WOLKITE UNIVERSITY SCHOOL OF GRADUATE STUDIES DEPARTMENT OF ECONOMICS ANALYSIS OF FACTORS AFFECTING DEPOSIT MOBILIZATION OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA BY MEKUANINT AYALEW FELEKE JUNE, 2019 WOLKITE, ETHIOPIA WOLKITE UNIVERSITY SCHOOL OF GRADUATE STUDIES DEPARTMENT OF ECONOMICS ANALYSIS OF FACTORS AFFECTING DEPOSIT MOBILIZATION OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA BY MEKUANINT AYALEW FELEKE MAIN ADVISOR: BADASSA WOLTEJI (PhD) CO-ADVISOR: BIRUK BIRHANU (ASSISTANT PROFESSOR) A THESIS SUBMITTED TO THE SCHOOL OF GRADUATE STUDIES OF WOLKITE UNIVERSITY IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN ECONOMICS JUNE, 2019 WOLKITE, ETHIOPIA i DECLARATION I declare that the thesis entitled, ANALYSIS OF FACTORS AFFECTING DEPOSIT MOBILIZATION OF PRIVATE COMMERCIAL BANKS IN ETHIOPIA, hereby presented by me in partial fulfillment of the requirements for the degree of Master of Science in Economics at Wolkite University. To the best of my knowledge, this study has not submitted for any degree in this University or any other University. In addition, that all sources of materials used for the study have been duly acknowledged. By: MEKUANINT AYALEW FELEKE Signature ---------------------------------- Date ---------------------------------------- ii WOLKITE UNIVERSITY SCHOOL OF GRADUATE STUDIES ADVISORS’ APPROVAL SHEET This is to certify that the thesis entitled “Analysis of Factors Affecting Deposit Mobilization of Private Commercial Banks in Ethiopia” submitted in partial fulfillment of the requirements for the degree of Master's with specialization in Developmental Economics, the Graduate Program of Economics Department, and has been carried out by Mekuanint Ayalew Feleke Id No GSE 083/09 under our supervision. To the best of our knowledge, it is an original work and not submitted earlier for any degree either at this University or for any other University. Therefore, we recommend that the student has fulfilled the requirements and hence hereby can submit the thesis to the department. Badassa Wolteji (PhD) --------------------- Main advisor Signature Date Biruk Birhanu (Assistant Professor) ----------------- --------------------- Co-Advisor Signature Date iii WOLKITE UNIVERSITY SCHOOL OF GRADUATE STUDIES EXAMINERS’ APPROVAL SHEET We, the undersigned, members of the Board of Examiners of the final open defense by Mekuanint Ayalew Feleke, have read and evaluated his thesis entitled “Analysis of Factors Affecting Deposit Mobilization of Private Commercial Banks in Ethiopia” and examined the candidate. This is, therefore, to certify that the thesis has been accepted in partial fulfillment of the requirements for the degree of Master of Science in Economics. ----------------------------------- ---------------------- ------------------------ Name of the Chairperson Signature Date ---------------------------------- ------------------------ ----------------------- Name of Internal Examiner Signature Date ---------------------------------- ----------------------- ----------------------- Name of External examiner Signature Date ---------------------------------- ----------------------- ------------------------- SGS Approval Signature Date Final approval and acceptance of the thesis is contingent upon the submission of the final copy of the thesis to the School of Graduate Studies (SGS) through the Department/School of Graduate Committee (DGC/SGC) of the candidate’s department. Stamp of SGS Date -------------------------------- iv ACKNOWLEDGMENT I praise the name of Almighty God who gave me power and patience in every endeavor of my life. My sincere and deepest gratitude goes to my advisors Badassa Wolteji (PhD) and Biruk Birhanu (Assistant Professor) for their unreserved assistance in giving me relevant comments and guidance throughout the study. My grateful thanks also go to my families for their every support to finish this thesis. Next, I would like to thank the concerned bodies of private Commercial Banks and National Bank of Ethiopia for their cooperation with me by providing necessary data. Finally, my acknowledgement also goes to my classmate and friends for their moral and spiritual supports throughout my carrier. v TABLE OF CONTENTS Contents Page ACKNOWLEDGMENT ........................................................................................................ iv LIST OF TABLES .................................................................................................................. ix LIST OF FIGURES ................................................................................................................. x ACRONYMS AND ABBREVIATIONS ............................................................................... xi ABSTRACT ............................................................................................................................ xii CHAPTER ONE ...................................................................................................................... 1 1. INTRODUCTION ............................................................................................................... 1 1.1. Background of the Study .................................................................................................. 1 1.2. Statement of the Problem .................................................................................................. 3 1.3. Research Questions ........................................................................................................... 5 1.4. Objectives of the Study ..................................................................................................... 5 1.5. Significance of the Study .................................................................................................. 5 1.6. Scope and Delimitation of the Study ................................................................................ 6 1.7. Organization of the Study ................................................................................................. 6 CHAPTER TWO ..................................................................................................................... 7 2. LITERATURE REVIEW .................................................................................................... 7 2.1. Theoretical Literature ....................................................................................................... 7 vi 2.1.1. Bank Led Theory ........................................................................................................... 8 2.1.2 .Savings Behavior Theories ............................................................................................ 9 2.1.3. Significance of Banks in Financial Systems ................................................................ 10 2.1.4. Commercial Banks Deposit ......................................................................................... 11 2.1.5. Major Types of Deposit Products ................................................................................ 11 2.1.6. Importance of Deposit Mobilization ............................................................................ 12 2.1.7. The Effects of Poor Deposit Mobilization ................................................................... 13 2.1.8. Factors Affecting Commercial Banks Deposits .......................................................... 13 2.1.8.1. Macroeconomic Factors ............................................................................................ 14 2.1.8.2. Bank Specific Factors ............................................................................................... 17 2.2. Empirical Literature Review ........................................................................................... 20 2.2.1. Related Empirical Evidence in Worldwide ................................................................. 20 2.2.2. Related Empirical Evidence in Africa ......................................................................... 23 2.2.3. Related Empirical Evidence in Ethiopia ...................................................................... 26 2.3. Conceptual Framework of the Study .............................................................................. 31 CHAPTER THREE ............................................................................................................... 33 3. DATA AND METHODOLOGY ...................................................................................... 33 3.1. Research Design ............................................................................................................. 33 3.2. Sources of Data ............................................................................................................... 33 vii 3.3. Sampling Techniques ...................................................................................................... 34 3.4. Model Specification ........................................................................................................ 34 3.5. Operational Definition and Expected Sign of Variables ................................................ 35 3.5.1. Operational Definition of Variables ............................................................................ 35 3.5.2. Expected Sign of Variables ......................................................................................... 37 3.6. Method of Data Analysis ................................................................................................ 38 3.7. Panel Unit Root Test ....................................................................................................... 38 3.8. Correlation Analysis ....................................................................................................... 40 3.9. Fixed Effects Vs Random Effects Models ...................................................................... 40 3.10. Diagnostic Tests ............................................................................................................ 42 3.10.1. Normality Test ........................................................................................................... 42 3.10.2. Multicollinearity Test ................................................................................................ 42 3.10.3. Heteroscedasticity Test .............................................................................................. 43 3.11. Panel Causality Test ..................................................................................................... 43 CHAPTER FOUR ................................................................................................................. 45 4. RESULT AND DISCUSSION .......................................................................................... 45 4.1. Descriptive Statistics ...................................................................................................... 45 4.2. Result of Panel Unit Root Test ....................................................................................... 47 4.3. Correlation Analysis ....................................................................................................... 48 viii 4.4. Choosing Fixed Effect Vs Random Effect Models ........................................................ 49 4.4.1. Hausman Test Result ................................................................................................... 50 4.5. Regression Analysis and Interpretation .......................................................................... 50 4.5.1. Regression Analysis..................................................................................................... 50 4.5.2. Interpretation on Regression Result ............................................................................. 52 4.6. The Diagnostic Test Result ............................................................................................. 55 4.7. Granger Causality Test Result ........................................................................................ 56 CHAPTER FIVE ................................................................................................................... 59 5. CONCLUSIONS AND RECOMMENDATIONS ............................................................ 59 5.1 Conclusion ....................................................................................................................... 59 5.2. Recommendation ............................................................................................................ 60 5.3. Suggestion for Future Studies ......................................................................................... 60 REFERENCES ...................................................................................................................... 61 APPENDICES ....................................................................................................................... 68 ix LIST OF TABLES Table 3.1 Expected sign of variables-----------------------------------------------------------37 Table 4.1 Summary of Descriptive Statistics -------------------------------------------------45 Table 4.2 Result of Panel Unit Root Test------------------------------------------------------48 Table 4.3 Partial Correlation Analysis---------------------------------------------------------49 Table 4.4 Results of Random Effect Regression ---------------------------------------------51 Table 4.5 Pair Wise Granger Causality Test --------------------------------------------------58 x LIST OF FIGURES Figure 1 Conceptual framework---------------------------------------------------------------32 Figure 2 Normality test result------------------------------------------------------------------68 xi ACRONYMS AND ABBREVIATIONS ADF Augmented Dickey-Fuller AIB ATM BDG Awash International Bank Automatic Teller Machine Bank Deposit Growth BOA Bank of Abyssinia CAR Capital Adequacy Ratio CBE Commercial Bank of Ethiopia CLRM Classical Linear Regression Model DB Dashen Bank ECM Error Correction Model EVIEW Econometric View GDP Gross Domestic Product FED Fixed Effect Model GTP Growth and Transformation Plan IMF International Monetary Fund LIQ Liquidity NBE National Bank of Ethiopia NIB Nib International Bank OLS Ordinary Least Square POS REM RGDP SMEs Point of Sale Random Effect Model Real Gross Domestic Product Small and Medium Enterprises UB United Bank UD United States Dollar VECM Vector Error Correction Model WB Wegagen Bank xii ABSTRACT The aim of this study is analyzing factors affecting deposits mobilization of private commercial banks in Ethiopia. In doing so, the study used Pearson correlation analysis, ordinary least squares (OLS) technique, Granger causality analysis and descriptive statistics using secondary data. The data are collected from national bank of Ethiopia (NBE) and sampled private commercial banks from the year 2002 up to 2017. The collected panel data also, regressed based on random effect model. Econometric view version 8 (Eview 8) and stata version 13 statistical software has been used to perform the analysis. The result of correlation analysis showed that, deposit interest rate and lending interest rate strongly correlated, while the inflation weakly correlated with bank deposit. As per the Granger causality analysis, the variables included in the estimation model have a unidirectional relationship in the long run. In addition to, the results of regression analysis showed that, deposit interest rate; the lending interest rate and return on asset were positively and significantly influence the bank deposit. However, inflation affects bank’s deposit negatively and significantly during the study period. Finally the study has recommended that, the private commercial banks should give due emphasis to deposit mobilization tasks and its determining factors by considering mobilizing deposit is a way to sustain in the banking industry. Key Words: - Deposit Mobilization, Ethiopia, Factors Affecting Bank Deposit 1 CHAPTER ONE 1. INTRODUCTION 1.1. Background of the Study Economic growth is the common objective of all nations. Everybody lives with a better standard of living than before and bring about a better welfare because of the surge in economic growth. The government of each country struggle to reduce poverty and increase the level of national income. Thus, to achieve the main target of economic growth, governments may implement various kinds of policies such as encouraging saving, stimulating investment and production in their countries. Mobilizing domestic resources are vital activity to achieve self-sufficiency. Therefore, the financial sector is one of the major sectors of the country’s economy that needs to revitalize constantly in mobilizing domestic deposits to increase investment (Pinchawawee, 2011). Financial institutions are an organization that provides financial services for their customers whose primary objective and function is to collect money from their customers and invest it in financial assets such as stocks and bonds, loans and leases and insurance policies. They are business organizations that act as mobilizes and depositors of savings and as suppliers of credit finances. Commercial banks, investment banks, insurance companies and brokerages are common examples of financial institutions (Peter and Keith, 2007). From the financial institutions in the world that give financing services is commercial bank. Commercial banks are banks whose main functions are to accept deposits and to lend, thereby facilitating the transfer of funds in the economy. So that, deposit provides the raw materials for bank loans and thus represents the ultimate source of bank profits and growth (Peter and Keith, 2007). Mobilization of commercial bank’s deposit plays an important role by offering satisfactory service to different sectors of the economy. The success of banking is highly lies on deposit mobilization. Deposit is the main source of funds to undertake lending operations and for profitable operation, the amount of deposits 2 is very important. Mobilizations of deposits for banks are as essential as oxygen for human being (Richard, et al., 2015). The financial resources of banking system provided from people deposit. So that, we can say that deposits are the main resources of commercial banks. Therefore, the amount of deposit a commercial bank should have at hand must be enough to make the bank that involve in the market and satisfy the financial wants of their customers. From this general fact, the bank should manage its deposit. However, properly managing deposits is not possible without knowing and controlling the factors affecting it. In literature, many factors claimed to be determinants of deposits (Mohammad and Mahdi, 2010). Factors affecting commercial bank deposits are divided into two, namely exogenous and endogenous factors. Exogenous factors are factors that not controlled by bank and endogenous factors are factors that are controlled by the bank. Exogenous factors are further sub divided into two, i.e. country specific factors and bank specific factors. Country specific factors includes saving interest rate, inflation, real interest rate, population growth of the country, per capita income of the society, economic growth, consumer price index, shocks etc. Bank specific factors include liquidity of the bank, profitability of the bank, security of the bank, number of commercial bank’s branches, bank size, reserves and transaction cost etc. The endogenous factors include awareness of the society, convenience of bank’s office and services in the bank etc. These variables claimed in the literature to affect the volume of total deposit of commercial banks (Wubitu, 2012). Commercial banks are the main player and the most active sector that is highly considered as the backbone of the country especially in the developing nation like Ethiopia where no capital market at all. They have been playing an essential and peculiar role in the progress of the Ethiopian economy through supporting the private sector and financing government mega projects. In addition to the huge sum paid by private banks as corporate profit tax, private banks are purchasing NBE bills valuing 27% of the total loan they disbursed since April 6, 2011. According to the Reporter newspaper published on August 1, 2015 the total outstanding bills peaks to 36 bullions Birr as of June 30, 3 2015. Since the past couple of years mobilizing deposit became the contest point among commercial banks be it government or privately owned. Unless commercial banks could manage to mobilize enough deposit, their existence questioned (Andinet, 2015). Currently in Ethiopia, it is not a new task to see the staff of commercial banks participating in deposit mobilization through door-to-door service to open accounts. This implies that how the commercial banks are highly needed the deposit because it is the question to sustain in the banking industry. In order to increase the deposit, the commercial banks first identify the factors that affect deposit mobilization and then implement different strategies and techniques to mobilize deposits. Thus the motivation to know the effect of such factors and to exert maximum effort on deposit mobilization of commercial banks in Ethiopia, enforce the researcher to undertake this study. 1.2. Statement of the Problem The commercial bank deposits are the primary sources of funds for banks, which facilitates the uses of funds such as loans and investments. The higher the deposit amount, the higher the lending and investment portfolio maintained through banks to sustain its expansion trend and future growth. The banks should have adequate deposits to meet the lending volume required by the public and at the same time maintain extra cash for withdrawals by depositors. The cash reserve is a component of liquidity reserves that measure the ability of the bank to meet its expected withdrawals and recurring withdrawals. The withdrawals made from their services are oddly offset against new deposits which the banks should continuously mobilize. The inability to get sufficient deposits could result in a negative fund situation. The increase in deposit growth also indicates the bank's performance in relation to customers' satisfaction on interest payout and services rendered (Ketema, 2017). The fast growing economy of Ethiopia, which is proactively investing in road infrastructure, building hydropower dams, constructing thousands of housing condominiums and expanding agriculture and other investments in the country are hugely relying on the commercial banks loans and credits. Moreover, there have been multiple smaller enterprises incubated in the last decades and increasing number of import and 4 export companies, heavily relying on commercial banks for loans, foreign currency and trade assurances. This calls for an increased demand for deposit mobilization of public institutions, private sector and other potential contributors (Hibret, 2015). Mobilizing deposit is not an easy task for commercial banks. The performance of any commercial bank is a derivative of the mobilized fund. The higher deposit the bank mobilizes, the higher the ability to lend it. So that, as long as a deposit has a vital role in commercial banks; we should trace out which factors are affecting it and determining the relationship between them. According to NBE (2015/16) annual report, the share of private commercial banks deposit mobilization increased only to 33.9 percent from 31.5 percent in 2014/15 despite their opening of 359 new branches. CBE alone mobilized 66.1 percent of the total deposits due to its large branch network. From various literatures and the researcher own observation, Ethiopian banking industry is still at its infancy stage. As a result, deposit not yet been mobilized as much as expected. NBE indicates that, from deposits that should mobilize by banks only 7% is mobilizing as of 2012. This indicates that, from the money that should be deposited in the bank 93% of it was not mobilized (Wubitu, 2012). The country had permitted the financial institutions for private investors 20 years back. Following the government approval, the first private commercial bank had opened its door in 1995. For various reasons, the deposits mobilized by all private commercial banks are by far less than the state owned commercial bank. According to the annual report issued by NBE for the fiscal year ended June 30, 2015, the total deposit mobilized during the year 2014/15 by all private banks were 26 billion Birr whereas 49 billion Birr was collected by public banks. In order to do well in the deposit mobilization activities, private commercial banks need to set certain mechanisms to mobilize such deposit rather than doing the old way of banking services (Andinet, 2015). In Ethiopia, as the knowledge of the researcher is concerned, the major points of analysis that put clearly as the research gaps are: The majority researcher were conducted on the determinants of commercial bank deposit as evidence only a single Ethiopian state owned bank, which is the Commercial Bank of Ethiopia. No previous work exists by this award. 5 The causal relationship between estimate variables of the study not examined. The methodology taken into account and variables incorporated in the econometric model for further analysis based on the expected results is also another area of disparity among these researchers. Thus, this study tries to address and fill the gap by taking into account the above noted issues using the panel data analysis. 1.3. Research Questions ➢ What does the correlation between estimate variables of the study? ➢ How factors affecting deposit mobilization of private commercial banks? ➢ What is the causal relationship between estimate variables of the study? 1.4. Objectives of the Study The main objective of this study is analyzing factors affecting deposit mobilization of private commercial banks in Ethiopia. More specifically, the research attempt to:- ➢ Examine the correlation between estimate variables of the study. ➢ Analyze factors affecting deposit mobilization of private commercial banks. ➢ Analyze the causal relationship between estimate variables of the study. 1.5. Significance of the Study Banks play an important role in economic development through mobilization of funds within and outside the country and channeling such funds to various needy and viable sectors of the economy. To put in place adequate bank deposit management tools, understanding factors that determine commercial bank’s deposit play a crucial role. The study has great contribution to existing knowledge in the area of factors that affect commercial banks deposit in the case of private commercial banks of Ethiopia. This in turn contributes to the well-being of the financial sector of the economy and the society as a whole. Therefore, the major beneficiaries from this study are private commercial banks of Ethiopia, regulatory bodies and the academic staff of the country. 6 1.6. Scope and Delimitation of the Study The work of this study was delimit to some major macro specific and bank specific factors that determine private commercial banks deposit mobilization in Ethiopia. This research could not assess all private commercial banks, rather only six private commercial banks selected purposefully Based on their establishment seniority for a period of sixteen years from 2002 to 2017. Because these banks only fit for the study in terms of period and existed in business for more than a decade that enables to get enough panel data for the study. 1.7. Organization of the Study This study is organized into five chapters. Following the introductory chapter, the second chapter presents a review of literatures. The third chapter deals about methodology and data used followed by Chapter four, results and discussion. Finally, chapter five presents conclusions and recommendation of the study. 7 CHAPTER TWO 2. LITERATURE REVIEW 2.1. Theoretical Literature Banking is one of the oldest professions in human history, it flourished with civilizations. Since humans started, using money bank services were in use throughout history. A modern banking system established in Italy and Greece in the 15th century. Different historical sources stated that, Goldsmiths and Silversmiths put the first foundations of the banking service in the world. They have a safe box to put & they were the most trusted. They used to receive gold, silver and various jewelries to part with them. Therefore, an individual or a merchant puts his wealth under their custody, for their service they charge a small amount of money and give the customer a receipt to guarantee their acceptance. Then they started using, money paying instrument what we now call this document as ‘cheque’. However, as time goes by, the Goldsmiths and Silversmiths observed that their customers wouldn’t take their jewelry soon, and those clients, whenever they face the shortage of money, they started lending to this person and started to get profit from their service. They encouraged depositing and lending and rather than making the customers pay a charge for depositing, they started to pay them interest and introduced the public to work with money. It believed that, ancient Assyrians, Babylonians, Athenians, Romans and Abyssinians also used the banking service (Devinaga, 2010). Some authorities, relying upon a broad definition of banking that equates it with any sort of intermediation activity, trace early banking as far back as ancient Mesopotamia, where temples, royal palaces, and some private houses served as storage facilities for valuable commodities such as grain and different important materials. There are records of loans by the temples of Babylon as early as 2000 BC. Temple considered as a special safe depositories because, as they were secured places watched over by the gods, their contents believed to protect from theft. The ancient time trader’s companies provided banking services that connected with the buying and selling of goods (Britannica, 2010). 8 A broader definition of a bank is any financial institution that receives, collects, transfers, pays, exchanges, lends, invests, or safeguards money for its customers. This broad definition includes many other financial institutions that not usually thought of as banks, but which provide one or more of these defined banking services. These institutions included the finance sectors, investment companies, insurance companies, pension funds, security brokers and intermediaries, and real estate investment trusts (Encarta, 2009). The commercial banks play a very important role in the economic development of every nation. They have control over a large part of the supply of money circulation. Banks are the main stimulus of the economic progress of a country. The financial sector's contribution to growth lies in the central role of mobilizing customers deposit and allocating these deposit effectively to more productive uses and investments in the real sector (Pinchawawee, 2011). 2.1.1. Bank Led Theory Bank led theory offers a distinct alternative to conventional branch based banking in that customer conducts financial transactions at a whole range of retail agents instead of at bank branches or through bank employees. The commercial banks are the ultimate provider of financial services and are the institution in which customers maintain accounts. Retail agents have face to face interaction with customers and perform cash in/cash out functions much as a branch based teller would take deposits and process the withdrawals. Eventually, any outlet that handles cash and is located near customers could potentially serve as a retail agent. Whatever the establishment, each retail agent outfitted to communicate electronically with the bank for which it is working. The equipment may be a mobile phone or an electronic point of sale (POS) terminal that reads cards. Once an account is established or loan approved, the customer goes to the retail agent to conduct all or certain financial transactions. The retail agent checks the customer identification documentation and the transaction, debiting the customer’s cash, crediting the payee’s bank account and a transfer of funds between accounts. Unless the transaction is merely a transfer of funds, cash either deposited to or withdrawn from the retail agent’s cash drawer. An electronic record of the transaction either is routed directly from the retail 9 agent to the bank or handled by the payment processing agent that settles the transaction between the customer’s account and the payee’s account (Lyman, et al., 2006). The bank led theory is related to the study as its focus on how financial institutions like bank delivery of financial services through a retail agent, where the bank develops financial products and services but distribute them through a retail agent. This can be a way of mobilizing deposits of commercial banks as a new model to increase financial inclusion and facilitate the transaction process. This theory facilitates the banks to raise its deposits and lead to financial performance. 2.1.2 .Savings Behavior Theories Existing literature to date presents three major theories behind savings: Life cycle hypothesis (Modigliani & Brumberg, 1954), Permanent Income hypothesis (Friedman, 1957) and the Buffer stock hypothesis (Deaton, 1991). The life cycle hypothesis is an extension to the Keynes (1936) absolute income hypothesis. It emphasizes that the main motive of saving is retirement accumulation. The theorem views consumption in any given period as a function of future expected lifetime income. As income fluctuates over an individuals’ life span, saving behavior influenced by one’s stage in the life cycle. As such, it has anticipated that, individual’s smooth consumption over their lifetimes, such that they save during their working years and consume upon retirement (Ozcan et al., 2003). The Permanent income hypothesis attempts to differentiate between permanent and transitory income as the determinants of private savings. Changes in income perceived by households to be permanent tend to reduce current savings because they can justify higher consumption today and in the future. On the other hand, income changes perceived to be transitory induced smoothing consumption, whereby today’s income is, saved for tomorrow’s higher consumption. In its basic form, the Buffer stock hypothesis of savings behavior proposes that consumers accumulate assets to hedge against unpredictable income fluctuations. It has 10 anticipated that whenever wealth is above a certain target, consumers tend to spend more and save less, while, when current wealth is lower than the perceived target, individuals become prudent leading to higher savings. 2.1.3. Significance of Banks in Financial Systems The financial sector plays a vital role in the overall economic system of every nation. The two components of a financial sector are the financial market and financial institutions. The former defined as a market in which financial assets (securities) such as stocks and bonds purchased or sold. Financial markets, thus, facilitate the flow of funds and thereby allow financing and investing by households, firms and government agencies (Madura, 2011). Financial institutions such as banks, insurances, micro finances etc are institutions that provide financial services for their customers. In the context of the African continent, financial institutions in general and banking industry in particular carry the greater share of the financial system (Sheku, 2005). Most of the businesses rely on the banking sector as a source of financing (Medhat, 2004). It is no exception to Ethiopia, where the others like insurance companies and microfinance institutions (MFI) are by far lesser than banks in terms of capital size, total assets, employment capacity and profits (NBE annual report, 2011/12). Commercial Banks have historically viewed as playing a role in financial markets for two reasons. The first one is that they perform a critical role in facilitating payments. Commercial banks, as well as other intermediaries, provide services in screening and monitoring borrowers; and the other one is by developing expertise as well as diversifying across many borrowers, banks reduce the cost of supplying the credit (Katherine, 2004). Thus, in their role as lenders, banks are often not merely buying some one’s debt; rather they are providing significant financial services associated with extending credit to their customers directly. The main providers of additional financing are domestic commercial banks (Herald et al, 2009). 11 2.1.4. Commercial Banks Deposit Commercial bank deposits are major liabilities of commercial banks. (Kelvin, 2001) said that deposits of commercial banks account for about 75% of commercial banks’ liabilities. Commercial banks keep lending as long as they possess adequate deposit. Mahendra (2005) had also mentioned deposits as a foundation upon which banks thrive and grow and deposit is unique items on a bank’s balance sheet that distinguish them from other type of business organizations. Commercial banks mainly depend on the funds deposited with them by the public to lend it out to others in order to earn interest income (Davinaga, 2010). However, banks attract deposits by paying a risk free return to the savers. Interest expense is the number one expense on the income statement of most commercial banks. As noted by Hamid (2011), if banks lose their deposit base, they rely on non-deposit based funding that is very expensive and consequently minimizes the profit margin. 2.1.5. Major Types of Deposit Products Deposit account is a savings account, current account or any other type of bank account that allows money deposited and withdrawn by the account holder. These transactions recorded on the bank's books, and the resulting balance recorded as a liability for the bank and represents the amount owed by the bank to the customer. Some banks may charge a fee for service, while others may pay the customer interest on the funds deposited. The account holder has the right to withdraw any deposited funds, as set forth in the terms and conditions of the account. The following are most common type of bank deposit. Demand Deposit: consists of funds held in an account from which deposited funds withdrawn at any time without any advance notice to the depository institution. Demand deposits can be "demanded" by an account holder at any time. Many checking accounts today are demand deposits and are accessible by the account holder through a variety of banking options, including teller, ATM and online banking. 12 Savings Account: is a deposit account, held at a bank or other financial institution that provides principal security and a modest interest rate. Depending on the specific type of savings account, the account holder may not be able to write checks from the account (without incurring extra fees or expenses) and the account is likely to have a limited number of free transfers/transactions. Time Deposit: is deposited or certificate of deposit (CD), held for a fixed-term, with the understanding that the depositor can make a withdrawal only by giving notice. A time deposit is an interest-bearing bank deposit that has a specified date of maturity (Dereje, 2017). 2.1.6. Importance of Deposit Mobilization According to Ongore and Kusa, (2013), the intermediation function of banks plays a vital role in the efficient allocation of resources of countries by mobilizing resources for productive activities. They transfer funds from those who do not have productive use of it to those with productive venture. Nwanko et al., (2013) States that, savings are resources which one decides to put aside for investment purposes and not for luxury. What people save, avoiding to consuming all their income called personal savings. These personal savings can remain in the bank accounts for future use or invested in houses, real estate, bonds, shares and other financial instruments. According to Varman (2005), the success of the banking sector highly lies in the deposit mobilization. A performance of the bank depends on deposits, as the deposits considered as a cost effective source of working fund. The ability of a bank‘s management and staff to attract checking and saving accounts for business and individuals is an important measure of the bank’s acceptance by the public. Deposits provide most of the raw materials for bank loans and thus represent sources of bank profits and growth. Tuyishime et al., (2015) also affirmed that, deposits are an indispensable tool for commercial banks and use to enhance its profitability through advancing deposits mobilized customers in the form of loans, which make in return interest to commercial banks. 13 According to Ongor and Kusa (2013), in addition to resource allocation, good bank performance rewards the shareholders with sufficient return for their investment. When there is a return, there shall be an investment, which in turn, brings about economic growth. On the other hand, poor banking performance has a negative repercussion on the economic growth and development. Poor performance can lead to runs failures and crises. Banking crisis could entail financial crisis, which in turn brings the economic meltdown. 2.1.7. The Effects of Poor Deposit Mobilization According to Khalayi, et al., (2014), there are a number of effects that bring about poor deposit mobilization. This includes-inability to disburse loans to qualifying members on demand, inability to meet operating costs, inability to service debts quitting of members to the competitors and falsification of financial reports. These can cause the voting out of elected officials on accusations of fraud and financial mismanagement practices. In addition, dissatisfied members can quit in large numbers to join alternative and emerging financial institutions for fear of losing their savings if the situation deteriorates. 2.1.8. Factors Affecting Commercial Banks Deposits An important indicator of the success and efficiency of any credit agency, which is also a banking institution, is the extent to which it is able to mobilize the savings of the community in the form of deposit. However, deposit mobilization is a very difficult task. It is upon various factors internal and external to the banking system. External factors are the general economic environment of the region, the volume of business transacted in the region, the confidence of the people in the banking system, the banking habit of the people and the saving potential of the region. Even when external factors are more conducive for deposit mobilization, banks may fail because of unfavorable internal factors such as location, type of building and window dressing (furniture, cheque books, vouchers, pay slips etc.), which assure the customers about the physical fitness of a bank. The variables, which claimed to have an effect on commercial bank deposit classified into two, namely exogenous and endogenous factors. Exogenous has further divided into country specific factors and bank specific factors for clarification purpose. Endogenous 14 (Internal) factors can control by the banking system. However, the Exogenous factors (The bank specific factors and the country specific factors) cannot be controlled by the banking system. The bank specific factors are factors that are specific to the banking system and the country specific factors are factors that are beyond the banking system (N. Desinga, 1975). 2.1.8.1. Macroeconomic Factors The country specific risks such as political, economic and financial risks may affect the propensity for depositors to place funds in the banking system. Any single bank operates under the rule and regulation of the country where it belongs to different problems and shocks that has happened in the country has its own concern in the banks operation. Generally, banks’ success in their operation is mainly depends on the environment where the business is undertaken (Herald and Heiko (2009). According to Mohammad and Mahdi (2010), real interest rate is nominal interest rate minus the inflation rate. In negative real interest rate condition, people withdraw their resources from the banking system. The decrease in real interest rate to the nominal nature of their assets and the asset- liability maturity mismatched. Therefore, it states that the interest rate and deposit of the banks have a positive relationship. The twin objectives of commercial banks, i.e. acquiring deposits and advancing credit cannot attain without good banking habits of the people (Mahendra, 2005). Especially, Mahendra (2005) stated that, the number of deposit accounts is more important. Because it ensures that, the probability of account is more important because it ensures that the probability of account holders withdrawing cash at a time decreases as the amount of deposit account increase, thereby creating an advantage for banks in terms of increasing the size of the loan able fund. Therefore, the higher number of deposits accounts the greater is the advantage to banks. The number of deposit accounts depends on the number of deposit account holders. According to Jim (2008), per capita is GDP of the country divide by the total population of the country. Changes in real GDP per capita over time, often interpreted as a measure 15 of changes in the average standard of living of a country. If households and firms desire to hold more money, deposits will increase (Evan, 2006). Therefore, the relationship between income and deposits is positive. That is, as the income of the society increases the same happens to the commercial banks’ deposits. Income expected to have a positive effect on deposits (Baqui et al., 1987). Therefore, as society’s per capita income increases the same will happen for commercial bank deposits. Mahendra (2005) also indicates that income of the society matters for banks’ deposit growth. Eshetu et al., (2009) stated that Ethiopia is one of the poorest countries in the world with an estimated per capita income of just $203 (IMF 2007 cited by the Financial Standards Foundation). As economic performance measured through gross domestic product (GDP), a variable that has also become the de facto universal metric for 'standards of living (Yanne et al, 2007). It universally applied according to common standards, and has some undeniable benefits mainly due to its simplicity (Yanne et al., 2007). According to Herald and Heiko (2009), growth is one of the determining factors for commercial banks deposits. GDP, calculated by adding up the value-added at each stage of production (deducting the cost of produced inputs and materials purchased from an industry’s suppliers) (Jim, 2008). Erna and Ekki (2004) finds four variables, GDP, number of Islamic bank’s branch offices, profit sharing rate, and interest rate that are thought to have influence on the volume of deposits. Therefore, GDP can influence the growth of commercial banks deposits. In addition, real gross domestic product growth is the economic output of a country minus the effect of inflation or deflation. The real GDP growth used as a proxy of business cycle in which banks operate and controls for variance in deposit due to differences in business cycles that influence the supply and demand for loans and deposits (Staikourasb & Wood, 2004;Ommeren, 2011). Higher (lower) GDP indicates favorable (unfavorable) business opportunities under which a bank can achieve higher (lower) deposits. This is because an increase in economic activities of the country signals that customers’ demand for loans will increase, and with improved lending activities make banks able to generate more profits. Government expenditure refers to all monetary expenditure on goods and services made by the government on behalf of the community. It includes both recurrent and capital 16 expenditure on items, health, education, administration and so on. The recurrent expenditure refers to the expenditures that occur at regular intervals in the annual budget of the government. These expenses include expenditure on defense, administration and debt servicing particularly payment of interest on loans, road maintenance, and cost of health and education services. As Sahoo et al., (2001) in the Indian case accepts that, saving is the engine of growth. Expenditure that creates jobs, ensures regular income and savings, hence, bank deposits increase. On the other hand, expenditure on investment such as importation of capital goods, development of institutional and infrastructure facilities which aid private sector investments may generate employment and multiplier on savings and output in the long run. Where the latter situation holds, all things being equal, deposit mobilization will increase. Generally, an increase in government expenditure injects more money into the hands of the people and assuming no change in inflation and tax rates as well as demand for more goods, services, more income will be available for savings, and deposits will increase accordingly. Also, where expansionary government expenditure leads to increase in domestic borrowing, interest rates on loans increase and all other things being equal, more deposits would be attracted (Osie, 2015). Monetary policy to be a policy used by a government or central bank to influence the supply of money and credit in private hands, used for controlling inflation. In Ethiopia, the government controls money supply through the central bank unlike in the United Kingdom where the Bank of England is independent of the government in pursuing monetary policies. The central bank being the main actor in this respect uses monetary tools such as reserve ratios, discount rates, and open market operations to control money supply and inflation in the economy. Control of money supply has a direct relationship with deposit mobilization and inflation control. An exchange rate has quoted as foreign currency per unit of domestic currency or domestic currency per unit of foreign currency (Bishop, 2006). Exchange rate allows denominating the cost or price of a good or service in a common currency. As Thomas’s explanation, the term depreciation and appreciation used to show the decrease and 17 increase in the value of currency. Depreciation is a decrease in the value of currency relative to another currency. Appreciation is an increase in the value of a currency relative to another currency. According to Nugel (2012), as currencies depreciated in one country deposit will be reduce since investors tend to withdraw deposit and exchanged to keep it by appreciating currency (hard currency) or invest in another form of investment rather than bank deposit. 2.1.8.2. Bank Specific Factors The Bank specific factors are factors that related to internal efficiencies and managerial decisions. Such factors include determinants such as Bank Profitability, Bank Liquidity, Bank Credit Risk and the like. The liquidity position of a bank should be ascertained, monitored and controlled daily. Liquidity measured as the ratio of loans over total deposits of the bank. The liquidity of an entity requires that its ability to pay its debts when due and the ability of its debtors to pay the amount they own to the entity are of great importance. However, the liquidity or solvency of a firm usually measured by liquidity ratios, which are a class of financial ratios used to determine a company’s ability to honor its short-term debt obligation. Commonly used liquidity ratios are the current ratio and the quick ratio. The current ratio used to test a firm’s liquidity because it shows the proportion of the firm’s current assets available to cover its current liability. The concept behind this ratio is to ascertain whether a company’s short-term assets (such as cash, cash equivalents, marketable securities, receivables and inventory) are sufficient to pay its short-term liabilities (notes payable, current portion of term debt, payables, accrued expenses and taxes). In this study, we shall use the ratio of total loan-to-total deposit as a measure of the liquidity of the deposit money banks (Fadare, 2011). According to Osie (2015), institutional governance, ownership and reputation of the financial institutions are key factors for successful deposit mobilization. Prior to offering voluntary deposit services, financial institutions must ensure that they have the institutional structures that allow them to mobilize savings legally. “Institutional capacity requires that adequate governance, management, staff and operational structures are in 18 place to provide savings services”. Klaehn, et al., (2002) expound that, the “vision, commitment and disposition of the pro poor institutions are critical in successfully mobilizing deposit from the public”. There is a relationship between commercial banks deposits and commercial bank’s branch expansion. The level of deposits in any area (M. A. Baqui et al., 1987) also influences not only deposits influenced by bank branches, but the expansion of bank branches. It expected that banks make decisions on expanding their facilities by considering factors such as level of competition, deposit potential, regional income and existence of road and vehicles. As deposit potential is one thing that banks consider in expanding its branches, the deposit can also be a reason for branch expansion strategy that the banking sector uses. There is a long run relationship between commercial banks branch and commercial banks deposits (Erna and Ekki, 2004). In addition to the factors prominently identified as affecting deposit variability is bank size. Evidence indicates that the number and diversity of the ownership of individual deposit accounts as well as the distribution of deposits by type vary with bank size (George, 1972). Herald and Heiko (2009) found that; although insignificant once controlled by other variables bank size have an effect on deposits. Smaller banks has to generate less deposits in absolute terms to achieve the same deposit growth than large banks, thus possibly favoring smaller banks in achieving higher deposit growth. However, a larger bank with economies of scale as well as larger branch network might be able to better attract deposits (Herald and Heiko, 2009). Now a day Competition in the banking industry operation is fierce; the competitive advantage strategy would be that the bank would be able to compete on deposit mobilization. Differentiation would be viable strategy in this case as there is like hood that the loyal customer would stay with bank. It would also be hard for competitor to cope with the specialist. When bank inaugurated will strive to be the best and to deliver better and quality service through well-trained and qualified workforce and win the competition through delivering better and quality service by well-trained and qualified workforce and by using differentiation strategy. Banks should win this competition by 19 providing excellent service for its customers to mobilize more resource and use their good will to attract its customers and for those that do not have good will recommended that Banks should build good will to be acceptable for the society and should win the public confidence (Brickwork, 2008). As Thomas Ogoro (2010) stated that, technological development removed repetitive and time-consuming tasks, reduced human error and extended access to banking related facilities. Technology also provides customer information that it would be much more expensive to provide on a person-to-person basis. The dilemma remains, however, as to how to maintain a satisfactory number of face-to-face interactions with the customers. 20 2.2. Empirical Literature Review The empirical literature part discusses past studies that conducted on the area of factors determining commercial bank deposits. In this Part, the variables that were included, the methodology that used to undertake the study and the results of the study under review has discussed. These will help to see where the literature on this study is and how this study been will add to the existing literature. 2.2.1. Related Empirical Evidence in Worldwide The study conducted by Prema, et al., (2001) in India examined the determinants of private saving in the process of economic development, in the light of the Indian experience during the period 1954 -1998. The independent variables in this study pointed to the real interest rate, growth and the level of per capita income, spread of banking facilities, and the rate of inflation, terms of trade changes and inward remittances by expatriate Indians; whereas, as domestic saving was the dependent variable. The methodology involves the estimation of a saving rate function derived within the life cycle framework while paying attention to the structural characteristics of a developing economy. The estimation process was by testing the time series properties of the data using the augmented Dickey - Fuller (ADF) test. The researcher found that, saving rate rises with both the level and the rate of growth of disposable income and the magnitude of the impact of the former was smaller than that of the latter. The real interest rate on bank deposits was a significant positive impact, but the magnitude of the impact was modest. Public saving seems to crowd out private saving, but less than proportionately, suggesting that public policy can influence the national saving rate. Among the other variables considered, the spread of banking facilities in the economy and the rate of inflation seem to have a positive impact and changes in the external terms of trade and migrant remittances a negative impact on private saving. 21 Erna and Ekki (2004) in Indonesia conducted the following studies. The aim of this study was to figure out the factors affecting mudaraba deposits in Indonesia using a well- known econometrics co integration method. It uses quarterly time series in the period of 1993 to2003. Four variables, GDP, number of Islamic bank’s branch offices, profit sharing rate, and interest rates thought to have influence on the volume of mudaraba deposits. The co integration test indicates that the number of Islamic bank’s branch offices and profit sharing rate are significantly affects the volume of mudaraba deposits in Indonesia in the end, while GDP and interest rate are not. After all the researchers concluded that, the volume of mudaraba deposits in Indonesia does not depend on income or interest rate, but depend on profit sharing rate and the number of branch offices of the Islamic commercial banks. And also they concluded that this finding supported the view that depositors are attracted to put their money in Indonesian Islamic banks partly due to welfare maximization reasons not only because of their religious considerations. Moreover, they concluded that in order to increase the volume of mudaraba deposits in Indonesia, it suggested that more branch offices of Islamic commercial banks built. Lastly, they concluded that Indonesian Islamic commercial banks should also provide an optimal profit sharing rate in order to attract more depositors. An empirical study examined by Hossein and Ali (2014), on Isfahan Sepah Bank in Iran with the aim of effective factors on the absorption of bank deposits in order to increase the relative share of Isfahan Sepah Bank. The purpose of this research applied in terms of research methods, the branch of the field is descriptive survey. The collected data was tested using panel data Stationary test and assumptions of classical co linearity regression model, t test, Fisher F test, Durbin Watson test was significant, F Lymr personal effects, Hausman test, the variance test anisotropy the remaining residues of Normality review for multiple regression analysis has been used. The research population was consisted of Sepah Bank deposits in the province during the period 1989 to 1999. Independent variables of volume of high powered money, inflation, interest rate, rate of exchange, electronic researchers used banking index, GDP growth and stock index. The results were indicating that, the effect of e-banking parameters like the relative contribution of POS 22 and ATM on bank deposits is positive and significant. The effect of variable and other variables such as market shares of competing money market were negative and significant. On the one hand, inflation versus fixed interest decreases the value of money; on the other hand, with the boom in the stock market in the contrary to fixed interest rates, money market deposits go toward this bazaar. The effect of production was positive and significant on the share of deposits and had shown that by increasing production, the relative share of bank deposits will increase. Effect of exchange rates on deposits were negative that indicating by increasing the relative contribution of the exchange rate, the discounted value of cash in banks and individuals seeking to become sustainable assets entrusted to the fixed return rate. The study conducted by Mohamed (2014) in Bahrain aimed at investigating the effect of Real Gross Domestic Product (GDP), interest rate and inflation rate on national saving rate in kingdom of Bahrain over the last twenty years. The study adopts Augmented Dickey-Fuller unit root test and co integration test to examine the long run relationship between the variables under study. The dependent variable was the national savings rate while the independent variables were real GDP, nominal interest rate and inflation. The findings indicate that the Real GDP growth rate has positive effect on national saving in the short run and significant at 5% level in the end. Nominal interest rate has positive and significant effect on national saving rate at 1%level on the short run; however, its effect in the long run appears to be positive but insignificant, while the inflation rate (as a measure of macroeconomic uncertainty) has positive and significant effect on national saving rate in both the short run and the long run. The study conducted by Mohammed and Mansur (2014) in Malaysia attempted to investigate the impact of selected macroeconomic variables on the level of deposits in the Islamic banking system. The data used from the period 2007 to 2013. They apply Auto Regressive Distributive Lag model, which has taken care of a major limitation of the conventional co integrating tests in that they suffer from pretest biases. Based on the above rigorous methodology, they try to measure both long and short run relationships among the dependent variable (total saving deposit of Islamic banks in Malaysia) and independent variables (GDP, inflation and Kuala Lumpur composite Index). By applying 23 ARDL techniques, we find that the determinants such as inflation has strong negative impact on deposits of Islamic banking system while other macroeconomic variables GDP and Kuala Lumpur composite Index do not have significant impact. 2.2.2. Related Empirical Evidence in Africa The study examined by Ngula (2012) in Ghana was the determinants of savings mobilization and its role in promote economic growth in Ghana. Data for the analysis cover the period between 1980 and 2010. Time series characteristics of data investigated by, applying unit root tests to examine the stationary of each variable. Estimated model was a single regression equation with total amount of deposits held by all banks as the dependent variable and explanatory variables as deposit interest rate, exchange rate, inflation rate and broad money supply. To determine the robustness of the Ordinary Least Squares (OLS) regression coefficients, a test for serial correlation and heteroscedasticity performed. The demand for real bank deposits modeled using the OLS technique. A result from the study shown that exchange rate, inflation rate and money supply (M2) significantly affect the mobilization of financial savings (deposit) in Ghana. Deposit interest rate however, proofed to be a weak determinant of bank deposit mobilization. This is because of the lack of confidence that people had in the banking system. The study investigated by Orji (2012) in Nigeria was the determinants of bank savings in Nigeria as well as examined the impact of bank savings and bank credits on Nigeria’s economic growth from 1970-2006. The researcher was adopted two impact models; Distributed Lag-Error Correction Model (DL-ECM) and Distributed Model. The time series properties of the data examined using the Ordinary Least Square (OLS) technique. The empirical results showed a positive influence of values of GDP per capita (PCY), Financial Deepening (FSD), Interest Rate Spread (IRS) and negative influence of Real Interest Rate (RIR) and Inflation Rate (INFR) on the size of private domestic savings. In addition, a positive relationship exists between the lagged values of total private savings, private sector credit, public sector credit, interest rate spread, exchange rates and economic growth. 24 The study conducted by Nathanael (2014) in Nigeria, empirically examined the macroeconomic determinants of bank deposits in Nigeria using data covering the period between 1980 and 2010. It tries to analyze the effects of various macroeconomic indicators, on the performance of banks within the context of deposit mobilization of banks and its determinants. Factors like interest rate, consumer price index, number of bank branches that determine bank deposits were carefully analyzed using the OLS technique and results are robust. The parsimonious ECM result showed that in Nigeria, bank investment, bank branches, interest rate and the general price level are important determinant of bank deposit. The Vector Error Correction and Johansen co integration test was indicate a long run relationship among the variables and the ECM result showed a satisfactory speed of adjustment. The researcher among others that both the banks and the monetary authorities should consider these factors when attempting to improve the deposits of banks and this will go a long way in increasing aggregate investment thus recommends it. The study conducted by Pauel and Omosefe (2014) in Nigeria investigated the effect of interest rates on customer savings behavior in the Nigerian banking sector using times series data from the period 1989 to 2012.After identifying a host of factors that are influence customer confidence in commercial banks, such as average income, commercial lending, legal right strength, central bank monetary policy and total annual commercial bank losses. Using quantify regression estimation method, a non parametric estimation process that is based on the premise that the sample median will tend to that of the distribution and addresses issues of heteroscedasticity errors and data stringency associated with the data used in the study under question. The bank deposit was dependent variable while interest rate, income, legal rights strength, bank lending, losses and money supply was independent variables. They found interest rates were having a positive effect on customer savings; income was also affecting customer’s savings, other factors such as bank lending was exerting a negative effect on bank deposits and money supply exerted a strong effect on customer savings. Since the impact of money supply on bank, deposits were not robust and exerting no significant effect on savings and bank lending found not to be commensurate with the current level of savings. 25 The study Conducted by Kalebe (2015) looked at the broad set of possible determinants of private savings in Lesotho using annual time series data for the period 1980-2010. The co-integration and Error Correction Methodology (ECM) utilized in this study to measure the relationship between the variables used. The study used independent variables of real deposit rate, public saving rate, external saving rate, real GDP growth rate and terms of trade and dependent variable of private savings. The results indicate that public savings are important in explaining changes in private savings, both in the short-run and long run and the terms of trade negatively influence private savings in Lesotho in the long -run. An empirical study Conducted by Eric et al., (2015), on commercial banks in Ghana with the aim of examines the effect of interest rate liberalization on bank deposits in Ghana. The study used secondary data on deposits, interest rates and inflation based on the consumer price index obtained from Bank of Ghana (BOG) and Ghana Statistical Service website (GSS) respectively. The analysis covers adjusted quarterly data from the year 1991 to 2012 to be seasonal. Research papers from the International Monetary Fund (IMF) publications, the World Bank publications and other scholarly peer reviewed journals considered. A deposit function model specified with long term deposit as the main dependent variable with real savings rate, real Treasury bill rate, exchange rate movement and gross domestic product as independent variables while controlling for inflation. Ordinary Least Squares (OLS) method used to estimate the specified model, which covered seasonally adjusted quarterly data drawn from Bank of Ghana and Ghana Statistical Service. The data input into a spreadsheet and exported into Econometric View 7, which used for processing the data. The results of the study revealed that the interest rate liberalization and gross domestic product jointly accounted for about 78% of the variation in the level of bank savings deposits in Ghana. The study has also shown that the liberalization of the interest rates has made it attractive for people with idle funds to save with financial institutions especially the banks. It also revealed a negative relationship between real savings rate and the real Treasury bill rate expected in a high inflationary environment. All the independent variables were significant. Based on this the researchers recommended that 26 the Bank of Ghana remains resilience on interest rate liberalization so that surplus funds can be made available for investors and also to reduce the level of inflation in Ghana. The study undertaken by Hassen (2016) was on the effect of interest rate on commercial bank deposits in Nigeria. Hence, this study examined how interest rates affects commercial bank deposits between 2000 and 2013 in Nigeria. The study made use of secondary data sourced from the Central Bank of Nigeria statistical bulletin and the National Bureau of Statistics between 2000 and 2013. The model for the study has as its dependent variable the Commercial Bank Deposits (CBD) while its explanatory variables were the interest rates and the Gross Domestic Product (GDP). Using the Ordinary Least Square (OLS) multiple regression techniques; the study revealed that there was a negative relationship between the interest rates and the commercial bank deposits suggesting that interest rates has not been responsible for customers deposits in commercial banks in Nigeria while the GDP has a positive relationship with commercial bank deposits. 2.2.3. Related Empirical Evidence in Ethiopia The study conducted by Wubitu (2012) had looked at the potential factors determining commercial bank deposit in Ethiopia by taking CBE as evidence. The study had used both primary and secondary data. The primary data collected by a means of interview and questionnaire. Secondary data for the study were the values of dependent and independent variables. The study had found variables that can affect the total deposit of commercial banks. Three variables were regressed with the dependent variable, i.e. total deposit, these variables include deposit rate, inflation rate and bank branches. The data for these variables collected from commercial bank of Ethiopia, national bank of Ethiopia and central statistics authority of the sample year from 2000 up to 2011. The multiple regression models constructed for the dependent variable and the three independent variables. Different diagnostic tests were tested to know whether the model is valid or not, having the model was valid the regression analysis and hypothesis testing was performed using EViews 8 software. Because of the hypothesis, testing it found that all the three variables could affect total deposit. Branch expansion had positive and 27 significant effect on total deposit whereas deposit rate and inflation rate had positive and insignificant effect on total deposit. The study conducted by Jembere (2014) investigates the determinants of deposit mobilization in private commercial banks of Ethiopia using panel data of six private commercial banks from year 2002 to 2012. The study used both quantitative and qualitative research approach. Secondary financial data analyzed using multiple linear regressions models for the six bank’s deposit. Fixed or random effect regression model applied to investigate the impact of bank branches, exchange rate, real gross domestic product, Capital Adequacy and Liquidity on private commercial banks deposits. Besides, the study used primary data analysis to solicit manager’s perception towards the determinants of private commercial banks deposit mobilization. The empirical results from regression analysis showed that bank branches, exchange rate, and real gross domestic product affects deposit of the bank positively whereas, capital adequacy and liquidity affects the deposit of the private banks negatively. This implication show that better capitalized banks tend to create less liquidity that leads to mobilize little deposit amount. On the other hand, the feedback of respondents depicted that managerial efficiency, government policy, convenience of bank office, technology, bank size and awareness of savings by society affected deposit level of the banks significantly. The conducted by Giragn (2015) explored, the theoretical as well as empirical analysis of those factors, have an impact on deposit volume in commercial banks in Ethiopia and even assesses which ones are more significant or less significant. To do the practical investigation in terms of commercial banks in Ethiopia, the researcher collected the relevant data from annual reports of twelve years (2001/2-2012/13) and from questionnaires and interviews made to senior bank officers of seven banks. The banks included in the survey were Commercial Bank of Ethiopia, Awash International Bank, Dashen Bank, Bank of Abyssinia, Nib International Bank, Wegagen Bank and United Bank. The data analyzed through econometric analysis using SPSS software. The study reveals that, the branch expansion, money supply, the exchange rate of Birr to USD and 28 general inflation are the most significant factors of deposit mobilization activity. The other variables deposit rate and real per capita GDP growth rate have insignificant power to influence the dependent variable. In this research, as opposed to the conventional economic theory, the deposit rate found to have negative relation against the deposit volume for the period under study. The study also exposed that the deposit mobilization activity was becoming challenging, its associated costs are escalating and the competition was becoming stiff-the outcome of the competition favoring the big size state banks. Beyond that, the government policies were also favoring the latter in an effort to mobilize huge fund for a national development activities. The research recommended that banks have to do much in branch expansion studying potential deposit areas. The study undertaken by Shemsu (2015) identify and evaluate those factors affecting bank deposit in general by taking Commercial Bank of Ethiopia as evidence. Accordingly, the researcher adopted mixed research approach. The rationale of using such a mixed approach used to gather data that could not obtained by adopting a single method. Regarding to the qualitative data; questionnaire was used to gather information from the employees of commercial bank of Ethiopia particularly for those employees who actively participated in deposit mobilization tasks in CBE city branches. Regarding to the secondary data; time series data covering 1998 -2014 was analyzed. First, the time series data were assessed using descriptive statistics for the variables as well as the test for heteroscedasticity, autocorrelation and normality testing to know if the assumptions of CLRM violated or not. Second, estimated model was a single regression equation with deposit as the dependent variable and explanatory variables as deposit interest rate, overall inflation rate, number of branch opening, gross domestic product, individual foreign remittance and dummy variable. Estimation undertakes using Ordinary Least Squares technique by E-views7 statistical package. The results from econometric analysis showed that, all the explanatory variables positively correlated with the explained variable. Among these variables, branch opening was an important strategy for deposit mobilization, it is highly significant than others. Individual remittances from Diasporas were also next to branch opening was significantly 29 affects CBE’s deposit. The others affected positively and can increased deposit of commercial bank of Ethiopia (CBE’s). The study conducted by Hibret (2015) primarily aimed at determining the short and long run impacts of determinant factors on deposit growth of commercial bank by taking Commercial Bank of Ethiopia for the period 1974/75 to 2013/14 using Vector Error Correction Model (VECM). The study also checked the causal relationships that exist between deposit growth and its determinant factors employing test of Granger causality. In the empirical VECM model, control variables (Economic Growth, Inflation, Interest Rate, Exchange Rate, Population Growth and Branch Expansion) were included to enable ceteris paribus interpretation of the relationship and impact on the growth of deposit in commercial bank of Ethiopia. The estimated results suggest that interest rate had positive but insignificant impact on deposit growth both in the end and in short run. While Exchange rate and branch expansion significantly increases, banks deposit contemporaneously both in the short run and long run. Population and Economic growth also had a positive relationship with deposit growth and it was significant in the long run but insignificant in the short run. However, Inflation had positive and significant impact on deposit in the long run and negative impact in the short run. Using test of granger causality, the study found unidirectional causality that runs from deposit to inflation, from exchange rate to deposit, from deposit to interest rate, from population growth to deposit without any feedback response. The finding also indicated that there was bidirectional causality between branch expansion and deposit and economic growth in Ethiopia. This implies that deposit can affect economic growth through investment. The study undertaken by Bahredin (2016) aimed to identify the determinants of commercial banks deposit growth in Ethiopia. The quantitative research approach has been used in order to achieve the objective. Target population was all banks that engage in commercial activities and registered by NBE to act. Consequently, eight banks, out of eighteen commercial banks in existence as at 2014, have purposively selected for the study. The panel dataset for the study used secondary source consisted of annual data 30 spanning from 2000 to 2014 gathered from the National Bank of Ethiopia time series database and commercial banks financial database. The dependent variable used to this study was bank deposit growth. Explanatory variables used in this study were inflation, deposit interest rate, loan to deposit ratio, bank branches, money supply growth, per capita income growth, and lagged bank deposit. Different diagnostic tests conducted to check the appropriateness of the model. The random effects technique applied to find out the most significant variables. According to the results achieved by applying panel data techniques, bank branches and per capita income growth influence was positively and statistically significant on bank deposit growth; whereas, lagged bank deposit and loan to deposit ratio influence was negatively and statistically significant on bank deposit growth. Money supply growth had insignificant negative influence on bank deposit growth; whereas interest rate and inflation had insignificant positive influence on bank deposit growth. The study implies that stimulation of economic growth; the presence of banks and financial intermediation were most important factors that affect bank deposit growth. The study undertaken by Andinet (2016) examines factors influencing deposit mobilization in private commercial banks in Ethiopia. In doing so, the study adopted quantitative methods research approach using secondary data. The study had found variables that can affect the total deposits of the banks. Seven variables are regressed with the dependent variable i.e. total deposit. The explanatory variables are number of bank branches, deposit interest rate, liquid asset to deposit ratio, lagged value of bank deposits, net interest margin, inflation rate and economic growth (GDP). The data for these variables collected from the respective private commercial banks’ financial statements, national bank of Ethiopia, central statistical authority and MOFEC of the sample year 2005 up to 2015. Different diagnostic test performed to know whether the model is valid or not. All the tests were valid and eventually regression analysis performed using E view statistical package. The result from regression analysis showed that number of bank branches, deposit interest rate, net interest margin and GDP significantly and positively correlated with the explained variable. Lagged value of bank deposit significantly and negatively correlated with total deposit. However, liquid asset to 31 deposit ratio and inflation rate insignificantly and negatively correlated with bank deposit. Finally, the study had recommended what should do to mobilize more deposits. The study conducted Dereje (2017) investigate the determinants of deposit mobilization in private commercial banks of Ethiopia using panel data of six private commercial banks from year 2002 to 2012. The study used both quantitative and qualitative research approach. Secondary financial data analyzed using multiple linear regressions models for the six banks deposit. Fixed or random effect regression model applied to investigate the impact of bank branches, exchange rate, real gross domestic product, Capital Adequacy and Liquidity on private commercial banks deposits. Besides, the study used primary data analysis to solicit managers‟ perception towards the determinants of private commercial banks deposit mobilization. The empirical results from regression analysis showed that bank branches, exchange rate, and real gross domestic product affects deposit of the bank positively whereas, capital adequacy and liquidity affects the deposit of the private banks negatively. This implication show that better capitalized banks tend to create less liquidity that leads to mobilize little deposit amount. On the other hand, the feedback of respondents depicted that managerial efficiency, government policy, convenience of bank office, technology, bank size and awareness of savings by society affected deposit level of the banks significantly. Thus, management bodies of private commercial banks should strive to strengthen the identified significant factors and government bodies should also see the adverse effect of tight polices imposed on the existing private commercial banks as well as for the new entrant banks. Evidences from prior studies shown the effect of various external and internal factors affecting commercial banks deposit. However, the significance of each factor differs across continent, countries and time. These differences also belong to model specification, sampling technique, reliability of data and methods of analysis during the study. 2.3. Conceptual Framework of the Study The researcher revealed that, there are independent factors determining deposit mobilization performance of private commercial banks in Ethiopia. Deposit mobilization 32 is a deliberate effort by relevant organ vested that right by the central bank. It normally not brought about by a single variable but rather an interaction of various networks of different variables and factors. Among the factors interest rate, inflation, population growth, per capita income, economic growth, consumer price index, shocks, liquidity of the bank, security of the bank, number of branches, reserves, transaction cost, awareness of the society, technology, competitive rivalry, convenience of bank’s office services in the bank are claimed to affect the deposit mobilization activity of the banks. The Conceptual framework of these variables is a guide to this research and shows how they determine deposit mobilization performance of private commercial banks in Ethiopia. In order to this, the researcher adopted five variables to perform this study from the year 2002 up to 2017. While assuming other variables remain constant during this research. These variables are, inflation rate, deposit interest rate, capital adequacy ratio, return on asset and lending rate. Figure 2.1 Conceptual Framework Source: Developed by the author, 2019 33 CHAPTER THREE 3. DATA AND METHODOLOGY 3.1. Research Design To achieve the objective of the study, explanatory type of research design and quantitative research approach were employed. The explanatory type of research design helps to identify and evaluate the causal relationships between the different variables under consideration (Creswell, 2009). Determining the research approach properly is a base for achieving the objective of the study. Therefore, in this study, explanatory research design and quantitative research approach employed to analyze the causal relationship between deposit mobilizations and its selected factors. 3.2. Sources of Data This study used secondary panel data set for six private commercial banks operating in Ethiopia from 2002 up to 2017. The researcher prefers to use panel data since it can take heterogeneity among different units into account over time by allowing for individual- specific variables. By combining time series and cross-section observations, it gives informative data. Furthermore, it can better detect and measure the effects that simply cannot observe in pure cross-section or pure time series data (Gujarati, 2004). The study used secondary sources of data that is panel in nature. The researcher preferred a secondary source of data since it is less expensive in terms of time and money during collecting the data. In addition, it affords an opportunity to collect high quality data (Saunders et al., 2007). Secondary data obtained from the audited annual financial statements of the concerned private commercial banks in Ethiopia. These data include both bank specific and macroeconomic factors. Bank specific data were sourced from annual reports and account statement of selected banks. However, data on macroeconomic variables (inflation rate, deposit interest rate and lending interest rate) sourced from annual report bulletins published by the National Bank of Ethiopia (NBE). 34 3.3. Sampling Techniques As noted by Kothari (2004), good sample design must be viable in the context of time and funds available for the study. Accordingly, this study employed purposive sampling technique to select the required sample of banks from the total banks in Ethiopia since it is viable in line with time and funds available for this study. This sampling method is a form of non-probability sampling in which decision concerning the individual source of data to be included in the sample taken by the researcher, based upon a variety of criteria. However, the major limitation of purposive sampling is making description rather than generalization (Dawson, 2002). The researcher considers that the sample size is sufficient to make sound conclusion about the population as far as it covers around 40% of the total population. Moreover, the big portion of total deposit of private commercial banks found in the banks selected as sample i.e. private banks established before 2005. The selection criteria set by the researcher was first, the required banks are only private commercial banks in Ethiopia. Second, those commercial banks should operate from 2002 to 2017 having financial statements. Third, the researcher chooses this sample banks because of their deposit share in the entire research period relative to others private owned banks. With regard to deposit shares, there was also concentration in favor of CBE, though with a declining trend. Whilst CBE takes a 65.2 % share in 2013, among the private banks, the highest share went to Dashen Bank (9.7%), followed by Awash International Bank (6.2%) and Bank of Abyssinia (5.4%) as of June 30, 2013 (Zerayehu et al., 2013). Based on, these criterions, six private commercial banks selected from sixteen private commercial banks operating since 2005. These banks included Awash International Bank S.C, Dashen Bank S.C, Bank of Abyssinia S.C, Wegagen Bank S.C, United Bank S.C and NIB International Bank S.C. 3.4. Model Specification In this study, panel data approach is adopted which includes cross-sectional and time series observations for six private commercial banks that range from the year 2002 up to 2017. The commonly used models for panel data are fixed effect and random effect models. The estimation technique carried out based on balanced panel data regression. A 35 balanced panel data have equal time series observations for the study entities. In this study, the cross sectional units are six and the time series is 16 years. Hence, the model of this study developed based on the variables selected (DEPO, DIR, INF, LIR, ROA and CAR) in order to address the objectives. Therefore, the functional form between dependent and independent variables specified as follows:- DEPO = f(DIR, INF, LIR, ROA, CAR) − − − − − − − − − − − − − − − − − − − −(1) Where: 𝐷𝐸𝑃𝑂 is bank deposit, DIR is deposit interest rate, INF is inflation, LIR is lending interest rate, ROA is return on asset, CAR is capital adequacy ratio. The deposit is the weighted performance of each commercial bank to their mobilization effort. The empirical model for this specification given as: 𝐷𝐸𝑃𝑂𝑖𝑡 = 𝛽0 + 𝛽1𝐷𝐼𝑅𝑖𝑡 + 𝛽2𝐼𝑁𝐹𝑖𝑡 + 𝛽3𝐿𝐼𝑅𝑖𝑡 + 𝛽4𝑅𝑂𝐴𝑖𝑡 + 𝛽5𝐶𝐴𝑅𝑖𝑡 + 𝑢𝑖𝑡 − − − −(2) The β0 is a constant term and β1, to β7 are estimate parameters in the model and “i” is a cross-section data for banks referred to, and t is a time series data and 𝑢𝑖𝑡 is an error term. 3.5. Operational Definition and Expected Sign of Variables 3.5.1. Operational Definition of Variables The private commercial banks deposit is the dependent variable in this study. Deposit represents the total accumulated amount of customer financial savings within the private commercial banks. The performance of private commercial banks is a measure of the size of its deposit liabilities. The large portion of commercial bank’s asset base financed by their deposit mobilized. Private Commercial banks ability to lend more loans for their customers determined by the size of their deposits. The growth of the bank is therefore subject to its ability to mobilize more deposit at cheaper cost from the public (Ketema, 2017). In view of this, it is worth studying and analyzing the major factors of efficient deposit mobilization. 36 Deposit interest rate (DIR) is one of the most effective factors for deciding to deposit in banking system (Mohammad and Mahdi, 2010). Banks usually pay interest on money collected from depositors. Particularly, saving deposits commonly earn interest for savers at a rate determined by individual banks and the directive issued by the national bank of Ethiopia. Herald and Heiko (2009) also revealed interest rate as one of the determining factor for commercial banks deposits. According to classical economists, deposits are a function of the rate of interest. The higher the rate of interest, the more money will be save since at higher interest rates people will be more willing to forgo present consumption. Low deposit rates are discouraging saving mobilization (Mustafa and Sayera, 2009). Inflation Rate (INFR) is the persistent increase in the average price of goods and services (Baherdin, 2016). The rate of inflation and the inflationary expectations might have some influence on the growth of overall deposits with the banking system. It is generally, assumed that the growth of total deposits is to be negatively related with inflationary expectation. As inflation accelerates, deposits become less attractive, depending on the interest rate. In this case, the assumption would be that as deposit interest rates rise, deposits would increase in principle as well. As the rate of inflation increases, people will be tempted to divert their savings from bank deposits to any other kind of tangible assets because these assets act as hedge against. Lending Interest Rates (LIR) refers to the price a borrower pays for the use of money he does not own and has to return to the lender who receives for deferring his consumption by lending to the borrower. The Interest also measured as a percentage of money taken over the period of one year, (Devereux and Yetman, 2002). An Interest, which is charged or paid for the use of money, often it expressed as an annual percentage of the principal. Lending interest rates often change because of the inflation and Government policies. It is also a tool used by the central bank of a country to keep a check on any major currency fluctuation. An increase in lending rates is necessary to stabilize the exchange rate depreciation and to curb the inflationary pressure and thereby helps to avoid many adverse economic consequences. 37 Return on Asset (ROA) refers to the profit earned per birr/dollar of assets and most importantly, it reflects the management's ability to utilize the banks financial and real investment resources to generate profits. For the purpose of this study, return on asset measures the overall financial performance of banks and it measured by the ratio of net profit to total asset. For any banks, ROA depends on the bank's policy decisions as well as on uncontrollable factors relating to the economy and government regulations. Capital Adequacy Ratio (CAR) refers to the ability of the capital base of a financial institution to absorb unexpected shocks. Capital adequacy of any financial institution is instrumental in the formation of risk perceptions about it amongst its stakeholders. Availability of capital affects every aspect of banking either directly or indirectly. As stated earlier, we can find many ways to determine capital adequacy ratio in the literature. Hence, total capital to total asset ratio (CAR) considered for this particular study (Ommeren, 2011). The ratio measures how much of the banks’ assets are funded with owners fund. 3.5.2. Expected Sign of Variables Table 3.1.Expected Sign of Variables Variables Measure Notation Expected sign Dependent Variable d Deposit Natural logarithm of total deposit DEPO NA Independent variables Deposit in