THE EFFECTS OF INVESTMENT ON FINANCIAL

PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

A Thesis submitted to the school of graduate studies of Jimma University in

partial fulfilment of the requirements for the award of the degree of Master of
Science in Banking and Finance

By: KANO BULA

JIMMA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF BANKING AND FINANCE

JUNE, 2021

JIMMA, ETHIOPIA
THE EFFECTS OF INVESTMENT ON FINANCIAL
PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

By: KANO BULA

Under the Guidance of

Dr. DEMIS HAILE GEBREAL

And
GADISE GAZU (M.Sc.)

A Thesis submitted to the school of graduate studies of Jimma University in

partial fulfilment of the requirements for the award of the degree of Master of
Science in Banking and Finance
JIMMA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF BANKING AND FINANCE

JUNE, 2021JIMMA,
ETHIOPIA
 CERTIFICATE
This is to certify that the thesis entitles “effects of investment on the financial performance of
commercial banks in Ethiopia”, submitted to Jimma University for the award of the Degree
of Master of Science in Banking and Finance (MSc) and is a record of bonafide research
work carried out by Mr. Kano Bula , under our guidance and supervision.

Therefore, we hereby declare that no part of this thesis has been submitted to any other
university or institution for the award of any degree or diploma.

Main Adviser’s Name Date Signature

____________________________ __________________ _____________________
Co-Advisor’s Name Date Signature
____________________________ _________________ _____________________

i
 DECLARATION
I hereby declare that this thesis entitled “effects of investment on the financial performance of
commercial banks in Ethiopia”, has been carried out by me under the guidance and
supervision of Dr. Demise Haile Gebreal and MissGadise Gazu.

The thesis is original and has not been submitted for the award of any degree or diploma to
any university or institution.

Researcher’s Name Date Signature

_________________________ ___________________ ___________________

ii
Acknowledgements

I am very thankful to God for enabling me to carry out this research successfully. I would like
to extend my deep indebtedness to my advisory, Dr. Demis HaileGebreal, and Miss. Gadise
Gazu who have played a major role in guiding me during this study, encouraging me and
offering invaluable comments from the initial stages of this work up to the final write up of
this thesis

I am deeply indebted to the staff of NBE, finance department, for providing me with the
required information and hospitality during the data collection. Appreciation goes to the
lecturers of the School of Business and Economics, who faithfully imparted their knowledge
and skills throughout the course

My special thanks go to my father Mr. Bula Shuramo for encouraging and supporting me,
concern during this study period. I sincerely appreciate my entire family, friends especially
Degago Bula. And Efa Bekele and acquaintances for their continued prayers, support and
encouragement.
May the favour and Grace of God be with you all

iii
Abstract
This thesis investigates the effect of investment on the financial performance of commercial
banks in Ethiopia. The objective of this study was to investigate the Effect of Investment on
the Financial Performance of commercial banks in Ethiopia. This aimed investment improves
the financial performance of commercial banks or not. The analysis considered the presence
of different commercial banks i.e. public and private commercial banks. The study used a
sample of 8 commercial banks out of 17 from 2006 to the 2020 year financial statements. The
fixed effect regression technique and correlation were used to analyze the data using the
econometric package stata 16 software. The sampled data was also presented and analyzed
by using descriptive statistics by mean, standard deviation, maximum and minimum. The
dependent variable used to estimate commercial bank's performances were return on equity.
The researcher used Investment in the national bank of Ethiopia bill purchase (NBE BILL),
Investment in foreign bank deposit (FBD), Investment in equity (IE), and Investment in fixed
asset (FAI) as independent variables. The researcher also used capital adequacy ratio,
inflation and GDP as control variables. The study finds that commercial banks performance
measurement i.e. ROE has a strong and significant relationship with investment in foreign
bank deposit and investment in equity. On the other handinvestment in national bank of
Ethiopia bill has a negative and significant effect on return on equity. Investment in fixed
assets has also shown insignificant and negative effect at 5% level of significant.
Furthermore, capital adequacy ratio has positive and significant effect on return on equity.
In addition inflation and GDP has insignificant and positive effect on return on equity. So the
study recommended commercial banks are advised to invest in equity & foreign bank deposit
in order to enhance the financial performances.

Keywords; Investment, Financial Performance, Commercial Bank

iv
Contents
List of tables........................................................................................................................................... ix
List of figures .......................................................................................................................................... x
List of Acronyms .................................................................................................................................. xii
CHAPTER ONE ..................................................................................................................................... 1
1. INTRODUCTION .............................................................................................................................. 1
1.1. Background of the Study ............................................................................................................. 1
1.2 . Statement of the Problem ............................................................................................................ 3
1.3. Research Hypothesis .................................................................................................................... 5
1.4. Objective of the Study ................................................................................................................. 6
1.4.1. General Objective ................................................................................................................. 6
1.4.2. Specific Objectives ............................................................................................................... 6
1.5. Scope of the Study ....................................................................................................................... 6
1.6. Significant of the Study ............................................................................................................... 7
1.7. Limitation of the study ................................................................................................................. 7
1.8. Organization of the Study ............................................................................................................ 7
CHAPTER TWO .................................................................................................................................... 8
2. REVIEW OF RELATED LITERATURE .......................................................................................... 8
2.1. Theoretical Literature................................................................................................................... 8
2.1.1 Overview of banking history in Ethiopia ............................................................................... 8
2.1.2 The neo classical theory of investment ................................................................................ 11
2.1.3The Q Theory of investment ................................................................................................. 12
2.1.4The accelerator model of investment .................................................................................... 12
2.1.5 The Agency Theory ............................................................................................................. 13
2.1.6 Resource Dependency Theory ............................................................................................. 14
2.1.7 The Capital Asset Pricing Model ......................................................................................... 14
2.1.8. Slack Resources Theory ...................................................................................................... 15
2.2. Empirical Literature Review ...................................................................................................... 15
2.3.Conclusion and knowledge gap .................................................................................................. 25
2.4. Conceptual Frame Work ............................................................................................................ 25
CHAPTER THREE .............................................................................................................................. 27
3. RESEARCH DESIGN AND METHODOLOGY ............................................................................ 27

v
 3.1. Research Design......................................................................................................................... 27
3.2. Research approach ..................................................................................................................... 27
3.3. Population of the Study .............................................................................................................. 27
3.4. Sampling techniques .................................................................................................................. 28
3.5. Types and Sources of Data....................................................................................................... 28
3.6. Data analysis .............................................................................................................................. 28
3.7. Variable and measurements ....................................................................................................... 31
3.8. Model Specification ................................................................................................................... 34
CHAPTER FOUR................................................................................................................................. 36
RESULTS AND DISCUSSIONS ......................................................................................................... 36
4.1. Descriptive statistics .................................................................................................................. 36
4.2 Correlation Analysis ................................................................................................................... 38
4.3. Regression model tests ............................................................................................................... 38
4.3.1 Model Selection (Random Effect versus Fixed Effect Models) .......................................... 39
4.3.2 Tests for the Classical Linear Regression Model (CLRM) assumptions ............................. 40
4.4. Result of Regression Analysis .................................................................................................. 42
5.1. Conclusion ................................................................................................................................. 50
5.2. Recommendations ...................................................................................................................... 51
Reference .............................................................................................................................................. 52
APPENDIX ........................................................................................................................................... 56

vi
vii
viii
 List of tables

Table 3. 1 Sampled commercial banks .................................................................................... 28

Table 3. 2 Variable measurement and expected sign .............................................................. 33

Table 4. 1 Descriptive statistics ............................................................................................... 37

Table 4. 2 Correlation Analysis of Variables .......................................................................... 38
Table 4. 3 Hausman test........................................................................................................... 39
Table 4. 4 Heteroskedasticity test ............................................................................................ 41
Table 4. 5 Multicollinearity ..................................................................................................... 41
Table 4. 6 Normality test.......................................................................................................... 42
Table 4. 7 Robust Fixed effect Regression Result .................................................................... 48
Table 4. 8 Summary of hypothesis testing ............................................................................... 49

ix
 List of figures

Figure 2. 1 conceptual framework or model of the study ....................................................... 26

Figure 4. 1Normality test…………………………………………………………………
Error! Bookmark not defined.

x
xi
 List of Acronyms
CA Capital Adequacy

CLRM Classical Linear Regression Model

EI Equity Investment

FA Fixed Asset

FD Foreign Deposit

FEM Fixed Effect Model

GDP Growth Domestic Product

INF Inflation

NBE National Bank of Ethiopia

NBEB National Bank Bill purchase

OLS Ordinary Least Square

REM Random Effect Model

ROE Return on Equity

xii
 CHAPTER ONE

1. INTRODUCTION
1.1. Background of the Study

The financial system plays a primary role within the economic process and development of
a country.The importance of a well-ordered financial sector lies within the reality that ensures
domestic resources mobilization, making of savings, and investments within the sectors.
Actually, this financial system is that the system by which a country desires the
foremost profitable and efficient sectors to form more productive bases for future
growth(Abate & Mesfin, 2019).). The many functions of a financial system aren't only to
shift funds from savers to investors but also to form sure that funds are being transferred to
the sectors which are most vital for an economy. Bank performance gets an excellent deal of
consideration within the finance economyliterature bearing in mind that banks function a
critical role within the economy(Ongore and Kusa,2013).Banks are important parts of a
nation’s. In their conventional role as financial intermediaries, banks make sure
the transmission of funds from surplus to deficit units and serve to satisfy the demand of
those who need funding. Banks facilitate spending and investment, which fuel growth within
the economy. However, despite their important role within the economy, banks are
nevertheless vulnerable to failure. Banks, like all other businesses, can go bankrupt.
However, unlike most other businesses, the failure of banks, especially very large ones, can
have far-reaching implications. The investment decision is one of the key decisions for the
management of any organization.They are a significant decision for a
corporation since they're hypothesized to influence its valuable by influencing profitability
and risk(Alslehat & Altahtamouni, 2014).
Investment decisions largely include acquisition,modernization,extension, and replacement
of the long–term assets.The investment decision that a firm makes is significant in firms
financial performance hence making it effective for a firm to be competitive and
efficient it's to form investment decision key to the business administration(Virlics, 2013)

The theoretical perspective on how investment and financial performance relate has also
advanced over years. The Q theory of investment asserts that a firm need to invest when it
expects the investment to bears profits then forth an efficient assets markets valuation of the
1
firm incorporates such prospects(Erickson & Whited, 2000)Thus, the sole things
thatdetermine firm’s investment are the existence of investment opportunities that are
profitable.(Balfoussia & Gibson, 2016).The theory supported resources suggest that in order
for firms to accumulate competitive advantage they ought to implement unique investment
which is rare,valuable,cannot be imitated, and non-substitutable(store, 2015). As
long because the anticipated revenue from an investment is above the chance cost of capital,
investments are going to be useful and undertaken by the firm(Warström & Niemelä,
2015).Investment plays a really significant role within the financial performance of banks.
Commercial banks invest their resource so as to earn a return that will enable them to
enhance their financial performance(Njiiri, 2015). Commercial banks normally invest in
government securities, which include government treasury bills and bonds. Other investments
of banks mainly include investment, which is listed in security exchange or
shares privately companies and bond issued privately by other firms. An addition to
debentures and common stock, commercial banks also invests in subsidiaries, associates,
joint ventures et al. miscellaneous investment which are either directly purchased or acquired
through takes over’s, merging or consolidation(Ismail, 2010). Additionally,commercial banks
also invest in land properties like commercial buildings, residential land , and other sorts
of land (Levišauskait, 2010).

In Ethiopia, commercial banks dominate the financial sector. In a country where the financial
sector is dominated by commercial banks, any failure in the sector has a huge implication on
the economic growth of the country. This is due to the fact that any bankruptcy that could
happen in the sector has a domino effect that can lead to bank runs, crises and bring overall
financial crisis and economic problems. However, a substantial amount of studies have not
been conducted to investigate the status of effects of investment on the financial performance
of the Ethiopian banking system according to the researcher's knowledge. This research
examined the internal and external factors that effect of investment onthe financial
performance of the Ethiopian commercial bank's industry from the period 2006-
2020.Moreover, the current banking failures in the developed countries and the bailouts
thereof motivated this study to evaluate the effects of investment onthe financial performance
of Commercial banks in Ethiopia. Thus, to take protective and qualifying measures, there is a
dire need to understand the effect of investment and the performance of banks.

2
1.2 .Statement of the Problem
In the dynamic globalized world, Commercial Banks play a crucial role as financial
mediators within the economic development of the state. Banks collect financial resources
from individuals and organizations and redistribute it to others so as to have further benefit.
They do so if they get the necessary earnings to hide the operational cost they incur. That is
to mention, for a sustainable intermediation function, banks need to be profitable. Beyond
the intermediation function, the financial performance of banks has critical implications
for economic growth of countries. Good financial presentation of Banks rewards the
shareholders for their investment. This, in turn, gives confidence for additional investment
and brings about economic growth. On the other hand, poor bank performance may lead to
banking failure and crisis which have a negative consequence on economic growth (Ongore
& Kusa, 2013).The commercial banking trend is around the world has witnessed rapid
changes. Competition is tough thus forcing banks to heighten their effectiveness and
competition by raising their performance (Jha & Hui, 2012).With growing competition
globally banks are directing their energies on investment to create value for shareholders so
as to survive extreme competition (irung, 2013).However, the decision to invest is subjective
and a wrong decision investment can leads companies even tobankruptcy. So investment
decisions are very risky and uncertain on whether the cost incurred to invest will be recouped
and profit gained within the specified time period (Virlics, 2013).

In Ethiopian economy, commercial banks have enlarged and opened many branches over the
past few years. During the last decade, the banking sector of Ethiopia has experienced a
major transformation in terms of investment and geographic distribution due to the financial
sector reform and liberalization act of 84/1994 (Fedlu, 2015). This has resulted in an
extremely tremendous increase in deposit liabilities and in turn, a rise in the volume of an
investment portfolio. As explained by (Michael et al., 2012). The three main types of non-
banking activities that must be considered are securities, insurance, and real estate (fixed
asset) activities. These activities will direct banks to earn additional profit that leads banks
performance higher.Due to the matter fact thatthe national bank of Ethiopia had a directive
for commercial banks in Ethiopia limit on investment. Commercial banks has a mandatory
to purchase national bank bill from NBE equivalent to 27% of new loan disbursement issued
at an interest rate of three-per cent as well as a banks aggregate equity investment in all non
bank business,including insurance companies,shall not exceed 10% of its networth. In
addition to this no commercial banks shall invest 10% of its net worth in real estate

3
acquisition and development other than for their own business premises without approval of
that national bank (NBE directive No.SBB/60/2015 as well as it can invest their excess cash
at foreign deposit bankinvestment. (NBE, 2004).

As far as the researcher's knowledge, a single study corresponding with this research is
conducted by (AKALU, 2016). About the effect of investment on the financial performance
ofcommercial banks in Ethiopia and the finding reveal that investment in foreign deposit, the
fixed asset had a positive relationship with performance of commercial banks and investment
in equity, NBE bill had a negative relationship with performance of commercial banks in
Ethiopia.However, such studies are few and there is a need for further investigation. Besides,
macroeconomic factors such as real growth rate in GDP and general rate of inflation were
evidenced to be highly associated with investment thereby affecting the ability of commercial
banks to generate profit ;(Pasiouras & Kosmidou, 2007). (Ali, Akhtar, & Ahmed,
2011)widely described that rapid economic growth increases profitability in a large number
of countries and movements in general activity are likely to generate direct impacts on the
profitability of banks.(Pasiouras & Kosmidou, 2007)explained that the effect of inflation can
substantially undermine the stability of the financial system. Furthermore,there is
inconsistency in the findings of the previous studies conducted in this research title. For
instance,(kuri,2014)(Abdikadir, 2017).showed that investment in equity had a positive and
significant relationship with the financial performance of commercial banks.On the other
hand,(AKALU, 2016)(Biniyam, 2018) showed that equity investment had a negative and
insignificant relationship with the performance of commercial banks. Also (Abdikadir,
2017).showed fixed asset had a negative and insignificant relationship with performance of
commercial banks; however,(Olantunji and Adegbite,2014),(AKALU, 2016)(Biniyam,
2018)showed fixed asset has a positive and significant relationship with performance of
commercial banks. Sothis study proves which variables have positively affected and which
variables have negatively affected the financial performance of commercial banks. And fill
the above-explained knowledge gap by providing information about the firm specific, and
macro-economic factors that affects financial performance by examining the untouched ones,
replicating the existing and utilization of the model by using ROE as a measure for
commercial banks‟ financial performance . This research also tries to include recent year’s
financial statements of all commercial banks‟.As result, it worthwhile to investigate the
effects of investment on the financial performance of commercial banks so as to determine

4
whether an investment has an impact of either reducing or increasing the overall financial
performance of the commercial banks operating in Ethiopia.

1.3. Research Hypothesis

Hypotheses are predictions about the outcome of the results that have capable of being tested
by scientific methods that relate independent variables to some dependent variable.
Therefore, in order to achieve the objective of the study, the hypotheses were developed
regarding the effects of investment on the financial performance of commercial banks in
Ethiopia based on different empirical research and theoretical reviews made. The hypothesis
developed by the study was based on empirical evidence and the theory of different
researchers.
As far as NBE bill purchase is concerned several studies tried to its influence on commercial
banks performance, like (AKALU, 2016), (Eden,2014),(Shibiru,20140),(Tesfaye,2014)
showed NBE bill has a negative and significant effect on the performance of commercial
banks. Based on it, this study develops the following hypothesis;
H1; NBE bill has negative effects on the financial performance of commercial banks.
Concerned in foreign deposit investment (AKALU, 2016) showed foreign deposit investment
has positive and significant effects on the performance of commercial banks. Based on it, this
study develops the following hypothesis.
H 2; foreign deposit has positive effects on the financial performance of commercial banks.
As far as fixed asset concerned several studies try to its influence on commercial banks
performance for instance (Olatunji and Adegbite,2014)(AKALU, 2016), (Biniyam,
2018)showed fixed asset has positive and significant effects on the performance of
commercial banks. However, (Abdikadir, 2017)found that fixed asset has a negative and
insignificant relationship with the performance of commercial banks. Based on it, this study
develops the following hypothesis.
H 3; fixed asset has positive effects on the financial performance of commercial banks.
Concerned in equity investment several studies tried to its influence on commercial banks
performance for instance,(Kuri,2012) and (Abdikadir, 2017) showed equity investment has
positive and significant effects on the performance of commercial banks but studies
conducted by (Biniyam, 2018) and (AKALU, 2016) showed equity investment has negative
and insignificant effects on the performance of commercial banks. As indicated above, a
result of researches shows different results, but the researcher assumes that based on the
majority of the literature result, this study develops the following hypothesis.

5
H 4; equity investment has a negative effect on the financial performance of commercial
banks.

1.4. Objective of the Study

1.4.1. General Objective
The general objective of the study is to analyze the effect of investment on the financial
performance of commercial banks in Ethiopia.

1.4.2. Specific Objectives

The specific objectives of the study are;
1. To examine the effect of NBE bill purchase on the financial performance of
Commercial banks.
2. To scrutinize the effect of foreign bank deposits on the financial performance of
commercial banks.
3. To examine the effect of equity investment on the financial performance of
commercial banks.

4. To analysis the effect of fixed asset investment on the financial performance of

commercial banks.

1.5. Scope of the Study

The scope of the study limited to assess the effects of investment on financial performance of
commercial banks in Ethiopia. By using fifteen years (2006-2020.C) audited financial
statements of each commercial bank. The study comprised all commercial banks which have
at least fifteen years data. As a result, out of the seventeen commercial banks in Ethiopia
including the largest government owned bank Commercial bank of Ethiopia, Awash
international bank S.c., Bank of Abyssinia, Dashen bank, Wegagen bank, United bank , Nib
international bank and Cooperative bank of Oromia. The study used one dependant variable
return on equity (ROE) ,and four independant variables were national bank bill purchase
,foreign bank deposit investment ,fixed asset investment and equity investment. In addition
the study used three control variables were capital adequacy,inflation and GDP. As the result,
these variables could explain the topic properly by referring to previous empirical works.

6
1.6. Significant of the Study
This study will provide benefit for the banking sector on the National Bank of Ethiopia
regulationlimitation on the area of investments and the effect of the regulation affect their
financial performance that will be earned from investment. In addition, the research will give
importance points to this sector to act on their investment policy by using the
opportunities that NBE allowed them and how to manage their investment portfolio
without rejecting the regulation. Findings from this study will also help national bank of
Ethiopia to improve the investment regulation without making the policy highly
restrictive. Furthermore, the study will help other researchers as a source of reference
and an initial point for those who want to make further study on the area of
commercial bank investment.

1.7. Limitation of the study

Secondary data for fifteen years (2006-2020) collected from all sampled commercial banks in
Ethiopia. In addition, the study focuses on firm-specific variables as well as macroeconomic
variables under this study. Thus, the primary limitations are the scope and sample size.
The analysis and its derived conclusions based on the secondary data sources (i.e. mainly on
published annual reports of all commercial banks in Ethiopian), both the dependent and
Independent variables proxies by numbers from these past data sources. Hence, the historical
data may not reflect the current and future economic situation

1.8. Organization of the Study

The research paper is organized into five chapters. Chapter one is an introduction part, which
includes back ground of the study, the statement of the problem, objectives of the study,
hypothesis ,scope, significance, and limitation of the study are presented. Chapter two is a
review of literature in which theories, empirical evidence, and conceptual framework are
identified. Chapter three contained research methodology where research design, research
approach, population, sampling method, sample size, sources of data, data analysis
technique, model specification, variable definition were covered. Chapter four focused on
the results and discussion in which the findings results that are interpreted. Finally, Chapter
five brought to an end the research with conclusion and possible recommendation

7
 CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

2.1. Theoretical Literature
A comprehensive review of published and unpublished works in the areas of investment and
the performance of commercial banks is made to develop and identify the problem, to
develop research hypothesis and so as to come up with appropriate research methods. It also
comprises various researchers point of view on related research works from the context of
various countries. Therefore, the literature review is organized and presented in two sections.
The first section discusses the theoretical literature about investment and the performance of
commercial banks from different perspectives and the second section presented empirical
literature.

2.1.1 Overview of banking history in Ethiopia

The first bank called Bank of Abyssinia was inaugurated in Feb. 16, 1906 following the
agreement that was reached in 1905 between Emperor Minilik II and Mr. Ma Gillivray,
representative of British owned commercial bank of Egypt marked the introduction of
recent banking in Ethiopia. The Bank was totally managed by the Egyptian commercial
bank .Within the primary fifteen years of its operation, Bank of Abyssinia opened
branches in several areas of the country. In 1906 a branch in Harar (Eastern Ethiopia) was
opened at an equivalent time of the inauguration of Bank of Abyssinia in Addis Ababa .
Another at Dire Dawa was opened two years later and at Gore in 1912 and at Dessie and
Djibouti in 1920. Mac Gillivray, the representative and negotiator of Bank of Egypt, was
appointed to be the Governor of the new Bank and he was succeeded by H Goldie, Miles
Backhouse, and CS Collier were in change from 1919 until the bank‟s liquidation in 1931.
Generally, in its short period of existence, Bank of Abyssinia had been completing limited
business like keeping government accounts, some export financing and undertaking various
tasks for the govt . Moreover, the Bank faced enormous pressure for being inefficient and
purely profit motivated and reached an agreement to abandon its operation and be
liquidated so as to disengage banking from foreign control and to form the institution
responsible to Ethiopia's credit needs. Thus by 1931 Bank of Abyssinia was legally replaced .
The new Bank, Bank of Ethiopia, was a purely Ethiopian institution and was the
primary indigenous bank in Africa (NBE, 2009/10,) and established by a politician decree

8
on August 29, 1931 with capital of £750,000. Bank of Egypt was willing to abandon it's on
cessionary rights reciprocally for a payment of British pound 40,000 and therefore
the transfer of ownership happened very smoothly and the offices and personnel of the Bank
of Abyssinia including its manager, Mr. Collier, being retained by the new Bank. Ethiopian
government owned 60 percent of the entire shares of the Bank and every one transactions
were subject to scrutiny by its Minister of Finance.Bank of Ethiopia took over the
commercial activities of the Bank of Abyssinia and was authorized to issue notes and coins.
The Bank with branches in Dire Dawa, Gore, Dessie, DebreTabor, Harar, agency in
Gambella and a transit office in Djibouti continued successfully until the Italian invasion in
1935. During the invasion, the Italians established branches of their main banks namely
Banco di Italia, Banco di Roma, Banco di Napoli and Banco Nazionale del lavoro and
began operation in the main towns of Ethiopia. However, all of them ceased operation soon
after liberation except Banco di Roma and Banco di Napoli which remained in Asmara. In
1941 another foreign bank, Barclays Bank, came to Ethiopia with British troops and
arranged banking services in Addis Ababa , until its withdrawal in 1943. Then on 15th April
1943, the depository financial institution of Ethiopia commenced full operation after 8
months of preparatory activities. It acted because the financial institution of Ethiopia and ha
d an influence to issue bank notes and coins because the agent of the Ministry of Finance. In
1945 and 1949 the Bank was granted the only right of issuing currency and deal in foreign
currency. The Bank also functioned because the principal full service bank within
the country and engaged altogether commercial banking activities. The State Bank of
Ethiopia had established 21 branches including a branch in Khartoum, Sudan and a transit
office on Djibouti until it ceased to exist by bank proclamation issued on December, 1963.
Then the Ethiopian Monetary and Banking law that came into force in 1963 separated the
function of commercial and central banking creating National Bank of Ethiopia (NBE) and
commercial Bank of Ethiopia (CBE). Moreover it allowed foreign banks to operate in
Ethiopia limiting their maximum ownership to be 49 percent while the remaining balance
should be owned by Ethiopians.

There were two other banks operational namely Banco di Roma S. C. and Bank of di Napoli
S.C. that later reapplied for license according to the new proclamation each having a paid up
capital of Eth. Birr 2million.The first privately owned bank, Addis Ababa Bank S.C., was
established on Ethiopians initiative and began operation in 1964 with a capital of
two million in association with National and Grindlay Bank, London which had 40 percent

9
of the entire share. In 1968, the original capital of the Bank rose to 5.0 million and until it
ceased operation,it had 300 staff at 26 branches.
There were other financial institutions operating within the country just like the Imperial
Savings and residential Ownership Public Association (ISHOPA) which specialized in
providing loans for the development of residential houses and to individuals under the
guarantee of their savings. There was also the Saving and Mortgage Corporation of Ethiopia
(SMCE) whose aims and duties were to accept savings and trust deposits account and provide
loans for the construction, repair and improvement of residential house, commercial and
industrial buildings and perform all activities associated with mortgage operations. On the
other hand, there was a bank called agricultural bank that provides loan for the agricultural
and other relevant projects established in 1945. But in 1951the investment bank of Ethiopia
replaced it. In1965, the name of the bank once more hanged to Ethiopian Investment
Corporation Share Company and therefore the capital was raised to Eth. Birr 20 million,
which is fully paid up. However, proclamation No. 55 of 1970 established the agricultural
and Industrial Development bank Share Company by taking over the asset and liability of the
former Development Bank and Investment Corporation of Ethiopia .

Following the declaration of socialism in 1974 the government extended its control over the
whole economy and nationalized all large corporations. Organizational setups were taken so
as to make stronger institutions by merging people who perform similar functions.
Accordingly, the three private owned banks, Addis Ababa Bank, Banco di Roma and Banco
di Napoli Merged in 1976 to make the second largest Bank in Ethiopia called Addis Bank
with a capital of Eth. birr 20 million and had a staff of 480 and 34 branches. Before the
merger, the foreign participation of those banks was first nationalized in early 1975. Then
Addis Bank S.C. and full service bank of Ethiopia were merged by proclamation No.184 of
August 2, 1980 to make the only full service bank within the country till the
establishment of personal commercial banks in 1994. The full service bank of Ethiopia
commenced its operation with a capital of Birr 65 million, 128 branches and three ,633
employees. The Savings and Mortgage Corporation S. C and Imperial Saving and Home
Ownership Public Association were also merged to form the Housing and Saving Bank with
working capital of Birr 6 million and all rights, privileges, assets and liabilities were
transferred by proclamation No.60, 1975 to the new bank Proclamation No. 99 of 1976
brought in to existence the Agricultural and Industrial Bank, which was formed in 1970 as a
100 percent state ownership, was bought under the umbrella of the National Bank of

10
Ethiopia. Then it was reestablished by proclamation No. 158 of 1979 as a public finance
agency possessing judicial personality and named Agricultural and Development Bank
(AIDB). It was entrusted with the financing of the economic development of the Agricultural,
Industrial and other sectors of the national economy extending credits of medium and long-
term nature as well as short-term agriculturalproductionloans.

The financial sector that the socialist oriented government left behind constituted only three
banks and every enjoying monopoly in its respective market, the subsequent was the
structure of the world at the top of the era: The commercial bank of Ethiopia (NBE),
the full service bank of Ethiopia (CBE) and Agricultural and Industrial Development Bank
(AIDB).Following the autumn of the Dergue regime in 1991 that ruled the country for 17
years under the rule of command economy, the EPRDF declared a liberal economy system. In
line with this, Monetary and Banking proclamation of 1994 established the commercial
bank of Ethiopia as a judicial entity, separated from the govt and outlined its main function.
Monetary and Banking proclamation No.83/1994 and the Licensing and Supervision of
Banking Business No.84/1994 laid down the legal basis for investment in the banking sector.
Consequently after the proclamation issued private equity holders began to join the Ethiopian
banking industry and as of (January, 2015) eighteen commercial banks are operated and out
of this sixteen are private owned.

2.1.2The neo classical theory of investment

This theory originates from Jorgenson (1963). The theory draws its fundamental from the
maximization of utility and wealth of a firm over time ((Warström & Niemelä, 2015).In the
neoclassical theory, investment is seen as a distributed lag function of variations in the
required capital. The required or desired capital here acts as a function to the output level,
user capital cost and output price (Twine, Kiiza, & Bashaasha, 2015). The theory presupposes
that investment is a function of cost of capital and the firms output. Additionally, the theory
contends that the capital and labour ratios adapt to the relative changes in price (Virlics,
2013).The neoclassical theory of investment is premised on preposition that agents can make
numerical probabilities and probability distribution of the expected returns.In the investment
models, the firm is seen to be neutral to risks, and capital cost causes the risk (Virlics,
2013).The neoclassical arguments assume that firm managers act in the best interest of firms
stakeholders.It also assumes managers and external suppliers of funds have the same
information regarding the quantity and quality of investment opportunities available to the
firms. These assumptions serve as a point of departure for models that demonstrate the

11
potential importance of internal funds in the investment decision (Ismail, 2010).For this
study, the neoclassical theory will be employed to explore whether investment maximize the
wealth and utility of the owners of the firms.

2.1.3The Q Theory of investment

This theory originated from (Tobin, 1969). The Q- theory is an extension of the neoclassical
theory since it incorporates the adjustment costs as explanations for outputs losses.
According to theory, firms choose investment levels, which maximize the estimated current
firm value (Twine et al., 2015).The theory presupposes that the market estimation of equities
is the major element of investment by firms. Thus, investment decision is stirred when
financing sources are highly priced in the market place than it would cost to create it
(Erickson & Whited, 2000)

This theory relates to investment rate as Q function where Q refers to market value ratio of
new added investment resource to their replacement cost. This investment theory suggests the
metric q ,which is the ratio between a unit of physical capitals market value and its value of
replacement ,done to recap the existence \ absence of opportunities for investments for a
precisefirm(Eklund,2013). Tobin reason that, when the capital adds marginal units to a firm
value more than it costs to obtain it, thatis, q is greater than 1; installing new capital will be
profitable to the precise firm. Hence 1 indicates that the firm should accrue more capital
(i e. embark on extra investment) and vice versa (Balfoussia & Gibson, 2016).According to
the theory, investment decision depends on the marginal Q level, defined as the imminent
investment marginal returns over the existing marginal investment cost. The Q theory also
argue that if the firms value of the market is more than the cost of replacement of capital
firms will choose to invest until the value of capital equals the replacement costs, thus
optimizing capital stock (Warström & Niemelä, 2015).In this study, the Q theory of
investment will be explored to explain whether the investment levels chosen by a firm
maximizes its current value.

2.1.4The accelerator model of investment

The model originated from (Clark, 1917)but its application in business cycle was advanced
by Samuelsson (1939). The model shows investment to be a function of growth of output
only assuming that the wanted capital stock is achieved in every period of time.The model
assumes that capital demand depends on the acceleration of that demand and not with the
demand volume for the finished product (Twine et al., 2015). The arithmetical value between

12
the increases in investment relations as result of income increases. If national income or
output remaining constant, the net investment that is induced will be positive (Loof and
Heshmeti, 2008).The accelerator is an advanced model of the neoclassical investment theory
which the price changes have been cut to the constant coefficients (Eklund, 2013). The
accelerator model shows the relationship between capital and output as determined by a
production function, and the cost of effects of capital that captures the substitutability among
the capital and other production factors.The accelerator model focus on growth output as the
main element of investment choice (Twine et al., 2015).This model shows that, a firm plan to
add to the capitalstock perperiod, that is, invest so as to make partial alterations account for
the gap between the wanted stock of capital and the current stock of capital Eklund (2013).
For this study, the accelerator model will be applied to explain whether investments
accelerate the value of the firm.

2.1.5 The Agency Theory

(Jensen & Meckling, 1976)were the first people to suggest the agency theory in a theory of
the firm based upon conflicts of interest between various parties such as shareholders,
corporate managers and debtors. However since then, the finance theory has developed both
theoretically and empirically to allow a fuller investigation of the problems caused by
divergences of interest between shareholders and corporate managers. The Agency theory
indicates that agency problems arise because of the impossibility of perfectly contracting for
every possible action of an agent whose decisions affect both his own welfare and the welfare
of the principal. (McColgan, 2001)further argues that despite its faults, with respect to agency
conflicts, the modern corporation appears to be the most popular form of corporate
organization. Perhaps this can largely be attributable to the evolution of governance
mechanisms designed to limit the scope of these problems. Pension schemes may be
considered as agents of the members. They are entrusted with money that belongs to the
members for them to manage on their behalf. This theory implies that the pension schemes
are only agents who need to act for the benefit of the owners who are the contributors to the
pension schemes. The pension schemes may have other divergent interests to pursue but the
main purpose of their existence is to create value for the contributors. The contributors have a
right to decide how their savings into pension schemes are invested and accessed including
early ace.

13
2.1.6 Resource Dependency Theory
This theory was developed by (Salancik & Pfeffer, 1978).The theory is based on the
assumption that environments are the source of scarce resources and organizations are
dependent on these finite resources for survival. A lack of control over these resources thus
acts to make uncertainty for firms operating in that environment. Organizations must develop
ways to exploit these resources, which are also being sought by other firms, in order to ensure
their own survival. They established factors that have significant influence on the level of
dependence an organization has on particular resources. The first factor relates to overall
importance of the resource to the firm; second is the scarcity of the resource. The scarcer a
resource is that the more dependent the firm becomes. Finally, another factor influencing
resource dependence is the competition between organizations for control of that resource.
Together, all three of those factors act to influence the level of dependence that an
organization has for a specific resource. Resource dependence theory also infers that a firm’s
strategic options are determined to a great extent by the environment. Since firms are
dependent on the environment for resources, they need to enact strategies that would allow
them to acquire these resources. Therefore, the external environment has already been
determined for these firms, and they experience little strategic choice (Salancik & Pfeffer,
1978).

2.1.7 The Capital Asset Pricing Model

The background of CAPM was the study of the influence of investor behaviour on asset
prices. The result of that study was a theory of asset valuation in an equilibrium situation,
drawing together risk and return, which is the CAPM (Lintner, 1966).Several authors have
contributed to the model, first and foremost (Sharpe, 1964)but also (French, 2003).The
CAPM is the first model to introduce the notion of risk into the valuation of assets. It
evaluates both asset returns in connection to market returns and the sensitivity of the security
to the market (Amenc & Le Sourd, 2005).CAPM is in principle a method to calculate the rate
of return which it is normal to demand of an asset of a certain nature. The search for the
normal rate of return is divided into two parts according to CAPM. On the one hand, a risk-
free rate is found. On the other hand, the rate of return on a risky asset is found, constituting
the risk premium.

In CAPM the standard deviation of a single asset does not matter greatly, rather the effect of
the asset on the systematic risk of the portfolio to which the asset is added. The main concern
is the conjunction between the rate of return of the efficient portfolio and a single asset. If the

14
conclusion of the CAPM is that the correlation between the rate of return of the portfolio and
an asset is high, then it is appropriate to demand a high risk premium of that asset. If the
correlation is low, on the other hand, only a low risk premium should be demanded .(Sciubba,
2006)

2.1.8. Slack Resources Theory

This theory equates an organization to a living organism that struggles to survive amid
turbulence from the environment within which it operates. Slack is a cushion of actual or
potential resources which allow an organization to adapt successfully to internal pressures for
adjustment or to external pressures for change in policy, as well as to initiate changes in
strategy with respect to the external environment. The theory suggests that slack performs
four main functions in an organization. The first function of slack is acts as an inducement to
members. The second function of slack is to act as a resource for conflict resolution. The
third is function of slack is to act as an insulation to protect the organization from
environmental turbulence. Finally, slack can be a facilitator of strategic behavior, which
allows the firm to experiment with new strategies such as introducing new products and
entering new markets (Tan et al, 2003). Organizational slack can be split into absorbed and
unabsorbed slack. The latter refers to resources that are currently not committed to any
activity hence can easily be redeployed to another activity depending on the environmental
requirements. This gives the management greater discretion on how to commit the resources
and it can impact on the performance of an organizationThe absorbed slack refers to excess
costs in the organization and these are usually very difficult to redeploy (Veronica, 2013).

2.2. Empirical Literature Review

In this section empirical studies that have been made regarding on the effect of investment on
performance of commercial banks.
AKALU (2016).on the effect of investment on banks performance in Ethiopia and interprets
the result by relating with the regulations. The study used balanced panel model in examining
the regression model and collect data from eight commercial banks covering the period of
eleven consecutive years, 2005-2015. The study used one dependent variable ROE, four
independent variables that are fixed asset investment, foreign deposit, equity investment and
NBE Bill purchase and one control variable capital adequacy. The regression result show that
fixed asset investment and foreign deposit had a positive and significant effect on
performance of banks. On the other side NBE Bill purchase had a negative and significant
effect on the performance of commerce banks. The control variable also had a negative and

15
significant effect on the performance of commercial banks. One of the independent variable
equity investments had negative and insignificant effect on banks performance. The research
concluded that investment plays a significant role on the performance of Ethiopian
commercial banks.
Franciso (2010) studied on the effect of equity investment on banks profitability. The
research objective was analyzes the influence of equity investments on banks‟ profitability in
a panel data of 24 OECD countries. He used time series and cross-country data derived from
balance sheets and income statements of commercial banks in OECD countries, as available
from the Bank Profitability database published by the OECD. The results show that bank
equity investments have a positive effect on net interest income and on net income. This
positive influence remains the same after controlling for the potential increase of bank risk
that higher equity investments can originate. Thus, the highest profitability that portfolio
theory suggests for banks with higherequity investments does not disappear after considering
the highest provisions and capital ratios that these banks are obliged to keep. The positive
influence on net interest income is consistent with the view that banks can use their
shareholder position in non-financial firms to obtain benefits in the lending relationship that
they usually keep with firms in which they also take equity. In fact, the positive influence on
banks interest margin is the main benefit of the bank equity investments because we do not
observe differences in banks' profitability caused by capital losses or gains derived from
equity transactions.

Bouheni, Ameur, Cheffou, and Jawadi (2014)Studied on the effect of regulation and
supervision European banking profitability and risk. The research objective was in
investigation of the relationship between regulation, supervision, profitability, and stability is
not very well developed, although the relative literature has increased, particularly after the
recent global financial crisis. The aims this paper was to fill the gap, while investigating the
impact of regulatory and supervisory policies on profitability and risk using recent data and
appropriate econometric methodology. In particular, they apply panel data modelling to test
whether restrictions on bank activities, capital requirement, deposit insurance, supervisors‟
power, and supervisory authority independence have an impact on the stability and
profitability of the biggest European banks. Their data was collected first an original database
collected from the World Bank by Barth et al. (2001, 2004, 2006, 2008). Second, they focus
on an interesting and original sample including the ten largest European banks in the selected
European countries (France, Germany, UK, Spain, Italy, and Greece) over the period 2005 to

16
2011. By using different approaches they conclude that, the paper investigates the effects of
regulatory and supervisory policies on profitability and risk-taking for a large sample of the
biggest European banks in a context of financial crisis and economic downturn from 2005 to
2011. Using an original sample of regulatory, supervision and profitability proxies, the study
carried out and back tested a panel data regression model. The findings offer interesting
results the show that increasing European banking regulations and supervision could improve
banks‟ profitability and decrease their risk taking, the restrictions on banking activities
decreases profitability, while capital adequacy and the deposit insurance system increases
banks‟ profitability, reinforcing supervisors‟ powers reduces risk taking and promotes
banking stability. These results can have different policy implications for bankers as well as
for regulators in terms of improving regulatory measures and adapting them to the banking
environment and financial context.
Another study made by Michael et al. (,2012) on Regulation and Its Effect on Banking
Industry Structure and Performance: Some Cross-Country Evidence. The measures of bank
activity regulation that the study consider in the paper are securities (SEC), insurance (INS)
and real estate activities (REA). These measures specify the degree to which the national
regulatory authorities allow banks to engage in each respective activity. In particular, these
measures quantify the degree of regulatory restrictiveness for each activity on a scale from
one to four, with larger numbers representing greater restrictiveness. These types of
regulation determine the degree to which a bank may diversify its business operations as well
as capitalize on any synergies that may arise from complementary activities. They concluded
that restrictions on bank activities tend to yield more government ownership, less private
credit, and a larger fraction of nonperforming loans. The effect on concentration is unclear,
with different activity constraints yielding different results. Having an implicit deposit
insurance scheme reduces bank concentration, foreign ownership, and private credit. Stricter
entry requirements reduce government ownership of banks. Restrictions on ownership only
affect concentration. In particular, restricting non-financial firms from owning banks reduces
concentration, while restricting banks from owning non-financial firms increases
concentration.

Study conducted by Karemera (2013).on the “relationship between regulation and financial
performance of Rwanda commercial banks”. The objective of the study is to establish the
relationship between regulation and financial performance of commercial banks in Rwanda.
The findings of his study in some areas concur with past studies while in others it contradicts

17
past findings by other scholar. Capital requirement may not explain the financial performance
due to the fact that the total asset increase more than the equity and this can lead to the to the
low rate of profitability of the commercial banks. The equity of all the commercial banks has
been increasing but this does not contribute to the increase of return on assets may be because
of the increase of total assets in the particular period. Liquidity ratio has shown that it does
not at all explain financial performance of commercial banks in Rwanda. The negative
relationship between management efficiency and financial performance is most likely to have
been come from the highest increase of total assets in that period. Particularly in this period
The cost of construction was very high to almost all the commercial banks in Rwanda
consequently this has increased the total assets of the banks.
Study conducted in Nigeria on the title of Investment in fixed asset and firm profitability
empirical evidence from the Nigerian banking sector by Nigeria and Nigeria (2014).The
objective of the study as to examine the effect of investment in fixed asset on profitability of
selected Nigerian banks and to analyze analyses the significant components of fixed assets
investment of Selected Nigerian Commercial Banks, examines the relationship between fixed
assets values and Return on Investment (ROI) and determines the effect of fixed assets
investment on Net profits of sampled Nigerian commercial banks. The study result showed
that investment in fixed assets has significant positive relationship to the performance of the
sampled banks. Investments in fixed assets have strong and statistical positive impact on the
profitability of banking sector in Nigeria. In order to improve bank profitability there should
be efficient management of fixed assets.

As studied byKipleting (2016) on the effect of investment diversification on the financial

performance of commercial banks in Kenya, the main purpose of this study was to investigate
the effect of portfolio diversification on the financial performance of commercial banks in
Kenya. The specific objectives was to: investigate the effect of insurance investment on the
financial performance of commercial banks in Kenya, establish the effect of government
securities on the financial performance of commercial banks in Kenya, determine the effect
of real estate investment on the financial performance of commercial banks in Kenya and to
establish the effect of buying shares on the financial performance of commercial banks in
Kenya. This study adopted exploratory research design because it was trying to explain the
cause relationship between independent variable and dependent variable. The population of
interest in this study consisted of 40 commercial banks. A sample of 40 operational
commercial banks in Kenya was studied. Secondary data was collected using data collection

18
sheets as the main data collection tool and interview schedule as the primary data. In line
with the above study conducted by Mathew (2016), data collection sheets were used to
collect data guided by the objectives of the study. The data collected was analyzed using
Explanatory and inferential statistics with help of SPSS package version 20 inferential
statistics were done through ANOVA and multiple regressions. The study concluded that a
majority of the banks over the years have in practice employed the use of insurance
investment on the financial performance of commercial banks in Kenya. The study
recommended that banks should focus its work to promote the confidence in portfolio
diversification, and develop marketing policies that encourage its use.
Veronica (2013) studied on the relation between investment & financial performance of
insurance companies in Kenya. The research objective was to establish the relationship
between investment and financial performance of insurance companies in Kenya. The
researcher uses 45 insurance companies in Kenya as target population. Out of the total
population secondary data was collected from 32 insurance firms. She used Multivariate
regression and correlation analysis. The results show that investments in real estate,
certificates of deposit, Government securities, corporate bonds and stocks have a significant
impact on the financial performance of the insurance companies since the variables have
major effect on financial performance.
Kuria (2012)studied on the relationship between investment in intangible asset and financial
performance of commercial banks in Kenya. The objective of his study was to establish the
relationship between computers fixed assets and financial performance of commercial banks
in Kenya and to investigate the relationship between investment in intangible assets and
financial performance of commercial banks in Kenya. Qualitative approach was used in order
to gain a better understanding and possibly enable a better and more insightful interpretation
of the results from the qualitative data. The study concludes that there was a positive
correlation between increase in investment in intangible assets and increase in computer
assets and the increase in financial performances of commercial banks in Kenya in the year
2006 to 2011. An increase in intangible assets evidently leads to an increase in commercial
banks financial performances during the 5 year period of study. In this paper, we explored the
impact of intangible assets and increase in computer assets on commercial banks „financial
performance. The significant relationship between investment in assets and operating
performance remains strong after controlling for other firm characteristics. He found that
banks with higher intangible assets and higher computer assets tend to earn higher net income
returns that gradually increase during the period.

19
Study conducted by Biniyam (2018)on the effect of investment on financial performance of
insurance company in Ethiopia. The study used a sample of 9 insurance out of 17 from 2006
to 2016 year financial statements. The random effect regression technique and correlation
was used to analyse the data using the econometric package Eviews software. The study used
one dependent variables return on asset and four independent variables that are Investment
in fixed asset (IFA), Investment in government securities (IGS), Investment in equity (IE)
and Investment in fixed time deposit (FTD) as independent variables. The researcher also
used insurance size and liquidity ratio as control variables. The study finds that insurance
performance measurement i.e. ROA has a strong and significant relationship with Investment
in fixed asset and investment in government securities. On the other hand investment in
equity has a negative and insignificant effect on return on asset. Investment in government
security and fixed assets has also shown significant and positive effect. However, investment
in fixed time deposit has a positive and insignificant effect on return on asset.
Furthermore insurance size and liquidity ratio has a significant and positive effect on return
on asset. So the study recommended insurance companies are advised to invest in fixed asset
& Government Securities in order to enhance the financial performances.
Kebede (2014)studied on The Impact of National Bank Regulation on Banks Performance:
Evidence from the Private Banks of Ethiopia”. Start her study by the general objective of
examine the impact of National Bank regulation on private banks performance in Ethiopia.
The conclusion of her study is that NBE-Bill purchase has negative and significant effect on
banks performance measured through both Return on Asset and Net Interest Margin. The
researcher concludes that investment in NBE Bills results a negative impact due to the lesser
amount of interest rate compared to the amount of interest rate if the amount invested on the
Bill was invested on other investments. Change in reserve requirement has negative and
significant effect on the banks cost of intermediation measured through Net Interest Margin.
This is due to the reason that banks reserve which is hold by National Bank of Ethiopia do
not generate any return since it doesn’t bear any interest at all. Credit cap has negative and
statistically significant effect on banks performance measured through both Return on Asset
and Net Interest Margin. The researcher concludes that credit cap has a negative impact on
banks performance and this is due to since there was credit ceiling any bank cannot give the
amount of loan above that ceiling so the interest income generated from loans will decrease
but the bank will pay an interest expense for the depositors no matter what amount the banks
get an interest income from the loan.

20
yodit (2012) with the use of in depth interview made on exploratory research to investigate
on the implication of NBE bill Purchase on performance of private commercial banks in
Ethiopia and found out that the directive affects the bank’s profitability in an adverse manner.
The directive states that banks should purchase 27% based on their total disbursement with
disregard to the nature of loan, which have revolving nature and are also short term, would
aggravate the liquidity problem. But taking into consideration the deposit structure of the
banks into account if the banks shift to loan term maturing loan in order to avoid the
aggravated problem of liquidity with such revolving loans the banks would be faced with
asset liability mismatch. The directive as can be seen excludes the state owned bank which
create an unfair ground for competition between the privateer and state owned banks
specifically CBE. The directive preferential treatment hence, resulted in the shift of
customers from the private banks to public banks as a result reduce the private banks market
share in the industry while increasing the already strong market share of CBE. In addition,
the directive is also a barrier to new entrants. The directive is also push the private banks to
change both their deposit as well as loan structure.
The study carried out by Mohana and Tekeste (2012)was to explore the key determinants of
profitability of commercial banks operating in Ethiopia by using unbalanced panel data set of
banks over the period 1999/00-2008/09. They used internal factors like capital adequacy,
liquidity, credit risk, loan portfolio, asset quality, and expense management and external
factors related to the industry and the macroeconomic factors within which the banks operate.
Moreover ROA was used as dependent variable. In their analysis the fixed effects model is
used to control the unobservable bank specific characteristics. The result of the study reveals
that Capital adequacy (equity to asset ratio), diversification (non-interest income to total
income) and bank size (log of total assets) are among the internal factors that have positive
and significant impact on the profitability of Ethiopian commercial banks. Moreover, the loan
loss reserve to total loans is also found to have negative impact on profitability though it is
statistically insignificant. In addition to this, liquidity and operational efficiency are among
the internal factors that negatively affect the profitability of the banks. Finally, the
macroeconomic factors have insignificant impact on the commercial banks profitability in
Ethiopia.
The purpose of the study made by Habtamu (2012) is to investigate determinants of private
commercial banks profitability in Ethiopia by using panel data of seven private commercial
banks from year 2002 to 2011. He used quantitative research approach and secondary
financial data are analyzed by using multiple linear regressions models for the three bank

21
profitability measures; Return on Asset (ROA), Return on Equity (ROE), and Net Interest
Margin (NIM). He applied fixed effect regression model to investigate the impact of capital
adequacy, asset quality, managerial efficiency, liquidly, bank size, and real GDP growth rate
on major bank profitability measures i.e., (ROA), (ROE), and (NIM) separately. Beside this,
he used primary data analysis to solicit mangers perception towards the determinants of
private commercial banks profitability. The empirical results shows that bank specific factors;
capital adequacy, managerial efficiency, bank size and macro-economic factors; level of
GDP, and regulation have a strong influence on the profitability of private commercial banks
in Ethiopia.
The main objective of the study made by Birhanu (2012) is to examine the effect of
bankspecific, industry-specific and macroeconomic determinants of Ethiopian commercial
banking industry profitability from the period 2000 - 2011 by using OLS estimation method
to measure the effects of internal and external determinants on profitability in terms of
average return on asset and net interest margin. The result reveals that, all bank-specific
determinants, with the exception of bank size, expense management and credit risk, affect
bank profitability significantly and positively in the anticipated way. In addition to this, no
evidence is found in support of the presence of market concentration. Finally, from
macroeconomic determinants GDP has positive and significant effect on both asset return and
interest margin of the bank. But interest rate policy has significant and positive effect only on
interest margin.
Amdemikael (2012), Carried out study to examine the bank-specific, industry-specific and
macro-economic factors affecting bank profitability for eight commercial banks operating in
Ethiopia covering the period of 2000-2011. He adopts a mixed research approach by
combining documentary analysis and in-depth interviews. He used ROA as a dependent
variable and capital strength, operational efficiency, income diversification, liquidity risk,
bank size, asset quality, industry concentration level, real GDP growth and inflation as
independent variables. The findings of the study show that capital strength, income
diversification, bank size and gross domestic product have statistically significant and
positive relationship with banks‟ profitability. On the other hand, variables like operational
efficiency and asset quality have a negative and statistically significant relationship
with banks‟ profitability. However, the relationship for liquidity risk, concentration and
inflation is found to be statistically insignifican.
Belayneh (2011)Examine the impact of bank-specific, industry specific and macroeconomic
determinants of Ethiopian commercial banks profitability that covers the period 2001- 2010

22
by applying the balanced panel data of seven Ethiopian commercial banks. He used the ROA
as a dependent variable and capital, size, loan, deposits, noninterest income, noninterest
expense, credit risk, market concentration, economic growth, inflation and saving interest rate
as independent variables. The estimation results show that all bank-specific determinants,
with the exception of saving deposit, significantly affect commercial banks profitability
in Ethiopia. Market concentration is also a significant determining factor of profitability.
Finally, with regard to macroeconomic variables, only economic growth exhibits a
significant relationship with banks‟ profitability
Study conducted by nahom (2015) on the title of determinants of banks performance of
private commercial banks in Ethiopia, analyzed on the determinants of banks performance by
classifying his independent variables on bank specific factors and macroeconomic factor and
significant determinant of performance among the banks specific and macroeconomic
variables. His banks specific variables are capital adequacy, liquidity and asset quality and
the external variables are real GDP growth rate, annual inflation rate, internal rate, NBE bill
purchase. He used two dependent variables to measure banks performance they are return on
equity and net interest margin. And he concludes that capital adequacy from banks specific
factors and NBE bill purchase from macroeconomic factors was the major determinate of
bank performance as measured by return on equity. And liquidity, real GDP growth rate,
annual inflation rate and NBE bill purchase are the major determinants of banks performance
as measured by net interest margin.
Another study conducted by Shibiru (2014) ) on the assessment of the implication of
regulatory policy on the development of private commercial banks in Ethiopia in case of
NBE bill purchase directive. The objective of his study was to assess the implications of NBE
bills purchase directive on the development of private commercial banks in Ethiopia. The
conclusions of his study were, implications of bills purchase directive of NBE negatively
reflected on almost all private commercial banks‟ performances/activities consequently on
the development of private commercial banks. The study also revealed the directive has
negative implications on the expense of the private commercial banks via increasing the
expenses of private commercial banks. Likewise, the study revealed that the negative
implication of bills purchase directive on the profitability, liquidity, and capital and reserve of
private commercial banks. The directive has no implication on the asset size of private
commercial banks since the bills are one of the elements of asset of private commercial
banks; however, it affected the potential growth of rate of assets and asset portfolio of banks.
The assessment also disclosed, the couples of positive implications that directive had,

23
enhancing branch expansion of private commercial banks and forcing them to develop new
products, services and system to attract customers. He also conclude that the implications of
the directive was rated as significant on asset, capital and reserve, branch expansion and very
significant on liquidity, income, Loan able fund and overall development of private
commercial banks.

Tesfaye (2014) made research on the impact of policy measures on Ethiopian private banks
performance on the case of government bill purchase. The major theme of the study is to
assess the effect of sector specific policy measures on bank performance. The study has taken
one of the top policy issues; the requirement to purchase government securities, and analyzed
its impact on profitability measure, ROA. The study finds that exposure to government bills
has negative and significant relationship with performance. Nevertheless, the magnitude is
not severe. Even the pre and post policy periods comparison revealed a relatively better
profitability record for private banks during times of policy restrictions. Hence, the bill seems
contributed positively to performance via moping the excess liquidity holding of banks or
providing an opportunity for private banks to invest their excess funds in government
securities than the customary practice of holding their liquid asset in zero earning accounts at
the National Bank of Ethiopia.
The study focused on historical impact of the bill measure and it can serve as initial work to
further pursue on the impact of policy measures on the long run performance of Banks.
Taddesse (2015 ) made a research on the Investment of Accounting information system and
performance of Private commercial banks in Ethiopia in financial terms, so by testing the
impact of the investment on AIS on some performance measures of financial common and
traded such as return on assets (ROA), and return on equity (ROE) and productivity as a key
proxy of financial metrics for the performance of private banks. His study adopted model for
the study of panel research design to realize a stated objective. His study was employed
quantitative research approach by using both primary and secondary data gathered from
managers and financial statement of private commercial banks respectively.
For primary data researcher were made discussion between head of accounting and finance
particularly designated accounting clerk of each bank at the head office level in order to get
the separated ledger cost of Infrastructure, software and IT service. The overall result
obtained from the regression model indicates that investment on AIS has positive significance
impact on performance of Private commercial Banks in Ethiopia to an important extent with
some improvement observed from implementation of appropriate software and quality of

24
services which leads the performance of AIS‟s on infrastructure. The independent variables
(components of AIS) used in order to achieve the objectives stated were; Infrastructure,
software and related service. Size factor was also taken into consideration which was
represented by the total Asset Investment of each private Banks in order to control its effect
on interpretation.

2.3.Conclusion and knowledge gap

Even though, the aforementioned empirical review tried to demonstrate different findings as
per their study area and countries context, it does not necessarily mean that it would replicate
elsewhere. Moreover; the target population or frame of reference, and research methodology
is different among countries and researchers. In addition, in the above studies revealed mixed
results, which ones conclusion contradicts with another.
On the above stated literature review some studies founds that there is a positive and
significant relationship between investment and commercial banks performance and other
studies founds that there is a negative and significant relationship between investment and
commercial banks performance. But as reviewed the related literature, research on the effect
of investment on financial performance of commercial banks on Ethiopian banking industry
is very scarce. So the researcher intends to work on the effect of investment on performance
of Ethiopian commercial banks. Therefore by taking into account above stated issues the
researcher seeks to investigate the effect of investment on performance of commercial bank
in Ethiopia .

2.4. Conceptual Frame Work

From the theoretical and empirical literature reviews, the following conceptual framework of
the study is developed by the researcher.

25
 Figure 2. 1conceptual framework or model of the study
Financial performance
Independent variable

 Investment in NBE
bill
 Investment in foreign ROE
deposit
 Investment in fixed
asset
 Investment in equity

Control variable
 Capital
adequacy
 Inflation
 Economic
growth

26
 CHAPTER THREE

3. RESEARCH DESIGN AND METHODOLOGY

This chapter deals with the research methodology used to carry out the research. This study's
aimis to assess the effect of investment on commercial banks' performance. It comprises
research design, researchapproach, and target population,sampling technique, method of data
collection, presentation and analysis, variable definition and measurement, and model
specification of the thesis.

3.1. Research Design

Cooperet al. (2003) discussed that explanatory studies unlike descriptive studies, go beyond
observing and describing the condition and tries to explain the reasons for the phenomenon.
Thus, explanatory research design used in this research because the study identified the cause
and effect of investment on commercial banks' financial performance which is appropriate for
the objective of the study.

3.2. Research approach

The quantitative aspect of the research method aimed to obtain data needed to explain the
relationship between the effects of investment on commercial banks' financial performance in
Ethiopia. Hence, a survey design (structured review of documents) is applied for this study. A
survey design provides a quantitative or numeric description of trends, attitudes, or opinions
of a population.

3.3. Population of the Study

The study populations are commercial banks registered by NBE. Currently, there are
seventeen commercial banks in Ethiopia that are one government-owned and sixteen
privately owned commercial banks these are ; Commercial bank of Ethiopia, Awash
International bank S.c., Bank of Abyssinia, Dashen Bank, Wegagen Bank, United Bank , Nib
International Bank , Cooperative Bank of Oromia,Abay Bank,Addis International
bank,Berhan international Bank,Bunna International Bank,Debub Global Bank,Oromia
International Bank, Lion Bank, Enat Bank,and Zemen Bank

27
3.4. Sampling techniques
This study includes all banks operating in Ethiopia as a population of the study. However,
banks that operate less than fifteen years were not taken since those banks have no experience
and have no data for fifteen years. Due to this reason, by using the purposive sampling
technique from 17 Commercial banks operating in Ethiopia this study took eight banks which
are established prior to 2006 G.C. which is listed on the below Table 3.1.

SAMPLE COMMERCIAL BANKS

Table 3. 1 Sampled commercial banks

Name of Commercial Banks Y e a r o f e s t a b l i s h m e n t
1.Commercial Bank of Ethiopia 1 9 6 3
2.Awash International Bank 1 9 9 4
3 . D a s h e n B a n k 1 9 9 5
4 . B a n k o f A b y s s i n i a 1 9 9 6
5 . W e g a g e n B a n k 1 9 9 7
6 . U n i t e d B a n k 1 9 9 8
7.Nib International Bank 1 9 9 9
8.cooperative bank of Oromia 2 0 0 5

The above table 3.1 is supposed to be representative of the banking sector of Ethiopia in this
study

3.5. Types and Sources of Data

This study obtained the necessary data through secondary data. This research used secondary
sources of data. Secondary data on all of the commercial banks in Ethiopia are obtained from
commercial banks’ audited financial statements and annual reports filed with NBE through
document review. Furthermore, secondary data are collected from books, journals, and
websites.

3.6.Data analysis
To achieve the objective of the study, the study only concentrated on quantitative analysis.
Hence, the researcher used an econometric model to identify and measure the effect of
investment on commercial banks' performance in Ethiopia and used the Ordinary Least
Square (OLS) method using Stata 16 econometric software package for the study. According

28
to Brooks (2008) regression is concerned with describing and evaluating the relationship
between a given variable (usually called the dependent variable) and one or more other
variables (usually known as the independent variables. Thus, the researcher adopted panel
data regression model to examine effect of investment on commercial banks financial
performance in Ethiopia.
As stated by Brooks (2008) panel data is favoured for situation often arises in financial
modelling where we have data comprising both time series and cross-sectional elements. In
addition, we can address a broader range of issues and tackle more complex problems with
panel data than would be possible with pure time-series or pure cross-sectional data alone
Accordingly, the study model focused on panel data technique that comprises both cross-
Sectional elements and time-series elements; the cross-sectional element is reflected by eight
sampled Ethiopian commercial banks and the time-series element is revealed by the period of
study (2006-2020). Therefore, the panel data would be analysed using descriptive statistics,
correlations and linear regression analysis. The rational for choosing Ordinary Least Square
(OLS) is that, if the Classical Linear Regression Model (CLRM) assumption should true, then
the estimators determined by OLS will have a number of desirable properties, and are known
as Best Linear Unbiased Estimators (Brooks, 2008). Diagnostic checking is done to test
whether the sample is consistent with the following assumptions. According to Brooks
(2008), the assumptions of ordinary least squares are:

I. The errors have zero mean (E (ut) = 0)

II. Variance of the errors is constant (Var (ut) = σ2 <∞)

III.Test for Normality (ut ∼N (0, σ2)

IV. Multicollinearity Test

If all the above assumptions are consistent with the sample, stata result will be accurate and
reliable. The following tests are done in this research to test the above assumptions.

I. The errors have zero mean (E (ut) = 0)

Relay on Brooks (2008), the first assumption required is that the average value of the errors
is zero. In fact, if a constant term is included in the regression equation, this assumption will
never be violated.

II. Variance of the errors is constant (Var (ut) = σ2 <∞) (heteroscedasticity)

29
According to Brooks (2008), the variance of the errors is constant this is known as the
assumption of homoscedasticity. If the errors do not have a constant variance, they are said to
be heteroscedastic. If heteroscedasticity occur, the estimators of the ordinary least square
method are inefficient and hypothesis testing is no longer reliable or valid as it will
underestimate the variances and standard errors. There are several tests to detect the
Heteroscedasticity problem, which are Park Test, Glesjer Test, Breusch-Pagan-Goldfrey Test,
White’s Test and Autoregressive Conditional Heteroscedasticity (ARCH) test. In this study,
the popular white test was employed to test for the presence of heteroscedasticity. The
hypothesis for the Heteroscedasticity test was formulated as follow;

H0: There is no Heteroscedasticity problem in the model.

H1: There is Heteroscedasticity problem in the model

α = 0.05
Decision Rule: Reject H0 if p-value is less than significance level. Otherwise, do not reject
H0.

III.Normality (ut ∼N(0, σ2)

As per Brooks (2008) normality tests are used to determine if a data set is well-modeled by a
normal distribution. With the normality assumption, ordinary least square estimation can be
easily derived and would be much more valid and straight forward. This study used Jarque
Bera Test (JB test) to find out whether the error term is normally distributed or not. The
hypothesis for the normality test was formulated as follow:
H0: Error term is normally distributed
H1: Error term is not normally distributed

α = 0.05
Decision Rule: Reject H0 if p-value of JB tests less than significance level. Otherwise, do not
reject H0.

IV.Multicollinearity
According to Brooks (2008), Multicollinearity will occur when some or all of the
independent variables are highly correlated with one another. If the multicollinearity occurs,
the regression model is unable to tell which independent variables are influencing the
dependent variable. This study used high pair-wise correlation coefficients method to test the
presence of multicollinearity problem in a regression model, because it shows the correlation
of independent variables between each other one by one. Malhotra (2007) stated that

30
multicollinearity problems exists when the correlation coefficient among explanatory
variables should be greater than 0.75. However, Brooks (2008) mentioned that if
thecorrelation coefficient along with the independent variables is 0.8 and above,
multicollinearity problems will be existed.

3.7.Variable and measurements

❖Dependent Variable

Profit is the ultimate goal of commercial banks. All the strategies designed and activities
performed thereof are meant to realize this grand objective. Therefore to measure
performance the dependent variable was used profitability. To calculate the profitability of
commercial banks there are variety of ratios used. For this research ROE used because to
identify & measure from which investment can get higher return.

 Return on Equity (ROE) is a financial ratio that refers to how much profit a company
earned compared to the total amount of shareholder equity invested or found on the
balance sheet. ROE is what the shareholders look in return for their investment. A
business that has a high return on equity is more likely to be one that is capable of
generating cash internally. Thus, the higher the ROE the better the company is in
terms of profit generation. It is further explained by (Khrawish & Al-Sa’di, 2011)that
ROE is the ratio of Net Income after Taxes divided by Total Equity Capital. It
represents the rate of return earned on the funds invested in the bank by its
stockholders. ROE reflects how effectively a bank management is using
shareholders’ funds. Thus, it can be deduced from the above statement that the better
the ROE the more effective the management in utilizing the shareholders capital.

The Independent Variables

NBE Bill Purchase

NBE-Bill was introduced in April 4, 2011 NBE has issued new directive which requires
private commercial banks to allocate assets amounting to 27% of their total disbursement for
priority sector financing . The banks are forced to redirect their disbursement to the purchase
of NBE bill which earns 3% interest (yodit, 2012). This represent amount of forced bill
purchase by a bank, which is measured as total amount of investment in NBE-Bills. NBE

31
request banks to invest significant amount of their return on the government bill. This study
was examine the effect of this bill purchase and the bank’s profitability.

Equity Investment

National bank of Ethiopia gave permission to commercial banks to invest their income on
different non-banking companies share with limited percentage. These companies can be
insurance company or other share companies. The banks invest on this business in order to
collect an additional income from interest payment. It is measured by the total amount of
investment on insurance company share and other share companies stock. The study was
examine on the effect of amount invested on equity purchased and the bank’s profitability.

Fixed Asset Investment or property investment

National bank of Ethiopia has allowed banks with limited percentage of amount to invest on
fixed assets, this refer to the business of buying and developing properties consistence of
houses and other building for facilitating their own operation or for reseal. It is measured by
the total amount of investment on fixed asset. This research was examine the effect of
investment in fixed asset on profitability.

Foreign Bank Deposit

Banks are permitted to deposit their excess cash in other foreign banks in order to facilitate
their services and also to generate an additional interest income. Deposit is measured by the
total amount of money that the bank’s deposit in foreign banks in a given time. This study
was examine on the effect NBE regulation on the banks foreign deposit and the interest
income they generate on bank’s performance.

Control Variables

Capital Adequacy

This measures capital strength of the banks. The ratio of Equity to total Asset is employed as
a measure for bank Capital Adequacy. This measures the percentage of the total asset that is
financed with equity capital. Capital adequacy therefore describes the sufficiency of the
amount of equity that can absorb shocks that banks may experience. It is expected that the
higher the Equity to Asset ratio, the lower the need for external funding and therefore the
higher the profitability of the bank. Bank with higher capital to asset ratio are considered

32
relatively safer and remained profitable even during economically difficult times. Conversely,
banks with lower capital adequacy are considered riskier relative to highly capitalized banks
Sufian and Chong (2008). Considering the fact that capital adequacy may have an ambiguous
effect on profitability, theoretical expectation of capital adequacy remains a puzzle to be
answered by empirical investigation.

Inflation

Inflation reduces the purchasing power of each unit of currency, which leads to increases
general price of goods and services over time. Inflation is a general increase in the overall
price level of the goods and services in the economy (Hadush, 2015). Expected inflation is
taken into account when actuaries set actuarially fair premiums and in this case inflation itself
is unlikely to seriously impact on the performance of insurance companies. Nevertheless, if
inflation is significantly greater than expected, it could cause insurance companies financial
difficulty. For instance, unexpected inflation makes real returns on fixed-rate bonds lower
than expected. As a consequence, profit margins of insurance companies are compressed and
financial performance is accordingly impaired (Browne, Carson, & Hoyt, 1999). The
inflation could affect commercial banks‟ financial performance by influencing both their
liabilities and assets.

Economic growth (GDP)

Growth domestic product is a macroeconomic variable and tells the total value of goods and
services produced in a given nation over a specified period of time usually a year. GDP
growth is indicative of overall business conditions and hence capacity to insurers (Hussain,
2015). Economic growth is an increase in the production of economic goods and services,
compared from one period of time to another. The poor economic conditions can reduce
investment of once country. This will have effect the performance of companies (Biru, 2017).
Table 3. 2 Variable measurement and expected sign

M e a s u r e N o t a t i o n expected sign
Variable

33
Firms financial performance Net profit before tax/total equity
ROE

National bank of Ethiopia bill natural log total NBE investment N B E B

Foreign deposit natural log total foreign bank deposit investment F B D

F i x e d a s s e t Natural log total fixed asset F A

Equity investment Natural log total equity investment E I

Control variable
Capital adequacy Equity to total asset ratio C A R
I n f l a t i o n Yearly average rate I N F
Economic growth Y e a r l y G D P G D P

3.8. Model Specification

Objective isto establish whether investment affects the financial performance of the
commercial banks in Ethiopia. Return on equity is consider as a measure for financial
performance and therefore, used as the dependent variable whereas national bank bill
purchase, foreign deposit, fixed asset and equity investment is considered as independent
variable and capital adequacy ratio, inflation and economic growth as control variable

ROE = f (NBEB, FBD, FA, EI, INF, GDP, CAR)

Upon linearization and parametization the model is specified as;

ROE
+ ……………………………………..1

Where,

ROE = return on equity

34
NBE national bank of Ethiopia bill time t

FBD foreign deposit i at time t

FA fixed asset i at time t

EI equity investment i at time t

CAR Capital adequacy ratio i at time t

INF inflation rate at time t

GDP gross domestic product at time t

35
CHAPTER FOUR

RESULTS AND DISCUSSIONS

This chapter presents the resultsand discussion. This study used the annual financial report,
where all the variables are observed for each cross-section and each time period. The study
has a time series segment spanning from the period 2006 up to 2020 and a cross section
segment which considered eight commercial banks in Ethiopia. Accordingly, the result of
descriptive statistics, correlation analysis, the test of CLRM assumption, and a result of the
regression analysis were presented in the following sub-sections.

4.1. Descriptive statistics

The descriptive statistics is presented below.As indicated in the below Table, the financial
performance measured by (ROE) shows that Ethiopian commercial banks have achieved on
average a positive net income over the last fifteen years. From the total sample, the mean of
ROE 20.7% with a maximum of 60.25% and also a minimum of 1.5%. Regarding the
standard deviation, it means the value of ROE deviate from its mean by 11.8% which
indicate there was low variation from the mean.

Regarding independent variable national bank bill investment of the commercial banks and
its relationship with financial performance, natural logarithm of total national bank bill
investment is used as proxy. The mean of the natural logarithm of total national bank bill
investment was 20.37. National bank bill investment of commercial banks was dispersed
from its mean value (i.e. 20.37) with the standard deviation of 1.9.The maximum and
minimum values were 22.99 and 14.65 respectively.

The second independent variable used in the study was foreign deposit investment of the
commercial banks and its relationship with financial performance, natural logarithm of total
foreign deposit investment is used as proxy. The mean of the natural logarithm of total

36
foreign deposit investment was 20.02. Foreign deposit investment of commercial banks was
dispersed from its mean value (i.e. 20.02) with the standard deviation of 1.63. The maximum
and minimum values were 23.99 and 15.60 respectively.

The third independent variable used in the study was equity investment of the commercial
banks and its relationship with financial performance, natural logarithm of total equity
investment is used as proxy. The mean of the natural logarithm of total equity investment was
18.30. Equity investment of commercial banks was dispersed from its mean value (i.e.
18.30) with the standard deviation of 2.73. The maximum and minimum values were 26.98
and 14.26 respectively.

The fourth independent variable used in the study was fixed asset investment of the
commercial banks and its relationship with financial performance, natural logarithm of total
fixed asset investment is used as proxy. The mean of the natural logarithm of total fixed asset
investment was 19.64. Fixed asset investment of commercial bank was dispersed from its
mean value (i.e. 19.64) with the standard deviation of 2.12. The maximum and minimum
values were 25.99 and 15.42 respectively.

The external variable used in the study was inflation and its relationship with financial
performance. The mean of the inflation was 15.77%. Inflation was dispersed from its mean
value (i.e. 15.77%) with the standard deviation of 9.41%. The maximum and minimum
values were 36.4% and 2.8% respectively. In addition GDP and its relationship with
financial performance. The mean of the GDP was 9.77%. GDP was dispersed from its mean
value (i.e. 9.77%) with the standard deviation of 1.55%. The maximum and minimum values
were 11.8% and 6.1% respectively. Finally, the capital adequacy and its relationship with
financial performance. The mean of the capital adequacy was 8.14. Capital adequacy was
dispersed from its mean value (i.e. 8.14) with the standard deviation of 4.3. The maximum
and minimum values were 24.13 and 7.9 respectively.

Table 4. 1Descriptive statistics

Variable Observation M e a n Std.deviation Minimu m Maximum
R O E 1 2 0 0 . 2 0 7 3 0 . 1 1 8 0 . 0 1 5 0 0 . 6 0 2 5
NB E B I L L 1 2 0 2 0 . 3 7 5 1 . 9 0 2 1 4 . 6 5 2 2 . 9 9 7
F B D 1 2 0 20.0279 1 . 6 3 8 15.6072 2 3 . 9 9 5
E I 1 2 0 1 8 . 3 0 3 2 . 7 3 2 1 4 . 2 6 7 2 6 . 9 8 0

37
F A I 1 2 0 1 9 . 6 4 2 . 1 2 6 1 5 . 4 2 9 2 5 . 9 9 8
I N F 1 2 0 0 . 1 5 7 7 0 . 0 9 4 1 0 . 0 2 8 0 . 3 6 4
G D P 1 2 0 0 . 0 9 7 7 0 . 1 5 5 0 . 0 6 1 0 . 1 1 8
C A R 1 2 0 8 . 1 4 1 4 . 3 6 9 8 0 . 7 9 8 5 2 4 . 1 3 5

Source: - annual report of sample commercial bank computed using stata 16 (2006-2020)

4.2 Correlation Analysis

Correlation measures the degree of linear association between variables. Values of the
correlation coefficient are always ranged between +1 and -1. A correlation coefficient of +1
indicates that the existence of a perfect positive association between the two variables, while
a correlation coefficient of -1 indicates perfect negative association. A correlation coefficient
of zero, on the other hand, indicates the absence of relationship (association) between two
variables (Brooks, 2008). As indicated in the below correlation matrix, national bank bill has
strong negative relationship with GDP for the last 15 years. And foreign bank deposit has
strong positive relationship with fixed asset investment. Equity investment has moderate
positive relationship with fixed asset investment and fixed asset investment has moderate
negative relationship with GDP.

Table 4. 2Correlation Analysis of Variables

R O E NBE bill F B D E I F A I I N F G D P C A R
R O E 1.000
NBE bill -0.1321 1.000
F B D 0.4446 0.2635 1.000
E I 0.2964 0.4287 0.5890 1.000
F A I 0.3361 0.3784 0.6197 0.4782 1.000
I N F 0.0645 -0.2307 0.0036 -0.1609 -0.0435 1 . 0 0 0
G D P 0.1726 -0.6386 -0.1646 -0.4085 -0.3584 -0.1269 1 . 0 0 0
C A R 0.8667 -0.1462 0.4240 0.3910 0.4208 0.0392 0.0633 1 . 0 0 0

Source: - annual report of sample commercial bank computed using stata 16 (2006-2020)

4.3. Regression model tests

For valid hypothesis testing and to make data available for reliable results, the test of
assumption of regression model is required. Accordingly, the study has gone through the

38
most critical regression diagnostic tests consisting of normality, multicollinearity,
heteroskedasticity, and model specification tests accordingly.

4.3.1 Model Selection (Random Effect versus Fixed Effect Models)

As Brooks (2008) referring on his book, there are broadly two classes of panel estimator
approaches that can be employed in financial research: fixed effects models and random
effects models. The choice between both approaches is done by running a Hausman test.
Thus, to determine whether the fixed effects are necessary or not this study run the Hausman
specification test as recommended by Brooks (2008) and others. The hypothesis for the
model selection test was formulated as follow;

H0: Random effects model is appropriate.

H1: Fixed effects model is appropriate.

α = 0.05

Decision Rule: Reject H0 if P value is less than significant level 0.05. Otherwise, do not
reject H0.

Table 4. 3Hausman test

v a r i a b l e ( b ) f e ( B ) r e (b-B) difference Sqrt(diag(v b-v B))

N b e b i l l - 0 . 0 0 9 9 1 6 3 - 0 . 0 0 6 6 7 45 -0.0032418 0 . 0 0 1 8 2 5 4
F b d 0 . 0 1 2 0 4 4 3 0 . 0 1 2 2 3 5 4 -0.0001912 0 . 0 0 2 0 5 6 7
E i 0 . 0 1 0 9 8 5 0.0094279 0.0015571 0.0021214
F a i - 0 . 0 0 8 3 4 5 - 0 . 0 0 5 0 7 2 -0.0032729 0 . 0 0 3 2 3 0 3
I n f 0.0518805 0.0682334 -0.016353 .
G d p 0 . 8 7 5 2 9 9 8 1 . 1 5 6 3 5 -0.2810505 0 . 1 4 4 0 3 6
c a r 0 . 0 2 4 0 5 6 6 0 . 0 2 4 4 0 4 2 -0.0003476 0 . 0 0 0 9 7 8 3
b= consistent under Ho and Ha;obtained from xtreg
B = inconsistent under Ha, efficient under Ho;obtained from xtre g
Test Ho: difference in coefficients not systematic
C h i 2 ( 7 ) = ( b - B ) ’ [ ( v b - v B ) ( - 1 ) ] ( b - B )
= 1 9 . 1 1
P r o b > c h i 2 = 0 . 0 0 7 9
( v b - v B i s n o t p o s i t i v e d e f i n i t e

Source: annual report of sample commercial bank computed using stata 16 (2006-2020)

39
The Hausman model selection test for this study has a p-value of 0.0079 for the regression
models. Thus, the null hypothesis which is random effect model appropriate was rejected and
the study used the fixed effect model.

4.3.2 Tests for the Classical Linear Regression Model (CLRM) assumptions
To maintain the data validity and robustness of the regressed result of the research, the basic
classical linear regression model (CLRM) assumptions must be tested for identifying any
misspecification and correcting them so as to argument the research quality (Brooks,2008).
There are different CLRM assumptions that need to be satisfied and that are tested in this
study, which are: errors equal zero mean test, heteroscedasticity, normality, multicollinearity
and model specification test.

I. The errors have zero mean (E(ut ) = 0)

This part shows the test for the assumptions of classical linear regression model (CLRM)
namely the error have zero mean, heteroscedasticity, normality and multicollinearity.

Relay on Brooks (2008), the first assumption required is that the average value of the errors is
zero. In fact, if a constant term is included in the regression equation, this assumption will
never be violated. Hence, study’s regression model has included a constant term, so that this
assumption was not violated.

II Test for heteroskedasticity assumption (var(ut ) = σ2 <∞)

As indicated by Brooks (2008), this assumption requires that the variance of the errors to be
constant. If the errors do not have a constant variance, it is said that the assumption of
homoscedasticity has been violated. This violation is termed as heteroscedasticity. In this
study test was used to test for existence of heteroscedasticity across the range of explanatory
variables. As show in below Table, when heteroskedasticty test was made there is evidence
2
for the presence of heteroscedasticity, since the chi p-value is statistically significant at 5%,
the model has heteroskadisticity problem. So, original pooled OLS regression is no more
efficient. In order to solve heteroskedasticity problem the study used robust fixed effect
model.
H0: The variance of the error is homoscedasticity

H1: The variance of the error is heteroscedasticity

40
Table 4. 4Heteroskedasticity test

Breusch –pagan /cook –weisberg test for heteroskedasticity

H o : c o n s t a n t v a r i a n c e
V a r i a b l e s : f i t t e d v a l u e s o f r o e
C h i 2 ( 1 ) = 7 . 6 5
P r o b > c h i 2 = 0 . 0 0 5 7

III.Test for multicollinearity

It is tested using VIF (variance inflation factor). By rule of thumb VIF>10 implies
multicollinearity is a series problem .That is, there is interdependence among explanatory
variable (one explanatory variable is a function of others). If VIF value is < 10
multicollinearity is not a problem implies there is no interdependence among explanatory
variables. Table 4.5 below shows the multicollinearity test result. Since all the VIF values are
less than 10 then, the data used has no multicollinearty problem.

Table 4. 5Multicollinearity

V a r i a b l e V I F 1 / V I F
N B E b i l l 2 . 7 2 0 . 3 6 8 0 0 6
F B D 1 . 9 6 0 . 5 1 0 2 4 9
E I 1 . 9 0 0 . 5 2 5 3 7 8
F A I 2 . 0 2 0 . 4 9 4 7 7 7
I N F 1 . 3 1 0 . 7 6 0 6 2 0
G D P 2 . 6 0 0 . 3 8 4 9 3 0
C A R 1 . 6 7 0 . 5 9 9 9 7 9
M e a n V I F 2 . 0 3

Source: - annual report of sample commercial bank computed using stata 16 (2006-2020)

IV .Test for normality (errors are normally distributed (ut ~ N(0,+2))

The normality test was made by using Anderson-darling (Skewnesskurtosis)
And Shapiro-Francia and Chapiro-Wilk tests

41
Table 4. 6Normality test
Variable obs erv ati o n W V Z P r o b > Z
Residual 1 2 0 0 . 9 9 2 7 5 0 . 6 9 7 - 0 . 8 0 7 0 . 7 9 0 2 5

Figure 4. 1normality figure

As shown in figure 4.1 since, the histogram is bell-shaped and the Shapiro wilk statistic is
not significant. This means that the p-value given at the bottom of the normality test screen
should be bigger than 0.05 to not reject the null of normality at the 5% level so, the residuals
are normally distributed in this study, concluded that there is no the problem of normality on
ROE model.

4.4. Resultof Regression Analysis

This section presents the empirical findings of the study. To identify the appropriate
methodology, the study performed Hausman test. It is used to test whether fixed-effect model

42
versus the random effect model is the best model. Therefore, the test results show that fixed
effect model is appropriate as the test. Under the following regression result the beta
coefficient may be negative or positive; beta indicates that each variable’s level of influence
on the dependent variable. P- Valueindicates at what percentage or precession level of each
variable is significant. The R-square value measures how well the regression model explains
the actual variations in the dependent variable(Brooks,2008).R- square statistics and adjusted
–square statistics of the model was 79% and 78% respectively. The adjusted R –square value
78% indicates the total variation of banks performance was explained by the variable in the
model. Thus these variables collectively, are good explanatory variable to identify the effect
of investment on banks performance.

In the regression result, FBD, EI, INF, GDP and CAR, have a positive impact on ROE and
NBE bill and FAI has a negative impact on ROE. On the other NBE bill, FBD, EI and CAR
are significant impact on return on equity. This is because the P value of the stated variables
is less than 5% significance level valued 0.028, 0.021, 0.028, and 0.0000 for NBE BILL,
FBD, EI and CAR respectively. However , FAI,INF and GDP have insignificant impact on
return on equity because of the P value is greater than 5% significant level, value 0.146,0.393
and 0.108 for FAI,INF and GDP respectively.

Discussion

ROE = -0.2018 -0.0099NBEBILL +0.012FBD +0.0109EI -

0.00834FAI +0.05188INF +0.8752GDP +0.0240CAR +

National bank bill (NBE BILL) and return on equity (ROE)

Table 4.7 below depicted that, the relationship between NBE bill and ROE is negative and
significant. More specifically the coefficient between NBE bill and ROE is -0.0099163 with a
p-value of 0.028 .This result implies that the national bank bill has anunfavourable effect on
the return on equity of commercial banks in Ethiopia. As result the first hypothesis (H1) that
national bank bill has negative and significant effect on financial performance of commercial
banks in Ethiopia is not rejected. The result of this study is consistent with the result
of(AKALU, 2016) ,Eden (2014), Yodit (2012) and Tesfaye (2014) that NBE bill has negative
and statistically significant relationship with financial performance of banks.

Holding other independent variables constant at their average value, when national bank bill
(NBE bill) increased by one percent, return on equity (ROE) of sampled Ethiopian

43
commercial banks would be decrease by 0.99%, and statistically significant at 5% of
significance level.This affect banks investment in different ways:- First and for most banks
are profits seeking organization and their first priority is to generate income. The main area
for the banks to generating income is giving loan to creditors and collecting higher amount of
interest. This regulation limits banks capacity to give loan to creditor because NBE collects
27% of their total disbursement in bill purchase. Secondly As indicated in different prior
research the interest rate that is 3% is the small Eden (2014) and Shibiru (2014). The rate is
even smaller than what banks paid as interest to their depositors that is 5%. The effect of the
interest rate directs the banks investment to be negative.

The other suggestion is that due to the higher amount of money invested in bill purchase the
banks are losing their benefit if it would have been invested in relatively high interest bearing
investment. If banks lend their money to borrowers with in interest rate of 12%15% they can
generate higher interest income but NBE bill only generate 3% return which result in 9%-
12% opportunity cost. Even though the government implements this regulation to support
other prior sector finance it decrease the loan facility that the banks can give to private
investors. This will limit the amount of money that banks can give to private investors. Due
to this the private investors will be discourage to involve in huge investment area. This lead
to a decrease in the overall investment in the country. Finally NBE implement this directive
on private commercial banks in this case the commercials banks of Ethiopian that is the only
government banks can rise it capital. Even though CBE purchase other government bills with
different interest rate and maturity date it does not obligated to purchase this bill. So CBE can
invest this money to other area of investment or can lend the money to customers. This leads
CBE market share to increase in the market and decrease private bank level of competition,
this beings more government owned banking system.

Foreign bank deposit bank (FBD) and return on equity (ROE)

Table 4.7 presented that, the relationship between FBD and ROE is positive and significant.
More specifically the coefficient between FBD and ROE is 0.012043 with p- value of 0.021.
This result implies that the foreign bank deposit has a favourable effect on the return on
equity of commercial banks in Ethiopia. As a result the second hypothesis (H2) that foreign
bank deposit has positive and significant effect on financial performance of commercial
banks in Ethiopia is not rejected. The result of this study is consistent with the result of

44
(Ghassan, Talal, Khalaf, & Yaseen, 2015) and (AKALU, 2016)that FBD has positive and
statistically significant relationship with financial performance of commercial banks.

Holding other independent variables constant at their average value, foreign bank deposit
(FBD) increased by one percent, return on equity (ROE) of sampled Ethiopian commercial
banks would be increase by 1.2 percent and statistically significant at 5% level of
significant.The implication of this result is that the national banks of Ethiopia do not restrict
banks on the amount of money that they can deposit on foreign banks. But the banks should
report there amount of deposit on their liquidity position report every week (NBE directive
NO SBB/57/2014). This freedom allows the banks to deposit there excess cash, that do not
affect their liquidity on foreign banks in order to earn an additional interest income. This
implies that banks with more foreign deposit might have earning much more interest income.
When Ethiopian banks have started to deposit their money on foreign banks the liquidity
position increase that they can decrease the risk of liquidity.

Foreign deposit is one of an investment area that Ethiopian commercial banks are permitted
to involve. As indicated in the above regression result amount of foreign deposit has a
significant effect on banks profitability in a positives way. When the amount of deposit
increases the performance of the banks also increase. This increase in performance can be
seen in many ways:- First to deposit money in foreign banks the Ethiopian banks should open
an account on foreign banks. Opening of accounts lead them to become a customer of that
banks and will have all the opportunity to receive services that the foreign banks give to its
customers and have safe and secure global access to their money. Secondly depositing
money in foreign banks can links the Ethiopian banks to engage in international market and
easily facilitates letter of credit to his customer. This situation give the banks opportunity of
expand their service in order to deliver to their customers. The banks will communicated with
foreign bank on payment and delivery of goods on behalf of their customers. Giving this
service will lead banks to earn higher profit. Finally According to NBE one of the liquid
assets on banks is foreign deposit. If the bank invested on foreign deposit it leads to decrease
liquidity risk. So an increase in bank liquidity ratio will decrease credit risk of banks. On the
other side banks with higher liquidity ratio will give loan to their customers and earn higher
interest income.

Equity investment (EI) and return on equity (ROE)

45
Table 4.7 below depicted that, the relationship between EI and ROE is positive and
significant. More specifically the coefficient between EI and ROE is 0.010985 with a p –
value of 0.028.This result implies that the equity investment has favourable effect on the
return on equity of commercial banks in Ethiopia. As result the third hypothesis (H3) that
equity investment has negative and insignificant effect on financial performance of
commercial banks in Ethiopia is rejected. The result of this study is consistent with the result
of Kuri(2012) and Abdikadir(2017) that equity investment has positive and statistically
significant relationship with financial performance of commercial banks.On the other hand
the result of this study isnot consistent with the result of Biniyam(2018), Eskdar(2016) and
Tsion(2018) that equity investment has negative and statistically insignificant relationship
with performance of commercial banks.

Holding other independent variables constant at their average value, when equity investment
(EI) increased by one percent, return on equity (ROE) of sampled Ethiopian commercial
banks would be increased by 1.09 %, and statistically significant at 5% of significance
level.The possible reason for the positive and significant association between EI and ROE
could be attributed to the fact that; First the control banks risk which is carried out by the
authorities under provision and banks capital regulation does not outweigh the higher returns
obtained from investment in banks performance, and Bank shareholding allows the banks to
take advantage of its lending relationship with the firm .In fact this is the main benefit of the
bank equity investment because ,the researcher do not observe differences in banks
profitability caused by capital gains or losses derived from equity transaction .Boyd et al
(1998) also suggest an additional reason for a positive influence of equity investment on
banks performance based on the idea that bank equity positions on non-financial firms
strengthen the banks’ ability to extract surplus from borrowers.

Fixed Asset Investment (FAI) and Return Equity (ROE)

Table 4.7 belowpresented that, the relationship between FAI and ROE is negative and
insignificant. More specifically the coefficient between FAI and ROE is -0.008345 with a p-
value of 0.146.This result implies that the fixed asset investment has unfavourable effect on
the return on equity of commercial banks in Ethiopia .As a result the fourth hypothesis (H4)
that fixed asset has positive and significant effect on financial performance of commercial
banks in Ethiopia is rejected. The result of this is study consistent with the result of
Abdikadir(2017) that fixed asset has negative and statistically insignificant relationship with

46
financial performance of commercial banks. On the other hand this result is inconsistent with
the result of Olantuji and Adegbite(2014), Akalu(2016), Biniyam(2018) and Tsion(2018) that
fixed asset investment has positive and statistically insignificant relationship with
performance of commercial banks.

Holding other independent variables constant at their average value, when fixed asset (FA)
increased by one percent, return on equity (ROE) of sampled Ethiopian commercial banks
would be decreased by 0.83 percent and statistically insignificant at 5% level of significant.
The national bank of Ethiopia has a directive on the investment of fixed asset like building
and land. No bank shall invest more than 10% of its net worth in real estate acquisition and
development other than for own business premises without approval of that national bank
(NBE directive No.SBB/60/2015.The relationship is negative and insignificant, this could be
attributed to the fact that; The commercial banks choice of investment on fixed asset
investment is based on the price and pressure from manufacturing rather than quantity and
utility. As well as the commercial banks cost of maintenance and repair of fixed asset might
be high. This may lead to fixed asset reduced the profitability of commercial bank.

Control variable

Inflation and ROE

Table 4.7 below depicted that, the relationship between INF and ROE is positive and
insignificant .More specifically the coefficient between INF and ROE is 0.0518805 with a p-
value of 0.393. This result implies that inflation has favourable effect on the return on equity
of commercial banks in Ethiopia. This result is consistent with the findings of Ongore (2013)
,Othori (2013),Jamsmine (2011) that inflation has positive and insignificant relationship with
financial performance of commercial banks.

Holding other independent variables constant at their average value, when inflation(INF)
increased by one percent, return on equity (ROE) of sampled Ethiopian commercial banks
would be increased by 5.18%, and statistically insignificant at 5% of significance level.The
possible reason for the positive association between INF and ROE could be attributed to the
fact that, a price level which is changing at constant proportional rate, fully anticipated and
acted up on by all economics actors act as a good signal to commercial banks for investment
decision.

GDP and return on equity (ROE)

47
Table 4.7 below depicted that, the relationship between GDP and ROE is positive and
insignificant. More specifically the coefficient between GDP and ROE is 0.8752998 with a p-
value of 0.108. This result implies that the growth domestic product has favourable effect on
the return on equity of commercial banks in Ethiopia .This result is consistent with Roa and
Lakew(2012),(imad z ramadan 2011),Ongore (2013) that GDP has positive and insignificant
relationship with performance of commercial banks. Holding other independent variables
constant at their average value, when GDP increased by one percent, return on equity (ROE)
of sampled Ethiopian commercial banks would be increased by 8.75%, and statistically
insignificant at 5% of significance level

Capital Adequacy (CA) and return on equity (ROE)

Table 4.7 below depicted that, the relationship between CAR and ROE is positive and
significant. More specifically the coefficient between CAR and ROE is 0.024056 with a p-
value of 0.000.This result implies that the capital adequacy has favourable effects on the
return on equity on equity of commercial banks in Ethiopia. This result is consistence with
Chris (2010), (Ayele, 2012),Mohammad and Tekeste (2012) and Birhanu (2012) that capital
adequacy has positive and statistically significant relationship with performance of
commercial banks. On the other hand this result is inconsistent with (Allen N Berger,
1997),(Aremu, 2013) that capital adequacy has negative and statistically significant
relationship with performance of commercial banks.Holding other independent variable
constant at their average value ,when capital adequacy increased by one percent ,return on
equity (ROE) of sampled Ethiopia commercial banks would be increased by 2.4%, and
statistically significant at 5% of significance level.

Table 4. 7Robust Fixed effect Regression Result

Variable Coefficient Std.error t statistic p > ( t ) (95% conf.interval)
NBE bill -0.0099163 0.0035787 - 2 . 7 7 0 . 0 2 8 -0.0183785 - 0 . 0 0 1 4 5 4
F B D 0.0120443 0.0040665 2 . 9 6 0.021 0.0024284 0.0 21 660 1
E I 0.010985 0.0039798 2 . 7 6 0.028 0.0015741 0.0 20 395 8
F A I -0.008345 0.0050987 - 1 . 6 4 0 . 1 4 6 -0.0204014 0.0 03 711 5
I N F 0.0518805 0.0569636 0 . 9 1 0.393 -0.082817 0.1 86 577 9
G D P 0.8752998 0.4754672 1 . 8 4 0.108 -0.2490016 1 . 9 9 9 6 0 1
C A R 0.0240566 0.0024365 9 . 8 7 0.000 0.0182953 0.0 29 817 9
C O N S -0.2018541 0 . 2 1 0 6 1 9 - 0 . 9 6 0 . 3 6 9 -0.6990445 0.2 95 336 4

48
R-squared =0.79 F-statistic = 61.41

Adjusted R- Squared 0.78 prob (F-statistic) = 0.0000

Source: - annual report of sample commercial bank computed using stata 16 (2006-2020)

Table 4. 8 Summary of hypothesis testing

V a r i a b l e s Exprcted result Actual result D e c i s i o n

National bank bill Neg and sign Neg and sign A c c e p t
Foreign bank deposit investment Pos and sign Pos and sign A c c e p t
Equity investment Neg and sign Pos and sign R e j e c t
Fixed asset investment Pos and sign Neg and ins R e j e c t
Where,pos = indicates positive ,sign = significant ,neg = negative , ins = insignifica

CHAPTER FIVE

49
CONCLUSION AND RECOMMENDATION

The preceding chapter presented the results and discussion, while this chapter deals with
conclusions and recommendations based on the findings of the study. Accordingly this
chapter is organized into two subsections.

5.1. Conclusion
The main objective of this study is to investigate the effect of investment on the financial
performance of commercial banks in Ethiopia based on panel data analysis on the period
from 2006 to 2020.Specifically the researcher examined the effect of bank specific (internal)
and macroeconomic (external) on effect of investment on financial performance of
commercial banks . The bank specific variable include national bank bill, foreign bank
deposit, equity investment ,fixed asset and capital adequacy. The macroeconomic variable on
the other side include gross domestic product and inflation. The bank specific data was
collected from audited annual financial reports of the sampled commercial banks and
macroeconomic data were collected from the national bank of Ethiopia .

Descriptive statistics,correlation analysis, and fixed effect regression model were used to
identify and examine the effect of investment on financial performance of commercial banks
in Ethiopia by using return on equity and advance as dependent variable . Before performing
the regression analysis,the five CLRM assumption of the mean value of error term is zero
,homoscedasticity,model spefication,absence of multicollinearity and normality were tested
and fulfilled in this study.Hausman test was used to choose the appropriate model and a fixed
effects model was chosen. For analysis,Stata version 16 was used.

Concerning the regression result measured by return on equity ,Investing in foreign deposit
has a positive and significant effect on the performance of commercial banks. This implies
that when banks increase the amount of foreign deposit it increases their performance as well
as Equity investment has positive and significant effect on the performance of bank. This is
due to the level of percentage that the government allowed banks to invest in other companies
stock and the banks willingness in investing on other companies share. On the other hand
NBE bill purchase has a negative and significant effect on the performance of commercial
banks. This implies that when banks increase the amount of NBE bill it decrease their
performance and Fixed asset investment has an insignificant effect on the performance of
commercial banks. This implies that fixed asset investment has a indirect relationship with

50
performance. As banks invested on fixed asset like building and other intangible assets either
for their business or in other industries they can earn less profit.Finally concerning control
variable capital adequacy has a positive and significant effect and inflation as well GDP has
positive but insignificant effect on the performance of commercial banks.

5.2. Recommendations
Based on the major findings of the study, the researcher indicated the following
recommendations.
NBE requires each bank to purchase bill which is 27% of their total loan with 3% interest
rate. This regulation affects banks profitability, therefore it is suitable if policy makers
minimize either the percentage of total loan required to purchase the bill or increase the
interest rate paid for the bill. In addition the analysis indicated that foreign deposit were
significant related to performance of banks. So Ethiopian commercial banks with excess cash
should deposit their money on foreign banks in order to generate additional income and also
to get addition experience and service with foreign banks. The analysis indicated that equity
investment were significant related to performance of commercial banks. So, Ethiopian
commercial banks should invest in equity investment in order to generate additional income.
The result examined that capital adequacy ratio has positive and significant association with
financial Performance of commercial banks. For this reason, commercial banks should work
to have high capital adequacy ratio to minimize the need for external funding by maximize
their net asset, for instance selling additional stock for the existing as well as new
shareholders.

51
Reference
Abate, T. W., & Mesfin, E. A. (2019). Factors affecting profitability of commercial banks in
Ethiopia. International Journal of Research and Analytical Reviews, 6(1), 881-891.
Abdikadir, A. H. (2017). The relationship between investments and financial performance of
commercial banks in Kenya. University of Nairobi.
AKALU, E. (2016). THE EFFECT OF INVESTMENT ON PERFORMANCE OF
COMMERCIAL BANKS IN ETHIOPIA.
Ali, K., Akhtar, M. F., & Ahmed, H. Z. (2011). Bank-specific and macroeconomic indicators
of profitability-empirical evidence from the commercial banks of Pakistan.
International Journal of Business and Social Science, 2(6), 235-242.
Allen N Berger, L. J. M. (1997). Efficiency and productivity change in the US commercial
banking industry; A comparsion of the 1980s and 1990s. Federal reserve Bank of
philadelphia working papers,.
Alslehat, Z. A., & Altahtamouni, F. R. (2014). The causal relationship between financial
decisions and their impact on financial performance. International Journal of
Academic Research in Accounting, Finance and Management Sciences, 4(2), 72-80.
Amdemikael, A. (2012). Factors affecting profitability: An empirical study on Ethiopian
Banking Industry. Addis Ababa University.
Amenc, N., & Le Sourd, V. (2005). Portfolio theory and performance analysis: John Wiley
& Sons.
Aremu, M. A. (2013). determinants of banks proftability in developing economy;evidence
from Nigeria. interdisciplinary journal of contemporary research in Business, 9,2013.
Ayele, H. N. (2012). Determinants of bank proftability;an empirical study on Ethiopian
private commercial banks. Unpublished.
Balfoussia, H., & Gibson, H. D. (2016). Financial conditions and economic activity: the
potential impact of the targeted long-term refinancing operations (TLTROs). Applied
Economics Letters, 23(6), 449-456.
Biniyam. (2018). effects of investment on financial performance of insurance company in
ethiopia .unpublished.
Biru, G. D. (2017). profitability determinants in the insurance sector in Ethiopia: a panel
evidence on non-life insurance. Addis Ababa University Addis Ababa, Ethiopia.

52
Bouheni, F. B., Ameur, H. B., Cheffou, A. I., & Jawadi, F. (2014). The Effects of regulation
and supervision on European Banking profitability and risk: a panel Data
Investigation. Journal of Applied Business Research (JABR), 30(6), 1665-1670.
Brooks, C. (2008). RATS Handbook to accompany introductory econometrics for finance.
Cambridge Books.
Browne, M. J., Carson, J. M., & Hoyt, R. E. (1999). Economic and market predictors of
insolvencies in the life-health insurance industry. Journal of Risk and Insurance, 643-
659.
Clark, J. M. (1917). Business acceleration and the law of demand: A technical factor in
economic cycles. Journal of political economy, 25(3), 217-235.
Eklund, J. E. (2013). Theories of investment: a theoretical review with empirical
applications. Paper presented at the Swedish Entrepreneurship Forum.
Erickson, T., & Whited, T. M. (2000). Measurement error and the relationship between
investment and q. Journal of political economy, 108(5), 1027-1057.
Fedlu, G. (2015). Determinants of banks profitability: a study on commercial banks in
Ethiopia.
Franciso. (2010). the effect of equity investment on banks profitability. unpublished thesis.
French, C. W. (2003). The Treynor capital asset pricing model. Journal of Investment
Management, 1(2), 60-72.
Ghassan, O., Talal, A.-S., Khalaf, B. A., & Yaseen, H. (2015). Determinants of capital
structure in various circumstances: Could they be similar? Research Journal of
Business and Management, 2(2), 158-168.
imad z ramadan , q. A. k. (2011). determinants of bank proftability ;evidence from Jordan.
international journal of academic research, 4.
irung, P. G., S.K. (2013). effects of financial performance indicators on market price of
shares in commercial banks of kenya . international journal of management and
business studies,3(3),72-77.
Ismail, M. A., ..Ibrahim,M.H.,Yusoff,M.,&Zainal,M.P. (2010). financial constraints and firm
investment in Malaysia: An investigation of investment -cash flow relationship .
international journal of economics and management,4(1),29-44.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency
costs and ownership structure. Journal of financial economics, 3(4), 305-360.
Jha, S., & Hui, X. (2012). A comparison of financial performance of commercial banks: A
case study of Nepal. African Journal of Business Management, 6(25), 7601-7611.

53
Karemera, J. (2013). The relationship between regulation and financial performance of
rwanda Commercial Banks. University of Nairobi.
Kebede, E. (2014). The impact of National Bank regulation on banks performance: Evidence
from the private banks of Ethiopia. Unpublished MSc thesis, Addis Ababa University.
Khrawish, H. A., & Al-Sa’di, N. M. (2011). The impact of e-banking on bank profitability:
Evidence from Jordan. Middle Eastern Finance and Economics, 13(1), 142-158.
Kipleting, M. (2016). Effect of investment Diversification on the Financial performance of
commercial banks in Kenya. IOSR Journal of Business and Management, 18(11),
102-115.
Levišauskait, K. (2010). Investment analysis and portfolio management. Leonardo da Vinci
programme project.
Lintner, J. (1966). Distribution of Incomes Among Dividends, Retained Earnings and Taxes.
American Economic Review,(May, 1956), 97-113.
Malhotra, N. K. (2007). Fundamentals of marketing research: Sage publ.
McColgan, P. (2001). Agency theory and corporate governance: a review of the literature
from a UK perspective. Department of Accounting and Finance working paper, 6,
0203.
Mohana, K., & Tekeste, B. (2012). Determinants of profitability of Commercial Banks in
Developing country, Evidence from Ethiopia. International Journal of Accounting
and Finance, 2(3).
nahom. (2015). determinants of banks performance of private commercial banks in Ethiopia,.
Unpublished MSc thesis, Addis Ababa University.
Nigeria, O. T. E., & Nigeria, A. T. A. (2014). Investment in fixed assets and firm
profitability: Empirical evidence from the Nigerian banking sector. Asian Journal of
Social Sciences and Management Studies, 1(3), 78-82.
Njiiri, V. (2015). The relationship between investment and financial performance of
insurance companies in Kenya. unpublished MBA project. university of Nairobi

Ongore, V. O., & Kusa, G. B. (2013). Determinants of financial performance of commercial

banks in Kenya. International journal of economics and financial issues, 3(1), 237.
Pasiouras, F., & Kosmidou, K. (2007). Factors influencing the profitability of domestic and
foreign commercial banks in the European Union. Research in International Business
and Finance, 21(2), 222-237.

54
Salancik, G. R., & Pfeffer, J. (1978). A social information processing approach to job
attitudes and task design. Administrative science quarterly, 224-253.
Sciubba, E. (2006). The evolution of portfolio rules and the capital asset pricing model.
Economic Theory, 29(1), 123-150.
Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions
of risk. The journal of finance, 19(3), 425-442.
Shibiru. (2014) ). assessment of the implication of regulatory policy on the development of
private commercial banks in Ethiopia in case of NBE bill purchase directive.
Unpublished MSc thesis, Addis Ababa University.
store, F. S. (2015). The relationship between information technology(IT) investment and
firms financial performance of public listed companies in Malaysia .unpublished
Thesis .universiti Tun Hussien Onn Malaysia.
Sufian, F., & Chong, R. R. (2008). DETERMINANTS OF BANK PROFITABILITY IN A
DEVELOPING ECONOMY: EMPIRICAL EVIDENCE FROM THE PHILIPPINES.
Asian Academy of Management Journal of Accounting & Finance, 4(2).
Taddesse. (2015 ). the Investment of Accounting information system and performance of
Private commercial banks in Ethiopia Unpublished MSc thesis, Addis Ababa
University.
Tesfaye. (2014). the impact of policy measures on Ethiopian private banks performance on
the case of government bill purchase. Unpublished MSc thesis, Addis Ababa
University.
Tobin, J. (1969). A general equilibrium approach to monetary theory. Journal of money,
credit and banking, 1(1), 15-29.
Twine, E. E., Kiiza, B., & Bashaasha, B. (2015). The flexible accelerator model of
investment: An application to Ugandan tea-processing firms. African journal of
agricultural and resource economics, 10(311-2016-5623).
Virlics, A. (2013). Investment decision making and risk. Procedia Economics and Finance,
6, 169-177.
Warström, O., & Niemelä, M. (2015). Interest Rates and Aggregate Corporate Investment.
yodit. (2012). the implication of NBE bill Purchase on performance of private commercial
banks in Ethiopia Unpublished MSc thesis, Addis Ababa University.

55
APPENDIX

APPENDIX 1. ; Descriptive Analysis

APPENDIX 2. Correlation Analysis

APPENDIX 3. Hausman Test

56
APPENDIX 4. Test of Heteroskedasticity

57
APPENDIX 5. Test of Normality

APPENDIX 5. Robust Fixed effect Regression

APPENDIX 6. Test of Multicollinerity

58
59