Islamic Banking and Finance: Why it is important for Ethiopia?

What Is Interest Free Banking?

Interest Free Banking (IFB) or Islamic Banking is banking business in which [mobilizing or] advancing of funds taken in a manner consistent with Islamic Finance (Shari'ah) Principle and mode of operation that avoids receiving or paying interests’, NBE, 2011). Shari'ah means Islamic law: and it has two parts i.e. the Book of Religious worship, Book of Business Transactions.

Motivations to Start IFB in Ethiopia

Access to formal financial service is low in Ethiopia;

Existence of large Potential demand, can be inferred from Request for IFB financing services from target population that represent large population (~27 million; CSA), and authorization IFB directive by the NBE.

Ethiopia's proximity to Middle East where majority of Islamic Financial Market existed.

According to Global Islamic Economy Report of 2016/17, the 57 mostly Muslim-majority member countries of the OIC had a GDP (PPP based) in 2015 of $17 trillion which represented 15 percent of the total global GDP (PPP based) of $113 trillion in 2015.

Of this $2 trillion, Islamic banking was responsible for $1.451 trillion, the Takaful (insurance) sector for $38 billion, sukuk (bonds) outstanding for $342 billion, Islamic funds for $66 billion, and other financial institutions for $106 billion. Islamic funds and sukuk led year-on-year growth at 15 and 14 percent, respectively. Takaful was close behind with a growth rate of 11 percent, while Islamic banking experienced more modest growth of 6 percent.

Total Islamic Finance assets are expected to reach $3.5 trillion by 2021, a CAGR of 12 percent, with Islamic banking responsible for most of this growth, and projected to reach $2.7 trillion in assets by 2021

Benefits of starting IFB in Ethiopia

To mobilize huge financial resources to finance national projects;

Facilitates financial inclusion;

Financial inclusion helps for financing outreach

When and How IFB Started In Ethiopia

Oromia International Bank (OIB), a private financial institution, become the first to

implement interest-free banking [Islamic banking] in Ethiopia after two years the NBE Directives on IFB has came into force in October 2011.

ZemZem, as a prospective new bank, asked to join the banking industry as a full-fledged interest-free bank, but was unable to start operations as the directive requires that interest-free banking to be given alongside conventional banking services.

The biggest state owned bank, Commercial Bank of Ethiopia (CBE), has started interest free banking on Monday, October 28, 2013, in 23 selected branches in Addis Ababa and in other major regional towns

The major services offered under the interest-free banking include deposits, foreign exchange and money transferring services.

The Three Legal Maxims

1. General Permissibility: - everything is allowed unless specifically prohibited by the Shari'ah Law. Consistent with sharia, the following undertakings are not allowed to utilize interest free banking services:

2. Profit and Loss Sharing Principle: - the one who takes the risk has the right to share in profit.

3. Asset Backed Financing: - is an asset-backed security that can be used to finance on investments since the underlying assets generate the return that is not directly linked to a predetermined interest rate.

Types of IFB Financing Contract Modalities.

There are four basic contract types that have 9 sub categories:

Sales/Exchange Contracts:	Partnership Contracts:	Security Contracts:
Markup (Murabaha ) Contract- For Buy and Sale Commodity, Fixed Asset, Working Capital	Profit/Loss Sharing(Mudaraba)-Silent Partnership-for any 'permissible' including deposits;	Guarantee(Kafala) Contracts- performance guarantees;
Forward Sale (Salam) Contract- For produce and Sale;	Profit/Loss Sharing(Musharaka)Joint Venture -for any 'permissible' business.	Transfer of debt(Hawalah- for Local/Foreign Money Transfer;
Leasing (Ijarah) Contract- For Make/buy and lease of durable, fixed assets;		Mortgage/Pledge(Rahn)- for debt collateral
Work-in-Progress-financing (Istisna) Contract-for Construction/Assembly of assets.		Safekeeping (Wadiah) - for safekeeping of money and valueables.

Tuesday, April 23, 2019