for criteria in
layer 2 for bank and insurance respectively are as follows:
Table 4.1: Pairwise Comparison matrix of bank performance indicators
Comparison of bank performance criteria
C1 C2 C3 C4 C5
C1 1 9 5 2 3
C2 1/9 1 ½ 1/5 1/3
C3 1/5 2 1 1/5 1/2
C4 ½ 5 5 1 2
C5 1/3 3 2 ½ 1

Table 4.2: Pairwise Comparison matrix of insurance performance indicators

Comparison of insurance performance criteria
C1 C2 C3 C4 C5
C1 1 7 9 6 8
C2 1/7 1 5 4 7
C3 1/9 1/5 1 1/3 6
C4 1/6 1/4 3 1 4
C5 1/8 1/7 1/6 1/4 1

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Filled judgment matrix has the following properties:
1) aij>0
2) aij= 1/aji
3) aii=1, (i, j = 1, 2 ,3, 4….n)
According to the characteristics above, judgment matrix has symmetrical and transitive.
4.3.3 Eigenvector and Eigen value
According to the filled out judgment matrix above, a certain mathematic methods were used to
calculate its Eigenvector and Eigen value.
Eigenvector 𝐸𝑖 First of all, to multiply all values in the row:
𝑀𝑖= 𝑎𝑖1+…𝑎𝑖𝑗 = 𝑎𝑖𝑗 n i (i,j=1...n),
W= 𝑀1 𝑛 +... 𝑀𝑖 𝑛 = 𝑀𝑖 𝑛 𝑛 𝑖 (i,j =1....n),
𝐸𝑖= 𝑀𝑖 𝑛 / W (i, j=1...n)
After normalized by each column, the priority vector for criteria was achieved as indicated below
for banks and insurance companies respectively.
Table 4.3: Respective Eigenvector value of bank performance indicators
C1 C2 C3 C4 C5 Eigenvector
C1 0.466 0.450 0.370 0.513 0.439 0.448
C2 0.052 0.050 0.037 0.051 0.049 0.048
C3 0.093 0.100 0.074 0.051 0.073 0.078
C4 0.233 0.250 0.370 0.256 0.293 0.281
C5 0.155 0.150 0.148 0.128 0.146 0.146

Table 4.4: Respective Eigenvector value of insurance performance indicators

C1 C2 C3 C4 C5 Eigenvector
C1 0.647 0.815 0.495 0.518 0.308 0.557
C2 0.092 0.116 0.275 0.345 0.269 0.220
C3 0.072 0.023 0.055 0.029 0.231 0.082
C4 0.108 0.029 0.165 0.086 0.154 0.108
C5 0.081 0.017 0.009 0.022 0.038 0.033

Eigenvector 𝐸𝑖 = (0.448, 0.048, 0.078, 0.281, 0.146) for bank and 𝐸𝑖 = (0.557, 0.220, 0.082, 0.108,
0.033) for insurance companies respectively. The sum of five values for banks and insurance
companies separately equal to 1, and these specific values refers to the proportions of each
criterion to the target factors respectively.
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4.3.4 Calculating consistency

Table 4.5: consistency matrix for bank performance indicators

Eigenvector 0.448 0.048 0.078 0.281 0.146

C1 C2 C3 C4 C5 weighted Eigenvector
sum value
C1 0.448 0.430 0.392 0.561 0.437 2.267 0.448 5.065
C2 0.050 0.048 0.039 0.056 0.049 0.241 0.048 5.051
C3 0.090 0.096 0.078 0.056 0.073 0.392 0.078 5.008
C4 0.224 0.239 0.392 0.281 0.291 1.426 0.281 5.085
C5 0.052 0.450 0.296 0.064 0.146 1.008 0.146 6.921

Eigenvalue λmax= = 5.4257

N
Table 4.6: consistency matrix for insurance performance indicators
Eigenvector 0.434 0.052 0.080 0.285 0.149
C1 C2 C3 C4 C5 weighted Eigenvector λmax
sum value
C1 0.557 1.538 0.738 0.651 0.267 3.750 0.557 6.737

C2 0.080 0.220 0.410 0.434 0.233 1.376 0.220 6.263

C3 0.062 0.044 0.082 0.036 0.200 0.424 0.082 5.173

C4 0.093 0.055 0.246 0.108 0.133 0.635 0.108 5.859

C5 0.010 0.002 0.002 0.005 0.033 0.053 0.033 1.582

Eigenvalue λmax= = 5.1229

N

4.3.5 Consistency Verification

After calculating Eigenvector and Eigenvalue, the next step is judgment matrix consistency
verification, for the purpose of explaining the judgment matrix is reasonable in logic. Only if
judgment matrix has passed the consistency verification, eigenvector and eigenvalue can
estimate the weight of indicators. And it is meaningful to continue analysis and to obtain the
final result based on the previous data. The steps for consistency test will take place as follows:
First, to calculate Consistency index C.I for bank and insurance performance indicators
respectively:

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C.I. = 𝜆𝑚𝑎𝑥 –𝑛/n 𝑛−1
C.I. = 5.4257−5/ 5−1 = 0.1064 (for bank performance indicators)
C.I. = 𝜆𝑚𝑎𝑥 –𝑛/n 𝑛−1
C.I. = 5.1229−5/ 5−1 = 0.03 (for bank performance indicators)
Second, determine corresponding average random consistency index R.I. by checking the table
below:
Table 4.7: Corresponding average random consistency index R.I. (Saaty 1982)
1 2 3 4 5 6 7 8 9 10
0 0 0.58 0.9 1.12 1.24 1.32 1.41 1.45 1.49

From the table we can see that different matrices have different values, for instance, for 5
matrices, R.I. =1.12.
Third, calculate consistency ratio C.R. And verify if the judgment matrix satisfy the requirement
of consistency.
C.R. = 𝐶.𝐼/𝑅.𝐼.
The judgment matrix consistency is acceptable if C.R. < 0.1, otherwise, the judgment matrix
does not meet the requirement of consistency, the judgment matrix should be modified.
For bank performance criteria matrix,
C.I. = 0.1064 and C.R. = 0.09 < 0.1,
For insurance performance criteria matrix,
C.I. = 0.03 and C.R. = 0.027 < 0.1,
Therefore judgment matrix is acceptable.
The importance of five performance criterion for banks is:
Liquidity>Capital adequacy >Asset quality >Profitability > Efficiency
The importance of five performance criteria for insurance companies is:
Profitability>Operating growth >Solvency >Asset quality>Management soundness
4.3.6 Calculating the relative importance of elements in single criterion
The relative importance of criteria for performance indicator ranking was done based on the
AHP calculation method above, for the solution factors to Layer 2. There are still five judgment
matrixes for banks sub criterion and three judgment matrixes for insurance companies sub
criterion need to be calculated and consistency tested by following the above calculation process.

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Sub criteria filled out judgment matrixes, their eigenvalues, consistency indexes and consistency
ratios are:
Bank performance indicators sub criteria evaluation
Table 4.8: Three alternatives judgment matrix based on liquidity
C1 C2 C3
C1 1 1/7 ¼
C2 7 1 3
C3 4 1/3 1
𝜆𝑚𝑎𝑥 = 3.033
C.I. = 0.16
C.R. = 0.028
Table 4.9: Three alternatives judgment matrix based on efficiency.
C1 C2 C3
C1 1 5 7
C2 1/5 1 3
C3 1/7 1/3 1
𝜆𝑚𝑎𝑥 = 3.066
C.I. = 0.033
C.R. = 0.057
Table 4.10: Three alternatives judgment matrix based on profitability.
C1 C2 C3
C1 1 5 7
C2 1/5 1 3
C3 1/7 1/3 1
𝜆𝑚𝑎𝑥 = 3.066
C.I. = 0.033
C.R. = 0.057
Table 4.11: Three alternatives judgment matrix based on capital adequacy.
C1 C2 C3
C1 1 1/3 1/7
C2 3 1 ¼
C3 7 4 1
𝜆𝑚𝑎𝑥 = 3.033
C.I. = 0.016
C.R. = 0.028

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Table 4.12: Three alternatives judgment matrix based on asset quality.
C1 C2 C3
C1 1 1/3 1/7
C2 3 1 ¼
C3 7 4 1
𝜆𝑚𝑎𝑥 = 3.033
C.I. = 0.016
C.R. = 0.028
Insurance company performance indicators sub-criteria evaluation
Table 4.13: Five alternatives judgment matrix based on profitability.
C1 C2 C3 C4 C5
C1 1 7 9 6 8
C2 1/7 1 5 4 7
C3 1/9 1/5 1 1/3 6
C4 1/6 ¼ 3 1 4
C5 1/8 1/7 1/6 1/4 1
𝜆𝑚𝑎𝑥 = 5.1229
C.I. = 0.0307
C.R. = 0.027
Table 4.14: Three alternatives judgment matrix based on operating growth.
C1 C2 C3
C1 1 7 5
C2 1/7 1 1/3
C3 1/5 3 1
𝜆𝑚𝑎𝑥 = 3.066
C.I. = 0.033
C.R. = 0.057
Table 4.15: Three alternatives judgment matrix based on asset quality
C1 C2 C3
C1 1 5 7
C2 1/5 1 3
C3 1/7 1/3 1
𝜆𝑚𝑎𝑥 = 3.066
C.I. = 0.033
C.R. = 0.057

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4.3.7 Vectors integrated for priority ranking
Consistency ratios for eight matrixes were tested acceptable. So eigenvectors and eigenvalues
which were calculated in criteria layer and sub criteria layer are reasonable in logic.
4.4 Establishing interdependency matrix using DEMATEL
4.4.1 Creating direct relation matrix
After ranking the performance indicators of financial institutions in the previous section, another
direct relation matrix was developed to investigate interdependency between each performance
indicator and performance indicators of capital market.
A combination of interview and scoring sheet is used to determine the influence relationship
among each performance indicators. The interview was conducted on experts from the banking
industry, insurance industry and researchers with capital market knowledge.
Table 4.16: Listed labels of bank and capital market performance indicators.
Label Description
F1 Market capitalization
F2 Trade volume (annual average)
F3 Liquidity of banks
F4 Efficiency of banks
F5 Profitability of banks
F6 Capital adequacy of banks
F7 Asset quality of banks

Table 4.17: Direct relation matrix for capital market and bank performance indicators.
F1 F2 F3 F4 F5 F6 F7 ∑nj=1aij
F1 0 4 4 4 3 3 1 19

F2 4 0 3 1 2 3 1 14

F3 2 4 0 1 4 2 1 14

F4 3 3 3 0 4 2 3 18

F5 4 4 3 3 0 3 1 18

F6 2 2 3 1 3 0 2 13

F7 4 4 1 1 3 2 0 15

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Table 4.18: Listed labels of insurance company and capital market performance indicators.
Label Description
F1 Market capitalization
F2 Trade volume (annual average).
F3 Profitability of insurance companies.
F4 Operating growth of insurance companies.
F5 Asset quality of insurance companies.
F6 Solvency of insurance companies.
F7 Management soundness
Table 4.19: Direct relation matrix for capital market and insurance performance indicators.
, F1 F2 F3 F4 F5 F6 F7 ∑nj=1aij
F1 0 4 3 2 2 3 2 16

F2 4 0 4 3 1 3 1 16

F3 4 4 0 3 2 3 3 19

F4 4 4 4 0 3 3 2 20

F5 4 4 4 2 0 2 2 18

F6 4 4 3 1 1 0 1 14

F7 3 3 3 3 3 2 0 17

4.4.2 Normalizing the direct relation matrix

Normalizing the direct relation matrix M according to equation (2) by using excel, the
normalized direct relation matrix N for bank and insurance companies respectively is as follows:
Table 4.20. Normalizing direct relation matrix N of capital market and bank.
F1 F2 F3 F4 F5 F6 F7
F1 0 0.210526 0.210526 0.210526 0.157895 0.157895 0.052632

F2 0.210526 0 0.157895 0.052632 0.105263 0.157895 0.052632

F3 0.105263 0.210526 0 0.052632 0.210526 0.105263 0.052632

F4 0.157895 0.157895 0.157895 0 0.210526 0.105263 0.157895

F5 0.210526 0.210526 0.157895 0.157895 0 0.157895 0.052632

F6 0.105263 0.105263 0.157895 0.052632 0.157895 0 0.105263

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F7 0.210526 0.210526 0.052632 0.052632 0.157895 0.105263 0

Table 4.21. Normalizing direct relation matrix N of capital market and insurance companies.
F1 F2 F3 F4 F5 F6 F7
F1 0 0.2 0.15 0.1 0.1 0.15 0.1

F2 0.2 0 0.2 0.15 0.05 0.15 0.05

F3 0.2 0.2 0 0.15 0.1 0.15 0.15

F4 0.2 0.2 0.2 0 0.15 0.15 0.1

F5 0.2 0.2 0.2 0.1 0 0.1 0.1

F6 0.2 0.2 0.15 0.05 0.05 0 0.05

F7 0.15 0.15 0.15 0.15 0.15 0.1 0

4.4.3 Creating total relation matrix

After normalized the direct relation matrix, we can create total relation matrix T based on Table
3 and equation (3) by using MATLAB.
Table 4.22: Total relation matrix t for capital market and banks.
F1 F2 F3 F4 F5 F6 F7 D
F1 0.8379 1.0974 0.9842 0.7183 0.97 0.8442 0.4596 5.9116

F2 0.8127 0.7045 0.7556 0.4702 0.7293 0.6791 0.3564 4.5078

F3 0.7402 0.8806 0.6151 0.4665 0.8046 0.6393 0.3536 4.4999

F4 0.953 1.0321 0.9098 0.5261 0.9782 0.7798 0.5269 5.7059

F5 0.9808 1.0603 0.9142 0.6603 0.7967 0.8181 0.4405 5.6709

F6 0.693 0.7544 0.706 0.4365 0.7265 0.5034 0.3787 4.1985

F7 0.8749 0.9374 0.7178 0.5053 0.8117 0.6828 0.3275 4.8574

R 5.8925 6.4667 5.6027 3.7832 5.817 4.9467 2.8432

Table 4.23: Total relation matrix t for capital market and insurance companies.
F1 F2 F3 F4 F5 F6 F7 D
F1 0.873 1.0396 0.9289 0.6577 0.5508 0.7838 0.5387 5.3725

F2 1.0485 0.8818 0.9718 0.7001 0.5167 0.7926 0.506 5.4175

F3 1.1852 1.1852 0.9319 0.7922 0.6326 0.8929 0.6547 6.2747

F4 1.2401 1.2401 1.1495 0.6957 0.6987 0.9331 0.6445 6.6017

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F5 1.1455 1.1455 1.0635 0.7285 0.5182 0.824 0.5972 6.0224

F6 0.9347 0.9347 0.8301 0.5486 0.4509 0.5767 0.4435 4.7192

F7 1.0673 1.0673 0.9899 0.741 0.6326 0.7916 0.4855 5.7752

R 7.4943 7.4942 6.8656 4.8638 4.0005 5.5947 3.8701

4.4.4 Calculating the influence degree, the affected degree, the centre degree and the cause
degree
After creating total relation matrix T, Then we calculate prominence (D+R) and cause-effect (D-
R) values based on equation (4) and (5). D is the influence degree of each indicator and R is the
affected degree of each indicator.
Table 4.24: Influence degree, affected degree, centre degree and cause degree of bank and
market performance indicators.
D R D-R D+R
F1
5.9116 5.8925 0.0191 11.8041
F2
4.5078 6.4667 -1.9589 10.9745
F3
4.4999 5.6027 -1.1028 10.1026
F4
5.7059 3.7832 1.9227 9.4891
F5
5.6709 5.817 -0.1461 11.4879
F6
4.1985 4.9467 -0.7482 9.1452
F7
4.8574 2.8432 2.0142 7.7006
Table 4.25 Influence degree, affected degree, centre degree and cause degree of insurance and
market performance indicators.
D R D-R D+R
F1
5.3725 7.4943 -2.1218 12.8668
F2
5.4175 7.4942 -2.0767 12.9117
F3
6.2747 6.8656 -0.5909 13.1403
F4
6.6017 4.8638 1.7379 11.4655
F5
6.0224 4.0005 2.0219 10.0229
F6
4.7192 5.5947 -0.8755 10.3139
F7
5.7752 3.8701 1.9051 9.6453

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D is the influence degree of each performance indicator, R is the affected degree of each
performance indicator, D+R is the centre degree of each performance indicator and D-R is the
cause degree of each performance indicator.
The centre degree represents factor‟s position and importance in the system, the bigger the
number of centre degree; the more important it is in the system. If cause degree D-R > 0, that
means influence degree is bigger than affected degree, the factor influences other factors. If D-R
< 0 that means influence degree is smaller than affected degree the factor affected by other
factors.

4.4.5 Creating visual diagram

Fig 4.12. Centre degree of bank performance indicators

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Fig. 4.13: casual diagram of bank and market performance indicators

Fig. 4.14: Centre degree of insurance performance indicators

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Fig. 4.15: casual diagram of insurance and market performance indicators
Bank and capital market interdependency interpretation
After created visual diagram, we can see that order of the centre degree follow the order as F1,
F5, F2, F3, F4, F6, and F7. The centre degree indicates that the importance of performance
indicators in the influence system. Therefore, based on the result, market capitalization,
profitability, trade volume, liquidity, efficiency and capital adequacy have bigger centre degree
that means have higher influence in the interaction to determine performance of banks and
capital market. But asset quality relatively shows lower centre degree meaning low influence in
the interaction to determine performance of bank and capital market.
We can see from the values of D-R that F1, F4 and F7 are bigger than zero, and F2, F3, F5 and
F6 are smaller than zero. As mentioned before, when cause degree is bigger than zero, the factor
influences other factors thus F1, F4 and F7 (market capitalization, efficiency and asset quality)
are the factors of influence also known as the cause group.
In figure 4.3 F1 – market capitalization has the highest D+R position indicator value which
means, that it is related in the strongest way with other perspectives, taking a central place in the
web of mutual relations. The lowest value of this indicator is attained by the F7 – asset quality.
In turn, D-R relation indicator allows to set a level of influence of analysed parameter on other
parameters. In fig. 4.4, F7 – asset quality has the highest, positive value of D-R relation indicator
which means, that this perspective has a dominating, casual influence on other perspectives but it
has a relatively lower D+R the implies its weak interdependence with all the criterion revealing it

Page 59
only influences mainly few of the performance indicators. In turn F2 and F3 – trade volume and
liquidity, having the highest negative value of the relation indicator implies highest degree
recipient of the influence extended by other perspectives. In figure 4.5, the F5 and F6 –
profitability and capital adequacy, also with a negative value of relation indicator, recipient of
influence extended from other criteria and are the most important criteria for bank performance.
Insurance and capital market interdependency interpretation
After created visual diagram, we can see that order of the centre degree follow the order as F3,
F2, F1, F4, F6, F5, and F7. The centre degree indicates that the importance of performance
indicators in the influence system. Therefore, based on the result, Profitability, trade volume,
market capitalization, operating growth, solvency, asset quality and management soundness have
bigger centre degree that means have higher influence in the interaction to determine
performance of insurance companies and capital market.
We can see from the values of D-R that F4, F5 and F7 are bigger than zero, and F1, F2, F3 and
F6 are smaller than zero. As mentioned before, when cause degree is bigger than zero, the factor
influences other factors thus F4, F5 and F7 (operating growth, asset quality and management
soundness) are the factors of influence on other factors or the cause group.
In figure 4.5 the F1 – market capitalization has the highest D+R position indicator value which
means, that it is related in the strongest way with other perspectives, taking a central place in the
web of mutual relations. The lowest value of this indicator is attained by the F7 – asset quality.
In turn, D-R relation indicator allows to get a level of influence of analysed parameter on other
parameters. Is simultaneously assumed, allowing to reflect the parameter‟s priority among other
analysed relations.
In fig. 4.4, the F5 – asset quality has the highest, positive value of D-R relation indicator which
means, that this perspective has a dominating, casual influence on other perspectives.
In turn F1 and F2 – market capitalization and trade volume, having the highest negative value of
the relation indicator, is in to the highest degree recipient of the influence extended by other
perspectives. In figure 4.4, the F3 and F6 – profitability and solvency, also with a negative value
of relation indicator, recipient of influence extended from other criteria and are the most
important criteria for insurance performance.

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4.5 Discussions
4.5.1 Introduction
Several steps were taken to rank performance criteria of banks and insurance companies by using
AHP. Then, DEMATEL is used to project influence relationship between capital market
indicators versus bank and insurance companies in Ethiopia. All achieved vectors and values
were tabulated to illustrate each weight. The table below summarizes the results of the assigned
criteria weight as well as degree of influence for bank and insurance companies respectively.
Interpreted findings are synthesised below.
4.5.2 Capital market and bank performance indicators
Table 4.26: Ranked performance indicators of bank
Criteria Criteria name Criteria weight Sub criteria Sub Criteria weight
Label label
C1 Liquidity 0.448 L1 0.6687
L3 0.2431
L2 0.0882
C4 Capital adequacy 0.281 Ca3 0.7014
Ca2 0.2132
Ca1 0.0853
C5 Asset quality 0.146 A3 0.7014
A2 0.2132
A1 0.0853
C3 Profitability 0.078 P1 0.7235
P2 0.1932
P3 0.0833
C2 Efficiency 0.048 E1 0.7235
E2 0.1932
E3 0.0833

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Table 4.27:Influence, affected, centre and cause degree of market and bank performance
indicators.
D R D+R D-R
Market capitalization
5.9116 5.8925 11.8041 0.0191
Trade volume
4.5078 6.4667 10.9745 -1.9589
Liquidity
4.4999 5.6027 10.1026 -1.1028
Efficiency
5.7059 3.7832 9.4891 1.9227
Profitability
5.6709 5.817 11.4879 -0.1461
Capital adequacy
4.1985 4.9467 9.1452 -0.7482
Asset quality
4.8574 2.8432 7.7006 2.0142

According to experts in the banking industry in Ethiopia performance indicators are ranked as
seen on table 4.26.
4.5.3 Bank performance indicators result interpretation
Liquidity
Liquidity is considered to be the first most important financial performance indicator among all
criteria in the banking industry. Liquidity is identified as critical indicator in the body of
knowledge by many researchers such as (Rachdi, 2013; Lipunga, 2014; Kumbirai and Web,
2010) but in contrary Lelissa, (2014) argued that liquidity is not the answer to performance rather
the ability of banks to control their credit risk. And banks need to diversify their income sources
by incorporating non-traditional banking services and control their overhead expenses which
could actually affect bank performance. However, researches such as Samad, (2004) describe
liquidity as „„the life and blood of a bank‟‟. This statement is supported by many researchers
implying liquidity not only serves as a critical performance indicator but also miss management
could lead to bankruptcy.
This research identified liquidity in Ethiopian banking industry to be measured by liquid asset to
total asset ratio. As much as this measurement is acceptable by researchers such as Mattana and
Panetti, (2012) others argue that bank can be solvent, holding assets exceeding its liabilities on
an economic and accounting basis, and still die a sudden death if its depositors and other funders
lose confidence in the institution (Elliott, 2015).
Although, liquidity is the most critical performance indicator in Ethiopian banking industry when
interdependencies were projected by introducing capital market indicators, it is highly influenced

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by others in the system such as market capitalization, efficiency and asset quality. This research
reports evidence that bank liquidity ratios (liquid assets to total assets) is going to be influenced
by market capitalization especially in early stages of development. As the findings indicate when
capital market is introduced depositors will have alternative investment opportunities in the
market which will become a competition for bank savings affecting liquidity directly. Therefore,
banks will have to provide better interest rate to saving and engage in profitable lending
activities to absorb high saving interest rate and still maintain their profit margin. Therefore
banks in turn will be forced to decrease their liquidity ratio to guarantee existence. This finding
is similar with Mattana and Panetti, (2012) that suggests liquid asset to total asset ratio of banks
decrease during the process of economic development. They stated in a new introduction of
financial markets banks engage in cross-subsidization of the impatient depositors to keep up with
the competitive pressure from the markets. Moreover, as the economy grows, it becomes easier
for the individuals to access the market, and the banks react to this by lowering their liquidity
ratios. In a panel investigation of 45 countries, they found evidence that such a mechanism is into
place. Concluding in a one-unit increase in an index of securities market liberalization leads to a
drop in the bank liquidity ratio between 15 and 22 per cent. This is also seen on the banking
industry liquidity trend analysis done based on NBE‟s data. The liquidity of the banking industry
is taking a descending trend every year and it only seems to get worse. Currently the NBE is
extending credit for the banks because of constrains they are facing to pay their demand deposits.
This liquidity problem is being addressed by the NBE. The NBE offered 5.5 billion birr for credit
which can only be used to pay demand deposit for banks. All of the 17 banks applied for a total
of 8.7 billion birr for loan, exceeding the initial 5.5 billion offers by 3.2 billion birr. And the
liquidity position of banks got worse forcing the NBE to extend another 9billion in a month time
(Tadesse, 2019). This is a critical sign how tight liquidity position could potentially lead the
banking industry to collapse. Moreover, without any sustainable improvement on its liquidity
position, the banking industry is going to face another competition from capital market in two
month time.
Capital adequacy
Capital adequacy measured by total capital to risk weighted asset in this study is the second
runner up of financial performance indicator among all criteria in the banking industry. Capital
adequacy is identified as critical indicator in the body of knowledge by researchers such as

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(Staikouras and Wood, 2004 and Bhandari and Nakarmi, 2014). They all claim the banks with
higher capital perform better than their undercapitalized peers. In contrary Goddard et al.,
(2004) and Abdul, (2017) argue that the banks‟ regulators should not only focus on capital
adequacy but also on supervisory review and market discipline to maintain banks‟ financial
strength and stability because if bank capital adequacy ratio is high it might mean the bank is
operating cautiously skipping investment opportunities to avoid risk which ultimately impact
performance. But researches such as Kombo and Njuguna (2017) in a more recent study in
Kenya concluded that capital adequacy requirement is an important performance indicator in
banks. There should be a need to increases capital requirements for counterparty credit risk
arising from derivatives, repurchase agreements and securities financing activities to guarantee
financial stability especially in developing countries like Kenya.
Being the second most critical indicator in the banking industry capital adequacy is highly
influenced by market capitalization, efficiency and asset quality when checked for
interdependency. This indicates that policy makers should put capital adequacy in to perspective
by leaning towards strengthening capital regulations with the goal of promoting a more resilient
banking sector; and improving the banking sector‟s ability to take up shocks resulting from
financial and economic stress.
Asset quality
The third indicator on the hierarchy is asset quality. Asset quality in this study is measured by
non-performing loan to outstanding loan. Asset quality is also identified as the cause group in
this thesis when checked for interdependency with other performance indicators of bank and
capital market. This finding is also in conformity with Rawlin et.al, (2015) that suggested bank
share price appreciation could come at the expense of asset quality. Although asset quality stood
third in the level of importance for bank specific factors it has the lowest D+R in DEMATEL
model which reveals weak interdependency in the model limiting its relationship to bank specific
factors more than market specific factors especially profitability. This is justified in the body of
literature especially regarding profitability by many researchers. Non-performing loans to
outstanding loan were identified as factors that affect profitability of banks specially ROE and
ROA by many researchers (Abata, 2014; Pasiouras and Kosmidou, 2007; Adebisi and Matthew,
2015; Bace, 2016; Bhattarai, 2016; Kiran and Jones, 2016; Etale, Ayunku, and Etale, 2016;
Güneş and Yilmaz, 2016; Ongore and Kusa, 2013; Ozgur and Gorus, 2016; Ozurumba, 2016 and

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Sarıtaş, et.al., 2016). On the other hand, Afiriyie and Akotey, (2013) and Bhattarai, (2016) found
positive correlation between ROE and NPL and Buchory, (2015) found positive correlation
between Return on Assets (ROA) and NPL.
In Ethiopian bank context the national bank has a series of policies regarding NPL and closely
follows bank asset quality to avoid any credit crunch which ultimately influences economic
growth.
Profitability
The fourth indicator on the hierarchy is profitability. Profitability in this study is measured by
return on equity. Profitability is identified as the affected group in this thesis when checked for
interdependency with other performance indicators of bank and capital market. In this study,
although profitability is in the affected group having one of the highest D+R in the system which
identifies strong interdependency relationship with in the system. This reveals profitability is
affected by bank specific as well as market specific factors. Gul et.al., (2011) in agreement
confirmed profitability is affected by both internal and external factors such as assets, loans,
equity, deposits, economic growth, inflation and market capitalization. In contrary Aburime,
(2008) argue there is insignificant relationship between stock market development and
profitability in evidence from Nigeria. But researchers such as Sayari and Shamki, (2016) in a
more recent and detailed study suggested ROE is a more superior measure of profitability and
market capitalization has a significant positive relationship with ROE.
Efficiency
The fifth indicator on the hierarchy is efficiency measured by total advance to total deposit.
Although efficiency stood last in the ranking of performance measure of bank specific indicators
when market specific factors are introduced it has one of the highest D+R conforming high
relationship in the system and having a positive D-R appearing in the cause group. This implies
that this performance indicator has low relative importance where bank specific factors are
concerned. But with the introduction of market specific factors in the system it could actually
become important influence factor in the system. This finding is in conformity with researches
such as Rawlin et.al, (2015), Vardar, (2013), Ioannidis et.al, (2008) and Sharma, (2018) that
suggested profit efficiency measures were key determinants of the share price in both developed
and developing economies. But other researcher such as Song and Thakor, 2010; Bossone and
Lee, 2004, Al Shubiri and Jamil, 2017 and Ahokpossi, 2013) in contrary identified reverse

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relationship stating capital market development has efficiency effects on banks. Similarly,
Mogbolu and Tizhe, (2017) on a more recent study conducted in Sub-Saharan African economies
inferred, low banking efficiency exists alongside rapidly developing but illiquid capital markets
elaborating trade volume of capital market affect bank efficiency.
4.5.4 Capital market and insurance companies’ performance indicators
Table 4.28: Ranked performance indicators of insurance companies
Criteria Criteria name Criteria weight Sub criteria Sub Criteria weight
Label label

C1 Profitability 0.557 P5 0.489

P2 0.254
P1 0.146
P3 0.068
P4 0.043
C2 Operating growth 0.220 O1 0.7235
O3 0.1932
O2 0.0833
C4 Solvency 0.108 Solvency ratio
C3 Asset quality 0.082 A1 0.7235
A2 0.1932
A3 0.0833
C5 Management soundness 0.033 M2 0.8333
M1 0.1667

Table 4.29: Influence, affected, centre and cause degree of market and insurance performance
indicators.
D R D+R D-R
Market capitalization
5.3725 7.4943 12.8668 -2.1218
Trade volume
5.4175 7.4942 12.9117 -2.0767
Profitability
6.2747 6.8656 13.1403 -0.5909
Operating growth
6.6017 4.8638 11.4655 1.7379
Solvency
6.0224 4.0005 10.0229 2.0219

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Asset quality
4.7192 5.5947 10.3139 -0.8755
Management soundness
5.7752 3.8701 9.6453 1.9051

According to experts in the insurance industry in Ethiopia performance indicators are ranked as
seen on table 4.28.
The interaction between capital market development and insurance company performance in
Ethiopia was projected in having complementarity. This projection is in consistency with
findings by (Catalan et al., 2000; Impavido et al., 2003; Skipper, 1997; Arena, 2008 and Turner,
2002).
4.5.5 Insurance performance indicators result interpretation
Profitability
Profitability is considered to be the first most important financial performance indicator among
all criteria in the insurance company industry. This finding is consistent with researchers such as
(Valahzaghard and Ferdousnejhad 2013 and Shahnawaz, 2018). According to the evaluations
taken in this study profitability in the insurance industry is proxied by return on investment. As
experts explain it the main reason behind this is that insurance companies do not make profits out
from their core business of underwriting. And yet profit is generated majority of the times from
cash flow and operations in liquidity management. This finding is supported by researchers such
as (Gonga and Sasaka 2017; Al-Nimer and Alslihat, 2015 and Mamun, 2010).
Profitability being critical performance indicator in the insurance industry when
interdependencies were projected introducing capital market indicators, it is influenced by others
in the system such as operating growth, solvency and management soundness. According to the
analysis based on expert opinion profitability in insurance companies are more influenced by
internal factors than market specific factors. But experts also indicated since insurance
profitability depends on return on investment the market could provide a platform for investment
diversification and should make more use out of the capital market instead of limited interest
profits. Accordingly, many studies conducted in order to examine the profitability ratios effect
on many variables as it‟s a critical indication for the firm's survival, growth, market
capitalization and various other variables.

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Operating growth
Operating growth mainly explained by premium growth in Ethiopian insurance industry is the
second on the ranking list to evaluate performance. The importance of operating growth in
determining insurance performance in the body of the literature is consistent with (Burca and
Batrinca, 2014 and Shahnawaz 2018). And when checked for interdependency operating growth
is categorised in the cause group influencing market capitalization, trade volume; profitability
and asset quality of insurance companies. According to the investigation when the insurance
premiums increase, mainly the stock transaction explained by trade volume also increases. This
finding is also supported by researchers such as (Guerineau and Sawadogo, 2015).
Solvency
Solvency mainly explained by solvency ratio in Ethiopian insurance industry is the third on the
ranking list to evaluate performance. And when checked for interdependency solvency is
categorised in the cause group influencing market capitalization, trade volume, profitability and
asset quality of insurance companies. According to Yildirım and Çakar, (2015) solvency capital
requirement amounts may assist in the identification and prevention of possible liquidity and
bankruptcy issues insurance companies may be faced with. The importance of solvency in
measuring performance of insurance companies is consistent with (Burca and Batrinca, 2014).
Asset quality
Asset quality mainly explained by tangible asset in Ethiopian insurance industry is the fourth on
the ranking list to evaluate performance. And when checked for interdependency asset quality is
categorised in the affected group influenced by solvency, operating growth and management
soundness of insurance companies. Tangible asset has been recognized as a performance
indicator in the body of the literature by researcher such as (Mehari and Aemiro, 2013 and Fenn
and Cole, 1994).
Management soundness
The fifth indicator on the hierarchy is Management soundness measured by asset per employee.
When checked for interdependency management soundness is categorised in the cause group
influencing market capitalization, trade volume, profitability and asset quality of insurance
companies. Although management soundness stood last in the ranking of performance measure
of insurance specific indicators when market specific factors are introduced it has one of the
highest D+R conforming high relationship in the system and having a positive D-R appearing in

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the cause group. This implies that this performance indicator has low relative importance where
insurance specific factors are concerned. But with the introduction of market specific factors in
the system it could actually become important influence factor in the system. This finding is in
conformity with researches such as (Liargavas and Skandalis, 2008; Merikas and Merika, 2006
and Almajali et.al., 2012) that suggested management soundness significantly affect firm specific
factors in influencing performance of insurance companies listed on a stock exchange.

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`

CHAPTER FIVE
SUMMARY, CONCLUSION and POLICY IMPLICATIONS
5.1 Summary
Findings on this study ranked performance indicators of financial institutions as follows.
Liquidity, capital adequacy, asset quality, profitability and efficiency for banks: profitability,
operating growth, solvency, asset quality and management soundness for insurance companies
according to their level of importance.
Banking industry performance indicators ranking showed liquidity to have more than 40 percent
weight in determining performance of the banking industry efficiency to have the lowest effect.
But as for the insurance companies profitability takes the majority share in determining
performance of the industry wile management soundness takes minor portion.
Interdependencies were also checked to verify the cause group and the affected group among
performance indicators of financial institutions and capital market. Accordingly, findings
revealed market capitalization, efficiency and asset quality are among the cause group
influencing liquidity, trade volume, capital adequacy and profitability for banks. As for insurance
companies operating growth, asset quality and management soundness are performance
indicators that influence market capitalization, trade volume, profitability and solvency.
This finding therefore summarises, although liquidity is the principal performance indicator in
the banking industry, it is highly affected by capital market and firm specific performance
indicators such as market capitalization and efficiency. And as much as efficiency is the least
recognized in contributing to performance in the banking industry, it could actually influence
bank and market specific factors such as trade volume, profitability and capital adequacy during
the introduction of capital market.
Moreover, profitability of insurance companies holds major share in determining performance
and is significantly affected by firm specific factors such as operating growth, asset quality and
management soundness. And as much as management soundness is the last on the list in
contributing to insurance performance, it is categorized in the cause group influencing both
market and firm specific performance indicators such as profitability, market capitalization, trade
volume and solvency.

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5.2 Conclusion
The finance-growth debate has evolved over the years, initiating a number of theories and
hypothesis including financial liberalization, finance-led growth; growth-led finance; market
feedback; bank-based and market-based. This study used market feedback or bi-directional
hypothesis and Finance-led Growth Hypothesis as a theoretical lens. Extant literature indicates
mixed interdependence between financial institution performance and capital market
development in a developing country context. This research aimed to examine the relative
importance of financial institution performance indicators and their potential interdependence
with capital market development using AHP and DEMATEL multi-criteria decision making
models.
The study revealed while liability portfolio management is a top priority for banks it is
profitability for insurance companies, implicating the difference in priority and possible
interaction with the forthcoming capital market in Ethiopia.
Accordingly, the study concludes competitive and complementary relationship between banks
and insurance companies with capital market development, respectively.
Therefore, this paper urges stakeholders that can be affected by performance of Ethiopian
banking industry in particular to be aware of the potential challenges that might arise during the
launch of capital market to craft strategies ahead. And stakeholders of insurance companies need
to see the upcoming opportunities and cease to the best outcomes.
5.3 Policy implications
This research directs to a number of opportunities and challenges that policy makers will have to
wrestle over in order to support the development of capital markets and existing financial
institutions. This can be achieved through promoting the participation of long-term institutional
investors in capital markets to take advantage of new investment trends and craft strategies for
the challenges this financial system integration brings. This awareness is believed to help
establish a more stable and resilient financial system that can absorb shocks.
While the benefit of launching capital market is well understood, it must also be recognized that
enormous interdependencies will occur with existing financial institution associated to
performance.
The most important bank performance indicator according to findings in this study is liquidity
and as much as it is important to assure performance in the banking industry it has a great

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potential of being affected by market. This study therefor recommends for banks to promote
financial inclusion through technology, increase liquidity by using shortened asset maturity and
issue more equity.
Financial inclusion through technology could help banks to decrease their cost of mobilizing
deposit by using technology rather than the old fashioned and expensive branch expansion. The
shorted asset maturity can also help reduce cash crunch. This implies for banks to monitor more
liquid asset to demanded deposit ratio instead of liquid asset to total asset.
Issuing more equity is also a means of maintaining liquidity position of a bank. Shares are sold
with a perpetual maturity, with the added advantage that no interest or similar periodic payments
have to be made.
As for insurance company‟s also known as institutional investors will have long investment
horizons and will contribute to the stability and development of capital market. It may therefore
be appropriate for insurance companies to engage in bond and equity markets. Moreover, the
policy makers should aim to encourage the insurance development (especially life insurance);
which will allow insurance companies to mobilize the significant stable resources for finance the
economy through the purchase of financial assets.
Concerning long-term orientation of institutional investors‟ investment portfolios it is
particularly recommended for policymakers to provide predictable macroeconomic and
regulatory frameworks as well as effective enforcement of the rule of law and absence of
corruption.
Therefore policy makers and stakeholders in the banking industry need to give it serious thought
and consider crafting strategies to cope with the financial system changes and assure stable
economic boost.

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Appendixes
Appendix I

Questionnaire

Dear sir/Madam

My name is Mekdes Bulti and I am currently doing my Master‟s degree in Business

Administration at Addis Ababa University, Faculty of Business and Economics. I have finished

my course work and now I am doing my MBA thesis entitled: An exploratory study on capital

market development and performance of financial institutions in Ethiopia.

I believe your experience and educational background will greatly contribute to the success of

my research which is aimed at contributing to the banking and insurance industry at large. So it‟s

with great respect that I ask you to fill this questionnaire with upmost HONESTY

&SINCERITY. I guarantee that your identity will be kept confidential and the information you

provide will only be used for academic purposes. I will be happy to share the findings of this

research when it‟s completed.

Thank you in advance for taking your precious time to fill this questionnaire. Please try to

answer all the questions openly, as your answers will have an influence on the outcome of the

research. Your 15 minutes or less will greatly contribute to the growth and advancement of

knowledge in the banking and insurance industry.

If you have any questions or comments, please don‟t hesitate to contact me. You can reach me
by;
 Mobile: +251911-120697
 E-mail: [email protected]

With Regards,

Mekdes Bulti

`
This study entitled “An exploratory study on capital market development and performance of
financial institutions in Ethiopia” is designed to identify potential benefits or potential treats
capital market might bring towards the banking and insurance industry. The information you
provide will be used purely for academic purpose and will be kept confidential. Participation in
this study is absolutely voluntary. Please answer with HONESTY & SINCERITY.

1. SECTION ONE: GENERAL PROFILE OF THE RESPONDENT

1.1. Gender: ____________

1 = Male 2 = Female
1.2. Age: _______________
1 = 20-25 3 = 31-40
2 = 26-30 4 = 41-50

1.3. Highest educational level: _________________

1 = Diploma
2 = BSc/BA
3 = MSc/MA/MBA
4 = PHD
1.4. Job category: _____________________
1.5. Job title: ____________________________
1 = Senior Management
2 = Middle Management
3 = Top Management
4 = Others: _________

1.6. Years of experience:

a) In the banking and insurance industry: _______________
1= < 1 year 2= 1-5years
3= 6-10 years 4= >10years

b) In regulatory government organizations and academic institutions : ________________

1= < 1 year 2= 1-5years
3= 6-10 years 4= >10years

2. SECTION TWO: Criteria ranking

Please indicate your opinion by ticking on the appropriate box for the questions:

`
Questionnaires were designed with the purpose of letting each participant to do pairwise
comparisons taking into account the relative importance of each criterion with all the criteria in
the same category.
Comparisons shall be made based on Semantics scale of Saaty.
Intensity of importance Definition

1 Equal Importance
3 Moderate importance
5 Strong importance
7 Very strong or demonstrated importance
9 Extreme importance
2,4,6,8 For compromise between the above values

2.1 Criteria evaluation for bank performance indicators.

(Remark: Banking operation experts.)
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank performance?
No Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
1 Liquidity Efficiency

2 Liquidity Profitability

3 Liquidity Capital adequacy

4 Liquidity Asset quality

5 Efficiency Profitability

6 Efficiency Capital adequacy

7 Efficiency Asset quality

8 Profitability Capital adequacy

9 Profitability Asset quality

10 Capital adequacy Asset quality

`
2.2 Sub – criteria evaluation for bank performance indicators
(Remark: Banking operation experts.)
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank liquidity?
No Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
1 liquid asset / total liquid asset / demanded
asset deposits

2 liquid asset / total liquid asset / total deposit

asset

3 liquid asset / liquid asset / total deposit

demanded deposits

According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank efficiency?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 total advances / to earnings before tax / total
total deposit
revenue

2 total advances / Total revenue/total number

total deposit of employee

3 earnings before tax Total revenue/total number

/ total revenue of employee

According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank profitability?
No Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
1 Profit before taxes / Profit before taxes / asset
equity

2 Profit before taxes / interest income / total

equity revenue

3 Profit before taxes / interest income / total

asset revenue

`
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank capital adequacy?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 total debt / total total equity/total asset
asset

2 total debt / total total capital / risk weighted

asset asset

3 total equity/total total capital / risk weighted

asset asset

According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring bank asset quality?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 allowance for loan loss reserves /
doubtful loans /
outstanding loans
total assets

2 allowance for non –performing loans/ total

doubtful loans / loans outstanding
total assets

3 loan loss reserves / non –performing loans/ total

outstanding loans loans outstanding

2.3 Criteria evaluation for insurance performance indicators.

(Remark: Insurance company operation experts.)
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring insurance performance?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 Profitability Operating growth

2 Profitability Asset quality

3 Profitability Solvency

4 Operating growth Asset quality

`
5 Operating growth Solvency

6 Asset quality Solvency

2.4 Sub – criteria evaluation for insurance performance indicators.

(Remark: Insurance company operation experts.)
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring insurance profitability?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 Net asset yield Total return on asset

2 Net asset yield Income profit

3 Net asset yield Expenditure margin

4 Net asset yield Return on investment

5 Total return on asset Income profit

6 Total return on asset Expenditure margin

7 Total return on asset Return on investment

8 Income profit Expenditure margin

9 Income profit Return on investment

10 Expenditure margin Return on investment

According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring insurance operating growth?
N Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
o
1 Premium growth Profit growth rate

2 Premium growth Economic profit margins

3 Profit growth rate Economic profit margins

`
According to your experience, how important is each criteria on the left compared to each
criteria on the right in measuring insurance asset quality?
No Description 9 8 7 6 5 4 3 2 1 2 3 4 5 6 7 8 9 Description
1 Tangibility of assets Recognized asset rate

2 Tangibility of assets accounts receivable ratio

3 Recognized asset rate accounts receivable ratio

3. SECTION THREE: Criteria interdependency

Please indicate your opinion by ticking on the appropriate box for the questions:
Level of influence Definition

0 No influence
1 Low influence
2 Medium influence
3 High influence
4 very high influence
3.1 List and label of factors.
Label Description
F1 Market capitalization of banks
F2 Trade volume of banks (annual average)
F3 Liquidity of banks
F4 Efficiency of banks
F5 Profitability of banks
F6 Capital adequacy of banks
F7 Asset quality of banks
3.2 Criteria interdependency evaluation for stock market and bank performance indicators.
F1 F2 F3 F4 F5 F6 F7
F1 0
F2 0
F3 0
F4 0
F5 0
F6 0

`
F7 0
3.3 List and label of factors.
Label Description
F1 Market capitalization on capital market.
F2 Trade volume on capital market.
F3 Profitability of insurance companies.
F4 Operating growth of insurance companies.
F5 Asset quality of insurance companies.
F6 Solvency of insurance companies.
F7 Management quality of insurance
companies.

3.4 Criteria interdependency evaluation for stock market and insurance firm performance
indicators.
F1 F2 F3 F4 F5 F6 F7
F1 0
F2 0
F3 0
F4 0
F5 0
F6 0
F7 0

`
4. SECTION FOUR: Capital market level of awareness measures
(Remark: Bank and insurance company operation experts.)
Please indicate your opinion by ticking on the appropriate box for the five-point scale
questions:

STRONGLY AGREE AGREE NEUTRAL DISAGREE STRONGLY

DISAGREE
5 4 3 2 1

No. Description Degree of agreement

5 4 3 2 1
1 Management of the bank/ insurance company should
have adequate awareness about capital market system
introduction in the financial system.
2 The management of the bank/ insurance should establish
a team to be trained about capital market operation.
3 The trained staff (if there is) should prepare strategies to
cope with changes capital market will introduce to the
financial structure.
4 Capital market will be complementary to the financial
systems and there is no need for preparation.

Thanks for your time.

`
Appendix II

Interview

Interview questions
Capital market and bank performance interaction questions. (Remark: Banking operation
experts.)
1. Why do we need capital market?
2. What are the most critical indicators of performance in the Ethiopian banking industry?
3. What is your view of capital market in terms of it being complementary or substitute to
the existing bank services and operations?
4. Which of the above performance indicators mentioned above are directly related with
capital market and how?
5. What are the potential contributions and awaiting challenges capital market might bring
towards performance of banks?
6. Is there any strategy in progress which is being followed with in the bank or formal
documented process on how to manage the upcoming competition?
7. Are strategy team members within the bank aware of the upcoming financial system shift
the introduction of capital market is going to bring? Are they given any kind training to
develop their knowledge and awareness on capital market and the change it is going to
bring in the financial system?
8. Is there a strategy that you suggest that could be applicable for banks in terms of areas
they should strengthen their performance on that could help the be beneficiaries of this
new market system? Possibly using key performance indicators?
Capital market and insurance performance interaction questions. (Remark: Insurance company
operation experts.)
1. Why do we need a capital market?
2. What are the most critical indicators of performance in insurance companies?
3. What is your view of capital market in terms of it being complementary to the existing
insurance services?
4. Which of the above performance indicators mentioned above are directly related with
capital market and how?
5. What are the potential contributions and awaiting challenges capital market might bring
towards performance of insurance companies?

`
6. Is there any strategy in progress which is being followed with in the insurance company
or formal documented process on how to manage the upcoming competition?
7. Are strategy team members within the insurance company aware of the upcoming
financial system shift the introduction of capital market is going to bring? Are they given
any kind of training to develop their knowledge and awareness on capital market and the
change it is going to bring in the financial system?
8. Is there a strategy that you suggest that could be applicable for insurance companies in
terms of areas they should strengthen their performance on that could help t be
beneficiaries of this new market system? Possibly using key performance indicators?
9. Is there any comment on the interview that you think that should have been included that
could help this study?

`
Appendix III
Interview protocol

1. Interviews will be conducted in the place of convenience for respondents.

2. The purpose of the interview will be explained to the respondents before the interview
starts.
3. The confidentiality of their answers will be explained. The researcher will guarantee the
respondents identity will not be revealed in the research paper and their answers will only
be used for this study only and analysis method will be elaborated. If their comments are
to be used as a caught the researcher will ask for a written permission on address terms of
confidentiality.
4. The interview questions will be open ended, and it will be explained to respondents to
wait until the end of the interview for and questions or suggestions.
5. The interview will take up to one hour.
6. The researcher will ask for any questions before both get started with the interview.
7. The researcher will ask for permission to record the interview or bring along someone to
take notes.
8. Researcher will often verify the tape recorder for functionality.
9. Researcher will ask one question at a time.
10. Researcher will remain neutral and great care should be taken while taking notes and
displaying inappropriate facial expression at all times.
11. Researcher will provide transition between major topics and stay in control of the
interview at all times to guarantee focus on the needed subject.
12. At the end of the interview the researcher will:
a. Make sure the recorder is still working.
b. Finalize clarification on the written note.
c. Write down any observation and unforeseen circumstances made during the
interview.
d. Express gratitude to the respondent leave contact information for further questions
and end the interview.

`
Appendix IV

List of interview participants and research meetings.

No Date Participants
1 29/08/[email protected] pm Fairfax Africa Fund, LLC (U.S). Ato Zemedeneh Nigatu (CEO)
2 22/08/[email protected] pm Awash Insurance Company S.C. Ato Jibat (Director of claim)
3 21/08/[email protected] pm Awash Bank S.C. Ato Henock Tessema(V.P retail banking)
4 20/08/[email protected] pm Addis Ababa University. Pro. Alemayehu Geda
5 26/08/[email protected] pm United insurance. Ato Zafu Eyesuswork Zafu ( Board chairman)
6 12/10/[email protected] am Awash Insurance Company S.C. CEO Ato Tsegaye Kemsi
7 14/10/[email protected] am Commercial Bank of Ethiopia. Ato Dereje Fufa. Chief whole sale
banking.