KORICHO TERM PAPER (2).pdf

UNITY UNIVERSITY
MASTER PROGRAM IN HUMAN RESOURCE MANAGEMENT
TERM PAPER: ASSESSMENT OF THE FINANCIAL
HEALTH/PERFORMANCE OF THE COMMERCIAL BANK OF
ETHIOPIA
BY: KORICHO GOSIE
UU83824E
SUBMITTED TO: DR. TIGIST BALEW
APRIL, 2022

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Contents
List of Tables .................................................................................................................................iii
List of Figures................................................................................................................................iii
List of Acronyms and Abbreviations............................................................................................. iv
Abstract........................................................................................................................................... v
CHAPTER ONE............................................................................................................................. 1
1. Introduction ............................................................................................................................. 1
1.1. Background of the study .................................................................................................. 1
1.2. Statement of Problem....................................................................................................... 3
1.3. Research Questions .......................................................................................................... 4
1.4. Objectives of the Study .................................................................................................... 4
1.4.1. General Objective ..................................................................................................... 4
1.4.2. Specific Objective..................................................................................................... 4
1.5. Methodology .................................................................................................................... 5
1.5.1. Study Design............................................................................................................. 5
1.5.2. Study Approach ........................................................................................................ 5
1.5.3. Sampling Design....................................................................................................... 5
1.5.4. Data Type and Data Collection................................................................................. 5
1.5.5. Method of Data Analysis and Interpretation............................................................. 5
1.6. Scope of the study ............................................................................................................ 6
1.7. Significance of the study.................................................................................................. 6
1.8. Organization of the Study ................................................................................................ 6
CHAPTER TWO ............................................................................................................................ 7
2. REVIEW OF RELATED LITERATURE............................................................................... 7
2.1. Theoretical Review .......................................................................................................... 7
2.1.1. Financial Statements ................................................................................................. 7
2.1.2. Financial Analysis in Banking Industry.................................................................. 10
2.1.3. Types of Financial Ratios Analysis ........................................................................ 11
2.2. Empirical Reviews ......................................................................................................... 14
2.3. Identified Literature Gap................................................................................................ 16
CHAPTER THREE ...................................................................................................................... 17
3. DISCUSSION OF RESULTS ............................................................................................... 17

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3.1. Data Analysis ................................................................................................................. 17
3.2. Results and Discussion................................................................................................... 17
3.2.1. Profitability ............................................................................................................. 17
3.2.2. Liquidity.................................................................................................................. 22
3.2.3. Gearing.................................................................................................................... 25
CHAPTER FOUR......................................................................................................................... 27
4. Conclusions and Recommendation ....................................................................................... 27
4.1. Conclusion...................................................................................................................... 27
4.2. Recommendations.......................................................................................................... 28
References..................................................................................................................................... 29
List of Tables
Table 3.1 1 Return on Equity.................................................................................................. 18
Table 3.2 1 Return on Assets........................................................................................................ 19
Table 3.3 1 Cost to Income Ratio ................................................................................................. 20
Table 3.4 1 Net Income Margin.................................................................................................... 21
Table 3.5 1Net Loan to deposit ratio (NLDST)............................................................................ 23
Table 3.6 1 Net Loans to Total Assets Ratio (NLTA).................................................................. 24
Table 3.7 1 Long Term Equity ratio (Equity/ total Asset)............................................................ 26
List of Figures
Figure 3.1 1Return on Equity........................................................................................................ 18
Figure 3.2 1 Return on Asset ........................................................................................................ 19
Figure 3.3 1 Cost to Income Ratio................................................................................................ 20
Figure 3.4 1 Net Income Margin................................................................................................... 22
Figure 3.5 1 Net Loan to deposit ratio (NLDST).......................................................................... 23
Figure 3.6 1 Net Loans to Total Assets Ratio (NLTA)................................................................. 25
Figure 3.7 1 Long Term Equity ratio (Equity/ total Asset)........................................................... 26

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List of Acronyms and Abbreviations
CBs Commercial Banks
CBB Construction and Business Bank
CBE Commercial Bank of Ethiopia
COVID Coronavirus Disease
EQTA Equity to Asset Ratio
EQL Equity to Loan Ratio
FRA Financial Ratio Analysis
IIAB Islamic International Arab Bank
JIBFI Jordan Islamic Bank for Finance and Investment
LATD Liquid Assets to Total Deposit Ratio
NBE National Bank of Ethiopia
NIM Net Interest Margin
NPTL Non- performing Loans to Total Loan Ratio
ROA Return on Asset
ROE Return on Equity
TLTA Total loans to Total Asset Ratio
TLTD Total Loans to Deposit Ratio
U.S. United States

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Abstract
Accounting data are useful in assessing the economic prospects of a firm. The paper shows how
financial ratios can be used to explore the sources of a firm’s profitability and evaluate the
“quality” of its earnings in a systematic fashion. Hence, the aim of the study is to analyze the
financial performance of Commercial Bank of Ethiopia for the period between 2009 and 2012.A
sample of data from the annual reports of the bank and NBE was selected based on the value of
its total assets at the end of the 2009 financial year. The results of the study indicated that CBE
showed the highest level of RoE all the time but this was driven by its high leverage levels.
Moreover, the bank was found to be unduly liquid affecting their revenue generating capacity.
This is partly because of government imposed loan restriction. For a sustained good banking
performance in the country, it is recommended that the banks invest more in interest bearing
assets, mainly loans, to fully utilize their revenue generating capacity. The Ethiopian
government is also recommended to balance its desire to control inflation with the need to
maintain lasting viability of the banking industry.
Keywords: Ratio analysis, financial performance, Bank performance, Commercial Bank of
Ethiopia, Ethiopia

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CHAPTER ONE
1. Introduction
1.1. Background of the study
The financial institution or banks are the crucial ways not only for financing activities but also
provides all types of activities related to finance. The main thing in the mind of financial
performance researcher and learner is that increasing financial performance is the way to improve
financial activities. Financial performance of financial institutions is well advanced in its
measurement within the field of finance and management. And these financial institutions are
constituent of good financial system and assist the investors to obtain capital and money market in
a country (Munir et al, 2012).
A bank is a financial intermediary that accepts deposits and channels those deposits into lending
activities. Banks are a fundamental component of the financial system, and are also active players
in financial markets. The essential role of a bank is to connect those who have capital (such as
investors or depositors), with those who seek capital (such as individuals wanting a loan, or
businesses wanting to grow) (http:/ / en.wikipedia.org/wiki / Bank)
Banks are susceptible to many forms of risk which have triggered occasional systemic crises.
These include liquidity risk (where many depositors may request withdrawals beyond available
funds), credit risk (the chance that those who owe money to the bank will not repay it), and interest
rate risk (the possibility that the bank will become unprofitable, if rising interest rates force it to
pay relatively more on its deposits than it receives on its loans)
Banking crises have developed many times throughout history, when one or more risks have
materialized for a banking sector as a whole. Prominent examples include the bank run that
occurred during the Great Depression, the U.S. Savings and Loan crisis in the 1980s and early
1990s, the Japanese banking crisis during the 1990s, and the sub-prime mortgage crisis in the
2000s. Usually, the governments bail out the bank through rescue plan or individual public
intervention (Michele, 2009).

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Rising and stiff competition, deregulation, globalization, and continuous innovation to provide
acceptable financial services to customers have given rise to the interest of all the concerned and
interested parties in detailed critical evaluation of banks (Banking 2010).
Various studies argue that the efficiency of financial intermediation affects economic growth while
others indicate that bank insolvencies can result in systemic crises, which have adverse
consequences for the economy as a whole, (Levine, 2005). Thus, the performance of banks has
been an issue of major interest for various stakeholders such as depositors, regulators, customers,
and investors. Certainly, performance means different things to different stakeholders in a bank.
For example, depositors are interested in a bank’s long-term ability to look after their savings; their
interests are safeguarded by supervisory authorities. Equity holders, for their part, focus on profit
generation, i.e. on ensuring a future return on their current holding (European Central Bank, 2010).
The European Central Bank report, 2010, defined bank performance as its capacity to generate
sustainable profitability. It stated, subsequent to the spectacular losses in the financial crisis and
the substantial government intervention, there is little public support for banks returning return on
equity (RoE) ratios of well above 20%, as these have mostly proved to be unsustainable (European
Central Bank, 2010).
The report also specified that the most common measure for a bank’s performance, RoE, is only
part of the story, as a good level of RoE may either reflect a good level of profitability or more
limited equity capital. This may explain why some of the high-RoE firms have performed
particularly poorly over the crisis, dragged down by a rapid leverage adjustment.
It is understandable that a more comprehensive analysis covering multiple aspects of performance
is necessary to assess the overall financial health of banks. Good financial performance of banks is
important not only to their shareholders but to the whole economy as it helps the banks to continue
their role of financial intermediation effectively and help economic growth of a country, especially
in countries where financial markets are not well developed.
Corporations are certainly not the only type of business; and the stock in many corporations rarely
changes hands, so it’s difficult to say what the value per share is at any given time. Therefore the
goal should be stated in a more general way as to maximize the market value of the existing
owners’ equity (Ross et al 2003).

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Though this is accepted as an objective, there is a problem of how we actually go about
determining the market value of the business. In the best of all worlds the financial manager has
full market value information about all of the firm’s assets.
There are also various equity valuation techniques. These techniques take the firm’s dividends and
earnings prospects as inputs. Although the valuation analyst is interested in economic earnings
streams, only financial accounting data is readily available. This study will only depend on the
accounting figures as it is difficult to find other market information from the bank under study.
Although economic earnings are more important for issues of performance measurement of this
kind, this study examines evidence suggesting that, whatever their shortcomings, accounting data
still are useful in assessing the financial health of the firm.
1.2. Statement of Problem
Assessment of financial performance is highly useful to identify the financial strengths and
weaknesses of the firm by properly establishing the relationship between the items of balance sheet
and profit and loss account (Drake, 2010). It also helps in short-term and long-term forecasting and
growth can be identified with the help of a financial performance analysis. Moreover, bank
performance assessment can also help improve managerial performance by identifying best and
worst practices associated with high and low measured efficiency.
Financial performance of a company, being one of the major characteristics, defines
competitiveness, potentials of the business, and economic interests of the company’s management
and reliability of present or future contractors.
However, according to Drake failures of commercial banks have been relatively high in recent
years in all over the world while the reason of each bank failure is somewhat unique experiences,
which differ from one bank to another. Recent studies have identified a few factors that most
failing banks seem to have in common. From those factors the main are problem regarding loan
portfolio, management efficiency, and uncontrollability of operating expenses. Besides, Non
performing loans grow to such an extent that revenues fall off and loan loss expenses as well as
operating expenses absorb all the earnings that remain. In addition to that failing banks often have
inadequate system of spotting loan problem early and frequently have expense control problem.
(Drake, 2010)

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The fact that, the commercial bank of Ethiopia is one of the dominant commercial bank operating
in the country in the pre and post liberalization or reform period. However, the commercial bank of
Ethiopia have been re-organized to operate based on the market-oriented policy framework in the
post reform period, the performance of the bank in terms of deposits, loans, capital, and
profitability that was expected has not yet been achieved. In addition, despite many reforms and
financial measures on the banking industry, critical evaluation of the financial performance of the
commercial bank of Ethiopia before and after the COVID -19 has not been investigated.
Although few studies have been made as related to financial performance analysis of banks, such
as performance comparison between the government and private banks, insurance, and other
financial institutions such analysis especially after COVID pandemic in the case of Commercial
bank of Ethiopia still remains unexplored. The researcher will try to fill this lack of evidence by
extending the issue to the specific context of the company.
1.3. Research Questions
The study expected to deliver an answer for the following questions;
 What does look like the financial trend of various elements of the financial statements of
the Commercial Bank of Ethiopia?
 Does the bank face difficulties in financing its loan and future investment expansions?
 Is the profitability of Commercial Bank of Ethiopia strong enough to exist in the
competitive financial industry?
 How is the company utilizing its assets?
 What is the company’s financial position to meet its current obligation?
1.4. Objectives of the Study
1.4.1. General Objective
The general objective of the study is to assess the financial performance/health of Commercial
Bank of Ethiopia.
1.4.2. Specific Objective
 To study and analyze the trends of various elements of the financial statements of
Commercial Bank of Ethiopia
 To analyze and compare the risk and solvency position of Commercial Bank of Ethiopia

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 To examine and compare the overall profitability of the Commercial Bank of Ethiopia
 To analyze and compare the liquidity position of the Commercial Bank of Ethiopia
 To evaluate and compare how effectively the company is utilizing its assets against the
industry average.
1.5. Methodology
1.5.1. Study Design
The study uses descriptive financial ratio analysis to measure, describe and analyze the financial
performance of Commercial Bank of Ethiopia during the study period. Financial statements from
annual reports of the bank have been used to describe the company’s financial performance.
1.5.2. Study Approach
The study makes use of quantitative type of approach. Quantitative method was employed to find
out the performance of the bank on the basis annual financial statements of the bank. The
relationship between performance indicators and financial performance of the bank in the study
period has been pin pointed.
1.5.3. Sampling Design
Sampling won’t have significance impact on the study, as the main aim of this study was a case
study to examine and compare the financial performance of Commercial Bank of Ethiopia. Hence,
the researcher used sample data from years 2009 – 2012 E.C.
1.5.4. Data Type and Data Collection
The study used secondary data in assessing the financial health of Commercial Bank of Ethiopia.
The researcher also collected data from secondary sources. To this end, annual reports for
Commercial Bank of Ethiopia for the period covering the year 2009 to 2012, Proclamation,
websites, Journals, different literatures and publications on financial performance have been
consulted to undertake both quantitative and qualitative evaluation of the performance of the
Commercial Bank of Ethiopia.
1.5.5. Method of Data Analysis and Interpretation
The researcher used financial statement analysis in evaluating the financial performance of the
bank by applying different financial ratios such as credit quality, profitability and liquidity and

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change in growth in net profit after tax, capital, deposits and loans. After that, it was presented in
the table and analyzed using descriptive method in the form of mean and percentage.
1.6. Scope of the study
The study highly paying attention on evaluating any changes that observed and reflected in the
financial performance of the commercial bank of Ethiopia. In addition the study attempted to
identify areas, which needs further reform measures so as to improve the bank performance.
Furthermore, only those data which can be publicly announced by the commercial bank of
Ethiopia or annual reports for the commercial bank of Ethiopia for the period covering the year
2009 to 2012 was referenced under the study.
1.7. Significance of the study
The study was conducted for academic purpose and the major significance relies on equipping the
researcher with the necessary skills and technique to undertake research. More specifically, the
study:
 Evaluate the financial performance of the commercial bank CBE and know the
performance of the bank and hence, to comment and recommend them on what they have
to do, for the banks’ prosperity
 Forward some suggestions for further taking reform measures in the banking sector in order
to improve the performance of the CBE.
 Give imminent to researchers and students about the problem and stimulate further
investigation of the issue.
1.8. Organization of the Study
The study is organized into four chapters. The first chapter deals with introduction part of the study
providing details related to the background of the study, statement of problem, objectives of the
study, research questions, methodology of the study, significance of the study, scope of the study,
and organization of the study. Chapter two deals with the literature review, chapter three is about
data analysis and interpretation and finally, chapter four contains conclusions and
recommendations.

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CHAPTER TWO
2. REVIEW OF RELATED LITERATURE
2.1. Theoretical Review
The problem of banking and financial system soundness has become more important in all
countries over the recent years. The financial sector, and especially the banking system, is
vulnerable to systemic crises which has led to the creation of costly safety nets, as depositor
insurance schemes with well-known moral hazard problem. It is argued that there is increasing
evidence that banks are “black boxes” due to the week transparency and banks’ unwillingness to
disclose information (Neely et al., 1997). To measure banks’ creditworthiness and risk exposures
is a complicated issue and it is not easy to interpret banks’ accounting data.
Kosmidou, K. (2008), argued that “Indicators of business failures and nonperforming loans are
also usually available only at low frequencies, if at all; the latter are also made less informative by
banks desire to hide their problems for as long as possible.” This means that it is needed to use as
fully and complexly as possible all available financial information from the official financial
statements of banks for making financial analysis of banks’ performance.
Currently, bank regulators commonly use the traditional method of financial indices based on the
financial statements to evaluate banks’ financial performance (Abdus, 2004)
2.1.1. Financial Statements
Financial statement analysis is the process of examining relationships among financial statement
elements and making comparisons with relevant information. It is a valuable tool used by investors
and creditors, financial analysts, and others in their decision-making processes related to stocks,
bonds, and other financial instruments.
Financial statement analysis begins with establishing the objective(s) of the analysis. For example,
is the analysis undertaken to provide a basis for granting credit or making an investment? After the
objective of the analysis is established, the data is accumulated from the financial statements and
from other sources. The results of the analysis are summarized and interpreted. Conclusions are
reached and a report is made to the person(s) for whom the analysis was undertaken.
The purpose of financial statement analysis is to examine past and current financial data so that a
company's performance and financial position can be evaluated and future risks and potential can

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be estimated. Financial statement analysis can yield valuable information about trends and
relationships, the quality of a company's earnings, and the strengths and weaknesses of its financial
position.11 Therefore, companies are highly required to publish their general annual audited
financial statements
2.1.1.1. Types of financial statement analysis
Financial analysts can obtain useful information by comparing a company's audited financial
statements of one company with other. There are three primary types of financial statement
analysis. These are commonly known as horizontal analysis, vertical analysis, and ratio analysis.
 Horizontal Analysis
When two or more years for a single company are compared, the process is known as horizontal
analysis. In this analysis, an analyst computes percentage changes from year to year for all
balances. When comparing financial statements for a number of years, then variation of horizontal
analysis called trend analysis may be preferred. Trend analysis involves calculating each year's
financial statement balances as percentages of the first year, also known as the base year. When
expressed as percentages, the base year figures are always 100 percent, and percentage changes
from the base year can be determined.
 Vertical Analysis
When using vertical analysis, the analyst calculates each item on a single financial statement as a
percentage of a total. The term vertical analysis applies because each year's figures are listed
vertically on a financial statement.
When using vertical analysis, an analyst reports each amount on income statement as a percentage
of total revenues, and similarly each amount of balance sheet as a percentage of total assets. After
the restated values, the balance sheet is known as common sized balance sheet, it allows
comparing it with another company’s statements or with industry averages.
 Ratio Analysis
Ratio analysis enables the analyst to compare items on a single financial statement or to examine
the relationships between items on two financial statements. After calculating ratios, an analyst can
examine the trends for the company with its past performance or compare it with the industry
benchmark.

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2.1.1.2. Role of Financial Statement Analysis
Financial analysis today is performed by various users of financial statements. Investors and
Management perform the financial analysis to understand how profitably or productively the assets
of the company are used. Lenders and Suppliers of goods look for the ability of the firm to repay
the dues on time. For instance, as a deposit holder of a Bank, you would be interested in liquidity
of the Bank and would expect the Bank to pay you the amount when you need. Customers would
like to know the long-term solvency of the Bank to get continued support. In addition, employees
would be interested in the profitability as well as liquidity of the bank.
Financial statement analysis involves careful selection of data from financial statements for the
primary purpose of forecasting the financial health of the company. This is accomplished by
examining trends in key financial data, comparing financial data across companies, and analyzing
key financial ratios. The financial statements are documents that tell what has happened during a
particular period of time. However most users of financial statements are concerned about what
will happen in the future. Despite the fact that financial statements are historical documents, they
can still provide valuable and economical information bearing on all of these concerns. Therefore,
in this study the researcher applied ratio analysis to evaluate the financial performance of the bank.
2.1.1.3. Limitation of Ratio Analysis
Ratio analysis is useful, but analysts should be aware of these problems and make adjustments as
necessary. Ratios analysis conducted in a mechanical, unthinking manner is dangerous, but if used
intelligently and with good judgment, it can provide useful insights into the firm’s operations and
the following are some of the limitations of ratio analysis.
 Creative Accounting
The businesses apply creative accounting in trying to show the better financial performance or
position which can be misleading to the users of financial accounting.
 Ratios are not Definitive Measures
Ratios need to be interpreted carefully. They can provide clues to the company’s performance or
financial situation. But on their own, they cannot show whether performance is good or bad. Ratios
require some quantitative information for an informed analysis to be made.
 Financial Statement contain Summarized Information
Ratios are based on financial statements which are summaries of the accounting records. Through
the summarization some important information may be left out which could have been of

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relevance to the users of accounts. The ratios are based on the summarized year end information
which may not be a true reflection of the overall year’s results.
 Interpretation of Ratios
It is difficult to generalize about whether a particular ratio is ‘good’ or ‘bad’. For example a high
current ratio may indicate a strong liquidity position, which is good or excessive cash which is bad.
Similarly non-current assets turnover ratio may denote either a firm that uses its assets efficiently
or one that is undercapitalized and cannot afford to buy enough assets.
 Price changes
Inflation renders comparisons of results over time misleading as financial figures will not be
within the same levels of purchasing power. Changes in results over time may show as if the
enterprise has improved its performance and position when in fact after adjusting for inflationary
changes it will show the different picture.
 Window Dressing
These are techniques applied by an entity in order to show a strong financial position. This can
improve the current and quick ratios and make the balance sheet look good. However the
improvement was strictly window dressing as a week later the balance sheet is at its old position.
In general, an inexperienced analyst may assume that ratios are sufficient in themselves as a basis
for judgment about the future. Conclusions based on ratio analysis must be regarded as tentative.
Ratios should not be viewed as an end, but rather they should be viewed as a starting point, as
indicators of what to pursue in greater depth. In addition to ratios, other sources of data should be
analyzed in order to make judgments about the future of an organization. Few figures appearing on
financial statements have much significance standing by themselves. It is the relationship of one
figure to another and the amount and direction of change over time that are important
in financial statement analysis.
2.1.2. Financial Analysis in Banking Industry
Unlike manufacturing industry, banks are trading on capital or funds. Hence some of the ratios
developed for manufacturing industry are not relevant to banks. While some of the ratios are not
relevant, there are ratios which require some modification. For example, Interest expenses are
minor for a manufacturing industry whereas for banking industry, it is a major expense item.

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In addition, there are some items, which are difficult to measure. For instance, if you want to
measure liquidity, normally we compute current ratio, which requires current assets and current
liabilities. But this data is not apparently available in the financial statements and one has to collect
from the internal sources. To give an example, we need to know the term structure of Term
Deposit and similarly loans and advances to classify whether they are current or not. Considering
the special nature of banking industry, the study uses the following financial ratios for measuring
credit or loan, liquidity, profitability, and growth of the Commercial Bank of Ethiopia.
2.1.3. Types of Financial Ratios Analysis
2.1.3.1. Credit Quality/Loan Performance
One of the most important sources of income for commercial bank is issuing of loans. However,
when a commercial bank makes loans, it is exposed to risks, because banks operate in asymmetric
information. The principal risk it faces is the risk of defaulting interest payment or the principal or
both interest and loans. Thus, loan performance measures bank's risk associated with loans created
by bank. In other words, it measures the quality of loans. Some loans default some do not. The
greater is the amount of loan and interest in default, the higher is a risk for a bank, and the bank is
rated poor. There are several financial measures for assessing the quality of loans (or credit risk)
for commercial banks.
I. Equity to Asset Ratio (EQTA)
It measures equity capital as a percentage of total assets. EQTA provides percentage protection
afforded by banks to its investment in asset. It measures the overall shock absorbing capacity of a
bank for potential loan asset losses. The higher the ratio of EQTA, the greater is the capacity for a
bank to sustain the assets losses.
This figure is determined as follows: EQTA = Common Equity/Assets
II. Equity to Loan Ratio (EQL)
It measures equity capital as a percentage of total loans. EQL provides equity as a cushion
(protection) available to absorb loan losses. The higher the ratio of EQL, the higher is the capacity
for a bank in absorbing loan losses.
This figure is determined as follows: EQL = Total Equity/Total Loans

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III. Non- performing Loans to Total Loan Ratio (NPTL)
It is one of the most important criteria to assess the quality of loans or asset of a commercial bank.
It measures the percentage of gross loans which are doubtful in banks’ portfolio. The lower the
ratio of NPTL, the better is the asset/credit/ performance of the commercial banks.
This figure is determined as follows: NPTL = Non-performing Loans/Total Loans
2.1.3.2. Liquidity Performance
Liquidity ratios attempt to measure a company's ability to pay off its short-term debt obligations.
This is done by comparing a company's most liquid assets to short-term liabilities. The higher
liquidity ratios mean bank has larger margin of safety and ability to cover its short-term obligations
So, commercial banks must hold sufficient liquidity. Liquidity means cash, or how quickly a bank
can convert its assets into cash at face value to meet the cash demand of the depositors and
borrowers. There are various financial ratios for measuring liquidity performance. Thus, the
researcher selects the following three financial ratios:
I. Total loans to Total Asset Ratio (TLTA)
The loan to assets ratio measures the total loans outstanding as a percentage of total assets. The
higher this ratio indicates a bank is loaned up and its liquidity is low. The higher the ratio, the more
risky a bank may be to higher defaults.
This figure is determined as follows: TLTA = Total Loans/Total Assets
II. Liquid Assets to Total Deposit Ratio (LATD)
It is a deposit run off ratio. It indicates the percentage of deposit and short term funds that are
available to meet the sudden withdrawals. The higher the LATD, the more liquid is a commercial
bank and less vulnerable it is to run the bank.
This figure is determined as follows: LATD = Liquid Asset/Customer Deposit
III. Total Loans to Deposit Ratio (TLTD)
This refers to the amount of a bank's loans divided by the amount of its deposits at any given time.
The higher the ratio, the more the bank is relying on borrowed funds, which are generally more
costly than most types of deposits. Bank with low LDR is considered to have excessive liquidity,
potentially lower profits, and hence less risk as compared to the bank with high LDR.
It is calculated as: TLTD = Total Loans/Total Deposit

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It indicates the percentage of the total deposit locked into non-liquid asset. The higher the TLTD,
the higher is the liquidity risk.
2.1.3.3. Profitability Performance
One of the most frequently used tools of financial ratio analysis is profitability ratios which are
used to determine the company's bottom line. Profitability ratios show a company's overall
efficiency and performance. We can divide profitability ratios into two types: margins and returns.
Ratios that show margins represent the firm's ability to translate sales dollars into profits at various
stages of measurement. Ratios that show returns represent the firm's ability to measure the overall
efficiency of the firm in generating returns for its shareholders. In general, profitability
performance is also known as managerial performance. It indicates how the top management of a
bank maximizes shareholders' profits by utilizing existing resources at their disposal. There are
several indexes for measuring profitability performance of a firm. However, in this study the
researcher uses the three most commonly used measures. They are:
I. Return on Assets (ROA)
The Return on Assets ratio is an important profitability ratio because it measures the efficiency
with which the company is managing its investment in assets and using them to generate profit. It
measures the amount of profit earned relative to the firm's level of investment in total assets. Net
profit is taken from the income statement and total assets are taken from the balance sheet. The
higher the percentage, the better it will be, because that means the company is doing a good job
using its assets to generate sales.
The calculation for the return on assets ratio is: ROA = Net Profit/Total Assets
II. Return on Equity (ROE)
The Return on Equity ratio is perhaps the most important of all the financial ratios to investors in
the company. It measures the return on the money the investors have put into the company. This is
the ratio potential investors look at when deciding whether or not to invest in the company. Net
income comes from the income statement and stockholder's equity comes from the balance sheet.
In general, the higher the percentage, the better it will be, with some exceptions, as it shows that
the company is doing a good job using the investors' money. In general, it shows a rate of return on
base capital, i.e. equity capital. The higher the ROE, the more efficient is the performance.
The calculation for the return on equity ratio is: ROE = Net Profits/Equity

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III. Net Interest Margin (NIM)
Net interest income is the difference between interest income and interest expense. It is the gross
margin on a bank’s lending and investment activities. Analysts focus on Net Interest Margin
(NIM) ratio because small changes in a bank’s lending margin can translate into large bottom line
changes. The higher the ratio the cheaper the funding or the higher the margin the bank is
obtaining. A bank’s net interest margin is a key performance measure that drives ROA. Net
interest income is the difference between interest income and interest expense. It is the gross
margin on a bank’s lending and investment activities.
It is calculated as: NIM=interest income – interest expense
2.2. Empirical Reviews
Abdus Samad (2004) in his paper examines the comparative performance of Bahrain’s interest-free
Islamic banks and the interest-based conventional commercial banks during the post Gulf War
period 1991-2001. Using nine financial ratios in measuring the performances with respect to (a)
profitability, (b) liquidity risk, and (c) credit risk, and applying Student’s t-test to these financial
ratios, the paper concludes that there exists a significant difference in credit performance between
the two sets of banks. However, the study finds no major difference in profitability and liquidity
performances between Islamic banks and conventional banks.
Ahmad and Hassan (2007) analyzed the asset quality, capital ratios, operational ratios such as net
profit margin, net interest income, income to asset ratio, non-interest income to asset ratio and
liquidity ratios for seven years from 1994 to 2001. Islamic banks on an average were the
preeminent performer in terms of lowest non-performing to gross loan ratio, capital funds to total
asset ratio, capital funds to net loans ratio, capital funds to short-term loan ratio, capital funds to
liabilities ratio, non-interest expense to average asset ratio and most of the liquidity ratios.
Therefore, it can be concluded that Islamic banks are outperforming others in capital adequacy and
adequate liquidity. Except Return on Equity Ratio, Islamic Banks were at par with the industry in
all other cases.
Saleh and Rami (2006) in order to evaluate the Islamic banks’ performance in Jordon examine and
analyze the experience with Islamic banking for the first and second Islamic bank, Jordan Islamic
Bank for Finance and Investment (JIBFI), and Islamic International Arab Bank (IIAB) in Jordon.
The study also highlights the domestic as well as global challenges being faced by this sector.

15
Conducting profit maximization, capital structure, and liquidity tests as performance evaluation
methodology, the paper finds several interesting results. First, the efficiency and ability of both
banks have increased and both banks have expanded their investment and activities. Second, both
banks have played an important role in financing projects in Jordan. Third, these banks have
focused on the short-term investment. Fourth, Bank for Finance and Investment (JIBFI) is found to
have high profitability. Finally, the study concludes that Islamic banks have high growth in the
credit facilities and in profitability.
Dejene.M and Asres.A (2008) evaluated the financial performance of Construction and Business
Bank (CBB) of Ethiopia by taking eight years audited annual reports. The study employs asset
utilization ratios, deposit mobilization, loan performance, liquidity ratio, leverage ratio,
profitability ratios, solvency ratios and coverage ratio as a measurement indicator of performance.
The study recommends that timely observation of financial performance measure by responsible
financial experts and remedial actions to the outcomes are two important components for
improvement in financial performance of CBs.
Mabwe.K and Robert.W (2010) investigates the performance of South Africa’s commercial
banking sector by employing financial ratios to measure the profitability, liquidity and credit
quality performance of five large South African based commercial banks. The study uses ROA,
ROE, and cost to income ratio in order to evaluate the profitability performance and LADST,
NLTA, and NLDST in order to evaluate liquidity performance of banks in South Africa. Besides,
it uses loan loss reserve to gross loan as a variable to measure the asset quality performance of CBs
in South Africa. Finally the study found that the previous variables are good measurement in order
to assess and conclude profitability performance, liquidity performance and asset quality
performance CBs in general.
Tarawneh (2006) in his study measured the performance of Oman commercial banks using
financial ratios and ranked the banks based on their performance. The study utilised Financial
Ratio Analysis (FRA) to investigate the impact of asset management, operational efficiency and
bank size on the performance of Oman commercial banks. The findings indicated that bank
performance was strongly and positively influenced by operational efficiency, asset management
and bank size.

16
2.3. Identified Literature Gap
The researcher observed that there haven’t been done studies which assess the financial health of
Commercial Bank of Ethiopia especially, after the birth of the COVID 19 pandemic. This study
includes the performance of the bank even in the year this pandemic attached our country and th
bank’s performance in response to this pandemic. In doing so, the study analyzed the performance
of the ban on the basis of recent financial reports found from the official website of the bank and
the NBE (National Bank of Ethiopia).
The performance every firm has to be evaluated periodically so as to know where the financial
position and health the company is in. In this regard the study fills the gap by making financial
performance assessment from the 2009 -2012 in commercial bank of Ethiopia which has never
been done by previous studies.

17
CHAPTER THREE
3. DISCUSSION OF RESULTS
3.1. Data Analysis
Financial ratio analysis (FRA) was used to analyze the general trend of the data from 2009 to 2012
for the variables which included in the study.
Ratio analysis is one of the main accounting techniques of financial analysis to evaluate the
financial position and performance of companies. It involves comparison and calculation of a
number of profitability, liquidity, efficiency, gearing and investor ratios which in turn paint a
thorough picture of the company’s performance over a period of time (BPP, 2012).
The main advantage of FRA is its ability and effectiveness in distinguishing high performance
firms from others and the fact that FRA compensates for disparities and controls for any size effect
on the financial variables being studied (Samad, 2004). Additionally, financial ratios can be used
to identify a bank’s specific strengths and weaknesses as well as providing detailed information
about bank profitability, liquidity and credit quality policies (Hempelet al, 1994: Dietrich, 1996).
FRA permits a historical sketch of bank returns and risks which Hempelet al, (1994) suggests
presents an opportunity to evaluate the past performance of the bank which is an important step for
planning for future performance.
Although accounting data in financial statements is subject to manipulation and financial
statements are backward looking, they are the only detailed information available on the bank’s
overall activities (Sinkey, 2002). Furthermore, they are the only source of information for
evaluating the management’s potential to generate satisfactory returns in future.
3.2. Results and Discussion
3.2.1. Profitability
Profitability in commercial banks is determined by the ability of the banks to retain capital, absorb
loan losses, support future growth of assets and provide return to investors. The largest source of
income to the bank is interest income from lending activity less interest paid on deposits and debt.
In this study, profitability was measured by four ratios which are return on equity, return on assets,
cost to income ratio, and net interest margin.

18
3.2.1.1. Return on Equity
Table 3.1 1 Return on Equity
Bank Years
CBE
2009 2010 2011 2012
38.1% 45.1% 45.9% 71.6%
Sector 28.7% 28.6% 33.1% 42.1%
Figure 4.1 1Return on Equity
Source: Own Construct, 2022
Figure 1 shows the profitability, as measured by RoE, trend of the banks under study as well as the
industry average for the years 2009 to 2012. First of all what is clear from the line graph is the
sector’s return on equity is raising slightly in the last two years 2011/12 and 2010/11 after being
relatively stagnant in 2009/10. Further, Commercial Bank of Ethiopia is consistently performing
above the industry average RoE as well as the RoE of all the banks under study. The CBE is also
showing the highest percentage increase in RoE of about 56% in the year 2011/12 after
maintaining relatively similar levels of RoE in the years 2010 and 2011. One reason for such a
dramatic jump in RoE is that CBE operates at a very large scale and its equity relative to its total
capital is very small. For example, while CBE’s total assets increased by more than 166% in the
period 2009 to 2012, its equity increased by only about 50% and its profit figure increased more
than 180% in the same period. The bank is doing is that it is increasing its profit by using a
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
2009 2010 2011 2012
CBE
Sector

19
significantly larger capital base but without a proportionate increase in its equity capital. This
highly leveraged position may be good for the bank as it has a multiplier effect on its RoE during
times of profitability, but it is also risky because it makes the bank’s ability to absorb shocks very
low (De Wet, etal., 2007).
3.2.1.2. Return on Assets
One of the variables that explain the above variation of RoE of banks is their ability to generate
enough net profit on the assets they employ. RoA is a measure of how efficiently a bank uses its
assets. That is, the amount of profit a bank is generating per one birr in assets that it employs. The
higher the RoA the more efficient the bank is in utilizing its assets.
Table 3.2 1 Return on Assets
Bank Years
CBE
2009 2010 2011 2012
3.2% 3.8% 2.5% 3.4%
Sector 2.9% 2.7% 2.7% 3.3%
Figure 3.2 1 Return on Asset
Source: Own Construct
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
2009 2010 2011 2012
CBE
Sector

20
The above figure depicts that CBE seem to be in a good position in RoE terms which are not
explained by its efficiency of its asset utilization but by the fact that its equity is relatively very
small.
3.2.1.3. Cost to Income Ratio
The Cost to Income ratio is an efficiency measure similar to operating margin. Cost to income ratio
measures a bank’s ability to earn a profit from the revenue it generates. This is purely a measure of
a bank’s cost control. No matter how much revenue it generates, a bank cannot be profitable unless
it is able to control its costs. A lower cost to income ratio is better as it indicates a lower cost
relative to revenue.
Table 3.3 1 Cost to Income Ratio
Bank Years
CBE
2009 2010 2011 2012
29.4% 37.0% 29.6% 22.6%
Sector 41.7% 30.8% 44.7% 40.0%
Figure 3.3 1 Cost to Income Ratio
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
50.00%
2009 2010 2011 2012
CBE
Sector

21
CBE was the most efficient bank in terms of cost to income ratio in three of the four years
considered in the study with costs being only 29.4%, 29.6%, and 22.6% of its revenue in the years
2009, 2011, and 2012 respectively. CBE’s unusual rise in its cost to income ratio to 37% in 2010
was the result of costs increasing in this year dramatically by 46% compared to the increase of
only 16% in revenues. A closer look at the income statement figures showed that CBE’s interest
and non-interest revenues increased by a similar around 16%, the expenses in the same year
increased at 47%. The breakdown of the expenses in to interest and non interest showed that
interest expenses raised by about 21% but noninterest expenses increased by 78%.
3.2.1.4. Net Interest Margin
Net interest margin (NIM) is a measure of the difference between the interest income generated by
banks or other financial institutions and the amount of interest paid out to their lenders (for
example, deposits), relative to the amount of their (interest-earning) assets. It is similar to the gross
margin of non-financial companies. Banks are keenly interested in their net interest margins
because they lend at one rate and pay depositors at another.
Table 3.4 1 Net Income Margin
Bank Years
CBE
2009 2010 2011 2012
3.13% 4.32% 2.73% 3.35%
Sector 2.90% 2.56% 2.51% 3.14%

22
Figure 3.4 1 Net Income Margin
CBE’s net interest margin was at its peak in 2010 at 4.32% which is the highest of all banks for the
whole four years under study. This accounts for an improvement of 38.13% from the figure in
2009 but it dropped by about 36.89% in 2011 to only 2.73%. This figure was better in 2012 by
22.86% at 3.35%.
It is possible to take an understanding that the government’s policy to restrict loan during those
years has caused the fluctuation (Access capital, 2011).
3.2.2. Liquidity
Liquidity performance measures the ability to meet financial obligations as they become due and is
crucial to the sustained viability of banking institutions. It can be described as the ability of a bank
to have sufficient funds to meet cash demands for loans, deposit withdrawals, and operating
expenses. For this reason, a balance should be found between the amount of deposits garnered and
the quantum of loans extended.
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
2009 2010 2011 2012
CBE
Sector

23
3.2.2.1. Net Loan to deposit ratio (NLDST)
Table 3.5 1Net Loan to deposit ratio (NLDST)
Bank Years
CBE
2009 2010 2011 2012 Average
43.1% 40.4% 37.5% 47.6% 42.2%
Sector 51.2% 49.4% 46.4% 55.2% 50.5%
Figure 3.5 1 Net Loan to deposit ratio (NLDST)
The NLDST is a commonly used measure for assessing a bank's liquidity by dividing the bank’s
total loans by its total deposits. This number, also known as the LTD ratio, is expressed as a
percentage.
A high loans to deposits ratio means that the bank is issuing out more of its deposits in the form of
interest-bearing loans, which, in turn, means it will generate more income. On the other hand, the
bank has to repay deposits on request, so having a ratio that is too high puts the bank at high risk.
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
2009 2010 2011 2012 Average
CBE
Sector

24
A very low ratio means that the bank is at low risk, but it also means it isn’t using its assets to
generate income and may even end up losing money.
CBE experienced lowest NLDST in all the four years making CBE the most liquid bank. CBE’s
ratio shows loans at 43.1% of deposits in 2009 and this even decline to 40.4% in 2010 and 37.5%
in 2011 before it finally increased to 47.6% in 2012.
This highest level of liquidity for CBE makes it safer but at the expense of the potential
incremental profit that could have been attained by extending additional interest earning loans and
still remaining as safe as the other banks. This can explain the bank’s inefficiency measured by its
RoA. Despite the asset size, this banks RoA was far below its competitors reflecting the high size
of assets not earning money. CBE should consider utilizing its asset to a greater extent in making
more profits.
3.2.2.2. Net Loans to Total Assets Ratio (NLTA)
Table 3.6 1 Net Loans to Total Assets Ratio (NLTA)
Bank Years
CBE
2009 2010 2011 2012 Average
31.5% 30.2% 29.2% 36.0% 31.7%
Sector 51.2% 49.4% 46.4% 55.2% 50.5%
Though the ratio of net loans to total assets does not directly measure liquidity, it gives an
indication of how much of the bank assets are tied into illiquid loans.
Similar to the NLDST, the banking sector’s overall NLTA showed what can be described as a u-
shaped trend over the four years, 2009-2012. It was 36.9% in 2010, showing a slight reduction of
about 1.3 percentage points compared to the 38.2% in 2009. This reduction even continued in 2011
by about 2 percentage points and was at 34.9% before finally soaring to 40.7% in 2012.
This was also the case for CBE. The NLTA reduced from its level in 2009 in both 2010 and 2011
and sharply increased in 2012.

25
This was consistent with the trend of net interest margin shown in figure 3.6 below for CBE. Since
loan figure compared to total assets is down during the two years 2010 and 2011, net interest
income (interest income minus interest expense) is due to decline relative to the assets of the bank.
This is because the banks’ interest earning depends on their being able to granting loans to its
customers. If its loan is reduced, so does its interest income without necessarily reducing its
interest expense as the bank still can have deposits from customers on which they pay interest.
Figure 3.6 1 Net Loans to Total Assets Ratio (NLTA)
3.2.3. Gearing
A European central bank’s report on EU banking structures states “recent events have shown that
the most common measure for a bank’s performance, i.e. RoE, is only part of the story, as a good
level of RoE may either reflect a good level of profitability or more limited equity capital.” The
report is of the position that a good level of RoE driven by high level of leverage rather than a
good level of profitability is largely unsustainable. Gearing is a two edged sword it magnifies your
shareholders returns, both positive and negative. So, while it is good at good times, it may be
devastating when your earnings turn south.
The researcher uses the equity to total asset ratio to measure the level of gearing each bank is
employing.
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
2009 2010 2011 2012 Average
CBE
Sector

26
3.2.3.1. Long Term Equity ratio (Equity/ total Asset
Table 3.7 1 Long Term Equity ratio (Equity/ total Asset)
Bank Years
CBE
2009 2010 2011 2012
8.5% 8.4% 5.5% 4.8%
Sector 10.0% 9.6% 8.3% 7.9%
Figure 3.7 1 Long Term Equity ratio (Equity/ total Asset)
The graph shows low equity levels for CBE. What’s more, CBE’s equity level is significantly
decreasing. CBE’s ratio dramatically declined from about eight and half percent in 2009 and 2010
to 5.5 and 4.8 percent in 2011 and 2012. This is driven by CBE’s campaign of mobilizing deposit
in recent years without increasing its equity base. This trend also supports the exceptionally high
RoE shown by the bank recently while its RoA is low. Thus CBE’s high level of profitability as
measured by its return on equity is not the result of the bank’s ability to earn high profits but a
result of its very low equity level. This makes it a bank with low shock absorbing capacity because
its RoE can swing greatly even with a slight movement in its earnings.
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Category 1 Category 2 Category 3 Category 4
Series 1
Series 2

27
CHAPTER FOUR
4. Conclusions and Recommendation
4.1. Conclusion
This paper has examined the performance of Commercial Bank of Ethiopian over a period of four
years, 2009 – 2012. The bank showed differing levels of profitability, liquidity, and gearing levels
which indicates its differing levels of return and risk.
CBE showed the highest level of RoE all the time but this was driven by its high leverage levels. It
is the bank that provides high return to shareholders but with substantial risk.
CBE was efficient bank in its Cost to Income ratio in all the years under study except in 2010. This
was the result of an unusually high increase in its costs especially its non interest costs.
Regarding liquidity of the bank studied, there is no problem in meeting its cash demands but there
are important areas in which the bank can do something to improve its performance. Liquidity is
not seen in this study only from the perspective of the bank facing a problem meeting its cash
demands but also from the potential effect on profitability.
2012 was the year in which the LTD ratio increased the bank under study after the decline in 2010
and 2011. This is due to the increase in the amount of loan extended in this year. The
government’s policy to restrict granting loans is most likely the cause for the low level of loan to
deposit ratio in the years before 2012.
Generally the bank is not extending enough interest bearing loans to help its profits. This is
especially proofed with CBE which stands to be liquid bank throughout the period under study.
On the other hand, CBE is with low and declining level of equity to total assets. This is potentially
dangerous as the high level of return to its equity remains unsustainable and is under undue
exposure to risk.
Generally speaking, it is possible to say that the bank is financial health or financial performance is
at risk though the bank is still found to be the largest bank in the country.

28
4.2. Recommendations
On the basis of the analysis and conclusions made above, the following recommendations are
forwarded to improve the bank’s performance.
 Commercial Bank of Ethiopia should accompany its capital growth by growth in equity.
This may be done by increasing their reinvestment rate; i.e. decreasing the dividend payout
ratio. Much emphasis should be put on improving the return on assets (RoA) rather than
increasing leverage as a means of improving shareholder return.
 CBE should utilize its capacity to generate revenue, and profit, by extending more loans
with its current levels of deposit than campaigning for more deposits. If put idle, deposits
are nothing but cost to the bank.
 The FDRE government is recommended to balance its desire to control inflation with the
need to maintain lasting viability of the banking industry. Net interest margin of all banks
dropped in the years 2010 and 2011. This was due to the fact that the banks did not issue as
much loan as they could during those years due to the government’s policy to restrict loans.
 Commercial Bank of Ethiopia needs to continue its cost consciousness. In 2012 CBE’s
costs relative to its revenue has increased significantly. This shows the bank is weakening
in terms of controlling its costs, especially non interest costs, as compared to its leading
position in this measure.

29
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