The federal government is set to establish an agency that will amass funds to be used as insurance payouts for depositors in times of financial crisis.

Drafted by the National Bank of Ethiopia (NBE), the regulation lays out a legal framework for the establishment of the Ethiopia Deposit Insurance Fund that will report to the central bank. The 19-page draft regulation states that the Fund will reimburse insured depositors during a crisis, dictate annual premiums, determine and regularly update the coverage limit for an insured deposit and collect premiums from financial institutions, development partners and the government.

The Fund will have a board comprised of the governor, vice governors and banking supervision director of the central bank, as well as its chief executive officer. Additional members will be appointed by the government.

The Governor of the central bank and the Minister of Finance will be the chairperson and deputy chairperson of the board of the Fund, respectively. The CEO and the deputy CEO will be appointed by the government with the recommendationfrom the central bank.

After the regulation is enacted, all members of financial institutions will sign a membership contract with the Fund and pay an initial premium, which will be determined by the Fund. The bill proposes the government put up 200 million Br as initial capital for the Fund.

It has not yet been decided how to define the government and the source of the initial capital from the government, according to a source close to the case.

“This is because the draft is going through a consultation process,” said this source.

The annual premium to be paid by financial institutions, which is subject to revision, is proposed to be 0.3pc of average bank deposits.

With a designed deposit insurance system, the new scheme aims to place troubled financial institutions in a safety net and avoid protections on ad-hoc terms, such as through restructuring a troubled bank or injecting capital, according to the source.

An example of implicit ad-hoc protection, the central bank had forwarded 57.5 billion Br of liquidity injections in four rounds to banks in the just ended fiscal year when banks were facing the most severe liquidity crunch in the industry's history.

In the event where there is a troubled bank or microfinance institution, the central bank will declare a revocation of the business license of the failed financial institution and the Fund will refund insured deposits.

The insurance coverage from the Fund, which will be paid to all depositors, is limited and covers the large majority of depositors but leaves a sustainable amount of deposits to market discipline. The limit of the coverage of the Fund will be proposed by the board, but it should not be less than 100,000 Br.

The Fund does not cover the deposits of capital goods leasing companies, other financial institutions and the government.

“It’s believed that these entities have their own safety net or can manage the loss,” said the source close to the case. “The focus of this scheme is for small depositors and SMEs.”