Forex Overhaul Shifts Power to Banks But Leaves Stability Exposed

Feb 21 , 2026
By Mikiyas Mulugeta (PhD)

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The reforms are ambitious in shifting authority, reshaping incentives and embedding market mechanisms more deeply into the foreign-exchange regime. They are also fragile because they rely on supervisory and risk-management systems that are still developing. The tension between ambition and capacity runs through the entire directive. Every new freedom it creates also exposes how much work still remains, writes Mikiyas Mulugeta (PhD) - mikiusc2017@gmail.com - a consultant and director of training and development programs at the Centre for African Leadership Studies (CALS) and XHub-Addis.

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The foreign exchange directive the Central Bank issued this month marks a new and uneasy stage in its efforts to reform the financial sector. A system long dominated by centralised discretion and administrative rationing is starting to hand the baton to commercial banks and market actors.

The authorities are trying to build a functioning foreign exchange market instead of merely declaring one on paper. Although the decision is deliberate, their speed carries clear risks. By decentralising execution before supervisory capability and risk-management tools are fully developed, they expose the system to liquidity gaps, regulatory arbitrage, and possible volatility in the formal and parallel markets. They are no longer moving policy levers. Instead, they are trying to rewire the market while structural weaknesses persist.

For decades, access to foreign currency depended more on permits and bureaucratic clearance than on price signals or market incentives. Companies and households lined up for approvals, while the state decided who received scarce dollars. The new directive begins to redistribute that authority. Commercial banks may now arrange external borrowing, process dividend repatriation and offer forward contracts without first seeking clearance from the National Bank of Ethiopia (NBE).

This is not deregulation in the casual sense but a controlled shift toward supervised intermediation, based on the assumption that banks now have the capacity to manage liquidity, assess counterparties and process flows efficiently. The same shift, however, reveals operational gaps that earlier discretion hid, especially where capacity varies widely across institutions.

One of the most far-reaching measures is the rule that allows service exporters to retain all their foreign-exchange earnings indefinitely. In the past, strict surrender requirements pushed many firms toward informal channels and weakened the official market. Retention changes the incentive structure. Exporters are converted into active suppliers within the formal system, potentially deepening the foreign exchange pool and easing pressure on the Central Bank. This is less a simple reward than a redesign of behaviour that keeps hard currency within the banking system.

Yet this expansion comes before regulators have fully tested how the system will cope with liquidity stress. If inflows fail to match the new freedom to retain and transact, mismatches could build up on bank balance sheets.

The directive also moves at the level of households and the diaspora. Individuals can use foreign exchange accounts for tuition, medical costs and travel. Families are allowed to receive larger remittance inflows without cumbersome approvals.

The idea pins hopes on drawing routine and legitimate transactions into formal channels, narrowing the space in which the parallel market thrives. Informal exchange has long been driven not only by speculation but by unmet demand that the official system could not process in time or at scale. Bringing this demand into the system should, over time, reduce the premium on the street rate. But widening access before monitoring tools, compliance practices, and liquidity buffers are fully ready creates vulnerabilities of its own. If banks struggle to track, report, and fund these flows, the system could face pressure from the very new uses it has invited.

In parallel, the directive should be read against the backdrop of the IMF’s fourth review under the Extended Credit Facility. At this stage, the Fund is not only checking macroeconomic targets. It is also looking at whether policy behaviour has become embedded in institutions. An endorsement from the IMF shows that structural reforms are beginning to move from theory to practice. Credibility now rests on stable rules and market mechanics rather than headline announcements alone. Even so, the same reforms that earn external approval may heighten fragility if the supporting infrastructure is slow to catch up.

What sets this round of liberalisation apart from earlier efforts is its focus on the plumbing of the market. Initial reforms focused on visible indicators such as the nominal exchange rate, reserve levels, and headline interest rates. The current measures reach into the microstructure.

Who has the right to decide how liquidity circulates between banks and customers? Which actors carry operational responsibility?

These changes form the scaffolding on which a self-correcting forex market could eventually stand. Shifting decisions closer to where transactions occur is intended to increase system elasticity. That elasticity is not abstract. When participants can hedge, hold, and transact through formal channels, shocks that might otherwise build up in parallel markets can be absorbed more smoothly.

The directive also tries to bridge short-term liquidity concerns with longer-term market development. New tools such as forward contracts, bank-level foreign-currency accounts and looser rules on dividend repatriation are designed to spread risk and improve price discovery. In principle, these instruments should help deepen the market and reduce the pressure on reserves by giving businesses more options to manage exposure. In practice, they demand strong operational capacity inside banks, timely data for regulators and continuous monitoring of positions.

If some institutions implement them well while others do not, the result could be pockets of weakness rather than a broad cushion. Gaps in regulation, uneven compliance or poor reporting can quickly translate into liquidity stress or local spikes in volatility, undermining the stability the reforms seek to promote.

By showing that foreign exchange can be held, transacted and repatriated under predictable rules, the Central Bank is trying to speak to exporters, diaspora investors and multinational companies at once. The message is that they intend to move away from case-by-case exceptions and toward rule-based management of scarce currency. But credibility in such a system is easily lost. If the regime appears liberal in principle yet remains inconsistent in practice, confidence can erode, and actors may return to informal channels. That, in turn, would keep the parallel-market premium alive and weaken one of the reform's core targets.

The pace and sequence of the changes thus carry as much weight as the content of the measures themselves. Slow movement risks stalling the process, while fast movement without safeguards risks instability.

The macroeconomic context makes these choices even more delicate. Foreign-exchange reserves remain limited relative to import bills and external financing needs, making careful management of liquidity essential. A more flexible and deeper market should, in theory, reduce the strain on reserves by allowing hedging, retention and other formal mechanisms to handle shocks. At the same time, the reforms explicitly expand the channels through which foreign currency can leave banks.

Export retention, higher remittance-funded spending and wider use of household accounts all increase potential outflows. If those outflows rise faster than inflows from exports, investment or concessional finance, banks could feel the squeeze. Shortages, even if temporary, can fuel expectations of depreciation and encourage speculative behaviour in the official and informal markets.

The directive, therefore, portrays a Central Bank in mid-transition. It is trying to move from being a direct allocator of scarce foreign exchange to acting as the architect and supervisor of a market that operates with more autonomy but within clear rules. Allocation regimes lean on discretion, while regulatory regimes lean on credibility and consistent enforcement. The current reforms point toward the latter model, but the shock absorbers such a regime requires remain uneven and only partly tested.

Instruments exist on paper, but their use and oversight vary. Institutions have been given new responsibilities, but their readiness differs. Practices intended to limit instability have yet to prove themselves through a full stress cycle.

Policymakers are, in effect, working on market architecture while the market is already in motion. They are trying to build an ecosystem that can generate reliable price signals, maintain investor confidence, and remain stable without heavy day-to-day rationing from the centre. Whether that effort succeeds will depend less on the directives' ambition than on consistent follow-through. The discipline with which rules are applied, the quality of supervision and the speed with which gaps are identified and closed. It will also depend on how well policymakers manage the political economy of change, including resistance from constituencies that benefited from the old allocation system and anxiety among new actors who are now asked to bear more risk.

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PUBLISHED ON Feb 21,2026 [ VOL 26 , NO 1347]

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